Efficiency Analysis of Islamic Banks in Indonesia*

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Nor Halida Haziaton Mohd Noor, Wan Yusrol Rizal Wan Yusof, Mohammed Hariri Bakri, Nor Raihana Asmar Mohd Noor, Nurazilah Zainal

Abstract

After the economic crisis of 1998, Islamic banking experienced significant growth in Indonesia. With the enactment of Law Number 21, Year 2008 concerning Sharia Banking issued on July 16, 2008, the development of the national Islamic Banking industry has an increasingly adequate legal basis and will encourage its growth even faster. Although there have been considerable developments in the Islamic banking sectors worldwide, very little attention has been given to the efficiency of its operations. Apart from focusing on the Islamic banks’ expansion, it is important to examine their efficiency level to ensure sustainability and competitiveness. This research is conducted to investigate the technical efficiency of Islamic banks in Indonesia. The sample consists of 10 banks in Indonesia from 2011 to 2016. This study employed the Data Envelopment Analysis (DEA) method to measure banks’ efficiency with a  specification of input and output variables. An overall view of the results indicates 85% for technical efficiency, 97.3% for pure technical efficiency, and 86.1% for scale efficiency. The majority of Islamic banks have been operating at the right scale of operations and keep increasing or decreasing which indicates its efficiency of performance. The inefficiency of Indonesian Islamic banks shows that it has not been optimal in managing output compared to inputs, therefore it is necessary to enlarge the customer base of financing products in accordance with shariah principles.

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