Comment on “If the Banks are Doing So Well, Why Can't I Get a Loan? Regulatory Constraints to Financial Inclusion in Indonesia”

Abstract

Rosengard and Prasetyantoko (2011) present the following two arguments: (i) there is a large unmet demand by micro, small, and medium enterprises (MSME) for loans; and (ii) Bank of Indonesia (BI) regulations have reduced the supply of loans by banks to MSME. One must exercise caution in agreeing with the first point because it is difficult to show empirically that an “unmet demand” exists that an economy is “underbanked,” or that in a given sector there is a “credit crunch.” To show this, one must derive the level of loan supplies that “should have been” realized in the absence of the issues raised by the authors. This can only be done with a concrete set of assumptions and modeling whose validity will not necessarily be agreed upon by everyone. At the micro level, the identification of a credit constraint is difficult without the use of panel data (Bigsten et al., 2003) or randomization (Banerjee et al., 2010), and studies have found that not all potential borrowers are in need of credit. In addition, at the macro level, the data in Rosengard and Prasetyantoko's (2011) table 5 does not make a strong case for the existence of a large unmet demand for loans by MSME. That table shows that total loans supplied by banks increased by 45% in real terms from 710 trillion rupiah in 2005 to 1800 trillion rupiah in 2010 (1029.39 trillion in 2005 rupiah), and that MSME credits maintained a relatively stable share at around 50%. So I would take it as a realistic assumption. On the other hand, Rosengard and Prasetyantoko illustrate their second point about the impact of BI regulations in a logically coherent manner. Their reference to the key regulatory changes is an important contribution to the relatively unstudied area of regulation and microfinance development. To make their novel contribution to the literature more explicit, however, the paper should refer to the earlier studies on microenterprise financing. While the authors' claims provide important insights, some of them are not supported with evidence. Due to space limitations, I will list some examples concisely.1 While contractionary monetary policies may have “contributed to the crowding out of MSME access to credit” (p. 281), why would this explain the reduced MSME lending relative to non-MSME lending? With village-owned microfinance institutions (VMFIs) and local government-owned microfinance institutions (GMFIs) converted to BPRs, can the authors back their claim with evidence that it resulted in a “decrease in microenterprise lending” (p. 290)? When banks comply with the minimum loan to deposit ratio (LDR) requirement, why would banks, or why did the banks in the past “increase credit without lending more to MSMEs” (p. 291)? After discussing the likely impacts of these reregulations, the authors recommend that the authorities intensify bank competition by removing entry barriers and diversify the type of financial institutions by encouraging the reestablishment of nonbank lenders. As the authors point out, BI regulations that may have reduced bank loans to MSMEs were put into place out of concerns over financial stability. One of the contributions of Rosengard and Prasetyantoko (2011) is that it makes the notion of this trade off explicit: the slow growth of bank loans was a cost incurred for achieving financial stability. However, the regulators do not seem to make the trade off explicit despite the fact that they have chosen a certain combination of the trade off. It may therefore be instructive to frame regulations in relation to the loan supply – stability trade off and balance deregulation recommendations against financial stability concerns. For example, regulators may want to know the impact of competition on bank asset soundness, or may worry about the potentially slacker monitoring/oversight of nonbank lenders by local governments, something which might compromise the prudential regulation framework. If Rosengard and Prasetyantoko (2011) had shown the stability implications of their recommendations, and/or derived complementary measures to keep the financial system stable, it would have allowed all the stakeholders to understand the policy options more clearly.