Banking Supervision Report 2005

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Banking Supervision Report

2005

BSR


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Table of Contents iii

Foreword vii

Executive Summary xi

Chapter 1 Banking System Overview 1

A. Banking Structure 3

B. Commercial Banks 3

1. Growth of Total Commercial Banks and Bank

Offices 3

2. Composition of Commercial Banks based on

Ownership 4

3. Share of Large Banks 4

4. Share of Foreign Acquisition Banks 4

C. Sharia Commercial Banks 5

D. Rural Banks 6

Table of Contents

Chapter 3 Banking Supervisory Framework 27

A. Objective and Strategy of

Bank Supervisory 29

B. Enhance the Effectiveness of

Commercial Bank Supervisory 29

1. Risk Management Implementation 30

2. Good Corporate Government Implementation 31

3. CAMELS Rating System Implementation 34

4. Know Your Customer Implementation 34

5. Commercial Bank Business Plan Implementation 36

6. The Impact of Mutual Fund 40

C. Enhance the Effectiveness of

Sharia Bank Supervisory 44

D. Enhance the Effectiveness of Rural BankSupervisory 45

E B ki Li i d I f ti S t 46


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Chapter 5 Strengthen the Banking

Infrastructure 69

A. Establishment of the Financial Sector Safety Net 69

B. Establishment of the Deposit Insurance Institutions 72

C. Establishment of the Credit Bureau 73

Chapter 6 Banking Policy Direction 2006 75

A. Commercial Banking 77

B. Sharia Banking 78

C. Rural Banking 81

Banking Policy and Regulation

2.1 The 25 Basel Core Principle Compliance 11

2.2 Consolidation of The Banking

List of Boxes

List of Appendices

1. Indonesian Banking Architecture 85

2. List of Banking Regulation 2005 91

3. Banking Key Indicators as of September 2005 97

4. Banking Key financial Ratio as of September 2005 102

Strengthen the Banking Infrastructure

5.1 The Facility of Emergency Fund Facility 70


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List of Tables and Figures

1.1 Commercial Bank Ownership

1.2 Share of Commercial Bank based on Ownership

1.3 Share Commercial Bank Ownership based on Foreign

Ownership

1.4 Growth of Sharia Banks and Sharia Banks Offices

1.5 Growth of Rural Banks Offices

1.6 Growth of Sharia Rural Banks

2.1 The Basel II Implementation Roadmap

3.1 Commercial Banks Ratings

3.2 Plan and Actual Examination Progress of Rural Banks

3.3 Fit and Proper Test for Prospective Commercial Banks

Managers and Owners/Ultimate Share Holders

3.4 Fit and Proper Test for Prospective Rural Banks

Managers and Owners/Ultimate Share Holders

Tables

1.1 Number of Commercial Banks

1.2 Share of 15 Largest Banks

4.1 Loan to Deposit Ratio

4.2 Earning Assets

4.3 Growth of Credit

4.4 Growth of MSM Scale - Enterprise Loan

4.5 MSM Scale - Enterprise NPL

4.6 Growth of Bank Loan based on Ownership

4.7 Growth of Loan based on Economic Sector

4.8 Share of Loan based on Economic Sector

4.9 Growth of NPL

4.10 NPL and Loan

4.11 Loan , NPL and Productive Asset Write-off Reserve

4.12 Liquidity to NCD4.13 Growth Deposit based on in Rupiah and Foreign

Figures


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Praise the Lord for His blessing such that the Banking Supervision Report 2005, which is the second edition of

Bank Indonesias performance report in regulating and supervising banks, is successfully published as evidence of

Bank Indonesias transparency and accountability to its stakeholders and the public.

This report details all of Bank Indonesias efforts in performing its duty in setting the rules, issuing and

retracting permits for bank institutions and certain banking activities, supervising and imposing sanctions on

banks, albeit commercial banks, Rural Banks (BPR) or Sharia Banks. In general, the main aspects covered in this

report are as follows: (1) Structure and Development of the Banking Network; (2) Banking Policy and Regulation;

(3) Banking Supervision; (4) Banking Performance; (5) Improvements in Banking Infrastructure; and (6) Direction

of Banking Policy in 2006. Furthermore, pertinent information and relevant issues concerning banking supervision

and regulation are presented effectively in boxes.

Various steps and measures taken by Bank Indonesia to facilitate the restoration of post-crisis banking conditions,

which include programs to recover public trust, recapitalization, credit restructuring and the improvement of bankingterms, along with enhancement of bank supervision, have shown significant progress. Therefore, Bank Indonesia

Foreword


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In spite of this, however, banking industry performance in general has shown improvements in intermediation,

which is supported by the profitability ratio, liquidity and adequate capital. Furthermore, confidence in bankinghas been retained due to the narrowing of the insurance range since April 2005 and the establishment of the

Deposit Insurance Corporation in September 2005.

Finally, this report is expected to provide useful information, in particular to stakeholders and the general

public.

DEPUTY GOVERNOR

BANK INDONESIA

Maman H. SomantriMaman H. SomantriMaman H. SomantriMaman H. SomantriMaman H. Somantri


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Executive Summary


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Despite this past year of 2005 being replete with

challenges, the banking industry maintained positive

performance. The year was filled with external turbulence,

in particular stemming from hikes in the global oil price,

which aggravated inflation and disturbed macroeconomic

stability. Against this backdrop, domestic interest rates

climbed, which inevitably placed additional pressure on

the growth of banking services.

To overcome such difficulties, Bank Indonesia

consistently improves the banking sector through four

main policies: (1) Accelerate the consolidation process; (2)

Strengthen infrastructure; (3) Improve prudential banking

principles; and (4) Enhance the role of banking

intermediation. These four policies are contained within

the Indonesian Banking Architecture (IBA) program, which

has achieved satisfactory progress in 2005. In the

implementation of all stated policies, Bank Indonesia

Executive Summary

Subsequently, to set the development policy and

strategy of rural banks, Bank Indonesia has focused on

five steps underscoring the usage and rise of BPR

competitive advantage in conjunction with Pillar I of

Indonesian Banking Architecture: (1) Improve BPR

arrangement; (2) Enhance supervision effectiveness; (3)

Reinforce institution building; (4) Augment capacity

building; and (5) Encourage the expansion of rural banks

beyond Java and Bali. Against this backdrop, in 2004, Bank

Indonesia refined its terms regarding institutions, human

resources, and BPR operations.

In terms of supervision and examination, in 2005,

Bank Indonesia improved the implementation intensity of

on-site and off-site, risk-based supervision and

examination, which have been carried out effectively since

2003. The development of the supervision system has

conformed to international best practices and standards


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of Bank Indonesia changed its status to the Directorate of

Banking Investigation and Mediation (DBIM). In line with

such status and name changes, and in addition to DBIMs

responsibility for investigating criminal conduct in banking,

DBIM has undertaken a new duty; that is to carry out

banking mediation, which represents an alternative dispute

remedial action to customers, especially customers of

MSMEs.

In general, banking performance continued to show

positive progress regardless of prevalent risk pressure

stemming from unfavorable economic conditions,

especially during the second half of 2005. The amount of

fund disbursals and deposits continued to rise for

commercial banks, rural banks, and sharia banks, which isalso supported by adequate capital. A slight drop in

profitability was recorded during the reporting year due

to rising operational costs driven by the mounting interest

rate in the third quarter of 2005.

In 2005, total assets of commercial banks amounted

to Rp197.5 trillion, followed by a credit increase of Rp135.1

trillion or around 22.7%, which exceeded the target growth

Sharia banking also remained relatively buoyant. Firstly,

intermediation of sharia banking, whose portfolio is

dominated by funding small and medium enterprises,

strengthened and the Financing-to-Deposit Ratio (FDR) stood

at 97.8%. However, this condition was followed by

heightened financing risk as shown by the climbing of Non-

Performing Financing Ratio, which stood at 2.8%. Despite

the increased risk remaining within relatively safe limits, tight

monitoring was required due to the lack of enjoyable growth

shown in economic conditions. Secondly, reported 36.2%

growth in total assets expanded sharia banks total asset

share of national banks total assets by 1.3% at year end.

