The Effect of Spatial Competition on Rural Banks Performance : Profitability and Efficiency

This study explores the effect of spatial competition as well as other factors (i.e. bank-specific characteristics, industry-specific characteristics, and macroeconomics variables) on rural banks performance (profitability and efficiency) in Indonesia. A distance proxy (physical distance from a bank to nearest bank) and market boundary (area of Thiessen Polygon) as the main spatial variables. The Panzar-Rosse test, Lerner Index, and Boone Indicator are used to assess the degree of competition in the market. Cost efficiency is measured using Stochastic Frontier Analysis (SFA). Preliminary results reveal that the distance of banks‟ to the nearest bank negatively affects profitability, but positively affects bank efficiency. However, the area of market boundary has positive impact to bank profitability and efficiency. The Lerner index shows that rural banks engage in mark-up pricing in all models since the index positively affects performance. Consistent with industrial organisation theory, the Boone indicator, a measure of competition based on profit efficiency, shows negative value indicative of competitive market conditions. Overall, the findings show that spatial competition exists in rural banking in Indonesia