Banks are sacrificing profitability to secure liquidity Analyst: Putri Amanda

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Banks are sacrificing profitability to secure liquidity Analyst: Putri Amanda The Indonesian banking industry survived the economic vulnerabilities of, but banks are bracing themselves for new challenges to business growth in as the economic environment remains tight. The nation s economy grew by 5.2% in the first quarter of (1Q), compared to 5.7% in 1Q. This slower pace of growth was due to adjustments in monetary policy, the USD strengthening against all currencies, and elevated levels of inflation and interest rates during. To date, PEFINDO has assigned ratings to 33 banks in Indonesia, with the highest rating assigned at idaaa and the lowest at id BBB, with a stable outlook, and one bank with a positive outlook and one with a negative outlook. We revised the outlook on Bank Saudara to positive from stable in ch due to the possible merger with PT Bank Woori Indonesia, which may result in a stronger business position in the industry. As for Bank Sumut, the revised outlook to negative from stable was triggered by its weakening asset quality in almost all loan segments. We expect these banks to maintain their ratings. However, if deterioration in financial performance continues due to a prolonged economic downturn, this could lead to a downgrade, particularly for smaller banks that are more susceptible to economic changes. Bank Indonesia (BI) has so far increased its benchmark interest rate (BI rate) to 7.5% in an attempt to narrow the gap in Indonesia s current account deficit, and to control inflation. As exchange rates still fluctuate due to the political uncertainty caused by the presidential elections in July, and the US Federal Reserve s tapering, PEFINDO estimates that economic growth in will be 5.5%-5.7%. We expect demand for loans to soften as commodity prices are affected by global economic conditions, and consumer spending is threatened by inflation. Against this background, banks are striving amid liquidity risks to meet their funding needs. As of 1Q, the industry recorded IDR3,618.1 trillion in total deposits and IDR3,306.9 trillion in total loans, growth of 11.6% and 19.5%, respectively, lower compared to 1Q at 14.8% and 22.2%, respectively. With greater loan growth and fewer funds coming into the banking system, the loan-todeposit ratio (LDR) increased month by month during and reached 91.2% as of 1Q, almost reaching the maximum level required by the central bank of 92%. Bank Central Asia had the strongest liquidity profile among the rated banks in our portfolio with its LDR at 78.3% as of 1Q, in line with BI s targeted minimum level of 78%. The low LDR was supported by its strong brand image, extensive network, and large customer base to penetrate funding. Bank Sumitomo Mitsui Indonesia, which recorded the highest LDR of 204.1% as of 1Q, is a joint venture bank that relies more on long-term funding from its parent than retail customer deposits, given its small customer base. We expect the LDR level to ease as loan growth is likely to slow down at 15%-17% in. However, this should also be followed by strong and steady deposit base expansion. http://pefindo.com 1/5 July

Figure 1.Loan to deposit ratio 92% 91% 90% 89% 88% 87% 86% 85% 84% Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Source: Bank Indonesia publication How do banks manage the liquidity situation? The current liquidity and funding situations in Indonesia pose challenges for banks to develop future funding. They are spurred to increase their deposit rates, which leads to unhealthy competition as depositors will look around for higher interest rates to protect their savings against inflation. Banks are exposed to deposit withdrawals that may force them to find necessary funding replacements, particularly for smaller banks with less stable deposit bases and weak funding channels. Such exposure will adversely affect banks asset-liability management and magnify the liquidity risk. To minimize liquidity issues, banks need to improve their deposit structure. PEFINDO believes that the development of a retail funding base is crucial to support the sustainability of long-term business growth. The enhanced competition for deposits will drive changes to deposit structures. However, it depends on how effective banks are in capturing customers not solely based on pricing. This includes improving brand awareness, providing comprehensive services, and enhancing the quality of distribution channels. PEFINDO believes that strong customer engagement could partly improve funding stability. Moderate exposure on asset quality As banks increase their deposit rates, they do not instantly increase their lending rate, which should weigh on their asset quality profiles. Rupiah depreciation has put pressure on Indonesian companies that have an asset-liability currency mismatch. A higher lending rate further weakens the debtors repayment capability, as reflected by a non-performing loan (NPL) ratio of 2% as of 1Q from 1.8% as of December 31, (FY). Special mention loans (loans up to 90 days past due) or potentially weak loans increased to IDR158.1 trillion as of 1Q from IDR128.8 trillion as of FY. Bank ICB Bumiputera had the highest NPL and special mention loans compared to the rated banks in our portfolio of 5.2% and 5.7%, respectively, as of 1Q. Bank Sumitomo Indonesia, due to its consistency in improving its credit risk assessment, reported the lowest NPL of 0.3% as of 1Q. The lowest special mention loans were held by Bank Sulut at 0.3% as of 1Q, as its function as the payment bank for the salaries of regional civil servants allowed it to deduct debt installments from salaries. However, we expect pressure on asset quality to be moderate as we do not expect a significant increase in bad debts as banks are being more selective in loan disbursement. Ongoing profitability pressure Banking financial reports showed that time deposits increased to IDR1,653 trillion as of 1Q from IDR1,604.5 trillion as of FY, accounting for 45.7% of the banks total deposits as of 1Q, up from 43.8% as of FY. A lower share of low-cost deposits (current account and saving account, CASA) saw the banks interest expenses rise faster at 25%, compared to interest income growth at 16%. http://pefindo.com 2/5 July

