1 Introduction and background 1.1 Key demographic and economic data The Indonesian people live in an archipelago of more than 13,000 islands extending over some 40 degrees of longitude along the Equator, a span not much less than that of the continental United States. With a population of some 193 million in 1995, Indonesia is the fourth most populous nation (after China, India and the United States). With a total land area of 1.905 million square kilometres, Indonesia’s population density is a relatively modest 100 persons per square kilometre. However, there is great internal variation; the three smaller islands of Java, Bali and Madura with some 7 per cent of the nation’s land area support around 60 per cent of its population. Much analysis of Indonesia’s economic and administrative problems hinges on this distinction between the ‘Inner Islands’ of Java, Bali and Madura, and the ‘Outer Islands’ which have much lower population densities and greater difficulties of transport and communications. These characteristics pose problems for the provision of all services in the Outer Islands, including microfinance. The rate of growth of population in Indonesia has been falling in a sustained manner since the 1970s. At 1.6 per cent per annum between 1990 and 1995, this growth was significantly lower than the rates in Malaysia and the Philippines and was, indeed, below those in all countries in this study other than Sri Lanka and Thailand. The rate of population growth in the Inner Islands is only around 1 per cent — another facet of the Inner/Outer contrast noted above. Indonesia is not yet a highly urbanised society; the urban proportion, at 34 per cent, is below that of other Southeast Asian states discussed here, in particular Malaysia and the Philippines (both above 50 per cent). With GNP per capita of $980 in 1995, Indonesia was classified as a lower middle-income economy by the World Bank. It had experienced quite sustained economic growth since the early 1970s, with per capita GNP growing at an annual 6 per cent over the period 1985–95. Income distribution (with a Gini coefficient of 0.317) was notably more even than in any of the other Southeast Asian countries in this study, and was broadly comparable with the distributions observed in the lower growth environment of South Asia. Commencing in the second half of 1997, and in common with other economies in East Asia, Indonesia has experienced a currency and banking crisis resulting in substantial loss of production, severe open unemployment and rapid inflation. At the time of writing it is becoming clear Indonesia has been much more adversely affected than any other country in the region, and that these events represent a decisive break (or at the least a severe check) in the long-term pattern of growth, with little prospect of its early resumption. Indonesia’s robust growth to 1997 had been accompanied by marked structural change. Agriculture now contributes only 17 per cent of GDP, while industry accounts for some 42 per cent. Agriculture has by no means been stagnant, however; vigorous growth of agricultural productivity has created many opportunities for informal off-farm economic activities with consequent burgeoning demand for microfinance services in the rural economy, especially on Java and Bali. In terms of social development, life expectancy (at 64 years) and the infant mortality rate (at 51 per 1,000) compare somewhat unfavourably with indicators in the other Southeast Asian countries in this study, as well as with Sri Lanka. The adult literacy rate is 84 per cent, and the Human Development Index, at 0.668, is at much the same level as in the Philippines, although well below the levels of Malaysia and Thailand, and slightly below Sri Lanka. 1.2 Poverty Estimates of poverty At the Microcredit Summit in February 1997, the Indonesian Minister of State for National Development Planning tabled figures showing a decline in the proportion of the Indonesian population living in poverty from 60 per cent in 1970 to below 12 per cent in 1996. Some 70 million Indonesians were said to be living below the poverty line in 1970; in 1996 the number was estimated at only 22.6 million. On the face of it, this was a remarkable achievement. The primary data source for measurement of poverty is the periodic national household expenditure survey known as Susenas, conducted since 1964. Since 1976, these data have been used by the Central Bureau of Statistics to calculate urban and rural poverty lines for Indonesia. These are based on estimates of calorific requirements and minimum basic needs for non-food items. An earlier attempt to relate the estimate of poverty to minimum consumption requirements was the poverty line calculated by Professor Sajogyo, dating from 1975 and based on rice consumption per capita. It is still employed in some studies. The World Bank has also estimated the incidence of poverty in Indonesia at intervals since the 1970s. Observers note that despite different estimates of the incidence of poverty at any one time, there is consensus that the trend over time had been for poverty to decline nationally from the late 1960s to 1996. Moreover, the proportion of the population living below the poverty line had declined in both urban and rural areas. Over the thirty years to 1996, while poverty had declined everywhere in Indonesia, the rate of decline was much faster in Java, especially urban Java. The trends were such that by the early years of the next century, the majority of the poor seemed likely to be found in rural areas outside Java. However, the estimate was quite sensitive to the poverty line chosen; raising the poverty line slightly would make a substantial difference to the numbers defined as poor. Thus, despite the remarkable achievements of the New Order government of Soeharto, the 1996 Susenas, which provided an estimate of poverty at less than 12 per cent overall, also showed that between 130 and 140 million people (that is, up to 70 per cent of the total population) spent less than a dollar a day. (For comparison, the urban poverty line was set at Rp1300 (56 cents) per capita per day, and the rural level at Rp900 (38 cents). Moreover, while all deciles of the income distribution had become better off over time, and while the evidence of the Gini coefficient, cited above, indicated a relatively equitable distribution of income by the standards of the region, absolute disparities of