Benchmarking the Intermediation Costs of Islamic and Conventional Banks: Evidence from Indonesia

Abstract

The number of studies looking at the intermediation costs of Islamic banking remain limited. This paper aims to benchmark the intermediation costs of Islamic and conventional banks as measured by their net profit or net interest margin. The question to be answered is whether the level of net margin is higher or lower in Islamic than in conventional banking. This paper relies on the system generalized method of moments (GMM) panel regression, in which net margin is treated as a function of “pure spread” determinants, bank-specific variables not formally seen as “pure spread” determinants, and macroeconomic conditions. The sample includes unbalanced panel data from 12 Islamic and 97 conventional banks in Indonesia over 2004-2018. The results indicate no strong evidence that the level of net margin in Islamic banking differs from that in conventional banking. The difference between net margin in the two banking systems is at best not robust. It is subject to the inclusion of different control variables, composition of sample and, most importantly, outliers. Both anecdotal belief saying that Islamic banking is more costly and an opposing claim that Islamic banking brings about a promise for lower intermediation costs should not be taken for granted.

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