March 2018

Asian Development Bank Support to Indonesia’s

Capital Market Development, 2002–2017:

A Background Paper

NOTE

In this report, “$” refers to US dollars.

Director General M. Taylor, Independent Evaluation Department (IED)

Deputy Director General V. Salze-Lozac’h, IED

Director W. Kolkma, Independent Evaluation Thematic and Country

Division (IETC), IED

Team leaders B. Graham, Senior Evaluation Specialist, IETC (until July 2017)

L. Ocenar, Evaluation Officer, IETC

Team members G. Castillo, Associate Evaluation Analyst, IETC

V. Melo-Cabuang, Senior Evaluation Assistant, IETC

A. Martinez, International Consultant

2

ASIAN DEVELOPMENT BANK SUPPORT TO INDONESIA’S CAPITAL MARKET

DEVELOPMENT, 2002–2017: A BACKGROUND PAPER

Table of Contents

A. Scope, Approach, and Overall Context………………………………………………………………………3

B. Financial System………………………………………………………………………………………………..6

C. ADB Support to Capital Market Development, 2002–2017……………………………………………...12

D. Assessment of Relevance and Results………………………………………………………………………18

E. Issues and Suggestions………………………………………………………………………………………34

Appendixes

1. Asian Development Bank Support to Finance Sector in Indonesia, 1970–2000

2. Capital Markets, Financial Development, Economic Growth, and Poverty Alleviation

List of Tables

Table 1: Finance Sector Development, 2000–2015

Table 2: Southeast Asian Capital Markets Development Index

Table 3: Banking System Soundness Indicators (%), 2002–2015

Table 4: Summary of Key Strategic Focus Areas of ADB Support to Financial Sector in Indonesia,

2002–2019

Table 5: ADB Finance Sector Loans, 2002–2017

Table 6: Ratings for Finance Sector Lending Operations, 2002–2017

Table 7: ADB Finance Sector Technical Assistance, 2002–2017

Table 8: Ratings for Finance Sector Technical Assistance Projects, 2002–2017

Table 9: Distribution of Policy Actions of ADB Policy-based Loans, 2002–2017

Table 10: Distribution of Market Infrastructure Policy Actions, 2002–2017

Table 11: Distribution of Issuer Policy Actions, 2002–2017

Table 12: Local Currency Government Securities Yield Curve, December 2017

Table 13: Government Bond Market Indicators, 2007–2016

Table 14: Capital Market Health Scorecard: Indonesia

Table 15: Comparative Data of Peer Countries

Table 16: Corporate Bond Market Indicators, 2007–2017

Table 17: Stock Market Indicators, 2007–2016

Table 18: Distribution of Investor Policy Actions, 2002–2017

List of Figures

Figure 1. Framework for the Capital Market Development Review

Figure 2. Theory of Change: ADB Support to Capital Market Development in Indonesia

Figure 3. Funding Sources to Fill the Infrastructure Investment Gap

Figure 4: Indonesia—Corporate Governance Scores, 2012–2015

Figure 5: Growth of Government Local Currency Sukuk, 2008–2017

Figure 6: Number of Articles on "Financial Deepening in Indonesia", 2005–2015

List of Boxes

Box 1: Weathering the 2008 Global Financial and Economic Crisis

Box 2: Designing Program Clusters

Box 3: Inflation Performance and Development of Bond Markets

Box 4: World Bank Group Support for Viet Nam Bond Market Development

3

A. Scope, Approach, and Overall Context

1. During 2002–2017, Asian Development Bank (ADB) supported Indonesia’s capital market

development with six policy-based loans (PBLs) amounting to $1.95 billion. While the PBLs covered

several aspects of the financial sector, support to capital market development was a significant

component in all of them. The other main areas covered by the PBLs were financial sector governance,

specifically the transformation towards an integrated supervisory system, and in the latter part the of

period, financial inclusion. PBLs represented about 95% of ADB’s lending to the financial sector in

Indonesia during the past 16 years. In addition, the PBLs were supported or accompanied by technical

assistance (TA) focusing on various aspects of capital market development.

2. This paper reviews ADB’s support to capital market development in Indonesia during 2002–2017

with the objective of identifying issues which may have to be addressed in developing ADB’s future

strategy in this area. This review was undertaken in connection with the program performance evaluation

report (PPER) for the Capital Market Development Program Cluster (CMDPC)–Subprograms 1 and 2.1 The

review will serve as an input to the next Independent Evaluation Department’s (IED) country assistance

program evaluation (CAPE) for Indonesia and the sector assistance and program evaluation (SAPE) for

Indonesia’s finance sector both set to commence in 2018.

3. The review methodology was based on document and file study; data analysis; and interviews

and consultations with ADB staff, government officials, and other stakeholders. The interviews and

consultations took place in ADB headquarters and during the PPER mission to Jakarta in April 2017.

Limitations of this background paper include the lack of validations/full evaluations of many

programs/projects as well as lack of engagement with market participants and the relevant regional

department as this is mainly a desk review, with consultations through the PPER. This review is organized

into five sections: Scope, Approach, and Overall Context; Financial System; ADB Support to Capital Market

Development; Assessment of Relevance and Results; and an Issues and Suggestions section.2

1. The 1997–1998 Asian Financial Crisis and Reforms to Develop Capital Markets

4. There were several weaknesses of the financial systems in the Asian region which were

manifested during the 1997–1998 Asian financial crisis.3 There was excess dependence on the banking

system—economic growth was financed primarily by banks, and the financial system did not have a

“spare tire.”4 Many financial institutions and corporations in countries most adversely affected by the

financial crisis borrowed in foreign currency without adequate hedging. In addition, much of the debt

was short term, while assets were longer term—banks were not well suited to finance long-term

investments on a large scale.5 This double mismatch was a contributory factor to the crisis.

5. However, policies were also to blame: poor sequencing of capital account liberalization

encouraged short-term borrowing, exchange rate policies (supporting local currencies) led borrowers to

underestimate currency risk, and monetary policies allowed domestic credit to expand too quickly.6 There

1 ADB. 2007. Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance

Grant to Indonesia for the Capital Market Development Program Cluster (Subprogram 1). Manila; ADB. 2009. Report and

Recommendation of the President to the Board of Directors: Proposed Loan to Indonesia for the Capital Market Development

Program Cluster (Subprogram 2). Manila. The key findings and suggestions in this background paper will be validated during the

consultations for the forthcoming CAPE for Indonesia and SAPE for Indonesia’s finance sector.

2 A documentation of ADB Support to Finance Sector in Indonesia (1970–2000) is provided in Appendix 1.

3 B. Eichengreen and P. Luengnaruemitchai. 2004. Why Doesn’t Asia Have Bigger Bond Markets? National Bureau of Economic

Research Working Paper 10576. Cambridge, Massachusetts.

4 A. Greenspan. 1999. Lessons from Global Crises. Remarks Before Program of Seminars. World Bank Group and International

Monetary Fund (IMF). Washington, D.C.

5 R. Fabella and S. Madhur. 2003. Bond Market Development in East Asia: Issues and Challenges. Economics and Research

Department Working Paper Series No. 35. ADB. Manila.

6 T. Lane. 1999. The Asian Financial Crisis: What Have We Learned? Finance and Development 36 (3). Washington, D.C.

4

was an overreliance on volatile capital inflows. Because of their reliance on international capital flows to

finance investments, Asian economies became vulnerable to shifts in capital flows.7

6. Various member-countries in the Association of Southeast Asian Nations (ASEAN) pursued

reforms to develop capital markets following the Asian financial crisis. Multilateral institutions such as

ADB and the World Bank provided support. In 1999, the International Monetary Fund (IMF) and the

World Bank established the Financial Sector Assessment Program (FSAP) to conduct comprehensive and

in-depth analysis of financial systems of countries, including development of capital markets.

7. After the crisis, the Government of Indonesia made financial development and stability

development a high priority. There were sustained efforts at laying the groundwork for the recovery of

the banking system and the prevention of a recurrence of a banking crisis. The supervision capacity of

Bank Indonesia (BI) was strengthened and the frameworks for debt recovery and bankruptcy were

improved. The financial sector safety net was strengthened with the establishment of a deposit insurance

scheme and clear procedures for lender of last resort support. The banks taken over by the Indonesian

Bank Restructuring Agency (IBRA) were returned to private ownership with IBRA closing in 2004.

However, state-owned commercial banks (SOCBs) continued to account for a large share of banking

assets and lagged private banks in terms of financial performance.

8. In 2000, the Government issued the Indonesian Capital Market Blueprint 2000–2004, which

included initiatives to improve trading systems and enhance information disclosure in public offering.

This was followed up by the Capital Market Master Plan 2005–2009 which served as a strategic plan.

From 2005–2010, the Government implemented several reforms focusing on strengthening the

institutional foundation to support capital market development resulting in an increase in the share of

the nonbank financial sector in total financial system assets during 2005–2010, from 17.9% in 2005 to

23.9% in 2010. Indonesia’s financial markets quickly rebounded from the 2008 global financial and

economic crisis (Box 1).

9. While noting the reforms since the 1997–1998 crisis, the 2010 FSAP found continuing challenges

in preserving financial stability and developing the financial system. The FSAP pointed to weaknesses in

the legal and governance framework as a major constraint to further development of the financial system,

which lagged comparable countries in terms of depth and contribution to the economy. Specifically,

there were gaps in the legal mandate and powers of supervisors, poor governance of financial

institutions, and concerns about creditor rights. The FSAP included a set of recommendations in various

areas including the development of capital markets.8 In 2010, the Government issued the Capital Market

and Nonbank Financial Industry Master Plan 2010–2014, which addressed many of the concerns raised

by the 2010 FSAP. Following the establishment of a single supervision authority in 2011, the Government

issued the Indonesian Financial Services Sector Master Plan 2015–2019, which emphasized support to

7 The statements in paras. 3 and 4 were sourced from IED. 2015. Performance Evaluation Report of Technical Assistance Grants to

Support Development of Cross-Border Bond Markets in the ASEAN+3 Countries. Manila: ADB.

8 IMF and World Bank. 2010. Financial Sector Assessment: Republic of Indonesia. Washington, D.C.

Box 1: Weathering the 2008 Global Financial and Economic Crisis

The banking sector proved to be resilient to the effects of the global financial turmoil in 2008. With a strong

capital position, the banks weathered the difficult operating environment in late 2008 and early 2009. The

Government and the Bank Indonesia were able to respond with a series of mitigating measures including injecting

liquidity and expanding deposit insurance. Financial markets recovered in 2009 after an initial shock. The 2010

International Monetary Fund-World Bank Financial Sector Assessment found that a decade of sound policies and

structural reform helped Indonesia recover quickly from the 2008 global economic crisis.

Source: IMF-World Bank Financial Sector Assessment 2010.

5

financing priority economic sectors such as infrastructure, financial inclusion including micro, small, and

medium enterprise (MSME) finance, and ASEAN financial market integration.

2. Framework of the Capital Market Development Program Review

10. This review follows the World Bank Independent Evaluation Group’s (IEG) framework for the

evaluation of World Bank Group’s support to capital market development (Figure 1). The elements in the

framework are presented below9:

(i) Capital markets are financial markets for the buying and selling of long-term securities

instruments. Capital markets provide an interface for allocating capital according to

market-based pricing of risk and returns. They channel savings toward long-term

productive investments, helping issuers—companies or governments—to raise long term

capital, and long-term investors, such as insurance and pension funds, to hold long-term

assets and earn returns. Key securities instruments are: (a) bonds or debt instruments

that earn investors a regular “coupon,” allowing them to become creditors to the issuer;

(b) equity instruments or stocks and shares that permit investors to acquire ownership

of companies and thereby share risk; and (c) bundles of claims, such as asset-backed

securities—mortgage-backed securities are an example.

(ii) Capital market instruments are generally deemed to have maturities of at least a year;

instruments of shorter maturity, known as money market instruments, provide the

liquidity to support secondary market development, also supported by repos and

derivatives. On primary markets, issuers of new stocks or bonds sell them to investors via

an underwriting process. In secondary markets, existing securities are sold and bought

among investors or traders, on an exchange, or on over-the-counter markets, sometimes

intermediated by brokers or primary dealers. Liquid secondary markets increase investors’

willingness to buy. Stable macroeconomic conditions (low inflation; stable interest rates)

are critical for capital market development.

(iii) Investors in securities instruments include institutions such as insurance and pension

funds. These institutions accumulate large sums of money through insurance premia

(especially life insurance) and pension deposits. Such investors hold long term assets such

as capital market instruments to match their long-term payouts. While institutional

investors have been major players in capital markets in advanced countries, their role has

been more modest in many developing countries due to several factors that include

shortage of liquid assets on the supply side and restrictive regulatory regimes such as

those mandating certain levels of holdings in government or state-owned enterprise

(SOE) securities.

(iv) Requisites for capital market development. Capital market development needs the right

infrastructure to develop, including “soft” aspects such as: a solid legal and institutional

environment; good corporate governance that protects investor rights, especially those

of minority shareholders; and “hard” aspects of sound financial infrastructure—including

the physical underpinnings of trading systems and securities clearance and settlement

arrangements.

9 IEG. 2016. The World Bank Group’s Support for Capital Market Development. Washington, D.C.

6

Figure 1: Framework for the Capital Market Development Review

3. Theory of Change

11. This review is anchored on the theory of change for ADB programs and projects for capital market

development in Indonesia supported mainly by loans approved during 2002–2017, with expected

development impacts, outcomes, and outputs (Figure 2).

B. Financial System

1. Macro Context

12. Since 2002, the Indonesian economy has performed relatively well and weathered a challenging

external environment. Because of macroeconomic fundamentals that were put in place since the Asian

financial crisis, the country’s economic growth has remained strong: gross domestic product (GDP, in $)

growth averaged 5.1% in 2002–2007, 5.9% in 2007–2011, and 5.3% during 2011–2016. The increase in

global commodity prices during 2003–2011 contributed to economic growth and poverty reduction.

However, since 2012, weaker global commodity prices resulted in a slowing of the growth momentum

and exposed structural weaknesses that need to be addressed to revert to higher levels of growth. The

rate of poverty reduction also slowed since 2011.

ADB = Asian Development Bank, IED = Independent Evaluation Department.

Adapted from: Independent Evaluation Group. 2016. The World Bank Group’s Support to Capital Market Development. Washington,

D.C.

Capital Market Infrastructure

• Regulation

• Corporate governance

• Securities clearance and settlement

Other: Creditor Rights, Rating Agencies

Instruments/Issuers

• Bonds: Sovereign/Treasury (Government)

Corporate bonds (Companies)

• Equities/Stocks (Firms/Businesses)

• Asset-backed/Mortgage-backed securities

Other: Repos, Derivatives

Investors

• Insurance companies

• Pension funds

Other funds: mutual funds, sovereign

wealth funds, individuals

Interm

ed

iarie

s

Interm

ed

iarie

s

Returns

Investments

Financing the Real Sector through Capital Market Instruments

Project finance

(infrastructure)

Mortgage

finance: housing

Other real

sectors

Corporations:

• Risk capital

(equity)

• Long-term

debt

Government

budgets/public

borrowing

Soft infrastructure

Hard infrastructure

AD

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up

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Figure 2: Theory of Change: ADB Support to Capital Market Development in Indonesia

13. A World Bank report10

identified three pathways to reducing poverty and increasing shared

prosperity: strong economic and jobs growth, improved access to key services, and better national

resource management. It also identified infrastructure bottlenecks and underdeveloped financial markets

as major impediments to economic and employment growth. To address the infrastructure gap, the

Government is embarking on a largescale infrastructure development program. The plan comprises

investments of roughly $450 billion (about 50% of GDP) during 2015–2019 with significant role of private

investment and capital markets (Figure 3). The financing of infrastructure investment, which declined

(as % of GDP) since the Asian financial crisis, has been a major motivation of various plans to develop

capital markets and the financial system.11

10 World Bank Group. 2015. Indonesia Systematic Country Diagnostic: Connecting the Bottom 40 percent to the Prosperity

Generation. Washington D.C.

11 Appendix 2 presents a review by the IEG on available literature in terms of the relation between financial sector development

and economic growth as well as poverty reduction and inequality reduction. This review also provides a summary information

on the recent evolution of capital market development of countries at different income levels.

Source: Asian Development Bank Independent Evaluation Department.

xxx

Assumptions: Macroeconomic stability, Political commitment, Effective collaboration among stakeholders

• Supporting the establishment

and strengthening of a

unified regulatory oversight

for banks and nonbank

financial institutions

• Strengthening of the

institutional foundation

supporting capital market

development

• Promoting issuance of new

instruments, and increasing

mobilization of long-term

savings by broadening the

investor base

• Promoting social security

reforms

• Infrastructure financing

• Promoting financial inclusion

(microfinance, branchless

banking initiatives, financial

literacy, consumer protection)

• Improved legislative frameworks and

enacted laws for social security governance

• Financially viable infrastructure finance

institution

• Improved long-term debt market

• Increased equity investments in

infrastructure projects

• Growth of viable institutions and financial

markets development

• Developed PPP projects

• Enhanced access to financial services

• Strengthened regulatory oversight for banks

and nonbank financial institutions

• Enhanced information disclosure and

improved price discovery

• Deeper and more liquid financial markets

• Improved market surveillance and investor

protection

• Stronger governance and human resource

capacity

• Increased mobilization of long-term savings

through a broadened investor base

• Strengthened

financial services

regulation and

supervision and

efficiency

• Strengthened

investor confidence

through improved

governance

• Improved national

social security

• Greater

contribution by the

capital market to

domestic financing

• Increased domestic

participation in the

nonbank finance

subsector

• Developed and

inclusive finance

sector

• Efficient allocation

of financing to

economically viable

infrastructure

projects

Development Impacts

Greater financial sector resilience and diversification; An expanded nonbank finance subsector; Increased annual growth rate of financial sector

supporting increased intermediation; Strengthened financial sector governance and social security system to facilitate broad -based economic

growth and reduced vulnerability to crises; Improved and equitable access to infrastructure for economic growth and poverty reduction

In

puts/A

ctivities

Ou

tp

uts/Interm

ed

iate O

utco

mes

Ou

tco

mes

8

Figure 3: Funding Sources to Fill the Existing Infrastructure Investment Gap

2. Financial System Structure and Oversight

14. Indonesia’s financial system continues to be relatively shallow and bank-centered, with a

substantial presence of the State and a narrow domestic institutional investor base. At end-2015, total

financial sector assets amounted to 72% of GDP, three quarters of which represents banking assets. The

insurance sector has been the fastest growing segment and drove the expansion of total system assets

by 8 percentage points of GDP during 2005–2015. Despite substantial progress since the 2010 FSAP, the

2017 FSAP found that the financial sector was not yet sufficiently able to fund development needs, and

that capital markets did not provide sufficient funding nor represented a competitive alternative to

banks.12

15. The financial system is composed of banks, nonbanks and financial conglomerates, with the

Government planning to establish a state holding company. Banks are the largest segment, with

commercial banks’ assets at 55% of GDP and 77% of financial system assets as of end-2015. Holdings of

state-owned commercial and regional development banks were close to 40% of the banking sector’s

assets and dominating certain credit segments such as microloans. Insurance companies and pension

funds accounted for 13% of financial system assets, with other nonbank financial institutions (NBFIs)

accounting for 10% as of end-2015 (Table 1). The 44 identified financial conglomerates accounted for

about 66% of financial sector assets, including 84% of banking sector assets and majority of insurers.

