The Determinants of Islamic Banking Growth in Indonesia

Total assets of Islamic banks in Indonesia contributed to a mere 1.6% of the total assets of banking system in 2006 and increased marginally to 1.8% by 2007. Despite the trivial market share, Indonesia's Central Bank has targeted that the Islamic banks should achieve a 5% market share by 2008. Accordingly, it is important to identify critical factors for the Islamic banking growth to expedite the industry's growth. This study examines the determinants and causal relationships among the major determinants of the growth, namely mudharaba investment deposit, interest rate, rate of return, Islamic banks' branches and income for March 2000 - August 2007 period. It employs time series econometric techniques including VAR model and its associated Impulse Response Function and Variance Decomposition Analysis. Results of this study contribute towards the implementation of more effective initiatives and banking policies to foster the Islamic banking growth in Indonesia