Abstract
Indonesia's financial sector has two paradoxes: (i) Indonesia has been a global leader in microfi- nance for the past 25 years, but access to microfinance services is declining; and (ii) Indonesia's commercial banks are liquid, solvent, and profitable, and the Indonesian economy has been doing well over the past decade, but small and medium enterprises are facing a credit crunch. Although Indonesia is underbanked, most commercial banks have been unresponsive to unmet effective demand. The behavior of banks has been in their own short-term best interests, primarily because of the unintended consequences of Indonesia's financial sector reregulation after the East Asian crisis and contradictory monetary policies, which have produced a prudentially sound but ineffi- cient, narrow, and homogenized banking oligopoly. Indonesia should not respond to financial exclusion by artificially pumping out and administratively allocating more credit. Instead, it should promulgate smart regulation so that banks maintain their sound risk management without pursu- ing noncompetitive and noninclusive business practices.
Highlights
Indonesia’s financial sector has two paradoxes: (i) Indonesia has been a global leader in microfinance for the past 25 years, but access to microfinance services is declining; and (ii) Indonesia’s commercial banks are liquid, solvent, and profitable, and the Indonesian economy has been doing well over the past decade, but small and medium enterprises are facing a credit crunch
The Twin Paradoxes of Indonesia’s Financial Sector The financial sector in Indonesia is currently characterized by two perplexing paradoxes: 1 Indonesia has been a global leader in microfinance outreach and innovation for the past 25 years, access to microfinance services is declining
We demonstrate that despite potentially lucrative unserved or underserved markets, both microfinance institutions (MFIs) and mainstream commercial banks, in choosing to invest their resources elsewhere, are acting rationally in response to perverse incentives created by the current monetary policy and regulatory regime of Bank Indonesia (BI, the central bank)
Summary
The financial sector in Indonesia is currently characterized by two perplexing paradoxes:. This is true whether assessed nationally by examining macro figures of financial depth, or determined at the household. We demonstrate that despite potentially lucrative unserved or underserved markets, both microfinance institutions (MFIs) and mainstream commercial banks, in choosing to invest their resources elsewhere, are acting rationally in response to perverse incentives created by the current monetary policy and regulatory regime of Bank Indonesia (BI, the central bank).
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