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Dr. Detlev Holloh Denpasar, March 2001 Pro motion of Small F inancial I nstitutions ProFI ProFI Microfinance Institutions Study Paddy Bank, Sumbawa Central Bank, Head Office

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Dr. Detlev Holloh

Denpasar, March 2001

P r o m o t i o n o f S m a l l F i n a n c i a l I n s t i t u t i o n s

ProFI

P r o F I M i c r o f i n a n c e I n s t i t u t i o n s S t u d y

Paddy Bank, Sumbawa

Central Bank, Head Office

ProFI Microfinance Institutions Study i

ProFI Microfinance Institutions Study Dr. Detlev Holloh

CONTENTS

Introduction 1

1. The Microfinance Sector in Indonesia 6 1.1 Economic, Social and Political Framework Conditions 7 1.1.1 The Economic Crisis and Policy Response since 1997 7

1.1.2 Poverty Incidence and Policy Response since 1997 11 1.2 Microfinance Sector and Poverty Alleviation Programs 15 1.2.1 Microfinance Systems Development Projects 15

1.2.2 Microfinance-focused Poverty Alleviation Programs 18

1.2.3 Crisis-related Programs with Microfinance Components 25

1.2.4 Non-Government Organizations and Microfinance 28

1.3 Structure of the Microfinance Sector: Institutional vs. Program Microfinance 31 1.3.1 Institutional Microfinance 32

1.3.2 Program Microfinance 35

1.3.3 Institutional and Program Microfinance Compared 37

2. The Commercial Banking Sector and BRI’s Unit System 38 2.1 Past and Current Development of the Commercial Banking Sector 39 2.1.1 The Commercial Banking Sector prior to the Financial Crisis in 1997/1998 39 2.1.2 Policy Response to the Financial and Banking Crisis 41

2.1.3 Development of the Commercial Banking Sector 1997 – 2000 43 2.1.4 Regional Distribution and Outreach of Commercial Banks 45 2.2 Bank Rakyat Indonesia (BRI) and its Unit Banking System 47

2.2.1 Overview of Bank Rakyat Indonesia 47

2.2.2 Inception and Transformation of the Unit System 48

2.2.3 Institutional Set-up and Framework 48

ProFI Microfinance Institutions Study ii

2.2.4 Products and Services 50 2.2.5 Development Trends 1997 – 2000 51 2.2.6 Regional Distribution and Outreach 53

2.2.7 Current Financial Situation and Loan Portfolio Quality 55 2.2.8 Assessment and Conclusions 57

3. Bank Perkreditan Rakyat (BPR) – The People’s Credit Banks in Indonesia 60 3.1 “BPR”: Definition and Clarification 61 3.2 History, Number and Types of BPR 62

3.3 Regulation and Supervision 65

3.3.1 Evolution of the regulatory framework 65 3.3.2 Supervision 68

3.4 Regional Distribution and Outreach 69 3.5 Current Financial Situation and Performance 72

3.6 Development Trends 1995 – 2000 74

3.7 The ProFI BPR Baseline Survey in East Java, Bali and West Nusa Tenggara 75 3.8 Assessment and Conclusions 78

4. Lembaga Dana Kredit Pedesaan (LDKP) – The Rural Credit Fund Institutions 84 4.1 General Description 85

4.2 Evolution of the Regulatory Framework 88

4.3 Lembaga Perkreditan Desa (LPD) in Bali 90 4.3.1 History, Ownership and Socio-cultural Environment 90 4.3.2 Regulation, Supervision and Support System 91

4.3.3 Organization and Management 94

4.3.4 Products, Outreach, Market and Image 95 4.3.5 Current Financial Situation and Performance 97

4.3.6 Development Trends 1994 – 2000 101

4.3.7 Assessment and Conclusions 102

4.4 Lumbung Pitih Nagari (LPN) in West Sumatra 105

4.4.1 Historical background 105 4.4.2 Regulation, Supervision and Organization 105 4.4.3 Current Financial Situation and Performance 105

4.4.4 Assessment and Conclusions 105 4.5 Badan Kredit Kecamatan (BKK) in Central Java 107 4.5.1 Historical Background and Development 107

4.5.2 Regulation, Supervision and Support System 109

4.5.3 Ownership, Legal Form and Organization 110 4.5.4 Products and Outreach 110

4.5.5 Current Financial Situation and Performance 112 4.5.6 Assessment and Conclusions 113

ProFI Microfinance Institutions Study iii

4.6 Lembaga Perkreditan Kecamatan (LPK) in West Java 115 4.6.1 Historical Background and Development 115 4.6.2 Regulation, Supervision, Support System and Organization 115

4.6.3 Current Financial Situation and Performance 116 4.6.4 Assessment and Conclusions 117 4.7 Badan Usaha Kredit Pedesaan (BUKP) in Yogyakarta 118

4.7.1 Historical Background 118

4.7.2 Regulation, Supervision, Support System and Organization 118 4.7.3 Current State of Development and Performance 118

4.7.4 Assessment and Conclusions 121 4.8 Lembaga Kredit Usaha Rakyat Kecil (LKURK) in East Java 122

4.8.1 Historical Background 122

4.8.2 Regulation, Supervision and Ownership 122 4.8.3 Current Financial Situation and Performance 122 4.8.4 Assessment and Conclusions 123

4.9 Badan Kredit Kecamatan (BKK) and Lembaga Pembiayaan Usaha Kecil (LPUK) in South Kalimantan

124

4.9.1 Historical Background and Development 124

4.9.2 Ownership, Regulation, Supervision and Organization 124

4.9.3 Products and Outreach 125 4.9.4 Current Financial Situation and Performance 125 4.9.5 Assessment and Conclusions 125

4.10 Lembaga Kredit Pedesaan (LKP) in West Nusa Tenggara 127 4.10.1 Background 127 4.10.2 Current State of Development and Performance 127

4.10.3 Assessment and Conclusions 128

4.11 Other Lembaga Dana Kredit Pedesaan (LDKP) in Indonesia 129

5. The Badan Kredit Desa (BKD) in Java & the UED-SP Village Credit Institutions 130 5.1 The Badan Kredit Desa (BKD) in Java 131 5.1.1 History and the Political Economy of BKD Development 131

5.1.2 Evolution of the Regulatory and Supervisory Framework 134 5.1.3 Ownership, Legal Form and Organization 137

5.1.4 Savings and Credit Products 138

5.1.5 Number and Outreach 139 5.1.6 Current Financial Situation and Performance 141 5.1.7 Development Trends 1997 – 2000 145

5.1.8 Assessment and Conclusions 147 5.2 Unit Ekonomi Desa – Simpam Pinjam (UED-SP) 150 5.2.1 UED-SP Promotion by the Ministry of Home Affairs 150

5.2.2 Guidelines and Regulations 151

ProFI Microfinance Institutions Study iv

5.2.3 Statistics and Findings 153 5.2.4 Assessment and Conclusions 155

6. The Cooperative Sector and its Microfinance Windows 156 6.1 The Political Economy of Cooperative Development in Indonesia 157

6.2 The Current Regulatory and Supervisory Framework 159

6.2.1 Regulation 159 6.2.2 Supervision 160 6.3 Number of Cooperatives and Structure of the Cooperative Sector 162

6.4 Bank Bukopin and its Swamitra Model of Microfinance 167

6.4.1 Overview of Bank Bukopin 167 6.4.2 The Swamitra Program 168

6.4.3 Swamitra Outreach and Financial Situation 169 6.5 The Credit Union Movement 171

6.6 Tempat Pelayanan Simpan Pinjam (TPSP) 173

6.7 Assessment and Conclusions 176

7. Banking and Microfinance based on Syariah Principles 179 7.1 Promotion and Development of Syariah Banking in Indonesia 180 7.2 Bank Muamalat Indonesia (BMI) 182

7.3 Yayasan/Pusat Inkubasi Bisnis Usaha Kecil (YINBUK/PINBUK) 183

7.4 Baitul Maal wat Tamwil (BMT) 183 7.4.1 General Description 183 7.4.2 Organization and Supervision 184

7.4.3 Number, Outreach and Financial Situation 185

7.4.4 BMT in South Sulawesi 188 7.5 The Dakabalarea Program of the Government of West Java 189

7.6 Assessment and Conclusions 190

8. Towards a Microfinance Sector Strategy: Major Issues and Elements 192 8.1 Major Microfinance Sector Issues 193

8.1.1 Demand for Microfinance Services 193 8.1.2 Supply of Institutional Microfinance 194

8.1.3 General Issues of Microfinance Supply 196 8.1.4 Legal, Regulatory and Supervisory Frameworks 200

8.2 Essentials and Major Elements of a Microfinance Sector Strategy 203

ProFI Microfinance Institutions Study v

CURRENCY EQUIVALENTS

Note: The report provides information in Rupiah only, as the exhange rate has been extremely volatile during the last years and the US Dollar does not reflect local financial intermediation exclusively done in Rupiah.

End of Year

Currency Unit: US Dollar

Currency Unit: Indonesian Rupiah (Rp.)

1983 $ 1 = Rp. 994

1984 $ 1 = Rp. 1,074

1985 $ 1 = Rp. 1,125

1986 $ 1 = Rp. 1,641

1987 $ 1 = Rp. 1,650

1988 $ 1 = Rp. 1,731

1989 $ 1 = Rp. 1,797

1990 $ 1 = Rp. 1,901

1991 $ 1 = Rp. 1,992

1992 $ 1 = Rp. 2,062

1993 $ 1 = Rp. 2,110

1994 $ 1 = Rp. 2,200

1995 $ 1 = Rp. 2,308

1996 $ 1 = Rp. 2,383

1997 $ 1 = Rp. 4,650

1997 $ 1 = Rp. 8,025

1999 $ 1 = Rp. 7,100

2000 $ 1 = Rp. 9,675

FISCAL YEARS

Until March 31, 2000: April 1 to March 31

Until December 31, 2000: April 1 to December 31

From January 1, 2001: January 1 to December 31

ProFI Microfinance Institutions Study vi

ABBREVIATIONS AND ACRONYMS

ADB Asian Development Bank AVB Algemeene Volkscredietbank: colonial predecessor of BRI ALTRABAKU Asosiasi LPSM – Mitra Lembaga Keuangan Mikro dan Pengembangan Usaha

Mikro: Association of Self-help Promotion Institutions - Partner for Microfinance Institutions and Microenterprise Development

BAPPENAS National Development Planning Agency BI Bank Indonesia: Central Bank of Indonesia BKD Badan Kredit Desa: Village Credit Board BK3I Badan Koordinasi Koperasi Kredit Indonesia: National Credit Union

Coordination Board BK3D Badan Koordinasi Koperasi Kredit Daerah: Regional Credit Union

Coordination Board BKK Badan Kredit Kecamatan: Sub-district Credit Board, LDKP in Central Java,

Bengkulu, Riau, South Kalimantan BKKBN Badan Koordinasi Keluarga Berencana Nasional: National Family Planning

Board BKPD Bank Karya Produksi Desa: old-style BPR in West Java BMI Bank Muamalat Indonesia, Syariah commercial bank BMT Baitul Maal wat Tamwil: non-bank microfinance institution, YINBUK/PINBUK BNI Bank Negara Indonesia: commercial state bank BPD Bank Pembangunan Daerah: Regional Development Bank BPR Bank Perkreditan Rakyat: People’s Credit Bank BPR-LDKP LDKP converted to BPR status BPS Central Bureau of Statistics BRI Bank Rakyat Indonesia: People’s Bank of Indonesia, commercial state bank BUKP Badan Usaha Kredit Pedesaan: Rural Credit Board, LDKP in Yogyakarta BUMD Badan Usaha Milik Daerah: Regional Government-owned Enterprise CAR Capital Adequacy Ratio CGI Consultative Group on Indonesia CRP Community Recovery Program CRS Catholic Relief Services CU Credit Union CUCO Credit Union Coordination Board Dakabalarea Microfinance program of the Government of West Java GDP Gross Domestic Product Gema PKM Gerakan Bersama Pengembangan Keuangan Mikro Indonesia: Indonesian

Movement for Microfinance Development GTZ German Agency for Technical Cooperation GTZ-PNT GTZ - Project Nusa Tenggara IBRA Indonesian Bank Restructuring Agency ICMI Association of Indonesian Muslim Intellectuals IDT Inpres Desa Tertinggal: Presidential Instruction on Backward Villages IMF International Monetary Fund INKOPDIT Induk Koperasi Kredit: national secondary cooperative of Credit Unions/BK3I JPS Jaringan Pengaman Sosial: Social Safety Net KCK Kredit Candak Kulak: petty trader credit program KPKU Kredit Pengembangan Kemitraan Usaha: credit scheme of UPPKS project KSP Koperasi Simpan Pinjam: Savings and Credit Cooperative KUD Koperasi Unit Desa: Multi-purpose cooperative at sub-district level KUKESRA Kredit Usaha Keluarga Sejahtera: credit scheme of UPPKS project KUT Kredit Usaha Tani: farmer credit program LDKP Lembaga Dana Kredit Pedesaan: Rural Fund & Credit Institution LKK Lembaga Kredit Kecamatan: Sub-district Credit Institution, LDKP in Aceh LKMD Lembaga Ketahanan Masyarakat Desa: village administrative body

ProFI Microfinance Institutions Study vii

LKP Lembaga Kredit Pedesaan: Rural Credit Institution, LDKP in West Nusa Tenggara

LKURK Lembaga Kredit Usaha Rakyat Kecil: Small Business Credit Institution, LDKP in East Java

LPD Lembaga Perkreditan Desa: Village Credit Institution, LDKP in Bali LPN Lumbung Pitih Nagari: Village Credit Institution, LPKP in West Sumatra LP2SD Lembaga Penelitian dan Pengembangan Sumber Daya: NGO in Lombok LPK Lembaga Perkreditan Kecamatan: Sub-district Credit Institution, LDKP in

West Java LPUK Lembaga Pembiayaan Usaha Kecil: Small Business Finance Institution, LDKP

in South Kalimantan MAI Maskapai Andil Indonesia: type of shareholder company (BPR) MCP Microcredit Project MFI Microfinance Institution MUI Indonesian Council of Ulamas NGO Non-Government Organization NTAADP Nusa Tenggara Agricultural Area Development Project P2KP Proyek Penanggulangan Kemiskinan di Perkotaan: Poverty Alleviation Project

in Urban Areas P4K Proyek Peningkatan Pendapatan Petani-Nelayan Kecil: Small Farmers'

Income Generating Project PDM-DKE Pemberdayaan Daerah dalam Mengatasi Dampak Krisis Ekonomi: Local

Empowerment by Overcoming the Impact of the Economic Crisis PHBK Proyek Hubungan Bank dengan Kelompok Swadaya Masyarakat: Project

Linking Banks and Self-help Groups, also: linkage project PINBUK Pusat Inkubasi Bisnis Usaha Kecil: Center for the Incubation of Small

Businesses, regional chapter of YINBUK PLPDK Pusat LPD Kecamatan: Sub-district LPD Centers PMD Pemberdayaan Masyarakat Desa: Empowerment of Village Communities

(organizational unit of the Ministry of Home Affairs) PNM Permodalan Nasional Madani: state-owned finance company in charge of

liquidity credit programs PPK Program Pengembangan Kecamatan: Sub-district Development Program ProFI Promotion of Small Financial Institutions PUSKOPDIT Pusat Koperasi Kredit: regional secondary cooperative of Credit Unions/BK3D RIGP/P4K Rural Income Generation Project, 3rd phase of P4K Rp. Indonesian Rupiah SHG Self-help Group SHPI Self-help Promotion Institution SMERU Social Monitoring & Early Response Unit SSN Social Safety Net SUSENAS National Socio-economic Surveys TAKESRA Tabungan Keluarga Sejahtera: savings product of UPPKS project TPSP Tempat Pelayanan Simpan Pinjam: Savings and Credit Service Posts UBPR Urusan Pengawasan Bank Perkreditan Rakyat: BPR supervision department

of Bank Indonesia UED-SP Unit Ekonomi Desa-Simpan Pinjam: Village Economic Unit-Savings and Credit UNDP United Nations Development Programme UPK Unit Pengelola Keuangan: Financial Management Unit of PPK project UPKD Unit Pengelola Keuangan Desa: Village Fund Management Units UPPKS Usaha Peningkatan Pendapatan Keluarga Sejahtera: Family Welfare Income

Generation Project USAID United States Agency for International Development USD US Dollar USP Unit Simpan Pinjam: Savings and Credit Unit (of multi-purpose cooperative) YBS Yayasan Bina Swadaya: NGO YDBP Yayasan Dharma Bhakti Parasahabat : NGO in West Java YINBUK Yayasan Inkubasi Bisnis Usaha Kecil: Foundation for the Incubation of Small

Businesses, NGO

ProFI Microfinance Institutions Study viii

TABLES

1.1 Key Economic Indicators (1996 – 2000) 10 1.2 Poverty Lines and Incidence (1996 – 1999) 12 1.3 Project Linking Banks and Self-help Groups (1997 – 2000) 16 1.4 Microcredit Project (1997 – 2000) 17 1.5 Rural Income Generation project (RIGP/P4K) as of May 2000 19 1.6 Family Welfare Income Generation Project (UPPKS) as of July 2000 21 1.7 Participants of the Microfinance Sector in Indonesia 31 1.8 Institutional Microfinance in Indonesia 33 1.9 Perum Pegadaian – State-owned Pawnshop Company 35 1.10 Program Microfinance Funds 36 2.1 Growth of Commercial Banks and Bank Offices by Ownership (1988 – 2000) 40 2.2 Commercial Banks’ Financial Development (1996 – 2000, in Trillion Rupiah) 43 2.3 Banking Indicators 2000 (in Trillion Rupiah) 44 2.4 Change in Banking Structure (1996 – 2000) 45 2.5 Regional Distribution of Commercial Banks, Outstanding Credit and Deposits 46 2.6 Development Trends of BRI Units (December 1994 – June 2000, in Billion

Rupiah) 52

2.7 Regional Distribution of BRI Units (June 2000) 53 2.8 Outreach of BRI Units by Region (June 2000) 54 2.9 Assets and Balance Sheet Structure of BRI Units by Region (June 2000) 55 2.10 Loan Portfolio Quality of BRI Units by Region (June 2000) 56 3.1 Number of BPR 1988 – 2000 63 3.2 BPR Types and Legal Forms by Region (March 2000) 64 3.3 BPR Regional Distribution (March 2000) 69 3.4 BPR Outreach (March 2000) 70 3.5 BPR Assets and Balance Sheet Structure (March 2000) 72 3.6 BPR Assets and Loan Portfolio Quality (March 2000) 73 3.7 BPR CAMEL Rating (March 2000) 74 3.8 BPR Development Trends December 1994 – March 2000 (in Rp. Million) 75 4.1 Number of LDKP by Province 86 4.2 LDKP Indicators by Province (June 2000) 87 4.3 Number of LPD 1988 – 2000 90 4.4 LPD Outreach (March 2000) 96 4.5 LPD Consolidated Balance Sheet (March 2000) 97 4.6 LPD Consolidated Income Statement (March 2000) 98 4.7 LPD Assets & Loan Portfolio Quality (March 2000) 99 4.8 LPD Financial Sustainability (March 2000) 100 4.9 LPD CAMEL Rating (December 1999) 100 4.10 LPD Development December 1993 – March 2000 (in Rp. Million) 101 4.11 LPD Loan Portfolio Quality and Soundness December 1995 – March 2000 102 4.12 LPN Consolidated Balance Sheet (June 2000) 106 4.13 LPN Performance Indicators (June 2000) 106 4.14 Number of BKK 1972 – 2000 108 4.15 BKK Outreach (June 2000) 111

ProFI Microfinance Institutions Study ix

4.16 BKK Consolidated Balance Sheet (June 2000) 112 4.17 BKK Assets & Loan Portfolio Quality (June 2000) 113 4.18 LPK Consolidated Balance Sheet (June 2000) 116 4.19 LPK Performance Indicators (June 2000) 117 4.20 BUKP Outreach (June 2000) 119 4.21 BUKP Consolidated Balance Sheet (June 2000) 119 4.22 BUKP Assets & Loan Portfolio Quality (June 2000) 120 4.23 LKURK Consolidated Balance Sheet (June 2000) 123 4.24 LKURK Performance Indicators (June 2000) 123 4.25 BKK/LPUK Outreach (June 2000) 125 4.26 BKK/LPUK Consolidated Balance Sheet (June 2000) 125 4.27 BKK/LPUK Performance Indicators (June 2000) 126 4.28 LKP Consolidated Balance Sheet (June 2000) 127 4.29 LKP Performance Indicators (June 2000) 128 5.1 Number of BKD 1905 – 1987 131 5.2 BKD Outreach by Province (June 2000) 139 5.3 BKD Consolidated Balance Sheet (June 2000, in Million Rupiah) 141 5.4 BKD Consolidated Income Statement (June 2000, in Million Rupiah) 142 5.5 BKD Loan Portfolio and Assets Quality (June 2000, in Million Rupiah) 143 5.6 BKD Financial Sustainability (June 2000, in Million Rupiah) 145 5.7 BKD Development December 1996 – June 2000 (in Rp. Million) 146 5.8 Unit Ekonomi Desa – Simpan Pinjam (UED-SP) as of March 1999 154 6.1 Cooperative Sector by Type of Cooperative (December 1998, in Trillion Rupiah) 164 6.2 Multipurpose and Savings & Credit Cooperatives by Region (December 1998) 165 6.3 Multipurpose and Savings & Credit Cooperatives in West Nusa Tenggara (May

2000) 166

6.4 Number and Outreach of Swamitra by Region (October 2000) 169 6.5 Assets and Balance Sheet Structure of Swamitra by Region (October 2000) 170 6.6 Credit Union Development 1998-1999 172 6.7 Credit Union Indicators by Region (December 1999) 173 6.8 TPSP Outreach (April 2000) 174 6.9 TPSP Consolidated Balance Sheet (April 2000) 174 6.10 TPSP Loan Portfolio Quality (April 2000) 175 7.1 Number and Outreach of BMT (November 2000) 186 7.2 Assets and Balance Sheet Structure of BMT (November 2000) 187 7.3 BMT in South Sulawesi (June 2000) 188

ProFI Microfinance Institutions Study

Introduction

Introduction ProFI Microfinance Institutions Study 2

Introduction

The international microfinance debate knows various microfinance definitions and strategies, which give different emphasis to the providers of microfinance (financial institutions, non-government organizations, government programs, informal lenders), the services provided (savings and/or credit), or the clientele of these services (the poor, low-income households, microentrepreneurs). Microfinance is commonly defined as the provision of financial services to low-income groups. A point of controversy, however, is how sustainable financial services can be provided to an increasing number of low-income households. Should microfinance strategies focus on directly targeting and benefiting the poor irrespective of who provides microfinance services or should they focus on the development of viable microfinance institutions that are able to sustain and expand services to low-income households and microentrepreneurs?

Microfinance programs directly targeting the poor are able to reach clients who are not yet served by financial institutions, and they are also important for upgrading target groups to more sustainable microfinance providers, thus increasing the outreach depth of financial institutions. At the same time, it is necessary to develop and strengthen microfinance institutions in order to sustain the provision of financial services to a growing number of low-income households. Both approaches may have their place within an overall microfinance strategy as long as poverty-oriented microfinance interventions do not undermine the growth and viability of microfinance institutions. The crucial problem is that both approaches are usually not coordinated within an overall microfinance strategy.

The high emphasis on easy and cheap credit of microfinance interventions in Indonesia has become a major constraint for the development of viable microfinance institutions. This study does not intend to continue the theoretical microfinance debate. But, taking into account the Indonesian context, the study was conducted based on the following points of view:

• Strengthening microfinance institutions aims at providing an increasing number of low-income households with sustained access to financial services. Poverty-oriented microfinance interventions play an effective role in the development of sustainable microfinance services, if they reach clients without access to microfinance institutions, aim at upgrading their clients to microfinance institutions, and do not undermine the growth and viability of microfinance institutions through the provision of easy and cheap credit.

• Sustainable microfinance has to comprise both savings and credit. Savings instruments are important for low-income households to manage their liquidity and accumulate resources for special expenditures. They are important for microfinance institutions for sustaining and expanding their credit outreach.

• The provision of sustainable microfinance services to a growing number of low-income households requires viable and sound financial institutions that effectively intermediate between savings and credit customers. These

Introduction ProFI Microfinance Institutions Study 3

microfinance institutions aim at reaching low-income groups, but they do not necessarily exclusively serve people living below narrowly defined poverty lines.

• The development of viable and sound financial institutions requires enabling legal, regulatory and supervisory frameworks, on the one hand, and institutionalized support systems in field such as deposit protection, training, and technical assistance. This includes also the self-organization of microfinance institutions in the form of associations.

This institutional and systems approach to microfinance corresponds to the objectives of the Promotion of Small Financial Institutions (ProFI) program. ProFI is a program of technical cooperation between the Republic of Indonesia and the Federal Republic of Germany. The German Agency for Technical Cooperation (GTZ) and Bank Indonesia as the implementing agencies have been carrying out the program in the three pilot provinces East Java, Bali and West Nusa Tenggara since 1999. ProFI aims at increasing the access of the population, including low-income groups and the poor, to sustainable financial services through viable microfinance institutions and the strengthening of systems and frameworks necessary to develop a sound and growing microfinance industry. To achieve its objectives the program comprises the following components and fields of intervention:

• Strengthening BPR regulation and supervision; • Developing a Deposit Protection System for BPR; • Strengthening BPR associations; • Strengthening LPD regulation and supervision; • Developing a support structure/association for LPD; • Developing training systems for small financial institutions; • Developing software and hardware systems for small financial institutions; • Improving the (re)financing of small financial institutions; • Developing a legal and regulatory framework for non-bank MFI; • Strengthening and upgrading of non-bank MFI.

The microfinance sector in Indonesia is made up of a high variety of institutions, programs, services, and legal, regulatory and supervisory frameworks. Considering the ProFI objectives and fields of intervention as well as its underlying institutional and systems approach to microfinance, it is useful to distinguish institutional microfinance from program microfinance. Institutional microfinance in Indonesia comprises commercial banks and people’s credit banks that are subject to the banking act and regulated by Bank Indonesia, local non-bank financial institutions that are regulated by the Ministry of Home Affairs and provincial governments, cooperatives that are subject to the cooperative law, pawnshops that are regulated by the Ministry of Finance, and non-regulated local organizations such as savings and credit associations. Program microfinance includes poverty alleviation projects that have established mechanisms of extending microcredit to poor target groups, social safety net programs that have been used for channeling funds to their target groups, subsidized credit schemes that target small farmers and entrepreneurs, and microfinance programs of non-government

Introduction ProFI Microfinance Institutions Study 4

organizations. Individual lenders such as moneylenders, shopkeepers and traders provide informal microcredit outside of these microfinance sub-sectors.

The ProFI Microfinance Institutions Study focuses on institutional microfinance. The study aims at providing a general overview of microfinance institutions in Indonesia and to assess their strengths, weaknesses, significance and viability. The objective to cover the microfinance sector in both breadth and depth was not an easy task to achieve within the given time and personnel limits. Compromises had to be made because of the unsatisfactory data situation. Information available at the national level is often not up-to-date, complete, consistent and reliable, on the one hand, and usually too aggregated to allow for a comprehensive assessment of financial institutions, on the other hand.

The study relied on information obtained from a) organizations at the national level, b) Bank Indonesia and Regional Development Banks at the provincial level, and c) related ProFI studies1. Depending on the source of information the description and analysis of microfinance institutions varies in quality and quantity. The ProFI baseline surveys provide an in-depth view of small financial institutions in East Java, Bali and West Nusa Tenggara. The reliable information systems of Bank Rakyat Indonesia provide a good overview of its own unit system and the Badan Kredit Desa in Java, though additional studies at the local and institutional level would be required for a more comprehensive assessment. The assessment of other financial institutions suffered considerably from their weak information systems. This is especially true for the cooperative sector. The information available makes it even impossible to accurately identify and quantify cooperatives with savings and credit activities, not to mention to analyze their financial situation and institutional viability.

Institutional and program microfinance are sometimes not clearly separated. Banks are also involved in channeling funds of governmental microcredit programs. This study considers only banks with own microfinance products as microfinance institutions. Contrary to other countries, non-government organizations in Indonesia do not play a significant role as independent microfinance institutions. Some NGOs established small banks, which are covered by chapters dealing with either commercial or people’s credit banks. Many NGOs provide financial services with funds obtained from either donors or governmental credit programs. These forms of microfinance are regarded as program rather than institutional microfinance in this study. The Indonesian Credit Union movement started as a non-governmental and informal form of microfinance. As Credit Unions and their secondary structures have been increasingly converted to formal cooperatives, they will be dealt with under the chapter of cooperatives.

1 Detlev Holloh, Small Financial Institutions in East Java, Bali and West Nusa Tenggara,

ProFI Baseline Survey Summary Report, Bank Indonesia and GTZ, Denpasar, June 2000; Detlev Holloh: Bank Perkreditan Rakyat (BPR) in East Java, Bali and West Nusa Tenggara, ProFI Baseline Survey, Bank Indonesia and GTZ, Denpasar, June 2000, Detlev Holloh, Lembaga Perkreditan Desa (LPD) in Bali, ProFI Baseline Survey, Bank Indonesia and GTZ, Denpasar, June 2000; Flora Giassemi, Wolfram Hiemann and Detlev Holloh, Appraisal of the Proposal “Development and Upgrading of Microfinance Institutions in Indonesia”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

Introduction ProFI Microfinance Institutions Study 5

There are various other types of non-regulated financial self-help organizations in Indonesia that may be regarded as self-organized forms of institutional microfinance.2 Rotating savings and credit associations (Arisan) are widespread in Java but much less prominent microfinance providers outside of Java. They are not included in this study as reliable data are not available and empirical studies are scarce. There are not many other independent and self-reliant savings and credit associations in Indonesia. Most of the many groups involved in microfinance activities were established and have been assisted in the framework of governmental and non-governmental microfinance programs. They are considered in this study insofar as they are recorded in statistics of these programs.

This report on the ProFi microfinance institutions study consists of 8 chapters, of which 6 chapters deal with different types of institutional microfinance.

The first chapter provides a general overview of framework conditions for the microfinance sector, a description of major microfinance and poverty alleviation programs, and an overview of the structure of the microfinance sector in Indonesia.

The second chapter describes the commercial banking sector and focuses on the largest microfinance network in Indonesia, the unit system of Bank Rakyat Indonesia.

The third chapter deals with Bank Perkreditan Rakyat, secondary banks that are also subject to the banking act and Bank Indonesia regulation and supervision.

The fourth chapter covers Lembaga Dana Kredit Pedesaan, a variety of non-bank microfinance institutions that are regulated and supervised by provincial governments.

The fifth chapter focuses on Badan Kredit Desa, village credit institutions that were recognized by the banking act but are not regulated and supervised as banks. The chapter also includes a description of Unit Ekonomi Desa – Simpan Pinjam, village savings and credit units that are promoted by the Ministry of Home Affairs to expand the BKD model throughout Indonesia.

The sixth chapter deals with the cooperative sector and its microfinance windows. The chapter also includes descriptions of the Credit Union movement and Bank Bukopin, a commercial bank that provides microfinance services though and in cooperation with cooperatives.

The seventh chapter provides an overview of microfinance services provided on the basis of Syariah principles. It includes descriptions of Bank Muamalat Indonesia, the first Islamic commercial bank established in Indonesia, Baitul Maal wat Tamwil, local financial institutions established by a national Islamic non-government organization, and the Dakabalarea microfinance program of the Government of West Java.

The eights chapter summarizes major issues identified for the microfinance sector in Indonesia and concludes with suggesting essentials and elements of a future microfinance sector strategy.

2 See: Detlev Holloh, Microfinance In Indonesia between State, Market and Self-Organization,

LIT-Verlag and Transaction Publishers, Hamburg-New Brunswick 1998.

ProFI Microfinance Institutions Study

Chapter 1:

The Microfinance Sector

in Indonesia

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 7

1. The Microfinance Sector in Indonesia

The first part of this chapter provides a brief overview of economic, social and political conditions relevant for the current and future development of the microfinance sector in Indonesia. The second part provides an overview of major microfinance, poverty alleviation and crisis-related programs that are relevant for the development of the microfinance sector. The third part describes the structure of the microfinance sector and distinguishes microfinance institutions from microfinance sector programs.

1.1 Economic, Social and Political Framework Conditions

1.1.1 The Economic Crisis and Policy Response since 19973

After phases of sustained economic growth, trickle-down effects and successful poverty alleviation until the first half of 1997, Indonesia was classified as a lower middle-income economy, with the per capita GDP exceeding USD 1,100 in 1996/97. The Asian currency crises revealed the structural weaknesses of this development and developed into a full-blown political, economic and social crisis within a few months.

When the Asian currency crisis spilled into Indonesia in July 1997, the Rupiah underwent strong fluctuations and depreciated from about Rp. 2,500 to Rp. 5,000 per US Dollar until the end of the year. Factors such as the withdrawal of foreign investments, the rising demand for the US Dollar due to huge foreign liabilities falling due, the increasing speculation on the Rupiah, the decreasing confidence in the ability of the government to deal with the financial crisis and the starting political crisis, resulted in a free fall of the Rupiah to Rp. 16,000 per US Dollar in January 1998. The government’s tight money policy and other measures succeeded to stabilize the exchange rate at Rp. 7,000 to Rp. 8,500 in February and March 1998 but, after the riots and the resignation of President Soeharto in May 1998, the exchange rate plunged again to Rp. 16,500 in June 1998.

As a consequence of the currency devaluation, the sharp increase in interest rates (the Jakarta inter-bank offered rate increased from 1% in July 1997 to 44% in June 1998) and the prolonged draught that led to disruptions in food supply, the inflation rate (consumer price index) soared from 5.2% during the financial year 1996/97 to 34.2% in 1997/98 and to 77.6% in 1998, the highest inflation rates since 1974/75. The gross domestic investment contracted by one third in 1998, compared to growth rates of 12.9% in 1996 and 8.6% in 1997. While the Gross Domestic Product grew by 7.8% in 1996 and by 7.6% in the first half of 1997, the economy contracted by more than 13% in 1998. The per capita GDP dropped from Rp. 2.2 million or USD 1,018 in 1997 to Rp. 1.9 million or USD 491 in 1998.

During the 1990s, Indonesia’s debt structure experienced a profound change. In 1993/94 the public sector still accounted for two thirds of Indonesia’s external debts (USD 83.3 billion). In 1997/98 total external debts had increased to USD 131.5 billion, of which 59% were made by the private sector. The debt service ratio of the private sector, mainly large investment companies and business conglomerates, had increased from 12.8% to 29.4%. The foreign debts of the private and public sectors

3 The following description is based on Bank Indonesia and World Bank reports.

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increased further to USD 151 billion in 1998. The ratio of foreign debts to GDP increased from 57% in 1996 to 153% in 1998. The currency mismatch in foreign borrowings (private sector loans were often used for investments not generating foreign currency) combined with the widespread corruption and collusion in the corporate sector rapidly transformed the exchange rate crisis into an external debt crisis.

In the course of the crisis the intermediation function of the banking industry virtually came to a hold. The pressure on the Rupiah and the massive withdrawals of deposits from private banks after the government had revoked the business licenses of 16 insolvent banks in November 1997 plunged the banking industry into a severe liquidity crisis. The tightening of liquidity propelled the inter-bank interest rate to 350% in January 1998, or an average 64% for the entire year, and made the banking industry dependent on massive liquidity support from the central bank. This support increased from Rp. 62.8 trillion in December 1997 to Rp. 177.1 trillion in July 1998. The rapid expansion of money supply gave further rise to the already high level of inflation. To prevent the breakdown of the banking system the government was also forced to declare a blanket guarantee for deposits in January 1998. The guarantee scheme includes an additional guarantee on the claims of creditors. Guarantee bonds amounted to Rp. 164.5 trillion in 1998.

On the asset side, the loan portfolio quality of the banking industry worsened drastically. The share of non-performing loans increased from 9% in March 1996 to 59% in February 1999. The halt of financial intermediation and the transfer of bad debts to the Indonesian Bank Restructuring Agency (IBRA) contracted the industry’s loan portfolio by more than 50% in 1999. The huge loan losses and the negative interest spread decapitalized the industry. At the end of 1998, the industry had a negative capital of Rp. 100 trillion and the capital adequacy ratio had plunged to minus 25%. Until October 2000, the government had to liquidate 68 commercial banks and had to issue recapitalization bonds amounting to Rp. 430 trillion.

The Asian exchange rate crisis hit an already fragile banking industry and uncovered its inherent weaknesses. Bank Indonesia attributed its vulnerability to external shocks to five factors4: a) the implicit government guarantee leading to moral hazard, b) non-compliance with prudential principles, ineffective bank supervision and lack of enforcement, c) unsound risk exposure through connected lending by private national banks in the ownership of few business conglomerates, d) low managerial skills and lack of internal control, and e) lack of transparency. The weaknesses of the legal, regulatory and supervisory systems contributed to the banking crisis. However, the roots of the banking crisis as well as of the financial crisis in general can be traced back to the incomplete and inconsistent market reforms since the 1980s. These reforms did not include a comprehensive reform of the corporate sector, in which most state enterprises were deemed financially unsound and large business conglomerates remained politically protected. The banking industry was not freed from political intervention and the interest of these business conglomerates.

In March 1998, the Indonesian Government embarked on a reform and stabilization program with substantial support from international institutions and partner countries

4 See: Bank Indonesia, Annual Report 1997/1998.

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coordinated by the International Monetary Fund. Fiscal policies such as improvements of the tax system, the gradual reduction of subsidies (fuel and electricity), and the cancellation of large infrastructure projects aimed at strengthening government revenues and budget discipline. Monetary policies aimed at stabilizing the Rupiah by controlling liquidity and interest rates. The financial sector reform strategy consisted of five major components, the bank restructuring and recapitalization program, the credit restructuring and recovery program, a program aiming at creating good governance, the improvement of the legal and regulatory framework, and the strengthening of bank supervision. Real sector reforms included the reduction of tariffs or the removal of restrictions on foreign trade products, the removal of restrictions on foreign investment as well as deregulation and privatization measures. Additionally, the government initiated a range of social safety net and small-scale credit programs in order to cushion the impact of the crisis and alleviate poverty.

Major efforts were made to improve public governance by combating corruption, improving decision-making and administrative structures, and strengthening public institutions. The Clean Government Law was passed in 1999 and requires public officials to declare their assets and to open their assets to official audit. The Eradication of Criminal Acts of Corruption Law established the basis for legal prosecution and criminal charges, and provides for the establishment of an independent anticorruption commission.

The Laws on Local Government Autonomy and on Fiscal Balances, which were also approved by the parliament in 1999, aim at improving the accountability of governmental decision-making and strengthening local development. Giving decision-making and budgetary powers to districts and villages, the decentralization law will also provide a new framework for the development of local financial institutions and microfinance programs.

On August 29, 2000 the government implemented a major cabinet restructuring that aims at ensuring greater coordination of economic policies. The new economic team announced a 10 Point Economic Recovery Program that became part of the new Letter of Intent signed with the IMF on September 7, 2000. The 10 program components aim at:

• Maintaining macroeconomic stability; • Reducing unemployment; • Improving agricultural productivity and farmer welfare; • Increasing non-oil export revenues; • Promoting domestic and foreign equity investment; • Expediting banking and corporate restructuring; • Accelerating privatization of state-owned enterprises; • Initiating small and medium scale enterprises development programs; • Ensuring sustainable development of natural resources; • Implementing economic decentralization.

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Despite the continued political turmoil and the slow progress in implementing the reform and stabilization program Indonesia’s macro-economic performance showed a tentative recovery in 1999 and some encouraging trends in 2000.

The Gross Domestic Product recorded a 0.8% increase in 1999 and grew by 4.8% in 2000. GDP per capita, which had fallen to only USD 491 in 1998, increased to USD 783 at the end of 2000 but has by far not yet reached the level prior to the crisis. While the low growth in 1999 was mainly due to consumption, the recovery had a broader base in 2000. All sectors but agriculture showed a positive growth. The gross domestic investment grew by 18% compared to a contraction of 33% in 1998 and 19% in 1999. Exports returned to positive growth in 1999 and increased by 23% in the first half of 2000.

With falling food prices, especially of rice, and the appreciation of the Rupiah, inflation (consumer price index) came under control and cumulated to only 2% in 1999. Price increases for fuel, electricity, transportation as well as the renewed depreciation of the Rupiah, especially in the second half of 2000, boosted the inflation rate to 9.4% in 2000, well above Bank Indonesia’s target of 5% to 7%. As of the end of 1999, the Rupiah exchange rate had strengthened to Rp. 7,100 per US Dollar. However, during 2000 the Rupiah depreciated continuously and had fallen to almost Rp. 10,000 per US Dollar at the end of the year. As the Rupiah recovered and new disbursements remained modest, foreign debt as a share of GDP declined in 1999 and 2000 but is still close to the total GDP volume.

The recovery of the Indonesian economy has been slow and far behind that of other East Asian crisis countries. Indonesia’s GDP is some 30 percent below what it would have been if pre-crisis trend growth had prevailed. At the current pace of growth it will take several years to return to the pre-crisis level. The corporate sector is still deeply in debt. In the mid of 2000 almost three quarters of corporate debt (USD 120 billion) was denominated in foreign currencies. This leaves the corporate sector highly vulnerable to further devaluations of the Rupiah.

Based on the finalization of the bank recapitalization program, recovering interest margins, and renewed profits, the banking industry started to recover at a modest pace. The aggregated loan portfolio of commercial banks grew by 41% in 2000, while the non-performing loan ratio decreased to 24% mainly because the industry had resumed lending. With the loan portfolio to assets ratio remaining at a low level (31%), however, the intermediation function of the industry was revived to a very limited extent only (see chapter 2).

Table 1.1 Key Economic Indicators (1996 – 2000)

Indicator 1996 1997 1998 1999 2000

GDP growth 7.8 4.7 -13.1 0.8 4.8

GDP per capita (USD) 1,177 1,018 491 703 783

CPI inflation (%) 6.5 11.1 77.6 2.0 9.4

USD exchange rate (Rp.)1 2,383 4,650 8.025 7,100 9,675

Gross dom. investment 2 12.9 8.6 -33.0 -19.4 17.9

Foreign debt (Billion USD)3 128.9 136.2 150.9 147.4 139.5

As % of GDP 56.7 63.3 152.7 97.5 -Source : Bank Indonesia, World Bank. 1 End of year rate. 2 Pecentage growth. 3 End of year and October 2000.

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Weak corporate and public governance as well as weak law enforcement continue to impede corporate restructuring. With the top ten families owning more than 60 percent of corporate assets, pervasive state ownership of economic assets, close relationships between business conglomerates, banks and government, and poor oversight by the regulators, still act against the fundamental changes necessary for sustainable growth and social development. The new Government has not yet been able to create new market and investment confidence, and faces severe constraints in cleaning the economy from rent-seeking behavior, enforcing the superiority of law, and solving political, social and ethnic problems.

The volatility of economic and social recovery has its origin in structural weaknesses and impediments, which were summarized in the World Bank’s new country assistance strategy5 as follows:

• Poor governance and corruption in the public sector; • The uncertainties surrounding the forthcoming decentralization process; • The absence of an effective court system and the longstanding need for

legal and judicial reform; • Poor corporate governance, particularly lack of information disclosure or

enforcement against offenders; • The need for effective rules and institutions to implement competition

policy; • A less than welcoming climate for foreign direct investment; and • The extended role of the state and its crowding out of private sector activity.

1.1.2 Poverty Incidence and Policy Response since 1997

There are different poverty lines and head count results depending on the methodology applied and the results of different surveys. In Indonesia, the national poverty line is calculated by the Central Bureau of Statistics (BPS) as the expenditure necessary for a fixed food basket that allows an intake of 2,100 calories per person. While the basket is fixed, the fixing of the basket is a matter of social choice and the resulting poverty line is highly sensitive to prices varying over time and between regions. Poverty estimates of the BPS were recently published in a paper presented by the National Planning Board to the tenth meeting of the Consultative Group on Indonesia (CGI).6

The National Socio-economic Surveys (Susenas) are the main sources of information on poverty in Indonesia. Since the outbreak of the crisis there have been a number of poverty estimates using different household surveys. These estimates use different bases as the "pre-crisis" poverty rate and different methods of updating the poverty line, so that they are not directly comparable. Using Susenas data and other household surveys, the Social Monitoring & Early Response Unit (SMERU), which is supported by the World Bank and other international institutions, recently tried to produce consistent 5 Memorandum of the President of the International Bank for Reconstruction and

Development, the International Development Association and the International Finance Corporation to the Executive Directors on a Country Assistance Strategy of the World Bank Group for Indonesia. World Bank Report No. 21580-IND, February, 2001.

6 Poverty Reduction Strategy in Indonesia. Prepared for Consultative Groups for Indonesia, Tokyo, National Planning Board, October 2000.

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series of poverty estimates and proposed an alternative iterative method to reflect regional and urban-rural price differentials more adequately than the BPS method.7

In the twenty years between 1976 and 1996, Indonesia’s rapid economic growth was accompanied by considerable improvements in living standards and social indicators. According to BPS statistics the population living in poverty decreased from 54.2 million or 40.1% in 1976 to 22.5 million or 11.3% in 1996. The crisis since 1997, however, showed that more than double as many Indonesians remained highly vulnerable and may at least temporarily fall below the poverty line under the condition of surging inflation and decreasing real income. According to BPS estimates the incidence of poverty increased by more than two times between February 1996 and February 1998 (49.5 million people or 24.2%).

The SMERU estimates reflect lower differentials in urban and rural poverty lines and, therefore, arrive at higher poverty rates for both 1996 (15.7%) and early 1999 (27.1%) than the BPS method. Based on a poverty index of 100 for the lowest poverty rate before the crisis, SMERU estimated that the poverty incidence in the second half of 1998 was more than two and a half times the estimated pre-crisis low in mid 1997. This explosion in the poverty index coincides with the worsening of the economic crisis, the rapid inflation with lagging nominal wages and incomes, and the rapid increase in the price of rice in 1998.

7 See: Arsep Suryahadi, Sudarno Sumarto, Yusuf Suharso, Lant Pritchett: The Evolution of

Poverty during the Crisis in Indonesia, 1996 and 1999 (Using Full Susenas Sample), SMERU Working Paper, March, Social Monitoring & Early Response Unit, Jakarta, SMERU Working Papers, Jakarta, March 2000; Menno Pradhan, Arsep Suryahadi, Sudarno Sumarto, Lant Pritchett: Measurement of Poverty in Indonesia : 1996, 1999, and Beyond, SMERU Working Papers, Jakarta, June 2000.

Table 1.2 Poverty Lines and Incidence (1996 – 1999)

Year/Source Poverty Line (Rp./capita/month)

Poverty Incidence (million people)

Poverty Incidence (%)

Urban Rural Urban Rural Total Urban Rural Total

February 1996 – (1) 38,246 27,413 7.2 15.3 22.5 9.7 12.3 11.3

February 1996 – (2) 36,887 31,645 5.1 25.7 30.8 7.2 20.5 15.7

February 1998 – (3) 96,959 72,780 17.6 31.9 49.5 21.9 25.7 24.2

December 1998 – (4) 92,409 74,272 15.7 32.7 48.4 19.5 26.1 23.5

February 1999 – (5) 93,869 73,898 - - - 20.0 25.9 23.6

February 1999 – (6) 90,490 81,184 13.2 42.6 55.8 16.3 34.1 27.1

August 1999 – (7) 89,845 69,420 12.4 25.1 37.5 15.1 20.2 18.2

Sources : Poverty Reduction Strategy in Indonesia. Prepared for Consultative Groups for Indonesia, Tokyo, October 2000 (presented by the National Planning Board) ; Menno Pradhan, Arsep Suryahadi, Sudarno Sumarto, Lant Pritchett : Measurement of Poverty in Indonesia : 1996, 1999, and Beyond, Smeru Working Papers, June 2000. (1) Central Bureau of Statistics, Social and Economic National Survey (Susenas) 1996. (2) Social Monitoring & Early Response Unit (Smeru), calculation based on alternative iterative method. (3) Central Bureau of Statistics, based on Susenas of February 1998. (4) Central Bureau of Statistics, based on Susenas of December 1998. (5) Social Monitoring & Early Response Unit (Smeru), calculation based on method of Central Bureau of Statistics. (6) Social Monitoring & Early Response Unit (Smeru), calculation based on alternative iterative method. (7) Central Bureau of Statistics, based on Susenas of August 1999.

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A major factor responsible for the increase in the poverty rate was the huge increase in the relative price of rice, which rose by 180% between February 1996 and February 1999. After February 1999, the sharp decline in food prices, especially rice, and increasing real wages appear to have led to a reduction in poverty. The poverty estimate of the Central Bureau of Statistics in August 1999 points into this direction. However, two years after the crisis started, the poverty incidence was still higher than prior to the crisis.

Though it can be assumed that the poverty rate has approached the pre-crisis level during 2000, poverty continues to be a central issue because most people crossing the poverty line are still highly vulnerable to expenditure poverty, on the one hand, and poverty includes dimensions other than expenditure poverty, on the other hand. A World Bank report8 argued that over a three-years period between 30% and 60% of all Indonesians face a greater than 50:50 chance of periodically falling into poverty. Poverty takes many forms in addition to expenditure poverty such as the lack of access to basic education, medical services, infrastructure (safe water, adequate sanitation, transport and roads, electricity), or participation in community life. The World Bank concludes in its new country assistance strategy9: “Once the multi-dimensional breadth and dynamics of poverty are acknowledged, poverty is a reality that, in one form or another, confronts more than half of all Indonesians.”

8 World Bank, Poverty Reduction in Indonesia: Constructing a New Strategy, October 2000

(Draft). 9 See footnote No. 5.

Profile of Indonesia’s Poor and Vulnerable in 1999

Characteristics of those in expenditure poverty and where they live… • 87 percent of the poor live in households in which the head of household has only a

primary education or less— only five percent of the poor have a secondary education or better.

• For almost 60 percent of the poor, agriculture provides the main source of income whether from labor or land).

• More than 75 percent of the poor live in rural areas. • Most of the poor (61 percent) live on Java. • The poorest regions, all rural, are scattered and include parts of the eastern islands

(Irian Jaya, East Nusa Tenggara, Maluku and West Nusa Tenggara), but also other areas (Southeast Sulawesi, East Java, Lampung, West Kalimantan, and Central Java).

Other ways in which poverty is experienced… • Expenditure poor households are also much more likely to be “human investment” poor,

but a significant share of the non-expenditure poor households also lag in human investment: 22 percent of poor children between 6 and 18 years who have yet to complete basic education are not enrolled in school, while for non-poor households the share is 9 percent.

• 78 percent of the poor, and 51 percent of non-poor, lack access to “improved” water sources. Access to sanitation is even more limited.

• When people are asked to define who are “the poor” in open-ended terms, the breadth and variety of responses is striking; from the common idea of not having enough to eat, to not having enough participation in community life, to being despondent or “having lost faith in God” (from Consultations with the Poor in Indonesia, 1999)

Source: World Bank, Indonesia Country Assistance Strategy, Box 1.2 (see footnote No. 5)

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Poverty alleviation was a top priority of the political agenda also before the crisis as disparities between regions and population groups tended to increase despite the reduction of absolute poverty. In this context the government embarked upon large national poverty alleviation programs such as the development program for backward villages (IDT), the family welfare income generation program, and the small farmer income generation project (P4K). Other programs such as the sub-district development and urban poverty alleviation programs were added in the second half of the 1990s and partly replaced the IDT program. In response to the ongoing economic, social and political crisis since 1997, the government, with support from the World Bank and other donors, launched several Social Safety Net (JPS) programs in the fields of food security, social protection in education and health, employment generation, and community empowerment. Some of these programs were set up to rapidly and directly channel funds and credit to the village level. Poverty alleviation programs with microfinance components are further described in the following chapter.

In October 2000, the new government presented its poverty reduction strategy to the tenth Consultative Group for Indonesia (CGI) meeting.10 The strategy focuses on alleviating poverty over the next five years and aims at reducing the incidence of poverty by 4% to 5%. The statement emphasizes the necessity of good governance, transparency and accountability in implementing the strategy. The coordination responsibility is given into the hands of the Vice President who will be supported by a task force made up of government and non-government members. A special stakeholder forum will be set up to monitor poverty reduction efforts. The new poverty reduction strategy is based on three pillars:

Promoting economic opportunities for the poor through 1) rapid, sustainable growth, 2) strengthening local governance and autonomy, 3) effective provision of core public services, and 4) building community infrastructure. Improved local governance and community participation, transparency and accountability are seen as key factors in empowering the poor.

Facilitating the empowerment of the poor by 1) strengthening community organizations and encouraging their network building to accumulate social capital within the community, 2) promoting sustainable rural development through rural industrialization and agribusiness, encouraging capital accumulation and self-financing within the local communities; and 3) revitalizing small-scale and medium enterprises by creating a conducive business environment, strengthening institutional support, improving access to credit and financial services on commercial terms, strengthening community-based financing institutions, and improving the environment for the expansion of micro-credit institutions.

10 A Poverty Reduction Strategy for Indonesia, Statement of Dr. Djunaedi Hadisumarto,

Chairman National Development Planning Agency/Bappenas, Tokyo, October 2000; Poverty Reduction Strategy in Indonesia. Prepared for Consultative Groups for Indonesia, Tokyo, National Planning Board, October 2000.

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Enhancing social security by 1) supporting community- and family-based safety nets and improving social safety net programs to protect the poor against shocks, and 2) accelerating development in remote areas through special programs.

1.2 Microfinance Sector and Poverty Alleviation Programs

“It is the era of microfinance” was the answer when the author asked an official of the Ministry of Home Affairs why the ministry sees its role in carrying out microfinance programs. Since the 1990s, there are many ministries and government institutions carrying out programs with microfinance components. Microfinance has become a standard element of governmental poverty alleviation programs as well as of programs of many non-government organizations. The following description focuses on larger programs with some national relevance. In the context of this study it is useful to distinguish four types of programs working in the microfinance sector: 1) programs that aim at building microfinance institutions and systems rather than directly providing microfinance services, 2) poverty alleviation programs that focus on providing microfinance services and were usually initiated prior to the crisis, 3) social safety net and similar programs with microfinance components, which were launched in response to the crisis, and 4) microfinance initiatives of non-government organizations.

1.2.1 Microfinance Systems Development Projects

There are several initiatives aiming at strengthening institutional microfinance, mainly through small financial institutions such as the People’s Credit Banks (BPR). These initiatives intend to improve access to microfinance services indirectly rather than directly. Initiatives such as the ProFI program of Bank Indonesia/GTZ, and UKABIMA, a private non-bank finance company sponsored by USAID and executed by CRS, focus on improving framework conditions and technical capacities of small financial institutions. The two major microfinance programs aiming at developing sustainable microfinance systems in cooperation with banks, non-government organizations and self-help groups have been carried out by Bank Indonesia in cooperation with GTZ (Project Linking Banks and Self-help Groups Project) and ADB (Microcredit Project).

Project Linking Banks and Self-Help Groups

Indonesia was the first country that translated the linking banks and self-help groups concept into practice. In 1989, Bank Indonesia in cooperation with GTZ launched the linkage project to make financial services available to self-help groups of small farmers and entrepreneurs by facilitating either direct or indirect financial transactions between banks and self-help groups. An essential feature of the Indonesian linkage project has been to support autonomous and sustainable linkages between banks, self-help promotion institutions (SHPI) and self-help groups (SHG). Emphasis was given to savings mobilization by banks and within SHG, market-based and cost-covering interest rates, respecting SHG as autonomous informal financial intermediaries, and cooperating with existing and eligible SHG. These principles distinguished the project from conventional credit and group lending programs, and implied an inseparable connection between the objectives of providing access to bank services and strengthening self-help groups as informal financial institutions.

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In the mid 1990s, when the limited number of eligible savings and credit groups, qualified SHPI and commercial banks as well as the high training and technical assistance costs involved in this approach became a constraint for project expansion, the project strategy was modified in three respects: a) people’s credit banks (BPR), the number of which was rapidly increasing, were encouraged to establish their own direct linkages with self-help groups; b) SHPI were discouraged from acting as financial intermediaries and encouraged to focus on their training and guidance functions; c) the group lending concept was introduced by promoting the establishment and participation of microentrepreneur groups, which function as channeling and joint liability groups without managing their own credit portfolios.

The linkage project provides technical assistance to banks and SHPI in the form of training, seminars, workshops, exposure field visits and consultancy. Bank managers and staff are trained in best practices for establishing and serving microentrepreneur groups. SHPI staff is trained in best practices of strengthening savings and credit groups. Short-term training courses and regular follow-up guidance for developing bankable savings and credit groups is financed by the project.

Concentrating program expansion on BPR and direct linkages between banks and channeling groups led to a rapid growth since 1996. Between March 1997 and December 1999, the number of participating BPR increased from 211 to 667 and the number channeling microentre-preneur groups with loans outstanding from 2,016 to 12,137. The number of savings and credit groups with loans outstanding decreased from 2,016 to 1,312. Savings deposited by self-help groups in banks increased from Rp. 3.7 billion to Rp. 10.8 billion and the amount of loans outstanding to self-help groups from Rp. 24.2 billion to Rp. 71.7 billion during the same time period.

In early 2000 GTZ phased out its project support and Bank Indonesia continued with considerably reduced technical assistance staff. As of June 2000, the project still had 184 commercial bank branches, 515 BPR, 99 SHPI, 1,229 savings & credit groups and 10,586 microentrepreneur groups participating in 24 provinces. The 11,815 self-help groups had loans outstanding amounting to Rp. 68 billion. The loan amount in arrears had increased to 10% because of the downward trend in new loan disbursements.

Since its inception the linkage project had facilitated linkages between 350 commercial bank branches, 847 BPR (about one third of all BPR operating in Indonesia), 238

Table 1.3 Project Linking Banks and Self-help Groups (1997 – 2000)

Indicator 3/1997 12/1998 12/1999 6/2000Number of participating institutions

Commercial bank branches 211 198 218 184

People’s credit banks (BPR) 225 610 667 515

SHPI/NGOs 130 142 131 99

Savings & credit groups 2,016 1,852 1,312 1,229

Microentrepreneur groups 3,065 7,992 12,137 10,586

SHG savings in banks (Rp. billion) 3.7 8.4 10.8 17.2

Loans outstanding (Rp. billion) 24.3 42.5 71.7 68.2*

Loan amount in arrears (%) 6.2 12.5 7.6 10.3

Long-term repayment rate (%) 96.2 94.8 96.5 96.3

Default rate (%) 0.6 2.4 2.2 3.1Source : Bank Indonesia, PHBK Report of July 2000. * Another table of the report records a lower loan amount (Rp. 55.1 billion).

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SHPI, 6,549 savings & credit groups, and 21,915 microentrepreneur groups. The banks had disbursed 47,864 loans with a total value of Rp. 249 billion. The long-term (accumulated) repayment rate of 96% points to the success of the linkage project.

Microcredit Project

The microcredit project has been implemented by Bank Indonesia since 1996. It aims at increasing income and employment of poor people by providing them access to financial services of small financial institutions. To achieve this objective the project provides People’s Credit Banks (BPR) and Rural Credit Fund Institutions (LDKP) with a credit line for onlending to microborrowers. Contrary to the linkage project, the microcredit project employs both an individual and group approach in lending, and does not require borrowers to deposit savings as partial collateral and a prerequisite for getting access to credit. Funds for the credit line and technical assistance come from the Asian Development Bank. Training and consulting services are provided to participating financial institutions and non-government institutions that are responsible for self-help group formation and microenterprise training. A separate credit line for participating institutions is made available for the purchase of computers and motorbikes.

Table 1.4 Microcredit Project (1997 – 2000)

Indicator 1996 1997 1998 1999 6/2000 TotalNumber of participating institutions per year

People’s credit banks (BPR) 44 113 251 316 - 724

Rural credit institutions (LDKP) 66 62 125 -130 - 123

SHPI/NGOs 21 6 8 12 - 47

Microentrepreneur groups - 93 1,423 3,177 133 4,826

Microborrowers per year

Individual 3,023 13,056 136,025 191,524 86,805 430,433

Group members 279 1,204 40,791 65,873 13,273 121,420

Loan amount disbursed per year (Rp. billion) 0.6 3.6 49.8 60.1 4.0 119.0

Loans outstanding end of period (Rp. billion) - - - - - 65.8

Loan amount in arrears end of period (%) - - - - - 1.6

Source : Bank Indonesia, Proyek Kredit Mikro, Laporan Perkembangan Juni 2000.

Since its inception the microcredit project cooperated with 724 BPR, 123 LDKP and 47 NGOs in eight provinces. The participating small financial institutions disbursed loans to 551,853 microborrowers, of which 121,420 are organized in 4,826 microentrepreneur groups. Half of the borrowers were women. The total loan amount disbursed amounted to Rp. 119 billion. As of June 2000, 523,142 borrowers had loans outstanding amounting to Rp. 65.8 billion, of which only 1.6% was in arrears. This repayment performance is an outstanding achievement compared to the generally much lower loan portfolio qualities of BPR and LDKP (see chapters 3 and 4).

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In 2000, the microcredit project experienced a considerable decrease in loan disbursements and support activities as the project planning foresaw its termination in this year and a decision on its extension were not yet taken.

1.2.2 Microfinance-focused Poverty Alleviation Programs

There is a range of poverty alleviation programs with microfinance components. The programs described in the following do not provide a complete picture, but they are the largest ones with some national relevance.

Rural Income Generation Project (RIGP/P4K)

The Rural Income Generation Project (RIGP/P4K) of the Ministry of Agriculture and Bank Rakyat Indonesia (BRI) is the oldest microfinance project in Indonesia. It was incepted in 1979 and underwent several changes in design and methodology. RIGP is the third P4K phase, which has been carried out in 12 provinces since 1998. Funds for the RIGP/P4K project come from the Indonesian Government, the Asian Development Bank, and the International Fund for Agricultural Development.

The project targets households with income generating activities and an annual per capita income equivalent to the local value of up to 320 kg rice. Project implementation is based on the infrastructure of agricultural field extension workers and an elaborated step-wise guidance and training methodology. The project facilitates the formation of small farmer and women groups (consisting of 8 to 16 members), assists them in developing savings activities and formulating business plans, and provides access to BRI credit based on these business plans and after the small farmer groups have fulfilled a set of eligibility criteria. Depending on the loan cycle, individual loan amounts range from Rp. 300,000 to Rp. 700,000.

The project differs from other poverty alleviation projects. The microfinance component is carried out independently by BRI. Data on financial transactions are detailed and usually reliable. Interest rates should cover bank transaction costs and are subject to adjustment if required. The groups have to mobilize savings and to deposit at least 5% of the loan amount applied in BRI accounts before getting access to credit. Misappropriation and misallocation of funds is not a prevalent feature. The target group is given time to go through a process of education and training before getting access to credit during four cycles of usually one year each. The project provides perspectives beyond the narrower project framework. Individual and eligible group members may be become regular customers of BRI units. The project framework includes also the possibility to facilitate linkages with other banks and seek the assistance of NGOs in this context.

A special feature of the project is that the small farmer groups are joint liability groups, which provide a mechanism for participation, training, savings motivation and channeling credit without requiring them to develop a comprehensive financial administration and management capability. Only in a later step, when the groups have successfully gone through several credit cycles and training modules, they are facilitated to join into larger savings and credit associations, which intermediate

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between savers and borrowers among their members, and may adopt the legal status of a cooperative.

The first P4K phase was carried out in 6 provinces between 1979/80 and 1985/86. During this phase the project facilitated the formation of 2,150 small farmer groups, of which 1,094 groups received credit. 85% of the loan amount was repaid during a time when credit programs usually experienced outstanding losses. The complete P4K approach, however, was developed during its second phase, which was implemented in 10 provinces from 1989 to March 1998. By September 1997, 48,169 small farmer groups consisting of some 500,000 members had been formed and 75,684 group business plans were financed by loans amounting to Rp. 117 billion. About 3% of the loan amount outstanding was in arrears. At the time of project termination it was estimated that the overall repayment rate was around 95% - a creditworthy performance by any standard.

Table 1.5 Rural Income Generation project (RIGP/P4K) as of May 2000

Indicator Sumatra Java & Bali

Kali-mantan Sulawesi West Nusa

Tenggara Total

Loan amount disbursed (Rp. m) 2,368 73,461 821 1,547 13,896 92,091

Loan amount past due (Rp. m) 1,110 37,265 405 578 7,066 46,428

Loan amount paid (Rp. million) 1,050 34,733 401 577 6,869 43,635

Loan amount outstanding (Rp. m) 1,317 38,728 414 970 7,026 48,456

Number of groups 714 19,168 216 391 4,074 24,563

Loan amount in arrears (Rp. m) 59 2,532 3 1 197 2,793

Number of groups 73 2,355 8 2 273 2,711

Arrears ratio (%) * 4.5 6.5 0.7 0.1 2.8 5.8

Long-term repayment rate (%) * 94.6 93.2 99.0 99.8 97.2 94.0

Group savings in BRI (Rp. million) 123 6,379 49 85 1,159 7,794

Number of groups 707 27,321 311 416 4,675 33,430

Source : Bank Rakyat Indonesia and Rural Income Generation Project, Reports of April and May 2000. * Arrears ratio : loan amount in arrears / loan amount outstanding as of May 2000. Repayment rate : loan amount paid / loan amount past due (accumulated November 1998 – May 2000).

As of June 2000, the RIGP/P4K project had 37,744 active small farmer groups, of which 28,030 had received loans amounting to Rp. 104 billion. 20,772 groups still had loans outstanding, while 16,972 groups had prepared business plans and loan applications that were not yet approved. More complete data were available for May 2000, when 33,430 groups had deposited Rp. 7.8 billion in BRI accounts, and 24,563 groups had loan amount outstanding of Rp. 48.5 billion.

5.8% of the total loan amount outstanding was in arrears, mainly because a deteriorating group performance in West, Central and East Java. The arrears ratio increased 2.9% at the beginning of the year to 6.1% as of June 2000. The project management regards fast loan approvals during the first half of the year (10,451 new loan disbursements) as a major reason for this development. Nonetheless, the long-term repayment rate is with about 94% still considerably high.

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Besides these achievements, the project had facilitated the establishment of 964 savings and credit associations, which were formed by 5,515 small farmer groups. 30 of these associations had adopted the legal status of a cooperative.

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Family Welfare Income Generation Project (UPPKS)

The UPPKS (Usaha Peningkatan Pendapatan Keluarga Sejahtera) program was launched by the government in 1996 and is implemented by the National Family Planning Coordination Board (BKKBN), a government agency well known for its effective family planning program. The family planning program has built up an infrastructure in practically every village in Indonesia, giving also the UPPKS program unrivalled outreach through the BKKBN extension workers and the women groups that enroll a high proportion of Indonesian women in child-bearing age.

The UPPKS program targets women who have economic activities and belong to families that are not able to meet their basic needs, and organizes them into small groups of approximately 20 members. These groups have to be formally recognized by the village head and are regarded as mechanisms for providing guidance, entrepreneurship training and credit.

The core elements of the program are the Takesra (family welfare savings) savings scheme and the Kukesra (family welfare loan) credit scheme. The UPPKS groups are first enrolled in the Takesra scheme, with each woman receiving an initial grant of Rp. 2,000 to open a savings account. The women are encouraged to save small monthly amounts for 6 months and will receive a bonus of Rp. 2,000 after this time. If they can accumulate Rp. 25,000, they become eligible for loans under the Kukesra scheme.

Kukesra is a soft loan provided to eligible group members at the highly concessional annual effective interest rate of 6%. The program emphasizes that cheap and easy credit is required for start-ups of family businesses. Kukesra loans are provided in five cycles. The first loan has a maturity of 5 months and amounts to Rp. 20000. The following loans, granted after each successful repayment cycle, amount to Rp. 40,000 to Rp. 320,000 and are provided for 7 to 13 months. 10% of the loan amount disbursed has to be deposited in the Takesra account.

The Kukesra program is a revolving fund that is financed by a foundation created by the former President Soeharto. The funds dropped by this foundation amount to Rp. 754 billion. The revolving fund is managed by Bank Negara Indonesia (BNI), a state bank, and channeled to UPPKS groups via the network of post offices. Post office staff can approve loans up to Rp. 5 million, whereas larger loans have to be approved by BNI.

