Credit Risk Management and Islamic Banking Performance
Evidence from Indonesia
Dedi Supiyadi
1
, Deddy Mulyadi
2
, Merry Fithriani
1
, Syaiful Syaiful
1
, Zulfikar Ikhsan
1
and Luthfi
Rahman
1
1
Universitas Pendidikan Indonesia, Jl. Dr. Setiabudhi 229, Bandung, Indonesia
2
STIA LAN Bandung, Jl. Cimandiri No. 34-38, Bandung, Indonesia
Keywords: Islamic Banking, ROE, Credit Risk, CAR, Bank Size, Liquidity Risk, Inflation.
Abstract: The growth of Islamic banking in Indonesia plays an important role for the economic growth, the growth of
Islamic banking itself is inseparable from the credit risk that determines the performance of the banking as a
whole. This study aims to determine the credit risk and performance of Islamic banking in Indonesia that are
listed in Indonesian Stock Exchange in 2007 – 2016. We use the secondary data obtained from the Indonesian
Stock Exchange and the annual reports and then we analyses the data by using multiple linear regressions.
The result of the study shows that performance of Islamic banks in Indonesia is influenced by Credit Risk,
Capital Adequacy Ratio, Company Size and Liquidity Risk. The study finds that credit risk and liquidity risk
have a positive effect while Capital Adequacy and firm size have a negative effect. Furthermore, the study
finds that inflation has insignificant effect on performance of Islamic banking in Indonesia. Based on the
studies, Islamic banks should increase the capital adequacy, and increase the company's assets through the
bond, increase the number of shares or other forms of financing. The need for external and internal monitoring
of debtor. Internal control is conducted by conducting intensive control over the process of disbursement of
credit funds. While the external control is done by monitoring and action the use of credit funds effectively
and efficiently by Islamic banking to customers. With the two aspects of control is expected to reduce the
credit risk of Islamic banking.
1 INTRODUCTION
Nowadays sharia banking is growing very fast in both
Muslim countries and non-Muslim countries (Azmi,
2017), with total assets of US $ 2,293 trillion,
consisting of 75% of Sharia Bank assets, 15% sukuk,
4% funding, 1% takaful and microfinance and 4%
other fields (GIFR, 2016). The banking system in
Indonesia is largely a conventional one that is not in
accordance with the Sharia principles. Indonesia as
the largest Muslim country in the world, requires a
banking system based on Sharia principles. Islamic
banking is an alternative one, where guarantee
interests free transactions and in accordance with
Islamic laws. Sharia is the origin and basis of Islamic
banking, and incorporates Islamic laws and
jurisprudence (Saiti et al., 2017). Based on statistical
data, the number of Islamic banks in Indonesia until
2016 were 199 banks consisting of 13 Islamic
Commercial Banks, 21 Islamic Business Units and
165 BPR sharia around Indonesia (OJK, 2016).
Competition in the financial industry and banking
in Indonesia is very tight, and the level of high
complexity, greatly affects the performance of banks
and increases the risk. Inadequate management,
insufficient lending to customers, and capital that
does not cover the risks faced by banks leads to a
decrease in bank performance. The decline in bank
performance can reduce the trust of society, investors,
business and government. The company must
perform an improvement. One indicator of Islamic
banking performance is profitability, and the higher
the level of profitability shows the best performance
of the banking.
The proxy used to measure profitability are ROE
(return on equity) and ROA (return on asset), these
ratios are the right to measure the performance of
Islamic banking. The performance of Islamic banking
will determine the sustainability of the company,
Supiyadi, D., Mulyadi, D., Fithriani, M., Syaiful, S., Ikhsan, Z. and Rahman, L.
Credit Risk Management and Islamic Banking Performance - Evidence from Indonesia.
In Proceedings of the 1st International Conference on Islamic Economics, Business, and Philanthropy (ICIEBP 2017) - Transforming Islamic Economy and Societies, pages 193-199
ISBN: 978-989-758-315-5
Copyright © 2018 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved
193

provide certainty to investors and provide shareholder
returns. Banking industry has an important role in
economic growth (Imran et al., 2012), both
conventional and Islamic banking have the same goal
that is seeking profit.
