Bank Indonesia, Financial Stability Review No. 11 September 2008

ii
Publisher :
Bank Indonesia
Jl. MH Thamrin No.2, Jakarta
Indonesia
The preparation of the Financial Stability Review (FSR) is one of the avenues
through which Bank Indonesia achieves its mission ≈to safeguard the stability of the Indonesian
Rupiah by maintaining monetary and financial system stability for sustainable national
economic development∆.
FSR is published biannually with the objectives:

To improve public insight in terms of understanding financial system stability.
To evaluate potential risks to financial system stability.
To analyze the developments of and issues within the financial system.
To offer policy recommendations to promote and maintain financial system stability.
Information and Orders:

This edition is published in September 2008 and is based on data and information available as of June 2008, unless stated
otherwise.
The PDF format is downloadable from: http://www.bi.go.id

For inquiries, comments and feedback please contact:
Bank Indonesia
Directorate of Banking Research and Regulation
Financial System Stability Bureau
Jl.MH Thamrin No.2, Jakarta, Indonesia
Phone : (+62-21) 381 8902, 381 8075
Fax : (+62-21) 351 8629
Email : BSSK@bi.go.id
Financial Stability Review
( No. 11, September 2008 )
ii
Table of Contents
Foreword vi Chapter 3 Financial Infrastructure and Risk

Mitigation 49
Overview 3 Developments in the Payment System 49
Payment System Developments 50
Chapter 1 The Macroeconomy and Real Sector 9 Risk Assessment and Risk Mitigation 51
The Macroeconomy 9 Steps Towards CPSIPS 52
The Real Sector 12 Business Continuity Plan 52
Box 1.1. Effect of Inflation on Bank Credit Growth Crisis Management Protocol 52
and Quality 16
Box 1.2. Energy and Food Security: Effects on Chapter 4 Prospects of the Indonesian
Financial System Stability 18 Financial System 57
Economic Prospects and Risk Perception 57
Chapter 2 Financial Sector 21 The Banking Industry Risk Profile: Level and Direction 58
Structure of the Indonesian Financial System 21 Prospects of the Indonesian Financial System 59
The Banking Industry 22 Potential Vulnerabilities 60
Funding and Liquidity Risk 22
Credit Growth and Credit Risk 23 Articles
Market Risk 29 Article 1 Market Liquidity Risk as Financial Stability
Profitability and Capital 31 Indicator: The Indonesian Case 63
Non-Bank Financial Institutions and Capital Market 33 Article 2 Operational Risk in Indonesia: Advanced
Finance Companies 33 Measurement Approach 79
Capital Market 36
Box 2.1. Bancassurance and Life Insurance 42 Glossary 93
Box 2.2. Development and Diversification of
Mutual Fund Risk 44
iii
List of Tables and Figures
Tables Graphs
1.1 Global Economic Indicators 9 1.1 GDP Growth of Industrial Countries 10

1.2 GDP Growth of Several Emerging Markets 10
2.1 Financial Composition of Financial Institutions 34 1.3 Price Indices of Several Commodities 10
2.2 Performance of Finance Companies 35 1.4 Inflation in ASEAN-5 and Vietnam 10
2.3 Funding Sources of Finance Companies 36 1.5 Inflation in Indonesia and the BI-rate 11
2.4 Index Performance of Several Regional Stock 1.6 Indonesian Real Interest Rate 11
Markets 37 1.7 IDR/USD Exchange Rate Performance 11
2.5 Sectoral Index Performance 37 1.8 Global Stock Price Index 11
1.9 Growth of Indonesian Exports 11
3.1 Settlement Value and Volume Growth in the 1.10 Composition of Capital Inflow 12
BI-RTGS System 49 1.11 ROA and ROE of Public Listed Non-Financial
3.2 Settlement Value and Volume Growth in the Institutions 12
Clearing System 50 1.12 DER and TL/TA of Public Listed Non-Financial
3.3 Transactions of Card-Based Payment Tools Institutions 13
(APMK) 50 1.13 Probability of Default (PD) of Public Listed
3.4 Compliance to CPSIPS by Bank Indonesia 52 Non-Financial Institutions 13
1.14 Unemployment in ASEAN 13
4.1 Projections of Several Economic Indicators 57 1.15 Growth of Wages and Inflation 13
4.2 Risk Perception of Indonesia 57 1.16 Household Assets 14
1.17 Household Debt 14
1.18 Growth of Household Credit 14
Box Tables : 1.19 Household Debt 14
2.1.1 Bancassurance Performance of Nine Banks 42
2.2.1 Composition of Mutual Funds prior to 2006 44 2.1 Assets of Financial Institutions 21
2.2.1 Composition of Mutual Funds post 2006 45 2.2 Growth of Deposits 22
2.3 Liquidity Gap Percentage 23
2.4 Loans and Deposits 23
2.5 Loan to Deposit Ratio 24
2.6 Credit Growth by Bank Group 24
2.7 Growth of Investment Loans, Working Capital
Loans and Consumption Loans 24
2.8 Growth of Consumption Loans 24
2.9 Growth of Property Loans 25
2.10 Growth of Rupiah and Foreign-Denominated
Loans 25
2.11 Growth of MSM and Non-MSM Loans 25
2.12 Undisbursed Loans 26
2.13 Non Performing Loan 26
iv
2.14 Nominal NPL & Loan Loss Provisions 26 2.47 Share Price of Several Banks 38
2.15 Nominal NPL Growth by Bank Group 26 2.48 P/E Ratio of Bank Shares 38
2.16 Gross NPL 27 2.49 Efficiency of Sectoral Shares 38
2.17 Nominal NPL Growth by Economic Sector 27 2.50 Capitalization Value and Share Issuance Value 38
2.18 NPL Share based on Economic Sector 27 2.51 Yield Growth of Rupiah Investment 38
2.19 Nominal NPL Growth based on Usage Type 27 2.52 Price of FR Series SUN 38
2.20 Gross NPL of Consumption Loans 28 2.53 SUN Ownership 39
2.21 Nominal NPL of Rupiah and Foreign- 2.54 SUN Portfolio: Investment - Trade 39
Denominated Credit 28 2.55 SUN Performance by Type 39
2.22 Nominal NPL of Micro, Small, and Medium 2.56 Liquidity of SUN based on tenure 39
Loans 28 2.57 Issuance and Position of Corporate Bonds 40
2.23 Performance of Rupiah Interest Rate and 2.58 Mutual Funds based on Type 40
Exchange Rate 29 2.59 Mutual Funds: NAV √ Units 40
2.24 Lending Rate by Bank Group 29 2.60 Redemptions-Subscriptions-NAV 40
2.25 Rupiah Maturity Profile 30 2.61 Investment Manager: Customer & Funds 40
2.26 Foreign Exchange Maturity Profile 30
2.27 SUN Portfolio of the Banking Industry 30 4.1 Bank Risk Profile and its Future Direction 58
2.28 NOP Performance 30 4.2 Financial Stability Index 59
2.29 Interest Rate Spread 31
2.30 Interest Income Composition of 15 BB 31
2.31 Interest Income Composition of the Banking Graphs included in Boxes:
Industry 31 1.1.1 Credit Growth Estimation Model 16
2.32 Spread between BI Interest Income and 1.1.2 Credit Quality Estimation Model 16
Cost of Interbank Call Money 32 1.2.1 Inflation, Oil Prices and Farm Products 18
2.33 The Banking Industry P/L 32
2.34 Risk Weighted Assets, Capital and CAR 32 2.1.1 Investment of Insurance Companies 42
2.35 CAR Ratio of Bank Groups - June 2008 32 2.1.2 Performance of Life Insurance Companies 43
2.36 Stress Test on Various Scenarios 33 2.1.3 Profit of Life Insurance Companies 43
2.37 Business Activities of Finance Companies 33 2.2.1 Mutual Fund Performance (2005) 44
2.38 Composition of Finance Companies 34 2.2.2 NAV Movement (2004-2005) 45
2.39 Financing NPL 34 2.2.3 NAV Movement (2006-2008) 45
2.40 Cash Flow of Finance Companies 35
2.41 Funding Sources of Finance Companies 35
2.42 Exposure of the Banking Industry 36
2.43 Inflow of SUN-BI Certificates-Shares 36
2.44 Total Inflow: SUN-BI Certificates-Shares 36
2.45 Price Indices of Regional Stock Exchanges 37
2.46 Share Capitalization by Sector 37
v
Foreword
I happily welcome the publication of Financial Stability Report No. 11, September 2008. This report bears important
weight as much development has ensued in the financial sector, both domestic and abroad, and therefore needing to be
analyzed and communicated to serve the best interests of our stakeholders. It is our hope that readers will be able to gain
much information on the recent developments in Indonesia»s financial sector and its resilience in the face of various
shocks and risk pressures.
In general, our analysis shows that the country»s financial sector resilience during the first half of 2008 has been well
maintained. The banking industry, the financial sector»s dominant industry, has been able to maintain relatively good
performance as evident by fairly high profitability and capital levels, low non-performing loans, and well-maintained
liquidity. However, such achievements are no reason for complacency as many challenges have recently surfaced within
the financial sector-all of which demanding our prompt attention.
A critical challenge is soaring credit growth. Occurring in a non-high inflation period, strong financial intermediation
displayed by banks would have been a welcomed feat. However, with inflation pressures on the rise, it becomes our
challenge to see today»s strong credit growth not evolving into tomorrow»s problem loans. Also of our concern is that
strong credit growth does not occur at the cost of liquidity in the banking system.
Meanwhile, it is also important to pay close attention to the developments of the financial crisis in the United States
and other countries in various parts of the world as caused by the subprime mortgage debacle. Our banking industry»s
non-exposure to subprime mortgage derivatives has avoided it from the crisis» direct impacts. However, with the increasing
degree of integration between international and domestic economies, it behooves us to carefully monitor the impacts of
the global financial crisis to the banking and financial sector as a whole.
Moving forward, with constantly growing challenges and uncertainties in the financial world, there is no option but
to increase financial sector resilience, alertness, and prudence. Undoubtedly, all this will steer us away from the path of a
crisis and enhance the financial sector»s contribution to economic growth and thus achieving greater prosperity for the
public.
Jakarta, September 2008

DEPUTY GOVERNOR
Muliaman D. Hadad
vi
Overview
Overview
1
Overview
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2
Overview
Overview
During the first semester of 2008, the financial system stability was preserved
amid intensifying pressures stemming from both the global and domestic
economies. Meanwhile, the banking industry, Indonesia»s financial sector
dominant industry, indicated favorable performance with well-managed
liquidity as well as relatively high profitability and capital. Additionally, for
the first time since the financial crisis in 1997/1998, loans expanded greatly
to 31.6% (y-o-y) with a loan-to-deposit ratio of 76.6% by the end of June
2008. This strongly reflects that the intermediary function of banks has
improved. Nevertheless, robust credit growth during this period of high
inflation necessitates increased vigilance to prevent greater credit risk.
Furthermore, as credit growth outpaced that of third party funds (deposits),
increased liquidity risk and long-term capital pressures should be anticipated.
Through accurate anticipatory and risk mitigation measures, financial and
banking system resilience in future is expected to remain positive.
1. SOURCES OF INSTABILITY pressures emerged a couple of months prior to the May-

1.1. External Volatility 2008 announcement of a hike in domestic fuel prices. To
External volatility was the principle source of help overcome inflationary pressures, the BI rate was raised
instability during the first semester of 2008. The ongoing to 8.50% at the end of June 2008. As of September 2008
impact of the subprime mortgage debacle in the U.S. raised the BI rate reached 9.25%.
volatility in global financial markets and triggered a global Increasing volatility in global financial markets had
economic downturn. The situation was aggravated further undesirable impacts on the domestic bourse and
by rising inflation coupled with soaring oil and commodity undermined the price of Government Bonds (Surat Utang
prices. Domestically, despite relatively high economic Negara or SUN). Banks with large SUN ownership in their
growth, inflationary pressures became a challenge. Such trading or «available for sale» portfolios, faced the challenge
3
Overview
of a relatively high loss potential due to the application of As a consequence, the repayment capacity of both
mark-to-market accounting. Meanwhile, the increasing household and corporate sectors deteriorated. Preventing
price of fuel raised costs, slowed production activities and a further increase in NPL will be particularly onerous should
suppressed sales, therefore exacerbating the repayment such conditions persist.
capacity for bank loans. Consequently, non-performing
loans (NPL) tended to increase. Moreover, efforts of raising 1.3. High credit growth
interest rates to reduce inflation, if not applied prudentially, Despite the sharp rise in loans during the first
may further threaten the NPL ratio. Over time, this could semester of 2008, maintaining bank and financial system
trigger instability in the financial sector. stability remains pivotal in ensuring increased credit
extension does not vitiate the economy. As the surge in
1.2. Real Sector Constraints as well as Energy loans occurred during a period of high inflation, it is
and Food Security essential to manage the growth in order to avoid further
One source of instability that requires immediate compounding inflation. Thus, credit extension must remain
attention is the numerous constraints in the real sector, prudent and prioritize productive loans. Consequently, any
such as manpower problems and limited infrastructure. rise in potential credit risk as a result of over-expansive
Data demonstrates that among ASEAN countries, credit can be minimized. Moreover, as credit growth
unemployment in Indonesia is the second highest after outpaced that of deposits, the possibility of intensifying
the Philippines. High unemployment can be precarious, liquidity risk and pressure on long-term bank capital should
both in the context of financial as well as security stability. be anticipated.
Meanwhile, limited infrastructure may impede financial
and corporate sector development. Energy security is one 1.4. Financial product innovation
issue of critical infrastructure that has been highlighted The innovation of financial products has varied
recently, including the supply of power. Any disruptions in recently. Concomitantly, bank products have become
the supply of electrical power will severely impede the harder to differentiate from the products of other financial
corporate sector, which constitutes the majority of bank institutions. In addition, the general public has become
debtors, restricting production and loan repayment more familiar with various types of structured products
capacity. and offshore products. This can be considered a sign of
In addition to energy security, the issue of food financial sector development. However, if financial
security in the real sector is also closely associated with institutions involved in issuing and marketing such products
financial system stability. Soaring prices of essential do not adhere to proper risk management, financial sector
commodities, including food, spurred further rises in resilience may be disrupted, and in turn harming the
inflation and weakened food security. Due to food price consumer. Moreover, as financial products become more
increases, household expenditure witnessed a integrated, the difficulties faced by banks can rapidly
corresponding rise to meet family requirements. In transmit to the non-banking industry. Additionally, banks
addition, the corporate sector was forced to spend more that become agents of non-banking products are exposed
to answer the growing call for wage hikes by employees. to greater reputation risk if issuers fail to pay.
4
Overview
2. RISK MITIGATION of surveillance methodology is an ongoing process to

Several risk-mitigation measures that have been and readily capture any signals of future problems.
will be implemented to lessen potential instability, among
others, include the following: 2.3. Bank risk management
As the largest industry in the financial sector, banks
2.1. Crisis Management Protocol and Financial play a vital role in maintaining financial system stability.
Infrastructure Therefore, banks must continuously strive to internally
Experience garnered from the 1997/1998 crisis improve their risk management capacity, for instance by
provided valuable lessons. It became clear that procedure continually attending education and training courses;
and mechanism clarity is imperative to deal with a crisis. including a risk-management certification program.
Without clear procedures and mechanisms, various forms Furthermore, by following the preparatory steps toward
of moral hazard can emerge and crisis resolution may Basel II implementation, banks are indirectly strengthening
become protracted and costly. Therefore, a Crisis their risk management capacity. Through effective risk
Management Protocol (CMP) is currently being prepared management, banks are expected to be resilient should
as a priority of the Financial System Stability Forum, whose undetermined crises or shocks transpire.
members include units from the Ministry of Finance, Bank
Indonesia and Deposit Insurance Corporation. It is expected 2.4. Bank supervision
that soon this crisis management protocol will be enacted Bank supervision determines the resilience of the
as Law legislating the Prevention and Control of Financial banking system in particular and the financial sector in
Sector Crises. general. To improve bank supervision effectiveness, Bank
Another important facet of financial infrastructure Indonesia continues to enforce compliance to the 25 Basel
to be bolstered is the payment system. Hitherto the Core Principles for Effective Bank Supervision, in which
payment system has performed well in terms of mitigating Basel II implementation is included. One aspect of bank
settlement and operational risks, however a more advanced supervision includes market liquidity surveillance. The
economy, with the connatural development of banking implementation of such surveillance is inline with ongoing
and financial services therein, necessitates ongoing signals of tight liquidity in the global financial sector.
payment system strengthening.
3. PROSPECTS OF FINANCIAL SYSTEM STABILITY
2.2. Financial system surveillance Looking ahead, financial system stability is expected
In line with greater financial sector complexity, to be maintained in Indonesia. This prediction is based on
effective financial system surveillance should be the following key indicators. First, widespread awareness
maintained. To this end, various methodologies and stress is emerging regarding the importance of maintaining
tests to gauge financial system risk and resilience have financial system stability. Awareness does not solely lie with
been developed. In addition, vibrant discussion among decision-makers and business players in the financial sector,
market players and academicians to hone surveillance but has also spread among academicians, observers and
process analysis is routinely conducted. The development other parties. The general public witnessed and experienced
5
Overview
firsthand the adverse effects of the 1997/1998 financial Third, bank risk management has improved, which
crisis, which has subsequently heightened awareness and is further supported by Bank Indonesia»s efforts to
caution regarding any nascent issues that could trigger strengthen bank supervision.
instability. Spreading social awareness and control is Fourth, the quality of financial sector surveillance has
expected to positively affect financial system stability. improved. Meanwhile, the results of surveillance using
Second, in the near future, Indonesia will have stress tests indicate that banks, as the dominate force in
introduced a standardized crisis management protocol the financial sector, are resilient to fluctuations in credit
(CMP). The protocol is expected to serve as a guideline for risk, interest rate risk, exchange rate risk and SUN price
all stakeholders to comprehensively understand and act in risk. Consequently, the stability of banks and the financial
accordance with determined procedures during a crisis. sector is expected to persist.
This is also expected to bolster financial system stability.
6
Chapter 1 The Macroeconomy and the Real Sector
Chapter 1
The Macroeconomy and
the Real Sector
7
8
Macroeconomic stability in Indonesia was well maintained throughout the

first semester of 2008. However, increasing external pressures due to the
global economic downturn coupled with escalating inflation attributable to
soaring oil and food commodity prices, discouraged business players in the
real sector from consuming as well as undertaking expansionary activities.
Rising production costs together with weaker consumer purchasing power
reduced profitability of the corporate sector. If such inauspicious conditions
persist, domestic financial sector resilience may be threatened.
1. THE MACROECONOMY Sluggish growth in developed countries, particularly

An economic slowdown and intense inflationary the U.S., precipitated a global economic slowdown. The
pressures marred the international economy during the subprime mortgage crisis, which began in the U.S., forced
first semester of 2008. In 2007 global economic growth the banking sector to tighten credit extension to the
slowed by 0.1% to a level of 4.9%. Consequently, household sector, thus vitiating economic activities,
economic expansion in 2008 is expected at around 3.7%. particularly consumption. Subsequently, this led to a
restriction of activities in the production sector, which
Table 1.1
Global Economic Indicators provoked a rise in unemployment in the U.S. from 4.8%
%
in December 2007 to 5.7% in June 2008.
Projection
Category 2006 2007
2008 2009 Economic activity in emerging market economies,
World Output: 5.0 4.9 3.7 3.8 such as China and India, remained relatively expansive.
Advanced Economies 3.0 2.7 1.3 1.3
Emerging & Developing Countries 7.8 7.9 6.7 6.6 However, as the largest importer in the world any
Consumer Price: weakening in the U.S. has the potential to retard global
Advanced Economies 2.4 2.2 2.6 2.0
Emerging & Developing Countries1) 5.4 6.4 7.4 5.7 economic growth, including emerging market economies
LIBOR2)
whose general income is primarily dependant on export
US Dollar Deposit 5.3 5.3 3.1 3.4
Euro Deposit 3.1 4.3 4.0 3.6 activities to the U.S and EU. Therefore, despite rapid
Yen Deposit 0.4 0.9 1.0 0.8
growth during Q1 2008 in China and India of 10.6%
Oil Price (USD) - average3) 20.5 10.7 34.3 (1.0)
Source: World Economic Outlook - IMF April 2008 and 8.8% respectively, these figures were down when
9
Graph 1.1 Graph 1.3

GDP Growth in Industrial Countries Price Indices of Several Commodities
%
1990 = 100
600 500
Oil Copper
6.00 450
Tin Gold
5.00 500 Palm Oil Coffee 400
Rice Rubber
4.00 Aluminium 350
400
3.00 300
2.00 300 250
1.00 200
- 200
150
(1.00) USA Japan 100
Germany UK 100
(2.00) 50
Canada
(3.00) 0 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4
2000 2001 2002 2003 2004 2005 2006 2007 2008
2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: BI
Source: Bloomberg
Graph 1.2 Graph 1.4

GDP Growth in Several Emerging Markets Inflation in ASEAN-5 and Vietnam
% y.o.y %
25
Philippines Singapore Thailand
12.00
20 Malaysia Indonesia Vietnam
9.00
15
6.00
3.00 10
-
5
(3.00)
Indonesia Singapore
0
(6.00) Thailand South Korea
China India
(9.00) (5)
Q1 Q2 Q3 Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Q1 Q2 Q3Q4 Jan Jun Nov Apr Sep Feb Jul Dec May
2000 2001 2002 2003 2004 2005 2006 2007 2008 2005 2006 2007 2008
Source: Bloomberg Source: CEIC
compared to the previous period, more specifically 11.7% The impacts of inflationary pressures emanating
and 9.7%. from increasing oil and food prices were also experienced
In addition to the downturn, intense inflationary in Indonesia. Inflation in Indonesia (y-o-y) at the end of
pressures stemming from oil and food commodity price Semester-I 2008 was 11.03%, representing an increase
hikes also affected the global economy during the first of 5.26% compared to the same period in the previous
semester of 2008. Limited supply amidst burgeoning year. Increasing inflationary pressures were anticipated
demand for oil and food sparked price increases. By the by raising the BI rate to 8.50% in June 2008 (and
end of June 2008, the global price of WTI oil (spot price) subsequently to 9.0% in August 2008). However, the
peaked at USD 141/barrel. Furthermore, in March 2008 real interest rate in Indonesia remained generally more
the price of rice had risen 46% to USD151 per metric attractive than in that of other countries, therefore despite
ton (MT) compared to September 2007. Increasing slight depreciation the rupiah stayed within the range of
inflationary pressures due to soaring oil and food prices Rp9,257 per USD. Meanwhile, the Indonesian composite
more severely affect emerging market economies due to index, notwithstanding a slight decline due to volatility
their relatively large share of consumption of these in the global equity market, remained attractive to
products. investors.
10
Graph 1.5 Graph 1.8

Inflation in Indonesia and the BI Rate Global Stock Price Index
% %
35000 35000
Singapore Dow Jones
30000 Hongkong Indonesia 30000
Inflation (y-o-y) New York Nikkei
16 16
25000 25000
12 12 20000 20000
15000 15000
8 8
BI-rate
10000 10000
4 4 5000
5000
0 0
0 0
2006 2007 2008
2005 2006 2007 2008
Source: Bloomberg
Sources: BPS & BI
quarter of 2007. Relatively robust export performance was

Graph 1.6
Real Interest Rate in Indonesia also supported by diversification of export target countries
Percent
to territories in Asia, particularly China and India.
4.00 Consequently, this off set the challenges associated with

2.00 weaker export performance due to the lacklustre U.S.
-
economy.
(2.00)
(4.00)
Indonesia
Graph 1.9
(6.00) USA Indonesian Exports
Singapore
(8.00)
Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar
Millions of USD
2003 2004 2005 2006 2007 2008
Non-Oil and Gas Oil and Gas Total
Source: Bloomberg 12,000
10,000
Graph 1.7 8,000

