Central bank determined to tighten its supervision<\/p>\n
This is the second of two articles based on a paper presented
\nby the Governor of Bank Indonesia Soedjadjad Djiwandono at the
\nannual bankers' meeting on Jan. 19, 1995.<\/p>\n
JAKARTA: In order to assist banks facing difficulties because
\nof problem loans, Bank Indonesia will encourage these banks to
\nmerge, consolidate or seek the possibility of acquisition.
\nThrough these actions, problem loans can at the same time be
\nrestructured, thus assuring that the merged bank remains sound.
\nTo help deal with problem banks, the government is also
\nconsidering the establishment of a rescue or pooling agency,
\nwhich is expected to enable these banks to recover within a
\nshorter period of time. Discussions have been held on the
\nformulation of the regulations for implementation aimed at
\nimproving the quality of these banks.<\/p>\n
To improve the effectiveness of bank supervision. Bank
\nIndonesia has also been working on improvements in organization
\nand personnel. In this regard, Bank Indonesia revamped its bank
\nsupervision organization in August 1994. The improvements deal
\nmainly with the combining of on-site examination and off-site
\nsupervision into bank examination teams. The change will enable
\neach team to focus fully on a specific number of banks. This
\nmethod is expected to bring about more intensive and effective
\nsupervision of bank operations.<\/p>\n
That was a brief overview of the key events in banking and
\nmonetary sector in 1994. Now, I would like to draw your attention
\nto the outlook for the future, for this year, and to take stock
\nof possible difficulties that may arise.<\/p>\n
The stable economic conditions of 1994 are predicted to
\ncontinue, enabling us to enjoy high economic growth in 1995. Added
\nto this are improving conditions in the world economy. Stronger
\neconomic growth in industrialized countries and particularly in
\nIndonesia's major trading partners is an extremely positive sigh for
\nour foreign trade prospects. In 1995, the heightened pace of
\neconomic activity in industrialized countries will boost the volume
\nof international trade, and strengthen commodity prices on the world
\nmarket.<\/p>\n
With these trends, we predict that in this year, economic
\ngrowth can be maintained at about 7 percent. On the demand side,
\nthere is definite potential for the Indonesian economy to grow by
\nmore than the projected 7 percent. This takes into accounts the
\nfact that some of the investment projects approved last year will
\nstart this year. It also appears that export demand will be
\nstrong. An additional factor is that rising incomes will
\nencourage high consumer spending again this year. Nevertheless,
\nwe should also bear in mind that higher growth also carries a
\ngreater risk of overheating the economy and also a deterioration
\nin the balance of payment which is a trade-off that we encounter.
\nWhat we want to achieve is reasonably high economic growth while
\nmaintaining economic and monetary stability. In short, we want to
\nhelp insure that growth is sustainable. For this reason, in 1995
\nthe monetary authority considers it essential to institute sound
\npolicies from the start to ensure that our economy remains on the
\npath of growth with stability. The dynamics of growth are visible
\nin a wide range of economic sectors. What is needed is the means
\nto control and direct these dynamics so that they work
\neffectively without disrupting economic and monetary stability.<\/p>\n
I am sure you agree with me that the task of maintaining
\neconomic and monetary stability is one that we share together, and
\nthat it is not a job for the government or monetary authority
\nalone. In the budget draft recently submitted to parliament, the
\ngovernment has demonstrated its determination to continue the
\ndevelopment process and other government-financed activities
\nwithin limits that are calculated not to disrupt economic and
\nmonetary stability. A similar stance is also expected from both
\nthe business community and banks. It is true that the government
\nhas now adopted the policy of encouraging a larger role for the
\nprivate sector and the business community in national
\ndevelopment. Efforts are continually being made to open more
\nopportunities to private business, to extend business
\nparticipation into more areas, and facilitate business growth
\nthrough the ongoing process of deregulation. However, this does
\nnot mean that the private business sector no longer bears any
\nsocial responsibility and are freed from any responsibility to
\nthe public interest and our common future. One of these
\nresponsibilities, along with the government is to maintain a
\nstable economic and monetary climate which will benefit all of
\nus.<\/p>\n
I would like to strongly encourage the banking community to
\nadjust their actions with those of the monetary authority to
\ndemonstrate their conscientiousness in carrying this social
\nresponsibility. This cooperation will create and maintain a
\ndynamic but stable economic and monetary environment I am
\nconfident that with a strong mutual understanding between the
\nmonetary authority and banks, this goal is achievable without the
\nuse of shock treatments or other harsh measures.<\/p>\n
