I am grateful for comments from Philippe Beaugrand, Thanos Catsambas, Eric Clifton, Olivier Frécaut, Lorenzo Giorgianni, Luc Jacolin, Michael Keen, Carl-Johan Lindgren, Hassanali Mehran, Elizabeth Milne, Anoop Singh, and Timo Välilä.
The Indonesian bank restructuring program as a whole, together with related issues, is to be discussed in “Indonesia: Anatomy of a Banking Crisis” by Charles Enoch, Barbara Baldwin, Olivier Frécaut, and Arto Kovanen (IMF Working Paper forthcoming).
See, for instance, “The East Asian Financial Crisis: Diagnosis, Remedies, Prospects,” Steven Radelet, Jeffrey D. Sachs, Brookings Papers on Economic Activity, Vol. 01, pp. 1–74, 1998, Harvard Institute for International Development.
Legislation passed subsequently enhanced the powers of IBRA in closing banks (see below). Since the 1997 closures predated the establishment of IBRA and the follow-up work continued to be handled outside IBRA, it continues under the pre-existing legislation.
These were all private banks. A state bank, Bank Exim, also had borrowings from BI of more than twice its capital—due to trading losses—and was the 55th bank to be brought under IBRA. Together these banks comprised 40 percent of the banking sector.
Liquidity support tapered off during the following month when the liquidity facility was redesigned to provide for nonfinancial sanctions—including takeover of the bank by IBRA—in the event of prolonged use of the facility.
It has been generally found that major liquidity problems arise after a bank has become insolvent. Thus, while reliance on liquidity criteria probably means that some insolvent banks will escape intervention, it is unlikely that those banks in which the authorities have intervened will, in the event, be found to have been solvent.
Reliance on this particular indicator was warranted also by the urgency of restoring monetary control.
Except for the one state bank among the seven banks, Bank Exim, where the treasury department managers (who had been responsible for the bulk of the bank’s losses) were replaced, but the remainder of the bank’s management were left in place.
Newspaper adverts were run across double pages with IBRA on the left hand page announcing the closure of the seven banks, and the designated recipient bank, Bank Negara Indonesia (BNI), advertising on the right hand page welcoming its new customers to its branches and summarizing the services it could provide.
In order to mitigate the moral hazard effects of the blanket guarantee, the authorities placed a cap on the interest rates that banks could offer depositors. At this time the cap was set at 500 basis points above the deposit rates offered by the “JIBOR banks” (the group of banks whose interbank rates were used as the benchmark for calculating JIBOR). Several of the BTO banks used the maximum premium afforded by the cap in order to safeguard, and later recover, deposits.
Amendments to the banking law were needed to give IBRA powers to take control of assets from former shareholders. After considerable and unexplained delays, the law was passed and signed by the President in October 1998. To be effective, enabling regulations from the amendments were also needed. These eventually received presidential signature in February 1999.
In May 1998 implementation of the program was interrupted as a result of rioting and looting and the further collapse of the exchange rate; President Soeharto was replaced by Vice-President Habibie. There were concerted runs on the largest private bank, as part of widespread targeting of Chinese-owned businesses. Following massive BI liquidity support, the bank was taken over by IBRA on May 16. IBRA at this point had taken over banks with 23 percent of the deposits of the system.
The operational importance of the February 1998 takeover of 54 banks decreased markedly during this period, no doubt due in part to lobbying on the part of the owners of some of these banks. IBRA inspectors were progressively removed from these banks, and in July 1998 responsibility for supervising these banks—which had been transferred to IBRA—was passed back to BI.
These 16 banks were selected on the basis of initial assessment by the authorities that these might be the “core” of a revised banking sector, given their relative size and good reputation.
For one additional bank a full determination had yet to be made. It subsequently passed the tests to achieve “A” bank classification.
The closed banks had employed 15,600 workers. The banks taken over by IBRA at this time employed an additional 11,900 workers—a significant factor in the decision to take them over rather than close them.
Foreign banks consistently maintained that this failure to honor the interbank guarantee was a severe impediment to the restoration of confidence in Indonesia.
Except in one bank, which had been taken over by IBRA only because there were no shareholders able to put up their share of the bank’s recapitalization requirement.
This takeover led to the discovery of side payments by the bank, Bank Bali, in order to obtain payments under the interbank guarantee in order to close the capital shortfall sufficiently that the bank would be able to participate in the joint recapitalization program. The “Bank Bali” scandal is beyond the scope of this particular paper.