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.