Warning on banks

Analysts and bankers have again warned that despite significant improvements in the key indicators of most banks, the banking industry remains fragile and highly vulnerable to shocks.

The average capital adequacy ratio or CAR (the ratio of capital to risk-weighted assets) has increased markedly to 26 percent, non-performing loans (on a net basis) down to 1.1 percent, loan to deposit ratio up to almost 42 percent and lending up to more than 10 percent over the past nine months.

However, analysts and even bankers themselves contend that the capital standards (CAR) of the local banks would not have been as high as claimed if they were measured fully against the 25 core- principles of the Basel Capital Accord of the Bank for International Settlement, let alone against operational and market risks.

This means that most Indonesian banks, which have spent the equivalent of more than US$75 billion in taxpayers' money for their restructuring and recapitalization, have yet to meet international capital standards.

Yet more worrisome is that almost 50 percent of the banks' core capital still consist of government bonds.

Most banks have yet to fully restore their financial- intermediation function to help accelerate the rate of economic recovery. The 10 largest banks, which account for more than 70 percent of the industry's assets, still depend on government bonds, Bank Indonesia's promissory notes (certificates of deposits) and the inter-bank money market for almost 50 percent of their earnings.

If banks remain highly averse to new lending and instead prefer investing their funds in financial market instruments such as mutual funds, government bonds, Bank Indonesia's certificates of deposits and inter-bank market instruments, the economic recovery will remain weak.

Still more threatening is that these liquid assets can easily be turned into ammunition to attack the rupiah in case of weakening market confidence in macroeconomic or political stability.

The government White Paper on the reform agenda after the end of the International Monetary Fund program later this year, stipulates six sets of reform measures to be taken in the financial sector. But it would take some time before banks could significantly expand their lending operations, given their inadequate institutional capacity to assess credit risks, the persistently high risks of doing business and the corrupt system of bankruptcy proceedings.

Needless to remind the government (Indonesian Bank Restructuring Agency) and the central bank of the imperative to be extra careful in supervising banks in view of their dominant role in the financial service industry, as banks account for nearly 91 percent of the total assets of the whole industry.

The banking industry is especially vulnerable to systemic risks because the ten largest banks alone control almost 70 percent of total banking assets and the quality of their risk management is still way below international standards .

Also challenging is that most banks, which before the 1997 economic crisis were riddled with corruption and collusive practices, have yet to enhance an organizational culture which ensures compliance with laws, rules and standards.

Take for example, the recent disclosures of the Rp 1.7 trillion ($200 million) lending scandal at state-owned Bank BNI and the Rp 50 billion lending scam at state-owned Bank Mandiri, respectively the second-largest and the largest banks in the country.

That such lending scams could have taken place at the largest banks with such tough disclosure requirements for such a long time without being detected by an internal-control mechanism simply reflect upon the utterly poor quality of their risk management.

The lending scams showed how poor the banks' know-your- customer (KYC) standards had been, as an essential element of risk management. The scandals also illustrated that bank executives with crooked mentalities had so easily violated the KYC principles and that their internal-control system had been inadequate.

All this further validates the great concern over the fragility of most banks, even those listed on the stock market and subject to tough disclosure requirements. Most banks, it seems, have yet to enforce strict compliance with laws, rules and standards by all employees, and the central bank is required to improve the effectiveness of its bank supervision.