2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC

 
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
February 2018

2018 Indonesia Banking Survey
Technology shift in Indonesia is underway
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
2018 Indonesia
                                                                 Banking Survey

David Wake
Financial Services Leader
PwC Indonesia               “
                            Technology, technology, technology. This is the recurring theme coming out of our 8 th
                            Indonesia Banking Survey. Respondents said technology is the #1 driver of business
                            transformation and the top risk to the industry. Transactions through digital channels are
                            surpassing traditional branches in Indonesia for the first time. The war for talent is strongest
                            for technology specialists.
Lucy Suhenda                Indonesia Banks are trying to keep pace with this change: only 8% of respondents said
Banking Leader
                            their bank has the same strategy as they did 18 months ago. Almost half have significantly
PwC Indonesia
                            changed their strategy in that time period. 9 out of 10 are undergoing some form of a cost
                            reduction program, and the most common approach to reducing operational risk is
                            automation.

                            The outlook is improved for 2018 over last year, but cautiously so. Concerns about credit
                            risk and net interest margins are subsiding, and there are improved expectations for
                            profitability.

                            There will be winners and losers in this rapidly changing environment. We see areas where
                            Indonesia banks need to take more action – clarity of strategy, a greater focus on customer
                            centricity, driving strategies through to execution, and investing further in systems and risk
                            management to move from a moderate to high level of preparedness.

                            We thank all of our respondents to our 2018 survey and trust it will be a helpful catalyst to
                            stimulating dialogue for the betterment of Indonesia banks and the industry as a whole.
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
Areas of Insight

         Outlook                  Transformation                       Risk

   Conditions and Profitability   Drivers of Transformation          State of Play

            Margins                      Disruption           Preparedness and Response

  Credit Risk and Loan Growth     Strategy Considerations             PSAK 71

         Opportunities             Customer Experience              Opportunities

                                                                                          3
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
Outlook

          4
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
Takeaways

                            Expected NPL decline, but           Net Interest Margin
  Cautious optimism       concerns on credit risk are still      optimism may be
                                      high                        overestimated

                                                               More effective steps to
 Loan growth driven by   More merger & acquisition activity
                                                              improve competitiveness
   consumer lending                expected
                                                                    are needed

                                                                                         5
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
Cautious optimism
                                                                                               Measures to improve competitiveness falling short of expectations
Mixed views on extent of improvement in 2018, with
those from local banks again being the most positive                                           In 2015, the government launched a                               This is an important component of
                                                                                               series of new initiatives to stimulate the                       Indonesia building its competitiveness
Q What is your view of Indonesia’s market conditions for Banking in 2018, compared to 2017?    economy and improve the ease of doing                            for an open ASEAN market. On the
                                improving                       same           worse           business. Last year, respondents felt the                        positive side, two-thirds of respondents
                                                      55%              41% 43%
                                                                                               actions were positive but views were                             feel banks are “somewhat prepared” for
                                                                                               mixed on the likely direct impact to their                       an open market. Those from foreign
                                                                                               business. Bankers now feel the actual                            banks are perhaps most well positioned
                                              Local
                                                                                               impact did not meet expectations. Only                           to reflect on this question, given they
                                            Foreign                                            3% felt a significant impact (compared to                        have operations across the region -
                                                                                               18% expected), and 60% in fact reported                          they were less optimistic with 42%
                                                                                               no noticeable impact at all. Where there                         feeling that Indonesia banks were
                                         % forecasting                                         was benefit, it appears to be felt more                          unprepared.
                                       improved market
                                          conditions                                           strongly among state-owned banks: 67%
                                                                                               feeling a moderate or significant impact
                            67%                                                                compared to only 29% of other banks.
                                                      42%
                                                                                               Few bankers believe Indonesia banks are very prepared
                                                                                               for an open ASEAN market
Source: 2018 PwC Indonesia Banking Survey

                                                                                                Q How well prepared are banks in Indonesia to compete in an open ASEAN market?
  The outlook is improved, with most                        Like last year, respondents from
  bankers feeling conditions will be                        foreign banks do not share the                                               State-owned              Other banks
  the same or better than in 2017.                          same level of optimism as from
  This is similar to a year ago,                            local banks, who are 50% more                                                                Very      10%
  however that was coming off a                             likely to expect better
                                                                                                      89%                                              Somewhat                       52%
  difficult 2016. Given that                                conditions. Having said that, we
  profitability already improved                            see almost no views that                                                            11% Unprepared                  38%
  across the sector in 2017, this new                       conditions will worsen.
  outlook could be viewed as an                                                                  Source: 2018 PwC Indonesia Banking Survey
  overall improvement year-on-year.
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
Moderate profit improvement expected in 2018

CEOs across Asia are optimistic about global                                                   Following the trend in 2017, respondents from local banks are
economic growth                                                                                much more optimistic than foreign bank counterparts.
Q (2018 PwC 21st CEO Survey) Do you believe global economic growth will improve, stay           Q What is your expectation for your Bank’s Net Income in 2018?
the same, or decline over the next 12 months?

                                                                 +113%         Increase from
 i     Chart shows percentage of Asia CEO
       respondents answering ‘improve’.
                                                                               2017 to 2018                                                                                     75%    8%
                                                                                                                                                                                       41%         All

                                                                                                                                                                                      83%    11%   State owned

                                                                        60%
                                                                                                                                                                                      89%          Local private

                                                                                                                21%           13%                                  58%      8%                     Foreign
                                                   45%
                                            45%

                                                                                                                        Decrease        Same    Moderate          Significant
                                                                                                                                                increase          increase
                                                                                                Source: PwC 2018 Indonesia Banking Survey

                                                                                                83% of bankers surveyed expected at                              a confidence on continued profitability in
                                                                                                least a moderate increase in net income                          2018, albeit not a significant increase for
                                                                 28%

                                                                                                in 2018. With loan growth falling below                          most players.
                                                          27%

                                                                                                expectations in 2017, the improvement
                                                                                                in profitability for many banks last year                        Respondents from foreign banks are
                                     20%
                              19%

                                                                                                was largely driven by a reduction in                             less optimistic with more than one-third
                                                                                                provisions for loan losses. In our                               not expecting an improvement in
                                                                                                conversations with CEOs, we note an                              profitability for 2018.
                                                                                                improved sentiment on credit risk and
                                                                                                                                                                                                                   7
                              2012

                                     2013

                                            2014

                                                   2015

                                                          2016

                                                                 2017

                                                                        2018

Source: PwC 21st CEO Survey
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
Most banks expect a stable or increasing NIM in 2018
Only one-third of Indonesia bankers expect a                                                          Will NIM hold steady in the short and
Net Interest Margin (“NIM”) decrease in 2018                                                          mid-term?

    Q What is your expectation for changes in your Bank’s Net Interest Margin for 2018 only?          Last year there was a clear shift towards an       Larger banks were more likely
                                                                                                      expectation of declining NIM, and in fact it did
                                                                                                      decline on average about 30 – 50 basis             to expect a decline in NIM in
                                                                                    54%               points. For 2018, concerns on NIM decline          the mid-term
         50%                                                                                          have subsided with only one-third of bankers
                                                               47%                                    expecting a relatively small decline. Even         Q What is your expectation for changes in your Bank’s Net
                                                                                                                                                          Interest Margin for the Cumulative NIM change over next
                                                                                                      more, one-third expect a NIM increase in the        4 years 2018-2021?
                                                                                                      coming year.
                                    40%                                                                                                                   BUKU 4                                           83%
                                                                                                      When viewed over a longer horizon of the            BUKU 3                                      71%
                                                                                              34%
                                                                                              35%     next 4 years, 63% expect some decline, but
                                     32%                                                                                                                  BUKU
                                                                                                                                                                                             45%
                                                                                    30%       31%     again, mostly for a mild decline of 1-50 basis      1&2
                                    28%                         29%
          27%                                                                                         points. A further 20% expect an increase in
                                                                                                                                                               0-50 bps            51-100 bps         101-150
                                                                24%                                   NIM over the next 4 years. Foreign banks and             decline             decline            bps decline
          23%
                                                                                                      larger BUKU 3&4 banks are less optimistic
                                                                                                      but most still view the 4-year decline as being     Source: 2018 PwC Indonesia Banking Survey
                                                                                    16%               less than 50 bps.

