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.