rising to the challenge in asia: a study of financial markets · (malaysia), ken-ichi takayasu...

Rising to the Challenge in Asia:A Study of Financial Markets

Asian Development Bank1999

Volume 6

Indonesia

Asian Development Bank

P.O. Box 789

0980 Manila, Philippines

The views and opinions expressed in this publication are those of the individual authors

and do not necessarily represent the views of the Asian Development Bank.

Published by the Asian Development Bank

All rights reserved

Publication Stock No. 060399

ISBN 971-561-233-4

Foreword

The Asian currency and financial crisis has had far-reaching effects on the regional economies and theirtrading partners. These effects have threatened to wash away the region’s significant social and economicadvancement achieved during the preceding years of rapid growth. The crisis has also unveiled many intri-cate problems and challenges in macroeconomic management, banking and capital markets management,institutional capacity, and governance of the financial systems in the region.

Recognizing the urgency of addressing these problems and challenges, the Economics and DevelopmentResource Center of the Asian Development Bank undertook a regional study of financial markets in ninedeveloping member countries: People’s Republic of China, India, Indonesia, Republic of Korea, Malaysia,Pakistan, Philippines, Thailand, and Viet Nam. The objectives of the study were to analyze and deepen theunderstanding of the sources of the crisis in currency and financial markets, to provide a useful basis fordesigning and implementing preventive measures and refocused country strategies, and to help the Bank andits member countries build robust and sustainable financial systems in the region.

The study was designed, supervised, and coordinated by S. Ghon Rhee, Resident Scholar, 1997–1999.A large number of Bank staff and renowned scholars and experts contributed to this study.

Regional policy issues and recommendations based on the findings of the study were discussed at theHigh-Level Workshop on the Asian Financial Crisis in Tokyo, on 25–26 March 1999. This workshop washosted by the Bank, the ADB Institute, and the Institute of Fiscal and Monetary Policy of the Ministry ofFinance of Japan.

The present series of publications seeks to bring the research findings to a much wider audience and hopesto contribute to a better understanding of the Asian financial crisis and how its recurrence can be preventedin the future.

Jungsoo LeeChief Economist

Preface

Rising to the Challenge in Asia: A Study of Financial Markets presents the findings of a study carried outunder Regional Technical Assistance 5770: Study of Financial Markets in Selected Member Coun-tries. Many Asian Development Bank staff members and outside experts contributed to the study’s success-ful completion.

The core members for the study were Ramesh Adhikari, David Edwards, Tobias Hoschka, Sudipto Mundle,Soo-Nam Oh, Pradumna Rana, Yutaka Shimomoto, Reza Siregar, Peggy Speck, Ramesh Subramaniam, andVo Van Cuong. The outside experts were Stephen Cheung (Hong Kong, China), Yoon Je Cho (Republic ofKorea), Jang-Bong Choi (Republic of Korea), Catherine Chou (Hong Kong, China), G.H. Deolalkar (India),Maria Socorro Gochoco-Bautista (Philippines), Akiyoshi Horiuchi (Japan), Masahiro Kawai (Japan),Mohammad Zubair Khan (Pakistan), Joseph Y. Lim (Philippines), Sang-Koo Nam (Republic of Korea),Anwar Nasution (Indonesia), Edward Ng (Singapore), Jaeha Park (Republic of Korea), Mohd. Haflah Piei(Malaysia), Ken-Ichi Takayasu (Japan), Khee Giap Tan (Singapore), S. K. Tsang (Hong Kong, China),Stephen Wells (United Kingdom), Richard Werner (Germany), Min-Teh Yu (Taipei,China), and BarentsGroup LLC (KPMG).

Thirty-seven reports are contained in a series of 12 volumes:

Volume 1: Regional Overview• Macroeconomic Policy Issues• Banking Policy Issues• Capital Market Policy Issues

Volume 2: Special Issues• Asset Management Entities• Deposit Protection Schemes

The volumes benefited extensively from constructive comments from the Bank interdepartmental workinggroup, and the ministries of finance, central banks, and securities and exchange commissions of the ninemember countries that participated in the regional technical assistance study program and in the High-LevelWorkshop on the Asian Financial Crisis in Tokyo, on 25–26 March 1999. Mitsuo Sato, former President ofthe Asian Development Bank; Bong-Suh Lee, former Vice-President (Region West); and Peter Sullivan,Vice-President (Region East) provided strong support and guidance throughout this project.

Soo-Nam Oh coordinated the research and publication activities. Wilhelmina Paz, Lagrimas Cuevas,Anthony Ygrubay, Ruben Mercado, Virginia Pineda, and Rosalie Postadan provided administrative andtechnical support. The volumes were edited by Gloria Argosino, Mary Ann Asico, Graham Dwyer, andMuriel Ordoñez. Typesetting, computer graphics, and conceptualization of the cover design were done bySegundo de la Cruz, Jr.

S. Ghon RheeK. J. Luke Chair of International Finance and BankingUniversity of HawaiiResident Scholar of the Asian Development Bank(June 1997–June 1999)

Volume 3: Sound Practices• Corporate Governance (Hong Kong, China)• Currency Board (Hong Kong, China)• Central Provident Fund (Singapore)• Dichotomized Financial System (Singapore)• Banking Sector (Taipei,China)

Volumes 4–12: Country Studies• Macroeconomic Policy Issues• Banking Policy Issues• Capital Market Policy Issues

THE CAPITAL MARKET IN THE SOCIALIST REPUBLIC OF VIET NAM v

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Contents

Foreword iii

Preface v

Acronyms and Abbreviations viii

Recent Issues in the Management of Macroeconomic Policiesin Indonesia 1

Anwar Nasution

INTRODUCTION 2

MACROECONOMIC POLICY 3

Exchange Rate Movements 5

Widening Current Account Deficit 8

Stock of External Debt 9

Inflation Rates 10

THE BANKING CRISIS 10

Surges in Capital Inflows and Lending 12

Increasing Bank Liabilities with Large Maturity/Currency Mismatches 13

Weak Financial Positions of Banks and Highly Concentrated Problem Loans 14

Heavy Government Involvement in Selection of Credit Customers 15

Bad Governance 16

Lender of Last Resort 16

POLICY RESPONSES 17

Confusing and Conflicting Policies 17

Social Safety Nets 18

Bank Restructuring 20

Fiscal Distress and Stabilization Program 22

Private Sector Debt Overhang 24

Outlook 25

CONCLUSION 25

NOTES 27

REFERENCES 28

APPENDIX 30

Indonesian Banks: Survival of the Fittest 35

Catherine Chou

OVERVIEW OF THE FINANCIAL SECTOR 36

BACKGROUND 36

vi A STUDY OF FINANCIAL MARKETS

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Banks 36

Nonbank Financial Institutions 38

RECENT DEVELOPMENTS 41

Prelude to the Crisis 41

The Crisis 42

ISSUES AND RECOMMENDATIONS 45

Sector Fragmentation and Undercapitalization 45

Defunct Bankruptcy Law 47

Role of Owner and Management 48

Supervision 49

Human Resource Constraint 50

Liquidity Management 51

Credit Management 52

Deposit Insurance 54

Accounting and Disclosure Standards 54

CONCLUSION 55

NOTES 56

REFERENCES 56

APPENDIXES 57

Moving Toward Transparency: Capital Market in Indonesia 73

Stephen Wells

OVERVIEW 74

BOND AND EQUITY MARKETS 75

POLICY ISSUES 75

Equity Market 75

Bond Market 84

Participants 90

POLICY RECOMMENDATIONS 92

Equity Market 92

Bond Market 95

Participants 97

NOTES 99

REFERENCES 99

APPENDIX 100

THE CAPITAL MARKET IN THE SOCIALIST REPUBLIC OF VIET NAM vii

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Acronyms and Abbreviations

ABS asset-backed security

AFCRA ASEAN Forum of Credit Rating Agencies

AMU Assets Management Unit

ASEAN Association of Southeast Asian Nations

Bapepam Badan Pengawas Pasar Modal, Capital Market Supervisory Agency

Bapindo Bank Pembangunan Indonesia

Bappenas National Planning Agency

BBD Bank Bumi Daya

BI Bank Indonesia

BNI Bank Negara Indonesia

BPD Bank Pembangunan Daerah

BRI Bank Rakyat Indonesia

CAMEL capital adequacy, asset quality, management, earning, and liquidity

CAR capital adequacy ratio

CD certificate of deposit

CP commercial paper

DVP delivery versus payment

EFT electronic fund transfer

FASB Financial Accounting Standard for Banks

FDIC Federal Deposit Insurance Corporation

FIBV Federation Internationale des Bourses de Valeurs

FIPF financial institution pension funds

FRCD floating rate certificate of deposit

FRN floating rate note

GAAP Generally Accepted Accounting Principles

GDP gross domestic product

IBRA Indonesian Bank Restructuring Agency

IMF International Monetary Fund

INDRA Indonesian Debt Restructuring Agency

IPO initial public offering

JIBOR Jakarta interbank offer rate

JSX Jakarta Stock Exchange

KDEI PT Kustodian Depository Efek Indonesia

KPEI Kliring Perjamin Efek Indonesia

KSEI Kustodian Sentral Efek Indonesia

KUK Kredit Usaha Kecil, small business credit

LDR loan deposit ratio

LLL legal lending limit

LLP loan-loss provision

viii A STUDY OF FINANCIAL MARKETS

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M&A merger and acquisition

MOF Ministry of Finance

MTN medium-term note

NBFI nonbank financial institution

NIE newly industrializing economy

NIM net interest margin

NOP net open position

NPL nonperforming loan

NYSE New York Stock Exchange

OTC over the counter

OTC-FIS over-the-counter fixed-income service

P&A purchase and assumption

PKLN Pinjaman Komersial Luar Negeri

ROA return on assets

ROE return on equity

S&P Standard and Poor’s

SBIs Sertifikat Bank Indonesia, Bank Indonesia Certificates

SMF secondary mortgage facilities

SPV special-purpose vehicle

SRO self-regulatory organization

SSX Surabaya Stock Exchange

VAT value-added tax

VWAP volume weighted average price

$ pertains to US$.

Korea refers to the Republic of Korea.

Indonesian Banks:Survival of the Fittest

Catherine Chou

Catherine Chou is Director, NetBcenter Inc., Hong Kong, China. She was formerly Senior Economist(1996–1997) at Indosuez (WI Carr) Securities, Hong Kong, China, and Senior Economist/Investment Strategist

(1991–1995), BZW Securities, London and Hong Kong, China.

36 A STUDY OF FINANCIAL MARKETS

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Overview of theFinancial SectorUntil late 1997, it seemed that nine years of financial

liberalization had paid off for Indonesia. (See Ap-

pendix 1.A for a detailed chronology of financial lib-

eralization and regulatory developments.) Seventeen

of the country’s top banks made the global Top 1,000

in a survey based on Tier-1 capital strength while the

largest, Bank Negara Indonesia (BNI), ranked 40th

in an Asian Top 200 survey (Appendix 2). Prolonged

buoyant economic growth, lowering of entry barri-

ers, loosening of lending restrictions, a stable ex-

change rate regime, and heavy capital inflow fos-

tered an environment of rapid credit expansion.

The increasing importance of the financial sector

is illustrated in the monetization ratio (M2/gross do-

mestic product [GDP]), from 30 percent in 1988 to

an estimated 58 percent at end-1997. During this

period, total assets of commercial banks increased

10-fold to Rp715.2 trillion, exceeding, for the first

time, the size of the country’s GDP. Concomitantly,

nonbank financial institutions (NBFIs) also flourished,

with total assets growing at an annual compound rate

of 56 percent in 1991–1996, reaching Rp80 trillion

by end-1996. In short, the financial sector was at the

heart of the economic boom.

The currency turmoil that swept across the re-

gion from Thailand in mid-1997 immediately exposed

the cracks in the banking system. A 70 percent plunge

in the value of the rupiah against the dollar (hitting a

record low of Rp16,500 in January 1998) started a

domino effect across the entire economy, resulting

in a financial crisis. Banks, having engaged in ag-

gressive lending to the cyclical sectors, and being

heavily exposed to foreign currency volatility through

substantial offshore borrowing, are going through a

survival test.

The Government’s defense of the rupiah, partly

through domestic interest rate hikes, dealt yet an-

other blow to the banks. Squeezed by tight liquidity,

negative interest margins, soaring bad debts, and

overseas liabilities (many short-term and unhedged),

a great number of banks have become technically

insolvent.

To date, 23 commercial banks have been closed,

7 are being nationalized, and 40 more are under in-

tensive supervision by the recently established Indo-

nesian Bank Restructuring Agency (IBRA). In hind-

sight, had the sector’s weaknesses been addressed

during the boom years, the problems currently fac-

ing both the authorities and sector participants would

have been mitigated. This study identifies issues and

recommends a policy framework to strengthen the

banking system.

Background

Banks

Although efforts at financial deregulation date back

to 1983, when interest rate ceilings and direct credit

targets were removed, the present banking system

is largely shaped by two laws: PAKTO 1988 and the

Banking Act of 1992. Earlier reform packages, start-

ing with PAKTO, aimed to encourage competition

by lowering the barrier to entry. The Government

avidly promoted banks as the key financial interme-

diaries in mobilizing funds, as prescribed by an or-

thodox development strategy.

Measures such as drastically cutting the reserve

requirement from 15 to 2 percent of third-party funds

(defined as all demand, savings, and time deposits,

plus certificates of deposit [CDs] from unrelated

parties) and easing branch office opening procedures

and the conversion to foreign exchange bank status

contributed to the banking sector’s explosive growth.

Even though the minimum paid-in capital was raised

from Rp1 billion to Rp10 billion ($5.8 million) for com-

mercial banks, it was offset by the relative ease of

obtaining a banking license.

Two months after PAKTO, there were 111 com-

mercial banks and 1,957 bank offices. By end-1992,

the numbers had jumped to 208 and 5,495, respec-

tively. Most of the new entrants were small or joint

37INDONESIAN BANKS: SURVIVAL OF THE FITTEST

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venture banks, which fragmented the sector and in-

tensified the competition for funds.

In 1983–1988, the seven State banks’ share of

total outstanding bank credit hovered around 65 per-

cent, but after three years of liberalization their share

dropped to 56 percent in 1991 and further to 40 per-

cent by end-1997. State banks have historically

played an important role in the allocation of subsi-

dized credit (at preferential interest rates), known as

“liquidity credit,” to priority social and economic sec-

tors assigned by Bank Indonesia (BI), the central

bank. The credit allocation system, often subject to

political abuse, curtailed the State banks’ ability to

compete with private banks. Liquidity credits and

access to BI rediscounting facilities were extended

to sugar estates and refineries, rubber and palm oil

plantations, and construction contractors by 1980. The

conglomerates obtained loans at sharply reduced in-

terest rates. Bank Pembangunan Indonesia’s

(Bapindo’s) massive subsidized credit to business-

man Edi Tansil’s grandiose schemes, for example,

which turned sour in the early 1990s, dragged the

entire State banking sector into the red in 1994.

Private bank expansion in the four years after

PAKTO is best illustrated by the 60 and 39.5 per-

cent annual growth rate in their assets and credits,

compared with 22 and 21 percent for State banks.

However, private banks’ rampant growth was

achieved at the expense of sector soundness. The

strains within the system finally came to light with

the collapse of Bank Duta (due to foreign exchange

trading losses) in 1990 and Bank Summa in 1992.

In the wake of the bank failures, BI finally took

the lead in financial reform. In February 1991, it

introduced prudential regulations, including the capi-

tal adequacy ratio (CAR) based on the Basle Ac-

cord. It incorporated them into the revised Banking

Act the following year, raising the minimum paid-

up capital for private national banks to Rp50 billion

($25 million).

In 1993–1996, it phased in more prudential regu-

lations and supervisory tools for ensuring bank

soundness—from reporting requirements, to self-

regulation, to capital adequacy, asset quality, man-

agement, earnings, and liquidity (CAMEL) bank

ratings. By end-1996, prudential practices in

Indonesia’s banking sector were largely in line with

those recommended by the Basle Committee and

comparable to those adopted in the US and EU

(Appendix 1.B.1).1 In order to ensure bank com-

pliance with the increasingly comprehensive regu-

lations, BI revamped its banking supervision divi-

sion in 1994. At present, 550 staff members are

assigned to the three commercial and one rural su-

pervision departments, and 100 to the regional of-

fices. Another 50 researchers work in the regula-

tion and development department.

However, the authorities’ efforts to improve and

promote best practice came when the sector was

already deeply troubled. Both State and private banks

inherited a high level of nonperforming loans (NPLs)

from the period of aggressive lending in 1989–1993.

The Bapindo loan scandal, for example, led to a sub-

stantial deterioration of State bank asset quality.

NPLs accounted for 20 percent of total State bank

credits in 1993, and State banks’ CAR plunged to a

mere 2.5 percent in 1993. Consequently, NPLs for

all commercial banks were a staggering 12 percent

in 1994 (Table A3.1, Appendix 3).

The absence of a developed domestic capital

market was the reason behind the Government’s off-

shore funding. Around 95 percent of rupiah deposits

(over 70 percent of total deposits) in commercial

banks are considered short-term (demand, savings,

and time deposits below one year), compared with

over a quarter of rupiah loans lent as investment cred-

its (loans over one year), and so it is not surprising

that banks have also relied on overseas funding to

bridge the maturity mismatch. An additional incen-

tive to borrow offshore was the large differentials

between local and international interest rates. For

banks with investment-grade credit ratings, going

offshore often represented savings of at least 7 per-

cent on local interbank rates and over 10 percent on


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rates for time deposits, which constituted about half

the rupiah deposit base.

The popularity of tapping foreign money was fur-

ther enhanced by Indonesia’s track record in cur-

rency stability, with an annual 3–5 percent nominal

exchange rate depreciation. Commercial banks were

among the first to take advantage of offshore fund-

ing, as evidenced by the 160 percent increase in for-

eign currency borrowings in 1993. By June 1997,

commercial banks’ foreign currency liabilities (de-

posits and borrowing) amounted to about 30 percent

of total liabilities.

Meanwhile, strong domestic economic growth, a

stable rupiah, and high local interest rates also at-

tracted plenty of foreign investors, who were more

than willing to lend to “booming” Indonesian busi-

nesses, mostly on a short-term basis. The biggest

corporations, with their apparent international cred-

itworthiness, were able to borrow, usually unhedged,

or to raise equity offshore directly, bypassing the

banks altogether. Consequently, in the past few

years, commercial banks’ loan portfolios also suf-

fered as the larger, more profitable customers were

replaced with smaller and often less creditworthy

ones. By March 1997, total private sector external

debt amounted to $60.5 billion, about a quarter of

the size of GDP.

The ease with which they got foreign funding en-

abled the banks to sustain brisk domestic credit

growth, which showed no sign of slackening. In 1993–

1997, bank loans expanded at the annual average

rate of 26 percent, much higher than the growth in

nominal GDP. Strong loan growth helped the banks

disguise deteriorating asset quality, as the sector’s

reported NPL fell from 14 percent in 1993 to 7.2

percent in 1997. Despite attempts by smaller banks

to attract potential customers with competitive rates

and new products, the sector remained dominated

by a handful of large banks. As of June 1997, the top

14 commercial banks (6 State, 8 private) controlled

68 percent of total sector assets, with the rest (32

percent) split among 197 small banks.

Profitability, as measured by return on assets

(ROA) and return on equity (ROE), has improved

for the State banks since 1993, but not for the pri-

vate foreign exchange banks. ROA for the banking

sector was 1.37 percent in 1997, higher than the av-

erage for medium-sized US commercial banks in the

past decade. Joint venture and foreign banks had

much higher returns due to more efficient credit and

liquidity management, relatively higher-quality loan

portfolio, and the difference in the definition of their

capital. Net interest margin (NIM) for the top 200

banks was only 2.6 percent in 1997, but has been

narrowing, according to annual reports of the two

largest banks.

On the surface, most of the commercial banks

complied with BI’s prudential requirements. In 1993–

1996, not only was CAR met across the board, but

the industry CAR was much higher than the recom-

mended 8 percent minimum. As for other ratios such

as legal lending limit (LLL), loan-deposit ratio (LDR),

and net open position (NOP), BI reported general

compliance and few violations, except for LLL.2

Nonetheless, one ratio—cost/income—did hint at

trouble ahead. It was very high, showing that, de-

spite years of liberalization, banks in Indonesia re-

mained extremely inefficient. Both State and private

banks have ratios above 90 percent, although a sepa-

rate study on the top 17 banks puts the figure at 59

percent (Table A3.2, Appendix 3).

3

Nonbank Financial Institutions

NBFIs are categorized into two: those engaged pri-

marily in capital market activities and the rest. The

former are regulated and supervised by the Capital

Market Supervisory Agency (Bapepam), while the

rest—finance companies, venture capital companies,

insurance companies, and pension funds—are su-

pervised by the Ministry of Finance (MOF), with as-

sistance from BI in some cases.

This study will focus only on NBFIs under the

MOF umbrella. At end-1996, 836 NBFIs (including

insurance-supporting companies) were engaged pri-


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marily in a broad spectrum of noncapital-market ac-

tivities. The finance companies had the largest

share of assets in the sector (43 percent), but the

insurance (and supporting) business had the greatest

number of firms (280).

FINANCE COMPANIES

Finance companies in Indonesia are not allowed to

draw funds directly from the public. They cannot

take deposits nor issue promissory notes nor en-

gage in the securities business. Because of their

limited scope of sourcing, they have been subjected

to less rigorous regulations and supervision than

commercial banks.

Before October 1995, finance companies were

permitted to conduct business in leasing, factoring,

consumer financing, credit card financing, as well

as venture capital activities. However, as venture

capital activities were perceived to carry much

higher risk than other financing businesses, they

were formally placed in a different category in

October 1995. At the same time, the minimum paid-

in capital for national private finance companies was

raised from Rp2 billion in 1988 to Rp10 billion ($4

million). They were given until October 1998 to

comply (Appendix 1.B.2).

The sector benefited most from the robust

economy in the first half of the 1990s. The ratio of

finance companies’ assets to bank assets increased

from 5 percent in 1991 to 6.6 percent in 1996, indi-

cating the sector’s expanding role in financial inter-

mediation. In 1992–1995, the sharpest growth was

in factoring, which experienced triple-digit annual av-

erage growth. Nonetheless, factoring declined in 1996

and lost its lead to leasing, which had a 46 percent

share of total business activities in the sector. Con-

sumer finance continued to expand steadily begin-

ning in 1992, averaging 43 percent annual growth in

contract value over four years. In contrast, competi-

tion from commercial banks in credit card financing

almost wiped out the finance companies. By end-

1996, NBFIs’ share of credit card financing had

plunged to Rp61 billion, from a peak of almost Rp1

trillion in 1994.

The Government has encouraged venture capi-

tal to promote small and medium-sized enterprises.

Although the number of venture capital companies

rose steadily, the volume of their business activity

dropped by 64 percent—from Rp118 billion in 1995

to Rp42 billion in 1996—when finance companies

separated from venture capital companies. Of the

43 venture capital companies licensed at end-1996,

20 were regional, with investments in 482 compa-

nies. Venture capital companies are regulated solely

by MOF.

Due to the restriction placed on their funding

sources, finance companies rely heavily on both do-

mestic and offshore loans. In 1996, their total funds

stood at Rp37 trillion, including outward borrowing

(funds raised from unrelated parties), equity, and

other sources of capital, of which two thirds were

from bank loans (Rp12.9 trillion or 35 percent of

the total) and offshore borrowings (32 percent). In

December 1995, recognizing the need to limit fi-

nance companies’ debt financing, MOF issued regu-

lations on the limits for borrowings and equity in-

vestment, as well as on reporting requirements. Fi-

nance companies were allowed to borrow up to a

maximum of 15 times their net worth, with offshore

loans limited to only 5 times their net worth. The

same month saw another important MOF deci-

sion—to stop issuing new licenses for finance com-

panies, of which there were already 254, a number

MOF considered adequate.

Since a great number of finance companies are

affiliates of commercial banks, BI assists MOF in su-

pervising all finance companies except venture capi-

tal companies. However, BI supervision is limited to

(i) domestic and offshore borrowing, (ii) issuance of

promissory notes (as collateral to banks), (iii) asset

qualities, (iv) truthfulness and completeness of reports,

and (v) interrelated activities between banks and fi-

nance companies. Reported cases of regulatory non-

compliance among finance companies were few and


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dwindling in 1996, according to BI, while NPLs stood

at 3 percent but appeared to be rising.

INSURANCE COMPANIES

The insurance industry and its supporting industries

have experienced modestly higher growth than other

NBFIs. When the Insurance Law was promulgated

in 1992, there were 145 insurance companies, then

171 by August 1997, with assets growing 25 percent

annually (to Rp22 trillion at end-1996). The expan-

sion was mainly attributable to joint venture compa-

nies, whose number rose from 19 to 40. Under the

Insurance Law, the minimum paid-in capital require-

ment for private national companies by 1998 was

Rp2 billion for life insurance, Rp3 billion for nonlife,

and Rp10 billion for reinsurance (Appendix 1.B.3).

Life and nonlife insurance accounted for much of

the sector’s activity. Life insurance enjoyed a 58

percent average yearly growth of assets in 1992–

1996. Indemnity (nonlife) insurance and reinsurance

accounted for the largest share of gross premium.

The rest of the sector—reinsurance and social in-

surance companies—was lackluster throughout the

period. Capital restraint has forced most of the rein-

surance business offshore, prompting the Govern-

ment to reestablish a second State-owned reinsur-

ance company with paid-in capital of Rp250 billion in

1997. By August, there were 120 insurance-support-

ing companies, made up of insurance and reinsur-

ance brokers, loss adjusters, and actuaries.

In a bid to step up regulation of the insurance in-

dustry, MOF issued guidelines on investment, finan-

cial soundness (including a solvency rating), and the

maximum retention limit on investment. Although in-

surance companies are allowed to invest in a wide

range of domestic financial instruments as well as

other assets, the lack of a well-developed capital

market and long-term investment instruments has led

to a bias toward short-term bank deposits and Bank

Indonesia Certificates (SBIs). At end-1996, 55 per-

cent of the Rp18 trillion invested by the industry went

into time deposits and 15 percent into SBIs. The

maturity mismatch is now a pressing issue, given the

insurance sector’s large portfolio exposure to the

soundness of commercial banks.

In early 1997, MOF warned that 33 insurance

companies had failed the solvency test based on a

variety of components, including company liquidity,

risk management, profitability, and legal aspects. Of

the 33, 19 were life insurance companies (i.e., a third

of the total number of life insurance companies), of

which 14 had solvency ratings below the minimum

101, and the other 5 had inadequate capital.

PENSION FUNDS

The Government promotes pension funds as it be-

lieves they will play an important role in mobilizing

long-term funds. The Pension Funds Act of 1992

outlines the legal framework for the voluntary estab-

lishment, administration, and regulation of employer-

managed (private) pension funds. Although the act

does not compel private companies to set up pension

plans for employees, it does provide clear guidelines

for those who elect to do so. Several other MOF

decrees followed, defining the eligible instruments

for investment of fund assets, as well as disclosure

requirements (Appendix 1.B.4).

In December 1996, there were 261 pension

funds—239 employer-managed and 22 financial in-

stitutional. There were also three sizable Govern-

ment pension programs: PT Taspen for the civil ser-

vice, Asabri for the armed forces, and PT Astek for

social security, with some benefits for participating

private companies. Much of the sector’s growth was

in the employer-managed funds, which increased at

an annual average rate of 26 percent since 1993 to

reach Rp13 trillion in 1996. However, the pension

participation rate is still low, covering less than 20

percent of the labor force. Total sector assets in 1996,

at Rp21 trillion, were equivalent to only 4 percent of

GDP (compared with 40 percent in Malaysia and 60

percent in Singapore).

The pension fund industry suffered similar invest-

ment constraints as the insurance industry, with a


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high concentration of assets in time deposits and CDs

(54 percent at end-1996, down from 74 percent the

previous year). The rest of the portfolio was spread

more or less evenly among listed stocks, bonds, pri-

vate equity, and real estate. Of particular concern is

the fact that financial institution pension funds placed

nearly all (97 percent) of the amount in short-term

bank deposits. In February 1997, in a bid to encour-

age portfolio diversification, MOF added mutual funds

to the eligible investment instrument list. However,

like insurance companies, pension funds are not al-

lowed to invest offshore.

Recent Developments

Prelude to the Crisis

Exchange rate volatility was an important factor in

triggering the financial crisis. It is thus ironic that

some of the factors contributing to the rupiah’s free

fall in January 1998 can be traced to BI’s then-

successful defense of the currency in the wake of

the 1995 Mexican crisis. In response to speculative

attacks on the rupiah, BI hiked SBI rates in 1995,

leading to sharply higher domestic real interest rates.

Real interest rates on SBIs of 4 percent or more (8

percent or higher for time deposits) made Indonesia

even more attractive to short-term foreign capital as

the rupiah’s reputation for stability was greatly en-

hanced after the Tequila effect.

To discourage short-term capital inflow, which had

been fueling money supply growth, BI accelerated

the widening of the exchange rate intervention band

and switched to a more market-determined mecha-

nism for SBI yields. BI widened the band five times

from 3 percent in January 1996 to 12 percent in July

1997, in the hope that greater interest rate and ex-

change rate flexibility would discourage the influx of

mainly short-term capital. The measure came too

late, as external debt stock (both public and private)

had already piled up to an estimated $108 billion by

end-1995, just as the current account deficit bal-

looned. Nonetheless, strong economic growth and

high domestic returns continued to draw foreign in-

vestors, who were undeterred by BI’s more “flex-

ible” exchange rate policies.

Meanwhile, local banks and businesses were rais-

ing foreign capital under the steady rupiah-deprecia-

tion regime, made possible by the comparatively low

funding cost. For instance, most commercial banks

with international credit ratings could source foreign

funds at rates around the London interbank offered

rate plus 70 basis points (bp) (about 6.3 percent) at

end-1996—minimal compared with the 16 percent

paid on rupiah time deposits. Given the rupiah’s stable

track record in the past decade, neither foreign credi-

tors nor domestic borrowers associated exchange

rate risk with such transactions, even though half of

them were short-term (maturity of less than one year).

The proliferation of debt instruments with mini-

mal documentation—such as promissory notes, float-

ing rate notes (FRN), or floating rate certificates of

deposit (FRCD), which were all readily accepted by

foreign creditors—also facilitated offshore borrow-

ing. It is worth noting that funding through debt proved

extremely popular among conservative business

groups, as it involved no share dilution. By March

1997, reported foreign borrowings of the private sec-

tor had increased to $61 billion from $48 billion at

end-1995, more than offsetting the fall in public sec-

tor foreign debt.

Foreign capital flooded the banking system with

liquidity, as reflected in the gradual decline in SBI

and interbank rates from mid-1996 onward. By early

1997, SBI rates had dropped below 10 percent for

the first time in four years. A status quo in the ex-

change rate regime was by then taken for granted,

as demonstrated by the fact that most commercial

banks held short-dollar NOPs in June 1997, immedi-

ately before the currency crisis.

Poor timing notwithstanding, it should be recog-

nized that both BI and MOF had paved the way for

consolidations within the banking and NBFI sectors

by setting higher capital requirements and prudential

regulations since 1995. Non-foreign-exchange banks


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were required to raise their minimum paid-in capital

to Rp100 billion and CAR to 10 percent by 1999. In

hindsight, the requirements were not stringent enough

and came after the industry had become fragmented.

In December 1996, Regulation No. 68 empowered

BI to advise MOF on revoking bank licenses, pre-

scribing remedial measures against problem banks,

and liquidating failed banks. To tighten liquidity and

to guard against liquidity risk, BI raised the statutory

reserve requirement of third-party funds from 3 to 5

percent in April 1997. Furthermore, in order to curb

loan growth, all new real-estate-related loans, with

the exception of those for low-cost housing, were

banned beginning in July 1997.

The Crisis

When the currency crisis spread from Thailand, BI

initially tried to defend the rupiah against speculative

attacks by intervening in the market and raising SBI

rates. Eventually, it decided to float the rupiah and

abandon the exchange rate bands on 14 August 1997,

precipitating a period of currency volatility, resulting

in a 30 percent depreciation of the rupiah by mid-

October and the collapse of the stock market. On 8

October, the Government requested assistance from

the International Monetary Fund (IMF). A $10-bil-

lion standby arrangement was agreed upon on 31

October. The IMF program also generated additional

funding commitments of over $40 billion, of which

$4.5 billion were from the World Bank and $3.5 bil-

lion from the Asian Development Bank. Individual

countries formed a second line of defense.

The Government pledged to restructure the fi-

nancial sector by closing banks under intensified

supervision with no rehabilitation plans and by es-

tablishing quantitative performance targets for State-

owned banks. The very next day, on 1 November, it

shut down 16 insolvent banks and placed more

banks under intensive supervision. Unfortunately,

in the absence of clear guidelines on depositor com-

pensation, the hasty decision triggered serious bank

runs. Depositors panicked and transferred money

from private national banks to State banks, which

they perceived to carry implicit Government guar-

antees, and to foreign banks both onshore and off-

shore. The “flight to quality” helped boost liquidity

of State and foreign banks, but also drained $2 bil-

lion out of the local banking system in November

alone.

Worse, capital flight was not confined to deposi-

tors. Financial institutions and corporations were all

accumulating dollars, partly in anticipation of upcom-

ing debt services, and partly due to an erosion of

confidence in the domestic financial system and cur-

rency. Commercial banks had reportedly switched

to a long-dollar NOP by this time, except for a very

few State banks (primarily the Exim Bank), which

the Government asked to continue supporting the

rupiah. Concurrently, foreign investors were beating

a massive retreat, causing further sell-offs of do-

mestic assets and the rupiah. The vast amount of

funds withdrawn from the private national banks

widened their liquidity gaps, which the banks were

barely able to bridge through the interbank market

(with rates ranging from an average of 40 to over

100 percent). To finance the liquidity shortfall, many

banks turned to the lender of last resort—BI.

The increasing dependence of some banks on

BI’s liquidity facility hampered BI’s attempt to

tighten money supply and stabilize the currency. It

was only in late November that the central bank

was able to intervene in the overnight interbank mar-

ket to maintain and push up interest rates. On 31

December, the Government unveiled plans to re-

structure the State banks through mergers and

privatization—an IMF requirement. Four State banks

were scheduled to merge by March 2000 into one

entity, while BNI, Bank Tabungan Negara, and

Bank Rakyat Indonesia were to be restructured.

A new entity, Bank Mandiri, would be established

to handle some of the nonperforming assets of the

merged banks.

On 1 January 1998, depositors of the 16 closed

banks were finally compensated (up to about $6,000


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per person), covering roughly 75 percent of the total

value of the banks’ deposits. However, by this time,

both domestic and foreign market participants had

lost faith in the financial system and the currency.

Concerns over Indonesia’s external debt (estimated

to be around $140 billion or two thirds of GDP at

end-1997),4 caused by the rupiah’s sharp deprecia-

tion, cast doubt on Indonesia’s debt service ability

relative to its foreign reserve position. Market play-

ers and local corporations were ready to sell rupiah

at the slightest hint of further uncertainty. Both pre-

election political jitters and budget blunders sent the

rupiah on a rapid downslide.

In a bid to restore confidence in the economy and

the currency, a second IMF agreement was signed

on 15 January 1998, which was essentially a stron-

ger version of the first one. Still, questions about

Indonesia’s commitment to reform and the deterio-

ration of the external debt position continued to fuel

capital flight. January saw huge net outflow of al-

legedly all-domestic capital of around $600 million

to $700 million per day. On 22 January, the rupiah

nose-dived to a record low of Rp16,500. To stem

the slide, on 27 January, the Government issued a

blanket guarantee on all 212 commercial banks’

domestic and foreign obligations, covering both de-

positors and creditors.

On the same day, IBRA was established as an

independent body under MOF to nurse the banking

sector back to health and to hold it to an internation-

ally accepted standard. IBRA also administers the

Government’s guarantee program. On 14 February,

54 banks, of which 4 were State banks, with liquidity

support from BI in excess of 200 percent of equity

capital or with CAR below 5 percent based on ad-

justed December 1997 figures, were placed under

IBRA’s supervision (Appendix 4). The Asset Man-

agement Unit was formed at end-1998 to resolve

the supervised banks’ bad debts.

After the Government’s call for a temporary freeze

on foreign debt repayment, the steering committee

of foreign bank creditors, the contact group of debt-

ors, and the private external debt team met for the

first time on 26 February to discuss the restructuring

of Indonesia’s external debt. The initial plan was to

model the debt solution on the 1983 Mexican Ficorca

strategy to enable private companies to service their

foreign currency debt through payments in local cur-

rency to the Indonesian Debt Restructuring Agency

(INDRA), which was launched in August 1998.

INDRA could, in turn, pledge equivalent dollar pay-

ments to creditors without issuing a formal guaran-

tee on the private debt. However, results of the re-

structuring remain to be seen. To accurately capture

the size of the private sector debt, the Government

issued a decree on 8 April, requiring all companies

with foreign borrowings to report their debt position

to BI by the end of the month.

Until the external debt problems are resolved,

Indonesia’s commercial banks are not likely to see

their creditworthiness improve. On 26 February, the

international rating agency Standard & Poor’s down-

graded credit ratings of Indonesian banks across the

board. Even previously investment-grade State bank

BNI saw a nine-grade drop to CCC- in its foreign

currency debt rating. Overseas creditors’ rude awak-

ening to the reality that Indonesian banks carried such

high counterparty risk pushed them to cut off most

local banks’ overseas credit lines, causing a stand-

still in trade finance and trading. Although several

major trading partners such as Japan and Singapore

offered to facilitate trade financing, the banking sys-

tem still suffers a chronic shortage of foreign ex-

change liquidity.

As part of the IMF program’s measures to

strengthen the supervisory framework for banking,

BI announced the new loan classification and provi-

sioning guidelines on 27 February (Appendix 1.B.1.c).

The stricter classification and higher provision are

gradually shedding more light on the actual size of

NPLs. The general slowdown in economic growth

and the tight credit condition are expected to pre-

cipitate large-scale defaults, particularly on dollar

loans. NPLs for the banking sector under the old


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classification were only 7.2 percent of total outstand-

ing credit at end-1997; recent industry estimates for

1998 are drastically higher—from 30 to 70

percent.5To put the problem in perspective, at 60

percent of total credit, NPLs would be roughly four

times the size of the sector’s capital.

The devaluation of the rupiah caused a sharp in-

crease in the rupiah value of banks’ foreign assets,

expanding the size of banks’ asset base and causing

most banks’ CAR to fall below the 9 percent re-

quirement. (The entire sector’s average fell from 11.8

percent at end-1996 to 6.9 percent in January 1998.)

The tight liquidity environment also forced many banks

to rely on BI’s liquidity support as the only means to

meet the 5 percent statutory reserve requirement.

To preempt an all-out funding competition for depos-

its among the banks, BI placed a ceiling on deposit

interest rates on 27 February. As the burgeoning

amount of liquidity support readily extended to the

banks had handicapped BI’s monetary policy, BI

announced on 6 March a series of punitive measures

and restrictions on the use of the discount window

facility. Banks are now entitled to the facility up to

14 consecutive days; those who fail to comply are

put under direct IBRA supervision. The charge for

using the facility was also raised substantially to dis-

courage abuse.

Seeing Indonesia’s reform efforts waver, IMF

suspended the second tranche of the $3-billion stand-

by agreement on 15 March, causing other multilat-

eral and bilateral funds to be suspended as well. The

Government reentered into negotiations with IMF,

and demonstrated its commitment to the program by

tightening liquidity (by raising the SBI one-month rate

from 22 to 45 percent) on 23 March and accelerat-

ing bank restructuring. On 4 April, IBRA suspended

operations of seven commercial banks and took over

the management of another seven, all of which have

received liquidity support from BI in excess of 500

percent of equity (Appendix 4). The move signaled

the authorities’ readiness to restructure and consoli-

date the banking sector. As the owners of the banks

are deemed politically well connected, IBRA’s ac-

tion also suggested that the authorities were now tak-

ing an evenhanded approach—the past lack of which

had impeded reform efforts.

Of the 14 banks, seven are listed banks and one

(Exim) is a State bank. The seven banks currently

under IBRA management accounted for 75 percent

of total BI lending to the banking system. The size of

BI liquidity support to all 54 IBRA-supervised banks

was subsequently disclosed as Rp80 billion, roughly

the same as the stock of credit outstanding of the 54

banks. (By 17 April, the amount had jumped to Rp103

trillion.) IBRA took over the Rp80 billion by repay-

ing BI in indexed bonds from MOF. Additional bonds

of Rp75 billion were launched in 1998 for the reha-

bilitation of the IBRA-supervised banks. IMF esti-

mated the total cost of restructuring and recapitaliz-

ing banks to a minimum 8 percent CAR to be around

15 percent of GDP. The final cost could be higher as

actual NPLs are likely to be way above the end-

January 1998 data on which the estimate is based.

(World Bank estimates put the cost at 30 to 40 per-

cent of GDP, although most banks are still doing their

1997/98 audits.)

Given that four out of the seven State banks are

under IBRA, the authorities are putting their original

merger plan on hold, except for Bank Bumi Daya

(BBD) and Bapindo, which were merged with BND

and Exim in October 1998. BBD and Bapindo are

expected to meet the capital requirement (5 percent

CAR) for leaving IBRA. Six private national banks

are also proposing merger plans and four were no

longer under IBRA supervision by 22 April. As for

the banks under IBRA management, five are man-

aged by a State bank and were audited by indepen-

dent auditors.

After lengthy negotiations, a third IMF program

was agreed upon on 8 April and a fourth signed on

26 June. The latest program supplements the previ-

ous three but sets precise structural policy commit-

ments and target dates requiring constant monitoring

by the executive committee of the Resilience Coun-


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Issues andRecommendationsA variety of factors contributed to Indonesia’s fi-

nancial crisis. They include macroeconomic, politi-

cal, social, structural, regulatory, and supervisory is-

sues. This study concentrates only on the last three.

Sector Fragmentationand Undercapitalization

Many of the banking sector’s woes are due to lack

of capital, which was partly caused by the sector’s

fragmented nature—a legacy of PAKTO deregula-

tion in 1988, which lowered barriers to entry. About

180 banks share less than 30 percent of total sector

assets. Most of the smaller banks are not listed and

thus denied the option of raising equity through the

market. Many exist only to cater to a few large cus-

tomers, mainly related parties. Consequently, their

sources of funding are limited and occasionally over-

lap with their assets. In many cases, LLL was

breached. Since the onset of the financial crisis, the

smaller banks’ deposit (particularly dollar) base has

contracted significantly, and their access to the in-

terbank market cut off. As a result, many small banks

are undercapitalized and insolvent.

Recommendation. Raise the capital requirement

to prompt consolidation, and liquidate insolvent banks.

The Government initially planned to impose a mini-

mum paid-in capital of Rp1 trillion ($125 million) by

end-1998. Clearly, the figure was set with a view to

boost Indonesian banks’ standing among their inter-

national peers, given that in 1997, the top 1,000 banks

all had Tier-1 capital exceeding $150 million. With

NIM deep into negative territory, most banks faced

a loss in 1998, so the easiest route of recapitaliza-

tion—via operating profit—was out of the question,

while other efforts were rendered difficult by the

financial crisis. In view of the drying up of capital

sources and in anticipation that vast LLP would

cause asset quality to deteriorate, the amount has

been reduced to Rp250 billion or below.

cil to preempt slippage (Appendix 5). IMF is now

monitoring Indonesia’s compliance monthly rather

than quarterly.

