May 24, 2016 22:02:40
Lending rates remain under scrutiny by government
Since the new government took office in November 2014, there has been increased focus on lowering lending rates to help boost  economic growth and improve Indonesia’s competitiveness vs. its neighbors. So far the Financial Services Authority (OJK) and Bank Indonesia have taken steps to ease borrowing conditions (see Exhibit 5). While average lending rates have begun to decline, overall lending rates/NIMs/ROAs remain higher than that of ASEAN peers.

Could it intervene further?
OJK has ruled out a formal cap on lending rates, but it has asked banks to propose how “single digit” lending rates could be achieved in 2016. So far, lower lending rates are already being targeted in three ways: (1) reducing deposit costs for lenders; (2) providing a lower-cost substitute, e.g. government subsidized lending; or (3) providing incentives for greater competition. Government officials have also discussed the potential for a further cut in the subsidized micro finance lending rate and a capping of SOE deposit rates to reduce system interest rates further.

Broader systemic risks a concern given structurally high rates
A broad-based reduction of industry lending rates could result in credit rationing as banks avoid riskier segments with higher credit risks, reduce lending in remote areas, and further shrink loan books of smaller banks with higher funding/operational costs.  Additionally, system liquidity risks are a concern given the already high LDR and slow deposit growth. Tax amnesty could boost to system liquidity, but falling deposit rates and policy uncertainty could dis-incentivize repatriation of offshore funds.

BDMN and BBRI most impacted; BBNI (CL-Buy) still attractive
We cut EPS for our coverage by up to 24% and adjust our target prices to reflect further cannibalization of high-margin lending into our forecasts and a slower recovery in credit costs. We downgrade BDMN to Sell given these headwinds and its larger earnings risk from single-digit lending rate pressures. Upside risk: Faster growth in SME lending; better funding costs. While BBNI could see downside 2017/2018 ROA of 1.8%-1.9 (vs. GSe of 2.0-2.1%) under single-digit lending rates, its valuation would still be attractive with a 2016E P/BV of 1.0X. At CL-Buy, BBNI remains our top pick.