Inflation extends credit worries for banking industry

Teguh Hartanto , Consultant | Wed, 07/09/2008 10:48 AM | Business

Cheap loans are becoming a thing of the past. Since the beginning of the year, the Bank Indonesia (BI) rate has increased 75 basis points to its current level of 8.75 percent, and it is likely to rise further as the government looks to curb inflation.

In line with inflationary pressure, we are seeing a contraction of economic growth squeezing consumer purchasing power.

Having said that, the pick up in interest rates has made consumers and corporations nervous about their ability to secure cheap credit facilities. Judging from past experience, lenders may be inclined to tighten their credit control to prevent ballooning non-performing loans.

Still, we do not foresee a credit crisis in the making, as we expect BI to be able to lower inflation to single digits and push up economic growth above 6 percent next year.

In general, these rising purchase price multiples and the falling ratio of cash that consumers and companies have on hand to cover expenses will make it harder for them to repay their loans and put pressure on default rates in the wake of this credit crisis.

However, we believe the magnitude will not be as immense as that in the United States, where billions of dollars were lost through bad loans and blundered investments.

During the "mini crisis" in 2005, non-performing loans in the domestic banking sector touched 8.5 percent before declining consistently.

It is worth noting, however, that the high non-performing loans were mostly in the form of inherited corporate loans triggered by state-owned banks (i.e. Bank Mandiri and Bank Negara Indonesia). That said, focus on loan quality has nowadays discouraged banks from aggressively channeling their excess funds.

Moreover, lower public purchasing power should pave the way for slower loan consumption, while over the past few years wages have not kept pace with inflation.

Indonesian banks will therefore focus their credit expansion on certain promising market segments, i.e. resources, agribusiness and infrastructure related industries.

The fear that banks will be not be able to generate future earnings growth nor curb the potential ballooning of non-performing loans has led to the recent more-than 20-percent plunge in share prices of many domestically-listed finance-related companies.

While these rather steep corrections in share prices might arguably give an exaggerated account of the situation given that Indonesian banks are not exposed to the sub-prime woes as the U.S. banks are, a global de-rating in the valuations of financial stocks in general has dragged down the overall sentiment of their Indonesian counterparts in our view.

And until the fear of global financial risks subsides, we can probably expect the impact on the American market to continue to spread to Indonesian banks.

Concerns linger as investors continue to weigh the possibility of a potential increase in the SBI rate to 9.50 percent by the end of 2008.

Most banks have upwardly adjusted their teaser rate as many predict inflation pressure could prompt the central bank to further raise its benchmark rate later in the year.

An interview with some prominent banks showed that they felt a 200 to 300 basis points increase in interest rates would not stretch their comfort zone in channeling loans.

At this stage, we do not expect significant increases in non-performing loans because the sector can draw from the lessons learned during the Asian financial crisis of 1998.

Although the outlook for the banking sector is currently far from rosy, we believe the steep alterations in the prices of bank shares have already largely taken into account the concerns on the current high inflation environment.

Depending on oil price movement, the predicted low inflation rate and strong economic growth next year should abate pessimism within the sector.

The best way to safeguard against uncertainty is to expect the unexpected and plan for the worst, while still hoping for the best.

Comments (0) | Post comment

A | A | A |