income (and hence the perception of relative poverty) had tended to increase. This, together with concerns about the distribution of income and wealth between ethnic groups and between regions of the country, had forced poverty close to the top of the political agenda. Given the vulnerability of that substantial group close to the poverty line, there can be little doubt that the current economic crisis, with its consequences of inflation and unemployment exacerbated by widespread losses of agricultural production due to drought, is leading to marked increases in the incidence of poverty. Income disparities are now an even more pressing political issue, and the likelihood of political, rather than economic, solutions being applied is correspondingly greater. Policies for poverty reduction Indonesia’s primary policy to secure the reduction of poverty has been the achievement of rapid economic growth. A noted observer of the Indonesia economy has commented on the remarkable transformation of the Indonesian economy during the 30-year period to 1995, during which: . . . sustained economic growth at an average rate of more than 6 per cent has more than trebled per-capita income. From near the bottom of the World Bank listing of ‘low-income’ countries, Indonesia has become one of the booming, industrialising ‘middle income’ countries. The proportion of the Indonesian people living in poverty has declined from over 70 to well under 20 per cent. There have been striking improvements in almost every sector of the economy . . . Rapid rise in rice yields has made it possible to reconcile greatly improved standards with food self-sufficiency. . . Remarkable improvements in the literacy and infant mortality rates reflect expansion in health and education services. Rising levels of income and education, reinforced by the effort that has gone into family planning, have yielded a significant decline in the birth rate. Rapid growth of industry and services has created enough jobs for a workforce increasing by more than two million a year without a serious rise in unemployment or underemployment (Arndt 1996). Arndt points to two pieces of good luck enjoyed by the New Order government from the 1970s: the ‘green revolution’ enabling Indonesia to move towards self-sufficiency in rice, and the OPEC oil boom. But other countries experienced green revolutions and/or oil booms, without necessarily handling them well. Arndt believes that: Indonesia’s outstanding economic performance is due to good economic management, prudent macroeconomic policies and, especially during the 1980s, major microeconomic reforms which in successive packages substantially deregulated the banking system and capital market, liberalised trade, facilitated direct foreign investment and reformed the tax system. Indonesia turned its back on the inward-looking strategy of industrial development based on import substitution by highly protected industries and opened its economy to international markets and competition.1 This is not to say that Indonesia had relied exclusively on ‘trickle down’ mechanisms to achieve the reduction of poverty. Major initiatives included the Transmigration Program under which more than 3.6 million people have been resettled by government from Java to the Outer Islands. The Kampung (urban village) Improvement Program is another long-running social program improving the provision of social services and infrastructure to the urban poor. Indonesia’s national family planning program and associated infant and maternal health programs are world leaders in the field. And, as noted above, the New Order government has made substantial investments in education, commencing with the elementary schools. Poverty alleviation became a more explicit element in national development planning during Repelita VI (the sixth five-year development plan, 1993–1998). This reflected growing political concern about regional disparities in income distribution in Indonesia. A special program directed at ‘backward’ village communities (the Inpres Desa Tertinggal, or IDT, program) was launched. It combines grants for the provision of infrastructure for more than 20,000 villages, with grants for microcredit to stimulate economic activities. These are targeted at the poorest one-third of all villages in Indonesia and are designed to address issues of regional, as well as inter-personal, distribution of income. The ‘mass movement’ character of the IDT program is echoed by a somewhat similar program launched in 1996 in response to current political concerns about inequality. Whereas the IDT program is coordinated by BAPPENAS (the national development planning agency) the ‘Prosperous Family’ program is based on infrastructure already in place for the national family planning program and implemented by the National Family Planning Coordinating Board. The initiative is unusual in being conducted outside the framework of the five-year planning process, and in being based on a levy collected outside the framework of the tax code. The Prosperous Family program also employs microcredit as a tool, and is discussed below. The World Bank World Development Report (1997b) noted that it was Indonesian government policy to eradicate absolute poverty within a decade. The Bank suggested that this posed a challenge since the remaining poor ‘are concentrated in isolated pockets of poverty with poor natural resource endowments, low population densities, and other socioeconomic characteristics that make them difficult to reach’, these ‘pockets’ being mostly located in the Outer Islands. However, the priority accorded this goal was indicated by the fact that the former President Soeharto himself chaired a special ministerial-level committee to oversee the national poverty eradication program. 