A

s ASEAN’s largest economy, Indonesia has been leading efforts to integrate the region’s banking sector. Indonesia, along with Malaysia, signed the first bilateral agreement under the ASEAN Banking Integration Framework (ABIF) in 2016.

Since its endorsement by the ASEAN central bank governors in 2011, the ABIF has been a cornerstone of ASEAN’s pursuit of greater financial integration. Financial integration is embedded in the ASEAN Economic Community (AEC) 2025 Blueprint as one of the three strategic objectives of the finance sector, along with financial inclusion and financial stability.

Banks designated as Qualified ASEAN Banks (QABs) will anchor the ABIF and are expected to be the backbone in facilitating intra-ASEAN trade and investment by 2020. These banks are blessed with benefits such as greater market access to branch networks and greater operational flexibility, and are entitled to treatment similar to local banks.

These benefits have fueled the interest of ASEAN member states to seek reciprocal agreements with one another to negotiate the entry of QABs into each other’s market.

In integrating the banking sector, however, each ASEAN member state needs to be prudent. Liberalization of the financial sector is not as straightforward as reducing tariffs or even liberalizing service sectors.

Ravi Menon of the Monetary Authority of Singapore believes that financial liberalization and integration must pay close heed to issues of systemic stability.

Financial integration, therefore, should not be the sole policy issue in the minds of ASEAN financial regulators.

Dirk Schoenmaker from Erasmus University argues that the three objectives of national financial policies, financial integration and financial stability cannot be met simultaneously, thus creating what is called the “financial trilemma.” National financial policies are unlikely to be sacrificed, and regulators would then have to choose financial integration or financial stability.

However, in Indonesia’s case, financial integration and financial stability can be undertaken simultaneously. The ABIF can support the banking consolidation policy it has undertaken since the 1997-1998 Asian financial crisis.

This policy was taken with the aim to push banks to improve their governance and strengthen their capital. One notable initiative under the consolidation policy is the single presence policy, which prohibits a single entity to hold a controlling interest in more than one bank at one time.

This has led to mergers, consolidation and acquisitions of banks. As a result, the number of commercial banks has been significantly reduced. Indonesia now has 118 commercial banks in operation, compared to 241
at the outbreak of the Asian financial crisis.

These banks have capital ranging from Rp 1 trillion (categorized as BUKU 1 banks) to those with more than Rp 30 trillion (BUKU 4 banks). As the ABIF aims to better facilitate the entry of ASEAN banks into other regional markets, the ABIF might appear to contradict Indonesia’s aim to reduce its number of banks at first glance.

However, on closer inspection, the ABIF can actually help accelerate Indonesia’s effort to consolidate its banks. For example, when bilaterally negotiating the entry terms for QABs, Indonesia may require that foreign QABs acquire existing banks and merge into one bank instead of establishing a new, locally incorporated subsidiary.

This will not only conform to the banking consolidation policy, but will also benefit foreign banks wishing to set up a commercial presence in Indonesia. This method benefits foreign banks, as it is economically and physically justified.

Acquiring small, BUKU 1 banks would economically benefit foreign banks, as this would cost less than establishing a new bank, which requires a minimum Rp 3 trillion in paid-up capital. On the other hand, foreign banks would gain the physical benefit of being able to tap into the acquired banks’ established banking networks.

The merger and acquisition process will likely result in more banks moving up into the higher commercial banking tiers in Indonesia.

The higher tiers allow banks to offer a wider scope of financial services and products. By moving up in the commercial bank classification, these banks would benefit by gaining more business opportunities, such as opening branches overseas.

However, this merger and acquisition process may face challenges. Owners of small banks might resist being merged and/or acquired by setting a high buying price, for example. If the buyer and the seller cannot agree on price, a regulator would intervene in assisting and facilitating the acquisition process.

The ABIF could also contribute to the national economy. Banks designated as QABs have been screened by their home authorities to meet certain criteria, such as being well-managed and well-capitalized. Aside from potentially offering better financial services, these banks will have greater lending capacity.

These stronger banks can provide financing to infrastructure and priority economic sectors as set out by the Financial Services Authority (OJK) in its 2015-2019 Financial Services Sector Master Plan.

Further, strong banks can also increase the banking sector’s capacity for private sector lending. Based on World Bank data, Indonesia still lags behind other ASEAN 5 countries in the ratio of domestic credit to private sector, which was only 33.1 percent of gross domestic product
(GDP) in 2015. This ratio trails the Philippines (41.8 percent), Thailand (117.3 percent), Malaysia (125.2 percent) and Singapore (129.7 percent).

Moreover, the benefits of being a QAB would lure the best Indonesian banks to strengthen their capital and management in order to meet the criteria. Before we know it, there will be plenty of banks competing to submit an application to the OJK to operate as QABs in their cross-border regional operations.

The way forward for Indonesia on the ABIF should be clear: Indonesia should be all in on the ABIF as it would not only help consolidate the banking sector and support the national economy, but also set a pathway for Indonesian banks to expand their operations in the region.
_______________________________

The authors work for the Indonesian Financial Services Authority (OJK). The views presented are their own.