This Selected Issues paper for Indonesia reports that following the major cleanup of the banking sector after the crisis, banks’ performance has improved as net interest margins and profitability have increased. Public and external debt ratios have declined and international reserves have risen, reducing domestic and external vulnerabilities. Indonesia stands out as having experienced a slower recovery in investment and exports than other countries hit by the Asian crisis. Recognizing the challenge, the government has adopted a sound medium-term strategy focused on boosting economic growth.


This Selected Issues paper for Indonesia reports that following the major cleanup of the banking sector after the crisis, banks’ performance has improved as net interest margins and profitability have increased. Public and external debt ratios have declined and international reserves have risen, reducing domestic and external vulnerabilities. Indonesia stands out as having experienced a slower recovery in investment and exports than other countries hit by the Asian crisis. Recognizing the challenge, the government has adopted a sound medium-term strategy focused on boosting economic growth.

IV. The Banking Sector: Recent Developments and Future Issues1

A. Introduction

1. The Indonesian banking sector has been slowly recovering since the Asian crisis. Measures undertaken during the crisis have on the whole been successful.2 Since then, the level of capitalization, profitability and liquidity of the overall banking sector has continued to improve, and bank credit growth have gained momentum in recent years, although bank intermediation has recovered slowly.

2. As Indonesian banks gradually resume their role as financial intermediaries, they may be entering a phase of increasing risks. These risks arise from growing lending activity and increasing competition that may put pressure on asset quality and margins. The banks’ capacity to manage these risks, as well as the supervisors’ ability to oversee risk management practices, will determine the future vulnerability of the sector and its scope for supporting economic growth.

3. This chapter reviews recent developments in the banking sector, and assesses the sector outlook going forward. To these ends, it analyzes the supply and demand factors underlying recent trends in bank credit, assesses the main risks and vulnerabilities facing the banking sector, and discusses policy measures to address these issues.

B. Structure, Performance, and Vulnerabilities

The structure of the financial sector has remained broadly unchanged since 2003

4. Indonesia’s financial sector is dominated by banks, a substantial proportion of which are state-owned or state-controlled (Table 1 and Text Chart). Following the dramatic reduction in the number of banks from 238 in 1997 to 138 in 2003, and the privatization of significant shares in banks, the banking system’s structure has remained relatively stable. The 15 largest banks account for about 70 percent of banking assets, while state banks and regional development banks account for about 46 percent (41 percent state banks, 5 percent regional development banks).3 Conversely, about 75 small banks each have assets below Rp 1 trillion and a market share of less than 0.1 percent. The weight of nonbank financial institutions (NBFIs)—finance companies, mutual funds, pension funds, and insurance companies— remains limited, although they have recently shown significant asset growth.

Table 1.

Indonesia: Financial System Structure, 2000–2004

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Sources: Bank Indonesia, Ministry of Finance, Insurance Council of Indonesia, and Jakarta Stock Exchange.

Total assets at end-2004 are estimated.

Assets have been restated from amounts reported in the 2000 Annual Report to reflect adjustment in technical reserve amounts.

Total credit provided.


Indonesia: Financial System Structure, 2004

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004

Bank intermediation has recovered slowly, while banks’ financial performance has improved

5. Over recent years, Indonesia has experienced significant growth in bank credit and a shift toward consumer lending. Over the period 2000–2004, annual loan growth averaged about 19 percent on a gross nominal basis, far outpacing growth in neighboring countries. Mirroring the strong growth in domestic consumption, banks have focused more on consumer lending and have moved away from lending for investment and working capital. In doing so, they have made a marked shift from the pre-crisis period, when their focus was almost entirely on lending to large corporations.


Indonesia. Growth Rate of Bank Credit to Private Sector

(2000–2004 average)

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004

Indonesia. Bank Credit Allocation, 2000–2004.

