14 Nov 2013

The Indonesian central bank, Bank Indonesia, recently issued two regulations which will change the way banks in this country do their business. These two regulations regulate the business activities of a bank on the basis of the bank’s capital.  As a result, commercial banks which in the past had more freedom in their operation thanks to Law No. 7/1992 regarding Banking (as amended) are now only allowed to conduct business transactions which are in line with their capital strength.


The two new regulations are: (i) Bank Indonesia Regulation No. 14/26/PBI/2012 regarding Banks’ Business Activities and Core Capital Based Office Network, dated 27 September 2012 (“BIR 14/26”), and (ii) Bank Indonesia Regulation No. 14/18/PBI/2012 regarding Minimum Capital Adequacy Requirement For Commercial Banks, dated 28 November 2012 (“BIR 14/18”).


It is clear that with BIR 14/26 and BIR 14/18 Bank Indonesia wants on the one hand to ensure that banks in Indonesia run their business in accordance with their capital strength and on the other hand that these banks boost their capital up to international level while being more resilient to risks faced in light of changes in the global financial system.


Capital Requirement


BIR 14/18 follows the international practice of linking a bank’s capital with its risk profile. It requires that the capital of a bank is in line with the bank’s risk profile.


The minimum capital requirement for local banks is calculated by using the Minimum Capital Adequacy Requirement ratio.  BIR 14/18 stipulates the following minimum capital requirements for the various risk profiles:[1]


      i.        8% (eight percent) of the Risk Weighted Assets (ATMR) for banks with a rating 1 (one) risk profile;

     ii.        9% (nine percent) to less than 10% (ten percent) of the ATMR for banks with rating 2 (two) risk profile;

    iii.        10% (ten percent) to less than 11% (eleven percent) of ATMR for Banks with a rating 3 (three) risk profile;

    iv.        11% (eleven percent) to 14% (fourteen percent) of ATMR for Banks with a rating 4 (four) or rating 5 (five) risk profile.


For banks with subsidiary companies, the above minimum capital adequacy requirements apply to the banks individually as well as in consolidation with their subsidiaries. To further ensure compliance with the requirement, BIR 14/18 prohibits a bank from distributing its profit if the profit distribution results in the bank’s capital requirement inadequacy.


Local Banks


BIR 14/18 futher regulates banks’ capital based on the banks’ residency status or where the bank is established. For banks with a head office in Indonesia, the capital consists of: (i) core capital (tier 1); (ii) supplementary capital (tier 2); and (iii) additional supplementary capital (tier 3).


Core Capital


The structure of a local bank’s core capital is determined by taking into consideration the following deduction factors:[2]

a. Goodwill;

b. Other intangible assets; and/or

c.  Other core capital deduction factor, such as:[3]

i.    the bank’s equity participation, which covers the bank’s participation in its subsidiaries, excluding temporary equity participations in credit restructuring and entire equity participations in an insurance company;

ii.   shortfall from completing the minimum solvability ratio level (Risk Based Capital/RBC minimum) of the insurance company owned and controlled by the bank; and

iii.  securitization exposure.


The above deduction is deducted by as much as 50% (fifty percent) from the core capital and 50% (fifty percent) from the supplementary capital. The entire capital deduction factors shall not be taken into consideration in the ATMR for Credit Risk.


Supplementary capital


Supplementary capital (tier 2) which consist of supplementary capital upper level (upper tier 2); and supplementary capital lower level (lower tier 2) can only be taken into consideration at the highest as 100% (one hundred percent) from the core capital.[4]  Whilst Supplementary capital lower level (lower tier 2) can only be taken into consideration, the highest at 50% (fifty percent) from the core capital.[5] 


Upper level supplementary capital (upper tier 2) consists of:[6]

i.     capital instrument in the stock form or other capital instruments that fulfill the requirements as referred to in Article 16;

ii.    parts of innovative capital that cannot be taken into consideration in the core capital;

iii.   fixed asset revaluation which covers: the difference in value of fixed assets revaluation which were classified into profit balance, as much as 45% (forty five percent); and the increasing in value of fixed assets were unrealized which have previously been classified into profit balance, as much as 45 % (forty five percent);

iv.   general reserves of PPA over productive assets which obliged to be formed with the highest amount at 1.25% (one point twenty five percent) from ATMR for Credit Risk; and

v.    Other comprehensive earnings, the highest at 45% (forty five percent), which is the unrealized profit that arises from the increasing in fixed value inclusion that classified in the available for sale category.


