Do Banks Respond to Capital Requirement? Evidence from Indonesia

Rasyad Parinduri and Yohanes Riyanto

Finance Working Papers from East Asian Bureau of Economic Research

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.

Keywords: banking crisis; capital requirement; bank regulation; dynamic panel data (search for similar items in EconPapers)
JEL-codes: C23 G21 G28 (search for similar items in EconPapers)
Date: 2007-09
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Journal Article: Do banks respond to capital requirements? Evidence from Indonesia (2011)
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