T

he latest string of new regulations announced by Bank Indonesia (BI), the central bank, last week are designed to accelerate bank consolidation, direct bank operations to meet the priority needs of our national economic development and to gear up national banks ahead of ASEAN economic integration.

The regulation on the multiple-licensing system, which will tie the expansion of foreign and national bank networks and services to capital and corporate governance standards starting next year, will certainly force a faster pace of consolidation of the banking industry, decreasing the number of commercial banks from around 120 at present.

 Capital is indeed vital for the banking industry because the level or standard of core capital determines the capacity of a bank to absorb shocks and manage risk. The new licensing system, which will replace the current blanket (single) license for full bank services and expansion of branch networks, will force small and mid-size banks to steadily increase their capital, thereby forcing mergers or acquisitions.

 Latest data shows that almost 100 banks have a core capital of less than US$500 million. The new licensing system will restrict their areas of operations and the kinds of services or products they can offer.

There are about 16 mid-size banks with core capital of between $500 million and $3 billion which are expected to become national anchor banks with full services and operations across the entire country. The four large banks with capital exceeding $3 billion are designed to be international-class banks, highly competitive within the ASEAN integrated economy scheduled to be in full-fledged operations by 2016. These banks should gear up for the liberalized financial services market in ASEAN scheduled for 2020.

Even though our banks are among the most profitable in ASEAN, they are unfortunately among the most inefficient, measured by loan-to-deposit ratios, lending rates, net interest margins and the ratio of bank credit to gross domestic product. Worse still, according to a recent study by BI, only half of Indonesia’s population of about 240 million people have access to banking services because of the lack of banks in remote areas due to high costs and risks. A recent report by McKinsey global consulting revealed that only 12 percent of businesses in Indonesia currently have access to bank credit, compared to 80 percent in Thailand.

Hence, the regulation which requires banks to allocate at least 5 percent of their total loans to micro and small and medium-sized enterprises (SMEs) starting in 2015 is a strategic move to boost economic activities and curb consumer lending which seems to have expanded at a rather reckless rate. The transition period to gradually increase lending to micro and SMEs to 20 percent of their total loan portfolio by 2018 is reasonable.

However, higher capital standards are insufficient to build a sound, strong and efficient banking system. Good corporate governance (GCG) and effective supervision are equally crucial for developing a sound, strong and efficient banking industry. Here lies the importance of a regulation BI launched earlier in July that ties ownership structures in banks to preset levels of GCG and financial health.

The general rules cap single ownership of local banks at 40 percent for financial service companies, 30 percent for non-financial institutions and 20 percent for individual investors. Existing banks can retain their current ownership structures as long as they maintain high levels of corporate governance and financial health (top tier by the GCG index).

But the regulation will require the shareholders of local banks that are rated in the lower ranks of the GCG index to meet the new ownership caps by 2019.