Before you start
What you'll be able to answer
- Why did closing 16 banks in November 1997 lead to runs on many others?
- Why did the rupiah collapse after the IMF rescue?
- How did the crisis bring down President Suharto in May 1998?
Where this sits
The Asian Financial Crisis — 1997 to 2000 · this module is lit
- 2 Jul 1997Thailand stops holding the baht at a fixed rate to the dollar and lets it float
- 14 Aug 1997Indonesia lets the rupiah float
- 20 Aug 1997The IMF approves a loan of about $3.9 billion for Thailand
- Nov 1997The IMF approves a loan of about $10.1 billion for Indonesia
- Nov 1997Indonesia closes 16 banks
- 4 Dec 1997The IMF approves a loan of about $21 billion for Korea
- 24 Dec 1997Korea's programme is speeded up
- 21 May 1998President Suharto of Indonesia resigns
- Aug 1998A crisis in Russia spreads panic beyond Asia
- 1-2 Sep 1998Malaysia brings in rules on money leaving the country
- 1999Growth returns in most of the region
In October 1997 a check of Indonesia's banks judged 34 insolvent
In October 1997 Indonesia was agreeing a rescue programme with the International Monetary Fund (IMF), which lends to countries that cannot pay their foreign bills. On 14 August Indonesia had let the rupiah float, leaving the market to set its price. On average a dollar that bought about 2,450 rupiah in June bought about 3,620 in October. IMF staff, with the World Bank and the Asian Development Bank, went through the central bank's figures on the banks. The combined team judged 34 banks insolvent: they owed more than they owned.
On monthly averages, a dollar bought about 2,450 rupiah in June 1997 and about 3,620 in October. By January 1998, about how many rupiah did a dollar buy?
Close to 9,700: the average for January was about 9,660, nearly four times June's figure. By the end of December the rupiah had already fallen further than any other East Asian currency hit by the crisis, the IMF's Independent Evaluation Office records.
Some banks were losing deposits before the rescue
Bank Danamon, a large bank for ordinary savers, had faced some runs, rushes by depositors to take their money out, before the IMF was called in. By the end of October the central bank, Bank Indonesia, had lent it 3.5 trillion rupiah, records the IMF's Independent Evaluation Office, the IMF's own watchdog. Bank Indonesia was already acting as lender of last resort, lending to banks that ran short of cash.
The October check used the banks' figures from June 1997, before most of the rupiah's fall. It concluded that only a limited number of private banks needed action, which the evaluation office calls a serious underestimate.
At the end of October 1997 Indonesia had three courses for its insolvent banks
The team had judged 34 banks insolvent. The programme had to say what would happen to them and to the people with money in them. Keeping the banks open would avoid the shock of closures, but they would go on borrowing from the central bank and their losses could grow. Closing them and paying every depositor in full would protect savers, but it would cost the government money and could leave bank owners and depositors less careful in future. Closing them and paying back only part would spare the budget, but larger depositors would lose part of their money, and other weak banks might look as likely to close.
Your decision
You are in Indonesia's economic team at the end of October 1997, agreeing the programme with the IMF. What do you do about the insolvent banks?
On this view, banks that are insolvent now might recover if the rupiah steadies, and nobody suffers the shock of a closure.
Where it was triedBank Indonesia already had agreements with some insolvent banks to nurse them back to health; under them a bank could not be closed unless the rescue failed, the evaluation office records.
What it costsThe central bank must keep lending new money to banks that may never repay it, and their losses can keep growing while they stay open.
On this view, if every deposit is safe, no depositor gains by rushing to withdraw, so runs on other banks have no reason to start.
Where it was triedWhen runs threatened their banks, Korea and Thailand both announced broad guarantees to calm depositors, an IMF review records.
What it costsThe government pays for every deposit in a failed bank. The Indonesians stressed this cost, the evaluation office records, and the IMF stressed moral hazard: owners and depositors take more risk if the state always bears the loss.
On this view, closing banks that cannot pay stops their losses growing, a cap on repayment protects most small savers, and large depositors, who could have judged their banks, share the loss.
Where it was triedIndonesia told the IMF it planned a deposit insurance scheme for later, protecting deposits up to a set amount. The IMF wanted Korea and Thailand, in time, to replace their broad guarantees with a funded, more limited scheme, an IMF review records.
What it costsDepositors above the cap lose part of their money. If other banks look just as weak, they may move their money before those banks are closed too.
The government closed the worst private banks and promised to repay their small depositors only, up to a cap. The closures were a condition of the programme, to be met before the IMF approved its loan. The authorities and IMF staff had agreed that a guarantee of all deposits was undesirable, the evaluation office records.
What followedRuns spread to many other banks within weeks, and at the end of January 1998 the government guaranteed all bank deposits and debts. Many, including IMF staff, came to see the lack of a full guarantee as the critical mistake of November, the evaluation office records, though it adds that the question needs careful thought in Indonesia's case.
Sixteen banks closed, and the payout covered most accounts
The government closed 16 banks on 1 November 1997. Other insolvent private banks stayed open because, Bank Indonesia argued, its agreements to nurse them back to health barred closing them unless the rescue failed. Three of the closed banks were partly owned by relatives of President Suharto.
Depositors of the closed banks would get back up to 20 million rupiah each, about 6,000 dollars, the evaluation office records. That covered 93 per cent of the accounts in those banks but only 20 per cent of the money in them. The Finance Minister said that from now on banks whose owners let them become insolvent would be closed, and at first the closures were welcomed.