                                                                                            Same
                                                                                                      37% of respondents do not expect NIM to
                                                                                                      decrease through 2021, and most of those
                                                                                           Increase
                                                                                                      are smaller banks that are more exposed to a
                                                                                           Decrease
                                                                                                      NIM decline due to smaller economies of
         2011         2012         2013          2014         2015           2016   2017     2018     scale and higher cost-income ratios. We
                                                                                                      continue to highlight that this is a risk to the
       Source: PwC Indonesia Banking Survey (2011, 2013, 2015, 2017, 2018)                            overall sector, particularly if there is a
       Base: All respondents
                                                                                                      convergence of negative cycles at the same
8                                                                                                     time – NIM decline, slower loan growth,
                                                                                                      increased credit risk and higher operating
                                                                                                      costs.
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
We see a downward direction for NIM over the mid and long term

PwC View
Over the mid-term we expect a further decline      NIM 12 month rolling average                                                                                                                Mild mid-term NIM decline expected
in NIM across the sector due to a range of
                                                                                                                                                                                               Q What is your expectation for changes in your Bank’s Net Interest Margin for the
factors:                                                 Net interest margin – rolling 12 month average (all banks)                                                                             cumulative NIM change over the next 4 years 2018 to 2021?

•   Increased competition                               6.6%                                                                                                                                                      % of Banks expecting a NIM decrease – next 4 years
•   Government focus on lowering the cost of            6.4%
                                                                                                                                                          BUKU 4                      51 bps
    banking to consumers, and increasing                6.2%
                                                                                                                                                                                                                                             Local      State-
    economic growth                                     6.0%                                                                                                                                                                      Foreign   Private     owned

•   Stable or declining inflation                       5.8%

•   Improved country risk                               5.6%
                                                                                                                                                          All Banks
                                                                                                                                                                                      28 bps
•   Inelastic deposit rates                             5.4%

•   Growth in consumer loans, particularly              5.2%                                                                                                                                                          0-50 bps

    mortgage loans                                      5.0%

                                                                Dec-15

                                                                                                             Oct-16
                                                                                                                      Dec-16

                                                                                                                                                                    Oct-17
                                                                                                                                                                             Dec-17
                                                                                  Apr-16

                                                                                                    Aug-16

                                                                                                                                        Apr-17

                                                                                                                                                           Aug-17
                                                                                           Jun-16

                                                                                                                                                 Jun-17
                                                                         Feb-16

                                                                                                                               Feb-17
•   Increased focus by banks on cost
    management and cost-income ratios
                                                      Source: OJK statistics, PwC Analysis

                                                                                                                                                                                                                                             50%
NIM trends on their own do not give the full       Given the growth environment, our advice to
picture of bank profitability. Banks with higher   most banks in Indonesia is to focus on cost                                                                                                                     50-100 bps                            61%
risk in their asset portfolio – and who have       and a lean environment – however, not solely
priced in that risk - will necessarily have        for cost sake, but for using those savings to                                                                                                                    > 100 bps

higher NIM. Nevertheless, we believe that          invest in other areas. “Cut 10 to spend 10”                                                                                                                                       79%
while there will be smaller ups and downs          and a Fit for Growth strategy will position
over the next 5 years, the ‘bouncing ball’ is in   banks to take advantage of the market
                                                                                                                                                                                               Source: 2018 PwC Indonesia Banking Survey
a downward direction..                             potential while not sacrificing on profitability
                                                                                                                                                                                                                                                                                   9
2018 INDONESIA BANKING SURVEY TECHNOLOGY SHIFT IN INDONESIA IS UNDERWAY - FEBRUARY 2018 - PWC
Overall loan growth improved, but sluggish

 Small increase in overall estimated loan growth in 2018
     Q What is your Bank’s target for loan growth for 2018?
                                                                                                    It was only a few years ago that fewer than                                          Credit risk still the top
                                                                                                    half of respondents even put credit risk in the
                                                                                                    top-3 list of challenges. That grew steadily                                         challenge to growth
                                                                                                    until 2017 when almost all bankers had it in                                         Q What are the top 3 challenges for achieving
              > 20%                 13%                                                                                                                                                   your loan growth in 2018?
                                                                                                    their list of top challenges. This has not
                                                                                                                                                                                              Chart shows % of respondents noting Credit Risk as a top-3
                                                                                                    changed significantly in 2018.                                                        i   concern
             16-20%                 13%
                                                                                                                                                                                         2018                                                         91%
             11-15%                                                38%
                                                                                                    While concern on credit risk has slightly
                                                                                                    subsided, concerns on Margin Pressure have                                           2017                                                          94%
              6-10%                                       30%                                       increased. In 2017, Margin Pressure was the                                          2015                                             67%

              0-5%
                                                                                                    #1 challenge to growth by 18% of bankers.                                            2014                                   49%
                            6%
                                                                                                    This is now up to 29%. As margins decline,                                           2013                      24%
                                                                                                    more pressure is put on profitability and the
                                                                    2017 level
              Source: PwC 2018 Indonesia Banking Survey                                             efficiency of the organisation becomes a
              Base: All respondents
                                                                                                    bigger factor in the bank’s ability to be
                                                                                                    competitive on pricing or to invest for growth.
                                                                                                                                                                                         Margin pressure is
 Based on responses, we estimate an                       Additionally, credit risk is still very
                                                                                                                                                                                         increasingly a top
                                                                                                    In fact, for respondents from larger BUKU 3&4                                        challenge
 increase in loan growth of between 2                     high on the list of challenges to         banks Margin Pressure was equal to Credit
 to 3 percentage points. While there                      growth, hardly moving from its top        Risk as the overall #1 challenge to loan                                             Q What are the top 3 challenges for achieving
 are clearly more robust plans for                        position from last year. We also see      growth (35% each). As noted earlier, the                                              your loan growth in 2018?
 growth in the mid-range of 10 to 15%                     some increased concern about weak         larger banks are 70% more likely to expect a                                              Chart shows the highest rated challenge to growth noted by
 (38% in 2018 vs 27% in 2017), there                      demand. Overall 30% of bankers                                                                                                  i   respondents
                                                                                                    decline in NIM in both 2018 and beyond.
 were also fewer bankers at the top                       noted this as a Top-3 concern last
 end of the range (loan growth greater                    year, and this is now up to 47%. This     Smaller BUKU 1&2 banks were instead more                                              Credit risk                                                      44%
 than 20%).                                               is especially higher amongst the          concerned about Credit Risk as the main                                                 Margin
                                                                                                                                                                                                                                              29%
                                                                                                                                                                                           pressure
                                                          larger BUKU 3 and BUKU 4 banks            challenge (52%).                                                                     Weak demand                          15%
                                                          (60%) that drive a lot of the nominal
10
                                                          loan growth.                              Source: PwC Indonesia Banking Survey (2013, 2014, 2015, 2017, 2018)
                                                                                                    Base: All respondents, composite calculation on respondent views on commercial and
                                                                                                    consumer lending growth
Concern about weak demand is also higher

 Weak Demand is increasingly
 noted by bankers as a Top-3
 challenge
      Chart shows % of respondents noting Weak Demand as a top-3 concern
  i                                                                        Concerns about weak demand are also
                                                                           higher year-on-year, noted now as a
  2018                                                           47%       top-3 challenge by 47% of banks.
  2017                                         30%                         BUKU 3&4 respondents were more
                                                                           likely to note weak demand as the #1
                                                                           challenge compared to smaller banks
                                                          67%
                                                                           (22% vs 8%).
 BUKU 4

  BUKU 3                                           56%                     This may be a reflective of overall
BUKU 1&2                                                                   weaker demand in the economy, but
                                     35%
                                                                           may also reflect tightened loan
                                                                           underwriting standards by banks over
                                                                           the last 18 months.

