Banking expected to improve, but slowly<\/p>\n
Fauzi Ichsan<\/p>\n
International investors and donors like to point out that
\nalthough Indonesia's economic growth is rising, investment in the
\nreal sector of the economy, and therefore economic growth, are a
\nlot lower than their full potential. There are two reasons why
\nreal investment is so low. First is legal uncertainty, which
\nhampers long-term investment like infrastructure and mining.<\/p>\n
Second is a \"malfunctioning\" banking sector. Still traumatized by
\ncorporate debt defaults in 1998\/99, the banking sector prefers to
\nkeep its assets in the form of government bonds, central bank
\ndiscount bills (SBI) and consumer loans to individuals, who are
\nbetter at repaying debt than corporations. But real sector
\ninvestment, the kind that accelerates economic growth and creates
\nemployment by the millions, is driven by corporations, not
\nindividuals.<\/p>\n
The role of the banking sector remains smaller than before the
\nfinancial crisis. Bank lending now generates less than 25% of the
\neconomy, compared to 60 percent in 1997. Bank loans now cover
\nonly 38% of the total banking sector assets, compared to 71
\npercent in 1997. Banks' reluctance to lend to the real sector is
\nironic since they have too much cash. In a recent parliamentary
\nhearing, Bank Indonesia (BI) Governor Burhanudin Abdullah even
\nsaid, \"Indonesia is still in an economic crisis\", as \"excess
\nbanking liquidity\" has reached Rp 180 trillion - Rp 190 trillion
\nor around 10 percent of the economy. The banks spend around 85
\npercent of this excess liquidity to buy SBI notes and place the
\nrest in the overnight BI facility, which is annually costing the
\ncentral bank about Rp 14 trillion to 16 trillion in interest
\nexpense and eating up its capital. Overall, the banking sector is
\nstill dependent on the government, as almost 40 percent of their
\ninterest income comes from government bonds and SBI. Given a weak
\nlegal system, banks remain reluctant to lend to the real sector,
\nparticularly the corporate sector. In addition to its \"generic
\nproblems\", the banking sector has also been affected by \"high-
\nprofile\" fraud cases at state-owned Bank Negara Indonesia (BNI)
\nand Bank Rakyat Indonesia (BRI). Given all these problems, it is
\nnot surprising that bank lending for corporate investment remains
\nlow.<\/p>\n
Looking over the medium term, however, the banking sector is
\nnow healthier than during the peak of the crisis. Between 1998
\nand 2003, non-performing loans (NPL) as a percentage of total
\nbank loans have sharply declined from 49 percent to about 7
\npercent. Over the same period, banks' net interest income has
\nincreased from minus Rp 61.2 trillion to around Rp 27.8 trillion
\nand banks' capital adequacy ratio (CAR) has improved from minus
\n15.7 percent to around 23 percent. The Indonesian Bank
\nRestructuring Agency (IBRA) has sold most of the troubled banks
\nthat it took over during the crisis, Including BCA, Danamon,
\nNiaga and BII, to strategic investors. The government has also
\npartially sold its non-IBRA banks, including Bank Mandiri,
\nIndonesia's largest, and BRI, a solid rural credit bank, through
\nsuccessful initial public offerings (IPO). Meanwhile, the
\ninternational rating agencies, like Standard and Poor's and
\nMoody's, have been upgrading the risk rating of several banks.
\nSo, there are good stories to tell about the banking sector and
\nfurther progress is expected, slowly but surely because of the
\ninherent problems the sector is facing.<\/p>\n
Banking sector in 2003<\/p>\n
In 2003 the banking sector experienced three major
\ndevelopments. The first of these has been a continually falling
\ninterest rate. BI has been willing to reduce SBI rates (the
\nbenchmark for banking rates) because of falling inflation and
\nbecause of excess liquidity in the banking sector. The immediate
\neffect of falling interest rates is falling profitability, given
\nbanks' dependence on government re-capitalization bonds and SBI.
