The $82b bank bailout

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.