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Deposit guarantee rate should be aligned with BI policy rate
The rigidity of national banking interest rates is accused of opening a dichotomy between the monetary sector and the real sector.
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An employee arranges rupiah banknotes at Bank Mandiri in Jakarta on June 23, 2022. Currencies in Southeast Asia and around the world dropped against the United States dollar in 2022 as the Federal Reserve hiked rates particularly fast. (Antara/Muhammad Adimaja)
T
he Deposit Insurance Corporation (LPS) is seen as disrupting Bank Indonesia’s (BI) monetary policy because when BI began raising its policy rate in August 2022 to 3.75 percent and continued to raise the rate gradually to reach 5.75 percent in January 2023, the LPS maintained its guarantee rate at 3.50 from January to August 2022 and only raised it by 25 basis points to 3.75 percent in September 2022.
This 3.75 percent rate was raised in January 2023 to 4 percent and again increased to 4.25 percent in late February 2023.
The LPS usually sets its guarantee rate three times a year: in January, May and September. An increase in the LPS rate outside the regular period has the potential to disrupt the financial market stability. Financial market players may very well not have anticipated it. The timing of the increase in the LPS rate is expected to follow the rhythm of the increase in the BI benchmark interest rate. In this way, financial market players can quickly adjust to reduce the potential for unnecessary shocks.
Another issue is the intensity of the increase. The deposit insurance interest rate should follow the benchmark interest rate. Initially, the LPS interest rate was above the BI policy rate. Now the position is the reverse, the BI policy rate (at 5.75 percent now) is higher than the LPS rate (4.25 percent). Accordingly, the increase in the LPS rate could be too late or less aggressive.
The BI benchmark interest rate is also part of the monetary instrument within the inflation targeting framework. The BI main target is the stability of the rupiah so that the determination is forward-looking. If inflation expectations and the exchange rate are seen as higher than the target, BI will raise its policy rate to anchor future developments.
As a cost of funds, an increase in the benchmark interest rate will have an impact on bank interest rates. However, the speed of transmission of bank interest rate adjustments is often different when the benchmark interest rate increases compared to cases where the benchmark interest rate is cut.
The facts show that the degree of interest rate pass-through is typically slow when there is a decrease in the BI rate. Banks tend to “play it safe” by not rushing to cut interest rates on their deposits. In contrast, when the BI rate increases, banks "played offensive" by immediately increasing their lending rates.