According to the current information and trends, the rate of
\nexpansion in the money supply (M1) in 1995\/96 that can reasonably be
\nconsidered safe for monetary stability is about 19 percent, while
\na safe level for credit expansion is around 19 percent. We need
\nto use these figures as a common benchmark in planning our
\nactivities for this year. Of course, the capacity and opportunity
\nfor expansion differ from one bank to another. One bank may well
\nbe able to grow more quickly than another, depending on its
\nobjective. However, I would like to ask that banks be very
\nthrough and selective in evaluating the projects. I ask that each
\nbank carefully assess its expansion, based on among others, the
\ncapacity for accumulating deposits from the public at reasonable
\ninterest rates. Bank should pursue sound plans for expansion to
\ncontinue the process of internal consolidation within the banking
\nsector. Reckless expansion is the antithesis of consolidation.<\/p>\n
Indonesia's growing economy will obviously require ever
\nhigher levels of finance. In view of the limitation on domestic
\nsources of funds, financing our development will continue to
\nencounter difficulties. Until now, we have turned to offshore
\nsources as an alternative for fulfilling the gap. As regards the
\nuse of foreign funds, there are some points that I would like to
\npresent to the business community and banks. There have been
\nincreasing signs of late that an increasing among of foreign
\nfunds are being offered to our business community, including both
\nstate enterprises and the private business sector. In this
\nregard, I would like to remind the business community to exercise
\ncaution in using funds from offshore, particularly funds offered
\non unfavorable terms and conditions, or which have complex
\nschemes for repayment. The use of offshore funds through the
\noperation of derivative transactions, for example, can
\npotentially put the bank or debtor in a position of considerable
\nrisk from movements in interest rate, and exchange rates. If we
\nare to honest with ourselves, it appears that we have much to
\nlearn in order to understand and take best advantage of offshore
\nfinancing by such methods. For this reason, I ask that our
\nbusinessmen and the banking community to be prudent and selective
\nin entering into such arrangements, Regarding the use of offshore
\nfunds, let me remind non-bank companies that foreign borrowings
\nmust be reported to the Monetary Authority as stipulated in
\nPresidential Decree No. 39 of 1991 concerning Foreign Commercial
\nBorrowing Management Coordination (PKLN).<\/p>\n
The increasing inflow of foreign funds requires the monetary
\nauthority to be more prudent in controlling monetary policy,
\nincluding financing strategies through the international capital
\nmarket. The current account deficit can be financed using the inflow
\nof funds through direct investment, capital market (bonds and
\nshares) and various kinds of loans. However, we should be cautious
\nof negative impacts, especially with foreign loans. We could also
\nlook into what has happened in Mexico, so that we can prevent the
\nsame thing from happening in Indonesia. The increasing current
\naccount deficit, financed by various forms of short term funds, is
\nvery vulnerable. Funds (short term funds) managed by fund managers
\nare very sensitive to the fluctuations. The behavior of trust fund
\nmanagers who get on the bandwagon can create massive over-reactions
\nthat lead to crisis. We must be aware of this and stay alert.<\/p>\n
Besides macroeconomic issues that I have already described,
\nthere are also a number of micro level issues that will require
\nserious attention in 1995. The main problems facing banks in
\nIndonesia center around the bank consolidation process steaming from
\nproblem loans. Although we have spent much time and energy on
\naccelerating the completion of the consolidation process and
\nsettlement of problem loans, it cannot be said that these
\nproblems are over. This year, we have to increase our efforts to
\ndeal more effectively with problem loans and other difficulties
\nfaced by banks.<\/p>\n
As you are aware, Bank Indonesia has issued many regulations
\naimed at creating a sound and efficient banking system. However, it
\nalso needs to be said that the regulations themselves are not enough
\nto ensure sound bank operations. The effectiveness of the
\nregulations depends on the management of the banks themselves. No
\nmatter how well the regulations are designed, a regulation may still
\ncontain loopholes that can be exploited to evade compliance. Because
\nof this, banks are required to adopt a stricter principle of self-
\nregulation by taking into account the risks that may arise in the
\ncourse of business. In applying the principle of self-regulatory,
\nit is also expected that banks will not conduct their operations
\nsolely on the basis of what is allowed or not allowed in general
\nregulations. What is more important is that banks apply internal
\nregulations that specify the detailed application of the general
\nregulations.<\/p>\n
Lending is still dominant business activity of our banks. I
\nmentioned earlier how important it is from a macro standpoint that
\nbanks exercise care in their evaluation and selection of projects.
