Part 1 of 2: Banking system amid the risk of currency crisis<\/p>\n
Ross H. McLeod, Canberra<\/p>\n
The government bailout of the banking system during the
\neconomic crisis of 1997-1999 burdened the Indonesian people with
\nadditional net debt of around US$50 billion, which will take
\ndecades to repay. With the sudden and disturbing gyrations of the
\nrupiah in recent days it seems timely to ask whether the banking
\nsystem is now capable of withstanding a similar currency crisis.<\/p>\n
In the last month of the Megawati Soekarnoputri government in
\nJuly, 2001, the House of Representatives (DPR) enacted Law
\n24\/2004 on the Deposit Guarantee Institution, commonly known by
\nits Indonesian acronym, LPS (Lembaga Penjamin Simpanan). The law
\nprovides the basis for establishment of the LPS, the function of
\nwhich is to guarantee bank customers' deposits, and actively to
\nprotect the stability of the banking system.<\/p>\n
Rather than seeking to avoid the policy mistakes that
\ngenerated the last financial disaster, however, the new
\nlegislation writes almost identical responses into law.<\/p>\n
The institution is intended to fulfill its functions in either
\nof two ways: By reimbursing depositors up to a certain monetary
\nlimit if their bank fails and is liquidated, or alternatively, by
\ninjecting new capital into troubled banks in order to
\nrehabilitate, rather than liquidate, them.<\/p>\n
Beyond the residual value of failed banks' assets, the funds
\nneeded by LPS in order to reimburse depositors or to inject new
\ncapital are drawn from three sources: First, a reserve that is
\nbuilt up from premium payments by the banks; then, if necessary,
\nfrom its own capital; and ultimately -- if the LPS itself becomes
\ninsolvent -- from new injections of capital to its own balance
\nsheet by the government.<\/p>\n
These new arrangements are intended to replace the existing
\nblanket guarantee of bank liabilities that was introduced in
\nJanuary 1998, at the peak of the last economic and financial
\ncrisis. It took almost seven years to enact this new legislation,
\nand it will be March next year before the blanket guarantee will
\nbegin to be wound back. Even then, this will be done in stages at
\nsix monthly intervals -- at first reducing the guarantee from
\n100 percent of all deposits to a limit of Rp 5 billion, then to
\nRp 1 billion, and finally to Rp 100 million.<\/p>\n
The size of deposits guaranteed can be increased in the future
\nin certain circumstances, however. First, the limiting amount can
\nbe adjusted from time to time in line with inflation. Second, the
\nlimit can be reset at any time in order that it will allow for
\n100 percent guarantee cover to at least 90 percent of all bank
\ndepositors. Third, and most importantly, the size limit for 100
\npercent coverage can be increased if there is a rush to withdraw
\nfunds from the banking system.<\/p>\n
The scheme is quite straightforward in the case of the failure
\nof individual, small banks -- that is, banks that are a
\nnegligibly small component of the banking system overall. In this
\ncase, upon being notified by Bank Indonesia (which is responsible
\nfor bank supervision) of the likely failure of the bank in
\nquestion, the LPS is required to choose between rehabilitation or
\nliquidation, with this choice determined by which option involves
\nthe least cost to itself.<\/p>\n
Rehabilitation will involve the injection of sufficient equity
\nto cover accumulated losses (in excess of shareholders' funds)
\nand restore at least the minimum capital adequacy ratio (CAR)
\nrequirement, making the LPS the new owner of the bank, which it
\nis obliged to sell within a period of six years.<\/p>\n
Liquidation, on the other hand, involves immediate closure of
\nthe bank, followed by the sale of its assets, the proceeds of
\nwhich are used to cover as much as possible of the expense of
\nreimbursing the small depositors. The LPS then meets any
\ndeficiency. If there are funds left over after meeting these
\ncosts and meeting the claims of the former employees of the bank
\nfor unpaid salaries and severance entitlements, the remainder is
\nreturned to other depositors in proportion to their share of
\ntotal non-guaranteed deposits at the time the bank was closed.<\/p>\n
Provided the losses accumulated by these banks are small
\nenough, the LPS will be able to meet such expenses out of its
\naccumulated premium income and investment earnings. Indeed, if
\nthere are sufficient non-guaranteed deposits to absorb the bank's
\nentire losses, the LPS will incur no expense at all -- in sharp
\ncontrast to the rehabilitation option, in which the bank's
\naccumulated losses are transferred to LPS. The guarantee
\ninstitution will therefore have a strong incentive to close
\nrather than rehabilitate banks, with all the social costs of job
\nlosses and wastage of bank-specific investments this implies.<\/p>\n
The more important case, however, is that of the failure of
\nlarge banks or multiple banks, to which we shall return in Part
\nII. Is the banking system ready for the next currency crisis?<\/p>\n
The writer is Editor, Bulletin of Indonesian Economic Studies,
\nAustralian National University, Canberra.<\/p>",
"url": "https:\/\/jawawa.id\/newsitem\/part-1-of-2-banking-system-amid-the-risk-of-currency-crisis-1447893297",
"image": ""
},
"sponsor": "Okusi Associates",
"sponsor_url": "https:\/\/okusiassociates.com"
}