Indonesia Banking Resolution Lesson Learned From Financial Reform (1997 & 2008) Kartika Wirjoatmodjo Indonesia Deposit Insurance Corporation

Indonesia Banking Resolution Lesson Learned From Financial Reform (1997 & 2008) Kartika Wirjoatmodjo Indonesia Deposit Insurance Corporation

Agenda Macro Economic and Indonesia Banking Update Lesson Learned: Financial Reform 1997 & 2008 The Role of IDIC Banking Resolution: Issue and Challenge Conclusion 1 1

Indonesia s growing economy as main attraction for foreign investors Indonesia s huge market coupled with an emerging middle class, a growing economy and increased consumer spending, have attracted foreign investors to invest into Southeast Asia s largest economy. 2 Source: CEIC 2

Current Account deficit tends to widen due to the increasing economic growth Indonesia s widening current account deficit along with a plunging in stock market as well as sharp rupiah (IDR) depreciation. Throughout 2013, current account deficit stood at USD 28.5 billion, or 3,3% of GDP. IDR depreciating over 21% against USD in 2013 due to broad strength in the greenback as well as risk aversion. Source: BI 3 3

Banking Sector is Robust Compare to Peers Source: IMF 4 4

Current Issues : Liquidity Adjustment (1) Small and mid sized banks chosen not involved in deposit war Δdeposits > Δloans cyclically~ Funding Stabilization Source: BI and CEIC 5 5

Current Issues : NPL Cycle is on Rise (2) Source: BI and CEIC 6 6

Agenda Macro Economic and Indonesia Banking Update Lesson Learned: Financial Reform 1997 & 2008 The Role of IDIC Banking Resolution: Issue and Challenge Conclusion 7 7

1997 Indonesian Crisis: Backgroud Despite having stronger macroeconomic fundamentals than Thailand, Indonesia suffered a contagion effect from the Thai Bath's devaluation in July 97. At the time the crisis hit, there were deficiencies in banking supervision and regulation, together with significant vulnerabilities of banks to market risk. While the first wave of effects were observed in August 1997, the true meltdown happened in early 1998 following system wide bank runs and a free fall of the Rupiah. The government declared a temporary blanket guarantee and a bank restructuring package that ultimately led to the closure of more than 60 banks and gross outlays of over 50 percent of GDP. Through May 2002, Bank Indonesia had closed 70 banks and nationalized 13, or almost 30% of a total of 237 banks. Official nonperforming loans for the banking system were estimated at 32.5% of total loans at the peak of the crisis. 8 8

Impact to macro economic indicators Indicators Crisis 1997 Crisis 2008 1996 1997 1998 2008 2009 2013 GDP (%) 7.98 4.65 13.13 6.01 4.63 5.78 Interest Rate (%) 12.75 20.00 35.52 9.25 6.50 7.50 Gross NPL (%) 9.50 8.10 50.00 3.20 3.30 1.77 Exchange Rate (IDR) 2,363 4,650 8,025 10,950 9,400 12,189 Crisis 2008 impacted less to Indonesia s economy than Crisis 1997 due to the resilient macroeconomy and financial system. Source: BI and CEIC 9 9

Indonesia Bank Restructuring Agency (IBRA) Objectives (President Decree No. 27, Year 1998): 1.Conduct administration on collateral given by government to recapitalized banks 2.Perform supervision and guidance on bank health improvement including those are restructured 3.Conduct legal actions required in order to improve bank health Source: Tumenggung (2005) 10 10

Banking Recapitalization (Crisis 1997) Source: Batunanggar (2002) 11 11

After Global Crisis 2008: Change Paradigm for Financial Regulation, Back to Basics? Source: Narain, Otker-Robe dan Pazarbasioglu (2013) 12 12

Crisis 1997 vs 2008: Some Contrasting Facts No. Aspects 1997 2008 1 Number of banks 248 124 2 Quality of regulation and supervision Weak due to liberalization euphoria Strong due to lessons from crisis (adopted Basel criteria) 3 Deposit Insurance Ad Hoc (Blanket Guarantee) Formal Institution 4 Central Bank Independence No Yes 5 Macro Economy Management Fair Conservative 6 FiscalCost IDR. 654 Tn (+/ USD 65 Bn) IDR. 6.7 Tn (+/ USD 670 Mn) 7 Worst growth performance 18.2% YoY (4Q98) 4.1% YoY (2Q09) 8 Bank Intervention Liquidated/Frozen/ Merged: 64 Recapitalized/ take over: 13 Liquidated: 1 Recapitalized:1 9 Bank Runs Yes No 10 Coincide with Global Crisis No Yes 13 13

Coordination is Very Important 14 Source: Batunanggar (2002)

Agenda Macro Economic and Indonesia Banking Update Lesson Learned: Financial Reform 1997 & 2008 The Role of IDIC Banking Resolution: Issue and Challenge Conclusion 15 15

