However, although still small compared to the country’s conventional banking industry, Indonesia’s Islamic finance industry has been growing rapidly in recent years on the back of growing awareness of Islamic banking and government support. Between the years 2010 and 2014, Indonesia’s Islamic banking assets grew from IDR 100 trillion (approx. USD $8 billion) to IDR 279 trillion (approx. USD $22.3 billion), or at a compound annual growth rate (CAGR) of 29.2 percent. This growth pace is considerably higher compared to the growth posted in other Islamic banking markets as Islamic banking growth in Indonesia comes from a low base. Meanwhile, Indonesian conventional banking assets expanded much slower at a CAGR of 16.9 percent over the same period (2010-2014).

That the Islamic finance industry in Indonesia still lags (far) behind its conventional counterparts is clear when knowing that Islamic banks in Indonesia only hold about 4.7 percent of the country’s total banking assets. In contrast, in Malaysia - where only 61 percent of a total population of 61 million people are Muslim - Islamic banks hold a 20 percent market share (in Indonesia nearly 90 percent of the total population, which numbers around 250 million people, is Muslim). Meanwhile, in Saudi Arabia (which contains the world’s largest Islamic finance industry) Islamic banks account for over half of the country’s total banking assets.

Islamic Banking Assets in Indonesia (in trillion IDR):

 2010  2011
 2012  2013  2014
Islamic Commercial Banks & Islamic Business Units   975  145.5  195.0  242.3  272.3
Islamic Rural Banks    2.7    3.5    4.7    5.8    6.6
Total Assets  100.3  149.0  199.7  248.1  278.9

Source: Financial Services Authority (OJK)

The current low market share of Islamic banking in Indonesia in combination with the recent high growth pace and government support implies that there is plenty of room for further growth of the Islamic banking industry in Indonesia. In fact, the Indonesian government is eager to turn Indonesia into a major global hub for Islamic banking as this would deepen Indonesia’s financial markets, hence making the country less susceptible to the negative effects of global economic turmoil.

In this context, Indonesia’s Financial Services Authority (OJK) developed and launched a five-year roadmap earlier this year, which aims to triple the market share of Islamic banks to 15 percent by 2023. This roadmap involves various strategies, such as the reduction of fees on sharia-compliant banking products and the development of educational and training programs (as the institutional framework and human resources need to be improved). It also involves intensifying coordination between the central government and private sector as well as strengthening monitoring in the Islamic banking industry and enhancing legal certainty. 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, and allow increased underwriting in the corporate and infrastructure sectors.

The OJK also announced that it considers to ease ceilings on foreign ownership for Islamic banks. Currently, foreign investors cannot own more than 40 percent of local Islamic banks. The Abu Dhabi Islamic Bank stated last week that it is considering entering Indonesia’s Islamic banking industry in 2016 due to the country’s large untapped potential. Meanwhile, Bahrain's Al Baraka Banking Group and the Dubai Islamic Bank plan to expand their business operations in Indonesia.

Another measure to boost Islamic finance in Indonesia was implemented in April 2015 after Indonesia’s national sharia board approved sharia-compliant currency hedging tools. Garuda Indonesia, the country’s national flag carrier, did not hesitate to tap this new tool. In May 2015 the airline received USD $1.8 billion in orders (56 percent from investors in the Middle East) through the issuance of USD $500 million worth of sukuk (Islamic bonds).

Furthermore, a standard contract template for sharia-compliant repurchase agreements was launched by Islamic banks in Indonesia. This template allows the use of government-issued sukuk as collateral. Other foreign currency tools still need to be developed in Southeast Asia’s largest economy in order to attract the interest of investors.

In June 2015, Indonesian President Joko Widodo threw his support behind efforts to boost Islamic banking in Indonesia by launching the “I Love Sharia Finance Program”, a program initiated by the OJK. At the launch Widodo, often called Jokowi, said that Indonesia should become the global center for Islamic finance.

Muliaman D. Hadad, Head of the OJK’s Board of Commissioners, recently stated that per March 2015 Indonesia’s Islamic banking industry comprised 12 general sharia banks (with a total of 2,138 branches), 22 sharia business units of conventional banks, and 163 sharia people's credit banks (rural Islamic banks). Problematically is that these Islamic banking units are unevenly distributed across Indonesia. Most are located on Java, Indonesia’s most populous island. In the less populous eastern region of Indonesia most people do not have access to Islamic banking services at all. However, it has to be noted that the number of Muslims is much lower in the eastern region of the country (although adhering to a different religion does not mean that the person cannot use Islamic banking services). Moreover, regarding conventional banking the eastern region of Indonesia is also under-banked (according to the World Bank only 36.1 percent of Indonesia’s adult population held a bank account in 2014). As such, a general problem in Indonesia’s banking sector is low financial literacy.

What is Islamic Finance/Banking?

Islamic finance is a form of banking or banking activity that is consistent with the principles of sharia (Islamic law). 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. Islamic 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. In recent years, the global market for sharia-compliant financial instruments has risen robustly.

Differences between Conventional and Islamic Banking:

Conventional Banking Islamic Banking
Money is a commodity besides medium of exchange and store of value. Thus, it can be sold at a price higher than its face value and it can also be rented out Money is not a commodity though it is used as a medium of exchange and store of value. Thus, it cannot be sold at a price higher than its face value or rented out
Time value is the basis for charging interest on capital Profit on trade of goods or charging on providing service is the basis for earning profit
Interest is charged even in case the organization suffers losses by using banks' funds. Thus, it is not based on profit or loss sharing Islamic banks operate on the basis of profit/loss sharing. In case the businessman has suffered losses, the bank will share these losses based on the mode of finance used (Mudarabah, Musharakah)
While disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods & services is made The execution of agreements for the exchange of goods & services is a must, while disbursing funds under Murabaha, Salam & Istisna contracts
Conventional banks use money as a commodity which leads to inflation Islamic banking tends to create a link with the real sectors of the economic system by using trade-related activities. Since the money is linked with the real assets it therefore contributes directly to economic development