Bank Indonesia, Financial Stability Review I, June 2003

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Financial Stability Review

June 2003


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This Financial Stability Review(FSR) is one the reports Bank Indonesiaprovides to public in order to achieve its mission to achieve and maintain stability of the Indonesian Rupiah

through maintaining monetary stability and promoting financial system stability for safeguarding long-term and

sustainable national development.

Published by:

Financial System Stability Bureau

Directorate of Banking Research and Regulation

Bank Indonesia

Jl. MH Thamrin No.2, Jakarta 10010

Indonesia

Information and Order:

This FSR document is also made in pdf format and is accessible at Bank Indonesias website at http://www.bi.go.id

All inquiries, comments and advice may be addressed to:

Bank Indonesia

Directorate for Banking Research and Regulation

Financial System Stability Bureau

Jl. MH Thamrin No. 2, Jakarta, Indonesia

Tel: (+62-21) 381 7990, 7353

Fax: (+62-21) 2311 672

Email: [email protected]

FSR is issued biannually and has the following objectives:

To foster public vision on financial system stability issues, both

domestically and internationally;

To analyze potential risks to financial system stability; and

To recommend policies to relevant financial authorities for promoting

a stable financial system


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fsrFinancial Stability Review

No. 1, June, 2003


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ii

FOREWORD, vii

EXECUTIVE SUMMARY, ix

Chapter 1 INTRODUCTION, 1

Chapter 2 THE IMPORTANCE OF MAINTAINING

FINANCIAL SYSTEM STABILITY, 4

LESSONS LEARNT FROM THE 1997 CRISIS, 4

FINANCIAL SYSTEM STABILITY: WHAT AND WHY IS IT

IMPORTANT?, 4

CORE COMPONENTS OF A STABLE FINANCIAL SYSTEM,5

CENTRAL BANKS ROLE IN FINANCIAL SYSTEM

STABILITY, 5


STABILITY , 7

CONCLUSIONS , 8

Chapter 3 EXTERNAL FACTORS, 11

INTERNATIONAL ECONOMY, 11

DOMESTIC ECONOMY, 12

Monetary Conditions, 12

Governments Finance , 13

Government Bonds, 14

Foreign Debts, 15

Market Confidence,15

Maturity Profile, 16

REAL SECTOR CONDITION, 17

Small and Medium Enterprises , 17

Pulp and Paper Industry, 19

CONTENTS

Chapter 4 PERFORMANCE AND PROSPECT OF

INDONESIAS BANKING INDUSTRY, 21

THE STRUCTURE OF BANKING INDUSTRY, 21

ASSETS STRUCTURE, 21

CREDIT RISK, 22

Non-Performing Loans (NPLs) , 23

Loan Restructuring, 25

Lending Growth , 25

LIQUIDITY RISK, 27

Liquidity Assets, 28

Exchange Offer, 29

Core Deposit, 29

Interbank Call Money, 29

Liquid Assets to Cash Outflow (COF) , 30

Corporate Funds , 30

Household Savings Pattern, 30

Maturity Profile, 31

MARKET RISK, 31

Capital Charge for Market Risk, 32

CAPITAL, 32

BANKS PERFORMANCE , 34

Profile of Banks at Stock Exchanges , 36

Comparative Performance with Other Selected

Countries, 36


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Chapter 5 CAPITAL MARKET, 38

CONFIDENCE TO CAPITAL MARKET, 38

Mutual Funds, 39

Impacts on Financial System Stability, 42

Bond Market, 46

Stocks Market, 46

Chapter 6 PAYMENT SYSTEMS IN INDONESIA, 51

RISKS IN PAYMENT SYSTEMS, 48

Clearing System, 49

Realtime Gross Settlement (RTGS), 49

ROLE OF PAYMENT SYSTEMS IN THE STABILITY OF

FINANCIAL SYSTEM, 49

Payment Systems Oversight, 50

Risks in Clearing System, 50

Risks in RTGS, 50

Chapter 7 CONCLUSION, 54

ARTICLES

1. Redesigning Indonesias Crisis Management S.

Batunanggar

2. Market Risk in Indonesia Banks Wimboh Santoso

& Enrico Hariantoro

3. An Empirical Analysis of Credit Migration In

Indonesian Banking Dadang Muljawan

4. New Basel capital Accord : Its likely impacts on

the Indonesian banking industry Indra Gunawan,

Bambang Arianto, G.A. Indira & Imansyah


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Ta b le s

3.1. Stress Test on Goverment budget (APBN)

2003-04

3.2. Foreign Debt Indicators

3.3. Indonesia Corporate yankee Bonds (Dec 2002)

4.1. Selected Items of Banks Balance Sheets

4.2 Details of Loan

4.3. NPL Stress Test

4.4. Distribution of Loans by Sector

4.5. 14 Large Banks Liquidity

4.6. Maturity Profile of Assets and Liabilites of 13

large Banks, December 2002

4.7. Large Exchange Rate Stress Test of Large Bank

to CAR

4.8 Interest Rates Stress Test of large of Large

Bank to CAR

F i g u r e s

3.1. Non-oil and Gas exports by Country Destination

3.2. US and JAPAN : GDP-Inflation

3.3 US and JAPAN : Current Account

3.4. US and Japan : Discount interest Rate and DJIA

& NIKKEI Indices

3.5. Direct and Portfolio Investments

3.6. Domestic Economic Indicators

3.7. Jakarta Composite and Property Sector Indices

3.8. Maturity Profile of Government Bonds

3.9. Fixed Rate Government Bond vs SBI

3.10. Indonesia Government Bonds Rating and Yields

3.11. Maturity Profile of Corporate Foreign Debt

3.12. Loans to SME and Non-SME

3.13. Lending growth to SME By Type of Banks

3.14. SME Loans by Type of Business Uses

3.15. GDP by Sectors to Total GDP

3.16. NPL by Sector

4.1. Total Bank and Asset

4.2 Bank Securities and Loans

4.3. Total Loans and NPL

4.4. NPL and Provisions for Loan Losses

4.5. Non Performing Loan

4.6. NPL Stress Test

4.7. Loan Restructuring

4.8 Loan to Deposit Ratio

4.9. Trends of IDR and Foreign Exchange Loans

4.10. New Lending

4.11. Loans by Business Uses

4.12. Property Loan

4.13. Deposit Growth

4.14. Liquid Assets

4.15. Core & Non Core Deposit

4.16. Stock Liquid Ratio


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4.17. Maturity Profile of Time Deposit

4.18. Stress Test Exchange Rate

4.19. Interest Rates Stress Test

4.20. Capital ratios

4.21. CAR Evolution

4.22. Source of Interest Income

4.23. Net Earnings and ROA

4.24. Paid-up Capital and ROE

4.25. Interest Income

4.26. Asian Banks ROA

4.27. Asian Banks NPL

4.28. Asian Banks CAR

5.1. Market Liquidity and Jakarta Composite Index

5.2. Development of Mutual Funds and Bank Deposit

5.3. Mutual Funds Growth

5.4. Development of Deposit vs Public Funds in

Mutual Funds

5.5 Development of YTM of Some Fixed-Rate Bonds

and SBI rate

5.6. Government Bonds by Portfolio

5.7. Financial Sector Stock Index

6.1 Real Time Gross Settlements, Clearing and Non-

cash Transactions

Boxes

1. Causes and Process of Financial Crisis

2. Bank Indonesias Strategy in Maintaining

Financial Stability

3. Pulp and Paper Industry

4. Market Risks

5. Yield Curve of Government Bonds

6. Mutual Funds

7. Risks in Payment Systems

8. Failure to Settle Scheme


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The financial crises that took place in almost all corners of the world, Indonesia included, have

driven growing awareness on the importance of financial system stability. Instability in a financial system

brings in adverse implications such as lower economic growth, loss of domestic productivity and gigantic

fiscal cost. Based on these adverse experiences, it is imperative that financial system stability is maintained

for the interests of the public.

Financial stability is basically avoidance of financial crisis. Maintaining financial system stability

is one of the primary functions of Bank Indonesia, which is not less important compared to maintaining

monetary stability. Financial system stability is a prerequisite for monetary stability. This issue is in line

with Bank Indonesias mission to attain and maintain stability of Rupiah by maintaining monetary stability

and promoting financial system stability to secure sustainable long-term national development. However,

maintaining financial system stability is not the sole responsibility of a central bank. Rather it is also

mutual responsibility of relevant government authorities including Ministry of Finance, Financial

Supervisory Authorities, Deposit Insurance Corporation beside the central bank.

