Indonesia’s banking sector, deep in crisis since 1998, is finally beginning to recover. The sale last month by the government of one of the biggest banks nationalized after the sector’s collapse, and a further successful international bond sale by the biggest state bank, has improved investor sentiment, prompting optimism about further privatizations still in the pipeline.
The optimism reflects growth in confidence about the broad stability of the macroeconomy. This has shown significant improvement across most indicators over the past year, including a strengthening currency, reduced inflation and debt, continuing growth of around 4% and a stable export performance. Only incoming foreign investment lags, still dogged by fears about corruption and a dysfunctional legal system.
Worries about political risk have diminished following Indonesia’s crackdown on terrorism in the wake of the Bali bombing last year, and its comparatively muted opposition to the war in Iraq.
Brightening foreign investment prospects The success of the sale of Bank Danamon has boosted prospects on the foreign investment front, which had been blighted by fears of a nationalist backlash similar to the one that accompanied the sale of telecommunications operator PT Indosat late last year. Both were sold to companies controlled by the Singapore government. But though the first created a short-lived uproar, the second has proceeded so far with little comment.
The majority 51% stake in Bank Danamon was sold by the Indonesian Bank Restructuring Agency (Ibra), the government body set up to dispose of companies and banks acquired after the 1998 collapse. It raised $347 million and a further 20% of the shares are being sold to the public through the market, with the first tranche doing well. The winning bid came from Asia Financial Indonesia in which Temasek Holdings, the Singapore state-owned investment company, holds 85%, in partnership with Germany’s Deutsche Bank, with 15%.
The bid was well received, with analysts noting that Deutsche has an excellent track record in Indonesia through its involvement as adviser in the creation of Bank Mandiri, now the biggest state bank. Mandiri emerged from a substantial restructuring, involving the fusion of four distressed state banks that had been severely injured by the crisis.
Bank Danamon is the third bank Ibra has sold through the strategic sale mechanism. A 51% stake in Bank Central Asia, the largest retail bank, was sold to Farallon Capital Management of the US in March 2002, and a similar controlling stake in Bank Niaga went to Commerce Asset Bank of Malaysia late last year.
The Danamon sale won praise from the IMF, which is still monitoring Indonesia’s progress, but also a warning. “Strengthening the financial sector is a central element of the programme,” says Anne Krueger, the IMF’s first deputy managing director. “With the launch of the sale of Bank Danamon, further progress continues to be made toward the goal of returning to private ownership banks that were taken over during the crisis. But further steps are required to strengthen the monitoring, governance, and accountability of state banks as they are prepared for divestment.”
The next planned sell-off is Bank Lippo, in which Ibra has a 59% holding. Two other banks remain under Ibra control. One is Bank Internasional Indonesia – formerly owned by the Sinar Mas group – whose pulp and paper company APP is the subject of debt restructuring negotiations with foreign creditors. The other is Bank Permata, the result of a merger of five banks, including the ill-fated Bank Bali, whose sale in 1999 to Standard Chartered Bank collapsed in a welter of political controversy and legal action and led to the departure from office of former Indonesian president BJ Habibie. Danamon is one of the many banks trying to access the retail lending and small and medium-size company sector following the collapse of the big conglomerates that were the mainstay of big Indonesian banks during the 1990s. Recapitalized with government bonds and merged with seven small banks in 2000, it has 465 branches and 700 ATMs but only 1.8 million customers after culling inactive accounts, compared with competitor BCA’s 7 million. Nevertheless it has increased its loan to deposit ratio to 50% following a 75% increase in loans last year and further growth of more than 50% is forecast this year.
Such rapid growth brings risks. Danamon is targeting a maximum 5% non-performing loan ratio, which might be difficult to meet. Its cost of funding is also higher than BCA’s, with 65% in time deposits paying around 13% interest. Profits rose 31% to Rp948 billion ($116 million) last year. Investor interest in the bank awaits the sale of the further Ibra tranches to raise its free float to 20%.
