Determinants of profit and loss sharing financing in Indonesia

Abstract

PurposeThis paper aims to investigate the dynamic relationship between profit and loss sharing (PLS) financing and banking-specific variables, macroeconomic variables and religiosity in Indonesia.Design/methodology/approachThis study used seven variables, such as PLS financing, Islamic financing rate, risk-sharing deposits, bank size, interest rate, economic growth and level of religiosity. The data used were monthly time series during the 2009–2019 period, and they used the structural vector autoregression method plus ARDL and ECM as a robustness check mechanism.FindingsThe results show that in the short term, PLS financing is more influenced by changes in the risk-sharing deposits and bank size variables. Meanwhile, analysis of variance decomposition illustrates that variations in PLS financing are more influenced by the dynamics of PLS financing itself than other variables. This finding also strengthens the characteristics of PLS financing that is immune to the influence of interest rates, and this result can strengthen the implementation of the PLS scheme as an alternative to the monetary channel in the dual banking system in Indonesia.Practical implicationsThe immunity of PLS financing to changes in interest rates has implications for the management of Islamic banking risk management. Evaluation must be carried out by increasing the skills of the bankers in response to losses arising from moral hazard and asymmetric information.Originality/valueThis paper used empirical evidence to show the influence of internal and external factors toward PLS financing performance. To the best of the authors’ knowledge, the study on determinants of PLS financing is limited, particularly in the context of Indonesia.