Cyrus Daruwala, Singapore
Indonesia's banking sector is set to create a remarkable growth story in 2007. Credit growth is expected to increase by about 18 percent this year, supported by more vibrant economic activity. Banks, which have traditionally kept low loan-to-deposit ratios, have gained a greater willingness to lend, particularly to retail customers and to the SME sector.
Regulation is also expected to play a significant role in the growth of lending, especially as changes are made to the rules and benchmark rates tied to the Bank of Indonesia Certificates (SBI). These changes will reduce the long-held reliance of banks on interest income from government bonds and certificates.
Prospects for mergers and acquisitions have also been heightened by the roll-out of specifics related to the Indonesia Banking Architecture, the master plan to encourage consolidation in the country's banking industry. Banks are mandated to meet the minimum required capital of Rp 80 billion in 2008 and Rp 100 billion in 2010.
Several small and medium banks are yet to articulate their plans to meet the 2008 requirements, but many institutions are intently looking at mergers or acquisitions in the months ahead. Furthermore, the country's largest banks have indicated their intention to acquire other banks, with Bank Mandiri explicitly admitting to looking at an acquisition in the near-term.
Competition for customers will intensify as foreign players roll out more aggressive market share-taking tactics. The fight for customer deposits will be especially frenzied. As the ceiling for deposit insurance was lowered beginning last week, dominant players will strengthen their current advantage, and other players will have to compete on price, efficient distribution and customer service.
As expected in a period of high growth, questions continue to be raised regarding how risk management systems are followed, and aboveboard lending practices are maintained. The need for effective risk management systems is reflected in Indonesian banks' IT budgets in the medium term. We expect risk management-related spending to show the highest growth among all spending areas, growing to take the third largest share in banks' IT budgets.
Following the success of Bank Rakyat Indonesia (BRI) in the microlending space, banks such as Danamon and Mandiri will strengthen their propositions in microlending. Other banks will choose to yield to microlending leaders if they fail to build sufficient capabilities in microlending by 2008.
Still, the promise of the microlending segment is compelling -- 50 percent of the country's income is estimated to come from the SME sector, most of them microenterprises. It is also reported that there are more than 550,000 informal microlending firms in the country, most of them informal and unregulated.
Crucial for banks intending to tackle this space is a cost-effective distribution strategy and a specialized risk management system -- and the speed in which these supporting infrastructure is built.
Profitability levels will be maintained, and will positively impact technology spending. The year 2006 was a profitable year for Indonesia's banks with the country's 130 banks reporting profit growth of about 14 percent. We expect similar growth in 2007, in light of strong credit growth although changes to SBI rules and rates will impact interest income. We believe better profitability will make banks more confident in investing in technology.
We expect the Indonesian Banking Technology Architecture (ATPI) initiative to gain pace by this year. The ATPI aims to create a shared services entity for the country's banks.
Within the ATPI, individual service bureaus will be developed and implemented under the ownership of network and service providers. We expect the ATPI to be rolled out within the next two years, with a few service sets available in the beginning. As the ATPI gains more experience and members, service offerings will increase and broaden to include various front-end to back-end services, including general IT infrastructure management, business processes, and financial advisory services.
The Bank Indonesia governor recently remarked that only four banks have ""very good"" risk management systems, indicating the need for banks to meet prudential lending standards, and Basel II requirements for credit and operational risk. This need is reflected in Indonesian banks' IT budgets in the medium term.
We expect risk management-related spending to show the highest growth among all spending areas, growing to take the third largest share in banks' IT budgets. We also expect debt restructuring to proceed in some banks, masking to some extent real delinquency problems in some sectors.
The writer is Managing Director of Financial Insights, a research and advisory company.
