april 2003 william haworth indonesia indonesia financial sector reform challenges

AprilApril 20020033

William Haworth William Haworth

IndonesiaIndonesia IndonesiaIndonesia

Financial Sector reform Financial Sector reform ChallengesChallenges

A.T. Kearney 28/M3507 Privatization Challenges V1.0 2

Overview of Financial Sector Reform in Indonesia


Indonesia’s underlying financial weakness was revealed by the ’97 crisis Indonesia’s underlying financial weakness was revealed by the ’97 crisis

Economic performance appeared strong until ‘97• Strong GNP growth – inflated by a massive bad debt bubble• Apparently improved GDP per person and household• 50% of the financial sector privatized

The Asia Crisis and ensuing political turmoil reversed economic progress• GNP shrunk, high inflation• Vast hardship on many people with high levels of

unemployment• Financial sector collapsed and was “nationalized” • Foreign Direct Investment turned negative

Recovery has been slower than hoped, but Indonesia has proven to be both tough and resilient

Economic performance appeared strong until ‘97• Strong GNP growth – inflated by a massive bad debt bubble• Apparently improved GDP per person and household• 50% of the financial sector privatized

The Asia Crisis and ensuing political turmoil reversed economic progress• GNP shrunk, high inflation• Vast hardship on many people with high levels of

unemployment• Financial sector collapsed and was “nationalized” • Foreign Direct Investment turned negative

Recovery has been slower than hoped, but Indonesia has proven to be both tough and resilient


The Indonesian Financial Crisis Was, First and Foremost, a Debt Crisis Caused by Underlying Structural ProblemsThe Indonesian Financial Crisis Was, First and Foremost, a Debt Crisis Caused by Underlying Structural Problems

• The Indonesian banks were riddled with bad debts that had been mounting for many years

• In addition, irresponsible international lending, much of it based in US $’s, exacerbated and deepened the crisis

• Political problems were both the cause and the effect of this financial crisis

• Ongoing political problems, caused in part by the economic crisis, discouraged foreign investment, deepening and prolonging the crisis

• Ultimately, our failed efforts at financial sector reform underlay a large part of the depth, breath and length of this crisis

• Leading us to ask: what should we have done differently? What could we have done differently?

• The Indonesian banks were riddled with bad debts that had been mounting for many years

• In addition, irresponsible international lending, much of it based in US $’s, exacerbated and deepened the crisis

• Political problems were both the cause and the effect of this financial crisis

• Ongoing political problems, caused in part by the economic crisis, discouraged foreign investment, deepening and prolonging the crisis

• Ultimately, our failed efforts at financial sector reform underlay a large part of the depth, breath and length of this crisis

• Leading us to ask: what should we have done differently? What could we have done differently?


The Starting Point: The Indonesian Banking Sector Under Suharto (Personal Observations) The Starting Point: The Indonesian Banking Sector Under Suharto (Personal Observations)

The managing boards (president directors and directors) of the Indonesian state banks were direct presidential appointments

There were often back-room deals that surrounded these appointments• Political favours to the military, Suharto cronies, etc• Positions were granted for contributions to “charitable foundations”, etc

It was very common practice to supplement low compensation with “Upati” from customers, suppliers, and so forth, throughout the banks

To a very large extent, there was no “commercial” credit process within the state banks• Many loans were directed from the top down – often Suharto would call and

instruct a president director how much to lend to whom• Many loans were granted for kick-backs with little real analysis or attempt to

develop meaningful cash flow or security analysis• Additional lines of credit were often extended to cover interest payments –

capitalization of interest was extremely common• These abuses were most common on the largest loans and were less

common on the smaller loans

The managing boards (president directors and directors) of the Indonesian state banks were direct presidential appointments

There were often back-room deals that surrounded these appointments• Political favours to the military, Suharto cronies, etc• Positions were granted for contributions to “charitable foundations”, etc

It was very common practice to supplement low compensation with “Upati” from customers, suppliers, and so forth, throughout the banks

To a very large extent, there was no “commercial” credit process within the state banks• Many loans were directed from the top down – often Suharto would call and

instruct a president director how much to lend to whom• Many loans were granted for kick-backs with little real analysis or attempt to

develop meaningful cash flow or security analysis• Additional lines of credit were often extended to cover interest payments –

capitalization of interest was extremely common• These abuses were most common on the largest loans and were less

common on the smaller loans


Indonesian Banking Sector Under Suharto….(Personal

Observations)…Indonesian Banking Sector Under Suharto….(Personal

Observations)… Asset values were grossly distorted due to capitalization of interest and

other poor accounting and reporting practices

Many of the largest companies in Indonesia, both state and private, were in very poor financial condition – sometimes from mismanagement, sometimes from abuses

The state banks had very weak internal controls, usually focused on tellers

State auditors applied lax standards in their reviews, often encouraged, where necessary, by supplemental donations to their favourite charities

Banking supervision was ineffective and often corrupted

Based on information that I was able to glean by 1989, I concluded that all of the Indonesia state banks had massive bad debt problems and huge capital shortfalls

