Silicon Valley and Our National Banking
BI and the OJK should continue to increase surveillance. BI should conduct periodic and non-periodic stress tests to measure how healthy commercial banks are in a certain period.
Global business eyes are currently observing the downfall of Silicon Valley Bank (SVB) headquartered in Santa Clara, California, the United States.
SVB used to focus on providing credit for start-ups in the technology sector. How are we supposed to dismiss the implications of the SVB case on national banking?
The bank, which was founded in 1983 as a commercial bank, had total assets of US$212 billion as of quarter 4 2022. The bank accepted deposits and channeled credit and provided treasury management, international banking, asset advisory, online banking, foreign exchange, trade finance and other services.
SVB's collapse prompted the bankruptcy of cryptocurrency business specialists Silvergate Bank, which went into liquidation as a result of poor risk management, followed by a rush of massive withdrawals of bank deposit. Another crypto specialist Signature Bank was also shut down by US banking authorities. It means three banks in the US collapsed in just a week.
How are we supposed to dismiss the implications of the SVB case on national banking?
What have the local authorities done? The US’s central bank the Federal Reserve, the Finance Ministry, and the Federal Deposit Insurance Corporation (FDIC), the latter acting as guarantor for bank customer deposits as Indonesia’s Deposit Insurance Corporation (LPS) does, have issued a joint statement that SVB customers can still access their savings and the authorities will not use taxpayers' funds to return their money.
The Fed has introduced the Bank Term Funding Program (BTFP), which provides $25 billion in reserve, the equivalent of Rp 384.27 trillion. BTFP allows banks to borrow funds from the central bank by using their government bonds as collateral valued at par or 100. The Fed states BTFP can be an additional source of liquidity for banks that are facing bond price stress (bloombergtechnoz.com, 13/3/2023).
Strong measures
What are the implications of the SVB case for national banking in Indonesia? What are the effective steps to ward off these implications? First, let's observe the performance of commercial banks.
Data at the Financial Services Authority (OJK) show credit grew 10.53 percent year-on-year (yoy) to Rp 6,310.88 trillion ($411.21 billion) from January to February. The credit growth, which fell slightly from 11.35 percent as of December 2022, was pushed by investment credit and working capital, which increased 12.61 and 10.03 percent respectively.
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Third party funds (DPK) grew 8.03 percent to Rp 7,953.8 trillion as of January, down from 9.01 percent in December 2022. This growth in the DPK mainly boosted by giro. As a result, the loan to deposit ratio (LDR) rose to 79.34 percent, which hovered in the middle of the 78-92 percent limit.
At present, the SVB case will not have an impact on the national banking sector due to the solid banking liquidity. This can be seen in the ratios of liquid assets/non-core deposits and liquid assets/DPK, which are maintained at 137.67 and 31.20 percent, respectively. The ratios are above the thresholds of 50 and 10 percent, respectively.
What does it mean? Commercial banks can be said to be healthy with moderate credit growth rates. Credit growth in the national banking seems to be neither aggressive nor slow after having been slapped by the Covid-19 pandemic for more than two years.
Second, the SVB case definitely is an early warning for banks. They need to raise capital even though the bank's capital position is currently getting stronger, reflected in the capital adequacy ratio (CAR), which strengthened to 25.93 percent as of January from 25.63 percent in December 2022.
Why should banks continue to increase capital? It is because capital plays the crucial function to absorb various potential credit, market, operational and liquidity risks. Banks endure liquidity risks up to even bankruptcy when under stress from large-scale withdrawal of deposits by customers (bank run). That's what happened to SVB, despite it being the 16th largest bank in the US.
That is why capital is crucial. Minimum capital is required as a buffer, by which a bank can absorb any losses from deposit withdrawals. The Basel Committee has agreed to institutionalize a capital buffer above the minimum. There are two types of capital buffers, namely a capital conservation buffer and countercyclical buffer (Thomas F Huertas in his book Crisis: Cause, Containment and Cure, 2011).