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6. The level of credit compared to the size of the economy appears, however, modest and bank intermediation overall has recovered slowly. The banks credit to the private sector (BCPS) ratio in Indonesia remains slightly above 20 percent and is significantly lower than in neighboring countries. Assessment of the recent credit growth should also consider the low base which the country is coming from; at end-2000, loans were just 24 percent of total assets (due to the substantial loan write-off during the crisis and the accumulation of recapitalization bonds) before growing to 42 percent by end-2004—versus about 70 percent before the crisis. Concurrently, banks’ recapitalization bond holdings have decreased from 56 percent of total assets at end-2000 to about 30 percent at end-2004, partly reflecting overall nominal asset growth, and partly sales of bonds in the secondary markets and to mutual funds.


BCPS as percent of GDP

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004

7. With renewed credit growth, the ratio of nonperforming loans has improved and profitability recovered, while capital adequacy has remained high (Figure 1, Table 2).4 Over the last few years, the nonperforming loans (NPL) ratio has continued to decline and reached about 4 percent at end-2004, driven largely by an expansion in loans. Profitability has been buoyant, with after tax net income-to-average equity (ROAE) at end-2004 as high as 26 percent due to robust credit growth, large margins, and lower loan loss provisions. At the same time, capital has remained high, with the sector capital adequacy ratio (CAR) around 21 percent at end-2004.

Figure 1.
Figure 1.

Indonesia: Financial Soundness Indicators for Large Banks, 2000–2004

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004

Source: Bank Indonesia.
Table 2.

Indonesia: Financial Soundness Indicators of Large Banks, 2000–2004

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Source: Bank Indonesia.

8. Indonesian banks’ financial performance compares favorably in the context of the ASEAN region.5 Indonesian banks have higher net interest margins, underpinning their profitability. Capital (as measured by the equity-to-total assets ratio) is about average, while costs are among the lowest. However, Indonesian banks have the lowest share of loans to assets ratio in the ASEAN context, reflecting the relatively more severe impact of the crisis (Figure 2).

9. Market indicators of performance have improved, reflecting robust valuations Distance-to-default (DD) measures for large listed banks, for instance, significantly increased during 2004 reflecting improved equity prices and stronger bank financial conditions (Figure 3). The DD measures the number of standard deviations a bank’s asset value is away from “default” (i.e., the firm’s assets are less than its current book value of liabilities). The smaller the DD the higher the probability of default.6

Figure 2.
Figure 2.
Figure 2.

Indonesian Banks in the ASEAN Context

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004

Source: Bankscope
Figure 3.
Figure 3.

Indonesia: Distance-to-Default Measures for Large Banks, 2000–2004

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004

Source: IMF staff calculations.

These registered improvements in financial performance may, however, overstate the actual improvements.

10. The above trends should be interpreted carefully, as the standard financial ratios may overstate banks’ performance and soundness. On asset quality, new asset classification rules introduced in early 2005 are likely to lead to higher reported NPLs. Moreover, a more complete measure than the NPLs is the compromised asset ratio, which at end-2004 remained high at 13 percent for all banks (mainly concentrated in state banks, see text table), although it has also been declining.7 Also, the recent strong profitability relies on high spreads that may not last given the increasing competition, especially in consumer lending. Finally, although banks’ capital adequacy ratio is high, it may reflect low risk-weighted assets as banks’ substantial holdings of government bonds are zero-weighted and loans to state-owned companies are given only a 50 percent risk-weight. Alternative measures of capital, such as equity to total assets, seem adequate in comparison to peer banks, bulternative measures of capital, such as equity to total assets, seem adequate in comparison to peer banks, but may be also not fully capture the specific risks in the Indonesian banking system.

State and Private Banks’ Financial Soundess Indicators, December 2003-04 1/

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Top 16 prior to 2003. Top 15 in 2004 reflecting mergers.

