The Role of State Owned Banks in Indonesia

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The Role of State Owned Banks in Indonesia

• Global Conference on
• The Role of State-Owned Financial Institutions
  Policy and Practice
• April 26-27, 2004, The World Bank
• P.S Srinivas
• Sector Coordinator
• Finance Private Sector Development
• The World Bank, Jakarta, Indonesia

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Indonesias Financial Landscape Dec. 2003
US1 Rp. 8500
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Role of Bank Indonesia

• Evolution of SOBs strongly influenced by role of
  BI
• BIs dual roles (until 1999)
• Agent of government for development
• Direct financing to public enterprises
• Refinancing/special credit programs mainly to
  SOBs
• Banking sector regulator/supervisor
• Historic problems of weak supervision and
  enforcement especially of SOBs
• Since 1999, BI independent, significantly
  improved regulation and supervision and more
  assertive in enforcement
• However, for SOBs enforcement is still an issue

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Overview of role of SOBs
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Evolution of SOBs in Indonesia

• Origins in the developmental view of state
  ownership
• Instruments of state in promoting development
• Each SOB assigned a specific sector of economy
• BRI rural, BDN minerals, Exim
  export/import, BNI manufacturing
• Transformed into political instruments
• Directed credit to SOEs, politically connected
  groups
• 1992 law removed all distinctions between SOBs
  and private banks, except for owner
• Situation continues at present

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Milestones in SOBs evolution - Prior to 1983

• SOBs main channel of BIs liquidity credit
  programs
• Lending at subsidized rates to qualified
  borrowers
• In 1982, liquidity credits over 40 of total
  loans
• Important part of overall development strategy
• Recycling oil revenues
• BI refinancing/state directed lending reduced
  need to
• Mobilize deposits
• Develop strong credit risk assessment skills

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Milestones in SOBs evolution - 1983 reforms

• First major financial sector reforms in Indonesia
  
• Driven by BOP problems and weak fiscal situation
  after decline of oil prices
• Main features
• Reduction of subsidized directed credit programs
• Deregulation of SOB deposit rates
• Elimination of credit ceilings
• Impact on SOBs
• Increased attention to deposit-taking
• Increased competition from private banks in
  lending
• Shortcomings of reform
• Continued presence of directed credit programs
• Weak incentives for SOBs to improve credit risk
  assessment

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Milestones in SOBs evolution- 1988-92 reforms

• Key aspects
• Entry of new private banks allowed
• SOEs allowed to move deposits to private banks
• Foreign exchange transactions rules changed
• Directed credit programs further reduced
• Mandatory subsidized credit insurance abolished
• Risk based capital adequacy standards introduced
• Impacts
• Dramatic increase in competition for SOBs
• No. of private banks from 77 (1988) to 206 (1994)
• SOBs share of banking system assets from 2/3rds
  (1988) to 40 (1995)

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Milestones1988-92 reforms (contd)

• Liquidity credits from 41 (1982) to 28 (1989)
  to 13 (1991)
• Liquidity credits (?), competition (?), and
  capital requirements (?) ? weak state of SOB
  balance sheets exposed
• Government committed to recapitalize SOBs to full
  8 CAR by 1992
• SOBs role as political instruments of state
• Revelations of large scale SOB funding of
  politically connected projects and persons
• Weak governance of SOBs exposed
• Bank Indonesias weak supervision of SOBs
  highlighted

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Milestones in SOBs evolution 1997/98 crisis

• SOB loan portfolios deteriorating for some time
  prior to crisis
• Serious SOB weaknesses known - Bapindo collapse
  (1993), BBD insolvency (mid 1997)
• Other SOBs with impaired capital
• Main cause lack of credit analysis
• Politically motivated lending that went bad
• Most SOBs found insolvent soon after crisis broke

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Milestones1997/98 crisis (contd)

• SOBs considered too big to fail
• Four were merged into Bank Mandiri and
  recapitalized
• Corporate loans of BRI also to Mandiri
• Other three recapitalized
• NPLs transferred to IBRA
• High cost of recapitalizing SOBs
• Total cost of banking crisis about 50 of GDP
• About US50 billion of recap bonds provided to
  banking sector
• SOBs accounted for about 40 of assets prior to
  crisis
• Accounted for about 2/3rds of recap bonds
• Bank Mandiri alone nearly 40 of total cost
• Poor incentives due to too-big-to-fail
  consideration potentially increased recap cost

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Current role of SOBs (Dec. 2003)

• SOBs still major players in the banking sector
• 28 of branches, 42 of deposits, 46 of assets,
  40 of loans of banking sector
• Two largest SOBs nearly 1/3rd of banking system
• Bank Mandiri 20, BNI 11 of assets
• Partial privatization in last year
• 30 of Bank Mandiri, 40.5 of BRI sold,
  Government has golden share
• Government bonds major role in the system
  influences SOB performance
• 30 of banking system assets
• SOBs hold 60 of all government bonds
• 40 of SOB assets
• Improving reported indicators
• Declining NPLs, improving CARs, increasing
  profitability
• Large presence of government bonds and regulatory
  treatment of restructured loans potentially
  exaggerates soundness

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Recent performance of SOBs Dec. 2003
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How real are the reported numbers?
The largest SOBs continue to be potentially risky
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Governance of SOBs

• Continues to be key issue
• Has been improving
• Performance contracts and management changes in
  return for recapitalization
• New and more professional Boards appointed
• Closer monitoring by shareholder
• Better supervision by BI
• But much more is needed
• Continuing weaknesses being exposed through
  scandals
• BNI
• BRI
• Questionable credit decisions continue

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What can be done going forward?

• Should Indonesia continue having SOBs?
• Partial privatization step forward, but
  inadequate
• Especially with governments golden share
• Full privatization would be idealbut
• Unlikely to be politically feasible in short-run
• Potential investors?
• Options for the short run
• Greater oversight by shareholder of SOBs
• Increase accountability of SOBs to government
• Closer attention to new loan origination
  especially corporate
• Ensure compliance with corporate plans
• More operational restructuring
• Enhanced supervision and enforcement by BI
• Make regulatory oversight of SOBs the same as
  private banks in practice

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Main messages

• SOBs always have and continue to play a major
  role in Indonesia
• After an extremely expensive recapitalization,
  government/regulator has begun taking steps to
  improve operations/management/supervision of SOBs
• Despite these measures, SOBs remain vulnerable to
  non-commercial pressures and continue to exhibit
  weaknesses in core banking areas
• Full privatization should be the goal but
  further restructuring, improved governance also
  necessary
• Key question Is government willing to give up
  political benefits of owning banks?