indonesian financial crisis and banking reform10feb03
DESCRIPTION
Brief Description of the causes and effects of the Asian 97-98 banking crisis to IndonesiaTRANSCRIPT
Jerry Ng
Former Deputy Chairman of IBRASenior Advisor to CEO Bank Danamon
Jakarta
INDONESIAN FINANCIAL CRISIS AND BANKING REFORM
- 2 -
BANKING CRISIS IN ASIA STARTED IN 1998
Indonesian financial crisis and Asian financial crisis can be attributed to external and internal factors
The crisis was triggered by external systemic events
1. Overheated economies that created confidence crisis in the tiger economies
2. Political instability
3. Massive currency devaluation
1.... Within the banking system, currency devaluation led to
4. Interest surge and mounting NPL
5. ... Negative margin ...
6. ... the financial system that is already comprised of small and undercapitalised banks is further weakened
- 3 -
OVERHEATED ECONOMY LED TO CONFIDENCE CRISIS ...
Over heatedEconomy
Over heatedEconomy
1
High current account deficit . . .High current account deficit . . . . . . Higher debt burden . . .. . . Higher debt burden . . . . . . triggered crisis confidence.. . . triggered crisis confidence.
294
243
137122
69
-3.3
-4.8 -4.7
-8.5
-3.7
Indonesia Korea Philippines Thailand Malaysia
Indonesia Korea Philippines Thailand Malaysia
Current Account Deficit (% GDP)
Debt Service & Short term Debt (% Foreign Reserved)
0.9
1.1
1.3
1.5
1.7
1.9
2.1
2.3
2.5
MayJuneJuly Aug Sep Oct Nov Dev Jan
Local Currency 1997 (Indexed to April’97 vs USD)
IndonesianRupiah
KoreanWon
ThailandBaht
Source: NYU Stern, International Financial Statistics, OANDA
- 4 -
... EXACERBATED BY POLITICAL CRISIS ...
Political InstabilityPolitical Instability
2
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
Jun 97 Jun 98Jul 97 Aug 97 Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 Feb 97 Mar 98 Apr 98 May 98
Habibie announced as VP candidate
Soeharto announced his budget – Rp plunged to
11,000Govenment announced
deposit guarantee
Government announced price hike, riots ensued
Soeharto announced his resignation
New cabinet was announcedThai Baht sharply fell
after crisis in confidence
Indonesia seeks IMF help
Indonesian Rupiah vs USD
Source: Worldbank, OANDA
- 5 -
... MASSIVE LOCAL CURRENCY DEVALUATION THAT LED TO CRISIS
Surge in Interest Rates
Rising Borrower Defaults
Crisis of Confidence
Banking Crisis3 4
Multiple sources of investor concern
• Unclear political transition
• Bank closures• Widespread riots• Droughts, forest
fires
Led to estimated US$18 Bn of capital flight, mainly to Singapore
Interest rates peaked at over 70% p.a, the highest rate since 1966
Average level of NPLs estimated to be >50% of total loans outstanding
Some banks have close to 100% NPLs
Foreign exchange losses due to open US$ net positions
Level of NPLs grew dramatically
Interest spreads became negative
Customers rushed to take deposits out of the system/country
Source: Analyst reports, literature, BCG analysis
i
Capital Flight
2
Massive Devaluation
Massive Devaluation
3
Rupiah Devaluation
1
Rupiah lost >75% of its value since 8/97
Unexpected removal of the currency intervention band left many companies and banks with mismatched and unhedged ($/Rp) assets and liabilities
Rp
- 6 -
DEVALUATION AND UNHEDGED DEBT POSITIONS LED TO A HIGH LEVEL OF NON PERFORMING LOANS
NPLs by Types of Banks in IndonesiaEstimated Non Performing Loans (%) in the Banking System in Indonesia
10 9 8
57
0
10
20
30
40
50
60
1995 1996 1997 1998
%
Total Loans (Rp. Tr.)
