## IMF FSAP — Indonesia (cr17152)

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**Canonical URL:** [IMF FSAP — Indonesia (cr17152)](https://www.imf.org/-/media/files/publications/cr/2017/cr17152.pdf)

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### Executive summary — background, cyclical dynamics, and financial structure
- Growth: "around 5-6 percent" since 2010 FSAP.
- Fiscal: fiscal deficit kept below the statutory "3 percent of GDP" ceiling.
- Monetary and exchange-rate policy: exchange rate and bond yields allowed to adjust broadly; BI occasionally intervened; monetary policy responded to inflationary and balance of payments pressures.
- Macroprudential: tightened to contain rapid mortgage loan growth; BI partly unwound earlier tightening as inflationary pressures eased.
- Cyclical dynamics:
  - Slowdown began in 2013, bottomed out in 2015; a small rebound in 2016 projected to continue over the medium term.
  - Credit growth peaked in 2011; credit-to-GDP gap falling steadily since 2013.
  - Household bank debt: "17 percent of GDP".
- Infrastructure financing challenge: 2015 government infrastructure program entails investments of roughly "US$450 billion (about 50 percent of GDP) in 2015-19".
- Financial system size and composition:
  - Total financial sector assets: "about 72 percent of GDP (end-2015)".
  - Bank assets: "55 percent of GDP".
  - Insurance companies: "7 percent of GDP".
  - Over ten years to 2015, total assets grew by "some 8 percentage points of GDP"; more than half of increase from NBFIs, particularly insurance companies.
  - Financial conglomerates (FCs): "49 FCs account for 70 percent of aggregate assets"; bank-led FCs hold "over 90 percent of FC assets"; more than half of FCs have a horizontal structure with an unregulated holding company.

### Systemic risk assessment and banking-sector resilience
- Overall judgment:
  - Systemic risk: "low"; banking system generally resilient to severe shocks.
  - Market-based indicators: relatively low systemic risk.
- Banking-sector health:
  - Profitability: high historically but fallen somewhat; system-wide return on assets average "2.7 percent" over the past decade; "1.7 percent" in 2016Q3; return on equity "11.7 percent (2016Q3)".
  - Capitalization: strong and well above regulatory minima.
  - Asset quality: NPLs increased from "1.7 percent in 2013" to "3.0 percent in late 2016"; special-mention loans around "4–5½ percent"; restructured loans up by "about 2½ percent of total loans" since June 2015.
- Stress-test highlights (most severe adverse scenario):
  - Real GDP deviates by "17 percentage points from the baseline by 2018 (equal to 2.4 standard deviations)".
  - Corporate sector NPL ratio would increase to "almost 19 percent in 2018".
  - Banking system losses: "13 percent of RWA (driven by credit losses of 12 percent of RWA)".
  - Thirty-eight banks accounting for "a third of banking system assets" would fail to meet the hurdle.
  - Aggregate capital shortfall: "0.7 percent of GDP".
- Sensitivity scenarios:
  - If all restructured and special-mention loans become NPLs and reserve coverage raised to 2009 highs: eight more banks fail; capital shortfall increases from "0.7 to 1.3 percent of GDP".
  - If net interest margins narrow by "100 basis points" throughout forecast: 12 additional banks fail; aggregate capital shortfall rises from "0.7 to 1.2 percent of GDP".
- Liquidity stress tests:
  - Simplified (all banks): aggregate liquidity shortfall of "-5.2 percent of system assets" (Rupiah: "-3.1 percent"; FX: "-2.7 percent").
  - D-SIBs (simplified): overall shortfall "-2.8 percent of system assets"; foreign currency buffers may be insufficient.
  - Cash-flows-based (D-SIBs): overall liquidity position "16.6 percent (Rupiah +46.5 percent, FX -16.6 percent)"; FX liquidity shortfall for D-SIBs in stress: "-2.8 percent (6-month horizon)".
  - Aggregate FX liquidity shortfall under stress: "2.7 percent of system assets", or about "only 6 percent of BI’s foreign currency reserves".
- Key systemic vulnerabilities:
  - Concentration: four largest banks account for almost half of banking system assets; D-SIBs account for "about 65 percent".
  - Shallow capital markets with high foreign participation amplify volatility.
  - Short-term deposit funding: nearly "90 percent" of deposits have maturity of less than 90 days.
  - Heterogeneity: smaller banks show wider dispersion in FSIs and greater vulnerability.

### Banking system structure, market depth, and key financial-soundness indicators
- Banking system structure:
  - Four largest banks (three majority government-owned) account for "almost half" of assets.
  - D-SIBs account for "about 65 percent" of assets.
  - "Slightly more than 20 banks" to reach 80 percent market share.
  - Four state-owned banks and "26 regional development banks" account for nearly half of assets.
  - Interbank market exposures: "3 percent of banks’ assets".
- Market depth and foreign participation:
  - Outstanding domestic debt securities: "16 percent of GDP (end-2015)".
  - Stock market capitalization: "41 percent of GDP (end-2015)".
  - Foreign investors hold "38 percent of government securities" (Asia average cited as "26 percent").
- Selected FSIs (exact figures unless otherwise noted):
  - Regulatory capital to risk-weighted assets: "20.6 percent (2016Q3)".
  - Regulatory Tier-1 capital to risk-weighted assets: "20.6 percent (2016Q3)".
  - Capital to assets: "15.0 percent (2016Q3)".
  - Over "90 percent" of bank capital is common equity tier-1.
  - Liquid assets to short-term liabilities: "33.1 percent (2016Q3)".
  - System-wide loan-to-deposit ratio: "99.2 percent (2016Q3)".

### Appendix II — detailed FSIs (selected time series)
- Capital adequacy (regulatory capital to RWA): "16.2 percent (2010)", "16.1 percent (2011)", "17.3 percent (2012)", "19.8 percent (2013)", "18.7 percent (2014)", "21.3 percent (2015)", "20.6 percent (2016Q3)".
- Asset quality (NPLs to gross loans): "2.5 percent (2010)", "2.1 percent (2011)", "1.8 percent (2012)", "1.7 percent (2013)", "2.1 percent (2014)", "2.4 percent (2015)", "3.0 percent (2016Q3)".
- Profitability (ROA): "2.7 percent (2010)", "2.9 percent (2011)", "3.1 percent (2012)", "3.1 percent (2013)", "2.7 percent (2014)", "2.2 percent (2015)", "1.7 percent (2016Q3)".
- Liquidity assets to total assets: "27.2 percent (2010)", "26.2 percent (2011)", "25.7 percent (2012)", "23.5 percent (2013)", "22.9 percent (2014)", "23.9 percent (2015)", "22.1 percent (2016Q3)".
- Foreign-currency loans to total loans: "15.6 percent (2010)", "16.6 percent (2011)", "15.2 percent (2012)", "17.0 percent (2013)", "16.3 percent (2014)", "15.6 percent (2015)", "14.2 percent (2016Q3)".
- Real estate loans to total loans: "13.8 percent (2010)", "14.2 percent (2011)", "13.8 percent (2012)", "14.3 percent (2013)", "15.1 percent (2014)", "15.6 percent (2015)", "16.2 percent (2016Q3)".

### Financial sector oversight, governance, and supervisory recommendations
- Institutional reforms since 2010: Basel III implemented; new Insurance Law adopted (effective October 2014); OJK established in 2011; BI developed systemic-risk tools and macroprudential instruments; 2016 PPKSK Law revamped crisis management.
- Key governance and supervisory issues and recommendations:
  - Mandates and legal protection:
    - Revise OJK Law to give primacy to financial stability; amend BI Law to include financial stability and macroprudential mandate covering systemic risk and access to data; revise LPS Law to focus objectives on financial stability, continuity of critical functions, protection of insured deposits, and minimization of resolution costs. (See FSAP Key Recommendations: ¶32, 38, 43.)
    - Strengthen legal protection of supervisors and officials in line with global standards.
  - OJK internal structure and approach:
    - Reduce silo structure; remove responsibilities of individual Commissioners for supervision of specific sectors; create cross-sector teams and harmonized regulations. (FSAP Key Recommendations: ¶31.)
    - Promote a more intrusive supervisory approach across sectors, including rigorous evaluation of risk management and internal audit functions.
  - Financial conglomerates (FCs):
    - Grant OJK power to require and license non-operating financial holding companies; strengthen group-wide supervision and governance; require FCs to create integrated governance, risk management, and capital plans. (FSAP Key Recommendations: ¶28, 29.)
  - Sectoral supervision:
    - Strengthen enforcement of credit and risk management regulations; revise insurance supervisory "three strikes" approach to allow prompt actions. (FSAP Key Recommendations: ¶35, 37.)
  - Macroprudential capabilities and coordination:
    - Strengthen BI capacity for systemic risk analysis and macroprudential stress tests; strengthen OJK capacity for regulatory stress tests and conduct bottom-up stress tests for D-SIBs regularly. (FSAP Key Recommendations: ¶24.)
    - Introduce a foreign currency liquidity coverage ratio and consider LCR by significant currencies.
    - Enhance BI–OJK coordination via finalized operating procedures and consider elevating the technical forum to a policy-level forum.

