Will Indonesia's new capital standards make an impact?

A few days ago, BI issued a new capital framework that will be effective as of 1 January 2014! The coming rule is a transposition from Basel III and aims to raise Indonesian banks’ quantity and quality of capital.

We have to appreciate the efforts to roll out the rule in time..

The introduction of the capital rule appears to be a non-event, however, since it has a couple of omissions or implementation choices that weaken the impacts of reforms intended by the capital accord i.e.: (a) to improve individual bank’s resilience and (b) to address systemic risks and procyclical amplification of these risks over time.

Most items omitted are understandable due to their limited relevance for the Indonesian banks e.g. the counterparty credit risk framework to capture derivative related exposures. Another omission regarding avoidance or reliance on external rating, however, might need to be taken on board next time.

The implementation choice to include interim profit without requiring appropriate review or verification procedures, and without deducting foreseeable pay-outs might be a missed opportunity to raise the quality of capital. Allowing banks to include surplus balance of the asset revaluation as additional tier one capital can also be improved by imposing haircuts or other conditions for example in term of saleability, say, within six months.

If the banking sector is so ready to adopt Basel III as often announced before, why not implement the good practice right away?

It means that when one was anticipating no compliance problem with the new capital standards, reference was made to the high average capital adequacy ratio in the industry (now between 17% - 18%). The reality is that solvency ratio of several banks stands far below the average and a more demanding capital regime might kill those banks without capital raising ability.

                                            Source: BI, Kajian Stabilitas Keuangan No. 21, September 2013

Given that larger banks are known to be capitalized around average, most vulnerable banks would be small in size, I would infer.

Therefore, it is remarkable that in the new capital rule, the capital conservation (cc) buffer provision will not apply to smaller banks (i.e. category “1” and “2”).

According to Basel III, the cc buffer ensures that banks, small and big, build up capital buffers outside periods of stress, which can be drawn down as losses are incurred. The framework imposes constraints on earning distributions on dividends and bonuses when banks’ capital levels fall within the cc buffer range. In my view, the cc buffer is also valuable to prevent pay-outs in the face of a debt overhang or at an early stage of crisis.

While all of the above-mentioned omissions and choices of implementation would not be characterized as material deviation, exempting smaller banks is inconsistent with the global standards.

That said, more important than the compliance issue is the need for better supervision on smaller banks, particularly those with a weak business model.
Regulatory forbearance is not the method to make them sustainable and healthy contributors to diversity and competition in the banking sector.

Conclusion
So how will the coming capital rule make a tangible impact for the whole banking sector? The answer is, it would unfortunately enhance neither quantity & quality of capital nor risk governance - at least until 2016 when some buffer requirements will start to be phased in.

Indonesia's next banking sector reforms (part 1)

Gauged by the significance of the rupiah depreciation compared to other fragile currencies, the current market turbulence has particularly informed us about Indonesia's internal growth constraints.

The country is being saddled with structural problems from its import-dependent consumption and investment growth combined with an undiversified export mix. More rupiah depreciation and/or significantly lower growth rates would appear necessary to restore the external balance in the short-medium term.

As the government is deliberating some structural reforms, the immediate question is whether we need reforms in the banking sector as well? Is finance part of the story here? And what has the banking sector to do with the quality and sustainability of economic developments?

It might sound odd to question the banking state of affairs when profitability, asset quality and solvency of Indonesian banks look strong. Average solvency of the banks is high and profit margins of Indonesia’s systemic banks are the highest among the G-20 countries.

The good average, however, can lead to complacency about the dangers coming from pockets of vulnerability in the banking sector.
In analogy to an ecosystem, the strength of the banking sector is significantly determined by its weakest member. A small Indonesian bank was distressed in 2008 and perceived - rightly or falsely - too big to fail and therefore rescued essentially to bail-out the whole banking sector.

A lesson from the experience is that minimum capital and liquidity standards should be raised in good time to ensure that all banks are better prepared for stress environment.The high average of Indonesian banks' performance indicators that I mentioned will turn out to have little value in adverse scenarios.

