Indonesia: Expanding Access to Islamic Finance for SMEs

Indonesia: Expanding Access to Islamic Finance for SMEs

In general it has been found that Muslim societies across Asia show lower levels of access to finance. However, Islamic financial institutions, regulations, products and services have grown rapidly in recent years and have matured substantially; Islamic financial products and services provide a vehicle to expand access to finance.

According to the IFC, in Indonesia SMEs account for 90% of the labor force and 60% of GDP; despite their contribution to the economy, it is estimated that about 80% of small and medium-sized enterprises (SMEs) are underfinanced. While they have limited access to finance, one of the most concentrated providers of financing to SMEs in the country are the Islamic financial institutions – 80% of all of their financing is to SMEs. However, the 28 banks with Islamic operations and three full-fledged Sharia banks and non bank financial institutions in total is still small, with total assets estimated of less 2% of total financial sector assets in Indonesia. The growth of Sharia banking in Indonesia has been rapid, with an almost tripling of the number of offices from 2006-2007 (from 456 to 1,195 offices) and 33% growth in assets and the overall performance has been strong with low levels of non-performing financing (less than 4%) and high profitability (return on assets of 1.8%).

The Indonesia Government is focusing on expanding access to finance across the country; and is also promoting the further development of Islamic finance. In 2008 the Bank Indonesia launched its “Grand Strategy for Islamic Banking Development under the Accelerated Islamic Banking Development Programme” that sets forth the target for 5% of all banking assets to be Sharia compliant and an increase of Sharia customer base to 3 million accounts.1

The Bank of Indonesia requested FIRST provide technical assistance to support the authorities in further developing Islamic finance as a vehicle for expanding access to underserved economic segments, such as household and small businesses. The objective of the project is to improve the effectiveness, efficiency, and outreach of Islamic financial products and services in Indonesia; with a longer-term goal of enhancing access throughout the East Asia region.

The short-term objective of the project is to systematically analyze the current status of Islamic financial services in Indonesia and to create a strategy for expanding access for under-served markets, with particular focus on SMEs as defined by Indonesian standards, through Islamic finance products and services in Indonesia. In addition, the work is intended to create a pilot assessment tool with two interlinked components: (i) the assessment on access to Islamic finance for SMEs, and (ii) the strategic framework for policy recommendations in improving access to finance for SMEs through Islamic finance products and services. It is hoped that this assessment tool could be applied across the East Asia region in relevant countries (i.e., Brunei, China, Malaysia, Philippines, Singapore, Thailand) and other countries around the world where Islamic finance is emerging as a potential instrument for expanding access to underserved market segments.

The immediate outcome of this technical assistance project will be an improved understanding of the supply and demand dynamics for Islamic finance in Indonesia, as well as a strategy and implementation plan for improving access to finance through Islamic products and services. Recommendations were expected to include the creation of a new pilot Islamic financing vehicle to expand access to finance for SMEs.

It is expected that there will be follow-on work to assist the relevant authorities in Indonesia on the implementation of the strategic recommendations. It was envisioned that the assessment and strategy tool would be rolled out to other relevant countries in East Asia to begin to develop a comprehensive picture of the potential for Islamic finance to expand access region-wide.

Based on the project output, the WB may also work with the authorities to develop the pooled Islamic financing facility to expand access to capital for SMEs in Indonesia on a pilot basis. If the pilot is successful, it can be scaled up both within Indonesia and within the East Asia region. As this project is still in the implementation stage we will need to wait to see what analysis, tools and lessons emerge and whether the project can be replicated in other countries to support improvements in the effectiveness, efficiency, and outreach of Islamic financial products and services. One potential indicator of this project would have been to follow up on the level of Islamic financing available to SMEs, and whether through targeted policy interventions as detailed under the project and the introduction of a pooled Islamic financing facility there is an increased in Islamic financing to SMEs in target areas.


1Bank Indonesia, “2007 Economic Report on Indonesia,” July 7, 2008,