An additional source of funds for UPPKS groups are funds collected from state enterprises. Some Rp. 200 million of these funds were available to finance a second credit scheme, Kredit Pengembangan Kemitraan Usaha (KPKU) later renamed into KPPTG-Taskin. This scheme was designed to support business partnerships between UPPKS groups, on the one hand, and small enterprises, medium enterprises and cooperatives, on the other hand. The scheme provides access to larger loans with a ceiling of Rp. 50 million per group or Rp. 2 million per member. Recent data about the progress of this credit scheme were not available.

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Table 1.6 Family Welfare Income Generation Project (UPPKS) as of July 2000

Indicator Sumatra Java & Bali

Kali-mantan Sulawesi West Nusa

Tenggara Total

TAKESRA deposits

Number of groups - - - - - 600,843

Number of members (,000) 2,220 8,280 524 872 1,016 12,913

Total amount (Rp. million) 31,141 152,786 6,538 15,544 11,219 217,227

KUKESRA loans

Loans disbursed (Rp. billion) 188.9 1,020.4 43.0 104.9 41.0 1,398.1

Loans outstanding (Rp. billion) 75.3 349.9 16.0 41.7 18.0 501.0

Number of groups 101,190 361,362 20,359 31,158 41,724 555,793

Number of members (,000) 1,632 7,282 407 727 745 10,795

Arrears (Rp. billion) 37.5 98.7 7.0 17.1 8.7 168.9

Arrears ratio (%) * 49.7 28.2 43.5 41.0 48.7 33.7

Source : National Family Planning Coordination Board (BKKBN), Takesra/Kukesra Report July 2000. * Arrears ratio : loan amount in arrears / loan amount outstanding.

According to BKKBN statistics of July 2000, the Takesra scheme involved 600,843 UPPKS groups with 12.9 million members in all of the Indonesian provinces. Assuming that one woman participates per household, this number is equivalent to between 50% and 60% of the Indonesian households classified by BKKBN into the two lowest family welfare categories.

555,793 of these groups and 10.8 million of these members participated in the Kukesra scheme. Since its inception the program had disbursed a total loan amount of Rp. 1.4 trillion, 73% of which were allocated to Java and Bali. As of July 2000, loans outstanding amounted to Rp. 501 billion, of which an outstanding 34% was in arrears. The long-term repayment rate (loan amount due to loan amount repaid since inception) was 13%. Assuming that each group member had loans outstanding, the average individual loan amount outstanding was only Rp. 46,500.

The UPPKS program as well as the IDT program (see below) represented a break from careful expansion of state-led microfinance in Indonesia. The huge losses and the highly subsidized interest rate indicate that financing under the program is not sustainable. The low loan amounts are hardly able to support the start-up or expansion of microbusinesses. Doubts must also be raised with regard to the capacity of family planning and family health field staff to implement a microfinance program.

With the program being led by concern for short-term political gains rather than for sustainable microfinance, the channeling of easy and cheap money reinforced the perception that Kukesra funds are funds that are distributed by the government for social purposes and do not have to be repaid.11

11 See: Khofifah Indar Parawansa, Keuangan Mikro dan Pembangunan, Lokakarya Nasional

Lembaga Keuangan Mikro, 4-5 July 2000, Bogor.

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Other and New Poverty Alleviation Initiatives

In the first half of the 1990s, poverty alleviation became a top priority of the Indonesian political agenda. The official expenditure-based poverty line indicated a considerable decrease in absolute poverty, but poverty and vulnerability to poverty continued to be main development problem. Additionally, income disparities between regions and population groups tended to decrease. The Indonesian Government reacted with initiating the first mass poverty alleviation program, which became known as Inpres Desa Tertinggal (IDT) or Presidential Instruction on Backward Villages, in 1993. As an ambitious crash program that targeted 44% of the Indonesian villages in only three years and focused on providing revolving funds at highly subsidized interest rates, the IDT program represented a break with the up to then prevailing careful expansion of microfinance in Indonesia.

The IDT program was coordinated by Bappenas, the national planning agency, and was implemented during the three financial years from 1994/1995 to 1996/97. The program provided three sorts of inputs to 28,376 backward villages: a) capital grants of Rp. 20 million per village and year to be used as revolving funds for income-generating activities of the poor; b) technical support services through facilitators; and c) grant of Rp. 100 million to Rp. 130 million per village for the improvement of the rural physical infrastructure. The revolving funds for income generation were allocated to community groups, which were usually formed for this purpose by the program facilitators. As of March 1997, the program involved 123,000 community groups with 3.5 million members. During the three financial years the program injected Rp. 1.3 trillion into these community groups.

The program, however, lacked a proper monitoring and supervision system. Information on group development, the flow and use of funds, and the program’s impact is scarce. Only about half of the funds channeled were repaid. Field evidence shows that group formation lacked sustainability and a considerable part of the funds were misallocated or misappropriated. Sajogyo argued that the government focused on distributing money in short time rather than the self-reliance of community groups and the sustainability of microfinance services.12

The unsatisfactory performance of the IDT program contributed to the rethinking of future program designs. Presently, there are two large poverty alleviation programs, which are built on the lessons learned from the IDT program, the Sub-district Development Program and the Urban Poverty Alleviation Project. Both programs are financed by World Bank loans and implemented by Bappenas, the National Planning Agency.

The Sub-district Development Program (Program Pengembangan Kecamatan – PKK) aims at alleviating poverty in backward villages, strengthening sub-district and village government in implementing development programs, strengthening community participation and organization, and building public infrastructure through labor-intensive

12 See: Sajogyo, Konsultasi Bersama menuju Tumbuhnya Lembaga Ekonomi Desa yang

Berkelanjutan: Tujuan dan Metoda. Seminar dan Lokakarya Memberdayakan Ekonomi Rakyat melalui Keuangan Mikro, Kerjasama Bank Indonesia Bandung, Pusat P3R Yayasan Agro Ekonomika, Bandung, Pemerintah Propinsi Jawa Barat, 7-8 September 2000.

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methods.13 Besides its technical assistance components, the program focuses on providing block grants to sub-districts. Program implementation was planned for the three financial years from 1998/1999 to 2001/2002. It started assisting 501 sub-districts in 1998/1999 and expanded to 727 sub-districts in 1999/2000. The budget allocation for these years and sub-districts amounts to Rp. 969 billion. The World Bank contributes some USD 200 million to the program budget.

Annual block grants of Rp. 500 million to Rp. 750 million are provided over this three-years period to each selected sub-district. A special sub-district forum (UDKP) is responsible for distributing these funds to villages based on their investment proposals. The funds are managed by a financial management unit (Unit Pengelolahan Keuangan - UPK), which is established and supervised by the UDKP forum. The UPK is staffed with a chairperson, an accountant and a secretary, who are appointed by the UDKP forum and confirmed by the sub-district head. The UPK has a central function as it is expected to develop into a viable unit capable of managing and coordinating various sources of funds of rural development programs.

The UPK disburses funds to and collects funds from community groups and responsible village government institutions. Funds are provided to community groups, which must have existed in the prior year, for financing seed capital for economic activities. These funds have to be repaid at commercial interest rates and are used to build up a revolving fund at the sub-district level. Funds channeled to the village government may also be used to finance public infrastructure on a grant basis.

Information and detailed data about program performance was not available.

The Urban Poverty Alleviation Project (Proyek Penanggulangan Kemiskinan di Perkotaan - P2KP) aims at improving basic infrastructure in poor urban neighborhoods and to promote sustainable income generation for its poor urban residents. The project also seeks to strengthen the capability of local agencies to assist the poor and to encourage broader participation in decision-making about community matters. The P2KP project targets families with a household income of less than Rp. 250,000 per month in the poorer kelurahan (urban administrative areas) of Java. The World Bank has made available a USD 100 million for program implementation in the financial years from 1999 to 2002.14

The core instrument of the program is a one-time grant provided to each selected kelurahan for financing of income-generating activities and basic infrastructure works. Depending on population size, the grants range from Rp. 150 million to Rp. 1,250 million per kelurahan. Microcredit for income-generating activities is provided to poor families, which are organized in groups of at least three members for this purpose. Loans are provided with a commercial interest rate and have to be repaid within one year.

13 See: Bappenas, Tim Koordinasi Pengelolaan Bantuan PKK, Pedoman Umum Bantuan

Program Pengembangan Kecamatan (PPK), Tahun Anggaran 1998/1999; Bappenas, Tim Koordinasi Pengelolaan Bantuan PKK: Petunjuk Pelaksanaan Bantuan Program Pengembangan Kecamatan (PPK), Tahun Anggaran 1998/1999.

14 See: World Bank, Urban Poverty Project Appraisal Document, World Bank Report No: 18359-IND, April 19, 1999.

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The corner stone of the project is facilitating the formation of legitimate kelurahan-level institutions, which are called Badan Keswadayaan Masyarakat (BKM) or community self-reliance boards. The BKM consist of community representatives and are responsible for managing funds and approving kelurahan proposals. Similar to the Sub-district Development Program, the BKM is supposed to establish a financial management unit (Unit Pengelolahan Keuangan - UPK) that manage and build up a revolving fund for microcredit to community groups.

In the first six months of operation, the project formed approximately 1,300 BKM, which have provided loans to roughly 28,000 community groups. Detailed information on project performance was not available.

Apart from these national poverty alleviation initiatives there are a variety of regional development projects with similar objectives and implementation mechanisms. Succeeding the IDT program and similar to the PKK and P2PK programs, these projects usually use a group approach and combine measures in the fields of infrastructure, agriculture, basic needs, and microfinance. Two examples are briefly described in the following.15

The Nusa Tenggara Agricultural Area Development Project (NTAADP)16 is financed by a World Bank loan and implemented by the provincial planning agencies in Nusa Tenggara. The project covers 27 villages and aims at increasing income of village communities through improved farm systems, livestock production, microenterprise development and basic infrastructure development. NTAADP facilitates the formation of community groups, provides grants for infrastructure development and has established a revolving fund to finance agricultural and short-term productive activities based on proposals prepared by the village community groups.

As in the other projects, the NTAADP strategy includes the establishment of financial management units (Unit Pengelola Keuangan Desa - UPKD). This village-level units have the task of managing program funds, provide guidance to community groups, assist them in preparing loan proposals, disburse and collect credit, and monitor community group activities. The UPKD is staffed with a chairperson, accountant, secretary and two additional persons who are responsible for administering the revolving fund and infrastructure projects. The project intends to develop these units into village financial institutions with the legal status of a cooperative.

The Project Nusa Tenggara (PNT) or “Self-help Promotion for Low Income Communities in Critical Rural Areas” is a poverty alleviation project carried out by the Ministry of Home Affairs in cooperation with GTZ. Besides carrying out labor-intensive infrastructure projects, providing agricultural inputs and training, and strengthening institutions involved in village planning and development, the project aims at strengthening self-help groups through savings and credit activities and active 15 See also: Detlev Holloh, Appraisal of the Proposal “Development and Upgrading of

Microfinance Institutions in West Nusa Tenggara”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

16 See: Badan Perencanaan Pembangunan Propinsi Daerah Tingkat I NTB (BAPPEDA), Technical Assistance for Implementation of Nusa Tenggara Agricultural Area Development Project, NTAADP, IBRD Loan 3984-IND. Panduan Praktis & Rumusan. PT. Insan Mandiri Konsultan in ass with PT. Global Adhikreasindi, PT. Hiway Indotek Konsultan.

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participation in village planning processes. The project assumed the task to reactivate village groups established under the IDT program.

As of April 2000, PNT operated in 19 villages and reached 9,575 households organized in 364 village community groups. The groups had received loans from the IDT program amounting to Rp. 1.5 billion, of which 1.2 billion still have to be repaid. Currently the project concentrates on recovering loans, inducing new group dynamics, improving group administration and motivating savings mobilization. The project aims at developing the groups into savings and credit associations and facilitating access to financial services from banks.

1.2.3 Crisis-related Programs with Microfinance Components

The impact of the crisis and the draught in 1997/1998, especially the outstanding increase in poverty and acute food shortages, necessitated a quick response by the Indonesian Government and to concentrate its efforts on those most affected by the crisis. In cooperation with international organizations, the government embarked on several programs, which were grouped under the name Social Safety Net (SSN) and should follow five basic principles: quick disbursement; direct and well targeting, transparency, accountability, community and civil society participation, and sustainability.

The typical delivery mechanism of SSN programs is that the central government allocates funds by each district/municipality. The local government determines village level allocations based on local conditions and the communities themselves determine the beneficiaries through village meetings. The funds are channeled from central government directly to the beneficiaries via banks and post offices. This mechanism was established to reduce the possibility of leakage and to ensure that the funds are quickly channeled to the needy families.

The SSN programs have been implemented since the financial year 1998/1999 and aim at:

• Ensuring the availability of food at affordable prices for the poor; • Preserving access to critical social services in the education and health

sectors; • Creating productive employment to increase purchasing power of the poor; • Generating community-level economic activities.

During the financial years 1998/1999 and 1999/2000 the SSN programs were categorized under five intervention sectors: food security, social protection in the education sector, social protection in the health sector, employment and income generation, and community empowerment funds. The total budget allocated for the SSN programs during these financial years was about Rp. 15 trillion. In addition, the World Bank has made available a Social Safety Net Adjustment Loan of USD 600 million to support the safeguarding of key safety net programs and the improvement of their designs.

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Of particular relevance for the microfinance sector are the community empowerment funds, which are channeled by a project called Pemberdayaan Daerah dalam Mengatasi Dampak Krisis Ekonomi (PDM-DKE) or Local Empowerment to Overcome the Impact of the Economic Crisis. The national planning agency and the Ministry of Home Affairs are the implementing agencies. Geographically, the program will be implemented in all provinces and in villages of sub-districts where the Sub-district Development Program and the Urban Poverty Alleviation Project are not operating.

The PDM-DKE project aims to increasing the purchasing power of the poor by generating employment and small business opportunities, and improving economic and social infrastructure at the community level. Community groups are supposed to participate in project planning with the assistance of sub-district and village facilitators. Project proposals are eligible to funding in the fields of a) construction, operation and maintenance of local infrastructure, and b) small scale business. Funds for approved proposals are channeled directly to the account of the “village implementing team” that is responsible for disbursing loans to community groups.

The PDM-DKE project was first launched in 1998/1999 and had the character of an emergency rather than a development project. SMERU17 reported that the annual budget of 1998/1999 foresaw expenditures of Rp. 1.7 trillion to cover almost all urban and rural villages and that both the scale of funding and the planned speed of disbursements was highly contested. SMERU’s rapid assessment of project implementation before funds were available for project financing found that a) the understanding of project objectives at the village level was inadequate and community groups were not formed as intended; b) the village implementation teams usually consisted of village officials, while poor community members were not involved in and informed about the project; c) the projects selected for financing usually did not directly target the poor. The appraisal concluded that “the program as currently designed and implemented would not reach the poorest and unemployed”.

The author has no information whether the project was implemented as planned in 1998/1999. It seems that both budget limitations and findings such as by SMERU have contributed to postponing project implementation. The annual SSN budget allocates Rp. 792 billion to the PDM-DKE project, but the government further postponed project implementations. Based on improvements in project design, the government included the project in its budget plan for the financial year 2000 (April to December) and reduced the project budget to Rp. 435 billion (PDM-DKE). While preparatory steps were taken in 2000, the program was not expected to be fully operational before November 2000.

The Community Recovery Program (CRP) is a civil society-led response to the crisis and channels funds to community-based organizations on the basis of project proposals for providing assistance to vulnerable populations groups, especially those most severely affected by the social-economic crisis. The CRP was formally announced at the Consultative Group for Indonesia (CGI) meeting in July 1998. It has 17 SMERU Newsletter March-April 1999, Results of A SMERU Team Rapid Assessment of the

First Phase of the PDM-DKE Program.

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received the backing of the government and is supported by various multilateral and bilateral donor agencies. The CRP is led by a National Council (NC), which consists of three government members and nine individual members elected by a Civil Society Consortium. The consortium is made up of Indonesia's 27 most prominent NGOs and functions as an advisory body to the NC. A Trust Fund for the Community Recovery Program is administered by UNDP. Audits of the Trust Fund and CRP expenditures are carried out in accordance with UN audit procedures, with regular reporting to donors, the NC and the public. The objectives of the CRP are to:

• Fill gaps in the Social Safety Net (SSN) program; • Reach vulnerable groups not covered by other SSN programs; • Support innovative approaches to the SSN; • Encourage and facilitate civil society potentials for SSN initiatives; • Respond immediately to poor communities most affected by the crisis by

reversing declining standards of living and conditions, helping communities restore their economic activities, and ensuring basic social services.

• Create synergy between civil society, government and the private sector as well as the international community.

Beneficiary and community needs are identified and project proposals are prepared by community-based organizations and local NGOs. The CRP appraises and selects project proposals. Funds are transferred directly to the bank account of local organizations. By the end of 1999 CRP had received a total of 2798 proposals, of which 466 had been approved with a total value of Rp. 45 billion.18

The CRP reports do not report on microfinance activities and the performance of revolving funds. They, however, mention that a great part of NGO proposals referred to the formation of savings and credit groups. Anticipating the ending of project support, CRP also encourages the establishment of revolving credit funds.

Distribution of Fuel Subsidies

Despite the signs of recovery the government continued with its emergency and recovery programs as is. Most strikingly, the government recently decided to convert subsidies (Rp. 800 billion) saved through the fuel price increase in October 2000 to funds that are to be channeled to poor households and villages through rapid channeling mechanisms known from social safety net and subsidized credit programs. The funds were to be channeled within only three months until the end of 2000. Rp. 450 billion was to be used for direct cash transfers to poor households and labor-intensive local infrastructure development. Coordinated by the Ministry of Cooperatives, commercial banks were supposed to channel Rp. 350 billion as revolving funds to eligible cooperatives (Rp. 100 million each) and other member-based microfinancial institutions (Rp. 57 million each). The individual member is entitled to receive a Rp. 1 million loan at an annual effective interest of 16%. The interest rate will be reduced to 6%, if repayment is good. Well performing cooperatives and microfinancial institutions can retain the entire funds as equity capital, thus receiving a grant rather than a revolving fund. 18 See: Community Recovery Program (CRP), Progress Report 2000, Jakarta 2000.

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1.2.4 Non-Government Organizations and Microfinance

Compared to the outstanding role of bank and non-bank microfinance institutions as well as of governmental microfinance programs, non-government organizations (NGOs) do not play a strong role in the microfinance sector. Contrary to other countries, Indonesia has no large-scale non-governmental microfinance institutions. Depending on political conditions and regulatory frameworks, NGOs have been focusing on small-scale development programs ‘form below’ and promoting self-help and self-organization at the village level. This promotion of grassroots development, particularly the promotion of self-help groups with the aim of increasing the self-reliance and collective bargaining power of the rural poor, has played an important role in strengthening civil society vis-à-vis the state at the local level. In promoting self-help and self-reliance, many NGOs have focused on the development of savings and credit groups, probably their major contribution to microfinance sector development.19

The concept of the linkage project (PHBK) to provide low-income groups organized in self-help groups with access to bank services gave NGOs or so-called Self-help Promotion Institutions for the first time a prominent place in the implementation of a national microfinance sector program. Since the inception of the linkage project in 1989 more than 200 NGOs participated as intermediaries between banks and self-help groups and as implementers of the project’s training component for self-help groups. Leading NGOs, particularly Yayasan Bina Swadaya, did not only participate as implementing agencies but played also a crucial role in designing the linkage concept and promoting the concept in and outside Indonesia. Bina Swadaya took also the lead in building an association of NGOs (Altrabaku) participating in the linkage project.

Altrabaku (Asosiasi LPSM Mitra Lembaga Keuangan dan Pengembangan Usaha Mikro), or the Association of Self-help Promotion Institutions - Partner for Microfinance Institutions and Microenterprise Development, was founded in 1995 by NGOs that were participating in the linkage project. The association’s objectives are to promote the linkage concept, expand linkages between NGOs and banks, and strengthen the institutional capacities of members in empowering the people’s economy through microfinance and microenterprise development. Altrabaku members are NGO partners of the linkage project as well as other NGOs with microfinance services. Presently, the association has 14 regional committees with 119 members. Unfortunately the association was not able to provide data about the microfinance activities of its members. The two largest Altrabaku members and NGOs with microfinance activities are the Credit Union Coordination Board of Indonesia (CUCO or BK3I) and the Yayasan Bina Swadaya (YBS).

The Credit Union Coordination Board is organized into 28 regional chapters, which have 1,115 Credit Unions with 252,226 members and assets of Rp. 186 billion. Chapter 6 describes the Credit Union movement in more detail, as its organization does not differ from that of savings and credit cooperatives and an increasing number of Credit Unions and their secondary structures have been converted to cooperatives.

19 See: P.J. Eldridge, Non-Government Organizations and Democratic Participation in

Indonesia. Kuala Lumpur: Oxford University Press, 1995; Detlev Holloh, Microfinance in Indonesia between State, Market and Self-Organization. Hamburg: LIT-Verlag, 1998.

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Yayasan Bina Swadaya is one of the oldest and biggest NGOs in Indonesia, and covers a wide range of development activities such as in the fields of education and training, production and marketing, research and publication, self-help group promotion, small enterprise development and alternative tourism. Financial sector activities include the development of savings and credit groups, a group interlending program and the establishment of people’s credit banks. As of March 2000, Bina Swadaya had 9 self-reliant regional chapters in Java and Sumatra, and 13 so-called newborn offices, which were established in Java, Central Kalimantan, South Sulawesi, East Nusa Tenggara and Irian Jaya in the second half of 1999. At the end of 1999, the self-reliant offices worked with 1,188 savings and credit groups, which had savings and loan outstanding totaling to Rp. 1.4 billion. The ‘new-born’ offices served 810 savings and credit groups with savings amounting to Rp. 1.2 billion.

Most other Altrabaku members are local NGOs for which data were not available. One example is the Lembaga Penelitian dan Pengembangan Sumber Daya (LP2SD) in East Lombok, West Nusa Tenggara. LP2SD cooperated with Bank Indonesia in the framework of the linkage and microcredit projects, and aims at developing financial self-help groups into formal savings and credit cooperatives. The NGO has set up an own credit cooperative providing an umbrella for its savings and credit groups, and sees the development of independent secondary structures (associations or cooperatives) of these groups as a crucial element in sustaining financial services to low-income groups.

The Altrabaku association organizes only a minority of the NGOs with microfinance activities. In East Nusa Tenggara, for instance, only 8 of the 21 NGOs participating in the linkage project are Altrabaku members. One of the largest non-governmental microfinance initiatives comes from Yayasan Inkubasi Bisnis Usaha Kecil (YINBUK) or the Foundation for the Incubation of Small Businesses, an Islamic NGO that established 2,914 so-called Baitul Maal wat Tamwil (BMT). BMT are non-bank savings and credit institution modeled on cooperative principles. Most of them resemble savings and credit groups, while a minority operates like Rural Credit Banks. YINBUK and BMT are described in more detail in chapter 7.

A different microfinance approch was adopted by Yayasan Dharma Bhakti Parasahabat (YDBP) in West Java. In directly targeting the poor YDBP replicates the Grameen Bank approach, but applies a cooperative approach with customers being registered as members. As of June, the NGO had 5,065 savings customers with deposits amounting to Rp. 114 million, and 4,888 borrowers with loans outstanding amounting to Rp. 440 million. YDBP intends to increase the number of its members to 30,000 until 2004.

Some few NGOs have gone beyond these microfinance approaches and have established Rural Credit Banks. Bina Swadaya is the most prominent example. Yayasan Purba Danarta in Semarang, Central Java, even succeeded to establish a locally operating commercial bank, Bank Purba Danarta.

The vast majority of small NGOs are not sustainable microfinance providers and lives on its involvement in governmental and donor-financed programs. The mushrooming of

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 31

small local NGOs during the last years was also due to the huge influx of donor money and the increasing involvement of NGOs in governmental credit, poverty alleviation and social safety net programs. The Community Recovery Program, for instance, allocated more than Rp. 4 billion to 35 NGOs in East Nusa Tenggara.

While the higher involvement of civil society and NGOs in the development process has been an important progress, this has not always contributed to improving the image of NGOs in Indonesia. Wrong concepts such as forming instant “self-help” groups for channeling money remain wrong when their implementation is transferred from government to non-government organization. NGOs with microfinance activities are not adequately regulated and audited. Flows of funds go often unchecked. The involvement of unreliable NGOs in the farmer credit scheme (KUT) has considerably deteriorated the NGO image. Many NGOs established especially for this purpose and "red-plate" NGOs were engaged in the disbursement of Rp. 8 trillion nation-wide. In the East Lombok district of the West Nusa Tenggara province, for instance, the default rate reached 75% of Rp. 3.2 billion channeled by NGOs. The ProFI microfinance appraisal reported a taxi driver, who had carried foreign donors to local NGO offices, saying: "If I could speak better English I would found an NGO. All these NGO-people have nice houses and a car." He was convinced that a considerable part of the donations does not reach the poor.20

A new initiative has recently announced to strengthen the microfinance movement in Indonesia The Gerakan Bersama Pengembangan Keuangan Mikro Indonesia (Gema PKM) or Indonesian Movement for Microfinance Development was established in March 2000 in a ceremony attended by the President of Indonesia. Gema PKM includes representatives of the government, NGOs, financial institutions, the business sector, and universities and research institutes. The State Minister for the Empowerment of Women and Head of the National Family Planning Board heads the organization, while leading NGOs such as Bina Swadaya appear to be the driving force.

The declaration of Gema PKM demands substantial changes in economic development strategies and the recognition of microfinance as a mainstream development sector. Gema PKM aims at alleviating poverty and socio-economic inequality by empowering the people’s economy. Special objectives are to:

• Increase the number and quality of microfinance institutions; • Increase the number and quality of support institutions for self-help group

development; • Develop linkages between microfinance institutions and support institutions; • Increase the participation of individuals, groups and financing institutions in

developing microfinance; • Increase access of the poor to financial services and technical support.

Gema PKM formulated the ambitious objective to reach 10 million poor families in 500,000 self-help groups during the five years from 2000 to 2005. 20 See: Wolfram Hiemann, Appraisal of the Proposal “Development and Upgrading of

Microfinance Institutions in East Nusa Tenggara”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 32

1.3 Structure of the Microfinance Sector: Institutional vs. Program Microfinance

The microfinance sector in Indonesia is made up of a high variety of institutions, programs, services, clients and target groups, which are also subject to various legal, regulatory and supervisory frameworks. This allows for different classifications of microfinance sub-sectors. The purpose of this study and the present situation of microfinance in Indonesia suggest starting with distinguishing institutional microfinance from program microfinance. The third sector of individual microcredit provided through moneylenders, shopkeepers, traders, neighbors or family members cannot be covered by this study, though evidence shows that these credit arrangements are still of considerable importance for low-income groups.

Table 1.7 Participants of the Microfinance Sector in Indonesia

Institutional Microfinance Program Microfinance Individual Microcredit

Commercial Banks (mainly BRI units) R&S: Bank Indonesia Level: District and sub-district

People’s Credit Banks (BPR) R&S: Bank Indonesia Level: Sub-district

Microfinance System Building - Linkage project (PHBK) - Microcredit project (PKM) Commercial relations between banks,

LDKP, NGOs, self-help groups, and individual customers. Strengthening small financial institutions.

Rural Credit Fund Institutions (LDKP) R&S: Provincial governments Level: Sub-district and village

Village Credit Institutions (BKD) R&S: BRI on behalf of Bank Indonesia * Level: Village

Village Savings & Credit Units (UED-SP) R&S: Ministry of Home Affairs Level: Village

State-owned Pawnshops R&S: Ministry of Finance Level: District and sub-district

Poverty Alleviation Programs - Rural Income Generation Project

(RIGP/P4K) : Commercial relations between BRI and small farmer groups

- Family Welfare Income Generation Project (UPPKS) : Subsidized credit to family welfare groups

- Sub-district Development Project (PKK): grant-based revolving fund for sub-district financial management units

- Urban Poverty Alleviation Project (P2KP): grant-based revolving fund for village-level financial management units

- similar regional projects Microfinance Cooperatives

- Savings & credit cooperatives (KSP) ** - Savings & credit units (USP) of coop. R&S: Ministry of Cooperatives Level: District and sub-district - Savings & credit service points (TPSP) R&S: MoC and BRI (TPSP) Level: Village

Crisis-related channeling of funds - Social Safety Net, i.e., PDM-DKE:

grants to villages and community groups - Community Recovery Program : grants

channeled through NGOs - Fuel subsidies converted to funds

channeled through cooperatives and microfinancial institutions

Savings & Credit Associations *** R&S: Non-regulated, apex organizations Level: Village

NGO microcredit programs

Moneylenders Traders

Shopkeepers Neighbors

Family members

R&S = Regulation and Supervision. Level = Location and predominant area of operation. * Note : BKD are recognized but not regulated as banks. ** Includes institutions such as Credit Unions, BMT that obtained the legal status of cooperative. *** Includes Credit Unions, BMT and other cooperative-like associations, which do not have a clear legal status and

operate as financial intermediaries; does not include credit channeling groups.

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 33

1.3.1 Institutional Microfinance

Institutional microfinance here is defined as the provision of microfinance services by bank and non-bank institutions that fulfill financial intermediation functions with their own products and funds. This excludes institutions that were established for the sole purpose to channel funds to target groups as well as commercial banks and other financial institutions the microfinance activities of which are limited to the implementation of governmental credit programs.

Institutional microfinance in Indonesia comprises commercial banks and people’s credit banks that are subject to the banking act and regulated by Bank Indonesia, local non-bank financial institutions that are regulated by the Ministry of Home Affairs and provincial governments, cooperatives that are subject to the cooperative law, pawnshops that are regulated by the Ministry of Finance, and non-regulated local organizations such as savings and credit associations.

Many commercial banks are involved in microfinance sector activities by acting as channeling institutions for governmental credit programs and by cooperating with small financial institutions and cooperatives. Only a few commercial banks, however, have their own microfinance windows or were established especially for providing microfinance services. Two recognized local examples are Bank Purba Danarta, which were established by a non-governmental organization in Central Java, and Bank Dagang Bali, a private bank in Bali that started as a small secondary bank and has not been loosing touch with the microfinance sector.

The only microfinance window of the commercial banking sector with national significance is the sub-district level unit system of Bank Rakyat Indonesia (BRI). The BRI unit system is the backbone of the rural financial system, which has gained international recognition for its outreach, profitability and soundness. The commercial banking sector and the BRI unit system will be described in chapter 2.

People’s Credit Banks or Bank Perkreditan Rakyat (BPR) are secondary banks, which are also subject to the banking law and are regulated and supervised by the central bank. The vast majority of these institutions were established after the banking reform in 1988 that introduced the new classification of primary and secondary banks. BPR usually operate at the sub-district level. Note that this category does not include non-bank financial institutions that are often subsumed under the generic term ‘BPR’. The BPR industry will be described in chapter 3.

Rural Credit Fund Institutions or Lembaga Dana Kredit Pedesaan (LDKP) are different types of non-bank microfinance institutions operating either at the sub-district or village level. They were established on initiative of provincial governments since the 1970s and are licensed, regulated and supervised by the provincial governments. Technical assistance and supervision is usually delegated to the Regional Development Banks (BPD), which are owned by the provincial governments. The different types of LDKP are described in chapter 4.

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 34

Village Credit Institutions or Badan Kredit Desa (BKD) operate in Java and are village-level financial institutions with historical roots dating back to colonial times. The evolution of banking laws and regulations has resulted in a strange and contradictory situation that BKD were acknowledged as BPR in word, but are neither regulated nor supervised as secondary banks. In reality, BKD are tiny institutions and lack all features characterizing BPR. In the context of this study, therefore, they are not classified as BPR as it is done by the generic term. BKD are supervised by BRI on behalf of Bank Indonesia. The BKD industry will be described in chapter 5.

Village Economic Unit – Savings and Credit or Unit Ekonomi Desa – Simpan Pinjam (UED-SP) are tiny village institutions that have been promoted by the Ministry of Home Affairs since 1995 for providing credit to low-income groups. The ministry is also responsible for their regulation and supervision. Actually, these institutions have to be regarded as part of the program microfinance sector as they highly depend on government subsidies and have been used for channeling funds rather than being developed into viable financial institutions. In this report they are described in chapter 5 because their organization was modeled on the BKD model and the UED-SP program can be regarded as an attempt to expand the BKD model throughout Indonesia.

Table 1.8 Institutional Microfinance in Indonesia

Deposits Loans Outstanding Institution Units Accounts

,000Amount

Rp. billionAccounts

,000Amount

Rp. billion

Members(,000)

BRI units ( June 2000) 3,694 24,883 18,055 2,627 6,713 -

BPR (March 2000) 2,427 4,837 2,252 2,197 2,632 -

LDKP (June 2000) 1,603 871 342 500 5 337 -

BKD (June 2000) 4,566 600 24 726 148 -

UED-SP (March 1999) 52,222 ?1 ? ? ? 116 7 345

Pawnshops (Dec. 1999) 645 - - 4,000 6 705 -

Microfinance cooperatives 15,000 ? 2 ? ? ? ? ?

Credit Unions (Dec. 1999) 1,105 252 117 ? 134 252 8

TPSP (April 2000) 1,582 254 16 240 37 254 8

BMT (Nov. 2000) 879 3 175 46 73 51 175 8

Savings & Credit Associations 10,000 ? 4 ? ? ? ? ?

1 This number reported by the Ministry of Home Affairs is not reliable (see chapter 5). 2 Reliable and new statistics differentiating between cooperatives with and without microfinance activities were not

available (see chapter 6). 3 PINBUK reports a number of 2,914 established BMT, though financial statistics include only 879 (see chapter 7). 4 The linkage project involved some 6,500 savings and credit groups. The estimate takes into account Credit Unions

and other savings and credit associations without a legal status. This estimate includes only institutions that build up own loan funds and intermediate between savers and borrowers independently of access to outside funds. Does not include pure credit channeling groups and rotating savings and credit associations (arisan).

5 Estimate based on data for 7 of 8 LDKP types (see chapter 4) 6 Estimate based on a number of 12.4 million customers served in 1999. The standard maturity is 4 months. 7 Reported as ‘revolving capital’ (see chapter 5). 8 Assumes that the number of members is equivalent to the number of deposit account, as members of cooperative

institutions have at least compulsory savings accounts.

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 35

Microfinance cooperatives here are defined as cooperatives that provide financial services and are licensed, regulated and supervised by the Ministry of Home Affairs. Cooperatives specialized in financial services are known as Koperasi Simpan Pinjam (KSP) or savings and credit cooperatives. Multi-purpose cooperatives are allowed to provide financial services, if they operate an organizationally differentiated savings and credit unit or Unit Simpan Pinjam (USP). Tempat Pelayanan Simpan Pinjam (TPSP) or savings and credit service posts operate at the village level under the umbrella KSP or USP, but they are independent organizations that are additionally supervised by BRI.

The chapter also includes a description of the Credit Union movement. Credit unions or Koperasi Kredit are organized by the non-governmental Credit Union Coordination Board, and have been increasingly converted from non-regulated savings and credit associations to licensed cooperatives since the liberalization of the cooperative law. Another type of microfinance institution that partly operates as licensed cooperatives and partly as unregulated savings and credit associations is the Baitul Maal wat Tamwil (BMT). This institution operates based on Syariah principles and has been promoted by the non-governmental Foundation for the Incubation of Small Businesses or Yayasan Inkubasi Bisnis Usaha Kecil (YINBUK). The NGO and the BMT microfinance institution are described in chapter 7.

Non-government organizations in Indonesia are usually not microfinance institutions in the sense that they act as bank-like intermediaries. Few have established small banks and most of them are either involved in or carry out their own microfinance programs. Their traditional field of intervention has been the promotion of savings and credit associations. The Credit Union Coordination Board and YINBUK are two examples of these NGOs. Savings and credit associations that build up their own loan funds have also been supported by other NGOs such as Bina Swadaya and other self-help promotion Institutions that participated in the linkage program.

There is also a large number of rotating savings and credit associations (Arisan) in Indonesia. These institutions are not included in this study as reliable data are not available and empirical studies are scarce. Part of the savings and credit associations are covered by the previous section as far as they are involved in microfinance program or were recorded in statistics made available by NGOs. The same is true for credit channeling groups, which are not regarded as microfinance institutions in the context of this study.

Perum Pegadaian – the state-owned pawnshop company

Pawnshops are an important part of institutional microfinance. As they will not be discussed in detail and a separate chapter, they are briefly described in the following.

The first pawnshops in Indonesia were established in the beginning of the 20th century. The control of pawnshops was transferred from the colonial to the Indonesian government. The pawning business has been a monopoly of the government and is organized in form of a profit-oriented state enterprise (Perum Pegadaian) since 1990. Since then the company has been professionalized and developed into a service-oriented institution that provides low-income households who hold their savings in

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 36

movable assets with an important source of liquidity. The Ministry of Finance is responsible for regulating and supervising the company.

Between 1990 and 2000 the number of the company’s offices increased from 505 to 645. Pawnshops can be found in every district capital and increasingly in sub-district capitals. Pawnshops are usually staffed with two managers and six other employees, and open six days a week from 7.00 hours to 15.00 hours. They provide simple and fast (transactions usually take 15 minutes) services, and have the comparative advantage that customers can turn their valuables easily into cash without having to sell them, particularly in cases of emergency.

Pawnshops accept collateral in the form of gold, jewelry, household items, electronic goods, motor vehicles, and even valuable fabrics and hand-woven cloth. They have five credit schemes depending on loan size, with the loan size ranging from a minimum of Rp. 5,000 to more than Rp. 20 million. Smaller loans are charged lower interest rates. The interest per 15 days ranges from 1.25% for loans up to Rp. 150,000 to 1.75% for loans larger than Rp. 500,000. The standard loan term is 120 days. Repeated loans using the same collateral are very usual.

The monetary crisis, with the intermediation function of the banking industry coming to a hold and the need for liquidity rising sharply, contributed to the growth of the pawning business. Between the end of 1996 and the end of 1999, the company’s assets increased from Rp. 647 billion to Rp. 1,151 billion, its loan amount outstanding from Rp. 414 billion to Rp. 705 billion, and its net profit from Rp. 34 billion to Rp. 61 billion. In 1999, the company served 12.4 million customers with a total loan amount of Rp. 3.2 trillion. The average loan size, therefore, amounted to about Rp. 260,000.

1.3.2 Program Microfinance

The main microfinance sector and poverty alleviation programs were already described in a previous part of this chapter. Program microfinance consists of a wide range of measures that aim at providing financial services to low-income groups but differ considerably in methods and impact. In the context of this study it is important to distinguish these programs with regard to their compatibility with institutional microfinance sector development strategies. As argued earlier, both microfinance programs directly targeting the poor and institutional development strategies have their place within an overall microfinance strategy, if direct interventions do not undermine the growth and viability of microfinance institutions.

Table 1.9 Perum Pegadaian – State-owned Pawnshop Company

(in Billion Rupiah) Indicator 1996 1997 1998 1999Number of offices * 598 622 635 645

Total assets * 674 798 1,221 1,151

Loans outstanding * 414 526 793 705

Equity * 308 333 371 407

Net profits * 34 35 53 61

Loan amount disbursed ** 1,724 2,088 3,131 3,229

Number of customers (,000) ** 5,030 5,305 9,822 12,428

Source : Perum Pegadaian, Annual Report 1999. * End of year ; ** During year.

The Microfinance Sector in Indonesia ProFI Microfinance Institutions Study 37

A major finding of the 1980s was that easy and cheap credit had undermined the viability of rural financial institutions. This finding resulted in a re-orientation of rural finance policies also in Indonesia. Until the early 1990s, microfinance sector strategies focused on rather careful approaches to increasing the access of low-income groups to institutional finance and developing viable small financial institutions. The linkage and microcredit projects of Bank Indonesia as well as the RIGP/P4K project of BRI and the Ministry of Agriculture are examples of microfinance programs that have been contributing to achieving these objectives. The linkage project introduced an innovative microfinance sub-system. Both the linkage and microcredit project have been focusing on strengthening small financial institutions in extending their outreach to low-income groups. The RIGP/P4K project provides a successful mechanism of directly targeting and reaching the poor with commercial microcredit and upgrading clients to more sustainable microfinance providers, thus supporting rather than inhibiting the growth of microfinance institutions.

In the light of mass poverty, however, these programs were regarded as moving too slow. The IDT and UPPKS programs represented breaks with the pattern of a careful microfinance expansion in Indonesia. Focusing on the number of loan disbursements, applying subsidized interest rates, neglecting essentials of successful institution building and sustainable financial services, and lacking prudential monitoring and supervision, these programs experienced a rapid decline in repayment performance. The emphasis on easy and cheap credit (or even grants) reached a new climax with the policy response to the financial, economic and political crisis since 1997.

It is probable that the huge funds channeled in reaction to the crisis have become a constraint for the growth of small financial institutions. Managers of such institutions, which were conducted in the framework of the ProFI baseline studies and the ProFI microfinance appraisal in East Java, Bali, South Sulawesi, West Nusa Tenggara, and East Nusa Tenggara, confirmed this assumption.

To underpin this argument it would be necessary to quantify and compare the volume of microcredit provided by microfinance institutions and through microfinance programs. The lack of reliable data, however, severely restricts the possibility of such a comparison. The following attempt can only convey a vague idea about the relative significance of institutional and program microfinance.

Table 1.10 Program Microfinance Funds (in Billion Rupiah) *

Program Channeling groups

Loans Outstanding

Total funds channeled

RIGP/P4K 38,000 49 ?

UPPKS 600,000 501 ?

IDT ** 123,000 ? 1,300

PKK - ? 900

P2KP ? ? 800

PDM-DKE ? ? 435

Fuel subsidy funds ? ? 350

Other crisis-related funds ? ? ?

NGO programs ? ? ?

Estimate of total funds channeled to/circulating at village level : Rp. 5 trillion (minimum)

* Does not include subsidized liquidity credit programs. ** The IDT program is already terminated. Field evidence, however, showed

that up to three quarters of the loan amount disbursed is still outstanding.

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1.3.3 Institutional and Program Microfinance Compared

The BRI unit system is the backbone of the rural financial system. This is especially true with regard to savings mobilization. With some 25 million deposit accounts and a total deposit amount of Rp. 18 trillion, the system covers between 70% and 80% of the microsavings market. The units’ limited outreach to the village level and their risk-averse lending approach, however, leaves other institutions with relative larger shares in the microcredit market. The number of loan accounts contributed by pawnshops and the BPR industry come close or exceed that of BRI units. Taking also the cooperative sector into account (for which information was not available), it is likely that BRI units contribute not more than 25% to the total number of loan accounts in institutional microfinance.

Based on the few data available it is not nearly possible to come up with a realistic estimate of the loan amount outstanding in or total microcredit channeled by poverty alleviation and crisis-related programs. The amount of Rp. 5 trillion would be a minimum guess. The author found villages in West Nusa Tenggara where funds channeled by poverty alleviation and social safety net programs approached the Rp. 1 billion mark (including funds other than microcredit). If the revolving funds of these programs average Rp. 250 million per village, their total amount for some 65,000 villages most probably would exceed the total loan amount outstanding of all microfinance institutions. However, even the minimum estimate of Rp. 5 trillion suggests that the channeling of these usually cheap funds must have narrowed the market for small financial institutions with outreach to low-income households. This amount is equivalent to half of the loan amount outstanding of BRI units and BPR, the majority of which does not have access to the village level, and exceeds the loan amount outstanding of LDKP, BKD, UED-SP, TPSP, BMT, and Credit Unions by 6 times.

ProFI Microfinance Institutions Study

Chapter 2:

The Commercial Banking Sector

and BRI’s Unit System

Commercial Banking Sector ProFI Microfinance Institutions Study 40

2. The Commercial Banking Sector and BRI’s Unit System

This chapter provides an overview of the commercial banking sector and deals with Bank Rakyat Indonesia (BRI) and its well-known unit banking system at the sub-district level. The chapter excludes governmental microfinance programs and small business liquidity credit programs, in which commercial banks have been required to participate. The microfinance window of Bank Bukopin, the Cooperative Bank of Indonesia, will be described in the chapter on the cooperative sector (chapter 6). Bank Muamalat and microfinance services provided on the basis of Islamic banking principles will also be separately described (chapter 7). There are few other commercial banks with independent microfinance windows. Two recognized examples are Bank Purba Danarta, which were established by a non-governmental organization in Central Java, and Bank Dagang Bali, a private bank in Bali that started as a small secondary bank and has not been loosing touch with the microfinance sector. Though these banks provide valuable microfinance services, time constraints did not allow including them in this study.

2.1 Past and Current Development of the Commercial Banking Sector

2.1.1 The Commercial Banking Sector prior to the Financial Crisis in 1997/1998

State dominance over economy and society was the essential feature of the Indonesian development model until the 1980s. The role of state banks was expanded especially during the oil boom period between 1973 and 1982, when state banks were used to channel huge amounts of government revenues in the form of 32 liquidity credit programs to domestic industries, state enterprises and the agricultural sector. By 1982, state banks accounted for 80% of total bank assets and 85% of total bank credit. The share of private domestic banks in total bank assets had declined from 25% in 1968 to only 12% in 1982. The rural financial system was closed for all banks but BRI, which had been instructed to establish an extensive network of village units for channelling subsidized credit to farmers, small entrepreneurs and cooperatives.

The collapse of oil prices in the 1980s made the adverse effects of this policy obvious. The abuse and repression of the banking sector had undermined domestic savings mobilization and the state banks’ viability. Unsound lending practices, misallocation of funds and high default rates prevailed in most subsidized credit programs. The BRI units operated at high losses and were near to collapse. Thus, in the mid-1980s the government had no option other than adopting adjustment measures and starting to deregulate the economy. The new market-oriented approach was most pronounced in a series of financial sector reforms. The first reform in 1983 removed credit ceilings, interest controls and nine subsidized credit programs. The BRI village units were transformed into viable profit centers through the introduction of market-oriented savings and credit products. The 1988 banking reform removed most entry barriers, allowing commercial banks to extend their branch network throughout Indonesia. In 1990, all but four subsidized credit programs were abolished. The 1992 Banking Act with its general emphasis on market-oriented banking removed the specialized functions of state banks and transformed them into limited liability companies.

Commercial Banking Sector ProFI Microfinance Institutions Study 41

Between 1988 and 1993, the number of private national banks increased from 67 to 161 and the number of their branches from 546 to 3,036. Deposits and outstanding credit of the banking industry grew by four to five times during the same period. The liberalization of financial markets constituted a watershed in the relationship between the state and private banking sectors. The private sector continuously increased its business share and exceeded that of state banks in 1995. As of December 1996, the private national banks accounted for 67% of all bank offices, 59% of total deposits and 51% to the total loan amount outstanding of the commercial banking sector.

Table 2.1: Growth of Commercial Banks and Bank Offices by Ownership (1988 – 2000)*

March

1988December

1993December

1996Growth

3/88-12/96December

1998September

2000Growth

12/96-9/00State Banks Number of banks 7 7 7 - 7 5 - 28.6% Number of offices 835 1,076 1,379 65.1% 1,602 1,507 9.3% As % of total offices 50.9 23.3 23.3 25.6 27.9 Number of BRI units 2,585 3,267 3,595 39.1% 3,703 3,694 2.8%Reg. Development Banks Number of banks 27 27 27 - 27 26 - 3.7% Number of offices 238 426 490 105.9% 555 548 11.8% As % of total offices 14.5 9.2 8.3 8.9 10.1Private National Banks Number of banks 67 161 164 144.8% 130 83 - 49.4% Number of offices 546 3,036 3,964 626.0% 3,976 3,258 - 17.8% As % of total offices 33.3 65.8 67.0 63.6 60.2Foreign & Joint Banks Number of banks 11 39 41 272.7% 44 52 26.8% Number of offices 21 75 86 309.5% 121 96 11.6% As % of total offices 1.3 1.6 1.5 1.9 1.8Total Number of banks 112 234 239 113.4% 208 166 - 30.5% Number of offices 1,640 4,613 5,919 260.9% 6,254 5,409 - 8.6%Source: Bank Indonesia, Monthly Financial Statistics. * Number of bank offices does not include BRI units. NOTE: Numbers reported by Bank Indonesia’s monthly financial statistics deviate considerably from figures presented in the bank’s quarterly reports (see below).

The roots of the coming banking crisis were laid prior to the financial crisis in 1997/1998. The deregulation of the banking sector was not accompanied by a comprehensive reform of the real sector, in which most state enterprises were deemed financially unsound and large business conglomerates remained politically protected. The banking industry was not freed from political intervention. Bank supervision by the central bank lacked the capacity to cope with the rapidly growing banking industry as well as independence and enforcement power. While the central bank and state banks were prompted to take unsound credit decisions in favor of specific business groups and economic sectors, private banks connected to large business conglomerates failed to comply with legal lending limits in extending loans to their own shareholders. Already in the first half of the 1990s several banks were at the brink of bankruptcy, and the huge amounts of bad debts of business conglomerates and subsidized credit programs had become a major issue of public debate.

Commercial Banking Sector ProFI Microfinance Institutions Study 42

2.1.2 Policy Response to the Financial and Banking Crisis

When the Asian exchange rate crisis spilled into Indonesia in mid 1997 it hit an already fragile banking system. The Rupiah exchange rate turbulence reached its height in January 1998 when the exchange rate of the US Dollar had soared to about 16,000 Rupiah. The inflation rate bounced to 78% in 1998. The pressure on the Rupiah and the massive withdrawals of deposits from private banks plunged the banking industry into a severe liquidity crisis. The inter-bank interest rate propelled to 350% in January 1998 and averaged 64% during the entire year. The interest rate for one-month deposits increased from 17% in 1996 to 52% in 1998. With large parts of its loan portfolio at risk, the intermediation function of the industry virtually came to a hold.

In a first response to the banking crisis the Government revoked the business licenses of 16 insolvent banks in November 1997. The declining confidence in the banking industry resulted in a massive withdrawal of deposits from private banks prompted Bank Indonesia to embark on a liquidity support program. Although Bank Indonesia liquidity credit was extended at high interest rates to discourage misuse of funds, the liquidity support given rose from Rp. 62.8 trillion in December 1997 to Rp. 177.1 trillion in July 1998. The absence of deposit insurance necessitated the Government to declare a blanket guarantee for deposits in January 1998. The guarantee scheme includes an additional guarantee on the claims of creditors. In 1998, the Government supported the guarantee scheme with bonds amounting to Rp. 164.5 trillion. This measure was followed by the establishment of the Indonesian Bank Restructuring Agency (IBRA) with two major functions: (i) to supervise restructured banks and, based on an evaluation of their viability, take over or suspend the operation of restructured banks; (ii) to manage the assets acquired in the course of bank restructuring.

By mid-1998, the Government had articulated a comprehensive reform strategy consisting of five major components: (i) a bank restructuring and recapitalization program, (ii) a credit restructuring and recovery program, (iii) a program aiming at creating good governance, (iv) the improvement of the legal and regulatory framework, and (v) the strengthening of bank supervision.

Restructuring and recapitalization of the banking industry. Prior to the formation of IBRA the government had liquidated 16 private national banks in November 1997. Based on the banks’ capital adequacy ratio, Bank Indonesia classified the banking industry into three classes. Class A banks, with a CAR of 5% and higher, were not required to participate in the recapitalization program. Class B banks, with a CAR between minus 25% and below 4%, were required to participate and their loans classified as loss were transferred to IBRA. Class C banks, with a CAR less than minus 25%, were given one month to upgrade to class B or their licenses were to be revoked. As of March 1998, Bank Indonesia had transferred 4 state banks, 37 private national banks, 2 joint banks and 11 regional development banks to IBRA.

As of June 2000, the Government had liquidated 68 and merged 12 out of 238 commercial banks. After the creation of two new banks (Bank Mandiri and Bank Ekspor Indonesia) there remained 161 banks, of which 19 still were in the recapitalization process and 12 were classified as bank take-overs. During the third quarter of 2000, 8 bank take-overs were merged with Bank Danamon, with the number of commercial

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banks decreasing further to 153. As of 31 October 2000, the Government completed the recapitalization program with the recapitalization of six major banks. The total value of government bonds issued as part of the bank recapitalization program amounted to about Rp 430 trillion. The most costly effort was the merger of four state banks into Bank Mandiri, with the value of government bonds amounting to Rp. 180 trillion.

The credit restructuring program has been aiming at the settlement of non-performing loans of banks outside of IBRA. To facilitate agreements between banks and debtors Bank Indonesia formed a credit restructuring task force in November 1998. As of August 1999, Bank Indonesia calculated the amount of problem loans to Rp. 127 trillion, of which Rp. 44 trillion were in the process of restructuring. As of August 2000, Bank Indonesia had succeeded to restructure loans of 16,996 debtors with a total loan amount of Rp. 54.1 trillion. State banks accounted for about 83% of the debtors and 90% of the loan amount restructed.

To instill good governance into the banking system Bank Indonesia implemented a fit and proper test program for bank owners and managers, carried out interviews with new candidate owners and managers, assigned compliance directors to the banks’ board of directors, and intensified investigations in criminal banking cases. As of September 2000, Bank Indonesia had carried out fit and proper test for 93 shareholders and 984 managers of 105 banks. 601 managers passed the test. Interviews were carried out with one candidate owner and 91 candidate managers. 81 candidate managers were found to meet the requirements set by Bank Indonesia. 161 banks had proposed 215 compliance directors of which 145 were accepted by Bank Indonesia. To emphasize law enforcement Bank Indonesia formed a special investigation unit. As of September 2000, Bank Indonesia had reported 14 banks suspected of being involved in criminal cases to police authorities for further investigation.

In the years from 1998 to 2000 the government made any effort to improve the legal and regulatory framework for the banking industry through the amendment of the Banking Act, government regulations and Bank Indonesia decrees. Banking Act No. 10 of 1998 amended Banking Act No. 7 of 1992 to respond to the new challenges. Substantial changes made were the transfer of licensing authority from the Ministry of Finance to Bank Indonesia; the lifting of foreign bank ownership restrictions; the accomodation of the banks operating based on Syariah principles; the limitation of bank secrecy to information on deposits and deposit customers and deposits; and provisions for the formation of a deposit protection institution and the bank restructuring agency. As a follow up Bank Indonesia issued new regulations for both conventional banks and banks operating according to the Syariah principles. Special regulations dealt with bank mergers and acquisition, purchase of bank shares, the revocation of business licences and bank liquidation. Other special regulations made provisions for fit and proper tests, credit restructuring, short-term financing, and bond portfolio trading. A set of Bank Indonesia decrees, such as on loan loss provision requirements, minimum capital requirements, assessment of assets quality, legal lending limits, and financial reporting, were designed to improve prudential banking practices in accordance with international standards.

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Bank Indonesia’s endeavors to improve the effectiveness of bank supervision are reflected in the fact that the Senior Deputy Governor was appointed to oversee and coordinate the bank’s supervision function. Off-site supervision and on-site supervision were organizationally separated, and more emphasis was given to direct inspections and enforcement. Compliance-based supervision was complemented with risk-based supervision in accordance with international standards. In this context, Bank Indonesia established on-site supervisory presence in four state banks and five private national banks that are considered to have systemic impact on the entire banking industry.

2.1.3 Development of the Commercial Banking Sector 1997 – 2000

During the financial years of the financial crisis the banking industry experienced a considerable growth of the nominal value of its business volume, loan portfolio and fund mobilization. Holding the Rupiah exchange rate against the US Dollar constant, however, the industry’s business volume slowed down. This is especially true for the loan portfolio that showed growth rates considerably below that of assets. The loan portfolio to assets ratio decreased from 76% as of the end of 1996 to 64% as of the end of 1998. At the same time, the non-performing part of the loan portfolio rose from 9% in March 1996 to 20% in December 1997 and 59% in February 1999.

Table 2.2: Commercial Banks’ Financial Development (1996 – 2000, in Trillion Rupiah)

December

1996December

1997Growth

12/96-12/97December

1998Growth

12/97-12/98December

1999Growth

12/98-12/99

Assets = Liabilities 387.5 528.9 36.5% 762.4 44.1% 815.1 6.9%Outstanding credit 292.9 378.1 29.1% 487.4 28.9% 225.1 - 50.4% As % of assets 75.6 71.5 63.9 27.6 Total deposits 281.7 357.6 26.9% 573.5 60.4% 651.4 13.6% As % of assets 72.7 67.6 75.2 79.9 Savings deposits 61.6 68.9 11.9% 69.3 0.6% 123.0 77.4% As % of total savings 21.9 19.0 12.1 18.9 Time deposits 162.7 206.4 26.9% 406.8 97.1% 387.1 - 4.8% As % of total savings 57.7 57.7 70.9 59.4 Equity * 37.1 46.7 25.9% - 98.5 - 310.9% - 21.6 78.1% As % of assets 9.6 8.8 - 12.9 - 2.7 Source: Bank Indonesia, Monthly Financial Statistics. * Includes reserves and profit/loss.

The nominal growth of assets was mainly due to the rapid increase of time deposits triggered off by exorbitant interest rates. Its share in total deposits increased from 58% to 71% until the end of 1998. The decline in public confidence, therefore, did not negatively affect deposit mobilization in absolute terms. Customers of private national banks transferred their deposits to state banks and foreign banks that were considered sound and safer places to save. The negative spread between time deposit and credit interest rates as well as the increasing amounts of non-performing loans decapitalized the industry. At the end of 1998, the industry had a negative capital of almost Rp. 100 trillion. As of February 1999, return on assets had reached minus 23% and the capital adequacy ratio had plunged to minus 25%.

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The financial development of the banking industry in 1999 showed the effects of the progressing bank restructuring and recapitalization as well as of the improving net interest margin because of declining deposit interest rates since May 1999. The loan portfolio contracted by 50%, mainly because of the bad debts transferred from state banks to IBRA and the liquidation of 40 banks in March and April 1999. The loan portfolio to assets ratio declined to 28% with major parts of assets placed in the government’s recapitalization bonds. Assets grew slightly because savings deposits mobilized doubled in 1999. As an effect of normalizing time deposit interest rates the structure of deposits adjusted again to that prior of the financial crises. As of December 1998, the industry still operated with a negative but considerably improved profitability and capital. The credit-restructuring program, however, had not yet succeeded to improve the industry’s loan portfolio, with its non-performing part still making up 37%.

In 2000, the banking industry showed clear signs of recovery. Assets grew by 25% and the loan portfolio by 41%. The bank inter-mediation function was revived, however, to a very limited extent. Credit extension increased at a low level, with the loan portfolio to assets ratio staying at 31% only. Due to the transfer of non-performing loans to IBRA, credit restructuring and new credit extension, the non-performing loan ratio decreased slowly but continually to 24% in November 2000. The less significant decline in the absolute amount of non-performing loans shows that the ratio declined mainly because the bank industry had resumed lending. With non-performing loans still exceeding capital, however, the industry still appears to be fragile. While the industry still recorded an aggregated loss in the first half of 2000, it returned to profitability in the second half because of widening net interest margins and improved loan portfolio quality. With the completion of the bank recapitalization program in the second quarter of 2000, the industry’s capital increased from minus Rp. 21.6 trillion at the end of 1999 to Rp. 55.7 trillion by November 2000. However, despite these signs of recovery, the industry has not yet returned to normal.

The banking crisis had a deep impact on the structure of the banking industry. The number of state banks decreased by only two banks (4 state banks merged into the new Bank Mandiri and Bank Ekspor Indonesia was additionally created), whereas the national private bank sector lost almost half of its institutions since 1997. As of December 1999, the state-owned banking sector (state banks and regional development banks) accounted for more than half of the industry’s assets, deposits and outstanding credit. The slow recovery of national private banks in 2000 did not allow them to recapture much of the business share they had prior to the crisis. Considering that the Government also holds significant stakes in the recapitalized private banking industry, its current control over the banking system is even higher than indicated by the figures mentioned above.

Table 2.3 Banking Indicators 2000 (in Trillion Rupiah)

Indicator December1999

November 2000 Growth

Assets 815.1 1,022.4 25.4%

Outstanding credit 225.1 317.3 41.0%

Total deposits 651.4 689.7 5.9%

Equity - 21.6 54.7 153.2%

Non-performing loans 83.3 75.8 - 9%

As % of outst. Credit 37.0 23.9 - 35.4%

Source : Bank Indonesia Website.

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Note on the number of banks: Figures in tables 1.1 and 1.4 are taken from Bank Indonesia’s monthly financial statistics. Other numbers of banks are recorded by the bank’s quarterly reports.21 According to the second quarterly report of 2000, there were 161 banks with 6,958 offices as of June 2000, consisting of 5 state banks, 26 Regional Development Banks, 120 private national banks and 10 foreign banks. It seems that the monthly financial statistics do not account for joint venture banks, that were liquidated, taken over by or coverted to private national banks. If this is the case, the business share of the private national banking sector would be considerably higher than indicated by table 1.4.

According to the third quarterly report of 2000, the number of commercial banks had decreased to 153 and the number of bank offices to 6,522 as of October 2000, as 8 bank take-overs were integrated into Bank Danamon. The newest information provided on Bank Indonesia’s website (Indikator Perbankan Nasional) records a further decline in the number of banks to 151 and in the number bank offices to 6,510. It is most problable that these figures rather than those of the monthly financial statistics are the more reliable ones. The latter are used here because the other sources do not provide a breakdown by ownership.

2.1.4 Regional Distribution and Outreach of Commercial Banks

Both the offices and business of the commercial banking industry are highly concentrated in the western and mainly urban parts of Indonesia. As of March 2000, two thirds of the banks’ head offices and 31% of their offices were located in the Indonesian capital and its surroundings. As of August 2000, the greater Jakarta area covered 58% of the deposits and 61% of the outstanding credit of the entire commercial banking industry. The most densely populated provinces Java and Bali added another 42% to the bank offices, 26% to the deposits, and 23% to the loan portfolio of the industry. Thus, the islands of Java and Bali, which cover 63% of the Indonesian households, accounted for 74% of the industry’s offices, 91% of its deposits and 94% of its outstanding credit. Including also Sumatra, Kalimantan and the eastern parts of Indonesia are left with only 13% of the bank offices and 6% of the deposits and outstanding credit of the industry.

21 See, Bank Indonesia: Laporan Triwulan II/2000 and III/2000. Perkembangan Moneter,

Sistem Pembayaran, dan Perbankan, Bab 3: Evaluasi Kebijakan dan Perkembangan Perbankan. Note that all sources mentioned are available on the Bank Indonesia website.

Table 2.4 Change in Banking Structure (1996 – 2000)

Bank Ownership December1996

December 1999

August2000

State Banks 7 5 5

Assets 36.5% 51.2% 50.5%

Outstanding credit 37.2% 49.9% 42.1%

Total deposits 32.1% 47.9% 45.5%

Private National Banks 164 92 83

Assets 51.8% 35.8% 35.9%

Outstanding credit 51.2% 24.9% 29.0%

Total deposits 58.6% 38.8% 40.0%

Foreign & Joint Banks 41 49 52

Assets 9.2% 12.6% 12.0%

Outstanding credit 9.4% 22.2% 25.0%

Total deposits 6.3% 11.1% 11.9%Source : Bank Indonesia, Monthly Financial Statistics.

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Table 2.5 Regional Distribution of Commercial Banks, Outstanding Credit and Deposits

Indicator DKI Jakarta

Java & Bali Sumatra Kali-

mantan Sulawesi Other E. Indonesia* Total

No. of households (million) 1.4 28.0 8.8 2.4 3.1 2.5 46.2

Number of banks ** 115 22 10 5 6 4 172

As % of total 66.9 18.6 5.8 2.9 3.5 2.3 100.0

Number of bank offices ** 1,810 2,432 761 267 297 194 5,761

As % of total 31.4 42.2 13.2 4.6 5.2 3.4 100.0

State banks & BPD (%) 23.0 32.5 51.6 64.4 62.3 75.8 36.5

Households per office 784 11,515 11,520 9,035 10,499 12,780 8,020

Outstanding credit *** 146.9 56.7 23.1 6.8 6.1 2.4 241.9

As % of total 60.7 23.4 9.5 2.8 2.5 1.0 100.0

Total deposits *** 383.6 172.6 60.7 18.6 14.4 8.1 658.0

As % of total 58.3 26.2 9.2 2.8 2.2 1.2 100.0

Sources : Bank Indonesia, Monthly Financial Reports. * West Nusa Tenggara, East Nusa Tenggara, Maluku, Irian Jaya. ** Number of banks and bank offices as of March 2000. *** Outstanding credit and total deposits as of August 2000.

The regional distribution of commercial banks and their offices is, of course, related to varying population numbers and density between the regions. 60% of the Indonesian population lives in Java and Bali, where population densities range from 550 to 750 (per province outside Jakarta) inhabitants per square kilometer. In other provinces, except of North Sumatra, Lampung and West Nusa Tenggara, population densities are not higher than and often far below 120 inhabitants per square kilometer. This is reflected in the fact that the number of households per bank office outside Jakarta, ranging from 9,035 in Kalimantan to 12,780 in the eastern regions, does not show an extreme variance between the regions.

The role of the state and private banking sectors varies considerably between the regions. Especially the eastern parts of Indonesia depend to a high extent on financial services provided by state and provincial government-owned banks. As of March 2000, the offices of state bank and Regional Development Banks (BPD) made up two thirds of all commercial bank offices in Kalimantan, Sulawesi and other eastern provinces. In Central Kalimantan, Southeast Sulawesi, East Nusa Tenggara, Maluku, Irian Jaya as well as in West Sumatra and Jambi these banks contributed three quarters and more to all bank offices. Contrary to government-owned banks, which set up 43% of their offices outside of Java and Bali, private national banks have not significantly extended their branch networks to other regions. 10% of their offices are located in Sumatra (with a high concentration four of the eight provinces) and only 7% in other regions outside of Java and Bali. In Java and Bali, however, private national banks contribute 70%, and in the greater Jakarta area, East Java and Bali even more than 70% to all commercial bank offices.

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2.2 Bank Rakyat Indonesia (BRI) and its Unit Banking System

2.2.1 Overview of Bank Rakyat Indonesia

Based on the Banking Act of 1997 became an independent commercial bank after changeable years of mergers and rapid changes in banking policies. With the banking act of 1992 BRI changed its status into a limited liability company, with 100% of its shares owned by the state. The bank is organized into four “Strategic Business Units” (SBU). The SBU Treasury and Investment handles treasury functions and controls BRI financial subsidiaries. The SBU Corporate makes corporate loans larger than Rp. 3 billion in both Rupiah and US Dollar. The SBU Retail Banking is in charge of some 330 branches that provide full banking services, make loans of up to Rp. 3 billion, and channel loans for government programs. The SBU Micro Banking is in charge of the 3694 BRI units, which maintain also 349 village service points and make loans of up to Rp. 25 million.

BRI has developed a range of deposit products, which are adjusted to the varying demand of its customers. Savings deposit products, which allow withdrawals at any time, are the rural savings scheme Simpedes, the urban savings scheme Simaskot, and the national savings product Tabanas. All of these products provide semi-annual lottery prices. BRI time deposit products (Depobri) are offered with maturities of one two 24 months in Rupiah and foreign currencies. Besides its normal corporate loan products, small-enterprise credit schemes and the rural loan product Kupedes, BRI channels loans to targeted sectors and cooperatives, and also participates as a stakeholder of microfinance programs such as the P4K project in cooperation with the Ministry of Agriculture (see part of microfinance programs).

In the 1990s BRI developed into one of the largest banks in Indonesia with assets boosting from Rp. 34 trillion as of the end of 1996 to Rp. 41 trillion as of the end of 1997. The financial crisis 1997/1998 and unsound banking practice had also a profound impact on BRI. As of December 1998, the bank had to make loan loss provisions (Rp. 22.1 trillion) making up almost half of its loan portfolio (Rp. 43.4 trillion), reducing assets to Rp. 34 trillion. Losses soured to Rp. 26.5 trillion decapitalized the bank. In 1998 BRI entered the restructuring and recapitalization program, with the government’s recapitalization bonds Rp. 20.4 trillion and bad debts transferred to IBRA. As of December 1999, Loan portfolio (27.8 trillion) reduces by 15.6 trillion, with loan loss reserves fall to 5.4 trillion and assets to Rp. 31 trillion. Loss accounted for in the consolidated balance sheet stood at 28.2 trillion. The bank’s recapitalization was finalized only in October 2000, with recapitalization bonds of Rp. 20.4 trillion bringing its assets again to about Rp. 50 trillion.

