Legal reform necessary for bank lending and investment

Indonesia's economy recovery relies heavily on the country's banking sector and the return of foreign investment into the country. The Jakarta Post's Rendi A. Witular and Riyadi Suparno interviewed Aman Mehta, chief executive officer of HSBC Asia- Pacific, to get his view on what needs to be done to reinvigorate the banking sector and attract investment. The following are the key points of the interview.

Q: How is business for HSBC in Indonesia currently?

A: Our balance sheet here is actually growing by double digits (percentage) for loans and deposits. We have opened new branches in the last 18 months or so. Really in organic terms, there has been a decent level of growth here. But we have not done anything major in terms of strategic acquisitions or anything of that sort, but organically the business is growing. Corporate banking, commercial banking and credit cards are all growing quite satisfactorily.

Q: What about your future business plans in Indonesia? Any acquisitions planned?

A: We're keeping our eyes open, we are an international acquirer. But we have not made any strategic acquisitions in Indonesia in recent times. I don't rule out the possibility. The primary thing for our management is to keep developing the business in organic terms.

But opportunistically, we are always on the look out for something suitable like portfolios, for example, such as loan portfolios, auto loan portfolios, card portfolios... Those are always interesting for us.

In the longer term I would not rule out even the possibility of legal entity acquisitions. We have done it in other parts of Asia.

Q: Are you uninterested in acquiring the number of banks on offer from the Indonesian Bank Restructuring Agency?

A: We have stood back from the auctions in the last two or three years on the basis that we've felt that the risk environment was such that we need to control them very tightly, credit risks as well as operating risks.

You can do much better with your own branch networks rather than acquiring something with hundred of branches, thousands of people, where we have to change the system and retrain the people, and that takes a long time to get comfortable with the risk environment.

Given the current state of the legal system, enforcement, security, contracts, compliance, etc... it's only appropriate for us to concentrate on our businesses, our branches so that we have tight control of the risks. But it does not mean that the day will not come when the legal system is more mature (and less risky).

Q: Does that mean the Indonesian risk profile is still higher compared to other countries in the region?

A: If you compare the robustness of the institutional framework here in legal terms, it's not yet on par with say Singapore, Hong Kong, Taiwan or Japan. That is the main reason I think that, so far we prefer to develop our own businesses where you have a very tight control of the risks.

Q: What is your assessment of the Indonesian banking sector and how to boost their role in the economy?

A: I think there is much to be pleased about in terms of positive things happening. You can look at major successes: The fiscal deficit has been kept in control, the currency has been very stable, the interest rate is coming down, the inflation is under control and there is moderate growth, comparable to the rest of the region.

Clearly there's a long way to go. Look at the balance sheet of local banks here... They have a liquid balance sheet but not much new lending.

And there are many important things like the mortgage market that has yet to evolve here. It's a huge market to drive growth and drive construction and so on. There is a long way to go.

If you ask me what is the single most important thing, I would say probably the legal infrastructure, and rights to enforce property or security or other rights. This will motivate banks to lend much more, enable small- and medium-sized companies to receive more loans and stimulate asset-based sectors like leasing and mortgages.

So, I think reforms in that sector are a long-term thing. It will have a huge positive effect on the development of the banking sector, and the entire financing sector in fact, and eventually on the economy as a whole... I think the stronger the infrastructure, especially on the legal side, the better the impact in terms of the ability of the banking sector to contribute more.

Q: Indonesian banks are said to be reluctant to lend their money to the real sector. What is HSBC's experience with this?

A: I think banks have a very good idea of who their target customers are. But the trouble is at this moment, the target list is quite narrow...

Frankly, our experience tells us that it is very difficult to realize on loans in terms of security, in terms of enforceability, in terms of getting a degree.

Unless, we are very, very comfortable with both the balance sheet standing and the viability of a company, and in fact its dignity, we won't lend to it... because our experience tells us if there is a default, we would have to take the loss, we cannot bind the company, we cannot appoint a receiver. So, one must be very careful.

The upgrading of the legal infrastructure and the ability to recover bad loans via legal channels would be a big catalyst for lending... But in the current conditions, we have to be very conservative. We have no choice.

Q: What measures do you take here toward defaulted debtors?

A: Well there have been many, many things tried. We have worked it out in some cases, for example, some agreements have been made to extend their debts; in some cases, they have been sent to the secondary market; in some cases, I know they bought their loans back. A whole range of measures.

Q: Have you tried to use the Commercial Court (for bankruptcy cases) to recoup your lost assets? What is your experience on this?

A: In that respect, our experience has been somewhat disappointing.

I cannot recollect any successful case ... I'm not aware of any successful case in our portfolio of an actual forced closure or liquidation of a company.

But I don't want to talk about negative things. There have been many positive things happening here.

Q: Those weaknesses in the legal infrastructure have not only affect banking but also foreign investment. What do you think about the foreign investment situation in Indonesia?

A: Still inadequate. The capital flow is still negative... This is unlikely to reverse until international investors become confident of the sanctity of laws, sanctity of contracts, otherwise, it (new foreign investment) will not happen.

They're all linked together, you know, bank lending, investment flows, mortgage market, etc... All these positive developments are linked to the same phenomena: The legal infrastructure...

However, I think this country is very, very competitive, and there is great potential to attract investment if you can solve these legal problems.

Q: Do you have a formula or suggestion on what it would take to improve our legal infrastructure to stimulate the banking sector and attract investment?

A: Looking at the Southeast Asia region, countries with the strongest legal infrastructure like Singapore, Hong Kong and Japan have very established institutions.

I think frankly how you enforce law is a matter of will, having an incorruptible judicial system, incorruptible police force etc....

Those structural weaknesses should be rectified. It will certainly lead to a much stronger banking sector with much greater role in the economy, in terms of being the stimulus, the driver of economic growth.

Q: Despite the legal system HSBC seems able to function in this environment here in Indonesia, and in fact you are still growing. What do you think?

A: We do grow, it's a large economy, a large market. Frankly, most people learn to manage risks in such a way like we do. As I told you we are still growing at a double digit rate here.

But our balance sheet it is still small for the size of this country and for the size of the market. So what we do instead is we grow internally at a very measured pace where we can carefully control the risks.

We are not inclined to raise the stakes a lot in terms of either very rapid balance sheet growth or new acquisitions that may sharply increase our level of investment. One must be very careful here.