Integrated financial authority must supervise financial conglomerates<\/p>\n
Fajar Hidayat, Financial Market Analyst, Jakarta<\/p>\n
Establishing the Financial Services Authority Institution
\n(FSAI) is one of the actions planned in the financial sector
\nreform under the Indonesian Post-IMF economic reform program.
\nThe FSAI will be set up as a fully-integrated financial
\nsupervisor, authorized to regulate and supervise all types of
\nfinancial institutions within the financial market, i.e. banking,
\nsecurities companies, insurance, and others.<\/p>\n
The FSAI blue print will be designed after the revision of the
\nCentral Bank Law (UU No. 23\/1999), which is being processed by
\nthe legislature. The FSAI is slated to operate by 2008.<\/p>\n
Ideally, an integrated financial supervisor exists in a
\ncountry with a significant number of financial conglomerates that
\nmake up a large proportion of the financial market. As financial
\nservices become intensely integrated in the conglomeration, an
\nintegrated financial supervisor is needed to mitigate the risks
\nof the conglomerates. Therefore, the FSAI should be prepared to
\nregulate and supervise financial conglomerates.<\/p>\n
A financial conglomerate is an integrated financial
\ninstitution offering financial services diversification to
\nmaximize market share and profit. The conglomerates also carry
\nrisks due to the different characteristics of the financial
\nservices mix offered in commercial banking, insurance, and
\nsecurities investment.<\/p>\n
Banking activities are converting liquid short-term
\nliabilities (deposits) into long-term assets (loans), which make
\nbanks vulnerable to credit risks and liquidity risks because of
\nuncertainty in depositors' behavior and long-term loan
\ncommitments. The maturity mismatch between assets and liabilities
\nexposes banks to interest-rate risks.<\/p>\n
Insurance companies, in contrast, are converting long-term
\nliquid liabilities into short-term assets, typically marketable
\ninstruments. They are, thus, not vulnerable to liquidity crisis,
\nbut exposed to market risks in their assets value, and
\ncatastrophe risks that require large payouts to their liability
\nholders.<\/p>\n
Securities companies have both short-term assets and
\nliabilities, whose value is marked-to-market on a daily basis,
\nreflecting their true financial position. Changing the market
\nvalue of assets will be accompanied by a correction in the value
\nof liabilities. Their assets are therefore robust to liquidity
\nshocks with the main risks being in the market, i.e. excessive
\ndeclines in assets values.<\/p>\n
The different characteristics of the integrated financial
\nservices mean financial conglomerates are at risk of internal
\ncontagion, i.e. the transmission of financial problems among the
\nvarious components of the organization. The level of risk (of
\ncontagion) depends on the organization model that financial
\nconglomerates adopt, i.e. the universal-banking model, the bank-
\nparent model, or the bank-holding-company model.<\/p>\n
The universal-banking model enables the bank to engage in a
\nfinancial services diversification within a single legal entity,
\nwhich allows the pooling of resources between the bank's
\ndifferent activities. This model increases vulnerability to
\ncontagion risks because there are no institutional barriers
\nbetween activities; e.g. losses in securities trading translate
\ndirectly into losses for the bank as a whole.<\/p>\n
In the bank-parent model, banking and non-banking activities
\nare separated into subsidiaries within the banking group. This
\nimposes some operational separateness between the activities
\nconducted by the units; hence it locks up the bank's loss to its
\ninvestment in the subsidiary in the event that subsidiary units
\nfail.<\/p>\n
In the bank-holding-company model, independent banking and
\nnon-banking subsidiaries are functionally separated and operate
\nunder a holding company's \"umbrella\", which oversees the
\nportfolio of activities. In this model set-up the relationship
\nbetween the bank and the non-bank subsidiaries is only indirect
\nand therefore should have the least likelihood of contagion.<\/p>\n
When a financial conglomerate operates through a complex and
\nopaque structure -- especially in the universal-banking model and
\nthe bank-parent model -- the contagion risk may be difficult to
\nmitigate if the management cannot adequately control the overall
\nscope and level of activities. Furthermore, the complexity in
\nstructure may be intentionally set to circumvent regulatory
\nrequirements, particularly in the areas of capital adequacy and
\nrisk concentration.<\/p>\n
In the United Kingdom (UK), for example, Financial Services
\nAuthority (FSA) was established in 1999 by merging eight
\nfunctional financial supervisors and took over responsibility for
\nbanking supervision from the Bank of England.<\/p>\n
FSA was established as a lead superviser, to supervise
\nfinancial institutions as a group, rather than supervising the
\nvarious functions of the institution separately. Financial groups
\nin the UK have been broadly diversifying their financial services
\nas well as integrating their management and controls on a group-
\nwide basis and lead-supervision has developed in response to
\nthis.<\/p>\n
According to Chairman of the FSA Howard Davies (1999), from a
\nmarket point of view there are many advantages and benefits from
\na one-stop regulatory stop in the FSA model. Under the previous
\nsystem there was a great deal of overlap: Securities companies,
\ninsurances, building societies and banks have gradually begun to
\nall look alike, offering the same services and products, yet
\ncontinuing to be regulated by different bodies to a large extent.
\nA single regulator would add to the efficiency of regulation.<\/p>\n
In Indonesia, financial conglomeration is still in the early
\nstages and there are some regulatory limitations. The banks can
\nadopt the bank-parent model or the bank-holding-company model by
\ncreating subsidiaries in non-banking financial services, but
\ncannot adopt the universal-banking model. The 1998 Banking Law
\nprohibits the banks to underwrite insurance products and common
\nstocks transaction in the capital market.<\/p>\n
Indonesian banks also can act as the sales agents of insurance
\nproducts (bancassurance) and mutual funds that are produced by
\neither the bank's subsidiaries or insurance and securities
\ncompanies. The banks are allowed to become the sponsors of mutual
\nfunds with non-common stocks underlying assets.<\/p>\n
Until now, at least 10 banks deliver bancassurance with the
\npotential market at roughly Rp 13.6 trillion. There are also at
\nleast 15 banks offering mutual funds, mostly based on government
\nbonds. Out of Rp 68.35 trillion in mutual funds selling up to
\nJune 2003, around 85 percent or Rp 58 trillion were sold via
\nbanking-distribution channels.<\/p>\n
The current trend reflects a strong demand for financial
\nservices diversification. In the future, the demand might be even
\nstronger as Indonesia gradually shifts from a savings-oriented
\nsociety to an investment-oriented society.<\/p>\n
Banks will have to diversify their business as they face
\nintense competition from new types of liquid assets and yield
\nattractive financial instruments provided by insurance and
\nsecurities companies. In such a situation, financial deregulation
\nmight be unavoidable to allow more extensive integrated financial
\nservices diversification within complex financial conglomerate
\nstructures.<\/p>\n
For that reason FSAI must ensure its competency to conduct
\nregulations and to supervise financial conglomerates. FSAI should
\nalso be able to mitigate the risk of financial conglomerates in
\norder to maintain the financial market stability.<\/p>",
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