Global Business Guide Indonesia

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Finance | Making the Banks Work for the Real Economy

Indonesia’s banking sector has been booking impressive profits over the past 5 years, even during the global economic downturn where it showed immense resilience. Looking beyond profits as a yardstick of the sector’s performance, the banking sector has come under criticism for its more limited contribution to the real economy. Having remained cautious after the Asian crisis, lending rates remain high and loans difficult to obtain for SMEs and entrepreneurs. Bank Indonesia has therefore stepped in and introduced strict loan to deposit ratios as well as measures for greater transparency to improve competitiveness and efficiency in the banking sector.

The low penetration rate of the banking sector and shallowness of the capital markets (see Capital Markets Overview) gives the banking sector plenty of leverage over lending rates. Indonesia’s net interest margin (NIM) stood at 5.8% for 2010 compared to 2.3-4.5% for the other ASEAN economies. This has dropped by only 27 basis points in Q1 2011 despite Bank Indonesia holding the benchmark interest rate steady at 6.75% (Bank Indonesia). The lack of lending is also illustrated in the loan to GDP ratio which was 26.1% for 2010 in stark comparison to 90% for Vietnam or 78% for Thailand. Banks blame the high overhead costs for keeping rates high which highlights issues of efficiency within the sector as a whole.

The issue of efficiency is a contentious one as Indonesia has one of the highest ratios of operational costs to revenue (BOPO) among the ASEAN’s 5 largest economies. Indonesia’s BOPO stood at 81.6% for 2010, compared to 31.7-73.1% for the other ASEAN 5 and a 50-60% average for developed economies. Costs for Indonesian banks have been gradually increasing, with a 17.7% rise between 2004 and 2010. The vast majority of operational costs are taken up by the cost of staff including board members and credit analysts to oversee the lengthy process involved in extending loans. Risk premiums are high in Indonesia due to the political and social environment as well as high volatility in dominant sectors such as real estate and commodity prices. Ironically, the poor efficiency of banks is coupled with high profits as they continue to take advantage of high NIM profit margins.

As of 2011, Bank Indonesia (BI) introduced penalties for banks that have a loan to deposit ratio (LDR) below 78%, thereby urging banks to meet the aim of a 20-23% credit increase for 2011 as well as to lower their net interest margins to facilitate borrowing. BI will levy a 0.1% fine of the bank’s deposit base for every 1% below the set LDR. Yet many banks will be prepared to pay the necessary fines to avoid lending on poor quality assets and trigger a rise in nonperforming loans in the short term. In addition, a further measure by the Central Bank has seen banks with more than 10 trillion RP of capital forced to disclose their rates to the public through their websites and to the media since March 2011. This is an effort to promote greater transparency and let the consumer decide thereby increasing greater competition among the banks to set in motion a lowering of lending rates for the sector as a whole.

Despite the high rates; lending has been increasing. The course of 2010 saw a 20.46% increase from 2009 in combined lending (Bank Indonesia). Working capital loans saw an increase in 21% and investment lending up by 18.4% year on year, although just over 30% of these loans remained undispersed. For 2011, there are signs that there will be further growth with lending up by an average of 5 trillion RP a week in the first half of the year which if maintained could well see lending reach the 23% target. Banks have also been pledging their commitments to a number of sectors that require investment such as manufacturing as well as increasing lending for home ownership. Islamic banks have been particularly active in offering financing to the agricultural sector (See Agricultural Overview of Indonesia). Yet, the beginning of 2011 also saw a surge in the rate of non-performing loans (NPLs) mainly in the working capital segment which could result in more prudent lending towards the end of the year. The total nominal value of NPLs in March 2011 stood at 50.95 trillion RP, up from 48.9 trillion RP from the same period last year (Bank Indonesia).

Banks have also been criticised for their reluctance to lend to development projects such as renewable energy (see Opportunities in Energy: Beyond Fossil Fuels) and infrastructure initiatives (see Land Acquisition Law). Focus has been maintained on areas with high margins such as consumer and retail credit as well as unsecured loans. However, government regulations are making lending to the private sector a challenge due to the sometimes conflicting legislation. This is particularly true for infrastructure projects under the PPP scheme whereby the law on land acquisition is stopping many projects from progressing. President Director of Permata Bank, David Fletcher notes that some of the initiatives the government are close to implementing such as reform to the land acquisition law will help but there is still a long way to go; ‘if there are bankable projects they will get banked, if there are projects that still require government involvement in some way then that is telling you they are not completely ready for private sector financing.’

Bank Indonesia’s policies to boost lending and decrease the NIM will take time to implement and be truly effective. The banking sector is rightfully cautious given the sluggish growth in sectors such as textile manufacturing (see Challenges in Indonesia’s FTG Industry) and agriculture (see Agriculture Overview of Indonesia) in the face of the rising value of the Rupiah. The uptake of more efficient methods in analysing risk and credit history through information technology will allow banks to increase their lending and lower the costs of doing so. The introduction of cost standardisation by Bank Indonesia will also force the banks to streamline their operations and decrease costs to maintain healthy profits without passing the cost on to consumers. This will require a reordering of the banking culture in the country where the increasing salaries and bonuses have been justified by the profits being produced. In order to meet the government GDP targets of 6.7% growth for 2011, banks must take a long terms and sustainable outlook on lending by extending loans to new enterprises that generate jobs and financing for large scale infrastructure projects.

Global Business Guide Indonesia - 2012

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Indonesia Finance Snapshot - Banking

Contribution to GDP: 2.87% (2016)
Return on Assets: 2.30% (Q4 2015)
Number of Commercial Banks: 120; 4 State/Partially State Owned, 10 Foreign, 16 Joint Ventures, 32 Non Foreign Exchange, 35 Foreign Exchange, 26 Regional Development Banks (August 2015).
Number of Islamic Banks & Units: 13 Banks, 32 Units (2016)
Total Assets: 6,244 trillion IDR (Q3 2015)
Government Bodies: Bank Indonesia, Ministry of Finance, Financial Services Authority (OJK).
Relevant Law: Bank Indonesia Regulation No. 14/8/PBI/2012 on Share
Ownership in Commercial Banks limits ownership by a single local/foreign financial institution to 40%, by a non financial institution to 30%, and by an individual to 20%. Larger stake is possible with the approval of Bank Indonesia.