The aim of this paper is to analyze the relationship between capital ratios, the cost of intermediation and risk taking in banking by considering the presence of self-interested managers. To our knowledge such problems have never been taken into consideration in the empirical literature on the link between bank capital and risk. Using a simultaneous equations model applied to monthly data over the 2004-2007 period for 99 Indonesian commercial banks, we find that a higher capital ratio is associated with an increase in the cost of intermediation and a decrease in risk and profitability. Hence, there is a strong presumption that managers might be driving banks to become safer but less profitable since more risky but also more profitable loans could be bypassed. Moreover, our results show that domestic private-owned banks are more likely to suffer from a managerial self-interest problem than state-owned banks, joint-venture banks, and foreign-owned banks. Our findings support the call for the implementation of the ownership consolidation policy to enhance shareholders' domination in Indonesian banks, notably in private-owned banks.
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