Diversification, capital buffer, ownership and credit risk management in microfinance: An investigation on Indonesian rural banks

We investigate the extent of credit risk management in the leading Indonesian Microfinance Institution (MFI's): rural bank. Specifically, we focus on the role of diversification, capital buffer, and ownership on the probability of incidence and trajectory of two credit risk proxies—loan loss reserve to non-performing loan ratio (LLR_NPL) and net non-performing loan to total loan ratio (NPL_Net). Proportional hazard parametric exponential regression and Kaplan Meier survival function are applied to a balanced panel dataset of 852 rural banks from June 2010 to March 2019 (30672 bank quarter observations). We find that credit risk began to surface between 16–23 quarters. Government ownership and funding diversification positively impact credit risk management. A different nature of credit risk proxy (LLR_NPL versus NPL_Net) significantly affects the role of capital buffer, type of ownership, and credit risk trajectory. Our study has highlighted the importance of coordinated regulatory-supervisory practices especially for rural banks owned by cooperatives.