The plan to disband the OJK, which was established in 2011, seemed to have been prompted by the public opinion that the OJK had not been up to its task in effectively supervising the financial service industry. Earlier this year, for example, the Supreme Audit Agency (BPK) revealed weaknesses in seven banks, which the OJK allegedly failed to detect.

It should be re-noted that the OJK was established because BI was assessed as incapable of effectively supervising the banking industry, which had collapsed in 1998. BI also was blamed for the failure of Bank Century (now Bank Mutiara) and Indover bank. The latter was a full subsidiary of Bank Indonesia in the Netherlands that was declared bankrupt by Dutch authorities in December 2008.

It is important to consider that wherever the supervisory function is located, some real reforms need to be implemented. As long as these reforms are not implemented, whatever model of supervision authority may later be set up would most likely fail to perform effective integrated supervision of the financial service industry.

The President may consider at least the following reforms as necessary.

First, the (new) financial services authority should be less process-orientated and more result-orientated. That means that it should be less bureaucratic, less feudalistic and more focused on mitigation. The organization should slash red tape and overcome biases for delaying reforms when changes in regulation and supervisory strategy are required.

Second, the central bank and financial services authority need to be more dynamic and open. A concrete example is the recruitment of human capital at BI, which began more than 50 years ago with the recruitment of talents (fresh graduates) under 30 years of age, who grew and then retired in the organization. As a result, there has been no diversity and healthy pressure for quality improvement within BI’s rank and file. This tradition of cultural recruitment has, unfortunately, been transmitted to the OJK.

The need for diversity is more compelling in the supervisory functions, considering rapid technological changes and ever-increasing complexities of risks in the financial sector. In the Netherlands, the central bank places advertisements for new employees. Therefore, each requirement should start from the functional requirement and can be brought in quickly from the private sector. I believe only with this system will the government be able to create a new culture at the central bank and at the financial service authority to serve the public interest optimally.

Third, the (new) financial service authority must be adequately funded to invest in technology, human resources and long-term capabilities, including sending staff out for relevant state-of-the-art training and education. But having stable and sufficient funding resources is not necessarily the only solution. One can additionally consider a smaller number of staff to support greater quality and diversity. Notably, staffing of financial services authority and central bank is generally much slimmer in other countries than at the OJK and BI.

Remarkably, in the current budgeting arrangement, the OJK’s effectiveness is further undermined by its reliance on revenues levied from the banking industry. The one who pays is then the one in charge. A solution would be to reduce the contribution from the financial sector, say to 50-60 percent, and the balance should be ideally covered by the state budget.

An alternative solution is to require BI make up the balance. After all, BI continues to enjoy cheap funding benefit received from the banking sector in the form of reserve requirements from banks. It is not a taboo to share a portion of “income” by investing the reserve requirement in producing assets with the OJK, which is also responsible for financial stability.

Fourth, while separating or merging the financial service supervision is not a factor that should be emphasized here, and whatever the institutional arrangement may be, it is important to maintain the independence of the central bank and what has been achieved so far by the OJK. International empirical evidence shows a clear tendency to eliminate banking supervision from the central bank. For example, Taiwan, Sweden, Australia and Canada have done it successfully.

The most common argument rests on a conflict of interest between maintaining stability of currency and banking supervision. It is no longer a secret that bankers are top class lobbyists, and because of the influence of the bankers, the central bank may also be tempted to prioritize bank protection, thus harming the wider public interest.

The main conflict is therefore related to setting interest rates. The central bank, when performing its supervisory role, may experience difficulties in raising interest rates to reduce inflation, because this action could hypothetically endanger the financial health of banks. This can affect the central bank’s credibility, which could lead to higher inflation at the expense of the public interest.  

 ***

The writer is a senior credit analyst at a Dutch bank. The views expressed are his own.

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