Major reforms tend to be pursued in a shadow of a crisis, which might be not (yet) the case today. This said, there is an urgent need for rebalancing of policy priorities in favor of long-term saving and lending, diversified economy, market discipline, competition, financial inclusion and truly risk-based regulatory regimes at individual entities as well as at macro levels.

My main references in formulating reforms objectives are the latest global regulatory initiatives such as Basel III and discussions in relation to a.o. safety nets, recovery & resolution mechanisms, future of banking and even the chicago plan. I believe they provide valuable insights that are relevant for Indonesia as well as for other emerging economies.

Formulation of reforms goals

Now that the time has come that less capitalized and more vulnerable banks are facing increased downside risks, a part of the reform initiatives has gained relevance for adoption sooner rather than later.

The reform calls could mean small steps from the current policy frameworks. Some unfortunately might implicate a change of paradigm in regulatory supervision and structures as well as in banking culture/philosophy.

The next reforms package is expected to be ambitious and aims to:

a. Decrease the likelihood of bank failures as well as the impact on the economy given bank failures;
b. Induce responsible lending to limit economic inefficiencies associated with defaults and over pessimism in downturns;
c. Support diversity that facilitates the poors' access to (basic) banking products and improve customer care;
d. Foster competition that broadens the access to credit and raises incentives to save long term;
e. Align interests of bankers more with those of their customers and the public;
f. Promote market discipline by fixing distortionary features of the current deposit insurance scheme and pricing systemic risks fully;
g. Encourage deepening of interbank & capital markets by strengthening market infrastructure like rating agencies and monetary policy frameworks;
h. Incentivize banks to finance new drivers of growth, away from consumption towards productive investment.

Any measure taken to achieve the above goals would not necessarily slow down the rupiah depreciation or accelerate growth in the short run.

Having said that, the deterioration of the Indonesian current account deficit might have been reinforced by the kind of developments seen in the banking sector over the last years. It has been coinciding with rapid growth in low productivity (e.g. consumers) or high collateral sectors (e.g. property). It has been coinciding with exceeding attractiveness of the financial sector for top talents, notably compared to employment in innovative, export-oriented sectors. And the overall credit expansion has spurred demand for imported goods too.

Several reform components above aim to improve the transmission of the central bank's monetary policy actions. BI's interest rates policy (this time in rate-hike biases) is lacking effectiveness due to distortive deposit guarantee scheme and reliance on the standing deposit facility - instead of reverse repos - to absorb liquidity (more on this in later posts). With robust macroprudential measures being absent (e.g.  debt-service to income limit & much greater reserve requirements), current account deficits and loan growth could remain high despite increases of the BI reference rate.

When envisioning next generation of reforms, one would focus on reforms agenda that is presently facing resistance, still being neglected or misconceived.

A competition policy, for example, needs to be introduced to allow for customer mobility and to bolster confidence in the ease of [account] switching. The policy also needs to be bold in incentivizing or forcing weak, smaller banks to merge into a strong challenger to bigger banks.

Another example may be useful.
On reform (a): While decreasing the likelihood of a bank failure is obviously the goal of the current regulatory regime, it is not clear if the current laws have a thought about limiting the impact on the economy given a bank failure .

The OJK law authorizes the parliament to ask the deposit insurance corporation to take over a problem bank when it is a systemic bank. The parliamentary decision must be made within 24 hours after receiving recommendations from the financial system stability forum coordinated by the finance minister.

This part of the law is a strong impetus for banks to compete on becoming big to seek a protected status. This is a form of moral hazard risks that can be mitigated, under reform (a), by instituting higher capital requirements for systemic banks, bail-in (i.e. conversion of debt to equity) provisions, resolution mechanisms (i.e. to make systemic banks easier to shut down in a crisis) and reduction of implicit too-big-to-fail subsidy.

Concrete measures to be taken:

This is a first in reform series to address several fault lines in the Indonesian banking sector.  As bad times make good policy, there is a chance that the missing prudential insights get their due attention now that the economy is starting to take a beating.

