Dewi Hanggraeni

This paper examines how competition affects bank fragility and how this relation varies in normal times and during a financial crisis using the data from Indonesian commercial banking industry. The author finds significant evidence, both statistically and economically, that more competition reduces bank fragility. In particular, the author finds that a decrease in Herfindahl-Hirschman Index (HHI) of deposits by 100 points leads to an increase in bank Z-score by 14.22 percent from its mean. Similarly, a decrease in HHI of loans by 100 points leads to an increase in Z36 by 20.44 percent. This finding is consistent across different kinds of robustness tests, including endogeneity, as well as alternative bank fragility and competition measures. However, this competition-stability nexus holds only in normal times and is reversed during a financial crisis. This suggests that the impact of competition on bank fragility is conditional on the economic condition.

It is believed that bank diversification increases financial stability. However, several theories argue that diversification can trigger the spread of failure because of the increased interconnectivity between institutions. The aim of this study is to determine the impact of diversification on the systemic risk of banks. The sample of the study consists of 21 conventional banks listed on the Indonesia Stock Exchange from 2009 to 2018. The study uses firm-year fixed effect panel regression and an instrumental variable approach to examine how firm-specific variables determine the level of systemic risk. Diversification is measured by bank assets, funding, and revenue diversification. To measure the systemic risk, the Conditional Value-at-Risk (ΔCoVaR) methodology is applied. The results show that an increase in funding diversification leads to a decrease in ΔCoVaR, indicating that funding diversification exacerbates the level of systemic risk, whereas asset diversification and revenue diversification do not have significant effects on the level of systemic risk. The empirical findings suggest that the interconnectivity between banks should be reduced by limiting the diversification of funding in the banks to minimize their systemic risks.