Comparing Credit Procyclicality in Conventional and Islamic Rural Bank: Evidence from Indonesia
Abstract
Financial instability has been caused by many factors, one of which is the pro-cyclicality of credit expansion. Many empirical studies in developed countries proved that excessive credit during economic booms would be accompanied by financial crisis. In the Indonesian context, Islamic and Conventional rural bank have an important role in the provision of loans since Small Medium Enterprises still dominates economic activity.
This study aims to examine the pro-cyclicality of the credit channeled into Small Medium Enterprises by both conventional and Islamic rural banks in Indonesia; by comparing of both of which are categorized as pro-cyclicality. This study applies both Autoregressive Distributed Lag (ARDL) model to explore the extent to which the pro-cyclicality derived from indicator variables of rural banks may affect the real sector, and frequency-based filter to construct credit/financing cycle characterised by rapid growth in credit from both conventional and Islamic rural banks.
The results of this study demonstrate that in the short term, conventional and Islamic rural credit banks do not follow economic growth. This means, both conventional and Islamic procyclicality do not behave in the short term. However, in the long term when the economy is in the expansion phase, Conventional rural bank tends to be more procyclical than Islamic rural banks. From the capital side, Islamic rural banks compared to Conventional bank show countercyclical behavior both in the short and long term. Moreover, to the credit risk of their bad loans, conventional rural banks have a negative response to the increase in credit risk, while Islamic rural banks are positively affected by credit risk. Finally, the results of frequency-based filter suggest that credit of conventional rural banks and financing in Islamic rural banks have different cycles in response to changing economic conditions.
References
Aikman, D., A. G. Haldane and B. D. Nelson. (2013). Curbing the Credit Growth. The Economic Journal, Bank of England.
Alamsyah, Halim, J. Adamanti, Diana Yumanita, and R. I. Astuti. (2014). Siklus Keuangan Indonesia. Bank Indonesia Working Paper (No. WP/8/2014), December.
Ascarya. (2009). Lessons Learned from Repeated Financial Crisis: An Islamic Perspective. Bulletin of Monetary Economics and Banking 12(1): 27 – 69.
Ascarya. (2016). Testing of the Procyclicality of Islamic and Conventional Banks in Indonesia. In M. Zulkhibri et al. (eds.). Macroprudential Regulation and Policy for the Islamic Financial Industry. Switzerland: Springer International Publishing. pp. 133-152.
Bank for International Settlements. (2008). Addressing Financial System Procyclicality: a Possible Framework. Note for the FSF Working Group on Market and Institutional Resilience.
Borio, Claudio. (2012). The Financial Cycle and Macroeconomics: What Have We Learnt?. BIS Working Papers No 395. (December).
Christiano, L. J. and T. J. Fitzgerald. (2003). The Band Pass Filter. International Economic Review 44(2): 435-465.
Claessens, S., M. A. Kose and M. E. Terrones. (2011). How Do Business and Financial Cycles Interact?. IMF Working Papers (WP/11/88). April.
Craig, R. S., E. P. Davis and A. G. Pascual. (2006). Sources of Procyclicality in East Asian Financial Systems. Hong Kong Institute for Monetary Research and Cass Business School.
Drehmann, M. (2013). Total Credit as An Early Warning Indicator for Systemic Banking Crises. BIS Quarterly Review (June).
Drehmann, M. and K. Tsatsaronis. (2014). The Credit-to-GDP Gap and Countercyclical Capital Buffers: Questions and Answers. BIS Quarterly Review (March).
Drehmann, M., C. Borio and K. Tsatsaronis. (2011). Anchoring Countercyclical Capital Buffers: The Role of Credit Aggregates. BIS Working Papers No 355. (November).
Drehmann, M., C. Borio and K. Tsatsaronis. (2012). Characterising the financial cycle: don’t lose sight of the medium term!. BIS Working Papers No 380. (June).
Drehmann, M., C. Borio, L. Gambacorta, G. Jimenez and C. Trucharte. (2010). Countercyclical Capital Buffer: Exploring Options. BIS Working Papers No 317 (July).
Galati, G., Irma Hindrayanto, S. J. Koopman and M. Vlekke. (2016). Measuring Financial Cycle with a Model-Based Filter: Empirical Evidence for the United States and the Euro Area. De Nederlandsche Bank paper. (January).
