This article first appeared in Corporate, The Edge Malaysia Weekly, on May 9 - 15, 2016.

THE Indonesian central bank’s move to use a new benchmark for its policy rate from Aug 19 puts pressure on commercial banks to bring down their lending rates.

This could lead to a decline in their profitability, analysts say, and raises an additional concern about CIMB Group Holdings Bhd and Malayan Banking Bhd’s (Maybank) Indonesian banks — PT Bank CIMB Niaga Tbk and PT Maybank Indonesia Tbk.

Investors were already watching them closely to see if a sustained improvement was imminent in the second half of this year. The two Indonesian lenders, CIMB Niaga in particular, have seen profits take a hit due to high provisions for bad loans for several quarters now, amid a slowdown in the Indonesian economy.

As it stands, asset quality concerns still linger for both banks. And with this latest development, profit margins could be under more strain than initially expected, a banking analyst with a local brokerage firm tells The Edge.

“You’re not going to see exciting growth at the two Indonesia banks, and net interest margins (NIM) will continue to come down,” he remarks.

On April 15, Bank Indonesia (BI) announced that from Aug 19 it will start using its seven-day reverse repurchase (reverse repo) rate — currently at 5.5% — as the new benchmark that will influence borrowing costs.

The repo rate, which is the interest the central bank pays to borrow from commercial lenders, will replace the 12-month reference rate — called the BI rate and currently at 6.75% — that has been used as the benchmark since 2005. The change is aimed at improving the effectiveness of its monetary policy transmission to money market and bank rates.

Analysts say the change in the benchmark adds to the government’s ongoing efforts to push commercial banks to lower their lending rates so as to spur lending and stimulate economic activity, to reverse the current slowdown.

The BI rate was deemed ineffective in having an immediate and large impact on lending rates. Analysts point out that lending rates only declined by four basis points (bps) despite the central bank having cut the BI rate by a total of 75bps in the first three months of this year.

Analysts say it remains to be seen whether the change in benchmark will ultimately lower the lending rates as it will depend on a few factors, including deposit rates and the liquidity of the interbank market.

“It may not necessarily be as effective as BI wants it to be, but the direction is there. Even if it doesn’t work, they may come up with a more forceful measure to get banks to lower their lending rates because the government is under pressure to stimulate the economy. This may start with the big state-owned banks — they may be told to toe the line and bring down their rates. And if these banks do, the other banks like CIMB Niaga and Maybank Indonesia have to follow suit if they don’t want to lose market share.

“So, to me, it’s imminent that their profit margins will come down further,” a banking analyst with a foreign research house tells The Edge.

The investment community’s concern is always more about CIMB Niaga as its earnings contribution to the Malaysian parent company is much more than Maybank Indonesia’s. It used to account for a third of CIMB Group’s profit  before tax (PBT), but this has since come down. Last year, it accounted for  just 8% of the group’s PBT.  Maybank Indonesia’s contribution has always been less than 5% to Maybank’s PBT.

Just last week, Indonesia reported lower-than-expected economic growth for the first quarter. The economy expanded by 4.92% year on year (y-o-y) in the quarter, below the median 5.05% in a Reuters poll and the October-December pace of 5.04%.

The Indonesian economy, Southeast Asia’s largest, grew just 4.79% last year, its slowest pace in six years and the first time it fell below 5% since 2009. 

“CIMB Group and Maybank are retaining their cautious stance on the Indonesian macro environment and asset quality outlook. Like the rest of the banks in Indonesia, CIMB Niaga and Maybank Indonesia are not spared the regulatory pressure ... to lower lending rates. While their strategy of focusing on growing deposits faster than loans could ease some of the pressure on NIM, we still expect NIM to be lower, arising from the shift in focus to better quality loans,” AllianceDBS Research says in a report last week after the two Indonesian lenders released their first-quarter financial results.

Both banks showed strong improvement in first-quarter earnings on a y-o-y basis, but analysts point out that CIMB Niaga’s still fell short of expectations because of continued high provisions and weak revenue. Of the two, they say Maybank Indonesia showed healthier underlying trends.

CIMB Niaga’s net profit came in at IDR269 billion, up 224% y-o-y and 13% quarter on quarter (q-o-q). It made up just 12% of Maybank Investment Bank (MIB) Research’s full-year forecast for the Indonesian bank.

“CIMB Niaga’s 1Q2016 earnings came in below our expectation as provision levels remained more elevated than expected. We nevertheless maintain our forecasts for now, given that mutual separation scheme (an exercise the group embarked on last year) savings should kick in fully from 2H2016. Niaga’s operating environment remains challenging,” the research house says in a May 3 report.

CIMB Niaga made loan-loss provisions of IDR1.34 trillion in the first quarter, similar to the IDR1.39 trillion provision it made in the preceeding quarter, but lower than the IDR1.45 trillion in the first quarter a year ago.

CIMB Group CEO Tengku Datuk Seri Zafrul Aziz, in an interview with The Edge last month, said he expected provisions at CIMB Niaga to remain at elevated levels in the first half of this year, before improving in the second half.

On a positive note, CIMB Niaga’s NIM improved to 5.35% in the first quarter from 5.25% in the preceeding quarter as funding costs were lower. But the bank’s management guided that the margin would come down to about 5% for the year due to competitive pressure on loan yields.

Loans contracted 3% y-o-y due to the weak economy and the bank’s gross non-performing loan (NPL) ratio continued to deteriorate. The ratio rose to 3.9% as at end-March from 3.74% at end-December, though this was partly due to the lower loan base. Worryingly, special mention loans — those that could potentially turn non-performing — accounted for 10.4% of total loans compared with 8.16% in the preceding quarter, as the slower economy resulted in an increase in delayed payments.

“Some of the sectors impacted include manufacturing, transport, construction and textiles. Management expects the ratio to decline in 2Q2016 as some of these loans will be restructured by then,” MIB Research says.

Meanwhile, Maybank Indonesia’s net profit came in at IDR444 billion, up 74% y-o-y but down 19% q-o-q. Provisions, at IDR388 billion, however, came down 47% q-o-q and 9% y-o-y.

“Maybank Indonesia’s 1Q2016 earnings showed healthier underlying trends as provisions declined significantly and revenue growth was stronger y-o-y. On a sequential basis, earnings dipped as non-interest income was particularly strong in 4Q2015,” notes AllianceDBS.

NIM was stable at 4.8% while gross NPL ratio improved to 3.7% from 3.83% in the preceeding quarter.

“The bank continued to manage down exposures from corporate accounts that led to the increase in NPLs and has actively carried out the restructuring of those accounts. Further improvements are expected over the next several months,” AllianceDBS adds.

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