RI needs credit clearing body

By C.J. de Koning

JAKARTA (JP): When a client puts money in a bank in Indonesia, or anywhere else in the world, he or she expects the bank to act in an honest, trustworthy manner. The money must be secure and safely looked after. When a bank lends money to a client, this same trust is or should be the key to the bank's client relationship. Honesty toward the depositors and by the borrowers is the lubricating oil on which the financial system in any country operates.

Honesty is not a financial or an economic factor. It reflects the character of the individual or the organization. During Indonesia's current financial crisis, the calls for more honesty have been strong, and culminated in the democratic election of the current government.

Why is it that so little attention has been paid to the interrelationship between individual and corporate honesty and the economic and financial policies that have been pursued over the last two years? Could policies that encourage honesty contain the seeds for faster economic growth?

In June 1997, just before the financial crisis started, the volume of outstanding credits -- the lending side -- of the banks was about US$315 billion. Foreign banks provided some $140 billion and local Indonesian banks the equivalent of some $175 billion. The clients for the foreign banks were the Indonesian government with $60 billion, local banks with some $15 billion and Indonesian corporates with some $65 billion.

All these credits were foreign currency credits, mainly in U.S. dollars.

The clients for the local banks were local corporates and local individuals and the principal currency of lending was the rupiah.

On the funding side -- the depositor side of the banks -- the picture looked similar, but one has to be aware that the $140 billion represented foreign savings ploughed into the Indonesian economy. Financial investors had simultaneously built up a market capitalization of the Jakarta Stock Exchange which reached the equivalent of $100 billion at the same time, approximately half of which was provided by foreign investors. The experience of foreign banks was a loan-loss ratio very much in line with other Asian markets. In comparison to other markets, there was certainly no additional risk premium for exceptional dishonesty among Indonesian clients.

After the Thai baht devaluation and the subsequent changes in Indonesia's exchange rate policy, which opened the door to unhindered rupiah fluctuations, foreign banks reassessed their volume of lending and the risks associated with this volume.

They started to withdraw from U.S. dollar lending to Indonesian corporates, something made easy by the short-term nature of many loan agreements and the ratios on capital adequacy incorporated in many of them. The Indonesian government called on the International Monetary Fund (IMF) for help. Sixteen small local banks were closed on Nov. 1, 1997.

This had a profound effect on the trust that local depositors and foreign banks had placed in the Indonesian banking system. It ended up with a blanket volume guarantee (principal plus interest) for the local depositors from the Indonesian government and the repayment of all international trade finance obligations of all non-performing local banks to foreign banks, again by the Indonesian government.

The impact that a change in the level of trust can have upon the volume of outstanding international trade finance can be illustrated by the fact that this volume fell from some $13 billion in September 1997 to $1 billion a year later. Just as striking is the reduction in the size of the market capitalization of the Jakarta Stock Exchange. It dropped from $100 billion at the end of June 1997 to $14 billion a year later.

The volume reduction that both foreign bankers and foreign investors on the Jakarta Stock Exchange were seeking, temporarily far outstripped the short-term capacity of Indonesia to generate foreign currency earnings. The country also did not have the foreign currency reserves to absorb such outflows.

The result was a dramatic rupiah devaluation. The government's policy response was raising rupiah interest rates to over 70 percent per annum. This not only raised the interest rates on deposits, but, of course, also on the rupiah loans.

With local incomes declining for nearly all individuals and for corporates, the effect was a massive move from performing to non-performing loans. A recent estimate put the cost of local non-performing loans at the equivalent of $75 billion, which is more than the 1997 year-end total local banking sector ($68 billion).

It will probably remain an eternal mystery why in the context of the outstanding loan volumes, the government chose to raise rupiah interest rates rather than Indonesian borrowers' U.S. dollar interest rates.

After all, the financial crisis was brought about by a very substantial reduction in dollar lending and portfolio investment volume and not by an excessive growth in rupiah lending.

Indonesia also did not use another policy option which was to underpin the local equity market. Both Malaysia and Hong Kong applied this measure, and in retrospect with substantial success.

Last but not least, the IMF funds made available neither restored the foreign lending volumes to Indonesia's corporate and banking sectors, nor restored orderly rupiah credit markets.

Indonesia still needs foreign and domestic funds if it wants to return to former economic growth levels.

The way forward can never be to bring half the Indonesian population and nearly all companies to court. Court action is needed for those who abuse the system and act dishonestly. For those cases, a proper functioning bankruptcy court is a must. However, the illusion that by having a court, the volume of lending will grow again should not be created. Lending -- just like deposit-taking -- is closely associated with honesty in the banking system. There are ways in which honesty can be encouraged rather than the no-win behavior of running away from previous obligations.

The key consideration is that most companies and individuals want a financial future as well as recognizing that they have a financial past. Of course, the past situation will have to be agreed upon between the lender and borrower, but this does not automatically restore normality.

The future may be strongly supported by setting up a system that follows the current behavior of both companies and individuals. As Indonesian companies and banks were, are and will be very dependent on U.S. dollar loans, a first initiative may be to set up an Indonesian Credit Clearing Corporation.

This corporation, which may be run by an independent international auditing firm, could be the country's international payment clearing agent for all payments in foreign currencies which arise out of international credit in whatever form. In other words, only cash payments for immediate delivery of goods and services are to be excluded. The feeders to this system could be the foreign banks involved in lending to Indonesia or in arranging finance for Indonesian borrowers in the capital markets.

Second, Indonesian borrowers could also be requested to register.

The potential benefits are clear. The volume of international borrowing can be followed very precisely and instantly. Second, the companies that do pay on time can be "white" listed, which means they can be made available on request and with the approval of the borrower to the foreign bank or banks with which the company plans to enter into a banking relationship. Companies that have agreed with their foreign bankers on a debt restructuring and are fulfilling their payment obligations can once again be "white" listed rather than blacklisted. It is in the interest of any company that wishes to use foreign credits, to get its name on the "white" list as soon as possible. Companies that wish to have a financial future will do so.

For domestic borrowers, especially individuals, it is also important that the past is settled as soon as possible. A well- established tradition in other countries -- for instance in Brazil and in the Netherlands -- is to have a Bureau of Credit Registration. The function is essentially the same as the proposed Credit Clearing Corporation, which is to know and make known to relevant banks whether the person is on time with his payments.

The difference between the Credit Registration Bureau and the proposed Clearing Corporation is that in the latter case the payment settlements are also channeled via the corporation. This is not the case for the bureau.

Both "white" lists encourage orderly credit behavior; they promote honesty and transparency in the banking system. In the current times of banking disorder, they could prove to be the fastest way to create order again.

The writer is a director of ABN AMRO Asset Management in London.