Indonesian banks' fundamentals remain strong despite recent market volatility and governance reforms, according to Moody's Ratings.

On 24 March, Indonesia’s (Baa2 stable) Danantara sovereign wealth fund formally announced its board and advisors in a move aimed partly at calming investor concerns over its governance and potential political influence. The fund's creation was among a series of recent reforms that triggered sharp falls on Indonesia's equity market on 18 March, including for some of the country's largest banks.

Bank Tabungan Negara (Persero) Tbk (PT)'s (BTN, Baa2 stable, ba1) Tier 2 note issuance was also postponed, as a result of the market volatility, but dollar bond prices for other banks held up over the same period, reflecting fixed-income investors' underlying confidence in the banks.

"We believe that Indonesian banks' fundamentals remain strong despite the market volatility. The banks also have only moderate exposure to currency weakness because of their modest net open foreign-exchange positions and because their dollar loans are mostly to exporters," Moody's said.

The recent sharp movements in bank share prices reflect questions over the governance of state-owned Bank Mandiri (Persero) Tbk (P.T.) (Bank Mandiri, Baa2 stable, baa2), Bank Rakyat Indonesia (Persero) Tbk (PT) (BRI, Baa2 stable, baa2), Bank Negara Indonesia (Persero) Tbk (P.T.) (BNI, Baa2 stable, baa3) and BTN, whose ownership has been transferred to Danantara under the proposed reform. The transfer could result in changes to the banks’ board structures, as well as their business and financial strategies.

As a consequence, we expect the banks' balance sheet buffers to moderately decrease over the next couple of years, reflected in weakening capital, funding and liquidity ratios. There is also a lack of visibility on the banks’ potential credit exposures to Danantara's projects and whether these will increase credit risks because of related and single-party exposures, industry concentrations, or both.

However, we expect government support for the banks will remain unchanged, at a very high level, because their policy roles will continue and the government will still indirectly own the banks through Danantara.

In terms of financial policy changes, Danantara notably aims to earn $8 billion per year in dividends from state-owned enterprises to fund its investments, 60% higher than current dividends, and we expect the banks to increase their dividends as a result. The banks in recent days have confirmed they are increasing their dividend payouts (Bank Mandiri: 78% of net income, up from 60% a year ago; BNI: 65% (50%); BRI: 86% (80%); BTN: 25% (20%)). Combined with expected strong loan growth, we expect the banks' capital ratios to decrease, although we expect their common equity tier 1 ratios to remain in the range of 16%-20%, above the 15% average for their Association of South East Asian Nations (ASEAN) peers.

Separately, we expect strong loan growth at the state-owned banks to continue to be a priority under Danantara's ownership. Notably, the government’s upsized affordable housing scheme, which targets building three million houses per year for the next five years - at a total cost of at least IDR1,500 trillion ($90 billion), based on our estimates - has the potential to strain banks' funding and liquidity, particularly for subsidised mortgage lender BTN. Although the government will partly fund the project through strategic partnerships, as well as the state budget, we expect that the funding gap will be significant and could fall to the banks.

Because Indonesian banks are largely deposit-funded, the system’s loan to deposit ratio of 89%, as of year-end 2024 indicates that the new programme will further strain banks’ funding and liquidity if alternative sources of funding are unavailable. To support banks’ liquidity, Bank Indonesia has provided reserve ratio requirement incentives for lending to the housing sector. If executed well, the programme could benefit BTN's credit growth and profitability.

Moody's Ratings report redisseminated by The Asian Banker.