Weak banking supervision

The preliminary findings of the investigations into bad banking practices which led into the closure of two small banks -- the Denpasar-based PT Bank Dagang Bali (BDB) and Jakarta-based Bank Asiatic -- by Bank Indonesia on April 8 raised great doubts about the integrity and technical competence of the central bank's banking supervision department.

We also have great doubts about the seriousness of, and coordination among, law enforcement agencies in dealing with those suspected of banking crimes.

The National Police had not even been able to apprehend Bank Asiatic's controlling owner, Ton Muk Keung, and had had to put him on their wanted list two weeks after declaring him a suspect. But suddenly National Police Director of Economic and Specific Crime Division Brig. Gen. Samuel Ismoko told reporters last Thursday that there was not enough evidence to implicate Tong in the case.

How could the controlling owner of a bank have not been aware of such big lending frauds at his own bank? How could such a banker have passed the fit-and-proper test of the central bank?

Latest developments around the case also raised big questions about the reliability of Bank Indonesia's claim that it had taken precautionary legal measures against the directors and shareholders of the two banks and their assets ten days before the banks were finally closed down on April 8.

We even doubt now that the value of the assets of the banks and their controlling owners that Bank Indonesia foreclosed on will be sufficient to recoup the government money (read: taxpayers' money) already used to reimburse depositors.

Bank Indonesia's Senior Deputy Governor Anwar Nasution explained last week that the central bank should be commended for closing the banks because the drastic measure reflected the effectiveness of its banking supervision. He admitted, though, that there had initially been inadequate coordination between Bank Indonesia supervisors in Jakarta and Bali in dealing with the two banks.

However, the results of the preliminary investigations into the two defunct banks reveal how the management and controlling owners of the two banks had being ignoring almost all the regulations on prudential banking operations since 2001 and yet the central bank failed to act firmly to resolve the problems.

We find it hard to understand why Bank Indonesia waited more than two years after finding indications of legal lending limit violations and the falsification of bond transactions at BDB in mid-2001.

The central bank not only should have put the two banks under special surveillance but also have conducted investigative (forensic) audits on their operations as early as 2002 given that the banks were controlled by families who are related through marriage and the controlling shareholders had a widely diversified range of business interests.

In most other countries, banks that are part of business groups are always subject to special scrutiny because there are usually pressures on the management to direct a significant portion of their lending to associated entities, making it extremely difficult for banking supervisors to evaluate the credit quality of loans and collateral.

Special surveillance is also mandated in family-controlled banks because concentrated ownership has a mostly bad influence on management, whereas the first line of defense against unsound banking is competent management. Bank Indonesia itself had witnessed how BDB shareholders had so often reshuffled the bank's management.

We also doubt the integrity of the central bank's supervisors given their long forbearance in dealing with the two banks even though BDB was found to have allegedly falsified documents and made fictitious loans to bogus companies in early 2002, and concluded fictitious transactions in corporate bonds and negotiable deposit certificates with Bank Asiatic in early 2003 involving almost Rp 800 billion (US$95 million).

Bank Indonesia's supervisors should have known that allowing such weak banks to continue operating entailed a serious risk that their managements would resort to extending high-risk, high- return loans, gambling that if they were lucky the high interest earnings would bring their banks back to solvency.

However, as experiences in other countries has shown, such forbearance mostly results in increasing the costs of bank closure.

Even though the closure of the two banks has not caused panic within the industry due largely to the blanket guarantee on bank deposits and claims, the latest bank failures should serve as a stronger warning to the central bank to always put family- controlled banks and those that are part of business conglomerates under special supervision.

The banking crimes at BDB and Bank Asiatic also make it more imperative and urgent now than ever to remove interbank claims from the blanket guarantee scheme.

We find it hard to understand why two of the country's largest banks, Bank Mandiri and Bank Permata, extended respectively Rp 40 billion and Rp 10 billion in loans to the two problem banks.

The managements of these large banks should have known the soundness of other banks they did business with. It is entirely unfair to ask the taxpayers to underwrite the business risks taken by bank managements in conducting interbank transactions.