Counting the years while banks recover

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