Bank Indonesia: Hunting for mice!

John Le, Jakarta

From the viewpoint of the regulators, there are the good banks, and there are the bad banks.

The latest Bank Indonesia's (BI) effort of going after the bad ones, especially the bad foreign banks that have been speculating on the Indonesian rupiah (IDR) via the swap market is admirable but impractical, thanks to its take-no-prisoner approach.

It comes in the form of regulation 6/20/PBI/2004 signed into law on July 15, 2004.

The regulation redefines the net open position (or NOP) as the absolute value of on-balance sheet to be less than 20 percent of capital. On top of that, the sum of absolute on-balance sheet and absolute off-balance sheet to be no more than 20 percent of the capital.

In layman's term, this new regulation stifles onshore banks' ability to support engineered swap commonly done by offshore parties who trade on the IDR.

By law, offshore parties cannot buy U.S. dollar in the swap market; hence they resort to buy dollar spot, which values in two days, from an onshore party. Next, they would sell the dollar at its value as of tomorrow (or "tom" in bankers' terminology), which values in one day, and buy dollar spot from different onshore parties. Positions are kept rolling over until they are squared off for profits.

In effect, this is just another short-term swap structure allowing offshore players access to purchasing dollar against IDR, without legal repercussion.

If the aim is to reduce offshore influence on the IDR by forcing the local players to avoid swaps and engineered swap positions, then the BI has partially succeeded. Local players must now be extra careful in watching the spot leg of the engineered swaps from maturing.

The negative implications, however, are enormous and worrisome for a country that is still trying to establish itself as a market friendly environment to do business.

For starter, this regulation has in essence shut down the overnight (O/N) swap market as one of the main instruments of liquidity management, arguably the most critical function of a bank.

With a money market flooded with IDR and dollar liquidity, a lackluster corporate loan environment, and risky government assets, there are not a lot of good choices to place the IDR or dollar.

Basic onshore transactions involving banks swapping their dollar to IDR and use the IDR to invest in local government assets are viewed as disadvantageous. Banks would then be forced to look beyond Indonesia's border to unload their dollar deposits.

Conversely, onshore banks, mostly local, with IDR liquidity cannot swap to dollar to fund their dollar assets.

This, in effect, kills the once vibrant swap arbitrage market with O/N volume in excess of US$1 billion per month.

Corporate clients are also not immune to this regulation. Corporations whose foreign exchange needs for cash value the same day used to be able to get their cash immediately because banks are able to square off positions using swap without incurring NOP.

With the new regulation, banks would have to tell their corporate clients to come back in a few days to receive the cash because squaring against the swap market will incur NOP for both on and off-balance sheet.

Thus, there is no rationale to giving the money to the clients immediately.

Enough said, if BI is going after offshore speculators, then it should go after them selectively. Recent issuance of warnings to those onshore branches of foreign banks shows good disciplinary action.

Better yet, BI should impose this draconian NOP rule only on those wrongdoers instead of punishing all market players.

This approach of burning down the hut to hunt for mice clearly does not bode well to the future of the Indonesian market and to those who are trying to develop it.

The writer is a financial market analyst working for a multinational firm in Jakarta.