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Net Interest Margin of Indonesian Banking is Too High?

Thursday, February 18, head commissioner of the Financial Services Authority (FSA), Muliaman Hadad, said that the average of net interest margin (NIM) of banks in Thailand was 3 – 4%, or higher than in Indonesia. To be more comparable with other countries in the ASEAN region, the NIM of Indonesian banks will be directed to be 3 – 4% as well, whereby the FSA will require banks to lower the interest rate for loan. A day later, Minister of State-Owned Enterprises, Rini Soemarno, also appealed to the state-owned banks to lower their NIM to around 4% by way of sharing the IT systems and ATM, thus lowering operating costs, and consequently the performance of the banks will be more efficient.

Apart from the details of the above statements, but the title of the news was that ‘The NIM of banks will be lower than 4%’. As the NIM of major Indonesian banks like Bank Central Asia (BBCA), Bank Mandiri (BMRI), Bank Rakyat Indonesia (BBRI), and Bank Negara Indonesia (BBNI), were all above 4%, the news title sounds like ‘the profit of the banks will be cut’. So you may guess the results: In Friday, February 19, most of the bank stocks in the Indonesia Stock Exchange (IDX) dropped significantly, and the Jakarta Composite Index (JCI) itself fell 1.7%.

So what is NIM? Can it be lowered? How? And if we do it (lower the NIM), what is its purpose? And if NIM of a bank could be lowered to below 4%, what is its impact on the overall financial performance of the bank?

Understanding the Net Interest Margin

Net interest margin, or NIM, is the ratio between the net interest income (interest income minus the cost of interest) and the value of productive assets. The interest income derived from loans, deposits in government bonds, certificates of Bank Indonesia, etc. While the cost of interest is when the bank must pay interest for third party funds, etc.

While productive assets are assets that produce the interest income, also called ‘net bearing assets’. For example, a bank has assets of US$ 100 million, and US$ 80 million of which was channeled to debtors in the form of loans, securities, bonds, etc., thus generating interest income for the bank. If a bank generated interest income of US$ 10 million in a year, and after the cost of interest it become US$ 4 million, then the NIM is 4 / 80 = 0.05 = 5%.

The latest data from Bank Indonesia (BI) showed that the average NIM in Indonesian Banking was 4.23%.

Well, from here we can see that there are three factors that influence NIM, namely: 1. The value of interest income, 2. The value of cost of interest, and 3. the value of productive assets. Just like any company in the world, banks in Indonesia will always focus on efforts to increase revenue, and on the same time suppress the ‘direct costs’ (while the value of assets will increase by itself overtime). The point is to increase revenue and reduce expenditure. And banks who are successful in these efforts will make a higher NIM compared to other banks that are less successful. The higher the NIM of a bank, the more efficient the bank in its operation. In Indonesia, the bank with the largest NIM is Bank Tabungan Pensiunan Nasional (BTPN) with NIM of 9.9% as of third quarter of 2015.

So if we want to lower the NIM, we can do the opposite: Reduce the interest income, or increase the cost. But does it make sense if a bank do that? Reduce their own income and increase the cost? What for? From logical standpoint, it is impossible if a bank would do that, so there must be another way to lower the NIM.

But why the NIM should be down? What is its purpose?

In the economy of a country, banks have role as a ‘bridge’ that connects the owner of the funds and the people/companies who need the funds to develop the business. In that role, banks charging interest on lending and paying interest to the owner of the funds. The difference between the loan interest, which is of course larger than the deposit interest, becomes the income of the bank. The greater the difference, the greater the net income of the bank.

If banks charge a huge rate of interest to its debtors, it will burden the business itself, and ultimately hamper the economic growth. So if the goal is to increase the economic growth, the bank interest rate can be lowered. How? By lowering the BI Rate, which is a domain of Bank Indonesia (BI) (only BI that can lower the BI Rate). If the BI Rate is declining, then not only the interest rate of lending, but the interest rate of deposits will also going down. In other words, even though the bank’s interest income will drop, but the cost will also go down substantially, and consequently its NIM unchanged.

Only indeed, if the BI Rate keep going down until a very low level, let say below 5% (the latter is still 7%), the NIM of the banks will come down. Here’s the illustration: When BI Rate was 7%, the bank would set a 12% interest on loans, and 6% for third party deposits, so that its margin (its NIM) would be 12 – 6 = 6%. Once the BI Rate fell to 4%, then the lending rate may drop to 9% (from 12 to 9, or dropped 25%), and interest on deposits will also go down but only to 4.5% (from 6 to 4.5, means dropped 25% as well, understand?), so its NIM will be 9 - 4.5 = 4.5%, or lower than 6% earlier.

