International Journal of Science and Research (IJSR) ISSN (Online): 2319-7064 Index Copernicus Value (2015): 78.96 | Impact Factor (2015): 6.391 Volume 5 Issue 12, December 2016 www.ijsr.net Licensed Under Creative Commons Attribution CC BY Islamic Banking: Banking Efficiency Analysis in Indonesia Nadiah Hidayati 1 , Hermanto Siregar 2 , Syamsul Hidayat Pasaribu 3 1, 2, 3 School of Business, Bogor Agricultural University (IPB), Jl. Raya Pajajaran Bogor, Indonesia16151, Indonesia Abstract: Banking sector has an important role for the Indonesian economy. Indonesia implementsthe dualbanking system, conventional banks and Islamic banks. It provides an excellent opportunity for the growth of Islamic banking industry in Indonesia. Islamic banking industry in Indonesia has improved in number of banks and branches but the performance of Islamic banks has decreased in recent years. In addition, Islamic banking still provides a lower rate of return than conventional banking. This study aims to measure the efficiency of Islamic banking in Indonesia using the intermediation approach and input orientation. The results showed that Islamic Banks (BUS) and Islamic Business Units (UUS) in Indonesia have not been operating efficiently based on Data Envelopment Analysis (DEA) method. The estimation results of data panel regression model showed total financing and CAR have positive and significant impact, whereas the deposits have negative and significant impact to the efficiency of BUS and UUS in Indonesia. Keywords: Data panel, DEA, efficiency, Islamic banking 1. Introduction In recent years, financial institutions have experienced a dynamic, fast-paced, and competitive environment at a cross-border scale. One of the most growing parts is the new paradigm of Islamic Banking, which has remarkably captured the interest of both Islamicand contemporary economists (Sufian 2007). Islamic bank is a bank that is operational and its products are developed based on the principles of Al-Qur’an and Al-Hadits. According to Antonio (2011), Islamic banks are banks that carry out operations following the provisions of Islamic rules. Islamic banking in Indonesia has experienced growth in institutional terms. Increasing the number of banks and offices over the years have a positive impact on the development of Islamic banking industry. It can be seen from the value of total assets, third party funds, and financing increased during the last three years. This can be seen on Table 1. Table 1: Development financial indicators of BUS and UUS 2013-2015 Indicator (billion) 2013 2014 2015 Total Asset 242 276 272 343 296 262 Third party funds 183 534 217 858 231 175 Financing 184 120 199 330 212 996 Source: Otoritas Jasa Keuangan, 2016 Islamic Banks (BUS) and Islamic Business Units (UUS) performance can also be seen through some financial ratios such as Non Performing Financing (NPF) and Financing Deposit Ratio (FDR). Over the past three years, BUS and UUS had a decreasing performance. It can be seen from the increasing of NPF and decreasing of FDR. NPF ratio improved explaining that Islamic banking is getting bigger in banking financing risks. This is due to the increasing of financing problems on BUS and UUS. The ability of banks intermediary function was seen from the ratio of FDR. Declining of FDR implies financing that channeled by Islamic banks has decreased. It indicates the performance of Islamic banking is still not running optimally. Figure 1: Performance of BUS and UUS 2013-2015 Source: Otoritas Jasa Keuangan, 2016 Islamic bankas a financial institution needs to maintain its performance in order to operate optimally. The efficiency of the banks became one of the indicators to analyze the performance of a bank. According to Wheelock and Wilson (1999), efficiency is an important measure of operating conditions of the bank and one of the key indicators of bank successful. Ratings of bank efficiency is needed so that banks can act rationally in minimizing the level of risk in undergoing operations. It is necessary for Islamic banks in order to have high competitiveness in the national banking industry and be able to expand its market share. Along with that, Muharram and Pusvitasari (2007) explains that the analysis of the efficiency of Islamic banks is important to do because the collection and distribution of expansive financing regardless of the efficiency factor will affect the profitability of a bank. Efficiency issues should receive serious consideration to encourage the development of Islamic banking industry and existence of Islamic banks. The majority of studies focused only on efficiency measurement, while research continues to analyze factors that affect the performance efficiency is still relatively limited (Berger and Humphrey 1997), especially for Islamic banking. Until now, no study has focused on determinants efficiency of Islamic banking using Paper ID: ART20163796 DOI: 10.21275/ART20163796 1907