Burhanuddin Abdullah: Managing the banking industry within the new
dynamics of the Indonesian economy
Speech by Mr Burhanuddin Abdullah, Governor of Bank Indonesia, at the Annual Banker's Dinner
2006, Jakarta, 13 January 2006.
* * *
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,
To begin, I would like to invite all of you to join me in expressing praise and thanksgiving to God
Almighty for once again extending us the opportunity to meet in this pleasant and congenial setting at
the Bankers' Dinner 2006. For the banking community, the Dinner is an event in which we have
established a tradition of taking time to reflect and build our communication with one another, among
Bank Indonesia and fellow bankers in Indonesia.
An event like this is an opportunity for reflection, to look at ourselves in front of a large mirror and
assess our strengths and shortcomings, make the necessary improvements, and move on to the
future. We are reminded of a quote from Chairil Anwar, oft cited at the beginning of each year, "Take
a look at yourself in the mirror, but not to get ready for partying". Tonight we shall reflect, self-improve
so that we could continue to deliver benefits to the people of Indonesia.
In departure from our tradition of hosting this dinner only for bankers, tonight we are privileged to have
with us special guests: The Economic Coordinating Minister, The Finance Minister, and The National
Development Planning Minister. Also present with us today are members of the Indonesian
Parliament, the Chair of the Indonesian Chamber of Commerce and Industry, economic analysts, and
leading media figures. Your presence here this evening clearly signifies that monetary and banking
issues are of concern to us all.
Distinguished Guests, Ladies and Gentlemen:
As I start to speak tonight, I am reminded by a night similar to this in early 2005. There, I stood before
you ladies and gentlemen as I am now. However, that night was different from tonight as there was a
big cloud of worry overshadowing us. By end of 2004, most of us had planned to ring in the coming
2005 with great celebration. To the contrary, at the end of 2004 we saw a massive Tsunami disaster
engulf Aceh and Northern Sumatera. We were left aghast and speechless. We all felt sadness. Tens
of thousands of our fellow countrymen lost lives and everything they had. We were touched by a
sense of shared loss. As the sadness and mourning began to finally ebb, a breeze of hope started to
flow. Slowly but surely, optimism towards Indonesia's economic revival was planted in the chests of
the people.
And tonight, I would like to ask you to give a momentary look at what we have achieved in 2005, to
review our implemented policies and to draw some lessons that can be learned and implemented for
the coming years. Subsequently, I would like to convey several steps and thoughts aimed to increase
the role of Bank Indonesia and the banking industry in supporting the nation's economic recovery. We
hope this effort is inline with the government's policies towards economic recovery. In the end, we find
that we all have a common goal: to reach an Indonesian society that is just and prosperous.
Distinguished Guests, Ladies and Gentlemen:
During the first quarter of 2005, optimism ran strong throughout our nation. Economic indicators were
on track. Nevertheless, we knew that our economy, having only just pulled out of crisis, still lacked the
resilience to withstand external and internal shocks. Excess liquidity, disharmony between strategy
and policy implementation, and the lack of economic infrastructure resilience towards external shocks
are among the risks potentials our economic stability must face.
This vulnerability became apparent in the second semester of 2005. Global financial imbalances,
increases in world oil prices, and hikes in domestic fuel prices in October were followed by an increase
in inflation (17.11%) in 2005. The Rupiah depreciated by 8.5% and the Balance of Payments showed
a deficit of USD 778 million. This contrasts with 2004's surplus of USD 309 million. The World
Economic Forum stated that Indonesia's competitiveness slipped from 69th position in 2004 to 74th in
2005. This position placed Indonesia in a rung lower than Vietnam. However, despite all the problems,
we have to be grateful that our economy was able to maintain a growth of 5.3 - 5.6% in 2005. This
growth has helped provide work for only some of those entering the job market and leaving the others
adding to the "openly unemployed" statistics.
Distinguished Guests, Ladies and Gentlemen:
From the policy making point of view, 2005 is a year full of challenges. The macroeconomic stability
faced great challenges. Faced with the shocks, Bank Indonesia issued several policies which included
tightening of the economy's liquidity, taking measures to minimize currency speculation, managing
demand and supply of state owned enterprise's foreign currency, and intensifying the commitment to
increase provisions of foreign exchange liquidity facilities in order to secure the situation through
Bilateral Swap Arrangement mechanisms. These policies proved to be effective in managing the
volatile movements of the exchange rate. The exchange rate returned under control and thus
remained stable at around Rp9.800 to the US dollar at year's end.
