Assessing the Economy-wide Impacts of Strengthened Bank Capital Requirement in Indonesia using a Financial-Computable General Equilibrium Model

After the 2008 global financial crisis, authorities across the globe stressed the importance of equity capital to absorb losses. While many countries have raised their banks’ capital adequacy requirements (CARs), the comprehensive impact assessment of this policy for emerging economies remains largely unexplored. We use a financial computable general equilibrium (FCGE) model of Indonesia called AMELIA-F to investigate the economy-wide impact of a 100 basis points increase in the CAR of Indonesian banks. We find that this causes small negative consequences on the economy. Bank balance sheets contract as they move away from holding riskier assets. This reduces investment in both non-housing and housing sectors, as equity financing raises banks weighted average costs of capital (WACC). The falling of real investments decreases foreign financing requirement, causing appreciation of the nominal exchange rate.