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Foreword
Rapid expansion in the financial services industry and globalisation of financial markets haveenhanced economic growth opportunities. They have also increased the risks in the financial sectorheightening challenges in the maintenance of financial system stability and hence, requiring greaterattention of the responsible country authorities as well as international organisations. Moreover,recent financial crises have clearly demonstrated the importance of maintaining systemic stability inthe financial sector. As a result, financial system stability has become a primary agenda item at thecountry level as well as international level. Consequently, it has become one of the key objectives of an increasing number of central banks. A stable financial system not only facilitates efficiency infinancial intermediation and resource allocation but also provides an effective conduit fortransmission mechanism of monetary policies. Meanwhile, absence of financial system stability iscostly as it may lead to financial crisis resulting in drastic consequences of lower economic growth,higher fiscal burden, and even social and political instability.Financial stability is a broad concept which does not have a simple or universally accepteddefinition. However, there seems to be a broad consensus that it refers to the smooth functioning of the key elements (i.e., institutions, markets and infrastrucutre, etc) that make up the financial system.As such, the role of the authorities responsible for promoting and maintaining financial stability (i.e.,central banks and other financial supervisory authorities) involves monitoring both domestic andinternational financial developments, identifying areas of concern relevant to the financial system andundertaking necessary measures in coordination with other relevant institutions.This Occasional Paper analyses financial system stability and how it is practiced as animportant task of a central bank, particularly in the context of Bank Indonesia. The Paper delves intothe definition of finanical stability, role of the central bank in maintaining financial stability,promoting financial stability in practice, coordination and cooperation, financial safety nets and crisismanagement and lastly, key challenges.The SEACEN Centre gratefully acknowledge the contribution of Dr. Wimboh Santoso, Headof Financial System Stability Bureau, and Mr. Sukarela Batunanggar, Executive Research, FinancialSystem Stability Bureau, both of Bank Indonesia, for authoring the Paper. The views expressed inthis Paper are, however, those of the authors and are not necessarily those of Bank Indonesia andThe SEACEN Centre.Dr. A.G. Karunasena The SEACEN CentreExecutive Director Kuala LumpurSeptember 2007
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