The day Bank Rakyat Indonesia (BRI) announced its 2010 earnings, which had grown nearly 60 percent from the previous year, the market welcomed the announcement cheerfully, and the company’s share price surged almost 6 percent.
BRI shares were not an exception as almost all shares of publicly listed banks did very well in 2010. On the back of strong economic growth and stable interest rates, the Indonesian commercial banks ended 2010 with stronger growth, marking a solid recovery from the depressed growth they experienced in 2009 in the aftermath of the global financial crisis.
Bank lending grew 23 percent, which was still below the peak in 2008, when their lending grew by
30 percent. But it was a strong growth from a depressed level of 9.9 percent in 2009. During the global financial crisis, the lending growth of the private banks fell more sharply than those of the state-owned banks.
But as private banks moved more aggressively to recover their lost ground after the crisis, their lending growth recovery was more robust than those of state banks. The ratio of state-bank loans to total bank loans slid from 38 percent to 36 percent.
From the current macro indicators it seems that the stage is set for more strong growth for the banks in 2011. GDP growth is expected to be stronger, and despite higher oil prices, the threat of inflation seems to be moderating, reducing the risk of monetary tightening by Bank Indonesia (BI), the central bank.
However, if banks are expected to maintain or even raise their loan growth this year, capital will be an important issue.
Indonesian banks have generally strengthened their capital to comply with a BI ruling on minimum capital requirement.
In 2010 banks were able to maintain their capital adequacy ratio (CAR) at 17-18 percent, far higher than the Basel II mandated level. Each bank has now more than Rp 100 billion of capital but the adequacy of these capital levels should be looked at in the context of high loan growth this year.
BI statistics show that there are still seven banks whose CAR are below 12 percent. As the CAR of
the state banks is lower than those of private ones, they would be under more pressure to raise capital.
For the state banks the most convenient way to strengthen their capital is by keeping retained earnings.
That’s why the issue of the dividend pay-out of the state banks will likely be hotly debated by the government and the House.
The Finance Ministry is asking the state banks to maintain their dividend pay-out ratio at last year’s level, because this has been used as the basis to estimate non-tax revenue in the 2011 budget.
The issue of loan growth is also related to the loan-to-deposit ratio (LDR), which is how much each bank loans per certain value of deposit. The overall LDR of all banks as of December 2010 was 75 percent.
This was below the minimum 78 percent required by the recent BI rulings.
This will force most banks to work hard to raise their LDR, otherwise they could face penalties by having to deposit more of their funds in the central bank to meet the required higher minimum deposit.
When the financial crisis hit in 2008, the net profit of Indonesian banks fell by 12 percent. The fall in earnings came mostly from the private banks, since they were apparently more exposed to global banking through their foreign ownership and networking compared to state banks.
The net profit of state banks surprisingly was only slightly affected by the crisis. But since the crisis, all banks have experienced robust growth.
In 2009 and 2010, they grew 47 percent and 27 percent, respectively. This growth surpassed the rate of growth before the financial crisis.
The high growth in bank profits has drawn criticism from the government and even from the central bank itself. The banks have been charged with charging their customers with too-high interest rates.
The net interest margin (NIM), the difference between interest received and interest paid by the banks, at 5.7 percent was considered too high, in fact the highest among their peers in the region. Critics said that high interest rates charged by the banks showed that the banks were actually inefficient.
The critics wanted to suggest that there was room for interest rate cuts by the banks by making bank operations more efficient. But data from BI actually showed that banks have been able to reduce their operating costs relative to their operating income.
The ratio of operating costs to operating income went down from 89.5 percent in 2005 to 86.1 percent in 2010.
The improvement in their efficiencies was made possible by their huge investment in Information Technology (IT) which has rewarded them with reduced transaction costs and has provided more convenience both to the banks and to the customers.
Banks have to keep abreast with the rapid development of IT and have to be ready to upgrade their
IT systems at any time. Otherwise they will be overwhelmed by fierce competition.
Now banks are facing pressure from authorities to raise their loan growth and at the same time to cut interest rates they charge to their customers. In other words the authorities are telling the banks that they should expand their lending but at reduced earnings growth. But for banks operating in Indonesia the problems of cutting interest rates is less related to efficiency.
The persistent high interest charged by banks reflects the structural problems of the economy
that is greatly influenced by extern-al factors.
In Indonesia bank lending constitutes the bulk of corporate financing, accounting for as much as 70 percent of corporate funding.
The rest is provided by the capital market either through public offerings or bond issuances. As long as bank lending dominates corporate financing, demand for bank loans will remain strong and keep interest rates high.
Historically, inflation in Indonesia has been high, and it remains so now. Because of this historical background, banks tend to include a premium for risk in their interest rates.
The risk also includes the difficulties of assessing the viability of their customers because of the opaque nature of their governance. Legal risk is another area that the banks have to deal with, since settlement of legal disputes through courts could be protracted for a long time.
Last year BI forced 14 major banks to cap their deposit rates in order to make lending rates lower.
Recently BI ordered those banks to announce publicly their base interest rate, that is the interest rate they charge to their prime customers in the hopes that open competition will ultimately bring down interest rates.
These kinds of measures would hardly succeed. Banks need a more favorable external environment to induce them to lower interest rates. That is why it is important for the government and BI to work together to create a better external environment for the banks.
The writer is an economist.
