Bill Guerin, Jakarta – A blueprint just released by the central Bank Indonesia (BI) spells out in some detail how banking-sector reforms will be implemented over the next 10 years. The document, termed simply "The Indonesian Banking Landscape", describes how higher standards of capital and good corporate governance will be imposed on a sector badly lacking in supervision.
Six years after the banking crisis hit, the banking industry remains fragile and highly vulnerable to shocks despite significant improvements in the key indicators of most Indonesian banks. Though all banks are now in compliance with the mandatory capital adequacy ratio (CAR) of 8 percent, with some even boasting up to 26 percent, almost 50 percent of the their core capital consists of government bonds.
Bank Indonesia governor Burhanuddin Abdullah said last week that the purpose of the new program is not reform for reform's sake, but to restore investor confidence. He said he wants to see bank lending grow by at least 20 percent this year to allow the country to notch up economic growth of between 4 and 4.5 percent.
But new borrowing and investment have almost dried up because of lingering problems such as legal uncertainty, labor unrest and volatility in overseas export markets. BI has been aggressively cutting its benchmark rate over the past year in hopes of encouraging banks to follow suit and reduce their lending rates significantly to make loans more affordable to the corporate sector. BI's efforts have been unsuccessful, however.
Though lending rates have remained high at about 17-18 percent, BI's benchmark interest rate for SBI (Sertifikat Bank Indonesia) promissory notes stands at less than 9 percent compared with an average of 13 percent in 2003.
The credit crunch affecting corporate Indonesia is, according to the banks, attributable to the high risks of doing business, the corrupt system of bankruptcy proceedings and the large number of companies still undergoing restructuring. In fact, the corporate sector has yet to take up some Rp80 trillion worth of available bank loans, according to BI.
Without better institutional capacity to assess credit risk, banks are unlikely to expand their lending operations significantly. For that matter, why should they? It is so much easier and safer for them to rely on government recapitalization bonds, BI's promissory notes (certificates of deposits) and the lucrative inter-bank money market. Indeed, the 10 largest banks account for more than 70 percent of banking assets, but still depend on such paper for almost 50 percent of their revenues.
The rebuilding of the entire Indonesian banking industry began in 1997 with the onset of the world's worst banking crisis since the 1970s. The three countries worst affected were Indonesia, Thailand and South Korea. The majority of Indonesian debtors, more than 2,000, were corporations. Much of their borrowing was highly leveraged, denominated in foreign currency, unhedged and short-term.
A World Bank report that year identified vulnerabilities in 10 major corporations that together owned more than 50 percent of the market capitalization of all of Indonesia's corporations. They all had close ties to the Suharto family and had used borrowed money to finance speculative investments in non-tradable projects, mainly property.
In Thailand and South Korea, short-term debt problems were addressed from the very beginning of the crisis and debt restructuring was implemented, but in Indonesia debtors and creditors agreed on a framework of corporate debt restructuring much later.
Renegotiating this debt involved reaching out to hundreds of creditors, mainly Japanese and European banks, and took a very long time. In short, the ongoing bank restructuring has proven to be been one of the most complex and costly efforts in the country's history. Cleaning up the balance sheets and non-performing loans (NPLs) of ailing banks has cost the equivalent of more than US$75 billion in taxpayers' money for restructuring and recapitalization. The return on this massive investment has been minuscule and NPLs continue to create major problems.
By early 1998 the government had set up the Indonesian Bank Restructuring Agency (IBRA) to take over a hodgepodge of grossly overvalued assets, mainly houses, hotels, apartments, warehouses, buildings and land from troubled banks and former bank owners.
IBRA was mandated to sell the assets to raise cash to help finance the state budget, which, in turn, has been continually drained by the cost of the protracted bank bailout program. In response, massive amounts of government bonds were issue to prop up banks during and after the crisis.
IBRA, due to be closed down on February 27, has been hard at work selling off the assets it holds, including the NPLs, at massive discounts. Recalcitrant debtors have been just as busy seeking financing to buy loans from the IBRA at between 15 and 20 cents on the US dollar.
