Indonesia

Financial Sector reform

Challenges

April 2003 William Haworth

Overview of Financial Sector Reform in Indonesia

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

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

   • •

Economic performance appeared strong Strong GNP growth until ‘97 – 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

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The 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? A.T. Kearney 28/M3507 Privatization Challenges V1.0

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

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

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

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

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

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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 A.T. Kearney 28/M3507 Privatization Challenges V1.0 10

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   Borrowers Financial  Managers  Employees   Tax authorities Auditors Institutions    Competitors Substitutes Acquirers  . . . With major legacy issues . . .

  Political Legal   Economic Structure Organizational/Operational  Culturalal  Personal relationship  Why is it so important? Cost to GDP of crisis: USA:  5% Mexico:  20%?

Japan:  15%?

Venezuela:  35%?

Korea:  20%?

Indonesia:  50%?

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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 A.T. Kearney 28/M3507 Privatization Challenges V1.0 12

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.T. Kearney 28/M3507 Privatization Challenges V1.0 13

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 structures, as well as building skills programs that bring “sunshine” to the system, as well as programs that change the compensation and incentive 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 A.T. Kearney 28/M3507 Privatization Challenges V1.0 14

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

 What is the alternative?

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Privatisation Presents Two Broad Sets of Challenges … Sectoral and Institutional Sectoral challenges affect the entire economy and privatization process

• • • • • • •

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

• • •

Institutional challenges affect all companies improving from state to share market ownership Ensuring “reasonable” price Ensuring responsible ownership Ensuring strong management

• •

Ensuring continuing capital investment Ensuring profitable growth and job creation

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Review of the BNI Privatization Experience

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The Market and Foreign Investors Remain Guarded About Investing in Indonesian Banks – in Part Because of the BNI Experience BNI financial performance has deteriorated significantly after financial crisis

500% 400% 300% 200% 100% 0% 1994 -100% 1995

Cost/Income ratio

1996

Interest income/ total income Net Interest Margin

1997

ROA

1998 1999 2000 160% 140% 120% 100% 80% 60% 40% 20% 0% Aug-96

BNI stock performance has under performed the market BNI stock price

Jan-98 May-99

JSX index

Oct-00 Feb-02 Time of IPO: Nov 1996

Stock price is closely linked to company’s key financial metrics Source: Bloomberg, A T Kearney analysis

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BRI Could Be Easier to Privatize Than BNI

0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0%

0.5% ROA 0.3% 0.8%

95% 90% 85% 80% 75% 70%

91.0% Cost/Income ratio (1) 92.0% 79.0% BRI BNI Mandiri BRI BNI Mandiri

80% 70% 60% 50% 40% 30% 20% 10% 0%

Gov. Bond To Total Assets 41.0% 53.0% 70.0%

5% 4% 4% 3% 3% 2% 2% 1% 1% 0%

4.2% BRI BNI Mandiri BRI Note: Figures as year 2000; (1) Operational expenses/ (net interest income + non-interest income) Net Interest Margin 2.7% BNI 2.7% Mandiri

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Privatization Experiences:

•

Mexico

•

Commonwealth Bank Of Australia

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The Recent Privatization Experience in Mexico Illustrates the Possibility to Successfully Privatize the Whole Banking Sector Situation of Mexican Banking Industry after 1994 Peso Crisis

• 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

Re-privatization of Banking Sector

• 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

Implications

• Privatization offers opportunity for massive government debt reduction • Privatization requires strong initial government regulation • Experienced and appropriate management is vital for privatization success A.T. Kearney 28/M3507 Privatization Challenges V1.0 21

Privatization Experiences:

•

Mexico

•

Commonwealth Bank Of Australia

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

• Australia’s 4 th 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

Source: Department of Finance, University of Melbourne Pre-Privatization Cost-Income Ratios

100 80 60 40 20 0

1986 1987 1988

CBA

1989 1990 1991

Major Competitors (mean)

1992 Pre-Privatization ROE

20 15 10 5 0

1986 1987 1988

CBA

1989 1990 1991

Major Competitors (mean)

1992

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

• Partial privatisation limited success • Transparent Management • CBA became 2 nd 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

Source: Department of Finance, University of Melbourne Cost-Income Ratio, Partial and Complete Privatization

80 60 40 20 0

1992 1993 1994 1995 1996 1997 1998 1999

CBA Major Competitors (mean)

ROE, Partial and Complete Privatization

25 20 15 10 5 0

1992 1993 1994

CBA

1995 1996 1997

Major Competitors (mean)

1998 1999

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

• Pre-privatisation preparation • Clear restructuring strategy • Full privatisation — Completed by 1997 — Allowed CBA to triple initial stock price

ROE, Partial and Complete Privatization

5 4 3 2 1 0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

ASX CBA

Source: CBA Annual Reports, ASX BRI Is In A Similar Position To CBA Prior To Privatization

