NON-PERFORMING FINANCING (NPF) AND COST EFFICIENCY OF ISLAMIC BANKS IN INDONESIA PERIOD 2012Q1 TO 2015Q2

Abstract

This paper investigates the inter-temporal relationships between non-performing financing (NPF) and cost efficiency of Islamic Banks in Indonesia during the period 2012(Q1) to 2015(Q2). This research uses quarterly published reports data of Central Bank of Indonesia (Bank Indonesia).The Data Envelopment Analysis (DEA) approach is used to measure cost efficiency of Islamic Banks. The inter-temporal relationship between NPF and cost efficiency is estimated using VAR model by testing two of the four hypotheses introduced by Berger and DeYoung (1997). The finding of DEA indicates that Bank Victoria Syariah (BVS) was the most cost efficient. The average cost efficiency of Islamic banks was 0.937 or 93.7%. The finding also indicates that Islamic banks are still inefficient in managing the costs. This result supports the “bad management” hypothesis. The ‘bad management’ hypothesis indicates that the major risks facing financial institutions are caused by the internal problems. In terms of variables that determine NPF by using panel least square, the findings reveal that GDP growth rate, Inflation and Capital Adequacy Ratio (CAR) have a negative and significant effect on NPF, while Exchange rate and Operational Efficiency Ratio (OER) have a positive and significant effect on NPF. Financing Deposit Ratio (FDR) has no significant effect on NPF.