Realigning blanket guarantee

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.