Banks need structural change, diversified ownership

Rizal Ramli, Former Coordinating Minister for the Economy, Jakarta

Although the Indonesian banking sector has been recapitalized to the tune of Rp 650 trillion, structural weakness remain a serious problem. These have not yet been handled in a systematic way. Instead, and at the behest of the IMF, top priority was given to selling off state banks and banks held by IBRA.

The sale of banks without first reaching a consensus on an appropriate banking landscape to be achieved over the medium term has a number of economic, financial and sectoral consequences. What would the characteristics of this banking landscape be? To begin with, the first objective of banking reform should be to create a banking system that is consolidated but not concentrated. Such a structure would provide consumers with security, convenience and all of the benefits of a diversified range of financial products.

Pre-crisis data from 1996 indicates that most of Indonesia's big banks were affiliated to other banks and financial institutions through cross-ownership and cross-management. Taken as a whole, the concentration of ownership in the banking sector before the crisis was extremely high.

According to a study by ECONIT and the Indonesian Bankers' Institute in 1997 entitled Structure and Strategic Policy for the Indonesian Banking Sector Post-2000, the concentration of ownership and management was associated with violations of intra- group legal lending limits, thus increasing systemic risk to unacceptably high levels. There were many loopholes to get around legal lending limits such as loan swaps between group banks, the use of finance companies and layers of corporation, as well as ownership and management nominees.

The crisis itself revealed the many structural weaknesses of the banking sector and the ineffectiveness of external supervision by Bank Indonesia. Based on this experience, the monetary authorities in the post-crisis period should have placed a high priority on achieving a diversified ownership structure. This would have helped to reduce the incidence of violations of legal lending limits and thereby reduce systemic risk in the domestic banking sector.

A diversified ownership structure brought about through ownership limits would encourage self-monitoring as shareholders defend their interest in transparency, profitability and risk minimization. Many advanced countries limit bank ownership to a maximum of 20 percent to promote self-regulation. Australia, for example, limits bank ownership to 17 percent.

But not the Megawati government, which plan to sell 51 percent of BNI shares to one buyer. The future new majority owner of BNI also, coincidentally, owns Bank International Indonesia (BII) and Bank Danamon. The government has thus promoted concentration of ownership as well as cross-ownership and cross-management. The plan clearly contradicts the principle of diversification of bank share ownership.

State ownership of the entire banking system cannot be justified on the grounds of efficiency or effective management and governance. On the contrary, the sale of minority stakes in state banks would promote positive changes in corporate culture, efficiency, accountability and transparency.

Yet the disposal of these assets must be carried out on the basis of a broad consensus on the desirable banking landscape to be achieved over the medium term. The sale of these shares should not be conducted in a random fashion for the sole purpose of revenue-raising in the short term.

This landscape should aim for a structure of ownership that is consolidated but not concentrated in order to promote self- monitoring and regulation and to provide consumers and investors with security, high quality services and choice.

In many cases, it is not state ownership that is holding back state-owned firms, but rather the quality of management. In many other countries state-owned companies perform exceptionally well. Singapore Airlines, Keppel and DBS Bank are just a few examples of well-run state-owned firms in Singapore.

The key to success is the quality of management combined with superior oversight and supervision. To argue that the performance of Indonesia's state-owned firms would automatically improve after privatization would be a naive, ideologically-inspired position that ignores the substantial governance and efficiency problems that plague Indonesia's private companies.

The hurried sale of a majority stake in Bank BNI-46 would be irresponsible. The state minister is behaving like a minibus conductor recklessly chasing fares to cover immediate costs, not unrelated to the upcoming general elections. The distress sale of Bank BNI-46 at a time when the bank is reeling from the recent letter of credit scandals will not maximize government revenue over the long term. We would expect the state minister of state enterprises to first improve the performance of Bank BNI-46, which, after all, is still under his supervision.

It is not always clear whose interests are served by the Megawati government's program of privatization. It is often said that while the New Order raised revenue through investment, the Megawati government relies on divestment. There is much truth in this. With state and private investment rates at historic lows, the present government has decided to meet short-term obligations by selling the family silver.

The tendency of the state minister of state enterprises to rely on strategic sales and private placements rather than public share offerings suggests a preference for backroom dealing over public scrutiny. At the moment the necessary controls and supervision are not in place, and the risk that these deals are disadvantageous to the state is high.

Until more credible and accountable procedures can be put in place, the legislature and the public must insist on a temporary moratorium on the sale of state assets. The moratorium should extend through the upcoming general elections until the new government is formed in order to ensure that the elections do not create perverse incentives for politicians and bureaucrats. Such a move would help reestablish credibility and prevent irreversible distress sales that impose heavy financial losses on the state.