Enforcement Approaches in Risk-based Regulation:
A Comparison of Two Regulators in Indonesia
Author: Enny Efriani (S1783033) Supervisor: Dr. Maarja Beerkens Second Reader: Dr. Gerard Breeman
Master of Science Public Administration
Faculty of Governance and Global Affairs
E. Efriani, Leiden University, 2017 2
TABLE OF CONTENTS CHAPTER 1 INTRODUCTION ... 3
1.1 Research Questions ... 4
CHAPTER 2 CONCEPTUAL FRAMEWORK ... 8
2.1 Risk-based Regulation ... 8
2.2 Risk-based Regulation Attractiveness ... 10
2.3 Risk-based Regulation Challenges ... 11
2.4 Image of Regulatees ... 13
2.5 Enforcement Approach ... 17
2.6 Relational Distance ... 20
2.7 Theoretical Argumentation ... 21
CHAPTER 3 RESEARCH DESIGN ... 25
3.1 Selection of cases-criteria ... 25
3.2 Data Collection ... 26
3.3 Data Analysis Method ... 29
3.4 Limitation ... 29
CHAPTER 4 RISK-BASED REGULATION AND LEGAL FRAMEWORK ... 31
4.1 Application of Risk-based Regulation ... 31
4.1.2 Risk-based regulation in the OJK ... 31
4.1.2 Risk-based regulation in the DGCE ... 35
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4.2.1 Legal Framework in the OJK ... 37
4.2.2 Legal Framework in the DGCE ... 39
4.2.3 Conclusion ... 42
CHAPTER 5 ANALYSIS ... 43
5.1 Enforcement Approach ... 43
5.1.1 Enforcement Approach in the OJK ... 43
5.1.2 Enforcement Approach in the DGCE ... 51
5.2 The Image of the Regulatees ... 57
5.2.1 The Image of Pension Funds... 57
5.2.2 The Image of Importers ... 62
5.3 Relational Distance ... 67
5.3.1 Relational Distance between the OJK and Pension Funds ... 67
5.3.2 Relational Distance between the DGCE and Importers ... 69
5.4 Hypothesis Analysis ... 70
CHAPTER 6 CONCLUSION... 78
REFERENCES ... 83
Appendices ... 88
Appendix 1: List of Abbreviation ... 88
E. Efriani, Leiden University, 2017 4
CHAPTER 1
INTRODUCTION
Risk-based regulation emerges correspondingly with the development of New Public Risk Management in England during 1980s/1990s (Black, 2005). Recently, risk-based approach in regulatory field seems to be attractive and is implemented in many countries and various sectors (Black, 2005; Hutter, 2005; Rothstein, Irving, Waldon, & Yearsley, 2006). It is adopted not only in developed countries such as The United Kingdom and The United States, but also implemented increasingly in developing countries. There are several reasons that make this possible. First, risk-based regulation is believed to bring a solution of limitation of resources to monitor and enforce regulatees’ activities (Lodge and Wegrich, 2012). Furthermore, risk-based regulation can be used as a legitimating tool because it can legitimate the decision of agencies to not inspect certain firms and give intense inspections to other firms (Black, 2005). Risk-based regulation is also considered to be able to improve efficiency and effectiveness of the rules (Rothstein et al., 2006).
Regarding risk-based approach’s development among sectors and countries, the definition of risk-based regulation includes a broad diversity of approaches from full adoption of risk-based frameworks to a loose implementation involving the utilization of small parts of based elements (Hutter, 2005; Black, 2010). There are three broad meanings of risk-based regulation existed in the literature (Black, 2010). First, it suggests risk-risk-based regulation as a tool to analyze which activities should be regulated and to what extent regulators can intervene. The second definition refers to banking and insurance regulations that control the limit of banks’ capital. Last, risk-based regulation applies to the risk in enforcement aspects in which the risk is used to prioritize supervision of activities or firms that pose a higher risk.
E. Efriani, Leiden University, 2017 5 For the purpose of this study, risk-based regulation refers to the one in enforcement frameworks.
Enforcement, by definition, is the application of coercion to force regulated parties to do things they would not do if there is no obligation and regulation (Lodge and Wegrich, 2012). It includes strategic actions to gather information on compliance and modify behavior of regulatees who conduct violations. In this case, risk-based regulation functions to achieve effective detection of non-compliance by deploying resources efficiently and establishing strategies to modify behavior of non-compliance. As Lodge and Wegrich (2012) explained, modifying behavior is highly correlated to sanctioning styles. It can be varied from monitoring, advising, warning, fining, revocation or prosecution. In many literatures, these enforcement approaches are classified into two main branches; deterrence and persuasion approach (Baldwin, 1995; Lodge and Wegrich, 2012). The challenge in the regulatory system then is deciding the enforcement approaches that can achieve a higher level of compliance at realistic costs to regulators and regulatees.
Each agency that implements risk-based regulation may have different enforcement strategies against non-compliance. There will be no two same risk-based regulations even in the same sectors because they involve a complex set of choices (Black and Baldwin, 2010). Black (2001) mentioned some factors that can affect enforcement approach and the two dominant factors are the image of regulatees and relational distance. The discussion leads to the purpose of this study which is to explore on how those two factors influence variation of enforcement approach in risk-based regulation.
1.1 Research
Questions
This study tries to examine the variation in enforcement approaches in risk-based regulation. It focuses on the effects of regulator’s perception of the regulatees and the relational distance
E. Efriani, Leiden University, 2017 6 between the regulator and regulatees as potential factors for explaining the variation in enforcement practices. Thus, the general research question set in this study is:
How enforcement approaches in risk-based regulation vary? And what explains the variation?
The paper will first examine the existing assumption that regulator’s perception of the regulatees has an effect on enforcement practices. Many studies have discussed how the image of regulated industries may affect enforcement approaches of regulators (Kagan & Scholz, 1984; Scholz, 1984; Baldwin, 1995). With regard to this, regulatees are considered to have different motivations toward compliance of regulations. They can be assigned to three types of characters; amoral calculators, political citizens, and lack of capacities (Kagan and Scholz, 1984). Regulatees are pictured as amoral calculators when their compliance is driven by economic calculation; and categorized as political citizens if the motivation to comply is due to the sense of duty. The third characteristic is given to regulatees who cannot comply because they do not have the capacities. The reasons of non-compliance then may influence the enforcement approach used whether towards punishment and sanction (deterrence) or support and information (persuasion) (Kagan and Scholz, 1984; Lodge and Wegrich, 2012).
