Indonesia grooms an Islamic megabank from its 3 major state-owned lenders

Islamic banking has grown exponentially in Indonesia.

A plan to create an Islamic megabank in Indonesia by merging parts of three major state-owned lenders in the country has gone down well with investors, in contrast to a similar deal involving as many companies in Malaysia that collapsed following drops in shares of the trio.

According to a research note from SNL Financial, on February 3, citing Indonesian Financial Services Authority Chairman Muliaman Hadad, Bloomberg News reported that a plan to combine the Islamic units of PT Bank Mandiri (Persero) Tbk, PT Bank Rakyat Indonesia (Persero) Tbk and PT Bank Negara Indonesia (Persero) Tbk may materialize in 2015.

Since then, Bank Rakyat's stock has climbed 9.2% through March 4, while Bank Mandiri shares have risen 4.4%. Bank Negara's market value has increased 3.5%, outpacing a 3.0% gain in the benchmark Jakarta Composite Index.

In Malaysia, shares of the companies involved in a three-way merger proposal went the other direction after it was announced. CIMB Group Holdings Bhd. shares dropped 17.6% from Oct. 9, when the plan was disclosed, through Jan. 13, the last trading day before the deal was called off.

RHB Capital Bhd.'s stock lost 12.1% during the period, and Malaysia Building Society Bhd. shares fell 8.9%, compared to a 4.8% decline in the Kuala Lumpur Composite Index. In the run-up to the deal termination, media reports had hinted at difficulties in getting shareholders on board amid unfavorable changes in circumstances, including the stock price losses.

Here's more from SNL Financial:

In recent years, Islamic banking has grown exponentially in Indonesia, home to the world's largest Muslim population, with assets tied to products complying with the religious ban on interest swelling fivefold from the end of 2008 through August 2014, according to Bank Indonesia data.

Still, Shariah-based finance accounts for just 5.5% of total banking assets in Indonesia, and there has been "huge" pent-up demand, Ernst & Young said in its latest annual report on global Islamic banking.

"Indonesia is a large Islamic country after all," Kevin Kwek, a banking analyst at Sanford C. Bernstein, who closely follows Islamic banking, told SNL Financial by email. "Technically, the potential lies in drawing out demand from retail and corporate segments that would otherwise not borrow, if against Islamic principles."

An Islamic megabank in Indonesia may target small loans, setting it apart from one that could have been created in Malaysia, where Shariah-compliant bonds, known as sukuk, dominate transactions, drawing on a much larger pool of funds from institutions.

In Indonesia, consumer finance channels are expected to widen, helping microlending grow, as expanding banking services for consumers is a key focus for the industry, as well as for regulators and the government.

"A mega-Islamic bank would focus on core strengths in microlending in Indonesia," Rahmi Marina, an analyst at Maybank Kim Eng, told SNL. "This also fits with the [Joko Widodo] administration's plans to improve credit penetration to farmers and fishermen."