Banking Regulation

in 27 jurisdictions worldwideContributing editor: David E Shapiro

2012Published by

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Banking Regulation 2012

Contributing editor David E Shapiro Wachtell, Lipton, Rosen & Katz

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62 Getting the Deal Through – Banking Regulation 2012

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Regulatory framework

1 What are the principal governmental and regulatory policies that

govern the banking sector?

At the Indonesian Annual Banking Summit held on 9 December 2011, a national banking industry policy was drafted to prepare the industry for the arrival of the ASEAN Economic Community in 2015, and to increase protection from the effects of a global eco-nomic crisis. This banking policy focuses on five key areas:• optimisingtheroleofmonetarypolicyinboostingeconomic

capacity and mitigating the risks arising from global economic slowdown;

• improvingbanks’efficiencytooptimisetheircontributiontothe economy, while strengthening the resilience of the banking system;

• improvingtheefficiency,reliability,andsecurityofbothnationaland international payment systems;

• strengtheningbankingresiliencethroughcoordinatedmacro-economic management and crisis prevention through a Crisis Management Protocol; and

• supportingempowermentoftherealsector,includingcontinuedefforts to expand community access to the banking system (ie, financial inclusion).

Oninflation,Indonesia’scentralbank(BankIndonesiaorBI)hastar-geted consumer price index (CPI) increases of 4.5 per cent (+/-1 per cent) for this year and 2013, with particular emphasis on strengthen-ing the team tasked with controlling inflation in the various regions of Indonesia.

Currently, BI is an independent agency that regulates and issues all policies and regulations on the banking sector in Indonesia. However, on 22 November 2011, Indonesia established the Finan-cial Services Authority (the FSA) through Law No. 21 of 2011. The establishment of an independent body overseeing the financial sector hadbeenmandatedina2004amendmenttothelawonIndonesia’scentral bank. The FSA is intended to become the sole regulatory agency for all financial services institutions, which include securities companies, insurance companies, pension funds, financing compa-nies, and banks. This new government body is modelled after the UnitedKingdom’sFSAanditsauthoritieswillincludebanklicensing,bank operations, setting policy on banking liquidity, and banking supervision, all of which it will take over from BI at the end of 2013. WhentheFSAtakesover,BI’sauthoritiesoverbankswillnot

be abolished entirely. The FSA will still be required to coordinate with BI in setting banking policies. These policies will concern the capital adequacy ratio for banks, an integrated banking information system, receiving foreign exchange, offshore funding and commercial loans, banking products, derivative transactions, and other banking activities. BI may also conduct special investigations on banks after informing the FSA, and the results of such investigations must also be conveyed to the FSA.

2 Please summarise the primary statutes and regulations that govern

the banking industry.

Law No. 7 of 1992 on Banking as last amended by Law No. 10 of 1998 (the Banking Law) generally regulates banks in Indonesia. The Banking Law applies to both commercial banks and rural credit banks, conventional and shariah banks, and branch offices of over-seas banks. A bank must obtain central bank approval to operate its business. BI approval is also required to open branch offices and to conduct a merger, consolidation or acquisition. The bankruptcy and liquidation of banks is regulated separately.

The Banking Law distinguishes commercial banks from rural banks by the scope of their services. Commercial banks may provide an extensive range of financial services, including raising funds from the public in order to offer loans, trading negotiable instruments, providing bank guarantees, issuing credit cards, and settling and receiving foreign currency payments. In contrast, rural banks have a very limited scope of services. They may raise funds from the public, provide loans and extend credit, but may not be involved in foreign currency transactions. Neither type of bank may engage in the insur-ance business except through a bancassurance arrangement with a licensed insurance company. Both commercial and rural banks may establish a shariah business unit to provide financial services based on Islamic banking principles.

Under the central bank law (Law No. 23 of 1999 on Bank Indonesia, as amended), BI currently assumes both regulatory and supervisory governmental functions in the national banking sector. As mentioned in question 1, the FSA will take over this role at the end of 2013. BI has the authority to grant and revoke bank licences, approve bank ownership and management structures, control and supervise bank performance and financial status, issue rules and regulations on banking activities and operations, ensure compliance, and impose sanctions for violations.

