Moody's: Outlook for Indonesia's banking system remains stable

Moody's Investors Service says the outlook on Indonesia's (Baa3 stable) banking system remains stable, reflecting an expectation that the country's banks will withstand a challenging operating environment owing to their strong buffers.

"Nonperforming loans will likely rise, given slowing economic growth," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.

Nonetheless, the banks are well-positioned to withstand any deterioration in asset quality and will maintain strong capital levels.

"In particular, Indonesian banks have strong buffers in terms of high profitability and capital. Moreover, both corporate and household balance sheets remain healthy," adds Vadlamani.

Moody's conclusions were contained in its just-released "Banking System Outlook: Indonesia", which expresses Moody's view of how bank creditworthiness will evolve in this system over the next 12-18 months.

The report looks at the banking system in the five categories of operating environment; asset quality and capital; funding and liquidity; profitability and efficiency; and system support.

While Moody's assesses asset quality as deteriorating, the other four categories are assessed as stable.

Indonesia's banking system outlook has been stable since January 2010.

Moody's expects Indonesia's GDP growth to be at 5% this year, compared to an average of 6.0% between 2010 and 2014.

The report points out that regulatory and monetary policies enforced in 2013 and 2014 are affecting growth rates with a lag, weighing on the growth outlook for 2015.

These policies include limiting loan-to-value ratios for mortgage and auto financing and a cumulative 175 basis points (bps) increase in the policy rate by Bank of Indonesia.

While Bank of Indonesia eased its policy rate by 25 bps to 7.5% in February 2015, further easing of monetary policy may be limited, given that Indonesia's current account deficit and rupiah remain under pressure.

According to the report, the key impact of slowing economic growth would be in the form of a deteriorating asset quality.

Mid-sized corporate and small- to medium-sized enterprise segments -- where investment-related loans had grown rapidly in the past few years -- should see the largest deterioration in asset quality.

At the same time, Indonesian banks have strong buffers in place to withstand significant asset quality stress. The banks are very well capitalized, while their high profitability means that they can absorb a much higher level of credit costs.

In addition, the banks' liquidity profiles should remain stable over the next 12-18 months, given that loan growth is expected to slow.

Moody's adds that it expects the Indonesian government to continue to provide strong support to the banks.

However, the reports points out that the lack of a proper legal framework for effective crisis management -- particularly uncertainties related to regulatory powers in crisis management and resolution process -- represents a key area of weakness for the system.

Draft versions of a Financial System Safety Net Law have been proposed multiple times in the past, but the legislation has yet to be passed.

Moody's also says that the stable outlook on the Indonesian banking system is consistent with Moody's stable outlook on the Indonesian government's Baa3 rating.

Moody's rates 10 of the largest banks in Indonesia by assets. These banks accounted for 65% of system assets at end-September 2014. All banks except Bank ICBC Indonesia (P.T.) are rated Baa3 for local and foreign currency deposits, and all the ratings carry stable outlooks. Bank ICBC Indonesia (P.T.) is rated Baa2 for local currency deposits and Baa3 for foreign currency deposits. Both have stable outlooks.