## _cr10288

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---

### Mission and assessment scope
- A joint IMF/World Bank team undertook the Financial Sector Assessment Program exercise for Indonesia during October 6–16, 2009 and February 24–March 10, 2010.
- Four standards and codes assessed: (i) Basel Core Principles (BCP); (ii) IOSCO Principles of Securities Regulation (IOSCO); (iii) Core Principles for Systemically Important Payment Systems (CPSIPS); and (iv) Monetary Policy Transparency (MPT).
- Six technical notes prepared: (i) Assessing Corporate Sector Vulnerabilities; (ii) Alternative International Structures of Financial Sector Supervision and Regulation; (iii) Stress Testing Indonesian Banks; (iv) Legal and Regulatory Framework of the Indonesian Financial System; (v) The Insurance Industry; and (vi) Capital Market Development in Indonesia.

### Macroeconomic and market context
- Indonesia expanded by 4.5 percent in 2009.
- Key rating agencies upgraded Indonesia’s sovereign rating to one notch below investment grade and its sovereign outlook to positive.
- Rapid recovery after contagion from the global financial crisis.

### Main strengths and overall challenges
- Strengths:
  - Improved health of banks and companies.
  - Strengthened supervisory framework.
  - Improved macroeconomic policy framework.
  - Large consumer base and natural resource endowment.
- Challenges:
  - Financial sector depth and contribution to the economy lag comparable countries.
  - Indonesian securities trade at a discount relative to regional peers.
  - Many wealthy Indonesians prefer to place savings offshore.
  - Weaknesses in legal and governance frameworks undermine investor confidence.
  - Gaps in legal mandate and powers, governance, and protection for some institutions hamper enforcement.
  - Concerns about creditor rights shift bank focus toward consumer and SME lending rather than large corporate lending.

### Critical governance and legal weaknesses
- Most critical gap: absence of legal protection for the financial sector regulator and supervisor.
  - Public questioning and political interference have slowed decision making and occasionally paralyzed the prudential system.
  - Legal uncertainty about timeliness and consistency of judicial support for supervisory interventions compounds the problem.
- Addressing legal and governance weaknesses is fundamental to achieving a sound and competitive financial system and to raise system resilience.

### Banking sector: performance, risks, and priorities
- Banking fundamentals:
  - Most Indonesian banks report high capital, comfortable liquidity, and solid profitability.
- Noted risks and vulnerabilities:
  - Rising credit exposures to retail and SMEs amid weak information quality.
  - Stress tests show vulnerability to credit risk; a few mid-sized banks vulnerable to liquidity risk.
  - A sharp rise in energy and food prices could depress domestic demand and trigger capital outflows and exchange rate pressures.
  - Priority: strengthen the soundness of the large state-owned banks (SOCBs).
- Policy recommendation:
  - Government should refrain from using moral suasion and prudential regulations to promote credit growth; avoid targeting higher loan-to-deposit ratios or reducing risk weights independent of associated risk.

### Banking supervision and regulatory gaps
- Bank Indonesia (BI) supervisory frameworks generally meet international norms.
- Shortcomings:
  - BI falls short in dealing with problem banks; prompt corrective action (PCA) would speed and make decisions more transparent.
  - Issues with quality of capital, loan provisioning rules, and home-host supervision.
- Non-bank regulator:
  - Bapepam-LK needs greater enforcement powers and independence for pre-emptive action against malpractices.

### Regulatory architecture and the proposed integrated supervisor (OJK)
- BI Act (as amended in 1999) requires establishment of an integrated supervisory agency (OJK) consolidating banking, insurance, and securities supervision.
- Observations:
  - Changing supervisory structure alone does not necessarily improve oversight or systemic risk assessment.
  - Transferring bank supervision out of BI risks losing competencies built over time and entails significant risk.
- Recommendation:
  - Strengthen existing regulatory and supervisory framework rather than relying solely on institutional reorganization.
  - Strengthen BI’s financial position and enshrine a simpler, more transparent process for selection of BI’s Board members.

### Financial safety nets and crisis management
- Authorities responded decisively in 2008 but the financial safety net law needs to be passed.
- Crisis Management Protocol lapsed.
- New legislation needed to:
  - Ensure timely crisis response.
  - Provide legal protection for policy makers and supervisors.
- Deposit insurance (LPS) requires increased funding commensurate with larger deposit coverage.

### Nonbank financial sector development: capital markets and insurance
- Capital markets: scope to diversify funding and provide long-term instruments; market capitalization of IDX ~48 percent of GDP at end-2009; bond market capitalization ~12 percent of GDP at end-2009; government accounts for 85 percent of bond issuance.
- Insurance: sector is small (~3 percent of GDP) and should be restructured and gradually expanded.

### Stress testing and systemic diagnostics (summary)
- Stress tests indicate:
  - Systemic vulnerability to credit risk across banks.
  - Liquidity vulnerability for a subset of mid-sized banks.
- Top-Down (TD) and Bottom-Up (BU) results differ; TD results generally more severe.

### Recommendations and implementation support
- Full list of FSAP recommendations summarized (Table 2 in source).
- Technical assistance could support design and implementation of reforms.

---

### Key risks and scenarios (from "1. Sharper than projected")
- 1. Slower-than-expected economic growth
  - Likelihood: Low/Medium
  - Findings: Forecast still for higher growth in 2010 onwards; depends on external factors and government stimulus; monetary policy room limited.
  - Banking-sector effects (Medium): deterioration of asset quality with lag; system appears adequately capitalized and profitable to sustain slowdown.
- 2. Reduced capital inflows and increased capital outflows
  - Likelihood: Medium-High
  - Findings: Political environment more stable but sovereign risk premium higher than peers; sustained outflows could trigger macro downturn and market access problems.
  - Banking-sector effects (Medium): initial impact on securities market and liquidity; BI has instruments to add liquidity; government funding costs could increase; banks less vulnerable to external finance cut-off than government.
- 3. Withdrawal of domestic retail deposits
  - Likelihood: Low
  - Findings: Systemic deposit run unlikely; deposit insurance coverage increased to IDR 2 billion.
  - Banking-sector effects (Medium): banks rely on short-term retail deposits; second-tier large and mid-sized banks more vulnerable.
- 4. Sharp increase in commodity prices (energy and food)
  - Likelihood: Medium
  - Findings: Households and companies vulnerable; potential inflation and interest rate increases.
  - Direct credit effects (Low): could trigger higher delinquencies for companies, SMEs and households.
- 5. Exchange rate volatility
  - Likelihood: High
  - Findings: Flexible exchange rate regime; banking-sector exposure limited; net open foreign currency positions tightly managed.
- 6. Shortcomings in bank intervention/resolution framework
  - Likelihood: Medium
  - Findings: Shared powers among BI, Bapepam-LK, and LPS and potential parliamentary/management intervention could delay actions.
  - Impact (Medium): delayed resolution of troubled banks could raise costs; systemic impact would require failure of a large bank.

### FSAP selected recommendations (priority and time frame preserved; selected items)
- Banking Issues
  - Issue revised regulation to strengthen the quality of capital by bringing risk weights to at least Basel I levels and tightening the accounting definition of Tier 1 capital. Priority: H; Time frame: 6
  - Strengthen asset classification and provisioning norms, including treatment of restructured loans. Priority: H; Time frame: 6
  - Submit to the House of Representatives (DPR) draft prompt corrective action legislation. Priority: H; Time frame: 12
  - Maintain capital adequacy requirement in line with the Basel I norms until Pillars 2 and 3 of Basel II are operational. Priority: H; Time frame: ongoing
  - Strengthen BI and banks' stress testing capability. Priority: M; Time frame: ongoing
  - Revise the law to give SOCBs more flexibility in dividend payout, debt restructuring, and management of capital structure and business risks. Priority: M; Time frame: 24
- Regulatory Structure
  - Review financial sector supervision and regulation to ensure micro-macro prudential coordination. Priority: H; Time frame: ongoing
- Central Banking
  - Strengthen BI’s balance sheet by agreement with the government to restructure zero interest government debt into market interest bearing debt. Priority: H; Time frame: 12
  - Improve the selection process of BI's Board members. Priority: H; Time frame: 24
  - Clarify BI's policy objective and reconcile inflation targets between MOF and BI. Priority: M; Time frame: 12
- Deposit Insurance
  - Increase the deposit insurance fund commensurate with increased coverage. Priority: H; Time frame: 12
  - Improve BI-LPS cooperation. Priority: M; Time frame: 24
- Capital Markets
  - Amend capital market law to augment regulators' independence and enforcement powers. Priority: H; Time frame: 12
  - Encourage SOEs to list or issue fixed income instruments. Priority: M; Time frame: 24
  - Improve price discovery mechanism for government bond trading. Priority: H; Time frame: 24
- Insurance
  - Pass an insurance law. Priority: H; Time frame: 12
  - Deal with insolvent insurance companies promptly. Priority: H; Time frame: 6
- Legal Protection Issues
  - Amend BI Act and Capital Markets Law to enhance legal protection of supervisors. Priority: H; Time frame: 6-12
  - Enact crisis management legislation including protection for officials. Priority: H; Time frame: 6-12
- Market Infrastructure (selected)
  - Improve national credit bureau; consider private credit bureaus. Priority: H; Time frame: 12
  - Improve certainty and speed of execution of collateral and bankruptcy proceedings. Priority: H; Time frame: 24
  - Ensure banks’ compliance with PSAK 55 (IAS 39). Priority: H; Time frame: 6
  - Transfer oversight of auditors and public accounts to Bapepam-LK. Priority: H; Time frame: 24
  - Speed up convergence to IFRS; assess constraints and actions. Priority: M; Time frame: 24

---

### Structure of the financial system (key facts)
- Total financial sector assets stood below 60 percent of GDP in 2009.
- Banks account for 50 percent of GDP and 80 percent of the financial system.
- Top three SOCBs account for one-third of banking sector assets and deposits; top 15 banks account for about 70 percent.
- Foreign banks represent 29 percent of banking assets; government owned banks represent 43 percent.
- Over 90 percent of banks’ funding structure is short (maturities of less than one month and at call).
- At end-2009, over 65 percent of time deposits had one month or less tenor; only 1 percent with more than one year.
- Non-bank financial sector accounts for less than 10 percent of GDP; insurance ~3 percent of GDP.
- Government dominates bond issuance (85 percent); commercial banks hold more than half of government bonds; foreign investors own ~20 percent.

### Banking sector stability — recent financial performance (selected figures)
- Annual loan growth averaged 21 percent since 2003.
- Consumer, micro and SME loans account for 54 percent of total loans (2009) vs 45 percent in 2002 and 30 percent in the 1990s.
- Corporate loans about 46 percent of banks’ total lending at end-2009.
- Post-1997 banks reduced government securities holdings, freeing liquidity for lending.

### Lending growth (section 11) — selected figures
- Annual loan growth:
  - Peaked at 38 percent (y-o-y) in October 2008.
  - Decelerated to 10 percent in 2009.
- Profitability:
  - After tax-ROA increased to 1.8 percent in 2009.
- Liquidity:
  - Loan-to-deposit ratio fell to 73 percent at end-2009 from 75 percent in 2008.
- Asset quality:
  - Gross NPLs increased by 14 percent for the year; NPL ratio steady at 3.2 percent.
  - Restructured loans rose to 3 percent of total loans in 2009 from 1.9 percent in 2008.
- Loan-loss coverage:
  - Coverage ratio increased to 62 percent of NPLs at end-2009 from 58.5 percent in 2008.
- Capital adequacy:
  - Average risk-weighted CAR increased to 17.5 percent at end-2009.
  - Regulatory minimum: 8 percent; BI’s informal target: 12 percent.
  - Leverage ratio: 10 percent.
  - Banks below IDR 100 billion minimum capital requirement declined to 11 from 24 at end-2008.

### Stress testing — Top-Down (TD) summary (end-September 2009 data, selected figures)
- Pre-shock end-September 2009 CAR: Total 17.8; Gov 13.8; SOCB 13.7; Foreign 23.7; Private 17.1; Large 17.3; Medium 21.9; Small 38.3; minimum 6.6; Median 18.8.
- Post-shock CAR examples: Total 6.8; Gov -1.1; SOCB -3.9; Foreign 15.3; Private 9.2; Large 5.9; Medium 14.9; Small 32.2; minimum -15.2; Median 13.0.
- Percent change in CAR: Total -11.0; Gov -15; SOCB -17.5; Foreign -8.4; Private -7.8; Large -11.4; Medium -7.0; Small -6.1.
- Number of undercapitalized banks: Total 37; Gov 15; SOCB 4; Foreign 7; Private 15; Large 17; Medium 19; Small 1.
- Percent of Total Assets in undercapitalized banks: Total 56.3; Gov 39.6; SOCB 36.5; Foreign 10.2; Private 6.5; Large 53.4; Medium 2.9; Small 0.0.
- Number of insolvent banks: Total 13; Gov 5; SOCB 3; Foreign 1; Private 7; Large 8; Medium 5; Small 0.
- Percent of Total Assets in insolvent banks: Total 33.6; Gov 28.8; SOCB 28.1; Foreign 0.6; Private 4.2; Large 33.0; Medium 0.6; Small 0.0.
- Recapitalization need (trillions Rupiah): Total 72; Gov 55; SOCB 53; Foreign 8; Private 9; Large 69; Medium 3; Small 0.
- Recapitalization needs in percent of 2009 GDP: Total 1.3; Gov 1.0; SOCB 1.0; Foreign 0.1; Private 0.2; Large 1.3; Medium 0.1; Small 0.0.
- Pre-shock NPL (end-September 2009): Total 3.8; Gov 4.4; SOCB 4.2; Foreign 3.9; Private 3.0; Large 3.7; Medium 4.6; Small 3.1.
- Post-shock NPL: Total 31.5; Gov 42.5; SOCB 37.6; Foreign 27.5; Private 24.0; Large 32.4; Medium 21.7; Small 23.6.

### Stress-testing interpretation and vulnerabilities
- Credit risk is main source of risk.
- TD shows severe outcomes (system NPLs peaking at 31.5 percent in 2011Q3 from ~3½ percent).
- BU results less severe under non-zero profit assumptions.
- SOCBs most vulnerable due to legacy restructured assets and lower provisioning/capital buffers.
- Liquidity: around three quarters of banks would cope with a run on deposits up to five days; remaining banks more vulnerable.

---

### Banking regulation, supervision gaps, and key reforms (selected)
- Legal protection for supervisors: urgent amendments to BI Act recommended to presume good faith, protect supervisory staff and BI institutionally.
- Capital base quality: certain Tier 1 inclusions and reduced risk weights lower effective CAR; adjusting for net inter-office funds and lower risk weights would reduce CAR by about 238 basis points to 15.2 percent from 17.5 percent.
- Asset classification and provisioning: concerns over restructured loans, collateral valuation, and exemptions allowing upgrades and conversions that may understate NPLs.
- Interest rate risk supervision: lack of regulation and supervision of IRRBB; BI collecting data on maturity mismatches.
- Home-host and domestic cooperation: need effective arrangements and MOUs beyond formal agreements.

### Dealing with problem banks — PCA recommendations
- If a bank has been in intensive supervision for 1 year and not exited, move it to special surveillance regardless of capital level.
- Enact PCA legislation with binding orders and time-bound corrective measures:
  - CAR below 8 percent: require corrective actions to restore capital within six months; failure leads to sale or license revocation.
  - CAR at 4 percent: impose limitations on wholesale funding; BI credit only with government guarantee; restore capital within three months or license revoked.
  - CAR at 2 percent: license revoked.

### Basel II implementation (section 29) — timetable and guidance
- Timetable:
  - Pillar 1: 2011
  - Pillar 2: 2012–2014
  - Pillar 3: 2011–2014
- Initial implementation based on simplified approach; advanced approaches allowed only with BI authorization.
- Recommendation: maintain Basel I capital until Pillars 2 and 3 operational; validate Pillar 1 and 2 elements during transition.

---

### Securities regulation and capital markets (Bapepam-LK and IOSCO assessment)
- Bapepam-LK increased regulatory transparency and operational programs aligned with IOSCO norms.
- Deficiencies: outdated Capital Market Law, enforcement challenges, need for augmented administrative enforcement powers and independence.
- Priority actions:
  - Expedite legislative changes to strengthen administrative enforcement powers and investor protection.
  - Strengthen regulator capacity to address insolvencies.
  - Implement accounting standards aligned with IFRS by 2012 and robust oversight of application.
  - Improve customer protection, security of customer funds, handling of orders, disclosures, and pricing.

### Payment systems and securities settlement (CPSS and CPSS-IOSCO assessments)
- BI-RTGS:
  - Links 149 participants; introduced in 2000; settles in central bank money; finality once debited/credited.
  - Operational reliability good; second generation migration planned for 2011.
  - Recommended: enact specific payment systems law; explicitly recognize netting; introduce documented access criteria.
- BI-SSSS and C-BEST/KSEI/KPEI findings:
  - Legal recognition of DVP, finality, and netting requires strengthening.
  - Settlement cycles: some negotiated market trades settle later than T+3.
  - Cash settlement often handled via four payment banks; recommendation to explore cash settlement in BI-RTGS.
  - Recommendation: proceed with second generation system replacement and strengthen governance and separation of oversight and operational functions.

### CSDs and CCPs — selected recommendations
- Explicitly recognize netting and finality in legal framework.
- Adopt rolling settlement with final settlement no later than T+3; assess benefits/costs of shorter cycles.
- Consider a CCP where appropriate; assess cost/benefit and risk controls.
- Encourage securities lending and remove double taxation barriers to repos.
- Strengthen oversight, expand disclosures, and consider integrating KSEI into RTGS for cash leg.

---

### Monetary policy transparency and BI’s balance sheet (annex and section 56)
- BI’s ultimate objective: achieve and maintain the stable value of the rupiah; internal regulation notes “inflation” as the ultimate objective but public clarity recommended.
- Recommendation: public statement endorsed by government or DPR clarifying primacy of domestic price target over exchange rate.
- BI disclosures: publishes monthly, quarterly, annual reports; meets SDDS since June 2000.
- BI balance sheet issue:
  - BI holds non-tradable government securities (SUPs) that earn near-zero interest; recommendation to replace with tradable interest-bearing securities to improve monetary operations without increasing consolidated public debt service cost.
- Operational improvements:
  - Disclose criteria for selecting counterparties in FX market.
  - Consider parallel external audit by internationally recognized accounting firm to add credibility.

### AML/CFT (sections 56 and annex)
- Authorities adopted National Strategy to Combat Money Laundering and Financial Terrorism for 2009–2011.
- FATF acknowledged progress but strategic AML/CFT deficiencies remain.
- Agreed action plan items:
  - (1) adequately criminalize money laundering and terrorist financing;
  - (2) establish and implement procedures to identify and freeze terrorist assets;
  - (3) amend and implement laws to fully carry out the 1999 International Convention for the Suppression of Financing of Terrorism.
- Progress monitored by FATF.

---

### Legal framework, judicial and insolvency weaknesses (selected)
- Legal protection of supervisors:
  - Article 45 offers protection for BI staff for acts in “good faith” but proof is onerous; BI as an institution is not protected.
  - Bapepam-LK has narrower protections and no indemnity for costs.
- Contract enforcement and recoveries:
  - Indonesia ranks 146 in contract enforcement (Doing Business 2010).
  - Recovery rate on unsecured credits to large and connected borrowers < 15 percent.
  - Bankruptcies take 5–6 years; enforcement of contracts takes ~570 days with costs ~123 percent of claim.
- Corporate registration:
  - Up to 95 percent of businesses outside Jakarta are not formally registered; limited corporate information complicates credit underwriting.
- Recommendation:
  - Comprehensive insolvency and creditors' rights assessment (ICR ROSC) and judicial reform to improve recovery and enforcement.

---

*Source: Executive Summary and selected chapters and annexes, Financial Sector Assessment Program for Indonesia (FSAP); IMF staff report content unit _cr10288._*

### Executive Summary ......................................................................................................

### _cr10288 - Executive Summary

### Mission and assessment scope
- A joint IMF/World Bank team undertook the Financial Sector Assessment Program exercise for Indonesia during October 6–16, 2009 and February 24–March 10, 2010.
- The first mission assessed the observance of selected international standards and codes, and initiated discussions on a broad range of financial stability and structural issues.
- The second mission completed the work and presented a draft aide-mémoire along with drafts of technical notes.
- Four standards and codes were assessed: (i) Basel Core Principles (BCP); (ii) International Organization of Securities Commissions Principles of Securities Regulation (IOSCO); (iii) Core Principles for Systemically Important Payment Systems (CPSIPS); and (iv) Monetary Policy Transparency (MPT).
- Six technical notes were prepared: (i) Assessing Corporate Sector Vulnerabilities; (ii) Alternative International Structures of Financial Sector Supervision and Regulation; (iii) Stress Testing Indonesian Banks; (iv) Legal and Regulatory Framework of the Indonesian Financial System; (v) The Insurance Industry; and (vi) Capital Market Development in Indonesia.

### Macroeconomic and market context
- Indonesia recovered quickly after being hit by contagion from the global financial crisis.
- The economy expanded by 4.5 percent in 2009, the third fastest among G-20 economies.
- Key rating agencies upgraded Indonesia’s sovereign rating to one notch below investment grade and its sovereign outlook to positive.

### Main strengths and overall challenges
- Strengths cited: improved health of banks and companies, strengthened supervisory framework, improved macroeconomic policy framework, large consumer base, natural resource endowment.
- Challenges cited:
  - Financial sector depth and contribution to the economy lag comparable countries.
  - Indonesian securities trade at a discount relative to regional peers.
  - Many wealthy Indonesians prefer to place savings offshore.
  - Weaknesses in legal and governance frameworks undermine investor confidence.
  - Gaps in legal mandate and powers, governance, and protection for some institutions hamper enforcement.
  - Concerns about creditor rights shift bank focus toward consumer and SME lending rather than large corporate lending.

### Critical governance and legal weaknesses
- The most critical gap: absence of legal protection for the financial sector regulator and supervisor.
  - Public questioning of and political interference in supervisory actions have slowed decision making and occasionally paralyzed the prudential system.
  - Legal uncertainty about timeliness and consistency of judicial support for supervisory interventions compounds the problem.
- Addressing these legal and governance weaknesses is fundamental to achieving a sound and competitive financial system and to raise system resilience.

### Banking sector: performance, risks, and priorities
- Banking fundamentals have improved: most Indonesian banks report high capital, comfortable liquidity, and solid profitability.
- Noted risks and vulnerabilities:
  - Rising credit exposures to retail and SMEs; while diversifying balance sheets, this may expose banks to new risks in an environment of weak information quality.
  - Stress tests show banks are vulnerable to credit risk, and a few mid-sized banks to liquidity risk.
  - A sharp rise in energy and food prices could depress domestic demand, sour market sentiment and lead to capital outflows and exchange rate pressures.
  - Priority: strengthen the soundness of the large state-owned banks.
- Policy recommendation:
  - The government should refrain from using moral suasion and prudential regulations to promote credit growth. Targeting a higher loan-to-deposit ratio or reducing risk weights of certain loans independent of associated risk weakens banks’ balance sheets and system stability.

