Consolidation leads banks to sound growth: Experts

JAKARTA (JP): Banks remain among the best reflectors of Indonesia's sustained and economic development, with gross domestic product (GDP) forecast to grow at over 7 percent a year in the medium term, securities analysts and bankers here say.

A lending cap of 18 percent is in place for 1997 and is expected to be rigorously applied.

The lending cap will ensure there is little pressure on lending rates to decline.

Meanwhile, ample liquidity in the system implies that, while they may not fall further, deposit rates are unlikely to rise, implying even wider margins, according to ING Barings securities company.

Bank Bira's vice president Parveen Gandhi said: "As inflation seems to be under control now, I expect a decline of at least 50 basis points in the bank's interest rate in the near future."

After several years of rapid banking sector expansion, Bank Indonesia (the central bank) introduced new regulations with a view to strengthening the industry and reining in the growth rate to more sustainable levels.

These measures cover areas including the issue of commercial papers, capital adequacy, minimum paid capital, minimum reserve requirements and legal lending limits to group companies.

The minimum capital adequacy ratio (CAR) is to be raised, from 8 percent currently to 12 percent by September 2001, to strengthen banks' capital bases.

Banks have to raise their CAR to 9 percent by September 1997. A minimum capital requirement of Rp 50 billion has also been introduced.

For banks that want to engage in foreign currency transactions, and all banks aspire to such status, this limit will be raised gradually to Rp 150 billion, although leniency will be granted to banks which enter into merger arrangements.

This move is clearly aimed at reducing the number of banks here.

After the sector was deregulated the number of banks rose to 240. It is now 237.

Investment bank Merrill Lynch said in its latest review of Indonesian banks: "We believe the higher CAR limits will accelerate the consolidation process of the banking industry."

The minimum reserve requirement was raised twice over the last year -- from 2 percent to 3 percent of third party deposits in February 1996 and to 5 percent in April 1997.

Further increases are likely, probably in early 1998, particularly if funds continue to flow into the banking system as depositors take advantage of the interest rate differential between Rupiah and dollar deposits.

Since loan growth rose 24.9 percent in 1996, in spite of the central bank's attempts at moral persuasion to moderate the pace, the central bank has taken a much tougher stance. The bank has examined the lending requirements of each bank and limited overall growth (again through moral persuasion) to 18 percent.

Larger banks (with assets of over Rp 5 trillion) are limited to a 15 percent increase (some have been given even tighter targets) while smaller banks have a more liberal 20 percent limit.

In an attempt to control offshore borrowing, banks are restricted to borrowing a maximum of 30 percent of their capital from overseas.

Eighty percent of the loan must be directed toward export- related industries.

In its latest banking review report ING Barings says that this is unlikely to have a significant impact on banks as the bulk of their foreign currency loans are financed through deposits.

To encourage lending to small enterprises, banks will be penalized if loans to such businesses do not meet the limits set by central bank.

Banks that fail to lend 20 percent of their total loans to small business as of March 1997 will be required to extend 25 percent new credit this year to small enterprises.

Banks that have met the target will be required to lend only 22.5 percent of their new loans to small business.

Banks will have to pay a 2 percent penalty on the shortfall and will receive an incentive of 0.5 percent to 1.5 percent if they exceed the limit.

As is the case elsewhere in the region, Indonesia's banks' performances are an excellent reflection of the underlying growth of the economy.

GDP is expected to expand over 7 percent annually in the medium term, a rate which should provide an excellent platform for future growth.

As central bank supervision has improved through the introduction of lending limits and tighter minimum capital and reserve requirements, so the quality of loans has improved.

Major private banks have taken advantage of the rapid growth over the last five years to strengthen their balance sheets by raising additional capital and increasing the level of loan provisions to 1.7 percent as at end-1996 from 0.5 percent in 1990.

Through increased automation and branch network expansion, major banks are seeking to tap the potentially huge retail market with its considerably lower cost deposit base (as opposed to the more expensive time deposits) which should lead to improvements in margins.

The operating environment for banks remains favorable. The curbs imposed by the central bank on loan growth will limit competition among banks for new loans, and thus reduce any pressure there might have been on lending rates.

Efforts to curb capital inflows will include further cuts in deposit rates. This will result in a further widening of margins.

In spite of solid growth prospects -- earnings per share is expected to expand an average 19.5 percent in 1997 and 19 percent in 1997 -- the sector is trading at an 18 percent discount to the market, according to ING Barings securities company here.

Lending by domestic banks to the property sector remains a concern. In spite of central bank disapproval, lending to the sector grew rapidly in 1996 -- by 36 percent -- well ahead of the industry average.

Although this is below the level experienced by some of Indonesia's neighbors, the fact that growth has been at these levels for some four years may impact negatively on loan quality.

But such loans represent just 20 percent of the total and, with the property sector showing no signs of recovery, is likely to decline in 1997.

After several years of near somnolence, there are signs that state-owned banks are becoming more active in the lending market.

Bank Negara Indonesia, after its initial public offering last year, entered the consumer lending market more aggressively.

But analysts remain unconvinced that most state-owned banks have the management expertise to make a major impact in the short term.

A more rigorous enforcement by Bank Indonesia of the minimum lending requirement to small enterprises may lead to a reduction in loan quality because such loans are generally perceived to be riskier than other forms of lending.

The banking sector is due open to foreign competition by 2003. It remains to be seen whether domestic banks will remain competitive in such an environment. At the very least, margins will come under further pressure at that time.