Banking crisis: Who's to blame?<\/p>\n
By Eddy Soeparno<\/p>\n
JAKARTA (JP): Many Indonesians find it difficult to accept
\nthat the economic crisis has changed their lifestyle -- as well
\nas their status, notably from being employed to unemployed -- in
\na matter of months.<\/p>\n
As late as July 1997, the World Bank announced that the
\nIndonesian economy was \"performing very well\" and had a chance to
\nmaintain an annual growth of about 7.5 percent in coming years.
\nNow it says the nation is \"near economic collapse\" and is in a
\n\"desperate\" situation that \"spells immense dangers and
\ndifficulties\" for its 202 million people.<\/p>\n
Much of the blame is pointed at the banking sector, which over
\nthe past three years had become a hotbed of speculation for
\nbusiness owners -- including bank owners. Speculative bubbles,
\nespecially in the real estate sector, were effectively nurtured
\nby continuous flows of bank credit which artificially lifted
\nasset prices as well as demand. As a result, the prices of these
\nassets soared, attracting even more investments into the sector.<\/p>\n
Because Asia's economies were growing at a very fast pace, the
\nnegative impact of this type of resource allocation was not
\nimmediately apparent. However at the end of the day, these assets
\nbecame so inflated that a price correction was simply inevitable.
\nBut it came too late -- forcing a full, immediate correction
\nrather than a gradual, less painful one.<\/p>\n
When the market finally realized the actual value and demand
\nof these assets, a significant gap between the value of the loans
\nand the value of the real estate backing them had already
\noccurred. Soon after that, the entire house of cards came
\ntumbling down as property prices went into a free fall and
\noverdue bank portfolios began to swell, while the financial
\nsystem virtually malfunctioned.<\/p>\n
Another form of speculation -- that is taking short-term loans
\nto finance long-term projects -- also contributed to the problems
\nnow faced by troubled banks. The confidence crisis in the banking
\nsector further triggered huge withdrawals of public funds from
\nthe banking system. Since most bank assets were tied up in
\nmedium- to long-term projects, the government -- in an effort to
\nstabilize the banking system -- bailed out a number of banks by
\nproviding immediate liquidity to meet depositor commitments.<\/p>\n
To date, the government has poured approximately Rp 145
\ntrillion (US$12 billion) into the banking sector to save it from
\ncollapse.<\/p>\n
To finance the move, however, the government actually printed
\nnew money, resulting in skyrocketing inflation rates up to 80
\npercent (projected to reach 100 percent by year end of the year),
\nfrom a modest single digit figure in 1997. The task of rolling
\nback this inflation rate has further resulted in high interest
\nrates of between 60 percent and 70 percent. Lending rates are
\ncurrently hovering between 80 percent and 90 percent, making it
\nvirtually impossible for banks to resume lending and disbursing
\nthe much needed liquidity to restart the engines of Indonesia's
\nfaltering economy.<\/p>\n
When the government realized it would have to take on the task
\nof salvaging and rehabilitating more banks, it summoned a team of
\ninternational auditors to look into the books of several troubled
\ninstitutions. The result was astonishing. Intercompany lending
\naccounted for as much as 85 percent of total loan portfolios,
\nwhile the amount of doubtful and bad loans at some banks
\nreportedly accounted for 90 percent of total assets.<\/p>\n
This comes as no surprise to anyone familiar with the
\ncountry's banking structure, mostly run and operated by owning
\nfamilies who normally use the bank as a vehicle to gain cheap
\nfunding to finance their own highly speculative projects other
\nbanks have refused to finance.<\/p>\n
The audit's findings prompted the government to pull the plug
\non several faltering institutions, resulting in the closure of
\nthree medium-sized banks. Another four banks, currently under the
\nIndonesian Bank Restructuring Agency's (IBRA) supervision, were
\ngiven until the third week of September to make good on all
\nobligations owed to the central bank.<\/p>\n
The exercise of closing and liquidating banks, however,
\nappears to have come at a higher price tag than previously
\nanticipated. First, the resulting layoffs will further eat into
\nthe government's pocket since it only increases the need to
\nmaintain its \"social safety net\" in the form of subsidies.<\/p>\n
Second, the move will result in tangible as well as intangible
\nlosses, such as the loss of customer relationships, banking
\nnetworks and management information systems.<\/p>\n
And finally, rehabilitating and selling off remaining assets
\nof liquidated banks is a long, cumbersome and complicated
\nprocess. Take French banking giant Credit Lyonnais, for instance,
\nwhich in 1994 set up an institution similar to the Resolution
\nTrust Corporation in the U.S. to sell off their non-performing
