Information about Asia and the Pacific Asia y el Pacífico
Journal Issue

Indonesia: Selected Issues

International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2018
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Information about Asia and the Pacific Asia y el Pacífico
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Financial Deepening and Inclusion1

Promoting financial deepening and inclusion is crucial to increase resilience to external shocks and is a priority of the government. The authorities issued a national strategy for financial inclusion in 2016 and are preparing a national strategy for financial market development. Indonesia’s financial markets are still underdeveloped and financial access is low compared to those of its peers, but they have potential to support inclusive growth with the proper reforms. This chapter assesses the status of financial market development and financial access, summarizes the national strategies, and discusses priorities to enhance the role of financial system for inclusive growth.

A. Financial Market Depth and Financial Access

1. Banks dominate the financial system, while the domestic institutional investor base is narrow. Aggregate assets of financial institutions amounted to 72 percent of GDP, and banks account for about 80 percent of the aggregate assets. Banks tend to be quite conservatively run and rely on retail deposits for funding; wholesale funding is very small. Given the short-term nature of the retail deposits, banks provide only limited financing for long-term investments and focus instead on commercial lending. Asset holdings by domestic institutional investors, such as pension funds and insurance companies, remain small, with outstanding assets under management of pension funds equal to about 2 percent of GDP and those of insurance companies at below 8 percent of GDP at end-2015. Each type of investor trails peers by a wide margin.2

2. The short-term funding markets are shallow and segmented. Money market liquidity remains low and is dominated by short-dated unsecured interbank transactions. The daily average volume of the unsecured interbank market was IDR11.8 trillion in 2016 (less than 0.1 percent of GDP, compared to 0.3 percent of GDP in Malaysia and Thailand). Turnover is skewed to the overnight, which accounted for about 60 percent of the interbank market activity in 2016. The main liquidity providers in the interbank rupiah market are state-owned banks. Foreign banks mainly trade with large domestic banks in the FX swap market, while small banks usually transact FX swaps among themselves. Segmentation, coupled with chronic excess liquidity, limits the effectiveness of monetary policy, complicates BI liquidity management, and constrains the development of money markets (IMF, 2017).

3. Domestic capital markets are also relatively underdeveloped and foreign presence is strong. At end-2015, outstanding domestic debt securities and stock market capitalization amounted to 16 percent and 41 percent of GDP, well below the peer median of 60 percent and 49 percent, respectively (Figure 1).3,4 The paucity of domestic institutional investors is associated with the underdevelopment of capital markets. Figure 4 shows a high correlation between the size of the institutional investor base and the size of capital markets. Foreign investors hold about 39 percent of government securities denominated in local currency, one of the highest penetration rates among EMs (26 percent in Asia on average). This combination of shallow markets, the narrow base of domestic institutional investors, and high foreign participation have left Indonesia susceptible to capital flow reversals.

Figure 1.Selected Countries: Size of Capital Markets and Institutional Investors

Figure 2.Financial Access in Asia

(Share of adult population with bank account, 2014)

Source: World Bank, Global Findex Database.

Figure 3.Bank Net Interest Margin1/

(In percent)

Source: World Bank, the 2017 Financial Sector Assessment and FinStats Database.

1/ Peer countries are Brazil, Chile, China, India, Mexico, Malaysia, Philippines, Russia, Thailand, Turkey, Vietnam, and South Africa. The expected median is a statistical benchmark based on a quantile regression applied to a global country database for the period 1980-2015 using a country’s structural characteristics such as its income, population size and density, age distribution, and whether it is an oil exporter or offshore financial market.

Figure 4.Fundamental Framework for Financial Market Development

Source: Draft National Strategy for Financial Market Development, mimeo.

4. Corporate financing through capital markets is also limited, compared to government financing. The government bond market—outstanding government bonds amount to about 22 percent of GDP in 2016, with nearly three-quarters denominated in rupiah—is relatively developed. The size of the corporate bond market, however, remains at less than 3 percent of GDP, two-thirds of which is accounted for by financial institutions and the rest mainly issued by SOEs. While corporate bond issuances almost doubled to IDR116 billion in 2016 from IDR58 billion in 2013, the development gap remains evident in the low outstanding amounts, the small share of issuances by nonfinancial corporations, and the short maturities, compared to its peer countries (Figure 1). The low demand for corporate bonds is partly driven by concerns about weak creditor rights and lengthy default resolution. Corporate financing through the stock market also remains low, as reflected in the number of companies issuing IPOs (16 firms a year on average during 2014–16) and thin market turnover (Figure 1). While the total number of listed firms has increased to 555, it is still small compared to the Asian peers (4,073 in India and 806 in Malaysia).