The Government is expected to create a holding company for state-owned financial institutions before

end-2017, bringing together the state-owned banks, a financial entity specializing in small and medium

enterprise (SME) lending, and a payment switch provider.

12 IMF and World Bank. 2017. Financial Sector Assessment: Republic of Indonesia. Washington, D.C.

Source: World Bank Group. 2015. Indonesia Systematic Country Diagnostic: Connecting the Bottom 40 percent to

the Prosperity Generation. Washington D.C.

In $ billion

2010 2011 2012 2013 2014 2015F 2016F 2017F 2018F 2019F 2020F

70

60

50

0

0

40

30

20

10

0

9

Table 1: Finance Sector Development, 2000–2015

Percent of GDP

Percent of

Total Financial System Assets

2000 2005 2010 2015 2000 2005 2010 2015

Financial System Structure

Total Assets 84.4 63.4 59.9 71.7 100.0 100.0 100.0 100.0

Deposit-taking Institutions 77.0 52.0 45.6 55.4 91.0 82.1 76.1 77.3

o/w state-owned banks … 18.7 16.3 20.0 … 29.5 27.1 28.0

NBFIs 7.6 11.3 14.3 16.3 9.0 17.9 23.9 22.7

Insurance Companies 2.2 4.4 5.9 7.2 2.6 6.9 9.9 10.0

Pension Funds 2.2 2.2 1.9 1.8 2.6 3.5 3.2 2.5

Other NBFIs 3.2 4.8 6.5 7.3 3.8 7.6 10.8 10.2

Financial System Performance

Domestic Credit to Private Sector 19.9 26.4 27.2 36.5

Credit to Government and SOEs 32.4 12.2 3.5 3.3

Stock Market Capitalization 16.2 28.5 47.7 41.0

Local Currency Bond Market 36.7 19.2 14.0 15.2

Government Bonds 35.4 17.1 12.3 13.0

Corporate Bonds 1.3 2.1 1.7 2.2

2011 2014

Financial Inclusion

Account (% age 15+) … … 19.6 36.1

Account, female (% age 15+) … … 19.2 37.5

Account, poorest 40% (% age 15+) … … 10.0 22.2

… = not available, GDP = gross domestic product, NBFI = nonbank financial institution, o/w = of which, SOE = state-owned

enterprises.

Sources: IMF-World Bank Financial Sector Assessments 2010 and 2017; World Bank Group Global Financial Database; Global

Partnership for Financial Inclusion, and Asian Development Bank AsianBondsOnline.

16. The 2017 FSAP reports that the financial sector lags peer countries in several areas although it is

not systematically out of line with countries at a similar level of economic development. Bank credit in

Indonesia is about 40% of GDP, thus, credit intermediation is low but roughly in line with other countries

with comparable GDP per capita. Equity markets are not at par with other countries, with stock market

capitalization at 41% of GDP, and underperform the median of peers by about 30 percentage points of

GDP. The fixed income market is underdeveloped relative to peer countries, with private debt securities

at about 2.5% of GDP and tradeable government securities just at 13% of GDP. Domestic institutional

investors’ assets are low relative to peer countries, with assets under pension funds at just below 2% of

GDP. Foreign investors play a significant role given the absence of domestic investor base, holding almost

40% of government securities and 54% of equities. Financial inclusion indicator is also below peer

countries, with 36% of adults holding transactional account which is far below the 69% regional average.

A McKinsey study performed a comparative review of capital market development in selected Southeast

Asian countries and found that Indonesia lagged most peer countries overall, but performed better in

certain areas (Table 2).

Table 2: Southeast Asian Capital Markets Development Index

Capital Market Development Index and Components SIN MAL THA PHI INO VIE

Capital Markets Development Index (Composite) 3.40 3.25 2.80 2.25 2.20 1.20

(i) Funding at Scale

Financial Depth of Primary Market 3 3 3 2 2 1

Availability of Long Term Debt 4 4 3 3 1 1

Availability and Stability of Foreign Investment 4 3 2 3 5 3

Competitiveness of Cost of Capital

Real Cost of Equity 4 5 3 1 4 1

Real Cost of Debt 3 3 3 3 2 1

(ii) Investment Opportunities

10

Capital Market Development Index and Components SIN MAL THA PHI INO VIE

Availability of Investment Opportunities Across Asset

Classes

4 4 3 2 1 1

Appropriate Risk-Adjusted Returns 0.76 0.60 1.13 1.38 0.88 0.72

(iii) Market Information

Quality of Pricing Information 0.170 0.191 0.185 0.185 0.131 0.224

INO = Indonesia, MAL = Malaysia, PHI = Philippines, SIN = Singapore, THA = Thailand, VIE = Viet Nam.

Scoring for each component:

Financial Depth of Primary Market: 1=very shallow; 2=shallow; 3=moderate; 4=deep; 5=very deep

Availability of Long Term Debt: 1=very shallow; 2=shallow, short term oriented; 3=shallow, long term oriented; 4=deep,

short term oriented; 5=deep, long term oriented

Availability and Stability of Foreign Investment: 1=closed; 2=local investor oriented, unpredictable; 3=local investor oriented,

predictable; 4=foreign investor oriented, unpredictable; 5=foreign investor oriented, predictable

Competitiveness of Cost of Capital: (i) Real Cost of Equity: 1=high; 5=low; and (ii) Real Cost of Debt (1=high; 5=low)

Availability of Investment Opportunities Across Asset Classes: 1=very shallow; 2=shallow; 3=moderate; 4=deep; 5=very deep;

(>0) = weak; <0.0 = very weak

Appropriate Risk-Adjusted Returns: >2 = excellent (not applicable for any markets analyzed; >1.20 = very strong; >0.80 =

strong

Quality of Pricing Information: <0.090 = highly efficient; <0.130 = efficient; (<0.170) = moderate; <0.210 = inefficient;

>0.210 = highly inefficient

Total score out of 5 (5 as the highest, meaning very deep capital market, 1 as very shallow).

Source: McKinsey & Company. 2017. Deepening Capital Markets in Emerging Economies.

17. A unified regulator for banks and nonbanks was established. In 2011, the Indonesia Financial

Services Authority Law was enacted establishing a new integrated regulator (Otoritas Jasa Keuangan or

OJK). OJK assumed responsibility for banking supervision from BI effective January 2014 and for nonbank

financial institution supervision effective January 2013. There are transitional and operational challenges

for OJK, including: need for capacity building for staff supervisory skills and experience; potential overlap

of supervisory activities between OJK, BI, and the Indonesian Deposit Insurance Corporation (LPS); and

need for change in governance structure within OJK which is sector-based resulting in operational silos.

There is a call for the amendment of OJK Law to place priority on financial stability objectives and make

legal protection in accordance with international best practice.

18. While the establishment of OJK presented transitional and operational risks, the financial system

has been stable—financial soundness indicators for the banking system continued to improve after 2010

(Table 3). The FSAP 2017 concluded that the financial system has been stable and has weathered a

simultaneous economic and credit deceleration. The framework for crisis management and resolution

and safety nets was revamped in 2016 with the enactment of the Prevention and Resolution of System

Financial Crisis Law and the establishment of the Financial System Stability Committee (Komite Stabilitas

Sistem Keuangan or KSSK)–composed of the Finance Minister and the heads of BI, OJK, and the LPS–

which is responsible for dealing with distress or failure of systematically important banks.

3. Development Challenges in the Finance Sector

19. The authorities have undertaken several measures to boost credit growth and improve

intermediation efficiency in banks. These measures included enforcing deposit rate caps for the largest

banks, using moral suasion by OJK to induce lower lending rates, and use of guarantees and credit

subsidies to boost MSME and micro lending. However, the 2017 FSAP raised concerns about the lack of

effectiveness and unintended consequences of many of the policy measures. The FSAP recommended

that the authorities focus on addressing cross-cutting financial system fundamentals such as

strengthening insolvency and credit rights regimes, improving quality of accounting and auditing for

banks, and enhancing the impact of digital financial services.

11

Table 3: Banking System Soundness Indicators (%), 2002–2015

2002 2005 2010 2015

Capital Adequacy

Regulatory Capital to risk weighted assets 20.9 19.9 16.2 21.3

Regulatory Capital Tier 1 to risk weighted assets 16.4 16.5 15.1 18.8

Capital to Assets 8.4 9.8 10.7 13.6

Asset Quality

Nonperforming Loans to Total Gross Loans 7.6 7.4 2.5 2.4

Earning and Profitability

Return on Assets 1.1 1.7 2.7 2.2

Return on Equity 16.2 21.4 25.9 17.3

Liquidity and Funding

Liquid Assets to Short Term Liabilities 30.2 31.5 32.1 35.0

Non-interbank loans to customer deposits 49.6 61.5 81.6 100.4

Sources: IMF Financial Soundness Indicator Database; IMF-World Bank Financial Sector Assessments 2010 and 2017.

20. Given Indonesia’s long-term finance and investment gap, particularly in infrastructure, capital

markets can play a larger role in mobilizing longer-term capital from foreign and domestic sources. In

addition, deeper local currency markets and a stronger domestic investor base can help reduce the impact

of currency shocks and risk of capital outflows posed by the currently large role of foreign investors.

However, to date, there is a strong concern that capital markets have not been a significant source of

financing infrastructure investments and have not been able to reduce reliance on banking and fiscal

finance. To develop the country’s shallow capital markets, the 2017 FSAP suggests the following:13

(i) Money markets should be developed. This will help spur a robust market for interest rate

derivatives and improve market infrastructure, standardization, and liquidity.

(ii) Government bond markets are relatively developed, but there is a need to enhance the

liquidity and the price referencing role of its yield curve.

(iii) Corporate bond markets are shallow. Companies still prefer bank loans and seem to be

the only funding option for many of them while investors seem to prefer SOE

instruments.

(iv) Equity markets have improved yet there are limitations on attracting new listings and

increasing the amount of initial public offerings (IPOs).

(v) Derivatives is an instrument that is not yet developed, limiting investors’ ability to

manage duration and currency mismatches—an impediment to deeper capital markets.

(vi) Investor base is yet to grow and market participation is yet to improve even if there have

been measures to mobilize savings such as social security reform and enhanced

regulations of capital market products.

21. The Government has begun to focus attention on financial inclusion with the issuance of the

National Financial Inclusion Strategy in 2012. According to the 2011 World Bank’s Global Findex survey,

only about 20% of adults held an account at a formal institution, which is a measly 16% in rural areas,

and even less for the poorest 40% of the adult population. This reflects a large number of the population

excluded from the formal financial sector and broadly reflects the widening income inequality. Access to

financial services in far-flung areas is poor. Aside from geography and lack of physical access, challenges

for improving financial inclusion include low levels of financial literacy and education, high transaction

costs, income level and socio-economic factors, and lack of identification documents (footnote 10). The

Indonesian National Kris Secretariat (Sekretariat Nasional Perkerisan Indonesia or SNKI), which enables

coordination and provides guidance to policy initiatives among different stakeholders, has an ambitious

goal of 75% of adults having a transaction account by end-2019. OJK’s National Survey on Financial

Literacy and Inclusion in 2016 showed an improvement in two indices compared to the 2013 survey: (i)

financial literacy (22% to 30%); and (ii) financial inclusion (60% to 68%).

13 IMF and World Bank. 2017. Financial Sector Assessment: Republic of Indonesia. Washington, D.C.

12

C. ADB Support to Capital Market Development, 2002–2017

1. ADB Sector Programs Strategies

22. ADB’s strategies for supporting Indonesia’s finance sector during 2002–2017 shifted focus

compared to prior years. ADB engagement from 1970–2000 mainly covered the banking sector (including

development banks) (footnote 2). Starting 2002, ADB focused on supporting reforms for transforming

governance structures of the financial sector into a single regulatory body and developing capital

markets. Towards the end of the period, ADB also begun addressing financial inclusion and access issues.

The strategies adopted were in line with the government’s strategies and priorities for the sector. Table

4 summarizes ADB’s strategies to support Indonesia’s finance sector during 2002–2017.

Table 4: Summary of Key Strategic Focus Areas of ADB Support to Financial Sector in Indonesia,

2002–2019

2002–2005 2006–2009 2010–2015 2016–2019

1. CAP, 2001–2003

continue to promote

good governance

through restructuring

and transformation

of new regulatory

institution for

financial markets,

and on reforms of

nonbank financial

sector

2. COS, 2001

encourage formation

and strengthening of

regulatory

institutions and

support broader and

deeper reforms for

the nonbank financial

sector

3. CSPU, 2002–2004

develop the nonbank

financial sector and

capital market,

including

improvement of

governance practices

4. CSP, 2003–2005

support financial and

corporate governance

and private sector

development

1. CSPU, 2004–2006

continue to support

efforts for improved

governance,

environment, and

investment climate

2. CSPU, 2005

support microfinance,

local government

financing, and financing

facility intended to

promote private sector

investments in urban

infrastructure

3. CSP 2006–2009

deepen the financial

sector by focusing on

strengthening of

nonbank financial

institutions and

development of capital

market

1. COBP 2011–2013a

contribute to deeper

and broader capital

markets to support

greater financial sector

resilience and

diversification

2. CPS 2012–2014

support the

implementation of

finance sector reforms

under the government’s

capital markets and

nonbank financial

industry master plan

3. I-CPS, 2015

support the

development and

application of the

country’s enabling

economic policies, which

was aimed to (i) deepen

and strengthen

Indonesia’s capital

markets, (ii) foster

greater financial

inclusion, and (iii) reduce

impediments to

investment and

economic growth

1. CPS 2016–2019

support capital market

and financial inclusion

reform to contribute to

better economic

governance

ADB = Asian Development Bank, CAP = country assistance plan, COBP = country operations business plan, COS = country

operational strategy, CPS = country partnership strategy, CSP = country strategy and program, CSPU = country strategy and

program update, I-CPS = interim country partnership strategy.

a The country operations business plans 2011–2013 and 2012–2014 extended the CSP to 2010 and 2011. The COBP 2011–2013

updated the CSP 2006–2009 results framework reflecting the finance sector as one of the core sectors supporting the government

sector objective of greater financial sector resilience and diversification. Supporting this objective, ADB was expected to contribute

to deeper and broader and capital markets. ADB’s planned interventions were in capital markets development, private sector

operations in microfinance, and nonsovereign operations to enhance access of companies to finance.

Sources: Asian Development Bank country planning documents for Indonesia; Country Assistance Program Evaluation, 2005.

23. ADB’s current country partnership strategy (CPS), 2016–2019 expects the finance sector to

contribute to better economic governance. One of the priority areas under this is capital market and

financial inclusion reform. The argument for the support is that a deeper, more broadly-based finance

13

sector should help to promote economic growth through productive investments, foster greater

economic stability, and support livelihoods and job creation by improving access by households and small

businesses to financial services. ADB support aims to improve market infrastructure and encourage

product diversification in the bond market. Financial inclusion will be enhanced by addressing regulatory

impediments, poor financial literacy, weak consumer protection, and by developing innovative

microcredit products to better meet the needs of the poor. TA and financial support to SMEs to enable

them to build viable value-chains and integrate into regional and global markets are also planned.

24. IED Program Review Ratings. The CAPE 200514

assessed that ADB had a comparative advantage

in providing loans in some sectors including in finance and ADB’s focus on advisory TA projects for the

finance sector improved over the years, with substantial impact on the sector. However, ADB’s

performance on the development finance loans was marginal (footnote 2).

25. The Country Partnership Strategy Final Review Validation (CPSFRV) 2011 reported that in the area

of deepening the finance sector, improved domestic resource mobilization to meet long-term financing

needs was expected to help leverage much greater private sector participation. However, targets in the

country strategy and program (CSP) results framework were missed, most notably in the failure to

stimulate private infrastructure investment and in relation to finance sector deepening.

26. The CPSFRV 2015 highlighted that project performance was better in some sectors including in

finance. ADB support for capital market reforms and capacity development has made a positive

contribution to: (i) strengthening regulatory and legal structures; (ii) developing the insurance, pension,

and Islamic financing markets; and (iii) improving the analysis and design of programs aimed at

enhancing financial inclusion.

2. Analytical Work

27. Prior to 2002, ADB had built up a body of knowledge through a series of TA projects. TA projects

supported a two-phased study on securities market development (1989 and 1991). There were several

TA projects focusing on the development of the pension fund, insurance, and venture capital industries.

There was a study on developing the secondary mortgage facility which would enable issuance of capital

market instruments.

28. Most of ADB’s analytical work during 2002–2017 were embedded in the PBLs which included

sections describing and identifying the development issues in various aspects of capital markets. In

addition, various TA projects produced several studies to further improve design of ADB interventions in

various aspects or segments of the capital market. The Financial Governance and Social Security Reform

TA, which accompanied the Financial Sector Governance and Social Security Reform Program, included a

feasibility study for social security reform and an assessment of the financial condition of the insurance

sector. The Strengthening Regulation and Governance TA, which accompanied the CMDPC, included a

diagnostic with recommendations on how to harness capital market to support SMEs. As part of ADB

Papers on Indonesia—quick-disseminating and informal publications maintained by the Resident Mission

in Jakarta—ADB issued a summary financial sector assessment15

in 2015. Several ADB regional TA

programs are supported by analytical work and provide information in Indonesia’s capital market.

