Indonesia Banking Industry

MARKET INTELLIGENCE REPORT ON

CONSOLIDATION OF INDONESIAN BANKING INDUSTRY

March 2007

Backgrounds

The country's banking industry has gone up and down especially after the 1998 crisis, which caused the liquidation of many ailing banks with a number of other undergoing restructuring under the bank restructuring agency (BPPN).

A number of the banks put under control of BPPN, during the 1999-2004 period, were later liquidated. Some of them were acquired by investors and some other were combined in merger. Those banks face financial problems mainly because of large non performing loans (NPL) in 1999, the country had 164 banks but the number was reduced to 133 in 2004.

In a bid to revitalize the banking industry, the government planned bank restructuring program in 1998. In 2004, Bank Indonesia launched its consolidation program called Indonesian Banking Architecture (API) to be fully implemented in 2010 when all banks must have capital at least Rp 100 billion.

Through API program the central bank hopes to create a healthy banking industry (both conventional and sharia banks) including bank owned by regional administrations - Bank Pembangunan Daerah (BPD). The consolidation program is aimed at increasing the capacity of banks including in facing risks and expanding business scale. Information technology will be used to support credit expansion.

Originally the central bank hopes that banks could increase their capital to the minimum level through market mechanism but since the API program was launched in 2004 it turned out the market mechanism did not work as expected. Until the end of 2006, there were still 26 small banks having capital below Rp 80 billion. Bank Indonesia, therefore, has to act more firmly in enforcing its rule.

There are still 8 months for the 26 banks to raise their capital to the minimum level of Rp80 billion by the end of 2007 and three years to go to meet the Rp100 billion level when the API is to be implemented fully in 2010. Unless they succeed in meeting the deadline their operations will be restricted by the Central Bank. They will not be allowed to operate normally as conventional banks.

Meanwhile, the Central Bank promises to incentives for banks which plan merger as part of the consolidation program toward full implementation of API. The Central Bank hopes that with API fully implemented the country's banking industry will be made up of healthy and competitive banks that could support the country's economic development.

The API scheme has encouraged merger among small banks and process of acquisition although not as originally expected as the procedure of merger and acquisition is quite complicated. The government policies are not always welcomed by banks especially as the policies are not always consistent.

Under President B.J. Habibie, foreign investors were allowed to become 100% owner of a bank. Now there is a regulation banning foreign investors from majority shareholders in more than one bank under what is called single presence regulation. Foreign investors such as Temasek from Singapore already have controlling stakes in a more than one bank in the country

Healthier banking industry is expected to attract foreign investors to the country. Following are more details about the prospects of mergers and acquisition of banks in the country.

Chronology of merger and acquisition

a. Program of Bank Restructuring/BPPN

During the years of economic malaise from 1999 to 2004 that followed the monetary crisis in 1997/1998 a number of ailing banks were taken over by the Indonesian Bank Restructuring Agency (IBRA or BPPN). The bank rescue agency was formed by the government to help restructuring ailing banks. Some of the banks failing to meet certain category were liquidated and other were recapitalized. In 2004, BPPN was replaced by PT. Perusahaan Pengelola Aset (PT. PPA).

The government launched recapitalization from 1998 to 2000 injecting capital in the form of bond totaling Rp 600 trillion to banks taken over by BPPN. Bank Indonesia ruled that a bank should have a capital of at least Rp 10 billion with capital adequacy ratio of less than 8%.

Those failing to meet that limits were categorized as unhealthy and would be taken over by the government to be put under BPPN's control.

In 1999, the government decided to combine four state banks namely Bank Dagang Negara (BDN), Bank Bumi Daya (BBD), Bank Ekspor Impor (Bank Exim) and Bank Pembangunan Indonesia (Bapindo), into one called Bank Mandiri.

In 2000, nine private banks under control of BPPN namely Bank Danamon, Bank Nusa Nasional, Bank Jaya International, Bank Risjad Salim Indonesia, Bank Duta, Bank Rama, Bank Tamara, Bank Tiara Asia, Bank PDFCI and Bank Pos Nusantara were combined with Bank Danamon as the surviving bank.

In 2002, five other private banks under BPPN namely PT Bank Bali Tbk, PT Bank Universal Tbk, PT Bank Prima Express, PT Bank Artamedia, and PT Bank Patriot were combined with PT Bank Bali Tbk as the platform bank using a new name Bank Permata.