### Banking supervision and regulatory gaps
- Bank Indonesia (BI) has established supervisory frameworks and methodologies that generally meet international norms.
- Shortcomings identified:
  - BI falls short in dealing with problem banks.
  - Legally mandated prompt corrective action (PCA) would speed up BI’s actions to resolve weak banks and make decisions more transparent.
  - Issues remain with the quality of capital, loan provisioning rules, and home-host supervision.
- The non-bank financial sector is small and its regulator, the Capital Market and Financial Institution Supervisory Agency (Bapepam-LK), needs greater enforcement powers and independence to enable pre-emptive action against malpractices.

### Regulatory architecture and the proposed integrated supervisor (OJK)
- The BI Act as amended in 1999 requires establishment of an integrated supervisory agency (OJK) consolidating banking, insurance, and securities supervision.
- Observations:
  - Cross-country experience shows changing supervisory structure alone does not necessarily improve oversight or systemic risk assessment.
  - Transferring bank supervision out of BI risks losing competencies built over time and entails significant risk.
  - Recommendation: strengthen the existing regulatory and supervisory framework rather than relying solely on institutional reorganization.
  - This course calls for a stronger BI financial position and for enshrining in law a simpler, more transparent process for the selection of BI’s Board members.

### Financial safety nets and crisis management
- The authorities responded decisively and successfully to the 2008 crisis, but the financial safety net law needs to be passed to ensure similar defenses can be mounted in the future.
- The Crisis Management Protocol functioned well during the crisis, but it has lapsed.
- New legislation is needed to:
  - Ensure timely response in periods of crisis.
  - Provide legal protection for policy makers and supervisors in performance of their duties.
- Deposit insurance (LPS) requires increased funding commensurate with the larger size of deposits being covered.

### Nonbank financial sector development: capital markets and insurance
- Much more can be done to develop Indonesia’s capital markets to diversify sources of funding and provide long-term investment opportunities.
- The insurance industry is small and should be restructured and gradually expanded to broaden the institutional investor base.

### Stress testing and systemic diagnostics
- Stress tests indicate:
  - Systemic vulnerability to credit risk across banks.
  - Liquidity vulnerability for a subset of mid-sized banks.
- Table 1 (Financial Stability Diagnostic and Assessment Matrix) and Table 3 (Stress Test Summary Results: Top-Down Scenario Analysis) summarize threats, likelihoods, and expected impacts, and stress-test outcomes (tables referenced in the source).

### Recommendations and implementation support
- The full list of FSAP recommendations, including key priorities and areas covered by the World Bank, are summarized in Table 2 (FSAP Recommendations).
- Technical assistance could be provided to support design and implementation of recommended reforms.

*Source: Executive Summary, Financial Sector Assessment Program for Indonesia (October 6–16, 2009 and February 24–March 10, 2010).*

### 1. Sharper than projected

### 1. Sharper than projected

### Key risks and potential impacts
- 1. Slower-than-expected economic growth
  - Scenario: slowdown in economic growth due to slower recovery in commodity markets, in regional or global growth, or decline in domestic consumption.
  - Likelihood: Low/Medium
  - Findings and conditional dynamics:
    - Forecast is still for higher growth in 2010 and onwards.
    - Much hinges on external factors, such as the global economic outlook, along with the government’s ability to provide further stimulus to the domestic economy. Increased spending on infrastructure would provide additional cushion.
    - Monetary policy will provide limited room for stimulus as policy rates have decreased sharply since mid-2008. However, if the economy weakens and commodity prices remain subdued, policy interest rates could decline somewhat.
  - Banking-sector effects (Medium):
    - A slowdown would deteriorate asset quality, although with a lag, and impact bank earnings and profitability.
    - On the whole, the banking system appears to be adequately capitalized and profitable to sustain an economic slowdown and absorb potentially higher NPLs.
    - Banks have remained resilient through the 2008 global downturn. Strengthened risk management practices (e.g., lowering exposures to more problematic sectors) and lower dividend payouts would provide additional buffers.

- 2. Reduced capital inflows and increased capital outflows triggered by heightened investor aversion toward Indonesia.
  - Likelihood: Medium-High
  - Findings:
    - The political environment is seen as more stable than before (e.g., credit default swap (CDS) spreads have decreased markedly), with a smooth 2009 presidential election.
    - Notwithstanding, terrorist threats and political risk are factors underpinning Indonesia’s higher sovereign risk premium than comparable countries.
    - Sustained capital outflows could trigger a sharp downturn in the macro environment (exchange rate, inflation, interest rates), market access problems and heightened roll-over risk for the government.
  - Banking-sector effects (Medium):
    - The impact would be felt initially on the securities market, in particular the government bond market, and overall liquidity in the system. However, BI has the instruments to quickly add liquidity. Banks are less vulnerable to a cut off from external finance than the government. Hence government funding costs could increase both domestically and externally, restraining its ability to provide stimulus to the economy.
    - Credit risk would increase as the second round effects of tighter monetary policy and slower economic growth affect domestic consumption and banks’ SME and retail portfolio.
    - Banks would also suffer from potential losses on their market risk exposures, although this risk may have been reduced when banks were allowed in 2008 to shift their government bond holdings from available for sale to hold to maturity, and book those in available for sale at fair market value.
    - Banks in Indonesia have experience in dealing with financial market volatility and carry a higher capital buffer to protect against these shocks. The 2008 crisis showed that the impact of capital outflows on credit risk has been minimal so far.

- 3. Withdrawal of domestic retail deposits
  - Likelihood: Low
  - Findings:
    - The threat of a systemic deposit run is unlikely at this stage as the banking sector is relatively sound. Banks did not experience major deposit withdrawals during the second half of 2008 when the global crisis severely affected the financial market in Indonesia.
    - Macroeconomic fundamentals have strengthened over the years, further lowering the threat of deposit runs. Public confidence in the banking system and in macroeconomic management has increased. The government also introduced a deposit insurance scheme in 2007, and more recently increased the coverage to IDR 2 billion.
    - The government also stands ready to support the domestic banking sector, if necessary.
  - Banking-sector effects (Medium):
    - Bank funding structure is short-term. Currently, banks rely mainly on retail domestic deposits, both foreign and local currency, for funding. Hence, they would be vulnerable to a sudden withdrawal of deposits to nearby off-shore centers.
    - Second tier large banks and mid-sized banks with tighter liquidity positions and greater reliance on deposits as a source of funding would be more vulnerable. These banks would likely have more difficulty accessing the wholesale market in times of heightened counterparty risk.
    - Banks’ relatively conservative loan-to-deposit ratios and high holdings of government bonds and SBIs minimize the impact of this risk, although banks’ margins and profits would be affected as a result of a higher cost of funding.
    - BI is seen as likely to step in during a general liquidity crisis. BI has the instruments to quickly provide liquidity to the market.

- 4. Sharp increase in commodity prices (e.g., oil and food) resulting in inflation and higher interest rates
  - Likelihood: Medium
  - Findings:
    - Indonesian households and companies are vulnerable to a sharp increase in commodity prices, in particular energy and food given that they account for a significant share of consumption. Corporate margins would be squeezed by higher energy prices. The knock-on effect to the broader economy would be high given that domestic demand accounts for the bulk of economic activity.
    - Inflation risk would be higher and this could trigger further rounds of interest rate increases to bring inflation under control.
  - Direct credit effects (Low):
    - Sharp commodity price increases could trigger an increase in payment delinquencies and default risk for companies, SMEs and households as their income and cash flows become more constrained.

- 5. Exchange rate volatility
  - Likelihood: High
  - Findings:
    - Indonesia has a flexible exchange rate regime that can move in both directions in response to changing economic conditions.
  - Banking-sector exposure (Low):
    - Exchange rate exposures are limited. Net open foreign currency positions are tightly managed.
    - The financial system is accustomed to dealing with exchange rate volatility.

- 6. Shortcomings in the framework for bank intervention and resolution accentuating banking risks
  - Likelihood: Medium
  - Findings:
    - The current framework encompasses shared power between BI, Bapepam-LK, and LPS. It also includes the opportunity for parliament and bank management to intervene.
    - Coordination issues, including delayed action, might emerge in the event of a crisis. Problem banks could be placed under intensive supervision for an indefinite period of time, with their resolution contingent on a number of factors.
  - Impact (Medium):
    - Delays in resolving a bank that has been troubled for an extended period of time could lead to higher than expected cost for the government and financial system.
    - For the impact to be systemic, this would have to involve the failure of a large bank and recent failures have been limited to small banks.

### FSAP recommendations (selected, priority and time frame preserved)
- Banking Issues
  - Issue revised regulation to strengthen the quality of capital by bringing risk weights to at least Basel I levels and tightening the accounting definition of Tier 1 capital. Priority: H; Time frame: 6
  - Issue revised regulations to strengthen the regulatory definition of exposure, including related-party exposure. Priority: H; Time frame: 6
  - Issue revised regulation to strengthen asset classification and provisioning norms, including treatment of restructured loans. Priority: H; Time frame: 6
  - Issue regulations and supervise interest rate risk on banks' banking book. Priority: M; Time frame: 12
  - Establish regular contacts with domestic and foreign supervisors to strengthen consolidated supervision and home-host cooperation and information exchange relationships. Priority: H; Time frame: 12
  - Submit to the House of Representatives (DPR) draft prompt corrective action legislation to achieve timely corrective measures, to remove discretion from the process, and limit the time banks can spend under intensive supervision. Priority: H; Time frame: 12
  - Maintain capital adequacy requirement in line with the Basel I norms until Pillars 2 and 3 of the Basel II framework are operational; more generally, handle the transition to Basel II and new accounting standards carefully to ensure the right balance between various interactive elements. Priority: H; Time frame: ongoing
  - Strengthen BI and banks' stress testing capability. Priority: M; Time frame: ongoing
  - Revise the law to give SOCBs more flexibility in dividend payout, debt restructuring, and management of capital structure and business risks. Priority: M; Time frame: 24

- Regulatory Structure
  - Review financial sector supervision and regulation to ensure micro-macro prudential coordination while reforming the financial supervision framework. Priority: H; Time frame: ongoing

- Central Banking
  - Strengthen BI’s balance sheet by agreement with the government to restructure zero interest government debt into market interest bearing debt. Priority: H; Time frame: 12
  - Improve the selection process of BI's Board members. Priority: H; Time frame: 24
  - Further clarify BI's policy objective and develop a mechanism to eliminate the discrepancy between the official inflation targets announced by the Ministry of Finance (MOF) and the targets used by BI. Priority: M; Time frame: 12
  - Disclose criteria for selecting counterparties in FOREX market. Priority: L; Time frame: 12

- Deposit Insurance
  - Increase the deposit insurance fund commensurate with the increased size of deposits covered, through higher premiums or capital injection. Priority: H; Time frame: 12
  - Improve cooperation between BI and the LPS. Priority: M; Time frame: 24
  - Adopt more transparent market-based ceiling rates on insured deposits, with a plan to review the effectiveness of the system going forward. Priority: M; Time frame: 24

- Capital Markets
  - Amend the capital market law to augment regulators' independence and enforcement powers, including the power to assist foreign regulators and gain more expeditious access to bank accounts. Priority: H; Time frame: 12
  - Encourage SOEs to list in the stock market or issue fixed income instruments to help capital market development. Priority: M; Time frame: 24
  - Expand the institutional investor base. Priority: M; Time frame: 24
  - Develop educational programs and professional training. Priority: L; Time frame: 24
  - Improve the price discovery mechanism of government bond trading. Priority: H; Time frame: 24

- Insurance
  - Pass an insurance law. Priority: H; Time frame: 12
  - Deal with insolvent insurance companies to avoid systemic failure. Priority: H; Time frame: 6
  - Explore options to develop the insurance sector. Priority: M; Time frame: 24
  - Develop micro and Sharia insurance products for low-income households. Priority: L; Time frame: Ongoing

- Legal Protection Issues
  - Amend the Bank Indonesia Act (BI Act) and the Capital Markets Law to enhance the scope and strength of legal protection of bank supervisors and securities regulators. Priority: H; Time frame: 6-12
  - Enact crisis management legislation including protection for officials involved. Priority: H; Time frame: 6-12

- Market Infrastructure (selected)
  - Consider measures to increase access to finance (A2F) and improve the quality of branch services. Priority: L; Time frame: Ongoing
  - Regulate and supervise Sharia finance to bring its capital requirement in line with those governing conventional commercial banks. Priority: L; Time frame: 24
  - Improve the national credit bureau; consider private credit bureaus. Priority: H; Time frame: 12
  - Improve the certainty and speed of execution of collateral and of bankruptcy proceedings. Priority: H; Time frame: 24
  - Strengthen and enforce registration of companies and filing of financial statements using unique identification. Priority: M; Time frame: 24
  - Carry out insolvency and creditors' rights assessment (ICR ROSC). Priority: M; Time frame: 24
  - Address weaknesses in laws governing payments systems, including finality of payments, delivery-versus-payment (DVP). Clarify who has access to the payment system and to enforce the regulatory and oversight responsibilities of BI and Bapepam-LK. Priority: M; Time frame: 12
  - Promote efficient sharing of infrastructure and the adoption of standards and support sharing in BI's oversight of the payments system. Priority: L; Time frame: 12
  - Establish countrywide infrastructure that supports electronic payments and educates consumers about the benefits of electronic means of payment. Priority: L; Time frame: 24
  - Ensure banks’ compliance with PSAK 55 (IAS 39). Priority: H; Time frame: 6
  - Increase the number of qualified accountants and actuaries. Priority: M; Time frame: 24
  - Transfer oversight of auditors and public accounts to Bapepam-LK. Priority: H; Time frame: 24
  - Enact new financial reporting and accountants laws. Priority: H; Time frame: 12
  - Build the capacity of accountancy organizations. Priority: M; Time frame: 24
  - Speed up convergence to International Financial Reporting Standards (IFRS) by an assessment of constraints and actions to deal with them. Priority: M; Time frame: 24
  - Enforce the law requiring audited consolidated accounts for major corporations. Priority: M; Time frame: 24

### Structure of the financial system (key facts)
- Total financial sector assets stood below 60 percent of gross domestic product (GDP) in 2009.
- The financial system is dominated by banks, accounting for 50 percent of GDP and 80 percent of the financial system.
- The top three state-owned commercial banks (SOCBs) account for one-third of the banking sector asset and deposit base, and the top 15 banks for about 70 percent.
- Foreign banks as a group represent 29 percent of banking assets (consisting of locally owned subsidiaries, joint venture banks and foreign bank branches) while government owned banks as a group represent 43 percent of banking assets (SOCBs and regional government banks).
- Banks rely on short-term funding: over 90 percent of the banks’ funding structure is short, with maturities of less than one month and at call.
- At end-2009, over 65 percent of the time deposits had one month or less tenor, and only 1 percent with more than one year.
- The non-bank financial sector accounts for less than 10 percent of GDP. The insurance sector is the largest among non-bank financial institutions, accounting for about 3 percent of GDP.
- The market capitalization of the Jakarta Stock Exchange (IDX) was about 48 percent of GDP at end 2009; the bond market capitalization amounted to 12 percent of GDP at end-2009.
- Government is the dominant issuer in the bond market, accounting for 85 percent of the bond market. Commercial banks hold more than half of the government bonds; foreign investors own some 20 percent.

### Banking sector stability — Recent financial performance
- Annual loan growth has averaged 21 percent since 2003.
- Consumer, micro and SME loans now account for 54 percent of total loans compared to 45 percent in 2002, and 30 percent in the 1990s.
- Corporate loans accounted for about 46 percent of banks’ total lending at end-2009, reflecting a comeback during 2007-2008 tied to government infrastructure spending.
- After the 1997 financial crisis, banks reduced holdings of government securities, freeing up liquidity for lending.

*Source: _cr10288 - 1. Sharper than projected.*

### 11.      Following several years of strong expansion, lending growth slowed in 2009

### 11.      Following several years of strong expansion, lending growth slowed in 2009

### Lending growth and sectoral patterns
- Annual loan growth:
  - Peaked at 38 percent (y-o-y) in October 2008.
  - Decelerated to 10 percent in 2009.
- Banks’ behavior:
  - Became more cautious given the deteriorating global macroeconomic environment.
  - Credit demand for working capital and investment declined, particularly from the manufacturing industry.
  - Banks continued to expand exposure to the retail sector as households proved more immune to the global slowdown.
- Bank types and currency composition:
  - SOCBs and regional government banks reported the strongest loan expansion, most coming in the second half of 2009.
  - Foreign currency loans fell sharply across all banks due to tighter foreign currency liquidity conditions and heightened external risks in early 2009.

### Profitability and liquidity
- After tax-ROA increased to 1.8 percent in 2009.
- Net interest income contributed positively through higher credit spreads and loan growth, helping offset higher provisioning charges.
- Liquidity and funding:
  - Banks held a higher level of liquid assets against short-term liabilities.
  - Loan to deposit ratio fell to 73 percent at end-2009 from 75 percent in 2008.

### Asset quality
- Gross non-performing loans (NPLs) increased by 14 percent for the year, while the NPL ratio remained steady at 3.2 percent.
- Composition of NPL increases:
  - Corporate loans accounted for about half of the increase.
  - SMEs accounted for another 40 percent.
- Other indicators:
  - Share of restructured loans rose to 3 percent of total loans in 2009 from 1.9 percent in 2008.
  - Deterioration was widespread; export-oriented sectors such as mining, manufacturing, and trade were most affected.
  - Data for listed companies showed a jump in default probabilities for the last quarter of 2008, subsequently declined and expected losses appear manageable.

### Loan-loss coverage
- Coverage ratio increased to 62 percent of NPLs at end-2009 from 58.5 percent in 2008.
- Past disparities in coverage between SOCBs and other banks have narrowed.

### Capital adequacy
- Average risk-weighted capital adequacy ratio (CAR) increased to 17.5 percent at end-2009.
  - Regulatory minimum: 8 percent.
  - BI’s informal target: 12 percent.
- Leverage ratio: 10 percent.
- Capital actions:
  - Several banks increased capital via rights and subordinated debt issuance in 2009 or through higher retained earnings after temporarily lowering dividends in 2008.
  - Number of banks below the IDR 100 billion minimum capital requirement (effective end-2010) declined to 11 from 24 at end-2008.
- SOCBs continue to report lower capital than private banks.

### Vulnerabilities and stress test results
- Stress testing approach:
  - Top down (TD) and bottom up (BU) stress tests subjected the sector to an extreme macroeconomic shock (GDP contraction of 5 percent compared with average growth of 5 percent over the past nine years) and single-factor shocks.
- General findings:
  - Credit risk is the main source of risk facing Indonesian banks.
  - TD results show severe outcomes; BU results are more positive for several reasons (banks’ own assumptions on profits, loan growth, and improved risk management).
- TD scenario results (key points):
  - System NPLs would peak at 31.5 percent in 2011Q3 from current levels of 3½ percent.
  - Capital for a number of banks would fall below the regulatory minimum, with a few becoming insolvent.
  - Small banks with significant capital and liquidity buffers weather the stress better than large and mid-sized banks; private banks fare better than the four SOCBs.
  - Foreign-owned banks relatively resilient, although seven become undercapitalized and one becomes insolvent.
- BU scenario results (key points):
  - With current profits (non-zero profit assumption), only 3 of the 8 banks would become undercapitalized and none would become insolvent.
  - With zero operating profit, 7 out of 8 banks would become undercapitalized, although no bank would become insolvent under BU.
- SOCB vulnerability:
  - SOCBs are most vulnerable due to legacy issues, including sizeable exposure to restructured assets and lower provisioning and capital buffers.
- Sensitivity and other risks:
  - Banks relatively resilient to market shocks; most sensitivity is to interest rate shocks on the banking book.
  - Second-tier large banks and mid-sized banks most vulnerable to liquidity risk.
    - Around three quarters of banks would cope with a run on deposits up to five days.
    - Remaining vulnerable banks have less diversified funding, higher loan-to-deposit ratios, and lower holdings of liquid assets.
  - Concentration risk:
    - If the 10 largest system-wide borrowers were to fail, average losses would amount to 1½ percent of CAR with four banks falling below BI’s minimum capital requirement (TD).
    - BU indicates greater concentration risk for the top 12 banks: if their 10 largest borrowers failed, average CAR would decline by 6½ percentage point and five banks would fall below the minimum regulatory capital requirement.
    - Higher losses reflect greater loan exposure to large companies, including SOEs, subject to a 30 percent legal lending limit (compared to 20 percent for single exposures).
  - Contagion risks through the interbank market are negligible due to small interbank exposures; interbank market does not play a significant role in funding or liquidity management.

### Top-Down Stress Test summary (selected figures, based on end-September 2009 data)
- Pre-shock end-September 2009 CAR: 17.8 (Total); Gov 13.8; SOCB 13.7; Foreign 23.7; Private 17.1; Large 17.3; Medium 21.9; Small 38.3; minimum 6.6; Median 18.8.
- Post-shock CAR examples: Total 6.8; Gov -1.1; SOCB -3.9; Foreign 15.3; Private 9.2; Large 5.9; Medium 14.9; Small 32.2; minimum -15.2; Median 13.0.
- Percent change in CAR: Total -11.0; Gov -15; SOCB -17.5; Foreign -8.4; Private -7.8; Large -11.4; Medium -7.0; Small -6.1.
- Number of undercapitalized banks: Total 37; Gov 15; SOCB 4; Foreign 7; Private 15; Large 17; Medium 19; Small 1.
- Percent of Total Assets in undercapitalized banks: Total 56.3; Gov 39.6; SOCB 36.5; Foreign 10.2; Private 6.5; Large 53.4; Medium 2.9; Small 0.0.
- Number of insolvent banks: Total 13; Gov 5; SOCB 3; Foreign 1; Private 7; Large 8; Medium 5; Small 0.
- Percent of Total Assets in insolvent banks: Total 33.6; Gov 28.8; SOCB 28.1; Foreign 0.6; Private 4.2; Large 33.0; Medium 0.6; Small 0.0.
- Recapitalization need (in trillions Rupiah): Total 72; Gov 55; SOCB 53; Foreign 8; Private 9; Large 69; Medium 3; Small 0.
- Recapitalization needs in percent of 2009 GDP: Total 1.3; Gov 1.0; SOCB 1.0; Foreign 0.1; Private 0.2; Large 1.3; Medium 0.1; Small 0.0.
- Pre-shock NPL (end-September 2009): Total 3.8; Gov 4.4; SOCB 4.2; Foreign 3.9; Private 3.0; Large 3.7; Medium 4.6; Small 3.1.
- Post-shock NPL: Total 31.5; Gov 42.5; SOCB 37.6; Foreign 27.5; Private 24.0; Large 32.4; Medium 21.7; Small 23.6.