29. There were several major economic and sector work produced by the World Bank and the IMF

during 2002–2017. The World Bank issued a major study of NBFIs in 1996—the study was comprehensive

and included short and medium-term recommendations for each NBFI segment. There were two joint

IMF-World Bank FSAP reports, one in 2010 and a follow-up in 2017. Both had substantive coverage of

capital markets and included specific recommended actions to be undertaken in the short to medium-

term. The 2017 FSAP also included a scorecard on implementation of recommended actions in the 2010

14 The first CAPE prepared for Indonesia, which covered ADB support during 1990 and 2004.

15 ADB. 2015. Summary of Indonesia’s Finance Sector Assessment. Jakarta.

14

FSAP. The World Bank and IMF also published in 2001 a handbook on how to develop government bond

markets.16

30. The Asian Bond Monitor (ABM)—published by ADB three times a year—provides detailed

information about the condition of local currency bond markets. The ABM covers ten ASEAN member-

countries, including Indonesia, plus the People’s Republic of China (PRC); Hong Kong, PRC; and the

Republic of Korea. In addition to monitoring development in the local currency (LCY) bond markets in

these countries, ADB examines outlook, risks, and policy options. ADB also provides an annual bond

market liquidity survey and in certain issues produces analytical pieces, such as the examination of

empirical evidence on whether LCY bond markets enhance financial stability.

3. Lending and grant operations

31. For 2002–2017, ADB approved 8 loans and a grant amounting to $2.0 billion to support

Indonesia’s finance sector. The interventions were supported mainly by PBLs ($1.95 billion) except for

two project loans and a grant (Table 5).

Table 5: ADB Finance Sector Loans, 2002–2017

Approval

Year

Loan/

Grant

No. Title

Modality Sub

sector

Approved

Amount

($ million)

2017 3541 Financial Market Development and Inclusion Program (Subprogram 2) Program FSD 400.0

2015 3274 Financial Market Development and Inclusion Program (Subprogram 1) Program FSD 400.0

2012 2895 Financial Market Development and Integration Program Program MCM 300.0

2009 2577 Capital Market Development Program Cluster (Subprogram 2) Program FSD 300.0

2007 2379 Capital Market Development Program Cluster (Subprogram 1) Program ICS 300.0

2009 2516 Indonesian Infrastructure Financing Facility Project FSD 100.0

2005 9079 Restoration of Microenterprise and Microfinance in Aceh Project MF 2.0

2004 2277(L) Microcredit Project MF 1.0

2002 1965 Financial Governance and Social Security Reform Program (Phase I) Program ICS 250.0

Total 2,053.0

ADB = Asian Development Bank, FSD = finance sector development, ICS = insurance and contractual savings, MCM = money and capital

markets, MF = microfinance.

Note: A program is supported by a policy-based loan.

Sources: Asian Development Bank Loan, Grant, TA, and Equity Approvals database; Loans and Grants Financial Information System.

32. 2002–2005: Financial Sector Regulatory Reform and Development of Contractual Savings

Institutions. The 2002 First Finance Governance and Social Security Reform (FGSSR)—designed as a

program cluster (Box 2)—was envisioned to support the establishment of OJK and promote social security

reform including governance of pension funds, an important part of the nonbank financial sector.17

The

FGSSR built on the core reforms under the 1998 Financial Governance Reforms: Sector Development

Program (FGRSDP) with additional actions in the areas of disclosure, transparency, and enforcement of

regulations to support strengthening of the financial sector while reducing vulnerability to crisis. The

FGSSR program included TA projects to strengthen the insurance industry and develop the social security

system. The second loan in the cluster did not materialize due to the adoption of a phased approach to

the establishment of a single regulatory institution.

16 World Bank and IMF. 2001. Developing Government Bond Markets: A Handbook. Washington D.C.

17 ADB. 2002. Report and Recommendation of the President to the Board of Directors on the Proposed Loans and Equity Investment

to Indonesia for the Financial Governance and Social Security Reform Program. Manila.

15

33. The project completion report (PCR) assessed the program successful. However, because

Parliament found the transition plan towards a single regulatory institution to be ambitious and required

the authorities to follow a phased approach, the PCR considered the program less than relevant and less

than effective. Nonetheless, the program resulted in the merger of Bapepam and the Directorate General

of Financial Institutions to consolidate supervision of capital markets and nonbank financial institutions.

The PCR based the overall rating of successful on improvements in the regulatory and supervision system

because of the measures supported by the program.18

While there were attribution issues, there were

improvements in several key financial system indicators: total assets of nonbank financial institutions as

percentage of GDP increased from 8% in 2000 to 11% in 2005 and stock market capitalization as

percentage of GDP increased from 16% in 2000 to 28% in 2005.

34. 2006–2009: Comprehensive Support to Capital Market. ADB approved the CMDPC Subprogram

1 in 2007 and the CMDPC Subprogram 2 in 2009 (footnote 1). The CMDPC aimed to promote

diversification and resilience of the financial sector by developing capital markets and the nonbank

financial sector through: (i) enhancing information disclosure and price discovery, (ii) promoting deeper

and more liquid financial markets, (iii) improving market surveillance and investor protection, and (iv)

strengthening governance and human resource capacity. In 2009, ADB approved the Indonesian

Infrastructure Financing Facility (IIFF) Project which had two components: (i) an ordinary capital resources

loan to the Government to be onlent to the Indonesian Infrastructure Financing Facility Company (IIFFC)

which is privately-owned; and (ii) a nonsovereign equity investment in IIFFC.19

35. The PPER for the CMDPC considered the program successful. Notwithstanding the gains in

establishing the institutional foundation for capital market development, some critical areas did not meet

expectations including corporate bond market growth. The development impact was viewed as less than

satisfactory overall because of the nonachievement of the target on increased share of nonbank financial

sector assets in total financial system assets.20

36. In 2009, ADB approved a sovereign loan to and a nonsovereign equity investment in the IIFF. The

PCR for the IIFF Project assessed the project successful based on the achievement of outcomes and

outputs in the design and monitoring framework (DMF). However, ADB performance was rated less than

satisfactory since ADB monitored only the loan agreement and not the project agreement, which was

only partially complied with. One of the lessons was the importance of coordination between the Private

Sector Operations Department (PSOD) and Southeast Asia Regional Department.21

18 ADB. 2006. Project Completion Report: Financial Governance and Social Security Reform Program. Manila.

19 ADB. 2009. Report and Recommendation of the President to the Board of Directors on the Proposed Loan and Equity Investment

to Indonesia for the Indonesian Infrastructure Financing Facility. Manila.

20 IED. 2017. Program Performance Evaluation Report: Capital Market Development Program Cluster. Manila: ADB.

21 ADB. 2017. Project Completion Report: Indonesian Infrastructure Financing Facility. Manila.

Box 2: Designing Program Clusters

One of main lessons in the program completion report (PCR) for the Finance Governance and Social Security

Reform (FGSSR) was the usefulness of the program cluster modality in supporting broad-based reforms requiring

long-term institutional development. The program cluster combines a long-term approach covering a wide range

of policy and institutional reforms with flexibility to adjust in response to changing circumstances. The long-

term approach allows for gradual introduction and appropriate sequencing of policies and reforms to result in

smooth implementation. The PCR recommended a shift from a multitranche program cluster to a medium-term

framework based on single tranche programs to focus on achievement of outcomes prior to disbursement.

Subsequent to the FGSSR were program clusters such as the Capital Market Development and Financial Market

Development and Inclusion.

Source: Program Completion Report for the Finance Governance and Social Security Reform.

16

37. 2012–2014: Support for Implementation of Financial Sector Reforms. ADB approved the 2012

Financial Market Development and Integration Program (FMDIP [Integration])22

which built on the

CMDPC and its Post Program Monitoring Framework. The FMDIP (Integration) aimed to expand the

nonfinancial sector by: strengthening regulatory oversight; deepening capital market through measures

promoting issuance of new instruments; and increasing mobilization of long term savings by broadening

the investor base. The FMDIP (Integration) was a milestone in ADB’s long standing efforts towards a

single regulator for financial institutions and supported to the Government’s Capital Market and

Nonbank Financial Industry Master Plan 2010–2014. A related TA was the 2013 Enhancing Financial

Sector Governance, Risk Management, and Depth Project.23

38. The PCR assessed the FMDIP (Integration) successful overall, but less than effective since the

program only partially met the outcome indicators in the DMF, mainly in domestic participation of the

nonbank financial sector in capital markets through ownership of tradeable government securities. The

PCR cited as one of the lessons the need for greater selectivity and reduction in the number of policy

measures by identifying the main bottlenecks to reforms. In addition, the PCR reconfirmed the

importance of TA in reform implementation.24

39. 2015–present: Financial Inclusion. The 2015 PBL for Subprogram 1 and the June 2017 PBL for

Subprogram 2 of the FMDIP (Inclusion) included a component on enhancing access to finance.25

The

program’s financial inclusion component focused on developing microfinance by enacting a legal

framework and strengthening related institutions, launching the branchless banking initiative, enhancing

financial literacy initiatives, and strengthening consumer protection. The enhancing access to financial

services component supported the 2012 National Strategy for Financial Inclusion which was updated in

2016. The program also included components on strengthening the regulatory structure and deepening

financial markets and followed up on some of the initiatives covered by previous programs. While the

CMDPC and the FMDIP (Integration) DMF impact and outcomes focused on capital market and nonbank

financial sector indicators, FMDIP (Inclusion) impact and outcome indicators covered the finance sector

as a whole.

40. Success Rate. The PCRs/program/project performance audit reports (PPARs)/PCR validation reports

(PVRs) assessed all five operations as successful (Table 6). All the PBLs were assessed as successful by the

PCR. The PPER assessed the CMDPC as successful.

Table 6: Ratings for Finance Sector Lending Operations, 2002–2017

Loan/Grant

No. Project Title

Approval

Year

Evaluation

Type

Evaluation

Year

Overall

Rating

1965 Financial Governance and Social Security

Reform Program

2002 PCR 2006 Successful

9027 Restoration of Microenterprise and

Microfinance in Aceh

2005 ICM 2010 Satisfactory

2379/

2577

Capital Market Development Program

Cluster

Subprogram 1

Subprogram 2

2007

2009

PVR

PPER

2015

2017

Successful

Successful

2516 Indonesian Infrastructure Financing Facility 2009 PCR 2017 Successful

22 ADB. 2012. Report and Recommendation of the President to the Board of Directors on the Proposed Policy-Based Loan to

Indonesia for the Financial Market Development and Integration Program. Manila.

23 ADB. 2013. Technical Assistance to Indonesia for Enhancing Financial Sector Governance, Risk Management, and Depth. Manila.

24 ADB. 2017. Project Completion Report. Financial Market Development and Integration Program. Manila; A validation report is

forthcoming.

25 ADB. 2015. Report and Recommendation of the President to the Board of Directors on Proposed Programmatic Approach and

Policy-Based Loan for Subprogram 1 Financial Market Development and Inclusion Program. Manila; ADB. 2017. Proposed Policy-

Based Loan for Subprogram 2 and Technical Assistance Grant for the Financial Market Development and Inclusion Program.

Manila.

17

Loan/Grant

No. Project Title

Approval

Year

Evaluation

Type

Evaluation

Year

Overall

Rating

2895 Financial Market Development and

Integration Program

2012 PCR 2017 Successful

ICM = implementation completion memorandum, PCR = program/project completion report, PPER = program performance

evaluation report, PVR = validation report of the PCR.

Sources: Asian Development Bank Independent Evaluation Department; Evaluation reports.

4. Technical assistance operations

41. From 2002 to 2017, 16 TA projects26

amounting to $15.6 million supported the finance sector

in Indonesia (Table 7). There has been extensive use of TA projects in ADB’s finance sector operations. TA

projects have been an important source of support for the implementation of PBL supported programs

since 2000, with many lessons from evaluations pointing to the contribution of accompanying or parallel

TA projects to program success. However, only three TA projects amounting to $2.5 million (or 16% of

total amount of TA) focused on capital market issues.

Table 7: ADB Finance Sector Technical Assistance, 2002–2017

Approval

Year

TA

No. Title

Type Sub

Sector

Approved

Amount

($ million)

2017 9333 Promoting Innovative Financial Inclusion PA FSD 0.8

2015 9054 Enhancing the Regulatory Framework of Financial Sector Development

and Oversight

PA MCM

1.5

2014 8753 Strengthening the Local Government Bond Market CD FSD 0.4

2013 8326 Enhancing Financial Sector Governance, Risk Management, and Depth CD FSD 1.0

2012 8318 Global Climate Partnership Fund - Indonesia Investment Program PP FSD 0.5

2012 8224 Improving Access to Finance in Aceh and North Sumatra CD MF 0.8

2011/2014 7793 Institutional Capacity Building of Indonesia Eximbank CD TF 1.7

2009 7466 Strengthening Indonesia's Capital Market CD MCM 1.5

2007 7000 Strengthening Regulation and Governance AD FSD 1.2

2005 4715 Secondary Mortgage Facility AD HF 0.6

2004 4550 Development of an Anti-Money Laundering Regime I AD FSD 0.5

2004 4368 Financing Integrated Settlements Development PP HF 0.8

2003 4250 Unified Registration System AD ICS 0.3

2002 4024 Financial Governance and Social Security Reform AD FSD 1.0

2002 3849 Development of an Anti-Money Laundering Regime AD FSD 1.5

2002 3850 Establishment of a Financial Services Authority AD FSD 1.5

Total 15.6

AD = advisory, ADB = Asian Development Bank, CD = capacity development, HF = housing finance, FSD = finance sector development,

ICS = insurance and contractual savings, MCM = money and capital markets, MF = microfinance, PA = policy advisory, PP = project

preparatory, TA = technical assistance, TF = trade finance.

Sources: Loan, Grant, TA, and Equity Approvals database; TA Financial Information System.

42. Technical assistance completion report (TCR) Ratings. Out of nine TA projects with ratings, six

were self-assessed as successful, one was less than successful, and two were viewed as unsuccessful

(Table 8). Of the two unsuccessful TA projects, one was not linked to financial sector projects or programs

and the other supported the development of a new institution that would contribute to the increase and

diversity of capital market instruments and issuers. An important lesson from the less than successful

project was the difficult challenge of sustainable capacity and institutional development.

26 Including project preparatory TA.

18

Table 8: Ratings for Finance Sector Technical Assistance Projects, 2002–2017

TA No. Project Title

Approval

Year

Overall

Rating Related Operation

2699 Institutional Strengthening of Regional

Development Account 2002 Unsuccessful None

3849 Development of an Anti-Money

Laundering Regime 2002 Successful

Finance Governance and Social

Security Reform

3850 Establishment of a Financial Services

Authority 2002 Successful

Finance Governance and Social

Security Reform

4024 Financial Sector Governance and Social

Security Reform 2002 Successful

Finance Governance and Social

Security Reform

4250 Unified Registration System 2003 Successful

Finance Governance and Social

Security Reform

4550 Development of an Anti-Money

Laundering Scheme II 2004 Successful

Finance Governance and Social

Security Reform

4715 Secondary Mortgage Facility 2005 Unsuccessful None

7000 Strengthening Regulation and

Governance 2007

Less than

Successful

Capital Market Development

Program Cluster

7466 Strengthening Indonesia's Capital Market 2009 Successful

Capital Market Development

Program Cluster

Sources: Asian Development Bank Independent Evaluation Department, Project documents, and TA completion reports.

D. Assessment of Relevance and Results

43. Table 9 provides the distribution of policy actions covering the PBLs during 2002–2017. Capital

market related policy actions accounted for 86%–97% of the total programs for FGSSRP, CMDPC, and

FMIDP (Integration). The FMDIP (Inclusion) capital market related policy actions were only 40% of its total

program, with support to OJK strengthening and banking system reforms accounting for 27% share each

(Table 9). Within the capital market segment for all programs, policy actions on market infrastructure

accounted for almost half, with actions on instruments/issuers and investors equally sharing the

remainder.

Table 9: Distribution of Policy Actions of ADB Policy-based Loans, 2002–2017

Policy-based loans

Capital Market Policy Actions Other Policy Actions

Total

Program

Capital

Market

Infrastructure

Capital

Market

Issuers

Capital

Market

Investors

Total

Capital

Markets Banking OJK Coordination

FGSSRP 35% 0% 51% 86% 7% 7% 0% 100%

CMDPC

Subprogram 1 39% 35% 20% 94% 4% 0% 2% 100%

CMDPC

Subprogram 2 63% 28% 9% 100% 0% 0% 0% 100%

Subtotal 51% 32% 15% 97% 2% 0% 1% 100%

FMDIP

(Integration) 39% 34% 22% 95% 2% 2% 0% 100%

FMDIP (Inclusion)

Subprogram 1 17% 13% 13% 43% 22% 26% 9% 100%

FMDIP (Inclusion)

Subprogram 2 24% 4% 8% 36% 32% 28% 4% 100%

Subtotal 21% 8% 10% 40% 27% 27% 6% 100%

Total 39% 21% 22% 82% 8% 7% 2% 100%

ADB = Asian Development Bank, CMDPC = Capital Market Development Program Cluster, FGSSRP = Financial Governance and Social Security

Reform Program, FMDIP (Inclusion) = Financial Market Development and Inclusion Program, FMDIP (Integration) = Financial Market

Development and Integration Program, OJK = Otoritas Jasa Keuangan.

Sources: Asian Development Bank Independent Evaluation Department, Policy Matrices.

19

1. Market Infrastructure

44. A sound market infrastructure is critical to the functioning of capital markets. The infrastructure

includes “soft” components, such as an appropriate legal and regulatory framework, non-distortionary

tax treatment of products and services, effective and credible institutions such as the supervision

agencies, good corporate governance and accounting standards, and protection of credit rights. The

“hard” components include trading systems, settlement and clearance mechanisms, and securities

depositories. Table 10 gives the distribution of policy actions supporting different components of market

infrastructure.

Table 10: Distribution of Market Infrastructure Policy Actions, 2002–2017

Policy-based loans

Legal,

Regulatory,

Tax Regime

(AML)

Supervision,

Rating

Agencies,

Investor

Protection/

Education

Corporate

Governance

and

Accounting

Standards

Trading

Systems

Studies/

Plans/Others

Total Market

Infrastructure

FGSSRP 20% 13% 47% 20% 0% 100%

CMDPC

Subprogram 1 26% 42% 11% 21% 0% 100%

CMDPC

Subprogram 2 28% 24% 10% 28% 10% 100%

Subtotal 27% 31% 10% 25% 6% 100%

FMDIP

(Integration) 25% 25% 31% 13% 6% 100%

FMDIP (Inclusion)

Subprogram 1 0% 25% 75% 0% 0% 100%

FMDIP (Inclusion)

Subprogram 2 17% 17% 17% 17% 33% 100%

Subtotal 10% 20% 40% 10% 20% 100%

Total 24% 26% 24% 20% 7% 100%

AML = anti-money laundering, CMDPC = Capital Market Development Program Cluster, FGSSRP = Financial Governance and Social

Security Reform Program, FMDIP (Inclusion) = Financial Market Development and Inclusion Program, FMDIP (Integration) = Financial

Market Development and Integration Program.

