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here has been a lot of psychological anxiety in the recent years over the entry of foreign banks.

First, there are fears that foreign-owned banks are not as “nationalistic” as domestic-owned banks. This assertion implies that domestic-owned banks are there to safeguard the national interest.

Second, despite the fact that the Indonesian government opened up the banking system to foreign investors in 1988 as a response to the sharp decline in oil prices in 1986, and again in 1998, to lure them to help recapitalize the collapsing banking sector, the “99 percent Foreign Equity Participation” limit created anxieties that Indonesia is too open relative to its ASEAN neighbors, which remain fairly protective of their banking industries.

Third, the country which is a major foreign owner and investor in Indonesia is Malaysia, with whom Indonesia often has conflict. Are these anxieties justified?

In 1995 the percentage of foreign-owned banks was 26 percent, and by 2009, it had reached 52 percent. There has been, however, a less significant growth of foreign bank assets out of the total assets in the banking system. In 2005, it was 32 percent and by 2009 it was still 32 percent.

Although the importance of foreign banks in regard to the share number is growing, its importance in regard to the asset share is not, which implies that foreign banks have been buying shares in banks with smaller assets. One possible reason is that it is more likely that smaller banks face shortages of capital.

Do foreign-owned banks bring competition to the domestic banking industry?

Competition should bring down the net interest margin (NIM), operating expenses to operating income (OEOI) and bank profitability. However, there is no evidence of this from these indicators. NIM remains high, and is higher for domestic banks, including non-foreign exchange private national banks, regional government banks, state-owned banks, and foreign-exchange private national banks, than for foreign banks and joint venture banks.

Indonesia’s high NIM is also highly related to the poor legal system. As a result, transaction costs are high because they rely on debt collectors to collect debts and to seize collateral. However, foreign banks also use debt collectors.

This is probably why the NIM of foreign bank branches is likely to be higher than that of their parent banks. For example, Malaysia’s banking-wide NIM is about half that of Indonesia’s.

Similarly, state banks have the highest OEOI among all types of banks since 2003, followed by non-foreign exchange private national banks, while foreign banks and joint venture banks have a lower OEOI.

Like their domestic counterparts, foreign-owned banks are very profitable. In fact, foreign banks were the most profitable type of bank for the years 2003-2012, with the return on asset (ROA) between slightly below 3 percent to above 7 percent.

The conventional range is 1.0 percent to 1.5 percent for banks in the Philippines, Thailand, Malaysia, Singapore and the US.

There are indications that the entry of foreign banks has not created much competition in the domestic banking industry, as shown by persistently high NIMs and OEOIs, as well as the increasing profitability of the banking industry as a whole.

The segmented markets that
foreign and domestic banks serve (corporate vs individual, money market vs micro-credit loans, etc.), and the oligopolistic banking structure are likely to be the main causes of a lack of competition in the banking industry.

There are also differences in ownership structure and treatment. Private banks are usually owned by conglomerates, serving a lot of their own businesses. Treatment toward state-owned banks is also different. Unlike Singapore’s state-owned banks which have been corporatized, Indonesia’s state-owned banks are the extensions of government bureaucracy.

They have exclusive access to public sector funds and they have become the supplier of funds in the interbank market, while the private and foreign banks become the consumers to buy these funds.

The most important question may be: How much do foreign banks contribute to the real economy?

Unless we add foreign exchange, private national banks, whose assets are about 50 percent foreign- owned, foreign bank branches and joint venture banks alone have not contributed much to loans, private deposit taking and credit growth.

 Foreign-owned banks may, however, provide cushions during host country-induced crisis, like in the 1997/1998 Asian financial crisis.

We should not be too anxious regarding foreign-bank entry. What we need to address is how the entry of foreign banks can contribute to the domestic banking sector, including its competitiveness, and the real economy.

Evidence shows that outstanding loans and private deposits were grossly and disproportionately located in favor of Jakarta, so one of the strategies could be to direct and encourage loans and private deposits away from Jakarta.

The wide and equal distribution of foreign bank’s presence is desirable so that less developed regions in Indonesia can also benefit from their presence.

Strategies regarding the entry of foreign banks may also include re-orienting loans toward investment, instead of only profiting from Indonesia’s lucrative market.

However, this rule must apply not only to foreign-owned banks, but all banks, because the World Trade Organization (WTO) commitment rules out discriminatory action against foreign-owned banks.

Lastly, how foreign-owned banks perform will depend on the environment in which they are operating. If monitoring of banks is effective, no foreign-owned banks will dare to behave recklessly, and vice versa.

It may not be our choice to host foreign banks, especially if our committment to the ASEAN Banking Integration Framework (ABIF) is serious, but it is certainly our choice to be a good and strategic host to these banks.

The writer is a researcher at the Centre for Strategic and International Studies and a lecturer at the University of Indonesia.