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BANKING STABILITY INDEX AND

BANKING SECTOR FRAGILITY INDEX:

ADDITIONAL INDICATORS TO MONITOR

INDONESIA BANKING SYSTEM STABILITY

By

Ratna Mutiarani

NIM: 19007099

Undergraduate Program

School of Business and Management

Institut Teknologi Bandung

2010

iii

VALIDATION PAGE





By

Ratna Mutiarani

NIM: 19007099

Undergraduate Program

School of Business and Management

Institut Teknologi Bandung

August 2010,

Validated By

_________________________

Deddy P. Koesrindartoto

NIP: 132 327 713

v





RATNA MUTIARANI

19007099 Examination Date: August 3rd, 2010 Graduation Date: October 23rd, 2010

Undergraduate of Business and Management Program, Institut Teknologi Bandung 2010

Final Project Advisor: Deddy P. Koesrindartoto

ABSTRACT

In Indonesia, Banking stability is substantial in financial stability due to its contribution to the financial stability, identified on the Financial Stability Index (FSI) as many as 80 percent. Therefore, the identification of financial stability appeared on Financial Stability Index (FSI) constructed by Bank Indonesia was giving 80 percent to the value of NPLs. On the other hand, the index specifically identifies the robustness of banking stability itself has not yet conducted by Bank Indonesia, recently. Therefore, the further research would be the applied models were adjusted by using Indonesia data.

This paper, “Banking Stability Index and Banking Sector Fragility Index: Additional Indicators to Monitor Indonesia Banking System Stability”, is suggestions of proposed model that observed from applied models, which can be used for further in identifying banking stability of Indonesia. The writer utilized the models of banking stability, which are conducted by Czech National Bank, and The Arab Bank. The similar background of the countries, data availability, and frequent sources of data that also used by Financial System Stability Bureau (BSSK) – Bank Indonesia in identifying financial system stability contributed as underline backgrounds of using the models from both central bank. The data variables within the models were gathered from General Banks Report or Laporan Bank Umum (LBU), International Financial Statistic (IFS), and Bloomberg. As the indexes would be compared one another to identify which one of them can capture the condition of banking sector based on historical data, the writer also expects to identify as the reasons why both models can differ from each other. The Banking Stability Index (BSI) was developed by Adam Gersl and Jeroslav Hermanek in 2008, while Banking Sector Fragility (BSF) index was developed by Aykut Kibritcioglu in 2003. To be surer of the sensitiveness of indexes to the real condition of banking sector in Indonesia, the writer uses NPLs net without channeling ratio as the representative of Financial Stability Index (FSI). Due to the weight of banking sector, identified by NPLs, contributed 80 percent to the final compounded index, from the discussions and literatures, the writer used this data to support the reason and basic thinking of banking sector stability in applied indexes. To identify whether the applied models are reliable to be used in identifying banking sector stability, the event-based analysis was also done to relate the indexes in 1997 to 2009. Key Words: Financial Stability Index, NPLs Net without Channeling Ratio, Banking Stability Index, Banking Sector Fragility Index

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RATNA MUTIARANI 19007099

Examination Date: August 3rd, 2010 Graduation Date: October 23rd, 2010

Undergraduate of Business and Management Program, Institut Teknologi Bandung 2010