Sources: Asian Development Bank Independent Evaluation Department, Policy Matrices.

45. Improving legal, regulatory, and tax framework. The policy actions covering the legal and

regulatory framework included amendments to the Capital Market, Pension and Insurance Laws and Anti-

Money Laundering Law, as well as issuance of regulations that would improve transparency and upgrade

professionalism in the sector. In the area of taxes, the policy actions focused on promoting a more

conducive tax environment. This included incentives for listed companies with a minimum public float of

40% as well as elimination of distortions such as the double taxation on repurchase agreements. The tax

disincentives (distortions) in Shariah-based products were also addressed.

46. About 65% of the legal, regulatory, and tax related policy actions were in the CMDPC, with

follow-up actions in the FMDIP (Integration) which accounted for 20%. The FMDIP (Inclusion) had one

policy action in this area (tax treatment of Islamic finance instruments).

47. The legal and regulatory policy actions were consistent with the capital market master plans

(CMMP) 2004–2009 and CMMP 2010–2014 which focused on establishing a fair and transparent

framework that guarantees legal and regulatory certainty. Many of the legal, regulatory, and tax issues

addressed by the ADB programs were identified in the 2006 World Bank NBFI study which was a major

economic and sector work discussed with the government. The CMDPC included many of the

recommendations in the World Bank NBFI study. In addition, the 2010 FSAP, which included a Review of

Standards and Codes (ROSC) on International Organization of Securities Commissions (IOSCO), identified

20

deficiencies in the legal structure including a need to update the Capital Market Law. The FMDIP

(Integration) addressed some of the 2010 FSAP recommendations.

48. In terms of results, the 2010 FSAP noted improvements in improving regulatory transparency. In

addition, the 2010 FSAP found that the regulator had instituted “comprehensive operational programs

that meet the IOSCO norms.” The 2017 FSAP included a scorecard on the status of the 2010 FSAP

recommendations which showed that the legal, regulatory, and tax related recommendations for capital

markets were implemented.

49. Improving institutions: capital market supervision, investor protection, and skills of market

participants. About 20% of policy actions in the area of market infrastructure focused on improving

capacity of capital market supervision. These included strengthening internal governance, adopting code

of conduct, developing and implementing a human resource development plan, ensuring sufficient

resources for capacity building, and establishing the Capital Market Institute to upgrade skills of market

participants. About 80% of the capacity building policy actions targeted at capital market supervision

were accounted for by the CMDPC, with some follow-up actions in both the FMDIP (Integration) and

FMDIP (Inclusion).

50. Another 5% of the policy actions focused on improving capacity of rating agencies, establishing

institutional arrangements for improved investor protection, and training of market participants. Investor

protection initiatives included the establishment of the Investor Protection Fund; the amendments to the

Capital Market Law to strengthen provisions governing conflict of interest in collective investment

schemes; and regulations on advertising, disclosure, and sales of securities. A facility to enable

submission, monitoring, and addressing of investor complaints was also established. The CMDPC, FMDIP

(Integration), and FMDIP (Inclusion) had policy actions on investor protection.

51. All of the government CMMPs starting in 2000 emphasized the improvement of supervision

capacity, with emphasis on the independence of the regulator and the establishment of a risk-based

supervision. A recurring finding of the 2006 World Bank NBFI study was the poor level of enforcement

across different NBFI activities, with adverse effects on market confidence. Policy actions strengthening

supervision capacity was highly relevant. The 2010 FSAP linked weak enforcement to deficiencies in the

legal structure to augment regulators’ independence and enforcement powers, hence the focus of ADB

programs on improving the legal basis for improved supervision.

52. The 2017 FSAP identified challenges in transitioning to integrated supervision, including loss of

skills and experience. More fundamentally, the OJK Act promoted silo-based governance arrangements,

which inhibited harmonization of supervisory practices across sectors and increased the incentives for

regulatory arbitrage. In addition, recent reforms to strengthen legal protection for staff—a key

recommendation in the 2010 FSAP—were not sufficient. However, the 2017 FSAP noted the

improvement in insurance supervision since the enactment of the new Insurance Law in 2014.

53. Nonetheless, the 2017 FSAP noted the good progress in enhancing interagency cooperation

which is necessary to develop capital markets. The recently established high-level Financial Market

Coordination Forum and lower-level technical platforms provide promising vehicles to ensure an

integrated approach. Other examples of cross-agency coordination include the Bond Market

Development Team and the Capital Market Infrastructure Development Team.

54. Improving corporate governance and accounting standards. About 20% of policy actions in the

area of market infrastructure aimed to upgrade corporate governance and accounting standards. All ADB

programs had corporate governance and accounting-related policy actions. The policy actions on

corporate governance included amendments to the company law imposing liabilities of directors for false

or misleading information, issuance of regulations on information on corporate governance, and

introduction of ASEAN corporate governance standards and scorecard to listed companies. OJK has

21

developed a corporate governance roadmap for listed companies.27

The International Finance

Corporation (IFC) has also commissioned the development of the Indonesia Corporate Governance

Manual.28

55. In the area of accounting and auditing, policy actions included regulations on independence of

accountants providing audit services, requirements for publication of audited and unaudited financial

statement, development of accounting standards for sharia-based financing, and convergence of

Indonesian accounting standards with international accounting standards and international financial

reporting standards.

56. Improving corporate governance and accounting standards were identified in the 2005 and 2010

CMMPs as well as in the current financial sector master plan. The 2006 World Bank NBFI Study placed

top priority to improving corporate governance and listed several recommendations. The 2010 FSAP

identified improving accounting standards as critical to the strengthening of investor confidence and had

seven recommendations on accounting and auditing. The 2017 FSAP scorecard showed that all the

accounting and auditing related recommendations were either fully implemented or partially

implemented. In terms of corporate governance, there has been an improvement between 2012–2015

though Indonesia continues to lag peer countries in the region (Figure 4).29

57. Improving trading systems and stock market governance. About 15% of policy actions in the area

of market infrastructure covered trading systems and stock market governance. Stock trading actions

included implementation of scripless trading and remote trading, and improvements in governance of

clearing, depository, and settlement institutions. Stock market related actions included implementation

of merger of Surabaya and Jakarta Stock Exchanges (JSX and SSX) and broadening of ownership of the

merged stock exchange.

58. The Government master plans included continuous improvements in the securities trading

systems, with later plans focusing on convergence with international standards and preparation for

ASEAN financial market integration. The ADB policy actions were consistent with the Government master

plans as well as the 2006 World Bank NBFI Study which recommended the merger of JSX and SSX, move

to remote trading, and improvements in trading systems. The 2010 FSAP found numerous weaknesses

in the clearing and settlement systems.30

The 2017 FSAP scorecard show that the 2010 FSAP

recommendations on payments systems were implemented.

27 OJK. 2014. Indonesia Corporate Governance Roadmap. Jakarta.

28 IFC. 2014. The Indonesia Corporate Governance Manual. Jakarta.

29 ADB. 2015. ASEAN Corporate Governance Scorecard Country Reports and Assessments 2015. Manila.

30 The 2010 FSAP produced a Review of Standards and Codes (ROSC) on CPSS-IOSCO Core Principles for Government Bonds, Equities,

and Corporate Securities.

22

Figure 4: Indonesia—Corporate Governance Scores, 2012–2015

2. Instruments/Issuers

59. Capital markets include both public and private corporate issuers who issue a range of securities

instruments: bonds or fixed-income securities, stocks or equities which are risk-sharing with variable

returns, and bundles of claims such as asset-backed or mortgage-backed securities. About 40% of policy

actions in the issuer component of the capital market program supported the development of

government bond markets, with corporate bond and equity market development segments accounting

for about 20% each (Table 11).

Table 11: Distribution of Issuer Policy Actions, 2002–2017

Policy-based loans

Government

Bond

Corporate

Bond

Municipal

Bond Sukuk Equity

Infrastructure

Facility

Total

Issuers

FGSSRP 0% 0% 0% 0% 0% 0% 0%

CMDPC

Subprogram 1 41% 29% 6% 12% 12% 0% 100%

CMDPC

Subprogram 2 38% 23% 0% 15% 15% 8% 100%

Subtotal 36% 14% 7% 7% 36% 0% 100%

FMDIP (Integration) 36% 14% 7% 7% 36% 0% 100%

FMDIP (Inclusion)

Subprogram 1 33% 0% 33% 33% 0% 0% 100%

FMDIP (Inclusion)

Subprogram 2 0% 0% 100% 0% 0% 0% 100%

Subtotal 25% 0% 50% 25% 0% 0% 100%

Total 38% 21% 8% 13% 19% 2% 100%

CMDPC = Capital Market Development Program Cluster, FGSSRP = Financial Governance and Social Security Reform Program, FMDIP

(Inclusion) = Financial Market Development and Inclusion Program, FMDIP (Integration) = Financial Market Development and

Integration Program, sukuk = Islamic bonds.

Sources: Asian Development Bank Independent Evaluation Department, Policy Matrices.

Source: ADB. 2017. ASEAN Corporate Governance Scorecard Country Reports and Assessments 2015

(Joint Initiative of the ASEAN Capital Markets Forum and the Asian Development Bank). Manila.

23

60. Developing government bond markets. Government bonds are the backbone of fixed income

securities in Asia, and provide a benchmark yield curve.31

In addition, a government securities market

provides a source of domestic funding of budget requirements as well as strengthens the transmission

and implementation of monetary policy. Prerequisites for an efficient government securities market

include: a stable and credible macroeconomic framework (Box 3); effective legal, tax and regulatory

infrastructure; smooth and secure settlement arrangements; and a liberalized financial system with

competing intermediaries.32

61. The government securities market has its roots in the bank recapitalization program in 1999 with

the issuance of the recapitalization bonds (footnote 2). Trading in recap bonds began in 2000, the

Ministry of Finance (MOF) Debt Management Office was established in 2001, and the Government Debt

Securities Law was enacted in 2002, followed by the first issuance of debt securities for budget financing.

ADB began supporting the development the government securities market with the CMDPC.

62. ADB program policy actions on government bond markets had three focus areas. First, the actions

sought to develop the benchmark yield curve by issuing appropriate benchmark securities for

government debt securities. Second, the actions supported the establishment of a system of primary

dealership with underwriting and market making responsibilities. Third, the actions sought to improve

liquidity mainly by facilitating the development of the repurchase market. In addition, the government

bond-related actions included regulations to strengthen price information disclosure as well as

establishment of an interagency committee to improve coordination.

63. The CMDPC incorporated many of the government bond-related recommendations in the World

Bank 2006 NBFI study, including developing a primary dealer system with market marking obligations,

further development of a repo market, improving the certainty of issuance through announcing a

calendar, improving post-trade price transparency, and improving high-level and operational

coordination between BI, Bapepam-LK, and the MOF. The FMDIP (Integration) followed up the reforms

begun under the CMDPC and supported the implementation of the recommendations in the 2010 FSAP,

including actions to improve the conduct of monetary policy through the securities market based on the

31 Issuance by ADB of bonds in local currencies in selected ASEAN+3 countries also help create domestic benchmarks. ADB

established a $10 billion equivalent Asian Currency Note Program (ACNP) in 2006, but the Indonesian rupiah is not one of the

currencies included in the program. ADB also has a MYR3.8 billion Medium Term Note Program in Malaysia.

32 World Bank and IMF. 2001. Developing Government Bond Markets. Washington, D.C.

Box 3: Inflation Performance and Development of Bond Markets

Several studies have found that economies with better inflation performance had more developed local currency

(LCY) bond markets (as percentage of gross domestic product [GDP]) and relied less on foreign currency bonds

(share of LCY bonds in total bonds outstanding). Inflation performance was also a determinant of sovereign bond

yields.

After the Asian financial crisis of 1997/1998, Indonesia pursued various reforms to achieve macroeconomic

stability and control inflation. In 2005, Indonesia adopted an inflation targeting framework in its monetary

operations with price stability as the primary objective.

An International Monetary Fund study found that when comparing 2006–2014 with 1991–2005, Indonesia

performed better in terms of GDP growth, inflation, and inflation volatility than other emerging market and

developing economies with inflation targeting regimes. Indonesia 10-year bond yields have gone down in line

with the improved inflation and inflation volatility performance.

Sources: ADB. 2015. ADB Economics Working Paper Series No. 448: Bond Market Developing in Developing Asia. Manila; IMF.

2016. ASEAN-5 Cluster Report – Evolution of Monetary Policy Frameworks. Washington, D.C.; IMF. 2016. ASEAN-5 Cluster

Report – Evolution of Monetary Policy Frameworks. Washington, D.C.

24

results of the assessment of Code of Good Practices on Transparency in Monetary Policy. The FMDIP

(Inclusion) further supported improvements in the repo market and the development of the sukuk.

64. ADB interventions contributed to several results. First, the government securities market has

provided the market with a yield curve (Table 12) though the 2017 FSAP recommended consolidating

the number of instruments issued. Second, there has been an improvement in the liquidity of LCY

government securities (Table 13), though there are opportunities for further improvements in liquidity

by addressing the small size of issuance across a variety of instruments (T-bills, T-bonds, and Sukuk).

Third, the primary dealer system is in place and the 2017 FSAP noted that the government securities

market is “relatively well developed.” Fourth, yields of benchmark 10-year government bond has been

declining, reflecting progress in maintaining macroeconomic stability, controlling inflation, and

establishing credibility of monetary policy (Box 3). Finally, ADB has been supporting the development of

a municipal bond market with TA though the first issuance is still in the works.

Table 12: LCY Government Securities Yield Curve, December 2017

ID - LCY Government

Bonds

Latest Closing

(6 December 2017)

YTD

(bp)

MTD

(bp)

1 Year 5.206 ↓172.1 ↓15.4

2 Year 5.681 ↓178.6 ↓3.5

3 Year 5.946 ↓162.1 ↓4.0

4 Year 6.032 ↓166.3 ↓0.7

5 Year 6.055 ↓152.5 ↓2.5

6 Year 6.301 ↓153.5 ↓2.0

7 Year 6.506 ↓150.9 ↓2.2

8 Year 6.574 ↓153.9 ↓2.5

9 Year 6.593 ↓148.4 ↓2.1

10 Year 6.528 ↓144.5 ↑1.1

15 Year 7.063 ↓113.8 ↑0.6

20 Year 7.212 ↓98.3 ↑0.8

30 Year 7.267 ↓129.9 ↑0.1

bp = basis point, ID-LCY = Indonesia local currency, LCY = local currency, MTD =

month-to-date, YTD = year-to-date.

Source: AsianBondsOnline.

Table 13: Government Bond Market Indicators, 2007–2016

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Outstanding Government

Bond Issues (Rp trillion) 726 705 842 844 847 847 903 1307 1500 1879

Government Bond

Turnover 71.0% 46.8% 35.8% 58.3% 71.3% 63.8% 52.0% 63.3% 63.5% 55.0%

Government Bond Bid-Ask

Spread 6.4% 3.7% 4.0% 4.8% 5.0% 5.9% 7.6% 6.0% 9.2% 5.2%

Rp = Indonesian rupiah.

Source: Asian Bond Monitor.

65. The 2017 FSAP recognized that the government bond markets were relatively well developed. It

nonetheless made two recommendations. First, MOF should enhance liquidity of its benchmark securities

since a growing number of instruments and larger holdings of buy-and-hold investors may adversely

affect liquidity along the curve. Second, in the primary markets, MOF should reduce fragmentation and

increase the standardization and size of benchmarks.

66. Developing corporate bond markets. Much of the emphasis in ASEAN countries on developing

corporate bond markets stem from the consensus diagnosis of the 1997 crisis, which could be traced to

several underlying problems in the region’s financial systems (para. 4). In addition, countries were

25

perceived to be excessively dependent on volatile capital inflows despite an abundance of domestic

saving.33

67. About 20% of policy actions in the area of instruments/issuers supported the development of

corporate bond markets. There were two areas of focus. First, the programs sought to strengthen price

information disclosure and transparency through regulations and the establishment of an independent

bond pricing agency. Second, the programs supported conditions that would enable specialized

institutions to issue bonds: (i) issuance of amendments to regulations that would enable the Secondary

Mortgage Facility, which became the Sarana Multigriya Finansial (SMF) to lend for long-term tenors to

develop mortgage backed securities; and (ii) establishment of infrastructure facilities to mobilize funds

from the bond market for lending to infrastructure companies (paras. 88–93).

68. The CMDPC accounted for about 80% of the policy actions supporting the development of the

corporate bond market, with the majority of CMDPC corporate bond related actions focusing on

information disclosure and transparency. The FDMIP (Integration) accounted for other policy actions on

bond market development, focusing on improving the functioning of the Bond Pricing Agency. There

were no follow-up actions on the corporate bond market in FMDIP (Inclusion). However, ADB supported

the development of the infrastructure financing facility with a project loan and a nonsovereign operation

(NSO) investment (paras. 88–93). In addition, there was a TA for the development of the SMF.

69. The focus on price information disclosure was highly relevant, and the establishment of the Bond

Pricing Agency was a significant institutional addition to improve the information basis for pricing

securities. The CMMP 2005–2009 placed emphasis on transparency of market information as a principal

constraint to development of the bond market. However, more could have been done to strengthen

credit rating agencies—the 2006 World Bank NBFI study had several recommendations focusing on

improving qualifications and independence of rating agencies. The initiatives to increase the supply of

bonds outstanding by developing mortgage backed securities and infrastructure financing facilities were

also relevant. More could have been done in follow-up programs on the development of the corporate

bond market, given the foundation that has been put in place in early programs and the current emphasis

in the Government financial sector plan on financing the real sector (para. 68).

70. The McKinsey scorecard rated price discovery 2 out of 5 indicating more could be done in this

area (Table 14). There is mandatory trade reporting for all trades executed with information available to

market participants—an IMF paper34

rates transparency to be at par with international best practices.

Indonesia has adopted disclosure-based approaches to the registration/review process for prospectus for

public offering of corporate bonds.

Table 14: Capital Market Health Scorecard: Indonesia

Parameters

Score

(1=lowest; 5=highest)

Foundational Policies

Benchmark Assets 3

Supply of Capital 2

Demand for Capital 1

Intermediation 2

Free Markets 2

Price Discovery 2

Market Architecture and Design

Regulatory Framework 2

Cornerstone Institutions 3

33 IMF. 2011. ASEAN5 Bond Market Development: Where Does It Stand? Where Is It Going? Washington, D.C.

34 IMF. 2011. Developing ASEAN5 Bond Markets: What Still Needs to be Done? Washington, D.C.

26

Parameters

Score

(1=lowest; 5=highest)

Regulations and Standards 2

Taxation 2

Market Infrastructure and Technology 2

Overall Score 2

Source: McKinsey. 2017. Deepening Capital Markets in Emerging Economies.

