Banking moral hazard

The closure of two small banks -- Denpasar-based PT Bank Dagang Bali (BDB), owned by I Gusti Made Oka, and Jakarta-based Bank Asiatic, owned by Tong Muk Keung -- by Bank Indonesia on Thursday due to insolvency is not likely to cause a major panic. Nor will the drastic measure damage the public's trust in the banking industry, which will contribute to facilitating an orderly exit of the banks from the financial system.

With combined liabilities of only Rp 3.4 trillion (US$400 million) and third party deposits of Rp 2.2 trillion the closure of the family-owned banks do not pose a risk on the stability of the banking industry, which had a total asset of Rp 1,115.6 trillion (US$131.5 billion) as of January.

As the government's blanket guarantee on deposits and claims remains effective at least until next January, depositors can relax and wait for the reimbursement of their savings.

Nevertheless, it is still mind boggling to learn from Bank Indonesia's press statement as to how brazenly the two families had been robbing their own banks through related party lending, fabrication of asset records and fictitious credit records.

It is also shocking to learn that the two banks had been used as nothing more than the treasuries of the controlling families' businesses.

The fact that the two families are also related by marriage -- Made Oka's son to Tong's daughter -- only made conditions perfect for collusion. All they needed to do was simply throw the principles of good governance and prudential banking regulations out of the window.

Bank Indonesia said it had placed the two banks under special scrutiny for the past year and had provided technical guidance and assistance to improve their performance, but to no avail.

Bank analysts also revealed how Bank Asiatic had been engaged in go-go lending over the past year, expanding its loan portfolio by sixfold, while its deposit base growth was moderate at best.

The insolvency of the banks and the bad banking practices that caused their failure demonstrate, once again, that the banking industry -- still reeling from the devastating 1997-1999 banking crisis -- remains vulnerable to mismanagement and fraud.

Made Oka and Tong should have known that their behind-the- scenes wrangling would not go undetected by Bank Indonesia, which has steadily improved the integrity and capability of its bank supervision department after the outbreak of the banking crisis.

That the two families still deigned to abuse funds in their banks shows a high degree of moral hazard within the banking industry, which comes as no surprise because almost none of the big bank owners who were directly or indirectly responsible for the country's 1997 economic crisis have been incarcerated.

Bank Indonesia's closure of the two banks should be welcomed as the right move to clean the industry of bad banks and bad bankers. However, it is still too early to judge as to whether the draconian measure had been timely or whether it should have been taken much earlier.

Further developments in the handling of the two defunct banks over the next few weeks also will tell us as to whether the central bank's supervision mechanism is capable of providing an early warning on the condition of each of the remaining 136 commercial banks.

We could say the supervision mechanism had been fairly effective if the government is able eventually to recoup a good portion of the Rp 2.2 trillion -- which the finance ministry will likely need to draw from the emergency fund to reimburse depositors of the closed banks under the blanket guarantee program.

It is a comfort to learn that the central bank had taken precautionary legal recourse against the directors and owners of the banks and their personal assets before it finally revoked their licenses.

This means that litigation against the banks' directors and owners and foreclosing their personal assets is likely to proceed smoothly, as none of those suspected of being directly responsible for the banks' failure have disappeared or fled overseas.

Learning from the bitter experiences of the 1997-1999 banking crisis, however, the finance ministry and Bank Indonesia should be extremely careful in assessing the eligibility of deposits and claims to reimbursement under the blanket guarantee.

In addition, to minimize moral hazard, the government should see to it that the shareholders of the closed banks lose every last cent of their investment -- so that they bear the full brunt of their failure before taxpayers are burdened with even part of their losses.

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