Signifikan: Jurnal Ilmu Ekonomi

Volume 9 (2), 2020: 153 - 166

P-ISSN: 2087-2046; E-ISSN: 2476-9223

Determinants of Bank Stability in Indonesia

Rahmatina Awaliah Kasri1*, Chairilisa Azzahra2

*Corresponding author

Abstract
This study aims to analyse the determinant of banks’ stability in Indonesia, which is very important to ensure
that the country’s banking system could be more effective in supporting transmission of monetary policy and
more resilient in facing financial crisis. To achieve the objective, this study collected a comprehensive dataset
from 94 banks in Indonesia, covering both conventional and Islamic banks, during September 2015 - June
2019 period. The data is subsequently analysed by employing dynamic panel data model. The results show
that the main factors that positively influenced banks’ stability in Indonesia are exchange rate, financial
inclusion, asset returns, and credit/financing growth. However, interest rates are found to be negatively
influenced the stability. The findings are expected to provide insights for policy makers and market players in
ensuring that the banks’ stability could be well maintained in Indonesia. The results are also hoped to enrich
literature in economics and banking, particularly in emerging markets like Indonesia.
Keywords: finance, financial intermediation, bank stability

Abstrak
Penelitian ini bertujuan untuk menganalisis faktor penentu stabilitas bank di Indonesia, yang sangat
penting untuk memastikan bahwa sistem perbankan di negara ini dapat lebih efektif dalam mendukung
transmisi kebijakan moneter dan lebih tangguh dalam menghadapi krisis keuangan. Untuk mencapai
tujuan tersebut, penelitian ini mengumpulkan data set yang komprehensif dari 94 bank di Indonesia,
yang mencakup bank konvensional dan syariah, selama periode September 2015 - Juni 2019. Data ini
kemudian dianalisis dengan menggunakan model data panel dinamis. Hasil penelitian ini menunjukkan
bahwa faktor utama yang secara positif mempengaruhi stabilitas bank di Indonesia adalah nilai tukar,
inklusi keuangan, tingkat pengembalian aset, dan pertumbuhan kredit/pembiayaan yang disalurkan
oleh sektor perbankan. Sedangkan, tingkat suku bunga berpengaruh negatif terhadap stabilitas bank.
Temuan ini diharapkan dapat memberikan wawasan bagi pembuat kebijakan dan pelaku pasar dalam
memastikan bahwa stabilitas bank dapat dipertahankan dengan baik di Indonesia. Hasil penelitian ini
juga diharapkan dapat memperkaya literatur di bidang ekonomi dan perbankan, khususnya di negara
berkembang seperti Indonesia.
Kata Kunci: keuangan; intermediasi keuangan, stabilitas bank
JEL Classification: G21

How to Cite:
Kasri, R. A., & Azzahra, C. (2020). Determinants of Bank Stability in Indonesia. Signifikan: Jurnal Ilmu Ekonomi, 9 (2),
153-166. doi: http://doi.org/10.15408/sjie.v9i2.15598.

