Foreign participation and banking competition: Evidence from the Indonesian banking industry

• Published in: Journal of financial stability 2015-08, Vol.19, p.70-82
• Main Authors: Mulyaningsih, Tri, Daly, Anne, Miranti, Riyana
• Format: Article
• Language: English
• Subjects: Banking competition; Foreign penetration; Modes of entry
• ISSN: 1572-3089; 1878-0962
• DOI: 10.1016/j.jfs.2015.02.001

•The mode of foreign penetration in the Indonesian banking industry has changed from the establishment of de novo banks to the acquisition of local banks.•Foreign penetration of Indonesian banking is increasing and was 45% of the sector in 2010.•Foreign banks, particularly de novo banks, behaved more competitively than local banks.•Sources of their competitiveness are small size, efficient cost structure, lower overheads, lower loan rates and higher disbursements.•Recent consolidation restricts the establishment of foreign de novo banks and may adversely impact competition. Foreign participation in Indonesian banking has expanded from the establishment of foreign de novo banks into the acquisition of existing local banks. The increase in foreign participation has therefore not been associated with a growing number of banks. This study aims to examine the competitive behavior of foreign and local banks as a competitive banking industry is important in boosting economic efficiency and economic growth. This study also examines the role of modes of entry of foreign banks on competition, either through the establishment of foreign de novo banks or the acquisition of local banks. The recent methodological refinements of the Panzar–Rosse method developed by Bikker et al. (2011) are employed to estimate the level of competition among local and foreign banks. Generally, the foreign banks, particularly foreign de novo banks behaved more competitively than local banks, and their penetration is therefore important in creating a contestable market. This study found that in terms of assets, on average foreign de novo banks were smaller, more efficient, and had lower overhead costs, so they could offer lower loan rates and disburse more loans. The recent consolidation in the Indonesian banking industry may have an adverse impact on competition as it restricts the establishment of foreign de novo banks.