The Bank Intermediary Function and ed Loans Phenomenon

8/14/2019 The Bank Intermediary Function and ed Loans Phenomenon

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Corespondence Address:

Directorate of Economic Research and Monetary PolicyBANK INDONESIA

Bank Indonesia Office, Tower B, 19 th floorJl. MH. Thamrin No.2, Jakarta 10010 Indonesia

Phone : +62 21 381 7733

: +62 31 381 8627Fax. : +62 21 350 2030E-mail : [email protected]

ISBN No : 979-96680-1-8


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This research was conducted as part of the Working Program of the Directorate of Economic Research and Monetary Policy,

Bank Indonesia for the 2004 fiscal year. The Research Team would like to express its gratitude to the managers of banks and

company managers who participated as respondents in this study; Banking Data Division, Directorate of Bank Licensing and

Information, Bank Indonesia and Monetary Statistics Division, Directorate of Economic and Monetary Statistics, Bank Indone-

sia for providing banking data; Mr. Halim Alamsyah, Director of Directorate of Economic Research and Monetary Policy for

his guidance and input; Mr. Triono Widodo, Deputy Director of Directorate of Economic Research and Monetary Policy for his

comments and suggestions; Mr. Suhaedi, Head of the Financial Market Studies Division, Directorate of Economic Research

and Monetary Policy for facilitating the work of the survey; Mr. Agung Budilaksono, Assistant Economist in Financial Market

Studies Division, for his assistance in processing the data collected in the surveys; and the senior managers, officers, and staff

of the relevant units at Bank Indonesia for all the input contributed during a workshop on June 14, 2004. The views expressed

in this paper are those of the authors, and do not necessarily represent the views of Bank Indonesia.


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Foreword

Foreword

The escalation in undisbursed loan in the aftermath of economic crisis, both in nominal terms

as well as in proportion to loan commitment, has captured the widespread attention of bankers,

businessmen, economists, and central bankers. Many come to believe that this phenomenon might

have undermined the performance of bank intermediary function at the time when banking sector

still assumed dominant role in financing business activity in Indonesia. Therefore, it might hinder the

process of Indonesian economic recovery.

It has been a subject of considerable debate whether the supply or demand side that is more

responsible for the occurrence of this phenomenon. The banking sector (supply side) stresses that

such phenomenon is more of the result of weak demand. Meanwhile the business sector (demand

side) puts the blame on banks hesitation to lower lending rate materially and to relax the perceived

complicated requirements on loan disbursement. Going forward, should this controversy continue

without a comprehensive solution, in the end both supply side and demand side are bound to suffer.

Banks stand to lose because they fail to optimize their porto folio, likewise business sector will incur

losses because they cannot get sufficient financing for their business activities. For the central bank,

the large stock of undisbursed loan will hamper the effectiveness of monetary policy transmission

mechanism. In this light, I commend this research that sought to explain empirically factors behind

the phenomenon and provides some policy recommendations.

In this opportunity I wish to express my appreciation to the research team for the completion of

this study. I also wish to extend my gratitude to respondent banks and companies for their participa-

tion and enthusiasm in providing data and sharing views during the survey, hoping that this study

would be of benefit for all of us.

Jakarta, October 2004

Directorate of Economic Research & Monetary Policy

Bank Indonesia

Halim Alamsyah

Director


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Executive Summary

General Characteristics of Undisbursed Loans

in Indonesia

For banks (the supply side), the rise in

undisbursed loans is a phenomenon that

bears some relationship with the nature of

its business as well as the degree of

concentration for each category of banks.

For debtors (the demand side), the rise in

undisbursed loans is closely linked to

sensitivity of business sectors to economic

cycles as well as to the scale of business and

market orientation of the debtors themselves.

The finding of these observations indicates

that there is a link between developments in

undisbursed loans and domestic economic

conditions, implying that the trend in

undisbursed loans could therefore yield

information on state of the domestic

economy.

Causes of Growing Undisbursed Loans

The phenomenon of rapid accumulation of

undisbursed loans in the last several years is

a result of loan commitments increasing at a

faster rate than the actual borrowing needs.

This phenomenon is not only atributable to

borrowers behaviour but also to banks

behaviour.

From the perspective of the debtors, the rapid

increase in loan commitments is explained

mainly by mounting demand for loan

commitments as a preventive measure in the

face of uncertainties in interest rates and

supply of funds (risk aversion). Loan

commitments driven by risk aversion motives

inherently have considerable potential for

becoming undisbursed loans.

While the demand for loan commitments

have risen sharply, loan disbursements have

been relatively slow because of adverse

business conditions and internal financial

conditions of debtors, high loan interest rates,

and expectations of further easing of interest

rates. Added to this, debtors are able to tap

alternative sources of funds at more favorable

rates and the fees charged by banks for

undisbursed loan commitments are only

marginal, thus eliminating the incentive for

debtors to accelerate their drawing down of

loans.

From the supply side, the escalation in loan

commitments has also been driven by the

aggressive behavior of banks in extending

loan commitments to high-quality debtors.

Banks have become emboldened to make

hefty increases in loan commitments because

of high levels of excess liquidity, the large

differential between lending rates and

deposit rates, and the availability of short-

term placement instruments which have

Executive SummaryThe Bank Intermediary Function and Undisbursed Loans Phenomenon:

Causes and Policy Implications


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Executive Summary

adequate return and liquidity, such as Bank

Indonesia Certificate (SBI), Bank Indonesia

Deposit Facility (FASBI) and Government

Securities (SUN).

Although banks succeed in increase loancommitments, actual levels of disbursement

are hampered by the extreme caution on the

part of banks in engaging in credit expansion.

This is reflected, among others, in the

charging of high risk premiums and stricter

requirements imposed on new debtors.

The cautious stance of the banks is not only

driven by the perception of high risk attachedto debtor prospects, but is also related to the

vulnerable internal condition of the banks

themselves, as reflected in the persistently

high level of NPLs.

Loan demand is more sensitive to interest

rates than loan supply, implying that given

conditions of relatively low disbursement,

efforts should be made to promote credit

expansion by lowering interest rates without

any significant reduction in loan supply.

Banks may respond by appropriately

lowering interest rates charged on borrowers

without affecting loan supply significantly.

However, as loan interest rate is entirely at

the disposal of banks given the banks

internal condition, it is expected that interest

rate will not see significant reduction.

Changes in the exchange rate has a powerful

affect over loan demand. Depreciation in the

rupiah will delay or reduce this demand

because of, among others, the heavy reliance

of business sector on imported goods and

raw materials.

Responses from Banks concerning Undisbursed

Loans

In order to facilitate loan disbursement, on

average, banks maintain a large amount of

liquidity (63% of total undisbursed loans).This is probably one of factors that encourage

banks to place their funds in SBI and FASBI.

Due to excess liquidity situation and the

availability of SBI and FASBI, the increased

undisbursed loans have yet to directly

affected internal bank condition in terms of

liquidity risk, cost of funds, and latitude to

engage in credit expansion. Most banks prefer to take a persuasive

approach aimed at encouraging reductions

in undisbursed loans by requesting debtors

to prepare more concrete schedules for

drawing down, rather than imposing

additional charges for undisbursed loan

commitments.

Policy Implications

The various conclusions of this research

have a number of policy implications that call

for attention and response. These are described

as follows:

The suboptimal bank intermediary function

as reflected in the increased undisbursed loans

points to the importance of accelerating the

development of non-bank financial markets

in order to promote national economic

recovery. Development in non-bank financial

markets and increased competition in

financial markets may ease the dependence

of business in bank financing and ameliorate

the rigidity in loan interest rates.


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Executive Summary

The rigidity of interest rates is a consequence

of the lack of confidence of banks in the

accuracy of information on debtor quality. This

underscores the need to support and accelerate

actions to improve transparency andavailability of debtor information such as by

establishment of the Credit Bureau and rating

agencies. It is also necessary to develop other

financing institutions with strong monitoring

capacity, such as venture capital firms.

