Banks remain fragile

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.