Indonesia needs a more diversified financial sector<\/p>\n
P.S. Srinivas, Jakarta<\/p>\n
Having put the crisis of eight years ago firmly behind it,
\nIndonesia is now looking ahead -- to a more promising economic
\nfuture for its people. The government is targeting a gross
\ndomestic product (GDP) growth rate of 6 percent or more from
\n2006. The private sector will be the engine of this growth and it
\nneeds financing. In addition, infrastructure development, small
\nand medium enterprises (SMEs), and housing have also been
\nidentified as key priorities.<\/p>\n
The achievement of all these objectives calls for substantial
\nfinancial resources. Indonesia would clearly do well to mobilize
\nas much of these resources domestically as possible. A strong,
\nvibrant, and diversified financial sector -- that consists not
\nonly of banks, but also capital markets and non-bank financial
\ninstitutions such as pension funds and insurance companies,
\nmutual funds, leasing and factoring companies, and venture
\ncapital firms -- can efficiently mobilize and effectively
\nallocate finance.<\/p>\n
Banks dominate the Indonesian financial landscape at present
\nholding over eighty percent of financial assets. After the costly
\ncrisis, in which over 50 percent of GDP was spent to put the
\nbanking sector back in order, the good news is that Indonesia's
\nbanking sector is much healthier now. It has been restructured,
\nis now much stronger, with fewer non-performing loans, higher
\ncapital-adequacy ratios, and higher profitability.<\/p>\n
While some concerns remain, especially on the role of state
\nowned banks, the time is now right to broaden the policy agenda
\nbeyond banks. Capital markets and non-bank financial institutions
\nneed to be further developed so that the financial sector can
\nplay a better role in supporting Indonesia's development.<\/p>\n
A dynamic economy needs access to different types of capital.
\nBanks typically provide relatively short term credit to
\nborrowers. This is line with the structure of their liabilities.
\nNearly all deposits at Indonesian commercial banks are less than
\none year in maturity.<\/p>\n
It is therefore not surprising that the majority of the
\nlending growth in bank is coming from short-term consumer credit
\nand working capital lending. While banks claim to be targeting
\nSMEs for their new lending, SMEs themselves complain of facing
\ncredit constraints from banks.<\/p>\n
The key point is that, even if attractive investment
\nopportunities were available, banks would not necessarily be a
\nsource of long-term capital. Neither would they invest in
\nfinancing entrepreneurship. While entrepreneurs are what drive
\nSMEs and job creation-- financing them is often too risky for
\nbanks. For long-term capital and for equity and risk capital, we
\nneed well functioning capital markets, non-bank financial
\ninstitutions, and institutional investors.<\/p>\n
Housing, infrastructure, and government's own financing
\nrequirements -- all call for long-term financing. Pension funds,
\ninsurance firms, and other institutional investors typically have
\naccess to long-term funds that can be used to finance long-term
\nneeds. These institutions also provide financial products that
\ncan help individuals and institutions better manage risks.<\/p>\n
Venture capital funds can finance entrepreneurship at early
\nstages -- when the ventures are risky but financing is critical,
\nso that new and dynamic firms can be established. Capital markets
\ncan mobilize debt and equity financing and offer products that
\noffer higher returns than bank deposits.<\/p>\n
Indonesia's non-bank financial institutions are small for a
\ncountry of its size. For example, Indonesia's insurance firms
\nhave assets of 5 percent of GDP -- compared to 20 percent of GDP
\nfor Malaysia. Pension funds assets in Indonesia are 3 percent of
\nGDP compared to Malaysia's 56 percent. Mutual funds are 5 percent
\nof GDP Indonesia compared to 12 percent in Thailand. Not only
\nthat, the investments are also sub-optimal. Pension funds and
\ninsurance firms in Indonesia invest nearly 60 percent of their
\nresources in short-term bank deposits -- in essence transforming
\nscarce long-term resources into short-term assets.<\/p>\n
But there is significant potential. Pensions and life
\ninsurance firms are estimated to have assets of more than Rp 130
\ntrillion (US$13.6 billion) and these are growing. Going forward,
\ngiven the demographics of Indonesia -- a country with a large and
\nrelatively young population -- these assets in these institutions
\nare likely to grow significantly. A small fraction of these -- if
\ninvested in sound long-term investments -- could begin to make a
\ndifference. Mutual funds have another Rp 100 trillion.<\/p>\n
This market needs careful nurturing and sound regulations to
\nensure that past growth is sustained. Equity markets have been
\nbooming and the Jakarta Stock exchange was the fifth best
\nperforming market in world (in local currency) last year.
\nHowever, there are less than 75,000 domestic individual investors
\nin a country of 220 million people and equity raised in 2004 was
\nRp 7 trillion (less than 3 percent of all private capital
\nformation.<\/p>\n
What needs to be done? A concrete first step would be the
\nclear recognition and articulation by the government that the
\ndevelopment of the non-bank financial sector is key to
\nIndonesia's future development. Based on this recognition, a
\nvision for the future of this sector can be developed, in
\nconsultation with key stakeholders, including industry. Second,
\nthere needs to be a focus on assessing and improving the \"market
\ninfrastructure\" that underlies the sound functioning of financial
\ninstitutions.<\/p>\n
Examples include strengthening creditor rights; developing
\nsound credit bureau; enforcing sound accounting and auditing
\nprocedures; improving corporate governance; and strengthening
\nregulation and supervision. This is a big agenda, but it can be
\nsequenced and implemented in a phased manner over time. Finally,
\ndetailed reform agendas for each segment of institution need to
\nbe developed and implemented.<\/p>\n
Indonesia's financial sector is at a crossroads. It has been
\nrescued from a debilitating banking crisis at a huge cost to the
\ntax payer. Much of the crisis management work is behind the
\nGovernment. However, the economy continues to be too dependent on
\nbanks and less emphasis has been placed on other financial
\ninstitutions.<\/p>\n
Therefore, the focus of policy now needs to shift to ensuring
\nthe development of a diversified financial sector that is able to
\nfinance economic growth in future on a sustainable basis.
\nIndonesia needs to develop a well functioning \"spare tire\" in its
\nfinancial system -- one that can mobilize and allocate long-term
\nresources, reduce vulnerability, and provide additional products
\nfor savings and risk management.<\/p>\n
Well developed capital markets and non bank financial
\ninstitutions are an integral part of the solution to the needs of
\nIndonesia. How best to do this: The upcoming NBFI conference on
\nApril 11-12 in Jakarta will try to address the challenge.<\/p>\n
The writer is Sector Coordinator, Finance & Private Sector
\nDevelopment, at the World Bank Office in Jakarta. The views
\nexpressed here are his own.<\/p>",
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