Determinants of Bank Performance in Indonesia: Evidence Rural

Banks in Pekanbaru City

Hamdi Agusti*, Syahdanur, and Azwirman

Faculty of Economics, University Islam of Riau, Jl. Kaharuddin Nasution 113 Pekanbaru Riau, 28284, Indonesia.

Keywords: Bank performance, Rural Banks and Return On Assets

Abstract: The purpose of study to find out how big the financial ratios related to Non Performing Loan (NPL), Operating

Expense to Operating Income (OEOI), Loan to Deposit Ratio (LDR), and Capital Adequacy Ratio (CAR) in

terms of affecting profitability that occurred in Rural Banks in Pekanbaru City. The population in this study

using Rural Banks in Pekanbaru City since 2012 until 2015. The number of Rural Banks in Pekanbaru City

as many as 19 RB. Of the total population is taken a sample by using purposive sampling method based on

certain criteria. From the sampling criteria can be obtained the number of Rural Banks that meet the criteria

of 13 RB. The result of study that operational risks proxied through BOPO variables have a negative and

significant impact on Return On Assets (ROA), is due to high operational costs of BR is still not working

efficiently, thus lowering ROA. liquidity risk proxied through LDR variable has a positive and significant

impact on profitability BR. This indicates that any increase in LDR will be followed by increased profitability,

where as the amount of credit disbursed increases, the income from such credit will increase so that the bank's

ability to earn profit is also increasing.

1 INTRODUCTION

Poverty reduction is a Rural Bank or hereinafter

referred to as RB. RB as one of the banking

institutions has an important role in supporting the

economy of Indonesia. One role of RB is difficult to

help people who have access to bank lending public

funds so that people do not need to borrow money

from moneylenders.

RB also participate in supporting the development

of Small and Medium Enterprises (SMEs) in

Indonesia, which became one of the largest business

sectors in Indonesia, is assisting the government in

job creation. RB role here is to help the development

of SMEs through lending capital raised from public

funds; RB should improve their business

performance. With good financial performance, the

public confidence in the RB as financial institutions

collector and distributor of funds will also be higher.

RB in Indonesia exist in every district. RB has two

systems, namely Islamic banking and conventional

banking. Hence this study will try to identify whether

the bank system pattern will affect the bank

performance. Why the rural bank performance at

Pekanbaru?. These are the questions that the study

wishes to answer.

The development of Rural Banks in Pekanbaru

City is very fast nowadays, because of the increase of

bank units. BR is one of the business entities that

provide banking services to micro, small and medium

enterprises. Increasingly, the increasing credit units,

time deposits, savings deposits, and withdrawals of

funds in the bank, thus raising a risk faced by rural

banks, the risks that may occur are credit risk,

operational risk, and liquidity risk, these risks will

cause losses to the bank if not managed properly.

Based on these developments, people and

investors can measure financial performance through

the financial statements of Rural Banks. The financial

performance of a company is often measured by how

the ability of a company to generate profits. From a

management point of view, the ratio of Retrun On

Assets (ROA) is seen as a useful measure because it

indicates how well the management utilizes the total

resources owned by the company to generate profits.

Profitability ratios used are Return On Assets

(ROA) which is the ratio of net profit before tax to

total assets. The greater the ROA, the greater the

profitability which means the better the company's

performance, the performance of rural banks

experienced fluctuations (not fixed) income or profit

558

Agustin, H., Syahdanur, . and Azwirman, .

Determinants of Bank Performance in Indonesia: Evidence Rural Banks in Pekanbaru City.

DOI: 10.5220/0010046405580563

In Proceedings of the 3rd International Conference of Computer, Environment, Agriculture, Social Science, Health Science, Engineering and Technology (ICEST 2018), pages 558-563

ISBN: 978-989-758-496-1

every year. The following data Ratio Profitability

Rural Bank In Pekanbaru City.

Research on the influence of financial ratios on

previous profitability has been done by several other

studies. From the results of this study seen the

difference in the influence of financial ratios to the

level of profit gain. RB looks still cannot maximize

profitability, it is seen from ROA ratio obtained is still

below the minimum limit set by the bank Indonesia is

1.5%. Return On Asset at Rural Banks is currently

experiencing fluctuations from year to year, this is

due to the unstable growth in profit at the Rural Bank.

The decline in earnings in Rural Banks is due to high

credit failure, and the bank's operational expenses are

too large and inefficient.