In the midst of these difficult trials and challenges in 2005, we were grateful that the banking industry
continued to consistently function well in its service to the public. Credit growth exceeded third party
fund growth, with the Loan to Deposit Ratio (LDR) significantly up to 68%. Bank's financing to
prospective economic sectors, such as the consumption sector and the Micro, Small and Medium
Enterprises (MSME's), remains high at levels exceeding 30%. However, a note of caution is in order
here as NPL's tend to move to unfavorable levels.
From the money and capital markets, the increase in interest rates in the second semester of 2005
has triggered redemptions from several financial instruments, particularly so for fixed income mutual
funds. The mutual funds industry got a bitter taste of large-scale redemptions after times of boom.
Distinguished Guests, Ladies and Gentlemen:
Based on the 2005 experiences in the economy and banking system, we can ask ourselves what
lesson is there to be learned? There are four lessons:
•
First, in the midst of a highly dynamic global economic, we must be able to recognize
problems immediately and make adequate decisions quickly. Our inability to make a
timely policy responds to external developments, such as rising world oil prices and global
imbalances, have often caused us to lose momentum, which brings a higher cost
consequences to be borne by the economy.
•
Second, the collapse of the mutual fund industry after such rapid growth has become a
source of financial system instability. In this regard, early warnings from authorities of the
financial sector become necessary to prevent the need for sudden and drastic
adjustments in portfolios. We also need to continuously improve the coordination between
the capital market authority (Bapepam) and Bank Indonesia.
•
Third, our relatively thin foreign exchange market that is dominated by large players like
Pertamina, is frequently colored by excessive volatility. This relatively high volatility would
negatively affect market confidence to the prospects of our macroeconomic stability. This
problem would continue if we do not make structural improvements in foreign exchanges
liquidity by improving exports performance and capital inflows.
•
Fourth, the need to think of ways to lessen our dependency on fuel products. In this
regard, the development of alternative energy sources and public transportation with low
levels of fuel consumption will become a must in the years to come.
Distinguished Guests, Ladies and Gentlemen:
Stepping into year 2006, it is common that in entering the new year, we would define the expectations
we want to achieve as well as identify challenges we hope to overcome within the coming year. In my
view, the major challenge we will face in 2006 will be to bring the economy to a new equilibrium.
From the external point of view, several international institutions have projected that the growth
prospects for the world economy will not change much. It will remain at around 4.3%, with America
and China still as the main engine in the global economic growth. Based on those external conditions,
we predict that the dynamics of the 2006 economy will largely depend on coordination between
monetary, fiscal, and the real sector's policies. Such coordination needs to be done optimally to
manage macro economy stability while promoting economic growth.
•
From the monetary side, Bank Indonesia will consistently make efforts to reduce the rate
of inflation to a single digits in 2006 to allow interest rates to be gradually lowered in order
to boost consumption and private sector investment.
•
From the fiscal side, fiscal stimuli through government consumption and investment would
provide a strong jump start towards economic recovery, especially if the government could
make use of the unrealized 2005 budgeted spending, carry it forward to 2006 and
immediately make it realized within the first quarter of this year.
•
From the real sector side, economic prospects will be more dynamic if the previously
planned infrastructure projects can be realized.
If coordination of these policies is able to be conducted coherently, we will see an improved economic
growth supported by the needed investment and consumption levels from the second semester of
2006 Overall, Bank Indonesia projects that the 2006 GDP will reach 5.0-5.7%.
Growth of that level is predicted to be achievable if investment financing sources from both domestic
and abroad can be secured. Aside from stimuli provided by government's capital expenditures, I
expect the banking industry to continue its role in funding long-term investment projects. An optimistic
level of economic growth may be achieved if the banking industry at least maintains last year's level of
credit extensions. Foreign sources are also assumed to play a significant role as well. It was noted in
2006 that foreign funding contributed up to approximately 40% of that year's growth level. These
foreign sources comprise of Foreign Direct Investment (FDI), portfolio investments, and foreign
corporate loans. Therefore, it is apparent that the steps we must take in improving investment climate
becomes the keys of success in achieving the level of growth we strive for.
