## _cr12335 — FINANCIAL SECTOR ASSESSMENT PROGRAM: BASEL CORE PRINCIPLES ASSESSMENT (DECEMBER 2010) — Selected Findings and Recommendations

## Source details

**Canonical URL:** [_cr12335 — FINANCIAL SECTOR ASSESSMENT PROGRAM: BASEL CORE PRINCIPLES ASSESSMENT (DECEMBER 2010) — Selected Findings and Recommendations](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12335.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12335.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12335.pdf.json)

---

### I. Summary, scope, and methodology
- Assessment focus: compliance with the Basel Core Principles for Effective Banking Supervision (BCP).
- Mission dates: conducted within the FSAP framework between September 29 and October 16, 2009.
- Assessment team: Damodaran Krishnamurti (World Bank) and William Ryback (IMF).
- Methodology: October 2006 Core Principles Methodology (BCBS); team limited work to study of the essential criteria by agreement with BI.
- Coverage: confined to regulation and supervision as applicable to commercial banks (small shares of sharia and rural banks).

### II. Financial sector structure and macroeconomic context
- Banking sector concentration and composition:
  - Banking sector accounts for about 80 percent of financial sector assets.
  - Market share (assets) by sector (BI Financial Stability Review No.13, September 2009):
    - Commercial Banks 79.5
    - Rural Banks 1.1
    - Insurance Companies 8.8
    - Pension Funds 3.1
    - Finance Companies 4.4
    - Securities Companies 2.7
    - Pawn Shops 0.4
  - At end-September 2009:
    - 121 commercial banks (98.6 percent market share) and 1,765 rural banks (1.4 percent market share) under BI supervision.
    - Commercial bank counts and market shares:
      - State owned banks (including regional government banks): 30 banks; 45.2 percent market share.
      - Foreign banks (including 10 foreign bank branches, joint venture banks and significantly foreign owned local banks): 42 banks; 30.0 percent market share.
      - Private banks: 44; 23.0 percent market share.
      - Sharia banks: 5; 1.8 percent market share.
      - Rural banks: 1,765; 1.4 percent market share.
    - Concentration: Fourteen major banks account for about 70 percent market share; Top 5 banks account for about 50 percent market share.
  - Total assets of commercial banks in September 2009: IDR 2,386 trillion (approximately USD 239 billion).
- Selected macro and banking performance figures:
  - GDP growth: 2007 growth: 6.3 percent; 2008 growth: 6.1 percent; BI projected 2009 growth to drop to around 4.0% with downside risk.
  - External sector 2008: Exports growth: 9.5 percent; Imports growth: 10.0 percent; Balance of payments deficit: USD 5.3 billion (2008 estimate); Current account surplus: USD 0.1 billion (2008 estimate).
  - International reserves end-December 2008: USD 51.6 billion (equivalent to 4.0 months of imports and servicing of official debt).
  - Rupiah depreciation: fell 15.5 percent after mid-September 2008; average 2008 depreciation: 5.4 percent vis-à-vis the US Dollar.
  - Bank funding and asset deployment (2008): deposits 78 percent of liabilities; shareholder funds 10 percent; dues to banks and BI 6 percent. Asset deployment: credit 57 percent of assets; BI 13 percent; government securities 13 percent; cash and bank balances 13 percent.
- Banking sector indicators (selected values, preserved verbatim):
  - Total assets (IDR Trillion): Dec 2007 1,987; Dec 2008 2,311; Sep 2009 2,386.
  - Total assets as percent of GDP: Dec 2007 50.3; Dec 2008 46.6; Sep 2009 ..
  - Capital adequacy ratio: Dec 2007 19.3; Dec 2008 16.2; Sep 2009 17.9.
  - Gross NPL ratio: Dec 2007 4.6; Dec 2008 3.8; Sep 2009 3.9.
  - Net NPL ratio: Dec 2007 1.9; Dec 2008 1.5; Sep 2009 1.7.
  - Credit growth (%): Dec 2007 26.5; Dec 2008 30.5; Sep 2009 4.4.
  - Loan to Deposit ratio: Dec 2007 69.2; Dec 2008 77.2; Sep 2009 73.6.
  - Liquid assets (as percent of total deposits): Dec 2007 30.1; Dec 2008 25.8; Sep 2009 26.1.
  - NIM: Dec 2007 5.7; Dec 2008 5.4; Sep 2009 5.4.
  - ROA: Dec 2007 2.8; Dec 2008 2.3; Sep 2009 2.6.

### III. Supervisory organization and operations (Bank Indonesia)
- BI internal supervisory structure:
  - Eight Directorates dealing with the banking system: commercial bank regulation and licensing (2 Directorates); supervision and investigation (4 Directorates); regulation and supervision of Islamic banks and rural banks (2 Directorates). They report to the Board of Governors through three Deputy Governors.
- Instruments and oversight:
  - BI monetary policy and liquidity instruments include open market operations, statutory reserve requirements, regulations for credit/financing, and ability to operate monetary instruments on Sharia principles.
  - BI maintains a real time gross settlement system and a standard clearing process for payment and settlement.
  - BI set up a Debtor Information System (SID) in June 2006 with mandatory bank participation; participation: all 121 commercial banks; 576 of the 1765 rural banks with assets of more than IDR 10 billion (1200 of the 3454 rural offices); seven finance companies.

### IV. Legal, institutional, and coordination frameworks
- Legal mandates:
  - Banking Act: Act Number 7 of 1992 as amended by Act Number 10 of 1998.
  - BI Act: Act Number 23 of 1999 as amended by Act Number 3 of 2004.
  - BI Act requires annual disclosure to the public along with intended goals and financial reporting; BI’s operational budget requires parliamentary approval.
- Institutional roles:
  - BI: authority to regulate and supervise the banking sector.
  - Bapepam-LK: regulates and supervises leasing and finance companies, insurance companies, pension funds, securities companies.
  - Indonesia Deposit Insurance Corporation (IDIC/LPS): insures customer deposits and resolves failed banks. LPS Law of 2004 established a Coordination Committee (MOF, BI, LPS).
- Crisis management and coordination:
  - June 2007 joint decree established the Financial System Stability Forum (FSSK) for technical cooperation among MOF, BI, LPS.
  - October 2008 Presidential Ordinance established the Financial System Stability Committee (Minister of Finance Chairperson; BI Governor Member); ordinance later lapsed. Draft Financial System Safety Net (FSSN) Law was rejected by Parliament; pending passage the Coordination Committee under the LPS law serves as mechanism for cooperation.
- Information sharing and legal protection weaknesses:
  - Lack of formal/informal gateways for information exchange with domestic and foreign supervisors impedes BI’s ability to discharge responsibilities.
  - Article 45 of the BI Act provides protection for supervisory staff when acting in “good faith” but does not include presumption of good faith, omissions, nor protect BI as a supervisory authority — assessed as a serious deficiency.

### V. Accounting, auditing, and disclosure — identified weaknesses
- Institutional bodies:
  - Indonesian Institute of Accountants (IAI); Indonesian Institute of Public Accountants (IAPI); DSAK (Indonesian Financial Accounting Standards Board).
- ROSC findings on PSAKs:
  - "23 PSAK are uniquely local standards with no counterpart in IFRS;"
  - "8 PSAK have no gaps with IFRS;"
  - "19 PSAK have minor gaps with IFRS;"
  - "2 PSAK have moderate gaps with IFRS."
- Audit and ethics standard convergence:
  - IAPI intended to converge local auditing standards with ISA by 2011; no practical arrangement yet in place.
- Practical deficiencies and implications:
  - Internationally comparable accounting and reporting requirements for financial instruments are not being implemented, causing reported results and financial condition of banks to tend to be distorted.
  - Review revealed gaps in compliance with PSAKs: segment information; related party transactions; consolidated financial statements; employee benefits; derivative transactions.
  - Instances of auditors yielding to undue management pressure; no proactive mechanism to ensure compliance with the code of ethics.
  - Of more than 400 accounting firms, only "6 to 8 firms appear to have a very high level of compliance with the applicable auditing standards."
  - Small and medium-size audit practices lack resources to implement audit quality control arrangements.
- Assessment grading and implications:
  - Principle 22 — Accounting and disclosure: Grading: LC.
  - Recommendation: BI should focus supervisory resources to ensure banks’ financial statements reflect true performance/position and develop a process for stringent quality assurance review of bank audits and auditors.
  - Monitor closely the implementation of IAS 32 and 39 equivalents in 2010-11.

### VI. Anti–money laundering / Countering financing of terrorism (AML/CFT) and abuse of financial services
- APG 2008 mutual evaluation:
  - Indonesia made significant progress in AML measures but relatively little implementation of CFT measures.
  - Significant money laundering (ML) and very significant terrorism and terrorist financing (TF) risks exist.
- Supervisory practice and responsibilities:
  - Banks file suspicious transaction reports with PPATK; supervisors assess KYC and AML controls at least annually (management oversight; policies; internal controls; MIS; training).
  - BI examiners verify compliance via regular reporting and on-site verification; at least once a year banks are subject to an on-site inspection.
  - Core Principle 18 — Abuse of financial services: Grading: LC.
- Remaining gaps:
  - Major deficiencies in identification and verification of beneficial owners.
  - Lack of comprehensive controls or oversight over wire transfers.
  - BI has begun addressing some APG 2008 gaps through revised regulations.

### VII. Risk management, capital adequacy, and prudential framework
- Capital regime and implementation gaps:
  - Minimum capital requirement: at least 8 percent of total risk weighted assets, both at solo and consolidated levels (Basel I methodology).
  - Minimum Tier 1 capital requirement is 5 percent; maximum innovative Tier 1 capital is 10 percent of Tier 1 capital.
  - BI allows recognition of 50 percent of current year’s profit as Tier 1 capital (after adjustments).
  - BI encourages top 14 banks to maintain a minimum CAR of 12 percent via suasion.
  - Full implementation of Basel II is expected from January 2014 (Pillar 1 from 2011, Pillar 2 2012–2014, Pillar 3 2011–2014 noted in context).
  - Finding: capital definition more liberal and dilution in some risk weights create weaknesses needing strengthening.
- Risk management process (Principle 7) — key findings:
  - BI prescriptions cover credit, market, operational, liquidity, legal, strategic, reputational, and compliance risks.
  - BI has not yet issued regulations on interest rate risk in the banking book (IRRBB) and on country / transfer risk.
  - Banks largely do not use internal methodologies for assessing overall capital adequacy relative to their risk profile; limited capacity to validate internal models.
  - Assessment: Largely Compliant for Principle 7, but supervisory capacity and regulatory guidance need enhancement.
- Credit risk and problem assets (Principles 8–9) — summary:
  - Regulations require Board-approved policies, asset grading, quarterly reviews, and supervisory access.
  - Weaknesses exist in large exposures, related party exposures, asset classification and provisioning, and country risk.
  - Asset classification/provisioning norms show weaknesses that could lead to understatement of NPLs, under provisioning, and overstatement of income with implications for capital adequacy — these need immediate remediation.
- Liquidity and market risk (Principles 13–14):
  - Revised liquidity guidelines became operational on October 30, 2009 to align with BCBS Principles for Sound Liquidity Risk Management and Supervision (September 2008).
  - Shortcomings: standards/benchmarks for slotting asset/liability items hamper aggregation and inter-bank comparison; banks not explicitly required to manage liquidity currency-wise or to inform BI when contingency funding plans are triggered.
  - Market risk capital charge applies only to banks meeting thresholds; capital requirements for market risk apply to banks with total asset base above IDR 1 trillion and trading book size above IDR 25 billion.
- Interest rate risk in banking book (IRRBB) and internal audit (Principles 16–17):
  - Regulations do not explicitly cover IRRBB; supervisors do not adequately focus on it.
  - Regulations require BoC and BoD oversight, independent internal audit and compliance functions, but do not explicitly require a risk–based audit framework; BI does not assess internal control as a separate function in its entirety.