I believe that these problems were widely recognized and were behind the drive to improve the performance, and to deregulate and privatise the financial sector

Asset values were grossly distorted due to capitalization of interest and other poor accounting and reporting practices

Many of the largest companies in Indonesia, both state and private, were in very poor financial condition – sometimes from mismanagement, sometimes from abuses

The state banks had very weak internal controls, usually focused on tellers

State auditors applied lax standards in their reviews, often encouraged, where necessary, by supplemental donations to their favourite charities

Banking supervision was ineffective and often corrupted

Based on information that I was able to glean by 1989, I concluded that all of the Indonesia state banks had massive bad debt problems and huge capital shortfalls

I believe that these problems were widely recognized and were behind the drive to improve the performance, and to deregulate and privatise the financial sector


Indonesian Banking Sector Under Suharto…(personal Observations)…Indonesian Banking Sector Under Suharto…(personal Observations)…

Offshore branches, bank pensions funds, and bank subsidiaries were also used to manage certain transactions, park funds, mask ownership, etc

These problems were allowed to fester – in fact the Suharto government encouraged these problems with specific policies issued by the MOF, BI and state audit agency

While the world bank was aware of these problems and insisted on revised business plans to address these issues, the banks and the government actively enabled the problem to continue to build

Financial collapse was only a matter of time

Offshore branches, bank pensions funds, and bank subsidiaries were also used to manage certain transactions, park funds, mask ownership, etc

These problems were allowed to fester – in fact the Suharto government encouraged these problems with specific policies issued by the MOF, BI and state audit agency

While the world bank was aware of these problems and insisted on revised business plans to address these issues, the banks and the government actively enabled the problem to continue to build

Financial collapse was only a matter of time


How Do We Deal With the Real Issues? How Do We Deal With the Real Issues?

The core issues in effective financial sector reform in most developing economies revolve around power and money controlled by an elite group

The question is: how do we alter this power structure and create a balanced set of incentives to encourage the development of a stable and productive financial sector?

Not surprisingly, most failures occur around our ability to change the power allocation from the elites to an institutional structure that can be controlled through a workable political process (not just creating new elites)

This was the main problem in Indonesia under Suharto and it remains a part of the problem today

However, the collapse of the Suharto regime, the shift to democracy, and ongoing improvements in the regulatory and governing structures create opportunities that were not present before

The core issues in effective financial sector reform in most developing economies revolve around power and money controlled by an elite group

The question is: how do we alter this power structure and create a balanced set of incentives to encourage the development of a stable and productive financial sector?

Not surprisingly, most failures occur around our ability to change the power allocation from the elites to an institutional structure that can be controlled through a workable political process (not just creating new elites)

This was the main problem in Indonesia under Suharto and it remains a part of the problem today

However, the collapse of the Suharto regime, the shift to democracy, and ongoing improvements in the regulatory and governing structures create opportunities that were not present before


Lessons Learned….Lessons Learned….

Deregulation by itself does not enable “market forces” to create efficient economies – Indonesia was the most deregulated market on earth for some time

Privatization, in and of itself, does not correct the incentive problems in banking:• Mexico• Venezuela• Indonesia

In fact, privatization and deregulation can cause even more destructive private sector behaviors than are possible in a state-owned, regulated economy

Introducing private sector competition into a state controlled system can have very perverse effects

Deregulation and Privatisation each require vastly stronger regulators and enforcement. We have consistently underestimated this challenge


Lessons Learned…..Lessons Learned…..

New laws and regulations, by themselves, do little to change behavior in settings where there is a history of endemic corruption and weak enforcement – you can still buy the judges

Building skills, without changing the institutional context and “culture”, will have little impact on behaviors

The better we understand the way a system really works, the better our chances are to change it

Real, effective change, requires addressing the entire matrix of issues that impact the structure of a financial system – legal, regulatory, political, skills, and incentives

Failing to make significant progress on all fronts simultaneously – so they reinforce each other – usually results in a slow catastrophe


Trying to create a stable and productive financial sector is difficult and important……….Why is it so difficult?Trying to create a stable and productive financial sector is difficult and important……….Why is it so difficult?

Every banking system is complex, interactive, opaque and filled with incentive problems and competing interests . . . Depositors Owners Regulators Competitors Borrowers Managers Tax authorities Substitutes Financial Employees Auditors Acquirers Institutions

. . . With major legacy issues . . .Political Economic Structure Culturalal Legal Organizational/Operational Personal

relationship

Why is it so important? Cost to GDP of crisis:USA: 5% Japan: 15%? Venezuela: 35%?Mexico: 20%? Korea: 20%? Indonesia: 50%

?