Rupiah Exchange Rate against the US Dollar
6,000
9,500 9,600 4,000

Monthly Average
9,400 Quarterly Average 9,500
2,000
Semester Average 9,400
9,300
9,238
9,259 9,257 9,300 0
9,200
9,181 9,258 Jan May Sep Jan May Sep Jan May
9,109
9,210 9,200
9,100 2006 2007 2008
9,039 9,100
9,000 Source: BI
8,968 9,000
8,900
8,900
8,800 8,800
8,700 8,700
Strong exports and surging inflows of portfolio
8,600
9,075
9,077
9,172
9,095
8,842
8,981
9,067
9,358
9,105
9,102
9,267
9,356
9,406
9,180
9,178
9,203
9,281
9,288
8,600
investment to Indonesia supported the surplus Balance of
8,500 8,500
1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6
2007 2008 Payments (BoP), which in the second quarter of 2008
Source: Bloomberg
reached around USD1.3 billion. A healthier balance of
On one hand, the spiralling prices of oil and primary payments shored up reserves to around USD59.5 billion
commodities improved Indonesia»s export performance, by the end of the second quarter of 2008; equal to five
which is predominantly based on natural resources. During months» imports and foreign debt repayments.
the first quarter of 2008, Indonesia»s exports totalled Despite the surplus balance of payments, the Current
USD34 billion, an increase of 29% compared to first Account ran a deficit due to increasing imports and
11
declining exports. Lower export value was associated with market inflows (58%) compared to Foreign Direct
modest export prices in the international market, yet Investment (42%).
imports continued to expand amidst strong consumption
Graph 1.10
supported by macroeconomic stability. Consequently, the Composition of Capital Inflow
%
Indonesian economic growth persisted despite reeling
FDI (in Indonesia)
70
slightly from the effects of the global slowdown. During 61
Portfolio Investment (investment)
59 58
60 55
Q1 and Q2 2008, economic growth reached 6.3% and
50 45
41 42
39
6.4% respectively; higher than that recorded in the 40
30
previous year of 6.1% and 6.4%.
20
In the near future, vulnerability risk pervading from 10
the external sector is expected to remain high. This will 0

2005 2006 2007 Q1-2008
Source: BI
stem from the ongoing impacts of the subprime mortgage
debacle and relatively intense inflationary pressures due Limited inflow investment to the real sector together
to soaring oil and food commodity prices. The global price with the rising cost of credit caused by higher lending rates
of oil has fallen since mid July 2008, however, widespread compounded by burgeoning operational costs due to the
uncertainty could quickly drive the oil price back up. soaring oil price and high inflation forced business players
Meanwhile, inflationary pressures originating from supply to cut their costs and restrict business expansion. Several
shocks and speculation in the commodity market are business players responded to the escalating oil price by
expected to develop if the supply of energy and food raising their retail prices, however the higher retail prices
commodities in the international market does not and sales volume were less than the rise in production
increase. costs. Consequently, the margin of the corporate sector
was eroded as indicated by the declining profitability (ROA
2. THE REAL SECTOR and ROE) of public listed non-financial corporations in Q4
Domestic macroeconomic fundamentals, which were 2007 compared with the same period of the previous year.
well maintained amid escalating external risk, such as For its financing, the corporate sector was more likely
increasing inflationary pressures and sluggish global to depend on internal funds. This is evidenced by the
economic growth, encouraged players in the real sector
Graph 1.11
to become more prudent in terms of business expansion ROA & ROE of Non-Financial Public Listed Companies
and consumption. Additionally, concerns regarding the 600 350

ROA (left) ROE (right)
300
persistence of the ongoing subprime mortgage turmoil 500
250
400
and the inability of the government budget to cope with 200
300 150
food and energy price hikes also prompted investors to
200 100
exercise more caution in investing. Investors tended to opt 50
100
0
for short-term investments in the form of portfolio financial 0 -50
assets over direct investment in the real sector. As a result, -100

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-100
2003 2004 2005 2006 2007

portfolio capital inflows in Q1 2008 dominated capital
Source: BEI
12
Graph 1.12 Graph 1.14

DER & LT/LA of Non-Financial Public Listed Companies Unemployment in ASEAN
%
14
1.20
2000 2003 2006 2008**)
12
1.00
10
0.80
8
0.60 6
0.40 4
0.20 2
DER Debt/TA 0
0.00
Indonesia Thailand Vietnam*) Philippines*) Malaysia Singapore
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2005 2006 2007 Source: CEIC
*) : Data 2008 belum tersedia
Source: BEI
**) : Data for Indonesia (February), Thailand (May), Malaysia and Singapore (March)
relatively stable debt-to-equity ratio (DER) and total indicated a slight increase. The total number of companies
liabilities to total asset ratio (TL/TA) in 2007 compared to with a PD>0.5 increased marginally from 32 in December
2006, when the sector was expanding. Such conditions 2007 to 34 in December 2008. For banks this indicates
are attributable to concerns of increasing domestic interest higher credit risk in the future.
rates due to higher inflation. The trend to limit corporate business expansion may
Corresponding to the decline in corporate lead to a reduction in employment opportunities.
performance, estimation results for the probability of Moreover, surplus export performance, primarily the export
default (PD) of public listed non-financial companies of natural resources such as oil, rubber, nickel and tin,
provided no significant additional employment. As a
Graph 1.13
Probability of Default (PD) for Public Listed consequence, despite a slight reduction in the rate,
Non-Financial Companies
unemployment in Indonesia remains the second highest
Total
250
in ASEAN after the Philippines.
210
200 A sharp wage hike in the mining sector, following
150 the escalating prices of mining sector commodities in the

international market, did not significantly increase
100
household income in Indonesia as only 1% of Indonesian

50
27
10
3 3 3 1 3 1 0
0 Graph 1.15
0.0-0.1 0.1-0.2 0.2-0.3 0.3-0.4 0.4-0.5 0.5-0.6 0.6-0.7 0.7-0.8 0.8-0.9 0.9-1.0
Probability of Default - December 2007
Wages and Inflation
%
Total
250 80 Mining (non oil) Hotel
Industry Inflation
210
60
200
40
150
20
100 0
-20
50 30
7 3 5 2 -40
1 1 1 0
0 2001 2002 2003 2004 2005 2006 2007
0.0-0.1 0.1-0.2 0.2-0.3 0.3-0.4 0.4-0.5 0.5-0.6 0.6-0.7 0.7-0.8 0.8-0.9 0.9-1.0
Source: BI-DSM yang disarikan dari Laporan BPS
Probability of Default - December 2008
13
workers are employed by the mining sector. A further demand1. This is evidenced by the increasing ratio of
78.4% work in industries where wage hikes are below household debt to household disposable income from
the inflation rate. 9.3% in December 2007 to 9.7% in June 2008.
In general, the condition of inflation outpacing wage Expansive household credit was principally due to
increases reduced the real income of the household sector. increasing property credit. The composition of property
Along with rising consumption costs due to inflation, the credit is only around 30% of total household credit,
requirement for funds by households also increased. This however, since 2003 it has increased. Credit risk from the
has forced households to maximize their income in order household sector tended to decrease, as indicated by a
to meet their consumption needs, rather than adding to lower NPL rate from 3.1% in December 2007 to 2.9% in
their financial assets, such as by opening a giro, savings June 2008. Nonetheless, persistent inflationary pressures
account or time deposit. This is reflected by the ratio of without any corresponding rise in income could undermine
household assets to household disposable income that the financial performance of the household sector.
dropped 2.6% compared to the previous semester to
Graph 1.18
25.6% in June 2008. Meanwhile, pressures from higher Household Credit Growth
(y-o-y)
consumption also led to increasing household credit
% %
Housing
Graph 1.16 100 100
Household Assets
Bank deposits per cent of household disposable income 80 80
60 60
% %
40 40
20 20
40 40
Total HH deposits bank Personal
0 0
30 30
-20 -20
Time Deposits Saving Deposits 2002 2003 2004 2005 2006 2007 2008
20 20
* Based on banks» on balance sheet
Source: BI
10 10
Demand Deposits Graph 1.19
0 0 Household Debt
2001 2002 2003 2004 2005 2006 2007 2008
Share of total household debt
Source: BI
% %
Graph 1.17
Household Debt 80 80
Personal loans
Per cent of household disposable income
% % 60 60
40 40
8 8
20 20
6 6 Housing loans
0 0
4 4 2001 2002 2003 2004 2005 2006 2007 2008
Source: BI
2 2
1 Kredit rumah tangga terdiri atas housing loan dan personal loan. Housing Loan meliputi:
0 0
(i) Kredit perumahan & apartemen s.d. tipe 70, (ii) Kredit perumahan & apartemen > tipe
2001 2002 2003 2004 2005 2006 2007 2008 70, (iii) Ruko & Rukan. Personal loan meliputi: (i) Kartu kredit, dan (ii) Kredit personal
Source: BI lainnya.
14
The challenges currently facing the real sector are efficient. In the short term, efforts to be more efficient
expected to remain in the future by reason of limited might be traded off against growth, however, in the longer
infrastructure and inauspicious economic conditions. With term it will benefit business (going concern) and real sector
limited energy and increasingly expensive food products, security. This, in turn, will positively affect financial system
the real sector will struggle to be more substantially stability as a whole.
15
Box 1.1 Effect of Inflation on Growth and the Quality of Bank Credit
The global economy is suffering from high 2. Estimation Model of Credit Quality (Non-Performing
inflation due to soaring global prices of oil and food Loan or NPL)
commodities. In addition, a shift in the usage of grains IPI = 17,56 + 0,85 IPIt-1 √ 0,24dinflasit-1 + εIPI,t
for bio-fuel as an alternative energy is viewed as a εIPI,t = 0,49 εIPI,t-1 + vt
contributing factor to the increase in food prices. NPL = 5,89 + 0,86NPL t-1 + 0,01creditgrw t-1 +
Inflation in the U.S, England and European Union 0,56dbir t-3 + 0,19lnoilt-3 √ 0,05^IPI t-3
surged to 3%. Furthermore, China and India, which dinflasi : change in inflation (y-o-y) from month t to
represent the strongest demand for energy and food, month t-1
endured inflation of 8% (March 2008) and 7.3% (April dbir : change in BI rate from month t to month t-1.
2008). Inflation in Vietnam was 21% (April 2008), dexrate : change in exchange rate from month t to
whereas in Japan, which had previously suffered from month t-1
perennial deflation, inflation reached 1.2% in March lnoil : lognormal of normal and global oil price
2008. Inflation in Indonesia was 11.03% in June 2008 (USCRWTIC)
y-o-y. IPI : Industrial Production Index
A fundamental question that arises is how such
inflation might affect growth and the credit quality of Empirical tests using the approach outlined above
domestic banks? for monthly sample data from March 2004 to March
To answer this question, an econometric analysis 2008 indicated that inflation significantly affects
was conducted using the Two Stage Least Square (TSLS) growth and credit quality (NPL). However, the inflation
approach as follows: effect is indirect as it is transmitted through economic
1. Estimation Model of Credit Growth (Credit Growth) growth with an Industrial Production Index (IPI) proxy.
IPI = 17,56 + 0,85 IPIt-1 √ 0,24dinflasit-1 + εIPI,t Furthermore, by adding IPI, the BI rate, exchange rate
εIPI,t = 0,49 εIPI,t-1 + vt and future oil price, simulation results indicated that
creditgrw = -10,57 + 0,95creditgrw t-1 √ 2,39dbir t-4 for every 1% increase in inflation, credit growth would
√ 0,00004dexrate t-2 √ 2,21lnoilt-2 decline by around 0.12% and NPL would increase by
^
+ 0,19 IPI t-2 approximately 0.02%.
Graph Box 1.1.1 Graph Box 1.1.2

Credit Growth Estimation Model Credit Quality Estimation Model
32 10
Loans Growth NPL
28 Loans Growth (Baseline) 9 NPL (Baseline)
24 8
20 7
16 6
12 5
8 4
2004 2005 2006 2007 2008 2004 2005 2006 2007 2008
16
Thus, it is important to maintain stability by degeneration in credit quality (increasing NPL) on the
balancing the need to raise the interest rate in order other. By striking such a balance, banking and
to manage inflation on the one hand, and the need financial system stability are expected to be
to maintain credit growth and prevent a maintained.
17
Box 1.2 Energy and Food Security: Effect on Financial System Stability
The world is currently facing a potential oil and Supply pangan &
energi (minyak
food crisis due to limited oil and food supply and strong bumi, electricity)
Domestic HH B/S Probability of
Output Default Stability
Inflationary Financial
demand. Soaring food and oil prices, principally since Gap
Pressure
- Bank
- NBFI System
Corporate
Demand pangan & B/S - Financial
the final quarter of 2007, have become a global energi (minyak Market
bumi, electricity)
phenomenon that has been transmitted to Indonesia.
The Government of Indonesia reluctantly had to raise Persistently high prices of food and oil as well as
the price of fuel of 28.7% at the end of May 2008 in limited electrical supply will place more pressure on
order to maintain the State Budget. Rising oil and food domestic financial system stability in Indonesia. The
prices are also considered a contributing factor of high government has to undertake measures to ensure
inflation in Indonesia. sufficient domestic food supply and limit rice exports.
There should be no problems on the supply side as
Graph Box 1.2.1. production of unprocessed rice in Indonesia in 2008 is
Inflation, Oil Price and Farm Products
estimated to reach 59.88 million tons; equal to 34.94
600 20 million tons of rice, and public rice consumption is 32-
Oil Price (USD, left axis)
18
500 Agriculture Price (USD, left axis) 33 million tons. Production of corn and soy are estimated
16
Domestic Inflation (%, right axis)
400
14 to reach 14.85 million tons and 723.54 thousand tons
12
of dry grains respectively; an increase of 11.79% and
300 10
8 22.11% compared to production in 2007. However,
200
6
the prolonged distribution channel incurs high economic
4
100
2 costs, which limits coverage and supply continuity. The
0
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
0 government also has to anticipate the possibility that
Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr
2003 2004 2005 2006 2007 2008 food producers in Indonesia prefer to export their
Source: BI, Bloomberg, Datastream products, as prices on the global market are currently
more attractive. This could reduce domestic stocks. To
The prohibitive prices of oil and coal, which
deal with limited energy supply, in the short run the
represent the raw materials of the State Electricity
government is expected to roll out energy saving
Company (PLN), along with inadequate infrastructure
programs, whereas in the long run, new alternative
for electricity generators resulted in inadequate
energy sources should be sought.
electrical supply. Consequently, Indonesia is currently
The government and the banking industry
also facing an electrical crisis. In general, this has
recently implemented a program of Food and Energy
undermined the business sector, which subsequently
Security Credit (Kredit Ketahanan Pangan dan Energi
disrupts financial sector resilience. The impact of energy
or KKP-E) with the aim to finance a food security
and food price increases on financial system stability
program and the development of plant material to be
can be described as follows:
used as bio-fuels in order to meet the need for
alternative energy and catalyze farm development.
Both programs are expected to help bolster food
security and deal with energy scarcity.
18
Chapter 2 Financial Sector
Chapter 2
Financial Sector
19
20
Compared to the previous semester, the Indonesian financial sector continued

to grow apace throughout Semester-I 2008 despite inauspicious economic
conditions. Meanwhile, even though banks remain as the dominant force of
the financial sector, non-bank financial institutions and the capital market
continue to grow. With strong capital, banks remained resilient to fluctuations
in risk, including credit risk, liquidity risk, interest rate risk, exchange rate risk
and SUN price depreciation risk. In the future, such resilience must be built
upon, not only by increasing capital alone but also through enhancing the
quality of risk management.
2.1. STRUCTURE OF THE INDONESIAN FINANCIAL Graph 2.1

Assets of Financial Institutions
SYSTEM
The Indonesian financial system comprises of % total aset sektor keuangan
2006
commercial banks and rural banks (BPR), as well as non-
bank financial institutions such as insurance companies, 3% 5% 4% 0%
8%
pension funds, finance companies, securities and 1%
pawnshops. Compared to the previous edition of FSR (FSR 79%
No. 10, March 2008), the structure of the financial system

has not changed significantly. In 2007 the total assets of
Bank Umum Komersial Bank Perkreditan Rakyat Perusahaan Asuransi
each financial institution grew by an average of 17% Dana Pensiun PerusahaanPembiayaan Persahaan Sekuritas
Pegadaian
compared to 2006, however, their share remained relatively

2007
constant. Banks continue to dominate the sector with 79% 3% 5% 3% 0%

9%
of total assets, whereas the 15 major banks command 1%
the majority (70%) of total bank assets.

The growth in total assets of financial institutions is
79%
welcome news because it demonstrates financial sector
Sumber: BI dan sumber lainnya
21
expansion in Indonesia as well as a diversifying number of by individuals. Based on the amount of savings, major
available investment options. However, the integration of depositors (whom represent only 2.6% of the total number
financial products must be supplemented with adequate of deposit accounts held at banks) account for 77% of
regulation and supervision to minimize potential risk that total deposits. This imbalance may place pressures on
may derail financial stability. liquidity particularly in cases of sudden withdrawals of large
amounts. Nonetheless, with good liquidity management
2.2 THE BANKING INDUSTRY banks are expected to avoid such potential risk.
2.2.1 Funding and Liquidity Risk
Deposits Liquidity Adequacy
At the end of Semester-I 2008 total deposits had Deposits, as the primary source of bank funding,
reached Rp1,553.4 trillion. After experiencing negative slumped at the beginning of the year, but did not affect
growth at the beginning of the year, deposits rebounded the intermediary function of banks. At the end of Semester-
during the second quarter in line with rising interest rates. I 2008, credit growth (including channeling) reached
As a result, reported growth in Semester-I was 2.82%, 13.8%, far outpacing that of deposits. This indicates that
which falls below that of the same period the previous banks funded their loan disbursements from other sources
year, namely 5.19%. The increase affected all components than deposits, one of which was by converting their liquid
of deposits with savings recording the most impressive assets.
growth at 4.29%, followed by time deposits and giro During Semester-I 2008 a more than 20% decline
accounts with 3.05% and 0.87% respectively. was recorded in the number of liquid assets.2 This was
primarily attributable to a decrease in bank placements at
Graph 2.2
Bank Indonesia, principally in the form of BI Certificates
Performance of Deposits
Rp triliun (SBI). Conversely, short-term liabilities rose by 3% in line
700
with deposit growth. The simultaneous occurrence of
630
declining liquid assets coupled with rising short-term
560 liabilities caused the ratio of liquid assets to non-core
490 deposits3 to decrease compared to the end of December
420
2007. However, with the liquid asset ratio still above 100%,
bank liquidity remains relatively secure.
350
Des '07 Feb '08 Aprl '08 Jun '08
The liquidity gap, which is defined as the difference
Giro Tabungan Deposito
between available liquidity and required liquidity, remained
In general, the structure of deposits remained positive at the end of Semester-I 2008.4 This provides a
imbalanced. At the end of Semester-I 2008, deposits

remained concentrated around short-term funding (up to 2. Liquid assets comprise of cash and placements at BI (checking accounts, SBI and Fasbi).
3. Non-core deposit (NCD) assumption is 30% current and savings accounts, plus 10%
term deposits of up to 3 months.
3 months) with a share of 93.4%. Individual savings and 4. Available liquidity includes bank placements at BI (excluding current accounts) and bonds
to be traded, available for sale, and owned to maturity, in the form of Government
major depositors also continued to dominate. Based on Bonds or Corporate Bonds. Liquidity required comprises of deposits that can be with-
drawn anytime (non-core deposits), credit commitment, inter bank net liability and off-
ownership, the majority of deposits (55.7%) were owned shore loans.
22
Graph 2.3 bank money market to fulfill their short-term liquidity

Liquidity Gap Percentage
requirement. Whereas banks with excess liquidity will
Rp triliun %
900
Likuiditas yg tersedia Gap
135 assume a «placing» position to generate profit. Therefore,
132,20% Kebutuhan Likuiditas
750 the resulting interest rate is a result of market mechanisms
130
600 that reflect market liquidity conditions.
126,20%
125
450 In order to reduce distortion on the overnight (O/N)
300
120
PUAB rate, at the beginning of 2008 Bank Indonesia
121,00%
150
announced a number of monetary policy operational
0 115
Des Mar Jun improvements aimed at maintaining O/N PUAB interest
2007 2008
Industri rate stability. As a result, the interest rate is less volatile
and more consistent with the BI policy rate.
general indication that the liquidity required by banks can
Based on observations, since the announcement of
still be met by the liquidity available. However, consistent
said improvements up to the end of Semester-I 2008, O/N
with the ratio of liquid assets to non-core deposits, the
PUAB interest rate volatility has eased and subsequent shifts
ratio of available liquidity to required liquidity also declined
have correlated more closely to the BI rate. Furthermore,
when compared to year-end 2007. Overall, this indicates
the spread between the lowest and highest O/N transaction
that bank liquidity is becoming tighter. Consequently,
interest rate is narrowing.
banks must exercise greater caution and be more selective
when extending credit to avoid intensifying pressure on
2.2.2. Credit Growth and Credit Risk
liquidity.
Credit Growth
As was mentioned in Chapter 1, during Semester-I
Grafik 2.4
Performance of Loans and Deposits (y-o-y) 2008 the global and domestic economies were beset with
% burgeoning inflationary pressures, particularly due to the
35
soaring global oil and food commodity prices. Global
30
Kredit
financial markets continued to fluctuate wildly and were
25
plagued with widespread uncertainty due to the ongoing
20
negative fallout stemming from the subprime mortgage
15
DPK
debacle. Nevertheless, the domestic economy faired
10
relatively better than the international economy. At a time
5
2005 2006 2007 2008
when the global economy experienced a marked
downturn, the Indonesian economy maintained in excess
Inter-Bank Money Market (PUAB) of 6% growth during the reporting period. Domestic banks
PUAB represents the activity of funding loans
reported no direct losses attributable to the subprime
between banks in order to manage short-term liquidity
mortgage turmoil because no investments were made in
(overcoming mismatch). Banks running a liquidity deficit
subprime mortgage instruments. As a result, during the
will consequently assume a «taking» position on the inter-
reporting semester credit expanded rapidly by 13.8% y-t-
23
d (31.6% y-o-y).5 Strong credit growth was also driven by June 2008, whereas the share of credit in productive assets
the banks» desire to hit their profit targets at a time when grew from 58.4% to 63.4% during the same period, which
the opportunity to arbitrate the interest rates of SBI and is its largest share since the crisis. Due to the deceleration
PUAB had diminished. Another important factor that in deposit growth, banks opted to convert their SBI in order
bolstered such impressive credit growth was the enactment to fund the expansion in credit. As a result, SBI fell 40%
of wide-reaching bank legislation over the last 2-3 years compared to its position at the end of December 2007 to
aimed at promoting the intermediation function post mini- Rp98 trillion.
crisis in 2004/2005 that resulted in slow bank credit
Graph 2.7
extension in 2006 (14.1% y-o-y). Growth in Investment Loans, Working Capital Loans
and Consumption Loans
Graph 2.5 %
Loan to Deposit Ratio 50
Rp Triliun % 45 Konsumsi
1.600 78 40
1.500 76 35 Modal Kerja
Kredit (kr)
1.400 30
74
1.300 25
1.200 72
LDR (kn) 20
1.100 70
15
1.000 68 Investasi
10
900 66
5
800
64 0
700
2004 2005 2006 2007 2008 Jun
600 DPK (kr) 62
500 60
2005 2006 2007 2008 Jun
Graph 2.8
Growth in Consumption Loans (y-o-y)
Grafik 2.6
%
Credit Growth by Bank Group
80,0
% KPR
70,0 Kartu Kredit
60,0
Lainnya*)
50,0 60,0
40,0 50,0
30,0 40,0
20,0 30,0
10,0
20,0
0,0
10,0
-10,0
0,0
-20,0
2002 2003 2004 2005 2006 2007 2008 Jun
-30,0
2002 2003 2004 2005 2006 2007 2008 Jun
PERSERO DEVISA NON DEVISA BPD During Semester-I 2008, the majority of credit was
CAMPURAN ASING INDUSTRI
extended for productive purposes. This was reflected by a
Credit growth in Semester-I 2008 was not entirely rise in working capital loans and investment loans by
funded by deposits. Deposits grew at a mere 2.8% y-t-d Rp73.7 trillion (36.1% y-o-y) and Rp27.1 trillion (28.5%
(14.7% y-o-y), which was far below the expansion in credit. y-o-y) respectively. By economic sector, credit was primarily
As a result, the loans to deposit ratio (LDR) rose from 69.2% absorbed by the manufacturing and trade sectors;
at the end of December 2007 to 76.6% at the end of accounting for 19.4% and 16.8% respectively of the
expansion in total bank loans. Meanwhile, four sectors
5. September 2008 data (temporary figures from the Commercial Bank Daily Report √
LHBU) even shows a higher credit growth, namely 35% y-o-y. also enjoyed above average y-o-y credit growth, namely
24
trade (32.1%), services (40.5%), construction (38.9%) and Graph 2.10