235 293 445 545
1998E (NPL) Korea
Thailand
Malaysia
Philippines
21%
44%
17%
28%
11
36
11
53
52
72
36
15
57
45
0
10
20
30
40
50
60
70
80
State Banks
Forex Private
National Banks
Non-Forex National Banks
Joint Venture Banks
Foreign Banks
Regional Develop-
ment Bank
1997
1998
Source: Bank Indonesia, BCG analysis
LargeNPL
LargeNPL
4
- 7 -
A MASSIVE RECAP PROGRAM OF RP 420 TN
Almost 2/3 of all banking assets were lost as a result of the crisis
• A majority of the banking sector was technically bankrupt
• Banks’ role as a financial intermediary was seriously eroded
The government could not afford the banking sector to collapse
• Indonesia’s economic foundation would be destroyed – perhaps permanently
• Political considerations and the welfare of people who would lose their savings(1)
... Therefore, a large amount of recapitalisation bonds were issued to save the banks
• Kind of “promissory notes” due for redemption within 2009 – initially ...
• Coupon at fixed and variable rates
Negative Spread
Negative Spread
5
(1) A deposit guarantee scheme was introduced
- 8 -
NPLS COUPLED WITH EXPENSIVE COST OF FUNDS CAUSED NEGATIVE SPREADS IN MOST BANKS ...
0
10
20
30
40
50
60
70
Jan Feb Mar Apr May Jun Jul Agt Sept Oct Nov Dec Jan Feb Mar Apr May Jun Jul Agt Sep Oct
Weighted Average Deposit Rate
Negative spread
Weighted Average Interest Rate%
Source: Economic Outlook 1999, BCG analysis
1997 1998
Weighted Average Lending Rate
Negative Spread
Negative Spread
5
- 9 -
... WHICH WEAKENED THE BANKING SYSTEM EVEN FURTHER
Small & Weak Banks
Small & Weak Banks
6
(1) In Asiaweek Financial 500(2) Based on assetsSource: Asiaweek, BCG analysis
Indonesia banking system was mostly made of small banks . . .
27 26
208
144
54
4634
Indonesia Japan India Taiwan Malaysia HongKong
. . . that is further weakened by the crisis
Philippines
Number of Banks Pre-crisis Equity/ Assets of Banks(%)
-13.6
-1.6
8.8
6.8
10.38.1
-12.9
-8.3
Overall State Private Foreign & JV
1997 1998
- 10 -
CRISIS CREATED IMPETUS FOR EXTERNAL AND INTERNAL REFORM
Over-heated economy
Political instability
Massive depreciation
Over-heated economy
Political instability
Massive depreciation
ExternalExternal InternalInternal
Crisis CauseCrisis Cause
ActionPost-Crisis
ActionPost-Crisis
Large NPL ...
... Negative margin ...
... Weakened the small and weak banking system
Large NPL ...
... Negative margin ...
... Weakened the small and weak banking system
1. Asset management
2. Bank recapitalisation
3. Banking sector consolidation
1. Asset management
2. Bank recapitalisation
3. Banking sector consolidation
4. Starts lending again
5. Risk management & corporate governance
6. Improving capabilities
4. Starts lending again
5. Risk management & corporate governance
6. Improving capabilities
- 11 -
INDONESIA LEAST SUCCESSFUL IN GOVERNMENT-LED REFORM
Asset Management &
Loan Restructuring
Asset Management &
Loan Restructuring
Recapitalization & Balance Sheet Restructuring
Recapitalization & Balance Sheet Restructuring
Banking Sector Consolidation
Banking Sector Consolidation
Korea Thailand Malaysia Indonesia
Established Kamco as AMC
So far, disposed ~50% of loans purchased by Kamco
Established Kamco as AMC
So far, disposed ~50% of loans purchased by Kamco
No centralized asset management companies were established
• AMCs were established by the banks
• Framework for AMC creation was established
No centralized asset management companies were established
• AMCs were established by the banks
• Framework for AMC creation was established
Established Danaharta as AMC
Established Corporate debt restructuring comm.
Danaharta has Disposed ~80% of loans purchased
Established Danaharta as AMC
Established Corporate debt restructuring comm.
