Senior Analyst at Moody's Srikanth Vadlamani expects that Indonesia's non-performing loans will increase moderately amid the country's 20 percent-plus loan growth rates in recent years in combination with the slowing economy. According to Moody's, Indonesia's economic expansion will slow to 5.4 percent in 2014. However, Vadlamani expects that the banking sector will have no difficulty to safeguard financial stability, particularly due to strong buffers in terms of high profitability and capital. "On profitability, Moody's report says Indonesian banks will remain amongst the most profitable globally. In addition, while net interest margins could trend down from the 5.8 percent seen in September last year - due to rising deposit costs - such contractions should be marginal."

Moody's new report "Indonesia Banking System Outlook" takes a look at Indonesia's banking system in five categories of operating environment; asset quality and capital; funding and liquidity; profitability and efficiency; and system support. The first two categories are assessed as deteriorating, while the other three categories are labeled "stable". Overall, the outlook for Indonesia's banking sector has been stable since January 2010. Even under an adverse scenario, it is expected to maintain healthy capital ratios.

Amid low international demand for Indonesian commodities (partly responsible for the country's wide current account deficit in 2013), high inflation after the government decided to increase prices of subsidized fuels in June 2013, and a sharply fallen Indonesian rupiah exchange rate, the central bank (Bank Indonesia) raised its benchmark interest rate gradually between June and November 2013 from 5.75 percent to 7.50 percent. This higher interest rate environment safeguards financial stability but comes at the expense of higher economic growth.

However, as supervision on Indonesia's banking sector has been transferred from Bank Indonesia to the new Financial Services Authority (OJK) since the start of the year, Moody's detects some potential transition risks. Conducive cooperation between both institutions is therefore a must.

Moody's also maintained the Indonesian government's Baa3/stable rating, which provides strong support to the country's banking sector.

"Moody's rates nine of the 10 largest banks in Indonesia by assets. The nine banks accounted for 59 percent of system assets at end-September 2013. All these nine banks are rated Baa3 for local and foreign currency deposits, and all the ratings carry stable outlooks."

Further Reading:

Moody's Investors Service Report: Indonesia Banking System Outlook