Tempest at Bank Mandiri

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.