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Finance | Indonesia’s Banking Sector; Under Pressure But Staying Strong

Reduced profit, a drop in lending and an increase in the rate of non-performing loans (NPL) are some of the challenges faced by Indonesian banks as we approach the close of 2015. The various challenges that have plagued the domestic banking industry have mainly been triggered by global financial turmoil such as the economic slowdown of China, the depreciation of the rupiah against the US dollar due to the uncertainty over the planned increase in interest rates by the Federal Reserve, as well as a relatively high Bank Indonesia (BI) interest rate. Despite these problematic conditions, marked progress was made in Indonesia’s banking sector over the course of 2015, specifically in relation to banking regulations. Joko Widodo’s government issued various incentives and regulations as well deregulations to encourage the growth of the Indonesian banking industry such as tax allowances on export proceeds (DHE) and a reduction in the interest rate of the People's Business Credit (KUR) programme among others.

Indonesia’s Banking Sector; Under Pressure But Staying Strong
Lending to small and medium enterprises has long been overlooked as a niche area designated for the largest state owned banks given its classification as high risk. Now, this attitude has changed significantly.

Decreasing profit & rising NPLs

With the exception of Bank Central Asia (BCA) who was able to post cumulative net profit growth of 9.6% (y-o-y) as per September 2015, other large domestic banks such as Bank Rakyat Indonesia (BRI), recorded a meager growth of just 1.9%. Others, such as Bank Negara Indonesia (BNI) and Bank Mandiri posted a net profit growth of only 0.9% and -21.2% respectively. Indonesian domestic banks' profits have been reduced due to the increase of funds allocated for loan loss provision (LLP). This is in line with the heightened risk of non-performing loans which has been in a state of advancement since 2013. Taking into account the current economic climate, the Deposit Insurance Agency (LPS) predicts that non-performing loans in Indonesian domestic banks will continue to rise until the end of this year (2015).

Over the past two years, NPLs continued to show an upward trend, both in nominal and ratio terms. NPL in nominal terms as of August 2014 reached 107.1 trillion IDR, a jump of 32.6% from the previous year which stood at 80.7 trillion IDR. During the same period, the value of ‘bad loans’ with level five collectability soared by 36.4% to 67 trillion IDR. As a result, the NPL ratio of Indonesian banks in August 2015 reached 2.76%; higher from the same period during the previous year which stood at 2.31%. To place the issue in context, this level is the highest ratio since July 2011. In contrast to the periods of 2005-2006 and 2008-2009 where the increase in collectability of bad loans occured suddenly, in 2013-2015 the increase has taken place gradually. As a result, according to the LPS, although credit growth in Indonesia is high, local banks are less able to handle the risks associated with credit growth.

The highest risk of non-performing loans occurred within the construction sector (See Indonesia's Commercial Property Sector in Temporary Slowdown), reaching 5.46%, followed by social services, sociocultural, entertainment and other sectors which equated to a rate of 4.46%. The NPL in the wholesale and retail trade sector was 2.11%. While non-performing loans in the transportation, storage, and communication sectors stood at 3.72%. For the mining and quarrying sector, the value of its NPL was 3.11% thus recording the highest increase in nominal NPL of 86.4% compared to last year, reflecting the depressed state of energy commodity markets worldwide (See The Coal Sector in Indonesia).

Drop in lending

Bank Indonesia revised down its bank credit growth target to 11-13% for this year (2015). Previously, Bank Indonesia targeted loan growth of 15-17%, which was later subject to revisions. According to some analysts, the economic slowdown has forced banks to revise down their credit growth target. They expect this year's lending to fall below 10%, significantly lower that earlier projections. The increase in the ratio of non-performing loan has also eroded lenders’ net profit.

In addition to the increase in non-performing loans, banks’ performances have therefore been hampered by the decline in lending due to a slowing economy. By August 2015, lending grew by 10.9%, lower than the same period in 2014 which reached 14%. Indonesian banks are thus proving to be cautious in the current business climate despite the targets set out by the central bank so as to encourage the take up of working capital loans and boost business growth.

Regulations and government support

The Government and the House of Representatives (DPR) are still in discussion regarding the draft law on the Financial System Safety Net (JPSK Bill). Both institutions have not yet reached an agreement on some of its provisions. As a result, the regulation, which will serve as the legal basis for the government to ward off the dangers of a financial crisis, are unlikely to be passed into law by the end of the year.

