An empirical analysis of Islamic microfinance institutions’ performance in Indonesia

Abstract

This study investigates the impact of Islamic microfinance institutions on rural household welfare in Indonesia. In particular, this study focuses on estimating the impact of financing, the level of shari’a compliance, the best financing mechanism, and the factors that impact on rural households that become clients of Islamic microfinance institutions. Islamic microfinance institutions play an important role in Indonesia because the country has the world’s largest Muslim population. Hence, the availability of financial products and services that parallel Muslim beliefs is crucial. This study estimates the impact of Islamic financing on rural household welfare using the difference-in-difference method followed by the adjusted difference-in-difference method. Next, the study evaluates shari’a compliance and the Islamic values of clients of Islamic microfinance institutions. The double difference-in-difference and adjusted difference-in-difference methods are adopted to investigate the financing impact of two Islamic microfinance institutions’ financing mechanisms; profit and loss sharing and non-profit and loss sharing. The logit model is used to identify factors that influence rural households to become clients of Islamic microfinance institutions. This study produces several important findings. The difference-in-difference method results show Islamic microfinance institutions’ financing helps to increase the clients’ annual income. The fixed effects results confirmed that Islamic microfinance institutions’ financing improved clients’ income compared with non-clients. The evaluation of shari’a compliance found that Islamic microfinance institutions’ financing parallels the shari’a standards of the National Shari’a Board of Indonesia. The results of the double difference-in-difference method confirm that the profit and loss sharing mechanism has a greater impact on rural household welfare than the non-profit and loss sharing mechanism. Finally, age, gender, and income are factors that significantly influence rural households to become clients of Islamic microfinance institutions.