Investigating Equity-Based Financing and Debt-Based Financing in Islamic Banks in Indonesia

Abstract

Purpose — This study empirically examines whether equity-based financing (EBF) generates fixed income similar to debt-based financing (DBF) in the context of Islamic banks in Indonesia. It also investigates whether the Islamic bank financing return rate (IBFRR) has a relationship with the conventional bank lending interest rate (CBLIR).

Design/Methodology/Approach — This paper uses monthly data for the period 2009–2019 and produces 132 units of analysis. The object of the study is Islamic banks (IBs) and conventional banks (CBs) in Indonesia. The study uses the Vector Error Correction Model (VECM) as the tool of analysis.

Findings — This study provides evidence that, contrary to DBF products, EBF does not have fixed income. EBF in Indonesian IBs has been executed according to the requirements of Islamic law. The study also finds that CBLIR is not correlated with IBFRR.

Originality/Value — This is the first study to correlate equity-based financing return rate (EBFRR) with debt-based financing return rate (DBFRR). This paper also examines the no-causality relationship between CBLIR and IBFRR.

Research Limitations — This study uses Islamic banking data in the aggregate. Therefore, it cannot explain whether research results differ between banks.

Practical Implications — EBF in Indonesian IBs has been applied according to its epistemology. However, the significant increase in mushārakah financing noted over the study period should be followed by a careful customer business feasibility analysis.