Weak bank management

The first line of defense against unsound banking is competent management with high integrity, but it is this fundamental asset that seems to be severely lacking at state Bank BNI, Indonesia's second largest bank.

Preliminary findings of investigators looking into the US$200 million lending scam at the publicly listed bank reveal how weak management, inadequate internal controls and weak supervision by the central bank allowed senior bank executives and businesspeople to collude in the bilking of Bank BNI through a lending scam between last October and July.

It is amazing to think that such a large credit scam could have taken place at the bank over such a long period (more than eight months) without being detected by the bank's internal auditors or members of its board of directors. We do not believe that honest mistakes, technical incompetence or a lack of expertise on the part of bank executives had anything to do with this scam.

The modus operandi used to rob Bank BNI was very simple, easily detected by even new bank executives. The transactions for export financing loans that were secured with letters of credit (L/Cs) were very crude, using only bogus export documents to deceive bank executives. All foreign-exchange banks have established procedures for the processing of export financing loans and for verifying L/Cs issued by overseas banks.

But, as investigators have found, Bank BNI executives appeared to have disregarded all the standard procedures and rules regarding such lending transactions. Surprisingly, these deals also escaped the scrutiny of internal auditors and directors, as well as supervisors at Bank Indonesia, who are supposed to conduct both on-site and off-site inspections of banks.

Lending procedures do not appear to have been the only rules disregarded by Bank BNI executives. They also violated the know- your-customer standards, with a major recipient of the loans a businessman notorious for his involvement in questionable deals at the now defunct Bank Pacific. Even more painfully surprising is the fact that the borrowing company turned out to be a completely new customer to Bank BNI.

These practices are blatant violations of the policies and procedures for accepting corporate customers, for identifying new customers and for monitoring customer account activities.

Even more puzzling is the fact that Bank BNI, as a publicly listed company, is required to have a compliance director specifically in charge of ensuring the bank fully complies with the laws, rules and standards set both by the bank itself and the central bank.

Also discouraging from the perspective of an overall banking supervisory system was the reaction of Bank Indonesia, as the main authority for bank supervision. Bank Indonesia Senior Deputy Governor Anwar Nasution immediately blamed the lending scam entirely on Bank BNI executives, without first examining how the central bank's supervisors failed to detect the fraudulent credits early on.

Bank BNI, besides being subject to tough disclosure requirements by the capital market watchdog, also is obliged to publicly issue quarterly financial reports comprehensive enough for supervisors to sniff out such scams. Bank Indonesia's supervisors assigned to oversee Bank BNI were either so incompetent as to be unable to smell the scandal or deliberately condoned the scam for personal benefit.

The government is finally getting to the bottom of the lending scam and working to contain the damage, but the bad practices at Bank BNI have caused great concern over the quality of governance within the still fragile banking industry and the capability of the central bank's supervisory and regulatory systems.

We are now worried that there may be more "time bombs" within the banking industry, which was bailed out with more than $75 billion in taxpayers' money just four years ago.

Issuing prudential regulations, policies and other operational procedures to ensure sound banking operations is one thing, but enforcing them is quite something else and requires not only technical competence but also, more importantly, integrity.

Quantitative regulations cannot ensure that a bank is soundly managed. Bank managers and bank supervisors must possess a great deal of integrity, adequate training and the experience to do the job.