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Der Open-Access-Publikationsserver der ZBW – Leibniz-Informationszentrum Wirtschaft

The Open Access Publication Server of the ZBW – Leibniz Information Centre for Economics

Holloh, Detlev

Working Paper

Financial systems development and local financial

institutions in Indonesia: Introduction and selected


Working paper / University of Cologne, Development Research Center, No. 1996,1

Provided in cooperation with:

Universität zu Köln Suggested citation: Holloh, Detlev (1996) : Financial systems development and local financial institutions in Indonesia: Introduction and selected bibliography, Working paper / University of Cologne, Development Research Center, No. 1996,1, http://hdl.handle.net/10419/23664

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zbw Leibniz-Informationszentrum Wirtschaft Leibniz Information Centre for Economics Universität zu Köln Arbeitsstelle für Entwicklungsländerforschung University of Cologne Development Research Center Working Paper No. 1996-1 Detlev Holloh



Introduction and Selected Bibliography Universität zu Köln University of Cologne Arbeitsstelle für Entwicklungsländerforschung Development Research Center Bernhard-Feilchenfeld-Str. 11, 50969 Köln Bernhard-Feilche

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From State-led to Market-led Development of the Financial Sector The interventionist rationale of economic policy-making in Indonesia was already laid down in the 1945 constitution, but only the abundant oil revenues during the oil boom period between 1973 and 1982 enabled the government to realize the envisaged state-led model of development. In order to channel revenues to domestic industries, state enterprises and cooperatives, the government strengthened the position of state banks vis-à-vis the private sector. By 1982, state banks accounted for 80 % of total banks assets and 85 % of total bank credit. The central bank established a system of 32 subsidized liquidity credit programs at controlled interest rates. More than 90 % of liquidity credit, which made up almost half of the total loan amount disbursed during the oil boom period, were channeled through state banks. By 1982, small-scale credit accounted for almost one quarter of the total loan amount channeled through subsidized liquidity credit programs. The rural financial system was virtually closed for the private sector. Bank Rakyat Indonesia (BRI) was instructed to establish an extensive network of village units for the implementation of the subsidized credit programs.

During the 1980s, the negative consequences of this development model became apparent. The abuse and repression of the financial sector had undermined the mobilization of domestic savings and the institutional viability of state banks.

Unsound lending practices, misallocation and misuse of funds and the consequent high default rates prevailed in most programs involving small-scale, rural and cooperative credit. BRI village units, which had been the major channel for subsidized credit programs, operated at high losses and were near to collapse. The BIMAS rice intensification program collapsed with at least 20 % of the total loan amount being uncollectible. Village cooperatives, which had to implement 19 subsidized credit programs, had become a field of appropriation for local officials and richer farmers. While the government had intended to supplant informal finance by subsidized credit programs, informal finance flourished because the vast majority of the rural population was not reached with these programs.

The collapse of oil prices in the 1980s diminished the government’s development budgets and undermined the state-led model of economic development. “Back to the Wisdom of the Market Economy” (Coordinating Minister for Economic Affairs, Radius Prawiro, Jakarta Post 16.12.1989) became a major slogan of economic policy. In order to improve the competitiveness of domestic industries, stimulate non-oil exports, reduce reliance on state enterprises, and improve domestic resource mobilization several trade, investment and financial sector reforms removed restrictions that had contributed to the high-cost economy. The new market-oriented approach was most pronounced in a series of financial sector reforms. The first reform in 1983 removed credit ceilings, interest controls and 9 of 32 subsidized credit programs. Most entry barriers to the still state-dominated banking sector, including the rural financial sector, were removed in 1988, and in 1990 the number of subsidized credit programs was further reduced to four. The new banking law of 1992 put a general emphasis on market-oriented banking, removed the specialized functions of state banks and transformed them into limited liability companies. The financial sector responded vigorously to deregulation. Between 1988 and 1994 the number of banks increased from 112 to 240, the number of their branches from 1,640 to 6,059, and the number of rural banks and credit institutions from 5,783 to 9,196. Demand, time and savings deposits were boosted from Rp 37.5 to Rp 168.9 trillion, and the amount of outstanding credit from Rp 35.1 to Rp 153.9 trillion during the same period. The liberalization of financial markets constituted a watershed in the relationship between state and private domestic banks. By 1995, the private sector exceeded the state banks' share in savings mobilization and credit disbursement for the first time.

By the early 1990s the economy and the financial sector faced serious problems.

