Indonesian Banks Resilient Against Financial Volatility

Major Indonesian banks' core profitability should remain healthy this year, following a solid financial performance in 2013, says Fitch Ratings. Strong margins and high core capitalisation insulate the banks against potentially heightened financial volatility and the risk of a macroeconomic shock.


The economy remains somewhat vulnerable to external events, though local markets have performed relatively well since the onset of Fed tapering. External balances continue to improve gradually, helped by policy tightening - as illustrated by the recent shift in the trade balance into a surplus. In light of this adjustment process, we expect GDP growth to slow to 5.3%, from 5.8% in 2013.


Against this backdrop, Fitch expects NPLs to rise from their historical lows of around 2% in 2013.


Key risks stem from rising interest rates and the adverse effects of weaker commodity prices and more challenging operating conditions. However, problem assets at major Indonesian banks should remain largely manageable, supported by the pro-active moves by some banks - including heightened vigilance of vulnerable borrowers, and restructuring solutions for viable businesses.


The potential increase in banking stress should be comfortably buffered by robust interest margins and profitability. Both of these remain among the highest in Asia, and should limit the risk of any capital impairment.


Indonesia's banking system booked strong profitability in 2013 with ROA at around 3%, despite a slight dip in net interest margin.


"Notwithstanding a modest increase in pressure, we still expect Indonesian banks to maintain higher profitability than most other banking systems in the region, as they still have a wide margin to compensate for pressures from higher funding and credit costs. This was also confirmed by our stress tests of rated banks in November 2013," says Fitch.


Indonesian banks' capital position has remained strong, with the Tier 1 capital ratio improving slightly to 16.99% in the first 11 months of 2013 (2012: 15.6%). Any prospective pressure on capital is counterbalanced by higher profit retention, lower loan growth targets and, at some banks, equity injections.


Deposit competition and higher interest rates may hamper deposit-gathering efforts, and could squeeze the liquidity of smaller banks with a weaker franchise. But funding is likely to remain sourced mainly from domestic customer deposits.


The loan/deposit ratio climbed to nearly 90% in 2013, but the pace should ease somewhat as loan growth is likely to moderate to around 15% in 2014, down from 20%.


Since the Asian Financial Crisis of 1997-1998, major Indonesian banks have generally been selective in extending foreign-currency (FC) loans, focusing on borrowers which generate income in matching foreign currencies, with the FC loans/deposit ratio of the banking sector staying below 100%.


The foreign-currency net open position exposure of the banking sector has averaged 2% of capital, well below Bank Indonesia's limit of 20%. This protects against capital impairment led by sharp depreciation of the rupiah, which has fallen by more than many other Asian currencies since mid-2013.



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