 Source: PwC Indonesia Banking Survey (2017, 2018)
 Base: All respondents, composite calculation on respondent views on
 commercial and consumer lending growth

                                                                                                                  11
Stronger, consistent expectations of NPL decline

     Our 2015 survey revealed significant         Overall the respondents believe that the         Another significant shift downward in expected
     concern about rising NPLs at that time.      worst is behind Indonesia banks in terms         NPLs for 2018
     This began to reverse in 2017, but with a    of NPLs. However, with credit risk still first
     large number of bankers still unsure about   and foremost on the minds of bankers             Q What is your expectation on the overall level of non-performing loans in your Bank in 2018
     whether NPLs had bottomed out. The           when it comes to loan growth, the
     outlook for 2018 is a growing confidence,    challenge will be whether credit risk                                       Decreasing NPL                           Increasing NPL
     with now two-thirds of respondents           management has improved to a level
                                                                                                                    65%                                       2018     13%
     forecasting NPLs to decrease. Of those       better able to manage risk as loan growth
     expecting a decrease, one-third expect it    slowly increases. This is a point that we                                    45%                            2017     16%
     to decline by more than 25%.                 noted in our prior year survey and believe
                                                  it is equally applicable to 2018 –                                                            17%           2015               47%
     Local banks continue to be slightly more     economic stress clearly plays its part in
     optimistic than foreign banks, but we did    the cost of credit, but is the industry better
     not note the same degree of disparity in     prepared now than it was 2 years ago to                                                                     2018
     views we noted last year. The most           manage risk? We explore this further in
     significant year-on-year change in views                                                                  72%                                      State/BPD
                                                  later sections of our survey.
     is from foreign banks. Last year only 28%                                                                       61%                               Local private
     were expecting a decrease in NPLs, and
     that has now more than doubled to 58%.                                                                             58%                               Foreign        21%

                                                                                                          80%                                             Syariah       20%

                                                                                                    Source: PwC Indonesia Banking Survey (2016, 2017, 2018)

12
Most NPL concern is concentrated on corporate loans and large SME

Corporate loans by-far still the area of
most concern to Indonesia banks
Q Which area provides the most concern to your Bank in terms of potential   There is no significant change in the main         Apart from BPD banks, the concern regarding
 NPLs in 2018?
                                                                            driver of NPLs – it remains corporate lending.     consumer lending NPLs is comparatively very
                          Areas of most NPL concern                         Consumer lending is much less of a concern,        low, even more than in 2017.
                                                                            with the exception of smaller BPD banks.
                 Corporate/    Consumer/         SME            Micro                                                          NPL ratios in the consumer segment are low
                 Commercial      Retail
                                                                            Among bank groups:                                 by comparison to other emerging markets,
                                                                                                                               and we expect over time to see more
 State-owned       50%            12%            38%                        SOE banks – results are consistent with our        sensitivity to the credit risk in this segment as
                                                                            2017 survey.                                       activity and growth intensifies.
                                                                            Local private – concern over SME lending
 Local private
                   56%                           33%            11%         has grown slightly, with it being now the #1
                                                                            concern among one-third of respondents.

                                                                            Foreign – As we can see, foreign banks
      Foreign       79%                           13%
                                                                            continue to be wary of the NPL risk in
                                                                            corporate loans disproportionately to other
                                                                            banks. This may partly be due to the fact that
                                                                            many foreign banks, particularly foreign
         BPD        40%           50%                           10%
                                                                            branches, have a higher proportion of such
                                                                            loans compared to local banks.

                                                                            BPD – there is a much larger concern noted
                                                                            on consumer/retail loans, but this is reflective
                                                                            also of the nature of the BPD portfolios in
                                                                            comparison to larger banks.
                                                                                                                                                                                   13
No significant change in corporate lending growth expectations
 Little change in expectation for year-on-year corporate loan growth.
 Smaller banks are more bullish.
 Q What is your Bank’s target for loan growth in 2018 for commercial/corporate/large SME?

                  2017                                                2018                  Bankers expecting greater than 10%
                                                                                                  corporate loan growth
                                    12%              > 20%      9%
                                                                                            BUKU 1&2                BUKU 3&4
                                    12%             16-20%      13%

                       32%                          11-15%              37%
                                                                                            80%                    46%
                       32%                           6-10%               38%

                                   11%                   0-5%   3%

                                      1%           Negative                                 Local banks            Foreign banks

                                                                                            66%                     43%

     Source: PwC Indonesia Banking Survey (2017, 2018)

14
And challenges continue in terms of credit risk

           On the whole, estimates for corporate loan        Last year we noted that there was very little
           growth are essentially flat year-on-year. While   correlation between expectations of loan
           there was a slight increase noted among           growth and expectations of NPL levels. This is
           some respondents, statistically it was            still the case for those expecting lower levels
           insignificant. We believe this is driven by       of growth – in fact, 65% of respondents who
           continued concerns about loan quality and         have more moderate expectations for
           tightened credit underwriting standards. 2017     Corporate loan growth (less than 10%)
           was below expectations for many bankers,          actually also expected NPLs to decrease in
           and therefore although the survey result is       2018.
           essentially the same year-on-year, this is
           indicative of a view that there will be some      For those expecting higher growth (greater
           slight increase comparative growth in 2018.       than 15%), there was indeed some correlation
                                                             in that 71% of those bankers also expected
           Estimated corporate loan growth is much           NPLs to decline. However, we note that this is
           higher among smaller banks, with 80%              influenced by state-owned banks who are
           expecting growth in excess of 10% compared        bullish on loan growth and positive on NPL
           to only 46% of larger banks. It is not clear      decline for each of the last 2 years.
           what is driving that optimism.

           Foreign banks are also more cautious
           compared to local banks where 50% more
           local bank respondents expect corporate loan
           growth in excess of 10%.

                                                                                                               15
Consumer lending expected to lead loan growth in 2018

     Consumer loan growth is projected to be     As the market heats up in consumer           Sharp increase in bankers expecting more than
     stronger in 2018 than in 2017. Last year    lending – particularly unsecured lending –   10% growth in consumer lending
     57% of respondents expected loan            our question for the industry is whether
     growth in excess of 10%. This year, that    banks have the necessary robust              Q What is your Bank’s target for loan growth in 2018 for Consumer?
     has expanded to 71%.                        systems and data analytics to price and
                                                 monitor risk appropriately. While that was                                2017                           2018
     In 2017 the broad increase in NPLs had      not the focus of our survey, we believe
     the effect of putting a premium on                                                                              22%                       > 20%       17%
                                                 there is a risk that many banks have
     collateralized lending such as mortgages.   growth ambitions in consumer lending                                      14%                16-20%       14%
     We now see an increased interest in all     that are not equally matched by their
     consumer categories for 2018. Clearly       investment in risk management                                        22%                     11-15%                  40%
     mortgages is still the main focus, but      preparedness.                                                 32%                             6-10%            20%
     overall we expect a higher level of
     competition across all consumer                                                                                        11%                    0-5%   9%
     segments.
                                                                                                                                                                                             3.21

                                                                                              Q Which product(s) are you principally targeting to drive growth in consumer loans at your Bank in 2018?

                                                                                                                  Products targeted to drive growth
                                                                                                        Mortgage                                          63%

                                                                                                        Cards                 29%

                                                                                                        Unsecured             27%

                                                                                                        Auto               25%
                                                                                                                                                                                      2017
                                                                                                        Micro        19%
                                                                                                                                                                                      2018

16                                                                                             Source: PwC Indonesia Banking Survey (2017, 2018)
Local banks in particular are focused on growth in retail lending
Both large and small banks                                 When we additionally analyse the             During that time, NPLs on consumer          Credit risk is still a challenge
                                                           respondents who expect particularly high     lending have also increased but are still
plan strong growth in                                      growth – defined as greater than 15% -
                                                                                                                                                    to growth but margin
                                                                                                        comparatively very low. The question to
consumer lending                                           we see that 43% of smaller BUKU 1&2          be asked is whether Indonesia banks         pressure is on the rise.
                                                           banks expect such growth. That is twice      have applied lessons learned, and
Q What is your Bank’s target for loan growth in 2018 for                                                                                            Q What are the top 3 challenges for achieving your loan
 Consumer?                                                 the level of larger banks that expect high   invested or will invest more heavily into    growth in 2018?
                                                           growth. Smaller banks tend to be less        their credit risk management in terms of         Chart shows the top challenge to growth noted by respondents
                                                                                                                                                     i
 Bankers expecting greater than                            advanced in their data analytics and we      retail lending as well.
                                                           highlight that the new requirements of
   10% consumer loan growth
                                                           PSAK 71 (“incurred loss” provisioning                                                     #1 challenge to Consumer loan growth
     BUKU 1&2                             BUKU 3&4
                                                           model to “expected loss” model) will add
                                                           additional burden in this respect.                                                         Credit risk

                                                           We note again that the challenge in a
                                        72%
     77%                                                   high growth environment for consumer
                                                           lending will be whether banks are
                                                                                                                                                                          43%                                         Margin
                                                           prepared not only on the front-end sales                                                                                                                 pressure
                                                           channel, but also with respect to robust
     Foreign banks                       Local banks
                                                           lending scorecards, data-analytics,
                                                           collection and overall risk management                                                     Weak                                       31%
                                                           systems. As corporate loan NPLs grew in                                                    demand              11%
    42%                                  85%
                                                           the last 2 years, many Indonesia banks
                                                           realized that there was more to be done
                                                                                                                                                                2018
                                                           in improving their credit risk
                                                                                                                                                                2017
                                                           management of corporate lending.