In accordance with the third program schedule,

three important bank-related policy measures were

announced on 22 April:

• The minimum paid-in capital requirement, after

loan-loss provisions (LLP), for all banks would

be raised to Rp250 billion ($31 million) by end-

1998.

• LLP would be fully tax-deductible (previously

capped at 3 percent).

• Amendments to Indonesia’s antiquated bank-

ruptcy law would take effect and a special com-

mercial court be established by August.

On 21 April, BI tightened liquidity again by rais-

ing SBI rates (the one-month SBI rate increased to

50 percent). At this level, banks suffered vastly

negative interest margins, paying over 52.5 percent

for rupiah time deposits and lending at much lower

rates (around 30 percent). Most local banks’ bal-

ance sheets hemorrhaged and expected to break

even at best in FY1998. A great number of banks

also faced serious maturity mismatch, sourcing one-

month time deposits but lending one-year-or-longer

working capital. Already undercapitalized due to the

currency depreciation, the banks faced possible

large write-offs on the increasing amount of NPLs

while having to comply with the increase in capital

requirement by end-1998. In view of the banks’

difficulties in raising capital (two listed banks’ at-

tempts in rights issue from April to July 1998 were

canceled at the last minute due to lack of investor

interest), BI, on IMF’s recommendation, relaxed the

capital requirement on 19 June. The minimum paid-

up capital target of Rp250 billion was made flexible

and CAR lowered to 4 percent until end-1998, to

rise gradually to 8 percent by end-1999 and to 10

percent by end-2000. Still, commercial banks are

looking at even tougher times ahead, and it is inevi-

table that the sector will be shaken out further and

consolidate in the medium term.


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There are only five recapitalization options open

to banks at the moment: (i) injecting equity by major

shareholders and owners, (ii) raising funds through

the stock market, (iii) revaluing their assets, (iv)

securitizing part of the assets, or (v) undergoing

merger and acquisition (M&A). Even at the most

conservative estimate of 30 percent NPL, and as-

suming an average rupiah exchange rate of Rp8,000,

NPLs will be roughly $20 billion. If the NPLs are to

be written off in one go against the banks’ capital,

there will be a shortfall of around $10 billion. Hence,

the cost of recapitalizing the banking sector, even

before meeting the 9 percent CAR requirement, is

likely to be in the region of $10 billion upward. BI

reduced CAR to 4 percent until end-1999 to allow

the banks to go through rehabilitation and restructur-

ing while recapitalizing—a tall order, and few, if any,

banks are expected to accomplish all three by end-

1999. (See Table A3.3, Appendix 3 for the estimate

based on more stringent assumptions of 65 percent

NPL and 9 percent CAR.)

With interest rates so high, few of the listed banks

will be able to raise capital through the battered eq-

uity market. Owners are just as cash-strapped as

their banks and heavily indebted. After asset prices

collapsed, asset revaluation generated little surplus

on Tier-2 capital, and dependence on such account

window dressing is not a long-term solution. Simi-

larly, securitization of mortgages or consumer loans,

which are becoming more popular among bank trea-

surers, addresses only the CAR requirement but will

not boost underlying bank capital. Understandably,

the Government has been actively encouraging

M&As, seeing them as the only way most small banks

can possibly meet the new capital requirement. In

the current rush into mergers, small banks are pro-

posing merger plans but paying little attention to their

feasibility, and they do not choose partners on the

basis of mutual financial or structural compatibility.

In anticipation of a period of M&A mania, the

Government has set up a “one-stop service” in order

to reduce the paperwork. IBRA treats failed banks

already under its supervision carefully even as it pro-

ceeds to nationalize some of the larger problem banks

while releasing the smaller ones upon presentation

of their merger proposals. The Government’s mes-

sage is clear: avoid too many closures. There are

various ways of dealing with failed banks. In the past

two decades, the Federal Deposit Insurance Corpo-

ration (FDIC) has used any of the following six op-

tions to sort out insolvent US banks:

• Purchase and assumption (P&A). The most

widely used method. A sealed-bid auction is held

on a uniform package consisting of the perform-

ing assets of the bank with a put-back option.

The winning bank bidder assumes the liabilities,

and FDIC liquidates NPL and other unwanted

assets. Given the struggle of even the largest

Indonesian banks to stay afloat and the potential

NPL-shock of the failed banks, however, there

may not be enough interested parties to warrant

this option in the near term.

• Deposit payoff. The second most commonly

used method. The insolvent bank is liquidated,

only insured depositors (all depositors in the case

of Indonesia) are paid off fully, and uninsured

depositors are partially paid off from residual

asset values. The 16 bank closures in Novem-

ber 1997 followed this route, but the banks lost

their goodwill.

• Insured deposit transfer. IBRA used this

method to close down seven banks in April 1998.

All bank deposits were transferred to BNI, the

most secure State bank. This method avoids de-

posit compensation.

• Open bank assistance. An acquiring bank in-

jects cash into the failed bank to preserve it

while FDIC receives notes of preferred stocks

of the acquirer. In Indonesia, this method has

limited feasibility, as healthy banks will only take

on problematic ones if instructed to do so by

the Government.

• Total asset P&A. A bid (usually negative) is sub-

mitted by the acquirer for all the assets (includ-


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in the event that their debtors were unable to repay.

In short, financial institutions were entirely at the

mercy of their customers when it came to interest

and principal payments, with no legal protection.

It defies logic that anyone would want to dabble

in such a high-risk business, and all the more amaz-

ing that many conglomerates even bothered to set

up not just one, but several banks and NBFIs. A

fundamental reason is ready access to cheap loans.

Anecdotal evidence suggests that no less than 70

percent of Indonesian companies are technically

bankrupt, but none filed for bankruptcy under the

former bankruptcy law. Commercial banks, their main

creditors, were entangled in a myriad of bad debts

that could not be resolved in the short term.

Recommendation. The Government announced

on 22 April 1998 that amendments to the bankruptcy

law would be effective in 120 days. The new com-

mercial law and regulations are largely based on the

US Chapter 11 bankruptcy laws and will allow credi-

tors to send debtors into bankruptcy nine months af-

ter a claim is filed, as well as to seize assets of the

insolvent companies. The commercial court can de-

clare bankruptcy where a debtor has two or more

creditors and has not repaid at least one loan by its

expiry date. Either the debtor or creditor can apply

for the order. The decree also gives BI and Bapepam

the right to petition for the liquidation of banks and

brokerages.

Hearings of petitions seeking a declaration of

bankruptcy are to be held within 20 days after the

filing of the petition, with the bankruptcy declara-

tion to be made within 30 days of lodgment of the

petition. The right of appeal to the Supreme Court

remains. However, dissatisfied parties have only 30

days to lodge their appeals. The amended law also

provides for the following: (i) expert advice, (ii) trust-

ees to oversee companies brought before the court,

and (iii) a 270-day moratorium on suits by nonsec-

ured creditors. So far, several outstanding issues

still need to be clarified, including indemnity for

trustees, court deadlines not being met, rights of

ing bad debts) of the insolvent bank, with detail

restructuring (capital, management, debt collec-

tion) filed with FDIC. This method will not prove

popular in Indonesia at the moment.

• Bridge bank. FDIC operates the bank until a

qualified buyer can be found. This option is akin

to IBRA’s strategy of nationalizing some of the

banks under its care and rehabilitating them until

they are fit to be privatized.

Much as it is preferable to salvage as many banks

as possible, the sector still needs to weed out un-

healthy banks that are primarily public financial in-

termediaries. Since the likelihood of bank-closure

panic is now greatly reduced following the Govern-

ment guarantee in March 1998, IBRA should con-

sider stopping its support for many of the nonviable

banks and put them through liquidation. The out-

standing loan portfolio of these banks should be trans-

ferred to the asset resolution company as previous-

ly proposed.

For NBFIs, it is the same sector-consolidation

story. From finance to insurance companies, acute

capital shortage has been the main problem. Although

the companies were expected to fulfill their capital

requirement in 1999, MOF hinted that it would raise

the minimum paid-in capital across the board. Given

that many finance companies are overleveraged

through their foreign exchange borrowing, MOF

should not hesitate to close the insolvent ones.

Defunct Bankruptcy Law

The former bankruptcy law, a legacy of the Dutch

colonial legal system, was seldom invoked due to its

long, drawn-out, costly, and sometimes unfair proce-

dures. A case could take up to seven years traveling

through three courts, with decisions subject to ap-

peal in the Supreme Court, before creditors were

informed of the final ruling. The proceedings were

subject to abuse, with politics and corruption fre-

quently influencing the outcome of the lawsuits. Banks

or finance companies had no effective means of ex-

ercising their rights as creditors to recover their loans


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nonsecured creditors, and a comprehensive law to

prevent the fraudulent transfer of assets.

To prevent unjustifiable delays in the adjudication

process and to enforce the new bankruptcy proce-

dures, the Government has created a Special Com-

mercial Court, to be staffed with especially trained

judges. Around 50 judges drawn from the country’s

27 provinces are being trained in the new commer-

cial law and regulations relating to the administration

of bankruptcies. It remains to be seen whether or

not the changes herald a new chapter in Indonesia’s

legal structure and indirectly improve the environ-

ment in which commercial banks operate. A demon-

stration of political will is vital to the independence of

the judicial process.

Role of Owner and Management

As Indonesia once lacked even the most basic legal

framework within which financial institutions could

operate and exercise their rights as creditors, why

did banks and NBFIs boom in the early 1990s, creat-

ing a crowded and fragmented financial sector?

Owning a bank must be especially profitable if busi-

nessmen bend over backward to obtain a license.

According to MOF, borrowing via affiliated finance

companies could often result in about 75 bp savings

for some groups. While financial institutions, given

their unique role, can obviously raise capital at a lower

cost than companies or conglomerates engaged in

other industries, there must be additional benefits that

make owning a bank attractive.

A closer examination of performance ratios sug-

gests that although Indonesian banks were histori-

cally profitable, returns were mediocre compared with

their counterparts in other countries. ROAs for all

banks hovered just above 1 percent since 1995 (com-

pared with over 4 percent for the world’s top 25

banks), while NIM was less than 3 percent in 1997

(Table A3.4, Appendix 3). Profit, therefore, is not

likely the main motive behind the scramble for bank

licenses. Currency movements and interest rate hikes

since mid-1997 have caused a temporary surge in

performance ratios. Actual losses and damage to

profit will be revealed only after negative margins

and bad debt are reflected in the audit of end-1998

results.

The relationship between most private banks and

their owners can be summarized in the immortal

words of a bank president: “Deposits are part of the

bank’s assets.” Incredibly, his statement represented

most owners’ business strategy, which guided man-

agement decisions. Essentially, many businessmen

viewed banks as leveraging tools for their capital.

Given that banks are allowed to absorb public funds

primarily in the form of deposits, a CAR of 9 percent

means that the owners’ paid-in capital can be geared

up 11 times into bank assets. A large portion of affili-

ated bank assets are then channeled into the parent

group’s many investment projects, even though LLL

is explicitly set at 20 percent of bank capital for a

listed group and 10 percent, at arm’s length, for a

single borrower or related party.

For the past few years, BI reported compliance

by the majority (around 86 percent at end-1995 and

in 1996), but the true extent of related-party borrow-

ing is much higher. Some bankers estimated average

related-party lending to be around five to seven times

the size of bank capital for many small banks. Con-

sequently, many banks had their funds tied up in in-

tergroup or intragroup lending, with their owners or

major shareholders incapable of injecting funds in

the aftermath of the financial crisis as they were

also heavily indebted to the same banks. Regardless

of bank size, many shareholders saw banking simply

as a convenient source of leveraged capital, as illus-

trated by the recent audited findings that all six ma-

jor banks under IBRA (Bank Dagang Nasional In-

donesia, Danamon, Modern, Bank Prima Dana Fi-

nance Corporation Indonesia (PDFCI), Tiara, Umun

Nasional) had extended more than 50 percent of their

credit base to affiliated companies.

It is not surprising that the integrity and compe-

tence of the senior management, shareholders, and

owners of banks have often come under fire. In the


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licensing process, BI required that board directors or

commissioners of commercial banks possess good

character and morals, and that at least half the board

members have a minimum of three years’ banking

experience. There are also restrictions on the ap-

pointment of family members into senior manage-

ment. Those failing the “fit and proper” test are sup-

posed to be banned from holding a bank manage-

ment position. Yet the measures have deterred few

private bank owners or managers from running the

bank as a funding source for group projects rather

than as a financial intermediary.

Recommendation. The issue is partly structural

and partly supervisory. Indonesia’s LLL is relatively

conservative compared with other countries’.6 How-

ever, the definition of “related party” in the Indone-

sian context should include listed but affiliated com-

panies. In the long run, bank owners will be dissuaded

from exploiting bank resources and assets only in an

environment where banks are highly profitable. The

owner of a healthy, well-established, and profitable

bank is less likely to undermine the franchise of his

bank license by engaging in high-risk activities or vio-

lating prudential requirements.

Economic and currency volatility notwithstand-

ing, the key to reducing connected lending is the

bank supervisors. Strict enforcement of LLL com-

pliance and detection of unreported related loans

using dummy accounts or derivatives (e.g., the so-

called loan swap, where an implicit agreement be-

tween two banks allows the crossing of loans to

designated parties, who are apparently unrelated to

the creditor banks), will be crucial to preempting

asset exploitation by owners. The BI banking su-

pervision division currently divides responsibilities

between teams on a group basis, with affiliated

banks or NBFIs monitored by the same team. Su-

pervisors are in theory familiar with the financial

partners and management style of a group of re-

lated banks. Board directors and commissioners

should closely monitor managers and strictly sepa-

rate strategic from day-to-day decision making. The

independence, enforcement, and quality of the su-

pervisors are crucial to reform.

Supervision

Although prudential regulations for banks and NBFIs

are generally up to the international standard (Ap-

pendix 1.B), the financial crisis is partly due to the

delay in their implementation, which lagged behind

financial liberalization. Specifically, lax supervision

and the lack of supervisory independence are to

blame. Given that many bank and NBFI owners or

major shareholders are politically well placed, nei-

ther BI nor MOF supervisors were in a position to

enforce swift corrective action in the event of non-

compliance. Incidents where senior BI officials were

replaced under political pressure due to their deci-

sion to penalize some delinquent but well-connected

bank owners are particularly damaging to BI’s au-

thority and credibility. Anecdotal evidence also sug-

gests that on-site supervisors were often targets of

bribery, resulting in weak governance.

Before the crisis, the BI banking supervision divi-

sion had 28 teams covering the commercial banks

and 8 teams dedicated to rural banks. BI has joined

forces with MOF in supervising NBFIs, except ven-

ture capital companies, and in closely monitoring

banks with affiliated NBFIs. Both banks and NBFIs

have rigorous and frequent reporting requirements

even by international standards. Banks are required

to submit weekly, monthly, quarterly, and audited an-

nual financial reports to MOF and BI, while NBFIs

must submit monthly, quarterly, and audited annual

reports. The amount of paperwork and volume of

data supervisors receive periodically is overwhelm-

ing, reducing the time that should be spent on infor-

mation analysis. In BI’s CAMEL rating system, the

factors of capital adequacy, asset quality, earnings,

and liquidity are mostly derived from the submitted

weekly and monthly reports.

Management factor assessment is based mostly

on on-site examinations. Before the crisis, on-site

examinations were conducted on an ad hoc basis,


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and about once every two years for the larger banks.

The length of each on-site examination depends on

whether it is an event-driven or routine assessment.

For a major commercial bank, it may take up to a

month for a full team of supervisors. With over 200

commercial banks under only 28 teams, the fre-

quency of on-site examinations is limited. The es-

tablishment of IBRA has strengthened supervision

of undercapitalized and technically insolvent banks,

although a little too late. It is recommended that, in

addition to a qualitative assessment of management

performance, BI adopt an efficiency measurement

model. Currently, the measurement of efficiency is

a simple cost/income ratio, but some sophisticated

quantitative models should be considered in order

to reveal both allocative and technical efficiency of

the banks.7

Historically, most cases of noncompliance were

resolved through compromise or negotiation between

BI and the bank involved. Such precedents invari-

ably reduced the effectiveness of prudential regula-

tions as banks tend to view them as flexible rather

than mandatory. Indeed, Regulation No. 68 empow-

ers BI to close down only failed banks. However,

there are still no clearly defined exit policies, as shown

by the prolonged liquidity support extended to the 54

banks under IBRA. Bankers also complain that many

supervisors’ lack of industry experience or product

knowledge makes them unable to detect breaches

of regulations, evaluate the risk profile, or locate in-

consistencies in bank financial statements.

Recommendation. It is imperative that the super-

visory bodies—BI, IBRA, and MOF—have suffi-

cient authority, independence, and well-qualified staff.

BI has thus adopted the 25 Core Principles for Ef-

fective Banking Supervision proposed by the Basle

Committee. To avoid delay and political intervention

in enforcing corrective measures, noncompliance

should be penalized by well-defined laws and regu-

lations such as the FDIC Improvement Act of 1991,

which classifies banks into five categories according

to their Tier-1 and Tier-2 risk-based capital ratios.

BI does have a list of corrective measures, rang-

ing from temporary suspension of certain bank ac-

tivities to revocation of bank licenses, but it does not

state what violations are to be penalized and by what

measures. Ambiguity should be minimized to protect

supervisors from forced informal compromise or pres-

sure from politicians. Prompt and orderly bank clo-

sures, although unpopular, will be viewed by the bank-

ing industry and business world alike as a sign of

supervisory efficiency and strength.

Where no public funds are directly at stake, exist-

ing regulations governing NBFIs appear to be ad-

equate. Again, emphasis should be on the enforce-

ment of the prudential regulations and prevention of

intergroup (bank-NBFI) asset abuse by the parent

company. MOF and BI must immediately impose

corrective action in case of banks’ noncompliance.

To remedy supervisors’ oversight and ineffi-

ciency arising from their lack of expertise and in-

dustry knowledge, BI should provide frequent train-

ing and, where appropriate, supervisors should be

seconded to commercial banks to gain “real world”

experience. Judging from commercial banks’ feed-

back, supervisors particularly need to understand

treasury and credit operations. BI should also con-

sider appointing outside consultants or industry ex-

perts in areas involving advanced technical knowl-

edge. Human resources are so important that they

warrant further discussion.

Human Resource Constraint

The shortage of high-caliber and experienced staff

is not confined to the area of supervision but is wide-

spread in the financial industry. Frankly, the lack of

managerial and industry expertise, even at the trea-

surer level, is simply appalling. Few senior managers

are well versed in the operational details of bank-

ing—a problem rooted in the ownership and man-

agement structure of Indonesian banks, and also a

reflection of the human resource constraints in the

financial sector. As a result, many banks are placed

in a precarious position as few officers or managers


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are able to gauge the bank’s credit, interest rate, li-

quidity, and capital risk profile—information vital to

the management and operation of a healthy com-

mercial bank.

Recommendation. Producing enough qualified

industry professionals starts in the education system,

which is beyond the scope of this study, which fo-

cuses on what the financial industry can do to en-

sure a high level of expertise. Although Government

regulations require banks to spend at least 5 percent

of their personnel budget on training, few officers

have benefited from the scheme. Foreign and joint

venture banks are now the main training grounds for

industry professionals; a few treasurers have over-

seas work experience. Local banks need systematic

training schemes for junior professional staff and a

well-structured training-testing-promotion path for

executives in order to encourage voluntary improve-

ment in technically demanding areas.

One area requiring particular attention is treasury,

which is usually in the hands of a few dealers and

traders, who may inadvertently commit the bank to a

high degree of risk exposure. Derivative products

are poorly understood by senior managers at even

the world’s leading banks, so it is important that bank

directors understand off-balance-sheet risk. Since

treasury is an area of intensive financial innovation,

the treasurer must be up to speed on the use and

valuation of the full range of derivative instruments

at the bank’s disposal. If possible, all senior staff

should be sent regularly to professionally run training

courses or seminars.

Liquidity Management

The banking sector’s heavy exposure to foreign ex-

change debt can be traced to the banks’ need to

balance their maturity profiles. Due to the absence

of a developed domestic capital market, banks were

forced to go offshore in their search for long-term

capital. What started as a prudential practice soon

degenerated into a pursuit of cheap funding, pushing

the sector’s total foreign borrowing to around $30

billion by end-1997, about half of which was due

within 1998. The rupiah’s plunge further augmented

foreign liability in rupiah terms. Following the “flight

to quality” in January and February 1998, many local

private banks suffered from liquidity shortages in both

dollar and rupiah assets. Banks relying on BI’s li-

quidity support in excess of twice their equity capital

are already under IBRA, while the rest are scram-

bling for deposits. However, from the reported LDR

figures (85 percent for all commercial banks and 93

percent for private foreign exchange banks in Janu-

ary 1998), it is difficult to picture the extent of the

liquidity squeeze (Table A3.2, Appendix 3).

Given that most banks have switched to a long-

dollar position, coupled with the amplification of dol-

lar assets relative to total assets in rupiah terms, many

banks have vastly exceeded the NOP limit (25 per-

cent of capital). To be in excessively long-dollar po-

sition is obviously less of a headache for the trea-

surer if the rupiah continues to depreciate, but few

banks want to be caught by a rupiah appreciation.

Some banks have been trying to unwind NOP by

converting some dollar loans into rupiah loans at a

preagreed exchange rate. However, the scheme is

not too popular with customers hoping for a rupiah

rebound to, say, Rp6,000 to the dollar. Given that trade

financing has dwindled, and along with it the for-

ward markets, commercial banks are being deprived

of their other option in squaring some dollar expo-

sure: selling dollar forward contracts to customers,

primarily importers.

Although it is generally accepted that the bulk of

banks’ deposits comes from time deposits, not all

banks impose a prematurity withdrawal penalty on

them. During the capital flight in November 1997–

February 1998, many time-deposit holders closed

their accounts at the private banks and sent the

money abroad or to State and foreign banks. The

instability of time deposits and the difficulty in dif-

ferentiating the maturity profile among demand,

savings, and time deposits rendered liquidity man-

agement a near impossibility.


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Like all central banks during financial crises, BI

faced a dilemma: whether or not to stick to its tighten-

ing stance, with high interest rates offered on SBI as

a main tool to sterilize liquidity from the system. The

result, as many distressed bankers have pointed out, is

that banks unfortunate enough to be short in liquidity

have no way out of their predicament. By end-July

1998, one-month SBI rates were offered at 58 per-

cent while time-deposit rates were 45–50 percent at

top-grade commercial banks. What chance did bank

deposits have against risk-free domestic instruments

offered at much higher rates? Worse, borrowers have

requested all banks to cap their lending rate in the

wake of Indonesia’s social and economic woes. For

instance, customers were not satisfied when the hous-

ing loan rate was lowered from 50 to 27 percent at

Bank Internasional Indonesia in early July, and de-

manded an even lower range of 19–21 percent. With

such interest rate mismatch, it is impossible for banks

to sustain massive negative interest margins for long,

even if the bank had been in perfect shape to begin

with. The only winners at the moment seem to be the

foreign banks. Seen as safe and sitting out the crisis

because their deposit rate is much lower than private

national banks’, they are now flushed with fresh li-

quidity from new customers, which is to be invested in

low-risk instruments such as short-term SBIs at lu-

crative rates (51 percent or above).

Recommendation. The issue hinges upon the de-

velopment of a domestic capital market and the suc-

cessful rescheduling of some of the banks’ foreign

liabilities, both of which are beyond the scope of this

study. In an active capital market, investors such as

insurance companies and pension funds can reduce

their exposure to the banking sector, which still ac-

counts for over half of their total investment portfolio.

At this stage, there is little that banks can do to im-

prove their liquidity, aside from injecting capital from

shareholders or competing intensely to attract depos-

its (at a negative margin). Without the overhang of

currency devaluation, BI could relax its monetary

stance and foster a low interest rate environment that

could accelerate the banks’ balance sheet rehabilita-

tion process. Sadly, this option is not open to BI now.

From a different angle, BI’s definition of LDR,

which includes bank capital and short-term borrow-

ing (under three months) in the calculation of deposit

base, distorted the true picture of bank liquidity. A

simple definition would put LDR at around 114 per-

cent for all commercial banks in January 1998. In

fact, LDR has not dipped below 110 percent in the

past decade, except in 1996.

It would appear that liquidity management among

Indonesian banks has been fairly reactionary. In a

properly run bank, treasurers, together with senior

management, must factor an asset-liability plan into

their annual business projection. Of the usual range

of liquidity ratios, BI monitors only net obligations of

interbank call money to liquid assets and the statu-

tory reserve requirement, besides LDRs. For inter-

nal reference and for their own guidance in liquidity

management, treasurers ought to closely monitor the

most common liquidity ratios: (i) liquid assets/total

assets, (ii) volatile deposits/total deposits, (iii) short-

term securities/total deposits, and (iv) total borrow-

ing/equity capital. In addition, it should prohibit or

impose a standard penalty on the early withdrawal

of time deposits to ease the treasurer’s task of man-

aging bank liquidity.

At present, although banks are reporting their con-

tingencies and commitments to BI on a weekly ba-

sis, all the positions are at book values. In other words,

they fail to capture the market risk profile of the de-

rivative instruments, whose value, being dependent

on the prices of underlying assets, can be extremely

volatile. Given the increasing importance of deriva-

tive products in liquidity management, it is essential

that all off-balance-sheet items should be marked to

market in order to capture the level of market risk

exposure they represent.

Credit Management

A combination of economic boom and lending re-

strictions has discouraged efficient credit allocation


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among Indonesia’s commercial banks. In 1993–1997,

credit in private national banks grew at 39 percent

compound rate each year. To remain selective at this

rate is difficult, and the result of aggressive lending

is finally showing up in the latest NPLs. The previ-

ous looser classification and the common practice of

evergreening NPLs, together with the 3 percent tax-

deductibility cap on LLP, have caused serious

underprovision for bad debts. In the past, commer-

cial banks conveniently limited their LLP to around 3

percent. At end-1997, total bank credit amounted to

over 70 percent of GDP. Given the high debt/GDP

ratio, the key longer-term question is whether or not

Indonesia is capable of generating sufficient cash

flow to service the debts. In the near term, the spec-

ter of high interest rates and economic contraction

will result in more corporate failures and, in turn, fur-

ther deterioration of bank and NBFI asset quality.

The Government’s long history of allocating sub-

sidized credit to “priority” sectors culminated in the

State banks’ lower-than-sector-average returns and

interest margins. Recently, various credit restrictions

were placed on private banks: (i) a minimum 20 per-

cent of total credit to be extended to small business

credit (Kredit Usaha Kecil [KUK]); (ii) a minimum

50 percent of all foreign bank credit for export credit;

and (iii) a ban on new loans for property develop-

ment, except for low-cost housing. Such rigidities

dented banks’ ability to allocate credit efficiently. All

too often, the creditworthiness of the borrower re-

ceived less weight than warranted in a normal credit

analysis. In some State banks, political influence

swung management’s decision toward awarding

cheap loans to well-connected borrowers, further

undermining the banks’ credit risk.

As for private banks, years of economic boom

enabled them to aggressively expand their balance

sheet. Many of the large and smaller banks alike

opened new branches in a bid to attract more de-

positors and borrowers in the mid-1990s. As a re-

sult, they placed little emphasis on the quality of as-

sets and did not standardize the lending process. They

approved corporate loans almost entirely without

paperwork. According to several treasurers, banks

competed intensely with each other for large corpo-

rate borrowers, who typically would also deposit a

portion of the funds with the creditor bank. Anec-

dotal evidence indicates that in the case of related-

party lending, the loan is almost always preapproved

regardless of what the funds will be used for.

In contrast, individual customers, particularly those

taking out mortgages, are viewed as most creditwor-

thy as they fear losing their property (automatically

used as collateral for a housing loan). However, few

of the major banks have a credit analysis system

allowing credit officers to review a potential cus-

tomer’s credit history, financial standing, income pro-

jection, and other relevant information. The situation

fostered kickbacks and corruption by both custom-

ers and bankers.

Recommendation. As part of the IMF program,

the Government plans to scrap all restrictions on bank

lending, except to KUK, encouraging banks to exer-

cise independent judgment in the risk-return man-

agement of their credit portfolios. As credit analysis

is a weak point in commercial banking, banks need

to exercise prudence in their credit policies. Trea-

surers need to monitor credit risk ratios such as

(i) risk assets/total assets, (ii) LLP/earning assets,

and (iii) interest-rate-sensitive assets/total assets.

A standardized credit approval procedure, incor-

porating detailed credit analysis, should go hand in

hand with staff training in order to safeguard the

loan quality of commercial banks. All banks should

state explicitly the financial information and docu-

mentation required from all potential corporate and

individual customers for scrutiny in order to avoid

abuse or preferential treatment. Junior officers han-

dling loan approvals should be allowed to report man-

agement intervention and all other irregularities in

credit decisions directly to BI’s supervision depart-

ment, with the matter kept strictly confidential so

as not to endanger the officers’ employment pros-

pects. Credit officers who approved loans paid back


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in full should be rewarded in order to deter them

from accepting kickbacks.

The recent tightening in loan classification and the

announcement of full tax deductibility of LLP will

pave the way for better bad-debt provision. But at

the end of the day, it is the supervisor’s duty to en-

sure that bad loans are properly reported and to weed

out evergreening. As the public sector’s involvement

in banking should be reduced gradually in the long

run, the Government should prepare to privatize State

banks in order to enhance sector competition.

Deposit Insurance

The bank runs and subsequent capital flight in No-

vember 1997 could have been mitigated by a system

of explicit deposit insurance. In the past, the Gov-

ernment had intervened in every isolated banking

problem; Indonesia thus had an implicit deposit in-

surance system. However, the closure of the 16 banks

sent public confidence spinning downward and the

system now requires a more explicit scheme.

In lieu of a formal system, and facing more bank

closures in March 1998, the Government issued a blan-

ket guarantee, administered by IBRA, covering all bank

deposits and obligations. Now banks pay an annual

premium of 0.25 percent of the average monthly

amount of guaranteed deposits and obligations. The

scheme covers all banks, irrespective of soundness,

and is thus viewed as inefficient. It will remain for

two years before it is replaced by a new scheme.

Recommendation. The Government should de-

cide whether the new scheme is to be voluntary or

compulsory, and run by Government or industry. The

recent financial crisis points to the necessity, at least

in the initial stage, of a compulsory scheme. In some

industrialized countries, the deposit insurance agency

also has regulatory and supervisory power over the

banking industry, providing additional checks and

balances in the sector. It remains to be seen whether

or not an industry organization will have enough au-

thority to take on this role. In the US, it is FDIC that

has full exit power over the commercial banks. Be it

Government- or privately run, the agency must have

the legal authority and political independence to re-

solve bank failures in conjunction with the supervi-

sory authorities, MOF, BI, and IBRA.

A mechanism to prevent owners and borrowers

from exploiting the system is necessary to avoid moral

hazard. Each bank must pass all the regulatory, capi-

tal, and solvency requirements set by BI. Every bank’s

soundness should be automatically reviewed as part

of the restructuring process. The premium should be

low and standardized, or risk-based, so that banks en-

gaged in higher-risk lending or with a less-than-spot-

less track record may be charged a higher premium

than those engaged in, say, mortgage lending.

The system may be funded initially by a start-up

levy borne entirely by members of the scheme, or

partially shared by the commercial banks, central

bank, and treasury in a Government-run system.8 In

the US, the cost of premiums is borne by the banks,

but insured deposits carry a much lower interest rate.

In the event of bank failure, the deposit insurer should

automatically act as receiver on behalf of all deposi-

tors and creditors, particularly in Indonesia, which

had only 16 receivers in August 1998, compared to

over 3,000 in the US.

A ceiling on the amount insured is necessary, al-

though it may favor the larger banks in the long run

as they will be perceived as “too big to fail.” In most

cases, insurance schemes protect the small deposi-

tors. However, insured depositors must have pre-

ferred status over other creditors so that the cost of

the insurance system will fall on uninsured deposi-

tors and other creditors, which is one way of increas-

ing discipline in the system.

Accounting andDisclosure Standards

Financial Accounting Standard for Banks reporting

requirements are fairly comprehensive and roughly

in line with international standards (Appendix 1.C).

One key exception is that the values of off-balance-

sheet items are not marked to market. The external


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auditing process is not strictly standardized; some

auditing firms are viewed as more lenient and coop-

erative in disguising potential violations of prudential

regulations and are therefore more popular. The Bank

Secrecy Code discourages transparency and disclo-

sure in banking. Thus, although a measure of bank

soundness—the CAMEL rating compiled by BI—

exists, the information is not publicly available.

Recommendation. BI needs its own internal model

of the valuation of complex derivative products, which

were largely overlooked by supervisors. All off-bal-

ance-sheet items should be based on market value in

order to correctly reflect their risk profile. The only

way to discourage excessive window dressing is to

have greater transparency and a tighter external au-

dit process. To this end, the Government should con-

sider watering down the Bank Secrecy Code. Greater

public disclosure of bank performance, income, and

balance sheet will delegate some of the regulatory

responsibilities to the more efficient market. Poorly

run and inefficient banks will then automatically be

penalized by the general public. Needless to say, to

prevent the reporting of misleading or false informa-

tion, professionalism and integrity of the internal and

external auditors also need to be strengthened.

ConclusionAfter three attempts to hammer out a feasible re-

form package, market participants are waiting to see

if Indonesia remains committed to the painful but

necessary process of consolidating and restructur-

ing its beleaguered financial sector. So far, the Gov-

ernment seems to be sticking to the reform schedule

and has announced a broad range of measures. How-

ever, a successful rehabilitation of the banking sec-

tor requires a consistently tight monetary policy to

prevent the rupiah’s further slide, and an agreement

to resolve the external-debt problem.

Restructuring begins with promoting sector con-

solidation by raising the capital requirement. Amend-

ing the legal framework is equally important, as is

changing the way owners and managers view the

banking business so that banks will cut down related-

party loans. Next, the supervisors need regulatory

and supervisory power and independence. Prudent

liquidity and credit management of the banks’ assets

and liabilities can then be promoted. At the same

time, a carefully tailored staff training program, to-

gether with strengthened accounting and disclosure

standards, will ensure better external and internal

assessment of banks’ performance and risk profile.

Finally, a safety net—a deposit insurance system—

should be introduced to enhance good governance

and to safeguard depositors’ interest.

Although there is no quick fix for the country’s

financial woes, the good news is that the Govern-

ment is finally addressing the very issues behind the

financial sector’s chaos and failures. With time and

perseverance, the sector will emerge from the crisis

on a much firmer footing than before.


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Notes1See Lindgren et al. (1996).

2See Bank Indonesia Reports (1995/96:79), and (1996/97:71).

3See The Banker (July 1997:140).

4See Memorandum of Economic and Financial Policies,IMF (15 January 1998).

5Perfindo, the credit-rating agency, estimated in April 1998that NPLs of commercial banks would rise to 60 percentby end-1998.

6See Goldstein and Turner (1996:22).

7See Wheelock and Wilson (1995:40).

8See Garcia G., IMF Working Paper 96/83.

References

International Monetary Fund. 1998. Memorandum of Eco-nomic and Financial Policies. 15 January.

Garcia, G. 1996. Deposit Insurance: Obtaining the Benefitsand Avoiding the Pitfalls. IMF Working Paper 96/83. IMF:Washington, D.C.

Goldstein, M. and P. Turner. 1996. Banking Crises inEmerging Economies: Origins and Policy Options. Bankfor International Settlements Economic Paper No. 46.October.

Lindgren, C., G. Garcia and M. Saal. 1996. Bank Sound-ness and Macroeconomic Policy. IMF: Washington,D.C.

Wheelock and Wilson. 1995. Federal Reserve Bank of St.Louis Review. July/August.


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Appendix 1

Policy and Regulatory Environment

A. Chronology of Regulatory Developments1953• Bank Indonesia (BI) is officially set up as the central

bank.1967• The Banking Act is passed.7 December 1968• The Central Bank Act defines the role of the central

bank.• Private local banks consolidate as 24 are ordered to

suspend operations temporarily.• Village banks are to be administered and supervised

by Bank Rakyat Indonesia (BRI) with guidelines fromBI.

1969–1970• Multiple exchange rates are unified.• The Government opens a capital account in line with

Article VIII of IMF membership rules.1974• 30 percent of foreign private sector borrowings (other

than for direct investments) are to be deposited at BI.• Credit ceilings are imposed and entry of new banks

strictly limited.June 1983• PAKJUN 1983 comes into effect.• Credit ceilings are replaced with reserve require-

ments.• Interest rates are deregulated.27 October 1988• PAKTO 1988 comes into effect.• Minimum paid-up capital for commercial banks is raised

from Rp1 billion to Rp10 billion.• The requirement for conversion to foreign exchange

bank status is eased to Rp100 billion in assets, withRp80 billion in deposits and Rp75 billion in loans.

• The legal lending limit (LLL) is put in place, althoughdefining it is complicated. It is 20 percent maximum ofequity capital to a single borrower and 50 percent ofequity capital to groups of affiliated borrowers.

• Opening of existing banks’ new branches isfacilitated.

• New foreign joint venture banks are encouraged.Minimum paid-in capital is set at Rp50 billion, withforeign ownership allowed up to 85 percent of total.

• State-owned enterprises are allowed to deposit up tohalf of their excess funds with private banks.

• Reserve requirements are reduced from 15 percent ofthird-party deposits (effectively 8 percent) to 2percent.

• Foreign and joint venture banks are required to grantat least 50 percent of total credit as export loans.

20 December 1988• Minimum paid-up capital for finance companies

engaged solely in factoring, consumer finance, orcredit cards is set at Rp2 billion for national privatecompanies or cooperatives, and Rp8 billion for jointventure companies.

• Minimum paid-up capital for finance companies engagedexclusively in leasing or venture capital is set at Rp3billion for national private companies or cooperatives,and Rp10 billion for joint venture companies.

• Minimum paid-up capital for finance companiesengaged in more than one business activity is Rp5billion for private national companies, and Rp15 billionfor joint venture companies.

29 January 1990• PAKJAN 1990 comes into effect.• Domestic commercial banks are required to extend at

least 20 percent of total credit as small-scale businesscredit (KUK).

28 February 1991• PAKFEB 1991 comes into effect.• A prudential regulation package is introduced to cover

reporting requirements to BI, treasury activitiescontrols, and new LLL.

• Three years’ experience is required for founders,bank directors, and commissioners, and limits areimposed on the number of senior management withclose family ties to them.

• Banks are required to spend at least 5 percent of theirtotal personnel budget on training.

November 1991• Offshore borrowing in the form of foreign commercial

borrowings (Pinjaman Komersial Luar Negeri orPKLN) is limited to an aggregate of 30 percent ofcapital.

• Banks with PKLN are required to allocate 80 percentof such funds for export loans.

25 March 1992• Banking Act No. 7 replaces the 1968 law.• Minimum paid-in capital is raised to Rp50 billion for

private national banks, and to Rp100 billion for foreignjoint venture banks.

• New foreign ownership of joint venture banks isreduced to 49 percent.

• Banks are allowed to issue share capital to the public.• Banks are required to maintain a capital adequacy ratio

(CAR) of 5 percent.20 April 1992• Pension Funds Act No. 11 provides for the establish-

ment, administration, and regulation of pension funds.• The Insurance Law establishes minimum paid-up

capital at Rp3 billion for local general insurancecompanies, Rp2 billion for life insurance companies,Rp10 billion for reinsurance companies, and Rp500million for insurance or reinsurance brokers. Theamount is treble for foreign companies.

29 May 1993• Banks’ CAR is to be raised to 8 percent by end-1993.• Banks’ interbank obligation is not to exceed 100

percent of capital.August 1994• BI reorganizes its banking supervision division into five

departments: three for commercial bank supervision,one for rural bank supervision, and one for regulationand development.

1995• The KUK ceiling is raised to Rp350 billion for all banks,

including foreign and joint venture banks. Penalties areimposed for noncompliance.

• A self-regulatory banking framework is introduced,under which banks are required to have a written

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credit policy covering loan principles, management,and bad-debt settlement.

25 January 1995• A “fit and proper” test to assess competence, integrity,

and qualifications of prospective bank management isintroduced.

11 August 1995• Guidelines on issuance and trading of commercial

paper (CP) are established. Commercial banks areprohibited from acting as underwriter of CP, but mayact as arranger, issuing agent, or dealer of invest-ment-grade CP with a maximum term of 270 days.

September 1995• Conditions to convert to foreign exchange banks are

tightened as minimum paid-in capital is raised to Rp150billion and CAR to 9 percent.

3 October 1995• Financing and venture capital companies are required

to be separate.• Minimum paid-up capital for finance companies is

increased to Rp10 billion for national privatecompanies, Rp25 billion for joint ventures, and Rp5billion for cooperatives, to be fulfilled by October1998.

• Minimum paid-up capital for venture capital companiesis set at Rp3 billion for national private companies,Rp10 billion for joint ventures, and Rp3 billion forcooperatives.

December 1995• The statutory reserve requirement is raised from 2 to 3

percent.19 December 1995• BI is to assist the Ministry of Finance (MOF) in the

supervision of finance companies.• Regulations on finance companies’ borrowing limits,

guidelines on investment, and reporting requirementsare introduced.

21 December 1995• MOF discontinues issuance of new finance company

licenses.29 December 1995• Guidelines on derivative transactions are issued.

Banks may conduct only derivative transactions onforeign exchange and interest rates.

• Cut-loss is limited to 10 percent of bank capital.• Banks are required to submit weekly reports on

derivative transactions to BI.3 December 1996• Government Regulation No. 68 on the revocation of

operating licenses, dissolution, and liquidation of banksis promulgated.

• BI is empowered to make recommendations to MOF torevoke the license of problem banks if remedialmeasures fail. Remedial measures include replacingthe management, requesting shareholders toincrease capital, writing off bad debts, merging withanother bank, selling off the bank to buyers, amongothers.

28 February 1997• Pension funds are authorized to invest in mutual

funds.

26 March 1997• PKLN ceiling for all commercial banks is set at $1.5

billion for the year. Commercial banks are required toextend export credit at a minimum of 80 percent ofPKLN.

• The CAMEL-rating system is introduced for all banks.16 April 1997• The statutory reserve requirement is raised to 5

percent.• All commercial banks, including foreign and joint

venture banks, are required to extend 20 percent oftotal loans (previously only rupiah loans) to KUK. Finesare to be imposed in case of noncompliance.

2 July 1997• Commercial banks are no longer allowed to extend

new loans for land purchase or property development,except for low-cost housing.

• The value of land is no longer counted as collateral inextending working capital loans to developers.

14 August 1997• The rupiah exchange rate is allowed to float.• Public sector enterprises, under instruction from MOF,

are to shift deposits from commercial banks to BI.September 1997• Commercial banks’ CAR is raised from 8 to 9 percent.1 November 1997• Sixteen insolvent commercial banks are closed.31 December 1997• The Government announces its plan to merge State

banks.1 January 1998• Small depositors of closed banks are compensated.27 January 1998• The Indonesian Bank Restructuring Authority (IBRA)

is established as an independent body under MOF toreturn the banking sector to solvency and toregulate the sector to an internationally acceptedstandard.

• The Government, through IBRA, guarantees all 212commercial banks’ previous obligations to foreign anddomestic depositors/creditors. The guarantee iseffective for two years and payment is to be made inrupiah in the event of a claim. Banks will need to paysemiannually to IBRA an annual premium of 0.25percent of the average monthly amount of guaranteeddeposits and obligations.

1 February 1998• Branch restrictions on foreign banks are lifted.14 February 1998• Fifty-four commercial and regional development banks

are placed under close supervision of IBRA.27 February 1998• New loan classifications are implemented. The

overdue period is shortened across the board.Collateral is no longer included in doubtful and lossloans. A new category, “special mention,” is intro-duced.

