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Do Banks Respond to Capital Requirement? Evidence from Indonesia

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  • Rasyad A. Parinduri

    (Singapore Centre for Applied and Policy Economics, National University of Singapore)

  • Yohanes E. Riyanto

Abstract

Using dynamic panel data models, we examine the effect of capital requirement on banks behavior in Indonesia. We find inconclusive results. Some banks tend to comply with capital requirement : They increase their capital ratio when their CAR is lower than, or falling towards, the eight percent regulatory minimum. However, most of our results are statistically significant at 20-30% level of significance only. Moreover, our results are mostly driven by private domestic banks and heavily-undercapitalized banks that were closely monitored by regulator in the aftermath of the 1998 crisis. Whether, in normal circumstances, banks in developing countries like Indonesia comply with capital requirement, therefore, remains questionable. This implies that, if regulators in developing countries continue relying on capital regulation, they would also need to improve their supervision capacity, increase the transparency of financial reporting, and strengthen market monitoring of banks.

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Bibliographic Info

Paper provided by East Asian Bureau of Economic Research in its series Finance Working Papers with number 21932.

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Date of creation: Sep 2007
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Handle: RePEc:eab:financ:21932

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Keywords: banking crisis; capital requirement; bank regulation; dynamic panel data;

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  1. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, Elsevier, vol. 87(1), pages 115-143, August.
  2. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, Elsevier, vol. 126(1), pages 25-51, May.
  3. Rime, Bertrand, 2001. "Capital requirements and bank behaviour: Empirical evidence for Switzerland," Journal of Banking & Finance, Elsevier, Elsevier, vol. 25(4), pages 789-805, April.
  4. Jeffrey M. Wooldridge, 2001. "Econometric Analysis of Cross Section and Panel Data," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262232197, December.
  5. Shrieves, Ronald E. & Dahl, Drew, 1992. "The relationship between risk and capital in commercial banks," Journal of Banking & Finance, Elsevier, Elsevier, vol. 16(2), pages 439-457, April.
  6. Frank Heid & Daniel Porath & Stéphanie Stolz, 2003. "Does Capital Regulation Matter for Bank Behavior? Evidence for German savings banks," Kiel Working Papers, Kiel Institute for the World Economy 1192, Kiel Institute for the World Economy.
  7. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  8. Raj Aggarwal & Kevin T. Jacques, 1998. "Assessing the impact of prompt corrective action on bank capital and risk," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Oct, pages 23-32.
  9. João A. C. Santos, 2000. "Bank capital regulation in contemporary banking theory: a review of the literature," BIS Working Papers, Bank for International Settlements 90, Bank for International Settlements.
  10. Mari Pangestu & Manggi Habir, 2002. "The Boom, Bust and Restructuring of Indonesian Banks," IMF Working Papers, International Monetary Fund 02/66, International Monetary Fund.
  11. Milne, Alistair, 2002. "Bank capital regulation as an incentive mechanism: Implications for portfolio choice," Journal of Banking & Finance, Elsevier, Elsevier, vol. 26(1), pages 1-23, January.
  12. Jacques, Kevin & Nigro, Peter, 1997. "Risk-based capital, portfolio risk, and bank capital: A simultaneous equations approach," Journal of Economics and Business, Elsevier, Elsevier, vol. 49(6), pages 533-547.
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