The performance of rural banks (BPR) remained

positive. BPR total assets grew by as much as 22.1% withthe largest allocation for credit disbursals. Financing

continued to show steady growth following a positive trend

accumulating to 18.1%. This shows that the advancement

of BPR credit primarily stemmed from deposits. The number

of customers rose from 5.8 million to 6 million, which

indicates that the BPR market remains promising and public

trust in rural banks continues to strengthen.


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If the coordination of these policies is performed well,

it is expected that, commencing in the second half of 2006,

economic growth will be buoyed not only by consumption

but also investment, and overall, GDP growth in 2006 will

optimistically achieve 5.0 to 5.7%. With regards to

financing, economic growth is anticipated, providing banks

are capable of maintaining their credit disbursals rate

similar to the previous year.

The year 2006 represents the start of a five-year

program of full-implementation of all organized IBA

concepts. In the short term, the policy to bolster the

banking structure will focus on banking expansion to

maintain its contribution in financing development. In the

interim, over the medium-to-long term, policy will

concentrate on improving banking foundations and further

exploring several IBA programs, including the application

of Basel II concepts.


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Chapter 1Banking System Overview


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A. BANKING STRUCTURE

Based on the prevailing Law1, Indonesian banking

consists of two systems: conventional bank activities and/

or activities based on sharia principles. Based on the

categories, conventional banks comprise of commercial

banks, including their overseas representatives and branch

offices, and rural banks (BPR). The most significant aspects

that distinguish commercial banks from rural ones are their

activities, legal formation and ownership.Based on their activities, commercial banks may

perform activities conventionally and/or based on sharia

principles, whereas rural banks specialize in one particular

activity only. Furthermore, in the course of their activities,

commercial banks may issue cheques and provide services

involving foreign currencies, while rural banks perform no

such activities in view of their limited operational coverage

Chapter 1

Banking System Overview

and branch offices, or regional government (Regional

Development Banks). In contrast, rural banks can solely

be owned by Indonesian citizens, Indonesian legal entities

whose owners are all Indonesian citizens, regional

governments or a combination of the three.

B. COMMERCIAL BANKS

1. Growth of Total Commercial Banks and Bank

OfficesThe commercial banks office network has grown

enormously, particularly since banking the deregulation

package issued in 1988 (October Package 88). Post October

Package 88, the number of commercial banks rose from

11 banks with 1,957 offices to 239 banks with 7,314

offices at year end 1996, dominated by the establishment

of Foreign Exchange and Non-Foreign Exchange National


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3. Share of Large Banks

The banking industry is dominated by 15 banks that

have significant effects on banking system stability. Their

share of total assets reached 73.9%, of credit 70.0%, and

73.4% of deposits in December 2005.

2. Composition of Commercial Banks based on

Ownership

Based on the ownership of commercial banks, thereare six categories of commercial banks: State-Owned Banks

(Banks owned by government), Foreign Exchange National

Private Commercial Banks (BUSN Devisa), Non-Foreign

Exchange National Private Commercial Banks (BUSN Non-

Devisa), Regional Development Banks (BPD - banks owned

by regional governments), Joint-Venture Banks (National

and foreign-owned banks), and Foreign Banks. Regardless

Graph 1.2

Share of 15 Largest Banks

Graph 1.1

Number of Commercial Banks

4. Share of Foreign Acquisition Banks

The implementation of a Divestment Program

conducted by the government on several National Private

Total Bank Total Offices

1957

7314

7878 7661

7113

6547

7001

6765

7730

7939 8236

111 239 222 206 162 151 145 141 138 138 131

1988 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

9000

80007000

6000

5000

4000

3000

2000

1000

0

Credit Total Assets Third Party Funds

15 Large st Banks Other Ba nks

Billion Rp

1,200,000,000

1,000,000,000

800,000,000

600,000,000

400,000,000

-

200,000,000


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C. SHARIA COMMERCIAL BANKS

Throughout 2005, the number of commercial banks

conducting their activities conventionally and based on

sharia principles, or Conventional Commercial Banks that

established Islamic Banking Units (UUS) increased by as

many as four banks: State Savings Bank, BPD of West Nusa

Tenggara, BPD of West Kalimantan, and BPD of South

Sumatra. Along with the growth in the number of active

sharia banks, the sharia bank office network also expanded

significantly. During the reporting period, the number of

sharia bank offices (including cash offices, sub-branch

offices, and Sharia Service Units) jumped by 103 offices;

from 355 offices at the end of 2004 to 458 offices at year

end 2005 (Table 1.4)

In terms of expansion, at the end of 2005, the sharia

bank office network was able to service the public in 68

districts/municipalities in 27 provinces. This is congruent

with the efforts of Bank Indonesia in supporting the

expansion of the sharia bank office network beyond the

province, as research in the potential of publics preferencefor sharia banks over the past 5 years has suggested.

Table 1.3

Share Commercial Bank Ownership based on Foreign

Ownership

BanksBanksBanksBanksBanks

Brand Offices of

Foreign Banks 11 140,679,024 24,1% 9,6%

Joint Venture Banks 17 58,975,657 10,1% 4,0%

Foreign Acquisitioned

Banks 9 383,161,705 65,7% 26,1%

Total 37 582,816,386 100,0% 39,7%Industry 131 1,469,827,372 39,7% 100,00%

Total AssetsTotal AssetsTotal AssetsTotal AssetsTotal Assets

( in million Rp)( in million Rp)( in million Rp)( in million Rp)( in million Rp)% total to% total to% total to% total to% total to

Foreign BankForeign BankForeign BankForeign BankForeign Bank% total to% total to% total to% total to% total to

Industry BankIndustry BankIndustry BankIndustry BankIndustry Bank

* Jumlah bank campuran turun disebabkan akuisisi oleh investor lokal

1) Termasuk Bank BUMN dan BPD

2) Termasuk kantor cabang bank asing, bank campuran dan bank akuisisi asing

Table 1.2Share of Commercial Bank based on Ownership

TotalTotalTotalTotalTotal Total aset (Rp)Total aset (Rp)Total aset (Rp)Total aset (Rp)Total aset (Rp) % to total industry% to total industry% to total industry% to total industry% to total industry

State Owned Banks 31 671,996,246 45,7%

Local 63 215,014,740 14,6%

Foreign 37 582,816,386 39,7%

Industry 131 1,469,827,372 100,00%

Total AssetsTotal AssetsTotal AssetsTotal AssetsTotal Assets

( in million Rp)( in million Rp)( in million Rp)( in million Rp)( in million Rp)


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D. RURAL BANKS (BPR)

The number of rural banks as of December 2005

reached 2,009, which comprised of 1,293 (64.4%) Limited

Liability Companies (PT), 663 (33%) Regional Enterprises

(PD), and 53 (2.6%) Corporations.

The unevenness of the population distribution and

economic growth constitute reasons why the distribution

of rural bank offices is uneven. As many as 2,572 offices

or 82.8% of all BPR offices are concentrated on Java and

Bali. On the basis of participating in the distribution of

economic development, Bank Indonesia encourages

investor candidates to establish rural banks beyond Java

and Bali, especially in East Indonesia, as stated in one of

its policies. Investors have responded positively due to theeconomic potential in such areas, as indicated by the

number of requests for founding rural banks in Sumatra,

Sulawesi, Kalimantan and Papua. The establishment of

rural banks in Sumatra, Sulawesi, Kalimantan and West

Nusa Tenggara has contributed towards growth in the

number of rural banks. However, this figure decreased by

2.1% compared to the previous year.

E. SHARIA RURAL BANKS (BPRS)

The number of Sharia rural banks continued to

increase throughout 2005. Seven Sharia rural banks that

have obtained permits, and six have sought agreement in

principles. One permit of an inoperative Sharia rural bank

was revoked , such that at the end of the reporting period,

there were 92 active Sharia rural banks.

Table 1.5

Growth of Rural Banks Offices

KeteranganKeteranganKeteranganKeteranganKeterangan 20002000200020002000 20012001200120012001 20022002200220022002 20032003200320032003 20042004200420042004 20052005200520052005


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Chapter 2Banking Policy andRegulation


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A. BANKING POLICY DIRECTION

Banking management and supervision policy is aimed

at establishing continuous economic stability through

stronger and more effective banking system and

institutions, which is congruent to the direction and

purpose of IBA. In 2005, Bank Indonesia endeavored to

bolster the banking sector through four key steps: expedite

the consolidation process, buttress infrastructure, improve

prudent principles, and enhance the role of bankintermediation.

