How Indonesia ended up not letting a financial crisis ‘go to waste’

The IMF actually ‘helped’ force us into economic reform

Sep 26, 2025

*Soeharto signing the IMF’s Letter of Intent, agreeing to accept a bail out package*

“Crises, however costly, offered opportunities for reform—the boundary between acceptable and unacceptable behavior could be shifted in the right direction, and institutional reform pushed through.” (IMF Independent Evaluation Office)

Remember the iconic photo above? It’s one of the most widely-circulated images from the 1998 Asian Financial Crisis: then-IMF managing director Michel Camdessus, hovered behind President Soeharto with his arms crossed; looking down (quite literally) as the president, who had been in power for 32 years, bowed down to sign the IMF deal.

Many Indonesians looked at this photo and saw a symbol of the country’s loss of economic sovereignty to the global elite… is this true?

In 1998, the IMF offered Indonesia a 43 billion dollars bail out package to “help” us recover from the Asian Financial Crisis. The aim of the package was to stabilize the Indonesian economy; but it also facilitated huge shifts in patterns of financial ownership and influence – many of which remain controversial to this day.

In this edition of The Reformist, we are taking you back to almost three decades ago to revisit how the IMF measures shaped Indonesian banking today.

The IMF’s demands through the years

Demands from the IMF began taking place in October 1997: banks and corporations were forced to disclose ownership, move towards market-based interest rates, and submit to foreign auditing standards. This resulted in the exit of insolvent banks and ownership changes of major private banks.

In some cases, foreign investors could take stake in recapitalized institutions at significantly low prices. At a high level, the IMF measures pushed Indonesia into a more market-oriented system.

By 2004, ten major state-owned companies ranging from finance to infrastructure were privatized (e.g. Indosat sale to Temasek). Local governments followed suit by privatizing public hospitals due to increased regional autonomy.

By the late 2000s, observers noted that Indonesian banks were playing by very different rules than under Soeharto: they were subject to strict capital requirements, independent oversight, and no longer bolstered by state bailouts.

Restoring the health of Indonesia’s banking sector

A foundational change was raising and enforcing bank capital adequacy (CAR). Post-crisis recap set transitional targets (4 percent by end-1999, rising to 8 percent by end-2001) and since then Indonesia has maintained a minimum CAR of 8 percent under BI/OJK rules. Essentially, this is a buffer to absorb potential losses. This was a high threshold that sought to ensure that banks stopped lending recklessly.

Another important change was the tightening and formalization of reserve requirements, known locally as Giro Wajib Minimum (GWM). While the IMF documents referred more generally to “reserve requirements” as a monetary policy lever, Bank Indonesia translated this into a statutory reserve framework.

In the early 2000s, BI issued regulations that obliged banks to hold a fixed percentage of their third-party funds (DPK) in reserves at the central bank. These rules meant that banks could no longer freely expand credit without keeping a liquidity buffer at BI, reinforcing prudence in an industry that had previously been highly leveraged.

By anchoring liquidity management in this way, the reserve requirement became a permanent macro-prudential tool, complementing the new capital adequacy rules and helping restore confidence in Indonesia’s banking system.

To solidify the bank cleanup, Indonesia formed Badan Penyehatan Perbankan Nasional (BPPN), or the Indonesian Bank Restructuring Agency, under Presidential Decree 27/1998. It sought to handle troubled bank assets to align with IMF expectations.

Essentially, this meant that BPPN was a huge “bad bank” – it received non-performing loans, took equity stakes in distressed banks (sometimes nationalizing them), and gradually resold its assets. It took over the above banks that did not hit the needed CAR.

During its six-year span, it ran a recapitalization scheme, an asset-management arm, a risk-management unit, and later managed government-held shares in banks under restructuring.

BPPN has… interesting results in recapitalizing significant parts of the banking system in late 1998.

