VZCZCXRO1576
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #0359/01 2280852
ZNR UUUUU ZZH
R 160852Z AUG 06
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 8880
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUEHKO/AMEMBASSY TOKYO 9985
RUEHBJ/AMEMBASSY BEIJING 3598
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RUEHBU/AMEMBASSY BUENOS AIRES 0033
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 06 JAKARTA 010359 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SEARLS 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON PGOV PREL ID
SUBJECT: INDONESIA'S FINANCIAL SECTOR POLICY PACKAGE 
 
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losses of 70 percent last year over non-transparent pricing 
and risk, the package also calls for information 
transparency for banking products and other consumer 
protection measures.  These include a standardized system 
for consumers to file complaints and the establishment of an 
independent dispute mediation body. 
 
¶9.  (SBU) Although Bank Mandiri and BNI lobbied BI to be 
allowed to establish special purpose vehicles that would 
take NPLs off their books, the policy actions will instead 
amend the rules governing NPLs.  They will allow state-owned 
banks to work around state laws that have thus far prevented 
them from resolving bad loans using techniques commonly 
employed by commercial banks.  Existing laws, such as the 
2003 State Finance Law, treat state-owned banks assets as 
"state" assets.  As a result, state-owned banks taking a 
haircut (loss) on non-performing debt or reselling it at a 
discount could be accused of causing a financial loss to the 
state, currently considered a criminal corruption offense. 
An international advisor at the Finance Ministry tells us 
that Bank Mandiri has been waiting for President Yudhoyono 
to sign the government regulation allowing state-owned banks 
to take haircuts on debt, which has been on his desk since 
the end of July. 
 
¶10. (SBU) Getting rid of the NPLs is only half the battle, 
however.  Resident expatriate economists note that because 
an excess of NPLs reflects a bank governance problem, bank 
management must be improved to prevent them from 
accumulating anew.  Besides allowing the state-owned banks 
to resolve NPLs using techniques employed by commercial 
banks, the Package also urges they emulate the more 
professional management practices of their private sector 
counterparts.  The package calls for the State Ministry of 
SOEs to "ensure the commitment of state-owned banks' 
management to corrective measures in governance and risk 
management and to efforts for resolving problem loans."  The 
medium specified for achieving this is the signing of 
management contracts on these subjects with the boards of 
directors of state-owned banks, a pretty weak mechanism for 
producing results. 
 
¶11. (SBU) The Finance Ministry advisor characterized Bank 
Mandiri as "very cooperative" in reform efforts.  A senior 
contact at Mandiri also pointed out that the bank's new 
president, Agus Martowardoyo, had replaced all the group 
heads at the bank, which took months.  In contrast, BNI is 
not replacing key staff, suspended an audit that was 
undertaken 18 months ago, and has a disengaged board of 
commissioners.  The IMF notes that BNI is bloated in terms 
of personnel, at two-thirds the size of Mandiri, and unlike 
the latter is still non-transparent about its NPLs. 
 
¶12. (SBU) An international banking consultant told us that 
it is not only the old legacy loans that are problematic, 
such as the Mandiri loans that have been the subject of 
headlines in the past year.  New loans are going bad at a 
worrisome tempo because banks do not have proper risk 
assessment procedures.  The consultant lamented that at 
least a third of Mandiri's employees are corrupt, 
incompetent, or both, and estimated that some 40-50 percent 
of new SME loans are going bad because Mandiri still does 
not have good risk managers or account officers. 
 
