Burhanuddin Abdullah: Progressing towards a sound, strong banking system
for promoting development
Address by Mr Burhanuddin Abdullah, Governor of Bank Indonesia, at the 2005 Bankers' Dinner,
Jakarta, 14 January 2005.
* * *
Fellow Bankers in Indonesia,
Senior colleagues at Bank Indonesia, distinguished guests, ladies and gentlemen
Assalamu'alaikum wr.wb,
Good evening, and greetings to you all,
I. Introduction
At the outset, let us first of all express our gratitude to God Almighty that we are still able to gather
here this evening in good health to attend the Annual Bankers' Dinner for the year 2005. For us in the
banking community, it has been our tradition to gather together for a moment of reflection and
communication among us.
Furthermore, on this occasion, allow me, on behalf of the Board of Governors of Bank Indonesia to
extend to you our very best wishes for the Year 2005.
Ladies and Gentlemen,
The year 2004 has just ended. As we reflect on the year 2004, we can say that it was a year that was
full of events that had meaning. It was a year full of accomplishments but also a year full of challenge.
Perhaps we can say that 2004 was a year where we experienced the peak of political transition and in
the process we have successfully conducted the general election in a democratic, peaceful, honest,
and fair manner. It was a year where our society has succeeded to recompose itself in an accelerated
fashion so that our social life can function in more tranquility. We can also note that the year 2004 was
also the year where we achieved macroeconomic stability which would provide a stronger basis on
which to base the growth of our economy. Exports and investment are beginning to show signs of
vitality in order enabling a more broad-based growth to take place. In our external relations, we can
also note that the year 2004 was the year that we have regained our place and our role as member of
the international community. We have shown we have achieved maturity as a nation and as a
democratic society. We have also shown that we are able to deal with the problems we faced in our
own way and with our own program. In short, the year 2004 was a year where we are beginning again
to show our own identity as a nation and our determination to stand on our own two feet.
With the record achieved in the year 2004 it was natural for us to look to the year 2005 with optimism.
However, as we approach the end of the year 2004 a series of serious natural disasters had also
occurred that overshadowed the record of accomplishments we achieved. The earthquake in Nabire
on the Eastern end of our country and the Tsunami disaster in Aceh and North Sumatera on the
Western end of the country had shocked all of us. We have been deeply saddened by the news of the
disaster where more than one hundred thousands of lives had been lost as well as property and
infrastructure.
In the face of the tragic losses of lives and property I wish to extend my deepest sense of gratitude for
the concern and commitment that have been shown by the banking community to help our brethrens
in Aceh and Sumatera who suffered from the calamities. Assistance for disaster relief from the banking
community coordinated by Bank Indonesia has so far reached Rp. 67.8 billion. I also wish to extend
my deepest appreciation to those in the banking community who institutionally or individually have
organized the relief efforts on their own, and to who had even delivered the assistance directly on the
location in the disaster areas.
Moreover, may I also take this opportunity to express my great appreciation for the strong commitment
of the banking community to restore economic activities in Aceh. In my visit together with the group of
the Coordinating Minister last week, I am gratified to note that all banks that have had operation in
Aceh have again resumed their normal operation.
It is also with great sadness to learn that more than 170 bank employees in Aceh have been reported
to have died or are missing in the disaster. More than 120 bank offices have been seriously damaged
in Aceh. Under such conditions it is heartening to learn that banks have begun their operation on
January 3, 2005, one week after the disaster occurred. Bank clearing operation had resumed on
January 5 2005. Thus the payments of salaries to civil servants in Aceh have been made according to
the normal process prevailing in the rest of the economy. Up to today, it has been reported that of the
13 banks operating in Aceh, 7 have resumed their operation in their premises, 2 in a newly-rented
premises, and 4 operating in premises made available by Bank Indonesia.
Distinguished guests, fellow officials from Bank Indonesia, ladies and gentlemen,
II. Theme: strengthening the banking industry
The theme I have chosen for my address this evening is "Progressing Towards a Sound, Strong
Banking System for Promoting Development." This theme has been deliberately chosen based on the
facts and urgency of future developments that challenge us to resolve fundamental problems
pertaining to the lifeblood of the industry. In recent years, various efforts have been targeted with
emphasis on maintaining macroeconomic stability, with Bank Indonesia's attention drawn more
towards resolving economic and monetary issues. Macroeconomic stability, as I frequently explained
last year, is an element of continuity, a matter of essentiality for any economy seeking to progress.
