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Indonesia

Core Principles for Effective Banking Supervision

Summary
A 2007 report by the International Monetary Fund (IMF) mentions that since the financial crisis of the 1990s, Indonesia has made rapid strides in aligning its banking sector supervisory practices with international standards. Over the years, Bank Indonesia (BI), the banking sector supervisor, has diligently conducted self-assessments of its supervision practices against the Basel Core Principles (BCPs). In its 2006 Banking Supervision Report the BI alludes briefly to a 2005 self-assessment which indicates that Indonesia is compliant with ten BCPs; largely compliant with thirteen; materially non-compliant with one; and non-compliant with one. Apart from this reference made to a self-assessment in the 2006 Banking Supervision Report, there is little further information publicly available addressing Indonesia's compliance with the BCPs. The IMF's 2007 report states that, in 2005, the BI introduced a tightening of certain prudential regulations relating to loan/asset classification and provisioning, in adherence with BCP requirements. However, the report adds that, in 2006, the BI modified these classification standards, thereby undermining the BI's credibility. Nevertheless, according to a 2006 report by Goeltom, one of several medium-term policies put forth by the BI is to create an effective system for bank regulation and supervision, in line with international standards.

    General Overview

    A 2007 report by the IMF titled "Indonesia: Selected Issues," indicates that, over the past several years, Indonesia has "made greater strides to strengthen banking supervision, align the regulatory framework with international practices, and improve risk management capabilities in the banking sector" (p. 57). A 2004 Selected Issues report by the IMF mentioned Indonesia's efforts to bring its banking supervision practices in line with the Basel Core Principles (BCPs). The 2004 report pointed specifically to changes in prudential regulations issued in 1998 and 1999 that brought the country's prudential norms generally into line with the BCPs. The 2007 IMF report states that, in 2005, the Bank Indonesia (BI) introduced a tightening of certain prudential regulations relating to loan/asset classification and provisioning in adherence with the BCP requirements. However, the same report noted that in 2006, the BI modified these loan classification standards, in effect, undermining the BI's credibility. A 2007 Article IV report by the IMF points to a further relaxation of provisioning and loan classification rules in April 2007. According to this report "while the measures are limited and intended to be temporary, some imply departures from international standards and risk having an adverse signaling effect on supervisors and banks" (p. 24).
    In 2003, the G-8 published a report in which it referred to an IMF assessment of Indonesia's banking supervision practices and concluded that Indonesia was fully compliant with two Core Principles (CPs): CP1 and CP2. It added that Indonesia was largely compliant with fourteen CPs; materially non-compliant with eight CPs; and non-compliant with one CP. However, the IMF assessment is not publicly available, and later IMF documents make no reference to this assessment. The G-8 report also mentioned the Indonesian authorities adoption of a Master Plan that "intended to provide a framework for the implementation of the broad reform efforts necessary to establish a bank supervisory process that fully incorporates international standards such as those outlined by the Basel Committee on Banking Supervision in its 25 Basel Core Principles (BCP) document" (p. 28).
    In 2006, the BI published the findings of its 2005 self-assessment in that year's Banking Supervision Report (herewith called 2006 BI report). This report found that Indonesia is: compliant with ten BCP; largely compliant with thirteen; materially non-compliant with one; and non-compliant with one. It is worth noting that this is one of many self-assessments undertaken by the Indonesian authorities in recent years. According to the 2006 BI report, the 2005 assessment was conducted by Alan Ball, an IMF assessor, in October 2005. However, the comprehensive assessment is not publicly available. The 2006 BI report offers only a summary of its findings.
    The Bank Indonesia was set up as an independent central bank by the enactment of the Central Bank Act of 1999, according to the BI website. The website further notes that the BI's functions include the regulation and supervision of banks through the granting and revoking of bank licenses. The BI conducts both direct and indirect supervision and imposes sanctions on noncompliant banks. Per the 2006 BI report, the Indonesian Banking Architecture (IBA) of 2004 defines banking policy. The IBA was fully implemented in 2006. According to the 2006 BI report, the "IBA is a comprehensive, basic framework that sets forth the direction, outline and working structures for the banking industry [with a] vision to achieve a sound, strong, and efficient banking system for achieving financial system stability in support of national economic growth" (p. 23).
    M. Goeltom reported in 2006 that the IBA provides a comprehensive framework for the banking system for the medium-term. According to Goeltom, the IBA is divided into six pillars with the following objectives: "(1) to establish a robust structure for the domestic banking system, capable of meeting the needs of the public and promoting sustainable economic development; (2) to create an effective system for bank regulation and supervision in line with international standards; (3) to build up a strong, highly competitive banking industry, resilient in the face of risks; (4) to ensure good corporate governance for internal strengthening of the national banking industry; (5) to provide a complete range of infrastructures to support the creation of a healthy banking industry; and (6) to empower and protect consumers of banking services" (p. 246).
    The 2006 BI report mentions that in 2006 there were a total of 260 banks operating in Indonesia, of which 130 were commercial banks, 5 were state owned banks, and 11 were foreign-owned banks. Of the total assets, however, 55.5 percent was controlled by state-owned banks, 41.9 percent was owned by foreign banks and only 2.6 percent was in hands of local private banks. Another important aspect of Indonesia's banking system is the presence of Islamic banks, which saw a noticeable increase in 2006. The BI added that "encouraging levels of commercial bank performance were reflected in strong capital, improving quality of earning assets, stable profitability and high liquidity" (p. 14). Furthermore, Basel II is expected to be implemented by banks in 2008 and, according to the BI report, the authorities have prepared a road map for its phased implementation.


