A closer look at Indonesian banks' declining NIM

Since reference rate is at its lowest throughout the history, whilst inflation stays low, the banks struggle to earn yield. The big banks cut interest rate for their clients with pleasure and aggressively grab loan market share as a means to maintain their profitability and bottom line growth.

Without any foreseeable prospects about the world economic growth that might be able to spike back to the previous growth level, the inflation is expected to remain subdued as the prices of commodities drift down. On the backdrop of such development, expect the competition for yield continue to heats up.

Furthermore, the funding cost might contrastingly increase since the banking sector liquidity is at its lowest level in the past decades. Additionally, in combination with the shallow interbank market, the nearly non-existent financial engineered funding instrument and the worsening country’s credit profile, pressure on cost of fund seems to mount. Consequently, Indonesia's banking sector high NIM quality might gradually soon perish.

At the first stage of structural NIM decline, we would like to see banking sector to conduct consolidation. This is because the big banks with lower cost of fund benefits in assertively entering the high yield segment, which was used to be the territory for rural banks and non-bank financial institutions. As the results, smaller players get pushed out of the game due to higher cost structure. This postulation is verified with the falling numbers of commercial and rural banks (2007: 130 commercial banks and 1817 rural banks vs. 2013: 120 commercial banks and 1654 rural banks).

Structural Challenges: Half Full – Half Empty Dilemma

With such situations in place, the discussion then moves onto how to attract more fee-based incomes into the equation in an attempt to diversify bank earnings. With 120 banks in the system, only four big banks (Mandiri, BCA, BNI, CIMB Niaga) have apparent customer based for investment/insurance product cross selling purposes, as Indonesians are by no means financially sophisticated.

This is proved by the Indonesian capital market total accounts, which is a mere 363k, while the mutual funds customer based only a minuscule of 161k in a nation with 237mn population! Another staggering statistic includes 50% of the total funding available for banking sector located within Jakarta, whereas money distribution amongst the customer accounts gives an even more extreme picture. Out of 123mn accounts existing, 97.59% or 120mn customers merely own 15% of total nation’s deposit with an average balance of Rp4.2mn/accounts (USD 430). These statistics suggest that most customers hardly opt for term deposit -since the big banks normally require Rp5mn – Rp10mn (USD515 – USD 1030) minimum balance for the opening of term deposit-, let alone choose other investment products.

Other structural challenges for Indonesia are its highly localized economic structure with net export contributing only to 11.6% of GDP and its infrastructure development badly backlogging behind demand. For banking sector, the aforementioned factors cause fee-based income sourcing from international trading and transaction/payment innovation services severely lagging behind the regional peers and hamper the fee-based income potential growth.

Consequently, the reasonable approach is continuously increasing penetration rate on the funding side, as being currently accomplished by an increasing number of keen bankers chasing after micro customers. In this process of penetrating huge potential customers, however, cost side is likely to be the obvious trade off.