Indonesia's banking sector holds much promise, thanks in large to the country's vast unbanked population. And with a new, business-friendly president in Joko Widodo, hopes are high that it can finally realise this vast potential.

“Jokowi [Joko Widodo] is a good president. He is for the people, not for the bankers,” says a taxi driver in Jakarta. Just 20 minutes later, a local bank chief executive excitedly discusses Mr Widodo’s appointment. “We have turned a new leaf in Indonesia with a business-friendly president,” he says. These are not signs of a split personality, but of a head of state successfully appealing to both Indonesia’s people and its business elite, even after the government slashed and fixed fuel subsidies in December 2014. 

Mr Jokowi’s election has generated a wave of positivity across Indonesia’s financial sector, and both the lower and upper strata of society feel represented politically. This is not to say that Indonesia does not face challenges. Its infrastructure hurdle is enormous, and sectors such as the maritime industry are being stifled as a consequence. How to generate enough capital to boost infrastructure spending is also fiercely debated.

But, as far as banks are concerned, conservatism since the Asian financial crisis in 1997 has generated well-capitalised institutions. A large, young and vastly unbanked population also offers enormous potential to local banks. Microfinance continues growing in breadth and Islamic finance offers new growth frontiers. But, there is still room for improvement. What many believe could help Indonesian banks strengthen further, as well as help the country’s development project, is a more standardised and transparent regulatory framework. 

Creaking infrastructure

Mr Jokowi revised Indonesia’s fuel subsidies in December 2014, reducing inefficient expenditure and providing more stability. According to finance minister Bambang Brodjonegoro, the exercise will reduce the government’s fuel subsidy bill by Rp200,000bn ($15.9bn) in 2015.

Indonesia’s government now only subsidises diesel fuel and kerosene. Diesel has a fixed subsidy of Rp1000 per litre. If global oil prices spike again, after the historic six-month low prevailing since mid-2014, fuel subsidies will no longer balloon in tandem. A variable subsidy to maintain a fixed price is still in place for kerosene, since it is typically used by Indonesia’s poorest households.

A lot of work remains in the infrastructure space, however. Shortfalls here are limiting business opportunities at a local level as well as in the financial sector. “Mr Jokowi needs to invest in infrastructure. Our infrastructure is creaking and it’s because the previous government did not have the money for it,” says Henry Ho, president of local lender Bank Danamon.

Ninis Adriani, vice-president at local lender Bank Rakyat Indonesia (BRI), believes that improving Indonesia's infrastructure will have a trickle-down effect, especially in the small and medium-sized enterprise segment, benefiting both the financial sector and the wider population. “The government wants to build infrastructure in rural areas [which will include improving agriculture, restructuring irrigation systems and building new dams], which will help people run their business better and eventually generate growth in our own business,” she says. 

Indonesia’s maritime industry is widely considered to be one of the country's largest untapped sectors, with inadequate infrastructure preventing it from reaching its full potential. “This is a maritime country. The first thing you need are ports, and ports in Indonesia are inadequate. If you can make them efficient then the cost of shipping will drop,” says Mr Ho.

Realistic goals?

While the areas in need of improvement are obvious, the best way to implement the necessary changes is not so straight forward. Government reforms will not be easy for Mr Jokowi since the opposition still retains the majority of seats in parliament. There is also an ongoing debate about how to support infrastructure spending. 

According to Jerry Ng, president of Bank BTPN, as it stands, Indonesia’s banking sector cannot even sustain Mr Jokowi’s 7% to 8% gross domestic product (GDP) growth projection. Even growth below this target is unfeasible, he says. 

In the past 10 years, when the country's economy grew by 6% or more, Indonesia’s banking sector’s lending grew by 23% to 27% annually, says Mr Ng. “Even if productivity improves to reach 6%, we would need lending to grow by 20%, the equivalent of Rp6,000,000bn to Rp7,000,000bn. Today, the aggregate balance sheet in our banking sector amounts to about Rp4,000,000bn. We will need to grow our banking sector by one and a half times to meet the 6% target."

