Indonesia working towards inclusive and efficient financial services

The Indonesian banking sector continues to strengthen after a lengthy period of expansion. Business remains sound with sufficient capital to support credit growth, while the regulatory environment is benign and supportive, poising the industry for further expansion.

Indonesia is the most populous nation in the ASEAN bloc, and has a great number of people without bank accounts as well as a fast-emerging middle class. Banks are set to grow as inclusivity improves and increasingly wealthy and sophisticated customers demand more complex and varied products. Questions about consolidation and foreign participation remain, and the structure of the sector going forward is a matter of debate (see analysis). Economic concerns also hang over the banks, but participants are confident the institutions themselves are sound. “We are still a bit cautious; we have to be realistic,” Ninis Adriani, vice-president and head of investor relations at Bank Rakyat Indonesia (BRI), told OBG. “But the potential for Indonesia is huge.”

From the Ashes

The Indonesian banking sector has been improving for more than a decade. After the outright failures, wholesale bailouts and bank runs of the late 1990s, the industry went through a period of reform and consolidation. The central bank, Bank Indonesia (BI), was made independent, capital increases were mandated, corporate governance was improved, regulations were put into place to introduce international best practices and the total number of institutions was decreased from more than 236 to about 120.

The sector has become progressively stronger and better able to withstand shocks, and by the time the 2008 global financial crisis hit the banks were in good enough shape to sail through without a bailout. Indeed, due to the resilience of the local economy and the soundness of the institutions, the sector actually kept growing and becoming more profitable through the period of insecurity. The turnaround has been remarkable. The sector went from experiencing a near collapse to becoming a global leader, and by 2013 Indonesian banks were by some measures the most profitable in Asia. The banks’ balance sheets have gone from distressed to very sound, with non-performing loans (NPLs) dropping from 49% in 1998 to an all-time low of 1.68% in 2013, according to World Bank data. In part this was a function of strong economic growth, wide spreads between deposit and lending rates, and growth into under-served areas where competition is low. But it was also the result, according to analysts, of good regulation, and sensible and successful business strategies.

Highly Rated

Indonesian banks are especially well capitalised. At the end of September 2014 BI put the sector’s core capital ratio at 17.9%. According to Morgan Stanley research published in early 2015, Indonesian banks had the strongest balance sheets in the ASEAN region. On a scale of one to five (five being the lowest), the investment bank gave Indonesia a rating of one for capital. No other country in the region was so highly rated in that category. Singapore and Malaysia came in with a four, while The Philippines scored a three. Regulations on capital have become stricter and more substantial over time, with new rules being issued by BI in 2012. The guidelines – the Regulation on Banks’ Business Activities and Core Capital-Based Office Networks, and the Regulation on the Minimum Capital Adequacy Requirement for Commercial Banks – call for banks to run businesses in line with supporting capital, to meet international capital requirements and to have sufficient capital to sustain them in the face of severe exogenous shocks. The actual minimum capital levels are set at 8-14%, depending on the risks of the business. Capital levels also depend on the location of a bank’s headquarters and its status within Indonesia.

Potential Too

In addition to being solid, the sector continues to offer visible expansion potential. Penetration is low and considerable opportunity exists to serve the unbanked and under-banked. Domestic credit to the private sector as a percentage of GDP was 37.9% in 2013, according to World Bank statistics. That is lower than all other major economies in the region. Singapore’s ratio was 128.9%, Thailand’s 154.4% and Malaysia’s 124%. World Bank inclusion data from 2014 put the percentage of people above 15 years of age with a financial account at 36% and the percentage with a loan from a financial institution at 13%. According to the study, 27% of Indonesians have saved money in an account within the past year. This compares poorly with some regional peers. The percentage of people over 15 years of age with a financial account was estimated by the World Bank to be 81% in Malaysia and 78% in Thailand, though just 31% in The Philippines.

In part, the lack of inclusion is a consequence of geography. Indonesia is a country of 17,500 islands, with an estimated 6000 of them inhabited. Some of the more remote parts of the archipelago have no banking presence whatsoever; others have a single ATM that runs out of cash quickly because it is so difficult for the banks to reach the site, according to the Consultative Group to Assist the Poor, a global partnership of 34 organisations working to advance financial inclusion. To an extent, the lack of inclusion is the result of the lack of a commercial case for the institutions themselves. Branches and ATMs in remote locations may not be profitable, especially when the people there have little savings, and credit analysis is difficult to do on relatively poor individuals and small businesses. Furthermore, the rural account holders that most interest banks and make the most sense to pursue – wealthy merchants, miners and agriculture industrialists – tend to keep their money in the city centres. There is no reason to set up a small branch to pursue their business.