But note: BI Rate can only be lowered to a lowest possible position when the economy is already efficient, characterized by low inflation. This means that if BI Rate fell sharply and the average NIM of banks also fell, it wouldn’t have a negative impact for the banks, because on the other hand the inflation rate has been dropped before. And that’s because the inflation is like a cost in bank operations, whereby if a bank generate an interest margin of 6% in a given year, but the inflation rate for the year was 7%, then the bank is actually losing money.

So why the NIM of banks in Thailand is lower than in Indonesia? Because the country’s inflation is only 0 – 1%, the latest data even negative 0.5%, far lower than 4.1% of Indonesia. And the interest rate of Thailand’s Central Bank is only 1.5%, lower than 7% of BI Rate. So even though NIM in Thailand is lower than in Indonesia, but it does not mean that the banks in Thailand are less profitable than in Indonesia. But the low NIM in Thailand also does not mean that the bank sector is better than in Indonesia, but that Thailand’s economy as a whole is more efficient than in Indonesia (efficient only, not better as a whole. The fact is, although have a problem with inflation, but Indonesian economic growth is still better than Thailand’s).

Okay, so back to the question above, why the NIM of banks in Indonesia should go down? What is its purpose? The answer is not that the NIM will be reduced directly, for example, by forcing banks to lower the income and increase the cost (that’s impossible, unless if our Government is a communist), but banks in Indonesia will be given certain incentives (by the FSA) so that they can lower the loan interest rate in accordance with the BI Rate (BI rate also fell in recent months). And it is expected to stimulate business sectors and promote economic growth in Indonesia. If on the other hand the inflation rate can also be maintained at least at the current level (the current data of inflation is 4%, lower than the average 6 – 7% per annum), then the BI rate could be lowered further, and the NIM would gradually going down by itself, of course, without interfering with the financial performance of banking itself because on the other hand, the inflation rate is already very low.

That is why it is said that the process of ‘decline in NIM’ might take 2 – 3 years, because the main job is to bring down inflation, while on the other hand maintain economic growth, so that NIM will then descend by itself, and it certainly needs time. The story would be different if NIM of a bank is directly lowered by forcing them to lower the credit interest and raise the deposit rate, for example, when inflation is still high. If it works that way, the decline in NIM is indeed a bad thing, but once again, it ain’t work that way. Just like when the Government aims to lower gas prices to stimulate the economy, the way is not by forcing Perusahaan Gas Negara (PGAS) for immediately lower the prices, but rather provide incentives, ease of business, and infrastructure so that PGAS could cut some of its distribution channels, making the operational of the company will be more efficient, and the selling price of the gas will be lower by itself without reducing the profit of the company.


The fall in the average NIM of Indonesian Banks is one of indicators, beyond other indicators such as an increased economic growth and low inflation, that the Indonesian economy improves. The FSA or even BI can not directly set a number of NIM, let say below 4%, just as they could not set the inflation rate (they can only set a target), because the NIM will automatically follow the development of the fundamental economy in the country. And when the NIM actually dropped to below 4%, it won’t impact the performance of the banks negatively because, it is like when your salary dropped from US$ 1,000 to US$ 900, but the prices of rice (and other daily needs) also fell from US$ 1.2 to below US$ 1 per kilogram. Thus the salary of US$ 900 was actually larger than before, right?

Then why the bank stocks still dropped after the statement from the FSA and the Minister of SOEs that 'the NIM will be lowered to 3 – 4%’? Well, it is just like when there was news that the price of gas would be lowered, cement prices would be lowered, mortgage rates would be lowered, which immediately dragged down the stocks of PGAS, SMGR and BBTN, because most people only read the title of the news and not really understand the contents of the news, and in-depth analysis of the news would usually appear some time later. Just like when some time ago the people blindly believe the story of ‘Ironman’ from Bali where a welder can build a robot hand by using electronic wrecks, but some time later it is revealed that it was just a hoax.

But well.. I’m already quite familiar with the phenomenon of ‘stocks falling because a bad news’ like this, that if the ‘victims’ are good stocks, it is usually an opportunity. Since 2009 until today, I cannot even remember how many times the banking stocks got attacked by such ‘bad news’, not including the correction of JCI which always hit the market almost every year, and yet the stocks of good banks like BBCA, BMRI, BBRI, BBNI etc., they all continued to rise in the last few years, and the total increase is also higher than the JCI. Will this long term uptrend be stop just because the story about this NIM? I do not think so!

Disclosure: When this article was written, Avere Investama were in positions of BBNI, BJBR, and BBKP. These positions can change at any time without prior notice.

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