    The Principles

    1. (1) Clear responsibilities and objectives for each supervisory agency.

    In 2003, the G-8 published a report that cited an IMF assessment of Indonesia's banking supervision practices. The G-8 concluded that Indonesia was fully compliant with this principle. However, this assessment is not publicly available and there is no information in later IMF documents pertaining to this assessment. Further the 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    1.(2) Operational independence and adequate resources.

    Refer to Principle 1. (1).

    1.(3) A suitable legal framework for authorization and ongoing supervision.

    In 2003, the G-8 published a report in which it cited an IMF assessment of Indonesia's banking supervision practices and concluded that Indonesia was fully compliant with this principle. However, this assessment is not publicly available and there is no information in later IMF documents pertaining to this assessment. Further, the 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    Per the 2006 BI report, the IBA defines banking policy. It was put forth in 2004 and fully implemented in 2006. The report states that "IBA is a comprehensive, basic framework that sets forth the direction, outline, and working structures for the banking industry [with a] vision to achieve of a sound, strong, and efficient banking system for achieving financial system stability in support of national economic growth" (p. 23).

    1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

    In 2003, the G-8 published a report in which it cited an IMF assessment of Indonesia's banking supervision practices and concluded that Indonesia was fully compliant with this principle. However, this assessment is not publicly available and there is no information in later IMF documents pertaining to this assessment. Further the 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    Per the 2006 BI report, the IBA defines banking policy. It was put forth in 2004 and fully implemented in 2006. According to the 2006 BI report, the "IBA is a comprehensive, basic framework that sets forth the direction, outline and working structures for the banking industry [with a] vision to achieve of a sound, strong, and efficient banking system for achieving financial system stability in support of national economic growth" (p. 23). However, the report notes that "Bank Indonesia does not have legal powers to investigate cases of suspected banking violations" (p. 7).

    1.(5) Legal protection for supervisors.

    Refer to Principle 1. (1).

    1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

    Refer to Principle 1. (1).

