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Publisher :

Bank Indonesia
Jl. MH Thamrin No.2, Jakarta
Indonesia

The preparation of the Financial Stability Review (FSR) is one of the avenues
through which Bank Indonesia achieves its mission ≈to safeguard the stability of the Indonesian
Rupiah by maintaining monetary and financial system stability for sustainable national
economic development∆.

FSR is published biannually with the objectives:


To improve public insight in terms of understanding financial system stability.
To evaluate potential risks to financial system stability.
To analyze the developments of and issues within the financial system.
To offer policy recommendations to promote and maintain financial system stability.

Information and Orders:


This edition is published in Maret 2009 and is based on data and information available as of December 2008, unless stated
otherwise.

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Email : BSSK@bi.go.id
Financial Stability Review
( No. 12, March 2009 )
ii
Table of Contents

Foreword vi Box 2.3. Segmentation in the Interbank Money Market


(PUAB) 46
Overview 3 Box 2.4. Structured Products and Offshore Products:
Their Impact to the Stability of the Financial
Chapter 1 Macroeconomic Conditions and System 48
the Real Sector 9 Box 2.5. The Impact of Foreign Debt to Financial
Macroeconomic Conditions 9 System Stability 50
Real Sector Conditions 12
Box 1.1. Indonesian Household Balance Sheet Survey Chapter 3 Financial Infrastructure and Risk
2008 15 Mitigation 53
Box 1.2. Corporate Sector Credit Risk: Credit Default Payment System Performance 53
Swaps (CDS) 17 Credit Bureau 56
Box 1.3. Transition Matrices: The Risk Potential of Financial System Safety Net 60
Corporate Credit of Three Sectors 18 Box 3.1. The Financial System Stability and PERPPU
on the Amendments to the Law on Bank
Chapter 2 The Financial Sector 21 Indonesia 63
Indonesian Financial System Structure 21 Box 3.2. Best Practices of Systemic Impact Analysis
Financial Stability Index 22 towards the Financial System 64
The Banking Industry 22
Funding and Liquidity Risk 22 Chapter 4 Prospects of the Financial System in
Credit Growth and Credit Risk 24 Indonesia 67
Market Risk 30 Economic Prospects and Risk Perception 67
Profitability and Capital 32 Bank Risk Profile: Level and Direction 68
Nonbank Financial Institutions and the Capital Market 35 Prospect of the Indonesian Financial System 69
Finance Companies 35
Capital Market 38 Articles
Box 2.1. Chronology of the 2008 Financial Sector Article 1 Impact of Contagion Risk on the Indonesian
Shocks and Policy Responses 44 Capital Market 73
Box 2.2. Bank Century»s Takeover, Bank Indover»s Article 2 Corporate Balance Sheet Modelling:
Closure and Financial System Stability 45 Determinants of Indonesian Corporate
Debt 83

iii
List of Tables and Figures

Tables Figures

1.1 Global Economic Indicators 10 1.1 Business Confidence Indicators 9


1.2 Price Index of several Commodities 10
2.1 Banking Profit and Loss 33 1.3 GDP Growth of Industrial Countries 10
2.2 Financing Growth of Finance Companies 36 1.4 GDP Growth of Several Emerging Market
2.3 Financial Ratios of Finance Companies 36 Countries 11
2.4 NPL of Finance Companies 37 1.5 Global Stock Price Index 11
2.5 Price Index Perfomance of Several Stock 1.6 Rupiah Exchange Rate against the US Dollar 11
Exchanges in the Region 39 1.7 Inflation in ASEAN-5 and Vietnam 11
2.6 Sectoral Price Index 40 1.8 Real Interest Rate in Indonesia, US and
Singapore 12
3.1 Debtor Identification Number (DIN) Data 1.9 ROA and ROE of Nonfinancial Public Listed
(2006-2008) 58 Companies 12
3.2 Financial Safety Net Framework 61 1.10 DER and TL/TA of Nonfinancial Public Listed
Companies 12
4.1 Projection of Several Economic Indicators 67 1.11 Probability of Default (PD) of Nonfinancial Public
4.2 Risk Perception of Indonesia 68 Listed Companies 13
1.12 Unemployment Rate in ASEAN 13
Box Tables : 1.13 Structure of Household Income Sources 14
1.3.1 Collectability of Debtor Migration of Three
Sectors 18 2.1 Assets of Financial Institutions 21
2.2 Financial Stability Index 22
2.1.1 Chronology of Shocks to the Indonesian 2.3 Performance of Deposits 23
Financial Sector in 2008 44 2.4 Performance of Foreign Exchange Deposits 23
2.1.2 Policy Response 44 2.5 Growth of Foreign Exchange Deposits vs Rp
2.3.1 Daily Average Transaction Volume of Rupiah Exchange Rate to US Dollar 23
PUAB from January to December 2008 46 2.6 Excess of Bank Liquidity 23
2.3.2 Daily Average Transaction Volume of Domestic 2.7 Transaction Volume of PUAB (daily average) 24
Foreign Exchange PUAB 46 2.8 Credit Growth (yoy) 25
2.5.1 Private Foreign Debt Maturing in 2009 50 2.9 Credit Growth during 2007-2008 25
2.10 Credit Growth by Bank Group (y-t-d) 25
2.11 Credit Growth by Usage (y-t-d) 26
2.12 Credit Growth by Economic Sector 26
2.13 Growth of Housing loans, Credit Cards and
Others 26
2.14 Growth of Property Credit 26
2.15 Credit Growth by Its Initial Denomination 26

iv
2.16 Credit Share by Usage 27 2.51 Foreign Investment: SBI √ SUN √ Stocks 38
2.17 Growth of MSM Credit 27 2.52 Foreign Placements: SBI √ SUN √ Stocks 38
2.18 Non Performing Loans 28 2.53 SUN and SBI Ownership by Foreign Investors 39
2.19 Credit, NPL and Provisions 28 2.54 SUN Absorption by Domestic and Foreign Financial
2.20 Gross NPL Ratio by Bank Group 28 Institutions 39
2.21 Gross NPL Ratio by Economic Sector 28 2.55 Performance of JCI, Global and Regional Index
2.22 Gross NPL Ratio by Credit Usage 28 (Based on Index per 31 Dec 2005) 39
2.23 Gross NPL Ratio of Consumer Credit 29 2.56 Volatility of Asian Stock Indices (30 days) 40
2.24 Gross NPL Ratio of Property Credit 29 2.57 Stock Transaction Value of Domestic and Foreign
2.25 Gross NPL Ratio of Credit in Rupiah and Foreign Investors 40
Exchange 29 2.58 Capitalization and Issuance Value 40
2.26 Gross NPL Ratio of MSM and Non MSM Credit 30 2.59 Stock Price Performance of Several Banks 41
2.27 Gross NPL Ratio of MSM Credit 30 2.60 P/E Ratio of Bank Stocks 41
2.28 Rupiah Interest Rate and Exchange Rate 31 2.61 Price Performance of Several FR Series Bonds 41
2.29 Rupiah Maturity Profile 31 2.62 Yield of 1 to 30 year SUN 41
2.30 Foreign Exchange Maturity Profile 31 2.63 Government Bonds: Market Liquidity of Various
2.31 Net Open Positions 31 Tenors 42
2.32 SUN Portfolio of Banking Industry 32 2.64 Issuance and Position of Corporate Bonds 42
2.33 Performance of SUN Owned by Banks 32 2.65 Net Asset Value of Mutual Funds 42
2.34 Bank Profitability 33 2.66 Mutual Funds: Redemptions-Subscriptions-NAV 42
2.35 Bank Interest Income 33 2.67 Mutual Fund: NAV-Participating Units 43
2.36 ROA by Bank Groups 33 2.68 Performance of Fund Collection of Mutual Funds 43
2.37 Ratio of Interest Expense to Interest Income by
Bank Group 34 3.1 Performance of BI-RTGS Transactions 53
2.38 Capital, Risk-Weighted Assets and CAR 34 3.2 Performance of Bank Indonesia National
2.39 Integrated Stress Test on CAR of 15 Major Banks 34 Clearing System 54
2.40 Interbank Stress Test 35 3.3 Performance of Card Based Payment Instruments 54
2.41 Business Activities of Finance Companies 35 3.4 E-Money Transactions 54
2.42 Finance Companies Source of Funds 35 3.5 Role of Credit Bureau 57
2.43 Composition of Financing by Finance Companies 3.6 Credit Bureau Strategic Policy 58
(Nov «08) 36
2.44 NPL of Financing by Finance Companies 36 4.1 Bank Risk Profile and Outlook 69
2.45 Developments of NPL Value 36
2.46 Cash Flow of Private Finance Companies 37 Figures included in Boxes:
2.47 Cash Flow of Joint Venture Finance Companies 37 1.1.1 Composition of Household Debt Percentage of
2.48 Bank Exposure 37 Total Debt 15
2.49 The Decrease of NPL of Bank Subsidiary Finance 1.1.2 Purpose of Household Credit 16
Companies 38 1.2.1 CDS Price in Indonesia 17
2.50 The Increase of NPL of Bank Subsidiary Finance 1.2.2 CDS Spread in Indonesia 17
Companies 38

v
Foreword

I welcome the publication of the Financial Stability Review No. 12 March 2009. This edition is critically important as
there recently have been many developments which need our analysis regarding their impact to financial system stability
as a whole.
Our analysis has revealed that the resilience of the Indonesian financial sector during semester II 2008, in general,
has been relatively maintained, despite the sharp increase in pressure to the financial system stability the global crisis has
brought. One of the indicators of the increased pressure is the Financial Stability Index (FSI) surpassing the indicative
maximum level of 2 in November and December 2008. In the capital market, the increase in pressure was indicated by the
drop of the Jakarta Composite Index (IHSG), while government bonds (SUN) were marred by a drop in their prices.
In the banking sector, the pressure manifests itself in the form of increases in liquidity risk, particularly from August
to September 2008. Liquidity pressures surface not only from the global crisis, but also from expansive growth of credit
which was funded by banks» secondary reserves as opposed to being funded from increases in deposits. Concomitantly,
the banking sector also faced increases in exchange rate risk as the rupiah weakened. As we neared the end of 2008, we
saw pressures to the financial system stability start to subside, although not completely returning to levels prior the crisis.
The decrease in pressures was attributed to the various policies taken, both by the government and Bank Indonesia.
Although lowered in intensity, still left on our plates, among others is the issue of segmentations in the interbank money
market (PUAB).
Even though pressures to the financial sector has increased, the most dominant industry of the financial sector, i.e.
the banking industry, has been able to maintain relatively solid performance. At the end of December 2008, the banking
industry»s capital adequacy ratio (CAR) remained at a high 16.2% while asset quality was well maintained as indicated by
low levels of NPL, i.e. 3.8% (gross) and 1.5% (net).
Looking forward, we must continue to be vigilant to various sources of instability, including the potential of increase
in credit risk and the possibility of liquidity pressure returning. Another potential pressure source is the increasing signs of
a credit crunch in the banking industry. Such can, in turn, disrupt the performance of the real sector, both at corporate
and household levels. Disruptions in the real sector will only come back to the banking industry in the form of credit risk
increases.

vi
The increase of challenges in the financial sector needs to be anticipated by our continuous efforts to improve and
increase surveillance quality to support an early warning mechanism. By knowing risk potentials early in advance, we will
be able to strategically prepare mitigating measures and thus enable us to minimize losses. Such accentuates the impor-
tance of the publication of this edition as it serves as an important medium to communicate surveillance results to our
stakeholders. It is our hope that the Review succeeds in its mission and the information contained within will be of great
use to all its readers.

Jakarta, March 2009


DEPUTY GOVERNOR OF BANK INDONESIA

Muliaman D. Hadad

vii
viii
Overview

Overview

1
Overview

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2
Overview

Overview

Financial system stability was well maintained during semester II 2008.


Pressures intensified on the financial sector during the period as a result of
the global economic crisis. The JSX Composite (IHSG) slid sharply and
government bonds (SUN) experienced a significant decline. The banking sector
also suffered liquidity pressures, due in part to the global liquidity crisis but
also to expansive credit growth that lasted until October 2008 and was
primarily funded by secondary reserves. In addition, rupiah depreciation since
the beginning of October 2008 further aggravated financial sector risk. Such
volatility in the financial sector triggered a steep rise in the Financial Stability
Index during the reporting semester, exceeding the indicative 2-point
maximum limit in November and December 2008. To maintain financial system
stability, the government issued a regulation in lieu of law (PERPPU), and
Bank of Indonesia promulgated several new regulations, including an
amendment to the minimum reserve requirement. Such measures improved
bank liquidity and alleviated exchange rate volatility, however, not to the
levels recorded prior to October 2008. Nearing year end 2008 and into the
new year of 2009 there were indications that bank credit growth was slowing
down. If this situation persists, it could adversely impact the economy
considering that the banking sector is the primary source of funds. Looking
forward, the financial system is projected to remain stable despite the
burgeoning challenges attributable to the unrelenting economic slowdown.

1. SOURCES OF INSTABILITY Furthermore, foreign sources of funds have become more


1.1. Global financial crisis important for banks and nonbank sectors alike.
The global financial crisis represents the major root Consequently, the financial turmoil currently impacting a
of instability. This is because Indonesia»s economy is multitude of countries can potentially reach Indonesia»s
increasingly integrated with the global economy. shores. Such financial volatility will not only destabilize the

3
Overview

domestic financial sector but also the corporate sector. As months has not shown any significant progress. Overall,
a result, businesses will have difficulty obtaining foreign such inauspicious conditions in both the real sector and
funds. Furthermore, the real sector, which relies heavily infrastructure could spark additional pressures on financial
on foreign funding, will face disruptions thus reducing its system stability, predominantly in terms of an increase in
debt repayment capacity. In the banking sector, these NPL and a contraction in bank credit extension.
constraints will trigger an increase in nonperforming loans
(NPL) and undermine credit growth and other 1.4. Financial innovation and structured prod-
disbursements in foreign exchange, which are required to ucts
support economic activity. As stated in the previous Financial Stability Review
(No. 11, September 2008), it is now mandatory for the
1.2. Macroeconomic conditions banking industry to adhere to strict risk management and
Macroeconomic stability is the foremost prerequisite customer protection principles in the innovation of financial
in achieving financial system stability. Some experts have products offered to the consumer, including structured
predicted that the domestic macro economy in 2009 will products. With the recent currency depreciation, several
not improve compared to that of 2008, principally due to countries have experienced difficulties due to losses from
the global economic slowdown. Deteriorating structured products. This has ignited disputes between
macroeconomic conditions will encumber financial stability banks and their customers. The losses suffered in Indonesia
due to the inherent increase in NPL. In addition, the banking were less than that in other countries; however, vigilance
sector will become more selective when extending credit, is still required to avoid an increase in credit risk and
which may spur a credit crunch. Accordingly, anticipatory exchange rate risk. Additionally, reputational risks and legal
measures are required in order to avoid an increase in bank risks of banks have the potential to increase in relation to
risk due to tightening macroeconomic conditions, including structured products, in particular if the ongoing disputes
intensifying monitoring and accelerating credit are not resolved quickly and amicably.
restructuring for debtors affected by the global crisis. Also, the banking industry must also be more prudent
in taking roles as agents of offshore products. Such is
1.3. Real sector conditions and infrastructure because excessive placements in these products represent
Instability may also arise from unfavorable real sector capital flight of domestic investors abroad, creates greater
conditions and inadequate domestic infrastructure. bank exposure to reputational and legal risks, and increases
Surveillance has revealed that corporate performance, in the potential of disputes with bank clients particularly if
general, are in decline, mainly in terms of profitability and consumer protection is not considered as priority by the
liquidity. In addition, leverage tended to rise in line with bank.
declining capital due to a drop in profitability. Furthermore,
despite positive survey results in 2008 showing that the 1.5. Segmentation in the inter-bank money
household sector was relatively safe, the threat of lay-offs market
at several companies has the potential to pinch households In general, liquidity pressure during the second
in the future. Meanwhile, infrastructure over the past six semester of 2008 was well mitigated and the banking

4
Overview

industry has become more liquid. However, interbank strengthening risk management and improving good
money market (PUAB) segmentation remained a key issue, governance implementation.
with major banks preferring to transact with other major
banks, while the small and medium banks faced increasing 2.2. Intensifying surveillance
difficulty in obtaining funds. Moving forward, PUAB Risk mitigation in the financial sector can also be
segmentation will require urgent resolution to ease achieved by intensifying surveillance. To this end, various
pressure on banking stability, particularly liquidity. tools and methods have been developed, such as stress
tests, probability of default analysis, a financial stability
1.6. The political climate and homeland security index as well as household surveys to support surveillance
The 2009 General Election will influence the future at a macro-prudential level. Each of these approaches is
political climate, homeland security, and in turn, financial reviewed regularly and developed further to become a
stability. However, as society becomes more familiar with capable early warning tool. At the micro-prudential level,
elections, such as for new governors and regents, which human resources were improved and various approaches
occur year round throughout Indonesia, the upcoming were applied in the implementation of risk-based
general election is expected to run safely and under control. supervision to strengthen bank surveillance. In addition,
A successful general election will catalyze domestic several new regulations to maintain financial system
investment, by both local and international investors. stability were also issued.

2. RISK MITIGATION 2.3. Improving the Crisis Management Protocol


2.1. Improving risk management and good To mitigate risk in the financial sector from a wider
governance perspective, a crisis management protocol was formulated
The best way to minimize financial sector instability and became an important aspect of the Financial System
is by strengthening risk management and good governance Safety Net (JPSK). To mitigate risk from volatility in the
in financial institutions, both banks and non-banks. financial sector in October 2008, the government
Improved risk management will be extremely helpful in promulgated three regulations in lieu of law (PERPPU) as
taking the necessary mitigatory measures against the risk follows: (i) Raising the guarantee limit covered by the
of losses. Meanwhile, the implementation of good Deposit Insurance Corporation (LPS) from Rp100 million
governance will encourage financial institutions to pay to Rp2 billion per customer; (ii) Amending the Law on Bank
more attention to transparency, accountability and fairness Indonesia to facilitate the use of credit classified as current
principles. This, in turn, will ensure adequate market as collateral for the short-term funding facility (FPJP) from
discipline and sufficient customer protection. Compared Bank Indonesia; and (iii) Implementing a Financial System
to previous years, the implementation of risk management Safety Net (JPSK).
and good governance in the banking sector has shown The issuance of these three PERPPU minimized bank
greater encouraging progress. However, in order to liquidity pressure and, consequently, the banking sector
anticipate the pervasive impacts of the deteriorating global remained stable. However, when liquidity pressure
economy, more efforts are required in terms of intensified, one bank was handed over to LPS for immediate

5
Overview

recovery. The People»s Representative Council approved the overseas banks. Second, the banking sector and the
regulation regarding a change in guarantee limit covered supervisory authority are more prepared to confront the
by LPS and the amendment to the Law on Bank Indonesia, crisis when compared to conditions in 1997/98. Third,
while the regulation legislating FPJP was not. At the time financial sector infrastructure has been improved with the
of writing the Government had prepared a draft regulation addition of a reliable Deposit Insurance Corporation (LPS)
concerning the JPSK, which had been submitted to the that provides assurance to consumers. Another important
People»s Representative Council for further approval. factor that supports financial stability is the Financial System
Safety Net (FSSN), for which the law draft has been
3. FINANCIAL SYSTEM STABILITY OUTLOOK submitted to the People»s Representative Council.
The prospects for the financial system is expected to Amidst such optimism, vigilance must be intensified
remain positive despite the onset of larger challenges as the current global crisis is seen as the most severe since
primarily from deteriorating economic conditions both the Great Depression in 1929. The collective impacts on
domestically and globally. As will be elaborated upon in the domestic economy of the downturn in global economic
more detail in Chapter 4 there are various factors growth will be difficult to avoid. Thus, it is vital to protect
underlying this projection. First, financial volatility has the domestic financial sector by creating a broad safety
reoccurred recently, principally caused by external factors, net and put prudential principles on the forefront of
however domestic banks are not suffering as severely as business activities.

6
Chapter 1 Macroeconomic Conditions and the Real Sector

Chapter 1
Macroeconomic Conditions
and the Real Sector

7
Chapter 1 Macroeconomic Conditions and the Real Sector

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8
Chapter 1 Macroeconomic Conditions and the Real Sector

Chapter 1 Macroeconomic Conditions and


the Real Sector

Macroeconomic stability in Indonesia was well maintained during semester


II 2008 despite pressures from the ongoing global financial crisis. A loss of
market confidence compounded the financial crisis, which spilled over into
the real sector and triggered an economic slowdown in many countries
including Indonesia. Meanwhile, weaker purchasing power coupled with
tumbling commodity prices undermined profitability in the corporate sector.
As a result, business players improved their efficiency through lay offs and
by curtailing business expansion, which subsequently eroded household
income. If such conditions persist, domestic financial system stability could
be threatened.

1. MACROECONOMIC CONDITIONS by only 3.4%; compared to 5.2% in 2007. This downturn


International economic performance during semester is expected to persist in 2009, with growth of just 0.5%.
II 2008 was marred by the escalating global financial crisis Growth is expected to rebound in 2010 to approximately
and its impact on the real sector. A lack of liquidity and 3.0%.
greater volatility in the money market undermined the
corporate sector (producers) as well as household sector Figure 1.1
Business Confidence Indicators
(consumers) confidence in the economy. A drop in the
Manufacturing PMls
Business Confidence Indicator, issued by the IMF, was clear 65
(values greater than 50 indicate expansion)

evidence of this. 60 Euro Area

Against this inauspicious backdrop, producers and 55

50
consumers took anticipatory measures, which manifested
45
in a slowdown in investment and consumption. Emerging
Economies
40
Consequently, such behavior contributed to a slump in United
States
35
economic growth, particularly in developed countries. Oct
1985 1990 1995 2000 2005 2008
During 2008, the global economy was projected to grow Source: World Economic Outlook-IMF November, 2008

9
Chapter 1 Macroeconomic Conditions and the Real Sector

Table 1.1 Figure 1.2


Global Economic Indicators Price Index of several Commodities
(%)
Projection 1990 = 100
Category 2007 2008 600 600
2009 2010 Oil
Tin
Copper
Gold
500 Palm Oil Coffee 500
World Output: 5.2 3.4 0.5 3.0 Rice
Aluminium
Rubber

Advanced Economies 2.7 1.0 (2.0) 1.1 400 400


United States 2.0 1.1 (1.6) 1.6
300 300
Euro area 2.6 1.0 (2.0) 0.2
Emerging & Developing Countries 8.3 6.3 3.3 5.0 200 200
Consumer Price:
100 100
Advanced Economies 2.1 3.5 0.3 0.8
Emerging & Developing Countries1) 6.4 9.2 5.8 5.0 0 0
2000 2001 2002 2003 2004 2005 2006 2007 2008
LIBOR2)
Source: Bank Indonesia
US Dollar Deposit 5.3 3.0 1.3 2.9
Euro Deposit 4.3 4.6 2.2 2.7
Yen Deposit 0.9 1.0 1.0 0.4
performance of emerging market countries including
Oil Price (USD) - average3) 10.7 36.4 (48.5) 20.0
Source: World Economic Outlook - IMF January 2009 Indonesia. The income of emerging market countries
generally depends on their exports, therefore the decline
Sluggish economic activity in developed countries in export performance instigated a slowdown in economic
caused a subsequent drop in demand for commodities, growth.
which brought down commodity prices on the global It is important to note, however, that despite a
market. In semester I 2008, US dollar depreciation and downturn in Indonesian economic growth during quarter
money market volatility encouraged the flow of investment III 2008, taken holistically, growth in 2008 remained strong
funds to the commodity market, which precipitated a hike at approximately 6.1%, exceeding that of other ASEAN
in commodity prices. The global price of crude oil peaked countries such as Singapore, South Korea and Thailand.
at nearly USD150 per barrel followed by a rise in other This was supported by robust private consumption growth,
commodity prices. Upon entering semester II 2008, in particular from nontradable sectors such as
however, in line with the decline in demand due to a slump transportation and communication, which offset the
in economic activity and a drop in speculative transactions decline in export-oriented sectors.
in the commodity market, the price of crude oil and other
key commodities plummeted. Compared to the end of Figure 1.3
GDP Growth of Industrial Countries
semester I 2008, the global price of oil plunged more than
%
50% to USD44.6 per barrel by the end of semester II 2008. 6.00
5.00
This dramatic drop in prices was also followed by a decline 4.00

in other global commodity prices. 3.00


2.00
Lower demand for goods and services, particularly 1.00
-
from developed countries such as the US and European
(1.00) USA Japan
Union, who had staunchly remained the primary export (2.00) Germany UK
Canada
(3.00)
market for emerging market countries, coupled with falling Q1 Q2 Q3 Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4
2000 2001 2002 2003 2004 2005 2006 2007 2008
commodity prices on global markets weakened the export Source: Bloomberg

10
Chapter 1 Macroeconomic Conditions and the Real Sector

Figure 1.4 Figure 1.6


GDP Growth of Several Emerging Market Countries Rupiah Exchange Rate against
the US Dollar
%
14,000 14,000
Monthly Average
12.00 12,000 Semester Average 12,000

9.00 10,000 10,000


9,258 9,352
6.00 9,039 9,210
8,000 8,000
3.00
6,000 6,000
-
4,000 4,000
(3.00)
Indonesia Singapore
Thailand South Korea 2,000 2,000

11,803
11,314
9,075
9,077
9,172
9,095
8,842
8,981
9,067
9,358
9,105
9,102
9,267
9,356
9,406
9,180
9,178
9,203
9,281
9,288
9,159
9,151
9,354
9,990
(6.00)
China India
(9.00) 0 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12
2000 2001 2002 2003 2004 2005 2006 2007 2008 2007 2008
Source: Bloomberg Source: Bloomberg

Financially, the growing intensity of the global end of semester I 2008, the rupiah weakened by 20.5%
financial crisis spurred investors to withdraw their to Rp11,120 per US dollar by the end of semester II 2008.
investment portfolio from emerging market countries for The exchange rate remained weak but volatility dispersed.
two main reasons: flight to liquidity as well as flight to Waning demand and lower commodity prices on the
quality. This has also affected Indonesia. Compared to the international market prompted inflationary pressures,
end of semester I 2008, the JSX Composite Index (IHSG) which had been significant in mid 2008, to ease. The
plummeted by 42.3% from 2,349 to 1,355 at the end of momentum of this drop in inflation encouraged the central
semester II 2008. The reversal of foreign investment banks of several countries to ease their monetary policy
precipitated a deficit in the Indonesian capital and financial by reducing their interest rates in order to stimulate
accounts in quarter IV 2008. In 2008, the Indonesian economic activity. In December 2008 the Fed Fund Rate
balance of payments was projected to run a deficit of reached its nadir at 0.25%, meanwhile the interest rate
USD2,302 million. of the European Central Bank was reduced to 2.5%. The
Increasing financial turbulence, particularly since the BI Rate was cut to 9.25% in December 2008 with further
beginning of semester II 2008, exacerbated rupiah cuts in February 2009 to 8.25%. Despite the lower BI Rate
depreciation and intensified volatility. Compared to the the investment climate in Indonesia is expected to remain