Danaharta has Disposed ~80% of loans purchased
Established an AMC underneath IBRA
Has managed to dispose xx % of loans transferred
- Most of loans disposed were unrestructured
Established an AMC underneath IBRA
Has managed to dispose xx % of loans transferred
- Most of loans disposed were unrestructured
Government recapitalized feasible banks in return for purchased NPL made by Kamco
Average banks’ capital has exceeded the minimum defined by BIS
Government recapitalized feasible banks in return for purchased NPL made by Kamco
Average banks’ capital has exceeded the minimum defined by BIS
Government plays an active role in banks M&A
So far has closed 5 banks and 23 merchant bank
6 banks and 3 merchant banks has successfully merged
Government plays an active role in banks M&A
So far has closed 5 banks and 23 merchant bank
6 banks and 3 merchant banks has successfully merged
Recapitalization was private sector led
However, the government provided capital support scheme
Recapitalization was private sector led
However, the government provided capital support scheme
3 local banks were acquired by foreign banks
56 finance companies were closed
However, limited consolidation amongst local banks
3 local banks were acquired by foreign banks
56 finance companies were closed
However, limited consolidation amongst local banks
Established Danamodal to recapitalize, revitalize and restructure banking sector
• A comprehensive framework of banking sector improvement is in place
Established Danamodal to recapitalize, revitalize and restructure banking sector
• A comprehensive framework of banking sector improvement is in place
Government is authoritative in pursuing consolidation
Government mandated merger of banks to 10 anchor banks possibly to 6 in the future
Government is authoritative in pursuing consolidation
Government mandated merger of banks to 10 anchor banks possibly to 6 in the future
11 private and 4 state banks were recapitalized by the government using bonds not cash
Many banks are still undercapitalized, exposed to interest rate risk and liquidity risk
11 private and 4 state banks were recapitalized by the government using bonds not cash
Many banks are still undercapitalized, exposed to interest rate risk and liquidity risk
Banks declined from ~225 to 162 some closed and liquidated
Limited M&A activity, 7 banks merged into Danamon while 4 state banks merged into Mandiri
Banks declined from ~225 to 162 some closed and liquidated
Limited M&A activity, 7 banks merged into Danamon while 4 state banks merged into Mandiri
- 12 -
STRONG LEGAL FRAMEWORK PRE-REQUISITE TO ACCELERATE LOAN RESTRUCTURING
Korea Thailand Malaysia Indonesia
Established Korea Asset Management Corporation which purchases NPL from banks
Financial Supervisory Commission (FSC) and Financial Supervisory Service(FSS) leads, formulate the policy and enforce the banking reform
• FSC & FSS in cooperation with other institution leads reforms in real sector (corporate sector)
Government takes an active role to reform the judicial system, including replacing commercial judges
Established Korea Asset Management Corporation which purchases NPL from banks
Financial Supervisory Commission (FSC) and Financial Supervisory Service(FSS) leads, formulate the policy and enforce the banking reform
• FSC & FSS in cooperation with other institution leads reforms in real sector (corporate sector)
Government takes an active role to reform the judicial system, including replacing commercial judges
Government plays supporting role rather than leading role in asset management
• Maintain low interest rate level as well as provide tax incentives to facilitate loan restructuring
• Developed a framework for creating a private AMC rather than creating a centralized AMC that would purchase loans from banks
Government plays supporting role rather than leading role in asset management
• Maintain low interest rate level as well as provide tax incentives to facilitate loan restructuring
• Developed a framework for creating a private AMC rather than creating a centralized AMC that would purchase loans from banks
Established Danaharta to purchase loans from banks as part of the recap program
Created a comprehensive framework to acquire loans, manage assets and defined clear exit/ disposal strategy
Established Danaharta to purchase loans from banks as part of the recap program