Despite the recent smooth progress, it seems unlikely that Ibra will find the planned sale of Lippo Bank later in the year so easy. The bank, founded by the Riady family, which maintained close relations with former US President Bill Clinton and has a financial empire that extends from Jakarta to Hong Kong, China and the US, has scarcely been out of the press for months. It was the subject of three separate inquiries by ministries and regulators, has had its board of directors replaced and has been fined hundreds of thousands of dollars for offences whose precise nature has not been disclosed. This has hugely embarrassed Ibra, which has a majority stake in Lippo and is supposed to be controlling it.
The saga began late last year when Lippo published a set of audited results. A few weeks later it published a further set of unaudited results indicating that the value of its assets had collapsed. This caused its share price to crash: suspicion grew that people with a vested interest in the bank might be attempting to acquire shares on the cheap, preparatory to the sale of the government stake later.
The explanation was more prosaic: the first set of accounts valued the assets (mainly properties the bank had acquired when it foreclosed on bad loans) as long-term income earners. But Ibra had instructed Lippo to sell off these properties before the bank’s sale – so their value was naturally much lower in the second set of accounts since they would be disposed of in a fire sale.
|
Mochtar Riady: chairman of Lippo Bank, |
Suspicions of skullduggery But by the time this was established, the noise that had been generated in the press and parliament about the possibility of crony capitalists again getting their hands on the banking system was doing damage to the government. Consequently, inquiries were announced by the stock exchange, securities regulator Bapepam and even the finance ministry. In due course, penalties were handed down and a few board positions changed. For now it appears that the damage has been contained, but despite lawsuits from aggrieved directors, it is likely that the minute the bank is put up for sale, the many who still suspect skullduggery will be back on the case.
And since the original family owners still hold a small stake, along with the chairman’s seat, occupied by patriarch Mochtar Riady, it seems likely that any interested strategic investor may have at least a working relationship with the family. In any case, most foreign banks are thoroughly disenchanted with any Indonesian bank that is prone to scandal, following the unfortunate experience of Standard Chartered.
Fortunately there was nothing scandalous to deter investors wooed by Bank Mandiri, the large state bank that plans an IPO later this year, when it launched a $300 million fixed-rate bond, increased from $200 million on heavy demand. This is the third issue since the bank was established in 2000. At the end of 2001 it issued floating-rate notes of $125 million, the second issue in August last year was also $125 million, with a sustained improvement in pricing. “We believe the improvement is partly due to the performance of the bank, and partly because of the progress in Indonesia itself,” says Bank Mandiri’s chairman, EC Neloe.
Other bankers agree that the sector is improving in line with the economy as a whole. After five years, they believe it is time to call an end to crisis talk since the consolidation phase has now begun. And the picture that is emerging of the post-crisis Indonesian financial sector looks encouraging, since it is being restructured in a way that should prevent many of the old bad habits from breaking out anew – a problem that has beset other recovered countries from the Philippines to Argentina.
Three changes are characteristic. First, there has been a widespread switch from banks’ former virtually exclusive concentration on lending to Jakarta-based crony corporates – often their owners – to the new targets of the retail consumer sector and small and medium-size crisis survivor companies, some of which are now rapidly getting bigger.
Second is the emergence of a functioning domestic bond market that will enable banks to match assets and liabilities, help the government fund itself and broaden investment opportunities.
Finally, there has been an overhaul of both ownership and internal procedures, which concentrate on good corporate governance and strict risk-management controls.
The focus on long-ignored business areas has proved problematic for many banks, which did not have the systems in place to manage risk-based lending and lacked a presence and contacts in the regions where many of the new customers live and do business. Staff had to be completely retrained in evaluating retail and small business customers, new products had to be designed, many more ATMs installed and IT systems adjusted. All this has taken several years. “Before, related party lending was dominant, but now there is a strict 5% limit,” says bank strategist Daniel Irawan at analysts IBAS. “Corporates are also moving to raise money through the bond market now, because it’s cheaper than loans. As a result working capital and consumer loans have doubled since the crisis.”