In inst i tut ing the bank management and

supervisory functions, Bank Indonesia holds in high

regard consistent and prudential principles. As a result,

over the past few years, Bank Indonesia has focused its

banking policy direction to protect and maintain

economic stability through a stronger and more effective

Chapter 2

Banking Policy and Regulation

2) Strengthen financial system infrastructure;

3) Enhance the adherence to prudential principles; and

4) Improve the role of banking intermediation.

Efforts to further strengthen national banking

structure play a critical role in developing a banking system

that is capable of fulfilling future public needs in the

globalization era. To this end, Bank Indonesia has

consistently taken steps to drive the banking consolidation

process in 2006, as stated in IBA.To reinforce banking infrastructure, Bank Indonesia,

the Indonesian Department of Finance and the Deposit

Insurance Corporation (DIC) have signed an agreement

which includes the roles and task allocation to preserve

financial system stability. In addition, to enhance the

coordination between institutions, the Finance System

Stability Forum (FSSF) was established.


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a. Internal Consolidation

To achieve this vision, 7 out of 19 IBA initiatives relate

to the internal consolidation of Bank Indonesia to attain

high quality management as well as an effective and

independent banking supervision system, including

improving the effectiveness of legal enforcement.

1) Establishment of panel banking experts in Bank

Indonesia and preparation of the blueprint to develop

banking research institutions to the end of formulating

more comprehensive regulations

As part of its efforts towards research based policy

principles, Bank Indonesia formed an expert banking panel

comprising of local and foreign experts from their

respective fields; prepared the blueprint for regional

banking research institutions; as well as planned to

establish banking research institutions at four sites

including KBI, universities and regional banks.

2) Improvement of the 25 Basel Core PrinciplesCompliance

banking fields, and also developed a supervision scheme

adopting risk-based management.

Bank Indonesia prioritized activities in support of

government policy to develop the micro, small and medium

enterprises (MSME) sector in its efforts to improve banking

intermediation. The coverage of such activities is contained

in the MSME Roadmap, drafted by Bank Indonesia in

collaboration with the government.

IBA initiatives to support the development of

MSME include: enhancing the roles of commercial

banks, rural banks (BPR), and sharia banks (linkage

program); forming a guarantee scheme; and establishing

banking research institutions on a regional basis.

Furthermore, Bank Indonesia continuously strives to

consult businesses and banks seeking opportunities to

build economic capacity by regularly conducting

international workshops. Bank Indonesia also fiercely

endeavors to improve technical support in the form of

providing information, research and training to banks.

Cooperation among related departments andinstitutions to develop MSME is well maintained at both


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To realize an effective national supervision

system, it is believed that 25 BCP, prepared by Basel

Committee together with supervisory authorities from

15 developing countries as well as input and intensive

consultation from other supervisory authorities around

the globe, must be applied. These principles consist

of the basic elements for an effective supervision

system. In general, they cover preconditions for

effective banking supervision, licensing and structure,

prudential regulations and requirements, methods for

ongoing banking supervision, information

requirements, formal powers of supervisors, and cross-

border banking.

The 25 BCP are intended to form the foundation

for supervisory authorities around the world to be

Box 2.1 The 25 Basel Core Principles Compliance

applied in the supervision of all banks within their

respective legal framework. Supervisory authorities

around the world are invited to employ Basels main

principles by October 1998 at the latest. The expected

implementation comes in the shape of a review that

compares the current conditions of the supervision

system against those stipulated in the principles. The

transformation pace varies depending on whether the

supervisory authority has the required legal authority.

If amendments to the law are necessary, legislators

from each country are immediately asked to offer

advice concerning the required changes to advocate

applicable principles. The document containing the

before aforementioned principles is available on the

BIS web site http://www.bis.org.


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1. Objectives, autonomy, powers 11111 11111 11111

2. Permissible activities 11111 11111 11111

3. Licensing criteria 22222 22222 22222

4. Ownership 33333 22222 222225. Investment criteria 22222 22222 22222

6. Capital adequacy 22222 22222 22222

7. Credit policies 33333 11111 11111

8. Loan evaluation 33333 11111 11111

9. Large exposures 22222 22222 22222

10. Connected lending 33333 22222 22222

11. Country risk 44444 44444 22222

12. Market risks 22222 11111 1111113. Other Risks 22222 22222 22222

14. Internal control and audit 22222 11111 11111

15. Money laundering 22222 11111 11111

16. On-site and off-site supervision 22222 22222 22222

17. Bank management contact 22222 22222 22222

18. Off-site data 33333 33333 22222

19. Validation supervisory information 22222 22222 22222

20. Consolidated supervision 33333 33333 4444421. Accounting standard 22222 22222 11111

22 Remedial measures 33333 33333 22222

Core PrincipleCore PrincipleCore PrincipleCore PrincipleCore Principle

Grading ByGrading ByGrading ByGrading ByGrading By

Self-AssessmentSelf-AssessmentSelf-AssessmentSelf-AssessmentSelf-Assessment IMF BCP AssessmentIMF BCP AssessmentIMF BCP AssessmentIMF BCP AssessmentIMF BCP Assessment

May 2005May 2005May 2005May 2005May 2005IMF BCP AssessmentIMF BCP AssessmentIMF BCP AssessmentIMF BCP AssessmentIMF BCP Assessment

Oct 2005Oct 2005Oct 2005Oct 2005Oct 2005

Table Box 2.1.1

The 25 of BCP Compliance


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4) The consolidation program for the banking sector of

Bank Indonesia

The consolidation program includes the ratification

of the High-Level Organization Structure (HLOS); the

consolidation of supervision and audit units; the

improvement and consolidation of the Directorate of

Rural Bank Supervision and Credit Bureau; as well as the

enhancement of the corresponding Directorate of Sharia

Banking. Such improvements are to be carried out

concurrently through the consolidation of the supervision

and audit units into a dedicated team structure.

Consequently, using this approach, off-site supervision,

on-site supervision, and an on-site supervisory presence

(OSP) will all be performed by the same team. This method

aims to raise the effectiveness of risk-based supervision.

(Box 2.2)

Box 2.2 Consolidation of the Banking Sector Program

Mounting supervisory duties and rising pressure

from stakeholders, coupled with banking growth as

well as the diversification of banking tasks from timeto time, require an improved supervisory function at

Bank Indonesia. The organizational structure has been

enhanced through internal consolidation in order to

more effectively enhance supervision through a risk-

based approach. Such improvements have lead to a

dedicated organization at the team level. The separated

supervisory and audit tasks will become unified and,

Supervisory documents are now centralized at

each Administration Department of each directorate

to ensure tighter control and an application programto better supervise related documentation is also being

developed by a third party.

An Implementation Task Force has been

organized to prepare the implementation of the

banking audit and supervisory unit consolidation

program to be performed by 1st March 2006, which

comprises of the Information Technology; Banking


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5) Bank Indonesia Certification Program for Supervisors

and Auditors

This program intends to boost the competency of

Bank Indonesias supervisors and auditors to enable them

to perform their supervisory role more effectively and

efficiently, and concomitantly, enable them to proportion

themselves with bank supervisors of supervisory authorities

in developed countries. In order to meet such a demand,

Bank Indonesia has taken various steps including, among

others, holding systematic, regular and continuous training

programs with the guidance of competent and credible

trainers (Box 2.3).

Box 2.3 Banking Sector Human Resources Development

Demand for improvements in the quality of

banking-sector human resources grew in line with the

development of the banking industry and its products

as well as the development of international banking

regulations. To satisfy such demand, Bank Indonesia

has undertaken various endeavors including, among

others, organizing a systematic, regular and continuous

training program taught by competent and credible

trainers. Through this training program, bank

supervisors are expected to gain high-level competency

and integrity to equate them with bank supervisors of

supervisory authorities in developed countries

is provided to produce bank supervisors with special

expertise.

Previously, education and training activities were

conducted by the Focus Group (FG) of Bank Supervision

Development; however, commencing 1st September

2005, these activities are currently conducted by the

Banking School FG under the Directorate of Banking

Research and Regulation. The Banking School FG is

considered as the embryo of a future Banking

Supervision School (BSS) of Bank Indonesia.

