Bailing out Bank Indonesia

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.