Financial reform: Achievements, problems (3)<\/p>\n
This is the last of a three-part article in a series based on
\na keynote address given by presidential advisor Ali Wardhana at
\nthe Indonesia Update 1994 seminar at the Australian National
\nUniversity in Canberra on Aug. 19.<\/p>\n
CANBERRA: The most important banking reform, adopted in
\nOctober 1988, reduced the barriers to the entry of new banks, to
\nthe establishment of new bank branches and to the carrying out of
\nforeign exchange operations by banks. New prudential requirements
\nfor minimum bank capital and lending limits to individual
\nborrowers or affiliated groups of borrowers, based on the bank's
\ncapital, were also adopted. Applicants wishing to establish new
\nbanks still had to meet both minimum capital and experience
\nrequirements, but the flood of new applicants indicated that
\nthese requirements were too low. They were later raised.<\/p>\n
Another regulatory change reduced the legal reserve
\nrequirements from a mixture of rates that averaged about 11
\npercent, to a uniform rate of 2 percent for all bank liabilities.
\nA major reason for this large reduction was to reduce the
\nintermediation costs to bank's to make them more efficient and to
\npartially offset the effects of the withholding tax on interest
\npaid on bank deposits that was imposed.<\/p>\n
The 1992 banking law also changed the status of the state
\nbanks to that of commercial banks, in the expectation that this
\nmove would force the banks to become more efficient and more
\nmarket responsive. Until recently the state banks continued to be
\ntreated as conduits for government programs and other goals, as
\nis suggested by the recent Bapindo case. Finance Minister Mar'ie
\nMuhammad, in response to the Bapindo crisis, has stated
\nemphatically and clearly that state banks must act efficiently
\nand professionally, analyzing carefully their customers' projects
\nand ability to repay loans while rejecting loans where repayment
\nis questionable.<\/p>\n
It has been argued that the Indonesian government has been
\nslow in fostering the development of money markets. In part this
\nresulted from the conservative approach that was followed in
\ndeveloping more flexibility in the SBI market and in related
\ninterest rates. This reflected Bank Indonesia's concerns about
\ncontrol over foreign exchange reserves and the feeling by Bank
\nIndonesia management that it lacked an effective tool to counter
\nspeculative capital movements. Developments since mid-1993 have
\ndemonstrated that Bank Indonesia can effectively influence
\ninterest rates through its management of indirect money market
\ninstruments, thus effecting foreign capital movements.<\/p>\n
Finally, let me mention the remaining direct controls
\naffecting the assets and liabilities of banks, such as the
\nrequirement on the loan portfolio of domestic banks that 20
\npercent of loans be allocated to \"small business\", and the rule
\nthat 50 percent of loans of foreign and joint venture banks be
\nallocated to foreign exchange generating activities. In January
\n1990, the long-standing system of liquidity credits, i.e.
\nsubsidized credits from Bank Indonesia to priority sectors, was
\nseverely curtailed. This was a major step towards a market-
\noriented system, but it was also a controversial step. It was
\njudged necessary to be sure that credit would be provided to
\nsmall business and the 20 percent rule was the policy adopted.
