Between Piety and Prudence: State Syariah and the Regulation of Islamic Banking in Indonesia

As in many other Muslim societies, it was chiefly the state that triggered the growth of Islamic banking in Indonesia and the development of Islamic financial products was encouraged as part of efforts by Soeharto's authoritarian New Order regime to co-opt Muslim groups. Local entrepreneurs, however, drew on models from elsewhere in the Islamic world to develop new financial institutions to a level that compelled more sophisticated regulatory responses. Since Soeharto's fall in 1998, the new democratic state has overseen a significant expansion of the Islamic finance sector, but successive governments have been consistent in keeping what is known in Indonesia as the ekonomi syariah (shari'a economy) firmly under state regulatory authority. Islamic banking is now a flourishing-if still small-part of the finance sector, and a specific-purpose statute has been passed recognising this. The system of regulation governing Islamic finance today nonetheless remains complex, but relies on two lead agencies. Bank Indonesia, the reserve bank, oversees prudential aspects of Islamic banking in a manner very similar to conventional banking. Religious aspects are, however, dealt with by the National Syariah Board of the Ulama Council of Indonesia ('MUI'), and Syariah Supervisory Boards lodged in each financial institution look to it for doctrinal guidance expressed through fatawa. The increasingly conservative MUI is an NGO but it is state-endorsed and state-funded. It is thus the key to state regulation of the sometimes questionable doctrinal 'Islamicity' of Indonesia's Islamic financial institutions, just as Bank Indonesia is the key to state regulation of their commercial activities. There is potential for future tension between these two institutions, but this has not so far weakened state control of Islamic finance in Indonesia. That has, in fact, deepened over the last decade.