  Source: PwC 2018 Indonesia Banking Survey

                                                                                                                                                                                                                           17
Growth through M&A:
 Increased likelihood over next 2-3 years

                                                                                                                                 What we see this year is an increase in the number of bankers
 Local and state-owned banks more likely to be acquisitive                                                                       considering M&A as a tool for growth, moving up from 46% to 60%.
 Q How likely are you to use M&A as a tool to achieve strategic objectives in the next 2 to 3 years?
                                                                                                                                 Among the large SOE banks and local banks, the likelihood is even
                                                                                                                                 stronger with between 70% and 100% expecting M&A. However, one
                                                                                                                                 should note that the number of bankers in the “Very likely” category is
     Very unlikely or somewhat unlikely to use M&A                             Very or somewhat likely to use M&A                still relatively low at 14% of all respondents.

                                         40%                      2018                                    60%                    The drivers for M&A also vary among bank groups: State-owned banks
                                                                                                                                 look more to the opportunity for corporate synergies, while Foreign and
                                54%                               2017                              46%
                                                                                                                                 Local private banks focus more on expanding business channels.

                                                                                                                                 In the prior year we noted that M&A activity was sluggish and this may
                                                                  2018
                                                                                                                                 have been due to many willing buyers but not many willing sellers. While
                                                                                                                          100%
                                                                  State                                                          it is still to early to extrapolate, we see many banks having re-evaluated
                                                         20%     Syariah                                            80%          their strategies in the last 18 months, seeking to focus on their core
                                                                                                                                 strengths. This may be a catalyst for further M&A in the future.
                                                    27%        Local private                                    73%
                                                                                                       3.21

                                 54%                             Foreign                           46%                           Key differences in drivers for M&A
                     70%                                           BPD                    30%                                    by type of bank
                                                                                                                                 Q If somewhat or very likely, what is the primary driver to use M&A?

     Source: PwC Indonesia Banking Survey (2017, 2018)
                                                                                                                                          Expand business channels                         Corporate synergies

                                                                                                                                                                  9%       State-owned                           64%

                                                                                                                                             45%                              Foreign                   27%

18                                                                                                                                                 38%                     Local private                 31%
Growth through Syariah and Infrastructure:
Little perceived change year on year

Less optimism on future Syariah market share                                                          Syariah banking assets stand at                                      Plans for infrastructure finance were
growth than in 2017                                                                                   approximately 5% of total banking assets                             relatively unchanged from 2017. There is
                                                                                                      in Indonesia. With the largest Muslim                                still a strong interest to participate.
Q Syariah banking is currently approximately 5% of banking sector assets in Indonesia. What is your   population in the world, many are looking
 forecast for this percentage in the industry by 2025?                                                                                                                     We noted that the expected involvement
                                                                                                      at the opportunity to grow Islamic finance
                         Estimated Syariah market share by 2025                                       at a faster rate than the conventional                               is significantly higher for state-owned
                                                                                                      market. However, in our survey most                                  banks than for foreign banks. Given that
                              2017                            2018
                                                                                                      bankers felt that the Syariah banking                                the government has acknowledged that
                                              > 15%                                                   share over the next 8 years would either                             foreign investment is essential to meet
                                                                                                      stay the same or just slightly higher. Only                          the country’s needs, especially in
                               14%           11-15%             17%
                                                                                                      22% of respondents expected it to reach                              infrastructure development, we believe
       53%                                    6-10%                           39%                     the levels equal to the government’s 2023                            this gap is something that will need to be
                                                                                                      ambition of 15%, of which two-thirds were                            addressed by the government, the
                      28%                  Same (5%)                          40%                                                                                          industry and stakeholders.
                                                                                                      from state-owned banks.

The same expectation on involvement in
infrastructure finance as in 2017                                                                     Is there a level playing field in infrastructure finance?
Q What is your expectation for your bank’s lending or involvement with infrastructure finance in      Q What is your expectation for your bank’s lending or involvement with infrastructure finance in
 Indonesia in the next year?                                                                           Indonesia in the next year?

                              Expected Infrastructure Finance
                                                                                                       State-owned                                           84%
                              2017                            2018
                                                                                                            Foreign                           54%
                              15%      Significantly more          20%

           46%                          Somewhat more                            45%

                      27%                     Same                    28%
                                                                                                                                                                                                                        19
                                12%            Less           7%
Transformation

                 20
Takeaways

 Technology still the main
                             Technology spending is focused    Many digital strategies
    driver of business
                                on the customer front-end       lack sufficient clarity
      transformation

    State-owned bank           Transactions through digital
                                                              Opportunities to improve
    footprint is getting        channels are surpassing
                                                                Customer Analytics
    bigger, and bigger             traditional branches

                                                                                          21
Technology continues to drive business transformation in 2018
Focus is on front-end customer platforms

Technology the #1 driver of business transformation                                                      Tech spending is most focused on front-end systems
                                                                                                         Q What is the primary focus of your technology spending?
 Q What will be the main drivers of transformation in your banking business for the next 3 to 5 years?

                                                                                                                                        Front end                        Core system                                 Back office

                                                                                                                                               46%

                                                                                                                                                         44%

                                                                                                                                                                         44%
                                                                                                                                33%
         43%
                              34%

                                                                                                                                                                                                                               25%

                                                                                                                                                                                                                                         17%
                                                                                                                                                                                       13%

                                                                                                                                                                                                                 11%
                                                                                                                                                                                                 11%
                                                  14%

                                                                                                                                                                                       Foreign

                                                                                                                                                                                                                               Foreign
                                                                                                                                               Foreign

                                                                                                                                                                         State-owned

                                                                                                                                                                                                 Local private

                                                                                                                                                                                                                 State-owned

                                                                                                                                                                                                                                         Local private
                                                                                                                                                         Local private
                                                                                                                                 State-owned
                                                                6%
                             Changing
                                                              Operational      Risk
     Technology              customer           Competition                      Competition
                                                                                           Regulation
                                                              Excellence    management
                              needs                                                                        What is noteworthy for 2018 is the                                                     Apart from front-end technology,
                                                                                                           rising importance of changing                                                          state-owned banks are also focused
                                                                                                           customer needs, which is driving                                                       on core systems, while other banks
  In our prior year survey, 84% of bankers                                                                 banks to rethink how they do                                                           more on the back-office. Foreign
  surveyed were likely to invest in technology                                                             business. This was noted as the #1                                                     bankers were also more likely to
  transformation in the next 18 months. The                                                                driver for transformation by one-third                                                 invest in risk management systems
  priority on technology continues with it still                                                           of respondents, up from 17% in                                                         (42% noting it as a top-3 priority vs
  being the #1 driver of business transformation                                                           2017. The customer-centric focus is                                                    22% from state-owned banks).
  in Indonesia banks.                                                                                      evident also in that most banks are
                                                                                                           directing their tech spending to front-
  Source: PwC Indonesia Banking Survey (2017, 2018)
                                                                                                           end web/app/e-banking systems.
                                                                                                           Source: PwC 2018 Indonesia Banking Survey
Transactions through digital channels
surpassing traditional branches