Growth of Rupiah and Foreign Exchange Loans
utilities (60.1%). %
40,0
Consumption loans also increased significantly
30,0
(Rp45.6 trillion or 31.5% y-o-y). Consumption loans consist 20,0
10,0
of mortgages (KPR), credit cards and others (vehicle loans,
0,0
multipurpose loans, etc). Others contributed 52.3% of total
-10,0
consumption loan disbursements in Semester-I 2008; up -20,0

Kredit Rupiah
-30,0 Kredit Valas
29% y-o-y. The key driver of such trends was the hike in
-40,0
2002 2003 2004 2005 2006 2007 2008 Jun
fuel prices that was not offset by a corresponding rise in
income. As a result, demand for loans to purchase loans only grew by Rp10.6 trillion (28% y-o-y), compared
motorcycles increased as such vehicles are considered more to rupiah-denominated loans that experienced 34.6%
fuel efficient and nimble than other means of growth during the same period. Notwithstanding, the
transportation. share of foreign exchange loans in total bank loans
remained relatively steady at 21%.
Grafik 2.9
Growth in Property Credit (y-o-y)
Graph 2.11
% Growth of MSM loans and non-MSM loans
70,0
Konstruksi
60,0 (y-o-y)
Real Estate
KPR 40
50,0 Kredit MKM
35
Kredit Non MKM
40,0
30
30,0
25
20,0
20
10,0
15
0,0
10
-10,0
5 Total Kredit
2003 2004 2005 2006 2007 2008
-
2004 2005 2006 2007 2008 Jun
Property loans also require closer monitoring due to
significant growth during the reporting period, namely Micro, Small and Medium (MSM) loans expanded
37.6% (y-o-y) to Rp180.4 trillion or 15.7% of total bank by 29.9% (y-o-y), which was exceeded by the growth of
loans. As such, the growth rate of property loans exceeded corporate non-MSM loans, namely 36.9%. The majority
the growth rate of bank loans as a whole. The rise in (59%) of MSM loans were for consumption purposes. As
property loans was principally supported by growth in a result, the overall share of consumption loans reached
mortgages and construction loans of 63.5% and 23.7% 51.6% of total MSM loans. Should it persist, this condition
respectively, whereas the remainder was made up by real will require additional monitoring in the near future
estate loans. Mortgages continued to dominate total considering that excess credit extension to non-productive
property credit with share of 62.5%. sectors could trigger inflation.
A stronger rupiah during the reporting semester With high credit growth, undisbursed bank loans (UL)
discouraged debtors from withdrawing foreign currency increased slightly by Rp17.1 trillion to Rp225.5 trillion, or
denominated loans. Consequently, foreign-denominated 18.9% of total bank credit by the end of June 2008.
25
Graph 2.12 As an aggregate no rise in NPL value was recorded,

Undisbursed Loans
Rp triliun Rp triliun
however, loan loss provisions swelled by Rp1.8 trillion.
260 1250
Undisbursed (kiri)
1150
Accordingly, Net NPL declined from 1.9% at the end of
240 Kredit (kanan)
1050
220
2007 to 1.7% at the end of June 2008. This represents
950
200 850 the lowest level since the crisis. The rise in loan loss provisions
180 750
illustrates one of the anticipatory measures taken by banks
650
160
550 to mitigate the possibility of growing credit risk in the future.
140 450
Rising inflation was one potential source of the rise in NPL.
120 350
2005 2006 2007 2008 Juni
Graph 2.14
Considering that the ratio of UL to total credit is usually NPL & Loan Loss Provisions
steady in the 20-21% range, the low UL ratio approaching Rp triliun
70,0
the end of Semester-1 only reinforces the shared belief NPL (kiri)
65,0 PPAP (kiri)
60,0 Linear (PPAP (kiri))
that bank intermediation continued to run as normal.
55,0
50,0
Graph 2.13
Non-Performing Loans 45,0
% Rp triliun 40,0
10 70
35,0
9 NPL Gross (kr) NPL Nominal (kn) 65
8 30,0
60 2003 2004 2005 2006 2007 2008 Jun
7
55
6
50
Graph 2.15
5
4
NPL Value by Bank Group
NPL Net (kr) 45
3 Rp triliun
40
2 45 6
35 40
1
5
- 30 35
2003 2004 2005 2006 2007 2008 Jun
30 4
25
3
Credit Risk 20
15 2
The inauspicious macroeconomic conditions 10
1
5
compared to the previous semester raised the possibility
- -
2004 2005 2006 2007 2008 Juni
of heightened credit risk during the reporting semester. In
BUMN (kr) Swasta (kr) BPD Campuran Asing
reality the value of non-performing loans (NPL) at the end
of Semester-I 2008 remained relatively steady compared During the reporting period, the NPL value of state-
to its position at the end of Semester-II 2007, namely owned banks fell by Rp2.5 trillion mainly due to write-offs
Rp48.5 trillion. In January and March 2008 the value of and credit restructuring. Fluctuations in the NPL value of
NPL rose by Rp1.2 trillion and Rp1.7 trillion respectively, the state-owned bank group significantly affected the
however write-offs and credit restructuring rendered these banking industry as a whole due to its 50.8% share of
increases negligible by the end of Semester-I 2008. total bank NPL value. With a declining NPL value for the
Moreover, the Gross NPL ratio declined from 4.6% to 4.1% state-owned bank group, instability stemming from bank
due to the sharp increase in loans disbursed by banks. credit risk was minimized.
26
Graph 2.16 NPL ratios, only the industrial sector exceeded the banking
Gross NPL
industry»s gross NPL.
%
7,0
In terms of credit usage, during Semester-I 2008 the
Des-07 Jun-08
6,0 NPL value of investment loans declined by Rp2.3 trillion.

5,0
Such a decline is beneficial for economic growth while
4,0
simultaneously reducing risk to banks as, in general, those
3,0
2,0
applying for investment loans are corporate debtors whom
1,0 represent the primary engine of economic and business
0,0
BUMN Swasta BPD Campuran Asing
activities. The NPL value of working capital loans rose by
Rp1.4 trillion, especially for non-individual debtors. As a
Based on economic sector, the industrial sector result, the share of NPL value for working capital loans in
displayed the highest potential of triggering instability the banking sector grew to 52.4%, thus persisting as the
stemming from credit risk due to its dominant credit share largest of NPL value.
(20.4%). Credit extended to the industrial sector was
Graph 2.18
predominantly received by corporate debtors who NPL Share by Economic Sector
%
represent core debtors of major banks and utilize
100
Gabungan Lainnya
investment loans and working capital loans denominated
80 Jasa Dunia Usaha
in rupiah and foreign exchange alike. In terms of NPL value,
Perdagangan
60
the industrial sector continues to prevail with 34.3% of
40
total bank NPL. This is a slight reduction from its position
Industri
at the end of 2007 (35.3%). As credit to the industrial 20
Pertanian
sector expands, the gross NPL ratio of the sector declined 0
2000 2001 2002 2003 2004 2005 2006 2007 2008 Jun
from 7.1% to 6%. Gabungan Lainnya = Pertambangan, Listrik, Jasa Sosial, Konstruksi, Pengangkutan
Two sectors experienced a rise in NPL value, namely

Graph 2.19
the transportation sector due to hikes in the prices of fuel NPL Value by Usage
and spare parts, and the construction sector due to Rp triliun
climbing raw material prices. However, in terms of gross

Konsumsi
Graph 2.17
NPL Share by Economic Sector
Investasi
Rp triliun
Lain-lain
Modal Kerja
Jasa Sosial
Jasa Dunia Usaha
Pengangkutan -3,0 -2,0 -1,0 0,0 1,0 2,0
Perdagangan
Konstruksi
Listrik
In light of such developments, by the end of
Industri
Semester-I 2008 the gross NPL ratio for investment loans
Pertambangan
Pertanian
dropped below 5%, namely 4.6%, for the first time.
-0,8 -0,5 -0,3 0,0 0,3 0,5 0,8 1,0
27
Although the NPL value of working capital and remained low at just 2.8%. The gross NPL ratio of
consumption loans increased, the amount of credit construction and real estate credit recorded 4.4% and
extended grew significantly, thus reducing their gross NPL 3.3% respectively. The relatively low NPL of property credit
ratio to 3.5% and 2.9% respectively. The rise in NPL value contributed positively to banking and financial system
of consumption loans mainly emanated from mortgages stability.
(Rp0.4 trillion), followed by credit cards (Rp0.3 trillion) and Rupiah appreciation coupled with credit write-offs
«miscellaneous credit». Credit cards witnessed the highest and restructuring boosted the quality of foreign currency
gross NPL ratio of 11.6% followed by mortgages and denominated credit, therefore, the NPL value slumped by
miscellaneous at 2.8% and 1.7% respectively. Rp2.1 trillion during the reporting period. Gross NPL of
foreign denominated credit also declined, from 4.2% to
Graph 2.20
Gross NPL of Consumption Loans 3.9%. Consequently, potential instability arising from
% foreign exchange credit diminished. Conversely, the NPL
14,0
KPR
12,0 Kartu Kredit value of rupiah denominated credit rose by Rp2 trillion.
Lainnya
10,0 Notwithstanding, the NPL ratio declined slightly from 3.7%
8,0
to 3.5%.
6,0
4,0
Graph 2.22
2,0 MSM NPL Value
0,0
2001 2002 2003 2004 2005 2006 2007 2008 Jun 50 21
45 19
17
During Semester-I 2008, the NPL value of mortgages 40
15
35
rose slightly by Rp0.3 trillion to Rp5.8 trillion. However, 13
30
the gross NPL ratio dropped from 3.6% to 3.2% due to 11
25
9
expansive credit growth. The rise in NPL value of property 20 7
credit was primarily attributable to mortgages and 15 5
2005 2006 2007 2008 Jun
construction loans. Although mortgages accounted for the
largest segment (62.5%) of property credit, gross NPL The NPL value of micro, small and medium credit
extended climbed rapidly by Rp2.2 trillion to RP19.78
Graph 2.21
NPL Value of Rupiah and Foreign Currency trillion; accounting for 52.1% of total bank NPL value
Denominated Loans
(excluding credit channeling). Based on loan utilization the
Rp triliun
45 rise in NPL value stemmed mainly from working capital
40 Kredit Rupiah
35
Kredit Valas loans (increased by Rp1.49 trillion). However, based on
30 economic sector, most NPL value originates from the
25
20
industrial sector (a rise of Rp0.83 trillion). The growth in
15
NPL value of working capital loans reflects closely the recent
10
5 inauspicious economic environment, which undermined
-
2002 2003 2004 2005 2006 2007 2008 Jun credit quality. Nonetheless, robust micro, small and medium
28
credit growth reduced the gross NPL ratio from 3.5% to Graph 2.24
Lending Rate by Bank Group
3.4%. %
40
Des07 Mar08
Mei08 Jun08
2.2.3. Market Risk 30
Increasing market risk pressures stemming from

20
global financial market fluctuations as well as unfavorable
10
international and domestic economic performance tainted
Semester-I 2008. The spiraling oil price throughout the 0
KMK KI KK KMK KI KK KMK KI KK KMK KI KK KMK KI KK
reporting period forced the government to no longer be persero bpd busn asing&camp seluruh
able to suppress domestic fuel price inflation. This further interest rate rise could negatively affect banks as it
exacerbated the already high inflation. A tight monetary potentially erodes profit and generates losses. This effect
policy was adopted to overcome inflationary pressures by has not, hitherto, come to fruition because not all banks
periodically raising the BI reference rate. During the have adjusted their interest rates yet. In the future,
reporting period, Bank Indonesia twice raised its BI rate, however, if conditions persist and no appropriate mitigation
once in May 2008 and then again in June 2008 to a level strategy is adopted banks could begin to record losses.
of 8.5%. Simulations demonstrate that a 1% increase in the interest
With the rising BI rate trend, banks rapidly followed rate would result in one bank suffering a decline in CAR
suit by raising their own interest rates. Interest rates on 1- to below the benchmark 8%.
month rupiah term deposits in June 2008 increased by 21 During Semester-I 2008, as a result of global financial
bps, whereas the rates on working capital, investment and market volatility there were numerous occasions when the
consumer loans rose by 7 bps, 15 bps and 4 bps stock market and bonds market, especially government
respectively. The increases affected banks by intensifying bonds (SUN) were threatened by excessive pressures.
market risk, particularly interest rate risk. Because banks represent one of the primary investors in
In terms of their maturity profile, towards the end of SUN, any depreciation in SUN price directly affects the
Semester-I 2008 banks generally continued to maintain a bank»s profit/loss, although not enough to reduce its CAR
short position in the short term and increasingly a long to below 8%. Based on stress tests, a 25% decline in SUN
position in the long term. With such a composition an price would be»required for bank CAR to fall below 8%.
As an impact of the global financial crisis, pressure
Graph 2.23
Interest Rate and Exchange Rate to the capital market and bond market (particularly the
% Rp
22 11500 SUN market) was observed as occurring several times
KI (ki) KMK (ki) KK (ki)
19 during semester I of 2008. As banks are one of the main
10500
16 investors in SUN, the drop of SUN price significantly
13 9500 affected the banks» profits and loss. However, no case in
10 which bank»s CAR dropped below 8% were reported.
8500
7
Kurs (kn) Deposito Based on stress tests, banks» CAR can drop below 8% if
1 bln (ki)
4 7500 the price of SUN falls by 25%.
2002 2003 2004 2005 2006 2007 2008
29

Rupiah Maturity Profile SUN Portfolio of the Banking Industry
Rp triliun
600
HTM
450 Rp127,3T
(45,7%) Trading,
300 Rp18,5T
(6,6%)
150
0
Jun08
(150)
Des06 Des07
(300)
Apr08 Mei08 AFS,
(450) Jun08 Rp133T
( 47,7%)
(600)
sd 1 bln 1 - 3 bln 3 - 6 bulan 6 - 12 bln > 12 bln
Sumber : LBU

Foreign Exchange Maturity Profile Net Open Position (Overall)
USD miliar %
10 20
19,2%
5 16 17,5% 17,1%
14,7% 15,3% 15,3%
0 12 14,2%
(5) 8
Des06 Des07
(10) Apr08 Mei08 4
Jun08
(15) 0
sd 1 bln 1 - 3 bln 3 - 6 bulan 6 - 12 bln > 12 bln Des Jun Des Mar Apr Mei Jun
2006 2007 2008
BUSN bank campuran BPD bank persero

bank asing SELURUH PDN Tertinggi
Based on calculations, during Semester-I 2008 the relatively low net open position (NOP), which is limited by
SUN price dropped by an average 15%. As a result, banks regulations (maximum 20% of capital). At the end of June
suffered losses of around Rp1.3 trillion through a process 2008, average bank NOP was 4.33%. The highest NOP
of marking to market based on current SUN ownership in was the foreign bank branches group with 7.45%. Based
the trading portfolio (6.6% of total bank SUN). Meanwhile on stress tests, one bank»s CAR had the potential to drop
unrealized losses recorded on the balance sheet stemming below 8% should the rupiah depreciate by Rp3,000.
from ownership of «available for sale» (AFS) SUN totaled With such information gained from stress tests, banks
approximately Rp7.4 trillion. The losses encouraged banks are expected to promptly adjust their portfolio to avoid
to switch SUN from their trading portfolio to AFS, which losses. Such measures may include hedging and other
was evidenced by the diminishing share of trading SUN appropriate risk mitigating steps.
from 10% at the end of the last semester to 6.6% in the If the interest rate trend persists, which has risen since
reporting semester. May 2008 in line with the increasing BI rate, it could trigger
In addition to interest rate risk and SUN depreciation another depreciation in SUN price and intensify exchange
risk, banks were also exposed to exchange rate risk. In rate volatility that could exacerbate bank market risk. It is
general during the reporting period, the exchange rate important to note that adequate capital was the key
remained relatively stable. Banks, on average, had a element that enabled banks to overcome market risk
30
pressures. This condition must be monitored closely in the Graph 2.30

Interest Income Composition of 15 Big Banks
future considering that recent developments have seen %
6,4 6,5 6,5 6,5 7,1 5,4
bank capital decrease with the increased credit extension.
In the near future, with Basel II implementation, banks
61,5 58,4 58,4 62,3 63,4 68,1
must also provide capital charge for operational risk. Such
could reduce CAR slightly and therefore making any shock
29,0 27,3 21,4
occurring in the market potentially disruptive to financial 27,8 21,6 19,0
6,2 7,8 9,9 7,8 7,4

4,3
sector resilience. Des'05 Jun'06 Des'06 Jun'07 Des'07 Jun-08
BI SSB KREDIT LAINNYA

Graph 2.29
Interest Rate Spread Graph 2.31
% Interest Income Composition of Banks
15
%
8,9 9,2 8,2 7,9 8,3 6,7

13
10 63,1 59,2 60,1 63,5 64,7 68,9
Dep KMK Spread

8
22,9 21,4 16,8 16,9
22,0 15,1
6,0 8,7 10,4 11,8 10,2 9,4

5
Jan Feb Mar Apr Mei Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun Des'05 Jun'06 Des'06 Jun'07 Des'07 Jun-08
2007 2008 BI SSB KREDIT LAINNYA
2.2.4. Profitability and Capital from 64.7% (December 2007) to 68.9% (June 2008).
Profitability Conversely, interest income gained from SBI and other
One profitability indicator is net interest income (NII). securities/bonds fell during the first semester of 2008.
During the reporting period, NII rose steeply from Rp8.9 Adjustment of the PUAB interest rate to a level
trillion per month at the end of December 2007 to Rp9.6 approaching the BI rate did not significantly affect bank
trillion per month at the end of June 2008. This rise in NII profitability. It was noted that several banks conducted
was principally supported by growth in earning assets arbitration by borrowing from PUAB and concurrently
(particularly credit) that outpaced expansion in deposits, investing in SBI. However, since the PUAB interest rate
namely Rp83.6 trillion compared to Rp42.7 trillion. NII has adjustment, this strategy is no longer profitable. The
also been bolstered since the beginning of 2008 by declining opportunity for arbitration was reflected by a
widening spread between the lending rate (working capital fall in net income between income from BI and the interest
loans) and deposit savings rate (1-month term deposits). cost of interbank call money from Rp1.3 trillion during
However, since the BI rate increase in May 2008 the spread Semester-I 2007 to Rp1 trillion during the same period
has tended to stop widening. this past year. The reduction in interest income from
Income from credit interest continues to dominate arbitration was recovered by the steep rise in credit interest
the composition of interest income derived by banks. The income, therefore, total interest income at the end of June
increasing amount of credit extended by banks still drives 2008 improved to Rp92.1 trillion compared to Rp87 trillion
a corresponding rise in interest income from credit, up during the same period in 2007.
31
Graph 2.32 increase of 23.6%. Consequently, bank CAR dropped

BI Interest Income and Cost of Interbank Call Money
from 19.3% to 16.4%. All bank groups suffered a decline
Rp triliun
18,0 in CAR, with the largest drop recorded for the non-major
16,0
14,0
banks.
12,0
10,0 Graph 2.34
8,0 Risk-weighted Assets, Capital and CAR
6,0
1.500 22%
4,0
2,0 1.250 20%
0,0
Jan Feb Mar Apr Mei Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun Jul
1.000 18%
2007 2008
750 16%
Graph 2.33 500 14%

The Banking Industry P/L
250 12%
Rp triliun
30
- 10%
L/R Op Des Des Des Des Jun Des Jan Feb Mar Apr Mei Jun
25 2003 2004 2005 2006 2007 2008
L/R Non Op
20 L/R Sblm Pajak Modal ATMR CAR (kanan)
15
Graph 2.35
10
CAR Ratio by Bank Group √ June 2008
5
%
0 25,0
(5)
Jan Feb Mar Apr Mei Jun Jan Feb Mar Apr Mei Jun 20,0
2007 2008
15,0
Although NII increased, bank profit/loss for the 10,0
current year as per the end of Semester-I 2008 (Rp24.9

5,0
trillion) was slightly lower compared to the same period in

0,0
Bank Besar Bank Lainnya Industri
2007 (Rp25.2 trillion) thus reducing the return on assets
Jun'07 Des'07 Juni'08
(ROA) as well. This is due to the introduction of mark to
market for bonds that placed pressures on profit/loss. It Despite a slight decline, bank CAR in general
must be noted that nearly 93% of total losses due to remained relatively high compared to the minimum
marking to market were experienced by the state-owned requirement of 8%. The ratio of core capital (Tier 1) to
bank group and foreign bank branches. risk-weighted assets also remained high, namely 14.7%.
Therefore, bank capital was adequate to absorb a plethora
Capital of risks.
The lackluster increase in profits led to slow bank However, there were several banks, especially
capital growth. Oppositely, expansive credit growth medium to small banks, with marginal CAR (9% - 12%).
caused the number of risk-weighted assets to rise sharply. Banks with marginal CAR are particularly vulnerable to
During the reporting period, capital witnessed just 5.1% any escalation in risk. Therefore, such banks are required
growth whereas risk-weighted assets experienced an to prepare concrete measures to strengthen their capital.
32
This is even more important considering that beginning at 2.3. NON-BANK FINANCIAL INSTITUTIONS AND
the end of 2010 banks will be required to maintain a THE CAPITAL MARKET
minimum core capital of Rp100 billion. Other measures to During Semester-I 2008, non-bank financial
reinforce capital include mergers and acquisitions, which institutions and the capital markets continued to develop
should accelerate bank consolidation. amidst mounting pressures emanating from global financial
market fluctuations and a decline in economic conditions
Stress Test compared to the previous semester. Vigilance must be
To gauge potential instability as well as measure the improved to prevent shocks emerging in the domestic
resilience of bank capital in confronting pressures from financial markets, whether originating from banks, non-
various risk sources, stress tests were performed on 15 bank financial institutions or the capital markets.
major banks using a balance sheet approach transmitted
to bank profitability and capital. The scenarios used include: 2.3.1. Finance Companies
(i) a decline in credit quality by downgrading outstanding Finance companies are other financial institutions
credit collectability by 10%; (ii) a 15% slump in SUN price; that provide many types of finance, including consumer
(iii) a 2% rise in the interest rate; and (iv) a Rp500 loans, leasing, factoring and credit cards. In Semester-I
depreciation in the rupiah against the dollar to Rp9,725/ 2008 (to May «08) financing from finance companies grew
USD. by 9.91% in line with corresponding increases in total
Stress test results demonstrated that under the assets and capital by 8.16% and 2.86% respectively.
scenarios mentioned bank CAR falls, on average, by 0.4% Optimism surrounding the future performance of financing
(lowest 0.1% and highest 3.3%) from 18.8% to 18.4%. encouraged finance companies to trim investments on
More positively, no banks suffered a decline in CAR to bonds, including money market bonds, mutual funds and
below the 10% threshold. It can therefore be concluded corporate bonds. The share of finance offered by finance
that potential instability in future will remain low companies was dominated by joint finance companies,
considering that bank capital is adequate to absorb many whereas finance from national private finance companies
risks such as credit risk, interest rate risk, exchange rate grew by 10.8%. Intense financing by finance companies
risk and SUN price depreciation risk. was primarily supported by the rise in financing offered
by banks.
Grafik 2.36 Graph 2.37

Stress Testing various Scenarios Business Activity of Finance Companies
% Rp miliar
30 160
CAR AWAL 2004
8,16%
25 CAR BARU 140 2005
9,91% 2006
120 Des'07
20 8,64% Mei'08
100
15 80
10 60
40
5 2,86%
20
0 0
A B C D E F G H I J K L M N O Aset Pembiayaan Pendanaan Modal
33
Finance company funding again concentrated on Table 2.1

