Although the decision to bailout the bank was taken during the height of the global financial crisis in November 2008, most lawmakers and analysts are nonetheless looking at the event within the current context of economy and banking system stability.

Opponents of Finance Minister Sri Mulyani Indrawati and Vice President-elect Boediono are hoping that a weak argument to justify the rescue, since the case for a systemic threat seems exaggerated, could help shift focus to the justifiability of actions taken to protect big depositors, rather than the theoretical greater good of the economy.

Bank Indonesia (BI) senior deputy governor Darmin Nasution, who was involved in the rescue of Bank Century when he was tax chief in November, argued the "systemic threat" justification was derived from the fact that there were 23 banks of the same size as Bank Century that were in a weak state , due partly to the massive flight of depositors into bigger banks.

It was therefore feared that the failure to help Century might cause a domino effect in the banking sector, especially hitting small and middle sized underfunded banks. Although 80 percent of banking assets are controlled by the 10 biggest banks, it is argued that the government-sanctioned Deposit Insurance Agency (LPS) might not have had sufficient reserves to cover guaranteed deposits should the 23 smaller banks have collapsed at that time.

LPS then had only Rp 14 trillion in reserves, while closure of Bank Century alone was estimated to cost Rp 5.2 trillion.

"If we had let Century fold, we do not know what would have happened to the 23 banks, and the entire banking system" said Darmin.

BI bureau head of financial system stability Wimboh Santoso said closure of Bank Century could have harmed the financial markets especially for state bonds and stocks. BI would have had to dump state bonds, destabilizing bond prices.

"Bank Century also has bills in other small and medium banks. This would disturb them as well," he said.

Closure of the bank would also have exacerbated the country's already expensive credit default swap arrangements (a kind of insurance if there is a default in an underlying financial instrument). The riskier the country's financial system, the higher the borrowers would have to spend in premiums to cover risks.

Finance Minister Mulyani added there could have been a psychological effect causing loss of confidence among depositors towards the banking sector if Century was left to fold.

"This would trigger a bank run that impacting on healthy banks. It's a psychological effect which is difficult to mend," she said.

Another problem arising would be a disturbance in the payment system, where international parties might become nervous of doing transactions involving Indonesia.

However, Mulyani said the systemic threat arguments were strongly delivered by BI officials who understand more of the banking situation during that time.

Aside from questioning the justification of a systemic threat, lawmakers have been digging into the legal grounds used for the bailout.

The now-defunct Financial Sector Stability Committee took the bailout decision based on government regulations in lieu of the law on the Financial System Safety Net (the crisis law issued in October) which was eventually scrapped by lawmakers in mid-December.

The law had granted an authority for the Finance Minister to act swiftly in preventing a financial crisis, including any bank rescue.

The Committee, chaired by the Finance Minister, including officials from the Finance Ministry, central bank and LPS, also used the central bank law and LPS regulations to justify their bailout decision.

Darmin said the decision to rescue the bank was based on sound legal protocols and procedures.

"If the crisis law is later being rejected by lawmakers, our legal grounds in the bailout decision come from an MoU between the Finance Ministry and the central bank, which was made in 2004."

Justification of systemic threat

1. Bank Century fallout may impact negatively upon 23 banks of similar size

2. Potential for havoc in the financial markets especially state bonds and stocks.

3. Bank Century had bills in other healthy small and medium banks.

4. Exacerbating the country's already expensive credit default swap (CDS)

5. The crisis could create a collapse of confidence and a run on the banks.

6. A disturbance in the payment system could cause bad knock-on effects.

Source: BI and Finance Ministry.

- JP/Rendi A. Witular, Aditya Suharmoko, Andi Haswidi and Andra Wisnu

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