Currency crisis exposes RI's bank shortcomings

Currency crisis exposes RI's bank shortcomings

By Marike Stellinga

JAKARTA (JP): The recent currency crisis has put the focus on
the weaknesses of Indonesian banks. Although none of the problems
seem as severe as in Thailand, the World Bank and the IMF have
pointed out that Indonesia's financial sector is in bad need of
correction as well.

Research shows that although a collapse in the banking sector
does not necessarily cause a recession, it definitely makes an
economic downturn worse. Banks are at the heart of economic life,
while overcoming the lack of information that small investors
have, they form an important stimulator for economic growth in
developing countries.

Since the 1980s, banking systems in 56 countries have
experienced a low or negative net worth -- meaning that losses on
loans were larger than capital. Among these countries were six
Asian economies, including the Philippines and Thailand in the
mid-1980s. The IMF estimates that over 130 countries were hit by
significant banking problems in this period.

Since the banking sector plays a dominant role in developing
countries where financial markets are shallow, the costs of these
crisis are much higher in developing economies -- reaching over
10 percent of GDP. In addition, it is estimated that emerging
market governments spent over US$250 billion in bailing out banks
in the past ten years.

Research of banking troubles show that the main causes are a
drop in the terms of trade, a recession, poor bank supervision
and regulation, deficient bank management, political interference
and connected lending.

Looking at this list, how do Indonesian banks stand?

The banking sector still forms the largest source of funding
to companies -- for instance capitalization of the stock market
consisted of about 21 percent of bank credit in May. Finance
companies' assets were about 6.5 percent of bank assets in 1995.
On top of that, more than 60 percent of these companies are owned
by banks.

At the end of last year, the ratio of capital equity to total
assets was 9.7 percent at Indonesian banks. Non-performing loans
(NPLs) stood in April at 7.6 percent of total assets. The
provisions banks make for these loans are highly dependent on
collateral. This does not constitute an immediate problem.
However, if the recent rupiah crisis caused these NPLs to turn
into bad debts along with a fall in real estate prices, bank
capital could be eaten away to dangerous levels.

The fall of the rupiah does mean a decline in the terms of
trade, as imports become more expensive and exports cheaper. The
decline in the price of exports is unlikely to have any
stimulating effect on the economy as Indonesia's main competitors
have experienced a currency depreciation as well. Overall,
economic fundamentals are very likely to show lesser performance.

As to the state of bank supervision in Indonesia, Bank
Indonesia (BI) itself admits that it has problems with enforcing
regulations. The share of banks not complying with required
ratio's -- as for instance the ratio of risk-weighed capital to
assets -- is about 8 percent. In addition, the situation of 17
banks is unclear as they have not published a report in the past
two to four years. Among these is state bank Bapindo.

Around 20 bank scandals since 1990 -- including recently Bank
Perniagaan, Arta Prima and Dwipa -- involving outright fraud with
commercial paper, collusion and connected lending, give the
impression that BI has a hard time controlling the illegal
behavior of banks. There even have been reports of involvement of
BI officials in some bank scandals.

Since 1988, not one bank -- not even Bank Summa -- has
actually been liquidated, even though about 10 percent of banks
reportedly have crossed the line to insolvency. With this policy,
BI signals to the market that the risks of misconduct are small
compared to the possible gains.

Since the deregulation of entry in 1988, it seems that many
banks are lacking human resources and expertise in assessing
risks. The fact that over 70 percent of private banks in
Indonesia are owned by conglomerates adds to the probability of
banks failing to correctly assess risks.

Moreover, a large number of these banks seem to be violating
the legal lending limit requirement of BI that restricts
connected lending to 20 percent of bank capital. This violation
has concentrated the exposure of banks to a small group of
borrowers, increasing their vulnerability to a change in the
performance of the companies.

In addition, some banks are expanding credit by 50 percent to
150 percent a year. Even the most developed banks lack the
resources to accommodate credit expansion that rapid. Banks with
this kind of policy can expect to encounter a large amount of bad
debts in the future.

Political interference into credit allocation is widespread in
Indonesia. The recent selective postponement of big projects by
the government does not give much hope for a change in this
situation. Loans like those for the national car seem exempt from
commercial evaluation -- often deterring money from better
commercial projects. This could reduce bank profits as well as
increase bad debts, putting a strain on the banking sector.

The market for bank credit is highly concentrated in Indonesia
and is a reflection of the largest private business groups and
state companies. Not only that, the private sector itself is
highly concentrated with a lot of hazy cross-holding and
alliances. This means that problems in either the banking sector
or the private sector are tightly connected.

The resilience of the banking sector ultimately depends on the
ability of its borrowers to service debt and the ability of banks
to absorb portfolio losses. It seems that companies are now
experiencing some trouble with large unhedged dollar liabilities,
due to the previous rupiah peg to the dollar. Private capital
inflows to Indonesia increased from $1.1 billion in 1993 to $17.9
billion in 1996, showing the increased dependence on foreign
currency denominated debt.

Of course the picture is not all bad. BI has tried to curb
bank exposure to the property sector, encourage the merger of
banks by raising capital and reserve requirements, and legal
actions have been initiated against bank managements involved in
fraud and collusion.

The rupiah fall may be a blessing in disguise by rocking the
bank boat now, when there still is time to solve problems. The
ball is now in the court of the financial authorities to make
good on their recent promises for hard action.

The writer is an MA student at the International Financial
Economies Department at the University of Amsterdam, Holland,
presently conducting research on financial stability in
Indonesia.