3

THE BANK INTERMEDIARY FUNCTION

AND UNDISBURSED LOANS PHENOMENON

Causes and Policy Implications

Doddy Zulverdi
M. Firdauz Muttaqin
Nugroho Joko Prastowo

Directorate of Economic Research and Monetary Policy

Bank Indonesia
2004
Corespondence Address:

Directorate of Economic Research and Monetary Policy

BANK INDONESIA
Bank Indonesia Office, Tower B, 19th floor
Jl. MH. Thamrin No.2, Jakarta 10010 Indonesia

Phone : +62 21 381 7733

: +62 31 381 8627
Fax. : +62 21 350 2030
E-mail : dzulverdi@bi.go.id

ISBN No : 979-96680-1-8
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.
 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

Foreword
i

The Bank Intermediary Function and Undisbursed Loans Phenomenon:
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
III
Executive Summary
Causes and Policy Implications
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 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 loan
commitments, 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 attached
to 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 bank‘s
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.
Executive Summary
IV
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.
• 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 and
availability 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, their
understanding 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
V
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 intermediation
need 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 of
transactions 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.
Executive Summary
 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 vs Draw 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 Findings

4.1 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

DaftarofIsiContents
Table
vii
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 Daftar
Contents
Isi
viii
 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 Credit
Expansion 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

Daftar
List of Tables
Isi
ix
Daftar Isi
x
 List of Diagrams
and Graphs

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
of
Use ................................................................ ............................................. 16
Graph 3.11 Composition of Undisbursed Loans at State Banks by Purpose
of
Use ..... ..... 16
Graph 3.12 Proportion of Undisbursed Loans in Foreign Currencies by Group of
Bank ...... 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 Scale
of
Business - Survey Findings .... ................................. 18
Graph 3.16 Proportion of Undisbursed Working Capital Loans to Working Capital Loan
Commitments by Market
Orientation - Survey Findings ................................... 18

Daftar
List of Diagrams
Isi and Graphs
xi
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

of
Loan Agreement .......................................................................................... 30
Graph 4.16 Respons Taken by Respondent Companies regarding Undisbursed Loans ........ 30
Graph 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

Daftar
Graphs
Isi
xii
Chapter
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
1 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
1
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
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
• Survey Method.
- Surveys were conducted in the banking
sector, representing the supply side, and
among companies, representing the
demand side. The objective of the twin
surveys 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 in
the 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
Introduction
2
two years. These companies represented
a range of business sectors: agriculture,
manufacture, mining, trade, construction,
transportation, and business services.
Among the targeted respondents, only 65
companies 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 IV
presents 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.
Chapter
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
2 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.
3
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 Framework
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
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 instruments
against 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
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]).
Analysis Framework
4
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 less
convincing 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 that
demand 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
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

risk premium that will in fact heighten the risk ˜ the interest rates charged
of funding needs (C),
of default. For this reason, it is more beneficial by banks on the disbursed portion of loans (p),
to the debtor and the bank to enter into a long- and the fees charged by banks on unused loan
term loan commitment, because availability commitments (z). Because risk-averse debtors
of the credit may create greater opportunity have a greater risk perception of uncertainty in
for taking the project forward. In other words, funding needs than do risk-neutral debtors, there
loan commitments are more efficient than will be stronger demand for loan commitments
standard loan agreements (Snyder, 1998). from risk-averse debtors in comparison to those
• A loan commitment serves as a tool for the who are risk-neutral.
company to demonstrate its quality to Qd=f (C̃,p,z)..................................(2.2)
creditors by virtue of the fact that by having
a loan commitment, the company enjoys a where d Qd >0;
d Qd<0; d Qd<0
dC̃ dp dz
good quality rating from the bank (Sofianos,
Wachtel, Melnik [1990]). Kanatas (1987) and Qdrisk-averse >Qdrisk-neutral
demonstrates that when credit risk cannot
be accurately monitored by creditors, low- On the supply side, the optimum level of
risk companies will seek loan commitments loan commitments from the viewpoint of the
in order to demonstrate to or inform financial bank depends on movement in interest rates,
market creditors of their standing as better availability of funding sources to meet these loan
lending prospects (lower risk) compared to commitments, and debtor behavior in regard to
other companies. The low-risk companies draw down of credit (Deshmukh, Greenbaum,
are then able to raise financing on financial Kanatas [1982]). This can all be summed up in
markets on more favorable terms than for the following equation.
high-risk companies. Qs = f([r-c1],c2,D,σ,ϑ).......................(2.3)
• An increased demand for funds for short-term
needs with higher frequency of disbursement where
will increase demand for loan commitment. dQs dQs dQs dQs dQs
>0; <0; >0; <0; <0
Under conditions like these, the transaction d(r-c1) dc2 dD dσ dϑ
costs borne by a debtor to make several loan
agreements in stages according to actual Equation (2.3) can be explained as
needs are relatively higher than the follows:
transaction costs incurred for getting a loan • Supply of loan commitments (Qs) is positively
commitment at the current time for future correlated to bank expectations of the spread
needs (Thakor [1982]). between lending rates and deposit rates
In line with these two lines of thought, offered to the public (r – c1).
Campbell (1978) shows that demand for loan • Supply of loan commitments (Q s ) is
commitments (Qd) is determined by expectations negatively correlated to bank expectations

Analysis Framework
5
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

of interest rates for non-deposit funds (c2). • Supply of loan commitments (Qs) is negatively
This negative correlation arises because the correlated to the degree of uncertainty over
bank has to allow for the possibility that draw down by customers (θ).
future draw down of loan commitments by
customers may exceed the depositor funds 2.3 Factors Influencing Draw Down of Credit
held by the bank. If this happens, the bank As shown in Equation (2.1), a rise in
will be forced to seek other funding sources undisbursed loans may not only result from
to meet these loan commitments. rapid expansion in loan commitments, but
• Supply of loan commitments (Qs) is positively also from weak actual demand for funds.
correlated to bank expectations of This weak loan demand is one of the reasons
accumulation of depositor funds (D). most frequently cited by bankers on the
• When future availability of funding sources underlying causes of the rise in undisbursed
is doubtful, the future movement in funding loans (SPPK [2004]).2 The analytical
interest rates also becomes uncertain. In this explanation of this argument is illustrated
regard, supply of loan commitments (Qs) is by Thakor, Hong, and Greenbaum (1981) in
negatively correlated to bank expectations the following diagram.
of future volatility in funding rates (σ). In Diagram 2.1, loan demand from

Diagram 2.1
Relationship of Undisbursed Loan to Loan Demand

d(B)
r

L*

rmT r(B)

rpT

0 B1 B* B

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

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

Analysis Framework
6
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
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 financing
and 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 (middle
segment), 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
7
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 and
right 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 on
unused 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,
Analysis Framework
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
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 freely
and 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 can
lead 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
Analysis Framework
8
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 the
bank. 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., r̂ * , may lead to adverse
selection and moral hazard that will diminish
3
the profit expectations of the bank.
Accordingly, the return for a bank on its loans,
– ˆ is not a monotonic (unidirectional)
.......,
p(r)
function of the loan interest rate, r̂ . This implies
that if r̂ *, the loan interest rate most profitable
for the bank, is lower than the lending rate that
creates equilibrium between loan demand and
loan supply , rm , 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, r̂ , and
the bank’s expectations of returns on its loans,
–
.....,
p 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 bank’s expectations of returns, p . By using
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.
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
Diagram 2.2
Excess Demand Equilibria (Credit Rationing)
Loan
Z
{
0
45
Ls
Loan Supply
p
Expected return
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, r̂ ,
shown in the upper right quadrant together with
d
loan demand curve, L .
In Diagram 2.2, credit rationing (to the
extent of z) 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 of rm, 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
9
Ls
LD
Loan Rate
r* rm r
fact, as illustrated in Diagram 2.3, under
conditions of sustained increase in loan supply
(curve L s ( p– ) 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 r̂ , 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
Analysis Framework
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
Diagram 2.3
Excess Supply Equilibria
Loan
0
45
Ls
rm1
Loan Supply
Ls (p)1 Ls (p)0
p
Expected return
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 loan
interest 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
Analysis Framework
10
} Z LS1
Lso
LD
Loan Rate
r* rm0 r
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 in
data 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
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

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
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 by
Desmukh, 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

Diagram 2.4
Analysis Framework for Undisbursed loans

Higher standby requirements in face of interest rate

Greater risk and funding risks (risk aversion)
Demand Increased expectations of future
Loan Com- transaction needs (risk neutral)
mitments Rise Broad spread between loan interest
rates and funding rates
Greater Flush liquidity in banking system
Supply
Undisbursed Greater stability in draw down of credit
Loans Rise
Actual need for credit
is low
Rigidity of loan Excess Asymmetric
Loan interest rates remain Supply
high interest rates Information
Delay in draw Equilibria
down credit Low interest rates for
alternative sources of funds
Expectations of lower
interest rates
Low commitment fees

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
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

Analysis Framework
11
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

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 and
characteristics 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
Diagram 2.5
Influence of Undisbursed loans on Monetary Policy Transmission Mechanism
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 money
supply. 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 and
partially 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.

Credit Less effective control over

channel money supply
Impeded
Fixed Rate
Interest rate Less effective control
channel impeded over interest rates
Undisbursed Loans
Increase Credit
channel Less effective control over
Floating Rate Impeded money supply

Interest rate Effectiveness of interest

channel continues rate control depends on
to function whether there is rigidity
in interest rates and the
extent of flexibility in
draw down of available
Rigidity in loan
interest rates Interest rate channel impeded

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.

Analysis Framework
12
Chapter
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

3 Undisbursed Loans in Indonesia:

Stylized Facts
Based on observations of data from 17%, in the end of the crisis declined to about
Commercial Banks’ Monthly Reports and survey 14% because the government transfered non
findings concerning banks and debtor performing loans to Indonesian Banking
companies, the research identified a number of Restructuring Agency (IBRA), but after the crisis
general characteristics of undisbursed loans in risen to about 20%. The steepest rise in the
Indonesia as described below. proportion of undisbursed loans has taken place
in working capital credit, which reached about
3.1 Undisbursed Loans by Purpose of Use, 27% in the first quarter 2004. Meanwhile,
Group of Bank, and Currency consumption credit and investment credit have
Commercial Banks‘ Monthly Reports been marked by contrasting trends in the
(LBU) show that the nominal level of proportion of undisbursed loans. Following a
undisbursed loans has steadily risen since 2000 significant increase in the wake of the 1997
for all purposes of loan use. At the beginning of crisis, the proportion of undisbursed
2004, undisbursed loans have surpassed pre- consumption credit has steadily declined since
crisis levels, following a temporary drop at the mid-2001. This is possibly related to the rapid
height of the crisis (1998-1999). During the growth in consumption over the past three
period of observation, undisbursed loans were years, which has encouraged greater use of
consistently dominated by working capital consumption lines of credit. In contrast to the
credit. Investment credit had previously
Billion Rp
accounted for the second largest proportion of 160,000
140,000
undisbursed loans, but was overtaken by
120,000
consumption credit in early 2000 (Graph 3.1.). 100,000
Accordingly, there has been steady 80,000

expansion in the overall proportion of 60,000

40,000
undisbursed loans to loan commitments.5 Before
20,000
the economic crisis, this proportion was about 0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Working Capital Credit Consumption Credit
Investment Credit Total Undisbursed Loan
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
Graph 3.1
obtained by means of the formula:: Loan Commitments = Loans Outstand- Position of Undisbursed Loan by Purpose of Use
ing + Undisbursed Loans
Loans. (billion rupiah)

Undisbursed Loans in Indonesia:

13 Stylized Facts
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
Percent
29
24
19
14
9 may also be repaid at any time, in part or in
4
1993 1994 1995 1996 1997 1998 1999
Proportion of Total UL to Total Loan Commitments
Proportion of UL on Working Capital Credit
Graph 3.2
Proportion of Undisbursed Loan to Loan
Commitments by Purpose of Use (%)
movement in consumption credit, the
proportion 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
Undisbursed Loans in Indonesia:
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 credit
full, and thus the average total for undisbursed
2000 2001 2002 2003
Proportion of UL on Investment Credit loans may remain high despite large cumulative
Proportion of UL on Consumption Credit
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
Billion Rp
900,000
800,000
700,000
600,000
500,000
400,000
300,000
200,000
100,000
0
1993 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
Graph 3.3
Position of Loan Commitments by Purpose of Use
(billion rupiah)
Stylized Facts 14
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Persent Percent
100 120
Scheduled Line of Credit NO (100%)
NO (95,92%)
100
80

80
60
60
40
40

20 YES
20
(4.08%)
YES (0%)
0 0
2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003
Bank Survey Companies Survey
State Bank Domestic Joint Venture & All Commercial
Private Bank Foreign Bank Bank
Graph 3.6
Graph 3.4 Results of Bank Survey on Results of Bank and Company Surveys on Changes in
Proportion of Various Types of Working Capital Loan Pattern of Credit Drawdown (%)
Commitments (%)
growth in undisbursed loans as a proportion of
undisbursed loans over the past two years is not loan commitments in the past two years, up by
thought to stem from this factor because the about 5.5 percentage points in comparison to
outcome of a survey of banks and companies 2-3 percentage points for private banks and state
does not indicate any change in the pattern of banks. Accordingly, the proportion of
draw down over the past two years (Graph 3.6). undisbursed loans to loan commitments at joint
In nominal term, LBU data shows that the venture and foreign banks reached nearly 40%
rise in undisbursed loans has taken place for all in 2004, almost double the approximately 20%
groups of banks. In volume of undisbursed and 15% proportion at domestic private banks
loans, domestic private banks are in the lead, and state banks (Graph 3.8).
followed by joint venture and foreign banks and Stark differences among the three groups
then by state banks (Graph 3.7). However, joint of banks were also evident in composition of
venture and foreign banks recorded the highest undisbursed loans by purpose of use. Almost

Billion Rp
Percent 120,000
80
House Ownership Loans Vehicle Ownership Loans 100,000
70
Credit Cards Others
60 80,000
50
60,000
40

30 40,000

20 20,000
10
0
0 Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb
2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003 2002 2003 2004
State Bank Domestic Joint Venture & All Commercial State Bank Joint Venture & Foreign Bank
Private Bank Foreign Bank Bank Domestic Private Bank Total Undisbursed Loan

Graph 3.5 Results of Bank Survey on

Graph 3.7
Proportion of Various Types of Consumption Loan
Position of Undisbursed Loan by Group of Bank
Commitments (%)
(billion rupiah)

Undisbursed Loans in Indonesia:

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

Percent Percent
40 100
35

30 80

25
60
20

15
40
10

5
20
0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb
2002 2003 2004 0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb
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
2002 2003 2004
Working Capital Credit Investment Credit Consumption Credit

Graph 3.8 Graph 3.10

Proportion of Undisbursed Loan to Loan Commit- Composition of Undisbursed Loan at Domestic
ments by Group of Bank (%) Private Bank by Purpose of Use (%)

all undisbursed loans at joint venture and foreign composition of undisbursed loans. At state
banks were divided between working capital banks and private domestic banks, the foreign
credit and consumption credit, while currency portion of undisbursed loans was
undisbursed investment credit was negligible relatively small, in contrast to the high
(Graph 3.9). At private domestic banks, working proportion at joint venture and foreign banks
capital credit accounted for the bulk of (Graph 3.12). This indicates that undisbursed
undisbursed loans in contrast to very low figures loans at joint venture and foreign banks are more
for investment credit and consumption credit sensitive to exchange rate movements in
(Graph 3.10). At state banks, undisbursed loans comparison to undisbursed loans at state banks
were divided more evenly among the three uses and private domestic banks.
of credit, despite the predominance of working The observations presented above
capital credit (Graph 3.11). indicate that for banks (supply side), the rise in
Significant differences among the three undisbursed loans is related to the
groups of banks are also evident in the currency characteristics/business concentration of each
Percent Percent
100 100

