PROGRESS ON BASEL II IMPLEMENTATION IN INDONESIA

1. PROGRESS ONBASEL II IMPLEMENTATIONIN INDONESIA DR. WIMBOH SANTOSO Directorate of Banking Research and Regulation BANK INDONESIA

2. SURVEY, POLICY & ROADMAP ON BASEL II

3. REASONS MOVING TO BASEL II • Motivating banking industry to continuously improve their risk management capabilities • Enhancing competitive equality by creating a level playing field in terms of international regulation of banking • Basel I as the capital requirements: • no longer match the risks encountered (e.g. operational risk etc.) • created counter-productive incentives (e.g. risk mitigation techniques not taken into account, and therefore discouraged) • Bank Indonesia conducted a survey on Basel II in 2004 • obtain a view of the extent of banking industry’s awareness and comprehension on the Basel II framework • Identify the level of industry’s preparedness to meet the Basel II requirements.

4. THE SURVEY SURVEY RESPONDENTS

5. THE SURVEY The majority of banks have realized the objective, benefits and consequences of Basel II framework. Banks assume that the framework will bring optimal benefits in the practice of risk management The majority of banks assume that the framework will likely be fully implemented by banking industry

6. THE SURVEY The majority of banks propose that Basel II framework be applied by all bank, starting with the simplest approachs The majority of banks has not conducted self assessment and gap analysis

7. POLICY DEFINED • Bank Indonesia has formally announced a policy on the direction of Basel II implementation. starting from year 2008. All commercial banks will be required to meet the capital requirements of the Framework by adopting the least sophisticated approaches. Any banks capable of making the necessary system changes and meeting all other requirements adequately will be allowed to move to more sophisticated approaches upon supervisors approval. Full scope implementation by year 2010.

8. THE ROADMAP • In early 2005, Bank Indonesia has introduced a roadmap toward Basel II implementation, which is aimed at : providing guidance for concerted efforts toward Basel II implementation; serving as basis for designing policy direction that is in alignment with Indonesian banking architecture; portraying more comprehensible picture in building supporting infrastructures, e.g. organization design, human resources capacity, information technology as well as research agenda.

9. THE ROADMAP • Remarks: • During parallel run period, bank has to submit its report by off-line basis • The improvement of market risk measurement in accordance with Basel II framework • This approach will only be applied to banks that meet all requirements adequately and upon BI approval • Including interest rate risk in banking book, strategic risk, reputation risk, etc. • All datelines are the project accomplishment target dates.

10. PREPARATION MEASURES “WHAT HAVE BEEN DONE”

11. PREPARATION MEASURES“What have been done” • Enforced risk management practice and good corporate governance (including transparency) • Introduced risk based supervision as an early step toward Pillar 2 (supervisory review process) • Conducted QIS 3 in 2002 to a number of sampling banks and QIS 4 on quarterly basis (April & July 2005) as well as QIS 5 (September 2007) so as to bring up to date the quantitative impact of Basel II. • an effective way to familiarize the Basel II substance. • number of sampling banks is increasing to cover all banks in the system • Formed a Working Group encompassing representatives from supervisor, banking practitioners & association to have dialogue & discuss various issues.

12. QIS5 (Risks contribution to increasing RWA) Group 1 : bank with TA ≤ IDR 1Trilion Group 2 : bank with TA >IDR1Trillion – IDR 10 Trillion Group 3 : bank with TA > IDR10 Trillion

13. QIS5

14. PREPARATION MEASURES “What have been done” • Conducted study pertaining to several issues that allows the exercise of national discretions. claims on sovereign, public sector entities (PSEs), banks, corporate, claims secured by residential property, claims secured by commercial real estate, retail portfolio, past due loans etc. • Published consultative paper on Basel II policy recommendations. CP I outlines policy proposals on standardized approach for credit risk, trading book and specific risk for market risk, the Basic Indicator Approach (BIA) for operational risk and market discipline issues. Issued in January 2007 CP II outlines policy for measuring capital charge incorporating internal model of market risks. Issued in July 2007. • Set forth an internal guideline to assess the eligibility of rating agencies, especially domestic rating agencies, aiming at observing the fulfillment of required qualifications to be listed as a recognized rating agency. 3 domestic rating agencies (i.e. PEFINDO, FITCH RATING INDONESIA, MOODY’S INDONESIA)

15. PREPARATION MEASURES “What have been done” • Required bank to conduct a self-assessment and gap analysis as well as establish action plans covering resources analysis and objectively measurable milestones by using prescribed format and template. It is expected that such an assessment and analysis will enable banks to better position themselves and act accordingly in line with the Roadmap. • Required bank to establish an internal monitoring team acting as a counterparty to Bank Indonesia. • Identified the need of designing Basel II organization, including the risk specialist (e.g. market risk internal model) • Adopted IFRS by coordinating with Indonesian Accountant Association. The new accounting standards (IAS 32 and IAS 39) has been issued to be implemented January 2009.

16. PREPARATION MEASURES “WHAT ARE BEING DONE”

17. PREPARATION MEASURES “What are being done” • Drafting and revising regulations pertaining to Basel II implementation, including other risks in Pillar 2 (e.g. interest rate risk in banking book, liquidity risk, concentration risk, etc.) • Revising bank reporting system to accommodate the needs of Basel 2 data requirements as well as the adoption of IFRS. • Keeps monitoring bank to implement risk management, improving the risk based supervision and developing the consolidated supervision framework. Bank Indonesia has issued the regulation on implementation of consolidated risk management for bank controlling subsidiaries. • Intensifying the discussion of Basel II Working Group covering issues on credit risk, market risk, operational risk and market discipline. • Disseminating and delivering training of Basel II framework for supervisors, bankers and other stakeholders.

18. “Consultative Paper”

19. Consultative Paper • CP I issued in January 2006 • Areas covered national discretions for credit risks (i.e. claims on sovereign); credit mitigation techniques; recognition of ECAI; issues on market risks and operational risk; and aspects in market discipline

20. Consultative Paper I

21. Consultative Paper I

22. NEXT AGENDA

23. NEXT AGENDA • Conducting a survey for assessing the bank readiness towards the implementation of standardised/the alternative standardised approach of operational risk Identification type and definition of business lines • Conducting gap analysis of the current risk based supervisory (RBS) system to meet principles set under Pillar 2 – supervisory review process. Defining the format of ICAAP (i.e. standardised or simplify standardised approach) Conducting studies on other risks including interest rate risk in the banking book, liquidity risk, concentration risk etc. Improving legal framework on banking supervision Issue Consultative Paper on Pillar 2

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