Final Project Advisor: Deddy P. Koesrindartoto

ABSTRAKSI Di Indonesia, stabilitas perbankan merupakan hal yang sangat dibutuhkan dalam stabilitas keunganan dikarenakan kontribusi yang diberikan untuk stabilitas system keuangan di Indonesia yang proporsinya sebesar 80 persen untuk stabilitas keuangan secara keseluruhan. Oleh karena itu, identifikasi pada stabilitas keuangan yang diukur pada Indeks Stabilitas Keuangan (FSI) yang dibuat oleh Bank Indonesia yang 80 persen komposisis index tersebut berasal dari pengaruh sector perbankan, terutama nilai dari non-performing loans. Di lain pihak, index yang secara spesifik mengidentifikasi kekuatan dalam stabilitas perbankan sampai dengan saat waktu penulisan belum dibangun oleh Bank Indonesia. Makalah, “Banking Stability Index and Banking Sector Fragility Index: Additional Indicators to Monitor Indonesia Banking System Stability”, dibuat sebagai media untuk mengeluarkan gagasan pada model yang dapat digunakan dengan menggunakan model yang telah digunakan sebelumnya di beberapa negara, yang kemudian dapat pula digunakan di Indonesia. Dalam Tugas Akhir ini, penulis mengajukan dua model untuk mengukur stabilitas perbankan yang dirncang oleh Czech National Bank (CNB), and The Arab Bank. Latar belakang yang sama dari kedua negara tersebut dengan Indonesia, keberadaan data yang dibutuhkan untuk keduanya, dan variabel yang juga tersedia di Biro Stabilitas Sistem Keuangan (BSSK) – Bank Indonesia dalam mengidentifikasi system stabilitas keuangan merupakan latar belakang yang mendasari dari penggunakan kedua model tersebut. Data variabel yang harus dikumpulkan sebagai variabel pendukung dari kedua index tersebut dikumpulkan dari Laporan Bank Umum (LBU), International Financial Statistic (IFS), dan Bloomberg. Sebagai index yang kemudian akan dibandingkan satu sama lain untuk menganalisa satu dari kedua model atau keduanya yang paling dapat mengidentifikasi kondisi perbankan berdasarkan data historical, dan juga untuk mengidentifikasi alasan terkait dengan hal tersebut. Banking Stability Index (BSI) yang dibangun oleh Adam Gersl dan Jeroslav Hermanek pada tahun 2008, sedangkan Banking Sector Fragility (BSF) index dibangun oleh Aykut Kibritciogly pada tahun 2003. Untuk lebih memastikan dalam kesensitifan kedua index dalam kondisi sebenarnya di Indonesia, penulis menggunakan perbandingan atas hasil yang ditunjukkan kedua index dalam mengidentifikasi keadaan sebenarnya dengan menggunakan NPLs net Tanpa Channeling sebagai representatif dari Indeks Stabilitas Keuangan (FSI) dan juga analisis berdasarkan analisa kejadian-kejadian terkait selama tahun 1997 sampai tahun 2009. Kata Kunci: Indeks Stabilitas Keauangan, NPLs Net tanpa Channeling Rasio, Banking Stability Index, Banking Sector Fragility Index

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FOREWORD

As the beginning process of compiling this Final Project, I was joining the 4-month

internship as the fulfillment of internship program in Bank Indonesia. During these 4 –

months I found my interest on identifying financial system stability due to the existence

of Financial Stability Index (FSI) to identify the financial stability condition in

Indonesia. I tried to have discussions with the researchers at Banking System Stability

Bureau (BSSK), about FSI and the result was giving me assurance that the identification

of financial stability would give more complexity and also banking stability aspects

were less than this. Therefore, I was tried to find out the banking sector stability that

still able to cope with. After joining in BSSK for 4-months internship, I was allowed to

continue my study there by having a permission to continue my final project

compilation there. I had two months permission to further consult my final project.

By the best opportunity that I can have from the internship and research in Bank

Indonesia, I want to shout out loud, Alhamdulillahirobbilalamin, finally the completion

of my final project has finished, as this is the only hope that I begged to Allah due to the

complexity of the analysis and the lack of knowledge of Economics that sometimes

came to mind and tried to slower down the progress. However, when I wrote this

foreword, I thought all of the fears were stood behind with only me who can move

along. Although there were many things interfering, such as pursuing the career

opportunity, illness, social activities, and other things except final project, my smiles

and confidence were not only coming from myself but also from the supporters as I may

count one by one on the followings:

• Allah SWT, for the chances for me to still alive and given times for studying and

playing, and also be grateful for all things that You gives in this living years;

• Dearest parents; papa and mama, thank you for being my parents since 21 years

ago, and still gave me anything that I need to support my study from smallest to

the biggest things in these years;

• My final project counselor, Pak Deddy P. Koesrindartoto for being the one who

really stated on evaluating, advising, complaining, alleviating, adding

something, and giving deadlines of the report, and also providing enough times

for having discussions;