### VIII. Asset classification, provisioning, and supervisory treatment (detailed)
- Earning asset classification framework (the “Three Pillars”):
  - All earning assets (except small exposures allowed under delinquency-only rules) classified by assessment of: business prospects; obligor performance; payment capacity.
  - Five classifications with delinquency periods and provisioning requirements (preserved verbatim):
    - Current — Delinquency period: -; Provisioning requirement: 1%
    - Special mentioned — Delinquency period: 1 to 90 days; Provisioning requirement: 5%
    - Substandard — Delinquency period: > 90 to 120 days; Provisioning requirement: 15%
    - Doubtful — Delinquency period: > 120 to 180 days; Provisioning requirement: 50%
    - Loss — Delinquency period: > 180 days; Provisioning requirement: 100%
  - Collateral haircuts between 30-70 percent depending on type/time since valuation.
- Exemptions and thresholds:
  - Exposures up to IDR 10 billion (USD 1 million) exempt from uniform one-obligor classification; BI Regulation No 11/2/PBI/2009 allows certain banks meeting criteria to apply delinquency-only criteria for credit exposures up to IDR 20 billion (USD 2 million).
  - Prior to 2005, one-obligor concept applied within bank only; since 2005, extended across banks (system-wide one obligor concept).
- Restructured debt and upgrading:
  - All restructured debt requires calculation of NPV loss using original effective interest rate and provisioning at restructuring.
  - Restructured debt shall be classified no higher than substandard for loans in a more severe category prior to restructuring; immediate upgrading of restructured NPLs is permitted after 3 consecutive payments under revised terms.
- Identified weaknesses with material implications:
  - Lighter classification and provisioning for temporary equity participation and foreclosed collateral; immediate upgrading rules enable restructured NPLs to be classified as “current” relatively quickly.
  - System-level provisions for NPLs were about 60 percent of NPLs at end-September 2009.
  - Relaxations (raising exemption thresholds to USD 1 million and USD 2 million for certain banks) have weakened regulatory framework.
  - Banks tend to maintain provisions close to regulatory minimums; Boards of Commissioners do not evidently actively manage problem asset portfolios.
- Supervisory powers and practice:
  - BI can require modification of reported adversely classified assets, require increased provisions, and take remedial supervisory actions; on-site verification and off-site reporting (monthly/quarterly) used to monitor compliance.

### IX. Main supervisory shortcomings, compliance grading, and recommended priority actions
- Key supervisory shortcomings:
  - Legal protection for supervisory staff: Article 45 deficiencies create heavy burden of proof and lack institutional protection for BI — graded Materially non-compliant for legal protection (Principle 1(5)).
  - Information sharing and cooperation gaps: lack of formal arrangements with domestic and foreign supervisors — graded Materially non-compliant for cooperation (Principle 1(6)).
  - Accounting/auditing weaknesses affecting disclosure and comparability — Principle 22 graded LC.
  - Gaps in coverage and supervisory focus on IRRBB, country/transfer risk, operational risk elements (outsourcing, business continuity), and consolidated scope exclusions.
- Selected compliance gradings (examples preserved verbatim):
  - Principle 1 assessments: Responsibilities and objectives — Compliant; Independence, accountability and transparency — Compliant; Legal protection — Materially non-compliant; Cooperation — Materially non-compliant.
  - Principle 2 Permissible activities — Compliant.
  - Principle 3 Licensing criteria — Largely Compliant.
  - Principle 6 Capital adequacy — Largely compliant.
  - Aggregate peer grading across Core Principles (context): Compliant (C) – 6; Largely compliant (LC) – 18; Materially noncompliant (MNC) – 4; Noncompliant (NC) – 2; Not applicable (N/A) – nil.
- Priority policy recommendations (selected, preserved wording and numeric thresholds where given):
  - Urgently amend the BI Act to:
    - Explicitly state a presumption of good faith in favor of supervisory staff.
    - Protect supervisory staff from omissions and all costs for defending their actions.
    - Grant legal protection to BI as a supervisory authority.
  - Strengthen information exchange arrangements:
    - Put in place effective information exchange arrangements with other domestic financial sector supervisors and with foreign supervisors.
    - Consider formal cooperation and information sharing arrangements with systemically relevant foreign institutions.
  - Capital and risk framework:
    - BI should initiate remedial measures to ensure the capital adequacy framework is consistent with the Basel I framework until full Basel II implementation is effective (Full implementation of Basel II is expected from January 2014).
    - BI may consider formally requiring systemically relevant banks and banking groups to maintain capital above the minimum prescribed in the Basel framework (example: BI encourages top 14 banks to maintain CAR of 12 percent).
    - Require banks to adopt a forward looking approach and factor stress test outcomes into capital management.
  - Asset classification and provisioning:
    - Review asset classification and provisioning norms to ensure adequate identification, management, and provisioning across the banking system.
    - Consider requiring a longer time frame than three payments before permitting upgrading restructured accounts to ‘current’.
    - Require banks to factor collateral and creditor rights enforcement weaknesses when estimating provisioning needs and consider higher provisioning or stricter haircuts where recovery prospects are weak.
  - Accounting and audit quality:
    - BI should develop a process for a stringent quality assurance review of bank audits and auditors.
    - Monitor closely the implementation of IAS 32 and IAS 39 equivalents in 2010-11.
  - Consolidated and foreign oversight:
    - Identify systemically relevant foreign institutions operating in Indonesia and consider the need to enter into formal cooperation and information sharing arrangements; consider remedial powers (e.g., ring-fencing local capital) when home-host information is insufficient.
  - Supervisory capacity and coverage:
    - Issue regulations and guidance on IRRBB and country/transfer risk; strengthen liquidity currency-wise management requirements and reporting when contingency funding plans are triggered.
    - Strengthen supervisory assessment of internal control functions and require a risk-based audit framework in banks.
  - AML/CFT:
    - Address APG 2008 gaps including beneficial ownership identification and oversight of wire transfers; continue implementation of revised regulations.

### X. Authorities’ response — summary points
- Republic of Indonesia broadly concurs with assessment and plans to utilize assessment as blueprint to enhance legislative, regulatory, and supervisory framework.
- Accounting standards: trend of convergence toward international accounting standards; authorities state by 2012 all remaining gaps will be closed (authorities’ view preserved as reported).
- BI has secured a seat within Indonesia’s accounting standards setting body and uses position to voice concerns; strengthening auditor competency ongoing (authorized auditors list; external audit firm rotation beyond a certain period).
- Legal/creditor rights: authorities acknowledge shortcomings and have imposed prudential measures (loss buffers ignoring collateral value for performing loans; significant haircuts 30 percent up to 100 percent for collateral; minimum regulatory standard measured against “time value” concept; prerequisites for valid collateral).
- Information exchange: BI recently signed MOUs with other domestic regulatory authorities; further efforts needed with foreign supervisors.

*Source: FINANCIAL SECTOR ASSESSMENT PROGRAM — BASEL CORE PRINCIPLES ASSESSMENT: DETAILED ASSESSMENT OF COMPLIANCE, DECEMBER 2010 (IMF staff report excerpt as provided).*

### 2010. The views expressed in this document are those of the staff team and do not necessarily reflect

### FINANCIAL SECTOR ASSESSMENT PROGRAM INDONESIA BASEL CORE PRINCIPLES ASSESSMENT DETAILED ASSESSMENT OF COMPLIANCE DECEMBER 2010

### I. Summary — Introduction and Scope
- Assessment focused on compliance with the Basel Core Principles for Effective Banking Supervision (BCP).
- Conducted within the FSAP framework between September 29 and October 16, 2009.
- Assessment team: Damodaran Krishnamurti (World Bank) and William Ryback (IMF).
- Methodology: October 2006 Core Principles Methodology (BCBS), with team limiting work to study of the essential criteria by agreement with BI.
- Coverage: confined to regulation and supervision as applicable to commercial banks, given small shares of sharia and rural banks.

### II. Information and Methodology Used
- Bank Indonesia (BI) performed a self-assessment and responded to a pre-mission questionnaire on banking supervision.
- Documents and inputs relied on:
  - Laws and regulations governing BI and banking activity in Indonesia.
  - Findings of the ROSC on Accounting and Auditing (2009).
  - Asia / Pacific Group on Money Laundering (APG) 2nd Mutual Evaluation Report (July 2008) on AML / CFT compliance.
- Stakeholders met: senior BI officials (licensing, regulation, supervision), senior officials of six selected banks, Indonesian bankers’ association, FITCH ratings, Ernst & Young, PPATK (Indonesian FIU).
- Assessment confined to commercial banks due to relative market shares.

### III. Institutional and Macro-economic Framework — Overview
- Financial sector composition:
  - Banking sector accounts for about 80 percent of financial sector assets.
  - Other players: insurance, pension funds, finance companies, securities companies, pawn shops — smaller shares.
- Legal mandates for BI derived from:
  - Act of the Republic of Indonesia Number 7 of 1992 concerning Banking, as amended by Act Number 10 of 1998 (Banking Act).
  - Act of the Republic of Indonesia Number 23 of 1999 concerning Bank Indonesia (BI Act), as amended by Act Number 3 of 2004.
- BI independence and reporting:
  - BI Act requires annual disclosure to the public along with intended goals and financial reporting.
  - BI’s operational budget requires parliamentary approval but does not appear to constrain regulatory or supervisory functions.
  - BI has sufficient powers to ensure compliance with laws, regulations, prudential standards, and guidelines.
- Institutional roles:
  - BI: authority to regulate and supervise the banking sector.
  - Bapepam-LK: regulates and supervises leasing and finance companies, insurance companies, pension funds, securities companies.
  - Indonesia Deposit Insurance Corporation (IDIC/LPS): insures customer deposits and carries out resolution of failed banks.
  - 2004 amendment to BI Act envisaged establishment of a supervisory board by December 31, 2010 to supervise banks and other financial services companies; details unclear, so assessment confined to existing bank supervisory framework.

