Islamic Banking in Indonesia: Emergence, Growth, and Prospects

Islamic Banking in Indonesia: Emergence, Growth, and Prospects

M. Luthfi Hamidi, Andrew C. Worthington
Copyright: © 2020 |Pages: 23
DOI: 10.4018/978-1-7998-1611-9.ch003
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The Indonesian banking sector has been stable and generally sound over the past decade, partly through efforts by the Bank of Indonesia as Indonesia's central bank and Otoritas Jasa Keuangan as its financial services regulator. This chapter identifies important issues that remain for both conventional and Islamic banking in Indonesia. Authors suggest the government continue its efforts to reform what remains a geographically concentrated industry, to increase the role of bank credit in the economy, and to widen the provision of banking services through technology. Authors highlight the vulnerability of smaller banks in Indonesia to ongoing competitive market pressures and the necessity of creating larger banks through merger or capital raising and improving credit allocation to small and medium-sized businesses. Islamic banking has an important role to play in these developments, and those relating to Islamic social banking.
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During the past three decades, Indonesia’s banking sector has experienced two major financial crises. In 1997, the Asian financial crisis severely affected the sector and a number of banks collapsed. By early 1999, Bank Indonesia (BI), the Indonesian central bank, had closed 61 banks, and nationalized another 54 (Caprio & Klingebiel, 2002). With a second crisis emanating from the global financial crisis in 2007–08, Indonesian banking was again adversely affected, although not as majorly as countries with more direct links to the US subprime mortgage market. However, among the outcomes, the Lembaga Penjamin Simpanan (Deposit Insurance Corporation) bailed out the failed Bank Century, while the Indonesian rupiah (IDR) exchange rate weakened to USD/IDR12,650, its lowest level since the 1997/98 crisis (Bank Indonesia, 2009) (as of 11 March 2019 USD/IDR14,298, AUD/IDR10,064 and GBP/IDR18,552).

It was after this second crisis that BI intensified its efforts at transforming what had hitherto been a very risky banking system, including its Islamic banks, into a stronger and more resilient industry able to provide the foundation for sustainable financial development and economic growth. However, these developments are largely unknown outside the country. Accordingly, this chapter has three purposes. First, to review the status of Indonesian banking. Second, to highlight some relevant ongoing challenges to both conventional and Islamic banking in Indonesia. Third, to describe how Islamic banking may be able to address some of the banking challenges present in Indonesia.

The structure of the remainder of the chapter is as follows. The first section examines the profile of the banking sector in Indonesia. The second section discusses its regulation and the third section its supervision. The fourth section considers the performance of the sector and the fifth section entails a critical discussion of current and future challenges and possible remedies. The chapter ends with a brief conclusion in the final section.

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