IMF warns of new bank regulator

Berni K. Moestafa, The Jakarta Post, Jakarta

Creating a new financial regulator is by no means a simple task. And a new entity in the making shows the potential for dragging the banking sector through a detour in its road to recovery, according to one study by the International Monetary Fund (IMF).

The Financial Sector Supervisory Institution (FSSI), as it is called, will oversee the banking, securities, and insurance sectors under a role now held by various regulators.

The FSSI is expected to streamline regulation of the financial sector, with the government hoping to have it up and running by the end of this year.

But getting there would put banks through new risks that are part of the change process, according to the IMF.

"Any change process involves risks, and the greater the proposed structural change the greater the risk," the IMF said in a paper issued in 2000 that examined the pro and cons of unifying financial sector supervision.

For Indonesia, the transition period could plunge banks into new uncertainties at a time many are still struggling to overcome the impact of the late '90s financial crisis.

"The change process may result in a serious reduction in existing regulatory capacity unless it is well-managed," the paper said.

"This is likely to be of particular concern in transitional or developing economies, where regulatory capacity may, in any case, already be relatively weak."

The paper said that in developing countries, where most financial sectors were centralized on banks, ample steps should be taken to assure banking supervision would not be compromised.

The local banking sector makes up about 80 percent of its financial sector, according to government estimates.

Any weakening in banking supervision would expose banks to added risk, as the threat of bank failure still remain high four years after the government bailed out the sector.

This has led Bank Indonesia to continue to retain 14 of the country's largest banks on its intensive-watch list, which normally is reserved for deeply troubled banks.

Bank Indonesia supervises bank operations as part of maintaining financial stability, but will lose that authority once the FSSI takes charge.

Subsequently, Bank Indonesia was the first to air concern over the FSSI, which, due to its crucial role in the financial sector, central bank officials charged as too dubious.

They warned that a lack of coordination between the two bodies could slow the response time in the event another banking crisis loomed.

It is unclear how the FSSI will coordinate, within the financial sector, its role with that which Bank Indonesia has on the monetary sector. Legislators have yet to produce an FSSI law.

"In any case, the benefits of change should be relatively clear and unambiguous before embarking on a proposed unification," the IMF's paper said.

The government said that one benefit of a unified supervision was to better control the operations of financial conglomerates.

Although many of the local ones have lost their ownership in banks as a result of the economic crisis, many have maintained interests across a number of firms that are being supervised by different regulators.

"Experience has shown that, while these firms generally claim to have financial "fire walls" between their various operations, they often prove to be illusory when serious difficulties arise," the IMF's paper explained.

Another benefit, it said, was in developing rules that were more flexible than could be achieved with separate regulating agencies.

"Whereas the effectiveness of a system of separate agencies can be impeded by turf wars or a desire to pass the buck, these problems can be more easily limited and controlled in a unified regulatory organization," it said.

But it added that if the benefits of unification were not clear or the cost too high, more modest institutional changes might suffice.

These, it said, could range from the formation of a unified oversight board to shared facilities with the central bank.