Some observers also blame policy. After the financial crisis in the late 1990s, the government focused on making the sector sound and it froze development to avoid risk, according to academics Jay Rosengard of the Harvard Kennedy School and A Prasetyantoko of Atma Jaya Catholic University of Indonesia. These policies have created a “non-inclusive banking oligopoly that discourages innovation and concentrates credit risk,” the authors argue in a report published by Forum Quarterly. Official efforts to reach smaller companies have tended to be top-down and not organic, resulting in less than optimal outcomes, they assert.

Antonius CS Napitupulu, president director of Askrindo, told OBG, “A community-based approach to lending and financial services is essential for banks and insurance firms if they are to expand into rural areas. Financial institutions need to consider local cultures and traditions when doing business in these places.”

Leading the Way

One bank that has continued to expand is BRI, which has been around since 1895 and was founded as an institution designed to lend to communities and to the poor. Despite having changed names many times – for a time becoming part of BI and at one point being used as a policy bank by the government – BRI has maintained its focus on financial inclusion. As of the end of 2014 the bank had 10,000 outlets throughout the country, including 461 branches, 584 sub-branches and 5293 micro-outlets. Almost 48% of its non-restructured rupiah loans were to micro, small and medium enterprises.

Beyond simply history and tradition, BRI has found serving poorer individuals and small and medium-sized enterprises (SMEs) to be a good use of resources. NPLs at the bank have historically been lower for loans made to small borrowers than those made to other commercial customers. BRI has consistently beaten its competitors in terms of net interest margin (NIM) and remains the most profitable bank in Indonesia. In 2014 it had an estimated NIM of 8.1%, according to Bank Mandiri research. That compared with Bank Mandiri’s 5.6%, Bank Central Asia’s 6.6%, Bank Negara Indonesia’s (BNI) 5.9% and Panin Bank’s 4.1%.

Another benefit of having such a broad, diverse and local customer base is stability. During the 1997-98 crisis, BRI did not face the troubles common to its competitors. Most of its loans were in rupiah, it had clients that were, for the most part, involved in local business and it had a committed following of depositors.

Financial inclusion is now changing from something reluctantly pursued by banks, more for corporate social responsibility than profit, to a business line increasingly embraced by institutions because it might provide fast growth and high margins. By moving into new areas, banks will be gaining new customers, and in under-served locations they will not face the level of competition found in the more developed, urban markets in the country. “The penetration is low,” said Tony Costa, president-director of Commonwealth Bank Indonesia. “That is where we see opportunity.”

Piling In

Bank Danamon was an early mover. It started its Danamon Simpan Pinjam micro-credit division in 2004. The institution now offers a wide range of products for small businesses. It will grant up to Rp50m ($4133) of credit on a secured basis in as few as two working days under its Dana Pinjaman 50 programme and up to Rp200m ($16,532) secured in as few as five working days under its Dana Pinjaman 200 programme. The bank will also make available some credit without collateral. At the end of 2013 the ratio of micro-loans to total loans outstanding at Danamon was 13.5%.

Bank Tabungan Pensiunan Nasional (BTPN) is another player on the micro end of the spectrum. While its market share in the sub-sector is low – an estimated 10% – it has received significant funding in recent years. In August 2014 the International Finance Corporation (IFC) and Japan’s Sumitomo Mitsui Banking Corporation (SMBC) provided a $50m rupiah-denominated loan to the bank and $150m in additional rupiah financing for the funding of micro-enterprises and SMEs. In March 2015 the two financial institutions provided BTPN with an additional $300m for smaller companies. SMBC owns 40% of the Indonesian institution.

Commonwealth Bank Indonesia’s strategy, both locally and internationally, is to build its SME strategy through the use of technology. The Australian bank has been in Indonesia since 1990. It formed a joint venture in 1997, with PT Bank International Indonesia, which it took control of in 2000. In 2007 it purchased Bank Artha Niaga Kencana, a Surabaya-based institution that expanded the company’s reach in the SME sector. The bank is now rolling out products globally that allow small firms to conduct analytics that would normally not be possible without a significant investment.

Policy Initiatives

Government policy is helping to promote inclusion. BI is requiring banks to make 20% of their loans to SMEs by 2018. The central bank classifies SMEs as companies with annual turnover of less than Rp50bn ($4.1m). In addition, the Financial Services Authority (OJK) is promoting inclusion through a financial literacy campaign. In early 2015 the OJK held a People’s Financial Market in Solo to introduce attendees to the risks and opportunities of banking and investment. Late in 2014 the authority said it was working on regulations to cap the interest rate on micro-loans. Indonesia has received significant international support for financial inclusion. In addition to the IFC loans to BTPN, in July 2014 the World Bank loaned the government of Indonesia $500m to make the banking sector more stable, and the package called for support for financial inclusion. With access and distribution being a major concern in Indonesia, the authorities are working on allowing for innovations that will help people connect to their financial institutions.