71. In terms of increased issuance, the policy actions targeting specific issuers or sectors have begun

to produce results. SMF begun to issue mortgage backed securities in 2009 and is the 13th largest issuer

of LCY corporate bonds.35

Other banks such as Bank Tabungan Negara (BTN) has also begun to issue

mortgage backed securities. Two infrastructure financing facilities had been established and both had

begun to issue corporate bonds, with one facility ranked 18th largest corporate bond issuer (paras. 88–

93).

72. While overall LCY corporate bonds outstanding has been growing at a compound annual growth

rate (CAGR) of 18% during 2007–2016, Indonesia continues to lag its peer countries based on LCY

corporate bonds to GDP (Tables 15 and 16). However, in terms of LCY corporate bond liquidity, Indonesia

outperformed Malaysia and Thailand. Nonetheless, the 2017 FSAP made several recommendations to

advance the development of the corporate bond markets (para. 98).

Table 15: Comparative Data of Peer Countries

Indicator INO MAL PHI THA

Corporate LCY Bond % of GDP (end-2016) 2.5 43.4 6.2 21.2

Market Capitalization % of GDP (end 2015) 41.0 129.3 81.7 88.3

Government LCY Bond Turnover Ratio (2016) 55.0% 38.5% na 69.3%

Corporate LCY Bond Turnover Ratio (2016) 20.5% 8.0% na 10.0%

Stocks Traded, Turnover Ratio of Domestic Shares (2016) 22.4% 26.9% 14.5% 81.0%

GDP = gross domestic product, INO = Indonesia, LCY = local currency, MAL = Malaysia, na = not available, PHI = Philippines,

THA = Thailand.

Sources: Asian Development Bank. AsianBondsOnline; World Bank Global Financial Development Database; Bank Indonesia;

websites of Central Banks of Malaysia, the Philippines, and Thailand.

Table 16: Corporate Bond Market Indicators, 2007–2017

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Outstanding Corporate Bond Issues

(Rp trillion) 79 73 88 115 147 187 218 223 250 312

Outstanding Corporate Bond Issues

(% of Gross Domestic Product) 2.0% 1.5% 1.6% 1.7% 1.9% 2.2% 2.3% 2.1% 2.2% 2.5%

Corporate Bond Turnover 24% 17% 12% 22% 24% 24% 23% 19% 20% 21%

Rp = Indonesian rupiah.

Source: Asian Bond Monitor.

73. Deepening equity markets. Prior to the CMDPC, Indonesia’s stock market was at 30% of GDP in

2005, lower than the stock markets in peer countries. There was an insufficient pool of listed companies,

inadequate infrastructure, weak investor protection, and lack of transparency and disclosure. The 2006

World Bank NBFI Study found that the stock market was unable to mobilize capital due to weak corporate

governance, including lack of controls on dominant owners and inadequate oversight over the integrity

of financial disclosure.

74. To deepen equity markets, ADB programs focused on the following areas. First, the CMDPC

encouraged the increase in listed companies by enjoining SOEs to list in the context of their privatization.

Second, the CMDPC set the conditions for the development of instruments such as stock options,

35 ADB. 2017. Asia Bond Monitor. Manila.

27

exchange traded funds, real estate investment trusts, and practices such as short selling. Third, the FMDIP

(Integration) sought to improve investor protection by establishing the Securities Market Investor

Protection Fund, improving industry disclosure, and issuing a code of conduct for market intermediaries.

Fourth, the FMDIP (Integration) supported initiatives to improve the ease of transaction, including the

reduction of timeline for IPO review and approval by regulator. The FMDIP (Inclusion) did not include

specific actions on developing the equity markets.

75. Stock market capitalization has been growing at a CAGR of 18% during 2007–2016, but at 41%

of GDP in 2016 remains well below peer countries. There has been an increase in number of listed

companies, from 344 in 2006 to 537 in 2016, with SOEs currently accounting for about 25% of market

capitalization. Nonetheless, a study36

found that the number of companies electing to list—relative to

peer countries—has remained low due to perceptions of a high regulatory burden on listed companies

as well as reluctance to engage in greater disclosures, which could potentially lead to higher tax liabilities.

The turnover ratio of domestic shares has declined during the past 10 years with Indonesia’s ratio in 2016

lower than that of the Thailand and Malaysia but higher than that of the Philippines (Table 17).

Table 17: Stock Market Indicators, 2007–2016

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Market Capitalization (Rp trillion) 1988 1076 2019 3247 3537 4127 4219 5228 4873 5753

Market Capitalization (% of Gross

Domestic Product) 50% 22% 36% 47% 45% 48% 44% 49% 42% 46%

Number of Listed Companies 383 396 398 420 440 459 483 506 521 537

Trading Value of Shares

(Rp trillion) 1050 1064 975 1176 1223 1116 1522 1453 1406 1845

Trading Value of Shares to Market

Capitalization 53% 99% 48% 36% 35% 27% 36% 28% 29% 32%

Rp = Indonesian rupiah.

Source: Indonesia Stock Exchange Statistics, various issues.

76. Developing the sukuk. The ADB programs supported the development of sukuk (Islamic bonds)

which are structured to generate returns consistent with Islamic law which prohibits interest (riba). Sukuk

is defined as certificates of equal value representing undivided shares in the ownership of tangible assets,

usufructs, and services. Sukuk issuance is backed by assets and is viewed as a useful instrument for

infrastructure financing since the underlying asset is the project itself. The development of the sukuk

market has been a main component of the Government capital market and financial sector master plans

since 2005.

77. The CMDPC supported the establishment of the legal and regulatory framework to enable the

issuance of sharia-based securities, as well as the establishment of a mechanism for effective cooperation

and coordination between Bapepam-LK and the National Shariah Board. The FMDIP (Integration) and

FMDIP (Inclusion) expanded the number of eligible investments by revising the rules and improved the

enabling environment by ensuring tax neutrality and equivalence between Islamic finance and

conventional finance.

78. The sukuk market has been developed (Figure 5). Sovereign LCY sukuk outstanding increased

from Rp 5 trillion in 2008 to Rp 256 trillion in 2016 representing about 14% of total LCY Government

bonds. LCY corporate sukuk increased from Rp 1.5 trillion in 2008 to Rp 11.6 trillion in 2016, but

represented only about 4% of total LCY corporate bonds. While the LCY sukuk remains small compared

to the market in Malaysia, Indonesia has become the largest sukuk issuer in terms of US dollars.37

36 Oliver Wyman and Mandiri Institute. 2015. Financial Deepening in Indonesia. Jakarta.

37 Rachmatarwata, Isa (MOF). 2016. Sukuk for Infrastructure Development: Indonesia Experience (ppt). Jakarta.

28

Sources: Asian Bond Monitor; Sukuk for Infrastructure (2016).

3. Investors

79. ADB has a long history of engagement in the insurance and pension sectors in Indonesia

(footnote 2). Insurance and pension funds are some of the largest investors in securities instruments and

can play a major role in the development of capital markets (para. 10). Within the investor component

of the ADB’s capital market programs during 2002–2017, about 50% of the policy actions supported the

insurance sector and about 40% supported pension funds (Table 18).

Table 18: Distribution of Investor Policy Actions, 2002–2017

Policy-based loans Pension Funds

Insurance

Companies Other Funds

Total

Investors

FGSSRP 45% 55% 0% 100%

CMDPC

Subprogram 1 40% 30% 30% 100%

CMDPC

Subprogram 2 50% 50% 0% 100%

Subtotal 43% 36% 21% 100%

FMDIP (Integration) 22% 56% 22% 100%

FMDIP (Inclusion)

Subprogram 1 33% 33% 33% 100%

FMDIP (Inclusion)

Subprogram 2 0% 100% 0% 100%

Subtotal 20% 60% 20% 100%

Total 38% 50% 12% 100%

FGSSRP = Financial Governance and Social Security Reform Program, CMDPC = Capital Market Development

Program Cluster, FMDIP (Inclusion) = Financial Market Development and Inclusion Program, FMDIP (Integration)

= Financial Market Development and Integration Program.

Sources: Asian Development Bank Independent Evaluation Department, Policy Matrices.

80. Developing the insurance industry. In 2000, the Indonesian insurance industry was characterized

by a large number of companies in poor financial condition due to insufficient capital, asset-liability

mismatches, and weak governance. The MOF Insurance Directorate was also characterized by lack of

independence and weak supervision capacity leading to lax enforcement of regulations. In 2002, 25 life

insurance firms accounting for about 60% of the market in terms of gross premiums had negative

solvency margins. A well-publicized bankruptcy case against an insurance firm brought attention to the

serious deficiencies in the legal framework and judicial process which had an adverse impact on investor

confidence.

520

44

78

124

169

206

165

256

0

50

100

150

200

250

300

2008 2009 2010 2011 2012 2013 2014 2015 2016

Figure 5: Growth of Government Local Currency Sukuk,

2008–2017 (Rp trillion)

29

81. The 2002 FGSSRP supported major reforms in the legal and regulatory framework for insurance

to improve transparency, increase capital requirements, and enhance sanctions on firms not in

compliance with insurance regulations. In addition, the program included provisions for increasing

supervision capacity through training as well as issuance of guidelines for on-site examination in line with

international best practices. The 2007 CMDPC supported amendments to the Insurance Law to achieve

greater compliance with International Association of Insurance Supervisors (IAIS) Core Principles (ICP),

updated risk-based parameters and minimum capital requirements, and developed programs to

strengthen the actuarial profession. The FMDIP (Integration) and FMDIP (Inclusion) supported

enforcement of the minimum capital requirements, improvements in the regulatory regime, and

strengthening of OJK oversight, notably in the risk management area.

82. The insurance sector has been the fastest growing segment in the financial system with a CAGR

of 15% during 2007–2016. While the planned consolidation in the industry has not yet been completed,

there has been a reduction in the number of insurance companies from 157 in 2005 to 137 in 2016, a

12% reduction compared to the CMDPC target of 20%–25%. The 2017 FSAP assessed that insurance

regulation and supervision had improved since the establishment of OJK and the enactment of the new

Insurance Law in 2014. OJK had also enhanced regulations for corporate governance and risk

management. Nonetheless, the 2017 FSAP assessment of insurance supervision against ICP found

significant shortfalls in the observance of core principles, mainly in the regulation and supervision of

insurance groups.

83. Developing the pension and provident funds. The old age or retirement benefit system in

Indonesia targets formal sector workers exclusively. The system has three mandatory programs covering

formal private sector workers, civil servants, and the armed forces through state-run monopolies. These

mandatory schemes can be supplemented by voluntary pensions of two types—employer pension funds

(DPPKs) and financial institution pension funds (DPLKs). There was no unified policy, supervisory,

regulatory framework for the pension sector with multiple ministries involved in the control and

regulation of pension programs. Fiscal sustainability of the Taspen and Asabri managed programs was a

critical issue with estimated unfunded liabilities in 2001 of Rp 380 trillion (footnote 17).

84. The 2002 FGSSR had policy actions that supported significant reforms in the pension system,

including the development of a new law to unify programs and improve social security framework and

improvements in governance of mandatory pension and retirement schemes. In addition, the FGSSR set

the stage for future reforms by including as policy actions: (i) assessment and development of options

for improving the financial condition, operations, and fiscal sustainability of mandatory programs; (ii)

improvement of management of voluntary pension funds through certification requirement for fund

managers; and (iii) development of proposals for expansion of social security systems to the informal

sector.

85. The CMDPC followed up the FGSSR by supporting: (i) changes in the Pension Law and regulations

to improve fund governance and expand the range of allowable investments, and (ii) implementation of

risk-based supervision of pension funds. The FMDIP (Integration) further enhanced governance of

pension funds by requiring a separation between pension founder and administrator, and introducing

fit and proper tests for administrators. The FMDIP (Inclusion) supported enactment of regulations on

asset liability management and OJK oversight of new social security agencies.

86. The National Social Security System (SJSN) Law was enacted in 2004, supported by ADB TA.

Implementation of pension reform included the transformation of current fund administrators into Badan

Penyelenggara Jaminan Sosial (BPJS, Social Insurance Administration Organization) bringing Indonesia in

compliance with established international practice, improvement of the legal and financial structure of

the social insurance system by legally separating the assets of BPJS from the assets in the social security

funds, and supervision of BPJS by the National Social Security Council, OJK, and the State Financial Audit

30

Board. ADB also provided the Government with assistance in a special audit of Jamsostek, the social

security organization for the private sector, which undertook several initiatives to comply with the SJSN

Law.

87. Pension assets grew by a CAGR of 12% during 2007–2016, though pension assets as percentage

of GDP declined from 2.2% in 2007 to 1.9% in 2016. Nonetheless, the pension reform is expected to

increase mobilization of domestic savings through stronger enforcement of mandatory contributions and

participation, expansion of pensions to informal sector, and better governance. To improve participation

of pension funds in capital markets, the 2017 FSAP recommended improvement in the tax framework to

encourage participation in different investment products (e.g., in mutual funds), and changes in

regulations that drive pension investments into short-term products and restrict pension funds’ ability to

use derivatives to manage their portfolios.

4. Infrastructure Finance

88. Financing Indonesia’s infrastructure investments has been one of main motivations for the

Government efforts to develop capital markets. The country’s core infrastructure stock has not kept pace

with economic growth with infrastructure stock as share of GDP declining over the past decade. This has

contributed to economic and social costs through high transport costs, poor water and sanitation, and

energy shortages. The World Bank estimates that Indonesia has lost more than 1% additional GDP growth

due to under-investment in infrastructure.

89. In addition to developing the corporate bond market, ADB supported innovative financing

mechanisms to develop infrastructure finance. In particular, the CMDPC had a policy action that

eventually led to the establishment of two infrastructure financing companies and one infrastructure

guarantee facility. The infrastructure financing companies—Sarana Mulit Infrastruktur (SMI) and

Indonesia Infrastructure Finance (IIF)—were institutional responses to the lack of long-tenor financing

from commercial banks, undeveloped capital markets, and lack of skills in developing public-private

partnership (PPP) projects. Both SMI and IIF were envisioned to create new financial opportunities, such

as by introducing innovative products, tapping underutilized sources of funds such as contractual savings

institutions, and developing capacity to syndicate financing. The Indonesia Infrastructure Guarantee Fund

(IIGF) provides coverage for certain central and government performance risks under PPP schemes.

90. SMI was established in 2009 initially as a conduit for ADB and World Bank loans to the IIF.38

Since

its establishment, SMI has become an active non-bank financial institution supporting the Government’s

infrastructure development agenda, including through partnerships with the private sector in PPP

projects. SMI has three product lines—financing, advisory services, and project development with clients

from both the public (including SOEs and municipal governments) and private sector. SMI has been

expanding its range of financial products that include promoter financing, bridge loans, and

subordinated loans, in addition to the traditional loan and equity investment products offered by other

financial institutions. SMI continues to be 100% state-owned.

91. SMI has experienced tremendous growth, with outstanding commitments increasing from Rp 2

trillion in 2012 to Rp 45 trillion in 2016. Total project cost of SMI investments as of July 2017 was Rp 265

trillion. SMI has a BBB-/Stable rating from Fitch since 2013. SMI’s LCY bond outstanding as of June 2017

was Rp 6.7 trillion, making SMI the 18th largest issuer in terms of bonds outstanding (footnote 35).

92. IIF was established in 2010 and currently has as its shareholders: the Government (through SMI),

three development finance institutions (DFIs) (ADB, IFC, and Deutsche Investitions-und

Entwicklungsgesellschaft [DEG]), and SMBC (PT Bank Sumitomo Mitsui Indonesia). The longer-term plan

is for the transformation of IIF into a private sector led institution, though at this time, there is no clear

38 ADB and the World Bank provided loans to the Government which were lent by the Government to SMI for relending to IIF in

the form of subordinated debt. This was done because IIF is a private sector company.

31

strategy—other than the exit of DFIs through IPOs—for IIF’s transfer to private sector control. IIF has two

main product lines—lending primarily to the private sector and advisory services to both the public and

private sectors. IIF was envisioned to address systemic gaps and avoid duplicating roles of or competing

against existing institutions mainly by developing new instruments and clients. IIF’s outstanding

commitments have grown to Rp 10 trillion as of end-2016—about one-fourth the size of SMI. To date,

IIF has not introduced new instruments and relied on traditional product offerings. However, it has issued

LCY bonds, with about Rp 1.5 trillion outstanding as of June 2017.

93. The contribution of SMI and IIF has been through its issuance of LCY bonds whose proceeds are

lent or invested to infrastructure companies, most of which are not able to access the bond markets or

are able to but at a higher cost. However, neither SMI nor IIF have developed or issued new capital market

instruments, such as infrastructure or project bonds. There is an initiative underway in OJK—supported

by World Bank—to develop regulations that would enable issuance of infrastructure bonds. The issuance

of enabling infrastructure bond regulations would help SMI and IIF utilize this instrument.

5. Assessment

94. Market infrastructure. ADB support to the development of the capital market infrastructure has

been relevant overall. The programs have appropriately focused on “soft” infrastructure and laid the legal

and regulatory foundation for capital market development. In addition, the programs paid attention to

developing and strengthening institutions, including the establishment of new ones such as the Bond

Pricing Agency and the Investor Protection Fund. The focus on enhancing price discovery and information

disclosure was an important building block to the development of markets. There was also sufficient

follow-up by the FMDIP (Integration) and FMDIP (Inclusion), including in the areas of corporate

governance, taxation, and accounting. Nonetheless, there is continuing need to upgrade and update

capital market infrastructure, especially the “soft” components, to keep pace with market developments.

95. The capital market programs resulted in improvements in the market infrastructure overall,

though there remains scope for further improvement. One study39

found that in terms of physical or

“hard” market infrastructure, Indonesia has the building blocks in place.40

As noted above, based on the

McKinsey scorecard for market architecture and design, Indonesia scored a “2” out of 5 overall, with

cornerstone institutions having the highest score among the different dimensions. The 2017 FSAP

identified several areas for improvement focusing on “soft” infrastructure: (i) further review of the tax

framework, (ii) strengthening of creditor rights, (iii) elimination of regulatory hurdles affecting investors,

(iv) enhancements in the Company Law and corporate governance frameworks, and (v) further

improvements in financial literacy of issuers and investors.