### Crisis management, financial safety nets, and operational capacities
- Legal and institutional updates:
  - PPKSK Law (2016) established KSSK and clarified crisis management roles; LPS serves as deposit insurer and bank resolution agency.
- Key recommendations and issues:
  - KSSK should be a coordination body and not have power to direct member agencies; consider amending PPKSK Law accordingly. (FSAP Key Recommendations: ¶43.)
  - PPKSK Law currently rules out public funding in resolution; amend to allow public funding in limited circumstances subject to safeguards and Presidential approval.
  - Presidential role: President decides whether a financial system crisis exists and whether LPS may use broader tools (e.g., bail-in); recommend narrowing Presidential role to decisions involving public funding to avoid diluting LPS and KSSK responsibility.
  - LPS and resolution:
    - Amend LPS and PPKSK Laws to specify triggers for resolution, empower LPS to require changes to facilitate resolution, enable bail‑in without Presidential approval, and ensure resolution powers cover FCs. (FSAP Key Recommendations: ¶45.)
    - Develop resolution options and implementation guidelines for banks; build resolvability assessments and resolution planning frameworks for D‑SIBs. (FSAP Key Recommendations: near term.)
  - Emergency Liquidity Assistance (ELA):
    - Adjust ELA framework to ensure effectiveness; consider extending ELA eligibility to banks assessed as viable by OJK even if temporarily below capital minima; coordinate solvency assessments, eligible collateral, and potential government indemnities with safeguards. (FSAP Key Recommendations: ¶48.)

### Financial deepening, market development, and inclusion
- Strategic priorities:
  - Authorities aim to deepen financial markets while protecting stability; recommend an integrated roadmap to promote financial deepening and inclusion. (FSAP Key Recommendations: ¶50.)
  - Roadmap priorities: strengthen creditor rights, address tax issues, and improve debt restructuring practices; consolidate debt issuance and improve secondary markets to enhance the bond yield curve. (FSAP Key Recommendations: ¶53.)
- Capital markets and institutional investor metrics (exact figures):
  - Stock market capitalization: "41 percent of GDP in 2016" (peer median "74 percent").
  - Government debt: "about 27 percent of GDP", with nearly "three‑quarters denominated in rupiah".
  - Corporate bond market: "2½ percent of GDP", two‑thirds by financial institutions.
  - Domestic institutional investor base: pension fund and insurance company assets around "2 and 7 percent of GDP", compared to "5 and 15 percent" in peers.
- Financial inclusion and digital finance:
  - Account ownership: "39 percent of adults have a transaction account" (World Bank Findex; up from "20 percent in 2011"); regional average "69 percent".
  - National Financial Inclusion Strategy (November 2016) goal: "75 percent by end‑2019".
  - E‑money and agent networks present in all provinces; servicing basic accounts currently costly given transaction volumes.

### Insurance sector—IAIS ROSC findings and supervisory gaps
- Assessment details:
  - Assessed against IAIS ICPs (October 2011, revised November 2015); assessment dates "September 21 to October 4, 2016".
- Sector features and risks:
  - Insurance sector grew "average of 20 percent per year" over last 5 years.
  - About "half of insurers belong to conglomerates", bancassurance prominent.
  - OJK introduced risk-based supervision and issued "more than 100 new regulations" since 2014.
- Main deficiencies and recommendations:
  - Lack of effective group regulation and supervision of insurance groups; intra-group transactions and possible double gearing not well addressed.
  - Legal framework: OJK Law does not recognize protection of policyholders as the primary objective; OJK, Commissioners and staff lack robust legal protection for acts done in good faith.
  - Supervisory capacity gaps: need for more actuarial expertise, thematic reviews of reserving, clearer guidance on control functions, and review of the "three strikes" enforcement approach.
  - Valuation and capital:
    - Concerns with discount rate methodology (3-year average) and suspension of mark-to-market valuation in 2015; catastrophe risk and contagion from related parties need stronger treatment in RBC.
  - Market conduct and intermediaries:
    - Disclosure requirements for intermediaries lack information on terms, relationships, and remuneration; cyber and operational risks need attention given internet/mobile sales growth.
- Key recommended actions mapped to ICPs include: specify policyholder protection as OJK’s primary objective; strengthen legal immunity and indemnification for OJK staff; expand fit-and-proper and suitability requirements; revise licensing clarity; establish dedicated risk management and internal control regulations; revise enforcement and valuation frameworks; enhance group-wide supervision and cross-border cooperation.

### AML/CFT progress and outstanding actions
- Progress:
  - AML law amendments (2010) and CFT law (2013) criminalized ML and TF per revised FATF standard and extended requirements to MVTS/remittance providers.
  - New procedures for freezing terrorist assets under UNSC Resolutions aided exit from FATF monitoring in 2015.
  - National ML/TF Risks Assessment completed in 2015; co-led regional TF multi‑country assessment.
  - APG scheduled to assess Indonesia’s regime in late 2017.
- Remaining gaps and recommendations:
  - Align AML/CFT framework more closely with revised FATF standard.
  - Ensure AML/CFT supervision is risk‑based and align agency priorities with identified ML/TF risks.
  - Enhance law enforcement capacity for financial investigations and improve information exchange with foreign counterparts.
  - Introduce legal requirement for reporting entities to identify, assess, and understand their broader ML/TF risks.
  - Implement targeted financial sanctions regime for terrorism and TF without delay.

*Source: IMF Financial Sector Assessment Program, Indonesia — Executive Summary and selected chapters (cr17152).*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Background
- Since the 2010 FSAP, macroeconomic performance has been robust with growth remaining strong at around 5-6 percent.
- Macroeconomic policy and outcomes:
  - Fiscal deficit kept below the statutory 3 percent of GDP ceiling.
  - Exchange rate and bond yields allowed to adjust broadly; BI occasionally intervened to prevent disorderly conditions.
  - Monetary policy responded to inflationary and balance of payments pressures.
  - Macroprudential policy was tightened to contain rapid mortgage loan growth and moderate housing price increases; BI partly unwound earlier macroprudential tightening as inflationary pressures eased and credit cycle eased.
- Recent cyclical dynamics:
  - Slowdown began in 2013, bottomed out in 2015; a small rebound in 2016 is projected to continue over the medium term (Appendix I).
  - Credit growth peaked in 2011; the credit-to-GDP gap has been falling steadily since 2013.
  - Household bank debt remained low at 17 percent of GDP.
- Infrastructure financing challenge:
  - Government infrastructure program (2015) entails investments of roughly US$450 billion (about 50 percent of GDP) in 2015-19, requiring mobilization of a broad investor base and new instruments (e.g., long-term infrastructure bonds).
- Financial system structure:
  - Total financial sector assets equal about 72 percent of GDP (end-2015); bank assets equal 55 percent of GDP; insurance companies equal 7 percent of GDP.
  - Over the ten years to 2015, total assets of financial institutions grew by some 8 percentage points of GDP; more than half of the increase contributed by NBFIs, particularly insurance companies.
  - Financial conglomerates (FCs) are prominent: 49 FCs account for 70 percent of aggregate assets of financial institutions; bank-led FCs hold over 90 percent of FC assets; more than half of FCs have a horizontal structure with an unregulated holding company.

### Systemic Risk Assessment
- Overall judgment:
  - Systemic risk is low and the banking system appears generally resilient to severe shocks.
  - Market-based indicators point to relatively low levels of systemic risk.
- Banking sector health and performance:
  - Banking system remains sound despite slowed economic growth: high profitability has fallen somewhat and problem loans have risen.
  - Banks’ capitalization remains strong and well above regulatory minima.
- Stress test findings:
  - Under severe stress test scenarios, banks experience sizable credit losses, particularly from corporate exposures.
  - High capital and strong profitability help absorb most losses; resulting capital shortfalls are modest.
  - Many banks face relatively small shortfalls in liquidity stress tests, including in foreign-currency; these appear manageable for Bank Indonesia (BI).
- Corporate vulnerabilities:
  - Corporate vulnerabilities broadly in check, though debt-at-risk is elevated in some sectors and external refinancing risk persists.
- Market perceptions:
  - Market indicators and a “Bird’s-Eye View on Systemic Risk” suggest low systemic risk (Figure 7).

### Financial Sector Oversight and Governance
- Institutional reforms since 2010:
  - Basel III implemented.
  - New insurance law adopted.
  - Financial Services Authority (OJK) established in 2011 as an integrated regulator.
  - BI developed analytical tools for systemic risk assessment and introduced macroprudential instruments.
  - 2016 reforms: Prevention and Resolution of Financial System Crisis Law (PPKSK Law) revamped crisis management and safety nets; BI started reforming its liquidity management framework to spur money market deepening.
- Key supervisory and governance challenges identified:
  - Mandates and legal protection:
    - Mandates for OJK and BI should be amended to give clear primacy to financial stability over developmental objectives.
    - Clearer division of labor and responsibilities across agencies needed to reduce redundancies and foster collaboration.
    - Legal protection for staff, agencies, and contractors involved in oversight and crisis management strengthened by recent reforms but still needs alignment with best international practice.
  - OJK internal structure and supervisory approach:
    - OJK needs to break internal silos; change in Board of Commissioners structure required.
    - OJK should promote a more intrusive supervisory approach across sectors, including rigorous evaluation of risk management and internal audit functions.
    - For effective oversight of financial conglomerates, OJK must be able to oversee conglomerates regardless of organizational structure.
  - Financial conglomerates governance:
    - Improve governance and risk management within financial conglomerates.
  - Sectoral supervision adjustments:
    - Revise insurance supervisory framework (three strikes approach) to allow prompt actions.
    - Strengthen enforcement of credit and risk management regulations.
  - Macroprudential and systemic risk capabilities:
    - Strengthen BI’s capacity for systemic risk analysis and macroprudential stress tests, and OJK’s capacity for regulatory stress tests; OJK should conduct bottom-up stress tests for D-SIBs regularly.
    - Introduce a foreign currency liquidity coverage ratio.

