Unpacking the 'Mathematics' of Growth: How Islamic Banking Can More Productively Spur GDP

In recent years, the grand narrative of the Indonesian economy has revolved around one ambitious target: escaping the middle-income trap and soaring to become a developed nation. The government has been busy rolling out the red carpet for investment, drafting various omnibus laws, and building massive infrastructure from Sabang to Merauke. However, a macroeconomic puzzle is often overlooked in public discourse, even though it holds the vital key to our prosperity. Indonesia’s fundamental economic problem today is not merely a lack of capital, but rather the low productivity of that capital itself. This weak link is clearly reflected in the nation’s persistently high Incremental Capital Output Ratio (ICOR). Simply put, ICOR is an indicator that measures how much additional capital (investment) is needed to produce one additional unit of output (economic growth). A higher ICOR figure signifies a more inefficient economy. This is where Islamic banking can step in, not just as a complement to the national financial industry, but as a substantive solution to boost national investment efficiency through increasing Total Factor Productivity (TFP).

To understand why our growth ‘mathematics’ is problematic, let us examine the data. Currently, Indonesia’s ICOR figure is stuck at around 6.09 percent. This is relatively high compared to other ASEAN countries, which average between 3 and 4 percent. Mathematically, an ICOR of 6.09 percent means that Indonesia requires investment equivalent to 6.09 percent of its GDP just to generate 1 percent of economic growth. This high ICOR is a danger signal indicating a misallocation of capital. Financial capital flows have tended to pour into non-productive or speculative sectors, or become trapped in capital-intensive projects with minimal multiplier effects for the wider community. Why does this happen? Conventional commercial financial institutions naturally operate on a collateral-based lending principle. Projects are funded not based on the value they add to the real sector or their operational efficiency, but on the security of the assets the client can pledge. As a result, innovative business actors who lack collateral—such as millions of MSMEs and farmers—are excluded from access to capital. Capital accumulates in elite circles that are capital-intensive but saturated in productivity, while the capital-starved real sector experiences a drought.

Islamic banking in Indonesia holds the golden key to dismantling this inefficiency. However, one absolute condition must be met: the Islamic banking industry must dare to conduct self-criticism and change the dominant landscape of its financing contracts. To date, the portfolio of Islamic banking financing is still dominated by fixed-income contracts rather than profit-and-loss sharing. This fixed income comes from sale-based contracts (murabahah) or musyarakah mutanaqisah (MMQ) hybridised with ijarah (where fixed income is derived from the lease contract). Although legally valid, the substantive character of these fixed-margin contracts resembles conventional debt. This approach does not fully differentiate Islamic banks from conventional banks in terms of collateral-based risk mitigation. Islamic banking will be able to contribute maximally to lowering the ICOR if it dares to shift its main growth engine to Profit-and-Loss Sharing Contracts (PLS), such as mudharabah and musyarakah. Why is this shift transformative? When an Islamic bank uses PLS, the business paradigm changes completely from collateral-based to feasibility-based. Because the bank shares the risk and is entitled to a portion of the client’s actual profit, it will naturally select projects based on their real business feasibility, growth prospects, and operational efficiency. The bank is no longer a passive ‘debt collector’ but becomes a strategic partner ensuring that every rupiah of capital disbursed works with the highest productivity. This mechanism automatically filters out inefficient investments and directs national capital to the most needed and most productive sectors.

One of the main pillars behind low capital efficiency is low Total Factor Productivity (TFP)—the portion of output growth not caused by increases in capital and labour inputs alone, but by factors such as technology, management capacity, and organisational efficiency. This is where the inherent advantage of the PLS-based Islamic banking business model lies. Because the bank’s profit depends entirely on the actual profit earned by the client, the institution has a strong economic incentive to intervene in productivity. Islamic banks cannot afford a ‘fire and forget’ strategy—disbursing financing and leaving the client to struggle alone. They are compelled to move beyond the traditional role of financial intermediary and enter the realm of client capacity building, particularly for MSME and agricultural sector players, through three tactical steps: facilitating technology adoption by encouraging the penetration of digital finance, digital marketing, and the use of modern production tools to cut operational costs; enhancing management skills by providing training in accountable business governance, supply chain management, and risk mitigation techniques.