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Do banks respond to capital requirements? Evidence from Indonesia

  • Rasyad Parinduri
  • Yohanes Riyanto

Using dynamic panel data models, and addressing a common inappropriate use of simultaneous equation models in the literature, we examine the effect of capital requirements on banks' behaviour in Indonesia. We find that banks tend to comply with capital requirements by increasing their capital ratios when the ratios are lower than, or falling towards, the 8% regulatory minimum. However, our results are mostly driven by large private-domestic banks and heavily undercapitalized banks that were closely monitored by the regulator in the aftermath of the 1998 crisis. Therefore, whether in normal circumstances banks in Indonesia comply with capital requirements remains questionable.

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Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 21 (2011)
Issue (Month): 9 ()
Pages: 651-663

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Handle: RePEc:taf:apfiec:v:21:y:2011:i:9:p:651-663
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  1. Barth,James R. & Caprio,Gerard & Levine,Ross, 2006. "Rethinking Bank Regulation," Cambridge Books, Cambridge University Press, number 9780521855761.
  2. Frank Heid & Daniel Porath & Stéphanie Stolz, 2003. "Does Capital Regulation Matter for Bank Behavior? Evidence for German savings banks," Kiel Working Papers 1192, Kiel Institute for the World Economy.
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  4. 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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  7. Mari Pangestu & Manggi Habir, 2002. "The Boom, Bust and Restructuring of Indonesian Banks," IMF Working Papers 02/66, International Monetary Fund.
  8. Jeffrey M. Wooldridge, 2001. "Econometric Analysis of Cross Section and Panel Data," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262232197, June.
  9. 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.
  10. 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.
  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. 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.
  13. Rime, Bertrand, 2001. "Capital requirements and bank behaviour: Empirical evidence for Switzerland," Journal of Banking & Finance, Elsevier, vol. 25(4), pages 789-805, April.
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