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.