Easing the credit crunch

The Jakarta Post ,  Jakarta   |  Thu, 05/04/2006 11:13 AM  |  Opinion

Even though inflationary pressures have weakened, as shown by the constant decline in inflation in April to 0.05 percent, the monthly meeting of Bank Indonesia's board of governors next Tuesday should refrain from significantly lowering the central bank's benchmark interest rate.

A 25 basis point decrease from the current BI rate of 12.75 percent would be sufficient to signal an easier monetary stance beginning in the second semester, as originally planned. But a sudden, sharp reduction could reverse portfolio capital inflows, which have so far been responsible for the increase in the country's international reserves to almost US$43 billion at present.

However important a lower BI rate is for easing the credit crunch, it is not enough to expand bank lending. In fact, the critically high level of non-performing loans (NPLs) at state banks, which collectively still account for nearly 50 percent of the banking industry's assets, is now among the biggest barriers to new lending.

Take, for example, state Bank Mandiri and Bank BNI, the two largest banks in the country, which together control approximately 27.50 percent of the industry's assets. These two banks alone were responsible for more than 60 percent of the total NPLs at all banks, which were estimated at an equivalent of $5.3 billion as of early this year.

So preoccupied have these banks been with the problem of their huge bad loans that their new lending has dropped sharply. In fact, Bank BNI disclosed last week it did not make any new lending at all during the first quarter and its credits outstanding as of March decreased by Rp 2.83 trillion ($320 million) due to repayment by borrowers.

These state banks have virtually been held hostage by their bad credits, debilitating their ability to fully perform their financial intermediary function. And as long as their net NPLs (after provisions) remain in excess of the maximum 5 percent of total loans, as set by the central bank, these banks cannot significantly expand their lending operations.

The central bank's package of policies in January that eased the uniform classification of loan collectibles to enable banks to reduce provisions for their loans, thereby increasing their funds available for lending, seems to have been ineffective in bolstering new lending by state banks.

The basic problem is that state banks do not have a lot of leeway in resolving their NPLs. Different from private banks, which can provide discounts and other forms of restructuring facilities to distressed debtors, state banks are prohibited by law from giving ""haircuts"" or other forms of debt reductions to debtors.

Loan restructuring by state banks has been rendered very slow and is often made almost impossible by the banks' inability to provide discounts or debt reduction, which are key to restructuring bad loans and helping borrowers to reduce their debts to sustainable levels. State banks are allowed only to reschedule loan repayments. However, rescheduling debts without helping debtors reduce these debts to sustainable levels is often not effective in resolving NPLs.

The legal barrier is the clauses in the laws on state finances and the audit of state financial accountability, which define state banks' credits and receivables as state assets. Since giving debt reductions to borrowers results in state losses this act falls into the category of corruption, as stipulated in the law on corruption. Certainly, no state bank director or credit officer is willing to go to jail in the process of NPL restructuring.

Moreover, government regulations and rulings by the finance minister also prohibit state banks from unloading their bad loans into separate subsidiaries or special purpose vehicles, and instead require them to transfer their bad credits, which cannot be restructured, to the State Receivership Agency. These rulings thus make state banks hostage to their NPLs, hindering them from focusing their resources on their core business of developing new lending activities.

Banks, state or private, always face the risk of bad loans because, as businesses are struggling with higher costs, high interest rates and other business risks, their revenue flows often turn out to be lower than originally estimated, making their debts highly vulnerable to default.

Therefore, there is always the need for loan restructuring. However, state banks will never be able to resolve their bad loans through commercially viable debt workouts if they remain legally prohibited from giving debt reductions and from siphoning off bad credits to separate subsidiaries.

It is thus imperative for the government and the House of Representatives to remove the legal barriers encountered by state banks in conducting viable loan restructuring processes to reduce their NPLs at least to a maximum 5 percent.

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