Supervising financial services

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.