VZCZCXRO2317
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #2690/01 2670602
ZNR UUUUU ZZH
R 240602Z SEP 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 6407
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 0842
RUEHBJ/AMEMBASSY BEIJING 4331
RUEHBY/AMEMBASSY CANBERRA 1234
RUEHUL/AMEMBASSY SEOUL 4208
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 002690 
 
SIPDIS 
 
SIPDIS 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-ABAUKOL 
SINGAPORE FOR SBAKER 
TOKYO FOR MGREWE 
COMMERCE FOR 4430/BERLINGUETTE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN 
DEPARTMENT PASS EXIM BANK 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: EXPERTS APPLAUD BANKING REFORMS BUT WARN OF LONGER TERM 
CHALLENGES FOR ASIAN BANKS 
 
 
JAKARTA 00002690  001.2 OF 003 
 
 
¶1. Summary.  Financial sector experts working in Asia gathered at 
the Federal Reserve Bank of San Francisco on September 6-7 to 
discuss the opportunities and challenges facing Asian banks over the 
next decade.  They lauded Asian policymakers for largely correcting 
the excesses that led to the 1997-98 Asian financial crisis and 
downplayed the likelihood of large-scale banking sector instability 
in Asia in the near term.  Experts expressed concern that the 
massive growth predicted for Asia over the next decade, along with 
financial sector innovation, will strain the ability of banks and 
regulators to manage risk.  While Indonesia's progress in 
implementing banking sector reforms has lagged some of its 
neighbors, experts consider the Indonesian banking sector to be 
generally sound.  End Summary. 
 
Regional Macro Reform Substantial 
--------------------------------- 
 
¶2. Regional experts at the Federal Reserve Bank of San Francisco 
conference on "Asian Banking: Challenges and Opportunities" lauded 
Asian policymakers for largely correcting the excesses that led to 
the 1997-98 Asian financial crisis.  They universally agreed that 
macroeconomic policymakers across Asia are now generally getting it 
right.  Asian countries have moved away from pegged exchange rate 
regimes; effectively discouraged short-term foreign currency 
borrowing in the public and private sector; and reined in fiscal 
deficits. 
 
¶3. Experts also highlighted the importance of strong political and 
regulatory leadership in the aftermath of the 1997-98 crisis.  Korea 
recovered relatively quickly due to the leadership of then-President 
D.J. Kim and his government's emphasis on improving financial sector 
regulation.  In contrast, Japan and Indonesia took longer to recover 
from their banking sector woes.  In Japan, the regulators 
consistently downplayed the level of problems faced by the large 
banks.  In Indonesia, the political transition and lack of 
interagency coordination slowed much needed reforms.  Once strong 
political and regulatory leadership emerged in Japan and Indonesia, 
the pace of banking sector reforms accelerated. 
 
Asian Banking Reforms Largely Successful, 
Indonesia Less So 
----------------------------------------- 
 
¶4.  Experts also discussed the success of Asian banking sector 
reforms, although progress on micro-level reforms was less even 
across the region, with a number of weaknesses concentrated in 
Indonesia.  The ten banking sector reform categories discussed at 
the conference were: 
 
-- Profitability:  The vast majority of banks across the region, 
including those in Indonesia, are now profitable. 
 
-- Consolidation:  Consolidation efforts in Asia aimed at 
strengthening banks and easing pressure on supervisory resources 
have been successful.  One unwanted side effect is that governments 
now have a vested interest in keeping their "creations" alive.  The 
Indonesian banking sector remains one of the most fragmented sectors 
in Asia with a large number of questionably viable, small 
institutions still in operation. 
 
-- State-ownership:  Most Asian governments are no longer in the 
banking business.  Indonesia and China are two very important 
exceptions to this trend. 
 
-- Foreign Bank Presence:  Foreign bank participation in Asian 
markets, particularly in Indonesia, has increased, bringing in more 
competition, fresh capital and international best practices. 
 
-- Credit Bureaus and Credit Rating Agencies:  A number of 
countries, including Korea and Malaysia, have established credit 
bureaus and domestic credit rating agencies in an effort to build a 
stronger credit culture.  These institutions have contributed to 
more robust bank balance sheets, particularly in the consumer loan 
portfolio.  International credit rating agencies are on the ground 
in Indonesia, but the domestic credit rating industry, which experts 
believe is integral to expanding rating capacity beyond the largest 
 
JAKARTA 00002690  002.2 OF 003 
 
 
Indonesian firms, remains underdeveloped. 
 
-- Supervision and Regulation:  Asian regulatory authorities have 
systematically overhauled their supervisory regimes in the last 5-10 
years.  While the rules are largely in line with international best 
practices, the supervisory skills of Asian banking regulators, 
including Indonesian regulators, still lag their European and US 
counterparts. 
 
