Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji 00074910302010
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
INDONESIA'S BANKING CRISIS: WHAT HAPPENED
AND WHAT DID WE LEARN?
Charles Enoch , Olivier Fre´caut & Arto Kovanen
To cite this article: Charles Enoch , Olivier Fre´caut & Arto Kovanen (2003) INDONESIA'S
BANKING CRISIS: WHAT HAPPENED AND WHAT DID WE LEARN?, Bulletin of Indonesian
Economic Studies, 39:1, 75-92, DOI: 10.1080/00074910302010
To link to this article: http://dx.doi.org/10.1080/00074910302010
Published online: 17 Jun 2010.
Submit your article to this journal
Article views: 87
View related articles
Citing articles: 5 View citing articles
Full Terms & Conditions of access and use can be found at
http://www.tandfonline.com/action/journalInformation?journalCode=cbie20
Download by: [Universitas Maritim Raja Ali Haji]
Date: 19 January 2016, At: 20:16
Bulletin of Indonesian Economic Studies, Vol. 39, No. 1, 2003: 75–92
INDONESIA’S BANKING CRISIS:
WHAT HAPPENED AND WHAT DID WE LEARN?
Charles Enoch, Olivier Frécaut and Arto Kovanen*
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
International Monetary Fund, Washington DC
This article traces the stages of the Indonesian banking crisis of the late 1990s. Almost every stage of the handling of the crisis was complicated by governance issues.
Beyond these, among the lessons identified are how quickly things can get out of
hand in an apparently strongly performing economy; that at the outset of a crisis
information will be very limited; and that management of a crisis will be an evolving
process. A blanket guarantee covering all bank liabilities may be indispensable; however, the authorities are ‘buying time’, and the more time that has to be bought the
more expensive the process will be. Transparency too is indispensable, to generate
public trust and support, and to ensure that actions taken by the authorities are irreversible. Overall, while not everything was done right, the strategy put in place had
positive elements that have served to protect a core banking system and establish
conditions for recovery.
INTRODUCTION
The economic crisis that engulfed Indonesia in late 1997 brought to an end
30 years of uninterrupted economic
growth.1 The banking crisis that ensued
proved to be one of the most serious in
any country in the world in the 20th century in terms of its immediate impact on
GDP and its ultimate impact in adding
to the country’s stock of debt. In part the
severity of the crisis derived from the
economic problems that hit all the countries in the region—from Japan to Korea
and Thailand—provoking a withdrawal
of foreign capital and removing possible
locomotives that could have supported
an economic recovery.2 Perhaps as importantly, however, the crisis in Indonesia was exacerbated by the political
transition that occurred during this period, which had a major impact on the
way the crisis was handled and on ex-
ternal reactions to it as it unfolded. The
political transition was played out both
in parliament and in the streets. With
President Soeharto’s period in power
coming to an end, memories were fresh
of the bloody consequences of the previous change of government 32 years
earlier.
This paper focuses specifically on the
banking crisis, which in part was driven
by—and in part drove—broader economic and political developments. It
covers the period from late 1997 until the
end of 1999 (see also Cole and Slade
1998; Nasution 2000). By this latter date,
the stabilisation phase of the overall restructuring program was largely complete. The situation was still extremely
fragile, and significant reversals were
very possible; many important tasks remained to be carried out, but the basics
ISSN 0007-4918 print/ISSN 1472-7234 online/03/010075-18
© 2003 Indonesia Project ANU
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
76
Charles Enoch, Olivier Frécaut and Arto Kovanen
were largely in place. At the same time,
a key element of the political transition
seemed to have been completed with the
inauguration of the new government
under President Abdurrahman Wahid.
The political situation, especially in
Jakarta, had been tense throughout the
previous two years, as evidenced, for
instance, by the permanent presence of
large numbers of troops throughout central Jakarta; with the election of the new
president, and Megawati Sukarnoputri
as vice president, in September 1999, the
troops disappeared from the centre of
Jakarta almost overnight.
The next section summarises the main
developments in the banking sector until end 1999. We then offer views on a
selection of salient issues related to the
banking crisis, and conclude with an
assessment of the system at end 1999
and a statement of core lessons.
THE BANKING SECTOR: 1988–99
Seven phases can be identified to elucidate developments in the Indonesian
banking system, from the bold but unbalanced financial sector liberalisation
initiated in the late 1980s to the crisis of
1997—which was initially limited but
then spun out of control—and the two
attempts that proved necessary to bring
stability back to the banking sector.
Phase I, 1988 to August 1997
Unbalanced Liberalisation
In October 1988 a comprehensive package of deregulation measures was introduced for the Indonesian banking
system, including liberalising the requirements for the establishment of new
private domestic banks and joint venture banks. The number of banks increased substantially, from 111 in 1988
to a peak of 240 in 1994–96, with a large
number of local conglomerates establishing their own banks.3
The regulatory and supervisory
framework was improved substantially,
but enforcement, particularly of the legal lending limit, remained a constant
problem. Moreover, while the doors
were wide open for new banks to enter
the market, no proper exit mechanism
was set up for failing banks. This was
well illustrated by the Bank Summa incident (MacIntyre and Sjahrir 1993:
12–16). Among the larger banks, with liabilities of $750 million, Bank Summa
began to face serious financial problems
as a result of the deteriorating quality
of its loans; most of them were in the
real estate sector and to related parties,
and far exceeded the legal limit for such
lending. For two years, Bank Indonesia
(BI) relied on its traditional approach of
holding talks with the shareholders and
trying to persuade them to solve the
bank’s problems, while continuing to
provide substantial liquidity support.
Eventually BI withdrew its support, and
Bank Summa’s licence was revoked in
December 1992. But, in line with the law,
the management of Bank Summa itself
was given the responsibility of liquidating the bank. The process was long and
difficult, and included public protests
and street demonstrations directed
against BI. This strenuous experience,
and the inadequacies it revealed in the
legal framework for resolving problem
banks, reinforced BI’s bias against bank
closures.
Serious problems also remained unaddressed in the state-owned banks,
which traditionally held a dominant
market position in Indonesia, with some
70% of market share in the late 1980s.
The track record of repayment of their
loans, especially those extended to the
largest and most influential Indonesian
conglomerates, was poor. Extensive and
repeated financial support became necessary, and was provided on several
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
occasions with World Bank financial
participation.
Phase II, October–November 1997
Contained Banking Difficulties
After the unpegging of the Thai baht on
2 July 1997, the rupiah came under severe downward pressure. The authorities had to widen, and then to abandon,
the fluctuation band for the rupiah. By
October 1997, when Indonesia requested
the IMF’s assistance, the currency had
depreciated by close to 40%—at that
stage the largest depreciation among the
Asian crisis countries.
To assess the impact of the macroeconomic disturbances on the banking
sector, a large scale review of individual
banks was undertaken. It concluded
that 34 banks were insolvent: two stateowned banks, six regional development
banks and 26 private banks. For 16 of
the insolvent private banks (with a combined market share of 2.5%), the financial situation was particularly dire, and
the prospects for recovery non-existent. All these banks were slated for
liquidation, including three that had
direct links with President Soeharto’s
family: Bank Andromeda, owned by
one of the president’s sons; Bank
Industri, whose main shareholders included one of the president’s daughters;
and Bank Jakarta, controlled by the
president’s half brother. The 10 other
insolvent private banks (market share
3.0%) were not closed, because they
were already engaged in a legally binding process of resolution under BI’s
monitoring.
In addition to the 34 insolvent banks,
the review identified a number of weak
banks, with problems of varying degrees of seriousness. These included
several of the largest banks in the country. The weak banks were placed
under conservatorship, subjected to re-
77
habilitation plans or placed under intensive supervision.
At that stage, there was a consensus
view among the authorities and the IMF
that the problems in the banking sector
were not of a systemic nature: the stateowned banks’ weaknesses appeared
manageable; the major private banks—
some, like Bank Central Asia, highly regarded by the international banking
community—still reported comfortable
cushions of positive equity; and depositors’ runs had essentially been limited
and reflected flight to quality.
The 16 insolvent banks were closed
on 1 November 1997. The authorities
decided to protect depositors up to
Rp 20 million (around $6,000 at the prevailing exchange rate), which covered
some 90% of the depositors, but a far
smaller share—less than 25%—of the deposits. A full guarantee of the deposit
was not thought appropriate by the authorities at that stage, because of the
moral hazard issue: most of the banks
that were closed had been offering deposit rates far above market rates, often
to connected parties, while it was widely
known to the public that they were in
dire financial condition.
The actual process of closure was
carried out smoothly, with eligible deposits being transferred promptly to
designated recipient banks. The immediate response to the announcement of
the program was positive, and the exchange rate rebounded from its earlier
steep falls. The fact that several well connected banks had actually been closed
was perceived as a major turning point
for the country. In the following days,
the public observed with astonishment
the son of President Soeharto, who
owned Bank Andromeda, protest loudly
but to no avail against the closure of his
bank. Similarly, the president’s half
brother initially rejected BI’s decision to
78
Charles Enoch, Olivier Frécaut and Arto Kovanen
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
liquidate his Bank Jakarta. He kept it
open, but had to give up after a few days
and see it closed.
Phase III, December 1997
Losing Control
Within a few weeks, however, the positive sentiment had entirely reversed. A
number of developments contributed to
the turnaround, including a further
rapid deterioration of the financial market situation in Korea, an equally rapid
deterioration in the domestic economic
environment, and rumours about President Soeharto’s health.
Then there was the Bank Alfa incident. The credibility of the bank resolution program was shattered when the
president’s son, whose Bank Andromeda had been closed on 1 November,
was allowed to take over the tiny Bank
Alfa. He then transferred into it most of
his former activities, customers and
staff, effectively reopening his former
bank under a new name. Domestic and
international observers concluded that
no real change had actually taken place.