### Financial Safety Net and Crisis Management
- Legal and institutional framework updates:
  - PPKSK Law (2016) revamped crisis management, resolution, and safety nets.
  - LPS (deposit insurance corporation) serves as deposit insurer and bank resolution agency.
  - KSSK (Financial System Stability Committee) created as a high-level body.
- Issues and recommendations:
  - KSSK should focus on coordination and should not have power to direct member agencies in their respective areas of responsibility.
  - PPKSK Law rules out the use of public funding in resolution; this restriction might be overly constraining in certain circumstances.
  - President’s central role: The President decides whether Indonesia is experiencing a financial crisis and whether LPS may use a broader set of resolution tools (e.g., bail-in); to avoid diluting LPS and KSSK responsibility for swift resolution, consider revising the law to narrow the role of the President to issues involving public funding.
  - Emergency liquidity assistance framework needs adjustment to ensure effectiveness.
  - Amend relevant laws to ensure resolution powers can be exercised over financial conglomerates.
  - Develop resolution options and implementation guidelines for banks, and resolvability assessment and resolution planning frameworks for D-SIBs.
  - Adjust ELA framework and ensure effectiveness for BI.

### Developmental Challenges and Financial Deepening
- Financial deepening objective:
  - Authorities aim to deepen financial markets while protecting stability.
  - Recommendation: an integrated roadmap to promote financial deepening and inclusion.
- Roadmap priorities:
  - Draw on existing plans and complement with measures focusing on institutional framework strengthening: creditor rights, tax issues, and debt restructuring practices.
  - Roadmap would help coordination among agencies promoting financial deepening and inclusion.
  - Enhance bond yield curve by consolidating debt issuance and improving secondary markets.

### FSAP Key Recommendations (selected, from Table 1)
- Institutional and legal arrangements (Medium term):
  - Revise OJK Law to give primacy to safeguarding stability; amend BI Law to include a financial stability and macroprudential policy mandate focused on systemic risk of the financial system, with access to data; revise LPS Law to focus objectives on maintenance of financial stability, continuity of critical functions, protection of insured deposits, and minimization of resolution costs. ¶32, 38, 43
  - Amend the Insurance Law to specify policyholder protection as principal objective of OJK. ¶43
  - Strengthen legal protection of supervisors and officials of all agencies involved in financial oversight and crisis management in line with global standards. ¶32, 43
- Systemic risk monitoring and prudential policy:
  - Strengthen BI’s capacity for systemic risk analysis and macroprudential stress tests, and OJK’s capacity for regulatory stress tests; OJK should do bottom-up stress tests for D-SIBs regularly. ¶24 (Near term)
  - Introduce a foreign currency liquidity coverage ratio. ¶23 (Near term)
- Financial sector oversight:
  - Reduce OJK’s silo structure, including by revising the OJK Law to remove responsibilities of individual Commissioners for supervision of specific sectors. ¶31 (Medium term)
  - Strengthen banking supervisory approach and continue enhancing supervisory practices for financial conglomerates. ¶34 (Near term)
  - Further strengthen enforcement of credit and risk management regulations. ¶35 (Medium term)
  - Revise insurance supervisory framework (three strikes-approach) to allow prompt actions. ¶37 (Medium term)
- Governance of financial conglomerates:
  - Strengthen corporate governance practices, including BoC oversight roles and responsibilities. ¶29 (Medium term)
  - Introduce legal provisions for licensed non-operating financial holding companies. ¶28 (Medium term)
- Crisis management and resolution, and safety nets:
  - Revise PPKSK Law to clarify KSSK as solely a coordination body; limit Presidential involvement to approving public funding. ¶43 (Medium term)
  - Adjust emergency liquidity assistance framework to ensure effectiveness. ¶48 (Near term)
  - Amend relevant laws to ensure resolution powers cover financial conglomerates. ¶45 (Medium term)
  - Develop resolution options and implementation guidelines for banks; resolvability assessment and resolution planning frameworks for D-SIBs. ¶45 (Near term)
- Financial integrity:
  - Integrate key ML/TF risks in priorities and operations of relevant agencies. ¶41 (Near term)
  - Finalize and implement risk-based AML/CFT supervisory tools. ¶41 (Near term)
- Financial deepening and inclusion:
  - Develop an integrated roadmap for promoting financial deepening and inclusion. ¶50 (Medium term)
  - Enhance bond yield curve by consolidating debt issuance and improving secondary markets. ¶53 (Medium term)

*Source: IMF Financial Sector Assessment Program, Indonesia — Executive Summary (cr17152).*

### 6.      Indonesia’s banking system is not as highly concentrated as those in other EMs but it

### 6.      Indonesia’s banking system is not as highly concentrated as those in other EMs but it features large state-owned commercial banks

### Structure of the banking system
- The four largest banks—three of which are majority-owned by the government—account for almost half of banking system assets.
- Banks designated as domestic systemically important banks (D-SIBs) account for about 65 percent of banking system assets.
- It takes slightly more than 20 banks to account for a market share of 80 percent.
- Four state-owned banks and 26 regional development banks (partly owned by regional governments) account for nearly half of banking system assets.
- Private banks: nine foreign subsidiaries and 31 foreign branches.
- Interbank market exposures amount only to 3 percent of banks’ assets.
- Deposit structure: nearly 90 percent of deposits have a maturity of less than 90 days.

### Market depth and foreign participation
- Outstanding domestic debt securities and stock market capitalization equaled 16 and 41 percent of GDP at end-2015.
- Foreign investors hold 38 percent of government securities (Asia average cited as 26 percent).
- Shallow local capital markets combined with high foreign participation can amplify financial market volatility.

### Banks’ financial health (capital, liquidity, profitability)
- Regulatory capital to risk-weighted assets: 20.6 percent (2016Q3).
- Regulatory Tier-1 capital to risk-weighted assets: 20.6 percent (2016Q3).
- Capital to assets: 15.0 percent (2016Q3).
- Over 90 percent of bank capital is in the form of high-quality common equity tier-1 capital.
- Liquid assets to short-term liabilities: 33.1 percent (2016Q3), fluctuating around 33 percent in recent years.
- System-wide loan-to-deposit ratio: 99.2 percent (2016Q3).
- Return on assets (system-wide): average 2.7 percent over the past decade; 1.7 percent in 2016Q3.
- Return on equity: 11.7 percent (2016Q3).
- Profitability drivers: largely net interest income; four largest banks and public regional banks are among the most profitable.
- Dispersion: medium-sized and smaller banks show wider dispersion in FSIs, indicating potential pockets of vulnerability.

### Asset quality
- Nonperforming loans (NPLs) increased from 1.7 percent in 2013 to 3.0 percent in late 2016.
- Special-mention loans have remained around 4–5½ percent of total loans.
- Increase in restructured loans of about 2½ percent of total loans since June 2015, most not classified as NPLs.
- Headline NPLs may understate the extent of asset quality deterioration.

### Corporate sector vulnerabilities (and linkage to banking stress)
- Corporate leverage declined further in 2016; share of foreign-currency denominated debt declined slightly.
- Remaining vulnerabilities: relatively high debt-at-risk in commodities, construction, and transportation; high share of foreign currency-denominated debt securities; increase in rollover needs in coming years.
- Corporate profitability and liquidity indicators show some rebound but pockets of potential liquidity strain persist.

### Market perceptions of systemic risk
- Market-based tail-risk indicator remained broadly unchanged at a low level despite a rise in the joint probability that several institutions experience distress.
- Large banks are the main drivers of systemic risk in absolute terms, but the four largest banks’ contribution to systemic risk is smaller than their size, suggesting a stabilizing role in times of stress.
- Spillovers from nonbanks to banks are increasing over time but remain limited.