• Loan-loss provisions (LLP) guidelines are tightened inaccordance with the new loan classifications,effective 31 March 1998. General provisions areraised from 0.5 to 1 percent.

Appendix 1

Policy and Regulatory Environment (Cont’d)


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• Prudential principles concerning interbank obligations,takeover of claims, and provisions for fund growth areintroduced. Banks failing to comply are prohibited fromincreasing fund growth.

• The ceiling on interest rates for third-party funds is setat 150 percent of Bank Indonesia Certificate (SBI)rates. The value of prizes on deposits is capped at 1percent of total interest expense.

6 March 1998• Interest rates on discount facilities are raised to 200

percent of seven-day Jakarta interbank offer rate(JIBOR) for less than seven days, and to 300 percentof seven-day JIBOR for more. Banks are given amaximum 14-day facility limit. Failure to comply results inIBRA supervision.

• The penalty for noncompliance with the minimumreserves is increased to 150 percent of overnightJIBOR rates, and to 200 and 400 percent of overnightJIBOR for noncompliance exceeding 7 and 14consecutive working days, respectively.

• Negative reserve balance of banks at BI is charged at500 percent of overnight JIBOR. Unsettled balanceresults in supervision by IBRA.

23 March 1998• The one-month SBI interest rate is hiked from 22 to 45

percent.4 April 1998• IBRA suspends operations of seven commercial banks

and takes over management of seven others.• BI liquidity support claims are transferred to IBRA.15 April 1998• The ceiling on interest rates for third-party funds is

reduced to 125 percent of SBI rates.21 April 1998• The one-month SBI interest rate is raised to 50 percent.22 April 1998• Minimum paid-up capital for banks is to be increased to

Rp250 billion, net of LLP, by end-1998.• LLP are to be fully tax-deductible in FY1998.• The merger plan of State banks is revised. Only BBD

and Bapindo are to merge in June 1998.• The amendment of the Bankruptcy Law and establish-

ment of a special commercial court is to take effect in120 days’ time.

19 June 1998• Minimum paid-up capital is reduced to below Rp250

billion.• Minimum CAR is reduced to 4 percent by end-1998,

8 percent by end-1999, and 10 percent by end-2000.

B. Present Regulatory Requirements1. Banks

(a) Establishment, licensing, and expansion• Minimum paid-up capitala

State or private national banks Rp50 billionJoint venture banks Rp100 billionRural banks Rp50 billion

• Management– At least 50 percent of the board directors

must have operating experience in banking ofnot less than three years.

– Board directors, whether severally or jointly,are prohibited from owning more than 25percent of another company.

– Board commissioners may not hold a similarposition in more than three commercial banks.

• For commercial banks to open an additional orsubbranch office, a “sound” CAMEL ratingmust have been achieved for 20 of theprevious 24 months and a “fairly sound” ratingfor the remaining 4 months. The CAR require-ment must also have been met for the pasttwo years.

• A non-foreign-exchange bank may convert toforeign exchange status provided it has aminimum paid-up capital of Rp150 billion, a“sound” CAMEL rating for the previous twoyears, and a CAR of at least 10 percent prior toconversion.

• A non-foreign-exchange bank may obtain alicense to trade foreign currencies provided ithas a “sound” CAMEL rating for 10 of theprevious 12 months and a “fairly sound” ratingfor the remaining 2 months.

(b) Regulation of business activities• Statutory reserve requirement. At least 5

percent of a bank’s third-party funds are to bedeposited at BI.

• KUK. At least 20 percent of total loans are to beallocated to KUK. If not, at least 25 percent ofloan growth is to come from KUK. Noncompli-ance will result in a fine equivalent to 2 percentof the shortfall.

• Foreign banks are required to extend at leasthalf of total loans and at least 80 percent offoreign currency loans as export credits.

• Banks are prohibited from underwriting CP, butmay act as arranger, issuing agent, or dealer ofinvestment-grade CP with a maximum term of270 days.

• Commercial banks are no longer allowed toextend new loans for land purchase orproperty development, except for low-costhousing.

(c) Prudential requirements• CAR. 9 percent for all commercial

banks, to increase gradually to 10 and 12percent by end-1999 and end-2001,respectively.

• Legal lending limit (LLL). 20 percent of bankcapital for an individual or a group (or listedcompanies) not affiliated with a bank, and 10percent for a related party.

• Net open position (NOP). Limited to 25 percent ofbank capital for the weekly average net positionof both on- and off-balance-sheet positions.

• Loan-deposit ratio (LDR). Maximum of 110percent.

• Asset quality and LLP

a Minimum paid-up capital for all commercial banks has been raised to Rp250billion, net of loan-loss provisions (LLP) since 22 April 1998. Banks have until end-1998 to fulfill the requirement. This replaces the BI’s previous plan to raise theminimum paid-up capital (gross of LLP) to Rp1 trillion and Rp2 trillion by end-1998and end-2000, respectively.

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ProvisioningRequirement

Classification Criteria (%)

Pass Interest fully paid 1Special mention Interest past due < 90 days 5Substandard Interest past due > 90 days 15Doubtful Interest past due > 180 days 50Loss Interest past due > 270 days 100

• Loans previously classified as “Doubtful” or“Loss,” but subsequently rescued, may becategorized as “Substandard” at the highestwithin six months from the beginning of therescue program, even though it can fulfill the“Pass” criteria.

• Securities are categorized as “Pass” if in theform of Surat Berharga Pasar Uang or if not yetdue. Otherwise, they are classified as “Loss.”

• PKLN. Limited to an aggregate of 30 percent ofbank capital. Banks with PKLN are to allocate atleast 80 percent to export credit.

(d) CAMEL rating

Factor Weight (%)

Capital 25Asset quality 30Management 25Earnings 10Liquidity 10

• Capital, asset quality, earnings, and liquidityfactors are calculated using the banks’ monthlyreport submitted to BI, while the managementfactor is derived from on-site examinations andupdated by reference to the results of day-to-day supervision and prudential meetings.

• Ratings are classified as “Sound,” “FairlySound,” “Poor,” and “Unsound.”

(e) Reporting requirements• All commercial banks are required to report on a

weekly, monthly, semiannual, and annual basisto BI.

• Weekly reportIncludes:– reserve requirements;– consolidated deposits and specific items of

balance sheet;– profit/loss statement of derivative transactions;– foreign exchange NOP.

• Monthly reportIncludes:– balance sheet and profit/loss statement by

bank offices;– credit reports by bank offices;– violation of LLL by bank head offices.

• Semiannual reportIncludes:– report of the board of commissioners on the

bank’s work program progress;– published financial statement.

• Annual reportIncludes:– audited report by registered accounting firms

and a management letter.2. Finance companies

(a) Establishment and licensing• Minimum paid-up capital

– Leasing, factoring, consumer financing, creditcardNational private companies Rp10 billionJoint ventures Rp25 billionCooperatives Rp5 billion

– Venture capitalNational private companies Rp3 billionJoint ventures Rp10 billionCooperatives Rp3 billion

(b) Regulation of business activities• Amount of borrowing is not to exceed 15 times

equity capital (net worth) minus participation.• Maximum overseas borrowing is five times net

worth.• Finance companies are not allowed to engage

in securities trading.• They are not allowed to draw funds directly

from the public in the form of deposits orpromissory notes. They are prohibited fromissuing promissory notes except as collateralagainst bank debt.

• They are allowed to participate only in acompany engaged in the financial sector, withparticipation not exceeding 25 percent of thepaid-up capital of the company concerned andthe total amount of participation limited to 40percent of net worth of the finance company.

(c) Reporting requirements• Finance companies (except venture capital

companies) are required to submit to MOF, witha copy to BI, the following:– monthly financial report;– quarterly business activity report;– annual financial report audited by a public

accountant.• Venture capital companies are obliged to submit

the following to MOF:– semiannual operational and financial reports;– annual financial report audited by a public

accountant.3. Insurance companies

(a) Establishment and licensing• Minimum paid-up capital

– General insuranceNational private companies Rp3 billionForeign companies Rp15 billion

– Life insuranceNational private companies Rp2 billionForeign companies Rp4.5 billion

– ReinsuranceNational private companies Rp10 billionForeign companies Rp30 billion

– Insurance/reinsurance brokerNational private companies Rp500 millionForeign companies Rp3 billion

Appendix 1



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(b) Regulation of business activities• Insurance companies are permitted to invest

assets in time deposits, promissory notes, SBIs,money market instruments, listed stocks andbonds, direct equity, properties and mortgages,as well as loans to policyholders.

• Their maximum retention limit is set relative tothe net worth of each insurance coverage orfor the company as a whole.

• Insurance companies are not allowed toparticipate in insurance-supporting companiesor in offshore investment, except in anotherinsurance company.

• They are not allowed to conduct derivativestransactions, including commodities andcurrency futures.

(c) Reporting requirements• Insurance and reinsurance companies are

required to submit the following to MOF:– quarterly financial report,– annual financial report audited by a public

accountant.4. Pension funds

(a) Establishment• Employer-managed pension funds

– They must be established as a separate entitywith assets properly segregated from thoseof the founder.

– Those implementing a defined benefit pensionplan, in which the benefits to an employee arebased upon a pay-out schedule to be met bythe employer, must appoint an administrator, asupervisory board, a custodian, an auditor,and an actuary.

– Pensionable earnings are capped at Rp5million per annum per employee.

– The employer’s maximum annual contributionon behalf of an employee is 20 percent ofannual pensionable earnings.

• Financial institution pension funds (FIPF)– They must have a defined contribution plan in

which employees’ benefits are limited to thereturn on investments made by the pensionfund.

– Maximum annual contribution is 20 percent ofpersonal earnings.

– Employees covered by employer-managedfunds may join an FIPF, with the maximumannual contribution limited to 10 percent ofearnings.

(b) Regulation of fund activities• Pension funds are permitted to invest assets in

time deposits and CDs, money market instru-ments, mutual funds, listed securities (exceptoptions and warrants), unlisted equity, certifi-cates of indebtedness, land, and buildings.

• They are not allowed to place deposits withaffiliated banks or to purchase money marketinstruments of affiliated companies.

• They are prohibited from investing outsideIndonesia.

• Contributions are tax-deductible, while benefitspaid to members are taxable.

• In the case of a defined benefit pension plan,the supervisory board is to monitor theadministrator’s management of the pensionfund, and to submit written annual reports onthe results of their findings to the founder.

(c) Reporting requirements• Employer-managed pension funds must file an

actuarial report with MOF at least once everythree years, or in the event of an amendment inthe regulations specifying required benefits.

• The actuarial report must state:– contributions required for funding the pension

plan,– asset adequacy for the payment of benefits,– additional contributions required to cover any

shortfall.

C. Accounting system1. Standards

• Financial Accounting Standard for Banks (FASB,Statement No. 31), which is based on GeneralAccepted Accounting Principles and theInternational Accounting Standards, includes acompilation of accounting principles, procedures,methods, and techniques. It covers accountingfor assets, liabilities, capital, commitments andcontingencies, revenues and expenses, andbank financial statements. Banks are required toapply FASB in all financial reports.

• For derivatives transactions, banks arerequired to submit weekly reports on gains orlosses, either realized or unrealized, and thenet position of derivative transactions, incompliance with the Special Standard forIndonesian Banking, drawn up in reference tothe Basle / International Organization ofSecurities Commission’s framework.

2. Audit(a) Internal

• Banks are to adopt the internal audit functionstipulated in the Standard Practices for BankInternal Audit Function, which requires banks todo the following:– formulate an Internal Audit Charter,– establish an Audit Committee,– establish an Internal Audit Unit,– formulate Internal Audit Guidelines.

• Compliance with standard practices ismonitored by BI.

(b) External• All banks are subject to external audit by

certified public accountants registered with BI.State banks are also subject to additional auditby the Financial and Development SupervisoryBoard.

3. Disclosure• Banks are required to publish annual consoli-

dated financial statements that include thefollowing:

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– balance sheet,– profit and loss,– off-balance-sheet statement,– other information, including list of ownership,

board of management and commissioners,audit committee, and the disclosure on eachitem in the published statements.

• The Capital Market Supervisory Agency(Bapepam) administers disclosure requirementswith respect to publicly listed banks.

• Finance (including venture capital) companiesare obliged to publish the balance sheet andbrief profit-and-loss statement annually in atleast one widely circulated daily newspaperwithin three months after the end of eachfinancial year.

• Insurance companies are obliged to publishannual reports in the newspapers.

D. Financial Management System1. Risk management

• BI has introduced the concept of self-regulationwithin the banking industry to help ensure theimplementation of prudent banking practices. Inparticular, banks are expected to take intoaccount the following types of risk:– liquidity risk,– market risk,– credit risk,– operational risk,– legal risk,– ownership and management risk.

2. Liquidity management• Banks’ liquidity positions are monitored based

on the following:– LDR,– net obligations of interbank call money/liquid

assets,– maturity profiles,– day-to-day interbank clearing with BI and

money market securities dealing,– day-to-day bank statutory reserve at BI

(minimum of 5 percent).

• Overall bank liquidity positions are consoli-dated from branches and subsidiaries.

E . Payment, Clearing, and Settlement Systems• BI is setting forth guidelines for a national

payment system, which will focus on threecomponents: large value transfer system,intercity clearing, and retail payment. Alltransaction settlements originating from themwill be processed through an integratedsystem operated by BI to enable commercialbanks to better monitor and control theirdemand deposits with BI.

• As of 1997, interbank clearing in Indonesiawas still paper-based and held in 103 localclearing regions. Processing was under-taken by BI, or, in the absence of a BIregional office, by an appointed regionalcommercial bank. A same-day settlementschedule was introduced in Jakarta in 1997.Processing is divided into three categories:– automatic local clearing: Jakarta, Medan,

and Surabaya;– semiautomatic local clearing: in 50 cities;– manual local clearing: in 50 cities.

• The Jakarta Electronic Clearing System wasimplemented in 1998. Electronic clearing willbe supported by a paper-based systemoperating with image technology. Settle-ments among participating banks withinJakarta will be managed by the centralclearing computer through an electronicnetwork to provide a fast, accurate, andsecure clearing process.

• BI has begun drafting regulations onelectronic fund transfer (EFT) to support asystem for electronic and non-paper-basedpayments.

• An on-line accounting system is beingdeveloped between BI and commercialbanks to facilitate intrabank, interbank, andintercity electronic transfers by banksthrough BI.

Sources: Bank Indonesia and Ministry of Finance.

Appendix 1


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Appendix 2

Top 20 Commercial Banks’ Global and Regional Ranking

( ) = negative values are enclosed in parentheses.na = not available, BIS = Bank for International Settlements, CAR = capital adequacy ratio, ROA = return on assets.a year-on-year.Source: The Banker, July and October 1997, based on December 1996 reported figures, except for Bapindo (December 1994).

Global Asian Tier-1 Capital Assets Domestic Rank ROA Cost/Income BIS CAR

Ranking Ranking Bank $ million % changea $ million % changea by Asset (%) (%) (%)

257 40 Bank Negara Indonesia 1,151 81.5 14,856 (6.2) 2 1.34 57.90 11.82

383 65 Bank Central Asia 745 12.2 15,374 35.6 1 0.72 64.22 9.53

377 67 Bank Rakyat Indonesia 698 0.8 14,656 20.5 3 1.00 81.40 8.69

413 71 Bank Dagang Negara 663 15.2 13,781 9.4 4 0.99 69.67 na

454 79 Bank Bumi Daya 604 28.5 10,443 10.2 6 0.42 82.05 11.48

462 80 Bank Ekspor Impor Indonesia 593 22.7 10,988 17.1 5 1.13 61.72 10.74

506 88 Bank Tabungan Indonesia 521 7.1 4,839 18.9 11 1.67 17.20 na

552 107 Bank Internasional Indonesia 470 24.4 7,541 35.9 8 2.08 54.70 8.72

599 127 Bank Dagang Nasional Indonesia 416 (8.6) 7,092 33.9 9 1.63 48.15 8.50

629 136 Lippo Bank 386 79.3 4,337 33.5 12 1.58 62.90 13.20

650 139 Bank Danamon 365 22.5 9,436 58.0 7 1.27 54.00 10.28

686 141 Bapindo 334 4.7 6,361 (6.9) 10 0.06 na na

828 159 Bank Bali 239 2.1 340 26.3 13 2.24 63.75 10.92

835 161 Bank Niaga 235 107.8 3,353 19.5 14 1.78 52.75 10.75

850 162 Panin Bank 230 10.9 2,289 28.8 16 2.18 36.03 14.87

868 166 Bank Umum Nasional 219 67.4 3,044 19.4 15 1.35 57.40 10.90

958 173 Bank Duta 184 3.7 2,248 60.5 17 1.34 65.05 14.00

na 188 Bank Tiara 115 10.8 924 64.6 20 2.72 44.96 11.51

na 195 Bank Bukopin 94 9.5 1,449 32.9 18 0.94 72.57 13.50

na 198 Tamara Bank 86 59.0 1,232 40.5 19 1.73 88.23 14.71

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Appendix 3: Selected Statistics on Banks and Nonbank Financial Institutions

Table A3.1: Commercial Bank Credit Collectibility, 1994–1998

NPL = nonperforming loan.Source: Bank Indonesia.

1994 1995 1996 1997 Jan 1998

Bank Type and Loan Classification Rp trillion % share Rp trillion % share Rp trillion % share Rp trillion % share Rp trillion % share

All Commercial Banks 217.02 267.81 331.29 444.96 645.67

Current 190.85 87.9 239.92 89.6 302.17 91.2 412.78 92.8 594.73 92.1

NPL 26.17 12.1 27.89 10.4 29.12 8.8 32.18 7.2 50.94 7.9

Substandard 7.30 3.4 7.36 2.7 8.55 2.6 11.72 2.6 20.35 3.2

Doubtful 10.20 4.7 11.73 4.4 11.07 3.3 11.38 2.6 18.36 2.8

Loss 8.66 4.0 8.80 3.3 9.50 2.9 9.09 2.0 12.23 1.9

State Banks 104.13 120.86 138.88 198.06 285.30

Current 84.73 81.4 100.84 83.4 120.23 86.6 176.06 88.9 251.94 88.3

NPL 19.40 18.6 20.03 16.6 18.65 13.4 22.00 11.1 33.36 11.7

Private National Banks 90.09 116.93 157.46 187.46 254.45

Current 85.26 94.6 111.22 95.1 149.42 94.9 180.66 96.4 243.33 95.6

NPL 4.82 5.4 5.72 4.9 8.04 5.1 6.80 3.6 11.12 4.4

Regional Development Banks 4.39 5.61 7.19 10.76 13.89

Current 3.52 80.1 4.71 83.8 6.22 86.5 9.59 89.1 12.60 90.8

NPL 0.88 19.9 0.91 16.2 0.97 13.5 1.17 10.9 1.28 9.2

Joint Venture Banks 10.91 14.44 15.99 29.17 55.67

Current 10.02 91.9 13.41 92.8 14.85 92.9 27.60 94.6 52.49 94.3

NPL 0.89 8.1 1.03 7.2 1.14 7.1 1.57 5.4 3.18 5.7

Foreign Banks 7.50 9.96 11.76 19.52 36.37

Current 7.32 97.5 9.76 98.0 11.44 97.2 18.88 96.7 34.37 94.5

NPL 0.19 2.5 0.20 2.0 0.32 2.8 0.64 3.3 2.00 5.5

All Rural Banks 1.56 1.88 2.14 2.21 2.21

Current 1.20 76.8 1.43 75.7 1.62 75.6 1.66 74.9 1.66 74.9

NPL 0.36 23.2 0.46 24.3 0.52 24.4 0.56 25.1 0.56 25.1


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Appendix 3

Table A3.2: Commercial Bank Performance Indicators, 1993–1998 (%)

( ) = negative values are enclosed in parentheses, FX = foreign exchange.a Latest data are for August 1997.Source: Bank Indonesia.

Performance Indicator 1993 1994 1995 1996 1997 Jan 1998

Return on AssetsAll Commercial Banks 1.04 0.62 1.13 1.22 1.37 2.01

State Banks 0.95 (0.30) 0.50 0.90 1.14 1.55Private FX Banks 1.17 1.47 1.41 1.51 1.02 1.56Private Non-FX Banks 0.20 0.80 0.39 0.36 1.15 1.27Regional Development Banks 1.87 1.60 2.23 2.40 1.80 2.52Joint Venture Banks 2.01 1.53 2.56 2.55 2.67 3.47Foreign Banks 0.96 3.23 4.62 4.40 5.71 9.08

Return on EquityAll Commercial Banks 2.95 16.14 16.38 19.06 28.04

State Banks (4.75) 10.78 15.18 21.80 30.71Private FX Banks 12.03 17.95 15.04 13.53 21.08Private Non-FX Banks 3.31 3.15 3.79 11.19 12.03Regional Development Banks 13.43 25.30 27.89 21.55 30.56Joint Venture Banks 5.98 20.17 20.19 20.73 30.11Foreign Banks 20.30 40.08 35.67 53.01 96.92

Efficiency (Cost/Income)All Commercial Banks 90 95 92 92 95 96

State Banks 92 104 96 93 94 96Private FX Banks 91 90 92 94 97 97Private Non-FX Banks 96 95 98 98 92 96Regional Development Banks 88 89 85 85 95 85Joint Venture Banks 85 81 80 84 82Foreign Banks 80 75 75 86 90

Capital Adequacy RatioAll Commercial Banks 9.90 12.50 11.85 11.82 9.19 6.93

State Banks 2.50 10.50 13.72 14.09 7.77 6.08Private FX Banks 9.40 13.10 9.87 9.38 9.60 7.18Private Non-FX Banks 9.40 15.50 10.48 11.83 17.55 17.84Regional Development Banks 12.10 11.40 12.64 13.74 11.45 13.00Joint Venture Banks 16.50 21.80 15.47 15.93 11.21 6.83Foreign Banksa 10.40 11.90 11.91 13.68 12.76 12.76

Loan Deposit RatioAll Commercial Banks 78.50 81.20 81.07 78.31 82.58 85.24

State Banks 81.70 80.20 79.64 75.63 83.38 79.27Private FX Banks 81.50 82.90 82.11 80.35 83.55 93.31Private Non-FX Banks 73.60 88.20 88.02 82.94 86.22 87.67Regional Development Banks 59.50 56.70 54.89 56.22 53.65 44.29Joint Venture Banks 81.80 81.80 89.85 86.81 107.73 115.79Foreign Banks 92.60 83.30 84.85 80.54 60.33 63.81


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Table A3.4: Performance of 200 Largest Banks, End-June 1997 (%)

CAR = capital adequacy ratio, LDR = loan-deposit ratio, NIM = net interest margin, ROA = return on assets, ROE = return on equity.Source: Infobank.

Type of Bank ROA ROE NIM CAR LDR

Top 200 1.15 10.02 2.55 14.63 97.71State Banks 0.69 6.84 1.51 10.23 95.02Private Banks 1.12 7.91 2.56 15.15 96.79Foreign Banks 2.05 50.6 2.98 7.74 116.35

Appendix 3

Table A3.3: Estimation of Recapitalization Cost of Commercial Banks,End-March 1998

( ) = negative values are enclosed in parentheses.CAR = capital adequacy ratio, LLP = loan-loss provision, NPL = nonperforming loan.a NPL provisions in accordance with latest BI regulations (see Appendix 1. B. 1c), current LLP around 3 percent.Sources: Bank Indonesia; Merill Lynch.

Item Amount (Rp trillion)

Industry Bank Loans 476.8

In Rupiah 286.9

In Dollar 189.9

Total Assets 737.6

Risk-weighted Assets (assumed 90% of total) 663.8

Industry Capital 44.2

Industry CAR (%) 6.7

NPL (assumed 65%) 309.9

Cash Collateral Coverage (assumed 15% of NPL) 46.5

Provisions for NPLa 132.5

Current LLP 9.5

Write-off to Capital 123.0

Net Capital Deficit (78.8)

Required Capital for 9% CAR 59.7

Total Cost of Recapitalization 138.5


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Appendix 3

Table A3.5: Commercial Bank Credit by Sector, 1990-1997 (Rp trillion)

( ) = negative values are enclosed in parentheses.Source: Bank Indonesia.

Sector 1990 1991 1992 1993 1994 1995 1996 1997

Total 96.98 112.83 122.92 150.27 188.88 234.61 292.92 378.13

Agriculture 7.18 8.47 10.28 12.06 13.86 15.53 17.63 26.00

(% of total) 7.4 7.5 8.4 8.0 7.3 6.6 6.0 6.9

(% change) 35.8 18.0 21.5 17.3 15.0 12.0 13.6 47.5

Rupiah 6.88 7.98 9.17 10.37 12.03 13.66 15.16 20.34

Foreign Currency 0.29 0.49 1.11 1.69 1.83 1.86 2.47 5.66

Manufacturing 30.50 33.13 37.29 51.43 60.21 72.09 78.85 111.68

(% of total) 31.5 29.4 30.3 34.2 31.9 30.7 26.9 29.5

(% change) 50.0 8.6 12.6 37.9 17.1 19.7 9.4 41.6

Rupiah 25.00 24.83 26.20 36.33 42.24 48.48 51.98 56.12


Mining 0.62 0.74 0.76 0.78 0.80 0.91 1.69 5.32

(% of total) 0.6 0.7 0.6 0.5 0.4 0.4 0.6 1.4

(% change) 4.1 19.4 2.6 2.6 2.6 13.4 85.7 214.8

Rupiah 0.57 0.61 0.61 0.42 0.36 0.43 0.72 2.77


Trade 29.74 33.05 32.94 37.79 44.37 54.22 70.59 82.26

(% of total) 30.7 29.3 26.8 25.2 23.5 23.1 24.1 21.8

(% change) 47.9 11.1 (0.3) 14.7 17.4 22.2 30.2 16.5

Rupiah 27.27 28.84 28.10 31.47 36.84 43.61 55.76 57.47


Services 17.21 20.07 25.87 35.82 50.81 66.58 91.66 113.57

(% of total) 17.7 17.8 21.0 23.8 26.9 28.4 31.3 30.0

(% change) 65.1 16.6 28.9 38.5 41.8 31.1 37.7 23.9

Rupiah 14.26 16.68 21.98 30.17 42.45 57.43 78.39 85.60


Others 11.74 17.37 15.77 12.39 18.83 25.28 32.51 39.30

(% of total) 12.1 15.4 12.8 8.2 10.0 10.8 11.1 10.4

(% change) 71.0 48.0 (9.2) (21.5) 52.0 34.2 28.6 20.9

Rupiah 11.17 16.33 14.84 12.37 18.82 25.27 32.48 39.23



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Appendix 3

Table A3.6: Commercial Bank Assets and Liabilities, 1991–1997a (Rp trillion)

( ) = negative values are enclosed in parentheses.FX = foreign exchange.a End of period for 1991–1996; as of October for 1997.Source: Bank Indonesia.

Item 1991 1992 1993 1994 1995 1996 1997

Assets 169.54 195.73 291.27 333.71 413.80 506.87 664.21State Banks 91.75 108.63 152.35 160.35 187.12 211.56 262.71

(% change) 18.4 40.2 5.3 16.7 13.1 24.2(% of total assets) 54.1 55.5 52.3 48.0 45.2 41.7 39.6

Private National Banks 60.03 65.83 108.02 136.73 179.50 240.20 322.18(% change) 9.7 64.1 26.6 31.3 33.8 34.1(% of total assets) 35.4 33.6 37.1 41.0 43.4 47.4 48.5

FX Banks 47.10 53.32 93.39 118.61 157.68 212.91 291.36Non-FX Banks 12.93 12.51 14.63 18.13 21.82 27.29 30.81

Regional Development Banks 4.83 5.50 6.94 8.74 11.19 13.10 15.40Joint Venture Banks 6.13 8.25 13.91 16.96 21.62 24.62 35.62Foreign Banks 6.80 7.53 10.05 10.93 14.37 17.40 28.31

Credit 121.39 130.89 177.47 217.02 267.81 331.29 439.98(% change) 7.8 35.6 22.3 23.4 23.7 32.8(% of total assets) 71.6 66.9 60.9 65.0 64.7 65.4 66.2

State Banks 67.85 77.61 94.14 104.13 120.86 138.88 175.15(% change) 14.4 21.3 10.6 16.1 14.9 26.1(% of total credit) 55.9 59.3 53.0 48.0 45.1 41.9 39.8

Private National Banks 42.20 40.95 65.02 90.09 116.93 157.46 212.92(% change) (3.0) 58.8 38.5 29.8 34.7 35.2(% of total credit) 34.8 31.3 36.6 41.5 43.7 47.5 48.4


Rupiah 103.52 108.76 133.13 167.22 205.01 252.04 300.60(% change) 5.1 22.4 25.6 22.6 22.9 19.3(% of total credit) 85.3 83.1 75.0 77.1 76.6 76.1 68.3

State Banks 60.35 67.50 71.96 82.43 95.14 109.69 125.70Foreign Currency 17.87 22.13 44.34 49.80 62.79 79.25 139.30

(% change) 23.9 100.4 12.3 26.1 26.2 75.8(% of total credit) 14.7 16.9 25.0 22.9 23.4 23.9 31.7

State Banks 7.49 10.10 22.18 21.70 25.72 29.20 49.45

LiabilitiesDeposits 95.12 111.43 160.60 187.61 235.50 303.21 373.61

(% change) 17.2 44.1 16.8 25.5 28.8 23.2(% of total liabilities) 56.1 56.9 55.1 56.2 56.9 59.8 56.2

State Banks 41.81 52.60 73.60 76.74 94.93 109.28 140.04(% change) 25.8 39.9 4.3 23.7 15.1 28.1(% of total deposits) 43.96 47.20 45.83 40.91 40.31 36.04 37.48

Private National Banks 43.14 47.67 73.54 93.67 119.18 167.62 197.28(% change) 10.5 54.3 27.4 27.2 40.6 17.7(% of total deposits) 45.36 42.78 45.79 49.93 50.61 55.28 52.80


Rupiah 74.10 86.70 114.09 134.81 170.72 225.67 241.02(% change) 17.0 31.6 18.2 26.6 32.2 6.8(% of total deposits) 77.90 77.80 71.04 71.86 72.49 74.43 64.51

Foreign Currency 21.02 24.74 46.52 52.80 64.78 77.53 132.53(% change) 17.7 88.1 13.5 22.7 19.7 70.9(% of total deposits) 22.10 22.20 28.96 28.14 27.51 25.57 35.47

69IN

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Table A3.8: Number of Commercial Bank Offices by Province, June 1997

Source: Bank Indonesia.

Type of Office Sumatra Java Kalimantan Sulawesi Others Total

Head Offices 9 202 4 5 9 229

Branch Offices 531 1,662 181 210 229 2,813

Subbranch Offices 290 2,483 65 119 168 3,125

Payment Point 226 991 40 29 94 1,380

Total 1,056 5,338 290 363 500 7,547

Appendix 3

Table A3.7: Number of Banks and Bank Offices, 1992–1997a

BRI = Bank Rakyat Indonesia, FX = foreign exchange.a End of period.Source: Bank Indonesia.

1992 1993 1994 1995 1996 1997

BRI BRI BRI BRI BRI BRINo. of No. of Unit No. of No. of Unit No. of No. of Unit No. of No. of Unit No. of No. of Unit No. of No. of Unit

Type of Bank Banks Offices Offices Banks Offices Offices Banks Offices Offices Banks Offices Offices Banks Offices Offices Banks Offices Offices

Commercial Banks 208 5,495 234 5,773 240 6,026 240 6,590 239 7,314 222 7,377

State Banks 7 1,434 3,195 7 1,455 3,267 7 1,490 3,267 7 1,635 3,512 7 1,707 3,595 7 1,762 3,647

Private FX Banks 40 2,258 50 2,699 60 2,918 75 3,335 77 3,865 76 4,015

Private Non-FX Banks 104 1,127 111 902 106 887 90 825 87 903 68 722

Regional Dev Banks 27 613 27 639 27 645 27 705 27 745 27 779

Joint Venture Banks 20 31 29 45 30 50 31 52 31 55 34 58

Foreign Banks 10 32 10 33 10 36 10 38 10 39 10 41

Rural Credit Banks 8,835 9,032 9,196 9,271 9,310 9,348

Rural Banks 1,512 1,709 1,873 1,948 1,987 2,116

Village Finance Entities 7,323 7,323 7,323 7,323 7,323 7,232


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Appendix 3

Table A3.9: NBFI Sector Profile, 1991–1997a

NBFI = nonbank financial institution.a End of period for 1991–1996; as of August for 1997.Source: Bank Indonesia.

Item 1991 1992 1993 1994 1995 1996 1997

Total Assets (Rp trillion) 8.4 19.1 29.7 42.5 58.3 77.1(% change) 127.6 55.6 42.8 37.2 32.4

Finance CompaniesNumber of Firms 136 150 176 206 254 252Total Business (Rp trillion) 5.8 6.2 9.1 16.8 25.9 26.6

Leasing 3.9 3.7 4.6 6.0 8.5 12.1Factoring 0.3 0.8 2.2 5.3 11.7 8.0Consumer Financing 1.6 1.5 2.2 4.5 5.4 6.4Credit Card 0.0 0.2 0.1 1.0 0.3 0.1

Financial Position (Rp trillion)Assets 8.4 10.1 11.9 19.1 23.9 33.6Equity 1.1 1.6 2.0 3.3 4.2 8.2Net Investment 5.2 7.8 9.2 14.8 18.7 26.7

Outward Borrowing (Rp trillion) 10.6 6.1 7.3 12.6 17.6 23.7Domestic 4.1 2.8 3.8 7.2 10.4 12.9Foreign 6.5 3.3 3.5 5.4 7.2 10.8

Venture Capital CompaniesNumber of Companies 20 33 43

Private National 7 10 12Joint Venture 7 7 11Local 6 16 20

Number of Investee Companies 47 154 527Private National 25 39 44Joint Venture 12 7 1Local 10 108 482

Business Activity (Rp billion) 49.6 117.8 41.9Private National 27.7 99.0 19.1Joint Venture 21.4 14.0 0.1Local 0.5 4.8 22.7

Insurance CompaniesNumber of Companies 145 145 150 160 163 171

Life 46 46 49 53 56 58State-owned 1 1 1 1 1 1Private National 39 38 40 37 38 38Joint Venture 6 7 8 15 17 19

Nonlife 90 90 92 98 98 103State-owned 2 2 2 3 3 3Private National 75 74 75 78 77 79Joint Venture 13 14 15 17 18 21

Reinsurance 4 4 4 4 4 5State-owned 2 2 2 1 1 2Private National 2 2 2 3 3 3

Social and Jamsostek 2 2 2 2 2 2Civil Service and Armed Forces 3 3 3 3 3 3

Assets (Rp trillion) 9.0 11.3 14.4 17.3 22.1 Life 1.2 2.4 4.0 4.9 7.3 Nonlife 2.2 2.6 3.1 4.3 5.0 Reinsurance 0.6 0.7 0.8 0.4 0.5 Social and Jamsostek 2.3 2.9 3.6 4.9 Civil Service and Armed Forces 3.3 3.6 4.0 4.4

Investments (Rp trillion) 7.2 8.8 10.7 13.4 18.0 Life 1.5 1.8 2.6 3.4 5.7 Nonlife 1.4 1.5 1.9 2.8 3.5 Reinsurance 0.4 0.5 0.5 0.3 0.3 Social and Jamsostek 2.0 2.6 3.4 4.6 Civil Service and Armed forces 3.0 3.1 3.7 4.0Pension Funds

Assets (Rp trillion) 6.6 8.9 17.0 21.4Employee Sponsored 6.5 8.8 10.6 13.0Financial Institution 0.0 0.1 0.2 0.3Civil Service 6.2 7.1Armed Forces 1.0


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CATEGORY A

Liquidity support needed in excess of 500 percent of totalequity and equal to or in excess of 75 percent of totalassets.

Action to be takenThe immediate freezing of the bank’s operations, transfer ofall liabilities to a healthy bank, suspension of shareholders’rights, and replacement of management. The IndonesianBank Restructuring Agency (IBRA) will function in place ofthe former shareholders with full control over the bank.

Banks suspended• Centris Bank• Deka Bank• Hokindo Bank• Bank Kredit Asia• Bank Pelita• Bank Subentra• Bank Surya

CATEGORY B

Liquidity support needed in excess of Rp2 trillion and inexcess of 500 percent of total equity.

Action to be takenThe immediate suspension of shareholders’ rights andreplacement of management. IBRA will function in place ofthe former shareholders, and a governance contract is tobe drawn up with a State-owned financial institution toprovide new management with full control over the bank.

Banks under managementa

• Bank Eksim• Bank Danamon Indonesia• Modern Bank• Bank Dagang Nasional Indonesia (BDNI)• Bank PDFCI• Bank Umum Nasional• Bank Tiara Asia

CATEGORY C

Liquidity support needed in excess of 500 percent of totalequity or in excess of 50 percent of total assets.

Action to be takenForeign exchange, derivatives, or other importanttransactions curtailed and strong supervision put in placethrough on-the-ground presence by IBRA officials.

Appendix 4

Banks Under the Indonesian Bank Restructuring Agency

CATEGORY D

Liquidity support in excess of 200 percent of total equity ora capital adequacy ratio of less than 5 percent.

Action to be takenIntensive supervision by IBRA staff.

Banks under supervision

3 State banks• Bank Bumi Daya (BBD)• Bank Pembangunan Indonesia (Bapindo)• Bank Dagang Negara (BDN)

11 regional development banks• BPD NTB• BPD Sumatera Utara• BPD Aceh• BPD Sumatera Selatan• BPD Lampung• BPD Kalimantan Barat• BPD Maluku• BPD Jawa Timur• BPD NTT• BPD Sulut• BPD Sulteng

26 private national banks• Bank Aken• Indomitra Development Bank• Bank Danahutama• Bank Baja Internasional• Bank Intan• Bank Putra Surya Perkasa• Bank Sewu• Bank Tabungan Pensiun Nasional• Bank Dewa Rutji• Bank Dagang dan Industri• Bank Tata• Bank Indonesia Raya• Bank Patriot• Bank Central Dagang• Bank Ficorinvest• Bank Lautan Berlian• Bank Uppindo• Bank Papan Sejahtera• Bank Asia Pacific• Bank Pesona Kriya Dana (Bank Utama)• Bank Nasional• Bank Nusa Internasional• Bank Sri Partha• Bank Umum Servitia• Bank Kharisma• Bank Nasional Komersial

a Banks in italics are expected to exit from IBRA management or supervision soon due to merger plans or additional capital injection, enabling them to meet capital adequacy andliquidity facility requirements. Of the State banks, BBD and Bapindo will merge, while Bank Eksim is set to receive additional capital through the Government equity scheme. Ofthe private national banks, Bank Kharisma, Bank Nasional Komersial, Bank Umum Servitia, and Bank Sri Partha have already met the capital adequacy ratio of over 5 percentand liquidity facility requirements, and were no longer under IBRA care as of 22 April 1998. Bank Nasional and Bank Nusa Internasional proposed to merge with Bank Angkasaand Bank Komersial, which will enable them to leave the IBRA soon.

Source: IBRA, Press Release, 4 April 1998.


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Appendix 5

Banking Policy Commitments Under the International Monetary Fund Program

Source: IMF: Second Supplementary Memorandum of Economics and Financial Policies of the Government of Indonesia, 24 June 1998.

Policy Action to be Implemented

1. Continue to take control of or freeze banks that fail to meet liquidity or solvency criteria(see Appendix 1.B.1). Where necessary, any such action will be accompanied bymeasures to protect depositors or creditors in line with the Government guarantee. Thisis the job of the Indonesian Bank Restructuring Agency (IBRA).

2. Reduce the minimum capital requirements for existing banks.3. Issue a presidential decree to provide appropriate legal powers to IBRA, including its

Asset Management Unit.4. Establish an independent review committee to enhance transparency and credibility of

IBRA operators.5. Amend the banking law in order to remove the limit on private ownership of banks.6. Merge and conduct portfolio reviews of two State banks.7. Draft legislation enabling State bank privatization.8. Submit to Parliament a draft law to eliminate restrictions on foreign investments in listed

banks and amend bank secrecy laws with regard to nonperforming loans.9. Update the reporting and monitoring procedures for foreign exchange exposure of

banks.10. Appoint high-level foreign advisers to Bank Indonesia (BI) to assist in the conduct of

monetary policy.11. Establish a Financial Sector Advisory Committee to advise on bank restructuring.12. Declare the insolvency of six private banks the Government intervened in April and write

down shareholder equity.13. Freeze, merge, recapitalize, or liquidate the six banks for which audits have already

been completed.14. Announce the restructuring of State banks through mergers, transfer of assets and

liabilities, or recapitalization before privatization.15. Issue Government bonds to Bank Negara Indonesia at market-related terms to finance

transfer of deposits of banks frozen in April.16. Conduct portfolio, systems, and financial review of all IBRA banks as well as major non-

IBRA banks by internationally recognized audit firms.17. Submit to Parliament a draft amendment of the banking law.18. Submit to Parliament a draft law to institutionalize BI’s autonomy.19. Conduct portfolio, systems, and financial review of all other banks by internationally

recognized audit firms.20. Introduce at least 20 percent private sector ownership in at least one State bank.21. Require banks to regularly publish more data on their operations.22. Prepare State banks for privatization.23. Impose limits on and phase out BI credits to public agencies and public sector

enterprises.24. Strengthen BI’s bank supervision department. Strengthen enforcement of regulations.25. Establish a program for divestiture of BI’s interest in private banks.26. Introduce a deposit insurance scheme.27. Eliminate all restrictions on bank lending except for prudential reasons or to support

cooperatives or small-scale enterprises.

Target Date

Over program period

19 June 199830 June 1998

30 June 1998

30 June 199830 June 199830 June 199830 June 1998

30 June 1998

30 June 1998

30 June 1998mid-July 1998

mid-July 1998

31 July 1998

31 July 1998

30 August 1998

31 August 199830 September 199831 October 1998

1 November 199831 December 19992001Ongoing

OngoingOngoingOver program periodOver program period

Recent Issues in the Management ofMacroeconomic Policies in Indonesia

Anwar Nasution

Anwar Nasution is Senior Deputy Governor, Bank Indonesia; Dean, Faculty of Economics;and Professor of Economics, University of Indonesia.


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Introduction

The currency and financial crisis in Thailand of

March-June 1997 spread rapidly to other Asian coun-

tries, including Indonesia. To defend its external re-

serve position, Bank Indonesia (BI), the central bank,

abandoned the exchange rate intervention band on

14 August 1997, and adopted a floating exchange

rate system. Since then, the exchange and interest

rates have been jumping wildly. The external value

of the rupiah has depreciated by over 80 percent

since July 1997, when it was trading at about Rp2,400

to the dollar. During the same period, the composite

stock price index at the Jakarta Stock Exchange

(JSX) plunged by more than 60 percent. A Pentasena

Securities analyst said that only 22 of 282 firms listed

on JSX were operating with sufficient cash flow by

end-1997. Bank deposit and loan interest rates have

soared to over 60 percent per annum. Meanwhile,

liquidity is very tight and depositors pay a stiff pen-

alty for withdrawing time deposits before their ma-

turity date.

A combination of factors caused the crisis:

• Excessive corporate short-term external borrow-

ings, which distorted product and financial mar-

ket structures, were not invested in ways that

would generate the export earnings necessary

for repayment.

• Financial sector reform was not accompanied

by strict implementation of rules and regula-

tions.

• A pervasive lack of confidence in the Govern-

ment, partly caused by the closure of 16 finan-

cially distressed banks in November 1997 and

by confusing Government policies, precipitated

a bank run, panic buying, and capital flight that

led to both internal and external liquidity crunch

and a sharp increase in velocity of money.

