Reform the banks or perish<\/p>\n
By Eddy Soeparno<\/p>\n
JAKARTA (JP): Developments in the past few months indicate
\nthat despite a stronger rupiah exchange rate and lower inflation,
\nthe economy continues to remain dormant as a result of a banking
\nsystem that is rotten to the core.<\/p>\n
Indonesian banks are notorious for their high level of
\nnonperforming loans, bad management and lending practices, while
\nthe system lacks the credibility which comes from sound
\nregulatory and supervisory standards.<\/p>\n
Clearly, for all of Asia's distressed economies, a stable
\nexchange rate alone remains insufficient for sustained recovery,
\nespecially if the financial system lacks the capital to extend
\nits balance sheets.<\/p>\n
In overcoming this critical issue, the government has recently
\nannounced a major bank restructuring and recapitalization program
\nfor economic revival by way of "fueling up" the banking sector
\nwith new capital.<\/p>\n
Unfortunately, in announcing the proposed Rp 257 trillion
\n(US$28.5 billion) recapitalization program, the government failed
\nto stress the importance of critical elements in a successful
\nrestructuring program, namely political and practical elements of
\na financial reform package.<\/p>\n
If the former is closely associated with the political
\nconsensus to tackle a banking crisis, the latter appeals to the
\nnecessary tools required to achieve successful reforms.<\/p>\n
Although the political will to push through with financial
\nreforms is a key factor in determining the speed and results of
\nthe entire restructuring process, finding a political consensus
\nalways takes time, even under favorable circumstances.<\/p>\n
As experienced by almost every nation with past banking
\nproblems, developing the political will to handle banking
\nproblems is a tough obstacle, given the unavoidable wealth and
\nincome distribution consequences.<\/p>\n
Instead, maintaining a status quo could be more convenient,
\nespecially if low interest rates and fiscal outlays are used to
\nprevent a total meltdown, as in the case of Japan. As for
\nIndonesia, the loss and distribution of wealth seems to top the
\nlist of factors hindering a speedy reform process.<\/p>\n
Although the government is currently pressing hard to
\ncompleting a restructuring and recapitalization program over the
\nnext couple of months, it normally takes a few months itself to
\nreach a much needed consensus.<\/p>\n
Strong resistance from bank owners and "rock bottom" asset
\nhunters make the process long and sometimes painful. And
\ncomplicating what is already an obscure situation is the fact
\nthat other parties interested in receiving handouts (be it in the
\nname of a "people's economy") are also trying to get their hands
\non these assets, thus prolonging an already lengthy process.<\/p>\n
Consequently, even if there is enough political will to push
\nthrough financial reforms, practical constrains -- ranging from a
\nlack of expertise and qualified manpower to weak legal,
\naccounting and supervisory standards along with limited financial
\nresources -- are likely to thwart reform.<\/p>\n
Notwithstanding the importance of other practical elements,
\nthe critical factor in Indonesia's financial reform program is
\nundoubtedly the availability, or lack thereof, of funds to meet
\nthe objectives of the program.<\/p>\n
Where will Indonesia raise such cash?<\/p>\n
Well, be prepared for some bad news: the ability to run a
\nlarger budget deficit seems out of the question, especially since
\nIndonesia is subject to strict deficit targets imposed by the
\nInternational Monetary Fund. Room for spending cuts and tax
\nincreases is also limited, given the poor cyclical conditions and
\nthe fact that most of it has already been largely exhausted.<\/p>\n
As such, with government's fiscal resources limited and
\nprivate domestic resources largely depressed, foreign capital
\nwill play have to a key role in funding the recapitalization of
\nbanks and acquiring troubled assets. Therefore, the government
\nhas to ensure that disclosure and transparency of information are
\nput up to international standards to meet investors'
\nrequirements.<\/p>\n
In addition, grassroots resistance needs to be put aside in
\nfavor of new cash, technical know-how and the ability to survive
\nthe crisis intact.<\/p>\n
The above funding issue also addresses the topic of using
\ntaxpayer's money to bail out ill-fated banks. As we all know, the
\nhuge recapitalization needs already imply an enormous burden on
\nthe public purse.<\/p>\n
Should the public then be responsible for the mistakes of bank
\nowners (many who are not bankers to start with) who practically
\nmisused public funds for their high risk ventures?<\/p>\n
