The Indonesian bank crisis and restructuring : lessons and implications for other developing countries

Abstract

Drawing on the Indonesian experience in 1997, this paper demonstrates the complexity of managing banking crises deals. It aims at deriving conclusions from this experience for other developing countries facing similar problems. The paper also refers to comparative experiences of other countries, in particular Malaysia and Thailand, examines the IMF programme and reveals its shortcomings. The key question is to what extent the ineffectiveness and slow progress of bank restructuring, corporate restructuring and continued dilemmas in macroeconomic management in Indonesia were due to shortcomings of the economic programme, its sequencing or emphasis, and to what extent it has to be attributed other factors, including corruption and lack of policy-making capacity. Although prudential requirements and regulations, such as lending limits, were introduced to address corporate governance problems, governance of the banking sector was generally weak, and there was little incentive for banks to make appropriate risk assessments in their activities. It is shown that structural weaknesses precipitated and aggravated the crisis. There is clear evidence for mistakes in the initial responses to the crisis by both the Government and the international financial institutions. The most difficult problems facing a country like Indonesia are the political and social constraints to rapid restructuring and reforms to strengthen the financial sector. Indonesia was obliged to implement second generation Washington consensus reforms focusing on corporate governance, bankruptcy procedures, business-government relations, and more restrictive prudential regulation. A clear message of the paper is that a "one-size-fits-all" programme is unlikely to be successful. Policy makers must be able to address linkages between the financial sector and macroeconomic performance, which, if not managed appropriately, can exacerbate macroeconomic cycles. There is also a need to reduce the concentration of bank ownership and to minimize moral hazards through the design of clear exit mechanisms. Moreover, attempts to restructure the banking system can only be successful in the context of an overall recovery of the domestic economy. The main message of the paper is the importance of appropriate speed and sequencing of necessary reforms, taking due account of the institutional, legal and human capacities that are specific to each country. [English only] Drawing on the Indonesian experience in 1997, this paper demonstrates the complexity of managing banking crises deals. It aims at deriving conclusions from this experience for other developing countries facing similar problems. The paper also refers to comparative experiences of other countries, in particular Malaysia and Thailand, examines the IMF programme and reveals its shortcomings. The key question is to what extent the ineffectiveness and slow progress of bank restructuring, corporate restructuring and continued dilemmas in macroeconomic management in Indonesia were due to shortcomings of the economic programme, its sequencing or emphasis, and to what extent it has to be attributed other factors, including corruption and lack of policy-making capacity. Although prudential requirements and regulations, such as lending limits, were introduced to address corporate governance problems, governance of the banking sector was generally weak, and there was little incentive for banks to make appropriate risk assessments in their activities. It is shown that structural weaknesses precipitated and aggravated the crisis. There is clear evidence for mistakes in the initial responses to the crisis by both the Government and the international financial institutions. The most difficult problems facing a country like Indonesia are the political and social constraints to rapid restructuring and reforms to strengthen the financial sector. Indonesia was obliged to implement second generation Washington consensus reforms focusing on corporate governance, bankruptcy procedures, business-government relations, and more restrictive prudential regulation. A clear message of the paper is that a "one-size-fits-all" programme is unlikely to be successful. Policy makers must be able to address linkages between the financial sector and macroeconomic performance, which, if not managed appropriately, can exacerbate macroeconomic cycles. There is also a need to reduce the concentration of bank ownership and to minimize moral hazards through the design of clear exit mechanisms. Moreover, attempts to restructure the banking system can only be successful in the context of an overall recovery of the domestic economy. The main message of the paper is the importance of appropriate speed and sequencing of necessary reforms, taking due account of the institutional, legal and human capacities that are specific to each country. [English only] Drawing on the Indonesian experience in 1997, this paper demonstrates the complexity of managing banking crises deals. It aims at deriving conclusions from this experience for other developing countries facing similar problems. The paper also refers to comparative experiences of other countries, in particular Malaysia and Thailand, examines the IMF programme and reveals its shortcomings. The key question is to what extent the ineffectiveness and slow progress of bank restructuring, corporate restructuring and continued dilemmas in macroeconomic management in Indonesia were due to shortcomings of the economic programme, its sequencing or emphasis, and to what extent it has to be attributed other factors, including corruption and lack of policy-making capacity. Although prudential requirements and regulations, such as lending limits, were introduced to address corporate governance problems, governance of the banking sector was generally weak, and there was little incentive for banks to make appropriate risk assessments in their activities. It is shown that structural weaknesses precipitated and aggravated the crisis. There is clear evidence for mistakes in the initial responses to the crisis by both the Government and the international financial institutions. The most difficult problems facing a country like Indonesia are the political and social constraints to rapid restructuring and reforms to strengthen the financial sector. Indonesia was obliged to implement second generation Washington consensus reforms focusing on corporate governance, bankruptcy procedures, business-government relations, and more restrictive prudential regulation. A clear message of the paper is that a "one-size-fits-all" programme is unlikely to be successful. Policy makers must be able to address linkages between the financial sector and macroeconomic performance, which, if not managed appropriately, can exacerbate macroeconomic cycles. There is also a need to reduce the concentration of bank ownership and to minimize moral hazards through the design of clear exit mechanisms. Moreover, attempts to restructure the banking system can only be successful in the context of an overall recovery of the domestic economy. The main message of the paper is the importance of appropriate speed and sequencing of necessary reforms, taking due account of the institutional, legal and human capacities that are specific to each country. [English only] Drawing on the Indonesian experience in 1997, this paper demonstrates the complexity of managing banking crises deals. It aims at deriving conclusions from this experience for other developing countries facing similar problems. The paper also refers to comparative experiences of other countries, in particular Malaysia and Thailand, examines the IMF programme and reveals its shortcomings. The key question is to what extent the ineffectiveness and slow progress of bank restructuring, corporate restructuring and continued dilemmas in macroeconomic management in Indonesia were due to shortcomings of the economic programme, its sequencing or emphasis, and to what extent it has to be attributed other factors, including corruption and lack of policy-making capacity. Although prudential requirements and regulations, such as lending limits, were introduced to address corporate governance problems, governance of the banking sector was generally weak, and there was little incentive for banks to make appropriate risk assessments in their activities. It is shown that structural weaknesses precipitated and aggravated the crisis. There is clear evidence for mistakes in the initial responses to the crisis by both the Government and the international financial institutions. The most difficult problems facing a country like Indonesia are the political and social constraints to rapid restructuring and reforms to strengthen the financial sector. Indonesia was obliged to implement second generation Washington consensus reforms focusing on corporate governance, bankruptcy procedures, business-government relations, and more restrictive prudential regulation. A clear message of the paper is that a "one-size-fits-all" programme is unlikely to be successful. Policy makers must be able to address linkages between the financial sector and macroeconomic performance, which, if not managed appropriately, can exacerbate macroeconomic cycles. There is also a need to reduce the concentration of bank ownership and to minimize moral hazards through the design of clear exit mechanisms. Moreover, attempts to restructure the banking system can only be successful in the context of an overall recovery of the domestic economy. The main message of the paper is the importance of appropriate speed and sequencing of necessary reforms, taking due account of the institutional, legal and human capacities that are specific to each country. [English only] Drawing on the Indonesian experience in 1997, this paper demonstrates the complexity of managing banking crises deals. It aims at deriving conclusions from this experience for other developing countries f

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