### Stress tests and scenario analysis
- Stress-testing focus: solvency stress tests (top-down covering all 117 banks and bottom-up for D-SIBs), three types of liquidity stress tests, contagion and interconnectedness analyses, and corporate vulnerability analysis.
- Most severe adverse scenario: real GDP deviates by 17 percentage points from the baseline by 2018 (equal to 2.4 standard deviations).
- Under the most severe scenario:
  - Corporate sector NPL ratio would increase to almost 19 percent in 2018.
  - Banking system losses: 13 percent of RWA (driven by credit losses of 12 percent of RWA).
  - Thirty-eight banks accounting for a third of banking system assets would fail to meet the hurdle (minimum capital requirements, and Pillar II and D-SIB surcharges as relevant).
  - Aggregate capital shortfall: 0.7 percent of GDP.
- Sensitivity tests:
  - Assuming all restructured loans not classified as NPLs and all special-mention loans become NPLs, and raising loan-loss reserve coverage to 2009 high levels: eight more banks fail, capital shortfall increases from 0.7 to 1.3 percent of GDP.
  - Assuming net interest margins narrow by 100 basis points throughout the forecast horizon: 12 additional banks (beyond the 38) fail, aggregate capital shortfall rises from 0.7 to 1.2 percent of GDP.
- Distributional results (most severe scenario): total CAR declines from 19.5 percent (2016) toward lower levels in 2018 under stress; CET1 and total CAR charts indicate sizable contributions to CAR deterioration from credit losses and changes in RWAs.

### Liquidity stress-test results
- Although system-wide liquidity is ample, many banks—mostly small—may experience liquidity shortfalls under severe scenarios.
- Simplified liquidity coverage analysis (all banks): aggregate liquidity shortfall of -5.2 percent of system assets (overall), comprising Rupiah: -3.1 percent and FX: -2.7 percent.
- D-SIBs: simplified analysis shows overall shortfall of -2.8 percent of system assets; D-SIBs would be able to manage overall liquidity stress but foreign currency liquidity buffers may be insufficient.
- Cash-flows-based analysis (D-SIBs): overall liquidity position 16.6 percent (Rupiah +46.5 percent, FX -16.6 percent); foreign currency liquidity shortfall for D-SIBs in stress of -2.8 percent (6-month horizon).
- Aggregate foreign currency liquidity shortfall under stress would represent 2.7 percent of system assets, or about only 6 percent of BI’s foreign currency reserves.

### Key systemic vulnerabilities identified
- Concentration: large share of assets concentrated in four largest banks and in D-SIBs (65 percent).
- Asset quality deterioration in commodity-related and manufacturing sectors; restructured and special-mention loans potentially masking true NPLs.
- Shallow domestic capital markets with high foreign participation, increasing sensitivity to global market sentiment.
- Short-term deposit funding: nearly 90 percent of deposits with maturity less than 90 days increases liquidity sensitivity.
- Heterogeneity across banks: smaller and micro-sized banks more vulnerable in liquidity and profitability metrics.

*Sources: OJK; and IMF staff estimates.*

### 21.      Domestic contagion through

### 21.      Domestic contagion through

### Interbank contagion and common exposures
- Domestic contagion through interbank or common exposures is limited.
- Hypothetical failure of a large bank would have a rather limited impact on other banks based on the interbank network analysis.
- When credit losses related to interbank exposures are incorporated into the solvency stress test (the most severe scenario), the additional reduction in the total capital ratio is around 0.3 percentage points in 2018 (Figure 10).
- The banking system does not appear to be vulnerable to common exposures.
- Key figure references:
  - Figure 10. Capital Adequacy Ratio (in percent)
    - Chart values present in the source: 19.2, 14.9, 13.0, 14.7, 19.2, 14.8, 12.7, 14.2 (years listed: 2016 2017 2018 2019; series: Benchmark (A), Benchmark + Interbank Network).

### Corporate sector stress
- Corporate stress tests indicate significant distress in an adverse scenario.
- Under the most severe scenario, the median default probability could rise above the levels observed during the global financial crisis (Figure 11).
- Heightened financial volatility together with a decline in economic activity would have an adverse effect on corporates.
- Key figure references:
  - Figure 11. Corporate Probability of Default (in basis points)
    - Chart values/time series present in the source include historical points from 1993 through 2019 and markers: Baseline, Median, 95th percentile.

### Banking system resilience and liquidity
- Overall, the banking system appears generally resilient under extreme events.
- Solvency resilience derives mostly from banks’ high capital and strong profitability that allow absorption of sizeable credit and market losses.
- Although aggregate capital shortfalls relative to the hurdles appear manageable, many banks (including some D-SIBs) would experience a significant reduction in capital, which could trigger a broad-based credit crunch if banks deleveraged aggressively to re-build capital buffers.
- Under the most severe liquidity stress test:
  - Many (mostly smaller) banks may not have sufficient liquidity to meet potential deposit outflows.
  - The needed amounts, including in foreign currency, are manageable according to the tests.
- Policy recommendation (liquidity): To contain liquidity risk, the authorities should consider introducing a liquidity coverage ratio (LCR) requirement by significant currencies.
- Policy recommendation (capacity building): The authorities should induce smaller banks to strengthen liquidity risk management capacity (see ¶51 in source).

### Supervisory capacity and stress-testing improvements
- The authorities should continue strengthening their capacity to monitor systemic risk.
- BI should continue strengthening its capacity to conduct systemic risk analyses.
- OJK should strengthen further the analytical basis of its supervisory stress tests.
- For stress tests, key priority areas are:
  - (i) strengthening data management systems to improve the timeliness of the exercises;
  - (ii) adapting the stress testing models to an expected-loss-approach);
  - (iii) continuing to strengthen its liquidity stress testing framework;
  - (iv) improving further the monitoring of the corporate sector, especially non-listed corporates of conglomerates.

### Main institutional and supervisory challenges
- OJK was established in 2011 as an integrated regulator; it assumed oversight over capital markets and NBFIs at end-2012, and over banks at end-2013.
- Since the last FSAP, Basel III implementation has begun, a new insurance law has been adopted, and supervisory practices have been strengthened across sectors.
- Main challenges stem from:
  - Complex structure and weak governance practices of financial conglomerates (FCs).
  - The still evolving organization and capacity of OJK.
- Structural supervisory issues:
  - Most FCs have a horizontal structure with an unregulated holding company controlling the group, creating challenges for consolidated supervision.
  - OJK has nominated a financial institution (usually a bank) as the lead entity of such groups, but the lead entity lacks legal authority to impose OJK’s regulatory requirements on the group.
  - Recommendation: The law should be amended to provide OJK the power to require establishment of, and to license and supervise, a non-operating financial holding company above the financial institutions to give it supervisory reach over the financial group.

### Corporate governance in financial conglomerates
- Weak governance of FCs complicates supervisory tasks.
- Despite regulations establishing a minimum corporate governance framework and integrated risk and capital management, FCs do not yet have effective group-wide risk management structures.
- The legal framework blurs the roles of the Board of Commissioners (BoC) and Board of Directors (BoD), weakening responsibility and accountability.
- OJK should elevate and strengthen corporate governance practices within the financial system, including clarifying and strengthening the BoC’s oversight roles and responsibilities.
- FCs should be required to create plans to ensure integrated governance, risk management, and capital management across the group.
- Box 1 findings (governance shortcomings):
  - Reputation, related party and intragroup transaction risks are not well understood and plans to address them are unclear.
  - Scenario analysis and contingency planning for business interruption or failure in the group are not well developed.
  - Legal framework weaknesses:
    - Lack of regulated holding companies hinders group-wide policy implementation.
    - Blurring roles of administrative bodies (BoC, BoD, shareholders) undermines accountability.
    - Company Law restricts BoC authority (appoint BoD, approve/supervise key BoD decisions, hold BoD accountable).
    - Risk management functions and the Internal Auditor formally report to both BoD and BoC but have stronger relations with BoD in practice, compromising independence of control functions.

### OJK organizational and mandate issues
- OJK needs to tackle silos in its organizational and governance structure.
  - Supervision remains effectively undertaken separately for banks, NBFIs, and securities, rooted in the OJK Law assigning three different Commissioners responsibility for these sectors.
  - Recommendation: Remove responsibilities of individual Commissioners for supervision of specific sectors; create cross-sector teams, harmonized regulations, and integrated supervisory processes that treat similar risks similarly across sectors.
- OJK’s mandate should be clarified and legal protection strengthened:
  - Financial sector supervisors should have financial stability clearly established as their primary goal to ensure timely action.
  - The OJK Law should be revised to establish financial stability as OJK’s primary goal and to improve legal protection of supervisors in line with global standards.

### Sectoral supervision: banks and insurance
- Banking supervision:
  - Progress mixed since last FSAP. Important regulatory improvements include implementation of Basel III and new regulations to improve risk management and corporate governance.
  - Remaining recommendations partially implemented: related-party exposures, asset classification and provisioning regulation, legal protection of supervisors, and interest rate risk in the banking book.
  - Areas needing improvement in supervisory approach:
    - Intensity of supervision: enforce regulations more consistently and rigorously in risk management, corporate governance, credit classification, and capital adequacy.
    - Holistic view of risk management controls: better integrate supervisory reviews of control systems into conclusions about control environment and BoC/BoD oversight capacity.
    - Validation of banks’ supervisory information: regularly review processes that generate supervisory information during onsite examinations; explicitly test and validate; feed results into supervisory assessments and strategies.
    - Focus of examinations: better link examinations to key risks identified in risk assessments and evaluate banks’ ability to identify and address emerging risks.
  - Credit risk regulation is appropriate, but implementation and enforcement need strengthening:
    - Shortcomings include inadequate BoC oversight and weaknesses in assessment of accuracy and integrity of credit quality reports from business lines.
    - Credit risk management function and its organizational position within banks need strengthening to guarantee accurate loan classification and provisioning.
    - Authorities should monitor closely restructured and special-mention loans and their proper classification to guard against evergreening.
- Insurance supervision:
  - Regulation and supervision improved since OJK establishment and the 2014 Insurance Law.
  - OJK has introduced risk-based supervision, taken decisive actions against insurers with material deficits, and enhanced governance and risk management regulations.
  - Remaining weaknesses, especially for insurance companies within FCs:
    - Deficiencies due to lack of effective group regulation and supervision of insurance groups.
    - Need to enhance macroprudential surveillance by integrating conglomerate analysis given interconnectedness and contagion risks through FCs and domestic reinsurance programs.
    - Intra-group transactions need more comprehensive consideration to preclude possible double gearing within FCs.
    - Skills shortages in areas like actuarial assessments need addressing.
    - Supervisory framework should be revised to allow corrective measures to be required more promptly and to ensure timely supervisory actions.
    - Suspending mark-to-market valuation (as done in 2015 for some companies) should be allowed only under extreme conditions and accompanied by enhanced oversight; authorities are encouraged to review the suspension episode and develop strict criteria for suspension of mark-to-market valuation.

