Asian banks: Now comes the real crisis

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Forget forced devaluations, plummeting stock markets and widening bond yields, south-east Asia's greatest headache is its weak banking sector. While central bankers looked the other way, the region's banks lent heavily to finance stock-market speculation, overexposed themselves to property and made dubious loans to their own shareholders. As Maggie Ford reports, it is time for the reckoning.

When the world started to melt

What will go wrong next?
Asian research: Worth the paper it's printed on?
Peregrine's still flying
Hedge funds: You can run but you can't hide
Country Risk December 1997: It could be worse
Global Economic Projections: Overall Rankings
Korea fingers the nettle

When Indonesia unveiled the measures to be imposed as part of a $23 billion economic stabilization programme backed by the IMF last month, a key condition was a clean-up in the banking sector. Making a start, finance minister Marie Muhammed and central bank governor Soedradjat Djiwandono announced the closure of 16 small and insolvent banks out of Indonesia's grand total of more than 230.

Out from the woodwork immediately crawled some of the most colourful characters ever to don a pinstriped suit. Shareholders of the liquidated banks included the sultan of Yogjakarta, scion of the former Indonesian royal family, and two children and a half brother of Suharto, the country's long-serving president. Two of the banks to be shut are owned by Hendra Raharjo, brother of the fugitive industrialist Eddy Tansil who escaped from jail after his conviction in 1995 for defrauding a state bank of $430 million.

Also on the list was a bank owned by the family of Ibnu Sutowo, the former head of the state oil company Pertamina. No slouch at accessing foreign funds, Sutowo was dismissed from his job in 1976 when the Indonesian government discovered that he had borrowed $10 billion without telling anyone. That debt was hastily rescheduled, but almost caused sovereign bankruptcy.

The most piercing howls of outrage at the bank closures arose from the camp of Bambang Trihatmodjo, second son of Suharto, who held a 25% stake in Bank Andromeda with his friends timber baron Prajogo Pangestu and industrialist Henry Pribadi. Admitting that his bank had broken the legal lending limit with a constellation of loans to the Chandra Asri petrochemical plant which he and his friends also own, Bambang accused the finance minister of trying to prevent his father's re-election to the presidency next year and filed a legal action against the ministry and the central bank. "We admit we broke the legal lending limit," he said, in one of the more damaging remarks in a week of drama. "But to be fair 90% of other Indonesian banks did the same."

At the head office of his Bank Jakarta in the capital, Suharto's half-brother Probosutejo donned his black peci hat, a symbol of Indonesian nationalism, and refused to obey the central bank's order, opening his bank and paying back some small depositors out of his own funds. Claiming that the closure order was an abuse of his human rights, he vowed to have it rescinded.

Across the Malacca Straits, the president remained unmoved. Attending a conference in Kuala Lumpur of large developing nations pondering ways to cope with the disruption caused by movements of international capital, he simply told reporters that with the help of the IMF, he expected the country and the region to recover.

As the week of drama unfolded, lists circulated of as many as 40 banks originally slated for closure, among them four others owned by Suharto relatives or close associates. Unlike Bambang, who had been given five days warning to deposit Rp350 billion ($109 million) to recapitalize Bank Andromeda and just missed the deadline, sister Tutut, brothers Sigit and Tommy, and other close associates of the president apparently raised enough funds to avert closure.

As customers queued to remove deposits to a safer place, such as state-owned banks, the central bank issued an assurance that no more liquidations were expected immediately. The government will repay up to Rp20 million to small account holders at the 16 banks. This covers 97% of total depositors and will cost Rp2.3 trillion.

"This is a terrible loss of face for president Suharto and governor Soedradjat," says William Keeling, head of research at Dresdner Kleinwort Benson. "These banks have been out of order for some time, it's nothing to do with the rupiah crisis. There will no doubt be more restructuring to come."

Indeed the restructuring has already started. The large conglomerate Bakrie has sold a stake in its Bank Nusa ­ which reportedly only just averted liquidation ­ to Malaysian Banking (Maybank) and has announced the merger of three other smaller banks it owns. The Modern group is negotiating to sell a stake in its bank and property division to Singaporean and Hong Kong interests, while Bank of Nova Scotia has bought a stake in a bank owned by the Ongko group, another medium-sized conglomerate. Tirtamas will merge three banks, a fourth having already been liquidated.