Funding Composition of Finance Companies
consumer financing with a share of 63.3%. National
private finance companies further intensified their leasing May 08 Total National Private Joint
activity, as reflected by the rise in share from 10.08% Leasing 33.74% 11.34% 45.28%
Factoring 1.83% 3.23% 1%
(December 2007) to 11.34% (May 2008). Conversely, joint Credit Cards 1.13% 0.01% 1.78%
finance companies tended to focus on consumer lending Consumption Financing 63.3% 85.42% 51.94%
Dec 08 Total National Private Joint
with its share expanding form 50.61% to 51.94%. This
Leasing 33.88% 10.08% 46.06%
was primarily attributable to the appealing automotive Factoring 2.04% 3.47% 1.24%
sector as indicated by The Indonesian Automotive Industry Credit Cards 1.34% 0.02% 2.09%
Consumption Financing 62.74% 86.43% 50.61%
Association (Gaikindo) report on vehicle sales during
Growth Total National Private Joint
Semester-I 2008, which exceeded estimations, namely 290
Dec 07 √ May 08 9.91% 10.8% 9.33%
thousand units and exports of 50 thousand units. In Dec 06 √ May 07 3.54% 6.11% 2.1%
addition, a report from the Indonesian Motorcycle

Association stated that national motorcycle sales during Meanwhile the efficiency of finance company activity
Semester-I 2008 increased by 2.5 million units. improved as reflected by a decline in the efficiency ratio of
The rise in finance company funding was Operational Cost to Operational Income (BOPO) from 83%
complemented by improved financing quality, as evidenced to 77%. Efficiency improvements occurred in line with
by a drop in NPL from 2.11% to 2.04%. The decline in refined management and better diversification of the
NPL occurred chiefly on leasing, factoring and credit cards, finance portfolio. Finance company profitability was well
whereas consumption NPL tended to increase. Based on maintained, as indicated by relatively steady ROA during
level, the NPL of factoring remained the highest. 2008 (to May «08), whereas ROE increased slightly.
Liquidity risk of national private finance companies In terms of funding, national private finance
and joint finance companies was well managed along with companies have increasingly relied on bank loans as their
the high cash flow originating from funding activity. dominant source of funds because of the high issuance of

Funding Composition (Value) of Finance Companies Financing NPL
Pembiayaan (dalam ribuan Rp) NPL (%)

140.000.000.000
18,00
120.000.000.000 16,00
100.000.000.000 14,00
12,00
80.000.000.000
10,00
60.000.000.000 8,00
40.000.000.000 6,00
4,00
20.000.000.000
2,00
0 0,00
Total Swasta Nasional Patungan Sewa Guna Anjak Pembiayaan
Kartu Kredit
Piutang pembiayaan 118.355.953.837 42.167.708.575 74.899.783.532 Usaha Piutang Konsumen
Sewa Guna Usaha 39.933.499.739 4.781.115.535 33.918.088.509 May'07 2,71% 17,08% 4,10% 1,52%
Dec'07 2,28% 11,59% 3,66% 1,68%
Anjak Piutang 2.169.138.644 1.362.855.013 752.117.596
May'08 2,18% 11,36% 2,82% 1,68%
Kartu Kredit 1.332.143.310 2.168.698 1.329.974.612
Pembiayaan Konsumen 74.921.172.144 36.021.569.329 38.899.602.815
34
Graph 2.40
Cash Flow of Finance Companies
Rp Miliar Rp Miliar
3.000 10.000
2.500 8.000
2.000
6.000
1.500
2.000
1.000
500 4.000
0 0
-500
-2.000
-1.000
-4.000
-1.500
-2.000 -6.000
-2.500 -8.000
Des 06 Mei 07 Des 07 Mei'08 Des 06 Mei 07 Des 07 Mei'08
Arus kas neto dari -1.281 928 1.184 -1.784 Arus kas neto dari
-1.676 -2.542 -7.133 -4.057
aktivitas operasi aktivitas operasi
Arus kas neto dari Arus kas neto dari
aktivitas investasi -133 -65 -162 -103 aktivitas investasi -87 216 494 845
Arus kas neto dari Arus kas neto dari

aktivitas pendanaan 1.526 -931 -811 2.596 aktivitas pendanaan 3.022 2.552 7.513 2.873
stocks and bonds. Throughout Semester-I 2008, only one Graph 2.41
Finance Companies» Source of Funds
finance company conducted a IPO, namely Verena Oto
Rp Ribuan
Finance and one finance company carried out a rights issue,
100.000.000.000 Des'06 Dec'07
namely Sinarmas Multiartha. Meanwhile three finance Mei'07 Mei'08
80.000.000.000
companies (Tunas Financindo Sarana, Astra Sedaya Finance
60.000.000.000
and Federal International Finance) issued bonds for
40.000.000.000
refinancing.
20.000.000.000
The rise in finance company loans to banks has the
potential to intensify the risk exposure of banks. To limit this 0
Pinjaman Bank Surat Berharga Total Sumber
Domestik yg Diterbitkan Dana*
risk, banks tended to reduce channeling and joint financing. *Total Sumber Dana : SSB. Pinjaman Subordinasi dan
Total Pinjaman Dalam dan Luar Negeri
As a result, growth in channeling and joint financing by

finance companies during the reporting period was far lower Based on the group of 15 finance companies with
than growth during the same period in the previous year. the largest foreign exchange loans, most are joint finance
companies that tended to focus on leasing activities.
Table 2.2
Performance of Finance Companies Expansive rupiah financing and foreign exchange loans
have triggered potential exchange rate risk. Finance
Dec-06 Mei-07 Dec-07 May-07
Asset 108,888,482,086 113,486,827,486 127,260,532,556 137,646,452,149
companies which are subsidiaries of banks have majority
Debt (Pinjaman/ of their funds sourced from rupiah denominated loans from
Obligasi) 75,473,577,190 79,283,278,757 90,319,642,214 98,124,081,115
Kewajiban 89,854,653,702 92,882,835,571 102,726,729,294 111,356,359,313 domestic banks which results to relatively low probabilities
Equity 19,033,828,384 20,603,991,915 24,553,803,262 26,290,092,836
of risk transfer from exchange rate risk.
Profit Before Tax 4,203,131,242 2,470,102,063 5,763,866,446 3,381,269,222
Profit After Tax 3,133,199,549 1,863,858,093 4,379,780,690 2,587,493,663 In 2008 (to May 2008) 25 finance companies were
ROA 0.04 0.02 0.05 0.02
ROE 0.22 0.12 0.23 0.13 affiliated with banks and 10 were subsidiaries of domestic
BOPO 0.89 0.81 0.83 0.77
banks. From a business point of view, five finance
Debt/Equity 3.97 3.85 3.68 3.73
Kewajiban/Equity 4.72 4.51 4.19 4.24 companies belong to banks that concentrate their funding
35
Graph 2.42 stock exchange, short-term profit taking by foreign

The Banking Industry»s Exposure
investors was one contributing factor that precipitated a
Rp Ribuan
Channelling
price bubble.
90.000.000.000
80.000.000.000 Joint Financing
70.000.000.000
Graph 2.43
60.000.000.000
Inflow of SUN-SBI-Shares
50.000.000.000
Rp triliun
40.000.000.000 30
30.000.000.000
20.000.000.000 20
10.000.000.000
0 10
Des'06 Mei'07 Des'07 Mei'08
0
Table 2.3
Finance Companies» Source of Funds -10
Saham SBI SUN

Semester I'07 Semester I'08 -20
Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun
SN 2007 2008
Pinjaman Bank 8.29% 15.86%

Surat Berharga yg Diterbitkan 26.55% 6.78% Graph 2.44
Total Sumber Dana 13.67% 11.25% Total Inflow: SBI-SUN-Shares
Patungan Rp triliun
40
Pinjaman Bank -4.21% 6.96% Total Inflows
Surat Berharga yg Diterbitkan 10.06% 2.89% 30
Total Sumber Dana 0.95% 6.70% 20

Total 10
Pinjaman Bank Domestik 0.73% 10.55%
Surat Berharga yg Diterbitkan 19.32% 4.82% 0
Total Sumber Dana 4.81% 7.95% -10
-20
-30
activity on leasing. In 2008 (to May 2008) financing Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun
2007 2008
performed well, as reflected by increasing ROA and ROE.
Stock Market
2.3.2. Capital Market Throughout the reporting period, global stock
Foreign Investor Portfolio exchanges continued on their bearish trends due to
Semester-I 2008 was marked by increasing widespread expectations of escalating global inflationary
inflationary pressures which, in turn, raised the domestic pressures, which are forecasted to aggravate already poor
interest rate. As a result, short-term capital inflows from US economic prospects as a result of the subprime
foreign investors surged, namely on SUN and SBI by Rp8.4 mortgage crisis. The bourses of emerging market countries
trillion and Rp4.7 trillion respectively. Net stock purchased in Asia also deteriorated, the most severe being the Chinese
amounted to Rp5.4 trillion. On one side, the surge in capital exchange index SIASA, which witnessed a 47% decline.
inflows from foreign investors reflected stronger In the domestic stock market, the Jakarta Composite Index
confidence in the domestic financial sector. However on slumped 14.5% to 2,349.11 (June 2008). During the first
the other side, the Indonesian financial sector became more semester of 2008 the JSX Composite recorded both its
vulnerable to the possibility of sudden reversal. On the highest level ever as well as its lowest at 2,180.09 (9th
36
April 2008) and 2,830.26 (9th June 2008) respectively. The The rise in domestic interest rates weakened the
average for the semester was 2,485.47. financial sector»s index. The share price of the majority
The index tumble affected nearly all sectoral indices, of banks plunged, although two banks did witness a
especially indices sensitive to the interest rate, namely the strong rally, namely Bank BII and Bank Niaga, of 69%
construction and financial sectors which declined 33% and and 12% respectively. The Price/Earnings (P/E) Ratio of
22% respectively. Sectoral indices sensitive to the exchange the majority of banks» shares also plummeted, except
rate also deteriorated significantly, namely the for Bank BNI and Bank BII»which reported dramatic
infrastructure sector (plummeting 25%) and the increases.
miscellaneous industrial sector (nose-diving 24.5%).
Table 2.5
Meanwhile, profit taking by investors to take advantage Sectoral Index Performance
of rising commodity prices spurred a rise in the indices of
Pertumbuhan (%)
the agricultural and mining sectors by 11% and 4.5% Des 07 Mar 08 Jun 08 Des-Mar
Mar-Jun Sem I-08
respectively. IHSG 2,745.83 2,447.30 2,349.11 -10.87 -4.01 -14.45
Pertanian 2,754.76 2,897.64 3,061.06 5.19 5.64 11.12
Industri Dasar 238.05 196.96 200.05 -17.26 1.57 -15.96
Table 2.4
Konstruksi 251.82 195.60 168.53 -22.32 -13.84 -33.07
Index Performance of several Regional Bourses
Konsumsi 436.04 405.01 398.29 -7.12 -1.66 -8.66
Keuangan 260.57 232.27 203.74 -10.86 -12.28 -21.81
Pertumbuhan (%) Infra Struktur 874.07 781.75 652.81 -10.56 -16.49 -25.31
Des 07 Mar 08 Jun 08 Des-Mar Pertambangan 3,270.09 2,840.04 3,415.96 -13.15 20.28 4.46
Mar-Jun Sem I-08
Aneka Industri 477.35 427.33 360.65 -10.48 -15.60 -24.45
IHSG 2.745,83 2.447,30 2.349,11 -10,87 -4,01 -14,45 Jasa Perdagangan 392.24 368.07 356.76 -6.16 -3.07 -9.05
STI 3.465,60 3.007,40 2.947,54 -13,22 -1,99 -14,95
KLCI 1.445,03 1.247,52 1.186,57 -13,67 -4,89 -17,89
Graph 2.46
SET 858,10 817,03 768,59 -4,79 -5,93 -10,43
Share Capitalization by Sector
PCOMM 4.422,22 3.755,33 2.987,85 -15,08 -20,44 -32,44
Rp miliar
HSCI 3.935,37 3.226,50 3.108,84 -18,01 -3,65 -21,00 500,00
NIKKEI 301,09 246,14 268,80 -18,25 9,21 -10,72 450,00
NASDAQ 2.652,28 2.279,10 2.292,48 -14,07 0,59 -13,57 400,00
DJI 13.264,82 12.262,89 11.348,73 -7,55 -7,45 -14,44 350,00

300,00
KOSPI 1.897,13 1.703,99 1.674,92 -10,18 -1,71 -11,71 Pertanian Aneka Indust Infra Str
250,00 Pertambangan Konsumsi Indust Dasar
SIASA 18.658,17 14.025,04 9.946,68 -24,83 -29,08 -46,69 Konstruksi Keuangan Jasa Perdag
200,00
FTSE 3.167,39 2.636,45 2.522,41 -16,76 -4,33 -20,36 150,00
100,00
50,00
Graph 2.45 0.00
23 12 26 9 23 8 22 5 19 3 17 31 14 28 12 26
Share Price Index of Regional Bourses Des Jan Jan Feb Feb Mar Mar Apr Apr Mei Mei Mei Jun Jun Jul Jul
2007 2008
5000
IHSG STI KLCI SET
4500
PCOMM HSCI NIKKEI NASDAQ
A stock price bubble undermined stock market
4000
3500 efficiency as evidenced by a rise in the exchange
3000
2500
efficiency coefficient, which is a ratio of short and long-
2000
term volatility. However, the coefficient remained below
1500
1000 75%. The erosion of market efficiency will eventually
500
0 lead to a slow recovery should market corrections
31 14 28 11 25 10 24 7 21 5 19 2 16 30
Des Jan Jan Feb Feb Mar Mar Apr Apr Mei Mei Jun Jun Jun
2008
materialize.
37

Share Prices of Several Banks Capitalization Value & Value of Issued Shares
(N Kapitalisasi, trl Rp) (N Emisi, trl Rp)
9000 2.500,00 450,00
Niaga BII Mandiri BNI N Kap (BEJ) N Kap (BES) N Emisi
8000 BCA Danamon BRI 400,00
7000 2.000,00 350,00
6000 300,00
1.500,00
5000 250,00
4000 200,00
1.000,00
3000 150,00
2000 500,00 100,00

1000 50,00
0 0,00 0,00
3 17 31 14 28 13 27 10 24 8 22 5 19 Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Mei
Jan Jan Jan Feb Feb Mar Mar Apr Apr Mei Mei Jun Jun
2007 2008
2008
Graph 2.48 Bonds Market

P/E Ratio of Bank Shares The bonds market weakened during Semester-I 2008
%
100
2005 2006 2007 2008
due to the effect of global financial market fluctuations
90
80 and the rise in domestic interest rates, which increased
70
60 the yield of rupiah investments of various tenures. The
50
40
most impressive yield jump occurred on rupiah investments
30
with a 3-5 year tenure (an increase of nearly 400bps). On
20
10
0 Graph 2.51
BRI Mandiri BNI BCA Niaga BII Danamon
Rupiah Investment Yield
Based on the issuance of shares, despite pressures %
15
14
from external fluctuations on the domestic stock exchange,
13
during the reporting period share issuances continued to 12
11
escalate, namely by 16% to Rp381.03 trillion.
10
Furthermore, 10 additional companies began issuing 9
8
shares, bringing the total to 478 issuers. Pressures on the
7
1th 3th 5th 10th 15th 20th
domestic stock market led to a decline in stock 6
12 16 30 3 27 21 26 3 23 7 21 4 18
Jan Jan Jan Feb Feb Mar Mar Apr Apr Mei Mei Jun Jun
capitalization by 9.8% to Rp1,793.59 trillion. 2008

Sectoral Share Efficiency Rupiah Investment Yield
%
35,00
130
30,00
120
25,00
110
20,00
100
15,00 90
10,00 80
Pertanian Indus Dsr Konstruksi
5,00 Konsumsi Keuangan Infra Str FR0024 FR0023 FR0028 FR0031
70
Pertambangan Aneka Industri Jasa Perdag
FR0033 FR0034 FR0047
0,00 60
29 12 26 9 23 8 22 5 19 3 17 31 14 28 28 11 25 8 22 7 21 4 18 2 16 30 13 27
Des Jan Jan Feb Feb Mar Mar Apr Apr Mei Mei Mei Jun Jun Des Jan Jan Feb Feb Mar Mar Apr Apr Mei Mei Mei Jun Jun
2007 2008
2008
38
Graph 2.53 to invest in short-term SUN. The SUN trading portfolio

SUN Ownership
Rp triliun
expanded by 14.7% whereas investment (hold to maturity)
300
SUN shrank by 15%.
250
200
Graph 2.55
SUN Performance based on Type
150 Rp triliun
350
100
FR VR ORI ZERO
300
50
250
0
, Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun 200
2007 2008
150
Perbankan Residen Asing
100
Graph 2.54 50
SUN Portfolio: Investment √ Trading 0
Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun
Rp triliun 2007 2008
500
Investasi Perdagangan
450 Graph 2.56
400 SUN Liquidity based on Tenure
350 Rp triliun
300 45
250 40 FR VR ORI Zero
200
35
150
30
100
25
50
0 20
Jul Apr Sep Okt Nov Des Jan Feb Mar Apr Mei Jun 15
2007 2008
10
5
the SUN market, the prevailing interest rate trend
0
1th 3th 5th 7th 9th 11th 13th 15th 17th 19th 29th
encouraged portfolio adjustments by investors, namely
through the sale of high-priced SUN for the purchase of Keen investor interest in SUN emboldened the
low-priced SUN, particularly through the primary market government to persevere with SUN issuance. To expand
as well as the purchase of Zero Coupon Bonds. Such its investment base, the government also increased the
investor behavior resulted in a weak SUN price, down by supply of other government bonds in the form of
15%, particularly the Fixed Rate series. Indonesian Retail Bonds (ORI)-jumping 70% to Rp32.07
Meanwhile, periodic BI rate increases provided the trillion and Zero Coupon Bonds-leaping 81.2% to Rp19.02
opportunity for investors to adjust their portfolio. trillion. As a result of imbalanced liquidity concentrated
Consequently, investor interest in SUN did not wane. This on short-tenure SUN, the drop in price for long-tenure
was evidenced by the burgeoning SUN ownership of SUN (over 10 years) tended to be large. During Semester-
foreign investors and banks, more specifically 20.39% and I 2008, the decline in price for long-tenure SUN exceeded
1.82% respectively. SUN ownership by domestic investors 15%.
(namely Mutual Funds, Insurance Companies, Retirement In the corporate bonds market, the rising domestic
Funds and various Foundations) also enjoyed a 17.85% interest rate tended to restrict stock issuances. Despite
rise. The rising interest rate trend also encouraged investors the issuance of corporate bonds growing 9% to
39

Corporate Bond Issuance and Position Mutual Funds: NAV-Units
(Emisi & Posisi, trl Rp) (Emiten) NAB, trl Rp - Unit Penyertaan, miliar NAB/Unit Penyertaan
160 179 120 1750
Emisi Posisi Emiten NAB
140 178 Unit Penyertaan 1700
100
177 NAB/Unit 1650
120
176 80 1600
100
175 1550
80 174 60
1500
60 173
40 1450
172
40 1400
171 20
20 1350
170
0 169 0 1300
Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun
2007 2008 2007 2008
Rp145.92 trillion and the number of issuers expanding Graph 2.60

Redemption-Subscription-NAV
by three to become 178 during the reporting period,
most issuances were the result of refinancing matured 14
Redemp
120
12 Subscrib
100
corporate bonds. Thus, the position of corporate bonds NAB
10
80
at the end of June 2008 had declined by 2.4% to
8
60
Rp82.53 trillion. 6
40
4
2 20
Mutual Funds
0 0
During the reporting period, increasing pressures on Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun
2007 2008
the financial market affected the performance of mutual
Graph 2.61
funds, especially fixed-income mutual funds, despite no
Investment Manager: Customers and Funds
significant redemptions. Generally, the sustainability of the Rp miliar Rp miliar
160,00 7.000
mutual funds market was maintained, as reflected by the Dana
140,00 Nasabah 6.000
3.68% increase in net asset value (NAV) to Rp94.4 trillion. 120,00
5.000
This was further supported by a rise in the NAV of money 100,00
4.000
80,00
market mutual funds (up 17.18% to Rp5.7 trillion), 3.000
60,00
2.000
40,00
Graph 2.58 20,00 1.000
Mutual Funds by Type
0,00 0
Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei
Rp triliun
40 2007 2008
Fix Inc P Uang
35 Saham Terproteksi
30 Camp Lainnya protected mutual funds (up 26.34% to Rp20.5 trillion)
25
and equity funds (up 2.1% to RP35.5 trillion). However as
20
15 a result of higher interest rates, the NAV of fixed income
10
mutual funds fell by 20.61% to Rp16.6 trillion
5
0 One factor preventing significant redemptions was
-5
Jun Jul Ags Sep Okt Nov Des Jan Feb Mar Apr Mei Jun the development of various types of structured mutual
2007 2008
40
funds, which in turn expanded the alternatives for investors redemptions (Rp47.6 trillion). The rise in the number of
to diversify, therefore minimizing risk. Keen investor interest customers and the amount of funds managed by
in mutual funds was evident from the increasing number investment managers, 15% and 5% respectively, also
of units by 17.44% to 62.6 billion units as well as the indicated the unwavering interest of investors in mutual
high subscriptions (Rp56.5 trillion) compared to funds.
41
Box 2.1 Bancassurance and the Performance of Life Insurance
Bancassurance represents collaboration between strategy of bancassurance has developed towards

banks and insurance companies, particularly life strategic alliances, particularly through the
insurance, in the marketing of insurance products. In amalgamation of insurance products with bank
the early stages, bancassurance focused on a products. Within the implementation of such a
distribution agreement strategy, which includes banks strategy, besides actively suggesting insurance
playing their role as agents which market insurance product modification, banks also serve as marketing
products and obtaining a fee from such activity. This agents. As banks become more active in modifying
activity only exposes banks to minor risks as long as it their products, it becomes harder to differentiate
is run abiding to a healthy marketing strategy. insurance products from bank products. As a result,
Since 2003 interest in running bancassurance has the potential risk (particularly reputation risk) faced
grown dramatically. This was triggered by rapid growth by banks becomes greater.
in non-conventional insurance products, for example Reports from nine banks, as of December 2007
life insurance products which contain an investment and May 2008, that run bancassurance demonstrate
element where funds from the insurance premium are that banks are becoming more active in marketing
invested in financial products, particularly shares, bonds non-conventional insurance products and modified
and mutual funds (unit link). insurance products. Although growth in the number
Rapid growth in non-conventional insurance of products is relatively small, namely only four
products was also supported by exponential growth in additional products, the rise in the number of
investments on financial market instruments by insurance policies is quite significant, namely 42%.
insurance companies, particularly SUN and mutual Total cover expanded by 61% whereas the amount
funds. Since 2005, investments made by insurance of premiums paid climbed 70%. Fee-based income
companies in SUN have continued to climb, reaching in 2008 is expected exceed that of 2007.
Rp47.4 trillion at the end of Semester-I 2008.
Table Box 2.1.1
Graph Box 2.1.1 Bancassurance Performance of 9 Banks
Insurance Company Investments
Total Premi Fee Base
Jumlah Jumlah
Triliun Rp Pertanggungan Dibayar Income
Produk Polis
50 Rp miliar Rp miliar Rp miliar
Surat Berharga Pem Reksadana SUN
Des 07 139 304.702 41.040 4.200 427
40
Mei 08 143 432.059 65.908 7.120 268
30
20 With the rapid growth of bancassurance,

potential reputation risk for banks will also heighten,
10
particularly if the corresponding life insurance
0
2003 2004 2005 2006 2007
company»s performance declines. Based on life
insurance company performance data for 2007, only
W ith increasing public interest in non- three life insurance companies had risk-based capital
conventional insurance products, the business (RBC) below the minimum limit of 120%. Meanwhile,
42
although the number of claims soared by 77%, total this data shows that the performance of life insurance
assets, capital, premiums and profit also increased by companies remains favorable for bancassurance
37%, 19%, 55% and 35% respectively. In general, development.

