The government’s new credit guarantee scheme is expected to boost lending for micro, small and medium enterprises (MSME) hit hard by the coronavirus pandemic, but analysts have expressed concerns that risk of rising bad loans now haunts the banking industry.

The scheme is one of the most popular stimulus programs for economies across the globe during the virus-induced economic downturn, said Bank Indonesia (BI) senior deputy governor Destry Damayanti. The scheme, she went on to say, would be crucial to stimulate credit growth.

“The loan guarantee program is crucial to allow banks to boost their lending for MSMEs and, therefore, support economic recovery,” Destry told an online discussion on Friday, adding that banks were previously reluctant to disburse their money amid fears of bad loans.

She stressed that Indonesian banks were better now prepared than during the financial crises in 1998 and in 2008 to deal with liquidity issues and the risk of rising non-performing loans (NPL) in the wake of the pandemic.

The government has disbursed credit insurance premiums worth Rp 5 trillion (US$341.02 million) to state-owned credit insurers PT Jaminan Kredit Indonesia (Jamkrindo) and PT Asuransi Kredit Indonesia (Askrindo) to guarantee working capital loans of Rp 100 trillion and help MSMEs survive the pandemic.

The scheme will provide guarantees for banks that channel loans to MSMEs until November 2021 and cover loans with a ceiling of Rp 10 billion and a tenor of three years available for 60.6 million MSMEs from all business sectors.

But the scheme may lead to mounting bad loans for banks as domestic demand remains sluggish due to weakening purchasing power amid slowing economic activity, said Institute for Development of Economics and Finance (Indef) economist Aviliani.

“If businesses have yet to pick up following a slump in demand, then banks are forced to lend money; we are risking mounting bad loans in the next one to two years,” Aviliani said at the same discussion, adding the government would need to step up stimulus spending to boost demand.

Indonesian banks’ non-performing loans (NPL), which calculate the ratio of bad loans to total loan value, continued to rise to 3.01 percent in May from 2.89 in April and 2.77 percent in March. Loan growth, meanwhile, fell to 3.04 percent year-on-year (yoy) in May from 5.73 percent in April.

“We think the government should move more quickly in spending stimulus money and it must pay special attention to the demand side,” she said, calling for the government to bolster its stimulus on social aid to stimulate demand.

The government is allocating Rp 695.2 trillion in stimulus funds to prevent a greater economic downturn, which is expected to shrink by 0.4 percent at worst or grow by 1 percent at best, with the budget deficit expected to reach 6.34 percent of gross domestic product (GDP).

Moody’s Investors Service expressed a similar view in a new report in late May, stating that Indonesian banks would see their asset quality and profitability deteriorate because of coronavirus impacts. However, their capital and liquidity will remain strong, providing ample buffers to absorb financial stress.

“Restructured loans in Indonesia have grown significantly since authorities relaxed rules for debt restructuring in March to provide financial relief for those impacted by the crisis,” said Moody’s analyst Tengfu Li.

“And while this, along with subsidies for consumers and small businesses will provide temporary relief for banks, nonperforming loans will still increase substantially in the longer term, given the scope of economic disruptions stemming from the coronavirus crisis.”

Indonesia’s financial authority has so far taken several measures to alleviate banking stress during the pandemic, including loan restructuring, interest relief for MSMEs and liquidity access from the central bank using the repurchase agreement (repo) route, among other measures.

According to the Bank Indonesia Banking Survey published on Wednesday, credit growth is expected to slow to 2.5 percent this year, a decrease from 6.1 percent booked in 2019.

BI Governor Perry Warjiyo said on Thursday that loan disbursement was limited due to slowing domestic demand, while banks try to avoid risks amid heightening debt restructuring. The central bank cut its benchmark interest rate to 4 percent to further support the economy.

The lower benchmark rate is expected to transmit into lower interest rates charged by banks on consumer loans, corporate loans and mortgages, as well as bond yields and other instruments, thereby boosting domestic consumption and investment.