BANK LENDING DECISION AND BUSINESS CYCLES: ARE INDONESIAN ISLAMIC BANKS DIFFERENT?

Abstract

This paper evaluates the relationship between bank lending decisions and the business cycle in Indonesia where both Islamic and the conventional banks operate side by side. Moreover, the paper also seeks to determine whether the response between the two types of banks is significantly different from each other with regards to the financing behavior observed during the business cycles. The current research paper employs a sample of 73 Indonesian banks (64 conventional and 9 Islamic commercial banks) and studies their financing behavior over a period of 16 years (2005 to 2019). The findings of the paper can be summarized as follows. First, bank credit in Indonesia is pro-cyclical, indicating that the financing behavior of Indonesian banks is positively correlated with the business cycle(s). In other words, during prosperous times, banks lend more while restricting the same during times of economic crisis. Overall, the findings show that the financing behavior of Indonesian commercial banks can aggravate the crisis as they reduce credit during adverse times. Secondly, and more importantly, the findings also reveal that the Islamic banks’ financing is less cyclical in nature, highlighting the potential smoothing abilities of Islamic banks. Not surprisingly, these fundings are fueled by the deposits, as is the case with any developing country. The findings are found stable to the following robustness tests: a) alternate proxy of loan growth, b) inclusion of competition proxy in the regression and the c) use of HP filter to get an alternate proxy of business cycles