Let bad banks die

What a knotty bind our nation has tied itself up in. Amid the seemingly relentless waves of rioting, positive announcements about key economic indicators such as the strengthening of the rupiah, rising exports and declining inflation look hollow and meaningless. With most people now harboring an increased sense of foreboding about potentially explosive political conflicts in the run-up to the general election -- scheduled for May or June -- economic instruments seem irrelevant until credibility is restored to the country's discredited legal, financial and political institutions.

True, the recovery of confidence ultimately cannot be separated from the successful transition to a more open and democratic political system which has the broad support of the populace. But delaying vital economic reforms until after the election might devastate the economic fundamentals so much that the new government will be brought down by a total economic collapse.

Hence, we welcome the steadfast stance on the part of Bank Indonesia (the central bank) regarding the bank recapitalization deadline as a strong signal that the government is really serious about restoring the moribund banking industry to a sound footing. Nothing else in the real sector of the economy will move unless commercial lending, at present virtually at a standstill, resumes.

Bankers' demand for the rescheduling of the deadline for meeting the 4 percent capital adequacy ratio (CAR) that is due on Jan. 31 seems utterly unreasonable. Postponing the recapitalization process means prolonging the current breakdown in financial intermediation and impeding the economic recovery.

The recapitalization scheme announced by Bank Indonesia on Sept. 29 remains the best, workable option to bail out the largely insolvent banking industry. Injecting four rupiah in public money for every one rupiah in fresh capital put up by bank owners to recapitalize their banks, as the central bank plans to do under the scheme, is the most credible alternative for shareholders to revive their banks and, at the same, still maintain their ownership.

All other options, such as issuing new shares and debt instruments, which are viable financing avenues in normal times are now impossible under the depressed economic conditions. Mergers are also out of question because most banks already have negative equity and merging banks is always extremely capital intensive.

If shareholders are not able or willing to recapitalize their banks under the scheme -- which has in fact been criticized as too generous because it is open to banks with CARs as low as minus 25 percent-- one may question both the seriousness of the bankers and the benefit of salvaging such banks.

The recapitalization scheme may require hundreds of trillions rupiah in taxpayers' money if the results of the banks already examined by international auditors are any guide to go by. Preliminary audit reports show that only about 3 percent of the 80 banks already audited have CARs of above 4 percent. This means that more than 70 of the banks will have to be recapitalized using public money. The audit results of other banks currently under due diligence are unlikely be very different.

Not all of the banking woes can be blamed on the bank owners. There are banks which have always held firmly to good practices and prudential rules and yet are now mired in mountains of bad credits as the impact of the depressed economy takes its toll. Even the best of the banks have seen their capital base devastated by the almost 70 percent fall in the rupiah's value against the American dollar.

But many other banks, notably the largest ones which mostly belong to conglomerates, are facing financial distress mostly of their own making. Their bad loans have been caused mainly by unscrupulous lending to their own business groups in violation of the prudential regulations.

The economy will never recover without the restructuring of the banking industry. That is why the government is willing to use public money to subsidize the bank recapitalization. Another backtrack on this vital front would delay the return of confidence to the banking industry, and hence further squeeze the blood supply to the local economy.

We think the government should remain committed to its decision to complete the recapitalization program as scheduled. The central bank should be prepared to let distressed banks die if their owners are not willing to put up fresh capital. What is the point of spending taxpayers' money to save all the banks that already have massive negative equity.

Moreover, there is no need for massive public misapprehension because the systemic risks of such a firm measure have been minimized since the government provided a blanket guarantee for all third-party deposits in local banks.