With respect to its corporate business BRI will undergo a profound change in the near future. The BRI business plan states that the bank will gradually divest its corporate loans until 2002. The letter of intent signed by the Indonesian Government and the International Monetary Fund in September 2000 requires BRI to transfer all corporate loans to other bank by the end of 2000, thus focusing its role on micro, retail, and small and medium businesses. This has led to an ongoing dispute between BRI and the Government. While BRI and banking experts have been highly pessimistic about the bank’s ability to meet this target, the Government has been adhering to the target.

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2.2.2 Inception and Transformation of the Unit System

The development of the BRI unit system is well documented and has been recognized as the world’s most profitable and sustainable microfinance system.22

Within the state-led development of the financial system until the early 1980s BRI was led by bureaucratic rather than banking logic. The establishment of the unit system was instructed by presidential decree in the early 1970s in order to handle credit component of the BIMAS (mass guidance) program of achieving national self-sufficiency in rice production, a typical example of targeted and subsidized credit scheme that led to the misallocation of resources and undermined savings mobilization and institutional viability. In 1974, the units were made responsible for channeling micro loans (Kredit Mini) for off-farm activities. In 1980, another credit scheme for larger non-agricultural loans (Kredit Midi) was added. In the early 1980s, the system could no longer be sustained as is because of the huge losses incurred by the BIMAS and other subsidized credit schemes, on the one hand, and the limitation imposed on the government budget at the end of the oil boom period, on the other hand.

Schmit (1991) provided a comprehensive analysis of the historical and political dimensions that led to the decision of transforming the unit system into a commercially viable system. A major condition for this transformation was the beginning financial sector deregulation in 1983, which removed credit ceilings and interest rate controls. The Kupedes loan product with a market-oriented and cost-covering interest rate was introduced in 1984. The Simpedes savings product was pilot-tested in 1985 and nationwide introduced in 1986. With a large part of the units relocated to economically potential locations, the number of units reduced from 3,626 to 2,247, and 79% of the units making profit in 1986, the transformation of the unit system was largely completed until 1987. As of the end of 1987, the units’ deposit accounts had a value of Rp. 250 billion, while their total loan portfolio amounted to Rp. 418 billion. Already two years later, deposits had grown to Rp. 927 billion and surpassed the value of the loan portfolio by 13%.

2.2.3 Institutional Set-up and Framework

The BRI unit system is a "strategic business unit" of BRI. The units operate at the sub-district level under the supervision of BRI branches at the district level, but they are separate profit centers with their own financial statements. The units’ financial operations are included in the financial statements of BRI. Some BRI units also maintain village services posts (Pos Pelayanan Desa) or village service points (Tempat Pelayanan Desa), which service areas in which units appear not yet profitable and able

22 The following description has benefited from the following publications: L. Th. Schmit: Rural

Credit Between Subsidy and Market, Leiden Development Studies No. 11, Leiden 1991; Richard H. Patten and Jay K. Rosengard, 1991. Progress with Profit: The Development of Rural Banking in Indonesia. San Francisco: ICS Press, 1991; James J. Boomgard and Kenneth J. Angell: "Bank Rakyat Indonesia’s Unit Desa System: Achievements and Replicability," in: Maria Otero and Elisabeth Rhyne (eds): The New World of Microenterprise Finance: Building Healthy Institutions for the Poor, 1994; Stephanie Charitonenko, Richard H. Patten, and Jacob Yaron: Bank Rakyat Indonesia. Unit Desa 1970 – 1996, June 1998; Richard H. Patten, The East Asian Crisis and Micro Finance. The Experience of Bank Rakyat Indonesia Through June 1999, Jakarta, July 1999.

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to break even. As of June 2000, the 3,694 units maintained 349 service posts and 266 service points. The first are typically manned by a cashier and bookkeeper, and open three to five days a week to handle financial transactions. The second may be better understood as mobile services that usually operate on market days and one to two times a week. Depending on the business volume, service posts may be upgraded to units and units downgraded to service posts. BRI follows a strict policy of closing or downgrading unprofitable units.

A typical BRI unit has a staff consisting of four to six employees, while larger ones have up to 11 employees. The basic staff is made up of a unit manager, who approves loans and is responsible for the unit’s performance, a teller, an accountant, and a loan officer. Growing units employ additional loan officers based on pre-defined standards. The unit’s staff is often recruited from its area of operation in order to inspire confidence and maintain close customer contact. A striking feature of the unit system is its staff incentive system. 10 percent of each unit’s annual profit is distributed to employees as bonuses based on individual performance. Features such as decentralized authority and responsibility as well as giving employees a stake in performance have to be regarded as a major factor predicating the units’ success.

Other success factors have been simplicity, standardization and transparency in organization and management. This is particularly true for the system’s accounting, supervision and financial reporting, which are functioning effectively and efficiently. The management information system consists of six reports, which provides information on the number of deposit customers, the Kupedes loan classification, the unit’s business development, the unit’s budget and annual performance, the balance sheet and income statement.

BRI district braches are responsible for the supervision of units in their area of operation. The branch manager is obliged to visit the units himself and is authorized to take swift action, including direct warnings and score penalties for employee performance. Branch supervisory personnel work under the supervision of a unit officer and, on average, are responsible for four units. Off-site supervision is carried out based on the management reports provided by the units. On-site supervision is carried out once a month for each unit and takes up to five days. These inspections are based on a standard report format that helps to examine financial and human resource aspects, and includes recommendations and a follow-up plan for the unit. BRI also maintains 12 regional inspection offices that carry out on-site audits once in 18 months. One of the few weaknesses of the supervision system is that BRI has not implemented a unit rating system such as the CAMEL systems used for local financial institutions. Nonetheless, it is safe to argue that BRI units are among the most accountable and professionally supervised local financial institutions in Indonesia.

It is also safe to say that unit staff members receive the best training available for microfinance professionals. BRI maintains five training centers, in which unit staff members are trained. The training covers not only technical aspects (financial and legal subjects) but also subjects such as customer satisfaction and cultural characteristics of the units’ clientele.

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2.2.4 Products and Services

Deposit products. BRI units offer checking accounts (Girobi), savings deposit accounts and time deposit accounts. Checking accounts have not yet met a significant demand in rural areas. According to Charitonenko et al. (1998), these accounts are used primarily by the national government to channel funds to local governments. BRI units offer also transfer services to any other account in Indonesia. The service, however, is expensive (up to Rp. 15,000)

Simpedes, the rural savings deposit product, is the unit’s basic savings product that constituted the popularity of BRI units. The success of Simpedes has been achieved, although the product usually provides lower returns than comparable products. Prior to the financial crisis its interest rate was 9% and currently approaches the same level after it had moved between 16% and 20% during the financial crisis. An important factor that contributed to the product’s success was that at its time of introduction it was the first and only banking product recognizing the demand for flexible savings instruments in rural areas. Other financial institutions were not permitted to mobilize savings from the public. In many rural areas of Indonesia BRI units are still the only bank offices or, as part of a state-owned bank, have the comparative advantage of being able to promote the high protection of deposits.

Another success factor has been the product’s design. It requires a minimum balance of only Rp. 5,000 and allows unlimited withdrawals, reflecting the need for instruments through which rural customers are able to flexibly manage their liquidity. Simpedes savings may also be pledged as partial collateral for loans. A special feature of the product is that it carries semi-annual non-cash lottery prices such as motorbikes and television sets. Considering that national lotteries were prohibited some years ago, the effect of this feature should not be under-estimated.

Tabanas is the national savings program sponsored by Bank Indonesia since 1976. Until 1984, it was the only savings instrument in the Village Units. The minimum balance is only Rp. 1,000 and withdrawals are possible at any time. Interests are calculated on the daily balance. The product carries semi-annual cash prices and similar interest rates as the Simpedes product.

Simaskot is the units’ urban savings deposit product that was introduced in 1989 to attract urban customers. The product carries semi-annual lottery prizes in cash and requires a minimum balance of Rp. 10,000. Its interest rate does usually not differ from the Simpedes product.

Depobri is BRI’s time deposit product with maturities ranging from one to 24 months. The minimum time deposit amount is Rp. 500,000. Time deposits can also be pledged as partial collateral. As of October 2000, the interest paid on time deposits ranged from 10.5% to 12%. During the financial crisis the rate moved up to 57% in September 1998.

Loan product. The BRI units have a single loan product, Kupedes or General Rural Credit. Kupedes loans are provided as working capital or investment loans to eligible borrowers from all economic sectors or to individuals with regular income such as civil servants and employees of local enterprises. Typical borrowers are government employees or pensioners, small traders and entrepreneurs. Loans can be provided with

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amounts ranging from Rp. 25,000 to Rp. 25 million, but loan applications below Rp. 500,000 are nowadays seldom. As long as the maximum ceiling is not reached one borrower can take both working capital and investment loans in parallel. Kupedes terms range from 3 to 36 months, with repayment schedules being adjusted to the borrowers’ cash-flows. All loans are monthly installment loans, partly with grace periods ranging from 3 to 6 months.

A special feature of Kudepes loans, that has proven to improve loan collection, are incentives paid for timely repayments, a refund of 25% of the interest paid when installments are not delayed for six consecutive months. The original interest rate was 1.5% per month on the loan principal. During the financial crisis the rate was increased to 2.2% flat per month flat and has currently returned to the original rate. Collateral is required equivalent to the value of the loan principal and interests to be paid. Loans are usually secured with a land certificate, motor vehicle ownership certificate or a cession of salary or pension. Loans larger than Rp. 5 million require a land certificate as collateral. Deposits may be pledged as partial collateral. The loan principal and interest is secured by a life insurance. The 0.75% premium is taken over by BRI.

The unit managers have the authority to approve loans of up to Rp. 5 million. Larger loans require approval from the district branch. Loan officers usually consider the present income for appraising the borrowers’ repayment capacity. The client has to sign an acknowledgement of his debt, an authorization for the bank to execute the collateral pledged, and his wife/her husband has to sign a guaranty. It is often claimed that loan processing takes not longer than one week. Field visits indicate that three to four weeks are not unusual. Even longer periods can be found depending on the time borrowers need to prepare the documents required.

2.2.5 Development Trends 1997 - 2000

As of December 1996, the number of BRI units had grown to 3,595 units, the Kupedes loan portfolio to Rp. 4.1 trillion, and their total deposits to Rp. 7.1 trillion, an amount more than 7 times as high as in 1989. The Simpedes product contributed 53% to total deposits. Deposits financed 85% of the unit’s assets, while Kupedes loans made up only 49% of their assets. The deposits to loan portfolio ratio of 212% points to the outstanding success in savings mobilization and, at the same time, to the restrictive lending policy of the units. On average, the units had 692 loan accounts with an average outstanding amount of Rp. 1.6 million. Charitonenko et al. (1998) reported that the unit system made about 160,000 loans per month in 1996.

Contrary to other financial institutions, BRI units maintained their good performance and experienced an unprecedented growth during the financial crisis in 1997/1998. Between December 1996 and December 1998, the units’ deposits increased by 128%. This was partly due to the liquidation and deteriorated image of other banks, motivating many customers to transfer deposits to the sound BRI units, which, as state-owned institutions, were regarded as comparably safe places to save. Another reason was the crisis’ economic impact on the units’ clientele. Part of the clientele experienced increasing incomes because of the inflationary pressure on prices of agricultural products. Another part lost investment opportunities that provide higher returns than interest rates offered on deposits during the crisis.

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Table 2.6: Development Trends of BRI Units (December 1994 – June 2000, in Billion Rupiah)

December

1994December

1996Growth

12/94-12/96December

1998Growth

12/96-12/98June2000

Growth 12/98-6/00

Number of units 3,388 3,595 6.1% 3,703 3.0% 3,694 - 0.2%Assets = Liabilities 5,957 8,354 40.2% 18,073 116.4% 19.449 7.6%Average assets per unit 1.8 2.3 32.2% 4.9 110.0% 5.3 7.9%Kupedes loan portfolio 2,458 4,076 65.8% 4,697 15.2% 6,713 42.9% As % of assets 41.3 48.8 26.0 34.5 Total deposits 5,232 7,092 35.5% 16,146 127.7% 18,055 11.8% As % of assets 87.8 84.9 89.3 92.8 Simpedes deposits 3,352 4,407 31.5% 7,392 67.7% 10,832 46.5% As % of total deposits 61.1 62.1 45.8 60.0 Time deposits 422 775 83.6% 6,323 715.9% 3,397 - 46.3% As % of total deposits 8.1 10.9 39.2 18.8 Kupedes accounts per unit 606 692 14.2% 664 - 4.1% 711 7.2% Avg. amount (Rp. Million) 1.2 1.6 36.9% 1.9 16.7% 2.6 33.7%Source : Bank Rakyat Indonesia.

The number of savings deposit accounts increased by more than 4 million, but the increase of deposits was mainly due to time deposits, which grew by an outstanding 716% during 1997/1998. While interest rates of savings deposit increased from 9% to 20%, time deposit rates jumped from 19% in January 1998 to 57% in September 1998. In response to these interest rate differentials, the share of time deposits in total deposits increased from 11% in December 1996 to 39% in December 1998.

Time deposit mobilization allowed the units to increase average assets to Rp. 4.9 billion, more than twice as high than prior to the crisis, but it also made the units extremely over-liquid. Though the Kupedes loan portfolio increased by 15% despite the crisis, its share in assets dropped from an already low 49% to 26% as of December 1998. The average number of loan accounts per unit declined to 664, while the average amount of loans outstanding increased from Rp. 1.6 million to Rp. 1.9 million.

According to Patten (1999), Kupedes borrowers have being paying back about 97% of all loans that ever have fallen due. The 12-months loss ratio at the end of May 1999 was 1.5% only. The arrears ratio rose from 3.7% at the end of 1996 to 5.6% at the end of 1998, but had declined again to 3.9% as of November 1999. According to BRI, more than 96 percent of the units were profitable in the third quarter of 1999.

Since 1999, the BRI unit system has been growing at a lower rate and its financial structure has been normalizing. With total deposits growing by 12%, the units’ assets grew by 8% during the one and half years until June 2000. In response to normalized interest differentials time deposits decreased and Simpedes deposits increased by 46%. The share of Simpedes in total deposits returned to the level existing prior to the crisis. Improving economic conditions allowed the units’ to expand the Kupedes loan portfolio by 43% and to increase the average number of loan accounts from 664 as of the end of 1998 to 711 as of June 2000, with the average loan amount outstanding increasing from Rp. 1.9 million to Rp. 2.6 million. With a deposit to loan portfolio ratio of 269%, however, the units remained extremely over-liquid.

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2.2.6 Regional Distribution and Outreach

National BRI reports provide information per regional branch. Regional branches are located in provincial capitals and supervise the district branches in one or more provinces, sometimes across the major islands of Indonesia. The regional branch in Jakarta supervises also the district branches in West Kalimantan. The regional branch in Denpasar, Bali, is additionally responsible for West and East Nusa Tenggara. The district branches in Maluku and Irian Jaya operate under the supervision of the regional branch in Ujung Pandang, Sulawesi.

55% of the BRI units are located in Java (outside Jakarta), while only 16% of the units operate in the eastern parts (including Bali) of Indonesia. The number of households per unit shows that this distribution corresponds to the varying population densities. With the exception of Jakarta BRI units have an average theoretical market of 11,500 to 13,500 households. The higher variance of the average number of villages (includes urban administrative areas) indicates large differences in the units’ area of operation. Field evidence from West and East Nusa Tenggara shows that the distance between units ranges between 10 and more than 100 kilometers, and that some units serve scattered villages in a distance of 100 kilometers from their offices. On average, 12 villages are covered by a BRI unit in Java compared to 41 villages in East Nusa Tenggara and 36 villages in the southern provinces of Sumatra. The lowest coverage exists outside of Jakarta exists in the provinces of Yogyakarta and Central Java, where the average market of a unit comprises only 10 villages and 9,500 households.

As of June 2000, the BRI unit system had almost 25 million deposit accounts, to which the Simpedes product contributed almost 17 million accounts. The average BRI unit had 6,736 deposit accounts, a number equivalent to 53% of all Indonesian households per unit. Note that this figure does not indicate the actual percentage of households reached, because one household often consists of members with separate deposit accounts or may use different deposit products at the same time. Considering that the rural Simpedes and the urban Simaskot products made up three quarters of all deposit account, and assuming that one household had two deposit accounts, it can be estimated that at least 20%, and more likely 25%, of the Indonesian households deposited their savings in BRI unit accounts. Outreach scope in terms of deposit accounts varies considerably between the regions. The BRI units under the Jakarta regional office had 8,400 deposit accounts, on average, and more accounts than their area of operation has households. The average unit in West Java had 5,820 deposit accounts equivalent to 32% of the households in the province.

Table 2.7 Regional Distribution of BRI Units (June 2000)

Region Number of Units %

No. of villages per unit

No. of households

per unit

Sumatra 653 17.7 33 13,425

Java 2,024 54.8 12 13,488

Jakarta & Kalimantan 432 11.7 15 8,868

Bali, East & West NT 202 5.5 18 11,699

Other East Indonesia* 383 10.4 31 12,285

Total 3,694 100.0 18 12,507Sources : Bank Rakyat Indonesia; Ministry of Home Affairs ; National Family Planning Board. * Sulawesi, Maluku, Irian Jaya

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Table 2.8 Outreach of BRI Units by Region (June 2000)

Outreach indicator Sumatra Java Jakarta & Kalimantan

Bali, West & East NT *

Other East Indonesia** Total

No. of households (million) 8.8 27.3 3.8 2.4 3.9 46.2

Total deposit accounts (,000) 4,422 12,923 3,503 1,459 2,575 24,883

Avg. number per unit 6,772 6,385 8,110 7,222 6,725 6,736

As % of households 50.4 47.3 91.5 61.7 65.4 53.3

Avg. amount/acc. (Rp. million) 0.8 0.6 1.1 0.8 0.6 0.7

Simpedes accounts (,000) 3,237 8,783 1,734 1,114 1,866 16,733

Avg. number per unit 4,957 4,340 4,013 5,515 4,871 4,530

As % of households 36.9 32.2 45.3 47.1 47.4 36.2

Avg. amount/acc. (Rp. million) 0.7 0.6 0.8 0.7 0.6 0.6

Loan accounts (,000) 391 1,547 306 141 242 2,627

Avg. number per unit 599 764 708 700 632 711

As % of households 4.5 5.7 8.0 6.0 6.1 5.7

Avg. amount/acc. (Rp. million) 2.9 2.4 2.5 2.8 3.2 2.6

Sources : Bank Rakyat Indonesia; National Family Planning Board. * Bali, West & East Nusa Tenggara. ** Sulawesi, Maluku, Irian Jaya.

The average number of time deposits per unit was 98, ranging from only 28 in the Aceh province to 226 in the area of the BRI’s regional Jakarta office. Nonetheless, time deposits have become an important source of funds. Average time deposits per account amounted to Rp. 9.4 million compared to Rp. 647,000 for the average Simpedes account. In Jakarta, Kalimantan, and North Sumatra had the customers with the highest savings capacities, with average time deposit amounts of Rp. 12 to 14 million. The units in West Sumatra, Yogyakarta and Central Java had mobilized about Rp. 7 million per time deposit account. Average Simpedes amounts ranged from about Rp. 470,000 in Aceh, North and Central Sulawesi, and West Java to more than Rp. 800,000 in North Sumatra and Kalimantan.

As of June 2000, the BRI unit system had 2.6 million Kupedes accounts and reached about 6% of the households in Indonesia. The highest outreach had the BRI units operating under the Jakarta regional office (10% of the households), whereas the units in the southern provinces of Sumatra reached only about 3% of the households. The average number of accounts per unit was 711, ranging from 450 in the Aceh province to 850 in North and Central Sulawesi. The average loan amount outstanding was Rp. 2.6 million and ranged from Rp. 2.2 million in Yogyakarta and Central Java to Rp. 3.3 million in South and Southeast Sulawesi.

Both the relatively high average deposit amounts and the relatively high average loan amounts outstanding indicate that a considerable part of the units’ clientele consists of middle-income rather than low-income groups. In comparison, the BPR industry had average savings deposits of Rp. 205,000 and an average loan amount outstanding of Rp. 1,2 million per account as of March 2000.

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2.2.7 Current Financial Situation and Loan Portfolio Quality

The average assets size per unit and region deviates considerably from the overall average of Rp. 5.3 billion. It was smaller than Rp. 4 billion in the Aceh province and West Java, but larger than Rp. 7.5 billion in Jakarta and the provinces of Kalimantan. While deposits contribute generally between 90% and 95% to the units’ total liabilities, the composition of deposits shows a high variance between regions and provinces. Time deposits made up one third of total deposits of the units in Jakarta and West Kalimantan, and 27% to the deposits of the units in Bali, West and East Nusa Tenggara. In other eastern Indonesian provinces and the Aceh province, however time deposits contributed less than 10% to total deposits. Simpedes accounts contributed more than three quarters to total deposits in Aceh, Central, South and East Kalimantan, whereas only 22% of units’ deposits in Jakarta and West Kalimantan were made up of Simpedes savings.

Table 2.9 Assets and Balance Sheet Structure of BRI Units by Region (June 2000)

Balance Sheet Item Sumatra Java Jakarta & Kalimantan

Bali, West & East NT *

Other East Indonesia** Total

Avg. assets per unit (Rp. b) 5.6 4.3 9.2 6.3 4.7 5.3

Total assets (Rp. billion) 3,651 8,730 3,970 1,281 1,817 19,449

Kupedes (%) x) 31.3 41.7 19.3 30.6 42.7 34.5

Total deposits (%) x) 94.0 92.1 94.5 94.8 89.1 92.8

% Simpedes 67.0 65.5 35.5 61.6 73.2 60.0

% Time deposits 14.3 17.0 28.1 27.1 9.5 18.8

Loans to deposits (%) 33.3 45.2 20.4 32.3 48.0 37.2

Source : Bank Rakyat Indonesia. * Bali, West & East Nusa Tenggara. ** Sulawesi, Maluku, Irian Jaya. x) as percentage of total assets.

A similar variance can be found with regard to both the loans to assets ratio and the deposits to loan ratio. The units in Jakarta, Kalimantan, North Sumatra and West Sumatra had less than 30% of their assets placed in the loan portfolio, whereas the loans to assets ration was higher than 50% in West Java, North and Central Sulawesi. The units in Jakarta and Kalimantan had mobilized deposits four to five times as high as the amount of assets placed in their loan portfolios, compared to deposits to loan ratios of 174% in West Java and 125% in North and Central Sulawesi.

With the exception of the latter provinces, the unit system has become extremely over-liquid. As huge amounts of funds have not been placed in the loan portfolio, it can be assumed that less profitable placements have considerably impaired the units’ profitability. And, as the unit system’s profitability has already been high because of the high interest net margin, it can be assumed that the high credit interest rates have been subsidizing the opportunity costs incurred through this inefficient use of funds. Both the high profitability of the units and their inefficiency in transforming deposits into loans indicate the great potential to increase the system’s positive impact on small businesses and low-income households by reducing the net interest margin without setting the system’s profitability at risk.

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Kupedes loan portfolio quality

Information about the unit system’s loan classification and the total amount of loans with late payments was unfortunately not available for this report. Information available is limited to the loan amount in arrears, or the amount fallen due but not yet repaid. The ratio between arrears and the loan portfolio presented in table 2.10, therefore, does not adequately express the risk the units’ loan portfolios are exposed to, because it does not cover the entire outstanding amount of loans affected by arrears. This ratio does also not allow assessing loan portfolio quality based on the aging of arrears as it is done by loan classification systems.

Table 2.10 Loan Portfolio Quality of BRI Units by Region (June 2000)

Indicator Sumatra Java Jakarta & Kalimantan

Bali, West & East NT *

Other East Indonesia** Total

Kupedes portfolio (Rp. b) 979 3,157 619 340 674 5,769

Arrears (Rp. billion) 46.3 106.8 27.9 13.7 28.2 223.1

Arrears ratio (%) 4.7 3.4 4.5 4.0 4.2 3.9

Loan accounts in arrears (%) 10.4 8.1 11.7 11.7 9.7 9.2

Source : Bank Rakyat Indonesia. * Bali, West & East Nusa Tenggara. ** Sulawesi, Maluku, Irian Jaya.

As of June 2000, 9.2% of the unit system’s loan account and 3.9% of the amount of loans outstanding were in arrears. The unit systems in Yogyakarta, Central Java, Central, South and East Kalimantan were the best performers with average arrears ratios for the regions ranging between 2.2 (Kalimantan) and 2.7% (Yogyakarta and Central Java) only. The units in the Aceh province (5.6%) and in Jakarta/West Kalimantan (5.4%) were the only ones that incurred average arrears larger than 5%. In the latter regions, however, close to 15% of the loan accounts were affected by arrears.

While the overall average arrears ratio of 3.9% indicates the outstandingly good loan portfolio quality of the BRI unit system, a further disaggregating of data most probably would identify single areas and units where the system is exposed to a level of risk much higher than indicated by aggregated data. This would be especially indicated by disaggregated loan portfolio at risk ratios, which are based on the entire outstanding amount of loans in arrears.

Though this approach may provide a more comprehensive insight into some of the unit system’s problem areas, the aggregated arrears are generally too low to affect the system’s profitability and soundness negatively. There can be no doubt that the BRI unit system is not only the most profitable microfinance system in Indonesia but also that with the best loan portfolio quality. This is also indicated by the 12-months loss ratio of 1.5% reported by Patten (1999) for May 1999.

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2.2.8 Assessment and Conclusions

Undermining the viability of financial institutions and, consequently, undermining sustained access to financial services by channeling targeted, cheap and easy credit according to political rather than banking logics was for long the prominent feature of rural finance. Sustainable financial services to a continuously growing part of lower-income groups can only be achieved through viable financial institutions. The development of viable financial institutions requires enabling legal, regulatory and supervisory frameworks, emphasis on market-orientation, savings mobilization and institution building, prudential banking practice, and the human resources capable of executing these functions.

The major merit of the BRI unit system has been to transform this theory into practice. Achieving an outreach to some 25 million customers and at the same time developing into a sound, profitable and self-sustained network of 3,700 units has been a superlative in the history of microfinance.

The BRI unit system has gained international recognition that, however, often focuses on Kupedes as “a success story in microlending”23. There is no doubt that Kupedes has been successful in holding losses extremely low and contributing to the profitability of the unit system. The essence of the success story, however, has been savings mobilization and financial intermediation rather than lending. At the time the Simpedes product was introduced rural finance was supply-led and credit-led, and governed by bureaucratic command rather than market logics. The rural population was not a market segment of business-oriented banking as it was considered too poor to save and in need of cheap credit.

The revolution commenced with Simpedes is two-fold. First, the BRI unit system has proved that serving the rural people's demand for savings instruments is just as important as satisfying their demand for credit. All rural households are in need of safe instruments that allow managing their liquidity in flexible ways. Only a part of the rural households, though a continuously growing one, is in need of working capital and investment loans that exceed their capacity of self-finance to a considerable extent. Second, the BRI unit system has proved that independent and cost-covering financial intermediation between savings customers and borrowers rather than targeted and subsidized credit is able to achieve both sound institution building and outreach to the masses of the rural population.

These outstanding achievements have to be taken into account before critical observers start to point to shortcomings and untapped potentials of the BRI unit system. In this sense, the following assessment points to the need for answering four questions: (1) what is the impact of BRI as a restructured bank on its microfinance arm; (2) what happens to the large profits of the unit system, (3) what happens to the huge amount of deposits mobilized by the unit system, and (4) why has the success of savings mobilization not been transformed in expanding rural credit outreach?

1) BRI emphasizes to focus on serving small businesses and low-income households. As of November 2000, Rp. 17.6 trillion of BRI’s bad debts transferred

23 This header was used in the World Bank News published in 1996.

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to IBRA was outstanding to only 168 borrowers (Kompas, 11 November 2000). This amount is equivalent to an estimated 40% of the bank’s loan portfolio at the time these debts were transferred to IBRA. Considering that also a considerable part of the well-performing loans were made up of corporate loans, it may be concluded that BRI has been giving high emphasis on serving a clientele other than its small business and low-income clientele. Though BRI remained a major source of rural credit, it has to be asked whether the corporate arm with its huge losses has not considerably inhibited the expansion of rural credit, particularly because profits made by the BRI unit system may have been used to compensate for the losses incurred by other BRI activities.

2) BRI units are not subsidized and have been highly profitable since the mid-1980s. From 1996 to 1999 the units made profits amounting to about Rp. 3.2 trillion. Prior to the financial crisis the units contributed to about one quarter of BRI assets and produced annual profits larger than the bank’s total retained profits, thus holding its returns positive. As of the end of 1999, BRI recorded a loss of Rp. 28.2 trillion, whereas the units had earned a profit of Rp. 1.2 trillion. Patten (1999) concluded that “the vast profits of the unit system have been used to cross-subsidize wealthier (non-low-income) clients of BRI”. The units’ impact on rural development and poverty reduction could have been much higher, if the “large surplus had been used to decrease the spread between its on-lending and deposit interest rates”.24

3) During the second half of the 1990s the unit’s deposits made up about half of BRI’s Rupiah savings and time deposits, but they contributed only 14% to 25% to the bank’s loan portfolio. Prior to the financial crisis the units reinvested less than 60% of deposits mobilized in their loan portfolios. This ratio was diminished to between 30% and 37% since the financial crisis. Also this drain of funds indicates that the many small savings mobilized by BRI units have been converted into larger loans provided to an urban and more affluent clientele of the bank. Thus, the assumption that rural savings are kept in rural areas cannot be fully adhered to.

4) Credit expansion has been limited in two respects, the lacking attempt of existing BRI units to expand their outreach to new clienteles and the lacking expansion of new units and service posts to areas not yet effectively served by the system. Most of the units are located in or in close vicinity of urban areas, most usually in sub-district capitals, where the important clientele of government employees and traders with sufficient collateral and fixed income is concentrated. The units’ risk-averse lending policy has severely restricted their outreach to potential customers without a fixed income or collateral such as land titles and motor vehicles.

Furthermore, services are mainly provided to people living in the vicinity of unit offices. Most units lack the human resources to expand their business to the village level. These restrictions are also reflected by the units’ loan sizes, which are usually larger than Rp. 1 million and relatively high for rural areas. The coverage of BRI units differs considerably. In some provinces they operate in

24 Richard H. Patten, The East Asian Crisis and Micro Finance. The Experience of Bank

Rakyat Indonesia Through June 1999, Jakarta, July 1999.

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almost all sub-districts, whereas in provinces such as West Nusa Tenggara and East Nusa Tenggara they can be found in only three quarters and half of the sub-districts.

BRI units are the backbone of the rural financial system. However, they have not yet developed into financial institutions of low-income households at the village level. The units’ potential to serve rural households and microentrepreneurs is not yet fully exploited. As Charitonenko et al. (1998) pointed out, the main challenge for the future development of the BRI unit system is to increase its outreach in breadth and depth, while maintaining its high degree of financial self-sustainability.

The high profitability and liquidity of the system given, it seems not be unreasonable to expect the system developing a less risk-averse lending strategy and expanding its credit outreach to rural low-income clients. BRI is in the favorable position to be a stakeholder of microfinance programs such as the RIGP/P4K project carried out in cooperation with the Ministry of Agriculture. With some 250,000 members organized in small groups, this program has been developing a huge market of low-income clients. A major constraint in this context is that BRI has been refraining from expanding the unit system’s outreach by actively approaching this clientele.

ProFI Microfinance Institutions Study

Chapter 3:

Bank Perkreditan Rakyat (BPR) –

The People’s Credit Banks in Indonesia

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 62

3. Bank Perkreditan Rakyat (BPR) – The People’s Credit Banks in Indonesia

3.1 “BPR”: Definition and Clarification

The term Bank Perkreditan Rakyat (BPR), or People’s Credit Bank, has been used in three ways that are often not clearly distinguished in descriptions of the BPR industry.

First, the term has been used retrospectively to distinguish the development of popular financial institutions since 1895 from the commercial banking sector.25 This point of view tends to neglect institutional discontinuities in the local financial system. With a few exceptions, older “BPR” are fresh start-ups by local governments in the 1950s and 1960s. Prior to the banking reform in 1988, the term was not part of the official banking language and emerged in the mid 1980s as part of the effort to formalize the secondary banking sector and enable new secondary banks to expand the outreach of the financial system to rural areas and low-income households.

Second, the term has been used as a generic term for various sorts of secondary banks and microfinancial institutions that are regarded as “BPR candidates”. The generic term includes a) local financial institutions established prior to the 1988 banking reform and allowed to continue as BPR, b) new BPR established on the basis of the 1988 banking reform, c) Badan Kredit Desa (BKD), or Village Credit Boards, which have their roots in colonial times and were declared BPR by the Banking Act of 1992, and d) Lembaga Dana Kredit Pedesaan (LDKP), or Rural Credit Fund Institutions, which were made “BPR candidates” by the 1992 Banking Act and following regulations.

Third, the term has been used as a legal, regulatory and supervisory category and stands for secondary banks that, according to currently valid laws and regulations, are legal entities (limited liability company, regional government enterprise, or cooperative), have to comply with the regulations enacted for secondary banks, and are subject to supervision and enforcement of secondary bank regulations by the central bank. This use of the term excludes BKD and LDKP, as they do not meet the requirements mentioned above.

Bank Indonesia uses the generic term in reporting the number of institutions and distinguishes three sub-groups: BKD, LDKP, and non-BKD. The latter sub-group is further divided into “old” (established prior to the 1988 banking reform) and “new” (established on the basis of the 1988 banking reform) BPR. Financial reports of the BPR industry, however, usually do not include BKD and LDKP. This has led to distortions in the description of the BPR industry and is unsatisfactory because of several reasons. First, the number of more than 9,000 institutions reported exaggerates the strength of the secondary banking industry. Second, BKD were acknowledged as BPR in word, but they are neither regulated nor supervised as secondary banks. Their organization, management and tiny sizes make it rather ridiculous to speak of them as banks (see chapter 5). Third, LDKP are non-bank microfinance institutions of which the majority was either not willing or not able to convert to BPR. They do not have to comply with BPR regulations and are supervised by provincial governments (see chapter 4).

25 See, Pandu Suharto, 100 Tahun BPR Di Indonesia, 1895-1995, Penerbit InfoBank, Jakarta

1996.

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To avoid confusion and stress the need for a separate legal, regulatory and supervisory framework for non-bank microfinance institutions, the very different worlds of the generic term have to be clearly distinguished and the “BPR” label should only be attached to institutions that have the legal entity necessary for secondary banks and are regulated and supervised as secondary banks. This description is limited to these BPR, while the BKD and LDKP industries will be discussed in the following chapters.

3.2 History, Number and Types of BPR

The commercial banking system established under the Dutch colonial administration served to finance large estates and import-export activities. The first independent bank founded by an Indonesian citizen for indigenous civil servants was established in 1895. This bank is nowadays referred to as the first Bank Perkreditan Rakyat (BPR) in Indonesia. Kuiper (1994)26 offered a more appropriate interpretation according to which this bank had been the beginning of the history of the popular credit system that became institutionalized into the “Algemeene Volkscredietbank” (AVB) and, after national independence, into the Bank Rakyat Indonesia (BRI).

Motivated by nationalistic pride and commercial interest, 90 of these independent banks were established until the early 1930s. Together with the huge number of village credit institutions (see chapter 5) they made up the “Volkskredietwezen” (popular credit system). Contrary to the intention of the colonial administration, this system strived for developing an independent network through which the popular credit banks expanded their outreach and capacity mobilize local savings resources. With an outreach comparable to that of BRI today and 80% of their capital mobilized from the village level, the financial independence of popular credit banks was a thorn in the colonial administration’s side.

Pointing to the large but fragmented resources of the popular credit system, the Dutch administrator Fruin argued that the “time was ripe for the merger of the local popular credit banks to form a general bank” (Kuiper 1994:10). Thus, in 1934 the popular credit banks and village credit institutions were joined into the “Algemeene Volkscredietbank” (AVB).27 Within this financially stronger single organization, the AVB branches became responsible for provide larger loans and channel government credit, while the village units were to provide micro loans. This system became the model for developing the broad BRI unit network in the 1980s (see chapter 2).

New secondary banks that emerged in the 1960s had mainly two origins. A network of Bank Pasar or market banks was developed by the Kosgoro organization, an umbrella organization of multi-purpose cooperatives. In 1970, this organization had 277 market banks of which only 6 were located outside of Java. After the establishment of the first Regional Development Bank (BPD) in West Java, the BPD tried to reorganize village banks by creating 217 Bank Karya Produksi Desa (BKPD) in the ownership of the

26 Klaas Kuiper (ed.), Provisional Manual for the Credit Business of the General Popular Credit

Bank by Th. A. Fruin, with A History of the “Volkscredietwezen” (Popular Credit System) in Indonesia (1895-1935), The Hague 1994.

27 The political and economic dimensions of centralizing the popular credit system are analyzed in L. Th. Schmit: Rural Credit Between Subsidy and Market, Leiden Development Studies No. 11, Leiden 1991.

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 64

district governments. 26 similar institutions were established by the local governments in Central Java (4), Yogyakarta (3), East Java (1), Bali (15), Lampung (1) and South Sumatra (2).28 The formation of new institutions was stopped when a decree of the Ministry of Finance prohibited the establishment of village and market banks in 1970.29

Together with a few privately owned small banks, these institutions make up the class of ‘old’ BPR established prior to the banking reform in 1988. In the 1980s, these institutions tended to move their business to urban areas. 86% of their assets were concentrated in large urban areas, and many of them faced severe credit collection problems.30 423 of these ‘old’ BPR operated in 1988, when ‘new’ BPR were not yet established.

The banking reform of 1988 (PAKTO 1988) had the objective to expand the outreach of financial services to rural areas. The government permitted the establishment of new secondary banks at the sub-district level with a paid-up capital of Rp. 50 million only. More than 1,000 new BPR were established during the following five years. The Banking Act of 1992 finally recognized BPR as secondary banks, while Presidential Decree No. 71 of 1992 required LDKP to seek a BPR license until October 1997. 630 LDKP converted to BPR between 1994 and early 1999. LDKP that obtained a BPR license were responsible for almost two thirds of the industry’s growth between 1994 and 1999 and for more than 90% of the industry’s growth between 1995 and 1999.

After the rapid growth of the BPR industry it has been facing a severe crisis caused by factors such as low capitalization, weak management and unsound banking practices. This situation was aggravated by the financial crisis in 1997/1998. Until 1996 the BPR industry experienced a loss of 98 institutions, 52 of which were ‘old’ BPR. Bank Indonesia withdrew the licenses of 58 BPR. 30 BPR were upgraded to commercial banks and 12 institutions were merged into two BPR. Between 1997 and 1999, Bank Indonesia withdrew five licenses and was forced to freeze the operation of 72 BPR.

This situation, among other factors, led Bank Indonesia to issue a set of BPR regulations in May 1999, which expanded the area of operation but increased the minimum paid up capital to Rp. 2 billion for the greater Jakarta region, Rp. 1 billion for provincial capitals, and Rp. 500 million for other areas. Aiming at a sound BPR industry with fewer but larger BPR, these requirements made the establishment of new BPR, especially in rural and economically less favorable areas, almost impossible. New BPR were not established after May 1999. Bank Indonesia liquidated or planned the liquidation of about 300 further BPR in 2000/2001.31

28 See: L. Th. Schmit (1991) and Pandu Suharto (1996). 29 Surat Keputusan Menteri Keuangan No. B-331/MK/IV/70 tentang Larangan Pembentukan

Bank Desa, Lumbung Desa, Bank Pasar dan Bank-bank Sejenis Lainnya. 30 See: Lembaga Pengembangan Perbankan Indonesia: Seminar Lembaga Dana dan Kredit

Pedesaan, LPPI, Jakarta 1987; Pandu Suharto (1996). 31 See, Bisnis Indonesia, 18 November 2000.

Table 3.1 Number of BPR 1988 – 2000

End of ‘Old’ ‘New’ * Total

1988 423 - 423

1993 391 1,045 1,436

1996 371 1,616 1,987

1998 371 1,891 2,262

March 2000 371 2,056 2,427

Source: Bank Indonesia, BPR Supervision Department. * Includes former LDKP

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 65

Table 3.2 BPR Types and Legal Forms by Region (March 2000)

BPR Type (%) Legal Form (%) **

Region ‘Old’ ‘New’ BPR-LDKP

Number of BPR LLC COP RGE

Sumatra 2.9 61.9 35.1 239 61.9 1.7 36.4

Java 17.4 56.7 25.9 1,854 56.1 3.0 40.7

Bali & West Nusa Tenggara 15.6 64.5 19.9 231 68.0 0.4 22.5

Kalimantan 9.1 45.5 45.5 44 47.7 4.5 47.7

Sulawesi 4.3 95.7 - 47 95.7 2.1 2.1

Other East Indonesia* - 100.0 - 12 100.0 - -

Total 15.3 58.8 26.0 2,427 58.6 2.6 37.7Sources : Bank Indonesia, BPR Supervision Department. * East Nusa Tenggara, Maluku, Irian Jaya. ** LLC : Limited Liability Company ; COP : Cooperative ; RGE : Regional Government Enterprise.

As of March 2000, there were 2,427 BPR32, of which 60% are ‘new’ BPR established after the banking reform in 1988, 26% former LDKP converted to BPR between 1994 and 1999, and 15% ‘old’ BPR established prior to the banking reform in 1988. 56% of the 630 LDKP that obtained BPR licenses are former BKK in Central Java. A considerable number of LDKP converted to BPR also in West Sumatra, East Java, West Java and West Nusa Tenggara (see chapter 4). Almost all of the 371 ‘old’ BPR operate in Java (86%) and Bali (10%), and 59% of them are the 217 BKPD in West Java. The latter are owned by district governments and have been struggling with governance problems, corruption and insolvencies.33 According to Pandu Suharto (1996), 45% of the BKPD were classified as less sound or unsound. As of March 2000, Bank Indonesia had frozen the operation of 76 BKPD.

59% of the BPR were registered as limited liability companies, 38% as regional government enterprises and 3% as cooperatives. The remaining 24 institutions (21 are located in Bal) have the legal form of Maskapai Andil Indonesia (MAI), a shareholder company in which only indigenous citizens are allowed to hold shares. All BPR-LDKP and 74% of the ‘old’ BPR are owned by local governments and operate as regional government enterprises. While only 15% of the ‘old’ BPR are registered as limited liability companies, this is the case for almost all (96%) of the ‘new’ BPR.

With regard to the regional distribution of BPR types it is striking that almost all institutions in the eastern parts of Indonesia (Sulawesi, East Nusa Tenggara, Maluku and Irian Jaya) are ‘new’ BPR registered as limited liability companies. Former LDKP have considerably contributed to the growth of the BPR industry in Sumatra (mainly West Sumatra) and Kalimantan (mainly South Kalimantan), whereas ‘old’ BPR do not play a significant role. This is also true for West Nusa Tenggara where 73% of the BPR are former LDKP, whereas more than three quarters of the BPR in Bali are ‘new’ BPR that are registered as limited liability companies.

32 Note that this number does not reflect BPR liquidations planned for 2000/2001. Currently,

the number of operating BPR may have declined to about 2,100 to 2,200. 33 See, i.e., Suara Pembaruan Daily, 6 January and 15 April 2000.

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 66

3.3 Regulation and Supervision

3.3.1 Evolution of the regulatory framework

1967-1970. The Banking Act No. 14 of 1967 recognized general banks, savings banks, regional development banks and foreign banks. It allowed BKD, BKPD and market banks to continue as is until a separate law regulates their status.34 This law was not enacted until 1992. In 1970, the Ministry of Finance permitted existing viable market banks and village banks functioning as market banks to continue their operations, but it closed the entry for new small banks.35 To revive the rural financial system Bank Indonesia allowed provincial governments to establish LDKP.36

1988-1989. The banking reform of October 1988 was enacted by presidential decree, while the establishment and operation of BPR was further regulated by subsequent decrees of the Ministry of Finance and Bank Indonesia.37 The reform allowed commercial banks to expand their branch networks and permitted the establishment of new BPR with a paid up capital of Rp. 50 million only. Their area of operation was limited to one sub-district. Existing local financial institutions were required to comply with the new regulations within two years. It is interesting to note that the circular letter of Bank Indonesia classified existing BKD, market banks and LDKP as BPR.

34 Undang-undang Nomor 14 Tahun 1967 tentang Pokok Perbankan, Article 41. 35 Surat Menteri Keuangan Republik Indonesia kepada Direksi Bank Indonesia Nomor B

331/MK/IV/8/1970. 36 Bank Indonesia, Surat Edaran Nomor 4/26-V/PPTR Tahun 1970. 37 Keputusan Presiden Repubik Indonesia Nomor 38 Tahun 1988; Keputusan Menteri

Keuangan Republik Indonesia Nomor 1064/MK.00/1988 Tanggal 27 Oktober 1988; Surat Edaran kepada semua BPR di Indonesia Nomor 21/5/BPPP Tanggal 27.10.88.

Note on Bank Indonesia Data and Sources of Information

Unless otherwise mentioned, the data provided in this chapter were taken from three Bank Indonesia sources: annual financial reports, monthly financial statistics and monthly BPR reports of the BPR supervision department. It is important to note that the monthly financial statistics, that can also be accessed via the Bank Indonesia website, only report the number of BPR, BKD and LDKP and are not up-to-date in this respect. Numbers presented for BKD include institutions that have terminated their operations (see chapter 5). Numbers presented for LDKP include institutions already converted to BPR and exclude a considerable number of institutions still operating as LDKP (see chapter 4). Numbers presented for BPR exclude almost all LDKP that obtained BPR licenses. Data made available by the BPR supervision department are more reliable in this respect and are usually used for describing the overall situation of the BPR industry.

Qualitative information and the assessment of the BPR industry are additionally based on studies carried out by the ProFI project in 2000:

Detlev Holloh: Bank Perkreditan Rakyat (BPR) in East Java, Bali and West Nusa Tenggara, ProFI Baseline Survey, Bank Indonesia and GTZ, Denpasar, June 2000. Detlev Holloh: Small Financial Institutions in East Java, Bali and West Nusa Tenggara, ProFI Baseline Survey Summary Report, Bank Indonesia and GTZ, Denpasar, June 2000. Flora Giassemi, Wolfram Hieman and Detlev Holloh: Appraisal of the Proposal “Development and Upgrading of Microfinance Institutions in Indonesia”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 67

The banking reform package of March 198938 provided BPR with the opportunity to open branches in other sub-districts outside of the national, provincial and district capitals, to upgrade to or merge with commercial banks, and to undergo mergers with other BPR. The time limit set for complying with the 1988 regulations was eliminated. Compliance with capital requirements was made dependent on the financial capacity of a BPR. This made the BPR industry subject to a double standard: part of the industry had to obtain licenses based on decree No. 1064/1988 of the Ministry of Finance and has to comply with BPR regulations; the other part is recognized as BPR in word, but has not been required to meet BPR standards and comply with BPR regulations.

1992-1994. The Banking Act No. 7 of 199239 synthesized the financial sector reforms since the 1980s. It distinguished commercial banks as primary banks, which are permitted to offer the full range of banking services, from BPR as secondary banks. BPR were defined as banks permitted only to accept deposits in the form of time deposits, savings, and/or equivalent forms (article 1). BPR were further permitted to provide credit and financing (based on the profit-sharing principle) services, and to place funds in deposit instruments of Bank Indonesia and other banks (article 13). Article 16 requires any party collecting funds from the public to obtain a bank license. BPR are required to operate as regional government enterprises, cooperatives, limited liability companies, and as other legal forms stipulated by government regulations (article 21). Article 58 states that BKD, BKPD, market banks and LDKP will be given the BPR status with fulfilling requirements to be stipulated by a government regulation.

The subsequent regulation40 declared institutions already in possession of a business license to be BPR. Other institutions were required to seek a license within five years until October 1997. For obtaining a license BPR had to be registered as a legal entity and had to deposit a minimum paid up capital of Rp. 50 million. BPR managers had to meet criteria to be stipulated by the Ministry of Finance. Requirements and procedures for converting LDKP to BPR were regulated by decree in 1993 and a joint agreement between Bank Indonesia and the Ministries of Finance and Home Affairs in 1994.41 Among other things, LDKP had to meet the same capital requirements as new BPR, to have operated profitably in three consecutive years, and to employ directors with certain formal qualifications. LDKP not meeting such standards until October 1997 were required to refrain from mobilizing deposits from the public.

1998. The amendment of the Banking Act in 199842 largely intended to accommodate the growing Islamic banking industry and to regulate banking operations based on Syariah principles more adequately. Two major changes were made with regard to BPR. First, the BPR industry was now defined as having conventional and Syariah 38 Keputusan Menteri Keuangan Republik Indonesia Nomor 278 dan 279/KMK-01/1989

Tanggal 25 Maret 1989. 39 Undang-undang Nomor 7 Tahun 1992 tentang Perbankan Tanggal 25 March 1992. 40 Peraturan Pemerintah Republik Indonesia Nomor 71 Tahun 1992 tentang Bank Perkreditan

Rakyat Tanggal 30 Oktober 1992. 41 Keputusan Menteri Keuangan Republik Indonesia Nomor 221/KMK.017/1993 tentang BPR

Tanggal 26 Februari 1993; Bank Indonesia, Departemen Keuangan, Departemen Dalam Negeri, Surat Keputusan Bersama tentang Persyaratan Dalam Rangka Pengukuhan LDKP Menjadi BPR Tanggal 26 September 1994.

42 Undang-Undang Republik Indonesia Nomor 7 Tahun 1992 tentang Perbankan Sebagai-mana Telah Diubah dengan Undang-Undang Nomor 10 Tahun 1998.

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 68

institutions that are not permitted to provide payment services (article 1). Third, BPR are required to guarantee funds mobilized from the public. A deposit protection institution shall be established for this purpose (article 37B). Article 58, stating that local financial institutions will be given the BPR status with fulfilling requirements to be stipulated by a government regulation, was not changed. The 1992 Banking Act and subsequent regulations had already revoked the elimination of time limits for complying with BPR standards, but they were not followed by consequent enforcement. The 1998 Banking Act and subsequent regulations sustained this ambiguity, as new time limits were not set, although the old deadline had expired in 1997.

1999. The new BPR regulations issued by Bank Indonesia in May 1999 substantially changed the framework for both BPR and non-bank microfinance institutions. Government regulation No. 30 of 199943 declared decree No. 71 of 1992, in which capital and conversion requirements had been stipulated, invalid. The regulation itself was to become valid when new BPR regulations were in place. Bank Indonesia issued these regulations separately for conventional and Syariah BPR on 15 May 1999.44

Article 2 stipulates that BPR may only be established and operated with a Bank Indonesia business license. Article 3 determines three legal forms for BPR (limited liability company, cooperative, regional government enterprise), thus omitting “other forms” as mentioned in the banking act. BPR may not have foreign shareholders. Article 4 changes the capital requirements. The minimum paid up capital is increased to Rp. 2 billion for the greater Jakarta region, to Rp. 1 billion for provincial capitals, and to Rp. 500 million for other areas.

BPR must have at least one commissioner. Commissioners must have knowledge of or experience in banking operations (article 20). The board of directors has to consist of at least two members. Half of the directors must have not less than 2 years experience in banking operations. Directors must have an educational attainment equivalent to at least the diploma 3-level (article 21). Family relationships between directors as well as between directors and commissioners are prohibited (article 22). BPR are now permitted to operate in urban areas and to open branches throughout one province (article 25), when they had been classified as sound for one year and have deposited additional capital required for branches in accordance with article 4. Sound BPR are also given the opportunity to expand their outreach through services such as payment points and mobile cash units (article 30). BPR that do not meet requirements for commissioners and directors have to comply with them within one year (article 56).

The decrees for conventional and Syariah BPR only differ in that BPRS have to be established and operated on the basis of Syariah principles. Additionally, BPRS have to set up Syariah supervision boards that supervise compliance with Syariah principles and the provisions made by the National Syariah Council. BPRS are not permitted to offer conventional banking services and to change their status to conventional BPR.

43 Peraturan Pemerintah Republik Indonesia Nomor 30 Tahun 1999 tentang Pencabutan (…)

Peraturan Pemerintah Nomor 71 Tahun 1992 tentang Bank Perkreditan Rakyat (…) Tanggal 7 Mei 1999

44 Surat Keputusan Bank Indonesia Nomor 32/35/KEP/DIR tentang Bank Perkreditan Rakyat Tanggal 12 Mei 1999; Surat Keputusan Bank Indonesia Nomor 32/36/KEP/DIR tentang Bank Perkreditan Rakyat Berdasarkan Prinsip Syariah Tanggal 12 Mei 1999.

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 69

Other relevant regulations

There are several other regulations dealing with ensuring prudential banking practice and the soundness of the BPR industry. Decree No. 30 of 199745 deals with the CAMEL system applied by Bank Indonesia and determines the benchmarks for BPR ratings. Decree No. 32/54 of 199946 deals with the revocation of BPR business licenses. Note that both decrees explicitly exclude BKD. The protection of funds mobilized by BPR from the public is regulated by presidential decree No. 193 of 1998 and Bank Indonesia decree No. 31/166 of 1998.47

3.3.2 Supervision

The banking reform in 1988 assigned the task of BPR supervision to Bank Indonesia. Prior to the reform local financial institutions were supervised by Bank Rakyat Indonesia (BRI) on behalf of Bank Indonesia. While Bank Indonesia took over BPR supervision, BRI continued to supervise the BKD in Java on behalf of Bank Indonesia and the provincial governments remained responsible for the supervision of LDKP.

In 1999, the government enacted a new Central Bank Law48 through which Bank Indonesia became an independent authority responsible for achieving and maintaining monetary stability. To be able to achieve this task Bank Indonesia was given the authority of licensing, regulating and supervising banks. Bank Indonesia gained full authority to enforce compliance with existing regulations and liquidate banks that are unviable or have a detrimental impact on the banking system and the national economy. The law mandates the transfer of supervisory functions to a new independent supervisory agency. This agency has to be established not later than December 31, 2002. Bank Indonesia continues to conduct bank supervision as long as the new agency has not been established.

BPR supervision lies in the responsibility of Bank Indonesia’s BPR supervision department (Urusan Pengawasan Bank Perkreditan Rakyat – UBPR) and is carried out by Bank Indonesia branches. The supervision task comprises both on-site and off-site supervision. On-site inspections may be conducted periodically or at any time it deems necessary. Bank Indonesia aims at inspecting each BPR once a year. Off-site supervision is based on the banks’ obligation to submit monthly reports and any information required by Bank Indonesia. Bank Indonesia has the right to impose sanctions on BPR that submit reports later than the 15th of each month.

For both on-site and off-site supervision Bank Indonesia has developed standard instruments, which cover qualitative and quantitative aspects of BPR operations. In assessing the soundness of BPR Bank Indonesia applies a CAMEL system, consisting

45 Surat Keputusan Direksi Bank Indonesia Nomor 30/12/KEP/DIR tentang Tata Cara

Penilaian Tingkat Kesehatan Bank Perkreditan Rakyat tanggal 30 April 1997. 46 Surat Keputusan Direksi Bank Indonesia Nomor 32/54/KEP/DIR tentang Pencabutan Izin

Usaha Bank Perkreditan Rakyat tanggal 14 Mey 1999. 47 Keputusan Presiden Republik Indonesia Nomor 193 tentang Jaminan Terhadap Kewajiban

Pembayaran Bank Perkreditan Rakyat tanggal 13 November 1998. Surat Keputusan Direksi Bank Indonesia Nomor 31/166/KEP/DIR tentang Persyaratan dan Tatacara Penjaminan Pemerintah terhadap Kewajiban Pembayaran Bank Perkreditan Rakyat tanggal, 1998.

48 The President of the Republic of Indonesia, Act of the Republic of Indonesia Number 23 of 1999 concerning Bank Indonesia, 17 May 1999.

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 70

of 7 ratios for measuring capital adequacy, quality of performing assets, profitability and liquidity, and 25 questions used for assessing general and risk management. Details of the BPR supervision system were analyzed by separate ProFI reports.49 The ProFI baseline survey pointed to the need for reviewing the current rating system, because it gives too much tolerance to short-term loans being in arrears, gives too little weight to assets quality and loan loss provisioning, and tends to over-state profitability when full loan loss costs are not accounted for in income statements.

As Bank Indonesia supervision staff did not grow in accordance with the rapid growing BPR industry, supervision practice often differs from theory. The ProFI baseline survey showed that only half of the BPR were inspected during the preceding year and that the frequency for on-site supervision did not correlate with BPR performance. BPR managers were found to be highly interested in improving Bank Indonesia’s supervision capacity. They asked for increasing the frequency of on-site inspections, combining supervision with technical assistance, more effectively enforcing the owners’ compliance with supervision recommendations, and focusing on supervision of unsound institutions.

New trends in BPR regulation and supervision

Bank Indonesia has realized the weaknesses of the current regulatory and supervisory frameworks for BPR and non-bank microfinance institutions. Currently, Bank Indonesia with technical assistance from GTZ-ProFI project is reviewing the existing frameworks with the aim to improve BPR regulation and supervision, on the one hand, and provide small financial institutions that do not want to convert to BPR with an adequately regulated place in the financial sector, on the other hand.

3.4 Regional Distribution and Outreach

The BPR industry is highly concentrated in Java. More than three quarters of the BPR operate in this region. Together with the BPR in Bali they make up 83% of all BPR in Indonesia. A considerable number of BPR was established in Sumatra, but 68% of the BPR are located in West and North Sumatra. This uneven distribution does also exist in other parts of Indonesia, while the relevance of the BPR industry generally has remained very limited. There are only 44

49 Hendrik Prins: Regulation and Supervision of BPR, Project Promotion of Small Financial

Institutions, Denpasar, March 2000; Detlev Holloh: Bank Perkreditan Rakyat (BPR) in East Java, Bali and West Nusa Tenggara, ProFI Baseline Survey, Bank Indonesia and GTZ, Denpasar, June 2000.

Table 3.3 BPR Regional Distribution (March 2000)

Region Number of BPR %

No. of villages

per BPR

No. of households

per BPR

Sumatra 239 9.8 90 36,700

Java 1,854 76.4 13 15,500

Bali & West Nusa T. 231 9.5 6 7,000

Kalimantan 44 1.8 138 54,800

Sulawesi 47 1.9 126 58,800

Other East Indonesia* 12 0.5 550 131,000

Total 2,427 100.0 19 18,900

Sources : Bank Indonesia, BPR Supervision Department ; Ministry of Home Affairs ; National Family Planning Board. * East Nusa Tenggara, Maluku, Irian Jaya

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BPR in Kalimantan, 61% of which operate in South Kalimantan. 94% of the 47 institutions operating in Sulawesi are located in South and North Sulawesi. With only 12 institutions in East Nusa Tenggara, Maluku and Irian Jaya, the BPR industry has not achieved a significant outreach in these provinces.

The ratios of BPR to villages (includes urban and rural administrative units) and households per region show a considerable variance depending on regional distribution, size of the regions and population density. On average, there is a (theoretical) market of 19 villages and 18,900 households per BPR. In Bali, the ratio of BPR to villages is only 1 to 4 and the ratio of BPR to households only 1 to 4,200. In Java, these ratios are also below the overall average, whereas they are far above the overall average in all other regions. In Kalimantan and Sulawesi, there are more than 100 villages and 50,000 households per BPR. In other eastern parts of Indonesia there is a ratio of one BPR to 550 villages and 131,000 households.

Table 3.4 BPR Outreach (March 2000)

Outreach Indicator Sumatra Java Bali & WNT**

Kali-mantan Sulawesi Other E.

Indonesia* Total

No. of households (million) 8.8 28.7 1.6 2.4 2.8*** 1.6 45.8

Savings deposit accounts

Avg. number per BPR 1,477 1,623 4,496 1,604 1,525 2,075 1,882

As % of households 4.0 10.5 64.4 2.9 2.6 1.6 10.0

Avg. amount/acc. (Rp.,000) 381 208 128 326 219 157 205

Time deposit accounts

Avg. number per BPR 37 124 97 25 20 44 109

As % of households 0.1 0.8 1.4 0.04 0.03 0.03 0.6

Avg. amount/acc. (Rp. m) 20.5 4.1 7.3 11.9 18.5 17.0 5.0

Loan accounts

Avg. number per BPR 381 1,019 727 469 364 845 905

As % of households 1.0 6.6 10.4 0.9 0.6 0.7 4.8

Avg. amount/acc. (Rp. m) 3.4 1.0 2.0 2.0 2.7 1.7 1.2

Sources : Bank Indonesia, BPR Supervision Department ; National Family Planning Board. * East Nusa Tenggara, Maluku, Irian Jaya ; ** West Nusa Tenggara ; *** There are no BPR in South-east Sulawesi ;

figure does not include the number of households of this province.

As of March 2000, the average BPR had 1,882 savings deposit accounts and, assuming one account per household, an outreach to about 10% of all households. With the exception of Bali, the average number of savings accounts shows a considerably lower variance than the percentage of households reached. This is due to uneven regional distribution of BPR. The BPR in West Sumatra, the greater Jakarta area, Central Java, Yogyakarta and West Nusa Tenggara reached between 15% and 20% of the households in their areas, whereas BPR in the eastern parts of Indonesia reached less than 3% of the households. Bali is an exceptional case with the number of savings accounts exceeding the number of households in the province. The ProFI baseline surveys showed that Balinese households usually have more than one

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 72

passbook. Besides socio-cultural factors, this is due to high competition among and effective mobile services of financial institutions in Bali.

BPR usually have only few time deposit accounts, with their average number ranging from 20 in Sulawesi to 124 in Java and Bali. However, as will be shown later, time deposit accounts have become the major instrument for mobilizing deposits from the public. Average time deposits amounted to Rp. 5 million, while average savings deposits amounted to only 205,000 per account. Contrary to average savings deposits, average time deposits vary significantly between the regions. While the BPR in Java mobilized Rp. 4 million per account, average time deposits in Sumatra, Kalimantan, Sulawesi and the other eastern parts of Indonesia were three to four times as high. Average time deposits exceeded Rp. 20 million per account in Lampung, the greater Jakarta, South Kalimantan, North Sulawesi, East Nusa Tenggara, and Irian Jaya. This suggests that many BPR in these provinces serve a rather different clientele compared to the BPR in Java. Contrary to savings deposit instruments, which are also needed by low-income households for managing their liquidity, time deposit products with much higher returns have attracted middle-income households.

As of March 2000, about 5% of the Indonesian households had loans provided by BPR. The average BPR had 905 loan accounts with an average outstanding amount of Rp. 1.2 million. The BPR in West Java with more than 2000 loan accounts, on average, had the highest outreach in terms of the number of borrowers, whereas the average number of loan accounts was below 500 for the BPR in Sumatra, Kalimantan and Sulawesi. It is interesting to note that the ratio of savings to loan accounts in Java was lower than 2 to 1, whereas the number of savings accounts in West Kalimantan, Central Sulawesi and Bali exceeds the number of loan accounts by seven to ten times. The Balinese BPR had the highest outreach in terms of the percentage of households reached with credit services (14%). With 8% to 10% this outreach was also significant in the greater Jakarta area, Central Java, Yogyakarta and West Nusa Tenggara.

The BPR in West Java (Rp. 469,000) and West Nusa Tenggara (Rp. 590,000) had the lowest average loan amounts outstanding. The Javanese BPR, in general, serve many borrowers with relatively low loans amounts. The BPR in the greater Jakarta area, for which loan amounts outstanding per account averaged Rp. 2.7 million, are an exception in this respect. Exceptionally large loans were provided by the BPR in West Kalimantan and Lampung, with average loan amounts outstanding amounting to Rp. 4.2 million in the first and even to Rp. 7.2 million in the second case. Also these findings indicate that the BPR industry does not serve a homogeneous clientele. They also indicate that, contrary to the expectation of the Banking Acts of 1992 and 1998, many BPR opened up an urban and middle-income market rather than providing financial services to rural areas and low-income groups. It can also be concluded that BPR fulfil their intermediation function in different ways. The BPR in Java tend to collect small savings from many customers to finance relatively small loans of many borrowers. The BPR in Bali collect small savings from an outstanding number of customers to finance larger loans of a relatively small number of borrowers. The BPR in West Kalimantan and Lampung collect relatively large savings from a large number of customers to serve a few number of borrowers with large loan amounts.

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3.5 Current Financial Situation and Performance

Assets size and financial structure

As of March 2000, the average assets per BPR amounted to Rp. 1.5 billion and ranged from only Rp. 573 million in West Sumatra to Rp. 9.3 billion in Lampung. 72% of the total liabilities and equity of the BPR industry was invested in the BPRs’ loan portfolios. In most provinces the loan portfolio to assets ratio was between 65% and 75%. Two major exceptions are the BPR in South Sumatra with a ratio of only 38% and the BPR in North Sulawesi with a ratio of 86%.

Table 3.5 BPR Assets and Balance Sheet Structure (March 2000)

Region Sumatra Java Bali & WNT**

Kali-mantan Sulawesi Other E.

Indonesia* Total

Avg. assets per BPR (Rp. b) 1.9 1.4 2.0 1.4 1.2 2.1 1.5

Total assets (Rp. b) 462.0 2,574.5 457.6 63.5 58.1 25.1 3,640.8

Inter-bank assets (%) x) 28.5 19.1 15.3 27.2 11.7 15.5 19.8

Loan portfolio (%) x) 67.3 73.2 72.3 64.5 79.1 68.6 72.3

Savings deposits (%) x) 29.1 24.3 29.1 36.2 27.0 15.5 25.7

Time deposits (%) x) 39.3 36.3 35.4 20.3 30.6 35.5 36.2

Inter-bank liab. & loans (%) x) 12.4 16.4 17.6 10.4 12.4 8.0 15.8

Sources : Bank Indonesia, BPR Supervision Department. * East Nusa Tenggara, Maluku, Irian Jaya ; ** West Nusa Tenggara ; x) as percentage of total assets.

Time deposits are the major source of funds for the BPR industry, and contributed 36% to its total liabilities and equity as of March 2000. There is high variance between the provinces also in this respect. The BPR in Lampung, Central Java, East Java, and East Nusa Tenggara had more than 40% of their funds mobilized through time deposit instruments, whereas time deposits contributed less than 20% to the BPR funds in Aceh, West Sumatra, South Sumatra, South Kalimantan and South Sulawesi.

Savings deposits are the second major source of funds and contributed 26% to the industry’s total liabilities and equity, and together with time deposits they financed 62% of total BPR assets. This share of savings and time deposits was less than 50% in Aceh, the greater Jakarta area, South Kalimantan and Maluku, while it exceeded 70% in Riau, Jambi and Lampung.

The BPR in the eastern parts of Indonesia generally depend to a much higher degree on equity as a source of funds than BPR in other regions. In Bengkulu, South Kalimantan and Maluku equity financed more than 35% of the total BPR assets in these provinces. Inter-bank liabilities and loans were most important as a source of funds in the greater Jakarta area and Aceh, where they contributed more than one quarter to the BPRs’ total liabilities and equity.

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Assets and loan portfolio quality

As of March 2000, the classified to performing assets ratio was 14% for the entire BPR industry and ranged from a low 2% in Lampung to 32% in the greater Jakarta area. As classified assets according to Bank Indonesia standards include only 50% of sub-standard assets, 75% of doubtful assets, and 100% of loss, these ratios already indicate that a considerable part of the industry experienced serious loan collection problems. The loan portfolio at risk ratio, which includes the total loan amount not classified as standard, is a better measurement for credit performance.

Table 3.6 BPR Assets and Loan Portfolio Quality (March 2000)

Region Sumatra Java Bali & WNT**

Kali-mantan Sulawesi Other E.

Indonesia* Total

Loan portfolio classification

Standard (%) 92.1 78.7 67.5 79.1 82.4 80.1 79.0

Sub-standard (%) 2.2 4.2 3.6 2.9 4.0 9.1 3.9

Doubtful (%) 3.0 6.7 4.7 2.7 6.6 9.3 6.0

Loss (%) 2.6 10.3 24.4 15.3 7.0 1.5 11.1

Loan portfolio at risk (%) *** 7.9 21.3 32.5 20.9 17.6 19.9 21.0

No. of loans at risk (%)*** 17.3 39.3 33.8 28.9 29.5 18.7 37.7

Classified to performing assets ratio (%)

4.2 13.9 24.4 13.2 12.1 10.6 13.8

Sources : Bank Indonesia, BPR Supervision Department. * East Nusa Tenggara, Maluku, Irian Jaya ; ** West Nusa Tenggara ; *** Includes loans not classified as "standard".