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• My field mentor in Bank Indonesia, and also the rest of researchers; Ita Rulina,

Suharso, Noviati, Advis Budiman, Elis Deriantino, Louvti R. Sidabalok, Dino

Harris D.P., Heny Sulistyaningsih, Reska Prasetya, Primitiva Febriarti, and I

Made Yogi, who always the very best friends of to have discussion with, and

also gave advices of the models that applied, and event analysis;

• My family who always stand behind, Bu Dedeh Kurniatin, Om Ahmad, Gilang

and Gilar, my greatest family in Bandung;

• My academic administration officers: Bu Ikum, Pak Setiawan, Bu Lia, for

always providing the best suggestions regarding to administrative requirements;

• My beloved best friends; Mega Pratiwi, Dyta Tri Utami, Alma Elizabeth,

Kartika Anisa, Hazrati Ramadhany, Raisa Aliya R., Kara Querida B, P. Agni

Parahita, Bhre Sandhya, Hadi Rama Putra, Ahmad Reizky A., Krisna Uvala H.,

Julian Kamil, and Yulia Wulandari who always stand beside in any feeling and

in needs of attention and also being my best cheerleaders;

• The rest of Deddy’s Children; Firra A., Hasya M., Hanel Topada, Satria Rezky

P., Erik K, and Prisca Okke, who always gave the best for our finest advisor;

• And also the Batch of 2010 who cannot be mentioned one by one, who always

encourage to each other, have time together and always be the greatest friends;

Thank you for the rest of your times and efforts to encourage me to complete

this final project, and give most of the times of yours to still have quality times

that always going to be remembered.

By the existence of this final project about banking sector stability, I hope further

project regarding to the findings on the real index that can be contributed for further

identification of banking sector stability can be developed, or to continue the findings

regarding to banking sector stability, specifically, and other Economics aspects that can

be further discussed to broaden our knowledge. The most perfect is owned by Allah,

any mistake was coming from human, and do not hesitate to corrected.

Bandung, July 23rd, 2010

Ratna Mutiarani

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TABLE OF CONTENTS

VALIDATION PAGE ............................................................................................... iii

ABSTRACT (English Version) ................................................................................. v

ABSTRACT (Indonesian Version) ............................................................................ vii

FOREWORD ............................................................................................................. ix

TABLE OF CONTENTS ........................................................................................... xi

LIST OF FIGURES ................................................................................................... xiii

LIST OF TABLES .................................................................................................... xv

LIST OF ABBREVIATIONS .................................................................................... xvii

LIST OF APPENDICES ............................................................................................ xix

“Banking Stability Index: An Additional Indicator to Monitor Indonesia Banking

System Stability”

CHAPTER I INTRODUCTION 1.1 Research Background .................................................................................... 1

1.2 Problem Identification ................................................................................... 3

1.3 Research Objectives ....................................................................................... 4

1.4 Research Scope and Assumptions ................................................................. 4

1.5 Writing Structure ........................................................................................... 5

CHAPTER II LITERATURE STUDY

2.1 Definition of Financial System Stability ....................................................... 10

2.1.1Financial System Stability Factors ........................................................ 12

2.1.2Monetary Stability and Financial System Stability ............................... 12

2.1.3Role of Macroprudential and Microprudential

to Financial System Stability ............................................................... 13

2.1.4Financial Stability Index ....................................................................... 14

2.2 Definition of Banking Sector Stability ......................................................... 15

2.2.1Bank Runs and Liquidity Risk .............................................................. 16

2.2.2Lending Boom, Non-Performing Loans, and Credit Risk .................... 16

2.2.3Bank’s Unhedged Foreign Liabilities, Devaluation,

and Exchange-Rate Risk ...................................................................... 17

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CHAPTER III METHODOLOGY

3.1 Introductory Survey ...................................................................................... 19

3.2 Literature Study ............................................................................................ 20

3.3 Problem Formulation .................................................................................... 20

3.4 Data Collection ............................................................................................. 21

3.5 Comparative Analysis ................................................................................... 22

3.5.1Non Performing Loans (NPL) Net without Channeling ....................... 22

