Banking Collapse and Restructuring in Indonesia, 1997–2001

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.
We propose a more market oriented approach that would have strengthened banks
by raising capital requirements and also minimized fiscal costs by auctioning those
that failed to meet these requirements. In the case of insolvent banks, bidders should
have 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 and
keeping them operational, after injecting enough cash to meet the new capital
adequacy requirements.