T

he limited room for a policy rate cut does not dampen the spirit of Bank Indonesia (BI) to loosen its monetary policy.

The central bank’s board of governors’ meeting in the middle of January opened the 2018 sheet by relaxing some macro prudential policies.

First, BI refined the primary reserve requirement (RR). The RR in rupiah for commercial banks that had originally been set at 5 percent of daily-fixed third-party funds with 1.5 percent average within the two weeks as maintenance period was reduced to 4.5 percent and 2 percent, respectively.

The difference of 0.5 percent at least adds liquidity of Rp 20 trillion (US$1.5 billion) to the banking system. The increase in liquidity is expected to improve the capacity of loan disbursement, targeted to grow 12 percent within this year. Therefore, the maneuver to realize the target of economic growth of 5.4 percent becomes lighter.

Second, BI converted the loan-to-funding ratio (LFR) rule for conventional commercial banks into Macroprudential Intermediation Ratio (MIR). With the change, banks can use more of their funds to purchase securities.

With this rule, BI implicitly encourages a bank to use the increase in liquidity resulting from the eased RR to buy securities. In turn, corporations will be encouraged to issue commercial papers. The financial market deepening is another important goal that BI will achieve.

Third, BI introduced the Macroprudential Liquidity Buffer (MLB) as secondary RR. The MLB is set at 4 percent of deposit, allowing 2 percent of a deposit to be used as repo to BI under certain conditions to fulfill a bank’s liquidity needs. This strategy closely relates to the behavior of banks.

The banking sector tends to be procyclical with the rise and fall of the economy. When the economy is well, banks will expand and increase risk-taking behavior. In contrast, when the economy is slow, banks are inclined to withhold expansion by retaining credit disbursement. Therefore, the MLB is aimed at maintaining the stability of banking’s liquid assets.

The basic idea that can be drawn from some policies above is banking intermediation function enhancement and flexibility in banking liquidity management. Ultimately, these three macroprudential policies will promote the effectiveness of monetary policy transmission to the real sector.

Theoretically, the above logic is acceptable. If the depositors do not put their funds in the bank but buy securities in the capital market, then the reduction of third-party funds will be followed by a loan slowdown at the equivalent amount. In this case, the funding needs of the corporate sector are not disturbed.

Similarly, the impact of the rise in the securities issued by corporations will be neutral when the weakening of loans is transmitted by banks on the purchase of other securities. Therefore, the impact of the slowing down of third-party funds is not substantial as far as it can be replaced by the funds from the securities sales.

Unfortunately, the conceptual proposition above seemingly is not applicable in the context of Indonesian banking. For example, until the end of 2017, banks experienced excess liquidity due to the growth of third-party funds, which was 11.16 percent while credit growth was 8.3 percent. Financing in the capital market skyrocketed 24 percent.

The above thesis does not change if we look at the absolute values. Last year, the excess liquidity of the bank reached Rp 626 trillion from the total loan portfolio of Rp 4.56 quadrillion. Meanwhile, total fundraising from corporate action in the Indonesia Stock Exchange (IDX) “only” reached Rp 276.5 trillion.

Accordingly, banks spread their potential loan disbursement to commercial papers, government securities and corporate medium-term notes (MTNs). Meanwhile, the decrease in the growth of third-party funds was responded to by selling the negotiable certificate of deposit (NCD).

However, the third-party funds and the NCD did not perfectly substitute each other. Similarly, the purchase of commercial papers and MTNs did not completely take over the role of bank lending.

In essence, banks prefer to allocate their excess liquidity to the short-term financial instruments in the secondary market to seek the best returns. In other words, the purchase of securities becomes a basket for transit of temporary funds instead of placing funds to develop the corporate sector.

Based on the existing conditions, the implementation of the three macroprudential policies above may not immediately arrive at the target. The effect of additional banking liquidity triggered by the easing RR on the purchase of securities could be greater. As a result, the magnitude of MIR offsets the tolerable range of 80 percent to 92 percent.

Amid the weakening demand for bank loans, the fund outflow from banks to buy securities is likely to be higher. At the same time, the incoming funds from repo proceeds to BI is too low, resulting in the high liquidity risk and further amplifies systemic risk.

Consequently, the basic idea of the MLB to restore the moral hazard will not have much effect. Moreover, the nature of countercyclical inherent in the MLB potentially becomes idle funds while the need for funds to finance infrastructures is currently increasing.

The above figure can be well illustrated by releasing the head without holding the tail. As a result, banks are transmissive to enjoy the higher returns obtained from portfolio investment and lazy to elevate credit disbursement to the real sector.

Under those circumstances, the “guts” of BI will be tested again to look for other complementary stimulus forms to the MIR and the MLB. In short, BI’s failure to address the behavioral issues in the banking industry becomes the anticlimactic macroprudential relaxation.
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The writer is research director at the Socio Economic & Educational Business Institute (SEEBI) Jakarta and lecturer at the School of Economics at the State University of Jakarta. The views expressed are his own.