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Provisions for impairment losses becomes a banking buffer
Based on Bank Indonesia (BI) financial sector statistics, government bonds currently constitute as much as 20 percent in total deposits in banks that are included in broad money.
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Indonesian banks’ loan growth 2010-2020. (Source/Morgan Stanley Research)
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mid the trend of economic recovery and increasing credit growth, it is important for the financial sector to remain cautious. This was mainly due to the monetary policy condition which is still on a tightening trend. At a time when many countries have problems with the stability of their banking systems, Indonesian banks need to maintain existing risk management tools.
Indonesian banking is more prepared to face potential crises compared with previous crises. This is indicated by the ratio of capital adequacy and liquidity, which is higher than in several crisis periods. The capital adequacy ratio (CAR), is currently at 25.88 percent as of January 2023, far from the minimum limit required by the authorities, which is 8 percent. This amount is also far above several periods, such as 2007 (9 percent) and 2012 (12 percent), respectively.
The loan to deposit ratio (LDR) was at 80,94 percent as of October 2022, well below the maximum limit of 110 percent set by the authorities. In addition, banking stability is also in a good position as reflected in the ratio of non-performing loans to total loans (NPL ratio), which is also quite low, namely 2.59 percent in January 2023, lower than the maximum NPL ratio set by the authorities of 5 percent.
More importantly, macroeconomic stability is also relatively better. Our inflation rate reached 5.47 percent in February 2023, lower than 2012 (8 percent), as well as the current account to gross domestic product (GDP) ratio, which amounted to 1 percent surplus in 2022, better than 2012, which recorded a deficit of 2 percent. However, currently banks face the risk that interest rates are starting to get tighter in the future which suggests no complacency should be in place. This can be seen from the Bank Indonesia (BI) rate which is at 5.75 percent, almost matching the tight interest rate conditions in 2012 of 6 percent even though at that time the inflation was also higher.
To deal with future uncertainties, one of the risk control instruments that has been running well in Indonesia and should continue is the Provisions for Impairment Losses (CKPN). The CKPN are basically reserves given for loans with the potential to default.
Year 2020 is a new era for the CKPN reserves due to improvement in international and national regulations through the implementation of new International Financial Reporting Standards (IFRS) 9 or Statements of Financial Accounting Standards/PSAK 71. The old rule required banks to recognize credit losses only when they are realized, while the new rule uses an Estimated Credit Loss/ECL approach that considers past, current and future conditions.
With the ECL method, banks can price in the debtor's business sector if they see an impact on future repayment earlier. With the new CKPN rules, banking risk is better reflected and serves as a cushion for recovery after the crisis. Since implementation in 2020, the CKPN has increased from 2019 of 2.9 percent of total loans, to 2020 of 5.5 percent, 2021 of 5.9 percent.