### IV. Structure of the Banking Market (selected metrics and composition)
- Market share (assets) by sector (source: BI's Financial Stability Review No.13, September 2009):
  - Commercial Banks 79.5
  - Rural Banks 1.1
  - Insurance Companies 8.8
  - Pension Funds 3.1
  - Finance Companies 4.4
  - Securities Companies 2.7
  - Pawn Shops 0.4
- At end-September 2009:
  - 121 commercial banks (98.6 percent market share) and 1,765 rural banks (1.4 percent market share) under BI supervision.
  - Commercial banks composition:
    - 4 state banks, 26 regional government banks, 86 private banks (including 16 joint venture banks, 16 significantly foreign owned local banks, and branches of 10 foreign banks), and 5 Sharia banks.
  - Market shares:
    - State owned banks (including regional government banks): 30 banks; 45.2 percent market share.
    - Foreign banks (including 10 foreign bank branches, joint venture banks and significantly foreign owned local banks): 42 banks; 30.0 percent market share.
    - Private banks: 44; 23.0 percent market share.
    - Sharia banks: 5; 1.8 percent market share.
    - Rural banks: 1,765; 1.4 percent market share.
  - Concentration:
    - Fourteen major banks account for about 70 percent market share.
    - Top 5 banks account for about 50 percent market share.
  - Sharia banks: about 2 percent of banking industry assets.

### V. Macroeconomic Context and Recent Performance (selected figures)
- Economic growth:
  - 2007 growth: 6.3 percent.
  - 2008 growth: 6.1 percent.
  - BI projected 2009 growth to drop to around 4.0% with downside risk.
- External sector 2008:
  - Exports growth: 9.5 percent.
  - Imports growth: 10.0 percent.
  - Balance of payments deficit: USD 5.3 billion (2008 estimate).
  - Current account surplus: USD 0.1 billion (2008 estimate).
  - International reserves at end-December 2008: USD 51.6 billion (equivalent to 4.0 months of imports and servicing of official debt).
  - Rupiah depreciation: fell 15.5 percent after mid-September 2008; average 2008 depreciation: 5.4 percent vis-à-vis the US Dollar.
- Bank funding and asset deployment (2008 description):
  - Funding sources: deposits 78 percent of liabilities, shareholder funds 10 percent, dues to banks and BI 6 percent.
  - Asset deployment: credit 57 percent of assets, BI 13 percent, government securities 13 percent, cash and bank balances 13 percent.
- Banking sector performance indicators (Table — selected values):
  - Total assets (IDR Trillion): Dec 2007 1,987; Dec 2008 2,311; Sep 2009 2,386.
  - Total assets as percent of GDP: Dec 2007 50.3; Dec 2008 46.6; Sep 2009 .. 
  - Capital adequacy ratio: Dec 2007 19.3; Dec 2008 16.2; Sep 2009 17.9.
  - Gross NPL ratio: Dec 2007 4.6; Dec 2008 3.8; Sep 2009 3.9.
  - Net NPL ratio: Dec 2007 1.9; Dec 2008 1.5; Sep 2009 1.7.
  - Credit growth (%): Dec 2007 26.5; Dec 2008 30.5; Sep 2009 4.4.
  - Loan to Deposit ratio: Dec 2007 69.2; Dec 2008 77.2; Sep 2009 73.6.
  - Liquid assets (as percent of total deposits): Dec 2007 30.1; Dec 2008 25.8; Sep 2009 26.1.
  - NIM: Dec 2007 5.7; Dec 2008 5.4; Sep 2009 5.4.
  - ROA: Dec 2007 2.8; Dec 2008 2.3; Sep 2009 2.6.
  - Total assets of commercial banks in September 2009: IDR 2,386 trillion (approximately USD 239 billion).

### VI. Supervisory Organization and Operations within BI
- BI internal structure for bank regulation and supervision:
  - Commercial bank regulation and licensing: handled in two Directorates.
  - Supervision and investigation: handled in four Directorates.
  - Regulation and supervision of Islamic banks and rural banks: handled in two dedicated Directorates.
  - Total directorates dealing with banking system: eight; they report directly to the Board of Governors through three Deputy Governors.
- BI’s monetary policy instruments (under inflation targeting framework):
  - Open market operations in rupiah and foreign exchange money markets.
  - Statutory reserve requirements.
  - Regulations for credit or financing, and ability to operate monetary instruments on Sharia principles.
  - BI rate (overnight rate), monetary operations, and standing facilities are used to achieve the inflation target, which is set by the government in consultation with BI.

### VII. Preconditions for Effective Supervision — Observations
- Key preconditions identified as important for supervision quality:
  - Sound and sustainable macroeconomic policies.
  - Well-developed public infrastructure.
  - Effective market discipline.
  - Mechanisms for providing appropriate level of systemic protection.
- BI’s contribution to macroeconomic soundness:
  - Maintains internal and external value of the Rupiah via monetary policy and bank supervision.
  - Took initiatives during the crisis to prevent increased banking system risks: increased monitoring; policy/regulatory measures including limitation on speculative currency transactions involving IDR, emergency credit facility, short-term credit facility, reduction of the BI rate.

### VIII. Key Findings (high-level)
- Banking sector dominates financial system (approximately 80 percent of assets).
- BI has statutory independence and sufficient powers for regulation and supervision; details on proposed supervisory board (per 2004 amendment) remained unclear at assessment time.
- Banking sector performance indicators in 2008–2009 reflect a relatively healthy and sound banking system with:
  - Capital adequacy ratio well above regulatory minimums (19.3 in Dec 2007; 16.2 in Dec 2008; 17.9 in Sep 2009).
  - Manageable NPL ratios (gross NPL 3.8–4.6 across 2007–2009; net NPL 1.5–1.9).
  - High credit growth in 2007–2008 followed by slowdown in 2009 (credit growth: 26.5 in Dec 2007; 30.5 in Dec 2008; 4.4 in Sep 2009).
- The global crisis impacted Indonesia but the banking sector remained relatively insulated due to conservative traditional banking focus and deposit-funded liabilities.

*Source: FINANCIAL SECTOR ASSESSMENT PROGRAM — BASEL CORE PRINCIPLES ASSESSMENT: DETAILED ASSESSMENT OF COMPLIANCE, DECEMBER 2010.*

### 16. There are several weaknesses in the accounting and auditing standards and practices in

### _cr12335 - 16. There are several weaknesses in the accounting and auditing standards and practices in

### Accounting and auditing standards and practices — key weaknesses
- Indonesian financial accounting standards are mandatorily applicable for financial reporting by public companies, banks, and financial institutions.
- Institutional roles:
  - Indonesian Institute of Accountants (IAI) — professional body of accountants.
  - Indonesian Institute of Public Accountants (IAPI) — professional body for public accountants; IAPI is an association member of IAI.
  - IAI develops and disseminates accounting standards through the Indonesian Financial Accounting Standards Board (DSAK).
  - IAPI develops and disseminates audit and ethics standards in line with international good practice.
- ROSC assessment findings:
  - Although most financial accounting standards statement (PSAK) are based on international financial reporting standards (IFRS), gaps remain:
    - "23 PSAK are uniquely local standards with no counterpart in IFRS;"
    - "8 PSAK have no gaps with IFRS;"
    - "19 PSAK have minor gaps with IFRS;"
    - "2 PSAK have moderate gaps with IFRS."
  - The auditing standard setter, IAPI, intended to converge local auditing standards with International Standards on Auditing (ISA) by 2011; however, no practical arrangement has yet been put in place for achieving this goal.
  - Internationally comparable accounting and reporting requirements for financial instruments are not being implemented, causing reported results and financial condition of banks and similar financial institutions to tend to be distorted.
  - Review of selected companies’ financial statements revealed gaps in compliance with the PSAKs, including gaps in:
    - segment information;
    - related party transactions;
    - consolidated financial statements;
    - employee benefits;
    - derivative transactions.
  - Instances observed of practicing accountants and auditors yielding to undue pressure from corporate management, resulting in compliance “in appearance” rather than “in substance.”
  - No mechanism exists to proactively ensure practicing accountants and auditors comply with the code of ethics for professional accountants.
  - Of the more than 400 accounting firms in the country, only "6 to 8 firms appear to have a very high level of compliance with the applicable auditing standards."
  - Small and medium-size audit practices generally lack necessary resources to implement audit quality control arrangements.

### Payment and settlement system
- Bank Indonesia (BI) manages the payment and settlement system, providing a real time gross settlement system in addition to a standard clearing process.
- BI set up a Debtor Information System (SID) in June 2006 with mandatory bank participation and optional NBFI participation; despite an MOU with the MOF to mandate NBFI participation, results have been weak.
- Participation figures:
  - "all 121 commercial banks" are participating;
  - "576 of the 1765 rural banks with assets of more than IDR 10 billion (1200 of the 3454 rural offices)" are participating;
  - seven finance companies are participating.

### Legal framework and enforcement weaknesses
- Shortcomings in corporate, bankruptcy, contract, and private property laws, inconsistent enforcement, and weaknesses in the legal profession and judiciary can undermine banking supervision.
- Improvements made over the last decade, including passage of improved bankruptcy laws, but weaknesses remain in enforcement of collateral and creditor rights, reflected in poor recovery rates.
- World Bank Doing Business indicators cited:
  - recovery rates in the region: "below 15 percent";
  - cost of bankruptcy procedures: "about 18 percent of the estate."
- Bankruptcy and contract enforcement metrics:
  - bankruptcies take "between 5 and 6 years" to be resolved;
  - enforcement of contracts takes "about 570 days";
  - associated costs are "about 123 percent of the claim."
- Legal system characteristics include:
  - inadequacies, absence, and overlaps in certain laws;
  - difficulties in enforcement of movable securities;
  - difficulties in enforcement of legal rights, especially in unsecured lending.
- Banks are hesitant to use the court process due to unpredictability of legal decisions; arbitration is used but enforcement of awards typically requires court assistance.
- Capacity and professionalism of implementing institutions and recovery levels reflect lack of efficient administration for rehabilitation and insolvency.

### Market discipline and prudential disclosure
- BI regulations seek to establish good corporate governance (GCG) and internal control functions in banks and require a minimum set of disclosures.
- BI requirements:
  - implement GCG principles in each business activity at all organizational levels;
  - create, maintain, and oversee an effective internal control mechanism.
- Minimum disclosure by banks includes:
  - ownership details;
  - strategies and management policies;
  - a set of audited financial statements;
  - the level of risk exposures;
  - risk management procedures implemented by the bank.
- BI applied an interest rate cap on deposits to be eligible for deposit insurance to increase market discipline by making high-rate deposits ineligible for insurance.

### Public safety nets and central bank facilities
- BI liquidity facilities:
  - short-term facility (up to a maximum limit of "90 days") against collateral of government bonds, BI certificates, and loans classified as ‘current’ (where bank lacks eligible government bonds or BI certificates);
  - traditional overnight and intraday facilities.
  - emergency liquidity assistance (ELA) for systemically important solvent banks allows longer term extensions (up to a maximum limit of "180 days"); ELA provided only with a Government of Indonesia guarantee and government compensation for any BI losses on such lending.
- Deposit insurance (LPS):
  - regime modeled after the U.S. FDIC;
  - LPS insures deposits and is responsible for resolving failed banks.
  - In response to the global crisis, coverage limit raised in October 2008 from "IDR 100 million (USD 10,000)" to "IDR 2 billion (USD 200,000)"; the revised limit covers "about 90 percent of the depositors."
  - Deposit insurance premia are not risk related, though this is under discussion.
  - Resolution of all failed banks is the responsibility of the LPS.

