Thinking ahead for Europe Discussion: Interlink of Macro-Prudential Policy, Banking Characteristics, and the Lending Channel of Monetary Transmission Willem Pieter de Groen, CEPS & EMEA International Workshop on Financial System Architecture and Stability 24-25 August 2017, Montreal (Canada)

Financial diversification Indonesia financially still underdeveloped Larger financial sector not always ‘improvement’ Size of the financial sector (% of GDP, end-2015)

Credit growth Indonesia Coming from low levels (large increase in % small in amounts) Credit growth (%) substantially higher than GDP growth (%) Credit growth volatile between 2005-2010 and downward trend since 2011

Credit growth Indonesia Stable credit growth in % requires exponential growth in amounts (untenable and undesirable for longer term -> financial stability) Linear growth results in declining growth rate

Credit growth Indonesia Adjustment for base and GDP leads to differences in magnitude Credit growth rate later years (>2010) relatively larger compared to first years Increase instead of decrease in credit growth rate (2010-2013)

Impact policy measures Correlation or causality? Stable funding (non core deposits) higher loan growth? Non-stable funding came up only when the market deepened Policy measures are in most cases re-active; Taking place in (economic) downturn (no counterfactual), which might explain limited impact of changes in interest rates

Financial diversification Indonesia’s financial markets are also underdeveloped Capital markets structure (% of GDP, end-2015)

Corporate bond markets development Financial markets in most countries only credible alternative for large companies (Top 30 represents 75% outstanding amount in Indonesia) Indonesia’s financial markets are dominated by financial services issuers (±50% of corporate bonds) Corporate debt securities – Outstanding amounts (% GDP)

Building blocks for efficient bond markets Price discovery Execution Enforcement Information about issuer Accounting standards Company data Credit scoring Conflicts of interests Information about products Prospectus rules Credit ratings Pre and post-trade reporting Yield curve Barriers to entry Capital controls Government intervention Primary issuance access Taxation Barriers to exit Prudential requirements Public enforcement Institutional set-up Securities laws Sanctions Private enforcement Insolvency proceedings Redress procedures Source: Amariei, De Groen, Valiante (2017)

Main recommendations Issuers Expanding the issuer base with private companies beyond the finance-related firms and capital-intensive sectors is key. Options to speed up and simplify the process for issuing corporate bonds (the so-called ‘hybrid’ issuance process) and to eliminate the discriminatory tax regime (making bond interest expenses deductible) could be considered. Investor base Incentives for institutional investors, which are much smaller than banks and prefer to hold instruments to maturity, in order to shift investments from short-term to long-term assets and trade more, e.g. adjusting risk weights for the computation of regulatory capital or mandating investment in corporate bonds or project bonds, could be considered. Market infrastructure The implementation of a clearing mechanism for over-the-counter transactions, in addition to the currently available delivery-versus-payment system, together with a greater development of hedging tools could be an important improvement.

Summary Dynamics emerging markets (EMs) can be different than advanced markets (AMs) Indonesian financial sector still underdeveloped, both in terms of institutions and markets Credit to GDP is despite substantial growth in past years still rather low Measurement issue denominator changes results/perspective (less issue AMs) Growth needs to be exponential to keep current pace in %, desirable? Impact on economy would increase Potential explanation negative impact non-core deposits could be found in gradual saturation that coincides with financial market development Financial market development no panacea. Additional policies need to be implemented to realize full potential

Contact: Willem Pieter de Groen willem.pieter.degroen@ceps.eu Thinking ahead for Europe Thank you! Contact: Willem Pieter de Groen willem.pieter.degroen@ceps.eu Disclaimer: Unless otherwise indicated, the views expressed are attributable only to the presenters in a personal capacity and not to any institution with which they is associated.