New draft bank legislation

Author: | Published: 24 Apr 2015
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Freddy Karyadi, Ayik Candrawulan Gunadi and Kartika Budianti Lestari of ABNR assess the House of Representatives’ draft legislation on banking, which would cap foreign ownership in Indonesian banks at 40%

www.abnrlaw.com


The Indonesian government has long been welcoming foreign investors and has provided an infrastructure that allows foreigners easy access to the country's industries. The government's desire to attract foreign investors is a response to what it sees as a lack of professional industry as well as addressing the need for fresh investment following the crisis. This approach is in line with Indonesian banking regulations, which are very open and have been liberal towards acceptance of foreign investors in the domestic banking sector, which was in great need of support in the form of investment. Based on the banking laws and regulations (Law No 7 of 1992 on Banking, as amended by Law No 10 of 1998 on Banking Law, and Government Regulation No 29/1999 on the Purchase of Shares of Commercial Banks), foreign parties may hold up to 99% of the shares in an Indonesian commercial bank (Indonesian Bank), whether directly or through the stock exchange. The remaining one percent must be held by Indonesian parties.

Ownership of Indonesian Banks, especially by foreigners, who in recent years have acquired a large amount of control in the Indonesian banking industry, has been the cause of heated debate among regulators, politicians, and the public. This is due to the fact that since the last Asian economic and financial crisis of the late nineties, foreign ownership of the industry has grown steadily and rapidly, either in terms of assets that foreign parties control, or market share of the industry. The problem has escalated as a result of certain foreign groups of companies obtaining control over a number of banks thus creating an unhealthy concentrated ownership, resulting in a certain amount of nationalistic sentiment as regards foreign ownership within the country's economy.

Indonesian Banks are supervised by a new independent financial institution called the Financial Services Authority (Otoritas Jasa Keuangan or OJK). However, the former bank supervisor, Bank Indonesia, in the past issued several regulations to limit foreign share ownership of Indonesian Banks, including regulation on the ownership of the shares of commercial banks and the single presence policy.

In 2012, Bank Indonesia introduced a new regulation to limit both foreign and local shareholding in local banks, based on: (1) the category of shareholders; and, (2) the relationship between the shareholders (Regulation 14/8/PBI/2012 on Ownership of Commercial Banks' Shares). The maximum shareholding that each category of shareholder may hold is as follows:

  • an individual may hold up to 20% of the bank's capital;
  • a non-financial institution (legal entity) may hold up to 30% of the bank's capital; and,
  • a bank or non-bank financial institution may hold up to 40% of the bank's capital.

This regulation was issued for the implementation of the structuring of bank ownership, and was aimed at enhancing good governance and bank soundness ratings. Accordingly, banks whose soundness ratings and governance were deemed to be strong would be exempted from this regulation as long as they successfully maintained strong governance and ratings.

Until the end of December 2013, all the shareholders of a local bank were permitted to increase their shareholding. However, by January 2014 they had to adjust their shareholding to the permitted maximum threshold, depending on the result of an assessment of the bank's soundness level and/or good corporate governance (GCG) during the December 2013 period of assessment (ie, the assessment to determine whether the bank had maintained its ranking in one of the top two levels of soundness and its GCG).

In addition, the Indonesian banking system's Single Presence Policy (SPP) provided that, with the exception of the branches of foreign banks, a party was only allowed to be the controlling shareholder in one bank, either a commercial bank or a shariah bank (a shariah bank is a bank that operates on Syariah principles based on Islamic Law). The amendment to Bank Indonesia regulations on SPP issued in December 2012 (Regulation 14/24/2012), provided an exemption to certain parties: controlling shareholders in two banks with different banking principles (a conventional bank and a shariah bank); and, controlling shareholders in two banks, one of which was a joint venture bank.


"Until the end of December 2013, all the shareholders of a local bank were permitted to increase their shareholding"


Recently, in tightening foreign ownership restrictions, the Indonesian House of Representatives' (Dewan Perwakilan Rakyat or DPR) Commission XI for Finance, Planning, Development, and Banking has issued draft legislation on banking (Draft Legislation) which would cap foreign ownership in Indonesian commercial banks at 40% and require the incorporation of any foreign bank operating in Indonesia. No foreign ownership would be allowed in Smallholder Credit Banks. Under the Draft Legislation, Smallholder Credit Banks may be established and owned by: (i) Indonesian citizens; (ii) Indonesian entities that are fully-owned by Indonesian citizens; and (iii) regional governments. If the Draft Legislation is passed in its present form, the landscape of the Indonesian banking industry in the future will certainly enter a new phase. Unlike the prevailing Banking Law, the Draft Legislation clearly bears a nationalistic spirit in its restricting of foreign ownership and encouragement of local investors to develop the national banking sector. The main objective in limiting foreign investment in the banking sector is to strengthen the implementation of the reciprocal principle, whereby the country of origin of foreign investors that wish to go beyond the 40% cap, must commit to giving the same flexibility to Indonesian banks in their own country.

