Asset-quality assessment for commercial banks

Author: | Published: 1 Jul 2005
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To ensure Indonesia's commercial banks maintain their stability and viability in the rapidly developing global banking market, they have been required to minimize potential losses they might incur when they lend money to bad debtors. Banks must be prudent when determining the creditworthiness of borrowers, and funds should only be provided once the bank has satisfied itself as to the quality of the borrower and its assets.

Bank Indonesia, the central banking regulatory body, early this year issued Bank Indonesia Regulation (Peraturan Bank Indonesia) 7/2/PBI/2005 (the Regulation). The Regulation comprehensively covers the standard measures banks should adopt when carrying out an asset quality assessment of a potential borrower. Several earlier regulations issued by Bank Indonesia in relation to asset quality assessment have been revoked and declared invalid.

The Regulation defines earning assets as funds provided by a commercial bank that earn revenue for the bank in the form of credit, securities, interbank placements, acceptances, claims on securities under reverse repurchase agreements, derivative claims, equity participations, off-balance-sheet items and any other equivalent forms.

The Regulation, which implements the one debtor concept and the one project concept mechanism, requires commercial banks to apply uniform procedures of quality classification towards multiple accounts of earning assets used to finance one debtor and of earning assets used to finance the same project. This uniform-quality classification also applies to earning assets granted by more than one commercial bank - that is, when the financing is provided by a syndicate of banks. The Regulation does not, however, apply to earning assets extended by any commercial bank to a single debtor or for each project, where the amount of the financing is less than or equal to Rp500 million ($52,000).

If there has been a difference in how multiple banks have assessed the quality of one borrower's earning assets, or a difference in how multiple banks have assessed the quality of earning assets granted to finance the same project, each earning asset will be classified based on its lowest earning assets quality.

Commercial banks must assess (and, if necessary, adjust) the quality of their earning assets every three months - that is, at the end of March, June, September and December each year. Bank Indonesia will monitor commercial banks' compliance with the Regulation by regularly reviewing their audited financial statements for each period.

Certain exceptions exist to the Regulation. These exceptions generally apply where the borrower is in a specified region, or is a small business in one of those specified regions. Bank Indonesia will also treat favourably situations where a commercial bank has provided funding to a borrower based on prompt repayment of the principal and/or interest. In short, exceptions generally apply to

  • funding less than or equal to Rp500 million;
  • funding to small businesses under the existing Bank Indonesia provisions; and
  • funding for businesses in specified regions (North Maluku, Maluku, West Irian Jaya, Papua and Poso village in the Central Sulawesi) up to Rp1 billion for investment and/or working capital credits.