Bond issuance may cause crowding out

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)