Received: April 05, 2020; Revised: May 30, 2020; Accepted: June 15, 2020
1, 2
Faculty of Economics and Business, Universitas Indonesia, Campus UI Depok, 16424, Indonesia
Email: [email protected], [email protected]
DOI: htttp://doi.org/10.15408/sjie.v9i2.15598
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Introduction
The importance of maintaining bank stability is an important topic for policy makers,
both in developing and developed countries (Beck et al., 2009). Policy makers and regulators
have devoted much effort to reforming banking systems aimed to improve bank stability in
response to the global financial crisis (Cihak et al., 2016). Additionally, considering that most
economic activity takes place through banking sector, it is important to promote and enhance
the effectiveness of monetary policy transmission mechanisms and efficient allocation of
funding sources in the economy system (Warjiyo, 2006). With such important roles, the
health and stability of banks are two basic things that must be maintained in an economy.
However, in practice, banks instability and failure often occurred. Hence, banking
stability has become a significant problem in many countries worldwide. A number of
literatures suggested that banks stability/instability can be caused by macroeconomic
factors and bank-specific or banks’ fundamentals factors (see, among others, Carretta et al.
(2015); Pascual et al. (2015) and Shim (2019)). In this respect, several banks specific factors
such as capitalization, bank size, profitability and efficiency are found to be determinants
of stability in banking institutions. Furthermore, volatility that occurs in macroeconomic
variables such as economic growth, unemployment, interest rates and inflation can also affect
banks’ risk which can ultimately affect the stability of banks (Nkusu, 2011; Chaibi and Ftiti,
2015; Ghosh, 2015; Karim et al. (2016)). Good performance of bank fundamental factors
supported by stable macroeconomic conditions will certainly improve bank performance and
reduce bank risks.
In relation to this, Pascual et al., (2015) investigated the determinants of banks’
stability in Europe. Proxies of bank risks employed are non-performance loans (NPL) and
bank’s z-score. The study found that the banks’ stability is influenced by equity to total assets,
non-deposit funding to total assets, return on assets, cost to income ratio, bank size, level of
industry concentration, GDP growth, inflation and interest rates. Thus, it was concluded
that the banks’ stability is determined by banks specific factors and macroeconomic factors.
Similar study conducted by Kabir et al., (2015) suggested that the determinants of banks’
stability were bank size, profitability, efficiency and diversification of banks’ income as well
as macroeconomic factors such as GDP growth and inflation. More recently, Shim (2019)
found that stability amongst commercial banks in America is determined primarily by bank
specific factors represented by diversification of loan portfolio, bank size, non-interest share,
brokered deposits and core deposits. Additionally, macroeconomic variables such as GDP
growth and unemployment rate also influenced the bank’s stability.
In Indonesian, only few studies investigate banks’ stability. One of the few studies has
been carried out by Cynthis (2016). The study shows that bank’s fundamental indicators –
including liquidity ratio, bank capitalization, capital volatility and bank ownerships - have
significant influence on stability of conventional banks in Indonesia from 2004 to 2012.
Furthermore, a research conducted by Yusgiantoro et al. (2019) using sample of Indonesian
commercial banks during 2010–2015 time period suggested that market power of banks
and level of total deposits have a positive influence on stability of conventional banks.

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More recently, Rizvi et al. (2019) analysed bank’s stability in Indonesia by using samples
from conventional and Islamic banks. There was a total of 71 banks in the sample, with 64
conventional and 7 Islamic banks. The study concluded that bank specific factors consisting of
bank size, cost to income ratio and diversification of bank products have a negative influence
on bank stability in Indonesia.
In addition to using bank specific factors, few other studies also use macroeconomic
variables to determine bank stability. A study by Karim et al. (2016) found that stability of
banking industry in Indonesia have a long run relationship with macroeconomic factors
during 1999-2013 period. It was also found that the stability is positively related to GDP and
interest rate, meanwhile the relationship was negative with inflation rate (which is proxied
by consumer price index). More recently, Rizvi et al (2019) also shows that GDP growth has
significant positive effect on banking stability in Indonesia during the period of 2005-2016.
More recent data shows that the Indonesian banking system appears to be relatively
stable in the last few years. These could be seen from the values of several banking indicators,
such as CAR and ROA (see Table 1). However, the average Net Interest Margin (NIM) has
tended to fall over the last five years. In terms of efficiency, by looking at the values of the
ratio of operating costs to operating income (BOPO), it appears that the bank’s efficiency has
varied in the last five years albeit there is an indication that they tend to be more inefficient in
2020. Taken together, there is an indication that the banks’ stability has decreased in several
aforementioned aspects in the last few years.

