Budi Mulya: Managing risk in the new landscape
Keynote speech by Mr Budi Mulya, Deputy Governor of Bank Indonesia, at the Banker
Association for Risk Management (BARa) seminar on "Managing Risks in an Uncertain
World", Jakarta, 26 October 2009.
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Chairman, Board members and members of the Indonesian Bankers Association and Banker
Association and Risk Management, Distinguished Speakers, Ladies and Gentlemen,
It is such a great honore to be here today, especially to join in a dialog amongst experts and
practitioners, on risk management. The risk management topic, has become an important
subject to be seriously addressed, considering on what we have observed during the most
recent global financial crisis.
The impact of the crisis that emerged back in September 2008, has spread deeply and
widely through, both financial market and real economic, in particular passing through
international trade channel. Since then, we all have witnessed that over the past year, there
has been dramatic change, in many aspects of the economy and financial market globally.
The magnitude impact of the crisis into individual country differs, depending on how, and to
what extent the economy of individual country, and its financial institutions is linked into the
global market. Yet, there is no single country immune from the recent turbulence. This is
mostly because at the first stage the financial turmoil which started in the US financial market
has triggered panic amongst financial market players, in face with high uncertainty, and this
behavior was spreading almost instantly worldwide.
To that respect I would like to emphasize, that such market behavior has much to do with risk
management, more specifically in the weakness, of its implementation in the real world.
Thus, the recent crisis shows somewhat in contrast of the fact that during the last decade risk
management has become one important topic in discussion. As a management tool, the
practice of risk management so far, has failed to change human being behavior that tends to
be easily trapped in complacency. That is, a tendency of not assessing risk properly in good
time, partly covered by expected high return, but then reacting so extremely in reverse when
thing goes in the opposite direction.
However, as we observed from the ongoing public debate with regard to the cause of the
recent turmoil, the similar phenomenon can be found within the authority's or regulator's
perspective. In particular, on how they perceived risk in setting policy and in regulating
financial industry. More specifically on the assumption that market discipline will always work
properly.
One highlight that we can derive from what has been happening so far, is that the financial
industry must always be closely linked with the real sector activities, the fundamental
economic.
The Indonesian economy and financial industry during turmoil
As in some emerging economies, Indonesia essentially has quite a strong fundamental, and
much better compare to what was during 1997/98 Asian crisis. However, as I previously
mentioned the crises that caused global economic growth slump and the international trade
volume squeeze, as well as a high degree of uncertainty that surrounded the international
financial market has also weakened the domestic economic activities. Yet, the economy is
still able to expand. The Indonesia's economy grew at 6.1% in 2008. The Indonesian
economic growth reached the bottom in quarter II 2009 at 4%, a 0.4% drop from previous
quarter of 4.4%. We expect that the Indonesian economy will grow at 4.0 to 4.5% in 2009,
higher than previously estimated. The domestic economic growth is mainly supported by
domestic demand which contribute more than 60% of GDP and natural resources export. In
2010, we expect the economy will grow at 5% to 5.5%. Along with declining domestic
economic activities in 2009, inflation rate has also descended. As of September 2009, the
year to date inflation rate is 2.28%. Inflation is expected back to its normal pattern in 2010 at
5 +/-1 % as economic activities start accelerating.
In addition, the domestic banking industry is also in relatively sound condition and well
capitalized. The average capital adequacy ratio (CAR) is around 17% and the gross
nonperforming loan (NPL) ratio is below 5%.
Those facts show that the Indonesian economy is relatively sheltered from the biggest
turbulence since the world's war II. However, foreign investors tend to undermine those facts,
and perceived risks exaggeratedly on the Indonesian economic fundamental. Despite that, it
was true that the crisis caused panic and lost of confidence, in particular post Lehman
Brothers collapsed on 15 September 2008, which led to the phenomenon of holding cash
alike and safe haven assets, it has put significant pressure on Indonesian economy and
increasing volatility in the domestic financial market. Risk perception on the Indonesian
financial market has been so high as shown in the hike of CDS spread, that reach a peak of
around 1000 bps in October 2008, the highest spread amongst countries within the region.
Further, the exodus from emerging market financial assets, led the government bond (SUN)
price index (IDMA index) to fall to its lowest level ever at 67.11 in October 2008, which mean
that across the board yield of SUN, has hike to above 15%. The IDR exchange rate again US
Dollar, has also weakened dramatically from around 9.200 levels, to reach its peak at 12.000
levels in November 2008.
However, the above symptoms of increasing counterparty and credit risk also could be
observed in domestic market. The inter-bank money market indicators also revealed similar
shape, to those found in global market during the crisis. The spread of JIBOR 1 month over
BI Rate for instance, has widened significantly to around 250 bps, despite that the interest
rate was in a declining trend, while in normal condition it is always below 50 bps. Further,
there was also a tendency that banks prefer to hold their reserve, in shorter maturity of Bank
Indonesia's OMO instruments (FASBI and short-term deposit collection, the so-called FTK).
These, along with nervous as observed in the banking industry with regard to its funding
source, public or third parties deposit that led to unhealthy competition amongst banks, has
showed that, there was some potential liquidity risk in the domestic banking sector.
