BCA: Major deal of the year

By Vincent Lingga

JAKARTA (JP): Barring opposition from the House of Representatives, the strategic sale of 51 percent of Bank Central Asia (BCA) could become the deal of the year.

The winning bidder will, in one stroke, be able to control Indonesia's largest retail bank with a depositor base of about seven million, 2,075 ATMs that are linked to the international settlement system and 795 branches across the country.

The government's bold decision to further divest 51 percent of its remaining 60.30 percent stake in the bank, and not 30 percent as previously planned, therefore deserves full support from the House because the transaction could jump-start the consolidation of the banking industry.

The deal could become the catalyst, an icebreaker in rekindling the interest of foreign investors, who have so far written Indonesia off from their business plans.

The offer should be more attractive now that the political uncertainty has been removed, and the stake put up for auction will allow the new investors (buyers) to control management.

However, many things could still go wrong even before the bidding process starts.

It is therefore most imperative for the government to do it right by involving, right from the outset, all stakeholders -- House members, employees, the investing public and customers -- in the process.

What is most important is that the bidding process should be designed in such a way that the deal will be seen as fair and credible by the stakeholders, particularly the market.

A conducive public opinion environment is vital, especially since the government divestment of BCA has caused a lot of controversy and allegations of corruption, collusion and nepotism.

BCA's initial public offering of 22.5 percent of its shares was postponed several times before it was finally launched in May 2000. Its secondary issue in July left behind allegations of price manipulation and a further divestment of 30 percent through a strategic sale in June, which ended in tatters as only two investors submitted bids at very low prices.

The government often wrongly assumes that the public is not knowledgeable enough to comprehend complex financial transactions. Hence, why bother with disseminating information that they cannot digest.

On the contrary, given the bitter experiences of the past, the first step in the whole process should be a massive campaign to sell the divestment plan to the stakeholders by enlightening them on why the deal is so pivotal for the consolidation of the banking industry and the sustainable recovery of the economy.

The public should be made well-informed on how the transaction will give greater value to BCA, its employees, its investing public, who now own 32.2 percent of the bank, and on how foreign investors will accelerate the bank's growth.

The House should be especially convinced that foreign control of BCA will not mean foreign domination of the national banking industry. Foreign banks now account for only about 10 percent of the total banking assets in the country.

House members need not make a comparative study overseas, however great is their penchant for such a foreign tour, to learn about the great benefits accrued from a foreign bank entry into the national banking industry.

The stronger economic recovery in Thailand and South Korea has been attributed partly to a fast consolidation of their financial industry brought about by foreign investors.

Take Korea, for example. The Korean government recapitalized in 1998 the Korea First Bank, one of the largest banks in that country, by injecting US$1.2 billion. But the government sold 51 percent of the bank to Newbridge Capital for only $500 million in January 2000.

Even this low price was sweetened with a clause stipulating that the Korean government would take over any loans that turned sour within a year after the acquisition transaction.

But Newbridge spectacularly succeeded in rehabilitating the bank within one year, turning it around from a loss of $850 million in 1999 to a respectable profit of $243 million in 2000.

A recent study by the International Monetary Fund (IMF) shows that foreign institutions (investors) have increased their role in the banking industry in crisis-ridden countries, especially in the late 1990s.

In Latin American countries, for example, the foreign banks' share of the domestic banking industry ranged from 18 percent in Brazil to as high as 53.5 percent (of total bank assets) in Chile.

In Central Europe, foreign domination of the national banking industry was even more stronger, ranging from 53 percent in Poland to as high as 80 percent in Hungary.

Restrictive policies before 1997 had kept the foreign institutions' share of national banking industries in Asia relatively small. But their role has been expanding rapidly, especially since the 1997 financial crisis, with a range of 7 percent in Thailand, 12 percent in Malaysia and 17 percent in South Korea.

The IMF report that compiles empirical evidence gathered from studies in various countries concludes that a foreign bank entry brings in competitive pressure to the industry to increase efficiency and help improve quality, pricing and availability of financial services.

As most major foreign banks have developed a good training system, they also have become the source of skilled banking personnel who will introduce the practices and technology of the foreign banks when they move to domestic banks.

Foreign banks have a more sophisticated system for evaluating and pricing credit risks associated with derivative products. They have more stringent disclosures, accounting and reporting requirements that are closely aligned with international practices, thereby gaining stronger trust from the public.

During the height of the economic crisis in Indonesia in 1998, foreign banks in Jakarta indirectly added to the stability of the banking system by allowing domestic residents to do their capital flight at home.

Although rich residents lost trust in national banks, not all of them transferred their financial assets overseas. Many simply shifted their deposits to foreign bank branches in Jakarta, thereby helping stabilize the overall stock of deposits.

The divestment will not be able to entirely recoup the Rp 60 trillion (US$6.6 billion) in bonds the government injected to recapitalize BCA in 1999.

But without new investors, BCA capital could erode steadily to a point that would force taxpayers to make a new recapitalization.

With so small a loan portfolio (8.5 percent of Rp 96.2 trillion total assets), and the bulk of its capital consisting of liquid government bonds, BCA significantly needs fresh funds to expand lending to generate earnings growth over time.

True, BCA has almost seven million savings accounts, totaling over Rp 40.5 trillion, which provide the bank with a strong cushion for funding.

But this large number does not automatically translate into account profitability, the factor that counts most for the bank's earnings. It seems the average account balance at the bank is relatively small, and individual customers with low balances are not a steady source of revenue for the bank as most limit their banking transactions to regular usage of the ATM network.

Demand deposit accounts at BCA, which normally make most of the high-value transactions to generate fee-based income, totaled only 16,208 with a Rp 18.43 trillion balance as of last December.

It should be noted realized that the 51 percent strategic sale will not bring in additional funds to the bank as the proceeds will be entirely transferred to the state budget.

Whoever wins BCA's majority stake should not only think long- term. The new owners should be willing to inject fresh funds, both to improve the bank's capital structure and to further modernize its information technology.

Amid the globalization of the financial services industry, banking is now inherently an information, communications and computation intensive industry.

Efficient and credible banks are vital to the economy because they reallocate money or credit from savers to borrowers and are at the heart of the clearing system to help individuals and firms fulfill transactions. No wonder that, in spite of the mounting deregulation drive all over the world, banks remain the most regulated industry.

It is no exaggeration then to say that the strategic sale of BCA could make or break the new LoI with the IMF. The deal is also a litmus test as to whether foreign investors have now reconsidered Indonesia as a potential place for business.

The issue here is not primarily whether BCA is attractive or not, but whether investors want exposure to the Indonesian banking sector in view of the weakness of the legal system and the persistently fragile economic condition that makes banking operations still highly risky.

The writer is a senior editor of The Jakarta Post