Every banking system is complex, interactive, opaque and filled with incentive problems and competing interests . . . Depositors Owners Regulators Competitors Borrowers Managers Tax authorities Substitutes Financial Employees Auditors Acquirers Institutions

. . . With major legacy issues . . .Political Economic Structure Culturalal Legal Organizational/Operational Personal

relationship

Why is it so important? Cost to GDP of crisis:USA: 5% Japan: 15%? Venezuela: 35%?Mexico: 20%? Korea: 20%? Indonesia: 50%

?


Do We Agree on the Ultimate Objectives ?Do We Agree on the Ultimate Objectives ?

First, a largely privatised financial sector, broadly held, profitable and well managed

— Able to gather deposits and employ these productively in building strong companies and create employment

— Able to facilitate trade and investment flows— Able to manage risks through a variety of tools such as insurance, etc— Able to operate transparent capital markets and provide underpinnings

for economic growth based on equity

Second, a strong supervisory structure and organization that effectively oversees the financial sector and maintains its strength and prevents abuses

Thirdly, assurance and reporting organizations that provide transparent, complete and comparative views on the health and returns in the financial sector leading to sound investment decisions and capital allocation

Fourthly, the legal infrastructure that underpins this financial sector, with laws and courts that support both the civil and criminal processes that facilitate business

First, a largely privatised financial sector, broadly held, profitable and well managed

— Able to gather deposits and employ these productively in building strong companies and create employment

— Able to facilitate trade and investment flows— Able to manage risks through a variety of tools such as insurance, etc— Able to operate transparent capital markets and provide underpinnings

for economic growth based on equity

Second, a strong supervisory structure and organization that effectively oversees the financial sector and maintains its strength and prevents abuses

Thirdly, assurance and reporting organizations that provide transparent, complete and comparative views on the health and returns in the financial sector leading to sound investment decisions and capital allocation

Fourthly, the legal infrastructure that underpins this financial sector, with laws and courts that support both the civil and criminal processes that facilitate business


A Possible Approach -- Creating a Change Master Plan….A Possible Approach -- Creating a Change Master Plan…. Study the People and the culture, not just the institutions--

• Leadership matters - look at Singapore• Understand the underlying relationships• Understand the incentives • Be objective• Be opportunistic

Seek out strong champions, nurture them, protect them

Focus on changing the way the underlying relationships operate

Study the incentives and disincentives to behavior change

Recognize that we need to change systems, behaviors and incentives together

Understand that we do not have enough power or influence to change things quickly – we must be relentless and strategic -- using influence to shift behaviours, incentives, and institutions over time

Understand that while the components of success are the same, the way that they can evolve and develop will be very different in different countries at different times


A Possible Approach…A Possible Approach…

Understand the real compensation levels and systems in the Central Bank, the commercial banks, the auditors and rating agencies and the government

Look at the lifestyle indicators - cars, houses, trips, etc

Make a judgment, is this a corrupt system

If it is corrupt, we need to focus on programs that bring “sunshine” to the system, as well as programs that change the compensation and incentive structures, as well as building skills

Start where we can – elites won’t give-up power willingly – work where we can succeed, look for explicit trades that can be offered

If we are working in a newly “deregulated” environment, watch-out for the poor risk management and destructive systemic competition that leads to asset bubbles• requires a system-wide analysis of both borrowers and lenders• involving both local and international players• Usually new and demanding roles for regulators and government


Elites, Culture Change, Political Change – Can Privatisation Provide a Bridge?Elites, Culture Change, Political Change – Can Privatisation Provide a Bridge?

What is the alternative? What is the alternative?


Privatisation Presents Two Broad Sets of Challenges … Sectoral and InstitutionalPrivatisation Presents Two Broad Sets of Challenges … Sectoral and Institutional

Sectoral challenges affect the entire Sectoral challenges affect the entire economy and privatization processeconomy and privatization process

Institutional challenges affect all Institutional challenges affect all companies improving from state to share companies improving from state to share

market ownershipmarket ownership

• Sequencing—Legal system—Regulations—Supervision and oversight

• Preparing industry segments for privatization/ sale

• Sequencing the sale of individual firms within industry segments

• Balancing conflicting political agendas

• Balancing conflicting financial pressures

• Ensuring appropriate levels of competition

• Balancing price, percentage sold and timing

• Ensuring overall economic growth

• Ensuring “reasonable” price

• Ensuring responsible ownership

• Ensuring strong management

• Ensuring continuing capital investment

• Ensuring profitable growth and job creation


Review of the BNI Privatization Experience


The Market and Foreign Investors Remain Guarded About Investing in Indonesian Banks – in Part Because of the BNI

Experience

The Market and Foreign Investors Remain Guarded About Investing in Indonesian Banks – in Part Because of the BNI

Experience

0%

20%

40%

60%

80%

100%

120%

140%

160%

Aug-96 Jan-98 May-99 Oct-00 Feb-02

BNI stock price

JSX index

BNI stock performance has under performed the market

Source: Bloomberg, A T Kearney analysis

Time of IPO: Nov 1996

-100%

0%

100%

200%

300%

400%

500%

1994 1995 1996 1997 1998 1999 2000

Cost/Income ratio

Interest income/ total income

ROA

Net Interest Margin

BNI financial performance has deteriorated significantly after financial crisis

Stock price is closely linked to company’s key financial metrics


BRI Could Be Easier to Privatize Than BNIBRI Could Be Easier to Privatize Than BNI