                                                                                                                For the first time in our survey,   This migration to mobile and
What is the future of the traditional branch?                                                                   mobile and internet has taken       internet is nothing new. But
                                                                                                                over the top channel spot for       the pace of the change in
Q What is your estimate of the proportion of the customers’ transactions which were processed through branch,   customer transactions.              Indonesia is significant to
 internet/mobile and ATM?
                                                                                                                Traditional branches no longer      note. That change is most
                                    % of respondents noting > 50% of                                            dominate the transactional          swift among the larger BUKU
                                 transactions in the following channels                                         landscape as it did only 3          3&4 banks. In last year’s
                                                                                                                years ago.                          survey, 53% of those bankers
                                                                                                                                                    estimated that more than one-
               75%                                                                                              In 2015, only 10% of                quarter of their transactions
                                                                                                                respondents noted that more         are via mobile and Internet.
                                             Traditional                                                        than 50% of their transactions      That number is now up to
                                             branch                                                             are processed via mobile or         75%. The shift among smaller
                                                                                                                internet banking. This is now       banks is occurring but more
                                                                                                                more than one-third of              slowly (42% to 52%).
                                                                                                                respondents. In 2015, 27%
                                                                                                                from our survey said at least       It is true that for many banks
                                                                        45%                                     one-fourth of transactions          even though the volume of
                                                                                                                were via mobile & internet.         transactions is lower, the
                                                                                                   35%          This is now up to 67% of            value of transactions through
                                                                                                   31%          respondents. In fact, even          the branch is still high.
                                                                                                                ATM transactions are                However, we believe that the
                                             Digital                                                            approaching the level of            pace of technology change
                                             channels                                              22%          traditional branches (though a      and move to a more cashless
                                                                        20%
                                                                                                                difficult measure given that        society will drive change in
                                                                        15%            ATM                      many ATMs are ‘in-branch’).         that respect as well.
               10%

                                                                                                                                                                                     23
               2015                        2016                        2017                        2018
Expected Fintech disruption is mild for 2018 but picks up
 substantially over the next 5 years

 For 2018, only 6% of respondents anticipate a     Fintech disruption anticipated over the next 5 years
 significant disruption from Fintech. However,
                                                   Q What is the level of risk that your bank’s business will be disrupted by new Fintech competition in the market in 2018
 when viewed over a 5 year horizon that             and over the next 5 years?
 number jumps to 28%, with a further 52%
 expecting a moderate disruption.                                                     Expected disruption to business from Fintech
 Respondents from larger banks feel even
                                                                                               In 2018                   Over next 5 years
 stronger that disruption is coming: 41%
 expect significant disruption over the next 5                                                      6% Significant                 28%
 years compared to only 19% from smaller
 banks.                                                                              32%                   Moderate                              52%

                                                                          51%                               Some             18%
 Our survey did not differentiate the types of
 Fintech: peer to peer lending, blockchain,                                                        8%        None
 process automation, etc. However, there is
 clearly a recognition that technology is a                                                               Don’t know
 game changer.

 Despite the views on Fintech disruption over                                                           Over next 5 years
 the next 5 years, Fintech investment was still
 relatively low among technology investment                                               BUKU 1 & 2                     BUKU 3 & 4
 for Indonesia banks in 2018. Only 22% of                                                    19%           Significant                     41%
 bankers listed Fintech in their top-3 areas for
 investment in the coming year.                                           52%                              Moderate                              52%

                                                                                       29%                   Some           7%

24
However, challenges remain in terms of needed clarity on strategy

Digital strategies are in need of further clarity
Q How clear is your bank’s digital strategy for reaching and transacting with customers on digital platforms such as
                                                                                                                       Half of respondents from foreign and            One interesting result is that despite the
  mobile, internet, smart phone, etc?                                                                                  larger SOE banks felt their digital             rapidly changing environment in terms of
                                                                                                                       strategies were ‘very clear’. This              technology, mobile banking, Fintech,
                                   % who feel their tech strategy is “Very Clear”
                                                                                                                       compares to only 21% for all other              robotic process automation, AI, etc, most
                              Foreign                                              50%
                                                                                                                       respondents, indicating much room for           bankers in Indonesia feel their current
                                                                                                                       improvement across the sector. On the           technology is as ready to meet future
                         State-owned                                               50%                                 other hand, only 11% felt their strategies      needs as it is to meet the current needs.
                         Local private                     22%
                                                                                                                       were unclear. Results were almost               This does not seem consistent with the
                                                                                                                       identical to those in our 2017 Survey.          views expressed about clarity of digital
                                 BPD                     20%                                                                                                           strategies.
                                                                                                                       We noted a strong correlation between
                              Syariah                    20%
                                                                                                                       the clarity of the digital strategy and the     Respondents also noted that technology
                                                                                                                       extent to which a respondent felt their         skills were the hardest to find in the
                                                                                                                       bank was prepared for the future. Among         market (43% noting as scarce or limited).
Moderate feeling of technology preparedness                                                                            those that felt ‘very prepared’, 73% also       Therefore at a time when it is critical to
                                                                                                                       felt the strategy was very clear. Among         have sharp strategies and
Q How well prepared is your Bank’s technology to meet the needs of your current, and future, banking business and      those that felt only ‘somewhat prepared’,       implementation, skills are also difficult to
  customers in Indonesia?                                                                                              the level of strategy clarity dropped to        find and retain.
                                                                                                                       30%.
                                                                           Somewhat
                          Preparedness of IT to meet current and future needs
                           Very
                                                                                                                       These results can be reflective of a lack
                                                                                      or very
                           prepared                  Somewhat prepared              unprepared                         of strategy, or a good strategy that is
               Current       28%                               62%                           11%
                                                                                                                       simply not well understood across the
                                                                                                                       organisation. We note also that our
                Future       17%                           66%                               17%                       survey respondents are from among top
                                                                                                                       management of banks. A wider selection
                                                                                                                       of bank employees may have any even
                                                                                                                       lower level of clarity on strategy, making it                                                25
                                                                                                                       difficult to implement effectively.
State-owned banks are getting bigger…and bigger

Who is growing or                                                                                                            State-owned banks are most optimistic about
shrinking their footprint?                                                                                                   conditions for 2018, and this shows in their plans
                                                                        Expansion                      Reduction             for expansion - more than two-thirds are
Q In 2018, what are your plans for growth in the                                                                             expanding both branches and employees, while
  following areas?                                                                                                           almost none indicate plans for reduction. This is
                                                               State-                Local    State-                Local    particularly the case with respondents from BPD
  Reduction       No growth        Growth                      owned      Foreign   private   owned      Foreign   private   banks, of which 90% expect growth.
                                                                67%                                                          Respondents from local private banks were also
                                                                                     61%                                     bullish, albeit not quite to the degree of state-
                                                                                                                             owned banks.
                                                                                                          50%
                                    44%
                                                   Branches

                                                                                                                             On the opposite end of the spectrum were
                      31%                                                                                                    Foreign bank respondents – half are expecting a
       25%                                                                                                                   reduction in the number of branches and only
                                                                                                                     17%     12% expected the number to increase. These
                                                                            12%
                                                                                                                             trends were noted in our 2017 Survey: state-
                                                                                               5%
                                                                                                                             owned banks and local banks are more
                                                                                                                             aggressively growing their footprint and getting
                                                                                                                             bigger in the process.
                                                                72%
                                                                                                                             There appear to be two very different strategies
                                                                                                                             at play. Among respondents from state-owned
                                    51%
                                                                                                                             and local private banks expecting higher loan
                                                   Employees

                                                                                     50%
                                                                                                          42%
                                                                                                                             growth (more than 10%), only 11% expect a
                                                                           33%                                               reduction in branches. This number is 69% from
                      26%                                                                                                    Foreign banks expecting the same growth.
       23%
                                                                                                                     17%     Foreign banks are less bullish on loan growth,
                                                                                                                             but where they are, they are seeking to do so
                                                                                               6%
                                                                                                                             with a smaller branch footprint, and are investing
                                                                                                                             in automation and digital capabilities.
Fit for Growth: “Cut 10 to spend 10”

There are a number of reasons why          In other words, to be successful,          A strong perceived need for cost reduction within
banks may take different strategies in     Indonesia banks are not only               growth environment
terms of growing their physical branch     addressing investment for growth, but
network: knowledge of the local market,    also how to reduce cost to make as         Q How do you feel about your Bank’s cost levels in order to be able to compete in the market and
                                                                                        meet your Bank’s growth and/or profitability goals?
region or customer base; different         much of that investment as possible
product focus (e.g., affluent vs mass
market); ambitions to grow market          In our Fit for Growth approach, we
                                                                                            Cost are competitive
share vs a more short-term focus on        recommend organisations to focus on                  or an advantage                      Cost reduction needed
                                           doing three things consistently and                                          BUKU
profitability, etc.
                                           continuously:                                              26%                1&2                                                  74%
However, as we can see from the
survey, there are two dynamics             1. Focus on a few differentiating                          24%                  3                                                  76%
impacting all banks in Indonesia: a           capabilities
                                                                                               42%                         4                                      58%
growth environment, and a rapid take-
                                           2. Align their cost structure to these
up of digital channels requiring new
                                              capabilities
investment and a reconfigured cost
base. This is driving banks across the     3. Organize for growth                       Q Is your Bank currently undergoing a review of costs or a program to improve efficiency?
market to be sharper on cost to free up
investment capital. This is the case for   It means to have resources, and thus          Banks undergoing a cost reduction program
many bankers more aggressively             cost structure, aligned to the company’s
expecting branch expansion as well;        overall strategy – deployed toward the
e.g., 61% of respondents from State-       right businesses, initiatives, and
                                                                                                                                          93% of respondents are
owned banks expect cost reduction. In      capabilities to execute the growth
                                                                                                                                       undergoing a cost reduction or
fact an overwhelming 93% of                agenda effectively. Fit for Growth                               93%                             efficiency program
respondents to our Survey said their       companies have the right amount of
organization is undergoing a review of     resources they need to compete
costs or a program to improve              effectively – no more, no less – at the
efficiency.                                right places.
                                                                                                                                                                                         27
Significant change in strategies over the last 18 months,
 needing more clarity