In accordance with the above, Bank Indonesia assesses and monitors trends and issues surrounding

stability of Indonesias financial system and provides recommendations to maintain stability of the financial

system. Results of such assessments and monitoring is laid down in a regularly updated Financial Stability

Review (the FSR). Unlike such other reports issued by Bank Indonesia, the FSR focuses on such potential

risks which may weaken stability of national financial system, and is more forward-looking orientation.

Every section of this report also describes the prospects of national financial system.

During the course of 2002, Indonesias financial system is relatively stable and is expected to remain

so in the years to come. However, alert needs to be maintained particularly on some pertinent issues

including delays in the recovery of loan quality and performance of the banking sector, as well as external

issues such as low growth in the global economy and the government budget deficit due to the huge

obligations from domestic as well as overseas borrowings.

This FSR is addressed to all stakeholders, Bank Indonesia and relevant financial authorities in

particular, and the public in general. The review and recommendations offered in this FSR are hopefully

useful to the Government as well as all other relevant authorities in the efforts of maintaining stability of

national financial system. In addition, this review will encourage concerns of all stakeholders to the adverse

movements in the financial system within their jurisdictions so that proactive measures can be taken.

F O R E W O R D


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The Board of Governor must be grateful and give its appreciation to the DPNP, all relevant units and

personnel for their dedications, contributions and collaboration for the completion of this first edition of

Financial Stability Review. Finally, we will appreciate all advice, commentaries as well as critics from any

and all parties for further improvements of this review in the future.

Jakarta, April 2003

Maman H. Somantri

Deputy Governor


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Indonesian financial system during the course of 2002 is stabilized. This is made possible by theeffective policies in stabilizing exchange rates and controlling inflation as well as the progress made

through the micro-prudential policies covering restructuring program of the banking sector as well as

improvement in banking supervisory and regulatory frameworks. However, certain aspects, the endogenous

and exogenous risks, need to be closely observed as they can potentially disturb financial system stability.

The weakening economy of the major trade partners of Indonesia is one of the driving factors

contributing to the slower growth of exports. As the results, exporting companies, particularly those

whose activities are financed by banks confront augmenting financial risks reducing their capacity to

pay their obligations in timely manner. Such condition is the major driving factor leading to decreasing

a quality of earning assets of banks.

Meanwhile, huge domestic fiscal obligations and international debts have prevented higher economic

and real sector growth. The yet to complete corporate debt restructuring also impedes domestic

corporations to expand their businesses and has brought in adverse impacts to the balance of payment

which may potentially prompt debt crisis and eventually jeopardizing stability of financial system.

Indonesias banking structure has not yet changed as the results of the banking crisis back in 1997

that led to the recapitalization of hard-hit banks, all of which have significant impacts to the economy.

Indonesias banking system is very much concentrated on the 13 large banks with combined assets of

74.9% from the total assets in banking system.

In general, the condition of the banking industry has been improving following the recap program

introduced since 1999. Aggregate ROE stays at 14.8% and CAR at 21.7%. However, the capitalization

capacity of the banks, particularly the recap banks, remains weak as the results of the low loan growth.

Main revenues of the 13 large banks are from bond coupons since their assets are mostly in the form of

recap bonds. Moreover, increased capital at some banks has not been able to absorb the potential

losses, particularly those arising from credit, market and operational risks. With the introduction of the

market risk capital charge, a number of banks will notice a slight capital decrease, although it will

remain above the minimum Capital Adequacy Ratio (8%).

In the course of 2002, the risks surrounding the banking system remain high and with stable trend.

Bank credit risks are high but decreasing. Meanwhile, market risks and banks liquidity risks are moderate

with stable trend. The high credit risk is characterized by high percentage of non-performing loans,

EXECUTIVE SUMMARY


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its roles, especially in monitoring and evaluating potential risks that may adversely affect financial

stability. Bank Indonesia also has drafted a blue print on Indonesias financial system stability including

policies and framework for Crisis Resolution, which is a prerequisite for the future financial stability.

Now that more defined and comprehensive policies are in place and with the effective coordination

between Bank Indonesia, Government and all stakeholders, a sound and more stable financial system

will be maintained and in order to encourage faster economic growth in Indonesia.


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Introduction

INTRODUCTION1CHAPTER

The financial crisis that swept over Southeast Asia,

Indonesia included, in 1997 has taught us a very

valuable lesson concerning the importance of

maintaining stability of financial system. During the

past few years, financial system stability has always

been the primary agenda at national and international

levels. The year 1999 saw the establishment of an

international institute and an international forum,

namely the Financial Stability Institute1 and Financial

Stability Forum (FSF)2, intended to assist central banks

and other supervisory authority in strengthening their

financial system. Similar concerns have also been

indicated by IMF and World Bank, who then introduced

a Financial System Assessment Program (FSAP) in order

to strengthen the financial system of the country being

assessed.3

Meanwhile, there has been increasing number

of publications in the forms of books, articles and papers

as well as seminars and conventions discussing financial

crisis and financial system stability. In addition, there

is growing number of central banks creating a unit or

even groups dedicated to addressing financial system

stability issues and financial stability reviews.

Central banks need to maintain financial system

stability based on three primary reasons. Firstly,

financial institutions particularly banks have important

roles -as financial intermediaries and as a transmission

means of monetary policies- in the economy. These

institutions are significantly exposed to high risks

inherent in their operations. Therefore, financial

institutions constitute one of the instability factors most

harmful to the financial system. Secondly, all financial

crises have brought in catastrophic implications to the

economy, lowering economic growth and income. These

eventually create negative impacts to social and

political life if prompt measures fail to address the

crisis rapidly and effectively. Thirdly, financial

instability brings in very expensive fiscal cost in the

course of mitigating the crisis.

In this extent, Bank Indonesia has designated

financial system stability as a complimentary objective

to achieve price stability. Considering the importance

of financial system stability in the course of achieving

the primary objectives, Bank Indonesia is to give more

priority and attention to addressing this issue. In order

to achieve financial system stability, Bank Indonesia

has adopted four major strategies: (i) fostering effective

coordination and cooperation with others; (ii) improving

research and surveillance; (iii) strengthening regulations

and market discipline; and iv) establishing crisis

resolutions and financial safety net. These will be

1. FSI is established by Basel Committee on banking Supervision (BCBS) to

assist supervisory authorities in strengthening their financial system.

For further details visit http://www.bis.org/fsi/index.htm.

2. FSF is meant to improve stability of international financial system

through exchange of information and international cooperation in the

area of research and surveillance. FSF is composed of such members

from relevant authorities (finance ministries, central banks, financial

supervisory authorities) from 11 countries, as well as international

organizations (such as IMF, World Bank, BIS, OECD), international

committees and associations (Basel Committee on Banking Supervision/ BCBS), International Accounting Standard Board (IASB), International

Association of Insurance Supervisors (IAIS), International Organization

of Securities Commissions (IOSCO), Committee on Payment and

Settlement System (CPSS), Committee on Global Financial System (CGFS)

and European Central Bank. For further details please visit http://

www.fsforum.org/home/home.html.

3. FSAP is a concerted effort of IMF and World Bank which is introduced in

May 1999. This program is intended to increase effectiveness in the

efforts of improving soundness of financial system in member countries.

For further details visit http://www.imf.org/external/np/fsap/

fsap.asp.


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Chapter 2

described in details in Chapter 2.

Furthermore, the function of maintaining

financial system stability is conducted by Bank Indonesia

through two major activities. First, by assessing andmonitoring any and all aspects affecting financial system

stability. The activities under this category are

attributable to crisis prevention. Second, by coordinating

and cooperating with relevant supervisory authorities,

particularly when dealing with crisis resolution.

Assessment of the financial system stability is

conducted by incorporating an early warning system to

monitor and analyze trends in the macro-prudential

and micro-prudential indicators 4. The economic macro-

prudential indicators include figures associated with

economic growth, balance of payment, inflation,

interest rate and exchange rate ; the contagion effects,

and all other relevant factors. The micro-prudential

indicators include financial indicators such as Capital

Adequacy, Asset Quality, Management, Earnings,

Liquidity and Sensitivity to Market Risk (CAMELS). The

assessment basically contains identification and

evaluation of risks that may adversely affect financial

system stability and recommendations made to the

government and relevant authorities to carry out

actions necessary to address the matter. The analysis

and recommendations are documented and publicized

on regular basis by Bank Indonesia in a Financial

Stability Review (FSR).