Combined with several other signs that
the authorities were not genuinely determined to implement the program
agreed with the IMF, this fostered a perception that the root causes of the crisis
were not being tackled.
Trust in the banking sector dissipated.
In the fast-deteriorating international
and domestic environment of that period, even the best banks in the country
began to lose the public’s confidence. By
early December 1997, bank runs had
become pervasive across the system,
along with rumours that a new wave of
bank closures was under preparation.
By mid December, 154 banks, representing half of the total assets of the system,
had to varying degrees faced erosion of
their deposit base.
BI was reluctant to consider any additional bank closures at that stage, and
thus had no other option but to provide
liquidity to banks unable to borrow directly from the interbank market, reflecting growing segmentation of the market
(see also Djiwandono 2000). Indeed, BI
liquidity support increased from about
Rp 24 trillion at end October 1997
(equivalent to 3.5% of GDP) to Rp 34 trillion (5% of GDP) in mid December. Liquidity support, paid in rupiah, was
used by banks in part to meet withdrawals of their dollar deposits; as a result, it
served in effect to fuel the continuing depreciation of the exchange rate. Concern
over the safety of banks had merged into
broader disquiet over the currency, and
indeed the stance of economic policy
overall. Dollar withdrawals from the
banks led to uncertainty about banks’
ability to continue to meet the demand
for liquidity, prompting further withdrawals. At this point the crisis had become fully systemic.
Phase IV, January–February 1998
Laying the Ground for Stabilisation
In January 1998, the rupiah went through
an episode of disastrous depreciation:
during that month, the rate fell from
Rp 4,600 to Rp 14,000/$, with some trades
even at Rp 17,000/$. At the same time,
BI continued to provide massive emergency liquidity support to the banking
system, with the total outstanding
amount reaching Rp 60 trillion (7% of
1997 GDP) by late January 1998. The prospect of hyperinflation and complete
financial sector meltdown became increasingly real.
On 27 January 1998 the government
introduced a new financial sector strategy. First, all depositors and creditors
were to be fully protected under government guarantee, with both rupiah
and foreign currency claims payable in
rupiah (at the exchange rate in effect on
the day of the claim).4 Second, a new
institution, the Indonesian Bank Re-
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
structuring Agency (IBRA), was established for a period of five years to take
over and rehabilitate ailing banks, and
manage their non-performing assets.
Third, a framework for handling corporate restructuring was proposed. The
impact of the announcement was immediate, with the exchange rate recovering to Rp 10,000/$ and appreciating
further in subsequent days, while rupiah deposits flowed back into the
banking system.
In the following two months, efforts
were made to re-establish monetary control by restructuring BI liquidity facilities
and developing effective penalties to deter banks from seeking access to these
facilities. At the same time, the authorities moved quickly to make IBRA operational. By mid February 1998 IBRA was
ready to take action. It proposed that all
banks that had borrowed at least twice
their capital from BI should be brought
under its auspices. On Saturday, 14 February, the owners of 54 banks (comprising 36.7% of the banking sector), of which
50 had borrowed heavily from BI and
four were state banks under restructuring programs, were summoned to BI,
warned about their perilous financial
condition, and invited to apply to come
under the auspices of IBRA. All the bankers agreed. IBRA officials entered their
banks before business began on the following Monday.
While the interventions were determined on a transparent and uniform
basis and were carried out smoothly, the
government introduced a last-minute
change that severely undermined the
operation: President Soeharto decided
that there should be no publicity. Thus,
instead of being able to demonstrate that
they had started to take hold of the situation, IBRA officials had to work over
the following weeks against a public
perception that the agency was still nonoperational.
79
Also, IBRA officials in the banks appear to have carried little credibility or
authority. They were not able to assert
full control over the staff of the institutions. IBRA was weakened further when
its first head was dismissed in late February.
Phase V, March–May 1998
First Initiatives and New Shock
The ensuing three months saw the authorities take a series of initiatives to resolve the problem of ailing banks, only
to face a major new shock. The main
focus turned to establishing the necessary infrastructure for handling the
banking crisis: making IBRA operational, preparing the legal framework,
obtaining better information on the financial condition of the banks, and beginning to take action.
In March 1998, BI announced the redesign of its liquidity support facilities,
with focus on non-market sanctions for
heavy users, that is, the transfer to IBRA
of banks that had borrowed heavily. In
early April, in its first major public action, IBRA took over seven large systemically important banks. At the same time,
seven small banks were closed and their
deposits transferred to a state bank. These
banks had all borrowed heavily from BI.
The focus at that stage was on liquidity, rather than solvency, in identifying
the banks for which intervention would
be appropriate, partly because reliable
data on the solvency condition of the
banks were not available, and partly
because of the urgent need to tackle the
provision of BI liquidity support in order to stabilise monetary conditions. The
criteria for takeover and closure were
simple and transparent, and the moves
were received favourably in the markets.
These actions were a major step to demonstrate the authorities’ commitment to
bank resolution and finalisation of a revised IMF program in late April 1998.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
80
Charles Enoch, Olivier Frécaut and Arto Kovanen
Within two weeks, the bank runs had
ceased and deposits began to flow back
into the system.
In May 1998, however, widespread
ethnic riots, directed at Indonesians of
Chinese descent who were blamed by
some elements of the public for the economic collapse, led to a reversal of the
recent stabilisation of the rupiah and a
further loss of confidence by both domestic and foreign investors. In the aftermath of the riots there were massive and
prolonged runs on Bank Central Asia
(BCA), the largest private bank (with a
market share of 12%). BI supplied over
Rp 30 trillion in liquidity support. On
29 May 1998, BCA was brought under
the auspices of IBRA.
The specific nature of the attacks
against BCA was especially devastating
to confidence in the banking sector, with
many viewing the run on the bank as
politically inspired. In this environment,
other bankers sought to maximise their
immediate liquidity in order to protect
themselves in the event of runs. The
stock of vault cash increased, intermediation declined even further, and interbank markets became more segmented.
With interest rates rising in the face of
the uncertainty, banks bid up deposit
rates to levels substantially above those
that they were able to charge their borrowers. The sizeable negative interest
spreads across much of the banking sector caused a continuing erosion of the
capital base of the affected banks. Nevertheless, liquidity support from BI—except to BCA—was limited.
Meanwhile, the bank restructuring
process was given a fresh impetus. International auditors were contracted—
financed by the World Bank and by the
Asian Development Bank—to conduct
portfolio reviews on the basis of international accounting standards and the
recently introduced new classification
and provisioning rules.
Phase VI, June–September 1998
Design of a Comprehensive Strategy
In June, the first results of the reviews,
for six large private IBRA-controlled
banks, concluded that they had catastrophic losses hidden in their loan portfolios: 75% of the total assets on average
were to be declared in the ‘loss’ category.
There were some serious questions as
to whether the accountants had been excessively diligent in applying the prudence principle in marking down the
portfolios, but there was no dispute
about their finding that the examined
banks were deeply insolvent. The results
of the audits were immediately leaked
to the press. Beyond the shock at the condition of the banks, the leaks prevented
any further denial of the seriousness of
the crisis, and forced the authorities to
recognise that drastic action was urgently needed. In August, IBRA closed
three of the banks. As in the case of the
previous closures, their deposits were
transferred to a state bank.
Meanwhile, also in August, the results of the reviews for a second group
of 16 large private banks, all of them
non-IBRA except for BCA, became available. These banks were clearly different
from the first group, with, overall, a far
higher quality of assets, even if many of
them were also insolvent. Given that
these banks were the strongest in the
country, this confirmed the deep insolvency of the banking system as a whole,
at that time estimated at Rp 300 trillion
(about 30% of 1998 GDP). While the insolvency of the entire banking system
was not surprising to many outside analysts, it was deeply shocking to policy
makers.
The recognition of the pervasive insolvency of the banking system led to
the idea that a joint recapitalisation program, through which the government
and the owners of selected banks would
jointly provide the resources needed to
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
absorb the losses, was in the country’s
best interest. This would restore a core
group of banks to financial health, and
preserve the financial expertise needed
to support the economic recovery. A feasibility review concluded that the government should provide 80% of the
recapitalisation needed, while the owners would provide the remaining 20%.
During the same period, the authorities pressed ahead with a comprehensive program of measures to address the
pervasive problems of the corporate sector, and sought passage of a bill providing IBRA with appropriate powers. BI
also conducted a thorough overhaul of
its prudential regulations. By September
1998, with the legal and regulatory requirements largely in place, the macroeconomic situation more stable, and
better information available on the condition of the banks, the authorities had
devised a comprehensive strategy to restore the banking system to health.
There were three central elements in this
strategy: first, resolving the banks under IBRA; second, restructuring the
state banks; and third, offering joint
recapitalisation under stringent conditions for private banks meeting specified conditions.
Phase VII, October 1998 – December 1999
Indecisiveness Increases Costs
If, by the last quarter of 1998, the resolution strategy was largely in place, its
slow and uneven implementation over
the following year—to the end 1999 cutoff date for this study—led to sharp increases in the total costs of the bank
resolution program.
Private Banks. By March 1999, after a
number of reversals of policy and other
delays, all private banks were eventually categorised into three groups. In the
first category were 73 banks (with 5% of
banking sector assets) classified as ‘A’
banks, i.e. considered strong enough to
81
carry on their activities on their own.
Sixteen banks were classified as ‘B’
banks, meaning that they were insolvent
but deemed salvageable. Among them
nine (accounting for 10% of banking sector assets) were eligible for joint recapitalisation with government financial
assistance (labelled as ‘B pass’ banks),
while the seven others failed the criteria
for joint recapitalisation and were taken
over by IBRA. Finally, 38 private banks
(5% of the banking sector) were classified as ‘C’ banks—meaning they were
non-salvageable—and hence were
closed.5
Subsequent work included drawing
up investment and performance contracts for the banks eligible for joint
recapitalisation, and monitoring implementation of all the conditions, which
were eventually met by seven of the nine
eligible banks.