Table 1. Banking Performance Indicators in Indonesia

Indicator (Commercial 2015 2016 2017 2018 2019 2020

Unit
Banks) Q4 Q4 Q4 Q4 Q4 Q1

Capital Adequacy Ratio

% 21.39 22.93 23.18 22.97 23.4 22.83
(CAR)

Return on Asset (ROA) % 2.32 2.23 2.45 2.55 2.47 2.70

Net Interest Margin

% 5.39 5.63 5.32 5.14 4.91 4.96
(NIM)

Operating Expenses/
Operating Income % 81.49 82.22 78.64 77.86 79.39 83.49
(BOPO)

Loan to Deposit Ratio

% 82.48% 82.17% 82.49% 82.28% 82.60% 80.91%
(LDR)

Rp
Total Third-Party Funds 5,952,279 6,570,903 7,177,549 7,667,803 8,280,812 8,269,379
Billion

Total Credit to Third- Rp

4,909,707 5,399,210 5,921,039 6,308,824 6,839,563 6,690,966
Party Billion

Rp
Total Banking Assets 6,095,908 6,729,799 7,387,634 7,913,491 8,562,974 8,385,407
Billion

Total Banking Assets to

% 76.59 75.66 77.28 77.71 77.22 77.15
the Financial Sector
Source: Indonesian Banking Statistics (Financial Services Authority), 2020

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Considering the lack of more recent studies regarding banks’ stability in Indonesia,
particularly studies which include both conventional and Islamic banks’ in the data set,
as well as the tendency that the banks’ in Indonesia tend to be less stable in the past few
years, this study is conducted with the aim to comprehensively analyse the determinant of
banks stability in Indonesia. In modelling the banks’ stability, it attempts to capture both
bank specific factors and macroeconomic factors, which is very important to ensure that
the banking system could be more effective in supporting transmission of monetary policy
and more resilient in facing financial crisis. To achieve the objective, this study also uses a
comprehensive data set of 94 banks in Indonesia that consist of conventional banks and
Islamic banks during September 2015-June 2019 period. The data is estimated using the
dynamic panel data model SYS-Generalized Method of Moments (GMM).
To proceeds, the paper is structured as follow. After this introductory section, section
two explains the methods employed in the study. Section three discusses the findings and
analysis of the study. The final section concludes the study and provides several policy
implications from the findings and analyses of the study.

Methods
Following the aforementioned literature and subsequently in attempt to answering the
research objective, this study employs a quantitative research method. Quantitative research
can be used in response to relational questions of variables within the research. Quantitative
research method can also be used to establish, confirm, or validate relationships and to develop
generalizations that contribute to theory (Leedy and Ormrod, 2001). This research method
is considered suitable to answer the research question which aims to establish relationships
and investigate the factors influencing bank’s stability in Indonesia which is the main focus
of this study.
In terms of data, this study uses secondary data with unbalanced panel data structure.
The data period is quarterly data, starting from September 2015 to June 2019. The data
used includes the data from all 94 commercial banks in Indonesia, which consists of 83
conventional banks and 11 Islamic banks. The data is obtained from the banks’ financial
statement during the abovementioned period. Additionally, macroeconomic data is employed
in the analysis. The data is taken from official publications of Indonesia Financial Services
Authority (OJK), Bank Indonesia, and other official publications.
The panel data is subsequently applied to a dynamic panel data model. The dynamic
model is chosen because it is understood that the relationship between economic variables is
a relationship that is not fixed. In other words, economic variables are not only determined
from current condition of economic variables, but are also determined by time variables in
the previous periods (Baltagi, 2005). Therefore, the application of dynamic data models is
considered more appropriate to be used in describing the actual conditions in economic
analysis.
The estimation model used in this study is the GMM (General Method of Moment)
estimator developed for dynamic panel models by Arellano and Bover (1995) and Blundell