Banks are required to report all suspicious or large cash transac-tions to the Financial Transaction Reporting and Analysis Centre (PPATK),whichwasestablishedunderIndonesia’santi-moneylaun-dering law. All cash transactions with a cumulative amount of at least 500 million rupiah in a single day must be reported.

3 Which regulatory authorities are primarily responsible for overseeing

banks?

BI currently oversees all banks, in coordination with the PPATK in respect of large and suspicious transactions. In case of bank sol-vencyproblems,Indonesia’sDepositGuaranteeInstitution(LPS)willbecomeinvolved(seequestion16).BI’srolewillbetransferredtothenewly formed Financial Services Authority on 31 December 2013.

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4 Describe the extent to which deposits are insured by the government.

Describe the extent to which the government has taken an ownership

interest in the banking sector and intends to maintain, increase or

decrease that interest.

AllbanksoperatinginIndonesiamustjoinIndonesia’sDepositGuar-anteeInstitution(LPS),whichcurrentlyunderwritesbankcustomers’deposits in an amount of up to 2 billion rupiah per customer (Law No. 24 of 2004, as amended).

In response to the 1998 financial crisis, the Banking Law requiredanewbody tobeestablished tounderwritecustomers’deposits. Formed in 2004, LPS answered this need by initially insur-ing customer deposits of up to 100 million rupiah. Any increases in the amount underwritten should be deliberated by Parliament before being enacted through a government regulation. The insured amount was increased substantially to 2 billion rupiah in 2008, although the LPS chairman is now proposing that the figure be put back down to 500 million rupiah.

The government has not recently taken on any ownership interest in Indonesian commercial banks. However, there are currently four state-owned commercial banks – BNI, BRI, BTN and Bank Mandiri. Bank Mandiri, which was created following the 1998 regional eco-nomiccrisisbymergingseveraldistressedbanks,isnowIndonesia’slargest commercial bank.

5 Which legal and regulatory limitations apply to transactions between

a bank and its affiliates? What constitutes an ‘affiliate’ for this

purpose? Briefly describe the range of permissible and prohibited

activities for financial institutions and whether there have been any

changes to how those activities are classified.

The prevailing legal lending limits allow a bank to loan up to 10 per cent of its capital to affiliates. This restriction also applies to unre-latedparties.Anyloantoanaffiliatemustbeapprovedbythebank’sboard of commissioners.

An affiliate is defined as an entity or individual that controls or is controlled by the bank, either directly or indirectly. This control may be acquired through share ownership, management or financial relationship. An affiliate includes an entity or individual that:• controlsoriscontrolledbythebank;• controlsanotherentityorindividualthatisalsocontrolledbythe

bank;• iscontrolledbythesameentityorindividualthatcontrolsthe

bank;• isacommissioner,directororexecutiveofthebank(together,thebank’smanagement);

• isafamilymemberofthepersoncontrollingthebankorthebank’smanagement;

• isacommissioner,directororexecutiveofanentitythatcontrolsor is controlled by the bank, controls an entity that is controlled by the bank, or is controlled by the entity that controls the bank;

• shares the same bankmanagement, orwith the entity thatcontrols or is controlled by the bank, controls the same entity controlled by the bank, or is controlled by the same entity that controls the bank;

• iscontrolledbythebankmanagement,ortheentitythatcontrolsor is controlled by the bank, controls the same entity controlled by the bank, or is controlled by the same entity that controls the bank;

• isfinanciallydependentonthebank,oronanentityorindividualas referred to above;

• ispartytoacollectiveinvestmentcontractwhereanentityorindividual as referred to above owns at least 10 per cent of the shares in the contract; and/or

• isanon-banklenderorguarantorofanyentityorindividualasreferred to above, or another bank that guarantees any entity or individual referred to above, insofar as there is a counter guar-antee provided by such a bank, entity or individual.

The main office and other branch offices of a foreign bank are not regarded as affiliates of a foreign bank branch operating in Indonesia. However, an affiliate of the main office is also deemed an affiliate of the foreign bank branch.

If the bank has listed its shares, then the capital market rules and regulations will apply. Affiliate transactions with banks will thus become subject to the applicable disclosure requirements. The capi-tal market rules provide that an affiliate relationship occurs where there is:• afamilyrelationshipbymarriageordescentuptothesecond

degree, horizontally or vertically;• arelationshipbetweenacompanyanditsemployees,directors

or commissioners;• arelationshipbetweentwocompaniesthathaveat leastone

director or commissioner in common; or• arelationshipbetweentwocompaniescontrolleddirectlyorindi-

rectly by the same party.

