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DE RUEHJA #0361/01 2280903
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FM AMEMBASSY JAKARTA
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INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
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UNCLAS SECTION 01 OF 06 JAKARTA 010361 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SEARLS 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON PGOV PREL ID
SUBJECT: INDONESIA'S FINANCIAL SECTOR POLICY PACKAGE 
 
REF: JAKARTA 1833 
 
¶1.  (SBU) Summary.  The Government of Indonesia issued its 
Financial Sector Policy Package on July 5, tackling two 
important issues of non-performing loans at state-owned 
banks, and insolvent insurance firms.  Success in these 
areas will represent one of the most significant changes in 
the financial sector since the post-crisis restructuring. 
This is the third of three economic policy packages that 
included Infrastructure (issued in February) and the 
Investment Climate (issued in March).  The Financial Sector 
Package was issued jointly by the Coordinating Minister for 
the Economy, the Minister of Finance, the State Minister of 
SOEs and the Governor of Bank Indonesia (BI).  It is 
designed to showcase achievements and bolster the GOI's 
credibility on financial reforms.  Like the other packages, 
the Financial Sector Policy Package is presented in matrix 
format: it has over 50 action items, each with a specified 
output, targeted timeframe, and responsible agency to 
address financial system stability; banking institutions; 
non-bank financial institutions; and capital markets. The 
matrix can be downloaded at from the Coordinating Ministry's 
website at 
http://www.ekon.go.id/v3/images/stories/versi inggris1.pdf. 
End Summary. 
 
New Financial Sector Policy Package 
----------------------------------- 
 
¶2. (U) The Government of Indonesia issued its Financial 
Sector Policy Package on July 5, mainly tackling two 
important issues: non-performing loans at state-owned banks, 
and insolvent insurance firms.  Success in these areas will 
represent one of the most significant changes in the 
financial sector since the post-crisis restructuring. 
President Yudhoyono noted in his August 16 annual policy 
speech that, "The Government and Bank Indonesia will 
continue to endeavor to perfect the policies, mechanisms, 
regulations, instruments and the quality of the economic 
institutions and the financial industry, such as, among 
others, stipulated in the package of policy reform in the 
financial sector.  This measure is necessary so that our 
economy has a growing elasticity and resistance to 
fluctuations and uncertainties." 
 
¶3. (U) This is the third of three economic policy packages 
that included Infrastructure (issued in February) and the 
Investment Climate (issued in March).  The package is 
divided into four principal chapters: 
 
A) Financial system stability; 
B) Banking institutions; 
C) Non-bank financial institutions; 
D) Capital markets. 
 
A short, fifth section for "miscellaneous issues" addresses 
the privatization of state-owned enterprises and 
establishment of a National Export Financing Agency.  The 
time horizon of the package runs through December 2007, but 
most measures are slated for action in 2006.  Several 
tougher issues such as a tax policy for the financial 
sector, infrastructure financing, and improving SME 
financing were deleted but may reappear in a follow-on 
package next year.  The Coordinating Minister plans to issue 
in 2007 a medium-term package mapping out financial sector 
reforms through the end of President Yudhoyono's term in 
¶2009.  A decree is in the works to establish an oversight 
committee to monitor Package implementation. 
 
¶4. (SBU) Minister Boediono, as Finance Minister under then- 
President Megawati, issued transparent policy matrices like 
these to show Indonesia's commitment to reform after 
completion of its IMF program in December 2003.  This 
package has been carefully designed to include achievable 
action items, many of which were already in train.  Many 
items simply call for the MOF to "improve" a regulation or 
issue a decree, or for Bank Indonesia to issue a circular on 
a certain subject.  In this respect, the package at least 
partly succumbs to the tendency of the bureaucracy to 
 
JAKARTA 00010361  002 OF 006 
 
 
measure implementation in terms of issuing official decrees, 
although we do not doubt the commitment of Coordinating 
Minister Boediono and in particular of Finance Minister Sri 
Mulyani to effecting tangible change. 
 
Improving Financial System Stability and Oversight 
--------------------------------------------- ----- 
 
¶5. (SBU) The first section of the package deals with 
financial system stability, a goal reinforced by the 
currency mini-crisis of August 2005, which was exacerbated 
by a lack of coordination between the fiscal and monetary 
authorities.  Our contacts at the International Monetary 
Fund (IMF) say it is unclear whether the package will 
actually improve policy coordination, noting Indonesia's 
tendency to "create domestic problems out of international 
shocks through a slow policy response."  The package calls 
for the drafting of a Financial Sector Safety Net Law and 
its submission to Parliament by December 2006.  In addition, 
the matrix echoes goals laid out in the State Ministry for 
National Development and Planning (BAPPENAS) National Medium 
Term Development Plan for 2004-2009 (issued as a 
Presidential Regulation in January 2005). 
 