0.5%

0.3%

0.8%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

0.9%

BRI BNI Mandiri

ROA91.0% 92.0%

79.0%

70%

75%

80%

85%

90%

95%

BRI BNI Mandiri

Cost/Income ratio(1)

41.0%

53.0%

70.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

BRI BNI Mandiri

Gov. Bond To Total Assets4.2%

2.7% 2.7%

0%

1%

1%

2%

2%

3%

3%

4%

4%

5%

BRI BNI Mandiri

Net Interest Margin

Note: Figures as year 2000; (1) Operational expenses/ (net interest income + non-interest income)


Privatization Experiences:

• Mexico• Commonwealth Bank Of Australia


The Recent Privatization Experience in Mexico Illustrates the Possibility to Successfully Privatize the Whole Banking Sector

The Recent Privatization Experience in Mexico Illustrates the Possibility to Successfully Privatize the Whole Banking Sector

• Nationalization of Banks, 1982• Rapid privatization 1991-92

— All 18 banks sold in 14 months• Weakness in Industry

— Inexperienced and inappropriate management

— Insufficient regulation• Mexican Peso crisis, Dec 1994• Government intervention 1995

— Government took over 12 banks — Lack domestic resources to re-

capitalize banking industry— Changed law to allow foreign

purchase of all but three largest institutions

• 1995 response to Mexico banking crisis— Government removed

restrictions on foreign ownership

• By 1998 Mexican banking industry successfully undergone rapid privatization— Bank of Montreal acquired 16%

of Bancouver— HSBC acquired 20% Serfin— Central Hispario acquired 20%

of Bital— BBV acquired 70% Probursa— Scotiabank acquired 55%

Inverlat— Santander acquired 75%

Mexicano— Citibank acquired 100% Confia

Situation of Mexican Banking Situation of Mexican Banking Industry after 1994 Peso CrisisIndustry after 1994 Peso Crisis

Re-privatization of Banking Re-privatization of Banking SectorSector ImplicationsImplications

• Privatization offers opportunity for massive government debt reduction

• Privatization requires strong initial government regulation

• Experienced and appropriate management is vital for privatization success


Privatization Experiences:

• Mexico • Commonwealth Bank Of Australia


The Commonwealth Bank of Australia (CBA) Performed at About Market Average Prior to PrivatisationThe Commonwealth Bank of Australia (CBA) Performed at About Market Average Prior to Privatisation

CBA HistoryCBA History• Formed 1912 to conduct savings and trading

business• After WWII took on central banking role• 1959 Reserve Bank of Australia established• CBA took on increasingly commercial focus• 1990 Australian Government established CBA

as a company• Purchased failing State Bank of Victoria

Pre-Privatisation SituationPre-Privatisation Situation• Australia’s 4th largest bank

— Revenue 1991 AU$10B— 51, 076 employees— 1786 branches

• Weak operational efficiency• Strong management strategy

— Experienced management team— 3year privatisation preparation

• Limited services offered

Pre-Privatization Cost-Income RatiosPre-Privatization Cost-Income Ratios

0

20

40

60

80

100

1986 1987 1988 1989 1990 1991 1992

CBA Major Competitors (mean)

Pre-Privatization ROEPre-Privatization ROE

0

5

10

15

20

1986 1987 1988 1989 1990 1991 1992


Source: Department of Finance, University of Melbourne


Cost-Income Ratio, Partial and Cost-Income Ratio, Partial and Complete PrivatizationComplete Privatization

ROE, Partial and Complete PrivatizationROE, Partial and Complete Privatization

The CBA Privatisation Was a Five Year Process, With Benefits Only Being Realised After Full PrivatisationThe CBA Privatisation Was a Five Year Process, With Benefits Only Being Realised After Full Privatisation

0

20

40

60

80

1992 1993 1994 1995 1996 1997 1998 1999


0

5

10

15

20

25

1992 1993 1994 1995 1996 1997 1998 1999


Source: Department of Finance, University of Melbourne

CBA Privatisation ProcessCBA Privatisation Process• 1991 Government sold 29.7% to private and

institutional investors— 230 million shares sold – AU$1.3B raised

• 1993 Further 19.6% CBA sold – AU$1.96B raised

• 1996 Government sold remaining 50.4% – AU$4B raised

Significant ChangesSignificant Changes• Partial privatisation limited success• Transparent Management• CBA became 2nd largest and most cost efficient

bank— From 1786 (1992) to 1162 (1999)— From 41, 500 FTE’s (1992) to 29, 000 (1999)

• Privatisation created new competitive market environment

• Expansion of CBA services


The CBA Privatisation Was a Clear Success, Which Can Be Translated Across to BRIThe CBA Privatisation Was a Clear Success, Which Can Be Translated Across to BRI