• Imports fell as foreign banks became reluctant

to roll over short-term debt and accept letters of

credit.

• The fear of further currency depreciation put

exchange and interest rates under even more

pressure.

• The Government’s decision to limit access to

foreign borrowings and to shift public sector de-

posits from (mainly State-owned) commercial

banks to the central bank squeezed liquidity.

• With banks suddenly illiquid, the risk of default

and bankruptcies also increased. BI adopted a

floating exchange rate system in mid-August

1997, suggesting that it had limited external re-

serves with which to defend the exchange rate.

The financial crisis occurred at an unfortunate

time. The long drought and massive forest fire in

1997-1998 seriously damaged the forestry and agri-

culture sectors. Crop production fell by 1.8 percent

and agricultural growth dropped to 0.6 percent in 1997.

At the same time, the country was devastated by the

fall in oil prices—to their lowest in 10 years—and

low demand for Indonesian exports (such as wood-

based products), which reduced foreign exchange

revenues. Meanwhile, economic difficulties and slow

growth have dried up capital inflows from Japan and

Korea.

Economic problems were compounded by politi-

cal uncertainty generated by the 1997 general elec-

tions and the March 1998 presidential election. An-

gered by rising prices and unemployment, mobs ri-

oted in a number of towns, forcing President Suharto,

who had ruled the country since 1966, to resign. But

political uncertainty remained, mainly because his

successor, Burhanuddin Jusuf Habibie, was a protégé

of Suharto, with no strong political base and a repu-

tation as a big spender.

The removal of President Suharto, however, ended

the uncertainty of economic policy. The present ad-

ministration is committed to implementing the Inter-

national Monetary Fund (IMF) program. This, along

with the depreciation of the dollar, raised the exter-

nal value of the rupiah from Rp11,550 in mid-Sep-

tember 1998 to Rp7,800 one month later. The stron-

3ISSUES IN THE MANAGEMENT OF MACROECONOMIC POLICIES IN INDONESIA

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ger rupiah helps reduce inflation and interest rates

and rehabilitate the banks and their customers.

The first part of this study reviews the economic

meltdown in Indonesia, its causes and impacts, and

the Government’s responses to it. The second ex-

amines precrisis macroeconomic developments. The

third discusses the banking crisis. The fourth deals

with policy responses to the capital inflows since the

early 1990s, analyzes the fiscal distress and stabili-

zation program, and forecasts the result of the re-

cent appreciation of the rupiah. Finally, the fifth sec-

tion presents the conclusion.

Macroeconomic PolicyThe currency crisis is the product of inconsistent fis-

cal and monetary policies in an exchange rate sys-

tem with an intervention band. The Government bud-

get deficit (hovering around 0.5-1 percent of gross

domestic product [GDP] in the five years before the

1997 crisis) was too small to check the rapid expan-

sion of private sector consumption and investment

expenditure. Lax implementation of banking rules and

regulations resulted in credit overexpansion. As will

be discussed later, some private sector expenditure

and bank credit were financed by short-term

unhedged external borrowings.

The exchange rate system has caused not only

real appreciation of the exchange rate, but also sub-

stantial bets when the intervention band was finally

abandoned on 14 August 1997. As the growing cur-

rent account deficit could not be financed by running

down external reserves, the Government had two

policy options to narrow or close the deficit: (i) cut

domestic absorption or (ii) depreciate the domestic

currency. The authorities opted to defend external

reserves by moving from the intervention band sys-

tem to a free float, which raised both interest and

exchange rates. As the banks had high bad-loan ra-

tios, the rising interest and exchange rate risks caused

many bankruptcies and hurt the financial system and

economic growth, especially since Indonesian com-

panies followed a high debt/equity financing strategy

and heavily relied on external debt.

Indonesia’s economic fundamentals began to

weaken and the international environment to change

in 1995. Massive capital inflows and the shift in their

composition toward short-term private sector capital

since the early 1990s caused bouts of domestic eco-

nomic overheating as rapid economic growth was

accompanied by rising inflation and interest rates and

current account deficits (Table 1). Low inflation, high

GDP growth, and high growth of nonoil exports, of-

ten quoted as the indicators of sound economic fun-

damentals, were largely artificial. The Government

subsidized State-vended products at great cost and

thereby kept the inflation rate below 10 percent per

annum in 1990-1996.

High GDP growth was mostly associated with the

“bubble” industries, including construction, public utili-

ties, and services in the nontraded sector of the

economy (Table 2). Moreover, most nonoil export

growth was in electronics, sport shoes, and textiles

and garments (Table 3), which utilized very little do-

mestic inputs and were associated with firms from

Japan; Korea; and Taipei,China—economies with

strong currencies. In contrast, domestically owned

firms that relied heavily on domestic inputs fared poorly.

Part of the problem was that palm oil and wood-based

exports were subject to quotas. Revenue from oil ex-

ports also declined as oil prices fell to as low as $12.14

per barrel in March 1998, their lowest in 10 years.

The IMF program signed on 24 June 1998, the

fourth since October 1997, predicted that economic

growth would fall by at least 10 percent in 1998 and

that the exchange rate would hover around Rp10,000

to the dollar by the end of the same year. The budget

deficit was forecasted to reach 8.5 percent of GDP

in FY1999. Despite a large subsidy (6 percent of

GDP) to control prices of State-vended products, the

inflation rate was expected to rise 80-100 percent in

1998. Rising unemployment and inflation brought the

number of people below the poverty line from 22.5


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million (11.3 percent of the total population) in 1996

to 79.4 million (39.1 percent) in 1998 (The Jakarta

Post, 3 July 1998). Poverty is more pronounced in

rural areas and on Java island, where the agriculture

sector relies heavily on rice and poultry. Rice fields

require plenty of water, and poultry need expensive

imported feeds. Over 45 percent of the rural popula-

tion, or 56.8 million people, live below the poverty

line. Of Indonesia’s more than 200 million people,

two thirds live on Java.

The current account balance is expected to im-

prove somewhat, but mainly because of reduced

imports (due to expenditure cut and rupiah deprecia-

tion) rather than increased exports. The agreements

reached in Frankfurt in June 1998, regarding private

sector external debt, and in Paris on 23 September

Table 1: Selected Key Economic Indicators, 1990–1999 ( % of GDP, unless otherwise indicated)

na = not available.( ) = negative values are enclosed in parentheses.a Up to second quarter of 1999.b Compared to second quarter of 1998.Sources: IMF, International Financial Statistics, various issues; World Bank, 1996; Bank Indonesia, Indonesian Financial Statistics, various issues; Central Board of Statistics, 1999.

Item 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999a

Internal StabilityReal GDP (% growth rate) 9.0 8.9 7.2 7.3 7.5 8.1 8.0 4.6 (13.6) (4.1)b

Consumption 63.7 63.9 62.0 67.5 65.1 69.1 70.3 70.4 78.3 naPrivate 53.9 54.0 52.2 58.5 56.5 61.0 62.7 63.1 70.9 na

Government 9.8 9.8 9.8 9.0 8.6 8.0 7.6 7.3 7.4 na

National Saving 27.5 26.9 26.9 27.0 28.4 28.0 29.3 28.0 na naPrivate 19.1 19.8 20.5 20.4 22.0 22.4 23.0 17.2 na na

Public 8.4 7.1 6.4 6.6 6.4 5.6 6.3 10.8 8.0 na

Investment 30.1 29.4 28.7 28.3 30.3 31.3 32.7 32.0 20.9 naPrivate 23.5 21.7 20.9 20.9 24.0 25.8 27.4 na na na

Public 6.6 7.7 7.8 7.4 6.3 5.5 5.3 na na na

Inflation (CPI, %) 9.5 9.5 4.9 9.8 9.2 8.6 6.5 11.6 77.6 2.7Fiscal Balance 0.4 0.4 (0.4) (0.6) 0.1 0.8 0.2 (0.2) na na

External StabilityCurrent Account Balance (2.8) (3.7) (2.2) (1.6) (1.7) (3.6) (3.7) (2.7) 0.1 9.9Real Effective Exchange Rate (1997=100) 95.1 93.2 90.8 85.6 82.5 80.1 78.0 100.0 315.8 114.6

Nominal Exchange Rate/CPI (1997=100) 111.3 107.7 104.2 97.7 93.2 88.6 85.5 100.0 238.1 343.4

Net Capital Inflows 4.9 5.0 3.8 1.7 2.0 4.0 5.4 (1.1) (45.8) (26.5)Of which:

Net Direct Investment 1.0 1.3 1.4 1.0 0.8 1.9 2.5 2.1 (0.7) (1.2)

Net Portfolio Investment (0.1) 0.0 (0.1) 1.1 2.2 2.0 2.2 (1.2) (14.4) (8.2)Other Capital 3.3 3.6 3.5 1.4 (0.9) 1.2 0.1 (0.2) (26.1) (17.2)

Net Error and Omissions 0.7 0.1 (1.0) (1.9) (0.1) (1.1) 0.6 (1.8) (4.6) 0.1

Net Resource Transfer/GDP (1997=100) (100.1) (86.1) (535.6) (749.0) (309.7) 396.3 198.5 100.0 190.3 naReserves (in months of imports) 4.7 4.8 5.0 5.2 5.0 4.4 5.1 4.4 7.3 na

Ratio of M2 to Reserves (%) 596.8 539.0 552.6 602.3 643.4 690.3 638.6 419.9 407.5 322.7

Total External Debt 65.9 68.4 69.0 56.7 55.5 54.8 49.3 101.4 127.1 naTotal External Debt (% of Exports of

Goods and Services) 222.0 236.9 221.8 211.9 197.4 197.4 188.7 255.0 232.2 na

Short-term Debt ($ billion) 11.1 14.3 18.1 18.8 21.1 27.6 35.0 37.0 41.0 naShort-term Debt (% of Total External Debt) 15.9 17.9 20.5 21.0 19.6 22.2 27.1 27.2 27.2 na

Debt-Service Ratio (% of Exports of

Goods and Services) 30.9 32.0 33.0 33.6 32.6 30.3 35.9 40.5 58.6 51.6Exports of Goods & Services 25.1 28.1 30.2 26.8 26.9 27.2 27.1 27.5 11.5 na

Exports of Goods ( % growth rate) 15.9 13.5 16.6 8.4 8.8 13.4 9.7 7.5 15.4 (18.8)b

Imports (1997 = 100) 112.0 123.4 131.7 134.6 136.9 165.0 175.4 100.0 24.9 na


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1998, to reschedule the public external debt, are an-

ticipated to ease the short-term pressure on external

debt repayment. A combination of the yen’s depre-

ciation against the dollar since 1995 and the still-weak

banking system in Japan slowed down Japanese di-

rect investment to Indonesia. Capital flows from

newly industrializing economies such as Korea also

dried up due to slow export growth and financial

strain. The rise in US interest rates and investment

returns further reduced capital inflows as they made

investment in emerging countries, including Indone-

sia, less attractive.

Exchange Rate MovementsThe exchange rate is the single most important rela-

tive price in the economy. In economies more open

than Indonesia, monetary transmission operates

through exchange rate effects on net exports and

interest rate effects on financial portfolio. The ex-

change rate policy in Indonesia, jointly with other

Table 2: Gross Domestic Product Share and Growth by Industrial Origin (%)

na = not available.( ) = negative values are enclosed in parentheses.a At 1983 constant market prices for 1985–1993, and 1993 constant market prices for 1994–1999.b Preliminary data; growth rates apply to January–June 1999 relative to the same period in 1998.c Includes nonfood crops, forestry and fishery, mining and quarrying, and manufacturing industries.d Covers farm food crops; livestock and products; electricity, gas and water supply; construction; and trade, hotel and restaurant.Source: Central Bureau of Statistics, Economic Indicators, various issues.

Share Rate of Growtha

Item 1985 1995 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999b

Gross Domestic Product 100.0100.0 7.2 7.0 6.5 6.5 7.6 8.1 8.0 4.6 (13.2) (4.1)

Gross Domestic Product (Nonpetroleum) 78.7 91.3 7.6 6.5 8.4 7.8 8.1 9.1 8.3 5.3 (14.3) (4.4)

1. Agriculture, Livestock, Forestry and Fishery 22.6 16.1 2.0 1.6 6.7 1.4 0.9 3.8 3.2 0.7 0.8 5.1

1.1. Farm Food Crops 14.0 8.6 0.5 (0.5) 7.7 (1.2) (2.1) 4.6 2.4 (2.7) 1.9 8.1

1.2. Nonfood Crops 3.6 2.6 4.9 5.4 4.8 5.8 5.1 4.7 4.2 1.2 2.8 6.9

1.3. Livestock and Products 2.4 1.8 3.7 6.0 7.9 5.6 4.0 4.2 6.1 4.9 (7.1) (0.4)

1.4. Forestry 1.0 1.6 3.0 0.0 (2.2) 1.7 0.5 0.0 1.3 8.0 (1.8) (4.5)

1.5. Fishery 1.6 1.6 5.0 5.2 5.8 5.7 8.8 1.9 4.6 5.8 4.1 2.0

2. Mining and Quarrying 18.2 9.3 5.2 10.2 (1.9) 2.2 5.6 6.7 5.8 1.7 (3.1) 0.1

2.1. Crude Petroleum and Natural Gas 17.1 6.2 4.2 9.3 (4.5) (0.3) 2.6 0.0 1.4 (0.6) (2.1) (4.5)

2.2. Other Mining and Quarrying 1.1 3.1 18.0 20.1 24.0 20.8 13.9 23.5 14.6 5.2 (4.7) 8.5

3. Manufacturing Industries 15.8 23.9 12.5 10.1 9.7 9.3 12.5 10.7 11.7 6.4 (11.9) (2.3)

3.1. Nonoil and Gas Manufacturing 11.5 21.3 13.0 10.9 11.0 11.6 13.5 13.0 11.7 7.4 (13.4) 8.2

3.2. Oil/Gas Industry 4.3 2.5 11.0 7.4 5.3 1.3 5.6 -5.4 11.1 (2.0) 1.6 (3.7)

4. Electricity, Gas and Water Supply 0.4 1.1 17.9 16.1 10.1 10.1 12.5 15.5 13.2 12.3 1.9 0.2

5. Construction 5.3 7.6 13.5 11.3 10.8 12.1 14.9 12.9 12.8 6.4 (40.5) (7.2)

6. Trade, Hotel and Restaurant 14.6 16.7 7.1 5.4 7.3 8.8 7.6 7.7 8.2 5.8 (18.0) (13.3)

6.1. Wholesale and Retail Trade 12.2 13.4 6.8 5.1 7.4 9.0 6.8 7.7 8.2 5.9 (18.5) (15.2)

6.2. Hotels and Restaurants 2.3 3.3 8.7 7.0 7.2 7.7 11.1 7.9 8.2 3.8 (16.3) (5.8)

7. Transportation and Communication 5.3 7.2 9.6 7.9 10.0 9.9 8.3 9.4 7.8 8.3 (15.1) (10.3)

7.1. Transportation 4.7 6.0 8.6 7.3 10.0 8.9 6.5 7.3 6.4 6.4 (19.9) (15.4)

7.2. Communication 0.5 1.2 16.9 12.3 10.0 16.4 20.4 21.1 14.5 17.4 4.8 7.5

8. Financial, Ownership and Business 6.4 9.0 10.1 9.7 9.8 10.3 10.2 11.2 8.8 6.5 (26.6) (16.5)

8.1. Banking and Other Financial Intermediaries 3.5 4.7 14.1 13.1 13.0 13.0 13.8 13.9 9.6 5.3 (34.0) (22.2)

8.2. Building Rental 2.9 2.8 4.2 4.0 4.2 5.0 4.0 5.5 5.8 5.0 (19.9) (11.9)

8.3. Business Services na 1.4 na na na na 12.0 14.2 12.1 8.5 (16.7) (10.8)

9. Services 11.3 9.2 4.7 3.7 4.3 4.3 2.8 3.3 3.4 2.8 (3.2) 3.1

9.1. Public Administration and Defense 7.6 6.0 4.6 3.1 3.0 2.0 1.3 1.3 1.3 1.2 (7.3) 1.9

9.2. Private Services 3.7 3.2 5.0 5.2 7.3 8.9 5.8 7.2 7.4 5.7 3.7 4.9

Traded Sectorc 40.2 38.9 8.5 9.3 4.5 6.2 9.5 8.5 9.1 5.2 (8.4) (1.2)

Nontraded Sectord 59.8 61.1 6.4 5.3 7.8 6.7 6.5 7.9 7.3 4.5 (16.6) (6.0)


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policies, was traditionally used to remove distortions

in the domestic economy and to help safeguard in-

ternational competitiveness.1 Until recently, the au-

thorities avoided the use of prolonged nominal and

real exchange rate overvaluation as a principal in-

strument for generating fiscal revenues and curbing

domestic inflation and interest rates.

To offset the “Dutch disease” effect of the oil

boom, the authorities (i) devalued the rupiah by 50

percent against the dollar in November 1978, (ii) re-

placed the dollar as external anchor with an undis-

closed basket of major currencies, and (iii) adopted

a managed floating exchange rate system. The

weight of the dollar in the currency basket, however,

remained substantial. The rupiah was further deval-

ued by 40 percent in June 1983 and by 31 percent in

September 1986. Normally, the authorities targeted

nominal depreciation of the rupiah against the dollar

Table 3: Exports by Commodity Group

( ) = negative values are enclosed in parentheses.a As of the first quarter of 1999; growth rates pertain to the first quarter of 1999 relative to the same period in 1998.b Includes processed wood, paper, and paper products.Source: Central Bureau of Statistics, Economic Indicators, various issues.

Commodity Group 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999a

Value ($ billion)

Agriculture 2.08 2.28 2.21 2.64 2.82 2.89 2.91 3.13 3.65 0.66

Industrial Products 11.88 15.07 19.61 22.94 25.70 29.33 32.12 34.99 34.59 6.95

Of which:

Forestry-based Productsb

3.48 3.87 4.53 6.01 5.86 6.00 6.09 6.24 5.85 1.25

Garments and Textile 2.93 4.08 6.06 6.18 5.80 6.20 6.55 5.27 6.53 1.37

Electronics 0.29 0.67 1.10 1.64 0.72 0.92 1.41 1.37 1.49 0.33

Mining and Mineral Products 0.64 0.89 1.45 1.46 1.80 2.69 3.02 3.11 2.70 0.67

Other Sectors 0.01 0.01 0.02 0.03 0.04 0.05 0.04 0.60 0.02 0.05

Total Nonoil Exports 14.60 18.25 23.30 27.08 30.36 34.95 38.09 41.82 40.96 8.33

Oil and Gas Exports 11.07 10.89 10.67 9.75 9.69 10.46 11.72 11.62 7.87 1.87

Total Exports 25.68 29.14 33.97 36.82 40.05 45.42 49.81 53.44 48.85 10.17

% of total exports

Agriculture 8.1 7.8 6.5 7.2 7.0 6.4 5.8 5.9 7.5 6.5

Industrial Products 46.3 51.7 57.7 62.3 64.2 64.6 64.5 65.5 70.8 68.3


13.6 13.3 13.3 16.3 14.6 13.2 12.2 11.7 12.0 12.3

Garments and Textile 11.4 14.0 17.8 16.8 14.5 13.7 13.2 9.9 13.4 13.5

Electronics 1.1 2.3 3.2 4.4 1.8 2.0 2.8 2.6 3.1 3.3

Mining and Mineral Products 2.5 3.1 4.3 4.0 4.5 5.9 6.1 5.8 5.5 6.6

Other Sectors 0.0 0.0 0.1 0.1 0.1 0.1 0.1 1.1 0.0 0.5

Total Nonoil Exports 56.9 62.6 68.6 73.5 75.8 77.0 76.5 78.3 83.8 81.9

Oil and Gas Exports 43.1 37.4 31.4 26.5 24.2 23.0 23.5 21.7 16.1 18.4

Total Exports 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Annual growth (%)

Agriculture 7.2 9.5 (3.1) 19.5 6.6 2.5 0.8 7.5 16.6 (17.8)

Industrial Products 7.7 26.8 30.2 17.0 12.0 14.1 9.5 8.9 (1.1) (21.1)


7.9 11.1 17.0 32.7 (2.4) 2.4 1.4 2.5 (6.3) 0.5

Garments and Textile 46.3 39.1 48.7 2.0 (6.2) 7.0 5.6 (19.6) 24.0 (12.6)

Electronics 50.5 133.9 64.0 49.2 (56.2) 28.5 53.0 (2.9) 8.8 0.8

Mining and Mineral Products 26.4 39.8 63.4 0.8 23.0 49.5 12.2 2.9 (13.2) 9.4

Other Sectors 10.3 35.9 108.0 38.1 54.4 19.2 (22.6) 1,574.4 (96.7) (32.4)

Total Nonoil Exports 8.3 24.9 27.7 16.2 12.1 15.1 9.0 9.8 (2.1) (19.0)

Oil and Gas Exports 27.5 (1.6) (2.1) (8.7) (0.5) 8.0 12.0 (0.8) (32.3) (17.8)

Total Exports 15.9 13.5 16.6 8.4 8.8 13.4 9.7 7.3 (8.6) (18.8)


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at 3-5 percent per annum. BI intervenes in the for-

eign exchange market by buying and selling the ru-

piah in an “intervention band” around the central rate.

Provided that the system is supported by other poli-

cies, the policy to stabilize the real exchange rate

helps avoid major macroeconomic crises even in an

inhospitable world economic environment.

Before shifting to the present flexible exchange

rate regime, BI had tried to defend the rupiah from

speculative attacks by widening the intervention band

in July 1997 (Figure 1), selling foreign exchange both

in forward and spot markets, and sterilization. In

theory, such exchange rate flexibility introduces un-

certainty that may well discourage part of the purely

speculative capital flows and allows the monetary

authorities a high degree of freedom to exercise control

over monetary aggregates. To support these policies,

the authorities also introduced a wide array of tight

monetary policies along with administrative measures

to limit external borrowings of commercial banks and

discourage short-term capital inflows, while maintain-

ing open access to the economy for long-term capital,

particularly foreign direct investment (Appendix). As

the authorities allow a temporary slight appreciation

of the rupiah, the policy should also reduce the need to

sterilize the surge in capital inflows.

BI finally had to abandon the moving band system

it adopted in 1992 in order to defend its foreign ex-

change reserve position, partly because the authori-

ties gave no clear signal that would restore public

confidence, prevent capital flight, and restore access

to the international money market. Until recently, the

Government had no clear program to solve the pri-

vate and public sectors’ external debt and banking

crises and no measures to promote growth by im-

proving economic efficiency and boosting nonoil ex-

ports.

The floating exchange rate system is the most flex-

ible and realistic for a big country such as Indonesia,

whose nontraded sector accounts for a large part of

its economy. The main objection to the currency board

system proposed to President Suharto by a US econo-

mist was that the only responsibility of the monetary

authorities would be to peg the external value of the

rupiah to an international currency, thus constraining

monetary policy to operate according to the gold stan-

dard. Money supply would contract in response to a

deficit in the balance of payments, which is caused

by a reduction in external reserves due to the fall in

oil exports, rising capital flight, and the increasing

burden of external debt repayments. It would also

require an adjustment program to suppress domestic

expenditures and to encourage nonoil exports. The

price of traded goods would have to increase rela-

tive to nontraded goods. These policies would have

traumatic and painful consequences in terms of both

unemployment and lost output. The alternative mea-

sure would be a combination of a devaluation of the

pegged exchange rate and a fall in domestic prices

brought about by a domestic recession.

In a floating exchange rate system, the domestic

currency’s depreciation can be used to adjust infla-

tion and interest rates. Inflation has been kept down

partly by Government’s policy to (i) run a “budget

surplus” or narrow down the budget deficit, (ii) sub-

sidize prices of State-vended products,2 and (iii) pur-

sue more vigorous trade liberalization. Trade policy

reform and productivity gains generated by the

economy-wide reform help relax the supply constraint

and check inflationary pressures. To control interest

Figure 1: Rupiah Exchange Rate and its InterventionBands, November 1995–August 1997

Sources: Bank Indonesia, Indonesian Financial Statistics, various issues; Universityof British Columbia Data Base.

Rp/$


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rates, the authorities had until recently adopted a

complex system of credit ceilings and directly con-

trolled allocation of banks’ credit as well as deposit

and lending rates. The selective credit policy helps

support the authorities’ allocation of resources, in-

cluding to projects favored by the remaining import-

substitution industrialization policy and the executing

firms.

Figure 2 shows a steady appreciation of the ef-

fective exchange rate of the rupiah in 1990-1996,

indicating a slight change in the Government’s ex-

change rate policy. The rupiah’s appreciation is also

due to the rising value of its main external anchor,

the US dollar, vis-a-vis the yen. This helped reduce

inflation and interest rates in 1996. In general, how-

ever, currency appreciation (i) erodes external com-

petitiveness; (ii) distorts saving and investment deci-

sions; and (iii) squanders scarce savings on unpro-

ductive projects, impeding the efficiency of the

economy at the micro level. The decline in inflation,

on the other hand, helps stabilize the rupiah.

Widening Current Account DeficitMaintained at below 2 percent of annual GDP in

1993 and 1994, the current account deficit rose to

3.6 percent in 1995 and 3.7 percent in 1996. Its dete-

rioration reflected not only higher investment, but also

an increase in overall investment from 30.1 to 32.7

percent of GDP in 1990-1996 (Table 1). One culprit

was the banking system, which converted part of

the increased liquidity into loans to finance invest-

ment, including those in the land-based industry (ho-

tel and tourist resorts, amusement and industrial parks,

real estate, commercial buildings, and shopping malls),

excessive infrastructure, and other nontradables.

Most of the private debt was directly borrowed from

foreign lenders and only a small fraction intermedi-

ated through the banking system.

Part of the capital inflows was probably used to

finance consumption expenditures, as shown by a

slight decline in the savings rate in the national ac-

count data. The number of credit cards issued and

volume of transactions using them also increased

rapidly. In FY1997, 1.6 million credit cards were in

use, having grown by nearly 30 percent, compared

to 28 percent in the previous year. In the same year,

the value of transactions using credit cards amounted

to Rp4.7 trillion, an increase of over 35 percent, com-

pared to 22 percent in 1996. Seventeen banks and

84 finance companies (with 40,000 merchant outlets

throughout the country) were licensed to conduct

credit card business.

Before the crisis, the authorities adopted two sound

fiscal measures to reduce the burden of external debt

repayment:

• Using the proceeds from privatization of State-

owned enterprises to retire expensive external

debt, which carries interest rates exceeding 10

percent per annum. Since FY1995, the Govern-

ment has repaid $1.5 billion, reducing the amount

of outstanding public debt by 2 percent.

• Introducing an expenditure-reducing policy, par-

ticularly measures to restrain public investment

demand and consumption.

Traditionally, cutting public expenditures is meant

to protect activities likely to produce high rates of

return and crucial for long-term growth, such as

investment in essential economic infrastructure

projects and in human resource development. As

public expenditures are to be spent mainly on such

nontraded goods, the structure of the public budget

cut also helps avoid an appreciation of the real ex-

change rate (Reisen 1996). The authorities, how-

Figure 2: Real Effective Exchange Rate Index,January 1990–May 1998 (1990 = 100)

Source: JP Morgan, Emerging Markets Data Watch, various issues.


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ever, protected investment in “strategic” industries,

the national car program, and excessive infrastruc-

ture projects, all of which require scarce foreign

exchange, skilled manpower, and protection from

imports.

The Government has also suffered a budget defi-

cit. However, a combination of greater tax effort,

tightening of fiscal policy, and improvement in the

operations of State-owned enterprises has reduced

the deficit and increased public sector savings. While

formally maintaining the “balanced budget principle,”

the Government has been running an annual budget

surplus of 0.2-0.8 percent of GDP since FY1994.3

Evidence suggests that the Ricardian equivalence

issue—which points to the possibility that the in-

crease in public savings will be offset by a decline

in private savings—has been relatively limited in

the Association of Southeast Asian Nations

(ASEAN) region, including Indonesia (Faruqee and

Husain 1995). The increase in public savings im-

mediately raised national savings, and thus helped

reduce inflation and interest rates and the current

deficit. Lower differential between domestic and

foreign interest rates slowed down capital inflow.

As a result, the widening of the tax base, removal

of egregious marginal tax rates, and significant im-

provements in the efficiency of tax administration

and operations of public companies have greatly

contributed to enhancing fiscal flexibility, stabilizing

domestic aggregate demand, and improving exter-

nal competitiveness.

The budget “surplus,” (actually, the excess of bor-

rowing fund), however, was inadequate to counter

the rapid expansion of off-budget expenditures and

Government-sponsored projects. There is no infor-

mation on the off-budget expenditures, but the list of

projects financed by it—including the aircraft and

national car industries4—rapidly expanded. Capital

inflows into this highly protected sector generated

welfare losses because, aside from producing nega-

tive value-added at international prices, they also re-

moved resources in the form of repatriated profits.

Fiscal position became more difficult because of the

revenue losses stemming from the introduction of

tax incentives for the national car program and other

pioneer projects owned by politically well-connected

business groups. Tax base was further eroded with

the grant of tax-deductible status for individual con-

tributions to poverty alleviation initiatives, such as

Takesra, headed by the former President.

Stock of External DebtMainly because of the surge in private sector direct

borrowings, Indonesia’s external debt shot up from

$66.9 billion in 1990 to $138 billion in March 1998

(Table 4), a level alarming by world standards. The

World Bank considers a debt/gross-national-product

(GNP) ratio of more than 80 percent as high risk and

a total debt-service/export ratio of 18 percent as the

“warning” threshold. The country’s external debt in

March 1998 was around 215 percent of export value

and about 160 percent of annual GDP. The debt ser-

vice ratio ranged from 30 to 34 percent and the in-

terest payment alone amounted to 12 percent of to-

tal exports in 1990-1996.

Table 4: External Debt by Debtor, as of March 1998($ billion)

Debtor Amount

Public Sector 65.56

Government 54.39

State-owned Enterprises 11.18

State Banks 5.61

Corporations 5.57

Private Sector 72.46

Private Banks 8.00

Nonbank Corporations 64.46

Total External Debt 138.02

Memo Items

Debt owed by:

Corporationsa 69.91

Bank Credit 64.48

Domestic Securities 5.43

Banks 13.61

Interbank Linesb 12.83

Domestic Securities 0.78

a Includes State enterprises’ debt.b Includes trade credits of about $4 billion.Source: Bank Indonesia.


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About 52 percent of the external debt in March

1998 ($72.5 billion) was owed by the private sector

and nearly 90 percent of it was received by non-

bank corporate entities. The average maturity of

the external debt is approximately 1.5 years (J.P.

Morgan, Global Data Watch, 16 January 1998:70).

In addition, short-term external debt denominated

in local currency amounted to $15 billion. Since the

late 1960s, the external borrowing strategy of the

public sector has been to maximize the inflow of

concessionary development aid from its nonsocialist

Western and Asian creditors. The “oil boom” of

the 1970s did not change this strategy. Together

with the resulting rise in real income, the oil boom

only shifted the country’s position to a less conces-

sional aid package. When it encountered rising debt

repayments following the currency realignment in

1986-1996, Indonesia turned to its creditors, par-

ticularly the Japanese.

Inflation RatesFigure 3 depicts the rapid increase in inflation rates

since the beginning of the economic crisis in August

1997, due to a combination of five factors:

• accelerated growth of money supply, which was

partly used to finance the budget deficit;

• erosion of public confidence in the Government’s

economic management and fear of banking in-

solvency that encouraged advance purchases of

consumer goods;

• depreciation of the rupiah, which raised prices

of imported goods;

• shortage of merchandise supply, including food,

because of import reduction and harvest failure;

and

• adjustment of prices of State-vended products.5

The efficiency and productivity gains from the

structural reforms have not been powerful enough

to check upward inflationary pressures. Loss of public

confidence in Government economic policy raised

velocity of money, as shown by the bank run, panic

buying, and flight of currency.

The role of money supply growth and confidence

can be distinguished from the long-run equation of

the quantity theory:

MV = PY (1)

where: M = stock of money supply,

V = income velocity of money,

P = general price level, and

Y = the level of real output.

By simple mathematical manipulation, identity (1)

can be rewritten in the following form:

DP/P = DM/M + DV/V - DY/Y (2)

Equation (2) indicates that inflation increases un-

der the following conditions: (i) rapid growth of money

supply (DM/M), (ii) rapidly rising income velocity of

money (DV/V), and (iii) low growth of real GDP

(DY/Y). When inflation is high, monetary factors

(M and V) are the most important in determining the

course of a stabilization program. The rate of growth

of real output affects fiscal deficit more than the

demand for money.

The Banking CrisisIndicators of banking system fragility are presented

in Table 5. In terms of total assets and bureaucracy,

the system is the core of the financial sector in Indo-

nesia (Nasution 1996). It has been the main source

of external financing for the corporate sector, which

traditionally adopts a financing strategy with high

debt/equity ratio. As a result, banking troubles have

precipitated a collapse in trade and production and

Figure 3: Monthly Inflation Rate, January 1996–August 1998 (percentage change ofCPI over previous month)

Source: Central Bureau of Statistics, various issues.

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A-2

0

2

4

6

8

10

12

14

1996 1997 1998

Percent

11IS

SU

ES

IN TH

E M

AN

AG

EM

EN

T OF M

AC

RO

EC

ON

OM

IC P

OLIC

IES

IN IN

DO

NE

SIA

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Table 5: Banking Sector Indicators, 1985–1999

GDPGR = GDP Growth Rate, IPGR = Industrial Production Growth Rate, LGR = Loan Growth Rate, NFL = Net Foreign Liabilities, TBL = Total Bank Liabilities.na = not available, ( ) = negative values are enclosed in parentheses.a Data as of June 1999.b Including 12 banks taken over by Indonesian Bank Restructuring Agency (IBRA) as of June 1999.c Ratio of M2 to Reserve Money.dAs percentage of total loan outstanding of commercial banks. Nonperforming loan data tend to be underestimated. The decline of nonperforming loans to 8.8 percent of total credit in 1996 was mainly due to the write-off of bad loans at State commercial

banks and private ‘nonforeign exchange’ banks. As of end-March 1998, bank nonperforming loans reached over 70 percent of total loans for several banks.Sources: IMF, International Financial Statistics, various issues; Bank Indonesia, Annual Report, various issues.

Item 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999a

Number of Banks 114 110 109 108 145 171 192 208 234 240 240 239 222 222 167

Private Banks 69 65 64 63 88 109 129 144 161 166 165 164 144 130 80

State-owned Banksb 5 5 5 5 5 7 7 7 7 7 7 7 7 7 19

Foreign Banks and Joint Venture Banks 11 11 11 11 23 28 29 30 39 40 41 41 44 58 41

Regional Development Banks 29 29 29 29 29 27 27 27 27 27 27 27 27 27 27

Loan to Deposit Ratio (%) 102.9 96.3 101.9 105.7 112.6 118.2 130.7 129.3 132.4 134.9 137.7 131.0 123.7 129.2 80.7

LGR Minus GDPGR (%) 14.7 19.8 8.8 23.1 31.2 48.1 (9.9) 7.7 6.9 5.7 4.0 4.7 12.1 45.5 (42.6)

LGR Minus IPGR (%) 29.0 20.8 35.9 34.4 44.2 61.4 9.0 25.9 22.4 16.0 23.1 22.5 16.2 45.1 na

NFL to TBL Ratio(%) (20.0) (23.6) (18.2) (14.1) (10.6) 0.9 0.7 2.2 4.9 5.8 3.8 2.8 5.2 2.6 6.4

M2 Multiplierc 3.4 3.4 3.8 5.0 5.4 6.7 7.7 7.0 7.8 7.4 8.0 7.5 7.6 7.7 8.2

M2/Forex Reserves (%) 414.2 415.4 367.5 481.5 597.2 596.8 539.0 552.6 602.3 643.4 690.3 638.6 419.9 407.5 549.1

Nonperforming loans (%)d na na na na na na 9.2 na 14.2 12.1 10.4 8.8 14.0 63.3 63.8

Of which: Bad Debt na na na na na na 1.7 na 3.3 4.0 3.3 2.9 2.3 23.4 28.5

Cash-assets/Deposit Ratio (%) 15.9 13.3 12.4 14.5 11.1 6.5 13.7 3.2 2.6 2.5 2.6 4.7 5.8 8.2 7.5

Loans/Assets Ratio (%) na 53.3 58.2 61.5 65.4 73.4 76.2 73.7 75.4 80.3 79.2 77.0 71.9 70.9 66.7


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aggravated an already-unfolding recession as trad-

ers and producers find their credit lines cut.

Meanwhile, faltering economic activity, sudden

depreciation of the rupiah, high interest rates, and

the bank run have dealt a devastating blow to the

financial system. Banks became illiquid as clients

withdrew their deposits and BI supported the rupiah

by cutting back base money supply. Banks’ equity

has been sharply eroded because of the sudden de-

valuation of the rupiah and high inflation rates.

Surges in Capital Inflows andLendingThe banking reforms which started in October 1988

have “overstretched” the banking system, as shown

by the rising loan-deposit ratio (LDR) and excessive

credit expansion. Following the reforms, LDR of the

banking sector rapidly rose from 106 percent in 1988

to 129 percent in 1992 and peaked at 138 percent in

1995 (Table 5), much higher than the maximum al-

lowable 110 percent. On the average, credit outstand-

ing of commercial banks increased by over 24 per-

cent per annum in 1992-1997, or three times the av-

erage annual growth rate of GDP. The average an-

nual growth rate of bank loans was also much higher

than that of the manufacturing industry, the most

dynamic sector of the economy.

Rapid credit expansion was induced by a combi-

nation of factors: (i) lifting of restrictions on bank

lending and regulations on asset portfolios, (ii) low-

ering of reserve requirements, (iii) market opening,

(iv) privatization, and (v) greater access to offshore

markets. The presence of new entrants in a more

competitive market environment may well increase

the pressure on banks to engage in riskier activities.

Yet bank credit officers reared in an earlier, more

controlled environment may not have the expertise

needed to evaluate new sources of credit and mar-

ket risk. When the economy is booming, it is difficult

to distinguish between good and bad credit risks be-

cause most borrowers look profitable and liquid. When

restrictions on bank lending were lifted, banks im-

mediately extended more credit to land-based indus-

tries and excessive infrastructure projects. Part of

the credit expansion was financed by foreign bor-

rowings, while the surge in private capital inflows

drove up equity prices.

The financial sector reforms relaxed requirements

for domestic banks’ foreign exchange transactions

and for opening branch offices overseas. They also

allowed greater penetration of the domestic economy

by foreign banks and larger ownership of domestic

assets by foreign investors. Moreover, the new rules

and regulations replaced the administrative ceilings

on offshore borrowings of commercial banks with a

more rational system of net open position. Along with

privatization, the authorities abolished the limits for

inflow of foreign direct investment and foreign own-

ership of equities issued in domestic stock markets.

Since 1971, Indonesia has adopted a relatively open

capital account and managed a unitary exchange

rate.6 Under this system, export proceeds, taxes, or

subsidies on the purchase or sale of foreign exchange

need not be surrendered. Indonesian citizens and

foreign residents are free to open accounts either in

rupiah or in foreign currencies at banks that are au-

thorized to extend credit in foreign currency.

To encourage foreign investment, BI made a spe-

cial exchange rate available to domestic borrowers

by providing an explicit subsidy on the exchange

rate through the exchange rate swap facility from

January 1979 to December 1991. It provided for-

ward cover to foreign exchange borrowing contract

swaps to banks and nonbank financial institutions

(NBFIs), and to customers with foreign currency

liabilities. The subsidy was a result of the time lag

in either an upward adjustment of the swap pre-

mium or a nominal depreciation of the rupiah, or a

combination of both.

Foreign investors’ herd behavior also increased

capital inflows and outflows. They bought stocks, com-

mercial paper, and even real estate, and invested in

excessive infrastructure projects. The reforms, which

cover nearly all aspects of the economy, combined


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deposits. A number of indicators point to a rising

percentage of debt instruments denominated in for-

eign currency, particularly the dollar, including the

higher ratios of (i) broad money (M2) to GDP, (ii)

dollar deposits as percentage of M2, (iii) dollar credit

as a percentage of total credit, and (iv) excess li-

quidity of commercial banks held in dollars (Table

6). As emphasized by Calvo (1994) and Mishkin

(1997), these make it more difficult to manage both

the banks’ portfolio and the macroeconomy. An ex-

pansionary policy, for example, is likely to devalue

the rupiah and raise the inflation rate.

When domestic interest rates are high, banks are

strongly tempted to denominate debt in foreign cur-

rency. Bank devisas (those licensed to deal in for-

eign exchange transactions) turn to short-term, for-

eign-currency-denominated borrowing in the inter-

bank market to fund longer-term bank loans. The

ratio of external liabilities of the commercial banks

to their assets rose from 9.5 percent in 1993 to over

18 percent in March 1998. The ratio of net external

liabilities to total liabilities also grew fast from -14.1

percent in 1988 to 0.9 percent in 1990, 4.9 percent in

1993, and 5.2 percent in 1997. External borrowings

of the financial sector increased from $6 billion in

1993 to $12.1 billion in 1995, but fell to $11 billion in

1996 and $10.1 billion in mid-1997 (J.P. Morgan

1997:3 and 1998:70).

with the perception of Indonesia as a stable country

and one of Asia’s success stories,7 attracted massive

capital inflow to Indonesia beginning in the early 1990s.

Demand for securities issued by both State-owned

and private companies increased as foreigners were

allowed to own up to 49 percent of the listed shares of

national companies (except banks). National compa-

nies were also permitted to raise funds by selling se-

curities in domestic and international stock and bond

markets. Capital inflows were encouraged further as

domestic interest rates (adjusted for relatively limited

actual exchange rate movements) rose and were sus-

tained through the 1990s. Peregrine, an investment

bank based in Hong Kong, China, collapsed in early

January 1998 due to a single massive bad loan ($265

million) to PT Steady Safe, a local taxi company in

Jakarta. Steady Safe used $145 million to buy 14 per-

cent of a toll road building company owned by Siti

Hardiyati Rukmana (Tutut), former President Suharto’s

eldest daughter, who was then named to Steady Safe’s

board (Spaeth 1998).

Increasing Bank Liabilities withLarge Maturity/Currency MismatchesA combination of liberal capital account, financial

sector reforms, and advances in technology and in-

formation processing has made it easier for Indone-

sian banks to alter the currency composition of their

Table 6: Selected Indicators on Dollar-denominated Instruments

Ratio of Credit Ratio of Excess Liquidityin Dollar to Dollar Deposits in Dollar to Total Liquidity

M2/GDP (%) Total Credit (%) to M2 Ratio (%) of Commercial Banks (%)

1990 43.0 12.2 20.6 9.1

1991 43.6 15.6 21.2 7.4

1992 46.4 17.9 20.8 12.0

1993 44.0 19.4 21.7 12.8

1994 45.7 19.1 21.7 8.3

1995 49.0 19.5 19.8 5.7

1996 54.2 19.9 19.5 4.0

1997 56.9 30.8 31.1 6.1

1998 58.3 35.8 24.8 21.1

1999 na 34.2 21.3 11.5

na = not available.Source: Bank Indonesia, Indonesian Financial Statistics, various issues.


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Partly because of the historically predictable and

low rate of the rupiah depreciation, a large portion

of the external debt is unhedged. This not only makes

banks and their customers more vulnerable, but also

makes it harder to deal with banking crisis, rise in

interest rates, and sharp devaluation of the rupiah.

