On Solid Ground

Indonesia

Economic News

22 Jul 2010
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Facing its toughest test since the 1997-98 Asian Financial Crisis, Indonesia's banking sector appears to be well positioned to weather the global financial storm. While lending and liquidity are being squeezed in line with the global trend, the country's leading banks appear to be in good shape, less exposed to the pitfalls that have plagued the banking sectors in the US and Europe.



Although the economy's overall growth rate is slowing due to the impact of the global downturn, the Indonesian banking sector remains remarkably intact. In large part this can be attributed to the aggressive reforms of the central bank, Bank Indonesia (BI), following the lessons learnt in 1997-98, when widespread bank failures and major currency depreciation spiralled the country into its worst-ever economic fall.



Many of the causes behind the current global financial crisis, which have exposed some of the world's leading financial institutions, such as subprime loans and exotic securities are almost non-existent in the Indonesian banking sector. Furthermore, Indonesian banks have relatively limited exposure to foreign currency loans and the real estate market. Housing loans account for only 30% of all consumer loans, which in turn account for only 20% of all outstanding loans.



Overall, most of the relevant metrics for health and stability point to the robustness of the country's banking system. Himanshu Mehta, the country head for BNP Paribas Indonesia, told OBG towards the end of 2008, "Looking at the current global economic downturn, the fundamentals of the country are dramatically improved from where they were prior to the 1997-98 crisis. Non-performing loans are comfortably below the tolerance level of 5%, while the capital ratio of banks is more than double the required level of 8%. Most importantly, the country has learnt from what happened in 97/98, and will not repeat the same mistakes."



Nevertheless, in the middle of April, news came that BI revoked the licence of Bank IFI after it failed to meet what it termed as "sound banking conditions". While the liquidation of any commercial lender is a concern, analysts are not expressing major anxiety over the collapse of the local bank, viewing this as an isolated incident rather than a major precedent or systemic issue. Bank IFI had been on special supervision from BI since 2002, and its assets stand at a mere 0.01% of the industry's total.



In fact, including Bank IFI, there have only been three incidents of lenders in Indonesia folding since the global financial crisis took shape. The other two were Bank Tripanca, a very small and rural player that faced liquidation anyway, and Bank Century, who had to be taken over by the government due to liquidity issues. These cases are pale in comparison to the defaults and government bailouts of leading financial institutions experienced in the US and Europe. While being greeted with caution, there is little evidence of depositor and regulator panic.



At present Indonesia has 127 banks, a number many consider to be too many for an economy of its size. With 85% of all third-party funds held by the 15 largest banks, some argue that the smaller players, many of whom are regional and family-owned, lack adequate capital and management expertise to sustain real operations under current pressures.



Eugene Galbraith, the president commissioner for Bank Central Asia, the country's largest private bank, told OBG, "Most of the large banks in the country, since the late 1990s, have been run by professional bankers and the capital adequacy levels they have built up are strong. Overall, the sector is ok. There will be some issues surrounding more small banks going under, but it will not be systemic risk and BI has thus far managed this well."



As most of the country's top lenders have still reported positive growth in their latest financial reports and are considered to have sufficient capital, the increased pressures on the smaller underleveraged banks to stay afloat are being viewed by some as a welcome side effect of the slowdown, adding further incentive for consolidation.



With most remaining optimistic that the country's banking sector will not see major casualties, the main issue remaining is the reduction in lending as credit conditions are tightened. Loan growth for the year is predicted to halve to around 15-16%, compared with 30.5% in 2008. This is a significant issue for the economy as a whole, as with a limited corporate bond market, bank borrowing is the most significant means for companies to access funding.



Shariq Mukhtar, the chief executive for Citibank Indonesia, told OBG, "Overall, a reduction in credit to a more reasonable 15-20% could actually be a good thing, as banks will increase their focus on the quality of new customers and the needs of their existing customers."

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