Resolving SME bad loans

Resolving SME bad loans

The government will most likely resist strong political
pressure to take populist measures against restructuring bad
small and medium enterprise (SME) loans, thereby refusing to
unilaterally set across-the-board discounts on debt principals
and interest.

The final draft of the presidential decree that will be issued
soon and will serve as the legal framework for the restructuring
of more than 414,700 SME debts worth about Rp 39 trillion (US$4.3
billion) demonstrates a strong policy consistency and will
enhance credit culture among the business community.

The presidential decree will outline only the basic principles
on restructuring SME debts, defined as loans below Rp 5 billion,
and set the timeframe in which the debt workout process has to be
completed. It will authorize the ministers of finance and state
companies to iron out the technical guidelines for banks and the
Indonesian Bank Restructuring Agency (IBRA) on how they should go
about resolving bad loans.

Had the government succumbed to political lobbying to
unilaterally set big discounts on the debts and apply them
across-the-board for all SME debtors, the policy would have
boomeranged on the SMEs, because banks would refrain from
extending new loans to them.

That would have also amounted to excessive intervention into
banks, which would be in contravention of the November 1998
directive of the central bank's board of governors on the basic
guidelines for loan restructuring.

Such a populist measure would have also damaged credit culture
among the business community and dispirited other SME borrowers
who have worked hard to meet their obligations.

Yet more damaging is the fact that automatic and across-the-
board haircuts on debt principals and interest payments would not
be fair to taxpayers, who would have to bear the losses resulting
from such a discount policy because quite a number of the bad
debts are consumer loans owed by rich debtors.

In fact, since almost all of the SME debts were extended
before the November 1997 banking crisis when the rupiah exchange
rate was still around Rp 2,400 to the U.S. dollar, quite a
portion of them were not SME loans by Indonesian standards.
Moreover, in view of the go-go lending practices that were quite
common among the banks before the banking crisis, many of the SME
loans presumably went to well-connected businesspeople who used
them for such consumptive spending as buying luxury cars or
property overseas.

For example, Bank Danamon and Bank Artha Graha, which bought
SME debts worth Rp 4 trillion through an auction by IBRA in 2000,
found that many of the debts were consumer loans related to
credit card billings.

Having said all that, we do not mean to argue against
granting big discounts on SME debts, nor to belittle the urgency
and importance of restructuring SME debts.

On the contrary, quickly resolving the bad loans is crucial
to strengthening economic recovery, given the large number and
size of the SME workforce.

It is entirely unfair to let them bear the full cost of the
political and economic crises that caused bank interest rates to
astronomically skyrocket to as high as 80 percent and depreciate
the rupiah exchange rate to as low as Rp 15,000 to the dollar in
1998.

Moreover, since IBRA has disposed of hundreds of trillions of
rupiah in large bad debts with discounts of more than 70 percent,
there is no reason whatsoever why SME debtors do not also deserve
haircuts of at least an equal amount.

The key issue here -- and this is the responsibility of the
ministers of finance and state companies who will issue technical
guidelines within one month for SME debt restructuring -- is to
ensure that only SME loans that were used for productive business
activities and mortgages for low-cost houses will be entitled to
discounts, lower interest rates and longer maturities and, if
necessary, refinancing facilities.

Restructuring SME debts into new loans with lower interest
rates and longer maturities and refinancing viable SMEs with new
working capital loans will help restore these businesses to more
profitable operations, increase their production rate and hence
spur employment, and consequently empower them to service their
debts.