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