Given the fact that there have been so many foreign banks in Indonesia for so long, and that they have controlled the majority of Indonesian commercial banks, it remains to be seen how the banking industry regulators will regulate and treat those foreign-controlled banks after the Bill has been passed. There has been a strong nationalistic sentiment towards foreigners in other industries, primarily in the natural resources sector. These industries have, to a certain extent, undergone the same process of nationalisation in recent years. Law No 4 of 2009 on coal and mineral mining, for instance, requires that foreign shareholders in a joint venture mining company begin the selling/divestment of their shares to an Indonesian party (either government, regional government, state-owned enterprise, or their partners) gradually as of the sixth year after exploration takes place.

According to the newest version of the Draft Legislation, existing established banks that are majority-owned by foreigners will be given a 10-year period to divest their shares after the Draft Legislation has been passed into law. This provision indicates that the Draft Legislation is applied retroactively. As the implementation of this Draft Legislation, the OJK will then further stipulate guidelines in separate regulation on the procedures for the divestment of shares. In contrast to the existing Banking Law, the Draft Legislation does not explicitly differentiate between direct share ownership and share ownership through the stock exchange. This generalisation should be further considered by the DPR and the OJK to avoid multiple interpretations in the future, as several of the largest banks are publicly-held companies. In addition, there is no specific stipulation on whether a foreign capital investment (Penanaman Modal Asing or PMA) company will be considered a foreign element entity or a local entity. This also should be clearly stipulated under the prospective banking law as it will be an important distinction for foreign investors. If a PMA company is not considered a foreign element entity, it is most likely that foreign investors will set up PMA companies to indirectly hold shares in Indonesian Banks.

The SPP is also regulated under the Draft Legislation. As approved by the OJK, a party can only become a controlling shareholder in one Indonesian Bank which is exempt from (a) the Indonesian government becoming a controlling shareholder in the Indonesian Bank; and, (b) the Deposit Insurance Corporation (Lembaga Penjamin Simpanan or LPS) becoming a controlling shareholder in an Indonesian Bank that is under the management and recovery procedure of LPS.

Although this Draft Legislation on banking will impact heavily on investment in Indonesia's banking sector, it still seems to provide flexibility for foreigners to own more than 40% of shares in Indonesian Banks, depending on the track record of the foreign bank (track record includes aspects like good corporate governance, adequacy of capital, and contributions to the national economy). The Financial Sector Stability Coordination Forum (FKSSK) (an agency that consists of the OJK, Bank Indonesia, the Finance Ministry and LPS) has discretionary power to provide a recommendation to the OJK to grant an extension period for achieving maximum foreign share ownership, based on data, documentation and information provided by the OJK. Upon receiving the approval from the DPR, the OJK will have the authority to decide whether a foreign investor is allowed to own more than 40% of the shares in the Indonesian Bank for a certain period of time. Although it is still unclear how this would work in practice, this mechanism indicates that in deciding on a period of extension, a certain amount of checking between the OJK and the DPR would be required. Administrative sanctions, from written warnings to revocation of the bank licence, may also be imposed on foreign citizens and/or foreign entities for violations of foreign share ownership restrictions.


"These limitations on foreign investment in the banking sector must be carefully regulated"


Several banking analysts agree with this Draft Legislation, which will encourage the Indonesian banking sector to develop without depending on foreign ownership. The concept of a 40% foreign ownership cap as an effort to protect the Indonesian banking industry is not unusual, since this kind of restriction already exists in many countries. On the other hand, the government of the Philippines and several other countries have recently announced that they will accept investment of up to 90% foreign ownership in the banking sector, which would make foreign investment in the Philippines more attractive than in Indonesia.

If this law came into effect, foreign share ownership restrictions would effectively prevent foreigners from being controlling shareholders. Even so, this might not necessarily discourage new foreign investment in the banking sector, as the global Basel III banking regulation provides that control of a company is defined as (1) ownership, control, or holding with the power to vote with 20% or more of a class of voting securities of the company or (2) consolidation of the company for financial reporting purposes. In accordance with Basel III banking regulation, this Draft Legislation also stipulates that a controlling shareholder (1) is any entity or individual who owns 25% or more of issued shares of an Indonesian Bank which have voting rights; or, (2) owns less than 25% of the bank's shares, but is considered to control the bank either directly or indirectly. Therefore, even when only holding 40% shares in an Indonesian Bank, it would still be possible for foreigners to be controlling shareholders in that bank.

