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oreign banks are still needed to supplement the poor capability of domestic banks and to raise long-term foreign currency funds in the international market to finance risky or long-term projects such as mining.

At the same time, foreign banks provide contingency loans to Bank Indonesia (BI) and the Finance Ministry in times of need and invest the foreign reserves of the central bank. Foreign banks come here to serve large multinational corporations from their home countries operating in mining and large-scale manufacturing.

They also provide loans to large domestic corporations, including state-owned companies such as Garuda and Telecom that cannot be provided by domestic banks. Because of this, the suggestion made by Perbanas (the national banking association) to convert the subsidiaries of foreign banks into locally incorporated subsidiaries is counterproductive.

The main objection to this proposal is that subsidiaries represent a net open position and the risk rating or premium of the recipient country affects interest rates.

Acquiescing to Perbanas, the new BI governor promises to use the reciprocity principle to force other countries to open their domestic markets for Indonesian banks. The principle, however, only opens the market. Penetrating the market is something else entirely. This requires meeting local standards and building a customer base. In 1989, a number of Indonesian banks opened branches in Hong Kong and other reputable financial centers as well as in money laundering centers such as the Bahamas and Cayman Islands.

BI had Indover, a commercial bank that operated in Holland and Hong Kong. Bank Niaga, where the present governor worked at the time, opened a branch in Los Angeles. They all closed after a few years due to severe losses. In reality, these banks were mainly for money laundering and evading taxes through transfer pricing. At present, overseas branches of Indonesian banks are mainly limited for the remittances of uneducated and unskilled workers working in those countries.

Aside from exporting low quality manpower Indonesia is also a supplier of unprocessed raw materials and energy to the world. Most of the booming mining and energy projects are either fully owned by foreigners or funded by foreign banks.

It is simply not reasonable or fair to require foreign banks to devote at least 20 percent of their loans to SMEs and to open branch offices in remote places as stated in the regulation. Based on density of bank offices, BI divides Indonesia into six zones. Jakarta belongs to Zone I and the less developed and sparsely populated areas with few bank offices such as West Papua and Gorontalo are in Zone VI.

Opening offices in each zone is subject to different capital requirements with the lowest in Zone VI. Those banks that give at least 20 percent of their credit to SMEs receive extra credit points.

 Except maybe foreign cooperative and rural banks such as Rabobank of Holland and Norinchukin of Japan, multinational banks do not have interest, expertise, experience or tradition of serving SMEs and cooperatives. The financial needs of these classes of customers are supposed to be the area of Bank Rakyat Indonesia (BRI) and Bukopin, the cooperative bank. BRI, Bukopin and other local banks as well as special purpose institutions should be able to serve this class of customers without foreign intervention. Regional development banks (RDBs) should promote themselves and open branches in remote places. At present, RDBs simply act as cashiers for their owners.

Recently BI relaxed the regulation on single presence ownership of banks by allowing holding companies to own more than one bank. BI can grant permission for foreign investors to own more than 40 percent of bank'€™s equity if they meet the standard of prudential rules and regulation, including Tier I capital requirement.

The recently introduced capital equivalent maintenance assets for foreign bank is a kind of soft capital control providing additional liquidity to local BI issued certificates (SBI), government paper and the capital market.

The bond and capital markets are narrow and shallow mainly because the availability of cheap, low-risk credit from state-own banks during the financial repression era that discouraged the corporate sector from raising funds through equities and the bond market.

During the 32 years of the Soeharto administration, the government did not need to issue sovereign bonds because budget deficits were entirely financed by concessionary development assistance from foreign donors. Securities on the local bond market are mainly the long-term sovereign bonds issued in 1998 to recapitalize ailing domestic banks. As the Treasury has not issued enough short-term Treasury papers, BI issues its own SBIs for open market operations.

To stabilize the domestic money market, authorities must deepen and enlarge it by, among other measures, revitalization of the postal saving bank. The existing wide network of post office can be used to vitalize domestic saving cheaply with low overheads. Like in Japan, and other countries, savings in the postal saving bank can absorb sovereign bonds and reduce dependency on volatile short-term capital flows or for financing infrastructure projects. Other avenues of developing money markets such as insurance and pension funds may take a long time.

A deeper money market and more competitive and healthier banks are needed to make the present monetary policy, with interest rates at its core, work.

The writer is professor of economics at University of Indonesia and former senior deputy governor of BI.