Regional Outlook, Global Perspective

SMALL BANKS VULNERABLE

SMALL BANKS VULNERABLE

INDONESIA

The Jakarta Post

12 Feb 2018

The conclusion of the latest International Monetary Fund (IMF) annual policy review on Indonesia, which was announced last week, presents glowing commendations on our macroeconomic stability and prudent fiscal and monetary management, but it also made a long list of recommendations on policies needed to maintain stability and generate a higher rate of economic growth.

The IMF assessment of financial sector stability finds that systemic financial risks have been contained and the banking system remains sound with a 23.2 percent capital adequacy ratio, ample liquidity and strong profitability.

But the report also warns that even though non-performing loans (NPLs) are rather stable below 3 percent due to corporate performance, problem loans, including NPLs, special mentions and restructured loans remain relatively high or more than 10 percent of total loans due to the impact of the fall in commodity prices since late 2014.

Even though the stress tests conducted under the IMF assessment showed that most banks could weather the most severe tests, small banks are vulnerable to liquidity shocks, including foreign exchange liquidity shortfalls due to their reliance on short-term deposits and limited access to the money market.

The biggest risk to the financial sector remains external: a sudden reversal in capital inflows triggered by global financial volatility and uncertainty caused by United States monetary and fiscal policies, notably the plan of the Federal Reserve Bank to raise its fund rates three more times this year. Domestic risks such as tax revenue shortfalls, political uncertainty in the run-up to the 2019 presidential elections and natural disasters are rather small. The upside though is that the commodity market has begun to pick up.

But even though the biggest risks of liquidity shocks would affect only small commercial banks, with capital ranging from Rp 100 billion (US$7.4 million) to Rp 1 trillion, which are not systemically important, and the Deposit Insurance Corporation may have enough funds to reimburse their depositors, we cannot simply sidestep the issue.

The Financial Service Authority (OJK) still needs to strengthen banking supervision. We should remember that our 1998 economic crisis was in part triggered by the closure in November 1997 of 16 small banks, which together accounted for a mere 2.5 percent of total banking assets. The psychological damage caused by the bank closures destroyed the public’s trust in the banking system.

A tighter banking oversight is even more imperative because many of the small banks (about 30 out of the estimated 120 banks) are subsidiaries of business groups. Many big business groups and financial conglomerates also have yet to build effective group-wide risk management structures. The legal framework of conglomerates also often blurs the roles of the board of commissioners and board of directors of their companies/ subsidiaries, thereby weakening their responsibility and accountability.

Latest data at the OJK put the number of financial conglomerates at around 50 that together account for 70 percent of the total assets of financial institutions, which in turn account for 75 percent of gross domestic product. Total bank assets alone account for 50 percent of GDP. That shows how vital a sound banking industry for economic stability is.

(First published in The Jakarta Post – http://www.thejakartapost.com/academia/2018/02/12/editorial-small-banks-vulnerable.html)

 

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