Because rigidity in interest rates is the result

of the continued perception of high level of

risk premium imposed by banks, theirunderstanding and capability to measure and

implement risk management need to be

improved.

Loan demand is more dependent on business

prospects and exchange rate stability than

loan interest rates. Therefore in the current

situation of flagging prospects and a

depressed business climate, efforts to

increase loan demand needs to be supported

by more concrete measures to improve the

investment climate. This drive must also be

assisted by fiscal expansion with multiplier

effects that can improve conditions in the

corporate sector.

The efforts to strengthen bank intermediationneed to be supported by clarity in the future

direction and level of interest rates that will

promote more stable expectations of interest

rates.

The phenomenon of undisbursed loans, like

that of credit rationing and rigidity of interest

rates, has emerged in an environment

shrouded in uncertainty and high costs oftransactions and information. For this reason,

efforts to promote the intermediary function

and strengthen effectiveness in monetary

policy transmission call for hard work and

participation not only from Bank Indonesia

as the monetary and banking authority, but

also from other stakeholders in ameliorating

the factors responsible for excessive

uncertainty and high costs of transactions

and information.


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Daftar Isi

Table of Contents

Foreword ............................................................................................................................... i

Executive Summary ................................................................................................................. iii

Table of Contents .................................................................................................................... vii

List of Tables............................................................................................................................ ix

List of Diagrams and Graphs ................................................................................................... xi

Chapter I Introduction

1.1 Background and Research Objectives ............................................................................. 1

1.2 Methodology .................................................................................................................... 1

Chapter II Analysis Framework

2.1 Undisbursed Loans:Loan Commitments vsDraw Down of Credit.................................... 3

2.2 Factors Influencing Demand and Supply of Loan Commitments....................................... 3

2.3 Factors Influencing Draw Down of Credit ........................................................................ 6

2.4 Asymmetric Information and Rigidity in Loan Rates ......................................................... 7

2.5 Relationship between Undisbursed Loans and Monetary Policy Transmission................... 10

Chapter III Undisbursed Loans in Indonesia: Stylized Facts

3.1 Undisbursed Loans by Purpose of Loan Use, Group of Bank, and Currency..................... 13

3.2 Undisbursed Loans by Sector, Scale of Business, and Market Orientation of Debtors ........ 17

Chapter IV Factors Influencing Undisbursed Loans: Survey Findings4.1 Factors Influencing Undisbursed Loans from the Demand Side ........................................ 19

4.2 Factors Influencing Undisbursed Loans from the Supply Side........................................... 24

4.3 Responses and Expectations of Companies and Banks concerning Undisbursed Loans....... 28

4.4 Statistical Issues of Undisbursed Loans ............................................................................. 31

Chapter V Factors Influencing Draw Down of Loans: Results of Econometric Testing

5.1 Model Specifications ...................................................................................................... 33

Table of Contents


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Daftar Isi

5.2 Results of Model Estimation ............................................................................................. 36

5.3 Results of Simulations and Projections ............................................................................. 40

Chapter VI Conclusions and Policy Implications

6.1 Conclusions ..................................................................................................................... 43

6.2 Policy Implications .......................................................................................................... 46

Bibliography ............................................................................................................................ 49

Appendix 1: Profile of Survey Respondents ............................................................................. 51

Appendix 2: Bank Survey Questionnaire .................................................................................. 53

Appendix 3: Company Survey Questionnaire .......................................................................... 63

Table of Contents


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Daftar Isi

List of Tables

Table 4.1. Composition of Loan Commitments Obtained by Respondent Companies,

Disaggregated by Purpose of Use........... ................................................................ 20

Table 4.2. Composition of Loan Commitments Obtained by Respondent Companies,

Disaggregated by Types of Draw Down ....... .......................................................... 20

Table 4.3. Business and Internal Financial Conditions of Respondent Companies by Scale of

Business ............................................................................. ................................... 22

Table 4.4. Business and Internal Financial Conditions of Respondent Companies by Business

Sector ............................................................................ ....................................... 22

Table 4.5. Range of Interest Rates Charged on Loans to Respondent Companies ............. ....... 23

Table 4.6. Perceptions of Respondent Companies regarding Current Loan Rates ........ ........... 24

Table 4.7. Composition of Financing Sources for Respondent Companies .................. ........... 24

Table 4.8. Range of Loan Commission and Commitment Fees Charged by Banks ...... ............ 25

Table 4.9. Composition of Respondent Bank Loan Commitments by Purpose of Use ........... .. 26

Table 4.10 Composition of Respondent Bank Loan Commitments by Loan Size ......... ............ 27

Table 4.11 Range of Risk Premiums Charged by Respondent Banks ........................... ............ 27

Table 4.12 Influence of Undisbursed Loans on Liquidity of Respondent Banks .......... ............. 29

Table 4.13 Influence of Undisbursed Loans on Cost of Loanable Funds (CoLF).......... .............. 29

Table 4.14 Influence of Undisbursed Loans on Headroom for CreditExpansion by Respondent

Banks ........................................................................................ ............................ 29

Table 4.15 Composition of Respondent Bank Lending Plan by Loan Size ................................ 31

Table 5.1. Selection of Variables Influencing Loan Supply and Demand ...................... .......... 34

Table 5.2. Estimation of Loan Supply and Demand ........................................................ ....... 37

List of Tables


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Daftar IsiDaftar Isi


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Daftar Isi

Diagram 2.1. Relationship of Undisbursed Loans to Loan Demand....... ................................ 6

Diagram 2.2. Excess Demand Equilibria (Credit Rationing) ................................................... 9

Diagram 2.3. Excess Supply Equilibria ................................................................................... 10

Diagram 2.4. Analysis Framework for Undisbursed Loans ............... ..................................... 11

Diagram 2.5. Influence of Undisbursed loans on Monetary Policy Transmission Process........ 12

Graph 3.1. Position of Undisbursed Loans by Purpose of Use............................................. 13

Graph 3.2. Proportion of Undisbursed Loans to Loan Commitments by Purpose of Use ..... 14

Graph 3.3. Position of Loan Commitments by Purpose of Use........................................... 14

Graph 3.4. Results of Bank Survey on Proportion of Various Types of Working Capital Loan

Commitments ............................. ..................................................................... 15

Graph 3.5. Results of Bank Survey on Proportion of Various Types of Consumption Loan

Commitments ............................................................................. ..................... 15

Graph 3.6. Results of Bank and Company Surveys on Changes in Pattern of Credit Draw

Down................................................................................................................ 15

Graph 3.7. Position of Undisbursed Loans by Group of Bank ............................................ 15

Graph 3.8. Proportion of Undisbursed Loans to Loan Commitments by Group of Bank ..... 16

Graph 3.9. Composition of Undisbursed Loans at Joint Venture and Foreign Banks by

Purpose of Use ..................................................... ........................................... 16

Graph 3.10 Composition of Undisbursed Loans at Private Domestic Banks by Purpose

ofUse ................................................................ ............................................. 16

Graph 3.11 Composition of Undisbursed Loans at State Banks by PurposeofUse ..... ..... 16Graph 3.12 Proportion of Undisbursed Loans in Foreign Currencies by Group ofBank ...... 17

Graph 3.13 Proportion of Undisbursed Loans to Loan Commitments by Business Sector Part 1 17

Graph 3.14 Proportion of Undisbursed Loans to Loan Commitments by Business Sector Part 2 17

Graph 3.15 Proportion of Undisbursed Working Capital Loans to Working Capital Loan

Commitments by ScaleofBusiness - Survey Findings .... ................................. 18

Graph 3.16 Proportion of Undisbursed Working Capital Loans to Working Capital Loan