80 80

60 60

40 40

20 20

0 0
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb
2002 2003 2004 2002 2003 2004
Working Capital Credit Investment Credit Consumption Credit Working Capital Credit Investment Credit Consumption Credit

Graph 3.9 Graph 3.11

Composition of Undisbursed Loan at Joint Venture Composition of Undisbursed Loan at State Bank by
and Foreign Bank by Purpose of Use (%) Purpose of Use (%)

Undisbursed Loans in Indonesia:

Stylized Facts 16
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Percent Percent
30
28
60
26
24
22
40
20
18
20 16
14
12
0 10
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
2002 2003 2004
State Bank Join Venture & Foreign Bank Domestic Private Bank Mining Manufacture Construction Trade Busines Services

Graph 3.12 Graph 3.13

Proportion of Undisbursed Loan in Foreign Currency Proportion of Undisbursed Loan to Loan
by Category of Bank (%) Commitments by Business Sector – Part 1

bank category. Foreign banks, which have The result from company survey shows that
concentrated their business more in retail/ medium-scale debtors (annual bussiness turnover
consumer banking, tend to operate more in between Rp1 – 10 billion) tend to have a higher
lending that involves greater levels of proportion of undisbursed loans to loan
commitments, such as working capital credit commitments in comparison to small-scale debtors
and consumption credit (including credit cards), (annual business turnover under Rp1 billion) and
and are thus most likely to experience growth large-scale debtors (annual business turnover
in undisbursed loans. Conversely, at state banks above Rp10 billion) (Graph 3.15). This is possibly
a significant—albeit in post-crisis years not explained by the impact of the economic crisis
dominant—proportion of lending is for that plunged many of the major corporations –
investment credit, which is less characterized ones that used to be prime debtors – into severe
by loan commitments in comparison to the other difficulties and even bankruptcy (some taken over
two categories of loan use, and this has by Indonesian Banking Restructuring Agency/
constrained expansion in undisbursed loans.
Graph 3.14.
Proportion of Undisbursed Loan to Loan
3.2 Undisbursed Loans by Sector, Scale of Commitments by Business Sector – Part 2
Business, and Market Orientation of Debtors Percent
30
Based on LBU data, there are indications
25
that in the post-crisis period, a high and
20
expanding proportion of undisbursed loans to
15
loan commitments (above 20%) is found in the
10
tradable sectors and/or sectors more sensitive
5
to economic cycles, such as trade, manufacture,
0
construction, mining, and business services 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Agriculture Transportation Others
(Graph 3.13 and Graph 3.14). Electricity, Gas & Water Social Services

Undisbursed Loans in Indonesia:

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

IBRA). Banks have thus become wary of extending undisbursed loans against loan commitments in
major loan commitments to such companies. comparison to debtors operating on the
Under these conditions, banks are forced to make domestic market (Graph 3.16). This may very
small and medium enterprises the focus of their well be linked to the flagging performance of
credit expansion. Even so, the proportion of Indonesia’s exports.
undisbursed loans for small-scale debtors is lower The observation of trends in undisbursed
than for medium-scale debtors, possibly because loans from the debtor (demand) side indicate
their high level of business turnover encourages that the phenomenon of rising undisbursed loans
them to make better use of available lines of credit. is closely linked to sensitivity of business sectors
The survey also indicates that export- to economic cycles, scale of business and
oriented debtors hold a larger proportion of market orientation of the debtors themselves.

Percent Percent
60 35

30
50
25
40
20
30
15
20
10

10 5

0 0
2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003
Small Scale Medium Scale Large Scale Export Oriented Domestic Oriented
(Less than Rp 1 billion ) (Rp 1 billion - Rp 10 billion) (More Than Rp 10 Billion)

Graph 3.15 Graph 3.16

Proportion of Undisbursed Working Capital Loans to Proportion of Undisbursed Working Capital Loans to
Working Capital Loan Commitments by Scale of Working Capital Loan Commitments by Market
Business – Survey Findings Orientation – Survey Findings

Undisbursed Loans in Indonesia:

Stylized Facts 18
Chapter
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

4 Factors Influencing Undisbursed Loans:

Survey Findings
Based on the analysis framework and obtained by respondent companies
stylized facts presented in Chapters II and III, comprised working capital credit, which has
the phenomenon of increased undisbursed loans greater flexibility in intended use, rather than
is thought to result from rapid expansion in loan investment credit and consumption credit
commitments without commensurate rise in (Table 4.1). About 60% of the loan
draw down of credit. The direction of movement commitments obtained by respondent
in loan commitments and draw down depends companies comprised loans that could be
on the conditions faced by debtors (demand) drawn down on demand (lines of credit).
and banks (supply). This chapter presents an Medium enterprises, which accounted for
analysis of the factors influencing undisbursed the highest proportion of undisbursed loans
loans, based on surveys of companies and (see Graph 3.15), held the largest portion of
6
banks. lines of credit (Table 4.2). The sizable
proportion of working capital credit and lines
4.1 Factors Influencing Undisbursed Loans from of credit indicates substantial need for
the Demand Side standby loans to counter uncertainty in the
Demand for Loan Commitments Driven More day-to-day supply of funds.
by Standby Needs • About 54% of respondent companies have
Survey findings indicate that the rise in opened new loan commitments accounts in
demand for loan commitments is driven more the past two years at the same banks or at
by the need for standby arrangements in the face other banks. Two of the three most dominant
of day-to-day uncertainties in need and supply reasons for opening new loan accounts are
of funds, rather than precisely measured or related to standby needs, namely to maintain
planned requirements. This observation is, adequate levels of liquidity and provide for
7
among others, reflected in: easier management of company operations
• Most of the loan commitments (about 70%) (Graph 4.1).

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

questionnaire are presented in Appendices 1, 2, and 3. Lack of Capacity and Interest Among Debtors
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 in Utilizing Loan Commitments
lowest score to responses indicated as least priority. These scores were
then multiplied by the number of respondents selecting one of the factors Despite the sharp rise in demand for new
as a priority and then an average calculated for all incoming samples. The
highest average indicated the leading priority according to the respondents. loan commitments, the mounting trend in volume

Factors Influencing Undisbursed Loans:

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

Table 4.1 Composition of Loan Commitments Obtained

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

Types of Small Medium Large Total

Credit 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 73,3
CC - - - - - - 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 4.2 Composition of Loan Commitments Obtained by Respondent Companies,

Disaggregated by Types of Drawdown (%)
Type of Small Medium Large Total
Disbursement 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

Small Enterprises Medium Enterprises

Aggressive credit promotion Others

Ease company operations Aggressive credit promotion

Others Ease company operations

Keep company liquidity Keep company liquidity

Provide projects financing Provide projects financing

0 10 20 30 40 50 0 10 20 30 40 50
Percent Percent

Large Enterprises All Companies

Others Aggressive credit promotion

Aggressive credit Others

promotion

Keep company liquidity Keep company liquidity

Ease company operations Ease company operations

Provide projects financing Provide projects financing

0 10 20 30 40 0 10 20 30 40
Percent Percent

Graph 4.1
Reasons Cited by Respondent Companies for Opening New Loan Commitments Accounts

Factors Influencing Undisbursed Loans:

Survey Findings 20
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

and proportion of undisbursed loans over the past were the primary reasons for low draw down of
three years points to low capacity and interest available loan commitments.
among debtors in using these loan commitments. Analyzed in greater depth, the
Among the three groups of respondent companies, consolidated survey findings regarding factors
the primary cause for low use of loan commitments that diminish the capacity or interest of debtors
varies widely. However, the factor of persistently in making use of available loan commitments
high interest rates consistently figured in the two can be described as follows:
main reasons cited by each of the debtor groups • Adverse business conditions and internal
(Graph 4.2). Among small enterprises, the two financial condition of debtors. In general,
most important factors in undisbursed loans were respondent companies have been confronted
rising debt burdens and persistently high loan with suboptimal capacity utilization and
interest rates. For medium enterprises, the main high debt levels with increasing trend. The
reasons were downturns in the business cycle mounting debt burdens are mostly faced by
and high loan interest rates. Among major large companies, while the low capacity of
companies, the availability of alternative funding utilization are experienced by small and
sources and continued high loan interest rates medium enterprises. Small enterprises have

Small Enterprises Medium Enterprises

Inadequate capital Mounting debt burden
Tightened procedures Inadequate capital

Downturn in business cycle Tightened procedures

Deteriorating business prospects Deteriorating business prospects

Alternative sources of financing*) Declining production capacity

Mounting debt burden Alternative sources of financing*)

Declining production capacity Loan rates still high

Loan rates still high Downturn in business cycle

0 20 40 60 80 100 0 10 20 30 40
Percent Percent

Large Enterprises All Companies

Deteriorating business prospects Inadequate capital

Inadequate capital Tightened procedures

Tightened procedures Deteriorating business prospects

Mounting debt burden Mounting debt burden
Others Others

Declining production capacity Declining production capacity

Downturn in business cycle Downturn in business cycle
Loan rates still high Alternative sources of financing*)

Alternative sources of financing*) Loan rates still high

0 10 20 30 40 50 0 10 20 30 40 50
Persent Percent
*) including internal cashflow

Graph 4.2
Causes of Undisbursed Loan from Viewpoint of Respondent Companies

Factors Influencing Undisbursed Loans:

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

also experienced low profitability (Table
4.3). Business sectors marked by high levels
of undisbursed loans, such as mining,
manufacture, construction, and trade, are
sectors that carry heavy burdens of debt
(Table 4.4).
• Deteriorating prospects. The five major
factors as reasons for deteriorating prospects
cited by respondent companies are slower
than expected growth in demand,
unsupportive social and political tensions
and security problems, bureaucratic red tape
and lack of legal certainty, labor issues, and
escalating unofficial levies (Graph 4.3).
Because of these conditions, companies are
exercising greater caution in business
expansion and this has led to higher levels
of unused loan ceiling.
Table 4.3
Business and Internal Financial Conditions of Respondent Companies by Scale of Business
• Loan interest rates remain high. The survey
findings show that only a gradual decline is
taking place in lending rates (Table 4.5). Small
and medium enterprises (SMEs), which
normally have less bargaining power than
large companies, are required to pay generally
higher rates of interest than those charged to
major corporate borrowers. Consistent with
this finding, about 43% of all respondents
expressed the opinion that loan interest rates
remain high. Among small enterprises, as
many as 75% of respondents cited persistently
high loan interest rates (Table 4.6).
• Availability of alternative funding sources
at rates lower than charges for use of loan
commitments. Although bank loans are by
far the most important source of financing
for debtor businesses, there is an increasing

Indicators Small Medium Large Total

Enterprises Enterprises Enterprises
2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003

Capacity Utilization (%) 63.9 63.3 64.1 58.9 61.3 68.9 67.1 70.3 75.7 65.9 68.4 73.7
Debt to Equity Ratio (%) 31.7 29.8 31.8 28.7 37.5 53.4 86.3 96.7 105.3 76.9 84.0 92.6
Gross Profit to Equity Ratio (%) 4.1 17.3 11.6 26.7 32.6 48.3 62.6 68.7 101.4 55.4 60.0 87.3

Table 4.4
Business and Internal Financial Conditions of Respondent Companies by Business Sector (%)
Business Capacity Utilization Debt to Equity Ratio Gross Profit to Equity Ratio
Sector (%) (%) (%)

2001 2002 2003 2001 2002 2003 2001 2002 2003

Agriculture n.a n.a n.a 36.0 41.9 47.9 10.6 20.5 18.0
Mining 94.0 80.0 85.5 53.0 50.0 72.6 36.0 26.0 59.5
Manufacture 72.6 74.3 80.4 44.1 57.8 46.9 46.6 43.3 39.6
Construction 54.7 51.0 54.3 145.4 198.0 265.0 14.4 17.1 15.2
Trade 90.6 87.0 89.3 187.2 137.2 157.0 150.2 152.4 281.8
Transportation & Telecomunication 65.3 72.0 75.0 7.5 33.3 53.9 7.1 31.0 50.7
Business Services 24.3 33.0 41.0 58.6 76.6 106.7 24.1 20.5 21.9
Social Services n.a n.a n.a 8.4 7.2 6.9 0.1 0.1 0.1
Total 65.9 68.4 73.7 76.9 84.0 92.6 55.4 60.0 87.3

Factors Influencing Undisbursed Loans:

Survey Findings 22
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Small Enterprises Medium Enterprises

Others Others

Rising unofficial levies Rising unofficial levies

Mounting labor Mounting labor

problems problems
Bureaucratic & Bureaucratic &
legal problems legal problems

Social & political Social & political

conditions conditions
Demand below Demand below
expectations expectations

0 20 40 60 80 100 0 10 20 30 40 50 60
Percent Percent

Large Enterprises All Companies

Others Others

Rising unofficial levies Rising unofficial levies

Mounting labor Mounting labor

problems problems
Bureaucratic & Bureaucratic &
legal problems legal problems
Social & political Social & political
conditions conditions
Demand below Demand below
expectations expectations

0 10 20 30 40 50 60 0 10 20 30 40 50 60
Percent Percent

Graph 4.3
Causes of Deteriorating Business Prospects for Respondent Companies

diversity of alternative sources of funding primary reason for the increased use of these
particularly for large and medium enterprises alternatives is lower cost of funds (Graph 4.4).
(Table 4.7).8 A rising proportion of the • Very low commitment fees charged by
financing secured by medium enterprises banks on unused loan commitments. To
consists of such alternatives as trade finance, promote credit expansion, some banks have
fund from affiliated company, and leasing, set loan commissions and commitment fees
while for large companies also include at low levels (Table 4.8). In the case of some
corporate bonds and foreign debt. The major debtors, a number of joint venture

Table 4.5
Range of Loan Rates Charged to Respondent Companies (%)

Types of Credit Small Enterprises Medium Enterprises Large Enterprises

2001 2002 2003 2001 2002 2003 2001 2002 2003

Working Capital Credit 16 - 30 17 - 32 16 - 35 16 - 21 10 - 21 10 - 20 11 - 24 10 - 22 10 - 20

Consumption Credit n.a n.a n.a n.a n.a n.a 16 - 20 15 - 20 14 - 20
Investment Credit n.a 18 - 19 18 - 19 18 - 20 16 - 20 14 - 19 15 - 27 15 - 27 12 - 27

8 Despite the emerging trend in alternative financing sources, the large proportion of loans in business financing indicates that the credit channel continues to play a
vital role in monetary policy transmission in Indonesia.

