The government of the world’s largest Muslim-majority country has been looking to develop its sharia economy since establishing the Indonesian Sharia Economy Master Plan 2019-2024 for becoming a prominent player in the global sharia economy.

Despite the ambitious plan, information on Islamic banking and finance has been generally lacking for consumers. According to the Financial Services Authority (OJK), Indonesia’s sharia financial literacy rate was a mere 8.93 percent in 2019, far below the conventional financial literacy rate of 37.72 percent.

Experts still maintain that sharia banking has potential to grow and even support the country’s larger halal economy.

Read also: Sharia finance thrives despite pandemic, to further grow in 2021: OJK

Law No. 21/2008 on sharia banking defines it as a banking system that is based on the principles of sharia, or Islamic law, and is regulated under a series of fatwas issued by the Indonesian Ulema Council (MUI).

Among the sharia principles are justice, equality and universal benefits, as well as shunning fraud, gambling, unjust and exploitative gains, cruelty and haram objects.

“Everyone, regardless of their religion, can use sharia banking services because banking is deemed as transactions between humans (muammalah). Some sharia banks also employ non-Muslims,” Yosita Nur Wirdayanti, the sharia banking head of the National Islamic Economics and Finance Committee (KNEKS) told The Jakarta Post on Monday.

According to the OJK, in terms of institutional structure, Indonesia has full-fledged sharia banks as well as sharia banks that are subsidiaries of conventional banks, called a sharia business unit (UUS). But this isn’t evident from just the name. For example, BCA Syariah is a full-pledged sharia bank and not just a business unit of Bank Central Asia (BCA).

Yosita says that, unlike the creditor-debtor relationship that conventional banks maintain, sharia banks treat their clients as partners. The OJK’s information on sharia finance also says so.

This relationship extends to all banking operations. While sharia banks also receive deposits and distribute financing like conventional banks, Yosita explained that sharia banks run under a profit-sharing system rather than one based on interest.

The bank and the customer agree to one of two financing akad, or contract.

One is the mudarabah contract, a partnership between the bank and the customer, wherein the bank provides the entire capital and the two parties split the profit according to an agreed amount. For such contract, the bank might take all of the potential losses unless the customer commits wrongdoing, according to the law.

The other is the musharakah, a contract under which all investors have a say. Musyarakah allows for a more balanced management of finance, wherein the capital is split and the profit is also shared as agreed, and losses are also shared by adjusting to the amount of capital each party has invested.

This business model is why sharia banks are required to be prudent in managing their customers’ finances.

“The difference between the interest-based and profit-sharing [models] is that the latter is not guaranteed. There is also an element of risk-sharing in Islamic banks,” said Yosita.

Aside from earning revenue through sharing profit, sharia banks also imposed fees on activities like bank transfers and clearance. Yosita added that some banks did not collect maintenance fees from wadi’ah  (savings) accounts.

Yosita said another difference was that Islamic banks also performed non-intermediary functions as a pawnshop or a real estate agent and made further earnings from lending and selling activities.

“Sharia banks can buy houses and sell them to clients for a margin. The banks can also lease these houses for which clients must pay rent but without imposing riba (interest),” she said.

Finally, sharia banks cannot participate in activities that are prohibited by Islamic law, such as investing in tobacco companies, pig farms or hotels that are not sharia compliant.

Read also: Sharia finance thrives despite pandemic, to further grow in 2021: OJK

The National Sharia Council of the Indonesian Ulema Council (DSN-MUI) is responsible for determining whether a banking product is sharia-compliant. Such a product must also have a permit from the OJK before it may be offered to the public.

Each sharia bank is also required to have a sharia advisory board (DPS) to oversee sharia compliance. The DPS members are appointed through the bank’s shareholders general meeting on the recommendation of the MUI.

Indonesia’s sharia finance sector makes up just 9.9 percent of the country’s finance industry, a very low penetration rate considering its majority Muslim population.

Anugerah Mega Investama director Hans Kwee said this was because sharia banks arrived in the country relatively recently.

“There are a lot of benefits in sharia banking that attract even [non-Muslims],” Hans told the Post on Feb. 2.

“Among Muslim consumers, I think as they get older, they want to comply with Islamic finance rules, [so] they will switch to sharia banks. So the prospect of sharia banking is bright,” he said, adding that sharia banking customers would also grow over time.

Despite the low penetration, sharia finance assets, including banking assets, grew 21.48 percent year-on-year (yoy) to Rp 1.77 quadrillion (US$125.31 billion) last year, while sharia loans grew 9.5 percent.

This is a stark contrast to the 2.41 percent contraction in loan disbursements recorded in conventional finance, according to the OJK.

For example, BRI Syariah booked a profit increase of 235.14 percent to Rp 248 billion in 2020, while state lender Bank Mandiri booked a 37.7 percent yoy drop in net profit to Rp 17.1 trillion last year.

“Most sharia banks that have done well during the pandemic are state-owned and as such, they can choose their clients and borrowers, so they are less affected,” Hans said.

The newly launched BSI is the seventh largest bank in Indonesia by total assets, according to its director, Hery Gunardi. BSI had total assets of Rp 240 trillion as of December, above his estimate of between Rp 220 trillion and Rp 225 trillion. Meanwhile, its total financing stood at Rp 157 trillion and it had third-party funds of Rp 210 trillion.

However, sharia banks still have smaller assets compared to conventional banks. According to the latest OJK data, sharia banks had total assets of Rp 576.81 trillion as of November 2020, up 13.5 percent yoy from Rp 507.76 trillion in 2019.

In contrast, conventional commercial banks recorded total assets of Rp 9.05 quadrillion in the same period, up 7.6 percent yoy from Rp 8.41 quadrillion in 2019.

According to the 2019-2024 sharia economy master plan, Indonesia is aiming to develop its sharia banking sector so it supports the halal economy value chain through sharia-compliant loans and investments.

“Islamic banking integrates commercial interests and social development. It can also optimize religious donations, alms and waqf [Islamic endowment] as instruments to empower the community,” Firman Wibowo, who chairs the Indonesia Sharia Bank Association (Asbisindo), told the Post by text message on Tuesday.