This thesis examines market discipline exercised by Indonesian depositors and peer banks from January 1980 to December 1999. Discipline exists if risky banks are forced to pay higher interest and suffer deposit withdrawals. However, to be effective, market discipline requires monitors to access and process reliable accounting information. In the case of Indonesian peer banks, these may serve as better monitors than depositors because they have better resources to collect and process information about their counterpart banks.; While discipline by depositors is measured in this study through interest rates and deposit growth rates, discipline by peer banks is measured through the ratio of call money exposure to the total interbank exposure between a given pair of banks. A low ratio indicates a given pair mostly engages in non-call money transactions or has more variety in their interbank transactions. Furthermore, a greater variety of interbank transactions signifies lending banks' confidence in their borrowing banks, as the former have collected information about the latter. Thus peer banks discipline their counterparts when their call money exposure is low.; In order to test discipline by depositors, this research uses Indonesian banks' call reports from January 1980 to December 1999 submitted to Bank Indonesia (the central bank). Detailed call money transactions from April 1993 to December 1999 are also used to test the market discipline exercised by peer banks. The difference in observation periods is due to data availability. Another important data source relates to Indonesian business groups, whereby this research classifies banks according to their ownership associations with Commercial Power Centres (CPCs). These CPCs consist of the 200 most prominent business groups; the government; foreign/joint venture investments; and the Soeharto family. Indonesian banks without such an association are classified as non-Commercial Power Centre banks. To test discipline by depositors, data from the entire bank population is used, while to test discipline by peer banks the data are split into two: the population of bank pairs (lending and borrowing banks) and a sample of those pairs which frequently engage in call money transactions.; The results suggest market discipline barely existed in Indonesian banking during the period January 1980 to December 1999. Indonesian depositors only punish banks without associations to pressure groups. Moreover, within the population of bank pairs, the borrowing banks' financial performance does not determine the lending banks' call money exposures. Within the sample of pairs that engage more frequently, both the borrowing banks' financial performance and the lending and borrowing banks' interlock (in this study a term denoting the special relationship between bank pairs based on banks' share ownership, or owners' kinship, or bank rescue) determine the lenders' call money exposures. However, the effect of interlock is stronger. Thus peer banks engaging frequently in call money transactions tend to discipline their counterparts based on their interlock.; Although convincing support for the existence of market discipline is lacking, this research contributes to knowledge about how two types of monitors---the depositors and the peer banks---exercise discipline in a country such as Indonesia. This is also the first research to study interbank interlock in market discipline exercised by peer banks. The overall findings suggest that Basel II's reliance on market discipline in its third pillar may prove less effective in the context of developing countries. Therefore, regulators may need to place greater emphasis on the first pillar (the capital requirements) and the second pillar (bank supervisory review of capital adequacy and internal assessment).
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