Erwin Riyanto: Unveiling macroprudential policy
Speech by Mr Erwin Riyanto, Deputy Governor of Bank Indonesia, at the 10th International
Conference on Bulletin of Monetary Economics and Banking and book launch, Jakarta, 8
August 2016.
* * *
Honorable,
Governor of Bank Indonesia
Bapak Agus Martowardojo
Former Governors of Bank Indonesia
Bapak Rachmat Saleh
Bapak Arifin M Siregar
Bapak Adrianus Mooy
Bapak Syahril Sabirin
Bapak Burhanuddin Abdullah
Chairman of Indonesia Deposit Insurance Corporation
Bapak Halim Alamsyah
Directorate General of Culture Ministry of Education and Culture
Bapak Hilmar Farid
Head of Fiscal Policy Agency, Ministry of Finance of the Republic of Indonesia
Bapak Suahasil Nazara
Head of National Library of the Republic of Indonesia
Bapak Muhammad Syarif Bando
Head of National Archives of the Republic of Indonesia
Mustari Irawan
Former Bank Indonesia Board Members
Distinguished Guests, Ladies and Gentlemen
Assalamu'alaikum Wr. Wb,
Introduction - greeting & objectives
1. It is a great honor for me to be here in this 10th International Conference and Book Launch
event. Please allow me to divert your attention to review the next book entitled "mengupas
kebijakan makroprudensial" or "unveiling macroprudential policy". This book I believe is not
just any other book. It is the first book ever published about macroprudential policy in
Indonesia. It is one that is meant to educate the public with a better understanding of what is
macroprudential policy, why is it important, what are the policy instruments, how it interacts
with other policies and who should better have the mandate.
2. Since work in the macroprudential field has only gained momentum globally following the
2008 crisis, much of the concepts are still evolving. In this book, we will come across many
new financial terminologies that in principle have already been around for some time but have
not yet explored. To name a few of the new terminologies are systemic risk, contagion,
interconnectedness, shocks, vulnerabilities, idiosyncratic vs cross-sectional risk dimensions
and macroprudential. While macroprudential policy and the aforementioned terminologies are
more understood by those directly involved in the field, there is a growing need to familiarize
the notion to the public-at-large.
3. Why? because evidently, implementation of macroprudential policy directly touches upon
financial agents and more than often requires inter-agency support for its effectiveness. With
proper knowledge and understanding of the macroprudential framework including the
transmission of systemic risk, the public can gauge their contribution to preserve financial
stability. In this case, limiting the tendency for risk exuberance behavior. Furthermore, the
recent enactment of the Law on Financial System Crisis Prevention and Resolution not only
compels the public to be equipped with a stronger understanding of systemic risk but also with
regards to the importance of institutional arrangement and crisis management protocol.
4. The Law on Financial System Crisis Prevention and Resolution provides a legal standing
for the institutional arrangements between BI, OJK, Ministry of Finance and the Deposit
Insurance as part of The Financial System Stability Committee.
The Act stipulates the roles of each institution in deliberating coordination to safeguard financial
system stability, mitigate financial system crisis and handling of systemic bank problems;
during normal and financial system crisis conditions. The Act was constructed on the basic
principle of alienating the use of tax-payers money. This is achieved with reference to Basel III
principles that focus heavily on mitigating systemic risk and strengthening banks' resilience,
particularly the ability of systemic banks to bail itself.
The basic concept of macroprudential policy and systemic risk
5. The next question is then what is systemic risk? What is macroprudential policy?
Macroprudential policy has been well defined in the IMF, BIS and FSB's documents, as well
as published papers. There are at least 3 (three) key elements to describe macroprudential
policy. First, it aims to safeguard financial system stability. Second, the focus is on
systemwide perspectives instead of individual financial institution's safety and soundness level. Third
and most central element is that it aims to limit the build-up of systemic risk.
6. Systemic risk itself is known as the risk of widespread disruption to the provision of financial
services, which can cause serious negative consequences for the real economy. Systemic risk
can be recognized through vulnerabilities related to the build-up of risks over time or from
interconnectedness and the distribution of risks within a financial system at any given point in
time. By mitigating systemic risk, macroprudential measures ultimately aim to reduce the
frequency and severity of financial crises.