Commitments by MarketOrientation - Survey Findings ................................... 18

List of Diagrams

and Graphs

List of Diagrams and Graphs


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Daftar Isi

Graph 4.1. Reasons Cited by Respondent Companies for Opening New Loan

Commitments Accounts .................................................................................. 20

Graph 4.2. Causes of Undisbursed Loans from Viewpoint of Respondent

Companies ...................................................................................................... 21

Graph 4.3. Causes of Deteriorating Business Prospects for Respondent Companies ........... 23

Graph 4.4. Factors Encouraging Respondent Companies to Use Alternative Financing ...... 24

Graph 4.5. Priority in Asset Placements by Respondent Banks . ....... ................................. 25

Graph 4.6. Factors Encouraging Banks to Extend Loans Beyond Debtor Needs from

View point of Respondent Companies ............................................................. 25

Graph 4.7. Factors Determining Priority for Respondent Banks in Asset Placement ........... 26

Graph 4.8. Causes of Difficulties in Applying for New Loans, Cited by Companies ........... 27

Graph 4.9. Causes of Interest Rate Gap, Cited by Respondent Banks................................. 27

Graph 4.10 Aspects Considered by Respondent Banks in Decisions for Credit Expansion ... 28

Graph 4.11 Impediments to Lending in Opinion of Respondent Banks............................... 28

Graph 4.12 Causes of Rise in Undisbursed Loans in Opinion of Respondent Banks ........... 28

Graph 4.13 Proportion of Liquidity Allocated by Banks to Total Undisbursed Loans........... 29

Graph 4.14 Actions by Respondent Banks regarding Undisbursed Loans ........................... 30

Graph 4.15 Actions by Respondent Banks regarding Undisbursed Loans after Expiration

ofLoan Agreement .......................................................................................... 30

Graph 4.16 Respons Taken by Respondent Companies regarding Undisbursed Loans ........ 30Graph 4.17 Ideal Spread between Loan and Deposit Rates in Opinion of Respondent

Companies ..................................................................................................... 30

Graph 4.18 Priority of Lending Plan by Respondent Banks by Purpose of Loan Use ........... 31

Graph 4.19 Priority of Lending Plan by Respondent Banks by Business Sector ................... 31

Graph 4.20 Proportion of Undisbursed Loans to Loan Commitments based on Commercial

Banks Monthly Reports and Bank Survey ........................................................ 32

Graph 4.21 Status of Undisbursed Loan Figures Submitted in Commercial Banks Monthly

Reports (Final or Preliminary) .......................................................................... 32

Graph 4.22 Period for Reporting Elimination of Expired Loan Commitments ...................... 32

Graph 5.1. Estimation of Loan Supply and Demand .......................................................... 38

Graph 5.2. Estimated Contribution by Factors Affecting Loan Supply ................................ 40

Graph 5.3. Relationship between Lending Capacity and Estimated Supply ........................ 40

Graph 5.4. Estimated Contribution by Factors Affecting Loan Demand ............................. 41

Graph 5.5. Projection of Loan Supply and Demand for 2004 ............................................ 42

List of Diagrams and Graphs


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THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Introduction

1.1 Background and Research Objectives

The growing awareness of the importance

of credit in the monetary policy transmission

process is driven among others by concerns over

the impact of financial sector weaknesses, bank

failures, non performing loans, and credit rationing

on the operation of the transmission process (see

e.g., Blinder [1987], Bernanke and Blinder [1988],

Brunner and Meltzer [1988]). In the past,

monetary literature had paid little attention to the

role of credit due to the emergence of monetarist

thinking and the overriding influence of

Keynesian thought on Liquidity Preference that

stresses the importance of money rather than

credit (Gertler [1988]).

Within this context, the escalation in

undisbursed loans over the past three years has

given rise to questions over the performance of

the bank intermediary function and the impact

of undisbursed loans on monetary policy

transmission in Indonesia. Key questions

relevant to this are: whether the escalation in

undisbursed loans is because of reluctance on

the part of banks (the supply side) to engage in

credit expansion or more the result of structural

problems in the real sector that lead to weak

demand; how strong is the impact of rising

undisbursed loans on effectiveness of monetary

policy transmission through the credit channel

and the interest rate channel; and what policy

response would be appropriate to mitigate the

negative impact of undisbursed loans on

monetary policy transmission.

The aswers to each question has different

policy implications, particularly in formulating

the most appropriate monetary policy for

promoting economic recovery without

sacrificing the gains achieved in

macroeconomic stability. This study tries to

answer some of those questions.

1.2 Methodology

Descriptive Analysis Method.

The objective of this method is to obtain

a detailed view (stylized facts) of the

phenomenon of undisbursed loans in terms

of group of banks, currency and purpose of

using credit, as well as in terms of business

sector, scale of business and market

orientation of debtors based on data

compiled by Bank Indonesia from

Commercial Banks Monthly Reports (LBU).

Econometric Method.

- Regression on the function of loan

supply and loan demand.

- Objective is to test the factors

influencing draw down of credit and

the possibility of influence exerted by

asymmetric information over rigidity in

interest rates.

Introduction

1

Chapter


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Introduction

Survey Method.

- Surveys were conducted in the banking

sector, representing the supply side, and

among companies, representing the

demand side. The objective of the twinsurveys was to obtain a picture of factors

driving the increase in undisbursed loans

that could not be identified from analysis

of secondary data.

- The loan supply survey was conducted

with the participation of the top 30 banks

by total loans representing various

categories of banks with head offices inthe Jakarta-Bogor-Tangerang-Bekasi area.

All respondent banks have answered the

questionnaire completely and on time

according to research schedule.

- The loan demand survey was conducted

to 100 companies in the Jakarta-Bogor-

Tangerang-Bekasi area that had

previously received or still held

outstanding bank loans during the past

two years. These companies represented

a range of business sectors: agriculture,

manufacture, mining, trade, construction,

transportation, and business services.

Among the targeted respondents, only 65companies have answered the

questionnaire and on time according to

research schedule.

After Chapter I, the report is divided into

several chapters. Chapter II presents the

analysis framework employed in the research.

Chapter III presents the stylized facts on

undisbursed loans in Indonesia. Chapter IVpresents an empirical study on the factors

influencing undisbursed loans, based on survey

findings. In Chapter V, an empirical study looks

at the factors influencing draw down of loans

based on econometric testing. Finally, Chapter

VI discusses the conclusions and policy

implications of the phenomenon of

undisbursed loans on monetary and banking

policy.


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Analysis Framework

2.1 Undisbursed Loans: Loan Commitments vs.

Draw Down of Credit

A company has two options to meet its

business financing needs (Campbell [1978]). The

first is to solicit financing on the credit market (banks

and non-bank financial institutions) after it is certain

of the amount of funds required and then borrow

and draw down the funds immediately (referred to

in literature as spot lending). In the second option,

the company negotiates and enters into a loan

agreement with a commercial bank before it is

certain of the amount of funds required and the

timeframe for drawing of those funds (forward

lending or loan commitment or line of credit).

Undisbursed loans arise mainly within the

context of forward lending, as these loans are

part of a loan commitment (loan ceiling) provided

by a bank but not drawn by the debtor. Using

this as a basis, undisbursed loans (UL) can be

expressed as the difference between loan

commitments (Q) and draw down of credit (L).

UL = Q L ...............................(2.1)

This simple equation shows that our

understanding of undisbursed loans relies

heavily on our understanding on one hand of

the factors affecting demand and supply of loan

commitments, and on the other hand, of the

factors influencing draw down of credit.

2.2 Factors Influencing Demand and Supply of

Loan Commitments

A loan commitment is a credit facility

providing the debtor with a flexible arrangement

for drawing down the credit, both in timing and

amount, as long as the funds are drawn within

the time frame and maximum loan ceiling

agreed between the debtor and the bank. Loan

commitments thus offer debtors protection

against uncertainties in loan supply over the

contracted period.