The net-interest margin (NIM) contracted to 4.3% in 1Q from 4.9% in FY, attributed to the narrowing spread between deposit and lending rates. Of all the rated banks within PEFINDO s portfolio, Bank Victoria reported the lowest NIM of 2% in 1Q, due to its focus on loans to the commercial and corporate segments. Bank Sulselbar generated the highest NIM of 10.7% in the same period through its lucrative captive market in distributing loans to civil servants. Due to economic and political uncertainties, we project that BI will raise its benchmark interest rate in the near term. Therefore, we expect the NIM will continue to fall as higher interest rates will stiffen competition to capture funding and high quality debtors. Figure 2. Net interest margin 6% 5% 4% Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Source: Bank Indonesia publication In an attempt to deal with thinning margins and anticipate a further profitability downturn, banks are emphasizing cross-selling and focusing on increasing their fee-based income. Fee-based income such as treasury transactions, bancassurance, and remittances could partly mitigate further declining profitability. We believe that in the long run, banks will pay more attention to their fee-based income to diversify their revenue streams. PEFINDO believes that these strategies will bode well in the medium to long term, although significant results will take some time. As such, we expect the banks bottom line profitability figures, as measured by return on average assets (ROAA), to slightly fall in the medium term. http://pefindo.com 3/5 July