### Crisis management framework and institutional coordination
- LPS Law of 2004 established a Coordination Committee comprising the Ministry of Finance, BI, and the LPS to determine policy for resolution and handling of failing banks predicted to have systemic effects.
- June 2007 joint decree by BI, MOF, and LPS established the Financial System Stability Forum (FSSK) for technical cooperation and information exchange among the three agencies.
- October 2008 Presidential Ordinance in lieu of law established the Financial System Stability Committee with the Minister of Finance as Chairperson and the BI Governor as Member; the Committee could determine whether a systemically important financial institution would receive BI emergency liquidity assistance and other resolution measures.
- Government and BI drafted a Financial System Safety Net (FSSN) Law to establish the Committee in law and address institutional coordination for identifying systemically important banks and NBFIs; the draft law was rejected by Parliament and authorities consider resubmission. The October 2008 ordinance has since lapsed.
- Pending passage of law, the Coordination Committee under the LPS law serves as the mechanism for cooperation and coordination for handling crisis management in the banking sector.

### Main findings on regulation and supervision
- Progress since the late 1990s banking crisis:
  - BI has engaged in improving regulatory and supervisory frameworks and methodologies aimed at maintaining a healthy banking system and improving staff competency.
- Remaining needs due to globalization and crisis lessons:
  - further improvements in regulation and supervision are required to equip the banking sector to play a more significant role in the economy.
- Objectives, independence, powers, transparency, and cooperation (principle 1):
  - BI’s responsibilities and powers are set out in the Bank Indonesia Act (the BI Act) and the Banking Act.
  - BI Act requires annual disclosure to the public along with intended goals and financial reporting; BI’s independence is contained in the BI Act.
  - Legal provisions do not provide adequate protection to BI as the supervisory authority and supervisory staff against personal prosecution.
  - BI’s operational budget needs parliamentary approval but BI does not appear constrained in performing regulatory or supervisory functions.
  - BI has sufficient powers to ensure compliance with laws, regulations, prudential standards, and guidelines.
- Information-sharing and cooperation gaps:
  - Lack of appropriate gateways for information exchange with domestic and foreign supervisory authorities impedes BI’s ability to discharge legal responsibilities.
  - BI uses its authority to examine domestic subsidiaries where warranted, but inability to freely exchange information prevents a full assessment of impacts from other financial sectors and may hamper supervisory prioritization.
  - Absence of formal/informal arrangements for cooperation and coordination with foreign home supervisors of systemically relevant foreign financial institutions could pose systemic risks to Indonesia’s payment and interbank settlement system if a parent encountered sudden problems.

### Licensing, structure, and ownership controls (principles 2 to 5)
- "Bank" is clearly defined in laws and regulations; permitted and impermissible activities are specified in the Banking Act.
- BI is the designated licensing authority and sets licensing criteria; no application for a banking license has been received since 1999.
- Use of the term “bank” is restricted to BI-licensed entities.
- Ownership thresholds and reporting:
  - significant ownership defined as "equal to or exceeding 25 percent of the total equity" and includes parties acting in concert or otherwise connected;
  - any transfer of ownership above "5 percent" must be reported to BI within "10 days";
  - any transfer resulting in ownership exceeding "25 percent" must be reported to BI for prior approval and shareholders are subjected to fit and proper tests.
  - BI has authority to enforce divestiture or reject proposals that hinder appropriate supervision.
- Investment approvals and gaps:
  - Regulations require banks to obtain BI’s prior approval for equity investment in financial entities and prohibit investment in equity of non-financial entities.
  - BI regulations apply at the bank level; equity investments by banks’ subsidiaries/group entities are not subjected to scrutiny or review and regulations do not apply to equity investments undertaken through the debt resolution route.

### Due-diligence framework and risk management (principles 6 to 18)
- Capital and Basel framework:
  - Indonesian banking system is on Basel I; framework broadly aligned but a more liberal capital definition and dilution in some risk weights create weaknesses needing strengthening.
  - Indonesian banks largely do not use internal methodologies for assessing overall capital adequacy in relation to their risk profile; little focus on internal models and limited capacity to validate them.
- BI risk management regulations cover credit, market, operational, liquidity, legal, strategic, reputational, and compliance risks.
  - BI has yet to issue regulations on interest rate risk in the banking book (IRRBB) and country / transfer risk.
  - Scope for improvement in liquidity risk and operational risk management as Basel II implementation commences.
- Asset classification and provisioning:
  - Broad components of asset classification and provisioning applied to delinquent loans are in line with international standards, but weaknesses in some elements could collectively lead to understatement of NPLs, under provisioning, and overstatement of income with implications for capital adequacy — these need to be fixed immediately.
  - These elements should be reviewed to ensure appropriate adjustment of capital and provisioning levels for institutional, local, regional, and global conditions.
  - Board oversight of NPL management may need strengthening; no evidence that Boards are actively managing problem asset portfolios.
- Large exposures and portfolio concentration practices:
  - System governed by single borrower, borrower group, and related party regulations prescribing prudential caps; regulations are close to international standards but shortcomings exist in the definition of exposure.
  - Concept of ‘large exposures’ and ‘portfolio concentrations’ are either not practiced or not practiced adequately.
- Internal control and operational risk:
  - Indonesian banks have a good framework of internal control and compliance functions governed by comprehensive regulations.
  - BI does not appear to undertake an on-site assessment of the internal control function in its entirety; assessments are indirect and piecemeal.
  - BI regulations do not explicitly require a risk based audit framework in banks.
  - BI regulations on operational risk (OR) do not explicitly capture:
    - outsourcing risk;
    - business continuity planning in areas other than IT;
    - legal risk in banks below the regulatory threshold;
    - supervisory reporting of significant OR events.
- AML/CFT and customer due diligence:
  - Banks file suspicious transaction reports with the PPATK; supervisors assess KYC and AML controls at least annually.
  - APG’s 2008 mutual evaluation report: Indonesia made significant progress in AML measures but relatively little implementation of CFT measures.
  - Significant money laundering (ML) and very significant terrorism and terrorist financing (TF) risks exist.
  - Major deficiencies remain in identification and verification of beneficial owners; effective implementation of the regime needs further pursuit.
  - Indonesia has not established comprehensive controls or oversight over the provision of wire transfers — significant shortcomings in AML/CFT preventative measures.
  - BI has begun addressing some APG 2008 gaps through revised regulations.

*Italic: Content excerpt from IMF staff report chapter as provided in the source content.*

### 31. BI’s supervisory system consists of both off-site and on-site supervision along with

### _cr12335 - 31. BI’s supervisory system consists of both off-site and on-site supervision along with

### Supervisory system and practices
- BI’s supervisory system consists of both off-site and on-site supervision along with regular contacts with bank management.
- Off-site supervisory system:
  - Includes receipt and analysis of periodic (daily, weekly, monthly, quarterly, and annual) reports on both a solo and consolidated basis.
  - Integrity of supervisory reports is ensured through on-site verification by supervisors as well as the external auditors.
  - Off-site reports are used well at the single institution level but are not fully utilized to generate efficient system trends and useful peer group analysis.
- Information sharing and legal protection:
  - Absence of formal and informal information sharing arrangements with other financial sector supervisory authorities adversely affects effectiveness.
  - Absence of effective legal protection dampens supervisors’ willingness to make decisions and deviate from manual methods.
- Supervisory insight and risk profiling:
  - Supervisors have developed a fairly good understanding of individual banks and banking groups.
  - BI has a system to produce a risk profile of each bank (solo and consolidated) requiring a risk assessment of each institution and a quarterly risk profile assessment that influences the examination plan.
  - Supervisory exercises are carried out in accordance with the risk profile.

### Accounting records and financial reporting (principle 22)
- Regulatory requirements:
  - Bank financial statements must be based on the Financial Accounting Standards Statement (PSAK) and Indonesian Banking Accounting Guidelines (PAPI).
  - Annual financial statements must be audited by a public accountant.
- Weaknesses and implications:
  - Gaps exist in reporting of segment information, related party transactions, consolidated financial statements, employee benefits, and derivative transactions, affecting disclosure quality.
  - Introduction of new accounting standards aligned to IAS 32 and IAS 39 is likely to pose challenges and needs close monitoring by BI.
  - Internationally comparable accounting and reporting requirements for financial instruments are not being implemented, causing reported results and financial condition of banks to tend to be distorted.

### Corrective measures (principle 23)
- Supervisory powers and use:
  - Supervisors have a large arsenal of tools: monetary penalties, administrative sanctions, cease and desist orders, change of management, and revocation of the license.
  - Under normal conditions, BI does not appear hesitant to use powers to require swift curative action.
  - Prompt corrective action is largely discretionary; BI tends to allow banks to remain under intensive supervision for several years without resolving underlying weaknesses.
  - Moderation or escalation in the application of sanctions was not always apparent.

### Supervision on a consolidated basis and international cooperation (principles 24 and 25)
- Organizational oversight:
  - BI performs oversight through dedicated teams for each commercial bank.
  - Regulatory reports are filed on a solo and consolidated basis.
  - On-site examinations include, where necessary, examinations of risk taking in subsidiaries.
- Limitations and gaps:
  - Consolidated supervision is largely accomplished by BI taking responsibility for on-site supervision of consolidated organizations where other regulators do not perform routine robust examinations.
  - Lack of formal arrangements to transfer information between domestic supervisors, combined with weaknesses in supervision of overseas branches, is a serious impediment.
  - Exclusions from scope of consolidated supervision, non-application to the consolidated bank of regulations on equity participation and the sale of structured products, and intra-group transactions where the bank is not directly involved can expose risks outside supervisory scope.
  - BI should pay increased attention to oversight of foreign operations; example cited: Cayman Island branches managed primarily by the New York branch purportedly to gather funds from the Eurodollar market despite few, if any, loans priced at LIBOR.
  - Both formal and informal arrangements for ongoing information sharing and coordination with other supervisors (domestic and foreign) are largely absent and hamper supervisory efforts.
  - Peer group analysis is not always efficient; a horizontal examination of a cross-section of banks may be useful.
- Home-host relationships and systemically important foreign institutions:
  - BI is making efforts to strengthen home-host relationships, but effective supervision of foreign banks requires continuing monitoring of the parent and frequent communication with home supervisors.
  - BI lacks a uniform policy for aligning supervisory requirements with risks.
  - Arrangements for exchange of information exist with close-by neighboring supervisors; lines of communication are less clear with home supervisors of systemically relevant foreign financial institutions.
  - Lack of formal and informal gateways for information exchange with home regulators of systemically relevant foreign financial institutions is a serious issue.
  - BI needs a program to identify systemically important foreign institutions, determine home supervisor competence/authority to enter information sharing agreements, and ensure regular visits to home supervisors of systemically important foreign banks in Indonesia.

