Fraud guaranteed

The alleged plundering of almost US$80 million from Bank Bali revealed two major flaws which, if not removed, may abort the budding recovery of Indonesia's economy.

First of all, the government blanket guarantee of bank deposits and claims, though succeeding in preventing the whole banking system from a total collapse, is killing market discipline and causing moral hazards among bank managers, owners and depositors. Political leaders need to act efficiently and prudently.

The guarantee system seems to be defective in its design. The almost unlimited categories and sums of bank deposits and claims the scheme covers and the loosely written rules on its implementation have made the scheme widely open to abuse. Since the scheme is funded entirely by the state budget, the costs and losses are fully borne by taxpayers. Thus far the government has issued Rp 53.8 trillion ($6.9 billion) in treasury bonds to finance the guarantee scheme but, given the persistently shaky condition of most banks, the costs will most likely increase further.

The defect was initially understandable as the blanket guarantee scheme was launched in a panic response to the massive runs on banks in January 1998, triggered by the loss of public trust in the poorly managed, inadequately supervised and corruption-ridden banking system.

It is in fact the artificial respiration provided by the guarantee system that has caused the domestic banking industry to stay alive now even though most banks are technically bankrupt with negative capital. Without the government guarantee, no one would be willing to deal with domestic banks.

But the government should have realized by now, more than 18 months after the introduction of the scheme, that without market discipline, the banking reform will never succeed in creating sound banks. And market discipline will never be restored if the scheme is not revised to minimize moral hazards.

We would not go as far as Amien Rais, chairman of the National Mandate Party, who demanded total abolition of the guarantee scheme, because such a drastic move would immediately lead the ailing banking system into a total collapse. But revision is most imperative. As we have suggested several times here before, a ceiling should be imposed on the sums of deposits covered by the scheme and interbank transactions should be excluded from the guarantee system to impose market discipline.

The rationale is that people who are adequately resourceful to analyze banking conditions, and able to collect banking information from analysts, should be allowed to exercise market judgment as to which banks they deal with. Likewise, bankers should be allowed to lose their shirts if they don't know the soundness of banks they make transactions with. Why should taxpayers be punished for the wrongdoings of unscrupulous bankers?

Here is the second appalling flaw. The Bank Bali scandal validates the public's fear that little has changed in the way of public and corporate governance. Poor management, corruption and the central bank's incompetent and highly venal supervision, which precipitated the explosion of Indonesia's banking crisis in late 1997, remain the biggest problems in the banking industry. Any incipient confidence in the $70 billion bank restructuring program under tight supervision of the International Monetary Fund turned out to be false.

The questionable deal that involved almost one-third of Bank Bali's total assets of Rp 10.01 trillion as of January caught the attention of the Indonesian Bank Restructuring Agency, Bank Indonesia, the finance ministry and the Capital Market Supervisory Agency (securities commission) only seven months later. Had Standard Chartered Bank not uncovered the big hole in Bank Bali's assets in the course of its due diligence, made in light of its plan to acquire 20 percent of the bank, the affair might have remained unknown. Had it not been for banking analyst Pradjoto's moral courage to reveal the scandal to the media, the scam would have been covered up by those in power.

One would then wonder that if the level of disclosure, transparency and accountability of publicly listed Bank Bali turns out to be so abysmal, the quality of corporate governance in other business entities must be maddeningly much worse. This is because Bank Bali, like all other financial institutions which mobilize funds from the public, is supposedly subject to tighter disclosure requirements in view of its fiduciary responsibility and the fact that it is owned by tens of thousands of investors through the stock exchange.

The government still seems oblivious to the alarming market bell. The sudden steep fall in the rupiah rate over the last two days, despite the positive macroeconomic indicators over the last few months, reflects the market assessment of the bombed-out state of our law enforcement and public and corporate transparency and accountability.