Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji 0007491042000205204
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Liquidity support to banks during Indonesia's
financial crisis
J. Soedradjad Djiwandono
To cite this article: J. Soedradjad Djiwandono (2004) Liquidity support to banks during
Indonesia's financial crisis , Bulletin of Indonesian Economic Studies, 40:1, 59-75
To link to this article: http://dx.doi.org/10.1080/0007491042000205204
Published online: 12 Jul 2010.
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Bulletin of Indonesian Economic Studies, Vol. 40, No. 1, 2004: 59–75
Taylor & Francis Group
LIQUIDITY SUPPORT TO BANKS
DURING INDONESIA’S FINANCIAL CRISIS
J. Soedradjad Djiwandono*
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University of Indonesia, Jakarta, and Nanyang Technological University, Singapore
During the 1997–98 financial crisis, Bank Indonesia provided liquidity support to
many banks experiencing difficulties. This policy became controversial because of
the magnitude of the likely losses to the government, which in the end would have
to be borne by the general public. Suspicions of corruption involving bankers and
officials of Bank Indonesia fuelled the debate. Surprisingly, however, concerns of
this kind have not been raised in relation to the far larger amount of support
provided to banks by the government in the form of recapitalisation bonds. The
public’s lack of understanding of the operations of the banking sector further complicated the debate. This paper attempts to shed some light on the central bank’s
actions and on the proposed solutions to the problems that arose from them.
INTRODUCTION
Several steps taken by Bank Indonesia (BI, the central bank) during the first several months of the financial crisis that began in mid 1997 have become the subject
of public controversy, particularly the provision of liquidity support to banks.1
This policy was intended to prevent the collapse of the banking industry and the
national payments system during the crisis, but it became controversial following
the issue of two reports by the Supreme Audit Agency (Badan Pemeriksa
Keuangan, BPK) after its audits of BI. The first reported the results of a general
audit, and was issued by the agency in November 1999. It was accompanied by a
disclaimer indicating that the auditor could not obtain sufficient information to
make a conclusive evaluation. The second, the report of an investigative audit
requested by the parliament was issued in July 2000. This report confirmed the
suspicion of possible criminal acts, either in the use of funds by the recipient
banks or in the provision of funds by the central bank, or both (BPK 2000).
In February 2000 the Parliamentary Working Committee on BLBI (Bantuan
Likuiditas Bank Indonesia, BI Liquidity Support) summoned officials and former
officials of BI and the Ministry of Finance to testify on the question of whether the
central bank or the government had initiated the liquidity support policy. This
led to public debate after a statement during the proceedings by three former
ministers of finance (Mar’ie Muhammad, Fuad Bawazier and Bambang Subianto)
that the central bank’s actions were based on its misunderstanding of actual government policy. According to the former ministers, the government’s involvement in liquidity support for banks was by way of a Presidential Instruction
dated 3 September 1997, issued after a cabinet meeting that day. They testified
ISSN 0007-4918 print/ISSN 1472-7234 online/04/010059-17
DOI: 10.1080/0007491042000205204
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that the central bank did not consult the Ministry of Finance in implementing this
instruction (Sukowaluyo 2001: 27–31).
The liquidity support issue had already been raised in news and gossip circulating on the internet as early as November 1997. In some writings it was alleged
that BI had been secretly helping a number of large ethnic Chinese conglomerateowned banks, such as BCA (Bank Central Asia), Danamon, BUN (Bank Umum
Nasional) and Lippo, with liquidity support amounting to trillions of rupiah. In
November 1997, these writings were collected and published in a booklet entitled
Konspirasi Menggoyang Soeharto [Conspiracy to Topple Soeharto] (Anonymous
1997). The public perceived the conglomerates as symbols of the social ills of
Indonesia—in particular, the corruption, collusion and nepotism of the Soeharto
era. Some argued that bankers and bank owners were the beneficiaries of funds
provided by BI as liquidity support to their banks—and that they constituted the
group that, in cooperation with BI officials, had caused the near bankruptcy of the
economy. It was therefore unfair, so the argument continued, that the general
public had to bear the burden of bailing out these conglomerates. This is a very
appealing argument, but it is flawed nonetheless.
The public’s perception of these matters appears to have been worse than the
reality. The decision to provide liquidity support to banks suffering distress
caused by bank runs was in line with the central bank’s function as lender of last
resort, and in conformity with the government’s then policy of not closing banks.
But in circumstances of non-transparency and weak governance, the public’s preconceptions about the banking system, and its lack of information about how the
system functioned, meant that the decision was bound to generate controversy.
WHAT IS LIQUIDITY SUPPORT?
Liquidity support is funding provided by a central bank to banks suffering a liquidity shortfall as a result of negative net cash flow; it may be extended on varying terms, depending on the precise nature of the liquidity problems the banks
face. As lender of last resort and guardian of the payments system, BI had introduced various schemes of liquidity support since its transformation from the old
De Javasche Bank in 1953 into the central bank of the new republic. Although the
public was reasonably familiar with the discount window or rediscount facility,
the term ‘BI liquidity support’ only became widely known in early 1998, when it
was alluded to in the government’s second letter of intent (LOI) to the IMF (GOI
1998: paragraph 15).
The term BLBI includes all lending by the central bank to the banking sector
other than BI Liquidity Credits (Kredit Likuiditas BI, or KLBI); the latter are loans
provided to commercial banks at subsidised interest rates to support government
programs such as finance for small and medium scale enterprises, cooperatives
and the logistics agency, Bulog. Using this broad definition, we can identify as
many as 15 different facilities that BI has employed to provide liquidity to banks.
These can be grouped into the following five categories:
1 Liquidity support to banks suffering shortfalls due to unexpected net cash outflows.
This was of two types: one that bore a very short term of 15–30 days and was
unsecured, termed Discount Facility I, and another for short terms of 90–150
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days, termed Discount Facility II. The latter required promissory notes as collateral.
Liquidity support through open market operations. This facility involved BI rediscounting promissory notes or other debt instruments of commercial banks
(known collectively as Surat Berharga Pasar Uang, SBPU), either through periodic auctions or through direct deals with banks in need.
Liquidity support in the context of bank rescues or ‘nursing programs. This involved
emergency and subordinated loans from BI to problem banks that were in the
process of being restructured through mergers or acquisitions.
Liquidity support to banks facing runs, provided to stabilise the banking industry and
the payments system. This facility allowed banks to overdraw their accounts
with the central bank without being excluded from the clearing (the daily
process of adjusting each bank’s balance in its clearing account with BI after
recording the impact of all cheques and other payment orders drawn against it
or in its favour).
Liquidity support provided to defend market confidence in the banking sector. These
facilities were in the form of advances by BI (on behalf of the government) to
compensate banks for taking over deposits previously held at other banks that
were to be liquidated, and to pay Indonesian banks’ arrears to their foreign
counterparts in relation to trade financing and interbank debt exchange offers.
The first two categories of liquidity support are similar to instruments that
most central banks provide in their capacity as monetary authorities and lenders
of last resort, and they had long been used by BI in its day-to-day operations. BI
had also resorted to the third and fourth types before the crisis in its attempts to
restructure certain problem banks. In other words, these four forms of liquidity
support were in use by BI in the normal conditions that existed before mid 1997.
The use of the fourth type of liquidity support, however, was greatly expanded
during the crisis as a means to avoid collapse of the entire banking system, while
the fifth arose during the crisis as a result of BI acting on behalf of the government
in meeting the claims of depositors and of foreign bank creditors of closed and
troubled domestic banks. The overdraft facility (type 4) was quantitatively the
most significant of the five types of liquidity support. Before going on to discuss
this, it will be helpful to provide some background on BI’s attempts to deal with
troubled banks in the last few years before the crisis.
STALLED ATTEMPTS TO DEAL WITH PROBLEM BANKS
In dealing with problem banks in the past, BI had adopted a case-by-case
approach, whereby it could take a variety of steps to restore a bank’s health
before resorting to liquidation. These steps, set out in article 37 of the 1992 banking act, ranged from requiring the bank to increase capital or change its management to assisting it to undergo merger with or acquisition by interested investors.
If all these efforts failed to make the bank healthy, it would then be liquidated. In
other words, bank closure was considered the last option, after all other alternatives had been exhausted. BI interpreted article 37 as reflecting a view that the stability of the banking sector, as an integral part of the national payments system,
was crucial for the central bank to conduct its operations.
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The case-by-case method was discarded when BI was faced with an increasing
number of problem banks following the weakening of the economy toward the
end of the 1980s and in the early 1990s.2 Instead, a more systemic approach was
adopted. In December 1996, together with two managing directors in charge of
bank supervision, I submitted a proposal to President Soeharto for the closure of
seven insolvent banks, after various efforts to overcome their problems had
failed. Unfortunately he did not approve this proposal, and instead instructed BI
to finalise a draft government decree on bank closures.3
At the time there was no specific regulation on bank liquidation, even though
this was provided for in the banking law of 1992. This implied that if a bank were
to be liquidated, the general liquidation regulations for ordinary corporations
would need to be applied. A problem here was that a liquidator could not treat
depositors as priority creditors in the distribution of proceeds from disposal of
the banks’ remaining assets. In other words, the payment to depositors of liquidated banks could only be done in parallel with payment to other creditors, as
had been the case with the long drawn out liquidation of Bank Summa in 1992
(MacIntyre and Sjahrir 1993: 12–16). Because of this consideration and the president’s disinclination to see banks liquidated, there had been no further bank closures up to this time.
