The banking industry is one of the most important components in the national economy in order to maintain a balance of progress and national economic unity. The stability of the banking industry referred to greatly affects overall economic stability. Several events at the end of 1997 included the liquidation of 16 banks followed by the monetary and banking crisis in 1998 which resulted in a decline in the level of public confidence in the banking system in Indonesia, resulting in the withdrawal of public funds from the banking system (bank runs) in very significant amounts. To increase public trust in the national banking system at the same time to prevent the weakening of the rupiah exchange rate, the Government provides guarantees for all bank payment obligations, including public deposits (Blanket Guarantee). The guarantee is stipulated in Presidential Decree Number 26 of 1998 concerning Guarantees Against Payment Obligations for Commercial Banks and Presidential Decree Number 193 of 1998 concerning Guarantees Against Payment Obligations of Rural Credit Banks.
From 1998 to February 2004 the Government guarantee program was implemented by the Indonesian Bank Restructuring Agency (IBRA). This agency handles the implementation of Government guarantees for the payment obligations of 52 banks that have been suspended from operations or business activities since 1998.
When IBRA ended its work on 27 February 2004, the implementation of the Government guarantee program was transferred to the Minister of Finance based on Presidential Decree number 17 of 2004. The guarantee program that had not been completed by IBRA was subsequently carried out by the Minister of Finance. To carry out this Government guarantee program, the Minister of Finance is authorized to form a Government guarantee implementation unit within the Ministry of Finance. Based on this, on February 27, 2004 the Minister of Finance formed the Government Guarantee Implementation Unit (UP3).
In its implementation, this vast guarantee is indeed proven to be able to stop the flow of withdrawal of public funds from the banking system and slowly foster public confidence in the banking industry. However, the vast scope of the guarantee has weighed on the state budget and can cause moral hazard both from the bank manager and from the public. Bank managers become less careful in managing public funds, while customers do not care to know the financial condition of the bank because their deposits are fully guaranteed by the government. Thus the guarantee program for all bank obligations does not encourage market discipline. In addition, the wide application of guarantees that are based on Presidential Decree is not able to provide legal force, causing problems in the implementation of guarantees. Therefore, we need a stronger legal basis in the form of a law.
To overcome the above and in order to continue to create a sense of security for depositors and to maintain the stability of the banking system, this very broad guarantee program needs to be replaced with a limited guarantee system. Law Number 10 of 1998 concerning Banking mandates the establishment of a Deposit Insurance Corporation (LPS) as an executor of public fund guarantees. On September 22, 2004, the President of the Republic of Indonesia passed Republic of Indonesia Law No. 24 concerning the Deposit Insurance Corporation. Based on this Law, LPS was formed, an independent institution, whose function is to guarantee the deposits of depositing customers and to actively participate in maintaining the stability of the banking system in accordance with their authority. The law was effective since September 22, 2005, and from that date the LPS was officially operational.