Factors Key to CBA Privatisation Factors Key to CBA Privatisation SuccessSuccess

• Pre-privatisation preparation• Clear restructuring strategy• Full privatisation

— Completed by 1997— Allowed CBA to triple initial stock price

CBA 1991 BRI 2000

ROA .34 .52

Cost-Income 63% 91%

Interest income as a percentage of total income

88% 91%

Source: CBA Annual Reports, ASX

ROE, Partial and Complete PrivatizationROE, Partial and Complete Privatization

0

1

2

3

4

5

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

ASX CBA

BRI Is In A Similar Position To CBA Prior BRI Is In A Similar Position To CBA Prior To PrivatizationTo Privatization


Challenges of Moving from Managing a State-Owned Bank to a Private Bank


Privatisation Requires a Transition in Management Focus …Privatisation Requires a Transition in Management Focus …

State Owned BankState Owned Bank Privatized BankPrivatized Bank

• Manage politically directed credit—Sect oral—Provincial—Developmental

• Provide comprehensive service provision—Widespread branch network—Deposits—Credit availability

• Maintain high levels of employment

• Balance political and commercial agendas

• Maintain depositor confidence

• Meet shareholder return requirements

• Ensure profitable growth

• Reporting detailed LOB results and discussing action plans

• Manage analysts and shareholder expectations

Key Metrics:• Liquidity• Employment• Credit growth

• Branches maintained• Rural lending extended

Key Metrics:• Return on equity• Cost to income ratio• Growth rate

• LOB performance• Acquisition targets• New products/

services


Boards and CEOs in privatized banks are primarily focused on two basic metrics that largely determine share priceBoards and CEOs in privatized banks are primarily focused on two basic metrics that largely determine share price

Share PriceShare Price

Cost to Income RatioCost to Income Ratio

Growth RateGrowth Rate

Versus Competitors


Privatization Is Critical to Meeting Government Budget Targets and Is Currently Behind SchedulePrivatization Is Critical to Meeting Government Budget Targets and Is Currently Behind Schedule

Source: BUMN Review, Kompas

Announced/PlannedCompleted

200320032002200220012001

Q1Q1 Q2Q2 Q3Q3 Q4Q4 Q1Q1 Q2Q2 Q3Q3Q4Q4

PT Indo FarmaPT Kimia FarmaPT Pupuk KaltimPT Wisma NusantaraPT SucofindoPTPN IIIPT SarinahPT SocfindoPT Tambang Batu Bara Bukit AsamPT Krakatau SteelPT Bank MandiriPT Angkasa Pura IIPT IndocementPT Semen GresikPT TelkomPT IndosatPT Bank Rakyat IndonesiaPT Bank Negara Indonesia

SOE’S NAMESOE’S NAMEQ4Q4Q3Q3Q2Q2Q1Q1

Delay?

Delay?

125125

3,000967

ProceedsProceeds(Rp Billion)(Rp Billion)

IPO Further Divestment

Indonesia Privatization Timetable Excluding IBRA Sales


IBRA’s Plan to Divest recapitalised Banks Is Also Moving Slower Than HopedIBRA’s Plan to Divest recapitalised Banks Is Also Moving Slower Than Hoped

BCABCA

NiagaNiaga

DanamonDanamon

BukopinBukopin

BIIBII

LippoLippo

Patriot, Artamedia, Bali, Patriot, Artamedia, Bali, Prima Express, UniversalPrima Express, Universal

• Recently completed the divestment process of 51% of BCA’s shares• Generated receipts of US$ 567 million

• Currently in bidding stage, but postponed due to lower-than-expected initial bids• Plan to increase share divestment to 71% (20% of which offered to public)

• Completed recapitalisation program and merger process• Divestment is still in planning stage

• Completed recapitalisation program• Now considered to be healthy and has been repatriated to Bank Indonesia

• Recapitalisation program in progress• In the process of rights issue

• Will be divested in near future, but discussion has not been initiated

• In a merger process

BankBank Plan & ProgressPlan & Progress

IBRA Bank Restructuring and Divestment


In the Banking Sector, There Is Likely to Be a Strong Competition for Potential Investors’ Funds In the Banking Sector, There Is Likely to Be a Strong Competition for Potential Investors’ Funds

Funds To Be Raised By Privatizing Indonesian State-owned Banking Sector (2002-2003)

Mandiri

BNI

BRI

Danamon

Niaga

BII

Privatizing Privatizing BankBank

100

99.12

100

99.35

97.15

56.78

Gov’t Gov’t Ownership Ownership

(%)(%)

30

30-60

~

51

51

Rights Issue

To Be SoldTo Be Sold((

(%)(%)

16

10

7

6

2

N/A

Market Value Market Value of Equityof Equity(2)(2)

(Rp Trillion)(Rp Trillion)

5

3-6

2

3

1

3

Value To Be Value To Be Privatized/Privatized/

RaisedRaised(Rp Trillion)(Rp Trillion)