The vast majority of state enterprises and officialized village cooperatives were deemed financially unsound; the exorbitant increase in money supply aggravated inflationary pressures and required a tight monetary policy; and increasing volumes of bad debts and widespread corruption in all business sectors became a major issue of public debate. Financial reforms had reduced existing distortions in financial markets, but new ones were added by further injecting government money into subsidized credit programs, obliging banks to allocate 20 % of their loan portfolio to small and medium enterprises, instructing state enterprises to allocate one to 5 % of their profits to small enterprises and cooperatives, and pressuring private companies to transfer up to 25 % of their shares to cooperatives. The scandals and crises of several private banks revealed that they had exceeded legal lending limits in extending loans to their own shareholders, who were connected to large business conglomerates. By the end of 1992, 15 % of the state banks’ loan portfolio was categorized as non-performing. Business collusion between the bureaucratic elite and private conglomerates and priority credit programs with arrears ratios of 20 % or more were the major reasons for this performance. High arrears ratios occurred mainly in credit programs implemented through village cooperatives. The farmers’ credit program (KUT) incurred arrears (29 %) mainly through the misuse of funds by officials of local government and cooperatives. The KIK/KMKP small-scale credit program was abandoned in 1990 with a default rate of about 27 %. The subsequent KUK credit program, through which banks were forced to allocate 20 % of their portfolio to small businesses, became also subject to manipulation.

Financial Sector Reforms 1983 - 1992 June 1983: 1. major banking reform: removal of all credit ceilings; reduction of subsidized priority credit programs (from 32 to 23); removal of deposit and lending interest rate controls; removal of subsidies on state banks' deposit rates.

1984-1987: Reintroduction of Bank Indonesia Certificates (SBI) to support open market operations (Febr. 1984); introduction of money market instruments (SBPU) - promissionary notes of bank customers, banks, NBFIs and trade bills (Jan. 1985); raising of interest rates for SBPUs, SBIs, discount facilities and swap premium in order to improve fund management (May 1987).

Oct. 1988: 2. major banking reform: removal of entry barriers for banks and the expansion of branches; allowing public enterprises to place up to 50% of their deposits outside of state banks;

permitting banks and NFBIs to raise capital in the stock market; easing entry to leasing, insurance, venture capital, consumer finance, and securities activities; reducing reserve requirements From 15% (for demand deposits) and 10% (for savings and time deposits) to 2%.

1989: Introduction of legal lending limits, joint venture capital ownership and bank mergers; new definition of bank capital, reserve requirements, bank investment in stocks (March); Jakarta Stock Exchange decontrolled and privatized (Dec.).

Jan. 1990: 3. major banking reform: reduction of subsidized priority credit programs to 4;

requirement for domestic banks to allocate 20 % of their portfolio to small firms and cooperatives;

requirement for foreign and joint ventures to allocate at least 50% of their portfolio to export oriented activities.

1991: New measures to improve bank management and supervision (February); reimposition of ceilings on offshore borrowing for the public sector (November).

Jan. 1992: New banking law: general emphasis on market-oriented banking; removal of the specialized functions of state banks; transformation of state banks into limited liability companies.


Arndt, H.-W. 1987. "The Financial System of Indonesia." Savings and Development 23(3): 305-315.

Bank Indonesia. Various "Reports of the Financial Year", and "Statistik EkonomiKeuangan Indonesia".

Bolnick, B.R. and E.R. Nelson 1990. “Evaluating the Economic Impact of a Small

Credit Program: KIK/KMKP in Indonesia.” Journal of Development Studies 26(2):


Fischer, B. 1994. “Financial Deregulation in an Open Developing Economy:

Lesson from the Indonesian Experience.” Savings and Development 3: 257-277.

Husaini, M., S. Hardjosoekarto, H. Nurasa, T. Mariman 1996. “Small-Scale Enterprises in Indonesia.” in Pangestu, M., ed. 1996. Small- Scale Business Development and Competition Policy. Jakarta: Centre for Strategic and International Studies, pp. 7-19.

Iqbal, F. 1995. “Deregulation and Development in Indonesia. ” Paper prepared for the conference Building on Success: Maximizing the Gains from Deregulation, April 26-28, 1995 in Jakarta.

McLeod, R. 1992. “Indonesia’s Changing Financial Landscape: The Evolution of Finance Policy in Indonesia.” Paper presented at the conference ‘Financial Landscapes Reconstructed’, Wageningen: 17-19 Nov. 1992.

Mubyarto 1991. Deregulasi Ekonomi dan Strategi Pengembangan Perekonomian Rakyat. Yogyakarta: P3PK-UGM.

Nasution, A. 1989. "Paket Deregulasi Sektor Keuangan." Prisma 3: 9-24.

Nasution, A. 1993. Reforms of the Financial Sector in Indonesia, 1983-1991.” The Indonesian Quarterly XXI(3): 284-310.

Pangestu, M. 1993. “The Role of the State and Economic Development in Indonesia.” The Indonesian Quarterly XXI(3): 253-283.

Pangestu, M. 1996. Economic Reform, Deregulation, and Privatization. Jakarta:

Centre for Strategic and International Studies.

Pangestu,M.1996. “Financing Small-Scale Business: The Indonesian Experience.” in Pangestu, M. ed. 1996. Small-Scale Business Development and Competition Policy. Jakarta: Centre for Strategic and International Studies, pp. 26-46.

Patten, R.H. and J.K. Rosengard 1991. Progress With Profits. The Development of Rural Banking in Indonesia. San Francisco: ICS Press.

Robison, R. 1986. Indonesia: The Rise of Capital. Canberra: Asian Studies Association of Australia.

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