Banking Sector Human Resources Training in


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through October 2005, commencing from the

foundation level up to the most advanced level,

attended by 596 banking sector employees from Head

Office and the branch offices. Selective training,

covering Consolidated Supervision, Market Risk and

Basel II aspects were attended by 168 banking sector

employees. Cooperation with international institutions

involved 25 banking sector employees.

Box Table 2.3.1.

Training Realization in 2005

Type of trainingType of trainingType of trainingType of trainingType of training Participants (persons)Participants (persons)Participants (persons)Participants (persons)Participants (persons)

Regular/Certification TrainingRegular/Certification TrainingRegular/Certification TrainingRegular/Certification TrainingRegular/Certification Training

1. Foundation Level 270

2. Intermediate Level 174

3. Advanced Level 142

Special TrainingSpecial TrainingSpecial TrainingSpecial TrainingSpecial Training

1. Consolidated Supervision 28

2. Market Risk 40

3. Basel II 100

Cooperation with International InstitutionsCooperation with International InstitutionsCooperation with International InstitutionsCooperation with International InstitutionsCooperation with International Institutions

1. BI-SEACEN-OSFI Seminar on Consolidated Supervision 15

2. BI-SEACEN-IMF Workshop on Financial Soundness Indicatorsand Stress Testing 10

TotalTotalTotalTotalTotal 779779779779779


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Box 2.4 Risk-Based Supervision

Among the factors conducive in creating a

healthy and stable banking system and considered as

having an important role is the implementation of an

effective banking supervisory system. The Basel

Committee on Banking Supervision has issued

fundamental, effective principles, which are used as a

reference by the bank supervisory authority to create

effective banking supervision. Included in such

fundamental principles is risk-based supervision. In

relation to this, since 20041 Bank Indonesia has applied

a risk-based supervisory system.

In terms of international banking supervision

practices, risk-based supervision is regarded as a

comprehensive and dynamic supervisory concept

because it considers both current and future banking

conditions, which includes evaluating banks ability to

deal with the potential risk, be it individual risk or

systemic risk.In principle, risk-based supervisionis a monitoring

2. Requires understanding of the types of risks2 and

the managements ability to manage risks (internal

and external), especially the risks beyond

management control, like systemic risk and risks

within the business environment; and

3. Uses the framework and terminology designated

especially to evaluate risks, policies, procedures

and risk-management practices.

With improvements in the supervisory

organization of Bank Indonesia, the implementation

of risk-based supervision is expected to generate

superior quality supervision results. This is reflected by

the completed stages of the risk-based supervision

cycle, for example, a bank supervisor can immediately

take a supervisory action based on off-site analysis

without waiting for the on-site supervision result. Adept

and rapid action will enable a supervisor, as early as

possible, to take the necessary enforcement proceduresto prevent further complications at the problematic


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7) Effectiveness of legal enforcement Improvement

Bank Indonesia enriched the Special Banking

Investigation Unit by transforming the organization into

the Directorate of Banking Mediation and Investigation,

and also renewing the joint decree concerning cooperation

for the criminal handling of illegal banking activities

between Bank Indonesia, the Police Department and

Prosecution Office on 20th December 2004. Beyond the

central level, the joint decree has also been applied

throughout Bank Indonesia regional territories. Hence, law

enforcement in the banking sector is expected to run more

efficiently and effectively.

b. Strengthen The Banking Structure

The banking structure advocated by the Indonesian

Banking Architect re (IBA) incl des banks ith strong

management, internal supervision, operational capability,

credit and the intermediary function. Accordingly, Bank

Indonesia has issued a regulation that obliges managers

and banking officers to earn certificates for the following:

improving their risk-management quality; driving the

implementation of good governance to improve internal

supervision; enhancing cooperation to boost HR quality;

encouraging operational cost efficiency to improve the

operational capacity; as well as establishing the CreditBureau for banking institutions to augment their credit

quality and intermediary function.

c. Develope The Micro and Medium Enterprises

(MSME)

In line with government policy direction to develop

micro, small and medium enterprises, the IBA initiative to

balance. Nevertheless, the early developmental stage

(since 2005) of risk-based supervision is directed

towards consolidated supervision, more specifically

concerned with the implications of the subsidiaries

risk profile on the risk profile of the bank as parent

company (down-stream supervisory).


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promote research and surveys, as well as foster innovation.

This is achieved by: (1) providing technical assistance; (2)

developing institutions; (3) defining policies and improving

credit regulations; and (4) enhancing cooperation between

the government and other relevant institutions.

In terms of providing MSME technical development

assistance, Bank Indonesia has adjusted the rules governing

technical assistance, enhancing the information supply to

micro, small and medium enterprises; as well as researching

and providing training to banking institutions and Business

Development Services Providers (BDSP). Cooperation

between relevant departments and institutions to develop

micro, small and medium enterprises is ongoing both at

the central and regional levels. In parallel, Bank Indonesia

continues to address the business community and bank

institutions, through regular workshops, seeking ways of

developing new economic activities.

d. Improve The Customer Protection

The customer protection initiative includes newregulations which define a customer complaint mechanism

G10 country central banks.

The application of the Basel II framework requires

thorough preparation by Bank Indonesia, the banking

industry and other related parties, because of the various

aspects demanded including effective risk-management

practices, competent HR, appropriate information

technology and database support, as well as the availability

of other supporting infrastructure, like an accounting

standard that refers to International Accounting Standard

(IAS) and credible ranking institutions.

To this end, Bank Indonesia has defined the following

implementation stages:

1) Basel II application in Indonesia from 2008 onwards,

for all banks, beginning with the simple approaches,

namely Standardized Approach for credit-risk

calculation and the Basic Indicator Approach to

estimate operational risk;

2) Upon the completion of all requirements and subject

to approval by Bank Indonesia, a bank may shift to

the more advanced approaches; and3) Basel II is expected to be fully implemented by 2010.


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- Provide a clearer and more explicit plan for

preparations toward the implementation of

Basel II. For example, providing supporting

infrastructure, supervisory organizational

structure and Human Resources);

f) Establishment of the Basel II Working Group with

members consisting of representatives from Bank

Indonesia, banking institutions and banking

associations. Banking institutions have also

established a Task Force for Basel II implementation

along with the Basel II Implementation Monitoring

Team;

g) Translation of Basel II documentation;

h) Quantitative Impact Study (QIS) 4 and QIS 5 of 40

banks (representing approximately 80% of total assets

in the banking system);

i) Gap analysis to identify the existing availability of

infrastructure and preparedness in accordance with

Basel II requirements;

j) Completion of 9 national discretion studies; and

k) A revision of banking accountancy standards referring

to IAS (IAS 32 and IAS 39).

Table 2.1

The Basel II Implementation Roadmap

PILLAR 1PILLAR 1PILLAR 1PILLAR 1PILLAR 1 PILLAR 2PILLAR 2PILLAR 2PILLAR 2PILLAR 2 PILLAR 3PILLAR 3PILLAR 3PILLAR 3PILLAR 3

Application of RiskApplication of RiskApplication of RiskApplication of RiskApplication of Risk

Calculation ApproachCalculation ApproachCalculation ApproachCalculation ApproachCalculation ApproachPBIPBIPBIPBIPBI

IssuanceIssuanceIssuanceIssuanceIssuance

Parallel RunParallel RunParallel RunParallel RunParallel Run

Standard sizedStandard sizedStandard sizedStandard sizedStandard sized 1)1)1)1)1) ororororor

Validation ProcessValidation ProcessValidation ProcessValidation ProcessValidation Process

(Internal Model)(Internal Model)(Internal Model)(Internal Model)(Internal Model)

EffektiveEffektiveEffektiveEffektiveEffektive

CalculationCalculationCalculationCalculationCalculation

CARCARCARCARCAR

LBULBULBULBULBU

ImprovementImprovementImprovementImprovementImprovementOther risksOther risksOther risksOther risksOther risks 4)4)4)4)4) TransparencyTransparencyTransparencyTransparencyTransparency

On line SystemOn line SystemOn line SystemOn line SystemOn line SystemPBIPBIPBIPBIPBI


EffektiveEffektiveEffektiveEffektiveEffektive

CalculationCalculationCalculationCalculationCalculation

CARCARCARCARCAR

PBIPBIPBIPBIPBI


Market RiskMarket RiskMarket RiskMarket RiskMarket Risk

Standardized2)

Q3 2007 Q1 2008 - Q4 2008 Q1 2009 Q4 2008 Q1 2009Internal-Model 3) Q3 2007 begin Q3 2007 Q2 2008 Q2 2008 Q1 2009

Credit RiskCredit RiskCredit RiskCredit RiskCredit Risk


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B. SHARIA BANKING POLICY DIRECTION

Regulations and supervisory policy for sharia banking

are directed toward strengthening the sharia banking

structure by focusing on adherence to sharia principles,

prudential regulations, operational efficiency,

competitiveness, system stability and benefit to the

economy.