IBRA and the IBRA Banks. IBRA was
slow in obtaining proper legal powers:
the relevant legal amendments were
passed in October 1998, but the necessary implementing regulations became
effective only in February 1999. Meanwhile, IBRA had been unable properly
to secure the assets of the banks that it
had taken over, or to transfer them fully
to its ownership.
By late 1999, IBRA had control of 13
banks, accounting for one-quarter of the
total banking market. Disappointingly,
very little progress was made during
1999 in enhancing the loan recoveries of
any of these banks, or in preparing them
for privatisation, and the costs increased
considerably. Concern also persisted
about the roles of, and coordination between, IBRA and the Jakarta Initiative
Task Force (JITF), the body responsible
for facilitating corporate restructuring,
as few of IBRA’s largest borrowers had
elected to participate in the JITF. IBRA’s
work program for 2000 was seen as
ambitious. It was expected to include
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
82
Charles Enoch, Olivier Frécaut and Arto Kovanen
cash collection targets of around Rp 26
trillion, a modest fraction of the total assets—with a face value of Rp 441 trillion (36% of GDP)—that had been
placed under IBRA’s control.
State Banks. As of mid 1998 there were
seven state banks, accounting for 50%
of total banking sector assets and for a
significantly larger share of the losses.
All were deeply insolvent and would
have been categorised as ‘C’ on the basis of the analysis employed for the private banks. However, the government
committed itself to recapitalising all the
state banks, with recapitalisation to follow operational restructuring.
By mid 1998 it had been decided to
merge the four weakest of these banks
into a single newly established bank, to
be called Bank Mandiri. The merger was
designed as a vehicle to downsize the
banks and make best use of scarce managerial and advisory resources. Bank
Mandiri was established as a corporate
entity during September 1998, and began as a holding company owning the
shares of the four banks. Its legal merger
with the four component banks took
place in late July 1999. Progress on the
three other state banks was slower. Several blueprints were considered for their
restructuring, but at end 1999 decisions
were still to be reached on the future
focus of these institutions.
SELECTED VIEWS
ON THE BANKING CRISIS
Challenges of
Large-Scale Intervention
The program the Indonesian authorities
put in place in the months following the
onset of the crisis in late 1997 was aimed
at restoring the viability of the financial
sector. This already formidable challenge was further complicated by the
fact that the banking crisis was coupled
with a general economic crisis that
brought about a severe depreciation of
the exchange rate and rapidly rising inflation. Even worse, the program was
undertaken in a period of political transition during which governance issues
were never far below the surface.
Progress in addressing banking problems was repeatedly set back, causing
the recovery process to be much more
protracted than it might otherwise have
been.
General reluctance to commit to the
future in Indonesia was heightened by
the political uncertainty resulting from
the twilight of the Soeharto regime and
the memories of the chaos that had accompanied the previous regime change
three decades earlier. An alternative
bank resolution strategy that relied more
on market mechanisms might have
proved successful, but would have been
substantially riskier, with a significant
possibility of total meltdown of the entire banking sector and the elimination
of payment services in the country.
Addressing a banking crisis is very
likely to involve interventions in particular banks—that is, closures or takeovers
by the authorities. If these occur at the
outset of a crisis, the authorities are
likely to have to rely on liquidity criteria, such as the amount a bank has borrowed from a central bank, in order to
determine in which banks to intervene.
Over time, as more information becomes
available, interventions can be determined on solvency grounds—the extent
to which a bank has negative equity. In
any case, it is important that the criteria
for interventions are credible and transparent, are applied uniformly, and are
explained well to the public.
The immediate costs of such interventions are likely to depend on the skill with
which the interventions are carried out,
to ensure that owners and managers are
not given a chance to strip the banks, that
the authorities get full access to the premises, and that depositors and other
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
liability holders can be reassured that
they are being fully protected. Successful intervention will require substantial
staff resources—several hundred took
part in the interventions in Indonesia—
and good coordination among the various official bodies.
Ultimate costs depend very largely on
how the authorities handle the banks
after intervention. In the case of banks
that are closed, the authorities need to
secure and manage the assets until sold.
With an approach where banks are kept
open the situation could be even more
difficult: a new management team needs
to be brought in to run the bank; former
owners and managers need to be kept
away; and the bank needs to be made
ready for sale. Where the crisis is deep,
and where there have been interventions
in a significant share of the banking sector, such rehabilitation may take years.
The ultimate costs will be very much
greater in Indonesia than they might have
been. Although the interventions in April
1998 were carried out effectively, the inordinate delays in passing and making
effective the necessary amendments to
the law meant that IBRA was unable fully
to take possession of the assets of the
closed banks until February 1999. Banks
taken over were initially managed under
twinning arrangements with managers
from state banks, but with limited success. Seeking to restore their deposit base,
these banks offered depositors among
the highest interest rates of any bank in
the country—far higher than the returns
they could make from using the funds.
Ultimately, these negative spreads led
to greater costs to the government, either in payments to meet the guarantee
obligations to depositors if the bank was
closed, or in recapitalising the bank if it
was kept open.
In Indonesia, where the banking system was complex and there were interventions in many banks, a wide variety
83
of techniques was relied upon to match
the specific condition of each bank or
group of banks with the most appropriate resolution approach. Among those
used were closure, merger, recapitalisation on the basis of operational restructuring, and creation of a platform bank
able to absorb efficiently a number of
other banks in which the authorities
have intervened. The new banking sector that is emerging reflects this variety.6
Moral Hazard
Moral hazard can arise in a number of
forms when a blanket guarantee is put
in place. Conventionally, a major risk is
thought to be that banks’ owners and
managers, when facing insolvency,
gamble on recovery and undertake especially risky business. In this case, however, the moral hazard seems also to
have extended to the depositors, as
weak banks sought to recover lost deposits by offering uneconomically high
interest rates. To limit this type of moral
hazard, the authorities introduced an
interest rate ceiling together with the
guarantee. However, the ceiling still offered sufficient room to generate interest rate differentials and redistribution
of deposits toward weaker banks, as
well as an overall level of deposit interest rates that led to negative interest
spreads for much of the crisis period.
The government commitment to
recapitalise all the state banks regardless of their condition also proved
costly. With this commitment, state
banks’ managements lost much incentive to pursue bad borrowers aggressively; recognising this, borrowers had
less incentive to continue to service
their debts. Loan performance fell dramatically from mid 1998, reportedly
even among those with the ability to
pay. The prospect of ‘haircuts’ (opportunities to renegotiate loan obligations)
for borrowers in difficulty added to this
84
Charles Enoch, Olivier Frécaut and Arto Kovanen
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
trend, with the presumption that it
would be hard for the banks to distinguish those unable to pay from those
merely unwilling to do so, and that
therefore it was unlikely to be beneficial for borrowers to continue to service
their debts fully.7
Costs and Government
Responsibility
The government recognised that bank
restructuring, particularly when a blanket guarantee is in place, is a government responsibility. Costs have three
main elements: compensation to BI for
the liquidity support extended to the
banks; compensation to those banks taking over the liabilities of the banks that
have been closed; and recapitalisation of
those banks that are undercapitalised
and stay open. In all cases finance is provided by bonds, the interest cost of
which appears as a budget item. There
is no alternative source of funding of
such expenditure in the economy. If the
burden were laid on BI, this would probably undermine BI’s ability to pursue its
monetary policy objectives, and would
ultimately lead to equivalent fiscal costs
through the need for the government to
recapitalise BI. With the cost assumed on
the budget, it is set out transparently with
other elements of public expenditure,
providing appropriate incentives to resolve the banking crisis expeditiously and
effectively. Recoveries, through IBRA or
other agencies, provide a direct offset to
these costs on the budget.
One depressing factor in this regard
was the persistent rise in estimates of the
cost of restructuring. This lasted until
the end of 1999, when estimates of the
total need for bonds passed the Rp 600
trillion ($80 billion) mark. In part, these
higher estimates derived from better
recognition of the depth of the problems
in the banking sector. In part, however,
they were due to the protracted nature
of the implementation process, which
greatly extended the period during
which the banking sector continued to
accumulate additional losses.
Assessment of the condition of a bank
depends primarily on an evaluation of
the worth of its loan portfolio. This in turn
requires assessment of the likelihood that
loans will be serviced properly, as well
as valuation of collateral—and calculation of the probability of securing it—if
the loans are not serviced. All these elements proved difficult during the Indonesian banking crisis, delaying full
recognition of its depth, and increasing
the cost of addressing it. Valuation of collateral may be difficult at any time. In
times when the market—for instance in
real estate—has become paralysed, as is
bound to be the case during a banking
crisis, it may be almost impossible. In the
case of the Indonesian crisis, these valuation difficulties were compounded in at
least two ways. First, as non-performing
loans were restructured, there were no
clear standards as to what would be the
minimum revised payments profile that
would allow the bank to declare a loan
to be once again performing. Second, legal uncertainties over banks’ ability to
seize collateral made it unclear to what
extent collateral should be recognised in
assessments of banks’ financial condition.
Together these issues had a substantial
impact, complicating the triage of the
banks by the authorities.
Blanket Guarantee
The issue of whether the blanket guarantee should have been introduced earlier—such as at the time of the October
1997 bank closures—is one of the most
contentious regarding the handling of
the banking crisis. With the benefit of
hindsight, there clearly would have been
a case for such a move. But the extent of
the banking sector’s difficulties was not
apparent at the time, nor was the Soe-
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
harto government’s lack of commitment
to carrying out many of the supporting
measures included in the agreement
signed with the IMF. Had the commitments to the IMF been implemented in
full, the original bank strategy might
have had a fair chance of success. Conversely, given the revelation over the
following months of the government’s
unwillingness to implement many of the
agreed measures, it is quite likely that
any bank strategy—including one with
a blanket guarantee—would have failed.
