THE EFFECT OF CREDIT RISK ON BANK PROFITABILITY WITH EFFICIENCY AS THE INTERVENING VARIABLE

Abstract

This research is based on a bank, a law entity in which one of the main activities is lending. This study aims to analyze the credit risk, i.e. non-performing loan and allowance for impairment losses towards the profitability represented by bank return on asset with operating expense to operating income as the intervening variable. The technique of data analysis is statistical descriptive analysis of research variable, multiple regression analysis and path analysis which aim to measure the effect of intervening variable. The results of this study show that Non-performing loan ratio has positive and significant effect on operating expense to operating income efficiency ratio, ratio allowance for impairment losses has positive, but not significant effect on operating expense to operating income efficiency. KEY WORDS Credit risk, profitability, efficiency, intervening variable. Bank is the largest financial institution in the world which main activities are funding and fund distribution in a form of credit for debtors (lending). Bad credit service and neglecting prudential principles can contribute to bank lose since the credit is highly risky which can affect the bank's performance; therefore, banking industry should be able to mitigate credit risk. The bank profitability development in Indonesia, from 2013 up to 2015, decreases because of the increase of Operating Expense to Operating Income and problem loans every year. Besides, domestically economic development in 2015 slowed down to 4.79% and the high lending on low quality loan causes the decrease of bank profitability. In this case, the credit risk scale can be seen in a form or Non-Performing Loan (NPL) ratio. In Indonesian bank regulation which is made based on Statement of Financial Accounting Standard (SFAS) No.50 and 55, Allowance for Impairment Losses should be formed in order to overcome the lose risk; the higher funds being proposed to cover losses because of loan problems the higher Operating Expense to Operating Income efficiency. As a result, the profit is decreasing. These NPL and Allowance for Impairment Losses ratio is then used to measure the credit risk. The management of risk management, especially in good credit risk, will affect the profitability of a bank in which profitability used is Return on Asset (ROA) ratio. Moreover, the increase of loan problems will affect the decrease of the ability in gaining profit. However, if it is followed by good efficiency management, it can affect the increase of profit. Regarding to the result of the previous studies, for instance a study conducted by Zou and Li (2014) who tested variable of Capital Adequacy Ratio (CAR) and Non-Performing Loan (NPL) to measure credit risk, and tested its profitability using Return on Asset (ROA) ratio and Return on Equity (ROE),stated that NPL affects significantly on ROA and ROE, whereas CAR does not significantly affect ROA and ROE; therefore, it can be concluded that the credit risk (NPL) positively affects bank profitability. On the other hand, Noman et al. (2015) states in their study that there is negative and significant impact on credit risk toward bank profitability in Bangladesh. The main objective of this research is to analyze the effect of credit risk on bank profitability across efficiency as the intervening variable. This study uses credit problem Non-Performing Loan (NPL) and Allowance for Impairment Losses as the indicator variables representing credit risk, efficiency using Operating Expense to Operating Income, and using Return on Asset (ROA) ratio to measure profitability. Then, the research problems are: (1)