Banking industry improves, but can't propel economy

Rikza Abdullah, Contributor, Jakarta

Indonesia's banking industry has shown improvement but it remains weak in its ability to fuel real economic growth in the country.

During the first 11 months of 2002, for example, Indonesia's commercial banks managed to improve their combined capital and total funds collected from depositors but they, for some reason, failed to channel most of the deposited funds to borrowers.

They, therefore, are now being challenged to improve their efforts to provide more credit for business players this year with an aim of propping up economic growth. But there seem to be further handicaps that may hamper them from extending substantial increases in loans.

According to the latest monthly report by Bank Indonesia, commercial banks (totaling 145 in January 2002 and 141 at the end of the year after the merger of five banks in September) managed to increase their combined capital by 52.6 percent from Rp 62.3 trillion (US$6.9 billion) as of the end of 2001 to Rp 95.1 trillion as of last November. However, their total assets declined by 0.35 percent from Rp 1,099.7 trillion as of December 2001 to Rp 1,095.8 trillion as of last November.

The capital increase helped improve their combined capital adequacy ratio (CAR -- the ratio of their capital against risk- weighted assets) from 20.5 percent to 22.8 percent during the same period.

The banks could also increase the total funds collected from third parties by 2.2 percent from Rp 797.4 trillion as of the end of 2001 to Rp 815.4 trillion as of last November and their credits at a higher rate, 12.1 percent, from Rp 358.6 trillion to Rp 402.2 trillion, thereby improving their loan-to-deposit ratio from 44.9 percent to 49.3 percent.

Bank Indonesia Governor Syahril Sabirin said in a meeting with bankers in Jakarta on Jan. 10 that because the health of the banking industry had improved, while the macro-monetary conditions were getting better, it was a good time for commercial banks to expedite the expansion of their credits.

He explained to the bankers' gathering -- the first of its kind to be held in five years -- that the country's macro- monetary conditions had improved since the start of the economic crisis in late 1997, marked by the recent stability of the rupiah's conversion rate against the U.S. dollar, the downward trends of the consumer price index and banking interest rates as well as the improvements in the country's balance of payments and foreign exchange reserves.

Executives of 80 banks surveyed recently by Bank Indonesia expressed optimism that commercial banks' assets were likely to grow by an average of 5 percent in 2003. In line with the expected asset increases, banks would also improve the quality of their productive assets and increase the volume of their credits, he said.

"However, in spite of the improvements, banks are now still facing various hurdles in improving their intermediary function," Syahril said.

Uncertainties and the high risks in the real business sector (such as production, trading and transportation) had lowered companies' capacity to absorb banking loans and at once caused commercial banks to be too cautious in extending new credits to them. As a result, companies operating in the real sector fell short in utilizing all the funds allocated by commercial banks for credit expansion in 2002, he said.

Because banks found many problems in increasing loans to companies for investment purposes last year, banks were trying to promote credits for consumption, particularly those for the purchase of houses and cars.

But consumption, which made a significant contribution to the economic growth in 2002, is expected to slow down this year due to the expected decline in the private sector's investment activities.

The expectation of the decline in the private sector's investment activities is based on an assumption that investors will continue keeping away from the country due to the poor law enforcement, the uncertainty in the implementation of rules on regional autonomy, the increase in labor disputes and the possible political instability prior to the 2004 general elections.

An expectation that the economy is likely to grow by only about 3.5 percent to 4 percent this year will also add problems to the expansion of banking credits because such a low level of growth would not improve employment conditions in the country.

Indonesia's economy grew by about 3.5 percent last year. That level of growth could help the country increase its employment by only about 1.2 million out of the 2.5 million new people entering the work force annually. As a result, the country's unemployment increased slightly to 8.9 percent as of the end of last year.

In trying to improve their intermediary function, banks may also face difficulties in extending more credits to exporters and export-oriented producing companies because the growth of economies in their main importing countries, such as the United States and Japan, is likely to continue slowing this year.

Commercial banks will also need to lower their interest rates on credits in line with the steady declines of interest rates charged by Bank Indonesia on its SBI promissory notes. Otherwise, borrowers will turn to non-bank finance companies or the capital market in procuring fresh funds.

Interest rates on one-month SBIs declined by 469 basis points from 17.62 percent per annum at the end of 2001 to 12.93 percent at the end of 2002. In line with the decline in SBI interest rates, commercial banks lowered their one-month deposit interest rates substantially from an average of 16.07 percent per annum in December 2001 to 12.87 percent in November 2002. But interest rates on their loans for working capital were slashed only slightly, from 19.19 percent at the end of 2001 to 18.44 percent last November. They even slightly increased interest rates on their loans for investment capital from 17.99 percent to 18 percent during the same period.

Their reluctance to lower credit interest rates have driven consumers to borrow money from non-bank finance companies for the purchase of vehicles or for the procurement of machinery and other industrial equipment by businesspeople.