BI-OJK’s interdependent relationship Rangga Cipta   ;   An Economist at Samuel Sekuritas Indonesia

JAKARTA POST,  30 Desember 2013

                           

The banking supervisory function of Bank Indonesia (BI) will this month be transferred to the infant financial supervisory body of the Financial Services Authority (OJK).  The long awaited change was officially proposed in 1999 and was finally granted by the House of Representatives back in 2011. The separation of banking supervision from monetary authority is needed to guarantee policy independence and maintain a strong banking structure, and to avoid conflicts of interest in the trade-off between monetary policy and financial stability.  According to those who support this separation, the need to manage financial stability demands the sacrifice of price stability. When that occurs, the effectiveness of monetary policy transmission and the central bank’s reputation could be heavily eroded.  However, many things have changed since 1999. The aftermath of the world financial crisis in 2007-2008 initiated many structural reforms, especially how the central banks should conduct their “bubble-sensitive” monetary policies. The German approach of a single supervisory mechanism has been abandoned by its proponent. Earlier this year, around 1,000 personnel of the UK’s Financial Services Authority (FSA) were transferred into a new body known as the Prudential Regulatory Authority (PRO). The supervisory body has become a subsidiary of the Bank of England (BoE).  The BoE maintains its function as a monetary authority with the additional mandate of looking after financial stability. It is important to note that the BoE was stripped of its bank supervisory responsibilities in mid-1997. The US Federal Reserve, which has been blamed for its inability to detect a housing bubble created by excessive risk-taking within an increasingly complex financial system, has been given additional responsibilities by expanding its power to being a supervisor of the banking industry from being a mere liquidity manager. As a result, the Dodd-Frank Act was signed by US President Barack Obama in July 2010 with the aim of reinforcing the Fed’s supervisory and regulatory responsibilities.  Meanwhile, the finance ministers of the European Union have recently finalized the state of play of the Banking Union this December. The EU has adopted a bank single supervisory mechanism (SSM), led by the European Central Bank (ECB).  Under the SSM, the ECB will work with national authorities to supervise credit institutions across the EU. It is expected the ECB will start conducting banking supervisory responsibilities in the second half of 2014.  Regarding the eurozone debt crisis, countless critics have blamed the ECB, as the current system did not work properly. The supervisory function was being taken care of by each member country inside the monetary union, while monetary authority belonged to one central bank (ECB).  While independency is considered critical in conducting monetary policy, the absence of a supervisory function within the central bank’s authority has allegedly been the Achilles’ heel of protecting financial stability.  Therefore, a central bank must have full control over the supervisory function to watch economic development in a business cycle. Under a single policy framework, the monetary policy must collaborate with macro-prudential as well as micro-prudential policies to ensure that economic adjustment to dynamic equilibrium will be as smooth as possible. Separating banking supervision from monetary authority would induce wasteful duplication, as there is great chance of overlap between the objective and the information required by both the supervisory body and the central bank.  Inefficiency will appear in a situation where the supervisory body might have valuable information about risk inside the banking system but is unable to perform market surveillance in the same capacity as the central bank. The central bank would also face obstacles in launching appropriate, immediate policy responses in the case of financial market turbulence. For example, in a situation where a liquidity crisis occurs, the financial system will require a quick injection of funds that can only be done by the central bank. The supervisory body is bound to focus on the rather longer term target of strengthening the financial structure.  Different cultures from both sides will provide another problem. The supervisory body is surrounded by micro-minded auditors and lawmakers, while the central bank is occupied mostly by well-trained economists. Distinct perspectives in digesting the ongoing problem might require additional time for the central bank to launch a proper monetary policy.  Given these facts, the seemingly revolutionary step to segregate monetary policy and banking supervision should be taken very carefully. It is certain that having an independent banking supervisory body will bring Indonesia a stronger financial industry structure. However, if it comes at the cost of less power in promoting bold monetary policy and maintaining solid financial stability, additional joint efforts should be attached to accompany this segregation. There is no retreat after the divorce of monetary policy from banking supervision. Yet being separated and independent does not need to lead to conflict. Like any couple, BI and the OJK should promote an interdependent type of relationship.  Unlike codependency, which could lead to overlapping power and control, interdependency requires two parties capable of autonomy in pursuing multiple parallel goals.  When the two realize that financial stability can only be achieved with an excellent combination of monetary policy and banking supervision in the form of an integrated policy framework, the threat of financial instability will be easier to overcome.  ●