Indonesian banks' earnings to be boosted by declining credit costs

Indonesian banks' core profitability will remain stable.

The Indonesian banking system's loan profitability will continue to be supported by net interest margins of around 5%, the widest amongst its regional peers such as Philippines (3%) and Thailand (3%), according to Moody's Investors Service.

Here's more from Moody's:

This is despite that the mid-tier and smaller banks could face some margin compression from higher deposit costs. This dynamic had worked in opposite to widen their loan spread, and consequently NIMS, in recent years of sluggish loan growth - their funding costs fell over 2015 and 2016 as weaker loan demand led to the runoff of expensive time deposits. As loan growth picks up this process will be reversed.

A downside risk to loan yields comes from a single digit lending rate scheme proposed by the Financial Services Authority (OJK) in early-2016, according to which banks cannot charge a blended average interest rate above 9%, implying a reduction of more than 160 bps from the current average loan yield of 10.6%. We assess the risk that this proposal will be legislated to be low.

Bank earnings will rise in this outlook. While lending income will be supported by our expectation of faster loan growth and stable overall NIMs, the larger contribution will come from lower credit costs, which took a heavy toll on earnings in 2016. Credit costs to pre- provision profit for our rated banks rose to 43% in 2016 up from the 19% average between 2010-2014.

We expect credit costs to fall back to 2015 level of around 30% of pre-provision profit on slowing NPL and restructured loan formation rates. However, a reversion to the 2010-2014 low is unlikely as banks will still face elevated asset quality pressures over the next 12-18 months.