The FSR has three basic characteristics: (i)

assessment on conditions and current developments in

the financial system; (ii) reviews are based on risks

which may adversely affect financial system stability;

(iii) a more forward-looking approach by presenting

assessments on the prospects of the financial system

for the year to come. With regard to these

characteristics, the format and focus of analysis of this

FSR may change from one edition to the next in linewith the prevailing conditions, issues, and trends

affecting the economic and financial system.

In general, this first edition of the FSR contains

three primary subjects as described below. Firstly, the

concept and practice at maintaining financial system

stability as presented in a short article entitled The

Importance Of Maintaining Financial System Stability

in Chapter 2. This concise article discusses the definition

and the importance of achieving and maintaining

financial system stability, prerequisites for stable

financial system, and the role of Bank Indonesia in

promoting financial system stability.

Secondly, external and internal factors that

adversely affect Indonesian financial system stability

are presented in Chapters 3 and 4. Chapter 3 contains

analysis on developments in the international and

national economies that may affect stability of national

financial system. This chapter also discusses in more

detail domestic financial issues covering foreign debts

and fiscal sustainability. Chapter 4 discusses in detail

the conditions, constraints and risks confronting the

banking system in Indonesia. This issue is very important

considering that the banking sector is the dominant

player with 75% market segment in national financial

system. This chapter also discusses structural issues

confronting the banking system including the remaining

high credit risks due to the slow pace of loan

restructuring programs, the low lending growth,

liquidity and market risks, and the performance of the

banking industry. Chapter 5 discusses in detail capital

market issues. Chapter 6 identifies recent developments4 Based on such indicators developed by IMF (Evans et al., 2002)


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Introduction

and risks in payment system with focus on Real Time

Gross Settlement [RTGS] and clearing system. Chapter

7 provides the conclusion.

Thirdly, it contains four articles. The first articleis entitled Redesigning Indonesias Crisis Management:

Lender of Last Resort and Deposit Insurance (S.

Batunanggar). This article argues fundamental issues

on crisis management: (i) absence of comprehensive

and clearly defined crisis management policies; (ii) the

weakness of the blanket guarantee creating moral

hazards and adding potential to future financial crises;

and (iii) the obscure function of Bank Indonesia as

Lender of Last Resort in the events of systemic crisis.

To redefine Indonesias crisis management, two primary

steps are proposed: (i) to gradually replace the blanket

program to limited explicit deposit insurance; and (ii)

to put in place a more transparent policy regarding

lender of last resort for both normal conditions as well

as during systemic crisis. A more transparent LLR policy

will not only function as a more effective instrument

in addressing crisis management but will also put in

place more defined accountability thereby increasing

credibility of central bank, reducing political

interventions and moral hazards, and encouraging

market discipline in order to eventually encouraging

financial system stability.

The second article, Market Risks In Indonesian

Banks (by Wimboh Santoso and Enrico Hariantoro)

compares the results of CAR calculation to market risk

between the standard model BIS and the alternative

models, which uses the Exponential Weighted Moving

Average (EMWA) both have been widely used by banking

practitioners. This review is intended to measure as to

how far market risk will adversely affect Indonesias

banks in terms of their capital condition. A significant

decline of capital would adversely affect the stability

of Indonesias financial system. This review will give

some pictures of how far banks would benefit from

lower capital charge if internal model is applied. Thisreview proves that the incentive obtained by banks will

be very much dependent on the volatility of the risk

factors. The higher the volatility, the higher capital

charge is. Based on data on volatility of exchange rate

and interest rate, this review concludes that

incorporation of market risk will not reduce a banks

CAR to a level below the minimum threshold and

therefore will not create distortions which would

otherwise impair financial system stability. In addition,

application of internal model will generate lower capital

charge considering that volatility of Indonesias

exchange rate and interest rate are relatively lower.

The third article, Empirical Analysis on Loan

Migrations in Indonesias Banking Sector (by Dadang

Muljawan), looks into the relations between industries

performance and the dynamic lending at certain banks.

From the statistics, two interesting phenomena were

found. Firstly, industrial performance significantly

affects credit migration process. Secondly, there is an

irreversible process in credit migration. This analysis

will provide more analytical information for the

supervisory authority in evaluating banking risks and

efficacy of external oversight.

The last article New Basel Capital Accord: What

And How It Affects Indonesias Banking Sector (by Indra

Gunawan, Bambang Arianto, Indira & Imansyah),

explores the New Basel Accord and its implications on

Indonesian banking sector.


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Chapter 2

4

THE IMPORTANCE OF MAINTAININGFINANCIAL SYSTEM STABILITY2

LESSONS LEARNT FROM THE 1997 CRISIS

There are two most important lessons learned from

the 1997 crisis. Firstly, the crisis was very

complicated to resolve. And secondly, it was very costly.

The fiscal costs borne by the government for

restructuring problem banks is huge, at 51% of annual

GDP. Indonesias crisis is the second worst, afterArgentina crisis (1980-1982), which is 55% of annual

GDP. The crisis not only devastated the national

economy but also affected social and political stability

in Indonesia. However, the crisis has also fostered a

realization of the importance of maintaining a sound

financial institutions and a stable financial market.

Basically, the crisis was caused by two factors.

Firstly, the weak fundamentals of Indonesias economy

coupled with inconsistent policies (internal factors).

Secondly, the contagion effects of the financial crisis

started in Thailand on July 1997 (external factors). In

general, the financial system fragility was initiated by

huge un-hedged foreign debts by corporations,

imprudent lending activities, violation of the legal

lending limit to affiliated parties, poor risk management

and governance, and weak bank supervision.

FINANCIAL SYSTEM STABILITY: WHAT AND WHY

IS IT IMPORTANT?

Basically, the term financial system stability or

financial stability pertains to the avoidance of financial

crisis (MacFarlane [1999] and Sinclair [2001]). To be

more specific, financial system stability means the

stability of financial institutions and financial markets

in the financial system (Crockett, 1997). Mishkin (1991)

defines financial crisis as disruption to financial markets

where adverse selection and moral hazards worsen so

that financial market is unable to channel funds

efficiently to parties having the best potentialproductivity to invest1 . From these definitions, it can

be concluded that a stable financial system will create

stable financial institutions and financial markets

capable of avoiding a financial crisis that may adversely

affect national economic infrastructure.

There are three main reasons as to why this

financial system stability [FSS] is important. Firstly, a

stable financial system will create trusting and enabling

environment favorable to depositors and investors in

investing their money in financial institutions as well

as to secure interests of small depositors. Secondly, a

stable financial system will encourage efficient financial

intermediation which will eventually promote

investment and economic growth. Thirdly, a stable

1 Adverse selection takes place prior to the choosing of a transaction

when a bank would select a potential borrower with greater chances

that the loan is going to become non-performing. Since adverse selection

factor has great potential of becoming non-performing loans, lenders

would not lend to potential borrowers which have low risks. Moral hazard

occurs after the transaction, where lender will be potentially injured

by borrowers which tend not to pay their obligations. Moral hazard

occurs as the result of asymmetrical information in which lenders do

not know much the activities of the borrowers which will allow borrowers

to give rise to moral hazard. Conflicts of interest between borrower

and the lender due to the moral hazard (agency problem) indicate that

most lenders decide not to lend, so that lending and investment

activities fail to be optimized, thus resulting in credit crunch.

CHAPTER


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The Importance of Maintaining Financial System Stability

5

financial system will encourage an effective operation

of markets and improve distribution of resources in the

economy.

On the contrary, an unstable financial system

will bring in harmful implications, such as higher fiscal

cost to resolve troubled financial institutions and

decreasing of gross domestic product due to currency

and banking crisis.

A series of developments which took place in the

past few years have placed maintenance of financial

system stability as a top agenda of the central bank,

supervisory authorities as well as the government,

namely: (i) significant growth in financial transactions;

(ii) growing number of non-bank financial institutions

including the products and services they offer; (iii)

increased complexity and risks in banking activities; and

(iv) huge fiscal cost required to remedy the banking crisis.

In addition, there are other constraints such as

changes of policies, financial instruments and others

faced by banking sector as well as real sector, all of

which will make the duty of maintaining financial

system stability to be complicated.

CORE COMPONENTS OF A STABLE FINANCIAL

SYSTEM

The stability of financial system depends on five

components which are associated one with another,

namely: (i) a stable macroeconomic environment; (ii)

well governed financial institutions; (iii) efficient

financial market; (iv) sound prudential oversights; and

(v) safe and reliable payment system (MacFarlane,

1999).

Crisis may be prompted by various risks originating

from the elements in the financial system. The process

leading to a financial crisis is described in Box 1.

