The Future of State-Owned Financial Institutions

6. State-Owned Banks in Indonesia

 State-Owned Banks in Indonesia 6 A   of the rest of the developing world, state-owned banks in Indonesia originated with the government’s objectives to channel resources to “priority” sectors of the economy as well as to provide financial services to underserved parts of a widely dispersed country. Each of the banks was also established with a mandate to finance a specific sector of the economy. For much of the country ’s history, these banks have played a major role in the country’s economy—at times controlling over three-fourths of deposits and assets of the banking system —and they continue to control almost half the assets and deposits of the banking system. Also in line with many developing countries, the banking sector dominates the country’s economy, accounting for over 80 percent of the financial sector. The role of state-owned banks has, however, evolved over time. After starting as agents for channeling subsidized credit (provided principally through rediscounting facilities from the central bank, Bank Indonesia) to specific sectors of the economy , these banks have become full-fledged commercial banks. While their privileged access to cheap funding from Bank Indonesia has declined over time, as Indonesia implemented reforms in the financial sector, and while their reported performance in terms of profitability and capital adequacy has improved since the 1997 crisis, they continue to face the usual gamut of problems associated with state ownership. Weak governance and susceptibility to political pressure is a major . .    06-1335-5-CH 06 12/9/04 3:36 PM Page 123 issue, while the implicit government guarantee (with or without the current blanket guarantee on deposits) to depositors in these banks weakens incentives to focus on performance. Despite efforts by the regulator, state-owned banks also face problems of weak regulation and supervision, given the political considerations involved. As Indonesia extricates itself from the devastating effects of the 1997 crisis and looks ahead, a key challenge is to squarely address the role of these banks in its economy going forward. Much has been written about the Indonesian financial sector. Nasution and Balino and Sundararajan provide detailed overviews of the Indonesian financial sector before and during the early 1980s and Indonesia’s first efforts at financial sector reform.1 Nasution and Woo focus on the issue of international debt in Indonesia’s economy and discuss the political economy of state-owned banks in the 1980s.2 Cole and Slade review the Indonesian financial sector development between the 1960s and the late 1980s.3 Hanna and Binhadi assess various financial sector reform packages in Indonesia from 1983 to 1991 and study their effects on the real economy.4 Harris, Schiantarelli, and Siregar focus on the impact of financial liberalization in Indonesia on corporate sector financing.5 During the mid- to late 1990s, much of the literature focusing on the East Asian financial crisis also discussed the Indonesian case at length.6 More recently, Santoso provides an in-depth review of Indonesian financial and corporate sector reform.7 Enoch and others, Kenward, and the World Bank provide excellent overviews of the evolution of banking crisis and its management.8 Boediono assesses the political economy of the International Monetary Fund’s (IMF) support programs under three Indonesian presidents and its impacts on financial sector reform.9 Redway assesses the role of the Indonesian Bank Restructuring Agency (IBRA) in reforming Indonesia’s banking sector.10 McLeod reviews the letters of intent from the government of Indonesia to the IMF and evaluates the crisis recovery program.11 Hofman and Rodrick-Jones provide an analysis of the institutional weaknesses     1. Nasution (1983); Balino and Sundararajan (1986). 2. Nasution and Woo (1989). 3. Cole and Slade (1990, 1996). 4. Hanna (1994); Binhadi (1995). 5. Harris, Schiantarelli, and Siregar (1992). 6. See for example Claessens, Djankov, and Klingebiel (1999). 7. Santoso (2000). 8. Enoch and others (2001, 2003); Kenward (2003); World Bank (1998, 2000). 9. Boediono (2002). 10. Redway (2002). 11. McLeod (2003). 06-1335-5-CH 06 12/9/04 3:36 PM Page 124 underlying Indonesia’s rapid growth before the onset of the crisis and address banking sector issues as part of the country’s overall institutional framework.12 Given the major role of state-owned banks in the Indonesian financial sector, many of the publications cited above necessarily touch upon issues related to these banks. This chapter’s contribution is as an analysis of recent...