ROA

CBA 1991

.34

BRI 2000

.52

Cost-Income 63% Interest income as a percentage of total income 88% 91% 91% A.T. Kearney 28/M3507 Privatization Challenges V1.0 25

Challenges of Moving from Managing a State-Owned Bank to a Private Bank A.T. Kearney 28/M3507 Privatization Challenges V1.0 26

Privatisation Requires a Transition in Management Focus … State Owned 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

Key Metrics:

• Liquidity • Employment • Credit growth • Branches maintained • Rural lending extended

Privatized Bank

• 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:

• Return on equity • Cost to income ratio • Growth rate • LOB performance • Acquisition targets • New products/ services A.T. Kearney 28/M3507 Privatization Challenges V1.0 27

Boards and CEOs in privatized banks are primarily focused on two basic metrics that largely determine share price Cost to Income Ratio Growth Rate Share Price Versus Competitors

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Privatization Is Critical to Meeting Government Budget Targets and Is Currently Behind Schedule Indonesia Privatization Timetable Excluding IBRA Sales SOE’S NAME

PT Indo Farma PT Kimia Farma PT Pupuk Kaltim PT Wisma Nusantara PT Sucofindo PTPN III PT Sarinah PT Socfindo PT Tambang Batu Bara Bukit Asam PT Krakatau Steel

PT Bank Mandiri

PT Angkasa Pura II PT Indocement PT Semen Gresik PT Telkom PT Indosat

PT Bank Rakyat Indonesia PT Bank Negara Indonesia

Source: BUMN Review, Kompas

Proceeds (Rp Billion)

125 125

Q1

3,000 967

Q2

 

2001 Q3

IPO

Q4



Q1 2002 Q2 Q3 Q4



Further Divestment Delay ?

 Announced/Planned Completed

Q1 2003 Q2 Q3 Q4 Delay ?

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IBRA’s Plan to Divest recapitalised Banks Is Also Moving Slower Than Hoped IBRA Bank Restructuring and Divestment BCA Bank Plan & Progress

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

Niaga Danamon Bukopin

• 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

BII Lippo

• Recapitalisation program in progress • In the process of rights issue • Will be divested in near future, but discussion has not been initiated

Patriot, Artamedia, Bali, Prima Express, Universal

• In a merger process A.T. Kearney 28/M3507 Privatization Challenges V1.0 30

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) Privatizing Bank Gov’t Ownership (%) To Be Sold ( (%) Mandiri 100 30 Market Value of Equity (2) (Rp Trillion) 16 BNI BRI Danamon Niaga BII Value To Be Privatized/ Raised (Rp Trillion) 5

25

99.12

30-60 10 3-6

20

100 ~ 7 2

17

99.35

51 6 3

8

97.15

51 2 1 56.78

Rights Issue N/A 3

Amount To Be Raised

Rp 17 - 20 Trillion BRI needs to stand out among the privatized banks Amount To Be Raised Value of Non-Govt Bank Ownership 30/5/02 (In Rp Trillion) Total FDI 2001

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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

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Experience to Date Shows That It Is Difficult to Attract Qualified Investors Even at an Attractive Price Latest Banking Privatization/ Divestment Efforts Schedule / Timing Bidding Process Outcome/ Progress BCA

• Privatization planned since 2000; actual completion March 2002 • 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 • 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

Niaga

• Privatization planned since 2000; privatization launched Feb 2002 • 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 • 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)

Mandiri

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

• 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

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

Timing Key Activities A.T. Kearney Investment Bank

Business Strategy Development Portfolio Alignment Business Restructuring

3-12 months 2-3 months • Conduct organization-wide diagnostic • Assess competitive environment • Generate and evaluate strategic options • Develop new strategic direction • Develop flight plan • Identify core and non-core businesses • Spin-off non core actions • Consider to strengthen portfolio • Develop new organization and governance • Implement improvement initiatives • Process quality and efficiency • Performance measurement systems • staff skills and capabilities

Privatization IPO

6 months • Structure share offering transaction • Financial restructuring • Due diligence and prospectus preparation • Road show and investor communications • Issue shares

Share Issue Date

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Business Strategy Development Involves Envisioning the Future Direction of the SOE in a Competitive Environment Corporatisation Phase — Step 1 (Business Strategy Development) Conduct Organization-Wide Diagnostic Develop New Strategic Direction Develop and Prioritize Improvement Initiatives

Timing Key Activities

2-3 weeks • 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

Competitive Positioning Assessment

> Industry Average 3-6 weeks • 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

Strategic Direction Improve revenue growth

Industry Average

Core Purpose Vision Enhance portfolio value

< Industry Average < Industry Average > Industry Average

Improve management and operation efficiency

2-3 weeks • 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

Project Flight plan 2002 2003 Expand operation to EU Maximise shared services Realign investment portfolio 2004 Reengineer core business processes

