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Asia-PacificFebruary 3 2004

Moving in the right direction

Since the Asian crisis, Indonesia’s banking system has been shaken up and streamlined. Despite this, scandals still occur. Tim Johnston assesses progress so far, and discusses what the priorities must be for the recovering industry.
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Indonesia’s banking system has come a long way since the Asian financial crisis of seven years ago exposed the rottenness at its core, but several recent scandals have shown that the country still has some way to go.

The discovery late last year of a $200m (Rp1680bn) hole in the accounts of Bank Negara Indonesia (BNI), the result of a scam involving false letters of credit, and a suspected inside job that cost Bank Rakyat Indonesia $35m, illustrate how much still needs to changed.

But such problems should not be allowed to obscure the progress that has been achieved. Six years ago, most private Indonesian banks were little more than slush funds for the huge corporations that owned them, and most of them were the inefficient and corrupt offspring of the kleptocracy that ran the country and the economy under President Suharto.

Slimmed down

Today, after five years of forced closures, mergers and government takeovers, the banking sector is slimmer and better coordinated. Many banks have passed through the hands of the Indonesian Bank Restructuring Agency (IBRA), which was formed to recapitalise them and take on most of their non-performing loan (NPL) portfolio before re-privatising them as part of a mammoth $70bn bailout.

Born-again industry

“I would say the banking industry in Indonesia is in a born-again phase. It’s in a renewed infancy, and that’s because balance sheets are basically starting from scratch as most of the sector was recapitalised in 1998-1999,” says Andrew Zlot, an analyst at UBS in Jakarta.

IBRA’s mandate runs out at the end of February, and there has been no shortage of suitors for the banks that the agency has put up for sale. Following the recapitalisation they have strong balance sheets and, by Asian standards, low levels of non-performing loans. “Although there are problems in the sector regarding regulation and supervision, generally asset quality within the banks is pretty good. NPLs are lower than most countries in the region – probably at about 6.5% of total gross loans system-wide, compared with Thailand, which is around 15%,” says Mr Zlot.

Privatisation postponed

But the privatisation process has not been without its problems. The sell-off of BNI had to be delayed after the loan scandal came to light. It is now expected to go ahead by the end of the second quarter this year.

There have also been problems with the privatisation of the government’s 52% holding in Bank Lippo. The original bidding process had to be scrapped after IBRA said none of the bids met its criteria. Analysts said the bids were depressed by fears that the bank’s founding family (the Riadys) was secretly trying to buy back control.

Three main problems are exercising observers: the banking sector is still not functioning fully; oversight and risk management are still major concerns; and the legal system is still riddled with corruption and provides little, if any, protection for investors.

Election year

The government has committed itself to continuing reform of the financial sector, including improving the regulatory framework. But Indonesia is entering an election year, which will inevitably take its toll on the legislative programme. Even after the new rules are in place, establishing the institutions necessary to implement them will take time.

It will also take time to upgrade the banks’ risk assessment and supervision. The loss at BNI seems to have arisen from a lack of supervision of just two individuals, one of whom was a branch manager in south Jakarta.

While the commercial banks have re-entered the retail sector with enthusiasm, fuelling an annualised 35%-40% rise in loans, they have been less keen to get into corporate lending. This is partly because their risk and portfolio management is still in its infancy and partly because they are worried that the courts will not protect their interests in the event of a default.

Lending levels low

Corporate lending is growing, according to Mr Zlot. “Some banks such as Bank Central Asia (BCA), which is a very conservative bank, have been quite cautious in terms of who they lend to because there really is no bankruptcy law and the banks don’t have much recourse in the event of a default – but that doesn’t mean that all banks have chosen not to lend,” he says.

But Fauzi Ichsan, an economist at Standard Chartered Bank in Jakarta, says that the real levels are still low, and that more money needs to be put into the economy. “Almost 50% of the banking sector assets are still recap bonds and other instruments, so they are not really providing sufficient stimulus to the real sector of the economy,” he says.

Risk concerns

The state banks – like the country’s largest lender, Bank Mandiri – are coming under pressure from the government to provide the economic stimulus by lending to the corporate sector, but Mr Ichsan believes the pressure might be premature. “I am concerned that by being pushed to provide lending to the real sector, the state banks may not have the optimal risk management systems,” he says.

Shares in Bank Mandiri, which launched an IPO last year, have consistently underperformed the market, partially on worries over the quality of its loan portfolio. It announced last month that it expected its NPLs to reach 9.7%, almost three percentage points above the industry average.

Recovering NPLs to the corporate sector is notoriously difficult in Indonesia. A hopelessly corrupt legal system makes it an expensive lottery to take someone to court, a fact of life that has discouraged commercial banks from large loans.

“What makes money in banking is the retail market, not corporate banking; because once we start talking about corporate banking we are talking about the legal system,” Mr Ichsan says.

Mr Zlot believes that Indonesian banks are currently undervalued. “Generally speaking, Indonesian banks are inexpensive in terms of their valuation, they provide great dividend yields, their NPLs are low for their provisioning. Indonesian banks offer good value to equity investors now.”

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