Why Indonesian banks must beware the rising credit risks

Rising special mention loans isn't good news.

According to Standard & Poor's, rising special mention loans are an early indicator that rapid loan growth is increasing the credit risks for Indonesian banks. 

Special mention loans--or loans overdue for up to 90 days but yet to turn bad--have been increasing since 2011.

Here's more from Standard & Poor's:

This divergence from long-term trends suggests borrowers are increasingly experiencing repayment difficulties. A sustained increase in these loans is a leading indicator of weakened repayment prospects or a potentially deteriorating loan portfolio.

"The main threat to asset quality stems from increased leverage in the private sector, aggressive regulatory measures to promote economic growth, and structural weaknesses in the banking industry," said Standard & Poor's credit analyst Ivan Tan. "All these factors could undermine the ability of the private sector to service debt in the long run."

On the other hand, the ratio of reported nonperforming loans declined to 1.9% in 2012 from 6.1% in 2006, partly reflecting the denominator effect of rapid loan growth.

Standard & Poor's doesn't expect any drastic deterioration in loan quality for the next two years, at least, and stands by its stable outlook for Indonesia's banking sector.

"Our base-case scenario assumes that Indonesia's resilient economic growth, which we forecast at 6.3% in 2013, and prevailing low interest rates should continue to help borrowers meet their debt payments," said Mr. Tan.