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Moody’s Investors Service has changed its outlook on the Indonesian banking system to positive from stable, reflecting their view that banks will see improvements in their operating environment, asset quality, as well as the capacity by the government to extend support when necessary.

“Indonesian banks will benefit from an improving operating environment in the coming 12-18 months, as economic growth picks up due to supporting macroeconomic policies and a stronger market for the country’s key commodities,” says Srikanth Vadlamani, a Moody’s Vice President and Senior Credit Officer.

“Our baseline scenario assumes real GDP growth in Indonesia of 5.2% in 2017 and 5.3% in 2018, compared to 5.0% in 2016,” adds Vadlamani.

Moody’s conclusions are contained in its just-released Banking System Outlook for Indonesia, “Improving Operating Environment Drives Positive Outlook”.

Moody’s assessment of Indonesia’s banking system is based on five factors: operating environment (improving); asset quality and capital (improving/stable); funding and liquidity (stable); profitability and efficiency (improving); and systemic support (improving).

The operating environment for the banks is, as indicated, improving on supporting macroeconomic policies and a stronger market for the country’s key commodities..

Asset quality will improve, driven by a recovery in corporate revenues that should constrain further rises in loan delinquency. Furthermore, this trend is accompanied by falling debt levels, which should result in stronger debt servicing capacity.

In addition, despite potential faster loan growth, capitalization at Indonesian banks will remain broadly stable — their structurally high core profitability and loan loss coverage ratios provide them with strong buffers to withstand asset quality deterioration, which in our view has already peaked.

Funding and liquidity for the banking system will be stable. The pressure from faster loan growth will be modest overall as bank deposits will also be growing at a similar pace.

The system’s loan to deposit ratio (LDR) should stabilize at the 90% level, from 89% at end-March 2017. Yet some banks could see their LDR approach the regulatory LDR limit of 92%.

Indonesian banks have little reliance on wholesale funding, and their balance sheets are liquid with government securities and other liquid assets comprising 27% of banking system assets at end-March 2017. All Moody’s rated banks comfortably meet minimum Liquidity Coverage Ratio (LCR) requirements.

The banks’ loan profitability will continue to be supported by net interest margins of around 5.3%, the widest amongst Indonesia’s peers. Another profit contribution will come from lower credit costs, which took a heavy toll on earnings in 2016.

Moody’s further notes that system support is improving as the government’s capacity to support banks benefits from the country’s declining vulnerability to external shocks and lengthening track record of macroeconomic stability and fiscal discipline.

Moody’s considers Indonesia a high support system, because of the importance of the banking system to the overall economy, as well as the government’s demonstrated past records of systemic support.

Moody’s rates nine banks in Indonesia. These banks accounted for 64% of total system assets as of end-March 2017. The standalone baseline credit assessments (BCA) of the nine banks range from ba2 to baa3, with an asset-weighted average of ba1. The local and foreign currency deposits for Bank Central Asia Tbk (P.T.), Bank Tabungan Negara (P.T.), PT Bank CIMB Niaga Tbk, Bank Rakyat Indonesia (P.T.), Bank Mandiri (P.T.), Bank Danamon Indonesia TBK (P.T.) and Bank Negara Indonesia TBK (P.T.) are all rated Baa3 and the outlooks for their ratings are positive, with the exception of Bank Permata TBK (P.T.) (Baa3 negative, ba2) and Pan Indonesia Bank TBK (P.T.) (Baa3 stable, ba2).

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