Performance of Life Insurance Companies Profit of Life Insurance Companies
120 3,5
Aset Klaim
100 Premi Modal 3
2,5
80
2
60
1,5
40
1
20 0,5
0 0
2003 2004 2005 2006 2007
2003 2004 2005 2006 2007
43
Box 2.2 Development and Diversification of Mutual Fund Risk
Since 1996, mutual funds have become a highly Graph Box 2.2.1
Mutual Fund Fluctuations in 2005
sought-after investment instrument. Rapid growth was
100.000.000,00
attributable to strong public demand for financial Fixed Income
90.000.000,00 Saham
market investment instruments excluding bank 80.000.000,00 Mixed
Pasar Uang
products, especially during periods of declining interest 70.000.000,00
60.000.000,00
rates. The similar characteristics found in mutual funds 50.000.000,00
and bank products, and projections of higher returns 40.000.000,00
30.000.000,00
encouraged the public to migrate their funds from term 20.000.000,00
deposits to mutual funds. In 2004, Net Asset Value 10.000.000,00
0,00
(NAV) significantly rose to Rp85 trillion with the largest Jan Feb Mar Apr Mei Jun Jul Ags Sep Okt Nov Des
2005
share being fixed-income mutual funds, namely 84%.
The rapid growth continued in 2005 with NAV authority instituted policies aimed at supporting the
peaking at Rp110 trillion in February. However, in 2005 development of mutual funds to become more secure
mutual funds faced the pressure of redemptions for investors. To this end, a structured mutual fund
triggered by the application of mark to market on was developed, namely a mutual fund with a
mutual funds, which coincided with an interest rate supporting asset structure that enables coverage of
hike. Consequently, the NAV of mutual funds plunged the principal amount of customer funds. The rapid
dramatically to Rp12.7 trillion in December. The sheer growth of many structured mutual fund alternatives
magnitude of redemption pressures also affected the has quickly expanded the classification of mutual fund
SUN market which was the primary support of fixed- types to nine, namely fixed income, equity, mixed,
income mutual funds. money market, protected, indexed, sharia, ETF-stock
During that time (2005), fluctuations in the and ETF-fixed income.
mutual funds market significantly undermined investor The growing number of alternative mutual funds,
confidence. To restore investor confidence and help particularly the structured type, has succeeded in
the mutual funds market recover, the financial market restoring investor confidence in mutual funds as well
Table Box 2.2.1

Mutual Fund Composition Prior to 2006
2003 2004 2005

NAB % NAB % NAB %
Fixed Income 55.556.336,51 82,47 85.036.011,81 84,21 12.689.904,47 44,71

Saham 409.746,78 0,61 1.885.081,42 1,87 4.934.190,39 17,38
Mixed 3.547.407,36 5,27 4.642.732,88 4,60 5.391.852,08 19,00
Pasar Uang 7.851.237,09 11,65 9.422.974,80 9,33 2.079.989,92 7,33
Terproteksi 0,00 - 0,00 - 3.008.460,88 10,60
ETF - Fixed Income 0,00 - 0,00 - 280.982,46 0,99
*NAB dalam Jutaan rupiah
44
Table Box 2.2.1

Mutual Fund Composition After 2006
2006 2007 2008**

NAB % NAB % NAB %
Fixed Income 18.497.338,61 36,36 20.354.436,80 22,33 16.558.260,47 17,53

Saham 8.249.016,98 16,22 34.799.665,99 38,18 35.533.788,67 37,63
Mixed 8.428.297,27 16,57 14.222.298,06 15,60 14.162.699,91 15,00
Pasar Uang 3.799.565,50 7,47 4.828.542,82 5,30 5.656.761,43 5,99
Terproteksi 11.504.353,78 22,62 16.249.560,16 17,83 20.529.499,82 21,74
Indeks 29.637,07 0,06 117.042,89 0,13 181.954,17 0,19
ETF - Fixed Income 360.983,36 0,71 504.274,98 0,55 556.052,25 0,59
ETF - Saham - - 77.952,53 0,09 59.626,36 0,06
Syariah - - - - 1.194.673,78 1,27
* NAB dalam jutaan rupiah; ** hingga bulan Juni 2008
as recovering mutual fund performance. In addition, reduction in risk is demonstrated by NAV volatility
the NAV of mutual funds has rebounded to Rp94 during the 2006-2008 period, which fluctuated within
trillion (June 2008). a narrower band compared to fluctuations from 2004-
Structured mutual funds diversify risk to investors 2005. Therefore it is expected that the sustainability
through the provision of an investment alternative. The of future mutual funds will be maintained.

NAV Movement (2004√2005) NAV Movement (2006√2008)
6,00 8,00
4,00 6,00
2,00 4,00
- 2,00
(2,00) -
(4,00) (2,00)
(6,00) (4,00)
(8,00) (6,00)
(10,00) (8,00)
Jan Feb Mar Apr Mei Jun Jul Ags Sep Okt Nov Des Jan Feb MarApr Mei Jun Jul Ags Sep Okt Nov Des Feb Apr Jun Ags Okt Des Feb Apr Jul Sep Okt Des Feb Apr Jun
2004 2005 2006 2007 2008
45
46
Chapter 3 Financial Infrastructure and Risk Mitigation
Chapter 3
Financial Infrastructure
and Risk Mitigation
47
48
The reliability of Indonesian financial infrastructure continued to support the

preservation of financial system stability. The payment system functioned
effectively despite the burgeoning settlement volume and value during the
first semester of 2008. This was underpinned by efforts to develop the financial
system, which focused on mitigating settlement risk and operational risk.
Meanwhile, preparations for crisis management protocol (CMP) continued
unabated by the Government, Bank Indonesia and the Deposit Insurance
Corporation through the Financial System Stability Forum. CMP will clarify
the inter-agency roles, responsibilities and action plans to prevent and handle
crises in the financial sector.
3.1. DEVELOPMENTS IN THE PAYMENT SYSTEM 3.7% (Rp20.84 thousand trillion). However, in terms of
The payment system remained reliable and fully volume, settlements increased by 3.6% (4.74 million
supportive of financial system stability during the first transactions). The decline in transaction value was primarily
semester of 2008. Fund transfer activities through RTGS attributable to large-value transaction activities associated
and the clearing system, which represent the principal with monetary operations, the inter-bank money market,
channels of inter-bank transactions, were not disrupted inter-bank foreign exchange transactions and settlements
and financial system stability was maintained. All financial in the capital market. The higher transaction value was
transactions were settled appropriately with a daily value due to surging public transactions processed through banks
reaching some Rp164.5 trillion. Similar performance was as well as the settlement transaction volume in the Bank
reported for other transaction activities, such as Payment Indonesia clearing system.
Cards (APMK), and e-money also displayed signs of
Table 3.1
improved administration quality. Settlement Value and Volume of the BI-RTGS System
The value of funds transferred through the BI-RTGS

Semester II 2007 Semester I 2008 Growth
system was recorded at Rp20.07 thousand trillion with a
Value Volume Value Volume Value Volume
volume of 4.91 million transactions. When compared to (thousand trillions) (millions) (thousand trillions) (millions)
the previous period, the value of settlements declined by 20.84 4.74 20.07 4.91 -3.7% 3.6%
49
Contrary to the large value transaction activity 3.1.1. Payment System Development
through the BI-RTGS system, retail fund transfers The trend of fund transfers through various payment
through the Bank Indonesia National Clearing System systems continues to indicate an increase from year to year.
(SKNBI) increased over the previous period. Transaction In line with economic growth, greater fund transfers were
value was recorded at Rp808.09 trillion (a 9.7% also driven by the issuance of various instruments,
increase), whereas transaction volume reached Rp42.32 innovative new payment infrastructure and financial
million (up 4.9%). products. Against this backdrop, Bank Indonesia responded
by consistently applying policies to address payment system
Table 3.2
operators under the framework of boosting efficiency,
Settlement Value and Volume of the National
Clearing System reliability and proper risk mitigation as well as emphasizing
customer protection.
Semester II 2007 Semester I 2008 Growth
Efforts were also applied to the RTGS and national
Value Volume Value Volume Value Volume
(thousand trillions) (millions) (thousand trillions) (millions) clearing systems. The RTGS system will become more
736.35 40.35 808.09 42.32 9.7% 4.9% reliable through the application of up-to-date payment
technology. As a result, the system will accommodate more
Retail payment transaction activities through complex transaction requirements. New infrastructure is
payment cards also demonstrated an upward trend. also being developed to meet the transaction requirements
Transaction value reached Rp1.224 trillion, up 24.8% for additional foreign currencies due to the unrelenting
compared to the previous semester (Rp981.4 trillion). The integration of the global economy. Furthermore, to satisfy
rise in value occurred across all instrument types, namely the requirements inherent with liquidity management, a
credit cards (23.8%) and savings account-based cards liquidity saving feature is being added to the system.
(24.8%). In terms of volume, activity reached 816 million In increasing efficiency and effectiveness of the RTGS
transactions; up 24.1% over the previous semester (657.5 system, Bank Indonesia along with several members is in
million). With particular reference to e-money, this past the process of formulating the inter-bank foreign currency
semester saw the number of operators expand to five, settlement requirement (payment versus payment). This
consisting of three banks and two non-bank financial will also minimize exposure to foreign currency settlement
institutions with a transaction value of Rp12.8 billion and risk originating from the time difference between
volume of 703.7 thousand transactions. settlements in rupiah and foreign currencies.
Bank Indonesia has introduced a plan to upgrade
Table 3.3
Card Payment Transactions the national clearing system to accommodate other
Semester II 2007 Semester I 2008 Growth payment segments that are already developed but not yet
Cards Type Value Volume Value Volume Value Volume integrated into one platform. The segments in question
(trillions of Rp) (millions) (trillions of Rp) (millions)
include the routine payment segment or ≈direct debit∆. In
Kartu Berbasis
Debit card (ATM the near future, by applying this national clearing system
and ATM+Debit) 941.6 590.0 1.175.4 736.5 24.8% 24.8%
facility, it will be possible for the general public to conduct
Credit card 39.7 67.5 49.2 79.5 23.8% 17.8%
Total 981.4 657.5 1.224.6 816.0 24.8% 24.1% routine payment transactions automatically, according to
50
the time period requested, without having to visit a bank future there will be one interoperable standard. This
or ATM. Furthermore, the payment order will only have commitment will be legislated in an e-money regulation
to be executed once. To the beneficiary bank this will to be issued in Semester-II 2008.
reduce overhead costs and simplify liquidity management.
To improve the efficiency of payment services to the 3.1.2. Risk Assessment and Risk Mitigation
government, Bank Indonesia has also developed an Risk management in the payment system is a pivotal
application for the government to simplify its account issue. Various risks, from credit risk, fraud, operational risk,
management. The application, known as Bank Indonesia liquidity and systemic risk are a real threat if risk mitigation
Government e-Banking (BIG-eB) covers the administration is inadequate.
of income, expenses and transaction settlement associated For the payment system administrated by Bank
with government transfers. The operation of BIG-eB is Indonesia, operational risk mitigation is applied, beginning
legislated by Law No. 1 year 2004 regarding the state with system design, reliability of technology and supporting
treasury. In addition, coordination will also be strengthened networks. This includes testing through security audits by
between the fiscal authority and monetary authority certified institutions and setting service level agreement
through service provision by Bank Indonesia to support with relevant supporting institutions, such as network
the needs of the government to improve budgetary control provision and technology maintenance. To combat fraud,
and management. rigorous security measures are applied such as data
Through the gradual establishment of BIG-eB, the encryption and registration of all technology. Steps to
government can access online, real-time financial preserve operational sustainability in the case of an
information/data in conjunction with the Treasury Single emergency are in place, including the testing of the primary
Account. This will accelerate the reporting process in the and backup systems. With reference to the RTGS system,
Ministry of Finance and expedite transaction settlements a guest bank facility or RTGS terminal was established
in the ministry. during this past semester for member banks that
Meanwhile, to augment payment system efficiency experience disruptions in their systems. Accordingly,
outside Bank Indonesia, persuasive efforts have been operations can be maintained at the Bank Indonesia office.
applied in order to facilitate operators to integrate their Meanwhile, to overcome credit risk that can
systems. In the initial stage, interoperability among ATM eventually become systemic, gridlock resolution and line
providers was applied, which involves mutual mechanism facilities have complemented the RTGS system
understanding among all to standardize their instruments. in order to alleviate liquidity tightness for members. Besides,
Efforts include cooperation among switching providers in Bank Indonesia also provides a daily liquidity facility to
four ASEAN countries (ASEANPay). Consequently, transfers banks that require funds, which are secured against quality
among ATMs in the four countries are currently available. bonds, such as BI Certificates and SUN as collateral. In the
Similar endeavors were also applied to develop e- past semester, the liquidity condition of RTGS members
money instruments, which have witnessed rapid expansion was good with no gridlock reported and sufficient liquidity
in recent times. Bank Indonesia actively encourages the in the system, as indicated by an equal liquidity spread in
industry to standardize its instruments; therefore, in the the system throughout the day.
51
In association with the efforts to minimize fraud risk Table 3.4

CPSIPS Compliance by Bank Indonesia (cont.)
within and outside of Bank Indonesia»s operations, such
as payment cards for example, close coordination with CP CP Compliance
relevant institutions is maintained, particularly to deal with 4 To provide assurance that BI-RTGS system can support
instances of credit card or debit card fraud. An issue already finality and irrevocability principles of fund transfers applied
through BI-RTGS system with final settlements conducted
agreed upon is to conduct security audits on the acquiring in real time according to the predetermined schedules
(window times)
bank. The security audit will involve internal auditors and
external auditors, for which the results will be jointly 5 To ascertain the availability of members» funds held in
accounts at Bank Indonesia, including funds from the
handled with the respective bank»s supervision working Intraday Liquidity Facility (FLI).
group.
6 To emphasize the obligation of operators to provide a secure
and reliable system, such as system trials, security audits
and BCP implementation.
3.1.3. Steps towards CPSIPS
7 To provide regulative materials aimed to establish
In early 2008, a new regulation regarding BI-RTGS
transparency regarding to of BI-RTGS efficiency, such as
(PBI No.10/6/PBI/2008) was promulgated to supersede the pricing policies (including considerations whether subsidies
are needed or not), transaction costs, and cost allocation
previous one. The new regulation reflects the four principles mechanism.
of payment system policy. In terms of risk management,
8 To obligate operators to assure that membership criteria
the new legislation clearly describes the risks that may are objective and published
affect the BI-RTGS system as well as detailing the risk- 9 To obligate operators to maintain good governance in their
management mechanism. The regulation also fully business
encompasses the Core Principles for Systematically

Important Payment Systems (CPSIPS). 3.1.4. Business Continuity Plan
The salient points supporting the compliance to Under the risk-mitigation framework, a Business
CPSIPS are listed as follows: Continuity Plan trial was conducted on 19 March 2008.
The trial involved Bank Indonesia as the administrator and
Table 3.4
CPSIPS Compliance by Bank Indonesia members of the BI-RTGS and SKNBI systems (industry
wide). The trial aimed to test the resilience of the backup
CP CP Compliance
system and its operational procedures to be applied by
1. The new regulation makes references to CPSIPS to simplify
the system provider and members in cases where the main
the legal foundation and legal certainty in employing BI-
RTGS, for instance, the need for legal opinion from system cannot function normally. The trial demonstrated
independent institutions on BI-RTGS implementation.
that both backup systems applied by Bank Indonesia are
2. The operator must prepare regulations and procedures reliable, thus ensuring the sustainability of the payment
which provide clarity to members regarding financial risks
a member may face with its participation in BI-RTGS system. system should abnormal conditions occur.
3 The regulation is required to smoothen the implementation

process of BI-RTGS system, particularly in terms of queue 3.2. CRISIS MANAGEMENT PROTOCOL
management, throughput guidelines and graduated
The Crisis Management Protocol or CMP is a priority
payment schedule.
agenda mandated to the Financial System Stability Forum,
52
including representatives from the Ministry of Finance, runs. Meanwhile, crisis management and inter-agency
Bank Indonesia and Deposit Insurance Corporation. CMP coordination mechanisms have been regulated under the
was developed to improve coordination among and Financial System Safety Net, which has been officiated in
prepare authorities in the face of a crisis. The Protocol also two Memorandums of Understanding: (1) Governor of
covers the area of crisis resolution. Bank Indonesia and Ministry of Finance on 17th March
The CMP covers four major elements of a crisis, 2005; and (2) Governor of Bank Indonesia and Chairman
namely: (1) Financial Institution Disruptions; (2) Major of Deposit Insurance Corporation on 29 June 2007.
Operational Disruptions, for instance natural disasters; (3) Over time, the financial sector»s crisis management
Financial Infrastructure Disruptions; and (4) Market protocol will be written into a law regarding Crisis
Disruptions. With a wide coverage area, CMP will include Prevention and Control of Financial Sector. This Law will
a financial safety net and business continuity plan. provide a solid legal foundation for the Government, Bank
Hitherto, CMP includes a crisis resolution mechanism Indonesia and Deposit Insurance Corporation to undertake
for the banking sector as described in the framework and the required actions to prevent financial sector crises,
MoU on a Financial System Safety Net. The policy tools particularly banking crises. The Law will also clarify the
currently available to settle a crisis include Government roles and responsibilities of each authority in financial crisis
Bonds (SUN), a Repo Facility to manage liquidity problems resolution and the coordination mechanism. Additionally,
under normal conditions, and an Emergency Financing the Law will elucidate inter-agency roles, responsibilities
Facility to prevent systemic impacts. In addition, deposit and action plans to prevent and deal with financial sector
insurance schemes, both explicit and limited, by the Deposit crises. Therefore, mitigating the risk of instability will
Insurance Corporation serves as a tool to prevent bank become proactive, helping to prevent financial sector crises.
53
54
Chapter 4 Prospects of the Indonesian Financial System
Chapter 4
Prospects of the Indonesian
Financial System
55
56
The outlook for the Indonesian financial system remains favorable, despite
the potential emergence of vulnerabilities. Strong bank credit growth will
continue to heighten liquidity risk and credit risk as NPLs increase. In addition,
expansive growth may undermine the capital adequacy ratio of banks.
Conversely, market risk will remain stable in the face of increasing pressures
stemming from the declining price of Government Bonds (SUN).
4.1. ECONOMIC PROSPECTS AND RISK Table 4.1

Projections of Several Economic Indicators
PERCEPTION
Along with the world economy»s slowdown, 2007 2008
Q1 Q2 Q3 Q4 Q1 Q2 Q3* Q4*
Indonesia»s economy will see a softening with growth levels
GDP (% yoy) 6.1 6.4 6.5 6.25 6.3 6.4 5.8 5.8
of 6.4% in 2008. Even if the recession currently unsettling
Inflation (% yoy) 6.5 5.8 7.0 6.6 8.2 11.0 11.5 11.4
the U.S. is categorized as mild, domestic and global Balance of Trade (Billions of USD) 7.7 8.1 7.5 9.4 7.5 5.3 7.5 8.2
inflationary pressures stemming from soaring fuel and food * Asia Pacific Concensus Forecast
commodity prices are relatively significant.

Even with the increasing perception of risk, as
Indonesia»s Trade Balance has run a deficit since Q2
reflected by the wider yield spread, foreign investors will
2008. Import value has grown rapidly, exceeding its falling
remain attracted to Indonesian investment instruments.
export growth. The falling price of Indonesia»s export
However, as foreign investment flows are generally short
commodities is the primary causal factor; meanwhile the
term, sufficient control is required to prevent potential
prices of imported products increased rapidly along with
volatility that could trigger a sudden reversal of capital.
strong domestic demand and demand for export materials.
Though relatively nugatory, appreciation of the real exchange Table 4.2
Risk Perceptions of Indonesia
rate will contribute somewhat to expansionary imports.
Yield Spread (bps)
Meanwhile, price pressures, principally from fuel and Bonds Rating Y-t-m (%)
Mar 2008 Jun 2008
food commodities, pushed inflation in Q2 to double digits, Indo 10 BB+ (S&P) 12.45 689.98 955.83
Indo 48 Ba3 (moody's) 13.18 684.99 901.69
namely 11.0%; increasing from 8.2% in Q1 of the same
Indo 45 Ba3 (moody's) 14.26 701.93 953.17
year. Source: Bloomberg
57
4.2. THE BANKING INDUSTRY RISK PROFILE: Market risk, in general, is relatively stable, despite
LEVEL AND DIRECTION slight pressures emanating from the falling price of SUN
As the dominant industry in the Indonesian financial since the end of 2007. Such pressures were kept in check
sector, the level and direction of the banking industry»s by comparatively strong bank capital.
risk profile will significantly affect overall financial system Meanwhile, market risk from the exchange rate is
stability. Consequently, improving risk management in the relatively low and stable in line with banks» strategy to
banking industry is imperative in order to enable banks to maintain a low net open position, far below the
maintain sufficient resilience in the face of persistent maximum of 20%. Similarly, market risk emerging from
volatility; domestically and globally. the interest rate is also fairly stable. However, vigilance
As described in previous chapters, during the first should be continued in the future due to the upward
semester of 2008, the financial sector was beset by interest rate trend. Furthermore, the bank maturity
significant challenges as a result of the increasing global profile is short in the short run which has the potential
prices of fuel and food, the multiplier effect of the subprime to trigger losses if the interest rate rises. Such is important
mortgage debacle, high inflation domestically and abroad, to note considering the limited financial instruments
as well as tumbling SUN prices. The resilience of banks available to be used to control interest rate risk as
during the past reporting period was relatively robust, as hedging and derivative markets in Indonesia are under
indicated by the capital adequacy ratio (CAR), and liquidity developed.
remained sufficient, as demonstrated by ratio of liquid Liquidity risk during the first semester 2008 was
assets to non-core deposits. Furthermore, bank risk was relatively low and stable with the ratio of liquid assets to
well controlled, which was supported by the risk control non-core deposits remaining above 100%. However,
system (RCS). However, vigilance is required as both CAR pressures are expected to exacerbate the liquidity ratio
and the liquidity ratios tended to decline. Meanwhile, risk along with a tighter interbank money market. This warrants
in the financial industry not linked to banks also remained a cautionary note as growth in deposits is outpaced by
relatively well under control, despite significant volatility credit growth. Consequently, this may undermine bank
in the bonds market as well as sliding share price indices. capital in the long run.
Graph 4.1
Bank Risk Profile and Outlook
Market Risk Liquidity Risk Credit Risk
Sem I'08 Sem I'08 Sem I'08

High
Outlook Outlook Outlook

Moderate
Interest Government
Rate Exchange Rate Bonds Price
Interest Government
Rate Bonds Price
Exchange Rate
Low
Weak Acceptable Strong Weak Acceptable Strong Weak Acceptable Strong
Risk Control System (RCS)
58
Bank credit risk is at moderate levels and relatively hampered further by a global economic downturn followed
stable. NPL ratios has also seen a downtrend. However, by intense inflationary pressures due to soaring fuel and
attention must be given to the impacts of escalating food commodity prices. Meanwhile domestically, despite
interest rates, fuel price hikes and high inflation, which relatively robust economic growth, increasing inflationary
can weaken consumer purchasing power. In addition, pressures, also stemming from spiraling fuel and food
limitations in the supply of electricity by the national electric prices, necessitate BI rate hikes. In addition, due to
company (PLN) could disrupt production activities. In escalating volatility and widespread uncertainty in global
general, such circumstances could lessen the repayment financial markets, the prices of domestic shares and bonds
capacity of debtors, which in turn could potentially intensify have slumped, which is demonstrated by the significant
credit risk. As discussed in Chapter 1, the ongoing threat drop in the price of SUN. The exponential increase in
of increasing credit risk is also confirmed by estimation pressure on the financial sector has led to a substantial
results that show an increasing tendency in the probability rise in the financial stability index from 1.25% at the end
of defaults for public listed, non-financial corporations. To of December 2007 to 1.6% at the end of June 2008.
mitigate the possibility of future credit risk, banks must In the near future, financial system stability is
also emphasize prudential credit extension and apply projected to remain under control despite expected
consistent improvements to the risk control system. increase in pressures. This is clearly demonstrated by the
One of the main risks of the banking industry, which results of stress tests which show banks as remaining
requires close monitoring, is operational risk, There are resilient to increases of various risks, namely credit risk,
numerous challenges associated with this type of risk, as exchange rate risk, interest rate risk and SUN price risk.
it is dependent on the capacity and integrity of human The resilience of the banking system is an effect of
resources in minimizing human error and fraud. Supporting improved bank risk management, supported by
infrastructure, such as information technology and good appropriate bank supervision and improved financial sector
governance, is also critical. In accordance with the surveillance by Bank Indonesia. Furthermore, optimism
implementation of Basel II, which mandates capital charge abounds due to the impending implementation of crisis
for operational risk commencing in 2009, banks are management protocol or CMP, which will strengthen
expected to be better prepared to confront risk, namely coordination between the banking authority, capital market
by improving their internal control function. and other institutional authorities in anticipating and
Graph 4.2
4.3. PROSPECTS OF THE INDONESIAN FINANCIAL Financial Stability Index
SYSTEM 2.5
FSI Projection FSI with real data of Jan-July 2008
FSI Based on June 2008
As discussed previously, pressures on financial system 2
1.79
1.60
stability escalated significantly during the first semester of 1.5
2008. The main source of such pressure is external volatility,