Something that should be anticipated is the possible circumvention of the law by foreign investors intending to invest in Indonesia. The proposed reduction in the maximum limit of foreign ownership of Indonesian Banks, might result in foreign investors establishing special purpose vehicle (SPV) companies as a means of indirectly owning more of an Indonesian Bank than the maximum limit allowed under the Draft Legislation.

Further, many of Indonesia's largest banks that are controlled by foreign entities, including CIMB Niaga (majority ownership held by Malaysia's CIMB Group), Bank Danamon Indonesia (Temasek), Panin (ANZ Bank Group), Bank Permata (Standard Chartered), and Bank Internasional Indonesia (Maybank) need to prepare an adjustment plan for divesting their shares to Indonesian entities or Indonesian citizens once this Draft Legislation is in effect. This being the case, these limitations on foreign investment in the banking sector must be carefully regulated, since the banking sector still requires a large investment injection to ensure that it remains compliant with the provisions concerning capital adequacy, asset quality, quality of management, liquidity, profitability, solvency and other components related to the operations of a bank.

About the author
 

Freddy Karyadi
Partner, ABNR

Jakarta, Indonesia
T: + 6221 2505125
F: + 6221 2505001
E: fkaryadi@abnrlaw.com
W: www.abnrlaw.com

Freddy Karyadi joined ABNR as senior associate in July 2007 and became a partner in January 2012. He read law at University of Indonesia (1998) and earned LLM in International Tax from Leiden University (2002). He also graduated cum laude in 1997 from the faculty of economics of Trisakti University in Jakarta. He has participated in various trainings and seminars in Indonesia and abroad. Prior to joining ABNR, he worked for a number of years in other prominent law firms in Jakarta. In 2010, he was seconded to a prominent Dutch law firm, Loyens & Loeff in Amsterdam. His special practice areas are capital markets, M&A, investment, property, natural resources, tax, banking and project finance matters. He has represented international financial institutions, banks, private equity, hedge funds, mining, e-commerce, and publicly listed companies. He is also a tax attorney, chartered accountant and licensed tax consultant. He receives awards from IFLR1000 and Asialaw profile.


About the author
 

Ayik Candrawulan Gunadi
Partner, ABNR

Jakarta, Indonesia
T: +62 21 250 5125
F: +62 21 250 5001
E: agunadi@abnrlaw.com
W: www.abnrlaw.com

Ayik Candrawulan Gunadi joined ABNR as an associate in September 2001 and became a partner in October 2013. He graduated in 1997 from the faculty of law, Parahyangan Catholic University, and in 2000 completed his LLM programme at the Erasmus University Rotterdam, the Netherlands. Before joining ABNR, he worked for a law firm and a prominent insurance company in Indonesia. He also worked in the Netherlands, as a foreign trainee with Loyens & Loeff, an international legal and tax consultant in Rotterdam, and then with a Dutch Bank in Amsterdam. He has extensive experience in matters involving corporate law, foreign investment, intellectual property and project finance, and has been actively involved in infrastructure projects in Indonesia. He returned to ABNR after a few months with a major Indonesian power company as its senior legal manager, and now heads the ABNR team which monitors regulations in connection with energy and mineral resources projects.


About the author
 

Kartika Budianti Lestari
Associate, ABNR

Jakarta, Indonesia
T: +62 21 250 5125
F: +62 21 250 5001
E: klestari@abnrlaw.com
W: www.abnrlaw.com

Kartika Budianti Lestari joined ABNR as an associate in June 2013. She graduated in February 2012 from the faculty of law of the Parahyangan Catholic University as the Best Graduate. During her university years, she received in 2011 the "Mahasiswa Berprestasi" award for the Kopertis Region IV of West Java and Banten. In 2010 she was the recipient of the Best Oralist award whereas her team was also an award recipient in the Sciencesational Debate Competition, which was held in University of Indonesia.

She had also been vice chairman of UNPAR's Student Representative Assembly and member of the Council of the Parahyangan Law Debate Community. At ABNR, she has assisted clients on transactions related to banking, financing, company restructuring, merger and acquisition, investment and corporate matters thus gained extensive experience and regulatory knowledge in these areas.