\nThis is also extremely important from a micro standpoint,
\nparticularly for the soundness and survival of banking
\noperations. In this regard, I would again like to invite you to
\nexercise greater caution in channeling credit. Although many
\nopportunities exist, banks should still be selective, and the
\ncredit commitments should be backed by adequate sources of funds
\nwithout having to resort to unhealthy means of competing for
\ndeposits. In this regard, we strongly urge banks to consistently
\nfollow prudent lending principles, and avoid the mere pursuit of
\nhigh credit growth. Excessive expansion beyond the reasonable
\ncapacity of available funds will result in an interest rate war
\nthat no-one wants. Not only would it burden the banking system
\nwith higher costs for funds, but it also put monetary stability
\nat risk. We all would lose in this event.<\/p>\n
As I mentioned earlier, I would also like to encourage you to
\nact with caution in extending credit for the purpose of property or
\nconsumer goods. Lending has grown very quickly in both areas as of
\nlate. We are all aware that the property sector is highly vulnerable
\nto changes in the macro-economic environment, and banks are
\ntherefore exposed to higher risk in property lending. This risk
\nbecomes even more pronounced when borrowing for property investments
\nis fueled by speculation. Experience in many countries shows that
\nwhen the market is oversupplied and property prices tumble, not only
\ndo problems arise within the property market itself, but the banking
\nsystem also suffers. These difficulties become especially acute when
\nthe value of assets put up as collateral is no longer on par with
\nthe amount owed to the bank.<\/p>\n
To improve the quality of credit portfolios and prevent
\nunhealthy practices such as \"mark-ups\", I would also like to
\nemphasize the need for banks to continually upgrade their project
\nappraisal and credit analysis system, as well as the quality and
\nconduct of their staffs, in particular credit analysts. I would also
\nlike to stress the needs for improved business ethics on the part
\nof banks debtors, Bank Indonesia also expects that new guidelines
\nand regulations which will be announced shortly. These regulation
\ninclude the Credit Policy Guidelines and Internal Standards for
\nbanks, as mentioned earlier. These measures are needed to limit
\nthe level of problem loans in the future that occur if changes
\ntake place in our economy.<\/p>\n
As regards compliance with the Legal Lending Limit, I would
\nlike to remind you that this year, banks must bring themselves
\ninto full compliance. The transitional grace period will be over.
\nAt the end of this year, credit to one group of borrowers may not
\nexceed 35 percent of bank capital. Credit to a borrower connected
\nwith the bank may not exceed 12.5 percent of bank capital. These
\nproportions will be gradually reduced to the maximum limits of 20
\npercent for one group of borrowers and 10 percent for a borrower
\nconnected with the bank by the end of March 1997. Similarly,
\ninsured credit that exceeds the legal lending limit but is
\ninsured will no longer be exempted from the legal lending limit.<\/p>\n
At the same time, to prevent possible difficulties arising from
\nproblem loans, this year banks will be required to make full
\nallowance for earning assets losses as stipulated in May, 1993
\nderegulation package. In practice, if the allowance for earning
\nasset losses is less than the amount that should be allocated,
\nthe shortfall will be deducted from core capital.<\/p>\n
Additional policies will also be introduced to ensure to sound
\nbanking industry. The various measures that have been introduced in
\nthe past few years will be expanded and improved in the coming year.
\nThese measures cover the areas of banking regulation, bank
\nsupervision, and the settlement of problem loans. Some of the
\nexisting bank regulations will be amended on the basis of the
\nBanking Act and in line with the dynamics of our banking industry.
\nThe various measures already taken to deal with problem loans,
\ncovering the settlement of existing loans, the prevention of new
\nproblem loans, and guidance for banks burdened by problem loans,
\nwill continued and developed further. With these measures, I am
\nconfident that the banking industry will realize higher growth, and
\nplay a more active role as a secure source of finance for economic
\ngrowth in the coming years.<\/p>\n
On the external front, we also need to take note that with the
\nratification of the Agreement for Establishment of the World
\nTrade Organization (WTO), all agreements and decisions produced
\nin the Uruguay Round have become part of our national laws, One
\nof the agreements resulting from the Uruguay Round is the General
\nAgreement on Trade in Services (GATS), which encompasses banking.
