Tempest at Bank Mandiri

The protracted investigations into alleged lending fraud and bad governance at state-controlled, publicly-traded Bank Mandiri are aggravating the already negative market sentiment about the country's largest bank.

And in banking, sliding sentiment means serious money. The incessant wave of negative media publicity that began after public prosecutors began questioning the bank's executives three weeks ago, has thus far eroded the bank's market capitalization by almost Rp 10 trillion (US$1.04 billion).

A bank is an institution of trust and its operations are founded on public good faith and positive market perceptions.

The piecemeal release of information by public prosecutors each time Bank Mandiri directors were questioned at the AGO has nothing to do with a transparent process. The bad publicity has actually, it could be argued, created a distorted impression; that a large number of Bank Mandiri executives have committed lending fraud or colluded with corporate borrowers. Meanwhile, not a single Mandiri executive has yet been declared a suspect in any wrongdoing.

However, the damage has been done. New lending has practically dried up at the bank and many corporate clients have considered moving their accounts to other institutions. Potentially new customers, concerned about the manner in which bad credit was treated at Bank Mandiri, have decided instead to choose other banks.

Meanwhile, Bank Mandiri, according to its audited 2004 financial report, is a fundamentally sound bank. The bank's capital adequacy ratio almost tripled the minimum level set by the central bank and its non-performing loans of 7.1 percent were way below the maximum allowed by a prudential ruling. The bank booked a net income of Rp 5.2 trillion last year, up almost 15 percent from 2003.

We wonder, therefore, why the AGO did not coordinate with Bank Indonesia, the supervisor of the banking industry, when it followed up the findings of the Supreme Audit Agency's report on Bank Mandiri.

The tempest the bank is now encountering would not have occurred had the investigations been conducted without a prearranged bang of media coverage.

Having said this, we do not suggest that the auditors' findings about suspected reckless lending practices, lax risk management and fraud at Bank Mandiri should be treated lightly.

On the contrary, the findings urgently require quick and firm action on the part of the AGO regarding any white collar crime committed, while Bank Indonesia needs to speedily identify and rectify any problems with the bank's risk management system.

The auditors' reports did raise great concerns and validate our apprehension that state-controlled banks, after spending billions of dollars in taxpayers' money for their recapitalization, have yet to restructure their operations and develop a strong system of good governance with an effective internal control mechanism.

At issue here is the manner in which the AGO conducted the investigations and the technical competence of many public prosecutors assigned to the case.

While auditors may have detected several bad loans at Bank Mandiri, they must carefully and thoroughly analyze them so that investigators can distinguish between outright lending fraud or imprudent lending practices and bad credit that has turned sour because of unavoidable business risks.

Effective risk management should be a vital component in the operation of a bank because banking inherently entails taking a wide array of risks because of credit, market, interest rate, liquidity, operational and legal uncertainties. That is also why banks are subject to so many prudential regulations as set by the central bank as the supervisory authority.

Credit risk is one of the biggest of all the risks inherent in banking operations. Lending, which is the primary activity of a bank and is its main source of income, requires careful judgment of borrowers' creditworthiness, which may decline overtime.

Credit-risk management at banks should therefore be based on sound principles related to loan approval and administration procedures, internal loan grading and classifications. Connected or collusive lending could cause bad loans and consequently erode a bank's capital base.

Bank Mandiri, according to the auditors' reports, had been lax in its assessment and monitoring of several big creditors. The auditors also concluded that the bank was careless in monitoring the quality of their collateral.

The AGO and Bank Indonesia need to cooperate to establish whether the lax risk management and reckless lending practices were caused by collusion between a few crooked credit officers or analysts and borrowers, or by inadequate system of risk management, including deficient internal controls.

If the latter turns out to be the case, we then have another, even greater worry -- the inadequate supervisory capacity on the part of the central bank, stemming either from technical incompetence or the questionable integrity of Bank Indonesia's bank supervisors.