Independent BI

Independent BI

The draft law on the central bank (Bank Indonesia), proposed
to the House of Representatives on Wednesday, is part of the
overall restructuring of the banking industry. The legislation,
designed to shield the monetary authorities from the myopic
interests of politicians, will address one of the main obstacles
to the development of a sound banking system: political
interference, which, aside from the lack of technical competence,
has often been cited as one of the causes, if not the main
reason, behind the banking crisis now engulfing the nation.

The fact that most problem banks have committed egregious
violations of legal lending limits testifies to the central
bank's impotency in enforcing its prudential rulings on banks
with strong political connections. The huge sum of bad credits
suffered by state banks and the profile of their main borrowers
show how dominant political influence has been in the lending
decisions made by directors of public banks.

The long-awaited legislation will provide a legal basis for
the central bank's authority in maintaining monetary stability,
safeguarding the rupiah and setting aggregate monetary targets.

Though the central bank's governor will still be appointed by
the President, his deputies, called managing directors, are
nominated by the governor and all are secured with a five-year
tenure. They cannot be fired by the President. They can resign in
special circumstances and can be sacked only if they are
convicted of criminal acts.

However, independence or autonomy alone is not effective
enough to enable the central bank to perform its task properly.
Past experiences have shown that Bank Indonesia, as a result of
the 1968 Central Bank Act, has been tasked with so many missions
that often the bank's duties have conflicting objectives.

The new law therefore seeks to eliminate the central bank's
role as supervisor of the banking sector by mid-2000. An
independent body is to carry out this function, and the central
bank will resume its role as a lender of last resort in the real
sense. This means that the central bank will provide emergency
funds only to temporarily illiquid banks, and not to insolvent
banks, as it has done until now. Bank Indonesia will also be
freed from the task of providing subsidized credit to farmers and
small businesses and other government-sponsored development
programs.

Its autonomous status will not, however, mean that the central
bank's policy-making process will be detached from the complex
process of macro-economic management. The draft law specifically
stipulates that the central bank's governor, though not a member
of the ministerial cabinet, attends cabinet meetings and that the
economics minister is present at the central bank's monthly
meeting.

But granting statutory independence to the central bank to
protect it from the hurly-burly of politics is not in itself a
guarantee for excellent performance. After all, the central bank
does not operate in a vacuum. Hence, it also needs a constructive
policy environment, meaning a government which looks beyond the
short-term political costs of its actions and focuses on the
long-term good of the economy.

Having the right people in the central bank is another
prerequisite. The central bank's governor, managing directors and
other key personnel must show not only excellent professional
qualifications but also a convincingly high degree of personal
independence and integrity.

Autonomy could lead to arbitrary decisions if the central
bank's independence is not underpinned by openness, transparency
and accountability. It is most important therefore that the
central bank announces to the public its annual financial targets
as a guidepost to its monetary policy stance in the year ahead.
The declaration of quantitative targets demonstrates the
projected path of monetary policy for everyone to follow and to
consider when making financial decisions. As, in the final
analysis, public support is pivotal to the effectiveness of the
central bank's monetary policies.