Bailing out Bank Indonesia

Bank Indonesia, the central bank, which holds the monopoly over fiat money and which in 1997 and 1998 bailed out dozens of commercial banks, has officially been declared insolvent, itself requiring a bailout capital to the tune of several billion dollars.

How could this absurd condition befall an institution that issues money, generates revenues from clearing, gets interest- free deposit reserves from commercial banks and collects income from various other central banking services? That is surely unimaginable to economics students because such a dire possibility is rarely mentioned in money and banking textbooks.

However mind-boggling the fact may seem, that is surely part of the enormous cost of the economic crisis left behind by the previous corruption-infested governments that has to be borne by Indonesian taxpayers. No technical mistakes could have incurred so big a loss, however collectively incompetent the central bank's board of governors might be.

Central banking is supposed to be a great business. Even its function as the lender of last resort to commercial banks, which has been blamed as the main cause of Bank Indonesia's big losses, should have racked up big revenues as emergency liquidity credits can by law only be given to illiquid, yet solvent banks, at a penalty interest rate on the back of adequate collateral.

But, as an investigative audit by the Supreme Audit Agency found last year, about Rp 138 trillion (US$15.1 billion) out of the Rp 144.5 trillion in emergency credits extended by Bank Indonesia to commercial banks between late 1997 and early 1999 would not be able to be recovered. The auditors discovered that most of the credits had not adequately been backed up by collateral, as required by law. Worse still, quite a portion of the emergency loans, supposed to be used to reimburse depositors during the massive runs on banks, had been misused by the recipient bankers for currency speculation or lending to their affiliate businesses.

The findings of the auditors prompted the government (finance ministry) not to recognize the allegedly misused Rp 138 trillion of the emergency credits as its debts, threatening to withdraw the treasury bonds equivalent to that sum it has issued to the central bank. This row has placed the legal status of the assets now held and managed by the Indonesian Bank Restructuring Agency, a unit of the finance ministry, in great doubt as Bank Indonesia in turn has threatened to take back all the bank loans and assets (collateral) from closed and nationalized banks it had transferred to the agency.

It is this dispute that is about to be settled once and for all on Friday after the central bank, the House of Representatives and government complete more than five weeks of negotiations to determine how Bank Indonesia and the government will share the Rp 144.5 trillion spending.

Some legislators who took part in the negotiations put the cost of the central bank's recapitalization at Rp 86 trillion ($9.30 billion) but the central bank's acting governor Anwar Nasution said it would be much less or just around Rp 24 trillion, depending on how much of the credits could be recovered.

Whichever amount is finally agreed upon, Bank Indonesia's equity capital will become negative and will either have to be liquidated or recapitalized. Given the devastating repercussions of liquidation, the government has chosen the recapitalization alternative. After all, the Rp 144.5 trillion in emergency loans has been paid with treasury bonds and the bond interest cost has been included in the 2001 state budget currently under House deliberation.

But the recapitalization measure will provide an opportunity for the government to reshuffle the Bank Indonesia board of governors, a job it should have done before Bank Indonesia became, by virtue of a new central bank law, a politically independent institution in May 1999.

Except for Senior Deputy Governor Anwar Nasution, who joined the central bank after passing a fit-and-proper test by the House in July last year, other members of the board of governors, including Governor Sjahril Sabirin who is now under house arrest while awaiting trial for alleged involvement in the Bank Bali scandal, were responsible for extending the controversial emergency liquidity credits.

True, the central bank law does not allow the government to dismiss the governor or deputy governors, except when they are proven guilty of crimes. But Bank Indonesia's insolvency should prompt the whole board of governors to resign en masse if they are truly central bankers of high integrity who uphold high ethical and moral standards.

The recapitalization measure should not, however, slacken the investigations by the Attorney General's Office into bankers and the central bank's executives implicated in the misuse of the emergency liquidity credits.