Entering the second year of the second-stage

implementation (2004-2008) of the strategic Blueprint for

Sharia Banking Development in Indonesia, sharia banking

policy remains a continuation of the development policy

conducted during the first stage. The initiative is divided

equally into the following four areas of focus:

1) Compliance to Sharia Principles

Bank Indonesia is standardizing the industry through

the issuance of PBI No. 7/46/PBI/2005 dated 14 th

November 2005 on the Agreement for Fund Collection

and Distribution for Sharia Banks after conducting studies

in line with research-based policy principles. The presence

of this standard provides market operators and regulators

support sharia banking using high expertise and dedicated

operators in running sharia banking operations.

Furthermore, an evaluation of the 25 BCP

implementation for Effective Banking Supervision within

sharia banking has been completed to gauge how far

Indonesian sharia banking can be evaluated using 25 BCP

and how large the implementation value is.

3) Operational Efficiency and Competitiveness

Bank Indonesia has been trying to create a strategic

alliance among sharia banks through the linkageprogram

pilot project, specifically between Sharia Commercial

Banks/Sharia Business Units with Sharia Rural Banks (BPRS)

to serve the micro and small enterprise customers. In order

to support this pilot project, Bank Indonesia will compile a

cooperation framework with related organizations, which

will effectively improve the sharia banking operational

efficiency.

Furthermore, a survey was conducted on the

Potentials, Preferences, and Perceptions of the public on

sharia banks in NTB province, which basically represents a


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of Trainers, particularly academic instructors of economics

and sharia concepts.

Seeking insight to the enhancement activities of HR,

at the end of 2005, Bank Indonesia together with IRTI-

IDB, The International Association for Islamic Economics

(IAIE), University of Indonesia and ISEI held an International

Conference on Islamic Economics and Finance in Jakarta.

The topics discussed at the conference related to sharia

banking and financing, and initiatives for the betterment

of their development.

4) System Stability and Benefit to the Economy

To realistically expand sharia bankings role in the

economy, a communication forum for sharia banking

development was established, namely the Sharia Economic

Communication Center (PKES) along with a feedback

mechanism. In addition, cooperation with related parties

to activate alternative funding sources (voluntary sector)

was also conducted.

C. RURAL BANKING POLICY DIRECTION

particularly eastern Indonesia, to provide more

extensive services nationwide.

3) A more distinct role in funding micro and small

enterprises as well as rural people for their

involvement in micro and small enterprises, both

geographically and psychologically.

To achieve the said goals, Bank Indonesia focused

on five measures to empower and strengthen BPR

competitiveness in line with IBA Pillar I as follows:

1) Improving the BPR arrangement

To create sound management in rural banks capable

of contributing positively to national banking activities,

particularly in funding the micro financial sector, Bank

Indonesia improved a number of regulations and

institutions in line with international best practices.

Furthermore, in 2005 a regulation was also ratified to

support supervisory effectiveness in the form of a BPR

database to be used as an early detection tool.

Correspondingly, Bank Indonesia is currently reviewing a

regulation concerning the minimum capital requirement,


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2006); and an inspection strategy based on potential risks.

In addition, Bank Indonesia continuously builds upon

supervisory quantity and quality through certification for

bank supervisors, periodic non-certificate training to

encourage information building and knowledge sharing,

as well as increasing the number of supervisors.

3) BPR Institutional Building

To foster a buoyant BPR industry, Bank Indonesia

continued its restructuring policy by aiding salvageable rural

banks through capitalization, mergers and acquisitions,

as well as encouraging the entry of new investors capable

of boosting capital and strengthening management. In

addition, Bank Indonesia encouraged cooperation between

rural banks and commercial banks by allocating credits to

micro and small enterprises through the linkage program.

Bank Indonesia also facilitated the establishment of Apex

for rural banks.

Linkage Program

The linkage program between rural banks,

The members include Bank Indonesia (Directorate of

Banking Research and Regulation, and Directorate of Rural

Bank Supervision), BPR Association (Perbarindo), 3 non-

Perbarindo BPR committees and commercial banks.

The agenda of the working group was to define a

Generic Model Linkage Program, to specify the Linkage

Programs terms and conditions, and to establish joint

agreements/recommendations/regulations with Bank

Indonesia concerning Linkage Program implementation.

The working group has hitherto compiled a Generic Model

Linkage Program, which contains minimum terms and

conditions for rural bank participation; interest rates, a

ceiling limit and guarantees for each type of linkage

program; namely executing, joint financing, and

channeling, ethic codes of linkage program participants;

and Bank Indonesia policy to encourage linkage program

implementation.

Subsequently, on 24th August 2005, the Lending

Agreement Notification Letter involving 10 commercial

banks and 38 rural banks with a credit ceiling of Rp104

billion was signed. To encourage the linkage program to


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Apex institution, including the payment system and

the types of documents to be used by rural banks to

interact with the Apex Institution and BPR clients.

Deciding upon the business format of the Apex

institution for an ideal rural bank based on research

and study results as well as input obtained during

seminars. As suggested, it is in the form of a

commercial bank owned by the BPR industry.

However, problems arose when establishing a new

commercial bank for apex, which requires substantial

funding besides the prevailing Banking Law prohibits

rural banks from acting as shareholders. Therefore,

supporting regulations for institutions, operations and

ownership, are required.

Establishing an Apex Working Group comprising of

members from rural banks, the

Perbarindo Association, three commercial banks and

Bank Indonesia in August 2005. The Apex Working Group

has agreed to execute Pilot Projects for Apex institutions

in seven regions following three patterns, namely the Apex

Institution conducted by BPR Leaders (in Yogyakarta and

Facilitating Focus Group Discussions on BPR

Development Direction

To consolidate inputs and views from various parties,

particularly external parties such as academicians,

practitioners, observers, associations and other stakeholders,

with regards to policies and the efforts necessary to create

a sound, robust and productive BPR industry, highly

competitive in serving micro and small enterprises and rural

residents, Bank Indonesia held a Focus Group Discussion

on 1st December 2005. The input obtained was subsequently

used to improve the BPR development blueprint.

4) BPR Capacity Building

To build BPR capacity, several measures were taken,

including: conducting a Professional Certificate Program

(CERTIF) for BPR directors, providing technical assistance

for manager-level BPR human resources to improve their

technical competency, and developing BPR information

technology to enhance efficiency.

The BPR Professional Certification Program


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September 2005 the fifth ToT was held and attended

by 27 teacher candidates.

(3) By the end of 2005, BPR director certification training

had been conducted 52 times throughout Indonesia,

attended by 1,312 persons; 3 certification tests of

BPR directors, attended by 1,252 participants have

taken place with 1,038 newly certified directors,

exceeding the specified target of 1,000 persons. In

support of CERTIF implementation, Bank Indonesia

subsidized 50% of the training costs to one BPR

director who already had a business license when PBI

No. 6/22/PBI/2004 dated 9th August 2004 regarding

the rural banks was promulgated. As of year end

2005, Bank Indonesia had provided subsidies to 1,082

certification participants.

Technical Assistance for Human Resources and BPR

IT Development

Technical assistance and IT development is as follows:

a. Providing technical assistance for manager-level BPR

human resources, in particular the Account Officer

(AO), to enhance technical competency in the form

5) Encouraging Rural Banks to Spread Beyond Java

and Bali

To enhance the role of rural banks and their

contribution to micro and small enterprises as well as

rural communities in Indonesia, rural banks are expected

to mushroom throughout Indonesia. Permits for rural

banks in Java and Bali are allocated very selectively;

however, rural banks are actively encouraged outside Java

and Bali.

