The Unconventional Reserve Requirement as A Macroprudential Policy for Managing Banking

Liquidity and Intermediary: The Case of Indonesia

Bogota, 26 October 2012

Filianingsih Hendarta

Outline

The Indonesian economy problems and policies

The existence of excess liquidity in Indonesian banking system

The unconventional reserve requirement policy

Challenges on implementation

Policy implications: banking performance

2

The Indonesian Economy Problems and Policies

Asian crisis in 1997-1998: lack of liquidity, high volatility in foreign exchange and loss of market confidence.

Policies: alteration foreign exchange regime, closing several banks, deposit insurance, Bank Indonesia Liquidity Assistance (BLBI), Bank Recapitalization Program, etc.

Policy implications: foreign currency imbalances and the persistence of excess liquidity in banking system.

Excess liquidity caused to weaken monetary transmission mechanism, to give a higher tension to foreign exchange, to increase the cost of OMO.

Policies: OMO, foreign exchange sterilization, reserve requirement, increasing bank lending and financial deepening .

3

The Existence of Excess Liquidity in Indonesian Banking System

Excess liquidity was high and had grown

Excess Liquidity Ratio

• Caused by the Asian crisis resolution 97/98. • Average ratio of OMO to deposits increased from 4.7% before the crisis 97/98 to

19.3% as of March 2011.

• Liquidity expansion (government) over period 2006-2007 and 2010 especially on

foreign exchange intervention.

Outstanding OMO, NIR & Fiscal Net Expansion

0

5

10

15

20

25

Jan

-95

Oct-

95

Jul-

96

Ap

r-9

7

Jan

-98

Oct-

98

Jul-

99

Ap

r-0

0

Jan

-01

Oct-

01

Jul-

02

Ap

r-0

3

Jan

-04

Oct-

04

Jul-

05

Ap

r-0

6

Jan

-07

Oct-

07

Jul-

08

Ap

r-0

9

Jan

-10

Oct-

10

Rasio OPT/DPK

Sep 98 - Feb 2007: 13,9%

GWM + DPK

GWM '04+LDR & Jual Va

Beli Valas

Jual Va > GWM

2010: 17,5 %

%GWM Primer 8%: Nov 2010

GWM LDR: Mar 2011

Mei 2011: 19,3%

Jan 95 - Agt 98: 4,7 %

OMO to Deposits Ratio Primary RR 8%:

Nov’10

RR-LDR: Mar’11 Buy forex

RR+Dep

Mar’11:

19.3%

RR’04+LDR Sell forex

Sell forex > RR 234

484

597

275

585

115

109 106

0

100

200

300

400

500

600

700

OPT Total NIR Net Ekspansi Fiskal

Rp Triliun

OMO Total NIR Fiscal Net Expansion

4

5

Open Market Operation

Monetary Operation

Standing Facilities

Deposit Facility

SBI Sharia

Reverse Repo Treasury Bills (SBN)

Lending Facility

Contraction

Expansion

Contraction

Expansion

Repo, SBN Outright (Buy)

Forex Intervention (Buy USD/IDR), SWAP (sell)

Forex Intervention (Sell USD/IDR), SWAP (Buy)

SBI Issuance

Term Deposits, SBN Outright (Sell)

Policies

Policies: Open Market Operation 6

1997-2003 2004 – 2008 2009 – Sept’2012

SBI DF LF SBI DF LF SBI DF LF

Instrument 1 and 3 month

O/N O/N 1 and 3 month

O/N O/N 1, 3, 6 and 9 month

O/N O/N

Pricing (%) 16.86 11.18 - 10.24 6.25 11.17 5.94 4.67 7.06

Outstanding (USD Billion)

6.84 3.30 17.20 4.17 0.07 21.13 9.05 0.04

Outstanding/ Deposits (%)

8.06 3.89 13.34 3.23 0.05 8.78 3.76 0.02

Policy Rate ≥5 July 2005: BI Rate, with 1 month SBI as operational

target ≥June 2008: BI Rate, with PUAB

O/N as operational target

BI Rate, with PUAB O/N as operational target

Reference Rate 1-month SBI <Jun’08: 1 month SBI ≥Jun’08: O/N interbank rate

O/N interbank rate

O/N Interbank Rate (%)

11.43 6.13 5.12

Reserve Requirement Policy

• Regarded as an old fashion in monetary policy

• A non-interest asset for bank

• Intended for bank liquidity reserve

• Usually a certain ratio of deposits

• Implementation is vary across countries

7

*) average 6 month before the policies issued **) August 2012

Reserve Requirement Policy in Indonesia Background * Time Implementation Policy Issues Description Results

Before July 2004 • Primary RR is 5%

• High excess liquidity OMO/Deposits: 18%

Gov.Bond/Deposits: 35% • LDR is low: 56% • Policy Rate: 7.5% • Credit Growth: 18% • GDP Growth: 4.2%

