Banks enjoy strong profit, but intermediary role still weak

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.