### Macroprudential oversight and BI–OJK coordination
- The current macroprudential policy framework is broadly adequate but needs strengthening.
- Framework features:
  - BI is responsible for macroprudential policy per the OJK Law of 2011.
  - BI has issued regulations to guide macroprudential policy, created a macroprudential policy department, developed analytical tools to assess systemic risk, and introduced macroprudential instruments (e.g., limits on loan-to-value ratios and loan-to-funding ratio-linked reserve requirements).
  - BI recently introduced a countercyclical capital buffer on banks, with value currently set at zero, in line with credit developments.
- Framework shortcomings and recommendations:
  - BI Law should be amended to include a macroprudential mandate focused on systemic risk and covering the entire financial system, not just banks.
  - Provisions should be made to grant BI access to nonbank financial data needed for systemic risk monitoring.
- BI–OJK cooperation:
  - Closer cooperation is needed; they currently coordinate via a technical micro-macroprudential forum.
  - Effective coordination required to avoid conflicting or counterproductive policies.
  - Recommendation: Finalize operating procedures for carrying out respective tasks and enhance coordination.
  - Over the medium term, consider elevating the micro-macroprudential forum to a policy level forum.
  - Proposed roles:
    - BI would provide regular assessments of systemic risks and propose macroprudential policy actions.
    - BI could have the power to issue recommendations on macroprudential policy on a comply-or-explain basis to OJK regarding prudential tools under OJK’s authority.
    - BI would report to the Financial Stability Committee (KSSK) periodically on macroprudential issues.

*Source: IMF staff, “Domestic contagion through,” cr17152 (excerpts).*

### 40.      The authorities have made substantial progress in addressing AML/CFT deficiencies

### The authorities have made substantial progress in addressing AML/CFT deficiencies

### AML/CFT: progress and remaining gaps
- Findings and recent actions:
  - Amendments to the AML law in 2010 and passage of the CFT law in 2013 broadly addressed key deficiencies, including by criminalizing money laundering (ML) and terrorist financing (TF) in line with the revised Financial Action Task Force (FATF) standard, and extending AML/CFT requirements to money value transfers services (including remittance service providers).
  - New procedures for freezing terrorist assets under United Nations Security Council Resolutions contributed to Indonesia’s exit from the FATF’s monitoring in 2015.
  - The authorities completed a comprehensive National ML/TF Risks Assessment in 2015 with broad participation from relevant stakeholders, and co‑led a multi‑country risk assessment on TF for the South‑east Asian region.
  - The APG is scheduled to assess Indonesia’s AML/CFT regime in late 2017.
- Remaining shortcomings and recommended actions:
  - Align the AML/CFT framework more closely with the revised FATF standard.
  - Ensure AML/CFT supervision is conducted on a risk basis and that relevant agencies align AML/CFT priorities with identified ML/TF risks.
  - Enhance the capabilities of law enforcement agencies to conduct financial investigations and strengthen mechanisms for exchanging information with foreign counterparts.
  - Introduce a legal requirement for reporting entities to identify, assess, and understand their broader ML/TF risks.
  - Implement the targeted financial sanctions‑regime for terrorism and TF without delay.

*Source: cr17152 - 40.      The authorities have made substantial progress in addressing AML/CFT deficiencies*

### Institutional setting for crisis management and resolution
- Legal and institutional developments:
  - In 2016, Parliament approved the Prevention and Resolution of Financial System Crisis Law (PPKSK Law), which clarifies responsibilities of agencies involved in crisis management and establishes the KSSK, comprising the Finance Minister (coordinator) and the heads of BI, OJK, and the LPS (as a non‑voting member).
  - KSSK responsibilities include determining and coordinating responses to the distress or failure of D‑SIBs and systemic banking crises, and recommending to the President to declare a status of financial system crisis that would open a wider range of resolution powers (particularly bail‑in).
  - At the time of the FSAP, authorities were working on regulations required under the new law, including on emergency liquidity assistance (ELA), recovery planning, systemic bank resolution, the Bank Restructuring Program (BRP), and non‑systemic bank resolution.
- Recommended adjustments to align with international principles (Key Attributes for Effective Resolution Regimes):
  - Mandates: 
    - OJK Law should give unambiguous primacy to OJK’s financial stability objective (consistent with the PPKSK Law).
    - LPS Law should specify LPS’ statutory objectives, focusing on maintenance of financial stability and continuity of critical functions, protection of insured depositors and minimization of costs associated with resolution.
    - BI Law should include financial stability assessment and macroprudential policy as part of BI mandates.
  - Legal protection:
    - Strengthen legal protection in agencies’ laws consistent with the Key Attributes (and BCP and ICP). Shortcomings in the PPKSK Law: test for legal protection is “misuse of authority” rather than “good faith”; applies only in near‑crisis or crisis situations; does not extend to the institution itself and persons acting on its behalf.
  - Role of the KSSK:
    - Current role includes designing resolution strategy and guiding/directing member agencies, creating risk of diluted responsibility and delayed decisions.
    - Recommend amending the Law to limit KSSK to a coordination body and remove power to direct member agencies; set out detailed guidance on roles in a decree.
  - Role of the President:
    - President decides whether Indonesia is experiencing a financial system crisis (on recommendation from KSSK) and whether LPS should be allowed to use a broader set of resolution tools.
    - This involvement risks diluting responsibility and politicizing decisions. Authorities should consider revising the PPKSK Law to focus Presidential role on decisions on the use of public funding.

### Crisis management and resolution: operational capacities
- OJK powers and preparedness:
  - OJK can respond promptly to emerging stress and has powers to implement regulations for D‑SIB recovery planning.
  - OJK developed early warning indicators (EWIs) to detect emerging stress in banks, and to some degree insurers and FMIs; recommended refinement, integration of EWIs into corrective action frameworks, and extension to FCs.
  - As required by the PPKSK Law, OJK implemented regulation on recovery planning for D‑SIBs; mission suggests extending recovery planning over medium term to FCs and medium‑sized banks and, longer term, to large and medium‑sized insurers, FMIs, and remaining banks.
- LPS resolution powers and challenges:
  - PPKSK Law and LPS Law should be amended to specify triggers for invoking resolution, empower LPS to require banks to implement changes to facilitate resolution per resolution plans, and enable LPS to apply bail‑in without Presidential approval.
  - Need to strengthen resolution powers over FCs and establish safeguards for application of resolution powers (including compensation for creditors left worse off than under winding up).
  - Practical challenges for bail‑in:
    - D‑SIBs and medium‑sized banks rely on deposits for funding, with only a small amount of market funding that would better support bail‑in.
    - Lack of a clear creditor hierarchy will make bail‑in challenging to implement.
    - Recovery planning regulation for D‑SIBs will require issuance of debt capable of contractual bail‑in.
    - Authorities need guidance on applying bail‑in to deposits and other instruments without bail‑in clauses, and on resolution options differentiating by bank size; develop policy and operational frameworks for resolvability assessments and resolution plans for D‑SIBs.

### Safety nets: deposit insurance, resolution funding, and ELA
- Deposit insurance (LPS):
  - LPS has power to make payouts to insured depositors but needs stronger legal and technical capacity to calculate and process payouts rapidly.
  - Deposit insurance limit is Rp 2 billion (about US$150,000); assessment: limit is excessively high relative to average retail deposits and per capita GDP, increases moral hazard risks and weakens market discipline, increases risk of funding shortfalls relative to LPS obligations and reduces scope for bail‑in.
  - Recommendation: reduce the deposit insurance limit to a level more consistent with international norms while still covering the vast majority of household deposits.
- Resolution funding framework:
  - New crisis management framework rules out use of public funding in resolution, other than limited context related to LPS funding, and envisages a new LPS‑administered funding mechanism (under development) for systemic bank resolution once the BRP has been triggered, based on a bank levy.
  - FSAP recommendation: amend PPKSK Law to allow use of public funding in limited circumstances justified by systemic stability considerations and subject to the President’s approval and robust safeguards (including preconditions for use and recovery processes from the banking industry).
  - Also recommend amending PPKSK Law to enable levies on the banking industry to build a systemic resolution fund without needing the BRP to be invoked.
- Emergency Liquidity Assistance (ELA):
  - BI can provide ELA to any solvent bank under the BI Law and PPKSK Law, but criteria for providing liquidity are too restrictive and may make ELA ineffective.
  - Consider extending ELA eligibility to a bank assessed by OJK as viable even if capital is temporarily below minimum requirements.
  - Further work needed on coordination among OJK, BI, and LPS on solvency assessment and eligible collateral to ensure ELA is practicable.
  - Framework should enable BI, where not satisfied with a bank’s solvency/viability or collateral, to request an indemnity from the government subject to appropriate safeguards.