Figure 1.5 Figure 1.7


Global Stock Price Index Inflation in ASEAN-5 and Vietnam
y.o.y %
35000 35000
Singapore Dow Jones
30000 NYA Indonesia 30000
New York Nikkei
10
25000 25000

20000 20000
5
15000 15000

10000 10000
0
5000 5000 Philippine Singapore Thailand
Malaysia Indonesia Vietnam
0 0 (5)
2006 2007 2008 Jan Apr Jul Oct Jan Apr Jul Oct
2007 2008
Source: Bloomberg Source: CEIC

11
Chapter 1 Macroeconomic Conditions and the Real Sector

Figure 1.8 This is reflected by the deteriorating financial performance


Real Interest Rate in Indonesia, US and Singapore
of nonfinancial public listed companies, which limited their
%
expansionary activities and sought lay offs. Consequently,
4.0 such conditions will undermine household purchasing
2.0
power.
0.0
Falling prices, waning export demand and weaker
(2.0)

(4.0)
public purchasing power due to the global crisis impinged
Indonesia
(6.0) USA on the margin of the corporate sector, in particular
Singapore
(8.0)
Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec
nonfinancial, public listed companies. This is evidenced by
2003 2004 2005 2006 2007 2008
Sources: Bloomberg and CEIC
the decline in business profitability (ROA and ROE) of such
companies in quarter III 2008 compared to that of the
attractive because the real interest rate remains higher than same period in the previous year.
those of several other ASEAN countries. From a financing perspective, the corporate sector
Looking forward, pressures emanating from the global suffered from limited capital. To fulfill its operational needs,
economic downturn are expected to continue to suffuse
Figure 1.9
the domestic economy. The drop in export demand due to ROA and ROE of
sluggish global economic activity may bring to bear Nonfinancial Public Listed Companies

additional pressures on national economic growth. 700 350


ROA (left)
600 300
ROE (right)
Notwithstanding, domestic monetary and fiscal stimuli are 250
500
200
expected to hasten private consumption and offset pressures 400
150
300
from the external sector. Monetary stimuli include a drop 200
100
50
in the interest rate, whereas from the fiscal side the impetus 100
0
0 -50
comes from a number of sources including a national -100 -100
-200 -150
government program to strengthen public purchasing Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2003 2004 2005 2006 2007 2008
power known as Pemberdayaan Masyarakat Mandiri; a drop Source: Bursa Efek Indonesia

in fuel prices and transportation fees; a hike in the Regional


Figure 1.10
Minimum Wage expected to exceed 11%; and a rise in the
DER and TL/TA of
salaries of civil servants. Just as important is the General Nonfinancial Public Listed Companies

Election as well as local and regional elections, which are 1.80


DER
1.60
expected to catalyze private consumption; vital to offset Debt/TA
1.40

the pressures from the external sector. 1.20


1.00
0.80

2. REAL SECTOR CONDITIONS 0.60


0.40
A slump in exports due to the global financial crisis 0.20
0.00
has also affected the performance of the domestic real Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2003 2004 2005 2006 2007 2008
sector, both the corporate sector and households alike. Source: Bursa Efek Indonesia

12
Chapter 1 Macroeconomic Conditions and the Real Sector

businesses began to rely on deposits; from banks or to take into consideration risk potential due to exchange
through the issuance of bonds and other securities. This rate fluctuations. Of the 46 major conglomerates regularly
was demonstrated by the rise in debt-to-equity ratio (DER) monitored, stress testing indicated that capital in general
and ratio of total liabilities to total assets (TL/TA) in quarter is well maintained and will only be effected to 100%
III 2008 compared to quarter III 2007. should the rupiah exchange rate exceed Rp 16.100 to
Along with the decline in performance of the USD.
nonfinancial public listed companies, estimations to Lower profitability due to weaker purchasing power
measure the probability of default (PD) also demonstrated and falling prices forced business players, particularly those
an increase. The number of companies with a PD of greater in export oriented sectors, to economize by reducing their
than 0.5 grew from 21 companies in September 2008 to workforce and limiting business expansion. This had the
29 in September 2009. For banks, this is an early indicator potential to raise national unemployment. Based on the
showing a potential increase in future credit risk. latest data from 2008 and despite a declining trend,
unemployment in Indonesia, at 8.4%, was the highest of
Figure 1.11
Probability of Default (PD) of all ASEAN member countries.
Nonfinancial Public Listed Companies
Total Figure 1.12
250
Unemployment Rate in ASEAN
215

200
%

150 2006 2007 2008*)

10.0

100
8.0

50 6.0
19
5 4 3 2 0 1 1 0
0 4.0
0.0-0.1 0.1-0.2 0.2-0.3 0.3-0.4 0.4-0.5 0.5-0.6 0.6-0.7 0.7-0.8 0.8-0.9 0.9-0.10
Probability of Default - September 2008 2.0
Total
180 0.0
171
Indonesia Thailand Malaysia Singapore
160
Source: CEIC
140 Note:
*) : Data for Indonesia (August 2008), Thailand (November 2008), Malaysia and Singapore (September 2008)
120
100
80 Results of the household balance sheet survey
60
demonstrated that in 2008 Indonesian households
40
21 23
20 14
6 9
4
maintained their debt repayment capacity. This was
0 1 1
0
0.0-0.1 0.1-0.2 0.2-0.3 0.3-0.4 0.4-0.5 0.5-0.6 0.6-0.7 0.7-0.8 0.8-0.9 0.9-0.10 reflected by the small ratio of debt to total income as well
Probability of Default - September 2009
as to disposable income, namely between 6.31% and
In addition to the onset of increasing credit risk, 28.62%. However, considering that 56% of total
companies in the real sector, particularly the major household income originates from salaries and benefits,
conglomerates in Indonesia, were also exposed to lay offs could potentially lower household income. If this
pressures from exchange rate risk. Based on data for was allowed to persist it could lower household repayment
September 2008, major conglomerates in Indonesia had capacity.

13
Chapter 1 Macroeconomic Conditions and the Real Sector

Figure 1.13 required considering that the increase in value of such


Structure of Household Income Sources
assets is heavily influenced by the increase in property price
index, which has persisted since 2004. Amid the current
Pension economic slowdown it is likely that demand for property
Income
3%
Others
10% will diminish, thus precipitating a decline in property prices.
Net Income Salary and Benefits
31% 56% If property prices slump, the value of household assets
will clearly also drop. Such a decline in asset value and
household income would place additional pressure on the
repayment capacity of households.

Source: Household Survey 2008 In the future, challenges in the real sector are
expected to persist in line with the limited development of
Based on asset composition, Indonesian households domestic infrastructure. The impacts of the global financial
have little exposure to financial assets. Indonesian crisis are expected to continue affecting the domestic
household assets are dominated by nonfinancial assets in economy. Anticipatory measures to mitigate significant
the form of houses, buildings and land with a 76.81% export pressure and promote growth in the nontradable
share of total assets. In line with the small exposure of sector are required. In the short term, the monetary and
household assets to the financial system, the direct effects fiscal stimuli introduced are expected to expedite
of financial market volatility on household assets are consumption growth and boost real sector resilience. If
expected to be relatively small. However, caution is still successful, the outlook for financial system stability is sound.

14
Chapter 1 Macroeconomic Conditions and the Real Sector

Box 1.1 Indonesian Household Balance Sheet Survey 2008

Household balance sheets are key indicator to supported by their ability to save. This was reflected
analyze the potential credit risk for the household by the ratio of total expenditure to total household
sector. In June 2008, Bank Indonesia collaborated with income and the ratio of consumption expenditure to
the Central Bureau of Statistics (BPS) in conducting a disposable income; both below 100%, more specifically
survey to tabulate Indonesian household balance 91.29% and 90.59% respectively.
sheets. The survey took place in 10 provinces, including However, the ability of households not in debt
West Sumatera, South Sumatera, Jakarta, West Java, to save tended to be larger, as reflected by ratio of
Yogyakarta, East Java, Bali, South Kalimantan, East total expenditure to total household income and the
Kalimantan and Gorontalo, with a total number 3,553 ratio of consumption expenditure to disposable income,
households as respondents. namely 83.64% and 83.39%. Meanwhile, the ability
of indebted households to save tended to be minimal,
Overview of Indonesian Household Balance therefore, such households were forced to borrow to
fund the additional purchase of assets. This is reflected
Sheet
by the ratio of total expenditure to total income and
Household Assets
the ratio of consumption expenditure to disposable
As a common theme in developing countries,
income; both surpassing 100%, namely 102.61% and
household assets in Indonesia are dominated by
103.12%.
nonfinancial assets in the form of property such as
houses, buildings and land with a 76.81% share of
Household Debt
total assets, followed by other nonfinancial assets
The majority (approximately 65%) of respondents
(15.57%) and financial assets (7.62%).
acknowledged that they have cash set aside to mitigate
Compared to 2007 survey results, the
unforeseen circumstances. However, if the cost of such
composition of other nonfinancial assets (gold, cattle,
unforeseen circumstances exceeds the reserve funds
etc.) increased slightly. This was triggered by the mid-
then the household would be forced to borrow.
2008 rise in the price of gold, which encouraged
households to divert some of their financial assets to
Figure Box 1.1.1
gold. Meanwhile, household financial assets were Composition of Household Debt
dominated by bank placements (73%), followed by Percentage of Total Debt
placements in nonbank financial institutions (13%).
Other Debts
10%
Household Source of Funds LKBB Debt
12%
Household»s primary source of funds came from
their net worth, namely 96.13% of total assets. Bank Debts
78%
Funding from bank credit only represented 3.01% of
total assets, followed by funding from nonbank
financial institutions (0.47%) and other fund sources
(0.39%). The relatively high household net worth was

15
Chapter 1 Macroeconomic Conditions and the Real Sector

Based on value, Indonesian household debt is Liquidity Mismatch Ratio


dominated by bank debt (78%), followed by debt to This ratio illustrates the ability of household
nonbank financial institutions (12%) and other sources income to cover household debt. Survey results
excluding financial institutions (10%). demonstrate that the ratio of household debt to total
The purpose of the loan is 24% for working or disposable income is less than 100%, namely
capital, 16% to purchase a vehicle, 14% to build or 10.38% and 11.22% respectively. The household debt-
renovate a house and 13% for food consumption. The servicing ratio is also below 100%; just 6.31%. The
average repayment period is approximately 20 months. small magnitude of these ratios indicates that
households are able to manage their expenditure in a
Figure Box 1.1.2 way that their income is sufficient to repay outstanding
Purpose of Household Credit
debt.
Others
Although the ratio of debt to disposable income
Electronic 16%
2%
To Open Business
24%
and debt-servicing ratio of indebted households to
Buying Vehicles
16% banks and nonbank financial institution (LKBB) is the
Food highest (72.11% and 33.08%), both ratios are below
13%
Buy House but
not occupying it
100%. Therefore, such households are expected to
2%
have a good repayment capacity.
Buy House Education
to occupy 8%
2% Building/Renovating Health
House 3%
14% Solvency Ratio
This ratio illustrates the ability of a household»s
assets to cover its debt in the case of default. Survey
Potential Risk results demonstrate that the ability of Indonesian
Along with the small exposure of household households» assets to cover debt is good, as reflected
financial assets, it is projected that the direct impact of by the very low household gearing ratio and ratio of
financial market volatility on household assets is total debt to net worth; 3.87% and 4.03% respectively.
relatively small. Risk against the financial system, The low household-gearing ratio is one indicator that
particularly transmitted through property price volatility, evidences a household»s ability to obtain additional
will increase considering that the majority of household bank funding.
assets are in the form of housing assets (property assets By grouping households based on their source
such as houses, buildings and land). Meanwhile, the of debt, it is found that indebted households to banks
risk of indebted households to the financial sector is and LKBB have the highest household-gearing ratio.
relatively low because their repayment capacity is However, the ratio is below 100%. This shows that
sound. Some salient analysis results using various indebted households also have a good repayment
financial ratios are as follows: capacity.

16
Chapter 1 Macroeconomic Conditions and the Real Sector

Box 1.2 Corporate Sector Credit Risk: Credit Default Swaps (CDS)

The real sector covers two components, namely Such perceptions tend not to depict the actual
households and the corporate sector. The latest condition because the excessively high CDS price and
developments in the household sector were elaborated spread was also attributable to a thin market.
in Box 1.1. Box 1.2 will cover one of the approaches For the purpose of financial system resilience
used to assess corporate sector credit risk, namely by surveillance, however, data on CDS price and spread
using Credit Default Swaps (CDS). can be used as an early warning tool.
CDS is widely known as a credit derivative
Figure Box 1.2.1
instrument. Conceptually, CDS can be seen as an
CDS Price in Indonesia
insurance or protection from the default of credit or
bonds (Duffie and Singleton, 2003; Lando, 2004). 1200 Indonesia Korea
Philippine Thailand
Lately, in accordance with the global financial market 1000

slowdown, the development of CDS price and spread 800

has become more of a concern. Technically, credit risk 600

is reflected by CDS spread. However, CDS price also 400

needs to be considered because it can illustrate the 200

development of market pressure. 0


3 2 1 1 31 30 30 29
With the recent deterioration of the global Jul Aug Sep Oct Oct Nov Dec Jan
2008 2009
Source: Bloomberg
financial market, the developments in CDS price and
spread have increasingly received attention. CDS no Figure Box 1.2.2
longer merely reflect corporate credit risk, but has CDS Spread in Indonesia
become an indicator of sovereign risk. 370
Indonesia Korea
320
Shocks beset the financial market in semester II Philippine Thailand
270
2008 and triggered a rapid escalation in CDS spread 220

and price. This peaked on 28 October 2008, when the 170


120
Indonesian Stock Exchange was temporarily closed as
70
a result of the Jakarta Composite Index (IHSG) nose- 20
diving to 1,111.4, its lowest ebb since 2005. However, -30
-80
after the government and Bank Indonesia instituted a 3 2 1 1 31 30 30 29
Jul Aug Sep Oct Oct Nov Dec Jan
number of key policy responses, CDS price and spread Source: Bloomberg
2008 2009

started to decline, albeit remaining higher than prior


to October 2008. References:
Compared to neighboring countries, CDS price Lando, D. (2004), Credit Risk Modeling, Princeton
and spread in Indonesia remained the highest. This University Press, Princeton, New Jersey.
indicates a strong market perception that corporate Duffie, D. dan Singleton, K.J. (2003), Credit Risk:
credit risk in Indonesia is high. Pricing, Measurement, and Management, Princeton
University Press, Princeton, New Jersey.

17
Chapter 1 Macroeconomic Conditions and the Real Sector

Transition Matrices: The Risk Potential of Corporate Credit of


Box 1.3
Three Sectors

Transition matrices are one of the tools or To further the research of Hadad, et al. (2006), a
approaches to detect the risk potential in corporations» new examination is conducted to study the 2008»s
credits, by calculating the probability of rating migration credit collectability migration in three sectors (property,
or the changes in the company»s last credit quality. The transportation and textile) using the SID quarterly data
transition matrices also serve as fundamental input in comprising of 448,183 debtors. The preferred
several risk management applications. In addition, the methodology is the Continuous Time method, with
calculation of capital requirements, as recommended the consideration that it is more advanced than the
by the New Basel Accord (BIS, 2001), must take into Cohort method.
account, among others, rating migration. The results of the estimation indicate that among
Previously, another research (Credit Risk the three sectors, the debtors in the property sector
Modelling: Rating Transition Matrices by Hadad et al., are relatively better than those of the other two sectors.
2007 as can be found in FSR No. 9 September 2007) This can be seen in:
also utilizes the rating published by PT Pemeringkat Efek The potential of debtor migration with collectability
Indonesia (Pefindo) from February 2001 to June 2006. of 1 and 2 (Performing Loans/PL) to the collectability
The research employs two methodologies, including the of 3, 4 and 5 (Non Performing Loans/NPL) in the
Continuous Time method and Cohort method, and using property sector is lower than the other two.
the assumption that the credit rating process follows The potential of debtor migration of NPL to PL in
the Markov chain. In conclusion, the Continuous Time the property sector is higher than the other two.
method delivers more efficient results in comparison to The potential of debtor migration of collectability
the Cohort method. In addition, the Continuous Time 2 to 5 in the property sector is smaller than that of
method also allows the probability of migrations to the two other sectors.
significantly different ratings (rating default).

Table Box 1.3.1


Collectability of Debtor Migration of Three Sectors

Property
Collect 1 2 3 4 5
1 89.7% 9.3% 0.3% 0.3% 0.4%
2 64.4% 28.0% 1.7% 1.5% 4.4%
3 37.7% 19.6% 5.8% 3.8% 33.1%
4 23.4% 10.8% 1.5% 4.7% 59.5%
5 0.0% 0.0% 0.0% 0.0% 100.0%
Transportation
Collect 1 2 3 4 5
1 89.5% 8.0% 0.5% 0.4% 1.7%
2 53.5% 28.7% 1.7% 2.0% 14.0%
3 7.5% 3.5% 3.3% 1.7% 84.1%
4 2.9% 1.1% 0.3% 3.0% 92.6%
5 0.0% 0.0% 0.0% 0.0% 100.0%
Textile
Collect 1 2 3 4 5
1 94.0% 3.8% 0.6% 0.3% 1.4%
2 77.9% 4.6% 1.0% 1.1% 15.3%
3 27.0% 2.3% 0.7% 1.5% 68.6%
4 0.0% 0.0% 0.0% 0.6% 99.4%
5 0.0% 0.0% 0.0% 0.0% 100.0%

18
Chapter 2 The Financial Sector

Chapter 2
The Financial Sector

19
Chapter 2 The Financial Sector

This page is intentionally blank

20
Chapter 2 The Financial Sector

Chapter 2 The Financial Sector

During semester II 2008, Indonesia»s financial sector continued to grow amid


growing pressures from the global financial crisis. In general, financial system
stability was well maintained. The banking industry, the most dominant
industry in the financial sector, performed positively. Hitherto, the global
financial turmoil has not significantly affected the banking industry in
Indonesia; however it has intensified pressures on the capital market, reflected
by the declining Jakarta Composite Index (IHSG) and falling price of
government bonds (SUN).

2.1. INDONESIAN FINANCIAL SYSTEM 2008) to 1.355,41 (December 2008); a 42.3% decline.
STRUCTURE Meanwhile, the price of SUN dropped 2.3% during the
Compared with conditions in the previous semester, period from 30 June to 25 September 2008, yet
the structure of Indonesia»s financial system in semester II experienced a subsequent rebound of 8.6% from 25
2008 did not experience any major changes. The banking September 2008 to 31 December 2008. Nevertheless, since
industry, which consists of commercial banks and rural December 2008 to mid March 2009, the price of SUN was
banks, dominated the industry with an approximate 74% beset by more pressures and dropped by approximately
share of total financial sector assets. Meanwhile, the 5.62%.
relative share of other players in the financial industry, such
Figure 2.1
as insurance companies, pension funds, finance Assets of Financial Institutions
companies, securities and pawn brokers remained low.
In terms of the banking industry, the 15 major banks 0.3% Commercial Banks
5.8% 2.7%
3.2%
account for the majority (70%) of total industry assets. In 8.0% Rural Banks
1.1%
Insurance Companies
semester II 2008, the total assets of commercial banks
Pension Fund
grew by Rp2,69.7 trillion (13.2%) to Rp2,310.6 trillion.
79.0% Finance Companies
Such growth serves as an indicator that the current global Securities Companies

crisis has not significantly affected the banking industry. Pawnshops

However, the crisis has lowered IHSG from 2.349,11 (June

21
Chapter 2 The Financial Sector

2.2. FINANCIAL STABILITY INDEX Figure 2.2


Financial Stability Index
Financial stability growth over time is reflected by
3
FSI Projections
the Financial Stability Index (FSI).1 Impacted by the global 2.5
FSI 2.10

2.13
financial crisis, the domestic financial sector encountered 2 1.95
1.77
turbulence, thus, putting pressure on financial stability 1.5

during semester II 2008 (refer to Box 2.1). As a 1

consequence, the FSI increased sharply from 1.60 at the 0.5

end of June 2008 to 2.10 by the end of December 2008, 0


2003 2004 2005 2006 2007 2008 2009
peaking in November 2008 at 2.43. Simultaneously, since
October 2007 the rupiah exchange rate has also faced 2.3. THE BANKING INDUSTRY
increasing pressures. 2.3.1. Funding and Liquidity Risk
Thus, FSI during the final two months of 2008 Deposits Growth
exceeded the maximum indicative level of 2. The high At the outset of semester II 2008, deposits, as the
FSI was primarily attributable to the declining IHSG main source of funds for banks, experienced negative
and tumbling SUN price as impacts of the global growth, however, this turned around mid semester.
crisis. Significant growth of deposits since September 2008
Latest developments indicate that pressures from the ensured that during the reporting period, deposits
global financial crisis have eased slightly, which was expanded by approximately 12.87% totaling Rp1,753.3
reflected by the improving IHSG and rising price trillion. Such growth affected all components of deposits,
of SUN. Policy response by the government and from demand deposits to savings and time deposits.
Bank Indonesia also softened the persistent financial Growing deposits since mid semester II 2008 are
turbulence. Consequently, FSI declined to 2.06 as of congruous to the high interest rate at the time, prior to
January 2009. subsequent reductions at the end of 2008. The high
The declining FSI reflects that, in general, financial interest rate generated public interest in bank placements.
stability was relatively well maintained. Moreover, up to In addition, amid unstable economic conditions, many
the end of June 2009 FSI is projected at approximately investors saw investment in nonbank institutions as high
1.77 √ 2.13; or using a moderate scenario at approximately risk with an uncertain yield compared with saving funds
1.95, which is relatively lower than the position at the end at the banks. Another important factor that also
of December 2008. Consequently, the outlook for financial contributed to the growth in deposits was government
system stability is expected to remain positive and well policy, instituted through a government regulation in lieu
preserved. of a law (PERPPU). The PERPPU, issued in mid October
2008, increased the deposit insurance coverage by the
Deposit Insurance Corporation (LPS) from Rp100 million
to Rp2 billion per customer per bank. This policy was
effective in maintaining and even increasing public funds
1 A detailed explanation on the methodology and approach applied to calculate the Financial
Stability Index can be found in the Financial Stability Review, No. 8 March 2007 and No.
9 September 2007. held at banks.

22
Chapter 2 The Financial Sector

Figure 2.3 denomination, growth of deposits in a foreign currency


Performance of Deposits
during the reporting period in fact decreased USD1.36
Trillion Rp
550 900
billion, mostly in terms of time deposits and demand
Time Deposits (right)
750
500
deposits, which declined USD0.98 billion and USD0.58
600
Savings (left) billion respectively.
450 450

Demand Deposits (left) 300


400 Liquidity Adequacy
150
Slow growth of deposits at the beginning of semester
350 0
Dec Feb Apr Jun Aug Oct Dec II 2008, which occurred concomitantly with decreasing
2007 2008
global liquidity, placed additional pressures on domestic
Based on currency type, growth of deposits bank liquidity. Furthermore, relatively high loan growth
denominated in a foreign currency was 18.94%, which up to October 2008, which had principally been financed
was slightly higher than growth of rupiah deposits at by cashing secondary reserves, undermined bank liquidity.
18.85%. However, due to rupiah depreciation against the Consequently, liquidity declined, with a further contraction
US dollar, which was relatively significant during the in August 2008 when excess liquidity reached its lowest
reporting period, when measured in foreign currency ebb2. Up to August 2008, excess liquidity declined by
approximately 30.18% (y-t-d), primarily causing holdings
Figure 2.4
Performance of Foreign Exchange Deposits of Bank Indonesia Certificates (SBI) to decrease.
Billion USD Trillion Rp
30 320 Figure 2.6
Deposits in USD Excess of Bank Liquidity
(left)
27 290
250 290

24 260 200
285
Deposits in Rp
(right) 150 SBI (left)
21 230 SUN (right) 280
100

18 200
275
Dec Feb Apr Jun Aug Oct Dec 50 Fasbi/FTK (left)
2007 2008

0 270
Dec Feb Apr Jun Aug Oct Dec
Figure 2.5 2007 2008
Growth of Foreign Exchange Deposits vs
Rp Exchange Rate to US Dollar
Other than reflected from the drop of excess liquidity,
Billion USD Rupiah
30 12,500 the decrease of bank liquidity adequacy is also apparent

11,700 from the ratio of liquid instruments to non core deposits


27 Foreign Exchange
Deposits in USD
(left) (NCD)3 which continues to fall and reaching its lowest
10,900
24 point, 84.9%, in August 2008. In principle, this ratio shows
10,100
Rp Exchange Rate
to USD
21 (right) 2 Excess liquidity consists of BI Certificates, other placements at Bank Indonesia and giro
9,300
accounts at BI (Fasbi/FTK) and securities.
3 Liquid instruments comprise of cash and placements at BI (BI giro, SBI, and other
18 8,500 placements). NCD is assumed to comprise of 30% giro + 30% savings + 10 time deposits
Dec Apr Aug Dec Apr Aug Dec up to (3 month time deposits).
2006 2007 2008

23
Chapter 2 The Financial Sector

the bank»s ability to meet deposit withdrawals. Ratios of To minimize the impact of PUAB segmentation, in
less than 100% indicate that a bank is less than adequate February 2008 Bank Indonesia enhanced its open market
in its liquidity. operation. Bank Indonesia also activated the Fine Tune
However, along with the significant increase in Operation (FTO) facility and followed up with
deposits since the beginning of September 2008, liquidity improvements in its features. The FTO with expansionary
pressure eased. The growth in deposits, as described earlier, effects is known as FTE and is provided for banks
was due to government policy to increase the deposit experiencing liquidity problems, while the FTO for
insurance coverage by the Deposit Insurance Corporation contractionary effects is known as FTK and is provided for
(LPS). Besides, Bank Indonesia also issued several policies banks with excess liquidity. The improvements in features
to alleviate liquidity pressures, including loosening the cover the extension of FTE tenor from 14 days to a
rupiah and foreign currency minimum reserve requirement. maximum of three months and thus allowing banks to
Consequently, liquidity in the banking industry improved have greater access to the central bank for liquidity. Bank
and liquidity stabilized. Such positive developments were Indonesia also held repo transactions with longer tenors
also reflected in continuously increasing ratios of liquid (two to 14 days) to help banks experiencing liquidity
instruments to NCD, which in December 2008 reached problems. These steps proved to be successful in
109.1%. Such indicates that banking liquidity has overcoming liquidity pressures in the banking industry.
increasingly become under control. Furthermore, in efforts to understand the banking
industry»s liquidity strength, particularly in the face of
Interbank Money Market (PUAB) sudden deposit withdrawals, a simulation exercise was
Along with increasing global liquidity pressure, held. This exercise assumed that decreases in or
domestic banks tended to hold their liquidity and limit withdrawals of deposits will be funded by a bank»s excess
interbank transactions, thus creating segmentation in the liquidity. Using end of December 2008 data, the exercise
interbank money market (PUAB). In addition, average daily results revealed that excess liquidity held by banks remains
bank transaction volume in the domestic interbank money adequate in withstanding up to 29.27% deposit
market has shown a declining tendency, both in rupiah withdrawals. Liquidity risk stress tests were also held to
and foreign currency. understand bank capital»s ability to absorb the costs of
securing liquidity from PUAB should the bank experience
Figure 2.7
Transaction Volume of PUAB funding problems. Stress test results revealed that in
(daily average)
general the banking industry»s capital level remains strong
Trillion Rp Million USD
14 500 in facing liquidity risk pressures.
12
400
10
300
2.3.2. Credit Growth and Credit Risk
8

