THE PROSPECT OF INDONESIAN BANKING INDUSTRY IN 2010

By: Adhy Basar P dan Ihsan Ismady P

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Introduction In 2010, Indonesian banking industry is expected to reinstate its optimum intermediary role since the global economy has started to recover from financial crisis. Many parties, especially entrepreneurs and government expect a more significant contribution of banking industry to drive the economy. During 2009, many parties had thought that banking industry has yet to run its intermediary function optimally, due to the fact that banks still implement high interest strategy to maintain their profit margin levels. This paper is trying to examine the condition of the Indonesian banking industry in 2009 and its prospect in 2010.

2009 Performance In 2009, the Indonesian banking industry started to recover from 2008 global crisis. It was shown in the second half of 2009, during which the growth of asset, loan and total deposits increased relatively higher than that of the first half

Figure 1: Growth of Asset, Loan, and Third Party Fund

Rp. T 3,000 2,500 2,000 1,500 1,000 500 2004 2005 2006 2007 2008 Jun 2009 * Des 2009 Asset (Rp. T) LDR (%) Loan (Rp. T) TPF (Rp. T) Loan Grow th (%) TPF Grow th (%) * Jun 2009, grow th year-to-date % 80 70 60 50 40 30 20 10 -

Source: Indonesian Banking Statistics - Bank of Indonesia

In 2009, banking assets grew by IDR 223 trillion or approximately 10%. It was driven by the growth of loan which reached 10%, or equal to IDR 130 trillion. However, this loan growth is lower than that of 2008 which reached 30%. The low
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Bankings professionals
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rate of loan expansion in one hand was caused by the banks negative sentiment on increased risk of real sector due to the occurrence of financial crisis. On the other hand, such a low loan growth was also caused by the slowing down of the economy and the high level of loan interest rates. As a result, the Loan to Deposit Ratio (LDR), a ratio indicating level of banks intermediary role reduced to 72.9% in 2009, lower than that in 2008 which reached 74.6%. Figure 2: Loan Rate, 2005
% 20

2009
% 20 16 12 8 4 0

16 12 8 4 0

Ot2 0 k 08

F b2 0 e 08

J n2 0 ui 08

F b2 0 e 09

J n2 0 ui 09

Mr 2 0 a 08

N v2 0 o 08

Mr 2 0 a 09

Ot2 0 k 09

Mi 2 0 e 08

Mi 2 0 e 09

N v2 0 o 09

D s2 0 e 08

Sp 2 0 et 08

BIC (SBI) (1 month)

Working Capital Loan

Investment Loan

Source: Indonesian Banking Statistics - Bank of Indonesia

Although in 2009 the outstanding of total loan increased, the working capital loan decreased compared to that in 2008, as a result of the surging loan rate, although the Central Bank of Indonesia - hereafter called BI, had reduced its indicative rate (BI rate 2 ) by 275 points so far, but the loan rate was only reduced by less than 100 points. Figure 3: Undisbursed Loan, 2004
Rp. T 1,400 1,200 1,000 800 600 400 200 2004 2005 2006 2007 2008 Jun 2009 Des 2009 19 18 21 20 Loan (Rp. T) Undisbursed Loan (Rp. T) UL/Loan (%)

2009
% 23 22

Source: Indonesian Banking Statistics - Bank of Indonesia

If the lending rate remains high, the real sector might be hesitant to utilize loans to support its businesses. Such hesitance can be seen on ratio of undisbursed loan to the total loan which reached 22.5% in 2009, the highest ever since 2005.
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BI rate is the rate used as reference on the determination of the interest rate of the Credit and the Third Party Fund.