Ms Adriani believes the government budget could be further supplemented if the government were to utilise the local financial markets, which would have the added benefit of increasing the sector’s depth and liquidity. Meanwhile, according to Mr Ng, raising capital and funding at home and abroad, collaborations between the public and private sectors, as well as opening up the banking industry will be key to achieve the state’s GDP growth targets. Mr Ho believes that the key lies with foreign investment. “With all the growth ambitions that this country has, it needs foreign capital to come in. Big money will mostly come from the outside,” he says.

Protectionism prevails

Indonesia’s financial sector, however, has a legacy of protectionism. While nearby countries such as the Philippines allow foreign banks to own up to 100% of a bank, as of 2013, both domestic and international investors are limited to a 40% stake in an Indonesian bank. This rule was enacted just as Singapore's DBS was in the process of acquiring a controlling stake in Danamon. Some observers say that the law was devised to obstruct the deal, while others, including Mr Ho, point out that the transaction could still have been realised.

A bank with 40% ownership demonstrating good governance for 18 months can, under the rules, increase its stake. “Also, DBS has operations in Indonesia," says Mr Ho. "The moment it bought 40%, it could have integrated DBS Indonesia into Danamon to give [DBS more than] 40% ownership."

Nonetheless, the 40% ownership limit is making domestic bank consolidation difficult, at a time when local institutions are looking to scale up in anticipation of the entrance of foreign banks to the market – which many deem an inevitable consequence of the establishment of the Association of South-east Asian Nations (Asean) Economic Community.

“The regulators are fully aware that this rule makes it difficult to consolidate the banking system. At the same time, OKJ [the Indonesian financial services authority, Otoritas Jasa Keuangan] is looking to implement Basel II and III, which makes it difficult for financial institutions to own less than 51% of a bank,” says Mr Ho.

Bankers also say that there is a lack of transparency and regulatory predictability. “Regulation cannot be on a case-by-case basis. When something has been put on the table and has met parameters, it must have a 95% chance that it will get approved. We need standardisation with no ifs and buts,” says Mr Ho.

Banks are also calling for stronger regulatory support in developing wealth management businesses. Ms Adriani deems stronger ‘know your customer’ regulation essential if banks are to build trust among high-net-worth customers. Only then will it be possible to exploit the full potential of Indonesia's fast-growing middle class, she says.

OKJ and government support is also necessary for the development of the local bond market. In Indonesia, banks are still deemed as key sources of funding, and limited liquidity is keeping foreign buyers away from the non-government local bond market. With the country's considerable spending needs, the development of the domestic bond sector will be a crucial step in order to raise the necessary funding.

Rich local base

Despite these regulatory shortcomings, Indonesia remains one of the most attractive destinations for international banks. It is considered the big Asean promise with a new, democratically elected, business-friendly government, huge maritime potential and a vastly untapped customer base – only 50 million to 60 million Indonesians out of a population of 250 million have bank accounts, according to the International Finance Corporation. The country's loan-to-GDP ratio is also the lowest in Asean, at 30%. 

Even domestic banks still prioritise the local market. “In terms of retail banking, Indonesia will be the most promising place to grow. If we just focus on the domestic market, it already provides us with huge potential,” says Ms Adriani.

Similarly, six years ago, when Mr Ng took the helm at the bank, BTPN made mass-market domestic banking its main focus. “We realised there were many underserved Indonesian people. Back then, many big banks thought that those customers were unprofitable and weren’t interested. I got excited,” says Mr Ng.

To cater for older customers using its pension services, BTPN has turned some of its branches offering these products into community centres with medical clinics. These branches open at 5:30am to service Indonesian elders, who are mostly Muslim. “When [most] bankers are still sleeping, we are already opening our branches. We are serving the old folks; they wake up early to pray and then go to the branch. They also stay until mid-afternoon to spend time with their friends,” says Mr Ng.

Keeping BTPN’s focus on the mass market continues making business sense. “We will not be entering wholesale, mergers and acquisitions or investment banking, and we will not have a trading desk. We are just a humble mass-market bank wearing short-sleeve batiks and no suits,” says Mr Ng.