11. State banks’ financial performance has been less favorable than that of private banks. With the exception of BRI, lending growth rates and financial performance of state banks are generally less favorable than that of private banks. State banks have compromised assets more than twice those of private banks, as they have made less progress in cleaning up their loan portfolios, partly because of restrictions on the type of restructuring that they may undertake.8 In addition, weaker lending and risk management practices and shareholder oversight in state banks create vulnerabilities that may lead to future NPLs, especially in an environment where lending (e.g., for infrastructure and to support economic growth) is being encouraged. State banks also have significantly less liquid assets than private banks, and their capital adequacy positions are more likely to be overstated because of their larger bond holdings and lending to state-owned companies.

Despite recent improvements, there is scope for strengthening corporate governance and risk management…

12. Governance practices, including in state-owned banks, could be further improved (Box III. 1). While financial restructuring is more or less complete, banks still have some way to go in improving internal governance and operations, including corporate governance, internal controls, risk management, and management information (MIS) and information technology (IT) systems. Weaknesses are most notable in state banks where management does not always have a clear strategic mandate, shareholder oversight is sometimes less effective, and outside interference is more likely. Indeed, in the last couple of years, three of the largest state banks have seen major cases of fraud. The recent changes in management at state banks should provide impetus to a renewed effort to strengthen governance. In contrast, strategic investors in private banks identified weaknesses early in the reform process and have made substantial investments to improve governance, bringing in professional managements with international experience.

13. Risk management capacity and procedures in large banks are being upgraded, although full implementation will take time. Banks are making efforts to improve risk management, and many of the larger banks aim to be ready for Basel II by 2008. However, implementing these changes will require a sustained effort, as they involve a major shift in the way banks are operated.

…as well as enhancing the legal and information environment

14. The operating environment for banks remains difficult despite recent improvements. The establishment of a credit reference bureau is a positive development toward sharing information covering bank’s debtors. However, governance and transparency in the corporate sector is not always up to standard, making it difficult for banks to assess a borrower’s true financial condition. The broader legal system also has shortcomings, with a bearing on banks’ operations. For instance, the bankruptcy process is slow, with courts tending to favor debtors, hence increasing moral hazard behavior and banks’ losses in the event of default. Against this background, corruption and fraud remain important concerns.

15. These structural weaknesses help explain why the Indonesian banking system faces lingering fragilities. The system continues to be rated among the lowest in the region (see Table), even after taking into account Indonesia’s sub-investment sovereign rating.

Moody’s Weighted Average Bank Financial Strength Index 1/

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Source: Moody’s Investor Service.

Constructed according to a numerical scale assigned to Moody’s weighted average bank ratings by country. “0” indicates the lowest posible average rating and “100” indicates the highest possible average rating.

C. Prudential Regulation and Supervision

Prudential regulation and supervision continue to improve…

16. Bank Indonesia has responded to the structural weaknesses of the banking sector by emphasizing stronger governance, internal controls, and risk management in banks. In recent years, prudential guidelines regarding corporate governance, internal controls, internal and external audit, and risk management have all been upgraded. BI’s Banking Architecture Plan (Box III.2) includes many important initiatives to further improve bank operations. In this respect, BI is requiring bank commissioners, directors, and risk managers to attend formal training and pass a certification process.

17. More generally, prudential regulations are being brought into line with the Basel Core Principles (Box III.3).9 BI is addressing remaining gaps, such as the lack of consolidated supervision and the need for further tightening of corporate governance and related-party definitions. In addition, BI has since 2000 begun to shift the focus of supervision from compliance regulations to a risk-based framework. The new framework emphasizes identification of risks faced by institutions, and assessment of their capacity to manage those risks. BI has also established an internal Financial Stability Unit to monitor and assess overall financial stability. BI now regularly publishes a Financial Stability Review, which includes a thorough discussion of the risks facing the financial system.10 Mindful that the financial links between banks and NBFIs (e.g., with mutual funds and finance companies) are becoming closer, the Ministry of Finance is strengthening the regulatory framework of NBFIs. Specifically, regulations are being brought into line with international good practice, “fit and proper” tests for senior management instituted, minimum capital requirements put in place, and on-site examination strengthened.