The second explanatory factor for enforcement approach is probably relational distance. Regulators which have high relational distance tend to implement more law to their regulated industries, vice versa. To determine the relational distance between regulatees and regulator, two approaches can be used; number of regulatees and frequency of interactions between regulatees and regulator. This paper uses frequency of interactions to examine relational distance between regulators and regulatees.
The empirical analysis in this study is built on two cases; the Financial Services Authority (OJK) and the Directorate General of Customs and Excise (DGCE) in Indonesia.
E. Efriani, Leiden University, 2017 7 Academic researchers have put lots of attention and carried out extensive researches of risk-based regulation in west countries such the United Kingdom, Germany, and Netherlands. However, development of risk-based regulation is growing rapidly recently in developing countries including Indonesia; thus, it is important to explore the theories in this new context.
Risk-based regulation in pension funds mainly stems from the extension of risk based regulation in banking industries. The implementation is triggered by a concern in the capability of pension funds to fulfill defined benefit amid declining equity prices and interest rates (Brunner, Hinz, & Rocha, 2008). Recently, the risk-based regulation has been implemented widely in the world including in South East Asia countries such as Indonesia. The OJK as regulator of pension funds in Indonesia started implementing risk-based supervision in 2008 by using risk rating system and risk-based monitoring system. Even though accumulated assets of pension funds in Indonesia are not relatively large, risk-based supervision is considered as an important policy to achieve good governance and provide supervision certainty to pension funds industry.
The DGCE adopted risk-based regulation in 1995 and it was fully adopted since 2006. The implementation of risk-based regulation is dominant in supervision of import transactions. It becomes essential because it allows the allocation of supervision resources efficiently in the middle of an increase in international trading activities and complexity of global supply chain (Hintsa et al., 2011). Moreover, due to terrorist attacks of September 11, 2001, the risk-based regulation is considered as a necessary tool to achieve stability of international supply chain. The DGCE decides which import transactions should be inspected and how deep the inspection based on risk posed by the import transactions. World Customs Organization, furthermore, introduces Customs Risk Management Compendium as guidance and recommends the implementation in member countries. The risk management uses profiling system that assesses the risk of importers and goods imported.
E. Efriani, Leiden University, 2017 8 The study is structured as follows; the next chapter elaborates conceptual framework of risk-based regulation, image of regulatees, relational distance, and enforcement approach. The conceptual framework also provides argumentation of the relationship of image of regulatees and relational distance with enforcement strategy and presents the hypothesis. Research design and methodology are explained in chapter three. Moreover, it discusses the qualitative method used, how data are collected and analyzed, and what the limitations of the study are. Chapter four elucidates detailed information of risk-based regulation and legal framework of the OJK and the DGCE, including an introduction of the OJK and the DGCE as the regulators. Chapter five provides analysis of the empirical facts regarding the hypotheses. Lastly, the sixth chapter concludes the result of the analysis.
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CHAPTER 2
CONCEPTUAL FRAMEWORK
This chapter provides the concepts of risk-based regulation and its attractiveness and challenges. Moreover, the chapter explains three models of regulatees, two enforcement approaches, and theory of relational distance. Information put in this chapter is important to define the key concepts for the research questions, examine what is already known about the topic, and develop theoretical framework for the empirical study. Thus in the end of this chapter, hypotheses and the argumentations are presented.
2.1 Risk-based Regulation
Risk-based regulation emerges notably and gets considerable attention as one of modern approaches for improving better regulation. Researchers put their interest to discuss the emergence of risk-based regulation in England such as Black (2005) and Hutter (2005). The concept of risk in England is explored firstly in the 1980s/1990s along with institutional changes namely New Public Management (Hutter, 2005) or specific term New Public Risk Management (Black, 2005). New Public Management and regulatory crisis put pressure on regulators to legitimate their activities; how efficient and effective they can manage their resources and cost (Hutter, 2005).
An adoption of the risk-based regulation varies widely due to the facts that some countries and sectors implement all risk based tools while some others only simply take the language of risk (Hutter 2005; Black 2010). Leading countries that comprehensively apply risk based regulation are the United Kingdom and the United States followed by Canada and Australia (Hutter, 2005). Some European and Scandinavian countries also promote their regulators to adopt a risk based regulation on the partial basis, while Germany shows that it
E. Efriani, Leiden University, 2017 10 applies more risk based principles (Hutter, 2005). Meanwhile in Asia, especially Southeast Asia, an adoption of the risk-based regulation is mainly because of international requirements. For example, an implementation of Basel II Accord on Capital Adequacy is mandated without exception in Southeast Asia Countries (Randhawa, 2005).
Generally, definition of risk-based regulation is
“A risk based approach to regulation explicitly acknowledges that the government cannot regulate to remove all risks and that regulatory action, when taken, should be proportionate, targeted and based on an assessment of the nature and the magnitude of the risks and of the likelihood that regulation will be successful in achieving its aims.” (OECD, 2010, p. 16).
The risk-based regulation also can be defined as a particular strategy or set of strategies that regulators use to target their resources at firms and activities that present threats to their ability to achieve their objectives (Hutter, 2005; Black, 2005; Black and Baldwin, 2010). The strategy is not only based on rules but also on risk thus concept of risk is a critical point in risk-based regulation. Regulators should define their objectives, identify activities that pose threats to the objectives and set the level of risk that can be tolerated. Two firm-specific risks recognized commonly in academic studies are the inherent risk, and the management and control risk (Black, 2004; Black, 2010). Inherent risk is the risk that is attached to business’s activities or location of the firm and is raised from the probability of potential future actions and possible impact of risk pressure on firms’ capital or earnings. On the other hand, management and control risk includes internal control systems, governance structures, and compliance history. The identification of risk requires complex consideration and can be a scientific activity. The impact may be expressed in the monetary unit, and the estimation of uncertainty put into probability score (Krieger, 2013).
E. Efriani, Leiden University, 2017 11 Besides of the concept of the risk, risk-based frameworks also play a significant role in building risk-based regulation comprehensively. In general, four elements of risk-based frameworks commonly exist in most risk-based regulations (Black, 2010). The four elements are the establishment of risk appetite that can be accepted both by regulators and public, an assessment of the probability and the impact of the hazard of the non-compliance, scoring of risks and categorizing regulatees to certain ranks based on the results of risk assessments, and the assignment of the risk levels to particular regulatory responses. The risk-based frameworks may result with two main branches of regulators’ intervention; inspection and supervision, and education and advice.