¶13. (SBU) Though the Financial Sector Package aims to 
improve the banks, some debtors still have an attitude 
inherited from the New Order, when one of the perks of crony 
capitalism was that it was understood that state-owned bank 
loans did not always need to be repaid.  Our senior contact 
at Bank Mandiri told us in confidence that after Bank 
Mandiri tried a "name and shame" strategy earlier this year, 
publishing the names of problem-loan holders, some debtors 
had started to pay, some were paying only interest, and some 
who could pay have a bad attitude and are refusing to. 
Mandiri's actions provoked a backlash from some companies 
that reached out to Palace contacts in an attempt to get the 
President to intercede, which he declined to do on advice of 
Finance Minister Mulyani.  We heard a similar story about 
debtors with bad attitudes from the Finance Ministry 
 
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advisor, who told us that Mandiri had "quite legally" seized 
a few cash deposits that were used as collateral on 
nonperforming loans.  In one instance, the customer 
complained to the police, who hauled in several dozen 
Mandiri staff members including a director for questioning 
until 4 a.m.  The advisor noted that in the past, Mandiri 
would have just made the problem go away by paying the 
police more than the client had, but now Mandiri's approach 
is to work things out through proper channels. 
 
Bank Consolidation 
------------------ 
 
¶14. (SBU) The Financial Sector package includes an item 
designed to encourage the consolidation of Indonesia's 131 
banks required under BI's Indonesian Banking Architecture 
vision.  The matrix calls for Bank Indonesia to provide 
"incentive" for banks to merge over the next two years, but 
does not explain what the incentive will be.  BI has had 
trouble energizing its bank consolidation program, since the 
owners of small private banks like being bank proprietors, 
do not want to sell or close their banks, and are unlikely 
to respond to rational incentives.  The large state-owned 
banks, however, have shown sustained interest over the past 
year or so in merging with each other, raising the 
undesirable prospect of too much banking sector 
concentration in precisely the segment that is most poorly 
managed.  BI has rebuffed these proposals.  However, BI's 
recently announced "single presence" policy, if it goes 
ahead, would bar investors from holding a majority ownership 
stake in more than one bank.  Designed to encourage 
consolidation (and possibly to mollify nationalists piqued 
at foreign investment in Indonesian banking), it is unclear 
whether the policy would apply to the government, which 
holds controlling stakes in the country's three largest 
lenders measured by assets-Mandiri, BNI, and Bank Rakyat 
Indonesia (BRI). 
 
Next Up, Insurance Sector 
------------------------- 
 
¶15. (U) The third section of the package deals with non-bank 
financial institutions, with a marked focus on the insurance 
industry.  (Note: Indonesia's insurance sector is in bad 
health and poorly regulated.  Some domestic insurance 
companies were merely appendages of conglomerates.  End 
Note.)  The matrix calls for improved implementation of 
"Know-Your-Customer" principles across the non-bank sector; 
general moves to strengthen the pension fund sector, 
including drafting a development road map for the industry 
and good governance guidelines; and MOF decrees on 
strengthening the capital structure, regulation and 
supervision of finance companies and venture capital firms. 
Both insurance pension industries are underdeveloped in 
Indonesia, depriving the nation of good sources of long-term 
capital that could be invested in infrastructure.  The 
insurance industry is small, according to the World Bank in 
January 2005, with assets equal to just 5 percent of GDP and 
6 percent of total financial sector assets.  The industry is 
also highly concentrated, with the ten largest insurance 
firms dominating three-quarters of the sector.  The pension 
sector is similarly small, commanding only about 3 percent 
of financial system assets. 
 
¶16. (SBU) Indonesia's insurance industry has made progress 
since international insurers Manulife (in 2002) and 
Prudential (in 2004), were declared "bankrupt" by the 
Indonesian court system on spurious grounds.  Now the GOI is 
wrestling with genuinely bankrupt insurance firms, in 
particular, Bumiputra 1912, Indonesia's preeminent domestic 
insurance company.  Bumiputra 1912 is "totally bankrupt," 
according to our insurance industry contacts, with premiums 
collected today being paid out tomorrow in claims.  It 
should theoretically be shut down, but since it insures 
teachers and similar professions in the lower-to-middle 
class, the GOI is concerned about disruptive social 
consequences if the firm were allowed to fail.  Upon 
discovering that Bumiputra 1912 is incorporated as 
Indonesia's only mutual life insurance company, the GOI made 
 
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