In this regard, we are thankful that in the midst of a multiplied challenges and tests, we have
succeeded in building and sustaining macroeconomic stability. The rupiah has been maintained at an
encouraging level, despite coming under pressure around mid-year, and the inflation rate is under
relative control at a low 6.4%, with the domestic economy growing at about 5%.
With the support of this macroeconomic stability and the fundamental understanding that higher levels
of economic growth would require a strong and efficient banking industry, we launched the Indonesian
Banking Architecture (API) at the beginning of 2004. This master plan for the future of the banking
industry received enthusiastic comments from many quarters. Suggestions, input, and criticisms came
from various parties with a concern and interest in our banking industry. All are aware that banking is a
key if not the most important industry in turning the wheels of the economy. From that time forth, we
have been buoyed with confidence in the ability of our banking industry to proceed with consolidation
and institution building by laying down the foundations that will set the course for the banking industry.
Having achieved macroeconomic stability, I envisage two important agenda for 2005. The first is to
maintain this stability with focus on sustainability, and the second is that it is time for us to devote
greater attention to the systems and institutions in the banking industry in order to build strength and
deliver results. The hard-won macroeconomic stability should not be frittered away because of the
fragile condition of some banks that could endanger the stability of the system as a whole. On the
other hand, the banking sector must be capable of building its strength and capacity so that it does not
disrupt the stability that we have in hand and can deliver greater benefits to the public. To this end,
banking policy in 2005 will be directed towards efforts to strengthen the banking industry with new
measures to reinforce policy and concrete actions to accelerate the bank consolidation process.
The primary objective of consolidation in the banking sector is to strengthen the banking industry in
the face of mounting future competition. It is this ability to face competition that will determine the
ability of banks to meet the demands of the public. It is for this reason that Bank Indonesia in the
period ahead will pay an increasingly serious attention toward banks which are unable to meet the
requirements in the process of consolidation. Bank Indonesia will not hesitate to take a firm policy in
order to ensure that the process will succeed.
Let it not be that one bad apple spoils the whole barrel. We must not allow the progress we have so
far achieved to be endangered by the problem faced by only a handful of banks with problems. The
growing momentum of improvements in the banking sector must be safeguarded and supported by
continuing corrective efforts.
At our gathering this evening, I will present a number of policies that we will pursue throughout 2005
and in the medium to long term. These are specifically the policies that we will institute to accelerate
the consolidation process in the banking industry, as I touched on earlier.
To elaborate and discuss the theme of my speech this evening, I will first explain the present
macroeconomic conditions and outlook and the performance and prospects of the banking industry.
This section will be followed by the views of Bank Indonesia on key problems and challenges
confronting the industry in 2005 and the medium term. In this section, I will also present the various
policies that we have developed and now expect to resolve the various problems and challenges and
build the Indonesian banking industry as a sound, strong, and efficient banking industry, of benefit to
the economy and society. In my closing remarks, I will attempt to present some conclusions by
reiterating the key messages that I see as important and deserving of attention from us all. These are
points that I expect to become the focus in our efforts to take the development of the banking industry
to a new level in support of 7% economic growth in year 2008.
Distinguished guests, fellow bankers, ladies and gentlemen,
III. The macro environment of the banking industry
Before I deal with future policy issues on banking, I wish to take this opportunity to glance at the
macro-economic factors that surround the operation of banks. If we examine the development of
several key indicators since the crisis, we can note with some satisfaction that they have generally
show improvements. Various stabilization efforts undertaken by the Government and Bank Indonesia
in the monetary and fiscal fields as well as in bank restructuring have been achieved according to
expectation.
