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.