This short paper suggests that Islamic instruments are simply a narrow group of familiar financing instruments. It notes that Islamic instruments generally avoid loans – although the scheduled distribution of proceeds may be the same as for a conventional loan, the legal risk in the case of default is often different in the different forms of financing. Those who promote Islamic finance often prefer partnership arrangements in which profits or turnover is shared because this conforms more fully to the goals of Islamic banking.
This paper, which discusses Islamic Banking and its potential impact, particularly in rural areas, takes Indonesia as the basis for its case study. The work of Shariah Bureau of Bank Indonesia, demonstrates that Indonesia, especially in particular parts of the country, has considerable unmet demand for Islamic Banking. The report begins by presenting data on the oldest and largest Islamic bank in Indonesia, Bank Muamalat, and on the Bait Maal Wat Tamwil (BMT), the Islamic savings and loan cooperatives.
The paper then moves onto a discussion of the key findings and recommendations. It argues that Islamic finance, as part of a financial sector development strategy, ought to be encouraged, mainstreamed, and adjusted to. In conclusion, the paper takes the view that donors should ensure that their assistance to financial system development includes Islamic financial institutions. It notes in particular that Islamic finance:
- enables financial services to an otherwise group including small, rural, and agricultural producers;
- furthers a social trust 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.