posted on 2011-02-11, 09:16authored byGanjar Mustika
This research has studied bank risk management in relation to efficient bank regulation
in the form of optimal bank financial reorganization. Efficient banking regulation can be
achieved only if it includes closure policies which prevent moral hazard behaviour; in
turn, they should enhance bank regulators' accountability. Yet, Basel II gives more
discretion to domestic banking authorities and focuses more on the implementation of
best practices of risk management. This creates a gap between the needs of efficient
banking regulation and the objectives of Basel II, on the one hand, and Indonesian bank
regulation on the other. To fill the gaps, the Fries, Mella-Barral, Peraudin (FMP) model,
under a robust regulatory regime concept, is used to provide a framework for banking
regulation.
Optimal bank reorganization aims at achieving efficient bank regulation, where bank
regulators are assumed to act as social planners. In this thesis, optimal bank
reorganization is analysed within the concept of a "robust regulatory regime". Optimal
bank reorganization comprises closure rules and bailout policies arising endogenously
through the interaction of two factors, namely regulators' attempts to minimize
discounted, expected bankruptcy costs, and equity-holders' incentives to recapitalise
banks. The shareholders will be allowed to continue to control the bank if the bank is
well capitalized. The cash flow approach to optimal bank financial reorganization is
adopted. The subsidy policies for financially ailing banks consider the implementation of
socially-optimal closure rules at minimum financial cost to regulators and which reduce
moral hazard. The FMP model implies that optimal bank reorganization requires a
deposit insurance scheme. The FMP model involves capital and risk management as
crucial factors.
This research includes an empirical study of the implementation of the FMP model in
Indonesia using the American call option approach. Maximum likelihood estimates in
VAR and GARCH are applied to monthly data on the market return and equity and
deposit values for relatively-large Indonesian banks, including regional banks and
foreign banks. The results indicate that the authorities can establish an optimal closure
rule for each bank, levy fair deposit insurance premiums that can be adjusted to take account of quantitative and qualitative factors, estimate optimal subsidies at different
deposit insurance premiums, and identify the banks' imminence to bankruptcy. (Continues...).