An Empirical Study of Optimal Bank Corrective Action for Indonesia Employing the Dynamic Contingent Claims Model

This study highlights how banking regulation in Indonesia can be improved with a view to enhancing the cost-effectiveness of banking regulation and social welfare, and preventing future financial instability. We employ the Fries, Mella-Barral, and Perraudin (FMP) model (1997) and analyze the model under a robust regulatory regime concept to provide a new framework for banking regulation. Maximum likelihood estimates in VAR and GARCH are applied to monthly data on the market returns and deposit values for relatively-large banks. The results show how the authorities in Indonesia can establish optimal closure rules for each bank, levy "fair" deposit insurance premiums, estimate optimal subsidies (for different deposit insurance premiums) and identify the banks' "imminence to bankruptcy".