Indonesian banks still in a bind: Moody's Inc

Indonesian banks still in a bind: Moody's Inc

JAKARTA (Dow Jones): Indonesia's banking system remains insolvent, despite some recent progress in restructuring bad debt, Moody's Investor Service Inc. said on Tuesday.

Without foreign investment in local banks - which remains unlikely in the short-term due to political instability - the sector will be too weak to start lending again, said Deborah Schuler, a senior analyst at Moody's in Hong Kong.

"Most banks remain insolvent on an economic basis. They have more bad loans than capital," she told Dow Jones Newswires.

"There will be some more capital needed," she added.

On Tuesday, Moody's released its annual report on Indonesia's banking system, which crashed in 1997 following years of wasteful lending by institutions to related companies.

Despite a multi-billion-dollar state bailout, which took the worst bad debt off banks' books, most institutions are still heavily weighed down with problem loans, Schuler said.

Most banks remain dependent on government bonds to give them adequate capital to continue to operate, she added. The government issued the bonds last year to banks as a way of pushing up capital-adequacy ratios to above the minimum 4 percent.

A major problem is that banks are unable to sell the bonds due to lack of investor interest. Also, any market price would likely be much lower than the book value of the bonds, which would further reduce banks' capital levels.

With such weak capital positions, banks are unable to make new loans, especially when the risk of companies defaulting remains high.

"With low capital-adequacy ratios, and a ton of government bonds on their books, the banks can't lend," Schuler said.

The banking system's inability to lend could hamper economic recovery, if local companies are unable to get access to fresh credit to meet a nascent recovery in consumer confidence, economists say.

Further state help isn't an option, as the current bailout program has already pushed government debt to alarming levels, sparking a heated political debate over the cost to the taxpayer, Schuler said.

The budget deficit this year is expected at a whopping 4% of gross domestic product, due in part to the cost of interest payments on the recapitalization bonds.

Foreign investors are also unlikely to buy Indonesian banks while the stability of President Abdurrahman Wahid's government remains in question, and violent sectarian clashes continue to rage across the archipelago.

Standard Chartered PLC's failure to push through a plan to take a majority stake in PT Bank Bali has added to negative foreign investor sentiment toward the system, Schuler said.

The deal fell through amid protests from Bank Bali staff against the take over, and against a backdrop of allegations the bank fraudulently lent $80 million last year to a company linked to the then-ruling Golkar party.

"The way the Bank Bali deal went has left a bad taste in the mouths of foreign investors," Schuler said. Banks Push Back Deadlines

Local banks have made some progress in debt rescheduling, which involves pushing back debt repayment deadlines, rather than writing-off debt.

Interest rates on rescheduled debt are higher than current deposit rates, or the cost of a bank's funds, and this is helping most institutions return to operating profits this year, Schuler said.

Banks with stronger capital-adequacy ratios - such as PT Bank Danamon Indonesia, PT Bank Central Asia, PT Bank Pan Indonesia, and Bank Internasional Indonesia - can move more aggressively to take losses on bad debt.

However most banks remain unwilling to write off loans because they still don't have enough capital to take the losses now, Schuler said.

Moody's puts the system's outstanding foreign currency debt at $70 billion, with only $5 billion restructured so far. The weak rupiah currency has pushed up foreign debt in local currency terms.

Simply pushing back deadlines for the repayment of this debt could lead to problems further down the line if companies are unable to meet the new repayment schedules, Schuler said.

Only fresh capital injections will allow the banks to start writing off the debt.

While foreigners remain on the sidelines, a push to get rid of the debt, and resume lending, is likely to remain on hold.