Estimating Systemic Risk and Interconnectedness of Islamic Banks: Evidence from Indonesia

Abstract

This research is designed to provide an analysis of the systemic risk of Islamic banks in Indonesia. As primary consideration in the systemic risk is the interconnectedness of financial institutions, this research proposes a novel method to measure the interconnectedness between the stability of Islamic banks by developing an econometric model for the indicator of individual banks’ soundness. In order to measure of systemic risk, this research develops a Vector Auto Regression (VAR) econometric model for the z-scores of Islamic banks in order to analyse the interconnectedness between stability Islamic banks in the data sample and determine the systematically important bank in the Islamic banking industry afterwards. Based on the VAR model results, the stability of Bank Syariah Mandiri, as the biggest Islamic bank and the second Islamic bank in Indonesia, in the previous month consistently influences three other Islamic banks in addition to its own stability. Furthermore, considering the VAR model is a novel method in measure a systemic risk, this finding also prove that the VAR model is a robust method as its finding also confirmed by additional information such as total asset and the trajectory of the development of the Islamic banks in Indonesia.