Unlocking Indonesia's Domestic Financial Resources : The Role

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  • 1.Unlocking Indonesias Domestic Financial Resources : The Role of Non-Bank Financial Institutions P.S. Srinivas Lead Financial EconomistThe World Bank Office, Jakarta, Indonesia January 11, 2007

2. Overview of Indonesian Financial Sector

  • Indonesias financial sector is currently dominated by commercial banks
  • Indonesian banking sector is not yet a source of long-term capital

29.4 N/A 801 Equity market capitalization (2005) 30.1 N/A 680 Equity market capitalization (2004) 67.6 100.0 1,844.5 Total 2.3 3.4 62.8 Outstanding corporate bonds (2005) 0.1 0.1 2.7 Venture capital companies (2005) 1.1 1.6 29.4 Mutual funds (2005) 0.6 0.8 14.7 Rural institutions (2004) 0.2 0.3 4.8 Pawnshops (pegadaian) (2005) 0.4 0.5 10.1 Securities firms (2004) 4.7 5.8 107.1 Pension funds (2004) 2.8 4.1 75.1 Insurance companies (2005) 2.5 3.7 67.7 Finance companies (2005) 13.7 20.3 374.5 Non-bank financial institutions53.9 79.7 1,470.0 Banks (2005) Percent of GDP Percent of assets Assets (Rp trillion) Type of institutionand year 3.

  • Countries need both banks and NBFIs to have a welldeveloped financial system
  • NBFIs mobilize and allocate long term domestic resources for financing development
    • Indonesia needs an additional annual infrastructure investment of US$ 5 billion to reach the governments 6 percent per year medium term economic growth target. Domestic resources help mitigate financing risks.
    • Governments borrowing strategy calls forincreasing share of long-term domestic debt
  • NBFIs help meet Government objectives:
    • Improving access to financial services
      • Leasing increases the financing available for SMEs
      • Venture capital firms support entrepreneurship and job creation
      • Pension and insurance companies offer risk mitigation products for individuals and companies
    • Reducing the cost of financial services
      • Increased competition between financial service providers lead to more efficient products and services offered at reduced costs
    • Improving the stability of the financial system to support sustained growth and poverty reduction
      • NBFIs are a critical part of the development of a diversified financial sector
      • Helps reduce the potential for future crises

Why focus on NBFIs?

  • The report focuses on the NBFI sector in Indonesia with two key outcomes in mind
  • improved mobilization and allocation of long-term domestic resources for development
  • development of a diversified financial sector

4. Highlights of the Report

  • Non-Bank Financial Institutions (NBFIs) control over Rp. 375 trillion in assets (of which pension funds and insurance firms control about half).
    • At 14% of GDP this is significant and these need to be better managed
  • Pensions and insurance assets are increasing annually at over 20%
    • Implies about Rp. 40 trillion per year of fresh resources being generated
  • Asset allocation needs to be substantially improved
    • Insurance firms are investing one-third of their funds (Rp. 23 Trillion) in short-term deposits and mutual funds
    • Pensions funds invest40% (Rp. 42 trillion) in short-term deposits and mutual funds
  • Indonesias NBFIs are still small
    • compared to its banks (about Rp. 1500 trillion) and
    • to NBFIs in other countries (Malaysia 138%, Thailand 32%, Singapore 170 % of GDP)
  • There is tremendous potential for growth of these institutions
    • Slightlymore than 10% of Indonesians have a life insurance policy
    • Only 15 million Indonesians have formal pensions or retirement savings including nearly 5 million civil servants
    • Around 100,000 domestic retail investor accounts in the stock market
    • Just 255,000 mutual fund investors
    • Leasing and venture capital firms are yet to play a major role in funding entrepreneurs and SMEs
  • What is needed are sound policies for the development of NBFIs. This report provides some recommendations.

5.

  • Regulatory framework is broadly reasonable
    • Passing new laws and/or regulations is not the priority
    • Implementation and enforcement of existing framework needs improvement
  • Make Bapepam-LK more independent as soon as possible
  • Strengthen regulatory and supervisory capacity
  • Harmonize regulation across sectors
  • Tax treatment plays a key role in sector development
    • Rationalize taxation across all NBFI sectors
  • Major driver of future market development will be consumer education and improvement of skills of market participants
  • Develop Public private partnerships with industry and SROs

Key Findings and Recommendations (1) Macro stability is a prerequisite for the development of the NBFIs this report assumes a stable environment and focuses on the sector specific issues 6. Key findings and recommendations (2)

  • Debt markets
    • Improve coordination between Bank Indonesia and the Ministry of Finance
    • Enhance the certainty of issuance
    • Improve market infrastructure for government bonds (for eg: KSEI participate in BI-SSSS as a subregistry already implemented)
    • Improve the collection and dissemination of secondary-market pricing information
  • Equity markets
    • Improve corporate health and governance
    • Improve market structure by demutualizing and merging the Surabaya and Jakarta stock exchanges
    • Improve market infrastructure by implementing straight-through processing and full remote trading
    • Improve the environment for IPOs
  • Mutual funds
    • Restructure the mutual funds industry after the 2005 debacle
    • Strengthen enforcement and market discipline
    • Develop, implement and enforce sound net asset valuation procedures
    • Strengthen custodians to protect investors

7. Key findings an drecommendations (3)

  • Pension funds
    • Improve offsite supervisory capacity
    • Improve capacity of pension fund managers
    • Taspen
      • Implicit civil service pension liability likely to be large
      • Continue on a pay-as-you-go basis and simplify administrative structure
    • Jamsostek
      • Improve governance and management
      • Encourage outsourcing of activities at Jamsostek to improve efficiency, i.e. outsource the management of a portion of Jamsosteks assets (i.e. 5 10%)
    • Employees and financial pension funds
      • Allow prefunding of severance benefits under Law 13 through tax sheltered vehicles such as a registered pension plan
    • Formulate a coherent master plan that focuses on the implementation of SJSN and determines the respective roles of private and public sector
  • Insurance firms
    • Rationalize the industry
      • Close down companies whose licenses have been revoked
      • Develop strategy, regulation and procedure for closing large and small insolvent companies
    • Defer establishment of any policyholder protection scheme until after industry is rationalized
    • Improve enforcement
    • Promote the industry
    • Establish a commission of key stakeholders including industry to guide future industry strategy

8. Key findings and recommendations (4)

  • Leasing/multifinance
    • Develop credit information systems to extend access to SMEs and new borrowers by relying on their reputation credit
    • Encourage BI to support private sector participation in consumer credit information systems.
    • Allow depreciation of leased assets
    • Increase the diversity of funding away from the banking sector