Banks need structural change, diversified ownership

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.