Academic journal article Global Business and Management Research: An International Journal

Risk Determinants on Foreign Exchange Banking Based on Endogenous Variable Using Probit Models

Academic journal article Global Business and Management Research: An International Journal

Risk Determinants on Foreign Exchange Banking Based on Endogenous Variable Using Probit Models

Article excerpt

Introduction

The role of banks in meeting the needs of business people and individuals is very important and makes banks very vulnerable to risk. In carrying out these business activities the bank faces various risks including credit risk. The global financial crisis that has been running since the late 1990s in Asia until 2010 has become the center of attention of stakeholders, including academics. In mid-1997 was the worst banking condition and provided valuable lessons for Indonesia. The costs used to save and restore the banking industry were so large that they reached more than fifty percent of Indonesia's GDP at that time (Hadad et al., 2003). Various studies were conducted to find a solution so that a similar crisis would not be repeated.

The economic impact caused by bank failures in risk management is a very important topic because most of the core activities of each bank are credit financing. Non-performing loans can affect the profits received by banks (Puspitasari, Setiadi, & Rizkiyanti, 2015). Strict competition in the banking industry requires banks, especially foreign exchange banks, to be able to compete in regional industry competition (Puspitasari, Setiadi, & Febrian, 2017). This study contributes to identifying risk determinants in foreign exchange banks, particularly credit risk.

Literature Review

The risk of financial instability is divided into endogenous risks and exogenous risks (Hauben, Kakes, Schinasi, 2004). This statement was reinforced by Bank Indonesia (2007) who argued that endogenous risk is a source of financial instability. Endogenous risk is the risk that depends on the actions of components in the financial system, therefore including the risks that exist in the financial system. Hauben, Kakes and Schinasi (2004), Schinasi (2005) they stated that there are 3 types of endogenous risks in the financial system, based on specific banks, markets and infrastructure. Non Performing Loan (NPL), credit volume risk and bank size including risks that are specific to financial banks. Interest rates include risks that occur in the market and capital requirements including risks that exist in the infrastructure.

Credit risk or often referred to as default risk is related to the possibility that when it is due, the counterparty fails to fulfill its obligations to the bank. Risks can arise due to several things, including:

1) the possibility of loans provided by banks or bonds (bonds) purchased by banks are not paid;

2) non-fulfillment of obligations, in which the banks involved can meet with other parties, for example failure to fulfill obligations on derivative contracts;

3) settlement with exchange rates, interest rates and derivative products.

The impact of default risk is:

1) increase reserves for loan losses (Waemustafa & Sukri, 2015; Bennet, et.al, 2014; Ayeni & Oke, 2012; Gordy, et.al, 2000)

2) profit reduction for banking industry (Kithinji, 2010)

3) bankruptcy of individual banks (Dermine & Carvalho, 2005)

4) leads to systemic risk for financial system stability (Fiordelisi & Ibanez, 2011)

Based on previous studies, the result shows relationship between default risk and endogenous risk is as follows:

Endogenous risk in this research is represented by NPL, bank size, credit volume, interest rates and capital requirements.

Method

This study uses descriptive verification which uses secondary data from foreign exchange banking statistics for 76 months from January 2011 to April 2017. This study using probit regression with independent variables is NPL, bank size, credit volume, interest rates, capital requirements. While the dependent variable is default risk.

The hypothesis proposed partially is as follows:

H1 : NPL influence default risk

H2 : Bank size influence default risk

H3 : Credit volume influence default risk

H4 : Interest rate influence default risk

H5 : Capital requirements affect default risk

The hypothesis proposed simultaneously is as follows

H6 : NPL, bank size, credit volume, interest rate, and capital requirement influence default risk simultaneously. …

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