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Jakarta Post

Will deposit rate-caps succeed in boosting loans growth?

While the effectiveness of using deposit rate-caps to boost lending remains to be seen, some potential drawbacks are clear

Helmi Arman (The Jakarta Post)
Fri, September 11, 2009

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Will deposit rate-caps succeed in boosting loans growth?

W

hile the effectiveness of using deposit rate-caps to boost lending remains to be seen, some potential drawbacks are clear.

Late in August, an agreement was brokered among 14 major banks to cap deposit rates at a margin of 1.5 percentage points above BI's policy rate, in a move that followed on from the unease of policy makers' over the snail's pace of growth in loans and the rigidity in bank lending rates, which did not respond to falls in the BI key rate.

Three weeks have passed since then. The good news is that the base lending rate of commercial banks continues to drop. The bad news is: The pace of decline is apparently no different than before the rate cap was introduced.

We must be fair though. Three weeks is not enough to gauge the effectiveness of any major policy (or shall we say "initiative" in this case).

This is why it's important to delve further into recent banking sector trends if we are to examine what impact the cap might have on the banking sector and the economy in, say, six to twelve months time.

When media reports say the growth in bank loans growth has been slow, what the general reader may conclude is that all the banks have been curtailing growth in lending. However, this is actually not the case.

Statistics show that rupiah loan growth rates have been varying markedly as between state-owned banks and private commercial banks.

Up to the first half of the year, private national banks were apparently not expanding their loan books. Loans even shrank by one percent while deposits grew by around three percent, resulting in a Rp 20 trillion build-up of excess funds.

On the contrary state banks actually expanded their loan books by 13 percent during the same period. This is consistent with an annualized growth rate of 25-30 percent, which objectively is a somewhat slower than the impressive 40 percent increases of last year, but these rates of growth are still significant.

The problem was that the rapid growth of lending by state banks was only accompanied by a 2 percent increase in deposits, so that new loans outpaced new deposits by around Rp 35 trillion.

This imbalance resulted in declining liquidity balances and increased needs for funding, which explains why state banks were apparently more aggressive in their deposit rate pricing compared to many other banks (i.e. before the cap was introduced).

Data from BI's monthly banking statistics show that state bank deposit rates had been declining at a slower pace compared to the BI rate since March; and they even increased in June.

This was in contrast to private national banks which had been cutting deposit rates at a pace shadowing the decline in BI rate.

Indeed before the cap was introduced, some medium-sized private banks apparently tried to measure-up to the rates offered by the state banks.

But given that their loan growth was generally stagnant, it is likely that such moves were mostly done for reasons of retaining, instead of expanding, the deposit base.

Given all this, the efficacy of deposit rate caps in achieving the objective (of boosting loans growth) should be further scrutinized.

Firstly, private banks have clearly preferred holding liquidity over lending, thus they were probably rationing credit.

In such conditions capping deposit rates would do little to increase their lending appetite and might even serve to simply widen their net interest margins.

Secondly if the caps induce the move of customer deposits towards big banks (after all big is beautiful), the mid-small private national banks will likely resort to non-interest rate schemes to lure back deposits.

This would entail additional costs that may offset any interest rate savings and serve to defeat the whole purpose of having deposit rate caps in the first place.

Of course banks have been forewarned against giving cash bonuses to depositors, but eventually there's a limit to what can and cannot be commanded. For example, will one also forbid prize giveaways... or even fee discounts?

Probably we would all be better off thinking about an exit strategy for the rate cap early on.

Running artificially low deposit rates could prove counterproductive in the long run, as periods of low deposit interest rates are usually associated with slower growth in deposits. This is because there is usually an increased leakage or currency drain during such periods.

If that happens, banks may eventually have to curtail lending as liquidity conditions tighten. And loans growth would be slower than if there had been no rate cap at all.

At the end of the day, the banks that have been rationing credit will only start lending once they feel it is safe to do so.

Luckily signs are emerging that the economic downturn is turning out to be not as deep as many had thought it would.

Thus if the base lending rates do decline going forward, the chances are it is probably because they were about to do so anyway.

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