A blanket guarantee without the robust
implementation of supporting measures
would not have been sufficient to stop
the crisis.
The blanket guarantee announced on
27 January 1998 followed closely the
provisions of that promulgated in Thailand. All depositors and creditors were
to be covered (except the holders of subordinated debt) for both domestic and
foreign currency claims, although the
latter too would be paid in domestic
currency, at the rate of exchange on the
day the claim was made. The guarantee
was given to domestic banks whose
owners were willing to sign a contract
with BI and the government agreeing to
a number of prudential restrictions. A
small premium—0.5% of the value of the
deposits—was levied for the guarantee.8
A number of measures were introduced in order to mitigate the moral
hazard resulting from the guarantee.
These included limits on interbank activity and, most importantly, caps on deposit rates to prevent weak banks from
trying to attract deposits by offering interest rates that they knew they could
not afford. Banks were allowed to offer
deposit rates up to 500 basis points
above the rates set by the JIBOR banks.9
While such a premium may have been
appropriate in the beginning in view of
the lack of confidence in many of the
banks, it eventually gave scope to banks
85
to maximise deposit shares by exploiting the guarantee. Chief among these
were some of the so-called BTO banks,10
which achieved a remarkable rebuilding
of deposits over the period. This may
have helped to stabilise the banking system to begin with, but since the deposits were attracted at rates above those
the banks could earn from them, pursuit of this strategy substantially increased the losses of these banks, and
thus raised the ultimate cost of recapitalisation.11
By early 1999, with the banking system largely stabilised, such a large premium was clearly no longer necessary.
In March 1999, BI announced an initial
reduction of 50 basis points. On 19 April,
it announced a further 100 basis point
reduction to a 350 basis point maximum,
and after May 1999 it reduced the maximum spread in stages to 100 basis
points. The announcement of the guarantee did not of itself generate confidence that the government would
indeed stand behind all depositors and
creditors. Depositors initially continued
to withdraw their funds, leading to a
continuing need for BI liquidity support.
Only after the bank closures of April
1998 had been succeeded by the prompt
transfer of deposits from the closed
banks to designated state banks was
credibility of the guarantee achieved in
the eyes of the public.
Although the authorities made immediate transfers of non-bank deposits
from closed banks, there were substantial delays in the payment of interbank
claims. Responsibility for the administration of the guarantee was passed from
BI to IBRA and back again; the continuing non-servicing of the guarantee,
which may have been a result of the bureaucratic passing of responsibilities, but
may also have reflected concern at the
insider nature of some of the claims, undermined the credibility of the guaran-
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
86
Charles Enoch, Olivier Frécaut and Arto Kovanen
tee in the international community, and
provided a serious irritant in its attitude
to Indonesia. In March 1999 the government committed itself to prompt payment of such claims for the banks that
were eligible for the joint recapitalisation scheme. However, these payments
were in some cases not subsequently
made, thus generating opportunities for
intermediaries to offer to facilitate them.
The use of government-connected facilitators by the owner of Bank Bali, a large
private bank seeking to meet the qualification requirements for the joint recapitalisation scheme, led to a major scandal
in August 1999, and possibly influenced
the result of the presidential election
under way at that time. Subsequently,
international accountants were brought
in to verify the eligibility of all remaining claims, and procedures were established to make the remaining payments
in the early part of 2000.
Initially the blanket guarantee was to
be maintained for a minimum of two
years, with the government indicating
that it would give at least six months
notice of its termination. By the middle
of 1998, there was a movement to terminate the guarantee on the earliest possible date, out of a feeling that it had
proved very expensive and had opened
the door to abuses, and that expenditure
could be saved by eliminating it at that
point. In the middle of 1999, when the
announcement would have to be made
if the guarantee was to be eliminated at
the earliest possible date, there was indeed momentum to make such an announcement. After some discussion,
however, it was realised that the costs
of the guarantee were essentially already
sunk, that the banking system was still
not sufficiently robust to withstand a
serious shock to confidence, and that the
announcement of the end of the guarantee might itself provide such a shock.
The authorities therefore announced
that the guarantee would be extended;
no termination date was given, but the
six-month minimum notice was reaffirmed.
There has been some domestic criticism of the guarantee, blaming it for the
high fiscal cost of the restructuring. This
criticism is misplaced. To have tried to
force depositors to bear the costs of the
banking failures could have led rapidly
to the collapse of most, or all, banks in
the country, turning Indonesia into a
wasteland of financial intermediation
and returning it to a cash or barter
economy, from which it would have
taken many years to recover. In the end,
the guarantee was fundamentally effective. It is likely to have been a major factor in the absence of significant runs on
the banks during the difficult political
transition of 1999 and the policy reversals before and since.
Lender of Last Resort Facility
In the period after the November 1997
closings of 16 small banks, the authorities had a clear preference not to close
any more banks, given evidence of the
increasing fragility of confidence in the
banking system. With closures ruled
out, and continuing depositor withdrawals, there was little alternative in
the short run but to supply central bank
liquidity. By end December 1997, over
Rp 25 trillion of liquidity support had
been supplied to banks. With the authorities unable to sterilise the impact on
overall liquidity conditions, reflecting
both the lack of effective instruments of
monetary control at the time and the authorities’ concern about the impact of
high interest rates on the banks, much
of this finance was converted into dollars.12 For the early part of the period
there may have been opportunities for
‘round tripping’ by banks, as the rates
for the lender of last resort (LOLR) facilities remained sticky and below the
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
rates that banks might be able to earn
from investing the funds. Later, LOLR
interest rates were made punitive, up to
double the JIBOR rate; however, it seems
that most banks simply capitalised the
interest payments, so the notionally high
rate may not have served as much of a
deterrent.
By June 1998, total support outstanding reached Rp 140 trillion—over 15%
of pre-crisis deposits. Interestingly, the
support was still heavily concentrated
in a small number of banks, with around
80% of the total accounted for by just five
banks: BCA, Bank Dagang Nasional Indonesia (BDNI), the state-owned Bank
Ekspor–Impor Indonesia, Bank Danamon, and Bank Umum Nasional (BUN).
Moreover, the granting of liquidity support was not constant over the period.
Times of intense liquidity support were
interspersed with periods when there
was no new support, or even small repayments.
The operation of an LOLR facility to
address banks’ short-term liquidity difficulties is one of the classic functions of
a central bank. Conventionally such
lending should be only to banks that are
solvent, and the banks should provide
collateral. There should be restrictions
against protracted use of such lending,
since this is likely to be an indicator of
solvency difficulties. However, after the
bank closures of November 1997, while
liquidity support escalated rapidly, no
attempt was made to distinguish between liquidity support and solvency
support, and collateral was no longer
taken. A criticism of BI’s LOLR practices
relates to the lack of control over such
lending—in particular over whether the
lending matched a commensurate loss
of deposits. While BI did undertake
such matching in the latter part of the
crisis—specifically in May 1998 when
BCA was subject to protracted withdrawals—there seems to have been less
87
control during some of the earlier periods.
When it became clear that the liquidity support was really solvency support, the government’s obligation to
meet the costs of bank restructuring
was recognised as including payment
for this support. The authorities agreed
to pay BI for liquidity support in the
form of bonds with the principal indexed to the rate of inflation, and to pay
interest at 3% of the index-linked principal. In exchange for this payment,
IBRA, as agent for the government,
would take an equivalent claim on the
banks.
In order to address the issue of lack
of collateral from borrowing banks, BI
required personal guarantees from bank
owners that their borrowings were being used to meet liquidity needs, and
that their banks were in compliance with
all prudential regulations. Those banks
that subsequently failed, or were taken
over by IBRA, were investigated by
IBRA to see if they had indeed been fully
compliant. For 10 of the 14 banks taken
over or closed in 1998, IBRA found that
there had been prudential violations—
generally breaches of the legal lending
limit. In all such cases, IBRA sought to
negotiate a pledging of the owners’ assets that should be sold so that the government could recover its outlays.
In September 1998 a ‘shareholders
settlement’ was agreed between the government and the owner of BCA that was
meant to serve as a model for settlements with the other owners, and was
to achieve repayment of the bulk of the
liquidity support extended to the banks.
However, there were protracted delays
in reaching these other agreements, and
their structure was such that the owners retained control over the assets
being pledged until the assets were actually to be transferred. Overall, receipts
to the government turned out to be
88
Charles Enoch, Olivier Frécaut and Arto Kovanen
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
much lower than earlier estimated, and
in 2001 the government decided that the
settlement agreements should be reopened and additional assets committed by the owners.
Governance Issues
Governance issues have been at the
heart of the banking crisis in Indonesia.
At the onset of the crisis, the banking
sector was weak because of directed
lending, breaches of legal lending limits, and inadequate capitalisation. The
fact that several well connected banks
were closed in November 1997 was perceived as a major turning point, but subsequent reversals of these closures by
the authorities rapidly led to a reversal
of the initial positive reaction. Thereafter,
governance problems included serious
ongoing issues with regard to each of the
principal institutions involved (BI, IBRA
and the state banks), and these were reflected in a series of well publicised
events that served to weaken the momentum for restructuring. These issues go
well beyond the scope of this study and
reflect the pre-existing structure, where
there was no autonomy for individual
public sector agencies, and limited adherence to the rule of law.
While governance issues are rather
diverse, nearly all had a key element in
common: they indicated to the public
that the government was not sufficiently
committed to thorough reform. The result was a loss of confidence in the domestic currency, reflected in repeated
depreciations that tended to wi
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
INDONESIA'S BANKING CRISIS: WHAT HAPPENED
AND WHAT DID WE LEARN?
