Indonesia’s financial services has experienced more than its fair share of difficulties over the years, particularly during Asian market turbulence of the late 1990s. However, today the sector is truly bouncing back and proving to be one of the most dynamic of markets, with something to offer domestic and international investors alike. with only around 20% of adults in what is the world’s fourth most populous nation having any kind of relationship with a financial services provider there are opportunities aplenty for companies willing to seek them out, something that prescient organisations, such as Citigroup and HSBC, have long recognised.
For those corporate organisations that do enter the Indonesian marketplace, they will find a sector that has proven remarkably resilient to events in the wider economic world. So while in recent years banks in Europe and North America were seeking bailouts from their respective governments, in contrast Indonesia’s lenders were posting record profits. with the market becoming ever wider and deeper, and with interest rates continuing to fall, the financial environment market could yet get more exciting.
In August 2011, the central bank, Bank Indonesia (BI) reported that there were 120 commercial banks in Indonesia possessing assets totalling more than $390.3 billion USD, with some 15 of them responsible for about 70% of the nation’s credit. Most of these are privatelrun local enterprises, along with a number of regional development banks, and more major banking organisations, four of which are, at least in part, state-owned – with three of these ranking among the top four In the country. However, the future of banking ownership is currently the subject of much discussion. Thanks to the government’s decision in 1999 to open up the financial sector to foreign financial institutions, saw an influx of international interest, which meant that by the middle of 2011 of all the banks operating in Indonesia, nearly one third were either partly or entirely foreign-owned. In all, this meant that foreign lenders were responsible for 27% of all outstanding loans.
Concerned that banking power might become too concentrated in just a few hands BI, which also has the authority to issue policy rules and regulations, is considering capping ownership of any one bank’s shares at 50% rather than the current 99%. It is not yet clear what this might mean in practice, or whether it would be applied just to privately run banks or state-owned banks as well. Should this new regulation come into force, the sector might find itself thrown into turbulence and confusion as investors worry about the prospect of massive dumping at discounted prices and just who exactly will take up the shares that must be released to comply with the new directive. Despite such uncertainties, the untapped nature of the Indonesian marketplace spells profit, although this is unlikely to be accompanied by the type of wild west feeding frenzy experienced in some parts of the world. This is largely because of the conservative approach the banking sector has adopted in the wake of the financial problems of 1997 and 1998. However, that conservative approach, while helping bring a degree of stability to the marketplace, has to some extent hampered growth and activity.
This has meant that most of Indonesia’s banks are focused on short-and medium term lending that provides them with a fast return generates confidence. But while this may limit their exposure to risk, it is of little use when it comes to funding large projects that require longer-term finance. It is this lack of availability of long-term funds that has been one of the stumbling blocks to improving Indonesia’s far from efficient infrastructure, something that continues to constrain its economic development. In an attempt to encourage additional lending, in September 2010 the government modified loan-to-deposit ratios, setting a lower level of 78% LDr, though establishing a 100% upper limit to prevent banks taking unnecessary lending risks.
The numerous mergers and acquisitions that took place after the financial crisis saw considerable consolidation within the sector. This is something that is likely to continue as land better capitalised banks buy up specialist operators to access specific market segments, and is certainly something that BI is keen should continue. For the moment though, rural banks and micro finance initiatives are still the significant mechanism for lending, particularly to the many small entrepreneurs who are looking to do business in what is one of the most commercially-minded regions of the world. Indeed, credit for small businesses is an important element of the Indonesian banking system and accounts for over 50% of total lending in the system, with lending to this sector experiencing significant growth. Howeller, there has been some weakening of credit quality, with the ratio of non-performing loans slightly higher for small business lending than for the sector as a whole.
Indonesia’s banking sector delivered consistently strong profits for investors even during the global economic downturn.
Consumer lending is also on the rise, with individual loan values on the increase, an indicator that is giving some cause for con- cern. As a result, BI has been giving a steer to banks by suggest- ing that they should be aiming their lending at productive invest- ments rather than towards encouraging consumer spending. The demand for credit amongst individuals and businesses shows no real signs of slackening, even though interest rate margins in Indonesia are the highest in South-East Asia. Attempts by BI to introduce greater transparency into the marketplace seem to have done relatively little to drive down the cost of borrowing as, with few alternatives to bank lending, those wanting credit are forced to pay the price that is asked. However, given the historic volatility of the markets, banks to some extent may be forgiven for building an extra comfort factor into the price of money.
