Loan loss provision index and bank risk: An empirical study in Indonesia

Abstract

The purpose of this study is to determine an index for loan loss provision as a new measurement and examine its effect on bank risk. The study also compared the results with a commonly used measurement, which is the ratio of loan loss provision (LLP). The population of this study is all conventional banks, including foreign banks with branch offices in Indonesia. The period of observation is from 2015 to 2018. The sample selection based on the purposive sampling method resulted in 86 banks. This study used panel data analysis. The data were collected from the annual reports of each bank and the website of the Financial Services Authority. The research findings show that the index of loan loss provision can decrease credit risk, liquidity risk, and operational risk. Meanwhile, the ratio of the loan loss provision only affects operational risk and does not affect credit risk and liquidity risk. The findings of this study suggest that the index for loan loss provision is more suitable to be used as an alternative measurement in the research design related to loan loss provision because the implementation of IFRS 9 requires more detailed disclosure of how banks estimate the amount of loan loss provision.