Earlier this week, Coordinating Minister for the Economy Boediono confirmed that the amendment of a 2005 regulation had been approved by President Susilo Bambang Yudhoyono last week. The regulation stipulates the procedures for the settlement of credits among national and regional administrations.
The amendment will especially affect state-owned banks, since it provides them with the legal basis to improve their non-performing loans (NPL) levels.
NPL have been a main concern in the country ever since the financial crisis of the late 1990s, when many loans turned sour due to a plummeting rupiah.
After a major restructuring of the banking sector conducted by the Indonesian Banking Restructuring Agency (IBRA), the Central Bank initiated the introduction of a new Indonesian banking architecture.
Implementation of the multi-phased blueprint started in 2004 and sets out the envisaged banking landscape over 10 years. It foresees in a consolidation of the market and the phased implementation of the 25 Basel II core principles for effective banking supervision.
The new architecture also limits the allowed NPL level to 5% of total lending.
In the wake of steep fuel price hikes of last year, caused by a cut in subsidies that was needed to reorganise the state budget, many banks again saw rising NPL ratios. Due to high inflation caused by the hike, many debtors were unable to fulfil their loan obligations.
While private banks were able to swiftly restructure their bad loans, by providing debt write-offs, state-owned banks were not allowed this luxury.
In the past, state-owned banks like BNI, did not have the authority to provide haircuts (debt write-offs) on principle, Sigit Pramono, the president director of Bank Negara Indonesia (BNI) told OBG. BNI is Indonesia's second largest state-owned bank in terms of assets.
Under two different laws, one on anti-corruption and the other on State Treasury, bank officials could have been tried for causing losses to the state, because the assets of state-owned banks were considered to be 'state assets'.
Pramono furthermore explained that "when restructuring loans, there were two possibilities. We could extend the tenure of the loan, or decrease the interest rate level".
This handicap resulted in rising NPL levels among state-owned banks this year.
As of June, the industry's net NPL amounted to Rp66.3 trillion ($ 7.19bn) of total loans. This equals almost 9% of the total amount of loans of Rp757 trillion ($82bn), which is much more than the 5% allowed by the Central Bank.
This prompted state-owned Bank Mandiri, the country's largest lender in terms of assets, to publicly announce its 30 biggest corporate debtors, all with loans exceeding Rp1 trillion ($109m).
But even after this remarkable move, Bank Mandiri's NPL level remained high. At the end of July, 26.4% of its total loan portfolio was still not performing, representing Rp26.4 trillion ($2.9bn).
Earlier this week, BNI announced that it reached agreement with 194 of its debtors to restructure Rp3.13 trillion ($340m) of problematic loans through renegotiated repayment terms and interest discounts. NPL levels at BNI reached 11.2% of its total outstanding loans of Rp60 trillion ($6.5bn) in June.
These alarming high levels of problematic debts caused banks to be very careful about extending new loans, which threatened to slow down the growth of Indonesia's consumer driven economy.
Calls for a solution have been increasingly voiced because state owned banks still account for around 50% of total banking assets and they heldhold more than 60% of all bad loans (as of June),
In July, the government introduced a financial sector policy package, which included the revision that would allow state-owned banks to provide debt write-offs without extensive red tape.
"After the new regulation has been approved, we will also be able to provide haircuts (debt write-offs) on principal, levelling the playing field with private and foreign banks" said Pramono to OBG, before the revision to the regulation was approved.
However, the implementation of this revision was delayed because the government asked the supreme court to review the revision, and scrutinise its legality.
When the supreme court recently ruled that the assets of state firms are different from those in the state budget, and should therefore be regulated in view of the relevant laws on state-owned enterprises, this paved the way for the President to approve the revision.
Some observers, however, have voiced concerns that the newly acquired right to write off bad debts could also be abused, citing a limited track record on good corporate governance in state-owned enterprises.
In the meantime, Finance Minister Sri Mulyani Indrawati announced that she would issue a decree soon to follow-up on the revision. This ministerial decree would regulate the mechanism and procedures needed for a debt write-off. In addition, a special supervisory committee will be created that will oversee the state-owned enterprises to ensure their accountability.