Costs of bank restructuring

Our major worries are increasingly being validated that Bank Indonesia (the central bank) has not really been well appraised of the real condition of the banking industry. The fact that the schedule for the bank restructuring program has been extended several times, due to continued haggling over key components of the plan, shows that the central bank seems to be encountering painful surprises day after day. This has once again cast great doubts on the supervisory capability of the central bank in keeping track of the more than 200 banks under its aegis.

Estimates of the funds needed for the program have been even more puzzling. Bank Indonesia officials initially put the need for recapitalization funds at around Rp 300 trillion (US$40 billion at the current exchange rate) and then cut this down to around Rp 100 trillion. But executives of the banks' association came up with some Rp 350 trillion.

Whichever of the estimates later proves accurate, one thing is brutally clear: the sum needed for the bank restructuring program will be huge. Compare, for example, those figures to the gross domestic product which totaled Rp 377 trillion in 1997. On top of this huge sum there is another Rp 136 trillion in emergency liquidity support the central bank has thus far pumped into ailing banks.

The varying estimates could mean one of two things. Either the central bank has not been adequately posted on the magnitude of the banking crisis or there are differences in the methods of asset evaluation.

Since the minimum capital adequacy ratio of 4 percent that all banks have to meet by the end of January should be clean of bad assets, the amount of recapitalization funds required by banks depends on the quality of their loan portfolios. And the outlook here is also bleak, given depressed economic conditions and the big losses incurred by most major banks in their foreign exchange positions. Conservative estimates put the volume of bad credits at between 50 percent to 60 percent of total credits outstanding.

Much of the problem could certainly be blamed on the financial meltdown. But international auditors who have completed the due diligence on 167 banks have come up with worrisome findings. Quite a portion of the bad credits was self-inflicted by excessive connected lendings in violation of the prudential ceiling (20 percent of total credit) as well as collusive and politically-directed lending decisions.

One may then wonder how the central bank could talk about injecting taxpayers' money into those banks without first having their problem loans settled. Are the state-owned banks which have not even attempted to recover the trillions of rupiah they lent to chronic debtors, including Soeharto family businesses, entitled to public funds? Do private sector bank owners who were found to have lent to their own business groups far in excess of the prudential limit deserve a bail out without first cleaning up their credit portfolio? Is it wise to recapitalize the banks which have proven to be tainted with a crooked mentality?

True, without the banking sector back on track, sustainable recovery is impossible. But we don't think the reforms will have any meaning if banks don't vigorously pursue debtors -- no matter how high-profile or politically well-connected -- and sue them under the new bankruptcy laws. Otherwise the notion that banks are places where little people save so that big ones can borrow will haunt the public.

The dilemma here is that as long as the government continues to drag its feet over painful but necessary banking sector reforms, access to credit will remain restricted. Without easier domestic credit conditions, economic activity will be even more depressed.

We fully agree that shouldering the fiscal burden of the bank restructuring can no longer be postponed, otherwise there will be a fiscal time bomb ticking away at the heart of the economy. A continued credit crunch would negate the positive effects of increased government spending and further cripple the private sector, undermining exports.

But the government cannot simply monetize the bad debts carried by banks by printing more money. This avenue could lead to disaster. The recapitalization program therefore should run together with a more vigorous clean-up of the bad credits and forceful weeding out of recalcitrant banks, even at the risk of salvaging only less than half of the 210 or so banks at present. It is much better to have far fewer banks which are sound and strong and that are easier to supervise.