The Role and Function of IDIC Formed under law of 24 Year 2004 : Functions 1. Insures customer deposits in banks 2. Actively contributes to maintaining banking system stability as covered by its authority Goals 1. Provide insurance for banks customer deposits 2. Conduct failed systemic bank handling and/or rescue 3. Conduct the resolution of failed non systemic banks in form of: a. rescue; or b. liquidation. Source: IDIC 16

Feature of IDIC IDIC Features 1. Independent legal entity; 2. Mandates are paying insured deposits, resolving systemic and unsystemic failed banks, as well as liquidating and distributing the assets of closed banks Advance Loss Minimizer; 3. Mandatory membership; deposit coverage IDR 2 billion (US$190,000); and annual premium 0.2% of total deposits; 4. Has paid insured deposits and liquidated 57 rural banks and 1 commercial bank, and rescued 1 commercial bank. 5. Initial capital IDR 4 trillion; backup funding from the Government; and manage one deposit insurance fund. 6. Total funding IDR 47,28 trillion Source: IDIC 17 17

Evolving Paradigm of IDIC from Cashier to Guardian of The Financial System Law No 24, Year 2004, article 4 point b: The role of IDIC, contributing to maintaining banking sector stability Today TOMORROW 18 Pay box Yesterday Source: FSB (2012) Pay box plus + resolution functions Examples: Argentina, Brazil, United Kingdom Reimbursement of insured deposit only Examples: Australia, Germany, Hong Kong, India, Netherlands, Singapore, Switzerland Loss Minimizer + expanded resolution functions Examples: Canada, France, Italy, Japan, Mexico, Russia, Spain, Turkey, Indonesia Risk Minimizer + prudential oversight Examples: Korea, United States IDIC as Advance Loss Minimizer: 1. Temporary Capital Placements 2. Asset restructuring 3. Hand over bank s management to 3rd parties 4. Merge failed bank with other bank 4. Transfer bank s ownership 5. Manage any contracts between the Failed Bank and 3rd parties 18

Non Systemic Banking Resolution Source: IDIC 19 19

Systemic Banking Resolution Source: IDIC 20 20

The Resolution of Century Bank Resolution : Bank C Case 6/11-08 Placed under Special Surveillance Unit 20/11-08 Indicated as Systemic Failed Bank Inform KSSK 21/11-08 Declared as Systemic Failed Bank Sent to IDIC IDIC took over shareholder authority Rescue Actions Prepare Cost of Handling Operation and Financial Improvement Divest 3Y+1Y+1Y Normal Bank BI KSSK/KK IDIC BI Source: IDIC 21 21

Resolution: Issue and Challenge 1. Politics! Dealing with a problem bank often involved politically powerful (conflicting) factions. 2. Should have enough time to do Financial Due Diligent (FDD) and Legal Due Diligent (LDD) before FKSSK made decision on rescuing failed bank. 3. Too few options of resolution, currently only rescuing (bail out) or liquidation. Other methods to be considered/developed: purchaseassumption, bridge bank, bail in (contingent capital) and merger acquisition. 4. The problem of systemic identification. There is a guideline (size, substitutability and interconnection) but it is very judgemental, should have clear CMP for Domestic Systemically Important Banks (DSIB). 5. Minimizing cost of resolution by early identification intervention. It might cause though cooperation: the problem of silos and coordination. 6. Managing rescued bank: the need to obtain full recovery of capital injection versus owning too long for growth (IDIC is not designed to run a business). 7. In addition the existence of resolution time limit also renders IDIC vulnerable to cornering by market. 22 22

Bank Resolution : Power of Reserve ~ USD3 bn Total 46 Banks 16 Banks 30 Banks For DSIB, still need goverment bailout programme and clear Crisis Management Protocol 23 Source: IDIC 23

Agenda Macro Economic and Indonesia Banking Update Lesson Learned: Financial Reform 1997 & 2008 The Role of IDIC Banking Resolution: Issue and Challenge Conclusion 24 24

Conclusion 1. Indonesia banking sector still robust compare with peer 2. The key challenge for Indonesia banking system is process of liquidity adjustment (liquidity cycle) and credit risk management. 3. Open bank assistance (bail out) should be the last alternative considered in resolving failed banks. If used, it should be complemented by tight conditionality based on sound management and involvement of existing owner(s). 4. A bank closure should be executed rapidly but with a well- devised strategy. The focus should be on timing and actions to quickly restore public confidence. Communication is vital in declaring that closed banks were unsound and the rest of the industry is sound. 5. Government needs to establish a bailout programme for DSIB and integrated CMP among all financial authorities. 25 25

Conclusion 6. Bank restructurings should be transparent, uniform and implemented consistently and selectively and encourage private sector participation. 7. Effective cooperation between all financial safety net participants is necessary for effective crisis prevention and resolution. 8. Institutional capacity to detect the crisis early and to devise proper resolution strategies is essential. The institutional capacity should be in the form of hardware, software, procedures and legal mandates (a comprehensive crisis management protocol) 9. Stronger internal capabilities for both bank and asset restructuring. 26 26

27 Thank You