Political stability remains key to foreign investment

JAKARTA (JP): The government's recent move to allow foreign investors to control a majority stake in local banks will not lure foreign companies if political uncertainty in the country remains high, a senior foreign banker said yesterday.

Executive vice president of the U.S. Exim Bank, Allan I. Mendelowitz, said political stability was the main factor foreign investors looked at in Indonesia.

Before investing in an Indonesian bank, investors would be sure to investigate whether the bank's operations were based on international standards, he said.

"World class financial institutions will only be tempted to invest here if political uncertainty and confidence has been restored," he told reporters on the sidelines of a seminar held by the Jakarta chapter of the Indonesian Economists Association (ISEI).

The government announced Monday that it planned to allow foreign investors to hold controlling ownership of Indonesian banks either through direct placement or portfolio investment as part of its effort to improve the country's ailing banking sector.

Mendelowitz said the move, combined with the government's suspension of three banks and the nationalization of four others last Friday, was not strong enough to restore market confidence since the key factor in the country's financial catastrophe was the banking industry's poor lending strategies.

"Foreign financial institutions will only bring their huge capital and professional financial management systems here if lending practices are based on international standards," he said.

The fact that many lenders had made important credit decisions based on "golf course" due diligence, or personal connections, had significantly intensified the region's economic crisis, he said.

"The main problem with much of the lending in East Asia, including Indonesia, is that it was not based on an arms-length credit analysis," he said, pointing out that its impact was further exaggerated because banks accounted for a much larger proportion of financial market intermediation here than is typical today in other countries.

He said lending policies in East Asian countries were largely based on "efforts by insiders to enrich themselves and their friends or political protectors".

The result of such corrupt lending practices was the inefficient deployment of capital into unproductive investments, such as unprofitable industries and real estate speculation, he said.

"Another result was the misallocation of capital, leading to bad loans," he said.

If the misallocation of capital was systematic, he continued, it would weigh down the entire banking system with bad debt and a system-wide banking crisis.

Cleaning up ailing banks' balance sheets is "only the easier part of the solution" to getting the financial sector of an economy back on track.

He said bad debt could be taken off the books of bad banks and that the banks could be recapitalized.

A greater challenge, though, would involve changing the credit culture and lending practices of East Asia's banking industry.

A second and equally important challenge, Mendelowitz said, was to build an effective regulatory system for financial markets so that governments could play the role of referee by keeping everyone playing by the rules of the game.

He stressed, however, that failure to make these kinds of changes would place any kind of recapitalization of the banking system at risk of sending good money after bad.

"If the structural problems are not resolved, there is no reason to expect that a future crisis will not put the banking sector at risk again, along with the industrial and commercial life of the country," he said. (aly)