The profitable and rapidly growing banking sector continues to attract interest from domestic and international financial institutions seeking to access the potential of the still largely underbanked population. To ensure financial services continue to advance in a stable manner, government regulators are working to adjust policies and regulations to protect the sector and secure its future.
Following its creation in 2011 and its later assumption of regulatory duties from the central bank, Bank Indonesia (BI), at the end of 2013, the Financial Services Authority (OJK) has been tasked with overseeing the banking sector and has been steadily rolling out new regulatory measures to keep pace with the evolving industry. Generally speaking, the transition of oversight from the BI to the OJK has been relatively smooth and well received by the banking industry, despite a degree of uncertainty surrounding a few sensitive topics, including the top officials within OJK, new regulations governing non-performing loans (NPLs), financial technology (fintech), credit risk and the potential need to re-draft an entirely new banking law.
“Regulation has moved up the list in terms of perceived risk to the industry. Most of the concern in 2016 was related to NPLs and engagement with the regulator on credit risk, as opposed to any new perceived onerous regulations,” David Wake, adviser for the financial services industry at PwC Indonesia, told OBG. “Banks generally would like to have more clarity, but reporting requirements are not perceived to be overly burdensome. The main concern is the recent change in leadership at OJK and to what extent this may drive new regulation or a change in approach. This is the first top-level change in this institution, which brings uncertainty.”
Since its inception in 2011 the nine members of the OJK’s board of commissioners have remained unchanged. The process to institute new leadership was initiated in 2016 and finalised in July 2017, when the new members were sworn in for the 2017-22 period. The new board is not expected to complete assignment of its support and staff until the end of 2017, meaning any major shifts in policy or regulation are unlikely to occur before 2018.
RISK ASSESSMENT: As a result of this and other concerns, the regulatory environment is seen as one of the most significant risks in the banking sector in 2017, according to the results of PwC’s “Indonesia Banking Survey 2017” report. Regulation ranked third out of 17 potential risk categories facing the banking sector over the next two to three years – it ranked behind only macroeconomic risk (1st) and credit risk (2nd). Meanwhile, it ranked ahead of liquidity risk (4th) and interest rates (5th). This represents a significant leap from the previous survey in 2015, in which regulatory risk ranked 9th.
Within the regulatory environment, the impending draft banking law appears to be generating the greatest amount of uncertainty: 71% of survey respondents said they would like to have more clarity or dialogue with the OJK on this measure. This was by far the most prevalent concern, but respondents considered other areas important as well, including risk management and corporate governance (40%), IT and technology (29%), and capital management and the Basel international regulations (26%).
Other potentially problematic regulatory issues included credit and provisioning, which 24% of respondents cited, along with IT onshoring (16%), and Know Your Customer due diligence and anti-money laundering concerns (13%).
DRAFT BANK LAW: Although the OJK has issued numerous regulations covering a number of sub-sectors, ranging from capital requirements and risk management to IT and fintech, perhaps the most important piece of regulation is one that has not yet come to fruition, despite years of consideration. First tabled in 2015, the draft banking law was introduced as a means to simultaneously modernise the existing regulatory framework and address many shortcomings and opacities present in its predecessor. Yet, after nearly three years on the Parliament’s agenda, a finalised bill has yet to materialise.
Many proposed provisions of the new law are likely to have a considerable effect on the banking sector. Some of the more significant areas addressed include: bank establishments and ownership structure, permitted activities of commercial and rural banks, bank secrecy and exemptions, and consumer protection. Several of these, such as bank secrecy, have already been addressed through various new initiatives rolled out by the OJK.
The new law would likely to be particularly problematic for foreign banks. The main issues relate to restrictions on foreign ownership of banks and new divestment requirements. This more domestically focused initiative follows precedents set in other sectors – such as mining and energy – where the government has sought to prop up domestic industries and increase its take of revenue sharing.
Initial proposals floated by regulators suggest that new restrictions would limit foreign investment in banks to a 40% stake and that foreign investors holding shares over that amount divest the excess to Indonesian citizens or legal entities within 10 years of the effective date of the law.
In addition, the draft bank law could require commercial banks, including branch offices of foreign banks, to incorporate as Indonesian limited liability companies. The law is also likely to require domestically operating companies to onshore their data. This would likely be met with resistance by foreign banks, particularly if they utilise centralised data centres, shared-service centres and IT strategies for their entire international networks, as opposed to isolated structures in each country of operation.
TECH SAVVY: As the sector increasingly turns to IT and fintech to boost efficiency, attract customers and offer electronic services, the government must continue to update regulations in a fluid business environment. The rise of fintech has already created some disruption in the banking sector, and the use of electronic banking applications in Indonesia is increasing in popularity. In response, the OJK has begun rolling out a series of regulations to bring these new operations into the regulatory fold.
No fewer than four significant measures relating to this trend were implemented in 2016: the amendment to the Electronic Information and Transactions (EIT) Act, the Protection of Personal Data in Electronic Systems, fintech regulations by BI and the founding of BI’s new Fintech Office.
The EIT Act is largely an update of its precursor law, which came into force in 2008, and includes revamped measures that require, among other things, electronic system operators to delete irrelevant electronic information upon request. This is known as the “right to be forgotten”.
The BI fintech regulation establishes comprehensive guidelines for the organisation of these payment systems, recognising nine types of payment service operators: principals, issuers, acquirers, clearing operators, switching operators, payment gateway operators, final settlement operators, fund transfer operators and e-wallet operators.
Other technology-related issues currently under scrutiny by regulators and the private sector, which are likely to be addressed in the near future, include cybersecurity and customer mobile and web applications that do not require a wet signature.
STABLE RESERVES: BI also introduced another initiative – a new reserve ratio (RR) requirement averaging measure, designed to help reduce volatility in the overnight money market. Starting in July 2017 RR averaging requires banks to fulfil their RR requirements by maintaining a daily RR of 5% of third-party funds along with an average RR of at least 6.5% over a two-week period.
This new averaging system provides greater flexibility in liquidity management than the previous fixed 6.5% RR daily requirements, giving banks the opportunity to increase efficiency.
The new system can also reduce interest rate volatility in the money market and provide space for liquidity placement to deepen the financial market. “There is a large surplus of liquidity in the system right now, but the distribution is not equal among banks and... smaller banks do not always have access to borrow from bigger banks in the money market,” Dody Budi Waluyo, executive director of economic and monetary policy at BI, told local press in April 2017, adding that the policy’s goal is to address this problem. Waluyo noted the new flexibility in the regulations could reduce volatility, because banks will not be compelled to resort to the overnight money market to meet their daily RR requirement if they miscalculate their daily deposit needs.
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