1
such as the ongoing impact of the subprime mortgage
0.5
debacle which precipitates additional uncertainty in the
0
global financial market. Economic conditions were 04 06 08 10 12 02 04 06 08 10 12 02 04 06 08 10 12 02 04 06 08 10 12 02 04 06 08 10 12 02 04 06 08 10 12
2003 2004 2005 2006 2007 2008
59
controlling crises. Meanwhile, pressures are expected to Indonesia. Hitherto, despite the ongoing increasing
intensify as a consequence of rising instability in the global pressures in the domestic equity and bonds markets due
financial sector. As a result, the financial stability index is to global financial market turmoil, foreign investors remain
predicted to increase to 1.79 by the end of December 2008. attracted to BI Certificates (SBI), SUN and domestic
corporate shares. However, it is important to note that
4.4. POTENTIAL VULNERABILITIES funds from foreign investors are generally short term, and
Attention should be given to pressures on the therefore vulnerable to volatility which may spark a sudden
domestic financial sector as the subprime mortgage reversal of investments, thus jeopardizing the Indonesian
debacle continues to adversely impact global financial financial system stability.
markets. Financial sectors in the U.S. and several major In the domestic market, volatility will continue to stem
economies in Europe and Asia were in distress during the from the ongoing trend of increasing food and energy
first semester of 2008. In the U.S. Bear Stearns, a major prices, which will subsequently drive up production costs
financial institution, filed for bankruptcy. This triggered of the corporate sector and weaken consumer purchasing
an immediate reaction from the relevant authority to power. As a result, non-performing loans may increase.
prevent further severe impacts. The backlash of such a Rising interest rates in accordance with corresponding hikes
failure was transmitted to major regional banks, such as in the BI rate may also trigger an increase in NPL.
IndyMac Bank, as well as huge mortgage lenders, more Anticipatory measures for natural disasters such as
specifically Fannie Mae and Freddie Mac. Additional fallout earthquakes and floods have been continued in order to
is expected to disrupt various parts of the world due to prevent low credit quality. Equally as important are the
the closely integrated global economy. Another important pre-emptive actions taken to avoid the possibility of security
impact of the subprime mortgage turmoil is the narrower disturbances due to the 2009 General Election. The
credit market in the U.S. and other associated countries election has the potential to exacerbate credit risk and
as financial institutions become more prudent in heighten Indonesia»s country risk from the perspective of
distributing funds. As a consequence, liquidity in global global investors.
financial markets has become even tighter. Meanwhile, several agendas are to be implemented
Despite a slight decline in the global oil price since in 2009, namely Basel II and international accounting
mid July 2008, it still remains relatively high. standards, which have been included in PSAK (Indonesian
Notwithstanding, decreasing fuel and commodity prices can Financial Accounting Standards) No. 50 and 55.
undermine Indonesia»s Trade Balance, which began to run Furthermore, bank consolidation will continue. The impact
a deficit in Q2. Set against a rising trend of inflation, the of Basel II implementation on bank capital will primarily be
global economy is projected to continue to slow down. Such experienced through the implementation of capital charges
conditions may disrupt the global financial sector, which for operational risk. PSAK No. 50 and 55 are associated
has deteriorated since the subprime mortgage debacle. with the application of marking to market for the assets
Consequently, this could threaten domestic financial stability. and liabilities of financial institutions, including banks. In
As discussed previously, another source of volatility general, it is expected that the implementation of the said
requiring closer attention is the inflow of investments to agenda will strengthen Indonesia»s financial sector.
60
Article I - Market Liquidity Risk as an Indicator of Financial Stability: The Case of Indonesia
Artikel
61
62
Article I
Market Liquidity Risk as an Indicator of

Financial Stability: The Case of Indonesia*
Wimboh Santoso1, Cicilia A. Harun2, Taufik Hidayat3, Hero Wonida4
The emerging financial market is somewhat a safe haven for investment especially during the global financial
crisis caused by the subprime mortgage crisis. However, the use of a liquidity risk measurement shows that the
emerging markets are still affected by the subprime mortgage crisis through the increase of liquidity risk. By
using the liquidity-adjusted value at risk method, we show that the liquidity risk of the Indonesian capital market
increases especially during the second semester of 2007. This suggest the importance of liquidity risk measurements
as financial stability indicators.
1. INTRODUCTION deemed as less important is market liquidity risk. Other

To safeguard the financial stability financial system things being equal, the performance of financial markets
authorities rely on market indicators. If we assume that will always be measured by their composite indices
market always conveys the right information then financial representing the weighted average of the prices of assets
stability can be measured using the information available traded in the markets. However, financial authorities have
in the market. Therefore, financial authorities collect long realized this type of index is no longer enough to
different kinds of financial stability measures in order to detect financial instability. The liquidity risk may be less
make an objective and thorough assessment toward the important than the indicators of transaction volume and
financial market. One indicator that may have been composite index which represents the performance of the
market. Nevertheless, illiquid markets are not favorable
for investors especially during turbulence. This makes the
* The opinions expressed in this paper are of authors only. They do not represent the
policy and stance of Bank Indonesia. The authors would like to thank Advis Budiman for indicator of market liquidity risk an important indicator
the technical support on the methodology.
1 Head of the Financial Sistem Stability Bureau, Bank Indonesia, email: wimboh@bi.go.id
2 Researcher at the Financial Sistem Stability Bureau, Bank Indonesia, email: charun@bi.go.id
for assessing the financial stability. A market has to continue
3 Research Fellow at the Financial System Stability Bureau, Bank Indonesia, email:
taufik1980@gmail.com showing that it is liquid in order to attract investors to
4 Junior Researcher at the Financial System Stability Bureau, Bank Indonesia, email:
hero_w@bi.go.id maintain their fund within the market.
63
Indonesia currently has a traditional equity market. describes the empirical work, including the results. Finally,
The impact of the subprime mortgagemay not be felt chapter six concludes.
directly in the first round; however, it was felt on the second
round. The financial depth of the equity market will 2. MARKET LIQUIDITY RISK AND MARKET
determine how much Indonesia can mitigate further shocks VOLATILITY: LITERATURE REVIEW
from the global markets. Shallow markets are characterized The liquidity risk can be divided into two categories:
with smaller number of investors, less diversified investors liquidity risk in trading and liquidity risk in funding (funding
and fewer choices of financial instruments. Investors have liquidity risk). Funding liquidity risk is considered as a part
more disincentives to stay in shallow markets as they fear of the asset liability management framework, which is
the markets are not able to facilitate risk management as related to the financial institution»s balance sheet and
well as the deeper financial markets. Foreign investors are the possibility that the financial institution (such as a bank)
dominant, thus, suddent reversal of capital flow is always drains out its liquidity to repay the debt (Marrison 2002).
a threat when the market risk increases. Therefore, shallow The liquidity risk in trading is also known as ≈market
financial markets will propagate the crisis worse than the liquidity risk∆. Different from the balance sheet liquidity,
deeper markets because of the liquidity risk. the liquidity risk in trading arises from the characteristics
This paper is aimed to provide an alternative of of the market, such as: atomicity of participants, free entry
financial stability indicator using the measurement of and exit at no cost, transparant information (Bervas 2006).
market liquidity risk. We measure the Indonesian market A liquidity in trading is also called ≈asset liquidity∆, which
liquidity risk and the correlations of the Indonesia market is the asset»s ability to be transformed into another asset
with the other markets, especially related to the events of without loss of value (Warsh 2007).
the subprime mortgage crisis.The empirical excercises show Kyle (1985) asses the degree of liquidity of the
that although the financial market of Indonesia seems market based on these three aspects: 1) tightness; 2)
relatively resilient against the global financial turbulence, depth; and 3) resilience. The tightness is measured with
the financial market risk is indeed increasing. This prompts the bid-ask spread of assets, which is defined as the cost
further consideration that the financial market may not of a reversal of position (from short to long or vice versa)
be deep enough to weather the second round effect. Aside at a short notice. This is also a direct measure of transaction
from focusing on the market liquidity risk, this paper will cost, excluding the operational cost. The market depth is
also discuss about the volatility of the asset returns to measured with the size of transaction required to change
compare the financial depth of the Indonesian financial the price of asset. The market resilience is the speed of
market with the developed financial markets. the prices to return to their equilibrium after a shock in
The rest of the paper is arranged as the following. the market. Figure 1 illustrates the three aspects of the
Chapter two provides literature review, especially in relation market liquidity. The first and second aspects are harder
with the assessment of financial market depth and financial to measure as they require detailed information on every
market risks. Chapter three illustrates the stylized facts of single transaction in the market which may not be
the Indonesian capital markets as the backdrop of the available.
empirical work. Chapter four explains the methodologies This paper will only use the tightness aspect to
used in for the arguments in the paper. Chapter five measure the market liquidity following the approach by
64
Bervas (2006). He incorporates the liquidity measure in both above and below the price at which a security now
the calculation of the value at risk (VaR)5. In the article, trades. They also added ≈immediacy∆ which defined as
Bervas finds that the liquidity risk is accounted for 17% of the speed with which orders can be executed, reflecting
the market risk of a long position on USD/Thai Baht and the efficiency of trading, clearing and settlement system6.
for only 1.5% for positions on USD/Yen since the market The measurements to reflect these characteristics may be
for the latter position is more liquid. The methodology for overlapping. Again, this paper will focus on the tightness
liquidity-adjusted VaR used for this paper will be explained of the market.
in depth in Chapter 3. The market liquidity risk is an important part in
measuring risk, since when incorporated it can add
Figure A1.1
significantly to the loss value of asset on the tail incidents.
Aspects of Market Liquidity
When the market is still shallow and has problems of
Price
asymmetric information, market liquidity becomes very
Depth important. Traders with different decisions over the
Resilience
Ask price Ap
Breadth underlying value of the asset will execute trade, and keep
Depth trading until more information is revealed.7 The shallow
Resilience
Bp Bid price
market facilitates speculative transactions increasing the
volatility of the asset prices. This is why shallow market is
Quantities Quantities
A 0 A»
characterized with a more volatile price/return.
Sale Purchase
Source: Bervas (2006)
3. THE INDONESIAN CAPITAL MARKET: STYLIZED

Another approach to define liquidity risk is by starting FACTS
from the market participant»s point of view. Investors expect Indonesian stock market was initially established by
a financial asset to be liquid that is easily sold in large the Dutch government in Jakarta by the end of 1912. It is
amount without losing the value when it was purchased. followed by the establishment of the stock market in
A liquid financial asset is characterized by having small Semarang and Surabaya in 1925. The stock market had
transaction cost; easy trading and timely settlement; and developed well until finally closed due to the World War
large trades having only limited impact on the market price. II. As Indonesia got its independency, the stock market
Sarr and Lybek (2002) combine this starting point with was re-activated, marked by the issuance of Indonesia
the market characteristics during periods of stress and Government bond in 1950. However, the development of
significantly changing fundamentals and come up with the stock market was sluggish since then. That situation
two additional characteristics along with the three aspects lasted up to the 1970s. Government then initiated the
mentioned by Kyle (1985). They use the previous definition effort to revitalize the stock market by establishing
of ≈depth∆ for the characteristic ≈breadth∆, while they BAPEPAM on 10 August 1977, which turned to be Badan
define ≈depth∆ as the existence of abundant orders, either Pengawas Pasar ModalΩ (Capital Market Supervisory
actual or easily uncovered of potential buyers and sellers,
6 Sarr and Lybec (2002) order the characteristics as the following: 1) tightness; 2) immediacy;
3) depth; 4) breadth, and 5) resiliency.
5 See Bangia,et.al.(1999), Hisata and Yamae (2000), and Bervas (2006) for detailed 7 He and Wang (1995) develop a model of stock trading with differential information
discussion. concerning the underlying value of the stock that illustrates this type of trading.
65
Agency) in 1991. To integrate the function, this agency Market capitalization during the period of 2000 to
currently has changed name into BapepamLK (Supervisory 2002 decreased following the unstable macroeconomic
Agency for Capital Market and Financial Institutions), which condition. However, the year 2003 saw improving
includes the supervisory function over the non-bank condition and as a result, total value of market
financial institutions. Bank Indonesia (the central bank) capitalization grew to Rp1,802.06 trillion level as of March
maintains the supervisory function over banks. 2008. In 2007, ratio of the market capitalization to gross
The development of the Indonesian capital market, domestic product stood at 50.24%, which is the new
especially fund pooling activities through capital market, record.
is very much influenced by the macroeconomic condition.
Figure A1.3
This can be seen with relatively slow growth within the Market Capitalization Ratio to GDP (1995 √ 2007)
period of 1997 to 1998 when financial crisis hit the country. %
60
The number of issuers during that period only grew by
50
1% and value of issues increased by 7.1%. The bond 40
market was even worse. There was virtually no new issue 30
during this period. 20
10
0
Equity Market
-10
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Following stagnancy during the financial crisis in
Source: Indonesian Stock Exchange, Central Bureau of Statistics
1997, the stock market was breathing fresh air again in

1999 when corporations conducted restructuring process Despite the slow growth with regard to the share
using capital market. Values of issuance increased by issuance, share trading activities in the Indonesia Stock
172.2% or increasing from Rp 75.9 trillion in 1998 to Rp Exchange (BEI) were relatively active. Average value of daily
206.7 trillion in 1999. In the following period, from 2000
Table A1.1
to 2007 the value of issuance only grows at an annual Average Trades √ Indonesian Stock Exchange
rate of 6% whereas the number of issuers grows at an

Indicator Index Average Daily Average Daily Average Daily
annual rate of 4.8%. Trade Value Trade Volume Trade
Frequency
(stock billions) (stock billions) (thousands)
Figure A1.2
Number of Issuers, Market Capitalization, Trading Value, 1995 513.847 131.50 43.28 2.48
and Issuance Value 1996 637.432 304.10 118.58 7.06
1997 401.712 489.40 311.38 12.08
IDR Trillion
2000 700 1998 398.038 403.60 366.88 14.19
1800
Market Capitalization Issuance Value 1999 676.919 598.70 722.58 18.42
Share Trading Value Number of Issuers 600
1600 2000 416.321 513.70 562.89 19.22
1400 500 2001 392.036 396.40 603.18 14.72
1200 2002 424.945 492.90 698.80 12.62
400
1000 2003 691.895 518.30 967.07 12.20
800 300
2004 1000.233 1024.90 1708.58 15.45
600 200
2005 1162.635 1670.80 1653.78 16.51
400
100 2006 1805.523 1841.80 1805.52 19.85
200
0 0 2007 2745.826 4268.92 4225.78 48.21
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Maret 2008 2447.299 5180.22 3049.25 56.56
Source : BapepamLK Source: Bappepam LK
66
transaction from the period of 1999 to March 2008 was Figure A1.4
Number of Issuers, Outstanding Bond Value,
around Rp 1,650.66 billion with shares volume of 1.6 billion Corporate Bond Issuance Value 1995 - 2007
and frequency of around 23.38 thousand transactions per IDR Trillion
200
day. 140 Outstanding Bond Value Billion Rp 180
Issuance Value (cumulative) Billion IDR
120 160
Number of Issuers
140
100
Bond Market 80
120
100
Bond market suffered a great burden during the 60 80
40 60
financial crisis in 1997-1998. There was no new issue of 40
20
20
bonds in 1998. Meanwhile, the outstanding issuers faced
0 0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
difficulties in paying interest rates and even repaying the
principles when the bonds reached maturity. However, Figure 5 illustrates the comparison of the movements
bond market rebounded in 1999 and achieved its top of stock market indices (first row) and returns (second row)
growth in 2003. During that year, the issuance value in the U.S. and Indonesia. The returns are represented in
increased by 68.82% of the previous year and the number the same scale. The figure roughly shows that the
of issuers increased by 36% compared to that of a year Indonesian stock market returns are more volatile than
before. The escalation kept continuing until 2007 so much those in the U.S. We see that the volatility in Indonesia is
so that the cumulative number of issuers reached 175 roughly 3 to 4 times the U.S. volatility. Figure 6 shows the
companies and the total bond issuance value achieved Rp daily volatility measured from the standard deviation
133.91 trillion. The significant progress showed an calculated by taking the square root of the forecasted
increasing role of bond market as an alternative of variance using GARCH(1,1).
financing for corporate sector. Indonesia applies free capital mobility. Therefore,
The optimistic growth of corporate bonds has been capital flows freely in and out of the financial markets.
well balanced with the development of Government Debt However, the country risk premium and the depth of the
Securities (Surat Utang Negara or SUN). Starting from financial market will determine how fluid the financial
September 25, 1998, the Indonesian Government has transactions flow in and out of the domestic markets.
issued some SUNs for Bank Indonesia, i.e. SUNs which Hence, we want to take into account the liquidity risk to
were intended to finance the blanket guarantee program illustrate the depth of the financial market. We use the
with respect to Bank Indonesia Liquidity Support ( Bantuan liquidity-adjusted VaR (Value at Risk) methodology
Likuiditas Bank Indonesia or BLBI) to prevent the collapse developed by Bangia et al (1999). The measurement of
of the banking system during the financial crisis in 1997- the liquidity-adjusted VaR should be able to show how
1998. These two securities cannot be traded. On May 28, the Indonesian stock market responds to the recent global
1999, the Indonesian Government started to use the capital crisis given the liquidity condition. First, if the volatility (or
market to pool public fund by issuing SUN to finance risk) in the local market is more pronounced than in the
banking restructuring program. These securities are U.S. market, the local market shows the indication of the
tradable (government bonds). Up to March 2008, the shallow stock market. Second, a shallow financial market
outstanding position of government bonds which can be may not be affected (the first round effect) directly by the
traded has reached Rp 498.40 trillion. declining value of a security product for reason of lack of
67
Figure A1.5
Stock Market Index and Returns
Dow Jones (DJIA) Index D J I A return

15000 .08
14000
.04
13000
.00
12000
-.04
11000
10000 -.08
9000 -.12
2004 2005 2006 2007 2004 2005 2006 2007
S&P 500 (SPX) Index SPX return

1600 .08
1500
.04
1400
.00
1300
-.04
1200
1100 -.08
1000 -.12
2004 2005 2006 2007 2004 2005 2006 2007
Jakarta Composite Index (JCI) JCI return

3200 .08
2800
.04
2400
2000 .00
1600 -.04
1200
-.08
800
400 -.12
2004 2005 2006 2007 2004 2005 2006 2007
Source: Bloomberg
Figure A1.6
Daily Volatility of Dow Jones, Standard & Poor»s and
Jakarta Composite Index using GARCH(1,1)
Dow Jones (DJIA) S & P 500 (SPX)

.06 .06
.05 .05
.04 .04
.03 .03
.02 .02
.01 .01
2004 2005 2006 2007 2004 2005 2006 2007

Source: Bloomberg
68
Figure A1.6 We can solve this equation, so that we have Rt process as

Daily Volatility of Dow Jones, Standard & Poor»s and
Jakarta Composite Index using GARCH(1,1) Rt = µ t + Φ −1 (1 − α )σ t
(cont.)
Therefore, the lowest return expected at date t with the
Jakarta Composite Index (JCI)
confidence threshold of α = 99% is
.06
Pt * = Pt exp (µt − 2.33 * σ t )
.05
The value at risk (VaR) at time t is the highest potential
.04
loss at confidence threshold α = 99%, or
.03
.02
[
PVaR = Pt − Pt * = Pt 1− e (µt − 2.33*σ t ) ]
Without loss of generality, we assume that the expected
.01
value of daily returns µt is zero, and variance is not constant
2004 2005 2006 2007
but changing overtime. The standard parametric VaR is
Source: Bloomberg
[
PVaR = Pt − Pt* = Pt 1− e (−2.33*σ t ) ]
product linkages with the underlying assets. However, a In order to capture the dynamic volatility over time we use
shallow financial market is sensitive toward a liquidity a different model. We can use exponentially weighted
shock, thus it propagates the crisis in response to the global moving average or another method using Generalized
illiquidity problem (the second round effect). We want to Autoregressive Conditional Heteroskedasticiy. If assets
illustrate that the shock may affect the financial markets returns deviate significantly from its normality, the standard
in the emerging economies in worse way than we think. normal distribution assumption will lead to an
underestimation of risk. So we need to apply a particular
4. METHODOLOGY: VALUE AT RISK AND QUAN- adjustment to maintain the standard normal distribution
TIFYING LIQUIDITY ASPECT assumption. The potential loss with the adjustment can
We use the Liquidity-Adjusted (L-VaR) methodology be written as
developed by Bangia,et.al.(1999). The measurement of the [
PVaR = Pt 1− e (µt − 2.33*θ *σ t )]
liquidity-adjusted VaR should be able to show how the This is an explicit relationship between kurtosis K and
stock and bond markets responds to the recent global crisis the correction factor is well captured by the relationship:
given the liquidity condition. We define the value of Rt as θ = 1 + φ ln(K/3), where φ is a constant whose value
the log-difference of mid-price of stock at time t while Pt depends on the tail of the probability. The value of φ is
is the asset price at time t. Therefore we can write the log estimated by regressing the potential loss of the historical
difference of mid-price as VaR. It is clearly that if the distribution of the return is
Pt * normal, we will have K = 3 and θ = 1.

