Directrices ONU: Objetivos del milenio y ONU Hábitat

This chapter presented a critical review of prior literature related to FSN, market discipline, and the influence of FSNs on market discipline. The main objective of the establishment of a FSN is to maintain the stability of financial systems. Therefore, the provision of FSN has been a key policy response implemented by financial sector authorities in dealing with financial crises. The FSN commonly consists of four key elements: a deposit insurance scheme, a LoLR function, a prudential regulatory and supervisory framework, and a resolution mechanism for failed financial institutions.

Market discipline, as the third pillar of the Basel Capital Accord, is a mechanism through which the financial market provides signals that are utilized by market participants to monitor and discipline banks’ excessive risk-taking behaviour. For this purpose, banks are supposed to increase the information available to the public by encouraging the release of timely information detailing their assets, liabilities and general financial information. This might enable market players to better evaluate bank conditions and diversify their portfolios accordingly. Market discipline can be manifested in the way in which holders of bank liabilities ‘punish’ banks that take higher risks. This is achieved through demanding higher yields or withdrawing their funds altogether. Holders of bank liabilities such as depositors, bond holders, and equity holders have a role to play in exercising market discipline. Depositors can exercise discipline by either demanding a higher return (price effect) or withdrawing deposits (volume effect). The threat of action, therefore, imposes discipline by signaling to deposit-taking institutions the riskiness of their activities. Similarly, bond holders can demand a higher yield on bank debt, thereby increasing the cost of funds for riskier institutions. Equity holders, even though they are sensitive to the potential for upside as well as downside movements, can still impose discipline by selling their shares if a bank becomes distressed. This action puts downward pressure on share prices and places management under increased scrutiny. These disciplinary actions are expected to lead banks to behave in a way consistent with their solvency.

In order to develop an effective market discipline mechanism as described above, the market requires the availability of reliable information, the capability of market participants to utilize the information, the mechanisms to adjust the securities relative to its risk level, and the ability of banks to respond to market signals. However, the necessary requirements for an effective market discipline in reality rarely exist in most developing economies. Furthermore, the implementation of FSN could foster moral hazard among banks as well as their stakeholders. Moral hazard problems for banks could occur because the provision of a FSN might incite banks

79 to take additional risks, which in the end could increase the risk of bank default. For bank stakeholders, the design features of a FSN could impact on the effectiveness of market discipline, potentially reducing the incentives for bank stakeholders to monitor banks since their funds are principally insured and their bank might be bailed out by government. In the case of developing economies, due to the lack of ideal conditions for effective market discipline and the provision of FSN that might potentially increase moral hazard, there is a significant concern in the existing literature on whether unsophisticated markets could foster market discipline. Interestingly, some literature on this topic indicates the possibility of the existence of market discipline in emerging economies, despite the poor market infrastructure and government guarantees.

Indonesian financial market provides a unique setting for studying the presence of market discipline and the influence of FSN on market discipline. Indonesia has implemented a series of financial sector restructure programs. This includes the provision of FSN comprising deposit insurance schemes, a LoLR facility, a prudential regulatory and supervisory framework, and a resolution mechanism for failed financial institutions. In 2005, Indonesia replaced the blanket guarantee program with a limited deposit insurance program. The main purpose of this replacement was to foster market discipline and to reduce direct exposure of government budgets. Hence, the study on the Indonesian financial sector during that period will provide empirical evidence on the influence of FSN on market discipline in an emerging economy. The last section of this chapter provided an overview of the Indonesian financial market structure and the Indonesian FSN framework. The banking sector traditionally dominated the Indonesian financial system. At the end of 2011, the banking sector accounted for approximately 78.07% of total financial sector assets and 50% of the Indonesian GDP. Most of the funds were collected by Indonesian banks from short-term deposits, and more than 90% of bank deposits had maturity of less than one month. Indonesian banks generally use these funds to make short- term loans for financing working capital requirements. The longer-term investments are supposed to be financed through a public offering facilitated by capital markets. In the midst of banking domination, capital market activity grew markedly in importance relative to banking after the capital market reforms in the 1990s began to take effect. After the 2008 global financial crisis, the Indonesian stock market was one of the best performing ones in the region, with a total market capitalization of about IDR 3.821 trillion (48% of GDP) with a listing of about 440 companies. Foreign investors accounted for about two-thirds of market capitalization. However, the Indonesian capital market remains limited in both scope and depth compared to other Asian

80 countries. This is partly caused by the illiquid market and the reluctance of family-owned companies in Indonesia to go public.

In Chapter 3, the research objectives and conceptual framework are described. Then the hypotheses and the model specifications to test the hypotheses will be developed to investigate the market discipline imposed by depositors, bond holders, and equity holders.

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