1.3 Overview of the financial system This overview is concerned principally with the banking system, and with the extensive network of small financial institutions supervised by Bank Indonesia, the central bank. It is also necessary to say something about the Indonesian cooperative movement, which occupies an important place in the national ideology. This account reflects the situation in mid-1997 when fieldwork was conducted; substantial structural change in the sector is, however, an inevitable consequence of the economic crisis underway as this study goes to press. Banks within the Indonesian financial system are regulated by Bank Indonesia (although the licensing of banks is the responsibility of the Ministry of Finance, acting under recommendation from Bank Indonesia). All non-bank financial institutions, with the exception of finance companies which are under the supervision of Bank Indonesia, are the direct responsibility of the Ministry of Finance. Under the Banking Act of 1992, there are broadly two kinds of banks in Indonesia. These are the commercial banks and the Bank Perkreditan Rakyat (BPR: literally, ‘people’s credit banks’, more usually translated as ‘rural banks’). Commercial banks ‘provide general banking services with access to the payments system and may also provide foreign exchange services (in fact, about one half of these banks provide foreign exchange services; these are the larger private banks with much more extensive branch networks). The rural banks (or BPRs) do not offer cheque or foreign exchange facilities. Cole and Slade (1996, p.128) describe them as: . . . basically small-scale savings banks; they are limited in terms of location, function, and portfolio composition. They are precluded from taking demand deposits and participating in the payments system. Their main role is to take time and savings deposits and to extend credit. In February 1997 there were 237 commercial banks in Indonesia, with 7,342 branches. Seven state banks had some 1,700 branches between them and there were also 27 commercial banks owned by provincial governments with around 750 branches. Seventy-nine private commercial banks authorised to conduct foreign exchange transactions had some 4,000 branches, while 83 private commercial banks not offering foreign exchange services had some 800 branches. There were in addition 31 joint venture banks and 10 foreign banks. The latter two categories are restricted to locations in a small number of major cities. At the same time, there were in operation some 2,000 rural banks (BPRs) and around 7,300 other rural financial institutions. This latter group consisted of institutions established prior to 1988, when significant changes (described below) occurred in the policy framework for banking. A range of rural financial agencies had developed throughout Indonesia during the Dutch colonial period, and more after Independence; these small financial institutions date from these earlier periods. They go by a variety of names depending on the province where they are located (for example, the Badan Kredit Desa (or village credit institution) dates back to 1898 and there are some 5,300 of these still active and operating in rural Java). Many have a close association with their respective provincial governments and have become self-sustaining rural financial institutions. The seven state banks, among them Bank Rakyat Indonesia (BRI) which was given special responsibility for the rural agricultural sector, also date from colonial times and dominated the financial system until the commencement of financial sector liberalisation in 1983. The removal of restrictions on interest rates for deposits and loans at that time freed the private banks to compete with the state banks and began a shift in their relative importance which has continued until today. Thus, in 1982 the private domestic banks owned slightly less than 10 per cent of all bank assets, while the major state banks controlled almost 80 per cent. By 1988, the private banks’ share of total bank assets had risen to more than 22 per cent and the major state banks held around 69 per cent. Another consequence of the financial sector reforms of 1983 was the commencement of BRI’s small deposit and loan programs, Simpedes and Kupedes, which have subsequently achieved international recognition for their outreach and effectiveness. They were constructed upon the failure of BRI’s earlier programs of rural financing, which had been designed to stimulate rice production, and for which purpose an infrastructure of 3,600 unit desa (village units) had been created. These were deployed to deliver rural financial services in which, following the freeing up of interest levels, rates paid on savings were sufficient to attract deposits while those charged on loans were high enough to cover costs. Over time this rural financial revolution was to transform BRI from a loss-making institution to a profitable one; thus in 1993, Simpedes and Kupedes accounted for about one-sixth of BRI’s balance sheet, but were the principal source of its profits (Cole & Slade, p.109). The trend of relative growth of the private sector was accelerated by further banking sector reforms in 1988. These significantly reduced barriers to the entry of new private banks to the system, as well as facilitating the expansion of existing branch networks. State-owned enterprises were permitted to deposit funds with private banks while the reserve requirements imposed on all banks were substantially reduced, permitting an expansion of bank lending. The number of branches of the major state banks rose from around 850 in 1988 to almost 1,200 in 1994. The number of private banks rose from 63 to 166 over the same period, while the number of their branches rose from around 560 to more than 3,200. By 1994, the private domestic banks controlled more than 44 per cent of all bank assets, while the share of the seven major state banks had fallen to just 43 per cent (Cole & Slade, tables 5.4, 5.5). Central bank officials regard the period from 1988 to 1991 as one of ‘acceleration’ of the liberalisation process, while more recent years have been a period of ‘consolidation’. Several bank crises contributed to a reassessment of policy and the emergence of some re-regulation was a result. A new Banking Act was passed in 1992; this enshrined the basic division of the banking sector between commercial banks and rural banks (BPRs). The latter had also been subject to some liberalisation in the 1988 reforms, which set a minimum capital requirement of Rp50 million as an incentive for small-scale indigenous entrepreneurs to set up these small banks. This stimulated rapid growth in their numbers. By 1992, when the Banking Act was passed, some 850 new rural banks had been established in addition to the thousands of pre-existing rural financial institutions. This law envisaged these institutions upgrading themselves ultimately to meet rural bank standards. A subsequent directive required institutions to conform by October 1997 or cease operations. The law also approved the provision of