The Crossroads between Direct and Indirect Finance Development in Indonesia Introduction

This paper will attempt to observe the relative importance between direct finance and indirect finance in Indonesia over the past 15 years.

Indonesia has had a remarkable change in its financial market in late 1980s and 1990s. In October 1988, the government removed restrictions on the establishment of foreign and domestic banks and as well as on the opening of new branches. Procedures for issuing securities were simplified. The capital market started to attract investors. Then, Indonesia suffered from an economic crisis in late 1997. The rupiah exchange rate declined sharply and exposed the bad debts problems in the banking system. Banks collapsed and the stock market index fell sharply. For the past fifteen years, the Indonesian financial market has been exposed to the rise and fall in modernization of its financial system.

In his article on the ‘Banking sector reforms in Indonesia, 1983-93’, Nasution (1994) concludes that the core of the financial system is the bank, where state owned institutions played a dominant role. The system also preferred bank loans over equity finance. But was that the patterns for Indonesia case over the past 15 years? Noerhadi (1994) points out that in 1993 the total value of funds raised by equity and bonds exceeded 10 per cent above the incremental value of investment loans. There are, however, other important explanations behind the patterns of finance development in Indonesia than an increase in funds raised through the capital market.

This paper will attempt to observe the relative importance between direct finance and indirect finance in Indonesia over the past 15 years. Due to the availability of data, the discussion will be limited to the bank institutions representing the indirect financing and the capital market representing the direct financing. Insurance, pension funds and other formal and informal financing forms will be discussed briefly. This paper begins by briefly reviewing macroeconomic background, it examines the overall structure of the financial system, particularly the relatives role of banks and securities market. Next, it provides an in-depth look at the banking system. Subsequent section considers securities market and finally it concludes the patterns observed.

Author

Bima P. Santosa

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