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Asia-PacificMarch 7 2005

No distractions from sell-off momentum

Indonesia’s banks are going back into private hands as the government continues with its economic reform plans, despite the huge post-tsunami rebuilding task it faces. Simon Montlake reports on progress.
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Eight years ago, Indonesia stepped in to refinance its crisis-ridden banks in what was to become one of the most expensive financial sector bail-outs in history. As a result, much of the sector was brought under government control as bankers began the painful process of rebuilding their loan books and restoring public confidence in financial institutions.

Now a recent flurry of privatisations and a fresh injection of foreign capital into the banking sector has put Indonesia back on the radar screen. The latest privatisation came in January with the government’s sale of 15% of Bank Internasional Indonesia (BII), which is controlled by a consortium led by South Korea’s Kookmin Bank. Foreign institutions that are seeking exposure to Indonesia’s economic recovery snapped up the $147m offering. They are following in the footsteps of international players, including Standard Chartered and Deutsche Bank, which acquired major stakes in Indonesian banks during the past two years.

Reassuring speed

The pace of sell-offs has reassured investors that Indonesia is open for business after a bumpy political transition that passed a crucial milestone last year when Susilo Bambang Yudhoyono became the country’s first directly elected president. His government went ahead with the BII sale despite the pressing task of rebuilding Aceh province, which bore the brunt of the December 26 tsunami. Observers say that Mr Yudhoyono’s cabinet is determined to keep up momentum and not be distracted from their economic agenda by the tragedy, which has a minimum impact on gross domestic product (GDP).

That agenda covers more bank privatisations, including a 10% stake in Bank Danamon, the fifth-largest lender, and a 5% stake in Bank Central Asia (BCA), Indonesia’s second-largest lender, which is controlled by a US-Indonesian consortium. Private-sector deals are also reshaping the country’s financial landscape. Singapore’s OCBC recently increased its stake in Bank NISP, a medium-sized Indonesian lender, to 51%, reflecting the increased appetite in Singapore for south-east Asian assets. Singapore’s wealthy state investment arm, Temasek Holdings, is part of the Kookmin consortium that owns a majority stake in BII. Malaysian and Australian banks also hold controlling stakes in Indonesian banks.

Bankers say that the dramatic increase in foreign ownership during the past few years has helped to sharpen the financial sector’s edge. “The competition is keen and will become greater. Most people are playing by the same rules: putting in place international best practices and making sure that the companies they lend to are efficient,” says Eugene Galbraith, president commissioner of BCA.

Despite the quickening pace of privatisation, however, it would be a mistake to assume that the government is out of the picture. State-owned banks, including the number-one lender Bank Mandiri, hold about 40% of total assets in the system, according to the World Bank. The new government has yet to outline its plans for these banks, making some donors uneasy about their governance. Although most state-owned banks have overhauled risk management systems and appointed independent commissioners, doubts remain over the eradication of dubious lending practices.

Regulators recently expressed concern about Bank Mandiri’s exposure to a large Indonesian textile company that defaulted on a bond coupon in January. However, the systemic risk to the financial sector that is posed by such lending is far smaller than was previously the case, says P S Srinivas, a financial sector specialist at the World Bank in Jakarta. “The banks are so well capitalised that a small problem will not endanger the system,” he says.

Banks look healthier

Indonesia’s banking system is looking healthier. Loan books are growing rapidly, helped by interest rates sinking to a six-year low in 2004. The loan-to-deposit ratio rose to 50%, up from 40% at the start of the year. Consumer lending remains the biggest item on the balance sheet but bankers say corporate demand is rising in certain sectors, including telecoms, transport and construction, while lending to small companies is growing fast.

Bank Indonesia, the central bank, forecasts loan growth this year of 20% ($11.4bn), based on GDP growth of 5%. That pace of lending looks sustainable as corporate spending rises and exports continue to climb. In the first 10 months of 2004, exports grew 14% year-on-year to $58bn. “Given that we have the appearance of political stability and efforts to address economic problems, we are going to see more requests for investment credit from companies,” says Mr Galbraith.

One of the key drivers in the next few years could be infrastructure spending. The government has drawn up a list of 91 private projects with a combined price-tag of $22bn. To encourage local lenders, the lending limit on infrastructure projects has been raised from 20% to 30% and other incentives are in the pipeline.

Given the mistakes of the past, though, bankers are cautious about project finance risk and say the higher limit will not in itself change their position. “It’s a nice gesture but it will not make a significant difference immediately,” says Pramukti Surjaudaja, president and CEO of Bank NISP. “The limit is already pretty high. Many banks have been burned before on infrastructure projects. Other lenders say they want to see multilateral agencies taking a share and a degree of transparency in any contract tenders.”

Although there is ample liquidity in the system, local banks are also constrained by their funding mechanisms: 95% of deposits are less than one-month terms.

“With this structure on the liability side, it’s hard to see how they can lend on seven to 10-year terms on the asset side,” says Mr Srinivas.

Consolidation prospects

In the medium term, one way forward for Indonesia is to consolidate banks and create larger lenders. Bankers say that this has long been on the cards, although privatisation of nationalised banks was a necessary first step.

In recent months, however, Bank Indonesia has signalled a renewed focus on consolidation, offering incentives and telling banks that it is ready to intervene if market-driven solutions do not deliver results. Addressing an annual bankers’ dinner in January, the bank’s governor, Burhanuddin Abdullah, said that consolidation must be led by larger, well-managed institutions that are deemed capable of expansion. Weaker banks could choose to merge with similar-sized lenders or be absorbed by so-called anchor banks. “The accelerated consolidation cannot be postponed any longer. We all know that the pain will continue to afflict us and will be difficult to heal if we persist in concealing a wound. For us to restore health, we must open the wound and take serious action, including possible amputation,” he said.

Bankers say that the push from Bank Indonesia has prompted boards to consider their options, although some larger banks are wary of what could be hidden under the carpet at potential acquisition targets. “A lot of larger banks see themselves as anchor banks going forward and are looking for smaller banks to take over… We see [merger and acquisition] possibilities. But there is a governance issue. We need to assure good due diligence,” says Sukatmo Padmosukarso, managing director of Bank Internasional.

Observers say that the government has its own M&A work to do on the banks that remain in its hands. One plan is to merge specialised mortgage lender BTN with another state-owned lender, such as BNI. One potential headache is the need to revalue assets sold by the now-dissolved Indonesian Bank Restructuring Agency, which was given the task of offloading non-performing assets taken over from failed banks. Bank Mandiri has reportedly complained that its 7.5% non-performing loan level is the result of its purchase of these assets.

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