Bank risk and non-interest income activities in the Indonesian banking industry

Abstract

The recent trend of product diversification in the Indonesian banking industry underscores the importance of non-interest income activities. This study examines the relationship between product diversification and bank risk over the period of 2002-2008. Our analysis shows clear evidence that the effect of product diversification on bank risk depends highly on the bank's asset size. Specifically, the degree of product diversification is negatively associated with bank risk for small-sized banks. Conversely, the degree of product diversification is positively related to bank risk for large-sized banks. This finding suggests that deregulation encouraging banks to become more involved in non-traditional activities may have an adverse effect on the overall banking system where large-sized banks are playing a significant role in Indonesia.

Does Income Diversification Benefit the Sustainable Development of Chinese Listed Banks? Analysis Based on Entropy and the Herfindahl–Hirschman Index

“…According to Baele et al, the diversification gains and costs are not significant for small and large banks in the European Union [15]. Hidayat et al [16] studied the relationship between risk and diversification in Indonesian banks, and the results showed that the effect highly depends on the scale of the bank.…”

Non‐interest Income, Profit, and Risk Efficiencies: Evidence from Commercial Banks in China

“…Non-interest Income, Profit, and Risk Efficiencies mission and fee income does not have a significant impact on profit efficiency, it has a negative and significant effect on risk efficiency, suggesting that for commercial banks in China, business that generates commission and fee income increases risk. In former studies, DeYoung and Roland (2001), DeYoung and Rice (2004), Stiroh and Rumble (2006), Hidayat et al (2012), andPennathur et al (2012) also find an inverse relationship between non-interest income and risk.…”

“…Few papers examine the relationship among non-interest income, profit, and risk in developing countries. Hidayat et al (2012) show that in Indonesia, greater reliance on non-interest income increases risk for small-sized banks but reduces risk for large-sized banks. In addition, commission and fee activities could intensify risk, but the effect of engaging in trading income on risk is less distinct.…”

Financial Fragility of Banks In Vietnam: The Role of Revenue Diversification and National Governance Quality

“…In addition, Hirtle and Stiroh [39] argue that a stronger focus on retail banking can reduce equity market volatility only for the large banks but not for small and medium banks. Conversely, Hidayat, Kakinaka and Miyamoto [40] suggest that in Indonesia, since the larger banks tend to involve more boldly in non-traditional income activities, which make them become more vulnerable to the volatility of net non interest income, product diversification has an association with bank probability of failure positively for large-sized banks but negatively for smallsized ones. Chen and Lai [41] argue that in case of Taiwan, there is a significant positive short-run relationship between income diversification and bank credit risk due to the earnings fluctuation; nevertheless, in the long run, the effect is reversed when the bank achieves a certain rise in income sources in order to enhance their liquidity reserve ratio and to minify the EPS fragility.…”