### Developmental challenges: financial deepening and inclusion
- Strategic priorities:
  - Deepening the relatively small financial sector can help tackle large development needs; promoting financial deepening is a government priority with a high‑level committee coordinating efforts.
  - OJK is implementing a Financial Services Sector Master Plan (2015‑19); government adopted an ambitious financial inclusion strategy with a steering committee chaired by the President.
- Policy guidance:
  - Policies promoting financial deepening and inclusion should focus on fundamentals (creditor rights, efficiency, legal and regulatory frameworks, financial services taxation, financial literacy).
  - Several recent policy initiatives may be ineffective or have unintended consequences (caps on deposit rates; moral suasion to induce single digit lending rates; mandatory minimum lending exposures to MSMEs; guarantees and interest rate subsidies via the “People’s Business Loan” (KUR) program).
  - Authorities should develop an integrated roadmap and assess the effectiveness and fiscal costs of the KUR program, including whether it increases lending to new borrowers (deepening).

### Financial markets: structure and reform priorities
- Shortcomings and market structure:
  - Short-term funding markets are shallow and segmented; chronic excess liquidity limits monetary policy effectiveness and constrains money market development.
  - In 2016, BI started reforming its liquidity management framework to spur money market deepening; recommended coordinated support for smaller banks, stronger enforcement of prudential regulations, and continuation of reforms to repo and monetary operations.
- Capital markets indicators (exact figures):
  - Stock market capitalization: 41 percent of GDP in 2016, well below the peer median of 74 percent.
  - Government debt equals about 27 percent of GDP, with nearly three‑quarters denominated in rupiah.
  - Corporate bond market: 2½ percent of GDP, two‑thirds of which is accounted for by financial institutions.
  - Domestic institutional investor base: pension fund and insurance company assets at around 2 and 7 percent of GDP, compared to 5 and 15 percent in peer countries.
  - Foreign investor presence is strong in government bond (particularly long end) and equity markets, but limited in corporate bond markets.
- Reform priorities to develop markets:
  - Improve yield curve efficiency by consolidating instruments and prioritizing issuance/re‑issuance of benchmark maturities for T‑bonds and increase issuance of T‑bills.
  - Remove legal obstacles to development of structured non‑recourse products for infrastructure financing.
  - Reform taxation of financial products (including replacing the tax applied to gross value of transactions with one more closely linked to firms’ performance).
  - Strengthen insolvency procedures and creditor rights to improve expected recovery rates.
  - Promote development of derivative instruments to enable risk hedging.

### Financial inclusion and digital financial services
- Access statistics and targets (exact figures):
  - World Bank Findex Survey: 39 percent of adults have a transaction account with a formal financial institution (up from 20 percent in 2011), compared to a regional average of 69 percent.
  - National Financial Inclusion Strategy launched November 2016 sets goal of reaching 75 percent by end‑2019.
- Digital financial services:
  - Development of digital financial services is central to the strategy.
  - E‑money issuers (banks and nonbanks) and banks providing basic accounts can engage agents; agents are now present in all Indonesian provinces and provide bill payments and transfers.
  - Cost challenges: cost of servicing basic bank accounts, given current transaction volumes and fee structure, exceeds receipts.
  - Recommendation: eliminate regulatory barriers that require direct interaction between providers and consumers and leverage telecom and ecommerce companies to optimize network size.

*Source: cr17152 - 40.      The authorities have made substantial progress in addressing AML/CFT deficiencies*

### Appendix II. Detailed Financial Soundness Indicators

### Appendix II. Detailed Financial Soundness Indicators

### Capital adequacy
- Regulatory capital to risk-weighted assets: 16.2 percent (2010), 16.1 percent (2011), 17.3 percent (2012), 19.8 percent (2013), 18.7 percent (2014), 21.3 percent (2015), 20.6 percent (2016Q3)
- Regulatory Tier-1 capital to risk-weighted assets: 15.1 percent (2010), 14.7 percent (2011), 15.7 percent (2012), 18.3 percent (2013), 17.8 percent (2014), 18.8 percent (2015), 20.6 percent (2016Q3)
- Capital to assets: 10.7 percent (2010), 11.0 percent (2011), 12.2 percent (2012), 12.5 percent (2013), 12.8 percent (2014), 13.6 percent (2015), 15.0 percent (2016Q3)
- Large exposures to capital: 1.4 percent (2010), 0.5 percent (2011), 0.5 percent (2012), 0.8 percent (2013), 1.0 percent (2014), 0.4 percent (2015), 0.6 percent (2016Q3)
- Net open position in foreign exchange to capital: 3.0 percent (2010), 3.0 percent (2011), 3.3 percent (2012), 1.7 percent (2013), 2.4 percent (2014), 0.9 percent (2015), 1.8 percent (2016Q3)
- Gross position in financial derivatives to capital: 3.8 percent (2010), 3.5 percent (2011), 3.2 percent (2012), 8.7 percent (2013), 4.9 percent (2014), 5.1 percent (2015), 3.8 percent (2016Q3)

### Asset quality
- Nonperforming loans to total gross loans: 2.5 percent (2010), 2.1 percent (2011), 1.8 percent (2012), 1.7 percent (2013), 2.1 percent (2014), 2.4 percent (2015), 3.0 percent (2016Q3)
- Specific provisions to nonperforming loans: 57.1 percent (2010), 60.7 percent (2011), 52.0 percent (2012), 50.9 percent (2013), 50.8 percent (2014), 51.5 percent (2015), 51.8 percent (2016Q3)
- Nonperforming loans net of provisions to capital: 6.1 percent (2010), 4.7 percent (2011), 4.7 percent (2012), 4.6 percent (2013), 5.5 percent (2014), 5.9 percent (2015), 6.1 percent (2016Q3)

### Sectoral distribution of total loans (in percent of total)
- Domestic economy: 99.6 percent (2010), 99.6 percent (2011), 99.6 percent (2012), 99.6 percent (2013), 99.6 percent (2014), 99.5 percent (2015), 99.5 percent (2016Q3)
- Depository institutions: 1.4 percent (2010), 1.2 percent (2011), 1.1 percent (2012), 1.3 percent (2013), 1.6 percent (2014), 1.5 percent (2015), 1.4 percent (2016Q3)
- Other financial institutions: 4.4 percent (2010), 4.8 percent (2011), 4.7 percent (2012), 5.0 percent (2013), 4.9 percent (2014), 4.9 percent (2015), 4.5 percent (2016Q3)
- Nonfinancial corporations: 43.5 percent (2010), 42.3 percent (2011), 43.7 percent (2012), 46.1 percent (2013), 45.6 percent (2014), 47.8 percent (2015), 48.2 percent (2016Q3)
- Other domestic entities: 49.6 percent (2010), 50.6 percent (2011), 46.4 percent (2012), 44.6 percent (2013), 44.3 percent (2014), 44.4 percent (2015), 44.4 percent (2016Q3)

### Earnings and profitability
- Return on assets: 2.7 percent (2010), 2.9 percent (2011), 3.1 percent (2012), 3.1 percent (2013), 2.7 percent (2014), 2.2 percent (2015), 1.7 percent (2016Q3)
- Return on equity: 25.9 percent (2010), 25.4 percent (2011), 25.3 percent (2012), 24.5 percent (2013), 21.3 percent (2014), 17.3 percent (2015), 11.7 percent (2016Q3)
- Net interest income to gross income: 60.5 percent (2010), 59.8 percent (2011), 65.0 percent (2012), 68.8 percent (2013), 69.0 percent (2014), 70.3 percent (2015), 68.4 percent (2016Q3)
- Trading income to gross income: 4.6 percent (2010), 3.5 percent (2011), 3.2 percent (2012), 3.2 percent (2013), 2.7 percent (2014), 2.8 percent (2015), 4.0 percent (2016Q3)
- Noninterest expenses to gross income: 49.2 percent (2010), 49.0 percent (2011), 48.8 percent (2012), 49.2 percent (2013), 50.3 percent (2014), 50.0 percent (2015), 46.3 percent (2016Q3)
- Personnel expenses to noninterest expenses: 37.3 percent (2010), 36.0 percent (2011), 40.5 percent (2012), 41.3 percent (2013), 40.0 percent (2014), 40.7 percent (2015), 44.4 percent (2016Q3)

