Banking system remains fragile

Banking system remains fragile

The People's Consultative Assembly recommended last week that
the government take firm measures against banks that fail to meet
the December 31 deadline for achieving the prudential standards,
notably the minimum capital adequacy ratio of 8 percent and
maximum nonperforming loans of 5 percent.

The recommendation reflects greater concerns about the
viability of the banking industry after the closure late last
month of the insolvent, publicly listed Unibank, and because a
number of banks, including those recapitalized in 1999 and 2000,
may not be able to meet the prudential standards.

As the economic condition worsens amid the gloomier outlook of
the global economy after the September 11 terrorist attacks on
the United States, banking operations now face greater risks of
bad credit.

True, banking, by its nature, entails a wide array of risks
even under stable macroeconomic conditions, let alone in
Indonesia, which has been mired in a multi-dimensional crisis
since 1998. That is why, despite the massive deregulation
campaign around the world, the banking industry remains the most-
regulated sector in all countries, subject to prudential
regulations and tough supervision.

But as the case of Unibank shows, Bank Indonesia's supervisory
mechanism seems ineffective. Worse still, the Indonesian Bank
Restructuring Agency (IBRA) has not done any better in overseeing
the 11 recapitalized (nationalized) banks under its management.

After its restructuring and recapitalization by the
government, which cost taxpayers almost US$65 billion or 50
percent of the country's gross domestic product, the banking
industry remains fragile as most banks have yet to reassume their
intermediation role to pump lifeblood into the economy.

More worrisome is that it was only last month that the IBRA
set up a special task force to examine and decide what to do with
the recapitalized banks that are most likely unable to achieve
the prudential standards set.

Yet another troublesome development was how the central bank
mishandled the closure of Unibank. Bank Indonesia has often
claimed that its supervision mechanism is fully based on the core
principles for effective banking supervision of the Basel,
Switzerland-based Bank for International Settlement.

Nonetheless, the cause of Unibank's insolvency was the same
diseased violation of legal lending limits to connected parties
that was mainly responsible for making Indonesia's banking crisis
in 1998 the worst implosion of a financial system any nation has
ever suffered over the past 50 years.

Whatever the argument raised by the central bank to justify
its latest action, Bank Indonesia failed to conduct sound and
prompt intervention when Unibank's financial condition was found
to be alarmingly fragile.

The same degree of delay and indecisiveness also seems to have
held up firm actions on several other distressed banks and put
off badly-needed improvement in the government's blanket
guarantee for banks' deposits and claims.

True, the blanket guarantee has to be maintained, otherwise
national banks would collapse. Yet we wonder why the government
has not yet lowered the interest rate ceiling for guaranteed
deposits to force depositors to judge for themselves the risk
premium of banks. Why have interbank loans remained covered by
the guarantee? If a bank is not able to judge the viability of
other banks, is there still a single reason to help support the
survival of such a bank?

All these delays and indecisiveness have increased the
contingent liabilities of the government with regards to the
banking industry, especially now that the government already owns
almost 80 percent of the banking industry as a result of massive
recapitalization in 1999 and 2000.

The government is now facing a great dilemma. Compromising on
the prudential standards means letting a time bomb continue
ticking within the banking industry. Closing below-standard banks
may further damage public confidence in the industry. Forcing
mergers among weak banks would only make a bigger time bomb.

It is needless to reemphasize, therefore, that firm action
must be taken next month. Below-standard banks that will not
cause big claims on the blanket guarantee fund should be closed
down once and for all, while medium-size banks under IBRA must be
consolidated with bigger ones.

Further delays would only postpone another, bigger banking
crisis, which the government could certainly not cope with, as
the public sector itself is already on the verge of being
defaulted under mountains of foreign and domestic debts.