18. Time and training will be required to build the experience needed to enable supervisors to fully assess the risk taking practices of financial institutions. Internal procedures will necessarily change and significant amount of investment in human capital will be required. Implementation will not only require changes in the supervisory culture but also a different response from supervised institutions. These changes will therefore be more difficult to implement than reforms in regulations, and will take time to put in place.

…while a new financial sector safety net is being phased in

19. The replacement of the blanket guarantee introduced at the time of the crisis with a financial safety net has begun (Box III.4). The first step in phasing out the blanket guarantee system was taken in April 2005, while preparations for the financial sector safety net are underway. The blanket guarantee will eventually be replaced by a limited deposit guarantee scheme that will cover deposits up to Rp 100 million by March 2007.

D. Credit Growth: Determinants and Risks

20. Credit growth is likely to remain buoyant and bank intermediation to improve, posing a challenge for banks in managing risks stemming from growing balance sheets and tougher competition. This section examines the factors underlying recent trends in bank credit, looking at both the supply and demand side, and considers the balance sheet risks that continued credit growth might entail going forward. As noted earlier, Indonesia has one of the lowest bank credit to the private sector (BCPS) ratios in the region and, loan-to-deposit and loan-to-asset ratios remain low, suggesting that banks have room to increase financial intermediation. Indeed, econometric analysis suggests that Indonesian banks are in a catching-up process, where banks with lower initial loan-to-deposit ratios tend to have greater rates of credit growth (Box III.5).

Credit growth has been closely related to supply-side variables, while demand variables have played a more limited role

21. Over the last few years, bank credit growth has been closely related to improvements in banks’ balance sheets and to an easing of supply-side constraints. Econometric analysis indicates that over the last four years the rate of credit growth has been positively correlated with capital adequacy ratios, and negatively correlated with the net compromised asset ratios of banks. Low capitalization, in particular, has constrained credit growth, as banks with capital below prudential limits have seen their credit growth significantly limited (dummies for CAR below legal limits are significant and with negative sign). The estimated magnitude of these correlations appears significant. For example, using the basic version of our econometric model (B2), a 1 percentage point increase in the capital ratio is associated with an increase in bank credit of about 0.7 percent, while a 1 percentage point reduction in the net compromised asset ratio corresponds to an increase in bank credit growth of about 0.4 percent. This indicates that continued progress toward better capitalization and healthier balance sheets would likely be associated with continued credit growth. At the same time, profitability and liquidity flow variables do not appear important in shaping credit dynamics.

Indonesia. Determinants of the Growth Rate of Bank Credit

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Include time dummies

The regression including this variable is not robust to the elimination of outliers and/or adjustments for heteroskedascity in the error term.

Note. Fix effects panel regression using quarterly data 2000–2004 with one-period lagged repressors. t-statistics in parenthesis. *, **, *** denote statistical significance at the 10 percent, 5 percent, and 1 percent level, respectively. Dependent variable is growth rate of performing bank loans.

22. While supply-side factors have been important in explaining credit growth, credit demand has so far played a limited role. Improvements in the balance sheets of large corporations (lower leverage ratio) and increasing rate of economic growth are positively correlated with credit growth, while interest rates enter the analysis with an unexpected positive sign. However, these estimates are not robust to the elimination of outliers and homeskedistic estimates. These results seem to reflect the slow increase in bank intermediation and in the BCPS ratio observed in recent years. Thus, while supply-side factors clearly influence credit growth, the role played by credit demand has so far remained limited. However, as the economic recovery continues and credit demand from large corporations rises, demand factors are poised to play a greater role in driving credit growth.