In April 1997, BI again proposed the liquidation of the seven problem banks,
since their status had not improved. This time the president gave his approval.
However, he instructed BI to postpone implementation until after the general
election in October 1997 and the general session of the Peoples’ Consultative
Assembly (MPR) in March 1998, because of his concern over the implications of
bank closures for social and political stability. Unfortunately, the financial crisis
intervened in July 1997. As conditions deteriorated the number of problem banks
increased, but BI did not have the option of closing them, because of the president’s instruction to avoid any closures until after the MPR session.
LIQUIDITY SUPPORT TO ADDRESS THE BANKING CRISIS
The government’s decision to float the rupiah on 14 August 1997 (Lindblad 1997:
4–5) proved a shock to Indonesian businesses. Uncertainty about the exchange
rate created panic among those members of the business community that had
high levels of foreign exchange exposure. They began to buy dollars heavily,
while other parties that might normally have been expected to supply dollars to
the market failed to do so, causing the currency to depreciate rapidly.4
To defend the currency the authorities responded by implementing a severe
liquidity crunch, through a combination of expenditure reductions by the government and administrative intervention; the latter took the form of an instruction
from the finance minister to state enterprises to switch their bank deposits into BI
Certificates (SBIs).5 The SBI interest rate was also increased significantly at this
time, but this would have had little effect, since market rates rose to much higher
levels still as a result of these other actions. In August the average interbank rate
rose from 20% to 90% p.a.—reaching as high as 200% for one or two days—making the purchase of SBIs unattractive to market participants. Indeed, one symptom of the severity of the liquidity squeeze was that a number of banks sold SBIs
back to BI before they matured.
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At much the same time, depositors began to withdraw funds from banks perceived to be weak, thus significantly exacerbating the impact on the banks of the
system-wide liquidity squeeze. The banking industry became distressed, and
many banks’ clearing balances fell to negative levels. Banks that still had excess
liquidity at this time chose to hold on to it for precautionary reasons, rather than
lending to other banks. Thus banks faced with net cash outflows were forced to
draw on funds deposited with BI in fulfilment of their reserve requirement, causing these to fall below the regulatory minimum: the number of banks failing to
meet the requirement rose from 14 on 15 August to 51 by the end of the month.
When massive deposit withdrawals continued, the remaining reserves were
quickly exhausted, and many banks began to have negative balances with BI; by
the end of the year 29 banks suffered from this problem.
With the benefit of hindsight, it can be seen that the liquidity squeeze resulting
from defence of the rupiah after its float was too stringent, resulting in a severe
blow to the banking system. As it became aware of this, the government specifically instructed BI to provide liquidity support on a discretionary basis to banks
experiencing liquidity problems. This policy was introduced on 3 September
1997, prior to the commencement of the IMF program, in the form of a set of
directives by the president to the cabinet (GOI 1997a).
In normal conditions, any bank that experienced a negative balance with the
central bank at the end of the daily clearing process was given one day to settle
the obligation, in accordance with a BI regulation adopted in 1990, which stipulated that a bank that failed to do so would be excluded from the clearing
process.6 The Supreme Audit Agency’s report on BI drew attention to this regulation, which has become a rallying point for critics of BI management’s continuing to provide liquidity support rather than halting many banks’ operations. The
regulation was not intended to apply in abnormal circumstances that threatened
a collapse of the banking system, however. As we have seen, BI interpreted article 37 of the banking act as requiring it to take whatever measures it considered
necessary to safeguard the stability of the banking system. Ordinarily, a bank
would restore its clearing balance by borrowing funds from other banks in the
interbank money market. It could also request BI to provide additional liquidity
but, as long as funds were available to it in the interbank money market, the bank
would avoid using the BI facility, since it bore a much higher penalty rate of interest; in addition, this would result in its financial problems being exposed to other
banks.
Liquidity support in normal conditions mainly took the form of discount facilities and the rediscount of banks’ promissory notes, which provided reasonable
security for BI. The procedure was somewhat cumbersome, however, and in the
face of system-wide liquidity shortfalls, speed is essential if support is to be effective in safeguarding the payments system (Sheng 1998). Thus BI decided to help
banks that had negative balances with it by allowing them to continue to participate in the clearing. This modification of the usual practice permitted the banks
to operate normally, thus maintaining the functioning of the payments system,
and giving the banks a chance to overcome their liquidity problems and to repay
their debts to the central bank later on. The alternative would have been widespread liquidation of distressed banks, with the disposal of their assets and liabilities effected through bankruptcy proceedings. Such an outcome would have
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been inevitable given the level of public confidence in the banking system, which
was so low that even a groundless rumour about a bank suffering a shortfall in
the clearing could lead to a run on that bank. Indeed, on several occasions during
this period banks suffered runs as a result of such rumours. Any announcement
by BI barring a bank from the clearing would have amounted to a ‘nail in its coffin’, and if such an announcement had involved a number of banks it would have
generated widespread bank runs.
In summary, in the first few months of the crisis BI provided liquidity support
to banks that were in need of it, in accordance with its function as lender of last
resort, and in defence of the banking industry and the payments system. The liquidity support was made available to banks without discrimination; it was certainly not restricted to banks owned by Soeharto’s cronies or to any other group.
The disadvantage of allowing banks with negative clearing balances to continue to participate in the clearing was that there were no safeguard measures to
protect BI. But the expectation was that the crisis would be over quickly, and that
the banks would soon be able to regain lost deposits; in the meantime, the banking industry would be saved from collapse. In the event, however, the cost of providing unsecured liquidity support proved to be very high. We do not know what
the outcome would have been if, instead of being provided with liquidity support, banks had been barred from the clearing, as critics of BI liquidity support
seem implicitly to advocate. Argentina in November 2001 and Uruguay in July
2002 elected to limit the withdrawal of deposits from banks, which would have
had much the same effect as barring banks from the clearing. It remains to be seen
what the end result of this policy will be, but it has been reported that the decision caused social and political turmoil in Argentina at least (Ashari 2002;
Mongid 2002; Mussa 2002).
BANK CLOSURES
With the rapid deterioration of economic conditions during September and October 1997, the government turned to the IMF for assistance. A prominent feature
of the program decided upon was the closure on 1 November of 16 small banks,
including the seven banks whose liquidation BI had earlier proposed. During discussions with IMF staff I pointed out that BI was already fully prepared to close
these seven banks (and that I had brought this to the attention of the president
before the crisis), but I also stated that my staff needed more time to prepare for
the closure of other banks. The IMF staff repeatedly asked me not to worry too
much, however. As Dr Bijan Aghevli, chief of the IMF negotiating team, pointed
out, the 16 banks constituted only 3% of the total assets of the Indonesian banking industry.
In fact, the turmoil in the banking sector became even more severe following
the closure of these 16 banks, leading the banking industry to lose credibility.
Depositors reacted by moving a large amount of funds to banks considered safe,
and the interbank money market became segmented: it functioned well enough
for the ‘safe’ banks, but not for the many others that lost deposits. The source of
the problem was not just withdrawals by depositors, but also the termination of
lines of credit by foreign banks for trade financing. Thus the number of banks suffering liquidity shortfalls increased further, resulting in a crisis for the banking
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sector as a whole. The government addressed the systemic liquidity problem of
banks by issuing a blanket guarantee of the banks’ liabilities and by creating a
special institution on 26 January 1998 to deal with problem banks, the Indonesian
Banking Restructuring Agency (IBRA). It also assisted banks in meeting payment
of trade financing arrears with foreign banks.7 Meanwhile, the previously
announced policy of avoiding additional bank closures was restated by President
Soeharto in an attempt to prevent further loss of public confidence in the banking system. After signing the second LOI to the IMF on 15 January 1998, the president stated that the government would not liquidate more banks, but would
urge those experiencing difficulties to merge with others; meanwhile, banks
would be subject to more stringent supervision than in the past (Suara Pembaruan,
16/1/98).
As the financial turmoil developed into a prolonged economic crisis, banks
faced an increasing volume of non-performing loans; the initial liquidity problem
had now become one of widespread insolvency. Since the closure of all banks that
had become insolvent would almost have wiped out the banking sector, in
August 1998 the government initiated a program of bank restructuring involving
recapitalisation of both state-owned and private banks (Fane and McLeod 2002).
The plan was for owners of problem banks to provide 20% of the capital needed
to raise the banks’ capital adequacy ratios (CARs) to 4%, and for the government
to provide the remaining 80%. Thus the focus of government policy switched
from the provision of liquidity support by the central bank to making good
banks’ losses through the injection of government bonds, the repayment of which
would be a call on the budget.
As policies for addressing problems encountered by banks during the crisis,
liquidity support and recapitalisation have not been fundamentally different, in
the sense that both were intended to help banks address problems arising from
the lack of funds needed to fulfil operational requirements. Liquidity support
supplemented the banks’ short-term assets so as to meet short-term payment
obligations, while recapitalisation injected new long-term assets to make good
accumulated losses, and thus to enable banks to meet the minimum CAR. In a
sense, therefore, BI’s liquidity support can be seen as a down-payment on guarding the banking system from collapse. It should be noted that the amount of
funds eventually committed by the government through recapitalisation (around
Rp 431 trillion) far exceeds the amount of BLBI (Rp 179 trillion). It is therefore surprising that only BI has been so heavily criticised in relation to the banking crisis,
even though the government has supplied a far larger share of the funds needed
to support the banks, and has even been commended for its recapitalisation
policy.
