How reliable is RI's banking system?

How reliable is RI's banking system?

Umar Juoro, Jakarta

The recent case of fraud at Bank Global that ended with the
closing down of the bank raises an old question about how
reliable the Indonesian banking system is, especially in the
post-crisis era. The blatant act of Bank Global's management to
manipulate subdebt issuance and loan allocations put the equity
of the bank into deep negative territory.

The Central Bank (BI) did not have any choice except to close
down the bank. However, those who hold bonds issued by the bank
will also likely lose their money, because the government
guarantee is limited only to time deposit accounts. Despite
significant improvements in banking supervision by BI, it is very
difficult to detect fraud that is planned well and covered up by
the management itself.

Previously, a different kind of scam engulfed state bank BNI
in the form of forged letters of credit to the tune of Rp 1.7
trillion. This involved the branch manager who cooperated with
outside parties. Fraud in taking advantage of RTGS (Real Time
Gross Settlement) facility that is supposed to make the
transferring of funds among banks a lot easier also happens at
several banks. BRI and BII are two of the largest banks that have
faced fraud charges for taking advantage of the facility
involving their own employees. Several other fraud cases have
come to light at other banks.

This news is quite troubling as we notice that the financial
reports of many banks, mainly in the top echelon, show
significant improvement, especially in their profit. The banks
also show progress in loan allocations, even though their LDR
(Loan to Deposit Ratio) is still only around 50 percent, and the
high loan growth is mainly in the consumer category. The overall
NPL (Non-performing Loan) is at a low level, and it does not seem
to show a possibility for serious deterioration. This performance
by the banks supports the tremendous increase in the Jakarta
Stock Exchange Index recently.

It is clear that the real and present danger of the banking
industry, whether small or large banks, is on the possibility of
fraud involving their own employees and even management. The
improvement of supervision by BI would not have a significant
impact, if bank employees intentionally and meticulously plan a
major scam in their own bank. The improvement of monitoring and
internal bank audits are also difficult, when the violators are
not punished because our law enforcement officials are too weak.

In the calculation of violators, pocketing billions of rupiah
illegally, while receiving a light prison sentence is a
worthwhile, compared to the future earning of those employees.
Not to mention, the possibility for collusion in the process of
investigation and trial. Until there is significant improvement
in the way the police, prosecutors and judges handle their jobs,
the temptation of bank employees to plan and execute a scam is
very difficult to deter.

For the time being, the challenge of the banks is not only how
to improve monitoring and auditing, but also in improving its
human resources. It is better to spend more money to do these
things, than face the problem later on that not only will cost
more money but also a lot of frustration in dealing with the
police and court system.

BI has several times warned the small banks to take necessary
steps to improve, including mergers and acquisitions. But the
common question is how can two or more weak banks merge to create
a better bank. For this reason, BI should not hesitate to close
down banks earlier, if the information and evidence to do so is
enough, rather than to wait until the problems have gotten out of
control.

This policy would not create a wider economic consequence if
just applied to small banks. Of course, there is a cost to the
government because of the deposit guarantee system. For this
reason, the shifting of deposit guarantees to deposit insurance
should be implemented soon to prevent problems. The government
previously announced that the year 2004 would be the starting
time for such a transition.

The other concern of the banking system, especially for large
(state) banks, is on the quality of corporate credit. Despite
reports of low NPL by such banks, there is a concern that the
quality of corporate credit might tend to deteriorate, especially
in the category of special mention.

For this reason, BI has asked the largest state bank, Bank
Mandiri, to reduce the percentage of corporate credit to the
level of 50 percent of its total credit. Another concern of large
state banks is on the appeal by the government to support
investment, and recently on the call for domestic banks to
support an ambitious infrastructure development thrust.

As investment, especially foreign direct investment, is so
disappointing, the government has urged domestic banks to be more
active in allocating credit to the productive sector, not only to
concentrate on the consumer sector. In terms of prudential
banking practices, the government seems have a different view
from that of BI.

The government should realize that it cannot use banks as an
agent of development as they used to be. Currently, banks have a
universal characteristic, which prompt them to allocate credit
wherever it is profitable with manageable risk.

Even the large state banks, are no longer fully owned by the
state, because Bank Mandiri, BNI and BRI are public companies,
even though the state still owns the majority of shares. Only if
a development program that would like to be financed by the state
bank in line with the principle of profitability and managed
risk, can the bank then allocate loans for the targeted program.

Based merely on the argument of development, without
considering profitability and managed risk, the credibility of
banking system in Indonesia is under serious threat for its
prudent practices. The way that banks operate under a universal
business principle is actually a consequence of the policy of the
government itself, mainly due to overly rapid liberalization,
beginning in 1988, and the recapitalized banking policy in the
post-crisis era.

Given all these considerations, the banking system need to be
allowed to develop gradually to create reliable banks that focus
on profitability and manage risk well. At this time, banks are
still in the stage of developing a focus on consumer and
commercial small businesses, because allocating credit to the
corporate sector, especially for investment purposes, is simply
too risky.

However, there have been some indications recently that show
the domestic banks are getting interested in investment, but on a
selected basis. The job of a supervisory body is to make this
progress manageable by strengthening supervision that is
consistent with solid business considerations.

While, for the government, it cannot use (state) banks as its
main agent for development any longer. Let the banks take their
own appropriate role in economic recovery, and not force them to
take a high risk role that might jeopardize not only the banking
system itself, but also the fate of economic recovery.

The government should focus more in improving the environment
for foreign direct investment to come to Indonesia rather than
forcing (state) banks to take on the job without the ability to
manage the risk properly. Certainly, it is important for a
concerted effort from the banks themselves, supervisory bodies,
and legal enforcers to prevent similar fraud cases over and over
again.

The writer is the Chairman of CIDES (Center for Information
and Development Studies); and a Senior Fellow at the Habibie
Center.