Financial systems and development

Box 7.5 Bank modernization: Indonesia's experience
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Indonesia began to deregulate its financial sector in The program had an institutional component and a
1983 and enacted a second set of measures in 1988. technology component. The institutional component
These signaled-at least potentially-a fundamental included an attempt to identify business opportunities
shift from a highly protected state banking oligopoly to following deregulation; a reorganization to refocus the I
a broadly competitive financial market. In a competi- bank on its marketplace priorities, reinforce risk mantive
environment, state banks would need to improve agement, and speed management decisions, manservice,
productivity, product innovation, and market- power management programs to improve the evalua- I
ing skills. They would also need to introduce better risk tion, deployment, development, and motivation of
management, because competitive pressures would staff; and a comprehensive revamping of the bank's
narrow lending spreads and increase balance sheet procedures for managing its assets and liabilities. The
volatility.
project was accompanied by a massive effort to train
Bank Negara Indonesia 1946 (or BNI) is the largest of staff.
Indonesia's five state commercial banks, which to- The technology component was the full-scale autogether
accounted for 71 percent of commercial bank mation of the bank's retail and wholesale functions. In
assets in 1987. BNI's board of managing directors re- preparation for automation, BNI greatly simplified its
acted to the changing environment by adopting an am- procedures. To attract and retain the necessary technibitious
modernization program with the support of an cal expertise, it paid higher salaries.
international consulting firm. This program was given It is too soon to judge the overall success of BNI's K
top priority from its inception in 1983 to the end of reforms. BNI's competitors have begun or announced F
1988. similar programs of their own.
works internalize a considerable part of the super- cessive concentration of risk is common. Too many
visory function.
loans to one borrower, an affiliated group, or bor-
The internal systems of banks in developing rowers in one industry means that the quality of
countries have some common problems. Many those loans could be jointly damaged by a single
banks are operated without the benefit of a formal factor. Banks in Texas are an example of excessive
planning process. Financial plans and budgets risk concentration. When the price of oil was high,
may not exist, and little is done to control costs. As Texas banks were among the nation's most profita
result institutions react to, rather than anticipate, able; when the price fell after 1982, they sustained
changes in the external environment. This makes large losses, and several of the leading banks
them vulnerable to sudden change.
failed.
The information available to management is nei- Excessive lending to related firms has proved a
ther timely nor complete. At one bank in Nepal, serious problem in Chile, Kenya, Turkey, and
unreconciled differences in interbranch accounts other developing countries. In Spain, the Rumasa
have existed for years and are equal to the whole of group contained twenty banks and more than 700
the bank's capital. Without good information, it is companies ancd used the twenty banks to finance
difficult to take corrective action on credit exten- the related firms. When the firms experienced difsions,
problem loans, or off-balance-sheet risks. ficulties, the banks became insolvent. In the after-
Commercial banks in many countries have lax ac- math of the crisis, it was discovered that 400 of the
counting and auditing procedures and continue to firms were phantom companies created to borrow
accrue income long after loans are nonperforming money, conceal the use of funds, and maintain the
and recovery has become doubtful. Sometimes appearance of financial health.
new lending is used to conceal debt servicing prob- Poor risk selection is the source of many problem
lems; overdraft facilities are particularly vulnerable loans. This includes advancing an excessive proto
such abuse.
portion of the required capital without demanding
Poor management is most often reflected in im- an adequate infusion of the borrower's own funds.
proper lending. A lack of written lending policies Speculative loans based on the appreciation of asmakes
it more difficult to manage risk; without set prices can also be dangerous. In Malaysia, a fall
written policies, senior managers find it hard to in property prices and a rise in the debt servicing
control the lending of their middle managers. Ex- costs in the early 1980s adversely affected loans to
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