Economic Review No. 218 December 2009

Sp 2 0 et 09

A s2 0 g 08

A s2 0 g 09

Consumer Loan

D s2 0 e 09

J n2 0 a 08

J n2 0 a 09

J li 2 0 u 08

Ar2 0 p 08

Ar2 0 p 09

J li 2 0 u 09

20 05

20 06

20 07

Similar to the loans, the growth of total deposits was also lower compared to the previous years. In 2009, these deposits rose only by IDR 220 trillion or equal to IDR 18 trillion per month; lower than the average monthly growth of 2008 which reached IDR 20 trillion per month, and of 2007 which reached IDR 19 trillion per month. In the future, with the recovery of non-bank financial market, it might be hard for banking industry to increase people confidence level to deposit their money in banks. Innovative strategies are needed to enable banks increasing these deposits, especially those low cost of funds such as saving and demand deposits. In the last two years, time deposit (the most expensive type of funds) had the largest portion in the composition of total deposits of the banking industry, which was 47% in 2008 and 46% in 2009. Such condition reduces this industry ability to cap its cost of fund which eventually restrict banks to optimally reduce their lending rate. As a result, the banking sector intermediary role may weaken. Table 1: Performance Ratios of Indonesian Banking Industry, 2005 2009 Ratio (%) 2005 2006 2007 2008 Nov Des 2009 2009
Operational Cost to Operational Income Return On Asset Net Interest Margin Non Performing Loan Loan to Deposit Capital Adequacy Amount of SBI to total loan 89.50 2.55 5.63 7.56 59.64 19.30 7.80 86.98 2.64 5.80 6.07 61.56 21.27 22.60 84.05 2.78 5.70 4.07 66.32 19.30 20.35 88.59 2.33 5.66 3.20 74.58 16.78 12.73 86.55 2.61 5.54 3.82 73.67 17.08 14.27 86.63 2.60 5.56 3.31 72.88 17.42 14.75

Source: Indonesian Banking Statistics - Bank of Indonesia

In 2009, despite the slower growth of credits and customer deposits, some ratios were better. Operational cost to operational income ratio (BOPO in

Indonesian abbreviation), a ratio which indicates the level of efficiency, showed an

improvement. Similarly, return on asset ratio was also increased, showing that banks performed relatively better. The banks capital was also stronger, indicated by the increase of Capital Adequacy Ratio (CAR) to 17.4%, although still lower than that in 2006 (21.3%). However, some other ratios were worse. LDR decreased, and the Non Performing Loan (NPL) increased. The rise of NPL confirms that the quality of loans declined, which then influenced banks policy on funds placement. It was shown by the ratio of SBI to the approved total loan which increased to 14.75% in 2009, whereas in 2008, this ratio was only 12.73%.

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Expectation on Economy and Banking in 2010 The recovery of global economy - which indicated by the improvement of US and Japan economy as well as the strengthening of emerging market economies such as China and India, will deliver a continuous improvement to the Indonesian economy. Indonesian export-import will continue to rise along with the rise of global demand. Household consumption will continue to drive the economy, and will also increase along with the increase of public purchasing power. Moreover, investment activities will also increase especially on infrastructure sector. Table 2: 2010 Projection of Economic Indicators
Indikator
Economic Growth (%) Inflation Rate (%) Averafe of 3 Months SBI (%) Exchange Rate (IDR/US$) ICP Oil Price (US$/barrel) Oil Lifting (MBCD) GDP (IDR Trillion) APBN-P* 2009 4.3 5.0 7.5 10,600 61 0.960 R-APBN* 2010 5.0 5.0 6.5 10,000 60 0.965 6,050.1 APBN 2010 5.5 5.0 6.5 10,000 65 0.965 5,981.4 APBN-P 2010 5.5 5.0 6.8 9,200-9,300 80 0.965 5,981.4

Note: APBN-P is the Amendment of Indonesian State Budget R-APBN is Indonesian State Budget Source: Ministry of Finance APBN 2010, Media publications

