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