    2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

    In 2003, the G-8 published a report in which it cited an IMF assessment of Indonesia's banking supervision practices and concluded that Indonesia was fully compliant with this principle. However, this assessment is not publicly available and there is no information in later IMF documents pertaining to this assessment. Further the 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which it finds Indonesia to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. The report states that "Bank Indonesia has issued a regulation on Implementation of Good Corporate Governance for Commercial Banks. The regulation, which [took] effect in 2007, requires the banking industry to comply with 5 (five) fundamental principles: transparency, accountability, responsibility, independence and fairness" (p. 30). The report adds that the BI has issued a regulation on Risk Management Certification for Managers and Officers of Commercial Bank which is expected to become effective in August 2010 and will require fit and proper test for managers and executive officers of commercial banks.

    4. Authority to review and reject transfer of ownership.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    5. Authority to review major acquisitions and investments.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is found to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. Per a 2006 report by Goeltom in July 2005, the BI issued regulation requiring commercial banks to have a minimum tier 1 capital of IDR 80 billion by end-2007 and IDR 100 by end-2010. The report also noted that any banks failing to meet this requirement will be subject to several sanctions. Banks are required to submit reports containing strategies for achieving the required capital levels and the current state of progress. The IMF's 2007 Selected Issues report indicates that after the 1997-1998 financial crises, the Indonesian authorities introduced a preventive framework that included bringing back capital adequacy requirements from 4 percent to 8 percent of risk-weighted assets.

    7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is found to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. The IMF's 2007 Selected Issues report indicates that after the 1997-1998 financial crises, the Indonesian authorities introduced a preventive framework that included setting up prudential regulations such as improved loan-loss provisioning regulations. However, the report also mentions that "in January 2006, [the] BI modified the uniform loan classification standards so as to apply only to the 50 borrowers whose loans are the largest exposures of a bank, or to loans of Rp 25 billion (US$2.7 million) or greater" (p. 54). The report adds that the "policy reversals could undermine BI policy credibility" (p. 54).

    9. Prudential limits and management information system on concentration of exposure.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. The IMF's 2007 Selected Issues indicates that after the 1997-1998 financial crises, the Indonesian authorities introduced a preventive framework that included setting up prudential regulations such as narrowing legal lending limits.

    10. Arm's length rule and monitoring for connected lending.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. The IMF's 2007 Selected Issues report indicates that among its post-financial crisis measures Indonesia set out the definition of, and the limits on, large exposures to both related and non-related parties.

    11. Policies and procedures for country risk and transfer risk.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. According to a 2004 report by the IMF, during the period 2000-2003, the BI introduced market-risk capital charge to its banking supervision framework.

    13. Comprehensive risk management processes.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. According to a 2004 report by the IMF, during the period 2000-2003, the BI made enhanced bank supervision by the completion of a risk-based supervision manual; development of risk management and internal control guidelines.

    14. Adequate internal controls.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. According to a 2004 report by the IMF, during the period 2000-2003, the BI introduced internal control guidelines to its banking supervision framework.

    15. Strict "know-your-customer" rules and high ethical and professional standards.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. A 2007 report by the U.S. Department of State (DoS) notes that the BI issued Regulation No. 3/10/PBI/2001 titled "The Application of Know Your Customer Principles," which requires banks to obtain information on prospective customers, including third party beneficial owners, and to verify the identity of all owners. The DoS report adds that the regulation "requires banks to establish special monitoring units and appoint compliance officers responsible for implementation of the new rules and to maintain adequate information systems to comply with the law. Finally, the regulation requires banks to analyze and monitor customer transactions and report to BI within seven days any suspicious transactions in excess of Rp 100 million (approximately $11,000)."

    16. Effective supervisory system consisting of on-site and off-site supervision.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. The report states that "Bank Indonesia conducts risk-based supervision through on-site supervision and off-site supervision, the latter using reports sent in by banks" (p. 42).

    17. Regular contact with bank management and understanding of bank's operations.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    18. Analytical reports and statistical returns on solo and consolidated basis.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    19. Independent validation of supervisory information through on-site examination or external auditors.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    20. Ability to supervise on a consolidated basis.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be non-compliant with this principle. Apart from this self-assessment, there is little further information publicly available addressing Indonesia compliance with this principle. According to the report, the BI's risk-based approach enables it to undertake consolidated supervision.

