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Foreign investors gravitate to Indonesian banks despite restrictive local rules

Enthusiasm for M&A dealmaking does not appear to have been significantly dampened by Indonesia's domestic rules on foreign investment into the local banking sector.

Indonesia's Financial Services Authority, or OJK, mandates that foreign investment in local banks is capped at 40% and that non-Indonesian investors may only hold stakes in one local company in any single sector. However, since 2015 the financial watchdog has allowed foreigners to buy up to 99% of local banks on the condition that two lenders are purchased and merged.

In one such deal, China Construction Bank Corp. bought Jakarta-based PT Bank Windu Kentjana International Tbk and PT Bank Antardaerah, merging them to form PT Bank China Construction Bank Indonesia Tbk.

Meanwhile Shinhan Bank Co. Ltd. of South Korea, a unit of Shinhan Financial Group Co. Ltd., recently completed a transaction that led to the merger of Jakarta-based PT Bank Metro Express and Surabaya-based PT. Centratama Nasional Bank.

Earlier in 2014, Seoul-based Hana Financial Group Inc.'s KEB Hana Bank also merged two local subsidiaries in order to comply with this rule.

"Whenever I have talked to officials from the OJK, I feel that the regulator welcomes notable investment from outside their banking industry as they believe having fewer banks [in the local sector] will bring more benefits to the entire financial industry," Lee Hwa-soo, CEO and president of Hana Financial unit PT Bank KEB Hana Indonesia, told S&P Global Market Intelligence.

Closer to home, Thailand's KASIKORNBANK PCL is also interested in snapping up Indonesian assets, Pongpol Nimmolrat, vice president of KASIKORNBANK's Business Intelligence Delivery Management Department, wrote in an emailed response.

"Consolidation to create fewer and stronger banks will strengthen the financial profile of the Indonesia banking system," said Ivan Tan, a Singapore-based director at S&P Global Ratings.

"This will enable the top Indonesia banks to build scale and compete effectively with larger ASEAN banks such as DBS Group Holdings Ltd., which is also pursuing a regional strategy. That said, it is likely to be a protracted process, given foreign ownership restrictions and generally low M&A activity," he added.

As of November 2016, 118 commercial banks and 1,632 rural banks were operating in the country, according to the most recent "Indonesian Banking Statistic" report.

The local regulator has sought to consolidate the sector to help bolster profitability and capital strength, said Kevin Kwek, managing director and senior analyst for ASEAN banks at Sanford Bernstein in Singapore.

The Indonesian banking industry saw a slight fall in combined net income in 2015 to US$15.88 billion from US$15.89 billion a year earlier, following a rise in provisions to US$6.29 billion from US$4.46 billion, according to the Economist Intelligence Unit.

However, given the relatively high net interest margins in Indonesia, as well as a growing population and robust GDP growth, the local banking sector remains attractive to foreign banks that have no presence there.

The Southeast Asian country's banking sector had an NIM of 5.50% for 2015, according to data by SNL Financial, an offering of S&P Global Market Intelligence. In comparison, the comparable ratios for Malaysia and the Philippines were 1.81% and 3.06%, respectively.

Meanwhile, comfortable capital buffers at banks in the country should also protect against potential headwinds. S&P Global Ratings has a stable outlook on lenders in the country.

"The industry’s Tier 1 ratio is 19%, one of the highest in the region. It will provide enough buffer against downside risks," S&P Global Ratings' Tan said.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.