Financial system stability can be maintained by

improving resilience of financial institutions and money

market against external volatility. A number of

measures may be taken, such as by applying prudential

standards and good corporate governance within

financial institutions and capital markets, conducive

monetary and fiscal policies, and real sector capable

of promoting economic growth.

Considering that internal weakness within

financial institutions and fragility in capital market,

crisis management policy needs to be put in place.

Therefore, a safety net mechanism and contingency

plan are required to address crisis. For this purpose,

central banks play a very important role in maintaining

stability of financial system, as well as in taking

preventive and corrective actions against crisis. This is

due to the fact that powers to regulate and supervise

as well as to enforce policies of financial institutions

are held by central bank.


STABILITY

Safeguarding financial stability is a core function

of the modern central bank, no less important than

maintaining monetary stability (Sinclair, 2001). Both

are closely correlated and affected one another.

Effectiveness of financial policies will only manifest

itself in an environment in which there is sound financial

system because financial institutions serve as medium

for monetary policy transmission.

There are two major approaches generally

adopted by central bank in maintaining financial system

stability. Firstly, reliance on market forces and market


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Chapter 2

8

Both roles are aiming at the same objectives which is

price stability.

In order to achieve a stable financial system,

Bank Indonesia adopts four strategies, namely: (i)

implementing regulation and standards to foster market

discipline; (ii) intensifying research and surveillance;

(iii) improving coordination and cooperation; and (iv)

establishing safety net and crisis resolution framework

(see Box 2).

CONCLUSIONS

Stability of financial system much depends on the

soundness of financial institutions, particularly banks

that dominate the financial system. This will also rely

on the effectiveness bank supervision. Therefore, it is

imperative to have an independent and competent bank

supervisor capable of assessing bank risks and taking

preventive and corrective actions on the problems faced

by banks effectively.

To achieve a stable financial system, effective

coordination must be in place among relevant

authorities. Therefore, there must be a clear division

of roles and responsibilities of each authority. More

importantly is the commitment of the stakeholders to

cooperate in achieving and maintaining financial system

stability. In addition, effective supervision and

consistent law enforcement will foster market players

and the general public to play their roles responsibly.


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The Importance of Maintaining Financial System Stability

9

In order to achieve financial system stability,

Bank Indonesia adopts four strategies:

(1) Implementing regulations and

standards. Consistent implementation of

international prudential regulations and standards

are required as a sound basis for both regulator

and the market players in conducting their

business. In addition, consistent discipline of the

market players need to be fostered.

(2) Intensifying research and surveillance.

Development of financial system the relevant

aspects affecting its stability should be assessed

and monitored. Risks which may endanger

Box 2.

BANK INDONESIAS STRATEGY IN MAINTAINING

FINANCIAL SYSTEM STABILITY

financial system stability are measured and

monitored by incorporating an early warning system

which is composed of micro-prudential and macro-

prudential indicators. Research and surveillance are

aimed at producing a policy recommendation for

maintaining financial system stability.

(3) Establishing safety net and crisis

resolutions framework. Safety net and crisis

resolutions framework and mechanism are required

for resolving financial crisis, once it occurs. These

include policy and procedures of the lender of the

last resort, and the deposit insurance which will

replace the blanket guarantee. Currently, there is no

An active involvement in creating and maintaining a sound andstable national financial system.

Financial System Stability (FSS) Framework

Achieving and maintaining the stability of Rupiah value by maintaining

monetary stability and promoting financial system

stability for sustainable national development.

ImplementingRegulation &

Standards

IntensifyingResearch &Surveillance

ImprovingCoordination &

Surveillance

Regulation &Standard e.gBasle principles,CPSIP, IAS,ISA, dsb.

Market Discipline

Early WarningSystems

Macro prudentialIndicators

Micro-PrudentialIndicators(aggregate)

- InternalCoordination

ExternalCoordination&Cooperation

Lender of lastresort

- Normal- Systemic Crisis

Crisis Resolution- Safety Nets

Establishing FinancialSafety Nets & Crises

Resolution

Instruments

FSS Objective

BI s Mission

FSS Strategies


23/153

Chapter 2

10

a clear legal framework for crisis resolution.

According to Law No. 23/1999, Bank Indonesia is

only allowed to provide lending to address liquidity

problem faced by banks during normal times, but

not for systemic crisis situation. Therefore, there is

an urgent need to formulate this policy in the law

which clearly stipulates the roles of Bank Indonesia

as the lender of the last resort in the events of crisis.

(4) Improving coordination and cooperation.

Coordination and cooperation with related gencies

is very crucial especially in crisis times. Usually, the

coordination was formed in a national committee

which is composed of the Bank Indonesia Governor,

Finance Minister and related agencies including the

Head of Deposit Insurance Agencies to be

established.


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11

External Factors

EXTERNAL FACTORS3

INTERNATIONAL ECONOMY

Along with globalization in economics,

Indonesias financial system will be affected

by instability in regional and global economies. It occurs

through international trade and money market

channels.

During the last few years, global economy tends

toward a downturn condition. This is provoked by

decreasing economic performances of the industrial

countries in the world, namely the United States and

Japan. Ultimately, this situation will influence

Indonesias financial system considering that the United

States and Japan are the largest markets for Indonesias

exports. Indonesias trade account states with the

United States and Japan reach 17.44% and 22.99%

respectively of total exports. In addition, both countries

are also primary lenders. The slowdown condition of

those industrial countries is expected to continue

following terrorists attacks at some places within the

United States in 2001.

The declining economic conditions of these two

major economies was indicated by decreasing Gross

Domestic Products (GDP), increasing in inflation, and

the current account deficit.

FIGURE 3.1:

NON-OIL AND GAS EXPORTS

By COUNTRY OF DESTINATION

FIGURE 3.2:

US and JAPAN : GDP-INFLATION

FIGURE 3.3:

US andJAPAN : CURRENT ACCOUNT

-

10

20

30

40

50

60

70

Percent

U S ASEAN Japan

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Inflation (Percent)GDP (Percent)

1995 1996 1997 1998 1999 2000 2001 2002

(2)

(1)

-

1

2

3

48

(6)

-

(4)

(2)

2

4

6

GDP-US GDP-Japan Inflation-US Inflation-Japan

Miliar USD

(140)

(120)

(100)

(80)

(60)

(40)

(20)

-

20

40

60

1995 1996 1997 1998 1999 2000 2001 2002

U S Japan

CHAPTER


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12

Chapter 3

The continuing recession in United States and

Japan also affects their capital markets adversely. This

was illustrated by the fall in composite indices of the

Dow Jones and Nikkei. In fact, such conditions should

have encouraged capital inflows to Indonesia.

Unfortunately, it is not the case, since Indonesias

investment environment is not yet conducive, as

evidence by a decision of a restructured corporation in

Japan to close their factories in Indonesia. Such policies

truly bring negative impacts to the money market due

to the decreasing of banks lending portfolio in respect

to Japanese corporations.

DOMESTIC ECONOMY

Monetary Conditions

During 2002, monetary condition is quite

conducive as reflected by lower interest rate and

stability of exchange rates. Hopefully, such condition

will prevail so as to stimulate economic growth in 2003.

Unlike the condition in 2000 and 2001, the SBI

interest rate tends to decrease in 2002. This condition

indicates that Bank Indonesia has started to ease its

monetary policy as inflation rate is still in control, while

the rupiah exchange rate remains relatively stable.

However, the lower trend of SBI interest rate is not

immediately followed by a reduction in lending rates.

The declining trend of SBI interest rate will

hopefully encourage more lending to real sectors. In

spite of such increase in lending, the amount is

relatively small and is mostly given to small and medium

enterprises. This reflects banks caution in lending and

At the end of 2002, United States and Japans

GDP slightly increased by 2.1% and 0.5% respectively.

This was mainly due to the lower discount rate policies

introduced by monetary authorities of both countries.

Compared to 1999-2000, their GDP in 2002 has not fully

recovered and monetary authorities continue their low

interest policies.

The fact that both economies were not improved

in 2002 caused Indonesias exports to decrease. This

adversely affect borrowers financial performance

which will eventually cause a negative impact on banks

assets quality.