Factors Influencing Undisbursed Loans:

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

Table 4.6.
Perceptions of Respondent Companies Regarding Current Loan Rates
Perception Small Medium Large Total
Enterprises Enterprises Enterprises

Low 0.0% 9.1% 2.0% 3.1%

Reasonable 25.0% 45.4% 58.0% 53.8%
High 75.0% 45.5% 40.0% 43.1%
Total 100.0% 100.0% 100.0% 100.0%

banks have waived these charges altogether. Others

The low level of fees encourages some Longer term

companies, and particularly major debtors Doesn`t require

large collateral
of banks, to take out more loan commitment
Lower interest rate
than actually needed. Instead, these funds
Easier loan
are intended more for contingencies. The requirements

low commitment fees charged on unused 0 10 20 30 40 50

Persen

portions of loan commitments removes the

Graph 4.4.
incentive for debtors to accelerate draw
Factors Encouraging Respondent Companies
down on their borrowings. to Use Alternative Financing

4.2 Factors Influencing Undisbursed Loans from
the Supply Side
Banks Keenly Interested in Expanding Loan
Commitments
Findings in the bank survey indicate that
the sharp rise in loan commitments in recent
years is a reflection of keen interest in the
banking system in credit expansion. This is
reflected among others in the following:
• For most respondent banks, with foreign
banks excepted, the leading priority in assets
placement is loans (Graph 4.5). Foreign
banks still place higher priority on asset
placement in Bank Indonesia Certificates

Table 4.7.
Composition of Financing Sources for Respondent Companies (%)

Sources Small Medium Large Total

of Financing Enterprises Enterprises Enterprises
2001 2002 2003 2001 2002 2003 2001 2002 2003 2001 2002 2003
Bank Loans 87.5 83.8 78.3 70.6 63.0 57.0 51.9 55.1 57.9 56.2 58.2 58.7
Bond Issues 0.0 0.0 0.0 0.0 0.0 0.0 0.5 1.1 4.2 0.4 0.9 3.3
Share Issues 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.5 0.0 0.0 0.4 0.0
Foreign borrowings 0.0 0.0 0.0 0.0 0.0 0.0 1.8 3.2 2.5 1.5 2.5 2.0
Equity/ Business Partner 0.0 9.2 13.3 20.6 22.8 23.2 24.4 23.2 19.8 22.9 23.6 20.0
Trade finance (Suppliers) 0.0 0.0 0.0 0.0 3.3 5.2 7.6 5.7 6.8 6.1 5.0 6.2
Affiliated Company 0.0 0.0 0.0 6.3 5.6 10.6 3.1 7.2 3.7 3.5 6.4 4.6
Leasing 0.0 0.8 0.0 0.0 3.1 2.0 7.7 1.7 2.9 6.2 1.8 2.6
Pawnshop 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Others 12.5 7.0 8.3 2.5 2.2 2.0 2.9 2.4 2.2 3.2 1.2 2.5

Factors Influencing Undisbursed Loans:

Survey Findings 24
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

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

Types of Expenses State Bank Domestic Private Bank Joint Venture & Foreign Bank Total

Biaya Provisi 0,5%-1,0% 0,2%-1,5% 0,0%-1,1% 0,0%-1,5%

Commitment Fee 0,5%-1,0% 0,0%-1,5% 0,0%-3,0% 0,0%-3,0%

(SBIs) because of the credit limits established by high levels of caution. This caution is
by the holding entities for these banks. reflected among others in the following:
• Banks have been highly aggressive in • In determining the scale of priority for asset
extending loan commitments to high quality placements, most banks still regard the factor
debtors. In the company survey, as many as of low risk as the primary consideration
20% of company respondents claimed that (Graph 4.7). Only state banks are inclined to
they had received loan approvals in amounts give leading priority to assets offering high
beyond their needs. The principal factor in returns. This difference is thought to result from
this growth is strong company track records more robust capital structure and greater
in their loan repayments and healthy certainty in the revenue structure of state banks,
prospects for debtor businesses. Other factors due to their massive holdings of government-
driving the provision of loans in excess of need issued bank recapitalization bonds.
are the preferred debtor status and affiliated • Banks tend to expand their lending in
company status enjoyed by some of the working capital credit (WCC) and
respondent companies (Graph 4.6). consumption credit (CC), which represent
more short-term purposes of use
Banks Extremely Cautious in Credit Expansion accompanied by relative ease in recovery
Although banks are keenly interested in of loan funds. In contrast, there is generally
credit expansion, this drive remains constrained much less channeling of funds into

Percent
80
The bank is company`s
70 subsidiaries
60
Preferred debtor
50 for the bank

40
Improving business
30 prospects

20 Company`s good
performance
10

0 0 5 10 15 20
Credit Bank Govenment Interbank Corporate Forex Others Percent
Indonesia Bonds Money Market Bonds Market
Sertificate

Graph 4.5 Graph 4.6 Factors Encouraging Banks to Extend

Priority in Asset Placements by Respondent Banks Loans Beyond Debtor Needs from Viewpoints of
Respondent Companies

Factors Influencing Undisbursed Loans:

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

Percent
57%
44%
27%
Low risk Highest Highest
return liquidity
Graph 4.7
Factors Determining Priority for Respondent Banks in
Asset Placement
investment credit (IC), except domestic
private bank which the second largest
portion of loan is investment credit and has
positive growth in last two year (Table 4.9).
• Banks prefer to rise proportion of loans for large
and medium enterprises with loan ceilings in
excess of Rp
500 million (Table 4.10). The
increased lending in this area is associated with
the risk of mounting undisbursed loans, given
that as a rule, this group has greater access to
alternative sources of financing.
The acutely cautious stance of banks has
not only increased proportion of loan
commitment to types of credit and group of
debtor that have higher probability to experience
undisbursed loans but also motivated
respondent banks to impose out various policied
that could further slow down the rate of loan
Table 4.9
Composition of Respondent Bank Loan Commitments by Purpose of Use (%)
draw down by debtors. Impediments
experienced by debtors include the following:
• Some respondent companies and
particularly small-scale and large-scale
3%
companies stated that they had experienced
difficulties in applying for new loans. Only
the medium enterprises had no perception
Others
of difficulty. In the opinions expressed by
small companies, the difficulties lie mainly
in the negative perception by banks of the
financial condition and business prospects
of debtors. From the viewpoint of major
companies, the difficulties lie mainly in the
numerous procedures that must be
completed in loan applications and the size
of collateral demanded by banks (Graph 4.8).
• Most respondent banks continue to charge
substantial risk premiums of about 2,5% to
5,0%. Survey data reveals that joint venture
and foreign banks have the highest cap on
risk premiums for working capital credit and
investment credit. Private domestic banks,
on the other hand, set the highest cap on
risk premiums for consumption credit (Table
4.11). This is also consistent with views
expressed by respondent banks in which the
high risk premium was rated the most
important cause of the broad spread between
loan and deposit interest rates (Graph 4.9).

Group of Bank 2001 2002 2003

WCC IC CC WCC IC CC WCC IC CC

State Bank 43.7 16.3 40.0 47.1 14.7 38.2 48.4 13.0 38.6
Domestic Private Bank 69.4 14.5 16.1 55.0 24.5 20.5 56.9 24.2 18.9
Joint Venture & Foreign Bank 74.9 15.0 10.1 77.1 10.7 12.2 74.9 9.3 15.8
Total 66.3 14.6 19.1 61.2 17.5 21.3 61.5 16.7 21.8

Factors Influencing Undisbursed Loans:

Survey Findings 26
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Table 4.10
Composition of Respondent Bank Loan Commitments by Loans Size

Group of Bank 2002 2003

<500 M 500 M - 5 B >5B <500 M 500 M - 5 B >5B

State Bank 54.3 18.2 27.5 51.6 16.0 32.3

Domestic Private Bank 23.6 20.8 55.6 20.7 22.5 56.8
Joint Venture & Foreign Bank 11.0 20.2 68.8 13.5 22.8 63.7
Total 24.7 20.0 55.3 23.9 21.4 54.7

Small Enterprises Large Enterprises

Insufficient capital

Others
Poor business
prospects Poor business prospects

Poor financial condition

Inadequate collateral
Poor financial
condition Lack of loan information

Complicated procedures

19 20 21 22 23 24 25 26 0 1 2 3 4 5 6 7 8
Percent Percent
Graph 4.8
Causes of Difficulties in Applying for New Loans, Cited by Respondent Companies

Table 4.11
Range of Risk Premiums Charged by Respondent Bank

Types of Credit State Bank Domestic Private Bank Join Venture & Foreig Bank Total

Working Capital Credit 0.5% - 2.5% 0.2% - 2.0% 0.25% - 4.0% 0.2% - 4.0%
Investment Credit 0.5% - 2.5% 0.5% - 3.0% 0.7% - 5.0% 0.5% - 5.0%
Consumption Credit 0.5% - 1.0% 0.5% - 5.0% 1,0% 0.5% - 5.0%

• Banks impose stricter requirements for assessing

loan approvals for new customers. In almost
Others
all areas of loan application requirements, the
High cost of fund
respondent banks assigned higher weightings
High overhead costs to new debtors in comparison to existing
debtors. For existing debtors, respondent banks
To maintain profit margin
gave greater weight to business prospects, but
Continued high risk
premiums
for new debtors, banks assigned the most
0 10 20 30 40 50 important weighting to character (Graph 4.10).
Percent
For new debtors, this emphasis on character
Graph 4.9 makes the process doubly difficult because, as
Causes of Wide Spread between Loan and
Deposit Rate, Cited by Respondent Banks can be expected, banks have no information
on the track record of these debtors.

Factors Influencing Undisbursed Loans:

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

Tightened requirements
Others
Government regulation
Proposed collateral Deterioration in business prospects
Others
Capital adequacy Mounting debt burden

Financial condition Loan rate still high

Social & political conditions
Character of debtor Declining production capacity

Debtor business Alternative sources of financing

prospects Downturn in business cycle
0 10 20 30 40 50 60 70 0 10 20 30 40 50 60
Percent Percent
New Debitor Existing Debitors

Graph 4.10 Graph 4.12

Aspects Considered by Respondent Banks in Deci- Causes in Rise in Undisbursed Loan in Opinion of
sions for Credit Expansion Respondent Bank

From the viewpoint of respondent banks, the 4.3 Responses and Expectations of Companies
external factors were the main cause of the and Banks concerning Undisbursed Loans
overwhelmingly cautious stance in engaging in The range of liquidity set aside by banks to
credit expansion. These external factors include anticipate draw down on loans varies widely from
adverse macroeconomic prospects, debtor business 5.0% to as much as 100% of total undisbursed
prospects fraught with risk, and unsupportive social, loans. On average, the amount of liquidity
political, and legal conditions (Graph 4.11). These provided by the banks to anticipate draw down
are in line with respondent banks’ views about the on loans is about 63% of total undisbursed loans
most dominant cause of increased undisbursed (Graph 4.13). This significanthly high demand
loans, which include downturns in the business for liquidity is considered as one of factors that
cycles of debtors, expanding availability of encourage banks to place their funds in SBIs and
alternative sources of financing, and declining Bank Indonesia deposit facility (FASBI). However,
production capacity at debtor companies. In most respondent banks do not see this
contrast, the only internal factor for banks, that of asdisruptive to bank liquidity management (Table
stricter lending requirements, was given the lowest 4.12). Similarly, most respondent banks hold the
ranking (Graph 4.12). opinion that the rise in undisbursed loans does
not affect the cost of loanable funds (Table 4.13)
High risk to bank capital
Human resources competency nor constrain the ability of the banking system
Most deposits are short-term
Lack of information on potential sectors
to expand lending (Table 4.14). This condition
Others is possible because respondent banks are able
Increasing non-performing loans (NPLs)

Availability of alternative sources of financing to put their huge liquidity into liquid high return
Unsupportive social & political conditions
assets, such as SBI, FASBI or Government bonds.
Debtor business prospects fraught with risk

Poor macroeconomic outlook Because the liquidity condition, cost of

0 5 10 15 20 25 30
Percent funds, and headroom for credit expansion by
Graph 4.11 banks do not generally exert much effect on the
Impediments to Lending in Opinion of rise in undisbursed loans, banks tend to take a
Respondent Bank

Factors Influencing Undisbursed Loans:

Survey Findings 28
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Persen of Respondent
70 soft view of the low rate of debtor use of lines of
60 credit. The prevailing policy is to request debtors
50
to prepare more concrete schedules for draw down
40
of credit. Only a few respondent banks charge fees
30
on unused loan commitments (Graph 4.14).
20

10
In the case of loans that remain
0 0- 20- 40- 60-80 80- 0- 20- 40- 60-80 80- 0- 20- 40- 60-80 80-
undisbursed at the expiration of the loan
20 40 60 100 20 40 60 100 20 40 60 100
State Bank Domestic Private Bank Joint Venture agreement, the main actions taken by banks are
& Foreign Bank
to extend the loan agreement with a revised loan
Percent of Liquidity
80 commitments, eliminate the line of credit, and
70
in the case of major debtors, provide additional
60

50
time for draw down of credit (Graph 4.15). The
40
Table 4.12
30
Influence of Undisbursed Loans on Liquidity of
20
Respondent Banks
10

0 State Domestic Join Venture

Answer Total
State Bank Domestic Joint Venture & All Commercial Bank Private Bank &Foreig Bank
Private Bank Foreign Bank Bank

a. YES 50.0% 30.8% 20.0% 28.6%

Graph 4.13 b. NO 50.0% 69.2% 80.0% 71.4%
Proportion of Liquidity Allocated by Banks to Total Number of Banks 4 13 10 28*)
Undisbursed Loan *) including 1 Regional Development Bank (BPD)

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

Influence of Undisbursed Loan State Bank Domestic Join Venture Total

Private Bank & Foreig Bank

a. Increases CoLF 25.0% 30.8% - 21.4%

b. Reduces CoLF - 7.7% - 3.6%
c. Does‘t Affect CoLF 75.0% 61.5% 100.0% 75.0%
Number of Banks 4 13 10 28*)
*) including 1 Regional Development Bank (BPD)

Table 4.14
Influence of Undisbursed Loans on Headroom for Credit Expansion by Respondent Banks

Influence of Undisbursed Loan State Bank Domestic Join Venture Total

Private Bank & Foreig Bank

a. Reduces headroom for expansion 33.3% 25.0% 20.0% 23.1%

b. Adds headroom for expansion 33.3% - 10.0% 7.7%
c. Has no effect on headroom 33.3% 75.0% 70.0% 69.2%
Number of Banks 3 12 10 26*)
*) including 1 Regional Development Bank (BPD)

Factors Influencing Undisbursed Loans:

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

Reviewing loan facilities

Reduce loan ceiling

Others
Others
Impose charges
Apply for lines of
No action taken credit elimination

Allow until expiration

Make concrete schedule of loan term

0 20 40 60 80 0 10 20 30 40 50 60
Percent Percent

Graph 4.16
Graph 4.14 Respons Taken by Respondent Companies
Actions by Banks Regarding Undisbursed Loans Regarding Undisbursed Loan

banks’ persuasive approach makes most investment credit, which is long term, is given
respondents tend to allow undisbursed loans the least priority (Graph 4.18).
until expiration of the agreed term for draw For respondent banks, the priority sectors
down (Graph 4.16). for future lending are manufacture, trade,
Efforts to reduce undisbursed loans still transportation and telecommunications, and
faced several constraints. In one side, to make business services (33%). Sectors of the least interest
greater use of available loan commitments, 59% to banks are social and public services, electricity,
of respondents would prefer to see loan interest water, and gas utilities, and mining (Graph 4.19).
rates eased to bring the spread between lending In terms of loan size, respondent banks
and time deposit rates to below 4%. In their said that they did not envisage any change in
view, this is the ideal spread (Graph 4.17). In the composition of new lending. Overall, new
the other side, respondent banks remain lending will be dominated by loans with ceiling
extremely wary of longer range lending, as in excess of Rp 5 billion (50.5%), followed by
evident from the many banks that make working retail loans with ceilings below Rp 500 million
capital credit their leading priority while (23.4%) and medium-sized loans with ceiling
Percent
80
Others 67 67
63
59
60
No action taken

