Bank Indonesia, the central bank of Indonesia, has been introducing several new institutional frameworks and rulings in the Indonesian economy. I suppose, that signifies that rate of reform in Indonesia.

One is the introduction of a trust fund. It is established to encourage Indonesian firms with earnings from abroad to keep it in Indonesia, at least for a bit longer than what typically happens now. The ultimate goal is to prevent the rupiah from depreciating further.[1] I do not understand how that will keep the money in. That is a polite way of saying, I do not think it will work too well.

Maybe the Indonesian central bankers know more than me about their economy and I am missing a piece of the jigsaw puzzle.

Another is the introduction of a new differentiated capital adequacy ratio ruling. Soon, different bank will face different ratio requirement based on their risks as determined by the central bank. But according to a report in the Jakarta Globe:

Under the new regulation, Bank Indonesia requires a minimum 8 percent capital adequacy ratio — which measures the lender’s financial strength — for banks with the soundest risk profile but it set a higher ratio for the riskiest. In the previous regulation, the ratio was set at 8 percent, regardless of the risk profile.

Bank Indonesia groups the country’s 120 commercial banks into five risk profiles. It usually updates a bank’s risk profile every 6 months but does not make the rankings or their specifications public to avoid a run on deposits at lower-ranked banks. [Dion Bisara. Bank Indonesia Sets New Rule to Strengthen System. Jakarta Globe. December 5 2012]

Bank Indonesia does not make the rankings or the specification public to avoid a run.

That is tough because as long as one can have access to the accounts of a particular bank, one can try to figure out the ratio faced (or really, ratio maintained) by the bank. From there on, the market can imply the imposed ratio.

In other words, the public can find out exactly what Bank Indonesia tries to not divulge. So, here is a ruling that I think is good but as far as risks, bank run and the differentiated capital adequacy ratio are concerned, I am quite certain that it cannot work. Bank Indonesia is revealing the very information it wants to hide.

To come to think of it, in times of banking crisis, it appears that banks with the highest ratio may face the highest likelihood of experiencing a run (ceteris paribus… and knock on wood).

The simplest and the most effective way to have a good ratio and not tell the market anything about individual banks is to impose a more or less uniform requirement across the board. There are issues with uniform requirement but it will address the problem of information superbly.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
[1] — The central bank on Friday took another step to retain foreign earnings by setting up a trustee fund that will ensure steady and sustainable flow of overseas earnings that will be repatriated into the country. The move might also help to stem the rupiah’s depreciation against the dollar by holding income earned from abroad over a period of time rather than being withdrawn quickly. [Francezka Nangoy. Dion Bisara. Central Bank Sets Rule to Keep Foreign Earnings. Jakarta Globe. November 24 2012]

2 Responses to “[2638] The market will see through the undisclosed, differentiated Indonesian capital adequacy ratio”

  1. on 11 Dec 2012 at 15:52 hishamh

    It might be a little harder than you think. Efficiency (and pressure for profitability) suggests that banks will only keep as much capital as they are required to hold. In practice however, this doesn’t seem to be true – banks appear to be holding a buffer of capital in excess of their regulatory requirements.

  2. on 12 Dec 2012 at 18:36 Hafiz Noor Shams

    Apart from the level, an increase in ratio can also give some signal as well. I guess that depends whether the new required ratio will be higher than what is maintained at the moment.

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