HISTORICAL STRESS TEST OF CREDIT RISK USING MONTECARLO SIMULATION: INDONESIA ISLAMIC BANKING

Abstract

This study was conducted to assess the vulnerability of Islamic banking credit portfolios under macroeconomic shocks and their impact on NPFs, using the linear regression analysis. From the three proposed models, namely OLS, ARIMAX and Error Correction Model (ECM), the ECM model was selected as the best. By using the Montecarlo simulation, an estimate was made of the possible future value of the NPF in Islamic banking. The study established that exchange rates, economic disparities, inflation, economic growth and interest rates showed positive and significant effects on bank credit risk whereas inflation produced negative effects. The non-performing finance (NPF) was also estimated using the Montecarlo simulation using one million trials. The results were subsequently used to conduct a stress test for the projected NPF. With 99% confidence, the maximum potential value of bad credit was 21%. The maximum NPF bad credit was attained under confidence level of 95%.