Does Credit Risk Mediate the Loan Growth–Profitability Relationship? A Panel Study of Rural Banks in East Java

Abstract

This study investigates the impact of capital adequacy, liquidity, and loan growth on the profitability of rural banks (BPRs), with credit risk examined as a mediating variable. Motivated by the declining national trend in BPR profitability, panel data from 21 BPRs in Malang Regency between 2019 and 2023 were analyzed using a random effects model and the Sobel test. Profitability was measured by Return on Assets (ROA), while the explanatory variables included Capital Adequacy was measured by Capital Adequacy Ratio (CAR), Liquidity was measured by Loan to Deposit Ratio (LDR), Loan Growth (LG), and Credit Risk was measured by Non-Performing Loans (NPL). The findings indicate that capital asequacy significantly enhances profitability, while credit risk negatively affect it. In contrast, liquidity and loan growth show no significant direct effect on profitability. Credit risk does not significantly mediate the relationship between loan growth and profitability. These results underscore the critical role of capital strength and credit quality in improving BPR performance, suggesting that liquidity and credit expansion alone are insufficient without effective risk management. This study contributes to the literature by contextualizing profitability dynamics within the post-pandemic recovery period and the Indonesian rural banking sector, offering actionable insights for bank managers and regulators focused on financial sustainability