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Viewing cable 07JAKARTA721, INDONESIA TAKES FINAL STEP TO ROLL BACK BLANKET BANK

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Reference ID Created Released Classification Origin
07JAKARTA721 2007-03-13 08:55 2011-08-24 01:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Jakarta
VZCZCXRO3555
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #0721/01 0720855
ZNR UUUUU ZZH
R 130855Z MAR 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 3815
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 0395
RUEHBJ/AMEMBASSY BEIJING 3979
RUEHBY/AMEMBASSY CANBERRA 0516
RUEHUL/AMEMBASSY SEOUL 4007
RUEAIIA/CIA WASHDC
UNCLAS SECTION 01 OF 05 JAKARTA 000721 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SETH SEARLS 
COMMERCE FOR 4430/BERLINGUETTE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR FINEMAN 
DEPARTMENT PASS EXIM BANK 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: INDONESIA TAKES FINAL STEP TO ROLL BACK BLANKET BANK 
GUARANTEE 
 
REF: A) 06 JAKARTA 1833 
 
1. (SBU) Summary.  Most analysts expect little short-term reaction 
from bank depositors when the Indonesian Deposit Insurance 
Corporation (LPS) takes the final step of reducing its deposit 
insurance coverage on March 22 to Rp 100 million ($11,050) per 
depositor per bank.  While some large depositors are dividing their 
accounts inside a single bank, moving them to larger banks, or 
distributing money among different banks, there is no evidence to 
date of capital flight overseas.  However, over the longer term, 
many questions remain about whether Indonesia has the regulatory 
structure to manage bank failures effectively.  Relationships and 
the information flow between LPS and bank regulator Bank Indonesia 
are uncertain, Indonesia's banking elites remain as powerful as they 
were before the 1997-98 financial crisis, and the country's 
state-owned banks enjoy an implicit blanket guarantee by virtue of 
their presumed status as "systemic banks."  A coordinating committee 
made up of representatives of BI, the Ministry of Finance (MOF) and 
LPS will attempt to set up a workable system for bank resolutions, 
but most parties expect the President would be forced to make the 
final decision if a large Indonesian bank were to fail.  USAID 
technical advisors have played an important role in supporting LPS's 
structure, operations and outreach efforts from the outset.  This 
cable uses an exchange rate of 9,050 per dollar.  End Summary. 
 
Crisis-Era Guarantee a Product of Duress 
---------------------------------------- 
 
2. (U) The 1997-98 financial crisis led to a meltdown of Indonesia's 
banking sector, eventually costing the GOI more than $70 billion in 
recapitalization bonds and liquidation costs.  The GOI liquidated 16 
banks, and consolidated many more, and the number of commercial 
banks in Indonesia fell from 239 before the crisis to 138 at the end 
of 2003.  As bank runs mounted in January 1998, the GOI instituted a 
blanket guarantee on third party liabilities of banks to restore 
public confidence in the banking system.  Although the blanket 
guarantee was successful in quickly restoring public confidence in 
Indonesia's banks, it also created a large scale contingent 
liability for the GOI and introduced a new element of moral hazard 
into the banking system.  Fortunately, as Indonesia's economic 
growth gathered momentum after 2000, only six small rural banks and 
a similar number of small private commercial banks failed through 
2006, none of which presented systemic risk.  In September 2004, 
Parliament enacted Law 24/2004 establishing the Indonesian Deposit 
Insurance Corporation, know by its Indonesian acronym LPS.  The law 
established LPS as an independent institution to protect depositors' 
funds and "actively participate in maintaining the stability of 
banking system" in cooperation with BI.  LPS officially started 
operations in September 22, 2005 and began its phased rollback in 
March 2006. 
 
------------------------------ 
Table 1: LPS Deposit Insurance 
------------------------------ 
 
Date                      Maximum Insured 
----                      --------------- 
 
Sept 2005 - March 2006   All deposits insured. 
 
