T

he Islamic financial sector in Indonesia is hoping a mix of state-backed infrastructure projects and regulatory reforms will help the country’s sharia-compliant lenders to continue their rapid expansion, allowing the industry to realize its full potential and to come out of the shadows of other regional banking powers.

Indonesia was a relative late-comer to the Islamic finance sector, only ratifying legislation to clear the way for sharia-compliant services a quarter of a century after Malaysia had opened the door to Islamic banking and associated activities.

Some four years down the road and Indonesia has 11 banks operating solely in compliance with Islamic finance requirements and a further 23 commercial lenders offering sharia-compliant services.

Between them, Indonesia’s Islamic banking institutions held more than $11 billion in assets as of the end of 2010, a steep increase on the $7.7 billion of the previous year. While this rate of growth represented an almost 50 percent increase, the total still only amounted to some 3 percent of the combined assets of the nation’s banking sector. This is a far cry from the 20 percent of Malaysia’s total banking assets held by that country’s Islamic lenders, with Indonesia’s Islamic banking assets equivalent to just 9 percent of Malaysia’s in 2010, according to data released by the Indonesian central bank.

Following its somewhat slow start, an understanding of the sector is developing, with Bank Indonesia forecasting that Islamic lenders can expect to see asset growth of more than 50 percent this year, in part due to an increase in acceptance by clients.

Islamic banking has emerged as one of the most rapidly expanding sectors in the nation’s economy and is expected to play a significant role in the coming years, according to the report, with asset levels topping $17.9 billion by the end of the year.

In a statement issued on Feb. 13, Mulya Siregar, the director of sharia finance at the reserve bank, said that the prospects for the sector were bright.

“If Indonesia’s economy grows at a decent pace, the assets of Islamic banks will increase by 55 percent,” said Mulya. “With total assets exceeding $11.2 billion last year, that should become a solid base for Indonesia’s Islamic banks, which now have more than 6 million customers and employ more than 20,000 workers.”

One of the factors expected to drive forward the economy, and to present significant growth opportunities for the Islamic financial sector in the coming years will be the government’s plans to strengthen the country’s infrastructure with investment of up to $140 billion over the next five years. The main focus will be on the
transport sector, with road and rail projects to the fore, along with utilities such as power stations and distribution grids, all of which are essential for economic development.

Having said it can directly fund only around one-third of the total outlays, the state is looking to the private sector to enter into partnerships on many of the projects. It is also counting on the Islamic banking sector to make a major contribution to the capital investments.

According to Baharudin Abd Majid, the president director of PT Bank Maybank Syariah Indonesia, a subsidiary of Malayan Banking, the government’s investment projects offer big opportunities for Islamic lenders. He suggests, however, that players in the sector may need to join forces to develop the levels of capital needed by the state.

“There are a lot of roads to be built, as well as power, oil and gas plants,” Baharudin told the Bloomberg news agency on March 23. “These are big projects and Islamic banks do not have the capacity to fund them alone, so we need to come together.”

While hoping to tap into the Islamic finance market to fund its own development program, the government is also looking at ways to deepen the sharia-compliant capital pool, mulling a series of measures aimed at attracting more investors and increasing the appeal of launching sukuk offerings.

Among the reforms put forward by Bank Indonesia is to cut taxes payable by banks and clients on income from Islamic finance accounts. Bank Indonesia is also working to smooth the way for more Islamic banking products to be floated on the market, setting up a committee of experts to develop a streamlined approval process for new products.

By making Islamic financial products more appealing and more readily accessible, Indonesia will be able to better utilize the high levels of local liquidity and potentially attract investments from overseas, though it will take some time for all of the proposed reforms to be put in place and have an impact.

The writer is the editorial manager of Oxford Business Group.