Move on bad banks

What had been rumored for the past few weeks turned into blunt reality over the weekend when the government moved to freeze the licenses of seven banks and put seven more under the management of the Indonesian Bank Restructuring Agency (IBRA). Minister of Finance Fuad Bawazier and IBRA chairman Iwan Prawiranata announced the drastic measure as a vital part of the overall strategy to strengthen the economy and establish much-needed normality for the rupiah's exchange rate, which has weakened by more than 70 percent against the U.S. dollar.

While the move should be welcomed as another concrete step on the long way toward cleaning the financial system of bad banks, it will not likely contribute much to improving public confidence in the national banking industry. IBRA's utter lack of explanation as to why the banks had failed and why huge sums of taxpayer money had been spent on a failed bailout effort will instead strengthen public concern over Bank Indonesia's perceived incompetence and lack of political autonomy.

The government's Jan. 27 bank restructuring program made the right step by establishing IBRA, an autonomous agency, which immediately took over bank supervision and restructuring responsibilities from Bank Indonesia, the central bank. But the public remained in the dark about IBRA's structure and management. Its chief, Bambang Subianto, was quietly replaced after less than two months in his post and the manner in which the agency's directors were later appointed completely ignored the need to build institutional integrity and autonomy in the public's eye.

This does not mean that IBRA's management is made up of questionable personalities. Instead, the appointment of Rini Soewandi, the highly respected finance director of PT Astra International, to its management should lend credibility to the agency. Our point is that the public's perception of IBRA's competence and autonomy should have been taken more into account by publicly communicating the agency's important activities and organization, especially because the banking industry is highly sensitive to information.

Saturday's announcement left behind puzzling questions as to why the central bank had spent more than Rp 3 trillion (US$353 million) for a failed bailout of the seven suspended banks. The central bank should have known which banks were insolvent, thereby liable for immediate closure and liquidation, and which ones were simply illiquid, thus eligible to liquidity credits to restore them to sound operations. The seven banks now put under IBRA management should have been assessed as still viable but illiquid, otherwise they should have been suspended as well. Yet, the public deserves an explanation as to why they had been granted more than Rp 14 trillion in liquidity loans.

Both Bank Indonesia and IBRA should have realized that the government's blanket guarantee for rupiah and foreign currency claims by depositors and creditors on all national banks from Jan. 27 poses the risk of causing moral hazards among bankers, creditors and depositors. The guarantee should have instead forced the central bank and IBRA to act firmly and quickly on insolvent banks to prevent further losses of public funds. Moreover, the risk of a panic by depositors in the case of any bank closings has now been minimized because of the full guarantee.

Acting only after the central bank has pumped taxpayer money into the suspended banks by as much as 500 percent of the banks' own capital is surely the most effective way of destroying market discipline on bankers and encouraging more crooked bankers to indulge in unsound banking practices.

IBRA's explanations that it had suspended the seven banks only because they had used the central bank's liquidity in excess of 500 percent of their total equity and that it had placed the other seven banks under its direct management because they had used in excess of Rp 2 trillion (US$235 million) each also left more questions unanswered as to the sins of the problem banks. This explanation implies that the problems of the country's banks have been caused only by inadequate liquidity, while Bank Indonesia and analysts have often stated that many banks have violated legal lending limits and many other prudential regulations.

Both IBRA and the central bank, in trying to bolster public confidence in the banking industry, seem to place too much emphasis on the government guarantee. We do not hear much about how bank owners and large creditors are required to bear a substantial part of the losses of failed banks, which is vital for maintaining market discipline. This is one of the three pillars for maintaining sound banks, the other two being effective official supervision and internal bank governance.