The pitfalls of guarantee<\/p>\n
The guarantee provided by the Indonesian government to all
\ndepositors and creditors at locally incorporated commercial banks
\nsince late January 1998 should be hailed as the government's most
\nstrategic move to restore public confidence in the banking
\nsystem. Without the blanket guarantee for both rupiah and foreign
\ncurrency claims, runs on banks set off by the closure of 16 banks
\nin November 1997 would have destroyed the industry.<\/p>\n
We only can imagine the chaos and panic which would have
\nerupted after the closure of 38 insolvent banks on March 13 if
\nthere was no government assurance that all depositors and
\ncreditors at the liquidated banks would be fully reimbursed.<\/p>\n
Even now, it is this guarantee that provides people the
\nconfidence to continue to deposit their money in domestic banks,
\neven though most banks -- and all the largest banks -- are
\noperating with negative capital.<\/p>\n
However, more than one year after the introduction of the
\nguarantee, we can see how costly the scheme has been to
\ntaxpayers. The recent closure of the 38 banks will cost taxpayers
\nat least Rp 50 trillion (US$5.8 billion), the estimated amount
\nneeded to reimburse the liquidated banks' depositors and
\ncreditors. Several trillion rupiah more is needed for severance
\npay for laid-off bank employees. Given the poor quality of the
\nliquidated banks' assets and the dire economic condition the
\ncountry faces until at least 2000, only a fraction of taxpayers'
\nmoney will eventually be recouped from the sale of the liquidated
\nbanks' assets. An additional Rp 21 trillion also will have to be
\nspent bailing out nine major private banks, plus some Rp 150
\ntrillion will be needed to revive state banks. And another
\nseveral trillion rupiah will be spent recapitalizing the seven
\ninsolvent private banks the government decided to take over.<\/p>\n
One could argue that the cost is justified because an economy
\ncannot run without a functioning banking system. Moreover, the
\nbanking problem should not be blamed entirely on banks'
\nmanagement and owners, but also on the country's economic woes,
\nparticularly the meltdown of the rupiah.<\/p>\n
Nonetheless, we wonder whether the government's guarantee,
\nwith its overall coverage for both depositors and creditors, can
\nbe sustained without entirely destroying market discipline and
\nproviding more leeway for crooks to plunder state funds.<\/p>\n
To our knowledge, no other government in the world provides a
\nblanket guarantee for claims on banks without any ceiling on the
\namount of deposits and without restricting the classes of
\ncreditors covered by the guarantee.<\/p>\n
Financial data from the 38 liquidated banks show the pitfalls
\nproduced by the blanket guarantee have not only enhanced moral
\nhazards in the industry, but also have led to the wastage of
\ntaxpayers' money because insolvent banks left behind mostly
\nworthless assets.<\/p>\n
Perusing financial data from the 38 liquidated banks, one can
\nsee, for example, several banks lent up to several hundred
\npercent more than their third-party deposits, while prudence
\ndictates limiting total lendings to a maximum of 110 percent of
\ndeposits. Several other banks owed the central bank as much as 20
\npercent more than their total gross assets. A number of banks
\nowed other banks (interbank debts) as much as 45 percent of their
\ntotal assets. Numerous other anomalies can be found in the
\nfinancial sheets of the liquidated banks. We believe these
\nanomalies could have occurred only because of the moral hazards
\ncreated by the government's blanket guarantee and the inadequate
\ntechnical competence and questionable integrity of the central
\nbank's supervisors.<\/p>\n
Our point is that by maintaining the blanket guarantee without
\nany ceiling on the amount of deposits and without restricting the
\nclass of creditors covered by the guarantee, the government risks
\nwasting more of the taxpayers' money at the expense of market
\ndiscipline, which is needed to force banks to remain prudent and
\ncompetitive.<\/p>\n
It is therefore time to rework the guarantee. True, setting a
\nceiling on deposits covered by the guarantee now, when the
\npublic's trust in the banking system is still shaky, could be
\ncounterproductive, at least until a self-financing deposit
\ninsurance scheme is in place. But we do not see any risks in
\nimmediately eliminating the guarantee's coverage of interbank
\ncredits. After all, bankers should be qualified to assess the
\ncondition of other banks -- their competitors. If bankers are not
\nable to assess which banks are sound enough to receive interbank
\nloans, let them lose their shirts. Excluding interbank loans from
\nthe guarantee will force tough market discipline on banks,
\nthereby making bank closures more expeditious. Such a measure
\nalso will sharply cut the potential loss of taxpayers' money in
\nfuture bank closures, which we believe are highly probable.<\/p>",
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