Loan commitments may be fixed rate or

floating rate. A fixed rate loan commitment

requires the bank to lend a sum of money over

a certain period at a fixed interest rate. Thus in

addition to protecting the debtor from future

uncertainty in loan supply, this type of loan

commitment also shields the borrower from

volatility in risk premiums and market interest

rates. In contrast, floating rate loan

commitments normally apply an interest rate

based on the formula for the prevailing rate on

risk-free instruments (or prime rate) at the

drawing date plus a relatively fixed premium.

Accordingly, floating rate loan commitments

have characteristics that are identical to fixed

rate loan commitments in terms of protecting

the debtors from loan supply uncertainty, but

with less protection against interest rate

volatility.

Analysis Framework2

Chapter


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Analysis Framework

In view of these characteristics, it is not

surprising that the emerging line of thought

initially concluded that rapid expansion in loan

commitments was the impact of actions by risk-

averse debtors who sought hedging instrumentsagainst various forms of risks.1 In this line of

thought, the risks that have created a need for

loan commitments include the following:

Risk of uncertainty in timing and amount of

funds needed and uncertain availability of

credit to meet these needs (Deshmukh,

Greenbaum, Kanatas [1982]).

Risk of uncertainty in interest rates. Litntner(1976) showed that volume and interest rates

of loan commitments are influenced by

expectations of future levels and variation

in interest rates. In a similar vein, Thakor,

Hong, and Greenbaum (1981) and Thakor

(1982) showed that under conditions of rising

uncertainty over future interest rates, debtors

also faced increased risks, and thus loan

commitments offer greater value or benefit

in the eyes of the debtors.

Risk of credit rationing in the event of a credit

crunch (Avery and Berger [1991]).

Because loan commitments are taken out

only for standby purposes, they are not drawn

in full except under compelling conditions,

leaving opportunity for vast build-up in

undisbursed loans (in literature, this is described

as the partial take-down phenomenon). There

is greater likelihood of expansion in undisbursed

loans during times of uncertainty, because the

situation will escalate the demand for loan

commitments without commensurate increase

in the actual need for funds.

Nevertheless, the argumentation of risk-

aversion and credit rationing offers a lessconvincing explanation for the increasing trend

in loan commitments extended to major

corporate debtors. Large companies are

normally far better positioned than small

companies to diversify their portfolios, and are

thus only moderately affected by credit risk,

interest rate risk, or credit rationing. Thus a new

line of thought emerged demonstrating thatdemand for loan commitments may also come

from risk-neutral or large-scale debtors. This

thought has contributed significantly to

explaining the growth in loan commitments

driven more by the need to conduct transactions

rather than for precautions.

In this line of thought, the rise in demand

for loan commitments does not depend on the

risk preference of the debtor, but on several

factors as follows:

In a situation of asymmetric information, loan

commitments become the preferred form of

loan contract for debtors in financing their

investments regardless of whether there is

any credit rationing (Berkovitch and

Greenbaum [1991]). When a businessman

investing in a multi-year project submits a

credit proposal for financing of that project at

the beginning of the year, he cannot know

with certainty whether the project can be

continued after the first year. Under such

conditions, if the loan agreement is partially

implemented only to finance investment for

the first year, the bank will set a relatively high

1 Many countries are undergoing sustained, rapid growth in loan commit-

ments. In the United States, for example, the proportion of bank loans

extended in the form of loan commitments with a term of less than 1 year

has risen sharply, climbing from about 40% in 1979 to 80% in 1989 (Duca

& Vanhoose [1990]).


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Analysis Framework

risk premium that will in fact heighten the risk

of default. For this reason, it is more beneficial

to the debtor and the bank to enter into a long-

term loan commitment, because availability

of the credit may create greater opportunityfor taking the project forward. In other words,

loan commitments are more efficient than

standard loan agreements (Snyder, 1998).

A loan commitment serves as a tool for the

company to demonstrate its quality to

creditors by virtue of the fact that by having

a loan commitment, the company enjoys a

good quality rating from the bank (Sofianos,Wachtel, Melnik [1990]). Kanatas (1987)

demonstrates that when credit risk cannot

be accurately monitored by creditors, low-

risk companies will seek loan commitments

in order to demonstrate to or inform financial

market creditors of their standing as better

lending prospects (lower risk) compared to

other companies. The low-risk companies

are then able to raise financing on financial

markets on more favorable terms than for

high-risk companies.

An increased demand for funds for short-term

needs with higher frequency of disbursement

will increase demand for loan commitment.

Under conditions like these, the transaction

costs borne by a debtor to make several loan

agreements in stages according to actual

needs are relatively higher than the

transaction costs incurred for getting a loan

commitment at the current time for future

needs (Thakor [1982]).

In line with these two lines of thought,

Campbell (1978) shows that demand for loan

commitments (Qd) is determined by expectations

of funding needs (C), the interest rates charged

by banks on the disbursed portion of loans (p),

and the fees charged by banks on unused loan

commitments (z). Because risk-averse debtors

have a greater risk perception of uncertainty infunding needs than do risk-neutral debtors, there

will be stronger demand for loan commitments

from risk-averse debtors in comparison to those

who are risk-neutral.

Qd=f ( ,p,z)..................................(2.2)

where

and

On the supply side, the optimum level of

loan commitments from the viewpoint of the

bank depends on movement in interest rates,

availability of funding sources to meet these loan

commitments, and debtor behavior in regard to

draw down of credit (Deshmukh, Greenbaum,

Kanatas [1982]). This can all be summed up in

the following equation.

Qs = f([r-c1],c

2,D,,).......................(2.3)

where

Equation (2.3) can be explained as

follows:

Supply of loan commitments (Qs) is positively

correlated to bank expectations of the spread

between lending rates and deposit rates

offered to the public (r c1).

Supply of loan commitments (Qs) is

negatively correlated to bank expectations

dQs

d(r-c1)

dQs

dc2

dQs

dD

dQs

d

dQs

d>0; 0; 0;


21/876


Analysis Framework

of interest rates for non-deposit funds (c2).

This negative correlation arises because the

bank has to allow for the possibility that

future draw down of loan commitments by

customers may exceed the depositor fundsheld by the bank. If this happens, the bank

will be forced to seek other funding sources

to meet these loan commitments.

Supply of loan commitments (Qs) is positively

correlated to bank expectations of

accumulation of depositor funds (D).

When future availability of funding sources

is doubtful, the future movement in fundinginterest rates also becomes uncertain. In this

regard, supply of loan commitments (Qs) is

negatively correlated to bank expectations

of future volatility in funding rates ().

2 The 2003 bank survey conducted by the Directorate of Banking Research

and Regulation (DPNP) also encountered the same line of argument.

Supply of loan commitments (Qs) is negatively

correlated to the degree of uncertainty over

draw down by customers ().

2.3 Factors Influencing Draw Down of CreditAs shown in Equation (2.1), a rise in

undisbursed loans may not only result from

rapid expansion in loan commitments, but

also from weak actual demand for funds.

This weak loan demand is one of the reasons

most frequently cited by bankers on the

underlying causes of the rise in undisbursed

loans (SPPK [2004]) .

2

The analyticalexplanation of this argument is illustrated

by Thakor, Hong, and Greenbaum (1981) in

the following diagram.

In Diagram 2.1, loan demand from

d(B)

L*

r

rmT

rpT

0 B1 B* B

r(B)

Diagram 2.1

Relationship of Undisbursed Loan to Loan Demand


22/877


Analysis Framework

debtors is depicted as curve d(B). The slope

(elasticity) of the demand curve for change in

interest rates becomes flatten when debtors have

a more flexible capital/debt structure and/or

greater access to non-loan sources of financingand wider selection of profitable investment/

business opportunities. Against this, curve r(B)

depicts the supply of alternative sources of

funding. This diagram assumes only three

alternatives of funding sources: very limited

amount of low-cost funds (far left segment),

funding sources in the form of loan commitments

totaling L* at floating interest rate rpT (middlesegment), and other sources of funds such as bank

loans not comprising commitments and carrying

interest at the rate of rmT

(far right segment).

