Interaction of Macroeconomic Variable Shocks and Monetary Policy Interventions on the Profitability of Sharia Commercial Banks in Indonesia

Indonesia's economic growth and financial development are significantly supported by its Islamic banking industry. The sustainability of these Islamic commercial banks hinges on their financial performance, particularly profitability. This study investigates the influence of macroeconomic variables and monetary policy on the profitability of these banks. The Indonesian Islamic banking sector, while showing a positive growth trend, has not yet reached expected profitability levels. This research is crucial because it aims to determine the extent to which external factors like macroeconomic shocks and monetary policy, as well as internal factors such as capital adequacy, impact the profitability of Sharia commercial banks. This understanding will enable the development of appropriate policies to enhance their financial health and contribution to the Indonesian economy. The study's objective is to analyze the short-term and long-term effects of shocks to macroeconomic variables (real effective exchange rate and consumer price index), monetary policy interventions (BI Rate), and the capital adequacy ratio on the profitability of these banks.

Existing literature highlights the impact of macroeconomic factors on commercial bank profitability. Studies by Hussain et al. (2023) and Joaqui-Barandica et al. (2022) emphasize the influence of economic activity and consumer price levels on bank performance. Mensi et al. (2020) demonstrate the impact of exchange rate fluctuations on commercial banks. Chen et al. (2022) underscore the significant role of monetary policy interventions in shaping the financial sector. Mamatzakis & Bermpei (2016) advocate for combining conventional monetary policies with unconventional strategies for greater adaptability to shocks. Jan et al. (2019) and Beck et al. (2013) emphasize the importance of capital adequacy for profitability and resilience to macroeconomic shocks. This study builds upon this existing literature by focusing specifically on Sharia commercial banks in Indonesia and employing an error correction model to examine both short-term and long-term effects.

This study utilizes an error correction model (ECM) to analyze secondary data from January 2015 to May 2022. The data, sourced from the Financial Services Authority's (OJK) Sharia Banking Statistics and Fred Economic Data (FED), include Return on Assets (ROA) as the profitability indicator, Real Effective Exchange Rate (REER), Consumer Price Index (CPI), Monetary Policy Rate (MPR – BI Rate), and Capital Adequacy Ratio (CAR). The methodology involved several steps: 1) A unit root test (Augmented Dickey Fuller test) was conducted to determine the stationarity of the variables. 2) An Engle-Granger cointegration test was employed to assess the long-term relationship among the variables. 3) A long-run relationship test using the ECM model was performed to identify the long-term effects of the independent variables on ROA. 4) A short-run relationship test, also using the ECM model, was conducted to analyze the short-term effects. The basic model is represented by the equation: ROA = f(REER, CPI, MPR, CAR). The ECM model was derived from this basic model, incorporating the lagged error term to capture short-term dynamics.

The unit root test revealed that all variables were stationary at the first difference. The cointegration test indicated a long-term relationship among the variables. In the long-run analysis, the real effective exchange rate (REER) and the consumer price index (CPI) showed significant positive effects on ROA, while the capital adequacy ratio (CAR) exhibited a significant negative effect. The monetary policy rate (MPR) was not significant. In the short-run analysis, the lagged error term (ECT) was significant at the 1% level, suggesting short-term adjustments to long-run equilibrium. In the short run, only CAR showed a significant effect on ROA, indicating the immediate impact of internal factors. REER, CPI and MPR did not show significant effects in the short run.

The long-term results confirm the influence of macroeconomic factors on the profitability of Sharia commercial banks. Exchange rate stability and stable price levels positively impact profitability, aligning with prior research. The negative coefficient for CAR suggests that higher capital adequacy is associated with lower ROA in the long run, possibly reflecting conservative lending practices or inefficiencies in capital utilization. The insignificance of the MPR in both the short and long run suggests that conventional monetary policy may not be effective in influencing this specific sector, possibly due to the unique characteristics of Islamic banking and the way it interacts with monetary transmission mechanisms, echoing similar findings in the existing literature. The short-run results highlight the immediate impact of internal capital management on profitability, whereas the lack of short-term effects from macroeconomic variables points to the necessity for resilient internal policies capable of mitigating external shocks.

This study demonstrates that macroeconomic variables, particularly the real effective exchange rate and consumer price index, significantly affect the long-term profitability of Sharia commercial banks in Indonesia. However, monetary policy interventions do not show a significant impact. Internal capital management, as reflected in the CAR, consistently plays a crucial role in both the short and long term. Future research could explore the specific mechanisms through which monetary policy influences Islamic banks, investigate the effectiveness of unconventional monetary policy tools, and examine the role of specific Islamic banking products and practices in shaping their response to macroeconomic shocks.

This study is limited by the use of aggregated data for Sharia commercial banks in Indonesia, which may mask variations in performance across individual banks. The analysis focuses on a specific set of macroeconomic variables and monetary policy instruments; other relevant factors may influence profitability. The study's time period is also limited, and future research could benefit from a longer time horizon to better capture cyclical effects.