Rt = ln
Pt Next, we define the exogenous cost of liquidity (CoL) based
We assume the daily return process as a Gaussian process on the average relative spread. The relative spread is
Rt ~ N (µt , σt2), where µt and σt2 are the first two moments defined as Relative spread
of the distribution of the asset return. This process can be ask - bid
Relative spread =
written as mid
 R − µt  r − µt We define Pt as the mid-price, S as the average of relative

Pr  t ≤ b  = 1 − α → t ≤ b = Φ −1 (1 − α )
 σt  σt ~
spread, σ as the volatility of relative spread, and α as the
69
scaling factor. Because of the spread distributions are far maturity).8 They are all tradable SUNs with fixed interest
away from normality assumption we can not relay on rate. We consider the data for these SUNs as the best series
Gaussian distribution theory for guidance on the value of of SUNs that we can find to represent the market liquidity
the scaling factor. But if the spread is normal, the scaling for government bonds.9
factor for 99% coverage probability is 2.33.
In order to combine the risk from liquidity and Equity Market
market, we make a reasonable assumption that extreme First, let us now focus on the second semester of
events of the returns happen simultaneously with the 2007 during which the subprime mortgage crisis did most
extreme events of the spread. Therefore, the worst case damage. By the end of 2007, DJIA and S&P 500 are
of price can be calculated by declining 2.95% and 4.42% respectively since June 1,
1 2007 while JCI is increasing 31,74%. The values at risk in

P' = Pt e (µt − 2.33*σ t ) −
2
[Pt (S + aσ~ ) ] the U.S. and Indonesia are increasing by 79.66% (DJIA),
The second part of the right hand equation is used to call 81.16% (S&P 500) and 23.78% (JCI). When we consider
exogenous cost of liquidity (CoL). Finally, we can write the the liquidity risk, the liquidity-adjusted VaR (L-VaR) of JCI
equation to calculate the Liquidity Adjusted Value at Risk is increasing 27.51%.10 There is additional 3.73% increase
for this event by: of VaR when we take into account the liquidity risk. The
striking difference in the development of the indices in
L − VaR = Pt − P' = Pt 1 − e [ (µ t − 2.33*σ t )
] [
1
]
+ Pt (S + aσ~ )
2 the U.S. and Indonesia is an evidence of the lack of co-
movement between the U.S. stock markets and the
5. EMPIRICAL WORK AND RESULTS Indonesian stock market during the subprime mortgage
5.1. Using the Value at Risk crisis. However, this is not necessarily reflecting the lack of
We illustrate the financial market depth in Indonesia contagion effect.
by measuring the risk using the simple method of Value at Let us now refer to the first semester of 2007. During
Risk (VaR). In addition, we also want to incorporate the the semester, all DJIA, S&P 500 and JCI were increasing
liquidity risk in the return measurement. The idea is that 9.67%, 8.32%, and 15.44% respectively. The VaR for
we want to show the liquidity condition of the Indonesian those markets are increasing 17.33%, 25.95% and
financial market compared to the advanced financial 44.96% respectively. The L-VaR for JCI is increasing
markets. Shallow financial markets are indicated by the 45.19%, or there is only 0.23% additional increase of risk
illiquidity of the market and the fragility toward external to the non-adjusted VaR. Recall that the additional increase
shocks. We use the Indonesian Stock Market Index to from the liquidity risk in the second semester of 2007 is
measure the VaR and apply the bid-ask spread for the 3.73%. The increase of the liquidity risk in the second
liquidity-adjusted VaR of the most globally exposed semester of 2007 in the Indonesian stock market occurs
financial market: the equity/stock market. In addition, to coincidentally with the subprime mortgage crisis. This
illustrate the bond market, we use the data on the supports the argument that the subprime mortgage crisis
government bond. We chose FR0002 (1 year to maturity),
8 All years to maturity are as of June 2008
FR0010 (2 years to maturity), FR0017 (4 years to maturity), 9 The Indonesian corporate bonds data are mostly not feasible for the calculation of VaR.
10 We calculate the liquidity-adjusted VaR for Indonesian stock market using a basket of
FR0019 (5 years to maturity) and FR0026 (6 year to stocks that are highly liquid (most traded).
70
Figure A1.10
impact to the Indonesian stock market is channeled
Liquidity-Adjusted Value at Risk of
through liquidity risk. Indonesian Stock Market Index
Figure 7 to 9 illustrate the increase of the parametric Jakarta Composite Index (JCI)
3000
value at risk during the subprime mortgage crisis in all 400
the 99% worst value (right scale)
JCI Index (right scale) 2500
Liquidity-adjusted VaR (left scale)
markets, with the U.S. markets showing steeper upward
300 2000
trend. This shows that even when the Indonesian market
1500
200
is not highly exposed to the subprime mortgage products,
1000
the turmoil in the U.S. market is still transmitted to 100
500
Indonesia. Figure 10 shows the liquidity-adjusted value at 0
2004M07 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
Figure A1.7
Value at Risk of Dow Jones Industrial Index risk measurement of the Indonesian market. The L-VaR in
Dow Jones Industrial (DJIA) Index Indonesia is always higher than the VaR.
15000
Dow Jones Index (right scale) 14000
Parametric VaR (left scale)
13000
Bond Market
500 12000
11000 We use the time series data of the mid-annual yield
400
10000
of the abovementioned SUNs to replace the mid-price in
300 9000
the VaR method. The data covers the daily yield during
200
100
the period of January 4, 2005 to June 9, 2008. SUN trades
2004M072005M012005M072006M012006M072007M012007M072008M01
very actively in the Indonesian capital market during the
Figure A1.8 period in review. This is partly caused by the issuance of
Value at Risk of S&P 500
S & P 500 (SPX) Index
SUNs (with different series, reflecting different tenors) by
1600
the 99% worst value (right scale) the government comes frequently. In 2005, 2006, and
S&P 500 Index (right scale) 1500
Parametric VaR (left scale) 1400 2007, the government issues and reopens series of SUNs
60 1300
for 13, 18 and 29 times. While in 2008, up to April, the
50 1200
40
1100 government already issues and reopens 15 times. Another
1000
30 reason is also due to the high demand for a risk-free
20
investment instruments as well as the excess liquidity
10
2004M07 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 problem in the banking system. Figure 11 illustrates the
Figure A1.9 volatility of the annual yields.

Value at Risk of Indonesian Stock Market Index
In the second semester of 2005, all annual yields are
Jakarta Composite Index (JCI)
3000 highly volatile. This is caused by oil price shocks. The effect
2500
JCI Index (right scale) is pronounced mainly because of the bonds are all at fixed
300 Parametric VaR (left scale)
2000
rates while facing the expectation of interest rates increase.
1500
200
Another interesting part is when we focus on FR0002 (the
1000
100
first chart on Figure 11). We notice an increase of volatility
500
in the first semester of 2008. The short tenor of FR0002 is

0
2004M07 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 attractive enough to increase the volume of transactions
71
Figure A1.11
Volatility of Indonesian Government Bond Annual Yields
3 4
3
2
2
1
1
0 0
-1
-1
-2
-2 RET_FR0002 -3 RET_FR0010
RET_FR0002+/-STDEV_FR0002*2.33 RET_FR0010+/-STDEV_FR0010*2.33
-3 -4
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
-3 RET_FR0017 -3 RET_FR0019
RET_FR0017+/-STDEV_FR0017*2.33 RET_FR0019+/-STDEV_FR0019*2.33
-4 -4
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
-2
-4 RET_FR0026
RET_FR0026+/-STDEV_FR0026*2.33
-6
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
Source: Bloomberg
causing annual yields to move. This is an evidence of the Table A1.2

Changes in VAR and L-VaR of Annual Yields
shallow bond market.
In terms of the VaR and L-VaR measurements, we find SUN series FR0002 FR0010 FR0017 FR0019 FR0026
Tenor 1 year 2 years 4 years 5 years 6 years
that most of the time the L-Var of SUNs moves closely with (June 2008)
the VaR. During 2005 √ 2006, the L-VaRs for all five series of Semester I / 2007
SUNs mostly score below the VaR, or negative cost of liquidity. ∆ VaR -45.81% 73.84% -59.37% 65.60% 48.07%
∆ L-VaR -45.18% 77.84% -59.28% 65.79% 48.63%
Especially for FR0002, FR0010, and FR0017 (with shorter
Semester II / 2007
tenors), the cost of liquidity becomes mostly positive beginning
∆ VaR 12.19% 193.52% 59.23% -21.92% -13.75%
the second semester of 2007, right around the outbreak of ∆ L-VaR 11.78% 192.24% 59.30% -21.73% -13.62%
the subprime mortgage crisis. The following table 2 illustrate
Semester I / 2008
the changes of VaRs and L-VaRs for all the SUNs observed. In ∆ VaR 349.48% -22.22% 53.05% 119.58% 101.65%
this case, we focus only on the years 2007 √ 2008. ∆ L-VaR 346.45% -22.88% 52.50% 118.63% 101.41%
72
With the exception of FR0010, the VaRs and L-VaRs increase of uncertainties. Figure 12 and 13 illustrate the
for FR0002 and FR0017 are decreasing in semester I/2007 VaR and L-VaR of all annual yields of the five SUNs
and increasing during semester II/2007, while they are the observed.
opposite for FR0019 and FR0026. For semester I/2008 all Although the SUNs are traded liquidly, the subprime
SUNs (except FR0010) experience increasing VaRs and L- mortgage still affects the bond market through the liquidity
VaRs Notice that during semester II/2007 √ coincidently risk, especially for the longer tenor. The analysis for the
with the subprime mortgage crisis √ the increase of VaR Indonesian government bond market has to be done more
slightly exceeds the increase of L-VaR for the shorter tenor careful. Additional observations related with the volume
of SUNs (FR0002, FR0010, and FR0017), while it is the of transactions («depth») and more event analysis with
opposite for the longer tenor (FR0019 and FR0026). This regard to the volume of issuance is required. For example,
shows how the trades for the SUNs are more concentrated the pattern for FR0010 does not seem to fit the hypothesis,
in the shorter tenor than the longer ones because of the suggesting more analysis on using different set of data.
Figure A1.12
Value at Risk of SUN Annual Yields
16 20
16
12
12
8 8
16 4 4
16 0
12 FR0002_BID 0 FR0010_BID
PVAR_FR0002 12 PVAR_FR0010
8 PW99_FR0002 PW99_FR0010
8
4 4
0 0
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
20 20
16 16
12 12
8 8
4 4
16 16 0
FR0017_BID 0 FR0019_BID
12 PVAR_FR0017 PVAR_FR0019
12
PW99_FR0017 PW99_FR0019
8 8
4 4
0 0
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
20
16
12
8
4
16 FR0026_BID 0
PVAR_FR0026
12
PW99_FR0026
8
0
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
Notes: FRxxxx_Bid: Annual Yields untuk SUN FRxxxx
PVAR_FRxxxx: (non-adjusted) Value at Risk
PW99_FRxxxx: 99% worst value.
73
Figure A1.13
Liquidity-adjusted Value at Risk of SUN Annual Yields
16 20
16
12
12
8 8
16 4 4
16 0
FR0002_BID FR0010_BID
12 0
LVAR_FR0002 12 LVAR_FR0010
8 P_FR0002_SP P_FR0010_SP
8
4 4
0 0
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
20 20
16 16
12 12
8 8
4 4
16 16
FR0017_BID 0 FR0019_BID 0
12 LVAR_FR0017 12 LVAR_FR0019
P_FR0017_SP P_FR0019_SP
8 8
4 4
0 0
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01 2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
20
16
12
8
4
16 0
FR0026_BID
12 LVAR_FR0026
P_FR0026_SP
8
0
2005M01 2005M07 2006M01 2006M07 2007M01 2007M07 2008M01
Notes: FRxxxx_Bid: Annual Yields untuk SUN FRxxxx
LVAR_FRxxxx: Liquidity-adjusted Value at Risk
PW99_FRxxxx: 99% worst value
5.2. Using the MGARCH markets share common market players as well as the
For this method, to limit the sample, we use the geographical closeness of both markets. The U.S. and
indices from the U.S. (DJIA), Japan, and Singapore to Japan indices started to decline in the first quarter of 2007.
accompany the Indonesian index. The data used in this Even when Japan had the chance to rebound in the second
analysis consist of the daily indices of Dow Jones Industrial quarter it never reached the highest point in the first
(DJIA, USA), Nikkei (NKY, Japan), Strait Time Index (FSSTI, quarter. Singapore»s and Indonesia»s indices also declined
Singapore), and Jakarta Composite Index (JCI, Indonesia). in the first quarter of 2007. However, the two markets
We use the time horizon between September 2, 1999 and rebounded in the second quarter. Although they
April 2, 2008 provided by Bloomberg. Especially after 2003, experienced an episode of decline in August 2007, they
the Indonesian index»s movement resembles Singapore»s. reached new high in October 2007 before they finally
This may be caused by the fact that Singapore and Jakarta trended downward. This illustration is another evidence
74
of the lack of contagion effect in the first round, as well as July 30 to September 18 represents the period where we
an evidence of propagation effect in the second round of observed a bank run on the UK»s Northern Rock Bank
the subprime mortgage. precipitated by liquidity problems related to the subprime
crisis; 3) January 22 to January 28 represents the global
Figure A1.14
Stock Market Index: US, Japan, Singapore, Indonesia plunge of the stock markets around the world. Figure 15
25000 4500
provides the snapshot of the shaded areas for better
US DJIA (left) Singapore (right)
Japan (left) Indonesia (right)
4000 observation.
20000 3500
3000
15000 Figure A1.15
2500
Stock Market Index Correlation
2000
10000
1500 .7
DJIA_FSSTI FSSTI_JCI
5000 1000 .6 DJIA_JCI NKY_FSSTI
DJIA_NKY NKY_JCI
500 .5
0 0
Sep Jan MeiSep Jan MeiSep Jan MeiSep Jan MeiSep Jan Mei Sep Jan Mei Sep Jan Mei Sep Jan Mei Sep Jan .4
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
.3
.2
We examine the correlations among equity market
.1
indices based on the dynamic conditional correlation .0
-.1
multivariate generalized autoregressive heteroskedasticity 2000 2001 2002 2003 2004 2005 2006 2007
(DCC-MGARCH)11. The method produces the correlation

Figure A1.16
measurements of the observed indices. Figure 13 shows Stock Market Correlation (2007 √ 2008)
the stock market index daily correlations. The numbers .7
.6
are generally positive, except between DJIA and JCI in
.5
mid 2000, early 2003, and mid 2005. The negative .4
DJIA_NKY NKY_FSSTI
.3 DJIA_FSSTI NKY_JCI
correlation also found between DJIA and NKY at the first DJIA_JCI FSSTI_JCI
.2
quarter of 2000. We notice the distinction in the
.1
magnitudes of the correlations generated as the .0
-.1
following. The correlation between the US stock market 01 02 03 04 05 06 07 08 09 10 11 12 01 02 03
2007 2008
represented by DJIA and the Asian stock markets are
always low (mostly below 0.2), while the correlations In the first event, the correlation between DJIA and
among the Asian stock markets are mostly- higher than the Asian stock market is increased significantly about a
0.2 particularly after 2001. month after the outbreak of the crisis. It followed by the
The shaded areas in Figure 14 mark the significant slowly but steady increase of correlations among the Asian
events in the subprime mortgage crisis: 1) February 1 to stock markets. In the second event, the Asian markets are
March 30 represents all the events related to the collapse more sensitive to the movement in the U.S. market when
of the subprime industry. More than twenty-five subprime the shocks came from the Northern Rock run. The
lenders declared bankruptcy, announced significant correlations increased even before the Northern Rock crisis
losses, or put themselves up for sale; 2) Shading Area: reached the peak. Even so, the correlations are slowly
declining as the crisis exacerbated. In the third event, the
11 This method was proposed by Engle (2002). Further discussion can be also obtained
from Engle and Sheppard (2001). correlations between the U.S. market and the Asian
75
markets did not change significantly. There were spikes in 6. CONCLUSION

the correlations of DJIA-Nikkei and DJIA-FSSTI in the middle Looking at the liquidity aspect of the financial markets
of the period of the event; however the numbers came proves that the emerging financial markets are still prone
down to the numbers before the spike. The correlation of to contagion effect. The event analysis on the recent
DJIA-JCI is a different story. The correlation increases as subprime mortgage crisis provides the evidence on how
the event resumed and stayed at a higher level than before financial turbulence in the developed market propagates
the event. However the increase is rather negligible. This to the emerging markets even when the returns of the
shows that the effects of the events in the subprime financial markets in emerging countries are still attractive.
mortgage affected the Asian markets more as a temporary Since the emerging financial markets are still tight,
negative sentiment toward the respective markets. The uncertainties increases the liquidity risk for both equity
more developed the markets (as in Singapore and Japan), and bond markets.
the least the negative effect is felt in the markets. The less-developed markets are characterized with
Indonesian market is the least developed compared to liquidity risk. This suggests the measurements for the
Singapore and Japan. The external shock propagates market liquidity risk will be useful indicators to measure
negative sentiment in the Indonesian market longer than the financial stability of the emerging financial markets.
in Singapore and Japan. This is the caveat of the shallow The existence of the other characteristics of market liquidity
financial markets. The market liquidity risk exacerbates the opens a lot of opportunities to develop other
external shock and propagates the crisis into the domestic measurements for liquidity risk. We aim and encourage
market. others to explore the other measurements.
76
Reference
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Implications for Traditional Market Risk Measurement Practical Application of Liquidity Risk Evaluation
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Incorporation into Risk Management∆, Financial Trading, Econometrica, Vol.53, No.6, pp. 1315-1335,
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A Simple Class of Multivariate GARCH Models∆, Measurement∆, McGraw-Hill.
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No. 3, July 2002. Liquidity in Financial Markets∆, IMF Working Paper
Engle, Robert and Sheppard, Kevin (2001), ≈Theoretical WP/02/232, International Monetary Fund.
and Empirical Properties of Dynamic Conditional Warsh, Kevin (2007), ≈Market Liquidity: Definitions and
Correlation Multivariate GARCH∆, University of Implications∆, Federal Reserve»s Governor Speech at
California at San Diego, Economics Working Paper the Institute of International Bankers Annual
Series, No. 2001-15, September 2001. Washington Conference, Washington, D.C., March
He, Hua and Jiang Wang (1995), ≈Differential Information 5, 2007.
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1995, pp. 919-972. timeline
77
78
Article II - Operational Risk in Indonesia: Advance Measurement Approach
Article II
Operational Risk in Indonesia:

Advance Measurement Approach
Wimboh Santoso1, Bambang Hermanto2
The research objective is to measure operational risk with a primary focus on exploring risk measurement in
accordance with the business line characteristics of the Indonesian banking structure and development of a
prototype bank loss distribution model. The data used includes survey data for operational risk loss of nine banks
in Indonesia, including various types of operational risk loss, time of incident, cause of loss, loss frequency and
value or amount of loss. Research results indicated that the largest operational losses occurred due to payment
and settlement event types, as well as the business lines of clients, products and business practices. The most
frequent incidents occurred in the retail banking business line and execution, delivery and process management
event types.
1.INTRODUCTION Accord stipulates that banks are required to maintain

1.1. Background sufficient capital subsequent to calculating their credit risk
The banking industry is highly associated with risks. exposure.
All banking activities, both on the assets and liabilities side, The Basel Committee (2001a) promulgated a new
contain various inherent risks, such as market risk, standard in the banking community, announced as Basel
operational risk, credit risk, liquidity risk and other risks. II, which provides three approaches to measure the capital
Operational risk is defined as the risk of incurring adequacy ratio for operational risk in increasing complexity
loss due to insufficient or failed internal processes, and risk sensitivity, namely: 1) the Basic Indicator Approach
personnel and systems, or from externalities including legal (BIA), 2) the Standardized Approach (SA), and 3) the
risk, yet excluding strategic and reputation risks. The Basel Advanced Measurement Approach (AMA).
Currently, banks in Indonesia are occupied with the
1 Head of Financial System Stability Bureau, Directorate of Banking Research & Regulation,
Bank Indonesia; e-mail address: wimboh@bi.go.id preparation of BIA implementation to calculate capital for
2 Lecturer at Faculty of Economics, University of Indonesia; e-mail address:
bherman@fe.ui.ac.id operational risk. In 2010 banks, particularly major ones,
79
are expected to commence the implementation of more Service, Asset Management, Retail Brokerage; and seven
sensitive approaches to risk, namely the Standardized loss events: internal deviation, external deviation, human
Approach and the Advanced Measurement Approach. To resources and workplace safety, consumer practices,
this end, several major banks have developed a database products, and business, physical asset damage, business
of internal loss over the last 2-3 years. disruption and system failure, and execution, delivery and
Therefore, early analysis is required to model the process management.
distribution of bank losses and loss events for specified Before commencing with the implementation of
future periods. The current constraint of limited operational AMA, banks are required to develop a database of internal
loss data availability will lead to inaccurate model behaviour loss data for a period of three consecutive years. After
or variance in the probability distribution function when building an appropriate internal loss database, calculating
loss data with a longer time horizon is applied. capital charge using the AMA approach should be
implemented in the following order:
1.2. Research Objective 1. Estimate loss frequency distribution.
The research is aimed at estimating and measuring 2. Estimate loss impact distribution.
operational risk with a primary focus on: 3. Estimate aggregate loss distribution. This is achieved
1. Exploring risk measurement in accordance with the by combining the above distributions into one
business line characteristics of the Indonesian banking distribution, in general, by applying the Monte Carlo
structure. simulation.
2. Developing a prototype model of bank loss 4. Determine Value-at-Risk for each combination of
distribution. business lines and events. This is repeated until an
average value is reached that represents the Value-
2. LITERATURE REVIEW at-Risk with 99.9% confidence as required by the
2.1. Advanced Measurement Approach accord- Basel Committee for calculations of expected loss (EL)
ing to the Basel Accord and unexpected loss (UL).
Under this approach banks are allowed to develop
VaR(i , j ) = EL(i , j ) + UL(i , j )
their own empirical model to quantify required capital for
operational risk. Banks can use this approach subject to The total capital charge allocated using this approach is
approval from their local regulators. This approach is based equal to the total summation of VaR of each business line
on the risk profile of each bank. From the three approaches, and event combination.
AMA is the most flexible and sensitive approach to risks; The aggregate loss distribution for AMA under Basel
therefore, this method is suitable to measure operational II is illustrated in Figure A2.1.
risks of varying complexities.
Notwithstanding, this approach necessitates the
support of reliable data. The Basel Committee suggested
classifying operational loss data based on eight business
lines: Corporate Finance, Trading and Sales, Retail Banking,
Commercial Banking, Payment and Settlement, Agency
80
Figure A2.1 Distribution (GPD). This research applies the GPD approach
Loss Distribution Approach (LDA) for AMA Operational
Risk based on the Basel Capital Accord to estimate the operational risk capital charge.
Probability
Fungsi kepadatan probabilitas (p.d.f) 2.3.1 Generalized Pareto Distribution

Capital Risk Capital for According to Moscadelli (2004), Generalized Pareto
Deduction Operational Risk Exposure
(until 20%)
Distribution (GPD) is associated with data exceeding a
certain set value (threshold). The cumulative distribution
VaRα=5% function can be stated as ≈full GPD∆ when:
pada kuantil 95%
Rerata distribusi
1
 −
1 − 1 + ξ x − µ  ,
ξ
jika ξ ≠0
Extreme
 σ 
GPDξ , µ ,σ ( x) =  
Expected Loss (EL) Unexpected Loss (UL) Loss
Kerugian Aggregat (Loss Severity)   x−µ 
Source: Jobst (2007) 1 − exp  − σ  , jika ξ =0
  
2.2. Operational Risk Modelling The interpretation of ξ in GPD is the same as in GEV, as all
The concept of operational risk distribution consists relevant information on the fat tail of origin distribution
of two categories, namely frequency distribution indicating are contained in this parameter. The function of density
the prevalence of operational loss incidents during a certain probability, namely excess GPD, is:
period of time, without considering the nominal value of
1
 −
loss. Second is the severity distribution, which indicates 1 − 1 + ξ y  ,
ξ
bila ξ ≠0
  β

the value of operational loss during a certain period of GPDξ , β ( y ) =  
  y
time. 1 − exp  −  , bila ξ =0
  β
Operational risk has unique characteristics, namely
LFHS (low-frequency-high-severity). This underlines the Where y = x - u = excess, ξ = index, β = scale and
infrequent loss yet significant value, therefore, operational supporting conditions namely: y ∈ [0, xF - u] if ξ > 0 and y
risk can lead to major problems when it transpires. From ∈ [0, β/ξ] if ξ < 0,l. Besides functioning as the threshold
the aspect of data distribution, this can be identified by value, u is also the location parameter in this distribution.
heavy-tailed distribution. Tail distribution is part of the Whereas β is the scale parameter and shape index ξ.
distribution that indicates the major value of a random
variable. This is due to the fact that more than 90% of 2.3.2 Calculation of Tail-Severity for Business
capital charge stems from a major loss/event of relatively Unit with POT-GPD
low frequency. Peaks Over Threshold (POT) is an approach taken to
check the compatibility of model to excess GPD on loss
2.3. Extreme Value Theory value variance with threshold u. It is dependent on three
Operational loss can be estimated by learning the elements, namely:
extreme loss of a bank. Extreme loss is defined as a loss The threshold value of u determined by an analyst.
that exceeds a specified threshold. When modelling Excess data = original data √ threshold value of u;
extreme loss, two models are commonly employed, namely exceedances data = excess data + threshold value of
Generalized Extreme Value (GEV) and Generalized Pareto u. GPD exceedances has the following distribution:
81
β +ξ ⋅u
 −
1
GPDES (u ) = L=u
1 − 1 + ξ x − u  , 1−ξ
ξ
jika ξ ≠0
  β 