Lower level supplementary capital (lower tier 2) consists, among others, of preferred shares that can be withdrawn after a certain period of time (redeemable preferred shares) and/or subordinated loan or subordinated obligation.


Additional supplementary capital


To be qualified as additional supplementary capital (tier 3), the capital must fulfill the following conditions and requirements:[7]

i.     It is used only for measuring the Market Risk;

ii.    It is not more than 250% (two hundred and fifty percent) of the bank’s core capital which being allocated to calculate the Market Risk; and

iii.   Together with the supplementary capital, it does not total to more than 100% (one hundred percent) of the core capital.


Included in this tier 3 capital are the following:

i.     Short term subordinated loans or subordinated bonds;

ii.    Supplementary capital which is not allocated to cover capital charges of Credit Risk and/or capital charges of Operational Risk, but which fulfill the requirements for supplementary capital (unused but eligible tier 2); and

iii.   The rest of the lower level supplementary capital (lower tier 2) in excess of the lower level supplementary capital limit. 


Supplementary capitals (upper tier 2 and lower tier 2 as well as tier 3) which are in the form of capital instruments must fulfill, among others, the following requirements:[8]

i.      They are issued and fully paid up;

ii.     For upper tier 2:  they are not restricted by a payment time limit and requirement (for upper tier 2), and the validity period of the agreement is at least 5 years.  For tier 3, the validity period of the agreement is at least 2 (two) years and the settlement requires the approval of Bank Indonesia (for lower tier 3) .

iii.    They are able to absorb losses where the amount of the bank’s losses exceeds the profit retained and deposits which include core capital although the bank is not in liquidation and is subordinated, which facts are clearly declared in the publishing documentation/agreement;

iv.   The principal payment and / or earning yield is being suspended and accumulated in between period (cumulative) if the referred payment can cause the ratio of KPMM, whether individually as well as consolidated, to fall short of the requirements stipulated by BRI 14/18.

v.    They are not protected or not guaranteed by the Bank or Subsidiary Company;


Supplementary capitals of upper tier 2 and lower tier 2 and tier 3 which bear “call option” features are required to fulfill the certain conditions imposed by BIR 14/18 before the call options can be exercised.


Foreign banks


Foreign banks are subject to CEMA.

Unlike banks with a headquarter in Indonesia which are subject to the above mentioned capital requirement, branches of foreign banks operating in Indonesia (currently limited to 10 foreign banks) are subject to the Capital Equivalency Maintained Assets (CEMA) requirement. BIR 14/18 stipulates that the capital of these branch offices consists of:[9]


i.      business funds;

ii.     profit retained and last year's profit after excluding certain factors such as deferred tax; the difference in value of fixed assets revaluation; the increase in value of fixed assets; and profit on sale of assets in the transaction of securities (gain on sale)

iii.    50% (fifty percent) of current year profit after excluding certain influence factors such as those mention earlier in ii;

iv.   general capital reserves;

v.    reserve capital purpose;

vi.   fixed asset revaluation with certain coverage and calculation; and

vii.  general reserves for provision for write off of asset losses over productive assets using certain calculation.


Banks are required to determine the financial assets for inclusion in the CEMA to meet the minimum CEMA. Once made, the determination cannot be changed until the next period of CEMA fulfillment. The following are assets that may be included and calculated as CEMA:


i.      Securities issued by the government of the Republic of Indonesia and held until their maturity;

ii.     Investment grade debt securities issued by banks with Indonesian legal entity and/or Indonesian legal entities and are issued not for trading purpose by the issuing banks; and/or

iii.    “A” rated debt securities issued by Indonesian legal entities. The value of the corporate debt securities is limited to 20% (twenty percent) of the total minimum CEMA required of the bank.