Indonesia has a large, complex and profitable banking sector. At close to 280m, Indonesia’s population is the fourth largest in the world, and the percentage of the population that are unbanked and underbanked is amongst the highest globally. This has caused significant socio-economic challenges, and a lack of digital infrastructure in the country’s more remote areas exacerbated the issue during the Covid-19 pandemic. In response, the government has unveiled a major reform package designed to modernise and consolidate the financial services sector. Meanwhile, banks and lenders are working to harness Indonesia’s vibrant financial technology (fintech) ecosystem to extend the reach and enhance the versatility of services, with the development of the large rural banking segment key to boosting financial inclusion and catalysing economic growth.
Sector Snapshot
Regulation and oversight of the sector is split between Bank Indonesia (BI), which is the country’s central bank, and the Financial Services Authority (OJK). As of December 2023 Indonesia was home to 106 commercial banks, 1405 rural banks and a combined total of 30,325 bank offices. At that time, commercial banks’ assets amounted to around Rp11,800trn ($765bn), while rural banks’ total assets amounted to Rp195trn ($12.6bn). Of the 106 commercial banks, four – Bank Mandiri, Bank Negara Indonesia (BNI), Bank Rakyat Indonesia (BRI) and Bank Tabungan Negara – are government-owned. These four banks are the largest in the country and account for approximately 50% of Indonesian banking assets combined.
The distinction between commercial banks and rural banks is that rural banks do not traditionally have access to the national payment system, which is overseen and developed by BI, and thus do not provide services related to payment transfers. A further nuance of the Indonesian banking sector is the distinction between conventional banks and sharia-compliant Islamic banks.
In December 2020 a consolidation process involving the sharia-compliant banking components from BNI, BRI and Bank Mandiri began, with the February 2021 completion of that process creating Bank Syariah Indonesia, the country’s largest Islamic bank by assets. Bank Mandiri is the parent company of the new entity. The move was designed to align and enhance the resources and commercial reach of three government entities previously competing in a rapidly expanding space, with the value of global Islamic banking assets growing from $1.3trn in 2012 to $3.2trn in 2022. While sharia financial literacy among its population is low – at 9.1% in 2022 – Indonesia’s status as the world’s most populous Islamic country means its Islamic banking segment has significant growth potential.
Foreign Banks
Foreign banks operating in the country – either as branch offices or Indonesian legal entities – number around 40, accounting for a market share of over 26% as of September 2023. A credit-to-GDP ratio of approximately 40% presents an attractive market proposition for foreign banks. However, following a period of rapid growth in terms of market share in the wake of the 1997-98 Asian financial crisis, the presence of foreign investors in the sector has dwindled due to the dominance of government-owned banks in the commercial and retail segments. This dominance has resulted in a number of high-profile stock sales and market exits as foreign entities rethink and remodel their Indonesian banking portfolios.
The government, however, appreciates the need for a banking sector in which national operators and major foreign players can thrive simultaneously. Indonesia has issued new regulations as part of the aforementioned policy overhaul to diversify the options available to foreign investors in the banking sector, such as allowing international banks to integrate or convert representative offices into Indonesian banks.
Notably, as of May 2024 financial services was one of the sectors still subject to foreign business ownership limits, which were set at 80% for insurance operators, 85% for multi-finance institutions and 99% for banks. The controlling shareholder and all board members must show appropriate qualifications and financial resources before OJK licences are issued, with BI carrying out similar evaluations for payment system operators. Additionally, certain financial sector activities, such as microfinance, are closed to foreign investment.
New Law
The lasting effects of the 1997-98 Asian financial crisis reshaped the Indonesian banking sector, with the number of government-owned banks consolidated down to the four and much of the foreign investment in the early 2000s coming by way of international companies purchasing recapitalised Indonesian banks. A major regulatory overhaul was also implemented. Similarly, recent global economic shocks and the rapidly evolving financial sector landscape have prompted the government to carry out a comprehensive regulatory upgrade relating to domestic financial systems.
Law No. 4 of 2023 on Financial Sector Development and Strengthening – also referred to as the P2SK Law – was enacted by Indonesia’s House of Representatives in January of that year, marking a significant development for the financial services sector. The new law seeks to strengthen and reorganise sector-relevant government authorities, and improve governance and enhance public trust in the national financial system. It also aims to encourage financial sector consolidation to establish a deeper funding pool capable of supporting sustainable national development and reliable welfare financing.
Other aims of the law are to bolster consumer protections and boost sector innovation, while raising financial literacy and inclusion among the country’s population. The pandemic ushered in the broad-based digitisation of transactions and financial services processes, stimulating a marked increase in digital financial solutions uptake, while also highlighting the need to improve digital infrastructure and financial inclusion in the country’s more remote regions. Implementing regulations for the new law will be drawn up by the central government, BI, the OJK and the Indonesia Deposit Insurance Corporation (LPS) by January 2025.
