Exploring The Legal Landscape of Islamic Fintech in Indonesia: A Comprehensive Analysis of Policies and Regulations

The Legal Landscape of Islamic Fintech in Indonesia

“FinTech” is a rather simple and obvious combination of an application domain (“financial”) and “technology” (Alt et al., 2018). It refers to the integration of digital technologies into financial services, which has the potential to transform the provision of financial services and spur the development of new ones (Feyen et al., 2023). The ongoing digitization of financial services and money creates opportunities to rapidly build a more inclusive and efficient financial sector landscape and blurs the boundaries of both financial firms and the financial sector, which presents a paradigm shift that has various policy implications (World Bank, 2023). Some of these policy implications include fostering beneficial innovation and competition while managing risks, broadening monitoring horizons and reassessing regulatory perimeters, ensuring that public money remains fit for the digital world, and pursuing strong cross-border coordination. Digital transformation has become a disruptor in almost every industry, including fintech, making the sector more customer-centric and technologically relevant. The evolution of digital transformation in the fintech industry has become a business imperative for improving customer experience through the development of new services and products (Alt et al., 2018). The pandemic has accelerated the adoption of fintech and the sector has experienced one of the most drastic changes in its transformation (Abdul-Rahim et al., 2022; Modgil et al., 2022; Nugraha et al., 2022).

Islamic fintech provided a solution during the pandemic for digital financial innovation with the ease of transactions, without physical meetings (Hasan et al., 2023; Karim et al., 2022; Yudhira, 2021). Islamic fintech is a growing sector in Indonesia, which has the largest Muslim population in the world (Muryanto et al., 2021). The Indonesian Sharia Fintech Association (AFSI) noted that from 2020 to 2021, there was a growth of approximately 130% in the Sharia fintech industry. By 2022, it will increase to 180%. Furthermore, The Global Islamic FinTech 2022 Index lists Indonesia as one of the top five conducive ecosystems for Fintech in the rest of the world, including Malaysia, Saudi Arabia, Indonesia, the United Arab Emirates, and the United Kingdom. The potential for Islamic fintech in Indonesia is huge, and the sector is predicted to reach US$179 billion, with a compound annual growth rate (CAGR) of 17.9% by 2026 (Hudaefi et al., 2023). Indonesia’s National Sharia Finance Committee has made the growth of Sharia fintech a top national priority (Potkin, 2020).

The basic concept of Islamic fintech in Indonesia revolves around combining the principles of Islamic finance with modern technological advancements (Oi, 2023) to provide financial services and solutions that are in line with Islamic teachings (Cherqaoui, 2022). Islamic fintech, also known as “Fintech Syariah,” aims to offer innovative financial products and services that adhere to the ethical and moral guidelines set forth by Islamic law or Shariah. Operating according to Shariah principles, which prohibits interest (riba), uncertainty (gharar), gambling (maysir), and unethical investment (haram) (Sugiarto & Disemadi, 2020). This is the difference between the conventional fintech and Sharia fintech. In Indonesia, Islamic fintech in operation must meet the operational and license requirements set by the regulator. In terms of supervision, the Indonesia Financial Services Authority (OJK) is responsible for supervising and regulating fintech activities in Indonesia, including Islamic Fintech. In order to improve supervision and customer protection, OJK has issued several regulations and policies related to fintech, such as OJK Regulation Number 77/POJK.01/2016 on Information Technology-Based Money Lending and Borrowing Services, and OJK Regulation Number 13/POJK.02/2018 on Digital Financial Innovation in the Financial Services Sector. Islamic fintech also refers to the Fatwa of the National Sharia Council of the Indonesian Ulema Council (DSN MUI), such as Fatwa DSN MUI Number 116/DSN-MUI/IX/2017 on Shariah-compliant electronic money, Fatwa DSN MUI Number 117/2017 on Information Technology-Based Financing Services Based on Shariah Principles, and Fatwa DSN MUI Number 140/DSN-MUI/VIII/2021 on Shariah-Compliant Securities Through Technology-Based Fund Management Services. DSN MUI is part of MUI, which is tasked with developing the application of Sharia values in economic activities in general, and the financial sector in particular, including overseeing Sharia compliance in Islamic fintech. DSN MUI’s fatwas and guidance serve as important references for Islamic fintech providers and users to ensure compliance with Shariah principles. The institution’s role in issuing fatwas and overseeing their implementation contributed to the development and advancement of Islamic fintech in Indonesia (Widyastuti et al., 2020).

The collaboration between DSN-MUI, OJK, and other regulatory bodies is crucial in formulating and implementing these regulations to ensure the proper functioning and oversight of Islamic fintech platforms in so that the benefits of Islamic fintech can be maximized. It is known that Islamic fintech can bring several benefits to Indonesia, including financial access, compliance with Sharia, and economic empowerment. Islamic fintech can help increase financial inclusion for micro, small, and medium enterprises (MSMEs) by providing easier access to finance (Dwijayanti et al., 2022; Putri & Akbary, 2021; Syarifuddin et al., 2021). Islamic fintech platforms also promote financial inclusion by providing access to Shariah-compliant financial services for underserved populations. Islamic fintech can empower the economy by providing easier access to finance for individuals and businesses, promoting entrepreneurship and increasing financial literacy. Islamic fintech conquers financial crises, such as COVID-19, and achieves SDGs for a sustainable nation (Alshater et al., 2022).

