Muhamad Al Azhari & Dion Bisara

BI Strengthens Oversight Of Investment Products

The rapid growth in high-risk structured financial products, and a rash of bitter disputes involving them since the outbreak of the financial crisis, has prompted Bank Indonesia to issue regulations requiring commercial banks to seek its approval before selling such instruments.

Broadly defined, a structured financial product is a portfolio of investments offered by a bank or nonbank financial institution based on the value of an underlying asset or index — the movement of a commodity, a currency’s value, equities or interest rates on bonds, for example. To make money, investors bet the value of the asset or index will move in a particular direction.

Effective since Wednesday, the central bank rule requires commercial banks to secure its blessing before selling structured products to retail investors. One condition that must be met is that the products be accompanied by full protection for the principle currency — if the products have currency as the underlying asset — when the product matures.

BI says that the instruments may impart great risks to banks and their customers because they are by nature highly complex and opaque, and that they could also undermine confidence in the banking sector.

A number of the nation’s lenders saw their 2008 profits slide due to losses arising from structured products.

PT Bank Danamon said that its unaudited net profit last year slumped 29 percent to Rp 1.5 trillion ($147 million) due to the bank taking a charge for a one-time loss of Rp 800 billion on forward foreign exchange contracts.

A number of conflicts have arisen this year between banks and customers who purchased structured products. One of the biggest palm oil plantation companies in North Sumatra, PT Permata Hijau Sawit, is suing Citibank, claiming the bank “duped” its corporate secretary into signing up for a derivatives product on which the company later lost more than $10 million.

Permata also named BI as one of the defendants because of its allegedly weak supervision of derivatives transactions.

In order to avoid such conflicts, the central bank is obligating lenders conduct risk assessments of structured products, as well as customer risk-profile assessments.

Banks that sell a combination of derivatives instruments to individual investors must seek collateral amounting to a minimum of 10 percent of the notional value of the transaction when it was entered into.

Banks are also barred from using terms like “deposit,” “protected,” or “saving” in the names of structured products on the grounds that they could give rise to a perception that the investments are secure or safe.

Full and transparent disclosure of all information related to a structured product — the issuer, the product’s characteristics and examples of potential risks — are also required.

Banks that sold structured products before the new regulations took effect must report them to the central bank for approval.

Financial institutions that breach the regulations face a variety of graduated sanctions, including downgrades of status and license suspensions.

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