The overall loan portfolio at risk ratio was 21%. Bank Indonesia classified 4% of the industry’s total loan portfolio as sub-standard, 6% as doubtful and 11% as loss. Note the loan classification system provides high tolerances. I.e., monthly installment loans in arrears for less than three months are classified as standard. These loans have to be classified as loss only after 27 months. The loan portfolio at risk ratio ranged from only 3% in Lampung to an outstanding high 48% in the greater Jakarta area. Extremely high ratios of more than 30% were also faced by the BPR in East Kalimantan and Bali. Loans classified as loss made up more than one quarter of the total loan portfolio in these regions. Apart from Lampung, only the BPR in Central Sulawesi, Jambi and Bengkulu had less than 10% for their loan portfolio value at risk.

CAMEL rating

The BPR supervision system includes a rating of BPR soundness based on 7 CAMEL ratios and 25 management indicators. As of March 2000, Bank Indonesia classified 62% of the BPR as sound or fairly sound, 8% as less sound and 26% as unsound. The soundness of BPR varies extremely between provinces. All or close to all BPR were classified as sound or fairly sound in Jambi, Bengkulu, Lampung, Central Kalimantan, Central Sulawesi, Maluku and Irian Jaya. More than or close to half of the BPR were rated less sound or unsound in West Sumatra, South Sulawesi and East Kalimantan. The worst performing region is the greater Jakarta area with 49% of the BPR classified as unsound and only 30% rated sound or fairly sound.

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Table 3.7 BPR CAMEL Rating (March 2000)

Classification in % of BPR Region Number

of BPR Sound Fairly sound Less sound Unsound

Not Classified

Sumatra 239 51.0 15.5 11.3 21.8 0.4

Java 1,854 44.1 16.2 12.7 27.0 4.9

Bali & West Nusa Tenggara 231 61.0 10.4 7.8 20.8 0.0

Kalimantan 44 50.0 23.7 15.8 10.5 13.6

Sulawesi 47 48.0 8.0 12.0 32.0 0.0

Other East Indonesia* 12 58.3 33.3 0.0 8.3 0.0

Total 2,427 46.7 15.6 8.3 25.6 3.9

Source : Bank Indonesia, BPR Supervision Department. * East Nusa Tenggara, Maluku, Irian Jaya

3.6 Development Trends 1995 - 2000

The number of BPR increased considerably in the second half of the 1990s, mainly because of the conversion of LDKP to BPR. Thus, the growth rate of average BPR assets has been slower than that of the total assets of the BPR industry, and it went negative during the financial crisis in 1997/1998. As of March 2000, total assets had grown by 42% and average assets by 15% compared to the end of 1996. The considerable growth of both total and average assets since 1999 indicates that at least part of the industry has been recovering from the impact of the crisis.

This is also suggested by the changing financial structure of the industry, the growth in the number and amount of loans outstanding, and the growth in savings accounts and amounts. While the loan portfolio to assets ratio decreased from 79% to 68% during 1997/1998, it recovered to 72% until March 2000. The BPRs’ gross loan portfolio decreased by 9% and the number of loan accounts by during the financial crises, but it grew by 41% during the 15 months until March 2000. The number of loans showed negative growth rates in both the period between 1995 and 1996 and the period between 1997 and 1998. During 1999 until March 2000, however, the total number of loan accounts increased by 49% and the average number of accounts per BPR by 38%. This trend can also be found for other financial institutions, as economic conditions for profitable loan uses have been improving since 1999.

A similar recovery can be found with regard to deposit mobilization, with savings and time deposits growing by 50% between December 1998 and March 2000, and their share in total BPR funds increasing to a level comparable to that prior to the crisis. The number of savings and time deposit accounts showed the fastest growth since 1994. In this respect, however, the BPR have been facing a different situation compared to financial institutions such as the BRI units and the LPD in Bali, which experienced an outstanding savings growth during the financial crisis. The lacking soundness and solvency of many BPR during the 1990s had undermined the public image of the entire industry. Many clients lost confidence in the industry and transferred deposits to financial institutions regarded as safe places to save.

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Table 3.8: BPR Development Trends December 1994 – March 2000 (in Billion Rupiah)

Dec 1994 Dec 1996Growth

12/94-12/96 Dec 1998Growth

12/96-12/98 Mar 2000Growth

12/98-3/00Number of BPR 1,873 1,987 6.1% 2,262 13.8% 2,427 7.3%Total assets 1,900 2,574 35.5% 2,751 6.9% 3,641 32.3%Average assets per BPR 1.0 1.3 27.7% 1.2 - 6.1% 1.5 23.3%Inter-bank assets 230 294 27.8% 624 112.4% 720 15.5%Gross loan portfolio 1,476 2,036 38.0% 1,861 - 8.6% 2,632 41.4%

As % of total assets 77.7 79.1 67.6 72.3Savings & time deposits 1,207 1,554 28.8% 1,500 - 3.5% 2,252 50.1%

As % of total assets 63.5 60.4 54.5 61.9Loan accounts Number (,000) 1,642 1,609 - 2.0% 1,479 - 8.1% 2,197 48.5% Avg. number per BPR 877 810 - 7.6% 654 - 19.3% 905 38.4% Avg. amount 1.7 2.5 49.4% 2.8 13.2% 2.9 2.2%Savings deposit accounts Number (,000) 3,806 3,865 1.6% 3,883 0.5% 4,568 17.6% Avg. number per BPR 2,032 1,945 - 4.3% 1,717 - 11.7% 1,882 9.6% Avg. amount (Rp. 000) 0.11 0.14 30.3% 0.16 9.3% 0.21 29.9%Time deposit accounts Number (,000) 160 122 -23.8% 117 - 4.1% 264 125.6% Avg. number per BPR 85 61 - 28.1% 52 - 15.8% 109 110.3% Avg. amount 9.1 16.2 76.5% 17.2 5.8% 12.1 - 29.5%Source: Bank Indonesia, BPR Supervision Department and Monthly Financial Statistics.

Since then, the BPR industry and its associations have been struggling with improving the BPR image and regain the trust of its clientele. Especially the outstanding growth in the number of time deposit customers shows that a great part of the industry has been succeeding in this respect. While this number decreased continually until 1998, the total number of time deposit account increased by 126% and the average number of accounts per BPR increased by 110% between December 1998 and March 2000.

3.7 The ProFI BPR Baseline Survey in East Java, Bali and West Nusa Tenggara

The ProFI baseline survey was conducted in the first half of 2000 and covered 115 BPR in East Java, Bali and West Nusa Tenggara, which were selected based on assets size and loan portfolio quality. An additional survey on the perceptions and preferences of BPR customers covered 552 respondents. The survey was conducted with standardized questionnaires covering organizational, management and financial information as of December 1999. Management information was complemented and discussed during four workshops with directors of BPR participating in the survey.

Major Findings

High variance. The baseline survey gave high emphasis to showing that the BPR industry is extremely differentiated in terms of governance, organization, management, outreach and performance. BPR are simple organizations with few employees or they are highly differentiated organizations with dozens of employees and a network of service units. They enjoy high management autonomy or operate with considerable involvement of owners and commissioners. They are market-oriented institutions or depend on bureaucratic decision-making. They operate in the boundaries of one sub-district or reach out to dozens of sub-districts. They operate in economically less favorable rural areas or are urban financial institutions. They serve low-income

Bank Perkreditan Rakyat (BPR) ProFI Microfinance Institutions Study 77

households or a clientele with rather high savings and credit absorption capacities. They reach out to dozens or thousands of customers. They reach financial volumes of small commercial banks or operate at scales similar to that of savings and credit associations. They are sound and highly profitable or unviable institutions at the brink of bankruptcy.

• Ownership and management. The BPR had 9 shareholders, on average, but 40% of them had less than 3 shareholders. One shareholder held the majority shares in 57% of the BPR. The board of commissioners usually includes owners and consists of two or three members, who often had no prior banking experience. 43% of the BPR had only one director. The percentage of BPR managed by directors without prior banking experience was also 43%. More than half of the directors had attained university degrees, but 16% of the BPR had directors with educational levels not higher than the high school level. 47% of the BPR enjoyed full or relatively high autonomy. Low management autonomy with owners or commissioners dominating operational decision-making was found in 13% of the cases. Owner involvement did not generally affect performance negatively. Findings, however, did also not show that owner involvement helps to improve BPR performance.

• Organization and staffing. The BPR organization may be simple or highly differentiated. In the first case, BPR had less than 10 staff and low degrees of organizational differentiation. In the latter case, BPR were managed by 2 or 3 directors, has more than 40 employees, several divisions and, in some cases, networks of service units. The average BPR had 22 but 28% had less than 10 staff. 60% of the BPR had hired only staff without banking experience. Educational attainments were usually not higher than the high-school level.

• Internal and financial management. The major management problems identified by BPR directors were loan collection and human resource problems. Loan losses were ascribed to character-related factors, adverse economic conditions, and internal factors such as inadequate credit analysis. One third of the BPR lacked an internal control system. Weak internal control and other management weaknesses were found to be striking features of poorly performing BPR. One third of the BPR lacked clear policies for lending to related parties. General lending limits applied did not prevent concentrating large parts of the loan portfolios in few hands. 26% of the BPR had 10% to 30%, and 10% had more than 30% of their loan portfolios allocated to only five borrowers. The loan portfolio quality was found to be significantly poorer for the letter institutions. Collateral is an unpredictable management field. 72% of the BPR had no experience with formal collateral execution. There is one theme independently of practical experience: collateral execution does not pay because of small loan sizes and low worth of collateral, on the one hand, and lacking law enforcement and corruptive jurisdiction, on the other hand. Many BPR had no clear standards for writing off loans. Small institutions were inclined to avoid write-offs because of undefined hope for loan recovery or insufficient loan loss provisions.

• Savings and credit products. All BPR offered savings deposit products that allow daily withdrawals and enable customers to manage their liquidity. The average annual effective interest paid on the main product was 12%, with 39% of the BPR paying less than 11% and 20% more than 12%. Almost all BPR offered time deposit products with varying terms. The average annual effective interest rate was 16%, with 39% of the BPR paying less than 15% and 21% more than 20%. The BPRs’ competitive position and demand for loanable funds were the major predicators for this variance. Credit products varied with regard to interest rates and terms. The average annual effective interest rate was 31% for the products with the lowest and 44% for those with the highest interest rate. Loan terms averaged 9 months for the shortest and 26 months for the longest terms provided.

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• Location and outreach. BPR usually operate one office in sub-district centers, at local markets or main arteries. Only 6% of the BPR operated in a distance of more than five kilometers from the sub-district capital. Average assets decrease and loan portfolio quality increases with the distance to the district capital. The outreach to sub-districts varied considerably with 35% of the BPR reaching up to 4 and 32% more than 9 sub-districts. Average assets increase with outreach. On average, 57% of the savings were mobilized and 51% of the loan portfolio was concentrated in one sub-district. The average BPR had 3,383 savings deposit accounts with an average amount of Rp. 437,000. The number of accounts ranged from below 10 to 58,429, and the average amount per account from Rp. 27,000 to Rp. 10.7 million. The BPR had 107 time deposit accounts, on average, with an average amount of Rp. 18 million per account. Large BPR are large because of time deposit services. BPR with assets larger than Rp. 5 billion had mobilized Rp. 19.7 billion from only 7,934 time deposit customers compared to Rp. 4.9 billion from 210,000 savings deposit customers. With 887 loans outstanding, on average, the number of loan accounts ranged from 35 to 8,263. The average loan amount outstanding per borrower was Rp. 2.9 million, but ranged from Rp. 181,000 to Rp. 54 million. Three quarters of the loans were working capital loans and 19% consumption loans. 52% of the loans were disbursed to the trading and 14% to the agricultural sector.

• Assets size and financial structure. The average BPR placed 20% of its resources in bank accounts and 68% in the loan portfolio. The average share of savings and time deposits in all resources was 53%. The average BPR generated 76% of its income from lending and 18% from bank placements. Financing costs contributed 43% operating costs contributed 56% to total costs. The financial structure varied dependent on assets size or vice versa. Assets were the larger the more savings and time deposit mobilization replaced dependence on equity and loans. With growing assets an increasing part of assets is placed in banks at the cost of the loan portfolio. Consequently, the role of income from bank placements increased at the cost of income from lending, while the role of financing costs incurred by higher degrees of deposit mobilization increased at the cost of operating costs. The crucial role of deposit mobilization for BPR growth is reflected in the fact that BPR with assets larger than Rp. 5 billion are much higher leveraged institutions (debt to equity ratio: 13:1) than BPR with assets smaller than Rp. 500 million (debt to equity ratio: 2:1).

• Financial performance and soundness. Based on the CAMEL ratios currently

applied by Bank Indonesia, three quarters of the BPR were found to be sound or fairly sound. Major problems were found with regard to assets quality. While the average ratio of classified assets to performing assets was 10%, 20% of the BPR were unsound in this respect. The average ratio of loan loss provisions made to provisions required was only 52% (without collateral taken into account), and 48% of the BPR were unsound in this respect. This rating does not require full loan loss

Financial Structure by Assets Class

Bank interests 10% Credit income 83%

Financing costs 27%Operating costs 72%

Income Costs

Bank interests 24%Credit income 72%

Financing costs 65%Operating costs 34%

Income Costs

Inter-bank 11% Loan portfolio 73%

Deposits 37%Equity 44%

Assets Liabilities & Equity

Inter-bank 27%Loan portfolio 65%

Deposits 80%Equity 8%

Assets Liabilities & Equity

Assets < Rp. 500 million (29 BPR) Assets > Rp. 5 billion (21 BPR)

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provisions and is based on a loan classification that provides high tolerances. Taking into account the total loan amount not classified as standard, the BPR had an average 17% of their loan portfolios at risk. Taking into account full loan loss provision costs as well as imputed capital costs, more than half of the BPR arrived at negative net margins in 1999. An alternative rating that gives more emphasis to loan portfolio quality and compliance with loan loss provision requirements showed that about 35% of the BPR would be rated less sound or unsound, if this approach is applied. The high losses incurred by one quarter of the BPR indicated that their financial sustainability was at stake.

• Trends in financial performance. While this situation is far from satisfying, the BPRs’ development showed encouraging trends of improvement after the financial crisis in 1997/1998. During the years from 1997 to 1999 the BPR experienced a similar financial development. Fund mobilization and asset growth stagnated in 1997 and increased slowly in 1998. Increasing fund mobilization in 1998 was not accompanied by growth in portfolio investment. The two years of the financial crisis and its aftermaths provided less favorable conditions for loan portfolio investments than for fund mobilization. The average value of loan portfolios declined by 19% until the end of 1998. Funds mobilized had to be placed in bank accounts the average value of which doubled between 1996 and 1998. The average loan portfolio at risk increased only slightly during this period, indicating that portfolio quality was not generally negatively affected by the financial crisis. 1999 was the year of recovery and new growth. Savings and time deposits mobilized grew by 54% and assets by 38%, on average. The growth in funds could be invested in the loan portfolio. The latter grew by 56% and bank placements by only 8%. The loan portfolio was also positively affected with the portfolio at risk declining by 8%. The BPRs’ assets quality and profitability improved slightly but continuously. The percentage of sound BPR increased from 55% in 1997 to 65% in 1999, and that of unsound BPR decreased from 18% to 9% during the same period.

• Perception and preferences of the BPR clientele. The most striking, and because of the industry’s poor performance partly unexpected, result of the customer survey was the relatively high satisfaction at least of the BPRs’ own clientele. Easy and fast services combined with door-to-door services are the dominating factors predicating the customers’ satisfaction and choice of financial institutions. The vast majority of customers felt that their BPR is a safe place to save, though state banks were ranked higher in this respect. Interest paid on deposits does not generally provide a strong savings motivation. In competitive environments such as in Bali, however, BPR customers regard lower interest paid on deposits as a disadvantage. The major disadvantages mentioned are the BPRs’ high credit interests and their lacking capacity to approve larger loans. In some regions actual and potential BPR customers missed an active market orientation of the industry. It was concluded that BPR might improve their image and competitive position by making deposit products more attractive, increasing loanable funds to be able to meet the credit of their potential clientele, and improving product marketing and mobile services.

3.8 Assessment and Conclusions

Strength and weaknesses

The BPR industry, in general, has achieved a considerable outreach and, in certain regions of Indonesia, serves a clientele that had no access to banking services prior to the banking reform in 1988. This is particularly true in provinces where large numbers of LDKP were converted to BPR. BPR contribute 20% to all bank offices in East Java (including BRI units, excluding BKD), 30% to all bank offices in West Sumatra, 32% to all bank offices in Bali, and 38% to all bank offices in West Nusa Tenggara. In the latter

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province they are, besides BRI units, the only banks with a significant outreach to the sub-district level. They have a similar number of savings customers as the Regional Development Bank and outclass the private banking industry in this respect. In the East Lombok district they account for one third of the banking industry’s total loan amount outstanding. BPR as independent bank units were able to adjust their products and services to local conditions and the demand of a clientele that has not been able to get access to commercial banks. Especially, simple products, convenient services and fast procedures have attracted and satisfied BPR customers.

These strengths of the BPR industry, however, most probably apply to only half of its institutions. After the rapid growth of the BPR industry in the first half of the 1990s it faced a severe crisis caused by factors such as low capitalization, weak management and unsound banking practices. Many BPR were established by business conglomerates and other parties in urban rather than in rural areas. Fast profit and rent-seeking motivations rather than sustainable institution building characterized part of the industry.

The idea of the 1988 banking reform and the 1992 Banking Act was to expand the outreach of banking services to rural and low-income households through a viable secondary banking industry. Already in the mid of the 1990s it became clear that the industry had fallen short of this expectation. The conversion of 630 LDKP to BPR in the second half of the 1990s contributed to improving this situation. The financial crisis in 1997/1998 brought the real state of the industry to light. Cases of mismanagement, fraud and insolvencies considerably deteriorated the image of the industry and the confidence of its customers. Bank Indonesia as well as the BPRs’ associations realized the need for cleaning up the industry in order to allow its sound and viable part to recover and regain public trust. As of November 2000, Bank Indonesia had liquidated about 90 BPR and planned to finalize the liquidation of a further 260 institutions. Signs of recovery and new growth since 1999 indicate that the BPR industry, will be able to overcome the causes of its crisis after the final cleanup of its unviable part.

The assessment of strengths and weaknesses of BPR would necessarily be very limited, if it has to be based on aggregated data only. The results of the ProFI baseline survey allow summarizing some major issues that have to be resolved by the BPR industry and other related parties. It has to be taken into account that these issues were derived from the analysis of BPR in East Java, Bali and West Nusa Tenggara. Most probably, however, they also apply to BPR in other provinces.

• Restricted management autonomy. The management autonomy of BPR is often restricted by the involvement of owners and commissioners in operational decision-making. BPR with strong owner involvement do not perform better and often worse than those enjoying high management autonomy. Higher degrees of functional differentiation, clearly distinguishing between the roles of owners, commissioners and directors, and making directors fully responsible for BPR operations may contribute to improving soundness.

• Bureaucratic governance. Restricted management autonomy is a special issue for BPR-LDKP. Owned by local governments they tend to be governed by bureaucratic command. Dependence on centralized decisions undermines market-oriented banking necessary to react flexibly to local conditions.

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• Ineffective internal control. Effective internal control is a major factor relevant for improving BPR soundness. Its lacking effectiveness is a striking feature of poorly performing BPR. Effective internal control requires functionally differentiated authorities for special internal control staff.

• Low functional and organizational differentiation. Low levels of functional and organizational differentiation characterize the institutional setup and practice of many BPR. The effectiveness and efficiency of these institutions suffer from an unclear division of labor and understanding of specialized functions. Institution building requires improving this differentiation in accordance with financial and human resources.

• Lacking compliance with loan loss provision requirements. The serious under-provisioning reveals unsound management practice and is a major problem to be solved in the field of financial management. Loan loss provision costs have to be fully accounted for in the income statement. Creating a sound BPR industry requires enforcing full loan loss provisioning.

• Unsound credit management. Loan loss was incurred through business failures, moral hazard, inadequate credit analysis, and deviation from prudential credit procedures. Neglect of lending limits is also a major issue in this respect. Loan portfolio quality worsened with large parts of the loan portfolio concentrated in few hands. Considering that prudential credit analysis and loan approval procedures would have prevented also much of the loss managers ascribe to business failures and the borrower’s character, improvement of credit management has to be regarded as a priority field of action.

• Low operating efficiency. The average operating costs to operating income ratio was unsound for the small BPR. The margin between income and costs is often too small to generate returns sustaining the real value of capital. The BPR-LDKP in West Nusa Tenggara, for example, have more than 10 staff but average assets of Rp. 547 million only. Their staff is two to three times as large but their assets four and more times as low as for the BRI units in the province. Operating efficiency has to be improved by reducing personnel costs and/or increasing outreach.

• Lack of capital versus over-liquidity. Lack of capital and over-liquidity are two opposite financial situations faced by BPR. Over-liquidity, mainly experienced by large BPR for which time deposits are the major source of funds, reflects difficulties in creating new credit markets. Lack of capital reflects low degrees of deposit mobilization of mainly small BPR and BPR-LDKP. Both situations required active market-orientation and entrepreneurship.

• Weak market-orientation and entrepreneurship. Innovative product, marketing and entrepreneurship are crucial for tackling both problems. Time deposit services of small BPR are considerably under-developed. Opening new credit markets requires diversifying loan products, convenient and fast credit procedures. Lack of market-orientation and entrepreneurship is a major weakness of BPR-LDKP operated by civil servants who depend on decisions of local governments.

• Low quality of human resources and lack of training impact. Low quality of human resources is the keyword most often used to define the core problem of BPR. The analysis of management aspects and the BPR directors’ own problem analysis pointed to lacking skills covering the entire range of banking operations. Training is often considered the key to solving these problems. There is, however, considerable lack of knowledge regarding the impact of training. Data and evidence do not show that training has positively affected performance. Training contents is often not tailored to the needs of a specific institution, and trainees are often not able or authorized to transform training contents into practice.

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Potentials and constraints

Despite the rapid development of the commercial banking sector and the large network of some 3,700 BRI units, the primary banking sector still has a highly limited outreach to rural areas, in general, and the village level, in particular. With more than 2,000 viable institutions the BPR industry has developed into an indispensable sub-system of the financial system in Indonesia. However, it has not yet been able to fully develop the huge market left by the primary banking sector. The BPR industry is highly concentrated in Java and Bali, and the majority of its institutions have been operating in urban and business centers.

This situation may suggest that the development of viable financial institutions has economically not been feasible in rural areas and regions outside of Java and Bali. Especially private investors avoided penetrating rural markets and regions that appeared to be less profitable. There is, however, every indication that this explanation is too simple and, therefore, misleading. Since the return to the “wisdom of the market economy”50 in the 1980s private entrepreneurship has been developing only slowly. Especially in the early 1990s, many private investors in the BPR industry showed a rent-seeking rather than profit-seeking orientation. The promise of fast and high returns rather than viable institution building determined their investment decisions. There are other examples of privately owned BPR that have expanded their outreach to rural areas and low-income households in profitable and sound ways. Non-governmental organizations such as Bina Swadaya proved the viability of rural BPR, which now serve a clientele formerly dependent on financial self-help and informal sources of finance. The same is true for many BPR-LDKP, although they have not yet fully succeeded to transform bureaucratic governance into market-oriented banking.

There is sufficient evidence that the majority of rural households have considerable demand for both savings and credit services. Moneylenders are still omnipresent and meet the existing credit demand at high interest rates. Microfinancial institutions with scarce loanable funds are not able to meet the existing credit demand. Loan approvals often distribute scarce funds, thus limiting the profitability of investments. Savings and credit groups need financial institutions to deposit excess funds and increase their loanable funds. There is a range of development projects with microfinance activities that prepare new markets for financial institutions and aim at sustaining financial services to their target groups. Poverty and social safety net programs channeling cheap and easy money to the villages have been inhibiting BPR from expanding outreach to the village level. These programs, however, are not sustainable. If the government changes its mind and returns to focusing on viable institution building in microfinance, BPR would be better able to develop their potential rural markets.

Based on these considerations, the assessment of the BPR industry’s potentials and constraints has to distinguish between the potentials and constraints of the currently existing institutions, on the one hand, and the potentials and constraints for expanding the BPR industry into regions and markets which are currently not yet reached by the industry.

50 Radius Prawiro, Coordinating Minister for Economic Affairs, Jakarta Post, 16 December 1989.

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Regarding the current BPR industry it is first of all necessary to distinguish its unviable from its viable part. Its unsound part has been detrimental to the entire industry and still constitutes a major constraint for realizing the potential of the industry. Furthermore, actions planned for strengthening the industry through, i.e., a new deposit protection system can hardly succeed before the industry is cleaned up. Bank Indonesia has already put substantial effort in liquidating about 350 BPR. Finalizing this effort has to be a short-term priority.

The still viable part of the industry does not only consist of sound and well-performing BPR. To improve this situation prudential regulatory and supervisory frameworks must be in place. BPR regulations and supervision instruments still have to be improved. It has, however, to be considered that the major constraints for influencing the soundness of the BPR industry in the past have been weak supervision practice and, above all, weak enforcement of compliance with existing regulations. The strict enforcement of full loan loss provisioning, compliance with legal lending limits and other regulations is of utmost importance for improving the soundness of the industry.

Supervision practice has to give more emphasis to assets quality, loan loss provisioning and prudential accounting, especially of loan loss and write-off costs. The frequency of on-site inspections has to be increased and inspections have to focus on BPR that are not sound. Recommendations of on-site supervision have to be followed-up and enforced. According to the Bank Indonesia Act of 1999, bank supervision has to be transferred to a new independent agency until the end of 2002. The objectives and tasks mentioned above would be difficult to achieve, if this agency, its quantitative and qualitative human resources, are not timely prepared.

The training of bank staff could not cope with the rapid development of the banking industry, in general, and of the BPR industry, in particular. The lack of a comprehensive training system, and the resulting human resource problems, has been a major constraint for the development of the BPR industry. Training did not necessarily improve institutional performance, as individual knowledge was not transformed into practice. The transformation of individual to institutional learning requires a training management system that includes participative training needs assessment, procurement of quality trainers, evaluation of training, and evaluation of training impact. However, training has only a limited function for the institutional development of individual BPR. Institutional strengthening requires setting up systems of internal control, financial and human resource management. Human resource problems are often related to low remuneration and lacking career opportunities. An important step in solving these problems is to establish clear remuneration and incentive systems, and to provide staff with personal development plans. Improving BPR governance by adequate functional differentiation of roles played by owners, commissioners, directors and employees is another crucial factor of institutional development. Institutional development requires institutional development plans and management consulting services. A major task ahead is to institutionalize both functions, training management and management consultancy, i.e., in BPR associations.

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The major constraint for expanding the BPR industry into new regions and markets are the capital requirements stipulated by the new BPR regulations in May 1999. With a minimum paid up capital ten times as high as the previous capital requirement new BPR establishments in rural areas are practically impossible. These high entry barriers contradict the idea of the banking reforms in the late 1980s and early 1990s. The intention of this policy change was to arrive at a sound industry with fewer but larger BPR. This tends to change the BPR character from a local secondary bank to a small primary bank, but it does not necessarily improve the soundness of the industry. There are a lot of smaller institutions that have proved their viability and provide important services to rural clients. Many of the unsound BPR were rather large ones operating in urban areas.

The further expansion of the BPR industry to rural areas and regions outside of Java and Bali would require decreasing the current capital requirements for rural areas. This would also allow growing non-bank microfinance institutions to develop into BPR. There is another, not necessarily alternative, possibility that increasingly has become important for strengthening the local financial system. The current legal and regulatory framework is too narrow to enable the high variety of microfinancial institutions to grow and to provide sustainable financial services with a significant outreach. Improving this situation requires distinguishing BPR as microbanks from non-bank microfinance institutions as a third category of financial institutions, and enabling the latter to develop by providing them with an own legal and regulatory framework. An enabling legal and regulatory framework would contribute to sustaining the local focus of BKD and LDKP, and to broadening the outreach to rural areas by new non-bank microfinance institutions. It would allow for upward mobility of non-bank microfinance institutions capable of converting to BPR and downward mobility of small BPR unable to sustain the BPR status.

Bank Indonesia and related parties are currently working on the issues mentioned above. The GTZ-ProFI project has been supporting these efforts. The regulatory framework for BPR has been reviewed and a new regulatory framework for non-bank microfinance institutions is being developed. The BPR supervision system is being improved and a deposit protection concept was designed. First steps were undertaken to strengthen BPR associations and develop a comprehensive BPR training system.

ProFI Microfinance Institutions Study

Chapter 4:

Lembaga Dana Kredit Pedesaan (LDKP) –

The Rural Credit Fund Institutions

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4. Lembaga Dana Kredit Pedesaan (LDKP) – The Rural Credit Fund Institutions

Lembaga Dana Kredit Pedesaan (LDKP) or Rural Credit Fund Institutions is the term that is used in Indonesia since the 1980s to summarize non-bank microfinance institutions established on initiative of provincial governments since the 1970s and to distinguish them from both banks and the older village credit institutions in Java (see chapter 5). The term stands for a variety of institutions, which have their own names and differ in ownership, organization, services and outreach.

4.1 General Description

The first LDKP, Badan Kredit Kecamatan (BKK) in Central Java, Lembaga Perkreditan Kecamatan (LPK) in West Java, and Lumbung Pitih Nagari (LPN) in West Sumatra, were established in the early 1970s. The Lembaga Kredit Usaha Rakyat Kecil (LKURK) in East Java were initiated in 1979/1980. The establishment of LDKP in other provinces was mainly a result of a seminar carried out by the Ministry of Home Affairs in February 1984 in order to disseminate the existing LDKP models to attending governors and officials from various provinces. In the following, provincial governments initiated the establishment of Lembaga Perkreditan Desa (LPD) in Bali, Badan Kredit Kecamatan (BKK) and Lembaga Pembiayaan Usaha Kecil (LPUK) in South Kalimantan, Badan Kredit Kecamatan (BKK) in Bengkulu, Badan Kredit Kecamatan (BKK) in Riau, Lembaga Kredit Pedesaan (LKP) in West Nusa Tenggara, Badan Usaha Kredit Pedesaan (BUKP) in Yogyakarta, and Lembaga Kredit Kecamatan (LKK) in Aceh.

With the exception of the LPD in Bali and the LPN in West Sumatra, which are owned by customary villages and operate at the village level, LDKP are owned by provincial and/or district governments and operate at the sub-district level. All LDKP are licensed, regulated and supervised by the provincial governments. Technical assistance and supervision is usually delegated to the Regional Development Banks (BPD), which are owned by the provincial governments.

According to the monthly financial statistics of Bank Indonesia, the total number of LDKP did almost not change between the late 1980s (1,936) and the end of 1996 (1,978), and then decreased to 1,626 as of March 2000 because of the conversion of LDKP to People’s Credit Banks (BPR). According to the reports of Bank Indonesia’ BPR supervision department, a more reliable source, this decrease does not correspond to the real number (630) of LDKP that were licensed as BPR until March 2000. 56% of these BPR-LDKP came from the BKK in Central Java and a further 32% from the LDKP in West Sumatra, West Java and East Java. Based on the numbers of presently active and converted LDKP it can be estimated that only about one quarter of the LDKP have become banks.

It is important to note that there is no system providing reliable LDKP data at the national level. The national statistics of Bank Indonesia are not reliable and consistent. The real number of still operating LDKP is not lower but the composition of the LDKP industry differs considerably from these statistics (see table 4.1). One the one hand, Bank Indonesia statistics still may include LDKP that either terminated their operations or converted to BPR. On the other hand, they do not include a great part of the LDKP operating in Bali, South Kalimantan and East Java.

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The Regional Development Banks provided up-to-date data for the purpose of this report. Those in Aceh, Riau and Bengkulu, however, were not informed whether the 28 LDKP found in Bank Indonesia statistics are still active. 13 LDKP converted to BPR. This is also true for 71 LPN in West Sumatra, while 122 LPN are still active as LDKP. 82 LPK operate in West Java and 62 were licensed as BPR. In Central Java, 351 BKK have a BPR license, while 160 operate as LDKP. None of the 75 BUKP in Yogyakarta and of the 912 LPD in Bali converted to BPR. 156 LKURK are active in East Java and 67 converted to BPR. There are 46 LKP with BPR licenses in West Nusa Tenggara. 6 LKP are still active. 90 LDKP (76 LPUK, 14 BKK) operate as LDKP in South Kalimantan. 20 BKK converted to BPR.

With the exception of West Sumatra and South Kalimantan, therefore, the present significance of the LDKP industry is greatly limited to Java and Bali. With an increasing number of LDKP converting to BPR, the LDKP in Java tend to become a phase-out model. The Balinese Government has resisted the pressure to convert LPD to BPR and demands a national regulatory framework that provides room to move for non-bank microfinance institutions. The LPD make up 57% of the presently active LDKP, and they operate with 77% of the assets and 85% of the deposits of all LDKP, though the number of households in Bali contributes only 2.4% to the total number of households in all provinces with active LDKP.

The LPD are an indispensable part of the financial system in Bali. Being owned by custom villages, they provide financial services in two thirds of these villages and to about one third of the Balinese households. Regarding savings mobilization it is safe to argue that they are the most successful non-bank microfinance institutions in Indonesia. The entire loan portfolio and more than three quarters of the total assets of the LPD industry is being financed through voluntary savings. Except of the BKK in Central Java, the average LPD has more than twice as many savings customers as other LDKP. Savings mobilization makes also the difference in asset size. As a village-level financial institution, the LPD industry has assets as large as the BKK in Central Java and much larger than that of other LDKP operating at the sub-district level. A smaller part of the LPD industry is financially stronger and sustainable than small BPR are. Compared to other LDKP, the LPD are the only ones with a relatively sound loan portfolio quality.

Table 4.1 Number of LDKP by Province

Province LDKP (1) (2) (3)

Aceh LKK * 7 12

West Sumatra LPN 122 498 71

Riau BKK * 5 1

Bengkulu BKK * 16 0

West Java LPK 82 63 62

Central java BKK 160 636 351

Yogyakarta BUKP 75 9 0

East Java LKURK 156 118 67

Bali LPD 912 264 0

West Nusa Tenggara LKP 6 0 46

South Kalimantan BKK/LPUK 90 10 20

TOTAL 1,603 1,626 630(1) Number of active LDKP (June 2000). Source: Regional

Development Banks and own data collection. (2) Number of LDKP (March 2000). Source: Bank Indonesia

monthly financial statistics (September 2000). (3) Number of LDKP converted to BPR until March 2000.

Source: BPR supervision department of Bank Indonesia. * Number of LDKP still active not available in Regional

Development Banks. Most of them may be inactive.

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Table 4.2: LDKP Indicators by Province (June 2000)

Province West Sumatra

West Java

Central Java

Yoya-karta East Java Bali *

West Nusa T.

South Kalim.

LDKP LPN LPK BKK BUKP LKURK LPD LKP BKK/LPUK

No. of households (million) 0.91 10.02 7.56 0.74 8.99 0.70 0.91 0.71No. of active LDKP 122 82 160 75 156 912 6 90Assets (Rp. billion) 2.5 16.0 67.9 9.3 11.3 375.3 0.8 4.1 Avg. assets (Rp. million) 21 195 425 124 72 412 128 45 Inter-bank assets (%) 11.4 5.1 16.2 5.8 4.5 29.9 0.0 4.1 Loan portfolio (%) 77.1 70.0 75.9 93.5 80.8 66.7 67.9 91.3 Deposits (%) 33.5 30.9 65.4 26.7 - 77.5 29.7 - Equity (%) 41.4 38.8 7.3 28.0 59.8 18.0 32.2 44.8Loan portfolio at risk (%) *** 35.6 50.2 25.9 22.5 22.5 8.9 20.3 27.3Loan accounts (thousands) 10.9 16.6 130.7 26.8 n.a. 211.3 2.4 19.8 as % of total households 1.2 0.17 1.7 3.6 n.a. 30.0 0.27 2.8 avg. number / LDKP 90 203 817 357 n.a. 232 404 220 avg. amount / acc. (Rp. ,000) 176 671 394 324 n.a. 1,185 215 188Deposit accounts (thousands) 22.2 24.7 179.7 22.7 - 584.6** n.a. - as % of total households 2.5 0.25 2.4 3.1 - 82.9** n.a. - avg. number / LDKP 182 302 1,123 302 - 641** n.a. - avg. amount / acc. (Rp. ,000) 38 199 247 109 - 283** n.a. -Sources: Regional Development Banks, National Family Planning Board (number of households, January 2000). * Data for LPD in Bali as of March 2000. ** These figures do not include time deposit accounts that numbered 37,470 and averaged to Rp. 3.3 million as of

March 2000. Note that households usually have one loan account but several deposit accounts. The actual coverage of households is about one third of the total number of households in Bali.

*** Percentage of loan portfolio not classified as “standard” according to LDKP classification systems. n.a.: Data not available

As almost 70% of the BKK in Central Java converted to BPR, the remaining 160 institutions contribute only 10% to the presently active LDKP. Nonetheless, they are still the second most important LDKP and, except of the LPD in Bali, the only one that effectively intermediates between deposit customers and borrowers. Deposits finance 65% of their assets, which are more than twice as large as those of comparable LDKP. Operating with village outlets, the average BKK has the largest outreach with regard to the number of deposit customers and borrowers served. However, as of June 2000 the BKK industry served not more than 2% of the households in Central Java. With one quarter of the aggregated loan portfolio at risk many BKK appear to suffer from poor loan portfolio qualities.

LDKP other than the LPD in Bali and the BKK in Central Java are much weaker institutions. They have a considerable lower outreach and financial capacities. A major factor predicating their weakness is the lack of deposit services or the low degree to which they mobilize voluntary savings. The LKURK in East Java and the BKK/LPUK in South Kalimantan have not developed deposit products. With equity and limited access to credit being the only sources of funds, the 156 LKURK have average assets of Rp. 72 million and the 90 BKK/LPUK of Rp. 45 million only. The loan portfolio quality of both the LDKP in East Java and South Kalimantan is poor.

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The BUKP in Yogyakarta and the LPK in West Java have larger but still small assets. The BUKP depend highly on loans provided by the government, while deposits finance only about one quarter of their assets. The fact that they have invested 94% of assets in the loan portfolio indicates considerable lack of loanable funds. 23% of their aggregated loan portfolio is at risk. The LPK have a more balanced structure of liabilities and equity, with deposits, however, not exceeding one third of their total funds. With half of their aggregated loan portfolio at risk they are the worst performers of all LDKP. With regard to outreach scope they play an insignificant role in West Java.

The 122 active LPN in West Sumatra are tiny institutions with average assets (Rp. 21 million) similar to those of many financial self-help groups and deposits contributing only one third to their total funds. They have an average outreach to only 90 borrowers and their average loan portfolio quality is worse than that of most of the other LDKP.

Since 46 of the formerly existing 55 LKP in West Nusa Tenggara converted to BPR, LKP are a negligible factor of the financial system in this province. The ProFI appraisal on the “Development and Upgrading of Microfinance Institutions” (Denpasar 2000) in West Nusa Tenggara found that only one of these institutions is performing well, whereas the others may not be able to sustain their operations.

4.2 Evolution of the Regulatory Framework

LDKP are regulated by provincial government regulations within the existing national regulatory framework. This description refers only to national regulations of relevance for LDKP, while provincial regulations are discussed in the following chapters that deal with each LDKP type.

The Banking Act No. 14 of 1967 and following decrees of the Ministry of Finance in 197051 enabled village credit institutions and popular credit banks, which were already operating at that time, to continue their operations as part of the banking system. The entry for new small financial institutions, however, was closed. In order to cope with this situation and to revive the rural financial system, that had suffered from extremely high inflation rates in the 1960s, Bank Indonesia issued a circular letter52 in 1970 that provided provincial governments with the opportunity to establish non-bank financial institutions. Until the early 1980s, however, the development of LDKP remained limited to the provinces of West Sumatra, West Java, Central Java and East Java.

The second wave of LDKP establishments was initiated in the mid of the 1980s, when the Ministry of Home Affairs disseminated the existing LDKP model to other provinces and Bank Indonesia, in cooperation with universities and its own training institute, carried out a research project on LDKP, the results of which were presented at a seminar in 1987.53 This national recognition of LDKP had much influence on the following financial sector reforms. The banking deregulation in 1988 (Pakto 88) established low entry barriers for a new secondary bank type (BPR).

51 Article 41, Undang-undang Nomor 14 Tahun 1967 tentang Pokok Perbankan; Surat Menteri

Keuangan kepada Direksi Bank Indonesia Nomor B 331/MK/IV/8/1970. 52 Bank Indonesia, Surat Edaran Nomor 4/26-V/PPTR Tahun 1970. 53 Lembaga Pengembangan Perbankan Indonesia:.Seminar Lembaga Dana dan Kredit

Pedesaan, LPPI, Jakarta 1987.

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Since the Banking Act No. 7 of 1992 LDKP are acknowledged as BPR candidates. Article 58 of the act states that the various types of non-bank microfinance institutions will be given the BPR status with fulfilling the requirements and procedures to be stipulated in further government regulations. Government regulation No. 71 of 199254 determined that LDKP are required to seek a BPR license within five years until October 1997. The vast majority of these institutions has not been able to fulfill licensing requirements55 or has not been willing to convert to BPR.

The new Banking Act No. 10 of 199856 requires any party mobilizing deposits from the public to obtain a business license from Bank Indonesia (article 16). Banks in a possession of a license are declared to have obtained a license based on the new Banking Act (article 55). Article 58 remained unchanged, thus still requiring LDKP to fulfill BPR licensing requirements. The explanation of article 58 emphasizes that the existence of these institutions is acknowledged, but that requirements and procedures for converting to BPR are still to be stipulated by following government regulations.

Government regulation No. 30 of 199957 declared regulation No. 71 of 1992 invalid as soon as new BPR regulations are issued, while its practical provisions are said to remain valid as long as they do not conflict with the 1998 Banking Act. On 15 May 1999, Bank Indonesia issued the new BPR decree58 that substantially changed the framework conditions for BPR and non-bank microfinance institutions. The minimum paid up capital for establishing a new BPR was increased to Rp. 2 billion for the greater Jakarta region, to Rp. 1 billion for provincial capitals, and to Rp. 500 million for other areas (article 4). Existing BPR are required to hire two managers with at least a diploma 3 level and two years banking experience. These entry barriers closed the BPR market for almost all still operating LDKP.

Presently, Bank Indonesia with technical assistance from GTZ through the ProFI project are reviewing the existing regulations with the aim to improve BPR regulations and provide non-bank microfinance institutions such as the LDKP with an adequately regulated place in the financial sector without requiring them to convert to BPR.

54 Peraturan Pemerintah Republik Indonesia Nomor 71 Tahun 1992 tentang Bank Perkreditan

Rakyat, 30 Oktober 1992. 55 Licensing requirements were determined by a joint decree of Bank Indonesia, the Ministry of

Finance and the Ministry of Home Affairs in 1994: Bank Indonesia, Departemen Keuangan, Departemen Dalam Negeri, Surat Keputusan Bersama, 26 September 1994. Among other requirements LDKP applying for a BPR license had to store a paid-up capital of Rp. 50 million, had to operate without loss for three consecutive years, and had to be managed by directors with certain formal qualifications.

56 Undang-Undang Republik Indonesia Nomor 7 Tahun 1992 Tentang Perbankan Sebagai-mana Telah Diubah dengan Undang-Undang Nomor 10 Tahun 1998.

57 Peraturan Pemerintah Republik Indonesia Nomor 30 Tahun 1999 tentang pencabutan Peraturan Pemerintah Nomor 70 Tahun 1992 Tentang Bank Umum (…), Nomor 73 Tahun 1998, Peraturan Pemerintah Nomor 71 Tahun 1992 Tentang Bank Perkreditan Rakyat, dan Peraturan Pemerintah Nomor 72 Tahun 1992 Tentang Bank Berdasarkan Prinsip Bagi Hasil. 7 Mei 1999.

58 Bank Indonesia, Surat Keputusan No. 32/35/KEP/DIR tentang Bank Perkreditan Rakyat, 12 Mei 1999.

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4.3 Lembaga Perkreditan Desa (LPD) in Bali

The Lembaga Perkreditan Desa (LPD) in Bali are village-level financial institutions which have been established since 1985 and of which 912 were operating as of June 2000. As shown by the previous comparison, they are the most successful LDKP type in Indonesia. This success has been greatly due to the high commitment of the Government of Bali to establish an enabling framework for the development of self-reliant and sustainable financial institutions in the ownership of the Balinese Desa Adat (custom villages).

This description is based on financial data (as of March 2000) provided by the Regional Development Bank (BPD) in Bali and the ProFI baseline survey59 on LPD carried out in the first half of 2000. It, therefore, is able to provide a more thorough and detailed analysis than the following reports on LDKP in other provinces of Indonesia.

4.3.1 History, Ownership and Socio-cultural Environment

Aiming at developing the people’s economy and fighting usury moneylending through sustainable community-owned financial institutions, the Governor of Bali took the initiative for establishing LPD in 1984/1985. The political motivation to sustain and strengthen the Desa Adat system in the light of central government efforts to impose an uniform village administration was as important as the economic motivation. The establishment of LPD became closely linked to the objective of empowering the Desa Adat as a recognized unit of village organization and customary law. The Desa Adat regulation60 of 1986 gave the Desa Adat the right to generate and use assets through their own organizations.

The first 161 LPD were established during a three-years pilot phase between March 1985 and March 1988. After the Governor and the provincial parliament had issued the new framework of LPD regulation and guidance (see below), the number of LPD increased rapidly during the next five years and reached 650 as of March 1993. Also during the following three years the LPD industry experienced a considerable growth with 206 additional LPD operating as of March 1996. Since then, however, only 56 new LPD were added. As of June 2000, 912 LPD operated in two thirds of the Desa Adat. The slower growth during the second half of the 1990s was due to a higher emphasis on consolidation and the lacking feasibility of new establishments.

59 See Detlev Holloh, Lembaga Perkreditan Desa (LPD) in Bali, ProFI Baseline Survey, Bank

Indonesia and GTZ, Denpasar, June 2000; Detlev Holloh, Small Financial Institutions in East Java, Bali and West Nusa Tenggara, ProFI Baseline Survey Summary Report, Bank Indonesia and GTZ, Denpasar, June 2000.

60 Peraturan Daerah Popinsi Daerah Tingkat I Bali Nomor 06 Tahun 1986 tentang Kedudukan, Fungsi dan Peranan Desa Adat sebagai Kesatuan Masyarakat Hukum Adat dalam Propinsi Daerah Tingkat I Bali. (The regulation became effective in February 1988)

Table 4.3 Number of LPD 1988 – 2000

March 1988 161

March 1993 650

March 1996 856

March 1997 856

March 1998 904

March 1999 910

March 2000 912

Sources: Regional Development Bank, Head office, Denpasar, and Bank Indonesia, Branch office, Denpasar.

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The Desa Adat is the owner of the LPD. The Desa Adat is a village unit in which customary symbols and regulations play an important role in community life and for social integration.61 As a custom village it has to be distinguished from the Desa Dinas, the administrative village unit. The boundaries of the Desa Dinas were determined along territorial lines, whereas those of the Desa Adat are related to the origin and social bonds of its members. Their boundaries and population do seldom coincide. One Desa Adat may be made up of several Desa Dinas or one Desa Dinas may cover several Desa Adat, or only parts of them.

The LPD as a financial institution is unique because the Desa Adat is not only its geographical but also its social place. The LPD is owned, operated and used by the members of the Desa Adat. The highest authority of the Desa Adat is the assembly of its members, the paruman. It elects its leadership board, the prajuru, and agrees upon the customary law. The prajuru and its chairman, the bendesa, take ongoing decisions on the basis of agreed upon customary law. They are, therefore, the main institutions dealing with LPD and play a crucial role in supervising LPD operations.

Ideally, the LPD is embedded in a community that is regulated and socially integrated by adat or customary law. Adat describes local practice codified in customary law and embodied in local institutions. It can be a powerful framework of social integration and control, and it determines sanctions that may also be a powerful tool for LPD management. In reality, there is a considerable variance between customary laws and between the Desa Adat with regard to their ability to enforce these laws. The degree to which customary law is able to fulfill the function of social integration and control is a major predicator for LPD performance. In this context, it is important whether the LPD becomes a subject of the village assembly and the customary law, and whether customary village leaders fulfill their supervisory function on this basis. Evidence shows that many LPD have not been performing well in villages where social integration and control through customary law is weak.

4.3.2 Regulation, Supervision and Support System

Regulation

The Government of Bali is responsible for regulating and supervising the LPD industry within the framework of national regulations. National banking regulations have been requiring LDKP to convert to BPR. Because of the unique features of the LPD industry, the Balinese Government has been resisting this requirement. A long debate with Bank Indonesia and the Ministry of Home Affairs resulted in the decision of Bank Indonesia (letter of 17 February 1999) that allows LPD to continue their operations as non-bank financial institutions. They are allowed to mobilize funds from members of the Desa Adat but are asked to refrain from using banking terminology. This compromise provided LPD with room to move without, however, solving the structural problem of how they can find a recognized and legalized place in the financial sector. Both the national and provincial regulatory frameworks are presently reviewed by Bank

61 See, i.e., Carol Warren, Adat and Dinas. Balinese Communities in the Indonesian State,

Oxford University Press, Kuala Lumpur 1993; I Gusti Ngurah Oka, Peranan Awig-Awig Desa Dalam Operasional LPD, Majelis Pembina Lembaga Adat Propinsi Daerah TK. I Bali.

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Indonesia and the Balinese Government with technical assistance provided by GTZ through the ProFI project. The presently valid provincial regulations are summarized in the following. More detailed examinations of these regulations can be found in two other ProFI reports.62

The establishment of LPD was initiated by a government decree63 issued in 1984. It made basic provisions for the establishment, organization and operation of LPD, which, after termination of the pilot phase, were replaced by the still valid LPD regulation64 of 1988. Important revisions were the new emphasis on savings mobilization and Desa Adat. Amendments of the regulation have been made by various government decrees.

Desa Adat may establish a LPD as an operational unit with the major functions of mobilizing deposits and providing credit (chapter 3 of 1988 regulation). The LPD capital may consist of retained profits and funds contributed by the Desa Adat, its members and the government (chapter 4). The LPD has to be managed by a committee consisting at least of a chairman, accountant and treasurer. The management committee is to be elected by and from Desa Adat members and is given the authority to appoint additional staff (chapter 5). The committee is required to prepare annual work and budget plans (article 11 of chapter 6) as well as annual reports and financial statements (article 12 of chapter 6), which have to be approved by the Desa Adat, ratified by the district head and to be forwarded to the government and the BPD.

The district head may dismiss the committee on recommendation of the Desa Adat, if it does not comply with existing regulations and inflicts losses on the LPD (article 10 of chapter 6). The LPD management committee is made liable for losses incurred through negligence and non-compliance with existing regulations (chapter 10). The Governor may dissolve a LPD on recommendation of the district head (chapter 11).

Article 14 of chapter 7 regulates the allocation of annual net profits. 40% have to be allocated to equity and general reserves, 20% to targeted reserves, 20% to the village development fund, 10% to the service and compensation fund, 5% to a LPD guidance fund, and 5% to the social fund. Government decree No. 1365 of 1999 specifies that general and targeted reserves have to be allocated to equity. The compensation fund is to be used for LPD employees. The social fund shall be used for social activities of the Desa Adat. The village development fund is transferred to the Desa Adat and the LPD guidance fund, to be used for compensation of the support teams and centers at the various levels, to a special account of the BPD.

62 Hendrik Prins: Regulation and Supervision of LPDs, Report to ProFI/GTZ Denpasar, March

2000. Detlev Holloh, Lembaga Perkreditan Desa (LPD) in Bali, ProFI Baseline Survey, Bank Indonesia and GTZ, Denpasar, June 2000. See also: Biro Bina Perekonomian Setwilda Tingkat I Bali, Himpunan Ketentuan Lembaga Perkreditan Desa (LPD) Propinsi Daerah Tk. I Bali; Made Adi Djaya, Kepala Biro Bina Perekonomian Setwilda Tingkat I Bali, Pemerintah Propinsi Daerah Tingkat I Bali, 1999; I Made Artha, Pembinaan dan Pengawasan Lembaga Perkreditan Desa, Bank Pembangunan Daerah Bali, 1999.

63 Keputusan Gubernur Kepala Daerah Tingkat I Bali Nomor 972 Tahun 1984 tentang Pendirian Lembaga Perkreditan Desa di Propinsi Daerah Tingkat I Bali.

64 Peraturan Daerah Propinsi Daerah Tingkat I Bali, Nomor 2 Tahun 1988, tentang Lembaga Perkreditan Desa.

65 Keputusan Gubernur Kepala Daerah Tingkat I Bali Nomor 13 Tahun 1999 tentang Pembagian dan Penggunaan Keuntungan Bersih LPD di Propinsi Daerah Tingkat I Bali.

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Governmental guidance boards at the provincial, district and sub-district level are given the tasks to design and implement policies, and to provide general guidance to LPD (chapter 8) Government decree No. 401 of 199766 made further provisions on the establishment, functions and composition of the provincial board. The board consists of eight members from various government institutions and is headed by the Governor.

Responsibility for LPD supervision is given to governmental inspectorates. Technical aspects of supervision and guidance are to be carried out by the BPD on the basis of monthly reports and quarterly financial statements of LPD (chapter 9). Article 20 of chapter 9 requires LPD to deposit excess liquidity in the next BPD branch.

Acknowledging the limited personnel resources of the BPD, the establishment of Sub-district LPD Centers (PLPDK) was decreed in May 1989.67 The PLPDK were to provide technical assistance and carry out supervision tasks under the authority of the LPD guidance boards. Technically, they became responsible to the BPD. An additional decree issued in 199368 specified BPD functions as to provide technical assistance via off-site and on-site supervision analyzing financial LPD reports (passive guidance) and on the spot visits (active guidance) in cooperation with other parties, and to prepare quarterly reports for the bureau of the Governor.

To improve internal control the government decreed69 the establishment of supervisory boards in 1998. The board has to consist of the Desa Adat head as its chairman and two other members. The Desa Adat assembly has the right to appoint and dismiss the board. The district head is given the authority to dismiss board members, if they cause losses or are not able to carry duties properly. The tasks of the board are to promote the LPD, improve its performance, and supervise credit management. Instruments and procedures of supervision are not clarified. Members of the supervisory board are prohibited to take advantage from their position and are made liable for losses incurred through negligence and lacking compliance with existing regulations.

Supervision and technical support

Supervision and technical support are not clearly distinguished and involve many parties. In practice, the governmental inspectorates carry out audits. Supervisory authority lies with the government, while the BPD credit management bureau is technically responsible but has no real authority and enforcement power. The BPD cooperates with so-called Sub-district LPD Centers (PLPDK), of which 16 were operational as of December 1999. Each PLPDK carries out supervision and technical

66 Keputusan Gubernur Kepala Daerah Tingkat I Bali Nomor 401 Tahun 1997 tentang

Pembentukan dan Susunan Keanggotaan Badan Pembina Lembaga Perkreditan Desa Propinsi Daerah Tingkat I Bali. (The decree replaced decree No. 242 of 1992.)

67 Keputusan Gubernur Kepala Daerah Tingkat I Bali, Nomor 180 Tahun 1989 tentang Pendirian Pusat Lembaga Perkreditan Desa Kecamatan (PLPDK) di Propinsi Daerah Tingkat I Bali.

68 Keputusan Gubernur Kepala Daerah Tingkat I Bali Nomor 344 Tahun 1993 tentang Penunjukan Bank Pembangunan Daerah (BPD) Bali sebagai Pembina Teknis Lembaga Perkreditan Desa (LPD) Propinsi Daerah Tingkat I Bali.

69 Keputusan Gubernur Kepala Daerah Tingkat I Bali Nomor 491 Tahun 1998 tentang Ketentuan Pembentukan, Pengangkatan dan Pemberhentian Badan Pengawas Lembaga LPD di Propinsi Daerah Tingkat Bali I.

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guidance for 40 to 80 LPD. While PLPDK function as technical arms of the BPD, the BPD does not have the authority to appoint and dismiss staff.

Theoretically, PLPDK are concerned with compiling monthly reports and financial statements, examining these reports (the PLPDK is the only party being able to carry out off-site supervision as all other parties do only receive aggregates!), and carrying out on-site supervision with a standard report including qualitative questions, loan classification and CAMEL rating. In practice, supervision is often carried out with emphasis on form rather than on substance. PLPDK often focus their work on preparing aggregate reports for higher levels rather than on examining the soundness and existing problems of individual LPD. On-site supervision is supposed to be carried out once a month for each LPD. The ProFI baseline survey found that in more than half of the cases on-site supervision had been carried for not more than twice a year.

The ProFI reports mentioned earlier pointed to the weaknesses of the LPD supervision system and recommended to reorganize and properly distinguish the different functions of supervision and technical assistance. Supervision is a formal act in which compliance to existing regulations is examined and ideally enforced from outside. Technical assistance works from inside and by means of communication rather than enforcement. Regarding the latter function the BPD lacks human resources in quantity and the PLPDK in quality. The improvement of these human resources and the establishment of a consistent LPD consultancy system would be required to strengthen the institutional development of LPD. The findings and recommendations of the ProFI reports are presently discussed with the Balinese government and the BPD. A new LPD regulation was drafted as a first result of these discussions.

4.3.3 Organization and Management

The LPD organization varies depending on duration and scale of operation. New and small LPD operate with a management consisting of a chairman, accountant and treasurer. Field staff is added with growing numbers of customers and increasing savings mobilization through door-to-door services. A smaller part of the LPD industry has been developing models of organizationally differentiated divisions and functionally differentiated field staff. The 81 LPD included in the ProFI baseline survey operate with 6 employees, on average, while large LPD with assets exceeding Rp. 1 billion usually operate with more than 6 employees. The LPD management usually consists of elder and male members of the Desa Adat. In contrast to most of the other government-initiated small financial institutions in Indonesia, village officials do usually not dominate LPD management. LPD staff often consists of younger members of the Desa Adat. A great part of the LPD managers consider the lacking quantity and quality of human resources as a major constraint for expanding and improving LPD operations.

The LPD usually operates from its own building in the Desa Adat. One quarter of the baseline survey LPD regarded the office space and facilities available to them as inadequate. Computers support operations only in a small minority of larger LPD. Software applications tailored to their needs, however, are not available. In about 10% of the cases records were not complete and easily accessible. LPD customers are served every working day with office hours ranging between four and eight hours a

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day. Half of the LPD provide door-to-door services. The lack of transport facilities is a major constraint for LPD with larger areas of operation.

LPD administration and management is usually carried out on the basis of annual plans and written guidelines. Financial reports are prepared periodically in accordance with existing regulations. Sometimes reports are seen as an obligation imposed by other parties rather than an internal instrument of control and decision-making. Decision-making processes vary considerably. Especially larger LPD enjoy high degrees of management autonomy, whereas smaller LPD experience a considerable involvement of the Desa Adat and its leaders in decisions such as staff employment, determination of product features, and loan approvals. An interesting finding of the baseline survey is that this external involvement in management does not lead to better performance.

4.3.4 Products, Outreach, Market and Image

Savings and credit products

LPD offer savings deposit, time deposit and credit services with varying terms. The majority of LPD collects compulsory savings as a percentage of the loan amount disbursed. The latter are only relevant for small institutions in areas with limited savings capacities. But, also in these cases compulsory savings seldom contribute more than 10% to total funds mobilized.

Voluntary deposit accounts are the major instruments of fund mobilization. As of March 2000, savings deposits made up 44% of the total liabilities and equity of the LPD industry. They are presently offered with annual effective interest rates (most usually 10%-12%) close to those offered by commercial banks. In determining interest rates most LPD react flexibly to local market conditions and their own need for funds. Time deposit accounts are offered by most LPD and are the major fund mobilization of large LPD. As of March 2000, time deposits financed one third of the total assets of the LPD industry. Time deposit services are offered with terms of 3 to 12 months and, depending on local market conditions, with interest rates ranging from 9% to 24%.

LPD provide mainly loans for productive purposes. Consumption loans are of some importance in larger ones in urban areas. Most loans provided are monthly installment loans that have a high variance with regard to both terms (10 to 36 months) and interest rates (2% declining to 3% flat per month). Loans with daily installments have most usually a 100-day term, with annual effective interest rates ranging from 36% to 72%. Seasonal loans for usually 6 months are provided with similar interest rates.

Outreach and market

Excluding the cooperative sector, the 912 LPD make up almost two thirds of all financial points (bank and LPD offices), and they have an outreach to two thirds of the 1,371 Desa Adat in Bali. With this geographical outreach the LPD industry has become stronger in terms of assets and funds mobilized than the 168 BPR operating in Bali. As services of commercial banks and most BPR are concentrated in urban and growth areas, the LPD industry contributes about one third to the total assets and loan portfolio of the entire financial sector in some rural areas and districts (see ProFI baseline survey report). At the village level, LPD are the major provider of microcredit.

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As of March 2000, the LPD industry served 584,634 savings deposit customers, 37,470 time deposit customers and 211,270 borrowers. Considering that one household usually holds one loan account but more than one savings account, it had an outreach to one third to half of the Balinese households. With an average number of 641 savings deposit and 41 time deposit accounts, the number of savings customers ranges from some dozens to some thousands of customers. The average amount per savings deposit account was Rp. 211 thousands and the average time deposit amount was Rp. 3.3 million as of March 2000. The average LPD had 232 borrowers with an average loan amount outstanding of Rp. 1.2 million. The number of borrowers ranges from about 10 to more than 1,000. The average loan size for all 25,222 loans disbursed by the 81 baseline survey LPD in 1999 amounted to Rp. 1.8 million, with half of the loans amounting to more than Rp. 500,000.

The ProFI baseline survey showed that the LPD market varies considerably with regard to area and number of households as well as with regard to location and competition. A direct dependence of LPD size on the number of households per Desa Adat does not exist. Large areas and low population densities do not support LPD growth. Large LPD flourish in relatively small areas with higher savings capacities and better investment opportunities. Growing and large LPD operate in areas with mainly non-agricultural sources of income, closer to urban centers, main roads and local markets. Large and well performing LPD usually have much more diversified loan portfolios than others. LPD managers regard cooperatives and BPR as their major competitors. Some LPD in urban and growth centers experience competition from commercial banks. Competition was not found to be a factor negatively affecting LPD growth and performance.

LPD image

The ProFI baseline survey included a survey on the image of 84 LPD, covering 396 savings customers and borrowers. Savings customers are attracted by door-to-door services as well as easy and fast procedures. Interest rates are an important criterion for a small minority of the customers. Borrowers are also attracted by easy and fast procedures as well as by low collateral requirements. Low interest rates play a role for one third of them. Beside its fast and easy procedures the comparative advantages of the LPD are seen in the short office distance and in the Desa Adat ownership. There is a generally high satisfaction with LPD services. The vast majority of customers regarded their deposits as safe, and loan terms and amounts as adequate.

The respondents ranked different types of financial institutions with regard to several aspects of financial services. In all aspects LPD were most frequently ranked first. The total score for LPD was more than three times as high as for BRI units and BPR, which

Table 4.4 LPD Outreach (March 2000)

Number of Desa Adat 1,371

Avg. number of households 514

Number of LPD 912

As % of Desa Adat 66.5

Avg. number of deposit accounts* 641

As % of total population 19.1

Avg. amount per account (Rp. ,000) 283

Avg. number of loan accounts 232

As % of total households 30.0

Avg. amount per account (Rp. ,000) 1,185

Source: Regional Development Bank, Denpasar. * Does not include time deposit accounts.

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were ranked second and third. LPD customers are ready to take disadvantages of LPD as long as these are able to prove their management credibility, retain close customer relationships and provide their customers with easy and fast access to financial services. While the image and competitive position of LPD is generally good, part of the industry may improve its position through better office management, higher operating efficiency in order to lower the gap between deposit and loan interest rates, and by developing credit products tailored to the needs of customers presently seeking loans from other financial institutions.

4.3.5 Current Financial Situation and Performance

Assets size and financial structure

As of March 2000, the average LPD had assets amounting to Rp. 412 million. The LPD world, however, is a highly differentiated one. The high variance in organization, management and outreach is reflected in highly varying assets sizes, ranging from some million to billions of Rupiah. 68% of the 81 LPD included in the ProFI baseline survey had assets smaller than Rp. 400 million, while in 19% of the cases assets exceeded Rp. 1 billion. The latter LPD are mainly located in southern urban and growth centers, whereas assets sizes below the overall average may already be large in some rural and more remote areas.

Table 4.5: LPD Consolidated Balance Sheet (March 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Cash 7,959 2.1 Savings deposits 165,459 44.1 Inter-bank assets 112,242 29.9 Time deposits 125,504 33.4 Loan portfolio 250,335 66.7 Inter-bank liabilities 548 0.1 (-) Loan loss provisions (4,751) (1.3) Loans received 2,276 0.6 Fixed assets and inventory 10,366 1.9 Other liabilities 5,060 1.3 (-) Depreciation allowance (3,348) Equity* 67,660 18.0 Other assets 2,470 0.7 Profits in current year 2.3

TOTAL 375,273 100.0 TOTAL 100.0 Source: Regional Development Bank, Denpasar * Includes reserves and accumulated profits not yet allocated.

The structure of assets is highly dominated by performing assets. Depending on scale of operation, higher proportions of non-performing assets can be found in newly established and small LPD. On average, the loan portfolio contributes 65% (net of loan loss provisions) and BPD placements 30% to total assets. As shown in the ProFI baseline survey, the assets structure varies significantly depending on two opposite financial situations. Large LPD with high levels of deposit mobilization are characterized by under-investment in the loan portfolio, when eligible borrowers cannot be found for their loanable funds. The placement of large proportions of assets in BPD accounts has become a source of inefficiency and affects earnings negatively. LPD with low levels of deposit mobilization or difficulties to incur additional debts at reasonable costs are often characterized by over-investments in their loan portfolios, a source of both liquidity and credit risks.

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The structure of liabilities and equity depends on deposit mobilization. As of March 2000, savings (44%) and time (33%) deposits contributed 77% to the total liabilities and equity of the LPD industry. Paid-up capital, reserves and profits accumulated prior to the current financial year made up 18% of total LPD funds. Small and newly established LPD depend on capitalized earnings to a much higher degree. LPD are generally successful in mobilizing voluntary savings. Time deposit accounts are the fund mobilization instruments enabling LPD to grow to sizes that are often not achieved by BPR. In some areas of operation and times of high inflation rates, however, many of these LPD have been experiencing difficulties in placing time deposits mobilized to eligible borrowers.

Table 4.6: LPD Consolidated Income Statement (March 2000)

Income Million Rp. % Costs Million Rp. % Bank interests 2,657 12.0 Interests to banks 38 0.3 Credit income 16,347 73.6 Interests on deposits 8,181 60.8 Other operating income 3,193 14.4 Personnel costs 3,730 27.7 Loan loss provisions 134 1.0 Other operating costs 1,369 10.2

TOTAL 22,197 100.0 TOTAL 22,197 100.0 Profits 8,746

Source: Regional Development Bank, Denpasar

The structure of income is highly dominated by credit income, contributing 74% to the total income of the LPD industry as of March 2000. Depending on assets structure, LPD with high loan portfolio investments earn close to 90% of their income from lending. The fact that BPD placements made up 30% of total assets but only 12% of the total income of the LPD industry indicates the negative effect of these placements on profitability. This situation is particularly given for LPD with high investments in BPD accounts. In these cases income from BPD placements do not seldom contribute more than 30% to total income.

LPD costs mainly consist of interest paid on deposit accounts and personnel costs. Interest paid on savings and time deposit accounts made up 61% of the total costs incurred by the LPD industry between January and March 2000. Depending on the structure of liabilities and equity, this share is even higher for LPD with high levels of time deposit mobilization. The role of personnel costs, contributing 28% to total costs as of March 2000, usually decreases with scale of operation and degree of deposit mobilization. In 1999, they contributed 45% to the total costs of small LPD but only 25% to the total costs of large LPD included in the ProFI baseline survey. Operating expenses such as for supplies, maintenance and depreciation of fixed assets, loan loss provisions and write-offs contributed 11% to the total costs of the LPD industry as of March 2000. It has, however, to be considered that many LPD do not fully account for loan loss provision costs in their income statements and tend to delay writing off loans. In accordance with the structure of funds, costs incurred from inter-bank liabilities do not play a significant role in LPD operations.

