Can small-medium banks become systemically important? Indonesia evidence

The global financial crisis of 2008 had a major impact on the bailout decision of Bank Century in Indonesia. Considering its enormous bailout cost of IDR 6.76 trillion, the focus shifts from merely looking at bank size to a broader notion of systemic risk. This paper investigates whether factors other than size determine systematic importance of banks. This study measures systematic importance of banks by utilizing the conditional value-at-risk (ΔCoVaR) approach. ΔCoVaR describes the contribution of each bank value-at-risk (VaR) to the value-at-risk of the whole banking system. Based on system-GMM dynamic panel data regression, we find that bank size is still the key determinant of banks’ systematic importance. However, external factors such as interbank money market rate and IDR/USD exchange rate also dynamically affect banks’ systematic importance. Hence, smallmedium size banks can become systemically important banks in Indonesia, especially when interbank money market rate is high and Indonesian Rupiah is depreciating against US dollar. Applying Granger causality test, we also illustrate how a small-medium bank becomes systemically important due to its interconnectedness with other banks. This paper contributes to the extant literature at least in three ways. Firstly, we use unique monthly data of all commercial banks in Indonesia that are both public and private firms. Secondly, we modify CoVaR estimation so that it is applicable to non-publicly listed banks. Finally, to the best of our knowledge this paper is the first to examine the determinants of systematic risk, and to show that small-medium banks can be systemically.