### Banking regulation, supervision gaps, and recommendations
- Legal protection for supervisors:
  - Serious shortcoming: absence of effective legal protection for supervisors leads to hesitancy in making supervisory judgments or taking decisions.
  - Amendments to the BI Act are required urgently to:
    - Explicitly state presumption of good faith in favor of supervisory staff.
    - Protect supervisory staff from omissions and assume all costs for defending their actions.
    - Grant protection to BI as a supervisory authority.
- Capital base quality:
  - BI regulation allows certain items to be considered as Tier 1 capital even if they may not meet certainty, permanence, and loss-absorbing ability tests (examples include foreign currency translation gains; specific reserves; unaudited current year’s profit inclusion rules; net inter-office funds of foreign bank branches).
  - Since March 31, 2006, BI has lowered applicable risk weights for certain categories of assets below Basel I levels.
  - Adjusting for net inter-office funds and lower risk weights would reduce the CAR by about 238 basis points to 15.2 percent from the current average level of 17.5 percent.
  - Addressing these gaps is important as system CAR could mask differences at individual bank level.
- Asset classification and provisioning rules of concern:
  - Rules on restructured loans, provisioning against unsecured loans, and collateral valuation could distort asset quality and result in under-provisioning or inappropriate recognition of income.
  - Concerns include:
    - Exposures backed by certain specified collateral do not have to be classified as NPLs even if in default.
    - High exemptions to uniform asset classification norm and forward-looking risk assessment.
    - Loose norms for restructured loans (immediate upgrades, repeated restructuring).
    - Allowing foreclosed collateral and dues to be converted to equity and immediately classified as current for up to one year.
  - Move toward full compliance with PSAK 55 will help bring greater transparency to impairment recognition.
- Interest rate risk supervision:
  - Regulation and supervision of interest rate risk on banks’ banking book is lacking.
  - Stress tests indicate vulnerability due to re-pricing mismatches; BI is collecting data on maturity mismatches.
- Domestic and cross-border supervisory cooperation:
  - Lack of effective arrangements for regular cooperation between domestic supervisory authorities and foreign supervisors impedes BI.
  - BI should develop effective operating arrangements with relevant supervisors, based on but going beyond formal Memoranda of Understanding (MOU).

### Dealing with problem banks — supervisory powers and prompt corrective action (PCA)
- Current deficiencies:
  - Supervisors’ ability to deal with problem banks effectively and expeditiously is lacking.
  - Procedures, rules, and reliance on protracted action plans slow resolution.
  - Problem banks can only be placed into special surveillance contingent on subjective factors.
    - Special surveillance triggers: liquidity problems or capital ratio falling below 8 percent.
    - Banks with other problems are placed into intensive supervision, where remedial plans can last several years and often do not include measures to prevent further deterioration.
    - Movement from intensive supervision to special surveillance is contingent on BI’s Board of Governors’ advice.
- Recommended tightening of rules (consistent with existing BI regulations):
  - If a bank has been in intensive supervision for 1 year and has not exited, it should be moved to special surveillance, regardless of its capital level.
  - Enact prompt corrective action legislation mandating:
    - If a bank’s CAR falls below 8 percent (or the statutory minimum), the supervisor must issue a binding order requiring management or shareholders to take actions that correct deficiencies and restore capital above the statutory minimum within six months. If not improved after six months, but the bank is solvent, shareholders must sell the bank or the license is revoked. Supervisors must place the bank under continuous on-site supervision.
    - If capital falls to 4 percent, impose limitations on the bank’s ability to fund itself with wholesale funding. BI should only extend credit to such a bank if it is guaranteed by the government. Capital should be restored to the regulatory minimum within three months or the license is to be revoked.
    - If capital falls to 2 percent the license should be revoked.

*IMF staff report content unit.*

### 29.      BI plans to commence Basel II implementation for all commercial banks over a

### _cr10288 - 29.      BI plans to commence Basel II implementation for all commercial banks over a

### Basel II implementation and supervisory sequencing
- Timetable and approach:
  - Pillar 1: 2011
  - Pillar 2: 2012–2014
  - Pillar 3: 2011–2014
  - Initial implementation based on the simplified approach; advanced approaches allowed only with prior authorization from BI.
- Risks and concerns:
  - BI is concerned that current regulatory initiatives might address issues not directly relevant to the local context.
  - Important to achieve the right balance among the various elements of the three pillars.
- BCBS guidelines highlighted:
  - A good baseline supervisory system must be in place before moving on to Basel II; successful implementation of the Basel Core Principles (BCP), including its “preconditions,” serves as the baseline.
  - Legal-regulatory infrastructure, the disclosure regime, and the status of corporate governance, accounting and provisioning practices will determine the pace of transition; Indonesia’s adoption of new international accounting standards (IAS) based on IAS 32 and IAS 39 should be managed carefully and implemented well.
  - Pillar 1 minimum capital requirements need to be complemented by supervisory review under Pillars 2 and 3.
- FSAP recommendation:
  - Banks should be required to maintain capital adequacy in line with the Basel I norms until Pillars 2 and 3 of the Basel II framework are operational.
  - Use the transition phase to validate effectiveness of Pillar 1 and Pillar 2 elements, including new supervisory processes, and to reflect any BCBS revisions.

### Securities regulation (Bapepam-LK)
- Findings:
  - Bapepam-LK has increased regulatory transparency and instituted comprehensive operational programs aligned with IOSCO norms.
  - Deficiencies remain in the legal structure, including the absence of a comprehensive and updated capital market law, making enforcement a challenge.
- Recommendations:
  - Pending enhancements to enforcement powers, accelerate greater independence and better cooperation among domestic and international authorities.
  - Focus on improving and intensifying oversight programs, develop written cooperation arrangements for information sharing in joint oversight, and take steps to combat market abuses.
  - Expedite move toward accounting oversight and practices in line with international standards, and advance contingency and business continuity planning.

### Insurance regulation
- Findings:
  - Supervisory powers to intervene and resolve insolvent insurance companies are incomplete.
  - Insurance law allows admonitions, sanctions, licensing restrictions, and license withdrawal but does not authorize taking control of a company’s assets, leaving policyholders unprotected.
- Recommendation:
  - Enact a legal framework to involve the supervisor in unwinding insurance companies and to force timely corrective action; present legislation to parliament.

### Integrated supervisory agency (OJK) considerations
- Proposal:
  - Authorities are considering establishing an integrated supervisory agency (OJK) to merge non-bank supervision functions of Bapepam-LK with bank supervision functions of BI.
- Risks and caveats:
  - Structural change alone does not guarantee improved supervision; authority, skills, and resources are essential.
  - Risks from transferring bank supervision out of BI:
    - Loss of supervisory continuity from staff transfers, pay and benefits comparability, and increased private-sector turnover.
    - Clash of supervisory cultures that can weaken supervision and information flows in crises.
    - Tension between market conduct and prudential responsibilities in some consolidated agencies can weaken prudential oversight.
    - Premature restructuring before the macro- and micro-prudential supervision nexus is better defined.
- If OJK proceeds:
  - Ensure close integration between BI and OJK to mitigate identified risks.

### Financial safety nets and crisis management capabilities
- Context and legal status:
  - Presidential decree providing crisis management framework has lapsed; country lacks a framework to deal with a systemic crisis.
  - Parliament rejected in late 2008 a proposed financial stability law that included emergency lending provisions; government preparing a revised Financial System Safety Net (FSSN) law expected to be discussed by Parliament this year.
- Emergency liquidity provisions:
  - BI can provide:
    - (i) a short-term funding facility (SFF)
    - (ii) an emergency liquidity assistance (ELA) facility for systemic banks.
  - Under the new FSSN, decision to provide ELA will be made by the President with a guarantee backing the loan issued by the Minister of Finance upon obtaining parliamentary approval.
  - Clarity required on how emergency lending should be handled.
- Deposit insurance (LPS):
  - System characteristics and recent changes:
    - LPS covers insured deposits and resolves failed banks.
    - In October, 2008, deposit coverage was increased from IDR 100 million (US$ 10,000) to IDR 2 billion (US$ 200,000); enacted into law in December 2008.
    - Deposits earning interest above a specified limit are not covered.
    - Prevailing maximum rate on covered deposits, set in October 2009:
      - 7 percent on IDR deposits for commercial banks
      - 10.25 percent for rural banks
    - Through end-2009, LPS has paid off depositors at 21 small banks, primarily in rural areas; depositors were paid off promptly with no spillovers to other banks.
  - Issues and recommendations:
    - LPS would benefit from establishing a market-based ceiling rate on insured deposits, possibly by referencing a market rate with a fixed margin.
    - Information on the ceiling rate should be prominently displayed in each bank branch.
    - Consider whether the indirect subsidy from a differentiated cap between rural and commercial banks is appropriate; it allows rural banks to attract insured deposits from commercial banks.
    - Review overall effectiveness of the system.
  - Cooperation and funding:
    - BI provides LPS with information on banks under special surveillance, but not those under intensive supervision; providing the latter would improve LPS planning.
    - Twenty-fold increase in coverage last year led to a substantial decline in the ratio of LPS resources to the insured deposit base.
    - LPS may seek a loan from the government in liquidity difficulties and additional funds if capital falls below the original level (Article 85), but potential delays exist.
    - To cope, LPS will need to increase resources through higher premiums or additional government capital so that fund size is adequate to handle the failure of at least two mid-sized banks; mission unable to quantify exact amount and recommends LPS conduct the necessary study.
  - Note on differentiated cap history:
    - The difference in rates has been reduced from 5 percent in 2006 to 3.25 percent in 2009 and likely to narrow further in the future.
    - Some banks are apparently circumventing the ceiling rate by offering vouchers to depositors, although this practice is not widespread.
- Bank resolution framework:
  - LPS is legally empowered to manage and resolve problem banks with systemic effect.
  - Coordinating committee of the Minister of Finance and the Governor of BI declares a bank systemically important, considering systemic effect beyond size.
  - Once declared systemic, the bank is handed over to LPS with or without existing shareholders’ participation (Article 22); LPS options include liquidation or taking ownership and all management rights.
  - LPS has substantial powers to resolve non-systemic banks, though it has not used these.
  - Legal risk for LPS staff:
    - Staff and seconded staff face substantial legal risks in managing rescued banks and need better legal protection against “second guessing”; legal concerns may inhibit use of LPS resolution powers.
- Crisis management protocol and legal protections:
  - No legally mandated protocol exists; a protocol introduced during the recent crisis by government regulation in lieu of law assigned decision authority to the Governor of BI and the Minister of Finance, with some decisions reserved for the President; where Governor and Minister disagree, the minister’s decision is binding.
  - Political controversy over 2008 decisions raises doubts about whether similar actions would be possible in future crises; likely that key decisions would have to be made at highest political level if decision makers lack legal protection.
  - Imperatives and recommendations:
    - Make an effective crisis management protocol law that allows speedy informed decision-making and provides a mechanism for reasoned recommendations to the decision maker.
    - President should decide only on whether a systemic crisis exists or an institution is systemic; implementation strategy decisions should be delegated to other officials.
    - Provide legal protection to all government officials involved in the crisis management process, with a requirement to report to parliament within a reasonable period on actions taken, likely fiscal cost (both real and gross) and follow-on strategy.

### Development issues in nonbank sectors
- Capital markets (findings and steps forward):
  - Indonesia’s capital markets are limited in scope and depth and are not a major source of funding or long-term investment.
  - Steps to develop capital markets:
    - Strengthen investor confidence by ensuring no single market stakeholder can unduly influence market functioning; augment capital market law to provide Bapepam-LK with enforcement tools and sanctions of sufficient magnitude; improve legal and accounting standards.
    - Government strategy to encourage a more diverse and liquid market: encourage listing of additional SOE shares, privatize more SOEs, encourage SOEs to issue fixed income securities; MOF to continue creating benchmarks and extending the yield curve while ensuring auctions do not crowd out corporate debt.
    - Expand institutional investor base by promoting insurance, pension and mutual fund industries; provide access to longer-duration instruments and hedging tools; consider increasing mandatory retirement savings as was done in Chile.
    - Review transaction costs and taxes on capital market transactions to assess relative levels; government provided a tax reduction: a 5 percent reduction for companies who float at least 40 percent of their shares, but reluctance to disclose financial information persists.
    - Self-regulatory organizations should promote education, professional training, and credibility of capital markets as an employment sector.
- Insurance sector development:
  - Priority to diversify institutional investor base; industry under strain and needs prompt corrective measures.
  - Suggestions:
    - Provide tax incentives to encourage shift from short-term to long-term saving products.
    - Expand served population through micro and Sharia insurance.
    - Establish a policyholder protection fund and build capacity in the industry and in Bapepam-LK.

### Monetary policy transparency and BI’s balance sheet
- Transparency and governance:
  - BI has achieved high transparency in conducting monetary policy; rules and regulations safeguard BI integrity; staff required to provide financial disclosure and abide by a code of conduct; BI regularly discloses information and is addressing remaining gaps related to policy objectives and operational procedures.
- Balance sheet concerns and recommendations:
  - BI currently mops up excess liquidity by issuing SBIs against non-tradable assets that earn close to zero interest, making BI a net borrower of the domestic financial system at extremes and potentially creating a disincentive to raise interest rates when warranted.
  - Recommendation: replace BI’s non-tradable assets with interest-bearing securities of the same maturity and with a market-determined rate; this requires no legislative changes and will not increase consolidated public debt service cost.
  - Governance recommendation: streamline the selection process of BI’s Board members; consider selecting a larger number of deputy governors from outside BI’s career stream to enhance oversight and introduce diversified perspectives.

### Anti-money laundering and combating the financing of terrorism (AML/CFT)
- Assessment status:
  - Indonesia’s AML/CFT framework was assessed in November 2007 against the FATF 40+9 Recommendations by the Asia/Pacific Group on Money Laundering.
- Findings:
  - Report indicates significant money laundering (ML), terrorism, and terrorist financing (TF) risks in Indonesia.
  - Challenges include domestic laundering of proceeds of crime and movement of funds to regional financial centers.
  - Indonesia has made noteworthy progress implementing AML measures but less progress on CFT measures.
  - Corruption remains a significant issue and national priority.
  - Legal and supervisory framework for AML/CFT would benefit from strengthening.

*Source: IMF staff report content unit _cr10288 - 29.      BI plans to commence Basel II implementation for all commercial banks over a*

### 56.      The authorities indicated that progress has been made since the APG evaluation,

### _cr10288 - 56.      The authorities indicated that progress has been made since the APG evaluation,

### AML/CFT progress and FATF action plan
- The authorities adopted a National Strategy to Combat Money Laundering and Financial Terrorism for 2009 to 2011.
- In early 2010, the FATF acknowledged progress but noted that certain strategic AMF/CFT deficiencies still remain.
- Indonesia made a high-level political commitment to work with the FATF and the APG and agreed to the following action plan:
  - (1) adequately criminalizing money laundering and terrorist financing;
  - (2) establishing and implementing adequate procedures to identify and freeze terrorist assets; and
  - (3) amending and implementing laws or other instruments to fully carry out the 1999 International Convention for the Suppression of Financing of Terrorism.
- Progress in implementing the action plan will be monitored by the FATF.

### Annex: purpose and scope of financial sector standards assessments
- The annex contains summary assessments of international standards and codes relevant for the financial sector.
- The assessment identified the extent to which the supervisory and regulatory framework addresses potential risks in the financial system.
- Detailed assessments undertaken included:
  - the Code of Good Practices on transparency in monetary policy by Ms. Li (IMF);
  - the BCP for Effective Banking Supervision by Mr. Damodaran (WB) and Mr. Ryback (external consultant);
  - the IOSCO Objectives and Principles of Securities Regulation by Ms. Corcoran (external consultant) and Mr. Conroy (WB);
  - the CPSS Core Principles for Systemically Important Payment Systems by Ms. Zanza with the assistance of Mr. Summers (both WB);
  - the CPSS-IOSCO Core Principles for government bonds, equities, and corporate securities by Ms. Wendt (external consultant).
- Assessments were based on:
  - self-assessments by the Indonesian authorities;
  - review of relevant documents;
  - discussions with the Indonesian authorities, market participants, and industry associations on actual practices.
- Conclusion: Indonesia’s observance of international financial sector standards and codes is broad, though in each area certain aspects were identified where further improvements would be desirable. The Indonesian authorities are aware of areas needing reform and are in the process of addressing them.

### A. The Code of Good Practices on Transparency in Monetary Policy — introduction and methodology
- Assessment covers transparency of monetary policy in the Republic of Indonesia, focusing on the role of BI in formulation and implementation of monetary policy.
- Assessment conducted according to the IMF’s Code of Good Practices on Transparency in Monetary and Financial Policies (issued September 1999) and supporting documents (approved July 2000).
- Assessment largely based on information available as of October 2009, particularly laws and regulations then in force.
- After receiving a draft assessment, BI took steps to enhance transparency and some practice ratings were marked up.
- Review incorporated a wide range of materials published by the Indonesian authorities, a self-assessment, a questionnaire response, and discussions during the FSAP mission with senior authorities and BI departments.

### Key documents and institutional overview
- Most important documents underlying the assessment:
  - (i) the BI Act,
  - (ii) the Banking Act,
  - (iii) the Act on Foreign Exchange Activities and Exchange Rate System.
- Other sources used: BI’s monthly Monetary Policy Review, quarterly Monetary Policy Report, Annual Economic Report, press releases, website pages, BI regulations and circulars, Board of Governors Regulations, BI’s Annual Financial Statements, and the Report on the Observance of Standards and Codes for Data Dissemination.
- Institutional roles:
  - BI conducts monetary policy, supervises commercial and rural banks, and is responsible for oversight of the payments system.
  - BI is an independent state institution; the BI Act explicitly safeguards the central bank against government interference in conduct of monetary policy, except for emergency liquidity lending to systemically important banks and the setting of inflation targets.
  - BI’s operational budget is subject to the DPR’s approval.
  - Board composition: the governor (chairman), senior deputy governor (vice chairman), and at least four but no more than seven deputy governors. Governor and senior deputy governor nominated by the president and confirmed by the DPR; other deputy governors confirmed by the DPR based on the governor’s recommendation.
  - Board members appointed for a term of five years, reappointment for no more than one consecutive term.
  - A clause in the BI Act states legal protection for BI staff in fulfillment of their duties, but uncertainties persist regarding scope and strength of this protection.

### Monetary policy objective, framework, instruments, and operational issues
- Ultimate objective of BI: to achieve and maintain the stable value of the rupiah, with two key aspects:
  - (i) a stable price of goods and services (internal price);
  - (ii) a stable exchange rate (external price).
- The priority of these two aspects is not explicitly stated in the Act; BI internal regulation explains that “price stability is the ultimate objective of monetary policy, while exchange rate stability is one of the prerequisite conditions for price stability, monetary stability and financial system stability.”
- A more recent BI internal regulation notes that “the monetary policy framework has one ultimate objective which is inflation.”
- Under the IT framework, BI is authorized to establish operational targets and to manage the money supply consistent with the official target.
- BI can set the overnight interest rate target (BI rate) as the policy rate.
- Instruments and actions used by BI include:
  - (i) conducting open market operations in the rupiah or foreign currencies;
  - (ii) setting statutory reserve requirements;
  - (iii) establishing regulations for credit or financing.
- BI securities (SBIs) are the main instrument for liquidity management and used to withdraw structural excess liquidity.
- Repos collateralized with SBIs and government securities (SUNs) used for standing facilities and fine-tuning; not a main instrument because of BI’s limited SUN holdings.
- Reserve requirements are sometimes used to manage liquidity.
- BI has a deposit facility (FASBI); the interest rate on FASBI and on the repo facilities form the interest rate corridor.

### Operational challenges and reforms suggested
- More work needed to anchor inflation expectations and counter perception that BI also aims to manage the exchange rate.
  - Recommendation: a clear public statement, endorsed by the government or the DPR, of the primacy of the inflation consideration.
  - Communication to the public about inflation targets could be made clearer; the target used in BI reports may differ from the official target announced by the MOF.
    - Example: September 2009 monthly report stated: “At 6.50 percent, the BI Rate level is also regarded consistent with achievement of the 2010 inflation target set at 5 percent ± 1 percent.” The official target for 2010, however, was 4±1 percent.
  - The measure of inflation—annual average or end-year—is not explicitly specified.
- Strengthening BI’s balance sheet could enhance effectiveness of monetary operations:
  - Restructure non-tradable government securities into tradable ones that carry market interest rates.
  - Context: BI received non-tradable government bonds (SUPs) in exchange for liquidity injections during the Asian crisis in the late 1990s; SUPs carry little interest and account for close to 1/3 of BI’s assets.
  - The interest rate on SUPs was cut from the initial 1−3 percent to 0.1 percent in January 2009; with this rate, the present value of the SUPs is worth less than 10 percent of the book value.
  - BI has been mopping up excess liquidity by issuing SBIs, the stock of which roughly matches the book value of the SUPs.

### Main findings
- “There is a reasonably high degree of transparency in Indonesia’s monetary policy. Considerable progress has been made over the last decade.”
- The primary objective of BI with respect to monetary policy is laid out in the BI Act, empowering BI to conduct monetary policy free from interference.
- Adoption of an inflation targeting framework in 2005 significantly enhanced BI’s ability to convey its objective to the public.
- BI has improved communication via internet web pages, publications, and regular press conferences.
- Data dissemination standards meet the Special Data Dissemination Standard (SDDS) developed by the IMF.
- BI’s accountability provisions:
  - The BI Act requires regular disclosure to the public and reporting to the President and DPR.
  - Audited financial statements of BI have been published annually since 2000.
  - BI staff required to provide financial disclosure statements and abide by a code of conduct.
- Post-draft-assessment improvements by BI:
  - Published on the BI website a plain-language description of its monetary policy decision-making process;
  - Published an explanation of its monetary operations and instruments;
  - Published a summary of internal regulations safeguarding the integrity of BI’s operations.
- BI’s planned further transparency improvements:
  - Clarify BI’s IT objective from a policy perspective.
  - Publicly disclose criteria for selecting BI’s counterparties in the foreign exchange market.

### Selected elements from Table 4: Summary Observance of the Transparency Code (Monetary Policy)
- Principle 1.1: BI Act states ultimate objective is to achieve and maintain the stable value of the rupiah. Clarity could be enhanced by explicit public statement endorsed by government or DPR regarding primacy of domestic price target over exchange rate.
- Principle 1.2: Institutional relationship between monetary and fiscal operations defined in the BI Act, government decrees, and MOU between BI and MOF.
- Principle 1.3: Agency roles performed by BI on behalf of the government defined in the BI Act and other laws.
- Principle 2.1: Framework, instruments, and targets publicly disclosed on BI’s website and in BI publications. Recommendation: MOF and BI should establish a clear mechanism for revising the official inflation target; BI should explain differences between official and BI’s target whenever developments render the official target unrealistic; criteria for selecting BI’s counterparties in the foreign exchange market should be disclosed.
- Principle 2.2: The Board is the highest decision-making forum; required to convene at least monthly to set monetary policy and at least weekly to assess implementation. After the draft assessment, BI explained procedures and organizational structure for formulation of monetary policy and achieved a higher grade.
- Principle 2.3: Changes to monetary instruments are decided in the monetary policy meeting and communicated immediately (within an hour) via press release on BI website and in the Official Gazette.
- Principle 2.4: BI publishes monthly, quarterly, and annual reports, as well as press releases covering economic and monetary developments.
- Principle 2.5: BI conducts public consultation prior to substantive technical changes to monetary regulations; consultation periods vary from 3–6 months depending on nature of changes.
- Principle 2.6: Regulations and BI circulars on data reporting by financial institutions are posted on BI’s website; BI’s powers to require data reporting are stated in the laws.
- Principle 3.1: Indonesia has met the Special Data Dissemination Standard (SDDS) since June 2000.
- Principle 3.2: BI discloses its detailed balance sheet monthly and condensed balance sheet weekly (with less than one-week delay); both available on BI’s website.
- Principle 3.3: BI has a Public Relations Bureau managing public information and a publication program.
- Principle 3.4: BI regulations are published in the State Gazette and supplements; most BI regulations and circulars issued after 2004 are available on BI’s website, often in both English and Indonesian; contact information for the Legal Information Team is listed on web pages.
- Principle 4.1: BI’s Board must regularly appear before legislative committees in the DPR to explain conduct of monetary policy and the state of the economy; BI is obliged to provide a written explanation to the DPR upon request.

