Cleaning up the banks
Bank Indonesia (the central bank) is right in persistently pushing ahead with its efforts to reduce the number of non- performing loans (NPls) in the banking industry to a maximum of 5 percent of outstanding loans by the end of 2002.
But the central bank is also wise in not blindly following the timetable for the enforcement of the minimum 12 percent capital adequacy ratio (CAR) requirement based on the new Basel Capital Accord being developed by the Bank for International Settlements. After all, even the developed economies with already well- established banking industries will only begin applying the new capital adequacy standards in 2006.
In the present circumstances where all large domestic banks are still weak and dependent on interest income from government bonds for almost 50 percent of their revenues, the central bank should be realistic.
Insisting on adopting the new capital standard accords, which revise the internal ratings-based (IRB) approach to credit risks to include operational and market risks, might force banks to resort to artificial risk-weighting of their transactions. What is the use of trying to show the international financial markets that our banks have met the international guidelines if in reality their capital adequacy ratios are merely cosmetic?
This is, however, not to suggest that banks should be allowed to operate with weak capital ratios. But the minimum 8 percent CAR requirement currently being enforced could well be adequate, given the present circumstances, if real ratios are revealed that result from true risk-weighting of assets and are then tightly monitored under an effective supervisory mechanism.
Moreover, even within the Basel Committee of the Bank for International Settlements, the debate is still going on about the definition of market and operational risks in view of the unique characteristics of national markets.
But enforcing the minimum 5 percent NPL level under more stringent rules is a must in light of the need to develop a sound banking industry. Even achieving this target has proved to be an uphill task in spite of the massive cleansing of the industry of bad loans in 1998 and 1999, when all the largest national banks had to be recapitalized by the government with bonds.
Latest Bank Indonesia data shows that industry-wide, NPLs still averaged 12.4 percent as of June. More than 33 banks were burdened with NPLs as high as 35 percent, and there is a high risk that more than 40 percent of the 148 banks in the country may not be able to achieve the maximum 5 percent NPL target later this year.
It is indeed most imperative now to minimize NPLs to allow banks to devote more resources to viably marketing loans to the corporate sector. The 1997/1998 banking crisis destroyed highly valuable bank assets in the form of reliable data banks on creditworthy borrowers, as well as the trust between the corporate sector and the banking industry.
It is now high time for banks to allocate more resources to rebuilding this trust and to developing a more reliable credit information system. Otherwise, banks will never be able to resume a full-fledged intermediation role.
The conditions now are more conducive for restructuring bad loans and extending new credits since overall economic risks have been decreasing as a result of the relative stability in the political situation and rupiah exchange rate, as well as reduced inflationary pressures. Previously, instability in almost all sectors made it virtually impossible to reasonably assess business plans in the light of loan restructuring or new credit assessment.
However, under more flexible CAR rules, it is most imperative for the central bank to steadily improve the effectiveness of its bank supervisory mechanism to ensure the sort of high-quality financial reporting that is essential for the efficiency and stability of the financial system.
The growing capacity for financial engineering and innovation, as revealed in several cases of aggressive accounting and corporate fraud that were uncovered recently in the United States, requires the central bank to put more emphasis on qualitative supervisory oversight.
But this is possible only if banks are subject to stringent disclosure requirements that force them to always issue meaningful and reliable financial and operational reporting.
It goes without saying that the financial information issued by banks and other corporations has a signaling function in that it facilitates the identification of the most productive use of economic resources, thereby enabling reliable assessment of prospective returns and risks.