We begin with addressing the current capital regulation, followed in next posts by the implementation of the liquidity standards, the role of the deposit insurance scheme, the monetary policy framework, the development of financial (data) infrastructures, remuneration in banking, themes surrounding financial inclusion, the functioning of the regulatory institutions, etc. The discussion will be short when the subject matters were covered in previous posts.

1. More robust capital framework

Key emerging markets escaped from the global financial crisis (GFC) of 2008 largely unscathed because of their focus on relationship banking and reliance on traditional funding model.

There are nonetheless valuable lessons from the GFC as well as its regulatory reactions (or over-reactions for some of us) for many developing economies.

One of the regulatory initiatives that should be seen as a minimum is the Basel III capital accords to raise loss absorption capacity and to align interest of bankers & shareholders with other stakeholders.
This means that Indonesian banks should face higher minimum capital requirements commensurate to their risks and macroeconomic environment. This seems an obvious rule of the game every risk manager knows.

However, it applies only to an extent because the range of minimum solvency for riskiest banks are capped at 14% by the current regulation. A bank with worst supervisory risk rating ('four' or 'five') might keep its license as long as this 14% minimum ratio is met.

Although the regulation says that minimum ratio can also be set above 14% if potential loss warrants a higher solvency ratio, the 14% threshold remains a sort of regulatory forbearance for weaker Indonesian banks. For example, reserve requirements are not raised when a bank's LDR is higher than 92% if its capital adequacy ratio (CAR) is at least 14%. It means that a higly risky bank can also allow itself to hold an aggressive maturity transformation as indicated by a high LDR.

In my view, the Indonesian Basel II’s Pillar 2 framework has to be repaired to warrant a more direct link between risk profile and capital requirement. A bank should hold capital as much as it needs to cover its risks based on a so-called bottom-up assessment embodied in its internal capital adequacy assessment process (ICAAP).

Investment and enthusiasms in risk management to adopt best practices would stall if Basel II & III are not implemented wholeheartedly. To my experience, introduction of appropriate Pillar 2 frameworks for capital (and liquidity as discussed in the next post) can greatly encourage banks to strengthen their risk system and methodology.

Supplementary to the bottom-up, risk-based calculation of capital requirement, banks also hold capital buffers to support business growth and to cope with their inherent cyclicality. In the context of Basel III, the buffers are pushed up during economic upturns and drawn down during downturns.

Additional buffers should also be imposed as part of macroprudential supervisions on systemically important domestic institutions, or on exposures in certain sectors/regions (eg. real estate, consumers, vehicles financing). Extra buffers now would prepare Indonesian banks to cope with impending reversals of the US monetary policy, or more seriously, China's hard landing, or rebalancing of the Chinese domestic demand away from Indonesia’s traded commodities as it becomes older and richer.

In sum then, risk-based capital requirements should not be capped with an explicit upper target (i.e. 14%) for the capital regulation to be effective. Including the impacts of risk-based capital add-on and buffer provisions, average CAR  in the industry would increase to about 20%! from just over 17% as at end-2012.

Most Indonesian banks would likely be able to meet the reasonable increase of capital requirements coming from the risk-based and macro-based assessments.

One might worry about the implications of a more demanding capital regime for credit and economic growth. Again here, unleashing sustained growth can be best achieved by stimulating investment and increasing productivity. The emphasis is thus on quality of financial developments, not on merely sustaining economic growth by credit expansion.

Asking a bank to meet additional capital requirements is an ultimate stress test to check who is the weakest link in the financial system. Those with weaker business model might find it difficult to meet a higher capital requirement.

Hence, a more credible capital regulation would improve prospects for especially smaller banks to become formidable and effective challengers of larger banks. This underscores the mutually reinforcing nature of financial stability and competition that will be revisited several times in next posts.