Distinguished Guests, Ladies and Gentlemen:
The dynamics of the macro economy in its path to reach a new equilibrium will in itself impact
developments in the banking industry. An example could be seen from the credit market. The increase
in interest, the increasing burden carried by the real sector, and lowered purchasing power result to
predictions of a lower credit demand. From the supply side, the increase of the real sector's credit risk
will cause the banking industry to be increasingly careful in considering the potential debtor's
repayment capacity. From the various discussion forums we have held, we are under the tentative
impression and conclusion that the banking industry percieves that there are many risks involved in
efforts to rejuvenate the real sector. The banking industry holds doubts regading the real sector. Some
of these doubts may have come from, among others, the economy's level of competitiveness and and
that of several commodities which nearly reached nadir levels, the limited information and the banking
industry's limited understanding towards the complexities of particular industries, and unclarity in
development direction and development priorities chosen in certain industries in a particular period. All
of this exist even though it is understood that clear information regarding to the above issues become
a critical navigational tool for banks in allocating their funding.
The opposite occurs in the fund market. The amount of third party funds collected by the banking
sector has been continuously increasing. The community in general believes that the banking industry
is an institution that is able to provide ease and benefits towards their business activities. It is our
prediction that the third party fund growth rate continue towards levels similar to those of in 2005.
Despite the positive outlook, deposit growth in 2006 demands our deftness and care in management
considering risk factors that are increasingly sensitive. As we understand, starting from 2006,
guarantee coverage of the Deposit Insurance Corporation will gradually decrease from Rp 5 billion on
March 2006 to become Rp 100 million in March 2007. Taking this into regard, the real competition in
deposit taking should be in areas of management and service quality, and banks soundness.
The ultimate effect of the developments I have elaborated are that profit and capital levels are
increasingly pressured. Taking that into consideration, for 2006, we view that a short term pain, while
harvesting long term gains
business strategies are a good choice. Bank Indonesia views that the
longer run perspective, which puts financial system stability on top of short term profits, should
become the option.
Distinguished Guests, Ladies and Gentlemen:
I would now like to convey to you Bank Indonesia's policy steps in banking. We have divided the policy
steps into two according to its completion periods, short term and intermediate to long term policy
steps. There are four short term policy steps aimed towards providing banks with bigger room to
maneuver in performing its intermediary function in 2006, five intermediate to long term policy steps
which basically is an elaboration of Indonesian Banking Architecture (API).
As the first short term step, Bank Indonesia will implement temporary adjustment to the
regulation regarding the quality of productive assets, while still maintaining the priciples of
prudentiality. Regulation 7/2/PBI/2005 issued in 2005 has been successful in bringing about positive
changes in the debtor behavior in dealing with banks. With such regulation, debtor's exposures and
performance will be tightly monitored by the bank providing its financing. On the other hand, we also
realize that the implementation of this regulation during these challenging times will not be easy.
Mounting production costs from higher oil prices and cost of capital following increases in interest
rates weakens the corporate balance sheets. The uniform classification requires improvements in the
operation of the credit bureau, a key part within the banking industry's infrastructure that provides
debtor information on a symmetric basis to all banks. At this point, the credit bureau is still on the
development process, with full operation expected to begin in the next one or two years.
Considering the abovementioned aspects, this year, we will be making adjustments to Regulation No.
7/2/PBI/2005. This policy is a temporary measure which in essence is a simplification and phasing in
of the regulatory provisions. For this reason, the phasing in of these provisions will begin with
syndicated loans, which is already supported by adequate means of communication and later to be
followed by bigger debtors and debtors of certain amounts.
Second, Bank Indonesia will consider a downward revision in the statutory reserves
requirement when the condition of macroeconomic stability permits. The adjustment in statutory
reserves requirement will be considered for the first quarter of this year. This consideration is based on
the belief that the 2006 macro economy will reach a relatively stable level and thus liquidity of the
banking sector can be relaxed.
Third, Bank Indonesia will work steadily to improve public access to sharia banking services.
We are preparing a regulation that permits branches of conventional banks with a Sharia Unit to also
provide sharia transactions through office channeling. By providing office channeling at conventional
branches, banks will no longer need to open Sharia Unit branches in numerous locations to offer
sharia banking services.