5. Access to the formal financial system is low given the Indonesia’s unique geographical challenges, although it has improved recently. About 36 percent of adults had a transaction account with a formal financial institution in 2014, up from 20 percent in 2011, per the Global Findex database (Figure 2). However, it is still low compared to the average among other EMs in the East Asia and Pacific region (53 percent).

6. Inefficient bank intermediation has held back financial inclusion. Net interest margins (NIMs), a commonly used measure for bank intermediation efficiency, is structurally higher in Indonesia than in many other EMs (Figure 3). The small size of the banking system, weaknesses in the legal and institutional environment, high market power, and operational inefficiencies have contributed to weak intermediation efficiency (World Bank, 2017). Given Indonesia’s bank centric system, these inefficiencies have adverse implications for savings mobilization, credit intermediation, and financial inclusion.

7. Current policy measures to address high NIMs are unlikely to be effective. They include caps on deposit rates, allegedly to discourage aggressive pricing behavior by some banks; moral suasion to induce banks to lower lending rates to single digit levels, particularly for the corporate and mortgage segments; requirements for all banks to meet minimum lending exposures quotas to micro, small and medium-sized enterprises. NIMs remain high despite these measures, which also hinder the effectiveness of monetary policy operations.

B. National Strategies and Recent Progress on Financial Deepening and Inclusion

8. Promoting financial deepening and inclusion has been a priority of the government in recent years. Indonesia faces a long-term finance and investment gap, particularly in infrastructure. The development of capital markets to mobilize private long-term finance is needed to supplement and alleviate traditional bank and fiscal channels. The government has created a national council for financial inclusion and a high-level joint forum for financial deepening to promote interagency coordination. The national council, chaired by the President, adopted the National Strategy for Financial Inclusion (SNKI) in 2016.

9. The high-level joint forum is currently preparing an ambitious national strategy for financial market development. Figure 4 summarizes the draft national strategy, which covers three pillars and seven elements of financial market ecosystem to develop six financial markets in parallel—money, foreign exchange, bond, equity, sharia financial, and structured product market. The strategy aims to allocate resources and manage risks efficiently through deep and liquid financial markets by developing market infrastructures and harmonizing regulations under close policy coordination. For successful implementation, the authorities will design a detailed multiyear strategic action plan with quantitative targets (size of each market in percent of GDP) along with key performance indicators through three separate phases (2017–19, 2020–22, and 2023–24).

10. The authorities have taken steps to advance money and foreign exchange market development. In August 2016, BI introduced a regular 7-day reverse repo operation with a fixed rate, full allotment, and the attached rate as the main policy rate. The interest rate corridor was narrowed to 150 basis points from 250 basis points. In July 2017, it also launched a partial reserve requirement (RR) averaging of 1.5 percent, out the 6.5 percent current primary RR ratio, over a two-week period, allowing the floor of the RR ratio to be at 5 percent on a given day. This reform has benefited small banks with shortage of liquidity. BI has already stopped issuing the 3-month tenor securities with the regular 3-month T-bills issuances planned by the Ministry of Finance (MOF). Issuance of T-bills has risen, providing more instruments at the short end of the yield curve. The Financial Services Authority (OJK) launched the Global Master Repurchase Agreement to develop the repo market, and BI offers seminars and workshops on the trading of repo operations.5 To spur FX market development, BI has overhauled FX regulatory framework to spur FX market development. In addition, the Indonesian version of the International Swap and Derivatives Association contract has been introduced, and call spread options are allowed as hedging instruments.

11. The authorities have made progress in enhancing inter-agency coordination to develop capital markets. Substantial cross-agency coordination and private sector consultation occurs through the Capital Market Infrastructure Development Program Team and the Bond Market Development Program Team. These initiatives have resulted in various positive reforms, including the development of a capital market data warehouse and the implementation of Single Investor Identification for government bonds. Initiatives under implementation include the development of infrastructure for third party repo and the establishment of a bond electronic trading platform.

