Determinants of Interest Rate for Industrial Loan in Indonesia Rina Indiastuti Since Indonesia experienced the economic crisis in 1998, banks are more prefer to disburse consumer loans than loans for investment and working capital. The higher economic growth in some previous years actually requires capital which are needed by companies in expanding their production capacity. The banks have a challenge to response the demand increase in credit with lowered its interest rate. Data shows the loan interest rate was gradually decreased although the level is still relativley higher than other ASEAN countries. A large number of commercial banks in Indonesia hopes the increase in competition that will result the more efficient bank in terms of lower loan interest rate. State owned banks are the four of ten largest assets which are expected to be able to decrease loan interest rate due to economies of scale and scope. The another large private banks have a capacity to mobilize a cheap funding from private sector due to differentiation strategy. Both of them absorb the certificate of Bank Indonesia (Central Bank) as one alternative of funding placement for increasing the interest income. The Behaviour of both state-owned and private-owned banks increased the portion of funds to certificate of bank indonesia which be proved to be able to reduce loan supply for industry. It also impacts the reduction of loan interest rate is going slow. This paper examines the factors behind the slow decrease in interest rate for loan of industry. Empirical evidence is somewhat the state owned bank as a development agent have a constraint to lowering loan interest rate comparing with private owned banks. However, both of state owned and private owned banks use instrument for placement their funds with certificate of Bank Indonesia as an alternative funding placement which have the impact on loan pricing. On the other side, expensive funding resulted the loan interest rate moving down slowly. The implication is that the large banks need to be pushed to be able collecting cheap funds as a source of loanable funds. In practical way, doing banking business not only have to be able to focus in loan disbursement, but also capable of offering various products for ease of transaction for getting cheap funding. Field of Research: loan interest rate, ownership, commercial bank. 1. Introduction Recovery of Indonesia s economic growth in last five years, is indicated by the necessity of larger investment, including investment funds source from banks. There are normative terms of capital needed in large quantities and should ideally be offered by commercial banks with relatively low interest rate. Total of commercial banks in Indonesia in 2011 is about 120 banks. The sign is the tight competition among banks and hope the competition will result the more efficient bank in terms of lower interest rate in credit. Real interest rate in Indonesia is relatively higher than other ASEAN countries. In 2011, capital work loans interest rate is approximately 9-14%. This number has decreased from 2009, which is 1 Rina Indiastuti is a Professor in Economics, Department of Economics, Padjadjaran University, Indonesia
approximately 12-15% (chart 1). The large-scale of commercial banks, especially foreign banks, can offer lower interest rate. From the available statistics, it is to note that the level of borrowing interest rate among banks is not the same; it depends on the funding condition and its distribution. Chart 1: Trend of Decrease in Bank s Interest Rate for Loan 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 - I II III IV I II III IV I II III IV I II III IV I II III IV I II 2006 2007 2008 2009 2010 2011 State owned banks Regional Development Banks Private owned banks Foreign and joint banks The interesting point is that the most banks could not push determination of interest rate with small differences yet. Like in theory, that high competition will encourage to form the small price variation. However, the large size of credit market in Indonesia have not been able to force interest rates move convergent. The differences in size of banks caused the difference in interest rate. Chart 2 illustrates the difference in loan interest rate that is influenced by size of banks. Banks with greater asset are able to offer lower interest rate, in line with the concept of economies of scale and scope. The asset increased for both state owned and private owned banks in subsequent years but the increase was sharper for state owned banks. The improvement seems to have been achieved due to a decline in interest paid. The interest rates declined for both types of banks. According to chart 2, the loan interest rate declines as bank s total assets increase. The reason is that larger banks are able to accumulate cheap funds, which will decrease interest rate. They also have ability to apply value chain of business banking, that can increase fee based income. This means those banks are more capable to accumulate cheap funds by saving deposits. 2