Figure 3.4:

US and Japan : Discount interest Rate and

DJIA & NIKKEI Indices

FIGURE 3.5:

DIRECT AND PORTFOLIO INVESTMENTS

Percent

10,000

-

5,000

15,000

20,000

25,000

1999 2000 2001 2002

U S Japan DJIA NIKKEI

-

1

2

3

4

5

6

7

2003

Million USD Million USD

0

500

1000

1500

2000

2500

3000

1998 1999 2000 2001 2002

Direc t I nves tment P or tf oli o I nves tment

-5000

-4000

-3000

-2000

-1000

0

1000

2000

3000

4000


26/153

13

External Factors

the low level of absorption by corporations due to

ongoing restructurings.

The lower interest rate in fact is not followed

with migration of third party capital to capital market

or property sector. However, there are indications that

banks third party funds have migrated to mutual funds.

relatively secure.6 However, we can expect to see

further pressures in fiscal during 2003 and 2004,

particularly in connection with budget deficits. Debt

to GDP ratio decreased from 88.4% as of June 2002

to 70.4% as of December 2002. However, Indonesias

debt ratio was much lower than that of other

countries such as Argentina (49.4%), Mexico (69.1%)

and Turkey (54.2%) before these countries

descended to financial crisis.

If the debt is not carefully managed, debt

crisis will adversely affect balance of payment and

financial performance of the Government.

Eventually the condition will also adversely affect

financial system stability. One potential issue for

the government is refinancing of government bonds

(refinancing risks), considering the huge amount of

the bonds to mature within a few years (IDR 36.3

trillion in 2004 and IDR 45.8 trillion in 2007).

Maturity dates of government bonds prior to and

after re-profiling is shown in Figure 3.8.

FIGURE 3.6:

DOMESTIC ECONOMIC INDICATORS

FIGURE 3.7:

JAKARTA COMPOSITE and

PROPERTY SECTOR INDICES

6 Policy Analysis and Planning Division (2002), Indonesias Medium-Term

Fiscal Sustainability.

Rp/USD Percent

-

2,000

6,000

8,000

10,000

12,000

14,000

4,000

0

10

20

30

40

50

60

70

80

1998 1999 2000 2001 2002

Exchange Rate SBI (%) Interbank (%) Credi t /GDP Rat io (%)

2003

0

100

200

300

400

500

600

700

800

0

20

40

60

80

100

120

140

160

180

200

1996 1997 1998 1999 2000 2001 2002

J C S I P S I

2003

Jakarta Composite Stock Index Property Stock Index

Governments Finance

Bank Indonesias review on medium term

fiscal resilience indicates that fiscal condition is

FIGURE 3.8:

MATURITY PROFILE OF GOVERNMENT BONDS

Before Reprofiling

After Reprofiling

Trillion Rp

2002 2003 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 20202004

0

10

20

30

40

50

60

70

80

90


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14

Chapter 3

Government Bonds

From the Government Budget [APBN] simple stress

test, re-profiling of Government bonds has not fully

taken pressure off the government financial condition.

There are potentials for budget deficit which will

eventually adversely affect the governments ability in

paying principal and interests of government bonds.

In order to address the obligation to pay principal

and interest of maturing government bonds, issued in

connection with banks re-capitalization program, the

Government restructure of maturities and interest rates

of the government bonds. As for an initial step, the

government re-profile the government bond in 4 State-

Owned Banks portfolio involving a sum of IDR 22.8

trillion.

By considering the process and other fiscal

assumptions, the stress test shows a negative difference

between new debt and maturing debts at 1.37% of GDP

or amounting to around IDR 29 trillion in 2004. The

condition needs to be resolved with another re-profiling

and other strategy such as conducting buy back,

boosting additional income from selling assets etc. On

the other hand, re-capitalization banks should work in

efficient manner and also improve their capital by this

means reducing dependence on government financial

support.

A developed and efficient government bond

market will encourage liquidity. The liquidity is needed

to further improve market confidence and capability

reduce risks if there is negative shock to the market.

Otherwise, market participants will rely on Bank

Indonesias liquidity support when crisis occurs. The

role of Bank Indonesia should be limited only in crisis

condition which have systemic impact to the financial

sectors and economy. Sound and liquid government bond

market will help government in reducing refinancing

risks and arranging bonds maturity profile.

Maintaining the governments ability to pay recap

bonds principal and interest at maturing date is critical.

Bonds sold at high discount rate may reflect an

overcrowded of bonds in similar maturity, investors

FIGURE 3.9:

Fixed Rate GOVERNMENT BONDS vs SBI

0

20

40

60

80

100

120

Average Fixed-Rate SBI 1 month

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2 0 0 2

Government Bond Price S B I (%)

0

2

4

6

8

10

12

14

16

18

Table 3.1

Stress Test on Goverment budget (APBN) 2003-04

State Revenues 17.76 17.33 15.70

State Expenditures 20.11 19.10 15.10

Primary Balance 3.04 2.45 4.00

Surplus (+) / Deficit (-) -2.35 -1.77 0.60

A. Financing of Government Debentures

1. Maturing Government Debentures -1.18 -2.73

2. Reprofiling of Government Debentures

at 4 State-Owned Banks 0.00 1.06

Sub Total -1.67

B. Overseas Borrowings

a. Program Loans 0.54 0.53

b. Project Loans 1.16 0.97

Sub Total 1.70 1.50 1.80

C.Instal lments of Overseas Loan Principal -0.76 -0.89 -2.10

Financing (A+B+C) 1.77 -1.97

% of GDP

2002 2003 2004

APBN RAPBN RAPBN


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15

External Factors

choice and the issuer financial conditions. It is therefore

necessary to maintain sound financial condition to

ensure timely payment of bonds principal and interest.

This will increase market confidence and maintain a

more liquid market for government bonds.

Post-crisis financial condition of the Government

is not quite promising. At the moment, the Government

carries huge burden from both domestic and foreign

borrowings. Such situation is worsened by the limited

ability to boost revenues considering the non-conducive

domestic and international economic environments.

Therefore, the future prices of recap bonds will rely

on the Governments ability to improve its financial

performance as well as performance of the economy

as a whole.

The huge bonds principal and interest payment

obligations which will prevail in 2004 through to 2008,

coupled with budget deficits, may give probability of

government debt crisis. The government needs to adopt

more stricter fiscal discipline while striving to increase

revenues. The re-capitalization banks also need to

support government by operating in more sound

governance and obtaining profitable financial condition

to avoid another possibility of government debt and

banking crisis.

Foreign Debts

Foreign debt crisis will adversely affect stability

of financial system. Increasing commercial borrowings

from overseas lenders under binding contracts without

strong repayment capacity, and with uncertainties in

social, political, economic and finance situations, may

impairs international confidence toward Indonesias

economy. This situation will damage Indonesias rating.

As the implications, lenders will demand higher interest

rate as risk premium raising, thus requiring us to

mobilize more and more US$ to repay the floating

interest obligations as well as for securing new loan

commitments. Consequently, there will be high

demands for US$ funds and US$-denominated deposits

at local banks will be rushed. Such situation will surely

adversely affect financial system stability, similar to

that which swept throughout Asia and in Argentina.

Market Confidence

The confidence level of investors and rating

companies on Indonesias financial solvability remains

low, as shown by the rating made by Standards & Poor.

Foreign investors perception on Indonesias financial

condition is still risky. Yield spread between Indonesian

governments Yankee bonds and US treasury bonds as

of December 2002 is relatively wide, namely 266.07

base points. Such condition results in relatively higher

risk premium for Indonesias government as well as

private foreign borrowings. In addition, (lower) rating

and (higher) risk premium may result in reduced

demands for Indonesian Rupiah, thus adversely affect

Rupiah exchange rate which will eventually increase

market risk.

Debt Service Ratio and total debt ratio against

GDP as of December 2002 are relatively high,

respectively at 30.8% and 70.4%. Despite their

decreasing trend, such rates are still above the normal

levels, namely 20% and 50-80%. Such condition will

indirectly adversely affect financial system stability in

the event of substantial depreciation of the IDR.

Therefore, there shall be concrete efforts to boost

exports by among others securing financing facility from


29/153

16

Chapter 3

FIGURE 3.10:

Indonesia Government Bonds Rating and Yields

banks, advancing technology in production and focusing

on productive investments particularly on export-

oriented activities. Approval given to the proposed

rescheduling of Indonesias debts in the amount of US$

5.4 million during Paris Club III on 12th April 2002 is one

such effort to address the potential risk of debt crisis

in Indonesia.

debts. Although, the private debts ratio to export

account for 30.8% which exceeding the benchmark

level of 20%. The amount of exposure has been

decreasing since quarter 4 2002. Moreover, most of

the debts have been restructured and anticipated. The

projected debt repayment in 1st quarter of 2003 is to

be at US$ 3.4 billion. This will expectedly increase

demand for United States Dollar. However, debt

repayment realization is relatively small due to the

fact that most borrowings have been estimated and

the withdrawal will be made only to meet working

capital needs of the corporations.

