Assets BSA. VLOAN is considered in the analysis, it uses to determine wheather the higher loan’s growth will effects in reducing capacity to raise bank’s capital reserve or
not. BSA also considered as independent variables, therefore in this study need to prove whether the bank with a substantial market power is relatively easier to get a profit so as
to encourage banks to increase of capital reserves from the profit.
2.1.6 The Determinants of Capital Buffer
As mentioned above, this research following Ayuso et al. 2004, Jokipii and Milne 2008, and Tabak 2011, there are three different types of bank
capital-related costs to model capital buffers: cost of holding capital, cost of financial distress, and adjustment costs.
2.1.6.1 Cost of Holding Capital
Holding capital implies direct costs of remunerating the excess of capital, that is the opportunity cost of the capital Ayuso, et al., 2002. Therefore, banks’
incentives to hold capital buffers depend on the cost of capital compared to the cost of deposits Fonseca and Gonzalez, 2009. Theoritical analysis see Myers
and Majluf, 1984; Campbell, 1979 has argued that in the context of information asymetries, equity is a more costly alternative to other bank liabilities. In this
research, include the banks return on equity ROE in order to capture direct costs of remunerating excess capital. this measures reveals how much profit company
earned in comparison to the total amount of shareholder equity found on the balance sheet.
2.1.6.1.1 Return on Equity ROE
t-1
When the return on equity is high, it is costly to hold excess capital. In this case, a profit-maximising bank may maintain a lower capital buffer when the
opportunity cost of capital is high. Several previous researches, Ayuso et al.2002 and Jokipii Milne 2008 found negative correlation between Capital Buffer
and the return on equity, it was suggested that banks would reduce capital holding when the cost of capital is high.
Ayuso et al. 2004, Jokipii and Milne 2008 use each institutions’ return on equity ROE to proxy cost of holding capital. As noted by Jokipii and Milne
2008, ROE may well exceed the remuneration demanded by shareholders and to this extent is a measure of revenue rather than cost. A high level of earnings
substitutes for capital as a buffer against unexpected shocks. Thus, as raising capital through the capital markets is costly, retained earnings are frequently used
to increase capital buffers.
2.1.6.2. Cost of Financial Distress
Holding higher level of capital can ensuring banks to reduces the probability of bankruptcy and therefore so called the costs of failure, which
include the loss of charter value, reputational loss and legal costs of the bankruptcy process Tabak, 2011. As mentioned by Milne and Whalley 2001,
higher levels of capital therefore reduce the risk of non-compliance and the subsequent costs of failure which are directly proportional to absolute value of the
negative net worth of the failing bank.
Related to these costs are those associated with the existence of compulsory capital requirements. Higher capital levels also reduce the probability
of not complying with those requirements, thus minimising the consequent costs. As a matter of fact, before regulatory limits are reached, supervisory authorities
usually place some restrictions on the activity of the bank. The risk profile of the bank determines it’s capital buffer.
Since a banks probability of failure is reliant on its risk profile, proxy for the cost of failure adopting from various measures of risk. As Ayuso et al. 2004
measured, in this research consider the ratio of non-performing loans. If banks set their capital corresponding to the true riskiness of their assets portfolios, then
would expect the relationship between capital buffers and the ratio of non- performing loans to be positive.
2.1.6.2.1 Non Performing Loans NPL
Based on Ayuso et al. 2004, Jokipii and Milne 2008, Fonseca and Gonzalez 2009, they use the non-performing loan ratio to total loans NPL to
proxy the bank risk. Banks risk is one of the banks business risks, those happened because of failed or no payback of loans by borrowers to the banks.
Therefore, the ability of credit management is really needed by the bank for managing their credit problem Sinungan, 2000. In this research use non-
performing loans NPL to proxy these risks credit risk, this ratio indicates the ability of bank management in managing problem loans.
According to regulation of Bank Indonesia BI No. 330DPNP on december,14 2001, Non Performing Loan NPL measured from the
nonperforming loan divided to total loans. The higher Non performing Loan level would increase costs, so it causes the potential bank to get losses. In accordance
with the regulations stipulated by Bank Indonesia, a good amount of Non Performing Loans NPL is below 5.
2.1.6.3 Adjustment Costs
Banks may face adjustment costs in moving toward their optimal capital ratios. An excess, or a deficiency, of capital can arise as a result of the difficulties
in capital adjustment. However, the consequence of falling short of capital is probably more serious, so banks are more likely to be “over-capitalised” than
“under-capitalised”. In other words, a part of the observed capital buffer may be held for precautionary purposes, due partly to frictions in adjusting capital
level.Wong, et al., 2005.
2.1.6.3.1 Increment of Capital Buffer ΔBUFF
Increment of Capital Buffer ∆BUFF is proxy of adjustment cost, it
represents the delta of excess capital over regulatory requirements in the period t now minus excess capital over regulatory requirement in the period t-1 one year
before. In order to illustrate the cost of capital adjustment, this study added from Ayuso et al. 2004 and Estrella 2004 model that used lag of capital buffer to
proxy adjustment cost.
2.1.7 The Other Determinants of Capital Buffer 2.1.7.1 Loans to Total Assets VLOAN
