VIEW POINT: Our banks: Grossly inefficient, yet highly profitable

Do you know that our banks are among the most inefficient yet the most profitable in the ASEAN region?

Perusing the financial reports of the publicly-traded banks, one would see banks in Indonesia enjoying an average net interest margin of 5.53 percent or nearly twice that of their peers in other ASEAN countries.

What is strange is that their cost to income ratio stood at almost 80 percent as of January, compared to 40 to 60 percent in neighboring ASEAN countries, indicating operational inefficiency.

But how could such an anomaly have occurred, while the market is crowded with more than 120 city-based banks, not to mention hundreds of secondary banks in the rural areas? Oligopoly, says the government anti-monopoly watchdog (KPPU).

The KPPU told a hearing with the House of Representatives on Wednesday it had found strong indications of oligopolistic practices in the banking industry whereby the top 10 largest banks control almost 80 percent of the market, leaving the other 110 banks with the remaining 20 percent. 

Further analysis reveals that the five largest banks, of which four are state owned, control more than 60 percent of the banking market.

It was this oligopoly that had enabled the largest banks to control lending rates and keep their net interest margin — the difference between the lending rates banks charge to borrowers and the interest paid by banks to depositors — unusually high, according to KPPU chairman Nawir Messi.

The five largest banks, as the market leaders, control the deposit market and set the trends in lending rates, but the other 115 banks, due to their negligible market share and their small deposit base cannot do much to challenge the market leaders.

So the mid- and small-sized banks simply follow the leaders.

Leaders of the banks association (Perbanas), who also attended the hearing with the House, certainly rejected the observations of the KPPU, blaming the high lending rates in Indonesia on high inflation (5 percent a year), the vast areas across the world’s largest archipelago that have to be served with branches or ATM networks and high business risks.

The central bank’s benchmark interest rate currently stands at a historic low of 5.75 percent, but data at Bank Indonesia (BI) shows that the average interest rates for working capital, investment and consumer credit currently stand at 11.5 percent, 11.3 percent and 14.3 percent, respectively.

These rates are charged only on the prime customers. The interest burdens could exceed 30 percent for high-risk borrowers such as credit card holders and small- and medium-scale businesses.

Another glaring shortcoming is the fact that only about 4 percent of banks’ third-party funds are placed in the interbank market, while only the 10 largest banks enjoy excess liquidity.

This not only causes oligopoly in the market but also forces the other 110 banks to compete fiercely for deposits, offering depositors rates higher than the 5.5 interest ceiling set by the Deposit Insurance Corporation (DIC), thereby further contributing to raising interest rates.

BI deputy governor Halim Alamsyah has confirmed that competition to raise deposits has been so fierce lately that several banks have been luring depositors with interest rates higher than the ceiling of 5.5 percent set by the DIC, putting depositors at risk of losing their money.

The Deposit Insurance Law stipulates that any bank with savings or time deposit accounts offering interest rates higher than the maximum rate set by DIC would not be refunded if the bank went bust.

Extremely high lending rates, acutely inadequate infrastructure and grossly inefficient logistics systems have become a big disadvantage for businesses in Indonesia. 

The interest costs Indonesian businesses have to pay are twice as high as those charged on their counterparts in Malaysia, Thailand, Singapore and China. These high capital costs have deterred new investments because new businesses have to generate unusually high returns.

It is simply unfair and economically unwise to allow commercial banks to continue to enjoy net interest rate margins of 5 to 6 percent while a large chunk of their funds have been ploughed into the financial market. The government, if necessary, should pressure state banks, which still account for around 40 percent of the industry’s total assets, to act as the trend setters, leading credit expansion at reasonably low rates to the government-selected priority sectors.

Seen from their multiplier impact on the economy, it is much better for the state banks to significantly expand lending to the real sector at relatively low credit interest rates, rather than booking high profits but at the expense of economic growth. 

The government therefore should inject more competition into the banking industry by allowing mergers between mid-size banks to build up strong competitors to the five largest banks.

One way of doing this is by approving the planned merger between Singapore’s Bank DBS and Bank Danamon and the planned acquisition by Bank of Tokyo-Mitsubishi UFJ, the largest bank in Japan, of Bank Tabungan Pensiunan Nasional to build strong contenders to the top five players.

However, only jawboning banks to lower lending rates may compromise the quality of their risk management.

It is also imperative for the government to reduce the persistently high business risks by accelerating reform measures in the civil service, taxation, customs and legal sectors. Adverse business condition would expose businesses to high risks of debt default.

It would be better for banks’ credit risk management if BI kept improving the capacity of its credit bureau to provide lenders with more reliable, comprehensive information on debtors. 

The writer is senior editor at The Jakarta Post.

Vincent Lingga | Opinion | Sun, March 17 2013, 9:47 AM Paper Edition | Page: 5