Rising Numbers of Non-Performing Loans Need to be Worried About

A report from a magazine shows an indication of an increase in non-performing loans (NPL) in national banks. According to the latest report of the Financial Services Authority (OJK), NPLs increased from 2.7 percent in 2015 to 3.1 percent in 2016.

Technically, the NPL classification is differentiated according to the length of the delay in the installment until the loan is completely not paid. The NPL figure above is gross, or the ratio of the problem loans to the total value of bank loans.

The NPL in 2016 was 3.1 percent of the total bank loans, which in January 2017 amounted to about Rp 4.31 quadrillion. Thus, the value of the NPL of the national banks amounted to Rp 134 trillion at the beginning of 2017.

The report said that most of the problem loans occurred in the commodities sector, such as mining and especially coal, after the end of the commodities boom in 2015 and in the infrastructure sector.

The bad loans in the infrastructure sector have received special attention because the economic program of President Joko “Jokowi” Widodo’s administration put special emphasis on the development of infrastructure. The NPL in the infrastructure sector is higher than the average, reaching 4.51 percent in January 2017, although that in the mining sector is higher at 6.29 percent.

Another thing that put it under the spotlight is that in 2016 six of the 10 largest banks reported an increase in their NPLs and most of the banks say that NPL is one of the biggest challenges for banks in Indonesia, in addition to economic and trade growth and sources of funding.

Does the level of NPLs of 3.1 percent need to be feared, in the sense that it could endanger national economic stability? What are the causes of the NPL and what should be done so that they would not become the source of instability or even crisis?

More prudent

Perhaps, many have argued that despite the increase in NPLs, the figure of 3.1 percent is relatively small and does not need to be worried about. For the authorities, usually for officials who manage the real sector, the main target is economic growth and anything that supports economic growth, including funding. That is something that should come first, while the risks come afterwards.

The funding certainly includes bank loans. In the economic approach, financing through bank credit is healthy and can be accounted for. Indonesia\'s borrowing rate is still relatively low compared to those in many other countries in the world. In many other countries the leveraging ratio is higher than 100 percent. It means the NPL figure of the national banks remains safe.

Perhaps, many people are also pleased to hear the opinion of Robert F. Engel, the recipient of the Nobel Prize in Economics in 2003, who last February delivered a speech at Atma Jaya Catholic University in Jakarta. Engel, as quoted in the media, argued that Indonesian banks were too cautious in their lending, although their capital was in very good condition. He said that Indonesian banks should instead give more credit to boost growth.

As a person who still has to face criticism over the handling of the monetary system during the financial crisis in 1997, I would side with the opinion that said that the NPL needs to be worried about. I also did not agree with Engel\'s comments.

The Indonesian experience in the last financial crisis, the Asian financial crisis in 1997 and1998, should be taken as a valuable lesson for the future in handling NPL problems.

The Asian financial crisis made Indonesia, which had previously been part of what the World Bank called (in a report in the early 1990s) the "Asian miracle", the hardest hit economy in the world. In fact, the crisis resulted in the resignation of president Soeharto.

However, like other emerging Asian economies, Indonesia was able to learn from past experiences, though not smoothly. In facing the impact of the world financial crisis in 2008, Indonesia has not only survived the crisis, but also quickly revived and grew, although at lower rates during the Great Recession until today – an era of slow recovery known as the era of the new normal.

For those who study the issues of the financial crisis, I also distinguish the epicenter and the periphery of the financial crisis. Like an earthquake or tsunami, the damage caused to the epicenter is always heavier than on the periphery.

The Asian financial crisis originated and evolved in Asia and the epicenter was also in Asia. Indonesia was part of that. In the global financial crisis, the epicenter was in the United States and Europe, while all Asian economies, including Indonesia, were on the periphery. Therefore, no matter how big the power of the global financial crisis, the biggest damage was in the epicenter.

The above statement does not diminish the efforts made by stakeholders who proved the toughness, endurance and adaptability of the Asian economies, including Indonesia\'s economy, in facing the volatile global financial crisis.

The financial condition of the national banks are shown in the data and information about bank capitalization in which the capital adequacy ratio is still much higher than the more than 20 percent that is required. The funding resources are much more robust than shown by the amounts of deposits, non-interbank loans, better exposure against the risk of mismatches, maturity, hedging activities and an improvement in banking management in general, including the compliance to prudent policies.

Ratio of loans

The authorities, with the abandonment of the exchange rate regime that was previously pegged to the US dollar, are now more flexible. The central bank is more independent. Exchange reserves have increased. There is a stronger supervision system and a more stable financial industry with the establishment of the Financial Services Authority (OJK) and the establishment of protocols to handle financial crisis. All indicate the strong resilience of the financial and banking sector in facing uncertainties in the world.

All stakeholders in the financial and banking sector in Indonesia, like in other Asian countries, have learned a lot from the experience in the Asian financial crisis as indicted in my brief review above. All this explains why the Indonesian financial and banking sector was much stronger when the global financial crisis hit the national economy, including the global uncertainty that seemed to accelerate until now.

All the success was possible only because of efforts made by all stakeholders – both the banking industry and authorities – in the financial and banking sector. Unfortunately, people often underestimated such achievements and there was also often less proportional claims from certain groups of stakeholders. However, what is actually the relation between the narrative above and the rising NPLs is the theme of this article.

The amount of NPLs, of course, is closely related to the amount of bank lending in the economy, how lending policy is determined and how the economy is running. The amount of public or government loans usually determines the magnitude of the NPL when the economic conditions are worsening.

However, the NPL could disappear by itself if the economy grows and thrives. However, sometimes it may worsen and even develop into a financial crisis.

On the one hand, it is not wrong to say that NPL of 3.1 percent is safe. However, it is not wise to give it less attention and neglect it, or to underestimate the situation, especially during rising uncertainties in the world and in our own economy today.

What is more certain is that the study of the financial crisis, which is constantly growing in the world these days, indicates that the amount of the loans in an economy or leveraging, which is measured by the ratio of loans to GDP, can determine the level of instability of an economy in the future.

An economy with high leveraging will be more severely hit when there is a crisis and the recovery process will take longer than those with smaller loans. The call to be aware of the increasing trend of the NPL ratio should be addressed by governments, monetary authorities and regulators, as well as with supervision by financial institutions, the banking and financial industry and the business world.

I put it in a broader context in order to be aware of the level of leveraging, the amount of the national loan to GDP ratio. Various indicators show short-term corporate loans have increased steadily lately. We must recognize the lessons of the past that I described earlier and translate them into a sort of adage that all have the limits, including the leveraging rate. All must learn to read the signs, even the slightest. Although they have yet to show a yellow light, the rise in the NPLs is one of the signs that we need to worry about.

J Soedradjad Djiwandono

Emeritus professor of economics, the University of Indonesia, and a professor of international economics at the S. Rajaratnam School of International Studies, Nanyang Technological University, Singapore