bank run – the _

[2638] The market will see through the undisclosed, differentiated Indonesian capital adequacy ratio

Bank Indonesia, the central bank of Indonesia, has been introducing several new institutional frameworks and rulings in the Indonesian economy. I suppose, that signifies that rate of reform in Indonesia.

One is the introduction of a trust fund. It is established to encourage Indonesian firms with earnings from abroad to keep it in Indonesia, at least for a bit longer than what typically happens now. The ultimate goal is to prevent the rupiah from depreciating further.^[1] I do not understand how that will keep the money in. That is a polite way of saying, I do not think it will work too well.

Maybe the Indonesian central bankers know more than me about their economy and I am missing a piece of the jigsaw puzzle.

Another is the introduction of a new differentiated capital adequacy ratio ruling. Soon, different bank will face different ratio requirement based on their risks as determined by the central bank. But according to a report in the Jakarta Globe:

Under the new regulation, Bank Indonesia requires a minimum 8 percent capital adequacy ratio — which measures the lender’s financial strength — for banks with the soundest risk profile but it set a higher ratio for the riskiest. In the previous regulation, the ratio was set at 8 percent, regardless of the risk profile.

Bank Indonesia groups the country’s 120 commercial banks into five risk profiles. It usually updates a bank’s risk profile every 6 months but does not make the rankings or their specifications public to avoid a run on deposits at lower-ranked banks. [Dion Bisara. Bank Indonesia Sets New Rule to Strengthen System. Jakarta Globe. December 5 2012]

Bank Indonesia does not make the rankings or the specification public to avoid a run.

That is tough because as long as one can have access to the accounts of a particular bank, one can try to figure out the ratio faced (or really, ratio maintained) by the bank. From there on, the market can imply the imposed ratio.

In other words, the public can find out exactly what Bank Indonesia tries to not divulge. So, here is a ruling that I think is good but as far as risks, bank run and the differentiated capital adequacy ratio are concerned, I am quite certain that it cannot work. Bank Indonesia is revealing the very information it wants to hide.

To come to think of it, in times of banking crisis, it appears that banks with the highest ratio may face the highest likelihood of experiencing a run (ceteris paribus… and knock on wood).

The simplest and the most effective way to have a good ratio and not tell the market anything about individual banks is to impose a more or less uniform requirement across the board. There are issues with uniform requirement but it will address the problem of information superbly.

Mohd Hafiz Noor Shams. Some rights reserved

[1] — The central bank on Friday took another step to retain foreign earnings by setting up a trustee fund that will ensure steady and sustainable flow of overseas earnings that will be repatriated into the country. The move might also help to stem the rupiah’s depreciation against the dollar by holding income earned from abroad over a period of time rather than being withdrawn quickly. [Francezka Nangoy. Dion Bisara. Central Bank Sets Rule to Keep Foreign Earnings. Jakarta Globe. November 24 2012]

[2475] Issues with the ECB’s soft loan

It was reported that European banks took out EUR489 billion worth of cheap loan from a facility provided by the European Central Bank. The Wall Street Journal revealed these banks will require more than EUR700 billion to meet their obligation next year, with more than EUR200 billion debt maturing in the first quarter of 2012 alone.

The facility is designed to avert or reduce liquidity crunch in Europe. These are two-fold. One, so that the bank have enough money to not default. Two, so that these banks do not cut loans to individuals and businesses.

Given the near panic that prevails in today environment that is ever looking for the big bazooka solution, it is understandable that the facility provides comfort and reduces the likelihood of bank runs.

But the interest rate of 1% is so low that there is an opportunity for some banks that have a better position than others to profit at the expense of the ECB. Some could probably borrow and reinvest in higher yielding assets like government finance to get essentially free pure profits. The Journal indeed did mention that the French President Nicholas Sarkozy has suggested this to kill two birds in one stone: the banks get their refinancing and the money flows into government coffer through the sales of sovereign debts to further postpone the sovereign debt crisis farther into the future.

Discounting banks which actually need the facility to refinance themselves in time when massive amount of debts are maturing, would the presence of the better-positioned banks compete with those who truly need the funds?

I would imagine some kind of controls is present in the ECB but in time of near-panic like this, I expect the controls to be weak. The tighter the controls, the longer it will take to disburse the money and that is not good. There is no time decide who really needs it. Just give it out and worry about it later.

The tightness of the loans would depend on the size of the facility. I tried to look for it but I have not found it. I would think it should be more than EUR700 billion so that the facility would be too big for the whole of 2012 requirement.

So, I would guess some banks would make pure profit. So, the presence of controls would not answer the crowding out concern.

Also, even if some of the banks actually needed the loan, what exactly prevents the banks from hoarding it like what happened in the United States with money from Troubled Asset Relief Program. Lending cost to businesses and consumers were high but the banks had access to cheap fund. The banks were saved

So, really, the facility is saving the banks. Liquidity issued faced by individuals and businesses will not be solved by the loan facility from the ECB.

p/s – an extremely helpful Q&A by FT Alphaville.