Review of Literature and Institutional Background
2.5 Institutional Background – The Indonesian Financial Sector
2.5.3 Overview of the Indonesia FSN
2.5.3.4 Deposit Insurance
75 All costs incurred by the LPS to rescue the bank will be recorded as the LPS’ temporary capital placement. The LPS is required to perform divestment within three years, which can be extended up to two times, with each extension lasting one year. The divestment of the bank is carried out in an open and transparent manner with due consideration for the optimal rate of return for the LPS. The optimal rate of return is equal at the very least to the value of the temporary capital invested in the bank. If by the time of the renewal period the LPS does not get back an optimal level of return, the LPS must sell the entire shares belonging to the bank for the best price the following year (the sixth year).
Figure 2.5 Procedure for Handling of a Systemic Failed Bank by IDIC (LPS)
Source: The Indonesian Deposit Insurance Corporation (2011)
76 incorporated banks. The implementation of the blanket guarantee represented a major change in banking regulation as, until this time, Indonesia had no explicit deposit insurance scheme (Batunanggar, 2002; Hadad et al., 2011).
The blanket guarantee scheme was endorsed by the Decree of the President of Republic of Indonesia Number 26 of 1998 concerning Guarantee in Commercial Bank Payment Responsibility and the Decree of the President of Republic of Indonesia Number 193 of 1998 concerning Guarantee on Rural Bank Payment Responsibility. The guarantee applied to all commercial banks in Indonesia, except for the branch offices of foreign banks. Under the blanket guarantee, the government guaranteed all bank liabilities, including off-balance sheet items.
However, the guarantee was not applicable to loan capital, subordinated capital, unproved/illegal liabilities, liabilities to the bank’s related parties, and derivative transactions (except for currency swaps). The blanket guarantee scheme membership cost a fixed-rate annual premium of 0.25%
of deposits. The Indonesian Bank Restructuring Agency (IBRA) was responsible for administering the blanket guarantee (Lembaga Penjamin Simpanan, 2005).
In practice, the blanket guarantee succeeded in reviving banking accountability. However, the government recognized two major drawbacks of this scheme. Firstly, it could create a serious moral hazard problem in the banking sector and, secondly, it could create a burden for the state budget (McLeod, 2004). In order to handle these two risks, as well as develop customer confidence in the banking sector and to maintain the stability of the banking system, the government decided to gradually phase out this blanket guarantee scheme. The system was then replaced by a limited guarantee system, which is carried out by the IDIC (LPS) (Batunanggar &
Santoso, 2007).
The establishment of LPS was based on the Law Number 24 of 2004 concerning Deposit Insurance Corporation, and came into effect on 22 September 2005. According to the Financial Sector Assessment Program (FSAP) Report on the Republic of Indonesia (2010) conducted by the IMF and the World Bank, the Indonesian deposit insurance regime is consistent with international practices. It can be evidenced by the LPS’s mandates, powers, governance structure, membership and insurance coverage. The LPS Law states that this body is independent of the MoF. It has responsibility for lessening the financial burden on the state budget and to minimize the moral hazard of bank management and depositors, to protect small depositors by insuring their deposits up to a certain limit should a bank have its operating license revoked, and to preserve public confidence in the banking system.
77 LPS membership is mandatory to every bank operating in Indonesia, including foreign bank branches and subsidiaries. The current official annual premium is 0.20% of deposits per year.
The coverage of the LPS insurance deposit scheme was decreased gradually from 2005, when all bank depositors were insured, until 2008 when the LPS only insured deposits up to IDR 100 million. However, in October 2008, in response to actions by other countries in the region and the financial crisis, deposit insurance coverage was raised from IDR 100 million (USD 10,000) to IDR 2 billion (USD 200,000). This policy amendment was necessitated by the desire to maintain public confidence in the domestic banking system and to prevent capital flight during any future global financial crisis (Hadad et al., 2011). The revised limit covers about 90% of depositors. The summary of the LPS deposit insurance coverage is shown in Table 2.7. In addition, to preventing weak banks from paying excessive deposit rates to attract insured deposits, the LPS limits the maximum rate on covered deposits both for commercial banks and rural banks. The limit is intended to make the market more cautious in their dealings with banks offering very high deposit rates, by making these deposits ineligible for deposit insurance (World Bank, 2010). The limit is reviewed periodically to adjust the current development in the financial sector (Lembaga Penjamin Simpanan, 2010).
Table 2.7 Brief History of Deposit Insurance in Indonesia
Time Period Coverage
Jan 1998 – Sept 2005 The government issued a blanket guarantee. It covered all commercial bank liabilities, including both depositors and creditors.
Sept 2005 – March 2006
LPS officially operated from 22nd Sept 2005. For an effective implementation, a two year transition period was introduced prior to a full fledge deposit guarantee scheme, divided into 4 stages:
Stage 1: All deposits were insured.
March 2006 – Sept 2006
Stage 2: Maximum amount of deposit insured was IDR5 billion for each depositor at one bank.
Sept 2006 – March 2007
Stage 3: Maximum amount of deposit insured was IDR1 billion for each depositor at one bank.
March 2007- Oct 2008 Stage 4: Limited guarantee for a maximum amount of deposit insurance at IDR 100 million for each depositor at one bank.
Oct 2008 – present As a response to the global financial crisis, the maximum amount of deposits insured was increased to IDR2 billion for each depositor within a bank.
Source: The Indonesian Deposit Insurance Corporation (2009)
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