Government-directed lending

Government-directed lending

Government-directed lending, risk concentration and connected
lending, besides the meltdown of the rupiah, were the main causes
of the banking crisis in late 1997. Yet the current government,
overzealous to prime the pump, seems unable to resist the
temptation to interfere in credit assessments, prodding state
banks to lend to particular projects or businesses it accords
high priority.

The state minister of state enterprises has asked state Bank
Mandiri, Indonesia's largest bank by assets, to "explore the
possibility" of injecting fresh funds into state-owned PT Kertas
Kraft Aceh to enable it to resume production, which was halted in
April 2003. The request, according to a report from the state
minister of state enterprises to the House of Representatives on
Tuesday, was made even though the paper manufacturer already has
Rp 300 billion (US$33.3 million) in bad debts, including Rp 165
billion to Bank Mandiri.

Though the request was simply a suggestion, the management of
Bank Mandiri could take it as a lending directive. After all, the
directors of state banks, like all other state companies, are
appointed by the state minister of state enterprises, in his
capacity as the nominee shareholder for the government in all
state companies. More worrisome is that what was disclosed at the
meeting with the House could only be the tip of the iceberg.

There is nothing wrong for the government or the central bank
directing or encouraging lending to particular sectors designed
to be prime movers of the economy, as long as the directive or
guidelines are based on across-the-board fiscal or monetary
policies, and not on preferential treatment for a specific
company or project.

Bank Indonesia, for example, issued new regulations last month
that eased legal lending limits for the development of
infrastructure and to businesses dealing in basic necessities.
This ruling, which is effective for all companies operating in
these two sectors, makes good sense because of the important role
of these sectors in improving economic efficiency and checking
inflation.

But a specific lending recommendation to Bank Mandiri could
resurrect the bad habit of government intervention in credit
decisions at state banks. This would undermine sound banking
practices and adversely affect the entire banking industry, in
view of the dominant role of state banks and given that Bank
Mandiri's nonperforming loans were already close to 7.50 percent
of its total credits, much higher than the maximum 5 percent set
by the central bank as a prudential guideline.

House members, during a hearing with the central bank board of
governors on Monday, criticized Bank Mandiri's management for the
size of its bad credits to state companies and for the
questionable manners in which the bank wrote off its bad loans.
It was disclosed at the meeting that Bank Mandiri's bad loans and
substandard credits to 13 state companies alone reached Rp 1.37
trillion.

However, not all was bad news at the bank. We should give
credit where credit is due. As Bank Indonesia Governor
Burhanuddin Abdullah noted at the meeting, the majority of Bank
Mandiri's big corporate credits remain good, though after some
restructuring, citing the bank's Rp 4 trillion in loans to the
Radja Garuda Mas business group as an example.

But government-directed lending should still be prevented
because such "pressure" could undermine risk management at state
banks. Credit assessments should be based solely on the
creditworthiness of borrowers, which can decline or improve over
time due to various factors.

True, the pace of credit expansion should be heightened to
support the government's economic growth target of 6 percent. It
is also true that the banking industry has significantly
improved, as can be seen from key indicators such as capital
adequacy ratio and the level of nonperforming loans.

However, the lending scandals (frauds) that led to the closure
of two banks in 2004 and another one last month indicate how
fragile the banking industry still is, and how credit assessments
and internal controls at commercial banks, and the quality of
supervision by the central bank, badly need further improvement.

The extension of credits should always follow prudential
regulations and sound assessments. This is especially imperative
for state banks, not only because their managements are often
vulnerable to pressure from government officials, but also
because it is difficult to determine the true condition of state
banks given the significant role of government bonds on their
balance sheets and their weak governance structures.

The most effective way for the government to reinvigorate bank
lending is to reduce the persistently high business risks by
accelerating reform in such areas as the civil service, taxation,
customs and the legal sector