Cleaning up banks

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.