OpVaRα β − ξ ⋅ u
GPDξ ,u , β ( x) =   GPDES (OpVaRα ) = + L = OpVaRα > u
  x −u  1−ξ 1−ξ
1 − exp  − , jika ξ =0
  β 
However, subsequent problems arise if the value of ξ
Appraisal of ξ and β parameters from excess data. approaches 1 or ξ > 1 as the denominator of the above
The core of GPD-POT modelling is setting the value equation will equal 0 or could even be negative.
of threshold u. Meanwhile, u is selected in the most Furthermore, there remains the possibility that ξ > 1 due
practical way by finding a value in the range of the 90% to the fat characteristic of the loss data on the tails.
empirical percentile. Therefore, GPDES(u) cannot be applied consistently.
After obtaining all parameter estimations, the One solution for the aforementioned problem is
calculation of Value at Risk with a confidence interval for Median Shortfall (MS) that employs the Median Excess
a certain operational risk using the GPD method is as Function [MEDEF(u)] √ median value for the loss value
follows: variance that satisfies the characteristic of X > u, with u
−ξ
representing the threshold value, as follows:
σˆ   N  
OpVaRα = µˆ +   (1 − α ) − 1 β + ξ (v − u ) ξ
ξˆ   N u   GPD MS (v ) = v +
ξ
[ ]
2 −1
For GPD exceedances, to estimate the σ scale As a consequence of the characteristics contained
distribution using standard deviation data exceedances, by GPDMS, this distribution can be applied as a
the location parameter for the µ distribution with threshold measurement of risk from the corresponding tail-severity
u, N is the total loss sample, and Nu is the number of and is applicable for all conditions.
samples with losses greater than u. Therefore, to calculate
operational value at risk, the exceedances parameter is 3. RESEARCH METHODOLOGY
used. 3.1. Data
The application of Value at Risk is only suitable for This research utilizes data sampled from an
data with a normal distribution as this is stable and operational risk loss survey of nine banks in Indonesia, which
consistent. In addition, a normal distribution rarely handles includes the type of operational risk loss, time of event,
extreme data. According to several researches, operational causes of loss, loss frequency and magnitude of loss.
loss data is seldom normally distributed; as such loss is Considering that data structure assumptions are not
infrequent, however, once it does occur the value is fully satisfied, in general, operational loss analysis is
significant. categorized into two channels, namely an aggregate loss
Therefore, for data that is not normally distributed, distribution based on data with on-to-one relationships
specific handling is required. One of the most popular and secondly, an aggregate loss distribution based on total
methods is Expected Shortfall (ES), which can estimate frequency and the severity, which are not equal.
potential loss that exceeds a selected value of L. L can be
the threshold value of u or value of Operational Value at 3.2. Goodness of Fit
Risk (OpVaR). Consequently, GPD according to L that is To determine which distribution fits a specific group
only valid for ξ < 1 is as follows: of data, a Goodness of Fit test is conducted. Distribution
82
fitting was applied using EasyFit 4.0 software, comprising protect losses for a certain percentile of expected loss (u)
of Kolmogorov-Smirnov (K-S) and Anderson-Darling (A- and unexpected loss (β (2ξ - 1)/ξ is quantified, which is
D) tests. applied using Moscadelli (2004) as follows:
β ξ
GPDMS (u ) = u + GPDMEDEF (u ) = u +  2 − 1
3.3. Frequency Aggregation and Severity ξ 
Frequency aggregation uses the formal framework GPDMS (u) is the GPD of median shortfall at the level of u,
of Cruz (2002), namely aggregate loss in a period t that and GPDMEDEF (u) is GPD of mead excess function. If v is
N (t)
can be defined by X (t) = Σ Ut with the following defined as the threshold value of u, therefore GPDMS (v)
i=1
distribution function: can be written as follows:
 N (t )  β + ξ (v − u ) ξ
FX (t ) (x ) = Pr (X (t ) ≤ x ) = Pr  ∑ U i ≤ x  GPDMS (v ) = v +  2 − 1
ξ
 i =1 
 ∞  Capital charge can be calculated by multiplying the
= Pr (X (t ) ≤ x ) = Pr  ∑ pk (t ) FU*k (x )
 i ,k =0,1  data above the 99.8% percentile.
where U is each operational loss, and the process of {N(t)}
and {Un} are independent stochastic processes. FU*k refers 4. ANALYSIS
to the convolution to k from FU where F*kU = Pr (U1 +...+Uk 4.1. Data Characteristics of each Sample Bank
< x). If the data processed is daily data, T is 365 (one full The data used in this research is survey data from
year) or 250 (working hours). Indeed, when monthly data nine commercial banks in Indonesia. The nine banks have
is processed, T=12. differences in their data, principally in association with data
quantity and observation period.
3.4. Measurement of Tail Severity Table 4.1 provides early analysis of loss data that is
After calculating the aggregate loss distribution it is applied in this research. This early analysis is explorative of
rated based on the percentile. The threshold value of u is
Table A2.1
then selected, which is the value at a certain position, for Descriptive Analysis Data of Loss
instance 90% and 95%. Exceedance values are calculated

AAAA BBBB DDDD KKKK NNNN
from the original value that is above u. The next step is to Frekuensi
kerugian 264 304 459 25 81
calculate the natural logarithm value, then to determine
Total 6,121,704,53 16,942,880,07
the shape index with Hill parameter estimates using the kerugian 68,403,580 7 4,801,458,909 988,924,650 7
Rerata
following formula: kerugian 259,104 20,137,186 10,460,695 39,556,986 209,171,359
Std, deviasi
1 k 
ξˆ =  ∑ ln (x j ) − ln (xk )
kerugian 1,047,710 217,389,104 66,630,962 81,321,485 763,159,518
 k j =1  TTTT UUUU XXXX ZZZZ

Frekuensi
Subsequently, several parameters can be defined: location
kerugian 251 62 68 471
is the threshold value of u, and the β = Σ (xi - u)2 scale
i<n
Total
kerugian
47,295,549,48
7 66,456,800
12,051,804,42 12,951,748,81
5 8
is the standard deviation measured from a data value above Rerata
kerugian 188,428,484 1,071,884 177,232,418 27,498,405
a certain percentile. Std, deviasi
kerugian 1,638,011,827 5,402,281 675,683,920 246,940,132
The data frequency, which is higher than the value- Keterangan:
Data kerugian dalam Rupiah, kecuali frekuensi kerugian.
of u, is then calculated. After that, the total required to
Source: olah data tim peneliti.
83
operational loss data in order to obtain information that banking with 88% of total observations. Analysis of loss
establishes the loss structure of each bank under based on loss event type is presented in Table 4.3. The
observation. most frequent cause of loss can be categorized into
Execution, Delivery and Process Management.
4.2. Data Characteristics Based on Frequency
All irrelevant data was purged from the bank data 4.3. Fitting the Aggregate Distribution of each
used in this research, for example data with no dates, dates Bank
that represent periods etc. Such data was excluded from A distribution estimation of operational risk for each
the analysis as it can lead to bias in the distribution group has to be conducted to observe unit behaviour, in
formation and further analysis. this case each bank, each business line and each loss event
Table 4.2 provides further information on total type. A distribution estimation requires adequate data for
frequency at each bank for business lines that have no analysis. Consequently, the minimum requirement used
association with loss event type. in this research is 30 units of data in each cell as described
in the tables. The total number of operational loss events
Table 4.2
Frequency of each Bank»s Business Line has been explained previously. The distribution selection
was based on K-S, A-D and Chi-Square tests, as well as by
Business Line AAAA BBBB DDDD KKKK NNNN TTTT UUUU XXXX ZZZZ Total
1. Cor Fin 1 9 10
Table A2.4
2. Trad Sal 1 3 1 1 11 4 21
3. Ret Ban 262 287 431 22 56 245 9 450 1762
Ikhtisar Fitting Distribusi Berdasarkan Lini Bisnis untuk
4. Com Ban 14 7 5 6 32
Gabungan Seluruh Bank
5. Pay Set 1 10 2 19 6 45 83
6. Ag Serv 1 2 3 Business Line Rerata St.Dev. Distribusi Par1: Par2: Par3: VaR 90% Var 95%
7. As Mgt 3 3
1. Cor Fin 508 2,323 Gamma 0.048 10,633,000 Ω 728 2,654
Tidak
2. Trad Sal 552 1,464 Gamma 0.142 3,884,700 Ω 1,622 3,068
teridentifikasi 9 62 71
3. Ret Ban 90,076 400,173 GEV 0.913 7,665,300 6,309,800 63,417 124,280
Source: data processing
4. Com Ban 242,498 975,593 Log-Logistic 0.128 1,25 Ω 33,505 11,263,000
From Table 4.2, it can be observed that in terms of 5. Pay Set 163,955 731,657 GPD 0.895 17,916,000 -6,834,100 130,360 265,510
6. Ag Serv 36,818 244,224 Gamma 0.023 1,620,000,000 Ω 9,040 103,140
business line, operational risk is most prevalent in retail
7. As Mgt 16,307 108,170 Gamma 0.023 717,520,000 Ω 4,004 45,684
In thousands of Rupiah, except for parameter value
Tabel A2.3 Source: data processing
Frequency of Operational Loss based on Loss Event Type
Table A2.5
Loss Event type AAAA BBBB DDDD KKKK NNNN TTTT UUUU XXXX ZZZZ Total Ikhtisar Fitting Distribusi Berdasarkan Event Type untuk
1. Internal Gabungan Seluruh Bank
Fraud 1 134 49 44 30 161 28 447
2. External Event type Rerata St.Dev. Distribusi Par1: Par2: Par3: VaR 90% Var 95%
Fraud 1 102 66 82 27 12 8 289 587
3. Employmen 1. In Fr 75,549 197,725 GPD 0,738 20,959,000 -4,593,900 122,450 226,330
Pract. 3 3 2. Ex Fr 55,756 153,758 Gen, Logis, 0,709 14,738,000 18,148,000 96,030 164,920
4. Client 3. Em Prac 1 7 Weibull 0,340 1 0 0,0116 0,0252
Products 2 2 1 6 11
4. Cli Prod 380 1,924 Gamma 0,039 9,729,800 0 396 1,800
5. Dam 9 9 4 3 2 1 4 32
5. Dam 203,289 1,190,971 Gamma 0,029 6,977,300,000 0 109,550 765,450
6. Bus Dis 44 39 506 64 73 1 10 54 791
7. Ex Del 218 182 206 1232 22 6 60 42 96 2064 6. Bus Dis 2,557 6,319 GPD 0,596 1,078,300 -109,360 5,216 8,863
Tidak 7. Ex Del 64,024 218,867 GPD 0,824 11,926,000 -3,927,400 78,168 152,610
teridentifikasi 1 1
In thousands of Rupiah, except for parameter value
Source: data processing Source: data processing
84
Notes Table A2.6

Ikhtisar Fitting Distribusi Aggregat untuk Sampel
Distribution Par1 Par2 Par3 Bank Tertentu
Gen. Pareto k σ µ
Gen. Extreme Value k σ µ Mean St. Dev. Distribution Par1 Par2 Par3 VaR 90% VaR 95%
Gen. Logistic k σ µ BBBB 9,758,094 26,125,161 GPD 0.773 2,403,200 -815,590 14,503,000 27,559,000
Gamma α β DDDD 8,779,666 20,501,985 GPD 0.600 3,671,300 -401,020 17,842,000 30,408,000
Log. Logistic α β TTTT 217,035,986 931,182,461 GPD 0.912 19,799,000 -6,800,500 148,660,000 304,770,000
Weibull α β
ZZZZ 38,282,340 108,953,039 GEV 0.753 8,274,800 8,915,400 57,753,000 100,800,000
considering parsimony aspects or the number of Aggregate distribution fitting for each loss event type
parameters for each distribution model. Table 4.4 provides for BBBB, DDDD, TTTT and ZZZZ banks is presented in Table
a calculation summary of distribution fitting, average value, A2.7.
standard deviation and VaR value at 95% and 90%.
Table A2.7
Both tables provide information on the distribution
Ikhtisar Fitting Distribusi Aggregat untuk Setiap Loss
curve that portrays the behaviour of prior operational risk, Event Type Sampel Bank Tertentu
particularly when associated with severity of loss. Each

BBBB Mean St.Dev. Distribution Par1: Par2: Par3: VaR 90% Var 95%
business line and loss event type has a different distribution. 1. In Fr 10,139,722 38,699,875 Gamma 0.069 147,700,000 21,541,000 58,179,000
2. Ex Fr 10,303,736 35,552,670 Gamma 0.084 122,670,000 25,158,000 60,009,000
However, almost all describe the two key characteristics
5. Dam 753,086 4,518,519 Gamma 0.028 27,111,000 355,340 2,700,700
of operational risk, namely ≈high-frequency low-impact 6. Bus Dis 5,806 34,838 Gamma 0.028 209,030 2,740 20,823
7. Ex Del 5,658,753 30,685,485 Gamma 0.034 166,400,000 4,448,000 24,370,000
events∆ and∆≈low frequency high-impact events∆.
DDDD Mean St.Dev. Distribution Par1: Par2: Par3: VaR 90% Var 95%
In general, such a distribution shows skewness to
1. In Fr 38,499,459 183,055,347 Gamma 0.044 870,380,000 49,343,000 194,620,000
the right (positive skewness). This means that each curve 2. Ex Fr 9,356,564 19,664,943 Gamma 0.226 41,330,000 28,238,000 46,613,000
4. Cli Prod 111,628 731,993 Gamma 0.023 4,800,000 29,798 322,970
parameter is influenced by observations at the left and 5. Dam 5,952,744 27,871,117 Log-logistic 0.187 1 127,500 6,896,700
6. Bus Dis 1,329,531 2,383,553 Gamma 0.311 4,273,200 3,903,600 6,010,800
centre of the empirical distribution. It reduces the
7. Ex Del 7,685,933 25,412,918 Gen. Pareto 0.832 1,356,200 -368,960 9,067,100 17,696,000
informative strength of data located at the extremes of TTTT Mean St.Dev. Distribution Par1: Par2: Par3: VaR 90% Var 95%
the distribution and provides relatively lower feedback than 1. In Fr 83,746,604 275,539,925 GPD 0.819 16,152,000 -5,332,000 104,890,000 204,150,000
2. Ex Fr 10,624,475 51,484,813 Gamma 0.043 249,490,000 12,817,000 52,715,000
an actual event. Besides, several distributions with no value
5. Dam 275,232,558 1,804,820,580 Gamma 0.023 11,835,000,000 73,471,000 796,320,000
in the middle were found. As there are several forms of 6. Bus Dis - -
7. Ex Del 15,753,019 95,049,439 Gamma 0.027 573,500,000 7,196,100 55,821,000
this distribution, EVT provides a solution to handle bias in
ZZZZ Mean St.Dev. Distribution Par1: Par2: Par3: VaR 90% Var 95%
analyzing the distribution tail.
1. In Fr 94,084,181 431,605,866 Gamma 0.048 1,980,000,000 134,060,000 490,810,000
Both tables also provided VaR value estimates at a 2. Ex Fr 32,172,028 39,628,787 GEV 0.456 13,705,000 13,163,000 66,938,000 99,481,000
4. Cli Prod - -
10% confidence level that is relatively large for the business 6. Bus Dis 2,476,688 3,141,949 Gen. Logistic 0.463 958,760 1,514,900 5,171,400 7,538,800
7. Ex Del 16,044,206 76,668,632 GPD 0.941 974,060 -357,350 7,639,100 15,943,000
lines of Retail Banking as well as Payment and Settlement.
4.4. Aggregate Distribution Fitting of Particular The VaR estimate value can be interpreted as a
Sample Bank measurement of the worst loss possibility with a certain
What follows are the results of distribution fitting level of confidence in a specified period of time. As the
for banks with adequate data and one-to-one relationships: data covers a three-year time period, therefore, the time
85
horizon used can also be assumed as three years. However, The most frequent loss event affected the retail banking
for operational loss, the VaR value estimated is insufficient business line and the execution event type, as well as
as the characteristics of operational loss differ from those delivery and process management.
of market and credit loss. Among the nine banks sampled in this research,
only four banks could be modelled, namely banks of code
5. CONCLUSION BBBB, DDDD, TTTT and ZZZZ. Among these four banks,
The available data appertaining to operational loss not all event types or business lines could be explored
events lacks any standardisation in the recording and accurately due to data limitations. In general, the
calculation of operational loss. Consequently, more time distribution of aggregate operational loss followed the
is required to accumulate sufficient, accurate operational Generalized Pareto distribution, with an average value
loss data. of Rp70,027,081 and standard deviation of
Operational loss of the greatest magnitude occurred Rp191,039,969. The VaR value at the 90% confidence
for payment and settlement event types, as well as the level was Rp111,990,000, and at the 95% confidence
business lines of clients, products and business practices. level was Rp204,90,000.
86
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89
90
Glossary
Glossary
91
Glossary
92
Glossary
Glossary
Bank Indonesia Real Time Gross Settlement (BI-RTGS): a infrastructures smoothly facilitate the flow of funds
system which allows real time, electronic transaction between depositors and debtors and thus promoting
settlements. System member»s account can be debited or economic growth.
credited several times a day as instructed.
Investment Manager: A party whose business is to manage
Business Continuity Management: the managing of risks share portfolios of its clients or groups of clients. Insurance
to assure that critical business functions continue to companies, pension funds, and banks do not fall under
function in times of disturbance and that recovery this definition as they manage their own portfolios and is
processes are effective govern under their own respective laws.
Capital Adequacy Ratio: A ratio measuring a bank»s capital Liquidity risk: The risks of banks unable to repay its
adequacy. It is measured by dividing the sum of tier-1, maturing short term obligations due to mismatches in its
tier-2 and tier-3 capital by the risk weight asset (RWA). cash inflow and outflow.
Credit risk: The risk of a debtor to make good on its Market risk: Risks which occur relating to trade positions
obligations as interest rates change
Crisis Management: A process which encompasses crisis Mark to Market: An accounting method which records
identification, mitigation and resolution financial positions based on the prevailing market price of
other financial instruments of the same type.
Crisis Management Protocol: A framework which defines
the actions, roles, and responsibilities of authorities in Non-performing Loans: Credits which in terms of collection
handling a crisis in efforts to minimize economic loss. potential fall under the category of sub-standard, doubtful,
and loss.
Exchange Traded Funds (ETF): A type of mutual fund with
characteristics mimicking that of shares of a publicly listed Operational risk: Risks which occur due to failures in
company in that the fund»s units are tradable in the internal, people, and external processes.
exchange.
Profit taking: Investors» actions of selling assets or securities
An ETF combines the valuation feature of a mutual fund, during periods of high prices for a profit.
in that it can be purchased or redeemed at the end of the
Redemption: The selling of securities prior to its maturity
day for its NAV, with the tradability feature of a closed-
Restructuring (credit): The adjustments of credit terms
end fund, in that it trades throughout the day at prices
through the addition of funds and/or by converting part
higher or lower than its net asset value.
or all interest payment arrears as new credit principal.
Financial System Stability: A condition of a financial system
Another means is to convert part or total amount of credit
which allows it to effectively carry the intermediation role.
as the bank»s placement in the debtor company. These
Financial institutions, the market, and supporting
93
Glossary
options may be coupled with credit rescheduling and Systemically Important Payment Systems (SIPS): Strategic
reconditioning. payment systems with the potential to cause systemic
impacts in the absence of adequate regulating and
Risk Control Systems: Bank control systems incorporated
supervision.
in the bank»s risk management policies and procedures
Undisbursed loans: Loans that have been approved of but
Risk Mitigation: Efforts to minimize the probability of risks
not yet disbursed.
occurring and its impacts
Value at Risk (VaR): A technique used to estimate the
Stress Tests: An estimation of potential loss a bank may
probability of portfolio losses based on statistical analysis
incur with its current credit exposure and liquidity levels
and price and volatility historic trends.
under various scenario involving, among others, changing
interest rates and volatility. Volatility: The standard deviations of value change of an
instrument during a specified period; used to calculate the
Subprime mortgage: A mortgage extended to debtors of
risks of a financial instrument of a certain time period.
lower credit quality.
Sudden reversal: A sudden outflow of capital from an

economy
94
Financial Stability Review
No. 11, September 2008
DIRECTOR
Halim Alamsyah Wimboh Santoso
COORDINATOR & EDITOR
Agusman
WRITERS
Ardiansyah, Linda Maulidina, Ratih A. Sekaryuni, Anto Prabowo, Difi A. Johansyah,

Tirta Segara, Pipih Dewi Purusitawati, Wini Purwanti, Endang Kurnia Saputra, Ita Rulina,
Ida Rumondang HS., Boyke Suadi, Ricky Satria, Fernando R.B., Noviati, Cicilia A.
Harun, Sagita Rachmanira, Reska Prasetya, Elis Deriantino, Primitiva Febriarti, Hero
Wonida, Mestika Widantri, Heny S.
COMPILATORS, LAYOUT & PRODUCTION
Ita Rulina Boyke Suadi Primitiva Febriarti
CONTRIBUTORS
Directorate of Banking Supervision 1
Directorate of Sharia Banking
Directorate of Credit, Rural Bank Supervision and SMEs
Directorate of Bank Licensing and Banking Information
Directorate of Banking Investigation and Mediation
Directorate of Accounting and Payment Systems
Directorate of Economic Research and Monetary Policy
Directorate of Monetary Management
Directorate of Reserve Management
DATA SUPPORT
Suharso I Made Yogi

Bank Indonesia, Financial Stability Review No. 11 September 2008

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Bank Indonesia, Financial Stability Review No. 11 September 2008

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ii

FSR is published biannually with the objectives:

Information and Orders:

The PDF format is downloadable from: http://www.bi.go.id

Foreword vi Chapter 3 Financial Infrastructure and Risk

1.1 Global Economic Indicators 9 1.1 GDP Growth of Industrial Countries 10

Jakarta, September 2008

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1. SOURCES OF INSTABILITY pressures emerged a couple of months prior to the May-

2. RISK MITIGATION of surveillance methodology is an ongoing process to

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Chapter 1 The Macroeconomy and the Real Sector

Macroeconomic stability in Indonesia was well maintained throughout the

1. THE MACROECONOMY Sluggish growth in developed countries, particularly

Graph 1.1 Graph 1.3

Graph 1.2 Graph 1.4

Source: Bloomberg Source: CEIC

Graph 1.5 Graph 1.8

quarter of 2007. Relatively robust export performance was

4.00 Consequently, this off set the challenges associated with

Graph 1.7 8,000

9,500 9,600 4,000

the external sector is expected to remain high. This will 0

and consumption. Additionally, concerns regarding the 600 350

assets over direct investment in the real sector. As a result, -100

2003 2004 2005 2006 2007

Graph 1.12 Graph 1.14

200 A sharp wage hike in the mining sector, following

150 the escalating prices of mining sector commodities in the

household income in Indonesia as only 1% of Indonesian

Graph Box 1.1.1 Graph Box 1.1.2

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Chapter 2 Financial Sector

Compared to the previous semester, the Indonesian financial sector continued

2.1. STRUCTURE OF THE INDONESIAN FINANCIAL Graph 2.1

pawnshops. Compared to the previous edition of FSR (FSR 79%

No. 10, March 2008), the structure of the financial system

compared to 2006, however, their share remained relatively

constant. Banks continue to dominate the sector with 79% 3% 5% 3% 0%

the majority (70%) of total bank assets.

490 deposits3 to decrease compared to the end of December

imbalanced. At the end of Semester-I 2008, deposits

Graph 2.3 bank money market to fulfill their short-term liquidity

trade (32.1%), services (40.5%), construction (38.9%) and Graph 2.10

consumption loan disbursements in Semester-I 2008; up -20,0

Graph 2.12 As an aggregate no rise in NPL value was recorded,

6,0 NPL value of investment loans declined by Rp2.3 trillion.

Two sectors experienced a rise in NPL value, namely

and spare parts, and the construction sector due to Rp triliun

climbing raw material prices. However, in terms of gross

2.2.3. Market Risk 30

Increasing market risk pressures stemming from

Graph 2.25 Graph 2.27

Graph 2.26 Graph 2.28

BUSN bank campuran BPD bank persero

pressures. This condition must be monitored closely in the Graph 2.30

6,2 7,8 9,9 7,8 7,4

BI SSB KREDIT LAINNYA

8,9 9,2 8,2 7,9 8,3 6,7

10 63,1 59,2 60,1 63,5 64,7 68,9

Dep KMK Spread

6,0 8,7 10,4 11,8 10,2 9,4

Graph 2.32 increase of 23.6%. Consequently, bank CAR dropped

Graph 2.33 500 14%