Double or nothing is way into Indonesian banking sector

SINGAPORE -- Foreign banks that have been frustrated trying to break into one of the world’s most-profitable countries for banking, Indonesia, now may have a way. Buy two lenders, merge them -- you may get management control while Indonesia gets to cut its weakest players and consolidate its banking sector.

After Indonesia imposed rules three years ago that limited foreign ownership of its banks to 40 per cent, the ground shifted again this year. Regulators started saying that bidders could go above the threshold if they bought and merged two local lenders. At least two deals, by China Construction Bank Corp and Korea’s Shinhan Bank, have been given the go-ahead.

“It may be an odd way of being allowed to enter the market, but maybe it’s a relatively small price if you are taking a long-term perspective on Indonesia,” said Mr Mark Young, the Singapore-based head of Fitch Ratings’ Asia-Pacific financial institutions group. “This market is something that any regional bank that has ambitions would look to enter.”

Most Profitable

Indonesia is among the most profitable lending markets in the world. The country’s four largest banks, with market value exceeding US$5 billion, have a return on equity of 20.4 per cent, the highest among similar-sized banks in the 20 biggest economies of the world, data compiled by Bloomberg show. The banking sector’s average net interest margin of 5 per cent is more than double that of Southeast Asian neighbors Singapore and Malaysia, the data show. Loan growth is expected to accelerate as much as 13 per cent next year, according to Indonesia’s banking regulator, Mr Muliaman Hadad, chairman of the Financial Services Authority.

Yet the problems and costs of merging two banks’ differing operational systems and family owners who may not want to fully cede management control make such acquisitions tricky, said Mr Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia. In addition, Basel rules requiring more liquidity buffers for banks mean lenders could be spending precious capital for an acquisition that may not end up delivering results for years -- especially in an economy that is heavily tied to commodities, which are currently in a down cycle.

“It might be double the trouble actually,” said Mr Antos. “A 2-for-1 sale is something that you find in a retail shop, not in a banking sector. It’s not a bad idea in theory, but the reality is going to be very tough.”

Valuations of Indonesia’s smallest banks have risen in the past year as indications emerged that regulations were shifting. Shares of the 10 smallest lenders listed in Indonesia have risen an average 38 per cent in the past 12 months. By comparison, the top 10 have fallen an average 29 per cent in value.

China Construction Bank said in September it would become the controlling shareholder of Jakarta-based Bank Windu Kentjana International, which handles trade financing and foreign currency from 78 outlets primarily on the island of Java, after the Indonesian bank bought Bank Antardaerah in July, a small commercial bank with 30 offices in Java, Bali and Lombok.

China Construction Bank said the acquisition would help it offer infrastructure lending in Indonesia as well as financing for cross-border settlements to facilitate trade with China.

“This is a critical step for CCB in entering the Indonesian market,” Mr Qi Jiangong, CCB’s deputy general manager for strategic planning and investment, said at the Sept. 18 signing ceremony in Jakarta for the purchase. “Indonesia has always been a high priority market for CCB’s overseas development.”

Shinhan Bank

Shinhan Bank also received approval to buy more than 40 per cent in two Indonesian banks it purchased in stages. Shinhan said it signed a deal for 40 per cent of Jakarta-based commercial lender Bank Metro Express PT in 2012, though it got Indonesia’s approval for the purchase only this year when it sought to buy Surabaya-based small-business lender Centratama Nasional Bank. The deal is also paving the way for Bank Negara Indonesia to open its first branch in Seoul.

The new rules allowing majority stakes make more sense for foreign buyers than buying minority stakes, said Mr Kevin Kwek, an analyst at Sanford C. Bernstein & Co. in Singapore.

“At 40 per cent or below, you are merely buying an exposure to growth,” he said. “Without effective control, there is a limit to how much a foreign buyer can bring in expertise, know-how and a host of other intent to drive value out of an acquisition.”

After failing to win regulatory approval for a majority stake in 2013, Singapore’s DBS Group Holdings scrapped plans to buy PT Bank Danamon Indonesia.

Pushing Consolidation

Indonesia, with 118 commercial banks, is pushing for banking consolidation. With its top 10 banks accounting for more than 60 percent of total assets, the country is trying to weed out the bottom performers. The Financial Services Authority’s Mr Hadad said last year that the regulator would push small lenders to merge or seek strategic investors, as well as increase industry oversight by tightening non-performing loan levels.

“For consolidation, it’s not enough for them to acquire just one bank,” Mr Irwan Lubis, the regulator’s deputy commissioner of banking supervision, said on Sept. 18. The CCB deal “should be a lesson for other investors interested in acquiring Indonesian banks. Hopefully with this example, they will know what to do next.”

He said regulators would consider previously stated criteria such as reciprocity between Indonesia and the buying bank’s country, and whether the buyer would help to grow the economy, when deciding whether to approve controlling-stake acquisitions.

No Plans

Mr Nelson Tampubolon, chief executive for banking supervision at the Financial Services Authority, said by text message that there are no plans by other foreign banks to buy another Indonesian lender at this time.

In addition to the CCB and Shinhan deals, Tokyo-based J Trust managed to buy 99 per cent of PT Bank Mutiara a year ago, with regulators making an exception for the Japanese financial-services firm because it was buying a distressed bank. The bank is aiming for as much as 20 per cent loan growth this year.

Others are content with less. Taiwan’s Cathay Financial Holding said in January it was buying 40 per cent of Bank Mayapada International, while Sumitomo paid US$460 million to raise its stake in Bank Tabungan Pensiunan Nasional to 20 per cent in February.

“If you look long-term the Indonesia market is very attractive, but it will need capital to support the growth,” said Fitch’s Mr Young. The government’s efforts at pushing banking consolidation “makes life easier for themselves, and if it means mopping up weaker entities, that’s smart too”.

BLOOMBERG