“Governance and Financial System Stability’’

Friday, 17 September 2021 

As we know Governance is the  implementation and enforcement of governance in the Financial Services Authority (OJK), where a conceptual framework is needed that integrates all elements of governance which includes the initial foundation, to the final goal to be achieved. .

For this reason, the Financial Services Authority (OJK) Governance Framework has been prepared which contains five main elements as follows: 

  1. The Financial Services Authority (OJK) Governance Principles, namely the principles that underlie the implementation and enforcement of good governance. Financial Services Authority (OJK)
  2. Governance Commitment The Financial Services Authority (OJK) is the commitment of the Board of Commissioners and employees of the Financial Services Authority (OJK) to implement and enforce the Governance of the Financial Services Authority (OJK).
  3. The Governance Structure of the Financial Services Authority (OJK), namely the design of the function of carrying out duties and authorities, as well as the supervisory function of the Financial Services Authority (OJK).
  4. The Financial Services Authority (OJK) Governance Process, which is a series of standards and procedures used by members of the Board of Governors and employees of the Financial Services Authority (OJK) to ensure that the implementation and enforcement of the Governance of the Financial Services Authority (OJK) has been carried out in a planned manner. , consequent, and sustainable.
  5. The results of the Governance Outcome of the Financial Services Authority (OJK) are the embodiment of the implementation and enforcement of the Governance of the Financial Services Authority (OJK) in the form of achieving the credibility of the Financial Services Authority (OJK).

With the existence of a complete and comprehensive framework, it is hoped that it will facilitate communication with internal and external stakeholders in explaining Bank Governance.

Implementation and enforcement of the governance of the Financial Services Authority (OJK) is realized in the form of achieving the credibility of the Financial Services Authority (OJK). . Central bank credibility is very important to give confidence to the public in the policies adopted so that policy effectiveness can be achieved. The increasing credibility of the central bank is seen as being able to increase the effectiveness of monetary policy implementation and affect public rationality, so that the central bank’s policy measures, especially in controlling inflation, will be responded positively by the public.

Therefore, the achievement of the credibility of the Financial Services Authority (OJK) must be maintained and improved to have a positive impact on value creation for stakeholders, the economy, and the welfare of society. This is done by improving the quality of communication policy in addition to the strengthening of policy mechanisms, frameworks, and the decision-making process in each of the central bank’s policy-setting.

The stability of the financial system is a condition that allows the nation’s financial system to function effectively and efficiently and can withstand internal vulnerabilities and externally, so that the allocation of funding sources or financing can contribute to the growth and stability of the national economy. 

As the central bank, the Financial Services Authority (OJK) has an interest in maintaining financial system stability in order to support economic stability. This is also related to BI’s function as Lender of Last Resort (LoLR), namely the authority authorized to provide liquidity in times of crisis.

Financial System Stability (SSK) actually does not have a standard definition that has been accepted internationally. Therefore, several definitions of FSS have emerged which essentially say that a financial system enters an unstable stage when the system has endangered and hampered economic activity. Below are some definitions of FSS taken from various sources:

‘A stable financial system is able to allocate sources of funds and absorb shocks that occur so as to prevent disruption to real sector activities and the financial system.’

‘ A stable financial system is a financial system that is strong and resistant to various economic disturbances so that it is still able to perform intermediation functions, carry out payments and spread risk well.’

‘ Financial system stability is a condition in which the economic mechanisms of pricing, allocation of funds and risk management function well and support economic growth.’

The meaning of financial system stability can be understood by conducting research on the factors that can cause instability in the financial sector. Financial system instability can be triggered by a variety of causes and fluctuations. This is generally a combination of market failure, either due to structural or behavioral factors. Market failure itself can be sourced from external (international) and internal (domestic). Risks that often accompany activities in the financial system include credit risk, liquidity risk, market risk and operational risk.

The increasing trend of globalization in the financial sector supported by technological developments has caused the financial system to become more integrated without time lags and regional boundaries. In addition, financial product innovation is increasingly dynamic and diverse with increasing complexity. These developments may not only increase and diversify the sources of triggers for financial system instability, but also make it more difficult to overcome this instability.

Identification of sources of financial system instability is generally more forward looking. This is intended to determine the potential risks that will arise and will affect future financial system conditions. Based on the identification results, an analysis is then carried out to what extent the risk has the potential to become increasingly dangerous, widespread and systemic in nature so as to paralyze the economy. The financial system plays a very important role in the economy. As part of the economic system, the financial system functions to allocate funds from those experiencing a surplus to those experiencing a deficit. If the financial system is unstable and does not function efficiently, the allocation of funds will not work properly so that it can hamper economic growth. Experience shows that an unstable financial system, especially if it results in a crisis, requires very high costs for its rescue efforts.

A valuable lesson was experienced by Indonesia during the 1998 financial crisis, at which time the cost of the crisis was very significant. In addition, it will take a long time to revive public confidence in the financial system. The 1998 crisis proved that financial system stability is a very important aspect in shaping and maintaining a sustainable economy. An unstable financial system tends to be vulnerable to various fluctuations that disrupt the economic cycle.

In general, it can be said that financial system instability can result in several unfavorable conditions, such as:

  • Monetary policy transmission does not function normally so that monetary policy becomes ineffective.
  • The intermediation function cannot function properly due to the inappropriate allocation of funds that hampers economic growth.
  •  Public distrust of the financial system will generally be followed by panicked behavior by investors to withdraw their funds, leading to liquidity difficulties.
  • The cost of saving the financial system is very high in the event of a systemic crisis.

Based on the above conditions, efforts to avoid or reduce the risk of possible financial system instability are necessary, especially to avoid further losses.​