Saving Bank BII

The Indonesian Bank Restructuring Agency (IBRA) has opted for what seems to be the least costly and least risky option to prevent publicly listed Bank Internasional Indonesia (BII) from going under, consequently putting out a spark that could have triggered a new banking crisis.

By guaranteeing Rp 12 trillion (US$1.2 billion) in BII credits to the Sinar Mas Group, instead of swapping the intragroup loans for government bonds, the agency in one stroke bolstered the bank's prospects for sound growth and, at the same time, saved the government a large amount of additional interest costs.

Not much information was immediately available on the agreement, as the complete details are still being worked out. But an earlier plan for IBRA to take over BII's loans and swap them for government bonds would likely have exacerbated BII's problems. Such a debt-resolution scheme would have met strong opposition from the House of Representatives, as the bonds to be exchanged with the loans would have further increased the interest on domestic debts, which for the current fiscal year already reach almost Rp 53.5 trillion.

Even if the plan was eventually approved by the House after lengthy and heated debates, BII might already have been too sick to be cured. The fate of the bank has been hanging in the balance over the past few weeks, and an increasing number of depositors have closed their accounts at the bank as the debt restructuring process became a public issue.

But the most damaging effect of the debt-bond swap would likely have been BII losing the largest source of income. The latest data shows the Sinar Mas debts account for more than 75 percent of the bank's outstanding loans that are classified by the central bank as current credits (with interest payments on schedule). Taking out the loans, which charge more than 18 percent interest a year, and exchanging them for government bonds that pay an average of 12 percent obviously would have slashed the bank's income at a time when it badly needs the revenue to replenish its capital to reach the minimum 8 percent capital adequacy ratio later this year.

At stake in BII is the government (taxpayers)'s investment of Rp 6.5 trillion, or the equivalent of 57 percent ownership of the bank, which was acquired when the bank was recapitalized in May 1999. Should the bank fail, the government not only would lose that investment but also would have to reimburse, under the government's blanket guarantee, third-party deposits at the bank, which recently were estimated at Rp 27 trillion.

However, because the government decided to guarantee the loans, BII will retain its earning capacity without having to put up a large sum of provisions, because government-guaranteed loans carry virtually no risk. While this scheme is not without risk to the government, the risk is much smaller than that inherent in the debt-bond swap arrangement. Sinar Mas core business--pulp, paper and palm oil--, though facing depressed international market at present, remain the most promising industry in Indonesia. Hopefully, the market would start to pick up before the whole debt has to be settled in 2003.

But by guaranteeing the loans, the government automatically assumes the credit risk, meaning that the government will pay the debts to BII if the Sinar Mas Group defaults. No wonder the government is asking for collateral from Sinar Mas worth 150 percent of the loans, including personal guarantees from the group's founders, the Widjaya family.

The trickiest problem, though, is how the government will scrutinize through a due-diligence audit any assets pledged by Sinar Mas to ensure the highest rate of recovery in case of default.

The Sinar Mas Group has been on the front pages of major newspapers in Indonesia and overseas almost every day over the past two weeks. The stories focus on the group's $1.2 billion in debt to BII and the $10 billion to $12 billion in foreign debts of Asia Pulp & Paper Co. (APP), the Sinar Mas holding company for its pulp and paper subsidiaries in Indonesia, India and China.

Though one of its paper-making units, PT Kertas Tjiwi Kimia, did make an eleventh hour bond-coupon payment of $30 million on Tuesday, thereby averting a possible default, the complex cross- guarantee arranged by APP for its debts still requires closer scrutiny. Analysts have warned that a default of one unit could trigger a cross-default of APP, bringing down all its subsidiaries and sister companies.