The rupiah’s depreciation caused banks’ and firms’

balance sheets to deteriorate because much of their

debt is denominated in foreign currencies. It rap-

idly raised the cost of renewing or rolling over the

short-term floating rate dollar or yen loans in real

terms. As Indonesian banks’ and firms’ indebted-

ness rose, their net worth fell. Banks became more

vulnerable as their capacity to absorb negative

shocks declined because of currency and maturity

mismatches. The rise in interest rates caused the

banks’ and banks’ customers’ balance sheets to

deteriorate.

The risk of maturity mismatch is higher for un-

listed banks, which cannot mobilize long-term sources

of funding (bonds, shares, and other types of securi-

ties) in stock markets. Selling equity in stock mar-

kets can also spread or distribute the risk. Risk is

high as most companies rely exclusively on bank

loans for financing, with land as the main collateral.

Only a handful supplement bank finance with equity

offerings. The high loan/value ratio of bank loans to

companies, such as property developers, exposed

banks to sharp declines in real estate prices. This

and the plunge in equity prices depressed the market

value of collateral and bank assets. The liquidity prob-

lem became more difficult because mortgages were

not securitized and there was no market for Govern-

ment bonds.

Weak Financial Positions ofBanks and Highly ConcentratedProblem LoansLiberalization of the banking industry will surely pro-

duce long-term benefits for Indonesia. In the short

run, however, deregulation inevitably exposed banks

to new risks, which led to the current banking crisis.

Despite Indonesia’s relatively high economic growth

of more than 6 percent per annum since 1990, the

national banks’ bad-loan problems have not dimin-

ished significantly. As Table 7 shows, they were more

severe at State-owned and nonforeign-exchange

banks. State-owned banks were the main providers

of credit programs, with subsidized interest rates,

during the long period of financial repression. They

are also the main victims of erratic Government poli-

cies, such as those that shifted public deposits from

them to the central bank. As of September 1998,

bad debts amounted to Rp42.4 trillion (equivalent to

about 2 percent of GDP or around 10 percent of

total loans), of which Rp7 trillion (68 percent) be-

longed to State-owned banks. The State-owned PT

Bapindo is technically insolvent as its bad loans are

much greater than its capital.

Close to 12 percent in 1995, the actual average of

risk-based capital ratio of all commercial banks was

higher than the Basle minimum standard for capital

adequacy ratio (CAR) of 8 percent. According to

the World Bank (1996), 22 banks (out of a total of

240 banks in mid-1995) did not meet CAR and 65

banks did not follow the legal lending limit regula-

tions, which restrict the aggregate amount of loans

and advances to insiders, a single borrower (person

or firm), or group of borrowers.8 It was reported

that on average over half of private bank loans were

given to companies in the same groups. Over 90 per-

cent of the loans of PT Bank Dagang Nasional In-

donesia and PT Danamon, two of the largest private

banks, were channeled into their own groups. Tradi-

tionally, State-owned banks were undercapitalized.

The low capital requirements of the past were hardly

enforced for these banks because it was presumed

that the Government would stand by them and that

their insolvency would just be reflected in the fiscal

balance.

Overstaffing and overextended branch networks

are also more prevalent among State-owned banks.

Because they are protected from closure on con-

stitutional grounds and since losses are covered by


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the public budget, State-owned banks tend to have

lower incentives to innovate, promptly identify prob-

lem loans at an early stage, and control costs. As

risks of State-owned banks are assumed by the

State, lending skills (including risk appraisal) of bank

officers are generally weak. These banks’ loan-

loss performance is usually inferior to that of their

private counterparts.

Heavy Government Involvement inSelection of Credit CustomersDespite privatization, the six State-owned banks

(Bank Bumi Daya, Bank BNI, Bank Exim, Bank

Rakyat Indonesia (BRI), Bapindo, and Bank

Tabungan Negara) still retain over 30 percent of to-

tal bank assets. This figure would be even higher if

computed assuming a broad definition of indirect

ownership, as BI, State-owned banks, line ministries,

and various branches of the armed forces also own

banks. The relatively high degree of State owner-

ship shows how political objectives intrude in almost

all aspects of bank operations, including personnel

and technology. It also encourages recourse to pub-

lic financing of bank bailouts.

For decades, loan decisions of State-owned banks

were subject to explicit or implicit Government di-

rection. All too often, creditworthiness of the bor-

rowers did not receive sufficient weight in credit

decision, so that State-owned bank loans were ve-

hicles for extending Government assistance to par-

ticular industries and a handful of politically well-con-

nected business groups. The conglomerates con-

trolled a large proportion of GDP and a vast range of

mainly rent-seeking activities. Deregulation has not

ended Government intervention in lending decisions

of State-owned banks and financial companies: busi-

nessman Edi Tansil and PT Timor Putra Nusantara

received credit even after the banking reforms and

allegedly at the behest of those who promoted the

reforms. Edi Tansil is a business partner of Hutomo

Mandala Putra (Tommy), former President Suharto’s

youngest son, in Golden Key Group. PT Timor Putra

Nusantara is jointly owned by Tommy and KIA Motor

Corporation.

Table 7: Commercial Banks’ Classified Credits, 1995–1998

na = not available.a The decline of bad loans to 13.4 percent of total credit at State Banks in April 1997 was mainly due to the write-off of bad loans at Bank Rakyat Indonesia in preparation for their

privatization.Sources: World Bank 1997; Bulletin Info Finansial 39/VIII, 16 July 1997; and Bank Indonesia, Recent Macroeconomic Indicators, various issues.

Item 1995 1996 Apr 1997 Mar 1998 Jun 1998 Sep 1998 Dec 1998

Total Credit (Rp trillion) 267 331 350 477 626 536 487

Classified Credits (% of total credit)

Substandard 2.7 2.6 2.8 6.9 16.6 19.3 13.5

Doubtful 2.4 3.3 3.5 3.3 6.8 13.3 17.0

Bad Debt 3.3 2.9 2.3 2.9 5.4 7.9 23.3

Total 8.4 8.8 8.6 13.1 28.8 40.5 53.8

Distribution of Bad Loans by Bank Ownership (%)

State-owned Banks 72.7 67.0 65.9 na na na na

Private Banks 16.3 22.8 24.5 na na na na

Provincial Development Banks 5.5 4.9 4.8 na na na na

Foreign and Joint Venture Banks 5.5 5.3 4.8 na na na na

Total 100.0 100.0 100.0

Ratio of Bad Loans to Total Credit by Group of Bank Ownership (%)

All Banks na 10.4 8.8 na na na na

State-owned Banksa na 16.6 13.4 na na na na

Private Foreign Exchange Banks na 3.7 4.3 na na na na

Private Nonforeign Exchange Banks na 13.8 1.1 na na na na


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Bad GovernanceIn February 1991, along with market liberalization,

financial sector reform also included a more restric-

tive capital adequacy, asset quality, management,

earning, and liquidity (CAMEL) system to regulate

and supervise banks. Indonesia adopted rules and

regulations limiting loans extended to bank insiders

(owners or managers and their related businesses),

but these were not strictly implemented.

Poor implementation of the prudential rules and

regulations is due partly to structural weaknesses

in the legal and accounting systems. The regulators

and bank managers do not have sufficient person-

nel to supervise and examine the fast-growing num-

ber and expanding powers of financial institutions.

In an autocratic political system such as Indonesia,

regulators may operate more in the interest of the

rulers than in the interest of the people. The cases

of commercial paper issued by PT Bank Pacific,

PT Bank Arta Prima, and PT Bank Perniagaan in-

dicated fraud and collusion with BI bank supervi-

sors. Four BI bank supervisors were arrested in

early August 1997 for allegedly receiving bribes in

1993-1996. Corrupt officials may have used BI

funds to buy shares of problem banks and to pro-

vide low-cost and low-risk liquidity credit to the

troubled banks. Underregulation of banks leads to

excessive investment (McKinnon and Pill 1996).

Moreover, as private banks belong to business con-

glomerates, they are not tough on affiliated compa-

nies as they can expect assistance from the central

bank. Attaching collateral is a costly and time-con-

suming process, reducing the effectiveness of col-

lateral in solving the problem of adverse selection

(Mishkin 1997).

Lender of Last ResortIndonesia has neither a deposit insurance scheme

nor a bailout program for domestic banks facing runs.

BI, however, provides ad hoc and nontransparent

support, including capital injection, liquidity credit, and

emergency financial assistance. To strengthen pri-

mary (Tier I) capital of commercial banks, BI ac-

quires shares of problem banks and provides them

with equity capital. The rapid growth of BI support

to distressed banks is reflected in the fast-rising

claims of the monetary system on the private sector,

including claims of the central bank on commercial

banks.

A combination of weak market infrastructure,

misfeasance, malfeasance, and malversation has al-

lowed certain individuals to misuse their banks by,

for example, swindling people out of their deposits

and using equity share and liquidity credit from the

central bank to issue fake commercial paper and to

obtain offshore loans, without proper backup for the

bank owners’ questionable projects, usually at inflated

prices. Liabilities of these banks are mainly deposits

owned by the general public, liquidity credit from BI,

unsecured commercial paper sold to the general public

(including foreigners), and equity shares owned by

BI and other State-related institutions. The latter in-

clude State-owned pension funds (such as PT

Taspen, the civil servants’ pension fund) and insur-

ance companies (such as PT Jamsostek, the work-

ers’ social insurance), and pension funds and other

financial resources administered by the enterprises

themselves and their cooperatives. Net worth of the

distressed banks is actually negative.

Newspaper reports indicate that the suspended

banks have long been saddled by financial problems,

surviving only because of financial resources from

the central bank. The reports also show that BI acts

as the lender of last resort only to State-owned banks

and politically well-connected institutions. The Gov-

ernment directed other State-owned enterprises

(such as PT Taspen and PT Jamsostek) to invest

and place deposits in banks and enterprises owned

by politically well-connected conglomerates. Pres-

sured to continually provide distressed banks with

lender-of-last-resort and other public sector funding,

BI often lent money to institutions that had no capital

and whose owners had no incentive to use the new

money wisely because they had nothing to lose. Aside


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from providing equity capital and credit, BI also ar-

ranged mergers, consolidations, and takeovers of

problem banks either by stronger institutions or new

investors.

Policy ResponsesTo address the crisis, Indonesia signed four economic

programs with IMF from October 1997 to June 1998

(Appendix). The first part of the IMF package is

designed to (i) restore macroeconomic stability and

economic growth and (ii) remedy structural weak-

ness in the economy by emphasizing short-run stabi-

lization and medium- to long-term structural reform,

including rebuilding market infrastructure. The pro-

grams outline a broad macroeconomic policy, which

includes (i) cutting domestic absorption and (ii)

switching expenditures from imports to domestically

produced goods and services. The second part of

the IMF package outlines broad economic reforms

to (i) remove impediments to market efficiency, (ii)

create a favorable climate for development, and (iii)

improve the efficiency of resource use. The struc-

tural reforms include (i) bank restructuring, (ii) re-

moval of regulatory and price controls in the product

and labor markets, (iii) efforts to tackle fiscal distress,

(iv) privatization of State-owned enterprises, and (v)

measures to improve market transparency. The re-

forms are expected to improve domestic market com-

petition by dissolving monopolies and opening up the

economy to foreign competition and capital.

The third IMF program of April 1998 also includes

frameworks for (i) Government assistance in solv-

ing the private sector’s external debt overhang and

(ii) budget subsidies for prices of State-vended prod-

ucts. The initiative to resolve the private sector’s in-

ternal debt problem was announced in early Sep-

tember 1998. On 24 September 1998, the Paris Club

creditor nations announced the rescheduling of $4.2

billion in principal repayments of Indonesia’s sover-

eign debt.

The 50-point IMF programs of January, April, and

June 1998 contain more detailed measures covering

(i) a wide range of fiscal, monetary, and banking poli-

cies; (ii) foreign trade; (iii) investment and trade de-

regulation; (iv) privatization and public enterprises;

(v) social safety nets; (vi) the environment; (vii) a

monitoring system for structural reforms; (viii) cor-

porate restructuring; (ix) competition policy; and (x)

rebuilding the legal system. The short-run stabiliza-

tion program and a wide range of medium- and long-

term structural reforms have to be completed by

March 1999.

Confusing and Conflicting PoliciesInconsistent implementation of the stabilization and

reform programs, and the social unrest that marked

the end of the Suharto regime on 21 May 1998 (see

Johnson 1998) eroded both domestic and international

confidence in the Government. Confusing policies

raised the velocity of money, triggering bank runs,

panic buying, and capital flight. The outflow of pri-

vate capital magnified the need for capital inflow to

defend the rupiah because of rising demand to pay

back short-term external debt. Moreover, the delay

in taking measures to restrict aggregate demand, in-

cluding fiscal tightening and monetary policy adjust-

ment, encouraged the private sector to convert rupi-

ahs into dollars.

The first sign of policy confusion was evident af-

ter the October 1997 IMF program, when the au-

thorities funneled the new loans back to the politi-

cally well-connected business groups’ excessive in-

frastructure projects that had been shelved in the

previous month. The projects were shelved again

under the revised IMF packages in January 1998.

The second sign was the closing of some banks in

November 1997 and tight liquidity. As part of the

conditions for receiving a $43-billion bailout from IMF,

the authorities revoked the operating licenses of 16

financially distressed private banks.9 Rather than

injecting more liquidity into the system while weed-

ing out the weak banks, they even squeezed liquidity

by shifting public sector deposits into the central bank,

thus tightening monetary policy. Because the banks


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were inadequately supervised, people could not dis-

tinguish between good and bad banks. All these set

off capital flight and bank runs as depositors with-

drew their deposits from domestic banks and trans-

ferred them to foreign banks in Indonesia and over-

seas. The worsening banking crisis, the rupiah’s con-

tinuous plunge, rising inflation, and concern about the

President’s health sparked panic buying and capital

flight. In January 1998, housewives discarded the

rupiah for staple goods and foreign currencies.

Since 20 February 1998, to restore public confi-

dence, the authorities have provided a blanket guar-

antee against losses to depositors by returning all the

money blocked in the liquidated banks. To prevent the

bankruptcy of BI, its role as lender of last resort has

been shifted to the Treasury through the Indonesian

Bank Restructuring Agency (IBRA). As the Trea-

sury has no resources, the funds are to be borrowed

from the central bank and repaid over 10 years. This

monetized the Government rescue credit to ailing banks.

The third sign was the Government’s standoff with

IMF and international donors. President Suharto

called the IMF program unconstitutional, saying that

it went against the principle of the family-based

economy. Fed up with the rupiah’s slide, the authori-

ties toyed with the idea of adopting a currency board

system (CBS) that would peg the rupiah to foreign

currencies. However, the market, IMF, and major

economic powers publicly disapproved the CBS sim-

ply because Indonesia did not have the key ingredi-

ents necessary for the system’s success.10

The pro-

posal had merit as the system would automatically

stop credit to distressed banks, the public sector, and

favored industries and companies, but temporary fi-

nancial support is often vital for banking stability.

The fourth sign was the appointment on 14 March

1998 of Cabinet ministers who were generally per-

ceived as incompetent, including Mohammad (Bob)

Hasan, a close confidant and business partner of

President Suharto, as minister for trade and industry,

and President Suharto’s eldest daughter as minister

for social affairs.

The IMF program began to work under President

Habibie. Nevertheless, strong leadership and sound

public policies—the basic ingredients needed to solve

the crisis—were also missing from his administra-

tion. Suharto’s immediate successor has not been

able to erase his reputation as a crony. President

Habibie was known as a big spender when he served

as minister for research and technology for over two

decades. He was concurrently president and direc-

tor of many now-defunct “strategic industries,” in-

cluding the National Technology of Aviation Indus-

try (PT Industry Penerbangan Teknologi Nusantara),

the aircraft manufacturing firm partly financed from

nonbudgetary sources, including reforestation funds.

Social Safety NetsThe malfunctioning financial system, worsening eco-

nomic recession, and surging prices have pushed

unemployment and underemployment rates up, de-

pressed labor and asset income, and put more people

below the poverty line. Because of a lack of access

to inflation and devaluation hedges, the income and

assets of the poor are most affected by the crisis.

The Government often tried to tame inflation by con-

trolling wages and prices. More frequent demonstra-

tions, looting, and other criminal activities all over the

country showed that the economic crisis had become

intolerable.

Indonesia has no accurate data on unemployment

and underemployment. A rough pessimistic estimate

put unemployment at about 15 percent in March 1998.

In 1996, about 37 percent of the employed were con-

sidered underemployed, as they worked less than 35

hours per week. Social problems were unevenly dis-

tributed across economic sectors and regions. All

urban economic sectors—construction, manufactur-

ing, trade, and other services—have been hit by the

crisis. The long drought was a boon for some agri-

cultural products such as tree crops and tobacco,

and for fishery, particularly in western Indonesia, but

a disaster in the poorest regions such as East Nusa

Tenggara, Timor, and Irian Jaya.


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Meanwhile, workers have lost over half their wages

to the rupiah’s sharp devaluation and rising prices of

food and other essentials such as education and health

services. The World Bank (1998) estimates that the

poverty level in urban areas is expected to increase

from 3.8 percent in 1997 to 8.3 percent in 1999, and

in rural areas from 13.7 to 17.6 percent.

To ease the short-run negative impacts of the eco-

nomic crisis, the Government introduced three types

of social safety nets:

• Programs that deal with the transitional social

costs of adjustment, including those that provide

income support. (The increase in secondary or

social income partly makes up for the erosion of

primary income. State-provided secondary in-

come is limited to administrative controls and

subsidies to keep prices of essential commodi-

ties at unrealistically low levels. Foreign aid helps

ease the food shortage.)

• Labor-intensive public work programs to tem-

porarily absorb the unemployed.

• Provision of health care through public hospitals

and village health centers (puskesmas) and of

education through primary schools.

Since the Government lacks money, it has no in-

come transfer (e.g., unemployment benefits) program.

Other sources of social income are private trans-

fers, mainly from extended families and charity or-

ganizations.

The distorted relative prices of State-vended prod-

ucts have begun to create problems. By limiting pro-

ducer prices of agricultural products (e.g., rice and

palm oil) the Government effectively taxes the farm-

ers and the agriculture sector, thus reducing incen-

tives to increase production. In fact, prices are so

low that food intended for human consumption is used

to feed livestock. The large wedges between do-

mestic and international prices encourage smuggling

of State-vended products to neighboring countries.

In addition, because those in the upper-income groups

in general consume more State-vended products (e.g.,

gasoline, electricity, and telephone services) than the

poor, subsidized prices benefit the well-off more than

the poor.

The delivery of scarce basic commodities is ad-

versely affected by the economic crisis, social un-

rest, and populist Government policies regarding dis-

tribution channels. Rising interest rates and perceived

risks, as well as the recent violence against ethnic

Chinese, who dominate the distribution systems, raise

the cost of maintaining inventory and encourage cash-

basis transactions. Government policy to replace the

well-established ethnic Chinese with less experienced

cooperatives and the pribumi (natives) may have

created employment, but it has not repaired the dis-

tribution systems.

The benefits of the present social security nets

are too accessible and too generous, making them

too expensive, distorting incentive systems in the la-

bor market. A number of policy approaches may

remedy these weaknesses:

• Identify the poor, partly by using the existing rela-

tively austere poverty line.

• Introduce either the cash benefit or in-kind sys-

tem to those below the poverty line. Eliminate

benefits for those above the line. Strengthen the

system so that it cannot be abused and eliminate

corruption to minimize costs.

• Create labor-intensive public works programs for

those not qualified for the cash or in-kind ben-

efits. Because much of the unemployment and

underemployment is structural and inasmuch as

some groups other than the unemployed are poor,

assistance needs to be coupled with other ben-

efits such as low-cost health care programs and

training schemes.

Measures that may support the well-functioning,

more flexible, and responsive labor markets include

(i) assisting workers to look for jobs in the outer

islands and abroad, (ii) helping deal with the fallout

from mass layoffs, and (iii) promoting training and

other public interventions to assist workers trans-

fer residence to get jobs or to learn another occu-

pation.


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Bank RestructuringEconomic recovery and export growth depend greatly

on the rehabilitation of the financial system, particu-

larly the banking industry. Otherwise it will be im-

possible to reduce the present punitively high lending

rates (nearly 40 percent per annum) and expand

credit, and thus use excess capacity and boost pro-

duction and exports.

The IMF program contains seven measures to

restructure the banking system:

• Encourage distressed banks to merge rather

than let them fail.

On 3 October 1998, the authorities announced the

merger of four State-owned banks (Bapindo, Bank

Dagang Negara, Bank Bumi Daya, and Bank Exim)

into one institution, PT Bank Mandiri.11

The corpo-

rate business of BRI was also transferred to this

bank, leaving BRI to fulfill its original purpose: to

serve the rural sector, small-scale enterprises, and

cooperatives. Deutsche Bank of Germany assisted

in the merger of these State-owned banks.

• Strengthen the capital base of bad banks by

merger, allowing new investors, including foreign-

ers and the Government, to inject capital into the

new bank.

Foreign institutions are expected to help in pack-

aging the bad debts by bringing in their expertise and

helping restore public confidence in the banking in-

dustry.

• Restructure the banking industry with the as-

sistance of IBRA, an independent “bridge”

agency under the auspices of the Ministry of Fi-

nance (MOF).

Established in January 1998, IBRA has two main

functions: (i) supervise the banks in need of restruc-

turing as well as oversee the restructuring process,

and (ii) manage the assets it acquires in the course

of bank restructuring. The interdepartmental Finan-

cial Sector Action Committee sets the overall re-

structuring policy guidelines. Committee members are

the (i) coordinating minister of economy, finance, and

industry; (ii) BI governor; (iii) minister of finance;

(iv) minister of trade and industry; (v) State minister

of planning; and (vi) head of Bappenas (National

Planning Agency).

IBRA’s Assets Management Unit (AMU) will pur-

chase the distressed banks’ nonperforming loans

(NPLs), including those of the four State banks and

nonperforming corporate credits of BRI. The take-

over of NPLs will allow banks to focus on their tra-

ditional activities (deposit taking and lending) and not

waste their resources on managing NPLs, which are

estimated to be 50-75 percent of all loans. Banks’

capability to extend credit will significantly increase

as IBRA purchases their NPLs for cash. The for-

mation of IBRA has also shifted the function of lender

of last resort from the central bank to the Treasury.

By taking over the NPLs, IBRA helps prevent BI’s

bankruptcy.

Of the 54 banks placed under IBRA supervision in

early September 1998, three were State-owned (PT

Bapindo, PT Bank Bumidaya, and PT Bank Dagang

Negara). As pointed out earlier, they were, along with

PT Bank Exim, merged into PT Bank Mandiri. Eleven

of the banks under IBRA were the provincial govern-

ments’ Bank Pembangunan Daerah (BPD). The 34

privately owned banks under IBRA supervision are

divided into two groups: 4 (PT Bank Central Asia

[BCA], Bank Danamon, PT Bank Prima Dana Fi-

nance Corporation Indonesia [PDFCI] and PT Bank

Tiara) are classified as viable and the other 30 as non-

viable. A viable bank has some franchise value and

useful infrastructure while a nonviable bank has none.

Since April 1998, the operations of 10 nonviable banks

have been either suspended or frozen.12

As a result,

23 banks or almost 10 percent of the 240 banks that

existed in July 1996, have been closed.

The viable banks’ shareholders are required to

repay intergroup loans and inject fresh capital and

management methods into their banks to improve

credit evaluation, credit management, and risk. The

banks were given until 21 September 1998 to repay

the intergroup loans and liquidity supports from BI.

Those unable to meet the deadline were classified


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as nonviable, their operating licenses immediately

revoked, and their shareholders made liable to repay

losses and required to transfer all the assets of the

shareholders to IBRA’s AMU. To give the banks

some breathing space, on June 1998 CAR was re-

duced to 4 percent until end-1998. The ratio was

raised to 8 percent at end-1999 and will be raised to

10 percent by end-2000.

Backed up by a Government guarantee, BI pro-

vided the credit to finance IBRA’s initial operation.

Additional funds are to be raised by issuing Govern-

ment bonds in international markets. Based on a con-

servative estimate of NPLs at 70 percent in 1998,

total funding requirement in the second quarter of

1998 was calculated to reach Rp440 trillion or 49

percent of annual GDP. Assuming that sharehold-

ers’ payment would reach 25 percent, that the NPL

recovery rate would be 20 percent, and that the sale

of banks would bring in Rp45 trillion, then funding

deficit would be as high as 22 percent of annual GDP

(Table 8). Over time, as recoveries increase, IBRA

will be able to finance itself.

IBRA will be wound up once the bank rehabilita-

tion program is completed. Given its expected lon-

gevity, IBRA can hold on to assets purchased until

their values rise again. Its financial losses will be

covered by the public budget. Collateral backing of

NPLs ranges from real estate and shares to toll road

and logging concessions. IBRA could buy a combi-

nation of performing or viable loans and NPLs, and

restructure them by injecting fresh capital and better

management methods into distressed but viable banks.

On the other hand, the distressed banks themselves

have the option to choose what NPLs they want to

retain. IBRA has hired international accounting firms

to evaluate NPLs’ values based on international com-

mercial standards.

• Restore the domestic and international com-

munities’ confidence in domestic banks by explic-

itly and fully guaranteeing demand, savings, and

time deposits of all banks in Indonesia.

Government should extend guarantees to credit

received and to guarantees and letters of credit is-

sued by the banks. The debts of the failed banks to

depositors and creditors are covered by the scheme,

but the credit received by bank owners and subordi-

nated debts are not. In two years, the scheme will be

taken over by the yet-to-be-established Deposit In-

surance Scheme, administered by IBRA. Participat-

ing banks are required to contribute a half-year fee

Table 8: Recapitalization Requirement of Indonesian Banks at Various NPL Estimatesa, Second Quarter,1998 (Rp trillion)

NPL Estimates

Item 50% 60% 70% 80%

NPL 323.2 387.8 452.5 517.1Provisioning (70%) 226.2 271.5 316.8 362.0Adjusted Asset 510.6 465.3 420.0 374.4Required Equity (8% of Asset) 41.0 37.2 33.6 30.0Required Recapitalization 236.0 257.9 299.6 341.6Bank Indonesia’s Existing Liquidity Credit 140.0 140.0 140.0 140.0Total Funding Requirement 376.0 397.9 439.6 481.6

(As Percentage of Annual GDP) 41.8 44.2 48.8 53.6Potential Sources of Funding:

Paid-in Capital from Shareholders (25%) 94.0 99.5 109.9 120.6Sale of NPLs (Recovery Rate: 20%) 64.6 77.6 90.5 103.4Sale of Banks 30.0 35.0 45.0 50.0

Funding Deficit 187.4 185.7 194.2 208.2(As Percentage of Annual GDP) 20.8 20.6 21.6 23.1

GDP = gross domestic product, NPL = nonperforming loan.a Based on total assets of the 54 banks under IBRA supervision amounting to Rp738.8 trillion, total risk assets of Rp646.4 trillion, and total equity of Rp50.8 trillion.Source: Indonesian Bank Restructuring Agency.


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of 0.05 percent of the guaranteed deposits and debts

to the Government guarantee scheme. Funds used

by BI to bail out depositors and creditors will be cred-

ited to the Government annual budget in tranches

over five years.

In the short run, the scheme will reduce bank runs,

which began after the closure of 16 banks in early

November 1997. In exchange for the guarantee, all

locally incorporated banks must submit to enhanced

supervisory oversight. Those that fail to meet BI stan-

dards are to be reviewed by IBRA. The scheme is

expected to restore the confidence of the interna-

tional community, which refuses to accept letters of

credit opened by Indonesian banks. In the long run,

however, the credit insurance scheme will create

moral-hazard problems, particularly because the eco-

nomic infrastructure is weak.

• Make operations of State-owned enterprises,

including State banks, more transparent and ac-

countable.

The performance of State bank managers will be

judged according to criteria detailed in performance

contracts. Political corruption can be significantly re-

duced by making State-owned enterprises more in-

dependent and by cutting their links to Government

bureaucracies.

• Strengthen BI by giving it full autonomy to

formulate and implement monetary policy.

A draft of the new central bank law is being pre-

pared and is soon to be presented to Parliament.

• Improve market infrastructure, including pru-

dential rules and regulations governing the fi-

nancial system, along with measures to strengthen

BI’s capability to enforce them and to supervise

the banking industry.

Fiscal Distress andStabilization ProgramThe meltdown of the Indonesian economy and the

collapse of its banking system have worsened fiscal

imbalance and sent inflation rates soaring. The bud-

get deficit grew mainly because of the rapid increase

of fiscal and quasi-fiscal Government expenditures.

In contrast, Government revenues have been declin-

ing in real terms due to the economic recession, ris-

ing unemployment, and high inflation. The economic

crisis has also limited the public sector’s access to

international markets for financing its budget deficit.

Because of low domestic saving, the local market

remains very shallow.

The financing constraints have put pressure on

the Government to redefine its scope. The budget is

no longer seen primarily as a tool of resource alloca-

tion (including “KKN”—corruption, collusion, and

nepotism), but as a macroeconomic instrument and

vehicle for providing public goods. The task of re-

source allocation should be given to the market. As

an instrument of the stabilization program, the Gov-

ernment budget and underlying fiscal and quasi-fis-

cal deficits need to be consolidated by integrating

and consolidating nonbudget revenues and expendi-

tures into the formal budget.

The key to fiscal consolidation is to raise Govern-

ment revenues from both tax and nontax sources.

This requires tax reforms and measures to improve

tax administration and to reduce the scope of State-

owned enterprises. Revenue from value-added tax

(VAT) can be raised by enlarging its base to include

products from which the tax can be easily collected

at minimal cost—for example, electricity, drinking

water, alcoholic and soft or nonalcoholic drinks, and

other products usually consumed by middle- and high-

income groups. The VAT-exempt status of imported

capital goods used by shopping malls, hotels, and the

public sector should be removed. The low income-

tax ratio (1.39 percent of GDP in 1996) and the small

number of taxpayers as a proportion of population

(0.5 percent in 1989, the lowest in ASEAN), indi-

cate widespread tax evasion and underreporting. It

is worth emulating the attempts of Hong Kong, China,

to raise revenue from income tax and to reduce its

collection cost by imposing a single rate of 15 per-

cent. The low revenue from property tax is partly

due to poor information or records on land and prop-


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erty holdings and market values, annual income and

expenses on property, land surveys, topography, and

other physical factors (UN-ESCAP 1995).

Government expenditures will consist of debt and

nondebt outlays. The Paris Club decision in Septem-

ber 1998 to reschedule $4.2 billion in principal pay-

ments of Indonesia’s sovereign debt to 19 creditor

nations greatly eased the pressure on the balance of

payments. The principal of soft loans ($500 million)

is to be repaid over 20 years with a five-year grace

period, and that of export credit ($1.2 billion) over 11

years with a three-year grace period. The agree-

ment also gives the Government a generous 20-month

consolidation period by rescheduling the repayment

of $700 million in soft loans and $1.2 billion in export

credits due in August-March 1999. Instead of rolling

over its loans maturing in FY1999, the Japanese Gov-

ernment has provided Indonesia with new untied

loans amounting to ¥1.3 billion for refinancing pur-

poses. The Government commercial external debt,

amounting to $2.26 billion, (made up of $426 million

in outstanding bonds and $1.84 billion in syndicated

loans), is to be rescheduled by the London Club.

The next biggest item in the Government budget

is expenditure for social safety nets, including subsi-

dies on prices of State-vended products. The poli-

cies to review and cancel Government contracts that

were obtained through corruption, collusion, and nepo-

tism help reduce Government expenditures. How-

ever, the Government’s contingency liabilities will

come from three sources: (i) implicit and explicit sub-

sidy on private sector infrastructure projects, (ii) fi-

nancial losses incurred by IBRA for (a) restructur-

ing ailing commercial banks and (b) providing a fi-

nancial blanket guarantee against losses to deposi-

tors, and (iii) the Indonesian Debt Restructuring

Agency (INDRA) exchange rate subsidy for repay-

ment of private sector external debt.

Just as important as the increase in the public sec-

tor deficit is the substantial shift to inflationary means

of financing deficit. The rapidly rising budget deficit,

from 1 percent of annual GDP in FY1998 to 8.5 per-

cent in FY1999 (Table 9), cannot be sustained. Since

the late 1960s, the essence of fiscal policy in Indone-

sia has been to cap the public budget deficit to a level

that can be financed by external borrowings, mainly

concessionary development aid from official sources.

As part of the $43-billion IMF package, foreign do-

nors pledged to provide $14 billion to finance the bud-

get deficit. No foreign donors are willing to continue

to provide such large budget supports. Moreover, this

external borrowing strategy is just deferred taxation.

To repay the external debts, the Government has to

raise revenue through taxation and to promote exports

in order to acquire foreign currency. Recently, part of

the deficit has also been financed by the proceeds

from privatization of State-owned enterprises. Because

of the availability of these sources of financing, the

Treasury does not have to borrow from the central

bank. In January 1998, the authorities began to bor-

row from BI to pay for IBRA’s operations. Printing

money to pay for a public deficit appears to be a soft

option, as raising taxes and selling State properties are

unpopular and unpleasant.

Table 9: Government Budget (% of GDP)

FY 1997/98 FY 1998/99Item Actual Revised

Revenues 16.2 15.7Oil and Gas 4.6 5.2Nonoil 11.6 8.9Privatization 0.0 1.6

Current Expenditures 10.6 17.0Subsidies 3.1 6.2Interest 1.7 3.3Others 5.8 7.5

Government Savings 5.6 (1.3)Development Expendituresa 6.6 7.2

Social Sectorsb 1.0 1.6Special Employment Schemes 0.0 0.9Others 4.6 4.7

Budget Deficit 1.0 8.5Financed by:

External Finance 1.6 4.8Domestic Finance (0.6) naExceptional Finance na 3.7

na = not available.( ) = negative values are enclosed in parentheses.aSum of components may not add up to total due to rounding.b Include education, health, food production and small scale credit.Source: Ministry of Finance.


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Private Sector Debt OverhangThe corporate sector’s rehabilitation and resumption

of access to international and domestic financial

markets are preconditions for the restoration of pro-

duction and exports. The exclusion from international

capital markets affects the private sector most as it

is the main debtor to foreign creditors. Out of $72.5-

billion private sector external debt outstanding, about

$30 billion fell due in March 1998.

In its policy statement of 27 January 1998, the

Government proposed to temporarily freeze servic-

ing the private sector’s external debts. It also made

clear that corporate debt problems should be solved

on a voluntary basis between borrowers and lend-

ers. The Government should not provide financial

resources, subsidies, or guarantees to bail out com-

panies that cannot survive surging real interest rates,

sharp devaluation of domestic currency, and falling

sales. Private sector default would be permitted, even

in the financial sector, as the Government would nei-

ther rescue those in financial difficulty nor guaran-

tee their external debts and repackage them into a

Government bond issue. Otherwise, creditors would

certainly lose (as Peregrine did), reducing Indonesia’s

access to international financial markets. Some of

the losses can be shifted to taxpayers through tax

credits in the source countries.

To relax the external debt constraint, the IMF pro-

gram of April 1998 addresses the private sector’s

short-term external debt. The agreement reached in

Frankfurt, Germany, on 4 June 1998, between repre-

sentatives of the Government and the private sector

and the steering committee of foreign lenders pro-

posed solving the private sector’s external debt prob-

lem through a scheme combining features of Mexico’s

Ficorca and Korea’s programs. The Korean-inspired

program would take the short-term, nontrade debts

of Indonesian banks ($8.9 billion) and restructure them

into loans with one- to four-year maturities. Interest

on the new loans would be paid based on LIBOR

(London interbank offered rate) plus margins, rang-

ing from 2.75 to 3.5 percent, about 50 basis points

wider than the original Korean agreement. The non-

bank corporate external debt ($58.79 billion) would

be rescheduled and restructured along the lines of

the Mexican program. INDRA, a trust institution,

would be established by the Government and admin-

istered by BI. It would “provide exchange rate risk

protection and assurance as to the availability of for-

eign exchange to private debtors that agree with their

creditors to restructure their external debt for a pe-

riod of eight years, with three years of grace during

which no principal will be payable.”13

In September 1998, the authorities announced the

Jakarta Initiative to help solve the private sector’s

$65-billion domestic debt by forming a task force to

facilitate and coordinate the restructuring process.

The task force works closely with the Corporate

Restructuring Advisory Committee (consisting of

representatives of domestic and foreign financial in-

stitutions, IBRA, and INDRA), which recommends

solutions to the debt workout problems. The legally

nonbinding principles being used to solve the prob-

lems are based on out-of-court commercial negotia-

tions between debtors and creditors. The elements

of the framework include the appointment of profes-

sional legal and financial advisors by each distressed

debtor. Debt restructuring requires accurate and

timely financial information from the debtors. On the

other hand, the creditors must agree to a “standstill”

or not charging default interest payment and other

penalties. They are to be treated as equals of equity

holders, who suffer the first losses.

As of October 1998, INDRA and the Jakarta Ini-

tiative have not made significant progress in resolv-

ing debt issues. In anticipation of a rebound in the

rupiah, and making use of the weak legal system,

many debtors have adopted a strategy of slowing

down the negotiation process by withholding infor-

mation and blocking auditors, valuers, and lawyers

from conducting the required investigations. Some

debtors continue to move funds and shift assets from

one distressed subsidiary to another without the con-

sent of the creditors.


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OutlookThe recent depreciation of the dollar and signifi-

cantly improved implementation of the IMF program

have resulted in the rapid appreciation of the ru-

piah. Its nominal value against the dollar rose sharply

from Rp11,550 in mid-September 1998 to Rp7,800

on 20 October 1998, an encouraging development

that helped lower interest and inflation rates and

rehabilitate the banks and corporate sector. The

reduction in lending interest rates and expansion of

credit will allow the corporate sector to increase its

utilization of existing capacity and to take advan-

tage of the nonoil export industries’ enhanced prof-

itability.

The rising growth rates of agricultural products

as well as oil and nonoil exports are expected to be

the main factors to revive the economy. Agricultural

output is expected to rebound with the resumption of

normal weather conditions. Petroleum, rubber, wood-

based products, copper, and coal still account for over

half of Indonesia’s total merchandise exports. Their

prices fell sharply in 1997. The turnaround of nonoil

exports is likely to occur with the upturn of commod-

ity prices. Measured in volume terms, Indonesia’s

export growth remains strong at 32.8 percent in the

first quarter of 1998.

ConclusionAt the root of the present financial crisis are the over-

invested and highly protected nontraded and manu-

facturing sectors and the weak financial system. The

crisis was aggravated by the Government’s lack of

sound macroeconomic management and by the po-

litical crisis and social protest against the 32-year-

long authoritarian regime of President Suharto. The

low quality of investment was funded by massive

short-term capital inflows as shown by the widening

current account deficit and mounting external debt.

Overinvestment with low quality implies that fewer

resources were devoted to expand the economy’s

productive capacity and to enhance its ability to ser-

vice and reduce external liabilities. Overinvestment

also caused asset overvaluation, especially in the

real estate sector.

The rising share of capital inflows (in the form of

short-term bank borrowings and portfolio flows) in-

vested in the stock market and in private sector in-

struments made the financial system even more vul-

nerable. Surging local interest rates and the deep

depreciation of the rupiah raised the cost in real terms

of renewing or rolling over short-term floating rate

dollar and yen loans. To some extent, the authorities

had influenced both the size and composition of the

volatile short-term capital inflows by imposing ceil-

ings on them and raising their costs.

As indirect policies (enforcement of prudential

rules and regulations, for example) cannot restrain

expansion of liquidity and widening of the current

account deficit, the authorities used direct adminis-

trative controls, including eliminating the subsidy of

the exchange rate swap facility and reinstituting ceil-

ings on the private sector’s external borrowing. The

link between the base money and broad money was

weakened by the rise in the nonremunerated reserve

requirement ratio and the introduction of a credit plan

which directly sets specific credit growth targets for

individual banks. Previously, moral suasion was ap-

plied only to lending to land-based industries. To sup-

port sterilization operations, MOF forced State-owned

enterprises to shift their deposits, mainly in State-

owned banks, to the central bank, thus drying up li-

quidity.

The massive capital inflows caused the rupiah to

appreciate, reducing the domestic economy’s com-

petitiveness in the international market and providing

incentives to invest in the nontraded sector. Because

it was not supported by proper fiscal and monetary

policies and a healthy banking system, the exchange

rate band system could not be maintained by the cen-

tral bank and was abandoned and replaced by a float-

ing system on 14 August 1997. This move caused

the rupiah to depreciate sharply, raised interest rates

to punitive levels, sharply pushed up the share price

index, and tightened the internal and external liquid-


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ity crunch, pushing banks and their clients to bank-

ruptcy, lowering growth rates, and raising both un-

employment and inflation rates. The economic re-

cession depressed investment and pushed down as-

set prices. Along with the closing of 16 financially

distressed private banks in November 1997, it trig-

gered the bank run, capital flight, and panic buying,

and made foreign banks reluctant to accept Indone-

sian letters of credit. Even domestic banks became

reluctant to lend to each other.

The financial system, particularly the banking sys-

tem, is plainly dysfunctional because of a combina-

tion of bad central bank policies and direct Govern-

ment intervention in selection of banks’ credit cus-

tomers. The private sector banks also risk moral haz-

ard as they are lax with respect to their sister com-

panies in their business groups. Rebuilding the shat-

tered financial system requires strengthening both

the central bank and commercial banks. State-owned

banks and nonbank enterprises need to be sepa-

rated from the Government bureaucracy and

corporatized. In addition, market infrastructure

should be improved in order to enforce prudential

rules and regulations, promote competition, and

implement strict credit policies.

The revised IMF programs announced on 15 Janu-

ary and 8 April 1998 focus on further reform in trade

and investment policies, the financial system, and

market infrastructure. They are good starts to

strengthen economic institutions, improve domestic

competition, increase efficiency, and remove distor-

tions that restrain exploitation of Indonesia’s com-

parative advantage in labor-intensive and natural-re-

source-based sectors. To restore public confidence

in the banking system and thus speed up the bank

restructuring program, the Government guarantees

claims of depositors and creditors of banks operat-

ing in Indonesia. The social and political costs of the

adjustment program are, however, very high. Con-

tracting domestic expenditures and economic growth

and rising bankruptcies have also pushed up the un-

employment rate. The distributive effect of the ad-

justment program was partly influenced by the struc-

ture of the expenditure cut and the absence of ef-

fective social safety nets for the poor.

Fiscal consolidation is the key component of

Indonesia’s stabilization and adjustment programs.

Its main objective is to eliminate fiscal and quasi-

fiscal deficits that cause high inflation. Fiscal disci-

pline requires the integration into the formal budget

of the Government’s nonbudgetary transactions or

quasi-fiscal operations that are off the balance

sheets of budgetary units. Deficit reduction requires

raising revenues and decreasing expenditures. On

the revenue side, the widening tax base following

the tax reforms of the early 1980s and 1995 en-

hanced fiscal flexibility. Meanwhile, the removal of

egregious marginal tax rates and replacement of

the cascading sales tax with a more neutral VAT

helped raise economic efficiency and improved ex-

ternal competitiveness. Nevertheless, the tax ad-

ministration still has to be improved. State-owned

enterprises need to be restructured in order to help

strengthen the State’s fiscal position and to prevent

them from obtaining excessive bank credits. On the

expenditure side, fiscal consolidation includes cut-

ting subsidies on State-vended products, reducing

public investment spending, and creating cheap

credit from State-owned banks. Bank restructuring

has to be sped up in order to restore public confi-

dence in the banking system and lessen pressure

on the public budget.

