Cuadernos de Economía

Inflation and Profitability of Commercial Banks – Evidence from Malaysian and Indonesian Banking Markets

  • Mohd Hanafia Huridi , Universiti Kuala Lumpur Business School, 1016 Jalan Sultan Ismail, Kuala Lumpur, MALAYSIA.
  • Mahfuz Abd Malek , Universiti Kuala Lumpur Business School, 1016 Jalan Sultan Ismail, Kuala Lumpur, MALAYSIA
  • Abdul Razak Abdul Hadi , Universiti Kuala Lumpur Business School, 1016 Jalan Sultan Ismail, Kuala Lumpur, MALAYSIA.

Keywords:

Inflation Rate, Bank Performance, Capital Asset Ratio, Return on Equity, Engle-Granger Cointegration Test..

Abstract

Prolonged and uncontrolled inflation can significantly harm an economy, particularly the financial sector. This study seeks to examine the impact of inflation on the financial performance of the banking sectors in Malaysia and Indonesia, given that financial stability within this sector is crucial for sustained economic growth. Grounded in the quantity theory of money, this research utilizes annual secondary data sourced from the World Bank database, spanning from 2005 to 2022. For empirical analysis, the study applies both Ordinary Least Squares (OLS) regression and the Engle-Granger Cointegration (EG) test as estimation techniques. The empirical findings reveal a significant long-term positive relationship between inflation and bank profitability in Malaysia, as measured by both the capital asset ratio (CAR) and return on equity (ROE). For Indonesia, however, a long-term equilibrium is observed only when bank performance is assessed through ROE. Regarding short-term dynamics, neither country demonstrates statistically significant evidence of a short-term relationship between inflation and bank performance. These results suggest that inflation does not exert a substantial detrimental impact on the banking sector over time. The findings indicate that bank profitability in both Malaysia and Indonesia tends to increase with rising inflation. One plausible explanation is that banks may anticipate inflationary trends and adjust accordingly. Nevertheless, this does not eliminate the need for vigilant oversight. Continuous monitoring by the central bank is essential to ensure that banks remain resilient in the face of changing market conditions over the long term.