Indonesian banking at crossroad

As the year draws to a close, it is timely to reflect on the nation's economy. Banking expert Laksamana Sukardi, is impressed by the central bank's success in containing the damages from mega credit scandals at state banks. But he sees an urgent need for new regulations to restrict maximum cumulative outflows at banks and to abolish overly dominant single majority shareholders at banks. This is the first in a series of articles on economics.

JAKARTA (JP): We are comfortable to note that in 1994 Bank Indonesia (the central bank) has made significant achievements in fostering public confidence in the country's banking system. This is despite the fact that this year also marks two mega- credit scandals involving the Golden Key and Kanindo business groups.

The increasing public trust is demonstrated by the decreasing differentials between the rupiah's interest rates and Singapore Inter-bank Offered Rates, which now stands at nine percent, down from 13 percent in 1990 and 17 percent in 1991. In the past a low interest rate differential usually triggered capital flight.

The growth of credits at national banks during the first nine months (January-September) of this year reached 18.2 percent, which can be considered a safe and sustainable rate. Discouraging, though, was that the credit growth rate at state banks was only 8.2 percent, much lower than the 30.3 percent at private banks.

Such unbalanced growth is understandable as state-owned banks had to restructure their bad mega credits, which have rendered credit expansion impossible. The situation had indirectly caused the lendings by private banks to grow too rapidly, and this could turn into a destabilizing factor in our banking system in 1995.

The 10.7 percent growth of private deposits raised by banks was not adequate to meet the credit expansion in the period. This has led to an increase in the loan-to-deposit ratio, which in turn will force interest rates to climb. Another less desirable development was the massive allocation of credits to the property sector, which, with its total amount of Rp 42.5 trillion, represented a 33.2 percent increase.

This situation has consequently increased the liquidity risk in our banking system, caused by excessive gapping activities (disbursement of short-term deposits in the form of long-term credits). These practices have been made possible by the absence of regulations on maximum cumulative outflows.

These developments will make the liquidity of Indonesian banks vulnerable to monetary fluctuations. The only possible step that these banks can take in order to avert liquidity risk is to jack up the interest rates of time deposits. That was precisely what they have done.

A rather discouraging trend is that the rise in interest rates that has been going on as we approach the end of 1994 has also caused the differential between the rupiah's interest rates and Singapore Inter-bank Offered Rates to increase as well to nine percent from seven percent.

This fact strongly indicates that the structure of our national banks still requires reworking. It is therefore imperative for the government to issue some prudential regulations in the form of maximum cumulative outflow which every bank has to implement in order to reduce liquidity risk.

If the restructuring process of non-performing credits at state- owned banks is not completed in 1995, they will become liabilities to our national banking, as the situation will cause the credits in private banks to grow too fast and become unsustainable.

In its efforts to curb problem loans, Bank Indonesia has taken a series of highly commendable steps for improving the implementation of the internal audit function of the banks, revising the guidelines for credit policy formulation, and improving the banking system's organizational structure by combining the tasks of on-site and off-site supervisions into several teams.

These steps will not be effective unless there is also a built-in control over the majority shareholders of banks.

In general, Indonesian banking is characterized by the existence of highly dominant majority shareholders. This characteristic can become a destabilizing factor, since overly dominant single majority shareholders will possess excessive power that becomes difficult for Bank Indonesia to keep under control. Management of banks will continue to be loaded with conflicts of interest that can lead to violation of the prudential banking practices.

As an illustration, it would be impossible to prevent excessive credit allocation to the property sector if almost all of majority shareholders also owned property businesses.

Therefore, it is high time for Bank Indonesia to restrict the amount of bank shares owned by groups or individuals so that there will no longer be single, overly dominant majority shareholders which control the full authority to appoint and dismiss members of their board of commissioners (supervisors).

One of the steps that can be taken is to impose relatively higher minimum capital requirements, so that it would become practically impossible for a single group or individual to dominate or control the ownership of a bank. As a result, natural mergers will take place, leading to diversification of share ownerships of every bank. Another possible consequence, which is positive, is that a larger number of shares will be owned by the public.

In 1995, the Indonesian banking system will find itself at a crossroad. It will have to choose between a quantitative banking system (consisting of a large number of banks that are not solid), or a qualitative one (consisting of a small number of solid banks).

By eliminating overly dominant majority shareholders, Bank Indonesia will face less challenge in its efforts to improve and supervise our national banking system, as shareholders will automatically and voluntarily exercise control over each other.

In turn, this will lead to the increase in the level of disclosure and more use of professionalism in the management of Indonesian banks.

The writer is the chief executive officer of ReFORMConsulting and Director of ECONIT Advisory Group.