For banks deemed to be “viable,” BPPN injected capital (mostly using government bonds) in exchange for ownership shares, and original bank owners only needed to provide about 20 percent of the funds. About 7 percent of the banking system was liquidated or fully taken over by BPPN (these banks were called Bank Take Over or BTO). The rest were recapitalized or merged, meaning that the recapitalization of banks was borne fully by the government.

However, as banks normalized, the BPPN divested government stakes, many of which were sold to foreign investors. For example, Bank Danamon was recapitalized with over Rp61 trillion in bonds, merged with nine BTO banks, and later saw government stakes sold off to foreign investors, namely Temasek Holdings and Deutsche Bank AG.

Like Bank Danamon, Bank Niaga couldn’t meet the recapitalization requirements, so BPPN stepped in and took control during the crisis. The government then sold its controlling stake (51 percent of Bank Niaga) to Commerce Asset-Holding Berhad (CAHB), a Malaysian financial giant that later became a part of CIMB Group. Allegedly, this was to “promote professionalism” and raise funds for the state.

Institutional overhaul: granting BI independence and the formation of LPS

There were many regulatory changes that guided austerity measures from the IMF, all of which fundamentally sought to end the central role of state credit guarantees.

However, there were two main institutional changes: the independence of the Central Bank (Bank Indonesia, or BI), and the formation of the Indonesia Deposit Insurance Corporation (Lembaga Penjamin Simpanan, or LPS).

Among other requirements, Indonesia was tasked with rewriting Law No. 23/1999, which granted full independence to BI. Under Article 4 of the new BI Law, the central bank was defined as an “independent state institution [...] free from any interference” of the government, with the objective of “achieving and maintaining” the stability of the rupiah.

Affording independence to BI meant that the government could no longer directly dictate its actions. This is important because without such independence, the government could pressure BI to buy bonds, print money, or pursue short-term policies that risk fueling inflation and destabilizing the economy.

This was a radical shift from the pre-Crisis era, during which BI governors were included in the executive cabinet. In practice, there were cases of politics testing BI’s independence. But there finally was a legal foundation for BI independence, consequently leading to BI adopting open market operations and inflation targeting that anchored inflation around 3-5 percent in Indonesia.

To complement BI, the state also introduced an explicit deposit insurance scheme to restore public confidence. This means that depositors were guaranteed the safety of their funds up to a certain limit, even if their bank failed.

This was institutionalized under Law No. 24/2004, which created LPS. It formally began operation in 2005; a huge change in how banks viewed risk management as banks previously had a de facto state guarantee of survival.

In this sense, LPS and its deposit insurance gave Indonesians a safety buffer against losing their savings if a bank collapses. This naturally rebuilt citizen trust in financial institutions after the 1998 Crisis and incentivized banks to be more prudent with managing money.

In addition to these two major changes, directed credit schemes (the mandatory allocation of credit to certain industries) were mostly phased out. Capital account controls were also liberalized to encourage greater integration with the global financial market.

The long-term impact for Indonesia

Analysts largely agree that the 1998 Asian Financial Crisis led Indonesia to be better-prepared for financial turbulence. This was particularly obvious during the 2008 Asian Financial Crisis.

In fact, an IMF country report from July 2008 noted that the financial sector displayed “resilience in the face of the global credit market turmoil,” and noted improvements such as non-performing loans falling to about 4 percent that year. This was due to a combination of factors, including strengthening external balances, increased foreign exchange reserves, reduced government debt, and improved banking supervision.

Due to different policy responses and improvements in fiscal, monetary, and banking conditions since 1998, Indonesia handled the global financial crisis “relatively well”.

Reform born out of crisis?

Earlier this year, former Minister of Finance Chatib Basri was quoted as saying, “Don’t waste the crisis; good policies are born in difficult times” to a local news outlet. He is right, mostly. The crisis did force Indonesia into reforms that ended up shielding the country through stronger capital requirements, tighter supervision, BI independence, and the establishment of deposit insurance.

So, yes, a crisis can be a catalyst for reform. However, it’s hard to argue that it’s the best case scenario. Ideally, we shouldn’t wait for disaster to strike.

Discussion about this post

Ready for more?