I

em>Indonesia is home to more than 100 conventional banks that may potentially drag the country into trouble if a collapse in any of the lenders, especially medium and small ones, triggers a possible "domino effect" of bank rushes. This condition, if not immediately resolved, poses a systemic threat to the overall financial system that may harm the country's economy.

The Jakarta Post's Rendi A. Witular recently talked with Bank Indonesia deputy governor Muliaman Hadad, who oversees the banking sector, on the current state of the nation's lenders amid the deepening global economic meltdown. Here are the excerpts from the interview:

Question: How worrying is the state of our banking sector amid this looming interbank liquidity clog and low demand for loans?

Answer: The liquidity problem that started last year is among the major issues *in the banking sector* this year. Although there's already an improvement in the context of liquidity flow in the interbank market, there's still a liquidity pressure faced by small and medium banks, especially those without secondary reserves.

Overall, the liquidity squeeze is starting to ease from its peak in October, November and December, due in part to the liquidity outlets provided by BI to streamline the flow of money in the interbank market.

The liquidity issue this year will be more on the flow of foreign currency supply and not the rupiah.

The small and medium banks should respond their best to these problems. In a recently issued regulation, we emphasized the importance of risk management, primarily liquidity. We have requested banks to meticulously look at their books so that we can make an early detection should they face difficulties.

I think banks will soon get realistic and more open to consolidation.

Actually, banks have the capacity to grow significantly as there's no problem in the *loan* supply side. The problem is in demand. This should be pushed primarily by government spending and public consumption.

There's a looming perception that if a bank turns to BI for liquidity help, it means the bank is dying. This has discouraged bankers to ask BI for help, over fears of a run on banks if depositors find out. How do you resolve this?

Yes, that's true. In the past, such perceptions prevailed. But we have convinced *bankers* that the liquidity squeeze is a global problem and every bank, big or small, is exposed to the possibility of the problem. This has to be seen proportionally.

There's already progress in understanding that banks coming to BI are not necessarily in trouble. BI has opened a repo window for any banks that need liquidity.

How many banks, on a daily average, have turned to BI for help since the end of last year?

They come and go. The liquidity squeeze is a normal daily problem. Today it's this bank, and the next day it's that bank. Bankers are used to this situation. But we are closely monitoring, and so far it's within the normal range. On average, five to 10 banks take up the rupiah liquidity facility each day. They are not always small banks, there are also some medium and big banks. Under normal conditions *in the past*, one or two banks, on a daily average, came to us for such facilities.

Are you going to push harder for bank consolidation?

Such efforts have been made a long time ago. This is what we've been expecting.

Consolidation is a process. At this time, banks' focus is on making their balance sheets healthier after being hit externally *by the global crisis*. In the current unfavorable environment, we will not issue any policy *on consolidation* that will exacerbate their problems. Our schedule and time frame for banking consolidation are still in line with the Banking Architecture guideline. By 2010, banks must have a minimum capital of Rp 100 billion. A lot of banks still have less than that. Our priority for now is to enable them to struggle with the hard times. Big banks are also losing their appetite to take over smaller rivals because they are still focused on fixing their balance sheets.

We hope any consolidation is driven by a need for the banks to be stronger. Without this consciousness, it will be difficult for them to face these hard times. BI is not forcing them into it, only appealing that consolidation is needed, and banks will be left out *from the competition* if they don't do it. They can't stay in their current forms without having to add capital. So it's a matter of survival to grow. Without capital, they can't grow. This is important because we forecast overall capital adequacy ratio *CAR* to decline to 14 percent this year, from 16 percent in 2008. This is something that needs to be taken into account.

There's a difference between regulatory capital *the 8 percent CAR tolerance* and economic capital. If a bank has met the 8 percent capital benchmark, it does not mean business as usual. Most important is the economic capital. This is the real risk. If they can't meet this, it's difficult for them to grow and do their intermediary function. We are waiting for the right time to push for a wave of banking consolidations.

Aren't you worried that there are still too many banks operating?

It depends whether *a disturbance in a bank* is systemic or not. If it shows contagious effects, then there's already a guideline in the planned financial safety net *currently being deliberated by legislators*. If it's not that serious, it can be handled by the existing *government-sanctioned* Insurance Deposit Agency *LPS* by ensuring depositors' money and then making the bank healthy.

How good is your supervision to anticipate future banking problems?

The financial safety net bill has been designed for bank rescue, including exit policy *if the bank can no longer survive*.

Not all banks turn to the LPS because of weak supervision *by BI*. The complex problem of Bank Century, for instance, is because the bank is also involved in the capital market, which is forbidden. Our supervision is entering a very challenging phase in the years to come because bank businesses are getting more complex.

BI is trying to keep up *with the more sophisticated business*. Everywhere, market players are always ahead of the regulators. Now we are trying to close the gap through capacity-building and a better supervision system.