Indonesian banking at crossroad

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.