Bank Consolidation and Financial Stability in Indonesia

This paper extends prior literature on the link between consolidation and stability in banking using a single country setting. From a sample of Indonesian commercial banks over the 2010-2015 time span, our empirical results show that higher bank market power is associated with lower insolvency risk and higher capital ratios. A deeper analysis however reveals that higher market power is detrimental for financial stability in state-owned banks and small private-owned banks. We therefore highlight that although consolidation among state-owned banks reduces cost inefficiency as in Hadad et al. (2013), further efforts to reduce state-owned banks' market power are necessary after consolidation. This paper also suggests that strengthening market power in large private-owned banks, but encouraging competition in small private-owned banks to reduce market power, are essential for financial stability