Banking moral hazard

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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