2.2 Risk-based Regulation Attractiveness
Countries and agencies adopt risk-based regulation because of various reasons. Risk-based regulation as contemporary regulation approach does offer some advantages that cannot be provided by the old practices. The first advantage of risk-based regulation mainly is providing the solution of limitation of resources to monitor and enforce regulatees’ activities (Lodge and Wegrich, 2012). Risk-based regulation is believed to be able to allocate the limited resources efficiently and effectively. Black (2005) argued that problem of imbalance of resources available to the activities monitored is an old problem and every regulator always has to decide which activities should get more attention. The best part of the risk-based regulation is that it can provide justification for distributing more resources and inspection to risky regulatees and less inspection to low risk firms and activities. One way to achieve this by developing spreadsheets documents or a matrix of assessments that include economic, impact, and probability calculation and can provide transparency of choices to public (Black, 2005; Lodge and Wegrich 2012).
E. Efriani, Leiden University, 2017 12 The next advantage is that risk-based regulation can be used as a tool to shift public’s parameters of blame to regulators (Black, 2005). Regulators always face two types of errors in regulations which are type I error and type II error. Type I error assumes firms are risky when they are not and type II error considers companies are safe when they pose risks (Schrader-Frechette, 1991). Risk-based regulation is able to create public and political perception not only to what regulators can and should do but also to what regulators cannot do and should leave. Thus regulators are implicitly or explicitly notify that they cannot apply non-zero failure. For instance, Advanced Risk-Responsive Operating Framework (ARROW) used by the UK FSA offers a defensive shield against critics because it can provide argumentation why the UK FSA takes particular enforcement actions (Black, 2005).
Furthermore, risk-based regulation is considered to be able to improve efficiency and effectiveness of the rules (Rothstein et al., 2006). For example, in cases of contaminated land and radioactive waste cases, stringent regulation can lead to the high cost for both industries and regulators. Risk-based regulation may offer economically and technically solutions to identify higher risk sites and direct the resources to focus more on those sites. Moreover, risk-based regulation can create new approaches to risk and more accurate decisions (Rothstein et al., 2006). It is because risk-based regulation encourages both industries and regulators to improve their knowledge. In the radioactive waste case, risk concept promotes regulators and companies to understand more and deeper about factors influencing safe radioactive waste disposals such as potential impacts of long-term climate change and radionuclide migration (Rothstein et al., 2006).
2.3 Risk-based Regulation Challenges
Risk-based regulation is not a perfect regulation method that can run without any criticism and challenge. Some potential problems may emerge in designing of risk-based regulation in
E. Efriani, Leiden University, 2017 13 public sector. Overemphasis in risk-based regulation can amplify blame avoidance in regulatory agencies and hinder regulators to disclose information about mistakes or failures (Hood, 2002). Too much pressure on mitigating risk at agencies’ level can generate a shift of risk to other regulators that in the end will result in zero public value. Otherwise, the risk moves to a weaker organization that is not politically strong and do not have many resources compare to other agencies.
Regarding the political position of risk-based regulation; there is concern whether risk assessment can be neutral of politics influence (Lodge and Wegrich, 2012). Intolerable risk is not recognized easily because of its subjectivity aspects. In the case of FDA’s saccharin ban, there is a dispute to decide what level of saccharin categorized as safe (Majone, 2010). Moreover, an accepted view of intolerable risk among citizens may be different to the economic perception of low probability incidents (Lodge and Wegrich, 2012). Events that have big impacts but very low probability may become a concern for citizens but agencies and industries face difficulties in identifying the probability and it can be too costly to put higher attention on the events.
The other issues are the systemic risk, and capacities of regulatees to manage risk (Lodge and Wegrich, 2012). Systemic risks can arise from any firm, but the impacts affect the whole industries. Regulators shall identify the risk connection between regulatees; however, the nature of risk-based enforcement is about particular firms rather than entire industries. Analytical capacities become necessary to understand characteristics and capabilities of regulatees in managing their risks. If regulators do not have the analytical capabilities, their intervention strategies may lead to gaming and undesirable events. Analytical capabilities are required even for events that do not pose a systematic risk in the past because the events may bring systemic risks in the future. For instance, risk based
E. Efriani, Leiden University, 2017 14 regulation is considered failed to overcome financial crisis in 2008 because it ignores irrational behavior (Lodge and Wegrich, 2008).
2.4 Image of Regulatees
In regulatory enforcement, image of regulatees is an important notion and many studies have explored it (eg Hawkins, 1984; Kagan and Scholz, 1984). Regulatees are categorized based on their motivation of compliance. The most common typology of regulatees is Kagan and Scholz’s tripartite classification of regulatees that are amoral calculator, political citizen, and lack of capacities (Kagan and Scholz, 1984).
Amoral calculators are regulatees who comply with the regulation because of economic calculation and market pressure. They calculate economic benefit of breaking law and compare it to the cost of non-compliance such as sanction and legal penalties (Kagan and Scholz, 1984). Amoral calculators will comply if the cost of breaking law exceeds the benefit they get from non-compliant activities. Thus the low level of compliance among amoral calculators may indicate that the legal penalties and sanctions are relatively low or the probability of evading the law without being caught is high.
Besides its wide acceptance as a model of corporate criminals, amoral calculator model poses some limitations (Kagan and Scholz, 1984). This model indirectly neglects other actors’ pressure and influence on firms’ compliance. Regulatees are expected to act responsibly by their counterparties such as insurance companies, trade associations, and labor unions. Thus, the companies are not solely under regulators’ supervision. Furthermore, amoral calculator’s model cannot explain the case of some companies that have same opportunities and cost to violate the regulation, but the companies partially comply to the regulation even though the others break the laws. Another case is the firms that are willing to obey regulation although it requires high investment but refuse to comply with OSHA’s
E. Efriani, Leiden University, 2017 15 requirements that require less investment. This limitation clearly indicates the existence of other regulatee’s classification besides amoral calculators.
The second model, regulatees as political citizens, argues that regulatees obey the regulation voluntarily because of the reasonableness of regulations and moral factors (Kagan and Scholz, 1984). This model answers the first limitation of amoral calculators. The idea is started from particular sociological perspective that labeling citizens or industries as non-compliant regulatees may increase the violations. Companies that are supposed to be law-abiding can change their behavior against the law due to disrespect treatment from officials. For example, executives from some companies are discontented to the responses of officials that impugn data provided by corporations. The other perception of reasonableness is how practical is the regulation to be implemented and whether the implementation disrupts business process or not. Companies believe that some regulations indeed seemed to make sense in theory, but the implementation burdens high cost to industries. For example, one large company that has good safety record encourages their plant managers to postpone the implementation of unreasonable OSHA’s regulation. Regulatees as political citizens will voluntarily comply even without any punishment threat when they agree with objectives of the regulations. It is supported by the study of Kagan and Scholz (1984) which found that many agencies officials believe that compliance activities in their sectors mostly come from voluntary compliance. Regarding moral issues, some business executives state that they obey the law because they are supposed to do that morally (Kagan and Scholz, 1984). In addition, some expertise in environmental and food industries share same values with regulators.