*Source: IMF staff assessment as presented in the annex "Observance of Financial Sector Standards and Codes—Summary Assessments" (material as of October 2009 and subsequent BI responses).*

### 4.2 The central bank should publicly

### _cr10288 - 4.2 The central bank should publicly

### Disclosure of audited financial statements
- Audited financial statements (balance sheet, surplus/deficit report, statement of changes in equities, cash flow report, summary of significant accounting policies, and the note to the financial statements) and an audit opinion have been published annually since 2000.
- The Supreme Audit Board (BPK) audits BI’s financial statements and this meets the requirement of Practice 4.2.1.
- Recommendation: having the accounts audited in parallel by an internationally recognized accounting firm would add to BI’s credibility.
- After receiving a draft of this assessment, BI published on its website its internal regulation on internal audit arrangements.

### Disclosure of expenses and revenues
- Information regarding expenses and revenues is published annually in the surplus/deficit section of the annual financial statement.

### Standards for personal financial conduct and conflict-of-interest rules
- After receiving a draft of this assessment, BI published on its website a summary of the financial disclosure requirement and regulations governing staff’s conduct.
- The legal protection provided by the BI Act meets the requirement; however, the clause should be refined to remove uncertainties regarding the scope and strength of this protection.
- Authorities’ comment: Article 45 of the BI Act explicitly provides legal protection for BI employees with no limitation on the scope; BI agrees Article 45, especially the criteria of good faith, needs to be refined.

### Recommended actions from the Transparency Code assessment (selected items)
- Clarity of Roles, Responsibilities and Objectives:
  - 1.1.1: The clarity of BI’s ultimate objective could be enhanced by a more explicit public statement with the endorsement of the government or DPR regarding the primacy of the domestic price target over the exchange rate consideration.
  - 1.1.3: Strengthen BI’s balance sheet by restructuring non-tradable government securities into tradable securities that carry market interest rates to increase collateral for monetary operations.
- Open Process for Formulating and Reporting Monetary Policy Decisions:
  - 2.1: MOF and BI should establish a clear mechanism for revising official inflation targets; whenever developments render the official target unrealistic, BI should clearly explain differences between the official target and BI’s projection.
    - After a draft assessment, BI initiated discussions with the MOF to resolve this issue.
  - 2.1.2: Disclose criteria for selecting BI’s counterparties in the foreign exchange market to facilitate an even playing field; BI is working on implementing this recommendation.
  - 2.4.2: Present to the public on a specified schedule a report on the evolving macroeconomic situation and its implications for monetary policy objectives; the forecast horizon in the quarterly report could be extended and a monthly report could note the scheduled date of the next policy meeting.
- Accountability and Assurances of Integrity:
  - 4.2.1: Financial statements should be audited by an independent auditor and include information on accounting policies and any qualification to the statements; while BPK audits meet the requirement, parallel audit by an internationally recognized accounting firm would add credibility.

### Authorities’ responses (selected points)
- BI welcomes the assessment and states monetary policy in Indonesia is conducted with a reasonably high degree of transparency.
- BI has communicated the priority of inflation over exchange rate:
  - Stated in the 2005 Board of Governors Regulation (PDG, amended in 2008), summary of the PDG on BI’s website, and monthly press releases covering BOG monetary policy decisions.
  - A statement highlighting primacy of domestic price stability (inflation) will be explicitly mentioned in the upcoming government decree that set the new inflation target for 2010, 2011, and 2012.
- Note of Agreement between Government and BI on Setting Mechanism of Inflation Target: if extraordinary conditions render the stipulated target unrealistic, BI shall submit a proposal on revising the inflation target and the Government will decide the target; currently the proposal is being discussed and a revised target is expected to be realistic and in line with the medium-term disinflation process.
- BI publishes procedures for monetary operations, including disclosure of criteria for counterparty eligibility in open market operations.
- Forecasting and reporting:
  - BI’s Monetary Quarterly Report forecast horizon extended to 1 year since Q3-2009, and the Q4 report gives the forecast for the next 2 years.
  - The schedule for the monthly BOG meeting is available on BI’s website and now in the monthly report.
- Conversion of non-tradable government bonds: since early 2009 BI and MOF have been discussing converting long-term non-tradable government bonds held by BI into tradable ones; a parliamentary hearing was held in February 2010; BI and MOF expect to resolve this matter soon.
- Audit practice: BPK audit of BI’s financial statements complies with the BI Act, the Indonesian Generally Accepted Audit Standard, and the Governmental Audit Standard (which incorporates the Professional Public Accounting Standards); BPK is not intending to use international accounting firms due to cost considerations.
- Article 45 legal protection: BI agrees refinement is needed in context of political and judicial systems of Indonesia.

### Basel Core Principles (BCP) assessment: institutional and supervisory findings (selected)
- Scope and methodology:
  - Assessment based on October 2006 Core Principles Methodology of BCBS but limited to essential criteria by agreement with BI.
  - Assessment relied on BI self-assessment, laws and regulations, meetings with BI officials and supervisors, meetings with six banks, representatives of bankers’ association, FITCH, Ernst & Young, and the Financial Intelligence Unit (PPATK), ROSC on Accounting and Auditing (2009), and the 2nd Mutual Evaluation Report (July 2008) of the Asia-Pacific Group on Money Laundering (APG).
- Banking sector context:
  - The banking sector accounts for 80 percent of financial system assets, consisting of 121 commercial banks, numerous rural banks and 5 sharia banks.
  - Assessment confined to regulatory and supervisory framework applicable to commercial banks.
- Preconditions and accounting/auditing weaknesses (2010 ROSC assessment):
  - PSAK comparability with IFRS: 21 PSAKs are fully comparable; 5 PSAKs are substantially comparable; 4 IFRS not yet adopted; and 8 PSAKs are substantially not-comparable with IFRS.
  - Financial statement reviews showed gaps in compliance including segment information, related party transactions, consolidated financial statements, employee benefits, and derivative transactions.
  - Instances observed of accountants and auditors yielding to undue pressure from corporate management, leading to compliance “in appearance” rather than “in substance.”
  - No mechanism to proactively ensure practicing accountants and auditors comply with code of ethics.
  - Of more than 400 accounting firms, only 6 to 8 firms appear to have a very high level of compliance with applicable auditing standards; small and medium-sized audit practices generally lack resources for audit quality control.
- Credit Information Bureau (SID):
  - Set up in June 2006; bank participation is mandatory; NBFI participation is optional; coverage of credit information in SID is incomplete despite an MOU with MOF to mandate NBFI participation.
- Legal and enforcement weaknesses affecting recoveries:
  - Indonesia exhibits one of the lowest recovery rates in the region at below 15 percent and the cost of bankruptcy procedures is about 18 percent of the estate.
  - Bankruptcies take between 5 and 6 years to be resolved.
  - Enforcement of contracts takes about 570 days and associated costs are about 123 per cent of the claim.
- Supervisory and safety-net arrangements:
  - BI regulations require banks to implement good corporate governance (GCG) and maintain effective internal control mechanisms; minimum disclosure requirements published by BI include ownership details, strategies and management policies, audited financial statements, level of risk exposures, and risk management procedures.
  - BI and LPS safety nets:
    - BI has a short-term (up to 90 days) liquidity facility against collateral of government bonds, SBIs, and loans classified as ‘current’.
    - As lender of last resort, BI caters to illiquid but solvent institutions not deemed systemically important.
    - For systemically important solvent banks, an emergency liquidity assistance (ELA) facility introduced last year allows longer term extensions of credit and allows banks to post ‘loans’ as collateral; BI will provide ELA to an insolvent bank only with the guarantee from the Government of Indonesia.
  - Crisis management framework and institutional arrangements:
    - LPS Law of 2004 established a Coordination Committee comprising MOF, BI and LPS to determine policy for resolution and handling of failing banks expected to have systemic effect.
    - A joint decree by BI, MOF and LPS in June 2007 established the Financial System Stability Forum (FSSK) for technical cooperation.
    - An Ordinance promulgated in October 2008 established the Financial System Stability Committee (FSSC) chaired by the Minister of Finance with the Governor of Bank Indonesia as Member; the ordinance has since lapsed and a draft Financial System Safety Net (FSSN) Law to formalize arrangements was rejected by Parliament. Pending passage of law, the Coordination Committee under LPS law serves as the mechanism for cooperation and coordination for handling crisis management in the banking sector.
- Main supervisory findings (selected):
  - Principle 1 (Objectives, independence, powers, transparency, and cooperation): BI has independence and sufficient powers, but two weaknesses identified:
    - BI and its staff lack necessary legal protection against prosecution.
    - Lack of appropriate gateways for information exchanges with domestic and foreign supervisory authorities impedes BI’s supervision.
  - Principles 2 to 5 (Licensing and structure):
    - Although BI is designated as licensing authority and can set licensing criteria, there has been no application for a banking license since 1999.
    - Regulations require banks to obtain BI’s prior approval for investment in equity of financial entities and do not permit investment in equity of non-financial entities; regulations do not apply to equity investments by banks’ subsidiaries/group entities or via the debt resolution route.

* _cr10288 - 4.2 The central bank should publicly *_

### 88.       Due diligence requirements and framework (principles 6 to 18).

### 88.       Due diligence requirements and framework (principles 6 to 18)

### Key findings on prudential framework and risk management
- Framework is broadly in line with Basel I standards, but weaknesses exist in the capital adequacy framework.
- BI has yet to issue regulations on:
  - management of interest rate risk in the banking book (IRRBB),
  - country / transfer risk.
- Scope for improvement in liquidity risk and operational risk management.
- Indonesian banks generally do not use internal methodologies for assessing overall capital adequacy in relation to their risk profile; there is inadequate focus on and capacity to validate internal models. This gains importance as the Indonesian banking system is commencing Basel II implementation soon.
- Asset classification and provisioning framework for delinquent loans is broadly in line with international standards but has some weaknesses. Board oversight of NPL management needs strengthening.
- Definitions of single borrower, borrower group and related party exposures could be tightened; the concepts of ‘large exposures’ and ‘portfolio concentrations’ are either not practiced or not practiced adequately.
- Internal control and compliance functions in banks are generally good and governed by comprehensive regulations, but:
  - BI does not appear to undertake an on-site assessment of the whole internal control function (assessed indirectly and piecemeal).
  - BI regulations do not explicitly require a risk based audit framework in banks.
- BI is addressing some gaps identified by the APG 2008 mutual evaluation through revised regulations.

---

### 89.      Bank supervision methods (principles 19 to 21)

### Supervisory system and practices
- BI’s supervisory system consists of both off-site and on-site supervision plus regular contact with bank management.
- BI has an efficient and comprehensive off-site supervisory system that includes receipt and analysis of periodical reports (daily, weekly, monthly, quarterly and annual) on both a solo and consolidated basis.
- Integrity of supervisory reports is ensured through on-site verification by supervisors and external auditors.
- Off-site reports are used well at the single institution level but could be better utilized to:
  - generate efficient system trends,
  - produce useful peer group analyses.

### Key weaknesses
- Two key weaknesses identified:
  - lack of formal and informal information sharing arrangements with other financial sector supervisory authorities;
  - absence of effective legal protection, which reduces supervisors’ willingness to make decisions and deviate from accepted methods in the manual.

---

### 90.      Requirements with respect to accounting records and financial reporting (principle 22)

### Findings
- Regulations require bank financial statements to be based on PSAK and accounting and reporting guidelines for banking (PAPI), and that annual financial statements be audited by a public accountant.
- Appropriate bank disclosure requirements are broadly in place, but there is scope for improvement.
- Introduction of new accounting standards aligned to IAS 32 and IAS 39 is likely to pose some challenges and needs close watching by BI.

---

### 91.      Corrective measures (principle 23)

### Findings
- Supervisors have a large arsenal of supervisory tools and BI does not appear hesitant to require swift corrective action under normal conditions.
- It was not always apparent that proper moderation or escalation was in use.
- Existing prompt corrective action is largely discretionary; BI tends to allow banks to remain under intensive supervision for several years without resolving underlying weaknesses.

---

### 92.      Supervision on a consolidated basis and international cooperation (principles 24 and 25)

### Findings and recommendations
- BI performs oversight through dedicated teams for each commercial bank; regulatory reports are filed on a solo and consolidated basis. On-site examinations include risk taking in subsidiaries.
- BI should increase attention to oversight of foreign operations of Indonesian banks by the banks’ management.
- Formal and informal arrangements for ongoing information sharing and coordination with other supervisors (domestic and foreign) are largely absent.
- Peer group analysis is not always efficient or useful; a horizontal examination across a cross section of banks may help comparisons and propagation of best practices.
- BI needs to set up programs to:
  - determine whether home country supervisors of foreign banks in Indonesia are competent and have authority to enter into an information sharing agreement;
  - make regular visits to home supervisors of systemically important foreign banks in Indonesia.

---

### 93.      Summary compliance with the Basel Core Principles (selected principle-by-principle findings)

- Core Principle 1 — Objectives, independence, powers, transparency, and cooperation
  - Laws/regulations clearly spell out BI’s responsibilities for licensing, prudential standards, supervision, and sanctioning powers; regulations and prudential standards are generally comprehensive and broadly meet minimum requirements.
  - BI Act defines supervisory objectives and provides operational independence; BI is accountable to the parliament and submits a quarterly report to the House of Representatives (DPR).
  - Removal procedures and broad reasons for removal are in BI Act; while removal is disclosed, the reason is not disclosed.
  - Article 45 provides some protection to supervisory staff for actions in ‘good faith’ but the law does not explicitly presume good faith and does not provide effective protection; protection for omission and defense costs is inadequate; protection to BI as supervisory authority is absent.
  - BI and LPS have a formal MOU covering regular information sharing; no formal MOU/regulation exists with Bapepam-LK, MOF, or foreign supervisors.

- Core Principle 2 — Permissible activities
  - Banking Act clearly defines ‘banking’, permitted and impermissible activities; deposit taking in cooperatives and micro finance institutions governed by appropriate laws; term ‘bank’ restricted to BI-licensed entities.

- Core Principle 3 — Licensing criteria
  - BI has authority to set licensing criteria, reject applications, and revoke licenses; no new bank applications since 1999, so licensing effectiveness could not be assessed.

- Core Principle 4 — Transfer of significant ownership
  - Significant ownership defined as equal to or exceeding 25 percent. Transfers resulting in ownership exceeding 25 percent require BI prior approval; transfers above 5 percent and up to 25 percent must be reported within 10 days. BI can enforce divestiture or reject proposals and can address changes of control that occurred without necessary notification.

- Core Principle 5 — Major acquisitions
  - Regulations prohibit banks’ equity participation in non-financial sector and require BI prior approval for equity participation in financial sector. Cap on aggregate ‘equity participation for long-term investments at 25 per cent of the bank’s capital. Gap: regulations do not apply to equity investments made through debt resolution or by banks’ subsidiaries/group entities.

- Core Principle 6 — Capital adequacy
  - Banks must maintain minimum capital in line with Basel I methodology of at least 8 percent of total risk weighted assets, both on solo and consolidated level.
  - Market risk capital charge applies to banks meeting specified criteria; covers 95 percent of banking system assets and 99 percent of trading book assets.
  - Capital adequacy norms are in some cases inconsistent with Basel principles (definition of capital, dilution of risk weights) and warrant immediate strengthening.
  - Full implementation of Basel II is expected from January 2014.

- Core Principle 7 — Risk management process
  - BI regulations require risk management policies: non-complex banks to cover credit, market, operational, liquidity risks; complex organizations to consider other material risks (legal, reputational, strategic, compliance).
  - Board and senior management involvement required; quarterly risk profile self-assessments of solo and consolidated positions must be provided to BI.
  - Banks largely lack internal methodologies for assessing overall capital adequacy vs risk profile; inadequate capacity/focus on internal model validation.
  - Recent events indicate system not fully equipped to manage risk exposures effectively during adverse situations; supervisory capacity needs enhancement.

- Core Principle 8 — Credit risk
  - Framework broadly compliant but gaps exist in large exposures, related party exposures, asset classification and provisioning, and country risk.

- Core Principle 9 — Problem assets, provisions, and reserves
  - Regulations require standards for identification/classification of problem assets, general and specific provisions, write-offs and restructuring.
  - Asset classification and provisioning norms for NPLs show weaknesses leading to understatement of NPLs, under provisioning, overstatement of income and capital adequacy; need review and revision.
  - Reporting requirements for NPLs at Board level exist, but no evidence Board actively manages troubled asset portfolio.

- Core Principle 10 — Large exposure limits
  - Legal lending limits prescribe ground rules for identifying borrower groups; supervisors have discretion to determine connected counterparties.
  - BI regulations need to: address exposure definition shortcomings; promote ‘large exposures’ and ‘portfolio concentrations’ with prudential limits; reduce time allowed for rectifying breaches.
  - From risk concentration perspective, BI should consider gross exposures without deductions and treat SOEs as a group.

- Core Principle 11 — Exposure to related parties
  - Definitions and limits stipulated and applied at solo and consolidated levels; processes for related party exposures must be at least as stringent as for non-related counterparties and require prior approval from the Board of Commissioners (BoC).
  - Regulations allow exemptions from definitions and do not cover non-credit transactions with related parties; do not explicitly require exclusion of interested persons from related party processes; do not cover handling of NPLs in related party transactions.

- Core Principle 12 — Country and transfer risks
  - BI regulations do not address country and transfer risk; supervisory process devotes inadequate resources to this element; risk is largely absent from supervisory radar.

- Core Principle 13 — Market risks
  - Regulations require market risk management and active supervision by BoC and BoD. Only banks above a threshold required to maintain capital for market risks.
  - Stress testing outcomes are not explicitly required to feed into banks’ risk management policies, practices, or contingency planning.

- Core Principle 14 — Liquidity risk
  - Regulations require liquidity risk management commensurate with size/complexity, on solo and consolidated basis.
  - BI issued revised guidelines on liquidity risk management operational on October 30, 2009, to better align with BCBS Principles of September 2008.
  - Shortcomings remain on standards/benchmarks for slotting assets/liabilities, making aggregation and inter-bank comparison difficult.
  - Banks are not explicitly required to inform BI when contingency funding plans (CFPs) are triggered or when facing liquidity problems.

- Core Principle 15 — Operational risk
  - Regulations define operational risk and require an operational risk management framework commensurate with size/complexity, on solo and consolidated basis.
  - Regulations do not explicitly capture outsourcing risk, business continuity planning beyond IT, legal risk in banks below threshold, and supervisory reporting of significant operational risk events.

- Core Principle 16 — Interest rate risk in the banking book
  - BI regulations do not explicitly cover IRRBB; banks do not actively manage this risk and supervisors do not adequately focus on it.

- Core Principle 17 — Internal control and audit
  - Regulations require BoC and BoD to ensure effective internal control, designate a compliance director, and establish independent internal audit.
  - BI regulations do not explicitly require a risk based audit framework; BI does not assess internal control as a separate function in its entirety.
  - Banks’ internal control functions lack capacity and methodologies for validating internal models and stress testing.

- Core Principle 18 — Abuse of financial services
  - Regulations detail banking supervisor responsibilities and require regular compliance reports; supervisors verify compliance.
  - Supervisors conduct at least annual assessments of KYC and AML controls (management oversight, policies, practices, internal controls, audit MIS systems, training).
  - APG 2008 mutual evaluation revealed gaps; BI has addressed a few through revised regulations.

- Core Principle 19 — Supervisory approach
  - System designed to produce risk focused supervision; on-site inspections at least once a year and additional exercises based on risk assessment.
  - Absence of a formal and encompassing review of banking system trends may lead to failure to detect emerging problems.
  - Risk based framework would benefit from sharper focus on consolidated supervision methods, techniques, procedures, and information sharing agreements with Bapepam-LK and the MOF.

- Core Principle 20 — Supervisory techniques
  - BI employs a satisfactory combination of on-site and off-site surveillance and frequent communication with banks.
  - Absence of formal information sharing arrangements with other financial sector supervisors and absence of effective legal protection reduce effectiveness of supervision.

- Core Principle 21 — Supervisory reporting
  - BI Act requires detailed prudential information covering risks; information also applies to subsidiaries and related/affiliated counterparties where pertinent.
  - Banks file returns on a solo and consolidated basis; off-site reports are verified during on-site examinations.
  - Off-site reports are not fully utilized to generate efficient and useful peer group analyses.

*Italic: IMF ROSC banking sector assessment — summary of principles 6–21 as presented in the source document.*

### 22. Accounting and

### _cr10288 - 22. Accounting and

### Accounting and disclosure (Core Principle 22)
- BI requirements on accounting, auditing, valuation, maintenance of accounts and public disclosure of financial statements are broadly in line with requirements.
- Weaknesses in accounting and auditing frameworks raise serious concerns with implications for the quality of financial statements and disclosures.
- Bank disclosure requirements are broadly in consonance with the core principle, but there is scope for improvement to promote availability and comparability of banks’ audited financial condition.
- There is value in increasing the scope of BI disclosures.
- The introduction of new accounting standards is likely to pose some challenges to the banking system and the supervisor and needs close watching by BI.
- In light of weaknesses, BI needs to:
  - focus more supervisory resources on ensuring that banks’ financial statements reflect their true financial performance and financial position;
  - develop a process to ensure a stringent quality assurance review of bank audits and auditors;
  - closely watch implementation of IAS 32 and 39 equivalents in 2010-11;
  - improve disclosures by both banks and BI to promote availability and comparability of banks’ audited financial condition.

### Corrective and remedial powers of supervisors (Core Principle 23)
- Each commercial bank is actively monitored.
- Supervisors raise issues and demand corrective action where appropriate; regular progress reports on addressing deficiencies are required.
- Supervisory actions range from administrative sanctions to removal of management and revocation of the license.
- The existing prompt corrective action is largely discretionary; BI tends to allow banks to remain under intensive supervision for several years without resolving underlying weaknesses.
- Recommendation: build objective and automatic triggers into the prompt corrective action framework and put in place appropriate governance mechanisms.