The rupiah has appreciated recently and foreign

reserves have also posted a slight increase. Under

the IMF program, foreign aid has been coming in,

and external liability was temporarily reduced with

the rescheduling of public external debt. The pres-

sure for external debt repayment is expected to ease

further with the resolution of private sector debt. The

private sector debt issues have been mainly resolved

through two initiatives: (i) INDRA, which gives pro-

tection against exchange rate risk on external debt;

and (ii) the Jakarta Initiative, which provides the

framework for direct out-of-court negotiation be-


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tween debtors and creditors. The revision of the bank-

ruptcy code will greatly assist the debt workout pro-

cess. The resolution of internal and external debt

problems, along with the decline in interest rates, has

given Indonesia breathing space and helped rehabili-

tate corporations, which are now taking advantage

of the enhanced profitability of export industries.

Notes1The exchange rate policy includes (i) rapidly devaluatingthe rupiah, (ii) widening the intervention band, and (iii)raising transaction costs in the foreign exchange markets.

2State-vended products include staple foods (rice, sugar,and wheat flour), building materials (Portland cement),energy (electricity and petroleum products), and services(transportation fares and school tuition).

3The World Bank (1996) suggests that fiscal surplusshould be 2 percent of GDP.

4The national car policy was promulgated in PresidentialInstruction No. 2/1996, which gives Perusahaan Terbatas([PT] public limited company) Timor Putra Nasional “pio-neer” status, exempting it from paying 65 percent maxi-mum import duties for car spare parts, 35 percent maximumimport duty, and the 60 percent luxury goods sales tax.While completing its own production and assembling ca-pacity in Indonesia, the company was allowed to import45,000 built-up cars from KIA Motor Corporation of Ko-rea. To boost sales, the public sector was required to buythe cars. In return, the company promised to manufacturethe national car in stages using local components, from 20percent in the first year of its operation, to over 40 percentin the second year, and over 60 percent in the third year.Fully backed up by the Government and BI, a consortiumof 4 State-owned banks and 12 private domestic banksextended a $960-million credit to the company to build aproduction and assembly facility. PT Timor Putra is jointlyowned by Hutomo Mandala Putra, former PresidentSuharto’s youngest son, and KIA.

5The price increases announced on 4 May 1998 were asfollows: gasoline, 71 percent; kerosene, 25 percent; dieselfor cars and trucks, 58 percent; diesel for factories, 39percent; fuel for generator sets, 46 percent; electricity, 20percent; bus fares (non-air-conditioned), 67 percent; mini-

bus fares (metro mini), 50 percent; train fares (withinJakarta), 104 percent; and train fares (intercity), 50 per-cent. Due to widespread demonstrations, some of the pricehikes were reversed on 15 May.

6The open capital account system was adopted partlybecause Indonesia has no effective and efficient bureau-cracy to administer capital control.

7Since 1969, the economy has grown on average by 6-7percent a year, with an annual per capita GDP growth ofover 4 percent. Nonoil GDP, which attracted most capitalflows, grew by 7.7 percent annually in 1991-1995. Alongwith this rapid growth rate, the proportion of the popula-tion living in absolute poverty fell to 15 percent in 1990from 29 percent in 1980 and 60 percent in 1970. Growthcoincided with a major restructuring of the economy fromone highly dependent on a few primary commodities, par-ticularly oil and natural gas, to one exporting a wider rangeof products. Capital goods and raw materials make up alarge proportion of total imports. The economy’s increas-ing openness to international markets and its broadeningexport base raised its capacity to service external debt asdebt service absorbed a smaller part of total exports. More-over, diversification of nonoil exports significantly reducedthe vulnerability of export revenues to commodity priceswings.

8Through networks of ownership and interlocking busi-ness and management, all domestic private banks areclosely connected to large business conglomerates. Thecollapse of a number of large conglomerates since 1990indicates that certain sectors within them could become aburden, in part because of their strategy of being highlyleveraged, which may have been suitable in the past era ofsubsidized interest rates and highly protected domesticmarkets (Nasution 1995).

9These included banks owned by members of PresidentSuharto’s family. PT Bank Jakarta, owned by Suharto’shalf-brother, brought its case to the Administrative Courtin Jakarta and won. Bambang Trihatmojo, Suharto’s sec-ond son, simply transferred the assets and liabilities of hissuspended Bank Andromeda to Bank Alfa, the newly ac-quired bank of his widely diversified Bimantara Group.

10President Suharto received phone calls or visits from Presi-dent Bill Clinton, Prime Minister Ryutaro Hashimoto, PrimeMinister John Howard, Prime Minister Go Chok Tong, ViceMinister Anwar Ibrahim, and envoys from the EuropeanUnion (Derek Fatcher), the United States (the former VicePresident Mondale), Germany (Theo Waigel), and Japan.


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11In January 1998, Bank Internasional Indonesia and BankDagang Nasional Indonesia, two of Indonesia’s largestprivate banks, agreed to merge with three smaller banks(Bank Tiara Asia, Bank Sahid Gajah Perkasa, and BankDewa Ruci). Four banks (Bank Duta, Bank Tugu, BankUmum Nasional, and Bukopin-Bank Umum Koperasi)owned by President Suharto’s four foundations are to bemerged into one bank. The widely diversified Bakri Groupannounced its plan to merge its four banks; the TirtamasGroup, its three banks; and the Ramako Group, its twobanks. However, IBRA forced many of these large andsmall banks to close in September 1998.

12The 10 liquidated banks were Bank Surya, BankSubentra, Bank Istismarat, Bank Pelita, Bank Hokindo, BankDeka, Bank Centris, Bank Dagang Nasional Indonesia,Bank Umum Nasional, and Bank Modern.

13“Joint Statement of the Indonesian Bank Steering Com-mittee and Representatives from the Republic of Indone-sia.” Press release. 4 June 1998.

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Appendix

Chronology of Policy Responsesto Speculative Attacks,March 1997-June 1998

1997

26 March. Administrative measures concerning

foreign borrowings of commercial banks (ceilings,

market entry, net open position, reporting, uses of

credit and fines) are tightened. Banks are required

to use at least 80 percent of the external borrowings

to finance export-related activities.

16 April. The reserve requirement ratio is raised

from 3 to 5 percent.

2 July. Commercial banks are asked to stop credit

to land-based industries, except low-cost housing.

11 July. The intervention band is widened from

Rp192 (8 percent of the central rate) to Rp304 (12

percent of the central rate).

20-22 July. Bank Indonesia (BI) intervenes by

injecting $1.02 billion into the forward foreign ex-

change market.

22 July to 18 August. Discount rates of Bank

Indonesia Certificates (SBIs) are raised four times

from 7 to 30 percent per annum.

13 August. BI intervenes by injecting $500 mil-

lion in the spot foreign exchange market.

14 August. BI abandons the moving exchange

band system and replaces it with a floating system.

14 August. Public sector entities (including State-

owned enterprises) are instructed by the Minister of

Finance (MOF) to shift their deposits from (mainly

State-owned) commercial banks to BI, which with-

draws at least Rp12 trillion of liquidity from the

economy.

31 August. A limit of $5 million per customer per

bank is imposed on foreign exchange transactions,

except for investment and trading purposes.

3 and 20 September. The State budget is re-

vised and $37-billion worth of 244 public-sector-re-

lated projects, especially those requiring heavy im-

ports, are postponed. The authorities, however, reaf-

firm policies to continue the aircraft and other stra-

tegic industries under the Ministry for Research and

Technology and the national car project. Fourteen

infrastructure projects, mostly owned by members

of President Suharto’s family, are reactivated in No-

vember.

4 September. The 49 percent limit on the stake

of foreign ownership in new stock offerings on the

local stock exchanges is lifted.

17 September. Import tariffs on 153 groups of

commodities are reduced.

3 October. BI reintroduces a foreign exchange

“swap” facility for exporters and a “forward” facil-

ity to import inputs needed to produce nonoil export

products.

6 October. BI sells another $650 million in the

foreign exchange market to stabilize the external

value of the rupiah.

8 October. Widjojo Nitisastro, presidential eco-

nomic advisor and architect of economic develop-

ment during the early years of President Suharto’s

government, is empowered to take all necessary ac-

tion in coordination with the responsible agencies.

His power is revoked in January 1998.

The Government requests assistance from the

International Monetary Fund (IMF), World Bank,

and Asian Development Bank (ADB) to overcome

the currency crisis and help strengthen the finan-

cial sector.

30 October. Indonesia reaches an agreement

with IMF on a financial and economic reform pack-

age. Funding commitments amount to nearly $43 bil-

lion ($23 billion for first-line funding and nearly $20

billion for second-line resources).

First-line financial resources consist of $10 bil-

lion from IMF, $4.5 billion from the World Bank, $3.5

billion from ADB, and $5 billion from Indonesian

sources. The sources of second-line credit are bilat-

eral loans from six countries.

The IMF package has two components: (i) a

broad outline of macroeconomic policy targets (for

economic growth, inflation rate, current account


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deficit, and fiscal balance); and (ii) a broad outline

of economic reform measures covering trade, in-

vestment, financial institutions, and market infra-

structure. Effective 1 January 1998, the trade policy

reform includes elimination of the Board of National

Logistics (Badan Urusan Logistik, or Bulog) mo-

nopoly on imports of wheat, wheat flour, soy beans,

and garlic. Industry policy reform includes elimina-

tion of the local-content program for automobiles

by the year 2000.

Banking policy reform includes suspension of op-

erating licenses of 16 commercial banks (announced

on 1 November 1997) and merging of four State-

owned banks and major private banks. IMF does not

insist on closing the distressed banks as a condition

for aid, but, with negative net worth, they are dying

anyway.

17 November. President Suharto instructs the

State-owned social insurance firm (PT Jamsostek)

to deposit Rp1 trillion of its funds into State-owned

Bank Tabungan Negara (BTN) at a lower-than-pre-

vailing market rate to enable BTN to finance low-

cost housing. He also instructs PT Jamsostek to de-

posit another Rp2 trillion ($588 million) into State-

owned banks at 14 percent interest rate per annum

to enable them to provide credit at 17 percent inter-

est rate to small-scale firms.

21 November. After meeting with President

Suharto, the chairman of the Indonesian Chamber

of Commerce announces that, to ease liquidity, the

President has instructed monetary authorities to dis-

burse a $5-billion standby loan from Singapore and

ordered State-owned companies to use 1 percent

of their net profits to buy shares on the Jakarta Stock

Exchange.

31 December. The Government announces its

policy to solve the problems of State-owned banks

by (i) merging four major State banks into one single

institution by end-June 1998, (ii) privatizing State-

owned banks, (iii) allowing foreign institutions greater

equity share, and (iv) solving the banks’ bad-debt

problem.

1998

6 January. The Government presents to Parlia-

ment a draft budget for FY1999 amounting to Rp133

trillion, a 32 percent increase over the Rp101-tril-

lion budget the year before. It is based on the “bal-

anced budget” principle, which limited the budget

deficit to a level that can be financed by foreign

aid and loans, and was calculated based on unreal-

istic assumptions concerning the exchange rate

(Rp4,000/$1), annual economic growth rate (4 per-

cent), inflation rate (low), and export price of oil

($17 per barrel or $2 below the average market

price in January 1998).

15 January. In a public ceremony witnessed by

IMF Managing Director Michel Camdessus, Presi-

dent Suharto personally signs a letter of intent pledg-

ing to IMF that the Government will carry out the

50-point memorandum on economic measures. The

new agreement strengthens the IMF package signed

on 30 October 1997.

The agreement calls for a revision of the FY1999

draft budget. The deficit in the revised budget, an-

nounced on 24 January, is capped at 1 percent of

GDP. To achieve this target, the Government is re-

quired to raise its revenues and reduce its expendi-

tures by, among others, eliminating fuel and elec-

tricity subsidies. Nonbudgetary expenditures, such

as investment and reforestation funds, are to be in-

corporated into the central Government budget.

Special taxes, customs, or credit privileges, and

budgetary and extrabudgetary supports to the na-

tional car and aircraft projects are to be discontin-

ued immediately.

BI is to continue its tight monetary policy and to

strengthen the legal and supervisory framework for

banking and its administrative capability. The exist-

ing banking law is to be amended to (i) make BI an

independent institution, (ii) allow full privatization of

State-owned banks, (iii) permit greater participation

of foreign investors in ownership of domestic banks,

and (iv) authorize existing foreign banks to open more

branch offices.


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Domestic competition is to be improved by elimi-

nating cartel-like marketing arrangements in plywood,

cloves, Portland cement, paper, and steel, among oth-

ers. Bulog’s monopoly is to be limited to rice. Re-

strictions on investment and foreign trade are to be

eliminated, including on (i) foreign investment in palm

oil and on wholesale and retail trade, (ii) local con-

tent regulations, (iii) importation of new and used

ships, (iv) marketing arrangements, and (v) exports

(quotas and bans). Punitive export and local taxes

are to be abolished.

State-owned enterprises are to be restructured

and the privatization program accelerated.

To help ease the burden of the poor, community-

based programs are to be introduced and programs

for the least-developed villages expanded. Programs

to improve the environment are to be initiated.

21-24 January. To comply with the revised IMF

Standby Arrangement, on 21 January, the authorities

announce a series of measures to reform trade and

investment policies, financial institutions, and State-

owned enterprises. A revised proposed budget for

FY1999 is disclosed on 24 January. The proposed

budget is set at Rp147.2 billion, a 46 percent increase

over the 1998 budget.

27 January. To restore public confidence in the

banking system, the authorities fully guarantee de-

mand, savings, and time deposits in all banks operat-

ing in Indonesia as well as the banks’ debts (credit

received and guarantees and letters of credit issued

by them). The Government guarantee, however, ex-

cludes debts of bank owners and subordinated debts.

In two years, the guarantee will be taken over by the

soon-to-be-established Deposit Insurance Scheme.

It is also announced that the Government will estab-

lish the Indonesian Bank Restructuring Agency

(IBRA), an independent institution under the aus-

pices of MOF. IBRA has two main functions: (i)

supervise the banks in need of restructuring and

oversee the restructuring process, and (ii) manage

the assets it acquires in the course of bank restruc-

turing.

The Government proposes to temporarily freeze

servicing corporate external debts, including finan-

cial loans (bank loans, bonds, commercial paper, and

similar debt instruments) and excluding trade-related

debts. It made it clear that public financing, guaran-

tees, or subsidies will not be used to bail out unguar-

anteed creditors. Private sector default is to be per-

mitted, even in the financial sector. A steering com-

mittee of creditors and a contact committee of debt-

ors is to be formed to resolve the corporate debt

problem through voluntary agreements between bor-

rowers and lenders. The steering committee is to

consist of senior international bankers from the main

creditors’ countries while the contact committee is

to be composed of executives from 228 local indebted

companies.

13 February. Emerging from a meeting with Presi-

dent Suharto, Steven Hanke, a US economist and

newly appointed adviser to the President, declares

that the Indonesian leader is in favor of a currency

board that pegs the rupiah to the dollar. IMF and

major economic powers and markets strongly disap-

prove because (i) Indonesia’s banking system is in

distress, (ii) the share of the nontraded sector in the

economy is large, and (iii) the country’s legal and

accounting systems are weak.

17 February. Sudradjad Djiwandono is fired as

BI governor in the face of a standoff with IMF. Presi-

dent Suharto calls the IMF program unconstitutional.

20 February. To restore fading confidence in the

banking system and macroeconomic management,

President Suharto personally decides to return all the

money blocked in the 16 banks liquidated on 1 No-

vember 1997, amounting to Rp3.1 trillion. Minister

of Finance Marie Muhammad says that the funds

for this program are to come from the central bank,

to be repaid by the Government over 10 years.

5 March. Following intense pressure from IMF,

US, Japan, and other members of the Group of Seven,

Indonesia reaffirms its commitment to the IMF re-

forms and suspends the plan to implement the con-

troversial currency board system.


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Government figures show that the economy is

on the brink of hyperinflation and growth decelera-

tion. Month-to-month inflation rose to 12.76 per-

cent in February, compared to a 6.88 percent rise

in January, with the year-to-year rate of around 31.74

percent.

10 March. President Suharto is reelected by the

People’s Consultative Assembly for a seventh five-

year term ending in 2003. Baharudin Jusuf Habibie,

former research and technology minister, is Vice

President. Habibie has a reputation as a big spender,

and his ambitious “high tech” projects are the main

targets of the IMF reform package. (In February,

IMF First Deputy Managing Director Stanley Fischer

implicitly criticized Habibie’s candidacy.)

15 March. President Suharto appoints to a new

Cabinet his eldest daughter, a business associate and

golf partner, and top officials linked to his family’s

businesses, ignoring urgent calls from the people,

world leaders, and IMF to institute reforms. The eco-

nomic crisis deepens.

8 April. Indonesia reaches an agreement with

IMF on a new package of economic reforms with

specific targets and timetable, which IMF is to watch

closely to ensure compliance. The Government calls

the new agreement “the IMF Plus” as it is based on

Mexico’s Ficorca program and includes the IMF

commitment to help solve the $72.5 billion private

sector external debt.

8-12 May. Violent demonstrations, social unrest,

riots, arson, and looting erupt in Medan, Solo, Jakarta,

and other cities after sharp hikes in electricity, fuel,

and transport prices. Joined by other sectors of soci-

ety, students demand the resignation of President

Suharto and the end of corruption, collusion, and

nepotism, which are the roots of the economic crisis.

Social unrest escalates in Jakarta after security forces

shoot and kill six students during protests around

Trisakti University in Jakarta on 12 May. In the fol-

lowing days, rioters loot and set fire to cars, banks,

shops, and shopping malls. In Jakarta alone, nearly

1,500 people die in the chaos. Expatriates and afflu-

ent Indonesians (mainly ethnic Chinese) are evacu-

ated from Jakarta. All outbound flights are full on 15

May, and airport hotels fully booked.

15 May. Because of the political and economic

chaos, President Suharto cuts short his state visit to

Cairo, Egypt, where he is attending a summit meet-

ing of 15 developing countries. Upon his return to

Jakarta, President Suharto promises to form a re-

form committee and hold early presidential elections

in which he will not run. The people demand his im-

mediate resignation and the return to the country of

his family assets, worth an estimated $40 billion.

21 May. President Suharto resigns after 32 years

as the head of the world’s fourth most-populous na-

tion. Vice President Habibie, his protégé, immedi-

ately takes the presidential oath of office. Suharto

says Habibie is to serve until 2003. Many analysts,

including his Cabinet ministers, predict that he may

be merely a stop-gap successor. In response to do-

mestic and international pressure, President Habibie

promises to call a special session of the Parliament

in late 1998 or early 1999 to approve changes in elec-

toral laws.

23 May. President Habibie swears in his Cabi-

net. During the Cabinet’s first meeting, he pledges to

implement the IMF program and bring Indonesia back

from the brink of economic collapse. He also prom-

ises to accelerate bank restructuring under IBRA

supervision and to give BI independence in exercis-

ing monetary policy, including on interest rates and

foreign exchange management.

29 May. The IMF representative returns to

Jakarta to review economic and political conditions.

Because of the uncertainty, IMF suspends disburse-

ments of a $10-billion balance-of-payments loan,

which is the central part of the rescue package. The

World Bank and ADB also postpone loans to Indo-

nesia. Private talks with international creditors are

delayed.

4 June. Indonesia reaches an agreement with re-

spect to a comprehensive program, based on the

Mexican Ficorca program, to address the private


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sector’s external debt. The scheme is to be adminis-

tered by the Indonesian Debt Restructuring Agency

(INDRA), a Government institution under BI. INDRA

provides “exchange risk protection and assurance

as to the availability of foreign exchange to private

debtors that agree with their creditors to restructure

their external debt for a period of eight years, with

three years of grace during which no principal will

be payable.” This delays pressure on the balance of

payments, but the exchange rate subsidy would raise

contingency liabilities of the Government and public

budget.

Moving Toward Transparency:Capital Market in Indonesia

Stephen Wells

Stephen Wells is Senior Partner of Stephen Wells Consulting; Research Fellowof the Financial Markets Group, London School of Economics; and was former

Chief Economist (1989–1997) of the London Stock Exchange.


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Overview

This report examines the efficiency of the Indone-

sian capital market within the context of the Asian

financial crisis. The extreme volatility of Indonesia’s

markets, and especially its currency, reflects the

uncertainties arising not only from the economy it-

self but also from the continuing vagaries and vari-

ances of Government policy. The state of the bank-

ing system and the uncertain duration of the re-

structuring process are certainly disturbing to do-

mestic and foreign investors. Moreover, the seem-

ing lack of direction as well as the insufficient

thought and analysis given to policy measures be-

fore they are implemented have caused panic and

fear especially among investors, adding to the un-

certainty and prolonging the crisis. The capital mar-

ket must therefore inevitably take a back seat until

orderly government is fully restored.

The crisis is more intense in banking than in the

capital market. The history of interest rate arbitrage

attracting huge inflows of foreign borrowing and re-

sulting in the subsequent crisis has been well docu-

mented. The capital market merely responded to the

banking and currency crises: both domestic and in-

ternational investors sold and ran for safety. Those

who have not done so are either fearless (and rarely

reap much reward in the world of portfolio invest-

ment) or in danger of breaching the trust of those

whose money they were looking after.

This analysis makes three points:

• The resolution of the current crisis is distinct from

the long-term development of the capital market.

Indonesia needs a developed capital market if it is

to realize its full potential. But while the rupiah is

down to 25 percent of precrisis rates, interest rates

have just been raised to over 40 percent (one-

month Government paper was raised from 22 to

45 percent on 23 March 1998), inflation is ex-

pected by many to top 30 percent, and shop assis-

tants are standing around in shops empty of cus-

tomers. Structural, long-term reform of the capi-

tal market may take second place to crisis man-

agement.

• However, the response to the crisis must be care-

ful of any longer-term, negative effects it may

have. It is inevitable that a bout of severe infla-

tion, for example, is likely to have persistent ef-

fects on the capital market, further stifling the still-

underdeveloped bond market. But it is important

to ensure that measures introduced to combat the

crisis do not have long-term distorting effects on

the financial sector. The recent changes in Ma-

laysian capital controls show how short-term poli-

cies may do long-term damage to the capital mar-

ket. The crisis also offers an opportunity, albeit

unwelcome, to address some structural issues that

have hampered the capital market’s development.

• Inflows of foreign money have spurred develop-

ment in most economies, including Indonesia and

other Asian countries, at some time in their his-

tory. Infrastructure projects that would not other-

wise have been feasible in such a short time and

other investments to develop the industrial and fi-

nancial sectors have been greatly facilitated by

foreign capital. Of course, the foreign investors

have gained too, achieving returns better than those

in more developed economies. But they have also

borne higher risks, as recent events have shown.

It is only rational that foreign (and domestic) in-

vestors try to protect their investment in times of

crisis. The problem of Asian economies has not

been foreign investors, but misalignment of policy

that led to overreliance on foreign capital at the

expense of domestic, and consequent misalloca-

tion of that capital. The message is that when

the crisis is resolved, Indonesia and the other

Asian economies will continue to want sustain-

able foreign investment, and it is important that

they do not introduce any confidence-damaging,

ill-advised, ill-considered measures.

To sum up, the Indonesian economy suffers from

(i) excessive dependence on bank finance for indus-

try, (ii) poor investment strategies by long-term sav-

75MOVING TOWARD TRANSPARENCY: CAPITAL MARKET IN INDONESIA

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ings institutions encouraged by distortions in the

economy, and (iii) overreliance on foreign capital. Thus,

while Indonesia has the infrastructure for a success-

ful capital market—a regulatory regime that, in terms

of formal rules, appears sound, and an open capital

account—its capital market is poorly developed, shal-

low, and with little resilience against economic shocks.

Bond and Equity MarketsThe combination of high and volatile interest rates and

inflation suggests that the corporate bond market that

emerged in 1996/97 will be quiet for some years. Both

investors and issuers in countries that have experi-

enced this combination prefer assets that offer an in-

flation hedge. While index-linked bonds are a possible

option for Government issues, they are not attractive

to private issuers (since they involve an unquantifiable

and possibly infinite commitment) or to investors (since

they are complex, technical instruments).

It is possible to develop structured finance tech-

niques, particularly securitization of trade (especially

export) and credit card receivables. Securitization

allows companies with low ratings to acquire cheaper

finance by pledging high-quality income streams as

collateral. Such conduits already exist in Indonesia

with Australian financiers. No Capital Market Su-

pervisory Agency (Bapepam) regulations govern the

conduits, so they are set up in offshore special-pur-

pose vehicles (SPVs). Tax rulings on SPVs have

been unclear and unhelpful.

Another potentially attractive development is

greater reliance on equity finance. However, it will

require company owners to (i) relinquish their tight

control, (ii) be open to disclosure, and (iii) accept a

more aggressive market. The results will benefit the

capital market, which, by international standards, is

small compared to gross domestic product (GDP).

A deeper equity market will stimulate existing

long-term savings vehicles whose assets have been

channeled into short-term assets. Equity is also an

attractive finance option for smaller, growing com-

panies, which have considerable upside but are more

of a risk than larger companies. Debt is expensive,

but equity can offer a cheap source of capital and

assist the nascent venture capital industry by provid-

ing a market for small-company equity and thus an

exit route for venture capital investors.

Foreign investors were burned by the crisis and

remain cautious. In general, they seem bullish about

the longer-term prospects for the Indonesian economy,

but remain fearful of the following:

• Policy drift resulting from a lack of vision neces-

sary to guide the economy out of the crisis and to

restructure the financial and banking systems.

• The lack of rules, and the possibility that the Gov-

ernment will not honor contracts and obligations.

• The lack of transparent and reliable information

on the state of companies and the economy.

Policy Issues

Equity Market

MARKET INFRASTRUCTURE

Microstructure

The trading system is based on a standard elec-

tronic order book, but has four slightly unusual, but

not unique, features.

• The ticker displaying trades to the market as soon

as they are made, showing the firms’ codes. (All

systems show the codes to the regulators, but

most do not publish them.) This has two effects:

– Firms can easily and precisely measure their

own and their competitors’ market shares.

Since brokerage is a network business, market

share is a critical competitive point: firms with

larger market shares, since they see more or-

ders, can be assumed to be better informed about

the current state of the market. Therefore, in

most stock markets, firms are secretive about

their market share and prone to exaggerate.

– Observers can easily tell where the business is

at any one time. As a rule, the number of or-

ders—probably only one sizeable order—is lim-

ited in the market at any one time. Knowing


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where they are assists other firms to capture

part of the counterparty business to that order.

It will be easier to negotiate deals outside the

trading system by calling directly to the firm

working the order.

It is difficult to predict the outcomes of the

above. The first effect probably benefits larger

firms by making it explicit who has the most

market share, but the second one benefits smaller

firms by allowing them to spot where the order

flow is and to consummate trades that other-

wise might have been crossed by the firm with

the order. It could go either way, but it seems

that the second effect is most likely: small firms

may gain sight of order flow of which they would

otherwise be unaware.

• Block trades and crossings (also known as the

nonregular market, as opposed to the order

book, which is the regular market). All markets

handle large orders differently from the way

they handle normal-sized orders. Otherwise, the

markets would not be able to offer institutional

liquidity at acceptable prices; the order would

move the market by stimulating front-running

behavior. In essence, the trading system offers

a private negotiation facility where the trade

can be constructed without alerting other trad-

ers. It is called upstairs trading on the New York

Stock Exchange (NYSE), protected trading or

worked principal agreements in London, and

block trading or crossing on the Jakarta Stock

Exchange (JSX).

When doing a cross, brokers find a counter-

party from their own client base. They negotiate

block trades with each other by telephone. They

agree upon a price and report the trade to the

exchange (usually the Surabaya Stock Exchange

[SSX], which offers marginally lower transac-

tion charges than JSX). Crosses or blocks are

not required to interact with other orders on the

regular market, and their prices are not con-

strained by the prevailing market price.

The existence of the nonregular market raises

two important issues:

– Fairness. Not requiring interaction is often

seen as allowing large trades to “jump the

queue.” If the order book shows, say,

Rp1,025-Rp1,050, and a cross takes place at

Rp1,075, then investors submitting offers at

Rp1,050 might feel that they are at a disad-

vantage as they would have liked the oppor-

tunity to sell at Rp1,075. The counterargument

is that a large trade commands a different

price from a small trade, and as long as

smaller orders are not unduly put at a disad-

vantage or deterred, then the price difference

is the cost of being able to offer liquidity in

size. The meaning of “unduly” is an empirical

question beyond the scope of this paper, but

warrants further study.

– Price quality. The regular market displays

prices that form the basis of trading for smaller

orders. However, the larger orders—those

done outside the order book—are often the

price leaders because of their size (Table 1)

and the heavy representation of foreign busi-

ness in the crosses and blocks.

A two-tier market may emerge where the pub-

lic order book imperfectly follows the nonregular

market. Arbitrage may keep the two markets in

line or it may not; again, this is an empirical ques-

tion deserving further study.

• The unusually large tick size (Rp25 for all

stocks). Tick sizes are designed to protect time

priority in the order book. In order to jump ahead

of the queue, an order has to represent a sig-

nificant price improvement over orders currently

in the book. Based on December 1997 figures,

(which were unusually low), about half the

stocks were priced Rp500 or below, so a tick

size of Rp25 was 5 percent or more. Even if

stock prices doubled, the tick size would still be

large.

The effects of a large tick size are the following:


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– It increases transaction costs. The minimum

bid-offer spread is one tick. A brief glance at

the screens suggests that spreads are fairly

wide anyway—more than one tick—although

further study is needed to verify this finding.

– It raises apparent volatility.

– It artificially increases the cost of improving

on order book prices and hence deters inves-

tors from doing so.

On the whole, an excessively large tick size

damages liquidity. There is no optimal tick size,

but markets that use it have a graduated scale

related to price.

• The market’s lack of preopening period when

orders can be entered and viewed without be-

ing executable. The market starts on the run at

9:30 a.m. Few investors commit themselves to

blind orders before the opening, so the market

opens with a very thin order book. Most mar-

kets open when most liquidity investors submit

orders to catch the period when there is maxi-

mum two-way business. As it is also the time

when most new information hits the market, hav-

ing a thick order book optimizes price discovery.

The absence of a preopening will likely in-

crease volatility around the opening as well as

deny investors a natural trading focus. In fact,

the maximum concentration of trading is said to

be around 4:00 p.m., when foreign brokers as-

sess whether they can trade and beat the vol-

ume-weighted average price (VWAP) execu-

tion measure used by many US funds.1

Since September 1997, short selling has been

permitted for 39 stocks, and 24 JSX member firms

have been allowed to offer margin trading to rich

investors. It is not clear how significant these

innovations will be, particularly in the absence of

any formal stock-lending system that will limit

short selling. (Informal stock lending has emerged

to deal with settlement failures in the face of

severe penalties for late delivery.)

Cost and Liquidity

Cost and liquidity are important attributes of mar-

kets seeking to attract large traders such as foreign

institutions. Liquidity is the extent to which large trades

can be made without moving the market. The evi-

dence is conflicting. A number of practitioners indi-

cated that in the top 20 stocks there was considerable

liquidity in the regular market and that orders of up to

$2 million could be accommodated before the crisis,

albeit by making a number of trades over a period of

time. Orders above that size—$5 million was the usual

figure—would go to the nonregular market. However,

statistics suggest that liquidity of that size is, at best,

only available in the top two or three stocks.

Table 2 presents the daily trading values for De-

cember 1997 for the top 10 most active stocks. (De-

cember total values were not out of line with those

for early 1997.) It shows that for most stocks the

majority of the activity took place on the nonregular

market and that average daily trading on the regular

market was below Rp20 billion for all but two stocks

and less than Rp5 billion for 7 of the 10 stocks. Even

at precrisis exchange rates, Rp5 billion was only $2

million, so it seems unlikely that orders of $2 million

could be traded on the regular market within a day

for any but the top two stocks.

Table 1: Trading Value and Volume in the Equity Market, December 1997

Source: Jakarta Stock Exchange.

Market Type Total Value (Rp billion) Total Number of Trades Average Value per Trade (Rp million)

Regular 5,365 221,958 24Nonregular 3,947 7,873 501

Of which:Crosses 3,664 6,985 525Blocks 252 649 388

Total 9,312 229,831 41


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The exchange transaction charge is 0.04 percent

of the transaction value. It includes the cost of clear-

ing, settling, and guaranteeing the fund. There is also

a tax of 0.01 percent, and 10 percent value-added

tax (VAT) on commissions. Commissions are nego-

tiable, with a maximum of 1 percent. Rates for insti-

tutional investors have come down during the 1990s

and are now averaging 0.4–0.6 percent.

However, Indonesia is a relatively high-cost mar-

ket by its neighbors’ standards. Table 3 shows the

results of the Elkins/McSherry analysis of transac-

tion costs for the fourth quarter of 1997. Elkins/

McSherry is a New York-based performance-mea-

surement house with a US institutional client base.

Its clients submit details of every transaction; it then

collates the results and calculates market impact us-

ing a comparison of trade price and VWAP for the

day, or an average of high, low, open, close when

VWAP is not available.

Elkins/McSherry’s results show that Indonesia has

the third-highest transaction costs among comparable

Asian equity markets, mainly because of its relatively

high commissions, fees, and taxes, which, for US

clients at least, are at the upper end of the negotiable

scale. Inevitably, the Elkins/McSherry methodology

is not without critics—it is flawed in a number of

ways—but its results are widely disseminated and

noted in the US market. As observed elsewhere, in-

vestors’ perceptions of a market are at least as im-

portant as the reality.

Table 2: Average Daily Trading Value for Top 10 Stocks, December 1997 (Rp billion)


NonregularStock Regular Nonregular Total (percent of total)

Telemunikasi 38.3 53.9 92.2 58.5

Astra 15.6 28.9 44.5 65.0

Bimantara Citra 2.9 25.7 28.6 89.8

Putra Surya Multidana 23.4 3.1 26.4 11.6

HM Sam Poerna 3.9 8.1 11.9 68.1

Gudang Garam 2.5 8.8 11.3 77.8

Bank Intl Indonesia 2.1 9.1 11.2 81.2

Daya Guna Samudra 3.8 7.1 10.9 65.4

Indah Kiat 1.3 9.0 10.3 87.8

Bank Negara 2.1 8.2 10.2 80.4

Total Top 10 95.6 161.9 257.5 62.8

Table 3: Global Transaction Costs, Fourth Quarter 1997 (basis points)

Source: Elkins/McSherry Co., Inc.

Equity Market Commissions, Fees, and Taxes Market Impact Total Cost

Hong Kong, China 46.45 9.46 55.91

India 20.70 49.53 70.23

Indonesia 77.90 23.38 101.28

Korea 60.77 158.81 219.58

Malaysia 71.36 16.36 87.72

Philippines 104.03 6.76 110.79

Singapore 55.32 16.64 71.96

Taipei,China 52.55 21.15 73.70

Thailand 66.79 20.66 87.45

Average 61.76 35.86 97.62

NYSE 12.36 22.11 34.47

World 44.28 27.17 71.45


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Primary Market

Up to mid-1997, JSX attracted new companies to

listing; it more than doubled the number of listed com-

panies from 139 to 282 since 1990. Entry require-

ments are reasonable, although the requirement for

two years’ profitability will preclude new, high-tech-

nology companies, mineral exploration companies,

and projects for new infrastructure.

There remains confusion over the merit-disclo-

sure debate. JSX clearly sees itself as having some

responsibility for the merit of companies admitted

and has, it claims, the right to refuse on merit grounds.

In practice, it does not seek to use this power and

has never done so. Few, if any, smaller companies

seek listing on JSX. SSX has attempted to attract

smaller companies, but so far only 11 companies have

sought listing.

The strong laws on preemption rights limit com-

panies’ flexibility, particularly in the area of execu-

tive remuneration. The arguments for preemption

rights are not entirely convincing, but where such

rights exist they are fiercely defended by investors.

Therefore, it is neither practicable nor necessarily

desirable to do away with them. However, in the

UK, where preemption rights are strongly supported

by institutions, their restrictiveness has been eased

by allowing companies to make relatively small is-

sues without respecting preemption rights. The fa-

cility has to be approved (and the approval renewed

periodically) to ensure that shareholders do not feel

they have lost control. But the greater freedom given

to companies has allowed them to develop executive

and employee share schemes as well as to finance

relatively small acquisitions. Such schemes are valu-

able for motivation and, over time, also lead to a wid-

ening of the shareholder base.

Derivatives

There is no organized derivatives market, but an

index futures market is planned. Trading is to be on

SSX using an electronic system. Settlement is to be

operated along conventional lines by the central

clearer through clearing members. The main con-

cerns relate to the risk-management systems of mem-

ber firms and exchanges. There is no evidence that

securities firms are sufficiently capitalized to handle

increased risk of derivatives or that the exchanges’

ability to monitor exposures is up to the task. In

practice, the clearinghouse will be exposed only to

clearing members rather than all trading firms. How-

ever, the clearinghouses themselves may not be ad-

equately capitalized or they may be excessively

exposed due to their inability to manage the firms

that clear through them.

Settlement

The equity settlement system is risky in that it is

not delivery versus payment (DVP), and it is expen-

sive because of the volume of paper it uses. DVP is

the international standard for settlement systems and

features in the Federation Internationale des Bourses

de Valuers’ (FIBV’s, International Federation of

Stock Exchanges’) Best Practice.2 A new system

is planned, but it is highly unlikely that it will be built

in the foreseeable future.

The current system of holding shares in multiple

certificates adds significantly to the costs of the sys-

tem. It also increases the risk and possibility of delay

for the following reasons:

• Costs are increased because of the sheer vol-

ume of paper to be moved and stored (the stacks

of certificates held by custodians are estimated

to have a total height of 60,000 feet); brokers

transport trolley-loads of certificates to the cen-

tral stock settlement operation. With an average

transaction size of 25,000 shares on JSX (1997),

settlement requires movement of 50 certificates

on average rather than just one. Each of the cer-

tificates has to be signed and stamped by the

selling broker. The most significant cost in an

initial public offering (IPO) is the administration

of share certificates, dwarfing the legal, account-

ing, and underwriting costs, which are the domi-

nant costs in other systems.


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• Risks and delays occur because of the need to sign

and stamp each certificate. The likelihood of miss-

ing or otherwise not completing the necessary pa-

perwork is great. The fact that all the certificates

are for the same amount further increases the

chance of error. The UK experience during privat-

izations, when many identical certificates were is-

sued to the public, demonstrates the problems that

a multiplicity of certificates for identical amounts

can cause. The result in the UK was a significant

backlog that took several months to clear and re-

sulted in limitations on trading for some firms.

• Issues of new certificates are frequently delayed

and service standards are not met. Since it is not

possible to sell shares without possessing the cer-

tificate, delays in the system of cancellation and

reissue can impose risks and costs on sharehold-

ers, especially in volatile markets. Short selling

is effectively deterred by the penalties for fail-

ure to deliver and by the absence of a formal

system for stock borrowing.

The system also carries another risk arising from

having no DVP—the risk of failure, and could result

in parting of investors from both stock and money.

The current guarantee fund is probably not adequate

for possible losses, and the implicit guarantee of the

membership’s collective responsibility is unlikely to

ensure the system’s ability to compensate for loss in

a crisis.

There is an informal stock borrowing system be-

tween brokers. How it functions is not clear, but any

informal system is certain to contain significant risk

that the same stock will be sold twice. A more formal

system exists for Indonesian stocks listed on NYSE.

The future system, which will possess a central

depository, could substantially reduce risks since the

synchronization of cash and stock movements (i.e.,

DVP) will eliminate risk of an investor being out of

stock and money. However, it is subject to three se-

rious, possibly critical, problems:

• It is unlikely that the depository will be completed

soon. The most pressing problem is cash. The

depository is to be built and supplied by outside

contractors—selection is going on, although with

few results—for $4.6 million. The collapse of

the rupiah has substantially increased the

depository’s rupiah cost, and none of the share-

holders is willing to stump up additional money

at the moment. It is not clear that there is any

plan to address the problem other than wait for

the rupiah to recover. The possibilities of build-

ing a partial system (which, given the economies

of scale and the high proportion of costs devoted

to software, is unlikely to help much) and of

handing the project to one custodian bank (which

is opposed by the other 13 custodians) have been

examined and rejected.

• A governance problem may jeopardize the

project when finance does become available.

The shareholder group seems too large for ef-

fective management and the three-person board

of directors too small to adequately represent

the competing interests. Depository systems must

compromise between meeting all special needs

of participants and remaining cost-effective. The

governance issues are critical and the structure

of decision making and consultation is what

makes a system viable.

• There has been little, if any, consultation with

users and no formal involvement of the other

custodian banks despite Bapepam’s claims to the

contrary. Users and custodians continue to har-

bor doubts about the new system’s security (es-

pecially reconciliation of depository holdings) and

compensation in the event of loss. A delegation

of worried users and custodians went to

Bapepam and brought up the following:

– The current proposals do not conform to in-

ternational best practice.

– Unless they do, users and custodians will ei-

ther withdraw from the market or continue to

insist on certificated holdings.

– Major users are not convinced of the proposed

system’s security.


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REGULATION AND ENFORCEMENT

Regulatory Position

Market players strongly feel that Bapepam is ab-

solutely dominant in the regulatory sphere and gen-

erally very powerful within the Government. They

do not sense that it is independent of Government

influence; indeed, as a department of the Ministry of

Finance (MOF) and funded by subvention from the

national budget, it is a direct extension of Govern-

ment power. This means that, however well inten-

tioned Bapepam may be, it cannot fulfill its stated

intentions: (i) setting principles and allowing market-

driven self-regulatory organizations (SROs) to oper-

ate within those principles and (ii) basing its rulings

on consultations with users (as legally required).

Observers believe that it is trying to engineer change

according to its own plan and not engaging in real

consultation despite its commitment to do so.

Bapepam’s influence can be seen in the lifecycle

of SSX, for example. The business share of SSX has

long been minimal, but the exchange has been kept

alive by the following:

• a requirement (before the Capital Markets Law

of 1995) that companies should list on both ex-

changes; and, more recently,

• permission to undercut JSX in transaction charges

(which confirms that the exchanges are not free

to set their charges).

Bapepam, however, has decided that SSX has no

future and that it is to be abolished, even though a

committee is still considering the exchange’s ultimate

role.

On the surface, the regulatory structure has a high

level of democratic accountability. For example, JSX

directors are answerable to the members of the ex-

change rather than to a chief executive. However,

this arrangement will almost certainly promote fac-

tionalism and unhealthy competition in the exchange

management. It will also strengthen Bapepam’s po-

sition, since it is the only fixed point in the regulatory

arena. Bapepam also sets the budgets for JSX and

SSX as well as determines their profit objectives and

pricing policy. Its role in rule making is supposed to

be limited to giving final approval, but many feel that

it does much more and that SROs are implementers

of Bapepam decisions rather than decision makers

and regulators in their own right.

Surveillance and Enforcement

The legal framework for prosecution of wrong-

doing is in place and successful. In 1997, for ex-

ample, Bank Pikko was penalized after a Bapepam

investigation found that it had attempted to manipu-

late the market. After the investigation, the Govern-

ment issued a public statement that because JSX’s

inspection and surveillance procedures were inad-

equate, its enforcement function was transferred to

Bapepam.

Both Bapepam and JSX appear to monitor price

movements. However, the techniques are not very

sophisticated. (JSX uses 180 parameters in its moni-

toring, but most have to do with whether or not a

stock has adequate liquidity to justify listings; inci-

dentally, no stocks have ever been delisted for lack

of liquidity.) Surveillance of price jumps comes down

to asking a company to explain jumps of 30 percent,

which is an extremely large cut-off; most markets

use 10 percent or less, depending on the size of stock.

In most cases, the concerned companies responded

that there was no reason for the jump, even when

there was, as found out later.