¶6. (SBU) The new package calls for the establishment of a 
long-discussed Financial System Stability Forum (FSSF), 
whose members will include the financial supervisory and 
regulatory agencies including BI, the MOF's Capital Markets 
and Financial Institutions Supervisory Agency (BAPEPAM-LK), 
and the Indonesian Deposit Insurance Agency (LPS).  The FSSF 
will be charged with conceptualizing an Indonesian Financial 
System Architecture and establishing a Macro Early Warning 
System for disturbances in the financial sector.  A senior 
international advisor in the Finance Ministry told us that 
the FSSF would normally sit within the Central Bank, but 
because Sri Mulyani does not trust BI, the forum is a hybrid 
and took two years of negotiations to finalize.  Bank 
Indonesia and LPS signed an MOU to develop the FSSF on 
December 30, 2005 (reftel).  On the same date, the Minister 
of Finance also issued a Decree on the Financial Safety Net 
(No 135/PMK 05/2005), in force until the new law is in 
place. 
 
¶7. (U) The proposed Financial Sector Safety Net Law would 
enhance the existing LPS law to help protect depositors from 
bank failures as well as protect the government from the 
risk of future bailouts.  It also creates a formal mechanism 
between BI, the MOF, and the deposit insurance agency (LPS) 
for dealing with troubled banks.  The GOI has been working 
on a financial sector safety net, consisting of a lender of 
last resort, deposit insurance agency, and institutional 
mechanism for dealing with distressed banks, since the 
financial crisis of 1997-98.  Building blocks of the safety 
net have been covered by other laws, such as the phrase-out 
of blanket deposit insurance (completed) and creation of a 
consolidated regulatory and supervisory agency for the 
financial sector (not yet completed).  (Note: The Financial 
Services Authority, or OJK, is mandated by Law 23/1999.  End 
Note.) 
 
Strengthening State-Owned Banks 
------------------------------- 
 
¶8. (SBU) The main policy goal of this part of the package is 
to improve the performance of state-owned banks by resolving 
their NPLs.  Bank Mandiri and Bank Negara Indonesia (BNI) 
are the principal targets of the measures elaborated in the 
package, having accrued large amounts of NPLs through years 
of lax governance, related lending, and poor risk 
management.  The package includes smaller policy programs to 
professionalize the banking sector, such as expanding 
certification testing for basic banking operations, 
including risk management; improving methodologies for risk- 
based banking supervision; implementing formal Good 
Corporate Governance standards for commercial banks; and 
bringing Indonesia's new credit bureau, inaugurated in June, 
into line with international standards and expanding its 
access to information.  BI Deputy Governor Maman Somantri 
told us he expects the credit bureau will be privatized in 
 
JAKARTA 00010361  003 OF 006 
 
 
two years.  After the nascent mutual fund industry suffered 
losses of 70 percent last year over non-transparent pricing 
and risk, the package also calls for information 
transparency for banking products and other consumer 
protection measures.  These include a standardized system 
for consumers to file complaints and the establishment of an 
independent dispute mediation body. 
 
¶9.  (SBU) Although Bank Mandiri and BNI lobbied BI to be 
allowed to establish special purpose vehicles that would 
take NPLs off their books, the policy actions will instead 
amend the rules governing NPLs.  They will allow state-owned 
banks to work around state laws that have thus far prevented 
them from resolving bad loans using techniques commonly 
employed by commercial banks.  Existing laws, such as the 
2003 State Finance Law, treat state-owned banks assets as 
"state" assets.  As a result, state-owned banks taking a 
haircut (loss) on non-performing debt or reselling it at a 
discount could be accused of causing a financial loss to the 
state, currently considered a criminal corruption offense. 
An international advisor at the Finance Ministry tells us 
that Bank Mandiri has been waiting for President Yudhoyono 
to sign the government regulation allowing state-owned banks 
to take haircuts on debt, which has been on his desk since 
the end of July. 
 
¶10. (SBU) Getting rid of the NPLs is only half the battle, 
however.  Resident expatriate economists note that because 
an excess of NPLs reflects a bank governance problem, bank 
management must be improved to prevent them from 
accumulating anew.  Besides allowing the state-owned banks 
to resolve NPLs using techniques employed by commercial 
banks, the Package also urges they emulate the more 
professional management practices of their private sector 
counterparts.  The package calls for the State Ministry of 
SOEs to "ensure the commitment of state-owned banks' 
management to corrective measures in governance and risk 
management and to efforts for resolving problem loans."  The 
medium specified for achieving this is the signing of 
management contracts on these subjects with the boards of 
directors of state-owned banks, a pretty weak mechanism for 
producing results. 
 
