Indonesia: Bank profits heat up

While Indonesia’s banking sector has seen soaring profits and healthier competition levels, a major contributing factor to the strong recent performance of the national economy, there are concerns that the credit-driven boom could get out of hand.

Indonesian banks have seen earnings climb steeply this year. State-owned Bank Mandiri and Bank Rakyat Indonesia, the first- and second-largest lenders in terms of assets, reported year-on-year (y-o-y) profit increases of 38.2% and 25.5% respectively.

Bank Central Asia saw a 20% increase in earnings, while Bank Danamon put some $250m worth of black ink in the ledger, a 61% hike. Bank Negara Indonesia, another state-owned lender, posted a third-quarter net profit of $113m, up 56% from the $74m recorded during the same period in 2009.

Much of this increase in revenue is the result of higher loan activity. In the first 10 months of the year, Indonesia’s banks increased lending by 16%, with outstanding loans totaling $185.8bn at the end of October. In that month alone, the credit advanced by local banks rose 21% y-o-y, reflecting growing confidence in the economy, with consumer loans representing 65% of all lending in the third quarter.

This loan-friendly economic environment appears set to continue, at least in the medium term. On November 4, Bank Indonesia announced it was keeping its benchmark interest rate at 6.5%, the 15th time in a row that the central bank had left rates at their record low level. The decision to keep rates at the level set in August last year was made easier by the fact that there is little sign of inflation breaking out. Price increases have remained within the 4-6% bracket set by Bank Indonesia at the end of October, when it eased to a four-month low of 5.67%, down from 5.8% in September.

Darmin Nasution, the governor of Bank Indonesia, said the decision to leave the benchmark rates unchanged was a result of the improved performance of the economy and better medium-term outlook.

By keeping its own rates at historic lows, Bank Indonesia will make it easy for commercial lenders to maintain their own rates at affordable levels, almost certainly assuring a continuation of the loan surge. However, there are concerns that the wave of capital inflow into the Indonesian economy could combine with rising consumer demand to create asset bubbles and the potential for a reverse of economic fortunes.

The World Bank raised these concerns in a report released in mid-October which called on authorities in Indonesia and other countries in the region to consider taking steps to cool the hot money flow. “Larger inflows, combined with ample domestic liquidity and rising confidence, have boosted stock markets, real estate prices and other asset valuations in some countries, precipitating fears of a new bubble,” the report said.

At the moment, the government does not currently see the need for direct intervention, with Finance Minister Agus Martowardojo saying on November 2 that there were no plans for additional capital controls. “Mainly, we see that we have a healthy economy, foreign exchange reserves are rising, we are in a good competitive position and our trade balance is also good,” he said.

This will reassure the country’s banks, some of which are eyeing the excess capital in the market and looking to hold bond or rights issues until next year.

Though there may be some concerns over the high levels of liquidity in the Indonesian economy, there is still a strong potential for growth in the banking sector, according to Syaiful Adrian, an equities analyst at Ciptadana Securities. “Our mortgage penetration is still the lowest in the world, meaning there is a lot of room to improve,” he told local media on October 27. “Meanwhile, Indonesia is expected to get an investment-grade credit rating next year. This will reduce the cost of funds and in turn increase demand for capital loans.”

As long as that demand remains and growth in the economy can be sustained, Indonesia’s banks can look forward to continued strong earnings into the coming year and beyond. They will, however, be keeping an eye on domestic inflation and for signs that the hot money that has flowed so heavily into many markets will dry up.