Bank Loans: Performance in 2011 and Expectation for 2012 Contact:

Kreshna D Armand Manager - Analyst Financial Institution ICRA Indonesia assessed the performance of the Indonesian banking industry (see our research titled Bank Loans: Performance in 2010, Expectation for 2011, and Impact on Credit Quality of Banking Sector) in which we analysed the impact of loan-to-deposit ratio (LDR) and minimum reserve requirement (RR) policy on loan growth rate and credit quality. We predicted that the loan growth in FY2011 would be 23.5% and similar to the growth (of 22.8%) in FY2010. This was predicated on the argument that banks would not compromise credit quality for growth. However, total bank loans grew by 24.6% year-on-year (y-o-y), higher than our forecast. This was despite factors that might have constrained loan growth in FY2011 such as increase in RR ratio, unfavorable economic conditions following the financial crisis in US and Euro zone, the tsunami that hit Japan and geopolitical changes across the Middle East region. However, the Indonesian banking sector witnessed a high foreign currency (FC) loan growth in 2011 due to rise in commodity prices [especially of crude palm oil (CPO) and coal], which had a positive impact on export-oriented mining and plantation companies. The underlying hypothesis in our analysis was that banks having LDR outside of a certain range (see our research, Assessing the Impact of Bank Indonesias New Policy: Linking Reserve Requirement Ratio to Banks Loan to Deposit Ratio) would be required to hold more reserves. ICRA Indonesia estimated that additional reserves of approximately Rp 60tn would have to be maintained at the central bank, Bank Indonesia (BI), thereby limiting loan growth. We have used a similar framework to analyse the performance of the banking industry in 2011 and outline our expectations for 2012. Summary - Bank loans grew by 24.6% in FY2011 -- reaching Rp 2,200tn -- as against 22.8% in FY2010, which was above ICRA Indonesias estimate of 23.5%. The growth was, among others, supported by a significant increase in foreign currency (FC) loans. - The banks have responded positively to the new reserve requirement (RR) stipulated by the central bank, as evident in the increase in the loan-todeposit ratio (LDR) to 79.0% in FY2011 from 75.5% in FY2010. - The overall credit quality of the banks was strong in FY2011 and ICRA Indonesia expects it to remain intact in FY2012. We expect the potential impact of unfavorable macroeconomic conditions to be managed by a more conservative approach to lending. - FY2012 seems to be a challenging year for banks due to the unfavorable global economic scenario. In Indonesia, we expect the plan to increase fuel prices in 2Q2012 and electricity tariff in the near future to result in higher inflation. The central bank has also imposed the regulation on the loan to value (LTV) ratio which could restrict vehicle and housing loans. - ICRA Indonesia thus expects total bank loans to grow by 20%-23% in FY2012 due to less favorable macroeconomic conditions and a relatively higher LDR than in FY2011, especially with regard to FC loans. (Icra Indonesia).

Loan Growth (2011 vs. 2010)

Total bank loans grew by 24.6% y-o-y to Rp 2,200tn as against 22.8% in FY2010 and 10% in FY2009. The growth was higher than our forecast of 23.5% (see our research, Bank Loans: Performance in 2011, Expectation for 2011, and Impact on Credit Quality of Banking Sector). A further breakdown by type of currency indicates that foreign currency (FC) loans grew by 32.0% in Rupiah (Rp) terms, up from 30.7% in FY2010. Meanwhile, Rp loans constituted 83.6% of total loans (down from 87.8% in FY2010) and grew by 23.2% in line with our expectations.

Figure 1: FC Loans Grew by 32.0% y-o-y in 2011 (in Rp billion)

Source: Bank

Figure 2: RupiahLoans Grew by 23.2% y-o-y in 2011 (in Rp billion)

Source: Bank Indonesia

ICRA Indonesia had predicted that there would be a more subdued growth of Rp loans as compared to FC loans due to the increase in RR and had factored this in our model. The morethan-expected FC loan growth in 2011 could be attributed to the rise in commodity prices (especially of CPO and coal), which had a positive impact on export-oriented mining and plantation companies. Loans extended to these sectors represented 9.2% of total loans (higher than 8.6% in 2010) and grew by 32% as compared to 26.6% in FY2010. Using a compounded annual growth rate (CAGR) with 2008 as a base year (thus ignoring the effect of lower base if figure in FY2009 is used)1, FC loans had grown by 3.9% in FY2010 and by 12.5% in FY2011.

