Performance of Market Discipline in Financial Crisis: The Case of Islamic and State-owned Banks in Indonesia

During a recession, state-owned banks in Indonesia tend to place their fund in the central bank’s certificate, as real sector becomes less attractive. On the other side, Islamic bank’s strong dependence on the accomplishment of its Profit-Loss Sharing (PLS) partners may pose significant liquidity threat in a slump economy, since the bank also directly bears its partners’ failure risk. Those environments may provide much less incentive to public to deposit their fund in state-owned and Islamic banks. However, such inconveniences may not be substantial to the public if the government either partially or fully guarantees any bank deposit at certain level. In other words, public can be indifferent to risk of any banks in the existence of deposit insurance. This study conducts empirical study on whether depositors in Indonesia are unresponsive to the risk of Islamic banks and state-owned banks before the US crisis hit the economy (2005.9 – 2008.8) and during the crisis (2008.9 – 2011.12), u