Banks Must Act Countercyclically to Fight Coronavirus

KOMPAS/TOTOK WIJAYANTO

Bank Indonesia (BI) Governor Perry Warjiyo (second right) accompanied by BI deputy governors (left to right) Rosmaya Hadi, Destri Damayanti and Erwin Rijanto, prepare to answer reporters’ questions on the results of the BI Board of Governors\' Meeting in Jakarta on Thursday (20/2/2020). BI again cut its benchmark interest rate by 25 basis points, pushing the rate down to 4.75 percent, amid threats to global economic growth due to COVID-19.

Banks function as intermediaries matching people who have a lot of funds with those who need them. As an economic actor, each bank has its own profit-seeking motive and risk preference that affect the allocation of funds it raises. This motivation can lead to a suboptimal performance of the real sector.

Banks can also be too conservative to avoid risk, meaning they only follow economic cycles in what is known as a procyclical approach. That way, they cannot play a role in influencing the economic cycle.

The conservative nature of the banking system reflects in gross domestic product (GDP) data over the 1984-2018 period. The data show that economic growth moved slightly faster than banks, with a lag of at least three months. Thus, the economic outlook is a reference for lending, and not vice versa. This approach is called procyclical. Two weeks ago, as a countercyclical measure against the impact of the COVID-19 outbreak caused by the new corona virus on the economy, Bank Indonesia lowered its benchmark interest rate to 4.75 percent.

The interest rate cut is usually immediately followed by a decrease in deposit interest rates. This decline in deposit interest rates drives the shift in funds from deposits to savings and does not necessarily lower the lending rates.

The increase in savings then pushes up household spending, which drives economic growth. For banks, this shift reduces the cost of funds, thereby increasing their net interest margin (NIM). An increase in the NIM will enable banks to extend more credit and allow banks to reduce lending rates. Banks can do this because the risk has already been divided in an increasingly broad credit or loan portfolio (Freixas and Rochet, 2008). Another factor causing the decline in lending rates is competition with other banks.

KOMPAS/LASTI KURNIA

Containers are being loading and uploaded at Operational Terminal 3 of Tanjung Priok Port in North Jakarta on Thursday (20/2/2020). Statistics Indonesia (BPS) noted that non-oil and gas exports and imports to and from China decreased in January but said the decline could not be entirely blamed on the outbreak of a new type of coronavirus.

What makes it slightly different is that fact that banks with types of transactions that bring in cheaper third-party funds (DPK) are more competitive, because they do not rely on interest instruments to attract the funds.

Such banks rely on services, convenience (with many branches), user-friendly online transactions and payroll services for institutional customers. This type of bank is usually more agile in lending and has the capability to fight the business cycle to attract a greater number of customers and deposits.

Data on banks in the Buku IV category (large banks) show that there are always certain banks that can individually pursue a countercyclical strategy during an economic slowdown. This strategy is pursued to expand in terms of customers and deposits in the hope that the economic situation will soon recover.

However, in the midst of an economic slowdown, banks must watch out for any possible deterioration of their loan portfolios. This may reflect in the decrease in loan quality from "current" to "special mention" and from "special mention" to "loss". If this happens, the bank will put the brakes on credit expansion in order to keep the loans at risk (LAR) from continuing to increase. This is the natural instinct of banks, and it is a procyclical one.

KOMPAS/Lasti Kurnia

A man walks in front of screens displaying stock prices at the Indonesian stock exchange in Jakarta on Monday (2/3/2020). After the government announced that two Indonesian citizens had tested positive for the coronavirus, the main stock market index fell to 5,361 points at the close of trade on Monday (2/3), down 1.68 percent from last week\'s close.

The role banks

The performance of subsidized small business loans issued under the KUR program in 2015 showed that banks have the ability to not be too conservative in the risk they take on, because the funds are guaranteed.

Based on one variant of the household production model (Huffman, 2010), small businesses have the potential to consume and tend to invest more than the formal sector. This policy can help micro-, small- and medium-scale companies (MSMEs) solve capital constraints for both working capital and business expansion. This also gives banks the potency to mobilize third-party funds now and in the future.

On the demand side, meanwhile, the government is pursuing a countercyclical strategy to compensate for the slowdown in tourism and trade due to the impact of the COVID-19 outbreak. It does so through the provision of financial stimuli.

KOMPAS/HERU SRI KUMORO

Ari Kuncoro

The steps are taken by reallocating government spending and shifting consumer spending by people from all walks of life to transportation, hotels and restaurants as well as more generally to the key tourism regions. The government can also effect a shift in spending from official overseas travel to domestic destinations to compensate for the decline in foreign tourists.

To deal with the shift in demand, the quality of goods and services in the regions must be improved, which requires increased capacity of hotels and restaurants as well as garment and handicraft-makers. One way to achieve this is to extend credit to MSMEs, without abandoning principles of prudence.

ARI KUNCORO, Rector, University of Indonesia