Lead BI and OJK into good collaboration Mohammad Nuryazidi ;  An Analyst at the Bank Indonesia Banten representative office

                                                JAKARTA POST,  11 Februari 2014                

                                                                                                                        

                                                                                         

                                                      

The beginning of 2014 was marked by a historic moment in the Indonesian financial industry when Bank Indonesia (BI) handed over one of its functions to the Financial Services Authority (OJK). Bank regulatory and supervisory functions are now entirely the responsibility of the OJK, while the central bank focuses on macro-prudential supervision and monetary management. Interaction between macro-prudential policies, in this case represented by BI and micro-prudential policies represented by the OJK, usually complement and reinforce each other. There is an analogy used by experts that illustrates how to distinguish the role of BI and OJK: If the financial system is a forest, then its tranquility and peace are the responsibility of the central bank, while the OJK is in charge of maintaining the health and survival of animals and trees that live in the forest. A fundamental concern of macro-prudential policy is that the interconnectedness of financial institutions and markets and their common exposure to economic variables may increase the riskiness and fragility of the whole financial system in ways and to an extent that will not be dependably captured by regulatory focus on individual institutions.  The Committee on the Global Financial System (CGFS) stated there are two distinguished aims of macro-prudential policy. The first is to enhance the resilience of the financial system to economic downturn and other adverse aggregate shock.  The second is to dampen systemic risks that arise and are propagated internally in the financial system through the interconnectedness of institutions by virtue of their common exposure to shocks and the tendency of financial institutions to act in pro-cyclical ways that magnify the extremes of the financial cycle.  Prudential standards are safety standards providing a backstop of resilience both to the firm and to the system. These two aims are not mutually exclusive. They both go beyond the purpose of micro-prudential policy, which is to ensure that individual firms have sufficient capital and liquidity to absorb shock to their loan portfolio and funding. In particular, micro-prudential supervision should be supplemented with macro-prudential policies aimed at increasing the resilience of the system as a whole, calming booms and softening busts, while mitigating systemic risks resulting from fallacies of composition associated with concentration and interconnectedness in the financial system.  Indeed, strong micro-prudential supervision is essential both to ensure that macro-prudential policymakers can draw on supervisory information in risk assessment and to ensure that the macro-prudential policy stance is effectively enforced across institutions. However, tensions may arise between micro-prudential and macro-prudential perspectives, because both policies rely on similar transmission mechanisms (Vinals, 2013). Both the OJK and BI use prudential policy instruments and tools that are applied at the level of the individual firm, such as buffers (whether capital or liquidity) and balance sheet restrictions. But they can do so with different objectives. Micro-prudential policy adjusts capital based on individual institutions’ risks, while macro-prudential policy adjusts overall levels of capital based on the financial cycle and systemic relevance to guard against systemic risk build up. Even though the purpose and calibration may differ, both policies depend on capital and liquidity tools that are deployed at the level of the individual institution.  Prudential standards are, in essence, safety standards providing a backstop of resilience both to the firm and to the system.  The use of similar instruments implies largely identical transmission channels, and makes the interaction between micro-prudential and macro-prudential policies particularly strong in comparison to relations between other public policies. Several elements of the micro-prudential and macro-prudential policies admittedly show overlaps that can create confusion regarding the border line of the policies. The lack of clarity in some aspects of the policies borders has both positive and negative aspects. Positive, as it provides flexibility to adjust the solutions to local circumstances; and negative, by making the accountability for the outcome of the policies less clear.  A clear understanding of the functions of the OJK and BI can help to exploit the complementarities between the two. It will facilitate coordination and consultation between the respective authorities. Open communication, information sharing and transparency are the essential foundation for effective functioning.  Arrangements can be more or less formalized; but frequency of contact, senior-level engagement and open exchanges are prerequisites for ensuring that full information is available to all parties.  Intensive coordination between the OJK and BI can go a long way in aligning policy action, while preserving their respective primary objectives. ●