A diverse financial sector<\/p>\n
It was simply a coincidence that a two-day workshop on the
\nrole of nonbank financial institutions was held in Jakarta as
\njittery investors have rushed to redeem an estimated Rp 20
\ntrillion (US$2.1 billion) in fixed-income mutual funds over the
\npast two weeks.<\/p>\n
The workshop, co-organized by the World Bank and the finance
\nministry, was timely as it reiterated the strategic importance of
\ndeveloping nonbank financial institutions such as the mutual-fund
\nindustry. The meeting of experts that ended on Tuesday also
\nanalyzed the main challenges of diversifying the financial
\nindustry away from too heavy dependence on banks.<\/p>\n
The meeting warned that the financial industry was vulnerable
\nto future shocks because it was still heavily dominated by banks,
\nwhich account for over 80 percent of financial assets.<\/p>\n
This domination by banks comes as the country is in urgent
\nneed of investment in infrastructure and new production
\nfacilities, which require long-term funding. But banks, by their
\nvery nature, have never been and will never be a major source of
\nlong-term funds.<\/p>\n
Such nonbank financial institutions (NBFIs) as pension funds,
\ninsurance companies, mutual funds, capital markets and
\ninstitutional investors must play a greater role in funding
\ninvestment, as they have access to long-term funds.<\/p>\n
But as this small crisis that has hit the mutual fund industry
\ndemonstrates, the development of NBFIs requires market
\ninfrastructure, adequate supervision, excellent accounting
\nstandards, reliable auditing procedures and a strong regulatory
\nframework.<\/p>\n
In only two weeks the mutual fund industry lost over $2
\nbillion as investors rushed to redeem their funds because of
\nconcerns over the falling yields on government bonds, the main
\nunderlying asset of fixed-income mutual funds, and a
\nmisunderstanding about the method of pricing mutual funds (net
\nasset value).<\/p>\n
It is natural for investors to shift from one investment
\ninstrument to another to gain higher returns. Because the yields
\non government bonds have declined as the central bank has raised
\nits benchmark interest rate to counter inflationary pressure
\ncaused by the fuel price increases and the depreciation of the
\nrupiah, some investors have moved their funds to bank deposits
\nand other investment instruments.<\/p>\n
But what turned an otherwise natural market development into a
\nsmall crisis was investor confusion over the pricing of their
\nfixed-income mutual funds. Many investors seemed to think that
\nbecause they invested in fixed-income mutual funds the net asset
\nvalue of their funds must be stable. They apparently were not
\nadequately educated by their fund managers to understand that
\neach mutual fund share (unit) represents the value of the stocks
\nor securities (bonds) in the portfolio.<\/p>\n
Hence, the funds are priced on the basis of the prevailing
\nmarket value of their underlying assets. This is called
\nmarked-to-market pricing, which is considered the fairest pricing
\nmethod. Since fixed-income mutual funds use government bonds as
\ntheir main underlying asset, their net value has declined as the
\ncentral bank has tightened its monetary stance.<\/p>\n
But even the combined impact of declining bond yields and the
\nmisunderstanding about the pricing of mutual funds would not have
\ncaused such a massive redemption had the Capital Market
\nSupervisory Agency (Bapepam) learned from a similar crisis in the
\nmutual fund industry in 2003 and improved market infrastructure.<\/p>\n
In November, 2003, when over Rp 30 trillion worth of fixed-
\nincome funds were redeemed by jittery investors who misunderstood
\nthe marked-to-market-pricing method, most market players urged
\nBapepam to establish a standard repurchase agreement to help fund
\nmanagers cope with such rushes without having to sell their
\ninvestment instruments at large discounts to raise cash. A
\nrepurchase agreement gives fund managers a provision to buy back
\ntheir investments at specific prices by specific dates.<\/p>\n
However, due to the absence of such a safeguard fund managers
\nover the past two weeks have been forced to dump their bonds on
\nthe secondary market to raise cash to pay back their fund
\ninvestors. The central bank did move to prevent an even worse
\nsituation by entering the secondary market to buy Rp 4.3 trillion
\nof government bonds. But a similar crisis could recur if fund
\nmanagers cannot use repurchase agreements as a source of funds to
\nmeet sudden demands for redemption.<\/p>\n
Hopefully, this second crisis will jolt Bapepam to introduce
\nsoon a master repurchase agreement to prevent mutual fund
\nmanagers from having to dump their bonds to raise funds.<\/p>\n
Yet another message from the rush by investors to exit fixed-
\nincome mutual funds over the past two weeks has been that,
\nbesides market infrastructure, the development of NBFIs requires
\nan adequate education for investors to prevent unnecessary panic
\nduring price fluctuations.<\/p>",
"url": "https:\/\/jawawa.id\/newsitem\/a-diverse-financial-sector-1447893297",
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"sponsor": "Okusi Associates",
"sponsor_url": "https:\/\/okusiassociates.com"
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