The effect of shariah governance and internal control on operational efficiency: comparative institutional insights from Islamic banks in Indonesia and Malaysia

Abstract

Islamic banks in Indonesia and Malaysia are central to regional Islamic finance, yet their operational efficiency remains uneven and not fully understood, particularly in light of differing Shariah governance and internal control frameworks. This study examines how these mechanisms shape efficiency using panel data for 29 Islamic banks (13 in Indonesia and 16 in Malaysia) over 2019–2023. In the first stage, an output-oriented Modified Slacks-Based Measure Data Envelopment Analysis (MSBM-DEA) is used to estimate efficiency scores based on labour costs as input and third-party funds, financing, and profit as outputs. A Mann–Whitney U test is applied to compare efficiency between the two countries. In the second stage, Fixed Effects panel regression links the efficiency scores to disclosure-based indices of Shariah governance and internal control. The results show that Malaysian Islamic banks are consistently closer to the efficiency frontier, and the cross-country gap is statistically significant. Shariah governance positively affects efficiency in Malaysia but is weakly negative in Indonesia, while internal control is positively and robustly associated with efficiency in both systems. The findings underscore the importance of substantively embedded Shariah governance and strong internal control for sustaining efficient and resilient Islamic banking.