Amount To Be Raised Rp 17 - 20 Trillion

BRI needs to stand out among the privatized banks

17

8

25

Amount To Be Raised

TotalFDI

2001

Value of Non-Govt

Bank Ownership

30/5/02

20

(In Rp Trillion)


Privatized banks also have a significantly more demanding financial reporting process – Adding “sunshine” to the system

Privatized banks also have a significantly more demanding financial reporting process – Adding “sunshine” to the system

Forward budget and earnings projections by quarter are released to stock market analysts, shareholders and public

These projections are evaluated and the share price is affected based on projected earnings, growth, risks, etc., And credibility of management estimates

Results are tracked quarterly – any divergence from budget is reflected in immediate changes in share price

In general, a privatized bank is “punished” for missing targets for volatility in earnings

As a result, privatized banks expend a great deal of energy managing the budgeting and reporting processes


Experience to Date Shows That It Is Difficult to Attract Qualified Investors Even at an Attractive PriceExperience to Date Shows That It Is Difficult to Attract Qualified Investors Even at an Attractive Price

Latest Banking Privatization/ Divestment Efforts

BCABCA NiagaNiaga MandiriMandiri

Schedule / Schedule / TimingTiming

• Privatization planned since 2000; actual completion March 2002

• Privatization planned since 2000; privatization launched Feb 2002

• IPO planned since 2001; privatization launch has been delayed to year end 2002 – could be further postponed to 2003

Bidding Bidding ProcessProcess

• Four bidders to the final round: Farallon Capital, Standard Chartered, GKBI, and Bank Mega Consortiums

• Two bidders passed BI’s fit and proper test: Farallon Capital and Standard Chartered Consortiums

• Three bidders to the final round: Commerce Assets Holding Berhad, PT Bank Panin Fotrine/ANZ, and Batavia Management Investment

• Two bidders passed BI’s fit and proper test: Commerce Assets Holding Berhad and PT Bank Panin Fotrine/ANZ

• N.A.

Outcome/ Outcome/ ProgressProgress

• Farallon Capital won bid for the 51% stake of BCA worth US$530 million despite StanChart’s slightly higher price than Farallon

• Market has been showing positive sentiment since successful result of BCA divestment

• Privatization was postponed as bid price was lower than market price (target was 50% above market price)

• Plan to increase share divestment to 71% (20% of which will be sold to public)

• Conducted road show at end 2001 resulted with minimal investor interests

• IPO launch delayed due to several reasons:— Changes in Mandiri’s equity structure still

require legal/formal settlement— Decision has not been made on primary

and secondary shares, and dividend distribution

— Annual shareholder’s meeting to decide on the bank’s budget has not been held


Privatization IPOPrivatization IPO

Business RestructuringBusiness Restructuring

Portfolio AlignmentPortfolio AlignmentBusiness Strategy Business Strategy DevelopmentDevelopment

Timing

• Conduct organization-wide diagnostic

• Assess competitive environment

• Generate and evaluate strategic options

• Develop new strategic direction

• Develop flight plan

• Develop new organization and governance

• Implement improvement initiatives

• Process quality and efficiency

• Performance measurement systems

• staff skills and capabilities

• Identify core and non-core businesses

• Spin-off non-core actions

• Consider to strengthen portfolio

• Structure share offering transaction

• Financial restructuring

• Due diligence and prospectus preparation

• Road show and investor communications

• Issue shares

Key Activities

Corporatisation Phase Privatization Phase

2-3 months 3-12 months 6 months

A.T. KearneyInvestment

Bank

Share Issue Date

Building Privatized Bank Management and Reporting Infrastructure Takes Time, and the Process Begins Years Before the Offering Date

Building Privatized Bank Management and Reporting Infrastructure Takes Time, and the Process Begins Years Before the Offering Date


Develop and Prioritize Develop and Prioritize Improvement InitiativesImprovement Initiatives

Develop New Develop New Strategic Direction Strategic Direction

Conduct Conduct Organization-Wide DiagnosticOrganization-Wide Diagnostic

Timing

• Conduct internal and external stakeholders’ interviews

• Identify distinctive capabilities and existing performance gaps

• Conduct staff surveys on overall readiness for change and on detailed values and behaviours

• Conduct interviews and surveys with operators and customers

• Survey other best practise organisations

• Conduct gap analysis

Key Activities

• Generate and evaluate strategic options

• Assess competitive environment• Conduct strategic direction

workshop to develop new core purpose, vision, strategic objectives, strategies and values

• Obtain hi-level stakeholders inputs on new strategic direction

• Finalise and communicate strategic direction

• Develop hi-level process maps of key business processes

• Develop detailed improvement initiative project plans, including objectives, scope, timing and resource requirements

• Develop prioritisation criteria and flight plan

Corporatisation Phase — Step 1 (Business Strategy Development)

2-3 weeks

Profit Growth 1)