If rmT

is greater than rpT

, debtors can take out

loan commitments in the amount of B* - B1 and

thus undisbursed loans will come to L* - (B* - B1).

Here it becomes evident that the level of

undisbursed loans depends on the condition

of debtor demand for funds (d(B)), interest rate

on loan commitments (rpT

), and interest rates

for alternative sources of funds (rmT

). If the

actual need for funds diminishes, the draw

down of loan funds will also decline and the

level of undisbursed loans will rise. If interest

rates ease for alternative funding sources,

there will also be less draw down because

debtors will opt for alternative sources to meet

some of their needs. In fact, when interest

rates for alternative sources are less than the

rates charged for loan commitments, debtors

will take full advantage of the alternative

sources and will not draw on available lines

of credit. In addition, the level of undisbursed

loans also depends on forward expectations

of interest rates. Expectations of higher rates

result in diminished availability of alternative

funding sources, including the sources of

cheap funds represented by segment to the

left, and the supply curve in the center andright segments will shift toward the left.

Because the demand curve is unchanged, the

shift in the supply curve encourages debtors

to draw down on some of the open loan

commitments and thus reduce the level of

undisbursed loans. There is also one other

factor not presented in the above diagram, that

of commitment fees charged by banks onunused portions of loan commitments. Any

increase in commitment fees will also

encourage debtors to draw down on open loan

commitments (Campbell [1978]).

In this context, even though banks are

unable to restrict the supply of funds that may

be drawn by debtors because of agreed loan

commitments, the bank is still able to exert

indirect influence on the size of draw down

through the setting of loan interest rates (rpT

) and

commitment fee. If a bank for certain reasons

slows the rate of decline in rpT

even in spite of

rapid decline in other rates (downward rigidity

in loan interest rates), it will be difficult to reduce

the level of undisbursed loans. The next question

is: what are the conditions under which banks

seek to restrict movements in loan interest rates?

2.4 Asymmetric Information and Rigidity in

Loan Rates

Under ideal conditions, a bank sets a loan

interest rate on the basis of the risk in the project

to be financed by the loan; at that rate, loan

demand will be equal to loan supply. However,


23/878


Analysis Framework

the effectiveness of interest rates in creating

equilibrium in the credit market depends on the

availability of information on the debtors or

projects to be financed. In reality, this

information is hard for banks to obtain freelyand with assurance of accuracy due to the factor

of asymmetric information, in which debtors are

better informed than banks of the risks in the

projects proposed for loan financing. Debtors

also have the incentive to act for their own

benefit, which is not always in the best interests

of the bank.

Imperfect/asymmetric information canlead to failure of interest rates to achieve

equilibrium between loan demand and loan

supply. One type of this failure occurs when

equilibrium takes place when demand

exceeds supply on the credit market (excess

demand equilibria or credit rationing). This

happens because banks hold back from making

additional credit available, even though debtors

are willing to pay higher rates.

Debtors are only interested in borrowing

from banks if their line of business is capable of

generating profits that exceed the borrowing

rate. Business that carries expectations of high

profits usually carries high risks. Thus when loan

interest rates rise, it is only businesses like these

that have repayment capacity and are interested

in taking out bank loans.

The maximum profit that may be earned

by a bank on a loan to a debtor is only to the

extent of the interest charged for that loan, and

any surplus income that the debtor receives from

the business financed by the loan in excess of

that interest expense belongs to the debtor. Thus

when a debtor opts for a more risky business

with the expectation of earning profits in excess

of the loan interest rate, the bank in fact becomes

wary of lending to that debtor because increased

risk is not balanced by higher returns for thebank. For this reason, banks are reluctant to

expand the credit supply even when debtors are

willing to pay higher rates of interest.

The explanations given above show that

any rise in loan interest rates beyond a certain

threshold that offers maximum profitability

for the bank, i.e., , may lead to adverse

selection and moral hazard that will diminishthe profit expectations of the bank. 3

Accordingly, the return for a bank on its loans,

......., is not a monotonic (unidirectional)

function of the loan interest rate, . This implies

that if , the loan interest rate most profitable

for the bank, is lower than the lending rate that

creates equilibrium between loan demand and

loan supply , , credit rationing will come into

play. This condition is illustrated by Stiglitz and

Weiss (1981) in the following diagram.

In Diagram 2.2, the non-monotonic

relationship between loan interest rates, , and

the banks expectations of returns on its loans,

....., is depicted by the curve in the lower right

quadrant. The lower left quadrant shows that

loan supply curve, Ls, is a positive function of

the banks expectations of returns, . By using

r*

3 As explained by Blundell-Wignall and Gizycki (1992):

When loan interest rates rise, the quality of debtors on the credit market

will decline because the debtors with low-risk projects, which normally

generate low returns, will exit the credit market and the debtors still in

the market will have high-risk projects that nevertheless will also be ca-

pable of earning greater returns. This situation is called adverse selection.

When loan interest rates rise, debtors will be encouraged to take on other

projects carrying higher risks (lower chance of success) because projects

like these generally have potential for higher returns. This situation is

described as moral hazard. The incentive to take on moral hazard is greater

when the cost of bankruptcy shouldered by a debtor is low.

p

p(r)

r*

r

rm

r

p


24/879


Analysis Framework

a 450 line in the upper left quadrant, interaction

between both curves resulted in a loan supply

curve as a function of the loan interest rate, ,

shown in the upper right quadrant together with

loan demand curve, Ld.

In Diagram 2.2, credit rationing (to the

extent ofz) arises because at interest rate, which

represents the level of interest rate offering

expectations of maximum profit for the bank,

loan demand will exceed loan supply. Any bank

that raises its lending rates above will see its

expectations of loan revenues diminish. At the

rate ofrm, loan demand will be equal to loan

supply. However, rm

is not an equilibrium level

of interest rate because it does not generate

maximum profit for the bank. Accordingly, the

excess demand at interest rate represents a state

of equilibrium (excess demand equilibria).

A similar illustration can be used to show

that when loan supply rises, the excess loan

demand (z) will decline but the loan interest rates

charged by the bank will remain unchanged. In

fact, as illustrated in Diagram 2.3, under

conditions of sustained increase in loan supply

(curve Ls( ) shifting to the left), a new

equilibrium will be reached at a point where

loan supply exceeds loan demand (excess supply

equilibria). Despite this, increase in supply will

not prompt any easing in lending rates. Loan

interest rates will remain at , higher than the

interest rates capable of matching supply with

demand, which under these conditions has fallen

to rm1

.

The condition of excess supply equilibria

that brings on downward rigidity in interest rates

can be explained as follows. Under situations of

imperfect/asymmetric information, banks tend to

monopolize information on the quality of their

debtors. If, for example, Bank A attempts to win

over debtors from Bank B by offering a lower

borrowing rate, Bank B will use every means at

its disposal to retain its high quality debtors,

including the offering of even lower rates of

interest, while no such offer will be made to low

Loan

Z

{

Ls

Loan Supply

450

r rm*

Ls

LD

Loan Rate

Expected return

p

r

Diagram 2.2

Excess Demand Equilibria (Credit Rationing)

r p

r*


25/8710


Analysis Framework

quality debtors. The result is that Bank A succeeds

only in winning over the low quality debtors from

Bank B. Thus banks with excess loan supply will

be reluctant to stimulate loan demand by easing

loan interest rates because this will succeed only

in getting low quality debtors. This is a condition

that hampers efforts to lower interest rates and

keeps credit in excess supply.