Therefore, this study aims to find out how big the

financial ratios related to Non Performing Loan

(NPL), Operating Expense to Operating Income

(OEOI), Loan to Deposite Ratio (LDR), and Capital

Adequacy Ratio (CAR) in terms of affecting

profitability that occurred in Rural Banks in

Pekanbaru City.

2 REVIEW OF LITERATURE

2.1 Financial Intermediary Theory

The main function of the bank is as a financial

intermediary where the bank will sell a financial

claiming product on the bank such as savings account

and current account. At the same time, banks will also

purchase financial products such as mortgages,

business loans and personal loans. With this activity

the financial transfers occur from units with surplus

funds to units with insufficient funds through

financial intermediaries. Financial intermediaries

have advantages over individual or non-financial

companies due to three factors. First, financial

institutions or intermediaries can reduce transaction

costs such as search costs, information costs and

contract costs. The cost of information exists because

there is one party who does not know exactly about

the information related to the other party.

There are two situations of asymmetric

information in financial markets ie adverse selection,

which occurs before a transaction occurs, and the

moral hazard, which arises after a transaction (Allen

& Santomero, 1998). Adverse selection occurs when

the surplus unit has no accurate information regarding

unit deficit. Therefore, the lack of information about

the deficit unit will expose the surplus unit to greater

risk if the surplus unit lend to a deficit unit. Financial

institutions through experience can reduce the

adverse selection problem.

Moral hazard refers to the misuse of the loan

obtained by the deficit unit where the deficit unit will

use the loan for a more risky and different purpose

than the stated purpose of the loan application.

Financial institutions can mitigate moral hazard

problems through loan contracts and oversight over

the operations of deficit units.

The advantage of the second financial institution

is that financial institutions can enjoy economies of

scale as financial institutions have the ability to

handle large and large-scale transactions. Therefore,

financial institutions can reduce the fixed cost for

each unit of output. Thirdly, since financial

institutions have the advantage of evaluating a decent

loan deal, it ensures that the loan issued will have a

lower risk. Furthermore, financial institutions will

manage a large amount of loans. Thus, financial

institutions can diversify their portfolio and thus

reduce the risk of such financial institutions. This is

different from those of non-financial intermediaries

or companies who do not have the skills in assessing

a loan and do not have a large capital to diversify their

portfolio.

2.2 Agency Theory

This section must be in one column.

In the area of study of the influence of ownership

on bank performance, the most frequently used theory

is agency theory. Agency theory describes the

relationship between the owner as a principal and

manager as an agent. The relationship is very

important because it affects the performance of a

bank. Thus the competitiveness of a bank depends

largely on the ability of managers to manage their

respective banks. In addition to the magnitude of the

role of managers in managing the bank in order to

perform well, the role of the bankers is also vital for

monitoring and ensuring that managers are working

hard to advance the bank under its management.

Therefore, in the relationship between the bank

owner and the manager usually there will be a

performance contract where the bank owners are

aligning the interests of the manager with the interests

of the bank's owner. Performance contracts are

formed so that rewards received by managers are

closely linked to bank performance. The contractual

relationship between the owner and the manager is in

line with agency theory (Jensen & Meckling, 1976).

Jensen and Meckling (1976) reveal that the difference

in importance between owners and managers that

creates an agency conflict occurs because the

Determinants of Bank Performance in Indonesia: Evidence Rural Banks in Pekanbaru City

559

manager does not hold company shares or has

insufficient ownership.

The concept of agency as disclosed by Jensen and

Meckling (1976) can be seen in the results of the

study of Berger and Bonnaccorsi (2006), Basu et al.

(2007) and Sulivan and Spong (2007) which indicate

that bank owners are handing over to the manager as

an agent to manage the bank. This is because the

owner has difficulty managing the company directly

because of the following factors. First, the size of a

growing bank will be difficult to manage. Second, the

need for specialized expertise to manage large banks

and generally the owners have no such expertise.

Third, bank ownership is determined by the number

of shareholders. If the number of shareholders is too

high and each person holds a small number of shares

then this situation does not allow all owners to

manage the activities of banks effectively.

The manager can be seen as an agent by the bank

owner who appoints them and is authorized and

responsible for making the best decisions in the

interest of shareholders. One way to measure success

and efficiency of managers is to look at the

profitability of the bank. Performance can be

measured through bank's ability to secure a stable

profit while at the same time maintaining shareholder

wealth increase in the company.

