* Bank lending growth of 25% a year may be too fast
* Strong capital ratios mask growing dangers
* Regulator requires high loan-to-deposit ratio
By Nachum Kaplan
April 2 (IFR) - Are Indonesia's banks really as safe as they
look? Perhaps a better question would be to ask whether the
Indonesian banking system is as robust as it seems. While there
are many individual success stories, there is more risk in the
system than at first appears to be the case - and those risks
Indonesia recapitalised its banking sector after the Asian
financial crisis 15 years ago, and the headline numbers
regarding the banking system's health are overwhelmingly
The country's banks are well capitalised, with capital
adequacy ratios generally far above the 8% minimum with new
regulations requiring a level of up to 14% about to take effect.
Non-performing loans stand at a modest 2%.
Additionally, the banks enjoy strong and growing deposits
with almost 80% of funding coming from their deposit bases,
meaning they are well protected from the vagaries of wholesale
The threat to this positive story lies in the fact that over
the past three years Indonesian banks have been lending more -
much more - often at the expense of credit quality. The
loan-to-deposit ratio for the Indonesian banking system now
stands at 84%, up from 66% in 2007, according to data from Bank
This trend has accelerated over the past two years, with
annual loan growth now running at almost 25%.
It is tempting to view this as a product of the country's
impressive economic growth, but that is only part of the story.
What is driving much of it is a central bank regulation that
requires banks to maintain a loan-to-deposit ratio of at least
78% from March 2011.
That unusual measure was aimed at increasing lending and
spurring economic growth, and banks that fail to meet this
target are liable for penalties in the form of additional
Boosting that ratio requires a bank to either increase
lending or scale back deposits. Indonesian banks have clearly
chosen to do the former: scaling back deposits is not something
that comes naturally to any bank, and certainly not in an
economy that is expanding at more than 6% a year.
In fact, the Indonesian economy's rapid growth is
exacerbating the problem. Wealth is being created quickly, and
the resulting deposit growth is increasing the pressure on banks
Increasing lending to meet a central bank requirement rather
than because it makes commercial sense to do so is hardly a
sound strategy. It virtually forces banks to lower their credit
standards which, axiomatically, must produce a corresponding
rise in non-performing loans when things go wrong.
Analysts often overlook this threat to the system because
they confuse the strength of individual banks with that of the
banking system. Indonesia has some strong banks, to be sure, and
the biggest institutions play a big role in shaping perceptions
of the sector.
That is fair enough given that the country's top five banks
account for half the market.
However, there are still way too many others. Despite
consolidation in the banking sector in recent years, including
some foreign acquisitions (notably by Malaysian institutions),
the country still has 120 commercial banks. That is too many and
explains why systemic threats can remain despite Indonesia
boasting some very strong banks.
History shows us that Indonesia's smaller banks do not fare
well when credit cycles turn sour. Ironically, increasing
lending to meet a mandatory 78% loan-to-deposit ratio is just
the kind of thing that could make them even more vulnerable.
Indonesia has some of Asia's strongest banks, but it does
not follow that it has one of the strongest banking systems.
Lenders and investors would be well-advised to draw that
distinction because, while the outlook for the banking sector
looks rosy right now, the risks are building within the system.