Are Indonesian Banks Resilient Amidst Rising Interest Rates?

An unexpected fallout of the rising interest rates in the U.S. was the closure of American banks with significant bond portfolios, such as Silicon Valley Bank (SVB) and Signature Bank. In SVB’s case, the bank had to sell its bond portfolio at a deep discount to cover a surge of deposit withdrawals that generated a loss, depleted the bank’s capital, and ultimately led to its closure.  

Like in the U.S. and elsewhere, interest rates in Indonesia have been rising and Indonesia’s leading banks hold sizeable government bond portfolios. Is this a cause for concern?  

Indonesian banks have traditionally held government bonds as assets. During the COVID-19 pandemic, the Indonesian government increased the supply of bonds by issuing a significant number of them to fund vaccination and economic stimulus programmes. At the demand end,  Indonesian banks were saddled with rising non-performing loans (NPLs) and had to restructure a large portion of their problematic loans. They grew their assets with lower-risk government bonds. Bonds currently account for about 14 per cent of total bank assets (Figure 1).

Indonesia’s central bank, Bank Indonesia, has raised its benchmark 7-day repo rate in phases from 3.5% to its current 5.75% since August 2022 (Figure 2 below). Its policy goal has been to control inflation and strengthen the rupiah’s exchange rate (at the time of writing, the exchange rate is Rp15,296/US$1; for comparison, the 2023 budget set the rupiah exchange rate as Rp14,800/US$1). As a result of the rising interest rates, the value of the banking sector’s Available for Sale (AFS) bonds, on their books, was adjusted downward. This in itself is not a worrying trend unless there is a serious liquidity crunch, which would force banks to sell these bonds at a significant loss.

In sum, Indonesian banks are relatively less exposed to the technology industry and have large capital bases with ample liquidity.

In Indonesia, with soft post-pandemic recovery and loans growing slower than expected, there was considerable market liquidity. Most banks were able to hold on to their government bonds while waiting for interest rates to decline, which would allow bond prices to recover. The banking sector’s loan-to-deposit ratio (LDR) remained at a low 80 per cent in the first half of 2023.

In the case of America’s SVB, there were other forces at work that led to the massive deposit withdrawals, which forced the bank to liquidate its bond portfolio at a loss. SVB had a large component of corporate depositors, whose sizeable deposits often exceeded the portion guaranteed by the government. The bank also largely serviced the technology sector, which was going through layoffs and restructuring. This eventually led to rising depositor concerns and deposit flight to safer banks. Digital banking services have made withdrawing funds easy and fast: the speed at which initial deposit outflow quickly snowballed from a trickle into a bank rush caught many by surprise. This also raised concern about the ability of bank management, in this digital age, to react quickly enough to address digitally-driven outflows.

Unlike in the SVB case, however, there is considerably less risk of Indonesian depositors initiating a bank rush that will cause a liquidity crisis. For starters, most deposits are from small individual depositors, where the average deposit is small enough to be covered by a state deposit guarantee scheme. In Indonesia, this guarantee covers up to Rp2 billion (about US$130,000) per customer deposit. 

Another difference is Indonesian banks’ high capital adequacy levels, which stand at 25 per cent, reflecting a sufficient cushion for earnings volatility. In contrast, U.S. banks’ capital adequacy levels stand at just 15 per cent.

Given these key differences, earlier concerns over Indonesian banks have since subsided. In sum, Indonesian banks are relatively less exposed to the technology industry and have large capital bases with ample liquidity. Thus, Indonesian banks will likely remain resilient amidst rising interest rates. Nevertheless, Bank Indonesia should continue to monitor the development of digital banking with the view of ensuring that the banking sector’s resilience does not fade.

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