1

RESEARCH PROPOSAL

PERFORMANCE OF MARKET DISCIPLINE DURING USA CRISIS:
EVIDENCE FROM INDONESIAN STATE-OWNED BANKS

Erie Febrian, SE, MBA, M.Comm, PhD


1 Research Background

Deposit insurance may be useful in preventing bank runs (Diamond &Dybvig, 1983) and
improving risk sharing (Niinimaki, 2003). However, Merton (1977) argues that deposit insurance
may also encourage banks to be more risk taker. Some scholars like England (1991) further explain
that presence of the high deposit insurance ceiling as well as the protection of the above the limit
deposits have made depositors almost insensitive to bank risk. Depositors are believed to be
indifferent to banks fundamentals and the associated potential risk to their deposits, as they trust
their government to ensure the safety of their deposits (Inakura, Shimizutani, &Paprzycki, 2005;
Demirguc-Kunt, 1998a, 1998b, and 2000a). This depositors insensitivity worsened the moral
hazard consequences of deposit insurance, inducing banks to engage in high-risk activities, which
in turn boost their default rate (Grossman, 1992; Wheelok, 1992; Thies &Gerlowski, 1989; and
Demirguc-Kunt&Detragiache, 2002).

Studies conducted on banking crises have also ended up with some proposed solutions that might
be effective in preventing the crises from reoccurrence. Among some of the popular suggested
instruments, the capability of non government agents to control bank risk-taking, i.e. market
discipline, has increasingly attracted both policy-makers and economists. Markets role in
stimulating appropriate banks risk taking behavior becomes more and more significant. This fact
has partly accounted for the growing policy-makers preference to and economists emphasis on
market discipline (See, e.g., Calomiris, 1999). The market discipline works through a mechanism,
in which depositors, bond-holders, and shareholders will punish risky banks by using their market
power. Most likely depositors will withdraw their deposits from, or will ask for high deposit
interests to risky banks. Similarly, bond-holders and shareholders will consequently demand a
suitable risk premium to compensate extra risk they will bear (Hosono, 2005).

The above discussion has shown that many studies have been done to explain conflicting impacts of
market discipline and deposit insurance toward bank risk-taking behavior. However, there have been
insufficient studies that cover issue on the impact of limited deposit insurance on depositors
behavior in government-owned banks. Particularly, the question on the effect of deposit insurance
on the behavior of depositors in chastising state-owned bank risk taking during USA Crisis still
needs to be answered.

This research is initiated to fill in the above concern. The study will conduct an empirical test on
the hypothesis that risk of state-owned bankhad influenced depositors in Indonesia during the
period of USA Crisis, 2008.9 2010.12. Right after the crisis spread globally, the Government of
Indonesia increased the ceiling of guaranteed bank deposit by 2,000%. This research also will
investigate whether market discipline works before the crisis, period of 2006.1 2008.8, using the
dataof Indonesian state-owned banks.

2




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Work Plan forPostdoctoral Research
7

Erie Febrian, SE, M.Comm, PhD


A. The Activities

1. Conduct literature study in the fields of Market Discipline, Risk Management, and Banking.
2. Jointly write one or possibly extended to two articles in the area of Market Discipline, Risk
Management, and Banking, with a senior lecturer or Professor at the Heriot Watt
University.
3. Help develop joint academic program for Master and Doctoral Programs between the
Faculty of Economics & Business Universitas Padjadjaran and the School of Management
and Languages, Heriot Watt University.


B. The Impact

Results of thePostdoctoral Researchand other academic activities at the School of Management and
Languages include:
1. A joint publication in an International Journal;
2. A Double Degree/Joint Degree in Masters;
3. A Sandwich Program in Doctoral Degree



C. The schedule
First Month
(weeki)
Second Month
(weeki)
Activities 1 2 3 4 1 2 3 4
Literature study
Data Gathering
Empirical Test
Writing the Article
Developing the Joint Academic Programs