The impact of inflation on Islamic banks' home financing risk: Before and during the COVID-19 outbreak

Abstract

The COVID-19 outbreak has had a severe impact on nearly all industries, including Islamic banking, which plays a significant role but is exposed to higher risk. This study aims to evaluate the credit risk that Islamic banks in Indonesia have been exposed to related to home financing before and during the COVID-19 outbreak. Panel data are employed covering the period January 2016 to September 2020 on a monthly basis. The data were analyzed using a dynamic panel approach to present a distinct picture of Sharia-compliant property financing before and during the COVID-19 outbreak. In general, the findings show that the macroeconomic variable reflected by regional inflation has had a different influence in the two periods, with Islamic banks having had much more exposure to macroeconomic risk, specifically in home financing, during the epidemic. In addition, the different influences are also shown by the study results, which show that provinces on Java Island face less risk exposure than those outside Java. In terms of impulse response factors and variance decompositions' result, before the outbreak, the response of home financing risk to inflation tended to be more stable. However, during the outbreak, the movement has tended to fluctuate more, especially outside Java Island. The same result for variance decompositions shows a similar trend, with inflation tending to have a larger impact during the outbreak.