The P2SK Law’s 27 chapters and 341 articles amend or revoke 17 existing laws, some of which have been in operation for 30 years. The law’s broad scope is likely to make full implementation challenging. Increased transparency is key to improving governance and boosting public and investor trust, with more stringent disclosure requirements for financial institutions to be introduced. This in turn is expected to boost the government’s ability to monitor and oversee those institutions’ activities. The new law prohibits public administrators or members of political parties from becoming members of, or running as candidates for, the BI board of governors, or the OJK or LPS boards of commissioners. Meanwhile, it mandates that BI, the OJK, the LPS and the Ministry of Finance should work to develop the financial sector through increased coordination with government ministries and agencies.
Structure
BI underwent several restructurings and operational changes between the time it was inaugurated in 1953 and 1968, switching between commercial, developmental and central bank status. Since 1968 it has been Indonesia’s central bank. BI is responsible for setting and issuing monetary policy and macroprudential measures in order to stabilise Indonesia’s currency, the rupiah, and oversee the development and operation of payment frameworks, thereby ensuring the resilience of the country’s economy and financial systems.
As part of its efforts to maintain financial stability, BI sets an annual inflation target each year, which it strives to meet using the monetary policy tools at its disposal, such as setting the seven-day reverse report rate, which is the benchmark interest rate introduced in 2016. In 2023 BI was able to achieve an average inflation rate of 3.7%, comfortably within its 2-4% annual target range (see Economy chapter).
BI’s operational mandate is based upon several key laws and acts. The central policy document – referred to as the Bank Indonesia Law, which has been updated multiple times since its launch in 1999, most recently by the P2SK Law – maintains that BI policy should provide the foundation for economic and financial system development. Macroprudential policies are implemented to enable sustainable and effective intermediation – ensuring that policy matches economic capacity – and to mitigate and manage systemic risk by monitoring economies of scale and national business ecosystems, in turn promoting economic and financial inclusion for the country’s large and diverse population.
BI operates as a lender of last resort for commercial banks and offers reverse repurchase services. It also purchases government securities from the LPS when that organisation, itself instrumental to national financial system efficiency, requires improved liquidity. Significant changes to BI jurisdiction ushered in by the P2SK Law include the directive that no person or entity is permitted to interfere in BI’s execution of its mandated duties, except in the case of national economic or financial system emergency. Following legislative updates, BI has greater authority and autonomy in the process of managing interest and exchange rates, foreign exchange flows and state foreign exchange reserves, with a key alteration stating that such policies should align with the targeted inflation rate.
In addition, through collaboration with the government, BI is in charge of managing the digital rupiah, which is formally recognised as an official currency under the P2SK Law. BI also now has greater licence in engaging investors and entities in developing the national payment system. A significant advancement in the payment system came in August 2019 when BI launched the Quick Response Indonesia Standard platform, enabling broader access to digital payment frameworks for fintechs and commercial banks. Due to overlapping interests, fintech activities are jointly overseen and regulated by BI and the OJK.
Oversight
The OJK is the chief regulatory and supervisory body for the sector, with its oversight covering activities within banking, capital markets, and derivatives and carbon exchanges, as well as fintech, venture capital and microfinance. It is in charge of licensing procedures, and the formulation and implementation of microprudential policy. The reconfiguration of financial sector oversight introduced by the P2SK Law saw a number of duties previously carried out by BI reassigned to the OJK. In addition to its newly acquired status as the primary authority in relation to bank licence issuance and revocation – duties previously belonging to BI – licensing procedures and criteria have been diversified and made more flexible to aid sector agility.
The OJK’s purview now includes supervision of banks’ business activities, and the authority to carry out investigations, and impose sanctions and penalties on banks. Furthermore, the P2SK Law establishes the formulation of a supervisory body that will assess and evaluate OJK’s performance and adherence to accountability and transparency regulation, while ensuring it maintains independence as a governing authority.
The OJK is also authorised to order mergers and takeovers, depending on the capitalisation status of banks and other financial institutions, if such moves benefit the broader financial sector. Similar authority is afforded to the OJK in ordering a bank to integrate new services or convert the status of an operational unit. An example in relation to the latter point is the February 2024 directive that if the asset value of a conventional bank’s Islamic banking unit reaches 50% of total assets or achieves a value of Rp50trn ($3.25bn), it must divest that unit into a separate Islamic banking entity or merge it with an existing Islamic bank. Further efforts to better organise Islamic banking activities have seen the OJK issue a development roadmap for the segment, covering the period 2023-27.
Sector Performance
By June 2023 the profitability of the Indonesian banking sector had surpassed pre-pandemic levels, reaching 2.7%. Growth was due largely to the subsidence of credit costs, which underwent significant hikes during the pandemic.
Between 2019 and 2023 the earnings of the 15 banks listed on the Indonesia Stock Exchange under the IDXFINANCE index underwent a compound annual growth rate (CAGR) of 14%. That figure incorporates a 37% contraction experienced in 2020, which was followed by growth of 56% and 47% in 2021 and 2022, respectively. It is also important to note that the CAGR was measured in September 2023, so earnings for the final quarter of that year were based on forecast. By September 2023, while as a whole those 15 banks had underperformed the Jakarta Composite Index by 3% year-to-date, the four government-owned banks had outperformed the index by 6%.