Figure 3.Published ratings of banks Bank Rating Outlook Total assets NPL NIM ROAA LDR Bank Mandiri idaaa Stable 729,483.0 2.0% 5.4% 2.9% 87.3% Bank Rakyat Indonesia idaaa Stable 615,718.6 1.8% 8.2% 3.8% 92.3% Bank Central Asia NR NR 502,187.8 0.5% 6.5% 2.9% 78.3% Bank Negara Indonesia idaaa Stable 371,461.1 2.3% 5.7% 2.5% 90.2% Bank CIMB Niaga idaaa Stable 218,355.2 2.7% 4.9% 2.0% 95.3% Bank International Indonesia idaaa Stable 140,076.5 2.0% 4.4% 0.5% 91.1% Bank OCBC NISP idaaa Stable 94,852.0 0.8% 3.9% 1.4% 100.8% Lembaga Pembiayaan Ekspor Indonesia idaaa Stable 48,025.6 3.1% 4.1% 2.4% N/A Bank Sumitomo Mitsui Indonesia idaaa Stable 43,714.7 0.3% 2.2% 1.5% 204.1% Bank Danamon idaa+ Stable 185,919.6 2.0% 7.9% 1.9% 95.6% Bank Permata idaa+ Stable 167,325.0 1.0% 3.1% 0.9% 94.3% Bank Syariah Mandiri idaa+ Stable 63,009.4 4.9% 5.5% 1.3% 91.2% Bank Negara Indonesia Syariah idaa+ Stable 15,611.5 2.0% 7.7% 0.9% 96.7% Bank Panin idaa Stable 162,690.9 2.1% 3.6% 1.8% 89.1% Bank Tabungan Negara idaa Stable 136,964.2 4.7% 4.3% 1.0% 100.8% Bank Jabar Banten idaa- Stable 78,899.3 3.8% 6.2% 1.7% 79.9% Bank Muamalat idaa- Stable 54,791.0 2.1% 4.3% 1.1% 105.5% Bank DKI idaa- Stable 29,605.6 2.7% 6.4% 3.5% 90.6% Bank Resona Perdania idaa- Stable 13,082.7 1.3% 4.0% 2.1% 154.4% Bank Bukopin ida+ Stable 72,315.6 2.7% 3.7% 1.4% 82.5% Bank Jatim ida+ Stable 35,464.2 3.6% 9.4% 3.7% 80.4% Bank Jateng ida+ Stable 33,858.4 0.7% 7.3% 2.8% 78.5% Bank Sumut ida+ Negative 22,837.2 4.8% 8.5% 2.8% 91.2% Bank Papua ida Stable 17,307.0 1.4% 8.7% 2.5% 84.8% Bank Nagari ida Stable 17,061.9 2.5% 6.5% 1.6% 92.8% Bank Sulselbar ida Stable 10,761.4 1.1% 10.7% 3.9% 83.3% Bank Mayapada ida- Stable 25,369.2 2.4% 4.2% 1.7% 86.9% Bank Victoria ida- Stable 19,458.8 1.3% 2.0% 0.9% 75.9% Bank Sulut ida- Stable 8,644.9 0.5% 8.8% 2.8% 82.6% Bank NTT ida- Stable 8,454.3 1.3% 10.0% 3.9% 78.5% Bank Saudara ida- Positive 8,239.1 3.0% 5.3% 0.3% 91.0% Bank Lampung ida- Stable 5,022.7 0.8% 6.6% 2.5% 77.7% Bank Capital idbbb+ Stable 7,410.7 0.4% 2.6% 1.0% 62.8% Bank ICB Bumiputera idbbb Stable 7,965.1 5.2% 3.2% -0.7% 83.3% All financial information as of 31 ch. The above ratios have been computed based on information from the companies and published accounts. Where applicable, some items have been reclassified according to PEFINDO's definitions. Total assets are stated in IDR billion. NR: not rated. N/A: not applicable. http://pefindo.com 4/5 July

DISCLAIMER PT Pemeringkat Efek Indonesia (PEFINDO) does not guarantee the accuracy, completeness, timeliness or availability of the contents of this report or publication. PEFINDO cannot be held liable for its use, its partial use, lack of use, in combination with other products or used solely, nor can it be held responsible for the results of its use or lack of use in any investment or other kins of financial decision making on which this report or publication is based. In no event shall PEFINDO be held liable for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses, including but not limited to lost profits and opportunity costs in connection with any use of the contents of this report or publication. Credit analyses, including ratings, and statements in this report or publication are statements of opinion as of the date they are expressed and not statements of fact or recommendations to purchase, hold or sell any securities or to make any investment decision. The contents cannot be a substitute for the skill, judgment and experience of its users, its management employees and/or clients in making investment or other business decisions. PEFINDO also assumes no obligation to update the content following publication in any form. PEFINDO does not act as a fiduciary or an investment advisor. While PEFINDO has obtained information from sources it believes to be reliable, PEFINDO does not perform an audit and does not undertake due diligence or independent verification of any information used as the basis of and presented in this report or publication. PEFINDO keeps the activities of its analytical units separate from its business units to preserve the independence and objectivity of its analytical processes and products. As a result, certain units of PEFINDO may have information that is not available to other units. PEFINDO has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process. PEFINDO may receive compensation for its ratings and other analytical work, normally from issuers of securities. PEFINDO reserves the right to disseminate its opinions and analyses. PEFINDO public ratings and analyses are made available on its website, http://www.pefindo.com (free of charge) and through other subscription-based services, and may be distributed through other means, including via PEFINDO publications and third party redistributors. Information in PEFINDO s website and its use fall under the restrictions and disclaimers stated above. Reproduction of the content of this report, in full or in part, is subject to written approval from PEFINDO. http://pefindo.com 5/5 July