DO FINANCING RISK AND OPERATIONAL EFFICIENCY EXPLAIN ISLAMIC BANK PROFITABILITY? EVIDENCE FROM INDONESIA

Abstract

Islamic banking in Indonesia has expanded rapidly since the 2021 consolidation of three state-owned Islamic banks into Bank Syariah Indonesia (BSI), yet little is known about how financing risk and operational efficiency jointly shape profitability. Prior studies treat the two as separate channels, rely on small samples or aggregate time-series data, and report contradictory findings across Indonesia and the Gulf Cooperation Council. This study examines whether operational efficiency mediates and moderates the effect of financing risk on the profitability of Indonesian Islamic commercial banks. Using secondary data for 2015–2025 from bank financial statements, the Financial Services Authority (OJK), Bank Indonesia, and Statistics Indonesia, we estimate two-step System-GMM dynamic panel models with a post-merger dummy. Profitability is measured by return on assets (ROA) and return on equity (ROE); financing risk by non-performing financing (NPF), decomposed by contract type; and efficiency by BOPO and DEA scores. Mediation and moderation are tested through bootstrapped moderated mediation. Higher NPF significantly reduces ROA (−0.19, p < 0.01), while efficiency raises it (DEA: 0.27; BOPO: −0.31). Efficiency partially mediates the NPF–ROA relationship (indirect effect −0.07; 95% CI [−0.11, −0.03]) and buffers risk (interaction −0.14, p < 0.05). Musyarakah raises financing risk, mudharabah has no significant effect, and murabahah lowers it. Early post-merger deterioration is consistent with the bad luck hypothesis, whereas later divergence favors bad management. Regulators should adopt integrated risk–efficiency supervisory thresholds, and managers should treat efficiency investments as risk mitigation.