Dilemma of Bank BII

Dilemma of Bank BII

Before 1998, it would have been impossible to analyze publicly
the distressed condition of a particular bank, let alone debate
whether it would be better to simply liquidate or recapitalize
that bank, without setting off massive runs and consequently
accelerating its failure.

But a public debate is precisely what has surrounded Bank
International Indonesia (BII) over the last few weeks, following
the announcement of its disastrously poor financial results for
2001, which showed a loss of Rp 4.13 trillion (US$435 million), a
negative capital of over 47 percent and bad loans of almost 63
percent of total lending.

However, the bank has been operating normally and has even
continued its aggressive advertising campaign for its products.
There have not been any runs on the bank, and BII depositors
remain calm even though the bank is already technically bankrupt.

This cool reaction should be attributed largely to the
government's blanket guarantee on bank deposits and claims, which
was set up in late January 1998, during the massive banking
crisis. BII depositors and customers seem assured that whatever
may happen to the bank, they will be fully reimbursed. They also
seem to reckon that as the sixth largest bank, with 75 percent
ownership by the government, BII is too big to fail.

But this "superficial" feeling of security is also the
disadvantage of the blanket guarantee, as it leads to moral
hazards for a bank's management and hinders the market from
working properly to screen out banks.

The guarantee scheme, which has so far cost taxpayers billions
of dollars, has even distorted the market by allowing unqualified
players to join the market. The dilemma, though, is that without
the guarantee program the national banking industry would have
totally collapsed.

The government stirred up a huge controversy earlier this week
by deciding to allow BII to go through with a rights issue in
June to raise about Rp 4.33 trillion to beef up its capital
adequacy ratio to at least 8 percent, the minimum capital
standard, contingent upon the House of Representatives' (DPR)
approval.

Most analysts and House members obviously oppose the rights
issue, considering it simply another form of recapitalization
using taxpayers' money, because the government will likely end up
as the lone buyer.

The investing public, which holds the other 25 percent of BII,
is not going to be willing to invest more in the beleaguered
bank. They believe it is no longer worthwhile to maintain BII,
given its utterly poor performance after its first Rp 11 trillion
recapitalization in March 1999, of which Rp 6.6 trillion was put
up by the government, and the second capital injection of Rp 14.4
trillion made wholly by the government last year.

Even the second recapitalization was sharply criticized as
preferential treatment for BII, since the financial distress was
caused by a "hidden" $1.2 billion in doubtful loans to the Sinar
Mas Group, the bank's founding shareholder, that turned bad last
year.

The government, however, argues that liquidating BII would
cost the taxpayers almost Rp 24 trillion, not to mention the
damaging contagion effect on the banking industry and, most
importantly, on the credibility of the entire bank restructuring
program.

There are many troublesome questions that have to be examined
before the fate of BII is decided. What is BII's chance of
survival with so dismal an operational record and after such a
public display of its distressed condition? Who will guarantee
that the bank does not carry another "ticking time bomb" like the
one that exploded last year? Is capital really the only problem
besetting BII? Will customers remain loyal to and proud of
banking with BII after its image has been so heavily damaged?
After all, a bank is a trust institution.

It is worth recalling that state Bank Mandiri, which intended
to acquire BII last year, canceled the plan after completing a
due diligence, even though BII's customer base, with around
500,000 cardholders, would have been a great synergy for Mandiri,
which is expanding its retail business.

Bank Mandiri did not disclose the reason for the cancellation,
apparently because of ethical considerations. But it can be
assumed that BII must have been extremely shaky structurally, to
force Bank Mandiri to call off such a potentially strategic
acquisition.

Moreover, banking operations in the country still carry
unusually great risks in view of the fragile economic situation,
high interest rates and huge corporate debt overhang. Banks will
never grow soundly and robustly under inimical economic
conditions.

In fact, the central bank admitted as recently as March that
it had put 14 recapitalized banks under special supervision,
meaning that their conditions are still quite fragile. How can
BII, with such a battered condition and damaged image, survive
the market competition? Wouldn't another capital injection only
postpone its failure?