RI needs deposit insurance system<\/p>\n
By Sumitro<\/p>\n
The government has pledged not to liquidate any more banks and
\nwhen announcing the new economic measure last Thursday President
\nSoeharto said that the government will set up a deposit insurance
\nscheme if necessary. The following article deals with this topic
\nderiving from the American experience. This is the first of two
\narticles.<\/p>\n
SINGAPORE (JP): Governments have long recognized that they
\nhave a responsibility to maintain stability and liquidity in the
\nfinancial markets. A case in point is when the Bank of England
\nplayed an essential \"rescue\" role by buying 4.2 million pounds
\nsterling of the stock of the collapsed South Sea Company when
\nspeculative mania in that government-sponsored enterprise
\ncollapsed in the year 1720.<\/p>\n
Fast forwarding to recent time in Indonesia, the closure of 16
\ncommercial banks prompted professionals in the banking industry
\nto voice their concern and hope for a formal structure and clear
\nmechanism to be put in place for the resolving of domestic
\nbanking insolvencies. This concern is well understood because
\nstability and public confidence in the nation's banking systems
\nis of utmost important to finance economic growth.<\/p>\n
Although the size and effects of the closure of the banks in
\nIndonesia are not comparable to the banking collapse in the
\nUnited States in the 1930s, it is worth noting the lessons
\nlearned from the U.S. experience so as to prevent future banking
\ncrises in Indonesia.<\/p>\n
This article attempts to provide a flashback on the world's
\noldest system of national deposit insurance. Since the system was
\ncreated in the United States, all of the examples here come from
\nAmerican experience.<\/p>\n
I will start with bank liquidity problems as the root of a
\nbanking crisis and then will elaborate more on the deposit
\ninsurance system of the United States. Just like any other bank,
\nthe deposit insurance could itself become insolvent. The last
\nportion of the article is dedicated to avoidance of such
\ninsolvencies.<\/p>\n
A bank liquidity problem can arise on either the asset side or
\nthe liability side. A problem on the liability side arises
\nwhenever the holders of a bank's liability, such as the
\ndepositors, seek to cash in their financial claims immediately.<\/p>\n
When this happens, the bank must either borrow additional
\nfunds or sell off assets to meet the withdrawals. The most liquid
\nasset of all is cash. However, banks tend to minimize assets of
\ncash reserve holdings because they pay no interest. To generate
\ninterest revenues, most banks invest in less liquid assets and in
\nthose with longer maturity.<\/p>\n
While most assets can be turned into cash eventually, it will
\nbe very costly if they must be liquidated immediately. The price
\nthe holder of the assets has to accept may be far less than if
\nthere was little urgency in the sale and a longer period over
\nwhich to negotiate it. Hence, the value of the assets may not be
\nenough to cover the liability claims.<\/p>\n
The second source of liquidity problems arises on the assets
\nside as a result of lending commitments. A lending commitment
\nallows a borrower to take down funds from a bank on demand. When
\nthe loan is taken down, the bank has to fund its balance sheets
\nimmediately; this creates a demand for liquidity. As with
\nliability withdrawals, a bank can meet such liquidity either by
\nrunning down its cash assets, selling off other liquid assets or
\nborrowing additional funds.<\/p>\n
Under normal conditions, net deposit withdrawals or the
\nexercise of loan commitments pose few liquidity problems for
\nbanks because borrowed fund availability or excess cash reserves
\nare adequate to meet anticipated needs. In America, for example,
\nduring December and the summer vacation season when deposit net
\nwithdrawals are high, banks anticipate these seasonal effects
\nthrough holding larger than normal cash reserves or borrowing
\nmore than normal on the wholesale money markets.<\/p>\n
Major liquidity problems can arise, however, if deposit drains
\nare abnormally large and unexpected. As depositors begin
\nwithdrawing their cash in amounts larger than banks can sustain,
\nbank operations are suspended and the country may declare a
\nmoratoria on bank transactions. Such deposit withdrawal shocks
\nmay occur for a number of reasons:<\/p>\n
1. Concerns about a bank's solvency relative to other
\nbanks.<\/p>\n
2. Failure of other banks leading to heightened depositor
\nconcerns about bank solvency generally (contagion effect).<\/p>\n
3. Sudden changes in investor preferences regarding holding
\nnon-bank financial assets (such as T-bills) relative to deposits.<\/p>\n
In the past, such behavior by depositors was not irrational.
\nThey had learned from hard experience that if they kept their
\nmoney in a bank it might not be available when they needed it,
\nand they could also lose a large portion of it. In general
\npractice, depositors were treated in the same way as other
\ncreditors -- they received funds from the liquidation of the
\nbank's assets after those assets were liquidated.<\/p>\n
Before the creation of deposit insurance, the time taken to
\nliquidate a failed bank's assets, pay the depositors, and close
\nthe books averaged about six years. Given the long delays in
\nreceiving any money and significant reduction in deposits when
\nbanks failed, it was understandable why anxious depositors would
\nwithdraw their savings at any hint of trouble.<\/p>\n
The Great Depression of the late 1920s and early 1930s caused
\nfinancial chaos in America. More than 9,000 banks closed between
\nthe stock market crash of October 1929 and March of 1933. For all
\npractical purposes, the U.S. banking system shut down completely
\neven before President Roosevelt declared a \"banking holiday\", and
\nsuspended all banking activities until stability could be
\nrestored.<\/p>\n
Among the actions taken by Congress to bring order to the
\nsystem was the creation of the Federal Deposit Insurance
\nCorporation (FDIC) in June 1933. Congress created the FDIC with
\nspecial powers to adjudicate failed banks. The government,
\nthrough the FDIC, guarantees that customers' funds, within
\ncertain limits, are safe and available to them on demand.<\/p>\n
Federal deposit insurance coverage is limited to deposits, and
\ndoes not include securities, mutual funds or similar types of
\ninvestments that may be offered for sale at FDIC-insured banks.
\nThe original level of individual insurance coverage at commercial
\nbanks was US$2,500 which in 1980 was increased to $100,000.
\nSavings, checking and other deposit accounts, when combined, are
\ngenerally insured up to $100,000 per depositor per bank or
\nfinancial institution insured by the FDIC. Deposits held in
\ndifferent ownership categories, such as single or joint accounts,
\nare separately insured.<\/p>\n
Wealthy investors and institutions can employ deposit brokers
\nto spread their funds over many banks up to the permitted cap of
\n$100,000. To cover all their deposits in this way, they could
\nhire a deposit broker such as Merrill Lynch to split $10 million
\ninto 100 parcels of $100,000 and deposit those funds at 100
\ndifferent banks.<\/p>\n
The writer works and resides in Singapore.<\/p>\n
Window A: Under normal conditions, net deposit withdrawals or the
\nexercise of loan commitments pose few liquidity problems for
\nbanks because borrowed fund availability or excess cash reserves
\nare adequate to meet anticipated needs.<\/p>\n
Window B: Given the long delays in receiving any money and
\nsignificant reduction in deposits when banks failed, it was
\nunderstandable why anxious depositors would withdraw their savings
\nat any hint of trouble.<\/p>",
"url": "https:\/\/jawawa.id\/newsitem\/ri-needs-deposit-insurance-system-1447893297",
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