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

Indonesia’s financial development is underpinned by its banking sector, with Islamic banking occupying a strategic role in a predominantly Muslim country. Although Islamic commercial banks are growing and public interest is rising, their profitability remains below the threshold established by Bank Indonesia (average ROA 2016–2021 of 1.29%, below regulatory benchmark). Ensuring profitability requires effective macro- and micro-level policies. Macroeconomic shocks (e.g., exchange rate and consumer prices) influence banking operations and profitability, while monetary policy is central to maintaining financial sector stability. Internal management, particularly capital adequacy, can enhance resilience to shocks. This study investigates how macroeconomic variable shocks and monetary policy interventions interact to affect the short- and long-term profitability of Islamic commercial banks in Indonesia, and the role of capital adequacy in that relationship.

The conceptual framework emphasizes: (1) Profitability as a key performance indicator reflecting management’s ability to optimize operations and adapt to macro shocks; (2) Real Effective Exchange Rate (REER) as a measure linking domestic and global economic conditions, where appreciation can support financial market sentiment and depreciation can raise crisis concerns, affecting bank profitability; (3) Consumer Price Index (CPI) as a proxy for household purchasing power and preferences between saving and investing, with stable prices supporting banking product usage and profitability; (4) Monetary Policy Rate (MPR, BI Rate) as the main macro policy tool influencing money supply, financing demand, and bank performance; (5) Capital Adequacy Ratio (CAR) as a measure of banks’ internal strength and capacity to absorb risk and expand, with regulatory minima (8% BI regulation; 12% API for healthy status) and an expected positive role in supporting profitability through resilience and growth.

Design: Quantitative econometric analysis using an Error Correction Model (ECM). Data: Monthly secondary data from January 2015 to May 2022 sourced from FRED (REER, CPI, BI Rate) and OJK Sharia Banking Statistics (ROA, CAR). Variables: ROA (profitability), REER (Real Broad Effective Exchange Rate, 2010=100), CPI (consumer prices), MPR (BI Rate), CAR (capital adequacy of Islamic commercial banks). Model specification: ROA = f(REER, CPI, MPR, CAR). Steps: (1) Stationarity tested via Augmented Dickey-Fuller (ADF); (2) Cointegration tested via Engle–Granger approach using ADF on residuals; (3) Long-run relationship estimated from the levels equation; (4) Short-run dynamics estimated in the ECM including the error-correction term (lagged residual). Equations: Long-run: ROA_t = α0 + α1 REER_t + α2 CPI_t + α3 MPR_t + α4 CAR_t + u_t. Residual: u_t = ROA_t − α0 − α1 REER_t − α2 CPI_t − α3 MPR_t − α4 CAR_t. Short-run: ΔROA_t = α0 + α1 ΔREER_t + α2 ΔCPI_t + α3 ΔMPR_t + α4 ΔCAR_t + ECT_{t−1} + ε_t. Estimation software: EViews 10.

- Unit root tests (ADF): ROA, REER, CPI, MPR, and CAR are I(1); all stationary at first difference (p < 0.001 at first difference). - Cointegration: Engle–Granger residual-based ADF on u_t: t = −3.4473, p = 0.0118 → residual is I(0), indicating a long-run relationship. - Long-run (levels) estimates: REER coefficient −0.200421 (t = −4.1041, p = 0.0001) significant and negative; CPI 0.389622 (t = 11.8304, p < 0.0001) significant and positive; MPR 0.051094 (t = 0.3027, p = 0.7628) not significant; CAR −0.929764 (t = −24.6792, p < 0.0001) significant and negative. R-squared = 0.9432. - Short-run (ECM): ΔREER −0.001658 (p = 0.9682) not significant; ΔCPI −0.134377 (p = 0.4553) not significant; ΔMPR 0.632134 (p = 0.0698) marginal at 10% but not at 5%; ΔCAR −0.844573 (t = −21.3376, p < 0.0001) significant and negative; ECT(−1) −0.929764 (t = −3.1125, p = 0.0026) significant, indicating rapid adjustment toward long-run equilibrium. R-squared = 0.8531. - Interpretation: REER and CPI significantly affect profitability in the long run; MPR does not in either horizon; CAR significantly affects profitability in both short and long run.

The study shows that macroeconomic conditions, especially the exchange rate and consumer prices, are key long-run drivers of Islamic commercial banks’ profitability in Indonesia. Exchange rate appreciation is associated with lower ROA (negative coefficient), while higher consumer prices correlate with higher ROA in the long run, consistent with literature linking stable price dynamics to increased usage of banking services. In the short run, neither REER nor CPI significantly move profitability, highlighting limited immediate pass-through of macro shocks to ROA. Conventional monetary policy (BI Rate) does not significantly influence profitability in either horizon, aligning with the notion that Islamic banking’s structures may not transmit policy rate changes in the same way as conventional banks. Internal resilience, captured by CAR, consistently and significantly shapes profitability in both horizons, suggesting that capital management is a central lever for sustaining performance and absorbing shocks. The significant and sizable negative ECT implies rapid correction back to equilibrium after deviations, evidencing strong long-run comovement among variables.

Profitability is a central performance metric for Islamic commercial banks and is shaped by macroeconomic and internal bank conditions. Empirical results indicate that the real effective exchange rate and consumer price index significantly influence profitability in the long run, whereas the BI Rate does not significantly affect profitability in the short or long term. Short-term macroeconomic fluctuations can disrupt profitability, suggesting the need for more flexible and adaptive short-term management strategies. Nonetheless, effective capital adequacy management supports profitability across horizons. Future work should examine monetary policy instruments tailored to Islamic banking to better capture policy transmission mechanisms impacting profitability.

The study does not explicitly model or test monetary policy instruments specific to Islamic banking, limiting conclusions about how Islamic-policy-aligned tools affect profitability. Additionally, the negative long-run CAR coefficient warrants deeper investigation into potential measurement, structural, or endogeneity issues that could influence the estimated relationship.