Central bank determined to tighten its supervision
Central bank determined to tighten its supervision
This is the second of two articles based on a paper presented by the Governor of Bank Indonesia Soedjadjad Djiwandono at the annual bankers' meeting on Jan. 19, 1995.
JAKARTA: In order to assist banks facing difficulties because of problem loans, Bank Indonesia will encourage these banks to merge, consolidate or seek the possibility of acquisition. Through these actions, problem loans can at the same time be restructured, thus assuring that the merged bank remains sound. To help deal with problem banks, the government is also considering the establishment of a rescue or pooling agency, which is expected to enable these banks to recover within a shorter period of time. Discussions have been held on the formulation of the regulations for implementation aimed at improving the quality of these banks.
To improve the effectiveness of bank supervision. Bank Indonesia has also been working on improvements in organization and personnel. In this regard, Bank Indonesia revamped its bank supervision organization in August 1994. The improvements deal mainly with the combining of on-site examination and off-site supervision into bank examination teams. The change will enable each team to focus fully on a specific number of banks. This method is expected to bring about more intensive and effective supervision of bank operations.
That was a brief overview of the key events in banking and monetary sector in 1994. Now, I would like to draw your attention to the outlook for the future, for this year, and to take stock of possible difficulties that may arise.
The stable economic conditions of 1994 are predicted to continue, enabling us to enjoy high economic growth in 1995. Added to this are improving conditions in the world economy. Stronger economic growth in industrialized countries and particularly in Indonesia's major trading partners is an extremely positive sigh for our foreign trade prospects. In 1995, the heightened pace of economic activity in industrialized countries will boost the volume of international trade, and strengthen commodity prices on the world market.
With these trends, we predict that in this year, economic growth can be maintained at about 7 percent. On the demand side, there is definite potential for the Indonesian economy to grow by more than the projected 7 percent. This takes into accounts the fact that some of the investment projects approved last year will start this year. It also appears that export demand will be strong. An additional factor is that rising incomes will encourage high consumer spending again this year. Nevertheless, we should also bear in mind that higher growth also carries a greater risk of overheating the economy and also a deterioration in the balance of payment which is a trade-off that we encounter. What we want to achieve is reasonably high economic growth while maintaining economic and monetary stability. In short, we want to help insure that growth is sustainable. For this reason, in 1995 the monetary authority considers it essential to institute sound policies from the start to ensure that our economy remains on the path of growth with stability. The dynamics of growth are visible in a wide range of economic sectors. What is needed is the means to control and direct these dynamics so that they work effectively without disrupting economic and monetary stability.
I am sure you agree with me that the task of maintaining economic and monetary stability is one that we share together, and that it is not a job for the government or monetary authority alone. In the budget draft recently submitted to parliament, the government has demonstrated its determination to continue the development process and other government-financed activities within limits that are calculated not to disrupt economic and monetary stability. A similar stance is also expected from both the business community and banks. It is true that the government has now adopted the policy of encouraging a larger role for the private sector and the business community in national development. Efforts are continually being made to open more opportunities to private business, to extend business participation into more areas, and facilitate business growth through the ongoing process of deregulation. However, this does not mean that the private business sector no longer bears any social responsibility and are freed from any responsibility to the public interest and our common future. One of these responsibilities, along with the government is to maintain a stable economic and monetary climate which will benefit all of us.
I would like to strongly encourage the banking community to adjust their actions with those of the monetary authority to demonstrate their conscientiousness in carrying this social responsibility. This cooperation will create and maintain a dynamic but stable economic and monetary environment I am confident that with a strong mutual understanding between the monetary authority and banks, this goal is achievable without the use of shock treatments or other harsh measures.
According to the current information and trends, the rate of expansion in the money supply (M1) in 1995/96 that can reasonably be considered safe for monetary stability is about 19 percent, while a safe level for credit expansion is around 19 percent. We need to use these figures as a common benchmark in planning our activities for this year. Of course, the capacity and opportunity for expansion differ from one bank to another. One bank may well be able to grow more quickly than another, depending on its objective. However, I would like to ask that banks be very through and selective in evaluating the projects. I ask that each bank carefully assess its expansion, based on among others, the capacity for accumulating deposits from the public at reasonable interest rates. Bank should pursue sound plans for expansion to continue the process of internal consolidation within the banking sector. Reckless expansion is the antithesis of consolidation.