Provide additional time 40

33 33
27
25
Eliminate lines of credit
20
13 14
Make new loan agreements
0 0
0
0 20 40 60 Small Enterprises Medium Enterprises Large Enterprises All Companies
Percent (below Rp 1 billion) (Rp 1bil - Rp 10 bil) (above Rp10 billion)
less than 4% 4% - 6% a bove 6%

Graph 4.15 Graph 4.17

Actions by Banks Regarding Undisbursed Loans After Ideal Spread between Loan and Deposit Rates in
Expiration of Loan Agreement Opinion of Respondent Companies

Factors Influencing Undisbursed Loans:

Survey Findings 30
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Percent Percent
100 Social Services
Electricity, Gas &
80 Water
Mining

60 Agriculture
Construction
40 Business Services
Transportation &
Telecomunication
20
Trade
Manufacture
0
State Bank Domestic Joint Venture & All Commercial 0 10 20 30 40 50 60 70 80
Private Bank Foreign Bank Bank
Working Kapital Credit Investment Credit Consumption Credit
Graph 4.19
Graph 4.18 Priority of Lending Plan by Repondent Banks by
Priority of Lending Plan by Respondent Banks by Business Sector
Purpose of Loan Use

ranging from Rp 500 million to Rp 5 billion Commercial Banks’ Monthly Reports (LBU) and
(21.1%). Analysis by category of bank showed the bank survey. Using samples from the past
that retail lending is a priority only for state three years, both data sources produce
banks, where retail loans hold a predominant relatively similar figures of undisbursed loans.
position with 56.6% of total planned new A significant difference was noted only in
lending. In contrast, private domestic banks and consumption credit. This difference is
joint venture and foreign banks give top priority attributable mainly to the number of bank
to loans with high loan ceilings (above Rp 5 included. Data presented in LBU include all
billion), accounting for 59.3% and 63.0% of banks that issue credit card, while the survey
planned lending (Table 4.15). includes only a few banks that issue credit
cards, and thus undisbursed loan data for
4.4. Statistical Issues of Undisbursed Loan consumption credit (which include credit
To identify the likelihood of statistical cards) produced using data from the LBU will
problems in the reporting of undisbursed loans, consistently exceed survey findings.
Graph 4.20 compares the proportion of The survey findings also show that almost
undisbursed loans to loan commitments against all reports of undisbursed loans presented in
calculations using data extracted from the the LBU each month were final (Graph 4.21).

Table 4.15
Composition of Respondent Bank Lending Plan by Loan Size (%)

Group of Bank 2002 2003 Future

<500 M 500M - 5B >5 B <500 M 500M - 5B >5 B <500 M 500M - 5B >5 B

State Bank 54.3 18.2 27.5 51.6 16.0 32.1 56.6 14.6 28.8
Domestic Private Bank 23.6 20.8 55.6 20.7 22.5 56.8 18.9 21.8 59.3
Joint Venture & Foreign Bank 11.0 20.2 68.8 13.5 22.8 63.7 13.8 23.6 63.0
Total 24.7 20.0 55.3 23.9 21.4 54.7 23.4 21.1 55.5

Factors Influencing Undisbursed Loans:

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

Percent
50 reported the elimination of expired loan
40 commitments within the same reporting month,
30
and 18.5% of respondents reported elimination

20
10
0
2001 2002 2003 2001 2002 2003
Working Kapital Credit Investment Credit
Monthly Report Data
Graph 4.20 Proportion of Undisbursed Loan
to Loan Commitments based on Commercial Bank’s
Monthly Report and Bank Survey
Of the 28 respondent banks, only two (7.1%)
said that some reports submitted in the LBU were
preliminary, while the remaining 26 banks
(92.9%) affirmed that their reports were final.
The frequency of corrections by the two banks
was also very low, with only 2-3 times
corrections per year for the state bank
respondent and one correction for the
respondent from the category of joint venture
and foreign banks.
Added to this was quick reporting of the
elimination of expired loan commitments.
Among respondent banks, 70.4% said that they
in the following month. A further 3.7% of
respondents reported their figures one month
after expiration of loan agreements and 7.4%
2001 2002 2003
Consumption Credit
of respondents awaited further developments
Data from Survey
(Graph 4.22). Concerning the formula used in
calculation of undisbursed loans, most
respondents (96.3%) used the formula stipulated
in the LBU, i.e., loan commitment subtracted
by loans outstanding. Only one respondent
(3.7%) applied a different formula, i.e., loan
commitment subtracted by draw down
accumulation.
Accordingly, there do not appear to be
any problems with the statistics in the data
on undisbursed loan reported by banks thus
far. However, it is also necessary to recognize
the weakness in the reporting method, which
is based on end-of-month data, and is thus
unable to capture volatility in drawing down
and repayment of working capital lines of
credit.

Percent Percent
120 120
Yes
(100%) Yes Yes
100 (90,9%) (92,9%) 100
Yes
(75%) 80
80

60
60

No 40
40 (25%)
No 20
No
20 (9,1%) (7,1%)
No
(0%) 0
State Bank Domestic Joint Venture & All Commercial
0 Private Bank Foreign Bank Bank
State Bank Domestic Joint Venture & All Commercial In the same reporting month Await further condition
Private Bank Foreign Bank Bank
In the following reporting month One month after loan agreement due

Graph 4.21 Status of Undisbursed Loan Figures Graph 4.22

Submited in Commercial Bank’s Monthly Reports Period for Reporting Elimination of Expired
(Final or Preliminary) Loan Commitments

Factors Influencing Undisbursed Loans:

Survey Findings 32
Chapter
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
5 Factors Influencing Draw Down of Credit:
Results of Econometric Testing
In this chapter, estimation will be made
on loan demand and loan supply functions with
the objective of examining factors that influence
draw down of credit. This will include
hypothesis testing on the impact of excess supply
equilibria on rigidity of loan interest rates, which
is thought to be one of the underlying causes in
the rise in undisbursed loans. Estimation will
be made using a macro-aggregate approach in
a disequilibrium model.
5.1. Model Specifications
Variables that may influence loan demand
and loan supply were initially identified in a
literature review. Melitz & Pardue (1973)
identified several factors that may influence loan
supply: (i) a scale of constraint obtained by
subtracting lending capacity by actual loans; (ii)
loan interest rates; (iii) interest rates for
alternative placements for bank assets (such as
SBIs or FASBI); and (iv) deposit rates (cost of
funds). Loan demand, on the other hand, is
influenced more by (i) permanent income and
transitory income that may be represented by
national income; (ii) loan interest rates; and (iii)
expectations of inflation.
Blundell-Wignall & Gizycki (1992)
identify a number of variables that significantly
influence loan supply in Australia: (i) deposit
funds accumulated by banks plus book value
33
of bank capital; (ii) average share price of the
banking sector; (iii) market capitalization of the
banking shares; (iv) loan interest rates subtracted
by deposit rates (cost of funds); and (v) cyclical
risk premium proxied from loan interest rates
subtracted by rates for certificates of deposits.
Variables influencing demand include: (i)
expectations of investment expenditure needs;
(ii) cost of capital proxied by the price earnings
ratio (PER); and (iii) expectations of inflation.
In their paper on the credit crunch
phenomenon in East Asia, Ghosh & Ghosh (1999)
cite a number of variables that influence loan
supply: (i) lending capacity calculated from total
assets subtracted by reserve requirement, liquidity
requirement, cash in vault, and capital; (ii) loan
interest rates subtracted by deposit rates (cost of
funds); and (iii) industrial production as a proxy of
corporate repayment ability. Factors influencing
loan demand are: (i) loan interest rates; (ii) total
output (GDP); (iii) output gap; (iv) share price index
as a proxy of output expectations; and (v) the
inflation rate. All data used in the Ghosh & Ghosh
research are in real terms.
Based on the identification of variables in
the literature review, other variables were added
that are regarded as specific to and historically
exerting influence on bank lending development
in Indonesia. This was followed by selection of
the variables for use in the estimation. The
Factors Influencing Draw Down of Credit:
Results of Econometric Testing
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
capital market variables, in particular market
capitalization, price earnings ratio, and the
index for banking stocks used in the estimation
by Blundell-Wignall & Gizycki (1992), were
regarded as less relevant to Indonesia because
of the relatively few banks listed on the capital
market. For this reason, the capital market
variables would not be representative of the
banking sector as a whole. The variables
considered for addition to the estimations were
the exchange rate and ratio of non-performing
Selection of Variables Influencing Loan Supply and Loan Demand
Variable
LOAN DEMAND (LDt)
Gross Domestic Product ( yt )
GDP Gap ( ygapt )
Loan interest rates subtracted by deposit rates
( r loant - r dept )
Inflation ( πt )
Exchange rate ( FXt )
LOAN SUPPLY (LSt)
Lending capacity ( Icapt )
Loan interest rates subtracted by SBI rates
( rloant - rsbit )
Deposit rates ( r dept - 1 )
Factors Influencing Draw Down of Credit:
Results of Econometric Testing
loans (NPLs). The exchange rate variable is
regarded as strongly influencing business and
investment actions because of the high import
content in domestic production and the behavior
of the public in keeping close watch on the
exchange rate in the wake of the crisis. The NPLs
ratio, a reflection of the internal condition of
banks, is seen as significantly affecting the level
of bank interest in channeling credit to the real
sector. The variables selected for use in the
estimations are summarized in Table 5.1.
Table 5.1
Hypothesis Remarks
- Loan data are in real terms (end of month position)
Positive Quarterly data interpolated to monthly data and converted to real figures using 1996
constant price.
Negative Actual GDP subtracted by potential GDP. The later was calculating using Hodrick-
Prescott filter method. If actual is below potential (-), companies will increase
capacity and thus loan demand will rise (+). Data in real terms.
Negative Loan interest rate data proxied using working capital credit, the dominant compo
nent of lending with greater sensitivity to other economic variables. For deposits,
the1-month rate is used. Both in real terms after offsetting for inflation. Debtors not
only keep watch on loan interest rates, but also on deposit rates as a proxy of the
opportunity cost of using own funds and expectations of future decline in loan inter
est rates. Any broadening in the spread will lead debtors to scale back their demand
for loans.
Positive Monthly inflation (m-t-m), a proxy of expectations of future inflation assuming that
the public thinks along adaptive lines. Future inflation means that prices for capital
goods and consumer goods will rise, resulting in increased demand for loans.
Negative The exchange rate can be used as a proxy for business prospects. Fluctuation or
deterioration in the exchange rate will cause debtors to delay or cut back demand for
loans. Exchange rate data is in nominal terms.
- Loan data are in real terms (end of month position)
Positive Total liabilities/assets subtracted by statutory reserve requirement, cash in vault, and
government bonds held in the investment portfolio. Unlike the Ghosh & Ghosh
concept, the lending capacity used was not subtracted by capital because bank
capital isalso a source of funds readily available for channeling into credit. In the
post-recapitalization period, the asset structure of banks includes non-tradable
government bonds, which cannot be used to expand lending capacity. Data in real
terms, adjusted using constant exchange rate.
Positive Higher loan interest rates in comparison to alternative placements for earning assets,
e.g., SBIs, will stimulate bank interest in lending. If the spread widens due to rise in
lending rates or drop in SBI rates, the bank will have stronger interest in expanding its
lending and vice versa. Data in real notation.
Negative There is a positive relation betwen deposit rates and demand of non-loan assets.
Increasing deposit rate will lead banks to optimize their portfolio, but they prefer to
invest their portfolio in low risk assets such as SBI and SUN. Thus, the loan supply
will decline. Empirically, banks need times to response the changes on deposit rates,
so we use lag. Data in real notation.
34
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
Variable Hypothesis
Non-performing loans ( NPLt ) Negative
Industrial Sector Production Index ( IPt ) Positive
Based on the above identification of
variables, we specify the loan demand and
supply equations as follows:
The supply function is as follows:
S
L t = α0 + α1 lcapt + α2 (rloan – rsbi)t + α3
rdept-1 + α4 NPLt + α5 IPt + ε1t ........ (5.1)
in which lcap is real lending capacity,
rloan is the real lending rate, rsbi is the real SBI
rate, rdep is the real time deposit rate, NPL is
the ratio of non-performing loans to total loans
extended by the banking system, and IP is the
industrial production index.
The demand function is as follows:
LDt = β0 + β1 yt + β2 ygapt + β3 (rloan-rdep)t
+ β4 πt + β5 FXt + ε2t ..................... (5.2)
in which y is total real output (GDP), ygap
is the real output gap (actual real GDP –
potential real GDP), rloan is the real lending
rate, rdep is the real deposit rate, πt is inflation
(month to month), FX is the exchange rate of
the rupiah against the American dollar (USD).
In addition to these basic equations,
testing was also performed using a dummy
variable to assess the impact of the banking crisis
on loan demand and loan supply (DUM1).9
Remarks
The ratio of NPLs to total loans, with adjustment for the period of takeover of loans by
IBRA in 1998-1999. Adjustment was done by multiplying the figure by zero to omit
the data content during 1998-1999. Any rise in NPLs reflects increased credit risk and
will thus reduce the interest of banks in channeling credit.
Monthly data is used as a proxy for the loan repayment ability of companies (debtors).
If debtors have improved ability to repay, banks will become more interested in
channeling credit.
Then, a second dummy variable (DUM2) was
introduced to test the impact of crisis to sensitivity
of loan demand and supply to loan interest rates.
For the supply function this second dummy
variable (DUM2) was derived by multiplying the
DUM1 variable by the spread between loan
interest rate and SBI rate, while for demand
function, it was derived by multiplying DUM1
variable by the spread between loan interest rate
and deposit rate. The spesification of supply and
demand function after incorporating both dummy
variables are as follows:
LSt = α0 + α1 lcapt + α2 (rloan – rsbi)t + α3
rdept-1 + α4 NPLt + α5 IPt + α6 DUM1t
+ α7 DUM2t + ε1t...................... (5.3)
LDt = β0 + β1 yt + β2 ygapt + β3 (rloan-rdep)t
+ β4 πt + β5 FXt + β6 DUM1t + β7
DUM2t + ε2t ......................... (5.4)
Next, the supply equations (5.1) and (5.3),
and demand equations (5.2) and (5.4) could be
simplified into two simultaneous equations as
follows:
LSt = X1t α + ε1t ............................... (5.5)
LDt = X2t β + ε2t ............................... (5.6)
9 The period of banking crisis started from August 1997 when exchange rate
crises erupted until June 1999 when the major part of bank recapitalization
program was completed.
Factors Influencing Draw Down of Credit:
35 Results of Econometric Testing
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
In which X 1 represents the factors
influencing supply and X2 the factors influencing
demand.
Equilibrium on the loan market would
be achieved when LS = LD. If the loan market
is operating flawlessly, loan interest rates will
move towards achieving the equilibrium
between LS and LD. However, as described in
Chapter II, if the loan market is not operating
as it should, and loan interest rates are unable
to move freely, loan demand (L D) will not
always be commensurate with loan supply (LS).
Theoretically, it is the minimum position
between LS and LD that exerts greater influence
on actual loans (L), so that this position can be
formulated as follows:
Lt = min (LDt , LSt) ............................. (5.7)
If L D > L S, actual lending (L) will be
influenced by the supply side or the bank.
Conversely, if LD < LS, actual lending (L) will
be driven by demand. This became the
hypothesis to be used to assess whether supply
or demand exerts greater influence on
channeling of loans and subsequently to
analyze the growth in undisbursed loans during
the past two years.
The research by Blundell-Wignall &
Gizycki (RBA), as well as Ghosh & Ghosh, and
in many other studies applied the maximum
likelihood estimation (MLE) method to estimate
the coefficients of the variables in the loan
supply and loan demand functions. This
approach refers to the likelihood function used
by Maddala (1983, 1989) in estimating the
disequilibrium model. To ascertain which side
Factors Influencing Draw Down of Credit:
Results of Econometric Testing
is dominant in influencing lending, the method
used is that of switching regression.
5.2. Results of Model Estimation
Estimation for loan supply and demand,
both in the basic equations (Estimation 1) and
the equations using dummy variables
(Estimation 2) were prepared using the June
1993-December 2003 sampling period
(monthly data). The results of these estimations
are presented in Table 5.2.
In the supply function, all coefficients
have consistent sign with the hypothesis and
are significant in t-statistic testing. Lending
capacity has a positive and significant sign.
Higher lending capacity will increase interest
of banks in channeling credit. The spread
between lending rates and SBI rates also has
a positive and significant sign. Higher loan
interest rates in relation to SBIs will encourage
banks to offer more credit. Deposit interest
rates variable has a negative sign, and thus
any rise in deposit interest rates will dampen
bank interest in channeling credit. The NPLs
variable also has a negative sign because higher
NPLs will limit room for credit expansion. This
factor is thought to have gained added
significance after Bank Indonesia set a
maximum target for banks of 5% NPLs (net).
The variable of debtor repayment ability
proxied by the production index has a positive
sign, meaning that increased debtor repayment
ability will encourage banks to channel more
credit into the real sector.
For the demand function, all
coefficients also have consistent sign with the
postulated hypotheses. The output variable
36
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Table 5.2.
Estimation of Loan Supply and Demand