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Assets and loan portfolio quality

The LPD supervision system as applied by the BPD examines assets quality by two ratios. The first ratio divides classified assets to performing assets. Classified assets include 50% of sub-standard assets, 75% of doubtful assets, and 100% of loss. The second ratio divides loan loss provisions made by provisions required. The latter include 0.5% of standard loans, 10% of sub-standard loans, 50% of doubtful loans and 100% of loss. Note that both ratios are based on the standard loan classification system of Bank Indonesia that was developed for commercial banks and provides high tolerances. I.e., monthly installment loans in arrears for less than three months are classified as standard. These loans have to be classified as loss only after 27 months.

As of March 2000, the classified assets ratio was 4.2%, thus indicating a generally sound assets quality of the LPD industry. This ratio, however, hides much of the loan portfolio at risk. It only covers weighted assets, and performing assets include bank placements. A more appropriate measurement for loan portfolio quality is the loan portfolio at risk ratio, covering the entire out-standing balance of loans with one or more past due payments. Data necessary to calculate this ratio were not available from the BPD. Considering the part of the loan portfolio that is not classified as standard at risk, the loan portfolio at risk ratio was 8.9% as of March 2000, thus double as high as the classified assets ratio. Loans classified as doubtful and loss made up 4% of the aggregated loan portfolio of the LPD industry. The ProFI baseline survey pointed to the high variance in these ratios. The majority of LPD shows an excellent performance. There is, however, also a considerable part of the LPD industry that suffers from poor loan portfolio qualities.

The reserve ratio reveals a major management weakness of the majority of LPD. On average, loan loss provisions made covered only 56% of the provisions required. Only 35% of the LPD included in the ProFI baseline survey were found to have made full provisions. This unprudential management practice over-states the real value of the loan portfolio and, as loan loss provisions are not fully accounted for in the income statement, over-states the profitability of LPD (see below).

Profitability and financial sustainability

The LPD industry is highly profitable according to the ratios and calculation methods applied by the LPD supervision system. The ProFI baseline survey showed that average return on assets (1999) decreases from 8.6% to about 4% for the sample LPD, if full loan loss provision costs are included in adjusted income statements. Note that this does not yet consider inflation costs.

Table 4.7 LPD Assets & Loan Portfolio Quality (March 2000)

Classified to performing assets ratio (%) 4.2

Loan loss reserve ratio (%) 56.2

Loan portfolio classification

Standard (%) 91.1

Sub-standard (%) 4.9

Doubtful (%) 1.6

Loss (%) 2.4

Loan portfolio at risk (%) * 8.9

Number of loans at risk (%) * 17.8

Source: Regional Development Bank, Denpasar. * Includes loans not classified as "standard".

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Without taking into account full loan provision and inflation costs, the LPD industry had a return on assets of 2.4% (based on aggregated data) in the first quarter of 2000. To assess whether the industry generates sufficient income to cover costs table 4.6 calculates the net margin by subtracting financing costs, operating costs and full loan loss provision costs from the average yield on performing assets, the financial income divided by average performing assets. According to this calculation the LPD industry had an average yield on performing assets of 6.5%, which, after deducting financing and operating costs results in an operating margin of 2.6%. The tentative “loan loss provision gap ratio” is used to indicate the difference between provisions required and provisions that are not accounted for in the income statement. This method shows that the overall profitability of the LPD industry is not as high as may be suggested by unadjusted balance sheets. Considering the high inflation rates during the second half of the 1990s the industry has not been able to maintain the real value of its capital. Including imputed capital costs, the ProFI baseline survey showed that the average net margin of the sample LPD was negative in 1999, although they generated an average yield on performing assets of 27%. While the vast majority of the LPD were found to be profitable institutions, almost one third of them incurred net losses (note that the survey sample with an equal share of well and poorly performing institutions is not representative for the entire LPD industry).

Classification of LPD soundness

The LPD supervision system includes a CAMEL rating similar to that applied by Bank Indonesia in supervising BPR. At the end of 1999 the BPD classified 84% of the 912 LPD as sound or fairly sound. Detailed CAMEL reports for September 1999 show that assets quality is the major factor predicating less sound and unsound ratings. As measurements for assets quality are weak because of the reasons mentioned above, alternative CAMEL ratings arrive at higher percentages of LPD classified as less sound and unsound (see ProFI baseline survey report). However, it has also to be considered that the loan portfolio quality of the LPD industry has been considerably improving during the last year. Therefore, it may be assumed that the CAMEL rating presented in table 4.7, approximately describes the present state of the LPD industry.

Table 4.8 LPD Financial Sustainability (March 2000)*

Return on assets (%) 2.5

Yield on performing assets (%) 6.5

(-) Financing cost ratio (%) 2.4

(-) Operating cost ratio (%) 1.5

(=) Operating margin (%) 2.6

(-) Loan loss provision gap ratio (%) 2.4

(=) Net margin (%) 0.2

* Note that these ratios are based on averages for the first quarter of 2000 only. Ratios for an entire financial year are higher as income and costs grow faster than assets. For more detailed information see LPD Baseline Survey of ProFI.

Table 4.9 LPD CAMEL Rating (December 1999)

Classification of LPD Number % Sound 625 68.5

Fairly sound 143 15.7

Less sound 75 8.2

Unsound 69 7.6

Source : Regional Development Bank,Denpasar.

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4.3.6 Development Trends 1994 - 2000

Between December 1993 and December 1999 the total assets of the LPD industry grew by an average annual growth rate of about 50%. During the first three-years period until the end of 1996 this growth was partly due to the establishment of 206 new LPD, while during the second period the number of LPD increased by only 56 from 856 as of the end of 1996 to 912 as of the end of 1999. As of March 2000, total assets had grown by 7 times and average assets per LPD by 5 times compared to 1993.

Table 4.10: LPD Development December 1993 – March 2000 (in Rp. Million)

Dec 1993 Dec 1996Growth

12/93-12/96 Dec 1999Growth

12/96-12/99 Mar 2000ASSETS = LIABILITIES & EQUITY 53,764 132,771 147% 336,679 154% 375,273Cash & inter-bank assets 18,806 33,293 77% 117,633 253% 120,201Gross loan portfolio 39,586 95,519 141% 215,774 126% 250,335

As % of total assets 73.6 71.9 64.1 66.7Deposits 39,508 94,007 138% 256,086 172% 290,963

As % of total assets 73.5 70.8 76.1 77.5Average assets per LPD 82.7 155.1 88% 369.2 138% 411.5Loan accounts Total number 144,900 207,000 43% 204,842 (1%) 211,270 Average number per active LPD 223 244 9% 225 (8%) 232 Average amount (Rp. ,000) 273 461 69% 1,053 128% 1,185Savings & time deposit accounts Total number 324,800 417,800 29% 611,531 46% 622,104 Average number per active LPD 500 488 (2%) 671 38% 682 Average amount (Rp. ,000) 122 225 84% 419 86% 468

Source: Regional Development Bank, Denpasar

The major motor of assets growth has been deposit mobilization. Between 1997 and 1999 deposits grew above average, mainly because of a general loss of confidence in the crisis-ridden banking sector and the financial crisis, when LPD customers faced difficulties in investing their funds in profitable businesses. The same situation was responsible for the fact that liquidity and bank placements grew by 253% but the total loan portfolio of the LPD industry grew by only 126% during the same period. As LPD had difficulties to find borrowers with profitable investment opportunities, the share of the gross loan portfolio in total assets decreased from 72% to 64%, while the share of liquidity and inter-bank assets increased from 25% to 35%. With the economy recovering, this trend has been reversed since 1999. While deposits continued to grow, the growth rate of the loan portfolio (16%) was higher than that of deposits (14%) in the first quarter of 2000, and the loan to assets ratio increased again to 67%.

Loan portfolio growth was due to increasing loan sizes rather than market expansion. While the average number of loan accounts did almost not change during the last years, the average loan amount outstanding per borrower increased by 2.5 times since 1996. Operating under highly competitive conditions in Bali and with an outreach to one third to half of the households in their area of operation, well-established LPD, in terms

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of the number of borrowers served, have approached limits of expansion. Provided the LPD industry continues to improve its soundness and to sustain its image as a safe place to save, these limits may not yet be given with regard to the number of savings customers. Attractive savings products, convenient services and the fact that all family members in Bali tend to open their own savings accounts has been enabling LPD to expand their outreach to above the average number of households per Desa Adat.

Table 4.11: LPD Loan Portfolio Quality and Soundness: December 1995 – March 2000

Dec 1995 Dec 1997 Dec 1999 Mar 2000 ChangeLoan portfolio classification Standard (%) 85.5 85.7 90.2 91.1 7% Sub-standard (%) 8.8 8.0 5.3 4.9 (44.3) Doubtful (%) 2.8 2.9 1.8 1.6 (42.9) Loss (%) 2.9 3.4 2.7 2.4 (17%)Loan portfolio at risk (%) * 14.5 14.3 9.8 8.9 (39%)CAMEL classification Sound (%) 47.8 61.7 68.5 43% Fairly sound (%) 26.2 21.3 15.7 (40%) Less sound (%) 23.9 11.5 8.2 (66%) Unsound (%) 2.0 5.5 7.6 280%Source: Regional Development Bank, Denpasar. * Percentage of loan portfolio not classified as “standard”. Note than loans classified as standard include

loans in arrears (i.e., up to 3 months for monthly installment loans).

During the second half of the 1990s the number of LPD grew slowly. The Balinese government re-orientated its support from expansion to consolidation and improving the soundness of the LPD industry. By and large, this move has been successful. Between December 1995 and March 2000 the loan portfolio quality improved considerably, with the loan portfolio at risk decreasing from 14.5% to 9%. Most remarkably, this improvement was achieved during times of adverse economic conditions and despite the financial crisis. The share of LPD classified as sound increased from 48% as of December 1995 to 68.5% as of December 1999. The share of LPD classified as less sound and unsound decreased from 26% to 16%.

In spite of these positive trends, the number of unsound LPD increased from 15 to 69 during the same period. The results of the baseline survey indicated that at least part of them is financially not sustainable. This situation has been caused partly by economic and internal management factors. Many of these LPD also suffer from lacking support by their Desa Adat and from weak social control exerted by customary law, factors which have proved to be decisive predicators of LPD performance.

4.3.7 Assessment and Conclusions

Strength and Weaknesses

The LPD in Bali are probably the most successful small financial institutions in Indonesia. Contrary to BKD and most of the other LDKP, they are effective financial intermediaries placing many small savings to productive loan uses. Contrary to most

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other financial institutions, they sustained their growth and even improved their performance under adverse economic conditions in the late 1990s. The vast majority of LPD has evolved into competitive financial institutions in a province that has the highest density of financial institutions in Indonesia. A considerable part of the LPD industry has reached scales of operation comparable to or larger than those of BPR, particularly LDKP that converted to BPR.

The strength and comparative advantage of LPD is based on their character as community-owned financial institutions, in general, and their integration into the organization and value system of the Desa Adat, in particular. Owned, controlled and operated by community members the LPD is able to inspire the trust necessary for mobilizing deposits and achieving self-reliance. LPD managers are well-known community members who maintain continuous and close customer contact. Readily available information necessary for prudential credit management reduces transaction costs for the LPD. Low distances to LPD offices and door-to-door services reduce the transaction costs of LPD customers. These comparative advantages are further strengthened when social integration and control based on customary law provide the LPD with effective means of enforcement.

Part of the LPD industry has been facing low growth rates and deteriorating loan portfolio qualities despite this generally successful development and favorable environment. This has also been due to external factors such as unfavorable economic conditions and socio-cultural conditions that deviate from the comparative advantages mentioned above. The ProFI baseline survey, however, has also pointed to considerable internal weaknesses. LPD managers often lack clear rules for prudential financial management. A major weakness is insufficient loan loss provisioning and inconsequent writing off of bad loans. Loan appraisal and management capabilities are often not sufficient for larger loans and investments of borrowers in businesses exposed to higher risks. Rules for lending to related parties have not been established. LPD risk management often lacks necessary instruments such as the aging of arrears. The financial administration of weaker LPD suffers from inadequate office space and facilities. These LPD lack also transport facilities required for door-to-door services. Supervisory boards, decreed by the government in 1998, do often not yet exist or function properly.

LPD operating in large Desa Adat face difficulties in maintaining continuous and close contact to their customers. For doing so and extending their outreach to remoter areas, the LPD industry has not yet developed a network of service posts or contact persons at the Banjar (hamlet) level. This would also be appropriate because the Banjar Adat is the focal point of customary law and practice.

The LPD industry lacks a system financially intermediating between LPD. As shown earlier, the LPD industry has been experiencing opposite financial situations. Part of it lacks the loanable funds necessary to expand its business, whereas another part is highly over-liquid and places large parts of assets in bank accounts. The most logical solution to this problem would be to develop a LPD inter-lending market, through which they are able to access loans at reasonable costs and to place excess funds to uses with returns higher than earned from BPD placements.

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Potentials and constraints

The LPD industry is an indispensable sub-system of the financial system in Bali. The future potential of the industry lies in its expansion to areas not yet served, through both service posts and new establishments, and in developing LPD networks with functions such as inter-lending, deposit protection, supervision and technical support. With regard to individual LPD well performing and poorly performing LPD have to be distinguished. Part of the first group has exhausted its growth potentials in terms of area and number of customers served. Most of them will continue as is and grow in line with their customers’ businesses. Fewer LPD tend to grow beyond the boundaries of the Desa Adat and may convert to BPR. The group of poorly performing LPD consists of two sub-groups. The first one with the potential to improve management practice and grow in sustainable ways will have to undergo a phase of consolidation. This requires adequate systems of support and supervision. The second one may not have the potential to recover because of structural problems in their Desa Adat. In these cases it seems to be advisable to clean up unviable institutions and, at a later point in time, initiate new start-ups based on deliberations of each Desa Adat concerned.

There are several constraints for achieving these objectives. The first is the Desa Adat system itself. Though it is ideally a place of social integration, it has not been free of communal conflicts. Some Desa Adat lack written customary laws required for making enforcement effective. The enforcement capacity well-functioning Desa Adat is limited in cases where LPD provide financial services beyond its boundaries.

The second constraint is the structural weakness of the support system available to LPD in need of technical assistance. While the BPD cannot provide the required number of trainers and consultants, the PLPDK staff is often not capable of providing the assistance required. Training provided to LPD is seldom based on an adequate assessment of training needs and training impact. Training provided does not appear to have a significant positive impact on performance. The transformation of individual learning into institutional practice requires a comprehensive training and consultancy system that is able to respond to the specific problems and needs of individual LPD.

The third constraint lies in the present state of the supervision system. It lacks a clear distinction from technical assistance functions and involves too many parties. The system also lacks the capacity to carry out on-site supervision adequately and has not been enforcing compliance with existing regulations. The ProFI project recommended the restructuring and improvement of LPD supervision and technical assistance and presently cooperates with the Balinese government and the BPD in preparing new LPD regulations and new systems of supervision and support.

The fourth constraint has to be seen in the lack of a consistent national regulatory framework. The requirement to convert LDKP to BPR has not been reflecting the needs of institutions such as the LPD. This led Bank Indonesia to temporarily allow LPD operating as non-banks. Presently, Bank Indonesia and the ProFI project are preparing a new enabling regulatory framework for non-bank microfinance institutions. As BPR have generally not been able to achieve a broad outreach to the village level, this is especially important for the development of microfinancial institutions outside of Bali. The LPD industry provides a valuable learning case for initiatives with such an aim.

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4.4 Lumbung Pitih Nagari (LPN) in West Sumatra

4.4.1 Historical background

The Lumbung Pitih Nagari (LPN) in West Sumatra is the second type of LDKP operating at the village level. Predecessors of the LPN, the Bank Nagari, were already established in colonial times but seem not to have operated for long (see chapter 5). In 1972, the provincial government initiated the establishment of new LPN with the aim to strengthen the local economy and village development. In 1987, the number of registered LPN had grown to 580 of which, however, only 40% were reported to be operational.70 71 LPN were converted to BPR during the 1990s. As of June 2000, the Regional Development of West Sumatra reported that only 122 of the previously some 600 units had sustained their operations as LDKP.

4.4.2 Regulation, Supervision and Organization

As in the cases of other LDKP, the provincial government is responsible for regulating and supervising LPN. The first institutions were established on the basis of governmental decree No. 85 of 1972. Presently, LPN are operating on the basis of governmental regulation No. 1 of 1982. The LPN supervision system is similar to that of the LPD in Bali. The overall authority for supervision lies in the hand of the provincial government and its LPN guidance boards, while the Regional Development Bank (BPD) carries out supervision technically. The BPD carries out supervision on the basis of monthly, semi-annual and annual LPN reports.

The organizational environment of the LPN resembles that of the LPD. It is owned by the custom village, in West Sumatra known as nagari, and established by decision of the village assembly. The LPN operates in the legal form of a village-owned enterprise (Badan Usaha Milik Masyarakat Desa - BUMD). Contrary to the LPD, the LPN organization was modeled on the cooperative organization model. Community members have to register and become members of the LPN by depositing an entry fee or share as well as obligatory savings. The LPN management is recruited from members of the village community. Internal control is carried out by the LPN management board, while supervisory boards of the village seem not to be part of the LPN system.

4.4.3 Current Financial Situation and Performance

As of June 2000, the 122 LPN operated with average assets of Rp. 20.5 million only. They had 77% of total assets placed in their loan portfolios. They are self-financed institutions with equity contributing 41% and savings mobilized from members contributing 34% to their total funds. They effectively intermediate between savings customers and borrowers, but their average outreach, the lowest of all LDKP, is limited to 182 savings customers and 90 borrowers only. The low degree of savings mobilization appears to considerably restrict credit services. The average savings (Rp. 38 thousands) and loan (Rp. 176 thousands) amounts per account are the lowest found for all LDKP.

70 See Infobank No. 115/1989, p. 25.

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Table 4.12: LPN Consolidated Balance Sheet (June 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Inter-bank assets 286 11.4 Savings 839 33.5 Loan portfolio 1,929 77.1 Other liabilities 490 19.6 (-) Loan loss provisions (6) (0.3) Equity* 1,036 41.4 Other assets 294 11.8 Profits in current year 138 5.5

TOTAL 2,503 100.0 TOTAL 2,503 100.0 Source: Regional Development Bank, Padang. * Includes reserves and accumulated profits not yet allocated.

The loan portfolio quality of the LPN industry as of June 2000 was poor. 22% of its total loan portfolio, or about half its equity, was classified as loss. The loan portfolio at risk ratio was 36% and the classified to performing assets ratio 27%. Based on the loan portfolio classification available from the BPD and the calculation method described for LPD, the LPN industry would have had to provide loan loss provisions equivalent to 21% of its total funds or 27% of its total loan portfolio. With a ratio of 1.2% between loan loss provisions made and required the industry was extremely under-provisioned. Considering that loan loss provision costs are not accounted for (total costs recorded in the income statement are almost three times as low as the amount required for loan loss provisions), it is safe to argue that the industry operates at a high loss.

4.4.4 Assessment and Conclusions

The data available for this report are not sufficient to come up with a comprehensive assessment of the LPN industry. While national statistics of Bank Indonesia still report the existence of some 500 LPN, the overall outreach of the industry appears to have been by far lower already since the 1980s. The industry was further weakened in the 1990s, when almost 40% of the active and best performing LPN obtained BPR licenses. As of June 2000, the LPN industry had an outreach to not more than 2% of the households in West Sumatra.

In terms of average assets LPN are tiny institutions that resemble small savings and credit groups rather than well-functioning financial institutions at the village level. The lack of voluntary savings mobilization, its low loan portfolio quality and its low profitability caused by high loss and inflation costs have been de-capitalizing the LPN industry. Taking additionally into account that they have been operating for a long time, it seems not to be probable that the many of these institutions will be able to develop into viable institutions that provide sustainable financial services.

Table 4.13 LPN Performance Indicators (June 2000)

Number of LPN 122

Avg. number of savings accounts 182

Avg. amount (Rp. ,000) 38

Avg. number of loan accounts 90

Avg. amount (Rp. ,000) 176

Avg. assets per LPN (Rp. million) 20.5

Loan portfolio classification

Standard (%) 64.4

Sub-standard (%) 6.1

Doubtful (%) 7.3

Loss (%) 22.2

Loan portfolio at risk (%) * 35.6

Classified assets ratio (%) 26.7

Loan loss reserve ratio (%) 1.2

Source: Regional Development Bank, Padang. * Includes loans not classified as "standard".

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4.5 Badan Kredit Kecamatan (BKK) in Central Java

The Badan Kredit Kecamatan (BKK) in Central Java operate at the sub-district level and are owned by the provincial government. The first BKK were established in 1970. With considerable assistance by the government and donors the BKK system developed into a large network of 511 units and about 3,500 service posts until the mid 1990s, when the first BKK were converted to BPR. As of June 2000, there remained 160 BKK still operating as LDKP, while 351 units had acquired BPR licenses.

4.5.1 Historical Background and Development

The development of the BKD industry is relatively well documented until the mid 1990s because, supported by international technical assistance, it was regarded as one of the most successful models for microfinancial institutions.71 As Patten and Rosengard (1991) pointed out, the BKK program was borne in 1970 as part of political stabilization efforts in order to promote off-farm economic opportunities for low-income groups. Fiscal constraints led the government aiming at developing the BKK industry into a self-sustaining system.

During the first half of the 1970s BKK were established in all but 6 of the then 492 sub-districts in Central Java. The establishment of these BKK was initiated with a government loan amounting to Rp. 1 million for each of them. During the second half the 1970s the program was not expanded. Without further injection of funds two thirds of the BKK were able to prove their financial self-reliance, whereas the other third did either collapse or stagnate at very low scales of operation. Until the early 1980s the program focused on rehabilitating the poorly performing part of the industry and improving BKK supervision by the Regional Development Bank (BPD). These activities received support from the USAID-sponsored Area Development Project incepted in 1979, especially through a revolving fund established at the BPD to provide continuous access to funds for 65 BKK in the project areas.

In 1981 the provincial government transformed the BKK system from a project into a government-owned enterprise and the Ministry of Finance provided a Rp. 3 billion loan for the further rehabilitation and expansion of the BKD industry. In the following the industry experienced an outstanding growth and improvement of its performance. The total loan portfolio grew by almost five times from Rp. 2.5 billion at the end of 1980 to Rp. 11.9 billion at the end of 1985, while the number of BKK increased by only 10 units. During the same period the number of non-active or very poorly performing BKK could be reduced from 184 to 80 institutions.72

71 See, i.e., Susan Goldmark and Jay Rosengard: Credit to Indonesian Entrepreneurs. An

Assessment of the Badan Kredit Kecamatan Program, Development Alternatives, Inc., Washington 1983; Richard H. Patten and Jay K. Rosengard: Progress with Profits. The Development of Rural Banking in Indonesia, ICS Press, San Franscisco, 1991; J. Yaron: Successful Rural Finance Institutions, World Bank Discussion Papers, Washington 1992; Jeffrey M. Riedinger: Innovation in Rural Finance: Indonesia's Badan Kredit Kecamatan Program, World Development, Vol. 22, No. 3, 1994.

72 The BKK supervision system includes a classification system that uses six weighted criteria to divide the BKK industry into five performance classes (see also part on supervision). The number of BKK referred to fall into the fifth class.

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Patten and Rosengard (1991) described the second half of the 1980s as a phase of consolidation and diversification that was supported by the USAID-sponsored Financial Institutions Development Project. In order to respond to the changing demand of customers major adjustments were made with regard to the design and diversification of BKK products. In 1987, based on a permission granted by the Ministry of Finance in 1984, the provincial government started to introduce a voluntary savings scheme in well performing units. This move enabled the BKK to attract new customers and opened the opportunity to reduce dependence on government funds and to develop into financial intermediaries.

As of December 1989, 499 BKK with 3,440 village posts provided financial services to 41% of the villages in Central Java. Total assets of the industry amounted to Rp. 27.8 billion with 85% of assets placed in its aggregated loan portfolio. Retained earnings and current profits contributed 45%, government loans 24% and savings 17% to total funds mobilized. 78% of these savings, however, consisted of compulsory savings collected from borrowers. The BKK industry had 509,584 loan accounts, 439,964 compulsory savings accounts and 60,599 voluntary savings accounts.

Pointing to the substantial profits generated and the low long-term loss ratio of 2.1% (the total amount overdue compared to the total amount due), Patten and Rosengard (1991) described the BKK performance as "remarkably good". To understand the present state of the industry it is useful to paint a partly different picture. As of December 1989, 19.7% of the industry’s loan portfolio value was classified as doubtful or loss and a further 7.4% was deliquent for less than 6 months. Neither the uncollectible loans nor the entire loan portfolio at risk (27%) were reflected in financial statements. With recorded profits of Rp. 1.7 billion and a loan amount of Rp. 4.6 billion classified as doubtful or loss (more than one third of retained earnings and current profit) the industry was operating at a loss. The BKK program was successful in reducing the number of poorly performing BKK from 120 in 1985 to 47 in 1989.73 It, therefore, can be said that the BKK industry consisted of a large part of well-performing institutions and a smaller less viable part when LDKP became required to convert to BPR in 1992.

In the second half of the 1990s the provincial government actively pursued the conversion of BKK to BPR by providing the paid-up capital required for BPR licenses from the regional government budget. As of July 1996, already 202 BKK had converted to BPR. This number increased to 351 until June 2000, while 160 of the 511 BKK existing in the mid of the 1990s have been continuing as LDKP. As the 70% of the BKK converted to BPR were the best performing ones, it can be assumed that this change has considerably weakened the remaining part of the BKK industry.

73 These numbers refer to the BKK classified in the two last performance classes of the BKK

classification system. See also previous footnote.

Table 4.14 Number of BKK 1972 – 2000

December 1972 200

December 1976 486

December 1981 486

December 1985 496

December 1989 499

June 1995 510

June 2000 160

Sources: Patten and Rosengard 1991. Regional Development Bank, Semarang.

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4.5.2 Regulation, Supervision and Support System74

During the first program phase BKK were established on the basis of decrees issued by the governor of Cental Java.75 In 1981, the BKK system was transformed from a project into a government-owned enterprise by means of a provincial government regulation that was ratified by the Ministry of Home Affairs on December 17, 1981. Since then the BKK industry has become incorporated into the hierarchical government structure. The governor, assisted by the provincial guidance board, has the overall authority and responsibility for BKK policies, coordination, supervision and support. Administrative authority is delegated to the heads of district and sub-district governments. As a regional government enterprise and a source of income and costs for the regional budget the BKK has also been subject of political accountability to local parliaments, particularly in cases of mis-management and fraud.

The government-owned Regional Development Bank (BPD) plays a three-fold role in the BKK system. First, it functions as a financial intermediary by managing the liquidity of and providing loans to the BKK. Second, it provides training, technical support and is responsible for developing the products and administrative instruments of the industry. Third, it carries out supervision through its BKK supervision department that consists of three sections responsible for administration, reporting and on-site supervision.

Full-time BPD field supervisers ideally visit each BKK once a month to provide technical support and carry out on-site supervision on the basis of inspection guidelines. Off-site supervision is carried out through a monthly reporting system. To measure BKK performance the BPD has been using a classification system that groups BKK into five performance classes on the basis of benchmarks and relative weights for six factors. The absolute amount of equity is weigthed by 50% and the remaining factors (village to village posts ratio, number of new borrowers, 6-months repayment rate, savings, capital circulation) by 10% each. The classification system measures the volume and outreach rather than the soundness of BKK. The high weight of equity dominates the overall rating, while typical CAMEL measurements are not applied.

Similar to other government-owned non-bank microfinance institutions, the system lacks clear governance and functional differentiation. The owner functions as policy-maker, manager, consultant, and owns the institution that is in charge of supervision. The BPD faces a conflict of interest being responsible for both technical assistance and supervision. The latter function requires enforcement power that appears to be lacking, especially when it comes to personnel and sensitive management issues. Prudential banking practice is difficult to enforce, if compliance with benchmarks such as those of CAMEL systems are not comprehensively regulated.

74 The following description is mainly based on: Patten and Rosengard (1991) and Legislation,

Regulation and Supervision of Microfinance Institutions in Indonesia. Joint Paper by Bank Indonesia and GTZ, Project Promotion of Small Financial Institutions (ProFI), Presented at Seminar “How to regulate and supervise microfinance?”, Kampala, Uganda, 22-26 November 1999. Note that information provided mainly dates from the early 1990s. The author had no information on possible changes in the course of the restructuring of the BKK industry in the second half of the 1990s.

75 Keputusan Gubernur Propinsi Jawa Tengah, 4 September 1969, and Keputusan Gubernur Propinsi Jawa Tengah No. 323/1970/12/19/24 Tanggal 19 Nopember 1970.

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4.5.3 Ownership, Legal Form and Organization

In terms of ownership, legal form and organization the BKK differ considerably from the LPD in Bali and the LPN in West Sumatra. The BKK units are part of a single system and legal entity that is owned by the provincial government and registered as a regional government enterprise. The entire system from policy-making, regulation and supervision to management, staffing and product design are under government control, with administrative responsibilities being delegated to the district and sub-district levels. Historically, the BKK were established to strengthen government control over local development, while the LPD in Bali have been promoted to strengthen the custom villages. The autonomy of the BKK units has been much lower and their exposure to intervention from government officials much higher.

Financially, each BKK unit is a relatively independent profit and loss center, and operational decisions are usually taken by local staff. Loans are approved based on recommendations of village heads. The head of the sub-district is responsible for the performance of the BKK in his area of administration. These features of local administration have led Patten and Rosengard (1991) to argue that the BKK system is characterized by in-built local accountability and incentives on local performance. This has not necessarily been true. It has to be taken into account that local officials have considerable control on personnel and operational decisions. Both BKK staff and local officials have not always been subject to public accountability. Nowadays, as an impact of the political reform process, public accountability is exerted by local parliaments and the press. A series of newspaper articles has currently been pointing to mis-management and fraud of government officials as a major cause for BKK losses (see below).

The BKK system is organized into units operating at the sub-district level and their village posts at the village level. The village posts do not consist of permanent offices but are run by mobile staff who visits villages most usually on market days once a week. A typical BKK unit has five to ten employees who run five to seven village posts. The units usually operate from small buildings equipped with simple furniture and have motorcycles for their mobile services.

4.5.4 Products and Outreach

BKK products and services are standardized, but important adjustments made in response to the changing customer demand and banking environment have significantly changed the character of BKK as financial intermediaries. Until the late 1980s, compulsory savings as a percentage of loan amounts approved were the single savings instrument. When BKK were allowed to mobilize savings from the public and recognized both the savings capacities and need for flexible savings instruments of their customers, the government introduced a voluntary savings instrument in 1987. The Tamades product provides market interest rates, flexible access and is guaranteed by the provincial government. After a slow start the BKK developed into savings-led financial intermediaries. The share of savings in total liabilities and equity increased from 17% at the end of 1989 to 63% as of June 2000. The fact that the savings to loan ratio increased from 20% to 84% indicates that Tamades has become the major fund mobilization instrument.

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The BKK credit system was also modernized and diversified in the late 1980s. The system comprises five loan types further differentiated according loan terms. ‘Daily loans’ are provided for 22 days. ‘Weekly loan’ terms range from 12 to 52 weeks and ‘monthly loan’ terms range from 3 to 12 months. Seasonal loans are offered for 6 months and market loans with terms ranging from 60 days to 300 days. All loan types do not require collateral but borrowers are required to deposit compulsory savings of up to 20% of the loan amount approved. Compulsory savings are usually repaid and a rebate is granted after successful loan repayment. Interest rates have been varying according to loan types and market conditions, with annual effective interest rates approximately ranging between 24% for seasonal loans and 120% for daily loans. The BKK system is well known for its easy and fast loan procedures that ideally take not more than one week from application to disbursement.

As of June 2000, the 160 BKK units had an outreach to approximately 30% of the sub-districts in Central Java, while most of the other areas are now being served by BKK already converted to BPR. The average BKK had 1,123 savings and 817 loan accounts. Assuming one savings and loan account per household, it served about 5% to 10% of the households in its sub-district.

The average loan amount outstanding per borrower increased by nine times since 1989, but it remained relatively small (Rp. 239,000), i.e., compared to the LPD in Bali. From studies conducted in the 1980s it is known that BKK borrowers were mainly female petty traders with fast turnovers and need for very short-term loans. More recent studies are not available. It is, therefore, difficult to say whether the average loan amount outstanding points to a specific clientele or to a lacking capacity to meeting the demand for increasing loan amounts.

There was a high variance of individual loan amounts outstanding that may support the second argument. Average loan amounts were less than Rp. 250,000 in 29%, but they exceeded Rp. 500,000 in 35% of the BKK. In 9% of the cases average loan amounts outstanding per borrower were even larger than Rp. 1 million. Higher amounts are typically found in larger BKK with high degrees of savings mobilization. Loan amounts outstanding averaged Rp. 547,000 in BKK with savings financing more than two thirds of assets, but only Rp. 204,000 in BKK with a savings to assets ratio of less than 33%, whereas the average number of borrowers did not vary significantly between these groups. A similar variance can be found with regard to the number of savings customers and borrowers. The number of savings customers ranged from below 100 to 12,420, with 26% of the BKK serving less than 500 and 44% more than 1,000 savings customers. The number of borrowers ranged from below 100 to 2,538, with 29% of the BKK serving less than 500 and 28% more than 1,000 borrowers.

Table 4.15 BKK Outreach (June 2000)

Number of BKK 160

Coverage of sub-districts (%)* 29.0

Avg. number of deposit accounts** 1,123

As % of households/sub-district* 8.0

Number of accounts < 500 (%) 25.6

Avg. Amount per account (Rp. ,000) 239

Avg. number of loan accounts 817

As % of households/sub-district* 5.8

Number of accounts < 500 (%) 29.4

Avg. amount per account (Rp. ,000) 394

Source: Regional Development Bank, Semarang.

* Calculation based on the number of households (7.6 million) and

b di t i t (544) i C t l J

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4.5.5 Current Financial Situation and Performance

Assets size and financial structure

As of June 2000, the average BKK had assets amounting to Rp. 424 million. The high variance in outreach is reflected in varying assets sizes, ranging from only Rp. 60 million to Rp. 2.1 billion. 27% of the 160 BKK had assets smaller than Rp. 250 million, and in 24% of the cases assets exceeded Rp. 500 million. In eight cases assets and in six cases even deposits were larger than Rp. 1 billion.

Table 4.16: BKK Consolidated Balance Sheet (June 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Inter-bank assets 10,887 16.0 Savings 43,039 63.4 Loan portfolio 51,529 75.9 Other liabilities 17,548 25.8 (-) Loan loss provisions (1,250) (1.9) Equity* 4,970 7.3 Other assets 6,745 10.0 Profits in current year 990 1.5

TOTAL 67,912 100.0 TOTAL 67,912 100.0 Source: Regional Development Bank, Semarang. * Includes reserves and accumulated profits not yet allocated.

The BKD industry had 74% (net of loan loss provisions) of its assets invested in the aggregated loan portfolio, while BPD placements contributed 16% to total assets. Savings were the major source of funds and financed 84% of the total loan portfolio. Considering that compulsory savings may not make up more than 20% of loans outstanding, it can be concluded that the promotion of voluntary savings during the 1990s has transformed the BKK from an institution dependent on equity and loans to a savings-led financial intermediary.

The extent to which BKK succeed to mobilize voluntary savings appears to have been a major factor predicating their growth. This is indicated by the high variance in the structure of their sources of funds in relationship to assets size. In 23% of the BKK savings contributed less than one third and in 39% of the BKK more than two thirds to total liabilities and equity. The first group of BKK had assets amounting to Rp. 204 million, and the second group had assets amounting to Rp. 547 million, on average. The savings to assets ratio was 32% for BKK with assets smaller than Rp. 250 million, compared to 71% for BKK with assets larger than Rp. 500 million.

Assets and loan portfolio quality

The overall loan portfolio quality of the BKK industry indicates that a great part of the BKK experienced considerable loan collection problems. 12% of the aggregated loan portfolio was classified as loss, 8% as doubtful and 6% as sub-standard, thus 26% of the total loan portfolio being at risk. Based on the BPD loan classification and calculation methods described in the LPD chapter, the classified to performing assets ratio was 17%. The assets quality was also unsound with regard to loan loss provisioning. According to loan classification mentioned above only 15% of loan loss provisions required were made as of June 2000.

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BPD data made available for individual institutions show that about half of the 160 BKK are unsound. More than one quarter of their loan portfolios was at risk in 49% and classified as loss in 17% of the cases. The ratio of loan loss provisions made to provisions required was higher than 50% in only 11% of the cases. 43% of the BKK had reserves ratios lower than 10%. The BKK with extremely high loan portfolio at risk ratios (>25%) were also the ones with extremely low loan loss provisioning. While an average 44% of their loan portfolios was at risk, they had made only 8% of provisions required. According to balance sheets available, 37% of these institutions were operating with negative capital and 23% of them with negative returns. Taking further into account their extreme under-provisioning and the fact that the value of uncolletible loans exceeded by far the equity of this BKK group, it can be concluded that the financial sustainability of up to half of the 160 BKK is at risk.

Both internal mismanagement and external intervention have greatly contributed to this situation. A series of recent newspaper articles76 reported such cases from, i.e., Banyumas, Pekalongan, Solo and Cilacap districts. The BKK in the Cilacap district alone reported a total loan loss of Rp. 2.4 billion, equivalent to 27% of their loan portfolios. Half of the loan amount was found to be in the hands of government officials and former BKK staff. Half of the loans concerned consisted of fictitious loans.

4.5.6 Assessment and Conclusions

Strengths and Weaknesses

In 1996 the BKK industry was described as “a self-sustaining system of rural financial institutions”.77 Since then, 351 BKK units converted to BPR, with 160 institutions remaining as of June 2000. LDKP applying for a BPR license are required to have been operating without loss during the preceding three years. As the BKK industry lost 70% of its best performing institutions, its assessment as a self-sustaining system has to be revised.

The information available for this report indicates both strengths and weaknesses of the BKK industry. A major strength is to be seen in the fact that the remaining BKK still

76 See, i.e., Suara Pembaruan Daily, 12 June 2000; Pikiran Rakyat, 26 June, 22 August 2000;

Suara Merdeka, 21 September 2000. 77 David C. Cole and Betty F. Slade. Building a Modern Financial System. The Indonesian

Experience. Cambridge University Press, 1996, p. 128. Also other publications until the mid of the 1990s and international organizations such as the World Bank praised the BKK as profitable and sustainable institutions.

Table 4.17 BKK Assets & Loan Portfolio Quality (June 2000)

Classified to performing assets ratio (%) 17.2

Loan loss reserve ratio (%) 14.6

100% ratio (% of BKK) 2.5

< 10% ratio (% of BKK) 42.5

Loan portfolio classification

Standard (%) 74.1

Sub-standard (%) 6.2

Doubtful (%) 7.8

Loss (%) 11.9

Loan portfolio at risk (%) * 25.9

< 15% (% of BKK) 25.0

> 25% (% of BKK) 49.4

Source: Regional Development Bank, Semarang. * Includes loans not classified as "standard".

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cover of up to one third of the sub-districts in Central Java with an outreach to around 200,000 customers. With their large network of mobile posts they have an outreach to the village level usually exceeding that of BPR and BRI units operating at the sub-district level. A second strength is their ability to respond to the needs of rural households and microenterprises with easy, fast and mobile services. Contrary to the BKD, which operate in about 20% of the villages in Central Java, the BKK industry adjusted its loan products to the changing and varying needs of its clientele. In comparison to the BKD, BKK units usually have a much higher management capacity and competence in serving their customers. Savings mobilization has become a third strength of the BKK industry. With the introduction of the voluntary savings product, they were able to develop into savings-led financial intermediaries.

In terms of geographical outreach through its units and village posts the BKK industry is still strong. The current state of the industry is less inspiring with regard to customer outreach per BKK unit, with less than 10% of the households covered in its area of operation and an apparently limited capacity to meet the increasing credit demand of its clientele. The major weakness inhibiting the growth of BKK units is their bad loan portfolio quality and the resulting deterioration of their financial sustainability. Prudential banking practice suffers from intervention of local officials and weak internal control. The BKK supervision system is weak in its capacity to improving this situation. It lacks functional differentiation from the BKK owner and support system, it lacks focus on assets quality and management factors, and it lacks enforcement power.

The BKK industry is highly differentiated with regard to both strengths and weaknesses. It can be estimated that the strengths described above predominate in up to one third of the BKK units, whereas the weaknesses described above may have jeopardized the viability of up to half of the BKK units.

Constraints and potentials

An assessment of constraints and potentials has to take into account the highly varying performance of the BKK units and the conversion of BKK units to BPR. The current development of the industry may be described as the survival of the second fittest. The fittest units were converted to BPR before the high capital requirements for new BPR establishments were established by Bank Indonesia in 1999. As these requirements are too high for almost all still operating units, the fittest among them may be integrated into the BPR-BKK system, i.e., through mergers with existing BPR. The second group of less performing but still viable units may have the option to become outlets of existing BPR-BKK or, with some efforts of rehabilitation, to continue as is.

The third group of apparently unviable institutions will most probably not be able to sustain their operations. New start-ups with reliable personnel and improved governance rather than rehabilitation may be an option in these cases. Externally, these prospects depend on the policies taken by the provincial government, on the one hand, and the legal and regulatory framework available for non-bank microfinance institutions in the future, on the other hand. Another factor that has to be considered is competition. BKK as independent units may have a future place in local finance only, if BRI units, BPR networks and village-level financial institutions such as the BKD prove to be incapable of covering the financial market at the village level.

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4.6 Lembaga Perkreditan Kecamatan (LPK) in West Java

4.6.1 Historical Background and Development

The Lembaga Perkreditan Kecamatan (LPK) in West Java, along with the BKK in Central Java, belong to the oldest LDKP that were established by provincial governments at the sub-district level since the early 1970s. Before the Banking Act of 1967 closed the entry for new banks, district governments had established so-called old-style people’s credit banks (see chapter on BPR) in 13 of the districts of West Java. After Bank Indonesia had allowed provincial governments to set up non-bank financial institutions in 1970, the LPK program was developed to expand the outreach of government-owned local financial institutions to areas not yet serviced by “old-style” BPR. During the 1970s, 114 LPK were established in 18 districts. The number of LPK increased to 146 units in 1988 and to 161 units until the mid of the 1990s.

When the new banking regulations of 1992 required LDKP to convert to BPR until October 1997, the provincial government supported this move by making available the required capital through government regulation No. 5 of 1996.78 According to this regulation the provincial government had to contribute 45%, the district governments 40%, and the Regional Development Bank (BPD) 15% to the paid-up capital required. Until Bank Indonesia increased capital requirements in May 1999, 62 LPK were able to obtain BPR licenses. Since then, no other LPK was able to fulfill the licensing requirements. As of June 2000, 82 of the remaining 99 LPK were still active.

4.6.2 Regulation, Supervision, Support System and Organization

The first LPK were established by governmental decree No. 446 of 1973.79 Since then several other regulations were issued dealing with the LKP organization, supervision and support system.80 The LPK operates in the legal form of a regional government enterprise and is owned by the provincial government (55%) and the district governments (45%).

The government has established a hierarchical support system comprising so-called guidance boards at the provincial, district and sub-district levels, which are made up of government officials. Governmental LPK inspectorates were set up at the provincial and district levels to take over the day-to-day task of the guidance boards. The BPD was made responsible for providing technical assistance to the LPK. The BPD receives and examines the financial reports of the LPK, but does not appear to have supervision authorities as in the case of other LDKP systems. Supervision is carried out by local supervision boards, which are assisted and coordinated by a secretariat at the provincial level. The supervision boards are responsible for five LPK each and consist of two to four members, including the BPD. They are supposed to carry out on-site inspections at least once a year for each LPK.

78 Peraturan Daerah Propinsi Jawa Barat Nomor 5 Tahun 1996 Tanggal 13 Pebruari 1996

tentang PD. BPR LKP Jawa Barat. 79 Surat Keputusan Gubernur Propinsi Jawa Barat Nomor 446/A.III/SK/1973 Tanggal 17

Desember 1973 Tentang Pendirian LPK di Wilayah Jawa Barat. 80 See, i.e., Surat Keputusan Gubernur Propinsi Jawa Barat Nomor 46 Tahun 1990 Tanggal

30 Oktober 1990.

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As a non-bank financial institution the LPK have not been allowed to mobilize deposits from the public. In the information made available by the BPD, LPK are referred to as savings and credit institutions providing financials services to members. As the LPK are restricted in mobilizing savings, they have been using compulsory savings as a source of funds. Lapenu (1998), however, reports that part of the LPK has placed savings boxes in the houses of borrowers in order to collect installments and mobilize excess cash. LPK usually provide collateral-free loans with first loan approvals requiring recommendations of the village or sub-district head. Sanctions are inflicted on late payments.

4.6.3 Current Financial Situation and Performance

As of June 2000, the 82 LPK had average assets of Rp. 195 million of which 68% (net of loan loss provisions) were placed in their loan portfolios. Equity, reserves and retained profits were the major sources of funds and made up 40% of total liabilities and equity. Savings contributed only 31%, while other liabilities such as loans from the government and BPD contributed 30% to their total funds. The entire LPK industry was operating at a loss in the first half of 2000.

Table 4.18: LPK Consolidated Balance Sheet (June 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Inter-bank assets 818 5.1 Savings 4,926 30.9 Loan portfolio 11,167 70.0 Other liabilities 4,702 29.5 (-) Loan loss provisions (256) (1.6) Equity* 6,358 39.8 Other assets 4,230 26.5 Profits in current year (27) (0.2)

TOTAL 15,959 100.0 TOTAL 15,959 100.0 Source: Regional Development Bank, Bandung. * Includes reserves and accumulated profits not yet allocated.

With an average number of 302 savings customers and 203 borrowers the LPK had a rather low outreach for a non-bank microfinance institution operating at the sub-district level. The average loan amount outstanding per account (Rp. 671,000) was the highest of all LDKP and more than three times as high as the average amount of savings per account (Rp. 199,000). The ratio between savings and loan amounts indicates that the LPK have been mobilizing savings other than compulsory savings as a percentage of loan amounts disbursed. The absolute number of savings customers and the share of savings in total funds, however, do not indicate that the LPK has become attractive for savings customers. Contrary to other LDKP such as the BKK in Central Java and the BUKP in Yogyakarta, the LPK has used scarce funds to serve fewer borrowers with higher loan amounts.

The lacking profitability of the LPK industry has been due to high loan losses. As of June 2000, it had the worst loan portfolio quality of all LDKP with half of the aggregated loan portfolio being at risk. According to the BPD loan classification system, 12% of the loan portfolio was classified as sub-standard, 16% as doubtful and 23% as loss. The classified to performing assets ratio was 38%.

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Based on the BPD loan classification and the calculation method described for LPD, the LPK industry would have had to make loan loss provisions equivalent to 23% of its total funds or 32% of its loan portfolio, and 57% of its equity. Despite or because of this situation the LPK were extremely under-provisioned, with loan loss provisions made making up only 7% of loan loss provisions required. Considering this low ratio and the fact that total costs accounted for in the first half of 2000 were more than three times as low as the amount required for loan loss provisions, it can be assumed that the LPK industry operated at a much higher loss than indicated by the balance sheet. Taking into account these findings it can be concluded that, according to Bank Indonesia CAMEL standards and by any standards, a great part of the LPK must have been unsound.

4.6.4 Assessment and Conclusions

Lapenu (1998) stated that non-bank microfinance institutions in West Java, including the LPK, “appeared to have been by-passed by the transformation process of the rural financial system”. She concluded that a vicious circle of low salaries, lack of motivation and professionalism and the relative absence of supervision “relegated them to a very secondary role within the rural financial system.”81 While information available for this report does not allow coming up with final conclusions, the findings presented above do also not disprove Lapenu’s conclusion.

It can be assumed that the LPK industry has considerably suffered from the conversion of 62 of its best institutions to BPR. Most of the remaining LPK have not achieved a significant outreach for sub-district institutions. The extremely low loan portfolio quality and the resulting lack of profitability tend to de-capitalize the industry. According to recent newspaper reports, corruption cases involving LPK management, government officials and even officials of the governmental inspectorates have greatly contributed to this situation.82 Information made available by the BPD indicated that internal control has been functioning very poorly. As the outstanding credit collection problems, in general, and corruption cases, in particular, must have negatively affected the credibility of LPK, they have not been able and most probably will not be able to attract savings to a significant extent. Thus, it will be more than difficult to improve this situation and sustain the financial services of many, if not most, of the still operating institutions.

81 Cécile Lapenu, Indonesia's Rural Financial System: The Role of the State and Private

Institutions, Report for the World Bank Project “Sustainable Banking with the Poor”, 1998. 82 See, i.e., Pikiran Rakyat, 27 June and 17 July 2000.

Table 4.19 LPK Performance Indicators (June 2000)

Number of LPK 82

Avg. number of savings accounts 302

Avg. amount (Rp. ,000) 199

Avg. number of loan accounts 203

Avg. amount (Rp. ,000) 671

Avg. assets per LPK (Rp. million) 194.6

Loan portfolio classification

Standard (%) 49.8

Sub-standard (%) 11.5

Doubtful (%) 15.7

Loss (%) 23.0

Loan portfolio at risk (%) * 50.2

Classified assets ratio (%) 37.7

Loan loss reserve ratio (%) 7.1

Source: Regional Development Bank, Bandung. * Includes loans not classified as "standard".

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4.7 Badan Usaha Kredit Pedesaan (BUKP) in Yogyakarta

4.7.1 Historical Background

The Badan Usaha Kredit Pedesaan (BUKP), or rural credit institutions, in Yogyakarta operate at the sub-district level and are owned by the provincial, district and the village governments. The provincial government and the Regional Development Bank (BPD) initiated the BUKP program as a pilot project in 1987 in order to broaden the access to cheap, fast and collateral-free credit for economically weak groups. The provincial government regulation of 1989 formalized the program and obliged the local governments to establish a BUKP in each sub-district. The 75 BUKP, established between 1987 and 1996, were still operational as of June 2000.

4.7.2 Regulation, Supervision, Support System and Organization

The establishment, ownership, organization and operations of BUKP are regulated by the provincial government regulation No. 1 of 1989 and the governor’s decree No. 273 of 1990.83 The establishment of a BUKP requires a paid-up capital of Rp. 5 million of local government assets. The provincial and district governments are the BUKP owners in district municipalities. The first had to contribute 70% and the second 30% to paid-up capital. Village governments are an additional BUKP owner in rural areas and had to contribute 40% to paid-up capital, while the provincial government contributed 40% and the district government 10%.

The ultimate responsibility for policy-making, supervision and technical support lies in the hand of the governor of the province. The governor has also the right to liquidate unviable institutions with the consent of the provincial parliament. The head of the sub-district is given the overall responsibility for the operation and performance of the BUKP in his area of administration. The governor and district heads are assisted by provincial and district BUKP guidance boards, which are responsible for carrying out general supervision and technical support. The economic bureau of the provincial government is responsible for internal supervision, while the BPD is given the task to technically supervise and assist the BUKP.

The BUKP have a standardized organizational structure and administration that was determined by government decree. The provincial guidance board selects, while the governor has the right to appoint and dismiss BUKP staff. The head of the BUKP is given autonomy in taking credit decisions in accordance with valid stipulations.

4.7.3 Current State of Development and Performance

Outreach

As of June 2000, the 75 BUKP had an outreach to approximately 5% of the households in the province. The average BUKP had 435 deposit accounts and 362 loan accounts. This is not too impressing for an institution operating at the sub-district level. There is, however, a considerable variance in customer outreach, with the number of deposit

83 Pemerintah Daerah Tingkat I Daerah Istimewa Yogyakarta Nomor 1 Tahun 1989; Surat

Keputusan Gubernur Kepala Daerah Istimewa Yogyakarta Nomor 273/KPTS/1990 Tahun 1990.

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accounts ranging from below 100 to 1,118 and the number of loan accounts ranging from 100 to 1,382. 27% of the BUKP had less than 250, while 35% of the BUKP served more than 500 savings customers. 39% of the BUKP had less than 250, whereas 19% served more than 500 borrowers with loans outstanding. In three cases the number of savings customers and in two cases the number of borrowers exceeded 1,000.

The average amount of savings per account was Rp. 91,000 and the average amount of loans outstanding per account was Rp. 324,000. These averages may indicate that the BUKP mainly serves low-income groups, or it may point to weaknesses in savings mobilization and capacity to meet a higher credit demand. The variance in average savings and loan amounts shows that these averages do not only reflect a specific clientele but also weaknesses of the BUKP industry. Average savings amounts per BUKP ranged from Rp. 17,000 to Rp. 262,000, with 27% of the BUKP having mobilized less than Rp. 50,000 per savings customer. As these amounts are much lower than low-income customers usually deposit with small financial institutions, it can be assumed that most BUKP have not yet fully developed into savings mobilizing institutions. Average amounts of loans outstanding per BUKP ranged from Rp. 102,000 to Rp. 867,000, and were higher than Rp. 400,000 in 28% of the BUKP. Based on these findings, it may be assumed that lacking savings mobilization has considerably restricted the growth of BUKP loan portfolios.

Assets size and financial structure

As of June 2000, the BUKP had average assets of Rp. 124 million. BUKP are generally tiny institutions with assets not exceeding Rp. 250 million in 92% of the cases. 49% of the institutions had assets even smaller than Rp. 100 million. The largest BUKP had assets (Rp. 339 million) lower than the average assets size of the village-level financial institutions in Bali.

Table 4.21: BUKP Consolidated Balance Sheet (June 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Cash & Inter-bank assets 730 7.9 Savings 2,477 26.7 Loan portfolio 8,670 93.5 Other liabilities* 3,153 34.0 (-) Loan loss provisions (485) (5.2) Equity** 3,326 35.9 Other assets 353 3.8 Profits in current year 312 3.4

TOTAL 9,268 100.0 TOTAL 9,268 100.0 Source: Regional Development Bank, Yogyakarta. * 76% of other liabilities consist of loans. ** Includes reserves and accumulated profits not yet allocated.

Table 4.20 BUKP Outreach (June 2000)

Number of BUKP 75

Avg. number of deposit accounts* 435

As % of households/sub-district** 4.8

Number of accounts < 250 (%) 26.9

Avg. amount per account (Rp. ,000)* 91

Avg. number of loan accounts 362

As % of households/sub-district** 4.0

Number of accounts < 250 (%) 38.7

Avg. amount per account (Rp. ,000) 324

Source: Regional Development Bank, Yogyakarta. * Based on data available for 52 BUKP. ** Calculation based on the number of households

(0.74 million) in Yogyakarta.

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The BUKP had 88% (net of loan loss provisions) of its assets invested in the aggregated loan portfolio, while inter-bank assets contributed only 8% to total assets. Equity and retained profits, contributing 36% to total funds, were the major sources of funds of BUKP. Together with loans provided by the government or the BPD, they financed 62% of the total assets of the BUKP industry. Contributing only 27% to total BUKP funds, savings played only a secondary role as a source of funds. In two thirds of the BUKP savings financed less than 25% of their assets, while only 7% of the BUKP were able to finance more than half of their assets by savings. Also these findings may support the assumption that lack of savings mobilization has limited the growth of BUKP. Institutions with assets larger than Rp. 250 million had four times as many savings customers and savings to assets ratios double as high as tiny institutions with assets smaller than Rp. 100 million.

Assets and loan portfolio quality

With regard to assets and loan portfolio quality the BUKP showed, compared to the BKK in Central Java and LPK in West Java, a better but still unsatisfying performance as of June 2000. The ratio of classified to performing assets was 11.2% and the loan portfolio at risk ratio was 22.5%. The large difference between the two ratios reflects the lower extent to which BUKP were exposed to loan losses. 7% of the industry’s aggregated loan portfolio was classified as loss, 7% as doubtful and 9% as sub-standard. Loan loss made up less than 10% of the loan portfolio in 81% of the BUKP. However, 36% of the BUKP had more than one quarter of their loan portfolios at risk.

The profitability of part of the BUKP industry has apparently suffered from these loan collection problems. The returns of 12% of the BUKP were negative. As BUKP generally did not meet loan loss provision requirements, it can be assumed that real returns on assets were negative for still a larger part of the industry. The ratio of loan loss provisions made to provisions required was with 49% considerably higher as in the case of the BKK industry. However, 45% of the BUKP had made provisions less than 50% of provisions required, and in 16% of the cases the loan loss provision ratio was even lower than 25%. Only a fifth of the institutions had made full loan loss provisions. The loan loss provision ratio was found to be significantly higher for larger and better performing BUKP. As loan portfolio quality also tends to be poorer in tiny BUKP, it can be concluded that especially these institutions may become de-capitalized through loan losses and may have difficulties to sustain their operations.

Table 4.22 BUKP Assets & Loan Portfolio Quality (June 2000)

Classified to performing assets ratio (%) 11.2

Loan loss reserve ratio (%) 48.7

100% ratio (% of BUKP) 20.0

< 50% ratio (% of BUKP) 44.7

Loan portfolio classification

Standard (%) 77.5

Sub-standard (%) 8.9

Doubtful (%) 6.7

Loss (%) 6.8

Loan portfolio at risk (%) * 22.5

< 15% (% of BUKP) 21.3

> 25% (% of BUKP) 36.0

Source: Regional Development Bank, Yogyakarta. * Includes loans not classified as "standard".

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4.7.4 Assessment and Conclusions

The BUKP program succeeded to expand its outreach to all sub-districts of the Yogyakarta province. Its customer outreach, however, remained limited, especially because the BUKP lack attractive savings instruments and, consequently, were not able to expand their loan portfolios. The Regional Development Bank of the province identified the lack of loanable funds as the major factor currently constraining the BUKP industry. This situation is also expressed in the high loans to assets ratio (88%) of the industry. Scarce loanable funds and an increasing credit demand may have led many BUKP to over-invest in their loan portfolios and to depart from prudential banking practice. Based on the data made available, at least one third of the BUKP experienced serious credit collection problems and only a minority of the BUKP appears to be sound with regard to CAMEL ratios usually applied for small financial institutions.

The BUKP supervision and support system is similar to and shares the weaknesses of those of other LPDK programs. Established as a governmental top-down program, functions such as policy-making, regulation, supervision, enforcement, techncial assistance and operational authorities are not clearly differentiated and seem to lack effectiveness. Information made available by the Regional Development Bank points to the lack of authority and to bureaucratic obstacles faced in professionalizing the system. As other bureuacracy-led microfinance programs have shown, this lack of professionalism and effectiveness at the level of supervision and support systems often corresponds to the lack of market-orientation and entrepreneurship at the institutional level.

The Yogyakarta province has always been among the first areas selected for new microfinance programs and has experienced a considerable growth of small financial institutions during the 1990s. The BUKP were established as a governmental top-down program in times when private people’s credit banks and non-governmental microfinance initiatives such as Credit Unions and other forms of financial self-help had already achieved a considerable outreach to rural areas and low-income clients. The BUKP may have been attractive for customers in search for cheap credit, but they have not been able to meet the increasing credit demand through voluntary savings mobilization. Contrary to the BKK in Central Java the BUKP program failed to recognize the demand for attractive and flexible savings instruments also among low-income groups.

In order to improve BUKP management the BPD has recently forwarded a proposal to the governor of the province that is supposed to restructure the BUKP supervision and support system and to establish clear authorities under the coordination of the BPD. The conditions of success for such an effort have considerably changed during the 1990s. The financial system of the province has become competitive and has extended its oureach to rural areas. The BPD effort, therefore, may only succeed in part of the province where well-managed BUKP with a good reputation are able to fill market niches left by other institutions. Viable and growing BUKP may later have the opportunity to convert to BPR, while others may not be able to survive.

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4.8 Lembaga Kredit Usaha Rakyat Kecil (LKURK) in East Java

4.8.1 Historical Background

The history of the Lembaga Kredit Usaha Rakyat Kecil (LKURK) in East Java began in 1979 as part of a regional development project on the island of Madura.84 Until 1983 the project had established 362 institutions in each village of Madura. Based on a governmental decree in 1984 the program was extended to other parts of the province. Contrary to other LDKP, the KURK were established as part of the cooperative system under control of the KUD (sub-district level cooperatives, which at that time had a monopoly on village-level economic activities) in order to improve the credibility of the cooperative system. With the village as the area of operation of the KURK, its members were organized into small joint liability groups. In 1987 the status of the KURK was changed from a village-level to a sub-district level institution, and from a KUD unit to a regional government enterprise. Its name was changed into LKURK, adding „institution“ to the (literally translated) name „small people’s business credit“. A special feature of the LKURK is that they are credit-only institutions and, contrary to other LDKP, have even not been mobilizing savings in the form of compulsory savings.

Until the mid 1990s the government had established 223 of these sub-district level institutions. When the new banking regulations required LDKP to convert to BPR, the provincial government actively pursued the conversion of LKURK to BPR. After having issued a regulation on the establishment of BPR-KURK in 199485, the government succeeded to obtain BPR licenses for 67 LKURK. As of June 2000, the remaining 156 institutions were still operating as LDKP.

4.8.2 Regulation, Supervision and Ownership

The LKURK as non-bank microfinance institutions operating at the sub-district level were established on the basis of provincial government regulation No. 5 of 1987.86 By means of this regulation the LKURK were given the legal status of provincial government enterprises (BUMD). The governmental decrees No. 275 and No. 276 of 1988 determined the organizational structure and internal control system of the LKURK and assigned the tasks of technical assistance and supervision to the Regional Development Bank (BPD).87 The BPD receives and examines monthly reports of each LKURK and prepares combined monthly reports for the provincial government.

4.8.3 Current Financial Situation and Performance

As of June 2000, the 156 LKURK had average assets of Rp. 72 million only. Their aggregated loan portfolios made up 77% (net of loan loss provisions) of total assets. To finance their credit activities LKURK do not rely on savings in any form. Equity,

84 See Infobank No. 115, 1989. 85 Peraturan Pemerintah Daerah Tingkat I Propinsi Jawa Timur Nomor 16 Tahun 1994. 86 Peraturan Pemerintah Daerah Tingkat I Propinsi Jawa Timur Nomor 5 Tahun 1987 tentang

Lembaga KURK Jawa Timur. 87 Surat Keputusan Gubernur Nomor 275 Tahun 1988 tentang Susunan dan Tata Kerja

Lembaga KURK (LKURK); Surat Keputusan Gubernur Nomor 276 Tahun 1988 tentang Penunjukkan Direksi Bank Pembangunan Daerah Jawa Timur untuk melakukan Pembinaan dan Pengawasan Tehnis Operasional Kegiatan Lembaga Kredit Usaha Rakyat (LKURK).

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reserves and retained profits were the major sources of funds and made up 60% of total liabilities and equity. Other liabilities such as loans from the government and BPD contributed 30% to total funds.

Table 4.23: LKURK Consolidated Balance Sheet (June 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Inter-bank assets 510 4.5 Savings - - Loan portfolio 9,113 80.8 Other liabilities 4,433 39.3 (-) Loan loss provisions (414) (3.6) Equity* 6,744 59.8 Other assets 2,065 18.3 Profits in current year 96 0.9

TOTAL 11,274 100.0 TOTAL 9,268 100.0 Source: Regional Development Bank, Surabaya. * Includes reserves and accumulated profits not yet allocated.

With regard to loan portfolio quality the LKURK did not show a better performance than other government-owned LDKP. As of June 2000, the BPD had classified 5% of the total loan portfolio as sub-standard, 3% as doubtful, and 19% as loss. The loan portfolio at risk ratio was 27%, and the ratio of classified to performing assets was 21%. The low difference between the two ratios reflects that 71% the loan portfolio at risk were bad debts. Based on the BPD loan classification and the calculation method described for LPD, the LKURK would have had to make loan loss provisions equivalent to 22% of their total loan portfolio. With loan loss provisions made making up only 21% of loan loss provisions required and provisions required exceeding their total income during the first half of 2000 by 2.5 times, it can be assumed that the LKURK operated at a much higher loss than indicated by the balance sheet. Data provided by the BPD per district show that they had negative returns in 11 out of 31 districts.

4.8.4 Assessment and Conclusions

As in the cases of other LDKP the LKURK industry has suffered from the conversion of 62 of its best performing institutions to BPR. The geographical outreach of the 156 LKURK is still considerable. The number of customers was not made available by the BPD. Thus, it is not possible to assess the significance of this outreach. The information provided on assets quality and losses made during 2000 suggests that many institutions are financially not sustainable. Furthermore, the lack of attractive savings instruments has undermined their competitive position. In a response to this situation and because of the new BPR capital requirements, the provincial government is presently planning to merge the existing BPR-KURK into one BPR operating at the provincial level and to integrate the LKURK into this system as BPR branches and service posts.

Table 4.24 LKURK Performance Indicators (June 2000)

Number of LKURK 156

Avg. assets per LKURK (Rp. million) 72.3

Loan portfolio classification

Standard (%) 72.9

Sub-standard (%) 4.6

Doubtful (%) 3.2

Loss (%) 19.3

Loan portfolio at risk (%) * 27.1

Classified assets ratio (%) 22.7

Loan loss reserve ratio (%) 20.9

Source: Regional Development Bank, Surabaya. * Includes loans not classified as "standard".

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4.9 Badan Kredit Kecamatan (BKK) and Lembaga Pembiayaan Usaha Kecil (LPUK) in South Kalimantan

4.9.1 Historical Background and Development

There are two types of LDKP operating at the sub-district level in South Kalimantan. The Badan Kredit Kecamatan (BKK) were modeled on the BKK system in Central Java and initiated by the provincial government in 1985. The first 16 BKK were established with support of the USAID-sponsored Financial Institutions Development Project. Prior to the Banking Act of 1992 the provincial government established a further 18 units. Since 1992 LDKP were required to convert to BPR until October 1997 or to refrain from mobilizing savings from the public. In response to this situation the provincial government stopped creating BKK and, instead, established 76 Lembaga Pembiayaan Usaha Kecil (LPUK) in 1994 and 1995 in order to expand LDKP services to all sub-districts in South Kalimantan. As of June 2000, 14 BKK and the 76 LPUK were still operational as LDKP, while 20 BKK had converted to BPR.

Raviscz (1996)88 found that the BKK and LPUK only differ in that the first accepted deposits and the second did not so. After the deadline for converting BKK to BPR in 1997, however, the provincial government stopped deposit mobilization also in the remaining BKK. Data provided by the Regional Development Bank (BPD) for June 2000 show that the BKK/LPUK system has become a credit-only system. The following description, therefore, does not differentiate between the two types of institutions.

4.9.2 Ownership, Regulation, Supervision and Organization

The provincial government owns, regulates and supervises the BKK/LPUK units. The BKK were established on the basis of governmental decrees issued in 1985 and 1993.89 The provincial government has established a support system similar to that described for the BKK in Central Java. Governmental guidance boards are responsible for general supervision and guidance, while the head of sub-district is made responsible for BKK/LPUK in his area of administration.

The government delegated the tasks of techncial supervision and support to the BPD as a member of the guidance boards. Supervision is carried out by the BPD braches at the district level. BPD supervision staff is responsible for seven to eight institutions each and are supposed to visit each unit at least once a month. BKK/LPUK prepare monthly financial reports which are analyzed and aggregated by BPD supervision staff. In addition to its supervision task the BPD has been responsible for the units’ product development, financial administration system, personnel affairs and training.

BKK/LPUK managers and staff are assigned by the provincial government. A typical unit consists of a manager, accountant, cashier, loan officer and one or two field staff. The units are usually equipped with motorbikes used to provide mobile services to the villages in their area of operation.

88 R. Marisol Raviscz: Searching for Sustsainable Microfinance: A Review of Five Indonesian

Initiatives. World Bank, Rural Cluster Development Economics Research Group, 1996. 89 Surat Keputusan Gubernur Daerah Propinsi Kalimantan Selatan Nomor EKU 09/85 Tahun

1985. Surat Keputusan Gubernur Daerah Propinsi Nomor 316 Tahun 1993.

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4.9.3 Products and Outreach

The savings and credit products offered by BKK/LPUK resemble those described for the BKK in Central Java. Loan terms range from 10 weeks to 18 months, and interest rates vary based on loan size and repayment frequency. Loans over certain ceilings may require collateral and may have to be approved by the head of the sub-district. Contrary to the BKK in Central Java, BKK/LPUK have also been lending to small joint liability groups, especially in the framework of the PHBK and microcredit programs of Bank Indonesia. As they were prevented from mobilizing deposits even in the form of compulsory savings, this enabled them to get access to additional loanable funds.