Study on commercial bank performance has been
largely done by previous researchers, but the study on
Islamic banks is still lack of literature, especially in
developing countries such as Indonesia; (Zarrouk et
al., 2016) found evidence that the profitability of
Islamic banks is largely determined by cost
effectiveness, asset quality and capital level, the study
also found that non-financial activities increase the
profitability of Islamic banks, no difference
determinant between conventional and Islamic
banks. According to (Ramlan and Sharrizat, 2016)
Islamic banks are more profitable than conventional
banks, and more efficient in managing credit risk,
bank size and customer growth are the most important
factors in improving banking performance (Hassan,
2009).
The study (Kayode et al., 2015) found that credit
risk negative effects on banking performance, the
proxy used is ROA, and increased credit risk reduces
profitability and decreases bank performance,
(Kodithuwakku, 2015) found that Loan provision to
Total Assets (LP/TL), Loan Provision to Non-
Performing Loans (LP/NPL), Loan Provision to Total
Assets (LP/TA) and Non-Performing Loans to Total
Loans (NPL/TL) significant effect on banking
performance.
According study (Alharthi, 2016), he found that
credit and capital risk affect profitability negatively
and significantly (ROA and NIM), Bank size
positively and significantly affects profitability (ROA
and NIM), while loan intensity (negative in case of
NIM), deposit ratio (positive), and foreign ownership
(negative) have no significant effect on profitability.
GDP macroeconomic variables are negatively and
significantly correlated with profitability (ROA and
NIM), as well as for market capitalization, except
NIM.
Based on the previous studies, the main objective
of this study was to analyze the impact of credit risk
and the factors affecting the performance of Islamic
Bank in Indonesia. The study is expected to
contribute to the enrichment of the literature to fill
Islamic Management, business & philanthropy
research gaps and as empirical evidence and reference
for further research.
2 METHODOLOGY
The method used in this research is explanatory
research. The sample in this research is 13 Islamic
Banks listed on Indonesia Stock Exchange (BEI)
from 2007-2016.
The sampling technique used is purposive
sampling, the criteria for selecting the sample under
study are as follows: (a) Firms must be Islamic
Banking (b) Firms must be listed in the Indonesia
Stock Exchange for the period of 2007- 2016, (c)
Firms must issue financial statements continuously
during the period of 2007-2016, (d) Firms have went
go public (e) Firms must report financial statements
with rupiah as a currency unit.
This study uses secondary data taken from
quarterly report from Indonesia Stock Exchange and
OJK. In this study the variable dependent is Banking
Performance measured by ROE (Return on Equity),
while the independent variable in this study is Credit
Risk as measured by Non Performing Financing
(NPL), Capital Adequacy (CAR) (Alshatti, 2016),
SIZE measure the total assets (Abiola and Olausi,
2014); (Ongore and Kusa, 2013); Liquidity Risk
measured by Cash & Cash Equivalent to Total Assets
(Almazari, 2014) and inflation (Zarrouk et al., 2016).
This study was adopted from the study (Ramlan
and Sharrizat, 2016), (Abiola and Olausi, 2014),
(Jara‐Bertin et al., 2014), (Idris et al., 2011), by
using multiple regression analysis technique, this
research done by using econometric equation as
follows:
= + + + +
+ + (1)
Where:
Y = Performance (ROE)
CR = Credit Risk (NPF)
CAR = Capital Adequacy Ratio
SIZE = Bank Size
LQR = Liquidity Risk
INF = Inflation
β
0
= Constanta
β
1
…β
n
= Regression Coefficient
ε = error
2.1 Conceptual Framework
Conceptual framework is theoretical concepts that
will be used as a reference in research, built from the
results of previous research. In this study, credit risk
(NPL), Capital Adequacy Ratio (CAR), Bank Size,
Liquidity Risk and Inflation Index as Independent
variable, and Return on Equity (ROE) as Dependent
variable.