Final remarks

Implementing a robust risk-based capital regime would help reduce excessive risk taking and better align the interest of short-term profitability and sustainability. This is essentially the task of a banking supervisory authority that is supposed to be assumed by the OJK (Indonesia’s financial services authority) starting from January 2014.

On the other hand, the buffer requirements are basically macroprudential tools that would address systemic risks and inefficiency associated with financial instability. The latter task is assumed by Bank Indonesia.

Indeed, the adoption of Basel III would help define more clearly the role of supervisory authority vs the central bank, which is still vague at this point of time (e.g. see page 21).

Relevance of Basel III and quality of implementation

The Basel Committee’s latest semiannual report shows progress by majority of Basel members in implementing new capital standards (4 April 2013).

However, timely implementation does not mean quality implementation.

Quality concerns can arise from lack of interest as well as from deficient institutional capabilities. In some rapidly growing emerging countries, the Basel III accords as well as other related prudential initiatives (e.g. on compensation, Living Wills, SIFIs charge, etc.) are not (yet) considered attractive or relevant by bankers & regulators alike. That Basel III is not a live agenda has also impacted negatively the necessary (operational) capacity building with regard to policy making and execution.

As stressed in many preceding posts, there is no better time than now to adopt the various global regulatory reforms in Indonesia (and in some other large emerging countries). For example, it is an opportune time for Indonesia's micro and macro prudential authorities to introduce higher capital and liquidity requirements when the profitability of the banking sector is being strong, in the backdrop of high loan growth, robust domestic demands and relatively favorable commoditiy export markets.

Even in 'bad' times, banks have ability to adapt to more demanding regulations without harming the wider economy according to this IMF study.

...but also a quality issue with the Basel III rule itself
One of Basel III's most relevant components is related to the the liquidity standards. Unfortunately, in January 2013 the liquidity rule (e.g. LCR) is made less rigorous with respect to retail funding.  The new rule says liquidity must be enough to cover a 30-day run on insured retail ("stable") saving deposits of 3 percent, instead of 5 percent.

Basel III's LCR is introduced to improve the short-term resilience of banks' liquidity risk profile under the assumption of a combined idiosyncratic and market-wide stress scenario. A higher run-off factor would force banks to hold high quality, but low yielding, liquid assets; or to reduce the share of demandeable deposits in the total retail funding in favor of more expensive time deposits.

In developing countries, if a medium-size bank is rumored to face solvency or liquidity problems, deposit run-off rate is likely to be very high, much higher than 5%; not in a 30-day horizon, but perhaps already in the first week. The run-off rate is even higher when more banks are said to be in trouble.

Frankly speaking, even a 30-day run-off factor of 10% for “stable” saving deposits is too low in many jurisdictions.

We have learned from the recent Cyprus crisis that the value of the deposit guarantee scheme is linked to creditworthiness of the government that is implicitly or explicitly backing it. Deposit guarantees would lose credibility when the government capacity to meet its obligations is in doubt.

The Basel III committee has actually anticipated the importance of idiosyncratic differences among member countries as it underscores the 'quality' aspects of implementation, for example from paragraph (77):

"Jurisdictions applying the 3% run-off rate to stable deposits with deposit insurance arrangements that meet the above criteria should be able to provide evidence of run-off rates for stable deposits within the banking system below 3% during any periods of stress experienced that are consistent with the conditions within the LCR."

That said, empirical evidence on the customer deposit run-off during stress conditions (e.g. IMF, 2012) and experience in recent months indicates that the 3% run-off rate as an anchor is rather optimistic, if not misleading.

Some emerging countries should really subject 'stable' deposits to much higher outflows to capture sovereign risks and weak legal enforcements, transparency, public awareness of deposit insurance etc. It underlines the importance of quality reviews and regulatory consistency assessments also with regard to the implementation of the liquidity standards.

The unique case of Indonesia

Because of its particular features of its deposit guarantee scheme, Indonesian banks continue to accumulate retail saving deposits at the expense of more stable time deposits. Due to the very low saving interest rates, Indonesian banks have increasingly used CASA (current account and saving account) ratio as a key performance indicator. The chart shows the rising share of CASA ratio especially in the last three years.