financial services by BPRs to small urban entrepreneurs; this led to the growth of ‘rural’ banks in urban areas. There are now more than 300 in Jakarta alone. By early 1997, there were some 1,350 of the ‘new’ rural banks and about 650 ‘old’ rural banks from the pre-1988 period. With the rapid growth of bank assets since 1983, and particularly since 1988, the ratio between broad money (M2) and GDP rose from less than 19 per cent in 1983 to more than 46 per cent in 1994. While well below the levels of Malaysia and Thailand, this measure of financial development is comparable with that achieved in the Philippines and higher than in most of the South Asian countries considered in this study. With inflation at 9.4 per cent in 1995, the real rate of interest on short-term deposits was between 5 and 6 per cent. This is a substantial real return to domestic savers and creates an environment conducive to savings mobilisation. Turning briefly to the cooperative system, it is notable that cooperation has a special place in the Indonesian national ideology of Pancasila. The New Order government has promoted cooperatives as a vehicle for government programs since 1967, especially in the agricultural sector, and has directed substantial resources to them. While subsidised credits channelled through the central bank and the state banks have been substantially reduced, the government-sponsored agricultural cooperatives benefit from those that remain. Neither the central bank nor the Ministry of Finance has authority over the credit activities of cooperatives, which are the domain of the Ministry of Cooperatives. Private cooperatives have been discouraged, but some independent credit cooperatives exist, coordinated by CUCO (the Indonesian Credit Union Coordinating Office), an affiliate of the world credit union movement. The 1992 Cooperatives Law entrenches the role of the 34,000 officially supported cooperatives (the Koperasi Unit Desa, village cooperative units, or KUD) and their continuing claim on government resources. Bank Indonesia data (cited in Cole & Slade, p.307) suggest that total credit extended to cooperatives from all sources may have been as much as 12.3 per cent of all credit outstanding as at March 1994. They cite one observer’s comment that the official cooperatives are ‘largely viewed as inefficient, corrupt and smothered by central government bureaucracy’. Notwithstanding this, Cole and Slade sum up the transformation of the financial sector as follows: During the period 1984–1994 the financial system expanded rapidly and became much more diversified and sophisticated. The number of enterprises engaged primarily in financial business quadrupled, and the ratio of total financial assets to the gross national product (GNP) nearly tripled. The lessons they draw are that: The Indonesian experience with implementing policies for the banking sector demonstrates that freeing up direct controls over price allocation and entry of new institutions . . . can result in reasonably healthy growth, expanded services and improved efficiency. It also demonstrates that both small, locally owned limited activity banks and widely dispersed units of a large state-owned bank can provide needed financial services and operate profitably in rural areas of a relatively poor country. The reference here is to the effective and sustainable operations of small, locally owned rural banks and of Bank Rakyat Indonesia, both of which are discussed in greater detail below. 1.4 Overview of microfinance An overview of microfinance in Indonesia must necessarily take a rather different form from the overviews presented in a number of the other country studies. There are two major reasons for this. The first of these is that certain formal financial institutions in Indonesia have been successful in extending sustainable financial services deep into the countryside, and that a wide range of small financial institutions exists which effectively provide financial services to rural populations, including many of the poor. They are not microfinance institutions per se, but rather financial institutions, both large and small, which have succeeded in incorporating elements of microfinance into their range of activities. The second element of difference concerns the role and status of NGOs, which in other countries underpin much microfinance activity. In Indonesia, an effective system of local administration under the Department of Home Affairs, together with widespread networks of cadres employed by line agencies (health, family planning, family welfare, agriculture) gives the central government considerable capacity to implement its policies and programs in the provinces. Coupled with some reserve felt by officials at all levels towards NGOs (which, despite their undoubted capacity to respond to local needs are also viewed as alternative foci of political energy and influence), this means that there has been less scope in Indonesia for the spontaneous emergence of private NGO initiatives than in, say, India or the Philippines. Many community-based structures exist for the implementation of government policies and programs, but these are closely associated with the system of village administration and do not have the character of NGOs. Indeed, NGOs do exist, but the climate is not conducive to their proliferation, by comparison with a number of other countries included in these country studies. For both the reasons outlined above, there is little direct support provided by the government for independent microfinance activities in Indonesia. Some individual NGOs have links with international NGOs which have brought limited funding and know-how from overseas. The Grameen Bank approach to microfinance is practised in Indonesia, but to a quite limited degree. It is estimated that there are rather more than 5,000 NGOs operating in Indonesia. They have a wide range of involvement, ranging from education and health services, cooperatives and rural community development, legal aid and human rights, to environment preservation and customer protection activities (Bambang 1997b). Relatively few are involved in microfinance, and very few exclusively so. One of the most important NGOs with multiple activities is Bina Swadaya. It was founded in 1967 and now has more than 700 staff and a multi-faceted program, which includes microenterprise development and microfinance. Besides being a leading player in the PHBK (Bank/SHG linkage program) where it specialises in developing the capacities of self-help groups, Bina Swadaya also owns five rural banks. The tendency for NGOs engaged in microfinance to create or acquire BPRs as vehicles for providing microfinance services is an interesting development in Indonesia. At least one NGO has taken the further step of establishing a commercial bank, Bank Purba Danarta, with initial capital of $5 million (Seibel 1997). The limited role of NGOs in microfinance does not mean that private initiative is lacking in Indonesia to promote this approach to poverty alleviation. As evidence of this, it is only necessary to mention again the proliferation of small, locally based financial institutions, totalling some 7,300 separate entities which serve the needs of lower income groups, including some of the poor. However, it is also necessary to recall that these small institutions are heavily concentrated in the Inner Islands; this suggests the need to establish microfinance institutions more widely throughout the country. In this process there is great scope for NGOs to contribute. The existence of many self-help groups in Indonesia, often based on traditional or customary arrangements, also suggests greater scope for NGO involvement than is presently occurring. Hans Dieter Seibel, a well-informed observer of microfinance in Indonesia, has calculated the volume of lending by microfinance institutions as at end-1995 (table 2). Total lending by BRI’s Unit Desa totalled more than twice as much as was lent by BPRs, while the lending of BPRs was, in turn, nearly five times as great as that of the small financial institutions. Strictly speaking, the table exaggerates the value of microfinance lending in Indonesia. It is stretching the definition of microfinance too far to include all the loans of BPRs and the other institutions under the heading of microfinance. Nonetheless, some idea of the relative importance of BRI, BPRs, and the other small lenders can be gained from these data. Seibel also points out that in Indonesia, as elsewhere, this subsector is minute in relation to the financial system as a whole. The loans recorded in table 2 account for only 2.2 per cent of those advanced by the commercial banking sector. The disparity in savings is even greater; the savings deposits held by the MFI sector as he defines it equal only 0.7 per cent of commercial bank deposits. However, Seibel estimates that in terms of outreach the institutions with which we are concerned serve around 8 or 9 per cent of all borrowers and depositors in the Indonesian financial system. This is a more relevant statistic. Most surveys of microfinance activity focus on the supply side, considering the range of microfinance institutions serving the market, and their sustainability. This account of microfinance in Indonesia reports much achievement in terms of the supply side. It also records the impressive record of macroeconomic growth which has contributed to a burgeoning demand for microfinance services in Indonesia. However, at the microeconomic level, observers point out that there are many examples of rent-seeking behaviour by particular economic interest groups which constrain output and income in particular sectors and subsectors of the economy. Some of these situations are addressed in the World Bank’s 1997 Report on Indonesia. Such circumstances constrain the demand for microfinance in many respects, particularly in rural areas and with respect to agricultural products.
2 Arrangements for direct support Aside from the work of Bank Indonesia in promoting and supervising rural banks, in the interests of financial sector development, the government does not provide direct support to microfinance institutions per se. It does give support to MFIs when they play the role of agent for government in one or another of the several poverty alleviation programs employing credit. These are described below. Nor does the government support the establishment or operation of ‘second tier’ institutions, such as Palli Karma Sahayak Foundation (PKSF) in Bangladesh or the People’s Credit and Finance Corporation (PCFC) in the Philippines. These have no direct equivalents in Indonesia, although BRI functions in some contexts as a second tier organisation. For the most part, the provision of microfinance is simply one aspect of the operation of certain formal financial institutions in Indonesia. To the extent that they provide financial services to the poor, they do so by virtue of their effectiveness in serving populations, especially rural populations, with appropriate financial products in a commercially viable manner. This brings us again to Bank Rakyat Indonesia (BRI), a state-owned financial institution which does not have the provision of microfinance services (at least as they are understood in this study) as a primary goal. Nonetheless, by virtue of its outreach and efficiency in the provision of financial services to low-income people, BRI succeeds in encompassing microfinance to some considerable degree. As mentioned in the overview of the Indonesian financial system in section 1.3, BRI is a world leader in the field of rural financing in low-income countries. 2.1 Bank Rakyat Indonesia: a rural financial institution encompassing microfinance Bank Rakyat is one of the largest banks in Indonesia. It had more than 300 branch offices, mainly in provincial and district centres, and $12 billion in assets at the end of 1996. Its rural operations are conducted through some 3,600 village banking units (Unit Desa), but it also provides a broad range of services including corporate and commercial banking (CGAP 1997). CGAP also reports that at end-1996 some 2.5 million loans were outstanding from Unit Desa, with a total value of $1.7 billion. These rural banking units also held some 16 million savings accounts totalling $2.6 billion. CGAP notes that the average loan balance outstanding is $680, which represents 65 per cent of annual per capita income in Indonesia, while the average savings balance, at $163, is around 16 per cent of average income. Some evidence concerning the distribution of loan sizes comes from a sample survey made in January 1995, at which time 14.6 per cent of Kupedes credits consisted of loans below Rp500,000 ($215) per individual. However, average loan size has been increasing, and in order to improve its service to small borrowers, BRI is now offering a smaller