BI under pressure to punish defiant banks

BI under pressure to punish defiant banks

JAKARTA (JP): Bank Indonesia, the central bank, has been under
pressure to take firm action against banks violating the legal
lending limit regulation.

Analysts have said firm action is needed to punish those who
do not abide by the legal lending limit. Otherwise, they will
continue to play cat and mouse with the monetary authority.

The central bank unveiled recently that the number of banks
not complying with the legal lending limit regulation nearly
doubled to 70 last year from only 44 in 1994.

The violation of the legal lending limit requirement by the 70
banks has received much attention. It has not only been debated
in the media but also became a dominant topic in a recent hearing
between Bank Indonesia and the House of Representatives.

The central bank has summoned executives of the defiant banks,
asking them to immediately solve their problems. But many
analysts doubt if the central bank's appeal would be effective
enough.

"Shock therapy is needed. Otherwise, banks will continue to
play cat and mouse with the central bank," said a noted banking
analyst, Laksamana Sukardi.

Other analysts consider legal action would be too harsh, that
punishing the defiant banks through legal procedures would be
counterproductive.

Legal action would be even worse for the banking industry
because such a move could undermine public confidence in the
banking system, they said.

The controversy continues, but most analysts want the central
bank to take a persuasive approach before taking any legal
action.

Capital adequacy

In addition to the legal lending limit violation by the 70
banks, 21 other banks have failed to meet the central bank's
minimum capital adequacy ratio requirement of 8 percent, and 18
other banks have broken the ruling on the maximum loan to deposit
ratio.

The failure of the banks to abide by the prudential
regulations indicate weaknesses in the series of government
deregulations in the banking sector issued since 1988.

In 1988, the monetary authority issued a package of
deregulation measures, liberalizing the previously closed banking
industry. The banking reform was initially hailed as appropriate
action in revitalizing the country's economic activities. But it
was later labeled a destructive factor in the infant banking
industry because the measure was introduced at a time when the
industry still needed the government's protection. Taiwan and
South Korea, for example, still protect their banks even tough
their economies are much more developed than Indonesia's.

The reform not only attracted foreign bankers to establish
operational networks in the country, but also lured local
businesspeople who needed more secure and cheaper sources of
funds to back up their business activities.

It became clear that to raise public funds to finance a
conglomerate's business activities became the main motive for
such a business to establish a bank in the post-reform era. Now
almost all business groups in the country have their own banks.

The number of commercial banks, which was only 112 in 1987,
grew to 171 only in two years after the reform. The number of
banks reached 240 as of June last year, with around 5,100 branch
offices stretching across the archipelago.

The number of secondary banks, which are at present allowed
only to operate outside provincial capitals, also increased
steadily to 8,955 as of last June from 5,780 as of 1987.

It is, therefore, quite understandable if almost all banks in
the country concentrate their lendings to their own business
activities or certain business groups.

Private banks mostly act as the funding agents of their
affiliated firms, while state-owned banks provide most of their
funds to those who have special connections either with their
executives or with government officials.

The banking law, which was introduced in 1992, clearly
stipulates the legal lending limit, which was then tightened in
May 1993 through the third of a series of deregulation measures.
The measure, which was introduced following the collapse of Bank
Summa, was, however, considered as being too late.

Bank Summa was dissolved in 1992 after being unable to pay its
financial obligations. The bank was reported to have concentrated
most of its loans to its own affiliated firms, which were mostly
later unable to repay the debts.

According to the May deregulation package, banks are allowed
to provide a maximum loan of 20 percent of their capital to a
non-affiliated business group and 10 percent to affiliated firms.

The lendings provided to affiliated companies before the
introduction of the regulation should not exceed 12.5 percent of
the capital by December 1995 and 10 percent by March 1997. And
yet, the number of banks not complying with the legal lending
limit almost doubled within just a year.

The 70 defiant banks consist of two state-owned banks, 56
private banks, three provincial-administration-owned banks, and
nine wholly owned foreign banks and foreign joint venture banks.

Most of them broke the ceiling for their lendings to
affiliated companies.

The increase in the number of banks not complying with the
legal lending limit was caused by many factors. The banks, for
example, intentionally raised their lending portfolio when their
affiliates could no longer find other financial sources to
support their business activities. This may have resulted from
their inability to trade over-limit loans to other banks.

The abolishment of the central bank's policy allowing banks to
exclude insured loans from the legal lending limit requirement
was also considered an important factor, which caused the
increase in the violations of the lending limit.

Roosiana Solikin, an executive of Panin Bank, said that
covering loans with insurance used to be widely used to reduce
over-limit credits.

"But such a practice is no longer allowed, so that the only
alternative left in dealing with over-limit credits is to trade
part of them with other banks," she told The Jakarta Post.

She, however, said that taking such action is not easy, given
the fact that loans given to affiliated firms often break
standard procedures.

"No banks will buy other banks' loans if they are not covered
by adequate legal documentation or collaterals," she said.

Laksamana acknowledged that it is not easy to adjust the
lending portfolio overnight to the existing legal lending limit.
"That's why the central bank has provided a significant
adjustment period," he said.

But the problem is that many banks have broken the legal
lending limit regulation not only on their old loans but also
those provided after the introduction of the lending regulation.

"How can such a practice be tolerated? In this case, the
central bank should take firm action. Otherwise, it would lose
its credibility," Laksamana said.

In an annual banking meeting last month, Bank Indonesia
Governor J. Soedradjad Djiwandono said that the increasing number
of banks not complying with the legal lending limit regulation is
alarming.

He said complying with the legal lending limit regulation is
important due to the fact that most problem loans in the banking
industry are related to the violation of that regulation.

In this regard, Soedradjad said, the central bank will
continue to closely monitor developments related to the
violations and that it will not hesitate to take legal action
against violators.

The central bank recently held a special meeting with
executives of the 70 banks which violated the legal lending limit
regulation to seek solutions. (hen)