                          Source: Bank Indonesia, Basel2risk.org

From an individual bank’s point of view, higher CASA is good for its profitability. But from the public interests’ point of view, the race for CASA will amplify the systemic liquidity risk because CASA is off course comprised of deposits that can be drawn down on demand.

The development shown in the chart is a form of maturity rat race as banks do not commit to limiting maturity mismatch (without government intervention). It is also a classic example of a collective moral hazard as banks do not fully internalize the social costs of systemic funding risks. The Basel III liquidity rule is expected to mitigate the collective moral hazard by giving more incentives for longer term time deposits.

For this reason, the liquidity rule is particularly relevant for the case of Indonesia because it reminds both bankers and regulators of the need to manage funding risks and to pursue the macro-prudential supervision, respectively.

To align the liquidity rule with the conditions of Indonesia's banking sector, I would suggest (at least) a 20% run-off factor for “stable” deposit and 30% for "unstable" deposits. The rates might be decreased upon sound regulatory arguments supported by proper empirical evidence as well as after fixing the deposit guarantee scheme.

Compare this with outflow rates now being pondered by the EBA for the EU.

Implementation of Basel capital standards in Indonesia and (dis-) incentives for better risk management

Just a few days before the closing of 2012, Bank Indonesia supplemented its capital regulation with further guidance on the Pillar 2 processes.
In doing so, it marked the completion of the Basel II adoption in Indonesia. Congratulations....

The Pillar 2 process is essentially the second phase of Basel II and involves an assessment of the additional capital that is required to mitigate those risks that are not adequately covered in Pillar 1.

The following table shows the new minimum capital ratios within the Pillar 2 framework:

Risk-based composite rating (composite of risk, profitability, capitalization and governance scores)	Required capital  (the minimum 8% + % add-on)
1	8%
2	9%
3	10%
4 – 5	11% - 14%

According to this new regulation, capital add-on is linked to a composite rating of inter alia: risk profile, profitability, capitalization and quality of governance. Hence institutions with a composite rating “4” should have a higher capital ratio than institutions with a composite rating "3" et cetera.

Is it a sound approach?

When this blog was launched over four years ago, the idea then envisaged was to share resources and experience about implementation of the Basel II accord with an emphasis on its Pillar 2. One of the thoughts or concerns was that Pillar 2 practices had been widely varying among early adopters- especially for the internal capital adequacy assessment process (ICAAP). The ambiguities and lack of standards would not help later adopters to interpret the depth and implication of Pillar 2 requirements, leading them to adopt a less robust approach instead.

The issues that I want to highlight now are related to the problematic use of the risk-based bank rating (RBBR) as determinant of the minimum capital adequacy ratio (CAR) and the inadequacy of the new rule to advance risk management practices and encourage sufficient capital buffers over the minimum requirements.

I also argue at the end of this post, that the minimum ratio for Indonesian banks should be much higher if the industry wishes to apply fully and thoroughly Pillar 2 of Basel II and all capital buffers under Basel III. After all, the regulatory minimum in good times must substantially exceed the minimum standard in bad times.

But first of all, I turn now to the use of BI's composite rating approach as key part of the new capital regime.

Drawbacks of the risk-based composite rating approach

The main concern with the use of the composite rating is that it is less useful for capital adequacy assessment because in practice, it unlikely becomes an integral part of banks´ risk management system and day-to-day decision making process. Such a scoring card system has been used in the Netherlands for example, basically as a first input to perform peer comparison and prioritize supervisory efforts (see APRA or Bank of Spain for a similar approach). Such a model is also used for strengthening the ability of supervisors to make better judgment and take effective actions.

Even as a supervisory tool, BI's composite rating model needs to be improved in a number of areas.

Firstly, it should explicitly account for interest rate risks in the banking book, which is one of key Pillar 2 risks and perhaps also liquidity risks.

