Pushing bank lending

Bank Indonesia has strengthened its moral suasion toward banks to expand their lending and to lower their credit interest rates in proportion to the central bank's significant easing of its money policy since last year. Yet businesspeople are still complaining of a credit crunch and persistently high lending rates, saying that banks have not yet fully resumed their financial mediational function.

However, an analysis by Michael Taylor, a banking expert at the International Monetary Fund's Jakarta office, dispels the notion that banks have been highly averse to new lending, saying that credit expansion in the country was very high, amounting to 18 percent in 2001 and 30 percent in 2002.

Why does the discrepancy seem so wide and what is the real problem in the credit sector?

An earlier study by the Investment and Banking Research Agency, a private research institution, found that new credit did expand by over 30 percent in 2002, but this lending growth was measured on the basis of approval -- or commitment -- and not on disbursement, because Rp 42 trillion (US$5.1 billion) of the total loans committed in that year remained undisbursed until January 2003.

Bank Indonesia Governor Burhanuddin Abdullah confirmed last week that about Rp 80 trillion of credit already pledged by banks had not yet been disbursed as of May, for various reasons.

Whatever the differences in calculations that led to the discrepancy in the quantitative and qualitative analysis of the credit sector, most businesspeople -- and even the bankers themselves -- did acknowledge that credit expansion had been much slower than expected, given the much easier monetary policy of the central bank and the strengthening macroeconomic stability.

Many reasons are provided for the slow lending growth and persistently high lending rates. The major factors often cited by bankers are the persistently high risk of doing business, inadequate institutional capacity at banks to assess credit risks, vulnerable composition of banks' capital assets and inadequate regulations on bankruptcy proceedings.

On the other hand, businesspeople cite persistently high credit interest rates, high risks they are still facing in their business operations and unusually high collaterals demanded by banks to explain the condition.

All these issues point to the as yet fragile condition of the banking industry and the slow progress in structural reforms, including corporate debt restructuring and long-delayed amendments to the Bankruptcy Law.

As around 50 percent of the capital of the ten largest banks -- which account for more than 90 percent of the banking industry's assets -- still consists of government bonds, they should certainly be extra careful in issuing new loans, especially because most big businesses have yet to restructure their debts and operations have yet to become creditworthy borrowers.

Since under the current the bankruptcy proceedings borrowers are still in a more advantageous position than creditors -- just witness how extremely difficult and legally complex it is for banks to foreclose on collaterals or bankrupt recalcitrant big borrowers -- banks remain highly averse to lending to big businesses.

Consequently, most lending has so far been extended to small and medium-scale borrowers, notably consumers. This group of borrowers is considered less likely to put up a strong legal battle against creditors in case loans turn sour.

Put another way, creditors consider it much easier and less costly to foreclose on the collaterals of pledges by these borrowers than dealing with the big ones who, because they are usually protected by high caliber lawyers, prefer to resort to protracted legal fights.

However, such a development is not conducive for economic recovery, because small and medium-scale enterprises, however important their role, they still depend on big enterprises for basic or intermediate materials.

The problems in the credit sector are once again dictating how imperative it is for the government to accelerate the pace of structural reforms to reduce the risks of doing business.

In fact, the persistently high risks in the business sector not only pose serious threats to the banking industry, which has yet to complete its operational restructuring, but also to economic recovery.

If banks remain highly averse to new lending and instead prefer investing their funds in financial market instruments such as mutual funds, government bonds, Bank Indonesia deposit certificates and inter-bank market instruments, Indonesia's economic recovery will remain weak.

More threatening, however, is that these liquid assets can easily be turned into ammunition to attack the rupiah in case of weakening market confidence in macroeconomic or political stability.