Credit and interest rate risks are considerable

23. Although they have becoming more robust, Indonesian banks, especially state and small private banks, remain sensitive to credit and interest rate risks. An important reason behind the continued sensitivity is the large amount of restructured loans remaining on banks’ books, especially of state banks. Credit risk stress tests illustrate the banks’ sensitivity to a decline in asset quality. At end-2004, under a scenario which assumes that 50 percent of the loans are lost (Scenario I), banks’ tier-1-to-total assets ratio declines by about 1 percentage point on average, with significant variation across banks (as indicated by the divergence between the minimum and maximum effects shown in the table).11 Out of the 15 banks under observation, 4 would have a tier-1-to-total asset ratio of less than 4 percent. Still, even if credit risks arising from the stock of restructured loans remain high, such risks are lower than in previous years. On the other hand, robust credit growth is leading to higher credit risk arising from a larger loan portfolio. In a more forward-looking scenario (Scenario II), the impact of an increase in NPLs is greater at end-2004 compared to 2003. On average, the impact was 0.6 percentage points at end-2004 compared to zero at end-2003. Interest rate risk on the banks’ books—i.e., risk arising from the reprising gap between assets and liabilities—continues to be large. This reflects the short-term nature of bank funding. Based on March 2005 data, a 5 percent increase in interest rates would result in a 0.7 percentage point reduction in banks’ Tier 1-to-total-assets ratio. However, as with credit risk, interest rate risk on banks’ books is lower than in earlier years, reflecting in part a reduction in their holdings of fixed rate recapitalization bonds.

Indonesia: Credit Risk Stress Tests

(percentage points)

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Source: IMF staff estimates.

Assumes that restructured loans classified as performing or special mention have a 50 percent loss.

Assumes that 50 percent of loans in each classification migrate to the next worse classification.

Liquidity risk is increasing while market risk is under control

Indonesia: Interest Rate Risk Stress Test

(percentage points)

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Source: IMF staff estimates

Tests done on an aggregate basis.

The interest rate stress tests on the banking book were calculated as the impact of an interest rate increase on the cumulative gap up to 12 months.

24. While aggregate liquidity is high—albeit declining in tandem with the loan growth—it is not evenly distributed and the interbank market remains segmented. Even among large banks, liquidity can differ substantially, with 4 banks having a liquid asset-to-total asset ratio below 10 percent. In addition, the planned transfer of government deposits from commercial banks to BI, in the context of treasury reforms, and the phasing out of the blanket guarantee could create pressures on banks.12


Indonesia: Large Banks’ Liquidity

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004


Indonesia: Large Banks’ Liquidity, Dec 2004

Citation: IMF Staff Country Reports 2005, 327; 10.5089/9781451818352.002.A004

25. On the other hand, most banks have been conservative in taking on market risk. BI’s stress testing indicates that, on average, banks’ capital adequacy ratios are barely affected by moderate movements in the exchange or interest rate. These tests assume (i) a 2500 point depreciation in the Rupiah versus the U.S. dollar, (ii) a 100 bps increase in interest rate, and (iii) a 100 bps decrease in interest rate. For all scenarios, the banks’ capital adequacy remains well above the minimum requirement. On average, the system’s CAR is hardly changed: it remains at about 19 percent before and after these scenarios. For individual banks, the most extreme adverse shock reduces CAR by less than 1 percent.13

E. Conclusions: Outlook and Policy Issues

26. Banks are well placed to continue expanding their lending, but will need to manage associated risks carefully. High CARs and low compromised assets mean that banks’ future credit capacity is not unduly constrained, while continued economic growth would likely foster demand for credit. The challenge will be to manage the balance sheet risks arising from lending growth, particularly credit and liquidity risks. These risks have to be managed in an environment where governance, informational, and legal frameworks are weak. This will be particularly challenging as competition is likely to increase in consumer and SME lending, where banks have been concentrating their growth, thus reducing spreads and leading to more normal profitability. Declining profitability, together with BI’s consolidation strategy, will likely lead to greater consolidation of the banking system.

27. In order to ensure sound credit growth expansion in support of economic growth while controlling risks, the authorities are focused on a number of key policy issues:

  • Preserving banks’ asset quality. This will be critical to support continued credit growth and limit risks associated with an expanding portfolio, particularly in large state banks with less strong financial positions and governance.

