Structural Attraction Remains Despite Moderating Loan Growth


BMI View: On the back of a slowing economy and a likely increase in borrowing costs, we expect to see the pace of credit expansion in Indonesia's banking sector start to slow in the quarters ahead. While this will certainly weigh on banking profitability in the near term, we see few risks to banks' solvency as they remain well capitalised and have thus far been adhering to a safer funding mix, compared to during the Asian Financial Crisis in 1997. Over the longer term, we believe that the banking sector has considerable potential for growth as the country is still in the early stages of a long-term credit up-cycle and the mortgage market has largely been untapped.

With economic growth in Indonesia set to slow in the coming year, we likewise envisage a concomitant cooling in the rapid expansion of the country's banking sector. Bank Indonesia (BI) introduced 175 basis points (BI) worth of interest rate hikes in H213, and enacted further macroprudential measures in order to temper loan growth and cool the overheating economy. The tightening measures appear to finally be feeding into the Indonesian economy. Loan growth, which has hovered around the plus-20% level over the past few years and admittedly remains fairly elevated, appears to be showing incipient signs of waning. To be sure, commercial lending posted growth of 20.9% year-on-year (y-o-y) in January, down from 21.4% in December 2013 and a recent peak of 26.1% in May 2012.

Loan Growth En Route To Moderation

Aside from its forecast for real GDP growth to slow this year, BI is also forecasting that commercial lending growth will recede through 2014. The central bank is targeting for lending growth to hover between 15-17% this year, down substantially from an average of 22.2% in 2013. In order to do so, BI tightened mortgage lending for the second time since 2012 in September 2013, lowering loan-to-value ratios to curb the demand for housing. As the accompany chart shows, these measures appear to be exhibiting some measure of efficacy, as property-related lending has been trending lower since then. While structural factors, such as a young, growing population and increasing urbanisation will undoubtedly fuel growth of Indonesia's property market over the longer term, we believe that BI's resolve to tightening lending conditions will weigh on credit expansion in the year ahead.

Mortgage Lending On The Retreat
Indonesia - Property-Related Lending To Household, % chg y-o-y

It is also instructive to note that while BI may have raised the benchmark interest rate, this has not been translated into higher borrowing costs for consumers and businesses as banks have been willing to sacrifice interest margins in return for a continued expansion in loan growth. On the contrary, Indonesian banks have, for some time, been engaging in an interest rate war as they seek to garner a greater share of the nation's deposits. As banks progressively start to pass on the higher cost of funds, loan growth will surely be hit. From a sectoral perspective, on top of mortgage lending, mining, construction and the infrastructure sectors are likely to bear the brunt of the slowdown in lending while domestic-demand focused sectors, such as retail, food and drink, and to an extent vehicles, are likely to see loan growth outperform.

BI Exhibits Pragmatism In Balancing Need For Slower Lending And Macroeconomic Stability

The rapid credit expansion over the past few years has also seen lending growth outpace that of deposits, resulting in a marked rise in the sector's loan-to-deposits ratio (LDR), from 79% in 2012 to 88% in 2013, prompting the central bank to lower the LDR to 92% (from 100%) in August 2013. The higher a bank's LDR, the higher the possibility liquidity problems may arise. That being said, a senior BI official said in late-February that the central bank was considering broadening the definition of what it classed as a 'deposit'. Currently, only plain vanilla demand, time deposits and current accounts are classified as 'deposits' but the monetary authorities are looking to throw in other items such as certificates of deposits into the mix. Widening the deposit base serves two purposes. Firstly, it will ensure that there is sufficient liquidity within the system, enough to allow banks to continue lending. Secondly, it will help to reduce the disparity between loan and deposit growth, which will in turn place less downward pressure on banking profitability. This consequently suggests to us that BI is making an effort to strike a balance between trying slowing loan growth and maintaining macroeconomic stability.

Long Term Supportive Factors Remain In Place

Banking fundamentals sound: Credit demand set to cool but banking sector remains well-equipped to ride out much of economic volatility in the year ahead. An impact on profitability does not equate to risks towards solvency. Indonesian banks remain well capitalised and are likely to be able to weather the rise in non-performing loans (which stand at a comfortable 2% presently). Furthermore, banks have been adhering to a safer funding mix, relying more on domestic deposits as opposed to offshore wholesale funding that subjected banks to substantial vulnerability during the Asian Financial Crisis in 1997. Additionally, upside risk also stems from election spending that is we are likely to see as we inch towards the legislative and presidential elections in April and July, respectively.

Property Set To Take A Bigger Slice Of The Pie
Indonesia - Sectoral Breakdown Of Bank Lending

Housing market carries considerable potential: Over the long-term, Indonesia is still in the early stages of a long-term credit up-cycle. The country's credit-to-GDP ratio stands at a still-low 33% of GDP and looks to have plenty of room to grow over the long-run. Also, the country's mortgage market is largely untapped (mortgage lending accounts for less than 10% of total lending) and a young, burgeoning middle class provides the necessary ingredients for a strong revival in property-related lending once the short-termed macroeconomic uncertainties have been ironed out.

This article is tagged to:
Sector: Country Risk
Geography: Indonesia