Indonesia's growing economy will obviously require ever higher levels of finance. In view of the limitation on domestic sources of funds, financing our development will continue to encounter difficulties. Until now, we have turned to offshore sources as an alternative for fulfilling the gap. As regards the use of foreign funds, there are some points that I would like to present to the business community and banks. There have been increasing signs of late that an increasing among of foreign funds are being offered to our business community, including both state enterprises and the private business sector. In this regard, I would like to remind the business community to exercise caution in using funds from offshore, particularly funds offered on unfavorable terms and conditions, or which have complex schemes for repayment. The use of offshore funds through the operation of derivative transactions, for example, can potentially put the bank or debtor in a position of considerable risk from movements in interest rate, and exchange rates. If we are to honest with ourselves, it appears that we have much to learn in order to understand and take best advantage of offshore financing by such methods. For this reason, I ask that our businessmen and the banking community to be prudent and selective in entering into such arrangements, Regarding the use of offshore funds, let me remind non-bank companies that foreign borrowings must be reported to the Monetary Authority as stipulated in Presidential Decree No. 39 of 1991 concerning Foreign Commercial Borrowing Management Coordination (PKLN).
The increasing inflow of foreign funds requires the monetary authority to be more prudent in controlling monetary policy, including financing strategies through the international capital market. The current account deficit can be financed using the inflow of funds through direct investment, capital market (bonds and shares) and various kinds of loans. However, we should be cautious of negative impacts, especially with foreign loans. We could also look into what has happened in Mexico, so that we can prevent the same thing from happening in Indonesia. The increasing current account deficit, financed by various forms of short term funds, is very vulnerable. Funds (short term funds) managed by fund managers are very sensitive to the fluctuations. The behavior of trust fund managers who get on the bandwagon can create massive over-reactions that lead to crisis. We must be aware of this and stay alert.
Besides macroeconomic issues that I have already described, there are also a number of micro level issues that will require serious attention in 1995. The main problems facing banks in Indonesia center around the bank consolidation process steaming from problem loans. Although we have spent much time and energy on accelerating the completion of the consolidation process and settlement of problem loans, it cannot be said that these problems are over. This year, we have to increase our efforts to deal more effectively with problem loans and other difficulties faced by banks.
As you are aware, Bank Indonesia has issued many regulations aimed at creating a sound and efficient banking system. However, it also needs to be said that the regulations themselves are not enough to ensure sound bank operations. The effectiveness of the regulations depends on the management of the banks themselves. No matter how well the regulations are designed, a regulation may still contain loopholes that can be exploited to evade compliance. Because of this, banks are required to adopt a stricter principle of self- regulation by taking into account the risks that may arise in the course of business. In applying the principle of self-regulatory, it is also expected that banks will not conduct their operations solely on the basis of what is allowed or not allowed in general regulations. What is more important is that banks apply internal regulations that specify the detailed application of the general regulations.
Lending is still dominant business activity of our banks. I mentioned earlier how important it is from a macro standpoint that banks exercise care in their evaluation and selection of projects. This is also extremely important from a micro standpoint, particularly for the soundness and survival of banking operations. In this regard, I would again like to invite you to exercise greater caution in channeling credit. Although many opportunities exist, banks should still be selective, and the credit commitments should be backed by adequate sources of funds without having to resort to unhealthy means of competing for deposits. In this regard, we strongly urge banks to consistently follow prudent lending principles, and avoid the mere pursuit of high credit growth. Excessive expansion beyond the reasonable capacity of available funds will result in an interest rate war that no-one wants. Not only would it burden the banking system with higher costs for funds, but it also put monetary stability at risk. We all would lose in this event.
As I mentioned earlier, I would also like to encourage you to act with caution in extending credit for the purpose of property or consumer goods. Lending has grown very quickly in both areas as of late. We are all aware that the property sector is highly vulnerable to changes in the macro-economic environment, and banks are therefore exposed to higher risk in property lending. This risk becomes even more pronounced when borrowing for property investments is fueled by speculation. Experience in many countries shows that when the market is oversupplied and property prices tumble, not only do problems arise within the property market itself, but the banking system also suffers. These difficulties become especially acute when the value of assets put up as collateral is no longer on par with the amount owed to the bank.
To improve the quality of credit portfolios and prevent unhealthy practices such as "mark-ups", I would also like to emphasize the need for banks to continually upgrade their project appraisal and credit analysis system, as well as the quality and conduct of their staffs, in particular credit analysts. I would also like to stress the needs for improved business ethics on the part of banks debtors, Bank Indonesia also expects that new guidelines and regulations which will be announced shortly. These regulation include the Credit Policy Guidelines and Internal Standards for banks, as mentioned earlier. These measures are needed to limit the level of problem loans in the future that occur if changes take place in our economy.
As regards compliance with the Legal Lending Limit, I would like to remind you that this year, banks must bring themselves into full compliance. The transitional grace period will be over. At the end of this year, credit to one group of borrowers may not exceed 35 percent of bank capital. Credit to a borrower connected with the bank may not exceed 12.5 percent of bank capital. These proportions will be gradually reduced to the maximum limits of 20 percent for one group of borrowers and 10 percent for a borrower connected with the bank by the end of March 1997. Similarly, insured credit that exceeds the legal lending limit but is insured will no longer be exempted from the legal lending limit.
