RETAIL BANKING | Staff Reporter, Indonesia

It's boom time for Indonesian banks as economic growth remains promising

Despite stable market conditions, the country’s economy is not quite out of the woods.

Better days seem to be up ahead for Indonesian bankers as analysts observe improvements in asset quality, profitability, and loan growth compared to negative trends that beset executives in 2016. However, banks should not be so quick to rejoice and should be wary of increasing pressure on margins, talent shortage, and Fed rate hikes, not to mention the sector’s large stock of restructured loans.

Growth seems to be the main trend for Indonesia’s economy at the present, as it clocked in a 5.3% GDP growth this year, up from last year’s 5.0% as a result of increased public investment and monetary easing in previous years. According to Raphael Mok, Asia analyst, BMI Research, the headline growth figure was also underpinned by strong export growth, lifted by higher commodity prices, a pickup in growth momentum in its major trading partners, and an easing of the mineral export ban earlier this year.

“Indonesian bankers clearly feel they are in the most attractive market in Southeast Asia. After all, margins are not only good in comparison, they are excellent. The survey highlights that more immediate prospects for loan growth and economic growth are not the main drivers for that attraction, but, rather, the longer-term upside potential of a large market with low penetration. But in the meantime, high margins make for attractive, profitable banking,” says Jusuf Wibisana, partner at PwC Indonesia.

However, analysts point out that there are risks lurking around the system, possibly adding pressure on the performance of banks in the coming months. The stability of the rupiah hangs in the balance, as the Federal Reserve continues its tightening cycle with two more expected rate hikes this year.

Gary Hanniffy, director, financial institutions at Fitch Ratings, says that a weaker rupiah would make it more difficult for domestic borrowers to service foreign currency denominated debt, which accounts for around 15% of bank loans. Meanwhile, the main domestic risk is the banks’ large stock of restructured loans, the slippage of which could put additional pressure on non-performing loans (NPL) ratios.

In the midst of improving conditions which are still coupled with uncertainty, Indonesian banks can hold on to strong capitalisation as their primary buffer to safeguard financial growth. “Capital buffers across Indonesian banks are among the highest in the region, and this will likely safeguard financial stability in the unlikely event of an economic downturn or external shock. Whilst the high capital adequacy ratio is partially buffed up by the government’s move to lower the risk allocation for SME loans under its insured-credit program, the overall capital buffer is still much higher than the regulatory requirement of 10% under the Basel III standards,” says Mok.

Better profitability
Despite declining over the last three years, profitability among Indonesian banks remains a bright spot in the region and maintains a high position thanks to strong pre-provision operating profitability as a result of the banks’ high NIMs. According to Hanniffy, the top four banks are expected to continue to perform better than the medium-sized banks in this regard, given the bigger banks’ stronger deposit and lending franchises which suggest a greater loss-absorption capability. Hanniffy adds that the lower Viability Ratings (VRs) of the medium-sized banks incorporate their moderate credit-cost tolerance and lower profitability.

Banks in Indonesia are also enjoying rather healthy net interest margins (NIM) compared to their ASEAN and global counterparts. Trinh Nguyen, senior economist for emerging Asia, Natixis, says that based on commercial bank data, NIM actually improved to 5.4 in recent months. Although slightly down from 2016, this is still rather high and has definitely helped banks in terms of profitability. Nguyen believes that Indonesian banks’ healthy NIM will continue to support banks going forward.

Asset quality is also experiencing better days as corporate earning improve and loan growth picks up amidst bullish consumer sentiment. Mok says that asset quality is expected to stabilise over the coming months as the operating environment improves. He says that this should have a positive effect on banks’ earnings and the accumulation of capital as lower provisions are required to be set aside.

PwC’s Indonesia Banking Survey 2017 shows that banks remain cautious in the presence of good news as two-thirds of bankers felt that their bank has a clear risk management strategy to guard against cyclical challenges and possibilities of economic shock. The survey reveals that a higher proportion of respondents from local banks felt that their risk management strategy is either in progress or unclear.

“The survey result indicates a solid foundation for risk management in the industry, but also a clear indication that there is much further room to strengthen and develop risk management, from strategy to implementation. Considering the dynamic risk environment, it is essential that banks have clear risk strategies that are understood and implemented throughout the organisation,” Wibisana says.

Moving forward
Further, Mok says that credit growth will accelerate for the time being, as economic recovery and Bank Indonesia’s accommodative monetary policy will drive an increase in credit uptake over the coming quarters. Analysts at BMI Research note that the central bank will remain accommodative for as long as possible, and is also planning to lower the Primary Compulsory Minimum Reserves in rupiah to 5.0% from 6.5% currently, effective 1 July 2017. Mok adds that the consumer confidence index hit a multi-year high of 121.50 in March 2017, and we expect bullish sentiment to drive overall loan growth to 10.0% in 2017, up from 8.8% in 2016.

Many analysts believe that most of the present risks and challenges to the stability of Indonesia’s banking sector are short-term in nature. According to Nguyen, one of the issues constraining Indonesian banks is sluggish loan demand. She says that although lending growth has rebounded, it is still rather low due to both weak demand from corporates and risk-averse lending decisions by commercial banks. Wibisana adds that whilst the current level of loan growth is excellent compared to other markets around the world, the numbers are clearly lower than they have been in any of PwC’s previous banking surveys. He says that 44% of respondents expect loan growth of less than 10% in 2017, compared to 2015 and 2014 surveys which clocked in 12% and 2%, respectively.

Meanwhile, analysts at BMI Research believe that the outlook for the Indonesian banking sector remains constructive given the country’s strong economic and loan growth outlook, the upside potential of a large market with low penetration, and strong capital buffers which suggest little risks to financial stability over the medium-term. The appointment of Wimboh Santoso as chairman of the Financial Services Authority, or OJK, also presents its own opportunities.

“Santoso is coming from Bank Indonesia and the IMF. He is likely a technocrat that will try to improve efficiency. Already, there are reports that he will lower fee collection from financial institutions and also will seek to lower costs through cutting unnecessary business travels and meetings. Given that he has a BI background, the hope is that he will leave BI to regulate the price of money rather than intervene in how banks price risk and money. He will likely focus regulating the risks of the financial system as well as using technology to educate, survey, and reduce backlog to financial red tape,” says Nguyen.


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