3.5.2Banking Stability Index (BSI) Applied by Czech National Bank ........ 23

3.5.3Banking Sector Fragility (BSF) Applied by the Arab Bank ................. 27

3.6 Discussion ..................................................................................................... 30 3.7 Conclusion .................................................................................................... 31

CHAPTER IV DATA ANALYSIS

4.1 Banking Stability Index (BSI) and

NPLs Net Without Channeling Ratio............................................................. 33

4.2 Banking Sector Fragility (BSF) Index and

NPLs Net without Channeling Ratio ............................................................. 44

CHAPTER V CONCLUSION & RECOMMENDATION

5.1 Conclusion ..................................................................................................... 51

5.2 Recommendation ........................................................................................... 52

REFERENCES ......................................................................................................... 52

APPENDIXES .......................................................................................................... 55

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LIST OF FIGURES

Figure 2.1 FSI 1996-2010 .......................................................................................... 15

Figure 3.1 Research Steps ......................................................................................... 19

Figure 3.2 BSI Adjusted Equation ............................................................................ 25

Figure 4.1 Partial Indicators of BSI; CAR, NPLs Gross, ROA ................................ 33

Figure 4.2 Partial Indicators of BSI; Quick Asset/ Client’s Deposit,

Monthly Net Balance Sheet/ Total .......................................................... 33

Figure 4.3 Plotted Banking Stability Index (BSI) and NPLs net without

Channeling Ratio ....................................................................................... 36

Figure 4.4 Exchange Rate of IDR to US$ in January 2001 to December 2009 ....... 41

Figure 4.5 FSI in 2003 to 2009 ................................................................................. 43

Figure 4.6 IHSG in 2001 to 2009 ............................................................................. 43

Figure 4.7 Partial Indicators of BSF index December 1996 to December 2009 ...... 45

Figure 4.8 BSF Index of Indonesia Banking Sector in December 1996 to

December 2009 ........................................................................................ 46

Figure 4.9 BSF in Period of January 2001 to December 2009 plotted with

NPLs Net without Channeling Ratio ......................................................... 46

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LIST OF TABLES

Table 2.1 Comparison of Monetary and Financial Stability ..................................... 12

Table 2.2 Comparison of macroprudential and microprudential approaches ........... 14

Table 3.1 Amount of Operated Banks in Indonesia from 2001 to 2009 ................... 21

Table 3.2 Partial Indicators in conducting BSI ......................................................... 23

Table 3.3 Rearranged Partial Indicators of BSI as consideration of

Indonesia Banking Sector ......................................................................... 25

Table. 3.4 Changes in the BSF Index and the Five Phrases of a

Hypothetical Banking Crisis .................................................................... 30

xvii

LIST OF ABBREVIATIONS

BFS Banking Fragility Index

BI Bank Indonesia

BSI Banking Stability Index

BSSK Financial System Stability Bureau (Biro Sistem Stabilitas Keuangan)

CAMELS Capital Adequacy, Asset Quality, Management Soundness, Earnings and

profitability, and Liquidity and Sensitivity

CAR Capital Adequacy Ratio

CPI Customer Price Index

FSI Financial Stability Index

FSIs Financial Soundness Indicators

IDR Indonesian Rupiah

IFS International Financial Statistic

IMF International Monetary Fund

LBU Banking Monthly Report (Laporan Bulanan Bank Umum)

NOP Net Open Position

NPLs Non-Performing Loans

PPAP Loan Loss Provision (Penyisihan Penghapusan Aktiva Produktif)

ROA Return on Assets

ROE Return on Equity

SBI Bank Indonesia Rate

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LIST OF APPENDICES

APPENDIX I Banking Stability Index (BSI) variables’ value .......................... 57

APPENDIX II Banking Sector Fragility (BSF) Index variables’ value .............. 58

APPENDIX III Bank Indonesia Regulation Number 7/49/PBI/2005:

The consideration fully on the banks’ liquidity and

the condition of economy that matters to increase

the remuneration of obligatory statutory reserves

in rupiahs at Bank Indonesia ....................................................... 59

APPENDIX IV Bank Indonesia Regulation Number 8/1/PBI/2006:

The Emergency Financing Facility ............................................. 60

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