Despite the above mentioned distinctions, political citizen’s model indeed has some limitations (Kagan and Scholz, 1984). It cannot give a clear explanation to differentiate companies which have voluntarily compliance motivation and corporations which are advantage seekers. Moreover, it is problematical to identify reasonable and unreasonable
E. Efriani, Leiden University, 2017 16 regulations based on companies’ perspective. Thus it may make no difference between amoral and principled violations. For example, managers in one company may consider the set of risk as minor thus the regulation requirement to remove it can be seen as arbitrary. Conversely, in the other company, managers may put the small risk as their priority and consider regulation requirements as reasonable. This limitation can lead to wrong regulatory responses. For instance, deviant groups are assigned to lenient regulations while they are potentially misappropriating the softness of regulatory responses.
In the last model regulatees are considered as lacking capacities. The idea is analogized from some criminal cases in which the offenders are lacking the abilities and knowledge to differentiate right and wrong actions (Kagan and Scholz, 1984). Companies are like individuals; they can go through difficulties and failure in understanding the norms and regulations. Thus it seems inappropriate to put these regulatees into categories of amoral calculator and political citizen. In this case, the breaches actions are commonly stemmed from disorganization or corporate mismanagement. Sometimes it is inevitable that managers lost their control upon subordinates or the illegal procedures taken to fix practical problems by the workers are hidden from the managers. Moreover, disorganization can occur when regulation importance in the internal of companies is different. For example, the production department runs their process without precisely following the regulation requirements due to the complexity of the rules. However, quality control and safety engineers may not have considerable authority to push production departments complying with the rules. The magnitude of disorganization may become bigger for large companies because the separation and division of particular function restrain the range of responsibilities in the internal of companies (Schelling 1974; Kagan and Scholz, 1984).
The limitations of lack of capacities’ model are similar to the limitation in the political citizen model. It has limited predictive value because this theory cannot provide an
E. Efriani, Leiden University, 2017 17 explanation of why and when companies are likely to be lacking of capacities (Kagan and Scholz, 1984). Hence, regulators may face difficulties to analyze distinction between amoral calculators and corporations which has good compliance motivation but lacks of capacities. The incompetence of firms to handle internal compliance problems may indicate that the top managers deliberately ignore the regulation requirements. In some cases, regulations have mandated specific licensing procedures for the main personnel and data collection on entire industries to cope with problems in incompetence companies.
All three models of regulatees’ motivation have covered most important characteristics of regulatees (Black, 2001). In practice, companies are not necessarily categorized into one type. Ayres and Braithwaite (1992) explained that corporations can indicate one or more motivations of compliance. Divisions, management levels, and offices in one company can have different motive towards compliance of regulation thus the company may be both amoral calculators and political citizens. The regulatees’ motivation also can change over time, for example, companies that are incompetence can improve their internal monitoring system then become political citizens (Ayres and Braithwaite, 1992; Black, 2001). Thus, to classify regulatees based on their motivation is not a stiff process but can be reevaluated over time. The characterizations can be an institutional memory of regulators and forwarded to officers that do not have the experience with the regulated industries (Hawkins and Hutter, 1993)
The assessments of regulatees’ motivation are subjective and can be based on the company’ resources dedicated to meet the regulation requirements; the company’ attitude that is posed by both managers and workers, and the quality towards regulation compliance (Black, 2001). The company’s capabilities include financial condition, technical skills and knowledge, workforce’s treatment, staff turnover, and incentives structures. The other way to examine regulatees’ motivation is using enforcement history. It is a regulator’s record of
E. Efriani, Leiden University, 2017 18 compliance, integrity, and responsiveness to enforcement’s demands (Hawkins 1984; Black 2001)
2.5 Enforcement Approach
Regulatory enforcement has evolved extensively following the broad range of regulatory sectors and complexity of regulatory practices. The two types of enforcement strategies that are discussed primarily in literatures are deterrence or sanctioning approach and compliance or persuasive approach.
Deterrence approach is formulated from the idea that affliction of punishment can affect the future behavior of potential offenders (Bishop, 2009). Deterrence approach activates deterrent fear to achieve compelling compliance among regulatees (May, 2005). It can also be defined as the sense of inspections or previous sanctions that convinces the company to take more vigorous endeavors to hinder forthcoming sanctions (Gunningham et al., 2005). The deterrent effect works directly to deviants and indirectly by giving an example for other firms (Bishop, 2009). It is commonly categorized into general deterrence and specific deterrence (Bishop, 2009; Gunningham, Thornton, & Kagan, 2005). General deterrence takes an assumption that punishment of one company is widespread among industries and creates an alarm for other firms while specific deterrence related directly to the effect of punishment on the company itself.
The principal characteristic of deterrence approach is that imposing the punishment to deviants is a substantial concern (Hutter, 1997; Black, 2001). Thus securing santions is an important issue in deterrence approach while compliance improvement is a by-product. The style of this approach is distrust and adversarial in which regulators are questioning whether the regulatees’ activities break the rules or not and how to detect the violation (Black, 2001). Hence, the proof of violation is an important thing in deterrence approach. There are only two
E. Efriani, Leiden University, 2017 19 possible decisions; there is or there is no violation (Hawkins, 1984). In this model, officials work more like police officers who lack the authority to give discretion to the violation. Bargaining process between regulators and firms is less likely to happen because regulators are likely to reject an exception or extensions of time for repairing harm.
The number of punishment or process of adjudication becomes an indicator of success in deterrence approach (Hawkins, 1984). Some scholars argue that deterrence approach can work properly. Severe penalties may be more efficient than other tools to encourage companies to comply (Gunningham et al., 2005). The application of severe penalties to deal with non-compliance is prevalent among agencies (Lodge and Wegrich, 2012).
