The existence of Rural Bank in Indonesia has a specific purpose; to provide financial services for low-income people and micro-Small enterprises (MSE) both in Urban and rural areas. Based on the (Greuning et al., 1999) categorization of microfinance institutions (1999), Islamic Rural Bank can be included as category C of MFIs whose sources of funds mainly contribute from the public in a limited product to raise funds because Islamic Rural Bank can only provide savings and time deposits supervised by the supervisory agency.

Initially, the Banking Law stated that Islamic Rural Banks (IRB) operations were relatively limited, covering activities to raise savings and provide financing as well as to diversify portfolios on deposit in Islamic commercial banks. Furthermore, Islamic Rural Banks are prohibited from providing financial services on demand deposits, issuing cheques, participating in remittance businesses, adopting business in foreign currency, capital investment, and conducting insurance businesses.

Based on Law No. 4 of 2023, IRB now allowed to provide remittance services and foreign currency exchange. However, it is still not permitted to provide demand deposit services, or foreign currency transactions, and there is a restriction on operating area (up to two/three neighboring provinces). Generally, Islamic Rural Bank has relatively similar objectives and characteristics to other MFIs. MFIs have two main objectives that must be achieved at once; sustainability and outreach. MFIs in running their business have to generate a decent profit so that their activities can be sustainable. MFIs are responsible for broadening their financial services to give low-income people affordable and inclusive services (Source Title, 2013).

Islamic Rural Bank assets, which are one of the microfinance institutions have been increasing exponentially for the past 15 years (Financial Services Authority of Indonesia, 2023). The tight competition in the microfinance segment and the requirement to be sustainable can hamper their responsibility to provide inclusive financial services(Assefa et al., 2013). Besides, the government enforces Commercial banks to provide their services in the MSE segment by raising the ratio of MSE loans to 30% of total financing (Department of MSMEs and Consumer Protection, Bank Indonesia, 2023).

How Islamic Rural Bank can maintain sustainability and outreach goals amid high competition in the micro and small financial services have discussed by (Muhari & Hosen, 2015), (Agustina et al., 2019), (Devi & Firmansyah, 2018),(Moechdi et al., 2016), (Muhammad et al., 2020),(Risfandy et al., 2019), (Risfandy & Pratiwi, 2022)(Sudarsono et al., 2021), (Trinugroho et al., 2018), and (Wasiaturrahma et al., 2020).

Prioritizing sustainability goals can hamper low-income people who have limitations in accessing financial services, on the other hand prioritizing outreach goals by reaching more low-income people cannot guarantee MFI sustainability. Thus, IRB must be able to remain efficient to be able to balance these two objectives (Muhari & Hosen, 2015). This research examines how Islamic Rural Bank as one of the microfinance institutions overcomes the trade-off between these goals to remain sustainable and maintain the outreach amid high competition.

In line with (Greuning et al., 1999), (Mersland & Strøm, 2014) defines MFIs as Institutions that lend in small amounts (which sometimes do not require collateral) with relatively short installments and target the groups that are not covered by commercial banking services. The trade-off between sustainability and outreach goals of microfinance institutions has been widely debated (Abeysekera, Oguzoglu, and Thanh, 2014), different results were stated by a study by Arief, Izmuddin & Puteri (2019) who found that sustainability has positive effect on increasing Islamic Rural Bank outreach.

To guarantee the sustainability of microfinance institutions, they need to maintain profitability at optimal levels while at the same time able to minimize the cost of providing financial services(Mersland & Strøm, 2014). The profit margin of microfinance market is relatively higher compared to commercial banking because the financial risk in this segment is relatively high as well (Bandyopadhyay & Shankar 2014). Therefore, many commercial banks are also targeting the micro and small business segment (MSE) to increase profitability (Assefa et al., 2013). Even non-bank financing institutions have started to enter this segment, thereby the level of profitability in financial institutions that were traditionally in the MSE segment was gradually reduced (Henthorne, 1988).

The increased level of competition in the MSE segment has led microfinance institutions to minimize costs that may arise while maintaining profitability levels. However, minimizing costs is a problem for microfinance institutions considering that operationally they have to reach lower-income customers who have limited access to commercial financial services (Mersland & Strøm, 2014). Several factors that can affect the sustainability of Islamic rural banks in Indonesia are the amount of assets, the spread of the cost of funds, and the amount of capital (Moechdi et al., 2016).