6
Credit Growth
200
4 Strong credit growth stood out in 2008. In fact, the
100
Rupiah PUAB
2
Forex PUAB
symptoms of expansive credit growth began in 2007. At
0 0
Jan Mar May Jul Sep Nov that time, credit growth reached 25%, which exceeded
2008

24
Chapter 2 The Financial Sector

the target of 22%. According to the banks» business plans, interest income earned on the inter-bank money market
the 2008 target for credit growth was 24%. However, and BI Certificates. Solid credit growth was also the result
before yearend, credit growth had far surpassed its target, of various policies previously taken by Bank Indonesia to
peaking at 37% y-o-y in October 2008. improve the bank intermediary function.
Along with increasing pressure due to the As described previously, during the reporting period
deteriorating economy, in November 2008 credit growth deposits grew by approximately 12.87%. As credit growth
began to slow, dropping to 29.5% by yearend. During exceeded that of deposits, the loan to deposit ratio (LDR)
the reporting period the rupiah experienced significant increased from 76.6% in June 2008 to 77.2% in December
depreciation, therefore, when excluding the exchange rate 2008. In addition, LDR reached its highest point since the
factor, credit growth in 2008 was actually lower at 25.7%. 1997/1998 Asian crisis, namely 81.6% in August 2008.
Robust credit growth was stimulated by high demand
Figure 2.10
from domestic businesses for working capital and Credit Growth by Bank Group (y-t-d)
investment credit, compounded by the constraints in
32%
Industry
obtaining foreign funds due to the global crisis.
46%
Foreign Banks
Maintaining relatively strong credit growth appeared to
50%
Joint Venture Banks
be banks» strategy to maintain their profit level amid thinner
36%
Regional Development Banks
spreads between interest payments on deposits and 27%
National Private Banks
2008
32%
State Owned Banks 2007
Figure 2.8
Credit Growth (yoy) 0 10 20 30 40 50
% %
50
Forex Credit (USD)
45 Total Credit By bank group, state-owned and private banks
Total Credit (fixed exchange rate)
40 Rupiah Credit
Forex Credit (in Forex)
35 continued to dominate the extension of credit. During the
30
25 reporting period, credit from state-owned banks expanded
20
significantly, principally to the manufacturing sector, others
15
10 (consumption) and trade sector. Despite persistently high
5
0 credit growth from private banks, it tended to be lower
Dec Feb Apr Jun Aug Oct Dec
2007 2008 than that of previous semesters. The trade and others
Data of Dec'08 is based on Commercial Bank Daily Report

(consumption) sectors were the primary contributors to


Figure 2.9 the waning credit growth at private banks, whereas credit
Credit Growth during 2007-2008
to the manufacturing sector remained strong.
2008
Forex Credit (USD T) 2007 A favorable aspect of credit growth in semester II
2008 was the relatively expansive credit extension to the
Forex Credit (Rp T)
productive sector. This was evidenced by the growth in
Rupiah Credit (Rp T) working capital credit and investment credit, which
contributed 49% and 27% respectively to total credit
Total Credit (Rp T)
growth. Working capital credit and investment credit
(15) 0 25 65 105 145 185 225 265

25
Chapter 2 The Financial Sector

experienced relatively high growth of 32% and 37% reporting period. With total credit amounting to Rp198.9
respectively. Based on sector, however, robust credit growth trillion, the share of property credit shrank slightly from
was found in the utilities sector (electricity, water and gas); 15.7% at end of June 2008 to 15.2% in December 2008.
transportation and communications sector; construction
Figure 2.13
sector; business services sector; and the manufacturing Growth of Housing loans, Credit Cards and Others
sector.
29%
Others
2008
Figure 2.11 2007
Credit Growth by Usage (y-t-d) 26%
Credit Card

2008
29% 2007
Consumer 29%
Housing Loan

37%
Investment 0 5 10 15 20 25 30
%

Working Capital 32% Figure 2.14


Growth of Property Credit

0 10 20 30 40
% Housing Loan

Figure 2.12 Growth in 2007 (%) Growth in 2008 (% ytd)


Credit Growth by Economic Sector Real Estate
Credit Delta 2007 (Rp M) Credit Delta 2008 (Rp M)

Electricity 133.8%
25.9%
Mining
11.1% Construction
Social Services
Business Services 39.6%
19.1% 0 9 18 27 36 45
Agriculture
Construction 42.8%

Transportation 70.2%

37.9%
Rupiah credit continued to dominate bank loan
Manufacturing
Others 29.1% 2008 disbursements during the reporting period with an 80%
20.7% 2007
Trade

0 20 40 60 80 100 120 140 share of total credit growth. Meanwhile, credit


%
denominated in a foreign currency grew by Rp32.4 trillion,
Despite weaker growth compared to other types of which was affected by rupiah depreciation factors.
credit, consumption credit still gained Rp39 trillion during
Figure 2.15
semester II 2008. Increasing consumption credit are mostly
Credit Growth by Its Initial Denomination
caused from automobile loans, uncollateralized loans and
% Rp
others, amounting to Rp25.6 trillion, followed by housing 60 14,000

loans totaling Rp10.1 trillion. During 2008, growth of other 40


12,000
credit and housing loans exceeded credit card growth. 20

- 10,000
Meanwhile, of the three types of credit incorporated in
(20)
property credit (housing loans, real estate credit and 8,000
(40)
construction credit), housing loans contributed 54.6% of
yoy Rp (%) yoy Va USD (%) Convention Value
(60) 6,000
the total, which reached Rp18.5 trillion during the 2000 2001 2002 2003 2004 2005 2006 2007 2008

26
Chapter 2 The Financial Sector

Expressed in US dollars, foreign currency credit actually Figure 2.17


Growth of MSM Credit
contracted by USD0.8 billion to USD23.1 billion. This was %
1400 54
in line with increasing risk due to exchange rate
1200
52
fluctuations and inauspicious global economic conditions. Total Credit Rp T (left)
1000
MSM Rp T (left)
50
In terms of project location, credit disbursements % MSM/Credit
800
48
remain centralized on the island of Java, mostly for working 600

capital credit (share of 72.9%). Growth of investment credit 400


46

and consumption credit were more evenly spread, as 200 44


2006 2007 2008 Dec
reflected in the share for Java at approximately 50% - 60%.
Meanwhile, credit on the islands of Sumatera, Kalimantan Credit Risk
and Sulawesi were more for investment credit. During semester II 2008, nominal NPL tended to
During semester II 2008, micro, small and medium increase along with increasing pressure from the sluggish
(MSM) credit increased by Rp58.6 trillion; up 26.1% y-o-y, economy. There was only a slight rise in nominal NPL of
falling short of total bank credit growth. As a consequence, Rp2.3 trillion to Rp50.9 trillion during the reporting
its share of total credit decreased slightly from 50.1% at period. However, it should be noted that the small
the end of June 2008 to 48.5% at the end of December increase was due in large part to the significant write
2008. In general, MSM credit remains dominated by offs by one major bank. Therefore, the rise in nominal
consumption credit with a 61.5% share of total MSM credit NPL requires vigilance bearing the current economic
growth. Productive credit in MSM credit was mainly conditions in mind.
disbursed in the form of working capital credit for daily In terms of the NPL ratio, compared with the final
operational needs, of which growth during the reporting position in semester I 2008, gross NPL ratio declined to
period reached Rp19 trillion (32.4% of total credit growth). 3.76%. The low NPL ratio was influenced by high credit
Meanwhile, the contribution of investment credit was growth that far exceeded the nominal NPL increase.
relatively small at approximately 6.1% of total MSM credit Meanwhile, the rise in nominal NPL was followed by
growth. By sector, the others and trade sectors experienced increasing loan loss provisions; rising Rp4.4 trillion to
the largest credit growth. Rp47.5 trillion during the reporting period. This caused
the net NPL ratio to decrease by 0.2% to 1.47%. The
Figure 2.16 expansion of loan loss provisions by banks, surpassing the
Credit Share by Usage
jump in nominal NPL, indicated that banks began to
Maluku + Papua Consumer Loan anticipate the possibility of higher credit risk in the future.
Bali + NusTra Investment Loan
Sulawesi
Working Capital Loan By bank group, the increase in nominal NPL affected
Kalimantan
private banks, foreign bank branches and joint-venture
Sumatera
East Java banks during the reporting period. The nominal NPL of
Central Java + DIY
DKI Jakarta
state-owned banks declined by Rp3.1 trillion due to credit
West Java + Banten write offs. Increasing nominal NPL at private and joint-
0 5 10 15 20 25 30 35
% venture banks was followed by a rise in gross NPL, which

27
Chapter 2 The Financial Sector

occurred from mid semester II 2008 onwards. The The business services sector and manufacturing
increasing NPL ratio at foreign bank branches began at dominated the increase in sectoral nominal NPL, to the
the end of the semester. The increase in NPL at private tune of Rp1 trillion and Rp0.7 trillion respectively, with a
and joint-venture banks was primarily due to loans to the gross NPL ratio of 2.12% and 5.41% respectively. Thus,
manufacturing sector and business services sector, while the manufacturing industry was plagued by relatively high
for foreign bank branches, credit to the others credit risk; despite a slight improvement by the end of the
(consumption) sector, particularly from credit cards, also reporting period in line with write offs by one major bank.
played a part.
Figure 2.21
Gross NPL Ratio by Economic Sector
Figure 2.18
Non Performing Loans
Others Dec-07
(%) (Trillion) Jun-08
10 75 Business Services Dec-08
Gross NPL (left)
9 70
Transportation
8 65
Trade
7
60
6 Construction
NPL Value (right) 55
5 Manufacturing
50
4 Mining
45
3
NPL Net (left) Agriculture
2 40
35 0.0 1.5 3.0 4.5 6.0 7.5
1
- 30
2006 Jun 2007 Jun 2008 Jun Dec
By credit usage type, increasing nominal NPL during
Figure 2.19 semester II 2008 only affected working capital credit; to
Credit, NPL and Provisions
the amount of Rp1.7 trillion. Nominal NPL for investment
75 1600
NPL Value (left)
and consumption credit decreased. In spite of an increase
70 1400
65 Credit (right) in terms of its nominal amount, the NPL ratio for working
1200
60
1000
capital credit decreased slightly (to 3.4%) compared to
55
50 800 that of the previous period. Furthermore, even though NPL
45
40
600 ratios were highest for investment credit, there was
400
35 significant decrease in credits not classified as current due
30 200
2006 2007 2008 Dec to write offs. Consequently, the gross NPL ratio of

Figure 2.20 Figure 2.22


Gross NPL Ratio by Bank Group Gross NPL Ratio by Credit Usage
7
Dec-07 7
6 Jun-08 Dec-07
Dec-08 6 Jun-08
5 Dec-08
5
4
4
3
3
2
2
1
1
0
State Owned National Private Regional Joint Venture Foreign 0
Banks Banks Development Banks Banks Working Capital Investment Consumer
Banks

28
Chapter 2 The Financial Sector

Figure 2.23 Credit denominated in a foreign currency has become


Gross NPL Ratio of Consumer Credit
the main source of bank nominal NPL. During semester II
%
12 2008, nominal NPL of credit in a foreign currency rose by
Dec-07
10 Jun-08 Rp1.9 trillion to Rp10.5 trillion due to the deteriorating
Dec-08

8 rupiah exchange rate. If calculated in USD, the nominal


6 NPL of credit in a foreign currency rose by just USD 29.7
4 million. Accordingly, gross NPL of credit in a foreign
2 currency also went up; to 4.14%. The largest increase in
0
Housing Loan Credit Card Others
nominal NPL of credit in a foreign currency affected state-
owned banks and amounted to Rp0.8 trillion, followed
investment credit decreased from 4.6% at the end of June by foreign bank branches with Rp0.7 trillion.
2008 to 3.8% by the end of December 2008. Meanwhile, Conversely, the gross NPL ratio of credit in rupiah
in line with the declining nominal NPL for consumption declined to 2.98% in line with the Rp0.7 trillion drop in
credit, the gross NPL ratio also decreased; from 2.9% to nominal NPL. Decreasing nominal NPL for credit in rupiah
2.5%. was mainly due to write offs by the state-owned bank
The declining nominal NPL of consumption credit was group amounting to Rp3.9 trillion. Looking forward, close
principally due to fewer housing loans (nominally), which surveillance is needed considering lower exports and the
reduced the gross NPL ratio of housing loans to 2.26%. weak rupiah exchange rate could potentially affect debtor
Meanwhile, the gross NPL ratio of credit cards remained repayment capacity, in particular their liabilities in a foreign
relatively high at 10.8% by the end of December 2008. currency.
This was after a modest decline compared to its position
Figure 2.25
in June 2008 of 11.6%. The majority (78.2%) of nominal Gross NPL Ratio of Credit in Rupiah and
NPL for credit cards affected the group of foreign bank Foreign Exchange

branches. Despite the decline in nominal NPL for housing


5
Dec-07
loans, as a whole, property credit experienced an increase Dec-08
4 Jun-08

of Rp0.3 trillion. This was due to increasing nominal NPL


3
of real estate credit which pushed NPL ratios up to 4.51%.
2
Figure 2.24
Gross NPL Ratio of Property Credit 1

6 0
Dec-07 Rupiah Foreign Exchange
5 Jun-08
Dec-08

4 During the reporting period, the nominal NPL of MSM


3 credit slid Rp1 trillion to Rp18.8 trillion. Accordingly, the
2 gross NPL ratio of MSM credit also declined to 2.97%.
1 Based on usage type, the nominal NPL of all types of MSM
-
Construction Real Estate Housing Loan
credit declined, mostly affecting working capital credit,

29
Chapter 2 The Financial Sector

totaling Rp0.5 trillion. By sector, the drop in nominal NPL 5.6%. However, stress test results on 15 major banks,
was evident in almost all sectors, except the manufacturing applying pessimistic scenarios (i.e., gross NPL ratio
sector. The most significant decline affected the trade increasing to 5.6%, which is the highest projection made
sector; to the amount of Rp1 trillion. Notwithstanding, for 2009) indicated that in general, banks can handle the
the nominal NPL of MSM credit in the manufacturing sector potential losses, therefore, bank CAR should not drop to
increased by Rp0.6 trillion, which raised the gross NPL to below 8%.
7.5%. This shows that credit risk in the manufacturing
sector does not only stem from major corporations (non 2.3.3. Market Risk
MSM), but also from small and medium enterprises. The domestic economic performance during the early
part of semester II 2008 was marked by high inflation as a
Figure 2.26
result of fuel price hikes and soaring commodity prices.
Gross NPL Ratio of MSM and Non MSM Credit
Relatively strong economic growth at that time also
5
Dec-07
Jun-08 generated inflationary pressures. In response to such
4 Nov-08
conditions, Bank Indonesia raised its policy rate (BI Rate)
3
to alleviate inflationary pressures. From July to October,
2 the BI Rate was raised repeatedly in increments of 25 bps,
1 reaching 9.5% in October 2008.

0
However, global economic conditions rapidly
MSM Non MSM
deteriorated, which began to spill over into the domestic

Figure 2.27 economy, primarily affecting the financial market. This


Gross NPL Ratio of MSM Credit precipitated a decline in the stock market, lower SUN prices

4.0 Dec-07 Jun-08 and significant rupiah depreciation. Additionally, the global
Dec-08
economic downturn undermined Indonesian export
3.0
growth dramatically, thus, exacerbating conditions in the

2.0 domestic economy. Against this unfavorable backdrop,


Bank Indonesia maintained its BI Rate at 9.5% in
1.0
November. By end of 2008, however, BI had begun to
0.0 reduce its BI Rate, initially by 25 bps to 9.25% in order to
Micro Small Medium
catalyze economic activities. Such measures were necessary
As elaborated in Chapter 1, potential increase in as the prospect of future domestic economic recovery was
credit risk was also evidenced by the results of the considered deeply protracted.
Probability of Default (PD) analysis, which indicated that The lower BI Rate at the end of 2008 did not
credit risk from the real sector (corporate) will tend to rise simultaneously propagate a corresponding decline in bank
in the future. Based on PD and econometric model interest rates. Indeed, bank interest rates continued to rise,
analyses, it is projected that by the end of 2009, the gross albeit slowly. During the reporting period, the interest rate
NPL ratio of banks will increase to approximately 4.9%- of 1-month time deposits increased 356 bps to 10.75%,

30
Chapter 2 The Financial Sector

whereas the lending rate increased at a lower level. liquidity. Oppositely, for assets/liabilities in a foreign
Relatively high bank interest rates, particularly time currency, the short position tended to be lower in
deposits, were the result of an interest rate war among accordance with increasing risk due to rapid rupiah
the banks to attract consumer funds to generate bank depreciation.
liquidity. The interest rates of working capital credit, The increase in short-term short position had the
investment credit and consumption credit rose respectively potential to aggravate bank market risk due to the rising
by 222 bps, 139 bps and 27 bps, thus narrowing interest interest rates, moreover with narrower spread. During
rate spread. semester II 2008, net interest revenue earned by banks
exceeded that earned in the first semester as result of
Figure 2.28
Rupiah Interest Rate and Exchange Rate
relatively expansive credit growth; however, this had the

% Rp
potential to reduce profitability. Stress test results indicated
20 12500
Consumer Credit (left) that if interest rates rise 1%, bank CAR would not drop to
18 Working Capital Credit (left)
11500
16
below 8%.
10500
14
Investment Credit (left) Figure 2.30
12 9500 Foreign Exchange Maturity Profile
10
Billion USD
1-month Time Deposits 8500
(left) 10
8
Exchange Rate (right)
6 7500 5
2006 2007 2008 Dec

Figure 2.29
(5)
Rupiah Maturity Profile
Trillion Rp (10)
500 Dec07 Mar08 Jun08
Sep08 Dec08
400
(15)
300 sd 1 month 1 - 3 months 3 - 6 months 6 - 12 months > 12 months
200
100
0
Figure 2.31
(100) Net Open Positions
%
(200)
9
(300)
Dec07 Mar08 Jun08 8
(400) Sep08 Dec08
7
(500)
sd 1 month 1 - 3 months 3 - 6 months 6 - 12 months > 12 months 6
5
4
The bank maturity profile, both rupiah and foreign
3

currency, which tended to be short in the short term and 2


1
long in the long term, meant that an increase in the interest 0
Dec07 Mar08 Jun08 Sep08 Dec08
rates was unfavorable because it reduced profit or National Private Banks Regional Development Banks Foreign Banks
Joint Venture Banks State Owned Banks All Banks
increased loss. In the reporting period, the short position
of rupiah assets/liabilities in the very short term (up to 1 Global financial market turbulence also intensified
month) tended to increase in line with considerable efforts pressures on the rupiah exchange rate. The rupiah
taken by the banks to accumulate public money to boost depreciated to Rp12,150 per USD in November 2008.

31
Chapter 2 The Financial Sector

Consequently, the average exchange rate of the rupiah (HTM). This alleviated much of the pressure on the banks»
against the US dollar in semester II 2008 was Rp10,138 balance sheets and profit and loss statements; as indicated
per USD, compared to Rp9,235 in semester I. However, by the net unrealized loss on the balance sheet and net
the relatively low NOP of banks (6.2%) limited bank loss on the profit and loss statement, both of which
exposure to exchange rate risk. Stress test results indicated decreased in December 2008 after spiking in October 2008.
that if the rupiah reached Rp5,000 per USD, the capital
Figure 2.33
adequacy ratio (CAR) of banks would remain above 8%. Performance of SUN Owned by Banks
However, the impact of exchange rate fluctuations on (Trillion Rp)

banks should be carefully monitored as it could undermine 300 AFS Trading HTM

debtor repayment capacity. 250

101.4
130.6
Pressures on the stock market and domestic bonds 200

16.9
150
market during semester II of 2008 were more intense due

28.2
100
to the deteriorating global financial market turmoil. One

156.4
126.8
50
impact of the crisis was a significant slide in the prices of
0
government bonds in October. Nevertheless, by the end Dec Jun Jul Aug Sep Oct Nov Dec
2007 2008
of 2008 bond prices had begun to rebound. Such
developments dramatically affected the banks» balance The tumbling SUN price encouraged banks to shift
sheets as well as profit and loss statements because most SUN ownership from AFS to HTM in order to reduce loss.
banks used SUN in their portfolio of earning assets. Consequently, during semester II 2008, AFS ownership of
To curtail higher loss, on 9 October 2008, Bank SUN declined by 10.8% to 36.9%, whereas the share of
Indonesia, the government (through the Capital Market HTM jumped 11.3% to 56.9%. The share of trading SUN,
and Financial Institution Supervisory Agency or BAPEPAM- which was relatively low, and the postponement of
LK) and Indonesian Accountant Association issued a joint marking-to-market reduced banks exposure to the drop
decree allowing banks to postpone the implementation of in SUN prices. Stress test results indicated that even if the
marking-to-market in setting a fair SUN value. In addition, SUN price slid by 20%, no banks would experience a drop
banks were also permitted to shift SUN ownership from in CAR to below the 8% minimum
Trading and Available for Sale (AFS) to Hold to Maturity
2.3.4. Profitability and Capital
Figure 2.32
SUN Portfolio of Banking Industry Profitability
% Amid greater pressure on the economy, the banking
60
Dec07
Jun08
industry maintained its profitability, despite a slight decline
50
Dec08

40
when compared to that of the previous year. Net interest

30
income (NII), as an indicator of profitability, increased from

20 Rp53.2 trillion (Semester I 2008) to Rp59.9 trillion

10 (Semester II 2008). Such an increase was due to expansive

0 credit growth since the beginning of the year, however, it


HTM AFS Trading

32
Chapter 2 The Financial Sector

began to slow in November 2008. Therefore, the rise in 2008) to Rp12.2 trillion (December 2008). After tax, profits
NII was supported by credit interest rate income. in semester II 2008 dropped 33.9% from Rp18.4 trillion
to Rp12.2 trillion.
Figure 2.34
Bank Profitability It is important to note that a decline in profits during

Trillion Rp the second half of 2008 is an annual phenomenon that


25
Interest Income
Interest Expense
also occurred in 2007. Nevertheless, increasing pressure
20 NII
on banks in 2008 exacerbated this annual phenomenon
15
and thus causing profits in 2007 to exceed those in 2008
10 (Rp35.0 trillion and Rp30.6 respectively). Meanwhile, in
5 the same period, total bank assets increased, which

0
precipitated a corresponding decline in ROA.
Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2007 2008 Less operational profit in 2008 was also due in part
to a drop in efficiency. Lower efficiency was reflected by
Figure 2.35
Bank Interest Income the increasing ratio of operational costs to operational
250 revenue (BOPO). Consequently, a priority on the banking
Others Securities
Credit Placement in BI industry»s agenda will be to boost efficiency.
200

Recent data indicated that inefficiency has primarily


150

been observed occurring more in the group of small banks


100
compared to other groups of bank. Therefore, one effort
50

Figure 2.36
0
Nov Dec Nov Dec ROA by Bank Groups
2007 2008
%

ROA Dec'07 ROA Dec'08


4
However, profitability garnered from interest income
cannot fully become net profit of banks. This is because 3

banks anticipate unfavorable credit quality in association


2
with upcoming sluggish economic growth by raising their
1
loan loss provisions. Consequently, operational profit
declined by 30.6%, namely from Rp17.6 trillion (June -
15 Major Middle Small Regional Dev. Joint Venture Foreign Industry
Banks Banks Banks Banks Banks Banks

Table 2.1
Banking Profit and Loss
Trillion Rp

2007 2008
Semester I Semester II Total Semester I Semester II Total

Operational P/L 18.07 16.97 35.04 17.63 12.23 29.86


Non Operational P/L 7.10 7.72 14.82 7.23 11.01 18.24
Before Tax P/L 25.17 24.69 49.86 24.86 23.24 48.10
After Tax P/L 18.38 16.63 35.02 18.39 12.16 30.55

33
Chapter 2 The Financial Sector

Figure 2.37 Bank resilience to pressures from various risks was


Ratio of Interest Expense to Interest Income
by Bank Group estimated using integrated stress testing, which included
%
120 credit risk, interest rate risk, exchange rate risk and SUN
BOPO Dec'07 BOPO Dec'08

100 price risk. Stress tests were conducted on 15 major banks


80 which make approximately 70% of the banking industry»s
60 total assets. By applying a scenario of 5.6% in gross NPL
40 (the most pessimistic NPL ratio projected for 2009), SUN
20 prices falling by 20%, interest rates dropping by 1% and
-
15 Major Middle Small Regional Dev. Joint Venture Foreign Industry the rupiah depreciating by Rp5,000/USD, stress test results
Banks Banks Banks Banks Banks Banks
showed that no bank»s CAR would drop to below the
to raise efficiency could be to expand the size or business minimum 8%. For the test, it is also assumed that shortfalls
scale of the smaller banks. This can be achieved by bank in liquidity are covered through the interbank money
consolidation through mergers and acquisitions. market.

