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Batunanggar and Budiawan, Problem Bank Supervision in Indonesia

Batunanggar and Budiawan, Problem Bank Supervision in Indonesia

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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 of the Indonesian banking system during the pre- and post-crisis period of 1997/98. Then, the supervisory tools are presented
in the following order: problem bank identifi cation (Part 4), problem bank intervention (Part 5), and problem bank resolution, including a range of remedial measures to resolve the defi ciencies of a problem bank and to resolve a failed bank (Part 6). Part 7 provides an outline of the crisis-management framework and policies adopted. Finally, Part 8 concludes
with the lessons learned and proposes the policy recommendations for more effective problem-bank management 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 of the Indonesian banking system during the pre- and post-crisis period of 1997/98. Then, the supervisory tools are presented
in the following order: problem bank identifi cation (Part 4), problem bank intervention (Part 5), and problem bank resolution, including a range of remedial measures to resolve the defi ciencies of a problem bank and to resolve a failed bank (Part 6). Part 7 provides an outline of the crisis-management framework and policies adopted. Finally, Part 8 concludes
with the lessons learned and proposes the policy recommendations for more effective problem-bank management in Indonesia.

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Categories:Types, School Work
Published by: Muhammad Arief Billah on Jan 13, 2009
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09/14/2012

 
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C
HAPTER
3
1. Introduction
Te Indonesian banking system has experienced structural developments
3
.Following the implementation o extensive bank reorms in October 1988, the bankingindustry grew rapidly in terms o the number o banks as well as total assets
4
. However, alack o eective 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 inormation technology and systems wereintroduced to strengthen the banks’ soundness. Unortunately, 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 enorcement 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
5
.During the pre-crisis period, besides having poor governance and control, the bankingindustry also suered 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
6
. 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
7
. 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
8
. Itwas the second highest in the world during the last quarter o the century aer 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 reect 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 helpul 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. Beore the 1997/98 crisis, the Indonesian banking system evolved in fve stages: (i) the rehabilitation period (1967-1973) to restorethe economy rom high ination; (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 reorms 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).
6
Foreign exchange risk was reected in the increasing ratio o oreign currency liabilities to assets and the signifcance o oreign currency loans inbanks’ portolios.
7
As short-term oreign currencies borrowings were replaced by medium-term and long-term rupiah loans.
8
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).
 
70
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 suered 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 painul and very controversial case.In line with the banking restructuring programme agreed with the IMF on July 1999,Bank Indonesia attempted to enhance the eectiveness o banking supervision to meetinternational standards, particularly the Basel Committee’s Core Principles or EectiveBanking 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 eectiveness 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
9
.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 eectiveproblem-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 eective 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
9
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 eective 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 cientexibility 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 perormingtheir supervisory duties. Tird, is the provision o a mechanism or inter-agency cooperationand sharing o the relevant inormation among the various o cial agencies.
2.1 Legal and Institutional Framework 
Financial saety-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
10
. Bank Indonesia is accountable to the parliament in carrying out itsduties and authorities. o ensure transparency and accountability, Bank Indonesia shoulddisclose inormation o its perormance and plans to the public through the mass media atthe beginning o every fscal year
11
.One o Bank Indonesia’s core unctions is to ensure a sae 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 aect 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 transer 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 Indonesias Act, the FSA will act as a “mega regulator” and superviseall the fnancial institutions (excluding rural banks) and fnancial markets
12
. 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
10
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.
11
Te inormation contains its perormance 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.
12
Initially, as promulgated in BI’s Act No.23 o 1999, the transer should be carried out by December 2002. However, due to inadequate preparation anddierences in viewpoints between Bank Indonesia and the government as well among the politicians in the parliament, the transer date has beenshied to December 2010, as provided under the amended BI’s Act No.3 o 2004.

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