Thu, 25 Dec 2003

Dec.26, 2003

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.