However, from the convenience and benefits of Islamic fintech in Indonesia, there are still challenges that Islamic fintech has to face. First, inadequate regulations, it’s because there are no regulations that specifically regulate or contain Islamic fintech lending (Hui et al., 2019; Muryanto et al., 2021; Noor et al., 2022). POJK Number 77/POJK.01/2016 leans more towards conventional fintech, creating confusion and legal uncertainty between Islamic and conventional fintech in Indonesia. Second, complicated permit procedures, fintech registration itself is divided into two, for lending-based fintech or Peer to Peer Lending is under the management of OJK. While those under Bank Indonesia (BI) supervision are those related to the payment system. Indonesian Bank Indonesia and OJK should walk together and make fintech licensing only one door. In addition, the existence of special requirements for sharia-based fintech also requires the existence of Sharia Supervisory Board to ensure sharia compliance which also makes regulations through Fatwa DSN-MUI. This complicated licensing has led to the emergence of many illegal fintechs, as evidence by the blocking of 173 illegal online lending entities by the Indonesian Illegal Financial Activities Eradication Task Force (In Indonesia known as Satuan Tugas Pemberantasan Aktivitas Keuangan Ilegal or Satgas Pasti). Third, consumer protection challenges in Islamic fintech in Indonesia encompass issues related to awareness, transparency, data security, dispute resolution, and risk of misuse (Sugiarto & Disemadi, 2020). The Indonesian Illegal Financial Activities Eradication Task Force is authorized to conduct consumer protection in Islamic fintech. This task force, which consists of OJK, Bank Indonesia, Ministry of Home Affairs, Ministry of Trade, Ministry of Communication and Information Technology, Ministry of Cooperatives and SMEs, Ministry of Investment/Investment Coordinating Board, National Police, Attorney General’s Office, National Intelligence Agency and Financial Transaction Reporting and Analysis centre (PPATK) and other relevant institutions, strengthens regulatory and supervisory relationships to achieve financial system stability. Authorized to regulate the strengthening of supervisory and regulatory relationships between institutions in the financial sector in order to realize Financial System Stability in this case between the Financial Services Authority, Bank Indonesia, the Deposit Insurance Corporation, and the Ministry of Finance. One of them is through the Financial System Stability Committee in the macroprudential and microprudential supervisory mechanisms in the financial system safety net. Furthermore, the strengthening of institutions authorized as regulators and supervisors of the financial sector is carried out to maintain the stability of the financial sector industry and increase public confidence, this aims to create a safer and more environment for Islamic fintech consumers in Indonesia.

The implication of such cases for legal regulation and industry practice is that they may influence how the Islamic fintech industry is regulated and operated. These cases could be an impetus for regulators to strengthen the rules and regulations related to Islamic fintech to protect consumers and ensure compliance with the Sharia principles. As such, legal cases of Islamic fintech operations in Indonesia have an important impact on the development and regulation of the industry. With a strong role in shaping regulations that support growth and innovation, law plays a key role in shaping the future of Islamic fintech in Indonesia. Thoughtful and progressive laws can help create a conducive environment for Islamic fintech to thrive and contribute to its national ecosystem.

Addressing these consumer protection challenges in Islamic fintech requires a combination of regulatory measures, industry self-regulation, consumer education, and technological protection. Ensuring that consumers are well-informed, have access to dispute resolution mechanisms, and are protected from data breaches and non-compliance with Sharia principles is critical to building trust and confidence in the Islamic fintech sector in Indonesia. Indonesia follows the example of other countries that have fintech industries in terms of regulations and policies. The following table compares the regulations in Indonesia with various countries that have fintech industries, such as Malaysia, Saudi Arabia, the UAE, and the United Kingdom:

Indonesia can emulate the experience of other countries with Islamic fintech industries mentioned above. In terms of Sharia compliance, Indonesia is very weak because the Sharia Supervisory Board operates under the Indonesia Ulema Council (DSN MUI), which is an independent institution. The DSN is authorized to establish and issue Islamic legal opinions (fatwas) regarding economic and financial activities. However, fatwas are religious opinions, not positive law issued by state institutions. Therefore, fatwas do not have binding legal force in a country, thus there are no sanctions or legal threats for non-compliance. Indonesia should emulate other countries that implement Islamic fintech, such as Malaysia, Saudi Arabia, and the UEA, where these institutions are under state auspices, so fatwas and regulations issued constitute positive law and have legally binding force that must be complied with and enforced. The clear regulatory guidelines and supportive infrastructure can help establish the Indonesia as a global fintech hub and attract investment to foster a conductive environment for startups to thrive.

