Dirty sweep of banks
The multibillion dollar bank clean up, though the most massive of such an effort ever attempted, is not as extensive or transparent as one would expect for the vital process of restoring public confidence in the banking industry. Saturday's announcement was lacking in so many details necessary for market mechanisms to work effectively that most of the insolvent banks not being liquidated will be able to survive mostly on the artificial respiration provided by of the government's blanket guarantee of bank deposits.
Apart from the decisive move to close down 38 insolvent banks, people remain largely in the dark about the real condition of most banks.
The government simply declared that 73 banks were sound because their capital adequacy ratio (CAR) is 4 percent or more. However, the government did not provide information on just how high these banks' respective CARs are. This information is crucial for the market because the viability and soundness of these banks was judged only by their CARs. The banks business plans and the integrity and competence of their managements and owners, two parameters which are as crucial as their CAR levels, have yet to be assessed.
Also lacking were strong reasons as to why the government took over seven insolvent banks which failed to qualify for recapitalization. The extensive networks and significant roles in the banking industry cited by the government to justify the use of taxpayers' money to acquire these banks are doubtful. Apart from Bank Duta, the other six banks which were taken over are virtually unknown outside Greater Jakarta. The government itself confirmed in its statement on Saturday that the seven state banks and four private banks taken over last August account for almost 70 percent of the banking industry's assets and operations. If this percentage is combined with those of the nine major banks already qualified for recapitalization, the 73 sound banks and 11 foreign bank branches, one can see how negligible these seven banks' market share is.
The question now, after the bad apples in the industry have been removed and the government owns or controls most of the major banks, is whether banks will resume lending money in the near future. Unless companies are again able to borrow money the economy will continue to be gripped by paralysis.
Unfortunately, the answer to this question is no. Since interest rates likely will remain high -- the central bank's quoted benchmark interest rate last week remained at 37.83 percent for three-month papers -- banks will continue to suffer losses from negative spread. This means their capital will continue to be eaten away. How long can banks with CAR levels only slightly higher than 4 percent survive the next nine months of possible political turbulence?
The prospect for a decline in interest rates remains slim as long as the rupiah's exchange rate remains above Rp 9,000 to the dollar, as it is currently. Because the economy is predicted to contract this year, with negative growth projected between 1 percent and 4 percent, the business environment likely will remain poisonous for both banks and companies.
Many of the credits which are still current could become bad debts soon, further eroding banks' capital. Even the nine major banks which will be recapitalized are highly vulnerable because of a severe shortage of liquidity. Though their CARs will soon be raised to 4 percent, only 0.80 percent of their CARs will be in cash. The remaining 3.2 percent will consist of government bonds which have dim prospects on the secondary market. In fact, the government likely will not allow these banks to sell the bonds as needed for fear of further jacking up interest rates.
True, the government has allocated Rp 34 trillion to pay interest on the bonds, but only Rp 17 trillion of this money has been secured by the state budget. The other Rp 17 trillion will have yet to be collected through the sales of the recapitalized and liquidated banks' bad assets.
All in all, the sweeping bank reforms launched over the weekend are only a small -- and very weak -- step toward the ultimate goal of establishing a pool of anchor banks. The reforms are quite vulnerable to failure, given the poisonous economic environment, the inadequate supervisory capacity of the central bank and continuing political uncertainty.