  • Addressing governance vulnerabilities, including at large state banks. State banks should be run on a commercial basis, and their internal governance and risk management processes improved. In this respect, every effort is needed to ensure that any bank lending to support infrastructure projects is commercially viable. Further private sector participation in state banks may help improve governance and performance of these banks.

  • Continuing to improve prudential regulation and supervision of all financial institutions. This would entail addressing gaps such as the lack of banks’ consolidated supervision, managing the transition to a risk-based supervisory framework, and continuing to improve implementation of existing regulations. The ongoing work to strengthen supervision of pension funds, and mutual funds, insurance companies and finance companies is also important, especially as their links with the banking sector are growing in importance.

  • Ensuring a smooth transition from the blanket guarantee scheme to the new limited deposit insurance scheme. This will require having the new scheme operational before the full removal of the blanket guarantee. A number of measures are underway to this end.

  • Implementing BI’s banking architecture plan consistently over time. The plan has many elements that would create a sounder banking system. In particular, steps to address structural weaknesses in banks’ governance as well as informational infrastructure are important. The push for bank consolidation is also welcome, and should be market-led.

Corporate Governance and Risk Management in Banks

Banks have taken steps to improve corporate governance although further efforts are needed to introduce international good practices in key areas.1 Recent improvements include steps to increase the independence and quality of Board members, especially for large private banks with strategic foreign investors. Many banks have established audit and risk committees to oversee major risks. Transparency has also been increased with the publication regular and more extensive data, and the participation of investors in both private and state banks. However, gaps remain in areas such as (i) setting and communicating strategic directives, (ii) establishing clear lines of responsibility and accountability, (iii) clarifying the roles of shareholders, management, and other stakeholders, (iv) appointing qualified bank commissioners and directors, (v) empowering commissioners to carry out their supervisory functions effectively, and (vi) making effective use of internal and external audit.

Risk management capacity in large banks has also been upgraded. These upgrades include: (i) introducing policies and procedures on risk management and oversight (ii) establishing centralized risk management functions, (ii) creating specialized functions to cover major risks such as credit, market, and operational risks, (iii) building databases and models to appropriately measure risk, and (iv) separating business and risk management functions (“four eyes principle”). The larger banks are also making efforts to comply with Basel II by 2008.

Although policies and procedures to ensure good risk management appear to be in place, there are still questions concerning effective implementation. Staff competence, policy adherence and management commitment could be further strengthened in some banks. Indeed, some banks face high operational risks because of weaknesses in policy adherence and a culture that tolerates exceptions. Furthermore, sophisticated technology needs to be adapted to local circumstances and integrated into day-to-day operations, MIS and IT challenges are also non-trivial. Most important, good practices in risk management require a change in thinking and the way business is done; this necessarily takes time and requires significant investment in human capital.

1 Conclusions are based on discussions with banks, supervisors, and banks’ annual disclosures. International good practices comprise the Basel Committee on Banking Supervision guidelines on good corporate governance as well as the OECD Principles on Corporate Governance.

The Banking Architecture Plan

In 2004, Bank Indonesia released the Banking Architecture Plan, a blueprint for creating a sounder and more efficient banking system.1 The API is a long-term plan (10–15 years) containing the vision of an optimum banking landscape, and a series of initiatives to improve banking sector performance. The API is built on six pillars, focused on: (i) banking sector structure, (ii) quality and effectiveness of banking regulations, (iii) banking supervision, (iv) quality of bank management operations, and corporate governance, (v) infrastructure to support the banking sector, and (vi) consumer protection.

As a part of the API, the central bank is about to launch a program to increase banks’ capital and foster greater consolidation in the sector. The API envisages a gradual move in the next 10–15 years towards a banking system where 2–3 banks emerge as international banks with large capitalization, 3–5 banks as smaller national banks, and 30–50 smaller banks as niche banks. In this context, banks with limited capital (below Rp 100 billion) would be restricted in their activities or downgraded to rural credit banks. The central bank is expected to announce criteria for “well-run” banks soon and these banks are expected to be the nucleus for the consolidation process.

