The Indonesian Financial System: Its Contribution to
Economic Performance, and Key Policy Issues

John D. Montgomery

 

This paper examines the structure and performance of the financial system in Indonesia and considers its past and prospective contribution to Indonesian economic performance. It reviews the considerable progress already achieved in establishing the regulatory system for the sector, and points to possible areas where improvements in implementation can be made.

The paper finds that the dominance of bank debt over other forms of finance facilitates monetary policy, although it may limit enterprises' financing choices (and could magnify the effect of a credit crunch on the economy). It points to the general experience in other countries with poorly capitalized banks, in particular, the increased risk that banks will make poor lending decisions were they to believe that they will be bailed out if the investments fail.

Five key policy issues are identified that should provide the focus for further improvement of the performance of financial markets and institutions; in many of these, substantial reform is already under way.

• Rapid resolution of the problem of undercapitalized banks;
• Continuing efforts to improve supervision and regulation of banks, in particular in the areas of compliance with capital adequacy ratios and legal lending limits, and vigilance in areas such as foreign exchange exposure and derivatives;
• Enhancement of the competitive structure of banking markets;
• Deepening of securities markets and expansion of the domestic investor base; and
• Continued improvements in the supervision and regulation of securities markets.

John Montgomery is an economist in the Capital Markets and Financial Studies Division of the Research Department of the IMF. He was educated at Yale University and the London School of Economics, and holds a Ph.D. from Princeton University.

 

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