Despite having the world’s largest Muslim population, Indonesia’s Islamic finance lags behind the more mature Islamic finance markets of Malaysia and the Middle East. According to the latest data from the central bank (Bank Indonesia), the domestic Islamic finance market of Indonesia - which consists of 11 Islamic banks and 23 Islamic business units of conventional banks - controlled IDR 244 trillion (USD $20.3 billion) in assets, or, only 4.5 percent of the country’s total banking assets in September 2014.

Meanwhile, growth of Islamic finance in Indonesia has slowed considerably, although it remains higher than growth recorded by conventional Indonesian banks (as Islamic finance still has a lot of catch up to do). With IDR 244 trillion worth of assets in September 2014, Islamic finance in Indonesia grew 7.2 percent year-on-year (y/y), whereas conventional banking in Southeast Asia’s largest economy grew 3.7 percent y/y. However, this growth pace of Islamic finance in Indonesia can be labelled disappointing as the OJK initially projected a 14.4 percentage point y/y growth of Islamic banking assets in 2014 (moderate scenario). The Islamic banking sector had grown 24.2 percent y/y in 2013 and 34.1 percent y/y in 2012.

What are the new requirements implemented by the Financial Services Authority (Otoritas Jasa Keuangan, OJK)?

Islamic banks (not Islamic business units of conventional banks) are to hold increasing levels of capital depending on risk assessment (those banks with the highest risk profile need to comply with a capital adequacy requirement of 14 percent).

Regulators can convert debt into equity if an Islamic bank faces insolvency.

Islamic banks are required to include ratios in contracts for profit-sharing financing (including mudaraba and musharaka), calculated based on a feasibility analysis of a customer's business and cash flows.

Other rules involve the separation of Islamic business units from their conventional parents as well as rules addressing how to turn a conventional bank into an Islamic bank.

Last week, the OJK announced it had signed an agreement with the country's national sharia board to strengthen oversight of the Islamic finance industry. In line with the global Islamic finance industry (except for the Gulf region), Indonesia will have a centralized model to supervise Islamic finance.

Further Reading:

Islamic Finance in Indonesia: Sharia Banking is Large Untapped Potential