Source : Bloomberg

S&P rating convertion : 1=SD, 2=C-, 3=C, 4=C+ etc. 15=BB, 20=A- (under BB is speculative)

S&P Yield

SD

Yield

A-

CCC+

BB

0

2

4

6

8

10

12

14

16

18

20

Jul Apr Oct Dec Jan Jan Mar May Mar Mar Sep Apr Oct May Nov Apr Sep Dec

92 95 97 9 7 98 9 8 9 8 9 8 99 99 9 9 0 0 0 0 01 0 1 0 2 02 0 2

0

2

4

6

8

10

12

14

16

Debt Service Ratio

Government 15% 11% 10% 10% 7% 11% 11%

Private 21% 33% 48% 47% 34% 31% 20%

Indonesia 36% 45% 58% 57% 41% 41% 31% 20%

Total Debt to

GDP ratio 49% 62% 146% 105% 94% 91% 70% 50%-80%

Ratio 1996 1997 1998 1999 2000 2001 2002 Benchmark

Table 3.2:Foreign Debt Indicators

Maturity Profile

Maturity profile of foreign debts is not yet

reasonable however it will not bring in significant

adverse impacts to financial system stability since the

corporate apply more prudential foreign borrowing

activities. Most of private debts (88%) are corporate

As for Indonesias bank foreign borrowing, there

are two banks issue bonds denominated in foreign

currency during 2002. Proceed from such bond issue is

primarily used to repay principal and interest of existing

foreign borrowings (exchange offer). Generally,

Indonesia banks adopt the refinancing pattern to repay

their foreign currency borrowing e.g. issue other short-

term bonds. Learning from 1997 crisis, although such

bonds will not bring much problem in short-term period,

FIGURE 3.11:

MATURITY PROFILE OF

CORPORATE FOREIGN DEBT

2 0 0 2

Million USD Million USD

2 0 0 3

Bank

NBFI

Corporate

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

0

200

400

600

800

1000

1200

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4


30/153

17

External Factors

but in the long run they may adversely affect banking

sector and financial systems.

With respect to that, some factors which might

adversely affect such foreign currencydenominated

bonds issued, must be monitored, such as (1)

uncertainty of international economic condition; (2)

the relatively low international confidence level on

Indonesias economy as shown by the low rating; and

(3) the relatively low profitability of banking sector. In

addition, banks need to be cautious of their foreign

currency borrowings by obtaining hedging instruments

in order to reduce market risk, considering the fact

that banks revenues are mostly in Indonesian Rupiah.

However, there are constraints such as insufficiency

data regarding private foreign debts. Learning from

1997 crisis, the condition will result in ineffectiveness

of monitoring activity such that the risks and instability

factors against financial system stability, particularly

from foreign debts, cannot be adequately and timely

anticipated. Therefore, foreign debts need to be

managed in prudential manner and monitored carefully.

REAL SECTOR CONDITION

Small and Medium Enterprises

Loan restructuring process faces with significant

obstacles as real sector has not recovered yet. This

condition will repress financial system stability.

After recapitalization process, Indonesian banks

have not found difficulties in obtaining funds to finance

their lending. This is reflected in the increased liquidity

in primary reserve (cash, minimum demand deposit and

SBI), secondary reserve (trade bonds, inter bank call

money) and tertiary reserve (investment bonds).

In fact banks are still reluctant to lend due to the

fact that banks are still facing some constraints, among

BNI Cayman Island B- 145 -

BNI KP CCC 150 728

Medco Energy Intl B+ 100 766

Indofood B 280 791

Bank Mandiri CCC 125 703

Telkomsel B+ 150 615Source: Bloomberg

Rating O/S (Million US$) Yield Spread

Table 3.3

Indonesia Corporate yankee Bonds (Dec 2002)

There is a significant risk in such corporate bonds

issued overseas against financial stability, due to the

volatility of the exchange rate. In addition, most of

debts are not fully hedged. Such condition might trigger

corporate debt crisis. Eventually, corporate crisis most

of them were financed by banks will have contagious

effect to the banking sector. This was what happen in

some east Asia countries, including Indonesia, during

the 1997 crisis.

In order to improve effectiveness in foreign debt

monitoring, Bank Indonesia has put in place prudential

policy and mechanism for monitoring foreign debts.

Figure 3.12

Loans to SME and Non-SME

Small - Scale Enterprise Loan Non Small - Scale Enterprise Loan

Trillion Rp

-

50

100

150

200

250

300

350

400

450

2 0 0 1

SepDec Mar Jun

2 0 0 2


31/153

18

Chapter 3

7 IBRA Report, September 2002.

others, relatively higher non-performing loans, higher

risks in real sector -particularly corporations with high

debt to equity ratio- and limited information regarding

potential borrowers. In addition, banks preference in

portfolio investments has changed to less risky

investment such as placements in SBI, Government

Bonds and inter bank money market.

will adversely affect banks performance improvement.

Therefore, providing loans to small and medium

enterprises is one of the options to accelerate economic

recovery and to improve banks lending portfolio.

In addition, new loans growth was still low because

most of large companies restructuring at IBRA were

incomplete. The process shows that out of the IDR 369.5

trillion of loans transferred to IBRA, only IDR 19.9 trillion

have been restructured, while IDR 17.1 trillion have

been fully settled.7

Significant growth in new loans may be expected

to occur after completion of the restructuring such

corporations. In fact, the restructuring has not gone

very well and time consuming due to various constraints

particularly uncertainty of business and legal process.

Corporate loans dominate banks portfolio. Delays

in the recovery of real sector particularly corporations

However, it must be noted that such strategy poses

risks as banks have insufficient experience in providing

loans to small and medium enterprises and time

consuming.

As of the third quarter of 2002, lending to small

and medium enterprises accounted for IDR 24.6 trillion,

which was 41.8% of the total new lending. For the same

period, private national forex banks were the biggest

lenders to SME, followed by regional development banks

and state owned Banks, contributing 12.9%, 10.1% and

6.2% respectively. This tendency needs to be monitored

mainly because SME debtors need technical or

management assistance as well as marketing training

of which not all banks can provide.

SMEs non-performing loan was still low (4.5%).

Consumption loan dominated SME lending, which might

increase demands for goods and services at local as

well as international market. On one side, increased

demand would generate enlarged goods and services

Q II 2002 Q III 2002

State BankForex Private

Bank

RegionalDevelopment Bank

Joint-venture Bank

Foreign Bank

Percent

-5

0

5

10

15

20

Non-Forex

Private Bank

Figure 3.13

LENDING GROWTH TO SME BY TYPE OF BANKS

Figure 3.14

SME LOANS BY TYPES OF BUSINESS USES

Working Capital Loan

43%

Investment Loan

11%

Consumer Loan

46%


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19

External Factors

fact that the figure was still higher than those of other

sectors. At the end of 2002, non agriculture and mining

sectors performance showed some improvements.

However, the improvement was still accompanied with

high non-performing loans in non agriculture and mining

sectors, particularly from manufacturing. Considering

the importance of non agriculture and mining sectors

role, particularly manufacturing sector in domestic

economy, the following box 3 illustrates performance

of pulp and paper industry.

inflows from international market which, if not properly

managed, may adversely affect balance of payment.

On the other side, increased demand created business

opportunities for companies in order to improve their

financial performance.

Pulp and Paper Industry

Due to the 1997 crisis, agriculture and mining

sector contribution to GDP decreased, in spite of the

FIGURE 3.16

NPL by SECTOR

10

2001

2002

Agriculture

Mining

Industry

Electricity

Construction

Trading

Transportation

Business Services

Social Services

Others

-

20

30

40

50

60

Percent

Figure 3.15

GDP BY SECTORS TO TOTAL GDP

Percent

-

2

4

6

8

10

12

14

29

30

31

32

33

34

35

36

Mining & Agriculture Non Mining & Agriculture

Percent

1996 1997 1998 1999 2000 2001 2002


33/153


34/153

21

Performance and Prospect of Indonesias BankingPERFORMANCE AND PROSPECT OFINDONESIAS BANKING INDUSTRY4

THE STRUCTURE OF BANKING INDUSTRY

Indonesias financial system stability relies heavily on

the banking industry covering of about 90% of total asset

of financial system. Similarly, the banking system is

dominated by 13 large banks, including 10 recap banks,

represent 74.8% of the total assets of banking industry.