\nloans. To date, it has only managed to sell about 40 percent of
\nits total asset portfolio.<\/p>\n
Another matter virtually ignored throughout the crisis is the
\ncondition of the country's six state-owned banks. Frequently used
\nas a tool for politically motivated lending, the state banks were
\nknown to have large single portfolios of non-performing accounts
\neven prior to the crisis. The only reason these banks did not
\nfall apart is because it had vast and almost certain access to
\ngovernment liquidity.<\/p>\n
In the past, if any of these banks suffered from mounting
\npressure from non-performing assets or liquidity problems, the
\ngovernment would normally step in and inject the necessary funds
\nneeded.<\/p>\n
In practice, should the banks then fail to service these
\ncentral bank loans, the government would normally decide to
\nincrease its equity in the bank by converting its loans into
\ncapital.<\/p>\n
If economists fear that a government-led bailout of the
\nprivate sector would increase the problem of moral hazards, it
\nshould be noted that continuous government bailouts in the public
\nsector has already created a special kind of moral hazard
\nproblem, unfortunately carrying a much larger impact.<\/p>\n
The fact is, state banks -- either by will or \"invisible
\nforce\" -- have engaged in larger and riskier projects than any of
\ntheir private sector counterparts.<\/p>\n
Worse still, no state bank has ever been allowed to collapse,
\nno matter how large its losses.<\/p>\n
Therefore, while pointing the finger at the state of the
\ncountry's private banks, we should also assess the condition of
\ngovernment-owned banks. The size of their portfolios is
\nsignificant and any problems resulting in their non-performing
\nloans could create another ripple in the economy.<\/p>\n
Long before the crisis, Indonesia's banking sector had been
\nwidely criticized as \"highly regulated but poorly supervised\".
\nThe regulatory and supervision function of the central bank
\nshould therefore share much of the blame for causing the banking
\ncrisis, along with other factors.<\/p>\n
Weak auditing by regulators has often resulted in inaccurate
\nbank reporting, which has misled the public over the actual
\nconditions of various banks.<\/p>\n
Recent investigations on the misuse of liquidity facilities to
\nailing banks by several former board members of the central bank
\nfurther indicates that corruption and collusion were partly
\nresponsible for the current banking chaos.<\/p>\n
Therefore, it is of paramount importance that the central bank
\nenhance its supervisory role to prevent future bankers from
\noutsmarting regulators in judging the health of their books.<\/p>\n
Increased audit transparency should also be emphasized in the
\nwake of growing criticism from the public as well as the need to
\nrestore confidence in the authorities' policymaking function.<\/p>\n
In 1988, the liberalization of the financial sector and the
\nprivatization of the banking system were central to the country's
\nstructural reform programs.<\/p>\n
This, together with the availability of more resources as a
\nresult of fiscal consolidation and capital inflows, led to the
\nconsiderable growth of credit to the private sector. From 1989 to
\n1994, financing from private sector banks expanded at an annual
\nrate of 22 percent, which further prompted the central bank to
\nlimit credit growth by allowing banks to expand their assets by
\nonly 18 percent per annum in 1994.<\/p>\n
Unfortunately, the credit explosion occurred at a time when
\nthere was inadequate financial supervision and regulation by the
\nauthorities and before the banks could establish the necessary
\ninternal controls to ensure that credit would be granted
\nprudently.<\/p>\n
The results of this are evident today with the collapse of
\nseveral medium to large financial institutions and the discovery
\nof more flaws in the entire banking system.<\/p>\n
Salvaging the banking system has proven to be costly in the
\npast and it will not cost the public any less by shutting down
\nailing and more ailing banks.<\/p>\n
Therefore, the central bank should provide clear guidelines on
\nbank closures as well as increased transparency in their role as
\nlender of last resort to ailing banks.<\/p>\n
On a final note, banks are institutions in which the public
\nput more than just pennies and dimes into. It is trust that a
\nsmall time depositor extends when placing his or her lifetime
\nsavings into a bank. Bankers should realize this trust and reward
\nit with prudent policies.<\/p>\n
The writer is a corporate finance director for American
\nExpress Bank.<\/p>\n
Window A: The exercise of closing and liquidating banks,
\nhowever, appears to have come at a higher price tag than
\npreviously anticipated.<\/p>\n
Window B: Weak auditing by regulators has often resulted in
\ninaccurate bank reporting, which has misled the public over the
\nactual conditions of various banks.<\/p>",
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