Financial reform: Achievements, problems (2)<\/p>\n
This is the second of a three-part article based on a keynote
\naddress given by presidential advisor Ali Wardhana at the
\nIndonesia Update 1994 seminar at the Australian National
\nUniversity in Canberra, on Aug. 19.<\/p>\n
CANBERRA: Initially the financial reform measures in Indonesia
\nwere focused on removal of credit and interest rate controls on
\nthe banking system, while developing indirect, market-oriented,
\ninstruments of monetary policy to replace the ineffective credit
\nceilings. These first steps resulted in a significant increase in
\nthe deposit mobilization and lending activities, especially of
\nprivate banks. Also, Bank Indonesia introduced new money market
\ninstruments, such as SBIs and SBPUs. But Bank Indonesia did not
\nsucceed in developing sufficient depth and breadth in the markets
\nfor these instruments to permit effective open market operations.
\nWhen a sudden loss of foreign exchange reserves occurred in 1987,
\nthe government had to resort to directed transfers of state-owned
\nenterprise deposits from commercial banks to the central bank to
\nachieve its monetary policy objectives.<\/p>\n
Since 1988 there has been a deliberate attempt to stimulate
\nthe development and growth of the various financial sectors in
\naddition to banking -- what Shaw labeled \"financial deepening.\"
\nBanking still had priority, simply because it was, by a
\nsignificant margin, the largest financial service sector and
\nbecause it was dominated by very large, but highly inefficient,
\nstate-owned banks. Far reaching decontrol measures were taken to
\nincrease competition in the banking sector. Moreover, in the
\nyears 1989-1990, the capital market sprang to life. This was
\npartly the result of special factors -- an active chairman of the
\nCapital Market Executive Agency, the stimulus of foreign demand
\nfor Indonesian securities, and relatively low interest rates
\nresulting in low returns on deposits -- but also as a result of a
\nseries of measures that removed many bureaucratic controls over
\nthe fledgling capital market.<\/p>\n
During this period there was increasing recognition of the
\nimportant role prudential regulations had to play in a market-
\noriented system. As a result much time and effort has been spent
\non formulating the principles and the drafting of three financial
\nlaws: The Banking Law, the Insurance Law, and the Pension Funds
\nLaw -- finally passed in 1992 -- and the comprehensive Capital
\nMarket Decree of December 1990. As you may be aware, the so-
\ncalled \"deregulation packages\" provided many of the guidelines
\nfor the banking and insurance laws; the capital market decrees
\nserve the same purpose to a large extent for the drafting of the
\ncapital markets law, which is currently underway. The Pension
\nFunds Law provided the first set of rules in the important area
\nsince the 1984 Income Tax Law granted tax exemption for pension
\nfund deposits. Measures addressing licensing of non-deposit
\nfinancial institutions such as venture capital, factoring and
\nleasing were also enacted in 1988.<\/p>\n
Looking back from our current vantage point, one can identify
\na number of specific components of the financial reform measures
\nthat might well have been done differently. Hindsight is, as we
\nall know, a powerful analytic tool. But at the time the
\nIndonesian government implemented the various financial reform
\nmeasures, it did not have the benefit of hindsight, or even of
\nany approximate models or good examples from other, similarly
\npositioned, countries. In many ways, Indonesia was a pioneer in
\nimplementing financial reforms. Moreover, it has pushed them
\nfurther than most other countries in the region, despite the fact
\nthat Indonesia is one of the poor countries in the region.<\/p>\n
Before attempting to review some of the main issues raised by
\nthe reforms and discuss whether they were handled in the best
\npossible manner, let me first raise, and give my answer, to what
\nI consider to be the basic question: \"Is Indonesia better off now
\nin terms of both economic growth and improvement in the general
\nwelfare of the people than it would have been if the broad set of
\nfinancial reforms introduced over roughly the past decade had not
\nbeen implemented?\" And, perhaps equally important, \"does the
\nexisting partially reformed financial system provide a better
\nfoundation for future economic development than would have been
\nprovided by a system still functioning along the general lines
\nthat existed in 1982?\"<\/p>\n
My answer to both of those questions is an unqualified \"Yes\".