One particular reform under discussion and set to be implemented under the new administration is branchless banking. The idea is to allow third-party, non-bank agents, such as shops, to provide basic banking services on behalf of existing licensed institutions. Technology is also seen as a potential way to get banking to the people, and regulations have been evolving to allow for the necessary services to develop. In 2012 the Regulation on Funds Transfer was issued with a provision that creates a framework for mobile money. The major mobile operators already offer their own form of e-money. Telkomsel has had T-Cash since 2007, Indosat has had Dompektu since 2008, and XL Axiata has had XL Tunai since 2012. While Indonesia is nowhere near Kenya in terms of utilising phones for financial inclusion, the country is beginning to see the potential.

Overhanging Issues

Despite the sector’s strengths and prospects, some concerns remain. Economic weakness could create problems for the banks, and some structural issues have gone unaddressed. To ensure growth continues and to make sure Indonesia does not face major financial bottlenecks in the future, certain reforms are needed, though these must be introduced with care so as not to erode confidence and materially lower international participation (see analysis).

Improved security could also boost confidence in banks and keep them open in challenging areas. Kobus Fourie, president-director at the security company G4S, told OBG, “There is a need to maintain professional security capabilities in Indonesia, primarily in the east of the country, and to improve the security performance of firms in diverse operating environments.”

Still, economic expansion is the main concern for banks. While Indonesia seems to have turned the corner – GDP growth will likely be higher in 2015 than in 2014 – confidence has not returned and businesses are hesitant to borrow. Loan growth at the end of 2014 was about 12%, or 10 percentage points lower than in 2013 – the slowest rate since 2010. Higher benchmark interest rates and the fear of high rates in the US have dampened enthusiasm for investment. However, this reduced enthusiasm overlooks the economy’s foundations. Armand Arief, president director of UOB Bank Indonesia, told OBG, “Any changes in interest rates from the US Federal Reserve may affect our local economy, but these effects would be limited due to our banking sector's strong fundamentals.”

Key oversight

Central bank policy is also relevant. In 2013 BI issued loan-to-value regulations for home mortgages. The ratio was set at 60%, meaning buyers would have to come up with 40% down payments. That came after the central bank established similar limits in 2012: 30% down for mortgages and car loans, and 25% down for motorcycle loans. While the programmes have succeeded in keeping consumer loans from growing too fast and have left Indonesians as some of the least leveraged people in the region, it has limited the expansion of bank balance sheets.

In October 2014 BI said it was hoping for a return to 15-17% loan growth in 2015, but analysts say they are seeing few signs of strong demand from borrowers. In early 2015 the benchmark interest rate was cut from 7.75% to 7.5%; however, its net impact is not clear. While the cut may stimulate demand, it threatens to increase the current account deficit, which is perilously close to the 3% limit. It could also further weaken the rupiah, which fell to Rp13,218 to the dollar in March 2015 in the wake of the rate cut, its lowest level since 1998. Inflation has been relatively tame, which suggests that borrowing costs could continue to drop. But twice in recent years Indonesia has experienced month-tomonth deflation – April 2014 and January 2015. Should prices begin to fall more steadily, demand for credit could decrease substantially in anticipation of price declines.

Balance Sheet Queries

The balance sheets of the banks are solid and the banks themselves are certainly well capitalised, but some pressure has been observed. In late 2014 BI said it saw full-year NPLs rising to an estimated 2.4%, up from 1.8% in 2013. The World Bank put NPLs at 2.09% for 2014. Some specific sectors, however, have shown worryingly high ratios of NPLs.

In July 2014 the NPL ratio for the mining sector was 4.43%, in construction it was 3.09% and in trading it reached 3.06%. While the absolute values are still within acceptable limits – with the OJK and BI setting a cap at 5% – the trend toward higher ratios is worrying for some. Critics have expressed more general concerns about the sector. They argue that the banks, while profitable, are also inefficient and that to a great extent their earnings are the result of systemic problems that need fixing, rather than signs of strength that should be admired. According to Anwar Nasution, professor of economics at Indonesia University, the high profitability of the sector is more a cause for concern than anything, a consequence of weak contractual rights, the lack of competition and the fact that the spreads between deposit rates and lending rates are some of the highest in the region. According to World Bank data, this gap was 5.4% in 2013 compared to 1.6% in Malaysia, and 4.1% in both Thailand and The Philippines.

