• New bank regulations on minimum capital requirements and multiple licensing.
  • July 31, 2014 | Author: Hamud M. Balfas
  • Law Firm: Ali Budiardjo, Nugroho, Reksodiputro (ABNR) - Jakarta Office
  • Introduction

    The Indonesian central bank, Bank Indonesia, recently issued two regulations that will change the way in which banks in the country do business. The regulations govern the business activities of banks on the basis of their capital. As a result, commercial banks which in the past had more freedom in their operations thanks to the Banking Law (7/1992, as amended) are now limited to undertaking business transactions that are in line with their capital strength.

    The two new regulations are the Regulation on Banks' Business Activities and Core Capital-Based Office Networks (14/26/PBI/2012) and the Regulation on the Minimum Capital Adequacy Requirement for Commercial Banks (14/18/PBI/2012). It is clear that with Regulations 14/26 and 14/18, Bank Indonesia wishes to ensure that, on the one hand, banks run their businesses in accordance with their capital strength and, on the other, that these banks increase their capital up to an international level while being more resilient to the risks faced following changes to the global financial system.

    Capital requirements

    Regulation 14/18 follows the international practice of linking a bank's capital to its risk profile. It requires a bank's capital to be in line with its risk profile. The minimum capital requirements for local banks are calculated by using the minimum capital adequacy requirement ratio. Regulation 14/18 stipulates the following minimum capital requirements for the various risk profiles:

    • 8% of risk-weighted assets for banks with a Rating 1 risk profile;
    • 9% to less than 10% of risk-weighted assets for banks with a Rating 2 risk profile;
    • 10% to less than 11% of risk-weighted assets for banks with a Rating 3 risk profile; and
    • 11% to 14% of risk-weighted assets for banks with a Rating 4 or Rating 5 risk profile.

    For banks with subsidiary companies, these minimum capital adequacy requirements apply to the banks individually as well as in consolidation with their subsidiaries. To ensure compliance with the requirement, Regulation 14/18 prohibits banks from distributing profits if the profit distribution causes the bank to fall short of its capital requirement.

    Local banks

    Regulation 14/18 further regulates banks' capital based on their residency status or place of establishment. For banks with a head office in Indonesia, capital consists of:

    • core capital (Tier 1);
    • supplementary capital (Tier 2); and
    • 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:

    • goodwill;
    • other intangible assets; and/or
    • other core capital deduction factors, such as:
      • the bank's equity participation, which covers its participation in its subsidiaries, excluding temporary equity participations in credit restructuring and entire equity participations in an insurance company;
      • shortfalls from meeting the minimum solvability ratio level (risk-based capital minimum) of an insurance company owned and controlled by the bank; and
      • securitisation exposure.

    These factors can trigger a deduction of up to 50% of both core capital and supplementary capital. Capital deduction factors do not apply to risk-weighted assets for credit risk.

    Supplementary capital
    Supplementary capital (Tier 2) that consists of upper and lower-level supplementary capital can account for no more than 100% of core capital, while exclusively lower-level supplementary capital can account for no more than 50% of core capital.

    Upper-level supplementary capital (upper Tier 2) consists of:

    • capital instruments in stock form or other capital instruments that meet the requirements of Article 16;
    • innovative capital that cannot be considered as core capital;
    • fixed asset revaluations which cover:
      • up to 45% of the difference in value of fixed asset revaluations that were accounted for in the profit balance; and
      • up to 45% of the increase in value of fixed assets that were unrealised and previously accounted for in the profit balance;
    • general reserves for the provision of asset losses over productive assets which were obliged to be formed at a maximum of 1.25% of risk-weighted assets for credit risk; and
    • up to 45% of other comprehensive earnings, constituting the unrealised profits that arose from the increase in fixed value inclusion that fell into the available for-sale category.

    Lower-level supplementary capital (lower Tier 2) consists of, among other things, preferred shares that can be withdrawn after a certain period of time (redeemable preferred shares) and/or subordinated loans or subordinated obligations.

    Additional supplementary capital
    Additional supplementary capital (Tier 3) must meet the following conditions:

    • It is used only for measuring market risk.
    • No more than 250% of the bank's core capital has been allocated to calculate market risk.
    • Together with the supplementary capital, it totals no more than 100% of core capital.

    Tier 3 capital includes:

    • short-term subordinated loans or subordinated bonds;
    • supplementary capital that has not been allocated to cover capital charges of credit risk and/or operational risk, but which meets the requirements for supplementary capital (ie, unused but eligible Tier 2); and
    • remaining lower-level supplementary capital (lower Tier 2) in excess of the lower level supplementary capital limit.

