Back to basics: The sector’s underlying architecture is set for change

Since 2004, the Indonesian Banking Architecture (API) has framed the development of the sector and established resilient counter-cyclical safeguards that place lenders in a strong position to weather any possible shortfalls in economic conditions. Consolidation in the sector, an aim since the Asian financial crisis, has remained elusive. Amid growing debate about the role of foreign banks and the lack of reciprocity in market access with key foreign investors’ home jurisdictions the pace of regulatory reform quickened in 2012.

A series of new amendments to the architecture in 2012, to be enacted before the shift of bank supervision from Bank Indonesia (BI) to the new Otoritas Jasa Keuangan (OJK) by 2014, significantly alter bank ownership, capital requirements and licensing rules. “Indonesia has been well ahead of neighbours like Malaysia and Singapore in terms of liberal bank ownership rules,” Clifford Rees, the director of PwC Indonesia’s advisory service, told OBG. “They have now started to pull back.”

While these measures do not in fact affect foreign investors more adversely than locals as originally feared, their implementation will likely spur significant market movements and reforms in corporate governance oversight. For many of the banks on the market, for whom ownership rules topped the list of most important regulations in a PwC Indonesia sector survey in April 2012, the next two years will be critical.

REGULATING OWNERSHIP: Indonesia’s banking sector has been one of the most open in the region to foreign investors since the 1990s, allowing 99% foreign ownership. Foreign-linked banks, accounting for roughly a third of the number of lenders as well as industry assets, have gained access while their home jurisdictions have rarely offered reciprocal access to local lenders. While access has been liberalised, BI implemented a single presence policy (SPP) from 2006, requiring investors to consolidate banking assets under one licence to reduce the scope for complex cross-holdings and contagion. Following the Development Bank of Singapore’s (DBS) takeover bid for Bank Danamon in early 2012 and subsequent political debate, however, the central bank passed new rules in July 2012 capping ownership levels for three main types of shareholders. “The issue of reciprocity in access to the banking market is key to BI’s outlook,” Destry Damayanti, chief economist at Bank Mandiri, told OBG.

Irrespective of investors’ origin, the new rules cap ownership at 40% for banks and non-bank financial institutions (NBFIs), 30% for non-financial corporates and 20% for individuals (a cap raised to 25% for sharia banks). The caps will not be applied to government stakes in three of the largest lenders (Mandiri, Bank Rakyat Indonesia and Bank Negara Indonesia) however. Exemptions to the 40% cap – theoretically up to 99% “super-majorities” – are also planned for banks passing three successive “fit and proper” corporate governance and financial health tests. Such banks would also need to be listed on the Indonesian Stock Exchange (IDX), maintain tier-1 capital ratios of above 6% and involve a shareholder committed to maintaining its stake for an unspecified “long” period. Meanwhile, banks partly held by other financial institutions are expected to float over 20% of their equity on IDX within five years of 2014. While the criteria for the tests were still unclear in late 2012, they are expected to be run every six months, meaning exemptions could be granted from mid-2014. Conversely, banks failing three successive tests by 2014 will be required to restructure shareholdings along the new rules.

NEW POWERS: Bolstering the regulator’s (BI for the moment, OJK from 2014) powers to intervene with bank boards through the conduct of governance tests, the aim is to reduce stakes held by families and individuals in favour of larger financial institutions. “New bank ownership rules are likely to affect domestic investors much more than foreigners,” Fauzi Ichsan, the managing director and senior economist at Standard Chartered Bank, told OBG. “Domestically owned banks are more likely to struggle with corporate governance tests than foreign-linked lenders, while the 20% cap on family ownership is more restrictive than the cap on financial institutions’ holdings.”

Though only two of the top 10 banks are majority held by family holdings – Bank Central Asia and Panin Bank – a number of mid-sized and smaller lenders are likely to require restructuring.

HIGHER REQUIREMENTS: Beyond shareholding limits and governance and health standards, BI announced an entirely new licensing system in November 2012, the most far-reaching banking structure reform since the API. Effective from January 2013, banks will need to apply for one of four new licences according to their capitalisation level. Banks with less than Rp1trn ($100m) in capital can only offer basic banking services and are barred from electronic banking and foreign exchange services as well as new branches. Banks with between Rp1trn ($100m) and Rp5trn ($500m) in capital will be allowed to provide such services and allocate 15% of capital to build new branches, although sophisticated structured and offshore products will remain off-limits. Banks (including sharia lenders) with over Rp5trn ($500m) in core capital may offer all products and may allocate 25% of capital for branch network expansion, rising to 35% for banks with over Rp30trn ($3bn).

The bank supervisor is also differentiating capital adequacy ratio (CAR) requirements according to banks’ risk profiles, away from the existing flat 8% CAR floor. Required CARs will be set for three levels of risk profile in tranches of 8-9%, 9-11% and 11-14% for the riskiest lenders. These CAR floors move standards closer to Basel III requirements for tier-1 capital ratios of 12% or above, expected by 2020. Also from 2013 banks with branches in densely populated centres like in Java will be required to open branches in more sparsely populated zones like Papua, Maluku or west Sumatra, for example. Meanwhile, from 2015 onwards loan allocations to small and medium-sized enterprises (SMEs) will double yearly from 5% of banks’ total loan portfolios to 20% by 2017 – excluding mortgage-focused lenders.

Foreign banks will need to comply with stricter requirements as well, enacted to reduce the potential for contagion from foreign banking crises. Although BI has since closed the window for foreign banks opening branches locally without a local incorporation, a number of established foreign banks like HSBC and Citi have been grandfathered in. From November 2012 foreign banks will be allowed to provide trustee services to manage export revenues domestically, though they will be required to incorporate locally within three years of launching such services. From June 2013 foreign banks are required to hold between 8% and 10% of their risk-weighted assets locally in government bonds, BI certificates (SBIs) or corporate bonds, with this minimum capital buffer rising to Rp1trn ($100m) by 2017. A draft bill, under consideration by parliament in late January 2013, would also require all foreign banks to convert into local institutions, in order to continue operations.

ENDING SPP: The aim of the combined set of measures is clearly to bolster banks’ intermediation to the real economy, expand their reach and promote consolidation in the sector. To facilitate the necessary market movements, the regulator has effectively moved away from the SPP, which had prompted past mergers such as those between Lippo and Niaga and UOB and UOB Buana, for instance. “The SPP is no longer relevant with the new ownership regulations,” Eddy Handall, ratings director at Fitch, told OBG. Shareholders will now be allowed to maintain stakes in a number of lenders by forming a bank holding company, as an alternative to full merger. Some consolidation took place when capital requirements were raised to Rp100bn ($10m) for rural banks and Rp1trn ($100m) for sharia banks in 2006, driven by larger banks acquiring smaller rural banks to turn into sharia lenders; capital requirements for existing sharia banks had been maintained at Rp100bn ($10m) at the time. As capital requirements for sharia banks are raised to Rp5trn ($500m) from 2013, this option will no longer be as attractive.

Foreign interest, particularly from Asia-Pacific banks from Singapore, Japan, South Korea, India, China and Australia (rather than US or European banks whose appetite has been reduced through more onerous capital requirements in core markets), should drive acquisitions without necessarily reducing the number of lenders that remain on the market.

With higher political pressure in Indonesia for reciprocal access to key foreign markets like Singapore, India and China, would-be acquirers like DBS will need to navigate murkier politics in the run-up to the 2014 presidential election. “Banks looking for acquisitions will need to insure appropriate access to their home markets for Indonesian banks,” Damayanti said to OBG.