Fourth, Bank Indonesia will pursue efforts to expand the coverage of banking services with
focus on the Micro, Small, and Medium Enterprises (MSME) sector for more equitable outreach
extending to all remote areas. We will take several steps to realize this policy particularly by
empowering the role and functions of the banking sector in providing the service truly needed by the
MSME. The mapping survey conducted clearly shows that the MSME sector has a high resilience
level. Profit levels of this sector is in the range of 10 - 50%, and profit levels of 50% is achieved by
30% of business in the MSME sector. It is clear that the MSME sector is prospective in terms of credit
and business management, and more importantly, there is a relatively big portion of this sector that is
capable to absorb and conduct healthy principles of economics without the need for subsidies. We will
continue the mapping survey in 2006 to identify MSME sectors which truly holds potential and capacity
to grow and develop. The results of the mapping process will then be synchronized with the Basel II
concepts to accommodate the need to finance the MSME sector. Basel II provides special treatment to
the retail portfolio by assigning a lower risk weight, assessments toward debtors in this group on a
portfolio basis, and requiring a more flexible criteria towards developments in the economy and
accommodate financing issues of small businesses. In this regard, we will make adjustments in Risk
Weighted Assets for certain retail business, including Risk Weighted Assets calculations for financing
the micro and small sector. We hope that through this step, the banking sector will have a regained
sense of enthusiasm and more room to provide financing support to various businesses in this sector.
Distinguished guests, ladies and gentlemen: God willing, we will issue regulations regarding to the
revision to Bank Indonesia Regulation 7/2/2005. Office Channeling, and MSME this month.
Distinguished guests, ladies and gentlemen
For the intermediate to long term, we will focus all regulations and policies towards the strengthening
of banks operational factors and the implementation of prudential principles. Therefore, as a vision, we
may expect to see a more complete picture of the banking industry's new shape by the end of 2010. It
would be a banking industry with greater resilience, higher competitiveness in the global environment,
and contributing towards the development of the nation's economy. To serve these purposes, we will
issue the following policies: first, to reinforce capital structures in order to accelerate the consolidation
process; second, to expand the role of foreign banks in the economy, third, to build the readiness of
the banking system in anticipation of future developments in banking business; fourth, to strengthen
bank internal management; and fifth, to improve the banking system infrastructure.
First, reinforce capital structures in order to accelerate the consolidation process. During the
beginning of 2006, we will conduct an in-depth evaluation of bank business plans through 2008.
According to our records, there is at least 27 banks which face an uphill struggle to reach the Rp 80
billion capital requirement by the end of 2007. We view that in order to make the consolidation
program effective we will need to focus on the supervision process as follow up steps. By referring to
Bank Indonesia Regulation No. 7/15/PBI/2005 regarding to Minimum Tier-1 Capital for Commercial
Banks, we will be able to see the effectiveness of the consolidation acceleration process during the
first quarter of 2006. This may be done through the evaluation of action plans to be submitted by
banks with capital levels under Rp 100 billion.
I should emphasize that Bank Indonesia will not hesitate to take necessary actions to ensure that the
regulations regarding to limitations in banking activities is upheld should regulation 7/15 cannot be met
by a certain bank. These policies are necessary to ensure that the banking industry develops in the
desired direction for the future.
Second, expand the role of foreign banks in the economy. As we know, during the last three
years, we have seen steady expansion in foreign ownership. Foreigners now hold 48.51% ownership
of the Indonesian banking industry, comparing to the government's decreasing stake of the 37.45%.
Amongst Indonesia's 131 banks, 41 are under the ownership control of foreign investors.
Bank Indonesia's policy regarding foreign ownership in banking has been very clear. We have been
very open. We realize that with their various strengths, foreign ownership banks have been able to
bring added value to the Indonesian banking industry. Their role in channeling capital flows,
supporting bonds secondary market activity, supporting international trade, creating product
innovations, and transferring knowledge, are decipherable. Foreign banks and foreign ownership of
domestic banks has created a positive circumstance for the strengthening of the national banking
industry. We convey our sincere thank you for all that have been done.
However, we also have hopes that foreign banks, as part of the national banking industry, increase
their roles in supporting financing for the development.
