OREANDA-NEWS. Indonesian banks' liquidity is likely to stay relatively tight through the medium term despite the latest 25bp interest-rate cut by the Indonesian central bank, says Fitch Ratings. Lenders with weaker franchises, particularly small- and medium-sized banks, are likely to be the most affected.

The surprise decision by Bank Indonesia (BI) on 17 February to reduce its benchmark rate to 7.5% is not likely to have a significant impact on the banking system. Interest rates remain relatively high compared with recent years, and it remains to be seen the extent to which the central bank would be able to loosen monetary policy further. Inflation remains above the BI's target range of 3%-5%. The potential for rate hikes in the US in 2015 also suggests that BI would be limited in its ability to cut rates without placing additional downward pressure on the IDR - and by extension, risk widening the nation's current account deficit.

Competition for deposits is also expected to remain stiff. This is especially true for smaller banks with weak market share and that rely heavily on high-cost time deposits.

The financial results of large second-tier banks in 2014 highlight weaknesses linked to higher cost of funds, tight liquidity and higher credit costs, and slowing growth at key industrial sectors due to falling commodity prices. Net profit fell by between 8% to over 50% at PT Bank CIMB Niaga Tbk, PT Bank Permata Tbk, PT Bank Danamon Tbk and PT Bank International Indonesia Tbk in 2014 from a year ago. Fitch expects these banks' profit to remain under pressure this year, though their Issuer Default Ratings should remain unchanged as they are primarily based on parent company support.

Regulatory reforms should continue to help banks contain risks through 2015 despite the challenges in the operating environment. The reforms include the prudential regulatory measures of recent years such as conservative downpayment rules on consumer loans. The Financial Services Authority (OJK) has also capped deposit rates for certain institutions, which should help ease some of the upward pressure on deposit rates for smaller banks.

Indonesia's largest banks are in a much stronger position to cope with the current operating environment. Profitability at the top four largest banks PT Bank Mandiri (Persero) Tbk, Bank Rakyat Indonesia (Persero) Tbk, Bank Central Asia (Persero) Tbk and Bank Negara Indonesia (Persero) Tbk's remained steady in 2014, and they remain well-capitalised, with return on assets (ROA) among the highest among banks in Asia Pacific. Hence, Fitch maintains the Stable rating on Indonesia's major banks.