Disentangling Indonesian banking competition based on size: implications on bank soundness

Abstract

Competition has long been debated as a vital factor determining banking performance and stability. The broad perspectives are divided into two streams, the ‘competition-fragility’ and ‘competition-stability’ view. Following the API framework, banking industry in Indonesia is experiencing consolidation waves as an effort to strengthen capitalization and enhance intermediation performance. The process, however, inevitably alter the degree of competition. This phenomenon puts forward the urgency of having a comprehensive insight regarding the repercussions of changing competitive environment. Realizing that markets are fragmented, and that, not all banks compete to each other directly, we propose a detailed assessment of competition effect through disentanglement amongst different clusters, particularly with respect to size. The separation is done through Fixed Effect Vector Decomposition method, complemented by interaction variables. Observing in a thorough manner, we expect to find a clear and reliable understanding on the effect of competition on Indonesian banking performances and stability.