(see Table 4.1)

Therefore, ensuring soundness of these large

banks is the key in maintaining stability of banking

system and financial system. The analysis in this report

is focused on the large banks using data as of December

2002.

ASSETS STRUCTURE

Assets of large banks is largely dominated by

marketable securities accounting for 45.1% while

portion of loans is only 29.1% of total assets of the

large banks as of December 2002. The biggest part

(95.7%) of such marketable securities is recap bonds

(see Figure 4.2).

Figure 4.1.

TOTAL BANKS & ASSETS

Trillion Rp

-

50

100

150

200

250

300

Number of Bank

Total AssetNumber of Bank

0

200

400

600

800

1,000

1,200

1995 1996 1997 1998 1999 2000 2001 2002

SELECTED ITEMS

Table 4.1.

SELECTED ITEMS OF BANKS BALANCE SHEET

AssetsBank Indonesia 153.8 103.5 67.3 134.3 94.0 70.0Inter-bank Placement 124.6 55.8 44.8 149.4 63.9 42.8

Marketable Securities 395.4 374.6 94.8 425.7 406.2 95.4

Loans 371.1 241.5 65.1 316.0 190.8 60.4Non-performing loans 33.2 19.7 59.3 43.4 22.2 51.1Total Assets 1112.2 830.6 74.7 1099.7 822.4 74.8

LiabilitiesDeposits 835.8 634.2 75.9 797.4 606.9 76.1Inter bank borrowing 81.3 60.4 74.2 93.6 70.7 75.5Provision for Loan Losses (39.1) (26.4) 67.5 (44.8) (26.7) 59.6Paid-Up Capital 96.4 71.7 74.4 88.1 66.8 75.8Donated Capital 188.9 188.8 99.9 188.9 188.9 100.0

2 0 0 2 2 0 0 1

Total Bank Large Bank Share Large Bank Total Bank Large Bank Share Large Bank

(Trillion Rp) (Trillion Rp) to Total Bank (%) (Trillion Rp) (Trillion Rp) to Total Bank (%)

BALANCE SHEET

CHAPTER


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22

Chapter 4

Figure 4.3.

Total Loan and NPL

L o a nNPL

0

100

200

300

400

500

600

700

800

1996 1997 1998 1999 2000 2001 2002

Trillion Rp

years maturity. The changed maturities of bonds, forces

banks to adjust their portfolio and lending strategies.

If interest rate decrease to below 12% it will

adversely affect the prices of floating-rate bonds.

Thereby, banks holding floating-rate bonds will have

to reduce their deposit rate in order to adjust their

cost and income structure. As impact they may lose

some of their deposit base, which in turn will hurt their

liquidity due to the migration of funds from these large

banks to such other banks offering higher interest rates

or to other type of investments such as mutual funds.

This will further give pressure to those banks to sell

their floating-rate bonds at big discount rate. However,

such problem can be avoided if the market of recap

bonds is more liquid, so that the trading portfolio bonds

may become an alternative reserves for banks.

CREDIT RISK

During 2002, non-performing loans (NPLs) tend to

decrease, which is mainly attributable to the transfer

of NPLs to the Indonesian Banks Restructuring Agency

[IBRA]. However, there is a potential of increasing NPLs

Thus, the primary source of income of these banks

is interest from recap bonds accounted for 39.0% of

total interest income. Consequently, the fluctuation

of interest rate will pose a high interest rate risk to

the large banks.

Most or 88.5% of total recap bonds held by the

large banks is kept in the investment portfolio, while

the rest is put in the trading portfolio. This strategy is

adopted by banks to minimize market risk.

Prior to reprofiling, most of the recap bonds are

fixed rate at 4 recap banks. Income from fixed rate

bonds, prior to reprofiling, was relatively low due to

low interest rate. Average income from fixed-rate bonds

is at 12.8%, while the average cost of fund of banks is

14.7%. In addition, fixed-rate bonds are traded at quite

huge discount rate. However, after reprofiling of bonds

(November 2002) the average rate for fixed rate bonds

is increased from 12% to 14%.

After reprofiling, bond composition is 35.8% fixed-

rate and 57.1% variable rate. The average market price

for fixed-rate bonds increases and bonds are transacted

at higher prices, particularly bonds with less than three

FIGURE 4.2

BANK SECURITIES and LOANS

Trillion Rp

Total Asset L o an Securities

0

200

400

600

800

1000

1200

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


36/153

23

Performance and Prospect of Indonesias Banking

Total Asset (trillion Rp) 1,112 831 74.7

IDR (%) 81.2 85.0 78.2

Forex (%) 18.8 14.9 59.2

Loan (trillion Rp) 371 241 65.0

IDR (%) 73.6 76.3 67.3

Forex (%) 26.4 23.7 58.2

NPL (trillion Rp) 33 20 60.6NPL Gross (%) 8.1 7.1 53.1

Provisions for Earning

Assets Losses (trillion Rp) 31 19 61.3

Loan Restructuring

(trillion Rp) n.a 48

NPL (%) n.a 9

Nominal % of Total Bank

Table 4.2 :

Details of Loan

13 Large BankTotalBank

from restructured and un-restructured loans purchased

by banks from IBRA.

The 1997 financial crisis has been so damaging to

banking industry, causing NPLs to soar to 54%. Quality

of bank loans then gradually improves in line with the

banking restructuring program. The gross NPLs

decreased to 8.1% and net NPLs reached 2.1% as of

December 2002 (see Figure 4.3). Meanwhile the NPL of

the 13 large banks is 7.1% (gross) or 1.6% (net). The

decrease in NPLs is mostly attributable to the transfer

of the NPLs to IBRA, while the rest are either

restructured or written off.

average Loan to Deposit Ratio is below 35% since

2000). New loans are mostly extended to small-

scale and consumers loans which explain why bank

lending portfolio is not growing fast.

iv. There are potentials for NPLs to increase out of

those restructured and un-restructured loans

purchased by banks from IBRA. Total ex-IBRA un-

restructured loans as of December 2002 were

approximately 6 trillion or 2.2% of the total lending

of large banks.

Non-Performing Loans (NPLs)As of December 2002, gross NPLs of banks is 8.1%

(gross), and 4.3% of which are qualified as loss. Most of

them are NPLs from large banks. Total gross NPL at

large banks is at 7.1% of total their loans. Banks and

large banks have provided adequate amount of

provisions for earning assets losses, so that the net NPL

of banks and large banks is 2.1% and 1.6% respectively.

However, four of the large banks have net NPL ratio

higher than 5%.

In order to assess the ability of large banks to

bear such NPL, a more conservative NPLEquity ratio

Some primary constraints faced by banks in

improving its credit risks are:

i. There are constraints in the process of

restructuring loans due to unfavorable economic

conditions.

ii. The capacity of real sector and corporations to

use credit is relatively low considering the fact

that most of them are still being restructured by

IBRA. New loans is relatively small (indicated by

Figure 4.4. NPL and PROVISIONS

FOR LOAN LOSSES

NPLProvisions for Loan Losses

0

50

100

150

200

250

300

350

1996 1997 1998 1999 2000 2001 2002

Trillion Rp


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Chapter 4

> 8% 9 7 7 6 7 6 5

0% - 8% 4 5 5 4 1 1 2

< 0% 0 1 1 2 5 6 6

5% 8% 10% 12% 15% 18% 20%

Tabel 4.3.

NPL Stress Test

Scenario of Increased NPLC A R

Figure 4.5.

Non Performing Loan

1997 1998 1999 2001 20022000

Mar Jun SepJun Sep Dec Dec Mar Jun Sep Dec Jun Sep Dec Jun Jul Sep Dec Mar Apr MayJun Jul Aug Oct Nov DecMar Jan Feb SepMar

Gross NPLs

Net NPLs

0

10

20

30

40

50

60

Percent

is used. As of December 2002, the ratio indicates that

29.6% of banks capital is to offset the provisions for

earning assets loss, so that the CAR of large banks might

fall from 22.0% to 15.6%. In aggregate this ratio is

adequate for banking industry. Under an even more

conservative measure, i.e. NPL to core equity, indicates

that 39.8% of the banks tier one capital will exhaust

to offset losses from NPLs.

Under the scenario that all the NPL are written

off, there will be four of the large banks with CAR less

than 8%, and even 2 of them have their CAR below zero.