### Consolidated supervision (Core Principle 24)
- BI performs oversight through dedicated teams for each commercial bank.
- Regulatory reports are filed on a solo and consolidated basis.
- On-site examinations include examinations of risk taking in subsidiaries where necessary and prudent.
- Consolidated supervision is accompanied by BI taking responsibility for on-site supervision of the consolidated organization to cover for other financial regulators where routine robust examinations are not part of the supervisory process.
- Weaknesses and gaps:
  - Lack of formal arrangements to transfer information between domestic supervisors.
  - Weaknesses in supervision of overseas branches.
  - Present exclusions allowed in the scope of consolidated supervision.
  - Non-application of regulations on equity participation and sale of structured products on the consolidated bank level.
  - Lack of focus on intra-group transactions where the bank is not directly involved.
- BI pays close attention to branches of Indonesian banks located in the region with frequent on-site visitations and exchanges with host supervisors, but supervision of foreign branches in New York, London, and the Cayman Islands needs improvement.
- Recommendation: enhance the scope of consolidation, promote consistency in consolidated supervision application, and develop effective operating arrangements for information sharing and coordination with relevant supervisors (domestic and foreign). Prudential requirements and consolidated reporting in all relevant areas can improve supervision quality. BI must pay greater attention to oversight of Indonesian banks’ foreign operations by their management.

### Home-host relationships (Core Principle 25)
- BI maintains relationships with home and host supervisors largely on an ad-hoc basis.
- BI lacks a uniform policy with respect to aligning supervisory requirements with risks.
- Exchanges of information with neighboring supervisors exist, but lines of communication with home supervisors of systemically relevant foreign financial institutions are less clear.
- Some home supervisors exhibit a non-cooperative attitude; information exchanges during routine examinations are usually at low levels and without a structured agenda.
- For legal reasons, many jurisdictions can provide supervisory information to a host country only if a formal information exchange agreement is in place, which could place BI at a significant disadvantage.
- BI must:
  - identify systemically important foreign institutions;
  - determine whether the home country supervisor is competent and has authority to enter into an information sharing agreement;
  - ensure a regular program of visits to home supervisors;
  - enter into formal agreements with relevant home supervisors to ensure effective supervision of foreign bank operations.

### Recommended Plan of Action (selected Core Principles and comments)
- 1.5 Legal protection
  - Urgent amendments to the BI Act are required to explicitly state a presumption of good faith in favor of supervisory staff; to protect supervisory staff from omissions and cover all costs for defending their actions; and to grant protection to BI as a supervisory authority.
- 1.6 Cooperation
  - BI should put in place effective information exchange arrangements with other domestic financial sector supervisors and foreign supervisors.
- 4. Transfer of significant ownership
  - Banks should be required to notify BI as soon as they become aware of any material information that might affect the suitability of major shareholders, including controlling shareholders.
  - BI should consider reducing the threshold of 25 percent for obtaining prior approval of transfers or consider applying the same level of detailed scrutiny to all transfers of 5 percent or more.
- 5. Major acquisitions
  - Temporary equity participation and group entities’ equity investments need to be brought within BI regulations; accounting norms for equity participation need review and alignment with intent to hold.
- 6. Capital adequacy
  - BI should review current regulations with respect to risk-weights and tier I capital items to ensure consistency with Basel I framework.
  - BI may consider formally requiring systemically important banks and banking groups to maintain capital above the minimum prescribed in the Basel framework.
  - BI should consider encouraging banks to adopt a more forward looking approach and incorporate more rigid stress test outcomes into their capital planning framework.
- 7. Risk management process
  - With move to Basel II, internal methodologies for assessing overall capital adequacy and validation of internal models gain greater importance.
  - BI must issue appropriate regulations and guidelines on these aspects and management of interest rate risk in the banking book.
  - BI must improve supervisory capacity for oversight of risk management systems in banks, particularly for new business lines and products.
- 8. Credit risk
  - BI should aim at removing all significant gaps in credit risk aspects such as large exposures, related party exposures, asset classification and provisioning requirements, and country risk.
- 9. Problem assets, provisions, and reserves
  - Review asset classification and provisioning norms for NPLs to ensure adequate identification and management of problem assets.
  - Matrix provisioning requires frequent review to align with actual system experience.
  - Regulations need enhancement to ensure the BoC is actively managing troubled assets.
- 10. Large exposure limits
  - BI regulations need to address shortcomings in the definition of exposure, adopt concept of large exposures and portfolio concentrations, prescribe prudential limits, and reduce time allowed to banks to rectify breaches.
  - BI should consider (i) gross exposures without any deductions; and (ii) SOEs as a group.
  - BI should review the concept of ‘market developments’ used to justify limits breaches and make it more restrictive.
- 11. Exposure to related parties
  - Review regulations to eliminate exemptions from definitions of ‘exposure’ and ‘related party’; include non-credit transactions; require interested parties to exclude themselves from decision processes; and lay down requirements for managing and reporting NPLs in related party transactions.
- 12. Country and transfer risks
  - BI must address the regulatory gap and enhance supervisory capacity as BI regulations and supervision do not address country and transfer risk.
- 13. Market risk
  - Consider extending definition of ‘trading portfolio’ to include the available for sale (AFS) portfolio if banks trade from it.
  - Revise stress testing guidelines to require banks to factor outcomes into risk management and draw up robust contingency plans.
- 14. Liquidity risk
  - BI must review regulations to consider (i) explicitly requiring banks to manage foreign currency liquidity risk; (ii) laying down standards or benchmarks for slotting assets and liabilities for meaningful aggregation and comparison; and (iii) explicitly requiring banks to inform BI when CFPs are triggered or when facing liquidity problems.
  - Ensure effective implementation of elements of July 2009 guidelines with reference to diversification of funding sources, stress testing, and validity of CFPs.
- 15. Operational risk
  - Review BI regulations and supervision to explicitly include outsourcing risk, business continuity planning beyond IT, legal risk in banks below threshold, and supervisory reporting of significant operational risk events.
- 16. Interest rate risk in the banking book
  - BI regulations and supervision do not cover this risk explicitly and comprehensively and banks are not actively managing it; BI must address this regulatory gap and enhance supervisory capacity.
- 17. Internal control and audit
  - Adopt remedial measures to explicitly require a risk based audit framework in banks; assess the internal control function separately; ensure internal control functions have capacity and methodologies for validating internal models and stress testing.
- 18. Abuse of financial services
  - APG 2008 mutual evaluation revealed several gaps; BI has addressed a few gaps through revised regulations; remaining gaps and effective implementation of recent initiatives by banks need to be addressed.
- 19. Supervisory approach
  - BI needs comprehensive reviews of banking system trends to detect emerging problems; sharpen focus on consolidated supervision; develop and internally share supervisory benchmarks at bank, peer group, and system levels.
- 20. Supervisory techniques
  - Specific MOUs with other domestic supervisory agencies and effective legal protection to supervisors would enhance supervisory efficiency.
- 21. Supervisory reporting
  - BI should consider requiring banks to submit a report on all major risk areas on a solo and consolidated basis; improve peer group analysis; consider horizontal examinations to spread best practices.

### Authorities’ response (selected points)
- The Republic of Indonesia welcomes the assessment and broadly concurs with overall findings beyond a few exceptions; plans to use the assessment as a blueprint to enhance legislative, regulatory, and supervisory framework.
- Preconditions: authorities are aware of issues regarding accounting and auditing standards and legal framework governing creditor rights and collateral enforcement; both are outside BI’s jurisdiction but steps taken to minimize consequences for banking sector oversight.
- Accounting standards:
  - There has been a steady trend of convergence between Indonesian and international accounting standards; by 2012 all remaining gaps will be closed.
  - Bank Indonesia has secured a seat within Indonesia’s accounting standards setting body and voices concerns on identified gaps.
  - Strengthening auditor competency is a work in progress; unilateral actions include maintaining a list of authorized auditors and required rotation of external audit firms at the same bank beyond a certain period of time.
- Legal framework and creditor rights:
  - BI has imposed loan loss provisioning framework requiring banks to establish loss buffers for performing loans that ignore collateral value and applies haircuts of 30 percent up to 100 percent of appraised value for other types of loans when establishing minimum required loss provisions.
  - The higher of the two approaches (regulatory minimum matrix vs. time value under IAS 39) is reflected in each bank’s capital adequacy calculation as a deduction to Tier 1 capital.
  - Prerequisites imposed for securing collateral include valid legal documentation, securing legal rights and first lien to collateral, and insurance coverage.
- Information exchange:
  - BI has recently signed MOUs with other domestic regulatory authorities to establish formal mechanisms to share supervisory information.
  - Lack of formal information sharing did not materially impede consolidated supervision in BI’s view.
  - Further efforts on information sharing with foreign authorities are needed and should be conducted at a multilateral level.
- Capital adequacy:
  - Some questioned capital component eligibilities are immaterial and/or lack clear international standard (e.g., inclusion of 50 percent of unaudited profits in Tier 1 capital, and nature of foreign branch capital).
  - Unilateral changes could raise level playing field concerns; noted dilutions to risk-weights are within parameters allowed under Basel II.
- Problem assets, provisions, and reserves:
  - Application of a minimum regulatory provisioning matrix subject to supervisory review is within international norms.
  - Supervisory review adjusts reported asset quality and adequacy of provisions during on-site examinations.
- Definition of single borrower, borrower group, related party exposures:
  - Indonesia has one of the most stringent coverages; covers almost all levels of group structure and direct and indirect transactions; comparable to developed economies.
  - Tightening further would have significant consequences given banking sector accounts for almost 80 percent of the total financial system.
- Liquidity risk:
  - BI does not believe there is one “right” method for slotting assets and liabilities; recommendation on CFP will be taken under advisement.
  - Supervisors through ongoing supervision will know whether a bank is experiencing liquidity difficulties.
- IRRBB:
  - BI has addressed interest rate risk in the banking book under CAMELS regulation; some larger banks manage IRRBB internally.
  - BI will issue a consultative paper to address IRRBB under Pillar 2 of Basel II.
- Internal control and audit:
  - BI concurs framework needs improvement but notes the risk based approach leads to piecemeal examination; comprehensive internal control audit is part of supervisory process.
  - BI requires auditors to assess a bank’s internal control function prior to performing internal audit; banks must periodically utilize an independent reviewer and submit results to BI.

*Source: _cr10288 - 22. Accounting and*

### Introduction

### Introduction

### Assessment framework and methodology
- Assessment conducted using the Methodology for Assessing Implementation of the IOSCO Objectives and Principles of Securities Regulation of 2003, reissued in 2008, the related e-methodology, and the reports, explanatory notes, instructions and guidance cited therein.
- Principle 30 is separately assessed under the Committee on Payment and Settlement Systems/IOSCO Recommendations for Securities Settlement Systems by another assessor.
- Sources used:
  - A comprehensive self-assessment by Bapepam-LK.
  - Review of relevant legislation, regulations, and guidance.
  - Statistical and descriptive information on the financial market; rules for securities exchange, clearing and settlement, and commodities transactions.
  - Relevant websites, media reports, annual reports.
  - Information obtained on the broader system during two on-site visits and multiple meetings with Bapepam-LK staff, the Commodity Futures Trading Regulatory Authority (Bappebti), brokers, fund managers, issuers, end-users, banks, state-owned enterprises, accountants and accounting associations, lawyers, the Indonesian Stock Exchange (IDX), the Jakarta Futures Exchange (JFX), related clearing and settlement entities, trade (broker) associations, on-site representatives of the IMF and World Bank, and informal information from technical assistance providers.
  - Intervening exchanges of comments.
- Bappebti did not provide a separate self-assessment under its authorizing legislation.

### Institutional and market structure—overview
- Regulatory responsibilities and institutions:
  - Bapepam-LK supervises the capital markets, including issuers, intermediaries, mutual funds, exchanges, securities depositories and clearing houses, and non-bank financial institutions such as multi-finance companies, insurance and pension funds.
  - Listed-derivatives on commodities defined by statute as “the objects of trade which become the subject of Futures Contracts being traded in the futures exchange,” are regulated by the Commodity Futures Trading Regulatory Authority (COFTRA or Bappebti) (Law No.32/1997). This assessment relates only to the capital markets and capital markets institutions.
  - Bapepam-LK implements Indonesia’s core securities legislation, the Capital Markets Law (CML), No 8/1995 effective as of 1996.
  - Securities exchanges and related clearing and depository organizations (KPEI and KSEI) are required by law to supervise their members and enforce their own rules.
  - The Minister of Finance plays a role regarding issuance of government regulations and ministerial decrees; Bapepam-LK handles day-to-day operations and develops its own rules.
  - Relevant Bapepam-LK rules can be found in English at http://www.bapepam.go.id/pasar_modal/regulasi_pm/peraturan_pm/indexEng.htm.
- Market structure and trading platforms:
  - The Jakarta Stock Exchange (JSX) and the Surabaya Stock Exchange (SSX) consolidated in 2007 to form the IDX.
  - The JFX was established in 1999.
  - A new electronic platform, the Indonesian Commodities and Derivatives Exchange (ICDX) licensed in December 2009 launched in 2010.
  - Corporate and retail government bonds, as well as equities, are traded on the IDX either by outright continuous auction or on the negotiated board, known together as the centralized trading platform (CTP), as well as over-the-counter (OTC).
  - The OTC equity market is unregulated, but may be settled in the KSEI system.
  - All bond transactions, even OTC, are to be reported to CTP in accordance with Bapepam-LK rules (Rule X.M.3).
  - The CML recognizes supporting institutions, such as custodians (including bank custodians) and mutual fund custodial activities supervised by Bapepam-LK, and supporting professionals required to have special qualifications (e.g., accountants and lawyers).
- Market openness and cross-border participation:
  - Non-domestic investors can own up to 100 percent of listed companies, except banks for which they can hold 99 percent both by direct investment and exchange purchase.
  - Non-domestic financial companies and brokers may own up to 85 percent and 99 percent, respectively, of unlisted securities companies.
  - Similar limits adopted in 2009 apply to owners of futures brokerages.
  - There are no restrictions on the sale of foreign products to Indonesian nationals from within Indonesia as well as from remote locations.
  - As of November 2009, as much as 70 percent of the value of shares held in the KSEI was held by foreign investors, and in 2009 approximately 25 to 30 percent of trading was of foreign origin.
  - These factors increase market depth and complexity and underscore the importance of capacity for cross-border enforcement assistance and application of customer protection to all products sold to and from Indonesia.

### Review of preconditions for effective securities regulation
- IOSCO-listed preconditions appear broadly satisfied, including absence of unnecessary barriers to entry and exit from Indonesian markets and products, subject to caveats below.
- Areas needing reinforcement:
  - Judicial enforcement sufficient to provide certainty that capital markets law will be applied as intended.
  - Certainty related to the application of sanctions for violations of the CML could be strengthened by:
    - Confirming administrative sanctioning powers against all market participants.
    - Considering extending the concept of a specialist expert prosecutorial corps or fraud squad under the Department of Justice to matters other than corruption, such as insider trading.
  - Accelerate comprehensive accounting reform underway; its swift progress is important to the integrity of financial reporting and market expansion.
  - Bankruptcy reform is desirable.
  - Monitor effectiveness of efforts to prevent investor confusion about regulatory requirements for certain investment products, especially those distributed through the banking network.
  - Consumer expectations for depositor-like protections for invested principal should be weighed by policy makers when assessing risk disclosures for structured products.

### Main findings and recommended priorities
- Progress and initiatives:
  - Substantial progress has been made and is ongoing to meet international norms.
  - Major initiatives to enhance customer protection and market integrity are in process.
- Priority actions to pursue and accelerate:
  - Expedite legislative changes to strengthen administrative enforcement powers and to expand cooperative enforcement by the authorities.
  - Strengthen the regulator’s capacity to address insolvencies.
  - Implement accounting standards that meet international standards and implement more robust oversight of the application of these standards swiftly.
  - Advance ongoing work to improve customer protections related to:
    - Security of customer funds.
    - Handling of orders.
    - Disclosures.
    - Pricing of securities.
  - Keep under close review newly developed practical protocols for increased cooperation between the banking supervisors and Bapepam-LK.
  - Ensure relevant authorities have sufficient powers and authority to oversee new developments and keep pace with evolving standards, including oversight over-the-counter trading and any new trading platforms that might emerge.

*Source: Introduction, _cr10288 - Introduction.*

### 104.     Table 8 contains a principle-by-principle summary of assessment results

### Table 8. Summary Implementation of the IOSCO Principles—ROSCs

### Principle-by-principle findings
- Principle 1. The responsibilities of the regulator should be clearly and objectively stated.
  - The legal and regulatory framework is highly transparent and the roles of the regulators and supervisors are clearly defined.
  - BAPEPAM-LK and BI have accountability in some instances for the same entities, and have recently executed a practical information sharing protocol. The operation of this protocol should be kept under review as experience with heightened information sharing and cooperation is made operational.
  - To the extent that there is significant over-the-counter securities trading or new platforms develop, attention should be paid to ensuring that existing regulatory arrangements are sufficient to prevent regulatory gaps.

- Principle 2. The regulator should be operationally independent and accountable in the exercise of its functions and powers.
  - Legislation in the process of becoming effective that reinforces regulatory independence should be promptly implemented. Such legislation will change the budget process.
  - The existing provision for preclearance by the MOF for reallocation of previously allocated funds should be eliminated—budgetary allocations should be subject to audit ex post as part of the budget process.

- Principle 3. The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers.
  - Administrative enforcement powers to fine third parties and cooperative powers should be clarified and enhanced.
  - Although BAPEPAM-LK reports no difficulty in recruiting and maintaining staff, assurance that BAPEPAM-LK has adequate technical skills should be kept continuously under review and development of defined career paths should be encouraged.
  - Efforts to promote investor/industry awareness of BAPEPAM-LK’s technical capabilities and resources should continue to be augmented.

- Principle 4. The regulator should adopt clear and consistent regulatory processes.
  - Clear processes are in place; enhanced attention should be paid to the extent to which such processes are supported by the judicial system.
  - Measures to heighten the awareness of prosecutors to the need for effective prosecution of financial crime should be pursued.
  - All regulatory interpretation including whether permissions or exceptions, if any, should be made public.

- Principle 5. The staff of the regulator should observe the highest professional standards.
  - Appropriate codes of conduct are being enhanced and compliance is being monitored.

- Principle 6. The regulatory regime should make appropriate use of self-regulatory organizations (SROs) that exercise some direct oversight responsibility for their respective areas of competence and to the extent appropriate to the size and complexity of the markets.
  - Appropriate use of self-regulatory functions is encompassed by the CML. See Principle 7.

- Principle 7. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.
  - Oversight of exchange programs, especially those of members (and members obligations with respect to non-members) upon which BAPEPAM-LK relies, should be intensified, documented, and reported.

- Principle 8. The regulator should have comprehensive inspection, investigation and surveillance powers.
  - Comprehensive powers are in place; on-site inspections of market intermediaries that are exchange members are handled largely by the exchange, subject to review by BAPEPAM-LK.

- Principle 9. The regulator should have comprehensive enforcement powers.
  - The regulator has wide-ranging administrative enforcement and intervention powers, which its staff has used proactively.
  - Administrative fining powers should be augmented and expanded.
  - It should be clarified that all BAPEPAM-LK’s administrative sanctioning powers are explicitly applicable to non-licensees.
  - As certain violations must be pursued through the criminal justice system which currently has no specially trained financial prosecution team and must attend to other priorities, efforts should be undertaken to provide a special prosecutorial corps or to expand the capacity of BAPEPAM-LK to participate directly in criminal cases.

- Principle 10. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.
  - Though the overall enforcement program has been enhanced, enforcement is not perceived by the public to be as effective as desirable for regulatory credibility.
  - BAPEPAM-LK has taken recent steps to bring actions which deprive malfeasors of the fruits of misconduct and to bar persons from practice and to revoke licenses. Nonetheless, improvements can be made.
  - Substantive violations can take a long time to pursue, may not be enforced judicially, and certain sanctions may continue be viewed as mere business expenses.
  - Efforts should be made to assure that the regulated community is sufficiently aware of all enforcement efforts.

- Principle 11. The regulator should have the authority to share both public and non-public information with domestic and foreign counterparts.
  - The regulator has appropriate information sharing authority, although in the case of banking records additional procedures are required that could potentially unduly delay, or adversely affect the use of such information. See also Principle 13.
  - There are, however, no blocking provisions.

- Principle 12. Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts.
  - The regulator has several bi-lateral information sharing arrangements with regulators, particularly in the South East Asia region, and has entered into Part B of the IOSCO Multilateral Memorandum of Understanding (MMOU) committing to undertake the changes to become a full signatory.

- Principle 13. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers.
  - While the regulator has the capacity to provide enforcement assistance to foreign regulators, it may have to commence its own investigation; the regulator should proceed with the legislation to permit it to become a full member of the IOSCO MMOU.

- Principle 14. There should be full, timely and accurate disclosure of financial results and other information that is material to investors' decisions.
  - In general, the disclosures for issuers and public companies meet international standards subject to accounting improvements; the recent addition of proper identification of second tier listings on the exchange platform should assure that such listings do not compromise disclosure with respect to listed companies.

- Principle 15. Holders of securities in a company should be treated in a fair and equitable manner.
  - Company law has recently been improved and enforcement of shareholder rights strengthened; but interconnections among shareholders and large share holdings, may still require more effective disclosure.

- Principle 16. Accounting and auditing standards should be of a high and internationally acceptable quality.
  - Indonesia is rapidly moving toward implementing IFRS, to be completed by 2012.
  - This process together with provision for enhanced accounting and audit oversight, should be accelerated to ensure appropriate reporting of financial information.

- Principle 17. The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme.
  - Effective standards are in place with respect to licensed Investment Managers, portfolio advisors, custodians, sales personnel, and funds.
  - Issues with the confusion as to whether discretionary funds were collective investments and as to the applicable regulatory requirements have been addressed by recent rulemaking. These changes should be kept under review.

- Principle 18. The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets.
  - Statutory provisions, addressing the form of collective investment contracts, make the participation unit in a contractual fund a security, subject to a custodial and management contract.
  - This contractual structure, and related accounting, is not atypical of civil jurisdictions where the objective is to insulate the interest of the customer from claims on the manager.
  - The concept of trust is not well developed. This structure, while meeting the spirit of the principle, should be clearly disclosed.
  - Further, to the extent that the judiciary does not actively enforce financial contracts, the effectiveness of this structure should be kept under review.

- Principle 19. Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme.
  - The requirements for disclosure are comprehensive and fulfill the list provided by IOSCO.
  - Care must be taken so that customers understand that the capital funds are not guaranteed funds.

- Principle 20. Regulation should ensure that there is a proper and disclosed basis for assets valuation and the pricing and the redemption of units in a collective investment scheme.
  - There is provision for calculation of a daily net asset value, and obligations on the Investment Manager and the custodian for the integrity of pricing and for documentation of prices not made in the market.
  - The system, however, for debt pricing, which is in the process of being reformed can be manipulated.
  - Regarding the majority of retail funds that are currently invested in debt, reform should be expedited.

