Friday, May 24, 2013

Indonesia's Capital Punishment

Earlier this year, Bank Indonesia issued a package of nine regulations that indicate the Indonesian government is taking a new nationalistic approach to the financial sector.

The package provides more protection to domestic banks, particularly public sector banks, by imposing more restrictions on foreign banks. But will the new regulations help Indonesia?

The regulations will require foreign institutions to invest in domestic businesses. The new capital equivalent maintained assets (CEMA) regulation requires foreign banks to invest a minimum amount of capital in their Indonesian branches. The regulations also require foreign banks to serve small and medium enterprises (SMEs) and open up branch offices outside Java. 

Additionally, domestic banks will stay in local hands. Foreigners used to be able to own up to 99 percent of domestic banks; now the total share that can be owned by foreigners will be limited to 40 percent. The stricter regulations end the red-carpet treatment previously extended to foreign banks and investors who do business and establish offices in Indonesia.

The CEMA requirement will serve as a kind of soft capital control because foreign banks will have to provide additional liquidity to local capital markets. The bond and capital markets in Indonesia are narrow and shallow because in the financial repression era the corporate sector did not need to use them to raise funds.

The new regulations are understandable because Indonesia badly needs foreign banks to finance development. Domestic banks do not have the capacity to raise long-term foreign currency from international markets, but this is necessary if corporations and the government are to pay for risky, long-term projects in mining and manufacturing. Foreign banks provide contingency loans to BI and the Ministry of Finance in times of need and invest in BI’s foreign currency reserves. The foreign banks come to serve large multinationals from their home countries which are operating in Indonesia in mining and large manufacturing. They also provide loans to large domestic corporations, including state-owned companies such as Garuda, which cannot be provided by domestic banks. Because of this, the suggestion made by the Indonesia Banking Association (Perbanas) to convert the subsidiaries of foreign banks into locally incorporated subsidiaries is counterproductive. The financial help given to subsidiaries is more restrictive because it is subject to the risk rating or premium of the recipient country, which raises the rate of interest that the companies pay.

There are more problems with the new regulations. It is not fair to require foreign banks to devote at least 20 percent of their loans to SMEs and to open branch offices in remote places off Java. BI has divided Indonesia into six zones based on how many bank offices there are per person in each area. Jakarta belongs to Zone I and the less-developed and sparsely populated areas with few bank offices — such as West Papua and Gorontalo — are in Zone VI. Banks that operate in Zone VI, for example, will face a more favorable regulatory environment.

However, apart from foreign cooperative and rural banks like Rabobank of the Netherlands and Norinchukin of Japan, multinational banks do not have the experience required to serve rural customers. Serving the financial needs of SMEs in rural areas is supposed to be the responsibility of companies like Bank Rakyat Indonesia and Bukopin. Local regional development banks, not large multinationals, should help finance remote areas.

The regulation package of 2013 does relax restrictions on cross-ownership by allowing holding companies to own more than one bank, and BI can eventually grant permission for foreign investors to own more than 40 percent of a bank’s equity if they meet BI’s standards. But overall, BI is trying to force foreign banks to perform functions to which they are not suited. Instead, what Indonesia really needs is structural reform of its financial industry.

East Asia Forum
Anwar Nasution is professor of economics at the University of Indonesia and senior institution specialist at Support for Economic Analysis Development in Indonesia.

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