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and Bond (1998). The use of dynamic data panels can be characterized by lagged from the
dependent variable as an explanatory variable (Baltagi, 2005). The used of system-GMM
estimator model is considered to be the most appropriate model due to endogeneity problem
and possible unobserved individual specific effects that are not included in the model.
Furthermore, in this study, the amount of observation time (T) used (i.e. 16 time points) is
less than the number of observations (N = 94 banks), so using GMM estimates is considered
to be able to produce unbiased and consistent estimates (Roodman, 2009). In this respect,
a two-step system-GMM estimation procedure with finite-sample corrected standard errors,
as proposed by Windmeijer (2005), is also employed as this method provides less biased
coefficient estimates and more robust and efficient than GMM’s one-step system (Roodman,
2009).
Based on the concepts and empirical studies explained earlier, it can be suggested
that the determinants of banks’ stability could be categorized into bank specific factors
and macroeconomic factors. The banks’ specific factors includes credit or financing growth
(CFGrowth)1, bank size (BSize), efficiency (BOPO), asset return (ROA), capitalization (ETA)
and loan loss provision (LLP) (see, among others, Bourkhis and Nabi (2013); Pascual et al.,
(2015), Chaibi and Ftiti (2015), Carretta et al. (2015), Yusgiantoro et al. (2019) and Rizvi et
al. (2019)). Meanwhile, the macroeconomic factors include GDP growth (GDPG), inflation
(INF), interest rate (IR) and exchange rate (ER), which were previously found to affect banks’
stability (Z-score) by many studies (see studies such as Nkusu, 2011; Chaibi and Ftiti, 2015;
Ghosh, 2015 and Rizvi et al. (2019)). With this perspective, the following empirical model
is proposed:

(1)

In equation (1), Ln Z-score is the dependent variable of this study that is also the
proxy of bank’s stability. The use of natural logarithms on the z-score variable is intended
to avoid the possibility of high skewness or extreme values in the data (Pascual et al, 2015;
Imbierowicz and Rauch, 2014; Carretta et al., 2015). This is considered suitable in accordance
with the conditions of the banking data in Indonesia, in which there are some extreme values
(outliers) that can reduce robustness of the estimation. The IBit variable is the dummy for
Islamic banks (IB=1 for Islamic bank and IB = 0 for conventional banks). Furthermore, the
use of lagged periods t-1 and t-2 is in accordance with what was initiated by Roodman (2000)
in the estimation of dynamic panel data models using Generalized Method of Moments
(GMM). The use of lagged z-score periods t-1 and t-2 is adjusted to the use of an appropriate
model, where there is significant autocorrelation in the first and second lagged, but in the
third lagged and so on it is not significant so it is not suitable for use in the model research.

1
Credit refers to financing provided by conventional banks, while financing refers to financing provided by Islamic banks.

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Table 2 presents summary of the operational variables, which consists of bank z-scores,
bank specific factors and macroeconomics variables. It also summarizes the hypotheses of
the study. Overall, it is hypothesized that the bank’s z-score in the previous period, asset
return (ROA), capital adequacy ratio (CAR) and capitalization (ETA) variables are positively
influencing banks’ stability in Indonesia. Meanwhile, CFGrowth, bank size (BSize), net
interest margin/net return (NIM/NR), efficiency (BOPO), and loan loss provision (LLP) are
negatively influencing the banks’ stability.

Table 2. Summary of Operational Variables and Hypothesis Developed

Type of
Name Variable Definition Hypothesis Source of Data
Variable

Dependent Bank Z score Logarithm natural of bank z Lnbzsi,t-1 and Quarterly Published
score. Lnbzsi,t-2 has Financial Reports
Bank z-score: ((return on asset/ positive influence from the Financial
equity to asset ratio)/sd. return (+) Services Authority
on asset) (OJK)

Bank specific variables

Independent Credit and Growth of total credit and CFGrowth (-) Quarterly Published
Financing financing ((difference between Financial Reports
Growth total CFt - total CFt-1)/total from the Financial
CFt-1)) (%) Services Authority

Bank Size Logarithm natural of total asset LnBSize (-)

Return on Profit before tax/Average Total ROA (+)

Asset Asset (%)

Capital Minimum Capital Requirements CAR (+)

Adequacy (%)
Ratio

Net Interest Differences between interest NIM/NR (-)

Margin or Net income minus interest costs (%)
Return

Capitalization Total Equity/Total Asset (%) ETA (+)

Efficiency Operational costs/operational BOPO (-)

income (%)

Loan Loss (Loan loss provision of financial LLP (-)

Provision asset / Total asset)

Macroeconomics variables

Economic GDP growth rate (%) GDPG (+) Bank Indonesia

Growth

Exchange rate Rupiah Exchange Rate against ER (-)

US Dollar (Rp)

Interest rate Interest rate (%) IR (-) BPS

Inflation rate Inflation rate (%) Inf (-)