scale Kupedes product, granting loans up to Rp500,000 ($215). It is hoped that this will more effectively meet the credit needs of the poor in rural areas. However, all BRI loans are collateralised, even if (at the lower end of the scale) ‘collateral’ is interpreted generously to include household removables. Nonetheless, this requirement is a barrier to the bank’s reaching the poorest. The importance of the financial sector liberalisation measures of 1983, which freed BRI and other banks to set interest rates adequate to mobilise savings and cover the costs of lending, has been mentioned. In addition, CGAP cited the stable macroeconomic environment, strong political leadership and substantial investment in professionalising BRI’s human resource base as factors in its success. When an additional factor cited by CGAP (‘clear and transparent financial reporting and accountability’) is taken into account, it is instructive to compare BRI’s market-oriented Unit Desa system of financial outreach with the subsidised activities of the Koperasi Unit Desa (village cooperative units). The lessons of BRI’s success should be studied carefully by all state agricultural banks in the region, to consider how they may be applied in support of sustainable rural financial (and especially microfinancial) services. 2.2 Support through the banking system Directed credit schemes Kredit Usaha Kecil (KUK): Small Scale Business Credit The most important instance of directed credit in Indonesia is the Kredit Usaha Kecil (credit for small activities or KUK). This commenced in 1990 as a political response to the reduction of Bank Indonesia’s subsidised refinancing of a range of economic activities (discussed above in connection with the cooperatives). All banks were required to extend at least 20 per cent of their total loans to small and medium enterprises, originally defined as firms with assets of less than Rp600 million ($257,000) (not including land and buildings). Considering that the maximum amount of such loans was to be Rp200 million ($85,000), it will be clear that this was not primarily directed to the microenterprise sector. It is principally concerned with supporting the development of indigenous small business, in the face of ethnic Chinese dominance of larger scale enterprise. Bank Indonesia estimates that there are some 30 million small-scale enterprises in Indonesia. Requiring relatively low capital, using simple technology and having the potential for substantial employment generation, small-scale enterprises are an important objective of government policy. However, the relevance of the KUK for microfinance is limited to the fact that any credits extended by the banks for genuine microfinancing may be counted towards the 20 per cent requirement. A directive from Bank Indonesia dated April 1997 redefines the maximum net worth of small-scale entrepreneurs eligible for KUK credits at Rp200 million (not including land and buildings) or around $85,000. The maximum credit allowable under the scheme is now Rp350 million (or around $145,000) (Bank Indonesia, 1997a). It is understandable that many of the private commercial banks in Indonesia have had difficulty in meeting the 20 per cent requirement for loans to small enterprise. Those which are focused on corporate lending and which lack extensive branch networks have been particularly affected. One response has been for these banks to channel funds through the rural banking system (BPRs) in partial satisfaction of the requirement. This arrangement has become institutionalised with the creation of a foundation, DABANAS, as a joint enterprise of Perbanas (the Association of Indonesian National Private Banks) and Perbarindo (the Association of Indonesian Rural Banks). The DABANAS Foundation will be funded by a spread of 1 per cent between the rate at which it receives money from the commercial banks (16.5 per cent) and the rate at which it on-lends to the rural banks. It will also provide technical assistance to the rural banks. Given that they have outreach to lower income sections of the population, the increasing involvement of BPRs in handling small-scale business credits for the commercial banks is likely to have some benefit for the microenterprise sector. DABANAS also has the potential to exercise some of the regulatory and supervisory functions of a second tier organisation, with respect to rural banks. This could be a valuable service, especially in regard to smaller rural banks which have access to poorer sections of the population. Programs channelled through the banking system Bank Indonesia liquidity credits As described in section 1.3, the village cooperative units (Koperasi Unit Desa, or KUD) are among the beneficiaries of the remaining ‘liquidity credits’, or subsidised refinancing, available from Bank Indonesia and channelled via commercial banks. The persistence of this financing for KUDs in the face of the more general move away from subsidised credit reflects the special role accorded to the official cooperatives in the state ideology. The credits are designed to support food self-sufficiency, small-scale enterprise in the agricultural sector and the viability of the cooperatives themselves. Schemes include the KKUD, which funds village cooperative units to purchase padi, food crops, and other agriculture output from farmer members, and also to purchase agricultural inputs for sale to their members. The average loan size to members is between Rp200,000 and Rp400,000 ($85 to $170). It is funded 75 per cent by the central bank’s liquidity credit at an interest rate of 14 per cent, with 25 per cent supplied by commercial banks at market rates of 18 to 20 per cent. Another program is the KKPA, which grants credit facilities to members of cooperatives for small business development up to a maximum of Rp50 million ($20,000). The financing arrangements are similar to those of the KKUD. The scheme of most general application is the KUT (farming activities credit) for which Bank Indonesia provides 100 per cent funding at 14 per cent interest, 5 per cent of which goes to the cooperative unit as the executing agent. Although sometimes described as microcredit, these lending arrangements are directed to landowners and to the support of the cooperative movement itself, and do not benefit the very poor to any significant extent. A somewhat similar comment can be made with respect to another Bank Indonesia program sometimes