Government set to phase out bank guarantee program

Government set to phase out bank guarantee program

Dadan Wijaksana, The Jakarta Post, Jakarta

The government is set to gradually terminate its costly
blanket guarantee for bank deposits and claims, starting in
January, 2003, in a bid to help remove "moral hazards" and
minimize the cost of any bank failures to the state.

The phasing out of the blanket facility will be completed in
February 2004, when third party funds above Rp 100 million (about
US$11,000) will no longer be guaranteed by the government. But
the government will continue to protect small depositors via a
new deposit insurance scheme.

Director General of Financial Institutions Darmin Nasution
said on Thursday that all technical preparations had been
completed, saying the new policy would be announced on July 31
once it had been approved by the Cabinet.

"Technically speaking, we're ready. But the final say will be
all up to the (Finance) Minister and the Cabinet meeting," Darmin
told reporters prior to a meeting with legislators.

The blanket guarantee scheme was introduced in 1998 to help
instill confidence in the ailing banking sector. Under the
scheme, if a bank is shut down, the government would cover all of
the bank's obligations including depositors' money. The policy
was also meant to avoid a widespread panic when the government
had to close down banks.

The government must announce six months in advance to the
public if it intends to change the scheme.

"We've been publicizing this with the banks since the end of
2001," Darmin said.

Under the phasing out plan, government guarantees on bank
accounts in the categories of on-balance sheet and off-balance
sheet would be terminated by January 1, 2003, the Kontan weekly
said in its latest edition. This includes debt notes issued by
banks, direct loans, letters of credit, standby loans, and
derivative transactions.

Third party funds worth over Rp 5 billion and interbank loans
will no longer be eligible for the blanket guarantee as of August
2003.

And finally, in February 2004, guarantees for third party
funds over Rp 100 million will be terminated, while funds Rp 100
million or less will continue to be protected via a deposit
insurance facility.

The blanket guarantee program has greatly helped in reviving
confidence in the banking industry despite their weak financial
conditions.

But the scheme has caused moral hazards among bankers as
market forces cannot function properly to screen banks and it has
created a huge amount of liability for the debt-ridden
government. For 2000, 2001 and 2002, the government had to
allocate Rp 42 trillion, Rp 61 trillion and Rp 59 trillion
respectively.

Stopping the blanket guarantee, however, could prompt
depositors to put their money in foreign banks due to the
industry's ongoing precarious condition.

Banking analyst Drajat Wibowo welcomed the plan, saying now
was the time to start phasing out the blanket guarantee.

"And the plans to take banks' trade facilities off the scheme
first is good, because by this the government can evaluate the
progress of the plans. Consider it a test case," Drajat told The
Jakarta Post Thursday.

When asked to comment on this, Minister of Finance Boediono
said that the plan would still be discussed further: "Bottom line
is that, we're very careful about this. This is a fundamental
policy."