July 2004 • Higher deposits, higher RR ratio

• Remuneration of 3% for excess reserves

• Primary RR is 5% • Additional RR : i. Deposits < Rp. 1 T 0% ii. Deposits Rp.1T-Rp.10T 1% iii. Deposits Rp.10T-Rp.50T 2% iv. Deposits > Rp.50T 3%

• Excess Liquidity ↓ but still high

• LDR ↑ but still low • Credit Growth ↑ • GDP Growth ↑

• High excess liquidity OMO/Deposits: 12%

Gov.Bond/Deposits: 29% • LDR is low: 66% • Policy Rate: 8.1% • Credit Growth: 27% • GDP Growth: 5.9%

September 2005 • Higher deposits, higher RR ratio

• Smaller LDR, higher RR ratio

• Remuneration increase to 5.5% for excess reserves

• Ratio of primary and additional RR related to deposits remains as the previous policy

• There is additional ratio of RR-LDR: i. LDR > 90% 0% ii. LDR 75-90% 1% iii. LDR 60-75% 2% iv. LDR 50-60% 3% v. LDR 40-50% 4% vi. LDR <40% 5%

• Excess Liquidity ↓ • LDR ↑ • Credit Growth ↑ • GDP Growth ↑

• Limited liquidity OMO/Deposits: 13%

Gov.Bond/Deposits: 17% RR effective: 9.3% • LDR : 78% • Policy Rate: 8.6% • Credit Growth: 32% • GDP Growth: 6.3% • Global Crisis

October 2008 RR ratio to 7.5% Consists of: i. Primary RR ratio is 5% ii. Secondary RR ratio (Excess

Reserves, SBI, SUN) is 2.5% which the implementation was delayed until October 2009

• Excess Liquidity ↑ • LDR ↓ • Credit Growth ↓ • GDP Growth ↓

• High excess liquidity OMO/Deposits: 18%

Gov.Bond/Deposits: 11% • LDR : 72% • Policy Rate: 6.5% • Credit Growth: 18% • GDP Growth: 6.0%

October 2010 RR ratio to 10.5% and RR-LDR

Consists of: i. Primary RR ratio is 5% ii. Secondary RR ratio (Excess

Reserves, SBI, SUN) is 2.5% iii. RR-LDR depends on bank’s LDR (implemented on March 2011)

** •Excess Liquidity ↓ OMO/Deposits: 11% Gov.Bond/Deposits: 9% •LDR ↑ (85%) •Credit Growth ↑ (23%) •GDP Growth ↑ (6.3%)

8

RR-LDR: The Concept

• RR Policy linked to LDR was built based on the optimal objectives of monetary, microprudential and macroprudential policies to promote financial stability.

• LDR was used because of several reasons:

– represent banking intermediation performance

– High LDR represents higher risk taking by bankers

– Lower LDR is a burden for BI if banks put their money on OMO

• In addition to deposits, banks can lend money to real sector using their capital.

– Higher LDR must be supported by higher and strong capital. In this case, banks could have higher LDR or taking more risks as long as they have more capital to absorb the risks.

The LDR target range is set with a lower limit of 78% and an upper limit of 100%. Banks with a loan to deposit ratio that falls outside of this range will face disincentives as follows:

• Banks with a loan to deposit ratio below the lower limit will face an additional 0.1 RR from rupiah deposits for each 1% short of the target.

• Banks with a loan to deposit ratio exceeding the upper limit and with CAR below 14% will face an additional 0.2 SSR from rupiah deposits for each 1% short of the target.

• Banks with a loan to deposit ratio in excess of the upper limit but which maintain CAR of 14% or above and will not face any disincentives.

9

with CAR 12%

Reserve Requirement Policy in Indonesia (2010 - Now)

• In October 2010, BI raised the primary RR for rupiah funds from 5% to 8% (effective November 2010)

• In addition, LDR-based reserve requirement was introduced and would be effective in March 2011

10

LDR

Reserve

Requirement

Secondary Reserve

(2,5%)

Primary Reserve (8%)

• This policy has been set in consideration of the present condition of banking liquidity.

Challenges on Implementation…

From Monetarists…

• Difficult to change the old view that RR is a monetary tool

• Increasing RR will end up with higher lending rate

• The impact of RR on excess liquidity will take time

• Mix signaling: boost up lending with increasing RR

From Banking Supervisors...

• Higher liquidity is good for banking system

• Each bank has a different business strategy, the RR policy could disrupt the bank's business strategy

• Boost up lending could end up with high non-performing loans

11

Policy Implications: Banking Performance

… moreover, non-performing loan consistently goes down

12

Credit growth has increased steadily in high pace since 2009

LDR increases significantly

Liquid asset to deposit ratio goes

down

Lesson Learned

• Excess liquidity most likely occurs after financial crisis

• There is no quick solution to tackle excess liquidity problem without harming banking system

• There is no “one fit all” policy for all banks

• Because excess liquidity could make economic theories do not work well, policy makers have to use an “unconventional” policy to solve their problems

• Policy review or evaluation is a must and never has ending story

• Coordination among departments and/or authorities is essential and communication to stakeholders from the early stage is crucial

13

End of Presentation

14