- Principle 21. Regulation should provide for minimum entry standards for market intermediaries.
  - The licensing requirements for market intermediaries appear to be comprehensive, apply to investment advisors as well as broker dealers, and are enforced through an initial due diligence exercise.
  - Oversight is conducted by the exchange for member firms.
  - More documentation should be made available; however, as to the ongoing monitoring of intermediaries in general, see Principle 7.

- Principle 22. There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake.
  - Capital requirements contain a leverage limiter and haircuts on assets; adequacy of coverage in light of market events and liquidity needs should be kept under rigorous review.

- Principle 23. Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters.
  - Good provisions for internal controls and for conduct of business are in place.
  - There are concerns as to how customer positions are handled in practice. BAPEPAM-LK has sought to address these concerns by the recent creation of a unique identifier to ensure transactions are properly credited to customers’ accounts.
  - The effectiveness of this reform to assure appropriate treatment of nominee accounts should be evaluated on an ongoing basis.
  - BAPEPAM-LK should be alert that remote branches can breed risks, and assure appropriate coverage of branch supervision is included in its risk-based oversight.

- Principle 24. There should be a procedure for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and to contain systemic risk.
  - Procedures are in place to limit exposures that are unsupported by capital and to limit leverage.
  - Nonetheless, a documented plan for handling intermediary defaults to the exchange or clearing or settlement systems is desirable.
  - Adoption of pending resolution reforms is also recommended. See also Principle 28.

- Principle 25. The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight.
  - The provisions for authorizing exchanges/self-regulatory organizations are comprehensive and the requirement for the exchange to have appropriate rules and to enforce them is in place.
  - If OTC equity trading is not bilateral, BAPEPAM-LK may need to ensure that trading facilities are clearly designated as exchanges or otherwise covered.

- Principle 26. There should be ongoing regulatory supervision of exchanges and trading systems, which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants.
  - There are provisions for the oversight of the exchange, including periodic reporting, rule enforcement reviews or inspections, the reporting of sanctions, the requirement for specified follow-up procedures in the case of member capital deficiencies, and the capacity to request raw data to complement BAPEPAM-LK’s monitoring activities.
  - Provisions for the halting of trading should be transparent and followed. Also, see Principle 7.

- Principle 27. Regulation should promote transparency of trading.
  - Trading on the exchange is transparent. But see Principle 20 regarding the pricing of debt traded OTC.

- Principle 28. Regulation should be designed to detect and deter manipulation and other unfair trading practices.
  - BAPEPAM-LK has the power to commence investigations and the exchange has state of the art tools to detect manipulation and other abuses.
  - The prosecution of cases to an effective conclusion, however, is lengthy and highly uncertain.

- Principle 29. Regulation should aim to ensure the proper management of large exposures, default risk and market disruption.
  - The taking of positions is governed by an exposure limit set by reference to net adjusted working capital; failure to deliver securities is severely punished, and so infrequently occurs; and there is a progression of access to various resources to fund defaults.
  - Nonetheless, the contingency arrangements between BAPEPAM-LK and the IDX, KPEI, and KSEI should be documented.
  - Delisting procedures might also be reviewed. See also the separate securities and settlement recommendations.

- Principle 30. Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective and efficient and that they reduce systemic risk.
  - Assessed under the CPSS/IOSCO Securities Settlement Recommendations by another assessor.

### Recommended action plan (Table 9) — key actions by principle groups
- Principles 2, 10, 15, 18, 24 and 28; see also Principles 8 and 13
  - Implementation of legislative changes to the Capital Markets Law, and other laws as necessary, intended to update and enhance the authority and power of BAPEPAM-LK and otherwise support the regulatory framework. These include:
    - (i) proper immunity from civil damages;
    - (ii) limitation of ministerial budget allocation review to ex post audit after initial budget approval;
    - (iii) the expanded ability to require governance enhancements;
    - (iv) the ability to proceed judicially under civil law or administratively against third parties to sanction securities violations;
    - (v) continued confirmation that contractual fund interests are enforced as a matter of law as well as by contract;
    - (vi) the ability to meet international norms for enforcement cooperation; and
    - (vii) a modernized resolution authority and insolvency law.
  - Enhancement of steps to assure investor awareness of the overall regulatory program should be continued and expanded.

- Principles 4, 14, 18 and 20
  - Enhancements should be pursued to strengthen the fairness and reliability of transactions in relation to transparency and pricing. These include:
    - (i) public clarification that the exemptions are not accorded by law or that such exemptions, if any, will be published;
    - (ii) confirmation that second tier offerings are clearly identified as such on the IDX trading platform;
    - (iii) augmented disclosure to ensure that the risks of capital protected funds are clearly disclosed and understood as not guaranteed ; and
    - (iv) review and modification of the corporate debt pricing methodology to ensure that prices used for mutual funds are equitably determined and are not unduly susceptible manipulation.

- Principles 18, 23 and 26
  - Augmentation of oversight regimes to confirm that:
    - (i) customer funds are properly identified;
    - (ii) the unique customer ID as adopted and implemented enhances customer fund protection as intended that maintenance of the segregation of customer from firm accounts is sufficiently rigorous, and that sales of non-member agents are appropriately overseen.

- Principles 7, 10, and 28
  - Continuation of efforts to assure that the public has due regard for the effectiveness of surveillance and enforcement programs.
  - Augmentation of legal powers to conduct administrative enforcement proceedings, in particular fining powers.
  - Enhancement of the documentation and conduct of on-going monitoring and coverage, particularly with respect to the oversight of customer trades and funds.
  - Extension and continuation of pro-active initiatives to assure that securities violations are punished in a prompt, meaningful way.

- Principles 22, 24, and 28
  - Continuing monitoring and documentation of contingency arrangements to address firm defaults and assurance that capital requirements provide sufficient liquidity cushion to withstand a significant standard deviation price moves in various markets.

- Principles 1, 12, and 13
  - Review of the operation, in practice of the new information sharing arrangement between BAPEPAM-LK and BI to assure the appropriate interchange of information and cooperation among entities with responsibility for the same licensed firm.

### Authorities’ response excerpt
- Paragraph 105:
  - The authorities express thanks to the IMF and the World Bank for continued support to assist Indonesia in reforming and transforming domestic capital markets.
  - They consider the FSAP exercise as an important reference in undertaking reform activities towards a more resilient and efficient capital market supported by a robust regulatory framework in line with the international best practice and standards.

*Content unit: _cr10288 - 104. Table 8 contains a principle-by-principle summary of assessment results*

### 106.     Indonesia as an emerging market member of G20, views the assessment and its

### Indonesia as an emerging market member of G20, views the assessment and its recommendations very seriously

### Ongoing legal and regulatory reforms (authorities' views)
- Indonesia believes the current assessment provides only a fraction of on-going reforms and will continuously undertake factual updates to the World Bank and IMF to facilitate greater awareness on the actual level of Indonesia’s International Standards compliance.
- Noted ongoing reforms (may not have been captured in the report as of April 2010):
  - Implementation of Single Investor ID for Fund and securities for all investors (inclusive of CIS Investors), to provide real time monitoring of end-investor activity and potential misuse by market intermediaries.
  - A revised Capital Market Law to include the ability of regulators to appoint statutory managers to takeover institutions (SRO’s, market intermediaries and NBFI’s); introduction of an investor protection fund; improvements to dispute resolution procedures to ensure effective management of customer disputes.
  - Submission of the OJK (Financial Service Authority) Bill to provide complete independence of the Capital Market Regulator (Bapepam-LK) from the Ministry of Finance; OJK to draw upon market resources; provision of a comprehensive “legal immunity” in addition to Criminal Code (Art 50/51) protections for staff acting in a “bona-fide” manner.

### Regional integration and market surveillance (technology and strategy)
- Indonesia is preparing for greater regional integration with ASEAN neighbors, including regulatory preparation for cross border activities via Mutual Recognition or Substituted Compliance.
- Anticipated operating environment changes over the next 5 years.
- On-going reforms include:
  - Reforming regulatory, supervisory and enforcement powers and tools to facilitate greater pre-emptive monitoring capabilities.
  - Building a consolidated information warehouse to link all related information concerning markets, products, issuers, activity (on/off exchange) and relationships of all economic agents domestically and regionally — a technology-oriented approach to enhance surveillance and monitoring capacity to detect capital market violations, emerging prudential risks and the buildup of systemic risk.

### Authorities’ view on the assessment process
- The Indonesian capital market regulator considers the amount of resources and time allocated for the IOSCO assessment by the IMF and World Bank insufficient to gauge comprehensiveness of regulatory systems, supporting tools, processes, and on-going reforms.
- Time and resource constraints reduced the ability to execute a detailed fact-finding mission to reach a more comprehensive understanding of the philosophy behind the Indonesian legal and regulatory framework.

### Scope and methodology of the CPSS Core Principles assessment (BI-RTGS)
- Scope:
  - Assessment covers BI’s real time gross settlement (BI-RTGS) system’s observance of the CPSS Core Principles for Systemically Important Payment Systems (SIPS) and BI’s responsibilities in applying the Core Principles.
  - BI considers the BI-RTGS system to be the only systemically important payment system in the country; assessment conducted on the RTGS as the sole SIPS.
- Information sources used:
  - Interviews with BI officials; several bank and non-bank participants in BI-RTGS; Bankers Association; Artajasa (ATM switching company); Bankers Association By-Laws Committee; post office; telecommunications companies and mobile service providers.
  - Detailed self-assessment of the BI-RTGS.
  - BI website information.
  - BI Act 23 of 1999; Bankruptcy and Suspension of Obligation for Payment of Debts Act; various BI regulations, rules, and circular letters.
- Assessment tools:
  - “CPSS Core Principles for Systemically Important Payment Systems,” January 2001.
  - “Guidance Note for Assessing Observance of Core Principles for Systemically Important Payment Systems and the Structure and Scope of the Assessment Report” (IMF/World Bank/CPSS).

### Institutional and market structure (key facts)
- BI empowered by BI Act 23 of 1999 to oversee payments system; 40 branches facilitate interbank clearing and cash distribution.
- BI provides settlement in central bank money for RTGS, government securities system, and national clearing system.
- Cash dominance:
  - Cash utilization levels have maintained an upward trend over the last 6 years and peaked in 2008.
- Payment instruments and networks:
  - Other means of payment: cheques, drafts, direct debit and credit transfers.
  - Various payment cards are switched through different, non-interlinked networks; Artajasa is the biggest in terms of number of banks serviced and has access to BI-RTGS to facilitate settlement of card and other retail transactions.
- BI-RTGS details:
  - Introduced in 2000 as strategy to address cheque clearing risks.
  - BI-RTGS links 149 participants to the central bank using a designated network.
  - Settles transactions in real time using central bank money.
  - Front end provided for participants; system works on a credit push basis — settlement account must be adequately funded before transaction can be settled.
  - Once processed in BI-RTGS—one account debited and the other credited—payment is final and cannot be reversed.
- National clearing system (SKN-BI):
  - Established in 2005.
  - Handles clearing through over 100 clearing facilities; in areas without BI representation, commercial bank agents carry out clearing on behalf of the central bank.
- BI involved in collaborative payment system reform; existing blueprint being revised to set strategic direction for critical international linkages.

### Main findings against CPSS Core Principles (summary)
- CP I — Legal Framework:
  - Legal foundation generally sound with explicit provisions for central bank involvement.
  - Authorities should consider enacting a specific law governing payment systems and explicitly recognize netting as a legal process (reference that circulars/rules mentioning “netting” do not constitute legal recognition).
- CP II–III — Management of Risk:
  - BI-RTGS generally functions well and is recognized as the only SIPS in Indonesia.
  - All risk related Core Principles (CPs) are observed.
- CP IV–VI — Settlement:
  - Finality: once accepted and accounts debited/credited, payment is final and irrevocable; participants understand finality and system operating hours are followed.
  - BI-RTGS settles in central bank money.
  - Collateralized intraday credit facility in place to ensure smooth flow of payments.
- CP VII–VIII — Operational Reliability and Efficiency:
  - BI has adequate contingency plans; general security policy and business continuity procedures are well documented and tested.
  - 40 kilometer separation between production and disaster recovery sites is acceptable as a minimum.
  - Advanced plans to implement a new second generation system in 2011; maintaining observance of CP IV depends on realization of these plans within stipulated time.
- CP IX–X — Access and Governance:
  - No clear, documented access criteria based on specific indicators because BI requires all banks to be direct participants.
  - BI would benefit from access criteria based on specific indicators agreed between Payment Systems Department and Banking Supervision Department to manage systemic risk from weak banks.
  - BI should consider final settlement needs when granting access to non-banks and distinguish between access to settlement account only and access to central bank credit and settlement accounts.
- Central Bank Responsibilities (A–D):
  - BI’s payment system objectives are documented and publicly disclosed via website and the National Payment System Communication Forum.
  - Communications could be deepened by explicitly stating direction to achieve blueprint objectives.
  - BI should ensure adequate resources (staff levels and skills) for an increased oversight profile as financial development proceeds.
  - BI cooperates with regional central banks and receives technical assistance; domestic cooperation with other authorities and regulators could be improved.

### Key statistics and factual indicators (preserved)
- Timeframe references and figures:
  - Report status as of April 2010.
  - Cash utilization trend over the last 6 years, peaking in 2008.
  - BI has a spread of 40 branches.
  - BI-RTGS links 149 participants.
  - BI-RTGS introduced in 2000.
  - SKN-BI established in 2005; handles clearing through over 100 clearing facilities.
  - Planned migration to new second generation RTGS (and Scripless Securities Settlement System—SSSS) platform in 2011.
  - Planned operating environment changes over the next 5 years.
  - 40 kilometer separation between production site and disaster recovery site noted.

### Table-based summary points (from Table 10)
- Legal foundation: generally provides basis for payment systems; explicit recognition of “netting” as a legal term should be addressed.
- CP II: System rules and procedures are clear; “credit push” design, prefunding and intraday facility help flow; lack of hybrid feature may limit liquidity optimization and lead to queue build-up.
- CP III: Credit risk minimized by system design, collateralized intraday credit facilities, throughput guidelines and a queue management system.
- CP IV: Finality understood; items can be discarded from queue at end of day if funding lacking — for RTGS purposes CP observed.
- CP V: Not Applicable.
- CP VI: Settles in central bank money; collateralized intraday credit facility in place.
- CP VII: System availability very good; SLAs could be strengthened; importance of migration to new platform in 2011 emphasized; number and skills of technical staff need evaluation for migration.
- CP VIII: Current design generally supports efficiency; second generation hybrid design will improve it; opportunities for benchmarking to ensure cost efficiency.
- CP IX: Need clear, explicit, well documented access criteria aligned with BI’s broader plans and final settlement needs.
- CP X: Good governance foundation through separation of duties and stakeholder engagement; room to strengthen oversight of securities settlement and proactive overseer role for BI.
- Central Bank Responsibilities A–D: Objectives and disclosure present; oversight on BI-RTGS carried out; placement of BI-SSSS oversight not clear; no formal oversight on other settlement systems with potential systemic importance; cooperation with regional central banks present; scope to increase domestic cooperation.

### Recommended action plan (selected recommendations from Table 11)
- CP I:
  - Consider enacting a specific law to govern payment system operations.
  - Consider explicitly recognizing netting as a legal process.
- CP IX:
  - Consider introducing clear documented access criteria based on specific indicators for both direct and indirect participants.
- CP X:
  - Consider setting up a BI-RTGS User Group to encourage dialogue on system specific issues.
  - Extend oversight activities to RTGS participants and broaden communications with stakeholders.
- Responsibilities B, C, D (Central Bank Responsibilities):
  - Consider measures to achieve full compliance for all CPs.
  - Widen the scope of oversight and strengthen activities through formal arrangements.
  - Improve and structure cooperation with other domestic authorities and regulators by signing formal MOUs and creating joint working groups where appropriate (e.g., with Bank Supervision Department, Bapepam, telecommunications regulatory authority).

*Source: IMF/World Bank assessment text as provided in the content unit.*

### 126.     CP I Legal Foundation: BI noted that currently there are regulations in existence

### _cr10288 - 126.     CP I Legal Foundation: BI noted that currently there are regulations in existence

### CP observations and institutional responses
- CP I Legal Foundation:
  - BI noted that currently there are regulations in existence governing netting settlement, e.g., in BI regulations on the national clearing system.
  - BI agreed that it is necessary to have an Act or statute that governs payment and settlement systems (including netting), but the process of enacting statutes is time consuming and involves many parties.
- CP IX Access:
  - BI agreed with the recommendation of introducing clear, documented access criteria that are based on specific indicators, for both direct and indirect participants.
  - The access criteria are being reviewed to give clear and explicit indicators.
- CP X Governance:
  - BI advised that the operator of BI-RTGS already conducts an on-site examination of several members as a tool for oversight.
  - BI noted the oversight function needs to extend its activities to the operational activities of the securities settlement system.
- Central Bank Responsibilities B, C and D:
  - BI fully agrees with taking appropriate measures to ensure full observance of all CPs.
  - Oversight of the BI-SSSS will commence in 2010 in accordance with the consolidation of BI-RTGS and BI-SSSS under the Payment Systems Directorate.
  - Coordination with the Bank Supervision Department has been conducted in the form of information exchanges and joint teams in on-site examinations.
  - Cooperation with other authorities (Bapepam-LK and Ministry of Information and Communication) will be discussed and followed up.

### Assessment scope, methodology, and market structure
- Assessment scope:
  - Two CPSS-IOSCO assessments covered the BI’s Government securities system (conventional and sharia) and the private sector equities and corporate bonds system.
  - Both assessments were conducted on processes and functions as opposed to institutions.
- Information sources:
  - Interviews with officials from BI, Ministry of Finance Debt Management Unit, Securities Companies, Association of Indonesian Securities Companies, several banks, and the Bankers’ Association By-Laws Committee.
  - Documents provided: detailed assessment of the BI-SSSS; information on BI and MOF websites; the BI Act; Government Securities Act; Government Sharia Securities Act; Bankruptcy and Suspension of Obligation for Payment of Debts Act; various regulations, pronouncements and circular letters issued by BI and MOF.
- Assessment tools:
  - IOSCO-CPSS “Recommendations for Securities Settlement Systems” (RSSS) and “Assessment Methodology for Recommendations for Securities Settlement Systems”.
  - Bank-Fund “Guidance for Writing Detailed Assessments for Reports on Observance of Standards and Codes.”
- Institutional responsibilities:
  - MOF: issuance of government securities.
  - BI: regulation of open market operations, registration of government and BI securities, and operation and administration of the BI-SSSS.
  - Bapepam-LK: regulation and supervision of the Indonesian capital market.
- BI-SSSS structure and participants:
  - Securities held/registered in BI-SSSS: Bank Indonesia Bills (SBI) and government securities (SBN) classified into conventional (SUN) and sharia (SBSN).
  - The system has 170 participants: BI, MoF, Ministry of Religion, banks, primary dealers, and sub-registries.
  - BI-SSSS components:
    - BI-ST: used to settle secondary market and government bond collateral execution transactions; used by brokers to submit bids into the bond auction component (Bid CC).
    - Bid CC: links MOF as issuer, BI as auction agent, and authorized primary dealers (4 securities companies and 14 custodian banks).
    - SCC: central registration (CSD function), user administration, coupon settlement, monitoring of secondary market coupon payments; directly linked to BI-RTGS for cash settlement.
  - Two-tier registry: first tier records holdings for direct participants (15 sub-registries, custodian banks, BI’s own holdings); second tier: sub-registries record holdings of individual beneficial owners.
  - Primary dealers: 18 authorized by MOF; 14 are banks with BI-RTGS settlement accounts; 4 are securities companies settling indirectly through commercial banks.
  - Market shares in primary market bids: approximately 80 percent allocated to bank primary dealers; securities companies take the remaining 20 percent.
- Equity and corporate bond market statistics (as at end-November 2009 unless otherwise stated):
  - KSEI counted 489 issuers, 130 securities companies, 22 custodian banks, 10 registrars and 360,340 sub-accounts.
  - Of the securities companies, 120 are exchange and clearing members, of which 114 are active.
  - Stock exchange average total turnover (value): IDR 4.49 trillion per day.
  - Corporate bonds average total turnover (value): IDR 161 billion per day.
  - Equity market capitalization: IDR 1,896 trillion.
  - Corporate bonds outstanding amount: IDR 79 trillion.
- Trading and settlement arrangements:
  - Stock exchange segments: regulated market (electronic order book, settlement T+3), cash market (two auctions daily, settlement T+0), immediate market (currently closed), negotiated market (trade-by-trade clearing, negotiable settlement cycles, not netted).
  - All securities issued after introduction of the scripless system in 2000 are held in dematerialized form; cannot trade physical-form stocks on the exchange.
  - OTC trades bilaterally concluded and settled by KSEI; corporate bond settlement T+2.
  - Cash settlement for equities and corporate bonds takes place in cash accounts of one of four “payment” banks: Mandiri, BCA, CIMB, and Permata.
  - KSEI mirrors securities accounts and payment bank cash accounts; settlement mechanism transfers securities and cash legs simultaneously, followed by reconciliation; once a day payment banks’ accounts are realigned using BI-RTGS.
  - Government bonds traded on the stock exchange have cash settlement directly in BI-RTGS; volumes are very low.
  - Possibility of linking KSEI to BI-RTGS for equity and corporate bond settlement is under discussion.

### Main findings and recommendations — Government Securities

- Legal Framework:
  - The legal framework governing BI-SSSS operations is based on three main statutes, supported by various regulations, pronouncements, and circular letters issued by BI and MOF.
  - These legal provisions need further strengthening to ensure settlement finality and recognition of netting as a legal process.

- Pre-settlement risk:
  - Shortcomings in trade confirmation:
    - BI as operator of BI-SSSS has no way of comparing trade information between direct and indirect participants and the confirmation pattern relating to those trades.
    - Although a reporting system exists for Bapepam’s requirements, it is not linked to BI-SSSS.
    - BI and Bapepam could benefit from a collaborative approach in defining information sharing arrangements.
  - Settlement cycle:
    - The settlement standard of T+3 is not met in the settlement of all government securities transactions; in some instances in the negotiated market it is even longer.
    - BI needs to explore measures to adopt a shorter settlement cycle using a cost benefit analysis.

- Settlement risk:
  - Trade failures:
    - Settlement risk is almost negligible for direct participants in BI-SSSS, but some trade failures—0.5 percent of trade volume per year—still occur.
  - Securities lending:
    - The securities lending market is very limited and this may be hampered by the imposition of double taxation on repo arrangements.

- Operational risk:
  - BI-SSSS shares the same operational structure as BI-RTGS, supplied and supported by the same vendor.
  - Both systems are scheduled for second generation replacement in 2010.
  - Recommendation: BI should proceed with this replacement as planned to fully observe operational risk standards in future assessments.

- Custody risk:
  - Adequate arrangements exist to ensure protection of customers’ securities in the central securities depository.
  - Custodians are required to separate their assets from those of customers when recording, and regular reconciliations are carried out.

