Closing bad banks
Closing bad banks
Fostering a sound banking sector through orderly financial
conditions and a good monetary system has always been a core
component of IMF-supported programs in its member countries, as
again amply evidenced by Indonesia's latest reform package. The
rationale is that banking problems can be costly for and
disruptive to economic performance. Moreover, in the current era
of integrated financial markets, one country's banking crisis
could result in regional and even international repercussions.
A recent study by the International Monetary Fund showed that
during the past 15 years, 133 of its 181 members have experienced
significant banking problems, with financial costs often
exceeding 10 percent of gross domestic product.
Nonetheless, the government decision over the weekend to close
down 16 bad banks, in a bold move to strengthen the financial
sector, revealed several worrisome tendencies.
The most troublesome of these is that the move served to
strengthen the market perception that the central bank (Bank
Indonesia) is often held hostage to political pressures, is short
of skilled supervisors and that the integrity of a number of its
supervisors is not high enough to guarantee reliable bank
assessments.
The problem has been exacerbated by the fact that information
and reports published by many banks have not been reliable or
comprehensive enough to enable a viable bank assessment.
Moreover, many bankers seem to hold the misperception that
capital, and not good management and prudential practices, is the
most important asset for a sound bank.
The market has long suspected that the central bank, as the
supervisory authority for the banking industry, does not have
adequate autonomy and freedom from political influences to
enforce all the prudential regulations it has imposed. The last
minute haggling to save a number of banks which the central bank
had recommended for closure clearly showed how vulnerable the
central bank has been to political pressures.
As the number and names of the 16 banks closed differ widely
from long-running market speculation, there is now also a strong
suspicion that the content of bank reports is often misleading.
As recently as June, for example, the trade magazine InfoBank,
which specializes in the banking industry, announced the rating
of all commercial banks on the basis of the parameters set by the
central bank to assess bank soundness. Six of the 16 banks which
were closed on Saturday were rated as fairly good or good. The
magazine did not give any rating for another 19 banks as they had
not issued quarterly or annual reports for years, some of them
since 1993. Yet, only seven of these 19 banks fell to the
liquidation axe.
The grim consequence of these developments is that the central
bank should prepare a huge financial safety net to prevent
another chain of bank liquidations in the near future, otherwise
systemic risk and panic will hit the whole industry.
We are confident, nevertheless, that the central bank and
related agencies, with technical and financial assistance from
the IMF, the World Bank and the Asian Development Bank, will
become more capable of and have broader political freedom to
strictly enforce market discipline and stronger prudential
regulations on the remaining banks. We anticipate that the
central bank will be tougher in forcing weak banks to merge or
obtain new investors.
Stronger enforcement of prudential banking regulations is even
more crucial now given the difficult economic situation, with
very slow growth or perhaps even recession predicted for the next
two years. In such a situation, banks are facing greater risks
related to market competition as well as credit, interest rate
and exchange rate risks.
But the central bank's supervision could be made more
effective, and preventive measures against new bank failures can
have stronger teeth only if the government fully enforces the
1992 Banking Law and Law No.68/1996 on bank liquidation upon the
16 closed banks.
Both laws stipulate that bank directors, supervisors and
shareholders who are responsible for leading their bank into
bankruptcy are liable for up to 15 years imprisonment and fines
of up to Rp 10 billion. On top of these penalties, they are also
held fully responsible for settling the debts of the liquidated
bank, meaning that their personal assets can also be confiscated
whenever the assets of the liquidated bank are insufficient to
settle its debts.
This is both a great challenge and opportunity for the central
bank to strengthen its integrity and political freedom. It must
conduct its investigation of the liquidated banks in a fair and
transparent manner because the owners or directors of the
liquidated banks include politically well-connected
personalities.