Jakarta, Indonesia’s banking sector is grappling with persistent tight liquidity conditions, a situation exacerbated by the Bank Indonesia (BI) Rate’s upward trajectory. This monetary tightening cycle, initiated to anchor inflation and stabilize the rupiah amidst global economic uncertainties, is now raising concerns among economists about its differential impact across various banking tiers and the potential for a competitive "interest rate war" for deposits. The primary concern is that this could impede the crucial function of financial intermediation, particularly for smaller and medium-sized banks, ultimately affecting broader economic growth.
The Intensifying Liquidity Squeeze on Mid-Tier Banks
Economists highlight that the liquidity crunch is not uniformly distributed but predominantly affects mid-tier banks, specifically those categorized as Commercial Banks Based on Core Capital (Kelompok Bank berdasarkan Modal Inti, or KBMI) II and III. M. Rizal Taufikurahman, Head of the Center of Macroeconomics and Finance at the Institute for Development of Economics and Finance (INDEF), articulated this concern, stating that the tight liquidity in these segments could indeed ignite a "war of interest rates" as banks fiercely compete to attract and retain customer deposits.
"Complaints regarding tight liquidity, especially from mid-tier banks (KBMI II-III), clearly indicate increasing competition in mobilizing public funds. This condition has the potential to trigger a deposit rate war," Rizal informed CNBC Indonesia in late July 2026. This competitive environment disproportionately disadvantages banks with a limited base of low-cost funds, primarily Current Account, Saving Account (CASA) deposits. CASA funds are considered the most stable and cheapest source of funding for banks, allowing them to maintain healthy net interest margins (NIMs) and offer more competitive lending rates. Should a full-blown interest rate war materialize, the cost of funds for these banks would inevitably surge, squeezing their NIMs and severely restricting their capacity to lower lending rates. Such a scenario could stifle credit growth, particularly for sectors heavily reliant on mid-tier banking support, such as small and medium-sized enterprises (SMEs).
Rizal emphasized the broader challenge this presents for policymakers: "If an interest rate war occurs, the cost of fund will increase, net interest margin (NIM) will be pressured, and the room for lowering credit rates will become even narrower." Consequently, he argued, the paramount challenge for the government and monetary authorities extends beyond merely maintaining monetary stability; it also encompasses ensuring adequate banking liquidity to prevent any disruption to the vital intermediation function of the financial system.
Uneven Distribution: A Deeper Dive into Banking Tiers
While acknowledging the existence of liquidity pressures, Josua Pardede, Chief Economist at Bank Permata, offered a nuanced perspective, suggesting that the core issue might not be an absolute shortage of liquidity within the system but rather an uneven distribution across different banking groups. According to Pardede, larger banks, classified as KBMI IV, possess inherent advantages due to their expansive low-cost fund bases and extensive transactional ecosystems. This enables them to withstand liquidity pressures more effectively.
"Liquidity distribution is not yet even across banks, where large banks (KBMI IV) tend to be stronger because of their low-cost fund base and wider transactional ecosystem, while mid-tier banks (KBMI II-III) are more sensitive to the movement of large depositors’ funds," Josua explained. He confirmed the nascent signs of an interest rate war, but qualified it as selective rather than an industry-wide phenomenon at present. "Indications of an interest rate war are indeed starting to emerge, but they are still selective, not yet a major interest rate war across the entire industry."
Data on deposits by KBMI classification from May 2026 underscores this disparity. KBMI IV banks collectively held a staggering Rp5,550.8 trillion in deposits, dwarfing the figures for KBMI I, KBMI II, and KBMI III banks. This concentration of funds provides KBMI IV banks with significant pricing power and stability, leaving their smaller counterparts to contend for a more limited pool of funds, often at higher costs.
