Another blow to the Indonesian banking sector

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.