\nI believe that the size and diversity of the present financial
\nsystem is much greater than it would have been; that the array of
\ninstruments offered is much broader and much better suited to
\nmeet the more varied needs of the economy; that the financial
\nsystem meets the needs of the economy more efficiently; that the
\nsystem is, and will continue to be, able to meet a much greater
\nshare of the country's demands for financial services than it
\nwould have been without the reforms; and, finally, that the
\nlevels of human skills and knowledge, as well as the intellectual
\nand organizational infrastructure now found in the financial
\nsector, are much higher than they might have been.<\/p>\n
It is generally agreed that the reform measures have had a
\nprofound impact on the growth and structure of the banking system
\nas well as on the services provided by the banking sector. The
\nrelaxation of ownership requirements for new banks, combined with
\nthe relatively small capital base required to establish a bank,
\nled to a dramatic increase in the number of Indonesian banks. The
\nnumber of private domestic commercial banks grew from 63 in 1988
\nto 158 at the end of 1993 and the number of foreign joint venture
\nbanks from eleven in 1988 to 39 at the end of 1993. The total
\nnumber of bank offices grew from 9,434 in 1988 to 13,330,
\nincluding many new branches of small rural banks, serving people
\npreviously excluded from the financial system. Private bank
\ngrowth outpaced that of state banks, with a rapid increase in
\ndomestic private bank market shares.<\/p>\n
Following PAKTO, as the measures introduced in October 1988
\nare commonly called, the Indonesian banking sector also
\nexperienced extraordinary credit and deposit growth. In 1989,
\ncredit to private enterprises and individuals grew by 56 percent,
\nand in the following year by 58.1 percent. Over the same two year
\nperiod, deposits grew 43.4 percent and 47.3 percent. Given the
\nrapid credit growth, it was not surprising that the economy began
\nto show signs of imbalance, evidenced by rising inflation and a
\nsurge in imports. Moreover, the aggressive growth that occurred
\neventually resulted in declining asset quality and system
\nuncertainty, forcing Bank Indonesia to take steps to limit credit
\ngrowth and enforce stronger prudential standards. These measures,
\ncommonly referred to as the \"TMP\" or \"Tight Money Policy,\"
\nreduced monetary growth and resulted in a rise in interest rates.
\nAs a result of the TMP measures, credit growth slowed and a
\nmeasure of macroeconomic stability was regained.<\/p>\n
Financial reform should also lead to improvements in the
\n\"cost\" and the \"allocative efficiencies\" of the banking system.
\nThere is evidence that the \"cost\" efficiency of the banking
\nsystem has improved, despite an expansion in the branch network
\nof private banks and the increase in salaries for banking
\nprofessionals. Since the freeing of domestic interest rates in
\n1983, competition has tended to force down bank margins across
\nall banks.<\/p>\n
Improvements in \"allocative efficiency,\" that is the lending
\nto projects with high returns, have been slower to materialize.
\nAlthough the removal of the interest ceiling gave banks an
\nopportunity to price and size loans in accordance with perceived
\nrisks, steps which should have improved efficiency, this is
\nevidence that the loan portfolio quality has deteriorated in some
\nbanks. Non-performing loans constituted nearly 16 percent of all
\nbank loans in October 1993, up from an estimated six percent
\nthree years earlier. The problem of non-performing loans is
\nespecially serious at the state banks, where some 21 percent of
\nall loans may be classified as non-performing. Though some of
\nthese problems may be due to the unwillingness, rather than
\ninability, of the borrowers to repay, the evidence suggests that
\na substantial portion of total bank credit has not been used
\nproductively.<\/p>\n
To deal with the issue of asset quality deterioration,
\nstronger prudential guidelines have been implemented. A major
\npackage, announced in February 1991, aimed at improving bank
\nsupervision and at encouraging banks to strengthen their internal
\ncontrols. The Bank for International Settlement capital-to-risk-
\nasset standards were also adopted. To ensure full compliance with
\nthese rules, Bank Indonesia is putting high priority on upgrading
\nits regulatory capacity. And in order to provide more accurate
\nstatistics, Bank Indonesia, in cooperation with the Indonesian
\nAccountants Association, has developed new accounting standards
\nfor banks.<\/p>\n
We have also seen major strides in the Indonesian capital
\nmarkets, despite occasional concerns that progress was too slow.
\nAs a result of the various reform measures, the market has
\nexperienced significant growth with the number of shares traded
\nrising from 6.9 million shares in all of 1988 to 513 million
\nshares being traded in only one month in 1993. Between 1988 and
\nthe end of June of this year, the number of listed companies has
\nrisen from 24 to 186 and market capitalization has increased from
\nRp 481 billion to Rp 70 trillion.<\/p>\n
Moreover, the Jakarta Stock Exchange has been privatized and a
\nclearing, settlement and depository institution has been set up.
\nIt is working, along with the Surabaya Exchange, to computerize
\ntheir activities with compatible systems. Finally, a
\ncomprehensive set of regulations, the Capital Market Decree of
\nDecember 1990, has served to improve disclosure, reporting, and
\noverall transparency of market operations. This decree deals with
\nthe legal issues of: fungibility, immobilization, self-regulatory
\nbodies, as well as providing more enforcement capacity to
\nBAPEPAM. An inter-ministerial team has been set up to translate
\nthese and other necessary regulations into law.<\/p>\n
Window 1: The reform measures have had a profound impact on the growth
\nand structure of the banking system.<\/p>\n
Window 2: Financial reform should also lead to improvements in the
\n\"cost\" and the \"allocative efficiency\" of the banking system.<\/p>",
"url": "https:\/\/jawawa.id\/newsitem\/financial-reform-achievements-problems-2-1447893297",
"image": ""
},
"sponsor": "Okusi Associates",
"sponsor_url": "https:\/\/okusiassociates.com"
}