    Supplementary capital (upper and lower Tier 2, as well as Tier 3) in the form of capital instruments must meet the following requirements:

    • It has been issued and fully paid up.
    • Relevant upper Tier 2 capital is not restricted by a payment time limit or requirement and the agreement is valid for at least five years. For relevant Tier 3 capital, the agreement must be valid for at least two years and the settlement requires the approval of Bank Indonesia (for lower Tier 3).
    • It can absorb the bank's losses in excess of the profits retained and deposits including core capital, although the bank must be subordinated and not in liquidation, as evidenced by the published documentation/agreement.
    • The principal payment and/or earning yield has been suspended and accumulated in between periods if the referred payment can cause the minimum capital adequacy requirement ratio - whether individually or consolidated - to fall short of the requirements of Regulation 14/18.
    • It is not protected or guaranteed by the bank or a subsidiary company.

    Supplementary capital of upper Tier 2, lower Tier 2 and Tier 3 which bears 'call option' features must meet certain conditions imposed by Regulation 14/18 before the call options can be exercised.

    Foreign banks

    Unlike banks with headquarters in Indonesia, branches of foreign banks operating in Indonesia (presently limited to 10 foreign banks) are subject to the capital equivalency maintained assets (CEMA) requirement. Regulation 14/18 stipulates that the capital of these branch offices can consist of:

    • business funds;
    • retained profits and the previous year's profits, excluding factors such as:
      • deferred tax;
      • the difference in value of fixed asset revaluations;
      • the increase in value of fixed assets; and
      • profits on the sale of assets in securities transactions (ie, gains on sale);
    • 50% of the current year's profits, excluding the same factors as above;
    • general capital reserves;
    • reserve capital;
    • fixed asset revaluations with certain coverage and calculations; and
    • general reserves for the write-off of asset losses over productive assets using certain calculations.

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

    • securities issued by the Indonesian government and held until maturity;
    • investment-grade debt securities issued by banks with Indonesian legal entity and/or other Indonesian legal entities, and which have not been issued for trading purposes by the issuing banks; and
    • 'A'-rated debt securities issued by Indonesian legal entities. The value of corporate debt securities is limited to 20% of the total minimum CEMA required of the bank.

    Multiple licensing

    To improve the resiliency, competitiveness and efficiency of Indonesian banks, the central bank has imposed rules on banks' eligibility to enter into different types of business transactions on the basis of the banks' capital strength. As a result, in the future banks in Indonesia will be assigned to one of four categories - or 'BUKUs' as they are referred to in Regulation 14/26 - in accordance with their core capitalisation, with BUKU 1 being the lowest rank and BUKU 4 the highest. Regulation 14/26 will become effective for most banks in 2016, with the exception of regional/provincial government-owned banks, which will become subject to it in 2018.

    Regulation 14/26 stipulates the following core capital amounts for the four BUKUs:

    • BUKU 1 - banks with a core capital of less than Rp1 trillion (approximately $90 million);
    • BUKU 2 - banks with a core capital of at least Rp1 trillion but less than Rp5 trillion ($450 million);
    • BUKU 3 - banks with a core capital of at least Rp5 trillion but less than Rp30 trillion ($2.6 billion); and
    • BUKU 4 - banks with a core capital of Rp30 trillion or more.

    This categorisation system will affect banks not only in terms of how they conduct their businesses and serve their customers (eg, BUKU 1 banks will not have the same ability to enter into business transactions as BUKU 4 banks), but also in terms of their ability to enter into capital investment/participation and to channel loans (eg, BUKU 1 banks cannot channel as many loans as BUKU 4 banks). Regarding capital investment, Regulation 14/26 stipulates the following maximum limits:

    • BUKU 2 - 15% of the bank's capital;
    • BUKU 3 - 25% of the bank's capital; and
    • BUKU 4 - 35% of the bank's capital.

    Regulation 14/26 also stipulates banks' obligation to channel loans or financing facilities to productive businesses in line with their BUKU categories, as follows:

    • BUKU 1 - at least 55% of the total loan or financing;
    • BUKU 2 - at least 60% of the total loan or financing;
    • BUKU 3 - at least 65% of the total loan or financing; and
    • BUKU 4 - at least 70% of the total loan or financing.

    A bank's BUKU category will also determine its branching ability. The opening of an office network overseas, for instance, may be undertaken only by BUKU 3 and BUKU 4 banks, with certain restrictions for BUKU 3 banks. BUKU 3 banks may open office networks only in Asia, while BUKU 4 banks may open office networks worldwide.