Basel III Capital and Conservation Buffers: Implications for the Credit Risk and Financial Stability of Indonesian Banks

The stability of Indonesia’s banking sector is closely linked to the effectiveness of capital regulations, particularly as a country that aligns its policies with Basel III standards. Ensuring that banks have adequate capital buffers is crucial for mitigating systemic risk. However, the interaction between regulatory requirements and actual banking behavior in developing countries remains poorly understood. This study aims to evaluate the impact of Indonesia’s capital requirement instruments, including the countercyclical capital buffer (CCyB), the capital conservation buffer (CCB), and the capital surcharge, on credit performance and financial stability across various bank categories. Using a quantitative approach, the analysis utilizes panel data from commercial banks, state-owned banks and regional development banks over several periods, using the panel regression method and Difference-in-Differences (DID) to assess how changes in buffer levels affect credit growth, Non-Performing Loans (NPLs), and the Capital Adequacy Ratio (CAR). The results show that capital buffers have a statistically significant effect on lending behavior: a 1% increase in buffer levels is associated with a measurable decrease in credit expansion across several bank groups, while CCBs exhibit a stronger stabilizing effect than CCyBs. Although these instruments do not eliminate financial uncertainty, they contribute to more prudent risk-taking. This study also revealed that the CCyB rate increases when the financial cycle is in an expansionary phase. Conversely, if the economy slows (as during the pandemic), the CCyB rate can be lowered back to 0% to encourage bank intermediation, thus shaping the bank’s responses to regulation. Several implications of implementing a capital buffer in Indonesia include the benefits of resilience and bank behavior during credit expansion. Overall, this study concludes that aligning regulatory frameworks with real-world banking behavior is crucial for enhancing financial stability in developing countries, such as Indonesia.