Competition, diversification, and bank margins: Evidence from Indonesian Islamic rural banks

Abstract

This paper examines the determinants of bank margins in Indonesian Islamic rural banks. We find that bank margins are affected mainly by competition and diversification. In this less competitive market, Islamic rural banks are able to set high margins. Islamic rural banks are also tend set high margins when they do not diversify their revenue, referring to the cross-subsidization strategy. We also find that the impact of competition and diversification on bank margins are more pronounced in the banks with lower banks’ loan contract diversification and also banks with a higher proportion of profit-and-loss sharing (PLS) lending. However, those impacts diminish when Islamic banks are located in provinces with above-average numbers of Muslims and located outside Java. Our empirical results therefore also suggest that regional differences matter for bank margins. Keywords: Bank margins, Competition, Diversification, Islamic rural banks, Indonesia, JEL classifications: G21, D40, L25, O18