Int'l auditors get bitter welcome

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.