Charles Enoch , Olivier Fre´caut & Arto Kovanen
To cite this article: Charles Enoch , Olivier Fre´caut & Arto Kovanen (2003) INDONESIA'S
BANKING CRISIS: WHAT HAPPENED AND WHAT DID WE LEARN?, Bulletin of Indonesian
Economic Studies, 39:1, 75-92, DOI: 10.1080/00074910302010
To link to this article: http://dx.doi.org/10.1080/00074910302010
Published online: 17 Jun 2010.
Submit your article to this journal
Article views: 87
View related articles
Citing articles: 5 View citing articles
Full Terms & Conditions of access and use can be found at
http://www.tandfonline.com/action/journalInformation?journalCode=cbie20
Download by: [Universitas Maritim Raja Ali Haji]
Date: 19 January 2016, At: 20:16
Bulletin of Indonesian Economic Studies, Vol. 39, No. 1, 2003: 75–92
INDONESIA’S BANKING CRISIS:
WHAT HAPPENED AND WHAT DID WE LEARN?
Charles Enoch, Olivier Frécaut and Arto Kovanen*
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
International Monetary Fund, Washington DC
This article traces the stages of the Indonesian banking crisis of the late 1990s. Almost every stage of the handling of the crisis was complicated by governance issues.
Beyond these, among the lessons identified are how quickly things can get out of
hand in an apparently strongly performing economy; that at the outset of a crisis
information will be very limited; and that management of a crisis will be an evolving
process. A blanket guarantee covering all bank liabilities may be indispensable; however, the authorities are ‘buying time’, and the more time that has to be bought the
more expensive the process will be. Transparency too is indispensable, to generate
public trust and support, and to ensure that actions taken by the authorities are irreversible. Overall, while not everything was done right, the strategy put in place had
positive elements that have served to protect a core banking system and establish
conditions for recovery.
INTRODUCTION
The economic crisis that engulfed Indonesia in late 1997 brought to an end
30 years of uninterrupted economic
growth.1 The banking crisis that ensued
proved to be one of the most serious in
any country in the world in the 20th century in terms of its immediate impact on
GDP and its ultimate impact in adding
to the country’s stock of debt. In part the
severity of the crisis derived from the
economic problems that hit all the countries in the region—from Japan to Korea
and Thailand—provoking a withdrawal
of foreign capital and removing possible
locomotives that could have supported
an economic recovery.2 Perhaps as importantly, however, the crisis in Indonesia was exacerbated by the political
transition that occurred during this period, which had a major impact on the
way the crisis was handled and on ex-
ternal reactions to it as it unfolded. The
political transition was played out both
in parliament and in the streets. With
President Soeharto’s period in power
coming to an end, memories were fresh
of the bloody consequences of the previous change of government 32 years
earlier.
This paper focuses specifically on the
banking crisis, which in part was driven
by—and in part drove—broader economic and political developments. It
covers the period from late 1997 until the
end of 1999 (see also Cole and Slade
1998; Nasution 2000). By this latter date,
the stabilisation phase of the overall restructuring program was largely complete. The situation was still extremely
fragile, and significant reversals were
very possible; many important tasks remained to be carried out, but the basics
ISSN 0007-4918 print/ISSN 1472-7234 online/03/010075-18
© 2003 Indonesia Project ANU
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
76
Charles Enoch, Olivier Frécaut and Arto Kovanen
were largely in place. At the same time,
a key element of the political transition
seemed to have been completed with the
inauguration of the new government
under President Abdurrahman Wahid.
The political situation, especially in
Jakarta, had been tense throughout the
previous two years, as evidenced, for
instance, by the permanent presence of
large numbers of troops throughout central Jakarta; with the election of the new
president, and Megawati Sukarnoputri
as vice president, in September 1999, the
troops disappeared from the centre of
Jakarta almost overnight.
The next section summarises the main
developments in the banking sector until end 1999. We then offer views on a
selection of salient issues related to the
banking crisis, and conclude with an
assessment of the system at end 1999
and a statement of core lessons.
THE BANKING SECTOR: 1988–99
Seven phases can be identified to elucidate developments in the Indonesian
banking system, from the bold but unbalanced financial sector liberalisation
initiated in the late 1980s to the crisis of
1997—which was initially limited but
then spun out of control—and the two
attempts that proved necessary to bring
stability back to the banking sector.
Phase I, 1988 to August 1997
Unbalanced Liberalisation
In October 1988 a comprehensive package of deregulation measures was introduced for the Indonesian banking
system, including liberalising the requirements for the establishment of new
private domestic banks and joint venture banks. The number of banks increased substantially, from 111 in 1988
to a peak of 240 in 1994–96, with a large
number of local conglomerates establishing their own banks.3
The regulatory and supervisory
framework was improved substantially,
but enforcement, particularly of the legal lending limit, remained a constant
problem. Moreover, while the doors
were wide open for new banks to enter
the market, no proper exit mechanism
was set up for failing banks. This was
well illustrated by the Bank Summa incident (MacIntyre and Sjahrir 1993:
12–16). Among the larger banks, with liabilities of $750 million, Bank Summa
began to face serious financial problems
as a result of the deteriorating quality
of its loans; most of them were in the
real estate sector and to related parties,
and far exceeded the legal limit for such
lending. For two years, Bank Indonesia
(BI) relied on its traditional approach of
holding talks with the shareholders and
trying to persuade them to solve the
bank’s problems, while continuing to
provide substantial liquidity support.
Eventually BI withdrew its support, and
Bank Summa’s licence was revoked in
December 1992. But, in line with the law,
the management of Bank Summa itself
was given the responsibility of liquidating the bank. The process was long and
difficult, and included public protests
and street demonstrations directed
against BI. This strenuous experience,
and the inadequacies it revealed in the
legal framework for resolving problem
banks, reinforced BI’s bias against bank
closures.
Serious problems also remained unaddressed in the state-owned banks,
which traditionally held a dominant
market position in Indonesia, with some
70% of market share in the late 1980s.
The track record of repayment of their
loans, especially those extended to the
largest and most influential Indonesian
conglomerates, was poor. Extensive and
repeated financial support became necessary, and was provided on several
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
occasions with World Bank financial
participation.
Phase II, October–November 1997
Contained Banking Difficulties
After the unpegging of the Thai baht on
2 July 1997, the rupiah came under severe downward pressure. The authorities had to widen, and then to abandon,
the fluctuation band for the rupiah. By
October 1997, when Indonesia requested
the IMF’s assistance, the currency had
depreciated by close to 40%—at that
stage the largest depreciation among the
Asian crisis countries.
To assess the impact of the macroeconomic disturbances on the banking
sector, a large scale review of individual
banks was undertaken. It concluded
that 34 banks were insolvent: two stateowned banks, six regional development
banks and 26 private banks. For 16 of
the insolvent private banks (with a combined market share of 2.5%), the financial situation was particularly dire, and
the prospects for recovery non-existent. All these banks were slated for
liquidation, including three that had
direct links with President Soeharto’s
family: Bank Andromeda, owned by
one of the president’s sons; Bank
Industri, whose main shareholders included one of the president’s daughters;
and Bank Jakarta, controlled by the
president’s half brother. The 10 other
insolvent private banks (market share
3.0%) were not closed, because they
were already engaged in a legally binding process of resolution under BI’s
monitoring.
In addition to the 34 insolvent banks,
the review identified a number of weak
banks, with problems of varying degrees of seriousness. These included
several of the largest banks in the country. The weak banks were placed
under conservatorship, subjected to re-
77
habilitation plans or placed under intensive supervision.
At that stage, there was a consensus
view among the authorities and the IMF
that the problems in the banking sector
were not of a systemic nature: the stateowned banks’ weaknesses appeared
manageable; the major private banks—
some, like Bank Central Asia, highly regarded by the international banking
community—still reported comfortable
cushions of positive equity; and depositors’ runs had essentially been limited
and reflected flight to quality.
The 16 insolvent banks were closed
on 1 November 1997. The authorities
decided to protect depositors up to
Rp 20 million (around $6,000 at the prevailing exchange rate), which covered
some 90% of the depositors, but a far
smaller share—less than 25%—of the deposits. A full guarantee of the deposit
was not thought appropriate by the authorities at that stage, because of the
moral hazard issue: most of the banks
that were closed had been offering deposit rates far above market rates, often
to connected parties, while it was widely
known to the public that they were in
dire financial condition.
The actual process of closure was
carried out smoothly, with eligible deposits being transferred promptly to
designated recipient banks. The immediate response to the announcement of
the program was positive, and the exchange rate rebounded from its earlier
steep falls. The fact that several well connected banks had actually been closed
was perceived as a major turning point
for the country. In the following days,
the public observed with astonishment
the son of President Soeharto, who
owned Bank Andromeda, protest loudly
but to no avail against the closure of his
bank. Similarly, the president’s half
brother initially rejected BI’s decision to
78
Charles Enoch, Olivier Frécaut and Arto Kovanen
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
liquidate his Bank Jakarta. He kept it
open, but had to give up after a few days
and see it closed.
Phase III, December 1997
Losing Control
Within a few weeks, however, the positive sentiment had entirely reversed. A
number of developments contributed to
the turnaround, including a further
rapid deterioration of the financial market situation in Korea, an equally rapid
deterioration in the domestic economic
environment, and rumours about President Soeharto’s health.
Then there was the Bank Alfa incident. The credibility of the bank resolution program was shattered when the
president’s son, whose Bank Andromeda had been closed on 1 November,
was allowed to take over the tiny Bank
Alfa. He then transferred into it most of
his former activities, customers and
staff, effectively reopening his former
bank under a new name. Domestic and
international observers concluded that
no real change had actually taken place.
