Rural banking spatial competition and stability

Abstract

This study empirically examined the spatial competition and stability of rural banks. Using detailed quarter-balanced panel bank-level data on rural banks in Indonesia, this study investigated spatial competition and bank stability using a spatial autoregressive model (SAR) constructed by weight matrices based on the inverse distance between a bank and its neighboring banks to measure market power using the adjusted-Lerner index. The significant characteristics of rural banks were discussed, and a unique dataset was used, such as provincial GDP, inflation, and forex. The results showed that banks exerted some pricing power with an existing inverted U-shaped relationship, which was consistent with the monopolistically competitive structure of the industry. This supported the competition-fragility hypothesis. In addition, the evidence showed that bank stability increased with a decrease in the stability of neighboring banks.