7. How can this be achieved? Lessons from the 2008 crisis taught us that microprudential
policy alone tends to overlook the build-up of risk taking behavior of financial institutions.
Furthermore, long periods of low interest rates and a single monetary objective geared towards
low inflation may also give rise to the build-up of systemic risk when uncoupled with sufficient
prudential measures. Therefore, macroprudential policy aims to maintain a balance between
macroeconomic and microeconomic objectives through implementation of prudential principles
in the financial system. The notion is to limit risk-taking behavior of financial agents.
The history of macroprudential policy in Indonesia
8. While much attention and work on addressing systemic risk through macroprudential
policies became viral after the financial global crisis, a number of countries in the emerging
market have used macroprudential tools well before. Bank Indonesia has implicitly paid due
consideration and acknowledgement to the importance of macroprudential aspects in terms of
maintaining financial system stability since early 2000. Such acknowledgment gave rise to the
establishment of the Financial System Stability Bureau in 2003.
9. The assessment on financial system stability has also been deliberated through the
publication of the Financial Stability Review every semester since 2003. Inevitably, our early
experience in managing financial stability following the Asian financial crisis in 1999 managed
to salvage the Indonesian economy from adverse impact of the 2008 turmoil.
Why the central bank has an important role in macroprudential policy?
10. Now, one might question, who should be most suited to receive the mandate for
macroprudential policy? Observably, there are considerable differences in the institutional
arrangements across countries as there is no "one size fits all". However, in most jurisdictions,
regardless of the type of institutional setup, the central bank is given an important role,
including veto powers in a committee setup.
11. The pivotal role of the central bank is mainly supported by the uniqueness of the central
banks function as lender of last resort and as an independent authority. The ability of the
central bank to create liquidity in the banking system is a unique advantage in preserving
financial stability. The central bank as monetary authority also has considerable information
advantage concerning the complex interactions of the financial intermediary system and the
operation of the real economy. Such advantage would allow the central bank to gauge potential
systemic risk, for example through calibrating the impact of macro-stress scenarios to the
resilience of financial intermediaries. Furthermore, the primary objective of the central bank to
achieve price stability, also goes hand in hand with financial stability; that is, they mutually
reinforce each other in most cases. Another unique function of the central bank is in the
payment systems. The central bank has the information and expertise to identify potential risks
and deadlocks in the payment system, which may cause serious disruptions to the financial
system.
Macroprudential policy mandate & the MP framework in Bank Indonesia
12. Based on a joint progress report of the FSB, IMF and BIS to the G20, effectiveness of
macroprudential policy is served by providing the relevant authority with a clear mandate. In
this case, Bank Indonesia has the mandate to perform the role of a systemic regulator and to
exercise macroprudential supervision as stipulated in the Act No.21 of 2011 concerning the
Financial Services Authority. Given the role of Bank Indonesia as the systemic regulator, we
continue to strengthen our expertise in monitoring systemic risk through developments in our
macroprudential policy framework. The framework must provide clear, transparent and
accountable objectives with a focus on maintaining financial system stability.
13. The macroprudential policy framework maintains financial system stability through four
objectives that are: (i) early identification and mitigation of systemic risk, (ii) minimization of
financial imbalances to improve the quality and soundness of intermediary functions, (iii)
efficient financial systems and (iv) improving access to finance by expanding SMEs access
and financial inclusion. In an emerging economy, improving access to finance is a continuous
effort integral to financial market development; either through financial broadening or financial
deepening. It also aids in mitigating systemic risk that may arise from a financial system that
is still concentrated in a particular corporate sector and certain segments of society.
14. In order to operationalize these macroprudential objectives, there are 4 main elements to
focus on that are: (i) identification of the sources of systemic risk; (ii) macroprudential
surveillance through monitoring and analyzing identified risks; (iii) formulation of policy
responses through implementation of macroprudential tools; and (iv) crisis management
protocol.
Sources of systemic risk: shocks and vulnerabilities
15. The process of identifying sources of systemic risk involves identifying shocks and
vulnerabilities. Materialization of systemic risk is triggered by an interaction between shocks
and vulnerabilities. In this case, a shock may come through changes in macro-economic
conditions. Meanwhile, vulnerabilities are associated with pre-existing fragilities of the financial
system which will amplify and propagate the initial shocks to the financial system. Examples
of vulnerabilities include high levels of leverage, maturity transformation, interconnectedness,
and complexity. Bank Indonesia is currently developing the Balanced Approach Method to
identify the key source of potential systemic risks that will be considered as top priority to
monitor and address.