Since 1995 the BKK/LPUK system has an outreach to all sub-districts in South Kalimantan. With 20 BKK having obtained a BPR license, the system currently still covers 83% of the sub-districts. According to Raviscz (1996) the units were able to reach about half of the villages in a sub-district and served customers as far as 15 to 25 kilometers away from offices. In terms of the number of outstanding loans, customer outreach was much less impressive as of June 2000. With an average number of 220 loan accounts, the BKK/LPUK had an average outreach to less than 4% of the households in their sub-district. The average amount per loan account (Rp. 188,000) was considerably lower than for the LDKP in Java. This does not only point to a different clientele or credit absorption capacity. According to Raviscz (1996) the average loan size disbursed in 1995 was already Rp. 226,000. Though loan amounts outstanding are, of course, lower than loan amounts disbursed, it can be assumed that the lack of deposits as a source of funds has considerably limited the institutions’ capacity to meet the demand for larger loans.

4.9.4 Current Financial Situation and Performance

As of June 2000, the 90 BKK/LPUK had average assets of Rp. 45 million only. Their aggregated loan portfolios made up 87% (net of loan loss provisions) of total assets. Equity, reserves and profits were the major source of funds and financed 52% of total assets. As deposits were not available as a source of funds, other liabilities such as government and bank loans contributed 48% to total liabilities and equity.

Table 4.26: BKK/LPUK Consolidated Balance Sheet (June 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Inter-bank assets 166 4.1 Savings - - Loan portfolio 3,725 91.3 Other liabilities 1,963 48.1 (-) Loan loss provisions (184) (4.5) Equity* 1,828 44.8 Other assets 375 9.1 Profits in current year 291 7.1

TOTAL 4,082 100.0 TOTAL 4,082 100.0 Source: Regional Development Bank, Banjarmasin. * Includes reserves and accumulated profits not yet allocated.

Table 4.25 BKK/LPUK Outreach (June 2000)

Number of BKK/LPUK 90

Sub-districts covered (%) 83.0

Avg. number of loan accounts 220

As % of households/sub-district* 3.4

Avg. amount per account (Rp. ,000) 188

Source: Regional Development Bank, Banjarmasin.

* Calculation based on the number of households (0 71 million) in South

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The loan portfolio quality of the BKK/ LPUK as of June 2000 was similar to that of the LKURK in East Java. 4% of the aggregated loan portfolio was classified as sub-standard, 5% as doubtful, and 18% as loss. The loan portfolio at risk ratio was 27%, and the ratio of classified to performing assets was 23%. Two thirds of the loan portfolio at risk was classified as loss. Using the BPD loan classification and the calculation method described for LPD, the BKK/LPUK would have had to make loan loss provisions equivalent to 21% of their total loan portfolio. With a loan loss provision ratio of only 21% and a total income making up only 82% of loan loss provisions required, returns of the entire industry must have been negative. Profits recorded in the balance sheet, therefore, do not reflect the high loan losses.

4.9.5 Assessment and Conclusions

Raviscz (1996) described the BKK/LPUK as a relatively successful industry with average assets of Rp. 148 million per institution and a significant outreach to the villages in their sub-districts. The fact that average assets amounted to only Rp. 45 million as of June 2000 indicates that the industry must have suffered from the conversion of 20 of its best units to BPR. The assets and loan portfolio quality of the industry is far from satisfying and its high loan losses indicate that a considerable part of the BKK/LPUK operate at a loss. Raviscz (1996) found that many institutions had not been writing off bad debts and over-stating their profitability because of political considerations.

While the geographical outreach of the BKK/LPUK system remained considerable, they served only 220 borrowers, on average, with relatively low loan amounts. Provincial governments responded in different ways to the new financial sector regulations issued during the 1990s. The government of South Kalimantan responded by converting 20 BKK to BPR and making other BKK/LPUK to credit-only institutions. Already in 1996 Raviscz found that the lack of loanable funds had been a major constraint for meeting the effective demand of the BKK/LPUK clientele. The current situation of the industry shows that the inability to mobilize savings retarded the growth of its loan portfolio and assets. The lack of savings instruments has deprived the units of an important means for assessing the creditworthiness of their borrowers, a weakness that might have contributed to their low loan portfolio qualities. Furthermore, the BKK/LPUK system has become unattractive for customers who are in need of savings instruments that allow managing their liquidity.

The example of the BKK/LPUK suggests a conclusion valid for the entire LDKP industry. Without attractive savings instruments and active mobilization of savings it is a non-growing industry. And, without creating a new regulatory framework that gives LDKP this room to move it might be a dying industry.

Table 4.27 BKK/LPUK Performance Indicators (June 2000)

Avg. assets per BKK/LPUK (Rp. million) 45.4

Loan portfolio classification

Standard (%) 72.7

Sub-standard (%) 4.2

Doubtful (%) 5.0

Loss (%) 18.1

Loan portfolio at risk (%) * 27.3

Classified assets ratio (%) 22.9

Loan loss reserve ratio (%) 23.1

Source: Regional Development Bank, Banjarmasin. * Includes loans not classified as "standard".

Lembaga Dana Kredit Pedesaan (LDKP) ProFI Microfinance Institutions Study 128

4.10 Lembaga Kredit Pedesaan (LKP) in West Nusa Tenggara

4.10.1 Background

The Lembaga Kredit Pedesaan (LKP) in West Nusa Tenggara are owned by the provincial government and were established as regional government enterprises in the late 1980s and early 1990s.90 The LKP organization and functions as well as the governmental supervision and support systems are similar to those of other government-owned LDKP. An important difference is that the LKP have not been stopped from mobilizing savings from the public. Since the conversion of the best 46 LKP to BPR, the 9 remaining institutions have not been playing a significant role. As of June 2000, only 6 LKP were still active and the provincial government regarded only one of these institutions as viable.

4.10.2 Current State of Development and Performance

As of June 2000, the six active LKP had average assets of Rp. 128 million. 68% of total assets were placed in their loan portfolios. The average LKP had 404 outstanding loans with an average loan amount of Rp. 215,000.91 Equity, reserves and retained profits contributed 32%, savings 30% and other liabilities such as government and bank loans 41% to total liabilities and equity.

Table 4.28: LKP Consolidated Balance Sheet (June 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Inter-bank assets 0 0.0 Savings 228 29.7 Loan portfolio 521 67.9 Other liabilities 317 41.4 (-) Loan loss provisions (0) (0.0) Equity* 247 32.2 Other assets 246 32.1 Profits in current year (25) (3.3)

TOTAL 767 100.0 TOTAL 767 100.0 Source: Regional Development Bank, Mataram. * Includes reserves and accumulated profits not yet allocated.

The assets and loan portfolio quality of the LKP industry was slightly better than that of other government-owned LDKP. 6% of the aggregated loan portfolio was classified as sub-standard, 4% as doubtful, and 10% as loss. The loan portfolio at risk ratio was 20%, and the ratio of classified to performing assets was 16%. Half of the loan portfolio at risk was classified as loss. All LKP did not make loan loss provisions. Full loan loss provisions would have made up 77% of their total income and 28% of their equity. The fact that the LKP had no inter-bank assets suggests that most of them must have been insolvent. The entire LKP industry was operating at a loss, although loan loss

90 The first LKP were established on the basis of a governmental decree in 1986: Surat

Keputusan Gubernur Daerah Propinsi Nusa Tenggara Barat Nomor 16 Tahun 1986 tentang Pembentukan LKP. The currently valid regulation was issued in 1994: Peraturan Pemerintah Daerah Propinsi West Nusa Tenggara Nomor 15 Tahun 1994.

91 Note that the aggregated information made available by the provicial government do not clarify whether the three LKP that had suspended their operations are still included. Averages presented here would be significantly lower, if they are calculated for 9 LKP (assets: 85.2 million, number of loan accounts: 269).

Lembaga Dana Kredit Pedesaan (LDKP) ProFI Microfinance Institutions Study 129

provisions were not made and most probably not fully accounted for in LKP income statements.

The loan portfolio classification made available may not reflect the real situation of the 9 remaining institutions. The author visited one of these LKP during an appraisal mission92. It operates with 5 employees but assets amounted to only Rp. 51 million, of which 90% were placed in the loan portfolio. The LKP served 421 borrowers with an average loan amount outstanding of Rp. 116,000. Most of the borrowers live in the surroundings of the office that is poorly equipped. Though salaries are low, 71% of the institution’s expenses were personnel costs. The LKP experienced two breakdowns between 1996 and 1999. Two managers who had misappropriated LKP funds were replaced. A new start was made in August 1999 with a remaining capital of Rp. 10 million only and a local government grant of Rp. 5 million. As of June 2000, 53% of the loans and 30% of the loan amount outstanding was categorized as loss. The loan portfolio at risk ratio was 46%. Loans provided under the new management performed relatively well, but the LKP faced considerable difficulties in regaining the trust of its customers. The LKP staff looked into an uncertain future as they felt that the local government had withdrawn its active support.

4.10.3 Assessment and Conclusions

The provincial government obtained BPR licenses for 84% of the LKP, leaving only the worst performing institutions behind. Representatives of the economic bureau of the provincial government and the BPD appeared to have lost interest in further promoting the LKP model and recovering the remaining LKP, of which only one was regarded as viable. Respondents at the district and sub-district levels, however, pointed to the need for establishing new LKP in sub-districts without BPR-LKP.

The LKP in West Nusa Tenggara appear to be a phase-out model. However, the BPR-LKP system has also been too weak in achieving a significant outreach to rural areas and the village level. It is, therefore, necessary to further examine the feasibility of developing viable non-bank microfinance institutions at the village and sub-district level. The appraisal carried out by ProFI presented various options. The option to continue with the existing LKP system is not realistic. New approaches require market-orientation, credibility, accountability and enforcement of prudential banking. These features have not been the strengths of the government-led and –staffed LKP system as well as of other LDKP systems.

92 Detlev Holloh: Appraisal of the Proposal “Development and Upgrading of Microfinance

Institutions in Indonesia”, Sub-Report 2: West Nusa Tenggara, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

Table 4.29 LKP Performance Indicators (June 2000)

Avg. assets per LPK (Rp. million) 127.9

Loan portfolio classification

Standard (%) 79.7

Sub-standard (%) 5.7

Doubtful (%) 4.4

Loss (%) 10.2

Loan portfolio at risk (%) * 20.3

Classified assets ratio (%) 16.3

Loan loss reserve ratio (%) 0.0

Source: Regional Development Bank, Mataram. * Includes loans not classified as "standard".

Lembaga Dana Kredit Pedesaan (LDKP) ProFI Microfinance Institutions Study 130

4.11 Other Lembaga Dana Kredit Pedesaan (LDKP) in Indonesia

Other LDKP than described above were established in the Aceh, Riau and Bengkulu provinces. Bank Indonesia’s monthly financial statistics still report the existence of 7 Lembaga Kredit Kecamatan (LKK) in Aceh, 5 Badan Kredit Kecamatan (BKK) in Riau, and 16 Badan Kredit Kecamatan (BKK) in Bengkulu.

Inquiries of the Bank Indonesia branch offices in these provinces were not able to confirm that these LDKP are still operating. The BPD in Aceh had no data available on LKK. The BPD in Riau did not refer to BKK in its response.

ProFI Microfinance Institutions Study

Chapter 5:

The Badan Kredit Desa (BKD) in Java

and the UED-SP Village Credit Institutions

Badan Kredit Desa (BKD) and UED-SP ProFI Microfinance Institutions Study 132

5. The Badan Kredit Desa (BKD) in Java and the UED-SP Village Credit Institutions

This chapter comprises village-level financial institutions other than those covered by the chapters on LDKP and cooperatives. The chapter focuses on the Badan Kredit Desa (BKD) in Java. BKD are tiny organizations with a long history and were often described as profitable and sustainable financial institutions providing demand-oriented financial services with a significant outreach to low-income groups. It is also suggested that BKD are BPR (see chapter 3), which have sustained their operations since colonial times and have been operating as licensed and regulated banks since the 1992 Banking Act. The following description and analysis challenges some of these views.

Unit Ekonomi Desa – Simpan Pinjam (UED-SP) or, literally translated, Village Economic Unit – Savings and Credit are even smaller organizations, which have been promoted by the Ministry of Home Affairs since 1995. They are only partly comparable with the BKD but were included in this chapter because of three considerations, namely a) the UED-SP organization was modeled on the BKD model; b) the UED-SP model is the only national approach to expand village-level financial institutions such as the BKD to areas outside of Java; c) despite the existence of BKD, and for reasons that are difficult to understand, the UED-SP have also been promoted in Java.

5.1 The Badan Kredit Desa (BKD) in Java

5.1.1 History and the Political Economy of BKD Development

The Dutch colonial administration distinguished the commercial banking system owned and managed by foreigners, on the one hand, from the “Volkskredietwezen” (popular credit system) that was promoted for the indigenous population in the framework of the colonial welfare policy, on the other hand.93 The popular credit system was made up of “Afdeelingsbanken” (district banks) and “Dorpscredietnstelling” (village credit institutions). The latter term was later translated into Badan Kredit Desa (BKD).

In the 1930s, the Dutch administrator Fruin referred to BKD as credit institutions of village councils. The term covers two sorts of institutions. Lumbung Desa (paddy banks) existed already before the Dutch administration started to promote them for coping with periods of food shortages. The first Bank Desa (village banks) were established in the first decade of the 20th century, when the village economy started to monetarize and district banks started to establish village banks. The first district bank, Bank Priyayi in Poerwokerto, was founded in 1895. This bank is now often referred to as the first Bank Perkreditan Rakyat (BPR) or People’s Credit Bank in Indonesia.

The major issue of developing the popular credit system since these times has been whether it should be organized through cooperatives or banks, whether it should operate along commercial lines or follow welfare objectives. Both the district banks and BKD rejected the intention of the colonial government to transform BKD into

93 The historical description is mainly based on: Pandu Suharto, 100 Tahun BPR Di Indonesia,

1895-1995, Penerbit InfoBank, Jakarta 1996. Klaas Kuiper (ed.), Provisional Manual for the Credit Business of the General Popular Credit Bank by Th. A. Fruin, with A History of the “Volkscredietwezen” (Popular Credit System) in Indonesia (1895-1935), The Hague 1994.

Badan Kredit Desa (BKD) and UED-SP ProFI Microfinance Institutions Study 133

cooperatives and to make district banks responsible for their development. This controversy continued until Fruin succeeded to establish the “Algemeene Volkscrediet Bank” (AVB) and to bring the BKD system under its control.

The colonial administration pushed the development of Lumbung Desa especially between 1905 and 1915 by making local government officials responsible. The fast growth under the pressure of the local bureaucracy proved not to be sustainable. The number of Lumbung Desa declined from 12,542 in 1910 to 5,761 in 1930. During the same period, the number of Bank Desa increased from 585 to 5,986.

With the monetarization of the village economy Lumbung Desa commended to lend money and increasingly converted to Bank Desa. In 1930, almost the entire Lumbung Desa capital was made up of money. Bank Desa had evolved into fund mobilizing and profitable institutions. This situation motivated popular credit banks to seek cooperation with Bank Desa, to transform Lumbung Desa into Bank Desa, and to initiate the establishment of Bank Desa as a source of funds and as their arm at the village level.

During the 1920s, village credit institutions reached more than 2 million clients from a total of 8 million households. As they placed their liquidity and reserves in district banks, the flow of money between them was rapidly growing. In 1933, they had deposited 20.3 million guilders and the village councils a further 16.8 million guilders in district banks, making up almost 80% of the latter’s resources.

These resources and the independet commercial relationship between village and district banks, and the objection of both institutions to follow the cooperative path, provided the background for the colonial government’s long-lasting efforts of breaking up the relationship between village and district level financial institutions, and to bring the village and district bank system under central control.

Attempts such as declaring the district banks as philanthropic or benevolent organizations, transforming village credit institutions into cooperatives, or providing a decentralized status to village credit institutions failed. A change in strategy, mainly advocated by the colonial administrator Fruin, departed from the cooperative idea and led to the establishment of the AVB Bank in 1934. Pointing to the fragmentation of resources and the finding that credit requirements of small businesses were insufficiently met by the district banks, Fruin argued that the “time was ripe for the merger of the local popular credit banks to form a general bank.” (Kuiper 1994:10) The village credit institutions and districts banks were joined into one popular credit system owned by the government and controlled by the AVB Bank. The village credit institutions were required to deposit their reserves in the AVB Bank and became subject to the management and supervision of the AVB Bank.

Table 5.1 Number of BKD 1905 - 1987

Year Lumbung Desa Bank Desa

1905/1907 5301 328

1910 12542 585

1920 9500 1987

1930 5761 5986

1940 5451 7443

1953 1711 2230

1958 3602 4587

1967 2854 3917

1975 2211 3556

1987 2063 3325

Source: Pandu Suharto, 1996

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Pointing to the large resources of village credit institutions as a “firm foundation for the whole system”, Fruin argued that the AVB system “could be expressed more purposefully, by linking them more closely in a financially stronger single organisation”, in which the AVB branches provide larger loans and channel government credit, while the village units provide micro loans. In 1934, he thus formulated the program for the successor of the AVB, Bank Rakyat Indonesia (BRI) and its development into a broad network of local units developed during the 1980s (see chapter on BRI).

The development of village credit institutions came to a standstill during the independence war. The number of Lumbung Desa had dropped to 5,451 units in 1940 to 1,711 units in 1953. The number of Bank Desa had decreased from 7,443 to 2,230. In the 1950s the Indonesian government put much effort in reviving the BKD system. As it applied the same unsustainable top-down approach as the colonial administration, however, the number of village credit institutions decreased continually since the 1960s. In 1987, 2,063 Lumbung Desa and 3,325 Bank Desa were still existent, though it is not clear how many of them were operational. Total assets of the BKD industry amounted to Rp. 51.2 million. Mainly compulsory savings collected as a percentage (10%) of loan amounts disbursed contributed only about 10% to total assets.

Village Credit Institutions Outside of Java

The colonial administration was less successful in promoting village credit institutions in the less

densely populated areas outside of Java. 127 Lumbung Desa operated in West Sumatra in 1916, but

since 1918 the existence of these institutions were not anymore reported for provinces outside of Java.

Bank Desa were mainly established in Sumatra, Bali and Lombok. Bank Nagari in West Sumatra, the

historical predecessor of Lumbung Pitih Nagari (LPN, see chapter on LDKP) numbered 293 in 1912

and 364 in 1937. Similar institutions operated in Bengkulu (Bank Marga, 20 in 1937), Riau (80 in

1937), Bali and Lombok (55 in 1937). The total number of Bank Desa outside of Java during the 1930s

ranged from 450 to 518 institutions.

There is scattered evidence that Lumbung Desa have been operating outside of Java also in modern

times. It is known that the government of the East Nusa Tenggara province promoted these institutions

in the 1970s and 1980s in order to increase food security of vulnerable groups during the annual

famine season and natural disasters. For West Nusa Tenggara, the regional village development office

of the Ministry of Home Affairs reports the existence of nine Lumbung Desa with 2,048 members as of

September 1999. Their scale of operation was small, and they were mainly engaged in lending money.

Six of these institutions had loans outstanding averaging to Rp. 34 million. Four institutions had stored

2,400 kg and six institutions had outstanding 3,000 kg of unhulled paddy.

The policy to promote a standardized cooperative system for rural areas as well as the evolution of the

regulatory framework closed the market for formal and autonomous village credit institutions. In the

1990s the government embarked on two ambitious programs to fill the gap of financial services at the

village level. Both programs were designed on the basis of the BKD model. The Ministry of

Cooperatives has been promoting so-called Tempat Pelayanan Simpan Pinjam (TPSP) or savings and

credit service points under the umbrella of the KUD system (see chapter on cooperatives). The

Ministry of Home Affairs has been promoting the establishment of so-called Unit Ekonomi Desa – Simpan Pinjam (UED-SP) or Village Economic Unit – Savings and Credit in each of the almost 70,000

Indonesian villages (see below).

Badan Kredit Desa (BKD) and UED-SP ProFI Microfinance Institutions Study 135

Pandu Suharto (1996) argued that after having implemented the crash program the government lost its interest in the BKD system, and that village credit institutions became increasingly exposed to competition from other financial institutions. To put it more clearly, the lacking interest in the BKD system was caused by the fact that the New Order government finally realized the plan of the colonial administration to establish a single general bank (BRI) with a broad network of local units responsible for channeling government programs, and to transform village-level finance into a standardized and instrumental cooperative system (KUD, see chapter 6). In the 1970s, attempts of the government to convert village credit institutions into cooperatives failed as they did during colonial times. The BKD system remained loosely linked to BRI (as its supervisor and reserve manager), while the network of local BRI units was developed independently from the BKD system.

In the early 1990s, BRI tried to revive part of the sleeping village credit institutions by providing basic capital, improving the administrative system, and introducing new savings instruments. The Banking Act of 1992, however, closed the opportunity to expand the BKD system particularly outside of Java.

5.1.2 Evolution of the Regulatory and Supervisory Frameworks

Regulation

Until 1992, BKD derived their legal status from an ordinance issued by the colonial government in 1929.94 This village credit institution act made provisions about BKD organization, administration, capital and supervision. It prohibited villages from carrying out credit activities without supervision of a central agency to be determined by the government. Supervision costs had to be borne by the BKD themselves. The BKD capital had to be separated from other village assets, and administration had to be carried out by a secretary paid by the BKD. Excess funds had to be deposited with a bank.

The Banking Act No. 14 of 1967 allowed Lumbung Desa, Bank Desa and popular credit banks to continue operating as part of the banking system. Their status was to be regulated by a separate law.95 As this law was not issued until 1992, the Ministry of Finance started in 1970 to license popular credit banks (mainly market banks) that had been established before August 1970 and were regarded as viable.96 Additionally, the Ministry of Finance issued decrees providing business licenses to a list of village credit institutions by district.

The banking reform in 1988 permitted the establishment of new secondary banks with a paid up capital of Rp. 50 million. The low entry barriers together with the provision to establish head offices at the sub-district level (operation through branch offices and mobile cash units was allowed within one district) aimed at strengthening the rural financial system through a new bank type, subsequently referred to as Bank Perkreditan Rakyat (BPR) or People’s Credit Bank. “Old-style” BPR (mainly the market

94 Staatsblad No. 357 about Provisions for Village Credit Institutions in Jawa and Madura, 14

September 1929. 95 Article 41, Undang-undang Nomor 14 Tahun 1967 tentang Pokok Perbankan. 96 Surat Menteri Keuangan kepada Direksi Bank Indonesia Nomor B 331/MK/IV/8/1970.

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banks licensed during the 1970s) were given two years to adjust to the new regulation. Further reforms in 1989 removed this time limit indefinitely. These reform measures did not deal directly with BKD.

The Banking Act No. 7 of 199297 recognizes two bank types: commercial banks or primary banks permitted to offer the full range of banking services, and BPR or secondary with their services limited to the provision of credit, and savings and time deposit products. New BPR located outside of cities were allowed to open branches in capital cities. Article 58 of the act states that Bank Desa, Lumbung Desa, old-style BPR, and village-level and sub-district-level financial institutions (without a bank license) will be given the BPR status with fulfilling the requirements and procedures to be stipulated in a government regulation. The act declared the colonial village credit institution act (Staatsblad No. 357/1929) invalid, while the government is expected to further regulate licensing and operational requirements (explanation of article 58).

Government regulation No. 71 of 199298 determined that a BPR may operate only with a license of the Ministry of Finance as a local government enterprise, limited liability company or cooperative. Village credit institutions already in possession of a business license were declared to be BPR. Other institutions were required to seek a license until October 1997. BPR managers (including those of Bank Desa and Lumbung Desa) were required to fulfill certain criteria to be stipulated by the Ministry of Finance. Decree No. 221 of 199399 required licensed institutions to be named “BPR” or otherwise to refrain from mobilizing deposits from the public. While the Banking Act made the BPR status dependent on requirements still to be stipulated, the following regulations simply declared BKD licensed in the 1970s to be banks though none of them has been able to fulfill any requirement stipulated for BPR.

The new Banking Act No. 10 of 1998100 defined BPR as banks permitted “only to accept deposits in the form of time deposits, savings, and/or equivalent forms” and prohibited to “provide any services in payment transactions” (article 1). Any party mobilizing deposits from the public was required to obtain a business license from Bank Indonesia (article 16). Article 21 determined that BPR may operate only as a legal entity (local government enterprise, cooperative, limited liability company, or another form determined by government regulation). Its explanation states that the latter provision accommodates Bank Desa, Lumbung Desa and other institutions mentioned in article 58. Institutions with a business license were declared to have obtained a license based on the new Banking Act (article 55). Article 58 remained unchanged, thus Bank Desa, Lumbung Desa and other institutions still having to fulfill requirements to be stipulated by government regulation in order to gain the BPR status. Also the explanation of article 58 mentioned that requirements and procedures for converting to the BPR status have still to be stipulated by government regulation.

97 Undang-undang Nomor 7 Tahun 1992 tentang Perbankan, 25 March 1992. 98 Peraturan Pemerintah Republik Indonesia Nomor 71 Tahun 1992 tentang Bank Perkreditan

Rakyat, 30 Oktober 1992. 99 Keputusan Menteri Keuangan No. 221/KMK.017/1993 tentang BPR, 26 Februari 1993. 100 Undang-Undang Republik Indonesia Nomor 7 Tahun 1992 tentang Perbankan Sebagai-

mana Telah Diubah dengan Undang-Undang Nomor 10 Tahun 1998.

Badan Kredit Desa (BKD) and UED-SP ProFI Microfinance Institutions Study 137

Government regulation No. 30 of 1999101 declared regulation No. 71 of 1992 invalid but also qualified that its provisions remain valid, if they do not conflict with the Banking Act No. 10 of 1998. The regulation was to become valid with a new BPR regulation that was issued by Bank Indonesia on 15 May 1999.102 This regulation substantially changed framework conditions for BPR and non-bank microfinance institutions. It allows BPR to operate in urban areas and to open branches throughout one province. The minimum paid up capital, however, was increased to Rp. 2 billion for the greater Jakarta region, to Rp. 1 billion for provincial capitals, and to Rp. 500 million for other areas (article 4). Existing BPR were required to hire two managers with at least a diploma 3 level and two years banking experience.

Article 2 and 3 of the decree allowed a BPR to operate with a Bank Indonesia license as a limited liability company, cooperative or local government enterprise (“other forms” as mentioned by the Banking Act was omitted). The decree did not make any reference to BKD. As it excluded institutions operating with other legal forms than determined, it is not applicable to the organization and operation of BKD. Other Bank Indonesia decrees such as decree No. 32/54 (14 May 1999) regulating de-licensing of BPR even exclude BKD explicitly from provisions made.

Supervision

Until 1934 BKD operated as decentralized institutions often in close business relationships with popular credit banks at the district level. In 1934, BKD came under the supervision of the “Algemeene Volkscrediet Bank” (AVB). Bank Rakyat Indonesia (BRI) as the AVB successor has been supervising BKD in modern times. Although supervision responsibility shifted to the central bank in 1992 (BKD were declared banks), BRI continued to supervise BKD on behalf of Bank Indonesia and is reimbursed for this service.

The responsibility for BKD supervision lies in the hand of BRI branch managers who are assisted by supervision staff. The BKD Mantri (junior supervisors) supervises 18 to 24 BKD and carries out on-site supervision based on an inspection manual at least once a month. On-site inspection and completion of a 5-page standard inspection form is usually carried out within one day. BRI aims at visiting BKD opening twice a week two times a month, BKD opening once a week one time a month, and BKD opening once in a Javanese month (36 days) one time every three months. BKD Mantri are also responsible to arrange excess funds to be deposited with BRI, to organize BRI loans to BKD, and to facilitate inter-lending between BKD.

Off-site supervision is carried out through a standardized reporting system. BKD accountants (Juru Tata Usaha – JTU) prepare monthly reports for 5 to 10 BKD. The reports consist of financial statements, details of certain accounts, and a loan portfolio classification. The BRI branches compile monthly reports and forward them to their 101 Peraturan Pemerintah Republik Indonesia Nomor 30 Tahun 1999 tentang Pencabutan

Peraturan Pemerintah Nomor 70 Tahun 1992 tentang Bank Umum (…), Nomor 73 Tahun 1998, Peraturan Pemerintah Nomor 71 Tahun 1992 tentang Bank Perkreditan Rakyat, dan Peraturan Pemerintah Nomor 72 Tahun 1992 tentang Bank Berdasarkan Prinsip Bagi Hasil, 7 Mei 1999

102 Bank Indonesia, Surat Keputusan No. 32/35/KEP/DIR tentang Bank Perkreditan Rakyat, 12 Mei 1999.

Badan Kredit Desa (BKD) and UED-SP ProFI Microfinance Institutions Study 138

regional head office on the10th of each month. The latter aggregates monthly reports and forwards them to the BRI head office on the 20th of each month. BRI does not apply sanctions for late reporting.

On-site and off-site supervision does not include a rating system for measuring BKD soundness. To measure credit performance loan arrears are classified into two groups. “Black” arrears are arrears of a loan that has not yet fallen due. “Red” arrears are arrears of a loan of which the entire loan principal has fallen due. The classification system applied in monthly reports provides better information on loan portfolio quality. Loans without late payments of installments, interests and compulsory savings are classified as standard. Loans with late payments within the loan period are classified as sub-standard. Loans with late payments that have entirely fallen due for up to 6 months are classified as doubtful. Loans with late payments that have entirely fallen due for longer than 6 months are classified as loss.

The supervisory regime of BRI lacks enforcement power. BRI reports point to lacking authority in imposing sanctions on BKD staff and responsible village heads found to deviate from prudential banking and being involved in the misappropriation of funds.

5.1.3 Ownership, Legal Form and Organization

BKD are usually described as village-owned financial institutions. It is useful to distinguish village-level institutions that are owned and controlled by the village community and those owned and controlled by the village government. The first model, i.e., applies to the village credit institution (LPD) in Bali, for which the assembly of village members is the highest organizational authority (see chapter on LDKP). The BKD, being managed and controlled by the village bureaucracy, seems to belong to the second model.

Village ownership of the BKD is not legally determined. The village credit institution act of 1929 defining BKD as a financial unit of the village administration was declared invalid in 1992, while it was not replaced with a new act specifying BKD ownership and legal form. BKD licensed by the Ministry of Finance were declared to be BPR without having to fulfill normal licensing requirements, although the Banking Act and following regulations do not provide for banks operating without a clearly defined legal form.

The BKD organization has not much changed compared to colonial times. The BKD’s place of operation is often not more than a table in the village government office. Most BKD operate only once or twice a week. A so-called commission, consisting of the village head as its chairperson and usually two other village officials as its members, manages and controls the BKD. The village head has to approve all loans and installs the other commission members who are responsible for loan disbursement and collection. Commission members receive a percentage compensation of the loan principle collected. The percentage applied seems to differ between regions. In East Java it is set at 4% for weekly loans and 5% for other loans.

BKD administrators or accountants (Juru Tata Usaha – JTU) are appointed by the district head based on recommendations of the BRI branch manager: They carry out the administrative work for 5 to 10 BKD and are paid from BKD fees through BRI branch accounts.

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BKD do not have supervisory boards or boards of commissioners as it is required for and known from licensed BPR and regionally regulated LDKP. It is not clear in how far democratically legitimized village institutions can exert any control over BKD operations.

5.1.4 Savings and Credit Products

The majority of BKD does not provide deposit services or is not significantly engaged in savings mobilization, although their bank status would allow doing so. As of June 2000, total savings made up only about 10% of total assets, and 87% of these savings consisted of compulsory savings collected as a percentage (10%) of the loan amount disbursed. Compulsory savings do not earn interest. BKD accept voluntary savings deposits since 1992. These deposits are mobilized through a savings product (Tabungan BKD) that is similar to and bears a similar interest rate as BRI savings products. As of June 2000, 82% of the active BKD mobilized voluntary savings. These savings, however, contributed only 2% to total assets.

Loan products are standardized and similar to those already described by Fruin in 1934. Four loan products are distinguished:

a) Loans with weekly installments provided for 12 weeks, in which the interest is paid in the first week, compulsory savings are paid in the second week, and 10 equal installments of the loan principal are made during the following 10 months;

b) Loans with weekly installments provided for 24 weeks, in which interests and compulsory savings are paid during the first 4 weeks, and 20 equal installments are made during the remaining 20 months;

c) Loans with monthly (or each 35 days according to the Javanese calendar) installments that are provided for 6 to 10 months (or 210 to 350 days according to the Javanese calendar). Interest and compulsory savings are also collected before installments of the loan principal are made;

d) Seasonal loans with a term of 5 to 6 months and repayment one months after the harvest.

As of June 2000, the first loan product covered 63% of all loans and 46% of the total loan amount outstanding. The second important loan product were loans with monthly installment covering 26% of all loans and 32% of the total loan amount outstanding. With a share of less than 1% in both respect the second loan product did not play a significant role.

Maximum loan ceilings are set between Rp. 1 million and Rp. 1.5 million, though the overall average loan size disbursed is much lower (Rp. 329,000 in June 2000). Larger loans are usually required by farmers for seasonal loans, while petty trader with a fast turnover borrow smaller amounts with usually weekly installments. Loan procedures usually take one week from loan application to disbursement. Currently, the most usual interest rate applied is 3% flat per month.

Note: The description above mainly applies to Bank Desa. It is not clear how many of the active Lumbung Desa apply the same credit terms and procedures. When Lumbung Desa provide paddy loans, they are usually disbursed at times of scarcity about three months before the next harvest and repaid at the time of the next harvest.

Badan Kredit Desa (BKD) and UED-SP ProFI Microfinance Institutions Study 140

5.1.5 Number and Outreach

According to BRI statistics, there were 5,373 BKD in Java of which 4,566 were operational as of June 2000. More than half of the active BKD are located in East Java and provide financial services in 28% of the villages in this province. A lower but still considerable coverage of villages is reached in the provinces of Yogyakarta (26%) and Central Java (20%). BKD services play a considerably lower importance in West Java, where 9% of all BKD reach about 6% of the villages in this province.

Table 5.2: BKD Outreach by Province (June 2000)

WestJava

Central Java

Yogya-karta

EastJava Total

No. of villages 7,197 8,531 438 8,419 24,585No. of households (million) 10.0 7.6 0.7 9.0 27.3No. of population (million) 42.3 31.0 3.1 35.2 111.6Established BKD 655 1,967 189 2,562 5,373Active BKD 414 1,709 114 2,329 4,566 % of villages covered 5.8 20.0 26.0 27.7 18.6Loan accounts Number 90,951 240,277 12,647 381,972 725,847 % of total households 0.9 3.2 1.8 4.2 2.7 Average number per active BKD 220 141 111 164 159 % of households per village 15.8 15.8 6.9 15.3 14.3 Average amount per account (Rp. ,000) 105 146 141 265 203Average loan size (Rp. ,000, in June 2000) 211 219 294 423 329Savings accounts Number 57,320 310,646 24,283 207,483 599,732 Average number / active BKD 138 182 213 89 131 Average amount / account (Rp. ,000) 21 30 21 62 40Sources: Bank Rakyat Indonesia, Ministry of Home Affairs (number of villages 1999), BKKBN, Family Welfare Data (number of households, January 2000), Central Bureau of Statistics (population 1999)

As of June 2000 the entire BKD industry had almost 726 thousand loans outstanding. Assuming that one household had not more than one loan outstanding at the same time, the BKD industry reached less than 3% of the total number of households in Java. The average active BKD had 159 loans outstanding and reached an average 14% of the households in villages with an own BKD. BKD in Yogyakarta, providing loans to less than 2% of all households and to about 7% of the households in villages with an own BKD, have the lowest outreach in this respect. The overall outreach of the BKD industry in West Java is not significant, but the active BKD reach a similar proportion of households in villages with an own BKD as in Central and East Java (between 15% and 16%). The average number of loans outstanding per active BKD ranged from 111 in Yogyakarta to 220 in West Java.

While other small financial institutions usually have more savings customers than borrowers, the BKD industry has not achieved a significant outreach to voluntary savings customers. As of June 2000, the average BKD had only 131 savings accounts and two thirds of these accounts were made up of compulsory savings only. In

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Yogyakarta and Central Java the number of savings accounts exceeded the number of loan accounts, but the relevance of voluntary savings accounts and amounts in these provinces was as low as in the other provinces.

In terms of outreach scope the average BKD is a tiny lending institution with a lower level of savings mobilization than found in many savings and credit associations, and a much lower credit outreach than found for comparable small financial institutions. The village credit institutions in Bali (LPD, see chapter 4), for instance, cover about two thirds of the Balinese Desa Adat (custom village) and reach about one third of the Balinese households with their services. As of March 2000, the 912 LPD had more savings accounts (584,634 savings deposit and 37,470 time deposit accounts) than the 4,566 active BKD in Java. The average LPD had 232 loan accounts, covering almost half of the average number of households (481) per custom village.

Average loan size or the average loan amount outstanding is often used as indicators of outreach depth. This may not be appropriate in the BKD case. The average loan size was Rp. 329,000 in June 2000, ranging from Rp. 211,000 in West Java to Rp. 423,000 in East Java. The average loan amount outstanding was Rp. 302,000 as per June 2000 and ranged from Rp. 105,000 in West Java to Rp. 265,000 in East Java. These amounts are generally lower than those of other small financial institutions and also of some poverty-oriented micro-finance programs. They may point to low levels of capitalization and savings mobilization that restrict the ability of BKD to meet their customers’ credit demand rather than to their outreach to a particular clientele. With the extremely high inflation especially in 1997/98, the average loan size did not increase in real terms since 1996 (Rp. 173,776). Recent assessments of credit demand indicate that loan amounts below Rp. 500,000 seldom

Note: Data Availability and Lacking Differentiation between Bank Desa and Lumbung Desa

The BKD statistics available from BRI do not differentiate between Bank Desa and Lumbung Desa. Bank Desa is the BKD type developed to meet the increasing demand for money credit. In the course of the BKD history Lumbung Desa were converted into or were increasingly operated as Bank Desa. In many cases only the name remains making a difference between both types of organizations. It is not known, however, for how many cases this is true. According to information of the BRI branch in Surabaya, BKD statistics in East Java include only active Bank Desa. The BRI head office could not confirm this information. Also a closer examination of BKD statistics at the district level in East Java did not reveal that they do not cover Lumbung Desa. This analysis uses the number of active BKD reported in order to calculate averages per BKD. Note that these averages would considerably understate BKD performance, if Lumbung Desa are not included in aggregated BRI statistics. It can be estimated that up to one third of the active BKD are Lumbung Desa.* For instance, average assets per BKD would increase from Rp. 56 million to Rp. 85 million, and the average number of loans outstanding would increase from 159 to 241 in this case.

* BRI prepared a BKD inventory as per June 2000, but could not make available differentiated data of active Bank Desa and Lumbung Desa. Data available from different sources before this inventory was made provide a clue but are not consistent.

Badan Kredit Desa (BKD) and UED-SP ProFI Microfinance Institutions Study 142

are adequate amounts for also poorer microenterpreneurs.103

5.1.6 Current Financial Situation and Performance

Assets size and balance sheet structure

As of June 2000, the average active BKD had assets amounting to Rp. 56 million. The average size of assets ranged from Rp. 22 million in Yogyakarta to Rp. 74 million in East Java. These amounts are similar to assets of informal savings and credit associations and much lower than average assets of other village financial institutions such as the LPD in Bali (Rp. 412 million). BKD assets were even smaller in real terms, when their inadequate loan loss provisioning (see below) is taken into account. Based on the adjusted balance sheet, net assets average to Rp. 50 million only.

Table 5.3: BKD Consolidated Balance Sheet (June 2000, in Million Rupiah)

WestJava

Central Java

Yogya-karta

EastJava Total

Cash 88 256 35 398 777Inter-bank assets 3,096 31,054 746 61,458 96,354Loan portfolio 9,507 35,102 1,783 101,256 147,648(-) Loan loss provision (123) (824) (55) (2,522) (3,525)Fixed assets and inventory 827 3,710 30 9,372 13,939(-) Depreciation allowance (213) (568) 0 (43) (824)Other assets 614 599 1 1,329 2,543TOTAL ASSETS = LIABILITIES & EQUITY 13,796 69,330 2,539 171,247 256,912Savings 1,186 9,416 521 12,880 24,003Inter-bank liabilities 1,953 3,194 68 1,939 7,154Loans received 17 379 21 833 1,250Other liabilities 50 375 3 828 1,255Equity 9,925 53,839 1,859 147,562 213,185Profits in current year 666 2,127 68 7,205 10,066

Source: Bank Rakyat Indonesia

Regarding the structure of assets it is most striking that the BKD industry placed only 56 % (net) of its assets in the loan portfolio, while 38.5% were invested in inter-bank assets, mainly BRI savings accounts. In Central Java the ratio between loan portfolio and inter-bank investments was close to one to one, whereas the BKD in West Java and Yogyakarta placed about 70% of assets in their loan portfolios. Net investments in fixed assets and inventory per BKD amounted to only Rp. 3 million or 5% of its assets.

The liability side of the balance sheet is characterized by the high dominance of equity as a source of funds. Excluding current profits, 83% of total assets were funded by equity. This share ranged from 72% in West Java to 86% in East Java. Savings contributed only 9% to the funds of all BKD. The importance of savings was most pronounced in Yogyakarta (20.5%), whereas savings did not play an important role in

103 See part on microfinance/poverty alleviation programs, and the recent ProFi appraisal on

the “Development and Upgrading of Microfinance Institutions in Indonesia”, Denpasar 2000.

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West Java (9%) and East Java (7.5%). Except for the BKD in West Java, BRI loans and loans from other BKD were not an important source of funds. Inter-bank liabilities funded less than 3% of the total assets of the BKD industry, but contributed 14% to total assets of the BKD in West Java.

Structure of income and costs

Almost the entire income of the BKD industry is derived from credit income. As of June 2000, 86% of its total income was made up of credit income. This share ranged from 80% in Central Java to 93% in West Java. Interest income earned from inter-bank assets contributed only 12% to total income, although 38.5% of BKD funds were placed in mainly BRI accounts. As these placements were not financed through voluntary savings, they did not negatively affect the profitability of BKD. The high spread between credit interest rates and interest rates on BRI savings accounts, however, points to considerable opportunity costs incurred by these placements. Non-operational income does not play a significant role in BKD operations.

Table 5.4: BKD Consolidated Income Statement (June 2000, in Million Rupiah)

WestJava

Central Java

Yogya-karta

EastJava Total

INCOME Interests on savings 94 1,097 25 1,790 3,005Credit income 1,465 5,319 200 15,196 22,180Other operational income 3 133 5 236 378Non-operational income 0 82 0 14 96

TOTAL INCOME 1,563 6,631 229 17,236 25,659COSTS Interests on savings 9 64 3 32 109Interests on loans 3 33 0 43 79Personnel costs 623 3,100 127 6,999 10,848Loan loss provision 113 491 18 1,244 1,865Other operational costs 149 779 14 1,708 2,650Non-operational costs 0 36 0 6 42

TOTAL COSTS 896 4,503 161 10,032 15,593Profits in current year 666 2,127 68 7,205 10,066

Source: Bank Rakyat Indonesia

The structure of costs incurred by BKD is highly dominated by personnel costs that made up 70% of total costs as of June 2000. As savings were mainly mobilized in form of compulsory savings on which no interest is paid, interest paid on savings was not an important cost item. In both respects there is no significant variance between the provinces. Another important cost item were loan loss provision costs. Its share (12%) in total costs, however, does not reflect real costs for loan risk and loss that are not fully accounted for in the income statement.

Based on the unadjusted financial statements, profits made during the first half of 2000 were equivalent to 39% of total income and almost 4% of average assets during this period. These figures, however, over-state the profitability of the BKD industry because

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of lacking loan write-offs and the lack of provisions made for potential loan losses. In the following the profitability and financial sustainability of the BKD industry will be examined by taking into account its loan portfolio quality and full loan loss provisions required based on a loan portfolio classification system.

Loan portfolio and assets quality

The BKD supervision system does not include a CAMEL rating as usually applied by Bank Indonesia in supervising the soundness of bank operations. BRI measures loan portfolio quality by a classification system that is stricter than that applied in the Bank Indonesia supervision system. Loans without late payments of installments, interests and compulsory savings are classified as “standard”. Loans with late payments within the loan period are classified as “sub-standard”. Loans with late payments that have entirely fallen due for up to 6 months are classified as “doubtful”. Loans with late payments that have entirely fallen due for longer than 6 months are classified as “loss”. This loan classification, however, is not used as a basis for measuring the risk exposure of assets and the adequateness of loan loss provisioning. This is highly problematic because BKD tend to refrain from writing off loans and do not fully account for loan loss provision costs in their income statements.

Table 5.5: BKD Loan Portfolio and Assets Quality (June 2000, in Million Rupiah)

WestJava

Central Java

Yogya-karta

EastJava Total

Total loan portfolio 9,508 35,102 1,782 101,255 147,647 Standard 2,555 16,552 878 66,638 86,623 Sub-standard 2,536 7,410 362 13,885 24,193 Doubtful 1,020 1,958 240 3,883 7,101 Loss 3,397 9,182 302 16,849 29,730Loan portfolio at risk* Number (%) 85.8 70.0 46.3 50.2 61.2 Amount (%) 73.1 52.8 50.7 34.2 41.3Loan loss Number (%) 58.7 42.4 17.4 28.3 36.6 Amount (%) 35.7 26.2 16.9 16.6 20.1Classified to performing assets ratio 43.1 21.7 26.2 16.4 19.3Loan loss reserve ratio 3.3 8.2 15.8 13.5 7.7Source: Bank Rakyat Indonesia * Loans not classified as “standard”

Table 3.4 reveals the poor loan portfolio quality of the BKD industry as of June 2000. Only 39% of all loans outstanding and 59% of total value of the loan portfolio was classified as standard. 37% of all loans and 20% of the loan portfolio was classified as loss. The BKD in East Java showed a considerably better performance than those in the other provinces, but their loan portfolio quality has still to be regarded as poor, with 50% of all loans and 34% of the portfolio value being at risk (non-standard). The BKD in West Java performed worst. Only 14% of their loans outstanding and 27% of their loan portfolio value was classified as standard. Almost half (47%) of their aggregated

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loan portfolios was classified as either doubtful or loss. Their loan losses were equivalent to one quarter of their total assets.

The classified to performing assets ratio, as applied in the Bank Indonesia supervision system for People’s Credit Banks, is a risk-based ratio that divides classified assets (here: loan portfolio) weighted according to collectibilty by performing assets (here: inter-bank assets and loan portfolio). Classified assets include 50% of sub-standard assets, 75% of doubtful assets and 100% of loss. With a ratio of more than 19%, on average, the BKD industry would be rated unsound according to the Bank Indonesia rating system. The lowest but still unsound ratio (16%) existed for the BKD in East Java, while the assets quality of BKD in West Java, with a classified to performing assets ratio of 43%, was extremely poor.

The loan loss reserve ratio is the second ratio used by Bank Indonesia to measure the quality of assets. The ratio divides loan loss provisions made by provisions required. The latter include 0.5% of standard loans, 10% of sub-standard loans, 50% of doubtful loans and 100% of loan loss. A ratio of less than 51% would be rated unsound. The comparison of loan loss provisions made and required shows that BKD neglect the necessity to provide for reserves. With an overall ratio of only 8% and the highest ratio of 16% found for the BKD in Yogyakarta, the BKD industry reveals unprudential banking practice in this respect.

Note that these CAMEL ratios and ratings are most useful to measure the soundness of individual institutions. The available data do unfortunately not allow classifying the 4,566 BKD into sound, fairly sound, less sound and unsound institutions. This is a major weakness of the BKD supervision system that is founded in the lacking regulation of requirements BKD would have to comply with. Although it is not possible to analyze the individual soundness of BKD, the high average ratios indicate that a considerable part of the BKD industry does not only experience a poor assets quality but also a severe threat to its financial sustainability.

Profitability and financial sustainability

According to balance sheets aggregated by BRI the BKD industry has been highly profitable with returns on assets of about 10% during the last years. With about 4% in the first half of 2000 return on assets was lower but still considerably high. This has led many observers to speak of BKD as financially sustainable institutions. The contrary can be demonstrated when financial sustainability is examined on the basis of adjusted balance sheets and loan loss provision costs not accounted for in BKD income statements are included. Table 3.5 shows that the financial sustainability of the BKD industry is at stake because of its low loan portfolio quality. The seriousness of this situation is underlined by the fact that high inflation costs were even not included in the calculation. To assess the financial sustainability of the BKD industry, the net margin is calculated by subtracting financing costs, operating costs and full loan loss provision costs from the average yield on performing assets, the financial income divided by average performing assets during the first half of 2000.

BKD incur negligible debts in the form of voluntary savings and inter-bank liabilities. This is expressed by an average financing cost ratio, the proportion of financing costs

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in average performing assets, of 0.1% only. The average operating cost ratio, the percentage average performing assets must yield to cover operating costs, was 6.3%. With these costs yields on performing assets averaging to 10.6% the BKD industry achieved an average operating margin of 4.2% before its inadequate loan loss provisioning is taken into account. The “loan loss provision gap ratio” used here is a tentative approach to account for the difference between provisions required and made. The ratio divides this difference by average performing assets. The average “loan loss provision gap ratio” of 12.7% results in negative net margins, ranging from 6% in East Java to 22% in West Java and averaging to 8.5% for the entire BKD industry.

These figures are sufficient to point to the serious threat that the BKD industry is exposed to because of its low loan portfolio quality. Additionally, its financial sustainability is at stake because of high inflation rates in the second half of the 1990s. The BKD industry has not been generating sufficient income to cover its costs and to maintain the real value of its capital.

Table 5.6: BKD Financial Sustainability (June 2000, in Million Rupiah)

WestJava

Central Java

Yogya-karta

EastJava Total

ROA (half year) 4.7 3.1 2.7 4.3 3.9Yield on performing assets (half year) 12.0 10.1 9.2 10.7 10.6Financing cost ratio 0.1 0.1 0.1 0.0 0.1Operating cost ratio 6.8 6.6 6.4 6.2 6.3Operating margin 5.1 3.3 2.7 4.5 4.2Loan loss provision gap ratio 27.5 14.5 13.2 10.8 12.7Net margin -22.4 -11.2 -10.5 -6.3 -8.5

5.1.7 Development Trends 1997 - 2000

Between December 1996 and June 2000 BKD assets grew with an average annual growth rate of 12%. This growth slowed down to 8% during the period from December 1998 to June 2000. The higher growth rate of average assets per BKD during this period can be explained by the inventory of active BKD carried out by BRI in the first half of 2000. It can be assumed that most of the 240 additional BKD found to be inactive were also not operational prior to the new inventory.

Inter-bank assets grew above average when the financial crisis in 1997/1998 put a break on profitable loan uses, whereas the loan portfolio grew three times as fast as inter-bank assets during 1999 until June 2000. The relative share of inter-bank assets and the loan portfolio did almost not change between December 1996 and June 2000. The lack of structural change in assets points to the fact that the BKD industry has not been able to expand its borrowing clientele. The number of loans outstanding decreased by 7% between December 1996 and June 2000. Loan portfolio growth was based on increasing loan sizes. The increase of the average loan amount outstanding from Rp. 134 thousands to Rp. 203 thousands during this period, however, has not been able to cope with the demand for higher loan amounts that evolved even among

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poorer microentrepreneurs because of the drastically declining purchasing power of the Rupiah since 1997/1998.

While the structure of assets did not show a significant change, the structural change was considerable with regard to sources of funds. The share of equity (excluding accumulated profits during current year) increased from 72% as of December 1996 to 83% as of June 2000. The share of deposits declined from 12% to 9% during the same period. The growth of deposits between December 1996 and 1998 corresponded to the overall growth in assets and reflected the lack of profitable credit investment opportunities during the financial crisis. The decline of deposits by 13.5% in the following period does not only point to changing economic conditions. It also points to the inability of the BKD industry to support the local economy by expanding its loan portfolio. Considering that most deposits consist of compulsory savings linked to credit access, it can be assumed that BKD customers had to withdraw deposits because their increasing demand for liquidity and credit was not matched with repeated and sufficient access to credit. The decline in the number of loan accounts, therefore, corresponds to the drastic decline (14%) of deposit accounts in 1999/2000, while the average amount of deposit accounts did not grow during this period.

Table 5.7: BKD Development December 1996 – June 2000 (in Rp. Million)

Dec 1996 Dec 1998Growth (%)12/96-12/98 Jun 2000

Growth (%)12/98-6/00

ASSETS = LIABILITIES & EQUITY 185,680 229,488 23.6 256,912 12.0Inter-bank assets 66,878 90,674 35.6 96,354 6.3

As % of total assets 36.0 39.5 37.5Loan portfolio 104,363 124,975 19.8 147,648 18.1

As % of total assets 56.2 54.5 57.5Deposits 22,827 27,740 21.5 24,003 -13.5

As % of total assets 12.3 12.1 9.3Equity 134,499 171,339 27.4 213,185 24.4

as % of total assets 72.4 74.4 83.0Average assets per active BKD 38.6 47.8 23.8 56.3 17.8

Loan accounts Total number 779,599 758,953 -3.8 725,847 -5.7 Average number per active BKD 162 158 -2.5 159 0.6 Average amount (Rp. ,000) 134 165 23.1 203 23.0Loan portfolio at risk*

% of total accounts 28.9 60.6 109.7 61.2 1.0% of total amount 29.5 37.9 28.5 41.3 9.0

Savings accounts Total number 727,667 700,332 -2.6 599,732 -14.4 Average number per active BKD 151 146 -3.3 131 -10.3 Average amount (Rp. ,000) 31 40 29.0 40 0.0Source: Bank Rakyat Indonesia * Loans not classified as “standard”

The quality of loan portfolios decreased drastically in 1997. The number of loans at risk as a percentage of the total number of loans outstanding increased from 29% as of

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December 1996 to 56% as of December 1997, and the loan portfolio value at risk increased from 30% to 37%. As of June 2000 the number of loan accounts at risk had further increased to 61% of all loan accounts and the loan portfolio at risk had increased to 41%. As the financial crisis reached its heights only in 1998, it is not adequate to explain the drastic decline in loan portfolio quality by economic factors alone, though they have been an ongoing constraint for solving the problems incurred also before the financial crisis unfolded. Internal monthly reports prepared by BRI indicate that inadequate management structures, unprudential banking practice and the misuse of BKD funds have greatly contributed to deteriorated loan portfolio qualities. A major predicating factor that has to be mentioned in this context is the lacking modernization of BKD management and operations in the context of rapidly changing economic conditions and demand for financial services also in more remote areas and among the poorer sections of the population.

In general, it may be argued that the BKD industry lacks dynamism. Efforts of BRI in the early 1990s to instill a new dynamism by introducing voluntary savings schemes failed. BKD limit their operations to extending credit to a small number of regular customers and have not succeeded or actively pursued to expand their customer base. The number of loans outstanding decreased continually and the number of savings customers dropped sharply. The loan portfolio has been growing only because of modestly increasing loan sizes. Already before 1998 the BKD industry had been slowly de-capitalized. The high inflation during the monetary crisis (88% in 1997/1998) eroded the real value of its capital to a great extent. The inflation of 12% from January 1999 to June 2000 was as high as the overall growth of assets. With management structures and practice almost not having changed over decades of dynamic economic development, the BKD industry tends to loose its role in the local economy.

5.1.8 Assessment and Conclusions

Strengths and weaknesses

It is difficult to identify strength and weaknesses of BKD institutions on the basis of aggregated data. The BKD industry, in general, has comparative advantages. It operates within a limited and familiar environment that allows keeping up close contact with its clientele and easily acquiring information about this clientele. Being operated on a part-time basis from existing village facilities, BKD incur low fixed and overhead costs. The large number of existing BKD provides a good basis for developing a strong network organization of village-level financial institutions. Scattered evidence from individual institutions as well as the analysis of aggregated data does not show that many BKD have made use of such comparative advantages. Why not?

The BKD industry lacks dynamism. Its organization, operations and products have hardly changed since decades of changing demand for financial services. Access to BKD services usually remained limited to one day per week. BKD have not become effective financial intermediaries. Efforts of BRI in the early 1990s to encourage BKD to expand their customer base and to attract new customers through a voluntary savings product failed. Neither did BKD actively promote savings mobilization nor did they succeed in gaining the trust of the village population. Credit services appear to remain

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limited to a small number of regular borrowers. Lending decisions often seem to be based on personal relationships and the borrowers’ standing in their villages rather than on credit worthiness. Unprudential lending practice has contributed to the deterioration of loan portfolio quality. Without savings mobilization and with a low loan to assets ratio the BKD industry has not been able to grow and, finally in times of high inflation rates, de-capitalized to a great extent. Why?

The situation described above does not have a simple explanation and requires further studies, particularly on the institutional development of individual BKD. Both internal and external factors may have contributed to this situation.

Externally, BKD have been tolerated as a historical legacy, while significant efforts of transforming them into independent and viable financial institutions have not been made. Until recently the government discouraged the growth and expansion of the BKD industry in order to strengthen an uniform cooperative system and protect this system from competition. As a historical legacy BKD were acknowledged as BPR in word. However, adequate support systems for transforming them into functioning banking institutions, and stengthening their management capacities and human resources were not developed. BKD remained unregulated institutions with an unclear legal status, for which compliance with BPR regulations cannot be supervised and enforced. BKD supervision by BRI is not carried out according to currently valid standards for people’s credit banks and lacks enforcement power. While the development of viable village-level financial institutions has not been a priority objective, poverty alleviation and social safety net programs have been distributing huge amounts of easy and cheap money, thus taking much of the potential market for village-level financial institutions. This constraint is also mentioned in BRI’s monthly BKD report of June 2000.

Internally, BKD lack market-oriented management and the human resources required for small banks. They are usually managed by persons who lack entrepreneurship, motivation, and independence from the village bureaucracy. As ownership and legal form are vague, and management and control functions are not clearly separated, they lack effective internal control and supervision by owners. Their financial administration depends on external accountants who are responsible for several institutions. This does not support developing effective self-reliance and self-responsibility. These factors have apparently also contributed to the lacking sense of ownership and trust among the village population. The analysis of aggregated financial data cannot contribute to improving the knowledge about such internal factors. For this purpose it is necessary to come up with more thorough studies on the institutional development of individual BKD and their local development conditions.

Potentials and constraints

The analysis of the BKD industry on the basis of aggregated data provides some insight into general factors constraining its present and future development. It does, however, not allow assessing the soundness and development potential of individual institutions of which many might perform well and play a significant role in the village economy. A short examination of the BKD industry at the BRI branch office level in East Java showed a high variance in growth and performance. The more thorough analysis of other small financial institutions carried out by the ProFI baseline surveys

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shows that, generally speaking, these institutions show either a very excellent or poor performance.

When framework conditions and management factors are right, village-level financial institutions are able to develop into successful institutions that play an important role in the local economy. The vision of transforming BKD into well-managed and sustainable financial intermediaries at the village-level is presently missing. The BKD system seems also to suffer from poverty alleviation and microcredit programs (see chapter 1), which target the same clientele and usually channel credit at lower interest rates..

BKD operate within an ambiguous legal and regulatory framework. They are acknowledged as people’ credit banks but they are neither regulated nor supervised as banks. Regarding their functions and operations, it is rather ridiculous to speak of them as banks and there is also no real foundation for developing BKD into people’s credit banks. Nonetheless, BKD may provide a starting point for developing viable non-bank microfinance institutions at the village-level. The realization of this objective would require getting framework conditions right, getting adequate training and support systems in place, reforming the BKD organization and management system, and developing innovative and adequate services in accordance with the real demand of the potential BKD clientele.

The evolution of BKD regulation has resulted in a strange and contradictory situation of the BKD industry. BKD are licensed but unregulated banks. Improving this situation first of all requires to abandon the generic “BPR” term under which BKD are usually classified and to distinguish people’s credit banks (BPR) as licensed and regulated (micro) banks from BKD as non-bank microfinance institutions. Furthermore, it requires recognizing non-bank microfinance institutions as a third category of financial institutions beside commercial banks and people’s credit banks through enabling legal and regulatory frameworks that contribute to deepening the outreach of the financial system. Finally, it requires a comprehensive supervisory framework that allows enforcing prudential banking practice also of non-bank microfinance institutions.

Need for further studies

The perspective of transforming BKD into viable and growing non-bank microfinance institutions is only one option available for developing a rural financial system with a significant outreach to the village level. Whether this option is applicable is a question that cannot be answered for the entire BKD industry and that goes beyond the BKD industry in Java. Its answer requires decentralized and more intensive research on individual institutions and their varying local development conditions. Presently, there are approaches such as the UED-SP (see below) and the TPSP (see chapter 6) that try to build on the BKD model. Which kind of institution is appropriate to close the gap of sustainable financial services left by the banking sector is a question especially important for less densely populated and economically favorable areas outside of Java. The ongoing government and donor initiatives show that the establishment of village-level financial institutions may become the next wave of microfinance in Indonesia. It is, therefore, advisable to come up with a thorough study on the institutional development

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of BKD and similar institutional approaches in the context of varying local development conditions and potentials.

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5.2 Unit Ekonomi Desa – Simpam Pinjam (UED-SP)

5.2.1 UED-SP Promotion by the Ministry of Home Affairs

The Direktorat Jenderal Pemberdayaan Masyarakat Desa (PMD)104 or Directorate General for the Empowerment of Village Communities of the Ministry of Home Affairs is currently responsible for the UED-SP program. It has a new sub-directorate called Usaha Ekonomi Masyarakat or directorate for people’s economy, which implements the program in cooperation with the provincial and district offices of the directorate. The recent and current reorganizations of the ministry and directorate reflect the new decentralization efforts giving more power and financial authority to the district and village levels.

The Ministry of Home Affairs has been involved in financial sector development since the 1970s, when provincial governments started to establish various LDKP (see chapter 4) that, as non-bank financial institutions, required some sort of legalization other than the banking act. With the higher emphasis on village development and ‘empowerment’ since the 1990s, the ministry made the establishment of village-level financial institutions its own task. The UED-SP program started by means of the Presidential Instruction on Village Development Assistance (Inpres Bantuan Pembangunan Desa) in the financial year 1995/96. The annual financial budget allocated Rp. 1.5 million to each village for on-lending to microentrepreneurs. The budgets of the following two financial years included further subsidies, which were increased to Rp. 2.5 million per village, to be managed and channeled by newly established UED-SP. The ministry claims to have established 40,622 UED-SP in two thirds of the Indonesian villages during these first three financial years (see following footnote).

In 1998, the Ministry of Home Affairs issued national guidelines for the establishment and strengthening of UED-SP.105 Together with these guidelines the ministry informed all provincial governors and district heads that village development subsidies are further available for continuing the UED-SP program and asked to support the program with funds from the provincial and district budgets. Since the financial year 1999/2000 village development subsidies have to be used for strengthening village infrastructure and institutions, thus limiting its use for UED-SP development to training and technical assistance. In 1999, the ministry issued guidelines for classifying the performance and soundness of UED-SP. 106

104 The directorate’s former name was Pembangunan Masyarakat Desa or Village Community

Development. Its offices at the provincial and district level often still use the old name. 105 Departemen Dalam Negeri Republik Indonesia, Surat Menteri Dalam Negeri Nomor

412/2440/SJ tentang Pedoman Pembentukan dan Pemantapan Pengelolaan Usaha Ekonomi Desa Simpan Pinjam (UED-SP), Ditjen Pembangunan Masyarakat Desa Departemen Dalam Negeri, 1998.

106 Departemen Dalam Negeri Republik Indonesia, Pengklasifikasian Kinerja Usaha Ekonomi Desa Simpan Pinjam, Kerjasama Direktorat Jenderal Pembangunan Masyarakat dengan Lembaga Pengabdian Masyarakat Institut Ilmu Pemerintah (IIP), Jakarta 1999.

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5.2.2 Guidelines and Regulations

Objectives. According to the national guidelines for the establishment and strengthening of UED-SP, the UED-SP program aims at providing easy and cheap credit to low-income groups in need of small business capital as well as at increasing the role of village communities in absorbing and managing financial assistance from the government and other sources of funds.

Ownership and establishment. The UED-SP is described as an organization owned by the village community and, at the same time, as an organization consisting of members who pay a membership fee (simpanan pokok) at the time they are registered as members. The decision of establishing an UED-SP is taken by the village head by means of a village decree and based on deliberations of the LKMD (body of village officials and representatives assisting the village head) meeting. Further approval is required from the next higher administrative levels. The meeting is also responsible to prepare UED-SP statutes based on a centrally designed standard format, select the UED-SP management and identify member candidates. UED-SP statutes and managers require approval of the village head.

Note: contrary to the description of UED-SP as a member organization owned by the village community, the UED-SP is better understood as an organization, established, owned, managed and controlled by the village government and bureaucracy. On the one hand, village and member ownership cannot be integration in one and the same organization. On the other hand, neither the village community nor the ‘members’ have a say in the establishment and control of the institution. Clients targeted by the village bureaucracy are called members because each targeted client participates in the organization with an initial fee handled as equity capital, and financial institutions other than member-based ones are legally prohibited from mobilizing savings.

Organization and management. The UED-SP staff consists of a chairperson, cashier, and an accountant, who are selected from the village population and appointed by the village head. The chairman is responsible for approving loans on the basis of recommendations of the village head or LKMD. All staff members are responsible for loan collection. Members of the management committee have to be trustworthy village residents, must have an education equivalent to at least the high school level, capabilities or experience required for managing the UED-SP, and must be willing to participate in training programs. The compensation paid to UED-SP staff is equivalent to 2.5% of the loan principal collected each month. The chairperson receives 35%, the cashier 30%, the accountant 25% of the amount. The remaining 10% may be paid to an additional bookkeeper.

Functions, services, and capital. The functions of the UED-SP, as determined by the guidelines, are to provide credit for productive purposes, to collect savings community members registered as members, to provide business advise to borrowers, and to establish business relationships with other financial institutions. Voluntary savings may be collected from members with a maximum annual interest rate of 12%. They require a minimum balance of Rp. 2000 and can be withdrawn after one month. Credit services may be provided to community members, non-community members living in the village and other customers from villages without an own UED-SP. Loans provided are

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installment loans with 12 weekly or 6 monthly installments. The maximum loan amount is Rp. 500,000. The borrower is required to deposit part (usually 10%) of the loan approved as compulsory savings.

The UED-SP capital consists of government subsidies, equity contributions of members, voluntary savings, loan capital and retained profit. Initial loanable funds are provided by the government’s village development funds. Operating costs such as for the procurement of office equipment and supplies are also borne by theses funds. Equity contributions comprise a membership fee (simpanan pokok) paid upon registration and compulsory deductions from loans disbursed (simpanan wajib pinjaman). The latter contributions are partly equity contributions and partly compulsory savings. A maximum 50% of the amount may be withdrawn once a year, while the other 50% can only be withdrawn with the termination of the membership. The guidelines determine a standard profit allocation ratio. 25% of the annual profits are to be retained as capital reserves and 10% are paid as dividends to members. The remaining amount is distributed to funds available for management (20%), the village administration (20%), guidance costs (20%), and management training (5%).

The guidelines point to the negative impact of subsidized credit channeled by social safety net programs since the financial crisis. The lack of capital is regarded as the major constraint development of UED-SP. This was aggravated by the fact that since the financial year 1999/2000 village development subsidies can no longer be used as working capital. Though the guidelines concede that UED-SP lack savings mobilization, the solution is sought in accessing governmental credit programs, thus giving UED-SP the function of channeling subsidized credit.

Guidance, training, supervision and reporting. Technical guidance and supervision have to be carried out by officials and staff of the PMD directorate of the Ministry of Home Affairs. Guidance teams are hierarchically organized from the national to the sub-district level. The national guidance team is responsible for formulating general policies and guidelines, and carrying out program monitoring and evaluation. The implementation of these policies and guidelines lies in the responsibility of government officials and guidance teams at the provincial, district, sub-district and village levels. Technical assistance staff of the local PMD offices, which is trained on the basis of detailed training guidelines, is responsible to guide and supervise between four and six UED-SP. This staff receives 10% of the annual UED-SP profits.

