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As a dynamic emerging economy and the country with the world's largest Muslim population, Indonesia would seem to be a natural champion in Islamic finance. Yet the country's shariah compliant banking industry lags behind that of neighbouring Malaysia and Middle Eastern economies both in terms of size and sophistication. There is, however, growing public awareness about Islamic finance and active government support for the industry, which is far outperforming the overall banking sector in terms of asset growth.
Low penetration and the rather immature state of the industry at present mean long-term growth potential for committed investors. As Indonesia hopes to establish itself as a major hub for Islamic finance, the industry needs to open itself up globally. It also needs to develop the institutional framework and human resources necessary for Islamic banking to flourish, which, again, presents business opportunities for experienced foreign banks, consultancies and providers of relevant education and vocational training (See Indonesia's Transforming Economy: Business Education in High Demand). Given clear and supportive government regulations, increased popular awareness and a build-up of institutional know-how, Indonesia should be able to attract enough investment to compete with the most sophisticated Islamic banking centres in the world.
Based on data from Indonesia's Financial Services Authority (OJK) as of March 2015, there are 12 commercial Islamic banks in Indonesia, which operate a total of 2,138 branch offices across the country. In addition, 22 major conventional banks have Islamic business units for customers seeking services that comply with shariah principles. Also known as Islamic windows, these units offer their products through 325 offices nationwide. Furthermore, 162 rural Islamic banks – which are much smaller than the commercial banks – cater to banking needs in their respective localities with 471 offices.
Islamic banks are extending their networks to accommodate more customers. While almost 3,000 offices would seem like a sufficiently large number even for a country of Indonesia's proportions, Islamic banking services are not spread out evenly. For example, 103 of the 162 Islamic rural banks are located on the island of Java, while numerous provinces in other regions have no rural Islamic banks at all. Many people living in the eastern part of the country, in particular, have no easy access to Islamic banking services. With fewer than 40% of Indonesia's adult population having a bank account (World Bank), extending banking services to under-banked regions of the country is a tremendous challenge as well as an opportunity.
Islamic banking in Indonesia has grown faster than in other major Islamic banking markets in recent years. Islamic assets in the country rose from a total of 100 trillion IDR in 2010 to 279 trillion IDR in 2014, or at a compound annual growth rate (CAGR) of 29.2%. By contrast, conventional banking assets grew at CAGR of 16.9% over the same five-year period. Yet Islamic assets represent merely 4.7% of total banking assets – compared to some 20% in Malaysia – even though Muslims in the neighbouring country account for a smaller portion of the population. In Saudi Arabia, the world's biggest Islamic banking marketplace, more than half of all bank assets comply with shariah rules.
Islamic Banking Assets in Indonesia (trillion IDR)
Source: OJK
Low market penetration for banking services in general and shariah-compliant ones in particular, means Indonesia harbours tremendous upside potential. In its “World Islamic Banking Competitiveness Report 2014-2015”, Ernst & Young points to “super-normal growth” in Indonesia's Islamic banking industry and expects assets to grow faster than in any other leading Islamic banking marketplace. Branchless banking offers opportunities to extend services to rural communities at viable costs, while micro finance promises to boost entrepreneurial activity where loans are hard to come by (See An Outlook on Indonesia’s Microfinance Sector). Banks are becoming increasingly engaged in micro-finance in Indonesia, either directly or via established micro-finance institutions. Developing the country's potential for Islamic banking, however, requires supportive regulations and lots of investment in human capital and industry know-how (See Islamic Finance & Business Education). Furthermore, Indonesian Islamic banks need to grow in size to take on better-capitalized overseas competitors.
Indonesian authorities have pledged to nurture the growth of shariah finance. The OJK and central bank (Bank Indonesia) target an increase in the market share of Islamic banks to at least 15% of total banking assets by 2023, which is a steep order given that the share has remained below 5% for years. Central to these efforts is a five-year roadmap from the OJK for the development of Islamic finance in Indonesia, which includes new regulations for Islamic banking. As the Jakarta Globe reported in June 2015, the roadmap “charts an extensive agenda ranging from reducing fees on shariah-compliant products to developing education and training programs.” The OJK has also undertaken steps to intensify coordination between the government and private sector, strengthen oversight in the industry and bolster legal certainty. In addition, the government is raising the bar for Islamic banks in terms of capital adequacy, which should not only help to limit systemic risks, but also drive mergers and acquisitions.
The government encourages local Islamic banks to merge in a bid to make them stronger (See Consolidation in Indonesia’s Banking Sector: A Boon for Business?), reduce operating costs and thereby enable them to offer more competitive products. Heeding the call, Indonesia's four state owned banks reportedly plan to combine their shariah-units into one new entity. Rules requiring commercial banks to spin off shariah units into separate entities by 2023 should also spur consolidation in the private sector and could offer inroads for foreign Islamic banks injecting capital into local firms. In a move to draw investment to the shariah segment, authorities are reportedly considering exemptions for shariah banks from a foreign ownership cap in the banking industry. An OJK representative told Reuters in June 2015 that the regulator was looking to relax overseas ownership requirements in cases where a foreign bank plans to convert an Indonesian commercial lender to an Islamic one.
With its profit- and risk-sharing principle revolving around hard assets, Islamic banking lends itself to infrastructure financing (See Indonesian Infrastructure: Tremendous PPP Opportunities). Indonesia looks to the industry to contribute significantly to its ambitious infrastructure programme, which envisions projects worth hundreds of billions of dollars to be realized by 2025. The government in Jakarta has also announced it will become a founding member of the multi-national Islamic Investment Infrastructure Bank.
In its five-year programme, the government has pledged to engage on both the supply and demand side of Islamic banking, by improving qualifications and certifications of the banks as well as promoting shariah-compliant banking among prospective clients. This creates an attractive market for providers of training courses and business consulting.
Unlike most formal education, vocational training is open to foreign investment on a commercial basis, and the same is true in the case of consulting. Demand for leadership training and business education is high, not least because Indonesian companies tend to be reluctant to invest heavily in in-house training.
While Islamic banking – along with the wider banking industry – has experienced a slowdown in the last two years, it is likely to be first out of the blocks once Indonesia's economy regains strength.
Global Business Guide Indonesia - 2015
Contribution to GDP: 2.87% (2016)
Return on Assets: 2.30% (Q4 2015)
Number of Commercial Banks: 120; 4 State/Partially State Owned, 10 Foreign, 16 Joint Ventures, 32 Non Foreign Exchange, 35 Foreign Exchange, 26 Regional Development Banks (August 2015).
Number of Islamic Banks & Units: 13 Banks, 32 Units (2016)
Total Assets: 6,244 trillion IDR (Q3 2015)
Government Bodies: Bank Indonesia, Ministry of Finance, Financial Services Authority (OJK).
Relevant Law: Bank Indonesia Regulation No. 14/8/PBI/2012 on Share
Ownership in Commercial Banks limits ownership by a single local/foreign financial institution to 40%, by a non financial institution to 30%, and by an individual to 20%. Larger stake is possible with the approval of Bank Indonesia.
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