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The Role of State Owned Banks in Indonesia

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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The Role of State Owned Banks in Indonesia

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  1. 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

  2. Indonesia’s Financial Landscape – Dec. 2003 US$1 = Rp. 8500

  3. Role of Bank Indonesia • Evolution of SOBs strongly influenced by role of BI • BI’s 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

  4. Overview of role of SOBs

  5. 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

  6. Milestones in SOBs evolution - Prior to 1983 • SOBs main channel of BI’s 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

  7. 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

  8. 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)

  9. Milestones…1988-92 reforms (cont’d) • 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 Indonesia’s weak supervision of SOBs highlighted

  10. 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

  11. Milestones…1997/98 crisis (cont’d) • 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 US$50 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

  12. 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

  13. Recent performance of SOBs – Dec. 2003

  14. How real are the reported numbers? The largest SOBs continue to be potentially risky

  15. 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

  16. What can be done going forward? • Should Indonesia continue having SOBs? • Partial privatization step forward, but inadequate • Especially with government’s golden share • Full privatization would be ideal…but • 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

  17. 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?

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