Rating bank soundness
Rating bank soundness
The new rules enacted by Bank Indonesia last week on the
rating of the soundness of commercial banks are designed to
strengthen the foundation of the banking system, even to the
extent of banishing a number of the 239 banks now operating.
The tougher requirements for achieving a sound rating will
force bank owners to increase their equity capital, thereby
staking out more of their own assets. If the bankers are not
willing or not able to do so they will have to merge their banks
to survive in the market. The new rulings also put stronger
pressure on bank managements to hold firmly to prudential
operations.
Banks which fail to achieve a sound rating will eventually be
edged out of the market because they will be shunned by the
public and the central bank will deny them the permits
to expand branches and upgrade to foreign exchange banking
operations. But a quicker process of getting rid of unsound
banks, irrespective of the political backing of their owners, is
still needed to give stronger teeth to the recent government
regulation on the procedures for bank liquidation.
Bank Indonesia apparently believes there are now too many
small and weak banks which, if allowed to operate in their
current condition, could affect the public's trust in the banking
industry. Unlike other kinds of businesses, a bank failure can
set off systemic risks with far-reaching repercussions on
monetary stability. In fact, the central bank is now coping with
a number of problem banks.
The new rating rules should be seen as part of an ongoing
reform process conducted by the central bank to further
consolidate the banking industry and remove the excesses of the
1988 massive banking deregulation which has almost doubled the
number of banks to 240 at present.
The rating remains based on international standards such as
capital adequacy, asset quality, management, liquidity, legal
lending limits and net open position in foreign exchange but
realigns the emphasis on several indicators to obtain a more
reliable assessment of soundness.
For example, the yardsticks to assess the quality of assets
were amended to prevent banks from carrying assets of a
questionable quality. The objective is quite obvious. It is not
only misleading to the general public but also meaningless for
assessing soundness if banks are allowed to book loans or
investment in securities which are not backed up with sufficient
provisions. Further down the line, the capital standards of a
bank are also influenced by the quality of its assets. A capital
adequacy ratio will have no meaning at all if the ratio is based
on assets whose quality is doubtful.
Legal lending limits or related-party lending -- lending
directly or indirectly to borrowers associated with the
shareholders -- have been given stronger scrutiny. This
apparently has been prompted by the central bank's experiences
with problem banks. Most of the problem banks have been driven to
financial distress not by fiercer competition but by plundering
by their own majority shareholders who made or countenanced
unwise lendings to their own business group.
The latest case in point is the almost bankrupt Bank Pacific
which is still in the process of being bailed out by the central
bank through a merger or acquisition by new investors. The new
rules also pay more attention to the quality of financial reports
by downgrading the rating of banks found to make window dressing
to embellish their bottom line.
The new rules therefore should not be seen as restrictive
regulations amid the current era of deregulation but as much-
needed prudential principles to improve the international
competitiveness of the banking industry. With economies
increasingly interdependent and huge capital flows, disruption to
a national banking system poses a risk to the entire
international financial system.