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Islamic Finance in Indonesia: Potential and Challenges

Friday, February 1, 2019



Indonesia and Malaysia may be called cognate (serumpun) countries. However, this does not make the fate of these two countries the same. Despite being younger, Malaysia has a more economically established position than Indonesia, especially in the Islamic financial sector.

According to the Global Islamic Finance Report, Malaysia was ranked first in the Islamic Finance Country Index (IFCI) 2017. This was the second time Malaysia was ranked first, the previous one being in 2016 since the index was first launched in 2011. Iran and Saudi Arabia respectively occupied the second and third positions.

Malaysia also obtained the same rating in the Islamic Finance Indicator (IFDI) 2017 ICD-Thomson Reuters. Meanwhile, the second and third positions were each occupied by Bahrain and the United Arab Emirates (UAE). You might have a big question mark, what about Indonesia’s global position in Islamic finance?

IFDI, which is often the primary foundation for evaluating a country's Islamic financial ratings, places Indonesia's at the 11th position. This position has decreased compared to the previous year which was ranked 10th. Meanwhile, IFCI Indonesia's ranking is in the seventh position. Again, the rating has decreased compared to the previous position which was ranked sixth.

As a matter of fact, the scoring system in IFDI and IFCI are different. Therefore, it is not surprising that the results are quite different, with often significant results. IFCI consider several factors such as the number of institutions and Islamic-based banks, government support, financial assets of Islamic, the Muslim population, ethnicity, education, and regulation. In total, there are 48 countries included in the IFCI data.

Meanwhile, IFDI assesses based on five factors, namely quantitative development indicator that shows how institutions and countries adapt to economic conditions, indicators of knowledge, the role of government, corporate social responsibility (CSR), and awareness indicator. The five indicators are used to assess a total of 131 world countries.

Current Conditions of Islamic Finance in Indonesia

Through IFDI and IFCI ratings, already you can see the picture of Indonesia's Islamic financial condition at the world level. What if you want to see a more in-depth Islamic-based financial conditions in Indonesia? Ernst & Young (EY) in World Islamic Banking Competitiveness The 2016 report states that the Islamic financial condition in Indonesia is still a fetus.

The report stated that Indonesia did have great potential in the world of Islamic finance. Moreover, Indonesia is known as the country with the most Muslim population in the world. However, the development of Islamic finance in Indonesia is moving very slowly. EY even compared the speed as a snail pace.

The government itself has big ambitions to make Indonesia a global Islamic financial center. This was expressed by President Joko Widodo in 2016. However, with Indonesia’s snail pace, Indonesia must work extra hard to compete with Malaysia as a country with a highly developed Islamic financial ecosystem.

The development of Islamic finance in Indonesia has actually begun long ago. It began in 1990 with the proposed establishment of Islamic banks by the MUI, which was then followed by the establishment of Bank Muamalat in 1992 as Indonesia's first Islamic bank.

Furthermore, PT Takaful Keluarga Insurance appeared in 1994, known as the first Islamic-based insurance company in Indonesia. Four years later, regulation in Indonesia allows conventional banks in the country to participate in the Islamic banking industry.

In 2004, the MUI issued a fatwa on interest conducted with the aim of encouraging Islamic finance. In 2008, the government specifically issued Law Number 21 of 2008 concerning Islamic Banking. At the same time, the government also launched SBSN, known as the first state sukuk ("Islamic compliant" bonds). Furthermore, in recent years, much financial technology (fintech) startup companies began to expand into the Islamic finance industry in Indonesia.

However, as stated by EY, the development of Islamic finance in Indonesia is very slow. As a proof, Islamic banking as the dominant Islamic financial industry in Indonesia, has a tiny market share, only 5.33% with a total value of Rp365 trillion. In fact, Indonesia’s total Islamic financial assets, including insurance and investment, is below 5%.

In fact, Indonesia has a huge potential to improve its Islamic financial ecosystem. There are three indicators of the huge Islamic financial potential, namely:

  • The majority of the population is Muslim

The biggest potential possessed by Indonesia in developing Islamic finance to become a global Islamic financial center is none other than its population. Moreover, Indonesia is known as the country with the largest number of Muslims in the world, reaching 10.7% of the total Muslim population in the world.

  • The conducive condition of the Islamic financial industry ecosystem

Indonesia also has a conducive Islamic financial ecosystem. This can be seen from the IFDI or IFCI ratings mentioned. Plus, currently, many Islamic institutions are keen on promoting the Islamic-based financial system.

Not only that, Islamic-based financial companies that apply technology in their services, aka fintech, also appear. Since 2017, the Financial Services Authority (OJK) noted that fintech companies in Indonesia continue to strive to comply with the rules of the regulations. This was done to ensure safe services and complying with the rules of the Islamic religion to the people of Indonesia.

  • Government support

Equally important, the Indonesian government is also serious in responding to the development of the Islamic financial industry in the country. This is indicated by the existence of the Islamic Banking Act.

Challenges to Develop Islamic Financial Potential in Indonesia

The potential in developing Islamic finance in Indonesia is indeed very large. However, the potential will just stay a potential if it is not developed in real terms. To do this, Indonesia must undergo four major challenges.

  1. Institutional quality

In general, the first challenge that must be faced in developing Islamic finance in Indonesia is the overall institutional quality. Various problems must be faced, including uneven human resource capacity, limited capital support, or lack of technology utilization.

  1. Literacy

The second challenge that must be faced is Islamic financial literacy to the general public. It is no secret that some Indonesians are technologically financial problems, let alone Islamic finance. The conditions are more severe when it comes to the middle to lower economic communities. Based on the 2016 National Financial Literacy and Inclusion Survey, Indonesian people only have an Islamic Financial Literacy Index of 8.11 percent.

  1. Small Market Share.

Overall, the market share of Indonesia’s Islamic finance is still very small. According to OJK’s data, as of June 2018, the Islamic finance industry assets stands at Rp1.204,48 trillion. The capital market is the dominant contribution, with 55%. However, the high contribution of the Islamic capital market does not significantly increase the market share of Islamic finance in Indonesia. In total, the percentage market share of Islamic finance only stands at 8.47% while the rest are assets by conventional finance.

 

  1. Limited products

The Islamic banking industry has indeed progressed. However, the financial products offered by the Islamic financial industry in Indonesia still cannot compete with variations in conventional financial products. As a result, people also prefer to use conventional financial products that they are more familiar and comfortable with.

In conclusion, the history of Malaysian Islamic finance is far longer than in Indonesia. The seed of Islamic finance in Malaysia has existed since 1963, marked by the existence of the Tabung Haji Institute. However, for them, it took 20 years to be able to establish the first Islamic bank.

Currently, Malaysia’s Islamic economy ecosystem is indeed more advanced compared to Indonesia. However, Indonesia’s Islamic finance is relatively faster. Indonesia only needs two years for establishing the first Islamic banks since the MUI Workshop. However, the question still remains, how long will it take for Indonesia to rival Malaysia?

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