Indonesia: The Bleak Outlook For The Banking Sector


Dr Ross H. McLeod

Indonesia's banking sector has changed enormously since 1997, with four of the large state banks merged into one, two of the largest private banks nationalised, two other large private banks and scores of others closed, and eight other private banks disappearing through forced merger. Huge amounts in non-performing loans have been transferred to the Indonesian Bank Restructuring Agency (IBRA), along with shares in numerous companies handed over by their owners in lieu of cash repayment of emergency loans to their banks from the central bank, turning IBRA into a giant state-owned holding company.

But despite all this, and despite recapitalisation of the surviving banks, the banking system is still making little or no contribution to economic recovery, because the bank restructuring program has been riddled with poor policy choices.

First, the authorities significantly reduced the minimum capital adequacy standard, despite the fact that the initial bank failures were mainly attributable to the already low pre-crisis standard. Now it is so low as to be almost meaningless.

Second, the government recapitalised banks by injecting bonds rather than cash. These have interest yields well below market levels, resulting in their true value being significantly less than their face value. Given the tiny capital requirement, this implies that banks supposedly recapitalised, in fact now have little or no capital.

Third, the concentration of bad loans and other assets in a single state-owned institution ignored the abysmal past performance of Indonesia's state-owned banks, pension funds and insurance companies. For decades these financial institutions have been irresistible flames to cronies of the politically powerful, and their abuse and mismanagement has caused untold losses to the public. IBRA has not been immune to outside pressure, nor is it completely free of the bureaucratic mentality that weighs heavily on other state enterprises. It has had little success pursuing defaulters in court or in divesting assets under its control.

Fourth, the drive to merge troubled banks has been, and will continue to be, both unnecessary and counterproductive. It is the smaller banks, by and large, that have best weathered the crisis, and experience shows that mergers involving even two companies are typically fraught with great difficulty let alone multi-firm mergers.

But perhaps the major obstacle to banking recovery is lack of progress with legal system reform. Banks depend on properly functioning courts, without which there can be no confidence that loans will be repaid.

WATCHPOINT: Until the courts are reformed, the future of Indonesian banking is bleak.


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