Figure 2.39
Capital
Integrated Stress Test on CAR of 15 Major Banks
In general, the capital adequacy ratio (CAR) of the
30%
OLD CAR
banking industry by the end of semester II 2008 was relatively NEW CAR
25%
high at 16.2%. However, there was a slight decline when
20%

compared to the final position of the previous semester,


15%

namely 16.4%. This was caused by high credit growth


10%

coupled with a concomitant slowdown in bank profit. If 5%

future bank credit expands in the range of 15%-18%, bank 0%


A B C D E F G H I J K L M N O
CAR by the end of 2009 is projected to drop to 14.3%.
The tier-1 capital to risk weighted assets ratio Currently, several banks are facing potential losses
remained high at 14.4%. Consequently, bank capital is due to structured products, therefore, a stress test was
sufficient to absorb risk and provide adequate room to conducted to assess the capital resilience of said banks.
grow and expand credit. The results indicated that, in general, bank capital is
relatively strong. However, the several foreign bank
Figure 2.38
Capital, Risk-Weighted Assets and CAR branches active in structured products must be prepared
Trillion Rp %
2,000 25 to promptly raise their capital should the loss potential
Capital
Risk -Weighted Assets

1,600
CAR (right)
20
increase.
However, when observed individually several banks
1,200 15
still maintain a minimum tier-1 capital of less than Rp100
800 10
billion. Regulations are in place that legislate a minimum
400 5
tier-1 capital of Rp100 billion by the end of 2010, therefore,
-
Dec Feb Apr Jun Aug Oct Dec
0 banks that have yet to reach Rp100 billion are required to
2007 2008

34
Chapter 2 The Financial Sector

take preparatory steps to meet this legislation. One possible the performance of finance companies improved
solution would be bank consolidation through mergers dramatically, as reflected by the increase in total assets
and acquisitions. and capital by 23.8% and 2.01% respectively.
To gain insight on banks» resilience in facing Furthermore, financing activities expanded by 16.58%.
macroeconomic shocks, a macroeconomic stress test was The rapidly growing business of finance companies
held for the 15 major banks. The stress test results show was supported by greater funding, predominantly
that NPL ratios of the banks are significantly affected by originating from bank credit, for which the share increased
GDP growth, exchange rate, inflation and the Jakarta from 24.42% to 42% of total funding. The global financial
Composite Index (IHSG). The stress test results also show crisis, which tightened liquidity, pushed up the costs of
that by the end of 2009, with the projected slowdown in shares and bonds» issuers. Consequently, finance
growth, NPL levels of the 15 banks will on average increase, companies became more dependent on bank credit.
but only to levels within the 5% range.
Figure 2.41
Moreover, interbank stress tests were also held to Business Activities of Finance Companies
understand the contagion effects of a bank failure to other 200.00
23.80% Jun 07
180.00
banks (contagion risk). The stress test shows that in a case Dec'07
160.00 Jun'08
16.58%
where eleven trigger banks fail (i.e., eleven single failures), 140.00 28.19% Nov'08
120.00
there will be 14 banks which capital are impacted. 100.00
80.00
Meanwhile, its second round effects will cause another 60.00
40.00
24 banks (multiple failures) to have their capital impacted. 2.01%
20.00
0.00
Assets Financing Funding Capital
Figure 2.40
Interbank Stress Test
Figure 2.42
Impacted Banks Finance Companies Source of Funds
F M N O P Q R S T U V J W K
Billion Rp
Trigger Banks

A 140,000
B 28.19%
C Jun'07 Jun'08
120,000
D
E Dec'07 Nov'08
100,000
F
G
80,000
H
I 24.42%
60,000
J
K
L 40,000
-7.33%
20,000

0
Credit from Securities Total of Funds*
2.4. NONBANK FINANCIAL INSTITUTIONS AND Domestic Banks

*Total of Funds: Securities, Subordination Borrowed and Total Domestic and Foreign Borrowed
THE CAPITAL MARKET
2.4.1. Finance Companies In terms of the finance provided, the share of
Finance companies (FC) are one type of nonbank consumer financing contracted and tended to diversify to
financial institution that provides finance through various leasing. The lower concentration of consumer financing was
means, such as consumer financing, leasing, factoring and mostly due to the decline at joint-venture finance companies
credit cards. During semester II 2008 (up to November), from 52.40% (June 2008) to 47.96% (November 2008).

35
Chapter 2 The Financial Sector

Figure 2.43 in 2008 also increased, reaching 6.22 million units, far
Composition of Financing by Finance Companies
(Nov «08) exceeding sales in 2007 of 4.69 million units.

Financing (in Billion Rp)


160,000 Table 2.3
140,000 Financial Ratios of Finance Companies
120,000

100,000 Dec-06 May-07 Dec-07 May-07


80,000 Asset 116,000,000,000 127,000,000,000 140,649,000,000 174,124,731,707
60,000 Debt 81,524,052,728 90,319,642,214 100,183,895,911 128,423,157,567
Liabilities 95,241,046,752 102,466,196,738 113,722,737,895 143,568,726,785
40,000
Equity 20,758,953,248 24,533,803,262 26,926,262,105 30,556,004,922
20,000
Profit Before Tax 2,978,914,227 5,763,866,446 4,134,560,328 8,078,856,892
0
Total National Private Joint Venture Profit After Tax 2,244,670,921 4,379,780,690 3,114,695,467 5,961,654,328
Financing Receivables 141,179 46,257 93,795 ROA 0.03 0.05 0.03 0.05
Leasing 53,480 5,759 46,634 ROE 0.14 0.23 0.15 0.26
Factoring 2,222 1,182 1,001
Ops Expense to
Credit Card 1,178 2 1,175
Consumer Financing 84,299 39,314 44,985
Ops Income 0.81 0.83 0.77 0.77
Debt/Equity 3.93 3.68 3.72 4.2
Liabilities/Equity 4.59 4.18 4.22 4.7
Table 2.2
Financing Growth of Finance Companies
Figure 2.44
Jun»08 Total National Private Joint Venture NPL of Financing by Finance Companies
Leasing 33.34% 11.31% 44.85%
NPL (%)
Factoring 1.82% 3.10% 1.05% 16.00
Credit Card 1.07% 0.01% 1.69% 14.00
Consumer Financing 63.76% 85.59% 52.40%
12.00

Nov»08 Total National Private Joint Venture 10.00

Leasing 37.88% 12.45% 49.72% 8.00

Factoring 1.57% 2.56% 1.07% 6.00


Credit Card 0.83% 0.01% 1.25% 4.00
Consumer Financing 59.71% 84.99% 47.96%
2.00

0.00
Leasing Factoring Credit Card Consumer
Financing
The profit of finance companies increased Jun'07 2.67% 14.14% 4.28% 1.55%
Dec'07 2.28% 11.59% 3.66% 1.68%
significantly from Rp2.85 trillion to Rp5.96 trillion. Stronger Jun'07 1.90% 11.32% 2.79% 1.70%
Nov'08 1.67% 9.04% 3.09% 1.66%
profits helped improve ROA and ROE. Business efficiency
was also well maintained with an Operational Cost to
Figure 2.45
Operational Revenue (BOPO) ratio of 77%. Developments of NPL Value
The performance of finance companies was Billion Rp
3,000,000,000
buttressed by robust growth in the automobile market
2,500,000,000
during the reporting period. Based on data from the
2,000,000,000
SGU PK
Indonesian Automobile Industry (Gaikindo), during 2008, AP Total
1,500,000,000 KK
automobile sales in Indonesia surged 40%, peaking at a
1,000,000,000
record high 607.15 units despite a slight downward trend
500,000,000
in November and December. Meanwhile, based on the
0
Jun Dec Jun Nov
Indonesian Motorcycle Association (AISI), motorcycle sales 2007 2008

36
Chapter 2 The Financial Sector

Relatively high lending rates during the reporting Figure 2.48


Bank Exposure
period heightened potential risk exposure to finance
Billion Rp
companies. In addition, a decline in customer income as 50,000
Channelling
45,000
Joint Financing
an impact of the global crisis also had the potential to 40,000
35,000
exacerbate NPL. In 2008, the NPL ratio of finance 30,000
25,000
companies decreased, however, when expressed nominally
20,000
NPL actually increased, particularly consumer financing and 15,000
10,000
leasing. 5,000
0
Liquidity risk also had the potential to rise, largely Jun Dec Jun Nov
2007 2008
due to an increasing liquidity mismatch. Liquidity inflow
from funding was relatively high but still could not offset Higher financing risk and liquidity risk could
the outgoing cash flow due to vast operational activities. subsequently disrupt the performance of or intensify risks
to banks as the main source of funds for finance
Figure 2.46
Cash Flow of Private Finance Companies companies. Therefore, banks with subsidiary finance

Billion Rp companies would be exposed to greater risk. Meanwhile,


4,000
increasing channeling and joint financing activities between
3,000

2,000 banks and finance companies had the potential to increase


1,000 risk to banks. During semester II 2008, channeling
0
increased 23.74% to Rp9.33 trillion, whereas joint
-1,000
financing increased 9.8% to Rp49.61 trillion.
-2,000

-3,000 - -
Based on the surveillance of 21 finance companies
Jun 07 Dec 07 Jun 08 Nov 08
Net cash flow of affiliated with banks, it was shown that 10 finance
792 1,184 1,312 1,772
operating activities
Net cash flow of
-45 -162 -177 -322 companies had NPLs with six of them showing a tendency
investing activities
Net cash flow of
financing activities
-903 -811 1,721 3,109 to increase. The significant rise in nominal NPL mostly
affected finance companies with a larger portion of leasing.
Figure 2.47
Cash Flow of Joint Venture Finance Companies Table 2.4
Billion Rp NPL of Finance Companies
15,000

%Change
10,000 ∆ Change in NPL Value
of NPL
5,000 Finance Jun»08 - Credit Consumer
Jun»08 Nov»08 Leasing Factoring
Companies Nov»08 Card Financing
0
1 0.54% 0.37% - - - -3,558,416
-5,000 2 32.63% 53.28% 93,069,554 413,988 - 42,591,752
3 0.37% 0.37% - - - - -990,623
-10,000
4 1.03% 0.00% - - - -26,578,328
5 1.20% 1.07% - - - -5,406,096
-15,000
Jun-07 Dec-07 Jun-08 Nov-08 6 0.00% 0.06% 799,020 - - -
Net cash flow of 7 0.20% 0.44% - - - 1,370,608
operating activities 3,528 7,133 5,221 9,786

Net cash flow of


8 0.79% 0.58% 142,127 - - -
174 494 944 724
investing activities 9 0.00% 0.66% -540,907 - - -
Net cash flow of 10 0.02% 0.03% - - - 279,805
financing activities 4,790 7,513 4,480 11,222

37
Chapter 2 The Financial Sector

Figure 2.49 encouraged profit taking by foreign investors. On the


The Decrease of NPL of Bank Subsidiary
Finance Companies domestic stock market, profit-taking behavior by foreign

12000000 12000000 investors triggered net stock buying totaling Rp11.5 trillion.
10000000 10000000
Figure 2.51
8000000 80000000
Foreign Investment: SBI √ SUN √ Stocks
6000000 60000000 Trillion Rp
35
40000000 SBI SUN Stocks
4000000
25
2000000 20000000
15
1 8 4 5
0 0 5
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
2008
-5

-15
Figure 2.50
-25
The Increase of NPL of Bank Subsidiary
Finance Companies -35
Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2007 2008
30000000 4500000
2 7
3 9 4000000
25000000 6 10
3500000 Figure 2.52
20000000 3000000 Foreign Placements: SBI √ SUN √ Stocks
2500000 Trillion Rp
15000000 35
2000000
10000000 1500000 25

1000000 15
50000000
500000
5
0 0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
-5
2008
-15

Meanwhile, the nominal NPL of consumer financing tended -25

to decrease. -35
Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2007 2008

2.4.2. Capital Market Profit taking by foreign investors could undermine


Foreign Investment Portfolio financial system stability as it has the potential to trigger a
In semester II 2008, foreign investors tended to realize sudden reversal. Vulnerability mainly stemmed from SUN
their gains. As a consequence, there were outflows of portfolio held by foreign investors to the tune of Rp87.4
foreign investment from rupiah financial assets totaling trillion at the end of December 2008, most being the
Rp20.4 trillion, despite inflows during the previous portfolio of foreign investment managers. In addition to a
semester of Rp18.5 trillion. The outflows were evidenced potential sudden reversal, the release of SUN by foreign
by less foreign ownership in SBI and SUN of Rp25.2 trillion investors could be detrimental to the rupiah exchange rate
and Rp6.7 trillion respectively. and SUN price.
Negative sentiment after the collapse of international Vulnerabilities were exaggerated by the herd behavior
financial institutions such as Lehman Brothers in the U.S. of SUN investors. This was clearly evidenced during the
and several investment banks in Europe as well as the reporting period when the release of SUN by foreign
failure of AIG Insurance, and volatile share prices have investors totaling Rp4.7 trillion was immediately followed

38
Chapter 2 The Financial Sector

by similar action by domestic investors (particularly financial increasing reports of losses posted by international financial
institutions) totaling approximately Rp10.1 trillion. As a institutions. The Dow Jones plummeted 23% reaching its
consequence, the weakening of the SUN market deepened lowest level of 7,552.2 (mid November 2008). The prospect
further and market recovery became very slow. of a deteriorating global economy and the expectations
Furthermore, as large SUN portfolios continued to be held of a recession in the U.S. as well as several countries in
by domestic financial institutions, such as banks (Rp253.9 Europe have seriously undermined the performance of
trillion), insurance companies (Rp53.2 trillion), pension Asian regional markets. Against this unpropitious
funds (Rp32.3 trillion) and mutual funds (Rp31.9 trillion), backdrop, the IHSG nose-dived 42.3% to 1,355.41
the above situation caused SUN market weakening to (December 2008), reaching its lowest ebb of 1,111.39 on
disrupt the performance of domestic financial institutions. 28 October 2008. With such poor performance, the
This requires close surveillance. average IHSG during semester II 2008 was approximately
1,723.06; much lower than the average for the previous
Figure 2.53
SUN and SBI Ownership by Foreign Investor
semester of 2,485.47.

Trillion Rp
120 Table 2.5
SBI SUN
Price Index Perfomance of Several Stock Exchanges
100
in the Region
80
Growth (%)
60 Jun 07 Dec 07 Jun 08 Sep 08 Dec 08
Sem II 07 Sem II 08 Jun-Sep 08
40
JCI 2,139.28 2,745.83 2,349.11 1,832.51 1,355.41 28.35 (42.30) (21.99)
20 STI 3,475.89 3,465.63 2,947.54 2358.91 1,761.56 (0.30) (40.24) (19.97)
SET 776.79 858.10 768.59 596.54 449.96 10.47 (41.46) (22.39)
0 KLCI 1,354.38 1,445.03 1,186.57 1,018.68 876.75 6.69 (26.11) (14.15)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2008 PCOMP 3,660.86 3,621.60 2,459.98 2,569.65 1,872.85 (1.07) (23.87) 4.46
NIKKEI 18,138.36 15,307.78 13,484.38 11,259.86 8,859.56 (15.61) (34,28) (16.48)
HSCI 21,772.73 27,812.65 22,102.01 18,016.21 14,387.48 27.74 (34.90) (18.49)
Figure 2.54 KOSPI 1,743.60 1,897.13 1,674.92 1,448.06 1,124.47 8.81 (32.86) (13.54)
SUN Absorption by Domestic and Foreign FTSE 9,873.02 9,740.32 8,660.48 7,532.80 5,757.05 (1.34) (33.53) (13.02)
Financial Institutions UKX 6,607.90 6,456.90 5,625.90 4,902.45 4,434.17 (2.29) (21.18) (12.86)
Trillion Rp DJIA 13408.62 13264.82 11350.01 10850.66 8776.39 (1.07) (22.68) (4.40)
20

10
Figure 2.55
0
Performance of JCI, Global and Regional Index
-10 (Based on Index per 31 Dec 2005)
-20

-30
2.20
-40
Domestic Financial Institution Foreign Financial Institution
-50 1.70
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2008
1.20

Stock Market 0.70

During the reporting period, the global stock market 0.20


Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

was corrected downwards due to negative sentiment 2007 2008


IHSG FSSTI SET KLCI
PCOMP NKY Hang Seng KOSPI
surrounding the bankruptcy of top investment banks and FTSE NYA DJIA

39
Chapter 2 The Financial Sector

Overall, sectoral indices have weakened; most Sharp declines in the stock market index were also
severely affected were the farming sector and mining followed by fewer transactions caused by end-of-year
sector, which spiraled 70% and 74% respectively. Sectors festivities. During semester II 2008, stock market
vulnerable to exchange rate fluctuations also witnessed transactions declined by 64% to Rp34.88 trillion. The stock
severe declines in their respective indices, for example the market transactions of foreign investors decreased, yet the
trade sector and the mixed industry sector, which persistently high interest of investors spurred net purchases
experienced declines of 58% and 40% respectively. of Rp7.77 trillion. Tumbling prices followed by less trade
sparked 45.86% lower market capitalization (Rp1.076
Table 2.6
Sectoral Price Index trillion). In addition, market liquidity remained low, as
reflected by share issuances, which only increased 6.94%
Growth (%)
Jun 07 Dec 07 Jun 08 Sep 08 Dec 08 to Rp407.46 trillion. The number of issuers increased by
Sem II 07 Sem II 08 Jun-Sep 08
JCI 2,139.28 2,745.83 2,349.11 1,832.51 1,355.41 28.35 (42.30) (21.99) just 17 companies to 485 companies.
Financial Sector Index 223.14 260.57 203.74 203.37 176.33 16.78 (13.45) (0.18)
Agriculture Sector Index 1,680.12 2,754.76 3,061.06 1,489.57 918.77 63.96 (69.99) (51.34)
Figure 2.57
Basic Industry Sector Index 196.10 238.05 200.05 162.93 134.99 21.39 (32.52) (18.55)
Stock Transaction Value of Domestic and
Consumer Sector Index 437.01 436.04 398.29 381.36 326.84 (0.22) (17.94) (4.25)
Foreign Investors
Property Sector Index 211.72 251.82 168.53 142.42 103.49 18.94 (38.59) (15.49)
Mining Sector Index 1,647.04 3,270.09 3,415.96 1,833.24 877.68 98.54 (74.31) (46.33) Trillion Rp
160
Infrastructure Sector Index 750.43 874.07 652.81 570.91 490.35 16.47 (24.89) (12.55) Total Indonesia Foreign
Trade Sector Index 387.38 392.24 356.76 261.33 148.33 1.26 (58.42) (26.75) 140

Miscellaneous Sector Index 324.96 477.35 360.65 326.15 214.94 46.89 (40.40) (9.57) 120

100

80
The easing of inflationary pressures and the lower
60
interest rate by the end of 2008 successfully slowed any 40

further declines in the financial sector index, which dropped 20

0
just 0.18%. Nevertheless, global financial market turbulence Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2008

created additional domestic stock market volatility from


September √ November 2008. However, on average, Figure 2.58
Capitalization and Issuance Value
domestic stock market volatility remained rather moderate Trillion Rp
3500 450
and thus investor interest in short-term profit taking persisted.
400
3000
Cap. Value (BEI)
350
Figure 2.56 2500 Cap. Value (BEJ)
Cap. Value (BES) 300
Volatility of Asian Stock Indices JCI (RHS)
2000 Issuance Value 250
(30 days)
% 1500 200
120 150
Indonesia Japan 1000
Thailand Malaysia 100
100 Singapore Hongkong 500
50
80 0 0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
60 2008

40
During the reporting period, the prices of most banks»
20
shares slid significantly, however, approaching the end of
0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
semester a rebound looked imminent.
2007 2008

40
Chapter 2 The Financial Sector

Figure 2.59 Figure 2.61


Stock Price Performance of Several Banks Price Performance of Several FR Series Bonds

9,000.00 1,200.00 140


8,000.00
1,000.00 120
7,000.00
6,000.00 800.00 100
5,000.00
600.00 80
4,000.00
3,000.00 400.00 60
2,000.00
200.00 40
1,000.00 FR02 FR49 FR27
FR48 FR47 FR45
- - 20
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2007 2008 2008
BCA (left) BRI (left) Mandiri (left)
Danamon (left) BNI (left) BII (right)
CIMB Niaga (right) Figure 2.62
Yield of 1 to 30 year SUN
%
Figure 2.60
20
P/E Ratio of Bank Stocks
% 18
90
Jun 07 Dec 07
16
80 Jun 08 Dec 08 14
70
12
60
10
50
40 8
1 year 3 years 5 years
30 6
10 years 15 years 30 years
20 4
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
10 2007 2008
0
Danamon BCA BRI Mandiri BNI BII CIMB
Niaga
Rp511.0 trillion. From a tenor perspective, SUN market
Bonds Market liquidity remained concentrated in short-term and medium-
The soaring interest rate from the beginning to mid term SUN, and thus resulting in less developments in
semester II 2008 undermined bond market performance. transactions for long-term SUN tenors. The lack of a proper
The SUN price decreased, as indicated by the 11% decline yield reference for long-term (more than 10 years) rupiah
in the IDMA index to 88.21. Moreover, the IDMA index investments also hindered the development of long-term
reached its lowest point of 67.11 on 29 October 2008. To SUN transactions.
reduce potential losses to investors due to the falling SUN
Figure 2.63
price, a loosening policy was applied to the regulation
Government Bonds: Market Liquidity of
regarding marking-to-market for SUN investors. Along with Various Tenors
Trillion Rp
the BI Rate cuts since early November 2008, the market 45
FR VR ORI Zero Coupon SPN
40
began to rebound, as indicated by the decreasing yield of
35
rupiah investments of various tenors. 30
25
In terms of liquidity, the absence of SUN auctions in
20
Q4 (since 14 October 2008) offset market liquidity where 15
10
selling was dominant. In addition, the position of SUN in
5

the reporting period dropped from Rp515.0 trillion to 0


2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2037 2038

41
Chapter 2 The Financial Sector

A depressed bond market reduced the interest of addition, the share of protected mutual funds by the end
issuers to issue bonds. In 2008, financing through of December 2008 was the largest at 36%. In December
corporate bond issuances was low, with issuer value only 2007 the share was only 17%. The higher NAV of protected
increasing by approximately 9% to Rp145.9 trillion with 3 mutual funds succeeded in alleviating some of the
additional issuers, making a total of 178. Corporate bond redemption pressures. During 2008, subscriptions
issuances did not affect liquidity on the corporate bonds exceeded redemptions, at Rp83.8 trillion and Rp81.6 trillion
market as most issuers refinanced. In general, corporate respectively.
bonds by the end of December 2008 recorded Rp73 trillion;
Figure 2.65
down 13.7% from the end of December 2007. Net Asset Value of Mutual Funds
Trillion Rp
40
Figure 2.64
35
Issuance and Position of Corporate Bonds
30
(Issuance & Position Trl Rp) (Issuer)
25
160 179
Issuance Position Issuer 20
140 178
15
177
120
176 10
100
175 5
80
174 0
60 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct
173 2007 2008
40 172 Fixed Income Equity Mixed Money Market Protected
20 171
0 170
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Figure 2.66
2008
Mutual Funds: Redemptions-Subscriptions-NAV

14 120
Rdmp, trl Rp, left Subscr, trl Rp, left NAV, trl Rp, right
Mutual funds 12 100
A weak financial market was detrimental to the 10
80
performance of mutual funds. Net Asset Value (NAV) in 8
60
6
the reporting period (up to October 2008) dropped 25%
40
4
to Rp68.9 trillion. With such negative growth, the NAV of 20
2
mutual funds decreased by approximately 27% in 2008. 0 0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct
The unfavorable stock market, which was followed by 2007 2008

increasing IHSG volatility, triggered a 53% decline in the Figure 2.67


NAV of equity funds to Rp16.6 trillion, whereas discretionary Mutual Fund: NAV-Participating Units

120 2000
funds dropped 38% to Rp8.7 trillion. Furthermore, NAV, trl Rp, left Participating Units, NAV/Unit, right
bil unit, left 1800
100
congruous to the weaker bonds market, the NAV of fixed- 1600
1400
80
income funds decreased 15% to Rp14.0 trillion. 1200
60 1000
Meanwhile, the introduction of a Bapepam-LK
800
40
regulation to prohibit the redemption of protected mutual 600
400
20
funds before its maturity has caused the NAV of protected 200
0 0
mutual funds to increase by 21% to Rp24.9 trillion. In Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct
2007 2008

42
Chapter 2 The Financial Sector

Figure 2.68 However, there were signs of waning investor interest


Performance of Fund Collection of Mutual Funds
in mutual funds; indicated by the subscription units. Even
160 560
Number of Participating Total Funds, Number of Mutual
Units, left Trl Rp, left Funds, right though there was a 17% increase in subscription units
140 540
120
520
during 2008, since September 2008 the number of
100
500 subscription units dropped to approximately 62.5 billion.
80

60
480 Nonetheless, the increase of funds generated in 2008 (up
460
40 to September) was considered small at only 2% to Rp135.5
20 440
trillion, whereas the number of mutual funds increased
0 420
Dec Jan Feb Mar Apr May Jun Jul Aug Sep
2007 2008 dramatically by 16% to 549.

43
Chapter 2 The Financial Sector

Chronology of the 2008 Financial Sector Shocks and Policy


Box 2.1
Responses

The financial sector experienced many shocks The following is a chronological summary of the
in 2008, and especially in the second half of the year. financial shocks in Indonesia in the second half of 2008
As explained previously, these shocks caused the and the policy responses taken to safeguard the
Financial Stability Index (FSI) to increase sharply in the stability of the financial system.
reporting period, even surpassing the maximum
Table Box 2.1.1
indicative level of 2 in the months of November and Chronology of Shocks to the Indonesian
December 2008. Meanwhile, the rupiah also came Financial Sector in 2008
under pressure. In the latest developments, the FSI
Date Event
has shown a slight decline in line with improvements
8-10 October 2008 Indonesia Stock Exchange is temporarily closed.
in the Jakarta Composite Index (IHSG) and the price 28 October 2008 IHSG: 1,111.4, lowest level since December 2005.
of government bonds (SUN), although the rupiah 29 October 2008 IDMA: 67.11, lowest level since first SUN issuance in
January 2005.
exchange rate has not yet returned to its level before
20 November 2008 LPS takes over one bank which is said to have been
October 2008, although its volatility has increasingly systematically hit (Bank Century).
lessened. 24 November 2008 The rupiah/USD exchange rate is at Rp12,650/USD,
its lowest level since the 1997/1998 crisis.

Table Box 2.1.2


Policy Response

Date Event

16 September 2008 BI lowers the O/N repo rate from the BI rate plus 300 bps to the BI rate plus 100 bps.
BI adjusts the FASBI rate from the BI rate minus 200 bps to the BI rate minus 100 bps.
23 September 2008 BI lengthens the time span for Fine Tune Operations (FTO) from 1 -14 days to 1 day - 3 months (BI Regulation No.10/14/PBI/2008).
13 October 2008 Issuance of PERPPU No.2 Year 2008 on changes in Regulations concerning Bank Indonesia, which allowed current credits to become
collateral to receive the short term liquidity facility (FPJP).
Issuance of PERPPU No.3 Year 2008 which regulates the increase in the value of a depositor»s funds guaranteed by LPS from Rp100
million to Rp2 billion.
15 October 2008 BI lengthens the tenor on the foreign exchange swap from a maximum of 7 days to 1 month (BI RegulationNo.10/21/PBI/2008).
BI committs to supply foreign exchange to domestic corporations through banks (BI Regulation No.10/22/PBI/2008).
Issuance of PERPPU No.4 Year 2008 concerning the Financial System Safety Net (JPSK).
24 October 2008 BI amends BI Regulation No.10/19/PBI/2008 to improve the calculation of Rupiah GWM, i.e. primary GWM being 5% of rupiah
deposits and secondary GWM being 2.5% of rupiah deposits (BI Regulation No.10/25/PBI/2008).
30 October 2008 BI issues a regulation concerning the short term liquidity facility for commercial banks (FPJP) (BI Regulation No.10/26/PBI/2008).
13 November 2008 BI issues a regulation which limits speculative foreign currency transactions to the rupiah by requiring an underlying transaction for
each foreign currency purchase in excess of USD100,000 (BI Regulation No.10/28/PBI/2008).
14 November 2008 BI issues an amendment in regard to PBI No.10/26/PBI/2008 concerning the Short Term Liquidity Facility (FPJP) for Public Banks
(BI Regulation No. 10/30/PBI/2008).
18 November 2008 BI issues a regulation concerning an Emergency Funding Facility (FPD) (BI Regulation No.10/31/PBI/2008).
16 December 2008 BI forbids derivative transactions of structured products in relation to foreign currency transactions (BI Regulation No.10/38/PBI/2008).

