The Political Economy of Islamic Banking in Indonesia : An Institutional and Analysis Development Approach

Abstract

Islamic banking has exhibited significant growth since its inception in 1975. As a predominantly Muslim country, Indonesian Governments have set ambitious targets, envisioning Indonesia as a global nexus of Islamic economics and finance. This vision is encapsulated in various strategic documents such as the Islamic Economic and Finance Master Plan by the Ministry of Planning and Development, the Blueprint of Islamic Banks issued by the Bank of Indonesia, and the Roadmap of Islamic Banks issued by the Financial Service Authority (FSA). However, these targets have recurrently been unattained, with the envisioned benchmarks being revised downwards over time. The trajectory of the Islamic banking industry has been propelled not solely by economic variables but also by intricate institutional and political dynamics within the country. Various contextual factors exert diverse impacts on the stakeholders in this financial sector. These factors, in conjunction with the formal regulatory framework, converge into what is termed as the institutional arrangement, which significantly shapes the sector's evolution over time. This study delves into the political economy underpinning the development of Islamic banking, analyzing the roles of government and political institutions in regulating, promoting, and fostering the growth of this sector. Hence, the primary research question of this thesis is 'How does the current institutional arrangement affect the development of Islamic banking?' Employing Elinor Ostrom's Institutional Analysis and Development (IAD) framework, this study navigates through the guidelines of institutional analysis to answer the research question. According to this framework, the analysis focuses on specific action situations wherein participants engage in decision-making and interactions. The actions undertaken by these participants are constrained and affected by contextual factors, comprising (1) the material conditions, (2) the attributes of the community, and (3) the rules in use. The findings underscore governmental support towards Islamic banking. Nonetheless, a discernible gap exists between the stipulated policies and the government's ambitious aspirations for the Islamic banking industry. The prevailing institutional arrangement does not favour a development pace in Islamic banks conducive to achieving the government's targets. This is evidenced by the lack of incentives, frameworks that do not fully resonate with the unique attributes of Islamic banking, partial and sectoral regulation within the Islamic economy ecosystem, pragmatic stakeholders, among others. Actors have intensified efforts in promoting Islamic banking to stimulate the demand side of the industry. However, in terms of performance, Islamic banking has yet to offer superior economic incentives to secure a more substantial market share compared to its conventional banking counterparts. Show more