Having achieved stability which we will continue to safeguard, we are now confident that the time has
come to look ahead. After the initial focus of managing the immediate impact of the crisis had been
undertaken, we had subsequently began to deal with the process of recovery by focusing on achieving
and maintaining stability. Our next phase is to prepare for the longer-run policy requirement to
generate the momentum for a higher and more sustained growth. This shift in the evolution of policy
can be seen from phasing out of institutions that was directed at dealing with the immediate impact of
the crisis. We have exited from the IMF program and the IBRA is now dissolved.
Improvements in macroeconomic and monetary situation have ushered a more favorable environment
to the economy. Stable inflation and interest rates levels have helped the business sector to obtained
cheaper funding through both banking system and the capital market. For the banking system, stable
interest rates at the level that was relatively low reduces credit risk of banks and hence progressively
facilitate extension of credit to real sector. For the public, gradually decreasing of the level of interest
rates, increases their access to bank credits and led to the increase in consumption of durable goods.
This in turn had a positive impact on the real sector as reflected in the increase of GDP by 5% during
year 2004.
Improved macro-economic situation has a salutary impact on the real sector. Although so far growth
has been spurt by consumption, it is gratifying to note that investment and exports are begining to
show improvements. Growth has taken place across wide spectrum of sectors, with the highest
contribution coming from the process industries, trading and transportation. The fact that growth has
taken fairly evenly across sectors can also be seen by looking at expenditures when outlays for
investments including investment credits have increased. In addition to the domestic factors that has
contributed to growth, favorable external situation has also been helpful. The open global economy
still provides opportunity for exports and prices of commodities of our interest have been improving.
As we enter 2005, we look forward to continued improvement in the Indonesian economy. I am
optimistic that macroeconomic stability will be sustained throughout the years to come. The rupiah is
set to remain stable with an appreciating trend, while inflation in overall terms will stay well under
control despite some expected pressure. The rupiah is forecasted to hold stable while inflation is
predicted to stay on track with the government-mandated inflation target of 6%-7%.
We predict that the Indonesian economy will grow in the range of 5.0%-6.0% while shifting to healthier
balance in sources of growth. The year 2005 will be the year of infrastructure. The government
commitment to promoting development projects with added value for the economy, such as toll roads,
ports, telecommunications and transportation, and the rail network is a key factor sustaining our
optimism for improvement in sources of economic growth and especially investment.
Alongside this, non oil-gas exports are predicted to maintain their heartening trend, consistent with the
favorable conditions in the international economy, a competitive exchange rate for the Rupiah, and
expanding access to international trade financing. Our estimation is that non oil-gas export will
continue to be driven by primary products, such as coal, nickel, and rubber, and some manufacturing
sectors such as electronics and the food and beverages industry.
Looking ahead, improvement in export performance will be contingent on none other than
improvement in export competitiveness. Global imbalances that could potentially push China towards
revaluation of the Yuan will indeed create new opportunities for Indonesian exports through
substitution. However, given China's high productivity and low labor costs, we will be able to avail this
opportunity only if we succeed making improvements in productivity and efficiency. The challenges in
penetrating export markets will become significantly harder in 2005 with the elimination of textile
export quotas, while so far, almost 60% of our textile and textile products have been sold to quota
countries such as the United States and the European Union. With the abolition of quotas, China and
India, the world's leading competitors in the textile industry, are predicted to control a 60% share of the
global market.
Distinguished guests, fellow bankers, ladies and gentlemen
IV. Performance of the banking industry
Improved macroeconomic condition and stability and growing momentum in growth has had a positive
impact on the banking sector. Extension of credits, which is the mainstay of banking activities has
gradually increased and it has now reached a significant level. Moreover, what is even more gratifying
is the increase in investment credits,which during the crisis had been lagging behind. It is reasonable
to expect that bank intermediation will further improve in the years ahead.
On the more microeconomic side, the banking industries have achieved some significant progress in
many fronts. A number of measures and programs for internal consolidation and restructuring which
have been implemented since a few years ago have continued to show satisfactory progress. This can
been seen from the strengthening in the capital structure of banks and from the reduction of credit
risks as well as increase in profitability. The Capital adequacy ratio of banks [CAR] has arrived at a
more satisfactory level, stabilizing at 20%. Problem credits has been under better control as shown by
our figures on net non-performing loans (NPL) of 2.1% and gross non-performing loans of 6.7%.