However, there are also some limitations posed by deterrence approach. The most apparent is that the effectiveness of financial penalties as punishment tools depends on the probability of detection (Lodge and Wegrich, 2012). High penalty will not generate a deterrent effect for lawbreakers if the companies find that their deviant behaviors are unlikely detected by officers. For example, large fines for illegal waste disposal are unlikely to produce a compliance effect if officers do not have adequate tools to detect the violation. In addition, deterrence approach has a potential of misappropriating usage or arbitrary implementation (Bardach and Kagan, 1982; Lodge and Wegrich, 2012). Companies may get punishment even though they are believed that they have put efforts to comply. Consequently, deterrence approach may result in adverse impact on compliance of regulatees.
Persuasion approach emerges from the notion that companies are willing to comply with rules, but they fail because of unreasonable regulations and lack of capacities issues (Kagan and Scholz, 1984; Black, 2001; Lodge and Wegrich, 2012). The other original idea behind persuasion approach is an acknowledgment of individuals and companies that they have a responsibility to avoid harm (May, 2005). There is strong assumption that most of the regulatees will comply with regulation due to their sense of duty instead because of
E. Efriani, Leiden University, 2017 20 regulation mandatory (May, 2005). The primary concern of persuasion approach is achieving regulatory objectives. Thus the aim of persuasion approach is not punishing regulatees but repairing harm and securing future compliance (Hawkins, 1984).
Persuasion approach brings regulatory responses to be more lenient. It promotes regulators to provide persuasion responses such as education, assistance, negotiation, and bargaining (Black, 2001). Negotiation and mediation are considered as major tools to improve compliance while legal punishments are saved for the last action (Lodge and Wegrich, 2012). Furthermore, persuasion approach builds openness between regulators and regulatees (Lodge and Wegrich, 2012). When regulators respond to non-compliance by giving advice and persuasion, companies do not mind to have an open conversation with agencies. Therefore, regulators can understand the complex operation in businesses and find the real problems in industries. The open conversation from regulatees cannot be obtained in one-off inspections using deterrence approach. For example, the persuasive approach adopted by Swedish agency in the workplace regulation is believed to be more effective than strict approach employed by the United States (Kelman, 1981).
Persuasion approach works by activating a sense of duty to comply (May, 2005). This sense of responsibility is a combination of moral obligation and the same needs or approaches to solving problems (Winter and May, 2001). One of the regulator's procedures in persuasion approach is the informational endeavor by giving an explanation regarding activities that may pose harm and how they contribute to the harms. The other technique is by suggesting one-on-one technical assistance. It helps firms to identify the harms and develop a solution on them. These approaches are expected to bring acceptance of the rules in the industries. However, the acceptance also depends on the quality of officials to what extent they are trusted and competent (Winter and May, 2002).
E. Efriani, Leiden University, 2017 21 However, persuasion approach poses some disadvantages. It has a tendency to degrade regulatory performance because companies may be less spirited to comply if offenders are not sanctioned (Lodge and Wegrich, 2012). Amoral calculators may also exploit the friendly approach to avoid the cost and get more profit. Hence, persuasion approach cannot offer a solution to improve obedience among amoral calculators.
2.6 Relational Distance
Discussion of relational distance mainly relates to the relationship between regulators and regulatees, including the individuals within the regulated firm. In this case, the main question is the impact of relationship between the related parties on the enforcement approach used. According to Black (1976), the relational distance may affect the number of law used in the enforcement; the larger the distance, the more law will be used.
There are several instruments that can be used to measure relational distance. Black (1976) suggested some of them including the scope, number of interaction and its duration, age of their relationship, and the nature and number of links between parties in the social network. For instance, some argue that the relational distance between regulators and regulated firms are lower compared to that between policemen and offenders. It is due to the different nature of the defiance. Reiss (1984) and Hawkins (1984) also suggested that little or no relationship between the offenders and the regulators will result in a more sanctioning strategy.
The study of Grabovsky and Braithwaite (1986) in Australian regulatory agencies tries to test relational distance theory. The study brings four hypotheses that are:
(i) Agencies with more staffs from regulated industries would prosecute less than those whose staffs are from elsewhere.
(ii) Agencies with fewer regulated firms would prosecute less than those with higher number of regulated firms.
E. Efriani, Leiden University, 2017 22 (iii) Agencies with homogenous regulated industries would prosecute less than those with
heterogeneous sectors
(iv) Agencies with more contact with regulated firms would use less formal sanctions than those with less contact.
The study result supports all the hypotheses except the first one. Other factors are also found to be relevant in reducing relational distance, such as shared professional experience (Hood et al. 2000, p. 60-65) and involvement in the same social community (Hutter, 1997).
2.7 Theoretical Argumentation
Risk-based regulation among regulators in many countries and sectors has obvious similarity; it puts the risk as its core analysis. Moreover, most of the agencies adopt risk-based regulation for similar reasons and set parallel risk-based frameworks. However, the challenges in the implementation of risk-based regulation allow the agencies to adapt it according to their own regulatory objectives, and political and social context. Thus despite the similarity of risk-based regulation across regulators, there is no two identical risk-based regulations (Black, 2005; Black and Baldwin 2010). Black (2005) mentioned that many regulators adopt risk-based regulation by learning from early adopters such as the Australian Prudential Regulation Authority’s risk-based regulation and they do modify the models. In some cases, regulators combine two models of risk-based regulation.
Risk-based regulation offers many choices of regulatory responses such as inspection, monitoring, audit, education and advice. Some regulators explicitly make link between risk categories and the regulatory responses such as in Australian Prudential Regulation Authority, De Nederlandsche Bank, and the Dutch environmental regulator while some do not (Black, 2010). Moreover, each regulator has different choices as shown in the food sector agencies that have implemented partial audits or inspections except for food sector regulators
E. Efriani, Leiden University, 2017 23 in the EU that just recently get partial audit or inspections as one of their regulatory responses (Black, 2010).
To be more specific, there are two major classifications in enforcement approach of non-compliance in risk-based regulation, namely deterrence approach and persuasion approach. There is no obvious evidences that show enforcement approaches in risk-based regulations are parallel. In addition, regarding the variation of risk-based frameworks and responses there is possibility that enforcement approach of non-compliance in risk-based regulation may be varied. Therefore, to examine the existence of the variation of enforcement approach of non-compliance in risk-based regulation, the following hypothesis has been developed:
H1: Enforcement approach of non-compliance in risk-based regulation is varied across regulators.