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Non-core or Non-performing Assets Should Be Divested While New Businesses With Strong Potential Should Be Added to Strengthen the Portfolio Corporatisation Phase — Step 2 (Portfolio Alignment) Identify Core and Non-Core Businesses Spin-off Non-Core or Loss Ridden Assets Consider Acquisitions Or Build New Business Units To Strengthen Portfolio

Timing

1 month

Key Activities

• 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 2-11 months • Prepare non-core assets for divestiture • Conduct valuation of non-core assets • Identify prospective buyers • Conduct negotiations and conclude deal Ongoing • 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

Portfolio Alignment

Independent Board

New Business “M&A / Build” BU “B” BU “A” “Defend” BU “E” “Diversify” “Harvest ” BU “D” BU “C”

Low

Core Competencies

High

Business Unit A Business Unit B New Business CEO Business Unit C

Non- Core

Business Unit D • or other options Business Unit E A.T. Kearney 28/M3507 Privatization Challenges V1.0 36

Business Restructuring Needs to Be Centrally Managed for Optimal Results Corporatisation Phase — Step 3 (Business Restructuring) Develop new organization structure Implement improvement initiative flight plan

Timing Key Activities

1-2 months • 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

Court of Directors

Audit Committee Monetary Policy Board

Monetary Stability

Monetary Policy Group Financial Market Group Public Relations Group

Top Management Committee FI Development Board

Financial Sector Stability

Money Market Committee

Operations Financial Sector Policy Group Supervision Group Governor

MP Steering Committee

Strategic Capabilities

Strategic Services Group Human Group Internal Audit Group Resources

Corporate Support Services

Note Printing Board

Note Printing Works

FIDF Board CDRAC Committee

Financial Sector Rehabilitation Operations

Finance Group IT Group Data Mgmt Group General Admin Group Security Group FIDF Group CDRAC Group

=Transferred to other departments or out of BOT in due course

Legal Group Litigation Group Cheque Clearing System HVP& Settlement Group Note Issuance Group

• • • •

Northern Region Northeast Region Southern Region Central Region

4 -10 months • Establish program office • Staff project teams • Establish unit goals, plans, metrics, etc.

• Implement initiatives • Monitor implementation progress and take corrective action as necessary

Validation of Strategic Direction/Roles and Responsibilities Organi sadditional Redesign

Wave N* Wave 3 Wave 2

Wave 1: Organisational and Process Improvement Roll - Out Change Management Program Management

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Maximizing Company Performance and Potential of SOEs Often Requires Organizational Transformation Potential Transformation Value Drivers 1. Develop Clear Business Strategy and Growth Plans for New Environment 2. Align Business Portfolio 4. Improve Operating Efficiency and Cost Position 5. Improve Management / Employee Capabilities and Prepare for Change 3. Reorganize Enterprise to Improve Efficiency and Market-Orientation 6. Improve Reporting and Risk Management Disciplines 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

A.T. Kearney 28/M3507 Privatization Challenges V1.0 38 Source: A.T. Kearney analysis and experience

The value of a privatized Bank will be strongly influenced by management actions taken over the next two years Key Determinants Of Privatization Value Company Performance and Potential 5 Key Areas of Management Focus Deal Structure and Sales Process 3 Financial Market Conditions 2 Areas of Govt. Policy Influence Industry Attractiveness 3 Ability of Privatizing Government to Influence Factors Within the Privatization Timeframe 1

Low/None

3

Moderate

5

High A.T. Kearney 28/M3507 Privatization Challenges V1.0 39

Privatized Bank Management Focuses on Income and Income and Growth Goal Guiding Rules Sustainable improvement in cost / income

plus

growth

•

Fundamental change

change … not incremental •

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 … A.T. Kearney 28/M3507 Privatization Challenges V1.0 40

Basle II presents some interesting challenges for Indonesian Banks

Credit Measure

Simple Standardized Intermediate Foundational Internal Ratings Advanced Advanced Internal Ratings

Mitigation

Simple Compre hensive Institution Calculated

Market

Standardized Internal Models

Operating

Basic Indicator Standardized Internal Models General intuition suggests that the advanced approach will provide the most capital relief

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

 Internal

Holdings



Holding Structure



Current ERM Capabilities Cost/Benefit?

 External

Supervisory Interpretation



Market Mandates

A.T. Kearney 28/M3507 Privatization Challenges V1.0 42

As 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 Operating

• •

Low High

• •

Low Medium Low

• •

High Medium Total economic capital Credit rating Low/ medium A-AA Medium high AA-AAA High 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

A.T. Kearney 28/M3507 Privatization Challenges V1.0 43

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

Geography Comparative Regulatory Risk Capital Business Line Standardized Foundational Advanced

Mortgage 8 N/A 1.60

US (AAA) Credit Card 8 N/A 5.76

Corporate 4 2.27

2.23

Mortgage 8 N/A 18.72

Indonesia (BB) Credit Card Corporate 8 12 N/A 23.04

31.2

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 A.T. Kearney 28/M3507 Privatization Challenges V1.0 44