### Summary compliance with the Basel Core Principles — selected findings (principles 1–17)
- Principle 1 — Objectives, independence, powers, transparency, and cooperation:
  - Laws and regulations clearly spell out BI’s responsibilities for licensing, prudential standards, supervision, and sanctioning; regulations and prudential standards are generally comprehensive.
  - The BI Act defines supervisory objectives and provides operational independence; BI is accountable to the parliament and submits a quarterly report.
  - Removal procedures and broad reasons for removal are contained in the BI Act; removal is disclosed but the reason for removal is not disclosed.
  - The BI Act provides authority to issue/withdraw banking licenses, regulate and supervise the banking system, set prudential requirements, gather information, and conduct examinations; BI consults with industry on major regulatory initiatives.
  - Article 45 contains provisions to protect supervisory staff from legal prosecution for actions in ‘good faith’, but the law does not explicitly state presumption of good faith, casting a heavy burden of proof on staff and not providing effective protection; protections against omissions or costs for defending actions are not provided; protection to BI as the supervisory authority is absent.
  - BI and LPS have signed a formal MOU covering regular information sharing for all banks; no formal MOU/regulation with Bapepam-LK or the MOF, nor with foreign supervisors.
- Principle 2 — Permissible activities:
  - The Banking Act clearly defines ‘banking’, permitted and impermissible activities; deposit taking by cooperatives and micro finance institutions is governed by appropriate laws; the term bank is restricted to licensed entities.
- Principle 3 — Licensing criteria:
  - BI can set licensing criteria, reject applications, and revoke licenses issued on false information; criteria are similar to ongoing supervision. No new bank applications since 1999, so licensing effectiveness could not be assessed.
- Principle 4 — Transfer of significant ownership:
  - Significant ownership defined as equal to or exceeding 25 percent, including parties acting in concert. Transfer exceeding 25 percent requires prior BI approval; transfers above 5 percent and up to 25 percent must be reported within 10 days. BI can enforce divestiture or reject proposals hindering supervision.
- Principle 5 — Major acquisitions:
  - Regulations prohibit banks’ equity participation in non-financial sector and require prior BI approval for equity participation in financial sector. Solo-level cap on aggregate ‘equity participation’ at 25 percent of bank capital. Gap: regulations do not apply to equity investments through debt resolution or those by subsidiaries/group entities.
- Principle 6 — Capital adequacy:
  - Minimum capital requirement: at least 8 percent of total risk weighted assets, both at solo and consolidated levels (Basel I methodology).
  - Market risk capital charge applicable only to certain banks meeting criteria; covers 95 percent of banking system assets and 99 percent of trading book assets.
  - Capital adequacy norms are inconsistent with Basel principles regarding definition of capital and dilution of risk weights and warrant immediate strengthening.
  - Full implementation of Basel II is expected from January 2014.
- Principle 7 — Risk management process:
  - Regulations require non-complex banks to establish policies/procedures for credit, market, operational, and liquidity risk; complex organizations must consider additional material risks including legal, reputational, strategic, and compliance risks.
  - Regulations require adequate board and senior management involvement.
  - Banks must perform quarterly risk profile self-assessments of solo and consolidated positions and provide them to BI.
  - Banks largely lack internal methodologies for assessing overall capital adequacy relative to risk profile; inadequate capacity and focus on validation of internal models.
  - Recent events suggest the system is not fully equipped to manage risk exposures effectively during adverse situations; supervisory capacity needs enhancement.
- Principle 8 — Credit risk:
  - Regulations require banks to manage credit and investment risks, establish policies and procedures, and emphasize Board involvement.
  - Framework broadly complies but gaps exist in large exposures, related party exposures, asset classification and provisioning, and country risk.
- Principle 9 — Problem assets, provisions, and reserves:
  - Regulations require minimum standards for identification/classification of problem assets, general and specific loan loss provisions, loan write-offs, and debt restructuring.
  - Asset classification and provisioning norms for non performing loans show weaknesses that could lead to understatement of NPLs, under provisioning, and overstatement of income with implications for capital adequacy; these need immediate fixing.
  - NPLs must be reported to banks’ Boards, but no evidence that Boards of Commissioners actively manage problem asset portfolios.
- Principle 10 — Large exposure limits:
  - BI regulations on legal lending limits (LLL) prescribe ground rules for identifying borrower groups; supervisors have discretion to determine connected counterparties.
  - Regulations need to address shortcomings in definition of exposure, promote concept of ‘large exposures’ and ‘portfolio concentrations’ with prudential limits, and reduce time allowed for rectifying breaches.
  - BI should consider (a) gross exposures without deductions, and (b) SOEs as a group for concentration risk.
- Principle 11 — Exposure to related parties:
  - Definitions and limits for related parties are in BI regulations and applied at solo and consolidated levels.
  - Regulations require processes/controls for related party exposures to be at least as stringent as for non-related counterparties, and require BoC prior approval.
  - Regulations allow exemptions from definitions of ‘related party’ and ‘exposures’, do not address non-credit transactions with related parties, do not explicitly require exclusion of interested persons from relevant processes, and do not cover handling of NPLs in related party transactions—resulting in gaps and incomplete conflict-of-interest coverage.
- Principle 12 — Country and transfer risks:
  - BI regulations do not address country and transfer risk; supervisory process does not devote adequate resources to this element in off-site or on-site processes, leaving the risk largely absent from supervisory radar. BI must address the regulatory gap and enhance supervisory capacity.
- Principle 13 — Market risks:
  - Regulations address market risk management and require Board active supervision; guidelines address interest rate risk and foreign exchange risk for solo banks and include equity and commodities risk for consolidated banks.
  - Only banks above a certain threshold are 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.
- Principle 14 — Liquidity risk:
  - Regulations require banks to manage liquidity risk commensurate with size and complexity on a solo and consolidated basis.
  - BI issued revised guidelines on liquidity risk management that become operational on October 30, 2009, to align with BCBS Principles for Sound Liquidity Risk Management and Supervision (September 2008).
  - Shortcomings exist in standards/benchmarks for slotting asset/liability items, hampering aggregation and inter-bank comparison.
  - Banks are not explicitly required to manage liquidity currency-wise or to inform BI when contingency funding plans (CFPs) are triggered or when facing liquidity problems.
- Principle 15 — Operational risk:
  - Regulations define operational risk but do not include legal risk (addressed separately for selected banks); require 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 a certain threshold, or supervisory reporting of significant operational risk events.
- Principle 16 — Interest rate risk in the banking book (IRRBB):
  - Regulations do not explicitly cover IRRBB; banks do not actively manage this risk and supervisors do not adequately focus on it. BI must address this regulatory gap and enhance supervisory capacity.
- Principle 17 — Internal control and audit:
  - Regulations require BoC and BoD to ensure creation, maintenance, and oversight of effective internal control mechanisms to safeguard assets, ensure reporting accuracy, strengthen legal/regulatory compliance, minimize irregularities/fraud, and improve efficiency.
  - Banks must designate a compliance director and establish an independent internal audit unit.
  - Regulations do not explicitly require a risk based audit framework.
  - BI does not assess the internal control function as a separate function in its entirety.
  - Banks’ internal control functions lack capacity and methodologies for validating internal models and stress testing.

*Source: _cr12335 - 31. BI’s supervisory system consists of both off-site and on-site supervision along with*

### 18. Abuse of financial

### 18. Abuse of financial services

### Regulatory framework and supervisory responsibilities
- BI regulations detail the responsibilities and powers of the banking supervisor.
- Banks are required to file regular compliance reports and BI examiners verify compliance.
- BI Act requires all banks to submit detailed information covering the range of prudential risks (solo and consolidated basis). Off-site reports are subjected to verification during on-site examinations.
- At least annually, supervisors conduct an assessment of the implementation of KYC and anti-money laundering controls including:
  - management oversight,
  - policies, practices and procedures,
  - internal controls and audit,
  - MIS systems,
  - training.

### Findings from assessments and supervisory practice
- The APG 2008 mutual evaluation has revealed several gaps that can expose the banking system either directly or indirectly to abuse.
- BI has addressed a few of these gaps through revised regulations.
- Supervisory practice:
  - BI examiners verify compliance via regular reporting and on-site verification.
  - At least once a year, banks are subject to an on-site inspection.
  - Supervisory exercises are carried out in accordance with the risk profile.
  - Off-site reports are not fully utilized to generate efficient and useful peer group analysis.
  - Off-site reports are not prepared on a consolidated basis for all risks.

### Supervisory impediments and legal protection
- The absence of formal information sharing arrangements with other financial sector supervisory authorities adversely affects the effectiveness of the bank supervision program.
- The absence of effective legal protection dampens supervisors’ willingness to make decisions and deviate from accepted methods listed in the manual.
- Legal protection aspects (from accompanying Core Principle comments):
  - The BI Act contains provisions under Article 45 that protect supervisory staff from legal prosecution for any actions or decisions made in ‘good faith’ when performing their supervisory duties.
  - The law does not explicitly state presumption of good faith in favor of supervisory staff and consequently the existing provisions cast a heavy burden of proof on them, which together do not provide effective protection.

### Core Principle grading summary (as reported)
- Core Principle: 18. Abuse of financial services — Grading: LC
- Key comment: BI regulations detail the responsibilities and powers of the banking supervisor. Banks are required to file regular compliance reports and BI examiners verify compliance. At least annually, supervisors conduct an assessment of the implementation of KYC and anti-money laundering controls including management oversight, policies, practices and procedures, internal controls and audit MIS systems, and training. The APG 2008 mutual evaluation has revealed several gaps that can expose the banking system either directly or indirectly to abuse. BI has addressed a few of these gaps identified by the APG 2008 mutual evaluation through revised regulations.

*Source: _cr12335 - 18. Abuse of financial (IMF staff report excerpt).*

### 22. Accounting and

### 22. Accounting and disclosure

### Assessment findings
- Grading: LC
- BI requirements on accounting, auditing, valuation, maintenance of accounts and public disclosure of financial statements are broadly in line with requirements, but:
  - 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 principle, but scope for improvement exists 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 monitoring by BI.
- The implementation of IAS 32 and 39 equivalents in 2010-11 can be tricky and needs close monitoring by BI.
- BI needs to focus more supervisory resources on ensuring banks’ financial statements reflect their true financial performance and financial position, and to develop a process for a stringent quality assurance review of bank audits and auditors.
- Aggregate peer grading across Core Principles (context):
  - Compliant (C) – 6
  - Largely compliant (LC) – 18
  - Materially noncompliant (MNC) – 4
  - Noncompliant (NC) – 2
  - Not applicable (N/A) – nil

### Recommended action plan (selected items relevant to accounting and disclosure)
- BI should focus supervisory resources on ensuring that banks’ financial statements reflect their true financial performance and financial position.
- BI should develop a process to ensure a stringent quality assurance review of bank audits and auditors.
- Monitor closely the 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.

