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.