Financial Bank Branch/100.000 adult FI (+) Bank Indonesia

Inclusion population in Indonesia

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It is also worth to note that prior to estimating the model, several model specifications
tests have been conducted to get consistent and efficient parameter estimators. The specification
tests used in the GMM model follow two stages, namely (i) Sargan-Hansen test, which is
used to determine the validity of instrument variables that exceed the estimated number of
parameters (overidentifying restrictions), and (ii) Autocorrelation test, which is employed to
see whether there is no autocorrelation in the first and second orders of residuals (Ghosh,
2015). The test used is Arellano-Bond test using AR (1) and AR (2) with the null hypothesis
is no autocorrelation (Elitza, 2007). Once the model passed the tests, then the GMM model
could be estimated. The results are explained in the next section.

Results and Discussion

As explained earlier, before estimating the model, two specification tests are conducted.
The results are presented in Table 3.

Table 3. Specification Test Result

No Type of Test Statistical Value P Value

1 Arrelano Bond Test:

AR (1) -3.54 0.000

AR (2) -0.36 0.718

2 Sargan/Hansen Test:

Hansen Test 57.80 0.238

From the results of the specification tests presented in Table 3, it can be seen that the
value of AR (1) shows a significant result with p-value of 0.000. This indicates that H0 is
rejected, which means that there is a first order serial correlation. Whereas for AR (2), the
opposite result is found in which the p-value of AR (2) is 0.718 (p value > 0.05); suggesting
that the null hypothesis fails to be rejected. Thus, there is no second order serial correlation
in the empirical model. Furthermore, the Hansen p-value test is found to be 0.238 (P value
> 0.05), which shows that the null hypothesis could not be rejected. These results imply that
there is no over identification of the model, and hence the instruments used in this model is
valid. Consequently, the abovementioned model could be further estimated.
Table 4 shows the results of dynamic data panel model of banking stability using SYS-
GMM. From the estimation results, it is found that variable Lnbzs are negatively influenced
by Lnbzs (t-2) and positively influenced by Lnbzs (t-1). These results indicate that banks’
stability in Indonesia changed very quickly in the short term. Even though in the past two
periods the banks were unstable, they could become stable at t = 1 if other independent
factors encourage their stability. These factors came from both banks’ internal and external
factors, such as Indonesia’s macroeconomic conditions that were also quite volatile but still
positive during the research period (as will be elaborated later). In other words, the banks
stability today is more determined by the stability of the banks in the previous period.

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Empirically, the estimation results are supported by research conducted by Pascual et

al (2015), Carretta, et al. (2015) and Morgan and Pontines (2014) which shows that variable
of bank stability in the previous period had a significant effect on the bank stability variable
in the future, which in this study was for a period of 3 months. More specifically, an increase
in the value of Zscoret-1 by 1 percent will have an effect on an increase in banks Zscore by
0.43 percent in the upcoming quarter. This shows that in the short term period of 3 months,
banks that were currently in stable condition, tend to still be in sound and stable condition.

Table 4. Dynamic Data Panel Estimation Results

Dependent Variable: Ln Bank Z Score

Independent Variable: Initial Hypothesis Coefficient t Statistic
Lnbzs (t-1) (+) 0.432*** 3.52
Lnbzs (t-2) (+) - 2.502** -2.00
Dummy Islamic Banks (+) - 0.018 -0.02
CFGrowth (-) 0.019** 2.09
ROA (+) 0.321* 1.71
LnBSize (-) 0.151 0.72
CAR (+) 0.034 1.27
NIM (-) - 0.034 -0.49
ETA (+) - 4.159 -1.09
BOPO (-) 0.024 0.78
LLP (-) 0.017 0.19
FI (+) 0.593* 1.90
GDPG (+) - 0.383 -1.21
ER (+) 0.000** 2.45
IR (-) - 0.123** -2.07
Inf (-) 0.087 1.13
Observation 1058
Prob F - Statistic 0.000
AR(1) (p value) 0.000
AR(2) (p value) 0.718
Hansen test (p value) 0.238
Notes: CFGrowth = Credit and financing growth, ROA = Return on asset, BS = Bank size, CAR = Capital adequacy ratio, NIM
= Net interest margin, ETA = Equity to total asset, BOPO = Bank efficiency, dan LLP = Loan loss provision; FI = Financial
inclusion, GDPG = GDP growth rate, ER = Exchange rate, IR = Interest rate dan Inf = Inflation; *** significant at 1%, **
significant at 5% dan * significant at 10%.

