Another blow to the Indonesian banking sector

David Sumual, Analyst, Danareksa Research Institute, Jakarta

The Indonesian banking sector, which has suffered a devastating series of setbacks since the economic crisis broke out in 1997, received another blow last week with the revelation of a case of fraud at Indonesia's fourth-largest bank, Bank Rakyat Indonesia (BRI). Nonetheless, thanks to the government's blanket guarantee program, the scandal did not lead to a "banking-rush" that could have paralyzed Indonesia's banking system.

The US$34.5 million in irregular loan transactions at the bank, which last month raised around $490 million in its Initial Public Offering (IPO), was the second loan scam involving a state-owned bank in less than two months. Earlier, banking authorities had uncovered a $200 million lending scam at the country's second largest bank, Bank Negara Indonesia (BNI).

The scandal at BRI has highlighted by weak supervision of the country's banking sector, confirming previous suspicions that the BNI scam was only the tip of the iceberg. Also raising concerns are the rumors of the alleged involvement of several prominent politicians in the scandal. However, there is also the possibility that these reports were due to negative campaigning, which is typical ahead of general elections.

However, if the scandals are similar to the Bank Bali scandal in 1999, they may, of course, rock the country's fragile banking sector, jeopardizing the nascent recovery in investor confidence as well as the nation's economic stability. This is apparent since the outcome of a case that allegedly involves politics (like the Bank Bali scandal) may end up with a political compromise rather than with a legal solution to settle the matter.

The suspicion of collusion between senior politicians and bank executives has emerged since the scam at BNI was apparently discovered one year after it had begun. It is hard to believe that the cases were only caused by poor internal controls since some suspects are clearly blacklisted for their involvement in Bank Indonesia's liquidity fund (BLBI) abuse cases.

It is also impossible for a bank's headquarters to have no knowledge of the disbursement of such huge amounts of funds at the branch offices. As such, it only strengthens the allegation that a culture of graft and collusion, backed by political patronage, may have coaxed the bank's internal officials to have become involved in the scandal.

There are also indications that both banks tried to cover the loan fraud cases up. According to the Attorney General's Office (AGO), both cases only came to light after the public and insiders at the banks informed Bank Indonesia and the AGO. Also raising many eyebrows was the apparent difficulty that the police had in arresting the key suspect in the BNI scandal, Adrian Woworuntu, considering how easy it was for some journalists to interview him.

Only after 28 days was Adrian, who is known to be close to law enforcement officials, arrested. Moreover, one of the suspects in the BRI case, Yudi Kartolo, was also a suspect in the BNI case, hinting that the two scandals may be linked.

The revelation of the scandals at the two state-owned banks does not mean, however, that the problem is endemic within the banking sector. First of all, the loan scams may only reflect weak human resources at those two banks. Also, the cases do not represent an inherent risk to the whole of Indonesia's banking system since the scandals only occurred at state-owned banks.

But both scandals emphasize the urgent need for the government to speed up the privatization of the nation's banks. At least the foreign investors, who have been allowed to purchase a controlling interest in some Indonesian banks, have brought new standards of best practices and a new mindset into the industry.

Nonetheless, these scandals are, of course, complicating the government's attempts to convince investors to place their money in this country. As foreign investors prepare to take a bet on controlling stakes in BII, Bank Permata and Bank Lippo, the scandals will provide investors with another reason to lower their bidding price or even rethink their investment plans in Indonesia.

Some lessons can be learnt from the scandals, mainly that Indonesia still has much to do in reforming the banking system. First, efforts to improve the corporate governance in the banking sector must be intensified in order to establish a sound banking system. The central bank must also intensify its spot checks and improve its surveillance system. A specific regulation may be required to guarantee that the board of directors of the banks certify any significant banking transactions that occur in a branch office.

Also of importance is that bank officials' competency is improved through strict fit and proper tests, as any system would be sure to fail if the people working within them remain unqualified. Moreover, by improving both the corporate and operational governance, the employees' behavior can at least be monitored by the banks' policies and procedures. In this case, the central bank's move to push banks toward better compliance and risk aversion must be supported.

The government authorities must also have the political commitment to combat nepotism, collusion and graft to break the vicious circle linking the sluggishness of economic recovery, corruption and a lack of law enforcement. Otherwise, these rampant abuses of power will hurt the Indonesian economy, which is now in the middle of a dramatic evolution from a New Order structure to a Reform structure.

Political will in combating corruption has at least been seen in the establishment of the Corruption Eradication Commission. As such, the police and AGO must expedite the investigations and bring to justice all the perpetrators in the BNI and BRI loan scams.

In order to clear up these scandals in an open and transparent manner, the new corruption commission could take over the BLBI, BRI and BNI cases from the ordinary courts in order to regain credibility and improve the tarnished image of Indonesia's banking system. An underlying reason for this maneuver is the reality that people have lost confidence in the courts as many high-profile corruptors remain free until the Supreme Court's decisions on their appeals.

Finally, the government must also pursue the signing of an extradition treaty, particularly with Singapore, which has been accused of sheltering Indonesia's white-collar criminals, including the key suspect in the BNI scandal.