¶11. (SBU) The Finance Ministry advisor characterized Bank 
Mandiri as "very cooperative" in reform efforts.  A senior 
contact at Mandiri also pointed out that the bank's new 
president, Agus Martowardoyo, had replaced all the group 
heads at the bank, which took months.  In contrast, BNI is 
not replacing key staff, suspended an audit that was 
undertaken 18 months ago, and has a disengaged board of 
commissioners.  The IMF notes that BNI is bloated in terms 
of personnel, at two-thirds the size of Mandiri, and unlike 
the latter is still non-transparent about its NPLs. 
 
¶12. (SBU) An international banking consultant told us that 
it is not only the old legacy loans that are problematic, 
such as the Mandiri loans that have been the subject of 
headlines in the past year.  New loans are going bad at a 
worrisome tempo because banks do not have proper risk 
assessment procedures.  The consultant lamented that at 
least a third of Mandiri's employees are corrupt, 
incompetent, or both, and estimated that some 40-50 percent 
of new SME loans are going bad because Mandiri still does 
not have good risk managers or account officers. 
 
¶13. (SBU) Though the Financial Sector Package aims to 
improve the banks, some debtors still have an attitude 
inherited from the New Order, when one of the perks of crony 
capitalism was that it was understood that state-owned bank 
loans did not always need to be repaid.  Our senior contact 
at Bank Mandiri told us in confidence that after Bank 
Mandiri tried a "name and shame" strategy earlier this year, 
publishing the names of problem-loan holders, some debtors 
had started to pay, some were paying only interest, and some 
who could pay have a bad attitude and are refusing to. 
Mandiri's actions provoked a backlash from some companies 
that reached out to Palace contacts in an attempt to get the 
President to intercede, which he declined to do on advice of 
Finance Minister Mulyani.  We heard a similar story about 
 
JAKARTA 00010361  004 OF 006 
 
 
debtors with bad attitudes from the Finance Ministry 
advisor, who told us that Mandiri had "quite legally" seized 
a few cash deposits that were used as collateral on 
nonperforming loans.  In one instance, the customer 
complained to the police, who hauled in several dozen 
Mandiri staff members including a director for questioning 
until 4 a.m.  The advisor noted that in the past, Mandiri 
would have just made the problem go away by paying the 
police more than the client had, but now Mandiri's approach 
is to work things out through proper channels. 
 
Bank Consolidation 
------------------ 
 
¶14. (SBU) The Financial Sector package includes an item 
designed to encourage the consolidation of Indonesia's 131 
banks required under BI's Indonesian Banking Architecture 
vision.  The matrix calls for Bank Indonesia to provide 
"incentive" for banks to merge over the next two years, but 
does not explain what the incentive will be.  BI has had 
trouble energizing its bank consolidation program, since the 
owners of small private banks like being bank proprietors, 
do not want to sell or close their banks, and are unlikely 
to respond to rational incentives.  The large state-owned 
banks, however, have shown sustained interest over the past 
year or so in merging with each other, raising the 
undesirable prospect of too much banking sector 
concentration in precisely the segment that is most poorly 
managed.  BI has rebuffed these proposals.  However, BI's 
recently announced "single presence" policy, if it goes 
ahead, would bar investors from holding a majority ownership 
stake in more than one bank.  Designed to encourage 
consolidation (and possibly to mollify nationalists piqued 
at foreign investment in Indonesian banking), it is unclear 
whether the policy would apply to the government, which 
holds controlling stakes in the country's three largest 
lenders measured by assets-Mandiri, BNI, and Bank Rakyat 
Indonesia (BRI). 
 
Next Up, Insurance Sector 
------------------------- 
 
¶15. (U) The third section of the package deals with non-bank 
financial institutions, with a marked focus on the insurance 
industry.  (Note: Indonesia's insurance sector is in bad 
health and poorly regulated.  Some domestic insurance 
companies were merely appendages of conglomerates.  End 
Note.)  The matrix calls for improved implementation of 
"Know-Your-Customer" principles across the non-bank sector; 
general moves to strengthen the pension fund sector, 
including drafting a development road map for the industry 
and good governance guidelines; and MOF decrees on 
strengthening the capital structure, regulation and 
supervision of finance companies and venture capital firms. 
Both insurance pension industries are underdeveloped in 
Indonesia, depriving the nation of good sources of long-term 
capital that could be invested in infrastructure.  The 
insurance industry is small, according to the World Bank in 
January 2005, with assets equal to just 5 percent of GDP and 
6 percent of total financial sector assets.  The industry is 
also highly concentrated, with the ten largest insurance 
firms dominating three-quarters of the sector.  The pension 
sector is similarly small, commanding only about 3 percent 
of financial system assets. 
 