44
Chapter 2 The Financial Sector

Bank Century’s Takeover, Bank Indover’s Closure and


Box 2.2
Financial System Stability

In semester II 2008, two major predicaments In addition, De Indonesische Overzeese Bank or


in the banking industry are highlighted. The first is Bank Indover is Bank Indonesia»s subsidiary based in
the takeover of Bank Century by LPS and the second Amsterdam, Netherlands. Bank Indover, used to have
is the closure of Bank Indover. The question remains, good performance but experienced liquidity problems,
do these problems interfere with the stability»s of due to a drastic drop in the money market line available
Indonesia»s financial system? to it as repercussions of the global financial turmoil,
Bank Century is a merger between Bank CIC, particularly those taken place in Europe. Later, the
Bank Pikko and Bank Danpac in December 2004. Dutch court ordered to freeze the bank on 6 October
When the drought of global liquidity hit this country, 2008.
in July 2008, Bank CIC experienced liquidity One of the potential pressures in the financial
problems and on several occasions, violated the stability is the investment of domestic banks to Bank
minimum reserve requirement. Afterwards, the Indover. Data show that more than 14 local banks
performance of the bank chronically deteriorated, had placements in Bank Indover before the bank was
until it was listed into Bank Indonesia»s special shut down. Taking into account that the exposure of
surveillance watch. The condition of the bank the local banks in Bank Indover was only IDR 1.6 trillion
continued to worsen and on 20 November 2008, or approximately 0.07% from the total assets of the
was considered a failed bank. Afterwards, the bank banking industry as per October 2008, the closure of
was regarded to have systemic impact and was Bank Indover did not generate significant impact to
seized by LPS to be restored. the resilience of Indonesia»s financial system.
In reality, the takeover of Bank Century by LPS Moreover, its impact to Capital Adequacy Ratio
did not generate a significant shock within the (CAR) was also trivial. The closure of Bank Indover
banking industry. Both the customers and the bank only instigated a slight decline in CAR from 16.18%
institution remained calm and the problem did not to 16.09%. The results of interbank stress test also
cause pressure to the stability of the financial system. illustrate that banks which declined in CAR due to
The undisruptive takeover also marks the strong the closure of Bank Indover are not banks with
coordination amongst all related stakeholders in systemic impacts. From a liquidity point of view, no
Indonesia»s financial system and the existence of crisis significant damage occurs as banks only experience a
management protocol and mechanism that has been slight decrease in liquidity ranging from 0.01% to
collectively agreed upon. 7.28% of banks» secondary reserves.

45
Chapter 2 The Financial Sector

Box 2.3 Segmentation in the Interbank Money Market (PUAB)

Segmentation in the interbank money market The following table divides 2008 into two time
(PUAB) is a situation in which interbank transactions periods. Period I represents the period prior to liquidity
tend to be limited and only occurring between certain pressures (January to August for the rupiah PUAB or
bank groups. As the PUAB is segmented, banks with January to September for the domestic foreign
liquidity become increasingly careful in placing or exchange PUAB), while Period II represents the period
managing their liquidity. Meanwhile, banks in need of in which liquidity pressures occurred (October to
liquidity become even more careful in borrowing funds December for the rupiah PUAB and October to
in the PUAB not only considering the limited level of December for the domestic foreign exchange PUAB).
liquidity, but also the bank»s reputation. By comparing the two periods, it can be observed
Segmentation in the PUAB is indicated by the that in Period II almost all bank groups limit their
decrease in average daily PUAB transactions. For the transactions, both in placing or taking funds. Also
rupiah PUAB, the decrease in average transaction noted is that even if transactions do occur, they will
volume occured from September 2008, while for the only take place within certain group of banks. The
domestic foreign exchange PUAB the decrease started bigger banks can be observed as only willing to
only a month later, i.e. October 2008. transact amongst them, while smaller and medium

Table Box 2.3.1


Daily Average Transaction Volume of Rupiah PUAB from January to December 2008
Million Rp
PLACING BANKS

Bank Group Major Banks Regional Joint Ventures Total


4 State Medium Small
(non-state Dev»t Banks & Foreign
Owned Banks Private Banks Private Banks
owned) (BPD) Bank Offices
Period I 266,184 260,786 99,627 8,628 706,069 143,799 1,485,093
4 State
Owned Banks Period II 17,690 30,547 4,762 0 112,154 3,962 169,115
Change -93.4% -88.3% -95.2% -100.0% -84.1% -97.2% -88.6%
Major Banks Period I 456,839 239,003 119,152 69,866 592,022 188,310 1,665,192
(non-state Period II 121,980 372,240 173,638 20,184 367,196 143,939 1,199,177
owned) Change -73.3% 55.7% 45.7% -71.1% -38.0% -23.6% -28.0%
Period I 49,585 62,317 36,332 50,926 81,815 17,459 298,434
Medium
Private Banks Period II 51,991 100,921 126,384 31,345 90,521 33,659 434,819
TAKING BANKS

Change 4.9% 61.9% 247.9% -38.5% 10.6% 92.8% 45.7%


Period I 9,382 53,515 63,656 36,223 7,424 22,954 193,155
Small
Period II 4,963 37,090 45,772 15,076 1,594 12,730 117,226
Private Banks
Change -47.1% -30.7% -28.1% -58.4% -78.5% -44.5% -39.3%
Regional Dev»t Period I 10,229 4,897 2,377 1,411 252,279 0 271,193
Banks Period II 2,500 11,701 2,778 0 318,728 0 335,707
(BPD) Change -75.6% 139.0% 16.9% -100.0% 26.3% - 23.8%
Joint Ventures Period I 873,565 695,964 197,388 71,858 97,870 917,118 2,853,763
& Foreign Bank Period II 225,304 614,915 355,914 15,469 51,586 1,090,923 2,354,112
Offices Change -74.2% -11.6% 80.3% -78.5% -47.3% 19.0% -17.5%
Period I 1,665,783 1,316,482 518,532 238,913 1,737,480 1,289,640 6,766,829
TOTAL Period II 424,429 1,167,415 709,247 82,074 941,778 1,285,213 4,610,157
Change -74.5% -11.3% 36.8% -65.6% -45.8% -0.3% -31.9%

46
Chapter 2 The Financial Sector

banks find it relatively difficult to obtain these government, both the rupiah PUAB and foreign
interbank funds. exchange PUAB showed increases in their average
The most recent developments show that, daily transaction volume. As such, it is expected that,
commencing the end of 2008, along with the looking forward, the segmentation issue in the PUAB
improvements in domestic liquidity attributed to a will be completely resolved and thus not putting
series of policies taken by Bank Indonesia and the pressure on financial stability.

Table Box 2.3.2


Daily Average Transaction Volume of Domestic Foreign Exchange PUAB
Thousand US$
PLACING BANKS

Bank Group Major Banks Regional Joint Ventures Total


4 State Medium Small
(non-state Dev»t Banks & Foreign
Owned Banks Private Banks Private Banks
owned) (BPD) Bank Offices
Period I 8,623 14,935 5,980 759 1,337 2,873 34,508
4 State
Owned Banks Period II 4,455 16,072 4,481 894 174 4,418 30,494
Change -48.3% 7.6% -25.1% 17.6% -87.0% 53.8% -11.6%
Major Banks Period I 10,481 9,057 6,014 1,109 52 6,561 33,274
(non-state Period II 2,209 7,193 4,530 1,065 50 2,121 17,168
owned) Change -78.9% -20.6% -24.7% -4.0% -4.5% -67.7% -48.4%
Period I 2,504 2,837 670 1,525 24 330 7,889
Medium
Private Banks Period II 1,170 1,568 648 1,212 8 376 4,982
TAKING BANKS

Change -53.3% -44.7% -3.3% -20.5% -65.0% 14.1% -36.8%


Period I 0 3 78 53 0 45 179
Small
Period II 0 0 0 18 0 25 43
Private Banks
Change - -100.0% -100.0% -66.9% - -44.7% -76.2%
Regional Dev»t Period I 32 14 0 0 0 94 139
Banks Period II 0 700 19 19 0 0 737
(BPD) Change -100.0% 5037.9% - -100.0% 429.7%
Joint Ventures Period I 45,668 60,364 24,368 5,943 144 81,611 218,098
& Foreign Bank Period II 2,585 41,127 13,445 6,093 0 71,763 135,014
Offices Change -94.3% -31.9% -44.8% 2.5% -100.0% -12.1% -38.1%
Period I 67,307 87,209 37,110 9,390 1,558 91,513 294,087
TOTAL Period II 10,419 66,660 23,122 9,300 232 78,703 188,437
Change -84.5% -23.6% -37.7% -1.0% -85.1% -14.0% -35.9%

47
Chapter 2 The Financial Sector

Structured Products and Offshore Products: Their Impact to


Box 2.4
the Stability of the Financial System

Structured Products importers unilaterally canceling contracts as a


A number of banks, especially branches of consequence of the global economic downturn. As a
foreign banks, have recently been active in offering result, these clients do not have sufficient funds to
investment products which are known in Indonesia as preserve the value of their savings, and, moreover,
structured products. In general, structured products they also face difficulties in canceling structured
can be viewed as derivative of a conventional financial product transactions due to the high cost of
product with an asset structure which is expected to unwinding these transactions. Meanwhile, because
provide optimum returns or give yield enhancement banks still have obligations with other banks in relation
to clients, based on specific assumptions from general to the structured product transactions of clients, banks
indicators in the financial markets, such as interest often paid for its clients» unpaid maturing»obligations.
rates, the exchange rate and stock indices. Nonetheless, this practice will increase the bank»s
The structured products which have been exposure to credit risk, and can become a source of
developed in Indonesia are generally derivatives from dispute with the customer. As such, structured product
time deposit options or hedging (usually forward) transactions have already created new problems in
options. Data shows that developments in options the banking sector and if this problem cannot be
transactions have been very brisk, that is increasing resolved in a wise manner, then it will increase the
by 251% in 2007 and by 134% in 2008. Meanwhile, risk of instability in the financial system.
forward transactions have also experienced an A valuable lesson which can be drawn from the
increase, up by 24% in 2007 and by 46% in 2008. current problems in regard to structured products is
Meanwhile, the weakening of the global the importance of banks adopting prudential principles
economy has put pressure on Indonesia»s balance of and transparent in their marketing of such products,
payments. This subsequently resulted in negative including in explaining risk mitigation aspects and
sentiment on the rupiah, causing it to depreciate. In consumer protection. If the problem of structured
2008, the value of the rupiah relative to the US dollar products cannot be resolved satisfactorily, then risks
weakened by around 18.5% and as such the exchange relating to the reputation of a bank will increase as
rate by the end of December was around Rp11,120/ the legal risks.
USD. The weakening of the rupiah had an adverse
impact on the performance of structured products Offshore Products
which generally had not anticipated the significant Meanwhile, the prevalence of mutual funds
depreciation in the value of the rupiah. transactions has encouraged banks to undertake the
In further developments, the weaker role of agent for mutual funds. As a result, the agency
performance of structured products resulted in losses role undertaken by banks is no longer limited to
for investors, while investors still had to supply funds onshore mutual funds, that is mutual funds which
to conserve the value of their savings. And customers are issued by domestic investment managers, but also
of certain structured products, like exporters, are even involves offering offshore financial products, including
facing problems at the present time with overseas both structured funds and structured notes. In

48
Chapter 2 The Financial Sector

principal, structured funds are a type of mutual fund Nonetheless, the number of banks competing in this
issued by an overseas investment manager, while field is increasing. This is due, among other things,
structured notes are a type of structured financial the increasing level of takeover of more domestic
product which is issued by investment banks abroad. banks by foreign banks.
There are a number of main reasons why banks Besides banking industry, the offering of offshore
offer offshore products to their customers: (i) there is financial products has also been done by domestic
demand for such products from the bank»s prime investment managers. Based on provisional data up
customers; (ii) to maintain good relationships with the to November 2008, the offering of offshore financial
customer so they do not switch to another bank; and products by domestic investment managers is much
(iii) to face competition given the increasing number smaller, only around Rp2.5 trillion. And in the semester
of overseas financial products offered by banks and II 2008 (data up to November), the amount had even
investment managers abroad which is done by directly declined by around 6% to around Rp2 trillion.
visiting prospective investors in Indonesia. Nonetheless, overall, the amount of offshore financial
With this background, offices of foreign banks products offered by banks and domestic investment
(KCBA) are the most active among all banks in managers is relatively small, that is its share is on
undertaking the role of agents for offshore financial average only around 29% of onshore mutual funds.
products, especially through their private banking units In general, the offering of offshore financial
or wealth management divisions. In some banks, the products as being done by banks is still rather limited
wealth management unit in Indonesia is directly and only directed at prospective investors who already
connected and is a part of the wealth management have an adequate understanding of the risks involved
unit at the bank»s global office overseas. Another in investing in offshore financial products. Although
factor which causes offices of foreign banks to be fairly still limited, caution needs to be increased given that
active in offering offshore financial products is because the activities of being an agent for offshore financial
similar activities are already being carried out at the products means the bank may be more exposed to
bank»s branch offices in other countries. reputational and legal risks, besides increasing the
Based on reports from a number of banks acting dangers of having a misunderstanding with investors,
agents for offshore financial products it is known that especially if the problem of transparency and customer
the offering of overseas financial products in the protection are not given due attention. Another
semester II 2008 fell 14% to around Rp32 trillion. important consequence that needs to be given
This decline is attributable to the weakening in the attention is the danger of excessive investment in
global financial markets which reduced investor offshore financial products, which potentially may lead
appetite for structured investment products. domestic investor funds to run overseas.

49
Chapter 2 The Financial Sector

Box 2.5 The Impact of Foreign Debt to Financial System Stability

The experience of the 1997/1998 crisis showed prediction is that USD27.5 billion of foreign debt, both
that banking and corporate foreign debt can trigger a government and private, will be repaid during 2009.
crisis, particularly if the exchange rate experiences The principal and interest of banking private
significant weakening. Learning from the past, banks foreign debt maturing in 2009 is only USD3.1 billion,
today are prudent in maintaining their Net Open while non-banking private foreign debt is approximately
Positions (NOP). This is indicated by the banking USD14.2 (not including foreign debt that is standstill).
industry»s low NOP levels, i.e. 6.2% when the allowable Foreign debt obligations for the banking industry are
maximum is 20% from capital. However, considering predicted to be under control considering that 60%
that the banking industry»s foreign exchange maturity of total foreign debt maturing in 2009 are in the form
profile shows relatively high short-term (tenors up to of banker»s acceptance. Meanwhile, the amount of
one month) short positions, prudence must be non-banking private foreign debt remains relatively low
increased. compared to foreign reserves. As such, pressure on
It is predicted that repayment of 2009 foreign foreign exchange from private foreign debt, including
debt, in general, remains to be manageable. Also under from banks, is predicted to be insignificant.

Table Box 2.5.1


Private Foreign Debt Maturing in 2009

PRINCIPAL
LOAN TYPE QI-09 QII-09 QIII-09 QIV-09 Million USD
Loan Agreement 4,208.97 2,191.40 1,919.57 3,190.13 11,510.06
Securities 1,614.73 750.35 223.03 93.36 2,681.46
Trade Credits 755.45 154.43 87.03 87.55 1,084.47
Other Loan 32.94 10.76 3.23 57.55 104.46
Total 6,612.08 3,106.94 2,232.86 3,428.58 15,380.46
INTEREST
LOAN TYPE QI-09 QII-09 QIII-09 QIV-09 Million USD
Loan Agreement 271.47 555.55 238.14 699.22 1,764.38
Securities 54.60 66.11 49.06 62.66 232.44
Total 326.07 621.67 287.21 761.88 1,996.82
Grand Total 6,938.14 3,728.61 2,520.06 4,190.46 17,377.28
Bank 3,140.50
Non Bank 14,236.70
Private Foreign Debt* 17,377.20
* Not including domestic securities held by foreign parties (USD 1,308 million).

50
Chapter 3 Financial Infrastructure and Risk Mitigation

Chapter 3
Financial Infrastructure
and Risk Mitigation

51
Chapter 3 Financial Infrastructure and Risk Mitigation

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52
Chapter 3 Financial Infrastructure and Risk Mitigation

Chapter 3 Financial Infrastructure and Risk Mitigation

The dependability of the financial infrastructure during semester II 2008 was


well maintained and thus provided significant support to the financial system
and the economy. Improvements continued to be made on the payment system
while use of information provided by the Credit Bureau has seen an increase.
The introduction of a Financial System Safety Net (JPSK), for which the draft
Law is currently awaiting parliamentary approval, will further reinforce financial
system stability.

3.1. PAYMENT SYSTEM PERFORMANCE Figure 3.1


Generally the role of the Bank Indonesia-Real Time Performance of BI-RTGS Transactions

Gross Settlement (BI-RTGS) in the payment system is 12.0 50,000


Volume (millions)
increasingly important as, in terms of transaction value, 10.0 Nominal Value (trillions)
40,000

93% of payments use this system. However, in terms of 8.0


30,000
volume transactions, card-based payments instruments 6.0
20,000
(credit cards, debit cards, and ATM cards) dominate as they 4.0

10,000
make a 97% share of total payments. 2.0

- -
Transaction value of the BI-RTGS system experienced 2004 2005 2006 2007 2008

14.68% growth, equivalent to Rp3.1 thousand trillion, to


a total of Rp23.9 thousand trillion (y-o-y). Transaction BI-RTGS. Over the last two years up to the end of Semester-
volume grew by 710 thousand transactions (14.9%) to II 2008, the value and volume of payments processed
5.45 million compared to that of the previous period. Such through the Bank Indonesia-National Clearing System
a rise in value and volume was primarily attributable to (SKN-BI) increased, however, during semester II 2008 a
the burgeoning number of transactions between downward trend was reported. Specifically, when
consumers and the government through BI-RTGS. compared to semester II 2007, retail transfers through SKN-
Conversely, settlements processed through the BI declined by Rp105.35 trillion (14.31%) to Rp631 trillion.
clearing system have shown a different pattern to that of Furthermore, transaction volume also declined by some

53
Chapter 3 Financial Infrastructure and Risk Mitigation

19.35 million transactions (47.96%) to 21 million Figure 3.4


E-Money Transactions
transactions.
500.00 20.00
Volume (thousands)
Value (billions)
Figure 3.2 400.00
15.00
Performance of Bank Indonesia National
Clearing System 300.00

Volume Value (million Rp) 10.00

6 200.00
120
Volume (millions)
Value (trillions) 5.00
5 100 100.00

4 80
0.00 0.00
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
3 60

2 40 3.1.1. Risk Assessment and Risk Mitigation


1 20 To mitigate credit risk in the payment system and in
-
1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12
- an effort to anticipate the impacts of the ongoing global
2007 2008
crisis, which has the potential to threaten liquidity in the
The use of card-based payment instruments was payment system, Bank Indonesia improved the Intra-day
high, dominated by ATM/Debit cards (89%), with credit Liquidity Facility (FLI) and short-term funding facility (FPJP),
card usage at just 11%. Based on transaction value, ATM/ as well as issued new regulations for an emergency funding
Debit cards were also most prevalent with a 95% share, facility (FPD).
compared to credit cards with just 5%. Meanwhile, to mitigate settlement risk in the
E-money transactions in semester II 2008 experienced implementation of the SKN-BI, Bank Indonesia introduced
significant growth compared to semester I 2008. Based prefunds as a failure-to-settle (FtS) mechanism as regulated
on value, e-money grew by Rp0.05 trillion (398.44%). by Bank Indonesia Regulation No. 7/18/2005 regarding
Moreover, based on volume, semester II witnessed an the Bank Indonesia-National Clearing System. Prefunds are
additional 1.15 million transactions (163.75%). Such mandatory for all participating banks in the national
increase was due to the emergence of new e-money clearing system in order to provide initial funds in the form
issuers, At the end of 2008 there were a total of eight e- of cash (cash prefund) as well as securities (collateral
money issuers. prefund) in demand deposit accounts and collateral held

Figure 3.3
Performance of Card Based Payment Instruments

5% 11%

95% 89%
Based Card (ATM and ATM + Debit) Credit Card Based Card (ATM and ATM + Debit) Credit Card

54
Chapter 3 Financial Infrastructure and Risk Mitigation

at Bank Indonesia to complete debit clearing activity. With tighten security and mitigate the potential misuse of
mandatory prefunds, the risk of a liquidity shortfall for payment cards and/or credit card fraud, including Electronic
debit clearing settlement can be minimized. Failure to meet Data Capture hardware, Bank Indonesia instituted a policy
the prefund within a specified time can lead to the that stipulates the mandatory use of chip technology on
participating bank being excluded from debit clearing on credit cards no later than 31 December 2009.
that day. Meanwhile, as a follow-up to a progress and security
To mitigate default risks of an interbank debit assessment results of chip implementation for credit cards
payment transaction clearing settlement, in 2008 Bank held in semester I of 2008, it can be reported that 46
Indonesia issued a policy imposing the «no money no game» findings or 58% of all 80 findings have been settled by
principle for debit clearing. Through such implementation the end of semester II 2008. Further on, issuers and
of interbank debit payment transaction clearing settlement, acquirers have been required to submit progress reports
the default risk in debit clearing settlement is mitigated regarding the implementation of the chip and follow-ups
and thus protecting Bank Indonesia as a clearing operator of the security assessments on a quarterly basis.
from default risks of banks participating in the debit To mitigate potential risk in the Indonesian interbank
clearing process. The implementation of the «no money payment system, a Payment-Versus-Payment (PVP)
no game» policy through the use of the pre-fund instrument Settlement mechanism will be developed for the BI-RTGS
entails that all debit payment transactions will be cancelled system. This is aimed at mitigating payment failure risk in
by the clearing operator should the amount of pre-fund settling inter-bank foreign exchange trades (FX settlement
to cover obligations to complete debit clearing is found risk) in Indonesia. Using PVP settlement, the payment of
insufficient. domestic and foreign currency through interbank foreign
In relation with efforts to mitigate risk in terms of exchange trade in Indonesia will be performed
money remittance, Bank Indonesia promulgated Bank simultaneously. Therefore, the final transfer of one currency
Indonesia Circular No. 10/49/DASP on 24 December 2008 occurs if, and only if, a final transfer of the other currency
regarding Money Remittance Permits, which superseded or currencies takes place.
the previous regulation (BI Circular No. 3/32/DASP dated The PVP settlement mechanism to be developed for
20 December 2006 regarding Money Remittance the BI-RTGS system is specifically designed for US Dollar
Registration). With the new circular, the transition period trading against the Rupiah (USD/IDR). This is because USD/
of two years provided to money remitters to register their IDR trading represents the largest share of interbank foreign
remittance business has expired and all remitters are exchange trade in Indonesia. The PVP mechanism, known
required to obtain a permit from Bank Indonesia. With as USD/IDR PVP, will be developed by building a USD/IDR
this new regulation it is expected that money remittance PVP link that connects the BI-RTGS system (for Indonesian
implementation can be better monitored and adhere to rupiah payment settlement) with the USD-CHATS1 System
standards in accordance with international best practices. in Hong Kong (for US dollars payment settlement). To this
Bank Indonesia also strives to improve card-based end, Bank Indonesia and the Hong Kong Monetary
payment instrument regulations and supervision in order Authority signed a Memorandum of Understanding on
to ensure that card issuers can manage potential risks. To 24 October 2008.