To foster BPR expansion, Bank Indonesia and the

management institution PPM conducted a scientific study,

the BPR Establishment Feasibility Study, to design a formula

for evaluating the potential and feasibility of appropriate

and accountable rural banks. Based on the study, BPR

Establishment Feasibility Study Evaluation Guidelines have

been drawn up. The guidelines will be socialized in the

form of training of Bank Indonesia staff/officers, which

are in charge of BPR permits, in January 2006.

6) Designing a BPR Blueprint

To design a BPR Blueprint, Bank Indonesia conducted


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2. Two PBIs; one to bolster banking institutions in terms

of capital and the other to augment the quality of

risk-management in commercial banks;

3. Three PBI revisions to ameliorate the effectiveness of

the reporting system and boost commercial bank

transparency;

4. PBI revision to raise the quality of collateral related to

the Short-term Funding Facilities of Commercial

Banks;

5. PBI revision to develop the supervisory follow-up

action mechanism and commercial bank status

determination, through ratifying laws regarding the

Saving Guarantee Institution;

6. PBI revision on rupiah exchange rate stability in the

form of regulations pertaining to the Minimum

Reserve Requirement of commercial banks, both in

rupiah and foreign currency, and on the Net Foreign

Exchange Position of commercial banks;

7. Seven PBI special regulations on sharia banking

stipulating capital issues, agreement standards,

enhancement of BPRS monthly reporting

effectiveness, a short-term financing facility for sharia

banks and transparency;

8. Four PBI for rural banks detailing special treatment

and post natural disaster protocol for rural banks in

Nangroe Aceh Darussalam, Nias and North Sumatra,

abolishment of the blanket guarantee and BPR follow

up in terms of new laws concerning the

Savings Guarantee Institution, and BPR monthly

reporting effectiveness; and

9. PBI outlining technical assistance to micro, small and

medium enterprises.


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Chapter 3Banking Supervisory

Framework


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A. OBJECTIVE AND STRATEGY OF BANKING SUPER-

VISORY

Bank Indonesia implements banking supervision

through on-site supervision and off-site supervision. On-

site and off-site supervision aims to provide a picture of

the banking financial situation, monitor the compliance

level towards prevailing regulations, and detect the

presence of unhealthy practices that may threaten banking

business continuity. The goal of banking supervision is to

create a healthy, strong and efficient banking system to

support national economic growth.

In reality, off-site supervision is conducted through

monitoring periodic reports submitted to Bank Indonesia

of inspection results and other kinds of reports. In terms

of on-site supervision, if required, Bank Indonesia performs

inspection on the bank, including its related parties such

Chapter 3Banking Supervisory Framework

improvement plan. In determining the banks status, a bank

may be categorized as: a bank under general supervision;

a bank under intensive supervision; a bank under special

surveillance; a bank with systemic impact; and a bank with

non-systemic impact.

In exercising supervision, the Directorate of Banking

Supervision conducts cross coordination among work units,

including:

UKIPthat later became DIMPin the case of following

up on inspection results indicating criminal actions;

The Credit Bureau to deliver Bank Indonesia Liquidity

Credit and its banking administration;

Directorate of Monetary and Economic Statistics to

oversee the Commercial Bank Monthly Report;

Directorate of Payment System and Accounting to

implement BI-Real Time Gross Settlement (RTGS); and

B ki S i i R t


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Indonesia has, among others, taken the following

measures:

1) Bank Supervisor Certification for Risk Management;

2) Calculation of bank CAR by calculating market risk;

3) CAMELS evaluation;

4) Bank risk profile compilation;

5) Individual Supervisory Strategy (ISS) compilation;

6) Bank internal control system effectiveness evaluation;

and

7) Basel II preparation with national banking institutions.

Furthermore, to ameliorate supervisor competency,

specialist supervisory groups have been established, namely

the Treasury, Information System Technology, Know Your

Customers/Anti-Money Laundering (KYC/AML), Aqua/

Trade Finance, and Risk-based Supervision (RBS). The

specialist groups mentioned employ the services of

inspectors with relevant expertise and experience.

1. Risk Management Implementation

Rapid change in internal and external banking

environments has been accompanied by more complex

(v) individual banks supervisory strategy; and (vi)

implementation of tailor made banking supervision and

supervisory follow up. Based on the mentioned cycles, close

coordination between off-site and on-site supervisors is

crucial to create an effective and efficient supervisory

system.

In addition, to enhance numerous facets of the

supervisory system, various program applications have been

implemented, including risk management, good corporate

governance,an evaluation system of a banks health based

on CAMELS, and the application of Know-Your-Customer

(KYC) rules. The practice of such programs is expected to

strengthen the supervisory system to create a sound, robust

and efficient banking system to support national economic

growth.

In the evaluation of risk-management

implementation, in particular related to internal control, a

supervisor shall conduct several measures, including:

1) Evaluating the internal control system guidelines

submitted by a bank. If considered inappropriate, the

supervisor shall present a letter of guidance to the



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amongs the board of commissioners and directors; policy,

procedure and limit determination adequacy; an

identification process, measurement, monitoring and risk

control, as well as risk-management IS adequacy; and a

thorough internal control system. Monitoring risk-

management application is conducted by classifying

banking risks into eight categories, viz. Credit Risk, Market

Risk, Operational Risk, Liquidity Risk, Legal Risk, Reputation

Risk, Strategic Risk and Compliance Risk.

The evaluation of those mentioned risks is very much

determined by the complexity of a banks business. A bank

with high business complexity, despite being classified as

a small or medium bank, will be evaluated using eight

risks in total. On the other hand, a bank with medium or

regular business complexity will only be evaluated using

five risks, namely Credit Risk, Market Risk, Operational Risk,

Liquidity Risk and Compliance Risk

Different banks are at different stages of

preparedness in terms of risk management

implementation. Large-scale banks, in general, already

have their own risk-management special work units,

develop parameters and models that really reflect their

business activity risks. In addition, banks also commonly

have a problem with data availability and adequacy, both

internally and externally (national banking).

The application of banking risk management requires

attention on the following issues:

1) Relatively uneven credit distribution will potentially

raise credit risk;

2) The domination of short-term core depositors and

deposits will potentially increase liquidity risk;

3) Inappropriate bank operational guidelines, with no

updating and no periodic evaluation will potentially

increase operational risk;

4) More integrated banking products and insurance, as

well as capital market products without proper

disclosure of information from banks personnel and

without clear explanation to customers, will potentially

intensify reputation, legal and compliance risks; and

5) Data availability and adequacy both internally and

externally (national banking).


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Box 3.1 Good Corporate Governance

The application of GCG should include the

ownership factor because of its specific uniqueness

and the underlying difference of issues. As we know,

a bank can be categorized as a state-owned bank; a

private-owned bank and a public-owned bank when

ownership is diffused (diffused nature of shareholder

base).

Moral hazard of a state-owned bank and a

diffused-ownership bank normally occurs in the

centralized power of top management or the bank

executives. The lack of a dominant shareholder role

may increase the role and power of the management

executives. On the other hand, for an individual or

group-owned private bank, moral hazard may occur

in the centralized power of the owners or controlling

shareholders that act as commissioners.

Nevertheless, in general, PSP influence to

distribute a banks money to their own companies has

been greatly reduced in line with growing awareness

is the most common fraud. This kind of fraud is

relatively easy to identify and detect as it is in the

form of a theft of a tangible asset.

2. Financial Misrepresentation or misleading financial

reporting that may misinform the financial report

user and lead to inaccurate decision making.

3. Corruption & Bribery, misuses office power for

mutual benefit, which is difficult to prove due to

the mutual benefit factor. For example,

cooperation between a company officer and

supplier in the form of cost or expense mark-up is

difficult to prove.