March 2006 - Sept 2006   Rp 5 billion ($550,000) 
 
Sept 2006 - March 2007   Rp 1 billion ($110,000) 
 
March 22, 2007 onward    Rp 100 million ($11,000) 
 
3. (SBU) LPS is now heading into its fourth and final reduction of 
the level of coverage of its deposit guarantee.  After 18 months of 
transition, LPS will guarantee deposits with value up to Rp 100 
million ($11,050) effective March 22.  Unlike in previous reductions 
of LPS's guarantee, reducing the level of per account coverage from 
Rp 1 billion to Rp 100 million will place a large amount of funds 
outside of the deposit insurance system, raising the possibility of 
depositor reaction.  According to LPS data (Table 2) as of December 
2006, almost 1.3 million Indonesian persons or institutions held 
account balances between Rp 100 million and Rp 1 billion.  After 
March 22, account balances over Rp 100 billion will not fall under 
 
JAKARTA 00000721  002 OF 005 
 
 
the LPS deposit insurance.  Previous reductions of the level of 
coverage of LPS's deposit guarantee affected far fewer 
accounts--only 23,000 in March 2006 and 116,000 in September 2006. 
In the case of a bank failure, the new LPS limit means that the LPS 
would cover directly the first Rp 100 million of each depositor 
account.  Sums above the Rp 100 million level would only be paid 
after the resolution of the bank and liquidation of assets, 
depending on the circumstances. 
 
---------------------------------- 
Table 2: Bank Deposit Distribution 
(as of December 2006) 
---------------------------------- 
Nominal              Deposit        Value of 
 Value              Accounts        Deposits 
Per Account         (in 000s)  %  ($ billion) % 
--------------------------------------------- ---- 
Rp 0-50 million       78,904  96.9% $20.9   14.6% 
Rp 50-100 million      1,108   1.4    8.8    6.1 
Rp 100 mill-1 bill     1,279   1.6   39.3   27.4 
Rp 1-5 billion           116   0.1   24.9   17.4 
Rp 5 billion+             23   0.0   49.6   34.5 
 
Total:                81,431  100% $143.4   100% 
 
Source: LPS 
 
4. (SBU) By luck or design, the GOI is taking the final step to 
reduce the blanket guarantee in the context of a strong operating 
environment for Indonesian banks.  GDP growth accelerated in four 
consecutive quarters in 2006, and most analysts forecast 2007 growth 
to top 6 percent.  Bank Indonesia has driven down its benchmark 
30-day rate aggressively since May 2006 to 9% on March 6, the lowest 
since September 2005.  Bank earnings are strong, loans are growing, 
and most banks have ample liquidity.  In this context, LPS CEO 
Krishna Wijaya told us that there had not been any significant 
outflow of money out of the banking system, but that LPS still had 
concerns about capital flight offshore after the March 22 deadline. 
 
 
5. (SBU) Jakarta bankers by and large confirm Wijaya's confidence in 
the current stability of the banking system. "Banks are very liquid 
now.  No one is screaming for deposits," a representative of Panin 
Bank, Indonesia's eighth largest bank told us.  "The big depositors 
are investing in other instruments such as senior bank debt, 
government bonds or SBI."  However, a representative in Jakarta of 
Bank Danamon, Indonesia's fifth largest bank said that, "The smaller 
banks pay higher rates, so there may be some additional flight to 
quality before or right after March 22 among the big depositors." 
The CEO of Permata Bank, Indonesia's ninth largest by assets, noted 
that the deposit situation is fairly stable.  There is "good 
awareness among customers" and he is not seeing any money move out 
of his bank.  "Money that wanted to move offshore would have done it 
by now.  I expect most of the money will be staying in the banking 
system here." 
 
If a Bank Fails: "Systemic" vs. "Non-Systemic" 
--------------------------------------------- - 
 
6. (SBU) Over the longer term, there is much less certainty about 
whether Indonesia's nascent deposit guarantee agency will be able to 
overcome the difficult institutional and political hurdles that have 
prevented effective bank resolution in the past.  One structural 
issue facing the LPS is Law 24/2004's explicit differentiation 
between "systemic" and "non-systemic" banks.  By writing this 
distinction into the law, Parliament signaled to depositors that the 
GOI will treat failed systemic banks differently, and presumably 
more generously, than non-systemic banks.  The same provision opens 
a wide loophole for wealthy Indonesian bank owners to argue that, in 
the event of difficulties, their banks are "systemic" and therefore 
deserving of extra GOI support.  For depositors, the distinction 
creates a bias against large depositors using small banks, possibly 
introducing instability into the system.  LPS and BI will need to 
monitor how significant the move of large depositors away from small 
banks is in the coming months. 
 
