Fane-McLeod, Banking Collapse and Restructuring in Indonesia, 1997–2001 | Equity (Finance) | Banks

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  Most of Indonesia’s banking system collapsed during the 1997–98 financial and economic crisis. We estimate that the net cost to taxpayers of the government’s blanket guarantee of banks’ liabilities, issued in February 1998, is about 40 per cent of annual GDP. Large banks fared worse in the crisis than small ones and state banks fared worse than private ones. Despite this, and despite the fact that bank capital turned out to have been inadequate, the government reduced the capital requirements for all banks, transferred the assets of closed banks, together with the lowest quality loans of those that were recapitalized, to a state-owned holding company, and thus excluded the private sector from participating in the process of liquidating these assets. The government offered to recapitalize several banks jointly with the private sector, but participation was restricted to the former owners, and even they could only participate on very unfavorable terms. As a result, too many banks were closed, too many nationalized and several were unnecessarily merged.
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  Banking Collapse and Restructuring inIndonesia, 1997–2001 George Fane and Ross H. McLeod Economics Division, Research School of Pacific and Asian StudiesThe Australian National UniversityAbstract : Most of Indonesia’s banking system collapsed during the 1997–98financial and economic crisis. We estimate that the net cost to taxpayers of thegovernment’s blanket guarantee of banks’ liabilities, issued in February 1998, isabout 40 per cent of annual GDP. Large banks fared worse in the crisis than smallones and state banks fared worse than private ones. Despite this, and despite the factthat bank capital turned out to have been inadequate, the government reduced thecapital requirements for all banks, transferred the assets of closed banks, togetherwith the lowest quality loans of those that were recapitalized, to a state-ownedholding company, and thus excluded the private sector from participating in theprocess of liquidating these assets. The government offered to recapitalize severalbanks jointly with the private sector, but participation was restricted to the formerowners, and even they could only participate on very unfavorable terms. As a result,too many banks were closed, too many nationalized and several were unnecessarilymerged.We propose a more market oriented approach that would have strengthened banksby raising capital requirements and also minimized fiscal costs by auctioning thosethat failed to meet these requirements. In the case of insolvent banks, bidders shouldhave been invited to submit tenders for taking over both their assets and liabilities.In all cases, bidders should have been able to choose between liquidating banks andkeeping them operational, after injecting enough cash to meet the new capitaladequacy requirements. JEL Subject classification: E44, E58, G21, G28, O16    Keywords : banking crisis, bank restructuring, capital adequacy, Indonesia, moralhazard, prudential regulation    1. I NTRODUCTION   Indonesia ’ s banking sector was devastated by the crisis that began in October 1997.Of the largest banks — the seven srcinal state banks and the ten largest formerlyprivate banks — none managed to remain solvent, and those that still operate undertheir srcinal names do so only because they were bailed out by the government. 1  The number of private banks was halved from 157 to 79: 65 were closed, 9 merged,and 4 nationalized (Table 1). Most of the assets of the banking sector are nowcontrolled by the Indonesian Bank Restructuring Agency (IBRA), which was set upto manage nationalized banks as well as the assets that the government acquiredwhen it took over the liabilities of insolvent banks as a result of a blanket guaranteeto bank creditors issued in early 1998.The net cost to the government of bailing-out depositors will probably be at least 40per cent of annual GDP. The exact amount will depend on IBRA ’ s ability to collectdoubtful debts and sell off its huge share portfolio. In order to amortize this costover several years the government has issued a large volume of bonds, the value of which exceeds the total liabilities of the whole banking system at the time theguarantee was issued. Despite the resources that have been poured into the bankingsector, however, its weakness continued to impede economic recovery as of mid2001. 2. T HE 1997– 98 BANKING CRISIS   The massive real depreciation of the rupiah in 1997 – 98, combined with the sharp rise ininterest rates and the refusal of creditors to roll-over loans led to the insolvency of many Indonesian businesses and banks. 2 At the beginning of November 1997, theIndonesian government entered into its first crisis support agreement with the IMF andsimultaneously closed 16 small private banks that were experiencing liquidityproblems and were seriously in breach of various prudential regulations. Thisexacerbated the public ’ s loss of confidence in the banking system because, in theabsence of clearly stated criteria for closures and of information on the soundness of  1 Indonesia ’ s banks can be classified into five different ownership categories. State banks are ownedby the central government, regional development banks (RDB) by the provincial governments, andprivate banks by the Indonesian private sector. Joint venture banks have both foreign and domesticbanks as shareholders, and foreign banks are local branches of foreign institutions. 2 Although the rupiah recovered much lost ground in late 1998, the rupiah price of the dollarremained nearly five times higher in mid 2001 than prior to the crisis. Interest rates had returned topre-crisis levels by late 1999.   2the remaining banks, there was great uncertainty about which banks might be closednext. At the time, the government guaranteed deposits in the closed banks only up toan amount of Rp20 million — then equivalent to about $6,000. Table 1: Bank mergers, closures and survivals Initial Lost RemainingClosed Merged Private& JVNational-izedState &regional State banks 7 3 4Regional developmentbanks26 26Private banks 157 65 9 79 4 Closed in 1997 16 16Nationalized in 1998 4 2 2Closed in 1998 10 10Audited in March 1999Category A 73 1 72Category BClosed in March199921 21Eligible forrecapitalization9 7 2   Nationalized 7 7 a Category C 17 17 Joint venture banks 32 2 30 Audited in March 1999Category A 15 15Category B 17 2 15 Total 222 67 12 109 4 30 a   The seven private banks nationalized in 1999 were subsequently merged with Bank Danamon,which had already been nationalized in 1998.  Several of the remaining private banks continued to experience liquidity problems inthe last quarter of 1997, and Bank Indonesia (BI, the central bank) supplied themwith large amounts of last resort loans. Late in January 1998 the government tried torestore confidence by issuing a blanket guarantee of all deposits and other liabilities(except equity and subordinated debt) at domestically incorporated banks. Althoughthe government initially intended to terminate this guarantee at the end of January
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