Lower NPLs improves profitability of bank. In fact, the banking industry enjoys one of the highest
returns to capital.
Even more impressive is the progress achieved in syaria banking. Rapid growth in this segment of
banking can be seen from the rapid increase in banks undertaking shariah banking, their total asset,
as well as the amount financing being extended by shariah banks. It is appropriate to note with
satisfaction that the intermediation function performed by shariah banks have been high where their
FDR had reached 104%. This level of FRD has placed Indonesian shariah banks high in the ranks
among shariah banks in any country in the world. This level of FDR is even higher than the level of
conventional bank which only reached 50%.
However, with market share still around the 1% mark, sharia banking has not yet reached the point of
providing a significant contribution to the economy. Nevertheless, with the record achieved so far
shariah banks have demonstrated the viability of alternative financing to the public. However, with the
brisk growth achieved in recent years, the sharia banking industry has vividly demonstrated its
capacity to offer an alternative avenue for financing to the small and medium-sized enterprises
(SMEs). Therefore, it would not be an exageration to anticipate that in the years to come the share of
shariah banking will increase significantly, at least comparable to the share in other countries
members of the Organization of Islamic Conference.
Looking ahead, it is envisaged that sustained macroeconomic stability will pave the way for the
banking system to strengthen the bank intermediary function. This is expected to boost lending in
2005 by 20% or about Rp 106.2 trillion. With the continued overliquid condition of the banking system
and the moderate 6% increase in deposit funds, this projected growth is seen as achievable.
Investment credit, which began to pick up in 2004, is predicted to expand further particularly as
infrastructure projects get under way. As I mentioned earlier, the banking system can play a
keyfinancing role in the Government plan to accelerate the construction of infrastructure. In this regard, I
call on banks to keep a close watch on their funding structure and experience and capacity in project
financing. In the consumer sector, credit expansion is predicted to remain strong and will be the first
choice for private banks and foreign banks as more banks enter into cooperation with multifinance
companies. In the property sector, banks need to exercise greater caution in lending because of the
higher risk of default on loans for purchase of apartments and office premises.
In the SME and microenterprise sector, lending soared in 2004 and this trend can be expected to
continue in the years to come. For many banks SMEs would remain one of the preferred areas for the
allocation of credits. We need to respond positively to the initiative launched by the UN to declare this
year as the International year of micro-credit to help SMEs. With the great potential that are available
in the SMEs given banks the opportunity to perform their intermediation function.
To extend support to the SMEs, efforts need to be devoted to encourage the Peoples' Credit Bank
(BPR), as the financial institution closest to SMEs in their operation, to enhance their capacity to deal
with SMEs. The proximity of BPR to SMEs, both physically and "psychologically", is part of the
strength of these banks that we will continue to build. Looking ahead at the next 1-3 years, Bank
Indonesia will pursue measures to promote institutional and capacity building to enhance the capacity
of BPR to perform this function and to assume the function of a community bank that would be the
spearhead of micro-credit extension.
Going forward, the banking industry need to examine and develop innovations to assist the
development of SMEs. These innovation could extend the scope of financing to SMEs and at the
same time reduce the risks of extending credits to the sector. In this connection, it may be noted that
since recent time, we have launched a pilot project in cooperation with local governments and
ASKRINDO to explore the possibility of creating a guarantee scheme for credits extended to SMEs. It
is our hope that the pilot project could be expanded to more regions if it proves to be effective to
reduce the credit risk to SMEs that has hitherto represented a major obstacle to lending by the
banking sector.
Distinguished guests, ladies and gentlemen
V. Problems and challenges
As I have mentioned, our goal is to develop a banking industry that would be strong and proactive in
order to be able to support a sustained growth of our economy. In the years ahead despite the
progress we have achieved, we are fully aware that we will continue to face a series of problems and
challenges. Given the dynamic nature of the banking industry, it can only be expected that routine,
technical, and operational issues will emerge from time to time as we move forward on our journey.
not
However, we will not be confronting only technical and operational issues. Our lives will be that
easy. The multidimensional crisis we have faced has left some deep scars at the level of the systems,
institutions, and individuals. Segments in our society have blamed us, the banking industry, for the
misfortunes that they have suffered arising from the crisis. At certain stage the banking industry had
suffered a loss of public confidence. This highly abstract but fundamental factor that is central to the
banking industry, trust, seemed for a while to have been uprooted from the core of the banking
community. There was a feeling at some quarters in the public that the banking industry have failed to
provide a sense of security. The reverse also took place. The trauma of debtors defaulting on their
loan agreements similarly led to a loss of confidence in the banking system in their debtor customers.
