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.