The effect of sharia supervision effectiveness and financial performance on Islamic banking efficiency in Indonesia

This study aims to investigate the effect of sharia supervisory effectiveness and financial performance on the efficiency of Islamic banks in Indonesia. Supervisory effectiveness is measured by the characteristics of the Sharia Supervisory Board (SSB), while financial performance is represented by the capital adequacy ratio (CAR) and net profit margin (NPM). The samples in the study are 11 fully-fledged Islamic banks registered with the Financial Service Authority of Indonesia (OJK), with an observation period of eight years from 2010 to 2017. The paper first measures Islamic banking efficiency using data envelopment analysis (DEA), a non-parametric statistical method; second, it analyses the effect of sharia supervisory effectiveness and financial performance on the efficiency of Islamic banks using panel data regression. The findings show that CAR and NPM have a negative influence on the efficiency of Islamic banks in Indonesia, while the effectiveness of the SSB has no influence. The originality of this research is that first, the findings show that higher capital tends to lower efficiency, particularly in Islamic banks in Indonesia, due to the low optimisation of capital. Second, the reputations, cross memberships, qualifications and the number of SSB members indirectly influence the efficiency of Islamic banks, particularly in terms of increasing costs and reducing the rate of return, as management might be late in anticipating sharia compliance risk.