In a Jakarta Post article entitled “Our banks: Grossly inefficient, yet highly profitable”, the newspaper noted that Indonesian banks’ cost-to-income ratios are far higher than the average in the region and that the sector is surprisingly anti-competitive. Despite the fact that the country has 120 institutions, the paper notes that serious concentrations exist. The top 10 banks control 80% of the business, while the top five banks control 60%. The Business Competition Supervisory Commission, Indonesia’s anti-monopoly body, has said the economics in the sector are potentially oligopolistic due to their concentration. Nasution is concerned about banks’ balance sheets as well. Much of the top-tier capital in the system is in the form of government bonds. After the crisis of 1997-98, these securities were injected into institutions by the authorities. While this has resulted in a nominally high capital adequacy ratio, it exposes the banks to the price of bonds and makes them vulnerable to a bond crash, which he points out has happened a number of times in recent years. On paper, the banks have a nice cushion, but under the wrong conditions that buffer could diminish quickly.

Not so Consolidated

While the Indonesian banking sector underwent rapid consolidation after the 1997-98 crisis, little in the way of mergers and acquisitions has happened since then. The number of commercial banks in the country fell from 124 in 2008 to 119 as of September 2014. While the number of rural banks dropped from 1772 to 1634 in that time, according to the Asian Development Bank Institute. Efforts have been made for a number of years to speed up consolidation, the most recent being a single-presence policy enacted in 2012 limiting a party to a 25% or more shareholding in only one institution. The policy included provisions designed to encourage combinations. Merging institutions could benefit from a temporary exemption from statutory reserve requirements, a temporary waiver from corporate governance provisions and an extension of time to meet lending limits.

The OJK has set consolidation as a priority and has encouraged mergers among the top state banks. It also recently started pushing for the merger of a number of smaller institutions, according to a 2014 Bloomberg report. The new administration is also focused on consolidation, according to local press reports; advisers to President Jokowi have put the ideal number at 80 commercial banks. “Compared to other countries in the region, the number of banks in Indonesia is much larger than needed,” Hartono Jap, president director of Intan Baruprana Finance, told OBG. “Many are fragile, with no strong capital base. Also, bank productivity should increase, as current cost of revenue remains high.”

Progress toward consolidation has so far been slow and it is not clear whether a major merger is likely to take place in the near future. Activity has remained at the margins and the key transactions have proved elusive. For example, a planned merger between Bank Mandiri and Bank Tabungan Negara collapsed in early 2014. While considerable synergy was seen between the two banks, according to the local press, the deal was actively resisted by politicians and employees.

BNI said in early 2015 that banks in Indonesia are strong enough as they are and do not need to combine in order to meet competition from outside. One of the rationales for consolidation is that Indonesian institutions have to face larger rivals once the ASEAN banking market is opened in 2020. But the bank said in comments published by Bloomberg that the four large state-owned lenders were in good shape and ready for the single market.

Others in the sector agree. “Local banks are prepared for the ASEAN Economic Community,” Herianto Pribadi, president-director of SKHA Consulting, told OBG. “They have the delivery, the technology and the products. The main issue, however, is the availability and access to funds, which may cause problems for local banks in the future.” Indeed,the commercial case for consolidation may be weak, as there is generally an overlap in business lines. While many Indonesians would like a massive national bank for matters of credibility and pride, the numbers do not, at this point, compel a combination. To some extent, the biggest push for an Indonesian banking giant is from the government. “Some political people think Indonesia should have a mega-bank,” Bob Ananta, vice-president of BNI, told OBG.

Islamic Banking

Where activity is likely to happen soon, and on many fronts, is in the sharia-compliant space. Since 2013 the creation of an Islamic mega-bank has been in discussion. The idea is to bring together the Islamic components of Bank Mandiri, BRI and BNI, according to OJK comments published in the local press. The combination would control about 40% of the country’s Islamic banking assets. Promotion of the sub-sector is the main reason for the proposed merger.

Indonesia has 11 sharia-compliant banking institutions, 23 Islamic business units and 163 Islamic rural banks, but only 4.9% of total banking assets are held by these institutions, compared with 20% in Malaysia. The OJK has a target of 15% by 2023, and a single institution would be better positioned to promote shariacompliant products. The other benefit would be the international reputation it could bring to the country’s Islamic finance segment. The country may not create a conventional giant to face competitors overseas, but it could take a leading role in Islamic banking globally.


The banking sector in Indonesia remains strong and well capitalised. Stability is forecast and growth is all but assured as the institutions begin to better cover under-served regions and businesses, and as the country’s middle class continues to become wealthier and more interested in relevant products. Sensible and proportional regulation is needed, alongside certain reforms. As long as Indonesia continues to refine its laws to encourage competition, the sector should remain on the course it has charted for a decade and reach new heights as it becomes more inclusive.

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The Report: Indonesia 2015

Banking chapter from The Report: Indonesia 2015