55
Chapter 3 Financial Infrastructure and Risk Mitigation

3.1.2. Business Continuity Plan (BCP) for the BI- 3.1.3. Effort to Fulfill CP-SIPS
RTGS System Bank Indonesia endeavors to meet international
Payment system failure could disrupt financial system standards in hosting its systemic payment system such as
stability. Therefore, it is imperative that the payment system the core principles of a systemically important payment
performs well, is reliable and risk is properly mitigated. system (CP-SIPS) issued by the Bank for International
This requires competent human resources and reliable Settlements (BIS) regarding the implementation of the BI-
infrastructure (applications, hardware and the network) RTGS system. Measures taken include the improvement
particularly in facing emergencies, for both, the of good corporate governance through the reorganization
administrator and participants. of a BI-RTGS work unit and the formation of a BI-RTGS
To maintain the continuity of the BI-RTGS system on working group comprising of several participants which
the administrator»s side, Bank Indonesia regularly tests the serves as communication forum between Bank Indonesia
backup system by simulating multiple scenarios. To ensure as an operator and banks as participants.
the continuity of the backup system on the participants» At the end of 2008, Bank Indonesia issued internal
side, Bank Indonesia provides a facility to test their regulation No 10/86/Intern dated 23 December 2008
connection. Also, Bank Indonesia also provides an regarding the Reorganization of the Accounting and
alternative transaction settlement mechanism that can be Payment System Directorate (DASP) as one of the measures
used in an emergency in the form of a Guest Bank facility to ensure an effective, responsible and transparent
(the use of hardware and software in Bank Indonesia) and payment system. DASP reorganization included the
the use of Bank Indonesia Cheques and Giro Biljet. introduction of good governance principles for the SIPS
To maintain the reliability of BI-RTGS system administrator through the separation of the reporting line
infrastructure in an emergency situation, Bank Indonesia for the work unit that handles payment system oversight
will continue to hold tests and analyses in order to minimize and the work unit responsible for the operational BI-RTGS
the recovery time objective (RTO). RTO is a time target set system.
for operation activity recovery to ensure the continuity of In addition, Bank Indonesia collaborated with several
operational activity should a disaster strike. RTO setting is participants of the BI-RTGS system to form a working group
both an iterative and negotiation process performed by in order to improve transparency between the
taking into account the cost and risk to bear. Considering administrator and the participants by involving the
that BI-RTGS is a large-value transaction settlement system participants in BI-RTGS system development. This approach
and part of the systemically important payment system is expected to improve the efficiency and reliability of the
(SIPS), RTO should be as low as possible. In this regard, existing system.
efforts to improve recovery time are ongoing through
technical analysis and the implementation of periodic 3.2. CREDIT BUREAU
disaster recovery plan (DRP) tests. The Credit Bureau (CB), established in June 2006,
represents one of Bank Indonesia»s efforts to further
bolster»the Indonesian banking system infrastructure and
4 CHATS is the Clearing House Automated Transfer System, one of the RTGS systems in
Hong Kong. the financial system. This is a realization of the Indonesian

56
Chapter 3 Financial Infrastructure and Risk Mitigation

Figure 3.5
Role of Credit Information Bureau

ECONOMY
GROWTH
REAL SECTOR GROWTH
FINANCIAL CREDIT INFORMATION BUREAU
SOCIETY
SECTOR TO SMOOTHEN
INTERMEDIATION
BANK

BANK

INSTITUTION
NON

INDIVIDUAL
FUNCTION
TO MINIMIZE
INFOR- GAPS BETWEEN INFORMATION INFOR-
NON FINANCIAL MATION AND RISK MATION
SECTOR TO SHORTEN
THE DECISION
PUBLIC UTILITY MAKING PROCESS
COMPANY
TO REDUCE
COSTS

POOL AND PROVISION FUNDS


TRANSPARENCY MARKET DISCIPLINE
GOVERNMENT / REGULATOR

Banking Architecture (API), in particular Pillar V, namely total assets of 10 billion rupiah for less than six consecutive
infrastructure improvement to establish sound, strong and months, non-bank financial institutions and savings/loans
efficient banks. cooperatives.
The primary role of CB is to collate, store and Statistically, CB implementation has yielded
distribute credit data as debtor information in support of satisfactory results. Two years since its establishment,
financial intermediation. CIB is expected to minimize significant improvements have occurred regarding the
asymmetric information between fund providers and number of reporters, debtors, credit facilities and access
beneficiaries. to debtor information. However, it is important to note
To support task achievement, CB operates and that SID reporting from non-bank financial institutions,
manages a Debtor Information System (SID). This system especially finance companies (PP) remains negligible. This
has undergone continuous improvements and has been is partly because participation is voluntary, but also because
web-based since 2005. Consequently, data reporting can of the wide gap between the data structure used by non-
be submitted online and debtor information can be bank financial institutions and the data structure required
requested online in real time. Credit data to be used as by SID.
SID input is collated from all fund providers, including Based on the utilization of SID output, requests for
commercial banks, rural banks (BPR) and non-bank debtor information in 2008 experienced a 55% rise
financial institutions (LKBB) including non-bank credit card compared to that of 2007. The largest share of debtor
issuers (PKKSB). information was utilized by commercial banks.
Currently there are two types of SID participation: Conversely, use of SID output by rural banks remains very
obligatory and voluntary. Reporting is obligatory for low.
commercial banks, rural banks with total assets of over 10 To further develop CB as well as overcome existing
billion rupiah for six consecutive months, and non-bank constraints, Bank Indonesia introduced several strategic
credit card issuers. Voluntary reporting incorporates rural policies, including aspects of data quality improvement,
banks with total assets of less than 10 billion rupiah or system and application improvement, expanding the

57
Chapter 3 Financial Infrastructure and Risk Mitigation

Table 3.1
Debtor Identification Number (DIN) Data, 2006-2008

December December December


2006 2007 2008
Number of Reporters (Institution) 486 751 777
Commercial Banks 130 130 127
Rural Banks 355 618 646
Finance Companies 1 3 4
Number of Reporters (Branch Offices) 3,374 3,788 4,054
Commercial Banks 2,548 2,788 2,790
Rural Banks 825 2,633 1,260
Finance Companies 1 3 4
Number of Debtors (Based on DIN) 20,359,850 28,187,986 35,900,857
Commercial Banks 19,535,979 26,312,078 33,070,536
Rural Banks 822,849 1,780,534 2,521,748
Finance Companies 1,022 95,374 308,573
Number of Credit Facilities*) 21,689,062 29,479,139 57,782,495
Commercial Banks 20,863,200 27,640,264 53,573,464
Rural Banks 824,839 1,697,186 3,813,657
Finance Companies 1,023 141,689 395,374
Number of Debtor Information Demand**) 782,626 1,178,957 2,050,957
Commercial Banks 751,769 1,147,096 1,833,158
Rural Banks 30,857 30,192 206,255
Finance Companies 0 1,669 10,915
Notes:
*) For December 2006 period, the number of credit facility is only for active accounts. Meanwhile for December 2007 and 2008 periods, the number of
credit facility includes active and passive accounts.
**) The number of demands in that months.

coverage of reporters and users, improving regulations, removal of redundant data, providing feedback on errors
developing the products and services, and educating the in reporting, and verification of reporters to boost their
public. awareness of prevailing regulations and the importance
of accurate reporting. Training has also been provided to
Figure 3.6
Credit Bureau Strategic Policy reporting clerks to improve their knowledge as well as
enhance the quality of the reports. In addition, the service
provided by the SID help-desk has also been improved.
RULES &
REGULATION
REPORTERS &
SYSTEM & USERS
APPLICATION
CREDIT BUREAU 3.2.2. Refining the System and Application
Improving the SID»s system and its application is a

DATA PRODUCTS & SOCIETY continuous process, which begins with an evaluation of
QUALITY SERVICES EDUCATION
the existing system and application performed by Bank
Indonesia internally with reporter involvement. Not only
are DIS applications evaluated so are other related
3.2.1. Improving Data Quality applications. The results of such evaluations are
To improve the quality of data and information subsequently used as a basis for improvements as well as
produced by SID, Bank Indonesia implemented a policy of inputs when in formulating the future CB improvement
periodic attendance to ensure report punctuality, the plan review.

58
Chapter 3 Financial Infrastructure and Risk Mitigation

The CB improvement plan review includes a SID constraints, were identified. Therefore, the harmonization
improvement plan for the short, medium and long term. of related regulations is necessary, which can be achieved
Initially, SID improvement will focus on improving data through the provision of relevant data by public utility
accuracy and system performance. In the subsequent companies to SID. Meanwhile, to increase the amount
phase, the submission of debtor reports will be changed of debtor information utilized by rural banks, SID
to become more effective and efficient. Implementation socialization and training has been provided to the
of this review will begin in 2009 and continue for the relevant staff members.
ensuing two years.
3.2.4. Regulation Improvements
3.2.3. Expanding Reporter and User Coverage To ensure the smooth operation of CIB, in 2007-2008
The reliability of debtor information produced by CB Bank Indonesia Regulations pertaining to SID were
is partially determined by the breadth of its data sources. improved and a Bank Indonesia Circular was issued. The
The small number of non-bank financial institutions that SID regulations legislate the parties that qualify as reporters;
currently report to SID demonstrates a clear potential for the reporters» obligations; coverage and procedures for
data yet to be utilized. To this end, Bank Indonesia, in debtor report submissions; parties eligible to request debtor
collaboration with the Indonesian Capital Market and information and its usage limitations; Bank Indonesia
Financial Institution Supervisory Agency (Bapepam LK), is supervision of reporters; and penalties for infringements.
encouraging non-bank financial institution participation With this regulation, the rights and obligations of reporters
in SID through a Memorandum of Understanding signed and debtors are much clearer.
in September 2007. As a follow up, a socialization activity The introduction of such policy has accommodated
plan for Bapepam LK staff has been compiled and periodic the requirements of the credit industry through the
workshops organized for the Finance Company Association involvement of SID reporter representatives, comprising
of Indonesia (APPI) and non-bank financial institution SID of government banks, foreign banks, rural banks and non-
reporting candidates. Furthermore, a standard operating bank financial institutions, all under the SID Working
procedure (SOP) has been issued for the joint procedure Group. The active contribution of the SID Working Group
of non-bank financial institutions to commence SID has enriched the relevant regulations and proved invaluable
reporting in 2009. as an input to the CB application and development
Adhering to international standards for credit improvement plan.
bureaus, SID data sources are to be expanded in order to
cover the customer data of public utility companies, such 3.2.5. Products and Services
as Telkom, PLN and PDAM. This is legislated through the The improvement of CB»s products and services is
Financial Sector Policy Package (PKSK) 2008, with the aimed at meeting the international standards of credit
goal of ≈incorporating public utility company data in SID∆. bureaus. CB currently offers debtor information, known
To this end, a review was conducted on database as BI Checking, to the banking community. Debtor
integration of public utility companies. Based on the information covers positive information (i.e., information
review, a number of constraints, including legal of loans not experiencing failure in repayments) and

59
Chapter 3 Financial Infrastructure and Risk Mitigation

negative information (i.e., information of loans failing to the importance of maintaining a good credit history. By
be repaid) for all fund provisions of more than Rp1, and understanding that one»s credit history is kept at CB and
also includes information on debtor credit history in the can be accessed by all fund providers that report to SID, it
last 24 months. Consequently, debtor information can is expected that debtor awareness to maintain a good
illustrate the credit exposure, performance and quality of credit history will improve.
credit of the related debtor. A number of measures have been taken to raise
Other products developed include the provision of public awareness of CB»s presence, such as through
consumer reports or debtor information that are also seminars and public education advertisements in the
available to the debtor from Bank Indonesia»s Information national mass media. The result has been a rise in the
Booth or a SID reporting financial institution. The provision number of consumer reports submitted to Bank Indonesia»s
of such consumer reports is one form of reporter Information Booth by the public. This is a positive sign for
transparency to the debtor, as well as a crosscheck platform future CB development. Frequent public access to SID
for the debtor on the report submitted. The consumer outputs will increase the pressure on CB to improve debtor
report provision service is currently being expanded to Bank data and information quality.
Indonesia branch offices and credit information counters
set up at special events such as the MSME Bazaar and 3.3. FINANCIAL SYSTEM SAFETY NET
Sharia Economic Festival. Another aspect of financial infrastructure deemed
For credit bureaus adhering to international crucial to financial system stability in a country is a Financial
standards, the products offered are not merely a basic System Safety Net (JPSK). Conceptually, a JPSK is extremely
report but also include value-added services, which are beneficial in mitigating systemic risk. In a JPSK, crisis
the result of data development and the technology used. management protocol is regulated as part of a coordination
Value-added services include credit scoring, fraud alert/ mechanism among the relevant institutions when the
detection, credit risk management, consultation, etc. Based financial sector experiences pressures. In greater detail,
on the data source, the data collated by international credit the benefits of a JPSK are as follows:
bureaus covers data from public utility companies, JPSK provides a strong legal foundation for the
cooperatives and court verdicts. As part of the efforts to prevention and resolution of a crisis;
bring CB in line with international standards, the provision JPSK allows greater transparency and accountability
of value-added services, in particular credit scoring and in the decision-making process in order to prevent
expanding the data source to include public utility and manage a crisis;
companies, is the immediate target of CB product JPSK is a coordination mechanism between the
expansion. relevant institutions when confronting disruptions that
could potentially threaten national financial system
3.2.5. Public Education stability, without impinging upon the independence
Establishing a healthy and efficient credit system not of each individual authority;
only depends on the awareness of fund providers when JPSK helps identify and resolve problems at financial
submitting reports, it also requires public awareness on institutions with systemic impact; and

60
Chapter 3 Financial Infrastructure and Risk Mitigation

JPSK ensures a clear source of funds to prevent and in the financial sector and coordinate with all relevant
resolve crises by adhering to the rules and budget authorities in its implementation.
constraints of the People»s Representative Council PERPPU No. 4 2008 did not garner the approval of
(DPR). DPR. Consequently, the bill was redrafted and resubmitted
During Semester-II 2008 Indonesia experienced to DPR for approval. Currently, the draft JPSK bill has been
protracted periods of intense pressure on the financial sector, compiled and awaits DPR approval.
marked by rupiah and foreign exchange liquidity shortfalls The scope of the draft JPSK bill includes crisis
coupled with significant rupiah depreciation. In response, prevention and crisis management, which in itself comprises
the Government issued several regulations in lieu of a law of measures to overcome liquidity shortfalls as well as issues
(PERPPU) in October 2008, one of which was in relation to with bank and non-bank financial institution solvency with
the JPSK (PERPPU No. 4 2008 dated 15 October 2008). systemic effect. Crisis prevention includes overcoming the
Based on PERPPU No. 4 2008, the JPSK is a financial problems of: (i) liquidity problems at banks with systemic
system security mechanism to protect against a crisis threat effect; (ii) insolvent banks or failure to repay an Emergency
that includes crisis prevention and resolution. Prevention Funding Facility (FPD) with systemic effect; and (iii) insolvent
and resolution includes: (i) the resolution of liquidity non-bank financial institutions with liquidity problems and
shortfalls and/or solvency of banks with systemic effects; systemic effect. Meanwhile, crisis resolution includes
and (ii) liquidity management and/or solvency of non-bank overcoming: (i) insolvent banks with liquidity problems,
financial institution solvency with systemic effect. To which individually have a systemic effect, (ii) banks that
achieve the goal of JPSK, the Financial System Stability individually do not have a systemic effect under normal
Committee (KSSK) was established whose members circumstances but do have a systemic effect under crisis
include the Minister of Finance (as its Chairman) and the conditions; and (iii) several non-bank financial institutions
Governor of Bank Indonesia. KSSK is authorized to set that suffer liquidity problems and/or solvency issues with
policy and roll out measures to prevent and resolve a crisis systemic effect. The proposed framework is as follows:

Table 3.2
Financial Safety Net Framework

Objectives/ Decision Tools/ Source of


Decision
Coverage Making Process Mechanism Funds
Crisis Prevention
1. Bank Liquidity KSSK is responsible for: 1. Liquidity bail out Emergency Funding Government finances
a. Evaluating the problem Facility from BI which is crisis prevention and
b. Identifying the problem guaranteed by government resolution from
2. Bank Solvability c. Deciding on problem 2.a. Temporary Placement 2.a. Temporary placement government income
solving steps for Systemic Banks by LPS and expenditure
2. b. Problem solving for 2.b. Bank closure and budget through
Non-systemic banks insurance payment by government
LPS securities issuance or
3. Bank Liquidity and/ 3. Providing lending 3. Providing lending facility cash
or Solvability facility or Placements or equity placement by BI is permitted to
for Non Bank Financial government buy government
Institution securities in the
primary market

61
Chapter 3 Financial Infrastructure and Risk Mitigation

Table 3.2
Financial Safety Net Framework (cont.)

Objectives/ Decision Tools/ Source of


Decision
Coverage Making Process Mechanism Funds
Crisis Resolution
The use of
1. Bank Liquidity and/ KSSK is responsible for: 1.a. Liquidity bail out 1.a. Emergency Funding government income
or Solvability a. Evaluating the problem 1.b. Temporary placement Facility from BI and expenditure
b. Identifying the problem 1.b. Temporary placement budget have to be
c. Deciding on problem by LPS or government approved by
solving steps or certain institutions parliament
2. Non Bank Liquidity 2. Liquidity bail out/ 2. Lending facility/
temporary placement Temporary placement by
LPS or government or
certain institutions

62
Chapter 3 Financial Infrastructure and Risk Mitigation

The Financial System Stability and PERPPU on the


Box 3.1
Amendments to the Law on Bank Indonesia

One of the principal policies undertaken by the not only include securities and/or bonds issued by the
Government in mid 2008 is the issuance of PERPPU Government or other legal entities with high ratings,
(government regulation in lieu of a Law) Article 2 in based on the valuation results of competent rating
2008 concerning the Second Amendment of Law 23 institutions and at any time, can be easily sold to the
1999 on Bank Indonesia. This PERPPU is essential to market in return for cash, but also credit assets with
the stability of the financial system, as it provides a legal high collectability. In other words, objects which can
ground for Bank Indonesia to provide a wider access be used as collateral for banks to obtain FPJP have
of short-term financing facility (FPJP) to banks in need. more varieties and hence, widen the access for banks
The wider access for the banks is based on the to utilize FPJP. In addition to providing wider FPJP access
amendments in Article 11 of the Law on Bank Indonesia. for banks with liquidity issues, this regulation can also
Before the amendments, Article 11 regulates that serve as background for Bank Indonesia to offer its
Bank Indonesia can only provide credit or financing emergency funding facility (FPD) to banks with financial
using the sharia principle for a period of not more than difficulties that might potentially create systemic
90 days to the banks in efforts to solve the banks» impact and later on, a crisis that can jeopardize the
short-term financing issues. The credit or financing financial system.
under sharia principles must be secured with high In the crisis prevention and management, a
quality collateral with a minimum value of the received strong legal ground and a clear operating mechanism
amount of credit or financing. What is referred as high are vital to support the important decision-making
quality and liquid collateral include securities and/or processes to prevent any crisis or to save the economy
bonds issued by the Government or other legal entities from crisis. The changes in the Law of Bank
with high ratings, based on the valuation results of Indonesia, exhibited in the above PERPPU, is an
competent rating institutions and at any time, can be example of the Government»s anticipative
easily sold to the market in return for cash. movements from the legal stand point to ensure the
The changes stipulated by PERPPU assert that stability of the financial system in confronting the
what is referred as high quality and liquid collateral global crisis.

63
Chapter 3 Financial Infrastructure and Risk Mitigation

Best Practices of Systemic Impact Analysis towards


Boks 3.2
the Financial System

Conceptually, the systemic impact towards the up-front. A financial institution can be considered to
financial system occurs only when the problems of a have systemic impact on one occasion, but might not
financial institution, both individually and collectively, on another circumstance. Therefore, the stipulations
due to the size of the financial institution and the on systemic impact requires professional judgment.
potential of contagion effect that might occur, can One of the widely used references on the
cripple the entire financial system. systemic impact analysis is the document of
Based on international best practices, the criteria Memorandum of Understanding on Cooperation
of systemic impact are not determined explicitly ex ante between the Financial Supervisory Authorities, Central
in the law»s stipulations, due to two main reasons. Banks and Finance Ministries of the European Union
Firstly, an ex ante stipulation might create moral hazard. on Cross Border Financial Stability (Annex 2 Template
With explicit criteria, banks and nonbank financial for Systemic Assessment Framework). On one of the
institutions might be encouraged to conduct excessive statements, it recommends the analysis of systemic
risk taking, because they are certain that the impact to be based on the impact of failure or impact
Government will bail them out when troubled. of issues faced by the banks to: (i) the other financial
Secondly, the systemic impact stipulations tend institutions overall, (ii) the financial market, (iii) the
to be situational. The triggers to systemic crisis are payment system and (iv) the psychology of the market.
varied depending on situations, can be both internally In addition, the analysis should also cover the
or externally, for instance, the global financial crisis, estimation of interference within the real sector by
terrorist»s attacks and natural disasters. For those examining the role or contributions of the related bank
reasons, it is difficult to decide on systemic impacts towards the particular sector.

64
Chapter 4 Prospects of the Financial System in Indonesia

Chapter 4
Prospects of the Financial
System in Indonesia

65
Chapter 4 Prospects of the Financial System in Indonesia

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66
Chapter 4 Prospects of the Financial System in Indonesia

Chapter 4 Prospects of the Financial System in Indonesia

In general, the prospects of the Indonesian financial system are predicted to


remain positive, despite pressures from instability in the global and domestic
economies. The banking sector»s positive prospect is supported by, among
others, its relatively high capital levels. Additionally, coordination between
authorities of the banking industry, capital market and non-bank financial
institutions will continue to be enhanced. Such coordination is a vital element
of the Financial System Safety Net (JPSK) and will bolster financial sector
resilience.

4.1. ECONOMIC PROSPECTS AND RISK Table 4.1


Projection of Several Economic Indicators
PERCEPTION
The Indonesian economic growth is expected to slow 2008 2009*

down to approximately 4-5% in 2009 as the global Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

economic downturn continuous. Slower economic growth GDP (% yoy) 6.3 6.4 6.4 5.2 4.5 4.3 4.4 4.7

Inflation (% yoy) 7.6 11.0 12.0 11.1 10.2 8.0 5.8 5.8
will reduce demand-side pressures thus making inflation
Balance of Trade (Billions of USD) 7.5 5.3 5.8 8* 6.7 7.1 6.8 7.7
easier to control. Furthermore, several other contributing
* Asia Pacific Concensus Forecast
factors will ease inflationary pressures, including: lower
commodity prices on the global market, which will bring The impact of the global financial crisis on the
down the prices of domestic commodities; a falling oil domestic financial sector has increased risk perception
price at the beginning of 2009; and a domestically concerning Indonesia. This is clearly reflected by the
produced rice surplus, which will persist in 2009. increasing yield spread. Greater perception of risk will
Consequently, in quarter II 2009 inflation is projected to impede the flow of investment into the country. Moreover,
drop to single digits, namely from 11.1% at the end of overseas investors are also confronted by liquidity
2008 to 8%. However, the global economic slowdown difficulties as an impact of the ongoing global turmoil.
and sliding commodity prices on the global market have Notwithstanding the higher perception of risk will
the potential to trigger a decrease in export value, which encourage banks to become more selective when
will undermine the trade account in 2009. extending credit. Sluggish credit growth since November

67
Chapter 4 Prospects of the Financial System in Indonesia

2008 and lackluster economic growth in 2009 could trigger stress tests, a CAR of 16% is sufficient to absorb various
a credit crunch. risks including market risk (interest rate risk, exchange rate
In addition, low investment in the country will risk and a decline in SUN prices), liquidity risk, credit risk,
pressurize economic growth and subsequently disrupt the as well as risks from losses caused by structured products.
real sector, both the corporate and household sectors Market risk was deemed moderate despite
which could intensify bank credit risks. Also, low experiencing a significant rise in semester II 2008 primarily
investment into the country could also aggravate the due to declining SUN prices and persistent rupiah
exchange rate. As a result, banks with a short position on depreciation, as well as the climbing interest rate trend.
foreign currencies will suffer losses due to exchange rate Approaching yearend 2008, however, the risk attributable
risk. These inauspicious circumstances need to be to falling SUN prices eased as a result of a new Bank
anticipated in order to maintain a sound banking and Indonesia Circular which allowed banks to postpone their
financial system. marking-to-market obligations.
Exchange rate risk remained relatively steady as
Table 4.2
demonstrated by the relatively low Net Open Position (NOP)
Risk Perception of Indonesia
held by banks (6.2%) and most banks held a long position
Yield Spread (bp)
Bonds Rating Y-t-m (%) September Desember
on foreign currencies. Furthermore, interest rate risk
2008 2008 declined in accordance with the periodic reductions in the
Indo 49 Ba3 (Moody's) 11.70 997.47 1015.41
BI Rate from December 2008 to a level of 8.25% in
Indo 48 Ba3 (Moody's) 11.86 932.46 965.17
February 2009.
Indo 45 Ba3 (Moody's) 11.95 918.30 925.92
Source: Bloomberg However, in the coming years banks will remain to
be highly exposed to market risk given that the global
4.2. BANK RISK PROFILE: LEVEL AND DIRECTION financial crisis remains a long way from being fully resolved.
The key challenges threatening financial system In addition, in line with rupiah depreciation, several banks
stability in semester I 2008 continued and grew in semester were found to face losses as a result of structured products.
II 2008. As elaborated in previous chapters, global financial As evident from stress test results, the potential losses can
volatility and the global economic slowdown, which have be absorbed by bank capital. However, banks will need to
compounded conditions in the domestic financial market be more cautious of similar products and derivative
and economy as a whole, placed additional pressures on transactions in general, including offshore products.
the Indonesian financial sector. This was indicated by a Liquidity risk tended to increase at the beginning of
decline in the Jakarta Composite Index (IHSG) as well as semester II 2008, especially in August, in line with the
falling government bond (SUN) prices. However, taken decline in excess liquidity due to slow growth in deposits
holistically the financial sector remains sound. and expansive credit extension. At that time, affected by
Meanwhile the banking industry, which dominates the global financial crisis, the condition of the interbank
the domestic financial sector, maintained a relatively good money market (PUAB) was tight and market segmentation
position as reflected by a satisfactorily high Capital appeared, which limited bank access (particularly medium
Adequacy Ratio (CAR) of 16.2%. Based on the results of and small banks) to PUAB. However, by loosening the

68
Chapter 4 Prospects of the Financial System in Indonesia

Figure 4.1
Bank Risk Profile and Outlook

Market Risk Liquidity Risk Credit Risk

Sem II-2008 Sem II-2008 Sem II-2008


High

Outlook Outlook Outlook


Inherent Risk

Moderate

Government
Exchange Bond Price
Rate
Interest
Rate
Low

Weak Acceptable Strong Weak Acceptable Strong Weak Acceptable Strong

Risk Control System (RCS)

minimum reserve requirement (GWM) and raising the limit operational risk, particularly those related with the capacity
of deposits guaranteed by the Deposit Insurance and integrity of human resources to minimize human error
Corporation (LPS), bank liquidity continued to improve. and fraud, including supporting infrastructure such as
Moreover, since November 2008, with burgeoning deposits adequate information technology and good governance.
and a contraction in credit extension, bank placements in Meanwhile, pressures permeating from the global crisis
liquid assets such as Bank Indonesia Certificates (SBI) also need to be considered, in particular their impact on
experienced a significant rise. Despite relatively stable the capability of banks to evaluate their operational risk.
liquidity risk, caution is still required regarding pressures To improve the preparedness of the banking industry during
from global liquidity, which remains sub-optimal, and PUAB this global crisis the implementation of Basel II, which is
segmentation. marked by mandatory capital charges for operational risk,
Bank exposure to credit risk is at a moderate level has been postponed from 2009 until 2010. The
and is relatively stable due to a declining NPL ratio. postponement of Basel II implementation is expected to
However, increasing credit risk due to deteriorating boost the awareness of banks with reference to aspects
economic conditions needs to be anticipated. As of operational risk, including strengthening internal control.
mentioned in Chapter I, potential credit risk is also
evidenced by estimation results for the Probability of 4.3. PROSPECT OF THE INDONESIAN FINANCIAL
Default (PD), using financial data from non-financial public SYSTEM
listed corporations on the Indonesian Stock Exchange. In The prospect of the Indonesian financial system is
addition, an increase in credit risk can also emanate from expected to remain positive amid the ongoing global and
debtors suffering from losses caused by rupiah exchange domestic economic slowdown. Such expectations are
depreciation, which will eventually affect their repayment based on a number of contributing factors. First, the recent
capacity. financial turmoil was principally triggered by external
Operational risk is also significant. In general, there factors; therefore, domestic banks are not beset with the
remain various challenges confronting banks in terms of same significant difficulties as banks overseas. This situation

69
Chapter 4 Prospects of the Financial System in Indonesia

is very dissimilar to the 1997/98 Asian Crisis that was quality of supervision, an expert panel will discuss
dominated by a multitude of weaknesses in domestic banks surveillance and investigation results.
such as high NPL, as well as countless Legal Lending Limit Financial stability is also bolstered by greater trust in
and Net Open Position violations. Consequently, the impact LPS by the wider community. LPS»s presence is becoming
of the ongoing global crisis on the domestic financial sector more visible through the closure of several rural banks and
is expected to be limited. the takeover of one commercial bank deemed as systemic
Second, banks are far more prepared to confront the in November 2008. In fact, the closure and takeover of
crisis when compared to conditions in 1997/98. Superior these banks did not trigger any volatility in the banking
bank preparedness is the result of improved risk sector. Efforts to strengthen financial infrastructure will
management and the implementation of good governance. be redoubled if the People»s Representative Council
Compared to a decade ago, the criteria to become a approves the draft regulations pertaining to the Financial
member of bank top management or shareholder are more Sector Safety Net (JPSK).
stringent through the use of Fit and Proper Tests. It is Overall, the positive outlook for financial stability is
envisaged that enhanced good governance will enable reflected by the Financial Stability Index (FSI), which after
banks to be more resilient to financial volatility. experiencing a sharp increase during semester II 2008,
Third, the bank supervisory authority is also more began to decline in the past few months. As described in
prepared to overcome a crisis when compared to 1997/ Chapter 2, at the end of June 2009, FSI is predicted to be
98. At that time, bank supervision was compliance-based within the range of 1.77-2.13, or using moderate scenario
oriented, as opposed to risk-based. At present, bank at 1.95. This is comparatively lower than the position at
supervisors are required to graduate from a certification the end of December 2008, namely 2.10. A lower FSI is
program and are given broader opportunities to participate predicted to garner optimism that the financial sector in
in capacity building training. In the future, to improve the future can be well maintained.