6 What are the principal regulatory challenges facing the banking

industry?

The interest rate set by the central bank as a guide for Indonesian banks is still considered high, preventing banks from offering attrac-tive products to consumers, and thus limits the competitiveness of Indonesian banks in regional markets. At the same time, banks face new challenges in extending credit to their customers. In early 2012, BI introduced tighter rules for banks planning to issue credit cards to their customers. These new rules are expected to reduce credit card market growth by 5 per cent per year.

7 How has regulation changed in response to the recent crisis in the

banking industry?

Indonesia’sbankingsectorescapedrelativelyunscathedfromtherecent banking crisis thanks to limited exposure to the complex derivatives and other financial products that so devastated US and European banks. Commercial bank lending to the US and Europe totals less than US$10 billion – well below the total value of Indonesian bank assets.

The policies announced by BI at the Indonesian Banking Summit in December 2011 are intended to protect the local banking industry from the continuing effects of the banking crisis. Their aim is to strengthen the resilience of the local banking industry by improving the overall efficiency of the local banking system, optimising mon-etary policy to boost the economy, and shoring up crisis management protocol (see question 1).

There have been no recent regulatory changes, although there has been talk of placing a maximum limit on individual sharehold-ings in banks, with the figure being proposed ranging from 50 per cent down to as low as 20 per cent (see question 8).

8 In what ways do you anticipate the legal and regulatory policy changing

over the next few years?

Over the next few years, legal and regulatory policies will most likely continue to focus on capital strengthening. BI has been gradually implementing Basel II principles since 2007 and this process should be completed by 2013.

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64 Getting the Deal Through – Banking Regulation 2012

In mid-2011, BI proposed to limit share ownership by any single shareholder or corporate group (domestic or foreign) so as to reduce their influence over Indonesian banks. This restriction is also intended to shield Indonesia from the effects of the international credit crisis by reducing the impact of foreign banks and their risky investment practices. It has been widely publicised that BI wishes to lower the limit to 50 per cent, but more recently a reduction to 20 per cent has been mooted, without any grandfathering clause. This means that the divestment rules would apply until such a threshold is reached. However, this restriction is not meant to apply to state banks. At the time of writing (March 2012), BI was still deliberating internally as to what safeguards might be needed to mitigate any potential side effects of enacting such a policy.

In addition to reviewing its policy on ownership, BI is also reviewing its licensing policy. With the growing complexity of the banking business, there have been proposals to switch from the cur-rent one-size-fits-all single licence to a policy of multiple banking licences.

Supervision

9 How are banks supervised by their regulatory authorities? How often

do these examinations occur and how extensive are they?

Banks must regularly report on their business activities to BI, includ-ing reporting on their annual profit-and-loss statements. They must also make available any information requested by BI for the purposes of oversight. Where a bank is deemed to be underperforming, BI may intervene by requiring the bank to increase its capital, replace its commissioners or directors, merge, consolidate, or be acquired. Ifsuchmeasuresaredeemedinsufficient,BImayrevokethebank’slicence to do business and instruct that it be dissolved.

BI continues to refine its regulations on bank supervision and follow-up action, most recently in April 2011. All banks are classified under one of three categories of supervision: normal, intensive, or special. Banks that fail to meet certain criteria, such as the minimum capital adequacy ratio and limits on non-performing loans, will come under intensive or special supervision schemes, including increased reporting obligations to BI on their business plans and commitments.

BI employs consolidated supervision for foreign bank subsidiar-ies. This extends down to subsidiaries and up to the holding com-pany. The emphasis is on cross-border information sharing between thebank’shomeandhostcountrysupervisors.Inthisregard,BIhasentered into memoranda of understanding on cross-border bank-ing supervision with Malaysia, Singapore, China, Korea, Japan and Australia.

To enhance public transparency, banks in Indonesia are now required to share their annual financial reports with several organisa-tions and institutes, including the State Financial Institutions Founda-tion (YLKI), Indonesian Ratings Agency, Association of Indonesian Banks, Indonesian Bankers Institute, two economic and financial research institutes, and two economic and financial magazines.

