Cleaning up banks

The Indonesian Bank Restructuring Agency (IBRA) has plunged immediately into full operations following its establishment on Jan. 27. The agency, in cooperation with Bank Indonesia (the central bank), is finalizing the assessment of all commercial banks and will soon be set to clear the banking industry of losses. This rapid pace of operation should indeed be the tempo at which the agency works, given the magnitude of the banking crisis and the urgency of restoring public confidence in the banking system.

It is encouraging to note in Sunday's joint statement from the central bank and IBRA that bank losses would first be distributed among the owners and holders of subordinated debts before the problem banks are put under IBRA's supervision. This measure is essential to maintain market discipline and should be welcomed as a strategic law enforcement measure. In fact, we think large creditors should also be made to bear a substantial proportion of bank losses. They are relatively well-informed and have more resources with which to monitor bank condition.

Clearing the banking system of losses is the next, logical step that should be taken by Bank Indonesia and IBRA after the Jan.27 decision by the central bank to guarantee rupiah and foreign exchange claims on all locally incorporated commercial banks from both depositors and creditors. In a broad sense, this means thorough reviews of bank assets.

But the process of valuing bank assets has been complicated by uncertainty resulting from the current macroeconomic distress. Valuation of bank loan portfolios is even more difficult amid rapid changes in both exchange and interest rates.

Given the poor quality, or lack, of financial data on bank debtors and doubts over the current and future viability of indebted business ventures, valuation of bank assets would be a useful input to restructuring, only if it is conducted by politically autonomous external supervisors from the central bank and IBRA.

The problem, in so far as Indonesia is concerned, is that many banks are owned by politically powerful shareholders. Furthermore, a high proportion of credits are often extended through what are known as connected lendings (lending to ventures undertaken by other parts of the bank's business group). This practice and a lack of technical competence was partly responsible for past failings in the supervision of the banking industry. External supervisors and auditors frequently failed to detect inflated loan values and inadequate provisioning in opaque financial data issued by banks. In other cases, competent supervisors acquiesced to political barriers and supervisory forbearance.

Hopefully these political barriers were removed when the central bank was granted full autonomy in the Jan. 15 reform package agreed with the International Monetary Fund. Staff competence can now be improved, since IBRA has freedom to recruit foreign experts to assist in the execution of its task.

Granting political autonomy to the central bank and IBRA, and the central bank's underwriting of claims made on all locally incorporated banks, now clears the way for bolder measures to rid the banking sector of insolvent banks without great systemic risks, irrespective of the influence of their shareholders.