Stronger banking reform

Stronger banking reform

The flurry of bank merger plans announced over the past two
weeks should be welcomed as part of a broad program to strengthen
the banking industry. The steady plunge in the rupiah's exchange
rate since July and the quick increase in the amount of bad
credits since early this year warrant an equally steep rise in
the minimum capital requirement for banks.

The minimum capital requirement of Rp 150 billion for a
foreign exchange bank is meaningless since it now amounts only to
an equivalent of US$11.5 million. This tiny sum, besides being
negligible for a financial institution dealing in domestic and
international transactions, is not conducive to forcing
shareholders to be extremely prudent. Given the liquidity crunch
at present, mergers and strategic alliances with foreign banks
are indeed the best option for banks to strengthen their capital
base.

However, a merger in of itself is not a guarantee for
strengthening a capital base unless the merging banks are
required to strip themselves of their bad credit to ensure that
the assets of the new bank is based on internationally recognized
accounting standards regarding loan classifications, provisioning
and consolidation. A credible asset valuation is even more
essential to make the merged banks viable for a joint venture
with a foreign bank.

On the other hand, a strong capital base alone, though
necessary, is not enough to ensure the growth of a sound bank. It
is instead only one of many other elements which make up an
overall framework for a sound financial system.

We wonder, therefore, why the central bank, as the banking
supervisory authority, has not yet enacted stronger rules on
internal and external bank governance. The central bank must have
realized that the weak, nontransparent banking system is one of
the main causes of the persistent weakening of the rupiah to as
low as 15,000 against the American dollar last week. Given the
inadequate depth and breadth of our financial market, banks are
still the main pipeline of money, the life blood of the economy.

It should have been quite obvious that the closing of the 16
banks in early November, however bold it might have been, was
merely a small part of what is supposed to be an overall
restructuring of the financial sector. The liquidation should
have immediately been supplemented with stronger measures to
strengthen the capital, ownership, management and supervision of
the remaining 220 banks.

Shareholders should form the first cornerstone of a bank's
internal governance. A good bank can exist even under an
inadequate supervisory framework but a good bank can never emerge
under a bad system of ownership governance. Good management
starts with the owners and extends down to the management
executives and employees. Set against this principle, it was,
therefore, quite strange how the owner of one of the liquidated
banks could have so easily opened a new bank.

Government supervision of banks starts with a strong legal
framework in the form of internationally accepted standard
reporting, disclosure and accounting. But these rules cannot by
themselves produce high-quality bank supervision if their
enforcement is not managed by a central bank with technical
competence and political autonomy.

The situation is already quite critical. Domestic depositors
have now shunned most private national banks, preferring to put
their savings in foreign bank branches or offshore banks. Another
devastating condition is the tendency among many foreign banks to
stop honoring letters of credit issued by most Indonesian banks.
Letters of credit are the wheels of international trade and if
these wheels stop rolling, the doors of international trade would
eventually close to our companies precisely at a time when we are
severely strapped for foreign exchange to get out of the current
crisis.

It is not an exaggeration to say that most of our banks are
now living on borrowed time. Unless the government acts firmly
and quickly on the overall restructuring of the financial sector,
as stipulated in the reinforced reform package agreed with the
International Monetary Fund on Jan. 15, our economy is in for a
deeper crisis from which it may take more than a decade to
recover.