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Indonesia's banking industry is attracting many investors — but there are major risks

  • Indonesia's banking sector has many fans, but there are still risks ahead
  • Those include the absence of a credit bureau, the large number of banks in Indonesia and the rise of financial technology firms

High margins, a large market with low banking penetration and healthy economic growth are key reasons why Indonesia is considered one of the most attractive markets for financial institutions in Southeast Asia.

Moody's recently changed its outlook on the Indonesian banking system to positive from stable, as it saw improvements in the country's operating environment, asset quality and sovereign creditworthiness.

Indonesian banking executives speak on a panel hosted by CNBC in August, 2017.
Blanche Lim | CNBC
Indonesian banking executives speak on a panel hosted by CNBC in August, 2017.

Kartika Wirjoatmodjo, president director and CEO of Bank Mandiri said at a CNBC panel earlier this month that he does not see margins or profitability decreasing anytime soon as "excess to financing is still limited and if all banks were to grow rapidly, it will take at least five years for the market to converge."

While Wirjoatmodjo was confident, macro-economic and credit risks still threaten the industry, according to PwC's 2017 Indonesian Banking Survey.

Fauzi Ichsan, CEO of Indonesian Deposit Insurance Company, however, said that the risks are "actually coming down" and he attributed it to the country's healthy economic growth and stability in commodity prices.

Ichsan added that he considered the recent investment-grade rating for Indonesia from S&P global ratings to be an important vote of confidence.

Indonesia's banking industry might be one of the most profitable in Southeast Asia, but at the same time, challenges are aplenty: the absence of a credit bureau, the large number of banks in Indonesia and the rise of financial technology firms.

Financial regulators in Indonesia have said they are planning to consolidate the sector through mergers and acquisitions, in order to create a stronger and more efficient banking system.

Wirjoatmodjo was involved in the merger of four banks in Indonesia during his time with Boston Consulting Group. When asked if there is still room for consolidation in the industry, he mentioned that Indonesia should have a target of 50 to 60 banks in the long run, and "investors like Japan, China and Taiwan, are actually willing to buy and integrate more banks."

There are reportedly 120 commercial banks in Indonesia.

President Joko Widodo has a target to grow the economy at 7 percent. Much of that growth could come from financial technologies: A McKinsey report on Indonesia's digitalization said fintech firms could add up to 10 percent of GDP to Indonesia's economy by 2025.

Ichsan said that it will be difficult to imagine Indonesia's economic growth accelerating to 7 to 8 percent over the next few years, so the country will have to "rely on infrastructure development and when it comes to the banking sector, fintech can facilitate growth."

The rise of fintech firms is intensifying and challenging the traditional banking space, but there are a lot of complements, executives said.

Wirjoatmodjo explained that "big banks can embrace technology and change the way we think about customer relationship, risk management and even direction."

Key industry leaders all echoed the same sentiment that fintech companies do not threaten the banking system. In fact, they said they're keen on investing and collaborating with them.

Wirjoatmodjo went on to elaborate that the bank's resources are often strained and "by investing, they have direct access to ideas and also people who can build it." Therefore, it will be much more efficient for them to invest in fintech companies rather than to construct their own from scratch.

Furthermore, Vera Eve Lim, CFO of Bank Danamon, stressed that collaboration with fintech companies is key and her bank is actually seeking to use technology to enhance data analytics and automate processes.

One thing is for sure: Fintech unicorns are already eyeing a slice of the pie, and Adrian Gunadi, CEO of Investree said his largest concern will be foreign fintech companies entering Indonesia.

"They will be coming, and we have to be ready," he said.

Programming note: Viewers in Asia can catch the full CNBC panel on Indonesian banking at 5 p.m. SIN/HK on Friday, Aug. 25