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Banking consolidation imperative for efficiency and to face ASEAN market

While banking consolidation is being demanded, there is a mounting call to build at least two Indonesian banks of international class in terms of capital, assets and governance to gear up for the ASEAN free financial market

Vincent Lingga (The Jakarta Post)
Mon, September 22, 2014

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Banking consolidation imperative for efficiency and to face ASEAN market

While banking consolidation is being demanded, there is a mounting call to build at least two Indonesian banks of international class in terms of capital, assets and governance to gear up for the ASEAN free financial market.

Bank Indonesia, the central bank, has been trying to accelerate the pace of banking consolidation since 2004 to build a sound, strong and efficient financial system able to compete within the ASEAN free financial service market, or banking integration, in 2020.

The central bank launched in January 2004 a banking architecture that imposed higher standards of capital and good corporate governance with the objective of creating a completely new banking landscape by 2014, featuring a leaner industry, much smaller in number than the 138 commercial banks operating at that time.

The then central bank governor Burhanuddin Abdullah projected that the national banking industry in 2014 resulting from the proposed architecture would feature two to three banks of international class with capital exceeding Rp 50 trillion (US$5.8 billion at the then prevailing rate) and three to five national anchor banks with Rp 10 to 50 trillion in capital. These banks would be supplemented by 30 to 50 smaller, specialized banks with capital ranging from Rp 100 billion to Rp 10 trillion, and thousands of rural or community banks with capital under Rp 100 billion.

But the banking architecture remained on the shelf even after the Financial Services Authority (OJK) took over from Bank Indonesia as the authority to regulate and supervise the whole financial service industry, including banks, early this year.

The number of commercial banks has decreased only to around 120 at present, even though banking penetration '€” people with access to banking services '€”is only about 50 percent of the country'€™s 250 million population because of the absence of banks in remote areas due to high costs and risk.

The anomaly, though, is that even though banks in Indonesia have been the most profitable in ASEAN, as they enjoy the highest net interest margin, they are unfortunately among the most inefficient measured by their cost-to-income ratio (Bopo). How come?

Oligolistic practices

Many analysts and the government anti-monopoly watchdog (KPPU) blame this anomaly on oligopoly. KPPU told a recent hearing with the House of Representatives it had found strong indications of oligopolistic practices in the banking industry, whereby the top ten largest banks controlled almost 80 percent of the market, leaving the other 110 banks scavenging for the remaining 20 percent.

Several analysts estimate that the five largest banks, of which four are state owned, control more than
50 percent of the banking market.

It was this oligopoly that seemed to have enabled the largest banks to control lending rates and maintain their net interest margin '€” the difference between the lending rates banks charge to borrowers and the interest they pay to depositors '€” at twice the region'€™s average.

The ten largest banks, as the market leaders, dominate the deposit market and set the trends in lending rates, but the other 110 banks, due to their negligible market share and their small deposit base, cannot do much to challenge the market leaders.

Leaders of the bank'€™s association (Perbanas) certainly denied the alleged oligopoly, instead blaming the high lending rates on high inflation (over 5 percent a year), the vast areas across the world'€™s largest archipelago that have to be served with branches or ATM networks, and high business risks.

Dissatisfied with the slow pace of banking consolidation, Bank Indonesia issued in 2012 a new package of rules that imposes a multiple-license system in the banking industry, which ties the expansion of foreign and national bank networks and services to capital and good governance standards.

Capital is indeed quite vital for the banking industry because the level or standard of core capital determines the capacity of a bank to absorb shock or risks. Under these new rules, banks will be allowed to compete nationwide only if they have core capital of between Rp 5 to Rp 30 trillion ($427 million-$2.56 billion at the current rate), while a bank can compete in both the regional and international markets if it has core capital in excess of Rp 30 trillion.

The package also includes regulations that limit single ownership of local banks at 40 percent for financial service companies, 30 percent for non-financial institutions and 20 percent for individual investors.

Slow progress


Existing banks will be allowed to keep their current ownership structures as long as they maintain high levels of corporate governance and financial health. However, these rules still fail to accelerate banking consolidation, especially after the imposition of the national bank ownership-cap on foreign investors to a maximum 40 percent.

Despite the slow progress, complacency seems to have seeped into the banking regulatory body as the industry seems sound and stable.

But it is still difficult to gauge the real strength of the industry as long as the government does not cut the maximum amount of deposits guaranteed by the Deposit Insurance Corporation (LPS) from the current Rp 2 billion back to the Rp 100 million that was effective before October 2008.

Banking consolidation could accelerate if LPS slashed the maximum deposit covered by its insurance scheme and imposed a risk-based premium, instead of a single, flat premium, on banks as it is now, as these measures would unleash much stronger market forces to screen banks.

Even though Indonesia is the largest economy in ASEAN, the country'€™s biggest bank, Bank Mandiri, ranks only eighth largest in the region in terms of assets. The seven largest banks in the region are dominated by Singaporean and Malaysian banks.

How will Indonesia be able to tap the new business opportunities, notably in trade financing, generated by the ASEAN economic community later in 2015 or early 2016, if none of the five largest banks in the country is able to achieve international standards in terms of assets, capital and governance?

Analysts and senior officials have again raised the urgent need to build at least two Indonesian banks of international-class in terms of capital, assets and governance to gear up for the ASEAN free financial market by consolidating the four state banks into two larger banks.

But ideas such as merging Bank Mandiri with Bank BNI (Indonesia'€™s third largest) or for Bank Mandiri to acquire state Bank BTN (a mortgage bank) have immediately encountered political noise and strong opposition from their employees.

Negotiations are still underway to finalize the principles and criteria for a Qualified ASEAN Bank (QAB) because under the ASEAN banking integration framework, a QAB operating within the ten member countries is treated as a local bank, not a foreign bank.

But for sure banking authorities in ASEAN will not apply the lowest common denominator for QAB as banks in the region would be unlikely to want to race to the bottom. This means Indonesian banks should further increase their capital and improve governance.
(Vincent Lingga)

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