Furthermore, credit/financing growth (CFGrowth) variable shows a significant positive

result at five percent confidence level. This implies that credit and financing growth could
increase bank’s stability. While this result is different from the finding of Foos et al. (2010),
which shows that credit growth will have an impact on increasing credit risk for the next three
years, this result is actually possible if increased in credit/financing growth is accompanied

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by high profitability and bank capital. As pointed out by Buchory (2015), a decline in bank
assets’ quality will have an impact on bank stability if not accompanied by high profitability
and bank capital. In other words, high profitability and bank capital are the conditions to
quality credit/financing growth that subsequently support in ensuring banks’ stability.
As shown in Table 5, over the past 5 years credit and financing have always increased
in both conventional and Islamic banks. These were accompanied by an increase in banks’
profits and capital, albeit with varying growth rates. The growth in the volume of loans/credits
and financing disbursed by the banks indicates that banks can convert their liabilities into
productive assets, which subsequently generated profits. Therefore, it can be concluded that
the increase in credit and financing can be followed by good quality of credit and financing
growth so it produced increasing profits and thus bank’s capital. These have presumably
caused a significant positive effect on bank stability.

Table 5. Credit and Financing Growth, Total Profit and Total Capital by Banks in Indonesia

2015 2016 2017 2018 2019 2020

Indicator Unit
Q4 Q4 Q4 Q4 Q4 Q1

Conventional Banks:

Total Credit to Third-Party Rp Trillion 5,953 6,571 7,177 7,668 8,281 8,269

Total profit Rp Trillion 104.63 106.54 131.16 150.01 156.49 42.83

Total bank capital Rp Trillion 914.66 1,052.6 1,166 1,269.62 1,377.56 1,311.59

Islamic Banks:

Total Financing to Third-Party Rp Trillion 219 255 293 329 347 346

Total profit Rp Trillion 0.98 1.43 1.7 3.81 5.60 6.48

Total bank capital Rp Trillion 23.41 27.15 31.11 36.76 40.72 41.75
Source: Indonesian Banking Statistics (Financial Services Authority), 2020

The next variable that has a significant positive influence on the banks’ stability is
return on asset (ROA). ROA is a reflection of bank’s profitability, as the value of ROA reflects
how banks manage their asset to minimize non-performing asset and improve banking
stability. This result is consistent with the findings of Kabir et al., (2015) and Pascual et al.,
(2015) which states that there is a positive influence between return on assets and banking
risk as measured by z-score. Indeed, data shows that ROA of banks’ in Indonesia always
show improvement during the research period, which indicate the consistency of Indonesian
banks in managing their productive assets to generate high profits. This is in line with the
aforementioned trend of increase in credit and financing growth that also occurred during
the study period.
Next, there are three macroeconomic variables that empirically have an influence on
the banks’ stability, namely financial inclusion, exchange rate and interest rate. It is found
that the level of financial inclusion, proxied by the number of banks’ branches, has a positive
effect on banks’ stability in Indonesia. The result is consistent with the studies conducted by

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Neaime and Gaysset (2018) and Albaity et al., (2019) which show the positive influence of
financial inclusion on financial stability. Increasing bank services through bank branches will
certainly have an impact on the community that has not been reached by the bank’s financial
services, particularly in terms of increasing the deposits base for the banks. In addition,
closeness of banks’ location to its customers will reduce the information asymmetry, thus
will subsequently have an impact on improving bank performance (DeYoung and Torna,
2013). Another area where financial inclusion could foster financial stability is by improving
the process of intermediation between savings and investments. A wider customer base for
banks could expands their balance sheets to new areas of business and makes them more
risk diversified and resilient to withstand unexpected losses. The higher level of financial
inclusion, the easier the public access to the most important financial services, i.e. saving,
such that increasing bank stability in terms of saving funds will be more easily achieved.
In line with these, Table 6 shows the development of financial inclusion in Indonesia that
indicated by the growth in the number of bank branches.

