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C
HAPTER
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1. Introduction
Te Indonesian banking system has experienced structural developments
3
.Following the implementation o extensive bank reorms in October 1988, the bankingindustry grew rapidly in terms o the number o banks as well as total assets
4
. However, alack o eective supervision resulted in imprudent behaviour by the banking industry. InFebruary 1991, prudential banking principles were introduced, and banks were urged tomerge or consolidate. Furthermore, in the mid-1990s sel-regulatory measures, includingthe improvement o internal controls as well as inormation technology and systems wereintroduced to strengthen the banks’ soundness. Unortunately, the wide-scale bankingconsolidation and the improvement o bank control systems never took place prior to therecent crisis. Tis was due to a lack o commitment by the owners o banks to strengthentheir organisations and weak law enorcement rom Bank Indonesia (BI) as the supervisory authority. Under the old law o 1968, Bank Indonesia lacked independence and, to a largeextent, was unable to apply tough measures on well-politically connected banks
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.During the pre-crisis period, besides having poor governance and control, the bankingindustry also suered rom undamental liquidity management weaknesses as indicatedby: (i) large volatile deposits in the composition o banks’ unds (ii) a high loan to depositratio and exposure to oreign exchange risk
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. As the currency crisis spread in mid-1997, thisgenerated other risks. Firstly, there was an increase o liquidity risk due to a huge maturity mismatch o assets and liabilities
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. Secondly, credit risk increased due to the inability o debtors to repay their oreign currency loans as the rupiah depreciated sharply.Indonesia’s banking crisis o 1997/98 was the most severe in East Asia and one o themost costly crises o the last quarter o the twentieth century. Te fscal costs o resolving theIndonesian banking crisis amounted to Rp654 trillion or 51 percent o its annual GDP
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. Itwas the second highest in the world during the last quarter o the century aer Argentina’s55.1 percent o GDP during its 1980–1982 crisis. Te experience o the 1997/98 crisis in
PROBLEM BANK IDENTIFICATION, INTERVENTIONAND RESOLUTION IN INDONESIA
by Sukarela Batunanggar
1
and Bambang W. Budiawan
2
1
Executive Researcher at Financial System Stability Bureau, Bank Indonesia. E-mail address: batunanggar@bi.go.id
2
Senior Researcher at Banking Research and Regulation Bureau, Bank Indonesia. Te views expressed in this paper are those o the authors and do notnecessarily reect the views o Bank Indonesia. E-mail address: bambang_wb@bi.go.idTe authors would like to thank Mr. Halim Alamsyah, Mrs. SWD Murniastuti, Dr. Wimboh Santoso, and Dr. I Gde Made Sadguna or great support,and Mr. S. Raihan Zamil or helpul comments and suggestions. All errors are those o the authors.
3
Under the Banking Act, 1992, banks are categorised into commercial banks and rural banks. However, the analysis in this paper only ocuses oncommercial banks. Beore the 1997/98 crisis, the Indonesian banking system evolved in fve stages: (i) the rehabilitation period (1967-1973) to restorethe economy rom high ination; (ii) the ceiling period (1974–1983) where the interest rate ceilings were applied; (iii) the growth period (1983–1988),ollowing the banking deregulation o June 1983, removed the interest rate ceilings; (iv) the acceleration period (1988–1991) ollowing the impact o extensive bank reorms in October 1988; and (v) the consolidation (1991–1997) in which prudential banking principles and sel-regulatory measureswere introduced including capital adequacy, bank ratings and internal controls. See Batunanggar (2002 and 2004) and Djiwandono (1997) or moredetailed discussions.
4
Within two years, Bank Indonesia granted licenses or 73 new commercial banks and 301 commercial bank branches.
5
See Cole and Slade, (1998).
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Foreign exchange risk was reected in the increasing ratio o oreign currency liabilities to assets and the signifcance o oreign currency loans inbanks’ portolios.
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As short-term oreign currencies borrowings were replaced by medium-term and long-term rupiah loans.
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Tis compares with Tailand 32.8 percent, South Korea 26.5 percent, Japan 20 percent, Malaysia 16.4 percent, and Philippine: 0.5 percent (1998); 13.2percent (1983 – 1987), see Honohan and Klingebiel (2000).