In 2004, three more private banks Bank CIC, Bank Pikko and Bank Danpac agreed to a merger to form one bank named Bank Century Tbk having 64 branches with total assets valued at Rp 9 trillion.

In April in the same year, 2 banks - Bank Asiatic and Bank Dagang Bali - earlier put under special surveillance of Bank Indonesia, were liquidated. The two banks respectively located in Surabaya and Bali had assets totaled Rp 1,278 billion. In 2005, another bank was liquidated namely Bank Global. State-owned bank BNI was named by the government to return the money of the customers of the bank.

In addition to mergers there were also banks being acquired especially by foreign banks. The cash strapped government was forced to sell the bank under its control as it needed large fund to repay debt in bond it had issued to recapitalize a number of banks. A number of foreign investors took over large recapitalized banks through tenders including BCA, Bank Danamon, Bank Lippo, Bank Internasional Indonesia and Bank Permata.

Other good performing banks such as Bank Buana, Bank NISP and Bank DBS have also been taken over by foreign investors.

b. Period after the launching of API

In 2004, Bank Indonesia launched AP program aimed at revitalizing the country's banking industry. However, in 2006, there was booming in bank acquisition by foreign investors.

In 2005, here was only one banks acquired that was Bank Shinta by local investor PT. Sinar Mas Multiartha.

Based on data at Bank Indonesia, there were 7 banks - Bank Haga, Bank Hagakita, Bank Halim, Bank Swadesi, Bank Nusantara Parahyangan, Bank Indo Monex and Bank Arta Niaga Kencana (ANK) falling under control of foreign investors by acquiring the majority stake.

Bank Haga and Bank Hagakita, which were owned by the same shareholders, were acquired by Rabobank from the Netherlands; Bank Halim of the Gudang Garam Group was taken over by Industrial & Commercial Bank of China (ICBC). Bank Swadesi and Bank Indo Monex was acquired by Bank of India and State Bank of India; Bank ANK was acquired by Commonwealth Bank from Australia, and Bank Nusantara Parahyangan by the consortium of Acom and Bank of Tokyo Mitsubishi UFJ. Meanwhile, an investor from Singapore plans to acquire Bank Sri Partha.

Some of the banks acquired by foreign investors are not small banks facing problem to meet the capital minimum limit of Rp 80 billion in capital set for this year. They have capital more than Rp 100 billion or more than the minimum limit set under API. Bank Hagakita, for example, had a capital of Rp 123.9 billion when it was acquired, Bank Halim (Rp 106.9 billion), Bank Swadesi (Rp 112.1 billion), Bank ANK (Rp 134.4 billion) and Bank Nusantara Parahyangan (Rp 278.4 billion).

Those acquired with capital below Rp 80 billion were Bank Haga with capital at Rp 74.5 billion, Bank Indomonex (Rp 26.5 billion), Bank Swaguna (Rp 21.9 billion) and Bank Sri Partha (Rp 46 billion).

The condition at present is still far from the expectation of Bank Indonesia as far as merger and acquisition concern as most of 27 small banks with capital of below Rp 80 billion have not taken concrete to increase their capital either through injection of fresh capital or mergers to acquisition by larger banks.

The launching of API program led to acquisition of a number of banks although the central bank encourages mergers.

Most owners of small banks chose a simple way of selling their assets rather than going into the trouble of seeking merger, which will take a long procedure. In addition merger between two banks with different backgrounds may leave post merger problems.

So far only three banks - Bank Jasa Arta, Bank Mitraniaga, and Bank Harfa planning merger. The three banks are to form a new bank Bank PAN Mitra Asia.

There are small banks manage to inject additional capital such as Bank MAS, which made capital injection of Rp 44.4 billion in September 2006 to meet the minimum limit of Rp 80 billion. The bank owners are convinced the bank will expand in the future as it has succeeded in establishing market foothold with many loyal customers.

Single Presence

In November, 2006, the central bank issued a new regulation called "single presence policy (SPP)" banning investors from being majority shareholders in more than one bank. The regulation is aimed at creating a healthy competition among banks.

