The road to quality: Rules regarding loans for automobiles and homes are being revised

In the face of rapidly expanding consumer lending in recent years, Bank Indonesia (BI) raised down payment requirements for two- and four-wheel vehicles as well as mortgages from July of 2012. With credit ratings agencies forecasting a medium-term rise in non-performing loans (NPLs) from their record low in 2012, the regulator has also sought to act counter-cyclically in order to maintain asset quality. “BI has taken a number of micro-prudential measures to curb excessive credit growth in 2012, such as limiting loans-to-value (LTV) ratios for mortgages,” Bimo Epyanto, a senior economic analyst at BI, told OBG. Despite much debate surrounding the cause of the relative slowdown in consumer lending, such interventions are a welcome sign of vigilance, which should help ensure overall domestic strength. Yuan Bin, the president director of ICBC Bank, told OBG. “We however are confident that as long as the domestic market remains strong, the country will maintain its positive outlook.”

The next step in assuring greater confidence will be to close a number of legal loopholes some lenders are using in order to circumvent restrictions to improve the effectiveness of these regulatory measures. While consumer finance will continue to expand in the double digits, stricter oversight will sustain banks’ recent shift towards channelling funding to more productive economic sectors.

CAPPING LTV: Falling prime lending rates and a resilient domestic economy have supported the rapid expansion of consumer lending, which has nearly tripled in the last five years. Such loans have expanded from Rp282.6trn ($28.26bn) in 2007 to Rp721.9trn ($72.19bn) by the first half of 2012 according to BI data, although equally rapid growth in lending for investment and working capital has kept consumer lending at nearly 30% of total bank loans by June 2012. Beyond driving down prime rates, intense competition between major lenders had also relaxed lending terms, particularly for two-wheelers. “There’s low correlation between interest rates and motorcycle sales; the connection is with the size of down payments and value of advance payments,” Wisnu Wardana, an economist at Bank CIMB Niaga, told OBG. Borrowers could secure motorcycle loans for as little as a Rp500,000 ($50) advance payment. On average clients could secure loans for up to 80% of the value of houses and cars and up to 95% for motorcycles, according to credit ratings agency Fitch.

SPEEDING UP: High consumer confidence in 2011 in particular spurred acceleration in lending growth. “We expect consumer lending to continue to grow strongly as the Indonesian economy expands and the key to managing NPL levels is clearly a robust risk management framework,” Alan Richards, the chief executive officer of HSBC, told OBG. Annualised mortgage lending growth rose from 18.8% in January 2011 to 34.6% a year later, while total vehicle loan growth reached 33.2% by 2012 according to data from local credit ratings agency Pefindo. Total outstanding loans reached Rp207.1trn ($20.71bn) by the start of 2012. While NPLs on mortgages and car loans were contained below the industry average of 2.9% in 2011, default rates on motorcycles reached above 4% according to Bank Mandiri. BI slapped on minimum requirements for down payments on conventional bank loans from July 2012. A floor was placed at 30% down payments for housing units and cars (both new and used), 25% for motorcycles and 20% for commercial vehicles.

Small shops with less than 70 sq metres of built-up space were excluded from the mortgage restrictions, however. “The new consumer credit rules were necessary to prevent potentially drastic growth in NPLs,” Fauzi Ichsan, the managing director of Standard Chartered Bank, told OBG.

FINE-TUNING: While analysts have welcomed the curbs aimed at maintaining asset quality, the more eager lenders have been able to find ways around the new rules. “There are still loopholes in these regulations and banks have been able to circumvent them,” the Development Bank of Singapore (DBS) noted in a late October 2012 report. Surprisingly sharia-compliant banks have been exempted from the rules, providing a means for lenders with a sharia subsidiary or window to circumvent the restrictions. “Although it is still too early to tell the impact of such measures, we have noticed banks finding ways around this,” said Bimo Epyanto. Most banks like Mandiri and Panin have not engaged in such practices, although other multi-finance companies like Federal International Finance (FIF), part of the Astra group and the market leader in motorcycle loans, and Adira Dinamika Multi Finance, part of the Danamon group and a leader in auto finance, have channelled some lending through affiliated sharia lenders. “There is potential for Islamic banking in Indonesia to capture about 10% of the market for banking products,” Ibrahim Hassan, the president director of Bank Maybank Syariah Indonesia, told OBG.