70
Artikel I - Impact of Contagion Risk on the Indonesian Capital Market

A r t i cle

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Artikel I - Impact of Contagion Risk on the Indonesian Capital Market

Article I

Impact of Contagion Risk on the Indonesian Capital Market

Wimboh Santoso1, Bagus Santoso2, Ita Rulina3, Elis Deriantino4

This article aims to assess the presence of contagion risk in the Indonesian capital market. The approaches
used are the Multivariate GARCHI Dynamic Conditional Correlation (DCC) and Markov Regime Switching. The
data applied is daily composite index data from 15 countries, namely Indonesia, Australia, United States (Dow
Jones and Nasdaq), United Kingdom, Germany, Japan, Korea, Hong Kong, China, Taiwan, India, the Philippines,
Thailand, Singapore and Malaysia; 3-month T-Bill data; RP/USD exchange rate; PUAB interest rate and global oil
price. All data covers the period from 2 January 1995 to 13 November 2008. Using Indonesia as the reference
point, the daily data is divided into four distinct periods. Estimation results showed that contagion exists between
Indonesia and the other sample countries used in this research. Furthermore, the research indicated that Indonesia
is a shock absorber rather than shock transmitter, particularly with regard to developed countries (Japan, Australia,
Germany, United Kingdom and the US).

Keywords: Financial Aspect of Economic Integration, International Financial Market, Time Series Model
JEL classification: F36, G15, C22

BACKGROUND another country. For example, the 1997 crisis that began
Financial globalization, with its inherent trend in Thailand due to baht devaluation followed by the floating
towards financial sector integration to the global financial exchange rate regime policy taken, rapidly spread to
market, has left many countries exposed to contagion risk. Indonesia, Malaysia, Korea and the Philippines, triggering
Consequently, a crisis in one country can spread and affect severe depreciation in these countries by an average of
other countries. Exchange rate devaluation, defaults about 75%. In 1998, bankruptcy of the domestic bonds
against sovereign obligation in one country will impact market in Russia and the fall of LTCM affected Hong Kong,
Brazil, Mexico and other emerging markets. The most

1 Head of the Financial System Stability Bureau, Directorate of Banking Research and
recent example is the 2007 US subprime mortgage debacle
Regulation, Bank Indonesia; email wimboh@bi.go.id
2 Researcher, Gadjah Mada University, email: bagussantoso@ugm.ac.id that has severely disrupted financial markets primarily in
3 Senior Researcher, Financial System Stability Bureau, Directorate of Banking Research
and Regulation, Bank Indonesia, email: rulina@bi.go.id the Euro Zone but which rapidly spread to other countries
4 Junior Researcher, Financial System Stability Bureau, Directorate of Banking Research
and Regulation, Bank Indonesia, email: elis_derianto@bi.go.id of the world.

73
Article I - Impact of Contagion Risk on the Indonesian Capital Market

The current growth in hot money flow is a blemish Philippines, India, Hong Kong, Taiwan, Korea, Japan,
on conditions in Indonesia. Deteriorating conditions and China, UK, Germany, Australia, Dow Jones and
the ongoing recession in the US has forced The Fed to Nasdaq).
slash its Fed Fund rate, consequently broadening the Tbil3m is the US Treasury bill √ 3 month. Multivariate
interest rate spread between Indonesia and US. As a result, conditional variance is written as follows:
Indonesian assets offer a higher return than that of the Ht = D t R t D t
US, thus further encouraging the surge in hot money flow. Dt is the diagonal matrix nxn with an element of time-
Global negative sentiment could trigger a sudden varying standard deviation from the univariate model
reversal so significant it would spark downward pressure with the i th diagonal and Rt nxn time-varying
on Indonesian asset prices. This would lower the return correlation matrix.
on such assets and could initiate panic among domestic In the DCC model, time-varying covariance matrix is
investors, encouraging them to sell following foreign written as follows:
investors. This would compound the decline in asset prices Qt = (1-a-β)Q = aut-1u»t-1 + βQt-1
and have other implications such as weakening the rupiah Qt=(qij,t) time-varying covariance matrix from ut with
exchange rate. Therefore, the detection of contagion is magnitude nxn, Q = E[ut ut»], matrix unconditional
critical, including identifying the source of such contagion. variance ut with magnitude nxn, and a, β non-
The purpose of this research is to find out whether negative scale. The correlation matrix can then be
contagion risk is present in the Indonesian capital market written as follows:
as illustrated by the following analytical framework: Rt = (diag(Qt ))1/2 Qt (diag(Qt ))1/2
Where: (diag(Qt ))1/2 = diag(1/ q1,t,...1/ qn,t).
RESEARCH METHODOLOGY The DCC model is then estimated using the log
This research employs several methodologies to test likelihood function as follows:
the presence of contagion in the Indonesian capital market: lt (Σ,f ) = - 1 Σ» (nlog(2p) + log l Dt l2 + e»tDt2et) +
2 t-1
1. Multivariate GARCH/Dynamic Conditional
- 1 Σ» (log l Rt l + u»tRt ut - u»tut)
-1

Correlations (DCC) 2 t-1

The Multivariate GARCH model proposed by Engle 2. Markov Regime Switching


(2002) can be used to estimate dynamic conditional The GARCH Multivariate method has its weaknesses,
correlation (DCC). This research uses GARCH (1.1) however, in detecting contagion. Bekaert et al. (2005)
multivariate model using an equation of mean propose one weakness, claiming that the GARCH
constant AR(1) and tbill3m as the world common model fails to take into account asymmetric volatility,
factor: which could affect correlations estimated during a
rt = a0 + ai rt-1 + a2 tbill3m + et crisis period. Therefore, the regime-switching method
Where: is used to detect contagion.
rt = (r1,t, r2,t,..., rn,t), ai = (a1,i, a2,i,..., an,i), et = (e1,t, e2,t,..., Markov-switching is a method to measure the change
en,t), dan et l Σt-1 ~ N(0, Ht) in stochastic time series data by modelling data using
rt is the composite index return of each country with several equations. The strength of the switching
n=16 (Indonesia, Singapore, Thailand, Malaysia, regime method compared to the GARCH model in

74
Artikel I - Impact of Contagion Risk on the Indonesian Capital Market

estimating is its ability to estimate data with extreme RP/USD exchange rate; PUAB interest rate and global oil
values, which is the indication of an extreme event. price.
This method is able to give a crisis period, which is Daily data is from 2 January 1995 to 13 November
endogenously defined in the equation system. 2008. Using Indonesia as the reference point, the daily
Therefore, the switching regime model is able to data is divided into four distinct periods. The periods are
overcome the initial problem of contagion testing, as follows:
namely that it requires a crisis and tranquil period to 1. First period, known as Pre-Crisis
Pre-Crisis. This period is from
be defined before testing can begin. 2 January 1995 to 15 July 1997.
For example, if the return on shares in the market 2. Second period, known as Crisis II. This period is from
has two states, namely a tranquil state (St=1) and a 16 July 1997 to 29 December 2000.
volatile state (St=2), to illustrate the transition from 3. Third period, known as Post Crisis
Crisis. This period is from
(St=1) to (St=2), the Markov chain principle is used: 1 January 2001 to 14 August 2007.
Pr (St = j l St-1 = i, St-2 = k,..., yt-1, yt-2,...) = Pr (St = j l 4. Fourth period, known as Crisis IIII. This period is from
St-1 = i ) = pij 15 August 2007 to 13 November 2008.
With first order Markov-switching, the transition One of the constraints found in this study is the
probability can be written as follows: determination of the break between daily and monthly
data. In determining the break, Indonesia is the reference
P11 P12
P= point or the relationship hub among the observed countries
P21 P22
in this study, except in determining the break for the
Where p11+p12=p21+p22=1 and Markov switching estimation. The estimation methods
used to determine the presence of a break in the daily
P11 - Pr [St - 1lSt -1- 1]
data is as follows:
P12 - Pr [St - 2lSt -1- 1]
The Second Period is set as Crisis I (16 July 1996 √
P21 - Pr [St - 1lSt -1- 2]
29 December 2000) based on the crisis in Indonesia. The
P22 - Pr [St - 2lSt -1- 2]
break in this period was chosen because of the high
In case St cannot be directly observed, information is volatility in the return on shares in Indonesia.
required about St stochastic behaviour. A parameter The break in Crisis II (15 August 2007 √ 13 November
estimation is calculated using the maximum likelihood 2008) is based on the global crisis. During that period, the
method. Dow Jones and Nasdaq composite index plummeted.

DATA ESTIMATION RESULTS OF CONTAGION


The data used in this study consists of the daily DETECTION
composite index data (based on five working days) of 15 1. Multivariate GARCH/Dynamic Conditional
countries: Indonesia, Australia, United States (Dow Jones Correlations (DCC)
and Nasdaq), United Kingdom, Germany, Japan, Korea, Figure A1.1 shows the correlation between
Hong Kong, China, Taiwan, India, the Philippines, Indonesia and Southeast Asian countries. It is evident that
Thailand, Singapore and Malaysia; 3-month T-Bill data; the correlation between Indonesia and Thailand is lower

75
Article I - Impact of Contagion Risk on the Indonesian Capital Market

compared to the correlation with other countries in this with Hong Kong, which indicates the presence of
region in mid 1997. However, the correlation contagion between Indonesia and Hong Kong. The Crisis
subsequently escalates significantly, peaking during the II Period shows a significant rise in correlation between
Asian Crisis in 1998. This shows that during the Asian Indonesia and all countries on the graph, except China,
crisis, there was contagion between Indonesia and with significant correlation between Indonesia and Hong
Thailand. During 2007-2008, there was significantly Kong.
correlated growth between Indonesia and Singapore as Figure A1.3 illustrates the correlation between
well as Indonesia and Malaysia. This indicates that Indonesia and developed countries. It can be seen that
contagion existed between Indonesia and Singapore and Indonesia does not have significant correlation with the
Malaysia during the Crisis II Period. countries on the graph. During the Crisis I Period, Indonesia
experienced negative correlation with the US (both the
Figure A1.1
Dow Jones and Nasdaq indices). However, during the Crisis
Dynamic Conditional Correlation (DCC) of Indonesia
with several countries in Southeast Asia II Period, correlation between Indonesia and Australia

0.8 increased dramatically. This indicates the presence of


Idn-sin Idn-mly
0.7
Idn-thai Idn-phl contagion between Indonesia and Australia.
0.6

0.5

0.4
Figure A1.3
Dynamic Conditional Correlations (DCC) of Indonesia
0.3
with Developed Countries
0.2

0.1 0.7
R_IND_UK R_IND_DOW R_IND_AUS
0 0.6
R_IND_GER R_IND_NASDAQ
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 0.5
0.4
0.3
Figure A1.2 shows the correlation between Indonesia
0.2

and countries in Asia (excluding countries in Southeast 0.1


0
Asia). It is evidenced that Indonesia has relatively low -0.1

correlation with countries on the graph until just before -0.2


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

the Crisis II Period, excluding Hong Kong. Indonesia


experienced increased correlation during the Crisis I Period To see whether the rise in correlation is significant,
the DCC obtained from Model 4 was divided into four
Figure A1.2
periods, namely the Pre Crisis Period, Crisis I, Post Crisis
Dynamic Conditional Correlations (DCC) of Indonesia
with several countries in Asia (excluding Southeast Asia) and Crisis II. From the correlation series obtained, the

0.8 average correlation value was calculated for all four


R_IND_HK R_IND_CHN R_IND_JPN
0.7
R_IND_TWN R_IND_INA R_IND_KOR periods. The results were then tested using the Fisher
0.6
0.5 Test. An increase in correlation on this test indicated
0.4
the presence of contagion between Indonesia and other
0.3
0.2 countries. The null hypothesis in this research represents
0.1
0
the absence of a difference in correlation between low
-0.1 volatility periods and high volatility periods (ii < ih).
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

76
Artikel I - Impact of Contagion Risk on the Indonesian Capital Market

Meanwhile, the alternative hypothesis in this research 2. Markov-Switching Regime Estimation Method
is that the correlation during high volatility periods is In this research, the switching regime method is
higher compared to correlation during low volatility estimated using GARCH (1.1) estimation with the mean
periods (ii < ih). and variance equations written as follows:
Results of the Fisher Test in Table A1.1 indicate the ridn,t = ac,St + a1,St ridn,t-1 + a2,St idn_exe_dlog + a3,St idn_int +
absence of a significant increase in the correlation between a4,St tbill3m + a5,St oil_dlog + a6,St rm,t + eSt,t
Indonesian share returns and the returns in other countries eSt,t ~ N(0, s2St,t)
during Period 2. This implies that during the Asian Crisis, s2St,t = VASt + VBSt e2St,t-1 + VCSt s2St,t-1
there was no contagion between Indonesia and the other
countries sampled in this research. Lengend:
For Period 3, estimation results using DCC show a ridn,t: return on shares in Indonesia
significant increase in correlation between Indonesia and rm,t: return on shares in other countries
Japan and India with a significance level of 5%, and idn_exe_dlog: rate of rupiah depreciation
between Indonesia and Korea and Taiwan with a idn_int: Indonesian interest rate (Inter-bank money market)
significance level of 1%. This suggests the presence of tbill3m: 3-month T-Bill
contagion in Indonesia stems from these countries. For oil_dlog: change in oil price
Period 4, a significant correlation increase occurs in almost e: error
all countries, except between Indonesia and the Philippines, s2: variance
Germany, Dow Jones and Nasdaq. St: regime 1 (non-crisis) and regime 2 (crisis)

Table A1.1
Contagion Detection using Dynamic Conditional Correlation (DCC) √ Daily Composite Share Return

P1 P2 P3 P4 Z-Stat P2 Z-Stat P3 Z-Stat P4

IDN - CHN 0.02885 0.01949 0.06040 0.21785 0.18315 -0.69170 -2.77582 ***
IDN - HK 0.38930 0.36340 0.35565 0.62349 0.59024 0.85513 -4.60957 ***
IDN - JPN 0.20369 0.21825 0.27484 0.44552 -0.29805 -1.65232 ** -3.92898 ***
IDN - KOR 0.14951 0.16979 0.29427 0.47997 -0.40707 -3.33905 *** -5.36774 ***
IDN - TWN 0.13661 0.16031 0.26543 0.44685 -0.47405 -2.94255 *** -4.94937 ***
IDN - PHIL 0.35927 0.32417 0.25437 0.37696 0.77732 2.53743 -0.29511
IDN - SIN 0.42429 0.40541 0.37972 0.54769 0.44598 1.16358 -2.33810 ***
IDN - MLY 0.33618 0.26867 0.27986 0.52233 1.45414 1.36211 -3.31258 ***
IDN - THAI 0.32858 0.33702 0.30109 0.44945 -0.18549 0.66773 -2.05835 **
IDN - AUS 0.28818 0.27669 0.30222 0.55227 0.24430 -0.33648 -4.68655 ***
IDN - UK 0.17723 0.15270 0.16984 0.31572 0.49313 0.16669 -2.13033 **
IDN - GER 0.18563 0.18358 0.15692 0.26901 0.04146 0.64712 -1.26861
IDN - INA 0.17594 0.13356 0.27282 0.47507 0.84920 -2.23446 ** -4.88472 ***
IDN - DOW 0.07272 0.03421 0.05611 0.12253 0.75542 0.36499 -0.72521
IDN - NASDAQ 0.05999 0.00406 0.04681 0.11701 1.09522 0.28916 -0.82877

Notes: P1 : 1st Period Correlation (January 1995 - July 1997)


P2 : 2nd Period Correlation (August 1997 - December 2000)
P3 : 3rd Period Correlation (1 January 2001 - 14 August 2007)
P4 : 4th Period Correlation (15 August - 13 November 2008)
*** : Significant for α = 1%
** : Significant for a = 5%
*: Significant for a = 10%

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Article I - Impact of Contagion Risk on the Indonesian Capital Market

Table A1.2
Markov Switching Mean Equation

a0 a1 a2 a3 a4 a5 a6

IDN - CHN regime 1 0.004 *** 0.010 -0.142 *** -0.014 *** -0.019 0.005 0.011
regime 2 -0.006 *** 0.714 *** -0.696 *** 0.035 *** 0.017 0.054 * 0.152 ***
IDN - HK regime 1 0.003 *** 0.053 ** -0.068 *** -0.009 *** -0.027 ** 0.001 0.174 ***
regime 2 -0.001 0.159 *** -0.518 *** 0.005 0.035 0.055 ** 0.616 ***
IDN - JPN regime 1 0.003 *** 0.002 -0.132 *** -0.010 *** 0.015 0.003 0.137 ***
regime 2 -0.002 0.658 *** -0.622 *** -0.002 0.036 0.046 0.393 ***
IDN - KOR regime 1 0.003 *** -0.004 -0.120 *** 0.014 *** -0.015 -0.001 0.090 ***
regime 2 -0.004 ** 0.484 *** -0.614 *** 0.026 *** 0.016 0.050 * 0.334 ***
IDN - TWN regime 1 0.003 *** 0.006 -0.128 *** -0.014 *** -0.013 0.006 0.059 ***
regime 2 -0.004 ** 0.538 *** -0.640 *** 0.029 *** -0.001 0.046 0.451 ***
IDN - PHIL regime 1 0.004 *** -0.010 -0.116 *** -0.013 *** -0.020 0.003 0.119 ***
regime 2 -0.005 *** 0.442 *** -0.562 *** 0.021 *** 0.033 0.021 0.549 ***
IDN - SIN regime 1 0.003 *** -0.002 -0.040 ** -0.012 *** -0.015 -0.006 0.194 ***
regime 2 -0.001 0.243 *** -0.415 *** 0.008 0.007 0.045 *** 0.686 ***
IDN - MLY regime 1 0.003 *** -0.015 -0.104 *** -0.014 *** -0.018 -0.008 0.112 ***
regime 2 -0.002 * 0.297 *** -0.500 *** 0.015 ** 0.020 0.051 ** 0.672 ***
IDN - THAI regime 1 0.003 *** 0.009 -0.127 *** -0.011 *** -0.019 -0.002 0.085 ***
regime 2 -0.004 ** 0.357 *** -0.474 *** 0.008 0.065 * 0.047 * 0.603 ***
IDN - AUS regime 1 0.003 *** 0.009 -0.127 *** -0.011 *** -0.019 -0.002 0.085 ***
regime 2 -0.004 ** 0.357 *** -0.474 *** 0.008 0.065 * 0.047 * 0.603 ***
IDN - UK regime 1 0.003 *** 0.014 -0.135 *** -0.016 *** -0.004 0.015 0.050 ***
regime 2 -0.002 0.522 *** -0.608 *** 0.045 *** -0.080 ** -0.018 0.754 ***
IDN - GER regime 1 0.003 *** 0.014 -0.135 *** -0.016 *** -0.004 0.015 0.050 ***
regime 2 -0.002 0.522 *** -0.608 *** 0.045 *** -0.080 ** -0.018 0.754 ***
IDN - INA regime 1 0.003 *** 0.004 -0.122 *** -0.015 *** -0.015 0.001 0.056 ***
regime 2 -0.004 ** 0.387 *** -0.582 *** 0.029 *** 0.008 0.053 ** 0.437 ***
IDN - DOW regime 1 0.003 *** 0.000 -0.142 *** -0.012 *** -0.020 * 0.006 0.042 **
regime 2 -0.004 ** 0.796 *** -0.650 *** 0.007 0.042 0.042 0.051
IDN - NASDAQ regime 1 0.003 *** 0.000 -0.141 *** -0.012 *** -0.020 0.006 0.034 ***
regime 2 -0.004 ** 0.800 *** -0.651 *** 0.007 0.043 0.043 0.020

The Markov-switching equation above assumes that Regime 1 (non-crisis), whereas higher persistence is
the direction of contagion is from the countries sampled categorized as Regime 2 (crisis). Contagion is said to occur
to Indonesia. The independent variable in the mean between Indonesia and another country should there be
equation is calculated based on estimation results using a significant increase in the return coefficient of another
Autoregressive Distributed Lag (ADL) to determine which country (a6) from Regime 1 to Regime 2. Table A1.2 shows
financial and economic variables affect Indonesia»s that the a6 coefficient value is significant and experiences
composite return index. growth during Regime 2 for all countries, except United
In this research, calculations were performed by States (both Dow Jones and Nasdaq).
dividing the state into two regimes, namely Crisis and Non- Based on the analysis using the Markov switching
Crisis Regime based on persistence and unconditional equation, it can be concluded that contagion occurs
variance obtained from conditional variance. Lower between Indonesia and nearly all countries sampled,
persistence between the two states is categorized as excluding the United States (both Dow Jones and Nasdaq).

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Artikel I - Impact of Contagion Risk on the Indonesian Capital Market

CONCLUSION The table evidences contagion between Indonesia


Table A1.3 summarizes the estimation results using and the other countries in this research. Contagion
the DCC-MG method (Dynamic Conditional Correlation √ primarily occurred between Indonesia and East Asian
Multivariate GARCH) and Markov-Switching. Both countries, such as Japan, Taiwan and Korea. There was
experiments were contagion experiments that disregarded also contagion between Indonesia and India. In addition,
the country initiating the crisis. Markov-switching tested the behaviour of stock market players in Indonesia differed
contagion without periodising the crisis. This method was little from stock market players in India. This is possibly
used to overcome the constraints of contagion testing due to the large number of foreign investors in India and
that requires the arbitrary setting of crisis and non-crisis Indonesia. Indonesia and India have similar fundamental
points. and social conditions, so investors use India as a signal of
Indonesia market conditions, and vice versa. This indicates
Table A1.3
the presence of wake-up call hypothesis.
Results of Contagion (1) Detection
Estimation results also showed that there is no
DCC/Multivariate GARCH
Markov-Regime Switching contagion between Indonesia and the United States, both
P2 P3 P4
using the Dow Jones index and Nasdaq index. Therefore,
IDN-MLY √*** √***
if Indonesia is affected by the current global crisis, with its
IDN-SIN √*** √***
IDN-THA √*** √*** roots in the US subprime mortgage crisis, it is not a direct
IDN-PHI √*** effect from the US market but rather indirect effects from
IDN-JPN √*** √*** √***
capital markets in Asia that share a direct relationship with
IDN-TWN √*** √*** √***
the US capital market.
IDN-HK √*** √***
IDN-CHN √*** √*** Table A1.4 shows that Indonesia has a contagion
IDN-KOR √*** √*** √*** relationship with several countries in Asia, such as Japan,
IDN-INA √*** √*** √***
Taiwan, Korea, Hong Kong and India. The relationship is
IDN-AUS √*** √***
IDN-GER √*** two way, which means that Indonesia also affects other
IDN-UK √*** √*** countries and other countries affect Indonesia. However,
IDN-US(DJ)
based on error detection tests, evidently Indonesia is more
IDN-US(NQ)
of a shock absorber than a shock transmitter, especially
Notes: *** : Significant for α = 1% (critical value: -2.32)
** : Significant for α = 5% (critical value: -1.64) for the developed countries (Japan, Australia, Germany,
* : Significant for α = 10% (critical value: -1.28)
Sign √ indicates that there is a contagion effect between two countries. United Kingdom and US).

Table A1.4
Conclusions of Test on Contagion Detection

Daily Monthly Daily Data Monthly Data


Country
Data Data P2 P3 P4 P2 P3*

IDN-MLY √ ^^^ √ ^ √ ^
IDN-SIN √ ^^^ √ ^
IDN-THA √ ^^^ √ ^ √ ^ √ ^ √ ^
IDN-PHI √ ^^^ √ ^

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Article I - Impact of Contagion Risk on the Indonesian Capital Market

Table A1.4
Conclusions of Test on Contagion Detection (cont.)

