Small Share of the Islamic Banks in Indonesia, Supply-side Problems?

About 21 years after establishment of the first Islamic banks in Indonesia, the share of Islamic banks is still small. About 86 percent Indonesian are Muslim, yet the asset share of Indonesian Islamic banks is only about 4 percent. Since Islamic scholars unanimously argue that bank interests are prohibited, we could expect that asset share of Islamic bank in Muslim-majority country is at least equal with Muslim share in the total population because all Muslims should choose Islamic banks over conventional banks. In this paper, we want to investigate what is the cause of small share of Islamic banks in Indonesia. To be more precise, whether it is caused by non-technical factor or it is caused by supply-side problems such as poor Islamic bank services or lower Islamic bank returns, or to be more extreme, it may be caused by people do not recognize Islamic banks. Using demand estimation model and elasticity exercises, we find that costumers appear to group separately Islamic and conventional banks, meaning that there is recognition and market segmentation. However, Islamic banks do not have greater market power compare to conventional banks. We argue that supply-side problems such as high services fee and low bank returns are not the reason why the market share of Islamic banks is so low. We also argue that non-technical factors such as the early-mover advantages and lack Muslim awareness may become the reasons. We also find that Islamic banks will not be able to effectively increase their market share by competing in price.