Counting the years while banks recover

Berni K. Moestafa The Jakarta Post Jakarta

The country's banking sector entered the year 2001 limping and, as the year comes to a close, it has yet to pick up the pace.

Banks have barely lifted themselves above the lows they first hit as the 1997 financial crisis swept the country.

All this comes after having entered this year fully recapitalized at a staggering bailout cost of US$60 billion.

This begs the question: What is impeding banks' recovery? Undercapitalization surely could not be the reason.

Actually it still is, however, and one of many reasons behind a slow recovery.

In 1998, at the peak of the financial crisis, the government began injecting banks with the so-called recapitalization bonds.

These bonds replaced banks' non-performing loans extended to industries that, because of the crisis, were unable to repay debts.

The costly recapitalization program was to save banks from being shut down, which would have been even costlier, as the government must cover their third party liabilities.

Banks face the liquidation axe if they fail to meet the minimum four percent capital adequacy ratio (CAR).

But now, after the recapitalization program has been completed, a frail CAR is still haunting the banking sector.

Using CAR, a bank's health is measured by the ratio of its capital against risked-weighted assets such as loans or bonds.

The higher the CAR, the better a bank's capacity to cover the risks of its assets with capital.

Recapitalized banks received zero-risk government bonds in exchange for their highly risky bad loans.

But when the recapitalization program was launched, the aim had been to secure banks' CAR to the minimum four percent demand.

While that target was achieved late last year, Bank Indonesia moved to raise the minimum CAR level to eight percent by the end of this year.

At the same time, the country's economy improved little to help banks secure a higher CAR or prevent it from falling.

This drove banks again at risk of undercapitalization.

As the year closes, six banks out of the country's some 150 banks have failed to improve their CAR levels.

Five of them are slated for merger, with another, Unibank, shut down last November.

Throughout the year, the five have been placed under the Indonesian Bank Restructuring Agency (IBRA), along with six others.

The six others being among the country's largest private banks, such as Bank Central Asia (BCA), Bank Danamon, Bank Lippo and Bank Niaga.

The fact that they remain hospitalized under IBRA speaks for the poor conditions banks are still in nearly five years since the financial crisis struck.

While outside IBRA, the number of banks whose CAR levels are vulnerable, tend to be on the rise.

A major drag on banks' CAR is the double blow of rare capital and a high, non-performing loan ratio.

On the capital side, banks can no longer expect bailouts from a new recapitalization program after it has been finalized.

That leaves banks turning to the private sector for capital.

Supply of fresh capital from local investors is scarce, which was the reason why the recapitalization program was brought in the first place.

Most owners of large private banks ended up heavily indebted to the state, and are in fact banned from re-entering their banks until they pay up their debts.

Foreign investors are in a better position to invest.

But as they scan for prospective banks, the sector's grim outlook on growth pose a major disincentive for coming here.

Putting aside the equally discouraging investment climate of this country what, then, is the outlook on banks' recovery?

As is apparent by now, there is little confidence in recovery if the question of CAR, and with it banks' survivability, remains on the forefront of the sector's problems.

Throughout the year, banks' recovery has been somewhat slack because new loans are scarce. Several factors lead to this.

One is that demand for new loans is low, and will remain so unless the domestic economy picks up.

True, the economy grew by 4.8 percent last year and is likely to grow by 3.5 percent this year, but it did so mainly on utilizing production capacity that went idle since the 1997 crisis.

Industries took advantage of an upswing in domestic consumption and export sales to finance the growth in output.

But now, since export earnings have been falling and with high inflation likely to eat into consumer spending soon, a drop in demand for output will further curtail appetite for banks' loans.

While demand is low, there is actually no incentive for banks to extend new loans amid a sluggish economy.

Here the aforementioned non performing loan (NPL) springs back to mind: a high NPL ratio impinges upon efforts to improve CAR.

Loans on which interest payments are 90 days overdue are categorized as non performing loans. The NPL ratio measures a bank's non-performing loans against its total loans.

With the economy still in the doldrums, the amount of NPLs have remained high despite efforts to restructure them.

A weak rupiah compounded on the rise of foreign denominated NPLs.

Worse still, Bank Indonesia's bid to defend the rupiah by raising interest rates undermines many companies' debt payment ability, and jacks up the risk of new NPLs.

Rising NPL means banks earn less. On top of that, new capital is needed to cover the risk of non payment; or CAR falls.

Recapitalized banks, however, still earn interest payments from the zero risk government bonds.

But to such an extent that the majority of the country's banks rely on government bonds; coming at the expense of taxpayers.

This is to say that, after pouring $60 billion into banks, the cash-strapped government must spend more on interest payments.

Plans to merge weak banks, five thus far, will entail the re- use of recapitalization bonds, dashing hope of retiring them.

The merger plan for next year however does allay concerns of dropping CAR levels and bank closures -- at least for now.

A relapse of dropping CAR levels is potential unless stern measures are taken to reform the banking sector.

Singapore-based research firm IDEAglobal.com warned the banking sector could be heading for another collapse amid signs the government is wavering on banking reforms.

Reforms here call for more bank mergers to squeeze out the sick, tougher prudential regulations, and for expediting loan restructuring.

But bank closures and mergers can be painful since they add up to the bailout cost, and jeopardize a shaky public confidence in the banking sector.

Ultimately, it will take from the government a strong will to ignore the pain when pushing the banking sector to stop limping and start walking.

For eyebox

Key indicators of banks performance as of Sept. 2001

Banks CAR NPL Credit growth*

BCA 36.72% 3.99% 7.88% Bukopin 22.47% 3.24% 3.68% Danamon 39.01% 7.00% 7.55% Lippo 23.25% 23.91% 2.54% Niaga 18.70% 9.75% 10.12% Bali 13.01% 15.53% 12.53% Primex 7.09% 18.09% 14.11% Patriot 6.10% 5.40% 5.00% BII 14.14% 17.93% 5.52% Media 5.32% 17.02% -20.50% Universal 4.07% 10.60% 2.94%

average 17.26% 12.04% 4.67%

*monthly credit growth from August to September 2001

Source: IBRA