10 How do the regulatory authorities enforce banking laws and

regulations?

For banking violations, Bank Indonesia may impose administrative sanctions ranging from fines to business suspension to license revoca-tion. A court may impose criminal sanctions against the members of abank’smanagement,itsshareholdersandemployees.

In mid-2011, BI imposed severe sanctions on Citibank, N.A. Jakarta branch in Indonesia. While its licence was not revoked, the sanctionsthatBIimposedhavehadasignificantimpactonCitibank’sbusiness. The bank was prohibited from acquiring any new private banking customers for a year, from acquiring any new credit card customers for two years, and from using the services of any third-party debt collection agency. These sanctions were imposed follow-

ing a widely publicised fraud case involving a private banking officer, and the untimely death of a credit card customer while being inter-viewedbyathird-partydebtcollectionagentonthebank’spremises.

In December 2011, BI followed up by issuing a regulation regarding the outsourcing of certain bank functions to third parties, including the outsourcing of debt collection activities. This regulation makes banks liable for any actions taken by third-party agents acting ontheirbehalfthatcauseinjurytothebank’scustomers.

11 What are the most common enforcement issues and how have they

been addressed by the regulators and the banks?

The most common enforcement issue in Indonesia relates to borrow-ers that default. Indonesia lacks the legal certainty needed to allow banks and lenders to promptly recover the collateral or assets of a bad debtor. Banks are often compelled to instigate court proceedings in the face of uncooperative debtors. As a result, the enforcement process can take years to be resolved.

Another common enforcement issue concerns the rule requiring a mandatory capital injection by shareholders when a bank faces liquidity problems. This requirement applies to both ultimate and immediate shareholders. Ultimate shareholders tend to negotiate with BI on this requirement, since they often consider that the parties mostresponsibleforabank’sparlousfinancialstateareitsimmedi-ateshareholders.Arecentcasewhereabank’sshareholdersavoidedthis obligation involved Bank Century. In this case, BI eventually intervened to bail out the distressed bank, somewhat controversially.

12 How has bank supervision changed in response to the recent crisis?

See question 7.

Capital requirements

13 Describe the legal and regulatory capital adequacy requirements for

banks. Must banks make contingent capital arrangements?

In implementation of the Basel II Accord, both Indonesian commer-cial banks and rural credit banks (Bank Perkreditan Rakyat or BPR) are required to maintain a statutory capital adequacy ratio (CAR) of at least 8 per cent of their risk-weighted assets. BI may require banks to reserve more capital if it deems this necessary in order to anticipate potential losses, depending on the risk profile of the bank concerned. In calculating this percentage, BI determines what should be classi-fied as capital and what constitutes risk-weighted assets.

14 How are the capital adequacy guidelines enforced?

BI has issued guidelines for banks on complying with the CAR requirements. BI offers several ways to calculate risk-weighted assets, which constitute one of the components used in determining the capi-tal adequacy ratio. Banks may choose whichever alternative is most suited to their capacity and needs. BI may impose administrative sanctions on banks that fail to comply with the minimum capital requirement. (See question 10 for more details.)

15 What happens in the event that a bank becomes undercapitalised?

Upon failure to comply with the CAR requirement, a bank will be placed under special supervision by BI. Such banks face increased reporting requirements and may be ordered to take certain action deemed necessary to improve their performance. For instance, they may be required to raise additional capital or to refrain from selling their assets. BI may also encourage the bank to merge or consolidate.

If these efforts fail to achieve compliance, or no agreement can be reached between BI and the affected bank on how to remedy the situation, then BI may suspend certain business activities of the bank,

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and ultimately revoke its operational licence. Furthermore, a bank that fails to meet the capital adequacy requirements is not permitted to distribute dividends to shareholders, under threat of administra-tive sanctions.

16 What are the legal and regulatory processes in the event that a bank

becomes insolvent?

When a bank faces insolvency, it is placed under intensive supervi-sion by Bank Indonesia. During this period, BI may compel the bank to undertake various remedial actions, including a capital injection bytheshareholders;replacingmembersofthebank’smanagement(including its directors and commissioners); and writing off loans and accounts. As a matter of practice, BI may also encourage the bank to engage in a merger, consolidation or acquisition, or to sell its assets or liabilities to another bank or third party.

