The impact of monetary policy and bank competition on banking industry risk: A default analysis

Abstract

In the financial system and economy, the banking industry plays a crucial role. Default risk takes central stage in preserving financial stability and needs to be mitigated as it can trigger a crisis. The study examines the combined effects of monetary policy and bank competition on banking defaults. Using a sample of 95 commercial banks in Indonesia between 2009 and 2019, this study employs the Generalized Method of Moments, a two-step dynamic panel-data estimation system, to analyze it. Empirical estimation results show that monetary policy, through an increase in the benchmark interest rate, negatively affects probability of default. The extent of banking stability is also enhanced by monetary policy. Banking competition has a negative and significant effect on probability of default and has a positive effect on the banking distance to default. Furthermore, the combined impact of monetary policy and banking competition positively affects probability of default but has a negative impact on the distance of default. Building on this study, to promote a stable and more efficient banking system, policymakers should develop policies that foster complementary monetary and competition policies.