Does Competition Diminish Indonesia’s Banking Stability?

In 2004, the Indonesian banking supervisory authority issued a series of policy guidelines to strengthen the banking sector in which consolidation is one of the agendas. Consolidation decreases the number of banks and affect competition. In 2015, the Indonesia Financial Supervisory Authority issued Financial Service Masterplan 2015―2019, in which it is stated that maintaining financial stability is one of the aims that need to be achieved. This study analyzed the relationship between competition and stability employing an Indonesian commercial bank dataset from 2001 to 2015. The results show that an increase in competition decreases stability. The relationship between the Lerner index and the Z index forms an inverse U shape. Moreover, as mergers and consolidations also affect ownership structure, this study includes an indicator of ownership dispersion as an additional regressor. Compared to banks with concentrated ownership, banks with disperse ownership were shown to be more stable.