Banking sector has yet to fully recover, says B

Despite major improvements over the past few years, the country's banking sector has yet to fully recover from its worst crisis in living memory 10 years ago, the central bank's governor says.

During a hearing with the House of Representatives' finance commission late Thursday, Bank Indonesia Governor Burhanuddin Abdullah said the fact that the banking sector had yet to fully recover could be seen from the banks' inability to reduce their deposit rates in line with the central bank's benchmark rate.

"The BI rate should be lower than the deposit rates," he said. However, the reality was that most bank deposit rates were still lower than the central bank's key rate, so that many banks preferred to place their idle funds in central bank SBI notes rather than converting them into loans.

With inflation having eased considerably this year, the central bank earlier this month trimmed its reference BI rate by a quarter percentage point to a two-year low of 8.25 percent, continuing the series of rate cuts that started last year when the BI rate stood at double-digit levels.

Despite BI's rate cuts, the deposit rates offered by the major banks remain lower than the reference rate. For example, Bank Mandiri, Indonesia's biggest lender by assets, offers deposit rates of between 6.25 and 7 percent, while Bank Central Asia (BCA), the second largest bank, offers rates of between 6 and 7 percent.

BI's latest quarterly survey on the banking industry found that the average deposit rate stood at some 7 percent, and average lending rates at between 14 and 16 percent.

The banks also set their deposit rates having regard to the Deposit Insurance Agency (LPS)'s ceiling rate for guaranteed deposits, which basically follows the BI rate trend. The agency lowered its ceiling rate Thursday to 8.25 percent, and extended its duration to three months up until September to allow more time for the banks to adjust both their deposit and lending rates. The duration of the ceiling was previously set at only one month

Burhanuddin said that BI could not cut its key rate drastically as this would affect investor interest in rupiah-based assets. This was particularly true at a time when other central banks around the world were either increasing or holding their reference rates steady. The U.S Federal Reserve last month held its key rate at 5.25 percent after previously lowering it.

Too large a rate cut, Burhanuddin said, could cause volatility in the rupiah, similar to what had happened during the 1997-1998 financial crisis, which would in turn fuel inflation and could force BI to increase interest rates again.

"That's why we will always be prudent with our monetary policy, and not lower the rate by more than 25 basis points at any time," he said.

Given lower inflationary expectations, the BI rate could come down to 8 percent or even less by the end of the year.

BI expects the banking sector to be able to continue increasing lending by as much as Rp 150 trillion (US$16.6 billion) by the end of the year, which would translate into lending growth of between 18 and 20 percent. Lending growth came in at only 14 percent last year.

Separately on Friday, Coordinating Minister for the Economy Boediono said the government would do all in its power to prevent sudden capital flight of portfolio investments, and try to redirect these investments so as to benefit the real sector through the offering of incentives to encourage more initial public offerings and the buying of government bonds.

"Companies making share offerings can use the funds raised for business expansion, which will create more jobs and income. The proceeds from government bond sales, meanwhile, can be used to fund infrastructure development," he said. "One remaining problem is the central bank bill question as these bills mostly attract idle funds."