     Strategies are changing: 45% of                Indonesia bank strategies are                              Strategies need more clarity in the
     respondents noted a significant change in      actively being re-evaluated                                organisation
     strategy during the last 18 months. In fact,
     only 10% of respondents have the same          Q How has your strategy changed over the last 18 months?   Q What do you feel is the level of clarity and understanding of your strategy to
                                                                                                                 people in your organisation?
     strategy as they did only 18 months ago.

     However, overall only 30% of bankers felt                    Modified strategies in the last                                Level of clarity of strategy throughout
                                                                           18 months                                                        the organization
     their strategy was well understood
     throughout the organization. This varies                        BUKU               BUKU
                                                                      1&2                3&4
     from a high of 63% among larger SOE

                                                                           94%
     banks down to only 10% among BPD

                                                                                       87%

                                                                                                90%
                                                                                                                                               30%

                                                                    80%
     bankers.

                                                                                                                                                          62%

                                                                                                                                              High       Moderate       Low

                                                                                                                                 Extent to which there is a high level of
                                                                                                                                            clarity of strategy

                                                                                                                 State-owned                                               63%

                                                                                       2017

                                                                                                2018
                                                                    2017

                                                                           2018

                                                                                                                      Foreign                                  45%

                                                                           Significant change                    Local private                17%
                                                                           Moderate change                                BPD              10%

28
Insights: How can Indonesia banks be more successful in driving
their strategies to execution?

Winning companies close the strategy-to-execution gap with five
acts of unconventional leadership

                                                                                     Commit to an identity: You are what you do, not what you sell

                                                                                     Translate the strategic into the everyday: Build your own
                                 5              Shape your future
                                                                                     distinctive greatness

                             4             Cut costs to grow stronger            $   Put your culture to work: Make it your greatest asset

                       3                     Put your culture to work
                                                                                     Cut costs to grow stronger: Stop cutting across the board. Invest
                                                                                     in unique capabilities

                 2                   Translate the strategic into the everyday       Shape your future: Focus on what you do best to own your own
                                                                                     future
            1                                 Commit to an identity

                                                                                     “
                                                                                                 Companies that commit to the 5 acts,
                                                                                                 grow 3X faster and achieve 2X profit
Source: Strategy& analysis
                                                                                                                         Source: Coherence profiler with 4,400+
                                                                                                                               respondents, Strategy& analysis

                                                                                                                                                                  29
Where are Indonesia banks in terms of the 6 Customer Experience
     Imperatives?

                                                          Well defined customer messages across touch               Structured feedback gathering and improvement
      Right channel and customer mix                      points                                                    process

        Foreign                                             Foreign                                                     BPD

         State-
                                                               BPD                                                    Foreign
         owned
                                                             State-                                                   State-
        Syariah
                                                             owned                                                    owned

           BPD                                              Syariah                                                   Syariah

          Local                                               Local                                                    Local
         private                                             private                                                  private

                   Weak       Moderate        Excellent                Weak         Moderate            Excellent               Weak         Moderate           Excellent

                                                          Digitalisation and innovation to retain and               Most bankers had a moderate view on their
      Consistent experience across channels               acquire customers                                         response to the 6 Customer Experience
                                                                                                                    Imperatives. Only 3% of respondents felt their
        Foreign                                             Foreign                                                 bank was ‘excellent’ in these areas. On average
                                                                                                                    Foreign banks were most confident, and Local
          BPD                                                  BPD
                                                                                                                    private banks were consistently the least
        State-
                                                            Syariah                                                 confident. However, we note that there was not a
        owned
                                                             State-
                                                                                                                    substantial difference across the range of
        Syariah                                                                                                     responses.
                                                             owned
         Local                                                Local
        private                                              private

                   Weak       Moderate        Excellent                Weak         Moderate            Excellent

30
Customer Analytics capabilities lagging behind views on Customer
Experience Imperatives

As noted earlier, changing            72% of responses were moderate          Bankers are less confident about Customer Analytics capability
customer needs was seen as the        or less, with 27% indicating a          than with overall approach to Customer Experience
#1 driver of business                 lower level of maturity. Overall we
transformation by one-third of        see that the confidence on              Q What is the level of maturity of your Bank’s Customer Analytics capability?
respondents, only surpassed by        Customer Analytics is not quite to
technology. Spending on               the level of confidence about the                                                                   Maturity of Customer Analytics capability
technology is also most directed      respective bank’s approach to
towards front-end web/app/e-          Customer Experience overall. A
                                                                                                                         Low                                         Moderate               High
banking investment.                   strong Customer Analytics
                                                                              Customer segmentation & Targeting                                                      3.23
                                      capability is the foundation for
What then is the maturity of          ensuring that limited resources are                      Profitability Analytics                                               3.22
Indonesia banks in terms of           focus in the right direction with the
analysing customers in order to be    most benefit.                                              Channel Analytics                                               3.08
most effective in the delivery of a
                                                                                    Customer acquisition Analytics                                            2.98
customer-centric strategy?            The most mature areas were in
                                      terms of customer segmentation                       Marketing mix Analytics                                            2.95
                                      and overall profitability analytics.
                                      Least mature were customer                                Retention Analytics                                       2.86
                                      retention analytics, measurement
                                                                                              Experience Analytics                                        2.85
                                      of the customer experience itself,
                                      and social media mining.                                 Social media Mining                                 2.66

                                                                                                                                                                     Customer Experience
                                                                                                                                                                     Imperatives midpoint

                                                                                                                                                                                                   31
Risk
Takeaways

  Technology and FinTech                                            Capital adequacy and
  disruption seen to be #1    Only moderate satisfaction with   corporate governance are felt
  and #2 risks to Indonesia        management of risks              to be strong and not a
           banking                                                         concern

 Impact of PSAK 71 to loan                                      Opportunities to improve Risk
                              Underinvestment in Cyber Risk
   provisioning potentially                                      Culture and Integrated Risk
                                      Management
      underestimated                                              Management strategies

