Islamic Banking and its Potential Impact

Drawing on the practice of Islamic banking experience in Indonesia, this paper analyses its impact in rural areas. The author finds that most Islamic credit in Indonesia has taken the form of trade finance, and the cost of credit is closely correlated to the average rates charged by other institutions.

The author further finds that Islamic banking:

• Enables financial services to an otherwise underserved group including small, rural, and agricultural producers;
• Furthers a social thrust to assist smaller producers and consumers and is often given in the context of a movement to assist them;
• Requires some adjustment, mostly formal, of techniques and regulation to take account of Islamic values.

Stating that Islamic finance, as part of a financial sector development strategy, needs to be encouraged and mainstreamed, the author concludes with the following suggestions:

• Islamic banking should be mainstreamed by maximizing the interaction between Islamic institutions and the rest of the financial system;
• The financial system and its regulation should be adjusted as necessary;
• Donors should ensure that their assistance to financial system development includes Islamic financial institutions.