Indonesia NPL reform to hit bank profits

Indonesia NPL reform to hit bank profits

Phelim Kyne, Dow Jones, Jakarta

Bank Indonesia is intensifying bank sector reform with stricter bad loan rules likely to take a sharp-but-temporary bite out of major corporate lender profits.

The short-term pain will deliver long-term gain in the form of tighter loan classification standards aimed at improving the health of a sector still recovering from the impact of the 1997- 98 Asian financial crisis, central bank officials and analysts say.

The central bank rolled out the rules in January, but their full impact won't be obvious until banks issue their first half results next month.

"We care about the problems that each individual bank will have (in complying with the new rules)," Bank Indonesia's director of Economic Research and Monetary Policy, Halim Alamsyah, told Dow Jones Newswires on Monday.

"What we would really like to achieve is try to improve the standards to international best practice so in the longer term...this will give positive benefits to the banking industry as a whole."

Under the rules, loans in arrears for 91-120 days are categorized as "substandard" versus 180 days before, and loans in arrears for 180 days (versus 270 days before) are now considered "lost" or not recoverable.

Bank Indonesia data indicate that the country's bank sector recorded a 15 percent year-on-year decline in total nonperforming loans to Rp 25.17 trillion (about US$2.6 billion) at the end of 2004.

The rules impose a "one debtor, one project" concept that requires banks to adopt a uniform, lowest loan classification category for borrowers with multiple loans from multiple banks.

Analysts say the new NPLs classification rules will have a bigger impact on Indonesia's large state-owned banks than the country's private banks.

Although Indonesia's bank sector has made strides in improving credit risk assessment and corporate governance levels, private banks have generally implemented higher standards than the state banks.

That will prompt the need for provisioning that will trim state-banks profits.

Alamsyah said that regulation aimed to rein in "unscrupulous" borrowing practices of unidentified firms.

"We've seen the behavior of debtors that tend to make arbitrage (in lending rates of different banks)," he said.

"(We) have some indications that (borrowers) use the money from one bank to repay the loans at another bank."

Bank Indonesia's move to upgrade NPL classifications address a long-standing Achilles heel in domestic commercial bank governance that brought the entire sector to the brink of bankruptcy during the crisis.

Domestic commercial banks for more than three decades served as funding spigots of lending to family and associates of former dictator Suharto. Those loans accumulated on banks' books for decades, unrepaid and ignored, until the financial crisis.

The rules are part of the central bank's gradual implementation of the Indonesia Banking Architecture, a ten-year master plan to promote bank sector consolidation and raise corporate governance to international levels.

"During the crisis...(Bank Indonesia) had more to do with damage control (like) working out the nonperforming loans and restructuring," Moody's Investor Service vice president Beatrice Woo told Dow Jones Newswires.

"Now they're working on new initiatives like Basel II and (NPL) classifications."

Bank Mandiri, Indonesia's largest bank by assets and a major corporate lender, felt the bite of the impact of the new rules in the first quarter of 2005.

The new regulations prompted the bank to more than triple on year its loan loss provisions to Rp 763 trillion ($79 billion) in the first three months of 2005, a Bank Mandiri statement issued last month said, citing Vice President I Wayan Agus Mertayasa.

That contributed to a 70 percent year-on-year decline in Bank Mandiri's net profit to Rp 519 billion in the same period.