Indonesian banks to face persistent headwinds in 2016: Fitch

Second-tier lenders are in a more vulnerable position.

The outlook for Indonesia's banking sector remains negative - with profitability declining, credit costs rising and NPL ratios likely to rise in 2016, says Fitch Ratings. That said, earnings buffers at the major banks remain robust, and should be sufficient to cover higher credit costs while also maintaining high profitability relative to other banks in the region. Indonesia's large banks are also well capitalised, with high core capital ratios sufficient to meet Basel III requirements.

Here's more from Fitch Ratings:

Fitch believes that operating conditions will remain challenging despite real GDP growth likely to improve slightly to 5.1%, from 4.8% in 2015. Persistent weak commodity prices will continue to drag on the economy. This will result in deteriorating asset quality in the key commodities and other sectors, and rising credit costs, although a large part of the impact may already be reflected in banks' results in 2015.

Credit costs should rise throughout most of the ASEAN region in 2016, including Indonesia. As a result, the ROA for Indonesian banks should moderate at around 2%. NPLs should also tick higher after rising to 2.5% of total banking industry loans by end-2015 from 2.2% at end-2014.

Notably, while reserve coverage for NPLs is generally healthy, it is insufficient if 'special mention' loans (SMLs) are included. The average ratio of reserves to NPLs and SMLs combined for 10 Fitch-rated banks was 52% at end-2015 versus 148% when SMLs are excluded.

The major banks' high profitability will continue to provide a significant source of protection, however. ROAs are declining but should remain well above the regional average, and there is a wide margin between pre-provision operating profit (PPOP) and estimated reported credit costs. Even under stressed conditions, credit-cost tolerance should be satisfactory for the big banks, which supports their credit ratings at current levels.

Second-tier lenders are in a more vulnerable position, lacking the robust buffers of their larger counterparts. Fitch views capitalisation at the smaller banks as satisfactory, but their lower profitability, weaker deposit franchises and higher exposure to the commodity sector makes them more vulnerable, especially in the event of a significant external macroeconomic shock and market volatility.

The major Indonesian banks have generally become more selective in extending foreign-currency loans, seeking to match these loans with funding from foreign-currency deposits.

The foreign-currency loans/deposits ratio in the banking sector was 84.9% at end-2015, and the foreign-currency net open position exposure of the banking sector was around 2% of capital, well below Bank Indonesia's limit of 20%.

This helps protect against impairments stemming from a sharp depreciation of the rupiah, which tends to be among the more volatile currencies in the region.