Feeling the squeeze in Indonesia

Analysts believe that up to 70 smaller banks could be merged in the next few months, helped along by a relaxed view about foreign participation. Foreign investors may own up to 49% of a listed bank and ownership of all other listed companies is unlimited. The government has already announced plans for mergers in the state banking sector, which will remove from the scene Bank Bumi Daya, repository of numerous bad loans from the 1980s and Bank Bapindo, looted by Tansil and never recapitalized.

Two large banks are believed to be in difficulty but are likely to be helped quietly to prevent further panic and loss of confidence. Bank Danamon, which experienced a run in October and has recently diversified heavily into property, is quickly winding down property exposure by selling assets and delaying projects. Late last month the Salim conglomerate announced that it will acquire 19% of Danamon, while its adviser Credit Suisse First Boston may take a further 10%. Salim denies that it is seeking to merge Danamon with its own Bank Central Asia, which itself suffered a run in mid-November.

In September Samsjul Nursalim chairman of the Gadjah Tunggal group, which owns Bank Daging Nasional Indonesia, was kidnapped and held to ransom in Indonesia's first kidnapping of a tycoon. Eight men have been arrested for the crime, which is believed to have been organized by a disgruntled customer who had been stopped from withdrawing his money from the bank.

Announcing its third-quarter results, the bank reported a 300% increase in provisioning to Rp118 billion over the previous year and said it expected a rise in non-performing loan from 1% of the total to 3% over the next year. The bank believes the outlook is challenging, but manageable, since it has achieved a capital-adequacy ratio of 10% following a rights issue earlier this year which raised Rp893 billion.

The rest of Indonesia's largest listed banks will face increasing stress over the next year, with non-performing loans expected to rise to perhaps as high as 15% of the total. Bank Indonesia, the central bank, classifies as non-performing 9.2% of total outstanding credit of Rp350 trillion, of which most is at state-owned banks and does not relate to the currency crisis.

Lending to the property sector amounts to 25% of bank credit and though interest rates have been brought down from above 30% to 20%, a liquidity squeeze imposed to support the rupiah is still hitting all banks and businesses. Some analysts expect a quarter of property loans to go bad. Fortunately, many large listed banks like Lippo Bank, Bank Internasional Indonesia, Bank Bali and Bank Niaga have recently raised new capital through stock market rights issues.

Concern remains focused on Indonesia's 200 small unlisted banks, many of which are expected to come under severe pressure to merge or face liquidation. The Indonesian government's refusal to step down from its liquidation order in the face of the strong political attack from members of the Suharto family has convinced bankers that the old ways are no longer to be tolerated.

Calling for an independent central bank modelled on the US Federal Reserve Board, banking analyst Laksamarna Sukardi says the liquidations reflect a lack of authority at Bank Indonesia. "It is not that Bank Indonesia is incapable of supervising banks," he says. "But the 'X factor', ownership of banks by politically-connected figures, makes it difficult to supervise effectively or impose sanctions." To increase independence further, he believes the central bank's governor should be appointed by parliament, not by the president, and that all state banks should be privatized.

Soft-centred banking systems

The revelation that even the respected technocrats running the Indonesian financial system have been unable to maintain control over banks may come as a shock to some outsiders. But it will not surprise those analysts who have been concerned for some time about the weakness of regional central banks in the face of political interfe ence. The loss of control may have added as much as $15 billion in unrecorded borrowing in Indonesia, where domestic borrowing at the end of 1996 was a reasonably moderate 60% of GDP.

In the Philippines, where career central bank governor Gabriel Singson has received backing for his independence from the country's president Fidel Ramos and ongoing guidance from the IMF, loans as a percentage of GDP are only 50%. But the low level of domestic borrowing also reflects the Philippines relatively recent entry into the club of Asian miracle economies.

Older members of that club are much more heavily borrowed, with Thailand's domestic borrowing at 100% of GDP and the figures for Malaysia and South Korea both over 140%. In addition, foreign private-sector borrowing is over $60 billion in Indonesia and around $100 billion in both Thailand and South Korea.