THE CONTROVERSY OVER LIQUIDITY SUPPORT
The provision of liquidity support became controversial when its financial implications began to become clear, and allegations of corruption in the process began
to emerge, as a result of which ‘ownership’ of the policy became an issue. Here it
is relevant to look at the government’s policy making role—as distinct from that
of BI—in this area. As we have seen, BI’s initial decision to allow banks to continue to operate despite having negative balances with it was based on its role as
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lender of last resort, on the one hand, and the president’s instruction not to allow
any bank closures until after the March 1998 MPR session, on the other.
The 3 September 1997 directives from the president referred to above modified
this earlier instruction to some extent, however. On liquidity support, the directives confirmed that healthy national banks suffering from liquidity problems
should temporarily be provided with additional liquidity. But it was now explicitly stated that banks that were clearly unhealthy should be put under a program
of merger and acquisition with healthy banks, and that if this effort failed they
would be liquidated, with a view to protecting the interests of deposit holders,
especially small depositors (GOI 1997a: point 8).
This raises questions about why unhealthy banks received liquidity support,
why there were no bank closures immediately after the issuing of this instruction,
and why there were no mergers or acquisitions of banks until much later. Part of
the explanation is that the president saw bank closures very much as a last resort,
as indeed was the underlying rationale of article 37 of the banking law. The decision to proceed with some closures was taken only in October 1997, as a ‘prior
action’ required by the IMF-supported program.8 In essence, the president’s
opposition had been overcome with the help of pressure from the IMF during its
initial negotiations with the government. (Even so, his position was soon
reversed, when many banks faced severe runs after the first group of bank closures in November 1997 generated a very negative public reaction.) The government promised in November 1997 not to liquidate more banks, and at the same
time it announced new economy policies for the real sector. The minister of trade
and industry, the finance minister and I as governor of BI announced the overall
policy package after we had reported to President Soeharto in his office (Kompas,
4/11/97).
What about bank mergers? This was not something that could be done
overnight. However, preliminary moves had commenced immediately following the announcement of the government’s policy package of 3 September 1997.
With respect to the state banks, initially the plan was to deal first with the downsizing and merger of two insolvent banks, Bank Bumi Daya and Bapindo. In a
document (‘side letter’) that accompanied the first LOI (but that was never made
public), it was stated that these banks would be merged by December 1997, after
separating their ‘good’ from their ‘bad’ assets. Before this merger could be
implemented, however, it was decided instead, in January 1998, to extend it to
include Bank Dagang Negara (BDN) and Bank Ekspor Impor Indonesia (Exim);
the merged entity was later to become Bank Mandiri. With respect to the private
banks, the process was even slower. By December 1997, with the assistance of BI
as mediator, a number of banks had produced memoranda of understanding
that formally stated their intention to merge, but without any concrete timetable
for doing so.
Opposition from the president aside, it is important to appreciate that implementation of mergers and acquisitions requires considerable time. Banks only
became willing to proceed with them toward the end of 1997; in the interim,
while negotiations between the banks and potential investors were under way,
there was nothing BI could do other than to help those in need of additional liquidity. In any case, the government’s policy on provision of, and ultimate responsibility for, liquidity support to banks was clearly stated in the first LOI to the IMF
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(GOI 1997b), which detailed the government’s program for addressing the crisis,
including the initial bank closures. Relevant points included the following:
• The government guaranteed small deposits at the banks that were to be liquidated, up to a maximum of Rp 20 million each (around $5,000 at the time). Payments to the depositors in question were to be administered by BI and funded
by the government (GOI 1997b: paragraph 26, emphasis added).
• BI would streamline its lender of last resort function. Loans to illiquid but solvent banks would be provided in accordance with stringent access conditions.
These loans would be collateralised and extended to individual institutions at
increasingly punitive interest rates. Any emergency assistance to banks to prevent systemic risks would be explicitly guaranteed by the government (GOI 1997b:
paragraph 36, emphasis added).
The liquidation of the 16 banks in November 1997 was one of the pillars of the
government’s IMF-supported adjustment program. Note the explicit stipulations
that the government would bear the cost of bailing out small depositors and
would guarantee any financial assistance to overcome systemic risks.
In the second LOI it was explained that the central bank’s liquidity support to
the banking sector was intended to defend the banking system from collapse:
By mid-November, a large number of banks were facing growing liquidity shortages,
and were unable to obtain sufficient funds in the interbank market to cover this gap ...
At the same time, another smaller group of banks were becoming increasingly liquid,
and were trading among themselves at a relatively low JIBOR (Jakarta Interbank Offer
Rate) ... As this segmentation continued to increase, while the stress on the banking system intensified, Bank Indonesia was compelled to act. It provided banks in distress with liquidity support, while withdrawing funds from banks with excess liquidity ... (GOI 1998:
paragraph 15, emphasis added).
This passage shows that the policy of providing liquidity to banks during the
crisis was a step that the central bank was compelled to take in an effort to prevent the banking sector and payments system from collapsing. The decision was
based on article 32 (3) of the Central Bank Act of 1968, which gave BI, as lender
of last resort, the authority to provide banks with the liquidity they needed in the
face of runs. The decision was also based on the explicit 3 September 1997 instruction from the president to BI to help banks with liquidity problems.
In late January 1998, the government announced a full (‘blanket’) guarantee to
depositors and creditors of all nationally incorporated banks. Claims against this
guarantee were also to be borne by the government budget. In late February 1998,
the government decided to extend this guarantee to all deposits that had been
held at the previously liquidated banks, not just those of small depositors.
From the sequence of decisions by the government (or the president) and BI as
outlined above, the ownership of the policy of providing liquidity support to the
banking sector and the resulting burden of financing is clear. And yet, after BI
was granted autonomy with the enactment of Law No. 23/1999 on Bank Indonesia, and when the worst period of the crisis was over, the question of ownership of the policy, and the question of who should be made accountable for its
costs, became political issues.
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Contrary to the claim by the three former ministers of finance and others during the parliamentary hearing in February 2000, the decision by BI to provide liquidity support to the banking sector was not an incorrect interpretation of
government policy, nor was it in violation of the Central Bank Act. In other
words, it was not an action that implied any misuse of the power or authority
bestowed on BI and its board of directors (of which I, as governor, was chairman).
Indeed, in its report on the investigation into the issue of liquidity support, the
Parliamentary Working Committee concluded that the decision that BI would
provide liquidity support was a government policy based on abnormal crisis conditions (BI 2002: 94; DPR 2000).
PROVIDING LIQUIDITY SUPPORT TO FRAGILE BANKS
Critics of the policy of providing banks with liquidity support have questioned
why BI allowed banks to overdraw their accounts, which amounted to making
unsecured loans to them, instead of providing the usual discount facilities, which
were more secure. There was in fact good reason for this. Technically, a bank must
be able to predict the shortfall in its clearing account (as a result of known, abnormally large, cash outflows) in order to be able to request access to the discount
facility. But in the face of mass deposit withdrawals triggered by panic, it will
only discover the actual shortage from the daily clearing process. By contrast, the
overdraft facility can be provided automatically, since the banks do not have to
submit an official proposal to use it. As already noted, rapid response is very
important during crises, and this was the simplest and quickest procedure for
helping banks—and thus averting the collapse of the national payments system.
Liquidity support provided in this way does have the disadvantage that the
facility is unsecured, but BI and the government continued to believe that the crisis would be of short duration. (Indeed, the president’s instruction, in response to
the first daily report on movement of the exchange rate after the float, was to
maintain the float for 2–3 weeks, which seemed to demonstrate his own expectation that the crisis would soon be over.) When it lasted longer than expected, BI
abandoned the overdraft facility in favour of a longer-term discount facility, as
well as using market debt instruments, both of which were more secure.
Providing liquidity support through the clearing mechanism has been very
costly, but the fact that at one point there were more than 160 banks receiving liquidity support, while only about one-third of these ultimately became problematic, implies that the rest complied with the rules. The very high interbank rates
on different occasions also showed that some banks did not resort to liquidity
support, but were able to meet their liquidity needs through the market process.
Finally, many banks, including some that received huge amounts of support, as
well as the national payments system itself, survived Indonesia’s worst financial
crisis. Whether this justifies the liquidity support policy, time will tell.
Another valid question, raised in BPK’s investigative audit, is why BI continued to provide liquidity support to banks that violated the rules on the use of
these funds. The explanation for this is that BI only learned through its supervisory practices whether the funds had been used in accordance with these rules,
and this involved significant lags. Supervision was conducted through analysis
of reports submitted by banks (off-site supervision), and through inspection vis-
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69
its to their offices (on-site supervision). Before the crisis, owing to a shortage of
bank supervisors (there were around 1,100 bank supervisors for 238 banks with
several thousand branches in total), banks were inspected once every 18 months
on average. Even the more up-to-date supervision based on reports submitted by
banks involved delays.
In short, with weak banking supervision, and with monitoring subject to considerable delays in a fast changing environment, violations in the use of liquidity
support were both possible and difficult to detect. Obtaining a clear picture of
whether there were indeed violations—and possibly criminal actions—in both
the provision and the use of liquidity support depends on whether the fund flows
relating to liquidity support can be traced.
