Effect of bank performance and macroeconomic conditions on productivity of Islamic banks in Indonesia

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More than 300 Islamic banks are operating globally, with a total asset value of more than US $ 1.50 trillion. These banks are projected to continue to proliferate in the countries where they operate due to the increase in the Muslim population, which is predicted to reach 2.3 billion by 2030. Although Islamic finance has not significantly penetrated the banking market in western countries, serving the banking market needs of a sizeable Muslim population is an essential opportunity for future growth. Islamic banking is believed to emphasise transparency and avoidance of undue risk and appeared to be more isolated from the crisis than conventional banking. Quoting Khan and Bhatti (2008), Southeast Asia is one of the centres of Islamic banking and finance. Islamic economics and finance have had a great influence on the economic growth of these countries in the last decade. At present, Islamic banks must also be able to compete with conventional banks. In order to improve the competitiveness of the sharia bank industry, it is necessary to operate efficiently to achieve optimal profit and productivity.

Rani et al. (2017) analysed a productivity comparison between Islamic and conventional banks in Indonesia during the 2008-2016 period, and also used determinant variables to observe their effect on productivity. The results of the study revealed that the productivity of Islamic banks during the study period had decreased due to the low level of technological innovation and a stagnant level of efficiency. Measuring the performance of Islamic banking is needed to determine the level of efficiency performance among Islamic banks. The formulations used to measure efficiency and productivity involve many variables which are also needed to overcome the problem of determining what factors to choose because they can represent all aspects of the company.

Total Factor Productivity (TFP) is a multifactorial measurement that is intended to measure the account using multiple input factors in the production process and is considered more suitable for measuring performance and making comparisons between firms over time. TFP is applied to measure the relationship between output and input. This relationship is expressed as the ratio of the output index to the aggregate input index. If the ratio increases, more output can be produced using a given number of inputs, or some outputs can be produced using fewer inputs. The study used the MPI quantitative method measured by DEAP 2.1 to estimate TFPCH, in line with Coelli (1996). Furthermore, TFPCH can be decomposed into TECHCH and EFFCH.  The intermediation approach was adopted to determine the input and output variables used by considering the function of banking institutions as intermediaries for channelling funds for investors and as fund collectors in the form of deposits from depositors.

The data were gathered from annual reports, specifically the balance sheets and income statements of eight Islamic banks operating in Indonesia during the period 2011-2018. These were available online on the websites of the Islamic banks sampled and the website of Bank Indonesia. The bank-specific variables used included Quality Management (MQ), as measured by total non-operational costs to total assets; Diversification (DIV), measured by total non-operating income to total assets; Credit Risk (RISK), measured by the ratio of loan provision to total loans; Return On Equity (ROE), the return on capital ratio; the Financing to Deposit Ratio (FDR), the ratio of financing/loans to deposits; and Liquidity (LIQ), as measured by cash to total assets. The macroeconomic variables consisted of four variables, which were used as proxies for the economic conditions of the Indonesian state, namely Gross Domestic Product (GDP), as measured by nominal GDP; Inflation (INFLS), measured using the GDP deflator; Value (KURS) measured by the exchange rate of the rupiah against the USD; and the BI Rate (BIRATE), as measured by the BI 7-day (Reverse) Repo Rate.

The productivity performance of the Islamic banking industry in the 2011-2018 period reached an efficient and productive state in the implementation of its operational activities. Productivity growth (TFPCH) was +5.3 percent (1,053), a figure which illustrates that company performance, especially in the Islamic banking industry, was able to manage and utilise available inputs to achieve maximum output levels. Productivity growth was mainly related to technological or technical changes, with TECHCH growth improving by +4.9 percent (1,049) in Indonesian Islamic banks. The use of old-fashioned technology without innovation will result in a decrease in bank performance.

With the development of information and communication technology, the product marketing process will be beneficial in reaching all potential customers of Islamic banks. For this reason, it is hoped that banks can periodically update their technology by following related developments. EFFCH decomposition in this period occurred due to an increase in PECH of +4.5 percent (1,045). The GDP and BI rate variables are determinants of the TFPCH of Indonesian Islamic banks during the 2011-2018 period. The influence of these two macroeconomic variables cannot be separated from the role of the banking industry in Indonesia, which is considered to be the driving force of the national economy.

Author: Siti Annita Otaviya dan Lina Nugraha Rani

Full article can be viewed on: http://jimf-bi.org/index.php/JIMF/article/view/1146

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