Berger and Bonnaccorsi (2006) point out that

managers may ignore the interests of shareholders,

instead paying attention to their interests such as job

continuity, luxury lifestyle, professional membership,

personal vehicle facilities, all of which are borne by

the company. Shleifer and Vishny (1997) stipulate to

address agency issues, shareholders have incentives

to monitor managers so as to minimize the problem

of principal-agents. However, the level of incentives

depends on shareholder ownership. If the owner holds

a small number of shares, the owner will not have the

incentive to monitor the manager's behavior. This is

because the profit earned by the owner is less than the

cost of supervision. Therefore, it is expected that

private banks, most of which are owned by a family,

will have a better performance compared to

government-owned banks.

For a bank that is largely owned by the family,

conflicts between bank owners and managers are rare.

Arifin (2003) notes that when a majority of the shares

are owned by the family, it reduces the agency's

problems compared to companies owned by many

shareholders. In Indonesia, 90 percent of the

company's shares are owned and operated by a

family. This situation is not much different from other

countries such as Spain (La Porta et al., 1999). Arifin

(2003) states that the advantages of a family owned

and operated company are family members will

manage the company and this will reduce agency

problems. However, because a family is also a

manager of the company, the agency problem will

arise between the family, as a majority shareholder

and a minority shareholder. In addition, according to

Allen et al. (2011) bank capital also affects the

performance of a bank. Due to the large capital of

private banks in Indonesia issued by individuals or

families, they have higher incentives to monitor loans

issued due to bank performance and their wealth will

be affected by repayments

. Government-owned companies may not be

efficiently managed because the board and

management do not hold any shares in the company.

This causes the company's performance to be affected

(Megginson, et al, 1994; Megginson & Netter, 2001).

The agency problem in the context of government

ownership is more complicated as the government

holds shares in the company on behalf of the public

or the people. Since governments are led by

politicians who have no ownership in these

companies, they may not monitor the actions of the

board of directors or management. In addition, the

objective of a politician who leads a government may

differ from an individual who owns a business.

Shleifer (1998) and La Porta et al. (2002) states that

governments tend to meet political goals that may

negatively affect the financial performance of the

company. This view is supported by Paskelian (2006)

and Xu and Wang (1999) stating that the company

becomes inefficient due to an agency problem arising

from government political motives. In addition,

government-owned banks may have lower profits

because they finance a project that does not bring

financial gain but brings social benefits.

The study Berger and Bonaccorsi (2006),

Mashharawi and Al-zu’bi (2009), Barry et al. (2011),

Hoffmann (2011), Gul et al. (2011) and Trujillo-

Ponce (2011) found that the ratio of equity have

negative influence on ROE. This suggests that the

cost of the agency consistent with the theory that the

increased use of debt to increase ROE. Meanwhile

Mashharawi and Al-Zu'bi (2009), Alexiou and

Sofoklis (2009), Sufian (2010), Davydenko (2010),

Sufian and Majid (2010), Barry et al. (2011), Javaid

et al. (2011), Ramadan (2011), Riewsathirathorn et al.

(2011) and Sufian and Habibullah (2012) found that

the ratio of equity have a positive influence on ROA.

This shows the high equity ratio to increase banks'

ability to overcome the loss of assets, including loans,

increase the income of the bankruptcy cost reduction,

higher gain if do offer some product expansion in

profitable bank. High equity can reduce the amount

ICEST 2018 - 3rd International Conference of Computer, Environment, Agriculture, Social Science, Health Science, Engineering and

Technology

560

of outside capital requirement which is higher than

the cost of equity capital to be able to reduce bank

profits.

Sufian (2011) and Trujillo-Ponce (2011) found

that the ratio of loans to assets have positive influence

on ROA and ROE. While Mamatzakis and

Remoundos (2003), Staikouras and Wood (2005),

Fernandez et al. (2005), Trivieri (2007), Mashharawi

and Al-zu’bi (2009) and Gul et al. (2011) found that

the ratio of loans have a positive influence on the

ROA. Demirguc-Kunt and Huizinga (2000)

Kosmidou et al. (2007), Garcia-Herrero et al. (2009)

and Javaid et al. (2011) found that the ratio of loans

to assets have an influence on ROA.