7. (SBU) On paper, the LPS's procedures for resolving systemic and 
 
JAKARTA 00000721  003 OF 005 
 
 
non-systemic banks are straightforward.  According to the LPS law, 
for bank failures "with systemic impact," a coordinating committee 
made up of representatives of BI, MOF and LPS will review possible 
actions.  For banks whose potential failure is non-systemic, LPS is 
to step in as soon as BI places the troubled bank under "special 
supervision."  LPS will receive data from the bank and BI, and can 
request additional information if LPS needs it.  If the bank fails, 
LPS has ten days to prioritize deposits, with "clear" deposits 
getting top priority.  LPS is also tasked with working with the 
police and immigration authorities to assure that bank officials 
under investigation do not flee the country (as happened with the 
Bank Global President Irawan Salim in 2004, who fled after the bank 
collapsed and is still wanted by Interpol). 
 
System Not Yet Tested: 
Can Indonesia Resolve a Big Bank? 
--------------------------------- 
 
8. (SBU) If Indonesia's recent history is any guide, the LPS's 
actual response to a failed bank is likely to be messier.  The 
1997-98 failures of a number of large Indonesian banks saddled the 
state with large losses; Indonesia has only experienced small, 
insignificant bank failures since 2000.  The relationship between 
the LPS, BI, and MOF, along with the continuing political power of 
many bank owners, leaves major unanswered questions about how 
smoothly bank resolutions are likely to proceed.  Key issues include 
the following: 
 
--Strengthening relationships, and information flow, between BI, LPS 
and the MOF:  During crisis-era bank resolutions, BI and the 
Indonesian Bank Restructuring Agency (IBRA--LPS's predecessor 
organization) had a poor working relationship and shared little 
information.  BI was reluctant to admit banks were failing, or pass 
them to IBRA, for fear that it would spark criticism of the 
effectiveness of BI's supervision.  By the same token, IBRA was 
reluctant to accept responsibility for failing banks because it 
would require the agency to make large payout of GOI funds.  This 
unproductive back-and-forth usually translated into a significantly 
larger loss for the state.  Strengthening coordination mechanisms 
and drafting clear guidelines and procedures for handling problem 
banks will be important for reducing these disincentives for 
cooperation.  One favorable sign is that all LPS staff are still 
seconded from other agencies such as BI and MOF, a sign, according 
to one advisor, that BI wants to maintain a tight relationship with 
LPS. 
 
--Clarity of "systemic bank" definition: As noted above, lack of 
clarity over the meaning of the term "systemic" could ignite 
political wrangling in the event a large or medium-sized bank faces 
troubles in the future.  Will BI and MOF provide guidance promptly 
to LPS in the case of a systemic bank, or will decision making 
become tied up in political battles? 
 
--Political interference by banking elites:  Indonesia's domestic 
bankers remain an extremely influential group.  During the crisis, 
in most instances they were able to inflict large losses on the 
Indonesian state while keeping their business groups intact. 
Although BI's bank supervision has improved markedly since the 
crisis, and law 24/2004 has set out a much clearer bank resolution 
framework, few Indonesian bank owners would allow LPS to liquidate 
their banks without a fight.  Several recent events demonstrate the 
continuing political power of Indonesian bank owners.  Owners of 
small banks have by and large ignored BI's pressure to merge with 
other banks as part of BI's Indonesian Bank Architecture program. 
In addition, only five years after IBRA took over Bank Internasional 
Indonesia (BII) at a loss of more than $1 billion, BI recently 
permitted BII's parent group, Sinar Mas, to purchase another 
domestic bank. 
 