Variables Estimation 1 Estimation 2

Coefficient t-stat Coefficient t-stat

LOAN DEMAND FUNCTION :

- Intercept 0,71596 (0.138) 1,2212 (0,237)
- GDP 1,72051 (3,358) *** 2,07637 (4,055) ***
- GDP Gap -0,000034 (-1,049) -0,000064 (-1,327)
- Spread between loan rates -0,03618 (-9,482) *** -0,03675 (-2,975) ***
and deposit rates
- Inflation (month to month) 0,06902 (9,044) *** 0,09103 (7,115) ***
- Foreign Exchange Rates -0,76905 (-8,371) *** -1,30231 (-6,903) ***
- Dummy 1 - - 0,60921 (1,597)
- Multiplicative Dummy - - -0,00512 (-0,998)

LOAN SUPPLY FUNCTION :

- Intercept -8,92876 (-11,591) *** -3,73316 (-7,483) ***
- Lending Capacity 1,56056 (32,730) *** 1,17475 (32,703) ***
- Spread between Loan Rates
& SBI Rates 0,01828 (9,263) *** 0,00385 (3,844) ***
- Deposit Rates -0,00776 (-3,242) *** -0,00737 (-3,939) ***
- Non-Performing Loans (NPLs) -0,00328 (-2,033) ** -0,00850 (-7,356) ***
- Industrial Production Index 0,34533 (2,597) *** 0,30411 (5,383) ***
- Dummy 1 - - -0,20919 (-13,949) ***
- Multiplicative Dummy - - 0,00774 (5,911) ***

- Log of Likelihood 132,791 169,597

- Number of Observations 126 126

Notes :

* Significant at 90% level of confidence (α = 10%), critical value = 1,645

** Significant at 95% level of confidence (α = 5%), critical value = 1,960
*** Significant at 99% level of confidence (α = 1%), critical value = 2,576

(GDP) had a positive and significant
correlation with loan demand. Although the
output gap variable (GDP gap) was not
significant, it has negative sign which
matched the hypothesis. When actual output
falls to below potential output, the company
will step up demand for loans in order to
boost production to the potential level.
The interest rate variable significantly
influences corporate interest in applying for
loans. Higher loan interest rates in relation to
deposit rates will diminish the interest of
companies in applying for loans. The broad
spread between lending and deposit rates will
also build expectations among debtors that
interest rates will move lower in line with the
cost of funds. This will encourage debtors to
hold back from applying for loans from banks
or delay draw down of loans approved by banks.
The inflation variable also had a positive
sign in line with the hypothesis. According to
the interpretation used by Blundell-Wignall and

Factors Influencing Draw Down of Credit:

37 Results of Econometric Testing
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
Gizycki (1992), mounting expectations of
inflation will boost loan demand for speculation
in assets such as properties, a practice
widespread in Indonesia before the 1997 crisis.
The exchange rate variable significantly had
negative influences to loan demand. Any rise
in the exchange rate (rupiah depreciation) will
cause debtors to scale back their loan demand
on banks because it had negative impact to debt
burder, cost of production and business outlook.
On the demand side, the crisis dummy
variable has a positive sign but not statistically
significant. None the less, it confirms with the
observation that there were temporary surges in
loan demand during the peak of the crisis. In our
opinion, this resulted from disruptions to company
cash flow that compelled companies to increase
their demand for loans to cover operating costs.
On the supply side crisis dummy variable
significantly has negative impact. The crisis
prompted banks to scale back the offered volume
of loans because of the more risk averse behavior
of banks that led to widespread credit rationing.
Ln Loans
13.25
13.00
12.75
12.50
12.25
12.00
11.75
11.50
11.25
11.00
1993 1994 1995 1996 1997
Estimated Loan Demand
Graph 5.1
Estimation of Loan Supply and Demand
Factors Influencing Draw Down of Credit:
Results of Econometric Testing
It was this escalating demand in combination with
tightened supply that brought about a credit crunch
in Indonesia in the initial period of the crisis.
The interest rate multiplicative dummy
variable (DUM2) has a positive sign and
significant for the supply function and negative
sign but not significant for the demand function.
Thus, in the supply function, the sign of DUM2
is similar with the sign of spread between loan
rate and SBI rate (positive). In the demand
function, the sign of DUM2 is similar with the
sign of spread between loan rate and deposit
rate (negative). The estimation is consistent
with the hypothesis that during the crisis period,
both demand and supply were more sensitive
to loan interest rates.
To obtain a picture of which side exerted
more influence on actual lending, the
estimations for the two functions of supply and
demand are presented in Graph 5.1.
Graph 5.1 shows that the period before the
1997 economic crisis was generally marked by
excess demand equilibria. During this period,
1998 1999 2000 2001 2002 2003
Estimated Loan Supply Actual Loans
38
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

the economy was booming with rapid growth in However, loan demand had plunged
loan demand from the business sector. In contrast, dramatically from early 1999 as a result of the
bank lending capacity was limited and banks thus currency crisis alongside soaring interest rates.
became highly selective in extending loans (non- The currency crisis and high interest rates
price credit rationing). Theoretically, banks severely impacted corporate balance sheets and
should have been able to adjust (raise) loan eroded the interest and capacity of companies
interest rates to reduce demand pressure, but this for engaging in investment, which in turn
did not happen because it would place added reduced demand for bank loans. The
burden on quality debtors and in turn increase contraction on the demand side and
the risk of default. In our estimation, the gap recapitalization on the supply side produced a
between demand and supply was closed by reversal, with conditions of excess supply
soliciting foreign borrowings or launching IPOs equilibria setting in from June 1999.
in the stock markets, both of which rose sharply In 2000-2001, loan supply was more or
during that period. less stagnant because banks had turned their
In the early days of the crisis, loan attention more to internal consolidation to
demand rose significantly. The rise in loan achieve the 8% targeted CAR by the end of 2001
demand at the onset of the crisis is thought to and the impact of soaring SBI rates. Loan supply
have resulted from cash flow problems at has returned to rising path since 2002 in line
companies that escalated demand for loans to with declining SBI rates and improved
cover operating costs. However, loan demand macroeconomic conditions. However, the
fell off significantly in response to the banking growth of loan supply was much faster than the
crisis. From August 1997 through December growth of loan demand. Consequently, the gap
1998, Indonesia showed the signs of a credit between supply and demand (excess supply)
crunch.10 The findings on the credit crunch in was widening 2002 and 2003. The rise in loan
the early stage of the crisis are consistent with supply has been driven by:
Agung, et. al. (2001) and Ghosh & Ghosh (i) Steady improvement in bank capital in the
(1999) and differ only in their predictions of post restructuring period, enabling banks to
when the phenomenon would end. book significant profits in the past two years.
Loan supply continued to drop until the The bank CAR is in much stronger shape,
first phase of bank recapitalization in mid-1999. well above the minimum required 8%, and
The completion of the first phase of bank thus banks have considerable headroom for
recapitalization program brought immediate expansion in loan supply.
improvement to bank balancesheets and (ii) Improved composition of bank assets
expanded their capacity for offering loans. following the introduction of trading in
government bonds. The last two years have
10 Agung et. al (2001) states that the credit crunch is a condition of steep seen rapid growth in government bonds
drop in loan supply brought on by lack of willingness on the part of banks
to extend loans.

Factors Influencing Draw Down of Credit:

39 Results of Econometric Testing
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
registered in banks’ trading portfolios, up
from 14.9% of total bond portfolios at end
2001 to 47% at end 2003. The expansion
in trading portfolios has given banks added
liquidity and expanded the available
capacity for bank lending.
(iii)Improvement in the ratios for non-performing
loans (NPLs). The improvement in the NPLs
ratio will also provide banks with more
headroom to expand loan supply. NPLs
(gross) has declining significantly, from
11.65% at end 2001 to 6.77% at end 2003.
(iv)Persistently high loan interest rates in relation
to yield on other earning assets, such as SBIs
and FASBI, and also to cost of funds can also
explain the interest of banks in channeling
credit.
Against this, the factors indicated to have
constrained loan demand and thus spurred
growth in undisbursed loans are:
(i) Actual borrowing needs remains low due to
minimum interest in investment. This is
consistent with the finding that the driving
force in the economy and largest contributor
to GDP growth in the past two years is
consumption.
(ii) Rigidity in decline of loan interest rates
compared to the downward movement in
deposit rates has also impeded growth in
loan demand. The broad spread between
loan and deposit rates has stirred the
expectation among debtors of future easing
in loan interest rates in line with the declining
cost of funds, and thus debtors are holding
back from applying to banks for new loans
or are delaying their draw down on agreed
loan commitments.
Factors Influencing Draw Down of Credit:
Results of Econometric Testing
(iii)High loan interest rates have prompted some
eligible companies to seek alternative
financing sources, for example, by issuing
bonds with a lower yield. This is evident in
the volume of private sector bond issues that
reached Rp 26.4 trillion in 2003.
(iv)Asymmetric information has resulted in
banks focusing their lending only on a
particular group of preferred debtors or
debtors with known track records, with the
result that new debtors are excluded from
access to bank credit facilities.
5.3. Results of Simulations and Projections
Graph 5.2 shows that the loan supply
function is strongly influenced by lending
capacity. Although other variables, such as the
spread between loan interest rates and SBI
rates, cost of funds, and NPLs exert a
statistically significant influence on the loan
supply function, in terms of magnitude these
influences are very low. The strong relationship
between supply function and lending capacity
is presented in Graph 5.3. This graph shows
that the level of offered loans moves in direct
proportion to changes in bank lending capacity.
Ln Loans
20.0
15.0
10.0
5.0
0.0
-5.0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Lending Capacity NPLs Ratio Loan Rates - SBI Rates
Deposit Rates Production Index Estimated Loan Supply
Graph 5.2. Estimated Contribution by
Factors Affecting Loan Supply
40
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Billion Rp
500,000 the factors influencing lending capacity. Based
450,000
on the specifications used for lending capacity,
400,000
350,000 the influencing factors are : (i) deposit funds; (ii)
300,000
250,000
bank capital; and (iii) government bonds held
200,000 in the trading portfolio. Bank deposit funds have
150,000
100,000 consistently risen even in spite of declining rates
50,000
0
on bank deposits, given the overwhelming
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Lending Kapacity Estimated Loan Supply
preference of the public to place funds in banks.
In the last three years, growth in bank deposit
Graph 5.3. Relationship between
Lending Capacity and Estimated Loan Supply funds averaged 7% or about Rp 4 trillion per
month. This trend is assumed to continue up to
Volume and trend of loan demand is the end of 2004.
positively influenced by the output (GDP) and Bank capital has also improved with
negatively influenced by exchange rate significant earnings (before tax) in the past two
variables, while monthly volatility in loan years. In 2002, pretax profit reached Rp 21.9
demand is influenced by the inflation and trillion and in 2003 Rp 26.4 trillion. Lack of
interest rate (loan rate – SBI) variables, as sensitivity of depositors to movements in interest
presented in Graph 5.4. However, the output rates means that banks have more room to adjust
gap variable both in statistical terms and in level their cost of funds, and thus banks will always
is not significant. be able to profit from a positive spread. This
Next, a projection of credit expansion is becomes even more likely if steady decline is
prepared for 2004 based on the estimation of projected for inflation while loan interest rates
loan supply and loan demand. To project the remain generally high. Bank profits are thus
loan supply, wich is heavily influenced by bank predicted to remain high in 2004, enabling
lending capacity, it is first necessary to identify banks to build up their capital in line with its
Ln Loans
pattern in the last two years.
25.0
The increase of government bonds held in
20.0

15.0 trading portfolios is expected to be relatively small

10.0 in view of the very thin market, and especially
5.0
after stagnant performance of mutual funds using
0.0

-5.0
government bonds as underlying assets during
-10.0 the first half of 2004. In addition to market factors,
-15.0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
banks also avoid risk of falling prices because
GDP GDPgap Forex Rates
Loan Rates - Deposit Rates Inflation Estimated Loan Demand they must consistently ensure marked to market
for bonds held in trading portfolios.
Graph 5.4.
Estimated Contribution by Factors Affecting Overall, based on the assumption on bank
Loan Demand deposits, bank capital and volume of

Factors Influencing Draw Down of Credit:

41 Results of Econometric Testing
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

government bond in trading portfolio, we predict
further growth in bank lending capacity during
2004, driven mainly by increased deposit funds
and stronger earnings.
To project the loan demand, the
assumptions of GDP growth, inflation, interest
rates, and exchange rate are used as follows.
GDP growth in 2004 is predicted to improve to
about 4.5%, up slightly from 4.1% growth in
2003 and 3.7% in 2002. The spread between
working capital loan rates and deposit rates is
expected to narrow. Time deposit rates are
forecast to hold stable at 6% while loan interest
Ln Loans
13.25
rates are gradually easing closer to the cost of
funds and could reach the level of 13%, thus
reducing the spread to 7%. Inflation in 2004,
as predicted by Bank Indonesia at the beginning
2004, is expected to reach 5.5%. These three
variables will stimulate demand for loans. Bank
Indonesia also predicts the exchange rate to hold
around Rp 8,700 to the US dollar.
The projections based on these various
assumptions show that, aggregate loan demand
will continue to rise in 2004. However, the
increased demand will be insufficient to cover the
gap between loan supply and demand (Graph 5.5).