However, there have been bright spots of regulatory progress. Chairman of the Board of Commissioners of the Financial Services Authority (OJK) Mr Muliaman D. Hadad said that his institution has relaxed the requirements of commercial banks and branches of foreign banks to enter into the foreign exchange management business or become a trustee. In addition, the government has also introduced tax exemption incentives for export proceeds (DHE) that are deposited in domestic Indonesian banks. Bank Indonesia estimates that export proceeds deposits have the scope to increase by $1 billion USD per month. Other reforms include regulations making it easier for foreign nationals to open foreign currency accounts in Indonesia which are aimed at increasing foreign exchange deposits.

People's Business Credit (KUR)

Since July 2015, the Indonesian government has cut the People’s Business Credit’s (KUR) (a government sponsored investment and working capital financing programme aimed at micro, small and medium enterprises as well as cooperatives) interest rate from 22% to 12%. The funds for the programme have historically been distributed by state owned bank BRI; however as of June 2015 the scheme was expanded to include more state owned banks including Bank Mandiri and Bank Negara Indonesia as well as regional development banks. The interest rate cut will be mainly borne by government subsidies and therefore will not impact bank earnings, thus the measure has been welcomed as an additional channel for boosting bank’s earnings.

The main objective of the KUR programme is to positively impact inclusive economic growth through bolstering micro, small and medium enterprises (See An Outlook on Indonesia's Microfinance Sector). The resilience of the MSMEs sector throughout economic shocks is rightly regarded as the backbone of the Indonesian economy. However, the high lending rates that this segment of the economy is subject to has been seen as an impediment to their growth, which is of vital importance as such companies will soon be subject to fiercer ASEAN competition.

For 2015, the Indonesian government set a ceiling for KUR lending at 30 trillion IDR. Of that total amount, approximately 20 trillion IDR will be channeled towards the micro enterprise sector, and the rest is earmarked for the retail sector. Three state-owned banks and six regional development banks (BPD) will be responsible for the disbursements of the loans. As of 16th October 2015, the total micro and retail KUR funds reached 6.2 trillion IDR with the total number of borrowers equating to 347,346 people. Looking forward to 2016, the scheme has been targeted to increase fourfold from 2015 to reach 120 trillion IDR. This therefore offers highly promising growth prospects to the lenders involved as well as having a much needed multiplier effect of MSMEs to encourage investment and job creation.

Looking forward

As consumer confidence has waned in a context of a general economic slowdown, Indonesian banks have had to seek out new growth channels besides the highly lucrative consumer loans segment. Lending to small and medium enterprises has long been overlooked as a niche area designated for the largest state owned banks and regional development banks given its classification as high risk and therefore subject to state subsidies. Now, this attitude has changed significantly with Indonesia’s small and medium scale banks including Bank J Trust Indonesia and Bank Victoria actively focusing on the SME (micro enterprises being a distinctive market segment served by microfinance) market given its vast growth potential as an underserved strata of the Indonesian market. Outside of the government’s KUR programme, Indonesian banks are recognising the need to service SMEs to a higher standard and to take a very different approach to attracting SME customers who are increasingly in a position of strength to shop around for banking services.

Mr Ahmad Fajar
Bank J Trust Indonesia
Mr Ahmad Fajar
Retail & Consumer Bank
We will shift the focus of our lending from corporate and multi financing to micro, small and medium enterprise financing. The challenge in small business loans is the education of our customer base and also to create competitive products.
See Interview Learn more about Bank J Trust Indonesia

Lending to infrastructure projects should be an area of significant growth for Indonesia’s large scale banks over the course of 2016 given the government’s infrastructure push and the pre-tendering of projects to ensure their timely commencement (See High Stakes for Indonesia's New Infrastructure Push). Foreign banks are eyeing opportunities to tap into infrastructure lending with three state owned banks namely BRI, Bank Mandiri and BNI due to receive loans of $3 billion USD from the China Development Bank. These loans will be used to finance a number of infrastructure projects in the country as domestic funding is inadequate to meet the current financing needs of private and state-owned infrastructure projects, which equates to $2,750 trillion or $187 billion USD.

The health of Indonesian domestic banks has been called into question by the sharp decline in the rupiah in response to the Federal Reserve’s mulling of raising interest rates in the USA. The drop in the rupiah versus the US Dollar to the lowest levels since the Asian Financial Crisis led to fears that banks and insurance companies exposed to US Dollar denominated liabilities could face the need to seek government financing support. Stress tests conducted by the Indonesian Financial Services Authority (OJK) across 50 banks showed that Indonesian banks are well capitalised and that their assets are not affected. Such tests were conducted with the US Dollar rate of 14,000 IDR. From these tests only up to five banks were revealed to be in a short position, illustrating the overall robustness of Indonesia’s banking sector and the lessons learned from 1998 in terms of prudent financial management.

Global Business Guide Indonesia - 2016

icone share

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.