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.