The privatization of state controlled banks

The privatization of state controlled banks

Anwar Nasution, Senior Deputy Governor, Bank Indonesia, Jakarta

Privatization and divestment of state assets (state-owned
enterprises and IBRA controlled assets) are the most feasible way
of fueling economic recovery and improving economic efficiency.
This is because the private sector can manage the productive
assets more efficiently than the state.

The high burden of both external and domestic debt services,
and an inefficient and inflexible tax system, limit the
capability of the government to stimulate the economy by
expanding non-debt expenditures. At present, servicing costs of
government debt account for nearly one third of government
spending. Domestic banks are unable to resume their intermediary
function as they are recuperating from financial distress.

From the macroeconomic point of view, the proceeds from the
sales of state controlled banks (and other assets) to the private
sector can be used to finance the budget deficit. The sales would
generate foreign exchange for financing balance of payments
deficit if the buyers were foreign investors. The resumption of
bank lending activities spurs economic activities. The push for
economic growth is higher if there is an increase in bank
efficiency and productivity after the takeover by the private
sector.

Sales of the state owned and IBRA-controlled banks could also
help these banks cure their internal weaknesses due to the long
period of financial repressions of the past. The new owners will
provide the badly needed additional capital and liquidity to
resume their lending activities.

If the new owners were internationally reputable banks, they
could also increase market competition in the banking industry,
upgrade technology and skills of human resources, modernize
internal system and improve their corporate culture. The presence
of international investors expand international network and
improve business confidence on the economy.

Judging from the number of banks, branch offices and total
assets, the state dominates the banking industry. The state owned
and controlled banks include the four state-owned banks, IBRA
banks and BPDs (Bank Pembangunan Daerah). As of September 2001,
the state owned and controlled banks controlled over 60 percent
of bank branches and 77 percent of total assets of the commercial
banks.

The four state-owned banks (Mandiri, BRI, BRI and BTN)
controlled 26 percent of bank branches and over 48 percent of
total assets. The seven IBRA banks (BCA, Bali, BII, Danamon,
LIPPO, Niaga and Universal) controlled about 30 percent of
branches and 25 percent of total assets. The group of 26 BPDs had
12.7 percent of branches and four percent of total assets. The
supply side approach adopted in the past requires state-banks to
expand branch networks to provide credit for financing government
programs all over the country.

As of September 2001, state banks and BPDs controlled 78
percent of bank deposits, 68 percent of bank loans, 57.5 percent
of foreign exchange assets of the commercial banks and 61.6
percent of banks' foreign exchange liabilities.

Most of the portfolios of the state-owned and controlled banks
are in forms of recap bonds and Bank Indonesia Certificates (SBI)
and only small fractions of their portfolios are in loans. A
significant portion of their income also generated from
government bonds and SBIs. These indicate that these institutions
are mainly operating as depository of illiquid recapitalisation
government bonds than normal banks.

As of September 2001, nearly 53 percent of assets of state-
owned banks were in recap bonds, over 3 percent in SBIs and 31
percent in loans (before provisioning). The figures for IBRA
banks were correspondingly 48 percent, 5.8 percent and 26.2
percent. The BPDs loans are primarily in form of personal loans
to employees of local governments, their owners.

Mainly because of massive injection of government bonds all of
state-owned banks and nearly all IBRA controlled banks have
capital adequacy ratios (CARs) in excess of the minimum 8 percent
mandated as of January 2002.

Around 40 percent of the recap bonds carry fixed rate interest
rates of 12 percent-12.25 percent per annum. At present high SBI
interest rates, the recap bonds are traded around 75 percent of
their book values. The inadequate liquidity limits banks'
capability to either lend or lower interest rates. The average
loan to deposit ratio (LDR) of all banks was relatively low at 35
percent in October 2001. The state-owned bank group has the
lowest LDR at 28 percent.

Despite massive transfers of bank dud loans to IBRA, non
performing loans (NPL) remain high. Gross NPL of banks amounted
to 14.4 percent in October 2001, compared to nearly 60 percent
during the crisis in 1997-1998.

To lure foreign and domestic investors to take over the state
owned and controlled assets, Indonesia needs to restore social
stability and create clime and environment that are conducive to
protection of private property rights.

These, among others, require major changes in our philosophy
about the role of state in development. Indonesia has a long
history and extensive record of state interventions, inward-
looking trade and investment regimes, financial repression, a
large state-owned enterprises and patrimonialism. The role of the
state in the market economy should now be mainly as regulator to
protect interests of general public and correct asymmetrical
transformation of market information and other market
distortions.

To protect property rights and avoid uncertainty, unilateral
changes, delay and cancellation of existing agreements and
contracts with the buyers, such in the current case of PT Semen
Gresik, should be avoided. Such a unilateral action of breaching
the agreements is similar to nationalization of ownership.

The solution to communal land, new relations between central
and local governments and between the government and the people
should be settled internally as they have nothing to do with
foreign investors. Protection of property rights also requires
improvements in legal and judicial system.

People perception and fear that neo-colonialists are coming
back through acquiring the state assets are baseless. Penetration
of foreign banks in Indonesia's domestic markets is still
relatively small as compared to those in neighboring countries.

At present, foreign and joint venture banks group only
controls slightly over 3 percent of capital of the commercial
banks, 12.4 percent of their total assets, 11.4 percent of
deposits and 20 percent of credit.

Again, the presence of foreign banks are badly needed to
strengthen the capital and liquidity of domestic banks, to
modernize their technology and internal system and governance, to
upgrade skills of human resources and change their corporate
culture. Foreign banks are training ground for many of our
bankers. The presence of foreign investors in domestic banks
regain confidence including confidence in their management.

To reap the benefits of privatization we should adopt the best
practices to do it. Selling off the state owned and controlled
banks directly to foreign strategic investors may be the best
solution to solve their crisis overhang and generate revenue for
state budget.

We should avoid the comeback of rent seeking activities widely
practiced during the long period of the Soeharto regime.
Privatization and deregulation under the Soeharto regime was
merely transfer of monopoly rights from the state to the
politically well-connected individuals at far below market
prices.

The above article is based on the writers's presentation at a
recent seminar held by the CastleAsia group.