Revisiting Policies on Lowering the Credit Cost for Indonesian Banks

This article is originally published in The Jakarta Post on January 2024

Lowering the cost of doing business such as financing costs is very important, especially for businesses that are cost competitive, like manufacturing.

Although credit cost in Indonesia has been on a declining trend since the 1998 Asian financial crisis, it was still not competitive at 8.5 percent in 2022 (World Bank). It remains the highest compared to its other ASEAN-5 peers: the Philippines at 7.1 percent, Singapore at 5.3 percent, Malaysia at 3.9 percent and Thailand at 3.1 percent. Meanwhile, the credit cost in China is at 4.3 percent.

Given the ongoing global monetary policy tightening, this poses a challenge for investment.

In a bid to bring down the credit rate, the government has issued many regulations, including on financial governance, literacy and bank consolidation, as well as transmission of monetary policy to credit rate.

However, the intervention model is rather ineffective and distortive. An example is the state budget allocation for government guarantees and interest subsidies for small and medium enterprise (SME) loans. The amount for just interest subsidy has increased 20 percent year-on-year to Rp 47 trillion (US$2.98 billion) in 2024, while banks’ SMEs portfolios have been stuck at 20 percent for years, indicating policy inefficiency in increasing SMEs’ access to loans.

Indonesia hence needs a different approach that could bring down the rate sustainably. To find the right solution, we need to examine the root causes of high credit rates. It should be noted that the cost of funds contributed only around 20 percent to the credit cost.

This is because around 60 percent of the total funds collected by banks are in current and savings accounts that carry interest rates of only 1 to 2 percent, much lower than the average 5.1 percent rate for time deposits. For the largest banks with core capital of more than Rp 75 trillion, the “cheap funds” ratio is even higher at 73-80 percent.

The big room for improvement is in the net interest margin (NIM), which is around 80 percent of the credit rate: The NIM of Indonesian commercial banks in October 2023 reached 4.9 percent, or 62 percent of the credit cost, and higher than in other ASEAN-5 countries and China (1.5-2.8 percent). The NIM has also never been significantly less than 5 percent, indicating a structural problem.

Around 50 percent of the high NIM is caused by high overhead costs. According to data on the global economy, the cost-to-income ratio in Indonesian banking is very uncompetitive at a high value of 47 percent. It is only lower than the Philippines at 51 percent, and is higher than all other ASEAN-5 countries and China (32-45 percent).

The biggest contributors to the high overhead cost in Indonesian banks are personnel and general expenses, as well as profit margin. Their general expense is relatively higher than other ASEAN-5 countries.

This can be explained by local banks’ high need for local branches to serve Indonesia’s huge population and vast area. This high level of general expense will remain for some time, as the digitalization effort is still in the early development stage.

The high overhead cost could actually be reduced because of the low credit risk. Banks’ nonperforming loans (NPLs) were only at 2 percent, falling at the lower end among ASEAN-5 and China (1-4 percent).

According to Financial Services Authority (OJK) data, the credit price is in direct competition with other assets like government bonds (SBNs). As of now, almost 30 percent of banks’ total assets are placed in Bank Indonesia (BI) and government bonds. The fact that SBN yields are very high also increases the cost of credit. The government bond yield in 2022 was 6.5 percent in 2022, the highest in ASEAN-5 and China (2.6-6 percent).

This high yield is mostly due to Indonesia’s sovereign credit rating of BBB stable, which is the lowest in the ASEAN-5 region; add to this the fact that the capital charge for banks holding government bond assets is even lower than credit.

On the other hand, the high number of banks in contrast with low banking assets to GDP (59.5 percent for Indonesia, 83-189 percent for ASEAN-5 and China) contributed to the lag in policy transmission. Even though the number of banks has declined to 104 as of now from 120 in 2011, that figure is still the highest in the region.

This contributed to slower adjustments to changes in the BI policy rate. When the policy rate or NPL decreases, for instance, the credit rate does not immediately decrease. But when they increase, the credit rate increases immediately, meaning that the NIM is never low.

Gradual consolidation of banks should be continued or even accelerated. Bank consolidation can also increase the number of well-capitalized banks and reduce reliance on interest income, which is currently the highest in low capitalized banks.

However, the concentration ratio can contribute to a high NIM due to its impact on competition. Currently, the four largest banks still control 60 percent of assets. These banks have the highest NIM at around 5.5 percent. Meanwhile, the NIM for other banking groups is below 5 percent. To push commercial banks to reduce their NIM, the role of non-bank financial institutions, such as insurance and pension funds, needs to be promoted.