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View point: New financial safety law will accelerate bank consolidation
The Financial System Crisis Prevention and Mitigation Law, which was approved by the House of Representatives on Thursday, will accelerate bank consolidation as big depositors, concerned about the safety of their savings, will most likely shun most small and medium-sized banks
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The Financial System Crisis Prevention and Mitigation Law, which was approved by the House of Representatives on Thursday, will accelerate bank consolidation as big depositors, concerned about the safety of their savings, will most likely shun most small and medium-sized banks.
Apparently learning from the political controversy and debacle over the November 2008 bailout of Bank Century (now Bank Mutiara), the new law has been designed to prevent the use of taxpayer money to help insolvent banks.
To minimize the moral hazard, the law prohibits the bailing out of insolvent banks, except big banks classified by the Financial Services Authority (OJK) and Bank Indonesia (BI) as domestic systematically important banks (DSIBs).
Only in a particularly vulnerable condition and in extreme cases that meet the stringent criteria set by the Deposit Insurance Corporation (LPS) can the OJK be authorized to instruct LPS to handle troubled non-DSIB banks similar to DSIBs.
This means that most small and medium-size banks that face problems of insolvency will either be taken over or closed down by LPS. However, both DSIBs and non DSIB-banks are entitled to short-term liquidity credit from BI as long as they can put up enough security for the loans.
Even the procedure for government (LPS) intervention to help DSIBs is quite tight and tough. If government intervention is needed due to systemic risks, it will be the shareholders who primarily take whatever losses the market doles out and creditors should be heavily penalized.
The legislation stipulates that owners of the DSIBs are to be primarily responsible for saving their ailing banks by injecting fresh capital to improve their solvency, a scheme called a 'bail-in'. Only if the scheme fails will state-owned LPS step in, using its own financial resources to cover customers' deposits and finance the lender's takeover.
But given the large number of banks in Indonesia ' 118 commercial banks and thousands of rural credit institutions covered by LPS ' the extremely small space for government intervention could turn a mini banking debacle into a full-blown financial crisis.
We reckon only about 20 of the 118 commercial banks with core capital of Rp 5 trillion (US$370 million) or more will be classified by the OJK as DSIBs worthy of government intervention during a financial crisis.
This means big depositors will most likely shun the other 98 commercial banks, because if these banks face severe financial distress, most of them will be allowed to close down and depositors would lose all their money, except the initial Rp 2 billion, the maximum sum per account that is covered by the LPS insurance scheme.
For sure, the banking industry will become more segmented.
The problem, though, is that we hardly know when or from where a financial crisis will strike. Therefore, effective banking supervision is even more crucial to prevent a financial crisis.
Given the experiences from the 1997-1998 financial and economic crisis, even the closure of small banks that are not systemically important could trigger severe financial panic and eventually a full-blown crisis if the number of bank failures is relatively big.
What's unique about such panicking, and most dangerous, is the amount of collateral damage they do to the innocent, to people who borrowed responsibly, who weren't overexposed. The banking system is the lifeblood of the economy.
It's like a power grid. One has to make sure the lights stay on because if the lights go out, then many people could face damage, such as that seen in 1997 and 1998 when Indonesia experienced what international analysts described as one of the biggest wealth destructions in the world.
Many people lost their jobs, more people lost their businesses, lost their savings and were devastated. Bailing out banks may look beneficial only for the banks' owners. But bailing out systemically important banks also actually protects people from the impact of bank failures.
The four members of the Financial System Stability Committee (KSSK) ' the Finance Ministry, BI, the OJK and LPS ' will be responsible for the nation's crisis prevention or firefighting approaches. They are in charge of performing regular monitoring of the financial system, purchasing government bonds in the secondary market and bailing out insolvent banks.
It is therefore crucial that decision-making by the KSSK be transparent, quick and firmly based on the most comprehensive data available at the time of a crisis.
Certainly, decision-making under duress during a crisis is different from that under normal circumstances. Any decision involves a choice from a number of alternatives. Decisions can be made from a complex mixture of facts and values, especially in a critical situation.
It is good to know that the law grants legal immunity or protects members of the KSSK from civil and criminal lawsuits for their decisions as long as their decision-making is in accordance to the law.
If politicians could dispute or even attack a policy judgment made by the KSSK in good faith and in full compliance with proper procedures, as stipulated in the law, no senior officials would be willing or have the courage to make any economic or financial decision no matter how urgent or imperative it may be.
The main purpose of this law is to give a clear direction on crisis-management protocol, which will give natural legal protection for policymakers who take action based on the preset steps.
The law is seen as crucial in encouraging policymakers to act decisively at times of financial crisis, with Indonesia in particular at risk of sudden shocks in the global economy given the vulnerability of its local financial markets due to the dominant role of foreign portfolio investors.
In Indonesia, threats of capital outflows are high as foreigners own at least 50 percent of shares and 40 percent of bonds traded in secondary markets, among the highest in the region.
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The writer is senior editor at The Jakarta Post.
