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Economic News

22 Jul 2010
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Last year, the IMF published a report on Indonesia, praising its improved economic resilience, singling out its banking sector. In a press release, the fund noted the “relatively strong corporate and banking sector balance sheet positions, high capitalisation and profitability of the banking system”. It added that financial soundness had improved in past years, particularly in terms of rising profitability and a strengthening capital base.



Its position today, and its ability largely to weather the international economic storms of the past two years, is the result of a painstaking process of recovery from the Asian financial crisis 13 years ago, which caused the collapse of banks and capital flight. The aftermath brought about a reappraisal of how the system should operate and be regulated. Bank Indonesia (BI), the central bank, tackled legacy non-performing loans, which had proliferated, and led a drive to increase capitalisation and enhance professionalism in the sector. Meanwhile, banks became somewhat more cautious in their lending and investment, as well as more willing to accept higher provisioning as insurance against bad loans. They have also made their loan portfolios less risky, lowering the proportion of foreign currency lending.



"The banking sector has emerged from the financial crisis in a position of relative strength largely due to the lessons the industry learned from the crisis in 1997-98," David Fletcher, the president director of Permata Bank, told OBG.



Structural changes since the last crisis have not been the only factor behind banks' ability to ride out the recent global financial turmoil. Indonesian financial institutions have tended not to expose themselves to the sort of toxic debt that has undermined large US and European banks. The system has also benefitted from what might previously have been seen as a weakness – a lower level of integration with international financial markets. Finally, they have been buoyed by Indonesia's continued growth through the global recession. The country's GDP expanded by 4% in 2009, providing banks with decent opportunities for deposit growth and domestic lending.



This is not to say that Indonesian banks have been unaffected. Liquidity became tight, as it did elsewhere, with banks looking to bolster their provisioning and scale back credit growth that had become a little too heady in previous years. Local press reports have suggested that banks remain cautious in lending to the manufacturing sector, particularly segments that are seen as uncompetitive or overstaffed. Some suggest that the market structure may be an issue.



Kamal Osman, the president director of BNP Paribas Indonesia, told OBG, "The interbank market is very limited, with several banks having a majority of the depositor base and thus controlling much of the liquidity. There might be a need for some form of intervention to encourage further liquidity, especially in the interbank market."



Osman asserts that encouraging mergers and acquisitions could help strengthen the sector. "Higher thresholds should also be introduced in order to encourage consolidation of the banking market," he said.



A degree of consolidation in a market that is both fragmented and led by a few big players could create more robust competitors. However, this is likely to be a medium- to long-term process, rather than a quick fix to immediate issues.



Meanwhile, the bigger banks, and those with access to financing from abroad, are relatively unconstrained. They can look forward to tapping a large and expanding market in 2010 and beyond.



Growth is likely to be driven by resurgent consumer confidence and the performance of underbanked parts of the economy, as well as BI's supportive policies. The bank has stated that it is aiming for 17-20% lending growth this year. On April 6, it decided to hold its key policy rate at 6.50%, and indicated that it would be willing to keep the rate at the same level all year if inflation stayed within its target range of 4-6%. While analysts surveyed by the international press suggested that tightening could start in the third quarter, the widespread expectation is that rates will be kept low for the coming months. This, and the positive economic outlook, is likely to boost bank and consumer confidence.



"Demographically, the market has developed with a growing middle class and an improved environment for access to financing," Fletcher said. "Looking forward, there are three distinct categories whereby the banking sector has an opportunity to capitalise; consumer banking, small and medium-sized enterprises, and commercial banking and project infrastructure. Many companies are looking to expand and grow their operations in 2010 and we should see lending increase. This is due mostly to a fundamentally strong economy."

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