The previous illustrations show that the

issue of imperfect/asymmetric information is a

reflection of shortcomings in financial markets

that cause banks to hold back in adjusting loan

interest rates (Stiglitz & Greenwald [1993]).

Under the condition of excess demand

equilibria, banks are reluctant to raise their loaninterest rates (upward rigidity), while under the

condition of excess supply equilibria, banks are

reluctant to lower their lending rates (downward

rigidity). When a bank is in trouble (for example,

bankrupt as has happened in Indonesia), the

debtors of that bank are forced to seek financing

from other banks. However, if the other banks

do not have complete information on the quality

of those debtors, the debtors are charged with

higher costs for loans by those banks even when

they are indeed in good standing. In the line of

thought expressed by Sharpe (1990), this situation

may explain why the risk premium remains high

even when the monetary situation has improved.

Based on the various points described

above, Diagram 2.4 presents the analysis

framework used in this research. Empirical testing

of the factors influencing loan commitments is

problematic because the various literatures use

variables that are difficult to observe (see Snyder

[1998]) and much of the data that is required,

such as commitment fees, are not available indata series form. For these reasons, the empirical

analysis of the growth in loan commitments and

the factors influencing these commitments relies

more on descriptive analysis of statistics and the

survey analysis presented in Chapter IV. Added

to this, the existence of excess supply equilibria

or excess demand equilibria and its impact on

Diagram 2.3

Excess Supply Equilibria

Loan

Z}

Ls

Loan Supply

450

Lso

LD

Loan Rate

Ls (p)1 Ls (p)0

LS1

Expected return

p

rm1 rm0r * r


26/8711


Analysis Framework

rigidity of loan interest rates in Indonesia are

tested empirically by estimating the functions of

loan demand and loan supply using a

disequilibrium model presented in Chapter V.

2.5 Relationship between Undisbursed Loans

and Monetary Policy Transmission

In monetary literature, economists have

attempted to identify possibilities of impact from

sharp increases in loan commitments on the

monetary policy transmission process. The general

conclusion is that loan commitments (particularly

the unused portion of loan commitments, or

undisbursed loans) may impede monetary policy

transmission(see the Diagram 2.5). By virtue of

their nature, loan commitments protect debtors

from any sudden drop in loan supply. This means

that banks are unable to make immediate

reductions in loan supply when the central bank

adopts a tighter monetary policy. Accordingly,

loan commitments may reduce the effectiveness

of monetary policy transmission through the credit

Diagram 2.4

Analysis Framework for Undisbursed loans

Undisbursed

LoansRise

Loan Com-mitments Rise

GreaterDemand

GreaterSupply

Actual need for creditis low

Loan interest rates remainhigh

Low interest rates foralternative sources of funds

Expectations of lowerinterest rates

Low commitment fees

Higher standby requirements in face of interest raterisk and funding risks (risk aversion)

Increased expectations of futuretransaction needs (risk neutral)

Broad spread between loan interestrates and funding rates

Flush liquidity in banking system

Greater stability in draw down of credit

Rigidity of loaninterest rates

ExcessSupply

Equilibria

AsymmetricInformation

Delay in drawdown credit

channel (Sofianos, Wachtel, Melnik [1989]). This

is one argument often cited by skeptics concerning

the effectiveness of monetary policy based on

control of the money supply. That condition

follows the same line as the analytical study byDesmukh, Greenbaum, and Kanatas (1982) and

the empirical study by Morgan (1998), which

concludes that monetary policy loses effectiveness

in controlling credit expansion when bank credit

is dominated by loan commitments. These studies

even presented indications that credit expansion

on the basis of loan commitments may in fact

escalate, at least in the short term, at a time of

increase in the Fed Funds rate.

Loan commitments do not necessarily have

to impede monetary transmission if the expanding

loan commitments are floating rate. In this case,

the transmission through the interest rate channel

continues to function, as loan demand remains

sensitive to changes in interest rates (Morgan

[1994]). Although loan commitments at floating

rates do not impede monetary policy transmission


27/8712


Analysis Framework

through the interest rate channel, the overall

effectiveness of monetary transmission through

interest rates still depends on the extent of impact

of asymmetric information on the rigidity of loan

interest rates.In addition, floating rate loan commitments

may also complicate the selection of the most

appropriate monetary strategy. As described by

Duca and Vanhoose (1990), the selection of a

monetary strategy, which according to William

Poole (1970) is solely determined by the

predominant nature of the shocks sustained by

an economy, is also determined by the types andcharacteristics of loan commitments in prevailing

use.4 On one hand, the rise in loan commitments

makes real incomes more sensitive to changes

in interest rates, and in this case the most suitable

strategy is monetary policy based on control of

interest rates. On the other hand, the flexibility

in use of the credit extended under loan

commitments creates a tendency for companies

to become more sensitive to changes in incomes,

and in this case, the most appropriate strategy is

monetary policy based on control of the moneysupply. The final decision on the most

appropriate strategy thus depends on the extent

of flexibility in the use of loans extended by banks

both in terms of lending ceilings and additional

requirements that are imposed on debtors.

In this research, the relationship between

undisbursed loans and monetary policy

transmission is only analyzed theoretically andpartially tested through the linkage between

undisbursed loans and rigidity in interest rates

(Chapter V). Empirical testing of the magnitude

of impact from undisbursed loans on the

effectiveness of monetary policy transmission

is envisaged for a subsequent stage of research.

Undisbursed Loans

Increase

Fixed Rate

Floating Rate

CreditchannelImpeded

Interest ratechannel impeded

CreditchannelImpeded

Interest ratechannel continuesto function

Interest rate channel impeded

Less effective control overmoney supply

Less effective controlover interest rates

Less effective control overmoney supply

Effectiveness of interest

rate control depends on

whether there is rigidityin interest rates and the

extent of flexibility in

draw down of available

Rigidity in loan

interest rates

4 Poole concludes that when an economy faces shocks on the real expendi-

tures side (IS shocks), the more appropriate strategy is monetary policy

based on control of the money supply, as this can produce more stable

movement in real output. Conversely, when an economy faces shocks in

demand for money (LM shocks), the more appropriate strategy is mon-

etary policy based on control of interest rates.

Diagram 2.5

Influence of Undisbursed loans on Monetary Policy Transmission Mechanism


28/8713


Undisbursed Loans in Indonesia:Stylized Facts

Based on observations of data from

Commercial Banks Monthly Reports and survey

findings concerning banks and debtor

companies, the research identified a number of

general characteristics of undisbursed loans in

Indonesia as described below.

3.1 Undisbursed Loans by Purpose of Use,

Group of Bank, and Currency

Commercial Banks Monthly Reports

(LBU) show that the nominal level of

undisbursed loans has steadily risen since 2000

for all purposes of loan use. At the beginning of

2004, undisbursed loans have surpassed pre-

crisis levels, following a temporary drop at the

height of the crisis (1998-1999). During the

period of observation, undisbursed loans were

consistently dominated by working capital

credit. Investment credit had previously

accounted for the second largest proportion of

undisbursed loans, but was overtaken by

consumption credit in early 2000 (Graph 3.1.).

Accordingly, there has been steady

expansion in the overall proportion of

undisbursed loans to loan commitments.5 Before

the economic crisis, this proportion was about

17%, in the end of the crisis declined to about

14% because the government transfered non

performing loans to Indonesian Banking

Restructuring Agency (IBRA), but after the crisis

risen to about 20%. The steepest rise in the

proportion of undisbursed loans has taken place

in working capital credit, which reached about

27% in the first quarter 2004. Meanwhile,

consumption credit and investment credit have

been marked by contrasting trends in the

proportion of undisbursed loans. Following a

significant increase in the wake of the 1997

crisis, the proportion of undisbursed

consumption credit has steadily declined since

mid-2001. This is possibly related to the rapid

growth in consumption over the past three

years, which has encouraged greater use of

consumption lines of credit. In contrast to the

Undisbursed Loans in Indonesia:

Stylized Facts

3

Chapter

5 Because at the time of writing the author was unable to obtain data series

on loan commitments based on information from the commercial banks

monthly reports, the data on loan commitments used in this research was

obtained by means of the formula: Loan Commitments = Loans Outstand-: Loan Commitments = Loans Outstand-: Loan Commitments = Loans Outstand-: Loan Commitments = Loans Outstand-: Loan Commitments = Loans Outstand-

ing + Undisbursed Loansing + Undisbursed Loansing + Undisbursed Loansing + Undisbursed Loansing + Undisbursed Loans.