And where borrowing is highest, the central bank tends to be most weak. Two governors of Thailand's central bank have resigned since its financial crisis began last year. Malaysia's central bank tarnished its international reputation years ago when it lost billions of dollars speculating with the country's reserves in the foreign-exchange markets.

When the Bangkok Bank of Commerce went bust in 1996, in the first clear sign of what was to come, the state of the bank confirmed the worst fears of those who regarded the Asian banking sector as shaky. With nearly $3 billion in bad debt, the bank had been propped up by the central bank, the Bank of Thailand, despite breaking all the rules. It had lent too much money to its shareholders, who accounted for about a third of the bank's lending; it had lent to politicians for speculation without collateral; and it had issued false statements to the regulatory authorities. Two of the owners of the bank now face embezzlement charges, one of them a former central banker with a formerly spotless reputation.

But when a run on the bank in 1996 plunged it into crisis, the Bank of Thailand, rather than biting the bullet and closing the bank down, took a 32% stake in the institution and injected two separate chunks of capital into it before arranging a merger with a state-backed company. The central bank's behaviour sent a clear signal to the Thai business community: political influence means softer treatment.

When the crash came with the July devaluation of the baht, firmer action was seen with the closure of 58 finance companies and the removal of foreign ownership limits on finance companies and banks, a move aimed at helping banks to raise capital. But capital-adequacy levels were not raised and classifications of non-performing loans were not tightened as the government had promised they would be under its $17 billion IMF bail-out package.

Thailand's half-measures

Thomson Bankwatch believes that capital-raising exercises announced by five Thai banks are unlikely to succeed if aimed at foreign investors. "The banks have not been forced to disclose the true level of non-performing loans, and the value of real-estate collateral is difficult to quantify," a recent report from the organization says. "Existing shareholders also appear to have unrealistic expectations over the value of their shares."

Already depositors have shifted funds away from riskier institutions with foreign banks experiencing a 35% rise in their market share. Many foreign banks have stopped all lending to Thai banks. Bankwatch has downgraded the short-term local-currency debt ratings of six banks which could have trouble rolling over their dollar funding or face liquidity shortages.

The lack of realism also extends to measures allowing foreign investors, the only source of capital in the cash-starved country, to buy into Thai banks and companies. The measures are designed to stop foreigners from maintaining majority control after 10 years which thus makes investment unattractive.

Dominique Maire at UBS Securities reckons that to recapitalize Thai banks and clean up their balance sheets would cost Bt140 billion ($3.7 billion), or 38% of shareholders funds. "The hangover has yet to hit Thai banks," she says, noting that only Bangkok Bank, the largest, is likely to emerge in good shape.

Malaysian banks face tougher treatment from the authorities. Banks were last month told to increase provisioning, to declare loans as non-performing within three instead of six months and to disclose more information in their financial statements. The measures are expected to push non-performing loans up to 15% of the total over the next year, analysts say.

The banks face the looming spectre of a major property shake-out. But despite the fall in the ringgit in tandem with the regional crisis, loan growth has not slowed; loans increased by 34% in the year to August. More than 60% of bank lending is believed to be "non-productive", that is to finance property, consumer goods such as cars, stock market speculation and corporate financial activity, rather than manufacturing. About half of this is to property, where a glut in office, residential and commercial estates is expected next year.

Unlike other south-east Asian countries, which hiked interest rates to protect their currencies, Malaysia capped rates at under 10% until last month, keeping them down to protect highly leveraged companies and consumers already ravaged by a major collapse in the stock market earlier this year. But the cap raised fears of a threat to the banking system, which faced a squeeze on margins.

When the cap was lifted, banks immediately pushed up rates. Home buyers have seen their monthly payments rise by 30%, and the proportion of non-performing loans has risen. In addition, the fallout from the collapse of the stock market, down 40% since April, is expected to be severe. Around 11% of bank lending is believed to be for share financing, mainly for speculation. But concern also focuses on deals where corporations have pledged shares as collateral for takeovers or for new project financing.

