• G21;
  • O16

Rosengard and Prasetyantoko (2011) focus in their excellent paper on two paradoxes in Indonesia's evolving past-crisis financial sector. First, why is access to microfinance declining when the country has been a leader in microfinance innovation for the past 25 years? Second, why are small and medium enterprises (MSMEs) in the country apparently facing a credit crunch when banks are liquid, solvent, and profitable, and the economy is growing quite strongly?

The authors show in their table 1 that Indonesia is under-banked according to the usual financial indicators. These indicators have generally declined since the late 1990s. The decline over 1997–1999 was to be expected, but they have not returned to pre-crisis levels, and in some cases have continued to decline further. Moreover, the ratios are much lower than a sample of comparators, including Thailand, another crisis-affected country. These figures refer to the formal financial sector, but similar conclusions also apply to the limited evidence on access to nonformal financial institutions. Survey results indicate that there is unmet effective demand for credit from credit-worthy MSMEs.

The authors further show that both the liquidity and the solvency of the commercial banks are sound. Bank credit has been expanding quite quickly, nonperforming loans are low, and the return on assets is above regional norms. Yet these aggregate figures are misleading. Two of the three largest banks have less than half their assets in loans. The banks have found it more attractive to invest in Bank Indonesia Certificates, Sertifikat Bank Indonesia (SBIs). This is in part because Bank Indonesia (BI) has been fighting inflation effectively with one hand tied behind its back. That is, owing to its reluctance to allow the exchange rate to appreciate as fast as market pressures would dictate, with an open capital account it has had to mop up excess liquidity through the issuance of SBIs at attractive rates of interest.

This costly strategy has stifled the growth of credit to MSMEs. Moreover, the loan portfolios of many of Indonesia's largest banks are dominated by loans to large businesses. And the volume of loans to MSMEs reported in the official statistics is actually overstated, since about half actually takes the form of consumer credit. It is important to also note here an additional cost of this policy beyond the direct scope of the paper. This is the very large gap between the interest rate BI pays to SBI holders and its yield on the funds that are invested primarily in very low return government securities in declining currencies, principally US Treasury Bills or T-Bills.

A central explanation for the concentration by the commercial banks on larger clients is the system of unintended but perverse incentives since the Asian financial crisis. Indonesia liberalized its finance sector in dramatic fashion in the 1980s. However, prudential and supervisory provisions remained lax with the result that, with the onset of the Asian financial crisis in 1997, the formal banking system experienced a catastrophic collapse. The authors show clearly that the new post-crisis financial architecture has “frozen” the development of small-scale and microfinance institutions. The reintroduction of various financial repression measures that had been phased out earlier has impeded the operations of village banks, which are very small scale and not in direct competition with the formal banking sector.

The result is a “prudentially sound but inefficient, narrow and homogenized banking oligopoly.” About half the banking sector assets are held by the five largest banks, Indonesia's net interest margins are high by regional standards, and the price-earning ratios of banks shares are high. The authors show that it is virtually impossible to create a new bank in Indonesia, and very few exit. Meanwhile, the government is under intense political pressure to promote MSMEs, but, rather than responding by creating the incentives for banks to service this sector, it has resorted to clumsy administrative fiats, such as requiring state-owned banks and enterprises to extend finance to the MSMEs. A more effective approach, the authors argue, is “smart regulation” that maintains sound risk management but removes the current barriers to entry.

I find the authors' arguments persuasive, and I have just a few minor comments and queries. First, it would be interesting to have more information on BI's behavioral objectives and operating constraints. BI itself has been under tremendous political pressure since the Asian financial crisis, with its governors forced to operate in a very difficult political environment; several have been subject to legal action. Second, it would be interesting to know a little more about the two major banks that have engaged with MSMEs, Bank Rakyat Indonesia (BRI), and Danamon. This is especially since they are very different institutions, one state owned, the other foreign (Singapore) owned. The BRI story is well known, but Danamon less so. Third, it might be useful for the authors to remind the readers of some of the other barriers to the provision of finance to MSMEs. For example, a recurring issue in the Indonesian context has been the lack of clarity with respect to land titling, and thus the difficulty that small borrowers have in providing collateral to financial institutions.


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