Solving the low loan-to-deposit ratio syndrome<\/p>\n
Lin Che Wei, Director, Founder, Independent Research and Advisory,
\nJakarta<\/p>\n
For the past five years since the crisis, Indonesia has
\ncontinued to suffer from a \"low loan-to-deposit ratio (LDR)
\nsyndrome,\" as the level of LDR among Indonesian banks continues
\nto be very low. The low LDR has resulted in the criticism that
\nthe banks are not lending out to the real sector.<\/p>\n
We also hear complaints that the banking system here is not
\nworking hard enough to resume its financial intermediary function
\nas they prefer to put their money in Bank Indonesia certificates.<\/p>\n
This has created a vicious cycle or, to quote Bank Indonesia
\nGovernor Burhanuddin Abdullah, it is like a dog chasing its own
\ntail.<\/p>\n
But wait a minute -- the amount of third-party deposits rose
\nfrom Rp 358 trillion (US$42 billion) in December 1997 to Rp 838
\ntrillion in May 2003, or a growth of 134 percent over the last
\nfive years. Loans grew by only 13 percent, from Rp 378 trillion
\nto Rp 428 trillion in the same period.<\/p>\n
What do these numbers mean? One reason for the low LDR may be
\nthat loan disbursement is too low compared with its full
\npotential. The second is that deposits collected by banks may far
\nexceed the real needs of the banking system.<\/p>\n
Politicians and central bank figures all seem to conclude that
\nthere is nothing wrong with too much deposits. They assume that
\nthe problem lies with loan disbursements that were too small and
\ntoo slow. They complain that banks are not doing their hardest to
\nlower lending rates. Numerous statements question continued high
\nlending rates while funding rates continue to fall. Why aren't
\nbanks trying harder to lend to the real sector to revive the
\neconomy?<\/p>\n
Let's suppose that the banks boost their loan growth as fast
\nas possible to increase LDR. Who would bear the risk for such
\nrapid growth in loans: politicians or the government, the central
\nbank or the banking sector itself?<\/p>\n
Those likeliest to suffer the most would be the banking system
\nand taxpayers, who would ultimately have to bear the cost in the
\nevent of another huge banking bailout. I do not believe in a
\nfinancial system where the true level of loans and deposits is
\ndetermined by politicians.<\/p>\n
I believe in a banking system that operates on a profit-
\nmaximizing principle and a resource-allocating principle based on
\nrisk-reward consideration. The banks should operate freely
\nwithout \"instruction\" or \"command\" from politicians or the
\ncentral bank.<\/p>\n
The most that BI can do is to set up a regulatory environment
\nand regulations to encourage banks to resume their financial
\nintermediation role.<\/p>\n
A low loan level could indeed mean that banks are \"lazy\" in
\nfinancing the real sector and prefer to lodge their money with
\nthe government, which has a better risk-return profile. The low
\nloan level could also mean that most banks are still haunted by
\nthe trauma of lending to corporates, due to a weak foreclosure
\nenvironment and legal infrastructure.<\/p>\n
This is understandable, given the very low average recovery
\nrates of loans transferred to the Indonesian Bank Restructuring
\nAgency during the crisis.<\/p>\n
The low loan level could also reflect that not only banks do
\nnot trust their customers, but also that banks do not believe in
\nthemselves -- especially as the old banking culture has hardly
\nchanged, despite the crisis.<\/p>\n
Given that lending practices and risk management have hardly
\nchanged, perhaps it is better that banks grow slowly rather than
\nrapidly.<\/p>\n
However, another likely possibility is that real demand from
\nviable business ventures has reached its optimum level; hence it
\nwould be quite difficult for banks to grow their loan books
\nfurther without compromising asset quality.<\/p>\n
If we assume the loan level has reached its optimum level, the
\n\"too high\" deposit level could explain the low LDR level. A high
\nlevel of deposits could mean that first, public confidence toward
\nthe banking system has been restored -- otherwise why would
\npeople deposit as much as Rp 838 trillion in the banking system?<\/p>\n
However, this does not mean that the public has complete trust
\nin the viability and the health of our banks. The blanket
\nguarantee, which provides protection for depositors in the case
\nof bank failure, may explain this high confidence. More
\nimportantly, Indonesians still prefer to keep their money in
\nbanks, so this is also why deposits have reached such high
\nlevels.<\/p>\n
But the most plausible explanation for high deposits is
\nprobably due to the very limited viable alternatives for people
\nto put their money into, such as rudimentary capital market
\ninstruments like bonds and the equity market.<\/p>\n
Therefore, low LDR may be more attributable to a high level of
\ndeposits rather than a low level of loans.<\/p>\n
As the crisis has resulted in an overall lower growth of gross
\ndomestic product, this also means that Indonesia is suffering
\nfrom a permanent output loss, which has ultimately resulted in
\nlower demand for loans.<\/p>\n
If this scenario were true, it would be better to let the
\nbanks grow at a prudent pace rather than push them to grow their
\nloan book just to meet a normal LDR level. Consequently, we
\nshould focus efforts on providing alternative financing (other
\nthan through banks) to allow the real sector access to financing.<\/p>\n
The important factor to resolve the problem of a high level of
\ndeposits is to create an alternative investment into which people
\ncan put their money, without having to go to the banking system.
\nThis means the creation of depth and liquidity in the capital
\nmarket. At the moment, the Indonesian capital market lacks
\nliquidity and depth and relies too much on banks for its funding
\nrequirements.<\/p>\n
Contrary to the perception that the withdrawal of funds from
\nthe capital market (or \"hot money\") during the crisis was the
\nmain cause of the liquidity crunch in Indonesia and the region,
\ndeposit withdrawal from banks was the main cause for the Asian
\neconomic crisis.<\/p>\n
Funding from banks often creates maturity mismatch between
\nassets and liabilities. Banks use short-term funds such as
\ndeposits and savings, which are prone to sudden withdrawal, to
\nfinance long-term projects. Development of capital markets would
\nlead to a healthier financial system, foster more market
\ndiscipline and improve corporate governance and disclosure.<\/p>\n
Focusing on a specified level of LDR is meaningless, let alone
\nfollowing instructions from politicians or the central bank,
\nwithout considering the risk-return profile of business lending.
\nPushing the banks to lend too fast will never succeed and might
\neven backfire.<\/p>\n
The important thing for Indonesia is to allow corporates to
\nobtain much-needed financing to enable them to revive the real
\nsector. This could be achieved either with or without the banks,
\nas long as there is a healthy capital market.<\/p>\n
A cure for \"low LDR syndrome\" is thus the creation of a
\nvibrant capital market; not pushing banks to loan recklessly,
\nsimply to meet an LDR target.<\/p>",
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