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What is BI 7-day Rate? And its Impact on Banking?

On Friday, April 15, Bank Indonesia (BI) as the central bank of Indonesia, introduced a new benchmark rate for banking in the country that called the BI 7-day Reverse Repo Rate, which will replace the previous rate known as the BI Rate. This is the first time the BI changes one of its well-known policies, and it certainly unnerve investors (let ‘BI 7-day Reverse Repo Rate’, some of you may not even understand what is 'BI Rate'), and consequently the banking stocks fell heavily on that Friday, as investors became unsure about how the impact of this new policy on the bank’s financial performance.

Anyway, I could say that the use of BI 7-day Reverse Repo Rate (hereinafter referred to as ‘BI 7-day Rate’) as the new benchmark rate, will not interfere with the performance of banking companies, instead it will generate a positive impact. Okay, let’s go.

Before using the BI 7-day Rate, during this time the BI using the BI Rate as a benchmark for interest rates on both loans and deposits for banks or financial institutions throughout Indonesia. So when BI Rate rises from 6.50% to 6.75%, for example, then the interests on loans and deposits in banks and other financial institutions will also rise. This benchmark rate is only a reference rather than law, so that its magnitude of influence on bank interest rates in Indonesia could increased or decreased over time. More about the BI Rate, read again the article here.

As for the BI itself, BI Rate is the interest rate of Bank Indonesia Certificates (Sertifikat Bank Indonesia/SBI) for a tenor of one year. When the BI Rate rose to 6.75%, the banks can put their funds in BI in the form of SBI, and will receive a 6.75% interest per annum. So if Bank Mandiri put Rp10 billion in BI, then after one year, they will earn Rp675 million without doing nothing.


During this time the BI using the SBI for monetary operations, in this case by increasing or decreasing the amount of Rupiah in the public, aka money supply. So when there’s too much supply of money, the inflation rate will rise, and the central bank will raise the BI Rate, so that the banks would prefer to put their third party funds in BI (in the form of SBI) rather than channel the money back into the public in the form of loan. Thus, money supply will going down, and inflation will also dropped.

Then, if after some time, the inflation rate came under control, the BI could cut down the BI Rate, so the banks will lend money to the public, companies can set up factories and create new jobs, and it will eventually boost economic growth. But here’s the problem: Although the BI Rate has been dropped, but the banks can only withdraw their funds from the BI after one year since they bought the SBI. So when the BI Rate dropped, the money supply will not increased immediately, but the process could take time from several months until one year, so that the objective of economic growth would need time to be achieved. Similarly, when the central bank raises the BI Rate, the rate of inflation may not go down immediately, because the bank will think twice if they’re about to put their funds in the central bank for a year.

So in order to make the monetary operations become more effective in balancing between inflation and economic growth, the BI changes its benchmark rate from BI Rate to BI 7-day Rate, whereby if the BI 7-day Rate is up, the bank could put their third party funds in BI for seven days (or 14 days, 21 days, and so on). Thus, if in the next month the BI 7-day Rate goes down, the bank will be able to immediately withdraw their funds and distribute it to the public (in form of loan). This BI 7-day Rate is also called ‘reverse repo rate’, because in this case BI as the ‘bank of banks’ is like borrowing money from the bank with the promise that the money will be returned 7 days later, plus interest.

In short, BI will have a more effective control towards money supply, the inflation and Rupiah exchange rate will be stable, and economic growth will be encouraged. Actually, before 2010, the use of BI Rate as a benchmark interest rate had been quite effective for monetary operations, where the inflation rate etc. could be controlled properly.

However, since 2010, foreign funds began to flow into Indonesia in large numbers, which causes the flow of funds in the interbank money market (IMM) becomes faster, and consequently the interest rate in the market has become very low because a bank sometimes only hold a large fund in an overnight, before ‘pass’ it later to another bank (remember that the shorter the holding period, the lower the interest). This low interest rates in the IMM also affect the overall interest rate of the banking industry, while the BI Rate as the benchmark rate is no longer received much attention because the period is considered too long, namely one year (while the interest rate on the IMM could even apply for a holding period of one day, aka overnight). So, with the use of BI 7-day Rate as the new benchmark rate, which the banks could buy SBI and holding it for 7 days only, then the bank will place their funds in the form of SBI (when the rate rises), as the period of 7 days is certainly not too long compared to the period in the interbank money market, and the central bank will once again have an effective control on the interest rate of Indonesian banking.

Then how the impact of these changes on bank’s performance?

Because it has a shorter period, the BI 7-day Rate will always be lower than BI Rate. Currently the BI Rate is at 6.75%, while the BI 7-day Rate 5.50% (but 5.50% is still counted for one year. If a bank bought SBI and immediately sold it seven days later, the total interest would be 0.10% only). So if BI start using BI 7-day Rate as the new benchmark rate, there would be an impression that the central bank has cut the rates drastically, so the banks will have to reduce the rate on lending and deposits, but that’s not true. BI Rate will remain at 6.75%, unless the central bank changes it, just like BI 7-day Rate will remain at 5.50% unless the central bank changes it.

But to avoid these misunderstandings, starting this April until August, BI will announce two benchmark rates, ie the BI Rate and BI 7-day Rate, every month, so that the market can adapt and can see that there are no drastic changes in BI Rate. After August, the central bank will only announce the BI 7-day Rate every month.

Thus, the banks do not need to change the interest rates of its loans and deposits (unless there are changes in BI Rate, as well as BI 7-day Rate). In fact, if the goal of this benchmark rate switching is achieved, where inflation becomes more controllable, the Rupiah rises against the US Dollar (if there are too much Rupiah supply, it can reduce its value/exchange rate), and the economy grows faster, then certainly banks will be benefited. Back in 2010 – 2011, when the Indonesian economy was in its peak growth thanks to the booming of coal and CPO, performance of banking were also excellent, where Bank Rakyat Indonesia (BBRI) posted ROE of more than 40% for two consecutive years (while for 2015, the ROE BBRI was only 29.9% ).

Because the central bank will have an effective control of the Indonesian banking interest rate, then although the foreign funds continue to flow into the country, either because of the implementation of the ASEAN Economic Community (AEC), the migration of investment from the Singapore, until the withdrawal of corporation’s assets from abroad, the bank interest rates will remain stable and unaffected, as the banks only need to stick on the latest figure of BI 7-day Rate, and no need to look the interest rate in the interbank money market. If the interest rates become stable, the process of lending etc. will be easier, and the risk of bad debts due to sudden changes in interest rates, will also be lower.

However, all the above changes will only have a positive effect on the bank’s performance in the long term, at least in the next few months. While in the short term, banking stocks may still be volatile. But one interesting thing: On the date when this new benchmark rate was announced, foreign investors sold a huge quantity of blue chip banking stocks, but they immediately spent their cash to buy non-banking blue chip stocks, in this case Astra International (ASII) and Telkom (TLKM), which both rose significantly, and this shows that foreign investors actually did not want to get out from the exchange (they only avoided banking stocks, for now).

So, if in the future these big boys are better informed about this BI 7-day rate, they will be back into banking stocks, as they have no other options for diversification (of 10 stocks with the largest market cap in the IDX, 4 of which are banks). In addition, in the near future, the companies will release financial statements for first quarter of 2016. And the good news, if we look at the published financial statements of Bank Jatim (BJTM) and Bank BNI (BBNI), the two banks scored increases in net income (in 2015, both banks had their profits go down), and the other banks should be same, and it will be a fundamentally positive sentiment for the stocks. We'll see!

Any inquiries about investment in Indonesia Stock Market, please send an email to teguh@averepartners.com

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