JAKARTA • Indonesia's ambitions to rival Malaysia as an Asian Islamic finance hub are shrinking along with its syariah-compliant banking assets.

While Indonesia is host to the world's biggest Muslim population, Malaysia's government has been more aggressive in supporting the industry and announced further tax breaks for sukuk or Islamic bonds in last Friday's Budget.

The Jakarta-based Financial Services Authority said the nation's Islamic banking assets fell 27 per cent to 200 trillion rupiah (S$20.5 billion) in the first eight months of this year from a year earlier, while those of its neighbour rose 13.7 per cent to a record RM672.6 billion (S$219.8 billion).

Malaysia's corporate Islamic debt sales are measured in the billions of dollars, compared with millions in Indonesia, where OCBC Al-Amin Bank said the industry is too focused on retail banking, leaving it more vulnerable to the global slowdown.

President Joko Widodo was forced to reshuffle his government amid policy U-turns and wrangling among regional authorities as he seeks to make good on a pledge to boost the economy in his first year in office. "We have yet to see the incentives that Indonesia said it was planning at the end of last year," said Mr Abas A. Jalil, chief executive officer at Amanah Capital Group in Kuala Lumpur. "The continuation of incentives for Islamic banking in Malaysia given by the government is a key factor for the industry's growth."

While both countries have infrastructure investment programmes, Malaysia is a step ahead in encouraging sukuk sales to fund projects. It broadened tax exemptions to environmentally friendly syariah-compliant bonds in its 2016 Budget, while Indonesia has yet to reveal similar incentives as part of an industry road map.

Mr Joko has put in place a 5,519-trillion-rupiah development programme to build roads, railways and power plants, but companies in South-east Asia's biggest economy have sold the equivalent of only US$81 million (S$113 million) of local-currency sukuk this year.

Issuance from its neighbour this year totals US$8 billion and includes syariah-compliant bonds in support of Prime Minister Najib Razak's US$444-billion investment plan.

Eyes will be on a stimulus package due next month from Indonesia's Financial Services Authority. It may include the easing of sukuk rules and the promotion of the nation's syariah stock index to encourage greater participation, according to an Oct 19 report in Investor Daily Indonesia, citing the authority's chairman, Mr Muliaman Hadad.

Islamic lenders are also struggling to lure Indonesians, who tend to choose bank deposits using economic parameters more than religious ones, which means they have to offer higher returns, according to PT BNI Syariah.

"We estimate only 20 per cent of our clients choose to bank with us out of principle or for religious reasons, while the other 80 per cent are more pragmatic and would seek higher rates even at conventional banks," said Imam Teguh Saptono, director at Jakarta-based BNI Syariah. "So most of our clients are sensitive to interest-rate moves."

While Malaysian banks are also facing a tough operating environment, the country's Islamic banking assets climbed 8 per cent in the first six months of the year, compared with 4 per cent for conventional ones, said Mr Alhami Abdan, head of corporate strategic planning at OCBC Al-Amin Bank.

Both nations have also faced obstacles in creating a syariah megabank with the financial clout to compete with bigger rivals and expand an industry estimated at US$2 trillion globally.

"The general sentiment is that it will be a challenging period for the Islamic finance industry worldwide next year," said Mr Alhami. "Indonesia's market still possesses good potential to continue its syariah banking growth."

BLOOMBERG