Liquidating insolvent banks

Liquidating insolvent banks

The new government regulation on the process and procedures
for liquidating insolvent banks should not make the general
public inordinately worried about the safety of their savings
deposits. The new ruling, as stipulated in Government Regulation
No.68/1996, is designed both to minimize the risks of having to
close down a bank and, in case of a bank failure, to better
protect the interests of depositors.

Commercial banks, because of their fiduciary responsibility,
are different in many substantial aspects from other business
entities. Banks therefore are governed by a special law (Banking
Law No. 7/1992), while most other companies are subject to the
Company Law. The impact of a failed bank is much more extensively
devastating than the bankruptcy of, say, an industrial company.
Because banks are involved in multiple transactions with
individual and corporate clients. A bank failure also causes
systemic risks, with a chain of impacts similar to that of the
domino theory.

The regulation on bank liquidation should be seen in light of
the special characteristics of the financial institution. The
ruling, designed to implement Article 37 of the Banking Law of
1992, governs the responsibilities of the management, supervisors
and owners of banks in case of failure and the rights of
depositors, creditors and other rightful claimants to the assets
of a liquidated bank.

The new ruling provides better protection to depositors,
because they are now treated as preferred creditors. That means
depositors will enjoy high priority in the distribution of
assets, in the event of the dissolution of a bank. Depositors'
rights of claim are preceded only by payments to employees,
taxes, operating costs, and court and auction fees. The better
protection should be good news, especially to small depositors,
because Indonesia has yet to establish a deposit insurance scheme
like those already well-developed in many other countries.
According to the central bank, a deposit insurance scheme is
being prepared in cooperation with several other related
institutions. But such a scheme will not likely materialize in
the near future, because most banks are still in the process of
internal consolidation. Moreover, the quality of banks is so
widely varying that it would be extremely difficult, complex and
sometimes, even delicate to determine the premium rate for the
would-be participating banks.

More encouraging, though, is that the regulation not only
stipulates "fire extinguishing" measures, but also clear-cut
provisions aimed at preventing bank failures. The ruling states
the stages of safety measures that the central bank has to take
before it recommends to the finance minister to revoke the
banking licenses. They include merger, new management and new
owners.

Experiences have shown that most bank failures were caused not
by incompetent bankers, but by executives, credit officers or
owners with a criminal mentality. The regulation conveys strong
warnings and stipulates heavy punishment for delinquent bankers.

It states that bank directors, supervisors and shareholders
who are found responsible for leading their bank into bankruptcy
are liable up to 15 years imprisonment and fines of up to Rp 10
billion (US$4.2 million), in line with the provisions of the
Banking Law of 1992. In addition to these penalties, they are
also held fully responsible to settle the debts of the liquidated
bank. That means their personal assets can also be confiscated
whenever the assets of the liquidated bank are not sufficient to
settle all its debts.

Given the strong preventive measures stipulated in the new
regulation and the Banking Law of 1992, and in view of the much
improved bank supervision mechanism installed by the central bank
after the failure of Bank Summa in 1992, we foresee a very remote
possibility of another bank liquidation within the foreseeable
future.