### Liquidity and funding
- Liquidity assets to total assets: 27.2 percent (2010), 26.2 percent (2011), 25.7 percent (2012), 23.5 percent (2013), 22.9 percent (2014), 23.9 percent (2015), 22.1 percent (2016Q3)
- Short-term liabilities to total liabilities: 95.2 percent (2010), 94.2 percent (2011), 80.2 percent (2012), 87.9 percent (2013), 78.7 percent (2014), 78.8 percent (2015), 79.5 percent (2016Q3)
- Liquid assets to short-term liabilities: 32.1 percent (2010), 31.2 percent (2011), 36.4 percent (2012), 30.5 percent (2013), 33.3 percent (2014), 35.0 percent (2015), 33.1 percent (2016Q3)
- Non-interbank loans to customer deposits: 81.6 percent (2010), 85.5 percent (2011), 94.1 percent (2012), 100.5 percent (2013), 99.9 percent (2014), 100.4 percent (2015), 99.2 percent (2016Q3)

### Sensitivity to market risk
- Foreign-currency loans to total loans: 15.6 percent (2010), 16.6 percent (2011), 15.2 percent (2012), 17.0 percent (2013), 16.3 percent (2014), 15.6 percent (2015), 14.2 percent (2016Q3)
- Foreign-currency liabilities to total liabilities: 16.5 percent (2010), 16.3 percent (2011), 18.6 percent (2012), 24.4 percent (2013), 22.9 percent (2014), 24.1 percent (2015), 20.5 percent (2016Q3)

### Exposure to real estate activity
- Real estate loans to total loans: 13.8 percent (2010), 14.2 percent (2011), 13.8 percent (2012), 14.3 percent (2013), 15.1 percent (2014), 15.6 percent (2015), 16.2 percent (2016Q3)

*Sources: IMF, Financial Soundness Indicator database; Bank Indonesia; and IMF staff estimates.*

### Annex I. Report on the Observance of Standards and Codes: IAIS

### Annex I. Report on the Observance of Standards and Codes: IAIS

### Information and Methodology Used for Assessment
- Assessment conducted as part of the 2016-17 FSAP.
- Assessed against the ICPs issued by the International Association of Insurance Supervisors (IAIS) in October 2011, as revised in November 2015.
- Assessment team: Nobuyasu Sugimoto (IMF) and Antony Randle (World Bank).
- Assessment dates: September 21 to October 4, 2016.
- Basis of assessment:
  - Laws, regulations, and other supervisory requirements and practices in place in September 2016.
  - Full and comprehensive self-assessment provided by the authorities, supported by examples of actual supervisory practices and assessments relating to unidentified insurance entities.
- Note: The assessment does not reflect new and on-going regulatory initiatives; key proposals for reforms are summarized as additional comments.

### Institutional Framework and Arrangements
- OJK responsibilities and mission:
  - OJK is responsible for regulation and supervision of the entire financial sector, including banking, capital markets, insurance, and pension funds.
  - OJK was established in 2011 to take over roles of Bapepam-LK and Bank Indonesia (BI).
  - OJK missions: 1) ensure activities in the financial sector are fair, transparent, and accountable; 2) promote growth in a sustainable and stable manner; 3) protect the interests of consumers and the public.
- Legal and institutional developments:
  - New insurance law effective October 2014.
  - Since 2014, OJK issued more than 100 new regulations, including those relating to risk based supervision, enhanced fit and proper requirements, governance and risk management requirements.
- Transition and gaps:
  - Bank supervision and regulation moved from BI to OJK in 2014; BI retained macroprudential policy responsibility.
  - Need to align legislation to new institutional arrangement.
  - Gaps identified: bank liquidity assistance and resolution frameworks; legal protection for supervisors for acts done in good faith.
  - Authorities submitted a bill to Parliament to remedy these matters.
  - OJK is developing a framework for consolidated supervision of banks and nonbanks (including insurance) and upgrading risk-based supervision.
- KSSK:
  - 2016 PPKSK Law established the KSSK for prevention and resolution of financial system crises.
  - KSSK membership: Minister of Finance (coordinator), Governor of BI, Chairman of Board of Commissioners of OJK (all with voting rights), and Chairman of Board of Commissioners of LPS (without voting rights).
  - KSSK authority includes recommending to the President to declare a systemic crisis status and on resolution measures.

### Main Findings: Sector Structure, Risks, and Supervision
- Sector growth and structure:
  - Insurance sector grew rapidly at an average of 20 percent per year over the last 5 years.
  - About the half of insurers belong to conglomerates, typically led by banks but including other financial and non-financial entities.
  - Bancassurance plays a very important role in distribution, mainly for investment products such as unit-linked products.
- Vulnerabilities and failures:
  - The insurance sector is vulnerable to material risks; a number of insurers have failed in the last 10 years.
  - Post-establishment of OJK, prompt actions taken against four insurers with material deficits to reduce loss to policyholders.
  - OJK monitors capital adequacy through its risk based supervision scheme.
- Economic environment impacts:
  - Recent economic slowdown and current low interest rate environment affected insurance growth and investment returns.
  - Life sector has significant exposure to equity and mutual funds; performance negatively affected.
  - In 2015, OJK temporarily allowed insurers to abandon mark-to-market valuation for solvency purpose (RBC calculation); OJK followed up with firms using the suspension and subsequently removed the suspension.
- Catastrophic and reinsurance concentration risks:
  - Indonesia prone to landslides, floods, storms, earthquakes, tsunamis, and volcanic eruptions.
  - Insurers required to set aside a catastrophe reserve and have mandatory reinsurance arrangements with domestic reinsurers.
  - One reinsurer is owned by all general insurance companies, creating potential contagion in significant catastrophe events.
  - OJK states risk in excess of domestic reinsurer capacity is retroceded to international reinsurers.

### Observed Improvements Since OJK Establishment
- Remarkable improvements in regulation and supervision since 2011 and October 2014 Insurance Law.
- OJK actions include:
  - Issuance of numerous new regulations.
  - Introduction of risk based supervision and active usage of supervisory powers, including revocation of licenses.
  - Enhanced regulations for corporate governance and risk management.

### Deficiencies and Areas Needing Improvement
- Shortfalls in observance with the Insurance Core Principles:
  - Lack of effective group regulation and supervision of insurance groups.
  - Intra-group transactions not well taken into account, allowing possible double gearing within insurance entities and investment arbitrage between insurance entities and non-financial entities.
  - Capital calculation for catastrophic risk and framework for imposition of capital add-ons need strengthening.
- Legal clarity and supervisory objectives:
  - Laws need amendment to enhance clarity of legal protection and the primary objective of the supervisor.
  - ICP requires primary objective of supervisors be protection of policyholders; OJK has multiple objectives and the objective of market development may conflict with policyholder protection.
  - Setting protection of policyholders as the primary objective would enhance OJK operational independence.
  - Law needs to provide clear and robust legal protection for OJK and its staff acting in good faith.
  - Clearer internal guidance for applying sanctions would assist timely and effective regulatory actions.
- Supervisory effectiveness:
  - Thematic reviews of reserving practices recommended to encourage more conservative reserving.
  - Need for closer dialogue with industry and clearer guidance on adequacy, independence, and reporting lines of key control functions to improve corporate governance and risk management of insurance groups.
  - OJK encouraged to increase expertise of human resources, in particular actuaries, to facilitate transition from compliance-based to risk-based supervision.
  - Revision of the “three strikes” approach is needed to ensure timely supervisory actions.
  - Enhance macroprudential surveillance by integrating conglomerate analysis to identify possible contagion among conglomerates and sectors.
- Risk-based capital and reserving framework gaps:
  - Capital framework covers default risk of investments, asset and liability mismatch (ALM), FX mismatch, premium and claim risk, operational risk and mutual fund related risk.
  - OJK introduced guarantee risk associated with unit-linked products.
  - Material risks needing further improvement: catastrophe risk addressed through reinsurance, and contagion risk from related parties.
  - OJK has not conducted thematic reviews for each risk in RBC calculation.

*Assessment conducted September 21 to October 4, 2016; Annex I. Report on the Observance of Standards and Codes: IAIS.*

### 16.      There is a need for more focus on the regulation of insurance intermediaries and

### 16.      There is a need for more focus on the regulation of insurance intermediaries and 

### Key observations on market conduct and intermediaries
- OJK has made tremendous efforts to ensure efficiency and fairness in claims payment and complaints handling, which will continue to be important especially in the non-life sector.
- The rapidly increasing life insurance sector and complex unit-linked products make conduct regulations even more important.
- Enhanced disclosure requirements for intermediaries and close coordination with the insurance associations will improve the quality of intermediaries.
- While intermediaries are required to provide certain information to policyholders, there is no disclosure requirement about terms and condition, relationship with the insurers, or information related to remuneration.
- Given the increasing share of internet and mobile sales, OJK needs to work closely with the industry to mitigate operational risks such as cyber risk.