What if BNI Fails? 
------------------ 
 
9. (SBU) Raden Pardede, the newly named Chairman of the Executive 
Forum of the Financial Sector Stability Forum told us that he is 
concerned that it will be difficult if a "systemic" bank fails.  The 
Financial Sector Stability Forum is a GOI initiative to clarify 
roles and responsibilities of relevant agencies in case of another 
 
JAKARTA 00000721  004 OF 005 
 
 
financial sector crisis.  Pardede said he was concerned, along with 
other financial sector watchers, about state-owned Bank Negara 
Indonesia (BNI).  BNI is the country's third largest lender, with 
total assets of Rp 157.5 trillion ($17.4 billion) as of the third 
quarter 2006.  It is suffering from high NPLs of 16.6%, or 
approximately Rp 12 trillion ($1.3 billion), more that triple BI's 
recommended maximum level of 5%.  Unlike Bank Mandiri, BNI has not 
opened up its books or improved its management.  It lacks 
transparency and Pardede said its financial condition is 
"worrisome."  Pardede told us that if a bank the size of BNI were to 
fail, it would leave the GOI in a tricky situation.  "Who will make 
the decision how to respond?" he said.  "It will be tough for the 
MOF and BI to decide on a course of action.  It may get kicked 
upstairs to the President." 
 
U.S. Advisors Helping to Build LPS 
---------------------------------- 
 
10. (U) In June 2005, Parliament budgeted an initial Rp 4 trillion 
($442 million) for LPS operations.  LPS has not had to deal with any 
significant bank failures since its creation in 2005, though six 
very small rural banks are currently under liquidation.  USAID has 
an ongoing project to assist LPS develop necessary operational 
policies, procedures and regulations to perform its deposit 
insurance activities, including the resolution of failing banks, 
payment of insured depositor claims, and the liquidation of failed 
bank assets.  It has also supported LPS management with guidelines 
and information on best practices.  The USAID assistance also 
includes outreach activities directed toward education the media, 
depositors and bankers about the insurance and claims payment 
function of the deposit insurer. 
 
LPS Not Yet Ready for a Medium-Sized, 
Near-Term Failure 
------------------------------------- 
 
11. (SBU) For its early stage of life, LPS is relatively sound but 
needs to get stronger.  Banks are complying with the requirement to 
pay a one-time membership contribution of 0.1% of paid-up capital 
and two insurance premiums a year of 0.1% of the average monthly 
balance of total deposits for each six-month period.  However, LPS's 
equity and loss reserves as of late 2006 were $785 million, about 
the size of Indonesia's twenty-second largest bank, Bank Buana, with 
deposits of approximately Rp 7 trillion ($773 million).  LPS would 
thus have a hard time with even a medium-sized bank failure in the 
near term, if it were a total collapse.  (Note: The FDIC uses the 
Designated Reserve Ratio (the fund balance divided by the amount of 
insured deposits) with a target range of 1.15% - 1.5% of insured 
deposits.)  The principal LPS balance sheet accounts are: 
 
--------------------------------------------- 
Table 3: LPS Principal Balance Sheet Accounts 
December 2006 
--------------------------------------------- 
 
Type of Balance                   Amount 
Sheet Account           (Rp Trillion)  $ million 
--------------          ------------------------ 
Principal Asset: 
Investment portfolio        Rp 7.1     $784.5 
 
Principal Liabilities: 
Equity                         5.6      618.8 
 
Contingent Loss Reserve        1.5      165.7 
 
International Banks Grudgingly Accept LPS 
----------------------------------------- 
 
12. (SBU) Foreign banks complain about LPS and say that it is just 
another cost of doing business in Indonesia, since they cannot rely 
on it for their wealthy customers.  A large foreign bank in 
Indonesia commented that, "Most of our depositors are too big to be 
covered by LPS anyway.  It is interesting that LPS is reducing the 
level of cover but not the basis for collecting the premium.  We 
don't like having to pay LPS, when we get little benefit."  Other 
foreign banks have made similar complaints.  The GOI, however, 
 
JAKARTA 00000721  005 OF 005 
 
 
admits that it did not create LPS to provide a benefit to banking 
organizations: its purpose is to protect depositors and the 
government's balance sheet in the event of bank failures. 
 
13. (SBU) The head of Southeast Asia for a large international bank 
noted that Indonesian deposit insurance is currently extremely 
inefficient.  The premiums are not risk adjusted, but merely a 
function of size of deposits.  An advisor to LPS noted that the 
first step of establishing LPS and getting the information about 
deposit insurance out to the public has been achieved.  The current 
premium level was designed build the insurance fund to a sufficient 
level over a reasonable period of time without being unduly 
burdensome on the banking industry.  Though this is not likely in 
the near term, LPS may eventually move to a more sophisticated, 
risk-based system, which will also reduce the burden on well-run 
banks, the advisor noted. 
 
HEFFERN