< IndustryAverage

Industry Average > IndustryAverage

Rev

enue

Gro

wth

< Industry Average

Industry Average

> Industry Average

Q3

Q2Q4

Q1

Company X

Competitor A Competitor C

Competitor B

Bubble size indicates relative revenue

Profit Growth 1)

< IndustryAverage

Industry Average > IndustryAverage

Rev

enue

Gro

wth

< Industry Average

Industry Average

> Industry Average

Q3

Q2Q4

Q1

Company X

Competitor A Competitor C

Competitor B

Bubble size indicates relative revenue

Core Purpose Vision

Improve revenue growth

Enhance portfolio value

Improve management and operation efficiency

Project Flight plan

2002 2003 2004

3-6 weeks2-3 weeks

Business Strategy Development Involves Envisioning the Future Direction of the SOE in a Competitive EnvironmentBusiness Strategy Development Involves Envisioning the Future Direction of the SOE in a Competitive Environment

Competitive Positioning Assessment Strategic Direction

Expand operation to EU

Maximise shared services

Realign investment portfolio

Reengineer core business processes


Consider Acquisitions Or Consider Acquisitions Or Build New Business Units To Build New Business Units To

Strengthen PortfolioStrengthen Portfolio

Spin-off Non-Core Spin-off Non-Core or Loss Ridden Assetsor Loss Ridden Assets

Identify Core and Non-Core Identify Core and Non-Core BusinessesBusinesses

Timing

Key Activities

Corporatisation Phase — Step 2 (Portfolio Alignment)

Ongoing

• Review business units’ objectives and performance against business strategy

• Identify non-core or non-performing business units

• Identify gap between current assets and strategies to determine potential for new line of businesses

• Prepare non-core assets for divestiture

• Conduct valuation of non-core assets

• Identify prospective buyers

• Conduct negotiations and conclude deal

• Identify options for new business lines (acquisition vs. build)

In case of acquisition

• Identify potential targets and conduct preliminary assessment

• Select target and conduct negotiation

• Conclude deal and perform post merger integration

Mar

ket A

ttrac

tiven

ess

Core Competencies

Low High

Low

H

igh

“Diversify” “Harvest ”

“M&A / Build” “Defend”

Strategic Option Matrix

BU “A”

BU “B”

BU “C”

BU “E”

BU “D”

New Business

Business Unit A

Independent Board

CEONon- Core

Business Unit C

Business Unit D

Business Unit E

Business Unit B

•Consider divestiture or other optionsNew Business

Portfolio Alignment

1 month 2-11 months

Non-core or Non-performing Assets Should Be Divested While New Businesses With Strong Potential Should Be Added to Strengthen the Portfolio

Non-core or Non-performing Assets Should Be Divested While New Businesses With Strong Potential Should Be Added to Strengthen the Portfolio


Implement improvement initiative flight planImplement improvement initiative flight planDevelop new organization structureDevelop new organization structure

Timing

Key Activities

Corporatisation Phase — Step 3 (Business Restructuring)

• Conduct functional analysis

• Assess gaps to identify missing functions

• Develop organization guiding principles

• Design and finalize new organization structure

• Design required changes in organizational governance

• Implement new organization structure

• Establish program office

• Staff project teams

• Establish unit goals, plans, metrics, etc.

• Implement initiatives

• Monitor implementation progress and take corrective action as necessary

FI Development Board

FI Development Board

Court of Directors

GovernorPublic Relations Group Internal Audit Group

Monetary Stability

Monetary Policy Group

Financial Market

Operations Group

Financial Sector Stability

Financial Sector Policy Group

Supervision Group

Strategic Capabilities

Strategic Services Group

Human Resources

Group

Corporate Support Services

Operations Finance Group

IT Group

Note Printing Works

IT/User CommitteeIT/User Committee

Monetary Policy Board

Monetary Policy Board

Legal Group

Litigation Group

=Transferred to other =Transferred to other departments or out of BOT departments or out of BOT

in due coursein due course

AuditAuditCommitteeCommittee

AuditAuditCommitteeCommittee

Financial Sector Rehabilitation

Note Printing Board

ChequeClearingSystem

Note Issuance Group

General Admin Group

HVP&Settlement

Group

HR CommitteeHR Committee

FIDF Group

CDRAC Group

Top ManagementCommittee

Top ManagementCommittee

Money MarketCommittee

Money MarketCommittee

Note: Detailed list of functions performed by each department atNote: Detailed list of functions performed by each department at tached in appendixtached in appendix

Data Mgmt Group

Security Group

• Northern Region• Northeast Region• Southern Region• Central Region

CDRAC CommitteeCDRAC Committee

MP Steering Committee

MP Steering Committee

FIDF BoardFIDF Board

Validation of Strategic Direction/Roles and

Responsibilities

Organi -sadditional Redesign

Wave 1 : Organisational and Process Improvement Roll - Out

Prepare ImplementPrepare Implement

Wave 2Wave 3

Wave N*

Change Management

Program Management

1-2 months 4 -10 months

Business Restructuring Needs to Be Centrally Managed for Optimal ResultsBusiness Restructuring Needs to Be Centrally Managed for Optimal Results


