Firmer measures needed to consolidate banks

Firmer measures needed to consolidate banks

The panel of economists urged the government to take firmer
measures against banks still failing to meet the minimum
prudential standards set by the central bank, otherwise the whole
banking industry would remain highly vulnerable to shocks.

"The banks have been cleaned up of their bad assets and
recapitalized, and their losses have been transferred to the
fiscal sector, yet they are still unable to resume proper
financial intermediation," one panelist noted.

What the panelist was referring to was the fact that the
government had recapitalized all state banks and seven major
private banks, reimbursed depositors and creditors of closed
banks and taken over bad loans from banks at a total cost of
around Rp 650 trillion (US$65 billion).

The government covered the huge cost by issuing bonds that
cost taxpayers almost Rp 60 trillion in interest charges
annually.

Another panelist asserted that it would be better to close
weak banks now than continue to support them at the risk of
threatening the whole banking industry.

Closure, he added, would involve spending up front but would
reduce costs over the medium term and at the same time generate
market confidence in the whole industry.

Further delays and indecisiveness would only increase the
contingent liabilities of the government with regard to the
banking industry, especially now that the government already owns
more than 70 percent of the banking industry as a result of
massive recapitalization in 1999 and 2000.

Further delays would only postpone another, bigger banking
crisis, which the government certainly could not cope with, since
the public sector itself is already on the verge of default under
a mountain of foreign and domestic debts.

Though the massive restructuring decreased the number of
domestic banks from 178 in 1997 to 120 at present, it is
considered still too many for the central bank to supervise.
While most other countries have raised the capital standards of
their banks to a minimum 12 percent, the capital adequacy ratio
(CAR) of most Indonesian banks is only 8 percent, the minimum
level set by Switzerland's Bank for International Settlement
(Basle).

Given the highly risky business environment in the country and
the lenient asset classification applied to banks, the minimum
CAR for Indonesian banks should at least be 15 percent to provide
a stronger cushion for shocks.

Most major banks, notably those recapitalized in 1999 and
2000, have been awash in liquidity but they still hesitate to
resume corporate lending, apparently due to the high risks of
eroding their capital standard.

Data at the central bank shows that bank loans outstanding as
of August totaled only Rp 287.8 trillion, compared to Rp 734
trillion third-party deposits raised by banks. This means a
lending-to-deposit ratio of less than 40 percent.

Worse still, nonperforming loans, though down from 36.14
percent in June 2000, to 20.60 percent in December 2000, remained
relatively high at 15.50 percent as of September, still much
higher than the minimum percent required by Bank Indonesia.

Lack of significant progress in corporate debt restructuring,
fragile economic recovery and continued uncertainties seem to
have forced banks to opt first for safety by investing the bulk
of their funds in central bank promissory notes or lending to the
interbank market.

As the CAR (the ratio between capital and risk-weighted
assets) of many major banks remain close to the minimum 8 percent
and the economic condition is worsening amid the gloomier outlook
of the global economy after the Sept. 11 terrorist attacks on the
United States, banks have been extra careful about new major
lending.

The persistently tight monetary policy imposed by the central
bank to cope with strong inflationary pressures caused by the
weakening rupiah has made things even much tougher for commercial
bank operations, with their costs of funds often higher than
their lending revenues.

Moreover, as the assets of the recapitalized banks are
dominated by government bonds, which are rather illiquid due to
an undeveloped secondary market, many banks are not really as
highly liquid as widely assumed because they cannot easily
convert their bonds to cash.

Without a significant increase in new lending, most banks will
remain highly vulnerable to shocks since domestic banks, unlike
foreign banks which have developed a significant source of fee-
based incomes, still depend mainly on net interest margin for
their incomes.

However, the pace of corporate lending will be determined by
the performance of the business sector. As long as most medium
and large business conglomerates remain in the care of the
Indonesian Bank Restructuring Agency (IBRA), being treated for
their huge bad debts, banks will find it difficult to get viable
borrowers.

The panelists sharply criticized the central bank's
persistently tight monetary policy, arguing that since the fiscal
sector cannot provide any stimulus, Bank Indonesia should
substantially ease the money supply to fuel economic activities.

They found it hard to comprehend the rationale behind the
credit crunch at a time when most businesses are in bad need of
credit financing and most other countries have sharply cut their
interest rates.

The tight monetary policy makes the environment inimical for
the restructured banks to expand lending operations.

The government would be well advised to sell as quickly as
possible most of the banks it now wholly owns or in which it has
a majority stake to new investors to speed up their operational
restructuring.

Without operational restructuring -- the rationalization of
branches and staffing level, improvements in credit practices,
risk management and internal governance -- the banks will never
regain public confidence and will therefore continue to depend on
the government blanket guarantee, under which the government has
guaranteed all depositors' money.

People are still willing to keep their money at domestic banks
mainly because of the government guarantee. But even with the
support of this guarantee, domestic banks are still perceived to
be highly risky, as reflected in the much higher deposit interest
rates they have to offer to attract depositors, compared to those
given by foreign banks.

But the blanket guarantee is only an emergency measure that is
supposed to be terminated within one or two years to allow the
market forces to screen out structurally weak banks.

It is nonetheless widely expected that the pressures on the
rupiah will decline next year as political stability takes deeper
root. A stable and stronger rupiah will decrease inflationary
pressures, thereby enabling the central bank to relax its credit
crunch.