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.