Weak bank management

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.