The SPP is to be fully implemented in 2010. If for some reason an investor could not fully comply with the regulation by 2010, the central bank will extend the deadline. The policy is part of the program of consolidation launched by the central banks, but it would be difficult for state banks to comply with regulation by 2010.

The new policy of the central banks is a reversal of the government policy allowing foreign investors to control up to 99% of a bank either through direct acquisition or through share market.

When most of the country's banks have shown good performance many have urged the government to restrict foreign role in the banking industry. Even in liberal countries like the United States, Japan, Australia and South Korea foreign investors are not allowed to control the majority of local banks.

In Australia foreign investors may not have more than 15% of the shares of a local bank. The limit is 30% in South Korea, and 25% in the United States.

According to Bank Indonesia Regulation, PBI No.5/25/2003 controlling shareholder either as individuals or corporate bodies have more than 25% of a bank shares alone or in consortium. Bank Indonesia could also determines persons or corporate bodies as controlling shareholders even if they have only less than 25% of the shares of a bank.

The SPP is concerned more with consolidation not with control over shareholders. Public shares in private banks are relatively small. Bank Permata, for example, is only 10.74% owned by investing public, Bank Danamon 30.38%, Bank Niaga 30%, Bank Mandiri 30%, and Bank BNI less than 1%.

A number of banks such as BRI, BCA, and Bank Mega are more than 40% owned by investing public, but the role of controlling shareholders remain important and the investing public have no power.

INDONESIAN COMMERCIAL NEWSLETTER

March 2007

List of Contents

FOCUS: CONSOLIDATION PROGRAM SPARKS BANK MERGER AND ACQUISITION 1

INDUSTRY PROFILE:

CONSOLIDATION OF INDONESIAN BANKING INDUSTRY 5

Backgrounds 5
Chronology of merger and acquisition 6
Government regulation and policy in banking consolidation 11
Criteria for good performing banks and anchor banks 13
Motives and goals of acquisition or merger 18
Model of acquisition/merger 21
Merger, acquisition and consolidation procedure and requirements 26
Related issues 28
Acquisition plan 29
Acquisition interest shown by foreign investors 31
Risks 32
Conclusion and prospects 33

PERFORMANCE AND PROSPECTS OF BANKING INDUSTRY IN INDONESIAN 35

Capital not evenly distributed 37
Structure will change with the merger and acquisition 39
Public funds held by large banks 41
Intermediacy role of banks still weak 42
Indonesian forex private banks relegate state banks 43
Large bank less active in extending credits 44
Interest rate declining 48
Joint venture banks more efficient 49
Profit ratio of foreign banks higher 50
Banking profit up in 2006 51
Joint venture banks healthies 53
Prospects 53

COMPANY PROFILE:

PROCESS OF MERGER OF BANK MANDIRI 55

PROCESS OF MERGER AND ACQUISITION OF BANK PERMATA 60

CORPORATE NEWS IN BRIEF:

Telkomsel expands operations to eastern Indonesia 68
Pertamina ready to wholly take over Polyprima 68
Japex-Mitsubishi invests US$ 400 million in Kangean block 68
Indosat-NTT cooperate in network operation 68
Indofood to invest US$ 177.5 million for business expansion 69
Bhakti investama owns 50% of Adam Air 69
Itochu to build railway transport facility in Kalimantan 69
Jasa Marga-Jakpro joint venture to build ring road section 70
KAB acquires 80% of Asuransi AEGIS 70
DJojohadikusumo Brothers to control Kiani Paper 70
Alcatel Lucent wins contract to build GSM networks for Indosat 70

ECONOMIC NEWS IN BRIEF:

Expansion of foreign retailers to be restricted 71
Asean to set up infrastructure fund 71
Govt. star building 52 units of low cost apartement tower in Jakarta 71
Jakarta city to stop issuing license for hypermarket 71
Indonesia to have first nuclear power plant in 2017 71
Govt. to draw priority list of projects with tax facility 72
Vietnam showns no enthusiasm in joining rubber cartel 72
Indonesia paradise for foreign portfolio investors 72

APPENDICES:

Directory of banking company in Indonesia 73
List of banks based on capital (per September 2006) 75

ECONOMIC INDICATOR:

Consumer Price Index in Indonesia 79
Oil Prices 80
Foreign Exchange and Gold Price in Indonesia 81
The Indonesian Economic Trends 82