Regional News
Indonesia boomed back to life after the 1997 financial crisis because those bad times made for good policy. The country instituted tough banking reforms which have proven their mettle through more recent crises. Indonesia is now an even hotter investment destination than in the heady pre-crisis 1990s. There’s just one problem: Indonesian leaders may not understand the secret of their success. They’re in danger of backtracking on those critical reforms.
The central bank currently is mulling a proposal to limit ownership in Indonesia’s banks. Any one entity—including foreigners—is now allowed to own up to 99% of a local commercial bank. The new rule may reduce the cap to below 50%. This is most likely to hit foreigners, because banks that are owned or controlled by them have about half of the banking system’s assets.
The rule would be a setback for what has become one of Indonesia’s most successful industries. After the 1997 crisis, Jakarta nationalized its near-defunct banks. But pushed by the International Monetary Fund, it quickly sold them off again, with a large portion going to foreigners. By destroying barriers for foreign capital as well as improving prudential regulation, the government freed the industry to flourish.
Indonesian banks enjoy some of the highest profit margins anywhere, despite intense competition. Corporate governance has improved in leaps and bounds; risk management is much improved.
The success, especially in corporate governance, stands out all the more because of the contrast with what came before. The industry pre-1997 epitomized the cronyism of the Suharto era. Back then, tycoons at the helm of family conglomerates wanted to funnel cheap cash to their other enterprises. They could easily start banks, thanks to low capital requirements, and then flout rules, including those limiting related-party loans.
These gaps in governance led to a systemic crisis in 1997, and have been fixed with the help of foreign ownership since then. Oversight and risk management improved dramatically at Bank Danamon under the watchful eyes of Singapore’s Temasek (which bought a stake, now at 67%, when the bank was denationalized), and at Bank NISP under OCBC Bank of Singapore (which gradually acquired a majority last decade, as the founding family diluted its holding).
Instead of thinking of ways to divert liquidity to family and friends, such owners have transformed the way banks in Indonesia serve their customers. Citibank has pioneered credit cards, while Bank Permata, the local affiliate of Standard Chartered, has become a leader in serving small- and medium-sized enterprises.
Nor has this been a boon only for foreign banks; locally owned banks also are booming. A number of them, including the state-owned Bank Rakyat Indonesia, compete to offer the poor microfinance. Such competition has been honest, thanks to the new business culture foreigners have fostered, as well as the level playing field smarter regulation has created.
To many eyes, it would look like this financial flourishing vindicates the reforms forced on the country in the dark days of the 1997 crisis. Yet evidently that is not how some in Jakarta see it. There’s a growing sense in some quarters that those reforms were only taken on in necessity, rather than as the building blocks for long-term growth.
The proposed bank-ownership rule is a case in point. Central bank officials say it is intended to improve banks’ corporate governance. Arguing that one dominant shareholder can hurt banking soundness, they implicitly invoke the murky governance of the pre-crisis period, along with some embezzlement scandals in the past year.
Yet, if there’s a problem, it’s unclear how capping ownership helps. The latest scams, where individual employees at Bank Mega and Citibank were caught fleecing clients, are different from the pre-’97 world in both type and scale; the regulator has already come down hard on both institutions. In a separate case involving the bailout of Bank Century in 2008—investigators allege misuse of bailout funds—the investigation is ongoing.
More likely, there is something sinister at play: protectionism. The presence of many foreign banks appears to be a sore spot as local banks, themselves increasingly in a position to expand overseas, run into other countries’ investment restrictions. When asked recently about the risk of protectionism in banking, Trade Minister Gita Wirjawan said there has to be “fairness and balance in the way we trade with anybody around the world.” In a similar vein, politicians don’t like that the phenomenal returns in this business have accrued to foreigners.
Animated by such jingoism, Jakarta is in danger of cutting off its nose to spite its face. Investors have been drawn to Indonesia—foreign direct investment was up 300% in 2010 compared to 2009—not only because of its political stability and 6% growth, but also because it looked like there was genuine reform momentum in the country. If reform is reversed, the loss will be Indonesia’s.
This also sets up a broader lesson about the nature of “crisis” measures. Enacting reforms in the middle of a maelstrom may have been a necessity. But consciously retaining those good policies through good times is key. Indonesia can only reap the rewards of its post-1997 reforms as long as reform remains the new normal.
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By: Abheek Bhattacharya
Source: The Wall Street Journal, November 30, 2011
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