13.00

12.75

12.50

12.25

12.00

11.75

11.50

11.25

11.00
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Estimated Loan demand Estimated Loan Supply Actual Loans

Graph 5.5.
Projection of Loan Supply and Demand for 2004

Factors Influencing Draw Down of Credit:

Results of Econometric Testing 42
Chapter
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
6 Conclusions and Policy
6.1 Conclusions
The analysis framework employed in this
study views banks more as actors on a forward
lending market rather than a spot lending
market. On the forward lending market, banks
exercise only a limited control over actual loan
disbursement. After a loan commitment is
agreed between the debtor and the bank, it is
the debtor who then determines the volume and
timing of draw down in keeping with needs. Up
to this point, the impression is that the
phenomenon of significantly increased
undisbursed loans in the last several years is
entirely the result of debtor behavior.
However, this impression is not valid.
Firstly, banks have the incentive to encourage
debtors to take on borrowing commitments that
may actually exceed actual needs, and secondly,
because of the incentive that banks also have
to slow down any increase in draw down by
debtors, for example by holding loan interest
rates high. In the first instance, the incentive for
banks is related to their efforts to retain the
loyalty of high quality debtors and discourage
them from turning to other banks, as well as to
raise fee-based income. In the second instance,
the incentive for banks is related to efforts to
sustain their capacity to meet loan commitments
efficiently and the desire of banks to limit default
risk in their credit portfolios.
43
Implications
Based on this analysis framework and with
support from empirical testing, a number of
conclusions are drawn as follows.
General Characteristics of Undisbursed Loans
in Indonesia
• For banks (the supply side), the rise in
undisbursed loans is a phenomenon linked
to the nature or concentration of business
particular to each category of banks. Foreign
banks and private domestic banks that have
concentrated more on retail/consumer
banking prefer to channel credit through
products involving some element of
commitment, namely working capital credit
and consumer credit, and these banks are
the most likely to see a rise in undisbursed
loans.
• For debtors (the demand side), the
phenomenon of increased undisbursed loans
is closely linked to sensitivity of business
sectors to economic cycles and also to the
scale of business and market orientation of
the debtors themselves. Sectors with greater
sensitivity to economic cycles, such as
manufacture and trade, tend to have high
rates of undisbursed loans. Similarly,
medium-scale and export-oriented
borrowing companies also have a tendency
towards high undisbursed loans.
Conclusions and Policy
Implications
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
• The findings of these observations indicate
a possible link between growth in
undisbursed loans and domestic
consumption and investment, and that
undisbursed loans could therefore yield
information on developments in these areas.
Causes of Growing Undisbursed Loans
• The rise in undisbursed loans is a result of
loan commitments increasing at a faster rate
than the actual need for credit.
• The rapid increase in loan commitments is
explained mainly by mounting demand for
loan commitments as standby provision in
the face of uncertainties in interest rates and
supply of funds (risk aversion). Loan
commitments based on risk aversion motives
have considerable potential for becoming
undisbursed loans
• The escalation in loan commitments has also
been driven by the aggressive behavior of
banks in extending loan commitments to
high-quality debtors. There are even
indications of banks extending larger-than-
needed loan commitments to selected
reputable debtors. The boldness on the part
of banks in arranging sizable loan
commitments is possibly reinforced by high
levels of excess liquidity, the broad spread
between lending rates and funding rates, and
the availability of fund placement
instruments that have adequate return and
liquidity, such as SBI, FASBI and Government
Bonds.11
• While loan commitments have risen sharply,
draw down has been relatively slow because
of adverse business conditions and internal
Conclusions and Policy
Implications
financial conditions of debtors, deteriorating
business prospects, high loan interest rates,
and expectations of further easing of interest
rates. Added to this, medium and large
debtors are able to tap alternative sources of
funds at lower costs than for drawing on loan
commitments and the fees charged by banks
for undisbursed loan commitments are
extremely low. This eliminates the incentive
for debtors to accelerate their drawing down
of loans. 12 Taken together, these factors
encourage debtors to delay their draw down
of available loan commitments.
• Although banks are keen to increase loan
commitments, actual levels of disbursement
are also 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 for new debtors.
• Loan demand is more sensitive to interest
rates than loan supply. This means that under
conditions of weak loan demand, efforts
could be made to promote credit expansion
by lowering interest rates without having to
worry about significant reduction in loan
supply. Nevertheless, movement in loan
interest rates is entirely under the control of
banks and thus interest rates will not see
significant reduction if banks are unwilling
to move in this direction.
• For these reasons, banks also play a major
11 The conclusion that high levels of banks» surplus liquidity indirectly drive
increased supply in loan commitments is also consistent with the results of
recent restricted discussions between Bank Indonesia and some major banks
(SPPK [2004]).
12 Issuance of corporate bonds will reduce actual borrowing needs, and a
bond issuing company that has secured loan commitments will use the
credit line only as an alternative source of funds or for standby purposes,
with the result that draw down will be low.
44
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
indirect role in slowing the growth in loan
draw down, particularly because of muted
decline in loan interest rates in comparison
to reductions in deposit rates and also
because of extreme caution in selecting
debtors.13 The high levels of caution on the
part of banks is not only the result of
perceived high risk in debtor prospects, but
also continued internal weaknesses in banks
themselves, reflected in continued high
levels of NPLs.
• Stability in the rupiah has a strong influence
over loan demand. Depreciation in the
rupiah will delay or reduce this demand
because of the dependence of business on
imported goods and raw materials.
Undisbursed Loans: Responses and Expecta-
tions from Companies and Banks
• In order to anticipate draw down on loans,
on average banks maintain a large amount
of liquidity (63% of total undisbursed loans)
which is considered as one of factors that
encourage banks to place their funds in SBI
and Bank Indonesia deposit facility (FASBI).
Due to excess liquidity situation and the
availability of SBI and FASBI, the
phenomenon of increased undisbursed loans
has not directly affected internal bank
condition in the areas of liquidity risk, cost
of funds, and headroom for the bank to
engage in credit expansion.
13 Bank lending that focuses only on favorite debtors will give rise to moral
hazard for those debtors, especially if the bank extends privileged treat-
ment by setting very low commitment fees or even no fees at all. Favorite
debtors will tend to apply for credit from a number of banks and only draw
down loans at banks offering low interest rates. Credit lines at other banks
will be retained for standby use only.
45
• For these reasons, most banks prefer to follow
a persuasive approach aimed at encouraging
reductions in undisbursed loans rather than
imposing additional charges for undisbursed
loan commitments. In the case of overdue
undisbursed loans, most banks have chosen
to conclude new loan agreements rather than
to remove these expired credit facilities from
the books. On other side, debtors prefer to
leave long-standing loan commitments
undisbursed to carry through to the end of
the remainder term for drawing down.
• Looking ahead, banks are likely to remain
cautious in extending their credits, as
reflected in the protracted low proportion of
investment credit in their lending plan.
• The priority business sectors for forthcoming
credit expansion are manufacture, trade,
transport and telecommunications, and
business services.
• Most debtors are of the view that the ideal
spread between loan and time deposit rates
is maximum about 4%.
Statistical Issues
• Survey findings indicate that the
understanding held by banks of the concept
for calculating undisbursed loans is in line
with the concept set out in the Commercial
Banks’ Monthly Reports.
• Virtually all respondent banks stated that
undisbursed loans data reported in
Commercial Banks’ Monthly Reports is final.
• Accordingly, there do not appear to be any
problems with the statistics in the data on
undisbursed loan reported by banks thus far.
However, it is also necessary to recognize the
Conclusions and Policy
Implications
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
weakness in the reporting method, which is
based on end-of-month data, and is thus unable
to capture volatility in drawing down and
repayment of working capital lines of credit.
Impact of Undisbursed Loans on Monetary
Policy Transmission
In this research, analysis on the impact of
undisbursed loans on monetary policy
transmission is only at the level of literature
review and is not so far based on empirical
testing. Nevertheless, the following conclusions
can be drawn on the basis of the analysis
framework and analysis of factors leading to the
rise in undisbursed loans:
• The occurrence of excess demand/supply
equilibria in the national banking system
indicates that the bank intermediary function
in Indonesia is falling short of expectations.
• Credit is still the primary source of business
financing in Indonesia, despite the significant
growth in non-bank financial markets during
the past few years. As a result, the credit
channel continues to play an important role
in monetary policy transmission. However,
loan commitments and the accompanying
undisbursed loans could hamper the
effectiveness of monetary policy transmission
through the credit channel.
• The loan commitments with floating rates do
not hamper monetary policy transmission
through the interest rate channel. However,
the overall effectiveness of monetary
transmission through interest rates continues
to rely on the extent the impact of
asymmetric information to rigidity in loan
interest rates.
Conclusions and Policy
Implications
• The existence of loan commitments with
floating rates will complicate the selection
of the most appropriate monetary strategy.
On one hand, an increase in loan
commitments will lead real incomes to be
more sensitive to changes in interest rates,
and on the other hand, the flexibility in the
use of credit extended under loan
commitments will make debtors more
sensitive to changes in income.
• Undisbursed loans – just like money supply
– represent potential public purchasing
power that can disrupt monetary stability if
their level steadily rises in excess of actual
needs.
6.2 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 ongoing suboptimal intermediation in
the banking system as reflected in the
increased undisbursed loans points to the
increasing importance of accelerating the
development of non-bank financial
markets in order to promote national
economic recovery. Growth in non-bank
financial markets and increased
competition on financial markets may ease
business dependence on bank financing
and ameliorate the rigidity in loan interest
rates.
• The rigidity in 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
46
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
accelerate actions to improve transparency
and availability of debtor information, such
as in the 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 (Boot & Thakor, 1997).
• Because rigidity in interest rates is a product
of the continued high level of risk premium
imposed by banks, their understanding and
capability to measure and implement risk
management need to improve.
• 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, the drive to
increase demand for credit 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 intermediation
need to be supported by clarity in the future
direction and level of interest rates that will
promote more stable expectations of interest
rates.
• In view of the potential negative impact of
undisbursed loans on monetary and financial
system stability, there is a need to develop a
mechanism to keep undisbursed loans in
check by creating a system which will entail
opportunity costs for banks, for example, by
requiring a kind of compulsory deposit at the
central bank in proportion to undisbursed
loans, or for debtors by charging more
47
significant levels of “penalty fees” for
undisbursed loans, compared to the present.
• For statistical purposes, as loan commitments
in the form of working capital lines of credit
and consumption credit for credit cards
provide debtors with flexible arrangements
for drawing funds, these facilities are
considered to be very similar to demand
deposit accounts that make up the money
supply. For this reason, it is necessary to
examine the possibility of including total
undisbursed loans from working capital lines
of credit and consumption credit for credit
cards as components of the money supply
in monetary analysis.
• The equations for loan demand and loan
supply developed in this research can be
used to prepare projections and policy
simulations.
• Bank Indonesia needs to conduct a regular
survey on Terms of Bank Lending in line with
the long-standing practice of the US Federal
Reserves (“Terms of Lending at Commercial
Banks: Survey of Loans Made,” Federal
Reserves Bulletin).
• The contribution of this research lies
primarily in setting out an analysis framework
and stylized facts on undisbursed loans in
an analysis of monetary policy transmission
in Indonesia. To the best knowledge of the
authors, no previous research had been
conducted at Bank Indonesia on undisbursed
loans and their relationship to the bank
intermediary function and monetary policy
transmission. Accordingly, it is the hope of
the author that this research will pave the
way for similar studies.
Conclusions and Policy
Implications
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
• Ultimately, as cited by Brunner and Meltzer
(1998), 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 incurred for transactions and
information. For this reason, efforts to
promote the intermediary function and
Conclusions and Policy
Implications
strengthen effectiveness in monetary policy
transmission call for hard work and
concerted efforts from Bank Indonesia as the
monetary and banking authority, as well as
from other stakeholders in ameliorating the
factors responsible for excessive uncertainty,
high transaction costs and costs of
information.
Jakarta, October 2004
48
 FUNGSI INTERMEDIASI PERBANKAN DAN FENOMENA UNDISBURSED LOANS: Faktor Penyebab dan Implikasi Kebijakan

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50
Appendix THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

1
6 Profile
of Survey Respondents
Profile of Respondent Companies
This survey conducted to 100 companies
in the Jakarta-Bogor-Tangerang-Bekasi area. The
decision to select this area as the sampling
location was based on the consideration that most
companies holding undisbursed loans have their
head offices in this area. The survey covered the
nine economic sectors used in the Commercial
Banks‘ Monthly Reports (LBU). Based on the
position of outstanding credit at end 2003, the
100 respondents were classified as follows:
Of the 100 respondents, 20% were small
and medium enterprises (SMEs). The 100
companies in this survey were selected according
to information in the Debtor Information System
(SID) managed by the Directorate of Bank
Licensing and Information (DPIP), Bank
Indonesia. At this point, SMEs were companies
receiving small-scale business credit (KUK)
facilities with loan ceiling of up to Rp 500 million.
This criterion is based on the provisions of Bank
Indonesia Circular Letter No. 3/9/BKr concerning
Directions for Lending of Small-Scale Business
Credit. This Circular Letter stipulates the criteria
for small enterprises as: businesses with no more
than Rp 200 million in net assets, not including
land and buildings used as business premises,
annual sales (turnover) not exceeding Rp 1.0
billion, ownership by Indonesian citizens, and
not a subsidiary owned directly or indirectly by
a medium or large-scale enterprise.
Of the 100 respondents, the final survey
results identified 65 respondents that valid to be
analyzed, consisting of 17 SMEs and 48 non-SMEs

Table Proportion of Respondent companies

Total Number Non
Loans Proportion of SMEs SMEs
(billion Rp) Respondent

1. Agriculture 24,307 7.4% 7 5 2

2. Mining 5,061 1.5% 2 2 0
3. Manufacture 123,125 37.4% 37 30 7
4. Trade 84,257 25.6% 26 20 6
5. Services 92,127
a. Electricity, Gas & Water 4,482 1.4% 1 1 0
b. Construction 12,478 3.8% 4 3 1
c. Transportation 16,121 4.9% 5 4 1
d. Business Services 48,603 14.8% 15 12 3
e. Social Services 10,422 3.2% 3 3 0
6. Others 109,067 - - - -
Total 437,944 100% 100 80 20

