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.