Bailing out BII

Bailing out BII

However the government defines it, state Bank Mandiri's plan
to acquire state-controlled Bank International Indonesia (BII) is
nothing but second-stage recapitalization using taxpayers' money.
The term "acquisition" is being trumpeted only to create the
perception that the process of bailing out debt-ridden BII is
simply a deal between two banks designed to build up strategic
synergy. It is also designed to circumvent the requirement of
having to obtain prior approval from the House of Representatives
in the case of outright recapitalization having to be made.

But as the acquisition will be made possible only after the
Indonesian Bank Restructuring Agency (IBRA) takes over US$1.2
billion (Rp 13.6 trillion) worth of BII's bad debts by using
government bonds, the direct cost of the transaction will be
borne by the state budget.

Acquisition by Bank Mandiri seems to be the least-cost
alternative to save BII from bankruptcy. Liquidation will not
only inflict tremendous costs as the government would have to
reimburse third-party deposits, estimated at about Rp 24
trillion, under the blanket guarantee scheme. Such a drastic
measure would also have a devastating impact on public confidence
in six other recapitalized banks, not to mention the systemic
risks to other solvent banks and the moral hazard of being "too
big to fail".

The financial distress currently faced by BII was caused by
the forbearing attitude adopted by the government in 1999 when it
went ahead with recapitalizing the bank even though it was found
to have violated the ruling on lending to affiliated parties.
True, the $1.2 billion in BII loans to the Sinar Mas Group,
formerly the controlling owner of the bank, was still current at
that time.

But it was simply mind-boggling to note how the government
could have overlooked such a blatant violation of the legal
lending limit that had placed the bank at such huge risk. The
lending to the Sinar Mas Group alone accounted for more than 60
percent of its total loans. Tolerating such a breach of
prudential regulations has now turned out to be a time bomb that
the government has to defuse by using taxpayers' money.

True, part of the woes that have been responsible for the
predicament of BII and most other banks should be blamed on the
political uncertainty, which has increased overall economic risks
and made the condition inimical to banking operations.

Bank Indonesia disclosed last week that BII was only one of
nine banks that had yet to meet the minimum 8 percent capital
adequacy ratio -- the ratio between capital and risk-weighted
assets -- by December, warning that they may have to be closed if
they fail to meet the requirement either by merger or private
placement.

It is simply because of the government blanket guarantee on
bank deposits and claims that the nine banks, including BII, have
not encountered massive runs despite such negative publicity.

The question, though, is whether the government, already
burdened with Rp 61.2 trillion in interest costs of bank
recapitalization bonds this year alone, could still afford to
reimburse depositors in case of another major bank failure. There
is now major concern that big depositors of a failed bank would
be reimbursed only with government bonds, which, like the Rp 650
trillion in recapitalization bonds, are entirely illiquid and
have no secondary market.

This concern has now markedly distinguished, at least in the
public perception, two groups of banks with strikingly different
conditions: One group consists of domestic banks perceived to be
fragile and highly risky, and the other made up of foreign bank
branches seen to be sound and strong as a safe haven for
financial assets.

The wide difference in the risk factor has certainly placed
domestic banks at a great disadvantage in raising funds and
attracting prime customers. It is this hostile environment that
has caused domestic banks to remain fragile.

Set against this inimical condition, the plan by Bank Mandiri
to acquire BII may put the state bank in great danger of
financial distress. It would not solve but only transfer the
problems of BII to the books of Bank Mandiri, and these problems
could become another time bomb within the state bank.

This is the big risk that the government has to thoroughly
assess in the due diligence process, especially because Bank
Mandiri, which is now the largest bank resulting from the merger
of four state banks in late 1999, is designed to become a core
domestic bank, the anchor of the banking sector.