Making the most of BI's new transparency ruling

Berni K. Moestafa, The Jakarta Post, Jakarta

When reading a bank's financial statement, here is what to look out for: net profit, capital adequacy ratio (CAR), and asset growth and quality, or so a number of analysts have said.

Knowing how to read financial reports properly will make more worthwhile a recent ruling by Bank Indonesia forcing banks to publicize their financial reports on a monthly basis. The reports are to be published on the central bank's website at www.bi.go.id.

As public concerns about bank closures and mergers linger, the ruling may help customers gauge the health of their investments.

For banks, tighter public scrutiny means improving prudential management practices or risking the loss of customers.

According to Bank Indonesia, its ruling No 3/22/2001 on the transparency of banks' financial conditions was effective as of today.

"The one thing people should look at is the bank's income statement showing its net profit," said Ahmad Subagja, an investment analyst with PT Niaga Sekuritas, over the weekend.

Banks derive their income from interest on loans and the fees they charge for services such as money transfers and bill payments.

A bank's net profit, Ahmad said, revealed its performance at a glance, but only if it were compared to its net profit in the past.

In evaluating a bank's earnings, people should also take note of the productivity of its assets, that is, the capacity of a bank's assets to generate income, he added.

One of the factors determining asset quality is the reliability of interest and principal payments. Hence, non performing loans (NPL) are those on which interest and principal payments are 90 days or more overdue.

Loans usually make up the bulk of a bank's assets, although most Indonesian banks currently own assets in the form of government bonds since the bailout program following the 1997 financial crisis.

The quality of loans reveals the soundness of a bank's management. Prudential management reduces the risk of loans turning bad, and with it the need to raise capital as a provision against risky loans.

One important tool for measuring a bank's capacity to back up its loans is called the capital adequacy ratio, or CAR.

CAR measures a bank's capital against its risk-weighted assets. Capital in this context is largely the money that bank owners have injected into their banks.

Assets are risk-weighted because loans carry different degrees of risk depending on the strength of their guarantee.

Government bonds or gold are risk free assets. This is not true however of loans tied to collateral such as corporate bonds.

Banks must show a CAR level of at least eight percent, meaning that for every Rp 12.5 in assets they must raise Rp 1 in capital.

The riskier the assets, the more capital is needed to maintain an adequate CAR level.

With the economy still in the doldrums, banks' CAR levels have become increasingly important due to Bank Indonesia's policy of closing banks with an inadequate CAR.

The alternative to this fate is merging with stronger banks.

An investment analyst at Mega Capital Indonesia, Erwin S. Widjojo, said customers should be aware of banks with marginal CAR levels of just above eight percent.

As many industries are still reeling from the economic slump, loans may quickly turn sour and add to pressure on banks' CARs.

To mitigate the risk of falling CAR levels, banks extend their loans evenly among large and small enterprises.

They reduce their loan exposure to affiliated companies and refrain from channeling loans to selected business groups only.

Under the legal lending limit ruling, banks must limit their loan exposure to affiliated parties to no more than 10 percent of their total capital.

In terms of loan growth, Erwin said a healthy bank should be able to record a growth rate of some five percent every three months.

He said new loans meant more income, but cautioned that expanding too fast ran counter to prudential management practices, and thus increased the risk of bad loans.

Thus far the demand for new loans has remained low, since many industries are still operating at production rates below their pre-crisis levels.

To survive, many banks rely on earnings from government bonds and fees.

Erwin said that, while a monthly financial report was helpful in monitoring a bank's progress, the quarterly ones were more comprehensive.

According to him, it takes about three months before the impact of various management policies can be seen in a financial report.