Double trouble: Indonesian banks at risk of high external debt and the presence of weak banks

But risks are lower than implied, says Moody's.

Moody's Investors Service says that the Indonesian banking system is well-placed to weather ongoing tail risks. "Recent volatility in emerging markets has led investors to examine the risks faced by Indonesian banks," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.

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Moody's identifies two key potential sources of tail risks for the system: high external debt and the presence of weak banks, but concludes that the risks are more than manageable for the banking system.

Its analysis is contained in a recently published report "Indonesian Banking System Well Placed to Manage Tail Risks" by Vadlamani.

Outstanding Indonesian private external debt more than doubled to $170 billion at end-June 2015 from $84 billion at end-2010, notes Moody's. This rapid growth, coupled with the 10% depreciation in the rupiah since the beginning of 2015, has created potential vulnerability for the system.

But the risks are lower than implied, as over 70% of this debt comprises debt owed to related parties, debt owed by state-owned enterprises, or debt in sectors with a natural hedge.

Moody's notes that at 30 June 2015, 25% of all corporate external debt — excluding the external debt owed by banks — was payable to a related party, in the form of either a parent or an affiliate company. Most of this debt should be essentially interpreted as foreign direct investment into Indonesia by overseas investors, rather than pure financial borrowings by the respective domestic entities, says the rating agency.

Around 17% of this outstanding debt was to Indonesian state-owned enterprises, excluding state-owned banks, which have adequate capacity to withstand currency fluctuations through natural hedges or protective subsidy arrangements, says Moody's.

The second risk highlighted by the rating agency is contagion risk to the banking system from weaker banks. The 10 Moody's-rated banks in Indonesia — which together accounted for 65% of total system assets at 30 September 2015 — exhibit strong buffers in the form of high capital and profitability metrics to withstand asset-quality stress.

In the top 20 largest banks by assets, those banks not rated by Moody's are owned by highly-rated foreign parents that are highly rated. The remaining smaller banks in the system do pose some risk, but most generally exhibit healthy financial metrics.