LIQUIDITY SUPPORT AND
GOVERNMENT RECAPITALISATION BONDS
As Dr Dradjad Wibowo has noted, increases in the size of the negative balance of
banks with BI seem to be associated with the government’s various steps in
addressing the crisis (Wibowo 2002). Greater forbearance towards banks with
negative balances seemed to follow the float of the rupiah in August 1997, the closure of the first 16 banks in November 1997, the introduction of the blanket guarantee and the transfer of authority over problem banks to IBRA in January 1998,
and the riots that precipitated Soeharto’s resignation in May 1998. All these steps
were associated with heightening uncertainty in the market, which seemed to
lead to a ‘flight to safety’ and bank runs. The commercial banks’ aggregate negative balance (overdraft) with BI increased from just Rp 1.4 trillion in July 1997 to
Rp 15.3 trillion by the end of 1997, and to Rp 79.7 trillion by May 1998 (table 1).
It remained at this level through much of 1998, despite BI’s efforts to replace this
liquidity facility with other, more secure instruments, and to cease allowing
banks to run negative balances. Indeed, this is the essence of a systemic bank run.
BI could not prevent people who were losing confidence in the banking system
from withdrawing their funds—to spend on goods and services, to shift to banks
perceived to be safe, or to transfer abroad.
The gross cost to the government of financial support provided to the banks is
very high (although some part of this cost will be recouped, to the extent that
IBRA is successful in recovering loans in default and in seizing assets pledged to
it by banks and their owners). From 1996 to 1999, the total amount of liquidity
support given to some 164 banks amounted to Rp 179 trillion (table 1), while the
amount of government bonds issued for bank recapitalisation amounted to
Rp 431 trillion. The total of these two components is close to 50% of GDP—higher
than corresponding figures for banking crises in Chile (1981, 43%), Uruguay
(1981, 32%), Japan (1992, 22%), Venezuela (1994, 25%), Thailand (1997, 35%),
South Korea (1997, 28%) or Malaysia (1997, 18%) (Rojas-Suarez 2002).
RESOLVING PROBLEMS OF LIQUIDITY SUPPORT
In its investigative audit, the Supreme Audit Agency found that liquidity support
to the banking sector from 1996 to January 1999 amounted to Rp 144.5 trillion.
The audit report claimed that because of deviations in the channelling of funds
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1.4
1.2
11.0
11.8
9.6
2.2
10.7
12.8
5.1
40.4
11.6
9.9
1.7
15.3
1.4
34.6
62.9
15.2
9.6
5.6
79.7
21.9
31.6
148.4
Jul-98 Aug-98 Dec-98 Jan-99 Feb-99 Apr-99 Dec-99
15.2
9.6
5.6
78.5
33.8
31.2
9.0
15.2
9.6
5.6
79.5
35.8
30.6
16.0
15.3
9.7
5.6
84.2
35.8
29.7
13.3
167.7
177.1
178.3
14.6
9.3
5.3
71.5
30.6
24.9
11.8
20.0
173.4
14.4
9.1
5.3
66.8
28.5
23.7
13.3
20.0
166.7
9.1
9.1
9.0
9.0
7.6
7.6
6.5
0.7
0.5
1.0
7.2
2.4
162.7
181.8
7.2
3.3
162.7
182.3
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8.4
8.4
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Extended lending
Subordinated/emergency loansa
Bridging loansb
Debit balance positionc
Discount facilitiesd
Commercial papere
Trade arrearsf
Government bondsg
Total
162.7
178.5
a
Pre-crisis loans to troubled banks.
Advances to repay small deposits (ultimately all deposits) of the first 16 banks liquidated (in November 1997).
c Overdrafts and facility to replace overdrafts at BI (introduced in August 1998).
d Discount window loans, including new discount facility (introduced in March 1998).
e SBPUs and special SBPUs (introduced in December 1997).
f Repayment of banks’ international trade transaction arrears.
g Bonds issued to BI by the government in exchange for most of BI’s liquidity support claims on the banks.
b
J. Soedradjad Djiwandono
Source: Adapted from Indonesia: Statistical Appendix, IMF Staff Country Report 00/133, October 2000: table 30.
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70
TABLE 1 Liquidity Support to Banks from Bank Indonesia and Government
(selected dates, Rp trillion)
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by the central bank and their use by recipient banks, the government might suffer losses of Rp 138.4 trillion, 95.7% of the total amount provided to the banking
sector throughout this period.
BI raised a number of concerns about the nature, procedures and findings of
this audit, the most crucial of which were as follows:
• The audit was more in the nature of a compliance audit than an investigative
audit, since it focused largely on whether central bank actions were generally
in compliance with existing rules and regulations. But the rules and regulations were set up for normal conditions, while the facilities in question were
provided in conditions of crisis. The prevailing economic and financial conditions that compelled BI to provide liquidity support were completely ignored
in the audit.
• The audit did not take into consideration the function and authority of the central bank in conducting monetary and banking policy, and no consideration
was given to whether the provision of liquidity support was outside the jurisdiction of BI, or whether it was a misuse of the central bank’s authority.
• The policy of not excluding banks with negative balances from participating in
the clearing during an emergency was in accordance with the Central Bank
Law of 1968 and with the government’s then policies of assisting banks with
liquidity shortages and of not liquidating banks.
BI raised various other concerns relating to the findings of the audit. For example, the audit report argued that BI’s advance for repayment of deposits at the liquidated banks was a deviation from the rules for bank liquidation. The
government regulation on bank closures stipulates that payments to deposit
holders should be financed through the sale of assets of the liquidated banks
(GOI 1996), so BI could not ask the government to bear this burden. However, this
ignores the fact that the decision to liquidate banks was a government decision,
and that the government promised to bear the burden of repaying small depositors. This was confirmed in a letter dated 20 February 1998 from the finance minister to me as BI governor.
In BI’s view, the liquidity support problem had been dealt with legally through
the Master Settlement and Acquisition Agreements (MSAAs), the Master Refinancing and Note Issuance Agreements (MRNIAs), and other agreements
between IBRA and bank owners regarding the repayment of what they owed to
the government through their use of the support they had received.9 The MSAAs
and MRNIAs are agreements between IBRA and the principal owners of private
sector banks that received large amounts of liquidity support, some of which had
seriously violated the legal lending limit regulations. Under the MSAAs, IBRA
acquired ownership of certain of these owners’ assets. By contrast, the MRNIAs
are agreements under which the owners pledged, but did not surrender ownership of, assets to back up their personal guarantee of repayment of the liquidity
support. MRNIAs were used to secure repayment of liquidity support by certain
problem banks with which the government was unable to negotiate the acquisition of sufficient assets to cover their BLBI liabilities.
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In November 2000 the Parliamentary Working Committee on BLBI reviewed
the issues raised by BPK in its investigative audit of BI, and came to a number of
conclusions, including the following:10
• BI’s liquidity support reflected a policy decision by the government taken on
3 September 1997 in the face of the crisis.
• Since this policy was intended to address the crisis it was not based on rules
and regulations that apply under normal conditions.
• Resolution of the liquidity support problem should aim to hasten recovery of
the real sector and minimise the loss to the government. Therefore the solution
that relied on the MSAAs and MRNIAs was acceptable.
• The liquidity support problem should be resolved in such a way as to minimise
the cost to the government budget, with bonds held by BI and recapitalised
banks being redeemed as soon as possible.
Parliament asked the government and the central bank to work together in
seeking a solution to the problem, with a view to minimising the budgetary costs
and resolving where financial responsibility for the liquidity support policy lay.
To these ends the government formed a working team comprising the coordinating minister for economics and finance, the minister of finance, the governor of
BI and the attorney general.
On 17 November 2000 the government and BI released a document entitled
‘Basic Agreements between the Government and BI’, which included the following points:
• The government and BI agreed that liquidity support had been provided by
the central bank in order to save the monetary and banking system, as well as
the national economy, from collapse.
• The cost of liquidity support would be shared between the government and BI,
with a view to minimising costs to the budget. IBRA would make concerted
efforts to maximise asset recovery, while BI would bear part of the costs, to the
extent its own financial condition allowed.
• Taking its financial condition into consideration, BI agreed to bear Rp 24.5 trillion of the total cost.
However, when the Megawati Sukarnoputri government took office in July
2001, the appropriateness of this agreement on burden sharing came into question. An independent team comprising several Indonesian and international
experts (among them Paul Volcker, the US Federal Reserve chair during the Reagan administration) was formed and asked to recommend a suitable resolution.
On the issue of burden sharing between the government and BI, the team proposed that the promissory notes that the government had issued to BI should be
viewed as capital support and maintenance for BI. Such support would reflect the
government’s ultimate responsibility to maintain the financial strength of its central bank. To make this support transparent, the existing interest-bearing promissory notes should be replaced by a special issue of perpetual zero interest capital
maintenance notes (CMNs). The team’s recommendation seemed to be acceptable
to the government and BI (GOI 2002).11
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Liquidity Support to Banks during Indonesia’s Financial Crisis
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FINAL COMMENTS
It is my conjecture that lack of transparency and the serious problem of weak governance, together with public misunderstanding of, and misinformation about,
the operations of banks and the central bank, have prevented the public from
acquiring an accurate perspective on these complex issues. Since the credibility of
government institutions and officials, including the central bank, had generally
been weak in the past, it was inconceivable to many members of the public that
support of the commercial banks involving trillions of rupiah could be undertaken in the absence of kickbacks. Sadly, this difficult issue lingers on, without
any clear prospect for its resolution. In such circumstances, straight and clean
officials can be accused and found guilty of corruption, even in the absence of evidence to support such accusations. The champions of justice in their fight against
corruption have tended to overlook the plight of such officials, forgetting that a
corrupt legal system (widely defined) can be used not only to protect wrongdoers
but also to attack the innocent.