described as ‘microfinance’, the Small Enterprise Development Project, which is not discussed in this survey. Bank Indonesia’s Microcredit Project Bank Indonesia is responsible for implementing two projects which have explicit microfinance elements; these are the Microcredit Project and the Project Linking Banks with Self Help Groups. The latter is described below. The microcredit project is funded by a loan of $25.5 million from the Asian Development Bank, with $17 million counterpart funding from Bank Indonesia. It will extend over the period 1995–2000 with the objective of reaching 300,000 borrowers in five of the provinces of Indonesia. It is located so as not to overlap with the IDT program described below. Loanable funds are disbursed by Bank Indonesia to BPDs (the provincial government commercial banks) and BPRs. BPRs on-lend directly to microentrepreneurs, while BPDs lend to small financial institutions. Bank Indonesia lends the funds at 16.5 per cent and these are on-lent at market rates of 2 to 3 per cent flat per month. NGOs do not play a financial intermediary role but are involved in organising self-help groups. BPDs receive a spread of 2 per cent for providing technical assistance to rural banks and small financial institutions. Apart from the objectives of income and employment generation, the project is also directed to the development of small financial institutions and NGOs dealing with microfinance. The belief is that if they are sufficiently strengthened, these institutions can continue to serve microentrepreneurs by accessing normal commercial funding sources. Many of the small financial institutions are already doing so, but one of the objectives of the project is to encourage these institutions to redirect credit to lower income people. The project is preparing to define its own poverty line. It will target one third of its loans to people below this line, and two thirds to the ‘nearly poor’ just above the line. However, while the project has some poverty focus, its other objective is to encourage financial development through further outreach by the existing rural banks and small financial institutions. This is what Bank Indonesia feels to be its primary function. In fact, the central bank does not have explicit policies in regard to microfinance per se, and poverty is seen as a broader government responsibility, for which mass campaigns such as the IDT and Prosperous Family programs are seen as more appropriate responses. The former Governor of Bank Indonesia recently acknowledged that the central bank’s policies in regard to ‘financial aspects of poverty alleviation’ have relevance to ‘national efforts to alleviate poverty’ but emphasised that these must be seen ‘within the scope of its role as a central bank’. He described the bank’s ‘core functions’ as monetary management, guardianship of the payments system and banking supervision (Soedradjad Djiwandono 1996). This description by the former governor of Bank Indonesia’s core functions is accurate and appropriate; current events indicate the importance of central banks in the region giving priority to traditional central bank functions. Nonetheless, Bank Indonesia has taken a strong incidental interest in microfinance development and its leadership, expressed through programs such as the PHBK and microcredit project, has sent valuable signals to the banking sector as a whole. Bank Indonesia should maintain this leadership, although pressing concerns arising from the crisis in Indonesia’s formal banking sector, commencing in the second half of 1997, will make it difficult for the central bank to do so. Income Generating Project for Marginal Farmers and Landless (P4K) The P4K project is conducted by the Ministry of Agriculture and is a multifaceted set of activities targeted at groups of the rural poor whose family income is below the Sajogyo poverty line, equivalent to 320 kg of rice per capita per year. It differs from all the other programs discussed above by reason of this exclusive poverty focus. The participants in P4K include small farmers, the landless, farm labourers, sharecroppers, marginal farmers and small fishermen who are organised in ‘small farmer groups’. Groups range in size from eight to sixteen persons and operate on the principles of homogeneous membership, group decision making, progress towards self-reliance, and learning by doing. Extension workers from the Ministry of Agriculture and other agencies provide support and training activities. NGO involvement is extremely limited. Groups undertake a range of training activities before the option of credit is introduced. Microfinance is a major component of the P4K, and the microfinance component is conducted for the Ministry of Agriculture by Bank Rakyat Indonesia. When P4K commenced in 1979, BRI acted simply as a channelling bank for loan funds in keeping with the operating methods common to that period. It had two elements: conventional credits repaid to the bank and also revolving funds. The former had much better results because of BRI’s supervision, with the result that the revolving funds were dropped from the second phase of the project. Also, over time the improvement in BRI’s general operating methods was reflected in its conduct of the P4K project, including greater emphasis on savings as a precondition for credit. In the second phase BRI became the executing, rather than simply the channelling, bank. Loans to groups were made by BRI branches, with repayments by individuals made to the Unit Desa. Loanable funds came from IFAD and Bank Indonesia at a mean cost of 6.3 per cent, and were on-lent to small farmer groups (SFGs) at 12 per cent flat (22.15 per cent effective annual). The BRI margin was 1 to 2 per cent after costs, which put the scheme on a commercial basis. So far, some 47,000 self-help groups (SHGs) have been formed with over half a million members below the poverty line. More than a third of groups are exclusively for women, a similar proportion exclusively for men, and around one quarter are mixed. Some 80 per cent of all groups have so far borrowed from the program in the second phase. Arrears in mid-1997 were about 3.6 per cent, with cumulative arrears as a proportion of current outstanding credit at 12 per cent. IFAD is said to regard this as the best performance of any project it supports in Asia, and to consider any cumulative repayment figure of 95 per cent or more as very good. All