Restoring this fundamental building block in the banking business is no easy task. Although we have
in general achieved much progress, there are many more things that need to be done in order to
regain the trust that had been undermined. We must take steps to regain some of the lost trust by
taking steps from the most simple to the most sophisticated. Some the the major challenges we will
continue to face and resolve are:
First, the problem of relying excessively on short-term fund leading to the predominance of
short term credits
Although on the average in 2004 deposits experienced a modest increase, the composition of deposits
have been dominated by those with maturity of 1 month. In the meantime, deposits with longer
maturities have gradually declined. They have been subsequently placed in instruments issued by non
bank financial institutions such as bonds and mutual funds.
With this composition of deposit funds, the banking system as a whole faces the problem of high
volatility of funds. This in turn will hinder the banking system from placing funds in long-term
investment financing. The present condition has encouraged banks to seek business in consumption
credit or working capital credit carrying relatively short terms in order to avoid difficulties with mismatch
between funding sources and placements.
Second, problems with information concerning the debtor soundness have eroded the
confidence of the banking industry in the real sector, hampering the intermediary function
We must admit that despite the improvement in the intermediary function over the years, among
conventional banks the function is still not operating as it should. This is indicated by the continued
high risk premium charged by banks, resulting in the slow decline in lending rates and the tendency of
banks to focus their efforts in credit expansion on existing debtors and short-term credit carrying
relatively low credit risk. This problem stems primarily from lack of information on the soundness of
debtors that would reduce the perception of risk in the banking system regarding prospective
borrowers.
Within this context, the challenge is how to improve transparency and accuracy on flows of information
on debtors/prospective borrowers and economic sectors with potential for lending. This also includes
information on the policy direction in the real sector, how to build the understanding and capacity of
banks in assessing risk, and how to improve legal certainty in the resolution of problem loans in order
to reduce the negative impact of the cost of problem loans on the risk perceptions of banks.
On the other hand, banks must be able to understand the wide ranging technical aspects and the
economic dynamics operating in the sectors where they intend to market their credits. Excessive
concentration of credits in certain sector, in the long term will lead to market saturation, which in turn
would increase the risk in extending credit to this sector. Accordingly, bank must be more proactive
and constructive in providing opportunity of financing in sectors which are productive and which have
not so far being touched optimally.
Third, the credibility of the banking system will be contingent on the ability of the banking
industry to strengthen good corporate governance, including management of operational risk
During 2004, we witnessed a number of cases generally related to the inability of banks to manage
operational risks, particularly in regard to fraud committed by bank owners and management. The
incidence of fraud points to bad faith on the part of owners and managers who exploit their banks for
dishonest personal gain. Failure on the part of individual banks, if allowed to continue, will undermine
trust to the banking system.
Another matter of fundamental importance and calling for urgent attention is the issue of integrity at all
levels, including bank employees. The issue of integrity does not stand in isolation, but comprises part
of another, larger problem of the deteriorating credibility of the banking system.
In view of these facts, it is time for the focus of our attention to move up to the more advanced level of
modern management of the banking industry, the application of good governance principles, and
meticulous, scrupulous management of operational risk.
Fourth, implementation of deposit insurance scheme requires banks to strengthen market
confidence
As I elaborated earlier, public confidence in the national banking industry at this time is not fully based
on objective considerations. For the public, the Government blanket guarantee is a dominant factor in
determining their opinion and confidence toward the banking system.
This condition cannot be allowed to persist. Beginning in 2005, the Government blanket guarantee will
be phased out and replaced by the Deposit Insurance Agency (LPS). This changeover will place
added responsibility on the banking industry to build and maintain public confidence. Without a high
level of confidence, the public will quickly move funds from the less trusted banks to sounder banks
with stronger capital resources.
