The Impact of Bank Capital Requirements in Indonesia

Abstract

This paper provides new evidence on the effects of bank capital requirements in Indonesia. In investigating the impact of bank capital requirements, we set up a simple model of the banking firm which can detect the impact of capital regulation on banks’ behaviour as well as having possible effects on the economy. In estimation, we use monthly panel data of all the banks that existed between 1997-1999, during which the crisis and regulatory forbearance occurred. Based on our econometric tests, we choose the Fixed Effects panel regression model because the bank specific characteristics are found to be crucial in Indonesia. Overall, the results suggest that regulatory capital takes part in the change of Indonesian banks’ behaviour. Bank credit is found to decelerate but with less than before the Indonesian government implemented a forbearance in capital requirements. The view that banks choose to shrink their balance sheet activities during the capital shocks is consistent with the findings.

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