Sunday, November 28, 2010

Challenges of Basel II implementation in Indonesia

After previous talks about the grand institutional and regulatory set up (re: discussion on OJK), lets step back for a minute and think about the challenges faced by the Indonesian regulator when Basel II is implemented (planned 2011 for Pillar 1). One way is to learn from experience in other countries having comparable conditions as Indonesia. The article describes the discussion before the Basel II era in India and several implementation challenges.

One of the pitfalls mentioned is related to the very limited rating penetration by external rating agencies. Moreover, ratings are often restricted to issues, not issuers.

Encouraging banks to adopt Internal Rating Based Approach is neither practical nor prudent, even for larger banks, which perhaps have staffs and infrastructure to carry out the program. If the banks are able, the question still is if the regulator has adequate capacity to supervise and validate rating models in the first place.

So, it will be sensible like in many other countries to require all banks to first adopt the standardized approach for credit risks and allow them to migrate to the IRB approach after several years.

This being perfectly understandable, implementation of Basel II will only be worth doing (in the Indonesian case after a delay of multiple years ...), if, among others, rating activities of external rating agencies are thriving and their quality of works is well overseen.

Today, Committee of European Banking Supervisors (CEBS) issues a guideline on the recognition of external credit assessment institutions. You know..., the track record and practices of ratings agencies have been heavily under attack. It is only proper that the supervisor starts to subject them to inspection mechanisms and better oversight.

While the need of more regulatory support for rating agencies sector is the main message of today's post, I find it equally important that Bank Indonesia has a framework to build national rating institutions according to good standards. Here is the mentioned CEBS publication.

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