Graph 3.1

Position ofUndisbursed Loanby Purpose of Use

(billion rupiah)

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Billion Rp

Total Undisbursed LoanWorking Capital CreditInvestment Credit

Consumption Credit


29/8714



movement in consumption credit, theproportion of undisbursed investment credit

dropped steadily after the 1997 crisis until mid-

2001, and has only begun climbing back in

the past three years albeit still short of the pre-

crisis level (Graph 3.2). This could be related

to depressed investment levels during the past

three years. This observation indicates that the

trends in undisbursed loans for consumption

credit and investment credit could be related

to, and thus yield information on trends in

domestic consumption and investment.

As described in Chapter II, the rising

proportion of undisbursed loans to loan

commitments may have resulted from stronger

interest among banks in expanding loan

commitments than increased debtor capacity to

make use of available credit. Based on LBU

data, the keener interest of banks in extending

loan commitments is reflected among others in

the sharp rise in loan commitments for working

capital credit and consumption credit in the

wake of the economic crisis (Graph 3.3).

Working capital credit and especially working

capital lines of credit have the greatest potential

for building up the level of undisbursed loans

by reason of their nature that permits funds to

be drawn on demand according to debtor needs

and customarily without incurring commitment

fees. Furthermore, working capital lines of creditmay also be repaid at any time, in part or in

full, and thus the average total for undisbursed

loans may remain high despite large cumulative

draw down. A similar trend is also observed in

consumption credit for credit card operations.

The result from banks survey shows that working

capital lines of credit remain high at about 40%

of total loan ceiling of working capital credit(Graph 3.4). The same survey shows that credit

cards account for 20% of total loan ceiling of

consumption credit, but at joint venture and

foreign banks, credit card operations represent

as much as 50% (Graph 3.5).

The rise in undisbursed loans as a

proportion of loan commitments may also result

from significant changes in the pattern of draw

down by debtors. After the economic crisis,

debtors became generally more conservative in

making use of the available loan commitments.

However, the increase in the proportion of

Graph 3.2

Proportion ofUndisbursed Loanto Loan

Commitments by Purpose of Use (%)

Graph 3.3

Position of Loan Commitments by Purpose of Use

(billion rupiah)

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

01993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Total Loan Commitments Loan Commitments on Working Capital Credit

Loan Commitments on Investment Credit Loan Commitments on Consumption Credit

Billion Rp

4

9

14

19

24

29

Percent

Proportion of Total UL to Total Loan CommitmentsProportion of UL on Working Capital Credit

Proportion of UL on I nvestment Credit

Proportion of UL on Consumption Credit

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003


30/8715



undisbursed loans over the past two years is not

thought to stem from this factor because the

outcome of a survey of banks and companies

does not indicate any change in the pattern of

draw down over the past two years (Graph 3.6).

In nominal term, LBU data shows that the

rise in undisbursed loans has taken place for all

groups of banks. In volume of undisbursed

loans, domestic private banks are in the lead,

followed by joint venture and foreign banks and

then by state banks (Graph 3.7). However, joint

venture and foreign banks recorded the highest

Graph 3.4 Results of Bank Survey on

Proportion of Various Types of Working Capital Loan

Commitments (%)

Graph 3.5 Results of Bank Survey on

Proportion of Various Types of Consumption Loan

Commitments (%)

Graph 3.6

Results of Bank and Company Surveys on Changes in

Pattern of Credit Drawdown (%)

Graph 3.7

Position of Undisbursed Loan by Group of Bank

(billion rupiah)

growth in undisbursed loans as a proportion of

loan commitments in the past two years, up by

about 5.5 percentage points in comparison to

2-3 percentage points for private banks and state

banks. Accordingly, the proportion of

undisbursed loans to loan commitments at joint

venture and foreign banks reached nearly 40%

in 2004, almost double the approximately 20%

and 15% proportion at domestic private banks

and state banks (Graph 3.8).

Stark differences among the three groups

of banks were also evident in composition of

undisbursed loans by purpose of use. Almost

State Bank

Domestic Private Bank

0

20,000

40,000

60,000

80,000

100,000

120,000

Dec2002

Jan Feb Mar2003

Apr May Jun Jul Aug Sep Oct Nov Dec Jan2004

Feb

Billion Rp

Joint Venture & Foreign Bank

Total Undisbursed Loan

House Ownership Loans Vehicle Ownership Loans

Credit Cards Others

0

10

20

30

40

50

60

70

80Percent

2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003

State Bank DomesticPrivate Bank

Joint Venture &Foreign Bank

All CommercialBank

0

20

40

60

80

100

2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003

Scheduled Line of Credit

Persent

State Bank DomesticPrivate Bank

Joint Venture &Foreign Bank

All CommercialBank

0

20

40

60

80

100

120

Bank Survey Companies Survey

Percent

YES (0%)

NO (100%)

YES

(4.08%)

NO (95,92%)


31/8716



all undisbursed loans at joint venture and foreign

banks were divided between working capitalcredit and consumption credit, while

undisbursed investment credit was negligible

(Graph 3.9). At private domestic banks, working

capital credit accounted for the bulk of

undisbursed loans in contrast to very low figures

for investment credit and consumption credit

(Graph 3.10). At state banks, undisbursed loans

were divided more evenly among the three uses

of credit, despite the predominance of working

capital credit (Graph 3.11).

Significant differences among the three

groups of banks are also evident in the currency

composition of undisbursed loans. At state

banks and private domestic banks, the foreigncurrency portion of undisbursed loans was

relatively small, in contrast to the high

proportion at joint venture and foreign banks

(Graph 3.12). This indicates that undisbursed

loans at joint venture and foreign banks are more

sensitive to exchange rate movements in

comparison to undisbursed loans at state banks

and private domestic banks.

The observations presented above

indicate that for banks (supply side), the rise in

undisbursed loans is related to the

characteristics/business concentration of each

Graph 3.8

Proportion of Undisbursed Loan to Loan Commit-

ments by Group of Bank (%)

0

5

10

15

20

25

30

35

40

Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb

2002 2003 2004

Percent

Proportion of Total UL to Total Loan Commitments Proportion of UL at State Bank

Proportion of UL at Domestic Private Bank Proportion of UL at Joint Venture & Foreign Bank

Graph 3.9

Composition of Undisbursed Loan at Joint Venture

and Foreign Bank by Purpose of Use (%)

Graph 3.10

Composition of Undisbursed Loan at Domestic

Private Bank by Purpose of Use (%)

0

20

40

60

80

100Percent

Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb2002 2003 2004

Working Capital Credit Investment Credit Consumption Credit

0

20

40

60

80

100Percent



Graph 3.11

Composition of Undisbursed Loan at State Bank by

Purpose of Use (%)

0

20

40

60

80

100Percent




32/8717



bank category. Foreign banks, which have

concentrated their business more in retail/

consumer banking, tend to operate more in

lending that involves greater levels of

commitments, such as working capital credit

and consumption credit (including credit cards),

and are thus most likely to experience growth

in undisbursed loans. Conversely, at state banks

a significantalbeit in post-crisis years not

dominantproportion of lending is for

investment credit, which is less characterized

by loan commitments in comparison to the other

two categories of loan use, and this has

constrained expansion in undisbursed loans.

