How reliable is the 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.