Recent turmoil in the international financial markets, including sub prime mortgage markets affecting corporations in Indonesia, has highlighted the need for better tools to monitor risks and vulnerabilities.

Monitoring tools are important to expose vulnerabilities in international capital flow reversals and shocks to the corporate and household sectors. However, the paucity of data and a lack of dissemination and comparison across countries are stumbling blocks.

Why are sound financial systems important? A country's financial system includes its central bank and national regulators, banks, and other fiancial corporations carrying out economic transactions and channeling savings into investment.

The role of financial institutions is primarily to intermediate between those that provide funds and those that need funds, by managing risks.

Problems in a financial system can reduce economic growth and the effectiveness of monetary policy. Troubled financial institutions cost money, and problems can trigger capital flight and deepen economic recession. Moreover, financial weaknesses in one country can rapidly spill over to others.

In response to the need for better tools to monitor financial risks and vulnerabilities, the International Monetary Fund (IMF) has worked closely with national agencies as well as regional and international institutions to develop a set of Financial Soundness Indicators (FSIs).

These FSIs comprise of 12 core indicators for banks and 27 encouraged indicators (13 for banks, two for other financial corporations, five for non-financial corporations, two for households, two for market liquidity, and three for real estate markets).

These FSIs monitor the health and soundness of financial institutions and markets, corporations and households, with the objective of enhancing financial stability.

Given the complexity of links between the financial sector and the real economy, there is no single method for assessing financial sector stability. In practice, analysts must rely on a range of indicators.

Nonetheless, FSIs are essential to financial surveillance. They provide a basic measure of a financial system's exposure to different types of risk and can help gauge its ability to handle shocks should they occur.

FSIs are viewed as current or lagging indicators of soundness, and they are often complemented by an analysis of market-based data, which can provide more forward-looking information every day.

FSIs for non-financial corporations and households have been found to be better indicators of vulnerability.

Indonesia, along with 56 other countries, has participated in the voluntary Coordinated Compilation Exercise (CCE) for FSIs, conducted by the IMF during 2004 to 2006. It has submitted 12 core FSIs and some "encouraged" FSIs for banks.

However, since empirical data has proven FSIs for non-financial corporations and households are better leading indicators of financial vulnerabilities, Indonesia has to hasten its compiling of FSIs for sectors other than the banking sector.

Bank Indonesia's cooperation with the Ministry of Finance, the Capital Market Supervisory Agency (BAPEPAM) and the Central Statistics Bureau (BPS) plays a pivotal role to develop a complete set of FSIs for Indonesia, in order to better financial system vulnerability.

As with most indicators, FSIs need to be interpreted cautiously. FSIs' legal and regulatory systems and the broader legal and governance structures can vary significantly across countries, and this can affect both the ability to compare and interpret international indicators.

The writer is an economist at the Statistics Department of Bank Indonesia, and is currently appointed as an economist at the Statistics Department of the IMF in Washington, D.C. The writer can be reached at afirmans@yahoo.com. This article reflects the personal views of the writer.

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