Banks remain fragile

Two years after the restructuring of the domestic banking industry that cost about Rp 653 trillion (US$65 billion), most analysts, including government economists, remain greatly concerned about the soundness of most national banks, amid the political uncertainty and economic woes.

A number of the remaining 122 domestic banks, including several newly recapitalized ones, may be unable to achieve the minimum 8 percent capital adequacy ratio (CAR) by the December deadline. These undercapitalized banks either have to merge with stronger banks or face closure.

Some analysts have even warned of a new bout of banking crisis that prompted an increasing number of the upper middle and top income group to move their savings to foreign bank branches or overseas for safety.

To the affluent and businesses active in international transactions, the government's blanket guarantee on deposits in domestic banks seems to matter less when it comes to ensuring the safety of their money as the tumultuous political condition, the sharply declining credibility of the government and the weakening position of President Abdurrahman Wahid are increasing the country's sovereign risks.

As the central bank has been steadily raising its benchmark short-term interest rates to curb inflationary pressures and currency speculation, caused by the weakening rupiah, we now see two strikingly different groups of banks; the first group consists of national banks that are perceived to be fragile and highly risky, and the second group consists of foreign bank branches that are seen to be sound and strong -- a safe haven for financial assets.

The wide difference in the risk factor puts national banks in a great disadvantage in raising funds or getting prime customers. On the other hand, although foreign bank branches offer interest on deposits as low as 8.50 percent, compared to between 13 percent and 15 percent from national banks, they are able to attract many large depositors. They also become the preferred banks among export-oriented businesses, currently considered the most bonafide corporate customers and borrowers.

Even though their lending operations have not yet returned to the precrisis (1997) level due to the large number of big businesses still reeling under huge debts, foreign bank branches can still earn a lot of money simply by parking their excess liquidity in the risk-free central bank's SBI promissory notes that now gives a 15.80 percent interest. This way, these banks, without any risk or doing anything else, can book a gross interest margin of more than 6 percent.

No wonder many domestic bankers have been complaining that as long as the business climate remains murky and the political condition uncertain, foreign bank branches will continue to make a windfall profit from the central bank's tight money policy -- at the expense of Indonesian taxpayers.

The future prospects of the domestic banking industry are worrisome indeed. The longer the present political uncertainty lingers, the more hostile will be the environment for banking operations. The recapitalized banks, which account for more than 80 percent of the industry's assets, will remain fragile as they are facing a multitude of risks related to market competition, credit, interest rate, liquidity and rupiah exchange rate.

Consequently, the economy will remain deprived of badly-needed lifeblood as most domestic banks will have to use their resources to maintain or achieve the minimum CAR standard. Most banks are refraining from big lendings, preferring to put their funds in Bank Indonesia's SBI debt papers because every loan is a risk while the capital standard (CAR) is based on risk-weighted assets. The dilemma though is that the financial market has not yet reached such a depth as to allow for a wide variety of fee- generating transactions. Lending remains the biggest source of bank revenue.

These predicaments once again testify that no amount of financial reform will be able to help the banking industry, especially the recapitalized banks, to fully recover, and become sound and strong institutions unless the macroeconomic condition becomes stable. But such a condition can only be achieved if there is a minimum level of social, political and legal certainties that allows for reasonable calculation of business risks.