Bond issuance may cause crowding out

Commercial banks need Rp 155 trillion (US$19.37 billion) of fresh funds to bail them out of runs by depositors. Economist Kwik Kian Gie discusses the impacts of the cash shortage.

Question: Bank Indonesia, the central bank, has injected Rp 80 trillion in liquidity credits to 54 unhealthy commercial banks. Do you think that such financial assistance is acceptable?

Kwik: It is acceptable because the proper functioning of the banking industry is vital to the country's economic survival. The 54 banks have been run in such a flawed way that they need that much money to help them survive a run by depositors. They will even need another Rp 75 trillion, the guaranteeing of which will be sought by the Indonesian Bank Restructuring Agency (IBRA), through the issuance of bonds.

What is unfair is that Bank Indonesia failed to detect the poor management of the banks until they needed so much money, so that the central bank had no alternative other than salvaging them from bankruptcy and guaranteeing the savings of depositors.

The funds needed for bailing out unhealthy banks are likely to increase in the near future because other banks are now also facing financial difficulties.

Q: How can so many banks be facing serious problems?

K: The damage to the banking industry stems from the arrogance of the authorities and corrupt practices.

When the government deregulated the banking industry in 1988 by allowing the opening of new banks with a small amount of capital, many analysts, while presenting detailed arguments, warned that such a measure might end up with a disaster. But the authorities paid no attention. The government took concrete action only after the International Monetary Fund required the restructuring of the banking industry in its reform package.

Many banks were also used by their shareholders as financial sources to finance their own business activities. They broke regulations on legal lending limits set by Bank Indonesia but the authorities did nothing against them because authoritative officials were given bribes. Banks would also provide loans for unfeasible projects if their managements were bribed, while public accountants were bribed to prepare reports indicating a better image of the banks' operations than was really the case.

Q: Will Bank Indonesia be able to recover the Rp 80 trillion already injected into unhealthy banks?

K: The funds will be converted into bonds to be issued by IBRA, which will repay them to the central bank with assistance from the government through its budgetary program. So the central bank will recover the funds when the bonds reach maturity.

Q: Why will IBRA issue other bonds worth Rp 75 trillion to the public?

K: It's not clear. Perhaps IBRA will use the funds to bail out more bad loans by commercial banks or to repay the bonds to be controlled by Bank Indonesia.

Q: What will be the impact of the bond issuance?

K: The issuance of the bonds worth Rp 80 trillion is inflationary in nature because they are bought by Bank Indonesia, which prints the money for buying them. The funds, which have been injected into unhealthy banks, are used to repay depositors, who withdraw their savings from domestic private banks and deposited them in foreign banks.

The issuance of the other bonds valued at Rp 75 trillion will be deflationary because they will be sold to the public. However, their public offering might cause the crowding out of the money market.

Q: The government will introduce due diligence after the Rp 80 trillion has been injected into the unhealthy banks. Won't this be too late?

K: No. The central bank was forced to suddenly inject liquidity credits into the unhealthy banks like pouring water onto a fire to prevent them from collapsing after the public rushed to withdraw a substantial proportion of their deposits. The planned due diligence is aimed at the uncovering of the huge bad loans and their causes -- whether they are caused by the monetary crisis, mismanagement, authority abuse or criminal activity.

Q: Isn't it also too late for the government to deliver a draft bill on corporate bankruptcy to the House of Representatives, which will need a long period of time before passing it into law, so that unhealthy banks can "salvage" part of their assets before they are stated as bankrupt under the planned new law?

K: Before the introduction of the planned new law, the government will launch a regulation in lieu of the law on April 21, so that the legal processing of bankruptcy cases can begin without having to wait for the enactment of the planned law. (riz)