We are also quite optimistic that the third wave of the COVID-19 pandemic caused by the spreading of the Omicron variant will have only a temporary impact on people’s mobility and spending, as many countries have shown a very fast decline in daily infections caused by the variant. Pandemic handling has become more effective and at the same time vaccination, including the third dose vaccination, has accelerated. 

As we transition from pandemic to endemic, economic recovery acceleration will have a positive impact on the banking industry.

Last year was a relatively good year for banks, as many experienced quite remarkable income performances. The four largest banks that are in the Banks Based on Core Capital (KBMI) 4 group, Bank Mandiri, BRI, BCA and BNI recorded average net-income growth close to 100 percent year-over-year in 2021, boosted by higher operating profit as well as nonoperating profit. The banking industry’s loan growth improved to 5.2 percent last year, following a contraction of 2.4 percent in 2020.

We believe loan growth will continue to accelerate, as banking indicators are showing very strong and healthy conditions. Liquidity in the financial system is ample. Banks’ total funds placed in Bank Indonesia’s (BI) open market operation instruments reached more than Rp 900 trillion (US$62.96 billion) the end of last month, increasing by close to Rp 150 trillion in only one month.

Another indicator of the banking industry’s liquidity is that the loan-to-deposit ratio (LDR) also indicates very loose liquidity. By the end of last year, the banking industry’s LDR, recorded at 77.1 percent, was at its lowest level since January 2011, as third-party funds growth remained well above loan growth. Loans and third-party funds grew last year by 12.2 percent and 5.2 percent, respectively. It means that banks have plenty of money to be disbursed into loans.

The banks’ third-party funds growth is dominated by cheap funds or current account and savings accounts (CASAs) that pay lower interest rates relative to time deposits. In October 2021, CASAs grew 16.1 percent, the highest growth in more than eight years, while at the same time, deposits only grew 0.8 percent. As a result, banks’ costs of funds continued to decrease and interest expenses to third parties contracted significantly by 26.4 percent year-on-year (YOY) as of November 2021, pushing the net interest income to increase by 13.3 percent YOY.      

Abundant liquidity in the financial system was fueled by an ultra-accommodative monetary policy by BI, using an unconventional policy known as quantitative easing to fight the economic impact of the COVID-19 pandemic. Since the start of the pandemic, BI has been buying large amounts of government bonds to ensure liquidity in the financial system. BI’s ownership in government bonds has increased by more than five times since the start of the COVID-19 pandemic, from Rp 222 trillion in March 2020 to Rp 1.2 quadrillion at the end of January 2022.

As the economy begins to recover, BI is planning to normalize the extraordinarily loose policy and will begin to reduce liquidity by gradually increasing the banks’ reserve requirement ratio starting next month. The ratio will gradually increase from 3.5 to 6.5 percent for conventional banks and 5 percent for sharia banks in September 2022, which is expected to decrease liquidity by approximately Rp 200 trillion based on current third-party funds data. Liquidity in the banking system, even after this episode of increasing reserve requirements, will still be ample, at around Rp 700 trillion by the third quarter this year, and still sufficient for banks to boost loan growth. Historically, during normal periods the banks’ fund placement in the open market operation instrument was only around Rp 200 to Rp 300 trillion.        

On the other hand, other aspects of BI’s policy mix will remain accommodative as part of continuing efforts to accelerate economic recovery. The policy mix includes macroprudential policy, payment systems, financial market deepening and green and inclusive financial market development. Furthermore, BI provides incentives to banks that disburse loans or financing to priority sectors, micro, small and medium enterprises (MSMEs) and/or banks that fulfill the the macroprudential inclusive financing ratio target (RPIM) requirement. These incentives will start next month, so that banks can participate in the government’s target to boost growth in the priority sectors as well as MSMEs. Priority sectors including health, renewable energy, infrastructure, the digital economy and many other sectors. Banks that meet those conditions will be given relaxation in the form of a 1 percent reduction in the average rupiah reserve requirement.

However, nonperforming loans (NPLs) remain the biggest risk, especially with the Financial Service Authority’s (OJK) relaxation on loan valuation scheduled to end next year. Currently, consumer loans had the lowest NPL at 1.8 percent. Although NPL has declined, to 3 percent by the end of 2021, the outstanding restructured loans were still quite high. As of November 2021, the total loans restructured reached Rp 693.6 trillion, while nominal NPL and special mention loans were at Rp 182.2 trillion and Rp 263 trillion, respectively. Hence, the total amount of loans at risk in the banking industry, which include NPL, special mention and restructured loans in November 2021 was Rp 1.1 quadrillion (20 percent of total loans). NPL in business loans, including wholesale and MSME were still quite high. Wholesale and MSME loans’ NPL were at 3.5 and 4.3 percent respectively as of November last year. There is still a possibility that the special mention and restructured loans could fall to NPL if the economy does not recover as strong as expected.

Therefore, banks still need to build up sufficient loan loss provisions to anticipate worsening loan quality. With the asset quality remaining under control and loan growth increasing, banks will have a very good period in the years ahead amid policy normalization.

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Senior Financial Market Analyst at Bank Mandiri

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