Against this backdrop, Bank Indonesia as

supervisor will continue to encourage all banks under

its supervision to keep improving GCG application

actively and proactively. Continuous improvement is

necessary of the banks internal control systems and

human resource development as human capital is

extremely important in GCG application. Yet, above all,



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g p p

No. of Banks %No. of Banks %No. of Banks %No. of Banks %No. of Banks %

1. Very good 2.3% 0.8%

2. Good 58.1% 53.1%

3. Adequate 36.5% 39.1%

4. Fairly good 3.1% 7.0%

5. Poor 0% 0%

TotalTotalTotalTotalTotal 100%100%100%100%100% 100%100%100%100%100%

Table 3.1Commercial Banks Ratings

Composite RatingComposite RatingComposite RatingComposite RatingComposite RatingDecember 2004December 2004December 2004December 2004December 2004 December 2005December 2005December 2005December 2005December 2005

3. CAMELS Rating System Implementation

Along with PBI No. 6/10/PBI/2004 dated 12th April

2004 regarding the Health Level Evaluation System of

Commercial Banks, Bank Indonesia has used an evaluation

system known as CAMELS (Capital, Asset Quality,

Management, Earning, Liquidity, and Sensitivity to Market

Risk) since the December 2004 evaluation period. Based

on the PBI, the bank health level is defined as a qualitative

evaluation result of various aspects influential to the

condition or performance of a bank through Quantitative

and/or Qualitative Evaluation of capital, asset quality,

management, profitability, liquidity and sensitivity factors

against market risk. For Foreign Bank Branch Offices, the

evaluation is only made on asset and management quality

factors.

Compared to the previous evaluation approach, there

are now several basic differences including: more emphasis

on qualitative evaluation, risk-management is calculated

in the management factor evaluation, and it is more risk

sensitive with the presence of a sensitivity evaluation

against market risk.

From the evaluation, Bank Indonesia may ask the

board of directors, commissioners and/or shareholders to

submit a follow-up plan containing improvement measures

to be taken by the bank within a specific time period.

A Comparison of Commercial Banks Composite

Ratings as of December 2004 and 2005 is presented in

Table 3.1.

4. Know-Your-Customer/Anti-Money Laundering

(KYC/AML)Principles Implementation

The banking industry is faced with money laundering



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Box 3.2

The Bank Indonesia regulation related to the KYC

or Know-Your-Customer principles has experienced a

number of improvements in line with prevailing best

practices. This means that Bank Indonesia now has

the tools applicable by supervisors to conduct its

enforcement function on banks under supervision. In

accordance with the issuance of PBI No. 6/37/PBI/2004

dated 10th September 2004 regarding the Evaluation

and Penalties concerning the Application of Know-

Your-Customerprinciples and other Obligations related

with the Money Laundering Criminal Law, the

evaluation of KYC and Money Laundering Criminal

Law application is included in the calculation of the

health level of commercial banks through management

factors covering Active Supervision by Management;

Policy and Procedures, Internal Control and Internal

Audit Function; Management Information System, and

Human Resources and Training with a rating from one

fi V G d G d Ad F i l G d P

Based on the inspection/supervision of KYC/AML

application, certain facets of implementation that

require enhancement are as follows:

- Support ing in fras truc ture for KYC/AML

application, such as information system

technology that supports banks efforts to monitor

financial transactions conducted by a banks client

(related to the Suspicious Transaction Report or

STR and Cash Transaction Report or CTR);

- Periodic adjustment/updating of customer data

Know Your Customer/Anti-Money Laundering and Anti Money Laundering

Criminal Law

BankBankBankBankBank KYC RatingKYC RatingKYC RatingKYC RatingKYC Rating %%%%%

Banks with a rating of 1 (Very Good) 4 3.13%

Banks with a rating of 2 (Good) 16 12.50%

Banks with a rating of 3 (Adequate) 68 53.13%

Banks with a rating of 4 (Fairly Good) 40 31.25%

Banks that are unrated 0 0%

Total Banks 128 100%

Source: Banking Supervision



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- KYC/AML policy and procedures; and

- Establishment of Know-Your-Customer Work

Units; with regards to the fact that the

organization will be more oriented towards costs,

particularly for small-scale and medium-scale

banks.

Supervision of KYC/AML application covers the

examination of KYC/AML Application Guidelines

submitted by banks, including any revisions/

improvements/adjustments. Based on such

weaknesses, continuous guidance must be provided,

for example by conducting special meetings with the

bank; meeting with the banks management to discuss

inspection results; sending a supervisory letter to

remind the bank to immediately follow-up on

outstanding issues; consider the importance of KYC/

AML implementation, for the sake of the bank, the

people and the country.

In addition, there is an information exchange

cooperation between bank supervisors and the

Financial Transaction Analysis Examination Center

particularly concerning Suspicious Financial Transaction

Reports, which may or may not have been submitted

by a bank that must be followed up by supervisors

based on inspection results.

In this case, it is the banking supervisors duty

to encourage and reinforce efforts to truly exert

preventive measures against money laundering

practice, among others through the Know-Your-

Customer (KYC) principle application. Subsequently,

in this case, a supervisor training on money

laundering will also be continuously conducted

periodically.

Several factors that require attention to enhance

KYC/AML application quality in the future included:

an internal control support; internal audit function

optimization; an adequate management information

system (MIS), and law enforcement enhancement

regarding the rules of KYC/AML. In addition it is

equally important to enhance bank officers

awareness in timely reporting of the Suspicious

Transaction Report



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The Business Plan should cover the upcoming three-

year period, however, the bank must submit it to Bank

Indonesia annually every January. For example, in January2005, a bank must submit its 2005-2008 plans, whereas

in January 2006, the bank must submit its 2006-2008

plans. The Bank Supervisor shall evaluate whether the

Business Plan submitted by bank has complied with

prevailing rules, namely being realistic, measurable,

responsive to internal and external factors, taking into

consideration prudential and sound banking principles. The

evaluation of whether or not the Business Plan projection

figures are realistic shall be conducted by a Bank Supervisor

using stress testingon the base casescenario and historical

data. When the Business Plan is deemed not to satisfy

those criteria, Bank Indonesia can request the bank to make

adjustments. On the other hand, the bank is allowed to

make one-off revision to its Business Plan when there is a

significant change in internal or external factors that affect

the banks financial condition. The Business Plan revision

must be submitted in writing to Bank Indonesia by or

before the end of first semester of the current year,

Based on the Business Plan recapitulation of all

commercial banks in 2005, total commercial bank assets

were projected to grow by 12.7%, namely from Rp1,272.1trillion at the end of 2004 to Rp1,434.0 trillion at the end

of 2005. By December 2005, commercial bank total asset

realization had exceeded the original target, more

specifically Rp1, 469.8 trillion, or 102.5% of the 2005 year

end target.

Commercial bank total assets surpassed their target

largely due to the realization of deposits. Total commercial

bank deposits (demand deposits, savings and time deposits)

reached Rp1,127.9 trillion by the end of December 2005;

or 102.4% of the 2005 year end target of Rp1,101.7

trillion. The relatively good realization of deposits cannot

be separated from the tremendous efforts of banks to

attract the publics money by offering higher interest rates

and many other incentives like prizes, bonuses and more.

The relatively good performance of deposits was

balanced by credit allocation realization. Until December

2005, total credit allocation from all commercial banks

totaled Rp730.2 trillion or 100.7% of the year-end target:



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Box 3.3 The Barriers of State-owned Bank Non Performing Loans Settlement

The relatively high NPL of State-Owned Banks, Finance includes self-managed state wealth/regional

8.3%, representing a hike compared to the year-end 2004

position of 5.8%. Meanwhile, despite remaining below

the maximum 5% level stipulated by Bank Indonesia, theNPL net ratio for commercial banks was 4.8% by the end

of December 2005, which was also higher compared to

the 2004 year-end figure of 1.7%.

For Micro, Small and Medium credit, gross NPL

remained relatively low, namely 3.2% at the end of

December 2004 and 3.7% at the end of December 2005.

Tighter competition between banks and the higher

deposit interest rate compared to the credit interest rate

narrowed the profit margin of banks. Overall, the total

net profit of commercial banks up to the end of December

2005 was Rp24.9 trillion; only 90.3% of the Rp27.6 trillion

target. The drop in banking profitability at the end of 2005

was also reflected by a falling Return-on-Assets (ROA) ratio

from 3.5% in 2004 to 2.6% at the end of December 2005.

The unfavorable net profits mentioned above, in

time, will affect capital realization. The Capital Adequacy

Ratio (CAR) of commercial banks was 19.5% at the endof December 2005; slightly below the target of 20.6%.