A Comprehensive Analysis of Policies and Regulations to Emerging Islamic Fintech in Indonesia

The legal landscape of Islamic fintech in Indonesia is complex and dynamic, and is influenced by broader global trends in financial technology. FinTech, which is an amalgamation of finance and technology, represents a fundamental shift in the provision of financial services. The ongoing digitization of finance has disrupted traditional boundaries within the financial sector, resulting in various policy implications. These implications range from fostering innovation and competition while managing risks to expanding regulatory oversight and ensuring the adaptation of public money to the digital world, while striving for robust cross-border coordination.

The advent of digital transformation has affected virtually every industry, including fintech. It has not only made the sector more customer-centric but has also positioned digital transformation as a business imperative (Chong, 2021). The COVID-19 pandemic has accelerated the adoption of fintech, resulting in significant changes in the industry’s transformation. In Indonesia, Islamic fintech has emerged as a viable solution during the pandemic, offering digital financial innovation with the convenience of remote transactions. Given Indonesia’s status as the country with the world’s largest Muslim population, the growth in Islamic fintech has been remarkable. The Indonesian Sharia Fintech Association (AFSI) reported a substantial increase in the Sharia fintech industry, with growth rates of 130% from 2020 to 2021, and 180% by 2022. Indonesia is recognized as one of the top five conducive ecosystems for fintech globally, as per The Global Islamic FinTech 2022 Index. Projections indicate that Islamic fintech in Indonesia could reach a market size of US$179 billion with a CAGR of 17.9% by 2026, making it a top national priority for Indonesia’s National Sharia Finance Committee.

The fundamental concept of Islamic fintech in Indonesia revolves around harmonizing Islamic finance principles with modern technology. Islamic fintech, often referred to as “Fintech Syariah,” aims to provide innovative financial products and services in compliance with the ethical and moral guidelines established by Islamic law Shariah. This adherence to the Shariah principles differentiates Islamic fintech from conventional fintech, particularly in its prohibition of interest (riba), uncertainty (gharar), gambling (maysir), and unethical investments (haram).

Regulation and supervision are integral to Islamic fintech’s functioning in Indonesia. The Indonesian Financial Services Authority (OJK) plays a central role in supervising and regulating fintech activities including Islamic fintech. The OJK has issued several regulations and policies to enhance supervision and customer protection, such as OJK Regulation Number 77/POJK.01/2016 and OJK Regulation Number 13/POJK.02/2018. Additionally, Islamic fintech operates within the framework of fatwas issued by the National Sharia Council of the Indonesian Ulema Council (DSN MUI), addressing matters such as Shariah-compliant electronic money, financing services, and securities through technology-based fund management services. The involvement of DSN MUI’s in ensuring Shariah compliance is a critical aspect of Islamic fintech oversight. Collaboration among regulatory bodies, including DSN-MUI and OJK, is pivotal for formulating and implementing effective regulations to maximize the benefits of Islamic fintech. Islamic fintech offers Indonesia a range of advantages, including enhanced financial access, Sharia compliance, and economic empowerment. By facilitating easier access to finance for micro, small, and medium enterprises (MSMEs), promoting financial inclusion, and encouraging entrepreneurship, Islamic fintech contributes to the country’s economic development and resilience during financial crises such as the COVID-19 pandemic (Muzdalifa and Rahma, 2018).

However, Islamic fintech faces several challenges in Indonesia. These include inadequate regulations specific to Islamic fintech lending; complex permit procedures that divide fintech registration between OJK and Bank Indonesia; and consumer protection issues related to awareness, transparency, data security, dispute resolution, and the risk of misuse. The legal cases and challenges within the Islamic fintech industry can influence regulations and operations. These cases may compel regulators to strengthen the rules and regulations to protect consumers and ensure Shariah compliance. The role of law in shaping regulations supporting growth and innovation cannot be understood. A thoughtful and progressive legal framework is essential for creating a conducive environment for Islamic fintech in Indonesia. Addressing consumer protection challenges requires a multifaceted approach that includes regulatory measures, industry self-regulation, consumer education, and technological safeguards. Ensuring that consumers are well informed, have access to dispute resolution mechanisms, and are protected from data breaches and non-compliance with Shariah principles is vital for building trust and confidence in the Islamic fintech sector in Indonesia.

To further develop Islamic fintech in Indonesia further, the country can draw lessons from other nations with established Islamic fintech industries. This includes continually evolving regulatory frameworks that maintain a commitment to Shariah compliance while accommodating innovation. Clear regulatory guidelines, such as those in the UAE, can attract investment and provide a conducive environment for startups. Indonesia can also learn from Malaysia’s inclusive policies, Saudi Arabia’s efforts to strike a balance between innovation and Shariah adherence, and the UAE’s initiatives to establish itself as a global Islamic fintech center. Additionally, exploring ethical finance options alongside Sharia-compliant offerings, as in the United Kingdom, can cater to diverse customer bases. In conclusion, Islamic fintech in Indonesia is a nexus of finance and technology, with tremendous potential for growth and financial inclusion. Effective regulations, collaboration among regulatory bodies, and a focus on consumer protection are critical for harnessing this potential. Learning from global experiences and adopting best practices can help Indonesia create a conducive legal environment for Islamic fintech, while ensuring compliance with Shariah principles and enhancing consumer rights and protection.