Training is provided to technical assistance staff and UED-SP staff on the basis of detailed procedures stipulated in the national guidelines. The planning and organization of training lies in the responsibility of a special training committee at the provincial level. Training plans and budgets have to be submitted for approval to the PMD head office. Trainers are selected from PMD staff and related institutions such as banks. Training workshops take 4 days. The national PMD office prepared standard training materials107, which include modules dealing with policies, administration and financial management, and follow-up planning. The training materials are used for both technical assistance staff and UED-SP staff.

107 Departemen Dalam Negeri Republik Indonesia, Modul Pelatihan Bagi Tenaga Asistensi dan

Pengelola UEDSP. Direktorat Jenderal Pembangunan Masyarakat Desa, Jakarta 1999.

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The local PMD offices are supposed to carry out on-site and off-site supervision in cooperation with local banks. On-site supervision includes the inspection of financial statements, management capability and reliability, and control of compliance with existing regulations. Off-site supervision is carried out on the basis of standardized reports, which include financial statements and statements on fund mobilization and supervision costs. The UED-SP has to submit monthly reports, signed by the village and LKMD heads, to the head of the sub-district who passes them on to the district head. The PMD district office is responsible to prepare consolidated monthly reports. Consolidated quarterly reports are submitted to the provincial governor and PMD office. The national PMD office receives semi-annual reports.

The national PMD office developed a sophisticated system for measuring the performance and rating the soundness of UED-SP. The system includes 5 indicators for institutional development, 6 indicators for management, 3 indicators related to office facilities, 3 indicators related to work planning, 5 financial ratios, 6 indicators related effectiveness, and 4 impact indicators. Effectiveness is measured in terms of loans disbursed, the number of members, and the members’ business activities and income. The system applies a modified CAMEL version that measures capital adequacy, the collectability of loans and other performing assets, solvability, profitability, and liquidity.

The rating system mingles CAMEL factors with indicators that are not crucial for the soundness and viability of UED-SP. CAMEL factors contribute only a 175 to the maximum 1,000 points of the rating system. The rating system classifies UED-SP into five performance groups: excellent (only to be achieved with ‚optimal’ impact on the community), sound, developing, start-up (not yet growing), and unsound.

5.2.3 Statistics and Findings

The national PMD office was only able to provide data for the financial year 1998/1999, which are supposed to describe the situation of the UED-SP program as of March 1999. The report, however, does not follow the standards as determined in the UED-SP guidelines and includes information on the number of UED-SP, their members and the amount of loans outstanding only. Data were found to be extremely inconsistent, incomplete and unreliable. The ProFI microfinance appraisal mission carried out in South Sulawesi, West Nusa Tenggara and East Nusa Tenggara collected additional information.108 Visits to local PMD offices and some UED-SP confirmed the striking weakness of the information system.

The national PMD statistics claim that 52,222 UED-SP had been established until March 1999. This number is equivalent to 77% of all Indonesian villages and must be a result of either typing errors or politically motivated reporting. Information and evidence obtained in the three provinces of the appraisal mission could not confirm this high coverage. The number is especially unrealistic for Java and Bali, where some 6,000 other long existing village-level financial institutions have not left much room to move for UED-SP. The data provided in Table 5.8 are more or less useless because the PMD has no information on the number of UED-SP that do really operate. Based on 108 See: Flora Giassemi, Wolfram Hiemann and Detlev Holloh, Appraisal of the Proposal

“Development and Upgrading of Microfinance Institutions in Indonesia”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

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the statistics made available, the average UED-SP would have had 7 members and loans outstanding amounting to Rp. 2.2 million only.

Table 5.8 Unit Ekonomi Desa – Simpan Pinjam (UED-SP) as of March 1999

Indicator Sumatra Java & Bali Kalimantan Sulawesi Other East

Indonesia * Total

Number of villages 21,508 25,508 6,059 7,368 7,251 67,694

Number of UED-SP 16,815 23,226 2,988 6,852 2,331 52,222

As % of villages 78.2 91.1 49.5 93.0 32.1 77.1

Number of members 134,633 114,832 12,717 74,923 7,759 344,864

Average per UED-SP 8 5 4 11 3 7

Loan portfolio (Rp. million) ** 70,820 15,696 3,811 24,246 1,418 115,991

Avg. per UED-SP (Rp. million) 4.2 0.7 1.3 3.5 0.6 2.2

Source : Ministry of Home Affairs, Directorate for the Empowerment of Village Communities (PMD), Jakarta. * West & East Nusa Tenggara, Maluku, Irian Jaya. ** The header of the report column is ‘revolving capital’.

The PMD office in South Sulawesi made available data on 27 UED-SP. Each UED-SP had received a start-up capital of between Rp. 2.5 million and Rp. 6.5 million. As of December 1999, these institutions had average assets amounting to Rp. 19.2 million, of which 15.6 million were outstanding to 93 borrowers. Only 3 of the 27 UED-SP had assets larger than Rp. 20 million. The average loan amount outstanding per borrower was Rp. 168,000. It has to be considered that the PMD regarded these institutions as successful UED-SP. One UED-SP visited had 40 members and assets amounting to Rp. 13.5 million as of June 2000. 94% of assets were placed in the loan portfolio. 63% of its total liabilities and equity consisted of government grants, whereas voluntary savings mobilized from 6 members amounted to only Rp. 151,000. During the first half of 2000, the UED-SP made a profit of Rp. 1.1 million. Note that the profit allocation system includes hidden operating costs not accounted for in the income statement.

In West Nusa Tenggara, the appraisal mission found 6 UED-SP in the East Lombok district, which had been established in March 1996 with an initial capital grant of Rp. 6.5 million each. As of May 2000, these institutions had 144 members and assets amounting to Rp. 26 million, on average. 44% of their total liabilities and equity consisted of government funds. Savings mobilization was not a priority. In East Nusa Tenggara, less than 20% of the UED-SP was found to report monthly transactions. One UED-SP visited in Flores was the only one still operating in the sub-district. It had disbursed only Rp. 4 million to 14 borrowers from its own funds, but it was also involved in channeling funds of a social safety net program (Rp. 40 million to 132 borrowers). A second UED-SP in the Timor district used funds provided by the government mainly to finance school dropouts and school fees of poor families. Only 10 persons had deposited savings. Another urban UED-SP had disbursed Rp. 60 million, of which only Rp. 30 million could be recovered. Financial intermediation had come to a standstill, as the recovered money was placed in a BRI account. Nobody deposited money with this UED-SP. Generally, loan portfolio qualities were found to be poor, records were in a poor state and the use of funds lacked transparency.

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5.2.4 Assessment and Conclusions

The UED-SP program makes the impression of another top-down program of the government. The emphasis on quantity and credit channeling has not resulted in the development of viable village-level financial institutions. The UED-SP cannot be regarded as a financial institutions owned and controlled by the village community. Only a small minority of community members are UED-SP members. The institutions have the size of small credit groups and would be superfluous, if they are intended to replace or formalize the already existing groups with financial activities. The UED-SP are often managed and controlled by village officials, who have little banking expertise and see their role in implementing a government program rather than in developing a viable financial institution. The prevailing orientation to use the UED-SP for managing and channeling program funds reflects neither lacking management capacities nor its incompatibility with the aim to develop sustainable financial services at the village level.

The UED-SP supervision and information systems show the usual weaknesses of large and hierarchically structured government programs. The systems were designed at the central level and are too sophisticated to be transformed into practice with the human resources available at the local level. Timely and crucial information necessary to assess UED-SP performance and soundness is not available. The supervision system applied, especially for rating UED-SP performance and soundness, is not only too sophisticated but also inappropriate for supervising small financial institutions effectively and efficiently. It gives only limited weight to factors determining the soundness of such institutions, while it introduces many other factors that are better examined by means of special studies. The system confuses program monitoring and evaluation with supervision of financial institutions. While government staff may carry out program monitoring, supervision and enforcement authority must be in the hands of an independent and specialized institution to be effective.

The current financial system has only a limited outreach to the village level. Village banks as non-bank financial institutions in the ownership and under control of the village community are one alternative for developing sustainable financial services at the village level. This, however, requires focusing on savings mobilization and institution building rather than on credit channeling. Highly problematic is the prevailing confusion of a financial institution’s intermediation function with the function to channel government funds available for village development. Also the top-down and government-centered approach to the development of village banks is not feasible.

ProFI Microfinance Institutions Study

Chapter 6:

The Cooperative Sector

and its Microfinance Windows

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6. The Cooperative Sector and its Microfinance Windows

The cooperative sector in Indonesia has been characterized by the dualism of formal cooperatives and a variety of informal organizations that work according to cooperative principles but refrained from adopting the legal status of cooperatives. This chapter focuses on cooperatives, which are licensed, regulated and supervised by the Ministry of Cooperatives.109

Special attention is given to the Swamitra microfinance cooperation model between Bank Bukopin and cooperatives. A description of the Credit Union movement is included in this chapter because Credit Unions have been increasingly adopting the legal status of cooperatives after the recent liberalization of the regulatory framework. Furthermore, the chapter also covers Tempat Pelayanan Simpan Pinjam or savings and credit service posts, which are independent village-level units of cooperatives but are supervised by BRI. Chapter 3 (Bank Perkreditan Rakyat) and chapter 7 (Baitul Maal wat Tamwil) cover other types of financial institutions that partly operate as cooperatives.

6.1 The Political Economy of Cooperative Development in Indonesia

Government intervention into the development of cooperatives has been legitimated with reference to article 33 of the 1945 constitution, which stipulates that the economy has to be organized according to cooperative and family principles. Already during the ‘guided economy’ (1957-1966) era cooperatives were instrumentalized for marketing purposes and channeling farm inputs and credit. The active role of the state in the formation and control of cooperatives was underlined by the establishment of the Ministry of Cooperatives in 1958. The cooperative law of 1967 re-emphasized the protective and controlling functions of the state.

In the framework of the integrated rural development strategy in the early 1970s farmer cooperatives were merged into sub-district cooperatives under the new name of Koperasi Unit Desa (KUD), which had the double function as agricultural production and crop purchase units. Presidential instruction No. 2 of 1978 provided the KUD with a monopoly status in rural areas, thus formally disallowing the establishment of independent cooperatives and requiring savings and credit organizations to merge with the KUD. Especially the oil price boom until the early 1980s allowed the government to heavily subsidize the KUD and to develop it into a ‘village conglomerate’110 that monopolized the entire range of economic activities in rural areas. KUD were made the channeling agencies for various subsidized credit packages.

Managed by government employees and without effective internal control, the KUD became a major field of appropriation for local officials and richer farmers. In the late

109 Note that during the last years the Ministry of Cooperatives used four different names. 1994:

Departemen Koperasi = Ministry of Cooperatives. 1996: Departemen Koperasi dan Pembinaan Pengusaha Kecil = Ministry of Cooperatives and Guidance of Small Entrepreneurs. 1998: Departemen Koperasi dan Pengusaha Kecil dan Menengah = Ministery of Cooperatives and Small and Medium Entrepreneurs. 1999: Menteri Negara Koperasi dan Pengusaha Kecil Menengah = State Minister for Cooperatives and Small and Medium Entrepreneurs.

110 “Konglomerat Desa”, Infobank No. 138, 1991.

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1980s and early 1990s, the widespread corruption and high losses incurred by subsidized credit programs had become a major issue of public debate. The vast majority of KUD would have had to be liquidated, if they were stripped of subsidies and preferential access to business deals with the government. 30% of the subsidized farmer credit channeled through KUD between 1985 and 1991 was classified as loss. The Ministry of Cooperatives had to acknowledge that one third of the loss had been appropriated by government officials.111

Despite this situation, the cooperative sector was virtually exempted from the market-oriented reforms implemented since the late 1980s. While financial sector reforms had reduced existing distortions, new ones were added by reinforcing the protection and subsidization of cooperatives. The government instructed the Ministry of Cooperatives to speed up the establishment of KUD and the central bank to increase the volume of subsidized cooperative credit. Commercial banks were obliged to allocate 20 % of their loan portfolios to small and medium enterprises, and state enterprises were instructed to allocate 1% - 5 % of their profits to small enterprises and cooperatives. Some 160 private companies were urged to sell about 55 million shares to 1,200 cooperatives though interest free loans. KUD were granted various marketing monopolies such as for the purchase and sale of the entire clove crop at fixed prices, and they were even instructed to participate in the national family planning program.112

The preferential treatment and subsidization of the cooperative sector has not been abandoned until today. The crucial question is: why have different governments continued to accept the high-cost-economy of the cooperative sector, although it has failed to achieve its economic and social objectives? The answer lies in the fact that 30 years of the policies described above have created strong strategic alliances reaching from the top bureaucracy down to the village level, which have been an important stabilizing and may become a de-stabilizing factor for the political system. Voices demanding the deregulation of and the withdrawal of the state from the cooperative system have become stronger during the last years. Especially at local levels, however, government and cooperative officials have not changed their interest in sustaining the cooperative system as their field of appropriation.

The political reforms and the liberalization of cooperative regulations in the 1990s gave a new impetus for the development of independent cooperatives. The transformation of the cooperative system from a state-controlled to a self-controlled system, however, is a long-term project in which the entire cooperative system and culture has to be turned upside down.

111 See, i.e., “Mencuci Kredit Macet”, Infobank 138, 1991; “Bank vs. Koperasi”, Infobank No.

139, 1991; “Corruption looms in West Java cooperatives”, Jakarta Post, 22 February1992; “Dilemma KUT” and “KUT Bagai Buah Simalakama KUD”, Kompas, 21 August 1992.

112 The number of subsidized credit programs was reduced from 23 to 4 in 1990. Direct credit channeled through cooperatives increased from Rp 0.4 trillion as of March 1990 to Rp 2.5 trillion as of March 1993. (Bank Indonesia Financial Statistics) Other sources of information are various newspaper articles published between 1990 and 1992; see: Detlev Holloh, Microfinance in Indonesia Between State, Market and Self-Organization, LIT-Verlag and Transaction Publishers, Hamburg 1998.

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6.2 The Current Regulatory and Supervisory Framework

6.2.1 Regulation

The cooperative law No. 25 of 1992 makes general provisions for the cooperative sector, while savings and credit cooperatives and savings and credit operations of cooperatives are regulated by government regulation No. 9 of 1995 and ministerial decree No. 351 of 1998.113

The cooperative law follows international cooperative principles (voluntarism, transparency, democracy, self-reliance and independence), but it differs in making the cooperative system responsible for national economic development and accountable to the “family spirit” of the 1945 constitution (articles 3 and 4). This has been the basis for the preferential treatment of cooperatives and the government’s direct involvement in their organization and development. Article 60 of the law explicitly requires the government and government officials at all levels to create favorable conditions for the growth of cooperatives and to provide ‘guidance’, protection and preferential treatment. Article 62 stipulates that cooperatives will be supported with regard to capital accumulation and access to credit. Article 63 gives the government the right to determine economic sectors that may be entered only by cooperatives.

The law distinguishes between primary cooperatives with a minimum of 20 individual members and secondary cooperatives established by at least 3 cooperatives (articles 1 and 6). Types of cooperatives are defined by common economic activities and interest (article 16). The organizational structure comprises the members’ assembly as the highest authority, a management and a supervisory board, elected by and responsible to the members’ assembly. The management board may appoint a professional manager and, in this case, assume supervisory functions (articles 21 to 36).

Cooperatives are allowed to serve extraordinary members without the right to vote (article 18). Article 43 stipulates that excess funds may even be used for serving non-members, and article 44 states that financial services may be provided to members, to other cooperatives and their members as well as to member candidates. These provisions obviously contradict the banking law, which restricts the mobilization of fund from the public to licensed banks.

Government regulation No. 9 stipulates that savings and credit activities may only be carried out by primary and secondary savings and credit cooperatives (KSP), and savings and credit units (USP) separated from other business units of primary or secondary cooperatives (articles 2 and 12). KSP/USP are allowed to establish branch offices, assistant branch offices, and cash offices. Branch offices have to be approved by the ministry (articles 6 and 7). The KSP/USP management board or professional manager, who may be a qualified individual or institution are required to sustain the institution’s soundness (articles 8 and 14).

113 Undang-Undang Republik Indonesia Nomor 25 Tahun 1992 tentang Perkoperasian

(cooperative law); Peraturan Pemerintah Republik Indonesia Nomor 9 Tahun 1995 tentang Pelaksanaan Kegiatan Usaha Simpan Pinjam oleh Koperasi, Departemen Koperasi dan Pembinaan Pengusaha Kecil (government regulation); Keputusan Menteri Koperasi, Pengusaha Kecil dan Menengah Republik Indonesia, No. 351/KEP/M/XII/1998 tentang Petunjuk Pelaksanaan Kegiatan Usaha Simpan Pinjam oleh Koperasi (ministerial decree).

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Financial services may be provided to members, member canditates, other cooperatives and their members. Member candidates have to become full members not later than 3 months after having deposited their equity shares or simpanan pokok (article 18). Loans to members of other cooperatives have to be made through their cooperatives (article 20).

Article 38 states that the ministry, in order to strengthen the cooperative sector, guides community groups with savings and credit activities to adopt the legal status of a cooperative.

Ministerial decree No. 351 aimed at motivating the establishment of new KSP/USP and improving the performance of the industry.114 The establishment of new KSP/USP requires a paid-up capital of only Rp. 15 million for primary cooperatives and Rp. 50 million for secondary cooperatives. The establishment of branches requires a paid-up capital of Rp. 15 million. The paid-up capital has to be deposited in a state bank account. Note: The decree states that KSP/USP that have not yet fulfilled capital requirements will nevertheless be legalized, while they have to limited financial services to members! The establishment of primary KSP requires at least 20 members and the establishment of secondary KSP at least 3 cooperatives. The operation of KSP is geographically not restricted. Financial services may be provided to members, member candidates and other cooperatives and their members.

The managing board of KSP has to consist of full-time managers or it may appoint a professional manager or a board of directors. In this case the former managing board has to assume the functions of a board of commissioners. At least one manager or 50% of the members of the board of directors must a training certificate or financial management experience. Managers may be individual persons or institutions with appropriate financial capacities and skills. Family relationships between managers are prohibited. USP operations have to be separated from other units of the cooperative.

The decree confirms that community groups with savings and credit activities will be directed to establish or join a cooperative. Groups that are not yet able to meet requirements for establishing a KSP are obliged to register with the ministry.

6.2.2 Supervision

Supervision is not subject of the cooperative law. General provisions on KSP/USP supervision are made in government regulation No. 9 under the header of ‘Guidance’ (articles 24 to 28). Guidance and supervision of KSP/USP are to be carried out by the Ministry of Cooperatives. The ministry is given the authority to carry out inspections, to provide advise with regard to capital requirements, change of management, mergers with other cooperatives, and sale of fixed assets, and to liquidate KSP/USP when problem cannot be resolved. The ministry is required to make provisions on the soundness and prudential business practices of KSP/USP. Annual financial statements have to be audited by a public accountant. Ministerial decree No. 351 stipulates that guidance and supervision has to be carried out by officials at all government levels with

114 The decree reflects Presidential Instruction No. 18 of 1998 (Inpres Nomor 18 Tahun 1998

tentang Peningkatan Pembinaan dan Pengembangan Perkoperasian), which allows the registration of new rural cooperatives without having to merge with KUD.

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the aim to sustain the soundness of KSP/USP. Supervision has to comprise off-site supervision based on financial reports, on-site inspections, and an assessment of KSP/USP soundness. KSP/USP have to make available quarterly reports at latest one month after the calendar quarter and annual reports at latest in June of the following year. Financial reports have to include statements on cash and inter-bank assets, loan portfolio, deposits and other liabilities, and equity.115 Audits by public accountants or audit cooperatives are required for KSP/USP with annual business volumes (loan disbursement) of one billion and more Rupiah.

More detailed provisions on the functions and organization of supervision (pengendalian = control) were made by ministerial decree No. 9 of 1999.116 The decree stipulates that control of primary and secondary KSP/USP operating at the district level has to be performed by the district offices of the ministry. The provincial offices are responsible to control primary and secondary KSP/USP at the provincial level. Secondary KSP/USP operating at the national level have to be controlled by the ministry’s head office.

The objective of control is defined as sustaining the soundness of KSP/USP. Control functions specified are: a) guidance on internal control, b) monitoring of financial, management and operational aspects, c) assessment of KSP/USP soundness, and d) KSP/USP inspections, especially with regard to funds mobilized from non-members. The guidelines stress the need for guiding, analyzing, monitoring, assessing and inspecting KSP/USP that serve non-members, but they do not deal with enforcement. Emphasis is given to the protection of assets rather than to deposit protection.

The assessment of KSP/USP soundness is to be carried out at the end of each financial year. However, the decree limits this assessment to KSP that have already operated for at least two financial years and to USP that are already operated as a separate unit and prepare separate financial reports. This is surprising as it is most problem that the course for an institution’s soundness is set during the first two years and major problems may be caused by the lacking separation of the banking function from other functions of multi-purpose cooperatives. With regard to inspections priority shall be given to KSP/USP that accept deposits from non-members, have assets of at least Rp. 1 billion, and/or were found not to comply with valid regulations.

Ministerial decree No. 194 of 1998 provides the Camel instrument to be used for rating the soundness of KSP/USP.117 The instrument consists of 9 financial ratios and 25 questions in 5 management fields. The overall rating weighs capital by 20%, assets quality by 30%, management by 25%, earnings by 15%, and liquidity by 10%.

Capital adequacy is measured by two ratios with a 10% weight each: the equity capital to assets ratio (maximal score with 10%) and a risk-based equity capital to loan

115 Provisions on the contents of financial reports seem to be made in a separate decree (No.

352 of 1998) that, however, was not available. 116 Keputusan Menteri Koperasi Pengusaha Kecil dan Mengenah Republik Indonesia, Nomor

09/KEP/M/I/1999 tentang Petunjuk Pelaksanaan Pengendalian Simpan Pinjam, Biro Hukum dan Organisasi Departemen Koperasi, Pengusaha Kecil dan Mengenah 1999.

117 Keputuasan Menteri Koperasi, Pengusaha Kecil dan Menengah Republik Indonesia, No 194/KEP/M/IX/1998 tentang Petunjuk Pelaksanaan Penilian Kesehatan Koperasi Simpan Pinjam dan Unit Siman Pinjam.

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portfolio ratio (maximum score with 100%). The quality of productive assets is measured by three ratios with a 10% weight each: the ratio of outstanding loans to total loans disbursed (maximum score with 60%), the ratio of classified loans to outstanding loans (maximum score with 0%), and the ratio loan loss reserves to classified loans (maximum score with 100%). Management is assessed by 25 questions regarding capital, assets, profitability, liquidity and management itself. Each positive answer gets 4 points. Profitability is measured by three ratios with a 5% weight each: the ratio earnings to operating income ratio (maximum score with 5%), return on assets (maximum score with 10%), and the ratio of operating costs to operating income (maximum score with 90%). Liquidity is measured by a ratio dividing the loan portfolio by total liabilities and equity (full score with less than 90%, otherwise no score).

The amount of classified loans includes 50% of sub-standard loans, 75% of doubtful loans and 100% of loan loss. The classification depends on loan terms and installment periods. Monthly installment loans, for instance, are classified as sub-standard when they are in arrears for more than three months but less than six months. Loans are classified as doubtful when they do not meet the criteria of non-standard loans, are still collectable and collateral covers at least 75% of debts, or are not anymore collectable but collateral covers 100% of debts. Loans are classified as loss when they do not meet the criteria of doubtful loans, or when they are not repaid after being classified as doubtful for 21 months.

KSP/USP with a score of 81 and more points are rated sound, KSP/USP with a score between 66 and 80 points are rated fairly sound, KSP/USP with a score between 51 and 65 points are rated less sound, and KSP/USP with a lower score are rated unsound. The rating may be corrected down by one level in cases such as non-compliance with internal and external regulations, wrong accounting, deviation from credit procedures, missing audits for institutions with a business volume larger than Rp. 1 billion, and lacking authority of USP managers. The rating is automatically downgraded to unsound in cases such as business collusion with external parties and manipulated accounting.

6.3 Number of Cooperatives and Structure of the Cooperative Sector

Note on data quality and availability

The cooperative sector is the worst documented microfinance sub-system in Indonesia. As the sector was systematically transformed into a “part of the government machinery”118, both development research and practice lost interest in the system and prioritized alternative approaches in microfinance and self-help promotion. Furthermore, lack of supervision and unreliable reporting has been an integral weakness of the system. Data available are not up-to-date and seldom reliable enough to serve as a basis of analysis.

The data available for this report can only serve to provide a rough overview of the cooperative sector, but they have a very limited value even for this purpose because of several reasons. First, data for all provinces and types of cooperatives were available 118 M. Dawan Rahardjo: “Development Policies in Indonesia and the Growth of Cooperatives”,

in: Prisma No. 23, 1991, p. 6.

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only for December 1998. Policy changes such as lifting the ban to establish rural cooperatives independently from the KUD have considerably changed the cooperative landscape. The regional office of the Ministry of Cooperatives in Central Java, for instance, reported an increase of primary cooperatives (non-KUD) from 6,715 as of December 1998 to 10,968 as of December 1999.

Second, the cooperative law (article 16) emphasized that types of cooperatives are defined on the basis of common activities, and that cooperatives formed on the basis of other criteria (functional, religious, gender etc.) are not acknowledged as separate categories. The reporting system of the Ministry of Cooperatives, however, does not follow this definition and does not allow identifying cooperatives that provide financial services. Third, the reporting system aggregates the great variety of cooperative activities, thus not giving attention to items important for assessing financial institutions, such as loans outstanding, assets quality and the structure of liabilities.

Fourth, the new regulations issued in the 1990s stipulate that only single-purpose savings and credit cooperatives or separate savings and credit units of multi-purpose cooperatives are allowed to provide financial services. Both the practice and reporting system of cooperatives have not yet consistently adjusted to this stipulation. Statistics of local cooperative offices that used this classification were found to cover only part of the cooperatives providing financial services. Fifth, statistics continue to distinguish between KUD as rural cooperatives and other multi-purpose cooperatives as urban ones. This legacy of the past is highly inadequate as KUD operate also in urban areas and there is a range of other cooperatives offering financial services in rural areas. Sixth, the quality of information obtained generally lacks analytical value because of long and distorting reporting ways, on the one hand, and the lack of attention given to information such as loan portfolio quality, soundness and management.

Types and business situation of cooperatives

As of December 1998, the Ministry of Cooperatives reported a total number of 59,441 cooperatives of which, however, only 46,420 with some 20 million members were classified as “active”. 56% of the active cooperatives were cooperatives of civil servants, military and police personnel, white-collar workers and various professions. The 7,342 KUD made up 16% of all cooperatives but contributed 50% to all persons registered as members of cooperatives. In this context, it has to be considered that persons without close relationship to KUD are registered as ‘members’ when they receive credit or other facilities channelled through KUD. Other cooperatives known to provide financial services are multi-purpose cooperatives (Koperasi Serba Guna) other than KUD, market cooperatives, Pesantren (Islamic schools or training centers) cooperatives, and women cooperatives. As of December 1998, these organizations contributed 15% to all cooperatives and 7% to their members.

Cooperatives specialized in financial services are people’s credit banks (see chapter 3) and savings and credit cooperatives (Koperasi Simpan Pinjam). The 942 savings and credit cooperatives reported for December 1998 contributed only about 2% to all cooperatives and their members. Considering the liberalization of cooperative regulations in 1998, this number should have experienced a significant increase (see also description of Credit Unions). Field evidence, however, shows that the rural

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population, women in particular, tends to establish multi-purpose cooperatives that allow for running small shops and other activities, although they focus on financial services as their main business.

Table 6.1 Cooperative Sector by Type of Cooperative (December 1998, in Trillion Rupiah)

Type of Cooperative Number 1 Members (‘000) Assets 2 ‘Own

capital’ 3‘Outside capital’ 3

Business volume 4

Profit/ Loss

Civil service, military, police 16,958 3,669 2,854 1,680 974 2,723 200

White collar, professional 8,904 3,144 1,737 786 815 2,246 137

Service, trade, manufacturing 954 362 233 112 112 342 10

KUD 7,342 10,083 3,033 1,302 1,675 4,810 57

Market, multi-purpose coop. 4,237 844 336 153 169 446 14

Pesantren* cooperatives 2,164 342 116 57 56 63 2.5

Women cooperatives 765 255 79 49 24 88 5.1

Savings & credit coop. 942 547 179 86 85 534 7.2

People’s credit banks 26 10 15 5.6 9 25 0.6

Other primary cooperatives 3,620 873 629 392 214 1,089 23

Sub-total 45,912 20,128 9,211 4,622 4,133 12,365 455

Secondary cooperatives 508 22 751 500 198 587 54

Total 46,420 - 9,962 5,122 4,331 12,952 509

Source : Ministry of Cooperatives. Figures include the East Timor province, which gained independence in 1999. * Islamic schools or training centers. 1 Does not include inactive cooperatives (22% of the total number of cooperatives reported). 2 Assumes that the sum of ‘own’ and ‘outside’ capital plus profits is equivalent to the total value of assets. 3 ‘Own capital’ (modal sendiri) is not equity capital in the narrow sense ; it includes membership fees and compulsory

savings. ‘Outside capital’ (modal luar) is assumed to include all other liabilities. 4 The business volume (volume usaha) includes both loans disbursed and/or total sales during the year.

The reporting system provides information on the cooperatives’ business volume (volume usaha), own capital (modal sendiri) and outside capital (modal luar), thus not allowing analyzing aspects such as loans outstanding and the structure of liabilities. The business volume is not equivalent to assets but stands for the accumulated amount of sales and/or loans made during the year. ‘Own capital’ consists of membership fees, compulsory savings, reserves and donations. ‘Outside capital’ includes both voluntary savings and loans. As of December 1998, the cooperative sector’s own capital amounted to Rp. 5,122 trillion, or Rp. 110 million per cooperative, and made up 51% of its total funds. Assuming that the sum of ‘own capital’, ‘outside capital’ and profits is equivalent to the total amount of assets, the cooperative sector’s assets amounted to Rp. 9,962 trillion, and the average cooperative’s assets amounted to Rp. 215 million.

The KUD accounted for 30% of the cooperative sector’s assets. Excluding BPR cooperatives, the average KUD had the largest assets (Rp. 418 million) and number of members (1,366) of all types of cooperatives. Other multi-purpose cooperatives were much smaller, with assets of Rp. 55 million and 199 members, on average. The average savings & credit cooperative had 571 members and assets amounting to Rp. 188 million. Taking into account the high variance in membership, the financial

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capacities of these types of cooperatives do not differ considerably. The average amount of assets per member was Rp. 306,000 for the KUD, Rp. 276,000 for other multi-purpose cooperatives, and Rp. 329,000 for savings & credit cooperatives.

Table 6.2 Multipurpose and Savings & Credit Cooperatives by Region (December 1998)

Indicator Sumatra Java & Bali

Kali-mantan Sulawesi Other E.

Indonesia* Total

KUD

Number of active units 2,386 2,141 775 1,156 819 7,277

Avg. number of members 543 3,318 411 717 484 1,366

Avg. assets (Rp. million) 266 627 129 462 526 418

Multi-purpose cooperatives **

Number of active units 515 1,659 336 370 147 3,027

Avg. number of members 154 252 109 111 86 199

Avg. assets (Rp. million) 49 65 26 43 29 55

Savings & credit cooperatives

Number of active units 138 608 23 130 79 978

Avg. number of members 192 731 848 399 205 571

Avg. assets (Rp. million) 87 218 225 192 117 188

Source : Ministry of Cooperatives. Figures do not include the East Timor province, which gained independence in 1999.* West Nusa Tenggara, East Nusa Tenggara, Maluku, Irian Jaya. ** Koperasi Serba Usaha

The comparison with non-bank microfinance institutions such as the LDKP (see chapter 5) or smaller BPR (see chapter 3) shows that these figures are not very impressive, especially when the large outside funds available to cooperatives are taken into account. Important factors predicating this situation is the dependence on outside funds, lack of savings mobilization and the unattractiveness of most cooperatives for deposit customers. Cooperatives involved in channelling subsidized credit provide access to credit without the active participation of members. Almost daily news on mismanagement and corruption in the cooperative sector has made even members of cooperatives to consider other financial institutions as safer places to save.

More recent data available for cooperatives with savings and credit activities in the West Nusa Tenggara province119 support the latter argument. Both savings & credit cooperatives and multi-purpose cooperatives with savings and credit activities were not able to finance more than 20% of their assets by deposits mobilized from members. Considering that deposits consist mainly of compulsory savings and membership fees, this low level of savings mobilization is even more evident. The extremely low average amount of deposits per member (Rp. 10,000) in KUD savings and credit units indicates that this amount consists mainly of the fee or share each person has to pay for being registered as a member.

119 See also: Detlev Holloh, Appraisal of the Proposal “Development and Upgrading of

Microfinance Institutions in Indonesia”, Sub-Report 2: West Nusa Tenggara, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

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Similar findings were also made during an appraisal mission carried out in East Nusa Tenggara and South Sulawesi.120 It was revealing that both cooperative officials and managers met during the mission emphasized the need for cheap funds rather than reflecting the weakness and constraints of cooperatives in mobilizing savings.

Single-purpose savings & credit cooperatives succeeded to mobilize considerable higher amounts of deposits per member and, in terms of assets, are usually larger than savings and credit units of cooperatives. Often, however, they are urban businesses founded by middle-class people who offer, in a moneylender-like fashion, easy access to expensive loans. Mobilization of savings is usually not a priority. Officials and public media make no secret out of the fact that some of these institutions have membership lists only as a matter of form and operate as ‘black’ banks, not being subject to banking regulations and enjoying the lax regulation and supervision of the cooperative sector.

There is a range of real member-owned cooperatives that have independently grown ‘from below’ through high participation of their members and reliance on their own resources. One example is the Credit Unions, which will be described later in more detail. Another example from West Nusa Tenggara is Koperasi Karya Terpadu in East Lombok, which emerged from 13 women groups participating in the P4K Rural Income Generating Project (RIGP-P4K), a microfinance and poverty-alleviation project implemented by the Ministry of Agriculture and Bank Rakyat Indonesia. This cooperative is a multi-purpose cooperative (Koperasi Serba Usaha), which focuses on financial services as its main business but also runs a small shop with basic goods, provides social funds for medical purposes and in the cases of births, marriage and death. As of June 2000, the cooperative had organized 42 small groups with 501 members. Assets amounting to Rp. 151 million were larger than that of many cooperatives with wealthier members and funded by cheap outside funds.

120 See: Flora Giassemi, Wolfram Hiemann and Detlev Holloh, Appraisal of the Proposal

“Development and Upgrading of Microfinance Institutions in Indonesia”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

Table 6.3 Multipurpose and Savings & Credit Cooperatives

in West Nusa Tenggara (May 2000)

Indicator KSP * USP- KUD *

USP-Kopta *

Number of units 13 129 529

Number of members (,000) 2.4 105.2 81.1

Average number of members 186 816 153

Assets (Rp. billion) 2.4 5.6 64.7

Average per unit (Rp. million) 187 43 122

Loan portfolio (Rp. billion) 2.1 4.5 51.1

As % of assets 87.5 80.4 79.0

Deposits (Rp. billion) 0.4 1.1 4.9

As % of assets 18.5 19.6 7.6

Average per member (Rp. ,000) 184 10 60

Source : Ministry of Cooperatives, West Nusa Tenggara regional office. * KSP = Koperasi Simpan Pinjam = Savings & credit cooperative ; USP

= Unit Simpan Pinjam = Savings & credit unit. Kopta = Koperasi Perkotaan = ‘Urban’ cooperative.

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6.4 Bank Bukopin and its Swamitra Model of Microfinance

6.4.1 Overview of Bank Bukopin

The history of Bank Bukopin (Bank Umum Koperasi Indonesia) commenced as the banking arm of eight secondary cooperatives in 1970. The founding cooperatives were the national army, air force, police and veteran cooperatives, the civil servants cooperative, the fisheries cooperative and the association of batik cooperatives. In 1985, all cooperative banks were merged into Bukopin in order to strengthen the financial arm of the cooperative movement. In 1989, after the banking reform of 1988 had increased the capital requirements for commercial banks, Bukopin was converted into a limited liability company under the name PT. Bank Bukopin. Capital shares were sold to the founding secondary cooperatives and its 2,287 primary cooperatives, to new cooperatives, the Government, and national private enterprises. Since the mid 1990s the member cooperatives hold only 28.1% of the shares amounting to Rp. 185.5 billion. The other shareholders are the Foundation of the national logistic agency (Bulog, 31.8%), the Government (24.6%), and the business tycoon H.M. Hasan (15.5%).

Bank Bukopin maintains a network of 25 branches, 54 assistant branches and 45 cash offices. All but 5 of the branches are located in Java and Sumatra, whereas there are only 2 branches, 2 assistant branches and 3 cash offices (South Sulawesi and East Nusa Tenggara) in the eastern parts of Indonesia. Bank Bukopin is organizationally divided into five divisions. The Micro Banking Division handles the Swamitra program, a special business partnership with currently 177 selected cooperatives (see below). The Small-scale Business and Cooperatives Division is responsible for channeling governmental program credit mainly through cooperatives and focusing on the financing of agribusiness. The Individual Banking Division targets individuals with stable sources of income with special deposit and consumer credit products, transfer services, ATM service points and online banking services. The Treasury and Investment Division is responsible for the bank’s assets and liability management.

While one of Bank Bukopin’s missions has been to support the development of cooperatives and small businesses, it were the large loans disbursed to the construction, manufacturing and transportation sectors that made Bank Bukopin one of the private national banks that had to be recapitalized in 1998/1999. As of the end of 1998, 38.6% of the bank’s loan portfolio was classified as loss and a further 15.3% as non-standard. The bank had to make loan loss provisions making up 38% of its loan portfolio. The bank’s losses had accumulated to Rp. 893 billion. It had a negative equity capital of Rp. 648 billion and the capital adequacy ratio had dropped from 9.2% as of the end of 1997 to minus 20.3% as of the end of 1998. The bank had to transfer its non-performing assets to IBRA, restructured its loan and was recapitalized with an amount of about Rp. 476 billion. Between December 1998 and March 2000 the bank’s assets increased from Rp. 4.8 trillion to Rp. 7.6 trillion, of which deposits funded 88%. The capital adequacy ratio had recovered to 12.4% and the bank had started to make profits again. The bank’s loan portfolio, however, did not grow significantly and made up only 45% of its assets. New loans were mainly made in the form of subsidized loans that were financed by Bank Indonesia’s credit liquidity programs.

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Besides providing the entire range of banking services, a great part of Bank Bukopin’s business is made up of its function as a channeling bank for governmental credit programs such as the various schemes channeled through cooperatives to farmers and small businesses. In 1998, this business arm contributed 45% to its annual profits before tax. The bank’s own microcredit window is a two-step loan provided to its Swamitra partners. The loan is used to provide working capital and investment loans to group members and microbusinesses. The maximum individual loan amount is set as Rp. 50 million and a self-financed contribution of 30% of the project financed.

6.4.2 The Swamitra121 Program

In 1985, Bukopin was involved in the development of Service Centers for Rural Credit Cooperatives, a multi-tiered program implemented with financial assistance from the Netherlands Government and the Rabobank Foundation in order to provide credit to group members organized under the KUD, at that time cooperatives with a monopoly status at the sub-district level. The new Swamitra model of microfinance is a professionalized and business-oriented version of this program. The Swamitra program was launched in 1998 in response to government regulations requiring commercial banks to allocate 22.5% of their portfolios to small businesses and to the deteriorated public image of government-led cooperatives.

Swamitra are cooperatives or other microfinancial institutions that, based on a memorandum of understanding, have entered into a business relationship with Bank Bukopin and are supported by the bank’s management and training systems. Swamitra may also be regarded as independent outlets of Bank Bukopin, which are provided with access to capital, effective liquidity management and inefficient financial transactions through the bank’s online system.

The Swamitra organization consists of credit, fund mobilization, administration, and internal control divisions, which operate under a commercial and an operating manager. The initial Swamitra capital has to be deposited by the partner organization in a Bank Bukopin account, which carries an interest rate 1.5% higher than the bank’s highest interest rate on time deposits. In return, Bank Bukopin provides investment loans for purchasing fixed assets and inventory, and refinance for the institution’s own credit business.

Bank Bukopin has designed standard products for its Swamitra partners. The savings deposit product requires a minimum balance of Rp. 10,000, allows unlimited withdrawals, and offers attractive prices. Time deposit products are offered with maturities between one and 12 months and require a minimum balance of Rp. 10,000. Interests paid on accounts of both products are exempted from tax payments up to a certain amount (1998: Rp. 144,000). Loan products comprise various types of investment loans, working capital loans, and consumption loans, with loan amounts ranging from Rp. 500,000 to Rp. 50 million, and loan terms ranging from 30 days to 3.5 years. Depending on the product, collateral is accepted in the form of movable and unmovable assets, the borrower’s business and deposits.

121 Swamitra is the synonym for ‘Voluntary Partnership’.

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6.4.3 Swamitra Outreach and Financial Situation

As of October 2000, Bank Bukopin had established 177 Swamitra, of which 83% were operating in Sumatra, Java and Bali. In accordance with the outreach of the bank’s branch network, Swamitra are under-represented in other regions, especially in the eastern parts of Indonesia.

Table 6.4 Number and Outreach of Swamitra by Region (October 2000)

Indicator Sumatra Jakarta Java & Bali Kalimantan East Indonesia * Total

Number of Swamitra 44 24 79 16 14 177

Number of deposit accounts 17,708 7,523 20,933 4,606 4,415 55,185

Average number 402 313 265 288 315 312

Avg. amount (Rp. million) 1.13 0.49 1.15 1.1 0.75 1.02

Number of loan accounts 6,799 7,486 11,413 2,976 3,415 32,089

Average number 155 312 144 186 244 181

Avg. amount (Rp. million) 2.0 2.9 2.3 2.4 2.0 2.3

Source : Bank Bukopin. * South Sulawesi & East Nusa Tenggara.

The Swamitra had some 55,000 deposit accounts or 312 accounts, on average. The average number of deposit accounts per institution was less than 250 in South Sumatra, Central Java, East Java and South Kalimantan, whereas the number exceeded 500 accounts in East Nusa Tenggara, Riau, Jambi and the Aceh province. The average amount per deposit account was Rp. 1 million and, ranging from Rp. 0.5 million in Jakarta to Rp. 2 million in Aceh, showed a high variance.

The total number of some 32,000 loan accounts averaged 181 per Swamitra. The average number of loan accounts, however, ranged from only 77 in South Sumatra to 331 in East Nusa Tenggara. The average loan amount outstanding of Rp. 2.3 million was similar to that of the BRI unit system. Swamitra in Jambi (Rp. 1.2 million) had the smallest and institutions in North Sumatra (Rp. 3.9 million) had the largest average loan amount outstanding.

The Swamitra’s outreach in terms of deposit and loan accounts already indicates a high variance in business volume. With total assets of Rp. 148 billion, the average institution had assets amounting to Rp. 836 million, six times as low as for BRI units, as of October 2000. Average assets per Swamitra varied between Rp. 423 million in East Java and Rp. 1.4 billion in the Aceh province.

The Swamitra usually had more than 80% of their assets placed in the loan portfolio. The loan portfolio to assets ratio was higher than 90% in West Java, North and West Sumatra, and East Nusa Tenggara. The major source of funds was loans provided by Bank Bukopin. On average, these loans made up 60% of all Swamitra funds, while deposits contributed only 38% to these funds. The Swamitra in East Nusa Tenggara, Bali, Jambi, and the Aceh province financed 60% and more of their assets from deposits, whereas deposits made up less than one third of the institutions’ funds in

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Jakarta, North Sumatra, South Kalimantan and South Sulawesi. The Swamitra in all provinces appear to be considerably under-capitalized. The average capital to assets ratio was only 1% and exceeded 2% only in East Java.

Table 6.5 Assets and Balance Sheet Structure of Swamitra by Region (October 2000)

Balance Sheet Item Sumatra Jakarta Java & Bali Kalimantan East Indonesia * Total

Avg. assets (Rp. million) 958 1,120 715 788 709 836

Total assets (Rp. million) 42,161 26,870 56,496 12,601 9,932 148,060

Loan portfolio (Rp. million) 35,858 22,150 48,985 11,145 8,923 127,061

As % of assets 85.1 82.4 86.7 88.4 89.9 85.8

Total deposits (Rp. million) 19,996 3,689 24,146 5,067 3,308 56,206

As % of assets 47.7 13.7 42.7 40.2 33.3 38.0

Equity (Rp. million) 346 236 878 346 73 15

Loans (Rp. million) 20,762 23,749 30,887 7,518 6,264 89,762

Profit & Loss (Rp. million) 1,074 (207) 1,553 (85) 369 2,704

Source : Bank Bukopin. * South Sulawesi & East Nusa Tenggara.

Information on loan portfolio quality was unfortunately not available. Some of the findings mentioned above, however, may indicate that many institutions had been performing less than satisfactory. The fact that the credit business of most institutions depended highly on Bank Bukopin funds shows that Swamitra had been functioning as credit channeling agencies rather than developing into independent financial intermediaries. The generally high loans to assets ratios indicate that many Swamitra were most probably exposed to both high credit and liquidity risks. As of October 2000, the entire industry had made profits amounting to Rp. 2.7 trillion, but the institutions in one third of the provinces operated at a loss. The Swamitra industry, in general, lacks capital adequacy. In the six provinces, in which the institutions experienced negative returns, losses came close to or exceeded the amount of equity capital.

High variance in outreach, assets size and performance

The institutions selected by Bank Bukopin as Swamitra partners differ extremely in outreach, assets size and performance. They are institutions with few customers and assets comparable to that of savings and credit association or they have hundreds of customers and assets amounting to more than Rp. 1 billion. One large and profitable market cooperative in Aceh had mobilized deposits amounting to Rp. 3.3 billion, financing 92% of its assets. An unprofitable KUD in Central Java had assets of Rp. 326 million, only 2% of which were financed by deposits. A highly profitable KUD in Riau, with assets amounting to Rp. 1.8 billion, had more borrowers (231) than deposit customers (214). Another Swamitra in Riau, with only 92 borrowers but 673 deposit customers, had incurred losses equivalent to 71% of its small loan portfolio (Rp. 136 million).

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6.5 The Credit Union Movement

Credit Unions in Indonesia are known under the name Koperasi Kredit (Kopdit) and, in terms of organizations and operations, do not differ from savings & credit cooperatives. Until recently, however, they usually operated as informal savings and credit groups because of the interventionist rationale of the cooperative system. Since the liberalization of cooperative regulations an increasing number of Credit Unions and their secondary structures adopted the legal status of savings & credit cooperatives.

Credit Unions have been promoted by a national non-government organization, first established under the name Credit Union Counseling Office, since 1970.122 In 1980, the organization’s name was changed into Badan Koordinasi Koperasi Kredit Indonesia (BK3I) or Credit Union Coordination of Indonesia. After having been prevented from doing so for many years, BK3I established the Induk Koperasi Kredit (Inkopdit), the national secondary cooperative for its registered savings & credit cooperatives, in July 1998. Presently, the movement has 28 regional chapters (Badan Koordinasi Koperasi Kredit Daerah – BK3D), of which 16 have already adopted the status of secondary cooperatives (Pusat Koperasi Kredit – Puskopdit). At the primary level, the movement consisted of 1,105 Credit Unions as of December 1999. Only one year after the liberalization of the regulatory framework, 29% of these Credit Unions had adopted the legal form of primary savings & credit cooperatives.

The mission of BK3I/Inkopdit and BK3D/Puskopdit is to strengthen the development of autonomous and self-reliant Credit Unions. The movement has continuously demanded that this emphasis on voluntary association, autonomy and self-reliance has to be clearly stated in a revised cooperative law. A special feature of the movement has been its high emphasis on education and participative decision-making, as expressed by its motto: “Credit Unions are an economic movement through educational activities and an educational movement through economic activities.” Other important pillars of the movement are its credit insurance scheme and its inter-lending system. Training, insurance, inter-lending and supervision are the major tasks carried out by the secondary structures of the movement. As of the end of 1999, 89% of the Credit Unions participated in the movement’s inter-lending system and 57% of the Credit Unions participated in its credit insurance scheme. Credit Unions receive training through their BK3D/Puskopit at the regional level. There are special courses for beginners, for advanced staff and for managers. The Credit Unions have to pay part of the training costs, while another part is subsidized from income of the secondary cooperative and from donations.

122 The following description is based on data provided the Credit Union’s national apex

organization BK3I/INKOPDIT and the following publications: Credit Union Coordination of Indonesia, “Peranan Gerakan Koperasi Kredit Bagi Masyarakat Ekonomi Lemah di Indonesia”, CUCO, Jakarta 1987; Credit Union Coordination of Indonesia, “Credit Union Movement in Indonesia”, CUCO, Jakarta 1987; CH Sukirman, “Koperasi Kredit sebagai salah Satu Pilihan Dalam Pemberdayaan Ekonomi Rakyat”, Seminar dan Lokakarya Memberdayakan Ekonomi Rakyat Melalui Keuangan Mikro, Bandung, September 2000; Flora Giassemi, Wolfram Hiemann and Detlev Holloh, Appraisal of the Proposal “Development and Upgrading of Microfinance Institutions in Indonesia”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

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In 1998 and 1999, the Credit Union movement experienced a period of consolidation and significant growth. The number of units dropped from 1,400 to 1,105. The movement lost also a considerable number of members, but the average number of members per unit increased from 192 to 228. Most remarkably, however, average assets per unit grew by 124% during this two-years period. Despite the financial crisis, the Credit Unions sustained high growth rates in both savings and credit. The loan portfolio grew by 35% and deposits by 38%, with deposits contributing 63% to their total liabilities and equity. With reserves and profits equivalent to 16% of total assets, the Credit Unions appear to be generally sound. Return on assets decreased from 13% in 1998 to 10% in 1999, but remained at a remarkably high level.

67% of the Credit Unions are located on the major islands Sumatra, Java and Bali. Contrary to the regional distribution of other financial institutions, however, the Credit Union movement shows a high concentration in the eastern parts of Indonesia. This is particularly true for East Nusa Tenggara, where 246 Credit Unions contribute 46% to the total number (530) of Credit Unions, savings & credit cooperatives, and multi-purpose cooperatives with savings and credit units. They are probably the major microfinance institutions on the island of Flores, where 212 Credit Unions are located.

As of December 1999, the Credit Unions had 228 members and assets of Rp. 168 million, on average. The size of Credit Unions varied considerably between the regions. With more than 1,000 members and assets of Rp. 868 million, on average, the Credit Unions in (West) Kalimantan had the size of small secondary banks. The Credit Unions in the eastern parts of Indonesia, with 138 members and assets of Rp. 79 million, on average, resemble savings and credit associations.

Credit Unions operate in urban and rural areas, and they organize members of various social strata. In urban areas they are often organizations with a high participation of professions such as teachers. The vast majority of Credit Unions in the eastern parts of Indonesia operate in rather rural areas. There are, however, also large urban organizations such as a Credit Union registered as a savings & credit cooperative in Flores, which had 1,485 members and loans outstanding amounting to Rp. 1.8 billion. Another example for a large Credit Union that is registered as a savings & credit cooperative is Koperasi Kredit Sejahtera operating in Cibinong, West Java. As of June 2000, it had 677 male and 1,140 female members. Assets amounted to Rp. 2.2 billion, of which 79% were loans outstanding. The Credit Union was entirely self-financed, with voluntary savings deposits contributing 62% and membership fees plus compulsory savings contributing another 13% to total liabilities and equity.

Table 6.6 Credit Union Development 1998-1999

Indicator December 1997

December 1998

December1999

Number of CU 1,400 1,265 1,105

Number of members 268,739 272,923 251,989

Average per CU 192 216 228

Assets (Rp. billion) 137.3 161.2 185.4

Average per CU (Rp. million) 75 127 168

Loan portfolio (Rp. billion) 104.9 120.5 134.3

Deposits (Rp. billion) 85.4 104.4 117.7

Reserves (Rp. billion) 11.8 13.7 16.3

Profits (Rp. billion) n.a. 19.3 13.7

Source : BK3I/Inkopdit, Jakarta.

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Table 6.7 Credit Union Indicators by Region (December 1999)

Indicator Sumatra Java & Bali

Kali-mantan Sulawesi Other E.

Indonesia* Total

Number of CU 254 484 29 54 284 1,105

Registered cooperatives (%) 18.1 41.9 34.5 5.6 19.7 28.8

Number of members 71,475 102,858 31,015 6,033 40,608 251,989

Average per CU 281 213 1,069 112 143 228

Assets (Rp. billion) 41.4 92.0 25.2 3.3 23.5 185.4

Average per CU (Rp. million) 163 190 868 61 83 168

Loan portfolio (Rp. billion) 33.1 59.4 19.5 2.8 19.6 134.3

As % of assets 80.0 64.5 77.5 83.9 83.2 72.5

Deposits (Rp. billion) 28.6 47.7 21.5 2.4 17.4 117.7

As % of assets 69.3 51.8 85.3 74.1 74.1 63.5

Average per member (Rp. ,000) 401 464 692 404 430 467

Source : BK3I/Inkopdit, Jakarta. * Still includes East Timor.

Contrary to the vast majority of cooperatives, the Credit Union movement has been emphasizing savings mobilization and the reliance on own resources. This is indicated by the fact that average savings per member (Rp. 467,000 for the entire movement) were 2.5 times as large as for savings & credit cooperatives in general and 47 times as large as for KUD savings and credit units. As of December 1999, deposits made up 63% and reserves and profits 16% of the Credit Unions’ total liabilities and equity, indicating that the movement has achieved a high degree of self-finance.

6.6 Tempat Pelayanan Simpan Pinjam (TPSP)

Tempat Pelayanan Simpan Pinjam (TPSP) are savings and credit service posts at the village level, which operate under the umbrella of savings and credit cooperatives or multi-purpose cooperatives with savings and credit units, while they are also supervised and technically assisted by Bank Rakyat Indonesia. Due to the latter fact, complete, reliable and updated data were available from the BRI head office.

TPSP have a simple organization with usually three part-time employees and operate often only once a week from a small village office. Their organization and operations is similar to that of the BKD in Java (see chapter 4). This has also historical reasons. When the new banking regulation in the early 1990s prevented the expansion of the BKD model, the Ministry of Cooperatives and BRI started to promote and establish TPSP in 1994 as an alternative to the BKD model and as a project thought to replace the terminated petty trader credit program (Kredit Candak Kulak – KCK).

The establishment of TPSP was initiated with grants provided by the National Development Planning Agency (Bappenas) to KUD. As of 1996, Bappenas had made available about Rp. 18 billion for the establishment of 975 TPSP. Each TPSP received a one-time sum of Rp. 8 million as seed capital and Rp. 500,000 for the purchase of equipment and supplies. BRI received some Rp. 3.1 million per TPSP for the training of

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TPSP staff members, KUD and BRI supervisors. KUD received some Rp. 6.9 million per TPSP as a compensation for technical support, monitoring, and other costs.

In contrast to BKD, TPSP are supervised by both BRI and the KUD system. Unlike BKD supervisors, BRI’s TPSP supervisors are paid entirely on commission. They receive 15 percent of the interest collected by the TPSP branches they supervise. The supervisors and technical administrators of KUD receive monthly salaries.

According to the national BRI statistics, 1,582 TPSP were operational as of April 2000. 1,381 TPSP operated under the umbrella of KUD, and 201 units operated under the umbrella of urban cooperatives (Kopta).

The average TPSP had 153 loan accounts, 161 compulsory savings accounts, but only 49 voluntary savings deposit accounts. This and the low average savings deposit amount of Rp. 39,000 per account already indicate that savings mobilization has not been the strength of these institutions. Compulsory savings are exclusively collected as percentage deductions from loan amounts disbursed. The average loan size in April 2000 was Rp. 308,000, while the average loan amount outstanding per account amounted to Rp. 153,000.

In accordance with the low level of savings mobilization, the average TPSP had assets amounting to Rp. 28 million only. 82% of the total TPSP assets were invested in the loan portfolio. The major source of funds was equity capital, which contributed 60% (including profits) to their total liabilities and equity. Assuming that each TPSP had received start-up funds of Rp. 8.5 million123, 50% of this equity capital consists of grants. Savings contributed 35% to total liabilities and equity, but 80% of these savings was compulsory savings deducted from loan amounts disbursed.

Table 6.9: TPSP Consolidated Balance Sheet (April 2000)

Assets Million Rp. % Liabilities & Equity Million Rp. % Cash 535 1.2 Compulsory savings * 12,720 28.5 Inter-bank assets (BRI) 6,345 14.2 Savings deposits 3,197 7.2 Loan portfolio 36,797 82.4 Other liabilities 1,254 2.8 Other assets 955 2.1 Equity ** 26,762 60.0 Profits in current year 699 1.6

TOTAL 44,632 100.0 TOTAL 44,632 100.0 Source: Bank Rakyat Indonesia. * Deducted as percentage of loan amount disbursed. ** Includes grants, reserves and profits not yet allocated.

123 Note that in many cases grants provided as start-up capital even reached Rp. 15 million.

Table 6.8 TPSP Outreach (April 2000)

Number of TPSP 1,582

Number of loan accounts 240,233

Avg. number per TPSP 157

Avg. amount per account (Rp. ,000) 153

Number of savings deposit accounts 78,183

Avg. number per TPSP 49

Avg. amount per account (Rp. ,000) 39

Number of comp. savings accounts * 254,022

Avg. number per TPSP 161

Avg. amount per account (Rp. ,000) 50

Source: Bank Rakyat Indonesia. * Savings deducted from loan amounts disbursed.

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As of April 2000, the aggregated TPSP loan portfolio amounted to Rp. 36.8 billion. According to BRI’s loan classification, half of the entire loan portfolio was at risk. 27% of the loans and 20% of the total loan amount outstanding was classified as loss. Doubtful loans contributed a further 13% to the number of loans and 12% to the loan amount outstanding. The consolidated TPSP income statement does not show any write-off costs and also loan loss provisions costs (Rp. 83 million) are almost not accounted for. Thus, it can be assumed that the TPSP industry operated at a high loss, although the balance sheet shows positive returns for the first four months of 2000. Both the extremely bad loan portfolio quality, the high dependence of grants, and the failure to mobilize significant amounts of voluntary savings indicate that the TPSP generally have not succeeded to develop into sound and sustainable institutions.

The ProFI microfinance appraisal mission to West Nusa Tenggara124 provided further insight into the operation of TPSP. The 71 TPSP in this province operate under the umbrella of 25 cooperatives and had average assets of only Rp. 6.6 million, though they served 335 savings customers and 197 borrowers, on average. Both compulsory and voluntary savings contributed 31% to their funds. 56% of their total loan portfolio was at risk, and one quarter of the total loan amount outstanding was classified as loss. The mission visited one KUD in the Bima district of Sumbawa, under which 5 TPSP are operating. The KUD’s savings and credit unit served 2,217 customers from 9 villages. The 5 TPSP were established in 1999 with a start-up grant of Rp. 15 million each. As of June 2000, average assets amounted to Rp. 30 million, one third of which was collected from members mainly through deductions from loans disbursed. The average loan amount outstanding to 655 borrowers was Rp. 204,000. Without loan losses and 84% of the loan amount outstanding classified as standard, these TPSP performed much better than the overall average.

The TPSP Ntonggo visited by the mission had 175 members and assets amounting to Rp. 35 million. It operates from one desk in the village hall and opens once a week. Its staff made a motivated impression. It performed very well. 90% of the loan portfolio was classified as standard. Loans are provided for 12 weeks or 7 months with a monthly interest rate of 2.8% flat. At the day of the visit the TPSP provided loans amounting to Rp. 3.8 million to 8 borrowers. Scarce loanable funds did not allow disbursing loans for more than once a week. Loan approvals are based on the availability of funds and the number of loan application per day rather than on credit demand.

124 See: Detlev Holloh, Appraisal of the Proposal “Development and Upgrading of Microfinance

Institutions in Indonesia”, Sub-Report 2: West Nusa Tenggara, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

Table 6.10 TPSP Loan Portfolio Quality (April 2000)

Loan portfolio (Rp. million) 36,797

Loan portfolio classification

Standard (%) 50.4

Sub-standard (%) 17.9

Doubtful (%) 11.6

Loss (%) 20.1

Loan portfolio at risk (%) * 49.6

Number of loans at risk (%) * 59.6

Source: Bank Rakyat Indonesia. * Includes loans not classified as ‘standard’.

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6.7 Assessment and Conclusions

The cooperative sector in general

Data and evidence produce three very different pictures of the cooperative sector. The first picture shows small cooperatives and cooperative-like organizations, which have grown ‘from below’, live on the participation and control of their members, and have gradually expanded their financial capacities through reliance on own resources. They are usually well performing financial intermediaries and have been able to provide sustainable financial services without significant direct ‘guidance’, preferential treatment and subsidies from the government. The Credit Unions are without any doubt part of this picture.

The second picture shows the large number of cooperatives, which have been managed by government officials and local influential persons without effective participation and control of members. They have been flooded with targeted and subsidized credit, and were not able or willing to rely on savings mobilization. The prevailing mismanagement, corruption, interference and instrumentalization for external purposes considerably deteriorated their performance and image. Most of these cooperatives would not be able to sustain their operations, if preferential treatment and subsidies are withdrawn.

The third picture shows moneylender-like savings & credit cooperatives, which are privately owned ‘black’ banks rather than member-owned and –controlled organizations. They are usually profitable organizations that provide easy and expensive credit with strict credit collection procedures.

The number of some 50,000 cooperatives with some 20 million members and assets of Rp. 10 trillion suggests a strong cooperative sector in Indonesia. The majority of these cooperatives, however, are urban cooperatives, cooperatives of civil servants as well as of white-collar workers and various professions. The more than 7,000 KUD do not exclusively serve rural areas, and a large number of registered members do not actively participate in these cooperatives. 30 years of government intervention, preferential treatment and subsidies have eroded voluntarism, transparency, democracy, self-reliance and independence as features of cooperative practice.

The political economy of the cooperative sector described above makes fast changes in this situation improbable. Local officials have not yet changed their top-down attitudes, are searching for new legitimations and sources of income, emphasize the lack of cheap funds rather than the need for a sound and self-reliant cooperative development. They are often not able or willing to carry out effective supervision and enforce compliance with existing regulations.

The major constraint for a sound and self-reliant cooperative development is the government-dependent system itself and the prevailing views of cooperative officials rather than the lack of funds or human resources. Even policies aiming at developing self-supporting savings & credit cooperatives125 focus on measures such as

125 See: Kebijakan bagi Koperasi dan PKM tentang Pembiayaan dan Pengembangan Koperasi

Simpan Pinjam (Policies of the Ministry of Cooperatives on Financing and Developing

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cooperation with banks, revolving funds, access to liquidity credit, and training rather than on measures required for increasing the autonomy, self-reliance and soundness of cooperatives. Government support for a sound and self-reliant cooperative development has to be appreciated. Direct intervention, preferential treatment and the creation of fields of appropriation through subsidies and cheap credit, however, undermine this development. The type of support required for enabling the development of viable financial cooperatives is making rural financial markets competitive, getting legal, regulatory and supervisory frameworks right, and strictly enforcing compliance with regulations and prudential financial practices.

Regulation and supervision of cooperatives

The new cooperative regulations have increased the opportunity for cooperatives to develop independently and in self-reliant ways. Provisions made on supervision and financial soundness exist and can support the sound development of cooperatives. However, there are still crucial problems with regard to both the regulations themselves and their translation into practice.

Provisions made in the cooperative law legitimate direct government intervention into the cooperative sector and even require the government to provide protection and preferential treatment. The regulations also include provisions that tend to force small informal groups with savings and credit activities into the formal cooperative sector. Forced formalization should not be part of enabling regulatory frameworks. Small village-level groups need time to learn managing their own funds, and often will not develop into larger financial intermediaries. It is neither desirable nor realistic that the state bureaucracy oversees some ten thousands of these groups.

A crucial problem of the existing regulations is that cooperatives are not prohibited from mobilizing funds from the public, because they a) lack a clear definition of membership and member candidates, b) allow providing financial services to members of other cooperatives, and c) even explicitly speak of financial services to non-members. This is also implied in the questionable provision that cooperatives will be licensed even without having deposited the minimum paid-up capital provided that they render services to members only. These provisions clearly contradict and undermine the banking act. Together with the low capital requirements (Rp. 15 million compared to at least Rp. 500 million for BPR), this has invited the establishment of moneylender-like cooperatives. Managers of cooperatives that lack common bonds and internal control are not used to prudentially handle money belonging to other persons. Loyalty to relatives and influential local persons is often rated higher than protecting the interests of deposit customers.

A further crucial problem is that existing regulations are not consequently translated into practice and, most important, are not effectively enforced by the regional and local offices of the Ministry of Cooperatives. Sanctions such as the withdrawal of the business license are uncommon. While it is common that cooperatives do not report according to schedule, the ministry’s offices appear usually not to take actions in such

Savings and Credit Cooperatives), Paper presented at a workshop on human resource development, 24 June 2000.

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cases. Consequently, reports and data available in these offices are often incomplete, inconsistent and unreliable. The offices also appear to be over-burdened with the task of carrying out on-site and off-site supervision for the large number of cooperatives. Supervision and reporting instruments lack effectiveness and efficiency, and are consequently not adequately applied. The major weaknesses of the cooperative system are related to the lack of supervision and enforcement. The fact that these functions have to be carried out by the same government organization that is also responsible for providing guidance and channeling funds to cooperatives does not contribute to improving this situation.

Bank Bukopin and its Swamitra partners

Bank Bukopin launched the Swamitra program only in 1998. Much of the high variance in outreach and assets may be due to the short duration of many Swamitra partnerships. The high losses incurred by some institutions may indicate that the selection of Swamitra partners was not always carried out appropriately. The generally low levels of savings mobilization and the high dependence of Swamitra partners on Bank Bukopin funds seems to indicate that Swamitra have been understood as credit channeling agencies rather than as independent financial intermediaries. Most important appears to be that the findings described above do not show that Bank Bukopin requires its partners to comply with prudential financial benchmarks such as those applied in CAMEL rating systems for BPR and LDKP.

The vast majority of Swamitra partners are cooperatives; especially KUD that have been used by the government to channel targeted and subsidized credit. Bank Bukopin started the Swamitra program also to improve the public image of cooperatives by a business-oriented and professionalized management system. As the cooperative system lacks accountability, effective supervision and compliance with prudential banking practice, the success of the Swamitra program depends highly on Bank Bukopin’s own role in supervising its partners and enforcing sound management practice. Furthermore, Swamitra partners would not be able to become successful and growing financial intermediaries, if Bank Bukopin treats them as credit channeling agencies, thus undermining the institutions’ own savings mobilization function.

Tempat Pelayanan Simpan Pinjam

The TPSP program is prudentially supervised by BRI. Reliable BRI data indicate that the program suffers from typical weaknesses of programs aiming at setting up a large number of institutions in short time. TPSP have been highly dependent on government grants, and most of them have not been able to develop into sound and sustainable institutions. The ProFI appraisal mission, however, found also well-functioning TPSP, which meet the demand of villagers without access to other financial institutions. The gap of sustainable financial services in rural areas exists at the village level. The TPSP model may become a staring point for the development of village-level financial institutions and deserves, as in the case of BKD and UED-SP (chapter 5), further examination. The successful development of the model, however, requires well-managed and sound cooperatives as umbrella organizations as well as refraining from using TPSP for channeling cheap government funds.

ProFI Microfinance Institutions Study

Chapter 7:

Banking and Microfinance

based on Syariah Principles

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7. Banking and Microfinance based on Syariah Principles

7.1 Promotion and Development of Syariah Banking in Indonesia

The provision of financial services on the basis of Syariah principles (Islamic norms and values) rejects the interest principle, as this principle is assumed to transfer the entire risk to only one side of the creditor-debtor relationship. This argument is often applied to credit interest and the transfer of risk to borrowers only. Syariah banking aims at promoting justice and equality by sharing income or profit/loss in both lending and deposit mobilization. Returns of loans depend on the income or profitability of the borrower’s business, while returns on deposits are paid as a percentage of income or profits of the financial institution. By bringing the viability of project proposals instead of collateral into the focus of lending it is also expected that a broader range of the population, including the poor, will get access to financial services.