Maximizing Company Performance and Potential of SOEs

Often Requires Organizational Transformation Maximizing Company Performance and Potential of SOEs

Often Requires Organizational Transformation

Potential Transformation Value Drivers

1. Develop Clear 1. Develop Clear Business Strategy and Business Strategy and Growth Plans for New Growth Plans for New

EnvironmentEnvironment

4. Improve Operating 4. Improve Operating Efficiency and Cost Efficiency and Cost

PositionPosition

2. Align Business 2. Align Business PortfolioPortfolio

5. Improve Management / 5. Improve Management / Employee Capabilities Employee Capabilities and Prepare for Changeand Prepare for Change

3. Reorganize Enterprise 3. Reorganize Enterprise to Improve Efficiency and to Improve Efficiency and

Market-OrientationMarket-Orientation

Source: A.T. Kearney analysis and experience

While many SOEs go through the motions of “transformation” prior to privatization, outside perspectives and support are often needed to drive real and significant change

6. Improve Reporting and 6. Improve Reporting and Risk Management Risk Management

DisciplinesDisciplines


The value of a privatized Bank will be strongly influenced by management actions taken over the next two years The value of a privatized Bank will be strongly influenced by management actions taken over the next two years

Ability of Privatizing Government to Influence Factors Within the Privatization Timeframe Ability of Privatizing Government to Influence Factors Within the Privatization Timeframe

5 High1 Low/None Moderate3

Company Performance Company Performance and Potentialand Potential

Company Performance Company Performance and Potentialand Potential 5555

Key Determinants Of Privatization Value

Key Areas of Management

Focus

Areas of Govt. Policy

Influence

Areas of Govt. Policy

Influence

Financial Market Financial Market ConditionsConditions

Financial Market Financial Market ConditionsConditions 2222

Deal Structure and Deal Structure and Sales ProcessSales Process

Deal Structure and Deal Structure and Sales ProcessSales Process 3333

Industry Industry AttractivenessAttractiveness

Industry Industry AttractivenessAttractiveness 3333


Privatized Bank Management Focuses on Income and Income and GrowthPrivatized Bank Management Focuses on Income and Income and Growth

• Fundamental change … not incremental change

• Sustainable platform for world class performance … not short term, slash and burn

• Well targeted on key revenue and cost levers … not uniform across the board

• Protecting long term strategic goals … while recognizing links and interdependencies to current initiatives

Guiding RulesGoal

Sustainable improvement in cost / income

plusgrowth

Sustainable improvement in cost / income

plusgrowth


Basle II presents some interesting challenges for Indonesian BanksBasle II presents some interesting challenges for Indonesian Banks

CreditMarket Operating

Measure Mitigation

Standardized Simple Standardized Basic Indicator

Foundational Internal Ratings

Compre-hensive

Internal Models

Standardized

Advanced Internal Ratings

Institution Calculated

Internal Models

Simple

Intermediate

Advanced

General intuition suggests that the advanced approach will provide the most capital relief

Dec

reas

ing

Cap

ital

Incr

easi

ng

So

ph

isti

cati

on


Several Factors Will Influence the Strategic and Financial Attractiveness of the Advanced Measurement DecisionSeveral Factors Will Influence the Strategic and Financial Attractiveness of the Advanced Measurement Decision

Internal Holdings

Holding Structure

Current ERM Capabilities

External Supervisory

Interpretation

Market Mandates

Cost/Benefit?


As Measurements Become More Granular, Capital and External Ratings Become More Directly LinkedAs Measurements Become More Granular, Capital and External Ratings Become More Directly Linked

Traditional Economic Risk Capital Expectations

Consumer Retail

Commercial Capital Markets

• Credit • Medium • Medium - High

• Low

• Market • Low • Low-Medium

• High

• Operating • High • Low • Medium

• Total economic capital

Low/medium

Medium-high

High

• Credit rating

A-AA AA-AAA AAA

Comments

• Credit ratings will become tightly aligned to both regulatory and economic capital

• Thus, driving funding avenues

• And, competitive positioning/pricing

• Market signalling will be more direct

• Business line specialization may become more common

• Geographic attractiveness will become more distinct


Variations in Return Under Basle II May Drive Foreign Banks Away From Indonesian RiskVariations in Return Under Basle II May Drive Foreign Banks Away From Indonesian Risk

Comparative Regulatory Risk Capital

GeographyBusiness

LineStandardized Foundational Advanced

US

(AAA)

Mortgage 8 N/A 1.60

Credit Card 8 N/A 5.76

Corporate 4 2.27 2.23

Indonesia

(BB)

Mortgage 8 N/A 18.72

Credit Card 8 N/A 31.2

Corporate 12 23.04 16.9

• Capital can be improved – but only for higher quality portfolios• Preferences for retail portfolios over corporate portfolios will be driven by mix and market

april 2003 william haworth indonesia indonesia financial sector reform challenges

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