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Asia-PacificFebruary 4 2008

Outstanding forecast

There is an air of excitement about progress in Indonesia’s banking sector and its prospects in the coming year. Neil Sen explains why.
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Indonesia’s newly resurgent banking sector is already beginning to attract some arresting forecasts. “By 2050, the size of the Indonesian banking sector could rival that of France or Italy, while returns could be considerably higher," PricewaterhouseCoopers (PwC) said in a recent report. Noting that domestic credit stood at $100bn in 2004, PwC projects a figure of $7000bn in 2050 at constant prices.

There is an air of excitement in Jakarta, the subprime crisis not withstanding; a feeling that the country has moved on from the financial crisis of the late 1990s and can now enjoy a solid period of growth. “Indonesia has largely recovered from the Asian crisis of the late 1990s and is making good progress,” says John Collins, president director of ANZ Panin.

“There is plenty of potential,” says Sebastian Paredes, president director (chief executive) of Bank Danamon. “It’s an attractive sector for investors looking for high growth: there is a low ratio of loans to gross domestic product [GDP] and low penetration of the population by the banking sector.”

The sector, shepherded by Bank Indonesia, the highly regarded central bank, can boast an increasingly solid appearance. There has been substantial foreign investment in recent years and this has had a strong positive effect on the banks. Return on assets has reached nearly 3% and, as of December, it looked likely that bank lending would grow by more than 20% in 2007, following several years of similar growth, according to Bank Indonesia. The overall compound annual growth rate in lending between 2002 and the end of 2006 was 21%, with the fastest expanding segment being consumer and retail credit.

Solid progress

A big driver has been small and medium-sized enterprise (SME) lending, which accounts for more than 50% of the market and the total value of which doubled to $45bn between 2002 and 2006. Bank Rakyat, a state-owned specialist in rural microfinance, and Danamon, which specialises in urban SMEs, have been especially aggressive in lending. The attractions of this market become more obvious when it is revealed that Rakyat can lend to its clientele at rates of 36% or more, at a time when base rates stand at 8%, providing a healthy boost to its net interest margin.

A further boost could come from the mortgage market. “There is tremendous pent-up demand for mortgages – they form a very low percentage of the country’s GDP. Appropriately priced products in this environment could be very successful,” says Eugene Galbraith, president commissioner (chairman) of Bank Central Asia (BCA) in Jakarta.

Non-performing loans (NPLs) are at a low level, thanks partly to the government bailing out the banks during the financial crisis. The gross NPL ratio of the commercial banks stood at 6% in 2007, compared with 49% in 1999, and Bank Indonesia is trying to drive the ratio down further. The central bank is insisting that institutions wishing to qualify as “anchor banks” will need to cut their NPL ratio to less than 5% by 2008. Most of the top 10 banks, however, will not find this a problem, and they account for more than 60% of total assets and credit.

The leading banks have benefited from competent managers, who have sought to broaden their offerings since the crisis. Edwin Gerungan, a former head of the Indonesian Bank Restructuring Agency who is now president commissioner (chairman) of Bank Mandiri, the biggest of the three main state-owned banks and the largest bank in Indonesia, says: “Mandiri cleaned up its book after the crisis, expanded its portfolio and expanded its fee-based income.”

Risk assessments

The rating agencies acknowledge that progress has been made. Standard & Poor’s said in a report last year that there had been an “enhancement of the Indonesian banking system’s financial profile” and noted that “the risk profile of the Indonesian banking industry remains high by international standards”. This perception of the risks involved in Indonesia is still difficult to shake off, and is perhaps one of the most important legacies of the Asian crisis.

Some bankers in Indonesia remain circumspect: “We have taken a relatively conservative approach to lending and we are a prodigious deposit-taking institution,” says Mr Galbraith. “There are reminders of the crisis all over Jakarta. But the country’s macro-economic management has achieved broad successes and we now see considerable potential in the consumer market.” BCA’s loans-to-deposits ratio is 40%, which is among the lowest in the domestic banking industry.

Some bankers and economists in Jakarta, however, take a more bullish view. “Our pricing models show that Indonesia’s risk profile is better than the rating agencies suggest,” says Mr Collins.

