Costs of bank restructuring

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.