Rescuing banks
The banking industry, which lies at the root of Indonesia's economic crisis, and the central bank are now mired in a vicious circle.
The government's blanket guarantee for foreign exchange and rupiah depositor and creditor claims on locally incorporated banks has been causing moral hazards not only throughout the industry but also for the bank supervisory mechanism and depositors. The guarantee, provided in late January to prevent banking panics and runs, has overtaxed the role of the central bank, Bank Indonesia, as the lender of last resort. It has unintentionally forced the central bank to provide liquidity support not only to illiquid but solvent banks, but also to outright insolvent ones.
We expected the central bank and the Indonesian Bank Restructuring Agency (IBRA) to act quickly and firmly on insolvent banks as soon its across-the-board guarantee was put in place because the risk of massive panics would be minimized.
But it is now painfully apparent that it is the central bank that is now in a panic, making huge liquidity injections into banks without proper evaluations of their assets and operational viability. The latest official reports show that as of June 5, Bank Indonesia has pumped Rp 132 trillion (US$12 billion) in liquidity credits into problem banks, up from Rp 101 trillion early last month. The total does not include liquidity injections to illiquid banks which are still sound enough to evade the IBRA hospital.
This anomaly is eroding market discipline among banks and cutting into the profitability of the banking industry as insolvent institutions are allowed to remain afloat to compete with solvent ones.
Likewise, large depositors and creditors, who are supposed to have more resources and are better informed of bank conditions, also seem affected by the moral hazard. They have become lax in enforcing market discipline on weaker banks because they feel secure that the guarantee scheme will bail them out of any trouble.
Worse still, the establishment of IBRA in late January, when the blanket guarantee was announced, has caused both a moral hazard at the central bank and dualism in bank supervision. IBRA is in charge of supervising and managing problem banks, while the central bank is to handle what are classified as sound banks. But the intensity and quality of the central bank's supervision of banks under its purview seems to have declined since it can now simply dump problem banks onto IBRA.
As the amount of bad credit steadily increases due to the battered economy and punitive lending rates as high as 70 percent, the quality of most bank assets has been deteriorating as well. This has raised concerns that the central bank or IBRA might not be able to recoup the huge liquidity credits already pumped into the banking system.
Contrary to official optimism, most analysts do not expect, at least until political uncertainty is removed, any significant strengthening of the beleaguered rupiah. Without a stronger rupiah, the high interest rates will most likely be maintained with devastating effects on both businesses and banks.
Recapitalization seems now the most effective and quickest way of restructuring the ailing banks. But not a single domestic investor is capable or likely willing to invest in the crippled banking industry since most large business groups, which are themselves major shareholders in most banks, are being overburdened with foreign debts. Foreign capital inflow or a return of Indonesian capital, which fled overseas after the recent riots in Jakarta and other areas, is not a prospect either.
The outlook is quite grim indeed. As the capital base of most banks erodes and with a virtual stop in new lending, more banks will eventually be forced to enter IBRA care, which is now tending to more than 45 distressed banks.
Given the severe banking crisis and the blunt fact that its resolution is crucial for the stabilization of the rupiah at a reasonable level, it is high time for both the central bank and IBRA to act firmly and quickly on insolvent banks. Allowing them to stay afloat with additional liquidity credits not only makes it more difficult to strengthen the whole banking industry but also risks wasting a huge sum of public funds and further hyperinflation.