A capital conservation buffer is additional capital that functions as a buffer in the event of a loss during a crisis period. The buffer against cyclical risk is additional capital to anticipate losses in the event of excessive credit growth that carries the potential to disrupt financial system stability.
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In this regard, through Regulation No. 12/POJK.03/2020 concerning consolidation of commercial banks, the OJK increased the minimum core capital for banks gradually to Rp 1 trillion on December 31, 2020, Rp 2 trillion in 2021 and Rp 3 trillion in 2022. Regional development banks (BPD) should fulfill this minimum capital requirement no later than 31 December, 2024.
Core capital refers to the entire capital owned by a bank to carry out business activities. Consisting paid-up capital plus profits after tax, core capital greatly determines the breadth and scope of a bank's business activities. The stronger the core capital, the wider the bank’s business scope. The smaller the capital, the more limited the range of bank business activities.
Third, it is time for the LPS to consider increasing the deposit guarantee amount from Rp 2 billion to Rp 3 billion per customer per bank, not only to increase market confidence in national banks but also to anticipate against the excess in the face of global economic uncertainty.
Banks are required to maintain NOP at the end of each working day at a maximum of 20 percent of the capital.
No policy on resolution measures is successful without commitment to full deposit guarantee, at least at a specified ideal amount. Thus, a solid deposit guarantee, being liable to pay insured deposits in the event of a bank failure, is essential for a sound financial system.
Fourth, the net open position (NOP) was recorded at 1.5 percent as of January, up from 1.23 percent in December 2022, which was far below the 20 percent threshold. Banks are required to maintain NOP at the end of each working day at a maximum of 20 percent of the capital.
According to Bank Indonesia (BI) Regulation No. 17/5/PBI/2015 concerning the Fourth Amendment to BI Regulation No. 5/13/PBI/2003 concerning net open position of commercial banks, the NOP is the sum of the absolute value of, (a) the difference between net assets and liabilities on the balance sheet for each foreign currency, plus (b) the net difference from receivables and liabilities either commitments or contingencies in the administrative account for each foreign currency, all of which are declared in rupiah.
Even if the NOP appears to be safe, banks must increase vigilance over foreign exchange transactions with the aim to mitigate credit and market risks in foreign currency credit, treasury transactions and international trade (trade finance), such as exports, imports, bank guarantees and derivative products.
Treasury transactions, such as placements, foreign exchange and money markets, are closely related to the rupiah exchange rate against the US dollar, which may increasingly fluctuate as a result of the SVB case.
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Banks are also required to be more prudent in trade finance transactions, especially letters of credit (LoCs) to avoid imitated LoCs. Banks need to be meticulous in examining the terms of the LoCs, including periods and commas in the required documents. These minor errors can become discrepancies in the LoCs that potentially give rise to high to very high loss-incurring cases.
Fifth, several top-tier banks have already diversified into several business units, such as in digital banks, insurance companies, securities, financing, printing, property and shipping services. Considered as business conglomerates, these banks have certainly implemented an integrated risk management system. When one of the business units is exposed to credit, market, operational or liquidity risk, it will not become systemic risk to threaten other business units.
Sixth, BI and the OJK should continue to increase surveillance. BI should conduct periodic and non-periodic stress tests to measure how healthy commercial banks are in a certain period.
When those required measures have been prudently implemented, the national banking system will remain healthy in the wake of SVB's bankruptcy.
The OJK is required to measure a bank’s liquidity adequacy as well as stamina to ensure that the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) are maintained 100 percent. LCR is the ratio between high quality liquid assets (HQLAs) and total net cash outflow for the next 30 days in a stress scenario.
HQLAs are cash and/financial assets that can be easily converted into cash at little or no reduction in value to meet the bank’s liquidity needs for the next 30 days in a stress scenario. NSFR is the ratio between available stable funding and required stable funding. This is all aimed at mitigating liquidity risk.
When those required measures have been prudently implemented, the national banking system will remain healthy in the wake of SVB's bankruptcy.
Paul Sutaryono
Paul Sutaryono, Banking Observer and BNI assistant vice president (2005-2009)
This article was translated by Mudthofid.