### Authorities’ response (Republic of Indonesia)
- The Republic of Indonesia welcomes the assessment and broadly concurs with the findings; plans to utilize the assessment as a blueprint to enhance legislative, regulatory, and supervisory framework.
- Preconditions:
  - Authorities note issues raised in the “preconditions” section regarding accounting and auditing standards and Indonesia’s legal framework governing creditor rights and collateral enforcement; these elements are outside BI’s jurisdiction, but steps have been 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.
  - Caution noted that “blindly” following international accounting standards may not suit national interests where local market conditions do not support greater use of “fair value” accounting.
  - Bank Indonesia has secured a seat within Indonesia’s accounting standards setting body and uses its position to voice concerns on identified gaps.
  - Strengthening auditor competency is ongoing; unilateral actions imposed include maintenance of 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:
  - Concurs with identified shortcomings in the legal-foreclosure framework.
  - BI has imposed measures to mitigate prudential concerns related to protracted court resolution processes, particularly on valuation of problem loans:
    - Loan loss provisioning framework requires banks to establish loss buffers for performing loans that ignore the value of any collateral.
    - Applies significant haircuts to collateral – 30 percent up to 100 percent of appraised value – for all other types of loans, for purposes of establishing the minimum amount of required loss provisions.
    - The minimum regulatory standard is measured against how much loss buffers would be required if banks applied the “time value” concept (e.g., the estimated time it takes to foreclose and liquidate collateral under IAS 39), with the higher of the two approaches reflected in each banks’ capital adequacy calculation (as a deduction to Tier 1 capital).
    - Prerequisites for securing collateral include valid legal documentation, securing legal rights and first lien to the collateral, and insurance coverage.
    - BI attempts to explicitly integrate the lengthy foreclosure process into its regulatory and supervisory framework.
- Information exchange:
  - BI has recently signed MOUs with other domestic regulatory authorities to establish formal mechanisms to share supervisory information across key financial sector regulators.
  - Lack of formal information sharing arrangements did not materially impede BI’s practice of consolidated supervision, as noted in the overall assessment.
  - Further efforts are needed on information sharing with foreign supervisors; such efforts must be conducted at a multilateral level given asymmetric host–home relationships.
- Capital adequacy (contextual remarks tied to accounting discussion):
  - Some capital components in question are either immaterial and/or lack a clear international standard (for example, the inclusion of 50 percent of unaudited profits in Tier 1 capital, and the nature of foreign branch capital).
  - Changing definition of capital unilaterally could raise level playing field concerns.
  - Noted dilutions to “risk-weights” are still within parameters allowed under Basel II.

*Source: IMF/World Bank assessment excerpt (Chapter 22: Accounting and disclosure) from the provided IMF staff report content.*

### 45. Problem assets, provisions, and reserves. While we concur that there are some gaps in our

### 45. Problem assets, provisions, and reserves

### Problem assets and provisioning framework
- The application of a minimum regulatory provisioning matrix—subject to supervisory review—is stated to be well within international norms of other countries that apply such a framework.
- Supervisory review process assesses and makes necessary modifications to both reported asset quality and adequacy of provisions during on-site examinations.
- Acknowledgement that there are "some gaps" in the overall system of classification and provisioning.

### Definition of single borrower, borrower group, and related party exposures
- Indonesia's coverage is described as "one of the most stringent" in terms of definitions for single borrower, borrower group, and related party.
- Coverage is extensive: it "covers almost all level of the bank’s group structure" as well as direct and indirect transactions.
- Assessment: coverage is comparable to the scope utilized by developed economies.
- Policy consideration: further tightening of definitions would have significant consequences for intermediation given:
  - the banking sector accounts for almost 80 percent of the total financial system;
  - the level of development of the financial market;
  - the structure of companies is tied within large conglomeration structures.

### Liquidity risk
- Assessor recommended that BI regulations should prescribe standards for slotting various assets and liabilities.
- Response: no single "right" method; approach depends on prevailing regulatory and supervisory philosophy.
- Recommendation on CFP (consultative/formalistic paper) will be taken under advisement.
- Practical supervisory stance: ongoing supervision enables supervisors to know whether a bank is experiencing liquidity difficulties.

### IRRBB (Interest Rate Risk in the Banking Book)
- BI has not yet issued regulations specifically on the management of IRRBB.
- IRRBB is addressed under CAMELS regulation—capital adequacy, asset quality, management quality, earnings, liquidity, and sensitivity to market risk—requiring banks to maintain soundness ratings that consider sensitivity to market risks, covering interest rate risk in banking and trading book.
- Some larger banks have developed internal frameworks and systems to manage IRRBB for internal management purposes.
- Near-term plan: BI will be issuing a consultative paper on IRRBB to be further addressed under Pillar 2 of Basel II.

### Internal control and audit
- Agreement that the framework for internal control and audit needs improvement, but the current "piecemeal" examination approach is attributed to adoption of a risk-based framework.
- BI asserts it does undertake comprehensive internal control audit as part of risk control system evaluations.
- BI requirements and practices:
  - Auditors must perform an assessment of a bank’s internal control function prior to performing internal audit.
  - Banks are obliged to periodically utilize an independent reviewer to review overall internal control and audit functions; results are submitted to BI.
  - Supervisors integrate various approaches to review internal control and audit functions to obtain necessary information on the effectiveness of banks’ control systems.

*Source: _cr12335 - 45. Problem assets, provisions, and reserves.*

### 50. The ratings for compliance were awarded according to the methodology prescribed in

### _cr12335 - 50. The ratings for compliance were awarded according to the methodology prescribed in

### Methodology and rating definitions
- Ratings awarded according to the BCBS document – Core Principles Methodology (October 2006).
- Four levels of compliance:
  - Compliant – "all essential criteria applicable for this country are met without any significant deficiencies."
  - Largely compliant – "only minor shortcomings are observed which do not raise any concerns" and "the overall effectiveness is sufficiently good, and no material risks are left unaddressed."
  - Materially non-compliant – "there are severe shortcomings, despite the existence of formal rules, regulations and procedures," and "the shortcomings are sufficient to raise doubts about the authority’s ability to achieve compliance."
  - Non-compliant – "no substantive implementation of the Principle, several essential criteria are not complied with or supervision is manifestly ineffective."

### Principle 1 — Objectives, independence, powers, transparency, and cooperation (selected findings and assessments)
- Principle overview: clear responsibilities and objectives; operational independence; transparent processes; sound governance; adequate resources; legal framework for authorization, supervision, powers, and legal protection; arrangements for information sharing and confidentiality.
- Principle 1(1) Responsibilities and objectives
  - Assessment: Compliant
  - Key findings:
    - The Republic Indonesia Act No. 23 (Bank Indonesia Act) spells out BI’s responsibilities for supervision.
    - BI regulations cover licensing, supervision, and sanctioning powers.
    - Banks required to make financial and performance information public on a quarterly basis; BI publishes statistical reports and financial stability reports.
- Principle 1(2) Independence, accountability and transparency
  - Assessment: Compliant
  - Key findings and comment:
    - No evidence of government or industry interference in practice.
    - Removal procedures for heads are specified in law (Article 48(1) of BI Act); removal is disclosed but the reason for removal is not disclosed.
    - BI required to disclose annual evaluation of policies and report quarterly to the House of Representatives.
    - Staff considered professional and of high moral integrity.
    - Operational budget requires yearly approval of Parliament; BI can continue to operate without new approval based on prior year’s approved budget.
    - Comment: "Removal procedures are consistent with good practice and contained in the BI Act. While removal is disclosed, reasons for the removal are not disclosed."
- Principle 1(3) Legal framework (authorization, rules, information powers)
  - Assessment: Compliant
  - Key findings:
    - BI Act grants authority to grant/withdraw banking licenses.
    - BI can set prudential requirements and frequently consults with industry.
    - BI Act empowers BI to gather periodic and ad hoc information and conduct examinations.
- Principle 1(4) Legal powers (enforcement and remedial actions)
  - Assessment: Compliant
  - Key findings:
    - Law/regulations permit qualitative judgment and provide powers to enforce compliance up to revocation of license.
    - BI has full access to bank boards, management, staff, and records.
- Principle 1(5) Legal protection
  - Assessment: Materially non-compliant
  - Key findings and comment:
    - Article 45 of the BI Act provides protection for supervisory staff when acting in "good faith" and defines four onerous requirements for "good faith":
      - action is not related to family
      - action has a positive impact
      - action is timely
      - action is within procedures
    - The Law does not provide presumption of good faith; Article 45 does not include omissions and does not protect BI as the supervisory authority.
    - Legal protection is available in the form of consultations, assistance, accessibility to data, information and security assistance to staff and families, but BI as an institution is not protected against costs of defending actions or omissions.
    - Comment: "The deficiency with respect to legal protection is serious and needs to be corrected. Supervisory staff is hesitant to exercise supervisory discretions... Urgent amendments to the BI Act are required to explicitly state presumption of good faith in favor of supervisory staff; to protect supervisory staff from omissions and all costs for defending their actions; and to grant protection to BI as a supervisory authority."
- Principle 1(6) Cooperation (information sharing)
  - Assessment: Materially non-compliant
  - Key findings and comment:
    - A Financial System Stability Committee formed in October 2008 under a Presidential decree included BI, MOF, and LPS; the Presidential decree has lapsed and a new bill is proposed.
    - BI and LPS signed a formal MOU covering information sharing; no formal MOU or regulation with Bapepam-LK or MOF.
    - No formal or informal arrangements for ongoing information sharing with foreign supervisors; BI examines overseas offices with permission of foreign authority.
    - Example cited: in a recent situation a foreign bank with significant operations in Indonesia was reported in difficulty; BI's request to the home supervisor yielded an unsatisfactory response and BI did not take further remedial steps such as ring-fencing local capital.
    - Comment: "The lack of appropriate gateways for information exchanges between supervisory authorities, both domestic and foreign, is a serious impediment... The BI should put in place effective information exchange arrangements with other domestic financial sector supervisors and foreign supervisors."