ICIEBP 2017 - 1st International Conference on Islamic Economics, Business and Philanthropy
194

Figure 1. Conceptual Framework.
Based on the conceptual framework, the
hypothesis of this research is:
= There is a positive impact between Credit Risk
on Islamic Bank Profitability
= There is a positive impact between Capital
Adequacy Ratio on Islamic Bank Profitability
= There is a positive impact between SIZES on
Islamic Bank Profitability
= There is a positive impact between Liquidity
Risk on Islamic Bank Profitability
= There is a negative impact between Inflation on
Islamic Bank Profitability
3 RESULTS AND DISCUSSION
The assumption classic test is used to determine
whether the research model is feasible or not, which
is includes the test of normality, multicollinearity test,
and autocorrelation test. Normality test result in
Figure 2. The graph confirms that the regression
model obtained is normally distributed, where the
data distribution is around the diagonal line. The
results of multicollinearity test in Table 1. shows that
Credit Risk, CAR, Bank Size, Liquidity Risk and
Inflation variables have a tolerance value between
0.299 to 0.809 for all observation data, the value is
greater than 0.10 so it can be concluded that there is
no multicollinearity among independent variables,
this is reinforced by the value of VIF (variant inflation
factors) between 1.237 to 3.343, where the value is
less than 10, it can be stated that there is no
multicollinearity problem in the prediction model.
Autocorrelation test results in Table 6, Durbin
Watson value is 1.209, from the analysis results show
that the Durbin-Watson value is greater than the value
of dL is 1.235, thus there is no problem
autocorrelation. This study meets the classic
assumption, so it can be concluded that the research
free of multicollinearity and autocorrelation.
Table 1. Collinearity Statistics
Model
Collinearity Statistics
Tolerance
VIF
(Constant)
CR
.809
1.237
CAR
.450
2.221
SIZE
.299
3.343
INF
.741
1.350
LQR
.620
1.613
a. Dependent Variable: ROE
Descriptive statistical test is used to provide
general overview of each research variable as
describes in Table 2.
Figure 2. Normal P-P Plot.
Table 2 shows Descriptive statistic results. The
profitability of Islamic banks in Indonesia has a
minimum value of 0.05 and a maximum value of
0.54, the average profitability of Islamic banks is
0.196 or 19.6%, shows that the performance of
Islamic banks in Indonesia only 19.6% has not shown
maximum results, it effects on the performance of the
bank itself and for stakeholders. The average value of
liquidity risk of 0.15% means that Islamic banks in
Indonesia have low liquidity risk, liquid and very
healthy, thus Islamic banks in Indonesia have a very
good performance.
ROE
CR
CAR
SIZE
LQRISK
INF
Credit Risk Management and Islamic Banking Performance - Evidence from Indonesia
195

Table 2. Descriptive Statistic.
Minimum
Maximum
Mean
Std.
Deviation
CR
4.230
439.060
48.248
103.909
CAR
.110
.170
.144
.017
SIZE
117.000
169.000
153.550
13.739
INF
.03
.12
.059
.023
LQR
.000
.030
.015
.008
ROE
.050
.540
.196
.123
Inflation is a macroeconomic indicator that often
affects the economic performance, the result of the
study shows that the average inflation rate is 0.59%,
the condition of Indonesian economy with the
inflation rate in this study period does not affect the
performance of Islamic banks in Indonesia. The
average value of the bank size is 153.5%, which
means that Islamic banks in Indonesia have excellent
asset quality. The average value of CAR is 0.14%,
indicating that in order to maintain stability, Islamic
banks should be able to maintain capital adequacy of
0.14%, and otherwise it will affect overall banking
performance. The average value of credit risk shown
in the descriptive statistical analysis is 48.248%,
meaning that Islamic banks in Indonesia have a high
risk, but with high risk is directly proportional to the
level of banking performance, high risk high
profitability.
Table 3. Correlation Analysis.
