INTRODUCTION

The costs of financial system failure in the form of a systemic banking crisis can be extraordinarily high, as illustrated by Indonesia's devastating financial crisis that began in 1997. It took many years for bank lending growth to resume and, by some measures, Indonesia's level of financial development has yet to return to pre-crisis levels. In comparison with this history, Indonesia's financial system has been working very well over the past decade. Government financial policy has the declared aim of promoting a financial system that facilitates economic growth, supports financial inclusion and safeguards financial stability. These goals require a balancing act that, so far, appears to have achieved a degree of success. Measures of growth and performance described in this chapter focus on the significant financial development over the past two decades and suggest a financial system that is more resilient than at any stage in the past. Notwithstanding potential costs and risks arising from increasingly interventionist financial policies and an inadequate financial safety net, the banking sector (to date) remains relatively robust in prudential terms. There is evidence of inefficiency arising from structural segmentation of the banking system, which has persisted despite foreign presence in the banking system. The financial sector as a whole has diversified as nonbank capital markets and the nonbank financial service sector have developed, albeit modestly.

The next section of this chapter presents basic data on the structure and performance of Indonesia's financial system. It goes on to discuss the policy framework governing the financial sector, with an emphasis on agencies and policies relating to banks, which remain the dominant players in the financial system. The third section identifies some of the policy conflicts and constraints affecting financial sector performance, with attention to the segmentation of the banking sector, the role of foreign ownership and the potential for financial sector diversification away from current levels of reliance on commercial banks. The final section concludes.

FINANCIAL SYSTEM STRUCTURE AND PERFORMANCE

Indonesia's financial system remains bank-dominated, with banks accounting for around 76 per cent of the assets of all financial institutions, as shown in Figure 5.1. Insurance companies, pension and mutual funds and all other financial intermediaries together thus account for less than a quarter of all assets held by financial institutions.