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COPYRIGHT 2006 Institute of Southeast Asian Studies (ISEAS)
I. Introduction
With the creation of new financial instruments and services offered by various financial institutions, countries have found that boundaries between the different types of financial institutions such as banking, securities, and insurance have blurred (Taylor and Fleming 1999). In their study of fourteen countries, Martinez and Rose (2003) found that at the end of 2001, the market shares of financial conglomerate in the banking sector, the securities industry, and the insurance industry had significantly and rapidly climbed to around 71 per cent, 63 per cent, and 70 per cent, respectively. (1) The increasing presence of financial conglomerates is also highly visible in major Southeast Asian economies. (2) The role of bancassurance (whereby commercial banks actively distribute insurance products as well) has seen a phenomenal growth as a result of broad-based financial deregulation in a large number of Asian economies. By 2006, bancassurance can potentially account for 13 per cent of total premiums collected in Asia's life insurance sector, and 6 per cent of the non-life insurance sector (Sigma 2002).
As in neighbouring economies, the commercial banks in Indonesia have also been permitted to play active roles in the security and insurance sectors (Table 1). While at present financial conglomerates in Indonesia are arguably still in an early stage, they are by no means insignificant. By end 2003, it is estimated that at least ten banks deliver bancassurance with a potential market of around Rp14 trillion, and at least fifteen banks offer mutual funds, mostly based on government bonds (see Hidayat 2003, and Table 2). It is estimated that up to June 2003, around 85 per cent (or roughly Rp58 trillion) of the mutual funds were sold via banking institutions.
As the role of financial conglomerates continues to rise, concerns become more apparent over the effectiveness of multiple regulatory and supervisory agencies (Taylor and Fleming 1999, Mwenda and Fleming 2001, and Claessens 2002). At the end of 2002, Martinez and Rose (2003) reported that at least twenty-two countries have adopted a fully integrated supervisory agency, and twenty-four countries have partially unified the supervision of two types of financial intermediaries (Table 3). The Scandinavian economies (namely, Denmark, Norway and Sweden) were the first to establish their integrated supervision agencies starting between 1986 and 1991. (3) The creation of the Financial Supervisory Authority in the United Kingdom was announced in 1997. As a consequence of Korea's restructuring process of its financial sector following the outbreak of the financial crisis in late 1997, the country consolidated all its supervisory agencies for bank and non-bank institutions, securities and futures markets, and insurance into a single supervisory board (the Financial Supervisory Service) on 1 January 1999. The most recent examples of countries adopting a single supervisory body are Estonia, Germany, Ireland, and Malta in 2002. Highlighting further the rising importance of this unified supervisory approach, an informal club of "integrated supervisors"--comprising representatives from Australia, Canada, Denmark, Japan, Korea, Norway, Singapore, Sweden, and the United Kingdom--met in Sydney, Australia in early May 1999 for the first time.
Like all the economies affected by the 1997 financial crisis in East Asia, Indonesia pushed forward a few key reform commitments, including a plan to establish a single financial supervisory board. Presently, the functions of regulation and supervision of the financial sector in Indonesia are shared among different institutions. The central bank as stated in Article 8 of Law No. 23/1999 is responsible for the tasks of regulating and supervising the banking sector. The Ministry of Finance is responsible for the insurance sector. The stock exchange is under the direct supervision of its own Capital Market Supervision Authority (BAPEPAM).
The new supervisory institution will undoubtedly alter the landscape of the financial safety net system of the country in the near future. The official target date for the establishment of the single supervisory agency is no later than December 2010. Clearly, this is a mammoth task for the country to deliver within a relatively short period of time. The objective of this paper is to identify selected key potential challenges associated with the initial design process of the integrated financial sector supervisory board in Indonesia.
The remainder of the paper is organized as follows. Section II briefly reviews a number of key aspects behind an integrated financial supervisory agency. Sections III to VI present selected main challenges in the process of establishing and operating the single financial supervisory agency in Indonesia. Brief concluding remarks end the paper.
II. Single Supervisory Agency: Brief Overview
Before we examine the Indonesian case, this section highlights some issues behind the ongoing strategic debate between the proponents and opponents of a single supervisor. Some of these fundamental matters underlined in the debate will provide guidelines for our analyses of the Indonesian case to be presented in subsequent sections.
II.1 Proponents of a Single Supervisor
Two broad arguments have often been made in favour of a single supervisory agency. The first is to enhance the overall supervisory capacity of the financial sector. Fragmented supervision bodies have been reported to be inept in forming an overall risk assessment of a financial conglomerate on a consolidated basis due partly to a range of sources of financial risks associated with each part of the institution. Abrams and Taylor (2000) for instance argue that while the supervision of banking and securities tends to focus on the risk associated with the asset side of the balance sheet (such as sizes of nonperformance loans and capital adequacy), the financial risk for the insurance company occurs mostly from the liabilities side of the balance sheet. Consequently, an integrated financial sector supervision body--in which banking, securities, and insurance regulations are combined within a single institution--has emerged as a preferred choice to deal with a complex financial system.
Martinez and Rose (2003) have further argued that, under a system of multiple supervisory bodies, accountability may be easily diffused in cases of regulatory failure at any of the independent supervisory agencies, and that a lack of harmonization in the regulations and in their implementation across institution may arise. However, a single supervisory agency is able to monitor the financial system as a whole, and to minimize regulatory arbitrage by applying a consistent approach to regulation and supervision across all segments of the financial system.
Achieving higher economies of scale--through centralized regulatory functions that permit the development of joint administrative, information technology, and other support functions--is another rationale behind the establishment of a single supervisory agency (Taylor and Fleming 1999). In most countries where there are few qualified personnel, a single supervisory agency should benefit from the pooling of all available skilled personnel.
II.2 Potential Shortcomings of an Integrated Supervisory Agency
There are at least three general concerns that have frequently been expressed against the establishment of an integrated, including that of a single, supervisory agency. First, the success of a single supervisory agency is highly dependent upon the strength of the pre-existing multiple supervisory agencies. Abrams and Taylor (2000) argued that to be effective, the newly established supervisory institution needs to emulate/reflect the structure of the sectors that it supervises. Hence, unless independent and effective supervisory agencies have been well established for each segment of the financial system, the merging of these institutions into one will not necessarily improve the supervision and regulation of the financial sector of the economy. In a similar vein, Martinez and Rose (2003) argued that it is imperative to address weaknesses of supervision and regulation at various levels of the financial system before even discussing the number of agencies that should supervise the financial system. It is also important to note that the integration process should be done only when the financial system is stable.
Second, at early stages of the transition from multiple agencies to a single one, the past experiences of countries (listed in Table 3) shows that they consistently had initially lower supervisory effectiveness....
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