\nNegotiations on commitments in financial services are now
\nunderway. Developed countries are continually pressuring
\nIndonesia to provide an expanded scope of opportunities for
\nforeign financial institutions, particularly regarding market
\naccess and national treatment.<\/p>\n
Rapid domestic economic growth itself could constitute a factor
\ncausing keen competition in the banking sector. As we all know,
\nduring last few years, the capital market and non bank financial
\ninstitutions have grown rapidly and their role has significantly
\nincreased. Capital markets are now becoming one of important source
\nof funds for the business community. Funds raised from the
\ncapital market are not only used to finance investment activity,
\nbut also to strengthen financial structures. Accumulated stock
\nvalue and bonds in 1990 reached only Rp 10,1 trillion or 10,4
\npercent of total credits; this rose to Rp 31.2 trillion or 19,5
\npercent of total credit by October 1994. Both domestic and
\nforeign investors increased their portfolio investments in the
\ncapital market as reflected in the hike of the volume and value
\nof stocks traded in the secondary market. Furthermore, products
\noffered in the capital market are also diversified. We now find
\nnot only stocks and bonds, but also trust funds and other
\ninstruments. In addition to growth in the capital market, non-
\nbank financial institutions, like leasing, factoring, insurance
\nand others, have also developed at a fast pace. In other words,
\nthe capital market and non bank financial institutions have
\nbecome good alternatives source of funds for the business
\ncommunity and will become strong competitors for the banking
\nindustry.<\/p>\n
I think that in the future, there will inevitably be tighter
\ncompetition in Indonesia's banking sector as progressive
\nliberalization affords greater access and business opportunities
\nto foreign banks. As a result, there is no alternative for banks
\nin Indonesia but to gear themselves for what will come, by
\nsteadily improving their performance to achieve optimal
\nefficiency. More attention should be given to research and
\ndevelopment. Also, because banking will become increasingly
\ninformation and skill intensive, there must be more systematic
\nefforts to improve the professionalism of bank employees. In this
\nregard, I would like to call your attention to the minimum 5
\npercent of personnel costs that is to be allocated to training.
\nAs you are aware, the purpose of this rule is to encourage banks
\nto recruit and train professional staff on an ongoing basis.
\nThese professionals will then be able to contribute to the
\nsuccess of the bank. We have noted that a few banks have still
\nnot put this rule into effect. This reflects a lack of
\nappreciation for the importance of developing a professional
\nbanking staff to ensure the survival of the bank in an ever more
\ncompetitive environment.<\/p>\n
In facing an increasingly open market, banks are also expected
\nto be more realistic in the way they do business. The pursuit of
\ngrowth aimed at propelling the bank into the big league cannot be
\nmade the primary goal. Instead, that target has to be subordinated
\nto necessity of making the bank a solid, competitive and sound
\norganization. We need to take advantage of opportunities for
\ncooperation between banks. These opportunities may range from the
\nmost flexible of arrangements to the most binding ones, such as
\nmergers. The national banking structure has to be strengthened. A
\nhighly fragmented banking system will be of little use in
\nconfronting the challenges that lie ahead. In looking to the
\nfuture, Indonesian bankers have few alternatives to choose from,
\nand if those alternatives do exist, they should be capitalized
\non. It is also necessary that domestic banks improve efficiency
\nto brace themselves to take maximum advantage of market
\nopportunities that may arise in other countries.<\/p>\n
In the face of progressive liberalization, banks will have to
\nprepare for stronger competition. We will soon issue a set of
\nrequired professional qualifications for becoming a bank employee.
\nThis difficult tasks should be entrusted to a professional
\norganization such as the Indonesian Bankers Institute. This
\nmeasure is urgent and must be completed to prepare ourselves for
\nthe new environment that will be created by the Uruguay Round.<\/p>\n
Allow me again to emphasize that our economy is now in
\nstrong shape. The economy is running in high gear. Our job
\ncenters on how best to manage our economic dynamism in a way that
\nwe are still able to safeguard the stable economic and monetary
\nenvironment that we have presently. Consolidation of the national
\nbanking system remains a priority item on the monetary policy
\nagenda, and we need to carry out that consolidation to the best
\nof our ability. The challenges we face are not easy, but there is
\nmuch that we have managed to achieve so far. Our job concerns how
\nto accomplish the duties set before us in our respective fields
\nand professions. Let us march forward together in full confidence
\nand with the noblest of intentions to carry out these tasks and
\nresponsibilities.<\/p>",
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