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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 (SCAPE) Department of Economics, National University of Singapore)

  • Yohanes E. Riyanto

    ()
    (Department of Economics, National University of Singapore)

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 National University of Singapore, Department of Economics, SCAPE in its series SCAPE Policy Research Working Paper Series with number 0712.

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Length: 32 pages
Date of creation: 04 Sep 2007
Date of revision:
Handle: RePEc:sca:scaewp:0712

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Web page: http://www.fas.nus.edu.sg/ecs/scape/index.html
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Keywords: banking crisis; capital requirement; bank regulation; dynamic panel data;

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  1. 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, issue Oct, pages 23-32.
  2. 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, vol. 58(2), pages 277-97, April.
  3. Heid, Frank & Porath, Daniel & Stolz, Stéphanie, 2004. "Does capital regulation matter for bank behaviour? Evidence for German savings banks," Discussion Paper Series 2: Banking and Financial Studies 2004,03, Deutsche Bundesbank, Research Centre.
  4. Blundell, R. & Bond, S., 1995. "Initial Conditions and Moment Restrictions in Dynamic Panel Data Models," Economics Papers 104, Economics Group, Nuffield College, University of Oxford.
  5. Jacques, Kevin & Nigro, Peter, 1997. "Risk-based capital, portfolio risk, and bank capital: A simultaneous equations approach," Journal of Economics and Business, Elsevier, vol. 49(6), pages 533-547.
  6. Mari Pangestu & Manggi Habir, 2002. "The Boom, Bust and Restructuring of Indonesian Banks," IMF Working Papers 02/66, International Monetary Fund.
  7. Milne, Alistair, 2002. "Bank capital regulation as an incentive mechanism: Implications for portfolio choice," Journal of Banking & Finance, Elsevier, vol. 26(1), pages 1-23, January.
  8. Shrieves, Ronald E. & Dahl, Drew, 1992. "The relationship between risk and capital in commercial banks," Journal of Banking & Finance, Elsevier, vol. 16(2), pages 439-457, April.
  9. Rime, Bertrand, 2001. "Capital requirements and bank behaviour: Empirical evidence for Switzerland," Journal of Banking & Finance, Elsevier, vol. 25(4), pages 789-805, April.
  10. Jeffrey M. Wooldridge, 2001. "Econometric Analysis of Cross Section and Panel Data," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262232197, December.
  11. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, vol. 126(1), pages 25-51, May.
  12. João A. C. Santos, 2000. "Bank capital regulation in contemporary banking theory: a review of the literature," BIS Working Papers 90, Bank for International Settlements.
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