This paper examines the growth of Islamic microfinance in Indonesia. It identifies challenges and urges decision-makers, government agencies, and donor organizations to examine various opportunities for the development of a healthy Islamic financial sector in Indonesia. The paper states that Islamic finance has been more of a political than an economic project in Indonesia, with a lack of broad popular demand and Islamic banking expertise. Experience differs by sub-sector. Commercial banks have been successful in training young and dynamic people, but lack microfinance experience. Islamic rural banks have failed to provide efficient and dynamic microfinance services. Unsupervised Islamic cooperatives are a threat to members savings. The paper states that Islamic microfinance can be promoted by assisting Islamic commercial banks to establish units with Islamic microfinance products and by reassessing the challenges and opportunities of Islamic rural banks and cooperatives. Recommendations include:
Commercial banks should learn about setting up branch networks of Islamic MFIs from the experience of successful microfinance strategies such as that of the Banka Rakyat Indonesia;
Islamic rural banks should be revamped;
Islamic cooperatives need a system of prudential regulation, mandatory auditing, and effective supervision by an appropriate financial authority.