Inflation rate is predicted to rise, to reach 6% due to the rising of global and domestic demand, as well as the increase of oil and commodities prices. Meanwhile, IDR exchange rate is predicted to appreciate, along with the high spread of yield of investment in IDR and the higher Indonesian foreign exchange reserves. The estimation of domestic inflation and the expected rise of global interest rate (by Semester 1-2010, the Fed is predicted to increase its rate), will eventually, push BI to also increase the BI rate in 2010. In 2010, the strengthening of Indonesian macroeconomy will deliver a better achievement of Indonesian banking industry. Besides, room to grow for the Indonesian banking sector remains wide-opened since the share of Indonesian banking assets to the national GDP is only 26%; extremely low compared to China and India with more than 60% share, or Singapore and Malaysia of 99% share. The expansion of the real sector which grow along with the recovery of the economy, will drive credit demand. However, demand growth is predicted only at a moderate level in 2010, between 13-16%, higher than last year of 10%. In 2010, sector that is predicted to drive the growth of loan is infrastructure (electricity, toll road, port) due to the governments policy to improve Indonesian
Economic Review No. 218 December 2009

infrastructure condition within the next 5 years. Beside loan for infrastructures, consumer loans which are mainly dominated by automotive loan and mortgage, will continue to grow. Other sectors which are expected to grow are trading sector and food & beverages industry due to the growth of economic activities. Agribusiness sector (CPO, rubber, and pulp) and cement industry are potential for banks financings due to the implementation of ASEAN-China Free Trade Agreement (ACFTA) in 2010. Those 4 sectors/industries would most likely reap more benefits from ACFTA implementation due to the competitive advantages they have. Indonesian banking industry will also continue to finance the micro and small scale enterprises (herewith called UMKM). Loan distributed to this segment will continue to rise since large portion of market of this sector has not yet to be occupied. High net interest margin (NIM) enjoyed by banks which provide financings for UMKM causing other banks to also enter this sector. Besides, low NPL ratio of UMKM (in 2009, NPL ratio of UMKM loan was only 1.7%, lower than the NPL of Indonesian Banking that reached 3.3%). In this business segment, Bank Mandiri has set a target to be the second largest bank delivering loans to UMKM sector in 2010, following BRI and Danamon. Meanwhile, the growth of total deposits is predicted to rise. However, due to the growing trend of high-yielding investment products offered by non-bank financial institutions, the growth of the deposits will still be lower than that of loan; estimated to grow only 10-15% in 2010, while loan is estimated to grow at 13-16%). As a result, LDR of 2010 is estimated to be higher and end up at 78-81%. Since the growth of loan is predicted to be higher than that of deposits, banks will undergo tight liquidity situation. This will then be worsened by the agreement between BI and 14 largest banks which decided that the highest level of Time Deposit rate should not be higher than the deposit insurance company (LPS) rate, whereas the authorities expect banks to cut the lending rate. As such, banks interest income will likely be degraded. Banking NPL ratio is estimated to be relatively stagnant at 3,5-4,5% (still lower than the maximum level of 5% set by BI). Probability that the NPL ratio will increase is relatively low since the growth of loan is relatively low while the economic condition is getting better so that the default rate of business sectors is also low. However, in regards to the implementation of ACFTA, products of sectors that would compete directly with China should be highlighted since competitive advantages of Indonesian products are relatively lower than Chinas.

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Figure 4: NPL of Banking Sector, 2004 - 2009

Rp. T 80 % 8 7 6 5 40 4 20 2004
NP L (Rp. T)

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3 2005 2006 2007 2008 Jun 2009 Des2009

NP L (%) M EA Wo R (P P A P YWD) (Rp. T) EA Wo R (P P A P YD) (Rp. T)

Source: Indonesian Banking Statistics - Central Bank of Indonesia

Banking Challenges in 2010 The main challenge of Indonesian banking in 2010 is efficiency. Many argue that if banks remain operate inefficiently, lending rate would remain stagnant. In January 2010, the acting governor of Indonesian Central Bank, Darmin Nasution, stated that keywords of the future banking institution is efficiency, beside the other 2 indicators, i.e. banks intermediary role and banks health. The Operational Cost to Operational Income ratio (BOPO) - although has showed an improvement, will still on the high level (exceeding the ideal level of 6070%). Such a high level of BOPO is correlated to the burden of deposits interest rate and overhead cost which remain high. Thus, this year BI will conduct a benchmark on cost of fund, overhead cost, risk premium and profit margin, so that banks are able to find the improvable-efficiency area to determine the more reasonable rate landing. Besides, BI will also push the development of short term money market instrument to compete with banking loan.

