Notes on Effective Supervision of the Financial Services in Indonesia
1.The stability of Indonesian financial system has been discussed and gained widely supports especially since the financial crisis of 1998 that ruined not only the authoritarian regime but also the country’s economy.Before the crisis, there had been indications on poor corporate governance, poor risk management, rampant cronyism benefited from public largesse to powerful bureaucrats, politicians and rent-seeker businessmen, huge corporate borrowing by groups from banks with links of ownership, unhedged bank financing, poor policy coordination fiscal and monetary authorities, of which all of these constitute reckless and fraudulent behavior in banking and financial services. The crisis itself has been too costly to Indonesia as much as Rp 650 trillion or about US$ 71 billion and still has prolonged negative impacts on County’s budget and has been further deteriorating Government’s ability to promote welfare and development programs.
2.Lessons learned from the crisis is that financial system has to be stabilized and coordinated in an integrated system for all kind of financial industry such as banking, stock market, insurance, multi-finance, mutual fund and pension fund. This financial stability will be closely related and affected, first, to changes in macroeconomic environment such as inflation and interest rates. Second, to the financial performance of corporate sector and of real sector. Third, to the susceptibility of the country’s overall economic activities in case of external shocks such as changes in international oil prices and or foreign exchange rates.
3.For example, in the case of oil price hikes in March and especially in October 2005, public finance policy coordination had been severely criticized. Rather than giving solutions, monetary and fiscal authorities had been busy with excuses. Blame was more to external shock that was increased international oil prices than the failure of policy coordination. What happened then inflation rates increased to 17,1% in 2005 which was far from early prediction from government (8,6%). Unfortunately, statements from Governor of Central Bank and Minister of Development Planning, in October 2005, may be to ease public tension, suggesting that the overall inflation rates by December 2005 will be only 14% and 12%, respectively. Two different numbers indicate failure of coordination between these two institutions which responsible to the stability of the country’s financial stability. Secondly, inaccurate prediction from the very leaders would not only spoil public and market trust but also cast doubt on the precision of planning related to the country’s financial system. The rest of the case has been known that Central Bank interest rate then increased and the “reksadana” industry ruined from its large market of Rp 130 trillion down to only about Rp 30 trillion.
4.Macroeconomic stability has to be strengthened by enhancing banking industry and the development of capital market so that economic growth improved thru the growth of corporate and real sector of the economy. The development of this sector will generate employment and rise income of the people and eradicate poverty level. This circular links of economic development will be fundamentals back up to macroeconomic stability and show the benefit of that financial stability to attack the basic problem of the country: unemployment and poverty. Empirical data shows that source of fund borrowing from banking industry for corporate sector has been down from 61% of GDP in 1997 to 25% in 2005. In capital market, the situation is even worst that corporate and real sector borrowing from this source of fund has been down from 35% of GDP in 1996 to 22% in 2005. Bank financing for SMEs sector has been low. However, it shows an increased trend which was 1,2% of GDP in 1999 to about 3% in 2005.
5.What should be done? Several agendas below might be beneficial to strengthen financial stability of the country: a.Establishing an early warning system to identify the likelihood of entering into future financial crisis is a must, not only because the cost of bailing out the crisis is so huge but also the integrity of the country facing such crisis could be in danger. Watch list on several economic indicators such as increase in debt burdens, external short-term loans vis-à-vis liquidity, currency and maturity mismatches, credit rating, governance structure, etc.
b.Convertibility of external debt/loans into domestic currency scheme and or diversifying them into several baskets of foreign currencies. This is to soft the effect of unforeseeable crisis caused by changes of external environment
c.At the saving side, depository insurance scheme already in place although still need some improvement especially in its institutional capacity and guarantee scheme, but at the borrowing side a similar scheme has to be designed reasonably as part of risk management system to increase bank intermediation
d.Any financial failure that has possible contagion effects to the financial system should have been detected by the early warning system and quarantined effectively
e.Any person or institution that deal with reckless and fraudulent behavior in the financial system has to have severely punishment so moral hazard will be minimized in the system
f.According the Law Number 3/2004, article 34 (1) and (2), banking supervision has to be separated from the Central Bank. The Central Bank main function is maintaining monetary stability, mostly currency stability, while banking supervision authority or as known as Financial Supervisory Authority (Otoritas Jasa Keuangan=OJK) is to maintain financial stability. As outlined by the Law, the OJK has to be established by December 31, 2010.
g.Main objectives in supervising financial services are how to maintain market trust or public confidence, increase public awareness on the risk they are taking, shield the customer’s financial resources when dealing with financial services and minimize the possibility of financial crimes to happen.