1 See

Prudential Regulation and Supervision

Enhancements to banking regulation and supervision, recently implemented or underway:

  • Introduction of tighter asset classification rules, including a requirement that banks follow BI’s assessments, if there is a difference between banks and BI’s credit assessment.

  • Development of guidelines to introduce consolidated supervision, including steps to identify banking groups, produce consolidated reports, and apply prudential norms on a consolidated basis.

  • Development of a more comprehensive definition of related parties.

  • Reassessment of guidelines on corporate governance in banks.

  • Introduction of risk-based supervision.

  • Preparations for Basel II.

  • Implementation of a risk-based capital charge for market risk.

  • Strengthening compliance with AML/CFT requirements, such as upgrading examination procedures and bank examiners’ skills.

Enhancements to NBFI regulation and supervision, recently implemented or underway:

  • Harmonization of insurance regulations with International Association of Insurance Supervisor (IAIS) principles, and introduction of risk-based and minimum capital requirements.

  • Introduction of requirement for more timely and complete provision of information.

  • Introduction of “fit and proper” tests for senior managements of insurance and finance companies; introduction of certification requirements for insurance agents and pension fund administrators.

  • Strengthening of on-site examination of NBFIs and closure of several small insolvent insurance companies.

Financial Safety Net and Deposit Insurance Scheme

The authorities have developed a framework for a financial safety net (FSN). The financial safety net aims at: (1) preventing weaknesses in financial institutions and instability in financial markets; (2) identifying and addressing financial weaknesses and instability; and (3) minimizing the costs of these weaknesses and instability.

The financial safety net has three pillars:

  • A deposit insurance scheme, that would eventually guarantee deposits up to Rp 100 million (currently covering about 90 percent of all depositors);

  • A lender of last resort facility at the central bank, that would provide intra-day and short-term liquidity support and, in case of systemic risk, emergency liquidity assistance to solvent banks;

  • A framework for bank resolution, defining the role and ensuring institutional coordination among various government agencies during a financial crisis, through a coordinating committee and financial stability forum.

As part of the introduction of the FSN, the government has started phasing out the blanket guarantee and plans its full removal in 2005. In April, the government started limiting the blanket guarantee to saving deposits and interbank loans (through the inter-bank money market). Moreover, for an interim period, the responsibility for administering the blanket guarantee has been transferred to the MoF. On September 22, 2005, the deposit insurance agency (LPS) is slated to become operational and a limited deposit insurance will substitute for the blanket guarantee. In the first six months following the establishment of LPS, the full value of eligible deposits would be insured. In the second six-month period, deposits up to a maximum of Rp 5 billion would be insured; in the third six-month period, this amount would fall to Rp 1 billion; and from March 22, 2007 onward, only deposits up to Rp 100 million would be covered.

The authorities are taking several steps to establish the financial safety net. These include completing the operational arrangements for the deposit insurance agency, and issuing BI regulations and government decrees on emergency lending assistance and the financial stability forum, as well as approving the financial safety net law that would put the safety net framework on firm legal grounds.

Empirical Analysis of Bank Credit Growth

We estimate an econometric model of how the quality of bank portfolios and factors potentially influencing credit demand link to bank credit growth in Indonesia. The basic model regresses the growth rate of performing bank loans on lagged summary measures of bank asset quality (e.g., net compromised asset to loans ratio, NCA/L; capital adequacy ratio-tier 1, CAR;and government bonds to assets ratio GOVB/A),profitability (return on asset ratio, ROA),and liquidity (liquid assets ratio, LA/A). This model is then augmented to include factors that may influence bank credit demand such as lagged leverage ratios of corporations, and macroeconomic variables such as lagged interest rates and GDP growth rates. The augmented specification intended to capture supply-side constraints, as well as trends in factors that may hinge on credit demand. The non-augmented basic model takes the following form:


where i=bank, t=time,and gL denotes the growth rate of performing loans. In this model, unobservable bank-level variables are controlled for by using fix effects.