Investors dumped shares in UEM last month as this profitable blue-chip toll-road operator was forced to bail out its parent Renong group. Renong, controlled by indigenous entrepreneur Halim Said, has been favoured with several projects by Malaysian prime minister Mahathir Mohamad in his efforts to promote a fairer share of the country's wealth for Malays. UEM will buy a 33% stake in Renong at a substantial premium, an injection of cash that will allow Renong to continue with projects close to the government's heart, such as a light-rail system it is building for Kuala Lumpur.

Renong has been one of the more active acquirers of assets. It pledged shares in its listed subsidiary Time Engineering against a loan of $262 million used to buy a telecom company. The collapse of the stock market has dragged down Time Engineering's stock price, raising concerns that Renong will have to raise funds to upgrade collateral.

The potential for trouble in companies which have used both the banking system and the stock market to raise funds may be exacerbated by the poor standards of disclosure in Malaysia, which are not expected to reach world levels until 2001.

Munir Majid, head of the Securities Commission told investors last month that improvements needed included an end to "unhealthy practices" in corporate governance such as the shifting of assets, conflicts of interest, lack of shareholder participation at annual company meetings, lack of transparency in accounting practices and inadequate investor protection.

For some time the Malaysian government has been promoting bank mergers, believing that the banking system needs strengthening to compete under new global trade rules which will be implemented within a few years. If the fallout in the Malaysian banking sector turns out to be as serious as some pessimists expect, the current reluctance to merge is likely to end in a rush to find a strong partner. Only one large merger has taken place so far with the creation of RHB Bank. This combination of DKB Bank and a subsidiary of Maybank is controlled by leading tycoon Rashid Hussain and is thought to have a reasonably strong loan book. Maybank is already considered big enough to stand alone.

Late arrival spares Philippines

One area of hope amid all this south-east Asian despondency is the Philippine banking system, where a combination of good economic management by the Ramos administration and reasonably independent regulation by Singson will probably limit the damage to the country's banking sector.

Another factor that may spare the Philippines from the worst of the crisis is that the country only began to participate in Asia's economic boom fairly recently. Although Philippine banks were enthusiastic converts to the regional cult of high growth fuelled by heavy borrowing and investment, economic recovery in the once almost bankrupt country only began in the early 1990s. In earlier years, particularly under the long regime of the late Ferdinand Marcos, the country was infested with all the ills of cronyism, corruption and ineptitude now bedevilling its neighbours.

It had, however, also inherited a regulatory and legal regime from the US, the former colonial power, and this framework has been revamped under Ramos to promote better disclosure and fewer loopholes through which cosy insider bank and stock-market deals could slip. Philippine banks are generally well capitalized with capital-adequacy ratios at an average of 20%. Non-performing loans stand at 3.5%, and around 11% of lending is to property, a comparatively low figure by regional standards. Real-estate lending has been capped by the central bank at 20% of the total, and vacancy rates in Manila, where most new office building has been concentrated, are less than 5%.

Concern focuses on foreign-currency lending, which had doubled to $8.6 billion by the end of last year and makes up 23% of total loans. While the banks are required to match loans to deposits and also to keep a 30% liquidity reserve, up to 40% of the banks' foreign-currency borrowing may be unhedged. The banks claim they have lent on the money only to exporters with dollar income, but analysts are sceptical.

Deterioration in asset quality is a certainty following the peso devaluation and the rise in interest rates to between 25% and 30% to defend the currency. Nonetheless, the Philippines, with the best export performance in the region, the lowest level of indebtedness, an open mind towards the involvement of foreign investors and a more vigilant regulatory system born of past excesses, is one of the better-placed countries to survive the turmoil.

For the rest, nothing but gloom is in sight. Banking analyst Robert Zielinski at Jardine Fleming in Singapore, a well known bear whose predictions are now coming true, expects south-east Asia to suffer five years of misery, the standard length of suffering following a speculative asset bubble. Zielinski points to property-lending exposure, rapid asset growth and a get-rich-quick mentality as the cause of banks' outperformance in the past few years. "Now it is clear that Asia is not different," he says. "The factors which made Asian banks profitable are now about to operate in reverse."