As the most populous Muslim- majority country in the world, Indonesia would seem an obvious target for investment in Islamic finance. However, in a country of 255 million people (210 million being Muslim); only 36% of the population have a bank account. Regardless of this, Islamic banking assets have nearly tripled in value from US$8 billion in 2010 to US$22 billion in 2014, making this rapidly growing sector an exciting prospect.

Currently, Indonesia’s entire banking system is only worth about 51% of its GDP, compared to 150% in Malaysia and 350% in China. The Indonesian Government, along with the financial services authority of Indonesia (OJK) have recognised the market potential eager to develop market, with a 5 year plan to double the market share of Islamic Banks to 11% by 2020.

As of 2015, the Islamic banking industry was made up of 12 general Shariah banks, 22 Shariah business units of conventional banks and 163 Shariah people's credit banks (rural Islamic banks).

There is growing support to merge the Shariah compliant units of 3 of the 4 state-controlled banks, Bank Rakyat Indonesia (BRI), Bank Mandiri, and Bank Negara Indonesia (BNI) to create a US$8 billion Islamic bank which would be able to quadruple Islamic banks’ market share in Indonesia to 20 percent by 2018.

Key Legislation and Regulation

Act No 21 of 2008 is the primarily legislation which provided comprehensive regulatory framework for Shariah banking in Indonesia. It was drafted in order to actively develop the Islamic banking sphere and provided for licensing as well as prohibitions for Shariah banking operations.

The Indonesian Central Bank (Bank Indonesia) issued regulations in 2009 and subsequently amended in 2013, relaxed ownership restrictions allowing foreign share ownership of up to 99% of the paid up capital of Islamic Banks.

The OJK now has sole regulatory oversight of the Islamic banking sector and has made great strides since taking over from Bank Indonesia in 2014.

New rules were issued by the OJK November 2014 to promote and regulate Islamic finance development in Indonesia. These rules include:

  • Fully fledged Islamic banks are subject to increased capital adequacy measures based on their risk profile, with the capital adequacy requirement being raised from 8% to 14% for the highest risk banks.
  • Conventional banks must split out their Islamic banking units by 2023.
  • Islamic banks must provide the ratios, based upon an analysis of a customer's revenue and cash-flows, of sharia'h compliant profit-sharing

In 2014, a memorandum of understanding was signed between the OJK and the National Shariah Board of Indonesian Ulama Council (DSN-MUI), which aims to support the Islamic banking sector. The DSN-MUI will issue fatwas (Islamic legal opinion) and oversee the implementation of sharia'h compliant financing in Indonesia. This centralised approach to shariah compliance differs from the Gulf States', whereby banks each have their own Sharia'h boards to determine compliance of Islamic banking products.

Looking ahead

As Indonesia seeks to establish itself as an Islamic finance hub in Asia, the government, Bank Indonesia and the OJK are actively promoting this growing market, with further developments planned by the OJK over the coming years.

The Indonesian government plans to issue about IDR 13.7 trillion (approx. USD $1.4 billion) worth of sukuk in 2016, highlighting it's confidence in the market.