Virus to weaken Indonesian banks' results from 2Q20
Fitch RatingsJakarta/Sydney-28 June 2020: The bulk of the coronavirus's effects on Indonesian banks will start to become apparent in their 2Q20 financial results, which they will begin to report from the end of July, Fitch Ratings says. We expect the 2Q20 results to show stress on the banks' asset quality and profitability, although regulatory forbearance on loan classification and provisioning should help to mitigate some of the damage to the banks' financial profiles.
The 1Q20 financial results for Indonesia's 12largest banks only incorporated some of the economic impact of the pandemic as Indonesia only reported its first cases of coronavirus at the start of March.
The large banks' average non-performing loan (NPL) ratio remained steady at 2.6% at end-1Q20 (2019: 2.5%), but their average "special-mention" loan ratio rose to 6.2% from 4.6% at end-2019. These are loans overdue by up to 90 days or otherwise noted as being at higher risk of becoming non-performing and are an early indicator of potential build-up in problem loans.
Under normal conditions, we would expect the increase in special-mention loans to put pressure on banks' NPL ratios, but the relaxation of rules governing loan restructuring - allowing loans to be classified as "current" until end-1Q21 - has led to a surge in loan restructuring, with the regulator reporting that around 10% of all industry loans have been restructured by 26 May 2020. We expect this to limit deterioration in banks' NPL ratios, but the stress will be visible in a spike in restructured loan ratios (large banks' average at end-1Q20: 5.5% of total loans), particularly those classified as "current" (2.1% of total loans).
The looser loan classification will reduce stress on regulatory provisioning, as will a relaxation on provisioning under the IFRS 9 accounting standard, which Indonesian banks implemented from 1Q20. However, banks that rely heavily on these changes to reduce provisions and maintain profitability in 2020 could face a considerable spike in credit costs when the relaxation ends in March 2021 if recovery in the economy and borrower repayment capacity lags expectations. The large Indonesian banks' high net interest margins (NIM) of 5.8% on average at end-1Q20 should continue to provide a buffer to absorb losses from higher credit costs and weaker income from reduced economic activity. While margins will not be unaffected, the effects on NIMs are likely to be less pronounced as most restructuring requires borrowers to continue to pay interest.
The introduction of IFRS 9 resulted in most Indonesian banks recording a one-time reduction in equity and lower capitalisation ratios at end-1Q20. However, capital buffers at the 12-largest banks remain satisfactory, as reflected in their average common equity Tier 1 capital ratios of 18.0% (2019: 20.6%), which is among the highest of Fitchrated banking sectors in the Asia-Pacific region. These buffers should provide adequate cushion to withstand weaker asset quality.
Liquidity at the large banks should remain ample, helped by their deposit-dominated funding profiles and low reliance on wholesale funding. We believe that recent regulatory easing on the minimum liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) requirements to 85% from 100% - together with a suspension of the capital conservation buffer of 2.5% - are likely targeted to help weaker mid- and small-sized banks, as the 12-largest banks average LCRs and NSFRs of 189% and 125%, respectively, were comfortably above the 100% minimum.
Fitch lowered the operating environment mid-point score for Indonesian banks to 'bb+' from 'bbb-' in March as we expect weaker operating conditions as a result of the pandemic.