If none of these remedial actions is successful, BI will deliver the banktoLPSforadeterminationonwhetherthebank’sinsolvencywould have a systemic impact on the Indonesian banking sector. If that is the case, then LPS may take over management of the bank and make significant decisions such as a sale of assets, merger or consolidation, or undertake a temporary capital injection. If the bank still does not achieve solvency through these remedial measures, BI mayrevokethebank’sbusinesslicence,tobefollowedbyitsliquida-tion. LPS will then pay out guaranteed claims on customer deposits.

17 Have capital adequacy guidelines changed, or are they expected to

change in the near future?

The capital adequacy requirement was increased in 2008 to become 8 per cent of total risk-weighted assets, in implementation of the Basel II Accord. This requirement is not expected to change before the end of 2013. BI has, however, confirmed that in 2013 it will begin to implement the Basel III principles, which set a higher capital adequacy ratio requirement of 10.5 per cent. BI plans to implement the scheme gradually from 2013 onwards, to achieve a minimum CAR of 10.5 per cent by 1 January 2019.

Ownership restrictions and implications

18 Describe the legal and regulatory limitations regarding the types of

entities and individuals that may own a controlling interest in a bank.

What constitutes ‘control’ for this purpose?

In order to hold a controlling interest in a bank, an individual or entitymustpassBI’sfitandpropertest.Bothlocalandforeignindi-viduals and entities are permitted to retain a controlling interest in a bank if they pass this test, which assesses whether they have the integrity and financial stability necessary to control a bank.Alegalentity’sownershipinabankmaynotexceeditsnetequity.

If the legal entity is a bank, it can only invest up to 25 per cent of its capital in another bank. If the bank is listed on the stock exchange, a new controlling shareholder must make a tender offer and file reports withIndonesia’scapitalmarketandfinancialinstitutionssupervisoryboard (Bapepam-LK) on share price negotiations, share purchases and the change in control.Undertheprevailingbankinglawsandregulations,‘control’in

this context means:• holding25percentormoreofthetotalsharesofthebank,either

individually or collectively;• directlymanagingand/orinfluencingthepolicyofthebank;• holdinganoptionorotherrightthat,ifexercised,wouldallow

the party concerned to hold at least 25 per cent of the total shares of the bank, either individually or collectively;

• cooperatingwithotherpartiestocollectivelyholdand/orcontrol25percentormoreofthebank’sshares;

• cooperatingwithotherpartiestocollectivelycontrolthebank,such that they hold options or other rights which, if exercised, would allow them to collectively control 25 per cent or more of thebank’sshares;

• controllingoneormoreothercompaniesthatcollectivelyhold25percentormoreofthebank’sshares;

• havingtheauthoritytoapproveand/ordismissmembersofthebank’smanagement;

• indirectlyinfluencingthebank’smanagementand/orpolicies;• controllingthebank’sholdingcompany;and/or• controllingapartythatretainscontrolasdescribedintheabove

points.

19 Are there any restrictions on foreign ownership of banks?

The rules regarding foreign participation in national banks are quite relaxed.Since1999,upto99percentofabank’ssharescanbeheldby foreign entities or individuals. However, growing concern at BI has led to discussions on whether any single entity or individual should be restricted to a maximum shareholding of as low as 20 per cent ofabank’ssharesinordertorestrictforeigncontrolofthenationalbanking system (see also question 8). In 2006, Indonesia introduced a single presence policy, whereby a party is prohibited from controlling more than one bank offering the same types of services.

20 What are the legal and regulatory implications for entities that control

banks?

To some extent, this depends on the type of entity controlling the bank. All entities must pass the fit and proper test. An individual shareholder of a bank is of course free to conduct non-banking busi-ness. Shareholders that are banks are restricted to a maximum invest-ment of 25 per cent of their capital in another bank, while other types of entity are free to invest up to the full amount of their net capital.

21 What are the legal and regulatory duties and responsibilities of an

entity or individual that controls a bank?