- Other issues:
  - Placement of business owner and oversight responsibilities for BI-SSSS within the same organizational unit poses separation of duties issues, making objective oversight difficult and potentially creating perceptions of lack of objectivity.

### Table 12 — Summary observance highlights (selected responsibilities)
- Legal risk (1):
  - The legal framework generally supported by statutes, regulations and circular letters still requires strengthening by recognizing “netting” as a legal term and legalizing finality in securities settlement.
- Pre-settlement risk (2–5):
  - Confirmation: BI cannot compare trade information between direct and indirect participants; Bapepam-LK’s system is not linked to BI-SSSS; absence of information on percentage of trades confirmed on T+0 poses assessment challenges.
  - Rolling settlement / T+3: No study has been undertaken to evaluate costs/benefits of accelerated settlement; T+3 not observed for all government securities transactions.
  - Central counterparty (CCP): No CCP arrangement in place; no study known to the assessment team.
  - Securities lending: SLB is very limited; BI participates via repos; MOF participates with Primary Dealers only; double taxation of repos could be hampering development.
- Settlement risk (6–10):
  - Dematerialization: CSD component holds securities in dematerialized form and transfers them electronically; dematerialization covered by statute.
  - DVP and finality: BI-SSSS is linked operationally and by regulation to BI-RTGS; government securities settled through BI-SSSS use DVP Model 1 (gross basis) with finality in central bank money.
  - End-of-day finality: Final settlement on a DVP basis occurs within the day of settlement; settlement takes place continuously throughout the business day.
  - Deferred net settlement: There is no deferred net settlement within BI-SSSS; unfunded trades are discarded at the end of the day; BI has not evaluated costs of ensuring settlement or introducing additional failure-to-settle arrangements.
  - Cash settlement asset risk: Central bank money is used to settle trades in BI-SSSS.
- Operational risk (11):
  - BI-SSSS and BI-RTGS share operational support structure and platform supplied and supported by the same third party vendor.
- Custody risk (12):
  - Sub-registries must maintain internal systems clearly separating their own holdings from clients’; holdings are audited periodically.
- Governance (13):
  - The CSD is operated by the Monetary Management Directorate of BI with key performance management indicators.
  - BI-SSSS By Laws Committee represents banking industry participants and enforces a code of practice.
  - Recommendation: Establishment of an all inclusive User Group would help promote users’ interests and BI.

*Source: IMF staff assessment content as provided in the supplied PDF content unit.*

### 14. CSDs and central counterparties should have

### 14. CSDs and central counterparties should have

### Participation criteria and access
- Participation criteria are disclosed and differentiate four types of entities: banks, sub-registries, primary dealers and securities issuers.
- The criteria that apply to BI-RTGS and BI-SSSS access appear to be harmonized to support DVP arrangements, particularly for bank participants.

### Cost-effectiveness and cost recovery
- While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users.
- The operational cost structures and approaches to cost recovery are virtually the same for RTGS and BI-SSSS.
- The central bank judges the cost efficiency of BI-RTGS against broad national payment system efficiency and effectiveness needs.
- Currently, the BI aims to recover its fixed costs for operating BI-RTGS but not variable costs; it is estimated that the fixed cost component accounts for approximately 90 percent of total cost.

### International communications standards
- Securities settlement systems should use or accommodate the relevant international communication procedures and standards in order to facilitate efficient settlement of cross-border transactions.
- Communications standards are adaptations of SWIFT standards that meet the needs of the domestic market and provide a basis for supporting international communications.
- It is noted that BI has made a decision to use SWIFT in the second generation systems; thus SWIFT ISO messaging standards will be used for category five messages which pertain to securities.

### Disclosure of risks and costs
- CSDs and central counterparties should provide market participants with sufficient information for them to accurately identify the risks and costs associated with using the CSD or central counterparty services.
- Disclosure framework requirements are being met.

### Regulation, oversight, and institutional arrangements
- Securities settlement systems should be subject to regulation and oversight; responsibilities and objectives of the securities regulator and the central bank with respect to SSSs should be clearly defined and publicly disclosed.
- The entities with regulatory cognizance over BI-SSSS and the participants in the markets supported by the system are BI and the MOF, including Bapepam-LK.
- There is a statute-based definition of these entities’ respective responsibilities.
- The placement of business owner and oversight responsibilities for BI-SSSS within the same organizational unit poses separation of duties issues, making objective oversight difficult and creating perceptions that oversight may not be objective.
- Recommended: BI should strengthen and formalize cooperation with other regulatory authorities in the market. Consider separating the BI-SSSS operational function from the oversight function. BI should also proceed with the second generation replacement of the BI-RTGS and BI-SSSS in 2011 as planned.
- There is a formal arrangement (MOU) between Bapepam-LK and BI since April 30, 2010 to facilitate greater information sharing and cooperation between the two institutions.

### Cross-border links
- CSDs that establish links to settle cross-border trades should design and operate such links to reduce effectively the risks associated with cross-border settlement.
- Currently, there are no cross border links.

### Recommended Action Plan — selected items (from Table 13)
- Legal risk
  - Recommendation: Securities settlement systems should have a well-founded, clear and transparent legal basis in the relevant jurisdiction.
  - Recommended Action: Explicitly recognize “netting” as a legal process and strengthen the provision dealing with bankruptcy of a non bank participant. Finality of settlement also needs to be legalized.
- Pre-settlement risk
  - Recommendation 2: Confirmation of trades between market participants should occur as soon as possible after trade execution, but no later than trade date (T+0). Indirect participants should confirm preferably on T+0, but no later than T+1.
  - Recommended Action: Introduce measures to formally collect information on the percentage of trades confirmed in the secondary market within T+0; collaborate with Bapepam-LK on data collection.
  - Recommendation 3: Rolling settlement should be adopted in all securities markets. Final settlement should occur no later than T+3. Assess benefits and costs of shorter cycles.
  - Recommended Action: Consider undertaking a study to evaluate the costs and benefits of accelerated settlement.
  - Recommendation 4: Assess benefits and costs of a central counterparty (CCP); where introduced, the CCP should rigorously control assumed risks.
  - Recommended Action: BI should carry out a cost benefit analysis assessment of a CCP given BI’s consideration of introducing Model I and Model 2 DVP settlement with second generation systems.
  - Recommendation 5: Encourage securities lending and borrowing (including repos) and remove barriers.
  - Recommended Action: Consider measures to promote active securities lending; review tax regulations that appear to hamper repo market development (double taxation) supported by the Master Repurchase Agreement.
- Settlement risk
  - Recommendation 9: CSDs that extend intraday credit should institute risk controls to ensure timely settlement if the participant with the largest payment obligation is unable to settle. Reliable controls include a combination of collateral requirements and limits.
  - Recommended Action: Consider measures to minimize incidence of security-related transactions in RTGS discarded from the RTGS queue at the end of the day due to insufficient funds.
- Other issues
  - Recommendation 16: Use or accommodate international communication procedures and standards to facilitate cross-border settlement.
  - Recommended Action: BI’s decision to use SWIFT in second generation systems; SWIFT ISO messaging standards will be used for category five messages pertaining to securities.
  - Recommendation 18: Systems should be subject to regulation and oversight; roles should be clearly defined and resources sufficient.
  - Recommended Action: BI should strengthen and formalize cooperation with other regulatory authorities; consider separating BI-SSSS operational and oversight functions; proceed with second generation replacements in 2011.

### Authorities’ response to the assessment (selected points)
- Bapepam-LK agrees with the observation on lack of explicit and granular legal basis in the Capital Market Laws for DVP, irrevocability and settlement finality within the KSEI system.
- Immediate-term measures:
  - Ensure that the “dedicated liquidity” within the KSEI system is the final position from a legal and business perspective.
  - Payment banks must guarantee balances in the system to ensure technical DVP becomes a true real time DVP in both KSEI and payment banks’ systems.
  - Move towards greater real time synchronization among the payment banks.
- Bapepam-LK will amend regulations together with respective SROs to explicitly lay out provisions for DVP settlement finality and irrevocability once DVP have been executed by counterparties.
- Long-term aim: phase out the usage of payment banks and integrate KSEI fully into the RTGS system on the payment leg of the transaction; this will require BI’s approval for KSEI to become an entity in the RTGS system to handle payment leg transactions with respect to all payment agents in the RTGS system.
- KSEI is developing straight through process (STP) capabilities within C-BEST to increase efficiency by replacing some manual processes.
- Harmonization of operating hours between the RTGS system and KSEI is being considered.
- BI and KSEI currently undertake daily reporting of all transactions executed under the BI-SSSS and C-BEST to the central trade reporting system (PLTE) via the X.M.3 rule which provides Bapepam-LK the full data of all trades executed in the Indonesian bond market.
- Ongoing discussion between Bapepam-LK, the directorate general of debt management and BI on the possibility of merging the two central depositories for KSEI into a single depository for all instruments.

### Key findings and recommendations: Equities and Corporate Bonds
- Legal framework deficiencies
  - The legal framework supports some, but not all, key elements of clearing and settlement.
  - The legal framework does not appropriately address:
    - finality of settlement (not specified when a trade is irrevocable and unconditional),
    - DVP is not defined in the rules of KSEI for all transaction types and guidance on cash settlement arrangements within payment banks is lacking,
    - netting is not legally recognized in any statutes.
  - Recommendation: Legal framework should include these three concepts, in line with international definitions.
- Settlement cycle and negotiated market
  - The settlement cycle of the stock exchange segment “negotiated market” has no standardized settlement process; settlement can occur later than T+3 if participants agree.
  - In 2009, 17 percent of the total value of transactions was concluded in the negotiated market.
- Central counterparty (KPEI)
  - KPEI, being the CCP for all stock exchange trades, broadly observes CCP requirements and has addressed legal, financial and operational risk in its rules and frameworks.
  - Recommendation: CCP should further improve legal risk, access criteria, financial risk methods, and operational procedures.
- Cash settlement and payment banks
  - Cash settlement takes place in the accounts of four dedicated “payment” banks that must meet KSEI requirements to limit credit and liquidity risk.
  - Settlement volumes are sufficiently spread over the different payment banks.
  - Recommendation: Explore introduction of cash settlement in the BI-RTGS system to reduce capital market risk as a whole; current use of payment banks exposes participants to settlement bank risk.
- Technical DVP and legal finality
  - KSEI has developed a settlement process in which securities and cash transfers occur simultaneously in the C-BEST system; the technical framework ensures DVP.
  - However, since KSEI has no real cash account in C-BEST, C-BEST accounts mirror cash accounts at the payment banks and the legal framework does not provide enough comfort that cash transfer in C-BEST is a final transfer.
  - This is important because a time lag exists between the securities transfer in C-BEST and the real cash transfer in the payment banks to participant accounts.
- Operational resilience
  - C-BEST observes operational risk requirements, but there is a need to prevent simultaneous unavailability of primary and secondary sites as occurred on 12 November 2009.
  - Encourage geographically disparate production and back-up processing for IDX, KPEI, and KSEI systems.
- Custody protections
  - Sub-registries holding securities on behalf of individuals are required to maintain internal systems that clearly record holdings separating their own holdings from clients’, safeguarding client assets in the event of a sub-registry’s insolvency.

### Summary observance highlights (from Table 14)
- Confirmation of OTC corporate bond trades is estimated at 68 percent on the same day; a watertight system for trade confirmation reporting on T+0 should be implemented.
- Settlement cycles for equities and corporate bonds vary from T+0 to T+3, in line with recommendation, but negotiated market segment may settle later than T+3.
- Securities lending and borrowing is available for equity trades on the stock exchange but not for corporate bonds traded OTC; KPEI’s securities lending and borrowing service should be extended to corporate bonds.
- KSEI holds securities in dematerialized form and transfers them electronically; dematerialization is covered by statute.
- There is no deferred net settlement within KSEI, nor does KSEI extend intraday credit to participants.
- Four payment banks are responsible for the cash settlement leg; authorities should consider analyzing possibility of introducing cash settlement in the BI-RTGS system.

*Source: IMF Financial Sector Assessment content unit _cr10288 - 14. CSDs and central counterparties should have*

### 13. Governance arrangements for CSDs and central

### 13. Governance arrangements for CSDs and central counterparties

### Governance and objectives
- Governance arrangements for CSDs and central counterparties should be designed to fulfill public interest requirements and to promote the objectives of owners and users.
- Finding: The governance arrangements of KSEI and KPEI observe the requirements of the recommendation.

### Participation, access and exit
- Recommendation: CSDs and central counterparties should have objective and publicly disclosed criteria for participation that permit fair and open access.
- Finding: In general, the assessment recommends that the access and exit criteria of KPEI focus more on the specificities of membership of the CCP.

### Cost-effectiveness and budgeting
- Principle: While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users.
- Findings and arrangements:
  - The budget plans of KSEI and KPEI are subject to the approval of Bapepam-LK.
  - Any profits should be used to enhance clearing and settlement systems.
  - User satisfaction surveys are conducted on an annual basis.

### Communication procedures and cross-border standards
- Principle: Securities settlement systems should use or accommodate the relevant international communication procedures and standards to facilitate efficient settlement of cross-border transactions.
- Findings:
  - KSEI as well as certain market participants use SWIFT.
  - Not all market participants are willing to migrate to SWIFT.
  - Migration of the current system to SWIFT for the full market is considered to be difficult.
- Recommendation (in action plan): All KSEI members should become members of SWIFT or should use domestic communication procedures that can be easily converted into SWIFT messages.
- Finding: Currently, there are no cross border links.

### Disclosure and information to market participants
- Principle: CSDs and central counterparties should provide market participants with sufficient information to accurately identify the risks and costs associated with using the CSD or central counterparty services.
- Finding: Disclosure framework requirements are being met.

### Regulation, oversight and institutional coordination
- Principle: Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities.
- Findings and recommendations:
  - The structure of regulation should be reviewed to ensure that all systems, especially the two CSDs, are regulated in a comparable way.
  - BI should consider including KSEI and KPEI in their oversight scope.
  - Bapepam-LK and BI should agree formally on the cooperation and coordination of their different responsibilities.
  - Recommended action plan: Bapepam-LK and BI should strengthen and formalize cooperation in the market.

### Key recommendations from the Recommended Action Plan (selected)
- Legal risk
  - Include the concepts of netting, finality, and DVP in the legal framework for all types of transactions in line with international definitions.
- Pre-settlement risk and settlement cycle
  - Rolling settlement should be adopted in all securities markets. Final settlement should occur no later than T+3.
  - Investigate whether T+3 should also apply to the stock exchange trades conducted in the negotiated market.
- Central counterparty (CCP) design and risk management
  - The benefits and costs of a central counterparty should be assessed.
  - Where a CCP is introduced, it should rigorously control the risks it assumes.
  - Specific recommended actions for KPEI:
    - Introduce explicit legal provisions for finality and DVP.
    - Improve access criteria so that only the largest, best capitalized securities companies are clearing members of the CCP to improve risk profile.
    - Use historic price movements and historic volatility to calculate margin, taking into account characteristics of different types of securities.
    - Introduce back tests for its margin model.
    - Conduct regular tests to check the adequacy of all its resources in case of default of the clearing member with the largest exposure.
    - Introduce a cap for the replenishment of the guarantee fund by clearing members in case of a loss not covered by the existing guarantee fund.
    - Operationally, implement procedures to avoid data loss and consider a larger distance between the primary and secondary sites.
- Delivery versus Payment (DVP) and principal risk
  - CSDs should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment.
  - To observe this recommendation, DVP should also be appropriately reflected in the legal framework.
- Finality
  - Final settlement should occur no later than the end of the settlement day.
  - The legal framework should explicitly state the moment at which both the securities leg and the cash leg are irrevocable and unconditional.
  - For stock exchange trades, the moment should be specified taking into account that the KPEI account within KSEI is used during the settlement process.

### Authorities’ response
- Authorities’ response to the assessment is recorded in pages 79-80, paragraphs 147-154.

*Source: _cr10288 - 13. Governance arrangements for CSDs and central counterparties (IMF staff assessment).*

### 173.     The shocks in the TD and BU sensitivity analyses are largely identical. Both

### _cr10288 - 173.     The shocks in the TD and BU sensitivity analyses are largely identical. Both

### Sensitivity analysis design and scope
- Both Top-Down (TD) and Bottom-Up (BU) approaches applied the same interest rate and exchange rate shocks to banks’ end-September 2009 balance sheet positions.
- Comparability constrained by inconsistent definitions of exposures or different reporting dates for exposures between the two approaches.
- Key differences in scope:
  - Concentration risk:
    - TD: impact estimated for a collective default of the largest 10 system-wide borrowers.
    - BU: impact estimated for the largest 10 borrowers for each individual bank.
  - Interbank contagion risk and liquidity risk were included only in the TD sensitivity analysis.
- Data and measurement notes:
  - TD interest rate risk (banking book) excluded off-balance sheet items and captured re-pricing risk for loans on a contractual basis rolled-over within the next year, not differentiating floating vs. fixed-rate instruments.
  - BU used the largest exposure for each bank between July–September 2009 for maximum NOP; TD used the largest system-wide exposure as a reference point (July 2009).
  - TD re-pricing limited to residual maturity; BU in some banks used the economic value approach taking into account the entire future cash flow.

### Liquidity shock calibration and mechanics (TD)
- Liquidity shock calibrated on the short-lived episode of liquidity stress experienced during September and October 2008.
- Scenario differentiates daily deposit withdrawal rates by:
  - currency denomination (local vs. foreign currency deposits), and
  - bank size.
- Assumptions:
  - Banks would face restrictions accessing interbank market funding.
  - Banks would face more difficulty liquidating assets viewed as less liquid and lower rated.
  - Haircuts assumed on less liquid assets to simulate losses from unexpected asset liquidation to meet deposit outflows.
- Interbank contagion:
  - TD simulated the failure of each of the largest banks to assess system impact; main contagion channel was interbank exposures.
  - Exposure to withdrawal of international credit lines was not considered given Indonesian banks’ low balance exposure to this risk.

### Key quantitative findings (sensitivity results and vulnerabilities)
- Overall resilience:
  - Sensitivity analysis showed Indonesian banks are relatively resilient to market shocks, explained by:
    - banks’ small proprietary trading positions;
    - tight management of net open foreign currency positions (NOP);
    - use of plain vanilla interest rate and foreign currency hedging instruments;
    - regulatory restrictions on banks’ risk exposure to equities and structured products.
- Interest rate risk (banking book):
  - TD result: a parallel upward interest rate shock would result in 22 banks, accounting for one fourth of the system, falling below BI’s minimum regulatory capital requirement.
  - On average, system CAR falls by 3 percentage points (size-weighted).
  - Private banks more vulnerable than government owned banks to repricing risk because of lower holdings of short-term, liquid assets.
  - BU qualification: none of the largest banks would fall below the minimum capital requirement in BU results; main explanation is BU participating banks included entire maturity structure, better incorporating time-to-repricing risk.
- Interest rate risk (trading book):
  - Banks have limited exposure; no bank falls below the minimum capital requirement.
  - A 20 percent price shock to government bonds reduces the average CAR of the system by 1.7 percentage points.
  - Larger banks more exposed given higher holdings of government securities.
  - Only 6 percent of banks’ portfolio of government securities is held in their trading book.
- Foreign exchange risk:
  - Exposure is negligible; most banks tightly manage their NOP limits.

### Selected numerical levels and impacts reported
- Baseline (pre-shock) CAR (Top-Down table): 17.92
- Pre-shock CAR (Bottom-Up / Top-Down comparison table): 13.1 and 16.2 (reported in table header as pre-shock CAR (end-September 2009))
- Interest rate shock impacts (summary lines):
  - Parallel upward interest rate shock (banking book): average system CAR falls by 3 percentage points (size-weighted); 22 banks fall below BI minimum capital requirement (one fourth of system) in TD.
  - Government bond (SUN) price shock: a 20 percent price shock reduces the average CAR by 1.7 percentage points.
- Concentration risk:
  - TD loss-rate shock on the top 10 largest system-wide borrowers produced severe impacts in table entries (see table for exact worst and average impacts across maturity buckets and scenarios).
- Liquidity episode reference date: September and October 2008 (used for daily withdrawal rate calibration).

### Comparisons and interpretation: TD versus BU
- Main comparability issues:
  - Differences in exposure definitions (system-wide vs bank-specific largest borrowers).
  - TD excluded off-balance sheet items; BU included off-balance sheet items.
  - TD limited repricing to residual contractual maturities up to one year; BU in some banks used economic value approaches that consider entire future cash flows.
  - TD measured NOP exposures at system-wide peak (July 2009); BU used largest bank-specific NOP during July–September 2009.
- Consequence for results:
  - TD produced more adverse capital breaches for some shocks (e.g., parallel upward interest rate shock) than BU, reflecting methodological and data differences rather than necessarily worse underlying solvency.

### Appendix II: policy interventions in response to the global financial crisis (selected measures and dates)
- BI policy rate and reserve requirement actions:
  - BI’s overnight repo rate cut by 200 bps to 10.25 percent and overnight deposit rate increased by 125 bps to 8.50 percent (September 16, 2008).
  - Reserve requirement for foreign currency deposits cut from 3 percent to 1 percent (October 13, 2008) and for rupiah deposits from 9.1 percent average to 7.5 percent (October 24, 2008).
  - BI policy rate lowered by 25 bps to 9.25 percent (December 4, 2008); lowered by 50 bps to 8.75 percent (January 7, 2009).
  - BI policy rate lowered by 50 bps to 8.25 percent (February 4, 2009).
  - BI policy rate lowered in 5 steps of 25 bps to 6.50 percent (April 3, May 5, June 3, July 3, and August 5).
- Deposit insurance and safety nets:
  - Deposit insurance coverage extended from IDR 100 million to IDR 2 billion for both local and foreign currency deposits (October 13, 2008).
  - Issuance of decree-in-lieu-of-law establishing a Financial Safety Net (October 15, 2008); legislation under discussion by parliament.
  - Deposit Insurance Corporation took over Bank Century (November 21, 2008); Deposit Insurance Corporation to handle liquidation process for Bank IFI (April 17, 2009).
- Market and liquidity support:
  - Ban of short-selling, stock market shut down for three days, and trading in Backrie shares suspended (October 8–10, 2008); short-selling allowed again in February 2009.
  - All bond auctions suspended until end-2008; government and BI initiate buy-back program of government bonds (October 2008).
  - Rupiah liquidity injected through repos, expansion of eligible collateral for short-term financing with BI, FX swap facilities expanded (October 13, 2008).
  - Banks allowed to use SBIs and government bonds worth 2.5 percent of their total rupiah deposits as secondary reserves (October 22, 2008).
- Other regulatory and fiscal measures:
  - Revision of mark-to-market valuation requirements on banks’ bond holdings (October 9, 2008).
  - New regulation banning structured currency derivatives products (November 27 and December 17, 2008).
  - Regulation to ease capital requirements on SME loans (February 2, 2009).
  - Agreed with Japan to double the maximum bilateral swap to $12 billion through Chiang Mai Initiative (April 5, 2009). Signed Chiang Mai Initiative Multilateralization agreement with ASEAN +3, establishing a fund of $120 billion for currency swap. Indonesia's quota is $12 billion. (December 28, 2009).

