Conservatism can Hinder Development

Oleh: Nurkholisoh Ibnu Aman, ST., MSc., Peneliti Ekonomi di Bank Indonesia, Kepala Divisi Litbang Ketahanan Ekonomi TANDEF

The global financial crisis has unmasked the real driver of economic growth in many countries. Economists around the world were left stunned by this truth about how the economy was actually fueled. In the United States, asset value soared outrageously when household income had in fact stagnated. Prices were no longer a reflection of fundamental interactions between supply versus demand because speculation and expectation were also in play.

On a micro level, many people were living beyond their means, thanks to highly leveraged financial services. Bank lending was apparently anything but prudent. The quest for growth and profit had circumvented even simple common sense: One must pay back credit with real money generated from sustainable income.

Amids the worldwide chaos, the Indonesian financial sector has stood firm. With the exception of a small bank being taken over for having liquidity problems and fraudulent practices in a number of securities houses, the stability of the country's financial system remains intact. This should not come as a surprise since Indonesia's financial sector is relatively conservative.

Banks are heavily regulated and stock market products are a luxury for most of the nation's people.

The 1997 economic crisis taught us a lesson about the need to be prudent in the banking business. Credit application is now carefully scrutinized and must be supported with credible collateral.

The process is often found to be so stringent that it has become notorious to the public that the banking sector is hard to access. A centralized customer database is also now in place to rule out defaulted debtors from obtaining more credit.

At a consumer level, being conservative is actually a value that Indonesians share with other Asians. Asia's saving culture can be traced back to the agriculture era when farmers needed to save part of their crops for a "rainy day". This saving attitude is also attributed to the lack of a social security system in most Asian countries so people need to prepare well in advance for their retirement period.

The advantage of being conservative is certainly not to justify the current state of Indonesia's financial market. A study by The World Bank (Unlocking Indonesia's Domestic Financial Resources, 2006) found that nearly 80 percent of financial system assets are managed by commercial banks. Compared to the region, the Indonesian financial sector is relatively underdeveloped.

The Indonesian banking sector obtains most of their funding from short-term deposits (i.e,. less than one month maturity) which restricts them from financing long-term credit. Banks can offer only short-term and floating-rate loans, a scheme that is not desirable for highly productive use of funds such as developing infrastructure and financing investment activities.

It is therefore imperative to broaden and deepen the financial market by developing nonbank financial institutions as well as by introducing a variety of sophisticated financial products. A well-diversified financial system is the key to mobilizing and allocating financial resources efficiently between surplus and deficit spending units.

While being conservative has paid off this time, a more developed financial market is necessary to support the country's development objectives of increased economic growth, greater job creation and ultimately, a higher standard of living.

A well-developed financial system can also enhance Indonesia's financial security. As Alan Greenspan once said, when discussing the 1997 financial crisis in East Asia, most East Asian countries had no "spare tires" to absorb shocks in the banking system. To avoid costly financial turmoil when switching to a more advanced system, Indonesia's policymakers need to learn from their US counterparts that the market cannot be trusted to regulate itself.

This article was also published in The Jakarta Post, 15 January 2009