Reforming the banking system

Reforming the banking system

The following is the first of two articles by I Putu Gede Ary
Suta, the former chairman of the Indonesian Capital Market
Supervisory Agency. It is based on his presentation at the
launching of his two new books Foundations of our Capital Market
and Menuju Pasar Modal Modern (Toward a Modern Capital Market) on
June 22 in Jakarta.

JAKARTA: We are in the 35th month of a serious crisis. Those
with resources still visit luxury shops in Senayan Plaza, but
ordinary people are facing hard times. Teachers, factory workers
and soldiers, among others, must support families on an income
depleted by inflation. Millions are jobless. Sectarian violence
and strikes have become routine. College graduates are entering
the ranks of the unemployed.

It would be nice to be able to say that there is a light at
the end of the tunnel and that foreign investment, which is so
necessary to growth, is returning. Some believe that with
positive statements, our troubles will vanish. If only it were
so. Road shows, seminars and optimistic forecasts cannot change
reality. Words may fool some -- for a while -- but permanent
money flows depend on convincing those whose job it is to be
skeptical.

It is fashionable to blame the crisis on the International
Monetary Fund (IMF). The IMF has prescribed medication that seems
to have done more harm than good. However, let us not forget that
every letter of intent signed with the IMF has had two parties.
Certainly, as a sovereign nation, those who have accepted these
policies on behalf of Indonesia are as responsible as the IMF.

Many suggest that the situation will improve when civil
violence stops and political stability returns. But this confuses
cause with effect. Riots and political upheavals followed -- not
preceded -- the banking crisis. A defective banking policy was
the cause. Violence and political turmoil were the effect.

The international media tells us that foreign investors have
turned away from Indonesia. Some funds will flow into the
country, even in the worst of times. However, the amount of the
investment falls short of what is needed to sustain growth and
provide jobs for our people. A recent economic report of a major
international bank has characterized our nation as "teetering on
the brink" and is representative of current opinion.

Nevertheless, there are still optimists that consider any
fractional improvement in economic statistics is a sign of
recovery.

Some say that unless the problems which caused the crisis are
fixed, the country is in for even worse times. Whether or not
this is so, the country cannot risk a wait-and-see policy. We
cannot afford the luxury of a learning curve for economic policy.
A rethinking of some economic planning is now necessary. Some
policies, especially with respect to banking reform, are not
working.

There is no mystery as to the cause of our current troubles.
The economic system collapsed because of a corrupt and
inefficient banking system. Government-controlled banks
distributed people's money in massive amounts to financially
unsound schemes of cronies and relatives of those in power.

Private banks, owned by economic conglomerates, used
depositors' funds for personal benefit, ignoring the fiduciary
responsibility of sound banking and exhibiting deplorable
business ethics. Foreign creditors and bankers channeled billions
of dollars of short-term hard currency loans to dubious, long-
term, rupiah-based projects that could not be repaid.

In August 1997, the house of cards collapsed. The government
announced the end of support for the rupiah. Foreign debts were
not repaid and foreign investment ceased. There were runs on
banks, causing the government to guarantee deposits, thereby
indirectly assuming the burden of bad loans which were the result
of unethical conduct by the nation's bankers.

It was clear at the time, as it is today, that a defective
banking system was to blame for our woes. The cause was not just
a few bad banks or bad bankers, but a whole system based on
flawed policies.

However, the remedies prescribed by our economic advisors have
been directed to secondary problems -- the effects rather than
the causes. We have yet to build the clean and sound banking
system that is needed. Let's look at the facts.

First, instead of privatizing state banks, thereby removing
the temptation of corrupt lending for political purposes, we have
increased the number of government-controlled banks, insuring the
continuation of practices that brought about the crisis.

If money is the mother's milk of politics, state banks are the
cash cows that feed our political system. Most government
officials and politicians cannot even conceive of a nation
without state banks. Does anyone really believe that it was the
IMF and not our own officials that insisted on recapitalization,
rather than privatization of state banks?

Second, instead of rigorously separating ownership of private
banks from borrowers and putting banks on a professional basis,
there is an eagerness to return banks to their original owners --
as long as they raise the capital to repay government loans.

Bankers should stick to the banking business and should not be
preoccupied with channeling depositors' funds to their own
enterprises. When bankers approve loans based on impartial and
skeptical analysis of credit, the overall quality of loan
portfolios will improve.

In the United States, which has one of the most successful
economic systems, laws rigorously separate bankers from
borrowers. The cost to our nation for not making this separation
has been severe, and the price may even be greater if we do not
exercise wisdom in making the necessary reforms.

Third, instead of recapitalizing sick banks with real money
which could be loaned to businesses and provide people with jobs,
we have performed cosmetic surgery by artificially writing up the
capital accounts of banks with overvalued, nonmarketable
government bonds.

It is obvious that these government bonds must be redesigned
if they are to be sold, but Bank Indonesia has fiddled and
delayed for over a year and still shows no sign of understanding
how to solve a problem that would be routine to any competent
investment banker.

Of course, foreign bankers and investors can see what is
happening. It is possible to fool some people with misleading
statistics and half-truths, but we cannot fool the market for
long. If optimistic statements were the solution, we would be in
prosperous times. The banking system is broken, and effective
measures have not yet been taken for true reform.