The traders interviewed for the study believe that

market abuses, including insider trading and manipu-

lation, are more common than is compatible with a

fair and efficient market. They also said that concert

parties are common.3 They have little confidence that

cases will be enthusiastically prosecuted by Bapepam

as it is too close to the Government and would rather

avoid unpalatable investigations. It is not possible to

judge the accuracy of the comments, but if important

market users believe them, then the system is failing,

if only in a presentational sense. This point is critical:

traders and investors act upon not what actually hap-

pens, but on what they think is happening. A market


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that is seen as fair and open will attract long-term

investment business. One that is perceived as murky

will attract largely speculative trading driven not by

fundamentals but by a momentum.4

Company Information and Disclosure

The current crisis has brought out issues relating

to the quality of information and disclosure. Essen-

tially, the foreign debt exposure of banks and corpo-

rations was not well documented in published ac-

counts and so investors did not see the warning signs;

they still maintain deep misgivings about possible new

disclosures. The fact that in the first six months of

the crisis the Government still did not have a clear

picture about the extent of private sector debt ex-

posed the severe weaknesses of its disclosure re-

quirements. One estimate revealed that about two

thirds of private cross-border borrowings were is-

sued by public companies listed on JSX, pointing to

the information gap in the capital market.

Indonesian standards are similar to US Generally

Accepted Accounting Principles (GAAP) except in

the critical area of treatment of financial assets. But

the more serious problem lies in the quality of report-

ing rather than the standards for compilation. The

accounts are generally regarded as opaque because

of the lack of accounting rigor and the complex struc-

ture of Indonesian companies.

The quality of auditing staff is often not as high

as it could be, and staff members are not as asser-

tive and inquiring as they should be. It is not appar-

ent that stiff investigative techniques will gain re-

ward for individual staff members or for the firm.

Indeed, many who were interviewed for this study

suggested that exactly the opposite was the case—

that auditors who come up with controversial or

contentious findings are not likely to progress well

in their careers. Of course, there is always a temp-

tation for auditors to give their customers an easy

ride, but this is usually offset by the possibility that

they will be held liable when audits fail to spot con-

cerns and by the need to be credible to investors

and companies. (Auditors need credibility in order

to get lucrative contracts for IPOs; IPOs that use

“easy” auditors command poorer prices.)

Bankruptcy Laws

While not belittling the cost of bankruptcy to those

dependent upon a company for their livelihood, not

terminating ailing companies has serious costs for

the economy:

• The industry retains excess capacity. (Rational-

ization of capacity levels would benefit and

strengthen other firms in the industry.)

• Healthier firms are subject to unfair competition

as they are forced to contend with firms that are

not servicing their debts.

• Opportunities to rationalize industrial structures

into larger, stronger units are lost.

• Capital resources are tied up in failing compa-

nies rather than used productively.

• Investors have no way of even partially salvag-

ing their investment through an organized work-

out of the assets.

• Strong recovery is prevented by a hangover of

insolvency, which stifles recovery potential.

• The industry environment becomes stagnant

and focused on job preservation rather than

job creation.

It is instructive to compare the experience of the

US, where destruction of failing enterprises and cre-

ation of new ones has been the thrust of economic

policy, with that of Europe, where policy has focused

on preservation. Statistics show that the US has had

greater success in generating new jobs to replace

those lost through insolvency and, as a by-product, a

more innovative industrial sector.

Until 1998, Indonesia had no bankruptcy law, so

that, in practice, failed companies were able to con-

tinue to operate and creditors had no way of forc-

ing the issue. A law was enacted in 1998 at the

suggestion of the International Monetary Fund

(IMF), but reports suggest that “it is still virtually

impossible to force a defaulted debtor into liquida-


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performance and market valuation across East

Asian corporations.

JSX listing requirements are not very demanding—

a minimum of 200 shareholders—although some pro-

pose to make them more stringent. However, there

seems little likelihood that this in itself will make much

difference as it would not affect the dominant posi-

tion of the founders. It is even possible that the need

to find a wider range of shareholders (and estimates

put the total number in Indonesia at only 200,000)

might increase the cost of IPOs and, at the margin,

deter further listings.

No separation of principal and agent

Most family businesses are run by their share-

holders, but in public companies the owners and the

management are usually separate. The arrangement

allows managers to manage the interest of all share-

holders (not just the insider group) and minimizes

problems of asymmetric information. Where man-

agers are also shareholders, there must be safeguards

to prevent abuse of position and misuse of informa-

tion. The lack of separation doubtless contributes to

the perception that insiders exploit information and

that minorities are at a disadvantage. Systems that

seem to be highly democratic in giving power to

owners are, in fact, not at all fair or democratic, and

usually lead to poor management and lack of initia-

tive, as the JSX management structure shows.

Monopoly power and lack of incentive to improve

While legal monopolies have been largely dis-

mantled, partly at the instigation of IMF, their legacy

remains. For example, much of the economy is still

controlled by strategically positioned distribution com-

panies that are able to exert monopoly power.

Monopoly power promotes inefficiency and opaci-

ty in companies, tolerates poor management, and

ensures that profits are sufficient to satisfy inves-

tors. Since corporate success depends more on con-

tacts than on business acumen, there is little incen-

tive to improve the transparency of companies. The

tion (the few creditors that have tried are still tangled

in legal appeals).”5

Corporate Governance

Foreign investors and securities firms are highly

critical of the standards of governance. The need

for good corporate governance is little appreciated

in Indonesia. Naturally, regulators stress its impor-

tance and strive to encourage it, but progress is gla-

cial because of (i) complex corporate structures,

(ii) tight ownership structures, (iii) no separation of

principal and agent, and (iv) monopoly power and

lack of incentive to improve.

Complex corporate structures

Indonesian corporate structures are extremely

complex for several reasons:

• The system encourages broad conglomerates.

For example, most large conglomerates include

a banking arm to exploit the retail-wholesale ar-

bitrage. At the same time, unlike in the US and,

increasingly, in Europe, the capital market is not

sufficiently strong to punish the excesses of con-

glomerate builders.

• Regulatory requirements—for example, to split

production and distribution functions—force a

multiplicity of subsidiaries.

• Acceptability of opacity and regulatory avoid-

ance allows complex structures to avoid exces-

sive scrutiny.

Tight ownership structures

Most Indonesian companies—at least outside the

top handful of international stocks—are very tightly

held: the founder’s family group normally holds 70

percent. A study of block holdings (holdings of 5

percent or more) showed that Indonesia has 67 per-

cent of equity in such holdings (second only to

Thailand’s 73 percent, although block holders in

Thailand tend to be financial institutions rather than

other corporations).6 The same study indicated that

ownership concentration damaged both operational


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held at artificially high levels for reasons of macro-

economic policy. The period of very high interest rates

in the early 1990s hurt bondholders, whose portfolios

were devalued. Since then, most bonds have involved

floating coupon rates. The recent high rates have

deterred borrowers from domestic issues.

It is also true that the shift to floating rates has

removed a key attraction of bonds for both issuers

and lenders. Typical bond issuers look for stability of

future servicing costs; bank finance offers easier ac-

cess to floating-rate finance. Typical bondholders look

for stable future cash flows to meet stable commit-

ments; deposits offer a more convenient investment

at floating rates (so floating-rate bonds need to offer a

premium to compensate investors for loss of liquidity).

If domestic bonds become less attractive, then com-

panies will look elsewhere for debt finance. Indone-

sian companies looked to the commercial paper (CP)

market until 1995, and after that increasingly to over-

seas sources of debt finance. CP grew rapidly in the

early 1990s as it offered a substitute for bonds. Since

CP programs can be rolled over almost automatically,

they are economically the same as floating-rate bonds,

but involve less cost and effort. The market received

a further boost in September 1994, when Bapepam

introduced a requirement that bonds (i.e., not CP) could

be listed only for rated companies, although it did not

specify a minimum rating. But just over a year later, a

similar requirement for CP introduced by the Bank of

Indonesia (BI) effectively stifled the market.

Indonesian blue-chip companies also started to tap

international bond markets beginning in 1994. Rates

were lower than in the domestic market and costs of

issue were substantially less. International investors

priced the debt on the assumption that the steady but

controlled devaluation of the rupiah would continue

in the long term. In hindsight, it may be that interna-

tional investors systematically mispriced the risk of

Indonesian companies, but in 1994–1997, some 400

Indonesian companies were able to issue dollar-de-

nominated debt as floating-rate notes (FRNs) or me-

dium-term notes (MTNs).

consequence is that Indonesian companies are prob-

ably badly managed by entrenched managements,

which are even further entrenched by the absence

of a proper bankruptcy law.

Bond Market

PRIMARY MARKET (INVESTORS AND ISSUERS)

The bond market in Indonesia expanded rapidly in

1992–1997, when listed bonds increased their mar-

ket capital by 700 percent. However, the bond mar-

ket remains small and bank finance is still the domi-

nant form of nonequity capital. Table 4 shows the

value of various assets in mid-1997 before the ad-

vent of the crisis.

Domestic corporate bond issues represented about

5 percent of equity capitalization and just 4 percent

of bank loans. Bond issuance was relatively short-

term as Appendix Table A11 indicates; most issues

were for five years, although some longer-dated is-

sues were made in 1997.

From the early 1990s until the current crisis, the

Government pursued a policy of slow but steady cur-

rency decline against the dollar, supported by high

interest rates. High nominal rates do not necessarily

prevent the development of active bond issuance and

trading. However, bond investors and issuers require

stability of real yields, otherwise bonds become ex-

tremely risky instruments. Stable real yields may well

be consistent with high nominal yields, but real inter-

est rates went through a period of high volatility in

the early 1990s, and more recent rates have been

Table 4: Asset Values in Indonesian FinancialMarkets, Mid-1997

Source: Pefindo.

ValueType of Asset (Rp trillion)

Bank Loans 375.8

Equity Market Capitalization 301.6

Bank Indonesia Certificates (SBIs) 7.0

Corporate Bonds (market capitalization) 15.8

Rupiah Commercial Paper 0.8

US$ Medium-term Notes, Floating-rate Notes, etc. 7.0


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by the State-owned electricity company PLN, Citra

Marga Nusaphala Persada, and State-owned Bank

Tambungan Negara.

Investors choose bank deposits as their main in-

vestment vehicle because there are few superior in-

vestment options open to them. Bonds are in float-

ing-rate form and so are unattractive to investors,

and are in short supply anyway. State-owned com-

panies are the large issuers, representing about 50

percent of current issued bonds. Industrial compa-

nies have become more important than infrastruc-

ture companies.

Since 1994, all listed bonds have been required

to have a rating. BI permits banks to invest only in

investment-grade paper. The rule does not affect

fund managers but, in practice, guides institutional

investors. Given the difficulty of evaluating sub-in-

vestment-grade bonds, even when skilled analysts

possess sufficient information, the rule is a prudent

one from which institutions should not be encour-

aged to stray at this time. Few Indonesian compa-

nies can meet the requirement, however, and they

are precisely the companies that were able to tap

international markets, thus limiting the number of

issuers who could and would issue bonds in the do-

mestic market.

Banks have been excessively willing to lend to

corporations at rates that probably did not accurately

capture the risk or their own cost of capital. Further-

more, the loans have not been backed by adequate

and reliable information about the borrowers.

Until the crisis, demand in the primary market

outstripped supply. The relatively fast growth of

Current interest rates are at unprecedented high

levels as the Government attempts to shore up the

currency and contain money-supply growth through

open-market issues of SBIs. High precrisis inter-

est rates were meant to give medium-term support

to the rupiah against the dollar, but the reliance on

foreign borrowing they engendered was a cause of

the crisis.

Artificially high interest rates have stifled the de-

velopment of the capital market, as it is easier to

invest in Government paper or in deposits of institu-

tions that have invested in Government paper. Prac-

tically all investments by domestic institutional inves-

tors are in bank deposits or SBIs. Generally, only

foreign institutions have made significant investments

in the equity market. Other equity-market players

are speculative traders or those who have special

access to information, who reckon they can beat

deposit yields in the equity market.

Corporate bonds are attractive to institutions with

long-term but predictable commitments, such as life

insurance companies and pension funds. Mutual

funds, as well as banks, have also been active buy-

ers. Since mutual funds are relatively small, so is

their demand for corporate bonds. The size of the

market is further limited by the tendency of the

natural buyers of bonds to concentrate their assets

in bank deposits. Table 5 shows the portfolio of two

classes of institutional investors.

Foreign investors’ participation in the rupiah bond

market represented 10–20 percent of new bond is-

suance, but was mainly limited to the most liquid

bonds with good credit standing such as those issued

Table 5: Institutional Portfolio, 1996 (Rp trillion)

a Includes property investments.Source: Pefindo.

Type of Investment

Investor Bonds Equity Deposits Totala

Pension Funds 1.2 1.2 6.6 12.2

Insurance Companies 1.0 1.0 9.9 20.0

Total 2.2 2.2 16.5 32.2

Share in Total Portfolio (%) 6.8 6.8 51.2 100.0


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mutual funds and demand from foreign investors put

pressure on the limited supply, stunting the domestic

bond market.

It is worth noting that while many economies as-

pire for deep and liquid corporate bond markets, such

markets are, in fact, rather rare. In most countries,

the top few blue-chip companies have access to in-

ternational capital markets and high debt ratings; thus,

they can and do borrow extensively in a range of

currencies. Most companies, however, do not have

access to bond markets and are largely reliant on

banks for debt finance. The main exceptions are US

companies, the smaller of which have access to debt

markets—even low-rated credits or the so-called

junk-bond market. The reasons for the success of

the US corporate bond market are the following:7

• Interest on corporate debt is deductible from cor-

poration tax but dividends are not. Companies

therefore tend to issue bonds, which are, in fact,

close to equity but have the tax-break advantage.

• The US is a large, single-currency area with a

relatively stable currency and inflation rate. Since

risk is low, lenders and borrowers are willing to

contract for the long term. Bond investors are

also less able to make money speculating on na-

tional interest rates, so they have to “move down

the credit curve,” something that European banks

are considering now that the multiple European

Government bond markets are drying up due to

the single European currency.

• US funds, particularly life funds, have developed

the skills to analyze lower-quality debt—that is,

to assess the risk of default and also to “work

out” defaulted debt to maximize what can be

salvaged. They are helped by the public avail-

ability of high-quality information and by clear

rules on seniority of debt, bankruptcy, and so on.

Many of these points can be identified in the policy

recommendations discussed below. But it remains

true that other countries with high standards of cor-

porate reporting and clear bankruptcy laws do not

have large corporate debt markets.

Yet, even if there were no crisis and even if all the

recommendations were implemented, the emergence

of a large corporate debt market in Indonesia would

by no means be assured or, at best, would be the

result of a long process.

MARKET INFRASTRUCTURE

Issue Process

The method of issue is similar to a book-building

process, with likely investors sounded out by the lead

underwriter. However, the pricing process is hindered

by lack of useable, risk-free benchmarks for longer

bonds—something provided by risk-free Government

bonds in most markets.

The process of issuing a public bond is slow and

expensive. Registration and listing of requirements

generally take several months. Bapepam is involved

twice, each time taking several weeks. There is no

facility for shelf registration (i.e., gaining approval

for a total bond issuance program that may then be

issued as a tap by the company at rates and in cur-

rencies to suit current market conditions).

Besides reducing their interest costs by using the

CP market and later the international market, Indo-

nesian companies also avoided the high costs and

long time scales associated with domestic bond is-

sues. One estimate put the average cost of domestic

bond issues at 259 basis points (bp). Another esti-

mate put the cost at 5 percent of the issues’ pro-

ceeds (including 4 percent underwriting fee) plus 2.5

percent annual cost. Whatever the precise figure, it

was very high. (Initial and annual costs in other mar-

kets are a few basis points, certainly far less than 1

percent of money raised by the issue.)

Given the costs plus the heavy commitment of

management time and protracted timetable, compa-

nies will seek bond finance only if it offers features

that are absolutely unattainable through other debt

instruments. By comparison, bank loans were

cheaper (although still expensive) at 200 bp, but CP

was about 8 bp. Overseas issues probably averaged

about 100 bp—not as cheap as CP, but BI’s regula-


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tory actions largely closed the CP market beginning

in 1995.

The Trading System

The World Bank noted in 1995 that Asian bond

markets were highly illiquid and that Indonesia was

no exception. Trading volume in Indonesia’s second-

ary market was estimated at below 10 percent of

total bond volume outstanding. A large part of the

trading was conducted over the counter (OTC) in an

informal market, and no information on liquidity is

available for that segment. However, all evidence

suggests that there was and continues to be limited

liquidity even in the OTC market.

Since 1997, SSX has introduced a series of mea-

sures to promote the development of the bond mar-

ket. An interdealer market (similar to the Bond Deal-

ers Club in Bangkok) was formed to organize whole-

sale trades among market makers. There are 15 such

market makers trading directly with other wholesale

traders and offering markets for retail clients trading

through brokers.

Both stock exchanges are licensed to list and

trade bonds. SSX has become the de facto main

market for debt instruments. About 95 percent of

bonds were listed on SSX by end-1997. To issue

debt instruments through SSX, issuers must fulfill

the following requirements:

• The financial statement must be audited by a

public accountant for the last three years with

“unqualified opinion without exception” for the

latest book year.

• The registration statement should be effective.

• The issuer should be a legal entity and recruit

willing market makers.

• It should obtain a rating from a rating agency

licensed by Bapepam.

Most secondary market transactions are OTC

between bond dealers. There is no official record of

OTC transactions, so SSX has been developing and

implementing an over-the-counter fixed-income ser-

vice (OTC-FIS) system since June 1997. Participa-

tion in OTC-FIS is open to dealers and market mak-

ers of fixed-income securities.

OTC-FIS, which is not yet functioning fully, is in-

tended to facilitate and promote bond trading by in-

troducing standard trading rules and transparency of

prices by reporting trades and quotes. It is difficult to

judge whether the measures have improved liquidity,

since it all but dried up during the crisis.

Clearing and Settlement

Bond trading is mainly OTC, and settlement ar-

rangements are similarly decentralized, i.e., interof-

fice between transacting parties. As most bonds are

issued in bearer form, most investors, to avoid risky

and costly physical delivery, maintain custodian ac-

counts. Custody services are now offered by about

a dozen large banks, including foreign ones. Almost

all large, domestic institutional investors have their

own custodian bank; foreign investors use a foreign

bank as their custodian. Besides the large custodian

banks, some smaller banks and brokerage houses

offer custody services for their individual clients on

an ad hoc basis. Payment includes accrued interest,

and settlement is normally T+4 (fourth business day

after the trade).

Where sellers and buyers use the same custodian

bank, the process is simple, secure, and fast. But this

is relatively rare, and most transactions involve move-

ment of bearer certificates between custodians and

corresponding movements of funds. The movements

are not synchronized—not DVP—so there are de-

fault risks involved as well as the normal security

risks of moving bearer documents.

The PT Kustodian Depositori Efek Indonesia

(KDEI), the country’s depository and clearing

agency, was set up in 1993 to offer settlement for

shares. An extension to offer immobilization of bonds

was originally planned for 1997. The reorganization

of KDEI into two new organizations—Kustodian

Sentral Efek Indonesia (KSEI, depository) and

Kliring Perjamin Efek Indonesia (KPEI, clearing

and guarantees)—under the Capital Markets Law


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interrupted this plan. The implementation of central

settlement and depository systems has been delayed

by lack of funds. A number of market users were

not satisfied with the design and have indicated that

they will not use the new system if it is implemented,

preferring to stay with certificates lodged with for-

eign custodians.

Benchmark Rates

While the market has short-term benchmark rates

from the SBI market and also had long-term bench-

mark rates for dollar issues based on the Govern-

ment-issued Yankee, there is no long-term bench-

mark rate for pricing. Various proxies have been used:

• the rate on three- to six-month deposits plus a

premium (1–4 percent was typical), which does

not really help longer-term asset pricing; and

• the rate on rupiah swaps, which can be manipu-

lated to give a yield curve up to 30 years, and

has been applied with some success.

They are not perfect substitutes for a Govern-

ment-bond-based yield curve, but the Government

has a balanced-budget policy and does not issue long-

dated bonds. Discussions about converting some

SBIs to longer-term debt (although in the current situ-

ation it may look like rescheduling) or issuing rupiah

debt by international agencies have yielded no re-

sults so far.

Credit-rating Agency

Indonesia’s local credit-rating agency, Pefindo,

was set up in 1994 by MOF and BI. Its international

partner is Standard and Poor's (S&P). Another

agency, Kasnik Duff and Phelps, was licensed in

1997, but is still preparing for operation. Pefindo has

rated some 180 companies involving 249 debt secu-

rities (all types including CP) amounting to Rp28.2

trillion. The requirements for rating of listed bonds

and CP have encouraged issuers to seek ratings, as

has a growing acceptance among Indonesian issu-

ers of the utility of a rating.

Pefindo works with S&P to ensure consistency—

and so gain international credibility—while at the same

time providing more meaningful credit-risk distinc-

tion among high- and medium-grade Indonesian is-

suers. Its ratings have generally been more conser-

vative than those of other Southeast Asian local rating

agencies. Pefindo revised its ratings during the crisis,

especially for the property and financial sectors. The

results are shown in Table 6, illustrating the small num-

ber of high-quality credits available in Indonesia.


Regulatory Framework

Under the Capital Markets Law, the bond market

is regulated by Bapepam, which is responsible for

policy guidelines, licensing of participants,8 regula-

Table 6: Distribution of Pefindo’s Public Ratings Before and During the Crisis (percent and number of debtsecurities rated)

Source: Pefindo.

Precrisis During Crisis

Category June 1997 (%) October 1997 (%) March 1998 (number) March 1998 (%)

AAA 1 0 0 0

A A 7 7 2 1

A 25 25 47 19

BBB 48 59 80 32

BB 20 9 65 26

B 0 0 25 10

CCC 0 0 15 6

D 0 0 15 6

Total 100 100 249 100


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tions, and day-to-day supervision of the capital mar-

ket. BI is also involved, since it regulates banks that

are major players in the bond market. JSX and SSX

are self-regulatory and have a broad range of powers,

including supervising trading and requiring listed com-

panies to disclose financial and other information.

The asset boundaries between Bapepam and BI

are supposedly clear. Under the Capital Markets

Law, Bapepam regulates debt securities with matu-

rity of more than one year, while the central bank

supervises the money market and banks. In prac-

tice, rupiah bonds are defined as having a maturity

of three years or more and are supervised by

Bapepam, while short-term paper (less than one year)

is regulated by BI. Therefore, a number of asset

types with maturities of one to three years, including

MTNs, particularly offshore MTNs, fall between the

two regulators. Since the rating requirement does

not apply to MTNs, many Indonesian companies have

issued them, often with structures that made them

identical to short-term CP.

The growing openness of the financial market has

encouraged innovation in financial products. The regu-

latory system has not always been flexible enough to

keep up with developments. Asset-backed securi-

ties (ABS) have increasingly gained popularity among

financial institutions seeking to clean up their bal-

ance sheets as well as to circumvent the regulatory

hurdles of capital adequacy and lending limits. But

ABS encountered daunting regulatory, legal, and tax

problems because Indonesia lacked a regulatory

structure to handle them. Consequently, all asset-

backed securitization is done offshore.9 Regulatory

authorities are working to cover the gaps. New but

untested measures are now in place to facilitate do-

mestic ABS issues, and disclosure requirements for

MTNs have been strengthened.

Indonesia’s legal and regulatory infrastructure has

a number of weaknesses that impede the develop-

ment of debt markets, including (i) the absence of an

effective bankruptcy law and (ii) a lack of clear pre-

cedents of commercial-dispute resolution and legal

enforcement of contracts. The weaknesses espe-

cially affect the development of structured-debt prod-

ucts, which are, by nature, complex, and they make

bonds from lower-quality credits less acceptable.

Much of the success or otherwise of an investor

hinges on being clear about what can be salvaged in

the event of a default.

Minimum Issue Standards

Since 1994, Bapepam has required that all listed

bonds should be rated, although it does not stipulate

the minimum acceptable rating. However, since 1995,

BI has ruled that banks can only (i) be involved in CP

programs where the CP carries an investment-grade

rating (prior to that, CP was not rated) and (ii) invest

in or guarantee investment-grade bonds. Institutional

investors as well as banks follow the ruling.

Since the ruling was issued, the CP market has

died and, until the crisis, issuers replaced CP with

offshore FRNs and MTNs. Only investment-grade

bonds have been acceptable and traded in the mar-

ket. Indonesia has few investment-grade entities.

Corporate Disclosure

Bond investors are highly dependent upon corpo-

rate disclosure, even more so than equity investors,

because they do not have the upside of equity inves-

tors: the best that can happen to a bond investor is that

the promised payments are met and that inflation has

not eroded their value. It is necessary to know what

the likelihood is that an issuer will default and what

will happen then, as a risky bond portfolio’s success

depends largely on being able to maximize recovery in

the event of a default. Clearly, the laws on bankruptcy

are critical in a recovery situation, but quality corpo-

rate information is vital throughout the process.

Investors in top-quality credits tend to rely on rat-

ing agencies and it is therefore crucial that the agen-

cies be reputable and have access to reliable infor-

mation. For smaller companies, ratings are not avail-

able or less likely to be relied upon, partly because

the situation of smaller companies is less clear from


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published information. (Smaller companies are more

vulnerable to economic downturn and published re-

sults rarely show this even in fully developed econo-

mies.) Another reason is that a normal institutional

holding in smaller companies is likely to represent a

significant proportion of the total issue, so the inves-

tor has a less diversified exposure. Investors in

smaller-company bonds will therefore do their own

extensive due-diligence examination of the issuer.

A due-diligence examination requires skill that is

rare among investors; in fact, such skill exists to any

extent only in the US, where the active junk-bond

market has spurred the development of credit analy-

sis techniques. US investors are skeptical of levels

of corporate disclosure that do not come up to US

standards, and tend to avoid situations where they

see disclosure as limited or defective. Indonesian in-

stitutional investors almost certainly do not possess

the skills for analyzing risky bonds and would there-

fore be wise to avoid the instruments in the mean-

time. In the short to medium term, therefore, the bond

market will grow only if the level of disclosure satis-

fies specialized US investors.

The quality of disclosure has been mentioned above

and the same comments apply here. While Indone-

sian accounting standards are similar to US GAAP,

except for the critical treatment of valuation of fi-

nancial assets and liabilities, both the quality of dis-

closure that goes into accounts and the rigor applied

by auditors are questionable. The domestic debt

market has also been harmed by investor concerns

over the quality of disclosures and market informa-

tion. In the Yankee market in 1996, for example, an

Indonesian entity with a BB rating from S&P or

Moody was charged a 200–400 bp premium over

T-bill, compared to about 130–200 bp premium for

US entities with similar credit rating.10

The Government has issued new decrees to im-

prove disclosure requirements. Privately held, unlisted

companies with assets of Rp50 billion or more are

now required to submit and publish their audited re-

ports. Bapepam and the securities exchanges have

issued new guidelines on disclosures, particularly on

cross-border borrowing and off-balance-sheet and

intragroup transactions. Statistics on cross-border bor-

rowings are now compiled and monitored regularly.

However, compliance and enforcement may continue

to be weak—a serious concern, as it was not a short-

age of regulations that allowed minimal disclosure but

a shortage of commitment to enforce them.

Participants

SECURITIES FIRMS

Stock exchange member firms’ capital requirements

are woefully inadequate and make no allowance for

the level of risk. The minimum working capital re-

quirement is Rp200 million, and all firms exceed it

(Table 7).

However, nearly one third of all firms had work-

ing capital of less than Rp1 billion. It is unlikely that

their position has improved since then—in 1996, a

good year, 42 firms incurred losses; 1997 was cata-

strophic—and Rp1 billion is now less than $100,000.

But since there is no monitoring of capital compared

to risk borne, little more can be said, which is cause

for concern. Since many firms do not have compli-

ance functions, there is little chance that best prac-

tice is being followed in any but the largest firms. (A

local firm that was visited during the study seemed

to have no record keeping or time stamping of cus-

tomer orders. A number of customers were hanging

Table 7: Net Working Capital, Mid-1997


Net Working Capital (Rp billion) Number of Firms

0–1 61

1–5 35

5–10 43

10–20 32

20–50 13

50–100 6

100–200 1

Over 200 1

Inactive 5

Total 197


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around the office and directing the brokers in trad-

ing, which seemed a recipe for front-running of or-

ders and for mistakes in execution.) The fact that 28

firms were disciplined for late or incorrect working

capital returns in the first nine months of 1997 con-

firms that the level of monitoring is inadequate to

deal with serious risk exposures.

PENSION FUNDS

While Indonesia has a legal and fiscal framework

for funded pension schemes and has developed a

wide range of scheme types, penetration is shallow

and asset allocation is distorted. Like other countries

in the region, Indonesia has a young population, but

projections suggest a significant increase in the de-

pendency ratio by 2025. The actuarial solvency of

funds is also questionable.

The total number of workers covered by schemes

was about 16 million at end-1996, which means that

most of the labor force of 80 million does not have

formal pension provision. Workers may have alter-

native schemes linked to family structures, but there

is a serious risk that these will not fully materialize.

The loosening of family ties as migration and devel-

opment continue, combined with the increased de-

pendency ratio, will strain informal arrangements. A

pension crisis may occur if more workers are not

brought into formal schemes.

Asset allocation is almost exclusively in fixed-in-

terest assets, except in private sector schemes, which

do have significant equity and property assets, includ-

ing a significant holding of unlisted equities, although it

is not clear whether or not these are in the parent

company. This makes it difficult to assess the viability

of the schemes since most assets are short-term. It

also leaves the schemes ill prepared for more volatile

times. Before the crisis, some observers were already

concerned that many schemes were not technically

solvent; their concerns must have since strengthened.

Inflation projections for Indonesia, if realized, will dev-

astate the funds, which have invested mainly in fixed-

interest assets, where real returns will fall sharply.

The distortion of allocations, while encouraged by

investment limitations on Jamsostek (a State pension

scheme), is largely a consequence of distortions in

the economy, which have kept interest rates high. In

addition to economic distortions, uncertain policy di-

rection has deterred issue of longer-dated assets.

Indonesia has a low dependency ratio, but experi-

ence elsewhere shows that increasing prosperity is

associated with a declining birth rate and, conse-

quently, an aging of the population. Projections show

that the proportion of population over age 65 to the

total Indonesian population will rise to 10 percent by

2025 (Figure 1)—not a large number, but still a rise

of 230 percent over the 1990 level. (It is also worth

noting that Jamsostek retirement age is 55.)

Besides providing for old age, pension funds also

play an important role in mobilizing national savings,

providing a conduit into the capital market. The capi-

tal market would benefit from the stabilizing influ-

ence of substantial domestic investors, and in most

developed economies pension funds have provided

that stability.

LIFE INSURANCE COMPANIES

Like pension funds, insurance companies’ funds have

been growing rapidly and are largely invested in short-

term deposits. The mismatch of assets and liabilities

presents a future problem. Funds are forced into

short-term deposits because of a lack of suitable long-

term assets (life insurance companies elsewhere are

active bond investors) and the rates paid on deposits

Figure 1: Population Over Age 65

Source: Far Eastern Economic Review, 26 March 1998.


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are too attractive to make it worth looking further.

The solvency problems of some companies resulting

from excessive exposure to failing banks is the other

side of the same coin.

MUTUAL FUNDS

Mutual funds were established under the Capital

Markets Law. By mid-1997, 60 funds had an esti-

mated total capitalization of Rp4.9 trillion. The funds

are tax-exempt and, consequently, have attracted in-

vestments from banks. In fact, over 60 percent of

mutual-fund capitalization was held by banks. At the

same time, mutual funds held most of their assets in

deposit instruments (60 percent), and very little in

equity (15 percent), the balance being in money mar-

ket instruments. Naturally, the current crisis has dev-

astated their portfolios.

VENTURE CAPITAL

The level of venture capital development is low. In-

donesia will need to develop new, smaller, possibly

high-technology companies. The Bapepam licensing

requirement for venture capital, which is essentially

a vehicle for sophisticated investors, might limit

growth. But given the large number of venture capi-

tal companies, this does not seem to be the case.

However, the venture capital industry does not sup-

port growing companies, partly because the venture

capital companies themselves lack the expertise to

assess companies: relationships tend to be based on

trust and influence rather than business assessment.

But the more important reason seems to be the gen-

eral reluctance of Indonesian companies to go pub-

lic, for which there are several reasons (in addition

to availability of bank finance):

• Non-enforcement of intellectual property rights

frightens new companies from exposing their

products. Laws exist but are not enforced.

• Distribution companies dominate their industries

and tend to keep companies confined to local

markets.

• Companies are generally averse to disclosure.

Policy Recommendations

Equity MarketMARKET INFRASTRUCTURE

Microstructure

There are no “right” answers to market micro-

structure questions. Each decision involves a trade-

off between different outturns guided by the condi-

tions, situation, and circumstances of the particular

market. Choosing the best answer requires detailed

analysis through empirical studies of the effects of

policy differences and changes. Without such analy-

sis it is impossible to judge the correctness or other-

wise of microstructure policies. Also, without quan-

titative analysis, the suspicion persists that microstruc-

ture features are there to benefit intermediaries rather

than market users, even where this is not the case.

The above analysis highlights a number of special

features of the JSX market that warrant further

empirical study either by JSX itself or by commis-

sioned outsiders: (i) tick sizes, (ii) lack of a preopening,

(iii) lack of integration of block and normal markets,

and (iv) public disclosure of dealing parties.

Cost and Liquidity

The Indonesian market is illiquid and costly to

trade. International investors have a choice and, other

things being equal, will pick the markets where they

can trade most cheaply. The problem seems to be

high commissions charged to foreign investors, since

taxes and charges are not excessive. JSX should

monitor commission levels and publish results as part

of a policy to reduce transaction costs.

Primary Market

Rather than focus on the minimum distribution for

IPOs—which is unlikely to increase liquidity or dis-

persion of holdings—JSX should examine the require-

ment for profitability. Relaxation of the rule for the

whole list or creation of a separate market segment

would open the market to a range of start-up com-

panies of all sizes.


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JSX should also do the following:

• Examine the restrictive effect of strict preemp-

tion rights with a view to introducing modest flex-

ibility, allowing companies to offer shares to ex-

ecutives and employees.

• Reappraise the market for smaller companies. It

is clear that the SSX version is not making much

progress; some say JSX would be the more logi-

cal and effective place to locate such a market.

• Resolve the confusion over merit. JSX and

Bapepam should clearly state that companies will

not be excluded on merit grounds, and strictly

adhere to this policy.

Derivatives

A derivatives market would seem an extremely

risky venture given the following: (i) the shaky state

of many Indonesian securities firms, (ii) the absence

of proper, risk-based monitoring, and (iii) high volatil-

ity in the near future. It may also have adverse ef-

fects on the cash market, which remains thin; the

index is heavily dominated by two companies (Indosat

and Telkom), which make up 25 percent of the in-

dex. Foreign speculators will use the index as an easy

way to manage their Indonesian exposure, and while

the arbitrage between the cash and future markets

will bring in some extra business, the overall effect

may be to reduce liquidity in the stock market.

The arbitrary decision of Bapepam to allocate de-

rivatives to SSX is questionable. It is based on conve-

nience rather than any business analysis of SSX’s ca-

pabilities. The following should be considered:

• The derivatives market should not commence

until capital adequacy monitoring is up to accept-

able, international standards.

• The possible impact on the cash market should be

assessed before launching the derivative contract.

Settlement

It is imperative that the system move toward full

DVP without delay. Regulators should do the fol-

lowing:

• Restructure governance of depository for proper

involvement of users, especially custodians. With

the commitment of the main users, the budget

issue, where the amounts involved are not huge,

could be resolved. But at the moment, users and

custodians do not have sufficient trust in the sys-

tem to commit new capital.

• Reopen consultations with custodians to ensure

that the planned depository system conforms, at

least, to FIBV best practice. The financing could

usefully be revisited as part of this progress. The

sums involved are not such as would frighten

major players if they were convinced of the

structure’s reliability.

• Reexamine settlement guarantees. Current

guarantees are insufficiently strong to be re-

assuring, relying as they do on implicit guar-

antees by organizations or firms that patently

do not have the funds to support such guar-

antees.


Regulatory Position

Below are the recommended measures:

• Increase Bapepam’s independence from MOF

by making it an independent body reporting to

MOF but funded by the industry it regulates.

Bapepam’s internal structure, where all author-

ity rests in the chief executive (reporting to the

minister), is unsatisfactory. A board of commis-

sioners or a similar body could bring an element

of independent scrutiny into its operations and

policies. Naturally, the board should include in-

dependent members.

• Remove Bapepam’s involvement in the day-to-

day management of the exchanges, particularly

in budgeting.

• Restructure JSX management to have a proper

chief executive officer (CEO) function and a

proper board including representatives of issu-

ers and investors to give it greater credibility and

strength.


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Surveillance and Enforcement

Recommended measures are the following:

• Demonstrate the separation of Bapepam from

political and other influences by separating it from

MOF.

• Reestablish the policing role of SROs by ensur-

ing adequate resources and independence of

operation.

Company Information and Disclosure

The following measures are recommended:

• Tighten accounting standards for mark-to-mar-

ket financial assets. Insist on consolidated ac-

counts for groups and clearer statement of group

accounting policies and close dates.

• Improve training of auditors.

• Encourage stock exchanges and give auditors

incentives to be hard on companies suspected of

failing to provide information. Exchanges often

avoid acting against companies because their

sanctions—such as suspension of listing—are

likely to hurt investors. However, the number of

examples required—especially given the current

circumstances where companies are less able

to raise funds—would probably be small, so the

overall gains to investors would be strongly posi-

tive. It is difficult to see what the role of the

exchange actually is if it has no disciplinary policy.

In practice, these measures are difficult to man-

date. However, the likelihood is that investors, hav-

ing been burned by nondisclosure, will be more cau-

tious in the future. They are likely to insist on audits

by reputable firms underwritten by commitments

from those firms to stand by their work. They will

heavily discount the stocks of companies where

opaque structures seem to be obscuring the view or

where international standards are not followed.

Bankruptcy Laws

The Government should investigate loopholes in

the new bankruptcy law. It is probable that default-

ers do not yet believe the law is real. The regulators

should make it clear that there is no going back to

the old system and that they are siding with creditors

rather than managements of failed enterprises.

Corporate Governance

Improvements in corporate governance are unlikely

to come about as a result solely of regulatory actions.

They will occur as a result of investor pressure (both

explicit and through the market) on companies that

fail to meet accepted standards. The current crisis

will make investors, especially foreign investors, less

likely to take things on trust, and so will intensify pres-

sure for more transparency. Enhancing transparency

by exposing weaknesses will create pressure for bet-

ter governance. But while regulators cannot mandate

good governance, they can be part of the standard

setting by writing codes and by example.

JSX should introduce a code of governance. There

are several such codes around the world and they

usually cover issues such as separation of functions,

remuneration decisions, and appointment of indepen-

dent, nonexecutive directors. Finding suitable

nonexecutive directors is difficult in all countries, es-

pecially at first, when there is no ready pool of people

with the necessary experience. It would be difficult in

Indonesia as elsewhere in the region since there are

relatively few suitable appointees; the demand for their

services, however, would create a supply. A model

code should not be mandatory—as it could unreason-

ably burden smaller companies—but companies should

be required to state the extent of their compliance.

Investors, especially foreign investors, would favor

companies that aim for better governance practices.

Privatization is an effective way of deepening

markets and setting standards. If the Government

intends to privatize significant State companies—

which it should—then it can take the opportunity to

set and adhere to good governance practices. State-

owned companies, to the extent that they are not

privatized, should similarly follow the code of best

governance practice. The privatization program

should, as already described, aim for best governance


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practice in the privatized entities and enshrine it in

their internal procedures and articles.

Bond Market

PRIMARY MARKET (INVESTORS AND ISSUERS)

The bond market is small because demand for bonds

is limited and supply is short. Recently, demand has

been rising, although it remains small. When Indone-

sia recovers from the current crisis, and if the

management of monetary policy and the banking

sector is reformed, then demand for bonds could in-

crease. Institutions that are the natural buyers of

bonds are developing and have shown an appetite

for fixed-income assets, as have foreign investors,

although their memories of the crisis may be long.

However, both demand and supply may remain lim-

ited unless bonds are able to offer issuers and inves-

tors what they want: stability of real-cash flows. This

requires macroeconomic stability, a restructured

economy and financial system, and a style of macro-

economic management that allows interest rates to be

market-driven rather than administered. Longer-term

rates should reflect the supply and demand for funds

at relevant risk premiums. Otherwise, the banking sys-

tem will retain its dominance over industrial finance,

long-term savings institutions will continue to atrophy,

and the capital market will remain shallow with little

resilience against shocks.

Bond supply may remain limited because of the

following:

• The number of high-quality credits is likely to

remain small, and the companies are more likely

to have access to international markets.

• Lower-quality credits (i.e., smaller companies)

can borrow only if lenders receive adequate, trust-

worthy information before and during the life of

the bond.

It is essential that there be clear rules for winding

up in the event of default. Otherwise, banks will likely

remain in a dominant position because of their mo-

nopoly of quality information and the security which

their grip on cash flows gives them.

The Government can act directly to improve the

supply of high-quality credits through privatization and

infrastructure development projects, which should be

pursued vigorously as soon as capital market condi-

tions allow. It can also set an example to demon-

strate that companies that offer investors high-qual-

ity information will gain access to cheaper, better

finance.

Innovative financing techniques should be encour-

aged by the Asian Development Bank’s initiative to

develop a secondary mortgage facility and should be

pursued as a way of developing ABS. More study of

the costs and implications of the rules governing ABS

could reduce costs and open the conduit market to

more companies.11

Issue Process

Below are the recommended measures:

• Examine ways to limit time taken for bond is-

sues. The process of getting regulatory approval

is too long and complex. Bonds are mainly at-

tractive to professional investors, and so a light

regulatory touch is more appropriate. If it is not

possible to simplify the approval procedure, then,

at least, examine some form of “shelf registra-

tion” to allow companies to scale the regulatory

hurdles once and then issue the bonds when mar-

ket opportunities arise.12

• Examine whether or not there are anticompetitive

practices and encourage active competition in

the market. Costs, particularly underwriting costs,

are high. Companies tend not to query under-

writing costs—or other issue costs for that mat-

ter—and it is not unknown for informal cartel

arrangements to keep issue costs excessively

high in relation to the risks and work undertaken.

The Trading System

Liquid corporate bond markets are rare. For all

but the most highly rated issues, investors tend to

buy and hold.13

However, reasonable liquidity, where

it exists, tends to be supported by two features:


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• A liquid Government bond market. Most primary

dealers trade the full range of high-quality debt in-

struments. The skills and systems required can

be supported only if there are major, liquid assets

to be traded, and these are usually Government

bonds. The Government bond market is small and

almost entirely made up of the very short SBIs.

The Government borrowed in the Yankee market

in 1996/97, but maintains a strictly balanced bud-

get so longer-term Government bonds have not

been issued. This is not the place to comment on

the balanced-budget policy, but in terms of interge-

nerational accounting, it may be inappropriate for

a country like Indonesia.14

A budget deficit would

certainly improve the secondary bond market.

• Market makers provide liquidity by going long or

short of bonds in order to meet the needs of the

market. To be effective, they need access to

borrowable funds and stocks. An interdealer mar-

ket helps by giving dealers a place to lay off posi-

tions, but for relatively illiquid stocks the inter-

dealer market merely transfers an imbalance rather

than resolves it. A system of stock borrowing and

money market borrowing would meet this need.

Typically, such a system grows up supported by

an active Government bond market, an active

money market, and clear legal structures cover-

ing ownership and resolution of failures.

Clearing and Settlement

The current system is risky and expensive. It is a

drag upon the development of the market. A central-

ized system should therefore be implemented as speed-

ily as possible. The Government should do the follow-

ing, which are similar to the equity-settlement recom-

mendations:

• Restructure governance of depository for proper

involvement of users, especially custodians.