NOTES
*
1
2
3
4
5
6
7
8
Emeritus Professor of Economics,
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Liquidity support to banks during Indonesia's
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J. Soedradjad Djiwandono
To cite this article: J. Soedradjad Djiwandono (2004) Liquidity support to banks during
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Bulletin of Indonesian Economic Studies, Vol. 40, No. 1, 2004: 59–75
Taylor & Francis Group
LIQUIDITY SUPPORT TO BANKS
DURING INDONESIA’S FINANCIAL CRISIS
J. Soedradjad Djiwandono*
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University of Indonesia, Jakarta, and Nanyang Technological University, Singapore
During the 1997–98 financial crisis, Bank Indonesia provided liquidity support to
many banks experiencing difficulties. This policy became controversial because of
the magnitude of the likely losses to the government, which in the end would have
to be borne by the general public. Suspicions of corruption involving bankers and
officials of Bank Indonesia fuelled the debate. Surprisingly, however, concerns of
this kind have not been raised in relation to the far larger amount of support
provided to banks by the government in the form of recapitalisation bonds. The
public’s lack of understanding of the operations of the banking sector further complicated the debate. This paper attempts to shed some light on the central bank’s
actions and on the proposed solutions to the problems that arose from them.
INTRODUCTION
Several steps taken by Bank Indonesia (BI, the central bank) during the first several months of the financial crisis that began in mid 1997 have become the subject
of public controversy, particularly the provision of liquidity support to banks.1
This policy was intended to prevent the collapse of the banking industry and the
national payments system during the crisis, but it became controversial following
the issue of two reports by the Supreme Audit Agency (Badan Pemeriksa
Keuangan, BPK) after its audits of BI. The first reported the results of a general
audit, and was issued by the agency in November 1999. It was accompanied by a
disclaimer indicating that the auditor could not obtain sufficient information to
make a conclusive evaluation. The second, the report of an investigative audit
requested by the parliament was issued in July 2000. This report confirmed the
suspicion of possible criminal acts, either in the use of funds by the recipient
banks or in the provision of funds by the central bank, or both (BPK 2000).
In February 2000 the Parliamentary Working Committee on BLBI (Bantuan
Likuiditas Bank Indonesia, BI Liquidity Support) summoned officials and former
officials of BI and the Ministry of Finance to testify on the question of whether the
central bank or the government had initiated the liquidity support policy. This
led to public debate after a statement during the proceedings by three former
ministers of finance (Mar’ie Muhammad, Fuad Bawazier and Bambang Subianto)
that the central bank’s actions were based on its misunderstanding of actual government policy. According to the former ministers, the government’s involvement in liquidity support for banks was by way of a Presidential Instruction
dated 3 September 1997, issued after a cabinet meeting that day. They testified
ISSN 0007-4918 print/ISSN 1472-7234 online/04/010059-17
DOI: 10.1080/0007491042000205204
© 2004 Indonesia Project ANU
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J. Soedradjad Djiwandono
that the central bank did not consult the Ministry of Finance in implementing this
instruction (Sukowaluyo 2001: 27–31).
The liquidity support issue had already been raised in news and gossip circulating on the internet as early as November 1997. In some writings it was alleged
that BI had been secretly helping a number of large ethnic Chinese conglomerateowned banks, such as BCA (Bank Central Asia), Danamon, BUN (Bank Umum
Nasional) and Lippo, with liquidity support amounting to trillions of rupiah. In
November 1997, these writings were collected and published in a booklet entitled
Konspirasi Menggoyang Soeharto [Conspiracy to Topple Soeharto] (Anonymous
1997). The public perceived the conglomerates as symbols of the social ills of
Indonesia—in particular, the corruption, collusion and nepotism of the Soeharto
era. Some argued that bankers and bank owners were the beneficiaries of funds
provided by BI as liquidity support to their banks—and that they constituted the
group that, in cooperation with BI officials, had caused the near bankruptcy of the
economy. It was therefore unfair, so the argument continued, that the general
public had to bear the burden of bailing out these conglomerates. This is a very
appealing argument, but it is flawed nonetheless.
The public’s perception of these matters appears to have been worse than the
reality. The decision to provide liquidity support to banks suffering distress
caused by bank runs was in line with the central bank’s function as lender of last
resort, and in conformity with the government’s then policy of not closing banks.
But in circumstances of non-transparency and weak governance, the public’s preconceptions about the banking system, and its lack of information about how the
system functioned, meant that the decision was bound to generate controversy.
WHAT IS LIQUIDITY SUPPORT?
Liquidity support is funding provided by a central bank to banks suffering a liquidity shortfall as a result of negative net cash flow; it may be extended on varying terms, depending on the precise nature of the liquidity problems the banks
face. As lender of last resort and guardian of the payments system, BI had introduced various schemes of liquidity support since its transformation from the old
De Javasche Bank in 1953 into the central bank of the new republic. Although the
public was reasonably familiar with the discount window or rediscount facility,
the term ‘BI liquidity support’ only became widely known in early 1998, when it
was alluded to in the government’s second letter of intent (LOI) to the IMF (GOI
1998: paragraph 15).
The term BLBI includes all lending by the central bank to the banking sector
other than BI Liquidity Credits (Kredit Likuiditas BI, or KLBI); the latter are loans
provided to commercial banks at subsidised interest rates to support government
programs such as finance for small and medium scale enterprises, cooperatives
and the logistics agency, Bulog. Using this broad definition, we can identify as
many as 15 different facilities that BI has employed to provide liquidity to banks.
These can be grouped into the following five categories:
1 Liquidity support to banks suffering shortfalls due to unexpected net cash outflows.
This was of two types: one that bore a very short term of 15–30 days and was
unsecured, termed Discount Facility I, and another for short terms of 90–150
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5
61
days, termed Discount Facility II. The latter required promissory notes as collateral.
Liquidity support through open market operations. This facility involved BI rediscounting promissory notes or other debt instruments of commercial banks
(known collectively as Surat Berharga Pasar Uang, SBPU), either through periodic auctions or through direct deals with banks in need.
Liquidity support in the context of bank rescues or ‘nursing programs. This involved
emergency and subordinated loans from BI to problem banks that were in the
process of being restructured through mergers or acquisitions.
Liquidity support to banks facing runs, provided to stabilise the banking industry and
the payments system. This facility allowed banks to overdraw their accounts
with the central bank without being excluded from the clearing (the daily
process of adjusting each bank’s balance in its clearing account with BI after
recording the impact of all cheques and other payment orders drawn against it
or in its favour).
Liquidity support provided to defend market confidence in the banking sector. These
facilities were in the form of advances by BI (on behalf of the government) to
compensate banks for taking over deposits previously held at other banks that
were to be liquidated, and to pay Indonesian banks’ arrears to their foreign
counterparts in relation to trade financing and interbank debt exchange offers.
The first two categories of liquidity support are similar to instruments that
most central banks provide in their capacity as monetary authorities and lenders
of last resort, and they had long been used by BI in its day-to-day operations. BI
had also resorted to the third and fourth types before the crisis in its attempts to
restructure certain problem banks. In other words, these four forms of liquidity
support were in use by BI in the normal conditions that existed before mid 1997.
The use of the fourth type of liquidity support, however, was greatly expanded
during the crisis as a means to avoid collapse of the entire banking system, while
the fifth arose during the crisis as a result of BI acting on behalf of the government
in meeting the claims of depositors and of foreign bank creditors of closed and
troubled domestic banks. The overdraft facility (type 4) was quantitatively the
most significant of the five types of liquidity support. Before going on to discuss
this, it will be helpful to provide some background on BI’s attempts to deal with
troubled banks in the last few years before the crisis.
STALLED ATTEMPTS TO DEAL WITH PROBLEM BANKS
In dealing with problem banks in the past, BI had adopted a case-by-case
approach, whereby it could take a variety of steps to restore a bank’s health
before resorting to liquidation. These steps, set out in article 37 of the 1992 banking act, ranged from requiring the bank to increase capital or change its management to assisting it to undergo merger with or acquisition by interested investors.
If all these efforts failed to make the bank healthy, it would then be liquidated. In
other words, bank closure was considered the last option, after all other alternatives had been exhausted. BI interpreted article 37 as reflecting a view that the stability of the banking sector, as an integral part of the national payments system,
was crucial for the central bank to conduct its operations.
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The case-by-case method was discarded when BI was faced with an increasing
number of problem banks following the weakening of the economy toward the
end of the 1980s and in the early 1990s.2 Instead, a more systemic approach was
adopted. In December 1996, together with two managing directors in charge of
bank supervision, I submitted a proposal to President Soeharto for the closure of
seven insolvent banks, after various efforts to overcome their problems had
failed. Unfortunately he did not approve this proposal, and instead instructed BI
to finalise a draft government decree on bank closures.3
At the time there was no specific regulation on bank liquidation, even though
this was provided for in the banking law of 1992. This implied that if a bank were
to be liquidated, the general liquidation regulations for ordinary corporations
would need to be applied. A problem here was that a liquidator could not treat
depositors as priority creditors in the distribution of proceeds from disposal of
the banks’ remaining assets. In other words, the payment to depositors of liquidated banks could only be done in parallel with payment to other creditors, as
had been the case with the long drawn out liquidation of Bank Summa in 1992
(MacIntyre and Sjahrir 1993: 12–16). Because of this consideration and the president’s disinclination to see banks liquidated, there had been no further bank closures up to this time.