Swapping government bonds for loans
|
Foreign direct investment in Indonesia Click to enlarge image |
Quite a lot of this has been extended as working capital to small and medium-size companies and may reflect the emergence of Indonesia’s substantial underground economy into the more formal financial sector.
One difficulty is constraining banks from making the switch as fast as they might like. The effect of switching from ultra-safe recapitalization bonds to lending can rapidly reduce the banks’ capital adequacy ratios, as loans must be accounted for as 100% risk-weighted assets, while the bonds have no impact. The difficulty arises especially at banks that have little real capital, where in effect they can be punished for lending by a swift reduction of their capital adequacy ratios. Many banks have ratios of 20% to 30% – well above the prescribed minimum of 8% – as a result of the bonds.
“The banks have quite a complex problem,” says a senior foreign banker, “they need to massage down the number of recap bonds, increase their loans while still safeguarding their capital adequacy ratio, and also find new equity – all at the same time. They really need a cash injection.”
The process is expected to take some time, especially at the state banks, which make up half the sector, and which have a higher proportion of bonds. These have now been reprofiled, as the government budget could not cope with the payments if they were to mature. Two planned IPOs for big state banks planned for this year may help on the equity side.
The emergence of a proper domestic debt market is giving a new depth to the financial system, which should strengthen its ability to cope with shocks in the future. Five years ago the local bond market was in its infancy, with most issues held to term and little trading. Now bond market capitalization has jumped from Rp14.1 trillion in 1998 to Rp419.5 trillion last year. The number of bonds traded rose from 76 to 162 and the annual trading value has increased from Rp4.9 trillion to Rp136.9 trillion.
This compares with a much smaller rise in the equity market, where market capitalization has moved from Rp157.8 trillion to Rp212.4 trillion and the number of listed companies has fallen from 222 to 206. There are now 39 corporate bond mutual funds marketed in Indonesia but only eight that invest in equities. Corporate issuers have been attracted to the market because of the yields, which are often higher than local deposit rates, currently in the 9% to 12% range, but cheaper than loan interest payments, which may be 17% or more.
New bonds have been introduced, including Shariah-compliant bonds suitable for Muslim investors, a bond (issued by Indosat) with a tenor of 30 years, along with rupiah and US dollar subordinated bonds issued by a bank. The first amortizing bonds were issued in 2001 and the first monthly amortising bonds last year.
Progress on the corporate governance and risk management front is also crucial to the banks’ revival. The appointment of a new governor at Bank Indonesia, the central bank, may help to improve government and regulatory scrutiny which, along with the dysfunctional legal system, is a worry among investors. Burhanuddin Abdullah, a career central banker with several years’ experience abroad with the IMF, will this month take over the post occupied by Sjahril Sabirin. Although the central bank has operated satisfactorily under Sabirin, the governor is one of a number of senior Indonesians who faced court proceedings dating to the discredited era of ousted president Suharto but refused to step down from their positions.
Sabirin’s case was related to the Bank Bali imbroglio, and eventually, like everyone else charged in the case, he was acquitted. But his refusal to step aside even temporarily – an attitude that has also been taken up by Akbar Tanjung, the speaker of the Indonesian parliament and leader of the second-largest political party – has created an atmosphere of suspicion and distrust.
“A new image for the central bank will be very positive,” says Liny Halim, senior investment analyst at ING Barings, Jakarta. “The new man has the right credentials to continue running the bank properly.”
Enormous efforts have been made to instil new principles into the state-owned banking sector, with foreign consultants redesigning systems, installing training programmes and rejigging procedures into a modern format. Compliance departments – formerly rubber stamps if they were in place at all – have been reinvented. Public announcements have stated that bank staff do not accept bribes.
