Digitalization and intermediation inefficiency in micro finance: a study of Indonesia rural banks

Purpose This study aims to investigate the effect of digitalization on intermediation inefficiency in Indonesian rural banks. Design/methodology/approach Using a stochastic frontier analysis (cost function type), the authors estimate a linear model where net interest margin serves as the outcome variable. The variables of interest include the regional digitalization index (RDI) and its interactions with bank size and return on equity (ROE). Control variables include non-performing loans, cost-to-income ratio, liquidity ratio, equity-to-total-assets ratio, ROE and bank size. The model is applied to an annual panel data set of 1,577 rural banks from 2017 to 2023. Findings The authors find that the RDI significantly reduces inefficiency, underscoring the role of digitalization in enhancing intermediation performance in rural banking markets. RDI and its interactions explain approximately 38.3%–43.5% of the variation in inefficiency. Cooperative rural banks exhibit the highest inefficiency (33%), while banks located in rural areas show the lowest mean inefficiency at 0.56%. The results remain robust across various specification checks. Originality/value This study seeks to answer how digitalization (a key current emerging issue), as measured by the RDI, influences intermediation inefficiency in Indonesian rural banks. The significance of this question lies in its potential to demonstrate how digital tools can address the persistent inefficiencies that have long characterized rural banking.