Strong anchor for banks

The criteria for national anchor banks that was announced by Bank Indonesia last week will accelerate the pace of consolidation of the 132 banks into a sound, strong and efficient, yet leaner banking industry through mergers and acquisitions.

The sets of qualitative and quantitative requirements are so comprehensive that most of the existing banks will need to merge with bigger ones in order to survive as national-class banks, or convert into specialized or rural banks with tight restrictions on both their scope of business and their location. Only an anchor bank will be eligible to acquire other banks and to operate nationwide.

These stringent requirements, combined with the phase out of the government's blanket guarantee on bank deposits and claims that will start next year, will unleash stronger market forces to screen out weak or under-performing banks.

The central bank said none of the 132 banks had fully met all the requirements for national anchor banks, but 40 of them had the potential to do so, meaning that they had already met many of the criteria.

The directives on the qualifications to become a national anchor bank are part of the framework of guidelines set for speeding up the implementation of the 2004 national bank architecture, which the central bank considered too slow.

The bank architecture, scheduled to be fully implemented by 2014, imposes even much tougher requirements in order to be qualified as a national and international class bank. Based on this design, the national banking landscape will feature only two to three international-class banks with capital exceeding Rp 50 trillion (US$5.13 billion) and three to five national anchor banks with capital ranging from Rp 10 trillion to Rp 50 trillion.

Thirty to 50 smaller, specialized or focused banks with capital ranging from Rp 100 billion to Rp 10 trillion, and thousands of rural or community banks with capital less than Rp 100 billion will supplement the national anchor and international-class banks.

However, higher capital standards, though very important, are not sufficient to build a sound, strong and efficient bank because, as the recent discovery of huge numbers of bad loans at the country's largest bank showed, effective risk management is the key to sound operations.

The central bank, therefore, has rightly set two layers of criteria for a bank to become a national anchor bank. The first layer features requirements to become a well-performing bank that includes a minimum core capital of more than Rp 100 billion, a good governance system, effective risk-management and a minimum capital adequacy ratio (CAR) of 10 percent.

The second layer covers a minimum CAR of 12 percent, minimum return on assets of 1.5 percent, credit growth of 22 percent, loan to deposit ratio of 50 percent, ratio of bad credit to total lending at 5 percent, and being listed on the stock exchange.

These two sets of criteria actually support each other. Good corporate governance is the foundation for developing effective internal control systems and a reliable risk management. Big capital is necessary to enable a bank to provide lifeblood to the economy and a bank must make reasonable earnings to further strengthen its capital and expand its operations. Effective risk management is pivotal for banks as banking inherently involves taking a wide array of risks.

The requirements for becoming an anchor bank are so tough that one may rest assured that the country's banking landscape will consist only of sound and strong banks.

This is, however, correct only on paper. The criteria are meaningless without proper enforcement and this in turn is possible only if the central bank, as the supervisor of the banking industry, is capable of conducting effective supervision.

Effective supervision requires Bank Indonesia's supervisors to be well appraised of the decision-making structures and operations of all banks. Only well-informed supervisors with high integrity will be capable of assessing, from time to time, the integrity and competence of bank management and understanding the risks taken by banks and their current and future profitability and earnings.

Recent cases where lending frauds and other banking crimes went undetected for almost a year shows how the central bank has to work much harder to improve the technical competence and integrity of its bank supervisors.