One of our studies indicates that foreign banks, both foreign bank branches and joint venture banks,
have a relatively small role in the intermediation process. In the post-crisis period, foreign and joint
venture banks moved relatively slowly in restoring their levels of lending. When other banks embarked
on credit expansion in mid-2001, lending by foreign banks on contrary declined and even showed a
negative credit expansion during the 2002-2003 period. Going forward, I expect and would like to see
foreign banks and joint venture banks to participate more in Indonesia's economic revival through its
financing activities as often said by their officials.
With the larger presence of foreign banks in the banking industry, it is understandable that the number
of expatriate staffs in Indonesia is on the increase. However, to create greater opportunities for local
talents, Bank Indonesia will limit the use of expatriate staff in middle management levels, with the
exception for positions that cannot yet be filled by the domestic work force. Bank Indonesia will
prepare a policy guideline concerning the development of human resources in the banking sector. This
policy will take important notice regarding the presence and role of expatriate staff, which presence
should be temporary, and during their stay, they are obliged to conduct transfer of know-how to local
staffs through various training processes.
Another topic related to foreign banks is regarding to ownership. It may be seen that several foreign
banks are owned by the same ultimate shareholder. From the point of view of bank supervision, this is
obviously neither effective nor efficient. The same should also hold true for the bank owners
themselves. It is not easy to harmonize the business strategy of several banks under their control and
avoid unnecessary competition. For this reason, we are looking at the possibility of adopting a single
presence policy for banks under foreign ownership control. Under the single presence policy, ultimate
shareholders controlling more than one bank in Indonesia will be asked to consolidate their ownership.
Third, Bank Indonesia will build the readiness of the banking system in anticipation of future
developments in banking business. Regarding to a global trend in the banking industry, it can be
said that consolidation is under way between almost all ownership of major banking institutions and
other financial industry corporations (such as insurance, money market, securities, mutual funds, and
other related derivative activities). Over time, this has rapidly become widespread practice, producing
a change in the nature of a bank's business from conventional operations to the more complex
business of universal banking.
Universal banking is a development that we must anticipate as part of the future of the national
banking industry. Considering the possible consequences, we will be very cautious and selective in
the policy to open the possibility to universal banking activities in Indonesia.
Fourth, strengthen bank internal management. The fast pace development of information
technology requires a level playing field in banking activities to enable the global market to be
accessible from all corners of the world. This will force us to realign our operational standards in order
to survive and to win in the competitive international banking world.
Understanding the importance of this issue, in the coming years, the implementation of best practices
in good governance and Basel II should become our focus of attention. It is hoped that when the time
comes where the momentum of strengthening shifts to become the momentum of growth, we will be
equipped with effective operational capacities which allow us to dynamically move forward in a
sustainable manner.
Fifth, improve the banking industry infrastructure. We realize that a strong stable financial system,
an efficient and effective operating industry, and consumers that fully understand their rights and
obligations will only materialize given that the supporting infrastructure is able to facilitate the
developing dynamics.
It is for that reason that improvements of banking industry must receive top priority. In 2006, Bank
Indonesia will improve and strengthen infrastructures in five areas, i.e., improving the Financial Sector
Safety Net, the establishment of APEX banks for Rural Banks (BPR's), Banking Mediation Agency,
Bank Research Institutions in various areas of Indonesia, and the regulation of Card Based Payment
Facilities.
Distinguished Guests, Ladies and Gentlemen:
All of this is what I intend to convey to you tonight. It is not hard to imagine the magnitude of problems
we must face ahead if we fail to act correctly and quickly. Our economic growth prospect is less than
optimal, world oil prices may endure shocks, global imbalances are predicted to rise, and inflation
pressure risks remain high. All the while, our time to act is very limited before the effects of those
various problems make its way to the banking and financial industry, and ultimately to our daily lives.
This gives us great reason not to delay our actions. It is my hope that the several policy steps I
mentioned will be able to fix the various problems within the banking sector.
To take the steps that I have elaborated, it is obvious that many sacrifices must be made. Therefore,
we must continue to work hard and rest only when we reach our goals. The banking sector will
continuously improve itself while Bank Indonesia will consistently and with strong discipline guard the
steps to take towards the improvements. This nation will also continue to work until all that is aspired,
a society that is just and prosperous, is achieved.
Once again, I would like to wish you a Happy New Year for 2006. May God Almighty bless us in this
new year to take the necessary steps for a better future.