\nThis requirement was made more flexible in May 1993, and in the
\nfuture, if there is adequate evidence that the financial system
\nis meeting the needs of small businesses fairly and effectively,
\nit may be possible to eliminate it altogether.<\/p>\n
Similarly, the requirement that joint venture banks allocate a
\nminimum share of their loans to foreign exchange-earning
\nactivities was an effort to ensure that these new largely
\nforeign-owned banks not just engage in currency speculation, or
\nlend primarily for import-absorbing projects of investors from
\ntheir home countries. Given current concerns about the growth of
\nnon-oil exports, it is unlikely that this rule will be changed
\nsoon, but if exports resume their recent growth rates, then this
\nrule, too, might be relaxed.<\/p>\n
After PAKTO there were predictions of imminent and numerous
\nbank failures, especially among the many newly licensed banks. In
\nfact there have been only two notable private bank insolvencies
\nand these have occurred in old established banks. The first
\ninstance, in August 1990, involved Bank Duta, and was
\nprecipitated by excessive, and unwise, foreign exchange
\nspeculation that violated the net open position rules imposed by
\nBank Indonesia in May 1989. The losses incurred were covered by
\nadditional capital contributions at no cost to the depositors or
\nthe central bank. The second instance, which led to the collapse
\nand liquidation of Bank Summa, resulted from the continued
\nprovision of credit to affiliated companies contrary to the new
\nPAKTO rules. The liquidation process is still underway and it is
\nexpected that all deposit liabilities will ultimately be honored.<\/p>\n
The state banks, which are seen as stolid but safe, continue
\nto have troubles. Lending by some state banks has in the past
\nbeen influenced by outside pressures, which has led to a large
\nnumber of problem loans. A joint Ministry of Finance -- Bank
\nIndonesia committee was established last year to deal with non-
\nperforming loans of the state banks, and this is leading to a
\nthorough examination of the kinds of steps that need to be taken
\nto improve the performance of the entire banking system.<\/p>\n
An outgrowth of the government's efforts in this area has been
\nthe ongoing Bapindo case, where, as you are undoubtedly aware, it
\ncame to light that the state-owned industrial development bank
\nBapindo suffered losses amounting to perhaps US$430 million, an
\namount in excess of the bank's total capital base. While I wish
\nthat this problem had never occurred, I believe that the public
\nairing of the bank's problem has been good for the banking
\nsystem. It has put bankers and borrowers on notice that the
\ngovernment is serious about improving the banking sector.<\/p>\n
One continuing criticism of the deregulation process in
\ngeneral, and the financial sector is no exception, is that the
\nmajor beneficiaries have been the so-called \"conglomerates\". What
\nimpact the deregulation measures have had on the growth of
\nenterprises by size, let alone on income distribution, is still
\nuncertain. International studies have consistently shown that
\nreducing regulations and protective measures is an important
\nmeans of improving income distribution. We also know that the
\nmeasured Gini-coefficient for Indonesia improved from 0.34 in
\n1976, to 0.319 in 1990. A recently published study, based however
\non data only through 1988, reaches the conclusion that \"...
\nfinancial ... liberalization has helped to reallocate domestic
\ncredit toward small establishments.\" Prior to the financial
\nsector reforms, small-scale establishments were faced with
\ncapital market imperfections in the form of liquidity constraints
\nor a schedule of rising costs for external funds. Such
\nconstraints, the study concludes, were relaxed after the
\nfinancial sectors reforms. However, the authors correctly note
\nthat not all of the changes in profitability of assets,
\nborrowing, and investment rates that they observe can be
\nattributed solely to the financial deregulation measures.<\/p>\n
Despite concerns about the potential for concentration of
\nfinancial activity in the large urban centers, there has been a
\nmajor increase in banking services for the rural population.
\nAlthough the Unit Desa program carried out by Bank Rakyat
\nIndonesia was not conceived as a part of the financial sector
\nreforms, the decision to provide banking services to people
\nresiding in rural areas, to pay positive real interest rates for
\nrural savings, and to charge loan rates sufficient to cover all
\ncosts and earn a reasonable profit for the bank, were consistent
\nwith the reform agenda. Research suggests that major benefits of
\nimproving the operation of the rural credit system benefited low
\nincome households. The Unit Desa program has a single loan
\nproduct, KUPEDES, which carries an effective annual interest
\nrate, if payments are made on time, of about 32 percent. The
\naverage size of loan made through the Unit Desa is about $750,
\nwith about 70 percent falling below this figure. Most important,
\nloan performance has been excellent, with losses running a little
\nover 3 percent, an amount easily covered by the interest spread.<\/p>\n
Finally, concerns about general financial instability or even
\nthe capacity to manage monetary policy effectively have been
\nlargely unrealized. There has been no serious instance of capital
\nflight, despite occasional political disturbances and, at times,
\nunfavorable economic developments. When stability problems have
\narisen, the government has not hesitated to take corrective
\naction quickly when that seemed required. I would submit that the
\noverall record of price, and exchange rate stability has been
\nquite good when compared with other countries.<\/p>\n
Window 1: Lending by some state banks has in the past been
\ninfluenced by outside pressures, which has led to a large number
\nof problem loans.<\/p>\n
Window 2: Concerns about general financial instability or even the
\ncapacity to manage monetary policy effectively have been largely
\nunrealized.<\/p>",
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