In April 1997, BI again proposed the liquidation of the seven problem banks,
since their status had not improved. This time the president gave his approval.
However, he instructed BI to postpone implementation until after the general
election in October 1997 and the general session of the Peoples’ Consultative
Assembly (MPR) in March 1998, because of his concern over the implications of
bank closures for social and political stability. Unfortunately, the financial crisis
intervened in July 1997. As conditions deteriorated the number of problem banks
increased, but BI did not have the option of closing them, because of the president’s instruction to avoid any closures until after the MPR session.
LIQUIDITY SUPPORT TO ADDRESS THE BANKING CRISIS
The government’s decision to float the rupiah on 14 August 1997 (Lindblad 1997:
4–5) proved a shock to Indonesian businesses. Uncertainty about the exchange
rate created panic among those members of the business community that had
high levels of foreign exchange exposure. They began to buy dollars heavily,
while other parties that might normally have been expected to supply dollars to
the market failed to do so, causing the currency to depreciate rapidly.4
To defend the currency the authorities responded by implementing a severe
liquidity crunch, through a combination of expenditure reductions by the government and administrative intervention; the latter took the form of an instruction
from the finance minister to state enterprises to switch their bank deposits into BI
Certificates (SBIs).5 The SBI interest rate was also increased significantly at this
time, but this would have had little effect, since market rates rose to much higher
levels still as a result of these other actions. In August the average interbank rate
rose from 20% to 90% p.a.—reaching as high as 200% for one or two days—making the purchase of SBIs unattractive to market participants. Indeed, one symptom of the severity of the liquidity squeeze was that a number of banks sold SBIs
back to BI before they matured.
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At much the same time, depositors began to withdraw funds from banks perceived to be weak, thus significantly exacerbating the impact on the banks of the
system-wide liquidity squeeze. The banking industry became distressed, and
many banks’ clearing balances fell to negative levels. Banks that still had excess
liquidity at this time chose to hold on to it for precautionary reasons, rather than
lending to other banks. Thus banks faced with net cash outflows were forced to
draw on funds deposited with BI in fulfilment of their reserve requirement, causing these to fall below the regulatory minimum: the number of banks failing to
meet the requirement rose from 14 on 15 August to 51 by the end of the month.
When massive deposit withdrawals continued, the remaining reserves were
quickly exhausted, and many banks began to have negative balances with BI; by
the end of the year 29 banks suffered from this problem.
With the benefit of hindsight, it can be seen that the liquidity squeeze resulting
from defence of the rupiah after its float was too stringent, resulting in a severe
blow to the banking system. As it became aware of this, the government specifically instructed BI to provide liquidity support on a discretionary basis to banks
experiencing liquidity problems. This policy was introduced on 3 September
1997, prior to the commencement of the IMF program, in the form of a set of
directives by the president to the cabinet (GOI 1997a).
In normal conditions, any bank that experienced a negative balance with the
central bank at the end of the daily clearing process was given one day to settle
the obligation, in accordance with a BI regulation adopted in 1990, which stipulated that a bank that failed to do so would be excluded from the clearing
process.6 The Supreme Audit Agency’s report on BI drew attention to this regulation, which has become a rallying point for critics of BI management’s continuing to provide liquidity support rather than halting many banks’ operations. The
regulation was not intended to apply in abnormal circumstances that threatened
a collapse of the banking system, however. As we have seen, BI interpreted article 37 of the banking act as requiring it to take whatever measures it considered
necessary to safeguard the stability of the banking system. Ordinarily, a bank
would restore its clearing balance by borrowing funds from other banks in the
interbank money market. It could also request BI to provide additional liquidity
but, as long as funds were available to it in the interbank money market, the bank
would avoid using the BI facility, since it bore a much higher penalty rate of interest; in addition, this would result in its financial problems being exposed to other
banks.
Liquidity support in normal conditions mainly took the form of discount facilities and the rediscount of banks’ promissory notes, which provided reasonable
security for BI. The procedure was somewhat cumbersome, however, and in the
face of system-wide liquidity shortfalls, speed is essential if support is to be effective in safeguarding the payments system (Sheng 1998). Thus BI decided to help
banks that had negative balances with it by allowing them to continue to participate in the clearing. This modification of the usual practice permitted the banks
to operate normally, thus maintaining the functioning of the payments system,
and giving the banks a chance to overcome their liquidity problems and to repay
their debts to the central bank later on. The alternative would have been widespread liquidation of distressed banks, with the disposal of their assets and liabilities effected through bankruptcy proceedings. Such an outcome would have
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been inevitable given the level of public confidence in the banking system, which
was so low that even a groundless rumour about a bank suffering a shortfall in
the clearing could lead to a run on that bank. Indeed, on several occasions during
this period banks suffered runs as a result of such rumours. Any announcement
by BI barring a bank from the clearing would have amounted to a ‘nail in its coffin’, and if such an announcement had involved a number of banks it would have
generated widespread bank runs.
In summary, in the first few months of the crisis BI provided liquidity support
to banks that were in need of it, in accordance with its function as lender of last
resort, and in defence of the banking industry and the payments system. The liquidity support was made available to banks without discrimination; it was certainly not restricted to banks owned by Soeharto’s cronies or to any other group.
The disadvantage of allowing banks with negative clearing balances to continue to participate in the clearing was that there were no safeguard measures to
protect BI. But the expectation was that the crisis would be over quickly, and that
the banks would soon be able to regain lost deposits; in the meantime, the banking industry would be saved from collapse. In the event, however, the cost of providing unsecured liquidity support proved to be very high. We do not know what
the outcome would have been if, instead of being provided with liquidity support, banks had been barred from the clearing, as critics of BI liquidity support
seem implicitly to advocate. Argentina in November 2001 and Uruguay in July
2002 elected to limit the withdrawal of deposits from banks, which would have
had much the same effect as barring banks from the clearing. It remains to be seen
what the end result of this policy will be, but it has been reported that the decision caused social and political turmoil in Argentina at least (Ashari 2002;
Mongid 2002; Mussa 2002).
BANK CLOSURES
With the rapid deterioration of economic conditions during September and October 1997, the government turned to the IMF for assistance. A prominent feature
of the program decided upon was the closure on 1 November of 16 small banks,
including the seven banks whose liquidation BI had earlier proposed. During discussions with IMF staff I pointed out that BI was already fully prepared to close
these seven banks (and that I had brought this to the attention of the president
before the crisis), but I also stated that my staff needed more time to prepare for
the closure of other banks. The IMF staff repeatedly asked me not to worry too
much, however. As Dr Bijan Aghevli, chief of the IMF negotiating team, pointed
out, the 16 banks constituted only 3% of the total assets of the Indonesian banking industry.
In fact, the turmoil in the banking sector became even more severe following
the closure of these 16 banks, leading the banking industry to lose credibility.
Depositors reacted by moving a large amount of funds to banks considered safe,
and the interbank money market became segmented: it functioned well enough
for the ‘safe’ banks, but not for the many others that lost deposits. The source of
the problem was not just withdrawals by depositors, but also the termination of
lines of credit by foreign banks for trade financing. Thus the number of banks suffering liquidity shortfalls increased further, resulting in a crisis for the banking
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65
sector as a whole. The government addressed the systemic liquidity problem of
banks by issuing a blanket guarantee of the banks’ liabilities and by creating a
special institution on 26 January 1998 to deal with problem banks, the Indonesian
Banking Restructuring Agency (IBRA). It also assisted banks in meeting payment
of trade financing arrears with foreign banks.7 Meanwhile, the previously
announced policy of avoiding additional bank closures was restated by President
Soeharto in an attempt to prevent further loss of public confidence in the banking system. After signing the second LOI to the IMF on 15 January 1998, the president stated that the government would not liquidate more banks, but would
urge those experiencing difficulties to merge with others; meanwhile, banks
would be subject to more stringent supervision than in the past (Suara Pembaruan,
16/1/98).
As the financial turmoil developed into a prolonged economic crisis, banks
faced an increasing volume of non-performing loans; the initial liquidity problem
had now become one of widespread insolvency. Since the closure of all banks that
had become insolvent would almost have wiped out the banking sector, in
August 1998 the government initiated a program of bank restructuring involving
recapitalisation of both state-owned and private banks (Fane and McLeod 2002).
The plan was for owners of problem banks to provide 20% of the capital needed
to raise the banks’ capital adequacy ratios (CARs) to 4%, and for the government
to provide the remaining 80%. Thus the focus of government policy switched
from the provision of liquidity support by the central bank to making good
banks’ losses through the injection of government bonds, the repayment of which
would be a call on the budget.
As policies for addressing problems encountered by banks during the crisis,
liquidity support and recapitalisation have not been fundamentally different, in
the sense that both were intended to help banks address problems arising from
the lack of funds needed to fulfil operational requirements. Liquidity support
supplemented the banks’ short-term assets so as to meet short-term payment
obligations, while recapitalisation injected new long-term assets to make good
accumulated losses, and thus to enable banks to meet the minimum CAR. In a
sense, therefore, BI’s liquidity support can be seen as a down-payment on guarding the banking system from collapse. It should be noted that the amount of
funds eventually committed by the government through recapitalisation (around
Rp 431 trillion) far exceeds the amount of BLBI (Rp 179 trillion). It is therefore surprising that only BI has been so heavily criticised in relation to the banking crisis,
even though the government has supplied a far larger share of the funds needed
to support the banks, and has even been commended for its recapitalisation
policy.
