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Cablegate: Banking Sector Update 2007 - New Regulation On

VZCZCXRO6283
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #2815/01 2770732
ZNR UUUUU ZZH
R 040732Z OCT 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 6580
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 0917
RUEHBJ/AMEMBASSY BEIJING 4385
RUEHBY/AMEMBASSY CANBERRA 1320
RUEHUL/AMEMBASSY SEOUL 4234
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 002815

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-ABAUKOL
SINGAPORE FOR BAKER
COMMERCE FOR 4430/BERLINGUETTE
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR FINEMAN
DEPARTMENT PASS EXIM BANK

E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: BANKING SECTOR UPDATE 2007 - NEW REGULATION ON
CONSOLIDATION


A) Jakarta 13420

1. (U) Summary. Since announcing its 2005 Indonesian Banking
Architecture plan, Bank Indonesia has launched several policy
packages and regulations to promote banking consolidation via
merger. On September 21, Bank Indonesia issued a new regulation
setting out additional incentives for bank consolidation. The
incentives include lower minimum reserve requirements, easier rules
for banks to upgrade their status to foreign exchange banks, relaxed
requirements concerning corporate governance, and streamlined
procedures for submitting a merger plan. End Summary.

Background on Bank Consolidation
--------------------------------

2. (U) In June 2005, the Bank Indonesia (BI) launched a banking
consolidation policy in an effort to prepare the banking sector for
the planned implementation of the Basel II Capital Accord in 2008.
Under the 2005 policy, banks were required to have at least Rp 80
billion (US $8.5 million) in Tier 1 capital by the end of 2007 and
at least Rp 100 billion in Tier 1 capital by the end of 2010.

3. (U) In October 2006, BI launched an additional banking policy
package that included incentives to promote bank consolidation and a
single presence rule (Ref A). Indonesia currently has 131 banks
(not including very small rural banks which operate under a
different classification and set of regulations). Of these 131, the
top 10 comprise nearly 60% of the assets in the sector, leaving many
small banks which contribute little to economic activity but create
a large supervisory burden for BI. The 2006 regulations provided a
host of incentives for banks to merge, including looser lending
limits, lower minimum capital requirements, and relaxed rules for
obtaining licenses to conduct foreign exchange operations.

Single Presence Policy
----------------------

4. (U) Under the single presence rule in the October 2006 package, a
single party is limited to controlling interest (25% or more) in
only one banking organization in Indonesia. Some observers
speculate that with this single presence policy, designed to
encourage consolidation, BI also intended to force the privatization
of Indonesia's state-owned banks. BI had hoped for a large number
of voluntary mergers before 2007, but to date, these policy changes
have induced only a very limited number of small banks
consolidations. BI expects banks to submit plans for compliance
with the single presence policy by the end of 2007.


New Regulation: Incentives for Consolidation
--------------------------------------------

5. (U) On September 21, 2007 BI issued a new regulation on
Incentives for Bank Consolidation, amending the 2006 regulation.
The new rules offer additional incentives to merge, including the
further relaxation of requirements for lenders to become foreign
exchange banks. Of the 131 banks in Indonesia, only 40 have foreign
exchange licenses. Under the new regulation, any bank formed by
merger or consolidation, regardless of the number of participating
banks, may apply to upgrade its status to foreign exchange bank.
However, these banks would need to meet a minimum Tier 1 capital
requirement of Rp 100 billion ($11 million) and have a bank
composite rating of a least two (sound), and a management rating of
at least three (fairly sound) within two years of approval for
merger/consolidation. (Note: BI rates banks on a scale of 1-5. The
ratings are defined as 1 (excellent), 2 (sound), 3 (fairly sound), 4
(poor) and 5 (weak). End note.)

6. (U) The consolidation incentives also include a reduction in
minimum mandatory reserve requirement (i.e., the amount of funds
commercial banks have to set aside as reserves at the central bank)
for newly merged banks. The new rules allow a 1% reduction in a
merged bank's minimum reserve requirement within one year after the
merger approval. BI currently sets the minimum reserve requirement
in a range between 5% and 13% of a bank's rupiah deposits, depending
on the bank's loan-to-deposit ratio (LDR). Banks with the lowest

JAKARTA 00002815 002 OF 002


LDRs have the largest minimum reserve requirements. In addition to
providing an incentive to merge, BI hopes the lower reserve
requirement will encourage commercial banks to allocate more funds
for investments in high-yielding assets such as bonds or to expand
lending, potentially boosting economic growth in Indonesia.
According to our BI contact, the banks have responded positively to
the lower reserve requirements.


Relaxed Corporate Governance for New Mergers
--------------------------------------------

7. (U) The new regulation also relaxes the corporate governance
standards required for newly merged banks. The new rules give a
six-month grace period for banks to comply with the BI regulation
that independent commissioners make up at least 50% of the Board of
Commissioners. Further, if a bank has only one independent
commissioner, he/she may concurrently chair three committees-Audit
Committee, Risk Monitoring Committee, and Remuneration and
Nomination Committee for up to six months after BI approves the
merger.

Streamlined Procedures for Consolidation
----------------------------------------

8. (U) The regulation also streamlines procedures for submitting a
consolidation plan. First, BI has eliminated the deadline for
submission of merger plans. Second, BI will require only one of the
banks participating in a merger to submit a consolidation plan.
However, the President Directors of all participating banks must
sign the plan. Any bank having submitted a merger plan prior to the
enactment of this new regulation may submit an addendum to the plan
and qualify for the new incentives.

Comment
-------

9. (SBU) BI's previous incentives for consolidation have failed to
prompt merger activity because most bank managers in Indonesia do
not perceive significant economic benefits from merging with their
peers. The business models at most large, well-run Indonesian banks
differ radically from the strategies employed at most smaller merger
candidates. As a result, the larger banks plan to grow organically
rather acquiring smaller institutions which would necessitate
significant retraining of staff and management. In addition,
Indonesian labor law requires large severance packages for laid-off
workers, significantly raising the costs associated with effective
consolidation. Since the new regulations do not address these
issues directly, analysts do not expect a significant number of
banks to take advantage of the additional incentives. Some bank
analysts also have questioned the prudence of the certain aspects of
the new regulations. History has shown that bank mergers generate
significant operational problems if experienced managers do not
carefully implement them. Relaxing corporate governance
requirements and requiring only a "fairly sound" management rating
for foreign exchange bank licenses are likely to generate more
problems down the road. End comment.

HEFFERN

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