Merging banks under duress

Merging banks under duress

The government has become notorious for its foot dragging and,
sometimes, even outright inaction with regard to the reform
measures that are badly needed to generate a sustainable economic
recovery.

The latest case in point is the consolidation of the private
banks that were nationalized in 1999. The government has finally
decided to merge five banks as four of them are not likely to be
able to achieve the minimum capital adequacy ratio (capital
against risk-weighted assets) of 8 percent by the December 31
deadline.

But why was that measure taken only two months before the
deadline? Was the government's monitoring and supervisory ability
so ineffective that it could not have known as early as June that
those banks had no chance of achieving the minimum CAR level?

The consequence of the hurried measure is that the merger is
now being completed under duress, rather than being a
consolidation directed by market forces.The enforced process will
certainly impose more costs on the government while its outcome
is not likely to be as favorable as what a market-driven merger
would produce.

Moreover, a merger process is never an easy and smooth
exercise even though the five banks -- Bank Universal, Bank Bali,
Bank Patriot, Bank Prima Express and Bank Artha Media -- are
majority or entirely owned by the government and are all medium-
size retail banks. Since a merger is by its nature a
consolidation process, it requires massive layoffs and the
closure of redundant branches to achieve maximum efficiency, not
to mention the initial complications inflicted upon the clients
of those banks.

Fortunately, though, the announcement of the merger did not
cause any jitters among depositors because all five of the banks
are either majority or entirely-owned by the government and, most
importantly, the blanket guarantee for bank depositors and
creditors is still effective.

In any case, since a merger, though rather late, is still much
better and less shocking than outright closure, the government
should make the most of the consolidation.

Even though some analysts initially estimated that the merger
of the five banks, which had combined assets of Rp 28 trillion
(US$2.6 billion), would create a new bank with a CAR of 10-11
percent, significantly higher than the minimum 8 percent, the
government should see to it that the capital standard of the new
bank is based on a strict asset classification.

Most crucial in ensuring high asset quality is the application
of tough standards in loan classifications. The latest
experiences with the closure of Unibank due to widespread bad
loans and the second recapitalization of Bank International
Indonesia that cost the government another Rp 2 trillion to Rp 3
trillion, point to the unreliability of the asset classification
system applied in the banking industry.

Lenient loan classifications are able to conceal weak assets
only for a short time, and these low-quality assets are like a
time bomb that could explode even at the slightest downward shift
in the economy. It is therefore most imperative to rid the new
bank entirely of doubtful and bad loans so that its non-
performing loans will be cut to a maximum 5 percent, as mandated
by the end of next month.

In fact, given the persistently high risks to be encountered
by banks in view of the weakening economy and the downward trend
in the rupiah exchange rate, the government, if necessary, should
inject additional capital to bring up its CAR to at least 12
percent, the level now applied in most Asian countries. Simply
achieving the minimum 8 percent CAR, particularly if the asset
classification system was based on questionable standards, would
only put the new bank on the verge of again falling below
acceptable standards. Moreover, a minimum capital standard will
not make the bank attractive to private investors and this will
certainly hinder its privatization, which should, after all, be
the next compulsory stage of its consolidation.

No less important is the kind of corporate image to be created
for the new bank, and this involves the selection of the
surviving entity from among the five banks. But since Bank Bali
and Bank Universal are the largest of the five, certainly one of
them will eventually emerge as the surviving entity. That does
not, however, mean that the highest CAR (Bank Bali with more than
15 percent) is the key prerequisite for becoming the merger
leader, especially in view of the tarnished image of Bank Bali
under the so-called Bank Bali scandal in 1999 that derailed its
acquisition by Standard Chartered Bank.

Since the corporate image of the new bank should appeal to its
market segment, that is small and medium-scale enterprises, Bank
Universal, well known for its good corporate governance
practices, and good track record in that sector, could emerge as
the surviving entity.