Purging bad bankers

Purging bad bankers

Good bank governance will remain an elusive ideal in Indonesia
if the supervisory and regulatory authority continues to place
too much emphasis on financial ratios such as capital adequacy,
as Finance Minister Bambang Subianto indicated Tuesday. He stated
that the majority owners of the four banks nationalized last
week, including the country's largest private bank, Bank Central
Asia, would be able to reclaim the banks after they absorbed the
losses resulting from loans extended to their affiliates and
repaid all the liquidity support given them by the central bank.
This implies that despite their sins, the bankers, who had used
their banks as the treasury department of their business groups,
will not be blacklisted by the banking industry, but instead be
given a second chance.

This is extremely unnerving given the many scandals in
Indonesian banks in the past resulting from either the peddling
of political influence or conflict of interests on the part of
bank shareholders.

The central issue in good bank governance is not only
financial ratios, as set in the prudential regulations, but, most
importantly, the competence and integrity of both the managers
and owners. The central bank governor has confirmed that most of
the three banks frozen and four nationalized last week were found
to have violated the legal lending limits.

This means that those banks extended loans to their owners'
businesses far in excess of the ceiling (20 percent of total
credits) set by the central bank. Further down the road, this
implies it was the owners, as the internal supervisors, and not
the professional managers, who made most of the lending decisions
and imposed target markets or strategies on their banks.

Even if the connected lendings did not go sour, the blunt fact
remains that the owners and managers violated banking
regulations. Excessive inter-group loans represent an obvious
breakdown of market discipline and pose big risks to banks.

If these owners are again allowed to repossess their banks,
even after they have settled all their obligations, the central
bank will find itself in a tricky situation. It is like putting
the central bank in a position of having to chase the horse after
it has bolted, whereas it is really the owner who controls the
stable and holds the key to its door.

The central bank should have known that almost all bank
failures in the country, as in most other countries, were caused
not by fierce competition but by bad lending decisions, based on
either political or business connections. Connected lending was
also the main reason behind the insolvency of the 16 banks that
were closed last November and the seven suspended in April.

Empirical studies on bank failures around the world clearly
indicate that effective internal governance is the cornerstone of
sound bank operations. Owners with high competence and integrity
are the key factor among the very complex institutions, laws and
regulations, customs and practices that control and influence
bank behavior.

The importance of good ownership and internal governance
cannot be overemphasized because of banks' fiduciary
responsibility. A good bank can exist even under an inadequate
regulatory environment but a bad system of ownership governance
can never have a sound bank even with a highly competent
management and under tight, external supervisory controls.

Tighter scrutiny is mandated especially for a bank whose
owners have a widely diversified conglomerate of businesses as
the former majority shareholders of Bank Central Asia and Bank
Tiara do. The central bank should first determine that the
ownership and organizational structures will not become a source
of weakness and risk to depositors.

Only owners with high integrity are able to exercise effective
internal supervision, to hold their bank managers responsible for
their decisions and to ensure that the managers have instituted
good governance and a reliable risk management system. And
bankers who are found to have forced their banks to breach the
legal lending limits do not deserve a second chance in the
banking industry.