Fri, 26 Dec 2003

Banking sector makes progress, challenges remain

Dadan Wijaksana, The Jakarta Post, Jakarta

It has been six years since the banking sector started its restructuring efforts. Still, while improvement in its financial health is undeniable, certain flaws remain -- indicating that the recovery process is still a long way off.

On a year-to-year basis, key indicators to gauge the sector's financial health are improving and on par, or even better in some cases, than those posted by banks in other countries that were also hit by the economic crisis in the late 1990s.

At the same time, however, the discovery of two massive fraud cases at two state-owned banks is yet another blow to the sector, which is still struggling to get back on its feet.

Lending fraud cases in state-owned Bank Rakyat Indonesia (BRI) and Bank Negara Indonesia (BNI), the nation's fourth and second largest banks respectively, have exposed weak internal controls in each bank, and a poor supervisory mechanism of Bank Indonesia -- two of the foremost reasons behind the sector's fall during the 1997-98 financial catastrophe.

Many say that it is only the government's blanket guarantee program that has prevented the sector -- or at least the two banks -- from being hit by a massive rush. Under this program, the government will cover all banks' public funds and other liabilities when they go bust.

The BNI case revolves around the disbursement of about Rp 1.7 trillion (about US$200 million) last year, in what was claimed to be export credit facilities to some exporters backed by fictitious letters of credit from foreign banks, which are not even BNI's foreign bank correspondents.

As for BRI, which has earlier successfully launched its initial public offering, the case centered on irregular banking transactions involving Rp 300 billion.

The alleged scams only confirmed that Indonesia had so far learned little from the last banking crisis. As such is worrying, as it could mean that the sector is back to square one despite more than Rp 600 trillion worth of public funds injected by the government.

Of equal significance is that the fraudulent practices could weaken investor confidence in the sector, putting at risk the government's drive to sell its stake in a number of banks. In months to come, the majority stake in Bank Permata will be on sale while the auction of the controlling block in Bank Lippo has recently been relaunched.

Even if investors are not second-guessing their investment plans in Indonesia just because of the scams, they might try to take advantage of it by lowering their bidding prices, according to experts, thus hurting the cash-strapped state coffers.

Another major concern overshadowing the banking sector's performance this year was the slow growth in lending to the corporate sector, albeit aggressive moves by Bank Indonesia to reduce its benchmark interest rate.

According to the central bank's latest assessment, banks loans to corporations have been so far growing by less than 2 percent from last year, insufficient for the sector to play a significant part in generating higher economic growth.

"Banks loans need to grow at between 20 percent to 22 percent per annum to be able to push the economic growth to around 5 percent," Burhanuddin Abdullah, the central bank governor, said recently, citing various economic surveys.

In their defense, bankers have said the country's corporate sector remained risky, amid slow progress in the restructuring of corporate debts. Most banks are consequently focussing their loans more on consumers, which includes credits for individuals and small and medium-sized enterprises (SMEs), rather than on the real sector.

The slow lending activities were in contrast if compared to other indicators to measure a bank's financial health. Among other things, the sector has managed this year to improve its capital adequacy ratio (CAR) and non-performing loans (NPLs).

Loans are categorized as non-performing if the interest payments failed to be repaid in 90 days. CAR meanwhile measures a a comparison between a banks capital against risk-weighted assets, such as loans.

As of September, the average CAR level was around 23 percent -- higher than some 21 percent posted last year and way above the central bank's minimum requirement of 8 percent. Meanwhile, the average NPL ratio stood at 7 percent as compared to 12 percent in the same period last year.

According to data from the World Bank, CAR and NPL ratios of Indonesia's banking sector were no less impressive than banks in other crisis-hit nations such as Malaysia, Thailand, the Philippines and even South Korea.

Such improvement has partly contributed in attracting the interest of foreign investors on local banks, which resulted in a series of fairly successful sales in both the majority and minority stake in local banks.

This year, the sales of a controlling stake in Bank Danamon, Bank Niaga and Bank Internasional Indonesia (BII) have all been a success story. That adds to the more remarkable showing in the sales of minority stakes (through the initial public offering mechanism) in Bank Mandiri and BRI.

To this point, indeed progress has been made.

It is up to the authority now whether or not the momentum would be maintained. To be sure, if the sector does not want to lose the interest of investors, steps are needed to ensure that banking scams similar to that of BRI and BNI would no longer occur.

Improving the corporate governance, intensifying surveillance systems, providing tougher screening process for bankers, are part of a must-do list of actions Bank Indonesia needs to undertake to speed up efforts and create a sound banking system.

There are also attempts by the central bank to help knock the banking sector into better financial shape, especially in the form of banks' prudential regulations. It plans to introduce a wider range of the Basel Accord II principles to help it help meet the international standard of best banking practices.

The success of such efforts would be crucial to maintain the momentum, accelerate the banking reform and thus restore confidence in the sector. It will also make the sector better equipped to enter yet another year of restructuring process and could probably end it on a high note.