Charges against central bank

Charges against central bank

A new investigative audit could be the most effective and fair
way of resolving the current spat between Bank Indonesia and the
government over the differences of opinions regarding the
disbursement of Rp 164.5 trillion (US$23.5 billion) in emergency
liquidity credits to distressed banks at the peak of the
financial crisis between late 1997 and the first half of 1998.

The charges, as implied in independent audits by the Supreme
Audit Agency and KPM international consultancy firm, that Bank
Indonesia might have violated procedures relating to Rp 80.24
trillion of the emergency liquidity credits, boil down to
questions about how the central bank executed its role as lender
of last resort. But since the audits cover Bank Indonesia's books
only as of May 1999, one should remember that the central bank
was then wholly a government institution which was subject to
then president Soeharto's orders.

Bank Indonesia became an independent monetary institution by
virtue of a new central bank law only last May, and has since
been prohibited from extending emergency liquidity credits to
distressed banks. Following the establishment of a government
blanket guarantee on bank deposits and claims in late January,
1998 the management of distressed banks has been entrusted to the
Indonesian Bank Restructuring Agency.

Standard lender-of-last resort policies in most countries have
three primary objectives: to protect the integrity of the payment
system, to avoid runs that spill over from bank to bank and
develop into a systemic crisis and to prevent illiquidity at an
individual bank from unnecessarily leading to its insolvency. The
basic rule for extending emergency liquidity credits is that such
facilities shall be given promptly only to illiquid but solvent
banks, but at a penalty rate and against adequate collateral.

Given the inadequate banking supervisory capability of Bank
Indonesia -- as it had then to oversee more than 220 banks -- and
its political incompetence to act firmly and quickly on bad banks
owned by politically well connected bankers, one could imagine
how ill-prepared the central bank was in facing the height of the
banking crisis between the last quarter of 1997 and the first
half of 1998, especially after the closure of 16 banks in
November 1997 under pressure from the International Monetary
Fund.

This self-fulfilling crisis of confidence led to panic
injection of liquidity credits to distressed banks, irrespective
of whether they were simply illiquid but solvent or whether they
were totally insolvent. Or whether or not the crippled banks had
adequate collateral to cover the credits they asked for. This
bailout move at all costs was made especially after the
government, faced by collapsing confidence in the banking
industry, implicitly pledged, after the harsh measure of November
1997, that there would be no more bank closures, at least within
the next year or two.

We think the allegations of procedural violations and lax
accounting and supervision practices made by the independent
audit were related to the indiscriminate disbursement of
liquidity credits by the central bank, sometimes far in excess of
the value of the banks' assets. But whether any criminal
violations occurred can only be established by an investigative
audit.

It is frequently difficult to distinguish between illiquidity
and insolvency of banks even in normal times, let alone between
late 1997 and the first half of 1998, when the country was hit by
the rupiah meltdown, the economy was crippled and the country was
enveloped in a political crisis and social upheaval.

But in addition to "honest" mistakes, it is nevertheless
possible that criminal violations occurred despite the crisis
situation in which the central bank disbursed the emergency
liquidity credits. An investigative audit could uncover whether
any central bank officials colluded with others in extending
emergency liquidity credits to banks far in excess of the value
of their assets. Such an investigation could also verify or
refute the rumors circulating at that time that many bankers
misused a good portion of the liquidity credits they received for
buying dollars for transfer overseas.

It is therefore most imperative to immediately start an
investigative (forensic) audit of the central bank. Further
protraction of the current spat between the government and the
central bank will only damage the budding confidence in the
nascent economic recovery.