Indonesia: Stable development

Recent reports indicate that Indonesia’s banking sector is growing, with profits, assets and loans showing significant year-on-year increases during the first four months of 2011. The system is also stable, with the sector’s average capital adequacy ratio (CAR) at about 16%. However, there have been calls for the country’s banks to improve corporate governance and implement risk management measures.

According to data reported in mid-June by Bank Indonesia (BI), the country’s central bank, the sector’s earnings amounted to $2.8bn for the period January-April 2011, an increase of 23% over the same period in 2010. Credit activity also grew apace, with the volume of bank loans up by 24% for the four-month term, most likely the result of BI’s low benchmark interest rate, which has remained at 6.75% since February.

The sector will be keeping a watchful eye on how core inflation performs over the next couple of months, as Ramadan usually triggers an increase. However, BI has stated that it should remain at about 5% and on an equal footing with the appreciation of the Rupiah. If that is the case, lending should continue to increase throughout the year.

Extending lending while curtailing risks was the aim behind the central bank’s decision to require banks to keep their loans-to-deposits ratio (LDR) between 78% and 100%, a regulation that came into force in March 2011. Although lending has risen, there has been concern in the sector that the rule is counterproductive.

“The manner in which current LDRs are calculated may deserve further consideration,” Michael Young, CEO president director of HSBC Indonesia, told OBG. “Perhaps a more conservative approach could should be implemented as the country has a fairly convertible market. A 78% minimum on LDRs is quite understandable, but a 100% maximum is worth re-examination.”

Indeed, according to a late-June report from Credit Suisse, the way in which LDR has been defined means that capital raised through non-customer deposits, such as bonds, debt or equity issuances, do not figure in LDR calculations, meaning that even reasonably well-capitalised banks may be penalised by high ratios. According to Credit Suisse, this has resulted in enhanced competition for deposits.

“In terms of risk management, what it does is highlight – and what should be at the forefront of everybody’s mind – is how the competition for deposits affects liquidity at individual banks,” David Fletcher, president director at Permata Bank, told OBG.

The issue of liquidity came into play at the opposite end of the spectrum as well, with, three banks that fell below the 78% minimum – BCA, BRI and BNI – opting to pay the penalty rather than take on risky loans, according to Credit Suisse.

Non-performing loans (NPLs) amounted to $3.9bn during the first four months of the year, an increase of $564m over the same period in 2010, the ratio of NPLs to all loans fell from 3.17% to 2.85%.

Despite the kinks still to be worked out in the LDR rules, the banking sector is expected to continue to grow, in part because there are potential customers who have yet to be reached. While speaking at a seminar on financial literacy organised by BI and the Organisation for Economic Cooperation and Development (OECD), Muliaman Hadad, BI’s deputy governor for banking research and regulation, said that 40m Indonesians do not have access to the financial industry.

The deputy governor noted that financial education programmes would be implemented in an effort to reduce the size of this population. “Sometimes, lack of access happens because of a lack of understanding. We have worked with the education ministry to improve education on financial issues,” he said.

A number of banks are taking steps to increase access by widening their networks and extending micro-loans, credit facilities of up to Rp1m ($116). According to Djemi Suhendra, the deputy president director of BTPN, the market share potential for these loans is estimated at 36m people. The bank is keen to tap into this market, and aims to increase its portfolio of micro credit by 35-40% over the next three years.

Another three banks, Bank Rakyat Indonesia, Bank CIMB Niaga and Bank Danamon Indonesia, have each seen upwards of 20% growth in their micro loan portfolios. This increase has been underpinned by significant network expansion undertaken by these banks, which will see them open some 600 new outlets between them.

Meanwhile, Bank Mandiri, the country’s second-largest bank by loan portfolio, saw growth of its micro loans outpace other credit options in the first quarter of the year. The bank now has some 560,000 customers making use of this form of financing.

Indonesia’s banking system is not only growing, it is also well-capitalised. According to a statement by Muliaman in late June, the CAR of the sector stands at about 16%, well above the minimum required by Basel II. Indeed, Indonesia’s banks are generally better capitalised than their counterparts in other Asian countries, including Singapore, Malaysia and the Philippines.

However, for the nation’s banks to continue to expand, they will have to find new sources of capital, Muliaman said in early June. “They need more capital. Without that, it will be difficult. [Lender] business expansion is determined by the power of capital,” he said while speaking at an event organised by a local investment magazine. Options for raising capital include a rights issue or an initial public offering, according to Muliaman.

Although the sector seems poised for growth, further steps need to be taken to improve risk management and good governance practices at local banks, according to Halim Alamsyah, BI’s deputy governor for banking supervision. Addressing a seminar in late June, Halim said that investigations into the activities of a number of banks had revealed a lack of control by top management and inconsistent implementation of standard operating procedures.

The BI deputy governor cited a recent PricewaterhouseCoopers survey that showed that 45% of Indonesia’s banks had yet to integrate governance, risk management and compliance into their daily banking operations. The main reason for this was that banks consider these measures “unnecessary costs that could hinder growth and expansion of the business”, Halim said.

Although it could be costly and take time for Indonesia’s banks to implement these changes, it would likely be a worthwhile investment. As Mas Achmad Daniri, the chairman of the Forum for Corporate Governance in Indonesia, told seminar participants, “Good corporate governance could help improve [banks’s] financial performance.”

Indeed, as Indonesia’s financial institutions continue to grow and perhaps look abroad for additional sources of capital, improved governance could be an important factor in attracting foreign investors.