The central bank has not explained why sharia lenders have been exempted from the rules. While support for a nascent industry is cited as the probable cause, BI will extend the LTV caps to sharia banks in April 2013, although sharia-compliant mortgages will be capped at a higher 80% of unit value.

Another technique has been to spread down payments over time to reduce upfront lump-sum payments, given the absence of regulated timeframes for such payments. Lenders are also able to spread out motor insurance premiums for their clients to reduce the upfront cost of acquisitions, a technique particularly used by lenders with affiliated insurance underwriters such as Bank Mandiri (and its multi-finance subsidiary Tunas Finance).

Property developers, meanwhile, have criticised the caps for penalising first-time buyers rather than speculators, who tend to either pay upfront or in instalments. The apex bank has constituted a working group that will revisit regulations regularly.

“There is an agreement to review the regulation every three months, – therefore we are positive that further amendments will be made as they are found to be needed,” Harun Hajadi, the managing director of the property development firm Ciputra, told OBG.

EXCESSES CURBED: The impact of the new rules has been uneven and mostly focused on the motorcycle segment as it is the most sensitive to the value of down payments. Larger purchases of homes and four-wheel vehicles tend to be more influenced by interest rate movements rather than the value of upfront payments. Total credit growth has nonetheless slowed since the second quarter of 2012, dropping from a peak of 27% year-on-year (y-o-y) in May 2012 to 23.6% in August 2012 and 22% in September 2012, according to Bank Mandiri, below BI’s full-year forecast of 24%. By the third quarter of 2012 consumer lending had dropped to below 20% according to Mandiri. However, much of the drop has been linked to a slowdown in motorcycle credit. “The biggest impact of the new LTV rules will be for the two-wheeler sales,” David Fletcher, president director of Permata Bank, told OBG. “Until people are able to find suitable ways to deal with the new rules, two-wheeler sales will be impacted heavily.”

Mandiri’s estimates that mortgage credit growth slowed slightly from 26% y-o-y in the first half of 2012 to 23% by September 2012. The government’s secondary mortgage corporation, Sarana Multigriya Finansial (SMF), estimated in early 2012 that 10 banks originated some 90% of mortgages. Specialists in low-income mortgages have witnessed the majority of the slowdown, while mid-market mortgage lenders have remained largely unaffected.

Four-wheeler sales have slowed only slightly according to data from the Indonesia Automotive Industry Association, from 27.9% y-o-y in September to 23.7% in October 2012. There has, however, been a marked slowdown in both motorcycle lending and new sales, although this had started earlier, during the first quarter of 2012.

“Motorcycle purchases started falling from the first quarter of 2012, before the LTV rules were introduced, which means this is more likely to be linked to the commodity price downturn,” Bret Ginesky, senior vice-president and head of investor relations at Bank Mandiri, told OBG. The concentration of motorcycle lending amongst a handful of lenders limited the impact of the slowdown on only a few ( mainly multi-finance companies like FIF’s) balance sheets.

While the full impact of the new LTV rules has been muted, a slight slowdown from the heady expansion in consumer finance of recent years is welcome in the name of financial stability.

FORECAST FOR 2013: The forecast rise in NPLs in 2013 by ratings agencies like Fitch will be easily contained by the liquid and well-capitalised banking sector. While consumer finance is still growing in double digits, banks have increasingly been rebalancing their loan portfolios towards loans for investment and working capital, a sign of lenders’ growing willingness to fund expansions in productive capacity domestically rather than a binge of consumer spending. Consumer confidence and spending has remained at record levels in 2012, despite the new curbs on consumer finance, and the closing of loopholes allowing lenders to circumvent the caps in 2013 are only expected to have a small impact on total lending within the segment as a whole. The regulator’s move to institute stricter micro-prudential policies for consumer lending is a welcome sign of its attitude in forcing lenders to adopt more counter-cyclical provisioning, further bolstering the sector’s resilience to any downturn in the coming years.