Combined with several other signs that
the authorities were not genuinely determined to implement the program
agreed with the IMF, this fostered a perception that the root causes of the crisis
were not being tackled.
Trust in the banking sector dissipated.
In the fast-deteriorating international
and domestic environment of that period, even the best banks in the country
began to lose the public’s confidence. By
early December 1997, bank runs had
become pervasive across the system,
along with rumours that a new wave of
bank closures was under preparation.
By mid December, 154 banks, representing half of the total assets of the system,
had to varying degrees faced erosion of
their deposit base.
BI was reluctant to consider any additional bank closures at that stage, and
thus had no other option but to provide
liquidity to banks unable to borrow directly from the interbank market, reflecting growing segmentation of the market
(see also Djiwandono 2000). Indeed, BI
liquidity support increased from about
Rp 24 trillion at end October 1997
(equivalent to 3.5% of GDP) to Rp 34 trillion (5% of GDP) in mid December. Liquidity support, paid in rupiah, was
used by banks in part to meet withdrawals of their dollar deposits; as a result, it
served in effect to fuel the continuing depreciation of the exchange rate. Concern
over the safety of banks had merged into
broader disquiet over the currency, and
indeed the stance of economic policy
overall. Dollar withdrawals from the
banks led to uncertainty about banks’
ability to continue to meet the demand
for liquidity, prompting further withdrawals. At this point the crisis had become fully systemic.
Phase IV, January–February 1998
Laying the Ground for Stabilisation
In January 1998, the rupiah went through
an episode of disastrous depreciation:
during that month, the rate fell from
Rp 4,600 to Rp 14,000/$, with some trades
even at Rp 17,000/$. At the same time,
BI continued to provide massive emergency liquidity support to the banking
system, with the total outstanding
amount reaching Rp 60 trillion (7% of
1997 GDP) by late January 1998. The prospect of hyperinflation and complete
financial sector meltdown became increasingly real.
On 27 January 1998 the government
introduced a new financial sector strategy. First, all depositors and creditors
were to be fully protected under government guarantee, with both rupiah
and foreign currency claims payable in
rupiah (at the exchange rate in effect on
the day of the claim).4 Second, a new
institution, the Indonesian Bank Re-
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
structuring Agency (IBRA), was established for a period of five years to take
over and rehabilitate ailing banks, and
manage their non-performing assets.
Third, a framework for handling corporate restructuring was proposed. The
impact of the announcement was immediate, with the exchange rate recovering to Rp 10,000/$ and appreciating
further in subsequent days, while rupiah deposits flowed back into the
banking system.
In the following two months, efforts
were made to re-establish monetary control by restructuring BI liquidity facilities
and developing effective penalties to deter banks from seeking access to these
facilities. At the same time, the authorities moved quickly to make IBRA operational. By mid February 1998 IBRA was
ready to take action. It proposed that all
banks that had borrowed at least twice
their capital from BI should be brought
under its auspices. On Saturday, 14 February, the owners of 54 banks (comprising 36.7% of the banking sector), of which
50 had borrowed heavily from BI and
four were state banks under restructuring programs, were summoned to BI,
warned about their perilous financial
condition, and invited to apply to come
under the auspices of IBRA. All the bankers agreed. IBRA officials entered their
banks before business began on the following Monday.
While the interventions were determined on a transparent and uniform
basis and were carried out smoothly, the
government introduced a last-minute
change that severely undermined the
operation: President Soeharto decided
that there should be no publicity. Thus,
instead of being able to demonstrate that
they had started to take hold of the situation, IBRA officials had to work over
the following weeks against a public
perception that the agency was still nonoperational.
79
Also, IBRA officials in the banks appear to have carried little credibility or
authority. They were not able to assert
full control over the staff of the institutions. IBRA was weakened further when
its first head was dismissed in late February.
Phase V, March–May 1998
First Initiatives and New Shock
The ensuing three months saw the authorities take a series of initiatives to resolve the problem of ailing banks, only
to face a major new shock. The main
focus turned to establishing the necessary infrastructure for handling the
banking crisis: making IBRA operational, preparing the legal framework,
obtaining better information on the financial condition of the banks, and beginning to take action.
In March 1998, BI announced the redesign of its liquidity support facilities,
with focus on non-market sanctions for
heavy users, that is, the transfer to IBRA
of banks that had borrowed heavily. In
early April, in its first major public action, IBRA took over seven large systemically important banks. At the same time,
seven small banks were closed and their
deposits transferred to a state bank. These
banks had all borrowed heavily from BI.
The focus at that stage was on liquidity, rather than solvency, in identifying
the banks for which intervention would
be appropriate, partly because reliable
data on the solvency condition of the
banks were not available, and partly
because of the urgent need to tackle the
provision of BI liquidity support in order to stabilise monetary conditions. The
criteria for takeover and closure were
simple and transparent, and the moves
were received favourably in the markets.
These actions were a major step to demonstrate the authorities’ commitment to
bank resolution and finalisation of a revised IMF program in late April 1998.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
80
Charles Enoch, Olivier Frécaut and Arto Kovanen
Within two weeks, the bank runs had
ceased and deposits began to flow back
into the system.
In May 1998, however, widespread
ethnic riots, directed at Indonesians of
Chinese descent who were blamed by
some elements of the public for the economic collapse, led to a reversal of the
recent stabilisation of the rupiah and a
further loss of confidence by both domestic and foreign investors. In the aftermath of the riots there were massive and
prolonged runs on Bank Central Asia
(BCA), the largest private bank (with a
market share of 12%). BI supplied over
Rp 30 trillion in liquidity support. On
29 May 1998, BCA was brought under
the auspices of IBRA.
The specific nature of the attacks
against BCA was especially devastating
to confidence in the banking sector, with
many viewing the run on the bank as
politically inspired. In this environment,
other bankers sought to maximise their
immediate liquidity in order to protect
themselves in the event of runs. The
stock of vault cash increased, intermediation declined even further, and interbank markets became more segmented.
With interest rates rising in the face of
the uncertainty, banks bid up deposit
rates to levels substantially above those
that they were able to charge their borrowers. The sizeable negative interest
spreads across much of the banking sector caused a continuing erosion of the
capital base of the affected banks. Nevertheless, liquidity support from BI—except to BCA—was limited.
Meanwhile, the bank restructuring
process was given a fresh impetus. International auditors were contracted—
financed by the World Bank and by the
Asian Development Bank—to conduct
portfolio reviews on the basis of international accounting standards and the
recently introduced new classification
and provisioning rules.
Phase VI, June–September 1998
Design of a Comprehensive Strategy
In June, the first results of the reviews,
for six large private IBRA-controlled
banks, concluded that they had catastrophic losses hidden in their loan portfolios: 75% of the total assets on average
were to be declared in the ‘loss’ category.
There were some serious questions as
to whether the accountants had been excessively diligent in applying the prudence principle in marking down the
portfolios, but there was no dispute
about their finding that the examined
banks were deeply insolvent. The results
of the audits were immediately leaked
to the press. Beyond the shock at the condition of the banks, the leaks prevented
any further denial of the seriousness of
the crisis, and forced the authorities to
recognise that drastic action was urgently needed. In August, IBRA closed
three of the banks. As in the case of the
previous closures, their deposits were
transferred to a state bank.
Meanwhile, also in August, the results of the reviews for a second group
of 16 large private banks, all of them
non-IBRA except for BCA, became available. These banks were clearly different
from the first group, with, overall, a far
higher quality of assets, even if many of
them were also insolvent. Given that
these banks were the strongest in the
country, this confirmed the deep insolvency of the banking system as a whole,
at that time estimated at Rp 300 trillion
(about 30% of 1998 GDP). While the insolvency of the entire banking system
was not surprising to many outside analysts, it was deeply shocking to policy
makers.
The recognition of the pervasive insolvency of the banking system led to
the idea that a joint recapitalisation program, through which the government
and the owners of selected banks would
jointly provide the resources needed to
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
absorb the losses, was in the country’s
best interest. This would restore a core
group of banks to financial health, and
preserve the financial expertise needed
to support the economic recovery. A feasibility review concluded that the government should provide 80% of the
recapitalisation needed, while the owners would provide the remaining 20%.
During the same period, the authorities pressed ahead with a comprehensive program of measures to address the
pervasive problems of the corporate sector, and sought passage of a bill providing IBRA with appropriate powers. BI
also conducted a thorough overhaul of
its prudential regulations. By September
1998, with the legal and regulatory requirements largely in place, the macroeconomic situation more stable, and
better information available on the condition of the banks, the authorities had
devised a comprehensive strategy to restore the banking system to health.
There were three central elements in this
strategy: first, resolving the banks under IBRA; second, restructuring the
state banks; and third, offering joint
recapitalisation under stringent conditions for private banks meeting specified conditions.
Phase VII, October 1998 – December 1999
Indecisiveness Increases Costs
If, by the last quarter of 1998, the resolution strategy was largely in place, its
slow and uneven implementation over
the following year—to the end 1999 cutoff date for this study—led to sharp increases in the total costs of the bank
resolution program.
Private Banks. By March 1999, after a
number of reversals of policy and other
delays, all private banks were eventually categorised into three groups. In the
first category were 73 banks (with 5% of
banking sector assets) classified as ‘A’
banks, i.e. considered strong enough to
81
carry on their activities on their own.
Sixteen banks were classified as ‘B’
banks, meaning that they were insolvent
but deemed salvageable. Among them
nine (accounting for 10% of banking sector assets) were eligible for joint recapitalisation with government financial
assistance (labelled as ‘B pass’ banks),
while the seven others failed the criteria
for joint recapitalisation and were taken
over by IBRA. Finally, 38 private banks
(5% of the banking sector) were classified as ‘C’ banks—meaning they were
non-salvageable—and hence were
closed.5
Subsequent work included drawing
up investment and performance contracts for the banks eligible for joint
recapitalisation, and monitoring implementation of all the conditions, which
were eventually met by seven of the nine
eligible banks.
