The release of new macroprudential instruments should be appreciated as policy response in order to strengthen banking intermediation and resilience.
ank Indonesia (BI) recently introduced a couple of macroprudential policy instruments in order to strengthen the banking intermediation function and its liquidity management.
The central bank converted the loan-to-funding ratio (LFR) policy (for conventional commercial banks) and the financing-to-deposit ratio (FDR) policy (for sharia banks and sharia business units) into the macroprudential intermediation ratio (MIR).
In addition, BI also introduced the macroprudential liquidity buffer (MLB) by converting the secondary reserve requirement for conventional commercial banks. Both instruments will be effective as of July 16 for conventional commercial banks and Oct. 1 for sharia banks.
As the macroprudential policy still grows in its developing phase, the MIR and the MLB are unique Indonesian policies that also made BI a pioneer in macroprudential policy development in the world. These new instruments were implemented as a response to dynamic activity in the economy, especially in the financial sector. Financial institutions, especially banks, naturally move in line with the cycle of the economy, which also represents their risk-taking behavior that is well known in financial literature as procyclical behavior.
When the economy is good, banks will expand their credits and increase their risk-taking behavior. Conversely, when the economy is slow, banks tend to withhold their expansion by withholding credit disbursement. Given this, it is important to note that this procyclical behavior can potentially disrupt the balanced and quality intermediation function in the financial system.
Corresponding to the banking procyclical behavior, the macroprudential policy response should be countercyclical. If the growth is excessive, the response of the macroprudential policy is to smooth the excessive growth, and vice versa. The MIR is expected to prevent and reduce risky and procyclical tendencies in banking behavior. This newly modified macroprudential instrument is implemented to promote banking intermediation function to the real sector in line with economic growth capacity and target while also maintaining prudential principles.
The MIR enhances the previous macroprudential instrument by accommodating the diversity of banking intermediation activities. In general, the formula of the MIR is credit plus securities held, divided by deposits, plus securities issued. By looking at the formula, it is interesting to note that in the new instrument, bank investments in securities are included as part of the banking intermediation in the real sector. By incorporating securities held by the bank, the MIR instrument is also expected to contribute to the deepening of the financial markets campaign.
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