Central bank law amended

Central bank law amended

The turbulent political process to amend the 1999 Bank
Indonesia Act -- amendments that were proposed by the government
in late 2000 -- finally ended last week after the House of
Representatives, the finance ministry and the central bank
reached a compromise on the most contentious provisions.

The finance ministry's proposal for setting up a supervisory
body for the central bank was accommodated in the amendments --
without compromising the basic principle of political
independence for Bank Indonesia.

The central bank's political independence should indeed be
nonnegotiable, as interfering with this principle will go against
the 1945 Constitution. The final amendments allow for the setting
up of a supervisory body which is tasked only to enhance good
governance at the central bank.

The supervisory body, therefore, will be only authorized to
oversee how the central bank manages its assets, budget and
investment.

The central bank's monetary management remains fully
independent of any government interference, either from the
executive or legislative branch. This independence is also
supported by the secured tenure of its board of governors and
adequate financial resources to fund its operations.

An independent central bank is especially vital, particularly
in view of the 2004 electoral period, when the incumbent
government will be faced with great temptations to introduce
populist measures and distribute political goodies in a concerted
bid to gain voter support, at the expense of the long-term good
of the economy.

The amendments also uphold the authority of bank supervision
at the central bank until 2010 at the latest to allow for
adequate preparations to establish a single supervisory authority
for banks and other financial service institutions, including the
stock market.

Forcing the establishment of such an integrated supervisory
agency within the next two to three years as proposed by the
finance ministry could cause instability in the financial service
industry, especially as most banks have yet to fully recover from
the combined impacts of the 1997-1998 crises.

Certainly, as a consequence of this policy, the amendments
further strengthen the function of the central bank as a lender
of the last resort. As the central bank is fully in charge of
supervising banks, it is also the most competent to decide which
bank is eligible to receive emergency liquidity loans and which
should be closed for insolvency.

Integrating the supervisory authority of financial services
that is now spread among the finance ministry, Bank Indonesia and
the stock market watchdog isn't a simple process. It requires a
lot of training, reorganization and establishment of standard
working procedures and the formulation of new rules.

An adequate supervisory capability is a basic element of the
financial safety net being prepared jointly by the government and
the central bank. Other fundamental components are the lender of
last resort and deposit insurance scheme.

The amended law mandates the finance ministry and central bank
to prepare a bill jointly on the broad framework of a financial
safety net and another draft legislation on which a deposit
insurance scheme and agency will be established.

The deposit insurance scheme will replace the blanket
guarantee on bank deposits and claims that have been responsible
in part for the public's trust in banks, but which, at the same
time, have caused major contingent liabilities on the government.

Postponing the phasing out of the blanket guarantee until
after the presidential election next year is quite a wise move,
given the as yet fragile condition of the banking industry and
the political turbulence the nation is about to undergo during
the 2004 electoral period.

The final version of the amendments that were approved by the
House certainly did not satisfy all parties; yet they seemed the
best political compromise to cap a turbulent three-year
deliberation process.

Most important is that the amendments do not erode the
political independence of the central bank, but at the same time,
they require it to perform at higher standards of accountability.

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