CR
CAR
SIZE
INF
LQR
ROE
CR
1
.135
.126
-.224
.192
.093
CAR
.135
1
.706
**
.289
-.153
-.686
**
SIZE
.126
.706
**
1
.421
**
-.493
**
-.921
**
INF
-.224
.289
.421
**
1
-.224
-.422
**
LQR
.192
-.153
-.493
**
-.224
1
.608
**
ROE
.093
-.686
**
-.921
**
-.422
**
.608
**
1
**. Correlation is significant at the 0.01 level (2-tailed).
Table 3 shows the results of the correlation
analysis, finding two significant positive variables,
are Credit Risk and Liquidity, meaning that every 1%
increase in credit risk and liquidity risk will increase
Return on Equity by 0.093 (0.1%) and 0.608 (6.1%),
thus higher credit risk and liquidity risk will increase
the profitability of Islamic banks in Indonesia. CAR,
SIZE and Inflation show a significant negative
relationship, meaning that every 1% increase in CAR
will reduce profitability by 6.9%, as well as the bank
size each time the company expansion will reduce the
level of profitability because expansion requires a
large cost, for variable inflation as variables macro
economy also shows a negative relationship so that
every 1% inflation increase reduce the profitability of
Islamic banks by 4.2%, inflation reduces purchasing
power directly reduces the profitability of Islamic
Banks because customer more selective in fulfil its
needs only for most important needs.
Table 4. Regression Analysis.
Coefficients
a
Model
Unstandardized
Coefficients
Standard Coefficients
B
Std.Er
Beta
t
sig
(Cont)
1.331
.092
14.513
.000
CR
.000
.000
.177
3.243
.003
CAR
-1.159
.533
-.159
-2.174
.037
SIZE
-.007
.001
-.747
-8.330
.000
INF
.107
.306
.020
.348
.730
LQR
3.049
1.024
.186
2.979
.005
a. Dependent Variable: ROE
The results of a study of 12 Islamic banks in
Indonesia within the period of research from 2007 to
2016, found that credit risk significant positive effect
on profitability, the study support the previous study
conducted by (Abiola and Olausi, 2014),(Li and Zou,
2014), (MS and N, 2016), credit risk is the most
important factor to maintain the survival, growth and
bank performance. However, this study is in contrast
to research conducted by (Kayode et al., 2015);
(Kodithuwakku, 2015), (Alharthi, 2016) The results
of this study show that Islamic banking in Indonesia
has a high level of credit risk, therefore Islamic
banking needs to increase prudence in giving credit to
creditors, with five ways: Pricing the loan, Credit
Limits, Collateral or Security, Diversification, Credit
Credentials and Asset Securitization, by using 5C
approach are: Character, Capacity, Capital,
Condition, Collateral. (Heffernan, 2005). The high
credit risk is proportional to the magnitude of
profitability (MS and N, 2016).
Table 4 shows the capital strength and efficiency
of Islamic banks, found that CAR as an internal factor
affecting the profitability of Islamic banks in
Indonesia, the ROE is negatively influenced by the
CAR, this finding indicates that the level of capital
adequacy of banks is inadequate, thus negatively
affecting profitability, in other words banks with low
CAR are less profitable, these findings are in line with
previous studies by (Zarrouk et al., 2016).
Firm size describes company strength, and firm
size tends to generate high profitability (Hall and
Weiss, 1967). the study found that bank size had a
negative effect on profitability, this study contradicts
the study conducted by, (Hassan and Bashir, 2005),
(Alharthi, 2016), (Ben et al., 2017). This negative
influence indicates that large (small) banks tend to
earn large (small) profits, the study found that Islamic
banks in Indonesia are small banks, this finding may
also be caused by factors: bureaucracy, economic
conditions, politics and regulations in Indonesia
ICIEBP 2017 - 1st International Conference on Islamic Economics, Business and Philanthropy
196

which is less support the development of Islamic
banks. The study support previous studies conducted
by (Sufian and Habibullah, 2009).