Monetary Policy and Global Headwinds: The Context of BI Rate Hikes
The current liquidity tightness is inextricably linked to Bank Indonesia’s aggressive monetary policy tightening cycle. Faced with persistent inflationary pressures—both domestic and imported—and the need to stabilize the rupiah against a strong US dollar, BI has steadily increased its benchmark rate. Starting from a relatively accommodative stance in late 2022, the BI Rate began its ascent, moving from, for instance, 3.50% in mid-2022 to reaching 6.25% by May 2026. Each hike was a deliberate move to curb inflation, manage capital outflows, and maintain the attractiveness of Indonesian financial assets.
This domestic tightening occurred against a backdrop of global monetary policy shifts, primarily led by the US Federal Reserve’s sustained interest rate increases. As the Fed continued to hike rates, it put pressure on emerging market currencies, including the rupiah, by increasing the allure of dollar-denominated assets. To counteract potential capital flight and imported inflation, BI was compelled to follow suit, albeit with careful consideration of domestic economic conditions. The consequence, however, is a higher cost of borrowing for banks and, subsequently, for businesses and consumers, inevitably leading to tighter liquidity in the banking system.
The Anatomy of Bank Classifications: KBMI Tiers Explained
Understanding the KBMI classification is crucial to grasping the dynamics of Indonesia’s banking liquidity. Introduced by the Financial Services Authority (OJK), this framework categorizes banks based on their core capital:
- KBMI I: Banks with core capital below Rp6 trillion. These are typically smaller, regional, or niche banks.
- KBMI II: Banks with core capital between Rp6 trillion and Rp14 trillion. These are mid-sized banks, often with a broader regional presence or specific market segments.
- KBMI III: Banks with core capital between Rp14 trillion and Rp70 trillion. These are larger national banks, often with significant market share and diverse operations.
- KBMI IV: Banks with core capital exceeding Rp70 trillion. These are the largest, systematically important banks in Indonesia, typically with extensive branch networks, diverse product offerings, and a dominant share of the market.
The original article specifically highlights KBMI II and III banks as being most vulnerable. These banks often lack the extensive branch networks and digital ecosystems of KBMI IV institutions, making it harder for them to attract a large, stable base of CASA funds. Their funding structures tend to rely more heavily on time deposits, which are more sensitive to interest rate fluctuations and depositor sentiment. This structural disadvantage becomes particularly pronounced during periods of rising interest rates, as they must offer increasingly attractive rates to compete, eroding their profitability.
The Battle for Deposits: CASA vs. Time Deposits
The competition for deposits is not just about quantity but also quality. CASA deposits are highly prized by banks because they come with little to no interest expense (current accounts) or relatively low interest rates (savings accounts). A high CASA ratio indicates a bank’s ability to fund its operations cheaply and stably, providing a strong foundation for profitability and lending activities. In contrast, time deposits, while providing a stable funding source for a fixed period, demand higher interest payments from banks, directly increasing their cost of funds.
Josua Pardede pointed out that in an environment of rising benchmark interest rates, compounded by the attractiveness of other investment instruments, the competition for deposits intensifies. Specifically, he cited Bank Indonesia Rupiah Securities (SRBI) and retail Government Securities (SBN ritel) as potent alternatives for depositors. SRBI, introduced by BI to manage liquidity and enhance monetary operations, offers competitive returns, while SBN ritel provides retail investors with relatively high, fixed coupon rates backed by the government. These instruments divert funds that might otherwise flow into bank deposits, forcing mid-tier banks to offer even more competitive (and costly) deposit rates to retain their customer base.
"In conditions where the benchmark interest rate is rising, SRBI is attractive, retail SBN offers high coupons, and large depositors are increasingly sensitive to returns, mid-tier banks must offer more competitive interest rates to retain their funds," Josua explained. This scenario creates a vicious cycle where the necessity to attract funds at higher rates further compresses NIMs, leaving less room for banks to lower lending rates and support economic activity.
Implications for Financial Intermediation and Economic Growth
The potential for a protracted "interest rate war" and the resulting squeeze on mid-tier banks carry significant implications for Indonesia’s financial intermediation function and broader economic growth. If KBMI II and III banks face sustained pressure on their NIMs and an inability to reduce lending rates, several adverse outcomes could follow:
- Slower Credit Growth: With higher costs of funds and diminished profitability, these banks will naturally become more cautious in extending new credit. This could particularly impact SMEs, which often rely on mid-tier banks for financing rather than the larger KBMI IV institutions. SMEs are a crucial engine of job creation and economic activity in Indonesia, and restricted access to credit could hinder their expansion and innovation.
