Nur Muhammad, Arief Wibisono Lubis

MSME Loan Composition, Financial Stability, and Government Ownership: Evidence from Indonesia’s Banking Sector

Introduction

Msme loan composition, financial stability, and government ownership: evidence from indonesia’s banking sector. Examine MSME loan composition, bank stability, and government ownership in Indonesia. Higher MSME loans reduce stability, but state-owned banks manage risks better. Policy alignment is key.

Abstract

The Indonesian government has promoted growth in MSMEs (micro, small, and medium enterprises) by targeting banks to allocate at least 30% by Q2 2022 of their loan portfolios to MSMEs. However, by Q4 2022, this target had not been met, partly due to the high credit risk and information asymmetry in the MSME sector. While past studies often suggest that MSME lending improves bank stability, this study finds otherwise. Using panel data from 96 banks between Q1 2019 and Q4 2022 and applying the GMM method, the result shows that a higher MSME loan share tends to reduce bank stability. Interestingly, when government ownership is considered, the effect turns positive, suggesting that government-owned banks may manage MSME risks better. This may be due to stronger oversight, policy support, their experience with development-focused lending, a broader business focus beyond profits, and their role as agents of change in supporting financial inclusion and economic stability. These findings suggest the need for better MSME policy alignment, risk mitigation tools, and a centralized MSME database to balance financial inclusion with banking sector stability.

Review

This study offers a timely and significant contribution to the literature on MSME lending and bank stability, particularly within the context of a developing economy like Indonesia. The authors effectively highlight a crucial policy dilemma: the government's push for MSME financing versus the inherent risks associated with this sector for banks. Their core finding, that a higher MSME loan share tends to reduce bank stability, directly challenges some existing perceptions and sets the stage for a more nuanced understanding. The most compelling aspect of this research is the discovery that government ownership moderates this negative relationship, turning the effect on stability positive. This interaction effect is a novel and highly relevant insight, suggesting that government-owned banks may possess unique advantages in managing MSME-related risks, possibly due to stronger oversight, policy support, or a broader developmental mandate. The application of the GMM method to panel data from 96 banks over a relevant period (Q1 2019 – Q4 2022) lends credibility to their findings. While the study provides valuable insights, the abstract leaves some areas where further detail or exploration would strengthen the overall argument. The period of analysis, Q1 2019 to Q4 2022, notably encompasses the global COVID-19 pandemic, which had profound and uneven impacts on MSMEs and the banking sector. The abstract does not explicitly state how these unprecedented external shocks were accounted for in the model, or if the findings are robust to such a significant macroeconomic event. Furthermore, while the abstract lists plausible reasons for government-owned banks' better risk management (e.g., policy support, broader business focus), these are presented as hypotheses ("may be due to...") rather than empirically tested mechanisms. Greater specificity on the measures of bank stability used would also enhance clarity for readers evaluating the findings' implications. Despite these minor points, the research carries substantial practical and theoretical implications. The findings underscore the complex trade-off between promoting financial inclusion through MSME lending and maintaining banking sector stability, a challenge faced by many emerging economies. The identified moderating role of government ownership provides critical guidance for policymakers, suggesting that the structure of the banking sector and the nature of institutional support play a vital role in the success of MSME financing initiatives. The recommendations for better policy alignment, risk mitigation tools, and a centralized MSME database are direct and actionable, offering concrete pathways to balance growth objectives with prudential banking practices. This study lays a strong foundation for future research to delve deeper into the specific channels through which government ownership enhances risk management capabilities in MSME lending.

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