At the same time, to prevent possible difficulties arising from problem loans, this year banks will be required to make full allowance for earning assets losses as stipulated in May, 1993 deregulation package. In practice, if the allowance for earning asset losses is less than the amount that should be allocated, the shortfall will be deducted from core capital.
Additional policies will also be introduced to ensure to sound banking industry. The various measures that have been introduced in the past few years will be expanded and improved in the coming year. These measures cover the areas of banking regulation, bank supervision, and the settlement of problem loans. Some of the existing bank regulations will be amended on the basis of the Banking Act and in line with the dynamics of our banking industry. The various measures already taken to deal with problem loans, covering the settlement of existing loans, the prevention of new problem loans, and guidance for banks burdened by problem loans, will continued and developed further. With these measures, I am confident that the banking industry will realize higher growth, and play a more active role as a secure source of finance for economic growth in the coming years.
On the external front, we also need to take note that with the ratification of the Agreement for Establishment of the World Trade Organization (WTO), all agreements and decisions produced in the Uruguay Round have become part of our national laws, One of the agreements resulting from the Uruguay Round is the General Agreement on Trade in Services (GATS), which encompasses banking. Negotiations on commitments in financial services are now underway. Developed countries are continually pressuring Indonesia to provide an expanded scope of opportunities for foreign financial institutions, particularly regarding market access and national treatment.
Rapid domestic economic growth itself could constitute a factor causing keen competition in the banking sector. As we all know, during last few years, the capital market and non bank financial institutions have grown rapidly and their role has significantly increased. Capital markets are now becoming one of important source of funds for the business community. Funds raised from the capital market are not only used to finance investment activity, but also to strengthen financial structures. Accumulated stock value and bonds in 1990 reached only Rp 10,1 trillion or 10,4 percent of total credits; this rose to Rp 31.2 trillion or 19,5 percent of total credit by October 1994. Both domestic and foreign investors increased their portfolio investments in the capital market as reflected in the hike of the volume and value of stocks traded in the secondary market. Furthermore, products offered in the capital market are also diversified. We now find not only stocks and bonds, but also trust funds and other instruments. In addition to growth in the capital market, non- bank financial institutions, like leasing, factoring, insurance and others, have also developed at a fast pace. In other words, the capital market and non bank financial institutions have become good alternatives source of funds for the business community and will become strong competitors for the banking industry.
I think that in the future, there will inevitably be tighter competition in Indonesia's banking sector as progressive liberalization affords greater access and business opportunities to foreign banks. As a result, there is no alternative for banks in Indonesia but to gear themselves for what will come, by steadily improving their performance to achieve optimal efficiency. More attention should be given to research and development. Also, because banking will become increasingly information and skill intensive, there must be more systematic efforts to improve the professionalism of bank employees. In this regard, I would like to call your attention to the minimum 5 percent of personnel costs that is to be allocated to training. As you are aware, the purpose of this rule is to encourage banks to recruit and train professional staff on an ongoing basis. These professionals will then be able to contribute to the success of the bank. We have noted that a few banks have still not put this rule into effect. This reflects a lack of appreciation for the importance of developing a professional banking staff to ensure the survival of the bank in an ever more competitive environment.
In facing an increasingly open market, banks are also expected to be more realistic in the way they do business. The pursuit of growth aimed at propelling the bank into the big league cannot be made the primary goal. Instead, that target has to be subordinated to necessity of making the bank a solid, competitive and sound organization. We need to take advantage of opportunities for cooperation between banks. These opportunities may range from the most flexible of arrangements to the most binding ones, such as mergers. The national banking structure has to be strengthened. A highly fragmented banking system will be of little use in confronting the challenges that lie ahead. In looking to the future, Indonesian bankers have few alternatives to choose from, and if those alternatives do exist, they should be capitalized on. It is also necessary that domestic banks improve efficiency to brace themselves to take maximum advantage of market opportunities that may arise in other countries.
In the face of progressive liberalization, banks will have to prepare for stronger competition. We will soon issue a set of required professional qualifications for becoming a bank employee. This difficult tasks should be entrusted to a professional organization such as the Indonesian Bankers Institute. This measure is urgent and must be completed to prepare ourselves for the new environment that will be created by the Uruguay Round.
Allow me again to emphasize that our economy is now in strong shape. The economy is running in high gear. Our job centers on how best to manage our economic dynamism in a way that we are still able to safeguard the stable economic and monetary environment that we have presently. Consolidation of the national banking system remains a priority item on the monetary policy agenda, and we need to carry out that consolidation to the best of our ability. The challenges we face are not easy, but there is much that we have managed to achieve so far. Our job concerns how to accomplish the duties set before us in our respective fields and professions. Let us march forward together in full confidence and with the noblest of intentions to carry out these tasks and responsibilities.