Bad loans: A sperate affairs

Bad loans: A sperate affairs

By Andrew Cainey & Andrew Clark

JAKARTA (JP): Banks need to separate their current operations
from the resolution of problem loans. Without this clarity,
ongoing business will be neglected and a work out will suffer
from lack of concentrated effort appropriate expertise. Clear
separation is important because the objectives, pace, type of
personnel required and measures of success are all so different.

Speed is of the essence in the work out: success rates in
recovery drop off steeply as every week goes by. Believing that
you will get 100 cents on the dollar is unproductive, which is
why you need different people working on the bad credits. Those
who were involved in extending the original loan are less willing
to settle quickly and move on to the next case.

"Bad bank" executives must be given clear negotiating
authority, and staff should be added up to where marginal cost
can no longer drive marginal revenue. It is also advantageous
that customers view this group as separate from their regular
account executives. On the other hand, prudence must be the
watchword for the ongoing "good bank" operations; credit
decisions must be carefully studied, costs controlled and
customer service delivered to a high standard.

Over the past few months, the Boston Consulting Group has seen
a number of Asian banks involve every one of their talented
executives in bad loan resolution, which soaks up all their time
and leaves none for maintaining ongoing business. The risk of
this approach is that there is no underlying business to return
to when the nonperforming loans are resolved.

To further protect the ongoing business, banks that have not
done so already, need to revamp their credit processes and tools,
moving from asset-based to cash-flow lending. In addition, they
need to free themselves of the type of top-level relationship --
or government -- directed lending demonstrated across Asia.

An effective recovery process is the biggest lever a bank has
in a crisis economy. Once bad loans have been reserved, any
incremental recovery goes directly to the bottom line. Even the
healthiest Mexican banks, which sold U$19 billion of bad loans to
the government, are still focusing on the recovery process; under
the terms of the bailout, banks continue to hold a 25 percent
stake in all loans they have sold.

To deal with profit pressure, banks need to reengineer and
restructure to reduce costs. Banamex and Bancomer, two of the
most profitable banks in Mexico, have such programs underway.
Banamex is preparing to lay off 10,000 of its 31,383 workforce.
Bancomer has announced an additional 8 percent reduction in its
workforce in 1998. Bital has sacked nearly 4,000 of the 4,389
employees that came with its acquisition of Banco Altantico.

While many Asian banks have undertaken similar efforts, they
have not usually included cost cutting. Staff lay offs, typically
the major source of cost reduction, are anathema in this region
given the absence of social safety nets and have been avoided by
leveraging rapid growth instead.

Most Indonesian banks have not actively played the key roles
of a banking system: the filtering and selection of investment
opportunities, attracting customers and profitable lending
activities.

In the future, Indonesian banks need to aggressively build the
capability to filter the good risks from the bad risks. This
means better collection and analysis of customer information. It
means banks need to conduct probing industry analysis. As the
judgment and experience is scarce today, banks will initially
need to centralize loan decisions in the hands of those with the
most experience. As capabilities grow, branches can play a more
active role again.

Above all, success requires a new mind-set and the courage and
ability to say "no" to unattractive but large lending
opportunities.

Banking crises usually create a high interest rate
environment. In Sweden, the interbank overnight rates went as
high as 500 percent, while in Mexico, the interbank overnight
rate leapt to 109 percent at one stage. Similar developments have
occurred in Indonesia, where the interbank overnight rate reached
150 percent for some smaller banks.

This causes problems for banks without local deposit bases.
Foreign-sourced funds dry up due to risk aversion and the central
bank becomes the primary source of liquidity. But increased cost
of funds often cannot be passed on, either due to preagreed loan
pricing or client inability to pay. Thus, banks that fund
themselves on a wholesale basis find their margins dramatically
squeezed, if not negative. In Mexico, all lending businesses were
pushed into the red, even before considering bad debt losses
because banks were unable to reprice loans fast enough to keep up
with the increasing cost of funds.

Banks that already have strong retail networks in the right
locations can leverage these with higher rates and focused
marketing. Banks with poorly placed branches or few branches at
all should consider strengthening their retail network through
acquisition.

According to the Boston Consulting Group, there are two areas
for domestic mergers and acquisitions. Banks need to think beyond
price/value and consider complementarity or overlap. In the
first, a bank with a strong presence in Jakarta may want to
capture a nationwide retail operation by acquiring banks which
focus on other regions.

In the second, a merger of two banks creates opportunities for
cost reduction and branch closure. For foreign capital
injections, domestic banks can benefit from thinking through
their preferred source of capital and positioning themselves
appropriately. Foreign players will typically want to invest in
the stronger banks, not the weaker ones.

In Mexico, Bital has emerged successful from the crisis. While
relatively small, it is considered to be one of the leading
banks, particularly in terms of new product innovation and
marketing. With the marketing experience of its international
partners, Banco Central Hispano and Banco Commercial Portugues,
it has created a small revolution in the retail banking segment.

It was the first bank to open afternoons and weekends, forcing
the rest of the sector to follow to defend their share. It rolled
out an impressive array of new products for the consumer, ranging
from credit for small appliances (BitaBonos) to innovative
savings products modeled on the informal economy (Tandas). Bital
also leads the sector in new branch openings, going from 450 in
1994 to 1,218 in 1997. All of this has been supported by an
aggressive advertising campaign poking fun at the rest of the
traditionally staid banks.

Finally, whatever merger and acquisition decisions are made,
they must be executed well. To realize the benefits -- greater
market penetration, increased scale in asset management, cost
reduction -- integration must be handled as a discrete, explicit
process. Strategic objectives must be clear and decisions must be
made quickly, communicated openly and executed relentlessly. Many
mergers actually destroy value because they are not properly
integrated.

Banks that waver, risk losing key personnel, high-value
customers and the momentum to make drastic cost reductions.

The main value of in-market mergers comes from growing the
customer base while reducing costs. If, however, customer
attrition is not carefully managed, the value is lost. In one
recent Mexican example, the acquiring bank should have boosted
deposits by 30 percent, yet one year later, its market share was
actually below the premerger level. In a different Mexican
example, disgruntled former employees of an acquired institution
who felt they were treated unfairly took their customer lists to
competitors.

Times are hard, and there are many urgent issues to distract
senior managements. Only the institutions that focus on the five
key success factors will emerge as strong competitors in the new
environment; banks which can honestly say that:

* their ongoing business and work out problems are being run
separately by focused groups of experts,

* intensive cost restructuring is underway,

* they have a program to build risk management capabilities,

* they have a secure and expanding deposit base, and

* senior management has clear views on complementary mergers and
acquisitions, as well as concrete plans for execution

Should be comfortable that they are on the right path.

Andrew Cainey is a vice president of the Boston Consulting
Group and Andrew Clark is a manager of PT Boston Consulting
Indonesia.

Window: Most Indonesian banks have not actively played the key
roles of a banking system: the filtering and selection of
investment opportunities, attracting customers and profitable
lending activities.