Banks too risk averse

The Jakarta Post ,  Jakarta   |  Mon, 02/12/2007 5:09 PM  |  Opinion

Djamester Simarmata, Jakarta

The governor of Bank Indonesia, Burhanuddin Abdullah, has expressed his concern with the failure of Indonesian economic growth to generate more jobs for the unemployed. The Indonesian economy, he says, has been growing mainly on the back of financial services.

While Indonesian corporations have been suffering from a lack of credit, the financial market is awash with liquidity. The banking sector invested more than Rp 235 trillion (US$25 billion) in government bonds and Bank Indonesian debt papers (SBI), rather than lending the money to the real sector.

This is quite inimical to business operations because the country's financial services are still dominated by the banking industry, unlike in most developed countries where non-bank financial institutions play an important role in financing the business sector.

The economy did grow by around 5.5 percent last year, but the expansion did not generate as many jobs as assumed because most small and medium enterprises, which usually generate the most jobs due to their labor-intensive operations, did not receive sufficient loans from banks.

Government bonds and the BI certificates are liquid assets with investment-grade quality. Without a strong directive from the central bank, commercial banks will prefer investing their surplus funds in short-term securities rather than plowing them into long-term industrial or developments projects, which carry bigger risks. But it is the long-term investments that produce economic growth, which in turn generates jobs and income for the people.

However, companies also need short-term funds or working capital loans to finance their operations and production, and these working capital loans are usually derived mainly from banks.

Unfortunately, short-term funds, notably from foreign sources, consist mostly of portfolio investments in debt instruments and shares, which are not necessarily channeled in the form of credits to the business sector. These portfolio investments also could easily be used for speculative transactions such as those in foreign exchange markets.

Since the 1997 financial crisis, the performance of Indonesian banks has for the most part been worse than that of their peers in other ASEAN countries, because the bulk of their capital consists of government bonds (known as recapitalization bonds). Between 1996 and 2004, the amount of government securities on the balance sheets of Indonesian banks rose by more than tenfold. This was much larger than at banks in Thailand and Korea, two countries also hard hit by the 1997 crisis.

Even though Indonesian banks have succeeded in raising more savings from the public, they still hesitate to lend to the business sector due to high business risks and the high interest rates offered by government and corporate bonds. This means the banks are failing to fully perform their role as financial intermediaries.

The financial market now trades a steadily increasing amount of both government and corporate bonds. As the government has decided to depend more on domestic financing, it has issued more bonds to plug its budget deficit. However, an increasing number of companies with good financial performances and high credit ratings also have been entering the debt market with corporate bonds.

This means that big corporations have again been able to tap funds directly from investors through the capital market. These companies were formerly the prime clients of those banks that suffered financial distresses in 1997 and 1998, and had thus been shunned by most banks.

Instead of relying on bank loans, there is also a rising trend among companies to use retained earnings for investments or other funding needs. This factor has further dampened demand for bank credits.

Many banks -- foreign and national -- now focus their attention on consumer lending and try to lend more to small and medium enterprises at the prodding of Bank Indonesia, which has issued several incentives to stimulate credit growth in this sector.

What should be done? It is clear that the share of government bonds and central bank certificates on the balance sheets of commercial banks is the highest in the region. There is therefore an urgent need to revitalize the banks' intermediation function.

Government bonds and Bank Indonesia securities are virtually risk free. But if banks still prefer putting most of their funds in these debt instruments, the economy will remain deprived of life blood (financing).

Bank Indonesia needs to be forceful in directing banks to extend most of their funds to the real sector for financing operations or production and the development of infrastructure.

The central bank has set strong frameworks for credit risk assessments, based on the guidelines issued by the Basle-based Bank for International Settlement. What is needed now is a better bank supervisory capability on the part of Bank Indonesia.

The BIS has stressed the vital role of the supervisory institution, which is now under the authority of Bank Indonesia. As such, many of the banking problems in relation to the lack of loans to the business sector should be solved by the central bank, with appropriate coordination with the Finance Ministry.

The writer is a lecturer at the University of Indonesia

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