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.