Thursday, January 7, 2010

Indonesia's central bank turns financial crisis on its head

Economists don't usually agree about much but the vast majority seem to have concurred that the near-collapse of the global financial system was caused by banks lending out too much easy money without having the necessary capital to back it up.

So since governments in Europe and the US stepped in to bail out the ailing banks, regulators have begun trying to ensure that the minimum capital requirements for banks are increased.

A sensible solution, you might think, but how to stimulate the corporate lending that's vital to economic recovery while requiring banks to sequester more cash?

Fearful that banks are hoarding cash rather than lending to needy businesses, Indonesia's central bank, Bank Indonesia, has come up with a novel solution:

Allow those banks that lend more to reduce the amount of regulatory capital they are required to put on deposit with the central bank. In other words, penalise those banks that have the most solid foundations and encourage banks to splash the cash with little regard to how much real money they actually have in their vaults.

Bank Indonesia has yet to release the full details of this new policy but it seems counter-intuitive at best and, in a country where memories of the devastating bank collapses of the 1997-1998 crisis are still reasonably fresh, completely barmy at worst.

Still, you have to admire BI's chutzpah in trying to drive economic recovery by encouraging reckless lending.


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