Realigning blanket guarantee

The blanket guarantee provided by the government for bank deposits and claims since January, 1998 has been mainly responsible for maintaining a reasonable degree of public confidence in the national banking industry despite its fragile condition.

Unfortunately, though, the scheme has caused moral hazards within the industry as market forces cannot function properly to screen banks and it has imposed huge contingent liabilities on the debt-ridden government. In fact, the scheme has so far cost taxpayers almost Rp 50 trillion (US$4.7 billion) and the guarantee fund had to be replenished with Rp 40 trillion last September.

Logically, terminating the scheme and replacing it with a deposit insurance scheme would help remove the moral hazards and minimize the costs of any bank failures to the state (taxpayers).

However, stopping the scheme now could kill national banks, given their fragile condition, as most depositors will certainly move their accounts to foreign banks. Setting up a deposit insurance scheme is not feasible either because most banks are still too weak and the macroeconomic and political condition is not yet sufficiently stable to allow for a reasonable assessment of risk premiums.

But since maintaining the blanket guarantee in its original format is no longer fiscally feasible, the government is scaling down the scheme to decrease its contingent liabilities and expose banks to more stringent market competition.

The new measures being finalized in cooperation with Bank Indonesia will maintain the guarantee scheme but will limit both the kinds of transactions and the amount of deposits covered by the program. The program will emphasize the protection of small depositors, who are not capable and do not have sufficient resources to analyze banks.

By setting a ceiling on the amount of deposits guaranteed by the scheme, big depositors or middle and high-income people will be forced to carefully select the banks where they want to put their money. This measure will slash contingent liabilities on the government because almost 75 percent of the estimated Rp 800 trillion in deposits at national banks now are owned by middle and high-income people and companies, who are all supposed to be capable and resourceful enough to assess the soundness of a bank.

It is indeed not fair to maintain this group of big depositors in the guarantee scheme. If they themselves cannot exercise market judgment, let them lose their shirts in any bank failure.

Derivatives transactions and inter-bank loans will also be excluded from the scheme so that bankers will be compelled to act prudently in selecting banks with which they do transactions. The independent audits on the inter-bank claims submitted to the Indonesian Bank Restructuring Agency for reimbursement under the blanket guarantee disclosed how poor some bankers' judgment had been. They had imprudently been motivated, mostly by high profits without assessing the viability of the deals, knowing that even if their bank debtors defaulted, the loans would be fully reimbursed under the blanket guarantee scheme.

Like the ceiling on deposits, the lifting of derivatives transactions and inter-bank claims from the scheme will release market forces to screen banks so that the surviving banks are really the fittest ones.

The scaling down of the guarantee program should be welcomed as temporary measures before a fully-fledged deposit insurance scheme is in place sometime in 2004, as scheduled. Without restrictions, the guarantee fund, even after its top-up last year, may not be sufficient because bank failures could still occur under the current adverse economic conditions.

However, people cannot make a reasonable assessment of a bank's condition if the bank's management are not subject to stringent disclosure requirements, higher standards of accountability and if the central bank does not improve its bank supervision capability.

It is nonetheless a comfort to know that Bank Indonesia has required banks to broaden the scope of their monthly report and to promptly submit the report for placement on its website beginning this month in a bid to enhance transparency and market discipline.