Fl Fluctuations in foreign exchange (forex) rates represent one of the main challenges in the global financial system, significantly affecting national economic stability, including the banking sector. Unexpected currency movements can impact business continuity, cash flows, asset valuations, and investment returns. For the Islamic banking industry, this challenge becomes even more complex because managing exchange rate risk cannot be conducted using conventional derivative instruments, which often involve speculative elements (maysir), uncertainty (gharar), or interest (riba)—all of which are fundamentally prohibited in Islamic law.

As one of the countries with the largest Muslim population in the world and a progressively growing Islamic finance sector, Indonesia faces significant challenges in managing exchange rate risks. According to data from Bank Indonesia, the average monthly volatility of the Indonesian rupiah (IDR) against the US dollar (USD) between 2020 and 2024 ranged between 1.8% and 3.2%, with significant spikes during the COVID-19 pandemic and global geopolitical instability. This situation highlights the urgency of providing risk mitigation instruments that are not only economically effective but also Sharia-compliant.

The rapid growth of Islamic banking in Indonesia has encouraged active involvement in cross-border financing, international trade, and Sharia-based treasury activities. However, this expansion has also increased exposure to foreign exchange risk. Without the implementation of appropriate Sharia-compliant hedging mechanisms, both financial institutions and corporate clients may suffer substantial losses. In conditions of sharp rupiah depreciation, the absence of risk mitigation strategies may negatively affect the resilience of the Islamic financial system, particularly amidst global uncertainty[1].

In the context of forex risk management, there are three main types of exposures faced by companies and financial institutions. First is transaction exposure, which arises when exchange rate movements affect payments or receipts in foreign currency contracts, potentially leading to unforeseen losses or gains. Second is economic exposure, which refers to the impact of exchange rate fluctuations on cash flows and the competitiveness of firms in the medium to long term. Third is translation exposure, which influences how multinational companies present consolidated financial statements that involve multiple currencies[2].

As Indonesian Islamic banks expand their international operations, these risks become increasingly relevant. However, due to the limited availability of Sharia-compliant hedging instruments, exposure to foreign exchange risk remains relatively high. In highly volatile currency environments, the lack of hedging instruments can lead to business uncertainty, unexpected financial losses, and a decline in investor confidence in the stability of the Islamic financial system.

Several previous studies have attempted to explore the use of Islamic hedging instruments in Indonesia. For example, Istutik et al. examined the implementation of forward contracts in Indonesian companies and concluded that such instruments are effective in reducing exchange rate risk[3]. Suryani and Fathoni compared the application of Islamic hedging between Indonesia and Malaysia and found that Malaysia is more advanced in terms of instrument diversity and regulatory support[4]. Other studies, such as those by Samsudin et al., emphasize that the implementation of hedging in Indonesian Islamic banks is still limited and requires strengthening in terms of regulation and outreach[1]. Muhtadi et al. also highlight the importance of regulatory and infrastructure readiness to support the national implementation of Islamic hedging mechanisms[2].

Although these studies have made important contributions, no systematic review has yet evaluated the combined effectiveness of the three main Islamic hedging instruments—wa’d-based forward, cross currency swap (CCS), and natural hedging—in the specific context of Indonesian Islamic banking. Most of the existing literature remains descriptive, limited to case studies, or focused solely on legal aspects without presenting a comprehensive synthesis of recent academic trends.

Islamic hedging is defined as a risk protection mechanism that addresses foreign exchange risk without involving speculation, gambling, or practices contrary to Islamic principles. Within the Sharia framework, hedging is permissible as long as it does not involve excessive speculation or uncertainty. According to Al-Suwailem, Islam does not encourage loss or harm in wealth management; therefore, risk mitigation actions such as hedging are ethically acceptable[5]. Bahri also asserts that the primary objective of hedging in Islamic economics is to neutralize risk, not to gain from market fluctuations[6]. DSN-MUI Fatwa No. 96/DSN-MUI/IV/2015 serves as a formal guideline for Islamic hedging transactions, including contract structures such as ‘aqd al-tahawwuth al-basith (simple contracts) and ‘aqd al-tahawwuth al-murakkab (complex contracts), which involve combinations of spot and forward transactions with physical currency delivery.

