As a new institution, Indonesia Deposit Insurance Corporation (LPS) experienced problems which are not much different from those of the Federal Deposit Insurance Corporation (FDIC) in the United States and other similar institutions. LPS faces problems related to the determination of normal premium, appropriate claim reserves and optimal value of insurance. In the practice, LPS applies constant tariff premium, formation of claim reserves is still arbitrary, and determination of value limit of deposit insurance is too high. This condition even encourages moral hazard problem and insolvency of LPS if there is a bank run.
That was delivered by Drs. Firman Pribadi, M.Si., in his open doctoral exam, Monday (21/2) at BRI Auditorium M.Si Master and Doctoral Program of Faculty of Economics and Business UGM. On the occasion, Firman maintained his dissertation entitled Application of Credit Risk Model to Estimate Premium Price of Normal Deposit Insurance and Moral Hazard Testing.
According to Firman, LPS in Indonesian banking system currently only handled failed banks without having the power to monitor members banks. With the current condition, this will inevitably encourage the emergence of moral hazard from member banks against LPS. “Member banks exploit the error of deposit insurance price determined by LPS by increasing risk of leverage/decreasing their capital ratio and asset risk, if LPS determines its premium not based on the risk. Bank will move the risk to LPS to get profit,” said the man born in Sungai Penuh, 17 June 1967.
Furthermore, Firman who is also guest lecture in Faculty of Economics and Business said that although deposit insurance system encourages moral hazard, history has shown that this system is useful to keep the stability of financial system of a nation. Therefore, he continued, that to be able to apply this system well, it needs a design of deposit insurance which considers exchange of moral hazard and stability.
Firman said that the transfer of risk from banks to LPS shows the expropriation from bank management to tax payers. Expropriation occurs when unhealthy banks have to be handled by LPS, using National Budget which is from taxpayers. The use of National Budget is allowed by Law No. 24 Year 2004 about Deposit Insurance Institution.
Several researches show that well-designed deposit insurance system can reduce moral hazard. This design feature, Firman said, is by forming normal premium system based on risk, adequacy of capital of bank, insurance limit, co-assurance, and tight prudential regulation supported by strong monitoring.
The research findings conducted by the husband of Titik Sri Winarni, S.E., on 22 open banks, it has been identified that claim reserves of LPS are now significantly lower than loss risk which will come from failed bank occurence. Furthermore, premium estimation which is based on the total risk for sample banks seems in line with claim reserve fund which is needed by LPS. Other findings also show the significant difference in determining the premium of deposit insurance for different sample banks. Meanwhile, an analysis related to moral hazard testing shows that there is moral hazard behavior for deposit insurance at a value up to 100 million rupiah per account and 1 billion rupiah per account.
“The system of constant premium tariff in deposit insurance system will encourage the emergence of moral hazard from bank members against LPS particularly in countries with weak banking system. The higher limit of value of insurance, the higher also the desire to do moral hazard. Therefore, the limit value of deposit guarantor up to 100 million rupiah seems to be the optimal limit value of deposit insurance,” he explained.