¶16. (SBU) Indonesia's insurance industry has made progress 
since international insurers Manulife (in 2002) and 
Prudential (in 2004), were declared "bankrupt" by the 
Indonesian court system on spurious grounds.  Now the GOI is 
wrestling with genuinely bankrupt insurance firms, in 
particular, Bumiputra 1912, Indonesia's preeminent domestic 
insurance company.  Bumiputra 1912 is "totally bankrupt," 
according to our insurance industry contacts, with premiums 
collected today being paid out tomorrow in claims.  It 
should theoretically be shut down, but since it insures 
teachers and similar professions in the lower-to-middle 
class, the GOI is concerned about disruptive social 
consequences if the firm were allowed to fail.  Upon 
discovering that Bumiputra 1912 is incorporated as 
 
JAKARTA 00010361  005 OF 006 
 
 
Indonesia's only mutual life insurance company, the GOI made 
an exception for mutual life insurance firms in the solvency 
law to avoid having to close Bumiputra down. 
 
¶17. (SBU) Our insurance industry contacts note some concern 
among foreign insurance firms that GOI will ask them to 
rescue bad firms.  The Minister of Finance apparently only 
learned recently that Bumiputra 1912 was insolvent, and that 
she and Isa Rachmatarwata, Director for Insurance at Bapepam- 
LK, are still trying to devise a strategy.  The 
international advisor in the Finance Ministry commented that 
Director Isa "has inherited a real rat's nest" in the 
insurance sector, referring to the Bumiputra problem.  The 
advisor told us that Isa has conferred with a World Bank 
actuary on the Bumiputra problem and believes the firm's 
deficit to be at least $500 million, but that international 
interest in buying into the firm should help resolve the 
situation. (Note: As part of the MOF's reorganization, the 
Capital Market Supervisory Agency, BAPEPAM, merged last year 
with the MOF's Directorate General of Financial 
Institutions, which supervised insurance, pensions, and 
other non-bank financial institutions, to form a 
consolidated regulator for all these institutions, now 
called BAPEPAM-LK, under the MOF.  This merger is a 
transitional step toward the formation of the fully 
consolidated and independent regulatory body for financial 
services or OJK, mandated under Law 23/1999. End Note.) 
 
Capital Markets 
--------------- 
 
¶18. (U) The section on capital markets includes a slew of 
measures to "develop," "improve," and "refine" supervision, 
infrastructure, systems and procedures.  One noteworthy 
program aims to develop the secondary market for bonds, 
including better price discovery mechanisms, starting up a 
bond repo market, and establishing a primary dealer system 
for government bonds.  All these measures would further GOI 
efforts to broaden and deepen the domestic capital market 
for better GOI debt management and deficit financing options 
in future.  The MOF has already completed one action item on 
the matrix, the issuance of Indonesia's first-ever 
government retail bond (ORI).  Most Indonesian citizens put 
their money into very short-term time deposits of 30 days. 
The government is promoting the three-year retail bonds to 
encourage the development of an "investment society" that 
will help finance national development through the capital 
markets.  The small retail bond issue, originally targeted 
to raise only about $230,000, attracted strong interest. 
The GOI accepted all bids for a final issue of over $360,000 
at the August 9 auction. 
 
Privatization of SOEs 
--------------------- 
 
¶19. (SBU) The last section includes a couple of measures to 
further the politically sensitive, stalled policy of 
privatizing State-Owned Enterprises (SOE).  According to the 
matrix, a Privatization Committee should be established by 
Presidential Decree this month, and a blueprint for SOE 
privatization should be drafted by November.  Our foreign 
advisor contact in the Finance Ministry described Minister 
of State Owned Enterprises Sugiharto as a stumbling block to 
privatization efforts, saying that Sugiharto would like to 
create a Temasek-style holding company and will not sell any 
SOE if he can help it.  The advisor said that Sugiharto has 
had to cede some power, however, and that the divestment 
committee will no longer be chaired by Sugiharto but by 
Boediono. 
 
Comment: Less and More 
---------------------- 
 
¶20. (SBU) The matrix contains less than earlier drafts the 
Embassy had seen.  This may not be a bad thing, however, as 
the GOI was criticized for slow implementation of earlier 
measures which were announced with great fanfare.  It would 
be better for the GOI to take small steps which build 
credibility in its ability to deliver, rather than broad 
 
JAKARTA 00010361  006 OF 006 
 
 
strokes which are ultimately realistic.  We believe many 
elements of this new package are feasible, though missing 
specific benchmarks and targets to measure results. 
 
¶21. (U) This cable was researched and drafted by TDY 
Economic Officer Juliet Berger. 
 
PASCOE