96. Issuer/Instruments. The support to issuer/instrument component of the capital market program

was relevant overall. Of critical importance was the support of the programs to the development of the

government bond market, which provides the benchmark rates for financial markets. The CMDPC

government bond market initiatives, including the support to the establishment of a primary dealer

system, were followed up by the FMDIP (Integration). The FMDIP (Inclusion) focused more on the sukuk

market, a component of the government bond market.

97. The initiatives supporting the corporate bond and equity markets suffered from a lack of long-

term roadmap. The CMDPC policy actions on pricing and information disclosure, along with the

establishment of the Bond Pricing Agency, were important building blocks towards deeper corporate

bond market. The FMDIP (Integration) strengthened the information aspects of the market, including the

39 Oliver Wyman and Mandiri Institute. 2015. Financial Deepening in Indonesia. Jakarta.

40 The study cited the formation of the Indonesia Stock Exchange resulting from a merger of two exchanges (also recommended

by the 2006 World Bank NBFI Study), the Indonesian Clearing and Guarantee Corporation (KPEI) providing transaction clearing

and settlement guarantee services, and the Indonesian Central Securities Depository (KSEI) providing securities depository and

transaction settlement services.

32

functions of the Bond Pricing Agency. However, there was less attention paid to deepening the corporate

bond market after the CMDPC. In retrospect, a roadmap would have helped define the sequencing of

government actions to develop the corporate bond market, and inform the design of ADB support over

the medium-term. Box 4 gives an example of sustained World Bank Group support to bond market

development.

98. Both the 2017 FSAP and the McKinsey study rated favorably the progress in the development of

the government bond market. While there has been progress in deepening the corporate bond with a

CAGR of 18% during 2007–2016, the corporate bond market remains shallow by international

standards—McKinsey scored issuer participation the lowest (1 in a scale of 1–5 with 5 being the highest).

Most of the instruments are plain vanilla bonds. The 2017 FSAP found preference for SOE instruments

and recommended the actions to accelerate the number of private issuers and instruments:

(i) Benchmarks. In the primary market for government bonds, reduce fragmentation and

increase standardization and size of benchmark issues;

(ii) Issuance framework. Expedite the approval process of public offers and implement a new

special offering regime to qualified investors;

(iii) Captive demand for SOE instruments. Review regulation that creates captive demand such

as investment requirements in state and SOE instruments for NBFIs; and

(iv) Secondary market liquidity. Potential solutions could focus on market making requirements

and the introduction of an organized call market.

99. The 2017 FSAP recommended several actions to improve equity markets including: (i) a review of

the tax framework for investors (e.g., the merit of tax exemptions for transactions below a maximum

amount); (ii) strengthening of securities firms’ qualification; (iii) diversification of the pool of IPO

investors; and (iv) enhancements in the company law and corporate governance framework to protect

minority shareholders.

100. Investors. ADB support to the insurance and social security (pension) sectors were relevant and

part of ADB engagement that pre-dated the 2002 FGSSRP (Appendix 1). The reforms in these two sectors

supported by the FGSSRP were substantive, eventually resulting in a restructuring of the insurance sector

and the establishment of new governance arrangements in the social security area. The FGSSRP initiatives

in these sectors were followed by the successor programs.

101. The various insurance industry reforms supported by ADB as well as by the World Bank41

have

begun to pay dividends in the form of growth in insurance assets with signs that the industry is

41 World Bank. 2014. Financial Sector Reform and Modernization Development Policy Operation. Washington, D.C.

Box 4: World Bank Group Support for Viet Nam Bond Market Development

The World Bank Group (WBG) had a continuous series of interventions to support bond market development in

Viet Nam since Fiscal Year (FY) 2008. The starting point was the development of the Bond Market Development

Roadmap (FY 2008), financed by a grant, followed by the Viet Nam Capital Markets project (FY 2009). The work

began with the creation of core institutions and setting of standardized market practice. The successor Viet Nam

Bond Markets Development project (FY 2015) drew on the 2014 Financial Sector Assessment Program (the first

for Viet Nam). The projects were mainly grant funded (by the International Development Association and the

Financial Sector Reform and Strengthening [FIRST] Initiative) and had strong participation by the International

Finance Corporation in project implementation. WBG’s Independent Evaluation Group found “an increase in the

volume of mid to long-term corporate bonds that could be associated with, if not attributed to, WBG

interventions.”

Source: Independent Evaluation Group. 2016. World Bank Group’s Support for Capital Market Development. Washington, D.C.

33

consolidating. There have also been major pension reforms which have taken several years to implement.

While these reforms set the stage for growth of pension funds, pension fund assets as percentage of

GDP have been stagnant since 2010. ADB programs also had components supporting mutual funds,

which had a CAGR of 29% during 2001–2015, though the ADB focus on the investor side of capital

markets were on insurance and pension. The 2017 FSAP recognized the various measures implemented

by the authorities to mobilize savings, but found scope for improvement in several areas, including:

(i) Tax framework. The framework currently deters broader participation in different investment

products such as by pension funds in mutual funds;

(ii) Regulation. Current features drive pension investment into short term products and restrict

pension funds’ ability to use derivative to manage their portfolios;

(iii) Investor literacy. There is a need to address conservative investor culture and judiciously

increase participation in capital market products; and

(iv) Hedging instruments. These instruments would allow banks and institutional investors to

manage longer term exposures and duration mismatches.

102. Infrastructure finance. The initiatives to support the development of infrastructure finance to

enable greater private sector investment in infrastructure were relevant. The CMDPC policy action

establishing the infrastructure finance facilities supported an institutional response to the lack of

infrastructure finance while contributing to the development of bond markets. While there were no

follow up actions in the PBLs after the CMDPC, the ADB loan to and equity investment in IIF helped in

the increase in the supply of corporate bonds. However, there were missed opportunities in terms of

assisting OJK in developing the regulatory framework that would enable the issuance of project and

infrastructure bonds.

103. The contribution of SMI and IIF has been through its issuance of LCY bonds whose proceeds are

lent or invested to infrastructure companies, most of which are not able to access the bond markets or

are able to but at a higher cost. However, there have not been new capital market instruments, such as

infrastructure or project bonds. Nonetheless, there is an initiative underway in OJK—supported by World

Bank—to develop regulations that would enable issuance of infrastructure bonds. The issuance of

enabling regulations would help SMI and IIF develop the infrastructure bond instrument. In addition, as

noted in various World Bank and ADB reports, improvements in the PPP process would help increase the

pipeline of projects to be financed by SMI and PPP—these improvements had been supported by both

ADB and the World Bank through infrastructure program loans. The 2017 FSAP recommended the

following specific measures to enable project and infrastructure finance:

(i) Legal and regulatory framework. There is a need to strengthen the framework for special

purpose vehicles (SPVs) and their tax treatment; improve the regulatory framework for bond

issuance (e.g., offering regime for qualified investors); and align investment regulation of

institutional investors with the framework for offering and listing bonds.

(ii) Project financing instruments and guarantees. Several capital market structures are being

used and tested internationally in project financing. In Indonesia, SMI, IIF, and IIGF could be

instrumental in the development of such instruments.

34

E. Issues and Suggestions

1. Issues

104. The capital market continues to be described as shallow (para. 14). There were areas where the

ADB programs contributed to results, mainly in government bond markets, Islamic capital market, and

the insurance sector. However, relative growth in the corporate bond market and pension funds has

lagged those of peer countries. The 2017 FSAP has provided some recommendations on how to stimulate

growth in corporate bonds (para. 98). In the case of pension funds, the pension reforms have yet to have

a significant impact on pension fund growth. In addition, the majority of pension fund assets are in time

deposits in banks and government securities, with only about 20% invested in corporate bonds.

105. While there was significant progress in developing the market infrastructure, there are important

gaps in “soft” infrastructure. Various reports have identified weaknesses in the insolvency and creditor

rights regime, and in the protection of minority shareholders. There is scope for improving the

frameworks for taxation of financial instruments and for corporate governance. In addition, the time and

cost for public offering process in both the equity and bond markets are relatively long and costly. Finally,

the regulatory regime creates an uneven playing field that favors SOE instruments.

106. ADB support to capital market development over the past 15 years addressed a wide range of

issues but lacked clear articulation of a longer-term reform roadmap. ADB engagement covered a large

number of capital market areas, and was both demand-driven and opportunistic. The 2002 FGSSRP, for

example, focused on investors—pension funds and insurance companies—building on previous work by

ADB in these sectors and responding to client demand despite capital markets lacking many of the

preconditions for development. The 2007 CMDPC was comprehensive and provided an opportunity for

defining priorities and sequencing, but did not do so. As a result, several important initiatives were not

sustained through follow-up support.

107. The use of PBLs was consistent with ADB policy, but could have been supported more effectively

by other ADB instruments. Accompanying TA has been a common feature of the ADB programs, but as

noted in the CMDPC PPER, such TA projects did not match the scope and complexity of the programs. As

noted in para. 41, only 3 out of 16 TA projects during 2002–2017 and only 16% of total amount of TA

focused on capital markets.42

With the exception of the IIF project, ADB had not utilized the project loan

instrument more extensively to support capital market development, which is a more effective instrument

than TA in building institutions. Project loans have more ADB involvement and monitoring, as well as

greater client ownership—due to the financing aspect—than TA projects.

108. There is scope for strengthening the economic and sector work supporting capital market

development. While there is no dearth of studies on capital markets in Indonesia (Figure 6) including the

FSAPs, there are opportunities for ADB to identify specific areas or topics which would provide the

analytical basis for the design of PBLs. The World Bank operational policy on the design of development

policy operations emphasizes the importance of analytical underpinnings, and World Bank development

policy loans include a section identifying supporting analytical work.

42 Several TA projects, including those supporting financial sector governance and social security reform, contributed to capital

market development.

35

Source: World Economic Forum. 2016. Accelerating Emerging Capital Markets Development in Emerging

Economies (Country Case Studies). Switzerland.

109. There is scope for more NSOs supporting capital market development. The main NSO with links

to capital market development is the investment in IIF, which contributed to the increase in supply of

corporate bonds. A planned equity investment43

to establish a secondary mortgage facility, which was

envisioned to issue new products in the bond market, did not materialize.44

Nonetheless, the facility was

eventually established in 2005 as SMF, a 100% government-owned company, which as of September

2017 was the 13th largest issuer of corporate bonds with ADB supporting the establishment of SMF with

TA.45

The PSOD has a $300 million housing finance loan46

for eligible private commercial banks, but this

is not directly linked to the development of corporate bonds.

110. Measuring progress in market infrastructure (both hard and soft)—beyond completion of agreed

actions—has been a challenge. However, there is a growing number of indicators that enable both

tracking of progress over time as well as comparisons with selected benchmark or peer countries.

Examples of these are the ASEAN corporate governance scorecard47

produced by the ASEAN Capital

Markets Forum Working Group Secretariat and the Doing Business indicators on credit legal rights and

protection of minority shareholders. ADB could develop indicators on efficiency of the IPO and bond

approval processes to measure results from related reforms.

2. Suggestions

111. As a starting point to developing its strategy of future engagement in Indonesia’s capital market

development, ADB could perform its own (selective) analytic work. ADB would have to decide on the

focus of the analytic work, which would build on, rather than replicate, ADB’s own accumulated body of

knowledge, the 2017 FSAP findings, and other studies. It is also suggested that major PBL programs

supporting capital market reforms include a section on analytical underpinnings. The analytic work would

add another instrument supporting ADB dialogue with authorities.

112. The selected area(s) of engagement could be accompanied by a longer-term roadmap agreed on

with the Government based on appropriate sequencing of reforms and actions.48

The roadmap should

43 ADB. 1998. Report and Recommendation of the President to the Board of Directors: Proposed Loans and Equity Investment to

Indonesia for Financial Governance Reforms: Sector Development Program. Manila. The program loan (budget support) was

accompanied by a sovereign investment loan and an equity investment.

44 The loan and equity investment were cancelled in 2001.

45 ADB. 2005. Technical Assistance Report on Republic of Indonesia: Secondary Mortgage Facility. Manila.

46 ADB. 2010. Report and Recommendation of the President to the Board of Directors: Proposed Senior Loans to Indonesia for

Housing Finance Program. Manila.

47 The scorecard is a joint publication between ADB and the ASEAN Capital Market Forum.

48 In the ongoing Financial Market Development and Inclusion Program, ADB has supported the newly-established integrated

financial services regulator (OJK) to formulate and implement an integrated financial sector strategy and action plan covering

banking and non-bank institutions.

269 244325

830 862

697

852900

831 820

1,001

0

200

400

600

800

1000

1200

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Figure 6: Number of Articles on "Financial Deepening in Indonesia",

2005–2015

36

include identification of outcomes (or intermediate outcomes) with measurable indicators and targets

which could be tracked during the implementation of reforms. Both the CPSs and ADB programs could

include a description of the roadmap.

113. ADB could consider utilizing, where appropriate, more instruments beyond PBLs and TA in

supporting capital market development. In addition to analytic work discussed above, ADB could use

more of project loans and NSOs. Given the Government’s strategic focus on increasing private investment

in infrastructure, there are opportunities for further ADB support in this area that could increase the

volume and variety of capital market instruments. ADB could also explore project loans with capital

market components in the areas of housing and SOE reform.

114. ADB could also consider developing more capital market indicators by building on the work in

producing the ABM and supporting ASEAN initiatives, such as tracking the state of corporate governance.

ADB could develop indicators similar to what McKinsey produced in its capital market deepening paper

(Exhibit A.2. McKinsey Asian Capital Markets Development Index), and to track performance against these

indicators over time. This would help expand the current set of capital market indicators, and help address

gaps in measuring progress in market infrastructure and institutional effectiveness. The use of systematic

market feedback by the ABM, as in the case of liquidity surveys, could be expanded to cover other areas.

37

Appendixes

38

Appendix 1. Asian Development Bank Support to Finance Sector in

Indonesia, 1970–2000

A. Introduction

1. This is a documentation of the Asian Development Bank’s (ADB) support to the finance sector in

Indonesia covering the period 1970–2000. This was prepared in connection with the Program

Performance Evaluation Report (PPER) for the Capital Market Development Program Cluster (CMDPC)

(Subprograms 1 and 2).1 It will serve as reference to the Independent Evaluation Department’s (IED)

financial sector assistance and program evaluation (SAPE) and country assistance program evaluation

(CAPE) for Indonesia, both set to commence in 2018.

2. This paper is based on various operational documents as well as available studies, reports, and

data from various sources. It builds on findings from the program/project completion reports and relevant

IED validations or evaluations, where available, and identifies the main take-aways that will feed into the

preparation of the SAPE and CAPE. This paper is organized into five sections, Introduction, Sector Context;

ADB Sector Program Strategies; Portfolio; Performance of ADB Operations; and a concluding section

highlighting some key findings.

B. Sector Context

3. This section gives an overview of the evolution of Indonesia’s finance sector covering the period

1970–2000.

1. 1970–1982: State Control of Banking System

4. In the 1970s, the Indonesian financial system was tightly controlled by the Government. Between

1978 and 1982, the rise in oil prices and domestic oil production resulted in a quadrupling of oil revenues

which provided the Government surplus funds to finance economic growth. The Government channeled

resources through the banking system using low-interest credits to achieve its development objectives.

Bank Indonesia (BI) set deposit and lending rates of state-owned banks and guided the allocation of

credit through a liquidity credit mechanism which had two components: (i) BI direct credit to certain

borrowers mainly state-owned enterprises (SOEs), and (ii) BI credit to the banking system by discounting

bank loans to designated activities at preferential interest rates.

5. By 1982, Indonesia had 118 deposit money banks (DMBs) with the 5 state-owned commercial

banks (SOCBs) managing about 66% of total DMB assets. Among the DMBs were 28 public development

banks2—the state development bank and 27 regional development banks—which had a less than 5%

share of total DMB assets (Table A.1). While managing only 15% of total DMB assets, private sector banks

(PSBs) had a 60% share of rupiah deposits but lent mainly for working capital. The nonbank financial

sector did not play a significant role. By 1982, only 24 companies had issued shares, mainly foreign-

owned companies who are required to sell equity to Indonesians.

1 Asian Development Bank (ADB). 2007. Report and Recommendation of the President to the Board of Directors: Proposed Loan

and Technical Assistance Grant to Indonesia for the Capital Market Development Program Cluster (Subprogram 1). Manila; ADB.

2009. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Indonesia for the Capital Market

Development Program Cluster (Subprogram 2). Manila.

2 In addition, there was one private development bank.

39

Table A.1: Financial System Structure, 1982

Number

Asset Size

(Rp billion)

Share of Total

Financial System

Assets

(%)

Share of Total

DMB Assets

(%)

Bank Indonesia 1 13,707 42

Deposit Money Banks

State-Owned Commercial Banks 5 12,257 38 72

Private FX Banks 10 1,168 4 7

Foreign Banks 11 1,172 4 7

Private Non-FX Banks 60 720 2 4

Development Banks 29 1,336 4 8

Savings Banks 3 452 1 3

Total Deposit Money Banks 118 17,105 53 100

Other Financial Institutions

Non-Bank Financial Institutions 113 1,447 4

Rural Banks 5,808 86 0

Total Other Financial Institutions 5,921 1,533 5

Total 6,039 32,345 100

DMB = deposit money bank, FX = foreign exchange, Rp = Indonesian rupiah.

Source: World Bank. 1994. Discussion Paper: Indonesian Experience with Financial Sector Reform. Washington, D.C.

2. 1983–1997: Financial Sector Liberalization

6. With the weakening of oil prices in 1982 and the resulting deterioration of the Government’s

financial position, the Government introduced major reforms in 1983 to encourage mobilization of

private financial savings to finance domestic investment. The reforms had three main elements: (i)

elimination of credit ceilings for all banks, (ii) freedom by SOCBs to set deposit rates, and (iii) reduction

in the number of special priority programs with access to BI liquidity credits. The interest rate

deregulation resulted in an increase in the cost of funds of SOCBs.

7. In 1988, a comprehensive package of deregulation measures was introduced including the

liberalization of requirements for the establishment of new private banks and joint-venture banks. These

measures resulted in an increase in the number of banks to 240 by 1994 with large local conglomerates

establishing their own banks. While there was progress in improving the regulatory and supervisory

framework, enforcement was problematic. In addition, SOCBs experienced loan losses, especially loans

to conglomerates, and had to be recapitalized by the Government. While the liberalization reforms

resulted in financial sector growth from 1983–1997 (Table A.2), the financial system suffered

fundamental weaknesses (Box A.1).