THE CONTROVERSY OVER LIQUIDITY SUPPORT
The provision of liquidity support became controversial when its financial implications began to become clear, and allegations of corruption in the process began
to emerge, as a result of which ‘ownership’ of the policy became an issue. Here it
is relevant to look at the government’s policy making role—as distinct from that
of BI—in this area. As we have seen, BI’s initial decision to allow banks to continue to operate despite having negative balances with it was based on its role as
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lender of last resort, on the one hand, and the president’s instruction not to allow
any bank closures until after the March 1998 MPR session, on the other.
The 3 September 1997 directives from the president referred to above modified
this earlier instruction to some extent, however. On liquidity support, the directives confirmed that healthy national banks suffering from liquidity problems
should temporarily be provided with additional liquidity. But it was now explicitly stated that banks that were clearly unhealthy should be put under a program
of merger and acquisition with healthy banks, and that if this effort failed they
would be liquidated, with a view to protecting the interests of deposit holders,
especially small depositors (GOI 1997a: point 8).
This raises questions about why unhealthy banks received liquidity support,
why there were no bank closures immediately after the issuing of this instruction,
and why there were no mergers or acquisitions of banks until much later. Part of
the explanation is that the president saw bank closures very much as a last resort,
as indeed was the underlying rationale of article 37 of the banking law. The decision to proceed with some closures was taken only in October 1997, as a ‘prior
action’ required by the IMF-supported program.8 In essence, the president’s
opposition had been overcome with the help of pressure from the IMF during its
initial negotiations with the government. (Even so, his position was soon
reversed, when many banks faced severe runs after the first group of bank closures in November 1997 generated a very negative public reaction.) The government promised in November 1997 not to liquidate more banks, and at the same
time it announced new economy policies for the real sector. The minister of trade
and industry, the finance minister and I as governor of BI announced the overall
policy package after we had reported to President Soeharto in his office (Kompas,
4/11/97).
What about bank mergers? This was not something that could be done
overnight. However, preliminary moves had commenced immediately following the announcement of the government’s policy package of 3 September 1997.
With respect to the state banks, initially the plan was to deal first with the downsizing and merger of two insolvent banks, Bank Bumi Daya and Bapindo. In a
document (‘side letter’) that accompanied the first LOI (but that was never made
public), it was stated that these banks would be merged by December 1997, after
separating their ‘good’ from their ‘bad’ assets. Before this merger could be
implemented, however, it was decided instead, in January 1998, to extend it to
include Bank Dagang Negara (BDN) and Bank Ekspor Impor Indonesia (Exim);
the merged entity was later to become Bank Mandiri. With respect to the private
banks, the process was even slower. By December 1997, with the assistance of BI
as mediator, a number of banks had produced memoranda of understanding
that formally stated their intention to merge, but without any concrete timetable
for doing so.
Opposition from the president aside, it is important to appreciate that implementation of mergers and acquisitions requires considerable time. Banks only
became willing to proceed with them toward the end of 1997; in the interim,
while negotiations between the banks and potential investors were under way,
there was nothing BI could do other than to help those in need of additional liquidity. In any case, the government’s policy on provision of, and ultimate responsibility for, liquidity support to banks was clearly stated in the first LOI to the IMF
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(GOI 1997b), which detailed the government’s program for addressing the crisis,
including the initial bank closures. Relevant points included the following:
• The government guaranteed small deposits at the banks that were to be liquidated, up to a maximum of Rp 20 million each (around $5,000 at the time). Payments to the depositors in question were to be administered by BI and funded
by the government (GOI 1997b: paragraph 26, emphasis added).
• BI would streamline its lender of last resort function. Loans to illiquid but solvent banks would be provided in accordance with stringent access conditions.
These loans would be collateralised and extended to individual institutions at
increasingly punitive interest rates. Any emergency assistance to banks to prevent systemic risks would be explicitly guaranteed by the government (GOI 1997b:
paragraph 36, emphasis added).
The liquidation of the 16 banks in November 1997 was one of the pillars of the
government’s IMF-supported adjustment program. Note the explicit stipulations
that the government would bear the cost of bailing out small depositors and
would guarantee any financial assistance to overcome systemic risks.
In the second LOI it was explained that the central bank’s liquidity support to
the banking sector was intended to defend the banking system from collapse:
By mid-November, a large number of banks were facing growing liquidity shortages,
and were unable to obtain sufficient funds in the interbank market to cover this gap ...
At the same time, another smaller group of banks were becoming increasingly liquid,
and were trading among themselves at a relatively low JIBOR (Jakarta Interbank Offer
Rate) ... As this segmentation continued to increase, while the stress on the banking system intensified, Bank Indonesia was compelled to act. It provided banks in distress with liquidity support, while withdrawing funds from banks with excess liquidity ... (GOI 1998:
paragraph 15, emphasis added).
This passage shows that the policy of providing liquidity to banks during the
crisis was a step that the central bank was compelled to take in an effort to prevent the banking sector and payments system from collapsing. The decision was
based on article 32 (3) of the Central Bank Act of 1968, which gave BI, as lender
of last resort, the authority to provide banks with the liquidity they needed in the
face of runs. The decision was also based on the explicit 3 September 1997 instruction from the president to BI to help banks with liquidity problems.
In late January 1998, the government announced a full (‘blanket’) guarantee to
depositors and creditors of all nationally incorporated banks. Claims against this
guarantee were also to be borne by the government budget. In late February 1998,
the government decided to extend this guarantee to all deposits that had been
held at the previously liquidated banks, not just those of small depositors.
From the sequence of decisions by the government (or the president) and BI as
outlined above, the ownership of the policy of providing liquidity support to the
banking sector and the resulting burden of financing is clear. And yet, after BI
was granted autonomy with the enactment of Law No. 23/1999 on Bank Indonesia, and when the worst period of the crisis was over, the question of ownership of the policy, and the question of who should be made accountable for its
costs, became political issues.
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Contrary to the claim by the three former ministers of finance and others during the parliamentary hearing in February 2000, the decision by BI to provide liquidity support to the banking sector was not an incorrect interpretation of
government policy, nor was it in violation of the Central Bank Act. In other
words, it was not an action that implied any misuse of the power or authority
bestowed on BI and its board of directors (of which I, as governor, was chairman).
Indeed, in its report on the investigation into the issue of liquidity support, the
Parliamentary Working Committee concluded that the decision that BI would
provide liquidity support was a government policy based on abnormal crisis conditions (BI 2002: 94; DPR 2000).
PROVIDING LIQUIDITY SUPPORT TO FRAGILE BANKS
Critics of the policy of providing banks with liquidity support have questioned
why BI allowed banks to overdraw their accounts, which amounted to making
unsecured loans to them, instead of providing the usual discount facilities, which
were more secure. There was in fact good reason for this. Technically, a bank must
be able to predict the shortfall in its clearing account (as a result of known, abnormally large, cash outflows) in order to be able to request access to the discount
facility. But in the face of mass deposit withdrawals triggered by panic, it will
only discover the actual shortage from the daily clearing process. By contrast, the
overdraft facility can be provided automatically, since the banks do not have to
submit an official proposal to use it. As already noted, rapid response is very
important during crises, and this was the simplest and quickest procedure for
helping banks—and thus averting the collapse of the national payments system.
Liquidity support provided in this way does have the disadvantage that the
facility is unsecured, but BI and the government continued to believe that the crisis would be of short duration. (Indeed, the president’s instruction, in response to
the first daily report on movement of the exchange rate after the float, was to
maintain the float for 2–3 weeks, which seemed to demonstrate his own expectation that the crisis would soon be over.) When it lasted longer than expected, BI
abandoned the overdraft facility in favour of a longer-term discount facility, as
well as using market debt instruments, both of which were more secure.
Providing liquidity support through the clearing mechanism has been very
costly, but the fact that at one point there were more than 160 banks receiving liquidity support, while only about one-third of these ultimately became problematic, implies that the rest complied with the rules. The very high interbank rates
on different occasions also showed that some banks did not resort to liquidity
support, but were able to meet their liquidity needs through the market process.
Finally, many banks, including some that received huge amounts of support, as
well as the national payments system itself, survived Indonesia’s worst financial
crisis. Whether this justifies the liquidity support policy, time will tell.
Another valid question, raised in BPK’s investigative audit, is why BI continued to provide liquidity support to banks that violated the rules on the use of
these funds. The explanation for this is that BI only learned through its supervisory practices whether the funds had been used in accordance with these rules,
and this involved significant lags. Supervision was conducted through analysis
of reports submitted by banks (off-site supervision), and through inspection vis-
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69
its to their offices (on-site supervision). Before the crisis, owing to a shortage of
bank supervisors (there were around 1,100 bank supervisors for 238 banks with
several thousand branches in total), banks were inspected once every 18 months
on average. Even the more up-to-date supervision based on reports submitted by
banks involved delays.
In short, with weak banking supervision, and with monitoring subject to considerable delays in a fast changing environment, violations in the use of liquidity
support were both possible and difficult to detect. Obtaining a clear picture of
whether there were indeed violations—and possibly criminal actions—in both
the provision and the use of liquidity support depends on whether the fund flows
relating to liquidity support can be traced.