As of December 2002, there were un-restructured

loans purchased by large banks from IBRA, which we

projected amounting to 2.2% of their total lending. In

fact this seems returning the problem loans back to

banks. Conditions might even get worse since there

are legal problems associated with the restructuring of

certain large debtors.

large banks is to increase from 7.05% to 9.2%. Such

increase in NPL is relatively high and therefore this

will adversely affect the capital of the 13 large banks.

In order to assess the impacts of lower credit

quality of large banks to their equity, stress test has

been conducted using a number of hypothetical

scenarios, i.e. NPL increase from 5% to 20%. The stress

test results indicate that some of large banks are very

sensitive to changes in NPL such that their equity would

fall down below the minimum capital adequacy. (see

Table 4.3.).

Efforts to restructure such debtors should be

placed as one of top agenda in the banks business plan.

Under worst case scenario, where all the loans

purchased from IBRA fail to be restructured or becoming

non-performing, there are potentials that NPL ratio at

Under 5% scenario, there are 4 banks with CAR

falling to 8%, 2 of such banks are stated-owned banks.

If NPL increases by 16%, the CAR of large banks fall

below 8%. However, it should be noted that capital

adequacy of each individual bank is differs.

Figure 4.6.

NPL Stress Test

NPL Delta (%)

CAR (Percent)

A B D K Average

-40.0

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

0 5 8 10 12 15 18 20


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Loan Restructuring

Total restructures loans of large banks as of

December 2002 is IDR 44.4 trillion, therein inclusive of

IDR 4.1 trillion NPL (9.4%). Internal restructure of NPL

conducted by large banks yields in positive results in

the course of 2001 and 2002. However, there are

chances that such restructured loans would get worse

considering the fact that the real sector and the

economic condition is not yet conducive.

Under worst-case scenario, in which all of pass

and special mentioned restructured loans and deposits

in the amount of IDR 40.2 trillion becoming non-

performing, the NPL of these large banks will get

worsened to 21.5%. The implication is that the banks

need to put aside a provisions for earning assets losses

to cover the potential NPL, and consequently large

banks CAR would plunge very significantly from an

average 22.0% to as low as 8.7%, and 3 of such large

banks will have their CAR to fall to below 8%. These

means that the restructured loans carry the potential

of disrupting financial system stability.

In connection with this, there has to be efforts to

closely monitor such restructured loans and there is

urgency for lending expansion. For that matter the

Government needs to create an enabling environment

such as deregulation of the real sector, privatization,

creating more conducive investment climate, good

corporate governance and rule of law. In addition, small

and medium enterprises need to be developed in order

to enable them to absorb more loans. To realize all

that, all relevant parties and stakeholders must give

their commitment to the efforts.

From the above analysis, we can sum up that

banks credit risks remain high but stable. However, in

the future there are chances that lending risks will rise

again. This will manifest particularly if there are further

delays for the recovery of the real sector and due

completion of loan restructuring program.

Lending Growth

Banks lending has not grown much during the

post-crisis period. Foreign currency denominated loans

as well as corporate loans tend to decrease. However,

retail loans is increase.

Lending growth after the crisis is relatively low.

During 20002002, average Loan to Deposit Ratio of

Figure 4.8.

Loan to Deposit Ratio

Trillion Rp

0

100

200

300

400

500

600

700

800

900

0

10

20

30

40

50

60

70

80

90

100

Percent

L o a n Deposit LDR

1996 1997 1998 1999 2000 2001 2002 2003

Figure 4.7

Loan Restructuring

Apr

Loan Restructuring (LHS)

NPL Restructuring (RHS) NPL (RHS)0

10

20

30

40

50

60

70

80

0

0.5

1

1.5

2

2.5

3

3.5

4

May Jun Jul Aug Sep Oct Nov Dec

2 0 0 2

Trillion Rp Percent


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Chapter 4

banks stay at a level below 35% compared to that before

the crisis, which is at 72%. In general, the condition is

attributable to lower economic growth and some large

loans portfolios were transferred to IBRA. On one side it

causes lower demand for loans and on the other side

there is increase in deposits. As the results, banks tend

to put their funds in Bank Indonesia Certificates (SBI) as

their source of income. In addition, placements in fixed-

rate recap bonds is also interesting to banks, considering

that this portfolio is exempted from capital charge (zero

risk in calculating risk weighted assets). The falling trend

of SBI interest rate forces banks to extend more loans.

In this regards, attention should be given to avoid lending

to borrowers with high credit risks.

New loans extended during 2002 amounted to IDR

79.4 trillion, of which 38% goes to small and medium

enterprises (see Figure 4.10). After the 1997 financial

crisis, banks tend to concentrate on retails lending

(small and medium enterprises) for the reasons that

they are more resilience to economic crisis and

unaffected by fluctuating exchange rate.

The change of focus from corporate lending to

retail lending gives rise to some implications. On one

side it provides banks with opportunity to diversify their

portfolio and risks. But on the other side, there are

chances for higher operating risk and strategic risk

attributable to insufficient knowledge and expertise

Agriculture 10.5% 7.2% 6.7% 6.1%

Mining 1.6% 1.7% 2.4% 1.7%

Industry 37.1% 39.4% 37.6% 33.1%

Trading 19.1% 16.3% 15.6% 18.1%

Services 19.0% 16.4% 15.8% 16.7%

Others 11.9% 18.3% 21.1% 24.4%

Table 4.4

DISTRIBUTION OF LOANS BY SECTOR

Sector 1999 2000 2001 2002

From demand side, the weak economy forces

borrowers and investors to delay their investments.

From the supply side, such situation forces banks to

behave more more conservative in their lending, and

thereby lending growth remains low.

In order the reduce loans concentration, banks

tend to reduce the corporate segment, while increasing

lending to retail segment. This is meant to diversify

their portfolio risks as well as supporting the

governments call for greater lending to micro and small

enterprises.

Figure 4.9.

TRENDS OF IDR & FOREIGN EXCHANGE LOANS

1996 1997 1998 1999 2000 2001 2002

Trillion Rp

IDR Forex

0

50

100

150

200

250

300

350

400

In addition, banks also tend to reduce foreign

currency denominated loans (see Figure 4.9). This is to

reduce exposure to bank credit risks. The crisis has taught

lesson that this type of loans was very risky, since the

foreign currency denominated loans was provided to

borrowers whose revenues are in Indonesian Rupiah.

When the financial crisis strikes, most of such foreign

currency denominated loans become non-performing.

This situation shall not be repeated in the future.


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Figure 4.10.

NEW LENDING

Trillion Rp

Total New Loan Small-medium Enterprise New Loan

0

4

8

12

16

20

24

28

32

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2 0 0 1 2 0 0 2

Figure 4.12.

PROPERTY LOANS

Trillion Rp

0

10

20

30

40

50

60

70

80

90

Property

Construction

Real Estate

Housing

1996 2001 20021997 1998 1999 2000 2003

of banks in managing retail lending for they have always

been focusing on corporate lending activities. If not

anticipated well, this will create new non-performing

loans.

The change of lending focus is also reflected in

the increase of consumers loans (see Figure 4.11).

Unlike other type of loans, consumers loans increase

in value even exceeding that during pre-crisis period.

The phenomenon is an indication that the risk of SME

loans is relatively lower than the risk in corporate loans.

One type of consumers loan which is most

attractive to the public is the housing loans (KPR) (see

Trillion Rp

Working Capital Loan

-

50

100

150

200

250

300

350

400

450

Investment Loan

Consumer Loan

1996 1997 1998 1999 2000 2001 2002

Figure 4.11.

LOANS BY BUSINESS USES

Figure 4.12). This type of mortgage loan carriesrelatively lower risk, since the borrowers are employees

whom have steady income.

KPR loans are mainly provided to finance purchase

of houses or real estates developed by realty companies

before the crisis. Since the beginning of 2001, KPR loans

tend to grow in value in line with the stable interest

rate and banks efforts to improve their performance

through, among others, diversifying their lending

portfolio.

Total property loans as of December 2002

amounted to IDR 35 trillion or 9.4% of the total loans

provided by banks. Amount and growth rate of property

loan (see Figure 4.12) indicates that property loans carry

relatively lower risks and insignificant to the aggregate

bank credit risks.

LIQUIDITY RISK

In general, Indonesias banks have adequate

liquidity. This is evident by the fact that banks liquid

assets account for a quarter of their total assets.

However, Indonesian banks still faces a moderate

liquidity risks due to dependence on short-term


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pledged as tertiary reserve reserves in the event of

emergency.

However, large banks have to manage their

liquidity prudently in order to prevent potential losses

from selling of recap bonds (tertiary reserve).

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Bank Indonesia, Financial Stability Review I, June 2003

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