Table A.2. Finance Sector Growth, 1983–1997

1983 1988 1993 1997

Bank Deposits (% of Gross Domestic Product [GDP]) 12.7 21.5 36.5 46.0

Domestic Credit to Private Sector (% of GDP) 14.8 28.4 49.0 60.8

Domestic Credit to Government and State-Owned

Enterprises (% of GDP) 4.0 4.9 3.3 3.2

Deposit Money Bank Assets (% of GDP) 16.5 28.0 48.0 56.3

Stock Market Capitalization (% of GDP) 1.2a 14.1 24.1

a as of 1989.

Source: World Bank Global Financial Development Database.

40

3. 1997–1999: Dealing with the Financial Crisis

8. Much of the work during and in the immediate aftermath of the crisis focused on stabilizing and

restructuring the banking system. The restructuring program had four pillars: (i) blanket guarantee for

all depositors and creditors of banks, (ii) creation of the Indonesian Bank Restructuring Agency (IBRA),

(iii) a recapitalization program for private and state-owned banks, and (iv) an out-of-court debt

restructuring mechanism. IBRA was established in 1999 and as part of the bank restructuring program

received assets with a face value equivalent to 43% of gross domestic product (GDP) in 2000. The

Government issued domestic bonds equivalent to 55% of GDP in 2000 to recapitalize the banks.

9. The crisis resulted in the consolidation of the banking system. Before the crisis, there were 238

banks with total assets representing 93% of GDP. By end-1999, there were 165 banks representing 61%

of GDP. However, the number of state-owned banks increased from 34 to 44, increasing their share of

total banking assets from 42% to 59%. The domestic private banks lost sizeable market share as a result

of closures and mergers (Table A.3). Between June 1997 and December 1999, a total of 66 banks

managing 13% of total banking assets were closed and 13 banks managing 21% of banking assets were

taken over by IBRA.3 Domestic credit to private sector as percentage of GDP fell from 60.8% in 1997 to

20.6% in 1999 while credit to government and SOEs as percentage of GDP increased from 3.2% in 1997

to 26.1% in 1999.4

Table A.3. Banking System Restructuring, 1997 and 1999

June 1997 September 1999

Publicly

Owned

Private

Domestic

Foreign

Controlled Total

Publicly

Owned

Private

Domestic

Foreign

Controlled Total

Number of Banks 34 160 44 238 44 81 40 165

Assets (% of GDP) 39.2 45.8 7.7 92.7 35.9 15.3 10.0 61.2

Market Share (%) 42.3 49.4 8.3 100.0 58.6 25.0 16.4 100.0

Source: IMF. 2001. Indonesia: Anatomy of a Banking Crisis: Two Years of Living Dangerously, 1997–1999. Washington, D.C.

3 International Monetary Fund (IMF). 2001. Indonesia: Anatomy of a Banking Crisis: Two Years of Living Dangerously, 1997–1999.

Washington D.C.

4 World Bank. Global Financial Development Database. Washington D.C.

Box A.1: State of Banking System, 1997

While the liberalization reforms resulted in financial sector growth, the financial system suffered

fundamental weaknesses which would play a role in the 1997–1998 financial crisis. Some notable

weaknesses were: poor credit assessment with approvals based on relationships, weak legal framework for

contract enforcement, and currency and maturity mismatches. There was an unsustainable level of problem

loans with numerous banks seriously undercapitalized. State-owned commercial banks, which accounted for

38% of banking assets in 1997, had high levels of problem loans due to directed lending. The rapid expansion

of private banks masked governance and credit problems. As the rupiah began to depreciate in July 1997,

loan portfolios deteriorated further as borrowers with unhedged foreign currency positions were unable to

make loan payments. Public confidence evaporated and depositors withdrew large amounts adversely

affecting banking system liquidity.

Sources: IMF. Working Paper: Indonesia Anatomy of a Banking Crisis Two Years of Living Dangerously 1997–1999.

Washington D.C.; Anwar Nasution. 1998. The Meltdown of the Indonesian Economy in 1997–1998. Jakarta; Bank

Indonesia. 2000. Indonesia's Financial and Corporate Sector Reform. Jakarta.

41

C. ADB Sector Program Strategies

10. ADB operations in Indonesia began in 1967. For the finance sector, ADB’s first technical

assistance (TA) project was in 1968 and first loan in 1971. Table A.4 summarizes ADB’s strategies to

support Indonesia’s finance sector over the years. The table shows that ADB’s strategy for supporting

Indonesia’s finance sector shifted from lending to the real sector through specific banks (initially state-

owned banks and later including PCBs) utilizing credit lines to improving financial intermediation by

supporting banking sector reforms.

Table A.4: Summary of Key Strategic Focus Areas, 1980–2000

1980s–early 1990s 1994–1997 1998–2000

improve industrial base and

develop a more efficient and

responsive financial system

(i) liberalize entry of new financial

institutions and reduce

restrictions on financial services

(ii) streamline legal framework for

money and capital markets

(iii) promote securities market

(iv) restructure public enterprises

mobilize domestic resources,

increase private sector

participation, and improve

efficiency of investments

Country Operational Strategy, 1994

create appropriate enabling

environment and encourage

efficient private provision of

financial services and productive

investment activities

Interim Operational Strategy, 1998–2000

support reforms for governance

structures of corporate and banking

sector and capital market

Sources: Asian Development Bank country planning documents for Indonesia; Country Assistance Program Evaluation, 2005.

D. Portfolio

1. Lending operations

11. ADB approved 12 loans amounting to $2.5 billion to support Indonesia’s finance sector during

1970–2000. Almost 80% ($1.9 billion) was accounted for by the finance sector development subsector.

Other subsectors such as banking systems ($0.5 billion) and microfinance ($26 million) had a combined

share of 21%. No grant was approved during the period (Figure A.1).

Figure A.1. Subsector Share: Loans, 1970–2000

Source: Asian Development Bank Independent Evaluation Department.

12. The year 1998, which coincided with the Asian financial crisis, saw finance sector approvals rise

to $1.5 billion, with one program (supported by two policy-based loans [PBLs]) and one project

(supported by one loan) (Figure A.2).

20.0%

79.0%

1.0%

Banking systems Finance sector development Microfinance

42

Figure A.2. Loan Approvals Supporting the Finance Sector, 1970–2000 ($ million)

Source: Asian Development Bank Independent Evaluation Department.

13. Prior to 1988, ADB utilized project loans mainly to provide subloans to targeted sectors such as

agriculture and industry. When ADB began focusing on supporting financial sector reforms starting 1988,

PBLs were utilized as the main instrument, though ADB continued to provide financial intermediation

loans (credit lines) in 1989 and 1993 (Table A.5).

Table A.5: ADB Finance Sector Loans, 1970–2000

Approval

Year

Loan/

Grant Title

Modality Sector Approved

Amount

($ million)

1998 1618 Financial Governance Reforms: Sector Development - Program Loan Program FSD 1,400.0

1998 1619 Financial Governance Reforms: Sector Development - Financial

Governance Reforms Support

Program FSD 47.0a

1998 1620 Financial Governance Reforms: Sector Development - Capacity Building

for Financial Governance

Project FSD 50.0

1994 1327 Microcredit Project MF 25.7

1993 1223 Second Development Finance Project BS 200.0b

1992 1160 Second Financial Sector Program Program FSD 250.0

1989 981 Development Finance Loan Project BS 200.0

1988 938 Financial Sector Program Program FSD 150.0

1988 939 Financial Sector Program Program FSD 50.0

1987 834 Second Bank Pembangunan Indonesia Project BS 60.0

1977 319 Bank Pembangunan Indonesia (BAPINDO) Project BS 30.0

1971 66 Bank Rakjat Indonesia Modernization Project BS 3.4

Total 2,466.1

BS = banking systems, FSD = finance sector development, MF = microfinance.

Note: A program is supported by a policy-based loan.

a Cancelled.

b $124.6 million was cancelled.

Sources: Loan, Grant, TA, and Equity Approvals database; Loans and Grants Financial Information System.

2. Technical assistance operations

14. From 1968–2000, 26 TA projects5 amounting to $6.4 million supported insurance and contractual

savings (31.1%), banking systems (26.5%), money and capital markets (19.7%), microfinance (12.8%),

finance sector development (7.0%), housing finance (1.5%), and small and medium-sized enterprise

(SME) finance and leasing (1.4%) (Figure A.3).

5 Including project preparatory technical assistance.

3.4 30 60

200 200250

200

25.7

1497

0

0

200

400

600

800

1000

1200

1400

1600

1971

1977

1987

1988

1989

1992

1993

1994

1998

2000

43

Figure A.3. Subsector Share: Technical Assistance, 1968–2000

Source: Asian Development Bank Independent Evaluation Department.

15. Advisory TA accounted for 80.0% ($5.1 million) and project preparatory TA for 20.0% ($1.3

million) (Table A.6). About 61% of TA projects (by number) were linked to PBLs either as

background/preparatory work or program implementation support.

Table A.6: ADB Finance Sector Technical Assistance,1968–2000

Approval

Year

TA

No. Title

Type Sector Approved

Amount

($ million)

1999 3228 Development of a Deposit Insurance Scheme AD ICS 0.2

1998 3119 Regulatory Reforms in the Insurance Industry AD ICS 0.8

1998 3116 Reform of Pension and Provident Funds AD ICS 0.9

1996 2699 Institutional Strengthening of Regional Development Account AD BS 0.6

1996 2586 Secondary Mortgage Facility AD HF 0.1a

1993 1849 Microcredit PP MF 0.5

1992 1753 Review of the Banking System PP BS 0.1

1991 1531 Securities Market Development - Phase II AD MCM 0.6

1991 1514 Financial Sector Review PP FSD 0.3

1990 1347 Review of the Pension Fund Industry PP ICS 0.1a

1990 1348 Review of the Insurance Industry PP ICS 0.1a

1990 1320 Development of the Leasing Industry AD SMEFL 0.1a

1990 1319 Development of the Venture Capital Industry AD MCM 0.1a

1990 1313 Strengthening of Term Lending Capabilities of Participating Private

Commercial Banks under Bank's Development Finance Loan

AD BS 0.1

1989 1161 Institutional Strengthening of Bank Umum Koperasi Indonesia AD MF 0.4

1989 1090 Study Relating to Securities Market Development AD MCM 0.5

1989 1089 Study of Regional Development Banks AD BS 0.2

1988 1063 Strengthening Bank Indonesia's Supervisory Capabilities AD BS 0.1a

1988 1008 Financial Sector Program PP FSD 0.1a

1988 977 Study on Establishment of Indonesian Venture Capital Company and a

Detailed Evaluation of P.T. Bahana

PP MCM 0.1a

1988 945 Indonesian Banking Development Institute AD BS 0.4

1987 856 Financial Sector Review AD BS 0.1a

1982 474 Second Agricultural Credit AD BS –b

1979 278 Second Agricultural Credit PP BS 0.1a

1970 24 Bank Rakjat Indonesia AD BS 0.1a

1968 006B Rural Credit Survey AD BS 0.1a

Total 6.4

ADB = Asian Development Bank, AD = advisory, BS = banking systems, HF = housing finance, FSD = finance sector development, ICS =

insurance and contractual savings, MCM = money and capital markets, MF = microfinance, PP = project preparatory, SMEFL = small and

medium enterprise finance and leasing, TA = technical assistance.

a Approved amount is less than $100,000, but due to rounding off, the amount is reflected as $100,000;

b Cancelled.

Sources: Loan, Grant, TA, and Equity Approvals database; TA Financial Information System.

26.5%

7.0%

1.5%

31.1%

12.8%

19.7%

1.4%

Banking systems

Finance sector development

Housing finance

Insurance and contractual savings

44

E. Performance of ADB Operations

1. Supporting Targeted Sectors through Credit Lines

16. Lending to State-Owned Financial Institutions. During 1970–1987, ADB financial sector

operations were mainly designed as credit lines to state-owned financial institutions to be onlent to

priority sectors such as agriculture and industry. While the projects were relevant, the loan designs often

failed to include critical capacity building components, which resulted in poor performance of

subprojects. Consequently, ADB activities in the finance sector during this period resulted in minimal

contribution to financial and industrial development. Of the three projects6 during the period, one was

assessed achieved, one partly achieved, and one had no project completion report (PCR)/project

performance audit report (PPAR). The PCRs for two finance sector loans emphasized the importance of

capacity building in project design and monitoring.7

17. Participation of Private Banks in ADB Credit Lines Projects. The First (1989) and Second (1993)

Development Finance Loan (DFL) Projects began to include PCBs in ADB’s finance sector lending

operations.8 The PCR for DFL-1 judged the project satisfactory based on loan utilization and the

generation of new jobs and incremental exports. It noted the positive impact of Bank of Indonesia (BI) in

enabling PCBs to comply with ADB loan covenants, compared to the failure of state owned financial

institutions to meet performance targets.9 The PPAR for DFL-2 assessed the project less than successful

due to underutilization of the loan and deterioration of participating financial institutions’ portfolios.

The PPAR noted poor design and weak diagnostic assessment despite two preparatory TA projects (Box

A.2).10

2. Strategic Shift in Focus Towards Financial Sector Development and Poverty Alleviation

18. Support for Finance Sector Reforms. Starting 1988, ADB began to focus on finance sector

development with PBL as the main instrument. Two Financial Sector Program Loans (FSPLs) supported

the Government’s program of financial reforms (PAKTO) announced in 1988.11

The reforms included

removal of entry barriers to the establishment of new private banks, abolition of monopoly of state-

owned banks over deposits of SOEs, and allowing more private banks to engage in foreign exchange

operations. The reforms would promote expansion of and competition within the banking system. ADB,

the World Bank, and the United States Agency for International Development (USAID) assisted the

government in developing PAKTO. Both the 1988 FSPL-1 and the 1992 FSPL-2 had two tranches with an

immediate release of the first tranche based on policy actions completed prior to Board presentation and

a second tranche release after completion of agreed policy actions. Parallel TA covered the role of regional

development banks and development of the securities market.12

6 ADB. 1971. Report and Recommendation of the President to the Board of Directors on the Proposed Loan to Indonesia for Bank

Rakjat Indonesia Modernization. Manila; ADB. 1977. Report and Recommendation of the President to the Board of Directors on

the Proposed Loan to Indonesia for Bank Pembangunan Indonesia (BAPINDO). Manila; ADB. 1987. Report and Recommendation

of the President to the Board of Directors on the Proposed Loan and Technical Assistance Grant to Indonesia for Second Bank

Pembangunan Indonesia. Manila.

7 ADB. 1980. Project Completion Report: Bank Rakjat Indonesia Modernization. Manila; ADB. 1986. Bank Pembangunan Indonesia

(BAPINDO). Manila.

8 ADB. 1989. Report and Recommendation of the President to the Board of Directors on the Proposed Development Finance Loan

to Indonesia. Manila; ADB. 1993. Report and Recommendation of the President to the Board of Directors on the Proposed Loan

to Indonesia for the Second Development Finance. Manila.

9 ADB. 1996. Project Completion Report: Development Finance Loan. Manila.

10 IED. 2004. Project Performance Audit Report: Second Development Finance Loan. Manila: ADB.

11 ADB. 1988. Report and Recommendation of the President to the Board of Directors on the Proposed Loans and Technical

Assistance to Indonesia for the Financial Sector Program. Manila; ADB. 1992. Report and Recommendation of the President to

the Board of Directors on the Proposed Loan to Indonesia for the Second Financial Sector Program. Manila.

12 See para. 28 of the Program Performance Audit Report for Financial Sector Program.

45

19. The PPAR for FSPL-I noted the improved outcomes in the finance sector: during 1988–1990,

banking assets grew by 70%; the number of deposit money banks increased from 79 to 134 with growth

coming from private banks; and deposits and outstanding credits more than doubled. However, the PPAR

found inadequacies in the legal framework and supervision capacity. One of the important lessons cited

in the PPAR was that institutional capacity needed to keep up with financial sector growth. The PPAR

concluded that it was too early to rate the performance of FSPL-1 due to concerns about financial sector

stability and several outstanding issues on prudential safeguards, legal, regulatory, and supervisory

framework to be addressed in FSPL-2.13

20. The PCR for FSPL-2 assessed the program successful based on implementation of the policy

actions and improved outcomes including increased deposits, higher share of private sector banks in

overall lending portfolio, and growth of stock market capitalization. The policy actions included

enactment of legal framework for the financial sector and the adoption of prudential regulation for banks

and regulatory framework for securities market. In terms of outcomes, the PCR reported that the share

of PCBs in outstanding credits had surpassed that of state-owned financial institutions and that there

has been a decline in the share of liquidity credits (from BI) in total banking credits. However, the PCR

raised concern about the deteriorating loan portfolio quality of banks.14

As noted in Box A.1, several

fundamental weaknesses in the banking system were not adequately addressed. In retrospect, the FSPLs

were less than successful.

21. Addressing Poverty Alleviation and Inclusion. In 1994, the Government launched a program to

accelerate the development of microenterprises in the rural areas. In support of the program, ADB

approved the 1994 Microcredit Project—a loan to the Government to be onlent to provincial

development banks and rural banks—which aimed to increase incomes and employment in rural areas

to reduce poverty and to improve the status of women.15

There was a preparatory project TA and an

13 IED. 1993. Project Performance Audit Report: Financial Sector Program. Manila: ADB.

14 ADB. 1980. Project Completion Report: Second Financial Sector Program. Manila.

15 ADB. 1994. Report and Recommendation of the President to the Board of Directors on the Proposed Loan to Indonesia for the

Microcredit Project. Manila.

Box A.2: Main Findings from Evaluations for the Development Finance Loan Series

The Asian Development Bank (ADB) continued using the credit line lending instrument after the 1983 and 1988

financial sector liberalization reforms, but expanded the participating institutions to include private banks. The

following are some of the main findings from the project completion report for the first (1989) Development

Finance Loan (DFL-1) and the project performance audit report (PPAR) for the second (1993) Development

Finance Loan (DFL-2).

First, there was a contrast in performance between state-owned development finance institutions (DFI) and

private commercial banks (PCBs) participating in the loan programs—in DFL-1, only 35% of DFI-financed

subprojects performed satisfactorily compared to 90% for PCB-financed subprojects.

Second, the DFLs had marginal contribution to improved financial intermediation at the national level, which

was one of the objectives of the projects. The project design did not sufficiently consider how the financial

intermediation process would be improved.

Third, there was a concern about bank governance issues in both state-owned and private banks and their

adverse impact on ADB’s reputational risk. The PPAR for DFL-2 recommended for more stringent measures in

assessing governance of participating institutions.

Sources: Project Completion Report for DFL-1 and Project Performance Audit Report for DFL-2.