### Summary observance of Insurance Core Principles (ICP) — key findings (selected ICPs)
- ICP 1 — Objectives, Powers and Responsibilities of the Supervisor
  - The Law does not recognize the protection of policyholders as the primary function of the supervisor; this needs to be addressed to ensure policyholder protection takes precedence over other roles such as market development.
- ICP 2 — Supervisor
  - OJK, its Commissioners and staff do not have adequate protection from actions brought by third parties for acts performed in proper performance of their duties; the Law needs to provide immunity for acts within scope and in good faith and indemnification for defense costs.
- ICP 3 — Information Exchange and Confidentiality Requirements
  - Arrangements for exchange of information and protection of confidentiality are ad hoc in practice; the Law should reflect that exchange arrangements should not be subject to reciprocity and OJK should develop processes and policies.
- ICP 4 — Licensing
  - The main Insurance Law poses doubts as to which entities are subject to licensing; OJK does not appear to have adequate powers in law to impose conditions, limitations and restrictions on licenses, although OJK does so in practice.
- ICP 5 — Suitability of Persons
  - Suitability requirements are detailed and appear effective, but the number of parties subject to requirements is less than required by the ICP; requirements should be extended to Senior Management and “Key Persons in Control Functions”.
- ICP 6 — Changes in Control and Portfolio Transfers
  - The Law requires OJK approval to changes in ownership and deems persons with 25 percent or more shareholding to be a “controller”; the Law should reflect that the 25 percent can be held alone or in conjunction with associates or related parties as defined in Law no 40 of 2014.
- ICP 7 — Corporate Governance
  - Reorganization and expansion of regulation needed to better set out duties, functions, roles, obligations, and reporting lines for directors, commissioners, Senior Management, and Key Persons in Control Functions; clarify reporting lines and relationship with external auditor and supervisor.
- ICP 8 — Risk Management and Internal Controls
  - OJK introduced requirements for good corporate governance but regulations should set out in greater detail duties, functions, roles, obligations and reporting lines for all parties involved in risk management.
- ICP 9 — Supervisory Review and Reporting
  - OJK has made significant progress in implementing an effective risk based supervision system; needs to supplement information collection and adopt a more formal framework for risk rating to improve consistency and accuracy.
- ICP 11 — Enforcement
  - OJK has, in some circumstances, a “three strikes and out” process (three sanctions before final action); this practice should be reviewed to ensure timeliness of action as required by the ICP.
- ICP 12 — Winding-up and Exit from the Market
  - OJK has sufficient powers to revoke a license and form a liquidation team, but there is no clear timeline after an insurer breaches the minimum capital level (which is 40 percent); policyholders have experienced significant delays in settlements.
- ICP 14 — Valuation
  - Methodology of discount rates does not necessarily reflect current economic conditions (3 years average may deviate); one discount rate of average duration applied fails to capture cash flow characteristics; MOCE required only for premium reserve and not claims reserves; mark to market was suspended for several months in 2015, potentially creating moral hazard.
- ICP 15 — Investment
  - Investment limit is based on total investments and is so high that it does not prevent excessive concentration risk; intragroup transactions limit set at 20 percent of the portfolio could permit excessive concentration.
- ICP 16 — Enterprise Risk Management for Solvency Purposes
  - ORSA and part of ERM requirements have been recently implemented; actual implementation in practice is yet to be seen.
- ICP 17 — Capital Adequacy
  - Catastrophe risk is not yet included though OJK is working to include it; capital add-on could be imposed without a transparent framework; no evidence of validations conducted by OJK for asset-liability and unit-linked guaranteed benefit components.
- ICP 18 — Intermediaries
  - Intermediaries lack disclosure requirements about terms, insurer relationships, or remuneration.
- ICP 19 — Conduct of Business
  - OJK requires protection of private customer information but must address cyber and other operational risks amid rising internet and mobile sales.
- ICP 20 — Public Disclosure
  - OJK requires detailed disclosures of investments, but disclosures relating to technical provisions and ALM are insufficient; no requirement about risk management practices and corporate governance.
- ICP 23 — Group-wide Supervision
  - OJK coordinates with home supervisors mainly through supervisory colleges, but information exchange with home supervisors is not yet active enough to effectively define scope of group supervision.
- ICP 24 — Macroprudential Surveillance and Insurance Supervision
  - Vulnerability analyses focus on individual entities or groups; no exercise captures interconnectedness among sectors and conglomerates; interconnectedness between banks, insurers and reinsurers could have systemic implications.
- ICP 26 — Cross-border Cooperation and Coordination on Crisis Management
  - MoUs with relevant regulators are still missing, which may prevent OJK coordinating cross-border supervision and crisis management effectively.

### Recommended actions — selected recommendations mapped to ICPs
- ICP 1
  - Principal Insurance Law should specify that the principal objective of OJK is to promote the maintenance of a fair, safe, and stable insurance sector for the benefit and protection of policyholders.
- ICP 2
  - OJK should work with MoF to amend Law no 21 of 2011 to ensure:
    - OJK, its commissioners and staff are protected from legal actions for acts done in good faith;
    - OJK has the power to meet legal expenses of any commissioner or staff member defending such actions; and
    - OJK review the adequacy of its expert resources, in particular actuaries.
- ICP 3
  - Remove or clarify balanced reciprocity requirements in Law no 21 of 2011; OJK should develop policies and processes for safe exchange of information; OJK should expand scope of MoU (for example by joining the IAIS MoU) and offer analysis (such as key inspection results) to home supervisors.
- ICP 4
  - OJK should work with MoF to review the Insurance Law to provide transparent licensing requirements and explicit power to impose conditions, restrictions and limitations on licenses (Insurance Law no 40 of 2014).
- ICP 5
  - Extend suitability requirements to Senior Management; define “Key Persons in Control Functions” and extend suitability requirements to them.
- ICP 6
  - Amend OJK regulation to include definitions of “associate” or “related party”.
- ICP 7
  - Revise and amend regulation no 02/POJK.05/2014 to better reflect requirements of ICP 7, clarifying duties, functions, roles, obligations and reporting lines.
- ICP 8
  - Establish a dedicated risk management and internal control regulation obliging insurers to have adequately resourced, independent, risk management, compliance, internal audit, and actuarial functions.
- ICP 9
  - Review quarterly reporting information against ICP 9.5 and require lodgment of missing information; develop written policies and processes for updating risk ratings.
- ICP 11
  - Revise the “three strikes” approach to sanctions to ensure timely supervisory action.
- ICP 12
  - Develop and publish guidance to ensure timely revocation of a license; clarify roles of two financial restructuring plans tied to target capital level (120 percent) and solvency level below 40 percent; establish policyholder protection (industry wide) funds with sufficient funds and flexibility while avoiding moral hazard; ensure winding up and exit procedures are clearly outlined in law; identify and document a legal point when an insurer must cease operations.
- ICP 14
  - Work closely with the actuarial association to establish more guidance around key assumptions; impose enhanced prudential standards (stress testing and business continuity planning) for firms that relied on the 2015 temporary suspension of mark to market; apply more market consistent discount rates by applying the entire yield curve of the most relevant securities; apply MOCE consistently over all insurance reserves.
- ICP 15
  - Enhance investment requirements to mitigate excessive concentration and contagion risk from affiliates or closely related entities; conduct thematic reviews on investment practices and challenge aggressive investment strategies; monitor concentration of single counterparties by aggregating all exposures (equity, bond, mutual funds, loan, deposits, derivatives, receivables, etc.).
- ICP 16
  - Enhance communication with industry about objectives of new regulations; conduct thematic reviews comparing industry practices; formulate clear expectations for stress tests and risk tolerance statements.
- ICP 17
  - Adjust capital adequacy ratios at the solo level if an insurance entity provides capital to financial entities within the group; conduct thematic reviews of schedules in the risk based capital requirement such as B (ALM), E (premium) and H (minimum guarantee of unit link).
- ICP 18
  - Continue and enhance coordination with the insurance association to improve training and examination for increasingly sophisticated insurance products; require intermediaries to disclose to customers their status and how they are remunerated.
- ICP 19
  - Conduct informal exercises (such as horizontal self-assessment) and enhance dialogue with industry and associations to encourage insurers to improve resilience to cyber risk.
- ICP 20
  - Implement recommendations related with ICPs such as ICP 14 and 16 before amending disclosure requirements; encourage insurers to voluntarily improve disclosure of risk management and corporate governance to find best practices balancing cost and benefits.
- ICP 23
  - Establish relationships with home and other relevant supervisors through more active participation in supervisory colleges and IAIS activities (including IAIS MoU); analyze intergroup transactions in detail to cooperate effectively with home supervisors on scope of group-wide supervision.
- ICP 24
  - Integrate conglomerate analyses across group levels to identify contagion among conglomerates and sectors; conduct contagion analysis due to domestic reinsurance concentration (stress testing catastrophic events and failure of a large domestic reinsurer); consider suppression of mandatory reinsurance programs if they could cause contagion among domestic insurers and reinsurers.
- ICP 26
  - Expand scope of MoU (for example by joining the IAIS MoU) and offer analysis such as key inspection results to home supervisors to enhance cooperation.

### Authorities’ response — summary points
- The authorities thank assessors and welcome the assessment results and recommendations.
- Authorities agree with many ICP comments but note some comments may not fully reflect the proportionality principle given the nature and scale of Indonesia’s developing insurance sector.
- OJK notes significant progress: adopting risk-based supervision, advancing corporate governance and internal control mechanisms, and strengthened regime for financial conglomerates.
- Authorities look forward to implementing most recommendations in due course.

*Source: IMF Financial Sector Assessment Program — Indonesia (excerpts from CR17152).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17152.pdf_