Income diversification and earnings stability in Indonesian Islamic banks: a U-shaped association

Septian Yudha Kusuma; Arin Pranesti; Nurseto Adhi; Rizki Dini Shandra Yunita

doi:10.21580/jiafr.2026.8.2.31800

Authors

Septian Yudha Kusuma Politeknik Negeri Semarang, Semarang, Indonesia https://orcid.org/0000-0003-3797-5402
Arin Pranesti Universitas Negeri Yogyakarta, Yogyakarta, Indonesia https://orcid.org/0000-0002-6507-3986
Nurseto Adhi Politeknik Negeri Semarang, Semarang, Indonesia https://orcid.org/0009-0007-9623-8898
Rizki Dini Shandra Yunita National Yunlin University of Science and Technology, Yunlin, Taiwan, Province of China https://orcid.org/0000-0003-0394-5942

DOI:

https://doi.org/10.21580/jiafr.2026.8.2.31800

Keywords:

Earning stability, Income diversification, Islamic bank, U-shaped relationship

Abstract

Purpose - This study examines the linear and non-linear relationships between income diversification and earnings stability in Islamic banks in Indonesia, and the direction of this relationship.

Method - This study uses quarterly panel data for 13 Islamic banks for the period Q4 2020 to Q3 2025 (260 observations); it applies fixed effects with Driscoll–Kraay standard errors (lag 4) to address heteroscedasticity and serial autocorrelation. Timing and direction are examined using non-overlapping lagged specifications, reverse regressions, and Dumitrescu–Hurlin panel Granger tests.

Result - No significant linear relationship is found. Instead, diversification and stability show a contemporaneous U-shaped association, with the lowest stability at a diversification level of 0.239. The pattern is robust to winsorization, alternative standard-error lag lengths, and the exclusion of the COVID-19 period, but does not hold when diversification precedes the stability window. Earlier stability is weakly and positively associated with subsequent diversification, indicating feedback from stability to diversification.

Implication - Diversification should not be treated as a standalone strategy for stabilizing earnings. Because most banks lie below the turning point and stability appears to shape diversification choices, diversification decisions should reflect each bank's risk-bearing capacity.

Originality - The study provides evidence of a non-linear, bidirectional relationship between income diversification and earnings stability in Indonesian Islamic banks, showing that the direction of the relationship matters for its interpretation.

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