Improving bank supervision

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.