The Effect of COVID-19 to Credit Risk and Capital Risk of State-Owned Bank in Indonesia: A System Dynamics Model

Abstract

The global COVID-19 pandemic has greatly affected people, especially in the economic and banking sectors. The Indonesian Financial Services Authority (Otoritas Jasa Keuangan, OJK) issued a credit restructuring policy, effective from March 2020 to March 2022, to reduce credit and bank capital risk. This study proposes the bank risk scenario after the credit restructuring policy of the OJK moratorium in March 2022 and proposes the internal bank policy simulation to mitigate credit and capital risks in terms of Non-Performing Loan (NPL) and Capital Adequacy Ratio (CAR). The difficulty of this study is how to develop the risk scenario and to simulate the bank risk mitigation policy after the policy moratorium, while the COVID-19 pandemic is still ongoing and the economy is not yet normal. To that purpose, this study uses a system dynamics methodology with Powersim Studio 10© software that is able to make scenarios on the level of credit risk (NPL) and bank capital (CAR) and able to simulate internal bank policy to overcome the risk by considering the environmental and policy changes. Based on the policy simulation, it is recommended that bank can implement the restructuring policy to control the credit risk and strengthening the NPL monitoring activity in order to manage and decrease the loan impairment expenses. To increase CAR, the result shows that the combined policy consists of the NPL monitoring program, the interest rate and the operating cost management program is able to produce a significant increase in bank’s capital (CAR). The original contribution of this study is to provide new model of credit and capital risk scenario and risk mitigation simulation during the COVID-19 pandemic. The advantage of this study is that the model can be tested and implemented to other banks.

Early Warning Early Action for the Banking Solvency Risk in the COVID-19 Pandemic Era: A Case Study of Indonesia

“…There should be some concerns from banks regarding the provision of advice to debtors regarding business management to maintain and improve the payment capacity of the restructured loans. Therefore, loan monitoring by banks suppresses non-performing loans and improves financial performance (Duong et al 2020;Hidayat et al 2021).…”

“…It aims to develop a simulation model to generate early warnings and identify early actions to mitigate bank solvency risks using Powersim Professional 10© software. Furthermore, it intends to advance the modeling of bank financial statements and several important financial ratios developed by Islam et al (2013); Pierson (2020) and Hidayat et al (2021) through causal-loop and stock flow diagrams.…”

“…In the banking sector, agency relationships occur between bank management with shareholders and banking supervisory authorities (Henrard and Olieslagers 2004) as well as with depositors (Kuritzkes et al 2003). Banking supervisory authorities play a role in protecting the interests of depositors by issuing various regulations that must be obeyed by bank management and shareholders (Donnellan and Rutledge 2016), including the issuance of policies for loan restructuring during the COVID-19 pandemic by the Financial Services Authority, then it is an agency relationship intervention in order to reduce the risk of bank bankruptcy and protect depositors (Hidayat et al 2021).…”

“…The pattern of the relationships between the accounts in the financial statements are modeled through causal-loop and stock-flow diagrams (García 2019). The financial statements model of system dynamics was developed in some studies by Islam et al (2013); Wu (2014); Istiaq (2015); Pierson (2020); Aksu and Tursun (2021); Pavlov and Katsamakas (2021); Hidayat et al (2021) to analyze financial reporting, banking risk management, management control systems, and solvency stress-testing.…”

The impact of Covid-19 on the banking industry efficiency: Comparison between Indonesia and Malaysian banks

“…Another sector that is also disrupted by the presence of Covid-19 is the financial institution sector, including banking. This pandemic has affected bank operations (Hidayat et al, 2021).…”