The variation of the enforcement approach of non-compliance in risk-based regulation may emerge because of many factors. Enforcement approach is related to legal framework. It may help to prompt or restrict responses to certain enforcement approaches but it is not a strong driving factor to determine the enforcement approach (Black, 2001). General rules that are vague in what is required and prohibited can create discretion for officers to interpret rules and negotiate responses of non-compliance. It can lead to imposition of lighter or tougher sanctions. On the other hand, precise rules provide clear standards and requirements for both regulators and regulatees leaving no room for interpretation and discretion. Therefore, this type of rules can hinder implementation of persuasive approach (Black, 1999). In addition, sanctions which are straight and clear such as fines close discretion for officers in choosing sanctions so it is preferable for the officers to impose penalty. It may be different when sanctions are available as an option; in this case officers have discretion and room to negotiate the sanctions. Hence, they will have more chance to apply persuasive approach.
E. Efriani, Leiden University, 2017 24 Discretion in legal framework then brings a question what is the other variable associated with enforcement approach. One variable associated significantly with enforcement strategies is the image of regulatees (Kagan & Scholz, 1984; Gunningham, 1987; Black 2001). If regulators perceive regulatees as amoral calculators, there is a tendency that the agencies take deterrence approach (Kagan & Scholz, 1984). Amoral calculators calculate the probability of detection, the magnitude of punishment, and the consistency of santions; hence, deterrence approach works to impose high cost of non-compliance to amoral calculators. In the case in which detection of non-compliance activities is low, deterrence approach will increase the magnitude of punishment (Lodge and Wegrich, 2012). An example of regulatory failure in Baryugil Mine case in Australia happened because the New South Wales Mines Inspectorate applied extreme persuasion approach while the company was rational calculators (Gunningham, 1987).
Regulators may not take deterrence approach but persuasion approach if they perceive the regulatees are political citizens and lack of capacities (Kagan &Scholz 1984; May, 2005). Political citizens are motivated by sense of duty so cooperation between agencies and industries will encourage regulatory compliance. The persuasion approach also involves the delegation of monitoring to the unit in the firm itself. The unit can be in the form of internal control, quality control, or environmental affairs department that monitors implementation of regulatory standards. For regulatees who lack of capacities, agencies are reluctant to punish violations. Instead, regulators choose an educational response to inform the regulatory problems and advise the latest technique to comply with the regulation (Kagan & Scholz, 1984). Regulators try to examine the causes of the violation to identify the limitation in the firm’s control system and show the cost-effective solution of complying with the regulation. Furthermore, regulators may also compel the company’s director to appoint high-level officers or qualified professionals to build and supervise compliance programs.
E. Efriani, Leiden University, 2017 25 Regulators may use the characterizations of regulatees as a basis to examine further what the motive behind the regulatees’ actions is, and identify appropriate enforcement strategies for certain characteristic (Kagan and Scholz, 1984; Black, 2001). Hawkins and Hutter (1993) found that inspectors of river pollution in England and Wales classified the companies into simple terms of bad and good companies. The inspectors considered pollution produced by bad companies as deliberate actions thus they tend to apply punishment than persuasive approach. It shows that perception of regulatees’ characteristics is associated with enforcement approach taken by regulators. Thus, the next hypothesis presented is:
H2: Image of regulatees is associated with the enforcement approach in risk-based regulation.
Enforcement approach is not only associated with image of regulatees but also related to interaction between regulatees and regulators (Black, 2001). The interaction involves frequency of interaction and the number of regulated industries supervised by regulators. Small number of regulatees and high frequency of communication or contact between regulatees and regulators means the interaction is intense while high number regulatees and less frequent interaction means the relational distance is far. According to the theory of relational distance by Black (1976), regulators tend to take formal actions in the condition of higher relational distance or less interaction between regulatees and regulator. In contrast, regulators that have close relation or intense interaction with regulatees tend to implement persuasion approach. Thus:
H3: Interaction between regulatees and regulator is associated with the enforcement approach in risk-based regulation.
E. Efriani, Leiden University, 2017 26
CHAPTER 3
RESEARCH DESIGN
This study takes qualitative approach and comparative case studies strategy. The qualitative approach can provide an in-depth description of interactions, actions, and events by understanding people’s perspectives, experiences, and histories (Snape & Spencer, 2003, p.22). It is in accordance with the objective of this study which is to explore perception of regulators on characteristic of regulatees and how the perception relates to enforcement approach. Furthermore, the qualitative approach allows the research to be done in its natural setting (Creswell, 2014). Thus this study can collect data in the circumstances where participants experience the subject under study and get close to the detailed answers of the research question.
3.1 Selection of cases-criteria
This research takes the comparative study of risk based regulation in Indonesia in two sectors, namely pension funds sector that is monitored by the Financial Service Authority (OJK) and customs sector that is supervised by the Directorate General of Customs and Excise (DGCE). Indonesia is chosen as one of developing countries that has significant reform of bureaucracy system in last decade and a large number of citizens and ethnic groups. It is unclear whether implementation of risk based regulation in developing countries that are mostly required by the international organization can result in the same outcomes found in developed countries or can be explained by existing theories. Thus selecting Indonesia as one of developing countries may add new empirical facts of risk based regulation, characteristic of regulatee and enforcement strategies. Indonesia is chosen partly also because it is the
E. Efriani, Leiden University, 2017 27 native country of the author, hence of personal interest to study. Moreover, data in Indonesia is accessible to identify that is necessary to make a convincing causal relation.
Risk based regulation is implemented in many sectors in Indonesia such as banking, insurance, food and environmental, pension funds, and customs sector. It will be comprehensive to explore more cases but regarding time limitation this study only takes two. Pension funds sector and customs sectors are chosen due to several reasons. First, pension funds sector and customs sector are two distinct industries thus companies who operated in both sectors are not connected. There is almost no influence from firms in pension funds sector to companies in customs sector and vice versa. Second, risk based regulation has been adopted by both the OJK and the DGCE more than five years. The risk based frameworks, outcomes, and understanding of risk based regulation among industries and officials have been consistent. Lastly, prior to supervision by the OJK in 2013, pension funds were regulated by Capital Market and Financial Institution Supervisory Agency. The OJK and Capital Market and Financial Institution Supervisory Agency were under the same ministry which is the Ministry of Finance.
3.2 Data Collection
The data for this study are collected through two methods which are documentations and interviews. Observation is not selected because enforcement strategies are irregular actions and cannot be scheduled during this study. However, documentation is considered as a useful source of information, particularly when situations or events cannot be investigated by direct observation or interviews (Ritchie, 2003, p.35). Interviews in this study are intended to get a full understanding of characteristic of regulatees in the officials’ perception and how it is linked to enforcement approach. Thus interviews are mainly used to gather perceptions of the
E. Efriani, Leiden University, 2017 28 characteristics of regulatees while documentations are used to describe elements of risk based regulation in the OJK and the DGCE.
