Bank recapitalization: Waiting for miracles

The government is trying to salvage the banking industry through a recapitalization program but economist Kwik Kian Gie anticipates the impossibility of its success.

JAKARTA (JP): The government is most likely to fail to salvage the ailing banking industry through a recapitalization program, which is deceptive in nature. The measure is deceptive because it will introduce "make-believe" bonds that will earn "real" interest payments.

The government, through this program, is apparently trying to cover up the real state of the banking industry. Trying to cover up real conditions is a typical habit of the New Order government that seems to be maintained by our highly educated bureaucratic technocrats.

The banking industry was neglected for a very long time in its process of decay so that it is now very difficult for the country to restore it to health. In 1994, for example, bad loans at domestic banks were estimated at about Rp 20 trillion (US$2.2 billion at the current rate) but the government insisted that they reached only Rp 1.5 trillion. Then the government told the House of Representatives (DPR) that bad loans were recorded at Rp 8.6 trillion only as of early 1998. But Minister of Finance Bambang Subianto indicated recently that the bad loans were now estimated at between Rp 600 trillion to Rp 700 trillion.

The minister did not frankly disclose those figures but said that the government might have to liquidate banks that failed to repay liabilities to their depositors unless it spent Rp 18 trillion from its budget for fiscal 1999/2000. The liabilities are projected at about Rp 600 trillion to Rp 700 trillion, an amount that will never be covered by the sales of the banks' assets.

Because the banks cannot restore their cash flows, the government will be forced to provide them with Rp 34 trillion per annum, of which Rp 18 trillion will be taken from its budget and the other Rp 16 trillion from the sales of the banks' assets. But this is inadequate and will not help much because Rp 34 trillion will account for only 5.6 percent of the total liabilities of, say, Rp 600 trillion, while the banks will have to pay 40 percent interest on them annually.

The government's measure is apparently based on the assumption that the banks will be technically bankrupt and will not be allowed to provide loans if their equities are negative.

As soon as the equities are negative, depositors will run on the banks and the government, which guarantees the repayment of banks' liabilities, will have to provide no less than Rp 600 trillion -- an amount that it, the government, cannot afford -- to repay the depositors.

To make the equities look positive, the government will pretend to inject sums of fresh money into the banks, which will have to immediately use the money to buy "government bonds". Even though the banks will have no additional cash, they can record an increase in their equities.

Furthermore, because they have bought the bonds, they will have the rights to receive annual interest from the government. The bond interest payments are expected to help improve the cash flows of the banks, which, due to the non-performance of their loans, cannot expect revenue from interest on their loans.

But for how long will the government have to inject such funds into the banks? Until miracles occur. Only miracles will be able to help the banks because the government's assistance will never be adequate to improve their cash flows.

A government official has said that the banks will need only Rp 300 trillion, not Rp 600 trillion, to make their equities positive, of which their shareholders are required to provide 20 percent or Rp 60 trillion, while the government will have to cover the Rp 240 trillion balance. The fund will not be provided in cash but in "bonds", whose interest will reach Rp 34 trillion per annum.

And yet, Rp 34 trillion will account for only 14 percent of the Rp 240 trillion, whereas the banks are required to pay annual interest of 40 percent on their liabilities to depositors.

Furthermore, the government's expectation that the planned sales of the banks' assets will reach Rp 16 trillion in 1999/2000 is questionable in this time of economic crisis.

Thus, it is clear from the discussion that the government will never succeed in its efforts to revive the ailing banks through its recapitalization measure.

And it is very difficult to look for an alternative measure. But it is irritating to learn that the government did not take any measure when it was told that the banking industry was in its process of decay. Now that the industry is about to die, the government is looking for a remedy. It is just impossible.

The government and its foreign consultants think that they can prolong the operations of the banks for another year by providing fresh funds worth Rp 34 trillion, while waiting for miracles.