The findings Beck et al. (2005), Mashharawi and

Al-zu’bi (2009) and Mirzaei et al. (2011) found that

the ratio of operating costs to total assets has a

negative influence on ROA and ROE. Meanwhile

Kosmidou et al. (2007) showed that the ratio of

operating costs to total assets has no influence on

ROA.

3 DATA AND METHODS

The population in this study using Rural Banks in

Pekanbaru City since 2012 until 2015. The number of

Rural Banks in Pekanbaru City as many as 19 RB. Of

the total population is taken a sample by using

purposive sampling method based on certain criteria.

From the sampling criteria can be obtained the

number of Rural Banks that meet the criteria of 13

RB. Multiple linear regression equation as follows:

Y = α + b1X1 + b2X2 + b3X3 + b4X4 + ε

Y = ROA

X1 = Credit Risk (NPL)

X2 = Operational Risk (OEOI )

X3 = Liquidity Risk (LDR)

X4 = Capital Adequacy Ratio (CAR)

ε = ResidualWe hope you find the information in

this template useful in the preparation of your

submission.

4 RESULT AND DISCUSSION

Table 1: The result Regression Dependent Variable: ROA

Mode

Unstandardiz

Coefficients

Standardiz

Coefficient

Sig

Std.

Erro

Beta

(Constan

13.21

.932

14.18

.00

NPL

.002 .041 .004 .050

.96

OEOI

-.138 .011 -.978

12.10

.00

LDR

.015 .005 .202 3.253

.00

CAR

-.016 .019 -.068 -.838

.40

Based on the results if statistical data can be seen that

the credit risk proxied through NPL has a positive but

not significant effect on profitability of BR. This

indicates that the RB has other income that can

overcome the losses of NPLs.

Based on the results of processed statistical data

can be seen that operational risks proxied through

OEOI variables have a negative and significant

impact on ROA, is due to high operational costs of

BR is still not working efficiently, thus lowering

ROA. The results of this study in consistent with

previous research is Beck et al. (2005), Mashharawi

and Al-zu'bi (2009) and Mirzaei et al. (2011) Luh and

Ni Luh (2013).

Based on the results of processed statistical data

can be seen that liquidity risk proxied through LDR

variable has a positive and significant impact on

profitability BR. This indicates that any increase in

LDR will be followed by increased profitability,

where as the amount of credit disbursed increases, the

income from such credit will increase so that the

bank's ability to earn profit is also increasing. The

results of this study are consistent with previous

research of Sufian (2011) and Trujillo-Ponce (2011)

found that the ratio of loans to assets have a positive

influence on ROA and ROE. While Mamatzakis and

Remoundos (2003), Staikouras and Wood (2005),

Fernandez et al. (2005), Trivieri (2007), Mashharawi

and Al-zu'bi (2009) and Gul et al. (2011) and Si Luh

and I Gusti (2014).

Based on the results of research, CAR has

negative and insignificant effect on Return On Assets

(ROA). This is caused by the increase in own capital

Determinants of Bank Performance in Indonesia: Evidence Rural Banks in Pekanbaru City

561

cannot increase credit. The results of this study are

inconsistent with previous research such as

Mashharawi and Al-Zu'bi (2009), Alexiou and

Sofoklis (2009), Sufian (2010), Davydenko (2010),

Sufian and Majid (2010), Barry et al. (2011), Javaid

et al. (2011), Ramadan (2011), Riewsathirathorn et al.

(2011), Sufian and Habibullah (2012) and Si Luh and

I Gusti (2014) found that the ratio of equity have a

positive influence on ROA.

5 CONCLUSION

In this study, we examine the Rural Banks in

Pekanbaru City performance of community

development banks in Indonesia from 2012 to 2015.

Our study uncovers interesting results. We find that

the the result of study that Based on the results if

statistical data can be seen that the credit risk proxied

through NPL has a positive but not significant effect

on profitability of BR. Operational risks proxied

through OEOI variables have a negative and

significant impact on Return On Assets (ROA), is due

to high operational costs of BR is still not working

efficiently, thus lowering ROA. liquidity risk proxied

through LDR variable has a positive and significant

impact on profitability BR. This indicates that any

increase in LDR will be followed by increased

profitability, where as the amount of credit disbursed

increases, the income from such credit will increase

so that the bank's ability to earn profit is also

increasing. CAR has negative and insignificant effect

on Return On Assets (ROA). This is caused by the

increase in own capital cannot increase credit.

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