Efforts to establish a dual financial system, which comprises both conventional and Syariah financial institutions and services, were intensified in Indonesia in the early 1990s, when the financial system was being deregulated but a regulatory framework for Syariah banking was not yet in place. The Banking Act of 1992 formalized the objective of a dual banking system and authorized the establishment of profit-sharing banks without, however, regulating their operations in detail. The Banking Act of 1998 and special regulations issued by Bank Indonesia in 1999 for both commercial banks and people’s credit banks (BPR) operating on the basis of Syariah principles substantially changed the regulatory framework. The latter regulations elaborate operational aspects of Syariah banking in detail, but they do not differ from regulations valid for conventional banks with regard to general requirements for establishing and operating banks.126

The Banking Act of 1998 extended the definition of Syariah banks and made their empowerment an explicit task of the government. Provisions are made for the establishment of new Syariah banks, the conversion of conventional banks to Syariah banks and the establishment of Syariah branches by conventional commercial banks. All banks providing financial services based on Syariah principles are obliged to appoint Syariah supervision boards with the task to ensure compliance with rules determined by the National Syariah Board. Syariah banks are prohibited from providing conventional financial services and from converting to conventional banks. Commercial banks with Syariah branches have to separate the accounting of these branches from the conventional activities of the bank.

Based on the Central Bank Act No.23 of 1999, which gives Bank Indonesia the authority to develop Syariah banks, Bank Indonesia has been actively engaged in promoting and strengthening the Syariah banking system through four strategies: 127

126 The two main regulations are: Surat Keputusan Direksi Bank Indonesia Nomor

32/34/KEP/DIR tentang Bank Umum Berdasarkan Prinsip Syariah Tanggal 12 Mei 1999 (for commercial banks); Surat Keputusan Direksi Bank Indonesia Nomor 32/36/KEP/DIR tentang Bank Perkreditan Rakyat Berdasarkan Prinsip Syariah Tanggal 12 Mei 1999 (for people’s credit banks).

127 See: Bank Indonesia, The Policy and Progress of Sharia Banking Development, Jakarta, August 1999.

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a. strengthening and improving the legal and regulatory framework for the dual banking system;

b. developing networks of Syariah banks to broaden access to Syariah banking products and services, and creating an inter-Syariah bank market;

c. creating monetary instruments that support both monetary objectives at the macro-level and operational objectives of Syariah banks;

d. promoting the Syariah banking concept to the public, and developing human resources for Syariah banking.

Further support has been provided to small financial institutions operating according to Syariah principles in the form of liquidity credit, first through Bank Indonesia and later through PT. Permodalan Nasional Madani (PNM), the state-owned finance company to which part of the liquidity credit programs was transferred in 1999/2000. PT. PNM maintains a division for small and Syariah financial institutions, which finances and places capital based on the income-sharing principle as well as managers and commissioners in Syariah BPR, BMT (see below), Pesantren cooperatives (see chapter 6), and secondary savings & credit cooperatives.128

Syariah commercial banks. Bank Muamalat was established in November 1991 and was licensed as the first commercial Syariah bank by the Ministry of Finance in May 1992. In 1993, Bank Muamalat sponsored the establishment of the first Islamic insurance company, Syarikat Takaful Indonesia, and became one of its shareholders. In November 1999, Bank Susila Bhakti converted to Bank Syariah Mandiri, the second Syariah commercial bank currently operating in Indonesia. As of September 2000, both banks had 21 branches. Three conventional commercial banks (Bank Negara Indonesia, Bank IFI and the Regional Development Bank in West Java) had established 7 full-fledged Syariah branches. According to Bank Indonesia, also other commercial banks (Bank Tabungan Negara, Bank Rakyat Indonesia, Bank Bukopin, Bank Niaga) have shown interest in setting up Syariah branches.129

Syahriah BPR. In the early 1990s the Moslem mass organization Nahdlatul Ulama started to set up Syariah BPR in cooperation with Bank Summa, which later was liquidated as a result of one of the country’s biggest bank scandals. The objective of establishing 2,000 new Syariah BPR130 could by far not be achieved. As of September 2000, only 79 of the 2,426 BPR in Indonesia operated on the basis of Syariah principles. The number of Syariah BPR had increased only by 8 institutions since March 1997. 47% of the 79 Syariah BPR are concentrated in West Java (17) and the greater Jakarta area (20), and a further 28% are located in East Java (6), South Sulawesi (6), Aceh (5) and North Sumatra. According to Bank Indonesia reports, 39 of the 79 Syariah BPR operated at a loss as of March 2000.

128 See: T. Fauzan, PT. PNM, Konsep Permodalan Madani Dalam Pengembangan Lembaga

Keuangan Mikro, Seminar dan Lokakarya Memberdayakan Ekonomi Rakyat Melalui Keuangan Mikro, Bandung, September 2000.

129 See: Bank Indonesia, Laporan Triwulan II and Laporan Triwulan III, 2000 (quarterly reports of Bank Indonesia).

130 See: BPR dan Pelepas Uang, Kompas, 27 June 1990.

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Apart from Syariah banks, there are also non-bank microfinance institutions and microfinance programs providing financial services based on Syariah principles. The most important non-bank microfinance institutions in this respect are the Baitul Maal wat Tamwil (BMT), which are organized by the national non-government institution Yayasan Inkubasi Bisnis Usaha Kecil (YINBUK) and its regional chapters. The government of West Java in cooperation with its Regional Development Bank has recently initiated a microfinance project (Dakabalarea) that works according to Syariah principles. Both approaches as well as the microfinance activities of Bank Muamalat will be described in the following.

7.2 Bank Muamalat Indonesia (BMI)

The establishment of Bank Muamalat Indonesia (BMI) was initiated by the Indonesian Council of Ulamas (MUI) and realized in November 1991.131 After a phase of preparation and training of executives and staff in cooperation with Bank Islam Malaysia, the bank obtained a business license in May 1992 and started to operate with an initial paid up capital of Rp. 106 billion. BMI received support from President Suharto, the Association of Indonesian Muslim Intellectuals (ICMI), and the Muslim business community. Among the 227 founding shareholders were ministers and ex-ministers of the Suharto government as well as several business tycoons of or closely related to the Suharto family.

BMI formulates its mission as to “assist in the development of the nation's economy, primarily, by enhancing the role of the Muslim people and entrepreneurs and maximize its economic value to its shareholders, while addressing its social responsibilities, in line with Islamic teachings.” BMI also “strives to be a catalyst in developing viable Islamic financial institutions.” BMI products were designed with emphasis on the promotion and servicing of small and medium enterprises. BMI’s deposits and financing products cover the entire range of banking services. BMI provides returns on investments (deposits) as a percentage of its gross income. Time deposits below Rp. 2 million or USD 1,000 are rewarded with an income share of 60%. With regard to larger time deposits the percentage income share varies according to deposit maturities. The individual customer is rewarded in accordance with his/her share in the total amount of funds mobilized from third parties.

BMI partnership with Syariah BPR and BMT (Muamalat-Net)

BMI’s concept of developing outreach to various population groups, small and micro enterprises is called Muamalat-Net, a network between BMI, Syariah BPR, BMT and Syariah cooperatives, and aims at supporting the economy of the Muslim community. Within this network, BMI provides refinance to BMT and takes over financing contracts (loans) exceeding Rp. 50 million. Syariah BPR are responsible for financing borrowers with amount between Rp. 5 and Rp. 50 million, and BMT finance borrowers with amount of up to Rp. 5 million. The concept includes the upgrading of customers to the next higher level and institution.

131 The following information was mainly obtained from the BMI website and: Bank Muamalat

Indonesia, Peran Lembaga Keuangan Syariah Mitra (BPRS&BMT), Presentation of the Mualmalat-Net Concept, without year.

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Commercial financing is provided to developed small-scale enterprises by BMI or in the form of two-steps loans through Syariah BPR. BMI and Syariah BPR function as sales points or channeling agencies of subsidized financing programs such as those for cooperatives and their members. Syariah cooperatives/BMT finance microenterprises and target groups below the poverty line with funds obtained from poverty alleviation and social safety-net programs. Furthermore, Syariah BPR and BMT function as payment points for BMI services such as collecting phone and electricity payments.

7.3 Yayasan/Pusat Inkubasi Bisnis Usaha Kecil (YINBUK/PINBUK)

Yayasan Inkubasi Bisnis Usaha Kecil (YINBUK) or the Foundation for the Incubation of Small Businesses is a non-government organization, which was founded by the chairman of the Indonesian Council of Ulamas (MUI), the chairman of the Association of Indonesian Muslim Intellectuals (ICMI), and the general director of Bank Muamalat Indonesia in March 1995. Its founder board includes B.J. Habibie, the former president, and its board of advisers consists of former central bank governors and directors, former finance and other ministers, university professors, and business tycoons. The objectives of YINBUK include developing human resources, the people’s economy, and businesses in the field of finance, savings and credit; and the real sector. Its major target groups are micro businesses (annual turnover less than Rp. 50 million) and small businesses (annual turnover of Rp. 50 to Rp. 500 million).

Pusat Inkubasi Bisnis Usaha Kecil (PINBUK) are operational boards of YINBUK operating at the national and provincial level. The national PINBUK is responsible for formulating and promoting the BMT concept; designing BMT development models; designing and implementing training; monitoring and evaluating BMT performance; establishing links to various other institutions and resources; providing business certificates to BMT and protecting the operations of BMT without legal status. Each regional PINBUK has its own boards of founders and advisers, and is legally and organizationally independent from the head office.

The promotion and establishment Baitul Maal wat Tamwil (BMT) as non-bank savings and credit institutions based on Syariah principles was initiated in response to the failure to rapidly expand Syariah bank networks and to the experience that the majority of the Moslem population, especially low-income groups, had no access to financial services based on Syariah principles.132

7.4 Baitul Maal wat Tamwil (BMT)

7.4.1 General Description

The term Baitul Maal wat Tamwil expresses the BMT’s social and business mission. The social mission, traditionally known as baitul maal, consists of the cost-free use of donations (zakat, infaq, shodaqah,) mobilized from the public. The business mission, traditionally known as baitul tamwil, where deposits mobilized are commercially used 132 The following description refers to: Pusat Inkubasi Bisnis Usaha Kecil (PINBUK),

Pemberdayaan Ekonomi Rakyat Melalui Pembinaan Balai Usaha Mandiri Terpadu (B.M.T.) Dalam Rangka Mempercepat Pengentasan Masyarakat Dari Kemiskinan. Pusat Inkubasi Bisnis Usaha Kecil (PINBUK) Sulawesi Selatan, Sistem dan Prosedur Operasional BMT dan Program Kerja PINBUK-BMT Sulawesi Selatan 2000-2003, Makassar, June 2000.

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and placed to productive investments. Sometimes BMT is also used as the abbreviation of Balai Usaha Mandiri Terpadu or Center for Self-reliant and Integrated Business development, thus pointing to self-reliance and integrated assistance as principles of services provided on the basis of revenue or profit sharing.

In December 1995, President Suharto declared the BMT program as a national movement aiming at empowering the people’s economy through institution building and small business development. In the same year, Bank Indonesia and YINBUK signed a memorandum of understanding through which BMT were given the opportunity to participate in the Linking Banks and Self-help Groups program.

The roles and tasks of BMT are seen in developing human resources and supporting small businesses by identifying viable businesses and potential microentrepreneurs, identifying their business needs and investment opportunities, assisting in preparing business plans and providing business consultancy, mobilizing funds from the public, providing or facilitating access to financial services and marketing channels, disseminating information and providing training.

7.4.2 Organization and Supervision

BMT are modeled on cooperative principles, but not all BMT operate as a legal entity. The establishment of a BMT has to be attested by a notary and, if not yet registered as a legal entity, receive a business certificate from the regional PINBUK. BMT statutes are standardized and include subjects such as identity, area of operation, objectives, and business activities based on Syariah principles. Sources of funds are determined as shares of the founding members, compulsory and voluntary savings, donations, loans, and retained profits. The mobilization of voluntary savings, borrowing from other sources of funds, and lending must be based on Syariah principles. 2.5% of annual profits have to be donated (zakat), and a minimum 10% (after zakat and tax) each have to be allocated to reserves and to compensation funds for management and commissioners. The allocation of the remaining profits is subject to decisions of the general meeting of members.

Membership is limited to the working environment of a BMT. In accordance with the cooperative law, the establishment of a BMT requires at least 20 founding members. Larger BMT split their members into sub-groups. BMT members must be willing to deposit money as working capital and to accept the principles of joint liability. The member assembly is the highest authority of the BMT organization and has to be carried out at least semi-annually. Decisions are taken by the one-member-one-vote principle. It is important to understand that a difference is made between founding and other members, which are entitled to receive BMT services. It seems that only founding members are involved in decision-making processes.

The (founding) member assembly elects a supervisory board or board of commissioners, which represents the founding members and determines general policies during meetings, which have to be carried out at least once a month. The BMT management consists of at least three persons but, depending on BMT size, may comprise the following six positions: 1) general manager, who is responsible for BMT operations, work planning, operational policies, reporting and financing (loan)

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approvals; 2) financing manager, who is responsible for servicing, guiding and supervising borrowers as well as for planning, analysis and reporting in the field of financing; 3) fund manager, who is responsible for the design of deposit products, fund mobilization and administration; 4) accountant, who is responsible for the financial administration and reporting, and the calculation of income and profit sharing; 5) cashier, who is responsible for financial transactions and daily cash administration; and 6) real sector manager, who is responsible for marketing and dissemination market information.

BMT operations are supported by detailed job descriptions, standardized administration and procedures, and operating manuals, which describe the accountancy system, explain each account and accounting procedures, and introduce financial statements and reporting formats. The BMT are required to prepare monthly reports and forward them to the regional PINBUK. PINBUK functions as the BMT regulator and supervisor. On-site inspections should be carried out at least semi-annually. Transportation and accommodation costs of supervisors have to be fully borne by the BMT. In South Sulawesi all operating costs of PINBUK (Rp. 11.8 million per month) are covered by the BMT depending on their net profits (from 27% of net profits up to Rp. 200,000 to 13% of net profits of more than Rp. 2 million).

7.4.3 Number, Outreach and Financial Situation

The national PINBUK made available BMT data for November 2000. Information about loan portfolio quality and the soundness of BMT was not available. The author had also the opportunity to visit the PINBUK in South Sulawesi and two of its BMT.

PINBUK reports the outstanding number of 2,914 BMT, whereas only 879 BMT reported to PINBUK and are included in the financial statistics. The information made available by PINBUK does not clarify whether the remaining vast majority of BMT did only fail to report or have terminated their operation. According to another source133 only 30% of the BMT established since the beginning of 1990s are still operating. Furthermore, the national PINBUK reports a higher number of BMT for South Sulawesi than the information made available by the regional PINBUK (see below). Therefore, it is most likely that the national data considerably overstate the number of existing BMT. The following description refers only to the 879 BMI, for which financial data were made available.

BMT operate in all of the Indonesian provinces, but more than half of the 879 institutions BMT are located in Java (451) with a high concentration in West Java (154) and Jakarta (100). BMT are also strongly represented in South Sulawesi (115). The only other stronghold in East Indonesia is West Nusa Tenggara (54). This 70% of the BMT are concentrated in Java and the latter two provinces.

As of November 2000, the average BMT had an outreach to 199 deposit customers and 83 borrowers. These averages, however, vary considerably between the regions. The BMT in Kalimantan had 454 deposit accounts and only 70 loan accounts, whereas the BMT in the eastern parts other than Sulawesi had 220 loan accounts and 223 deposit accounts, on average. The ratio between loan and deposit accounts shows an 133 Tazkia Institute, BMT: Terus Maju atau Mundur, October 2000.

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even higher variance between the provinces, ranging from 1:0.7 in Irian Jaya to 1:18 in Bali. The average number of loan accounts per BMT ranged from below 10 in Riau and Central Kalimantan to 1,328 in Irian Jaya. The average number of deposit accounts per BMT ranged from below 10 in Riau to 943 in Irian Jaya.

Table 7.1 Number and Outreach of BMT (November 2000)

Indicator Sumatra Java & Bali

Kali-mantan Sulawesi Other E.

Indonesia* Total

Number of BMT 427 2,061 64 225 137 2,914

Number of reporting BMT 141 466 26 163 83 879

Deposit accounts

Number of accounts 17,331 79,483 11,814 47459 18,495 174,582

Average number per BMT 123 171 454 291 223 199

Avg. amount per acc. (Rp. ,000) 149 128 438 559 97 265

Loan accounts

Number of accounts 8,109 30,883 1,826 14,284 18,239 73,341

Average number per BMT 58 66 70 88 220 83

Avg. amount per acc. (Rp. ,000) 412 384 2,778 1,948 172 698

Source : Pusat Inkubasi Bisnis Usaha Kecil, Jakarta.

According to the data provided by the national PINBUK, BMT customers had deposited an average amount of Rp. 265,000. Average deposit amounts were lower than Rp. 200,000 in 19 of the 26 provinces, whereas they were larger than Rp 1 million in Central Kalimantan (Rp. 1.2 million) and Riau (Rp. 4 million). The average loan amount outstanding was Rp. 698,000 for the entire BMT industry, while it ranged extremely from Rp. 84,000 in Central Java to Rp. 27.5 million in Riau.

The interpretation of this extremely high variance in outreach scope and depth is not easy. It is likely that the BMT industry consists of institutions that have operated for many years as well as of institutions that were only recently established. BMT are urban and rural institution, and operate in economically favorable or less favorable regions. Apparently, they serve both low-income households and clients with rather high savings and credit absorption capacities. The variance in loans to deposit ratios, both in number and amount, points to different types of financial intermediation. There are BMT with low degrees of savings mobilization and scarce loanable funds. Other institutions collect many small savings from a large number of customers in order to serve fewer borrowers with larger loans. And there appear to be BMT that collect large deposit amounts from few customers to serve few borrowers with large loans.

It is necessary to point to a further possibility of this variance, namely the lacking reliability of the national statistics. Calculations could only be made on the basis of regionally aggregated data. These provincial data reveal some inconsistencies and improbabilities that point into this direction. One example is the case of Riau where, according to the national PINBUK data, 36 BMT had 2 borrowers with loan amounts outstanding of Rp. 27.5 million, on average.

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Table 7.2 Assets and Balance Sheet Structure of BMT (November 2000)

Indicator Sumatra Java & Bali

Kali-mantan Sulawesi Other E.

Indonesia* Total

Assets (Rp. million) 5,390 19,156 6,872 54,887 4,532 90,836

Average per BMT (Rp. million) 38 41 264 337 55 103

Loan portfolio (Rp. million) 3,338 11,846 5,073 27,820 3,142 51,219

As % of assets 61.9 61.8 73.8 50.7 69.3 56.4

Deposits (Rp. million) 2,589 10,194 5,170 26,511 1,790 46,254

As % of assets 48.0 53.2 75.2 48.3 39.5 50.9

Equity (Rp. million) 2,102 5,729 824 2,537 2,075 13,267

As % of assets 39.0 29.9 12.0 4.6 45.8 14.6

Source : Pusat Inkubasi Bisnis Usaha Kecil, Jakarta.

The vast majority of BMT are tiny financial institutions, with average assets amounting to less than Rp. 50 million in 16 provinces and exceeding Rp. 100 million in only 4 of the 26 provinces. With average assets between Rp. 320 million and Rp. 465 million, the BMT in East Kalimantan, Irian Jaya and South Sulawesi have reached a financial volume comparable to that of smaller BPR.

As of November 2000, the 879 BMT had 56% of their total assets invested in the loan portfolio. Loans to assets ratios per province usually ranged between 50% and 80%. The BMT in Jambi, Bengkulu, East Java and Southeast Sulawesi, however, had placed less than 40% in their loan portfolios. Information of loan portfolio quality was unfortunately not available.

Deposits contributed 51% and equity capital 15% to the industry’s total liabilities and equity. Information on loan capital and profits was not available. Based on the data available it can be estimated that loan capital made up between 25% and 30% to total BMT funds. In the provinces of Yogyakarta, Bali and West Kalimantan deposits financed more than 70% of assets, whereas more than 70% of the BMT funds in Jambi and Bengkulu were made up of equity. Loan capital contributed more than 50% to the total liabilities and equity of the BMT in East Java and Southeast Sulawesi.

While more than half of the 879 BMT are located in Java, South Sulawesi is the stronghold of the BMT industry in terms of financial capacity. It is striking that more than 50% of the assets, deposits and loans outstanding of the reporting BMT is concentrated in this province. With average assets of Rp. 465 million, the BMT in South Sulawesi exceed average assets of the entire industry by almost 5 times, although their outreach in terms of loan accounts is not higher than the overall average and their outreach in terms of deposit account is only 1.5 times as high as the overall average. The author visited the PINBUK in South Sulawesi and two of its BMT during a ProFI appraisal mission. Some findings of this mission are presented below.134

134 See also: Flora Giassemi, Wolfram Hiemann and Detlev Holloh, Appraisal of the Proposal

“Development and Upgrading of Microfinance Institutions in Indonesia”, Project Promotion of Small Financial Institutions, Denpasar, September 2000.

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7.4.4 BMT in South Sulawesi

The data made available by the PINBUK in South Sulawesi differ considerably from those provided by the national organization. PINBUK South Sulawesi has been aiming at establishing 368 BMT, but only 93 BMT were operating as of June 2000. These institutions had a total amount of assets of Rp. 23 million or Rp. 247 million, on average. Though the national statistics were prepared for November 2000, it is most unlikely that the BMT in South Sulawesi experienced the outstanding growth indicated by the national statistics within four months only. This questions the usefulness of the national statistics. Also the regional report did not make a good impression. It did not follow the standards determined in PINBUK/BMT manuals, were partly inconsistent and incomplete. Data were up to date (June 2000) for only 37 of the 93 BMT, while other information was derived from BMT reports dating back up to February 1999.

Nonetheless, the report and additional information collected during the mission provide a rough overview of the structure of the BMT industry in South Sulawesi. The vast majority of the BMT are tiny institutions, which resemble self-help groups rather than non-bank financial institutions. 59% of the BMT had assets smaller than Rp. 50 million, and in a further 12% of the cases assets did not exceed Rp. 100 million.

A large number of the tiny institutions are Pesantren (Islamic schools) pre- cooperatives or cooperatives. These small group-like BMT often highly depend on access to governmental credit programs as a source of funds. Sometimes they seem to have been established because of this opportunity. Examples for this sort of BMT are two Pesantren pre-cooperatives, which had 20 and 31 members and assets of only Rp. 8 million each. 63% of their total funds consisted of loans received from a governmental poverty alleviation credit program, whereas deposits contributed only 5% to their total liabilities and equity. A similar situation was found in three non-BMT Pesantren cooperatives, which had received Rp. 15 million each from this credit program, while their assets amounted to between Rp. 15 million and Rp 20 million only.

At the other end of the scale are a few BMT with assets comparable to that of BPR. 10% of the institutions had assets between Rp. 250 million and Rp. 500 million, and in 5% of the cases assets exceeded Rp. 500 million. The largest BMT in South Sulawesi had assets amounting to Rp. 4 billion. It had reached this size mainly by an outstanding success in savings mobilization. Deposits financed 79% of its assets. 58% of its assets were loans outstanding to only 235 borrowers. With an average amount of loans outstanding of Rp. 9.9 million, the institution seems to serve a clientele rather different

Table 7.3 BMT in South Sulawesi (June 2000)

Number of BMT 93

Average assets (Rp. million) 247

< Rp. 50 million (% of BMT) 59.1

Rp. 50 – < Rp. 250 million (% of BMT) 25.8

Rp. 250 – Rp. 500 million (% of BMT) 9.7

> Rp. 500 million (% of BMT) 5.4

Loan portfolio as % of assets 62.9

Average number of loan accounts 134

Small trading loans (%) 73.3

Average amount per account (Rp. million) 1.2

Deposits as % of assets 62.9

Loan capital as % of assets 25.9

Equity as % of assets 9.8

Profits as % of assets 1.4

Source: Pusat Inkubasi Bisnis Usaha Kecil, Makassar.

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from that suggested by the poverty alleviation objective of PINBUK. Two other large BMT with assets exceeding Rp. 1 billion served their borrowers with lower loan amounts. The average loan amounts outstanding of Rp. 1.2 million in the first and Rp. 2.4 million in the second case, however, are still considerably higher than usually found in microfinancial institutions. A major difference between the latter two BMT was the degree to which they mobilized savings. Deposits contributed 75% to total liabilities and equity of the first institution, whereas the second institution depended mainly on its equity capital and loan capital as sources of funds. Deposits contributed only 3% to its total liabilities and equity.

7.5 The Dakabalarea Program of the Government of West Java 135

Dakabalarea is the acronym of the development strategy formulated by the government of West Java.136 The Dakabalarea credit program is intended to contribute to this strategy, in general, and to empowering micro and small entrepreneurs through easy access to financial services based on Syariah principles, in particular. The program was launched in August 1999 and was a response to the ongoing financial and economic crisis.

The Dakabalarea program is essentially a rotating fund (Rp. 12 billion) fully financed by the government, with the Regional Development Bank (BPD) of West Java functioning as the channeling agency. The rotating fund is accompanied by a support system consisting of government agencies at various levels and university graduates, who were recruited for this purpose and are responsible for the preparation of business proposals and loan applications.

Finance is provided to groups of micro and small entrepreneurs (5 to 15 members) through “People’s Economy Institutions” (cooperatives of Muslim organizations, BMT and NGOs). Project proposals are assessed on the basis of business viability. 10% of the loan principal has to be deposited as partial collateral. Group and member savings are not required to access finance.

Loans usually have a term of one year, and the maximum loan amount is set at Rp. 2 million. The sharing of profit is agreed upon between the borrower and the bank, and is limited to a maximum of 10% of the loan principal per year. The bank does not participate in profit sharing. The government bears the entire risk and compensates the bank with a fee equivalent to 1% of the loan amount disbursed. Loan loss provisions are not made. The profit share received from borrowers is allocated to the groups and “People’s Economy Institutions” (50%), to the technical guidance teams (25%), and to the technical support staff (25%).

135 Sources: Pemerintah Propinsi Jawa Barat, Dakabalarea sebagai Program Pemberdayaan

Ekonomi Rakyat; Iwan Abdurrahim, Bank Jabar Tasikmalaya, Dakabalarea; Bambang Sutrisno, Konsultan BI Bandung, Evaluasi Program Kredit Dakabalarea. The papers were presented at the Seminar dan Lokakarya Memberdayakan Ekonomi Rakyat melalui Keuangan Mikro, Kerjasama Bank Indonesia Bandung, Pusat P3R Yayasan Agro Ekonomika, Bandung, Pemerintah Propinsi Jawa Barat, 7 - 8 September 2000.

136 The strategy consists of six objectives: sufficiency in food supply, increase of purchasing power, improved quality of human resources, improved public services, continuous reform, and development of productive businesses to alleviate poverty and increase welfare.

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As of July 2000, the program had disbursed Rp. 9.3 billion to 10,113 borrowers in 714 groups. Loans outstanding amounted to Rp. 8.6 billion and arrears to Rp. 112 million. The average loan size was Rp 13.1 million per group and Rp. 924,000 per member. Between different program areas, individual loan amounts ranged from Rp. 237,000 to Rp. 3 million.

A program evaluation carried out by a Bank Indonesia team in April 2000 stressed that the Regional Development Bank will make a loss of about Rp. 132 million on the rotating fund of Rp. 12 billion. Despite the high subsidies the program tends to become decapitalized as costs exceed income derived from profit sharing. The program operates with a technical support staff of 182 university graduates, while the evaluation team regards a number between 64 and 96 persons as optimal. Other constraints identified are the bureaucratic program organization involving too many parties to ensure fast credit procedures. It is argued that the lacking incentive system has been deteriorating motivation and quality. Groups do not have to mobilize savings internally, thus often being established only for the purpose of getting access to finance.

An interesting observation made by both the evaluation team and the BPD branch in Tasikmalaya is the difficulty of making the profit sharing principle acceptable to intermediaries and borrowers. As people are used to calculate and compare costs of borrowing in the form of interest rates, the costs of profit sharing are often thought to be higher than comparable interest rates. Many groups have not yet understood the profit sharing principle and find it too difficult to calculate profit, particularly because proper records for their members’ micro businesses are not available.

7.6 Assessment and Conclusions

The Indonesian Government and Bank Indonesia have been promoting banking and microfinance on the basis of Syariah principles since the 1990s. This promotion was also accompanied by the hope that a dual banking system and non-interest-based financial services would contribute to alleviating systemic problems incurred during the financial and economic crisis, such as high costs of funds, negative interest margins and the standstill of financial intermediation.137 Various Moslem organizations have been especially promoting Syariah BPR with the aim to establish several thousands of these institutions. With regard to microfinance it was hoped that non-interest-based financial services would be better able to reach microentrepreneurs and the poor as well as to contribute to equitable development.

These objectives could not yet be realized. The development of Syariah banks, with only 2 commercial banks and 79 BPR, is still in a rudimentary stage. The financial and economic crisis has also adversely affected Syariah banks. There is no sign that Syariah banks have been performing better than conventional banks. As mentioned above, more than half of the Syariah BPR operated at a loss as of March 2000.

According to Bank Indonesia (see last footnote), the development of Syariah banking has been suffering from three major problems, namely a) the problem that benefits offered by Syariah banks have not been fully recognized by the public that is still used

137 See: Bank Indonesia, The Policy and Progress of Sharia Banking Development, Jakarta,

August 1999.

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to conventional banking services, b) the lack of Syariah banking infrastructure such as inadequate networking and the lack of liquidity and monetary instruments, and c) the lack of human resources and expertise for Syariah banking.

The major argument used in Indonesia to promote financial services based on Syariah principles has been that loan interests transfer the entire risk to the borrower. While prudential Syariah financing can certainly claim certain advantages, the argument often neglects the fact that all types of banks are exposed to the risk that the loan principle may not be repaid in cases of business failures or moral hazard. This risk cannot be transferred and has been experienced by both Syariah and conventional banks, especially during the financial and economic crisis. The argument also tends to ignore that both sides of financial intermediation have to be taken into account. In the case of bank failures, unprudential lending and deteriorating profitability of Syariah banks, risks are transferred from the bank to deposit customers.

These theoretical advantages or disadvantages, however, are not crucial for the current development of Syariah banking and microfinance in Indonesia. Prudential management practice and effective supervision given, it can be expected that Syariah banking will grow in the future and become a viable alternative to conventional financial institutions. A major problem, especially with regard to Syariah microfinance initiatives, appears to be that fallacies of conventional microfinance have been continued.

The first fallacy is to focus on quantitative objectives, which are determined by normative decisions taken at central levels without taking into account local conditions. This has not resulted in a high growth of sustainable financial institutions. The performance of Syariah BPR, BMT and the Dakabalarea program is less than satisfying.

The second fallacy is the high emphasis on credit. Great parts of the microfinance world in Indonesia have not yet discovered voluntary savings as the second side of microfinance. Microfinancial institutions of any type will fail to grow and to sustain their function as independent financial intermediaries, when they do not meet the demand for various savings instruments and focus on savings mobilization.

The third and related fallacy is to understand microfinance as the channeling of credit funds made available by the government. Many BMT highly depend on these funds or even were established because such funds were available. The Dakabalarea program focuses on quantitative credit targets, while ignoring profitability, viability and sustainability. The author is not aware of examples where the long history of channeling governmental credit funds, especially of targeted and subsidized credit, in Indonesia has resulted in a sustained and growing access to financial services, particularly for low-income groups. Instead, programs become decapitalized and the development of viable institutions is undermined.

The fourth fallacy is that concepts and instruments are often well designed but in practice not effectively applied. This is the case for the internal management of programs and institutions as well as for external supervision. A major problem in this context is the prevailing low quality of information systems or the bad quality of information produced by such systems.

ProFI Microfinance Institutions Study

Chapter 8:

Towards a Microfinance Sector Strategy:

Major Issues and Elements

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8. Towards a Microfinance Sector Strategy: Major Issues and Elements

8.1 Major Microfinance Sector Issues

8.1.1 Demand for Microfinance Services

The demand for microfinance services varies between and within regions. Though thorough studies are required to assess local conditions of developing viable microfinance institutions, it is safe to argue that the existing demand is only partly met by institutional microfinance and provides the opportunity to either expand the outreach of existing microfinance institutions or to establish new microfinance institutions. This is also reflected in the sustained role of informal credit and its high interest rates, the rationing of scarce loanable funds often found in small financial institutions and credit programs, the prevailing role of program credit, the difficulties of savings and credit groups in meeting their members’ credit demand, the need of microfinance programs to upgrade their clientele to more sustainable microfinance providers, and the high transaction costs of households to access institutional microfinance in remote areas.

Demand for microfinance services is not a general demand but a demand of a particular clientele in a particular location for a particular savings or loan product. This is often not reflected by centrally designed credit programs and products of small financial institutions. Low-income households first of all need savings instruments that enable them to effectively manage their liquidity and finance special expenditures. This demand for savings instruments is often confused with the demand for business credit. The microfinance sector comprises borrowers with highly varying credit absorption and repayment capacities. The microcredit clientele ranges from tiny family businesses characterized by subsistence orientation, low productivity and high volatility to fast-growing businesses with features such as entrepreneurship, differentiation from the household economy, and the potential to graduate to the small enterprise sector.

At the bottom of this scale are households that are the typical target group of poverty alleviation programs. Both the high credit risk and the non-financial needs of this clientele require program interventions that include more than credit alone. At the top of this scale are borrowers who have grown out of poverty and have access to BRI units. In between are various sub-groups of low-income households and microentrepreneurs that are potential customers of both microfinance programs and microfinance institutions. The boundaries between these levels are fluid and microcredit may contribute to upgrading clients to higher levels.

The crucial issue to which this rather theoretical model would like to point is the need for a microfinance strategy that reflects the varying and dynamic local demand for microfinance services, works with multiple and locally adjusted approaches to giving different clienteles access to appropriate microfinance programs and institutions, and focuses on upgrading clients from microfinance programs to viable microfinance institutions, thus sustaining their access to microfinance services.

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8.1.2 Supply of Institutional Microfinance

BRI Unit System. With its sound, profitable and self-sustained network of 3,700 units and an outreach to some 25 million customers the BRI unit system is the backbone of the rural financial system in Indonesia. Especially the units’ savings products allow a large number of low-income households to effectively manage their liquidity. However, the system’s outreach to the village level is limited, and BRI’s risk-averse lending policy concentrates credit outreach to borrowers with sufficient collateral and fixed income. The future challenge of the unit system is to increase outreach in breadth and depth, while maintaining its financial self-sustainability. The high profitability and liquidity of the system given, it is not unreasonable to expect BRI adopting a less risk-averse lending policy and expanding the units’ credit outreach to rural low-income clients.

BPR. With almost 2,500 institutions the BPR industry has become an indispensable financial sub-system in Indonesia. Besides BRI units, BPR are the only banks with a significant outreach to the sub-district level. In some areas they account for one third of the banking industry’s total loan amount outstanding. Nonetheless, the BPR industry has not realized the idea of the 1988 banking reform to develop into a secondary banking system with a nationwide outreach to rural low-income groups and the village level. The industry is highly concentrated in Java and Bali, and has been mainly operating in urban and business centers. At least a quarter of the industry is unsound, and its unviable part still has to be cleaned up in order to overcome the industry’s crisis. A considerable part of the remaining institutions face problems such as weak management, low capitalization, lack of savings mobilization and market-orientation. The expansion of the BPR industry through the establishment of new institutions, particularly in economically less favorable areas, is almost impossible since the at least tenfold increase in capital requirements in 1999.

LDKP. With only a few exceptions the development of LDKP remained limited to Java and Bali, and they also lost must of their relevance in Java since LDKP were required to convert to BPR. Currently, the Balinese LPD make up 57% of the 1,600 still active LDKP, and they operate with 77% of their assets and 85% of their deposits. LDKP other than the LPD have considerably suffered from the conversion of their best performing units to BPR. The remaining LDKP industry outside of Bali is characterized by low loan portfolio qualities, low profitability, lack of savings mobilization (except of the BKK in Java), and bureaucratic governance. Their outreach to low-income groups, particularly at the village level, is limited. The analysis of the LDKP industry showed that it will a non-growing industry without the introduction of attractive savings instruments and market-oriented strategies to expand outreach to the village level. It will be an unsustainable industry without the enforcement of prudential banking practice. And, it will be a dying industry without creating a new regulatory framework giving non-bank microfinance institutions the necessary room to move and grow.

The Government of Bali has resisted converting LPD to BPR. The LPD system is the most successful and the only viable system of village-level financial institutions in Indonesia. The vast majority of LPD has evolved into competitive institutions in a province that has the highest density of financial institutions in Indonesia. Their character as community-owned, -operated and -controlled financial institutions as well as their high emphasis on savings mobilization makes the difference to other non-bank

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microfinance institutions. The LPD system can be regarded as a model, though not a blueprint, for the development of non-bank microfinance institutions at the village level.

BKD. Though about 4,500 BKD operate in some 20% of the villages in Java, the BKD industry lacks dynamism and tends to loose its role in the rural financial system. Its organization, operations and products have not been adjusted to the changing local economy and demand for financial services. Without savings mobilization, prudential lending practices, and market-oriented management, the vast majority of BKD have not been able to grow and to develop into effective financial intermediaries. Contrary to the LPD in Bali, BKD depend on decisions of the village bureaucracy, lack effective internal control and a sense of ownership and trust among the village population. BKD were recognized as BPR, but they are neither regulated nor supervised as banks. Adequate support systems for transforming them into functioning banking institutions do not exist.

A vision of transforming the BKD system into a network of sustainable financial intermediaries is presently missing. The realization of such a vision would require getting framework conditions right, getting adequate training and support systems in place, strengthening community ownership, reforming the BKD organization and management, focusing on savings mobilization, and developing innovative products in accordance with the real demand of the potential BKD clientele. Above all, it would require the political will to achieve this objective. This will is currently not reflected in the preferential promotion of cooperatives and the high emphasis on credit channeling.

UED-SP. The UED-SP program has been a top-down approach to establishing or decreeing the establishment of village-level institutions nationwide and in short time. The UED-SP is not owned and controlled by the village community. This together with the emphasis on credit channeling has not resulted in the development of a viable system of village-level financial institutions. The information and supervision systems of the program are weak. There is no reliable information about the number of still operating UED-SP and their performance. Therefore, it is not clear whether existing UED-SP can serve as a starting point for the development of non-bank microfinance institutions at the village level. This development would require the same changes in orientation as mentioned for the BKD system.

Microfinance cooperatives. The cooperative organization of microfinance has a great potential in Indonesia. The Credit Union movement and other independently organized savings and credit associations have demonstrated this. The state-centered promotion and instrumentalization of cooperatives, however, has not produced a large number of viable financial intermediaries with effective member participation and control. While cooperatives are massively used to channel subsidized credit, the cooperative system lacks effective supervision and enforcement of regulations. The prevailing mismanagement and corruption, the unchanged ‘top-down’ and interventionist culture of the local offices of the Ministry of Cooperatives, and the unchecked operation of ‘black’ banks operating under the name of savings & credit cooperatives, has considerably deteriorated the cooperative image and often prevents grassroots organizations from seeking the legal status of cooperatives.

Changing this situation is foremost a political question. It requires a new political consensus about the role of the state in cooperative development. This role would have

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to move from direct intervention, protection and preferential treatment to policy-making required for making rural financial markets competitive, getting legal, regulatory and supervisory frameworks right, and strictly enforcing compliance with regulations and prudential financial practices. This would also require refraining from pressuring village-level savings and credit groups to seek a cooperative license. These groups need time to learn managing their own funds, and often will not develop into larger financial intermediaries. It is neither desirable nor practicable that the state bureaucracy or another supervisory agency oversees some ten thousands of these groups.

TPSP. Microfinance cooperatives other than the credit unions and a number of formalized savings and credit associations usually operate above the village level. One effort to institutionalize cooperative microfinance at the village level is the TPSP program. The TPSP has features similar to that of BKD and UED-SP and also shares their weaknesses. TPSP may serve as a starting point for the development of microfinance cooperatives at the village level. Presently, however, they suffer from the program’s emphasis on channeling government funds and the weaknesses of those cooperatives functioning as TPSP umbrella organizations. Changing this situation requires similar efforts as mentioned for BKD and UED-SP.

BMT. Institutional microfinance on the basis of Syariah principles is primarily provided by BMT, which are non-bank microfinance institutions, often with the legal status of cooperatives. Only a minority of the BMT seems to have developed into financial intermediaries with significant outreach and financial capacities. Most of them are comparable to savings and credit groups. These small institutions often highly depend on access to governmental credit programs as a source of funds. Syariah microfinance, in general, has not yet lived up with the expectation that microfinance based on Syariah principles would be better able to serve low-income groups. This is particularly due to the fact that Syariah microfinance initiatives have not broken with major fallacies of conventional microfinance, especially the high emphasis given to credit channeling rather than to savings mobilization.

8.1.3 General Issues of Microfinance Supply

Outreach scope and depth of microfinance institutions. Despite the large number of microfinance institutions, a great part of rural and low-income households does not have sustainable access to institutional microfinance. Microfinance institutions are highly concentrated in Java and Bali, and they are particularly scarce in the eastern parts of Indonesia. Microfinance institutions such as BRI units, BPR, LDKP and cooperatives operating at the sub-district level have only a limited outreach to rural villages and their low-income groups. Village-level institutions such as the BKD and UED-SP are weak financial intermediaries, which have not been able to grow and meet the demand for microfinance services. Savings and credit groups provide basic financial services, but they are not able to meet the credit demand of their members.

The major demand-supply gap in institutional microfinance exists at the village level. Depending on local conditions, this gap may be closed by a) expanding the outreach of existing BRI units, BPR, LDKP and cooperatives, b) establishing business relationships between these institutions and financial intermediaries at the village level, c) strengthening existing financial intermediaries to develop into viable non-bank financial

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institutions at the village level, or d) establishing new non-bank financial institutions at the village level. The LPD in Bali and the Credit Unions provide two successful models for the latter two options.

Fund mobilization and financial cooperation of microfinance institutions. Successful microfinance institutions such as BRI units, LPD and Credit Unions rely on savings mobilization. These institutions have proved that satisfying the demand of low-income groups for savings instruments is as important as satisfying their demand for credit. They have also proved that savings mobilization is crucial for the sound and sustainable growth of their loan portfolios. The majority of microfinance institutions, however, lack this focus on savings mobilization. This has severely limited their growth and outreach, and deprives them of an important means of screening their borrowers’ creditworthiness. Many of these institutions become unattractive for their customers because they do neither meet the demand for flexible savings instruments nor their increasing credit demand.

Success in savings mobilization also depends on savings capacities varying depending on local economic conditions and the clientele of microfinance institutions. The ProFI studies on BPR and LPD showed that these industries experience both the lack of loanable funds and over-liquidity. An important issue in this context is that most microfinance institutions lack institutionalized forms of financial cooperation through which they are able to access refinance at reasonable costs or to place excess funds to uses with returns higher than yielded on current bank accounts.

A related issue is that microfinance institutions such as BPR, LDKP and cooperatives often depend on governmental credit programs as a source of refinance. These programs are limited in time and amount, and they tend to reverse prudential banking practice. Funds are often dropped before the microfinance institutions have identified eligible borrowers. As fast disbursement is a major success indicator, these programs suffer from inadequate loan appraisals and misallocation.

Alternative refinancing facilities in the form of regular business relationships with commercial banks or finance companies, which can be used at the right time and on the basis of identified demand, are not available for the vast majority of microfinance institutions. A special form of financial cooperation is the linking banks and self-help groups approach. While this approach enjoys a high reputation and there is considerable demand for its continuation, it has been phased out as a program led by Bank Indonesia and supported by GTZ. The approach needs new and strong stakeholders to sustain its success.

Governance of microfinance institutions. Governance is a crucial issue particularly for microfinance institutions owned by or facing high involvement of governments. Local governments possess a large part of the BPR and LDKP. The ProFI baseline survey found that government-owned BPR tend to be governed by bureaucratic command and to lack management autonomy. This corresponds to the weak entrepreneurship and market-orientation in these institutions, and has often negatively affected their performance. LDKP outside of Bali are usually owned by local governments, which at the same time function as policy makers, regulators, supervisors, operators and providers of technical support. This lack of functional

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differentiation has resulted in conflict of interests, weak supervision and enforcement, interference of local officials and fraud. Weak entrepreneurship and market-orientation correspond to bureaucratic governance also in these cases.

Microfinance institutions at the village level may be community-owned and community-controlled as in the case of the Balinese LPD or governed by village officials without effective community control as in the case of BKD and UED-SP. The first institution is usually a much better performer than the latter institutions. The cooperative sector, especially those cooperatives entitled to channel subsidized credit, has been notorious for the lack of effective member participation and control, corruption and high losses. 30 years of government intervention, preferential treatment and ineffective supervision have eroded transparency and accountability. Local officials have sustained their interest in using the cooperative system as their field of appropriation.

Governments can weaken the microfinance sector by bringing political considerations into the operations of microfinance institutions, granting preferential treatment and power to special sub-sectors, and failing to establish prudential regulatory and supervisory frameworks. Improving governance of microfinance institutions requires that governments terminate preferential treatments, limit their functions to policy making and setting of prudential regulatory and supervisory frameworks, that managers of microfinance institutions are autonomous and fully liable with respect to operational decision-making, and that independent supervisory authorities strictly enforce prudential regulations.

The role of microfinance programs. Expanding the outreach of viable microfinance institutions is necessary to sustain the provision of financial services to a growing number of low-income households. This implies long-term institutional development processes that are not able to immediately close the gap between the demand for and supply of institutional microfinance services. The role of program microfinance, therefore, may be seen in closing the demand-supply gap in institutional microfinance. Microfinance programs directly targeting the poor are able to reach clients who cannot yet be served by financial institutions, and they can play an important role in upgrading their target groups to regular clients of microfinance institutions, thus preparing the market for rather than undermining the growth and viability of microfinance institutions.

This role of program microfinance is, by and large, successfully played by the RIGP/P4K project of BRI and the Ministry of Agriculture. The project effectively targets low-income groups without access to financial institutions and provides them with immediate access to credit at commercial interest rates. Most important, however, it has a longer-term strategy that allows microbusinesses to access increasing loan amounts in accordance with gradually growing credit absorption capacities, and prepares its target groups to become individual customers of microfinance institutions, develop independent linkages between joint liability groups and financial institutions, or to develop their own savings and credit associations or cooperatives. The RIGP/P4K project is an example of a poverty alleviation program that is compatible with system-oriented and institutional microfinance sector development strategies. It is, however, also an exception in this respect.

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The prevailing features of poverty alleviation and crisis-related programs with microcredit components are: a) bad targeting, thus resulting in over-lapping of and competition between different programs and serving a clientele that has or could have access to more sustainable microfinance providers; b) emphasis on channeling easy and cheap credit; c) neglect of savings as the first side of microfinance; d) lack of viable institution building for sustaining financial services; e) top-down program design and implementation that neglect locally varying demand for financial services and conditions to sustain these services; f) instant intervention, especially in the form of block grants and subsidized credit, that neglect the need for longer-term and gradual strategies for achieving objectives such as microenterprise development and poverty alleviation; g) lack of prudential program monitoring and credit supervision; h) bad repayment performance and decapitalization of loanable funds.

These features represent a break with recognized microfinance standards. They impair rather than support low-income groups in getting access to sustained and growing microfinance services, and they undermine rather than complement the development of viable microfinance institutions. The flood of donor and government money directed at alleviating poverty and mitigating the impact of the financial crisis has become part of the problem rather than part of the solution in building up sustainable financial services for a growing number of low-income customers.

Coordination and decentralization. The microfinance sector comprises of large number of institutions and programs. Both institutional and program microfinance are important for providing sustainable financial services to an increasing number of low-income households. Wrong design and implementation of microcredit programs, however, can undermine the viability of microfinance institutions and, therefore, the sustained access to microfinance services.

The microfinance sector can also be weakened by incompatible approaches in institutional microfinance or competition between microcredit programs. Evidence shows that programs compete for target groups so that one and the same household participates in various programs. As almost all programs operate with a group approach, it is most convenient and usual for field staff to use groups established by another project for the own one. A competitive environment is an important element of institutional micro finance. The objective to provide an increasing number of low-income clients with access to institutional microfinance, however, is not achieved when one and the same clientele is served by this institution today and will be served by that institution tomorrow.

Coping with these risks would require effective coordination within and between the institutional and program microfinance sub-sectors. Such an effective coordination between the various actors in the microfinance sector does not exist. A crucial problem involved here is that effective coordination is only possible on the basis of a consensus about the essentials of an overall microfinance sector policy. Also such a consensus does not exist. This consensus is difficult to achieve because it is a political rather than a technical question.

Working towards coordination and consensus requires also decentralized concepts because of two reasons. First, socio-economic conditions as well as the existence and

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potential of different types of microfinance institutions vary considerably between and within regions. This situation requires local microfinance sector concepts that reflect existing resources and potentials within the basic parameters of a general microfinance sector policy. Second, the coming implementation of the decentralization laws launched in 1999 will give decision-making and budgetary powers to district and village governments. As these laws also aim at promoting community development and making local governments responsive to the poor, they provide a new framework also for both the development of local financial institutions and the design and implementation of microfinance programs.

8.1.4 Legal, Regulatory and Supervisory Frameworks

Regulation

Since 1999, the licensing of BPR requires a paid-up capital at least ten times as high as before. New BPR were not established since then. While this policy tends to change the BPR character from a local secondary bank to a small primary bank, it practically prevents the establishment of new BPR in rural and economically less favorable areas, and it also severely restricts the upward mobility of non-bank microfinance institutions. This is a far-reaching break with the mission of the 1988 banking reform, which promoted the BPR model to expand the outreach of the banking industry to rural areas and low-income groups. Thus, the BPR model has lost much of its relevance for the future expansion of institutional microfinance.

If the currently valid capital requirements for rural areas will not be revised, the future expansion of institutional microfinance would depend on the development of non-bank microfinance institutions and the legal, regulatory and supervisory frameworks available to them. The present and future status of LDKP needs clarification. According to the banking act and regulations, LDKP are required to convert to BPR or refrain from mobilizing funds from the public. The vast majority of LDKP that have not converted to BPR are either not able or not willing to do so. Those that perform well are usually successful savings mobilizers. Providing LDKP with an enabling regulatory framework, which allows mobilizing savings in their area of operation, would offer them the opportunity to develop into effective financial intermediaries for rural areas and low-income groups. Prohibiting the mobilization of savings would most probably result in stagnation and make the LDKP industry a dying industry. In the case of the Balinese LPD this would kill one of the most if not the most successful community-owned financial institution in the world.

Village-level microfinance institutions other than cooperatives generally lack a clearly defined legal entity and a prudential regulatory framework for their establishment and operation. Initiatives to establish such institutions, therefore, take the form of projects (i.e., UED-SP) that grant room to move outside of regular frameworks available to financial institutions. This situation is unsatisfactory because it does not guarantee effective supervision and enforcement of prudential practice standards. The BKD industry is a special case. The evolution of banking regulations has resulted in the contradictory situation that BKD are licensed but not regulated as BPR. Their future status is vague because they have neither the potential to develop into real secondary

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banks nor are they required to comply with the regulations valid for BPR. The status of village-level and village-owned microfinance institutions urgently needs to be clarified because the development of ‘village banks’ is an important option for closing the demand-supply gap in institutional microfinance.

The liberalization of its regulatory framework, which removed the entry barriers for rural cooperatives, gave the cooperative sector fresh impetus. The cooperative law and other regulations, however, include provisions that are highly questionable and conflict with the banking act. Provisions made legitimate direct government intervention and even require the government to provide protection and preferential treatment. Another provision gives the government the task to pull small informal groups with savings and credit activities into the formal cooperative sector. Small village groups need time to learn managing their own funds, and often will not develop into larger financial intermediaries. It is neither desirable nor practicable that the already overburdened offices of the Ministry of Cooperatives oversee some ten thousands of these groups.

The currently valid regulations for cooperatives with an own savings and credit business do not prohibit mobilizing funds from the public. They lack a clear definition of membership and member candidates, allow providing financial services to members of other cooperatives, and even explicitly speak of financial services to non-members. This is also implied in the provision that cooperatives can be licensed before having deposited the minimum paid-up capital provided that they render services to members only.

Currently, there are two regulatory frameworks available for the establishment of new microfinance institutions. However, as the high capital requirements for BPR exclude the first alternative, all new establishments would have to obtain licenses as cooperatives. This is a highly inadequate and much too narrow framework for the development of viable microfinance institutions, but it corresponds with the strong political tendency to organize the people’s economy within the government-controlled cooperative sector.

Supervision and enforcement

Supervision requires reliable information systems. These are available for BRI units, BPR, BKD and most of the LDKP. Information systems do also exist for other microfinance institutions, but in practice they often fail to produce reliable information required for their effective supervision. Unless banks such as BRI carry out microcredit programs and their supervision, this is also true for many of the government programs with microcredit components. Lack of reliable information and reporting has been a structural, if not often a deliberate, weakness of the cooperative system.

Bank supervision by Bank Indonesia is independently organized and functionally differentiated from the operation of banks. A major issue in this context is that the Central Bank Law of 1999 mandates the transfer of supervisory functions to a new supervisory agency, which has to be established not later than December 31, 2002. The decision whether commercial banks and BPR will be supervised by the same agency is still pending. The capability of this new agency and the smooth transfer of

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supervision responsibility are of utmost importance for improving the soundness of the BPR industry.

The lack of independency and functional differentiation of the supervision function is a major issue with respect to non-bank microfinance institutions, which are usually supervised by provincial governments or local offices of ministries. The same government organizations are responsible to provide technical support, a function that works from inside by means of communication rather than from outside by means of enforcement as in the case of the supervision function. This lack of functional differentiation is even more problematic in the case of most LDKP, which are not only supervised but also owned and operated by provincial governments. The same government offices that are responsible to allocate subsidized credit to cooperatives are also responsible for their supervision, a situation that contributes to creating fields of appropriation. Another issue related to the organization of supervision is that supervisory agencies often lack enforcement powers. This is the case for BRI in its function to supervise BKD and TPSP as well as for Regional Development Banks as the supervisory agencies for LDKP. To improve the soundness of non-bank microfinance institutions supervision and enforcement power must be in one hand, the independency of the supervisory agency must be guaranteed, and the supervision function must be separated from other, incompatible functions.

The designs of the BPR and LPD supervision systems are currently being improved with support from the ProFI project. LDKP supervision systems are not standardized and, as they were partly modeled on the instruments of bank supervision, do often not reflect the particularities of microfinance services. Practicable supervision systems and instruments for village-owned microfinance institutions other than the BKD are lacking. The UED-SP program has a sophisticated system on paper, which is not effectively applied in practice, probably because it is too sophisticated for both staff of the Ministry of Home Affairs and the simple operations of UED-SP. Furthermore, the system confuses program monitoring with the supervision of financial institutions by including non-financial indicators that are not required for measuring the soundness of these institutions. This confusion is typical also for microfinance programs, if at all they care for the soundness of microfinance providers.

While design matters, the crucial issue rather is that existing supervision designs are often not consequently applied and that supervision findings are often not followed by sanctions and enforcement. This sort of ineffective supervision can be found in all microfinance sub-sectors but seems to be most pronounced in the cooperative sector.

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8.2 Essentials and Major Elements of a Microfinance Sector Strategy

The greatest difficulty in the world is not for people to accept new ideas, but to make them forget about old ideas. (John Maynard Keynes)

In the late 1980s and early 1990s the old idea of supporting rural development and alleviating poverty by channeling subsidized targeted credit appeared to be replaced by the new idea of financial systems development as an approach to microfinance. The new idea was increasingly accepted, but the last decade has shown that the old idea is not only forgotten but has regained its predominant role in microfinance policy and practice. The findings presented in this report suggest that new efforts have to be undertaken to make us forget about old ideas, to formulate a realistic microfinance sector policy and strategy, and to identify prudential interventions for strengthening the microfinance sector.

This report concludes with pointing to essentials and major elements of a microfinance sector strategy. A comprehensive and effective strategy has to take into account the high variety of local conditions, on the one hand, and can only be the result of a policy dialogue between the stakeholders of microfinance sector interventions, on the other hand.

Policy dialogue. The microfinance sector comprises a large number of stakeholders with their own and often conflicting policies. This study indicated the need for coordinating these policies. Strengthening a small financial institution with the aim to expand the outreach of microfinance services to low-income households at the village level, for instance, cannot succeed when cheap program credit undermines savings mobilization and the potential market of these institutions. Effective coordination, however, is only possible on the basis of a policy consensus between decision-makers and microfinance sector stakeholders. Creating this consensus by means of a policy dialogue must be an integral part of an effective microfinance sector strategy. A minimal consensus formulates the objective of the microfinance sector strategy and should provide basic guidelines for prudential microfinance sector interventions of different stakeholders.

Core problem and objective. Microfinance is often brought into a too direct relation to poverty alleviation. Poverty consists of various dimensions and poverty alleviation requires a variety of interventions. Microfinance can contribute to poverty alleviation, but it cannot achieve this objective alone. To formulate a realistic and an effective microfinance sector strategy it is important to define the problems it can solve and the objectives it can achieve directly. The core problem to which a microfinance sector strategy can provide a solution is that low-income households and microentrepreneurs with demand for microfinance services have only partly and limited access to sustainable and growing financial services. The core objective of a microfinance sector strategy, therefore, is that an increasing number of low-income households and microentrepreneurs get access to sustainable financial services that meet their demand.

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Poverty alleviation and financial systems development. Microfinance is one component of poverty alleviation, but is also more than this component, particularly when poverty is not narrowly defined by an expenditure poverty line. Microfinance is required to bring people out of poverty, but it is also required to keep people out of poverty and sustain the growth of their microenterprises. The microfinance sector consists of different market segments of low-income groups and microentrepreneurs, which together comprise the majority of the population, and it consists of different microfinance providers, which are necessary to serve the different segments of this market. Keeping people out of poverty and contributing to the sustainable growth of their income and microenterprises requires sustainable financial services provided by a variety of financial institutions. A microfinance sector strategy, therefore, has to be a financial systems development strategy that does not only contribute to poverty alleviation but also to strengthening and integrating the total financial system.

Financial systems development does not necessarily exclude poverty lending as it was sometimes suggested by the international microfinance debate. Microfinance programs aiming at serving the poor or poverty alleviation programs with a microfinance component are necessary to reach target groups that cannot yet be served by microfinance institutions, and they can play an important role in upgrading their target groups to more sustainable microfinance providers and expanding the market of microfinance institutions. To be able to contribute to sustaining and increasing their target groups’ access to financial services poverty lending programs must be demand-driven, have to refrain from replacing savings mobilization by subsidized credit, and should apply indirect approaches through appropriate microfinance institutions, including autonomously organized organizations of the poor.

Sustainable financial services provided to a growing number of low-income customers requires viable microfinance institutions. The core elements of a financial systems development approach to microfinance are strong microfinance institutions and an enabling regulatory and supervisory framework that supports the sound growth of these institutions. The microfinance sector comprises various types of institutions. The findings of this study indicated that all of them will only be able to sustain and expand their outreach to low-income groups if they are demand-driven, savings-driven and adhere to the principles of prudential banking, if their regulatory frameworks give them adequate room to move, and if their supervisory frameworks succeed to enforce their compliance with prudential practice standards.

Basic guidelines for prudential microfinance sector interventions. Adhering to basic guidelines could create synergy between microfinance sector interventions of different stakeholders. Such guidelines are particularly important for integrating program and institutional microfinance into an overall microfinance sector strategy. Based on the findings of this study, the following guidelines appear to be important for prudential program and institutional microfinance interventions.

Program microfinance • Microcredit should be separated from social safety net or emergency programs. • Short-term microcredit interventions should be replaced with longer-term

strategies that support the balanced growth of savings, investment and repayment capacities.

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• Poverty lending should be organized indirectly through appropriate microfinance institutions, and credit channeling should be replaced with demand-led refinance of these institutions.

• A demand-led approach should be applied in facilitating the development of the target groups’ own organizations, thus refraining from forming instant groups for project purposes.

• Emphasis should be given to facilitating access to convenient and safe savings instruments, which allow low-income groups to manage their liquidity and accumulate funds for special expenditures.

• Poverty lending should be limited to target groups that cannot yet adequately served by microfinance institutions.

• Supply-led subsidized credit should be replaced with demand-led credit and interest rates that at least cover the costs of financial intermediation.

• Upgrading target groups to microfinance institutions that provide program-independent access to sustainable financial services should be an integral part of program design and implementation.

• Increased savings, credit absorption, and credit repayment capacities rather than credit disbursement, and the number of beneficiaries graduated from rather than served by a program should be used as success indicators.

• Microfinance programs should only be carried out, if effective supervision of financial transactions and microfinance institutions can be guaranteed.

Institutional microfinance • Regulatory frameworks must be both enabling and prudential to facilitate

expanding the outreach of sound microfinance institutions to low-income customers and areas without sustainable access to financial services.

• Regulatory frameworks should not give preferential treatment and protection to special microfinance institutions, and they should not conflict with each other.

• Supervision systems must be prudentially designed and, above all, they must have the resources and power required to enforce compliance with regulations.

• Supervision agencies must be independent, and the supervision function must be separated from technical and financial support functions.

• Governments should not be owners, managers, and supervisors of microfinance institutions at the same time, and they should not bring considerations other than prudential practice standards into the operation of microfinance institutions.

• Good governance of microfinance institutions requires management autonomy and liability, on the one hand, and effective internal control by special units, staff, members or the village community (depending on the type of microfinance institution), on the other hand.

• For the sake of sustainability and growth both the establishment of new and the operations of existing microfinance institutions have to be demand-driven and savings-driven.

• Emphasis must be given to institution building by strengthening management and market-orientation of existing microfinance institutions; facilitating the establishment of new microfinance institutions that are demand-driven, savings-driven and can fully cover operating costs; developing institutionalized cooperation between microfinance institutions; and developing cooperation of microfinance institutions with financial and technical service providers.

• Governments and donors may subsidize these forms of institution building for a limited time, but they should not subsidize credit.

• Financial assistance provided to microfinance institutions should take the form of demand-led commercial refinance rather than of supply-led and targeted subsidized credit programs.

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Components of a microfinance sector strategy in Indonesia. Besides facilitating the microfinance policy dialogue and the formulation of a microfinance sector policy, there are four broad components of a microfinance sector strategy: a) improving legal, regulatory and supervisory frameworks for different sorts of microfinance institutions, b) institutional strengthening of microfinance institutions, c) institutional innovations or establishment of new microfinance institutions, and d) re-orienting poverty lending and strengthening microfinance programs. The following sub-projects of these components should be considered as elements of a future microfinance sector development strategy in Indonesia.

Improving legal, regulatory and supervisory frameworks • Review the banking act and regulations with the objectives a) to clearly

distinguish BPR as microbanks from non-bank microfinance institutions such as BKD, LDKP and cooperatives, b) to enable non-bank microfinance institutions other than cooperatives to grow by mobilizing savings and time deposits from the public within clearly defined limits (i.e., maximum balance, geographical), and c) to allow for the upward mobility of non-bank microfinance institutions and the downward mobility of BPR that are not able to sustain the BPR status.

• Review the regulatory framework of the BPR industry with respect to capital requirements for the establishment of rural BPR and other regulations that prevent expanding the industry’s outreach to rural areas and low-income groups.

• Provide non-bank microfinance institutions other than cooperatives with an own regulatory framework that a) defines entry, management and operating requirements for sub-district and village-level institutions, b) provides a menu of legal entities available to them, c) allows them to offer certain savings products, d) defines requirements for converting to BPR (i.e., maximum deposit balance, savings mobilization outside of a defined area of operation), and e) establishes a regulatory and supervisory framework for enforcing compliance with prudential practice standards.

• Design and institutionalize a supervision system for non-bank microfinance institutions other than cooperatives, which is independent from ministries and the local government bureaucracy, separates the supervision function from ownership and other functions such as technical support, and gives enforcement power to supervisory agencies.

• Review the cooperative law and regulations for microfinance cooperatives with the objectives a) to withdraw the government from the cooperative sector and strengthen the institutional autonomy of microfinance cooperatives, b) to terminate preferential treatment and protection, c) to strengthen participation of and internal control by members, d) to limit savings mobilization and credit extension to ordinary members, e) to establish an independent and effective supervisory regime, and e) to abandon the explicit task of local officials to ‘motivate’ small informal groups at the village to convert to formal cooperatives.

• Design and institutionalize an effective supervision system for microfinance cooperatives, which is separated from financial and technical support functions of the Ministry of Cooperatives and able to enforce compliance with prudential regulations.

• Focus on making supervision systems of all microfinance institutions effective by detecting non-compliance and enforcing compliance with prudential regulations at fast as possible.

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Strengthening microfinance institutions • Review BRI’s risk-averse unit lending policy with the objective to place more

funds mobilized by BRI units to microborrowers and low-income households, while maintaining the units’ profitability and soundness.

• Clean up the unviable part of the BPR industry and strengthen viable BPR with respect to governance and internal control, fund mobilization and entrepreneurial marketing, credit analysis and supervision, deposit protection and association building.

• Clean up the unviable part of the LDKP industry and strengthen the different LDKP systems by standardizing prudential regulations and effective supervision, granting LDKP management autonomy, replacing bureaucratic governance with market-oriented banking, introducing sound financial management practices and internal control, improving their intermediation function by focusing on savings mobilization, and association building.

• Establish a reliable database of cooperatives with microfinance activities, assess the viability of existing microfinance cooperatives, design and implement pilot-projects for strengthening the self-reliant capacities of microfinance cooperatives, support savings and credit associations to adopt the status of microfinance cooperative provided they are willing to do so and do not become subject to external interventions by doing so, and strengthen the cooperative movement in building up independent secondary support structures.

• Assess the feasibility of transforming the BKD industry into a viable and growing network of village financial institutions; if feasible, plan and implement (at best with BRI as the lead agency) a program aiming at developing BKD into savings mobilizing financial intermediaries that are owned and effectively controlled by village communities.

• Establish a reliable database of other microfinance institutions (such as the UED-SP) that operate at the village level and assess whether these institutions may serve as a starting point for the development of viable village financial institutions; if yes, these institutions should be integrated into the BKD system and its support program.

• Facilitate independent business relationships and technical cooperation between commercial banks and microfinance institutions.

• Facilitate independent business relationships between capable microfinance institutions and financial self-help groups.

• Strengthen NGOs in their capacity to facilitate the development of self-reliant savings and credit associations with and without the formal status of a cooperative.

• Assess feasibility of finance companies (national or local) specialized in providing financial and technical services to microfinance institutions, including savings and credit associations.

Establishing new microfinance institutions • Assess which types of microfinance institutions are locally appropriate and

feasible to close the demand-supply gaps in institutional microfinance, particularly in the eastern parts of Indonesia and at the village level.

• Develop models for viable village financial institutions and, if prudential regulatory frameworks are in place, promote and support the development of these institutions where demand and other prerequisites are given.

• Strengthen or establish local support structures that are capable of promoting and assisting the development of community-owned financial institutions, savings and credit associations and/or microfinance cooperatives at the village level.

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Re-orienting poverty lending and strengthening microfinance programs

• Change direct approaches to poverty lending to indirect approaches through capable banks and microfinance institutions as independent financial intermediaries, and revise program designs and implementation according to the guidelines for prudential program microfinance interventions mentioned above.

• Make the RIGP/P4K project the national program for poverty alleviation through microfinance and complementary measures as included in the P4K approach.

• Expand and strengthen systems-oriented microfinance programs such as the Linking Banks and Self-help Groups approach, and support the development of strong stakeholders for these programs.

The need for local microfinance sector strategies. There is no one and best microfinance strategy. The elements of a microfinance sector strategy listed for the strengthening of existing and the establishment of new microfinance institutions have to be regarded as a menu from which the formulation of area-specific strategies can depart. Effective microfinance strategies have to be developed and agreed upon locally because a) local economies and socio-cultural conditions in Indonesia show a high variance, b) the different types of microfinance institutions are distributed unevenly, and part of them do even not exist in many regions outside of Java and Bali, and c) the implementation of the law on local autonomy will make local governments a major stakeholder also of microfinance sector interventions. The development of a national microfinance sector strategy, therefore, will not become effective, if local resources and particularities are not considered in future approaches.

The most important action that has to be commenced now is carrying out a series of microfinance sector studies at the district level, which identify the local demand for financial services, analyze the existing local resources, and assess the feasibility of different options for strengthening the microfinance sector. This has also to include creating a local policy consensus between the relevant stakeholders of a local microfinance sector strategy.