The 2016 National Strategy for Financial Inclusion has raised the profile of the financial inclusion agenda (Figure 5). The SNKI has five pillars—financial education, public property rights, expansion of financial products, distribution of government transfers, and consumer protection—supported by three foundations, including conducive policies and regulations, supportive IT infrastructure, and effective coordination and implementation. It targets an ambitious goal to reach 75 percent of adults with a transaction account by end-2019. Prior to the launch of the SNKI, the government established the “People’s Business Loan” (KUR) program in 2007 to enhance the access of medium, small, and micro enterprises (MSMEs) to bank loans through the provision of subsidized, partial credit guarantees covering 70 percent of the loss. Under this program, the government provides interest subsidies to participating banks allowing them to lend to MSMEs at capped interest rates. The total loans supported by KUR reached IDR53 trillion in August 2017.

Figure 5.Pillars and Foundation of the National Strategy for Financial Inclusion

Source: Coordinating Ministry of Economic Affairs, 2016, National Strategy for Financial Inclusion.

12. The increasing use of digital financial services (DFS) offers a promising channel to overcome geographical barriers to financial inclusion.6 Recent regulatory changes have allowed e-money issuers (banks and nonbanks) to engage Layanan Keuangan Digital (LKD, digital financial services) agents and allowed banks to provide basic bank accounts and other financial services via Laku Pandai (LP, branchless banking) agents to expand service delivery outreach. These agents are now present in all provinces and in 99 percent of the districts in the country. LKD agents provide access to cash-in, cash-out, bill payments and transfers services, while LP agents can offer these same services and facilitate opening basic bank accounts and conduct transactions. At end-2016, 23 banks were offering LP services to around 3.7 million customers.

13. BI and OJK are supportive of the rapid developments of FinTech.7 The Fintech sector has expanded rapidly in recent years and attracted around US$15 billion in investments in 2016. BI has established a FinTech office and OJK has established an internal cross-departmental group to promote sustainable growth of FinTech and mitigate risks to the financial system. OJK recently issued a regulation on Peer-to-Peer lending and proposals to establish a FinTech incubator. BI issued regulation in December 2016 on FinTech players in the payments system.

C. Key Priorities for Successful Implementation of National Strategies

14. Effective prioritization and sequencing of the strategic actions will be essential. The authorities’ progress in developing a national strategy for capital market development is commendable, and reflects high-level political support and enhanced inter-agency coordination. Priority should be given to improve fundamentals for financial deepening and inclusion in a manner that does not give rise to undue stability risks, as recommended in the latest FSAP (IMF, 2017). They include: (i) strengthening credit culture; (ii) upgrading supervisory and regulatory framework along with financial market development; (iii) establishing a liquid benchmark yield curve; (iv) promoting long-term financing with new financial instruments; and (v) expanding the domestic investor base.

15. A stronger credit culture and improved financial infrastructure are important for sustainable financial development. The authorities have improved the use of movable collateral by transitioning to an online collateral registry in 2013. The transformation from manual to online registry resulted in a huge increase in the number of total registrations (World Bank, 2017).8 The introduction of a credit registry and the recent licensing of private credit bureaus were positive steps towards improving credit culture, and efforts can be stepped up to operationalize the credit bureaus. Current Indonesian insolvency and creditor rights (ICR) legislation represents a significant improvement over pre-2004 laws, but out-of-court restructuring is still the preferred method because of the costs of using formal procedures, which still require some improvement (World Bank, 2017). Adequate ICR regimes would further improve recovery rates and increase access to credit, particularly for MSMEs.

16. The supervisory and regulatory framework needs to evolve along with financial market development. To reduce the silo structure in financial oversight, which will require changes to the OJK law, OJK has established a new department for integrated supervision (the Integrated Supervisory and Regulatory Department) which brings internal coordination directly under the authority of the Chairman. OJK should tackle its silo structure formally through the amendment of its law and also strengthen the financial oversight and the enforcement of prudential regulations, including with respect to financial conglomerates, as recommended in IMF (2017). Other priorities include eliminating interest rate caps, which will help improve monetary transmission. Portfolio exposure targets, including minimum MSME exposure targets and the minimum investment requirement on government bonds and infrastructure-related SOE bonds on nonbank financial institutions, should be reviewed.