It is not uncommon for microfinance institutions to rely on subsidies and grants for operational costs (Doshi, 2010). Instead of receiving donations such as grants or donors, Islamic Rural Banks in Indonesia should be incorporated as Limited Liability Companies (Perseroan Terbatas/PT) to generate profit. Moreover, the subsidies to microfinance institutions can lead to high dependency and be unsustainable when the subsidies are revoked (Kar & Swain, 2014). Therefore, Microfinance Institutions should be able to create sustainability while maintaining outreach to their customers (Tamanni & Liu, 2017) and(Balkenhol, 2007). There are three aspects in understanding the performance of microfinance institutions, namely financial sustainability, service coverage, and the relationship between the two(Mersland & Strøm, 2014).

In addition based on the sustainability aspect, microfinance institutions must be able to provide outreach in financial services to customers, through both savings products and financing products (Abeysekera, Oguzoglu, & Thanh (2014), Kar & Swain (2014), (Balkenhol, 2007), (Luzzi & Weber, 2007)). Not only to raise the quantity but also the financial products are expected to be of higher quality by taking into account customer needs (Tamanni & Liu, 2017). Therefore, it is expected that the financial services needed by lower middle-class people can be bridged by microfinance institutions. Moreover, microfinance institutions or Islamic Rural Bank have an advantage in maintaining close relationships with their customers compared to commercial banks. Among recent technological developments, office services for MFI customers are still needed, especially those in rural areas who require face-to-face services (Meyer, 2013).

Amid microfinance institutions that must be financially independent and are expected to be able to expand financial inclusion, competition is also the main problem for microfinance institutions. This challenging situation is proved by the competitive conditions in this sector in Indonesia, where at least five market players are controlling around 70–80% market share. The microfinance sector is controlled by commercial banks that have micro and small financial services and may be able to achieve outreach goals considering the large amount of capital they have (Tamanni & Liu, 2017). Responding to this competition, microfinance institutions will focus on commercial principles which are feared to sideline their outreach development mission. This shift occurred in small credit institutions in Vietnam, where the goals of outreach were still maintained at the beginning of the institution's establishment and remained in line with the age of the institution (Abeysekera, Oguzoglu, and Thanh, 2014).

Islamic Rural Bank can optimize its performance for both sustainability and outreach purposes by increasing its efficiency. The results of the research suggested by (Wasiaturrahma et al., 2020) suggested that Islamic Rural Banks experience inefficiency when perceived from the financial intermediation approach, whereas, in the production efficiency approach, Islamic Rural Banks are much more efficient. The problem with increasing efficiency lies in the small economies of scale and economies of scope of Islamic Rural Bank because of the requirement of minimum equity.

This is also in line with (Devi & Firmansyah, 2018) which states that capital capacity will affect the efficiency of the Islamic Rural Bank, especially in its role as a financial intermediary institution. (Sudarsono et al., 2021) explains that an increase in assets owned by islamic rural banks has an impact on decreasing profitability, which indicates that there are problems in asset management that should be able to be optimized to generate higher profits. Assefa, Hermes, & Meesters (2013) and (Trinugroho et al., 2018) state that microfinance institutions, including Islamic rural banks, do not have sufficient ability to dominate a wider market compared to commercial banks who have larger equity. Islamic rural banks as microfinance institutions tend to use operational instruments as well as profit optimization to remain competitive. Therefore, the Lerner Index (LI) is more suitable to use in Islamic Rural Bank and other microfinance institutions compared to the Herfindahl–Hirschman index (HHI) in measuring the level of competition for Islamic Rural Bank in the micro, small and medium financial markets.

With this high level of competition, microfinance institutions will respond by diversifying their financial services to retain customers or attract new customers (Assefa et al., 2013). Islamic rural banks are one of the microfinance institutions as well as one of the forms of Islamic banks whose goals are not only to generate profit but also have social concerns such as poverty alleviation, meeting financial needs, and fulfilling spiritual needs (Hassan & Mollah, 2018).

Islamic Rural Bank as a financial institution with Sharia principles also benefits from its status as an Islamic bank, for instance, the high financing margin does not affect customers who have strong religious belief (Risfandy et al., 2019). In line with the objectives of sustainability and outreach, Islamic Rural Bank has many contract innovations both in savings and financing products. Trinugroho, Risfandy & Ariefianto (2018) stated that Islamic banks have more diverse financing characteristics compared to conventional banks. Ideally, Islamic banks manage to finance using contracts based on profit sharing (syirkah), buying and selling (bai'), and leasing (ijarah).

Furthermore, diversification of financing is proven to be able to reduce Islamic Rural Bank margin levels and generate more affordable lending products by Islamic Rural banks. Islamic Rural banks are expected to maintain profitability level while they must expand their inclusive financial services to alleviate poverty (Msellek, 2020). However, (Risfandy & Pratiwi, 2022) suggested that Islamic Rural Banks should focus more on their function as financial institutions compared to diversifying income outside of banking activities after perceiving the impact that occurred on Islamic Rural Banks during the Covid-19 pandemic which had an impact on economic activities. This also considers that the Islamic Rural Bank has a role in optimizing financial services in its niche market, especially for those underserved by commercial financial services.