But although analysts believe the state banks are aware that they must tackle the problem, stories still circulate of lending through connections. “It’s fine to install the system, but is it implemented effectively?” asks one sceptic. The process may still have a way to go, as the IMF believes. In the meantime a strict surveillance procedure has been put in place by the finance ministry – the state banks’ shareholder – under which senior foreign bankers keep up heavy scrutiny of the state banks until they complete the process.
Cases of good governance The position is better in local banks that have foreign shareholders and in those that survived the crisis intact, the latter being almost a guarantee that corporate governance had been good all along. These banks include BCA, Panin Bank (where Australia’s ANZ Banking Group is a shareholder) and newly sold Bank Niaga and now Bank Danamon. Bank NISP, a rapidly growing smaller bank that coasted through the crisis and has the IFC as a shareholder, is another bank with a good reputation.
For portfolio investors, although the choice of suitable Indonesian banks is now expanding, their new look-alike character could be a problem. Analysts say they are all chasing the same clients and unless some of them develop niche activities they may just become a proxy on the Indonesian economy. But targeting a market may be a different thing from actually conquering it.
Pramukti Surjaudaja, president director of Bank NISP, which has for years lent to consumers and small and medium-size companies, says the bank found itself virtually without competition over the past few years. It rose to be the country’s 15th-largest bank from a lowly 241 in the league table five years ago. “Most of the other banks didn’t have the right systems in place to do this kind of lending,” he says, “and evaluating credit risk may be harder than they think.”
Bank NISP has one of the highest loan-to-deposit ratios in the market at 80% – compared with an average of less than 40% – and is finding that long-term customers that also survived the crisis are also growing rapidly now. “These survivor companies are generally good-quality businesses, though they may have a low profile,” says Pramukti. “Some of them can now afford to buy Jakarta office blocks with cash. The corporate landscape has changed a lot and the market is spreading rapidly, especially in the regions.”
The event that could signal Indonesia’s recovery to the outside world is its exit from its IMF programme at the end of the year. The planned exit is believed by government ministers and economic planners to be well timed, with only next year’s general election as a possible cause of disruption.
Although sceptics have brought up worries about whether any additional debt rescheduling through the Paris Club might be affected, IMF officials have offered reassurance and approving words, in particular on Indonesia’s success in reducing debt levels. An IMF exit could well provide a fillip on both the economic and political fronts, boosting confidence and reducing the constant crisis talk in press and parliamentary criticism of the government.
But the IMF itself has pointed to two areas where considerable work still needs to be done. First, a comprehensive plan for the reform of the financial sector safety net needs to be developed, including the creation of a deposit insurance agency and the transition to an independent financial sector supervisory agency.
Second, more legal and judicial reform needs to be undertaken, including strengthening the commercial court, amending the bankruptcy law and making sure the newly established Anti-Corruption Commission is actually doing its work.
Complete reform of Indonesian banking cannot be achieved, analysts believe, until the blanket government guarantee on the system, which covers everything from deposits to loans and even interbank credits, is replaced by a conventional deposit guarantee system. The blanket guarantee was imposed in 1997 (on IMF advice) after the closure of 16 banks had created a run on the whole banking system. But it has distorted investment choices and disrupted public perceptions of risk. It also led to Indonesia’s bank bailout being the most expensive ever, a burden that will take many years to be resolved. Removal of the guarantee is likely to be started soon on a step-by-step basis, with interbank credits being removed first.
Independent financial regulation will take much longer to introduce. At the moment much banking regulation is being performed by government agencies such as the finance ministry unit covering the state banks; the Ibra, which has appointees on the boards of all nationalized banks, but which is clearly having difficulties; and by Bank Indonesia, which also has consultant assistance and a surveillance plan on those banks that are not in the first two categories. In the long term, the plan is to introduce a super-regulator, modelled on the UK’s Financial Services Authority.
Improvements in the legal system are not expected soon and will probably have to wait until after the next elections – both parliamentary and presidential elections take place next year. Depending on who wins, reform of the judiciary may or may not be a priority. In the meantime the better companies and banks are likely to soldier on with their own internal improvements; for the rest, expect business as usual.
){kind=link}