    21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    22. Adequate supervisory measures to ensure timely corrective action.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be largely compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment. According to the report, during 2006, the BI made improvements to the quality of its risk-based supervision, which is constantly revised and updated based on the risk profiles of banks.

    23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be materially non-compliant with this principle. Apart from this self-assessment, there is little further information publicly available addressing Indonesia compliance with this principle.

    24. International exchange of information with other supervisors.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

    25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

    The 2006 BI report refers to a self-assessment conducted by the authorities in which Indonesia is stated to be fully compliant with this principle. However, there is little further information publicly available substantiating the findings of this self-assessment.

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    Sources of Assessment

    Bank Indonesia, "BSR: Banking Supervision Report 2006," 2006. Available from Bank Indonesia website. Accessed on February 05, 2008. (BI 2006)

    G-8, "Globalization: The Role of Institution Building in the Financial Sector -- The Case of Indonesia," October 2003. Available from G-8 website. Accessed on March 05, 2008. (G-8 2003)

    Goeltom, M., "Indonesia's Banking Industry: Progress to Date," in "The Banking System in Emerging Economies: How Much Progress Has Been Made?" Bank for International Settlements Paper No. 28, Basel, Switzerland: BIS, August 2006: pp. 243-247. Available from Bank for International Settlements website. Accessed on February 05, 2008. (Goeltom 2006)

    International Monetary Fund, "Indonesia: Selected Issues," Country Report No. 07/273, Washington, D.C.: IMF, August 2007. Available from International Monetary Fund website. Accessed on February 06, 2008. (IMF 2007)

    Relevant Organizations

    Bank Indonesia (BI)

    Capital Markets Supervisory Agency -- Badan Pengawas Pasar Modal (Bapepam) (website in Bahasa Indonesia only)

    Ministry of Finance -- Departemen Keuangan (MoF) (website in Bahasa Indonesia only)



    Relevant Legislation/Regulation

    Act of the Republic of Indonesia concerning Bank Indonesia No. 23, 1999

    Act of the Republic of Indonesia Concerning Amendment to the Act of the Republic of Indonesia Concerning Bank Indonesia No. 3, 2004

    Indonesian Banking Architecture (IBA)

    Law of the Republic of Indonesia concerning the Crime of Money Laundering, No.15, 2002 (as amended by Law No. 25, 2003) https://www.imolin.org/pdf/imolin/Indon25.pdf

    Bank Indonesia Regulation concerning Good Corporate Governance Implementation by Commercial Banks Number 8/4/Pbi/2006, 2006

    Regulation of Bank Indonesia concerning Amendment to Regulation of Bank Indonesia Regarding Implementation of Good Corporate Governance for Commercial Banks Number 8/14/Pbi/2006, 2006



    Supplementary Sources

    Bank Indonesia, "Financial Stability Review 2007," No. 9, Jakarta, Indonesia: Bank Indonesia, September 2007. Available from BI website. Accessed on January 25, 2008. (BI 2007)

    Bank Indonesia website. Accessed on February 12, 2008. (BI website)

    International Monetary Fund, "Indonesia - Selected Issues," Washington, D.C.: IMF, July 2004. Available from International Monetary Fund website. Accessed on February 12, 2008. (IMF 2004)

    International Monetary Fund, "Indonesia: Post-Program Monitoring Discussions - Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Indonesia," Country Report No. 05/108, Washington, D.C.: IMF, March 2005. Available from International Monetary Fund website. Accessed on February 05, 2008. (IMF 2005)

    International Monetary Fund, "Indonesia: 2007 Article IV Consultation - Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Indonesia," Country Report No. 07/272, Washington, D.C.: IMF, August 2007. Available from International Monetary Fund website. Accessed on February 05, 2008. (IMF 2007)

    U.S. Department of State, Bureau for International Narcotics and Law Enforcement Affairs, "International Narcotics Control Strategy Report 2007," March 2005. Available from U.S. Department of State website. Accessed on February 05, 2008. (U.S. DoS 2007)
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