Indonesian banks outlook stable, says Moody's

The Jakarta Post, Jakarta

The outlook for the debt and deposit ratings of Indonesian banks is stable at an average B2 and B3, respectively, international rating agency Moody's Investors Service said in its annual report.

The average bank financial strength rating remains at E+, reflecting the system's still weak financial fundamentals.

"Consolidation and divestment have significantly altered the Indonesian banking landscape," says Beatrice Woo, a Moody's vice president/senior analyst and the report's author.

"The number of players has been pared down by a third, but excess capacity remains," she adds.

As the top four banks control 55% of system assets, the other 134 are unlikely to achieve economies of scale, the report says.

Moody's expects tightening regulatory requirements - which will remove weak or marginal players - to drive the next round of consolidation.

In the divestment process, an increasing proportion of system assets have ended up with strategic foreign investors, the report says, adding that Moody's anticipates bank managements will introduce global best practices and operate on a more commercial basis, prompting other domestic banks to follow.

Nonetheless, the government remains the largest shareholder in the banking industry, controlling more than half of system assets, the study says.

On balance, however, from a credit perspective, structural developments have been positive, as Moody's expects the eventual restoration of pricing discipline and market stability.

As with other regional banking systems, Indonesian banks have reformed and restructured their operations, particularly in risk management, corporate governance and transparency -- seen as key reasons for crisis-related troubles.

However, Woo notes that "rapid progress has been impeded by the magnitude of the crisis, as well as the difficult and volatile nature of the operating environment, a condition which persists, although improvements are apparent. "

As evidenced by several cases of substantial fraud in the past year, the implementation of controls is proving elusive, given the nature of Indonesia's high operating risk culture. Hence, Indonesian banks continue to lag their regional peers in terms of sophistication and standards, but Moody's expects greater foreign participation to accelerate reform.

Financially, balance sheets have been largely repaired although the true situation is less robust than the figures suggest, the report says, adding that the impressive high capital levels are mainly a function of the high proportion of zero risk- weighted government recapitalization bonds.

"We think this situation overstates the economic capital positions of the banks, particularly those with large balances of restructured loans and those forecasting strong loans growth. While these government securities provide a stable and passive source of earnings, they could expose the banks to a greater level of interest rate risk due to the relatively high proportion of fixed-rate instruments," Woo says.

The report adds that problem assets have been cleared through substantial transfers to the Indonesian Bank Restructuring Agency, but those restructured loans which stay on bank books will be vulnerable to any economic downturn.

Finally, the report says Indonesian banks should sustain their near-term profitability, in the absence of sizable loan loss provisions. The degree or portion of earnings generated from core operating performances is likely to vary among banks.