Bank soundness

Even in normal times banking, by its very nature, entails taking an array of risks. Given this, one can imagine the enormous risks banks run in Indonesia's current situation, pregnant with political uncertainty, legal imbroglios and complex economic woes. The banking industry, particularly the 15 major banks recapitalized in 1999 and 2000, must run the gamut of risks related to market competition, credit, interest rates, liquidity and foreign exchange rates.

In light of this, we were flabbergasted by comments made on Monday by Soebowo Musa, an official of the Indonesian Bank Restructuring Agency, to the Dow Jones NewsWires. Musa, the head of IBRA's bank restructuring division, said, among other things, that Bank Universal would need fresh capital to meet the minimum 8 percent capital adequacy ratio (CAR) required by the central bank by the end of this year. He also hinted that the bank might have to merge with another bank to meet this 8 percent CAR level.

As the story resulting from the interview was short of details on such elements as financial and operational ratios, which could provide a more complete view of the overall condition of Bank Universal, the statements could cause a disproportionate and unnecessary misperception of the bank. As a senior executive of IBRA, the controlling shareholder in all recapitalized banks, including Bank Universal, Musa should have realized that the financial industry is one of the sectors most sensitive to information, particularly premature and incomplete information.

Fortunately, IBRA chairman Edwin Gerungan, fully aware of the sensitivity of the bank to public perception, felt it imperative to issue a statement on Tuesday to clarify any misperceptions arising as a result of Musa's remarks before any damage could be done.

Gerungan acknowledged that Bank Universal's CAR level was only 4.75 percent, but he added that the bank still had ample time before the end of the year to meet the 8 percent CAR level. He asserted that anticipatory measures had been taken by the bank's management, together with controlling shareholder IBRA, to find the optimum solution to raise its CAR to 8 percent by the Dec. 31 deadline.

To provide a better context to understand why Bank Universal's CAR level is currently below 8 percent, Gerungan said that Bank Universal had been quite aggressive in lending money, notably to small and medium-scale businesses. Last year alone, it channeled Rp 3 trillion in new loans. Obviously, as every loan contains risks, and the capital standard is based on the ratio between capital and risk-weighted assets, the bank has to put up provisions for every credit it gives, thereby affecting its capital reserves.

This is one of the dilemmas being encountered by most banks still reeling from the 1997 financial crisis. They have to resume lending at significant levels to generate income, but these new loans will initially eat into capital until credit revenues are generated. Moreover, as most medium and large-scale businesses are still either being treated at IBRA's debt restructuring "hospital" or are hostage to foreign debts, it is now difficult to find major enterprises with reasonable creditworthiness.

No wonder many banks have chosen to maintain their CARs at very high levels by parking their funds in Bank Indonesia's debt papers, for which no provisions are needed, rather than lending to provide sorely needed lifeblood to the economy. But by doing this, the banks are failing to execute their basic function -- financial intermediation--, instead acting more as a treasury office.

Given the credit crunch currently hitting Indonesia's weak economy, it is imperative for banks to resume lending at significant levels. Most importantly, though, is that they do this with the least risk of incurring new bad loans.

IBRA officials should refrain from untimely comments, particularly summary remarks, about the CAR levels of banks as long as the capital standard is still above the prevailing minimum level. Premature comments on and too much scrutiny of the CAR levels, without assessing the other financial and operational ratios of banks, may keep the economy acutely short of credit financing because banks will remain inordinately preoccupied with their capital to the neglect of their basic function.

With the central bank having assigned permanent supervisory staff at recapitalized banks to ensure full compliance with prudential regulations, we can rest assured that the "go-go lending" practices that took place prior to the 1997 crisis will not recur.