The agency has been strongly criticized for its sale of these loans amid claims that many of the assets have been bought back by their former owners with the assistance of banks that were rescued by the government. As Dradjad H Wibowo of the Indonesian Institute for Economic and Financial Development (INDEF) puts it, banks that have already been recapitalized are the ones now providing loans. IBRA classifies NPLs into those that have been caused by business risks not properly covered by the lenders and those stemming from debtors refusing to repay their debts. Clearly, if banks buy up the latter type of loan there is a strong possibility they could still remain non-performing.
The giant state-owned and publicly listed Bank Mandiri, the country's largest bank in terms of assets, has been the prime mover in buying up assets, including NPLs, from the IBRA. Mandiri was created in 1998 by a merger of four insolvent state-owned banks which had been crippled by non-performing loans of some 60 percent, causing them losses totaling Rp103.1 trillion.
But now, Mandiri, with assets of Rp250 trillion and a capital level of some Rp22 trillion, has been aggressively buying up such poisoned chalices as NPLs. Last year it struck a deal to purchase IBRA loan assets worth some Rp4.9 trillion.
The blueprint also promises efforts to maintain confidence in international trade and to improve good corporate governance particularly relating to transparency of banking transactions.
Rampant corruption and weak law enforcement have resulted in the country being a safe haven for money launderers, but a government committee has now been set up to combat this after the passage of the new Money Laundering Law last year.
Presidential Decree No 1/2004 tasks the committee, chaired by the coordinating minister for political and security affairs, with coordinating measures between several state agencies to prevent and combating money laundering. It will then make recommendations to the president on policies designed to prevent money laundering.
Despite this, the country remains on the list of non-cooperative countries and territories (NCCTs) drawn up by the Financial Action Task Force (FATF), a global money-laundering watchdog set up by the Organization for Economic Cooperation and Development (OECD).
Before the crisis most banks were riddled with corruption and collusion, and the sector may not yet be wired in to the drastic changes in organizational and institutional changes needed to ensure full compliance with laws, rules and standards. The government imposed a 20-year ban on ex bankers owning a controlling stake in any bank, even after they settled their debt with the state.
But last year's disclosures of the Rp1.7 trillion ($200 million) lending scandal at state-owned Bank BNI and the Rp50 billion lending scam at Mandiri, respectively the second-largest and largest banks in the country, jolted the industry. That such scams could have taken place at the biggest banks for such a long time without being detected by internal control mechanisms speaks volumes about the quality of their risk management.
The principles of effective banking supervision set out by the Basle, Switzerland-based Bank for International Settlement in 1997 will now be followed in creating effective banking supervision using international standards, and the minimum capital requirement for domestic banks will be increased drastically from Rp10 billion to Rp100 billion.
The banking sector, after implementing the new structure, should be leaner and meaner, with much fewer banks than the current total of 138. Many Indonesian banks lack the capital needed to be a strong bank and are incapable of absorbing external shocks.
But the future still holds major challenges and presents a dilemma for the government. Currently, banks are putting their excess liquidity in central-bank bills (SBIs) and in return BI has to pay interest on SBIs and thus pump more liquidity into the banking sector. If banks continue to invest their funds in financial instruments rather than expand lending, economic recovery will remain weak. BI senior deputy governor Anwar Nasution has slammed banks for preferring to boost their capital adequacy ratio through the issuance of bonds. "Banks should earn their profits from interest on loans rather than from bonds," he said. To be sure, rebuilding their loan portfolios and decreasing their reliance on recapitalization bonds is a major challenge for the banks. By increasing and rebuilding their lending portfolios with proper risk management frameworks, Indonesian banks could minimize the possibility of another crisis.
Governor Abdullah describes the new program as a comprehensive and forward-looking platform for banking policy and frequently highlights the excess liquidity in the banking sector and non-functioning intermediation (the lack of lending). Abdullah has said that under these circumstances, setting monetary policy is like "chasing our own tail".
The recently amended central bank law calls for a single supervision authority in the financial services industry, a task which must be completed by 2008. The new supervision authority, along with sound risk-management practices, may well underpin the establishment of a comprehensive financial safety net for the banking sector. But before this is accomplished, there is likely to be more than just a little tail-chasing if banks continue to turn a deaf ear to the central bank's advice.