To be sure, it is morally unjust for the public to bear the
\nfull cost of the recapitalization process. However, under current
\ncircumstances, public help is at least needed as a "booster" to
\njump-start the recapitalization process.<\/p>\n
Ideally, fiscal resources from the public should be recovered
\n(sooner rather than later) through the sale of nationalized banks
\nor other acquired financial assets, such as problem loan
\nportfolios. This scheme will likely minimize the burden shared by
\nthe public while getting the recapitalization program off the
\nground.<\/p>\n
Whether Indonesia's economy will return to robust growth over
\nthe next few years or simply drag its feet forward will largely
\ndepend on efforts in recapitalizing and restructuring the banking
\nsystem.<\/p>\n
There is enough evidence, earlier in Latin America and
\npresently in Japan, to prove this statement right. Japan's long
\nperiod of economic stagnation and its recent plunge into
\nrecession highlight that a sustained recovery is unattainable if
\nproblems in the financial sector are not well addressed.<\/p>\n
Even next-to-nothing interest rates and series of fiscal
\nstimulus packages will be useless in pulling the country out of
\nits current economic slump. With high exposure in the property
\nsector, Japan's private domestic banking and financial industry
\nseem to be loaded with nonperforming loans and several banks are
\nalready suffering from negative capital.<\/p>\n
In other words, more than a handful of Japanese banks are
\ntechnically insolvent, with lack of serious efforts undertaken to
\novercome this problem. Another mixture to this deadly cocktail is
\nthe fact that Japan's banking sector consist of more than 900
\nprivate domestic banks, and 3,500 financial institutions,
\ntherefore intensifying the magnitude of the problem.<\/p>\n
Thus Japan's message for Indonesia is simple: Failure to clean
\nup the banking mess will result in more economic suffering,
\nespecially now that Indonesia's financial institutions are in a
\ndeeper mess than Japan's.<\/p>\n
Coming back to financial reforms, these efforts should not be
\nlimited to only injecting fresh money into troubled banks. Bank
\nrestructuring should also leave the window of "bank closure and
\nliquidation" wide open. Preventing panic and chaos in the banking
\nsector should not hinder the government from closing down clearly
\nill-conceived banks.<\/p>\n
Past experiences taught us that the cost and consequences of
\nrescuing ailing banks in the long run could prove more costly and
\nsevere rather than closing them down immediately. Moreover, the
\nfact that the government has already acted as de facto deposit
\ninsurance institution will in fact, minimize the risk of a run on
\nthe domestic banking system in the event of further bank
\nclosures.<\/p>\n
Finally, let us not forget the ultimate goal of Indonesia's
\nfinancial reform, namely to build a sound and stronger financial
\nsystem. As such, efforts undertaken should not cease at merging,
\nacquiring and injecting fresh capital into the domestic banking
\nsystem, but continue by improving accounting, supervisory and
\nlegal standards in general. Banks, especially government owned,
\nshould not be treated as tools of state industrial policy, having
\nthem finance uncreditworthy borrowers and ventures.<\/p>\n
Furthermore, the central bank's function as "savior of last
\nresort" should also be replaced by a well secured and well funded
\ndepository insurance scheme, responsible for stabilizing the
\nindustry during in the event of crises. Last but not least, the
\ntraditional role of banks channeling public deposits to the
\nbusiness sector should gradually be reduced.<\/p>\n
A bank's intermediary function should, in the future, be
\ntransformed into one that raises public funds to finance business
\ngrowth, thus a move towards securitized funding. Depositors money
\nwill be invested in less riskier ventures, while business in
\ngeneral will be financed using public funding with the public
\ndetermining their own risk-reward scheme.<\/p>\n
The road to reform the banking sector is undoubtedly long and
\nmost likely rough. It is hardly a Sunday ride in the park. But,
\nrest assured; once you reap the reward, it sure feels like one.<\/p>\n
The writer is a director in a foreign bank in Jakarta. This
\narticle represents the writer's personal opinion.<\/p>\n
Window: Consequently, even if there is enough political will to
\npush through financial reforms, practical constrains -- ranging
\nfrom a lack of expertise and qualified manpower to weak legal,
\naccounting and supervisory standards along with limited financial
\nresources -- are likely to thwart reform.<\/p>",
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