Indonesia: Enhancing Financial Sector Governance, Risk Management, and Depth

Sovereign Project | 44252-012

Summary

The TA will build on key reforms initiated under the Financial Market Development and Integration Program (FMDIP) and will support the government's initial efforts to develop OJK as a world class financial regulator. The TA will also provide long-term support to the continuing implementation of select activities within the Capital Market and Nonbank Financial Industry Master Plan for 2010-2014 (CMNMP) that aim to deepen the capital market. Finally, the TA will support the government's efforts to increase the demand for domestic capital market instruments. It will do this by reducing resistance to the coordinated development of the traditional capital markets and the contractual savings sector. The TA will also strengthen the nonlife insurance sector's risk management capacity.

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Project Name Enhancing Financial Sector Governance, Risk Management, and Depth
Project Number 44252-012
Country Indonesia
Project Status Approved
Project Type / Modality of Assistance Technical Assistance
Source of Funding / Amount
TA 8326-INO: Enhancing Financial Sector Governance, Risk Management and Depth
Japan Fund for Poverty Reduction US$ 1.00 million
Strategic Agendas Inclusive economic growth
Drivers of Change Governance and capacity development
Partnerships
Private sector development
Sector / Subsector Finance - Money and capital markets
Gender Equity and Mainstreaming
Description The TA will build on key reforms initiated under the Financial Market Development and Integration Program (FMDIP) and will support the government's initial efforts to develop OJK as a world class financial regulator. The TA will also provide long-term support to the continuing implementation of select activities within the Capital Market and Nonbank Financial Industry Master Plan for 2010-2014 (CMNMP) that aim to deepen the capital market. Finally, the TA will support the government's efforts to increase the demand for domestic capital market instruments. It will do this by reducing resistance to the coordinated development of the traditional capital markets and the contractual savings sector. The TA will also strengthen the nonlife insurance sector's risk management capacity.
Project Rationale and Linkage to Country/Regional Strategy

A number of development constraints have continued to restrain growth in the financial markets. First, the "twin silo" approach to financial sector supervision exhibits a number of weaknesses. The banking sector is regulated by Bank Indonesia, the country's central bank while the capital markets, insurance, and nonbank financial sectors are regulated by Bapepam-LK. This means that regulation of financial conglomerates is bifurcated and cannot be applied on a consolidated basis. Regulations covering one part of the financial sector often constrain development in the other. Disparate access to resources and the lack of qualified immunity for nonbank regulators has produced an uneven application of supervision which is susceptible to arbitrage. Responsibility for financial sector development is likewise split between the two regulators and the Ministry of Finance's Fiscal Policy Office (FPO). The end results of these issues include a lack of coordinated development, low investor confidence, and limited domestic participation in the capital markets. An increase in foreign capital inflows due to an upgrade in Indonesia's credit rating has made the need to address these problems and modernize the supervision of financial markets even more urgent.

Government debt issuance continues and the outstanding debt stock has increased. However, the size of the debt market, relative to GDP, has declined as the pace of issuance has not mirrored the growth in the economy. This situation has been exacerbated by the fact that half of the outstanding government debt stock is thinly traded or not tradable. Market participants currently have no effective hedging mechanisms such as repurchase agreements, for example, and no derivatives. This forces market participants to close positions rapidly in response to nominal events and creates a feedback loop of elevated volatility. The FMDIP establishes a framework to increase the stock of tradable government debt by converting bank recapitalization bonds into government debt. However, more needs to be done to help develop more efficiently functioning primary and secondary government debt markets and to boost the role of the contractual savings subsector as a source of domestic demand for capital markets products. The contractual savings subsector needs to migrate to more advanced portfolio management methodologies but is constrained from doing so by an acute shortage of trained risk management professionals, including actuaries.