To prevent this unhelpful phenomenon, the banking industry must be capable of proving that it exists
as a secure, sound industry. In order to adequately functional in this environment, going forward banks
soundness would be determined not only by its quantitative prudential indicators, but will be much
wider to include a more qualitative assessment. Banks must be able to show their ability to strive in
situation of fierce competition. In doing this, must be managed by professionals with high integrity who
are able to govern between prudence and the management of risks on the one hand, and
aggressiveness and creativity in developing new opportunities on the other hand. All transactions must
be conducted quickly, promptly, and accurately by means of an extensive office network with optimum
utilization of information technology. Banks ability to implement modernization and to adopt best
practices must become a distinct feature of strategic management that has selling value and can
always be transparently monitored by the public.
Conversely, banks that are unable to meet the expectation and aspiration of the public as described
above would inevitably be abandoned by its customers. Failure to anticipate this means that the banks
concerned will inexorably find difficulty in keeping up with normal business, suffer substantial loss or
even deteriorating its soundness to the level that may endanger its existence.
Fifth, the banking industry is constantly challenged by competition from non-bank products,
such as mutual funds, bonds, and insurance
As I have mentioned in our bankers' dinner last year, banks in 2004 would face an increasingly tight
competition both among each other and competition arising from other financial institutions. If we
compare the banking and non-banking industries, it is obvious that growth in non-bank instruments
such as mutual funds has outpaced growth in bank products. Last year, the level of banks deposit has
only increase slightly by 4.5% whereas net asset value of mutual funds increased by an impressive
40%. On the other hand, bank credits during 2004 grew only by 20% whereas the Jakarta Composite
Index grew more rapidly, especially during the second half of the year, to close 44% higher at year
end.
The higher return in bullish capital market is also a contributing to a tighter competition faced by banks
in mobilizing deposit funds. On one hand, the rate of interest offered on bank funds is limited, being
tied to movements in the blanket guarantee scheme rates. On the other hand, mutual funds that
comprised of fixed income instruments can offer a fixed and significantly higher return as compared to
any bank product. Return from investment in the stock exchange was even higher. Moreover,
competition also stemmed from insurance company that also offer hybrids of insurance and
investment services, known as unit links.
The highly active bonds market in the recent period is expected to escalate in the periods ahead. This
in part is attributable to eminent issuance of new bonds by both the government as well as the private
sectors in order to finance physical development. The volume of transaction in the bond market is
expected to be relatively high would of course influence the decision of the public to place their funds
in this instruments.
The increasing trend of types of financial instruments offered to public is expected to continue the
period ahead. This condition in turn would have an impact in slowing the growth time deposit
especially those deposits with maturity longer than 1 month. On the assumption that interest rates
would remain relatively stable, it can be expected that the share of this product in the market would
continue to decline while the mutual funds that are sold through banks will experience significant
increase.
It is important to note the increasing role of banking industry in the growth of mutual funds. The extent
of the involvement can be attributed to the close relationship between banks with security companies
which issued mutual funds. The closeness of this relationship makes it difficult to distinguish between
activities of banks from those of other financial institutions. This phenomenon in bank operation of the
banking system and the coming strengthening of the regulatory framework for collateralized securities
products linked to the banking system appear likely to take bank industry to a new dynamic that would
lead toward a more universal characteristics of banking practices. In turn, however, this will aggravate
the inherent risks in the banking system and lead to a wider contagious effect. This is because
instability in the market for one type of product will quickly spread, affecting the overall stability of the
banking industry.
It is logical to expect that strategic alliance would continue to develop, as the operation of financial
institutions become more integrated and interrelated to one another. Nonetheless, our expectation is
that the bank sector would be able to continue to be the driving force in development of these new
products. This strategic function can operate directly and indirectly. Directly, banks can serve as the
originator of such products. And indirectly, banks can act as selling agent, creditor to financial
institutions or as owner of non bank financial institutions such as insurance and security companies.
Distinguished guests, fellow bankers, ladies and gentlemen
VI. Future policy direction
Within the banking industry, we have long been aware of these problems and challenges. Responding
to this, we have worked