Supervising financial services

The Manila-based Asian Development Bank (ADB) threw its weight behind the Indonesian government's initiative to establish an independent financial service supervisory authority (FSSA), asserting on Tuesday that the size of its future loan disbursements to the country would depend on the setting up of an oversight body that was separate from Bank Indonesia (the central bank).

ADB principal financial sector specialist Michael Ryan said here that Indonesia might need a larger sum of loans from the ADB to cover its fiscal gap after the termination of its program with the International Monetary Fund later this year. But he cautioned that any increase in ADB lending would be contingent upon the integration of the supervision of banks and other financial intermediaries into a single, independent authority.

The plan to set up FSSA dates back to the 1999 Central Bank Act which, among other things, gave Bank Indonesia political independence but at the same time required the hiving off of bank supervision from the central bank to FSSA by Dec. 31, 2002, at the latest.

But the plan was delayed for political and economic reasons and due to resistance from the central bank. The supervision of financial intermediaries now remains the responsibility of separate institutions. The central bank is in charge of supervising banks, the finance ministry oversees nonbank financial institutions and the Capital Market Supervisory Agency is responsible for supervising securities companies.

President Megawati Soekarnoputri recently proposed to the House of Representatives a bill on FSSA establishment, recommending that deliberations on the draft legislation be given high priority. However, the central bank has lobbied the House to postpone enactment of the bill, arguing that FSSA establishment would be feasible only within the next five to 10 years in view of severe funding restrictions.

Most countries have traditionally considered it ideal to place banking supervision under the umbrella of central banks because this function is key to the conduct of monetary policy and financial stability oversight. After all, wherever bank supervisors are physically located they must work closely with the central bank to manage systemic stability in the financial system.

Moreover, achievement of the central bank's macro objectives of maintaining monetary and price stability is still dependent upon the maintenance of micro-level financial stability in the payments and banking systems, and the smooth working of the whole financial system.

There has, nevertheless, been a recent trend toward the hiving off of banking supervision to a separate agency, as Britain, Japan, South Korea, Australia and several other European countries have done.

Supporters of this tendency argue that the dividing lines between differing kinds of financial institutions become increasingly fuzzy and the continuation of banking supervision by the central bank threatens inefficient overlap between supervisory bodies.

But insofar as Indonesia is concerned, the demand for shifting bank supervision away from Bank Indonesia has been prompted by the perception that incompetence and a corrupt mentality within the central bank's banking supervision department was largely responsible for the banking crisis in 1997 and 1998.

Witness how the government and the central bank have been in dispute since 1999 over how to share the losses incurred by the massive injection of Rp 144 trillion (US$17.5 billion) in liquidity support into the banking system by the central bank during the height of the crisis.

This trauma should have greatly influenced the government and House members to insert a special stipulation into the 1999 Central Bank Act calling for the integration of the supervision of all financial intermediaries into a single, independent authority.

Moreover, as the law has provided the central bank political independence, lawmakers at that time seemed to be concerned that the concentration of operational independence in monetary policy and supervisory authority in the hands of the central bank, not only would make the nonelected body too powerful, but could also cause conflicts of interest.

Whatever the benefits of integrating the supervision of all financial intermediaries -- in fact, there are very few case studies on which to draw a final conclusion -- the government needs to tread very carefully in setting up the FSSA.

Funding is not the only issue here. The transfer and integration of thousands of personnel from dozens of departments at the central bank, finance ministry and Capital Market Supervisory Agency, currently in charge of separately supervising banks, nonbank financial companies and securities firms into a single body, is a very complex process.

Since the bill on the amendments to the 1999 Central Bank Act is designed also to reinstate the central bank's role as the lender of last resort, it is vital that the flow of information between bank supervisors and the central bank remains smooth and effective, however the FSSA may be organized and structured. After all, the transmission mechanism of monetary policy flows mainly through financial intermediation within the banking system.

Thorough preparations are needed and, we think, there is not much urgency to set up the FSSA this year. A poorly designed, inadequately structured FSSA could, instead, endanger the financial service industry, which is still fragile.

Despite its notorious reputation as a "den of thieves" before 1999, the technical competence and integrity of Bank Indonesia's banking supervision department have improved greatly since it gained political independence by virtue of the 1999 Central Bank Act.

It would be best for the government and the House to deliberate the bill on FSSA together with the bill on amendments to the 1999 Central Bank Act and the bill -- yet to be proposed to the House -- regarding the establishment of a financial safety net (deposit insurance scheme) to replace the current blanket guarantee.