Aset (Billion IDR) Interest rate (%) Chart 2 : Bank Asset and Loan Interest rate for Private owned Banks 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 - Assets Interest IV IV IV I II 2008 2009 2010 2011 18 16 14 12 10 8 6 4 2 - To improve financial performance in line with the increase in total asset, banks have alternative way to allocate the funds, either for credit supply or securities placement in money market. The alternative that more preffer is placement their funds for Bank Indonesia (central bank) certificate. This instrument is made by central bank to control the money supply, and as source of revenues for commercial banks. The intensity of placement funds for Bank Indonesia (central bank) certificate varied among banks. The portion of its funds to total asset was ranged between 5% up to 30%. The greater portion of this will complicate banks in loanable fund offering, especially for industrial loan that have higher credit risk comparing with consumption credit. The constraints faced by banks to extend industrial loan is a relatively high credit risk especially many banks lack the experience in the industry credit penetration. This resulted in the offering credit interest rate for industry is higher than consumer credit. Another thing, the placement of funds in a bank certificate of Indonesia is a reasonable alternative to profit As far as the determinants of short term interest rate are concerned, the basic question in the paper is whether they are determined by market forces. If market forces determine short term interest rates, then its necessary to know of the supply of and demand for money in credit market. This discussion is focus on what kind of challenges that banks have to decrease interest rate loans in response to rising demand for credit in a situation of high economic growth. There is a hope that large banks, especially state owned banks as development agents, are able to decrease interest rate faster than other bank. The ability of large banks to mobilize saving deposits should be able to offer lower interest rates for credit. 2. Literature Review Borrowing and lending in financial market depend to significant extent of interest rate. In economics, interest is a payment or price paid for use of loanable fund. The interest rate is determined by the monetary forces of demand and supply (Keynes, 1936, 2007). In monetary theory, the short run interest rate is the cost of borrowing money and selling securities, and the yield on lending money and purchasing securities 3
(Greenwald, 1981). Monetary policy adopted by central bank of Indonesia such as changes in interest rate regarding the control in money supply. Another instrument of monetary policy that used by the central bank of Indonesia is the offering for placement of bank s funding with certificate of Bank Indonesia. This instrument is as a monetary policy to control the amount of money supply, which also has effect on credit supply The government has implemented certificate of bank indonesia instrument as a monetary policy to control the amount of money supply, which also has effect on credit supply. This certificate is bank to grow their money without risk because banks will receive their money plus all accrued interest. There are varied interest rates in the financial market and they do not always move in the same extent. There has some factors in determining interest rate levels in the long run. In the macro level, these are state of economy, monetary policy, inflation expectation, and government budgets. For banking institution, the short run interest rate was determined by macro economic indicators and market factors. Gupta (2011) explained that the bank ownership can characterize the behavioral supply in funding placement either in loan or in securities. The commercial banks in Indonesia now have a financial dealings with businesses, individuals, and capital markets. Financial dealings with businesses or industry that provides loans, credit, savings and checking accounts. On the bank s asset side, the large portion of funding placement in Indonesian banks consists of placement with Bank Indonesia (central bank) certificate, placement with other banks, government bonds, and loans. In the demand side, the funding placement for credit depends on the prospect business and industry. The increase in Indonesian industrial growth in previous years needs large amount of capital from bank as well as financial market. It is to say that banks has an opportunity room for choose the kind of funding placement in purpose to increase in bank income. The net interest income differs between Bank Indonesia certificate and loans. The pricing of loans was influences by the price of funding source especially from deposits, and its price was also reffered to the competitor price. However, the measure of interest rate for Bank