16. It is important to highlight that while shocks are inevitable, identifying and addressing
vulnerabilities becomes the key to ensuring robustness of the financial system. In addition, a
number of early warning indicators and methodologies can be useful to assess vulnerabilities
well before the emergence of stress. In this case, Bank Indonesia has employed many
indicators and developed several models to detect the vulnerabilities in the financial system as
well as the build-up of systemic risk. We have also developed models to assess the systemic
impact and the resilience of the financial system to systemic risk, such as the Indonesian
Financial Cycle as imbalances indicator, Financial System Stability Index as stress indicators,
macro stress test and also top-down bank stress test models.
17. Given that vulnerabilities and systemic risks may arise from different sectors as well as
changes in market behavior and in macro-economic conditions, Bank Indonesia must have
access to a wide-range of information sources. This includes the authority to conduct off-site
and on-site examination if needed. It is worth highlighting that there is a considerable difference
in the main objective of Bank Indonesia's examination to the OJK. That is to identify the
potential systemic risk as an impact of macroeconomic condition to the bank's resiliency, and
its potential contagion impact to the industry. Furthermore, on-site examination will have an
objective to ensure compliance of Bank Indonesia regulation covering monetary, payment
system and macroprudential.
Macroprudential policy instruments
18. Furthermore, following the identification of possible systemic risks, macroprudential policy
instruments are tailored to address such risks in both time and cross section dimensions.
Macroprudential instruments in the time dimension, aim at increasing resilience to shocks and
contain pro-cyclical build-up of systemic risk. The instruments often used include (i) capital
based tools (ii) asset side tools or loan restrictions and (iii) liquidity related tools. In a cross
section dimension, macroprudential tools aim to reduce contagion risks by improving resilience
of systemic institutions for example, via additional capital surcharge and loss absorbency
requirements. Other prudential tools in the cross section dimension include increasing risk
weights and large exposure limits.
19. Overtime, Bank Indonesia has implemented a broad range of macroprudential instruments
including capital-related tools as required by Basel III such as Counter Cyclical Capital Buffer
as well as asset-side tools and liquidity-related tools. Asset-side tools include certain loan
restrictions, such as LTV caps and to boost credit have put in place incentives and
disincentives in the form of reserve requirements linked to loan to funding ratios. To strengthen
corporates resilience to exchange rate shocks, Bank Indonesia also introduced requirements
for hedging ratio and forex liquidity ratio.
Macroprudential policy interaction with others policies
20. In the areas where macroprudential policy interacts with microprudential policy, Bank
Indonesia and OJK work hand in hand in formulating the optimum policies. For instance, Bank
Indonesia has contributed work and research to the formulation of LCR requirements with OJK
and in the identification of systemically important bank as mandated by the Law on Financial
System Crisis Prevention and Resolution. Bank Indonesia and OJK have also established a
bilateral coordination framework to facilitate and to optimize cooperation and coordination in
carrying out the function, duties, and authorities of Bank Indonesia and OJK.
21. Recognising the potential interaction of macroprudential policy with other policies that also
have a bearing on systemic risk, requires strengthening of inter-agency coordination. Such
interaction between macroprudential policy not only applies with microprudential policy but also
with monetary and fiscal policies. As mentioned by the IMF in their recent stock taking paper,
boundaries and interactions between policies are complex and can give raise to both
complementarities and tensions that may need to be resolved. For example, via suitable
institutional arrangements which we effectively already have in place.
Closing remarks
22. To conclude, it is my greatest hope that this book can serve as a gateway for the public to
better understand macroprudential terms and concepts as well as its main objective in
mitigating systemic risk. With better understanding of the systemic risk transmission, we as
individuals can help contribute in preserving financial system stability by limiting exuberance
risk taking behaviour. Hopefully, despite our inability to read the crystal ball of the next crisis,
we would presumably have better ammunition to deal with the headwinds and financial
turbulences that are yet to come.
Thank you.