Profile
51 of Survey Respondents
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications
companies. However, only 4 of all the companies
meeting the SME criteria had business turnover at
not more than Rp 1 billion, while the 13 other
companies booked turnover in excess of Rp 1
billion and among these, turnover for as many as
6 companies surpassed Rp 10 billion. This led to
concerns of possible masking of the criteria for
small-scale enterprises as determined earlier.
Accordingly, the companies were reclassified by
annual turnover of less than Rp 1 billion for small-
scale enterprises, Rp 1 billion through Rp 10 billion
for medium enterprises, and turnover exceeding
Rp 10 billion for large companies. Under the new
classification, 76.5% (50 companies) were large
companies, 16.9% (11 companies) were medium-
scale, and only 6.2% (4 companies) came in the
small-scale enterprise category. Only 23.1% (15
companies) were export-oriented, while the
remaining 76.9% (50 companies) were non-export
oriented. Disaggregated by business sector, 43.1%
(28 companies) operate in manufacture, 18.5%
(12 companies) in trade, 13.8% (9 companies) in
the business services sector, 10.8% (7 companies)
in transportation, storage, and communications,
6.2% (4 companies) in construction, 3.1% (2
companies) in mining, 3.1% (2 companies) in
social and public services sectors, and 1.5% (1
company) in the agriculture sector.
Among the corporate officers interviewed,
the largest group consists of middle-level
managers, who represented 61.5% (40
respondents) of the total. Next were senior
managers at 33.8% (22 respondents), while the
remaining 4.6% (3 respondents) were company
owners. Among the respondents interviewed,
66.1% (41 respondents) were financial managers,
Profile
of Survey Respondents
with the remainder varied from president
directors to project managers, heads of treasury,
accounting, and internal division. Analyzed by
level in the decision making hierarchy, 83.1%
(54 respondents) were persons involved in
decision making concerning the financing of the
company. The remaining 16.9% (11 respondents)
were persons with ultimate decision making
responsibility in the area of financing.
Profile of Respondent Banks
The survey was conducted with the
participation of 30 banks based in Jakarta, which
have 86.9% of total assets in the banking system
and 82.6% of overall bank lending. The 30
banks were grouped by category into 4 state
banks, 14 private domestic banks, 1 regional
development bank, 5 joint venture banks, and
6 foreign banks. This grouping, it was expected,
would help establish whether behavior regarding
undisbursed loans is influenced by the
characteristics of individual categories of banks.
Among the 30 banks covered by the
survey, 60% of respondents were senior
managers such as CEOs, Directors, or General
Managers. The remaining 40% were middle-
level managers such as credit managers, Division
Heads, or Department Heads. The position of
respondents within the organizational structure
interviewed varied from one respondent to
another, from credit department and credit risk
control to credit management and others. Most
interviewees (88.0%) were persons involved in
the decision making process for lending. Only
12% were the ultimate decision makers in
extending loans.
52
Appendix THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

2
6 Survey Questionnaire
for Banks

BANK Q’naire No. : ______________

QUESTIONNAIRE Interviewer No. : ______________

BANK INDONESIA

Name of Bank _______________________________________________________________________________

Address of Bank _______________________________________________________________________________

_______________________________________________________________________________

Name of Respondent _______________________________________________________________________________

Position _______________________________________________________________________________
E-mail _______________________________________________________________________________

Telephone No. __________________________________ Fax Number _________________________________

CATEGORY OF BANK

State Bank 1
Private Domestic Bank 2
Regional Development Bank 3
Joint Venture Bank 4
Foreign Bank 5

Quality Control Name Date Initials Remarks

Interviewer
Witness
Recall
Supervisor Check
Coding / Punching

I. SCREENING

INTRODUCTION & INSTRUCTIONS FOR INTERVIEWER:

Good morning/afternoon.
REQUEST TO SPEAK TO THE CREDIT DEPARTMENT.

Survey Questionnaire
53 for Banks
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

AFTER SPEAKING TO/MEETING WITH THE APPROPRIATE DEPARTMENT, SAY:

“Bank Indonesia is conducting research on the bank intermediary function and the phenomenon of
undisbursed loans (unused credit). Who would be the most appropriate person for us to interview?”

• AFTER SPEAKING/MEETING WITH THE APPROPRIATE PERSON, INTRODUCE YOURSELF

AGAIN AND EXPLAIN THE PURPOSE/OBJECTIVES OF THE SURVEY, THEN PROCEED WITH
QUESTIONS S1A AND SO ON.
• if the respondent is unavailable to talk/be interviewed at this time, arrange an appointment.

S1a. What is your current position?

S1b. What department or division are you employed in?

S1a. POSITION
Senior management (e.g. CEO, Director, GM) 1
Middle management position (e.g., Manager/Division Head/Department Head) 2 } S1b. Department:

Other 3 STOP

S2. Which of the following sentences best describes your involvement in the decision making
process for lending to corporate customers (not individuals) at this bank?

I am the ultimate decision maker on lending to customers 1

in decisions making on lending to customers 2
Iam not involved in any way in decision making on lending to customers. 3 STOP

IF THE PROSPECTIVE RESPONDENT PASSES SCREENING, ARRANGE APPOINTMENT FOR FACE-

TO-FACE INTERVIEW BY SAYING:
“We will continue with a face-to-face interview with you on the subject of undisbursed loans. This
interview will take about 20 minutes. What would be the most convenient time to come and meet
you?”

Day/date: ____________________ Time: __________________

THEN EXPLAIN: “At various points in the interview, I will be requesting information in the form of
data or figures for the years of 2001 through 2003. We will fax you the questions to enable you to fill
in/prepare the information in advance. This sheet will be collected at the time we meet for our
interview.”

Survey Questionnaire
for Banks 54
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

FACE TO FACE INTERVIEW

THE QUESTIONS IN SECTION II AND THEREAFTER ARE PUT FORWARD DURING THE FACE-TO-
FACE INTERVIEW.

BEFORE CONDUCTING THE FACE-TO-FACE INTERVIEW, ENSURE THAT THE RESPONDENT HAS
COMPLETED THE FORM TRANSMITTED BY FAX AT THE TIME OF INITIAL CONTACT.

INTRODUCTION & INSTRUCTIONS FOR INTERVIEWER:

• IF YOU WERE NOT THE ONE WHO CONTACTED THE RESPONDENT, START BY INTRODUC-
ING YOURSELF.
• REQUEST THE FORM FILLED IN BY THE RESPONDENT, THEN CHECK ANSWERS FOR CON-
SISTENCY. IF THE FORM CONTAINS DATA THAT YOU BELIEVE TO BE IRRELEVANT, SEEK
CONFIRMATION WITHOUT DELAY.
• COPY THE RESPONDENT’S ANSWERS ON THE FORM TO THE QUESTIONNAIRE
• ATTACH THE FORM TO THE QUESTIONNAIRE

II. Bank Portfolio Management

1. (SHOW CARD) What kind of portfolios are priority for the asset placements of Bank ………….
[STATE NAME OF BANK] at this time? Please state order of priority, with “1” as the most important
priority, “2” as second priority, etc.

Loans
Government Securities (Government Bonds)
Bank Indonesia Securities
Corporate Securities (private sector bonds)
Interbank Money Market (PUAB)
Forex Market
Other, PLEASE SPECIFY ……………………………………

2. (SHOW CARD) What are the factors considered by Bank …………. [STATE NAME OF BANK] in
determining the priority of the above portfolios? Please state order of priority, with “1” as the most
important priority, “2” as second priority, etc.

Highest yield
Low risk
Highest liquidity
Other, PLEASE SPECIFY ……………………………………

Survey Questionnaire
55 for Banks
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

III. CREDIT INFORMATION

CHECK CONSISTENCY OF ASNWERS TO QUESTIONS NO. 3 THROUGH NO. 6 ON THE SHEET
FILLED IN BY RESPONDENT. IF ANY ANSWER IS NOT RELEVANT, CONFIRM DURING FACE-TO-
FACE INTERVIEW.

3. What is the composition of the overall new loan commitments approved by Bank ………….
[STATE NAME OF BANK] in the last three years, disaggregated by purpose of use (in %)?

Purpose of Loan Use 2001 2002 2003

Working Capital Credit

Investment Credit
Consumption Credit
Total 100% 100% 100%

4. IF WORKING CAPITAL CREDIT IS FILLED IN FOR QUESTION 3: For new loan commitments
used for Working Capital Credit, what is the proportion of scheduled loans and how much com-
prises lines of credit?

Purpose of Loan Use 2001 2002 2003

Scheduled Working Capital Credit

Working Capital Lines of Credit
Total 100% 100% 100%

Note: Scheduled Working Capital Credit is credit for which disbursement and repayment is set out in an agreed schedule.

Working Capital Lines of Credit are loans in which disbursement and repayment are not tied to any fixed schedule.
5. IF CONSUMPTION CREDIT IS FILLED IN FOR QUESTION 3: For new loan commitments used
for Consumption Credit, what are the proportions for home ownership loans, vehicle loans, and
credit cards?

Purpose of Loan Use 2001 2002 2003

Home purchase loans

Vehicle purchase loans
Credit cards
Other, PLEASE SPECIFY…………………
Total 100% 100% 100%

6. For each type of credit approved by Bank …. [STATE NAME OF BANK], what is the proportion
(percentage) of total loans not used by debtors (undisbursed loans) compared to the loan commit-
ments for each purpose of loan use (end year position)?

Survey Questionnaire
for Banks 56
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Purpose of Loan Use 2001 2002 2003

Working Capital Credit

Investment Credit
Consumption Credit

7. For each type of credit approved by Bank …. [STATE NAME OF BANK], what is the general
pattern of draw down (percentage of draw down against loan commitments) by debtors (quar-
terly for working capital credit/consumption credit, annually for investment credit)? (CHECK CON-
SISTENCY WITH QUESTION NO 6)

Purpose of Loan Use 1st Quarter 2nd Quarter 3rd Quarter 1th Quarter

Working Capital Credit

Consumption Credit
1st Year 2nd Year 3rd Year 4th Year
Investment Credit

8. Has there been any change in the pattern of draw down in the past 2 years?

Yes 1 Go To 8a No 2 Go To 9

8a. What is the new pattern?

Purpose of Loan Use 1st Quarter 2nd Quarter 3rd Quarter 1th Quarter

Working Capital Credit

Consumption Credit
1st Year 2nd Year 3rd Year 4th Year
Investment Credit

IV. FACTORS INFLUENCING CHANNELING OF CREDIT

9. At this time, are there any obstacles that hamper credit expansion by Bank …. [STATE NAME OF
BANK]?

Yes 1 Go To 9a No 2 Go To 10

9a. (SHOW CARD) What are the factors that hamper credit expansion? Please rank by degree of
constraints with “1” as the most important, “2” as the second constraint, etc.

Survey Questionnaire
57 for Banks
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

High risk to bank capital

Mounting non-performing loans (NPLs)
Lack of information on business sectors with potential
Most deposits held in the bank are short-term
Bank personnel lack competence for breaking new ground in credit expansion
Debtor business prospects fraught with risk
Poor macroeconomic outlook
Unsupportive social, political, and security conditions
Availability of more attractive alternatives for fund placements
Other, PLEASE SPECIFY ……………………………………

10. (SHOW CARD) What factors are considered by Bank …. [STATE NAME OF BANK] regarding
new loan applications by …………. debtors [STATE EACH CATEGORY OF DEBTORS]? Please
state order of importance, with “1” as the most important, “2” as the second important factor, etc.

Criteria Existing Debtors New Debtors

(Exluding Debtors in 2003) (Debtors in 2003)

Proposed collateral
Adequacy of debtor business capital
Financial condition of debtor
Character of debtor
Debtor business prospects
Other, PLEASE SPECIFY………………

11. What is the range of loan commissions and commitment fees that Bank …. [STATE NAME OF
BANK] charges debtors on these new loans?

Loan Commission Charges …… % through …….%

Commitment Fees ……% through …….%

12.What is the range of risk premium set by Bank …. [STATE NAME OF BANK] for new loans,
disaggregated by purpose of use?

Working Capital Credit ……% through …….%

Investment Credit ……% through …….%
Consumption Credit ……% through …….%

V. LENDING OUTLOOK

13.(SHOW CARD) What kinds of loans are priority for the future credit expansion of Bank …. [STATE
NAME OF BANK]? Please rank in order of priority, with “1” as the most important priority, “2” as
second priority, etc.

Survey Questionnaire
for Banks 58
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Purpose of Loan Use

Working Capital Credit (KMK)

Investment Credit (KI)
Consumption Credit (KK)

13a. (SHOW CARD) What are the priority business sectors for the future credit expansion of Bank ….
[STATE NAME OF BANK]? Please rank in order of priority, with “1” as the most important priority,
“2” as second priority, etc.

Bussiness Sector
Agriculture
Mining
Manufacture
Trade
Electricity, Gas and Water
Construction
Transport, Storage and Telecommunications
Business Services (including financial services, non-medical professions, etc.)
Public and Social Services (including hospitals, education, and places of entertainment)
Other, PLEASE SPECIFY ……………………………………

14.(SHOW CARD) What actions/measures have been taken by Bank …. [STATE NAME OF BANK] to
promote channeling of credit? Please rank in order of priority, with “1” as the most important
priority, “2” as second priority, etc.

Simplify loan application procedures

Reduce loan interest rates
Conduct promotions to offer loans
Strengthen the competence of bank personnel
Other, PLEASE SPECIFY ……………………………………

CHECK CONSISTENCY OF ANSWERS TO QUESTION 15 WITH THE SHEET FILLED IN BY THE

RESPONDENT. IF ANY ANSWERS ARE NOT RELEVANT, SEEK CONFIRMATION DURING FACE-
TO-FACE INTERVIEW.

15.(SHOW CARD) What is the composition of new loan commitments provided by Bank …. [STATE
NAME OF BANK] in the last 2 years and of planned future lending?

Survey Questionnaire
59 for Banks
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

Loan Approvals 2002 2003 Ke depan

a. less than Rp 500 million

b. Rp 500 million – Rp 5 billion
c. more than Rp 5 billion
Total 100% 100% 100%

VI. FACTORS INFLUENCING UNDISBURSED LOANS

16.(SHOW CARD) What are the causes related to mounting undisbursed loans or loans unused by
debtors, in the opinion of Bank …. [STATE NAME OF BANK]? Please rank by importance of
cause, with “1” as the most important cause, “2” as the second, etc.

Deterioration in debtor business prospects

Downturn in business cycle of debtors
Declining production capacity utilization at debtor companies
Mounting debt burdens of debtor companies
Loan interest rates remain high in relation to debtor expectations
Social and political conditions leading up to the election
Availability of alternative sources of financing
Other, PLEASE SPECIFY ……………………………………

17.Has the increase in undisbursed loans led Bank …. [STATE NAME OF BANK] to set aside liquid-
ity in anticipation of draw down of credit by debtors?

Yes 1 No 2

17a. What is the average proportion of funds (liquidity) set aside by Bank …… [STATE NAME OF
BANK] against total undisbursed loans to anticipate draw down of credit by debtors?

__________________________%.

18.What influence does the rise in undisbursed loans have on determining the loan interest rates for
Bank …… [STATE NAME OF BANK]? (S)

Increases cost of loanable funds 1

loanable funds 2
cost of loanable funds 3

Survey Questionnaire
for Banks 60
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

19.(SHOW CARD) In your opinion, what are the reasons for the persistently wide gap between
deposit rates and lending rates? Please rank reasons by importance of cause, with “1” as the most
important cause, “2” as the second cause, etc.

Continued high risk premiums

High cost of funds for some deposits
To maintain profit margin
High overhead costs
Other, PLEASE SPECIFY ……………………………………

20.What effect does the increase in undisbursed loans have on headroom for new credit expansion
by Bank …. [STATE NAME OF BANK]? (S)

Reduces headroom for credit expansion 1

room for credit expansion 2
on headroom for credit expansion 3

21.(SHOW CARD) What policy does Bank …. [STATE NAME OF BANK] apply in regard to rising
undisbursed loans? ……….. Please rank in order of priority, with “1” as the most important
priority, “2” as second priority, etc.

Request debtors to prepare more concrete schedules for draw down of credit
Impose charges on the remaining portion of undisbursed loans
No action taken with regard to debtors
Other, PLEASE SPECIFY ……………………………………

22. (SHOW CARD) What actions are taken by Bank …. [STATE NAME OF BANK] regarding
undisbursed loans after expiration of the loan agreement? Please rank by order of priority, with “1”
as the most important priority, “2” as second priority, etc.