Indonesia certificate was decided by Bank Indonesia as a Central Bank. 3. Methodology and Research Design The research purpose is to investigate the determinants of interest rate for industrial loan in Indonesia. The study was conducted in ten largest commercial banks, focussing on theoretical implication that more large bank size can change the interest rate caused by economies of scale and scope. There has 120 commercial banks in Indonesia by November 2011 with total assets of IDR 3.471 billion. According Indonesian Banking statistics, 10 largest banks accounted 66,20% the portion to total assets. The name and its portion of each banks are PT Bank Mandiri (14,32%), PT Bank BRI (13,43%), PT Bank BCA (10,69%), PT Bank BNI (7,70%), PT Bank CIMB Niaga (4,62%), PT Bank Danamon (3,67%), PT Bank Pan Indonesia (3,22%), PT Bank Permata (2,80%, PT Bank BII (2,49% and PT Bank BTN (2,77%). The 10 banks consist of 4 state owned banks and the rest of foreign exhange private owned banks. 4
Data of interest rates, assets, and placement in certificate of bank indonesia are provided by each bank financial report. Data from 10 large banks will be used because they have similar supply force, so that the demand for industrial loan can be responded by large banks with competitive interest rate. The data are quaterly measure during 2009-2011. We regress all independent variables on interest rate for industrial loan using two models. First, we want to know if the ability of banks accumulate cheap funds, which is measured by interest rate for saving deposits, will be followed by cheaper interest rate loan offering. Bank behavior on placement of their funds with certificate of Bank Indonesia is suggested to affect loan interest rate formation. Other variables is ownership variables, with expectation that state owned banks, as development agent, are not excited to offer lower interest rate for industrial loan. The second model is used to prove whether behavior on placement of their funds with certificate of Bank Indonesia is apply generally for both state-owned and private-owned banks. 4. Discussion of Findings During the liberalization period a more easy entry of private and foreign banks was allowed, as a result of which the total amount of their banks assets in the industry increased at 2,54% during 2008-2011. Nevertheless, the Indonesian banking industry remains predominantly nearly 34,88 % assets belonging to 4 state-owned banks. There has a variation between the level of loan interest rate and placement of funds in certificate of Bank Indonesia for every bank for both of state-owned and privateowned banks can be seen in Table 1. Lending rates offered by private banks more competitive than state banks. However, the magnitude of the funding placement with certificate of Bank Indonesia among private-owned banks varies greatly between one to another. Table 1 The Statistics of State-owned and Private-owned Banks Stateowned banks Interest rate for Industrial loan (%) Privateowned banks Ratio certificate of Bank Indonesia to Assets (%) Stateowneowned Private- banks banks Average 13,35 12,17 9,99 11,60 Maximum 15,53 15,46 22,27 23,40 Minimum 11,12 9,97 4,39 3,25 Descriptive analyses of data results some main points. (1) In the same size of banks, state-owned banks are highly competing with private-owned banks. They were competing in saving deposits collection. Interestingly, the interest rate of saving deposits continued to fall down, compared to interest rate of certificate deposits. Larger banks are able to increase economies of scope by expanding variety of products and services, so the customers are willing to save their money with lower interest rate. 5
(2) To improve the profits, large-size banks are also relying on certificate of Bank Indonesia as interest income source. This is become alternative way for bank s funds placement of industrial loans. However, the larger portion of the placement of funds to certificate of bank Indonesia will reduce the morale of the credit channel. This will reduce credit supply availability, so that loan interest rate is slowly fall down compared to reduction in interest rate of deposits. (3) Indonesia economy keeps growing and that is as loan demand factor. Banks currently do not consider the magnitude of the demand for credit in the loan interest rate setting decisions. From that descriptions, it can be designed econometric model to explain interest rate determinant of interest rate for industrial loan. We regress these loan rate averages on independent variables representing interest rate for saving deposits, placement bank s fund for Bank Indonesia certificate, ownership, and economic growth. For the purpose whether the behavior of state owned banks differ from private owned bank, the model adds interaction variable of ownership and placement bank s fund for Bank Indonesia certificate. The regression results are reported in Table 2. The cheap funds measure, as proxied by