Monetary and fiscal policy have been very accommodative. The policy rate, Bank Indonesia’s (BI) seven-day reverse repo rate, is currently at a historic low of 3.5 percent. To ensure sufficient liquidity in the financial system, BI has provided as much as Rp 798.9 trillion (US$55.37 billion) in quantitative easing since the beginning of the pandemic.

BI also issued several macro prudential relaxations to support loan growth, including relaxing the regulation on down-payment to boost property and automotive sales to as low as 0 percent. These relaxations were followed by a temporary luxury tax cut policy by the Finance Ministry for property and automotive sales to boost spending of the middle-upper class. The government also continues to support micro, small and medium enterprises (MSME) through fiscal spending as part of its National Economic Recovery Program. In 2020, the government spent approximately Rp 114.8 trillion to support MSMEs, through interest subsidy, loan restructuring and loan guarantees. 

However, loan demand is still very weak as the economy is showing slow recovery during the first quarter of 2021. Loans continued to contract deeper during the first quarter, by 3.8 percent year-on-year, deeper than the 2.4 percent contraction at the end of 2020. At the same time, undisbursed loans increased to their highest level in almost three years. Loans to some major industries, including wholesale and retail trades and the processing industry, which contribute approximately 33 percent to total loans, still have a stubbornly high NPL of 4.7 percent and 4.8 percent, respectively.

The Financial Services Authority (OJK) issued Regulation No.11/POJK.03/2020 related to relaxation of credit restructuring up until March 2022 with the additional requirements that banks should increase their risk management function and provide regular reports to the authorities concerning stimulus implementation. Furthermore, banks are required to conduct stress testing to assess the impact of restructuring on financial performance, capital and liquidity in particular.

Some COVID-19 impacted debtors may still fall into NPL even after they have been restructured. Banks may need to conduct a second round of restructuring to ensure the soundness of asset quality. To anticipate further increases in NPL, banks have continued to build loan loss provision to Rp 237.4 trillion as of January this year, an increase of 40 percent compared to a year before.  

Economic activity is the main factor for an improvement in demand for loans. Unfortunately, economic recovery has been quite slow. Data on 2021's first quarter domestic GDP is released on Wednesday. Many expect the economy was still contracting in the last quarter because of surging daily COVID-19 infections, especially in January and February that has led to stricter rules on mobility and social distancing.

Hopefully, economic growth in the second quarter will begin to turn positive and demand for loans will also start to recover. Economic recovery will largely depend on continuous efforts to handle the pandemic, including vaccinations and the enforcement of health protocols.

Banks are much more optimistic in the second quarter. BI's latest banking survey revealed that banks were predicting much stronger loan growth in the second quarter. It showed that the weighted net balance increased substantially to 93.3 percent from 30.4 percent in the first quarter of 2021. A sharp increase is expected to come from consumer loans, both for housing and vehicle ownership, following a relaxation on down payments. Working capital loans and investment loans are also expected to grow higher supported by looser lending policy.   

BI and government stimulus policies should give banks some room to increase lending in some segments, particularly consumption and MSMEs. Credit quality in consumption loans, which include loans for home and vehicle ownership remains stable with the lowest NPL of 1.8 percent, compared to working capital and investment loans' NPL of 4.1 percent and 3 percent respectively. Hence there is opportunity for higher loan disbursement in those segments.

A credit guarantee scheme provided by the government for MSMEs and other certain type of loans will also support loan expansion in other segments going forward.

For loans to MSMEs, banks need to be more cautious due to their relatively higher NPL of 4 percent as of January 2021. However, some sectors in the MSME segment have good loan quality and better prospects of recovering sooner, such as agriculture, health and individual services. In the wholesale segment, agriculture and health services also have a stable and low NPL ratio.

The agriculture industry is expected to recover faster as commodity prices have strengthened due to increasing optimism about the recovery of export destination countries, such as the United States and China. For the health industry, we expect demand for health services and products to continue increasing amid the ongoing pandemic, especially related to COVID-19 testing and treatment.

Loan expansion and asset quality are both important during economic recovery after the worst economic downturn in more than 20 years. Increasing loan growth is required to accelerate economic recovery and to improve banks’ profitability at the same time.

On the other hand, we still have to anticipate the risk of increasing bad loans if the economy has not fully recovered yet from the impact of the pandemic. At this moment, banks may have to prioritize asset quality and targeting moderate loan expansion. Banks should consider carefully in determining, not just segments and sectors, but also individual borrowers that have good cash flows to prevent a sudden increase in bad loans.

***

Senior financial market analyst at Bank Mandiri

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