Liquidation debate

Liquidation debate

Bank Indonesia Governor J. Soedradjad Djiwandono should have
felt uncomfortable at having to answer questions from reporters
before Wednesday's cabinet meeting on the possible liquidation of
troubled banks, even though the questions would have been
expected after Finance Minister Mar'ie Muhammad touched on the
same sensitive topic Tuesday.

Soedradjad was quite right to reiterate bluntly that
liquidating a troubled bank was not a simple process and was
meant to be the last resort after all rescue efforts had failed.
We reckon the central bank governor wanted to stop any
unnecessary debates. After all, Bank Indonesia has established
monitoring and supervision mechanisms to minimize the risks of
having to close down banks. Soedradjad's top priority now is to
further improve the effectiveness of the mechanisms and to
enforce the rules imposed on the banking industry consistently.

The crux of the problem is that many aspects of banking
operations are sensitive, as can be seen from the banking secrecy
provisions in the banking law. Debating in public the troubles of
a particular bank, let alone disclosing its name, could have
devastating repercussions.

Banks and finance companies are special because of their
fiduciary responsibilities and the crucial role of public trust
in their survival. Moreover, an unexpected bank failure could
trigger a domino-like collapse throughout the entire banking
system. So it would not only be counter-productive but might also
threaten the survival of the finance companies or banks if their
problems and names were laundered publicly.

The US$1.2-billion run on deposits at financially distressed
finance companies in Bangkok last week and early this week is a
vivid example of what could ensue if the existence of troubled
banks or financial institutions was announced in such a manner
that the general public could accurately guess their names. It
has not helped that many banks and finance companies in Thailand
(like their Indonesian counterparts) have incurred bad loans
estimated at $2.5 billion, as a result of too-aggressive lendings
to the property sector. Financial analysts would agree that these
bad loans should be addressed to maintain the soundness of the
financial system.

But the bad loans alone would not have triggered the massive
run on the troubled Thai finance companies over the last few days
had the central bank of Thailand handled properly the
announcement of the finance companies that had to increase their
registered capital. The virtual singling out of the troubled
finance companies worsened the situation instead of helping to
accelerate the solving of their problems. The affected
institutions lost the trust of most of their depositors and
creditors who understandably ran for their money. One should
remember that most banks own maximally only between 10 percent
and 12 percent of their total assets while the remainder belong
to depositors and creditors.

It is because of their fiduciary responsibility that banks and
finance companies are always subject to tougher disclosure
requirements. Their financial reports must be audited by publicly
certified accountants and scrutinized by examiners of the central
bank. This does not mean that problems do not crop up now and
again but they should not be disastrous if the central bank's
early-warning system is effective enough.

It would therefore be much better to stop the latest debate on
bank liquidation right now. The question as to whether a problem
bank should be liquidated or not has been clearly answered by
Government Regulation No.68/1996. Issued last December, this
regulation stipulates the procedures for liquidating a bank and
the measures which have to be taken before a bank can be put into
liquidation.