INDONESIA - ARTICLES - Effect of Capital Structure on Banks Performance: A Profit Efficiency Approach Islamic and Conventional Banks Case in Indonesia

Effect of Capital Structure on Banks Performance: A Profit Efficiency Approach Islamic and Conventional Banks Case in Indonesia

Ade Salman Al-Farisi

affiliation not provided to SSRN

Riko Hendrawan

affiliation not provided to SSRN Abstract: Banks were knowned to have volatile capital structure caused by their financial liquidity. This paper aims to examine the impact of capital structure towards performance of two group of banks, conventional and Islamic banks, by using profit efficiency approach. Two stages procedure were employed. In the first stage we measure profit efficiency score for each bank in Indonesia during year 2002-2008 by using distribution free approach (DFA). In the second stage we employ banks’ capital ratio to measure their impact towards their performance.

Output from the first stage indicate that bank’s average profit efficiency scores equal to 0,60. Whereas the maximum score equal to 0,78. So there is still room around 0,18 Indonesian banks to improve their performance. The output also indicate the Islamic banks in Indonesia succeed to place their position at top 20% highest profit efficiency score.

Result from the second stage indicate that bank’s capital ratio have a negative effect on their profit efficiency. Futhermore, the negative effect happened to be higher for the Islamic bank group compared to conventional bank. This result consistent with Diamond & Rajan (2001) opinion that higher capital could degrade bank’s profit performance. (source)