In some crises, bank closures may be more effective than resolution efforts

• Author: Closures and their aftermath. -Lessons from the closure process.
• Pages: 166-167

Page 166

Intervention in banks by the public authorities is often an integral element of a government’s program for resolving a systemic banking crisis. Banks may be closed outright (“closure”) or permitted to remain open, but under new rules for conducting business (“open bank resolution”). In some circumstances, closures may be more effective than open bank resolution. In a recent study, Interventions in Banks During Banking Crises: The Experience of Indonesia,Charles Enoch, Senior Advisor in the IMF’s Statistics Department, examines a number of interventions in Indonesia, most of which included bank closures.

Closures and their aftermath

Between November 1997 and March 1999, there were four major bank closures in Indonesia. This process, Enoch notes, has been controversial, particularly in its early stages, although the more recent closures have been viewed more positively.

November 1997. Indonesia began negotiations with the IMF on a comprehensive adjustment program, as the effects of the currency crisis in Thailand, which began in July 1997, spread to Indonesia. By October 1997, the rupiah had depreciated by almost 40 percent. At the same time, runs had been building up on some private banks, as depositors sought to move their funds out of banks believed to be in trouble into banks that were thought to be more secure. As part of the comprehensive program, the government adopted a bank resolution package. On November 1, it was announced that 16 banks, comprising about 2.5 percent of the assets of the banking sector, would be closed immediately.

The immediate response to the program, Enoch observes, was positive. The exchange rate rebounded slightly, and the runs on the banks declined after a few days. However, within a few weeks, sentiment turned negative. Runs became pervasive across the system as concerns over banks’ safety merged into broader concerns about the currency and the stance of economic policy overall. Liquidity support provided by Bank Indonesia, the central bank, and currency depreciation intensified, approaching 60 trillion rupiah at the end of January 1998 and threatening imminent financial meltdown.

Although some commentators have blamed the economic problems that occurred after November 1997 on the closure of the 16 banks, Enoch points out that this closure was only one element of an overall bank resolution and macroeconomic program; it was...