• Reopen consultations with custodians to ensure

that the planned depository system conforms to

FIBV best practice. The financing could use-

fully be revisited as part of the process.

Benchmark Rates

The Government might reconsider its balanced-

budget policy once the current crisis has passed and

a more democratically accountable government is in

place after the elections. In addition, it might con-

sider switching its international infrastructure bor-

rowing (which will be difficult anyway) to rupiah debt

issued in the domestic market.

Credit-rating Agency

Pefindo appears to have been prudent in its rat-

ings. Foreign investors tend to be suspicious of

non-US agencies, but the link with S&P adds cred-

ibility, and results show that Pefindo was, in fact,

more conservative than S&P would have been. It

remains to be seen how competition will affect the

situation, but the international reputations of the

partners, plus the skill and integrity of Pefindo, should

prevent any pressure from issuers to lower stan-

dards. There seems little need for policy changes,

although it is worth examining, in credit rating or

elsewhere, whether or not it is necessary to have

a licensing requirement for commercial, competi-

tive organizations.


Regulatory Framework

The overcentralization of power in Bapepam and

the agency’s lack of independence prevent proper

development of SROs. However, SROs are closer

to the market and have a better concept of new de-

velopments. The consequence of the system is that

too many details are decided by the central regula-

tors. At the same time, gaps allow regulations to be

circumvented and regulation tends to obstruct rather

than facilitate beneficial innovation.

The following are recommended:

• Set up a more flexible structure allowing more

power to be devolved to SROs, with less formal

division of responsibility. For example, it is al-

most impossible in a developing financial market

to have watertight boundaries between the cen-


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tral bank and the capital market regulator. One

possibility is to merge the supervisory function

of the central bank with capital market supervi-

sion; failing that, continuous communication and

consultation between the bank and the regulator

is a minimum requirement.

• Investigate loopholes in the new bankruptcy law.

Defaulters probably do not yet believe the law is

real. As recommended earlier for the equity mar-

ket, the regulators should make it clear that there

is no going back to the old system and that they

are siding with creditors rather than manage-

ments of failed enterprises.

Minimum Issue Standards

The regulation allowing banks to invest only in

investment-grade bonds and CP was introduced

clearly because of BI concerns about banks’ in-

vestment portfolios and may have been sound from

that viewpoint. However, its effect was probably to

force some borrowing offshore and exclude smaller

companies from the bond market. This is not ben-

eficial from a capital market viewpoint. Two mea-

sures are suggested:

• Reexamine the BI regulation, particularly

whether or not there are alternative methods of

risk management that will not exclude whole

asset classes. After all, it is reasonable for a bank

or institution to hold some risky assets. The regu-

lation probably had a perverse effect of making

bank portfolios more risky since subinvestment-

grade companies would have been forced to

borrow from the banks. The banks, however,

would not have been able to divest part of the

risk by holding only a part of the borrowing (as

they would had the borrowing been through trad-

able bonds).

• Be aware of any unintended impact of regula-

tions beyond their immediate targets as overlaps

between regulatory responsibilities are increas-

ingly common. Bapepam and BI should always

coordinate their initiatives.

Corporate Disclosure

Recommended measures are the following:

• Tighten accounting standards for mark-to-mar-

ket financial assets. Insist on consolidated ac-

counts for groups and clearer statement of group

accounting policies and close dates.

• Improve training of auditors.

• Encourage investors and regulators to hold au-

ditors responsible for disclosure failures. Most

Indonesian companies are audited by interna-

tional firms since they rely on the latter’s repu-

tation for rigor and probity that they would not

want to impair. If the accounting firms were held

accountable for disclosure failures then the threat

to their reputations would force them to apply

more rigor to Indonesian companies.

• Encourage stock exchanges and give them in-

centives to be hard on companies suspected of

failing to provide information.

• Encourage the rating agency, which is con-

strained by poor reporting, to highlight these con-

cerns publicly. If nothing else, its own reputation

would be further strengthened by a public stand

against poor disclosure.

In the aftermath of the financial crisis, the Gov-

ernment issued new decrees to improve disclosure

requirements. Privately held, unlisted companies with

assets of Rp50 billion or more are now required to

submit and publish their audited reports. Bapepam

and the securities exchanges have issued new guide-

lines on disclosures, particularly on cross-border bor-

rowing and on off-balance-sheet and intragroup

transactions. Statistics on cross-border borrowings

are now compiled and monitored regularly.

ParticipantsSECURITIES FIRMS

Regulations should be overhauled to allow for lev-

els of risk. The innovative developments in margin

trading (planned for JSX) and derivatives (planned

for SSX) make this essential. JSX should adopt in-

ternational standards for assessing position and


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counterparty risk. An effective system will require

facilities for frequent monitoring of member-firm ex-

posures. Enforcement should be improved and strength-

ened to ensure that firms make returns. Exposures

incurred through trading and periodic spot-checks

should be monitored to ensure that firms’ returns are

honest. Firms should be obliged to demonstrate that

they have a working compliance function.

PENSION FUNDS

Indonesia has a sound basic framework for the de-

velopment of pension schemes, but their growth has

been distorted by macroeconomic policies favoring

high interest rates. Macroeconomic policies should be

changed to avoid distorting allocation decisions in the

capital market. The management of the State scheme

is not highly regarded. It should be restructured to give

a role to genuinely independent trustees.

It is likely that Indonesian schemes will face seri-

ous problems in the current crisis given their inap-

propriate asset mix. There will be a loss of confi-

dence in their ability to meet future liabilities as infla-

tion erodes the asset base. The Government should

ensure that liabilities will be met as part of a planned

restructuring of pension scheme investment policies.

The reconstruction should include removing limita-

tions on Jamsostek investment allocations—especially

those relating to equity, property, and, ideally, foreign

investment—but also require Jamsostek to demon-

strate long-term solvency.

LIFE INSURANCE COMPANIES

The actuarial solvency requirements for life insur-

ance companies (and pension funds) should operate

so as to deter inappropriate investment—i.e., exces-

sive reliance on short-term assets. Investing heavily

in short-term assets against long-term liabilities im-

plicitly assumes that the short-term assets will be

replaced at equivalent yields when they expire, which

is usually not the case. A solvency requirement that

ignores such a duration mismatch is not, therefore,

prudent or useful.

MUTUAL FUNDS

Mutual funds are intended to function as a retail in-

strument to develop a strong retail investor base, al-

though pension funds and insurance companies some-

times also invest in mutual funds. Mutual-fund in-

vestment should be restricted to nonbanks.

VENTURE CAPITAL

The lifecycle of companies should be studied with a

view to adjusting the regulation of venture capital

companies to allow greater freedom of action in the

sector. Typically, the sector is unregulated in other

countries because it caters only to professional in-

vestors. In Indonesia, however, venture capital com-

panies must be separately licensed and constituted.

The following are recommended:

• Encourage smaller companies by enforcing in-

tellectual property rights and limiting the power

of distribution companies, which were important

when transportation was more difficult. Now,

however, with better infrastructure, the role of

distribution companies has become restrictive

rather than permissive.

• Examine fiscal assistance for venture capital.

It is common to give tax breaks to investors in

venture capital companies. Capital gains tax

does not allow losses to be offset against gains,

which is essential in a high-risk venture capital

portfolio.

• Ensure that listing rules and processes do not

block exit routes for venture capitalists. JSX

rules do not exclude smaller companies but, in

practice, only large companies come to the

market. Admitting high-risk companies to the

main list can tarnish an exchange’s reputation

for quality. Most European exchanges have set

up second-tier markets, as Malaysia has done,

to accommodate this type of company. The SSX

market for smaller companies has not suc-

ceeded so far, and some of our respondents

suggested that JSX could run the market more

successfully.


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Notes

1Volume-weighted average price (VWAP) is a crude mea-sure used by fund managers to see if their brokers achieveda good execution. It is calculated for each stock as valueof trading in a day divided by share volume in the sameday. A fund manager judges a good execution as a buybelow VWAP or a sell above. Brokers in most markets,including Jakarta, try to game the measure by delayingexecution of orders until the end of the day to see if theprice at that time gives them an opportunity to beat VWAP.If they cannot beat VWAP, then they report that there wasno liquidity or that conditions were not right, and delaythe trade until the next day.

2FIBV is a voluntary body of which JSX is a member.Among other activities, it defines benchmarks for effi-cient exchange operation.

3Concert parties are agreements between apparently un-connected investors to act in concert to move the price ofa stock.

4Momentum traders act on the basis of short-term move-ments in the market. In particular, they try to get out be-fore the bubble bursts.

5“Indonesian Business—a Survival Guide,” Economist,30 January 1999.

6Claessens, Djankov, Fan, and Lang (1998).

7The secondary market for corporate bonds in the US isalmost entirely off the stock exchanges. Most investorsbuy and hold, so the markets for all but the most highlyrated bonds are illiquid.

8Licenses are required for stock exchanges, clearing guar-anty institutions, central securities depository, investmentfunds, securities companies, individual market profession-als, and credit-rating agencies.

9In fact, few jurisdictions have yet to develop workableasset-backed securities (ABS) regulations; hence, ABScontinue to be arranged through offshore special-purposevehicles. The lack of a simple procedure saddles issuerswith large legal bills.

10The quality of disclosure, nonetheless, had improved.In 1994, Indonesia was ranked as having the poorest ac-

counting standard among eight other Asian countries. In1996, however, there were more Indonesian listed compa-nies (89 percent) audited by the Big-6 accounting firmsand affiliates, compared to 70 percent in Korea and Ma-laysia and 71 percent in Japan.

11Conduits are arrangements whereby rolling loans arecollateralized against trade receivables. They are a form ofsecuritization.

12Indonesian issuers need to get approval for each issue,and a bond must be issued all in one go. Other marketsallow issuers to gain approval for omnibus issues, whichthen allows them to place the stock in smaller tranches atvarious rates and currencies as market conditions suggest.

13The information costs incurred by investors cannot berecouped easily in the secondary market, so swappingone bond for another causes the investor to lose his infor-mation on the sold bond and requires him to build up newinformation for the purchased bond.

14Intergenerational accounting measures the extent towhich expected tax revenue will be sufficient to cover thetransfer payments to the taxpayers and other Governmentexpenditures during the taxpayers’ lifetimes. In most de-veloped countries, the current generation will pass on adeficit to be paid by future generations as populations areaging and declining in number. The current generation,however, has a pension entitlement, which has not beenfunded properly. Emerging countries have different de-mographics, and evidence for Thailand shows a substan-tial surplus—i.e., future generations can look forward to alighter tax burden than the current generation.

References

“Business Briefing.” 1998. Far Eastern Economic Review.26 March.

Claessens, Stijn, Simeon Djankov, Joseph PH Fan, andLarry HP Lang. 1998. Ownership Structure and Corpo-rate Performance in East Asia. World Bank.

“Indonesian Business—A Survival Guide.” 1999. Econo-mist. 30 January.

Pefindo. General Rating Information.


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Appendix

The Indonesian Capital Market

THE CAPITAL MARKET SECTOR

Indonesia’s capital market lags behind its neighbors’.

The equity market, which has expanded quickly since

liberalization in 1988, still represents a share of GDP

smaller than that of other emerging Asian econo-

mies. As Table A1 shows, only Korea has a market-

value/GDP ratio in the range of Indonesia’s.

Korea, however, has a much more developed bond

market than Indonesia. Listed bonds are very small

in Indonesia, although they grew rapidly in 1996 and

early 1997.

Participants

Securities Firms

By end-1997, 215 brokers were licensed by the

Capital Market Supervisory Agency (Bapepam), 197

of which were Jakarta Stock Exchange (JSX) mem-

bers. Since foreign ownership up to 85 percent is

permitted, the larger firms, which consist of 45 joint

ventures, are in every respect foreign-controlled.

Firms range in size from large to very small. The

largest has a market share of just under 10 percent,

and the top 20 account for 60 percent of total value.

The top 20 firms’ share of large (block and crossing)

business is disproportionately high at 75 percent, and

their share of transactions is disproportionately low

at 34 percent.

Brokers are required to be licensed by Bapepam.

Minimum paid-up capital and working capital are

required for this purpose (Tables A3 and A4).

There are no other requirements, although larger

firms have prudential policies, which means they

maintain more than the minimum. Joint venture firms

are governed by their home regulator’s requirements

and so are adequately capitalized with appropriate

risk adjustments. Most small, domestic brokers are

seriously undercapitalized. Many broker-dealers (40

or more) have a minimum capital of Rp500 million

Table A1: Equity Market Capital and GDP, 1995

Source: Federation Internationale des Bourses de Valeurs (FIBV) Annual Report, 1996.

Equity Market Equity-market-Capital GDP capital/GDP Ratio

Equity Market ($ billion) ($ billion) (percent)

Jakarta 66.5 196.6 34

Korea 182.0 392.0 46

Kuala Lumpur 213.8 82.4 259

Philippines 58.8 72.6 81

Singapore 151.0 77.5 195

Thailand 135.9 142.9 95

Table A2: Number of Licensed Brokers, end-1997

Source: Bapepam, 1997 Annual Report.

JointFunction Domestic Venture Total

Broker/Dealer and Underwriter 71 39 110

Underwriter Only 0 3 3

Broker/Dealer Only 99 3 102

Total 170 45 215

Table A3: Minimum Paid-up Capital Requirements(Rp million)

Source: Implementing Regulation No. 45 (1995) Article 31 et seq., Capital MarketsLaw.

Domestic Joint VentureSecurities Securities

Type of Business Company Company

Broker/Dealer 500 1,000

Broker/Dealer and Underwriter 10,000 10,000

Investment Manager 500 1,000

Broker/Dealer and

Investment Manager 1,000 2,000

Broker/Dealer, Underwriter

and Investment Manager 10,500 11,000

Table A4: Minimum Working Capital Requirements(Rp million)

Source: Implementing Regulation No. 45 (1995) Article 31 et seq., Capital MarketsLaw.

Domestic Joint VentureSecurities Securities

Type of Business Company Company

Broker/Dealer 200 200

Broker/Dealer and Underwriter 500 500

Investment Manager 200 200

Broker/Dealer and

Investment Manager 400 400

Broker/Dealer, Underwriter

and Investment Manager 700 700


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($200,000 at precrisis rates and below $20,000 at

current rates) and nearly half have less than Rp10

billion. The Government plans to impose more re-

quirements, but only by raising the absolute levels,

probably of paid-up capital.

Foreign Investors

Foreign access to the market has been liberalized

and, on the surface, Indonesia has a fairly liberal re-

gime, with no restrictions on ownership of listed com-

panies outside the banking and brokerage sectors.

Foreign investors are limited to 49 percent holdings

in the banking sector and to 85 percent in the broker-

age sector. However, foreign ownership is forbidden

in large sections of the (unlisted) economy defined

as “strategic,” such as minerals and distribution com-

panies, which are a dominant force in Indonesia since

they are industry-specific, generally monopolies, and

effectively run.

Foreign investors—which throughout Asia mean

US and European (mainly UK) fund managers—

owned approximately 25 percent of the total listed

equity capital at end-1997. Inevitably—because of the

size of their transactions and familiarity—foreign hold-

ings tend to be heaviest in the best-known blue chips,

where foreign ownership is around 50 percent.

Foreign investors are generally more active than

average. Even in late 1997, when foreign investors

were less active than normal, they accounted for two

thirds of trading.

Their trades are usually larger than domestic in-

vestors’ (Table A7) and their orders are expected to

be bigger in the future.

Table A5: Foreign Ownership of JSX Stocks, December 1997

Source: Jakarta Stock Exchange Monthly Statistics, December 1997.

Top 10 Market Foreign Foreignby Market Capital Ownership Ownership

Capital Stock (Rp billion) (Rp billion) (percent)

1 Telemukasi 27,299 5,259 19.3

2 Gudang Garam 16,114 1,913 11.9

3 Indosat 10,562 3,648 34.5

4 Indah Kiat 4,513 2,262 50.1

5 Indocement 4,246 248 5.8

6 Polysindo 4,284 623 14.5

7 HM Sam Poerna 3,735 1,544 41.3

8 Astra 3,314 1,746 52.7

9 Indofood 3,296 1,541 46.8

10 Tambang Timah 2,969 1,016 34.2

Total, Top 10 80,332 19,800 24.6

Next 35 Stocks 46,609 10,881 23.3

Remaining Stocks 32,989 8,639 26.2

All Stocks 159,930 39,320 24.6

Table A6: Foreign Investor Participation,November–December 1997 (percent)


Buyer

Foreign DomesticSeller Investor Investor Total

Foreign Investor 31 17 48

Domestic Investor 19 33 52

Total 50 50 100

Table A7: Average Trade Size, December 1997


Average SizeType of Trade (Rp million)

Foreign Sell/Foreign Buy 123

Foreign Sell/Domestic Buy 39

Domestic Sell/Foreign Buy 53

Domestic Sell/Domestic Buy 24


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Pension Funds

Indonesia has a mix of pension provision schemes:

• public schemes for government employees

(Taspen and Asabri);

• a general State scheme, which is compulsory

for all employees, except in very small enter-

prises (Jamsostek);

• company schemes; and

• schemes run by financial institutions.

The legal framework for pensions was established

in 1969 when a law was passed governing pension

benefits for the civil service and armed forces. It

became the template for private schemes. The Pen-

sion Law of 1992 established pension funds as sepa-

rate legal entities with assets separate from those of

their founders. It also allowed financial institutions—

banks and insurance companies—to set up pension

funds for individuals, including self-employed work-

ers. The Social Security Law was also passed in

1992.

The framework theoretically allows all income

earners in Indonesia (over 80 million as of 1996) to

participate in a pension scheme, although in practice

only a small portion of workers are covered by pen-

sion schemes (Table A8).

All schemes are funded. Most are of the defined-

benefit type, i.e., related to final salary, so the opera-

tor of the scheme bears the actuarial risk of meeting

the obligations. Contributions to schemes are largely

employer-financed, limited in relation to salary, and

tax-exempt. Profits of schemes are tax-exempt, but

pension payments and retirement lump sums are not.

The Social Security scheme is limited in its asset

allocation. Table A9 compares the assets and invest-

ments of pension schemes.

The main points about pension funds are the fol-

lowing:

• Private schemes are the largest in the market

by a significant factor.

• Assets per active member are low for all

funds but disproportionately low for the public

schemes.

• Asset allocations are very heavily weighted to-

ward time deposits and Government debt (which,

in Indonesia, is all short-term).

• Only the company schemes have any significant

equity or property allocations.

Funds have no foreign assets. (Jamsostek is pro-

hibited from having any.)

Life Insurance Companies

There are some 90 life insurance companies

in Indonesia and they have been growing rapidly.

Their funds are invested in deposits (55 percent),

certificates of deposits (CDs), or SBIs (15 per-

cent), making a total of 70 percent in short-term

assets.

Mutual Funds

Mutual funds were allowed into Indonesia in 1988,

but grew slowly until the Capital Markets Law of

1995 established a clear legal framework for their

operations. Since then, the sector has expanded rap-

idly, from 7 funds in mid-1996 to 77 (managed by 20

firms) by end-1997, with 200,000 investors and as-

sets of Rp1.6 trillion (an average of Rp8 million per

investor). Mutual funds are tax-exempt on income

and capital gains.

Due to high interest rates, the funds are invested

mainly in fixed-income assets and bank deposits,

unlike in other markets, where they are invested

mainly in equity. The investments have performed

badly and the sector is depressed. The funds were

targeted at high-net-worth individuals and at institu-

Table A8: Scheme Membership, 1996

na = not available.Source: Directorate of Pension Funds, MOF.

Number ofScheme Members (million)

Civil Service—Taspen 4.00

Armed Forces—Asabri na

Social Security—Jamsostek 11.00

Private Schemes 0.90

Financial Institutions Schemes 0.14


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tional investors. In any event, most investors were

banks, which meant that the banks were buying their

own deposits through mutual funds in order to avoid

paying taxes.

Venture Capital and Private Equity

Venture capital companies, which number over

500, are licensed by Bapepam. However, there is

little domestic expertise to manage them, and, with

the exception of one partly State-owned company,

they are foreign-owned. The exception is a joint ven-

ture (State and stockbroker) entity that channels

money from the Government to small enterprises

throughout Indonesia. Most observers believe that

the private venture capital companies do not operate

properly. Their investments are relatively small (Rp40

billion in 1996) and declining. Like most Indonesian

investors, their focus has been on deposit investments

rather than on equity of small companies. There are

also companies linked to multifinance companies that

follow a typical venture capitalist style of heavy in-

vestment and board-level involvement in a small num-

ber of companies.

The sector does not enjoy any special tax advan-

tages, and its exit routes are limited by (i) the shal-

lowness of the domestic equity market for any but

the largest companies, (ii) the difficulty of gaining a

listing for smaller companies, and (iii) the absence of

any domestic, long-term equity investors.

The Surabaya Stock Exchange (SSX) did launch

a market aimed at smaller companies, but has so far

failed to attract all but 11 companies.

INFRASTRUCTURE

Equity Market

Equity markets are operated by JSX and SSX.

JSX is reckoned to have over 95 percent of the busi-

ness, but this was before the current crisis, when

crossings were usually directed to SSX. SSX vol-

ume is minuscule and it is unlikely that SSX will sur-

vive as an equity market much longer. Previous at-

tempts to preserve it as a regional exchange have

been abandoned, although it shares a building, listed

companies, and membership with JSX. Bapepam

plans to merge the equity markets, and SSX is ac-

tively pursuing other niches, notably derivatives and

bonds, following the path of the American Stock

Exchange in New York.

Turnover has also increased rapidly, reaching

Rp120 trillion in 1997 (Table A10). Velocity of turn-

over (computed as a ratio of trading to market capi-

talization, expressed as a percentage, and often used

as a measure of market liquidity) has risen since 1995,

reflecting increased foreign participation. By local

standards (and indeed by international standards) the

velocity is about par. It is similar to that in Hong Kong,

China; Singapore; and Thailand. It is higher than in

the Philippines and less than in Malaysia.

Table A9: Assets and Investments of Pension Schemes, 31 December 1996 (Rp billion)

na = not available.Source: Directorate of Pension Schemes.

Jamsostek FinancialMaximum Private Institution

Item Taspen Asabri Amount % allowed Schemes Schemes

Time Deposits 2,620 70 6,741 231SBIs 637 100Listed Equity 257 50 1,247 3Listed Bonds 388 50 1,300 6Unlisted Shares 1,353Direct Investment 71 10Property 22 10 1,729Others 80 10Foreign Assets 0 0Total 4,039 1,000 4,075 12,370 240

Assets per active member (Rp thousand) 1,010 na 374 4,572 1,707


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The JSX trading system is an automatic electronic

order book of the type found in many markets. Trad-

ing terminals are located on the exchange floor, al-

though remote terminals allowing read-access are

located in brokers’ offices. There is no technical rea-

son why the trading terminals are not located re-

motely, except, perhaps, the risks associated with

uncertain telephone connections.

Indonesian stocks are traded in New York and

London. Four stocks are listed on the NYSE: Gulf

Indonesian, Indonesian Satellite, PTT Telkom, and

PT Tri Polytu—the first three through initial public

offerings (IPOs). London trading of Indonesian

stocks in 1997 amounted to £1.3 billion ($2.2 billion).

NYSE trading in 1997 was $2.1 billion, compared to

JSX trading of Rp120 trillion or $42 billion (Federa-

tion Internationale des Bourses de Valeurs [FIBV]

figures converted at month-end exchange rates).

Equity Primary Market

JSX, the dominant equity market, lists 287 com-

panies with an end-1997 market value of Rp160 tril-

lion (down from Rp265 trillion in July 1997). Since

1990, it has attracted a significant number of new

companies’ IPOs (35 IPOs valued at Rp4 trillion in

1997) and privatization issues. It has also seen a strong

upward price movement. These have combined to

contribute to rapid growth in market capitalization,

which became even stronger in 1993/94.

Issuers on JSX include private companies, State

enterprises, and a large number of subsidiaries of

listed holding companies. The companies represent

a range of industries. The size of issues is heavily

concentrated in the largest companies. The top 5

percent of companies (14) represent 56 percent of

the total listed market value but only 42 percent of

the trading. FIBV figures indicate that these levels

are about normal. Widespread, but anecdotal, evi-

dence suggests that almost all companies are very

tightly held, with the founder group holding about 70

percent.

Companies can be listed on either JSX or SSX

and are generally listed on both. The listing require-

ments are the following:

• two years of profitability before application,

• minimum of 1 million shares (Bapepam is trying

to enforce a minimum of 50 million),

• minimum of 200 shareholders,

• total assets of at least Rp200 billion and equity

capital of at least Rp7.5 billion, and

• paid-up capital of at least Rp2 billion.

None of these is especially demanding and most

listed companies easily exceed them. The require-

ment for two years’ profitability will, however, ex-

clude start-ups and high-technology companies. Ex-

emptions may be granted by the Ministry of Finance

(MOF), but it is not clear how often these are sought

or gained.

Table A10: JSX—Basic Statistics, 1990-1998

a Using end-year market capitalization.b As of March.c Annualized.Source: Jakarta Stock Exchange.

Number of Market Value Trading Velocitya

Year Companies (Rp trillion) (Rp trillion) (percent)

1990 123 14.2 7.3 51.41991 139 16.4 5.8 35.41992 153 24.8 8.0 32.31993 172 69.3 19.1 27.61994 217 103.8 25.5 24.61995 238 152.2 32.4 21.31996 253 215.0 75.7 35.21997 282 159.9 120.4 75.3

1998b 287 212.4 117.2c 55.2


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Issuers are required to deliver regular reports to

Bapepam and to publicly announce any material events

that may affect the share price (within two days accord-

ing to Bapepam but within the same day according to

JSX rules). Directors or any party holding more than 5

percent must announce any changes in their holding.

Indonesia has strong laws on preemption rights: only

rights issues are allowed for listed companies, pre-

venting the emergence of share-option schemes, which

require issues to new shareholders in management.

Companies are admitted to listing on JSX if they

conform to the listing requirements. Since early 1998,

they have no longer been required to list on SSX as

well. The number of IPOs has been substantial; 1997

saw 35 IPOs with a total value of Rp4 trillion. The

average size of over Rp100 billion and the fact that

the smallest IPO value was Rp27 billion suggest that

the IPO market is mainly for larger companies; smaller

companies seem not to have access to the market.

IPO methods differ according to the firms’ size.

Larger issues (over $100 million) go through a book-

building process; the organizing broker assesses inter-

est among investors before the issue and a price is

established to clear the market. Smaller issues tend to

be offered at a fixed price and underwritten. New

shares are traded in allotment-letter form (i.e., a ne-

gotiable note specifying an allocation). The process-

ing of allotment letters or scrips represents a major

(some say the major) cost of running an IPO. Before

the crisis, IPOs attracted numerous retail applications.

Existing companies can issue more shares only

through underwritten rights issues. In 1997, there

were 35 such issues with a total value of Rp15.8

trillion. Again, the average size of Rp450 billion for

rights issues confirms that the listed primary market

is for large issues only. Both IPOs and rights issues

continued through the second half of 1997.

The Bond and Fixed-income Market

Domestic Bonds

The bond market is relatively underdeveloped.

Private sector bodies were prohibited from issuing

bonds until 1988, and the Government has been ef-

fectively prohibited from issuing bonds since 1967

by the balanced-budget requirement. In 1988, pri-

vate bonds were permitted, but the market was slow

to take off until the Capital Markets Law set a

clearer regulatory framework.

In contrast, the equity market grew rapidly in the

same period. A part of the differential reflects the

greater interest among foreign investors in equities,

which offer exposure to the long-run growth of the

Indonesian economy; bonds have no upside, only

downside risk. (An investor will, if all goes well, get

no more than what is promised. But if the issuer de-

faults, the investor gets less. In contrast, equity has

upside potential.) Main investors in bonds are pen-

sion funds, insurance companies, and corporations.

Since 1997, mutual funds have been active buyers.

The wholesale bond market remains largely over

the counter and illiquid. Of the 14 firms that act as

informal market makers, 7 are SSX members and 7

are banks; hence, they are regulated by Bank Indo-

nesia (BI), not SSX. It is clear from SSX statistics

that the secondary market is still illiquid, with the turn-

over at about 5 percent of the outstanding issues

before the financial crisis. During the crisis, trading

dropped even further to less than 1 percent, although

market participants interviewed for this study noted

that there is less “buy-and-hold” behavior now and

that liquidity has improved.

From 1996 to the onset of the crisis, Indonesian

corporate bonds—both listed and private place-

ments—expanded considerably. Issuance was es-

pecially rapid up to August 1997, but ceased at the

onset of the currency crisis. Bonds are normally is-

sued at par with quarterly coupon payments. Matu-

rities vary but have mainly been stable for five years

in the 1990s.

Bonds for public offerings must be listed on a do-

mestic stock exchange—which, in practice, has

meant SSX—and obtain Bapepam approval. The

bonds must comply with SSX listing requirements,

which are not particularly demanding and potentially


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open the bond market to a large number of compa-

nies. However, issuers are the largest companies in

the Indonesian market and only the best-known names

have managed to gain investor acceptance and to is-

sue bonds. Bapepam regulations require bonds to be

rated—a complex and demanding, although not very

costly, process for lesser corporations.

Costs for issues are high. A study by Pefindo

shows that bond-issue costs are over 5 percent of

money raised by the issue, consisting mainly of the 4

percent underwriting charge (also payable on MTNs

but not on commercial paper [CP]). Annual costs

are also high, estimated at over 2.5 percent. (Initial

and annual costs in other markets are a few basis

points, certainly far less than 1 percent.) Given these

costs, plus the heavy commitment of management

time and protracted timetable, companies will seek

bond finance only if it offers features which are ab-

solutely unattainable through other debt instruments.

There is no Government bond market since the

Government is prevented by the Balanced Budget

Law of 1967 from issuing bonds to finance deficits.

BI conducts open-market operations using SBls,

which dominate the market. They are, however, only

short-term bills rather than bonds, having a duration

of less than one year. There is, in consequence, no

“risk-free” yield curve to serve as the basis for pric-

ing other bonds. Difficulty in pricing is a further im-

pediment to the development of a domestic corpo-

rate bond market.

International Bonds

In 1996/97, Indonesian issuers were significant

players in the international bond market. The lower

interest rates charged on dollar and yen debt attracted

Indonesian borrowers. In 1996, loans totaled $5.3

billion—90 percent in dollars, the rest in yen. Most

were unhedged or swapped.

The main issuers were private finance companies

(80 percent), although the Government, private banks,

private corporations, and public entities all partici-

pated. Bonds were issued and traded under Interna-

tional Securities Market Association rules for the

Eurobond market.

Table A11: Private Bond Issuance by Maturity, 1990-1997

na = not available.a No data on maturity.Source: Sigma Batara Special Analysis.

Maturity

Year 1–4 Years 5 Years Over 5 Years Othersa Total

Number of Bonds

1990 0 3 1 0 4

1991 0 3 1 0 4

1992 0 12 4 0 16

1993 0 12 4 0 16

1994 1 4 1 0 6

1995 1 7 1 0 9

1996 0 10 2 0 12

1997 0 11 7 1 19

Nominal Value (Rp billion)

1990 na 85 150 na 235

1991 na 125 25 na 150

1992 na 906 500 na 1,406

1993 na 780 1,125 na 1,905

1994 25 475 250 na 750

1995 688 1,548 100 na 2,336

1996 na 2,450 300 na 2,750

1997 na 3,800 1,725 600 6,125


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Commercial Paper

CP has been an attractive alternative source of

funding. The issuer derives little additional benefit

from funding itself in the bond markets, and this ac-

counts for issuers’ eager acceptance of the CP or

private placement market. Aside from offering fund-

ing for a shorter period and at a lower cost than bonds,

CP market issues that can best identify a client’s

funding needs can be arranged by banks. For an is-

suer, the cost of borrowing using CP is generally

below that of conventional bank borrowing rates.

Short-term CP can usually be rolled over and there-

fore offers medium-term funding.

The market expanded rapidly in the early 1980s,

but a regulatory change in 1995 requiring CP to be

of investment grade has stalled growth, particularly

of property and finance companies, which were

major users.

Private Placements

Like the public bond market, the market for pri-

vate placements was a strong feature of the Indo-

nesian capital market in 1996/97. Private investors

were attracted by its cheap and quick issuing pro-

cess. By its nature, the market is unregulated (and

therefore unmeasured) and investors need to exer-

cise considerable due diligence. This, in turn, means

that the costs to investors are high and they will

therefore only take (i) issues by large companies

which have chosen to issue privately or (ii) large

proportions of issues by smaller companies with

which they develop a deep and significant relation-

ship. (The norm for a placement by a US corpora-

tion is from one to six investors.) Since (ii) is not

possible with Indonesian companies, private place-

ments, like public offerings, have been confined to

the largest Indonesian companies. The practice in

this market is to hold to maturity. There is little sec-

ondary-market activity.

The difficulties of small companies in accessing

bond markets are not unique to Indonesia. (The Euro-

pean Commission has sponsored a study of the prob-

lem in Europe.) Only the US seems to have devel-

oped procedures and, more important, investors who

are willing to invest in bonds of smaller companies.

Asset-backed Securities

Indonesian regulators have only recently started

to build the framework for asset-backed securities

(ABS). SSX is working on rules to accommodate

ABS, and Bapepam promulgated rules in late 1997.

However, the tax and accounting regime remains

unclear. But this is not unusual outside the US. In

Indonesia, as elsewhere, ABS are operated through

offshore special-purpose vehicles, which are typi-

cally expensive to set up but effective.

In Indonesia, the only current ABS are conduits

for trade receivables run by Australian banks. An

Asian Development Bank proposal supports devel-

opment of secondary (housing) mortgage facilities

(SMFs), and a ministerial decree enables establish-

ment of a market for them.

Derivatives

Indonesia has no formal derivatives market. How-

ever, there is a proposal for SSX to launch an index

futures contract, which would provide a niche for

SSX as its equity business disappears. The contracts

would be for one- and three-month cycles. There

are no proposals for other derivatives.

The situation as of 1998 was as follows:

• A member-based risk management committee

met twice.

• Rules drafting was half finished. SSX was re-

sponsible for trading rules and Bapepam for suit-

ability and other client rules.

• The SSX trading system was judged to be ac-

ceptable.

• Risk management and margins were to be man-

aged by the central clearer.

• Simulations using live data commenced in May

1998 and ran for six months.

Live running was expected in six to nine months.

(However, this was not yet achieved as of 1999.)


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SETTLEMENT

Equity Settlement

The equity settlement system remains paper-

based, with net cash payments. The stock side is

complicated by the fact that all Indonesian

shareholdings are represented by certificates of one

round lot of 500 shares. Therefore, a holding of 5,000

shares requires 10 individual certificates of 500

shares each. Until recently, the lot size was 1,000

shares, but reduced to 500 shares in order to im-

prove liquidity.

Holdings are in registered form, i.e., each certifi-

cate bears the name of the holder, and trading re-

quires cancellation of the old certificate and issu-

ance of a new one. The system runs on T+4, (i.e.,

settlement occurs on the fourth business day after

the trade) and penalties for failure to deliver are se-

vere, including fines and suspension from trading.

Registrars, of which there are five, are required to

deliver new certificates within seven days, but stan-

dards are frequently not met.

Foreign and large local investors leave their hold-

ings with depositories. Five operate in Indonesia: Hong

Kong and Shanghai Banking Corporation, Standard

Chartered, Deutsche, Citibank, and Jardine Fleming.

The lack of a formal system of stock borrowing

and the existence of penalties for late delivery force

firms to rely on an informal interfirm system. A for-

mal system exists in New York for the Indonesian

stocks listed on NYSE.

The settlement system was restructured under the

Capital Markets Law. Before 1995, the two settle-

ment functions of cash clearing and stock transfer

were performed by one organization. The new law

follows the US model and separates the two func-

tions—clearing being the responsibility of the PT

Kliring Perjamin Efek Indonesia (KPEI) and stock

transfer falling to the Kustodian Sentral Efek Indo-

nesia (KSEI), which was intended to become the

central depository.

The KSEI was incorporated in late December

1997. It is owned by 54 shareholders (Table A12).

KPEI is owned by JSX (90 percent) and SSX (10

percent). It became operational in 1997 and handles

net payments among member firms. Only some mem-

ber firms are eligible to be clearing members by vir-

tue of their size and strength. The rest are required

to clear through a clearing member. KPEI has three

directors—the president and one representative each

from Citibank and KPEI.

Under the Capital Markets Law, KPEI implements

a central depository system, which will involve immo-

bilization or dematerialization—a choice left to users,

as both can be accommodated under Indonesian law.

The depository is a self-regulatory organization (SRO)

and, as such, its rules require Bapepam approval.

The new system will reduce transactions to elec-

tronic messages. Uplift of certificates will be an op-

tion for investors. Certificates for lodgment in the

depository will first be validated for good delivery by

registrars before delivery to the depository. The new

system is designed by a small team made up of rep-

resentatives from KPEI, KSEI, and Bapepam. KSEI,

the depository, was granted a Bapepam license on

11 November 1998, while the book-entry settlement

system is scheduled for implementation in 2000.

Bond Settlement

Bond market settlement is all interoffice. Bonds

are issued in bearer form.

Credit Rating

Pefindo conducts credit rating. Its international

partner since 1996 has been Standard and Poor’s

Table A12: Number of KSEI Shareholders

SE = stock exchange.Source: KDEI website and interview.

Type of Shareholder Number

SE Members (only the most active) 32

Custodian Banks 14

Registrars 5

Stock Exchanges 2

Clearing Corporation 1

Total 54


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Pefindo sees itself as stricter than the other mem-

bers of the ASEAN Forum of Credit Rating Agen-

cies (AFCRA). Its precrisis (May 1997) ratings were

generally lower than others (Table A14).

Information problems among Indonesian compa-

nies include (i) multiple layers of ownership; (ii) tight

ownership (even in listed companies, only 30 per-

cent is held outside the founder family); (iii) complex

corporate structures; and (iv) doubtful quality of au-

dit staff and reporting.

Pefindo rates both long-term debt and CP. Only

companies with a rating are allowed by Bapepam to

issue bonds and only companies with investment-

grade ratings are permitted by BI to issue CP. Com-

panies were not particularly concerned with rating,

seeing it merely as a stamp necessary for Bapepam

registration or BI approval. However, since 1996,

prices have reflected ratings, and companies have

become more concerned about ratings; some have

even engaged in corruption to secure a desired rating.

Pefindo’s staff includes 27 analysts, 21 of whom have

or are studying for a master’s or doctorate degree.

Regulation and Enforcement

Bapepam

The structure of regulation was put in place by

the Capital Markets Law and augmented by various

decrees. Bapepam is the overall regulator, with SROs

below it.

Bapepam is the pivotal player in regulation; it

grants licenses and regulates trading, investment

settlement, and issuance. (BI’s role is small, being

(S&P), which gives Pefindo a degree of credibility.

Duff & Phelps commenced operations in Indonesia

in 1998 and formed the PT Kasnic Duff and Phelps

Credit Rating Indonesia.

Established in 1994, Pefindo is nominally indepen-

dent of the Government, although Bapepam appoints

its steering committee. Its ownership is dispersed

among 120 shareholders, including securities firms,

pension funds, and stock exchanges.

Pefindo started slowly, but its rating activity picked

up in 1996 and early 1997. By then, about 250 com-

panies had been rated, although only 140 ratings had

been published. It generally gives higher ratings than

S&P (Table A13).

Pefindo claims the rating difference reflects a

more refined gradation suitable for local investors.

(International investors will go to the international

agencies anyway.) International agencies are con-

strained (while Pefindo is not) by the rule that corpo-

rate ratings cannot exceed the sovereign rating.

Table A13: Distribution of Ratings of IndonesianCompanies, 1997 (%)

Source: Pefindo.

Pefindo S&PRating Rating Rating

AAA 1 0

A A 14 0

A 26 3

BBB 38 28

BB 21 56

B 0 13

Total 100 100

Table A14: Distribution of Credit Ratings in Selected Asian Markets, May 1997 (%)

Source: Pefindo.

Rating Agency Credit Information Thai Rating andRating Pefindo Indonesia of Malaysia Bureau, Inc. Philippines Information Services

AAA 1 9 13 4

A A 14 19 29 21

A 26 23 52 47

BBB 38 40 3 27

BB 21 9 3 1

B 0 0 0 0

Total 100 100 100 100


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confined to regulating CP issues.) MOF determines

capital market policy while Bapepam is responsible

for the guidance, regulation, and day-to-day supervi-

sion of the market. It has rule-making powers but is

legally obliged to consult with the industry. Bapepam

is an administrative unit of MOF and is funded like

any other Government department. However, a num-

ber of persons interviewed for this study suggested

that its power and command over resources are

greater than those of the other departments.

SROs have independent rule-making competence

but must clear rules with Bapepam. The annual bud-

gets of SROs are set by Bapepam, whose chairman

is appointed by the minister of finance and approved

by the President for an unspecified term. The cur-

rent chairman is a long-term staff member.

Bapepam currently has the following departments:

(i) legal, (ii) enforcement (added in 1997), (iii) in-

vestment management and research, (iv) securities

transactions and institutions, (v) corporate finance,

and (vi) accounting standards (added in 1997).

It (i) oversees IPO and issuance processes, (ii)

regulates the securities firms (including capital ad-

equacy), (iii) controls the settlement process, and

(iv) generally governs access to the industry. Theo-

retically, the exchanges regulate trading among

members while Bapepam regulates the clients.

Some areas, especially insider trading, straddle this

divide. Bapepam also controls the qualifying exami-

nations for those intending to work in the securities

industry. About 4,000 people take the examination

each year.

Stock Exchanges

Since SSX is in transition, this section focuses on

JSX. Privatized in 1992, JSX operates as a limited-

liability company owned by licensed brokers and un-

derwriters. It is limited to 200 members, which must

be securities companies, and each has one vote.

The exchange is governed by a board of five com-

missioners and operated by a board of four direc-

tors. Both boards are elected by the members. The

commissioners must be stockbrokers. There is no

chief executive position. The exchange has three

committees: membership, listing, and trading. JSX’s

main income sources are a transaction fee of 0.04

percent and a listing fee of 0.1 percent of the face

value of listed shares.

SRO = self-regulatory organization.Sources: Capital Market Blueprint—Five-Year Development Plan (1996–2000), Ministry of Finance; Bapepam.

Figure A1: Capital Market Regulatory Structure


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Bapepam licenses exchanges and can license

competing exchanges, but only if a sufficient num-

ber of broker-dealers request it.

Accounting standards and disclosure

Indonesian accounting standards are broadly simi-

lar to international standards such as US Generally

Accepted Accounting Principles (GAAP), the ma-

jor difference being that Indonesian standards do not

require marking of financial asset holdings to mar-

ket. As a consequence, corporations, particularly

banks, can carry depreciated assets at book value

without revealing their true market value.

Bankruptcy law

Indonesia has no equivalent of the legal process

by which creditors can force a company into receiv-

ership. In essence, as long as a company can con-

tinue to meet its current costs of wages and raw

materials, it can continue indefinitely without ser-

vicing its debts or capital commitments. It is pos-

sible to get a court order, but the process is long

and tortuous—one estimate is two years for the court

order and five to ten years for the final wind-up.

The process has worsened during the current crisis

as the number of companies in default has risen

and will continue to rise.

Intellectual Property Rights

Indonesia has laws on intellectual property rights,

but many feel that they benefit only foreign compa-

nies and will not be applied to protect Indonesian

intellectual property, which is one reason why smaller

companies tend to avoid public capital markets.

rising to the challenge in asia: a study of financial markets · (malaysia), ken-ichi takayasu...

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