Documentations used in this study are collected from many sources of information such as regulations, operational guidelines, annual reports, and socialization materials from the OJK and the DGCE. The information from documentations is used to provide the researcher with the fundamental background and guidelines to analyze enforcement approach adopted by the OJK and the DGCE. In particular, an issue generated from an analysis of relevant documentation can be used to direct proper interviews. Documentation is considered as a useful source of information that can further support other data collection methods for social research (Marshall & Rossman, 2006, p.107).
The interview was conducted to get perception, opinion, and implementation in field from point of view of respondents. Questions given to respondents include the aim and the implementation of risk-based regulation, regulatory goals, the clarity of regulations and the range of available sanctions. Respondents were also asked to identify dominant regulatory responses they use as well as accompanying reasons, capability of regulatees to comply and acceptance of regulatees towards regulations. The answers of respondents are pure opinions despite little improvement upon their translation into English.
Interviews are conducted with six supervisors of the OJK and six enforcement officers of the DGCE totaling twelve interviews. The details of participants are presented in table 3.1. It is important to have more than one participant from each regulator because answers from many participants can give broader picture and eliminate individual perception. The participants are selected using purposive sampling that they are chosen deliberately based on a theoretical framework that connects to the questions being addressed (Ritchie, Lewis & Elam, 2003, p.107). To get fair interviews, interviewed officials are picked from both management and operational levels. Interviews with management levels provide an overall
E. Efriani, Leiden University, 2017 29 picture of the policy or decision-making process on enforcement strategies and perceptions towards characteristics of regulatees. Interviews with operational levels are essential because they experience the actual situations and the practical supervisions and inspections to regulatees. The approach used in interviews is an in-depth semi-structured interview. It is suitable for this study because it is more flexible than a structured interview and more focused than an unstructured interview. Thus it can provide comprehensive and structured information of the central topic while also allows some spaces for exploration when new issues emerge (Wilson, 2013).
Table 1 Profiles of Respondents
Label Gender Age The latest Education Institution Working Years
R1 Male 30 Bachelor, Accountancy The OJK 6
R2 Female 37 Bachelor, Accountancy The OJK 14
R3 Female 33 Bachelor, Law The OJK 8
R4 Female 30 Bachelor, Accountancy The OJK 6
R5 Female 42 Bachelor, Mathematics The OJK 19
R6 Female 55 Master, Economics The OJK 26
R7 Male 34 Bachelor, Law The DGCE 12
R8 Male 32 Bachelor, Law The DGCE 10
R9 Male 35 Master, Law The DGCE 12
R10 Male 33 Master, Economics The DGCE 11
R11 Male 43 Bachelor, Law The DGCE 20
R12 Male 50 Bachelor, Law The DGCE 28
All respondents from the DGCE are men because 95% of enforcement officers are men while five participants from the OJK are women because women dominate the employee composition with percentage of 74%. Respondents of the DGCE have experience in the field
E. Efriani, Leiden University, 2017 30 of supervision more than 10 years, while only three respondents of the OJK have more than 10 years experience.
3.3 Data Analysis Method
Documentations used in this study are analyzed using thematic analysis. The dominant themes are sanctions available, and type of rules in the meaning of how precise and specific the requirements and standards set in the rules. The other themes are risk-based regulation and framework, and data of compliance.
Regarding interview analysis, literature provides some methods to be used. Interview analysis includes the processes of organizing and preparing the data, reading through all the data, coding the data, interpreting and developing thematic analysis, and presenting the research results (Creswell, 2014, p.206; Ritchie, Spencer & O’Connor, 2003, p.261). This study follows these processes; first, the author writes down the interviews then examines the interviews scripts and notes. The next step, the author codes the data according to topic guidelines and analyzes the results. The themes used to code are regulatory responses of non-compliance, perception of regulators towards reasons of violations, interaction between regulator and regulatees, and legal framework including sanctions available and type of rules. The last step is interpreting the data on the basis of the core concepts of the conceptual framework, and then summarizing and presenting the research findings.
3.4 Limitation
The first limitation in this study is data collection process. Author considers that the DGCE does not have same organization culture with the OJK because respondents from the OJK are more open to answer and discuss the questions. Respondents from the DGCE tend to answer by elaborating procedures that have been written, as oppose to telling their own experience. In addition, one of respondents from the DGCE did not respond whether he is willing to be
E. Efriani, Leiden University, 2017 31 respondent or not until the last day of data collection schedule thus author replaced him with other respondent from other enforcement unit in the DGCE.
The other limitation is small number of cases that can be researched. This study compares two cases, namely pension fund sector that is supervised by the OJK and customs sector that is overseen by the DGCE. This design is very simple and cannot isolate heterogeneous effects or complex relationship between the main explanatory variable and other variables. In this study, small number of cases cannot accommodate complex relationship among enforcement approaches, image of regulatees, and relational distance. In addition, as the study is a master thesis thus the time available is under six months.
E. Efriani, Leiden University, 2017 32
CHAPTER 4
RISK-BASED REGULATION AND LEGAL FRAMEWORK
This chapter starts with an introduction of the Indonesia Financial Service Agency (OJK) that regulates pension fund industry, the Directorate General of Customs and Excise (DGCE) which supervises import transactions, and the elements of risk based regulations both in the OJK and the DGCE. In addition, this chapter describes legal framework of rules that have to be obeyed by regulatees and the sanctions available for non-compliance in the OJK and the DGCE. The explanation is obtained from analysis of documents and transcripts of interviews.
4.1 Application of Risk-based Regulation
4.1.2 Risk-based regulation in the OJK
The OJK is a new regulatory agency that is established in 2013 as a merger of then bank supervisory function in the Central Bank with the Capital Market and Financial Institution Supervisor Agency (Bapepam-LK) that was located under the Ministry of Finance. It is an independent institution that regulates and supervises the financial services sector in Indonesia. The OJK functions as a host of integrated regulation and supervision over all activities in the financial services sector such as banking sector, the capital market, financial service institutions, as well as pension funds (OJK, 2015). Pension funds were supervised by the Bapepam-LK but since 2013 it has been regulated by the OJK.
Pension funds in Indonesia consist of two types of firms, namely Employer Pension Funds (EPF) and Financial Institution Pension Funds (FIPF). EPF is a Pension Fund voluntarily established or formed by an individual or entity that employs employees to provide defined benefit program or defined contribution program, for the benefit of partial or the whole employees. The establishment inflicts obligation toward the employer to allocate
E. Efriani, Leiden University, 2017 33 funds for pension program managed by pension funds. Generally, they are enterprises, educational institutions, or social foundations, e.g. the church or hospital. FIPF is a Pension Fund established by a bank or life insurance company to provide a defined contribution program for individual, either the employee or independent worker.
