Concern over bank restructuring

Concern over bank restructuring

By Sidesh Kaul

This is the second of two articles on banking and corporate
restructuring in Indonesia.

JAKARTA (JP): The rehabilitation of the banking system is the
other top priority item on the International Monetary Fund's
agenda. Here too, the problems are manifold and complex.
Indonesia has traditionally been a country which borrowed heavily
and the national debt has been increasing at a rapid rate. The
private sector has contributed the most to this significant rise
in debt levels. Local banks have smaller foreign exposures which
suggests that most of the international borrowing has been done
by corporates.

Most of the domestic borrowing was also dollar denominated.
Irrespective of whether the borrowing was international or
domestic, the bulk of the debt was short term in nature. Before
the crisis, firms had the opportunity to put borrowed capital to
unproductive use (borrowing offshore dollars for short-term
investment spreads domestically). It was this uncontrolled
borrowing on the private side that fueled the collapse of the
banking system.

Unlike Thailand and Korea, Indonesia reacted very slowly to
the problems of short-term corporate borrowings. The IMF, in
Korea and Thailand, dealt with short-term corporate debt from the
very inception of the crisis.

The IMF has made an extremely late start in this regard. It
was only in June 1998 (the Frankfurt Agreement) that the IMF
reached some agreement with regards to the corporate debt and
then later in September 1998 a framework was agreed to under the
Jakarta Initiative. The IMF has to wake up to the fact that the
corporate side debt is the core of the banking problem and that
it merits urgent attention.

In Indonesia, bank restructuring is an especially onerous
exercise even though the exposures of Indonesian banks constitute
a smaller portion of the national debt. The reason for this
phenomenon is because of the large amount of private side debt.
Complicating this issue is the ownership of these banks. Almost
every non-state bank in Indonesia has connections to a wider
conglomerate. The IMF as well as Bank of Indonesia (BI) are
strangely silent on the aspect of ownership of these banks and
their contribution to the private side debt burden.

An analysis of the debt would reveal that substantial parts of
the leveraging of the top ten borrowers (who incidentally own
more than 52 percent of the market capitalization of Indonesian
corporations) are denominated in dollars. Most of these "top dog"
borrowers have close ties to the banking system and the powers
that be.

Indonesia's banking system is one of the most compromised in
the region. Most of the major private banks have a wide range of
non-financial businesses. Incestuous lending is rife. Although
the government has set rules to prevent and discourage in-house
lending (the legal lending limit or LLL) these have not been
implemented earnestly. It is extremely difficult to monitor and
track incestuous lending and most private banks (who have
diversified interests other than in banking) have found creative
ways to circumvent the LLL rule.

The recent recapitalization program of banks is a culmination
of months of due diligence by international auditors under the
aegis and guidance of the IMF. The results of this exercise are
out of the 128 private banks that were given a chance to
restructure, 73 banks (Class A) with a capital adequacy ratio of
4 percent or higher survived. Nine banks (Class B) with ratios
from -25 percent to 4 percent were open to recapitalization (with
20 percent of the funds shelled out by owners and the rest from
the government). The nine banks (Class B) were taken over by the
Indonesian Bank Restructuring Agency (IBRA) and 38 banks (Class
C) were closed.

While this exercise served as a good filtering and
prioritizing mechanism, it has left many questions still
unanswered. This ignorance has partly been compounded by the fact
that there is little or no transparency in this process. Other
than summary and periodic press releases by the government and
the IMF, precious little information has been released for a
serious and more technical study of this subject. The results of
the due diligence done by the offshore external auditors must be
made public for one.

This issue is not just of academic interest but one that could
throw light on the existing state of disclosures within the
Indonesian banking system and what steps need to be taken to
improve the auditing procedures in the future. If a capital,
asset quality, management, earnings and liquidity (CAMEL) or
value-at-risk (VAR) analysis was done then the results must be
made public, too. There must be total transparency as to how
these banks qualified.

Both the IMF as well as the government must realize that
routine regulatory inspections within banks in Indonesia could
not identify any potential problems in the past and so the entire
system of disclosure is highly suspect unless it is replaced by a
more transparent mechanism. The debate on capital adequacy ratio
or whether the capital has been adjusted for in-house lending is
premature and meaningless and fraught with conjecture if the
information is not credible enough.

Other than the malaise of in-house lending, there is the
problem of off-balance sheet items to deal with. Contingent
accounts have for long been the window of opportunity for
dishonesty within banks. These contingent accounts (given the
penchant for Indonesian banks to indulge in derivative deals)
constitute a potential time bomb. While contingent items by
themselves do not constitute a threat (if reported and treated
honestly) they can pose a threat to a banks integrity.

To give you a rough idea, Asian banks have on an average (data
derived from annual reports) 30-35 percent of their total assets
as contingent items. A glance at the 1996 balance sheet of the 9
banks (Class B) that have qualified for recapitalization have on
an average almost 50 percent of their total assets as contingent
items. Currently this number has mushroomed to a level that would
definitely warrant legislation or regulatory measures to control
and monitor it.

Recapitalization by itself is a costly exercise. The
government plans to issue about Rp 300 trillion worth of bonds
(almost 28 percent of the Gross Domestic Product). The annual
damage to the state budget on interest payments alone is
estimated to be about 4 percent of the GDP. No details are
available yet as to the structure and mechanism of these bonds.
One only hopes that there is a genuine injection of cash in real
terms. The fear is that taxpayers would have to shoulder the
burden of these recapitalized banks.

Most of the owners of the closed and recapitalized banks have
diversified interests that must be deployed towards
recapitalization to cover the evaporated capital before taxpayers
and creditors are hit. Legal lending violations must be quickly
identified and penalties settled without further ado. Failure on
the part of the government and the IMF to implement this would be
fatal.

The IMF, from the beginning, has been sending confusing
signals on the aspect of corporate debt restructuring. This is
perhaps why the preliminary process of bank restructuring has not
been completed yet. What is needed is an emergency legislation
(something along the lines of the Danaharta Act 1998 in
Malaysia) that would provide transparent guidelines as to how
NPLs would be treated.

Without effective legislation and transparency, IBRA would be
a toothless tiger prone to manipulations and other similar
problems of the past. The government and the IMF have to remember
that the private sector has been the core of the banking
collapse. Recent belligerent and bellicose posturing by BI and
IBRA officials to bring "errant debtors" to heel is meaningless
and irresponsible and reeks of politicization of a sensitive
issue.

Right now it appears that the government and the IMF is quite
content with letting individual banks deal directly with non-
performing loan debtors (NPL) on an independent basis. This is an
extremely dangerous and irresponsible strategy, since for the
banks the NPLs are a mere collection issue while for the
government it implies employment, productive capacities and
inflation. We are talking about productive national assets that
need to be carefully rehabilitated (just like the banks) and not
about ridding this world of failed entrepreneurs. Harshness is
being confused with firmness and clarity.

Amid this cacophony of sage advice and economic mumbo jumbo
the powers that be are becoming increasingly insensitive to the
human side of this problem. In the days to come one hopes that
the government and the IMF will take a step back from time to
time to introspect and, before any measure is executed, look at
themselves in the mirror and ask themselves: how is this
particular measure going to affect the common man?

The writer is an observer of Indonesian economic and political
affairs based in Jakarta.