- Increased Loan Default Risk: While not immediately apparent, a prolonged period of high lending rates can increase the burden on borrowers, potentially leading to higher non-performing loans (NPLs) if economic conditions weaken or businesses struggle to service their debts.
- Consolidation in the Banking Sector: Persistent profitability pressures could accelerate consolidation within the banking industry, with smaller, weaker banks potentially being acquired by larger, stronger ones. While this could lead to a more resilient system in the long run, it could also reduce competition and choice for certain customer segments.
- Impact on Economic Activity: Reduced credit availability and higher borrowing costs act as a drag on investment and consumption. Businesses defer expansion plans, and consumers may postpone major purchases, leading to a slowdown in overall economic activity.
Regulatory Oversight and Proactive Measures
Both Bank Indonesia and the Financial Services Authority (OJK) are acutely aware of these challenges and are expected to intensify their monitoring and deploy various tools to mitigate risks. Bank Indonesia’s mandate includes not only price stability but also financial system stability. While rate hikes are necessary to control inflation, BI must carefully balance this with the need to ensure adequate liquidity for the banking sector to function effectively. Potential measures from BI could include:
- Liquidity Management Operations: BI might increase the frequency or volume of its open market operations to inject liquidity into the system, particularly for banks facing acute shortages.
- Macroprudential Policies: OJK, as the primary banking regulator, would likely enhance its oversight of banks’ capital adequacy, asset quality, and liquidity risk management. It might also consider temporary relaxations or adjustments to certain prudential regulations if necessary to ease pressure on banks, without compromising overall financial stability.
- Encouraging Consolidation: In the long term, OJK might continue to encourage the consolidation of smaller banks to create stronger, more resilient entities capable of withstanding market shocks.
Industry associations, such as the National Banks Association (Perbanas), are also likely to voice their concerns and engage with regulators to find collaborative solutions. Their perspective would emphasize the need for a balanced approach that supports monetary stability without unduly stifling credit growth or endangering the health of mid-tier banks.
Expert Perspectives and Outlook
Beyond the immediate concerns, analysts are watching for several key indicators to assess the trajectory of this liquidity challenge. The pace of future BI rate adjustments, global interest rate movements, and the government’s fiscal policy (which can influence overall liquidity through spending and debt issuance) will all play a role. Some experts suggest that if the "interest rate war" remains selective, as Josua Pardede indicated, the systemic risk might be contained. However, a widespread escalation could necessitate more direct intervention from BI and OJK.
There is also a broader call for banks, particularly KBMI II and III, to innovate and diversify their funding sources. This could involve greater emphasis on digital banking to attract a younger, tech-savvy demographic with a higher propensity for CASA deposits, or exploring alternative financing structures beyond traditional deposits.
The Path Forward: Balancing Stability and Growth
The current tight liquidity conditions and the looming threat of an "interest rate war" present a complex challenge for Indonesia’s financial sector. While Bank Indonesia’s commitment to monetary stability is crucial for long-term economic health, the uneven impact on different banking tiers requires careful navigation. The focus for policymakers, as Rizal Taufikurahman rightly points out, must be on balancing stability with ensuring that the banking system can continue its vital role of financial intermediation.
For mid-tier banks, adapting to this new landscape by enhancing their digital capabilities, optimizing their funding mix, and prudently managing their balance sheets will be paramount. For regulators, a vigilant and agile approach—combining macroprudential oversight with targeted liquidity management—will be essential to steer the Indonesian banking sector through these turbulent waters, safeguarding financial stability while continuing to support sustainable economic growth. The coming months will be critical in determining whether the selective skirmishes for deposits evolve into a full-scale "interest rate war" and what its ultimate implications will be for Indonesia’s dynamic economy.