A controller of a bank has a clear duty to ensure the bank complies with the laws and regulations, including the CAR requirements. A controller of a bank is also responsible for maintaining bank liquid-ity and soundness, and undertakes to resolve any problems arising inthatregard.Failuretodosomayresultinmembersofthebank’smanagementbeingplacedonBI’sblacklist,whichwouldpreventthem from becoming an executive, board member or shareholder of any bank. Controllers of banks, whether individuals or corporates, that have caused banks to become insolvent or bankrupt, or that are found guilty of embezzlement, fraud or corruption, are also no longer eligible to participate in the fit and proper test, and are prohibited to hold similar positions in the future.

22 What are the implications for a controlling entity or individual in the

event that a bank becomes insolvent?

Directors and commissioners may be held personally liable for the insolvency of any company if they have been negligent in carrying outtheirduties.Ashareholder’simmunityfromliabilitymayalsoberemoved if the shareholder has exploited the bank in bad faith for his or her personal interest, is involved in illegal acts committed by thebank,orusesthebank’sassetsforpersonalinterest.

See also questions 16 and 21.

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66 Getting the Deal Through – Banking Regulation 2012

Changes in control

23 Describe the regulatory approvals needed to acquire control of a bank.

How is ‘control’ defined for this purpose?

Any merger, consolidation or acquisition of a bank requires prior approval from BI as the central bank. Any acquisition without such prior approval would be deemed invalid, and the parties carrying out the acquisition would then be prohibited to take actions as share-holders.Seequestion18forthedefinitionof‘control’.TheprovisionsofIndonesia’sCompetitionLaw(LawNo.5of

1999) are also relevant. An acquisition may not be carried out if it results in monopolistic practices or unfair business competition. Notification is required to the Business Competition Supervisory Commission (KPPU) of any acquisition involving a bank where the totalvalueofthecompany’sassetsexceeds20trillionrupiahpost-acquisition and where the acquisition is conducted between unaffili-ated companies.

24 Are the regulatory authorities receptive to foreign acquirers? How is

the regulatory process different for a foreign acquirer?

A considerable number of foreign banks have been able to acquire Indonesian banks. There is no difference in the regulatory process for foreign acquirers, apart from the maximum ownership threshold of 99 per cent. All shareholders (local and foreign) are required to pass the fit and proper test. (See question 8.)

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Indonesia

The plan to reduce the maximum level of ownership in a bank, perhaps to as low as 20 per cent, is seen by many observers as being overprotective of the Indonesian banking industry. Many investors are nervous about the potential issuance of this policy, which was initially planned to be announced before the end of 2011. According to Bank Indonesia Governor Darmin Nasution, the plan is still being discussed by stakeholders to determine the best form for it to take. If the plan is to be implemented, a new government regulation will need to be approved by Parliament.

Update and trends

25 What factors are considered by the relevant regulatory authorities in

considering an acquisition of control of bank?

BI may take at least four factors into account in deciding whether to approve a proposed acquisition:• whethertheacquisitionwillimprovetheconditionofthebank,

is consistent with the Indonesian banking architecture, and will help to create a robust domestic banking system;

• whethertheacquiringpartymeetsBIeligibilityrequirements;• whethertheacquisitionconflictswiththeinterestsofbankcredi-

tors, minority shareholders, employees or the public; and• whethertheacquisitionreflectsfairbusinesscompetition.

26 Describe the required filings for an acquisition of control of a bank.

Several steps are required for a bank acquisition:• theacquiringpartymakesknownitsintentiontoacquirethe

bank to the board of directors of the bank to be acquired;• theboardofdirectorsofeachpartypreparesaproposalonthe

acquisition plan;• eachproposalshouldbeapprovedbythecommissionersofthe

respective parties;• theboardsofdirectorsofbothpartiesshouldjointlypreparean

acquisition plan based on their proposals;• theboardsofdirectorsshouldannouncethesummaryofthe

acquisition plan in two national newspapers at least 30 days before convening the general meeting of shareholders to approve theacquisition,andannounceittothebank’semployeesatleast14 days before this meeting;

• theacquisitionplanshouldbeapprovedbythegeneralmeet-ing of shareholders of both the acquired bank and the acquiring party; and

• theshareholders’approvalshouldbecontainedinanacquisi-tion deed that is executed once BI has issued its approval for the acquisition.

27 What is the typical time frame for regulatory approval for both a

domestic and a foreign acquirer?

The acquisition will be approved (or rejected) within 30 days after BI receives complete and accurate application documents. If BI fails to announce its decision within this time frame, it is deemed to have approved the acquisition.

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