17. Financial innovation needs to be accompanied by financial stability. BI and OJK could step up their oversight activities of DFS and FinTech, and expand collaboration to fully monitor and ensure safety, efficiency and reliability of these services. Weakness in the communication infrastructure, particularly in remote and rural areas, may pose operational risks which could adversely affect agent and customer confidence in DFS (World Bank, 2017). Especially, the authorities should engage the telecom regulator and payment system operators to enhance operational reliability. In partnership with financial institutions, the authorities could consider launching a nationwide campaign to spread awareness on DFS. The authorities should also review the effectiveness of the KUR program, including its potential fiscal costs and whether it is achieving increased lending to new borrowers, as recommended in IMF (2017).

18. Continued efforts are needed to build a liquid benchmark yield curve. MOF observes good practices regarding its issuance program, including market communications and auctions. Benchmark securities of 5, 10, 15, and 20-year maturities are perceived to be reasonably liquid, but liquidity is thin in shorter segments of the yield curve. BI has already stopped issuing securities on the 3-month tenor with the regular 3-month T-bills issuances. Further improvements can be considered, including: (i) the gradual move to further reserve averaging already planned; (ii) the gradual consolidation of BI liquidity management instruments to support the move to the mid-corridor system; (iii) the maintenance of regular issuances of T-bills to avoid competition between BI instruments and T-bills on the same maturities.

19. The authorities have been mobilizing private long-term financing with new financial instruments, but there is scope for further improvement. The development of capital markets to mobilize private long-term finance for infrastructure is needed to supplement and alleviate traditional bank and fiscal channels. The government has sought to fund infrastructure projects by issuing SOE bonds and structured products (e.g., asset backed securities) in addition to traditional bank funding. It will be important to ensure that these products are introduced without compromising prudential standards or creating undue risk in the form of high and concentrated exposures to infrastructure-related instruments or SOE debt in the balance sheets of financial institutions. Also, the development of FX and derivatives markets is important to support the development of bond and stock markets, as the former helps market participants manage existing risk exposure to their holdings of debt and equity securities.

20. The enlargement of the domestic investor base should go hand in hand with the expansion of capital markets. The paucity of domestic institutional investors is not just a constraint on capital market development but also a source of vulnerabilities in the financial system. Institutional investors, in addition to serving as major asset holders, could help provide market liquidity and act as market stabilizers, as capital market development would broaden their investment opportunities. They can also help intermediate large national savings domestically and thus mitigate the heavy reliance on foreign funding. Therefore, developing a critical mass of long-term institutional investors will be important to support economic development as well as financial market deepening. Improved financial literacy and IPO distribution could enhance participation of retail investors, helping diversify the investor base. Also, greater participation of domestic institutional and retail investors in capital markets require improvements in tax framework for financial products and hedging instruments (World Bank, 2017).9


    Coordinating Ministry for Economic Affairs2016“National Strategy for Financial Inclusion—Synergizing Efforts to Expand Financial Access for the People’s Welfare,” (Jakarta: Coordinating Ministry for Economic Affairs).

    International Monetary Fund2017Indonesia: Financial System Stability Assessment,IMF Country Report No. 17/152 (Washington).

    World Bank2017Republic of Indonesia Financial Sector Assessment,” (Washington).

Prepared by Heedon Kang (MCM).

The shadow banking activities accounted for less than 1 percent of GDP in Indonesia according to FSB (2017).

Peers include Brazil, China, India, Malaysia, Mexico, the Philippines, Poland, Russia, South Africa, Thailand, and Turkey.

The size of domestic bond market and stock market has continued to increase, standing at 18 percent and 48 percent of GDP in July 2017.

Currently, 74 out of 103 conventional banks have signed the Global Master Repurchase Agreement, and 55 banks engage in repo transactions.

DFS is defined in Indonesia as tailored financial services and products delivered through channels other than traditional bank branches.

FinTech is defined as innovative use of technology to introduce new approaches to the provision of financial services and products.

Since its launch, the registry has facilitated over US$30 billion in financing for more than 200,000 small-scale businesses. In total, there were 19.3 million registrations of corporates, MSMEs, and consumers in the three years since the launch, compared to only three million registrations in total during the ten years of operation of the manual registration system that preceded it.

The withholding tax rate of foreign investors is 20 percent, while ranging from 0 to 15 percent in its peers.

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