Created a comprehensive framework to acquire loans, manage assets and defined clear exit/ disposal strategy
Established AMC under IBRA which purchases loans from banks and conducted restructuring
Financial Sector Policy Committee is established to play an active role in establishing policies for financial sector
• Involved in making decisions for large loans restructuring
However, lack of reforms in legal framework and infrastructure has so far impeded progress in asset/ loans restructuring
Established AMC under IBRA which purchases loans from banks and conducted restructuring
Financial Sector Policy Committee is established to play an active role in establishing policies for financial sector
• Involved in making decisions for large loans restructuring
However, lack of reforms in legal framework and infrastructure has so far impeded progress in asset/ loans restructuring
Improvement in legal infrastructure
Improvement in legal infrastructure
Private led asset management
Private led asset management
Create clear framework and
targets
Create clear framework and
targets
Lack of clarity of decision makers of asset management
Lack of clarity of decision makers of asset management
Asset Management
Asset Management
1
- 13 -
SEPARATING BAD ASSETS REDUCED THE NEED FOR BANKS TO FOCUS ON LOAN RESTRUCTURING
NPL increased significantly after the crisis ...NPL increased significantly after the crisis ... ... reduced significantly after transfer to AMC ... reduced significantly after transfer to AMC
(1) Indonesia as of April 2001, Korea June 2001, Malaysia & Thailand July 2001Source: ADB Asia Recovery Report Sep 2001
19
1310
4
Indonesia KoreaMalaysiaThailand
NPL 2001(1) (%)
48
42
1310
Indonesia Korea MalaysiaThailand
NPL End of 1998 (%)
Asset Management
Asset Management
1
- 14 -
ALL GOVERNMENT UNDERTAKE MASSIVE RECAP PROGRAM TO RESCUE BANKS
Massive Cost of RecapitalizationMassive Cost of Recapitalization At the cost of Large Government DeficitsAt the cost of Large Government Deficits
9
3031
70
Indonesia Korea Thailand Malaysia
Expected recapitalisation need (US$ ‘b)
-5.0%
-3.9%
-6.0%
-9.0%
Korea Thailand Malaysia Indonesia
Source: JP Morgan, MSDW 1998, IBRA
Government Deficit in 1998 (% GDP)
Recap & B/S RepairRecap &
B/S Repair2
- 15 -
IN INDONESIA, MORE THAN RECAPITALIZATION IS REQUIRED TO REPAIR BANKS’ BALANCE SHEET
Source: Financial Statements June 2001, BCG analysis
Low
Medium
High
Market Risk:
Asset Size:
3
4
LowHigh
Low
High
NPL as % of Loans (%)
CAR(1) (%)
Credit Risk:
Capital Solidity:1
2
Panin
Mandiri
BNI
Citibank
Lippo
Danamon
Bukopin
Buana
BII
SCBNiaga
BaliUniversal
0
HSBC
Healthy bank
Rp. 100 Tn
Recap & B/S RepairRecap &
B/S Repair2
BCA
- 16 -
WHY CONSOLIDATION AND/ OR SALE IS IMPORTANT?
Allow relatively strong banks to use their balance sheet to address problems of weaker banks around work outs of bad loans and recaptalising
Contain possibility of loss of confidence which could result in bank runs and breakdown of banking system; capital flight e.g. in Indonesia real Rupiah deposits have fallen by 30% between 1997 and 3Q 1998; foreign currency deposits have fallen 50% in the same period
Restore confidence of depositors and investors in the banking system, this will be key for the banks to begin value creation
Complements banks’ capabilities especially in the area of risk management, scale in operations and application of technology
Bring in new capital from foreign strategic investors and expertise in risk, new product development, management, global network through sales to foreign investors
1
2
3
4
5
Consolidation Consolidation3
- 17 -
SALE AND CONSOLIDATION PLANS
Pre-crisis had 78 banks (local and foreign)
• 5 commercial banks and 23 merchant banks already shut down
• Govt has ordered healthy banks to take over weaker banks in 1998 for restructuring and recapitalisation; Merger of 6 banks and 3 merchant banks has taken place so far
Pre-crisis had 33 banks (local and foreign)
• 3 local banks were acquired by foreign banks (DBS, Stan Chart & ABN Amro)
• so far, only 1 merger took place between local banks
Govt has encouraged consolidation from original number of 34 (local and foreign); banks to 10 anchor banks
• Recently completed the stage 1 (10 banks) and moving to stage 2 (six banks)
Pre-crisis had 225 banks (local and foreign); 16 have been liquidated and 54 banks put under supervision. Govt aiming for 4 “mother banks”
• So far, only BCA and Niaga is successfully divested ...
