Identifying Systemically Important Banks in Indonesia: CoVaR Approach

The Global Financial Crisis of 2008 had a significant impact on banks' bailout decisions due to its high cost of Rp. 6.76 trillion (USD 499.5 million). That shifted the focus from analyzing bank size to a broader notion of systemic risk. Therefore, this research aims to systemically identify important banks in Indonesia using Conditional Value-at-Risk (CoVaR) approach. We conduct the following three steps measurement for population-based on all commercial banks data. Firstly, this study uses Merton Model to gauge the probability of default of commercial banks. Secondly, this study quantifies the value at risk of each bank, including its contribution to the whole banking systemic risk. Finally, this study measures financial linkage among banks and the individual bank value at risk contribution, conditional on other banks being in financial distress, i.e., at its Value at Risk (ΔCoVaR A|B). A threshold of 20% ΔCoVaR (A|B) was used to determine 12 out of 119 Indonesian commercial banks that are systemically important and the size ability to affect CoVaR positively. The novelty of the research is to integrate Probability of Default derived from the Merton Model into the CoVaR Model developed by Adrian & Brunnermeier.