### Selected findings across Principles 2–6 (high-level)
- Principle 2 Permissible activities
  - Assessment: Compliant
  - Key findings:
    - "Bank" clearly defined (Article 1(3) of the Banking Act).
    - Permissible and impermissible banking activities are clearly defined; use of "bank" limited to licensed institutions.
    - BI publishes and keeps current listing of domestic banks and foreign bank branches.
- Principle 3 Licensing criteria
  - Assessment: Largely Compliant
  - Key findings and comment:
    - BI holds licensing authority and power to set criteria and reject applications.
    - No application to open a commercial bank during the last 10 years; operational effectiveness of licensing could not be verified.
    - Minimum initial capital for a new bank is IDR 3 trillion (USD 300 million).
    - Fit and proper processes appear in line with criteria but not tested in practice.
    - Comment: "The general regulatory framework is in place. As no application for establishment of a bank has been received during the last ten years, the operational effectiveness of the licensing function of BI and compliance with several related criteria in the Principle could not be verified."
- Principle 4 Transfer of significant ownership
  - Assessment: Compliant
  - Key findings:
    - "Significant" ownership defined as equal to or exceeding 25 percent; transfers above 25 percent require BI prior approval; transfers above 5 percent must be reported within 10 days.
    - BI can enforce divestiture or reject proposals that hinder supervision.
    - Comment: BI may consider reducing the 25 percent threshold or applying detailed scrutiny to transfers of 5 percent or more.
- Principle 5 Major acquisitions
  - Assessment: Largely Compliant
  - Key findings and comment:
    - BI regulations prohibit banks’ equity participation in non-financial sector companies without permission and cap aggregate equity participation at 25 percent of bank capital (solo level).
    - "Temporary equity participation" (debt-equity swaps, convertible bonds) is exempted from prior approval and regulatory ceiling; not reported separately.
    - Accounting treatment for equity participation requires mark-to-market for holdings; this is contrary to IFRS treatment suggested for strategic investments.
    - Comment: "These [temporary equity participation and group entity investments] may need to be brought within the purview of the BI regulations for equity participation."
- Principle 6 Capital adequacy
  - Assessment: Largely compliant
  - Key findings and comments:
    - BI regulation requires minimum capital of 8 percent of total risk weighted assets, applied at solo and consolidated levels.
    - Minimum Tier 1 capital requirement is 5 percent; maximum innovative Tier 1 capital is 10 percent of Tier 1 capital.
    - BI allows recognition of 50 percent of current year’s profit as Tier 1 capital (after adjustments).
    - BI plans to implement Basel II using standardized approaches; effective international benchmark currently is Basel I.
    - BI modified certain risk weights (e.g., small business loans, house ownership) with lower BI risk weights than Basel I in specified categories.
    - BI may require higher capital by supervisory action but has not formally invoked this power; BI has encouraged top 14 banks to maintain a minimum CAR of 12 percent via suasion.
    - Comment: "The capital adequacy regime as operating on the ground reflects weaknesses, particularly in respect of the quality of capital, and the application of risk weights that are below the applicable risk weights under Basel I."

### Key numeric values and thresholds (preserved verbatim)
- Four compliance levels per methodology: compliant, largely compliant, materially non-compliant, and non-compliant.
- Article references: Article 48(1), Article 45, Article 57 (1).
- Dates and timelines:
  - Core Principles Methodology (October 2006).
  - Financial System Stability Committee formed in October 2008.
  - Last amendment to the Banking Act was in 1998.
  - BI regulations effective from January 1, 2009 for Basel II requirements; timelines for implementation: Pillar 1 is 2011, Pillar 2 is 2012–2014, and Pillar 3 is 2011– 2014.
  - As at end-September 2009: about 58 banks account for about 95 percent of banking assets and 99 percent of trading assets.
- Licensing and capital amounts:
  - Minimum initial capital for setting up a new bank is IDR 3 trillion (USD 300 million).
  - Foreign branch opening criteria: at least an ‘A’ rating by a leading international rating agency, rank among the top 200 largest banks by total assets, and have operating funds of at least IDR 3 trillion (USD 300 million).
- Capital adequacy:
  - Minimum capital required: 8 percent of total risk weighted assets.
  - Minimum Tier 1 capital: 5 percent.
  - Maximum innovative Tier 1 capital: 10 percent of Tier 1 capital.
  - BI encourages top 14 banks to maintain a minimum capital adequacy ratio of 12 percent.
  - BI allows banks to recognize 50 percent of the resulting net amount of current year’s profit as Tier 1 capital.
- Risk-weight adjustments listed (BI vs Basel I):
  - Small business loans: Basel I risk weight 100 percent; BI risk weight 85 percent (further reduced from Jan 2009).
  - Small business loans (if guaranteed by state owned credit insurance agency): Basel I 100 percent; BI 20 percent.
  - Small business loans (if guaranteed by non-state owned credit insurance agency): Basel I 100 percent; BI 20 to 75 (depending upon the credit rating of the insurance agency).
  - House ownership: Basel I 50; BI 40.
  - Loans to retirement / employees: Basel I 100; BI 50.
  - State owned enterprises (undertaking commercial activity): Basel I 100; BI 50.
- Market risk capital requirement applicability:
  - Banks with total asset base above IDR 1 trillion and trading book size above IDR 25 billion required to hold capital for market risk.
  - Of the 63 banks that are not required to maintain capital for market risks, two have a very small trading book.
- Historical licensing activity:
  - BI has not received an application to open a commercial bank during the last 10 years (no license granted since 1999).
  - No applications for establishment of foreign branches/subsidiaries since 1999.

### Policy recommendations and priority actions (from assessments/comments)
- Urgently amend the BI Act to:
  - Explicitly state a presumption of good faith in favor of supervisory staff.
  - Protect supervisory staff from omissions and all costs for defending their actions.
  - Grant legal protection to BI as a supervisory authority.
- Strengthen information exchange arrangements:
  - Put in place effective information exchange arrangements with other domestic financial sector supervisors and with foreign supervisors.
  - Consider formal cooperation and information sharing arrangements with systemically relevant foreign institutions.
- Enhance oversight of foreign banks:
  - Identify systemically relevant foreign institutions operating in Indonesia and consider the need to enter into formal cooperation and information sharing arrangements where appropriate.
  - Consider remedial powers (e.g., ring-fencing local capital or requiring asset maintenance agreements) when home-host information is insufficient.
- Bring exposures and reporting into supervisory purview:
  - Consider bringing "temporary equity participation" and equity investments of group entities within the BI regulations for equity participation.
  - Review accounting treatment for strategic investments to align with appropriate standards (noting divergence from IFRS).
- Strengthen capital regime and capital quality:
  - Address weaknesses in the quality of capital and reconsider recognition of items that may not meet permanence or loss-absorbing criteria.
  - Consider formal invocation of powers to require capital above the regulatory minimum where necessary.

*Source: _cr12335 - 50. The ratings for compliance were awarded according to the methodology prescribed in*

### 1. Within disclosed reserves, it allows 'retained earnings', which is the residual amount

### _cr12335 - 1. Within disclosed reserves, it allows 'retained earnings', which is the residual amount

### Capital adequacy: definition, implementation gaps, and remedial steps
- Finding: Inclusion of "retained earnings" (the residual amount after appropriation of profits for the year) within disclosed reserves can distort the quantum and quality of Tier 1 capital because current year unaudited profits might not qualify as retained earnings (they are yet to be audited and are yet to be voted upon by the shareholders).
- Finding: Foreign bank branches are required to hold capital locally; supervisory assessment methodology is akin to the capital adequacy requirements prescribed under the Basel I standards.
- Finding: BI is computing and disseminating capital adequacy numbers for the system, including foreign bank branches.
- Finding: Local capital is used for (a) assigning a supervisory rating; (b) determining supervisory intervention; and (c) administering prudential requirements such as net open positions, exposure limits, related party exposures.
- Finding: Inter-office funds, a primary form of Tier 1 capital held by foreign bank branches, induce day-to-day volatility in the capital held by these branches.
- Finding: Deductions from capital are required for cross-holdings of Tier 2 bonds, but not stipulated for equity, Tier 1 innovative capital, and Tier 3 bonds.
- Finding: A more liberal definition of capital, dilution of risk weights, and weaknesses in asset classification and provisioning have resulted in inconsistencies with the Basel principles and may not appropriately capture banks’ risks.
- Recommendation: BI should initiate remedial measures to ensure the capital adequacy framework is consistent with the Basel I framework.
- Recommendation: BI may consider formally requiring systemically relevant banks and banking groups to maintain capital above the minimum prescribed in the Basel framework.
- Recommendation: BI should encourage banks to adopt a forward looking approach and factor stress test outcomes into their capital management framework.
- Implementation timing note: Full implementation of Basel II is expected from January 2014; until Pillar 2 and Pillar 3 of the Basel II framework are effectively operational, BI should require banks to maintain capital adequacy in line with the Basel I norms.
- Statutory/regulatory driver cited: BI’s minimum absolute capital requirement of IDR 100 billion and BI’s advice (suasion) to the top 14 banks to maintain a higher capital adequacy of at least 12 percent are described as drivers of higher capital levels in banks.

### Principle 7 — Risk management process: structure, deficiencies, and supervisory approach
- Principle summary: Supervisors must be satisfied banks have comprehensive risk management (including Board and senior management oversight) to identify, evaluate, monitor and control or mitigate all material risks and to assess overall capital adequacy relative to risk profile; processes should be commensurate with institution size and complexity.
- EC1 (policies and processes)
  - Requirement: Individual banks and groups must have comprehensive risk management policies and processes; supervisor assesses adequacy and can require strengthening.
  - BI regulations: Non-complex banks must establish policies/procedures for credit, market, operational, and liquidity risk; complex organizations must also consider legal, reputational, strategic, and compliance risks.
  - Banks must perform quarterly risk profile self-assessments (solo and consolidated) and provide them to BI; supervisory framework vets these as part of off-site processes and verifies selected aspects on-site.
- EC2 (Board and senior management oversight)
  - Implementation elements include: (i) independent risk-management unit and Board-level risk management committee; (ii) BoD and BoC oversight in formulating and overseeing comprehensive written risk management policies and strategies; (iii) adequacy of policies/procedures and limit setting; (iv) adequacy of risk identification/measurement/monitoring/control and MIS; (v) effective internal control functions.
  - Supervisory actions: On-site supervision at least once a year; supervisors may examine bank subsidiaries to ensure effective consolidated risk management.
- EC3–EC4 (documentation, communication, understanding risk vs capital)
  - Supervisor requires documented, reviewed, updated, communicated, and adhered-to risk management strategies, policies, processes and limits.
  - Supervisors can determine senior management and Board understand nature and level of risk taken, but cannot determine that senior management and BoC understand how risk assumed relates to adequate capital levels due to absence of robust internal capital methodologies and absence of a regulatory methodology for capital requirements for various risks.
- EC5 (internal capital adequacy assessment)
  - Finding: Banks are developing internal methodologies; a few have internal models for market risks but efforts to link risks to capital levels are a work in progress.
  - Finding: In most banks there is no internal capital adequacy assessment process.
  - Finding: Higher capital levels in banks are driven by BI’s minimum absolute capital requirement of IDR 100 billion and BI’s suasion to top 14 banks to maintain at least 12 percent, rather than risk-driven internal assessments.
- EC6 (model validation)
  - Finding: Banks are increasingly using internal models for market risk measurement, but some large banks lack appropriate methodologies for validating models; in one large bank the core component of a model is opaque to the bank.
- EC7–EC9 (information systems, product approval, segregation of duties)
  - Finding: Adequate information systems are required for timely reporting to Board/senior management (see EC 2, 4, and 5).
  - BI regulations require approval processes for new products and major risk management initiatives; compliance is assessed through off-site and on-site supervision.
  - Risk evaluation, monitoring, and control functions must be segregated from risk-taking functions and report directly to senior management and the Board.
- EC10 (standards issuance)
  - Finding: BI prescriptions cover credit, market, liquidity, operational, legal, strategic, reputational, and compliance risk; BI has not yet issued regulations on interest rate risk in the banking book.
- Assessment: Largely Compliant
- Supervisory concerns and recommendations:
  - BI needs to issue appropriate regulations and guidelines on interest rate risk in the banking book, internal capital methodologies, model validation, and to improve supervisory capacity to ensure meaningful implementation.
  - Operational example of weakness: Sale of certain types of forex derivatives where banks sold products without verifying customers’ underlying risk exposure, revealing serious shortcomings in risk management systems and lack of effective suitability/appropriateness requirements.

