This thesis studies the role of public banks operating at a regional level, namely regional development banks (RDBs) in addressing the market failure due to the preferential lending in the banking sector. This study concerns RDBs in Indonesia. We employ three different approaches to understand the role of RDBs that will be discussed in three investigative chapters; which are, how RDBs deal with political issues, geographical issues, and opaqueness issues in micro, small and medium enterprises (MSMEs). This thesis enriches literature by presenting unique data, some of which are collected by hand at the regional level. Employing the regional election data, the first chapter (Chapter Two) investigated the political motives behind the lending. We found that near to the election years, allied RDBs seem to attract more voters from low-income societies by distributing more loans to MSMEs, while the clientelism is detected in allied RDBs once the election ends and leads to a negative spread. Political lending can also be seen when RDBs have more politicians sitting in as commissioners, but unclear findings were found when we examined an elected governor who will run for a second time. Moreover, we have little evidence that the National Government is involved in directing the political loans in RDBs during election years. Furthermore, as we focus on public banks at a regional level, geographical issues are crucial in explaining the role of RDBs, which is discussed in Chapter Three. By comparing with the non-RDBs, we found that, the quantities of the RDBs’ loans are disproportionately distributed due to the differences in endowment levels across regions. The same phenomenon is also detected when a region is far from a strategic location or from a financial centre.
This sheds light on the crucial contribution of RDBs, whilst non-RDBs allocate their capital so as to maximise a positive return. Concerning the potential of spatial dependence, we found that the capital flight tends to occur in non-RDBs, but no indication that spatial clustering affects loans to MSMEs. While using spatial panel models, we indicated that the poverty gap is the main issue in the triggering of capital outflows for both banks (RDBs and non-RDBs). To examine the RDBs’ attitude towards small business, the third investigative chapter (Chapter Four) observes how the support from RDBs to MSMEs, through lending, boosts regional economic growth. Empirically, the quantities of lending
in combination with better allocations stimulate regional economies as an aggregate, and especially affect the sector that most MSMEs operate—the agriculture sector; yet loans do not help to mitigate the income inequalities across regions and within regions; instead MSMEs loans erode RDBs’ NPL.
Whilst, the contribution of RDBs on improving their region becomes significant when the banking market is less concentrated. Regional income increased as well as income in the agriculture sector. Unemployment also lowered, yet it does not affect the poverty gap within regions and across regions, as it might have related with their effort to maintain their NPL. Concerning the spatial impact, the
profit orientated banks are effective in preventing capital spill-over, while cost orientated banks, if neighbouring regions have more endowment, tend to allocate their capital outside their region.