• ... Stakeholders management makes it difficult to divest the banks
Consolidation Consolidation3
- 18 -
GOVERNMENT INITIATIVE IS KEY FOR CONSOLIDATIONExample of Banks M&A in Korea
Gov’t decision-making treeMerger of banks (in1998)
Due diligence on banks, identify banks with
BIS ratio <8%
Evaluation on bank management performance
FSB ‘verdict’ on bankruptcy
SurvivedSurvival on condition
Bankrupt
Normal operation
Restructuring plan within one month
Transfer of asset & liability
‘Voluntary’ M&A
Reach BIS ratio of >8%
Kookmin• W 57 trillion(1)
• 9.78%(2)
• 12,000(3)
Hao Sing • W 38 trillion• 10.29%• 11,000
Shinhan• W 42 trillion• 10.29%• 4,700
Koram• W 15 trillion• 8.57%• 2,100
Hana• W 15 trillion• 9.29%• 1,700
Commercial Bank of Korea
• W 50 trillion• 3.28%• 7,806
Daedong• W 8.6 trillion• 2.98%• 1,700
Dongnam • W 7.5 trillion• 4.54%• 1,700
Dongwha• W 12 trillion• 5.34%• 1,800
Kyonggi• W 7.6 trillion• 6.69%• 2,200
Chungchung• W 6.1 trillion• 7.05%• 1,400
Hanil• W 55 trillion• 4.53%• 7,488
+
+
+
+
+
+
1
2
3
4
5
6
Note: (1) Total asset (2) BIS ratio (3) No. of employeesSource: FSB, Korea Daily Economic
Merger of equals
Consolidation Consolidation3
- 19 -
INDONESIAN BANKS NEED TO START LENDING AGAIN
Start LendingStart
Lending4
Indonesia has a smaller proportion of loans particularly in consumers ...
... when compared to other Asian countries
Deposits are significantly larger than corresponding wholesale and retail assets
• Loans write-off, corporate de-leveraging and a high interest rate environment are the main drivers
Retail lending still small compared to deposits
• Customer sophistication and income levels are the main drivers for future growth
Deposits are significantly larger than corresponding wholesale and retail assets
• Loans write-off, corporate de-leveraging and a high interest rate environment are the main drivers
Retail lending still small compared to deposits
• Customer sophistication and income levels are the main drivers for future growth
52%
72%
7%4%6%
21%
28%
7%
1%2%
Total Other Asian Countries
Indonesia
Deposits
Wholesale Loans
MortgageConsumer LoansRetail Funds(1)
Total Bank Assets & Liabilities(1)
(1) Other Asian countries 1999, Indonesia 2000
- 20 -
IMPROVING RISK MANAGEMENT AND GOVERNANCE IS A PRE-REQUISITE
Corporate Governance
Risk Management
Many banks are still lagging the 4 core principles of good corporate governance
• Ineffective board partly due to banks ownership structure
• Lack of transparency
• Weak internal controls and audit performance
• Unreliable reporting
Many banks are still lagging the 4 core principles of good corporate governance
• Ineffective board partly due to banks ownership structure
• Lack of transparency
• Weak internal controls and audit performance
• Unreliable reporting
Many banks lack robust integrated risk management systems that can be considered compliant to Basel II requirement
• Building banks with a strong credit risk management will continue to be the key challenge
• Only one bank is expected to be FIRB(1) compliant by 2002
Many banks lack robust integrated risk management systems that can be considered compliant to Basel II requirement
• Building banks with a strong credit risk management will continue to be the key challenge
• Only one bank is expected to be FIRB(1) compliant by 2002
Areas of Focus Improvement Opportunities
(1) Fundamental Internal Rating Based Approach according to Basel II requirementsSource: Basel II Capital Accord
Risk Mgt & Governance Risk Mgt &
Governance5
- 21 -
DOMESTIC BANKS ARE TRYING TO IMPROVE THEIR CAPABILITIES
Improvement Areas Improvement InitiativesImplementation by Domestic Banks
• Headcount reduction• Training• Performance incentives
• Network rationalisation (e.g., branches)• Network optimisation (e.g., ATMs)• Network sharing (e.g., ATMs, card
businesses)
• Outsourcing of processes• Back office centralisation (within a bank)• Back office sharing (among banks)
Human
Resources
Human
Resources
NetworkNetwork
ProcessProcess
1
2
3
= all or almost all banks = many banks = few banks = very few banks = none
ImprovingCapabilities ImprovingCapabilities
6
- 22 -
WHAT’s NEXT FOR THE INDONESIAN BANKING SECTOR?
Banks are expected to play a key role in financial intermediation over the next 5-10 years, with the typical pattern of
• People placing money with the banks (small savings) instead of pursuing capital market products (affordability)
• Banks channeling the funds to companies, which have limited sources of finance given a stagnant domestic capital market (low demand)
Competition expected to increase - domestically
• A wave of consolidation may follow a tighter regulatory environment
• Foreign banks hesitate to enter – albeit BCA and Niaga divestments – and Danamon in the pipeline
An after-thought: Have the Indonesian banking sector learnt its lesson (corporate governance and risk management) to avoid a “second crisis”?