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Indonesian M&A to still prove attractive for Asian banks in 2019

Indonesia's banking sector will likely continue enticing foreign M&A investors, despite near-term local and global headwinds.

There are a number of reasons why foreign banks are being drawn to Southeast Asia's most populous nation, not least because Indonesia's banks are among the most profitable and capitalized in the region. Average return on equity for Indonesian banks could reach 16.5% in 2019, up from 16% in 2017, according to a Dec. 10 report from S&P Global Ratings.

"Most importantly, there is a very large 'unbanked' population in Indonesia," said Simon Chen, a senior analyst for the financial institutions group in Asia at Moody's, referring to the low levels of total credit for a country with a population of more than 260 million.

Japanese banks have been among the most active foreign acquirers in recent times. For some Japanese lenders, Indonesia has the added attraction that it offers the growth prospects unthinkable at home, where stiff competition and unfavorable demographics have weighed on the entire sector.

Since the beginning of 2014, Japanese financial institutions have paid or pledged at least US$9 billion for stakes in several Indonesian lenders. Notable recent deals include that of Japan's largest lender by assets, Mitsubishi UFJ Financial Group Inc., becoming PT Bank Danamon Indonesia Tbk's controlling shareholder after acquiring a 40% stake in August 2018.

But Japanese banks are not alone. South Korean groups, after sealing three bank deals in 2015, became active in M&A again in 2018. That included KB Kookmin Bank's July acquisition of 22% in PT Bank Bukopin Tbk.

Among the acquirers, four financial institutions — Japan's Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group Inc., as well as South Korea's Industrial Bank of Korea and APRO Service Group Co. Ltd. are merging their local acquired lenders into a single entity, a move that will enable them to be exempt from Indonesia's foreign ownership limit of 40%.

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Home and away

It is no coincidence that these banks are pursuing M&A in Indonesia at a time when foreign direct investment is robust.

Banks are essentially following their home-turf clients, Chen noted.

In the nine months ended September 2018, Singapore companies were the largest investors in Indonesia, with total investments of US$6.70 billion, according to data from Indonesia's Investment Coordinating Board. Japanese companies were the second-largest foreign investors, with a total of US$3.75 billion.

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For both foreign banks and their corporate clients investing in the country, local factors will likely continue to be favorable. In terms of economic growth, the World Bank is projecting Indonesia to outpace most other emerging markets through 2021, if not longer.

Furthermore, the World Bank has noted that domestic credit to the private sector as a percentage of GDP, an indicator of financial inclusion, stood at 38.7% in Indonesia in 2017, compared with, for example, Japan's 161.7% in 2016, the latest available figure, suggesting far greater opportunities for growth abroad for Japanese and other lenders.

However, Indonesia-focused lenders will keep an eye on global economic pressures, including interest rate moves. Between May and November 2018, Indonesia's central bank hiked interest rate six times, or 175 basis points combined, to arrest the fall of the Indonesian rupiah amid capital outflows from emerging markets in general. But as 2019 begins, the U.S. Federal Reserve has signaled a pause in U.S. interest rate hikes, and Indonesia has stood pat on interest rates since December 2018 as the rupiah recouped some of its lost ground.

All told, various tailwinds and headwinds continue to leave Indonesia in relatively fine form. "When foreign players are looking from the outside and wanting to put their money in a new market, they would be balancing out the economic growth landscape, incremental growth prospects, as well as profitability and asset quality trends within the particular market. ... That's where Indonesia stands out," Chen said.