Table 6. Banks’ Branches and Financial Inclusion in Indonesia

2015 2016 2017 2018 2019 2020

Number of Bank Branches
Q4 Q4 Q4 Q4 Q4 Q1

Conventional Banks 28,935 30,035 30,256 30,817 31,127 31,007

Islamic Banks 1,990 1,869 1,825 1,875 1,919 1,923

Total Bank Branches 30,925 31,904 32,081 32,692 33,046 32,930

Source: Indonesian Banking Statistics (Financial Services Authority), 2020

Other macroeconomic variable that have a significant positive influence on bank

stability is exchange rate. This result is consistent with Beck et al., (2013) which found that
depreciation of local currency can reduce the occurrence of non-performing loans through
an increase in the company’s export volume, which will subsequently improve the company’s
financial position in paying their obligations (Beck et al, 2013). Moreover, according to
Chaibi and Ftiti (2015), an increase in exchange rate could had a negative effect on bank
risk. This is presumably because depreciation of local currency seems to improve the ability
of people who borrow in foreign currency to service their debts and could increase bank
stability.
Interest rate is another macroeconomic variable that has a significant yet negative effect
on the banks’ stability. The estimation result suggests that an increase in interest rate by one
percent will have an impact on reducing the stability of the banks by 0.12 percent. This is
consistent with the finding of Karim et al (2016), which investigates the banking stability in
Indonesia during 1999-2013 periods. Similar conclusion also shows by Espinoza and Prasad
(2010), which concludes that weakening economic conditions with an indicator of increasing
interest rates could increase non-performing loans and hence reduce bank stability. Pascual
et al. (2015) and Ghosh (2015) also suggested that, while high interest rates will cause bank
margins to increase, it could also head towards bank defaults and affect the banks’ stability.

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Determinants of Bank Stability in Indonesia

Overall, the study found that the stability of banks in Indonesia is influenced by bank
specific factors and macroeconomic factors. Bank specific factors that have a positive effect
on bank stability are credit/financing growth and return on assets. Whereas macroeconomic
variables that have a positive effect on bank stability are financial inclusion and exchange rate
variables. It was also found that interest rate variable has a negative influence on the banks’
stability during the period of observation.

Conclusions
This study aims to analyse the determinant of banks’ stability in Indonesia, which
is very important to ensure that the banking system could be more effective in supporting
transmission of monetary policy and more resilient in facing financial crisis. This study
therefore collected data from 94 banks in Indonesia, consisting of 83 conventional banks
and 11 Islamic banks, during the period of September 2015 to June 2019. The data is
subsequently analysed by employing dynamic panel data model. The findings show that
the main factors that positively influenced banks’ stability in Indonesia are credit/financing
growth, returns on assets, financial inclusion and exchange rate. However, interest rates are
found to be negatively influenced the banks’ stability.
The results of the study has several implications for banking stakeholders in Indonesia.
First, considering that macroeconomic variables (interest rate, exchange rate and financial
inclusions) are the most important determinants of banks’ stability in Indonesia, it is
important that the policy makers are committed to ensure stability of the variables such that
the banks’ stability could be well maintained in Indonesia. Second, as banks’ specific factors
are also influencing the banks’ stability, banking regulators and market players also need to
scrutinize these factors. The regulators should implement policies that could increase or at
least maintain the growth and quality of credit/financing provided by the banks, so that it
could contribute positively towards the stability. Lastly, realizing that this study has several
limitations (such as in terms of sample and model), future research could attempt to expand
this study by utilizing larger sample, longer time period and better model (for example,
by using other measure of banking stability, distuingishing crisis and non-crisis period,
comparing conventional banks and islamic banks, etc). Taken together, the implications of
the study are expected to provide insights for policy makers, market players as well as enrich
literature regarding banks’ stability in Indonesia.

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