To address these issues, the government has made it a priority to strengthen the financial sector's infrastructure and assure investors of stability and proper governance. It has begun to harmonize supervision across the financial sector, reduce regulatory arbitrage, and improve the overall competence and integrity of supervision. Under the FMDIP, the government will launch an independent, unified financial sector regulator through the newly authorized Integrated Financial Services Authority (OJK). The FMDIP also includes support for significant revisions to the three primary sector laws governing capital markets, insurance, and pensions. This is intended to provide a legal framework for harmonized supervision, as well as supervisory immunity and the power to resolve problem institutions. While the establishment of OJK represents a landmark in the government's reform efforts, broad-based TA will be necessary to ensure its success. Support will be needed to ensure rapid integration of diverse corporate cultures within the new organization so that it can exercise its regulatory function effectively. The operational and procedural standards OJK adopts will have to reflect international sound practices. In addition, the creation of OJK has triggered FPO's emergence as the Government's designated agency for coordinating financial sector policy. Specifically, the FPO's responsibilities will now expand beyond fiscal matters to include high-level coordination of financial sector development and stability. This will provide FPO and ADB more flexibility to address a wider range of development constraints, including taxation issues, which had proven challenging under Bapepam-LK. To ensure a smooth transition across all affected agencies, FPO will require a rapid build-up of technical capacity. It will need these skills to maintain the existing momentum of financial sector reform and to exercise its expanded mandate efficiently and effectively.

Concurrent efforts are also needed to develop the domestic debt markets and to encourage domestic investors to participate in the capital markets. Many of these reforms are currently being supported by ADB and are complex and technically challenging. ADB is currently providing real-time technical advice to senior policy makers through an onsite resident advisor. This assistance has been directly responsible for a number of key reforms completed under the FMDIP and will be continued. Further, specific steps are needed to encourage broader and deeper participation in the government debt market. Basic inventory management tools, including the Global Master Repurchase Agreement (GMRA) and interest rate derivatives, must be provided to support the efforts of primary dealers to make two-way markets. These tools, which will strengthen risk management and reduce volatility, will foster a more active Government debt issuance program. In conjunction with these efforts, the tax code applicable to the financial system as well as specific financial transactions must be modified to provide the proper incentives to support financial sector development.

Finally, efforts are needed to raise awareness of the important role played by contractual savings in financial sector development and economic growth. Financial literacy must be improved both within and outside of the government to reduce entrenched resistance to coordinating efforts to develop Indonesia's financial system. In addition, the reforms already implemented under the FMDIP must now be further supported by building technical capacity in the sector. Developing greater actuarial and risk management capacity in the insurance subsector is particularly important, because this will lead to enhanced returns and provide more diverse choices to investors.

Impact Increased domestic participation in the non-bank finance sub-sector.
Project Outcome
Description of Outcome Financial sector development enhanced.
Progress Toward Outcome

The outcome has two stated performance targets;

1) OJK initiates operations and completes absorption of bank supervision

2) The Capital Market and Nonbank master Plan is at least 50% complete, including key objectives as follows; procedures for public offerings streamlined, GMRA launched, IPF established, corporate governance standards strengthened, convergence with IAS and launch of straight-through processing.

Progress is satisfactory. OJK has been launched and has absorbed banking supervision from Bank Indonesia. Efforts to launch the Global Master Repurchase Agreement have resumed and are expected to be completed by year-end 2014. Straight-through-processing has been acheived and initiatives to streamline procedures for public offerings and to imporve corporate governance are progressing under the Asian Capital Markets Forum. An Investor Protection Fund has been established.

Implementation Progress
Description of Project Outputs

Regulatory Oversight Strengthened.

Improved Market Infrastructure.

Increased Growth in Contractual Savings.

Status of Implementation Progress (Outputs, Activities, and Issues)

Initially, TA implementation was delayed due to transition issues associate with the migration of financial sector supervisory responsibilities to OJK, the newly created unified regulator, from Bapepam-LK, the previous nonbank financial sector regulator. In the interim, the TA's Executing Agency, the Ministry of Finance's Fiscal Policy Office, requested and received support for a variety of workshops and focus group discussions which were undertaken to strengthen financial sector stability and to provide for sustainable economic growth. In effect, the TA provided the Fiscal Policy Office with technical advice, capacity development, and enhancements to staff as the agency developed national economic policy.

