The impact of “Islamic banks only” policy on financial and economic development in Indonesia’s Aceh region

Purpose This paper aims to evaluate the impact of an “Islamic bank only” policy in the Aceh region, Indonesia, which allows only Islamic banks to operate in the region starting from 2019, on the region’s financial and economic developments. Design/methodology/approach This paper use the synthetic control method (SCM) to measure the causal impact using data from the other 33 provinces in Indonesia, appropriately weighted to form a control region mimicking Aceh without the policy. Robustness is tested via placebo and leave-one-out analyses. This paper supplements this with a discussion of comparative natural experiment insights from other provinces and countries. Findings The findings indicate that the Islamic banks-only policy has had a significant negative impact on short-term financial development in the region. The policy adversely affects all four financial development outcomes – the Gross Regional Domestic Product (GRDP) of the financial sector, the ratio of credit to GRDP, the ratio of investment to GRDP and total savings. However, among the three economic development outcomes analyzed, only labor income has shown some negative impact of the policy, while the poverty rate and overall GRDP has not yet been affected. Practical implications Given the legally entrenched nature of the policy, the findings point to the urgent need for complementary, strengthening measures. Recommendations include incentivizing the expansion and product diversification of Islamic banks – particularly into risk-sharing instruments – enhancing financial literacy, attracting new Islamic financial entrants and developing targeted credit programs for rural and MSME sectors to mitigate the observed negative effects on credit and savings. Originality/value To the best of the authors’ knowledge, this is the first study to apply the SCM to assess the causal impacts of implementing an Islamic bylaw policy on the financial and economic performance of a specific region in a large developing country. It integrates this with comparative lessons from other Islamic banking transitions.