How Well Is Indonesia’s Financial System Working?

Indonesia’s banks and financial markets have developed considerably over the twenty years following the country’s devastating financial crisis of 1997–98. Government policy has balanced a variety of objectives involving the financial sector, such as seeking growth, financial inclusion, and stability. Recent data shows that financial stability indicators are mostly robust, suggesting a relatively resilient banking sector. Also, interventionist policies under the government of President Joko Widodo, aimed at promoting financial inclusion and growth, have so far not been excessively costly. However, a degree of inefficiency may be the price to pay for financial stability. This article explores some of the policy and structural sources of inefficiency in the banking sector as they have developed over recent years. It shows that Indonesia’s banking sector is structurally segmented, with limited competition among the largest banks and a competitive —but constrained—mid-size bank segment. Foreign takeovers of existing banks are a possibility, but that does not necessarily improve banking sector performance. Alternative sources of finance and vehicles for private saving in Indonesia may reduce the impact of the inefficiency.