Daily Monthly Daily Data Monthly Data


Country
Data Data P2 P3 P4 P2 P3*

IDN-JPN √ ^^^ √ ^ √ ^^^ √ ^ √ ^^^ √ ^^^


IDN-TWN √ ^^^ √ ^ √ ^^^ √ ^^^ √ ^^^
IDN-HK √ ^^^ √ ^^^
IDN-CHN √ ^ √ ^^^ √ ^^^ √ ^^^ √ ^^^
IDN-KOR √ ^^^ √ ^ √ ^^^ √ ^^^ √ ^^^ √ ^^^
IDN-INA √ ^^^ √ ^ √ ^^^ √ ^^^ √ ^^^
IDN-AUS √ ^ √ ^
IDN-GER √ ^ √ ^ √ ^^
IDN-UK √ ^ √ ^
IDN-US(DJ) √ ^ √ ^
IDN-US-(NQ) √ ^

Keterangan: P2 : 2nd Period (daily data: 16 July 1997 - 29 December 2000; monthly data August 1997-December 2000)
P3 : 3rd Period (daily data: 1 January 2001 - 14 August 2007; monthly data January 2000-September 2008)
P4 : 4th Period (15 August - 13 November 2008)
^^^ : Causality relationship
^^ : Contagion relationship with Indonesia as the source of the shock
^ : Contagion relationship with other countries as the source of the shock
Sign √ indicates that there is a contagion effect between two countries
Level of significance is 5% and 1%

80
Artikel I - Impact of Contagion Risk on the Indonesian Capital Market

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Agenor, Aizenman, dan Hoffmaister. 2008. ≈External Collins dan Gavron, 2004. ≈Channels of Financial Market
Shocks, Bank Lending Spreads, External Shocks,Bank Contagion∆, Applied Economics, 36:21, 2461- 2469.
Lending Spreads, and Output Fluctuations∆, Review Collins dan Gavron. 2005. ≈Measuring Equity Market
of International Economics,16:1, 1-20. Contagion in Multiple Financial Events∆, Applied
Arestis, et al. 2005. ≈Testing for Financial Contagion Financial Economics, 15:8, 531-538.
between Developed and Emerging Markets during Dornbusch, Park, dan Claessens. 2000. ≈Contagion: How
the 1997 East Asian Crisis∆, International Journal of It Spreads and How It Can be Stopped∆, Forthcoming
Finance and Economics, 10, 359-367. World Bank Research Observer.
Caporale, Cipollini, dan Spagnolo. 2005. ≈Testing for Duggar dan Mitra. 2007. ≈External Linkages and
Contagion: a Conditional Correlation Analysis∆, Contagion Risk in Irish Bank∆, IMF Working Paper.
Journal of Empirical Finance, 12, 476-489. Engle, G. 2000. ≈Dynamic Conditional Correlation √ A
Caramazza, Ricci, dan Salgado. 2004. ≈International Simple Class of Multivariate GARCH Models∆, UCSD
Financial Contagion in Currency Crisis∆, Journal of Economics Discussion Paper, 2000-9.
International Money and Finance, 23, 51-70. Essaadi, Jouini, dan Khallouli. 2007. ≈The Asian Crisis
Cartapanis, Dropsy, dan Mametz. 2002. ≈The Asian Contagion: A Dynamic Correlation Approach
Currency Crises: Vulnerability, Contagion, or Analysis∆, Documents De Travail-Working Papers, 07-
Unsustainability∆, Review∆of International Economics, 25.
10(1), 79-91. Forbes dan Rigobon. 2000. ≈Contagion in Latin America:
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the Central Bank∆, Journal of Banking and Finance, NBER Working Paper Series, 7885.
31, 81-101. Hatemi-J dan Hacker. 2005. ternative Method to Test for
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Chu-Sheng Tai. 2004. ≈Contagion: Evidence from the U.S Subprime Crisis on Developed Countries∆,
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Contagion∆, Journal of the European Economic Equilibria∆, Journal of Economic Policy Reform, 10:4,
Association, 3(2-3), 556-566. 283-296.

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Marais dan Bates. 2006. ≈An Empirical Study to Identify Suliman. 2005. ≈Interest Rate Volatility, Exchange Rates,
Shift Contagion during the Asian Crisis∆, International and External Contagion∆, Applied Financial
Financial Markets Institutions and Money, 16, 468- Economics, 15:12, 883-894.
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of Currency Crisis for Developing Countries: an Based Approach∆.
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Rodriguez. 2007. ≈Measuring Financial Contagion: A Central European Economies: the Impact
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Sojli. 2007. ≈Contagion in Emerging Markets: the Russian Yang dan Lim. 2004. ≈Crisis, Contagion, and East Asian
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82
Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

Article II

Corporate Balance Sheet Modelling:


Determinants of Indonesian Corporate Debt1

Wimboh Santoso, Viverita, Ardiansyah, Reska Prasetya, Heny Sulistyaningsih

This study attempts to investigate the determinants of Indonesian corporate debt which in turn will affect
the financing and investment decisions of companies. The model employed is developed by extending the model
by Gibbard and Stevens (2006) and combining it with the traditional trade-off theory and pecking order theory
of capital structure. Based on these theories, this study also models corporate leverage by combining debt,
equity issuance as well as investment models and applies the Generalized Moment of Method (GMM) to a panel
data of 128 Indonesian listed corporations. It is found that the level of corporate debt is determined by default
probability effect and thus careful consideration in financing decisions is required. The result also imply that the
pecking order theory contributes significantly to Indonesian corporations balance sheet model.

Keywords :Corporate debt; balance sheet;capital structure;speed of adjustment


JEL Classification: C51;C33;N65

1. INTRODUCTION A decrease in earnings not coupled by a decrease of


The increase of volatility in the commodity and operational and production costs will cause companies»
international financial markets coupled with the world need for financing from third parties, banking institutions
economic slow down has decelerated national economic or nonbanking institutions. The more debt a corporate
growth. Indirectly, such condition potentially puts has, the greater it is exposed to the financial system.
pressures on the corporate sector»s performance. Lower Furthermore, if increases in debt are coupled by decreases
consumer purchasing power will cause corporation sales in earnings, corporate repayment capacities will suffer.
to decrease and hence pulling down corporate earnings. Moreover, the drop in corporate earnings potentially
causes its debt repayment capacity to third parties to
1 The author gratefully acknowledge support from the Directorate of Research and decrease and thus can become a source of financial
Banking Regulation Bank Indonesia. I acknowledge with thank participants at the Research
on Stability of Financial System and Outlook Seminar, the Central Bank of Indonesia,
Solo 17-19 December 2007.
system instability.

83
Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

There are a variety of reasons to issue debt as a source as Stiglitz (1972) suggest that the difference between
of firm»s financing. For example, Jensen (1986) found that personal income tax applied to capital gain and regular
debt is an efficient way of reducing costs related to issuing income diminish theoretical beliefs of the tax benefits of
shares, while Klaus and Litzenberger opine that debt will using debt which results in the refusal to use debt as source
optimize corporate capital structure through its tax of capital. Meanwhile, literature on credit rationing gives
benefits. In addition, Ross (2008) and Leland and Pyle insight on creditors and the banking sector»s view as to
(1977) suggest that debt is a critical indicator of to a firm»s why corporations limit the amount of their borrowings.
value. Raviv (1991) found that leverage increases as debts, Jaffe (1971) described the manager»s unwillingness to
non-debt tax shields, investment opportunities and firm obtain more debt in order to maintain their position and
size increases. In contrast, leverage decreases as volatility, stabilize their wealth. Other factors considered affecting
advertising expenditure , default probability and the the use of debt is bankruptcy costs or cost of financial
uniqueness of the products increase. Therefore, optimal distress (Warner, 1976 and Robichek and Myers, 1966).
debt ratio is determined by the trade-off between benefits According to theory, a firm will consider an
and costs of issuing debts (Frydenberg, 2004). investment opportunity when it has cash. Therefore, the
Until June 2008, the banking sector»s contribution decision of choosing internal or external financing sources
in financing corporates through extending working capital does not only depend on time of investment, but also the
and investment credit made approximately 71 per cent of availability of investment opportunities. Furthermore, the
total financing by banks. This is an indication of the banking decision to not issue stocks and therefore not take any
and financial sector»s significant exposure to Indonesian investment opportunities will cause misallocations, which
corporations. Therefore, the need to model factors which in turn will decrease the firm»s value. Such is known as
determine the Indonesian corporate balance sheet financing trap (Myers and Majluf, 1984). Based on this
becomes critical. This is done by investigating the role of phenomenon, firms tend to use debt as external source of
optimal debt in financing and investment decisions. The financing when existing shareholders are passive investors.
study aims to construct a corporate balance sheet model As a result, corporations with large enough financing slack
to investigate its debt structure as well as factors affecting tend to take all available investment opportunities. Jensen
firm»s optimal level of debt. (1986) suggests that firms which prefer issuing and using
debt as sources of financing will benefit not only managers
2. LITERATURE REVIEW in the form of delaying future dividends, but also give right
Many literature on corporate capital structure have to the owners to take legal action in the case of default.
been published in finance journals. Among them were Increasing use of debt will increase the firm»s leverage as
Modigliani and Miller (1963), who proposed that a well as agency and bankruptcy costs.
corporation tends to maintain its reserve borrowing There are two main theories generally used to explain
capacity in an ideal market and therefore, incremental the corporate debt structure, i.e. the trade-off theory and
benefits of borrowing decreases as amount of debt the pecking order theory. The trade-off theory of capital
increases. As such, credit facilities received by a corporation structure states that the level of corporate debt can be
will decrease with the increase in debt extended to the explained by the balance between costs and benefits of
corporation. In addition, Farrar and Selwyn (1967) as well using debt as a source of financing, with cost of bankruptcy

84
Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

as the cost of debt and tax deductions as the benefits of corporate debt level. This study also found that debt is
using debt. This explains the trade-off between tax benefits positively correlated with corporate financing needed,
and the cost of financial distress. Accordingly, it focuses while the optimal level of corporate debt is negatively
on the balance between the benefits cost of using debts correlated to market-to-book ratios. In addition, the
and opportunities of financial distress. This theory, then, procyclicality of debt is an effect of procyclicality of
explains the effect of connectivity between debt and financing gap. Other findings show that growth of
default risk as well as debt and growth opportunities. corporate debt in the bullish economy cannot be explained
The pecking order theory tells the hierarchy of the by the increase in optimal debt but by increases in financing
firm»s long-term financing strategy and the preferred use gap, while Welch (2002) suggests that the corporate capital
of internal sources of financing. In general, this theory structure is determined by the lag of the stock returns (i.e.
explains the firm»s priority in choosing internal sources of equity value, predict current equity value, dan debt equity
financing over debt financing. However, if external ratio). Therefore, the main determinant of the capital
financing is in great need, debt is preferred to equity (Myers structure is the external influence rather than internal
and Majluf, 1984). Therefore, this theory focuses on how capital structure decision. On the other hand, Welch (2004)
to manage firms to achieve the best balance between its found that 40 per cent change in the corporate debt
economic needs and financial stability. The rules of this structure most likely are due to stock returns, while issuing
theory can be explained as (1) internal financing (retained long-term debt only explains 30 per cent of change in
earnings) is used as it is considered safer than debts as it debt level.
carries with it default risks, (2) issuing debt is the safest Fama and French (2002) conducted a two-step
means of external financing in cases where the use of regression to determine the optimal level of debt
external financing cannot be avoided. Furthermore, combining the trade-off and pecking order theories, and
according to this theory, issuing stocks as sources of found four factors considered as the main determinants,
financing is not the best financing decision as it will in i.e. (1) profitability, (2) investment opportunity, (3) firm size
turn need other sources of financing. Such situation creates (proxies by total assets),and (4) target dividend payout.
a gap between corporate expenses and free cash flow This finding shows different and contradictory results when
which need to be financed by debt (gap financing). Based applying the two theories. For example, applying the trade-
on this theory, a change in debt must be equal to financing off theory, it is found that corporations with higher
gap. Other studies done by Shyam-Sunder and Myers investment have lower debt. In contrast, using pecking
(1999) used debt ratio as a proxy for optimal levels of debt order theory, they found negative association between
assuming constant target level of debts. expected investment and book leverage. In addition, there
Based on those studies, Gibbard and Stevens (2006) is a positive association between leverage and corporate
explored the determinants of corporate debt of firms in size as well as between dividend payout and size. It
the UK, US, French and Germany. They explain the role of indicates that big corporation earnings has significant
corporate debt by estimating its investment and equity influence to capital structure.
issuance. Using embedded equation, it is found that Tsiplakov (2007) used a dynamic model of optimal
pecking order variables, particularly simultaneous cash capital structure, and found a strong association between
flows and acquisition have significant impacts on the company»s stock returns and change in debt level. This

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Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

finding supports Welch (2004). In addition, Drobetz and cash as sources of financing. To cope with shortages in
Wanzenried (2002) examine the influence of firm specific cash, the companies will use debt as primary sources of
factors and macroeconomic factors to speed of adjustment external financing. Meanwhile, the trade-off theory
to corporate target leverage of 90 Swiss companies. They suggests that change in debt position is the different
found that firms with higher growth rates and those further between the optimal level of debt and the actual debt.
from the optimal debt level adjusted faster to their target Figure A2.1 shows the conceptual framework of
leverage. In addition, it was also found that tangibility and Indonesian corporate balance sheet debt model.
size have a positive relation with leverage. In contrast,
Figure A2.1
profitability is negatively related to leverage. Furthermore, Conceptual Framework of
high growth (market to book ratio) firms have lower Corporate Balance Sheet Model

leverage compared to firms with lower market to book


DEBT
ratio. Historical market to book value is used by Hovakimian EQUITY Use to finance
INVESTMENT
ACQUISITION
CASH
(2003) to investigate the effects of this factor to investment
and financing decisions, and found its significant effect to
investment and financing decisions. This means that A study by Gibbard and Stevens (2006) combined
current market to book value of debt failed to reflect the the two theories of the capital structure. This gives us the
firm»s growth opportunity. possibility to watch the cyclical movements of corporate
debt and quantifying how far debt movements trigger
3. METHODOLOGY AND MODEL DEVELOPMENT financing needs and speed of adjustment of debt levels,
This study combined the trade-off theory and the as describe below:
pecking order theory to construct a corporate balance sheet Dit = αGit + βDit* + (1-β) Di,t-1 (1)
of Indonesian corporation. While the pecking order theory where Dit is the corporate debt at time t; Gi = Financing
suggests of using internal sources as a primary financing Gap; where the main observed variables are Cash Flows,
sources compared to issuing stocks. It urges that issuing Investment expenditure dan Acquisitions. Dit* is the Optimal
stocks will be received by investors as bad news. Debt (Implied by trade off theory) and can be determined
Furthermore, the trade-off theory proposed the concept by one of three methods: (1) Market to book value (Gibbard
of optimum level of debt proxies by the level of debt by and Stevens 2006, Welch 2002); (2) Average of debt ratios
comparing the marginal benefit and marginal cost of using over the observation period (Sunder and Myers 1999); and
debt. Based on the purpose of this study, an Indonesian (3) determine the level of optimum debt by regressing
corporate balance sheet will be developed by adapting possible factors that affect the corporate target debt ratio
models from previous empirical studies on capital structure, (See also, Fama and French, 1999). Therefore, the fitted
primarily from the work of Gibbard and Stevens (2006). values from the regression results will present the corporate
There are different views in the way we look at the optimal debt.
change in debt position based on the two theories. The Some empirical work have been done to model
pecking order theory suggests that change in debt position corporate capital structure using various models such as
is dependent on financing gap i.e. the gap between debt model, equity issuance model, and investment model,
corporate spending (for investments and acquisitions) and as follows:

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Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

3.1. Debt Model (C) position is expected to be negatively associated with.


This model explains factors that affect level of In addition, the level of optimum debt has an ambiguous
corporate debt. According to the pecking order theory, association with increasing numbers of stocks issued while
investment (I) and acquisition (A) variables are positively the level of optimum debt may be positively or negatiely
associated with the level of corporate debt, meanwhile, associated with the number of stocks issued. The equity
cash (C) is negatively associated with the level of debt. In issuance model is shown in equation (3) below:
addition, the level of optimum debt (M) is expected to Eit = α + α1Di,t-1 + α2Iit + α3Ait + α4Cit + α5Mit + η1 + εit (3)
have negative associationss with the actual level of
corporate debt. Another study by Welch (2002) gives a 3.3. Investment Model
different conclusion, in which market to book value of Equation (4) models the level of corporate
debt is negatively associated with level of corporate debt. investment. It expects that cash (C) is positively associated
However, this association is not statistically significant. with the value of corporate investment. First, the Q variable
These ambiguos results can be explained by two (a variable based on an empirical evidence of Blundell,
approaches: the growth opportunities effect (Myers, 1977) at.al.,1992) is included in the equation. This variable is
and default probabilities effect (Welch, 2002) as follows: expected to positively affect corporate investments. The
Dit = α + α1Di,t-1 + α2Iit + α3Ii,t-1 + α4Ait + α5Ai,t-1 + α6Cit + model can be written as follows:
α7Ci,t-1 + α8Mit + α9Mi,t-1 + η1 + εit (2) Iit = α + α1Di,t-1 + α3Ii,t-1 + α4Ait + α6Cit + α7Ci,t-1 + α8Qit +
η1 in equation (2) represents firm specific effect, which will α9Qi,t-1 + η1 + εit (4)
cause inconsistency in the regression coefficients, but can
be solved using differencing techniques. However, 3.4. Model Specification
differencing endogeneous variables may cause a correlation Based on those previous models, a model is
between differenced of error term and differenced lag of constructed for this study particularly by extending the
endogenous term. This problem can be resolved by model proposed by Gibbard and Stevens (2006). In
applying more than one lags to the variable levels. For addition, referring to Welch (2002) this study includes
example, Arellano and Bond (1991) used the Generalized stock returns (R) as one of the variables affecting the
Methods of Moment (GMM) to produce efficient Indonesian corporate debt level. The inclusion of stock
estimators. returns aims to test the inertia of using debt in the capital
structure. This behavioral approach implies that negative
3.2. Equity Issuance Model stock returns will deliver negative signals and therefore
Equation (3) presents a model of equity issuance that will increase the corporate debt level. The model is
is affected by financing gap as well as the optimum level presented as follows:
of corporate debt, based on an empirical model developed Dit = α + α1Di,t-1 + α2Iit + α3Ii,t-1 + α4Ait + α5Ai,t-1 + α6Cit +
by Benito and Young (2002). This model supports the debt α7Ci,t-1 + α8Mit + α9Mi,t-1 + α10Ri,t,t-1 + η1 + εit (5)
model in equation (2) and is used to determine the level where Di,t-1 is debt at time t-1; I is the investment at time
of Indonesian corporate debt level. This model expects that t; Ait denotes as acquisition at time t; Cit is the corporation
capital expenditures (A and I) are positively associated with cash flows at time t; Mit is target debt ratio at time t; and
increasing in number of stock issuing. Meanwhile, cash Ri,t,t-1 represents the corporation»s stock returns at time t.

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Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

3.4.1. Determining Corporate Debt Optimum industries, agriculture, trading and miscellaneous industries
Level from 2004 to 2007. Data sources include Bloomberg and
Based on Fama and French (2002), the ratio of the Indonesian Stock Exchange.
corporate target leverage is determined by the fitted values
Table A2.1
of the equation 6. The corporation leverage target ratio
Descriptive Statistics of Indonesian Corporation,
(M), will then model the Indonesian corporate balance 2004-2007

sheet. All
Variable
Mt = b0 + b1MVt-1 + b2EBITt-1 + b3DPt-1 + b4RDt-1 + Mean Standard Deviation

b5 ln(At-1) + b6FAt-1 + b7MIt + b8Mt-1 + et+1 (6) Total Asset (Trillion IDR) 6,133.65 55,821.59
Current Asset (Trillion IDR) 872.02 1,891.74
It is assumed that firm with high earning assets (EBIT) Fixed Asset (Trillion IDR) 1,118.58 4,157.16
could operate with high or low levels of leverage. In Tangible assets (Trillion IDR) 6,024.73 55,745.80
Intangible Asset (Trillion IDR) 90.11 558.83
addition, low leverage could occur in corporations with Total Debt (Trillion IDR) 25,471.62 437,384.39
Net Sales (Trillion IDR) 1,935.43 5,641.06
high retained earnings or when the firm limits its leverage
Net income (Trillion IDR) 246.87 1,812.31
to protect its franchises producing these high earnings. Depretiation (Trillion IDR) 644.08 3,079.11
Amortization (Trillion IDR) 46.55 473.89
Higher leverage might reflect the firm»s ability to meet debt
Capital expenditure (Trillion IDR) 167.08 992.40
payments out of its relatively high cash flow. Furthermore, EBIT 327.52 1,658.52
Cash per total asset 0.33 0.34
high market to book ratio (MV) in general reflects better Depreciation Expense per tangible asset 0.27 0.24
growth in the future. In this case, high growth of firms R & D Expense per total asset 0.05 1.11
Size (Log of Total Asset) 27.14 1.85
tend to be protected by limiting its leverage. Fixed asset per total asset 0.38 0.24
Debt per total asset 0.78 1.04
Depreciation (DP) is a proportion of total assets. Firms
Investment (Capex per total asset) 0.04 0.10
with high depreciation will have more interest deductions acquisition (Acquisition per total asset) 0.03 0.08

with the use of leverage as its source of financing. In


addition, firms with higher value of assets, tend to use Table A2.1 shows that the average value of total debt
more debt compared to those with lower assets. This occurs of Indonesian corporations were more than 400 times its
as these firms tend to be more transparent or have greater total assets. However, the standard deviation of these
access to public debt markets. Firms with high tangible variables were also much higher that their average. To
assets (FA) tend to have higher debt capacity, while firms estimate factors that determine the corporate level of debt,
with more intangble assets in the form of R&D prefer equity this study applies the generalised methods of moments
as their financing source. Furthermore, the firm»s lagged estimator (GMM-SYS) following Arrelano and Bover
industry median debt ratio (MI) is used to control industrial (1995). This method is used to reduce the effect of firm-
characteristics which cannot be represented by other specific effects of the corporations in the sample as they
independent variables. come from various industrial sectors.
Following Fama & French (2002) and Hovakimian et.
4. ANALYSIS al. (2003), this study found that the level of optimum debt
This study uses unbalanced panel data of 218 of Indonesian listed corporations are negatively and
Indonesian listed corporations covering eight sectors, i.e. significantly affected by levels of profit. This is inline with
consumption, infrastructure, mining, property, basic the expected relations. This indicates that in general,

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Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

Indonesian corporations prefer to use their profits (internal are in agreement with the pecking-order theory,
sources) rather than debt as source of financing. In contrast, in which the higher the firm profits, the more it
it is found that firm size is negatively and significantly uses debts (excess cash is used for other matters
related to the use of external source of financing. such as divident payout).
Table A2.2 presents the debt equation of the ACTA : The regression results indicate a negative
Indonesian corporation. The table verifies that the pecking relationship in the use of corporate debt even if
order theory can significantly explain corporate debt. This the results found it to be insignificant. Empirical
also shown by significant coefficients and signs of two studies find that different coefficients. The
financing gap factors, i.e. investment and cash flows. negative relationship between acquisitions
Meanwhile, another component, namely acquisition, has indicate the priority for other funding sources to
an unexpected (negative sign) and is not significant. fund acquisition activities.
The estimation results, as shown by Table A2.2 also
Table A2.2
imply that the Fitted Values of Debt (OD-1) as a proxy of
Determinants of Corporate Debt
optimum level of the corporate debt shows a negative
DEBT EQUATION (GMM Sys)
Dependent Variable :DEBT
and significant association to the level of actual debt. The

Variable Coefficient t-Statistic Prob. negative sign of the coefficient supports default probability

DEBT(-1) 0.5740 13.0137 0.0000 effects (Myers, 1977 and Jensen, 1986). This implies that
ACTA -0.1456 -1.2976 0.1971
the decision to take debt as a source of financing is crucial
ACTA(-1) 0.0692 0.4581 0.6478
CASH 0.0574 0.6196 0.5368 and needs to be carefully considered by the corporations.
CASH(-1) 0.0359 0.6204 0.5362
INVTA 0.1816 2.0067 0.0472 In addition, a company»s stock returns variable as a proxy
INVTA(-1) 0.1186 1.3022 0.1956 for market expectation shows that stock returns negatively
OD 0.0054 0.5342 0.5943
OD(-1) -0.5757 -41.0524 0.0000 and significantly affects the level of optimum debt. This
RETURN -0.0341 -3.0392 0.0030
RETURN(-1) -0.0158 -4.1306 0.0001
means that the market poses high and positive expectation
Cross-section fixed (first differences) to the corporate»s future performance and as such, the
R-squared 0.983631
P-value (Chi square) 0.00000 corporation needs less debt financing. This implies that
SSE 0.07645
corporate stock returns affect the variability of optimum
N (Firms) 201
Notes debt level. The result is inline with Welch (2004).
DEBT : Total debt per total assets
ACTA : Total Acquisition per total assets
CASH : Total Cash per total assets
INVTA : Total Investment per total assets 5. CONCLUSIONS
RETURN : Return of share per year
This study aims to model the Indonesian corporate
INVTA : The coefficient of investments to the ratio of balance sheet and investigate the determinants of the
corporate debt is positive (+) and significant at a optimum level of corporate debt, by combining the well-
5% level. This indicates that the more a firm known capital structure theories i.e. the trade-off theory
invests, the more it uses debt. This agrees with and pecking order theory. Using the generalised methods
the pecking-order theory. of moment estimator (GMM-SYS), this study also captures
CASH : The coefficient of investments to the ratio of the dynamics of the corporate debt level in adjusting to
corporate debt is positive (+). The two variables the optimum level.

89
Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

Results of the estimation show that the level of is 0.43. This means that corporations take into account all
Indonesian corporate debt is determined significantly by factors affecting their level of debt. They carefully pay
its level of investment and cash flows. This finding also attention to adjustments in cost as the level of debt is
indicates that the pecking order theory contributes determined by default probability effect.
significantly to Indonesian corporations balance sheet In summary, the findings of this study shed some
model. In addition, the optimum level of debt provides light on the determinants of corporate debt as corporates
support for the default probability effect as explained by adjust their level of debts to the optimum level.
Myers (1977) and Jensen (1986). As it is found that the Furthermore, the findings can be used to monitor firm»s
model of the Indonesian corporate balance sheet in general debts for investment and acquisition activities, which in
is affected by the pecking order theory, it indicates that turn can be used to calculate its default risk potential. As
investment and acquisition activities will influence their such, lenders and regulators need to hold rigorious
level of debt. assessments to reduce the negative impacts of excessive
Based on GMM-SYS estimation, it found that the use of debts. Good management of debt levels will move
Indonesian corporate debt adjusts itself to a level slightly towards achieving optimum levels of debt and in turn
lower than its optimum level. The implied adjustment rate promote high value of the firm.

90
Article II - Corporate Balance Sheet Modelling: Determinants of Indonesian Corporate Debt

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92
Financial Stability Review
No. 12, March 2009

DIRECTOR

Halim Alamsyah Wimboh Santoso Suhaedi

COORDINATOR & EDITOR

Agusman

WRITERS

Ardiansyah, Linda Maulidina, Ratih A. Sekaryuni, Anto Prabowo, Tirta Segara, Wini
Purwanti, Endang Kurnia Saputra, Ita Rulina, Boyke Suadi, Ida Rumondang, Azka Subhan,
Pipih Dewi Purusitawati, Noviati, Rosita Dewi, Erma Kusumawati, Darmawan Tohap B,
Sagita Rachmanira, Reska Prasetya, Elis Deriantino, Hero Wonida, Mestika Widantri,
Heny Sulistyaningsih, Primitiva Febriarti, Adidoyo Prakoso

COMPILATORS, LAYOUT & PRODUCTION

Boyke Suadi Primitiva Febriarti

CONTRIBUTORS

Directorate of Banking Supervision 1

Directorate of Banking Supervision 2

Directorate of Banking Supervision 3

Directorate of Sharia Banking

Directorate of Credit, Rural Bank Supervision and SMEs

Directorate of Bank Licensing and Banking Information

Directorate of Banking Investigation and Mediation

Directorate of Accounting and Payment Systems

Directorate of Economic Research and Monetary Policy

Directorate of Monetary Management

Directorate of Reserve Management

DATA SUPPORT

Suharso I Made Yogi

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