0 Editorial: Poorly-capitalized banks

Bank Indonesia (the central bank) has reiterated the imperative that banks to increase capital to deal with current and potential financial and operational risks to promote financial stability. By holding more capital, banks will not be as vulnerable to loss in times of economic turmoil. But the banking industry remains crowded with 120 commercial banks, the majority of which still operate with less than US$500 million in capital, and thousands of secondary (rural banks) with capital below $10 million. 

With the increasing complexity of banking operations, the central bank considers $1 billion as the minimum capital needed for a commercial bank. We wonder how the central bank could effectively supervise so many banks, especially during the transition period to 2014 when the newly-established Financial Service Authority takes over the oversight of all financial service companies. The central bank uses a combination of market forces and regulations to promote a sound banking industry. 

The problem, though, is that with such a large number of commercial banks authorized to provide full banking services, the industry remains highly vulnerable to economic shocks. Yet more worrisome is the fact that the industry seems to be gripped by oligopoly whereby the four largest banks — Bank Mandiri, BRI and BNI (all state-owned) and BCA — control more than 70 percent of the market. It is, we think, this oligopoly that allows for the anomaly in the industry: Indonesian banks are among the most inefficient in the region, yet our large banks are among the most profitable. 

This anomaly hurts the consumers because lending rates in the country are among the highest in the region. The latest data available from the Deposit Insurance Corporation (DIC) shows that as of last year, the four largest banks held almost 60 percent of all bank accounts (savings, time deposits and demand deposits) , with the other 116 banks sharing the remaining 40 percent, thereby often setting off a “rate war”. Many small and mid-size banks often resort to offering deposit rates higher than the ceiling set by the DIC at big risks to their unsuspecting customers because their deposits will not be reimbursed in the case of bankruptcy. 

But how do small commercial banks survive without feeling any urgency to consolidate through a merger? One of the main reasons is because market forces do not properly screen players in the industry. Many people still bank with small banks because the DIC still insures up to Rp 2 billion ($200,000) in deposits per account. If the maximum amount of deposits covered by the DIC is halved, we think that many people will shun small banks, thereby forcing these banks to merge. But both the central bank and the Finance Ministry do not seem significantly confident yet about the strength of the industry to reduce the deposit insurance coverage. 

Bank Indonesia last year issued a string of new regulations, including one on multiple licenses, which ties bank operational expansion to bigger capital and higher standards of good corporate governance. Another regulation on bank ownership limits the single ownership of local banks at 40 percent for financial service companies, 30 percent for non-financial institutions and 20 percent for individual investors. These new rules are expected to speed up bank consolidation as banks have to increase capital if they want to expand and owners with shares exceeding the new limits will have to divest. 

We believe it will take more than 10 years to fully enforce these regulations as the domestic market will not be able to supply all the funds needed to take up the shares to be divested, while foreign investments in the banking industry have increasingly been restricted. Bank consolidation will remain slow if the industry is not subject to higher capital requirements and a stronger dose of competition, and the maximum deposit covered by the DIC is not decreased.

source : the jakarta post