46

accompanying TA for institution building to strengthen lending institutions, nongovernment

organizations, and women self-help groups.16

22. The PCR assessed the Microcredit Project successful based on substantial outreach to the poor

and good prospects for sustainability of microcredit institutions. Social impact surveys indicated

improved incomes of borrowers. One of the lessons and recommendations in the PCR was that ADB

should promote private sector participation in microfinance and reduce the scope of public sector activity

in future ADB microfinance projects.17

The 2001 IED impact evaluation of ADB’s rural credit assistance

included the following lessons: (i) projects should improve targeting of the poor, (ii) project design should

be commensurate with capacity of microcredit institutions, (iii) TA projects are useful mechanisms for

capacity building, and (iv) projects should focus on the development of a sound and sustainable rural

financial system. 18

23. Overall, ADB operations during 1988–1997 supported financial sector reforms that resulted in

increases in bank deposits (as share of GDP) from 21% to 46%, domestic credit to private sector (as share

of GDP) from 28% to 61%, DMB assets (as share of GDP) from 28% to 56%, and stock market

capitalization (as share of GDP) from 1.2% to 24%. However, the completion and evaluation reports

raised concerns about the inability of the regulatory framework and supervision capacity to keep up with

financial sector growth. The rapid expansion of PCBs masked their governance and credit problems, while

SOCBs had high levels of problem loans due to directed lending through liquidity credits. As cited in Box

A.1, there were several notable weaknesses in the banking system which were not sufficiently addressed

and which played a role in the 1997–1998 financial crisis. With respect to support to microfinance, while

the ADB project was successful, the development impact on the microfinance was unclear. There was no

follow-up to the support to microfinance until 2015 with the approval of the Financial Market

Development and Inclusion Program (Subprogram 1) which included components on developing

microfinance. ADB could have continued its support to microfinance between 1997–2015.

3. ADB Support During and After the 1997–1998 Financial Crisis

24. 1997–1999: Lending Support During the Crisis. The 1998 Financial Governance Reforms: Sector

Development Program (FGRSDP) was part of a multi-donor program (Box A.3) and had three components:

(i) a PBL, (ii) an equity investment in a secondary mortgage facility (SMF), and (iii) a TA loan.19

The FGRSDP

focused on restructuring the banking system, improving financial and public sector allocation of

resources by strengthening governance, increasing disclosure and transparency of financial information,

and reinforcing the financial sector’s legal and regulatory framework. The program was intended to

respond to crisis as well as initiate longer-term reforms to address the root causes and reduce

vulnerability to future crises. The equity investment component was eventually cancelled because the

adoption of a new Central Bank Law in 1999 precluded BI from taking a stake in the SMF.

25. The PCR for the FGRSDP assessed the program highly relevant and successful overall. In the

lessons section, the PCR highlighted the importance of a credible commitment to long term structural

reforms during a crisis.20

It also stressed the importance of country and sector knowledge, as well as

diagnostic work, in designing a PBL. Different instruments may be needed for different policy conditions.

Given the number and complexity of reforms and need for sustained policy dialogue, field presence was

critical. In addition, implementation may require adjustments as circumstances change, as in the case of

the cancellation of the SMF component.

16 See para. 3 of the Report and Recommendation of the President and para. 25 of PCR of Second Financial Sector Program.

17 ADB. 2005. Project Completion Report: Microcredit. Manila.

18 IED. 2001. Impact Evaluation Study on ADB’s Rural Credit Assistance in Bangladesh, People’s Republic of China, Indonesia, Nepal,

Philippines, Sri Lanka, and Thailand. Manila: ADB. The study did not cover the two rural/microcredit loans in Indonesia but

included two TA projects.

19 ADB. 1998. Report and Recommendation of the President to the Board of Directors: Financial Governance Reforms: Sector

Development Program and Technical Assistance Loan. Manila.

20 ADB. 2004. Project Completion Report: Financial Governance Reforms: Sector Development Program. Manila.

47

26. A separate PCR assessed the TA loan component of the FGRSDP successful but found ADB

performance to be less than satisfactory due to lack of guidance and assistance provided to the

implementing agencies.21

In addition, the program had an unwieldy design with multiple agencies

involved. In retrospect, the TA project could have been unbundled into smaller packages and targeted at

specific issues.

4. Summary Ratings and Findings from Evaluations

27. Financial Sector Lending Operations Assessments. Out of the nine operations with ratings, the

PCRs/PPARs/project completion validation report (PVR) assessed six as successful and two as less than

successful (including one considered partly achieved). One project with PPAR had no rating (Table 7).

There had been mixed success in the overall performance of credit line operations. In part, this was due

to loan designs that did not emphasize capacity building and governance improvements in participating

financial institutions. On the other hand, all the PBLs were assessed as successful by the PCRs. The PBLs

linked policy actions with disbursements, while TA provided inputs to program design and support for

program implementation.

Table A.7. Finance Sector Lending Operations with Ratings 1970–2000

Loan/Grant Project Title

Approval

Year

Evaluation

Type

Evaluation

Year

Overall

Rating

66 Bank Rakjat Indonesia Modernization 1971 PPAR 1980 Achieved

319 Bank Pembangunan Indonesia (BAPINDO)

Project

1977 PPAR 1986 Partly

Achieved

938/939 Financial Sector Program 1988 PPAR 1993 No rating

981 Development Finance Loan 1989 PCR 1996 Satisfactory

1160 Second Financial Sector Program 1992 PCR 1996 Successful

1223 Second Development Finance Loan 1993 PPAR 2004 Less than

successful

1327/

2277(L)

Microcredit 1994 PCR 2005 Successful

1618/1619 Financial Governance Reforms: Sector

Development Program

1998 PCR 2004 Successful

1620 Capacity Building for Financial Governance 1998 PCR 2006 Successful

PCR = program/project completion report, PPAR = program/project performance audit report.

Sources: Asian Development Bank Independent Evaluation Department; Evaluation reports.

21 ADB. 2006. Project Completion Report: Capacity Building for Financial Governance. Manila.

Box A.3: Relationship with the International Monetary Fund, 1997–1998 Financial Crisis

According to the International Monetary Fund’s (IMF) Independent Evaluation Office (IEO) 2003 Evaluation

Report, the Asian Development Bank’s (ADB) participation in the design of a multi-donor program focused on

analysis of regional development banks and nonbank financial institutions. However, the IMF staff did not keep

the ADB team informed of discussions with Indonesian authorities. In addition, ADB disagreed with the IMF on

the creation of the Indonesian Bank Restructuring Agency (IBRA). This led to a deterioration in the relationship

between the two institutions and a delay in the approval of the Financial Governance Reforms: Sector

Development Program. Subsequently, working relationships were reestablished with ADB taking the lead on

analysis of “non-IBRA banks”.

Source: Independent Evaluation Office. 2003. Evaluation Report: The IMF and Recent Capital Account Crises, Indonesia, Korea,

and Brazil. International Monetary Fund. Washington, D.C.

48

28. Technical Assistance Project Completion Reports (TCRs). The two TCRs with ratings were assessed

successful, with one TCR having no rating (Table A.8).

Table A.8. Finance Sector Technical Assistance Projects with Ratings

Technical

Assistance Project Title

Approval

Year

Overall

Rating Related Operation

945 Indonesian Banking Development Institute 1988 No rating Agro-Industries Credit

3116 Reform of Pension and Provident Funds 1998 Successful

Financial Governance Reforms:

Sector Development Project

3620 Development of a Financial Services

Supervisory Institution 2000 Successful

Finance Governance and Social

Security Reform

Sources: Asian Development Bank Independent Evaluation Department, Project documents, and TA completion reports.

29. Country Program Review. The CAPE 200522

assessed that ADB had a comparative advantage in

providing loans in some sectors including in finance sector and ADB’s focus on advisory TA projects for

the finance sector improved over the years, with substantial impact on the sector. However, ADB’s

performance on the development finance loans was marginal.

F. Key Findings

30. The strategic shift of ADB’s financial sector operations to program loans to support sector

reforms was appropriate. Initially, ADB finance sector operations in Indonesia focused on providing credit

mainly to the agriculture and industrial sectors through financial institutions using credit lines. These

projects had mixed success and did little to improve financial intermediation. The ADB country strategies

began to shift focus from financing enterprises to improving the financial system, and supported

government reforms to transform the financial system from state-controlled to market-based. The use of

PBLs as the main instrument supporting the financial sector reforms was appropriate.

31. The PBLs supporting reforms were based on analytic work and accompanied by TA for

implementation. A financial sector review in 1987 was an important input to the 1988 Financial Sector

Program, with another financial sector review in 1991 feeding into the 1992 Second Financial Sector

Program. TA projects covering areas that included strengthening of BI’s supervisory capabilities and the

Indonesian Banking Development Institute accompanied the program loans. The 1998 PBLs were based

on multi-partner analytical work during the financial crisis.

32. The PBLs that supported PAKTO did not address the inability of supervision capacity to keep up

with the growth in lending unleashed by the reforms, as well as the weaknesses in bank governance and

lending practices. The PPAR for 1988 Financial Sector Program issued in 1993 had raised concerns about

inadequacies in the banking regulatory framework, inability of the supervisory authorities to cope with

the high growth in the financial system, and emergence of signs of potential instability in the banking

system. The Second Financial Sector Program was not able to adequately address these concerns, which

eventually manifested themselves during the 1997–1998 financial crisis.

33. There may have been missed opportunities in developing micro and small and medium-sized

enterprise (MSME) finance. ADB could have followed up on its successful microcredit project in support

of the Government’s program to accelerate the development of microenterprises in rural areas. In

addition, the SME sector was and continues to be an underserved segment in terms of financing.23

In

2007, MSMEs accounted for 97% of employment and 56% of GDP, while MSME loans to total loans in

the banking system was about 21% in 2011, of which 77% was for working capital.24

22 The first country assistance program evaluation prepared for Indonesia, which covered ADB support during 1990 and 2004.

23 IFC. 2016. Women-owned SMEs in Indonesia: A Golden Opportunity for Local Financial Institutions. Washington, D.C.

24 ADB. 2014. Asia SME Finance Monitor 2014. Manila.

49

Appendix 2. Capital Markets, Financial Development, Economic Growth

and Poverty Alleviation

1. The following note taken from the Independent Evaluation Group’s evaluation of World Bank

support to capital market development reviews available literature in terms of the relation between

financial sector development and economic growth as well as poverty reduction and inequality

reduction.1 It also provides summary information on the recent evolution of capital market development

of countries at different income levels. To the extent that information is separately available on the capital

market segment of the financial system, it is provided. The relative scarcity of information on capital

markets’ effects, as a distinct segment of the financial system, is not surprising as available evidence

points towards the complementarity of bank driven and market driven financial systems, with an increase

in the relative share of the latter as countries grow and develop.

1. Finance

2. Financial systems help to allocate capital, mobilize and pool savings, monitor investments,

facilitate risk diversification and management, and ease the exchange of goods and services (Levine

2005). Evidence of a causal link between financial depth and economic growth was traced by King and

Levine (1993), in a multi-country study that showed that financial development predicts long-run

economic growth. Gerschenkron (1962), Allen and Gale (2000) and Demirguc-Kunt and Levine (2001),

provided theoretical and empirical reasons to look at the financial sector beyond banks as a driver of

growth. Beck and Levine (2005) expanded the analysis to include stock markets and found that the size

of the banking sector and stock market development were both positively related to economic growth.

Extending this further, Fink, Haiss and Hristoforove (2003) found that in addition to banks and stock

markets, bond market development also influences economic activity.

3. Levine (2002, 2005) based on an empirical examination, shows that classifying countries as

having bank-based versus market-based financial systems is not very fruitful. Although overall financial

development is robustly linked with economic growth, there is no specific support for either the bank-

based or the market-based view. As pointed out by IEG (2006a) ‘Research on the best mix of financial

institutions, in terms of bank-based systems versus market-based (capital markets), shows a striking lack

of results. Rather, it is the overall level of financial sector development, regardless of which structure

dominates, that matters for growth. Thus, whether to promote the establishment or expansion of capital

markets in a country will depend on the circumstances, including the ability of the country to reduce

informational asymmetries.’

4. Studies also showed that financial depth influences not just the level of economic activity, but

also the nature of real sector activity, and the industrial structure of an economy. Capital market

development encourages industries that need external finance (Rajan and Zingales1998), Demirguc Kunt

and Maksimovic (2000) also show that stock market development is more related to the availability of

long term financing, whereas banking sector development is more related to short term finance. While

Beck, Demirguc-Kunt, Laeven and Levine (2004) suggest that financial development, overall,

disproportionately helps small firms, Didier and Schmukler (2013) point out that larger firms, especially,

benefit from stock and bond market access in some prominent emerging economies.

2. Finance Sector Development and Capital Markets

5. The extent to which financial structure (bank-based versus market-based) affects economic

growth has also been explored, and the implications of financial structure on growth. Cross-country

empirical research (reported by Levine 2005) finds fairly consistently that there is no single preferred

system, even for financially-dependent industries, or firms with external financing needs. Overall, the

1 Independent Evaluation Group. 2016. The World Bank Group’s Support to Capital Market Development. Washington, D.C.

50

conclusion from the literature to date is that while financial sector development is good for growth, the

financial structure adopted by a country is less important. However, Demirguc-Kunt, Feyen and Levine

(2011) find that as countries develop they increase their demand for the services provided by securities

markets relative to those provided by banks. Bank-based structures tend to dominate in the early stages

of growth, but the relative importance of banks decreases as economies develop.

3. Finance and Macroeconomic Volatility

6. The financial sector has played a contributing role in many, if not most, of the economic crises

that have taken place in recent years. The implications of such events on both growth and poverty are

significant. Even before the 2008 crisis, Easterly, Islam and Stiglitz (2000) found that the development of

the financial sector as measured by both bank credit to the private sector and stock market traded value

are negatively related to macroeconomic volatility. But they also pointed out that while bank credit is

negatively related to macroeconomic volatility, the relationship is not linear; above a certain level of

credit, financial sector development adds to macroeconomic volatility. This is similar to the finding of

Arcand, Berkes and Panizza (2012), who find that financial sector development, defined in this case as

private credit to gross domestic product (GDP), is positively related to economic growth, until it reaches

100% of GDP, beyond which it has a negative impact.

7. The development and expansion of capital markets, and indeed financial markets as a whole, is

not without risk. Instability may limit the impact of financial development on poverty alleviation. Banking,

a central part of most financial systems, is highly leveraged and has been prone to exaggerated credit

cycles that sometimes end in crisis, and there are some signs of increasing global levels of leverage and

possibly nascent bubbles in the real economy. The greater role of capital markets in more developed

financial systems can diversify some risk away from banks, dampening overall economic effects of shocks

to the banking system. Yet, in a changing world, technological shifts have introduced new forms and

delivery mechanisms of financial services that bear their own risks.2 And dynamic changes in global

financial structure, in a post-crisis environment, including regulatory shifts in the banking system, could

shift risks towards 'shadow banks’ and capital markets, and towards emerging as opposed to developed

markets.

8. Caprio and Klingebiel (2003) showed that fiscal costs of financial crises often exceeded 20% of

GDP. Bordo et al. (2001), determined that twin (banking and currency) crises have led to cumulative GDP

losses on the order of 18%, and Halac and Schmukler (2004) discuss the significance of regressive wealth

transfers unleashed by financial crises. During the course of the 2008–2009 financial and economic crisis,

it was estimated by the World Bank that an additional 53 million persons were plunged into poverty in

the developing world. Banking, a central part of most developed and developing financial systems, is

highly leveraged and has been prone to exaggerated credit cycles that sometimes end in crisis. But

historical evidence informs us that, in fact, financial crises are more frequent in developing than in

developed countries, likely due to better macroeconomic policy, regulation, and supervision (Reinhart

and Rogoff [2009]). And the greater role of capital markets in more developed financial systems

diversifies some risk away from banks, dampening overall economic effects of shocks to the banking

system.

2 Certain complex institutional and legal structures are deliberately designed to fall outside the traditional purview of regulators.

‘Shadow banking’ structures provide an example, and they are not new, nor are they illegal, untaxed, or unmonitored. While

these complex structures may use capital markets as financial intermediaries for transactions that would likely have previously

involved banks, this is primarily a challenge for regulators in the most developed financial markets. Credit derivatives are another

recent example. And certain market processes, such as high frequency trading, now increasingly present in the larger middle-

income countries, also carry own risks of exacerbating volatility.

51

4. Finance, Poverty, and Inequality

9. Does financial development help the poor through better resource allocation and more

information? Or does financial development inordinately help the rich, because the poor rely mostly on

informal networks and family? Beck, Demirguc-Kunt and Levine (2007) and Clarke, Xu and Zhou, (2006)

find that that financial development, measured by growth in private credit, disproportionately boosts

incomes of the poorest quintile of the population and reduces income inequality. Akhter and Liu (2010),

using a broader measure of financial development that includes non-bank financial institutions, find that

financial development helps the poor in countries with stable financial systems. However, instability may

limit the impact of financial development on poverty alleviation, a caution echoed by Jeanneney and

Kpodhar (2008). Perez-Moreno (2010) also points out that it is the moderately poor that clearly benefit.

Kim and Lin (2011), using measures of both bank and stock market development, also find that the

relation between financial development and inequality depends on the development level the country

has reached. Studies on individual countries also exist, though most use bank-based measures of financial

development. Ayyagari, Beck and Hoseini (2013) also find that financial development is strongly

associated with poverty reduction, a result echoed for Kenya by Odihambo (2010) and for Pakistan by

Imran and Khalil (2012), using bank-based data. Jalil and Feridun (2001), in a study on People’s Republic

of China (PRC), which uses a wider spectrum of financial development variables, also finds that increased

financial development will reduce income inequality in the PRC. Studies that isolate the effects of capital

markets as a component of the financial system, and poverty, are rare, as are those that use stock market

development alone as a proxy for wider financial development.

10. It should be added that some recent arguments suggesting a link between capitalism, inequality,

and instability, e.g., Piketty (2014), are not linked to capital markets. His argument is against the tendency

of capitalism, in general, to concentrate wealth in the hands of capitalists. There is not a single variety of

capitalism and some countries, for example, Sweden and Japan, operate capitalists systems with well-

developed capital markets and low inequality. Rajan and Zingales (2009) also recognize the inherent

problems with capitalism, but argue that financial markets offer a way out of poverty when they are well

managed and developed. Galbraith (2014) offers four factors impeding a return to normal growth after

the 2008 crisis, among which is the breakdown of law and ethics of the financial sector, but he does not

differentiate between the financial sector and capital markets.