Banking sector improving, but in snail's pace

Banking sector improving, but in snail's pace

Dadan Wijaksana, The Jakarta Post, Jakarta

Much has been done for the country's banking sector. Five
years after the crisis however, its pace towards recovery is
still yet to reach full swing.

The banking sector -- supposed to become the frontline of the
economy -- is in for yet another sluggish year as the rebuilding
process remains slow.

This certainly impinges on efforts to revive the corporate
sector, which has been on the receiving end of the economic
fallout, during and after the financial crisis.

True, the intermediary role of the domestic banks and most of
the banking indicators are improving, but not yet by much, and
not factoring in all the painful efforts and large costs the
country has been forced to make to bail them out of trouble.

Bank loan exposure is steadily rising, even better than last
year, and so are other indicators used to gauge a bank's
financial health, such as the capital adequacy ratio (CAR) and
non-performing loans (NPLs).

Loans on which interest payments are 90 days overdue are
categorized as non-performing. The NPL ratio measures a bank's
non-performing loans against its total loans.

As for CAR, it measures a bank's health by the comparison of
its capital against risked-weighted assets such as loans. The
higher the CAR, the better a bank's capacity to cover the risks
of its assets with capital.

While the NPL ratio is currently averaging around 10 percent,
as against more than 12 percent last year, measures on CAR has an
even better comparison.

As of September, none of the 141 banks operating in the
country had their CAR levels below the minimum requirement of
eight percent set out by Bank Indonesia.

In 2001, as many as five banks had to be placed under the
"intensive care" of the Indonesian Bank Restructuring Agency
(IBRA) for failing to meet the requirements.

One bank, namely Unibank, had an even more bitter pill to
swallow, being closed down by the central bank for the same
reason.

So to this point, there is indeed some on-the-ground evidence
that progress was made during the year.

But one question remains: Is this progress worth all the
effort made to bring the banking sector back to health?

In the aftermath of the financial crisis, the government
injected Rp 430 trillion (US$48 billion) worth of capital in the
form of bonds into domestic banks in 1998, under a costly bank
recapitalization program.

These bonds were injected to replace the banks' loans that had
gone sour as industries failed to repay them because of the
crisis.

The government has said that the costly program was needed to
avoid closures.

The consequences however, were severe.

Not only was it the world's largest bail-out package, the
government had to cover the interest on the bonds, at the expense
of the taxpayer.

Against this backdrop, the banks' performance looks pale by
comparison.

Nevertheless, there are also some factors that have
contributed to the banking sector's slow progress.

The most profound reason is that demand for new loans remains
low amid the country's sluggish economic growth.

Despite the economy managing to grow this year, around 3.8
percent according to analysts, it should be attributed to robust
domestic consumption, not to massive expansion in industries as
improvement in investments and export sales remain hard to come
by.

Emulating last year's trend, industries utilized what was left
of their production capacity, most of which has been idle since
the crisis, and took advantage of surging domestic consumption to
finance the slight growth in output.

On the supply side, temptation for banks to invest in Bank
Indonesia SBI promissory notes proved to remain hard to resist.

The declining trend of the interest which saw the rate drop to
around 13 percent now, from 17 percent early in the year has yet
to fully convince banks to stay away from it and to immediately
start pouring in lots of new credits to the real sector.

This has surely something to do with the fact that banks still
face a high risk of having their loans turn bad, which actually
was the reason why the crisis occurred in the first place.

Another factor that has hindered the banks' recovery progress
lies on IBRA's lack of commitment to restructuring most non-
performing credits under its supervision.

To date, around half of the total Rp 430 trillion non-
performing loans held by IBRA is still left unrestructured. This
means banks would still be reluctant to purchase those assets, as
it would only add to the risks of them turning bad and jeopardize
further the banks financial condition.

All these have come despite intensifying efforts on the part
of the government to accelerate recovery in the banking sector,
thus restoring public confidence in the industry.

In March, it sold the majority stake in the country's largest
private bank, Central Bank Asia (BCA), followed recently by the
sale of the controlling block of shares in Bank Niaga, also among
the top-ten banks in the country.

Five banks have also been merged as part of those attempts.
The five, all under the supervision of IBRA, emerged as Bank
Permata, which, in terms of assets, can also be included in the
country's top-ten list.

There are also attempts by the central bank to improve the
banking sector, this time in the form of prudential regulations.

Among others, there were plans to put into effect a ruling
restricting a bank's NPL ratio to less than five percent.
However, taking into account the current banking condition, the
ruling would not be effective until after June next year.

The regulation was initially scheduled to take effect by the
end of the year.

The central bank has also aired an idea to increase the
minimum CAR requirement to 12 percent from the current eight
percent. This will also be unlikely to be effective any sooner
than the end of next year.

To this extent, it seems the government has done almost
everything to restore public confidence in the banking sector,
only to find the progress moving in slow motion.

But, one can still argue that despite the slow progress, signs
of improvement in the sector are there, and that what is
happening at the moment is the journey the country has to endure
before things improve.

What is left to do is to maintain the reform momentum in the
sector.

If such reform requires more bank mergers to squeeze out the
sick, tougher prudential regulations and expediting loan
restructuring, then do so.

After going through all these painful steps, the last thing
this country needs is to give itself up and kiss the ongoing
banking reforms goodbye.