IBRA and the IBRA Banks. IBRA was
slow in obtaining proper legal powers:
the relevant legal amendments were
passed in October 1998, but the necessary implementing regulations became
effective only in February 1999. Meanwhile, IBRA had been unable properly
to secure the assets of the banks that it
had taken over, or to transfer them fully
to its ownership.
By late 1999, IBRA had control of 13
banks, accounting for one-quarter of the
total banking market. Disappointingly,
very little progress was made during
1999 in enhancing the loan recoveries of
any of these banks, or in preparing them
for privatisation, and the costs increased
considerably. Concern also persisted
about the roles of, and coordination between, IBRA and the Jakarta Initiative
Task Force (JITF), the body responsible
for facilitating corporate restructuring,
as few of IBRA’s largest borrowers had
elected to participate in the JITF. IBRA’s
work program for 2000 was seen as
ambitious. It was expected to include
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
82
Charles Enoch, Olivier Frécaut and Arto Kovanen
cash collection targets of around Rp 26
trillion, a modest fraction of the total assets—with a face value of Rp 441 trillion (36% of GDP)—that had been
placed under IBRA’s control.
State Banks. As of mid 1998 there were
seven state banks, accounting for 50%
of total banking sector assets and for a
significantly larger share of the losses.
All were deeply insolvent and would
have been categorised as ‘C’ on the basis of the analysis employed for the private banks. However, the government
committed itself to recapitalising all the
state banks, with recapitalisation to follow operational restructuring.
By mid 1998 it had been decided to
merge the four weakest of these banks
into a single newly established bank, to
be called Bank Mandiri. The merger was
designed as a vehicle to downsize the
banks and make best use of scarce managerial and advisory resources. Bank
Mandiri was established as a corporate
entity during September 1998, and began as a holding company owning the
shares of the four banks. Its legal merger
with the four component banks took
place in late July 1999. Progress on the
three other state banks was slower. Several blueprints were considered for their
restructuring, but at end 1999 decisions
were still to be reached on the future
focus of these institutions.
SELECTED VIEWS
ON THE BANKING CRISIS
Challenges of
Large-Scale Intervention
The program the Indonesian authorities
put in place in the months following the
onset of the crisis in late 1997 was aimed
at restoring the viability of the financial
sector. This already formidable challenge was further complicated by the
fact that the banking crisis was coupled
with a general economic crisis that
brought about a severe depreciation of
the exchange rate and rapidly rising inflation. Even worse, the program was
undertaken in a period of political transition during which governance issues
were never far below the surface.
Progress in addressing banking problems was repeatedly set back, causing
the recovery process to be much more
protracted than it might otherwise have
been.
General reluctance to commit to the
future in Indonesia was heightened by
the political uncertainty resulting from
the twilight of the Soeharto regime and
the memories of the chaos that had accompanied the previous regime change
three decades earlier. An alternative
bank resolution strategy that relied more
on market mechanisms might have
proved successful, but would have been
substantially riskier, with a significant
possibility of total meltdown of the entire banking sector and the elimination
of payment services in the country.
Addressing a banking crisis is very
likely to involve interventions in particular banks—that is, closures or takeovers
by the authorities. If these occur at the
outset of a crisis, the authorities are
likely to have to rely on liquidity criteria, such as the amount a bank has borrowed from a central bank, in order to
determine in which banks to intervene.
Over time, as more information becomes
available, interventions can be determined on solvency grounds—the extent
to which a bank has negative equity. In
any case, it is important that the criteria
for interventions are credible and transparent, are applied uniformly, and are
explained well to the public.
The immediate costs of such interventions are likely to depend on the skill with
which the interventions are carried out,
to ensure that owners and managers are
not given a chance to strip the banks, that
the authorities get full access to the premises, and that depositors and other
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
liability holders can be reassured that
they are being fully protected. Successful intervention will require substantial
staff resources—several hundred took
part in the interventions in Indonesia—
and good coordination among the various official bodies.
Ultimate costs depend very largely on
how the authorities handle the banks
after intervention. In the case of banks
that are closed, the authorities need to
secure and manage the assets until sold.
With an approach where banks are kept
open the situation could be even more
difficult: a new management team needs
to be brought in to run the bank; former
owners and managers need to be kept
away; and the bank needs to be made
ready for sale. Where the crisis is deep,
and where there have been interventions
in a significant share of the banking sector, such rehabilitation may take years.
The ultimate costs will be very much
greater in Indonesia than they might have
been. Although the interventions in April
1998 were carried out effectively, the inordinate delays in passing and making
effective the necessary amendments to
the law meant that IBRA was unable fully
to take possession of the assets of the
closed banks until February 1999. Banks
taken over were initially managed under
twinning arrangements with managers
from state banks, but with limited success. Seeking to restore their deposit base,
these banks offered depositors among
the highest interest rates of any bank in
the country—far higher than the returns
they could make from using the funds.
Ultimately, these negative spreads led
to greater costs to the government, either in payments to meet the guarantee
obligations to depositors if the bank was
closed, or in recapitalising the bank if it
was kept open.
In Indonesia, where the banking system was complex and there were interventions in many banks, a wide variety
83
of techniques was relied upon to match
the specific condition of each bank or
group of banks with the most appropriate resolution approach. Among those
used were closure, merger, recapitalisation on the basis of operational restructuring, and creation of a platform bank
able to absorb efficiently a number of
other banks in which the authorities
have intervened. The new banking sector that is emerging reflects this variety.6
Moral Hazard
Moral hazard can arise in a number of
forms when a blanket guarantee is put
in place. Conventionally, a major risk is
thought to be that banks’ owners and
managers, when facing insolvency,
gamble on recovery and undertake especially risky business. In this case, however, the moral hazard seems also to
have extended to the depositors, as
weak banks sought to recover lost deposits by offering uneconomically high
interest rates. To limit this type of moral
hazard, the authorities introduced an
interest rate ceiling together with the
guarantee. However, the ceiling still offered sufficient room to generate interest rate differentials and redistribution
of deposits toward weaker banks, as
well as an overall level of deposit interest rates that led to negative interest
spreads for much of the crisis period.
The government commitment to
recapitalise all the state banks regardless of their condition also proved
costly. With this commitment, state
banks’ managements lost much incentive to pursue bad borrowers aggressively; recognising this, borrowers had
less incentive to continue to service
their debts. Loan performance fell dramatically from mid 1998, reportedly
even among those with the ability to
pay. The prospect of ‘haircuts’ (opportunities to renegotiate loan obligations)
for borrowers in difficulty added to this
84
Charles Enoch, Olivier Frécaut and Arto Kovanen
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
trend, with the presumption that it
would be hard for the banks to distinguish those unable to pay from those
merely unwilling to do so, and that
therefore it was unlikely to be beneficial for borrowers to continue to service
their debts fully.7
Costs and Government
Responsibility
The government recognised that bank
restructuring, particularly when a blanket guarantee is in place, is a government responsibility. Costs have three
main elements: compensation to BI for
the liquidity support extended to the
banks; compensation to those banks taking over the liabilities of the banks that
have been closed; and recapitalisation of
those banks that are undercapitalised
and stay open. In all cases finance is provided by bonds, the interest cost of
which appears as a budget item. There
is no alternative source of funding of
such expenditure in the economy. If the
burden were laid on BI, this would probably undermine BI’s ability to pursue its
monetary policy objectives, and would
ultimately lead to equivalent fiscal costs
through the need for the government to
recapitalise BI. With the cost assumed on
the budget, it is set out transparently with
other elements of public expenditure,
providing appropriate incentives to resolve the banking crisis expeditiously and
effectively. Recoveries, through IBRA or
other agencies, provide a direct offset to
these costs on the budget.
One depressing factor in this regard
was the persistent rise in estimates of the
cost of restructuring. This lasted until
the end of 1999, when estimates of the
total need for bonds passed the Rp 600
trillion ($80 billion) mark. In part, these
higher estimates derived from better
recognition of the depth of the problems
in the banking sector. In part, however,
they were due to the protracted nature
of the implementation process, which
greatly extended the period during
which the banking sector continued to
accumulate additional losses.
Assessment of the condition of a bank
depends primarily on an evaluation of
the worth of its loan portfolio. This in turn
requires assessment of the likelihood that
loans will be serviced properly, as well
as valuation of collateral—and calculation of the probability of securing it—if
the loans are not serviced. All these elements proved difficult during the Indonesian banking crisis, delaying full
recognition of its depth, and increasing
the cost of addressing it. Valuation of collateral may be difficult at any time. In
times when the market—for instance in
real estate—has become paralysed, as is
bound to be the case during a banking
crisis, it may be almost impossible. In the
case of the Indonesian crisis, these valuation difficulties were compounded in at
least two ways. First, as non-performing
loans were restructured, there were no
clear standards as to what would be the
minimum revised payments profile that
would allow the bank to declare a loan
to be once again performing. Second, legal uncertainties over banks’ ability to
seize collateral made it unclear to what
extent collateral should be recognised in
assessments of banks’ financial condition.
Together these issues had a substantial
impact, complicating the triage of the
banks by the authorities.
Blanket Guarantee
The issue of whether the blanket guarantee should have been introduced earlier—such as at the time of the October
1997 bank closures—is one of the most
contentious regarding the handling of
the banking crisis. With the benefit of
hindsight, there clearly would have been
a case for such a move. But the extent of
the banking sector’s difficulties was not
apparent at the time, nor was the Soe-
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
harto government’s lack of commitment
to carrying out many of the supporting
measures included in the agreement
signed with the IMF. Had the commitments to the IMF been implemented in
full, the original bank strategy might
have had a fair chance of success. Conversely, given the revelation over the
following months of the government’s
unwillingness to implement many of the
agreed measures, it is quite likely that
any bank strategy—including one with
a blanket guarantee—would have failed.