LIQUIDITY SUPPORT AND
GOVERNMENT RECAPITALISATION BONDS
As Dr Dradjad Wibowo has noted, increases in the size of the negative balance of
banks with BI seem to be associated with the government’s various steps in
addressing the crisis (Wibowo 2002). Greater forbearance towards banks with
negative balances seemed to follow the float of the rupiah in August 1997, the closure of the first 16 banks in November 1997, the introduction of the blanket guarantee and the transfer of authority over problem banks to IBRA in January 1998,
and the riots that precipitated Soeharto’s resignation in May 1998. All these steps
were associated with heightening uncertainty in the market, which seemed to
lead to a ‘flight to safety’ and bank runs. The commercial banks’ aggregate negative balance (overdraft) with BI increased from just Rp 1.4 trillion in July 1997 to
Rp 15.3 trillion by the end of 1997, and to Rp 79.7 trillion by May 1998 (table 1).
It remained at this level through much of 1998, despite BI’s efforts to replace this
liquidity facility with other, more secure instruments, and to cease allowing
banks to run negative balances. Indeed, this is the essence of a systemic bank run.
BI could not prevent people who were losing confidence in the banking system
from withdrawing their funds—to spend on goods and services, to shift to banks
perceived to be safe, or to transfer abroad.
The gross cost to the government of financial support provided to the banks is
very high (although some part of this cost will be recouped, to the extent that
IBRA is successful in recovering loans in default and in seizing assets pledged to
it by banks and their owners). From 1996 to 1999, the total amount of liquidity
support given to some 164 banks amounted to Rp 179 trillion (table 1), while the
amount of government bonds issued for bank recapitalisation amounted to
Rp 431 trillion. The total of these two components is close to 50% of GDP—higher
than corresponding figures for banking crises in Chile (1981, 43%), Uruguay
(1981, 32%), Japan (1992, 22%), Venezuela (1994, 25%), Thailand (1997, 35%),
South Korea (1997, 28%) or Malaysia (1997, 18%) (Rojas-Suarez 2002).
RESOLVING PROBLEMS OF LIQUIDITY SUPPORT
In its investigative audit, the Supreme Audit Agency found that liquidity support
to the banking sector from 1996 to January 1999 amounted to Rp 144.5 trillion.
The audit report claimed that because of deviations in the channelling of funds
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1.4
1.2
11.0
11.8
9.6
2.2
10.7
12.8
5.1
40.4
11.6
9.9
1.7
15.3
1.4
34.6
62.9
15.2
9.6
5.6
79.7
21.9
31.6
148.4
Jul-98 Aug-98 Dec-98 Jan-99 Feb-99 Apr-99 Dec-99
15.2
9.6
5.6
78.5
33.8
31.2
9.0
15.2
9.6
5.6
79.5
35.8
30.6
16.0
15.3
9.7
5.6
84.2
35.8
29.7
13.3
167.7
177.1
178.3
14.6
9.3
5.3
71.5
30.6
24.9
11.8
20.0
173.4
14.4
9.1
5.3
66.8
28.5
23.7
13.3
20.0
166.7
9.1
9.1
9.0
9.0
7.6
7.6
6.5
0.7
0.5
1.0
7.2
2.4
162.7
181.8
7.2
3.3
162.7
182.3
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8.4
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Extended lending
Subordinated/emergency loansa
Bridging loansb
Debit balance positionc
Discount facilitiesd
Commercial papere
Trade arrearsf
Government bondsg
Total
162.7
178.5
a
Pre-crisis loans to troubled banks.
Advances to repay small deposits (ultimately all deposits) of the first 16 banks liquidated (in November 1997).
c Overdrafts and facility to replace overdrafts at BI (introduced in August 1998).
d Discount window loans, including new discount facility (introduced in March 1998).
e SBPUs and special SBPUs (introduced in December 1997).
f Repayment of banks’ international trade transaction arrears.
g Bonds issued to BI by the government in exchange for most of BI’s liquidity support claims on the banks.
b
J. Soedradjad Djiwandono
Source: Adapted from Indonesia: Statistical Appendix, IMF Staff Country Report 00/133, October 2000: table 30.
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70
TABLE 1 Liquidity Support to Banks from Bank Indonesia and Government
(selected dates, Rp trillion)
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by the central bank and their use by recipient banks, the government might suffer losses of Rp 138.4 trillion, 95.7% of the total amount provided to the banking
sector throughout this period.
BI raised a number of concerns about the nature, procedures and findings of
this audit, the most crucial of which were as follows:
• The audit was more in the nature of a compliance audit than an investigative
audit, since it focused largely on whether central bank actions were generally
in compliance with existing rules and regulations. But the rules and regulations were set up for normal conditions, while the facilities in question were
provided in conditions of crisis. The prevailing economic and financial conditions that compelled BI to provide liquidity support were completely ignored
in the audit.
• The audit did not take into consideration the function and authority of the central bank in conducting monetary and banking policy, and no consideration
was given to whether the provision of liquidity support was outside the jurisdiction of BI, or whether it was a misuse of the central bank’s authority.
• The policy of not excluding banks with negative balances from participating in
the clearing during an emergency was in accordance with the Central Bank
Law of 1968 and with the government’s then policies of assisting banks with
liquidity shortages and of not liquidating banks.
BI raised various other concerns relating to the findings of the audit. For example, the audit report argued that BI’s advance for repayment of deposits at the liquidated banks was a deviation from the rules for bank liquidation. The
government regulation on bank closures stipulates that payments to deposit
holders should be financed through the sale of assets of the liquidated banks
(GOI 1996), so BI could not ask the government to bear this burden. However, this
ignores the fact that the decision to liquidate banks was a government decision,
and that the government promised to bear the burden of repaying small depositors. This was confirmed in a letter dated 20 February 1998 from the finance minister to me as BI governor.
In BI’s view, the liquidity support problem had been dealt with legally through
the Master Settlement and Acquisition Agreements (MSAAs), the Master Refinancing and Note Issuance Agreements (MRNIAs), and other agreements
between IBRA and bank owners regarding the repayment of what they owed to
the government through their use of the support they had received.9 The MSAAs
and MRNIAs are agreements between IBRA and the principal owners of private
sector banks that received large amounts of liquidity support, some of which had
seriously violated the legal lending limit regulations. Under the MSAAs, IBRA
acquired ownership of certain of these owners’ assets. By contrast, the MRNIAs
are agreements under which the owners pledged, but did not surrender ownership of, assets to back up their personal guarantee of repayment of the liquidity
support. MRNIAs were used to secure repayment of liquidity support by certain
problem banks with which the government was unable to negotiate the acquisition of sufficient assets to cover their BLBI liabilities.
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In November 2000 the Parliamentary Working Committee on BLBI reviewed
the issues raised by BPK in its investigative audit of BI, and came to a number of
conclusions, including the following:10
• BI’s liquidity support reflected a policy decision by the government taken on
3 September 1997 in the face of the crisis.
• Since this policy was intended to address the crisis it was not based on rules
and regulations that apply under normal conditions.
• Resolution of the liquidity support problem should aim to hasten recovery of
the real sector and minimise the loss to the government. Therefore the solution
that relied on the MSAAs and MRNIAs was acceptable.
• The liquidity support problem should be resolved in such a way as to minimise
the cost to the government budget, with bonds held by BI and recapitalised
banks being redeemed as soon as possible.
Parliament asked the government and the central bank to work together in
seeking a solution to the problem, with a view to minimising the budgetary costs
and resolving where financial responsibility for the liquidity support policy lay.
To these ends the government formed a working team comprising the coordinating minister for economics and finance, the minister of finance, the governor of
BI and the attorney general.
On 17 November 2000 the government and BI released a document entitled
‘Basic Agreements between the Government and BI’, which included the following points:
• The government and BI agreed that liquidity support had been provided by
the central bank in order to save the monetary and banking system, as well as
the national economy, from collapse.
• The cost of liquidity support would be shared between the government and BI,
with a view to minimising costs to the budget. IBRA would make concerted
efforts to maximise asset recovery, while BI would bear part of the costs, to the
extent its own financial condition allowed.
• Taking its financial condition into consideration, BI agreed to bear Rp 24.5 trillion of the total cost.
However, when the Megawati Sukarnoputri government took office in July
2001, the appropriateness of this agreement on burden sharing came into question. An independent team comprising several Indonesian and international
experts (among them Paul Volcker, the US Federal Reserve chair during the Reagan administration) was formed and asked to recommend a suitable resolution.
On the issue of burden sharing between the government and BI, the team proposed that the promissory notes that the government had issued to BI should be
viewed as capital support and maintenance for BI. Such support would reflect the
government’s ultimate responsibility to maintain the financial strength of its central bank. To make this support transparent, the existing interest-bearing promissory notes should be replaced by a special issue of perpetual zero interest capital
maintenance notes (CMNs). The team’s recommendation seemed to be acceptable
to the government and BI (GOI 2002).11
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FINAL COMMENTS
It is my conjecture that lack of transparency and the serious problem of weak governance, together with public misunderstanding of, and misinformation about,
the operations of banks and the central bank, have prevented the public from
acquiring an accurate perspective on these complex issues. Since the credibility of
government institutions and officials, including the central bank, had generally
been weak in the past, it was inconceivable to many members of the public that
support of the commercial banks involving trillions of rupiah could be undertaken in the absence of kickbacks. Sadly, this difficult issue lingers on, without
any clear prospect for its resolution. In such circumstances, straight and clean
officials can be accused and found guilty of corruption, even in the absence of evidence to support such accusations. The champions of justice in their fight against
corruption have tended to overlook the plight of such officials, forgetting that a
corrupt legal system (widely defined) can be used not only to protect wrongdoers
but also to attack the innocent.
NOTES
*
1
2
3
4
5
6
7
8
Emeritus Professor of Economics,