BTPN might use its mass-market expertise to expand in populous countries, such as Vietnam, Myanmar or Philippines, but not in the short term. A more urgent priority for the bank is the launch of several new technology-related projects. “We have just assigned a deputy CEO to be responsible for starting three brand new, very different kinds of mass-market banking initiatives at the same time. They will come into play in 2015 and 2016,” says Mr Ng.

Islamic push needed

Although about 90% of the Indonesian population is Muslim, Islamic finance is far less widespread than in bordering Malaysia, where Muslims account for about 60% of the population. Indonesian bankers attribute this discrepancy partly to the tax advantage granted to sharia-compliant products in Malaysia. Buyers face a withholding tax when investing in any bank product, including sharia-compliant products, in Indonesia.

“Officials' rhetoric and implementation on the ground are not well aligned, unlike in Malaysia where there is ample support from the government. Sharia banking started very late here. You already had a very established conventional banking system. So if you want to make a case for sharia banking, you need to give it a bit of a push,” says Mr Ho.

Mr Ng is more sceptical about the sector. “If between two products, the non-sharia one is less costly, customers will probably go for conventional products. Only relying on emotions won’t get you far,” he says. Nonetheless, BTPN has committed to sharia banking by acquiring local microfinance specialist Bank Sahabat Purba Danarta in 2014 – now called BTPN Shariah – which it is now working to further capitalise. 

Since 2011, BTPN has built its Islamic finance business to almost 10,000 employees and 1500 distribution points. Danamon has also seen growing demand for its Islamic finance products, especially its Hajj pilgrimage savings products.

Micro age

A much more established market segment is microfinance, which remains key for local banks as there is still enormous demand for such products. But firms have been modernising and upgrading their microbusinesses with wider ranges of products, technology and new ways of reaching customers. BRI launched a new product called BRILink in 2014, offering new savings and transaction banking services. By the end of the year, 7 million borrowers were using BRILink.

A number of banks are also shutting down branches to optimise costs. Microfinance is very labour intensive and a rising minimum wage in Indonesia has challenged firms. BRI launched a scheme in 2014 using staff called ‘agents’ to substitute branches in remote areas. By the end of last year, BRI had 14,000 agents. It aims to have 50,000 by the end of 2015. 

Danamon also rethought its micro business offering. It shut 1400 lending units and made loan origination more efficient through technology. 

“The level of activity in the units we shut down was very low. We made up for it by having mobile vans that spend two or three days in more remote areas. We have also changed our collection means so that customers don't need to come to the branch. We use electronic data capture terminals to collect cash or reach out via mobile phones. Everyone has smartphones now; it is almost a machine that was made for banking,” says Mr Ho.

BRI’s mobile banking users have increased from 1.6 million in 2011 to 8.1 million in September 2014.

People business

New microfinance initiatives, however, are not entirely replacing conventional microbusiness. Physical branches focused on nurturing client relationships retain their raison d’être. Staff in Danamon’s Mayestik branch in Jakarta spend most of the day visiting clients in the market. According to branch manager Hasan Fahmi, microfinance remains first and foremost a people business, where client relationships often resemble friendships. Making micro customers feel comfortable is essential to ensure loan repayment; that is why Danamon staff wear batik shirts and work in a very humble office, says Mr Fahmi. The Mayestik branch has a 99% success rate in 2014’s microloan repayments.

Most micro lenders in Indonesia remain state owned, since government support allows these banks to offer low interest rates. Danamon is one of the few private institutions still in business despite its comparatively higher rates. Mr Fahmi says that the bank's success is due to its especially strong client relationships.

Danamon also looks to its corporate customers and worker co-operatives for different penetration techniques. Co-operatives' microfinance makes loan origination more efficient and creates peer pressure to repay loans, says Mr Ho. It also makes sense demographically. “In the past 10 years, many workers have reached retirement age, they have increased their living standards and there is now higher demand for consumer products, spending on education, life events and marriages,” says Mr Ho.

BTPN has also developed its microbusiness by adding capacity-building training services, such as cash management or inventory management training. “What we are selling to our customers is not just credit but an opportunity to grow their business,” says Mr Ng.

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