Non-Performing Financing Response to Inflation and Exchange Rate Shocks in Indonesian Islamic Commercial Banks: A First-Difference VAR Approach (2019–2025)

Abstract

The quality of Islamic banking assets serves as a foundational indicator of financial system resilience in Indonesia, yet the dynamic transmission of inflation and exchange rate shocks to Non-Performing Financing (NPF) remains underexplored for the post-pandemic period. This study examines the dynamic response of ΔNPF in Indonesian Islamic Commercial Banks and Islamic Business Units to shocks in inflation and the USD/IDR exchange rate, employing a first-differenced Vector Autoregression (VAR) framework. Monthly data spanning January 2019 to June 2025 yield 78 observations; ADF and KPSS tests confirm that all variables are integrated of order one, I(1), while Johansen cointegration tests find no robust long-run equilibrium relationship, justifying a VAR(2) specification in first differences with Cholesky ordering: Exchange Rate → Inflation → NPF. Impulse Response Functions reveal that ΔNPF responses to both inflation and exchange rate shocks are statistically insignificant across the full 1–12 month horizon, with 95% bootstrap confidence intervals crossing zero at every point. Forecast Error Variance Decomposition further confirms that own shocks account for 98.94% of NPF forecast error variance at horizon 12, while inflation contributes only 0.36% and the exchange rate 0.70%. These findings suggest that macroeconomic transmission to NPF during this period is substantially weaker than previous literature implies, consistent with the potential moderating role of OJK's post-pandemic financing restructuring policies and strong path dependency in NPF dynamics; the results underscore the primacy of direct prudential instruments over indirect monetary stabilization in managing Islamic bank asset quality.