Islamic Banking in Indonesia: I Love Sharia Finance Program

Indonesian President Joko Widodo stated during the launch of the “I Love Sharia Finance Program” that Indonesia should become the global center for Islamic finance (also known as sharia banking). The program, initiated by the country’s Financial Services Authority (OJK), was launched in Jakarta on Sunday (14/06). Islamic finance is a form of banking or banking activity that is consistent with the principles of sharia (Islamic law). In recent years, the global market for sharia-compliant financial instruments has risen robustly.

However, with nearly 90 percent of the 250 million people living in Indonesia adhering to Islam, the market share of sharia banking is remarkably low. Assets controlled by Islamic banks or Islamic banking units of conventional banks in Indonesia only account for approximately five percent of the country’s total banking assets. In contrast, in Malaysia - where only 61 percent of the total population (about 61 million people) are Muslim - Islamic banks hold a 20 percent market share.

As such, there remains a huge potential for the development of sharia-compliant financial services and therefore policymakers in Indonesia are eager to tap this potential as it is one of the ways to deepen Indonesia’s financial markets, hence making the country less vulnerable to the effects of global economic turmoil. By 2023 Indonesian authorities target Islamic banks to control at least 15 percent of the market. However, this is considered a too ambitious target if not supported by substantial reforms in the country's Islamic banking industry.

Islamic finance assets in Indonesia have grown at a 33 percent compound annual growth rate, thus outpacing asset growth in the conventional banking sector. However, growth of Islamic finance has not been optimal and missed targets set by the financial authorities.

Muliaman D. Hadad, Head of the OJK’s Board of Commissioners, said that per March 2015 the Islamic finance banking industry of Indonesia comprised 12 general sharia banks, 22 sharia business units of conventional general banks as well as 163 sharia people's credit banks with assets totalling IDR 264.8 trillion (roughly USD $20 billion), or 4.88 percent of Indonesia’s total finance and banking market.

One general problem in Indonesia’s banking sector is low financial literacy among the Indonesian population, hence banking penetration remains at a relatively low level. Based on data from the World Bank, only 36.1 percent of Indonesia’s adult population had a bank account in 2014. The OJK has designed a five-year roadmap for the development of the Islamic finance sector. This roadmap involves various strategies from reducing fees on sharia-compliant banking products to developing education and training programs. The roadmap also supports the consolidation of state-owned and commercial Islamic banks, which will in turn increase the size of the banks' capital bases, enhance cost efficiency, as well as to allow increased underwriting in the corporate and infrastructure sectors.

President Joko Widodo, often called “Jokowi”, emphasized that Indonesia is the country with the largest number of micro financial institutions in the world, the largest Islamic debt paper (sukuk) publisher, and the only country that issues retail Islamic debt papers for wide use and developed.


What is Syaria Banking or Islamic Finance?
 

Syaria banking or Islamic finance are financial services that are in accordance with Islamic principles, for example the prohibition of interest (riba) payments and excessive uncertainty (gharar) or gambling (maysir). Instead, risks and rewards should be shared and the transaction should have real economic purpose without undue specification. Syaria banking involves banking, leasing, sukuk (Islamic bonds) and equity markets, investment funds, insurance and micro finance. However, the banking and sukuk assets account for about 95 percent of total Islamic finance assets.

According to data from the International Monetary Fund (IMF) global Islamic finance assets have grown at annual double digit rates from USD $200 billion in 2003 to USD $1.8 trillion in 2013. However, this type of industry is still mainly concentrated in the Middle East and Malaysia.