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Islamic banking and finance has gained greater recognition throughout the world since its inauguration as a contemporary finance subfield in the mid-1970s. Indonesia, the country with the largest Muslim population in the world, established its first Islamic bank in 1991. Presently, there are 11 Islamic commercial banks (BUS), 24 Islamic windows (UUS) and 163 Islamic rural banks (BPRS) operating within Indonesia. However, despite the upward trend in the growth of Islamic finance in Indonesia, its size and growth has been rather constrained when compared with other countries. In particular, Indonesia has much larger Muslim population than that of Malaysia yet the growth of Islamic banking of Indonesia lags behind that of Malaysia. The growth of Islamic banks within Indonesia faces many obstacles that limit their outreach and constrains their level of market penetration. The growth of Islamic banks is influenced, on one the hand, by practices and policies employed by Islamic banks, and on the other, by customers' knowledge regarding Islamic banks. Therefore, this study examines the causes and consequences of policies adapted by Islamic banks in Indonesia and compare these with conditions in Malaysia. Access to finance by Small and Medium Enterprises (SMEs) is recognised as a major issue for developed and emerging economies and Indonesia is no exception. However, it is suggested that Islamic banks are in a better position to meet the needs of SMEs. Theoretically, the profit and loss sharing (PLS) principles confers advantages to Islamic banks over conventional banks as IBs share risk with their borrowers, and lend money on the strength of the proposal and not on the basis of the collateral, as often is the basis for conventional bank lending. Risk sharing is preferred by SMEs which commonly do not have financial information or assets for collateral. In the context of Indonesia where the number of SMEs is large, there is a potential for Islamic banks to grow. Therefore, this research investigates lending practices, policies and access to Islamic bank financing by SMEs in Indonesia. This thesis examines the supply and demand side experiences and the obstacles that may hinder SME access to finance from Islamic banks. To examine the experiences of borrowers and Islamic Bank lenders, the study used triangulation, a combination of quantitative and qualitative methods, to analyse the data and to test the hypotheses. Quantitative data obtained from questionnaires was used to investigate the experiences of SMEs regarding the theory and practice of Islamic banks and to examine whether there was a financing gap. To corroborate the findings, interviews with SME owners and bank managers were undertaken and analysed through the case study methodology. Furthermore, interviews with Islamic bank managers were analysed using Interpretative Phenomenological Analysis to investigate their experiences in assessing the loan applications of SMEs. The empirical analysis undertaken in this study demonstrates: (i) the number of Islamic banks (in terms of either assets or market share in Indonesia) is small when compared to that of conventional banks, (ii) access to Islamic banks is motivated by ii a combination of religious and profit considerations, (iii) similar to conventional banks, collateral remained the main obstacle for SMEs in accessing funds from Islamic banks, (iv) a financing gap exists for SMEs exists in Indonesia, and (v) customer mind-set is a crucial barrier in the penetration of Islamic banks into the market.
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