\nMany banks hence try to protect their profits by maintaining high
\ninterest rates on loans, inviting criticism from BI and the
\nbusiness community. But the positive effect of a falling interest
\nrate is that banks are increasingly forced to look for
\nalternative sources of income, either through increased lending
\nor service fees, to reduce their dependence on the government and
\nBI debts.<\/p>\n
The second development is domestic consumption growth. A
\nfalling interest rate, stronger rupiah exchange rate and falling
\ninflation have all supported domestic consumption, which
\ngenerates 80 percent of the economy. If banks are reluctant to
\nlend to corporations, they are more than happy to lend to retail
\nconsumers to buy cars, motorcycles and residential houses. While
\nthis may not be a healthy strategy in the long run, the banks at
\nleast are lending to the real sector of the economy.<\/p>\n
And the third development is the emergence of the mutual fund
\nindustry. The tax-free mutual fund industry has grown rapidly
\nfrom Rp 46.6 trillion at the end of 2002 to Rp 85.8 trillion by
\nSeptember 2003. The growth of the industry has simply exceeded
\nthe growth of the bank deposit market. Many banks used the
\nopportunity to rapidly sell their re-capitalization bonds to
\nmutual funds, both to book trading profits (because of rising
\nbond prices due to falling interest rates) and to reduce their
\ndebts by persuading bank depositors to move their money from
\ndeposits to mutual funds. The emergence of the mutual fund
\nindustry allows the banking sector to slowly reduce its
\ndependence on government bonds.<\/p>\n
All in all, in spite of the highly publicized bank fraud
\ncases, the banking sector in 2003 has become healthier, judged on
\nbasic banking indicators, such as NPLs, CAR and loan-to-deposit
\nratio (LDR). Falling interest rates are squeezing profits but
\nthat has also reduces the government's interest expense (and
\ntaxpayers' burden) on re-capitalization bonds while slowly
\nforcing banks to resume their capital intermediary role in the
\neconomy.<\/p>\n
Banking sector in 2004<\/p>\n
In 2004, the banking sector can also expect three
\ndevelopments. The first of these is the general election. The
\nelections will mean two things. First, that real investment is
\nlikely to remain flat. And second, that political parties will be
\nspending money on their campaigns at the grass-roots level, which
\nwill help consumer spending. This will support the bank consumer
\nlending business, as households will have more cash to repay
\ntheir loans and credit cards. Businesses, which \"profit\" from the
\n\"spillover\" of money politics, will also need working capital
\nfinancing from banks. All in all, unless it descends into a
\npolitical disaster, which is unlikely, the general election is
\nlikely to be positive for the economy, including the banking
\nsector.<\/p>\n
The second likely development is higher interest rates.
\nInterest rates are expected to rise, albeit slightly, because of
\nthe general election, due to likely rupiah volatility during the
\nelection and possible U.S. interest rate hikes. This would
\nprevent banks' interest income from falling further. Because
\nbanks' are unlikely to raise their deposit rates (unless interest
\nrate goes up sharply - which is unlikely), the \"spread\" between
\nSBI rates and deposit rates could widen, improving banks'
\nprofitability.<\/p>\n
And the third likely major development is further bank
\nprivatization and consolidation. The government is already
\nplanning to sell Bank Permata and Bank Lippo to strategic
\ninvestors in 2004. The fraud cases at Bank BNI and BRI, as well
\nas the likelihood of higher non-performing loans at Bank Mandiri,
\ncould increase public pressure on the government to divest state-
\nowned banks. This could both insulate the government from future
\nfinancial liabilities while improving the management and capital
\nbase of the banks. On the regulatory side, further progress is
\nexpected but mainly after the election. This would include the
\nremoval of the blanket deposit guarantee scheme and the gradual
\nintroduction of the financial services authority (FSA) that could
\ntake over supervision and regulatory powers from BI.<\/p>\n
All in all, 2004 is likely to be a year of further
\nprivatization and consolidation for the banking sector. In spite
\nof all the structural problems it faces, the banking sector is
\nlikely to continue to progress, surely albeit slowly. In the long
\nrun, progress in the banking sector could only be accelerated by
\na combination of factors. First, continual political stability.
\nSecond, a better investment climate for investors. Third, a
\nstronger legal system, particularly in the bankruptcy court and
\nits legal enforcement. Fourth, improved bank internal risk
\nmanagement, particularly on credit risks. And fifth, prudent
\nsupervision by the government, particularly strong coordination
\nbetween the Ministry of Finance, Bank Indonesia and the Capital
\nMarkets Supervisory Board - BAPEPAM.<\/p>",
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