Moral hazard

Moral hazard

Bank Global's operations have been frozen. For many people, this
news came without warning. Although Bank Indonesia has had the
bank under supervision since late October because of its
deteriorating financial condition, it was not until late November
that information about Bank Global's problems began to leak out.

It started with news reports that some of the bank's mutual
fund customers were unable to withdraw their money. The bank's
management issued a classic denial, swearing its finances were
sound. But eventually the truth came out that the bank was
insolvent, possibly bankrupted by its management or owners, with
a police investigation expected to determine the exact cause of
this case.

All of the reports coming out about Bank Global are worrying.
They describe a combination of alleged financial engineering to
make the bank's finances look good, suspected criminal acts in
the extension of unsound credits, the manipulation of mutual
funds and a lack of supervision from the authorities.

This is not the first time since the wave of bank closures in
the late 1990s that the authorities have been forced to freeze a
bank's operations because of suspected criminal acts.

In April this year, the central bank closed down two small
commercial banks, Bank Dagang Bali (BDB) and Bank Asiatic. The
two banks -- owned by two families related by marriage -- became
insolvent as a result of illegal transactions involving massive
lending to companies affiliated to the owners.

Nevertheless, the case of Bank Global is more disturbing
because it is a publicly listed company. In practice, public
banks like Bank Global should be more closely supervised by Bank
Indonesia, the Stock Market Supervisory Board, the Jakarta Stock
Exchange and public accountants. The fact that Bank Global found
itself in such a dire financial position as a result of
suspected criminal acts is beyond comprehension.

It is very simple to look at this case and arrive at this
conclusion: if this could happen at publicly listed Bank Global,
it could easily happen at any bank, particularly those family-
owned banks whose primary purpose is to finance the families'
businesses -- despite the legal lending limit.

It is troubling to consider the consequences of Bank Global's
troubles, especially on smaller local banks. People are now more
likely to think twice about putting their money in less
reputable, smaller banks. Banking is a business of trust. Once
the public no longer trusts a bank, that bank cannot survive.

Therefore, we expect the authorities to take action to restore
public confidence in local banks, especially smaller ones. The
government's blanket guarantee scheme for bank deposits is
helpful in preventing the carefully built edifice of public
confidence from crumbling.

However, the government must also stand by its own policy of
guaranteeing bank deposits but not mutual funds, because people
have to learn that investments carry risks. This way, people will
invest more prudently.

The next goal for authorities handling the Bank Global case
should be to minimize the losses to the state. In past bank
closures, the state always bore the lion's share of the losses,
while bank owners were allowed to run away unpunished and
unrepentant.

The government has said it will seize the private assets of
the owners of Bank Global to help cover any losses to the state,
but the real test will come when the government has to act on
this promise. Punishing those responsible for Bank Global's woes
is surely an important step in rebuilding public confidence.
Otherwise, it will create a moral hazard for bankers and bank
owners alike.

In the future, tighter supervision of banks is necessary
considering the information gap in this industry, especially with
the banking secrecy clause. Most people are kept in the dark
about the financial condition of their banks. Laymen cannot
examine every nook and cranny of banks' financial reports. It is
the responsibility of regulators to keep a close eye on any
transactions that even hint at a conflict of interest.

Most of all, banking authorities must work to improve the
health of the industry. With 135 banks currently operating in the
country, it is safe to say some of them are operating
inefficiently. The authorities must help, or if necessary force,
smaller, less healthy banks to merge or find suitable investors
to inject fresh funds into the banks. Otherwise, we can expect to
be surprised by yet more bank defaults.