Is Indonesia’s Sharia fintech industry here to stay?

Photo: Laksono Aji from Pexels

The rise in Sharia financial technology is transforming Indonesia’s economy, as Muslims seek banking and financing options that adhere to Islamic law.

By Helena Kerr

Indonesia, the biggest emerging market in Southeast Asia, has already become a hub for new enterprises specializing in financial technology, or fintech. Many investors are lured by its huge market potential: the large population of 270 million people, 178 million internet and smartphone users and a government that is investing heavily in digital infrastructure.

According to the Asian Development Bank, Indonesia can boost its GDP by 2-3% by providing banking services to the 35% of its population that is currently unbanked. This is particularly important as 97% of the Indonesian workforce is in the small and medium-sized enterprise (SME) segment, which needs affordable access to financing. At present, 80% of the sector is unable to access these financing options.

A growing segment within fintech is sharia fintech: digital payment or peer-to-peer (P2P) platforms that abide by Islamic laws

Sharia fintech differs from conventional fintech in at least three defining ways. First, as charging interest is prohibited by Sharia law, Sharia fintech utilizes a profit-sharing model. The borrower will pay the lender the principal plus a percentage of the profits enabled through the loan. Most Sharia fintech firms in Indonesia are P2P, a model that suits this arrangement well.

Second, Sharia fintech companies are committed to investing profits in only halal investments, which exclude ventures in the alcohol, pork and gambling industries.

Finally, Sharia fintech companies are encouraged to invest in projects that help the low-income and underserved groups. Herston Powers, managing partner at Singapore-based fintech firm 1982 Ventures, predicts that Indonesia’s Sharia banking assets will soon match or even exceed those in Malaysia, which reportedly include over 25% of the country’s banking assets.

Most Sharia fintech companies also have a function allowing people to calculate their zakat, Islamic compulsory alms-giving, and enable them to direct payments to their mosques. These additional features in Sharia fintech are appealing to the growing conservative Muslim population.

The Indonesian Central Bank in Jakarta. Photo by CEphoto, Uwe Aranas / CC-BY-SA-3.0

Deputy Governor of the Indonesian Central Bank (BI) Dody Dedy Waluyo cites rapid growth in demand for halal products and lifestyle. He estimated around 40% of Indonesia’s GDP comes from the Sharia economy. Between 2014 and 2017 alone, halal consumption of food, travel, fashion and cosmetics increased by 13%. According to research by Media Kernels Indonesia, the words “hijrah” and “halal” were mentioned 5,000 times on social media over the span of a month, highlighting product marketers’ move to target conservative Muslim markets.

The appeal of Sharia fintech firms goes beyond religion

Qazwa, a Sharia fintech firm in Indonesia, has reportedly already helped users save more and lower their financial risks. Unlike conventional fintech firms where borrowers are required to pay interest regardless of their own financial status or that of their business, Sharia fintech firms incentivize lenders to help borrowers profit through a profit-sharing model. This collaborative effort between the lender, the fintech firm and the borrower not only lowers financial risk, but also fosters a healthy, mutually beneficial relationship between the stakeholders.

Sharia fintech has much room to grow. “There is a significant potential for sharia fintech’s prospect in Indonesia due to the low Sharia banking penetration—around 6%—in the country,” said Dima Djani, CEO and founder of Alami, a leading P2P Sharia fintech servicing SMEs. Djani aims to target the under-served segment of Sharia banks. He observes that traditional banks are unable to serve the rapidly expanding financial needs of conservative Muslims in the country. Sharia fintech could close this gap.

However, for Sharia fintech to succeed in Indonesia, the government must address some of its shortfalls

There is still a challenge to ensuring compliance with Islamic law among Indonesia’s Sharia fintech companies. Despite the exponential growth in Indonesia’s Sharia fintech scene, only nine out of 165 fintech companies that are registered with the government under the Financial Services Authority (OJK) are Sharia-compliant. The Indonesian government has sought to address this by launching the National Committee of Islamic Finance (Komite Nasional Keuangan Syariah, KNKS), chaired by the Indonesian president and vice president. KNKS’ primary responsibility is to invest in Sharia fintech companies and improve their compliance rate.

With the onset of the COVID-19 pandemic however, the budget of KNKS was slashed by nearly 60%. This greatly impeded government efforts to scale up the country’s Sharia fintech scene.

Nonetheless, the future of Sharia fintech companies in Indonesia is still promising. The combination of Indonesia’s huge market size, growing conservative Muslim population, low Sharia banking penetration and government investment will likely see the sector through this pandemic.