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“Indonesia is no more risky than other south-east Asian economies,” says Henk Mulder, president director of Lippo Bank. “The prospects are very exciting: our loan growth was 54% last year and our NPL was less than 2%.”

 

According to Mr Paredes of Danamon: “The risk profile is improving. Liquidity ratios are improving and the whole sector is operating in a healthy environment.”

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Anton Gunawan, country economist at Citibank, believes that Indonesia’s sovereign rating of BB- will soon be enhanced and that the banks will follow. “The banks’ ratings are already higher than in the Philippines and they should improve further,” he says.

 

Bank Indonesia is determined to improve the banks’ risk profile further. Its regulatory regime attracts genuine admiration from expatriate and local bankers alike. “There is a serious intention on the part of the [Bank Indonesia] governor to implement Basel II, and [the bank] has set a realistic objective for full implementation by 2010,” says Mr Mulder.

Good works in progress

“Bank Indonesia is doing a good job,” says Mr Collins. “They are very efficient and have listened to and engaged with stakeholders. They are also rightly encouraging privatisation as we have seen recently with the sale of 30% of BNI.”

“The government and Bank Indonesia learned a great deal from the financial crisis,” says Mr Gerungan. “They have upgraded the regulatory system, set up a financial stability monitoring committee and are doing well.”

Reforms have included controls on lending, more scrutiny of non-executive directors, a requirement to have formal risk committees in place and efforts to control nepotistic board appointments.

The central bank is also keen to cut the overall number of banks, which stands at 130, because most of the smaller institutions are poorly capitalised. Its policy framework, known as the Indonesian banking architecture (API), includes new capital tiers for banks according to whether they wish to operate internationally, nationally or regionally.

One of the principal pillars of the API is stirring a flurry of activity. The single presence policy (SPP) prohibits shareholders from owning a controlling stake in more than one bank by the end of 2010, a move intended to make regulation easier. This has implications, in particular, for the Singaporean sovereign fund Temasek, which owns stakes in Danamon and Bank Internasional Indonesia, and for Khazanah, the Malaysian sovereign fund that controls Lippo directly and Bank Niaga through its holding company CIMB. Both sovereign funds have said they wish to merge their two banks.

But Indonesia’s banking sector remains open to further foreign investment. Foreign companies are allowed to own 99% of an Indonesian bank, and the process itself is relatively straightforward. According to PwC: “While target identification through to due diligence, negotiation and sale can take four to six months, this is still considerably less than the green-field route. Bank Indonesia is also far more likely to grant approval.”

Unfortunately, however, no banks of any size are available now. “A lot of foreign banks want to get in but there’s nothing for sale,” says Mr Gerungan. In these circumstances, valuations are creeping up: three times book value seems to be the going rate.

Several formidable foreign institutions have had to settle for acquiring obscure banks and attempting to build a business from scratch. China’s ICBC, for instance, bought Bank Halim, a small provincial bank of which Jakarta bankers know little; and the Bank of India and the State Bank of India made similar moves last year. But the Chinese and Indian banks are said to be on the prowl for further opportunities, as are one or two Australian institutions, such as Commonwealth Bank, which already owns a small bank in Java. Institutions such as Temasek, Khazanah, Standard Chartered and ANZ can consider themselves fortunate that they entered the market between 2002 and 2005, when acquisition prices were still low.

Shape of the future

While the banking sector on the whole has had a good story to tell in the past few years, some areas have been slow and will remain so. For example, there is little demand for investment banking services and perhaps little potential for the moment. Apart from perhaps the largest 20 Indonesian companies, among which JPMorgan and Goldman Sachs patrol assiduously, few corporates use the capital markets. It also comes as something of a surprise to people unfamiliar with the country that there is little demand for Islamic financial products, although Bank Indonesia is trying to expand the market.

On the other hand, and subject to global economic conditions, Indonesia’s banks are set to tap into huge consumer and SME demand for loans. For all the perceived risks, there is no ignoring a market that is projected to be as large as that of France or Italy by 2050 and to produce higher returns.

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