Insuring small depositors

Insuring small depositors
JP/6/ED26

Insuring small depositors

People with large financial assets should be more careful in
choosing the banks they deal with because the government blanket
guarantee is gradually being phased out to cover only deposits to
a maximum of Rp 100 million (US$10,000) by March, 2007.

The gradual dilution of the blanket guarantee began last week
with the start-up operations of the state-owned Deposit Insurance
Agency, with a paid up capital of Rp 4 trillion. It is this
agency that will reimburse depositors in case a bank becomes
insolvent and has to be closed and liquidated.

Many depositors these days are often influenced more by levels
of deposit interest rates or such factors of convenience as
location, rather than the soundness of the financial
institutions, because they can rest assured that whatever may
happen to the bank, all their savings or deposits will be
reimbursed by the government.

But this unlimited guarantee is now considered a big
disincentive to sound competition within the banking industry.
Large depositors have the resources to monitor and assess the
conditions of their banks. Moreover, the blanket guarantee
creates moral hazards and imposes large contingent liabilities on
the government.

The new deposit insurance scheme run by the agency will cover
deposits of only up to Rp 5 billion by March, 2006. This ceiling
will further decline to Rp 2 billion in September, 2006 and
finally fall to a maximum Rp 100 million by March, 2007.

Deposit insurance is one of two key components of the
financial safety net, vital to promoting the stability of the
financial system by enhancing public confidence in the banking
industry. The other key component -- the lender-of-last- resort
function -- has been strengthened under the amendments of the
central bank act last year.

The phasing out of the blanket guarantee, which was launched
at the height of the banking crisis in January, 1998, will likely
ensure people become more careful when choosing banks they deal
with.

As big depositors put banks under stronger scrutiny, giving
more attention to their soundness and franchise, rather than
their deposit interest rates, deposits will likely move from one
bank to another to seek higher quality (capital flight to
quality). But it is this process that will strengthen the market
screening of banks.

This, and the tough new criteria for a national anchor bank,
which was announced by Bank Indonesia last July, will further
accelerate the consolidation of the 130 banks into a sound,
strong and efficient, yet leaner banking industry through mergers
or acquisitions.

The sets of qualitative and quantitative requirements for
becoming a national anchor bank are so comprehensive that most of
the existing banks will have to merge with bigger ones to survive
as national-class banks, or convert into specialized or rural
banks with tight restrictions on the scope of business and
location.

The deposit insurance program will focus on the protection of
small depositors, who are supposed to be incapable of assessing
the conditions of their banks. The final ceiling of Rp 100
million is considered ideal for Indonesia because, according to
Bank Indonesia's reports, more than 90 percent of bank depositors
hold small accounts with less than Rp 100 million in savings,
although they account for only around 20 percent of the total of
around Rp 1,000 trillion in third-party funds at banks now.
Protecting small depositors will therefore increase household
confidence and help protect the payments system.

However, the deposit insurance scheme and the strong lender-of
last resort function of the central bank, though vital for
maintaining the public's confidence in the banking industry, is
not enough. The Deposit Insurance Agency now has a capital of
only Rp 4 trillion -- compared this to the Rp 1,000 trillion in
third-party deposits at banks now -- and its capital will
increase only incrementally because the insurance premium it
charges on banks is limited to 0.2 percent of deposits.

Bank Indonesia should continue strengthening its bank
supervisory system to force banks to accelerate their operational
restructuring. The Deposit Insurance Agency will not be able to
execute its function properly and will not have enough money to
reimburse depositors, if the banking industry remains fragile and
the incidence of insolvent banks remains high.

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