Improving bank supervision
It is encouraging to note that amid the political battle to take control of Bank Indonesia (central bank), both the government and the House of Representatives remain fully aware of the vital importance of effective supervision in preventing a financial crisis. Bank Indonesia's deputy governor Achjar Iljas confirmed over the weekend that an integrated financial supervision agency would be set up sooner than the December, 2002 deadline, as stipulated in the 1999 Central Bank Law.
Though the feasibility of the new schedule for establishing such an important institution is still debatable as a new law has yet to be enacted to become the legal foundation of its operations, the drafting of the required legislation would be better started right now so as to coincide with the proposed amendments of the central bank law.
The need for an independent financial supervision agency that is free from political intervention had, in fact, been felt immediately after the financial crisis in late 1997 as analyses then strongly confirmed that weak, ineffective supervision by the central bank was one of the main reasons of the banking crisis. As the audit of the multi-billion dollar in emergency liquidity support poured into ailing banks during the peak of the crisis in 1998 and early 1999 has found out, the central bank was mostly in the dark about which of the banks were simply illiquid and which were already insolvent. No wonder, quite a portion of the liquidity loans has not adequately been covered by collateral and may not be recovered at all.
Part of the problem was resolved in May, 1999 by the enactment of the central bank law that grants political independence to Bank Indonesia. But since establishing a completely new, independent supervision agency from scratch takes a lot of time and requires a new law, bank supervision remains under the authority of Bank Indonesia. However, two articles of the central bank law stipulate that bank supervision shall be integrated into an independent financial supervision agency that is separate from Bank Indonesia. This new supervision agency, which will also be charged with overseeing non-bank financial institutions, such as leasing and insurance companies and pension funds, will have to be set up by the end of 2002 at the latest.
Drafting the law on an integrated financial supervision agency along with the amendments of the 1999 central bank law will prevent duplication or overlapping authority between Bank Indonesia and the new agency, especially with regard to the regulatory function of the banking industry. Even though the central bank law calls for the separation of banking supervision from Bank Indonesia, the legislation still stipulates that the central bank will retain the regulatory and guidance function in the banking industry. This provision, if retained, may become a source of dispute in the future between the central bank and the new supervision agency.
But of most importance in the preparations for the new financial supervision agency is to ensure that the law on the new institution should guarantee its independence from undue political influence in the exercise of its mandate, especially concerning its decisions with regard to individual financial institutions, the areas of licensing, closure and liquidation.
However, the law on the new financial supervision agency should avoid the shortcomings of the 1999 central bank law that virtually vests Bank Indonesia with absolute power because the provisions on its independence are not supplemented with clear rules on accountability and performance standards.
Moreover, an effective financial supervision system needs to be sufficiently transparent so that supervisors can be seen to be exercising their power in a way which is beneficial to the objectives of maintaining a stable and sound financial system, and that their performance can be monitored by the government, the supervised institutions and the public at large. To ensure the accountability of supervisors, the shareholders or directors of supervised institutions should also be provided with a legal recourse to appeal against the actions or decisions of the supervisors.
As the central bank, which is now still in charge of supervising banks pending the establishment of the new integrated financial supervision agency, is already independent and adequately competent, there is actually no urgency in hastening the setting up of the new agency. Most important is that the legislative foundation of the new financial supervision institution and its staffing and resources should be prepared thoroughly.