FINANCIAL SYSTEM SAFETY NET
The Financial System Safety Net (FSSN) provides the underlying framework for the deposit insurance scheme and the emergency financial facility under the central bank's lender of last resort function. It also forms the basis for crisis resolution policy. The FSSN is targeted more at crisis prevention but includes crisis resolution mechanisms to prevent crises from incurring enormous costs to the economy. The objective of the FSSN is thus to safeguard financial system stability so that the financial sector can operate normally and contribute to sustainable economic development.
In 2005, the Government and Bank Indonesia developed a framework for the Draft Law on the Financial System Safety Net. The framework clearly specifies the tasks and responsibilities of the relevant institutions involved in the operation of the Safety Net: the Ministry of Finance, Bank Indonesia (BI) and the Indonesian Deposit Insurance Corporation (DIC). In principle, the Ministry of Finance is responsible for drafting legislation for the financial sector and providing funds for crisis resolution. BI, the central bank, is responsible for safeguarding monetary stability, maintaining a sound banking system and ensuring the secure and robust operation of the payment system. The DIC, on the other hand, has responsibility for guaranteeing bank customer deposits and resolution of problem banks.
The FSSN framework is set out in the Draft Law on the Financial System Safety Net, which is currently undergoing a consultation process. In this way, the Financial System Safety Net Law will provide a strong foundation for the financial system stability policies and regulations to be established by the relevant authorities. The Draft Law specifies all components of the FSSN: (1) effective bank regulation and supervision; (2) lender of last resort; (3) adequate deposit insurance scheme; and (4) effective mechanism for resolution of crisis.
1. Effective Bank Regulation and Supervision
In the FSSN, effective bank regulation and supervision represents the first line of defence. Effective regulation and supervision have a very important role. The framework therefore defines the guiding principle that the regulation and supervision of financial institutions and markets must always aim to maintain financial system stability. Regulation and supervision, of course, must be guided by best practices and applicable standards.
2. Lender of Last Resort
Well-designed lender of last resort (LoLR) policies have proved their effectiveness in crisis prevention and resolution. BI has therefore formulated a more clearly defined LoLR policy for normal and emergency conditions, with reference to best practices. Under normal conditions, the LoLR is only available to illiquid but solvent banks able to provide liquid, high-value collateral. When assistance is extended under the LoLR function in a crisis, the primary consideration is the potential for systemic impact. Nevertheless, the bank must also be solvent and able to provide collateral.
To resolve liquidity difficulties with systemic impact, Bank Indonesia may provide the emergency financing facility to commercial banks under the lender of last resort function. This assistance will be funded by the Government under the Bank Indonesia Law (Act No. 23 of 1999, amended by Act No. 3 of 2004). The implementing regulations governing the lender of last resort function are Regulation of the Minister of Finance No. 136/PMK.05/2005 dated 30 December 2005 and Bank Indonesia Regulation No. 8/1/2006 dated 3 January 2006. Funding for the emergency financing facility is allocated from the State Budget.
3. Adequate Deposit Insurance Scheme
Experience demonstrates that deposit insurance is a key element in financial system stability. The government blanket guarantee introduced in response to the economic crisis in 1998 succeeded in restoring public confidence in the banking sector. Even so, research also shows that the blanket guarantee was fraught with moral hazard, creating a potential trigger for a new crisis in the long term.
To address this issue, Indonesia has adopted the Deposit Insurance Corporation Law (Act No. 24 of 2004). Under this law, the Indonesian Deposit Insurance Corporation (DIC) will have two key responsibilities: (i) to guarantee bank customer deposits; and (ii) to resolve cases of problem banks. To avoid any negative impact on financial stability, the deposit insurance scheme is being phased in over an extended period. From March 2007, the bank customer deposit guarantee will be restricted to Rp 100 million per account.
4. Effective Crisis Resolution Policy
A policy for effective crisis resolution is set out in the policy framework for the FSSN to ensure that any crisis can be speedily resolved without incurring high costs for the economy. The FSSN specifies the roles and responsibilities of each authority in dealing with crisis. Each institution therefore has clear lines of responsibility and accountability. This ensures that any crisis can be dealt with effectively, quickly and without high social and economic costs.
On a practical level, the Financial System Safety Net can only operate with effective coordination among the relevant authorities. To this end, a Coordinating Committee has been set up, consisting of the Minister of Finance, the Governor of BI and the Chair of the Board of Commissioners of LPS. In a Joint Decree issued by the three Coordinating Committee members, the Financial System Stability Forum is designated the coordinating forum for BI, the Ministry of Finance and LPS for the purpose of maintaining financial system stability.