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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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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

Indonesia’s Financial Landscape – Dec. 2003

US$1 = Rp. 8500

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

Overview of role of SOBs

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

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

  • 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

    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)

    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

    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

    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

    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

    Recent performance of SOBs – Dec. 2003

    How real are the reported numbers?

    The largest SOBs continue to be potentially risky

    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

    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

    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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