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Jun 2023

Weaknesses in governance remain a major risk for Indonesian financial industry

Source: Asia Insurance Review | Aug 2020

According to Fitch Ratings a recent string of defaults due to corporate governance failings in Indonesia’s financial industry highlights governance remaining a major risk for creditors and investors.
Fitch’s non ratings action commentary published on 6 July 2020 said, “These weaknesses in the corporate governance are likely to be magnified by tougher economic conditions caused by the coronavirus pandemic and could lead to a rise in governance-related bankruptcies and potential losses for investors in the near term.”
The commentary said most of the failures have emanated from the non-banking financial institutions (NBFI) sector, which it believes are not as stringently regulated as Indonesia’s banking sector, despite some strengthening of regulation and supervision in recent years.
Defaults have often been linked to high-yielding time deposit products marketed by insurance, cooperative and asset management companies to the general public. The deposits typically bear returns significantly above market interest rates and are frequently sold to retail customers through bancassurance channels or third-party agencies.
According to local media reports governance-related defaults have resulted in losses of up to $3.5bn to investors since 2018.
Indonesia’s banking sector has not suffered any recent defaults as a result of corporate governance failings, while Fitch sees governance in the sector continuing to lag more developed markets. ESG scores assigned to Indonesia’s state-owned banks include a relevance score of ‘4’ for governance structure, reflecting the risk of the government using its majority ownership to exert undue influence on the banks’ boards.
This has a negative effect on the banks’ credit profiles and is relevant to their ratings in conjunction with other factors. Our assessment of Indonesia’s regional development banks takes into account their lower standards of governance, which are weaker in terms of accountability, effectiveness of risk management and transparency than other larger banks in Indonesia.
The commentary said, “We see smaller, privately held NBFIs as more vulnerable to governance lapses than larger, listed entities which would typically attract greater scrutiny. Many of Fitch’s rated NBFIs are owned by stronger parents (often banks) and are required by regulation to operate under their parents’ typically more robust integrated corporate governance and risk-management frameworks.”
Fitch believes that the large number of participants in Indonesia’s financial sector - augmented recently by the advent of the rapidly expanding fintech sector - poses a significant challenge to regulatory bodies in ensuring adherence to regulation and supervision of governance practices. Fitch believes that industry consolidation could allow for more efficient allocation of regulatory resources. A 
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