-- Corporate Governance:  Building a strong corporate governance and 
risk management culture requires a significant shift in mind-set at 
all organizational levels, which can take as long as a generation. 
Asian banks have made progress in adopting sound corporate 
governance rules and stronger risk management practices, but bank 
managers, particularly state-owned bank managers, have not yet 
successfully imbedded these cultural changes throughout their 
organizations. 
 
-- Financial Market Depth:  Both equity and debt markets in Asia 
have grown significantly in the past 5-10 years, diversifying risk 
in the financial sector, but banks continue to be the primary source 
of external finance in Asia.  Analysts predict that bank dominance 
will wane over the next decade as capital markets develop further. 
 
-- Financial Infrastructure:  All of the countries impacted by the 
1997-98 financial crisis have made significant progress in improving 
the capacity of payments systems and crisis management over the past 
decade.  However, interagency coordination remains a problem in a 
number of Asian countries, including Indonesia. 
 
-- Vitality of Corporate Sector:  In contrast to the pre-crisis 
years, the majority of Asian corporations now generate income at 
levels that exceed their cost of capital.  Moreover, the Asian 
corporations that survived the crisis have largely de-leveraged, 
generating much healthier balance sheets.  The Indonesian private 
sector has mirrored these trends, but the true condition of 
state-owned enterprises is largely unknown. 
 
-- Asset Bubbles:  While Asian growth rates have recovered from the 
crisis period, asset price growth in many Asian countries has been 
somewhat subdued.  Nevertheless, experts expressed concern about 
real estate price bubbles in Jakarta and Singapore and an equity 
price bubble in Indonesia. 
 
-- Transparency:  Lack of transparency remains a problem across 
Asia, inhibiting Asian regulators and investors from forming a clear 
picture of risk in the region. 
 
Likelihood of Major Near-Term 
Financial Instability: Very Low 
------------------------------- 
 
¶5.   The general view among conference participants was that the 
likelihood of major financial sector instability anywhere in the 
region in the near term is very low. 
The region's macro- and micro-level reforms have significantly 
lowered the probability of large-scale capital flight from Asia or 
banking problems in the near term.  The relative lack of complexity 
of financial instruments in the region has also shielded the 
regions' banks from recent US-led volatility.  Nevertheless, most 
speakers at the conference reject the notion that Asia has 
"de-coupled" from the U.S.: U.S. recession would have a significant 
impact on Asian financial and real sectors.  Experts consider the 
Indonesian banking sector generally sound, though inconsistencies in 
bank regulation may open the door for future vulnerabilities.  Other 
potential sources of vulnerability in Indonesian banks include rapid 
growth in the banks' consumer portfolio in the absence of a strong 
risk management culture and the potential overheating of property 
markets. 
 
Massive Future Growth to Stress Risk Management 
--------------------------------------------- -- 
 
¶6. Asia is poised to experience massive growth in the next ten 
years, stressing Asian banks' capacity to manage risk.  Fueled by 
rapid growth and a growing pool of foreign currency reserves, Asia 
 
JAKARTA 00002690  003.2 OF 003 
 
 
is set to become a dominant source of financial power in the world. 
Four of the top ten financial centers in the world are already in 
Asia.  Yet banking analysts at the conference asserted that Asian 
risk management systems are currently too weak to cope with rapid 
growth and financial innovation.  Competition from foreign banks 
with the ability to attract the best talent will put additional 
pressure on Asian bank profitability and soundness.  If Asian 
bankers do not match rapid growth rates and the ensuing war for 
talent with significant new investment in risk management and 
information technology systems, Asian banks are likely to have 
weaker balance sheets and experience more volatility in the next 
decade.  In the face of Asia's newfound global power, experts also 
cautioned Asia bankers to avoid becoming arrogant, and thereby blind 
to potential vulnerabilities. 
 
Challenges for Regulators 
------------------------- 
 
¶7. Rapid growth, financial innovation and globalization in the 
region pose parallel challenges for Asia's banking sector 
regulators.  Asian banking supervisors will need significant 
additional training and improved information flows to stay ahead of 
these issues.  At the same time, the demand for private sector 
talent is likely to pose staffing challenges for supervisory 
authorities as the private sector lures away seasoned supervisory 
staff.  Asian regulators also need to improve information sharing 
and regulatory coordination at the national and international levels 
in order to keep problems in one institution from spilling over into 
other sectors or markets.  Finally, conference participants warned 
Asian regulators not to rush to adopt the Basel II capital accord. 
In their view, premature adoption of some advanced capital models 
under the new accord will strain supervisory capacity and further 
cloud their understanding of risks in the banking sector. 
 
HUME