IMF Executive Board Approves Indonesia’s 2017 Financial System Stability Assessment

June 12, 2017

On May 24, 2017, the Executive Board of the International Monetary Fund (IMF) discussed the Financial System Stability Assessment (FSSA) of Indonesia. [1]

Since the 2010 Financial Sector Assessment Program (FSAP), Indonesia’s macroeconomic performance has been robust and the financial system has been stable. The financial system has weathered well a simultaneous economic and credit deceleration. Corporate vulnerabilities have remained broadly in check, though debt at risk is elevated in some sectors and external refinancing risk persists. The banking system remains sound even though, as economic growth has slowed, banks’ high profitability has fallen somewhat and problem loans have risen. Banks’ capitalization remains strong and well above regulatory minima.

Indonesia’s financial system is relatively shallow and dominated by banks belonging to financial conglomerates. Total financial system assets equal about 72 percent of GDP, three quarters of which reflect banks’ assets. Financial conglomerates play a key role in the financial system and pose a challenge for effective oversight. Capital markets are relatively thin, and external financing is important for long-term financing due to a small domestic investor base.

Systemic risk is low and the banking system appears generally resilient to severe shocks. Market based indicators point to relatively low levels of systemic risk. Under severe stress-test scenarios, banks experience sizable credit losses, particularly from corporate exposures, but high capital levels and strong profitability help to absorb most of these losses and the resulting capital shortfalls are modest. Many banks face relatively small shortfalls in liquidity stress tests, including in foreign currency, and these appear manageable for Bank Indonesia (BI).

The authorities have been pursuing an ambitious agenda to strengthen financial oversight and crisis management. Since the last FSAP, the authorities have implemented the Basel III capital framework, adopted a new insurance law, and improved supervisory practices across sectors. Importantly, in 2011, the Financial Services Authority (OJK) was established as an integrated regulator to oversee the entire financial sector. In addition, BI has developed analytical tools to assess systemic risk and has introduced several macroprudential instruments. The framework for crisis management and resolution, and safety nets was revamped in 2016 under the new Prevention and Resolution of Financial System Crisis Law (PPKSK Law).

The FSAP took stock of the progress that has been made and identified areas where further progress will be needed. Notably, the mandates for OJK supervision and BI’s macroprudential policy do not give clear primacy to financial stability over developmental objectives and this can undermine timely actions. Further, although legal protection for staff and agencies involved in oversight and crisis management has been strengthened with recent reforms, it is not in line with best international practice and risks causing inaction bias. On supervision. the main remaining challenges to effective supervision stem from the complex structure and weak governance practices of financial conglomerates and OJK’s capacity to supervise them, silos in OJK’s internal structure, and an insufficiently intrusive supervisory approach across sectors. As for the improved crisis management framework, the role of the Financial System Stability Committee in designing resolution strategies and directing member agencies in implementing them as well as the important role envisaged for the President of Indonesia in crisis management risk diluting the responsibility of relevant agencies in taking swift action. Also, the new framework rules out the use of public funding in resolution which can be overly constraining. Finally, the restrictive criteria for providing emergency liquidity assistance risk making it ineffective in crisis.

Executive Board Assessment [2]

Executive Directors agreed with the findings and the key recommendations of the FSSA. They commended the Indonesian authorities for undertaking major reforms since the 2010 assessment, notably the integration of financial sector supervision, the upgrading of the crisis management and resolution framework, and the implementation of Basel III. Directors encouraged the authorities to build on this progress by implementing the recommendations of the FSSA to further enhance financial sector resilience, while also promoting financial deepening and inclusion based on a clear roadmap.

Directors welcomed the findings that systemic risk is low and that the banking system appears generally resilient even to severe shocks. They nevertheless emphasized the need to closely monitor systemic risks and remain vigilant to events that can disrupt financial stability. Directors also recommended that the authorities implement liquidity requirements in foreign currency, carefully monitor special mention and restructured loans, and improve loan classification and provisioning.

Directors stressed the importance of interagency cooperation in financial oversight and crisis management, and welcomed in this regard the establishment of the OJK. They concurred that legislative amendments would be useful to clarify institutional responsibilities for OJK and BI that prioritize financial stability over development objectives, include a macroprudential mandate for BI, reduce overlap in supervisory activities, and improve legal protection for staff involved in supervision and crisis management.

Directors saw a need to strengthen the framework for supervising financial conglomerates given their systemic importance in Indonesia. Achieving effective, risk based supervision of conglomerates will require broad based efforts, including through legislative changes, improved corporate governance, and more integrated supervisory processes.

Directors noted that the adoption of the Prevention and Resolution of Financial System Crisis Law represents an important improvement to the framework for crisis management and resolution. Further efforts to enhance its effectiveness should include refining the emergency liquidity assistance framework, clearly defining the roles of the President and the Financial System Stability Committee in crisis management, and allowing for public funding of resolution in limited circumstances justified by systemic stability considerations and under appropriate safeguards.

Directors welcomed the progress in enhancing the framework for anti-money laundering and combating the financing of terrorism. They looked forward to continued efforts to address remaining deficiencies and align the framework with the revised Financial Action Task Force standard.

[1] The Financial Sector Assessment Program (FSAP), established in 1999, is a comprehensive and in-depth assessment of a country’s financial sector. FSAPs provide input for Article IV consultations and thus enhance Fund surveillance. FSAPs are mandatory for the 29 jurisdictions with systemically important financial sectors and otherwise conducted upon request from member countries. The key findings of an FSAP are summarized in a Financial System Stability Assessment (FSSA), which is discussed by the IMF Executive Board. In cases where the FSSA is discussed separately from the Article IV consultation, at the conclusion of the discussion, the Chairperson of the Board summarizes the views of Executive Directors and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in a summing up can be found here: .

[2] At the conclusion of the discussion, the Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing up can be found here: .

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