Let us cheer, not fear, the arrival of foreign banks

Vincent Lingga, The Jakarta Post, Jakarta

The dilution of the deposit insurance scheme to a maximum of Rp 100 million (US$10,500) per account next month will unleash stronger market forces to screen banks, as depositors will have to be more careful about choosing the financial institutions they deal with.

Depositors with savings of up to Rp 2 billion have often been influenced more by the level of interest rates or the location of the bank than the soundness of the financial institution. They can rest assured that whatever may happen to the bank, all their savings will be reimbursed by the government.

This narrower deposit-guarantee program and the higher capital standards -- minimum capital of Rp 80 billion this year and Rp 100 billion by 2010 -- as well as the tougher risk management imposed by Bank Indonesia will certainly speed up the consolidation of the banking industry.

Obviously, the consolidation process will reduce the number of banks, now around 130, either through mergers or acquisitions. If last year is any guide, more local banks will be acquired by foreign investors. Last year foreign investors bought seven small banks.

This trend will undoubtedly heighten the concerns about increasing foreign domination of the banking industry, whipping up nationalist sentiments against what is seen as outside control of a vital service industry.

However, there is nothing much to worry about, because the foreign banks must still operate by the rules of the central bank, Bank Indonesia.

Higher foreign investor interest in the financial services industry should instead be welcomed as a vote of confidence in the long-term outlook of Indonesia's economy. Foreign investors would not be willing to stake out more capital in the financial sector if the economic outlook were poor. The financial services industry can grow soundly only in an expanding economy.

Even more important, the experiences of most other countries have proven the great benefits of the entry of major international banks to the development of a sound domestic financial industry. Banks are the heart that pumps oxygen and lifeblood throughout the economy.

Strategic investors with good reputations will accelerate the operational restructuring of banks as they bring in expertise, technology, credibility and better risk management.

Look at how all the big nationalized banks -- Bank BCA, Bank Niaga, Bank Danamon, Bank International Indonesia, Bank Lippo and Bank Permata -- which were acquired by investors from the U.S., Singapore, Malaysia, South Korea, Germany and Britain, have improved by strengthening their governance. On the other side, state banks such as Bank Mandiri and Bank BNI are still struggling with large amounts of non-performing loans and remain vulnerable to interference from politicians and senior officials.

A bank is not just a business entity in the ordinary sense, given its fiduciary responsibility, the multiplicity of transactions it does and its key function within the economy.

That is why the principles for good corporate governance for banks are much more comprehensive than those for other commercial entities. Good governance and corporate responsibility are prerequisites for the integrity and credibility of market institutions.

For that reason, not everybody who has tons of money can have controlling ownership of a bank. Those who want to become majority owners and commissioners have to pass the central bank's fit-and-proper test to assess their technical competence and integrity.

Because of their special role, banks are put under a multi-layer supervisory mechanism. Banks are an institution of trust, and the domestic banking industry, which collapsed in 1998 under bad governance practices, badly needs to regain the public's full trust.

Foreign banks, which together now control almost 50 percent of the banking industry's assets, can help accelerate reforms in risk management, corporate governance and competitiveness. In return, these foreign players can tap the attractive growth opportunities the country offers.

Regardless of ownership issues, however, the most important step of all is for the Finance Ministry and Bank Indonesia to focus on further strengthening the systems that supervise and regulate the financial services industry.

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