interest rate of saving deposits has the proper sign in both regressions and significant in the loan interest rate regression. The bank decision in placement bank s fund for Bank Indonesia certificate has the proper sign and significant in the first regression, although it is not significant in the second regression. The ownership also increase significantly with loan rates charged by state owned banks, but insignificant when we concerned bank decision in related with placement bank s fund to Bank Indonesia certificate. In both regressions, economic growth as a proxy of loan demand factor is positively insignificantly correlated with loan rates, especially for industrial loans. One explanation for the reason is that loan demand factor is not yet as a bank concern in charging the loan interest rate. It is reflecting the need for better economic growth quality such that industrial loans require a lower premium for default risk. Most important from our point of view is the generalization behavior for both large size state owned and private owned banks. They are still preferred to placement their fund to certificate of Bank indonesia that have a positive relationship with loan price, suggesting that greater the portion of certificate of Bank Indonesia on assets leads to higher loan rates. 6
Table 2 Determinants of Interest Rates for Industrial Loan Variable Model 1 Model 2 Coef t-stat p-value Coef t-stat p-value constant 4,26 1,34 0,19 6,12 1,51 0,14 Interest rate for 3,57 3,18 0,00 3,34 2,85 0,00 saving deposits Placement of bank s 0,09 1,69 0,09 0,03 0,35 0,72 funding with central bank certificate Dummy of 1,20 2,27 0,03 0,16 0,10 0,91 Ownership Economic growth 0,32 1,06 0,29 0,19 0,52 0,60 Dummy*Certificate of bank indonesia - - - 0,09 0,75 0,46 Note: The dependent variable is the quarter of the industrial loan rate of largest banks. The sample consists of 10 largest banks for the years 2009 to 2011. Placement of bank s funding with certificate of Bank Indonesia as a its ratio to bank s total asset. The proxy of ownership used dummy variable 1 for state-owned banks and 0 for otherwise. We view loan interest rate as slow market process endogenously equilibrating an independent for supply factors, not for demand factor. We find out loan interest rate determination was concerned on internal bank condition such as ability to collect cheap funding and the portion of funds placement in credit. Loan interest rate do adjust with the supply of savings deposits, but do not adjust to equilibrate demand for capital. Theoretical implication is larger size of loan market that can be entered by any banks, despite facing tough competition from market segment penetration with different packaging services with one another. This condition could make difficulties in reduction of loan price. However, banks with large asset are able to operate with economies of scale as well as scope. So that they are able to offer loan with competitive price. 7
5. Conclusion In explanation of the theory of the firm, if using input with competitive price, the cost of production will be efficient. This applies to explain the determination price of loans that are significantly influenced by the price of deposits obtained. The level of interest rate for industrial loan is influenced significantly by price of saving deposits. Implication of this study is the necessity for banks in Indonesia to improve their intermediate function as a business banking. That means business persons will need their bank providing products and services based on both of the assets and liabilities side. The Indonesia central bank s effort to encourage commercial banks to reduce the price of loan along with the increasing ability of accumulating deposits, turned out has difficulties in monetary instrument offering in the forms of funds placement to certificate of Bank Central. The increase in the portion of the amount of central bank certificate to assets leads in reduction of credit supply and will complicate the reduction in loan price, that occurred both in state-owned and private-owned banks. This study can explain the supply factors that are still important considerations for bank in determining loan price. Demand factors is currently not a concern of banks in indutrial loan pricing. References Bank Indonesia., 2009-2011, Indonesian Banking Statistics, Jakarta. Kai Guo, K., and Stepanyan, V., 2011, Determinants of Bank Credit in Emerging Market Economies, IMF Working Paper. Greenwald., 1981, Encyclopedia of Economics, New york, Mc. Graw Hill. Gupta., Kochhar, K., and Panth, S., 2011, Bank Ownership and Effects of Financial Liberalization: Evidence from India, IMF Working Paper. Keynes, John Maynard (2007) [1936]. The General Theory of Employment, Interest and Money. Basingstoke, Hampshire: Palgrave Macmillan. Hannan, T, H., and Berger, A.N., 1991., The Rigidity of Prices: Evidence from the Banking Industry, American Economic Review. Update: 1-2-2012 8