The $82b bank bailout

The government's disclosure last week that costs of recapitalizing private and state banks had risen to over Rp 550 trillion (US$82 billion) -- or almost 150 percent as large as Indonesia's real inflation-adjusted gross domestic product of Rp 376.05 trillion in 1998 -- confirmed the staggering mangnitude of the banking crisis. Measured on a fiscal cost-to-GDP basis, Indonesia's banking fiasco ranks as the world's worst since the 1970s.

The latest estimate validated the public's concern that the banking implosion is continuing, making estimates about the costs of restructuring akin to taking potshots at a moving target.

Last December, when most banks had been audited by international accountants under what the government claimed as the most comprehensive due diligence ever made on the banking industry, the finance ministry estimated the recapitalization costs at Rp 155 trillion. A few weeks later, after more audited reports were finalized, the estimate was revised to Rp 257 trillion. In March, when the recapitalization program was wrapped up and the banks qualified for the government-sponsored recapitaliation scheme were selected, the costs inflated again to Rp 300 trillion. When the first tranche of recapitalization funds was finally injected through treasury bond floatation late in May, the amount exploded again to more than Rp 351.62 trillion.

These developments testify how rapidly has been the deteroriation in the banking condition due primarily to three factors: the punitively high interest rate policy pursued by the central bank to check inflation and to stabilize and strengthen the rupiah has forced commercial banks to suffer negative interest rate spread; the depressed economic condition has turned more current loans into bad ones; and the slow progress in the restructuring of domestic bank debts has hindered loan recovery.

Finance Minister Bambang Subianto said that the recapitalization program would hopefully restore people's confidence in domestic banks. However, even though bank recapitalization is a must to an economic recovery, it is yet highly questionable as to whether the mere booking of the untradeable treasury bonds in the recapitalized banks' balance sheet has anything to do with public confidence.

Instead, the government blanket guarantee on bank depositors and creditors seems to have been the primary resuscitator of the banks. The fact that the major private banks and the seven state banks have remained in operations, and people continue to bank with them even though their negative capital has made them technically bankrupt since early this year, proves that it is the guarantee, rather than the recapitalization, that has sustained the public's confidence. For depositors, feeling assured by the blanket guarantee, financial ratios such as the capital standard of a bank does not matter much. People pay more attention to banking convenience, such as the area coverage of bank branches, and interest rates offered, than to the capital adequacy ratio.

But the government is also right in its firm stance regarding the recapitalization policy, though the program makes it the controlling shareholders in all major domestic banks. Moreover, the blanket guarantee scheme, which will end in December, cannot be sustained in its present form without causing moral hazards in the banking industry. The guarantee has been posing a great burden to the state budget, as can be seen from the Rp 53.78 trillion in government bonds issued to repay the central bank for its payments to depositors and creditors of closed banks under the guarantee scheme.

The recapitalization program cannot by itself secure the success of the bank restructuring. The program's costs may even rise further if the macroeconomic condition does not improve, something that is not impossible if the upcoming presidential election is not able to produce a credible government.

International Monetar Fund's Asia-Pacific Director Hubert Neiss was not exagerating when he pointed out last week that the bank recapitalization cost looms as the life and death issue for Indonesia's fragile economic recovery.

We fully agree with Neiss' view that the way to defuse this issue is to maximize loan recovery and asset sales by the Indonesian Bank Restructuring Agency to offset the huge cost. This agency needs full support from all parties to carry out its uphill task. The move of the House of Representatives last week to challenge the constitutionality of the extra judicial power vested with IBRA to execute its onerous job was a dangerous politicking game at this point of time.

IBRA requires such power to deal with bad debtors and bad bankers, many of which belong to the country's most powerful political interest group. But given its big power and the huge assets in its management, IBRA's Review Committee (supervisory board) should be strengthened to ensure that the agency executes its task in a highly transparent, fair and accountable manner.