### Principle 8 — Credit risk: supervisory framework, practices, and gaps
- Principle summary: Supervisors must be satisfied banks have a credit risk management process that reflects the institution’s risk profile, with prudent policies and processes to identify, measure, monitor and control credit risk (including counterparty risk).
- EC1 (Board approval and supervisory confirmation)
  - BI regulations require Board-approved policies and procedures for credit activities (loans, treasury, investment, trade financing) including identification, measurement, monitoring, and control of credit risk.
  - Supervisors use off-site analysis and CAMELS to review credit risk profiles and perform on-site examinations to verify compliance and obtain full access to credit/investment portfolio information and responsible officers.
- EC2 (controlled credit risk environment)
  - Required elements: documented strategy; criteria/policies for new exposures, renewals and refinancing; effective credit administration; comprehensive reporting; problem asset identification; prudent lending controls/limits.
  - BI regulations require Board approved policies consistent with risk tolerance, cyclical considerations, and minimum asset grading mapped to BI regulatory definitions: “current”, “special mention”, “substandard”, “doubtful”, and “loss”.
  - Banks must review asset classification and provisions at least every three months.
  - Some larger banks have more refined internal grading systems mapped to BI definitions.
- EC3 (arm’s length credit decisions)
  - BI regulations require credit approval procedures based on prudential principles and require related party credit policies to be at least as stringent as for non-related parties; all related-party exposures must be approved by the BoC.
  - Compliance is verified via internal audit, compliance function, and BI off-site/on-site assessments.
- EC4 (supervisor access)
  - Off-site supervision relies on reports such as asset quality and provision, legal lending limit (LLL), and financial statements; BI can obtain additional information ad hoc and has ease of access to records and officials.
- Assessment: Largely Compliant
- Supervisory concerns:
  - Gaps remain in compliance with principles on large exposures, related party exposures, asset classification, and provisioning.
  - Experience with forex derivatives transactions indicates deficiencies in credit risk management and inadequate assessment of credit risk elements in certain products.

### Principle 9 — Problem assets, provisions, and reserves: classification and provisioning framework
- Principle summary: Supervisors must be satisfied banks establish and adhere to adequate policies and processes for managing problem assets and evaluating the adequacy of provisions and reserves.
- EC1 (requirements for policies and periodic review)
  - BI regulations require banks to comply with standards for identification and classification of problem assets, establishment of general and specific loan loss provisions, loan write-offs, and debt restructuring; compliance is assessed during on- and off-site reviews.
  - Asset classification applies to all earning and non-earning assets (other than government securities and BI bonds (SBIs)), including placements, securities, loans, derivatives (positive MTM value), equity participations, foreclosed collateral, abandoned property, and off-balance sheet items.
  - Restructured debt shall be classified no higher than substandard for loans previously in more severe categories.
  - Banks must review asset classification status and provisions at least every three months.
- EC2 (supervisor confirmation of adequacy)
  - BI regulations prescribe methods for classification and provisioning of assets in adequate detail (description continued in source).
- Assessment and comments (context from surrounding sections):
  - BI’s regulatory framework sets out classification and provisioning rules and supervisory assessment mechanisms, but earlier sections highlighted weaknesses in asset classification and provisioning that contributed to inconsistencies with Basel principles and warrant more prudent requirements and remedial action by BI.

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

### 1.  Earning Asset Classification based on promptness of payment

### 1.  Earning Asset Classification based on promptness of payment

### Key provision
- Earning assets which are deemed to be small in terms of amount/exposures may be classified only based on the promptness of the payment of principal/and or interest.

### Conditional allowance for MSME loans
- Banks that meet certain norms relating to capital adequacy, the risk control system, and rating may also classify loans to micro, small, and medium enterprises based on promptness of payment.

*Source: _cr12335 - 1.  Earning Asset Classification based on promptness of payment*

### 2.  Earning Asset Classification based on the “Three Pillars”

### 2.  Earning Asset Classification based on the “Three Pillars”

### Classification framework and provisioning matrix
- All other earning assets must be classified based on an assessment of the “3 pillars”: business prospects; obligor performance; and payment capacity.
- Earning assets are categorized into five classifications: (i) current, (ii) special mentioned, (iii) sub-standard, (iv) doubtful, and (v) loss.
- Specific delinquency periods and provisioning requirements:
  - Current — Delinquency period: -; Provisioning requirement: 1%
  - Special mentioned — Delinquency period: 1 to 90 days; Provisioning requirement: 5%
  - Substandard — Delinquency period: > 90 to 120 days; Provisioning requirement: 15%
  - Doubtful — Delinquency period: > 120 to 180 days; Provisioning requirement: 50%
  - Loss — Delinquency period: > 180 days; Provisioning requirement: 100%
- Provisions are maintained after netting the value of collateral from gross amounts outstanding. Collateral values are subject to BI-prescribed haircuts, dependent on type of collateral and time since last valuation (haircuts between 30-70 percent).

### Treatment of collateral, secured exposures, and system adequacy
- Given weaknesses in collateral and creditor rights enforcement frameworks in Indonesia, and the consequent low recovery rate, regulatory provisioning requirements are assessed as being on the low side—even for secured exposures.
- At the system level, provisions for NPLs held by banks were about 60 percent of NPLs at end-September 2009.
- BI regulations state minimum provisioning requirements and encourage banks to develop more robust internal assessments of loan loss provisioning adequacy.
- Adequacy of provisions is verified off-site via reported details and on-site assessments.

### Uniform asset classification, exemptions, and thresholds
- Prior to 2005, asset classification of different earning assets of an obligor had to be applied uniformly within a bank (one obligor concept). Since 2005, BI extended the uniform asset classification requirement across banks (system-wide one obligor concept).
- Regulations exempt all exposures up to IDR 10 billion (USD 1 million) in each bank from the requirement of uniform asset classification; this exemption also applies if assets are classified on the basis of different assessment factors.
- Bank Indonesia Regulation No 9/6/PBI/2007 relaxed the one obligor concept by increasing the threshold and enabling banks to switch from the one obligor concept when certain requirements are met.
- Bank Indonesia Regulation No 11/2/PBI/2009 allows certain banks demonstrating “strong” credit risk management to apply the delinquency-only criteria for credit exposures up to IDR 20 billion (USD 2 million) (specifically for small and medium enterprises meeting certain criteria); previously the delinquency-only criteria applied to exposures up to IDR 500 million (USD 0.05 million).

### Restructured debt, NPV loss, and immediate upgrading
- All restructured debt requires a calculation of net present value (NPV) loss using the loan’s original effective interest rate and provisioning at the time of restructuring.
- BI regulations stipulate that restructured debt shall be classified no higher than substandard for credit that was classified in a more severe category prior to debt restructuring, allowing immediate upgrading of restructured NPLs.
- Regulations allow immediate upgrading of restructured accounts: restructured NPLs in doubtful and loss categories can be upgraded to substandard immediately after restructuring, and can be upgraded further to “current” after satisfactory performance for a short period of 3 consecutive payments under revised terms.

### Treatment differences: credit vs temporary equity vs foreclosed collateral
- Asset classification norms differ for credit, temporary equity participation (conversion of debt to equity at restructuring), and foreclosed collateral.
- Periods for which higher classifications can be maintained:
  - Current: Credit — up to -; Temporary equity — Up to one year; Foreclosed collateral — Up to one year
  - Special mention: Credit — 1 to 90 days; Temporary equity — --; Foreclosed collateral — --
  - Substandard: Credit — > 90 to 120 days; Temporary equity — 1 to 4 years; Foreclosed collateral — 1 to 3 years
  - Doubtful: Credit — > 120 to 180 days; Temporary equity — 4 to 5 years; Foreclosed collateral — 3 to 5 years
  - Loss: Credit — > 180 days; Temporary equity — If not withdrawn even though debtor company has not posted cumulative profits; Foreclosed collateral — More than 5 years
- The lighter classification rules for temporary equity and foreclosed collateral make it possible for banks to classify portions of NPLs as “current” immediately after restructuring or foreclosure.

### Exemptions for guaranteed exposures and operational reporting
- Exposures covered by government guarantees, GoI bonds, BI bonds, prime bank guarantees, and MDA guarantees (cash collateral) do not require classification below ‘current’ provided banks submit claims for encashment no later than seven days after the event of default (permitting classification as current even when payments are in arrears for 97 days).
- BI receives monthly and quarterly off-site regulatory reports detailing banks’ asset classifications, associated provisions, and restructured loans to verify accuracy and adequacy.

### Supervisory powers, on-site adjustments, and enforcement
- BI can require banks to modify reported volumes of adversely classified assets; require increased provisions; and take other actions including downgrading CAMELS ratings. Results are reported to the bank’s BoC and BoD via meetings or supervisory letters.
- BI regulations require banks to have independent units for identification, monitoring and resolving problem loans (special asset management unit and credit risk review function). Compliance is verified on-site.

### Identified weaknesses with material implications
- BI’s approach is compliance-oriented and largely guided by regulatory minimums; banks tend to maintain provisions close to regulatory requirements.
- Weaknesses in legal, economic and accounting environments are not adequately factored into regulatory and supervisory frameworks.
- Weaknesses in collateral and creditor rights enforcement and uncertainty over valuation/collectability of certain collateral items (e.g., inventory, warehouse receipts, boats under hypothecation).
- Regulations allow immediate upgrading of restructured accounts and do not limit the number of times a loan can be restructured—creating potential bias toward repeated restructuring.
- Lighter classification and provisioning norms for temporary equity participation and foreclosed collateral compared to credit.
- Recent relaxations: raising exemption for uniform asset classification threshold to USD 1 million and expanding delinquency-only criteria up to USD 2 million for certain banks have weakened the regulatory framework.
- Lack of supervisory adjustments or compensatory measures following NPL norm relaxations raises concerns about supervisory effectiveness.
- Reporting requirements ensure NPL information reaches Boards, but BoCs do not evidently actively manage problem asset portfolios.

### Policy recommendations and supervisory enhancements
- Review asset classification and provisioning norms for NPLs to ensure adequate identification, management, and provisioning across the banking system.
- Frequently review the provisioning matrix to align with actual system experience.
- Enhance regulations to ensure Boards of Commissioners (BoC) actively manage problem assets.
- Consider requiring a longer time frame than the current requirement of three payments before permitting upgrading restructured accounts to ‘current’.
- Require banks to factor collateral and creditor rights enforcement weaknesses when estimating provisioning needs and consider higher provisioning or stricter haircuts where recovery prospects are weak.
- Ensure supervisory verification includes stronger assessment of valuation practices and collateral haircuts (haircuts between 30-70 percent remain in regulation).

*Source: IMF staff summary of Section 2, “Earning Asset Classification based on the ‘Three Pillars’.”*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12335.pdf_