BI calls on banks to improve their internal controls

JAKARTA (JP): Bank Indonesia (BI) Governor J. Soedradjad Djiwandono has called on banks to tighten their internal controls to ensure all division, especially credit and treasury divisions, do business prudentially.

He said at a seminar Thursday that internal controls became more important when a bank entered fee-based income business involving sophisticated financial techniques and products like derivatives.

"Almost all bank failures were caused not by the complexity of financial instruments or inadequate risk management but more by the failure to observe the basic principles of internal control and audit," Soedradjad said.

Banks were often lured into taking excessive risks when using transaction tools like derivatives, Soedradjad said.

He cited Nick Leeson, a former securities trader at Barings in Singapore, as an example of a bank executive who took excessive risks in derivative transactions. The huge loss inflicted by Leeson's transactions caused his bank to collapse in early 1995.

"Observing prudential principles in business is always important not only for the banking industry but also for the real sector," Soedradjad said.

"Yes, the systemic risk is in the financial sector. However, if the financial sector is spoiled, it will affect other sectors," he said.

The governor called on local firms in the real sector to improve their equity financing, saying most local firms were still highly leveraged and burdened the banking industry with large bad debts.

Bad loans at the country's 239 commercial banks reached Rp 10.4 trillion (US$4.34 million) as of the end of November. This was 3.26 percent of their total credits.

Soedradjad said Bank Indonesia was preparing a blue print for the development of an efficient, secure and reliable national payment system to anticipate the increase in noncash transactions.

Increasing noncash transactions have challenged the government to provide legal frameworks to minimize pressure on the current account deficit and inflation, he said.

Noncash transactions involve a wide range of noncash payment instruments, ranging from cheques and drafts to credit cards.

Noncash transactions have increased tremendously as is shown by the increasing volume of daily interbank clearances organized by the central bank. These have risen from Rp 4.5 trillion in 1991 to Rp 25 trillion (US$10.5 billion) now.

Soedradjad said many central banks were devoting greater attention to their payment systems and shared similar concerns about the safety of such payment systems.

He said the payment system had considerable potential risks that could affect national economic stability.

"Just-in-time services are important but they must be safe because white collar crimes, like banking fraud, have been increasing," he said.

He said the blue print detailing matters relating to institutional organization, policies, legal provisions, infrastructure, procedures and programs would be developed progressively.

In the short term, the central bank plans to introduce an electronic clearing system in Jakarta to speed up the clearing process, which is still handled manually.

The manual clearing system has caused inefficiencies in the payments system because it depends on traffic and other factors. (rid)