This study uses time series data from monthly industry data reports of Islamic Rural Bank for more than 14 years from January 2009 to March 2023. This research examines how Islamic Rural Bank achieves sustainability and outreach objectives amid tight market competition in the micro and small enterprise services and lower-income customers. In the first analysis, an estimate of the level of market competition is measured by the Lerner Index (LI) for micro, small, and medium finance. Furthermore, the efficiency analysis of Data Envelopment Analysis (DEA) is used to measure Islamic Rural Bank's efficiency performance which allows estimation of efficiency performance using multiple inputs and outputs to better understand sustainability and outreach goals. In the final stage, a Vector Autoregression/Vector Error Correction Model (VAR/VECM) analysis is used to analyze the relationship between the level of market competition and the efficiency of Islamic Rural Bank in achieving sustainability and outreach objectives. Lerner Index is used to estimate market competition where this index estimates the balance between the output value produced and the average marginal cost incurred by banks, in other words, the Lerner Index will analyze whether banks can monopolize or there is perfect market competition (Gischer et al., 2015). The Formula of Lerner Index of Islamic Rural Banks is explained in Equation (1) and (2).

In determining inputs and outputs in the DEA method, several approaches can be used. (Hadad et al., 2003) explained that there are three approaches used in defining input-output from financial institutions in parametric and non-parametric methods namely; first, the production approach, which perceives financial institutions as producers of deposit accounts and loans; defines output as the sum of those accounts or related transactions. The inputs in this case are calculated as the sum of labor, and capital expenditures on fixed and other material assets. Second, the intermediation approach perceives a financial institution as an intermediary: Changing and transferring financial assets from surplus units to deficit units. In this case institutional inputs such as labor and capital costs and interest payments on deposits, with outputs measured in terms of credit loans and financial investments. Third, the asset approach perceives the primary function of a financial institution as a credit creator. The latter is an asset approach that visualizes the primary function of a financial institution as a credit creator; it is very close to the intermediation approach, where output is defined in terms of assets.

Based on the purpose of Islamic Rural Bank as a part of Microfinance Institutions which has the goal of expanding outreach and continuing to be sustainable, a production approach is used as previous research conducted by (Wasiaturrahma et al., 2020) with the argument that banks provide output in the form of financial services either in savings and financing/lending products. The input component is operational cost, assets, branches, and labor, meanwhile, the output component are number of saving, number of financing, and revenue.

Referring to (Mersland & Strøm, 2014) output component, the Average Savings (AVS) variable which calculates the average amount of savings owned by customers, and Average Financing (AVF) which calculates the amount of financing provided to customers is used as a proxy for Islamic Rural Bank outreach. Another output component is the Islamic Rural Bank revenue variable, which is a proxy for Islamic Rural Bank sustainability. The input component in this study used variables that are the basis for the operation of microfinance institutions, namely assets, operational costs, branch offices, and workforce.

This research empirically proves how market competition can affect the efficiency of Islamic Rural Bank in overcoming trade-offs between sustainability and outreach goals and the results of the study found evidence that Islamic Rural Bank as a microfinance institution able to overcome the trade-off. Islamic Rural Bank can provide inclusive financial services for customers who are not served by Commercial Banks since Islamic Rural Bank competes among tight competition in the micro and small financial service market. Furthermore, Islamic Rural Banks have an advantage in a very segmented niche market, where customers in the religious MSE segment are expected to become loyal customers, considering that Islamic Rural Bank products are in accordance with the beliefs held and have many variations of product development considering the various Islamic contracts. On the other hand, the impact of tight competition in the micro and small financial services segment quite significant to the sustainability and outreach because Islamic Rural Bank tend to focus on maximizing efficiency rather than expanding markets and competing with commercial banks directly. It can be concluded that customers in microfinance institutions need financial services that are able to understand their needs and build strong emotional bonds. Indeed, Islamic Rural Bank must be able to focus on the basic needs of financial services including saving and lending/financing services. Furthermore, this evidence also suggested that the trade-off between sustainability and outreach goals in microfinance institutions, especially Islamic Rural Bank, can be overcome by understanding the characteristics of customers

Empirical findings suggested that Islamic Rural Bank can take an important role in encouraging Islamic financial inclusion by utilizing the role of microfinance functions. The ability of Islamic Rural Bank to achieve outreach goals by providing financial services to the segments who are not served by commercial banks whilst pursuing sustainability can be realized. Amid the recent rapid technological developments, Islamic Rural Bank can be sustainable by keeping in the traditional business model by optimizing and adding new branch offices as well as providing bankers who are capable of maintaining strong relationships with their customers.