Indonesia may be the world’s largest Muslim country, but it has not taken the lead when it comes to Islamic finance, ostensibly happy to leave that role to Malaysia, which has imposed sharia banking as the norm. But with that market reaching saturation point and political unrest in a number of Middle East countries, this has given Indonesia the opportunity to catch up at a natural growth point for sharia compliant banking. Consequently, this has already seen some banks spinning off their sharia lending components to create stand-alone companies that conform to the special requirements regarding interest and excessive risk that the Islamic marketplace demands. With just 5 dedicated Islamic banks and 27 conventional banks with a separate sharia platform to handle Islamic transactions, there is much scope for growth, though this will require mass market education to improve the limited knowledge of the largely financially unsophisticated Muslim market as to how the financial community can best meet its needs. Though coming from a low starting point, the last five years have seen sharia banks achieving asset growth of nearly 40% compared to the 15% of conventional banks. Consumer lending to the sector has been strong, with auto financing in particular proving to be quite literally a driving force for growth, given that the vast majority of car purchases in Indonesia are made using loans. This trend is more than likely to continue as demand among the middle classes pushes the market forward. Interest has also grown in Islamic or sukuk bonds, which are now being used to fund both state infra- structure projects as well as private company investment. However, sharia banking regulations are still relatively complex, making transactions awkward and time-consuming, something that will need to be addressed if the market is to achieve its full potential.
Though considered small for a country of its size, the Indonesian Stock Exchange (IDX) is being considered an increasingly attractive new destination by investors looking to move funds to more buoyant pastures and away from the uncertainties found in their traditional markets. This, along with a growing domestic appetite for shares, has bolstered the Jakarta Composite Index (JCI), helping it to become the best performing market in the Asia- Pacific region, and one that despite its previous reputation for volatility, has remained remarkably tranquil, even during the height of the recent Euro debt crisis. With that said, Indonesia’s capital markets remain relatively thin, with only a limited number of rather non-representative companies listed on the exchange. So while finance, commodities and consumer goods dominate the listings, they actually make up less than one third of GDP. Mindful of the situation, the IDX is looking to reinvent itself, turning to the Asian Development Bank to help it reform and boost capacity. However, along with a lack of corporate variety, there is also one other thing missing from the IDX and that is any real activity from institutional investors. Though Indonesia does, of course, have pension funds, asset managers and insurance companies, these are less energetic in the market than they are in other parts of the world, focused as they are more on capital preservation than capital gain. This means that once they have bought into large blocks of stock, typically blue-chip companies, they prefer to hold on to them, trading infrequently. The positive impact of this is that they create a ‘sheet anchor’ that stabilises the market, but the flipside is that it leaves capital illiquid, and trapped rather than flowing to where it is needed. The Asian financial crisis did have a significant impact on Indonesia’s capital markets, though this has been largely shaken off as Indonesia’s financial sector has developed further. Now banks are moving from their previous status as primarily small rural lenders and turning instead into national and international players with an active role in developing a real credit and capital structure for the country.
For the financial services sector, Indonesia is an increasingly open market, with huge potential for growth in both conventional and Islamic banking. And with the establishment of a new financial service regulator (OJK), there is growing confidence that Indone- sia’s markets are growing in stature and maturity. A strong sector will be essential as the middle class grows in numbers, and more and more Indonesians look to build ongoing relationships with fi- nancial providers. Inevitably, this growth will generate greater com- petition between banks, with the financial services market becom- ing ever more innovative as investment in new IT and systems leads to improved services and differentiated banking products. Similarly, the capital markets are responding, again demonstrating that they have the capacity to grow, and to resist the economic waves coming from elsewhere.
With Indonesia’s growth rate standing at 6.5% in 2012, and forecasts suggesting similar figures for 2013 and beyond, the country is once again presenting to the world an appealing eco- nomic landscape, something that has not gone unnoticed. This has seen the country’s credit rating lift to investment grade, helping ensure Indonesia will become an increasingly attractive proposi- tion for outside funds and all at cheaper rates. What’s more, as planned infrastructure building moves forward apace, this will stimulate further economic activity, with consequent beneficial ripples for the banking sector as more investors are attracted to the country, all helping position Indonesia as the largest and most important developing economy in South-East Asia.