Impact of Related Lending on Bank Health: Case Study in Indonesia Banking Industry

Abstract

Related lending is a critical driver of banks’ health, particularly on its profitability and risks profile. As banks engage in related lending activities, they face challenges in managing profitability and assessing various risks, including systemic and credit risks. Nevertheless, the banking literature presents divided views on this: the information view and the looting view. The information view posits that related lending could enhance bank profitability and reduce risks through improved information symmetry between banks and borrowers. Conversely, the looting view theorizes that related lending may deteriorate banks’ performance, reducing profitability and increasing risks, primarily due to the misallocation of resources and the prioritization of personal interests by banks’ insiders. The challenges of related lending have been intensified by the global crisis of the COVID-19 pandemic. Empirical research indicate that banks tend to increase lending to related parties by up to 20% during economic difficulties, with more significant effects in emerging economy such as Indonesia. This trend is reflected in increasing related lending ratio and deteriorating financial indicators of publicly listed Indonesian banks, such as declining profitability ratios of return on assets (ROA) and net interest margin (NIM), as well as increasing risk ratios of higher non-performing loans (NPL) during the pandemic’s onset. Therefore, this study will investigate the impact of related lending on bank health of publicly listed Indonesian banks across two critical periods, before crisis (2013-2019) and during the crisis due to the pandemic (2020-2022). By employing a quantitative approach through regression analysis, this study will be able to assess the relationship between bank profitability and risk ratios with their corresponding variables. The aim is to provide empirical evidence on whether related lending enhance or impair bank performance in terms of profitability and risk, particularly under the economic strains brought by the pandemic.