Int'l auditors get bitter welcome

By Andy Budiman

JAKARTA (JP): International auditors assigned by Bank Indonesia (BI) and the Indonesian Bank Restructuring Agency (IBRA) to carry out the due diligence of banks in the country have been assailed with so many unkind remarks.

Since the start of the implementation of the Agreed Upon Due Diligence Procedure (ADDP), they have been condemned for having done a lousy job, not understanding the domestic banking situation and making the banks look so much worse than they should be.

Actually, the auditors have been following the terms of reference that were agreed upon and mandated by BI and IBRA, with the blessings of the Asian Development Bank (ADB), the International Monetary Fund (IMF) as well as the World Bank.

They simply did what they had been told, informed of and briefed upon. And that is the nature of ADDP -- a procedure that is agreed and needed to be followed strictly, word for word. If not, they would not get paid for services rendered.

And opening the Pandora's box, the so-called international auditors also consist of local auditors -- those who know the language, culture, and business as well as the political climate of Indonesia, those with many years of experience in banking, accounting and bank auditing.

So, if bankers have said that the auditors' judgment was unsound because they did not know the actual situation, the language and the culture -- this would simply be like telling them that men have not stepped foot on the moon.

Yes, the auditors did not account collateral value other than cash, as instructed. It was certain that they simply applied a matrix drawn up by BI in determining the risk rating and provision of the customers of the banks.

The matrix has many variables to be considered -- financial, economic, industrial, etc. So, it is not only delinquency that is used to measure the risk rating of borrowers.

It is true that judgment and interpretation of the new regulations came into play, but as auditors, they have to be conservative at all times.

But, many things are crystal clear and yet bankers still want to dispute them because they claim that they know more about the customers and the situation compared to the international auditors.

The matrix accompanying this article can be used to make a comparison with a close to real life example.

A borrower, with outstanding loans (unsecured) of Rp 20 billion (around US$220,000), who has not made an interest payment for more than six months and has most recent financial statements dated 1996, which indicated that at the time the loan was made their debt to equity ratio was more than 10 times. This would have raised the alarm at that time.

But, the bank simply kept the borrower on a "Pass" rating, with a provision for loan losses of 1 percent, since the borrower always paid interest on time.

And now, two years down the road and the borrower has not paid a single rupiah in the past six months and with no means to assess his financial conditions, but with only oral assurance from the borrower that the loan will be repaid. Now, how does an auditor expect to assess the risk that this borrower will not go into default?

As there is only little evidence that the borrower could repay the loans, the auditor may conclude that the borrower will not be able to repay his debt and the loan should be provided a loan loss provision covering the whole amount. If he was able to keep payments current, the loan would not have been delinquent and the financial information would have been kept up to date. On the other hand, bankers would be adamant in having the borrower rated, at a maximum, as "Special Mention" with 5 percent provision or a slightly worse rating of "Substandard" with 5 percent provision, simply because the bank claims that the owner has a lot of money or they have promised to pay the loan by next week.

However, it should be remembered that only cash can be used to repay the loan -- the first C in banking i.e. cash flows.

If the situation is not as bad as the ADDP reports say, how could it happen that last year's audited financial statements, which were audited by local accounting firms, did not reflect even a scintilla of the problems that the reports indicate? This assumption should be made without blaming the economic crisis that came so suddenly and caught every one off guard.

If banks and their auditors were acting prudently and did their jobs in a professional manner, problems would have surfaced earlier. This is one of the reasons that international auditors were hired, simply because the integrity of the local public accounting firms is being questioned. Even some of the big-named accounting firms associated with well known international accounting firms are simply known to be too close to clients which discolor their independent judgment at the expense of the investing public, uninformed shareholders and also the government. This situation continues in much the same way.

In the extreme, the public shareholders should be encouraged to bring these accounting firms to court as they may have misled the investing public by signing audited financial statements that do not reflect the true financial condition of these banks in the prior years.

Some publicly listed banks' audited financial statements for the year 1996 had been restated for no apparent reasons. Don't the investing public have the right to question their practices related to the audited financial statements that had been released months or years ago and are now being restated?

That is simply an act of gross negligence on the auditor's part. It is very unacceptable, unprofessional, misleading and would have caused a big court battle if it had happened in a country like the United States.

The international auditors believe that their reports reflect the true picture -- in accordance with the terms of reference -- of the financial conditions of the banks that went through the exercise on that specific balance sheet date.

In general, the majority of the banks would have to write off, at least, 50 percent of their loan portfolios to make them healthy again. Some of them even have to write off a loan portfolio close to 100 percent -- for some of these banks, the ADDP could have taken place two or three years ago and the result would have been the same.

Bankers should wake up because the majority of their customers will not be able to repay their loans -- not in the next two or three years at minimum. They have to face this fact, as the situation is pretty bad, and their customers are unlikely to pay them back, even if they have personal liquid assets stashed somewhere in Switzerland (which, of course, they would not see on paper).

This is very problematic and is rooted in the culture of this country. We tend to wait and wait and wait for things to get better. Most of us tend to act like ostriches -- sticking our heads in the sand and pretending that nothing is happening. It is simply human not to want to deal with problems that are in an unchartered territory as well if we know for sure that we can not deal with them.

The fact is, if nothing is done very quickly, worse will certainly happen soon. More monies will be needed to save the country's banking industry or whatever is left of it.

This is true, considering that the bulk of the ADDP was done as of March 31, or June 30, 1998. As an example, if a bank was rated a C as of March 31, 1998, new capital to the tune of Rp 250 billion was needed to achieve a 4 percent capital adequacy ratio (CAR), added to a net loss of Rp 20 billion.

Then, as of Dec. 31, 1998, if the new capital has not been injected and the loss position is more than Rp 200 billion and the asset base has not changed a whole lot, how much more money will the Bank need to achieve a 4 percent CAR? The answer is a lot more because the problem is at a dangerous level.

Things have to move very quickly to save the banking industry. The prudent way is with international benchmarking as the standard, and leaving the old ways of doing businesses. This would go some of the way to saving the banks and letting them have a future.

Indonesian banks cannot afford to be doing business in the old way, breaking legal lending limits simply because other banks do the same thing, shifting related party loans to other financial institutions at year end so that this will not be disclosed in the audited financial statements, or even risk sharing with the default risk remaining with the original underwriter of loans.

Banks are public depository institutions -- they serve the interests of the public. The banking industry has to be heavily regulated and strictly monitored, so that all prudent regulations and measures are strictly followed. The slightest infraction should be fully penalized to protect the public at large.

The writer is an auditor of an international accounting firm. This article reflects his opinion, not necessarily of the firm where he is currently employed.