Indonesia: Crippled banks imperil attempts at financial restructuring

By Peter Montagnon and Sander Thoenes,
in London Financial Times
15 January 1998

Today's London Times includes a story about IMF acknowledging past blunders in a "secret report." It's too soon to know what the report actually says, but here is a related FT story which suggests (to me)that the blunder was really a supervision failure.

Indonesians have so little trust in their banks, says Theo Toemion, a Jakarta economist and money market trader, that they have been withdrawing money from their accounts and putting it into safe deposit boxes.

With foreign banks confirming that the central bank was unable to keep up the supply of bank notes as withdrawals reached a peak during last week's collapse of the rupiah, a flight into cash is evidence of the deep crisis pervading Indonesia's financial system.

It also explains why today's new agreement with the International Monetary Fund is expected to focus heavily on financial sector restructuring.

Economists say no IMF programme can succeed without far-reaching financial reforms designed to shake the economy free of the burden of bad debts and restore credit to sound companies, which now even face difficulty raising the working capital required for exports. But it is hard to see how such reform can be designed, given the depth of the troubles. The IMF's first attempt to do so last October backfired after government action was confined largely to the closure of 16 smaller banks.

"They should have gone for a big bang approach and shut down all of the bad banks at once - or none at all," said Neil Saker of SocGen-Crosby. "By doing it as a half-measure, they were sending the wrong message. They wanted to show they were moving. Everybody knew more would go, but nobody knew which ones."

Analysts say the situation has since deteriorated sharply with small banks and even some larger private sector ones finding it hard to raise deposits, while their loan books deteriorate in the wake of the rupiah's collapse. "The cracks are visible in the clearing system. There are local banks which cannot meet their dollar commitments on the interbank market," said one foreign banker. That could drain precious currency reserves as the central bank is forced to step in to help.

According to an analysis by SocGen-Crosby, the currency's fall has decimated the balance sheets of Indonesian banks. Not only because it has made it much harder for companies with rupiah revenues and dollar debts to meet their obligations. It has also undermined the capital base of large and medium-sized private sector banks whose capital is denominated in rupiah but whose lending is on average one-third in dollars.

There is thus an urgent need for restructuring which would reduce the total number of banks from almost 200 at present and recapitalise those which are capable of survival, analysts say. At the same time, Indonesia needs improved regulation and proper bankruptcy laws to allow bad debts to be collected.

No one has tried to collect debts from the 16 banks that were closed, says William Keeling of Dresdner Kleinwort Benson. This means the large bad debt problem remains unaddressed. Eventually companies will have to be allowed to go bankrupt. The state may have to take responsibility for the bad debts and sell off the affected assets.

So far, however, the central bank has moved cautiously both with closures and the enforcement of proper accounting. Officially, bad debts are put at only 2 to 3 per cent of loan books, but in reality the problem is much larger, analysts say, and the authorities are reluctant to draw attention to the problems facing large corporate borrowers with strong political connections.

Similarly, there is concern that closure of larger banks would cause alarm in the public, and possibly spark social unrest as depositors tried to get their savings back. "The authorities have to intensify their efforts at merger and acquisition and the government should participate in this," said Frans Seda, a former finance minister.

Nor is the situation encouraging among the private banks. Bank Danamon, one of the largest, which is known to have a weak balance sheet, is negotiating a capital injection from the Salim group and CSFB, the international investment bank. Bank Dagang, which is controlled by the Gajah Tunggal group, is heavily exposed to property.

Even with restructuring, regulation would be critically important notably with regard to the need to stop intra-group lending, says Tom Inglis of ING Barings.

"The problem isn't so much the rule book as its enforceability," he adds.

International faith in the first IMF package was upset following the efforts of one of President Suharto's sons, Bambang Trihatmodjo, to prevent closure of his Bank Andromeda. After threatening the finance minister with a lawsuit, he was allowed to acquire another bank, Bank Alfa, which now operates from the original bank's premises. Whether the new programme will fare better remains to be seen.

Copyright the Financial Times Limited 1998
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