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Figure 5: Operational Income to and Operational Expenditure of Banking, 2004 - 2009

Rp. T 350 300 250 200 150 100 2004 2005 2006 2007 2008 Jun 2009 Des 2009 BOPO (OE/OI) Operating Income Operating Expenses % 100 95 90 85 80 75

Source: Indonesian Banking Statistics - Bank of Indonesia

Expansion of credit which is accompanied by the implementation of operational risk 3 started this year is predicted to squeeze CAR of banks. As such, many banks prepare some corporate actions such as right issue, bond and subdebt issuance. Besides, strengthening of banks capital is also needed to provide adequate support if risk of economy increases. Competition among banks, especially on distribution of credit, is predicted to be tighter. This will force banks to reduce their lending rate, and causing banks to lose some of their future incomes. The reduction of banks income compels banks to enlarge the portion of their deposits by increasing their technology-based service system. Such system has been proved to give lots of benefits such as customer satisfaction, fast and precise data consolidation, fee based income (FBI) enlargement, and reduction and avoidance of frauds, which eventually increase banks efficiency. In recent years, the aggressiveness of foreign investors in acquiring local banks has tended to increase. Such aggressiveness has been driven by the attractiveness of the Indonesian banking industry since Indonesian market is very extensive, Net interest margin (NIM) of Indonesian banking of 5,6% is one of the highest in the region, and foreign investors are allowed to own up to 99% share in a local bank capital structure. In 2010, India and South Korea have also planned to acquire some Indonesian banks whereas Malaysia and Singapore have already acquired some of Indonesian banks during 2007-2009. Beside reasons mentioned above, the acquisition of some small-scale local banks by foreigners is also to support the trading of those countries in Indonesia when free-trade agreement takes place. Entrepreneurs who conduct business from and to those countries are the main target of those investors. This causing competition among banks becomes
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Basel 2 has decided that the Operational Risk should be calculated along with the expansion of credit, and the Central Bank of Indonesia defined that such regulation must be applied in 2010.

Economic Review No. 218 December 2009

tighter, especially on small-scale ones. Foreign banks with ample amount of capital are easy to fulfill the capital requirement of Basel II, whereas small-scale ones will face difficulty. Beside challenges from banking sector itself, some external challenges will affect the Indonesian banking industry in 2010. The crisis has not yet totally been over although the critical period of 2008 global crisis has been passed away. There are some latest developments i.e. the crisis of Dubai World and the beginning of bankruptcy of Austria and Greece banking industries that need to be highlighted as they may trigger bigger impact to the global economy, and eventually, affect the Indonesian economy. This may lead banks to hold their level of risk premium and thus becoming risk averse. Besides, real sector will remain stagnant (likely to wait and see), which indicated by the low level of loan demand.

Conclusion 2010 is a tough year for Indonesian banking industry. Post-crisis economic recovery faces big challenges due to the implementation of ACFTA that put pressure to the real sector which in turn affect the performance of the banking industry especially the down-grading risk of debtors credit quality. Tight competition occurred in 2009 will continue in 2010. The declining trends of lending rate causes banks to become more aggressive in offering loans. Such tight competition will also occur in attracting deposits having lower-cost (saving and current account deposits) to come to the banks so that they must prioritize to apply sophisticated technology and excellent service. Utilization of cutting-edge technology will also be one of banks strategies to increase efficiency in their operational activities, which in turn optimizing their performance.

Economic Review No. 218 December 2009