Many Indonesian banks suffered problems and some even failed in the early 1990s.
This provided evidence that risk-based capital adequacy regulation in Indonesia had
failed to prevent banks from taking excessive risks. Such observations provide the
motivation for this thesis which seeks to identify the nature of bank risks in Indonesia
and also analyses the operation of risk-based capital adequacy regulation in Indonesia.
To obtain a general view of risk in Indonesian banks, this thesis includes an empirical
study to identify the determinants of problem banks in Indonesia using a logit fixedeffect
model. The model also can be used as an "early warning" device in banking
supervision. This study finds that credit risk and operational risk contributed
significantly to banking problems. State banks, non-foreign exchange banks and
regional development banks are shown to be also sensitive to interest rate risk. Foreign
exchange rate risk is less significant for banks (by group) in Indonesia. If we examine
cases individually, however, there were some bank failures which were due to
excessive foreign exchange rate risk.
This thesis also finds that the adoption of risk-based capital adequacy regulation in
Indonesia contains some deficiencies, such as focusing only on credit risk (ignoring
market risk). This study suggests that market risk should be included in capital
adequacy assessment and a number of alternative models of risk assessment
[exponential weighted moving average (EWMA) and generalised autoregressive
heteroscedasticity (GARCH)] are analysed.
The results of the empirical study show that the inclusion of foreign exchange rate risk
in capital adequacy assessment results in a higher capital requirement than that
resulting from the application of the BIS's standardised methodology. This study also
finds that the decay factor of 0.94 suggested by J. P. Morgan (J. P. Morgan, 1995,
1996) is irrelevant for [DR (Indonesian Rupiah) exchange rate returns. Additionally,
assessment of foreign exchange rate risk using GARCH suggests a lower capital
charge than that applicable under the BIS's standardised methodology and EWMA.
The policy implications of these findings are also considered.
A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University.