Tony Hotland, Jakarta – The country's commercial banks have booked strong third quarter profits, thanks mainly to low cost of funds that allowed them to enjoy fat net interest margins.
But analysts warned that as pressure on the central bank to increase interest rates intensifies, banks may no longer enjoy this kind of good fortune next year without working hard to revive lending to the corporate sector. "I think this kind of profit growth will not be sustainable," said banking analyst Fendi Susiyanto.
He said that current economic developments, such as rising oil prices, rising interest rates in the US and elsewhere, and inflationary pressures at home, indicated that Bank Indonesia would likely increase interest rates, a move that would increase the interest expenses paid by banks to depositors, and eat into their profit margins. He said that this would erode the profits of banks if they continued to solely depend on lower cost of funds.
The strong third quarter profits earned by publicly listed banks, in some cases reporting a doubling of profits compared to the same period last year, was not caused by hard work on the part of the highly paid bankers, but rather the effects of the aggressive cutting of central bank benchmark interest rates, which in May fell to a record low of 7.32 percent compared to over 13 percent in 2003.
The lower benchmark rates forced interest rates on time deposits and savings to fall as well, but interest rates on loans remain high as the banks are still reluctant to channel their excess funds to the corporate sector due to lingering risks as reflected in a relatively low loan to deposit ratio (LDR) of around 50 percent, compared to 80 percent prior to the late 1997 financial crisis. This situation had allowed banks to enjoy net interest margins (NIM) of as high as 8.5 percent. "The current (interest rate) spread is still too wide (about 8.5 percent), and should be narrowed to at least 4 percent," said Fendi.
Seconding Fendi, economist Faisal Basri said the situation here was different from neighboring countries such as Malaysia, Thailand, the Philippines and Korea, where NIMs were below 5 percent.
Ideally, banks should be charging much lower interest rates on loans than they are doing now, and could still make good profits though increased lending activity.
Fendi, however, said that major banks would not immediately pump up their lending rates even if the Bank Indonesia benchmark interest rate started to climb as these banks had better sources of funding compared to smaller ones.
"Only around 15 large banks control up to 70 percent of our banking industry. They won't have critical problems in offsetting losses in NIMs unlike dozens of smaller banks, and possibly won't raise lending rates, at least as long as the SBI rate remains below 8.5 percent," said Fendi, referring to the interest rate on Bank Indonesia SBI promissory notes.
Given these considerations, one of the biggest challenges ahead will be how to preserve profit levels, whether or not the SBI rate moves up, based on more sustainable sources.
"Banks can maintain profits by accelerating lending and maximizing their fee-based income, which is even more essential in improving their profitability. For example, by being an investment advisor or upgrading their service sector. Banks need to increase the contribution of fee-based income to profits from the current average of 7 percent to about 16 percent," Fendi said.