Monetary shock, banking risk and bank lending channel: Evidence from Indonesian banking industry

This study examines the existence of a bank lending channel in the Indonesian banking system and tests whether monetary policy shock is transmitted via bank risk in bank lending activity. We use banking micro-data from 2007 to 2016. Using static and dynamic panel data, we find some contrary results from the US banking evidence, in which less-liquid banks and smaller banks and not highly liquid and larger banks are able to insulate their credit supply against the monetary shock. These types of the banks could raise funds from their business group, loyal depositors, and strong lending relationships to shield their loan portfolio from risk. Additionally, well-capitalized banks face minimal problems raising uninsured funding. Therefore, they can provide more loan supply. Moreover, riskier banks suffer more in their lending supply against monetary policy shock. Even stable banks (characterized by higher Z score) are unable to protect their capacity to channel their loans when interest rates increase. It should be suspected that larger banks convert their loanable funds into short-term investments and also focus on generating income from high-risk non-traditional bank products during the contracting period. Hence, they suffer more with their loan portfolios. This provides a signal for Financial Services Authority (OJK) to scrutiny the behavior of larger banks that might take on riskier businesses. To anticipate this activity, the banking regulator must also refine the minimum loan-to-deposit ratio for different sizes of banks so that they can increase their participation in spurring economic growth.