3.2 Undisbursed Loans by Sector, Scale of

Business, and Market Orientation of Debtors

Based on LBU data, there are indications

that in the post-crisis period, a high and

expanding proportion of undisbursed loans to

loan commitments (above 20%) is found in the

tradable sectors and/or sectors more sensitive

to economic cycles, such as trade, manufacture,

construction, mining, and business services

(Graph 3.13 and Graph 3.14).

Graph 3.12

Proportion of Undisbursed Loan in Foreign Currency

by Category of Bank (%)

The result from company survey shows that

medium-scale debtors (annual bussiness turnover

between Rp1 10 billion) tend to have a higher

proportion of undisbursed loans to loan

commitments in comparison to small-scale debtors

(annual business turnover under Rp1 billion) and

large-scale debtors (annual business turnover

above Rp10 billion) (Graph 3.15). This is possibly

explained by the impact of the economic crisis

that plunged many of the major corporations

ones that used to be prime debtors into severe

difficulties and even bankruptcy (some taken over

by Indonesian Banking Restructuring Agency/

Graph 3.13

Proportion of Undisbursed Loan to Loan

Commitments by Business Sector Part 1

Mining Manufacture Construction Trade Busines Services

10

12

14

1618

20

22

24

26

28

30

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Percent

Graph 3.14.

Proportion of Undisbursed Loan to Loan

Commitments by Business Sector Part 2

Agriculture Transportation Others

Electricity, Gas & Water Social Services

0

5

10

15

20

25

30

Percent

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

0

20

40

Percent


State Bank Join Venture & Foreign Bank Domestic Private Bank

60


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IBRA). Banks have thus become wary of extending

major loan commitments to such companies.

Under these conditions, banks are forced to make

small and medium enterprises the focus of their

credit expansion. Even so, the proportion ofundisbursed loans for small-scale debtors is lower

than for medium-scale debtors, possibly because

their high level of business turnover encourages

them to make better use of available lines of credit.

The survey also indicates that export-

oriented debtors hold a larger proportion of

Graph 3.15Proportion of Undisbursed Working Capital Loans to

Working Capital Loan Commitments by Scale of

Business Survey Findings

Graph 3.16Proportion of Undisbursed Working Capital Loans to

Working Capital Loan Commitments by Market

Orientation Survey Findings

undisbursed loans against loan commitments in

comparison to debtors operating on the

domestic market (Graph 3.16). This may very

well be linked to the flagging performance of

Indonesias exports.The observation of trends in undisbursed

loans from the debtor (demand) side indicate

that the phenomenon of rising undisbursed loans

is closely linked to sensitivity of business sectors

to economic cycles, scale of business and

market orientation of the debtors themselves.

0

10

20

30

40

50

60

2001 2002 2003 2001 2002 2003 2001 2002 2003

Small Scale(Less than Rp 1 billion )

Medium Scale(Rp 1 billion - Rp 10 billion)

Large Scale(More Than Rp 10 Billion)

Percent

0

5

10

15

20

25

30

35

2001 2002 2003 2001 2002 2003

Export Oriented Domestic Oriented

Percent


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Factors Influencing Undisbursed Loans:Survey Findings

Based on the analysis framework and

stylized facts presented in Chapters II and III,

the phenomenon of increased undisbursed loans

is thought to result from rapid expansion in loan

commitments without commensurate rise in

draw down of credit. The direction of movement

in loan commitments and draw down depends

on the conditions faced by debtors (demand)

and banks (supply). This chapter presents an

analysis of the factors influencing undisbursed

loans, based on surveys of companies and

banks.6

4.1 Factors Influencing Undisbursed Loans from

the Demand Side

Demand for Loan Commitments Driven More

by Standby Needs

Survey findings indicate that the rise in

demand for loan commitments is driven more

by the need for standby arrangements in the face

of day-to-day uncertainties in need and supply

of funds, rather than precisely measured or

planned requirements. This observation is,

among others, reflected in:7

Most of the loan commitments (about 70%)

obtained by respondent companies

comprised working capital credit, which has

greater flexibility in intended use, rather than

investment credit and consumption credit

(Table 4.1). About 60% of the loan

commitments obtained by respondent

companies comprised loans that could be

drawn down on demand (lines of credit).

Medium enterprises, which accounted for

the highest proportion of undisbursed loans

(see Graph 3.15), held the largest portion of

lines of credit (Table 4.2). The sizable

proportion of working capital credit and lines

of credit indicates substantial need for

standby loans to counter uncertainty in the

day-to-day supply of funds.

About 54% of respondent companies have

opened new loan commitments accounts in

the past two years at the same banks or at

other banks. Two of the three most dominant

reasons for opening new loan accounts are

related to standby needs, namely to maintain

adequate levels of liquidity and provide for

easier management of company operations

(Graph 4.1).

Lack of Capacity and Interest Among Debtors

in Utilizing Loan Commitments

Despite the sharp rise in demand for new

loan commitments, the mounting trend in volume

Factors Influencing Undisbursed Loans:

Survey Findings

4

Chapter

6 The respondent profile, company survey questionnaire, and bank survey

questionnaire are presented in Appendices 1, 2, and 3.

7 For responses based on scale of priority, the survey was analyzed by assign-

ing the highest score to the answers indicated as leading priority and the

lowest score to responses indicated as least priority. These scores were

then multiplied by the number of respondents selecting one of the factors

as a priority and then an average calculated for all incoming samples. The

highest average indicated the leading priority according to the respondents.


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Types of Small Medium Large TotalCredit Enterprises Enterprises Enterprises

2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003

WCC 100,0 75,0 66,7 96,0 87,0 96,5 63,4 70,8 68,6 70,4 74,1 73,3CC - - - - - - 0,8 1,5 2,1 0,6 1,1 1,7

IC - 25,0 33,3 4,0 13,0 3,5 35,8 27,7 29,3 29,0 24,8 25,0

Table 4.1 Composition of Loan Commitments Obtained

by Respondent Companies, Disaggregated by Purpose of Use (%)

Type of Small Medium Large TotalDisbursement Enterprises Enterprises Enterprises

Can be Drawn anytime 60,00 72,73 57,92 60,55

Requires prior notice 40,00 27,27 42,08 39,45

Table 4.2 Composition of Loan Commitments Obtained by Respondent Companies,

Disaggregated by Types of Drawdown (%)

Graph 4.1

Reasons Cited by Respondent Companies for Opening New Loan Commitments Accounts

0 10 20 30 40 50Percent

Provide projects financing

Keep company liquidity

Others

Ease company operations

Aggressive credit promotion

0 10 20 30 40 50Percent





Others

0 10 20 30 40Percent




Aggressive creditpromotion

Others

0 10 20 30 40Percent




Others


Small Enterprises Medium Enterprises

Large Enterprises All Companies


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and proportion of undisbursed loans over the past

three years points to low capacity and interest

among debtors in using these loan commitments.

Among the three groups of respondent companies,

the primary cause for low use of loan commitmentsvaries widely. However, the factor of persistently

high interest rates consistently figured in the two

main reasons cited by each of the debtor groups

(Graph 4.2). Among small enterprises, the two

most important factors in undisbursed loans were

rising debt burdens and persistently high loan

interest rates. For medium enterprises, the main

reasons were downturns in the business cycleand high loan interest rates. Among major

companies, the availability of alternative funding

sources and continued high loan interest rates

were the primary reasons for low draw down of

available loan commitments.

Analyzed in greater depth, the

consolidated survey findings regarding factors

that diminish the capacity or interest of debtorsin making use of available loan commitments

can be described as follows:

Adverse business conditions and internal

financial condition of debtors. In general,

respondent companies have been

The Bank Intermediary Function and ed Loans Phenomenon

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