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.