Deviation from the targeted CAR was less drastic than for

net profit as well as total capital because it was partially

compensated by the Weighed Asset According to Risk (as

a denominator component in the CAR calculation), which

was also below the stipulated target.

Against this backdrop, the realization of commercial

banks business plans in 2005 has not been fully

successfully in line with designated targets. Although the

realization of total assets and deposits was considerably

good, the economic condition during the last quarter of

2005 was not favorable and the interest rate hike reduced

commercial banks profit gain.



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Loans, among others specifies that government

loans will only cover central government loans.

The absolute annulment of state enterprise loans

can only be conducted after management is taken

over by the Branch of the Committee for

Managing Government Loans (article 3)

It is stated in Article 9, PMK No. 31/PMK.07/2005

that an absolute annulment is meant as the dissolution

of the government enterprise loan claim. Meanwhile,

the claim termination shall be conducted by:

a. Principle loan termination shall be decided by the

Minister of Finance;

b. Loan interest, penalty and or costs of the

annulment shall be decided by the concerned

government enterprises.

Hence, considering that state-owned banks must

follow the above mentioned loans/credit procedures,

therefore, they do not have any authority to terminate

loans against the principle loan to resolve non-

performing loans as conducted by private banks that

can sell the dissolved credit and/or credit collateral by

institution or enterprise... Further it was said that if

not successful, the resolution must be handed over to

the Committee for Managing Government Loans. The

sense/scope of the first level asset settlement is clarified

in the following implementation guidelines:

a. Article 2 paragraph 1 of Minister of Finance Decree

No. 300/KMK.01/2002 regarding the

Management of Government Loans emphasized

that the settlement of first level government loans

must be resolved by the concerned state

enterprises themselves in accordance with

prevailing rules of law.

b. Article 2 paragraph 2 of the mentioned Minister

of Finance Decree further regulates that in the

case of unsuccessful first level settlement, the

related state enterprise must hand over the

management of such government loans to the

Committee for Managing Government Loans

Based on these rules, there remains no clarity in

the scope of first level settlement that can be conducted

by state-owned banks. Considering the high NPL of



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6. The Impact of Mutual Funds

One of the barriers that affected national banking

system sustainability during 2005 was constraints in mutualfunds. Unlike 2002 and 2003, which saw the kindling of

mutual funds products, 2005 marked the turning point

with huge redemptions and withdrawal actions.

Meanwhile, the mutual funds heyday in 2002 and 2003

triggered the banking industry to join the party by acting

as mutual funds selling agents - with among others,

underlying government bonds - issued by investment

managers, from the banks subsidiaries (securities

companies).

Actually, investor funding withdrawal from mutual

funds products was not something extraordinary, because

as an investment product, it has major inherent market

risk stemming from fluctuating investment value, which

depends on existing market parameters against the

benchmark. Unlike traditional banking products, such as

savings and time deposits, mutual funds have specific

consequences. Consequently, investors must have

sufficient knowledge and understanding when involved

probably did not fully educate or socialize the risks to

prospective investors or only explained the potential profit

gain rather than any consequences of loss. Moreover, banksacting as selling agents spread through various areas of

the country instead of being concentrated in the head

office. This spread existing expertise thinly, which lead to

a lack of knowledge in the branch offices.

To combat these problems, the Deputy Governor

issued a circular addressed to all banks in the form of

Circular No. 5/13/DPG/DPNP dated 3rd October 2003

concerning Prudential Principles for Banks in Conducting

Activities related to Mutual Funds. Through this bill, in

essence, Bank Indonesia prohibited any banks involved in

mutual funds activities to act as standby buyers for bonds

portfolios available with the investment managers. As a

consequence, bonds transactions between banks and

investment managers (partly owned subsidiaries) must be

conducted transparently and should refer to mark to

market. Ergo, a bank must include its investment manager

logo and clearly explicate the inherent investment risks to

clients regarding mutual funds, which are not guaranteed



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Box 3.4 The Mutual Funds Case of Bank Global (Management Integrity as a Key Factor)

The criminal case of PT Bank Global in 2004

almost happened without warning; everything seemed

to be running fine. One of the rating agencies even

raised Bank Globals rating from BBB to A- in July 2003.

Beyond Bank Indonesias and Bapepams(Capital

Market Supervisory Authority) knowledge, banks

without valid permits/certification to act as selling

agents had, in fact, been selling mutual funds1 to the

public since 2003. This caused bank deposits to plunge

from Rp1.5 trillion in mid 2003 into Rp800 billion at

the end of 2004.

The funds collected from the sales of mutual

funds to the public were not used to actually buy

mutual funds, but were embezzled by corrupt

management for personal use This was a blatant

management. No matter how good the system is if

management has no integrity it is useless. Nevertheless,

all systems have flaws and this is what Bank Indonesia

strives to continually improve as the banking supervisor

authority.

In the Bank Global case, the weak point exploited

by the corrupt executives was poor coordination and

weak legal infrastructure that served as an umbrella

covering the banks activities in terms of financial

services. This was reflected by the following points:

(i) Reporting of financial services business activities.

The bank did not report/acknowledge its mutual

funds selling activities to Bank Indonesia. However,

the problem remained that mutual funds were not

a bank product and are regulated by Bapepam

b) Ensure that the respective mutual funds have obtained

an effective statement from the capital market

authority in accordance with prevailing rules of law;

c) Identify, measure, monitor and control risks stemming

from activities related to mutual funds; and

d) Provide complete and transparent information tocustomers.



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Based on mutual funds inspections of banks during

the 20042005 inspection period, the unhealthy banking

practices were found to be as follows:

submitted investor data to the custodian bank and

likewise the custodian bank never submitted any

report to the bank.

Coupled with risk-management imple-

mentation, Bank Indonesia issued Circular No. 7/19/

DPNP dated 14th June 2005 on Risk-management

Application for any Bank Conducting Activities related

to Mutual Funds. This circular obliged concerned

banks to provide complete and transparent

information to customers. In particular, to explain that

mutual funds are a capital market product for which

the bank has no responsibility for any risks incurred.

Also, that those mutual funds are not covered by the

Government Guarantee Program.

Whats next?

Financial services products have been developingso rapidly and the business conflict of interest between

non-bank financial institutions and banks is becoming

more intense. Against this backdrop, coordination with

the related financial services authority must be

continually enhanced. To this end, the idea of universal

banking in that financial services institutions can

conduct both banking and non-banking business

activities requires a clear legal umbrella. This would

enable due supervision to be executed more

comprehensively.

Bank Indonesia will also continue to monitor

financial services products that involve banking

activities. Despite awareness that legal infrastructure

development always lags behind societal dynamics (in

this case financial services products), Bank Indonesia

should have been alerted to this alarming condition asearly as possible in order to take immediate anticipative

measures.



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Box 3.5 The Mutual Funds Case of PT Bank Negara Indonesia Tbk.

The huge redemptions that occurred in 2005could basically have been resolved by mutual funds

players, but not the BNI Dana Plusmutual funds issued

by BNI Securities and marketed by PT Bank BNI (Persero)

Tbk (Bank).

The bank served as a mutual funds selling agent,

known as BNI Investment, since October 2002. BNI

Investment was the product link for selling BNI Dana

Plusmutual funds issued by BNI Securities (the banks

subsidiary). One of the banks objectives in marketing

the BNI Investment was not to lose its depositors.

Therefore, initially, BNI Investment was designed to look

like a deposit account, promising a fixed return of 2.5%

above the deposit interest rate within a certain time

frame.

The bank did not fully act as a BNI Dana Plus

mutual funds selling agent exposing the bank to

liquidity risk, market risk, legal risk and reputation risk.

If the bank had acted solely as a selling agent, it would

The banks mutual funds activities developedrapidly, as signified by an increase in NABand the number

of participating units. However, triggered by higher

interest rates that lowered the bond price, in early July

and September 2005, huge, rush redemptions from

customers followed. This was generated by a NABper

unit drop due to a falling government bonds price in the

investment portfolio of the BNI Dana Plusmutual funds.

The bank was trying to socialize and educate its

selling agents spread throughout the branches, but it

seems the socialization and education process falte

Banking Supervision Report 2005

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