To cope with the above mention situation, the Government and Bank Indonesia took some
necessary measures to safeguard the domestic economy. Government has provided fiscal
stimulus to secure the real sector activities, as well as to prevent the deterioration purchasing
power of the poor. Meanwhile, the monetary policy stimulus, took form in accommodative
stance, as inflation has fallen, by reducing BI Rate 300 bps since November 2008, from 9.5%
to 6.5%. In addition, from the operational level, Bank Indonesia has also undertaken some
measures aimed at addressing market liquidity concern, by providing and ensuring the
supply of liquidity in cash money market, both in US Dollar and in Rupiah.
In US Dollar market, Bank Indonesia reduced the required reserve ratio, from 3% to 1%,
lengthening the maturity of swap operation, and ensuring the US Dollar liquidity need for
domestic corporations via banks, by providing window for rediscounting export underlying
instrument. Meanwhile, in the rupiah money market, Bank Indonesia took similar measure,
such as providing window for "repo" transaction, using underlying assets of government
bonds, and certificate of Bank Indonesia ("SBI"), for various maturity, recently up to 3
months, through an auction mechanism. The auction mechanism is also aimed at averting,
the negative "stigma" from banks' perspective in dealing with the central bank to obtain
temporary liquidity in fair market price.
All those measures, which in essence is similar to those taken by major authorities globally,
even though differ in scale and instrument variety, has so far help the Indonesian economy
and financial sector, in passing by the most challenging episode during the crisis. Along with
improvement in global economy and financial market, those indicators have move back to
their more normal level. The spread of JIBOR 1 month over BI Rate, for instance, has decline
significantly at around 15 bps. Yield of SUN has declined to 10%-11% for the 10 years SUN
and longer maturity. The CDS spread has also dropped to below crisis level of below 200
bps, close to the pre crisis level. Meanwhile, the IDR exchange rate has also recovered and
hover around 9,400 recently, despite still at higher volatility compare to the pre crisis period.
However, the policy transmission into the real sector has been slowing down as uncertainties
remain. The banks' lending, needed to support the economic growth, is still quite slow. The
year to date banks' lending growth up to September 2009 is still below 5%. In addition, the
lending rate also does not decline as expected. Despite that, this is sensible, in face with the
declining economic slowdown and uncertainty, but is also closely linked with the way banking
implement risk management. For some extent, this reflects, that they tend to avoid risk rather
than, properly identifying and manage risk accordingly.
We also observe that the way financial investors globally, do not show any change in their
behavior, as mainly reflected in the high volatility of stock market. They tend to over react on
every single news and data announcement, which indicates their eagerness, to try to recover
their lost during the crisis, and nervousness of potential lost. This behavior, is potentially
threatening the sustaining economic recovery.
The risks and challenge ahead
There are now more signs of global economic recovery and improvement in the prospect of
financial market. However it is still too early to conclude, that the recovery path will be
smooth and sustainable, since as I previously mention, the lag of policy transmission tend to
lengthen and uncertainty remains. In addition, issues concerning the implication of
extraordinary measures, that has been taken by major authorities, such as the widening of
fiscal deficit in major countries, and the "exit policy" of quantitative easing taken to fight
deflationary pressure in those countries has started to emerge. To cope with this issue,
authorities have intensified their policy communication, to convince that all needed measures
and tools have been prepared. Yet, it seems that all of those are not convincing enough, as
at this stage, the political involvement in every country tends to increase.
With the above background, we have to keep optimistic, but still have to be cautious. From
the risk management perspective, the challenge in the period ahead, is in identifying the
potential risk appropriately, which is the key in risk management. The recent turbulence has
changed the global economy and financial market landscape. Consequently the standard
indicators, both in financial market and real economic, might have also changed, and we
cannot rely on their empirical behavior. In face with this situation, we all have to widen the
indicators to be considered, including qualitative indicators.
The recent development has also lead the authority, to adjust and shift their paradigm and
approach in setting the macroeconomic policy, and supervising as well as regulating financial
sector. In addition, authorities globally have been challenged, with a more serious dilemma.
On one side, their need to maintain sustainable economic recovery process, which means
need to be expansionary or accommodative. While on the other side, they need to maintain
financial system stability, mainly by strengthening regulation and supervision and improve
the balance sheet structure of financial industry, banking in particular, and its risk
management as well as to avoid the potential inflation in the medium to long term horizon.
Striking the optimal balance between these two situations will be challenging and dynamic.
The situation we have in Indonesia is considerably better than those faced by developed
countries, but we have to always be aware, that we are in an integrated world, and that there
is structural changes. Hence, more prone to external shock. In this regard, Bank Indonesia
always commit, in achieving a balance between financial stability and monetary stability, in
order to maintain low and stable inflation needed to safeguard a healthier and sustainable
economic growth.
The situation I just described, should always be taken into account in conducting business in
a more challenging period ahead, more specifically in the risk management practice. For
banking industries, considering their important role in the economy, and the severe impact in
the society when they fail, I hope there will be more professional, and more proper
implementation of risk management, and in particular a more efficient asset and liabilities
management.
From today's seminar, I hope we will have a better insight in risk management area and a
fruitful discussion to enhance our understanding and more importantly to increase confidence
in implementing it.
Thank you.