Emergency liquidity loans<\/p>\n
We greatly welcome the government's effort to draw a clear-cut
\nagreement with Bank Indonesia on the definition of the central
\nbank's role as lender of last resort to the banking industry.<\/p>\n
The government, Bank Indonesia and the House of
\nRepresentatives should indeed learn carefully from the 1997 to
\n1999 banking crisis, to prevent a protracted dispute over which
\nbanks are eligible for emergency liquidity support from the
\ncentral bank and which should be allowed to go under.<\/p>\n
Their wrangle over the sharing of the costs of the banking
\ncrisis, which was resolved only last August, indicates how
\nimperative and urgent is now the need for clear-cut rules and
\nprocedures for the extension of liquidity credit by Bank
\nIndonesia to commercial banks in financial distress.<\/p>\n
The recent amendment of the law on Bank Indonesia, which
\nstrengthened the function of the central bank as lender of last
\nresort to the banking industry, has removed the uncertainty
\nregarding contingency programs to bail out banks facing severe
\nliquidity crises.<\/p>\n
But this stronger mandate should be based on higher standards
\nof accountability; that requires clear-cut rules on the extension
\nof emergency liquidity support to prevent the recurrence of
\nprotracted disputes such as those that took place between 1998
\nand 2003.<\/p>\n
The central bank's role as lender of last resort requires it
\nto provide promptly temporary support to illiquid banks to
\nprevent panic and massive runs that could lead sound institutions
\nto financial distress and consequently precipitate their
\ninsolvency.<\/p>\n
This was what Bank Indonesia did between late 1997 and early
\n1999 when the public lost trust in the banking industry. But the
\nabsence of clear-cut procedures and rules for such emergency
\nsupport and inadequate banking supervision made the bailout
\nprogram highly vulnerable to abuse.<\/p>\n
The basic rules of such emergency liquidity support stipulate
\nthat the central bank help only illiquid banks but not insolvent
\nones and that the loans be secured by adequate collateral.<\/p>\n
However, as the bitter experiences in 1997 to 1999 clearly
\nshow, the central bank found it extremely difficult to
\ndistinguish an illiquid bank from an insolvent one, especially
\nduring the height of the crisis. The panicky situation made it
\nwell-nigh impossible for the central bank to verify each of the
\nthousands of clearing transactions it conducted daily with
\ncommercial banks.<\/p>\n
The problems were made even worse because before May 1999 the
\ncentral bank was part of the government and was thus highly
\nvulnerable to cronyism and corruption. As the Supreme Audit
\nAgency discovered in 2000, many commercial banks misused the huge
\nsupport loans they received from the central bank.<\/p>\n
As Bank Indonesia has been politically independent since mid-
\n1999 it is no longer vulnerable to intervention from vested
\ninterests within the government or the House. But this autonomy
\nalone is not sufficient to prevent misuse of emergency liquidity
\nloans. There are at least two other conditions needed to
\nsafeguard the bailout program.<\/p>\n
First, as earlier suggested, the finance ministry, Bank
\nIndonesia and the House should formulate clear-cut rules and
\nprocedures for the extension of such emergency loans, covering
\nbasic requirements, step-by-step procedures for disbursement,
\nsecurity to back up such loans and tenure.<\/p>\n
The other requirement is that the central bank should further
\nstrengthen the capability of its bank supervision system to keep
\nit adequately informed on the up-to-date situation with regard to
\nall commercial banks. Effective supervision will enable the
\ncentral bank to distinguish illiquid from insolvent banks,
\nthereby preventing the misuse of its emergency liquidity support.<\/p>\n
__________<\/p>", "url": "https:\/\/jawawa.id\/newsitem\/emergency-liquidity-loans-1447893297", "image": "" }, "sponsor": "Okusi Associates", "sponsor_url": "https:\/\/okusiassociates.com" }