Commonly used Islamic hedging instruments include wa’d-based forward, a unilateral promise between the Islamic bank and the client to perform a foreign exchange transaction at a fixed rate in the future. Meanwhile, Cross Currency Swap (CCS) involves the exchange of two currencies using Murabahah and Wa’d contracts to avoid elements of riba and speculation. The natural hedging strategy is used by companies to balance assets and liabilities in the same currency. Other instruments, such as Islamic Profit Rate Swap (IPRS), are more commonly used in Malaysia, and Sharia-based options using Kafalah or Wakalah contracts are also being developed. Although these instruments conform to Sharia principles, challenges remain, including low market liquidity, lack of regulatory standardization, and relatively high transaction costs

This study employs a Systematic Literature Review (SLR) approach to evaluate the implementation of Islamic hedging in managing foreign exchange risk in Indonesian Islamic banks. The research is qualitative descriptive in nature, using a systematic review of scholarly literature to identify patterns, gaps, and topic developments within a specified time frame.

The population of this study consists of all scholarly articles discussing the implementation of Islamic hedging within the context of Islamic banking in Indonesia. The sample was selected using inclusion and exclusion criteria. The selected articles include both national and international journals published between 2016 and 2023, focusing on Islamic hedging practices in terms of regulation, instruments, and implementation challenges.

Data collection was conducted by identifying key search terms based on the PICOC framework (Population, Intervention, Comparison, Outcome, Context). The search process used keyword combinations such as “Islamic hedging,” “Islamic bank,” “foreign exchange risk,” and “hedging syariah.”

Research questions are formulated to ensure that the systematic review remains focused. These questions are developed using the PICOC criteria: Population, Intervention, Comparison, Outcomes, and Context[7]. Table 5 presents the PICOC structure for the research questions related to the Systematic Literature Review: Implementation of Sharia Hedging in Managing Foreign Exchange Risk in Sharia Banks.

The selected primary studies were extracted, and their data were collected to contribute to answering the research questions in this study. A data extraction form was designed to collect the necessary information from the primary studies to address the research questions. The properties were identified based on the research questions and the analysis conducted by the researchers. Four key properties were used to answer the research questions, as shown in Table 7. The data extraction process was carried out iteratively.

Table 7.

This study provides a specific contribution in identifying the effectiveness of Sharia-compliant hedging instruments and the challenges faced by Islamic banks in managing foreign exchange risk. By analyzing the comparison between Indonesia and Malaysia, the study highlights the need for enhanced regulation, product innovation, and strengthening of the Islamic financial market.

The practical implication for the industry is that Islamic banks can adopt a more diverse range of hedging instruments to improve the effectiveness of foreign exchange risk management. In addition, business actors and exporters can utilize Sharia-compliant hedging tools to increase certainty in international transactions, while Islamic financial institutions need to intensify awareness and education efforts regarding the benefits and mechanisms of Sharia-compliant hedging for customers and investors.

In terms of regulation, Bank Indonesia and the National Sharia Council (DSN-MUI) are advised to adopt more adaptive regulatory frameworks that support the development of more liquid Sharia-compliant hedging instruments. Moreover, financial product innovation in Islamic banking should be encouraged, including the development of new instruments such as the Islamic Profit Rate Swap, which has been successfully implemented in Malaysia. International collaboration is also necessary—Indonesian Islamic banks should strengthen partnerships with global Islamic banks to improve liquidity and access to a wider variety of hedging instruments.

By implementing these measures, Sharia-compliant hedging will continue to grow and has the potential to become a key instrument in financial risk mitigation within the global Islamic banking industry.

The author would like to express sincere gratitude to the State Islamic University of North Sumatra for the facilities and academic guidance provided throughout the writing of this article. Appreciation is also extended to the reviewers and editors of the UMSIDA Journal for their constructive feedback and corrections, as well as to all parties who have contributed, directly or indirectly, to the completion of this research.