Role of Islamic banks in Indonesian banking industry: an empirical exploration

Abstract

Islamic banks have been gaining traction in Indonesia, which is the world's largest Muslim population. Although the share of Islamic banking is small, the growth potential poses challenges and questions that need an inquiry. Our paper is a response to this. We investigate whether competition from Islamic banks adds to the financial stability and profitability. We then test the source of any such stability/instability. We find, consistent with the competition-stability theory, that the presence of Islamic banks has not impacted profitability but has made the banking industry more stable. We show that Islamic banks have improved both lending and deposit growth of the banking system, suggesting that Islamic banks have contributed to stability through both asset and liability channels.