Recent merger and acquisition (M&A) trends suggest that Indonesia is turning more welcoming to foreign banks, said Morgan Stanley in a latest report - Photo by World Bank

JAKARTA (TheInsiderStories) – Recent merger and acquisition (M&A) trends suggest that Indonesia is turning more welcoming to foreign banks, said Morgan Stanley in a latest report. The company believe this could accelerate consolidation and improve efficiency, risk management, and capital support, driving a structural re-rating.

“In the near term, it should reduce national service risk for SOE (state-owned) banks,” said the report.

Indonesian banking industry has turned more active with Rp101 trillion (US$6.97 billion) of acquisitions taking place since 2019 or $4.7 billion per year, following a relatively slow period in 2013 – 2018 with Rp54 trillion of acquisitions or $600 million per annum, after the 40 percent stake cap regulation in 2012. Foreign banks dominated acquisitions in 2019 – 2020 with 99 percent share by value.

“We believe the recent acceleration is driven by the regulators’ more accommodative gestures, expressed in relaxation of the caps, as well as good appetite from foreign investors,” the report stated.

Recent relaxations of the 40 percent stake cap, which have usually involved additional mergers after the acquisitions, should accelerate banking system consolidation. Its expect the trend to persist, and be supported by a few more potential acquisitions in the pipeline.

Foreign Banks Accessing Higher Growth Market

Growth and regional diversification appear to be the main motivations for foreign banks to acquire Indonesian banks, particularly for Japanese and Korean banks that have been active in M&A recently. This is well sup- ported by the regional data comparison, where Indonesian banks look very attractive with a 10-year loan CAGR of 16 percent in 2019 compared to 2 and 7 percent for Japanese and Korean banks, respectively.

Net interests margin (NIM) of Indonesian banks was also high at 5.9 percent in 2019 vs. 1.0 and 1.9 percent for Japan and Korea, respectively. Yet, there is no guarantee that all acquirers will be successful – outcomes depend on how the acquirers adapt to the lending and funding dynamics in Indonesia.

“We expect higher foreign bank participation to drive efficiency in the system, via increased domestic competition and an improving cost culture (including the use of digital technology) to be infused in their Indonesian subsidiaries,” the report said.

Indonesian banks‘ cost or asset ratio at 3.3 percent in 2019 needs to improve, its high compared to 0.7 percent and 1.1 percent for Japanese and Korean banks, respectively. Similarly, foreign banks could instill better risk management practices, which could inspire peer banks in Indonesia.

“Last, we would expect a strengthening of capital bases and liquidity, considering that foreign acquirers are among the most solid banks in their home countries,” it said.

In the near term, the direction of how regulators overcome headwinds for smaller banks is becoming clearer by involving foreign investors and it should mean that the likelihood of big SOE banks being involved in supporting unrelated smaller Indonesian banks – which has been a key market concern – will subside.

In the longer run, the bigger banks should strive to cope with increased competition and digital initiative adoption, which we expect to lower the cost/asset ratio from 3.4 percent in 2020 to 3.1 percent in 2025 for the banks in our universe.

“We also lower our discount rate assumptions for the banks to reflect lower market and national service risks. Our price targets thus increase 10 – 20 percent. The key beneficiaries of this theme should be PT Bank Mandiri Tbk (IDX: BMRI), PT Bank Rakyat Indonesia Tbk (IDX: BBRI), and PT Bank Negara Indonesia Tbk (IDX: BBNI),” said Morgan Stanley.

The agency observe rising M&A activities, especially by foreign banks, among Indonesian banks recently, which believe is due to more-accommodative moves from the regulators toward foreign banks, as well as good appetite from foreign investors. Its expect the trend to persist and this more open approach should bring more positives than negatives to the Indonesian banking system.

In addition, higher foreign banks’ participation in domestic M&A could drive efficiency via increased competition, and improving risk and operational management, apart from solid liquidity and capital support. The higher efficiency could inspire banks in our universe to evolve in a positive way to maintain their leading positions.

With the industry’s potential declining operational costs and provisioning charges, we lower our mid-term cost assumptions, raising 2021 – 2025 earning per share by 3 – 13 percent. In the near term,

“We expect the national service risk on Indonesia’s big banks, which has been a key concern for investors, to diminish, due to the regulators’ strategy that involves higher foreign participation in the domestic banking system. Big SOE banks, Mandiri, BBRI, and BBNI , should be the key beneficiaries, in our view,” the report concluded.

Edited by Editorial Staff, Email: theinsiderstories@gmail.com