Secondly, the model should rely less on historical financial ratios. The current approach would not be responsive to changes in risk conditions and is not very forward looking. Today's banking supervision has drawn lessons from the financial crisis by paying more attention to the story of the future, i.e. business models, strategic choices, behavior and culture of a bank. Traditional financial ratios are deficient because they tell an old story.

The use of profitability ratios for example as an important determinant of the rating is suspect as long as the front-loading of banking earnings is enabled by the current accounting regime. The current global financial crisis shows how higher profitability in the banking industry is often obtained by relaxing underwriting standards, taking liquidity risks or levering up.
Even the forward looking provisioning regime currently in consultation could only partially mitigate the short-run orientation of the profitability ratios.

Last but not least, the composite rating as a basis to calculate capital add-on provides reduced incentives for advanced risk and capital management, to which we now turn.

Need of more direct links between specific risks and capital coverage

The objective of risk sensitivity championed by the Basel II accord could be better achieved by banks specifically establishing for which risks a quantitative measurement is warranted, and for which risks qualitative factors are dominant and to be mitigated using risk management tools. A lesson from the recent financial crisis is that a bank failed especially due to its overweight exposure to idiosyncratic material risk (eg. liquidity risk, concentration risk in real estates and excess credit growth).

As we all know, Basel II identifies three major risks to be covered by Pillar 1 capital: credit, market and operational risks. Accordingly, for the Pillar 2 framework, assessment and capital coverage of non-Pillar 1 risks should continue to be direct and transparent just like under Pillar 1.

Pillar 2 risk types need to be identified as relevant and material for a given bank. Subsequently, the material risks need to be quantified and backed with an adequate amount of economic (or ICAAP) capital, according to models that are appropriate for the size and complexity of the bank (ie. risk based, bottom-up assessment).

The following figure shows an example of how each relevant material risk type is accounted for in an ICAAP:

Source: The Austrian guidelines on ICAAP (chart 15)

The key point is that bespoke methodologies to determine capital needs for each risk type, as illustrated in the chart, would incentivize banks to link risk models and capital management more closely, leading to a better risk capture.

Furthermore, such ICAAP can be used operationally to set risk limits, capital allocation over business units, performance evaluation (eg. risk adjusted performance measurement, RAPM) and other risk management applications.

Highlights of alternative steps to calculate risk capital can also be found in e.g. papers by EBA/CEBS, Bank of Finland and Bank of Spain. For the European banks perspective, see here.

Explicit capital targeting above the minimum capital ratio should be part of the ICAAP

The rule stipulating the minimum capital requirement can lose its relevance as prudential measure because available capital to meet the minimum capital ratio cannot be used to absorb losses (Goodhart 2010).

Therefore, a sensible institution would maintain capital buffers over and above the regulatory minimum to be consistent with banks’ risk appetite, growth ambition, external factors or reputation enhancing objectives (such as high credit rating). In the case that capital ratio falls below the internal capital target due to rapid growth, etc., a sound bank would consider in its ICAAP document a realistic and prudent plan for returning to their capital target.

In many jurisdictions, the UK for instance, capital buffer above a total of Pillar 1 and Pillar 2 capital should also be in place so that regulatory capital requirements continue to be met even in economic downturns.

Link to Basel III

Basel III is essentially a reform on the Pillar I of the Basel II framework. Hence, pillar 2 process will continue to embody the spirit of Basel II/III. 

In the ICAAP, capital target ratios should also be calculated using Basel III parameters, at least within the context of migration to the Basel III end-states in 2019. By doing so, the ICAAP could help pave the way for implementing Basel III before its implementation is formally effected (between 2014 - 2018).

The rationales and ramifications of Basel III will be better understood by the banking sector if they have performed a sound ICAAP and established appropriate capital targets to cover their specific risk exposures, external factors, business plan, and stress testing. In fact, capital targeting and capital planning have been partially formalized in Basel III’s capital conservation measures that generate buffers for bad times (see further in the last part).