Loan Growth outpacing Deposit Growth (2007-2011)

Loans grew at a CAGR of 21.7% in the period from FY2007 to FY 2011, slightly down from the CAGR of 22.18% in the period from FY2006 to FY2010. This figure still outpaced the CAGR of deposits of 16.5% in the period from FY2007 to FY2011 (slightly better than 16.1% in FY2006FY2010). Total loans grew by 24.6%, thereby increasing the LDR to 79.0% in FY2011 from 75.5% in FY2010 and 72.9% in FY2009. Thus, the LDR of the banking system seems to be within the expected range. (1 The lower loan figure in FY2009 reflected the negative impact of the global
financial crisis)

Figure 3: Loan Growth versus Deposit Growth

Source: Bank Indonesia

Loan Distribution (2011 vs 2010)

The contribution of commodity-based sectors such as mining and plantation to total loans increased to 9.2% in FY2011 from 8.6% in FY2010. However, the contribution of other major sectors (such as manufacturing, trade/restaurants/hotels, and business services) did not show any significant improvement. In fact, despite nominal growth, they recorded a decline in contribution due to slower growth than the rest of the sectors.

Distribution of Loans Table 1: Loan Distribution by Sector

2009 8.37% 17.21% 1.71% 4.47% 20.96% 5.09% 10.49% 1.18% 30.52% 100.00% 2010 8.63% 15.60% 1.93% 3.60% 19.23% 4.26% 10.16% 2.50% 34.09% 100.00% 2011 9.20% 15.66% 2.08% 3.43% 18.43% 4.33% 10.19% 2.64% 34.04% 100.00%

CPO and Coal Manufacturing Electricity, gas and water Construction Trade, restaurants and hotels Transportation, warehousing and communications Business services Social services Others TOTAL
Source: Biro Pusat Statistik

Table 2: Loan Growth by Sector

LOAN GROWTH IN 2011 CPO and Coal Manufacturing Electricity, gas and water Construction 19% Trade, restaurants and hotels Transportation, warehousing and communications Business services Social services Others
Source: Biro Pusat Statistik (processed)

33% 25% 34% 19% 19% 27% 25% 31% 24%

Increasing Ratio of UL to Total Loans

Undisbursed loans (UL) in FY2011 grew by 23.2% y-o-y to Rp 683tn from Rp 555tn in FY2010. The growth was not as significant as the growth of 71.4% in FY2010. In terms of percentage to the total loans extended, the 31.1% figure in FY2011 was comparable with 31.4% in FY2010. This indicates that borrowers prefer to request for higher loan limits above their immediate needs to improve their financial flexibility. Banks also allocated higher loan limits. However, companies adopted a cautious approach to loan withdrawals and looked for the lowest cost of funds.

Figure 4 - Undisbursed Loans to Total Loans

Source: Bank Indonesia

Improved Loan Penetration In FY2011, loan penetration (defined as loan to gross domestic products [GDP] ratio) showed a significant improvement. By using IMF approximation of Indonesias GDP figure in FY2011 of Rp 7,222tn2, the 30.5% ratio was above 27.5% in FY2010. This figure is on the lower side as compared to the figures of other countries for 2010 (Malaysia: 115%; Thailand: 117%; Vietnam: 125%; Brazil: 57%; Russia: 45%; India:49%; China: 130%; and South Africa: 145%)3. Thus, we still see potential for further penetration despite the impending global economic slowdown. Banks may need to venture into new markets/segments that they avoided earlier due to perceived higher risks.

Figure 5: Loan to GDP Ratio

Source: Bank Indonesia, IMF and World Bank

Impact of September 2010 Increase in RR ratio on Rp Deposits

In our previous research, we had assumed that the 3 percentage point (ppt) increase in RR ratio would absorb approximately Rp 60tn from the banking system. However, this proved to be only a small fraction of the large excess placed at BI. As seen in figures 6 and 7, the increase in BI placement was 29.5% as opposed to increase in Rp loans of 23.2% and increase in Rp deposits of 20.5%. Source : IMFs World Economic Outlook Database http://www.imf.org/external/pubs/ft/weo/2011/02/weodata/weorept.aspx?pr.x=25&pr.y=19&sy =2011&ey=2011 & scsm=1&ssd=1&sort=country&ds=.&br=0&c=536&s=NGDP&grp=0&a=