Data include a quarterly panel of the 16 major Indonesian banks (about 80 percent of total system-wide assets) over the period 2000–2004 (272 observations), quarterly aggregate leverage ratios of corporations listed on the Jakarta stock exchange, and quarterly economic variables, including lending interest rates and de-seasonalized real GDP growth rates.

The model suggests that bank credit growth in Indonesia has been closely related to supply-side variables, while the role played by credit demand has so far been limited. Specifically, bank credit growth is positively correlated to capital adequacy ratios, and negatively correlated to the net compromised ratios of banks, while profitability and liquidity flows variables do not appear significant. Contrary to one may expect, in recent years, banks’ holding of government bonds have been positively associated with future credit growth, indicating that banks with large stock of bonds are set to have higher credit growth rate in the future. Finally, the role played by factors associated with credit demand, such as corporations’ balance sheets and macroeconomic conditions, including economic growth and interest rates appears to have been limited. The lending behavior of state-owned banks does not differ substantially from that of private banks (ownership dummies make no difference to the results). These results are rather stable, and robust to alternative model specifications and random effects estimates. They are robust to heteroskedasticity, and correlated disturbances (AR-1 disturbances). Moreover, results remain similar (but less significant) when annual data are considered.

These results should not be seen as reflecting causality links, rather, they identify correlations between credit growth and a set of bank balance sheet indicators and variables that potentially affects demand for credit. Furthermore, the period under study is one that has seen great structural changes, which means that it may not be a good predictor of developments during normal times.


  • Cole and Slade (1998), “Why has Indonesia’s Financial Crisis Been so Bad,” Bulletin of Indonesian Economic Studies, Vol. 34, August, pp.6166.

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  • Enoch C, Balwin B, Frecaut, O. and Kovanen A (2001), “Indonesia : Anatomy of a Banking Crisis: Two Years of Living Dangerously, 1997–99,” IMF Working paper 01/52, International Monetary Fund, Washington DC.

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  • Pangestu M. and Habir M. (2002), “The Boom, Bust, and Restructuring of Indonesian Banks,” IMF Working paper 02/66, International Monetary Fund, Washington DC.

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  • Seelig, Steven et al. (2004), “Assessing Indonesia’s Banking Sector Reforms,” Indonesia: IMF Country Report 04/189.

  • Bank Indonesia (2004), Financial Stability Reviews.


Prepared by Geremia Palomba (APD) and Leslie Teo (MFD).


See Cole and Slade (1998), Enoch et al. (2001), Pangestu and Habir (2002), and Seelig et al. (2004) for a detailed discussion of these measures.


The 26 regional development banks are owned by provincial governments, and have expanded rapidly on the back of fiscal decentralization.


The data presented cover the top 15 banks until end-December 2004. Note that although there has been some improvement since the crisis, the quality of banks’ financial statements remains uneven.


Indonesia, Malaysia, Singapore, Thailand, and the Philippines.


These calculations are based on daily equity prices and annual accounting data, following the Black-Scholes’ option pricing model.


Net compromised assets include reported NPLs, restructured loans currently categorized as pass or special mention, foreclosed real estate, and equities obtained under debt-equity swaps.


The government recently issued a new regulation to facilitate resolution of nonperforming state bank loans through write-offs.


BI’s ongoing work to improve prudential regulation and supervision is being supported by IMF technical assistance.


Recognizing that CAR may overstate banks’ capital adequacy, the tier-l-to-total-assets ratio is used for the stress tests.


BI’s stress testing indicates that the planned transfer of government deposits from commercial banks to BI in the context of treasury reforms could create problems for large banks, especially if the transfer was done over a short period of time. In addition, there is potential for pressures on smaller banks if there is a flight to quality during the removal of the blanket guarantee.

Indonesia: Selected Issues
Author: International Monetary Fund