Total commercial banking assets grew by 6% from Rp11,100trn ($722bn) in December 2022 to Rp11,800trn ($765bn) in December 2023. Improved business activity and increasing consumer confidence were contributors to the solid year-on-year credit growth of 10.6% between December 2022 and December 2023 for commercial banks. Taken as a whole, commercial banking profits rose by 20.6% over that period, from Rp252trn ($16.4bn) to Rp304trn ($19.8bn), with those banks carrying a combined capital adequacy ratio of 27.7%, a loan-to-deposit ratio (LDR) of 84% and a net interest margin ratio of 4.8% at the close of 2023.
Meanwhile, the total assets of rural banks grew by 7% from Rp182trn ($11.8bn) in December 2022 to Rp195trn ($12.7bn) in December 2023, while the segment experienced 8.9% credit growth in that time. In addition, rural banks displayed an LDR of 76.6% in December 2023, up from 75.8% in December 2022, while the segment’s non-performing loan ratio rose from close to 8% in 2022 to just under 10% in 2023, a significant reason behind the government’s aim to better regulate the segment.
Sharia-compliant banking is trending upwards too, with sharia-compliant loan growth of 11.4% across the first three quarters of 2023 outpacing conventional loan growth of 6.4% during the same period, with credit ratings agency Fitch forecasting a continuation of that dynamic through 2024-25. Notably, in October 2023 Fitch upgraded its Indonesian banking operating environment outlook score to “bb+ positive” from “bb+ stable”, reflecting the banking sector’s strong performance and improving fundamentals.
Commercial Banking
Many of the major changes to banking sector regulations are designed to create a more efficient commercial banking ecosystem, thereby providing a more robust financial backbone for Indonesia’s business community and economy as a whole. Under the P2SK Law, commercial banks can no longer operate as cooperatives and must establish a presence as a limited liability company, while players seeking to enter the market must obtain approval from the OJK. Mergers and acquisitions – or other such activities not ordered by the OJK – must receive OJK approval and be conducted in accordance with the relevant laws. Furthermore, in the case where a customer cannot fulfil its commitments to a given commercial bank, that bank is now authorised to sell collateral assets belonging to the defaulting customer. The law states that those assets must be swiftly resold, the ownership status of said assets clarified and any excess profit channelled back to the defaulting customer.
The list of business activities open to commercial banks has been extended under the new law and includes payment systems activities, while cooperation agreements between commercial banks and other financial institutions are permitted as well. Both of those allowances signify recognition on the government’s part that a comprehensive approach is required in establishing cohesive, sophisticated financial service delivery, and come partly in response to the pandemic-induced and continuing proliferation of partnerships between conventional banks, fintechs and microfinance operators. Meanwhile, commercial banks are permitted to operate as digital banks under the new law, again deepening the array of products commercial banks can offer their customers and broadening the reach and convenience of commercial banking.
Fintech, Rural Banks & Inclusion
Another dynamic to have arisen in recent years has involved larger commercial banks converting long-established subsidiaries into dedicated digital banks, or acquiring smaller banks and converting those. Such instances include BNI purchasing Bank Mayora in April 2022 and rebranding it as digital banking operator Hibank in 2023. Additionally, in September 2021 BRI converted its subsidiary BRI Agro – which had operated as a long-term agricultural lender for 30 years – into digital short-term lender Bank Raya. By harnessing its existing network of over 600,000 agents and their business linkages throughout Indonesia’s vast informal economy, BRI has equipped Bank Raya to provide much-needed liquidity for entrepreneurs, and micro-, small and medium-sized enterprises (MSMEs), with significant room for expansion. Indeed, as of 2022 MSMEs accounted for 61% of Indonesia’s GDP and around 97% of its workforce.
Many MSMEs are located in rural areas. Fintech company Komunal is deepening the digitisation of rural banks, partnering with around 376 operators from that segment. Through its platform DepositoBPR, Komunal channelled deposits and loans valued at around $230m to rural banks and MSMEs in 2022, with the annual figure rising to $600m in 2023. Komunal operates an additional platform through which it connects MSMEs with alternative lenders. The company’s success in penetrating the vast rural banking segment has enabled it to secure significant investment, most recently in late 2023, when it raised $5.5m in series A+ funding.
Outlook
In spite of the increasing assimilation of digital solutions into the banking ecosystem, the proportion of rural banks cooperating with fintechs and commercial banks was below 28% as of August 2023. Continued innovation will help provide finance options and facilities to the country’s rural population and the MSME ecosystem, and present sizeable opportunities for private investors. Reforms cover multiple verticals, further strengthening a sector that has performed well in recent years. Those developments should enable the establishment of a banking ecosystem better equipped to both serve the country’s diverse population, and respond with agility to external and internal shocks.
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