                                                                                                33
Technology now at the forefront of risk in the industry

 Cyber risk and FinTech disruption are challenging                                                              For the first time we see technology          Credit risk was the #2 risk in 2017, and is
                                                                                                                related risks at the top of banker            now #4. This reflects a more positive
 bankers to rethink strategies and response to risk                                                             concerns for the industry in Indonesia.       sentiment on NPLs, and a better overall
 Q Please score the risks facing the banking industry in Indonesia over the next 2 to 3 years                   Both Technology/Cyber Risk and FinTech        outlook, but bankers are still cautious
                              Low                                 Moderate              High
                                                                                                                disruption were a clear #1 and #2. By         about the credit risk that is inherent in the
       Technology/Cyber                                                      4.03                               comparison, technology risk was #6 in         sector. Only respondents from the large
      Fin Tech disruption                                              3.89
                                                                                                                2017 and #7 in 2015. FinTech disruption       state-owned banks did not note credit risk
                                                                                                                was #12 last year.                            in their top-5 risks (#6).
         Macro-economy                                              3.63
                                                                                                                Business Model risk has risen sharply up      At the bottom of the list, capital availability
                Credit risk                                    3.51                                             the list from #11 in 2017 to #5 for 2018.     is the least of concerns to bankers in
         Business model
                                                                                                                Given the extent to which technology is       Indonesia. Capital adequacy levels are
                                                              3.40
                                                                                                                rapidly changing the entire financial         generally high and banks do not feel this
     Quality of risk mgmt                                  3.23                                                 services sector, bankers are concerned        is a risk. That is an overall positive factor
                                                                                                                whether the current business model is         for the industry as a whole, however we
            Pricing of risk                                3.23
                                                                                                                appropriate. Blockchain, payments, peer-      see that the challenge for Indonesia
       Human resources                                     3.22                                                 to-peer lending, cryptocurrency, digital      banking is not currently constraint in
                                                                                                                channels – new risks are emerging.            terms of capital and finance, but rather
            Interest rates                              3.20                                                                                                  one of competitiveness, agility and ability
                                                                                                                Risk in the macro-economy had been the        to manage risk. The one exception here
                 Currency                               3.12                                                    top risk since 2015, and this has fallen to   is among respondents from smaller
               Regulation                              3.09
                                                                                                                a distant #3 as many concerns about the       regional BPD banks where capital
                                                                                                                Indonesia economy have subsided and           availability tied for #6 in their ranking of
     Political interference                            3.06                                                     global optimism is much improved. In our      industry risk.
                                                                                                                recent PwC Global CEO Survey released
         Economic crime                              3.00
                                                                                                                at the World Economic Forum in Davos,
                  Liquidity                         2.97                                                        60% of CEO’s in Asia expect improving
                                                                                                                global economic growth. That compares
       Conduct practices                            2.91                                                        closely to the 57% of Indonesia bankers
                                                2.75
                                                                                                                in our survey who expected improved
  Corporate governance
                                                                                                                conditions for the sector in 2018.
                                                                                     Source: PwC 2018
       Capital availability                  2.65                                    Indonesia Banking Survey
Foreign banks are most confident in their ability to manage top risks
relative to the market as a whole

While technology risk is noted by many, bankers have                                                                 All respondents feel their bank is more prepared to
diverse views on other risks                                                                                         address the risks than the industry as a whole
Q Please score the risks facing the banking industry in Indonesia over the next 2 to 3 years                         Q How well prepared is the industry in Indonesia to address top risks?
                                                                                                                                                     Low                    Medium                  High
        State-owned                         Foreign                 Local private                       BPD
                                                                                                                            Industry preparedness                                3.23
  Technology                         Technology               Fin Tech disruption              Credit risk                                                                                                 10%
  Fin Tech disruption                Fin Tech disruption      Technology                       Fin Tech disruption      Respondent preparedness                                       3.54
  Business model                     Credit risk              Macro-economy                    Macro-economy
  Macro-economy                      Macro-economy            Credit risk                      Liquidity
  Interest rates                     Regulation               Business model                   Technology                                    State                      3.25

                                                                                                                                           Foreign                                           3.83

Respondents from foreign Banks are                                 Foreign banks not only feel the most                              Local private                      3.17
much more sensitive to regulation than                             confident about their own ability to                                       BPD                              3.60
other bankers. While they noted                                    manage top risks, but they also have the
regulation at #5, other banks rank it only                         largest gap (25%) between their view of
as #14. Of particular concern is data-                             the industry’s ability to address top risks
onshoring, IFRS 9 and KYC/AML.                                     and their own ability to address those
                                                                   risks. This gap was much lower for other
BPD banks note liquidity as the #4 risk                            bank groups where all were less than 5%
and capital adequacy as #6. This points to                         difference.
potential challenges unique to these
smaller banks. They are generally less
diversified and have a smaller market
footprint.

Source: PwC 2018 Indonesia Banking Survey
                                                                                                                                                                                                                 35
Lower satisfaction with credit risk management is driving changes in
local banks compared to foreign banks

Indonesia Banking Risk Focus Map - 2018                                                                                      Credit risk management still under a dynamic
Q Which are your top risk management focus areas in 2018?                                                                    pace of change
                  Credit              Liquidity         Market           Operational       Compliance          Technology    Q Which are your top risk management focus areas in 2018?
  State                               Satisfied         Satisfied                                                Satisfied                               Expected change in Credit Risk Management

                                                                                                                                                  None           Minor            Moderate              Significant
Foreign         Satisfied             Satisfied         Satisfied                                                Satisfied
                                                                                                                              Enhance scoring                                             2.06
 Local                                Satisfied                                                                                  and approval
private                                                                                                                      Limit exposure to                                                                        Foreign
                                                                                                                                                                                   1.75                               banks
                                                                                                                             certain industries
   BPD                                                                                                                           Enhance loan                                                    2.39                 Local banks
                                                                                                                                   monitoring
Syariah                                                 Satisfied                                                                                                                                                     (incl. State-
                                                                                                                                       Enhance                                                                        owned)
                                                                                                                             collection process                                              2.22
                  High focus = greater than 60% said a top-3 priority      Satisfied with risk management = 3.67 or more
                                                                           Unsatisfied with risk management = 2.33 or less      Data analytics                                               2.19
                  Medium focus = 30 to 60% said a top 3 priority
                                                                           No indication = “neutral”
                  Low focus = less than 30% said a top 3 priority

 The Indonesia Banking Risk Focus Map                                   It makes sense that bankers would                    As we can see, respondents from                          54% of respondents were satisfied with
 highlights the main risk management                                    direct their attention towards risk areas            foreign banks and large state-owned                      their management of credit risk
 focus areas of bankers, and whether                                    where they are less satisfied with                   banks are overall more satisfied with                    compared to 65% in 2017. The level of
 bankers are satisfied or unsatisfied with                              progress. However, these areas,                      their level of risk management. We                       satisfaction with the management of
 their actual management of that risk.                                  particularly Credit Risk and Technology              noted a strong correlation between                       credit risk was highest among
                                                                        Risk, are also noted as top risks for the            banks that have an integrated risk                       respondents from foreign banks (75%),
 Generally, we see that bankers are                                     industry as a whole by almost all                    management strategy and their                            compared to 44% among state-owned
 most satisfied with their management of                                respondents. The lack of satisfaction                satisfaction with risk management.                       banks and 39% in local private banks.
 risk areas they see as lower priorities -                              with the management of those risks
 Liquidity Risk and Market Risk – and                                                                                                                                                 As a result, Local banks are expecting to
                                                                        should be a call for action for Indonesia                                                                     be much more active in making changes
 less satisfied with higher priority risks                              banks to invest more heavily into those
 such as Credit Risk, Operational Risk                                                                                                                                                to their Credit Risk Management in
                                                                        areas.                                                                                                        2018, particularly in enhanced loan
 and Technology Risk.
                                                                                                                                                                                      monitoring and collection.
  Source: PwC 2018 Indonesia Banking Survey
Larger banks are addressing Operational Risk through Automation
Following a similar trend from 2017,    As we can see, Cyber security was         Larger banks investing in automation to reduce Operational Risk
larger BUKU 3 and BUKU 4 banks are      fairly low in priority as a strategy to   Q What is your strategy to reduce and manage operational risk in 2018?
investing more into Automation to       manage operational risk.
                                                                                                                         Top-3 initiatives to reduce Operational Risk
reduce Operational Risk. On the other
hand, smaller banks are investing                                                                                     Smaller banks                             Larger banks
more into foundational areas such as
                                                                                                      58%                                  Automation                                       93%
People Development, a review of
Standard Operating Procedures, Risk                                                     87%                                           People development                              72%
self assessments and Internal audit.
                                                                                                68%                                       Review SOPs                           52%

                                                                                                                39%                   Risk self assessment                31%

                                                                                                                                 6%       Cyber security                24%

                                                                                                                               10%         Compliance           14%

                                                                                                                   32%                    Internal Audit        7%

                                                                                                                                                                                                  37
Banks may be underestimating their response to Cyber Risk?
                                                        Although Technology Risk was                We believe the industry in                  Only one-third of Indonesia
     Global CEOs’ concern about
                                                        viewed as the top risk to Indonesia         Indonesia is underestimating the            banks have a CISO
     Cyber threats spikes                               banking, there does not seem to be          effort needed to address Cyber
                                                                                                                                                Q Does your bank have a Chief Information Security Officer?
     How concerned are you about Cyber Threats?         a similar intensity to managing that        Risk. It is not a question of “if” but
     Showing only “extremely concerned”                 risk.                                       rather “when” the organization is                             Showing only “Yes” response
                                                                                                    subjected to a successful cyber
                                                        Only 5% of respondents noted                attack. While many response plans           All banks            31%

      2018                                        40%   Technology as the #1 risk                   and roles exist on paper, in our
                                                        management focus area. Similarly            experience most banks do not run
      2017                                  24%         only 6% of smaller banks and 24%            simulations with multiple                       Local 17%
                                                        of larger banks noted Cyber                 stakeholders when testing whether
      2016                          21%                                                                                                          Foreign                          52%
                                                        Security as a top-3 strategy for            those plans will be effective in
      2015                          21%                 managing Operational Risk.                  practice.
      2014               14%                            The level of respondents’ overall           In our recent PwC 21st CEO
                                                                                                                                                 Source: PwC 2018 Indonesia Banking Survey

                                                        satisfaction with the management            Survey, global CEOs expressed a
       Source: PwC 21st CEO Survey (2018)               of Technology/Cyber Risk was high           sharp increase in concern about
                                                        at 62%. However, two-thirds of              Cyber threats compared to past
                                                        respondents noted their bank does           years.
                                                        not yet have a Chief Information
                                                        Security Officer. Only 17% from
                                                        smaller banks had a CISO.