OJK became operational in 2012 and absorbed banking supervision on 1 January 2014. Since that time, OJK has begun to prioritize improvements in the agency's internal infrastructure and operating capability. Utilizing a minor change in implementation, ADB has supported a number of IT projects. One project provided a team of individual experts to transition financial sector reporting to XBRL format. A second project, which is undergoing consultant recruitment, will provide an IT firm to develop e-licensing and e-reporting across the financial sector.

In addition, the TA has provided support to the government's continuing efforts to introduce the Global Master Repurchase Agreement (GMRA) as the standard repo documentation for Indonesia. This engagement provided an international and national law firm to provide legal advice, drafting and translation services, and market education. Finally, the TA has supported the government's efforts to encourage municipal finance to support infrastructure projects. Specifically, a local investment bank was retained and provided a shadow issuance including the completion of a prospectus. The output of this engagement provided substantial levels of knowledge transfer and established a base through which a live issuance could proceed.

In a continuation of prior engagements, ADB supported the placement of a long-term resident advisor to the Office of the Chairman who provided assistance with project management and capacity development. Currently, the advisor is focusing on the creation of a coordinated financial sector development plan. A second long-term resident advisor remains in place at OJK to act as a project manager in support of the IT master plan. Various additional TA projects have been organized around these two resident advisors.

Geographical Location
Summary of Environmental and Social Aspects
Environmental Aspects
Involuntary Resettlement
Indigenous Peoples
Stakeholder Communication, Participation, and Consultation
During Project Design The impact, outcome, and outputs of the TA reflect the findings of consultations with the government during the processing of the FMDIP, as well as the recommendations of an ADB TA project designed to identify constraints to increasing liquidity in the government bond market. All other facets of the TA have been discussed with and reflect the priorities of the executing agency and the implementing agencies.
During Project Implementation Became effective on 27 June 2013.
Business Opportunities
Consulting Services Expressions of interest solicited from qualified consulting firms and individual consultants will establish the appropriate packaging of the consulting services (one or several packages, or a combination of firms and individuals, depending on market testing). ADB will hire consulting firms through quality and cost-based selection (80:20), according to its Guidelines on the Use of Consultants (2010, as amended from time to time). Individual consultants will be recruited using Individual Consultant Selection (ICS) method. In lieu of direct support, the TA will organize and coordinate the research projects as necessary and will provide a platform for evaluation and publication of the research papers.
Procurement NA
Responsible ADB Officer Stephen Schuster
Responsible ADB Department Southeast Asia Department
Responsible ADB Division Public Management, Financial Sector and Trade Division, SERD
Executing Agencies
Fiscal Policy OfficeFiscal Policy Office-Ministry of Finance
Gedung RM Notohamiprojo, 8th floor
Jl. DR. Wahidin No. 1,Jakarta, Indonesia
Timetable
Concept Clearance 07 Sep 2012
Fact Finding 09 Apr 2012 to 18 Apr 2012
MRM -
Approval 24 Jan 2013
Last Review Mission -
Last PDS Update 31 Mar 2015

TA 8326-INO

Milestones
Approval Signing Date Effectivity Date Closing
Original Revised Actual
24 Jan 2013 27 Jun 2013 27 Jun 2013 31 Jan 2015 31 Jan 2016 -
Financing Plan/TA Utilization Cumulative Disbursements
ADB Cofinancing Counterpart Total Date Amount
Gov Beneficiaries Project Sponsor Others
0.00 1,000,000.00 0.00 0.00 0.00 0.00 1,000,000.00 24 Jan 2013 593,303.10
Title Document Type Document Date
Enhancing Financial Sector Governance, Risk Management, and Depth Technical Assistance Reports Jan 2013

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