A blanket guarantee without the robust
implementation of supporting measures
would not have been sufficient to stop
the crisis.
The blanket guarantee announced on
27 January 1998 followed closely the
provisions of that promulgated in Thailand. All depositors and creditors were
to be covered (except the holders of subordinated debt) for both domestic and
foreign currency claims, although the
latter too would be paid in domestic
currency, at the rate of exchange on the
day the claim was made. The guarantee
was given to domestic banks whose
owners were willing to sign a contract
with BI and the government agreeing to
a number of prudential restrictions. A
small premium—0.5% of the value of the
deposits—was levied for the guarantee.8
A number of measures were introduced in order to mitigate the moral
hazard resulting from the guarantee.
These included limits on interbank activity and, most importantly, caps on deposit rates to prevent weak banks from
trying to attract deposits by offering interest rates that they knew they could
not afford. Banks were allowed to offer
deposit rates up to 500 basis points
above the rates set by the JIBOR banks.9
While such a premium may have been
appropriate in the beginning in view of
the lack of confidence in many of the
banks, it eventually gave scope to banks
85
to maximise deposit shares by exploiting the guarantee. Chief among these
were some of the so-called BTO banks,10
which achieved a remarkable rebuilding
of deposits over the period. This may
have helped to stabilise the banking system to begin with, but since the deposits were attracted at rates above those
the banks could earn from them, pursuit of this strategy substantially increased the losses of these banks, and
thus raised the ultimate cost of recapitalisation.11
By early 1999, with the banking system largely stabilised, such a large premium was clearly no longer necessary.
In March 1999, BI announced an initial
reduction of 50 basis points. On 19 April,
it announced a further 100 basis point
reduction to a 350 basis point maximum,
and after May 1999 it reduced the maximum spread in stages to 100 basis
points. The announcement of the guarantee did not of itself generate confidence that the government would
indeed stand behind all depositors and
creditors. Depositors initially continued
to withdraw their funds, leading to a
continuing need for BI liquidity support.
Only after the bank closures of April
1998 had been succeeded by the prompt
transfer of deposits from the closed
banks to designated state banks was
credibility of the guarantee achieved in
the eyes of the public.
Although the authorities made immediate transfers of non-bank deposits
from closed banks, there were substantial delays in the payment of interbank
claims. Responsibility for the administration of the guarantee was passed from
BI to IBRA and back again; the continuing non-servicing of the guarantee,
which may have been a result of the bureaucratic passing of responsibilities, but
may also have reflected concern at the
insider nature of some of the claims, undermined the credibility of the guaran-
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
86
Charles Enoch, Olivier Frécaut and Arto Kovanen
tee in the international community, and
provided a serious irritant in its attitude
to Indonesia. In March 1999 the government committed itself to prompt payment of such claims for the banks that
were eligible for the joint recapitalisation scheme. However, these payments
were in some cases not subsequently
made, thus generating opportunities for
intermediaries to offer to facilitate them.
The use of government-connected facilitators by the owner of Bank Bali, a large
private bank seeking to meet the qualification requirements for the joint recapitalisation scheme, led to a major scandal
in August 1999, and possibly influenced
the result of the presidential election
under way at that time. Subsequently,
international accountants were brought
in to verify the eligibility of all remaining claims, and procedures were established to make the remaining payments
in the early part of 2000.
Initially the blanket guarantee was to
be maintained for a minimum of two
years, with the government indicating
that it would give at least six months
notice of its termination. By the middle
of 1998, there was a movement to terminate the guarantee on the earliest possible date, out of a feeling that it had
proved very expensive and had opened
the door to abuses, and that expenditure
could be saved by eliminating it at that
point. In the middle of 1999, when the
announcement would have to be made
if the guarantee was to be eliminated at
the earliest possible date, there was indeed momentum to make such an announcement. After some discussion,
however, it was realised that the costs
of the guarantee were essentially already
sunk, that the banking system was still
not sufficiently robust to withstand a
serious shock to confidence, and that the
announcement of the end of the guarantee might itself provide such a shock.
The authorities therefore announced
that the guarantee would be extended;
no termination date was given, but the
six-month minimum notice was reaffirmed.
There has been some domestic criticism of the guarantee, blaming it for the
high fiscal cost of the restructuring. This
criticism is misplaced. To have tried to
force depositors to bear the costs of the
banking failures could have led rapidly
to the collapse of most, or all, banks in
the country, turning Indonesia into a
wasteland of financial intermediation
and returning it to a cash or barter
economy, from which it would have
taken many years to recover. In the end,
the guarantee was fundamentally effective. It is likely to have been a major factor in the absence of significant runs on
the banks during the difficult political
transition of 1999 and the policy reversals before and since.
Lender of Last Resort Facility
In the period after the November 1997
closings of 16 small banks, the authorities had a clear preference not to close
any more banks, given evidence of the
increasing fragility of confidence in the
banking system. With closures ruled
out, and continuing depositor withdrawals, there was little alternative in
the short run but to supply central bank
liquidity. By end December 1997, over
Rp 25 trillion of liquidity support had
been supplied to banks. With the authorities unable to sterilise the impact on
overall liquidity conditions, reflecting
both the lack of effective instruments of
monetary control at the time and the authorities’ concern about the impact of
high interest rates on the banks, much
of this finance was converted into dollars.12 For the early part of the period
there may have been opportunities for
‘round tripping’ by banks, as the rates
for the lender of last resort (LOLR) facilities remained sticky and below the
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
Indonesia’s Banking Crisis: What Happened and What Did We Learn?
rates that banks might be able to earn
from investing the funds. Later, LOLR
interest rates were made punitive, up to
double the JIBOR rate; however, it seems
that most banks simply capitalised the
interest payments, so the notionally high
rate may not have served as much of a
deterrent.
By June 1998, total support outstanding reached Rp 140 trillion—over 15%
of pre-crisis deposits. Interestingly, the
support was still heavily concentrated
in a small number of banks, with around
80% of the total accounted for by just five
banks: BCA, Bank Dagang Nasional Indonesia (BDNI), the state-owned Bank
Ekspor–Impor Indonesia, Bank Danamon, and Bank Umum Nasional (BUN).
Moreover, the granting of liquidity support was not constant over the period.
Times of intense liquidity support were
interspersed with periods when there
was no new support, or even small repayments.
The operation of an LOLR facility to
address banks’ short-term liquidity difficulties is one of the classic functions of
a central bank. Conventionally such
lending should be only to banks that are
solvent, and the banks should provide
collateral. There should be restrictions
against protracted use of such lending,
since this is likely to be an indicator of
solvency difficulties. However, after the
bank closures of November 1997, while
liquidity support escalated rapidly, no
attempt was made to distinguish between liquidity support and solvency
support, and collateral was no longer
taken. A criticism of BI’s LOLR practices
relates to the lack of control over such
lending—in particular over whether the
lending matched a commensurate loss
of deposits. While BI did undertake
such matching in the latter part of the
crisis—specifically in May 1998 when
BCA was subject to protracted withdrawals—there seems to have been less
87
control during some of the earlier periods.
When it became clear that the liquidity support was really solvency support, the government’s obligation to
meet the costs of bank restructuring
was recognised as including payment
for this support. The authorities agreed
to pay BI for liquidity support in the
form of bonds with the principal indexed to the rate of inflation, and to pay
interest at 3% of the index-linked principal. In exchange for this payment,
IBRA, as agent for the government,
would take an equivalent claim on the
banks.
In order to address the issue of lack
of collateral from borrowing banks, BI
required personal guarantees from bank
owners that their borrowings were being used to meet liquidity needs, and
that their banks were in compliance with
all prudential regulations. Those banks
that subsequently failed, or were taken
over by IBRA, were investigated by
IBRA to see if they had indeed been fully
compliant. For 10 of the 14 banks taken
over or closed in 1998, IBRA found that
there had been prudential violations—
generally breaches of the legal lending
limit. In all such cases, IBRA sought to
negotiate a pledging of the owners’ assets that should be sold so that the government could recover its outlays.
In September 1998 a ‘shareholders
settlement’ was agreed between the government and the owner of BCA that was
meant to serve as a model for settlements with the other owners, and was
to achieve repayment of the bulk of the
liquidity support extended to the banks.
However, there were protracted delays
in reaching these other agreements, and
their structure was such that the owners retained control over the assets
being pledged until the assets were actually to be transferred. Overall, receipts
to the government turned out to be
88
Charles Enoch, Olivier Frécaut and Arto Kovanen
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:16 19 January 2016
much lower than earlier estimated, and
in 2001 the government decided that the
settlement agreements should be reopened and additional assets committed by the owners.
Governance Issues
Governance issues have been at the
heart of the banking crisis in Indonesia.
At the onset of the crisis, the banking
sector was weak because of directed
lending, breaches of legal lending limits, and inadequate capitalisation. The
fact that several well connected banks
were closed in November 1997 was perceived as a major turning point, but subsequent reversals of these closures by
the authorities rapidly led to a reversal
of the initial positive reaction. Thereafter,
governance problems included serious
ongoing issues with regard to each of the
principal institutions involved (BI, IBRA
and the state banks), and these were reflected in a series of well publicised
events that served to weaken the momentum for restructuring. These issues go
well beyond the scope of this study and
reflect the pre-existing structure, where
there was no autonomy for individual
public sector agencies, and limited adherence to the rule of law.
While governance issues are rather
diverse, nearly all had a key element in
common: they indicated to the public
that the government was not sufficiently
committed to thorough reform. The result was a loss of confidence in the domestic currency, reflected in repeated
depreciations that tended to wi