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Indonesia showed that excessive risk-taking combined with poor risk management andbad governance contributed mostly to the banking crisis. Batunanggar (2002 and 2004)argued that Indonesia’s crisis resolution suered rom two main problems: (i) a lack o understanding on the part o the International Monetary Fund (IMF) and o the authoritieshandling the crisis which resulted in inappropriate strategies both at the macro- and micro-level; and (ii) a lack o government commitment to take consistent and objective measures.Te intense political intervention also worsened the situation. In addition, the absence o aclear mechanism o the crisis resolution has created costly Bank Indonesia Liquidity Support(BLBI) during the 1997 crisis, which in turn created a painul and very controversial case.In line with the banking restructuring programme agreed with the IMF on July 1999,Bank Indonesia attempted to enhance the eectiveness o banking supervision to meetinternational standards, particularly the Basel Committee’s Core Principles or EectiveBanking Supervision. Essentially, the plan covers improvement o bank entry and exitpolicies, adoption o risk-based supervision and consolidated supervision, incorporationo market risk in the capital adequacy, and improving market discipline by enhancingbanks’ transparency. Bank Indonesia continues to improve the eectiveness o its bankingsupervision as part o the Indonesian Banking Architecture (API) which is aimed at a strongand resilient banking system capable o supporting economic growth
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.During the past six years, there was voluminous research on the cause and experienceo Asian crises, including that o Indonesia’s. However, the previous studies on the Asianand, especially, the Indonesian banking crisis were primarily aimed at the origin o crises.Tey outlined causes as well as lessons learned, but there was less attention given to theissues o problem bank management. Tis study aims to describe and analyse a rameworkand process or dealing with problem banks in Indonesia.Tis paper is organised in six main parts. Following this introduction, the Indonesianlegal ramework in dealing with problem banks is presented in Part 2. Part 3 outlines thedevelopment o the banking regulation and supervision o the Indonesian banking systemduring the pre- and post-crisis period o 1997/98. Ten, the supervisory tools are presentedin the ollowing order: problem bank identifcation (Part 4), problem bank intervention(Part 5), and problem bank resolution, including a range o remedial measures to resolvethe defciencies o a problem bank and to resolve a ailed bank (Part 6). Part 7 provides anoutline o the crisis-management ramework and policies adopted. Finally, Part 8 concludeswith the lessons learned and proposes the policy recommendations or more eectiveproblem-bank management in Indonesia.
2. Legal Framework in Dealing with Problem Bank
A comprehensive legal ramework - which provides or and clearly defnes theobjectives, roles, responsibilities, powers, independence, and legal protection o supervisors- is essential or eective banking supervision. Te provision o autonomy, accountability and legal protection o bank supervisors requires three components to be in place. First,operational independence to pursue the objectives set by legislation. Second, adequate
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Te API is BI’s comprehensive programme or the period o 2004-2010 or the development o a strong and resilient banking system capable o supporting economic growth. Among the key elements o API is the creation o eective banking supervision in line with international standards.
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resources to meet the objectives o banking law and provide the ramework or setting theminimum standards that the banks must meet as well as to allow supervisors su cientexibility to set the prudential rules and to accord them legal protection rom personal andinstitutional liability or supervisory actions taken in good aith in the course o perormingtheir supervisory duties. Tird, is the provision o a mechanism or inter-agency cooperationand sharing o the relevant inormation among the various o cial agencies.
2.1 Legal and Institutional Framework
Financial saety-net players in Indonesia involve three authorities, namely, BankIndonesia as the bank supervisor and lender o last resort, the Indonesian Deposit InsuranceCorporation (IDIC) responsible or insuring bank deposits as well as resolving ailed banks,and the government who provide unds or emergency liquidity assistance and systemicbank resolution.
2.1.1 Bank Indonesia
Bank Indonesia obtains its legal and operational independence with the ratifcationo its new act in 1999
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. Bank Indonesia is accountable to the parliament in carrying out itsduties and authorities. o ensure transparency and accountability, Bank Indonesia shoulddisclose inormation o its perormance and plans to the public through the mass media atthe beginning o every fscal year
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.One o Bank Indonesia’s core unctions is to ensure a sae and sound banking systemthrough the regulation and supervision o individual banks. Bank Indonesia also plays animportant role in maintaining fnancial system stability through its role as lender o lastresort and surveillance o systemic risks that may aect the entire fnancial sector.As the bank supervisor, Bank Indonesia prescribes regulations, grants and revokesbank license, supervises banks and imposes sanctions on a bank in accordance with theprevailing regulations. Bank Indonesia has a range o mandatory and discretionary tools toaddress problem banks. Tese tools can impact on bank’s shareholders, management andbank operation.Tere is a plan to transer bank supervision rom Bank Indonesia to a new agency, theFinancial Supervisory Authority (FSA) to be established by the end o 2010. As promulgatedin Article 34 o the Bank Indonesia’s Act, the FSA will act as a “mega regulator” and superviseall the fnancial institutions (excluding rural banks) and fnancial markets
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. Tree criticalissues on the creation o Indonesia’s FSA are: (i) it status may not be ully independent sinceit is under the President; (ii) budget constraints since it will be solely unded by supervision
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Bank Indonesia’s Act No. 23 Year 1999, which replace Act No.13 Year 1968, where Bank Indonesia’s Governor is a member o Monetary Board, chairedby Finance Minister.
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Te inormation contains its perormance on monetary policies o the previous year, a proposal o monetary policy strategies or the ollowing year aswell as the developments in the economic and fnancial sectors, including bank supervision reports. Bank Indonesia should also submit a report onthe implementation o its tasks to the House o Representatives quarterly.
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Initially, as promulgated in BI’s Act No.23 o 1999, the transer should be carried out by December 2002. However, due to inadequate preparation anddierences in viewpoints between Bank Indonesia and the government as well among the politicians in the parliament, the transer date has beenshied to December 2010, as provided under the amended BI’s Act No.3 o 2004.
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Batunanggar and Budiawan, Problem Bank Supervision in Indonesia
This paper is organised in six main parts. Following the introduction, the Indonesian legal framework in dealing with problem banks is presented in Part 2. Part 3 outlines the evelopment of the banking regulation and supervision…
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