Profitability is very sensitive to macroeconomic
conditions, in general high economic growth, tend to
improve bank performance. An indicator of
macroeconomic conditions that has the possibility of
increasing profitability is inflation. High inflation
raises interest rates, with rising interest rates
increasing bank profitability, the study finds that
inflation does not significantly affect the profitability
of Islamic banks in Indonesia, these findings are in
line with research by (Sufian and Habibullah, 2009);
(Khediri and Khedhiri, 2009); (Zarrouk et al., 2016).
The results of the study found a significant
positive liquidity risk to profitability, these findings
show that Islamic banks in Indonesia have a good
liquidity risk that can improve profitability, these
findings are in line with the study (Bassey and Moses,
2015); (Almazari, 2014).
Table 5. ANOVA Test.
ANOVA
a
Model
Sum of
Squares
df
Mean
Square
F
Sig.
1
Regression
.544
5
.109
76.246
.000
b
Residual
.049
34
.001
Total
.593
39
a. Dependent Variable: ROE
b. Predictors: (Constant), LIQRisk, CAR, CRISK, INF,
SIZE
Anova test is used to test the influence model of
Liquidity Risk, CAR, CRISK, INF, SIZE variable to
ROE. Table 5 shows F value 75.246 with significance
level 0.05 obtained significant value 0.000, hence H
rejected and H accepted. It can be concluded that the
performance of Islamic Bank in Indonesia is
influenced by Credit Risk, Capital Adequacy Ratio,
Company Size, Liquidity and Inflation Rate.
Table 6. Determination Coefficient
Model Summary
b
Model
R
R
Square
Adjusted
R Square
Std. Error of
the Estimate
D-W
1
.958
a
.918
.906
.03780
1.209
a. Predictors: (Constant), LIQRisk, CAR, CRISK, INF, SIZE
b. Dependent Variable: ROE
The coefficient of determinant is used to explain
the control variable to the dependent variable. The
greater the coefficient of determinant the better the
ability of the independent variable to explain the
variable Return on Equity. The determinant
coefficient value (R Square) shown in table 6, is 0.918
or 91.80%, the result of analysis shows that control
variable Credit Risk, CAR, Size, Liquidity Risk and
Inflation Rate can explain as a factor affecting
profitability of Islamic Bank in Indonesia equal to
91.80% and 9.20% influenced by other factors.
4 CONCLUSIONS
Research on the profitability of Islamic banks has
become one of the topics of concern for researchers
in the world, especially after the global financial
crisis. This study aims to highlight the profitability
and factors affecting the performance of Islamic Bank
in Indonesia. The empirical findings show that the
profitability of Islamic banks in Indonesia is
significantly influenced by credit risk, capital
adequacy ratio, firm size and liquidity risk, but
inflation does not significantly affect the profitability
of Islamic banks in Indonesia. We found that credit
risk has a positive effect on the performance of
Islamic banks in Indonesia, therefore Islamic banking
needs to increase prudence in lending.
The results of the study found that CAR was
significantly negative to profitability, therefore
Islamic banks in Indonesia need to increase capital
adequacy in order to increase profitability, as well as
company size, the study found that firm size
significantly negative to profitability. Indonesia
Islamic banks has a very good liquidity risk level
which is indicated by the result of study, where
liquidity risk is significant positive to profitability.
Based on the studies, Islamic banks should
increase the capital adequacy, and increase the
company's assets through the bond, increase the
number of shares or other forms of financing. The
need for external and internal monitoring of debtor.
Internal control is conducted by conducting intensive
control over the process of disbursement of credit
funds. While the external control is done by
monitoring and action the use of credit funds
effectively and efficiently by Islamic banking to
customers. With the two aspects of control is
expected to reduce the credit risk of Islamic banking.
This study has limitations, for further research it
is recommended to include Islamic Rural
Development Banks (BPD) as the unit of analysis,
increasing the number of variables such as GDP,
government regulation or other relevant variables as
well as measuring the performance of Islamic banks
with ROA and NIM proxies to obtain comprehensive
results.
Credit Risk Management and Islamic Banking Performance - Evidence from Indonesia
197

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