38
                                                    “    The average estimated total financial loss as a
                                                         result of security incidents in Asia is $2.6 million.
                                                                                      Source: PwC Global State of Information Security Survey
PwC’s Global State of Information Security® Survey 2018

Our Global survey reveals that organisations in Indonesia are actively exposed to
the top vectors of Cyber security incidents compared to global responses

         40%                                                          26 %
                                      29 %
         23 %                         27 %                            15 %

                                                  Employee                                              Software
                     Phishing                     Exploited                                             Vulnerabilities

         30 %
                                      26%
         28 %                         23 %
                                                  Consumer                 Indonesia
                    Mobile
                                                  Tech
                    Device                                                 Global
                                                  Exploited
                    Exploited

                                                                 Source: PwC Global State of Information Security Survey

                                                                                                                           39
Increased compliance risk anticipated for KYC/AML

 Fewer bankers expecting an increase in
 Compliance Risk in 2018
 Q Do you foresee your Bank facing increased legal and compliance risk in 2018?          Compliance Risk has been seen to be                                 Smaller banks were expecting the most
                                                                                         on the increase for the last several                                increase in Compliance Risk in terms
                                       Bankers expecting increased Compliance            years. However, for 2018 most                                       of fraud – 69% noted this as a Top-3
                                                    Risk in 2018                         Indonesia bankers (55%) do not expect                               risk. There was also a sharp difference
                                                                                         an increase in Compliance Risk.                                     between foreign banks and local banks
                                                                                                                                                             in this respect: 80% of local banks
                                                                                         The areas of most focus are related to                              noted Fraud Risk in their top-3, as
                                                               67%                       Know-your-customer (KYC, AML)                                       compared to only 25% of foreign
                                                                                         which was a top-3 risk noted by 75% of                              banks. This may be reflective of a
                58%                                                                      larger banks.                                                       number of foreign branches that have
                                                                                                                                                             smaller retail portfolios. Nonetheless,
                                                                                         Increased KYC/AML risk                                              KYC – high on the list for foreign banks
                                                                                  45%    Q Which are your top risk management focus areas in                 - is closely related to Fraud Risk as
                                                                                         2018?                                                               well.
                                                                                         Areas of increased

                                                                                                                                                       66%
                                                                                         compliance risk (Top-3)

                                                                                                                                          59%

                                                                                                                                                 59%
                                                                                                                                         93%
                                                                                                                                   38%
                                                                                                                             24%
                 2015                             2016         2017               2018

                                                                                                              protection 10%
     Source: PwC Indonesia Banking Survey (2015, 2017, 2018)

                                                                                                              Consumer

                                                                                                                                   Tax

                                                                                                                                                       KYC
                                                                                                                  Other
                                                                                                                   Regs

                                                                                                                                         Fraud

                                                                                                                                                 AML
40
The clock is ticking on PSAK 71 implementation
                                                                       Only one-third of respondents noted that                            Among those who had a view, 61% of
 Most bankers expecting a PSAK 71                                      their bank has completed an impact                                  respondents expect increased volatility in
 impact of less than 25%                                               assessment of PSAK 71. As a result, there                           reporting results as a result of PSAK 71.
                                                                       may not yet be sufficient knowledge from                            This was as high as 78% from local
                                                                       which to draw a conclusion about the                                private banks and 71% from state-owned
 Q What is the estimated expected impact to the level of your Bank’s   cumulative impact on provisions for                                 banks Furthermore, 42% of respondents
  loan impairment provisioning from the implementation of PSAK 71?
                                                                       impairment. However, at this point most                             expect an impact to the way loans are
                                                                       respondents estimated an impact of less                             priced.
          Expected increase in loan impairment                         than 25%, which is below our experience
             provisioning due to PSAK 71                               from other markets.

                                                                       Larger banks are farther ahead in their
                                                                       progress in that 48% are in advanced
                       52%                                             stages of impact assessment compared to
                                                                       only 10% of smaller BUKU 1 and BUKU 2
                                                                       banks.

                                                                                   1 Jan 2018                                1 Jan 2019                                1 Jan 2020
                                                                                                           10 months                              12 months

                                                                                     IFRS 9                                                                              PSAK 71
                                                                                 effective date                                                                       effective date

                                    23%

         16%                                                           IFRS 9/PSAK 71 requires an “expected-loss” impairment model for more timely recognition of expected credit losses.
                                                  9%                   This requires entities to account for expected credit losses from first recognition of the loan and to recognize full lifetime
                                                                       expected losses on a more timely basis. Entities will be required to use not only historical losses and current
                                                                       information, but also reasonable and supportable forward-looking information.
      No change                                                                                                                                                                                         41
                  0%         25%           50%          75%
Two-thirds of Indonesia banks have not yet assessed the impact
                                                                                                                      Challenges                                                           Mitigation

     PSAK 71 presents a number of practical                                                                            • Definition of BM by senior management                              • Use of existing BM documentation and
     challenges that go beyond the core

                                                 Classification & Measurement Considerations
                                                                                                                       • Selling decisions with impact on accounting                          portfolio structures as starting point
                                                                                                 Business model
     classification and measurement issues.                                                                            • Processes and systems required to document BM and                  • Informing SM about requirements and
     System modifications, FV models,                                                                                    reasons for sales                                                    strategic options (e.g. on transition date)
     communication management with
     stakeholders, forecasting and sensitivity
                                                                                                                       • SPPI assessment at instrument level                                • Improvement /implementation of systems
     analysis, training, engagement with OJK                                                       Contractual
                                                                                                                       • Required information not available                                 • Clustering & use of efficient questionnaires
     just to name a few.                                                                           cash flows
                                                                                                                       • Business units to be included                                      • Training of business units
     Only 8% of respondents to our survey
     were in a “very advanced stage” of
                                                                                                                       • High quality FV needed for (structured) loans
     implementation, 80% of which are foreign                                                      Fair value                                                                               • Implementation of FV models for loans
                                                                                                                       • FV needed for modified loans
     banks whose parent companies typically                                                       measurement                                                                               • Improvement of existing IT systems
                                                                                                                       • May result in P&L and Equity volatility
     must already comply with IFRS 9 as of 1
     January 2018. Although, as of the date of
                                                                                                                                                                                            • Identify data gaps and capacity of existing IT
     this survey publication, 22 months remain
                                                                                                                       • Availability of data on transition                                   systems
     for implementation of PSAK 71, we                                                         Transitional impacts    • Determining opening position impacts                               • Deploy simulation tools to identify and quantify
     recommend that banks who have not                                                                                 • FV may be needed for loans currently at amortised cost               impacts
     already started an impact assessment                                                                                                                                                   • Develop, build and test FV models for loans
     begin to do so as soon as possible.
     Looking to IFRS 9 as an example, large
                                                                                                                       • Reconciliation between PSAK 55 measurement and new
     banks globally began their assessments at                                                                                                                                              • Mock up of disclosures
                                                                                                                         measurement categories under PSAK 71.
     least 3 years before the standard’s                                                                                                                                                    • Regular contact with regulators and investors
                                                                                                   Disclosures         • Additional qualitative and quantitative information is required
                                                                                                                                                                                            • Potential for national disclosures and / or
     effective date.                                                                                                     to be disclosed.
                                                                                                                                                                                              guidelines
                                                                                                                       • Need to communicate clearly to investor base.

42
                                                 Source: PwC Analysis
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