Since 2008 Bapepam-LK has applied risk-based supervision (RBS) in monitoring the operation of pension funds. The implementation is regulated in Bapepam-LK rule number PER-04/BL/2008 about Risk-based Supervision of Pension Fund. The main objective of the RBS is to assess the risk of pension funds that cannot fulfill the payment of retirement benefits so that the OJK can anticipate the failure of pension funds and its effect to industry. Moreover, RBS can envisage conditions of pension fund from financial and investment aspects thus helps the supervisors in reducing the time needed to do on-site examination because supervisors can focus examining activities that pose higher risk.
The RBS has two programs, namely Risk-based Rating (SPERIS) and Risk-based Monitoring System (SANBERRIS). SPERIS is applied to recognize the probability of failure of pension funds and impact of the failure to the entire of pension funds industry. Furthermore, it can help the OJK to discover the impact of the failure to other financial industries such as fund investment sector (Bapepam-LK, 2008). SANBERRIS is a system used to determine a regulatory response for each risk rating generated from SPERIS and to assure trustees, supervisory boards and founders of pension funds operate in controlled risk.
SPERIS performs analysis activities comprising of initial analysis, risk analysis, and special analysis. The initial analysis is performed toward all pension funds to calculate the initial risk level of pension funds by using financial data available in the Pension Fund Bureau database (Bapepam-LK, 2011). By using an application called basic analysis application, such data are processed and made to generate output in the form of a table of initial risk level. After initial risk level of pension funds is identified, risk analysis activity is
E. Efriani, Leiden University, 2017 34 then started to further measure the risk level of pension funds. Some of the pension funds are selected to be the object of risk analysis based on the output of initial risk analysis. While the special analysis is only conducted if there is special request beyond predetermined plan (Bapepam-LK, 2011).
In identifying the risks of a pension fund, SPERIS follows nine assessment modules which were revised in the OJK rule number 10/POJK.05/2014 about Assessment of Risk Level of Financial Institution. The modules are simplified into six, namely management, governance, asset and liability, strategy, operational, and funding modules. Particularly for FIPF, it is only assessed using five modules except for module of funding. Modules of asset and liability, strategy, and operational are assessed based on their inherent risk and management and control risk. Each module has value of risk with different weights, depending on the type of pension funds. The sum of all risk of the six modules is called total of risk. The total risk determines the probability of the pension fund to fail in paying the retirement benefits. It is classified into low, medium-low, medium-high, and very high.
Another important aspect in RBS is the impact of the risk to industry that is measured by the amount of assets of pension funds. There are four levels of impact, namely low, medium, high, and very high. Impact rating represents potential losses that could occur should the pension funds fail to meet its obligations to the participants. Potential disadvantages include not only direct financial impact to the participants of the pension fund but also the potential losses that will be experienced indirectly by the pension fund industry and the national financial sector. Currently, there are twelve pension funds out of 248 that have very high impact and the percentage their assets is 51.79% of total asset in industry
The supervision strategy in risk based supervision is expected to be more consistent because SANBERRIS counts the total risk and impact level to determine the appropriate supervision strategy. Pension funds in the same level of total risk and impact will get the
E. Efriani, Leiden University, 2017 35 same intensity of supervision. SANBERRIS classifies pension funds into four types of supervisory status, namely normal monitoring, intensive monitoring, mandated improvement, and restructuring. Pension funds with normal monitoring status are those that have good reporting record and well-managed investment. The pension funds are considered enough to be supervised using regular reports and on-site examination every three or four years. Towards pension funds categorized in intensive monitoring the OJK conducts intensive examination to find their problems. Supervisors may find that the problematic aspect is the funding or asset and liability of the pension fund thus the monitoring will be focused on that aspect. The OJK can monitor through routinely meeting with pension funds and reports of actions that have been taken by pension funds. Pension funds in mandated improvement status are unhealthy pension funds thus the OJK should take remedy action e.g. inquiring improvement plan from pension funds. If the pension funds have been in mandated improvement for a year but there is no improvement, the OJK can liquidate the pension funds. Restructuring status shows that the pension funds are in serious unhealthy conditions that almost late to be cure.
SANBERRIS is also used to decide whether on-site examination is needed for pension funds. The on-site examination plan is arranged at the beginning of the year. Considerations that are used in determining pension funds to be examined are the specific risk level, the size of assets, the complexity of its investment, the time elapsed since its last examination, and its inclusion in last year’s examination list (Bapepam-LK, 2011). Based on the on-site examination reports completed in 2011, the average risk level of pension funds examined was qualitatively at a medium level. According to the modules, the risks with highest average level were the operational risk and asset management risk, while the lowest average level were design and strategy risk and contribution risk. Certain findings related to the operational risk were found in the form of pension fund management and control
E. Efriani, Leiden University, 2017 36 weaknesses, such as unarranged organization structure and job description, improper Standard Operating Procedure, unavailability of Disaster Recovery Plan, and weak data processing system. While findings related to asset management risk were weak prudential principles in the investment activities, the lack of proper study for investment activities, unavailability of risk management guidelines, and unsatisfying subsidiary company performance (Bapepam-LK, 2011).
4.1.2 Risk-based regulation in the DGCE
The DGCE is a regulatory agency under the Ministry of Finance. Its principal task is to carry out the policies of the Ministry of Finance in the area of customs and excise including performing government policy related to goods entering or exiting Indonesia and the collection of import duties and excise. To conduct its tasks, the DGCE has a function to plan, implement, control, and evaluate technical operations of government policies related to supervision of traffic on goods entering or leaving the customs area (DGCE, 2013).
Supervision of import transactions is known as customs clearance. Customs clearance can be defined as customs formal procedures of examination before allowing goods enter or leave the country. The DGCE monitors compliance of importers doing self-assessment of import duty and obeying regulations of prohibited and restricted goods. Each import transaction is assessed based on the collection of extensive documentation and physical inspection of the goods. In fact, it is almost impossible for the DGCE to conduct examinations to all import transactions. Therefore, DGCE uses risk-based regulation that is called risk management as an instrument to reach efficient examinations.
Risk management emerges because international trading volume is getting bigger and almost all international customs have adopted the risk management. The latest rules that regulate risk management are the Ministry of Finance rule number 139/PMK.04/2017, the
