Ng Boon Yian, Singapore – Years after being battered by the financial crisis, the Indonesian banking sector seems to have picked itself up again, luring more foreign investors to take up stakes in local banks. Just recently, Khazanah Nasional Bhd, Malaysia's state-owned investment arm, decided to acquire a controlling 52.05% interest in Indonesia's PT Bank Lippo, paying US$325-340 million for it. This came only two days after Singapore's United Overseas Bank Ltd announced that it would pay about $168.7 million to raise its stake in PT Bank Buana by 30% to 53%.
The growing optimism about the Indonesian banking sector is not surprising, given some positive developments in recent years. Khazanah justified its acquisition by reportedly pointing to the "strong underlying fundamentals" of the system. Such optimism should, however, remain guarded as the picture of the Indonesian banking sector is still a mixed one. But first, the good news. After massive recapitalization and restructuring efforts, Indonesian banks – which were brought down by corruption, imprudent lending and excessive bad loans in 1998 – are certainly in better shape today. A wave of consolidation and divestment has pared down the overcrowded banking sector from 222 banks in 1997 to 132 today. Bank operations also improved after global consultants were hired to help upgrade risk management and corporate governance.
In balance sheet terms, the picture has also become more encouraging. Non-performing loans are down to about 6% of the total credit, according to official statistics. In addition, the capital adequacy ratio has been hovering at an impressive 20%, well above the Basel requirement of 8%. To boost growth, the banks have been increasingly focused on lending to consumers and SMEs (small and medium enterprises) over the past two years.
In the regulatory realm, the Indonesian authorities have been making the right policy moves as well – at least on paper. Starting in September, for instance, Indonesia will score a first in the region by implementing a deposit insurance scheme and doing away with the prior blanket deposit guarantee. Under this new arrangement, the Indonesian government will insure just up to 5 billion rupiah (US$513,315) of deposits, a move expected to help reduce moral hazard and discourage excessive risk-taking in the system.
Indonesia is also in the process of setting up a credit bureau with information on about 1 million borrowers, which will help to enhance credit risk assessment by banks. Giving a further fillip to foreign investors' hopes is the improving macroeconomic situation in the country. Growth is expected to cruise along at 6% this year, buoyed by rising investment and exports. Not only does this produce a conducive environment for banks to grow, the slew of infrastructure projects in the pipeline provides further lending opportunities down the road.
The rosy scenario notwithstanding, scratch the surface and it becomes apparent that the Indonesian banking sector is still laden with many structural challenges. While some promising reforms have been undertaken, the full recovery of banks back to robust financial and operational health cannot be conducted in isolation from wider changes. For one, the extent of banking reform success depends crucially on the progress of Indonesia's war on corruption. Although President Susilo Bambang Yudhoyono has evinced determination to fight the socioeconomic plague, that has yet to be translated into broad results.
The various cases of bank fraud during the past year, including the replacement of the head of Bank Mandiri – the country's largest bank – in the wake of a lending scandal this May are a case in point. It shows the road to cleaning up the sector will be a long one before local banks can meet international standards. To do so, there must be a strong reform mindset that pervades beyond the president and extends across later administrations.
In this regard, Bank Indonesia's regulatory authority has definitely been bolstered by its legal independence from political interference. However, as a World Bank report pointed out, in practice, the central bank is sometimes seen to have less authority over the state-owned banks than private banks. This is a serious challenge as state-owned banks still form some 35% of Indonesia's banking system. A positive sign, however, is that the Indonesian government has recently started to sell minority stakes in state-owned banks. Further privatization will bring in the market discipline needed to enhance the banks' operational standards.
Even in terms of financial restructuring, Indonesian banks still have some way to go before regaining their full financial health. While the banks enjoy a high capital adequacy ratio, much of their capital came from the government recapitalization bonds, which generally form about one-third of the banks' balance sheets. While these government securities do provide a passive source of income for banks, they also pose interest rate risks as most of them are fixed-rate instruments. Meanwhile, the fact that the bonds form such a substantial part of bank assets means that less loans have been made. As such, the loan-to-deposit ratio of banks is still low at about 40-50%, compared with the normal 80-90% seen during the pre-crisis days.
While the good news is that growing investment in Indonesia means greater opportunities for banks to provide long-term financing and boost loan growth, the catch is that their hands are tied by the lack of long-term funds at their disposal to do so. Nearly all bank deposits in Indonesia are three months or less in maturity. Little surprise, therefore, that most Indonesian banks are now only providing short-term loans of between three to six months in order to avoid maturity mismatch.
Besides, most banks in Indonesia remain risk-averse, especially in terms of lending to the corporate sector, the culprit which brought them down during the financial crisis. Indeed, whether it is to tap upon the growth potential in investment financing or consumer lending, Indonesian banks need to seriously beef up their risk assessment and management capabilities. That, in turn, depends crucially upon human expertise and sophisticated technology, which Indonesia still sorely lacks.
In this regard, the entry of foreign investors, which also include Deutsche Bank, Standard Chartered as well as Singaporean and Malaysian investment funds, is good news as they can help to accelerate reforms in risk management, corporate governance and competitiveness. In return, the foreign players can tap the attractive growth opportunities in Indonesia. After all, only about 20% of its population have saving accounts today. The Islamic banking market is another potential growth area, as Islamic banking products account for just 2% of the system's assets, compared to 10.5% in Malaysia.
Still, Indonesia remains a notoriously volatile market. Susilo Bambang Yudhoyono's presidency has ushered in some measure of stability, and this is therefore an opportune time for foreign investors to enter the market. But such optimism should be guarded, as the positive developments can be easily overturned by structural woes such as corruption and weak corporate governance. Building sound balance sheets and a robust credit culture cannot be done overnight: it will be some time yet before Indonesian banks can stand fully on their own feet.
[Ng Boon Yian is a research associate at the Institute of Southeast Asia Studies, Singapore. The views expressed here are her own, not the institute's.]