Banks enjoy strong profit, but intermediary role still weak

Dadan Wijaksana, The Jakarta Post/Jakarta

Business-wise, the banking industry is in for probably the best year of showing since the crisis.

With most large banks posting a sharp increase in profits this year (as the table shows), one would be tempted to think that the banking sector has finally recovered from the crushing 1997-1998 crisis, and started cashing in on rewards from a painful and costly rebuilding process.

The steady improvement in other banking indicators such as non-performing loans (NPLs), capital adequacy ratio (CAR), and loans exposure should also help support that argument.

Looking closer, however, such an assessment would prove to be either too optimistic, or premature.

Try this argument.

The NPL ratio measures a bank's non-performing loans -- categorized as loans on which interest payments are 90 days overdue -- against its total loans. CAR measures a bank's health by comparing its capital against risk-weighted assets such as loans.

The higher the CAR, the healthier the financial condition of the bank.

NPLs are currently averaging some 10 percent, as against more than 12 percent last year, while CAR is averaging 20 percent as compared to 16 percent the year before.

As for lending, in the first nine months alone, credits have grown by 22 percent, more than last year's growth of close to 20 percent.

In fact, it is lending (particularly in the form of consumer loans) that is the major factor behind the banking sector's rapid profit growth this year, as the banks' third party liabilities grew slower at between 6 percent to 7 percent during that period.

Consequently, banks enjoyed a hefty net interest margin (NIM), as they get more interest payment from debtors than the payment they have to pay to their depositors.

By comparison, while credits carry a double-digit interest rate, the rate for time deposits and savings is still averaging 5 percent.

There are even banks here that gain an interest rate margin as high as 8 percent, higher than the average 5 percent NIM enjoyed by banks in neighboring countries.

All seems to have justified claims that the banking sector has reached the light at the end of the tunnel.

Sadly, in most cases, the strong financial showing -- notably the huge profits -- was not purely due to the hard work of the bankers, but more by the impact of the central bank's aggressive move to cut its benchmark (SBI) interest rate, which hovers at a record low of slightly above 7 percent these days.

"Such a spread is way too wide. I think the normal margin should be around 4 percent," banking analyst M. Fendi Susiyanto acknowledged.

The lower benchmark rates forced interest rates on bank time deposits and savings to fall.

But in contrast, the rates on loans remain high as the banks are cautious about channeling their funds to the corporate sector, partly because of the high risk they claim the business sector possesses -- which eventually further discourages businessmen from seeking loans.

This is reflected in the relatively low loan-to-deposit ratio (LDR) of some 50 percent, compared to more than 80 percent in the pre-crisis period.

So, in another words, while progress is indeed being made and should be appreciated, the conclusion that the sector has fully renewed its image and become the locomotive of the economy is somewhat unfounded.

They appear to be more interested in keeping the rates high in return for a fat interest rate spread, rather than making all-out efforts to lower them so as to help ignite the real sector, which would otherwise have a much bigger impact on the overall economy.

The economy is set to grow by 4.8 percent this year, but many analysts share the opinion it could have grown faster had the corporate sector been supported by abundant bank lending.

The banks are indeed entitled to reap as much earning as possible as they are after all a profit-oriented entity.

But, taking into account the huge cost the country -- c.q. taxpayers -- had been forced to make in bailing out banks during and after the crisis, greater sacrifice from them would still be justified.

During the aftermath of the financial crisis, the government injected some Rp 430 trillion in the form of bonds to domestic banks, under the recapitalization program.

These bonds were injected to replace the bank loans that had turned sour due to the crisis, thus strengthening their capital.

The government had said the costly program was needed to avoid a systemic collapse in the banking sector, which would have then dragged the economy into deeper problems.

The consequence however, has been severe. From then on, the state, at taxpayers' expense, has to spend tens of trillions of rupiah every year for the interest payments of those recapitalized banks.

True, many of those banks have gradually unloaded some of the bonds, but to date, they still constitute a large share of their interest-based revenue.

As of September, recap bond interest payments made up around 25 percent on average of the banks' total interest-based income.

Take for instance Bank Negara Indonesia (BNI), the country's second largest lender. From its third-quarter Rp 8.6 trillion interest-based income, some Rp 2.7 trillion (30 percent) came from interest revenue obtained from the recap bonds.

Another example is Bank Internasional Indonesia (BII), which enjoyed up to 42 percent of its interest revenue from recap bonds.

Against this backdrop, the banks' accomplishment in reaping huge profits pales by comparison.

Still, one can well argue that signs of progress are there, and that the banking industry is on the right track toward achieving its ultimate goal of playing a significant -- if not leading -- role in the economy.

It is now the task of Bank Indonesia, at least in terms of regulations, to make sure the momentum of reform is maintained.

Aside from pushing more loans to the corporate sector, and improving its financial condition, efforts to improve corporate governance should also form part of an action plan Bank Indonesia needs to undertake to speed up efforts to create a sound and reliable banking system.

Boosting corporate governance -- intensifying the surveillance system and implementing a tougher screening process for bankers -- is crucial to help avoid banking fraud which still takes place despite years of restructuring.

The success of those efforts will play a major role in retaining and even accelerating the pace of reform, and thus most importantly, restoring public confidence in the banking sector.