Wed, 12 Jan 2000

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.