Banks face higher credit risks

Banks face higher credit risks

Bank Indonesia (central bank) should closely monitor the
quality of banking assets because the tsunami of inflationary
pressures generated by the Oct. 1 fuel-price hikes is increasing
the risks of bank credits turning sour.

Even before the bold fuel policy was taken, net non-performing
loans (after provisions) within the banking industry had reached
the maximum 5 percent (of total loans), the highest level since
2002. According to the latest report by Bank Indonesia, in terms
of gross non-performing loans (NPL), the ratio was almost 9
percent as of September, up by 3.32 percentage points from a year
earlier and by 1.16 percentage points from August.

Even though Bank Indonesia's director for strategic assessment
Halim Alamsyah does not yet see the NPL level as alarmingly
inimical to banking performance, he did acknowledge higher risks
of bank loans turning bad.

Businesses have yet to absorb the multiplier-impact of the
doubling of fuel prices. But certainly, as businesses are
struggling with higher costs and higher interest rates, their
debts become highly vulnerable to default because heightened
business risks will adversely affect the business plans on which
loans were previously assessed. Cash-flow estimates, which were
earlier assessed as adequate to sustain debt service payments,
could be upset, as costs will rise.

The textile industry association has rung the alarm bell,
warning that without special assistance from the government as
many as 200 textile and garment companies could go bankrupt
within the next few weeks as higher costs would make them
uncompetitive against imports.

As credit risk is certainly one of the biggest of all the
risks inherent in banking operations, this risk requires the most
careful analysis because bad loans erode a bank's capital base.
Likewise, as the central bank is likely to tighten its monetary
stance within the next three months to control inflation, banks
will be exposed to adverse movement in interest rates at the risk
of slashing their earnings or even the economic value of their
assets.

It is hardly necessary to stress the urgent imperative for the
central bank to step up its supervision of loan quality to ensure
that commercial banks properly implement an effective management
of risks related to credits and interest rates.

A more stringent supervision will enable the central bank to
act immediately or, if necessary, take contingency measures as
the one it took in November, 2002, to cope with the devastating
impact of the terrorist bomb attacks in Bali on Oct. 12, 2002.

Bank Indonesia (the central bank) eased the requirement for
banks to clean up their non-performing loans (NPLs) to allow them
some leeway in dealing with corporate borrowers facing financial
distress with the impact of the bomb blasts.

True, the impact of the second bomb attacks in Bali on Oct. 1
were not as damaging as those inflicted by the Oct. 12, 2002
attacks. But the wave of price hikes businesses will be facing
within the next few weeks as the result of the Oct. 1 fuel price
increase will not be any less adverse.

Persistently enforcing the NPL ruling is not only impossible
but could also unnecessarily cause a new shock in the fragile
banking industry and force banks to resort to acts of deception
by artificially classifying their loan assets. Given the grave
condition businesses are facing, it would be more realistic to
slightly relax the NPL requirement, but under tight supervision
to ensure that banks classify their credits fully according to
the central bank's standards and set aside adequate provisions
for their NPLs.

Fully enforcing the stringent NPL requirement could
unnecessarily put the still weak banking industry into another
shock, especially now as banks are gearing up for the phasing out
of the government blanket guarantee on bank deposits and claims
that started last month.

The government, however, could greatly help reduce the
business risks and the regulatory and bureaucratic costs of doing
business by accelerating reform measures in the civil service,
taxation, customs, transportation and trade.