Summary

The central tenet in the above commentary is that even a bank perceived to have the lowest risk profile according to the composite rating model still needs to perform capital attribution per risk type, comply with its own internal capital target over the minimum capital ratios and demonstrate that its own fund is adequate according to supervisor's and its own firm-specific stress tests.

Sound implementation of Pillar 2 could foster risk management standards, as banks would make important strides in developing their capital adequacy procedures.

The use of composite rating to determine capital add-on could hold back the necessary transformation in the banking sector, which is desired by the Basel II/III accords: to improve risk management, to better align risk with capital needs - and although emphasized only recently - to strengthen financial stability and reduce moral hazard.

A more direct, specific and transparent framework approach for risk capture along with respective capital attribution as mentioned above would compel banks to understand their risk drivers and further intensify their risk management efforts.

Within the interim period up to 2019 when Basel III reaches its end-state, a full and sound Pillar 2 process is suitable to tackle possible gaps in capital and liquidity adequacy in the Indonesia banking sector.

Future direction of capital regulation in 2013 and beyond

So it seems obvious that we need to have a more risk-sensitive capital regime and thereby incentivizing the adoption of state of the art risk models, when applicable.

A more fundamental requirement eventually however is to ensure that Indonesia banks remain adequately capitalized also during difficult economic conditions. 

The banking sector is currently highly profitable. In particular, domestic systemically important institutions (D-SIFIs) have managed to sustain profitability - staggering by international standard - on the back of implicit government support and rapid loan growth. In my view, the high profitability is providing an ample incentive for banks to maintain a high level of capitalization in order to protect their franchise, thus even without minimum capital standards.

This highly profitable episode that has been aligning interests of shareholders, bankers and taxpayers could end in face of less conducive economic, regulatory, funding/liquidity and competitive environments. The potential for a misalignment of interests among stakeholders is also a feature of financial stability risks. Unfortunately, despite this being a central theme of the global regulatory reforms, you do not hear much in Indonesia about the risk of moral hazard from the rise and fall of banks.

That is why, future revisions of the capital adequacy regime should ensure that the required Pillar 2 capital add-on can capture:

a. Country specific risk  (2% point) associated with Indonesia being an emerging economy, etc.;

b. Institution specific risk capital add-on based on a proper Pillar 2 process (say 5% point). This will foster the link between day-to-day risk and capital management;

c. Specific capital add-on for systemically important bank (eg. add 1.5% point). See for a Swiss example here and for why bigger banks should hold a greater capital buffer here ;

d. Basel III's capital conservation buffer (2.5%);

e. Basel III's countercyclical buffer (0% - 2.5%).

In this case, the 8% minimum capital is amplified by a summation of: 2% (systemic risk) + 5% (individual Pillar 2 charge) + 1.5% (in case of systemic banks) + 2.5% (capital conservation buffer). Hence, 19% in total.

Such an enhanced capital regime would have combined the intents and insights of the global financial reforms comprising of a proper implementation of Basel II Pillar 2 and full implementation of Basel III. 
For international comparison of add-on percentages over the regulatory minimum, see here and here.

Under this enhanced capital regime, a normally profitable, most robust, systematically important Indonesian bank which is currently operating in an average credit growth environment could face a minimum CAR of 14% (i.e. 8% + 2% (country specific) + 2.5% (conservation buffer) + 1.5% (systemic buffer)). 

In a scenario that the same bank turns reckless during a credit boom period, the minimum CAR could rise from 14% to 21.5% due to:

* deployment of the countercyclical buffer of 2.5%;
* additional capital charge of 5% - for example because it is running a highly concentrated credit portfolio combined with material interest rate and liquidity risks.

If the capital regime just announced turns out to be too meager, is a considerably more prudential capital framework achievable and sensible?
The answer is yes because average commercial banks CAR has already exceeded 17% for some time (CEIC).

In good times like now, why not just seize the global momentum to introduce a capital rule that also arrests incentive distortions and moral hazard risks? 
After all, good and prudent banks will welcome a more risk sensitive and conservative capital regime because they want to keep their banking franchise sustainable.