Eliminate lines of credit

Require customers to enter into new loan agreements
Provide debtors with additional time
No action
Other, PLEASE SPECIFY ……………………………………

Survey Questionnaire
61 for Banks
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

VII. STATISTICAL ISSUES

23.Are the figures for undisbursed loans reported by Bank …. [STATE NAME OF BANK] in the Com-
mercial Bank Monthly Report final?

Yes Go To 24 No 2 Ke 23a

23a.As a rule, how often does Bank …. [STATE NAME OF BANK] correct its figures during the course
of a year? (S)

Once 1
2-3 times 2
4-5 times 3
More than 5 times 4

24. If Bank …. [STATE NAME OF BANK] eliminates a line of credit not used by a debtor, when
is this reported in the Commercial Bank Monthly Report? (S)

In the same reporting month 1

In the following reporting month 2
Await further developments 3
Other, PLEASE SPECIFY ……………… 4

25. What formula does Bank …. [STATE NAME OF BANK] use to calculate the figures for total
undisbursed loans reported to Bank Indonesia?

Formula:

~ Thank you for your time and cooperation ~

Survey Questionnaire
for Banks 62
Appendix THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

3
6 Company
Survey Questionnaire

COMPANY Q’naire No. : ______________

QUESTIONNAIRE Interviewer No. : ______________

BANK INDONESIA

Name of Company _______________________________________________________________________________

Address of Company _______________________________________________________________________________

_______________________________________________________________________________

Name of Respondent _______________________________________________________________________________

Position _______________________________________________________________________________
E-mail _______________________________________________________________________________

Telephone No. __________________________________ Fax Number _________________________________

Quality Control Name Date Initials Remarks

Interviewer
Witness
Recall
Supervisor Check
Coding / Punching

CATEGORY OF COMPANY

SME Company (n=20) 1

Non-SME Company (n=80) 2

INTRODUCTION & INSTRUCTIONS FOR INTERVIEWER :

Good morning/afternoon.
ASK TO SPEAK TO THE DEPARTMENT RESPONSIBLE FOR CORPORATE FINANCING OR
ARRANGement OF LOANS FROM BANKS.

Company
63 Survey Questionnaire
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

AFTER SPEAKING TO/MEETING WITH THE APPROPRIATE DEPARTMENT, SAY:

“Bank Indonesia is conducting research on the bank intermediary function and the phenomenon of
undisbursed loans (unused credit). Who would be the most appropriate person for us to interview?”
• AFTER SPEAKING/MEETING WITH THE APPROPRIATE PERSON, INTRODUCE YOURSELF
AGAIN AND EXPLAIN THE PURPOSE/OBJECTIVES OF THE SURVEY, THEN PROCEED WITH
QUESTIONS S1A AND SO ON.
• if the respondent is unavailable to talk/be interviewed at this time, arrange an appointment.

I. SCREENING

S1.This survey is being conducted among selected members of the public. Do you or any relative or
close friend work at any of the following companies? [READ OUT ONE BY ONE]

No Yes
Market research 0 1 STOP
Bank 0 1 STOP
Other financial institution 0 1 STOP

S2a. What is your current position?

S2b. FOR ‘Non-owner’: ASK IN WHICH “Department” IS THE RESPONDENT EMPLOYED

ANSWER (S2a)
Owner 1
Senior manager (e.g. CEO, Director, GM)
Middle management (e.g., Manager/Division Head/Department Head)
2
3
} Section (S2b) : ___________

Other 4 STOP

S3.Which of the following sentences best describes your involvement in this company in the deci-
sion making processes in company financing / arrangement of loans from banks?

I am the ultimate decision maker on corporate financing/arrangement of loans from banks 1

decisions on company financing/arrangement of loans from banks 2
way involved in decisions on company financing/arrangement of loans from banks 3 STOP

S4.In the last 2 years (2002-2003), has your company ever applied to a bank for credit?
Yes 1 MAKE APPOINTMENT
No 2 STOP

Company
Survey Questionnaire 64
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

IF THE PROSPECTIVE RESPONDENT PASSES THE SCREENING, ARRANGE AN APPOINTMENT

FOR FACE-TO-FACE INTERVIEW BY SAYING:
“We will continue with a face-to-face interview with you on the subject of undisbursed loans. This
interview will take about 20 minutes. What would be the most convenient time to come and meet you?”

Day/date: ____________________ Time: __________________

THEN EXPLAIN: “At various points in the interview, I will be requesting information in the form of data
or figures for the years of 2001 through 2003. We will fax you the questions to enable you to fill in/
prepare the information in advance. This sheet will be collected at the time we meet for our interview.”

FACE TO FACE INTERVIEW

THE QUESTIONS IN SECTION II AND THEREAFTER ARE PUT FORWARD DURING THE FACE-TO-
FACE INTERVIEW.
BEFORE CONDUCTING THE FACE-TO-FACE INTERVIEW, ENSURE THAT THE RESPONDENT HAS
COMPLETED THE FORM TRANSMITTED BY FAX AT THE TIME OF INITIAL CONTACT.

INTRODUCTION & INSTRUCTIONS FOR INTERVIEWER:

• IF YOU WERE NOT THE ONE WHO CONTACTED THE RESPONDENT, BEGIN BY INTRODUC-
ING YOURSELF.
• REQUEST THE FORM FILLED IN BY THE RESPONDENT, THEN CHECK ANSWERS FOR CON-
SISTENCY. IF THE FORM CONTAINS DATA THAT YOU BELIEVE TO BE IRRELEVANT, SEEK
CONFIRMATION WITHOUT DELAY.
• COPY THE RESPONDENT’S ANSWERS ON THE FORM TO THE QUESIONNAIRE
• ATTACH THE FORM TO THE QUESTIONNAIRE

II. COMPANY PROFILE

1. What sector does ...... [STATE NAME OF COMPANY] operate in? (S)

Agriculture 1
Mining 2
Manufacture 3
Electricity, Water, and Gas 4
Construction 5
Trade 6
Transportation, Warehousing, and Telecommunications 7
Business Services (incl. financial services, non-medical professions, etc.) 8
Social and Public Services (including hospitals, education, and places of entertainment) 9

Company
65 Survey Questionnaire
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

2. What is the annual business turnover of ...... [STATE NAME OF COMPANY]? (S)

Less than 1 billion 1

Between 1 and 10 billion 2
Over 10 billion 3

3. Is ...... [STATE NAME OF COMPANY] an export-oriented company?

Yes 1 Go To 3a No 2 Go To 4

3a What proportion of the production/sales of ...... [STATE NAME OF COMPANY] is for the
export market?

BUSINESS ORIENTATION

Export Market ………… %

Domestic Market ………… %

II. INFORMATION ON COMPANY BORROWINGS

CHECK CONSISTENCY OF ANSWERS TO QUESTIONS No. 4 AND 4a ON SHEET COMPLETED BY

RESPONDENT. IF ANY ANSWER IS NOT RELEVANT, CONFIRM DURING FACE-TO-FACE INTER-
VIEW.

4. What is the composition of new loan commitments used by ...... [STATE NAME OF COM-
PANY] over the last three years?

Purpose of Loan Use 2001 2002 2003

Working Capital Credit

Consumption Credit
Investment Credit
Total 100% 100% 100%

4a. What is the range of interest rates (in percentages) charged to .....[STATE NAME OF COMPANY]
for [STATE EACH LOAN TYPE BY PURPOSE OF USE] over the past three years?

Category of Loan Range of Interest Rates (%)

2001 2002 2003

Working Capital Credit ...... % to .......% ..... % to .......% ...... % to .......%

Investment Credit ...... % to .......% ......% to .......% ...... % to .......%
Working Capital Credit ...... % to .......% ......% to .......% ...... % to .......%

Company
Survey Questionnaire 66
 THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

5. Of the new loan commitments obtained by ...... [STATE NAME OF COMPANY], what is the
overall pattern of draw down of credit (percentage of draw down against loan commitments) by
[STATE NAME OF COMPANY]? (quarterly for working capital credit and consumption credit, annu-
ally for investment credit)

Purpose of Loan Use 1st Quarter 2nd Quarter 3rd Quarter 1th Quarter

Working Capital Credit

Consumption Credit
First Year Second Year Third Year Fourth Year
Investment Credit

6. Has there been any change in the pattern of draw down over the past 2 years?

Yes 1 Go To 6a No 2 Go To 7

6a. What is the new pattern of draw down (quarterly for working capital credit and consumption
credit, annually for investment credit)

Purpose of Loan Use 1st Quarter 2nd Quarter 3rd Quarter 1th Quarter

Working Capital Credit

Consumption Credit
First Year Second Year Third Year Fourth Year
Investment Credit

III. FACTORS INFLUENCING DRAW DOWN OF CREDIT

7. Has ...... [STATE NAME OF COMPANY] ever experienced any difficulty in applying for new
loans in the past 2 years?

Yes 1 Go To 7a No 2 Go To 8

7a. (SHOWCARD) In your opinion, what are the factors behind these problems? Please rank in
order of priority, with “1” as the most important priority, “2” as second priority, etc.

Inadequate collateral
Insufficient capital
Poor financial condition of company
Poor business prospects
Lack of information on loan application procedures
Other, PLEASE SPECIFY …………………………………

Company
67 Survey Questionnaire
THE BANK INTERMEDIARY FUNCTION AND UNDISBURSED LOANS PHENOMENON: Causes and Policy Implications

8. Has a bank ever approved loans for ...... [STATE NAME OF COMPANY] beyond the amount
needed?

Yes 1 Go To 8a No 2 Go To 9

8a. (SHOWCARD) In your opinion, what factors led the bank to approve credit for ...... [STATE
NAME OF COMPANY] in excess of the amount needed? Please rank in order of importance, with “1”
as the most important cause, “2” as second cause, etc.

Your company’s good performance

Improving business prospects for your company
Your company is a preferred debtor for the bank
The bank is one of your company’s subsidiaries
Other, PLEASE SPECIFY ……………………………

9. Has ...... [STATE NAME OF COMPANY] taken on additional lines of credit during the past 2
years, whether at the same bank or at other banks?

Yes 1 Go To 9a No 2 Go To 10

9a. (SHOWCARD) Why has ...... [STATE NAME OF COMPANY] taken on additional lines of
credit? Please rank by importance of cause, with “1” for most important cause,”2” as second cause,
etc.

To provide financing for new projects

To ease the management of company operations
To keep liquidity on hand for the company
Because of aggressive credit promotion by a number of banks
Other, PLEASE SPECIFY …………………………………

CHECK CONSISTENCY WITH ANSWERS TO QUESTION NO. 10 ON THE SHEET FILLED IN BY

RESPONDENT. IF ANY ANSWER IS NOT RELEVANT, CONFIRM DURING FACE-TO-FACE INTER-
VIEW.

10. Please state the composition of additional sources of financing used by ...... [STATE NAME
OF COMPANY] over the last 3 years (in %)!

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

Source of Financing 2001 2002 2003

a Bank loans
b Bond issues
c Share issues
d Foreign borrowings
e Equity/Business partner
f Suppliers (trade finance)
g Affiliated company
h Leasing
i Pawnshop
j Other (PLEASE SPECIFY)
Total 100% 100% 100%

11. (SHOW CARD) What are the factors that encourage ...... [STATE NAME OF COMPANY] to
continue using bank loans as a source of financing? Please rank by importance of cause, with “1” as
the most important cause, “2” as the second cause, etc.

Good relations between the company and the bank

Easier procedures for loan application
Aggressive offerings of credit by the bank
Ease in drawing down credit as needed
Reasonable interest rates
Adequacy of collateral held by the company
Other, PLEASE SPECIFY …………………………………

12. (SHOWCARD) IF THE ANSWER TO QUESTION 10 IS FILLED WITH OTHER THAN BANK
LOANS (CODE A), ASK: What has encouraged ...... [STATE NAME OF COMPANY] to use a source of
funds other than the bank? Please rank in order of priority, with “1” as the most important priority,
“2” as second priority, etc.

Lower cost of funds

Longer term
Does not require large collateral
Easier requirements
Other, PLEASE SPECIFY …………………………………

13. (SHOW CARD) What is the policy of the bank used by ... [STATE NAME OF COMPANY] in
disbursement of loan commitments? What is it as a proportion of the total credit commitments!

A. May be drawn at any time on demand

B. Requires prior notice to the bank
Total 100%

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

CHECK CONSISTENCY OF ANSWERS TO QUESTIONS No. 14,15, DURING THE FACE-TO AND
17 ON THE SHEETS FILLED IN BY THE RESPONDENT. IF ANY ANSWER IS NOT RELEVANT,
CONFIRM -FACE INTERVIEW.

14. What is the proportion of undisbursed loans held by ...... [STATE NAME OF COMPANY] in
comparison to loan commitments for each purpose of loan use approved by the Bank (in %)?

Purpose of Loan 2001 2002 2003

Working Capital Credit

Consumption Credit
Investment Credit

15. What is the composition of all undisbursed loans held by ...... [STATE NAME OF COM-
PANY] by currency (in %)?

Currency 2001 2002 2003

Rupiahs
Foreign Currencies
Total 100% 100% 100%

16. (SHOWCARD) In your opinion, for what reasons is loan commitments approved by the
bank not put to use? Please rank order of importance, with “1” as the most important cause, “2” as
the second cause, etc.

Declining production capacity of the company

Mounting debt burden of the company
Inadequate capital held by the company
Deteriorating business prospects
Downturn in company business cycle
Loan interest rates still high
Availability of alternative sources of financing
Tightened procedures for draw down of credit
Other, PLEASE SPECIFY …………………………………

17. Please state production sales capacity utilization, debt to equity ratio, and gross profit to
equity over the past 3 years!

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

No Description 2001 2002 2003

A Capacity Utilization (%)

B Debt to Equity Ratio (%)
C Gross Profit/Equity (%)

Note: capacity utilization = total production (sales) divided by maximum production/sales capacity

18. What is the highest rate of production (sales) ever sustained by ...... [STATE NAME OF COM-
PANY] in the past 5 years? ………………………………………….. (in millions of rupiahs).

18a. Which was the year of highest production (sales)? ________________________

19. (SHOWCARD) If deteriorating business prospects is one reason for the rise in undisbursed
loans. In your opinion, what are causes of the deteriorating business prospects? Please rank in order
of importance, with “1” as the most important cause, “2” as the second cause, etc.

Growth in public demand below expectations

Rising unofficial levies
Mounting labor problems
Unsupportive social and political conditions at this time
Bureaucratic difficulties and legal uncertainty
Other, PLEASE SPECIFY …………………………………

20. What is your opinion of the level of interest rates charged to [STATE NAME OF COMPANY] at
this time? (S)

Low 1 GO TO 22
Reasonable 2 GO TO 22
High 3 GO TO 21

21 IF CODE 3 OF QUESTION 20 IS CIRCLED, ASK: If in your opinion the current level of

interest rates is high, what do you think is the ideal spread between loan interest rates and bank
deposit rates that would encourage ......... [STATE NAME OF COMPANY] to make greater use of
available loan commitments? ..............to...............%

22 (SHOWCARD) What actions have been taken by ...... [STATE NAME OF COMPANY] in
regard to long-standing unused loan commitments? Please rank in order of priority, with “1” as the
most important priority, “2” as second priority, etc.

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

Apply to the bank for elimination of the loan commitments

Allow loan commitments to remain until expiration of term for draw down to anticipate any need for funds.
Other, PLEASE SPECIFY…………………………………

~ Thank you for your time and cooperation ~

Company
Survey Questionnaire 72