Reforming the Indonesian banking system<\/p>\n
The following is the second of two articles by I Putu Gede Ary
\nSuta, former chairman of the Indonesian Capital Market
\nSupervisory Agency. It is based on his presentation at the
\nlaunching of his two new books, Foundations of our Capital Market
\nand Menuju Pasar Modal Modern (Towards a modern capital market)
\non June 22 in Jakarta.<\/p>\n
JAKARTA: Not only have the remedies prescribed for the banking
\nproblem been ineffective, the medicine actually contains a slow
\npoison that makes the situation worse. This slow poison is the
\ncost of interest on the government bonds that have been used for
\nthe superficial repairs of bank balance sheets.<\/p>\n
These bonds require interest payments that now absorb most of
\nthe income taxes collected by the government. As the ineffectual
\nplan to recapitalize the banks moves forward, even more bonds
\nwill be issued for the same doubtful purpose, increasing the
\ndrain on our resources.<\/p>\n
Not only do these over-valued government bonds fail to provide
\nfunds for recovery, but the interest diverts money that could be
\nused to pay fair salaries to teachers, soldiers, public health
\nworkers and others on whom we depend for safety and well-being.<\/p>\n
The problem with the bank restructuring program is that there
\nis no end game strategy. The illiquid government bonds will
\neventually come due. Unless interest rates are increased so that
\nthe bonds are marketable, perpetual rollover of these bonds is
\nthe logical outcome, permanently burdening the budget and
\npostponing recovery.<\/p>\n
There are many things wrong with the political and economic
\nenvironment. However, it is necessary to separate prime causes
\nfrom secondary problems. Does anyone doubt that civil disturbance
\nand violence would decrease if employment were to recover? Is it
\nnot obvious that dealing with the debilitated banking system is
\nthe most urgent matter?<\/p>\n
Sometimes in the affairs of nations, policies become entrapped
\nin what seems to be \"political reality\". Even though many
\nrealize that a certain course leads to disaster, no one is able
\nto take the necessary corrective action in time. Empires and
\ngenerations are lost due to temporizing, uncertainty and the
\nfatal assumption that \"nothing can be done\". Let us hope that
\nthis is not the case in Indonesia.<\/p>\n
Our banking policies were cast in the early 1980s and were
\nalready obsolete at that time. Economic policy makers gave little
\nconsideration to securitization. Attention to capital market
\ndevelopment was restricted to a state-owned securities company.
\nAlmost no incentives were provided for long-term capital
\nformation. The focus was almost entirely on banking.<\/p>\n
Privatization of state banks and separation of borrowers from
\nlenders were already recognized as prudent policies in the 1980s.
\nNevertheless, the temptation to keep control of funds in the
\nhands of government officials and cronies was too great to be
\nresisted.<\/p>\n
The tragedy that we now face is that when the banks collapsed
\nin 1997-1998, instead of realizing the errors of the past, we
\nlistened to the same advisors who had designed the flawed system
\nin the first place.<\/p>\n
The result, predictably, has been an attempt to reconstruct an
\nobsolete and defective structure, rather than the prudent option
\nof seizing the opportunity to establish a modern financial system
\nof which the country could be proud.<\/p>\n
As the cost of nonproductive interest on government bonds
\ncontinues to erode the state budget and lackluster economic
\npolicies discourage foreign investment, we are moving into an
\narea in which even funds from the International Monetary Fund
\n(IMF) may be insufficient. No one will be safe if the social
\nstructure falls apart.<\/p>\n
Strong economic leadership, courageous policies and a credible
\nprogram for implementation could turn the course of the economy
\nstrongly upwards in a relatively short time, even though it will
\ntake longer to repair the damage.<\/p>\n
The world will recognize the difference between credible
\nreforms and cosmetic patching. Rather than halfhearted repairs of
\na financial system that is already corrupt, it would be better to
\nmove forward with true reform:
\n* Privatize government banks,
\n* Separate bank owners from borrowers, and
\n* Redesign government bonds so that money is raised to finance
\nrecovery rather than just incurring interest that will further
\ndrag down the economy.<\/p>\n
Technically, it is not as difficult to reform the banking
\nsystem as is sometimes suggested. First, competent bankers are
\nneeded, but the world has an ample supply of those who can do the
\njob. The reform of government bond issues can be accomplished by
\nredesign, using techniques proven in other markets.<\/p>\n
The difficulty is not technical, nor market-related, but
\npolitical. Many seemingly technical arguments are only excuses to
\nmaintain the status quo. Some will even say, \"It is too late for
\ntrue banking reform -- we have already signed a letter of intent
\nwith the IMF.\"<\/p>\n
But would the IMF oppose privatization of the state banks?
\nWould they be against the separation of bank ownership from
\nborrowers? Does the IMF prefer cosmetic restructuring with
\nilliquid bonds over funding that puts money into the system? It
\nis clear that opposition to reform comes not from abroad, but
\nrather from within.<\/p>\n
The capital market was not the cause, but rather a victim of
\nthe current crisis.<\/p>\n
The future of our capital market now depends on the
\nmodernization of banking. If the banking system is not reformed,
\nand if economic recovery is delayed five years or more, not only
\nwill we experience unpredictable social and political turmoil,
\nbut we may also find that our capital market has moved offshore.<\/p>\n
Already, our stock exchange is badly out-of-date, hanging on
\nto inefficient, floor-based trading. Most broker-dealers do not
\nhave safe operational procedures to support scripless trading.
\nAs the income of market institutions declines, it will be less
\nfeasible to raise funds to build a strong securities industry.<\/p>\n
Continued development of our capital market depends on
\neconomic recovery and reform of the banking system. Due to
\ninevitable technological change and advances in other countries,
\ndelayed recovery may have irreversible long-term implications on
\nthe ability of Indonesia to take the lead in regional markets.<\/p>\n
Every month that the crisis is prolonged represents a setback
\nto our dream of creating a major regional capital market by 2020.<\/p>\n
Misuse of the banking system and lack of attention to the
\ncapital market are characteristics of the current crisis.
\nResolution of the crisis calls for the introduction of banking
\nreform and the provision of incentives for capital market
\ndevelopment.<\/p>",
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