Harun, C. A, A. A. Taruna, R. R. Nattan, N. Surjaningsih. (2014). Financial Cycle of Indonesia—Potential Forward Looking Analysis. Bank Indonesia Working Paper (No WP/9/2014) December.
Jeong, Hyung-Kwon. (2009). The Procyclicality of Bank Lending and Its Funding Structure: The Case of Korea. Paper prepared for 2009 BOK International Conference “The Credit Crisis: Theoretical Perspectives and Policy Implicatons.
Kindleberger, Charles P. and R. Z. Aliber. (2005). Manias, Panics, and Crashes: A History of Financial Crises. Fifth Edition. New Jersey: John Wiley & Sons, Inc.
Landau, Jean-Pierre. (2009). Procyclicality—What It means and What Could be done. Remarked at the Bank of Spain’s conference of Procyclicality and the Role of Financial Regulation, May 4. BIS Review 94.
Mankiw, N. Gregory. (2007). Principles of Macroeconomics. Fifth edition. Mason, OH: South-Western Cengange Learning.
Minsky, Hyman. P. (1970). Financial Instability Revisited: The Economics of Disaster. Paper prepared for the Steering Committee for the Fundamental Discount Mechanism Appointed by the Board of Governors of the Federal Reserve System. 1-64.
Minsky, Hyman. P. (2016). Can “It” Happen Again?: Essays on Instability and Finance. With a new foreword by Jan Toporowski. London and New York: Routledge Classics.
Mises. Ludwig Von. (1953). The Theory of Money and Credit. New Haven: Yale University Press.
Mises. Ludwig Von. (2006). The Causes of The Economic Crisis and other Essays Before and After the Great Depression. Auburn, Alabama: Ludwig von Mises Institute.
Pahlavani, M., E. Wilson dan A. C. Worthington. 2005. Structural Breaks and Cointegrating Relationships in Iranian Exports, Imports and Economic Growth: An Application Incorporating the Autoregressive Distributed Lag (ARDL) Procedure. American Journal of Applied Sciences 2(7): 1158-1165.
Pramono, B., J. Hafidz, J. Adamanti, M. H. Muhajir and M. S. Alim. (2015). Dampak Kebijakan Countercyclical Capital Buffer terhadap Pertumbuhan Kredit di Indonesia. Bank Indonesia Working Papers (WP/4/2015). December.
Pesaran, H.M., Y. Shin, dan R. J. Smith. (2001). Bounds Testing Approaches to The Analysis of Level Relationship. Journal of Applied Econometrics 16: 289-326.
Pesaran, M. H. dan Pesaran B. (1997). Working with Microfit 4.0: Interactive Econometric Analysis. Oxford: Oxford University Press.
Pesaran, M. H. dan R. P. Smith. (1998b). Structural Analysis of Cointegrating VARs. Journal of Economic Surveys 12(5): 471-505.
Pesaran, M. H. dan Shin, Y. (1998a). An Autoregressive Distributed Lag Modelling Approach to Cointegrating Analysis. In S. Strom, A. Holly and P. Diamond (eds.). Centennial Volume of Ragnar Frisch. Cambridge: Cambridge University Press.
Schuler, Y. S., P. P. Hiebert and T. A. Peltonen. (2015). Characterising the Financial Cycle: a Multivariate and Time-varying Approach. ECB Working Papers No 1846 (September).
Strohsal, T., C. R. Proano and J. Wolters. (2015). Characterizing the Financial Cycle: Evidence from a Frequency Domain Analysis. Discussion Paper Deutsche Bundesbank No 22/2015 (July).
Surjaningsih, N., D. Yumanita and E. Deriantino. (2014). Early Warning Indicator Risiko Likuiditas Perbankan. Bank Indonesia Working Paper (WP/1/2014). December.
Utari, G. A. D., T. Arimurti and I. N. Kurniati. (2012). Pertumbuhan Kredit Optimal dan Kebijakan Makroprudensial untuk Pengendalian Kredit. Bank Indonesia Working Paper (WP/12/2012). December.
Warjiyo, Perry. (2014). The Transmission Mechanism and Policy Responses to Global Monetary Developments: the Indonesian Experience. BIS Papers No 78 (August).
Warjiyo, Perry. (2016). Central Bank Policy Mix: Key Concepts and Indonesia’s Experience. Bulletin of Monetary, Economics and Banking 18(4): 380-407. April.