1. Banks enjoy risk-free returns at BI that are better than the returns from the market after adjusting for risks and operational costs. 2. The debt markets (as alternative sources of funding with similar profile as bank loan) were favorable. Bond issuance in 2011 reached Rp 45.7tn (as against Rp 38.6tn in 2010). However, the uptrend was dampened by unfavorable global economic conditions. ICRA Indonesia expects banks to give higher priority to liquidity than loan growth. Despite BIs efforts to encourage lending by linking RR to LDR, the low loan penetration and lowering of the base rate, banks are likely to pay the penalty than force themselves to lend, if the risk-adjusted returns are not commensurate with their expectations. Loans Quality in 2011 The quality of bank loans in Indonesia has improved over the years. Banks classify their loans into five categories, namely, categories 1 to 5. Non-performing loans (NPL), comprising categories 3 to 5, decreased to 2.2% in 2011 from 6.1% in 2006. The percentage of Category 5 NPL to total loans also improved to 1.5% of loans in 2011 from 4.2% of loans in 2006. Performance of Top 10 Banks ICRA Indonesia analysed the performance of the top 10 banks against that of the industry to check for any material deviation from the general trend. The commonly held view is that the performance of the top 10 banks is a good proxy for the performance of the industry. This makes sense given that the asset size of these top 10 banks represented 63.30% of the systems assets in 2011 (down from 64.75% in the same period last year). Total loans of these top 10 banks grew by 22.4% (as compared to 24.6% of the industry) while total deposits grew by 16.2% (as against 19.1% of the industry). Meanwhile, the NPL of top 10 was also in line with that of the industry (2.05% versus 2.2% for categories 3-5 and 1.3% versus 1.5% for category 5). We can conclude that the performances of the top 10 banks and the industry had a strong correlation. Expectation for 2012 In FY2012, we expect the following factors to affect the pace of loan growth despite continuing expansion of FC loans: - FC LDR at above 90% level: ICRA Indonesia had expressed concern that the LDR in FC was at 78.5% in 2010 and that there was very little scope for FC loans to grow. However, in 2011, banks seemed to disregard the common view that a 90% LDR level is optimal and increased it to 93.4%. The Rupiah began to weaken in Q3 FY2011 as a result of capital movements out of the country and thus made FC deposits attractive. However, FC deposits recorded a growth of 10.9% (versus a growth of 32% in FC loans) in FY2011. As the Rupiah is expected to continue to face pressures from the US Dollar, we expect FC deposits to strengthen further. However, an LDR of more than 90% remains a concern for loan growth. - Euro zone concerns, slow recovery of US and Japan and embargo on Irans oil: Revenues from non-oil and gas exports to Euro zone accounted for 12.6% of Indonesias total revenues from non oil and gas exports as of November 2011. Although this was compensated by the rising demand from China, the risks remain as Germany, Netherlands and Italy are among the top 10 export destinations of China. Further, US and Japan, which are among the top three export destinations of China, have shown a slow recovery from economic recession and natural disaster, respectively. The embargo sanctioned on Irans oil by US and countries in the Euro zone, followed by the threat by Iran to close the Strait Hormuz, increases the uncertainty over oil prices. As there is limited visibility on the end of the crisis, we expect oil prices to increase further, and in turn increase operating costs and weaken purchasing power in some major export markets.

Conclusion In FY2011, bank loan growth was stronger than expected amidst several constraints that we pointed out in our previous research. This was supported by a significant increase in FC loans. In the midst of the turbulent second and third quarters of 2011, domestic demand -- driven by production (mining, plantation and manufacturing) and consumption (property, retail and vehicle sales) -- has mitigated the negative global impacts. The Indonesian banking system has also subsequently weathered the Greek debt crisis and the US debt ceiling debacle. Banks adjusted to the RR requirement, as stipulated by the central bank, by keeping a notable portion in BI placement and allowing LDR to increase by 3.5 ppt to 79.0% in 2011 from 75.5% in 2010. ICRA Indonesia Comment Bank Loans: Performance in 2011 and Expectation for 2012 ICRA Indonesia Page 13 The banking sector is expected to maintain its credit quality in 2012 due to the conservative policy of banks in view of the unfavorable global economic situation and its impact on the domestic economy. In addition, the regulation on maximum loan to value (LTV) ratio -- in vehicle and housing financing and the threat of higher inflation (especially from fuel increase in 2Q2012 and and electricity tariff increase some time in near future) could challenge banks in FY2012. With UL remaining above 30%, banks have been targeting micro loans and small and medium enterprises (SMEs) to support growth rates. ICRA Indonesia expects government thrust on infrastructure development to enhance loan growth. However, with the LDR nearing the 80% level, banks have to manage the trade-off between increasing loans and maintaining asset quality. Overall, ICRA Indonesia expects the total loans to grow at around 20-23% in FY2012.

Reference
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