Dirty sweep of banks

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.