Economic Update

Published 22 Jul 2010

Last week, Indonesia’s central bank called upon the country’s banks to increase lending, while deliberating measures to increase supervision in the sector and thereby prevent non-performing loans (NPLs) in the future. NPLs are considered one of the main problems holding banks back from expanding their loans portfolio.

The governor of Bank Indonesia, Burhanuddin Abdullah, encouraged the banking sector to review its business strategies in order to accelerate credit growth in the second half of 2006. Although 20% growth was targeted for 2006, figures released this week revealed that lending only increased by 3.75% to roughly Rp721 trillion ($79.2bn).

Credit growth is considered to be an important impetus for the country’s economic growth. Banks have not been able to increase their lending rates due to the central bank’s high benchmark rates. After fuel prices caused steep inflation at the end of 2005, Bank Indonesia raised its main interest rate to 12.75%, to only ease it very cautiously recently, as it awaits monetary and inflationary stability.

Although Bank Indonesia lowered its rate by 50 basis points, and last week, senior deputy governor Miranda Goeltom indicated room for further downward movement, banks are not expected to achieve explosive growth in lending any time soon.

Next to decreased consumer spending and a subsequent fall in loan demand, one of the main obstacles for banks to increase lending is the risk of NPLs. This has been a sector-wide problem that followed the Asian financial crisis in the late 1990s.

While privately owned banks have been able to write off their bad debts, state-owned banks cannot, as regulations qualify such debts as state assets. State-owned banks are vulnerable to growing NPL ratios in the wake of strong inflationary pressures.

The authorities are presently working on ways to solve the NPL problem. Last month, Finance Minister Sri Mulyani Indrawati indicated that state-owned banks would be allowed the same flexibility as private banks in resolving their bad debts without having to first consult the ministry.

Meanwhile, the central bank is seeking ways to increase supervision over Indonesia’s 131 banks. In the framework of the new Indonesian Banking Architecture (API), launched in 2004 to restructure the banking sector, several measures aimed at consolidating the market are currently under consideration and implementation.

Consolidation would facilitate supervision, which is expected to prevent more NPLs in the future.

One of the measures the central bank is now studying is a single presence policy. Under this policy, shareholders are not allowed, directly or indirectly, to control more than one bank in Indonesia. Central bank regulations (Rule No. 5/25/2003) determine that ultimate shareholders owning 25% or more are considered “controlling shareholders”.

Last month, Governor Burhanuddin Abdullah announced that shareholders controlling more than one bank in Indonesia are given three options by the central bank. First, they could merge the banks under their control. Second, they could create a financial holding company accommodating all entities under their control, and third they could divest.

The move is likely to have consequences for several, mainly larger institutions active in the Indonesian banking sector. Singapore’s investment arm Temasek Holdings has a strategic interest in three banks (DBS Indonesia, Bank Danamon and Bank Internasional Indonesia). Malaysian Khazanah Berhad directly owns Bank Lippo and has a controlling share in Bank Niaga.

Foreign banks like Standard Chartered (Permata Bank), UOB (Bank Buana) and OCBC (Bank NISP) will also be affected by the rule, even though it is still unclear to what extent their offices in Indonesia could be considered as fully fledged banks or merely representations of their international activities.

The numerous small banks might be less affected since only few of these have the same controlling shareholder.

The shareholder with the most to do will be the government itself. Currently, it has controlling (majority) stakes in five banks, among which are three of Indonesia’s four largest: Bank Mandiri, Bank Negara Indonesia (BNI) and Bank Rakyat Indonesia (BRI).

It is still unclear which one of the three options the government – as shareholder in five banks and in principle subject to the central bank policy – will favour. Earlier this week, in a conversation with OBG, senior vice president and chief economist of Standard Chartered bank in Indonesia, Fauzi Ichsan, shared his views on possible scenarios for the government.

“As far as the state banks are concerned, a merger is unlikely because it would be costly for the government, and entail lay-offs, and I can not imagine the four state banks merging just before the elections in 2009,” he explained.

“The second option of setting up a holding company is unlikely since Bank Indonesia indicated additional cash is needed for this,” said Ichsan. “Given the current priorities of improving the infrastructure and alleviating poverty, it is unlikely that parliament will grant the government additional cash just to continue having the four state banks.”

The third option of divesting its interest in (at least four of) the state banks is most likely according to Ichsan, even though potential nationalistic sentiment might not favour such a move. “If you can privatise the banks through IPOs [initial public offerings] to domestic investors, then opposition to such divestment could be neutralised,” he explained. “Especially if you can ensure that the IPO, the divestment, will involve a cap to individual investors, which means effectively you are redistributing wealth to Indonesians”.