*Source: IMF and BI calculations, end-September 2009 data (as presented in the provided content).*

### Appendix III. Figures and Tables

### Appendix III. Figures and Tables

### Recent Economic Performance (Figure III.1)
- Equity indices and exchange rates
  - MSCI Asia-Pacific excluding Japan; Jakarta Composite Index shown (indices normalized to January 2, 2007 = 100).
- Exchange rate and reserves
  - “The rupiah exchange rate has been rebounding...”
  - “... and foreign exchange reserves are rising, reflecting renewed capital inflows.”
  - Reserves and cumulative portfolio inflows plotted in billions of U.S. dollar.
- External balances and trade
  - “The current account is in surplus, largely reflecting weak imports.”
  - Export value growth y/y and Import value growth y/y shown; CA/GDP (RHS).
- Inflation and interest rates
  - “Inflation has declined substantially partly reflecting lower commodity prices...”
    - Headline, y/y; Core, y/y; Inflation target (CPI Inflation, year-on-year).
  - “...and interest rates have dropped correspondingly.”
    - SBI 1-month; Bank Indonesia rate; JIIBOR O/N (Interest Rates, percent per annum).
- Sources: CEIC Data Co., Ltd.; Bloomberg L.P.; country authorities; and Fund staff calculations.

### Corporate Sector Soundness Indicators (Figures III.2a and III.2b)
- Liquidity and leverage (simple mean, 2000–2008 and 2009 cross-sections)
  - ST debt/total debt and Quick ratio series plotted (2000–2008).
  - Debt to Equity, 2009 (In percent, Simple mean): Philippines; Malaysia; China; Thailand; Emerging Asia; Indonesia; Korea; India (bar ordering shown).
  - Quick ratio and Current ratio, 2009 (Simple Mean) plotted by country.
  - International exposure: Foreign Assets to Total Assets, 2009 (In percent, Simple Mean) with country ordering including China, India, Indonesia, Emerging Asia, Thailand, Malaysia, Philippines, Korea.
- Profitability and coverage
  - Return on assets and Return on equity series (2000–2008).
  - Interest coverage ratio shown (RHS).
  - Profitability: Return on Assets, 2009 (In percent, Simple mean) with country ordering: Korea, Malaysia, Philippines, Indonesia, Emerging Asia, Thailand, China, India.
- Corporate credit conditions and default probabilities
  - Bank credit growth (y/y percentage change) for Large corporates and SMEs (Jan-05 to Jan-09 series).
  - Domestic corporate bonds (traded through Bapepam) — New issuance and Outstanding (RHS) in billions rupiah (Jan-05 to Jan-09 series).
  - Default Probabilities for Corporates (75th percentile, in percent) shown by country: Thailand, Indonesia, Korea, Malaysia, Philippines (Mar-08 to Jun-10 series).
  - Default Probabilities for Banks (75th percentile, in percent) shown by country (Apr-08 to May-10 series).
  - JPMorgan CEMBI Broad Indonesia Blended Yield (Jan-05 to Jun-10 series).
- Sources: CEIC Data Co., Ltd.; Bloomberg L.P.; and Moody KMV.

### Credit Growth and Distribution (Figure III.3)
- Aggregate growth (preliminary figures for end-2009)
  - Asset, Credit, and Deposit Growth (in percent) time series (Dec-05 to Sep-09).
  - Credit Growth by Type (in percent): Working Capital; Investment; Consumer (series Dec-05 to Sep-09).
  - Sector Distribution of Credit, 2008 (in percent): Manufacturing; Trading, restaurants, and hotel; Business Service; Transportation and communications; Agriculture; Construction; Mining; Others.
  - Sector Distribution of Credit, 2009 (in percent) — same sector categories shown for comparison with 2008.
- Loan composition and NPLs
  - Credit Distribution by Business Type (In percent of total loans) for 2002, 2008, 2009: Corporate Loans; SME Loans; Consumer loans.
  - “The share of consumer loans has increased at the expense of the corporate sector...”
  - NPL Share in Loans by Business Type (In percent) for 2002, 2008, 2009: Corporate Loans; SME Loans; Consumer loans.
  - Note: “...but this has not yet resulted in a pick up in NPLs for consumer loans.”
  - “... with the export oriented manufacturing industry most affected.”
- Source: Bank Indonesia, and staff calculations.

### Banking Sector Soundness Indicators, 2002–2009 (Figure III.4)
- Profitability and assets
  - ROAA after tax (In Percent) series (2002–2009): “Profitability edged down in 2008 but picked up in 2009 ...”
  - Net Interest Margin (In Percent of assets, LHS) and Bank Loans (In trln. rupiah, RHS) series (2002–2009): “...due to solid loan growth ..”
- Asset quality and provisions
  - NPL Ratio (In percent of total loans) and Special Mention ratio (In percent of total loans) series (2002–2009): “While declining, the share of problem loans remains high...”
  - Credit Risk Coverage: Credit Risk Coverage in percent of NPL (LHS) and in percent of total loans (RHS) series (2002–2009): “...although reserve coverage against these risks has slightly improved.”
- Capital and liquidity
  - Solvency Indicators (In Percent): CAR; Tier 1 capital; Leverage ratio. Regulatory CAR = 8%.
    - “Capital is well above regulatory requirements...”
  - Liquidity Indicators: Loans as percent of deposits; Liquid assets as percent of short-term liabilities series (2002–2009): “...and banks hold ample liquidity.”
- Source: Bank Indonesia, and staff calculations. (Preliminary figures for end-2009)

### Asset Quality and Risk Coverage by Bank Groups, 2002–2009 (Figure III.5)
- NPL and Special Mention by bank ownership and size
  - NPL Ratio by Bank Ownership (In Percent of Total Loans): Private banks; Government banks; Foreign owned (2002–2009).
  - NPL Ratio by Bank Size (In Percent of Total Loans): Large; Medium; Small (2002–2009).
  - Special Mention Loans by Ownership and by Bank Size (In Percent of Total Loans) (2002–2009).
- Loan loss provisions and coverage (2008–2009 comparisons)
  - Loan Loss Provision to NPL by Bank Ownership (In Percent): Private Banks; Government Banks; Foreign Owned (2008/2009).
  - Loan Loss Provision to NPL by Bank Size (In Percent): Large; Medium; Small (2008/2009).
  - Loan Loss Provision to Distressed Loans by Bank Ownership (In Percent): Private Banks; Government Banks; Foreign Owned (2008/2009).
  - Loan Loss Provision to Distressed Loans by Bank Size (In Percent): Large; Medium; Small (2008/2009).
- Source: Bank Indonesia and staff calculations.

### Bank Solvency Indicators by Bank Groups, 2002–2009 (Figure III.6)
- CAR and leverage by ownership and size
  - CAR Ratio by Bank Ownership (Regulatory Capital in Percent of Risk Weighted Assets): Private Banks; Government Banks; Foreign Owned (2002–2009).
  - CAR Ratio by Bank Size (Regulatory Capital in Percent of Total Assets): Large; Medium; Small (2002–2009).
  - Leverage Ratio by Bank Ownership (In Percent): Foreign Owned; Government Banks; Private Banks (2002–2009).
  - Leverage Ratio by Bank Size (In Percent): Large; Medium; Small (2002–2009).
- Source: Bank Indonesia, and staff calculations. (Preliminary figures for end-2009)

### Structure of Financial System (Table III.1)
- Financial sector assets (in trillions rupiah)
  - Financial Sector Assets: 1,172; 2,172; 2,592; 2,974; 3,060 (years shown across columns).
  - In percent of GDP: 84.4; 65.0; 65.6; 60.0; 56.0.
- Deposit-taking financial institutions (in trillions rupiah)
  - Deposit-taking financial institutions: 1,066; 1,835; 2,147; 2,500; 2,499.
  - Commercial Banks: 1,040; 1,764; 2,065; 2,402; 2,386.
    - Government 2/: ...780; 908; 1,028; 1,086...
    - Private banks: ...411; 485; 237; 569...
    - Foreign-majority owned: ...502; 589; 1,039; 731...
    - Subsidiaries: ...346; 413; 807; 518...
    - Branches of foreign banks: ...156; 176; 232; 213...
  - Rural Banks: 523; 283; 335; 0; 111; 1? (table entries varied).
  - Micro Finance 3/: 214; 85; 46; 67; 82; 11; 11.
  - Cooperatives: 204; 247; 556; 63.
  - State Owned Pawnshops (Branches): 16; 7; 11; 16.
- Non-Bank Financial Institutions (in trillions rupiah)
  - Non-Bank Financial Institutions totals and subcomponents listed (Insurance companies; Mutual Funds; Pension Funds; Finance Companies) with values across years.
- Number of institutions (selected)
  - Commercial Banks: ...130; 130; 124; 121...
  - Rural Banks: 2,419; 1,880; 1,817; 1,772; 1,765.
  - Micro Finance 3/: 103,769; 142,195; 150,903; 157,053; 168,421.
  - Cooperatives: 103,077; 141,326; 149,793; 154,964; 165,155.
  - State Owned Pawnshops (Branches): 692; 869; 1,110; 2,089; 3,266.
- Notes:
  - 1/ As of September 2009
  - 2/ State-owned and regional development banks
  - 3/ Cooperatives and state-owned pawnshops (branches)
- Source: Bank Indonesia; BAPEPAM.

### Core and Encouraged Financial Soundness Indicators (Table III.2)
- Capital adequacy (Consolidated Commercial Banking Sector; In percent or otherwise indicated)
  - Regulatory capital as percent of risk-weighted assets*: 20.9; 20.9; 18.8; 19.9; 20.6; 19.2; 17.0; 17.6 (2002–2009 **).
  - Regulatory Tier I capital to risk weighted assets*: 16.4; 16.3; 14.5; 16.3; 17.1; 16.4; 15.4; 15.9.
  - Capital as percent of assets*: 8.4; 9.5; 10.3; 9.8; 10.2; 10.1; 9.2; 10.3.
- Asset composition
  - Risk weighted assets to total assets: 41.7; 46.4; 52.8; 56.5; 53.0; 56.6; 62.0; 60.7.
  - Total loans to total assets: 33.4; 38.4; 40.4; 47.3; 46.8; 50.5; 56.8; 56.7.
  - Government claims in percent of total assets: 33.9; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0; 0.0.
- Sectoral distribution of bank corporate credit (as percent of total loan exposure)*
  - Mining: 8.7; 9.1; 10.1; 10.1; 10.3; 10.1; 9.4; 11.6.
  - Manufacturing: 2.4; 2.6; 3.1; 2.3; 4.8; 6.9; 5.8; 6.2.
  - Electricity, gas, and water: 50.4; 44.3; 43.6; 43.7; 42.7; 36.6; 35.7; 31.9.
  - Construction: 2.7; 2.5; 3.1; 2.5; 2.3; 2.1; 4.2; 4.6.
  - Trading, restaurants, and hotel: 2.9; 3.8; 5.7; 7.3; 7.0; 6.7; 6.1; 5.9.
  - Transportation, warehousing, and communications: 10.2; 11.3; 16.4; 14.8; 15.0; 17.7; 17.0; 17.7.
  - Business Service: 5.3; 6.1; 4.8; 3.8; 5.7; 7.8; 10.0; 11.4.
  - Social Community Services: 7.4; 8.6; 8.4; 9.0; 8.6; 9.4; 10.2; 8.8.
  - Others: 0.9; 5.1; 1.0; 1.3; 1.8; 1.3; 0.7; 0.7.
- Distribution by user (as percent of total loans)
  - Corporate: 54.8; 51.3; 49.6; 46.6; 45.9; 47.4; 49.1; 46.2.
  - SME: 23.6; 23.4; 23.4; 23.6; 25.5; 24.4; 22.8; 23.4.
  - Consumer loans: 21.6; 25.3; 26.9; 29.7; 28.6; 28.2; 28.1; 30.4.
    - Of which mortgage lending: 2.9; 4.7; 5.4; 6.6; 7.7; 7.8; 7.8; 8.0.
- Asset quality
  - Non-performing loans (NPL) as percent of gross loans*: 7.6; 6.8; 4.4; 7.4; 6.0; 4.1; 3.2; 3.3.
  - Special Mention as percent of total loans: 11.6; 10.3; 8.9; 8.7; 8.2; 6.3; 5.8; 5.7.
  - Restructured loans as percent of total loans: 3.5; 2.5; 5.5; 3.7; 3.2; 2.8; 1.9; 3.2.
  - Foreclosed assets as percent of total assets: 0.6; 0.6; 0.5; 0.5; 0.4; 0.2; 0.2; 0.2.
  - Write-offs as percent of total loans: 535.2; 49.2; 244.8; 924.4; 924.9; 3312.4; 229.0; 200.1 (table values as presented).
  - NPL net of provisions as percent of tier I capital*: 18.4; 16.0; 13.4; 23.4; 15.6; 8.9; 8.0; 7.4.
  - Loan loss provision to NPL: 50.9; 53.0; 47.2; 38.1; 49.1; 59.8; 58.5; 62.0.
  - Total provision to gross loans: 6.0; 5.3; 3.9; 4.3; 4.1; 3.8; 3.3; 3.8.
- Earnings and profitability
  - Net profits as percent of average assets (ROA, before tax)*: 2.1; 2.2; 2.7; 2.5; 2.6; 2.8; 2.3; 2.6.
  - Net profits as percent of average assets (ROA, after tax)*: 1.1; 1.5; 1.7; 1.7; 1.8; 1.9; 1.5; 1.8.
  - Net profits as percent of average equity capital (ROE, after tax)*: 16.2; 18.8; 21.1; 21.4; 22.4; 23.2; 15.5; 18.4.
  - Net interest margin (net interest income as percent of earnings assets)*: n.a.; 97.2; 5.9; 5.7; 6.0; 5.1; 3.9; 4.7 (table entries as presented).
  - Net interest income as percent of gross income: 26.5; 33.6; 44.5; 39.9; 39.2; 43.6; 43.3; 43.3.
  - Non-interest income as percent of gross income: 3.7; 2.4; 2.9; 2.7; 2.8; 2.6; 2.8; 3.1.
  - Trading and foreign exchange income as a percent of gross income*: 2.9; 1.0; 1.7; 1.7; 0.9; 1.0; 2.5; 2.1.
  - Non-interest expenses as percent of gross income*: 24.1; 26.4; 34.0; 32.7; 30.2; 33.2; 33.2; 32.6.
  - Non-interest expenses as percent of average assets*: 3.6; 3.5; 4.3; 4.3; 4.2; 4.0; 4.2; 4.1.
  - Provisioning costs in percent of gross income*: 14.7; 10.8; 9.6; 11.3; 12.1; 11.5; 15.6; 15.5.
  - Staff costs as percent of non-interest expenses*: 32.3; 38.0; 36.6; 39.3; 40.2; 42.8; 41.3; 40.9.
- Structural indicators
  - Number of employees: 190,763; 193,860; 202,436; 215,006; 228,581; 1,915,668; 276,594; 289,847.
  - Number of branches: 2,507; 2,452; 2,489; 2,494; 2,589; 2,688; 2,814; 2,982.
- Liquidity and FX exposure
  - Liquid assets as percent of total assets*: 25.5; 26.2; 25.4; 26.7; 31.5; 30.1; 25.8; 28.6.
  - Liquid assets as percent of short-term liabilities*: 30.2; 31.1; 30.3; 31.5; 37.4; 35.6; 30.8; 33.9.
  - Foreign currency loans as percent of total loans*: 26.6; 22.6; 21.7; 18.7; 19.4; 20.9; 19.4; 14.6.
  - Foreign currency liabilities as percent of total liabilities*: n.a.; n.a.; n.a.; 20.0; 17.2; 18.4; 19.9; 17.8.
  - Deposits as percent of total liabilities: n.a.; n.a.; n.a.; 85.1; 84.7; 84.8; 83.9; 86.8.
  - Loans as percent of deposits*: n.a.; n.a.; 49.6; 58.1; 61.5; 61.6; 66.3; 74.6; 72.9 (table entries as presented).
  - FX loans-to-FX deposits: n.a.; n.a.; n.a.; 65.6; 79.4; 92.8; 86.5; 66.1.
- Sensitivity to market risk
  - Gross liability position exposed to market risk (in percent of tier I capital*) values across years: n.a.; n.a.; n.a.; n.a.; 4.0; 3.2; 2.4; 12.1; 3.6 (table entries as presented).
  - Gross asset position exposed to market risk (in percent of tier 1 capital*): n.a.; n.a.; n.a.; n.a.; 3.6; 2.3; 2.1; 12.2; 2.6.
- Source: Bank Indonesia, and staff calculations.
  - * Core FSI
  - ** Preliminary figures for 2009

### Capital Market (Table III.3; Figures III.7–III.8)
- Equities (2005–2009)
  - Total market capitalization (IDR trillion): 80; 1,1249; 1,988; 1,076; 2,019 (table formatting as presented).
  - In percent of GDP: 28.8; 37.4; 50.2; 21.7; 36.0.
  - Average daily trading volume (million shares): 1,654; 1,806; 4,226; 3,216; 6,090.
  - Average daily trading value (IDR billion): 1,671; 1,842; 4,269; 4,345; 4,046.
  - Number of listed companies: 336; 344; 383; 396; 398.
- Warrants
  - Number and Value (IDR trillion) series shown with values including 85; 55; 5,423; 11,284; 2,088; 2,363 (table entries as presented).
- Over-the-counter markets - corporate bonds
  - Total corporate bond outstanding listed on IDX (IDR billion): 62,891; 67,806; 84,553; 72,979; 88,452.
  - In percent of GDP: 2.3; 2.0; 2.1; 1.5; 1.6.
- New offers and IPOs (counts and values)
  - Number of new offers — Equity IPO and Bond Offering (including IPO and other seasonal offering) listed across years (values presented in table).
  - Value of new offers (IDR billion) — Equity IPO: 3,520; 3,014; 17,182; 23,484; 3,854.
  - Value of new offers (IDR billion) — Bond Offering (including IPO and other seasonal offering): 8,185; 11,450; 31,275; 14,100; 27,215.
- Investors (based on the KSEI sub-accounts)
  - Equity market share of retail investors (% total value): 5; 6; 7 (table entries).
  - Equity foreign ownership (% total value): 66; 68; 67 (table entries).
  - Corporate bonds market share of retail investors (% total value): 1; 1; 1.
  - Corporate bonds foreign ownership (% total value): 5; 4; 3.
- Government securities (SUN)
  - Total nominal value of traded government securities (IDR trillion): 400; 419; 478; 521; 582.
  - In percent of GDP: 14.4; 12.5; 12.2; 10.5; 10.4.
  - Share of foreign holding: 7.8; 13.1; 16.4; 16.7; 18.6.
- BI Certificates (SBI)
  - Total and Share of foreign holding values: SBI totals and foreign holding share presented (e.g., Share of foreign holding: 19.8; 8.7; 11.4; 4.8; 17.3).
- Sources: BAPEPAM, IDX, and BI.
- Capital market development series (Figure III.7)
  - Time series in trillions Rupiah: Corporate Bonds; Government Bonds; Equities; Composite index (RHS) (Jan-03 to Jan-10).
- Equity market metrics (Figure III.8)
  - Stock Market Capitalization: In percent of GDP and In trillion Rp (2002–2009 series).
  - Returns in Selected Emerging Stock Markets, 2009: Average return in $ and in local currency for listed countries including Indonesia.
  - Income and Capitalization of Selected Emerging Markets, 2009: Market Capitalization in Percent of GDP plotted against Per Capita GDP ($).
  - Stock Capitalization in Selected Emerging Markets, 2009 (In percent of GDP) — country bars presented.
- Sources: CEIC database; World Federation of Exchanges; and IMF, World Economic Outlook database.

*Source: _cr10288 - Appendix III. Figures and Tables (figures and tables extracted from the provided PDF content)._

### 177.     The improvement and amendments to the general legal framework governing

### _cr10288 - 177.     The improvement and amendments to the general legal framework governing

### Overview
- The legal system is based on Roman-Dutch law, custom, and Islamic law and "has undergone substantial improvement since 1998."
- Financial system related laws and subsidiary legislation "are being continuously amended and updated to meet new demands from a growing financial sector."
- Despite improvements, "the legal framework underpinning supervision and regulation could benefit from strengthening in a number of important areas."

### Main areas for improvement and findings
- Protection of supervisors
  - The BI Law states that supervisors cannot be punished for any decisions taken "in good faith."
  - The proof of "good faith" is described as "so onerous that it nullifies the protection in practice."
  - "BI as an institution is not protected."
  - For Bapepam-LK, the law is "narrower in protection, has no indemnity for cost and adds additional penalty for mala fide actions."
  - Conclusion: "The current defects in the laws need to be rectified to ensure protection of regulators."
- Ambiguity, overlaps, discretion, and gaps in financial sector laws
  - Recommendation: "The Banking Law should be reviewed in its entirety to provide comprehensive provisions, clear triggers, minimum criteria, and procedures to ensure predictability and consistency."
  - Gaps in the Capital Market Law include lack of "express power to impose fines and ability to enter into MOUs."
- Weak contract enforcement and judicial performance
  - According to the Doing Business Indicator for 2010, Indonesia ranks "146" globally in contract enforcement.
  - Regional peers cited: Thailand "24", Malaysia "59", and the Philippines "118".
  - "The cost of contract enforcement [is] two and a half times the regional average."
  - Recovery rate on unsecured credits to large and connected borrowers is "less than 15 percent."
  - Banks reflect these costs in higher lending rates.
  - Policy implication: "Comprehensive reform is required to improve the performance and credibility of the judicial system."
- Limited registration and corporate information outside Jakarta
  - "Up to 95 percent of businesses outside Jakarta are not formally registered and therefore do not file annual basic information."
  - Only listed companies and public companies fall under Bapepam-LK’s jurisdiction and must adhere to corporate governance requirements.
  - Result: Banks have limited information on unlisted companies, making it difficult to identify related parties and adding to the cost of funds.
  - Suggested measures: "More stringent accounting and auditing standards, along with an improved Debtor Information System, would help ensure sound credit underwriting."
- Bankruptcy law and insolvency framework shortcomings
  - "The Bankruptcy law is infrequently used for rehabilitation and is not a credible exit mechanism for inefficient and insolvent companies."
  - Banks prefer out-of-court negotiation and loan restructuring, which "although leading to less efficient outcomes, is preferred to court supervised rehabilitation."
  - Recommendation: "A comprehensive assessment of insolvency and creditors’ rights assessment (ICR ROSC) is needed to identify the problems affecting the rehabilitation and insolvency system and the steps to address them."

### Relevant legal instruments referenced
- Bank Indonesia Law (BI Law), No. 3/2004
- Bankruptcy Law 34/2004
- new Limited Liability Companies Act 40/2007
- Eradicating Criminal Acts of Corruption Law 31/1999
- Eradicating Money Laundering Law 15/2002
- Establishment of the Commission for Eradication of Corruption (KPK) Law 30/2002

*Source: IMF staff content unit _cr10288 - 177.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10288.pdf_