Coordinate monetary policy, supervision<\/p>\n
Fajar Hidayat, MBA, Int'l Banking & Finance, Birmingham University,
\nUK<\/p>\n
According to Central Bank Law No. 23\/1999, Bank Indonesia (BI)
\nwill no longer be responsible for supervising banks by the end of
\n2002. This task will be transferred to a separate agency
\nresponsible for the supervision of all types of financial
\ninstitutions, including banks, insurance agencies, securities
\ncompanies and pension funds. There is an ongoing process to
\nestablish the Financial Services Authority, although its
\nestablishment might not be on schedule due to the amendment
\nprocess to the law.<\/p>\n
Particularly in banking supervision, an agreement has been
\nreached between BI and the government about authority allocation.
\nBasically, the central bank continues to have the authority to
\nsupervise the macro-banking system, while the Financial Services
\nAuthority would supervise banks individually or the micro-banking
\nsystem. The central bank concentrates on the monetary policy and
\npayment system. The Financial Services Authority would focus on
\nthe banks' compliance in following prudential banking regulations
\nand sound banking examinations.<\/p>\n
This allocation of authority reflects an apparent separation
\nbetween the central bank and the Financial Services Authority in
\nbanking supervision. When the separation is accomplished, the
\nremaining question will be how can the monetary policy and micro-
\nbanking supervision be synchronized to achieve sustainable
\nmonetary and banking stability?<\/p>\n
The broad objective of a monetary policy is to achieve stable
\nprices. Price stability means that changes in the general level
\nof prices in the economy are relatively small and gradual, or in
\nother words, prices do not rise much from month to month and from
\nyear to year. In practice, price stability equates to low and
\nstable inflation. Central bank conduct on the monetary policy
\nfits within some sort of regime, such as money targeting,
\nexchange rate targeting or inflationary targeting. The policy can
\nbe implemented by open market operations, determination of
\ninterest rates and minimum reserves requirements.<\/p>\n
The aims of micro-banking supervision are to insure banks
\ncomply with banking law and regulations; to examine the soundness
\nof banks; and to prevent bank management from undertaking
\nexcessive risks to the disadvantage of existing depositors and
\ncreditors. The expected magnitude of micro-banking supervision is
\nbanking stability, in which banks have good quality assets and
\nliabilities, adequate liquidity and capital solvency.<\/p>\n
Monetary policy and micro-banking supervision are closely
\nrelated. The transmission mechanism of monetary policy
\ninstruments, e.g. the effect of short-term interest rates on
\ninflation, flows largely through the intermediation of the
\nbanking system. Tradeoffs between monetary stability and micro-
\nstability of the banking system could occur when there is a
\nconflict of interest between the monetary policy and the micro-
\nbanking supervision.<\/p>\n
For example, in a period of high inflation or exchange rate
\nvolatility, in the view of the monetary authority, increasing the
\ninterest rate is a proper policy to decrease the circulation of
\nmoney, reduce inflation or to stabilize the exchange rate. While
\nfrom the view of micro-banking supervision, a higher interest
\nrate could have an adverse effect on banking stability due to the
\npossibility of it deteriorating the banks' quality of assets,
\nprofitability, liquidity and solvency.<\/p>\n
On the other hand, the monetary authority would prefer to
\nconduct an expansionary policy by providing more funds to the
\neconomy and speeding up its recovery, hence it might demand a
\ntemporary relaxation of the bank's lending standards. These
\ntradeoffs occurred during the nation's financial crisis in 1997
\nand 1999.<\/p>\n
Will a separation between macro-banking (the monetary policy)
\nand micro-banking supervision be more effective in resolving the
\ntradeoffs or, in the worst case, to resolve the financial crisis?
\nHow can the monetary policy and micro-banking supervision be
\nsynchronized?<\/p>\n
These questions are very difficult to answer due to a lack of
\nempirical evidence or test cases in Indonesia.<\/p>\n
However, the practice conducted in the United Kingdom, where,
\nsince 1997, there has been a separation between the Bank Of
\nEngland as the monetary authority and the Financial Services
\nAuthority as the micro-banking supervisor, could become a
\nconceptual framework.<\/p>\n
In the UK, synchronization between the monetary policy and
\nmicro-banking supervision is carried out by the Tripartite
\nStanding Committee arrangement that was established under the
\n1997 memorandum of understanding between the authority, the
\ntreasury and the Bank of England. The memorandum not only
\ncontains the allocation of authority, but also the assurance of a
\nsmooth and reliable flow of information and crisis management
\nprotocol.<\/p>\n
Ensuring a smooth and reliable flow of information is
\nmaintained by regular meetings among representatives of the three
\ninstitutions in the committee. So far, the committee has worked
\nvery well in enabling a much fuller and quicker exchange of
\ninformation and views. The arrangements have proved highly
\nvaluable in helping the UK to respond quickly to the events of
\nSept. 11.<\/p>\n
In the immediate aftermath, a lot of business was switched
\nfrom New York to London, which required a rapid response to the
\nregulatory changes and adaptation to UK's market infrastructure.
\nFor the most part, those changes were smoothly handled under a
\ntripartite overview. In crisis management protocol, the Bank of
\nEngland and the Financial Services Authority are committed to
\ninforming each other as soon as they consider that there is a
\nthreat to financial stability. Based on the allocation of
\nauthority, the Financial Services Authority is the sole
\nprudential supervisor; hence, an assessment of solvency would
\nlargely depend on it. The Bank of England would automatically
\ntake the lead in managing threats to monetary stability.<\/p>\n
Both institutions would manage the situation and coordinate
\nthe authorities' response and share the responsibility. The form
\nof the response would depend on the nature of the event and would
\nbe determined at the time. In all cases, the Bank of England and
\nthe Financial Services Authority would immediately inform their
\ncourse of action to the treasury, to give the minister of finance
\nthe option to accept or refuse the action. Thereafter, they would
\nkeep it informed about the developing situation.<\/p>\n
For a long time, the UK has benefited greatly from a well-
\ncapitalized banking system and its good track record in
\nmacroeconomics and price stability has strengthened the
\nfundamentals of the UK's financial market in general.<\/p>\n
For Indonesia, where stability in the monetary and banking
\nsystems remain fragile, the separation between the monetary
\nauthority and micro-banking supervision has to be absolutely
\nguaranteed by a solid collaboration among the central bank,
\nFinancial Services Authority and the government. A tripartite
\narrangement as implemented in the UK could be a suitable model
\nfor it.<\/p>",
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