credit has been non-collateralised. Since the beginning P4K has employed only ‘social collateral’, with group guarantees, while group savings are blocked for the duration of the loan. A third phase of P4K is under negotiation, to commence from 1998 with IFAD and ADB support. It is proposed to increase the number of groups to 85,000. Whereas during the current phase credits to individuals have had an upper limit of Rp100,000 ($430) for first loans, rising to a maximum of Rp300,000 ($1,280) for the fourth loan cycle, in the next phase the maximum for individual loans will be raised to Rp500,000 ($2,140). It is hoped that, after individuals have received three successive loans at that level, it will be possible for them to graduate to standard BRI Unit Desa loans. There they will face collateral requirements and the higher interest rates applicable to Kupedes. However, it is hoped that persons graduating from the scheme will have an excellent chance of succeeding with Kupedes loans, because they will have been identified by officers of BRI’s Unit Desa responsible for the P4K lending. The Ministry of Agriculture claims that evaluations of P4K activities indicate benefits in productivity, employment, social and community life, and the status of women. The project claims increases in the volume of production in 80 per cent of groups and qualitative improvements in 65 per cent. Perhaps equally significant are changes in the ‘relations of production’ with many beneficiaries graduating to self-employment. The project claims increased working hours in two-thirds of groups, with an average of 27 hours additional gainful work per week per household. Benefits are seen in social and community life through the improvement in self-confidence of beneficiaries and in their social standing. The organisation of women in groups (with 35 per cent of all groups being exclusively for women and 40 per cent of all beneficiaries being women) is regarded as an achievement. The most common activity funded for women is petty trading (in 38 per cent of cases). While cautioning against the too ready acceptance of these kind of survey data, Hans Dieter Seibel (1997) describes the impact of the project as ‘remarkable’. He notes, however, that despite the ‘spectacular’ growth of P4K’s outreach it still has reached fewer than 10 per cent of the population below the official poverty line. In regard to the prominent role played by women in P4K, Seibel comments that: Special programs focussing solely on the poor like P4K made the experience that a strong though not necessarily exclusive focus on women will greatly contribute to the viability of the program and also be more effective in poverty alleviation in terms of donor investment (p. 12). Seibel believes this suggests the need for a special effort to transform the P4K program, and others of similar nature, by creating ‘large numbers of autonomous local MFIs owned and run by women’. We endorse this view. Linkages between banks and specialised microfinance institutions PHBK: Linking Banks and Self-Help Groups In Asia, the initial impetus for financial linkages between banks and self-help groups (SHGs) came from APRACA (the Asia Pacific Rural and Agricultural Credit Association) which recommended that its member institutions should trial such linkages to improve access for the poor to financial services. Bank Indonesia was the first APRACA member to take up this challenge, and in 1989 in partnership with the German aid agency GTZ launched the PHBK program (project linking banks and self-help groups) in four provinces of Indonesia. By 1992 this project had gone beyond the pilot phase and had spread to twelve provinces. To seek to use self-help groups as intermediaries for microfinance raises the question of how such groups are to be established. In other countries, and in Indonesia initially, NGOs were regarded as the logical institutions to create and prepare SHGs for microfinance. Informal savings and credit groups, suitable for organisation as self-help groups and appropriate for participation in such programs as PHBK, P4K and the Microcredit Project, are described by Seibel (1997) as ‘ubiquitous’ in Indonesia. A number of leading Indonesian NGOs participate in the PHBK program, but the NGO movement has not shown the capacity to meet the targets for expansion of PHBK outreach. Efforts to establish an umbrella organisation for NGOs engaged in the PHBK program, which might facilitate improved performance by them, have also languished. Much work in group formation has also been done by other agencies and community groups linked with government programs; these groups and the NGOs collectively are known in Indonesia as self-help promoting institutions. Quite recently, the PHBK has tapped the energies of Indonesia’s rural banks, which has enabled more rapid expansion of the program’s outreach. In September 1996 the PHBK program involved 410 banks, 183 NGOs and some 6,800 SHGs in 16 provinces. Total savings mobilised had reached Rp8,625 million ($3.7 million), while the cumulative total of credit extended was Rp44,808 million ($19.2 million) (with current outstandings of Rp19,625 million [$8.4 million]). The cumulative repayment rate was said to be 96.4 per cent. A flexible savings to credit ratio which typically ranges from 1:3 to 1:6 determines the size of the loan. Interest rates are market based and transaction costs are covered by interest margins. As its operational methods have evolved, the PHBK has tended to discourage ‘self-help promoting institutions’ from acting as financial intermediaries, in favour of a model of ‘social’ intermediation in which training and guidance for the SHG are provided by NGOs and other community-based groups. However, since 1995 a third path has rapidly come into use, with a dramatic increase in the involvement of rural banks in the PHBK program. Small rural banks and even commercial banks which have local branch networks close to the target group are encouraged to establish their own direct linkages with self-help groups, and to take the initiative to form such groups themselves if necessary, a process which will be facilitated by the operations of the new DABANAS Foundation, discussed above. Other commercial banks are encouraged to create indirect linkages with the poor by providing refinancing to BPRs. Such lending counts towards these commercial banks’ requirement to support small enterprise under the 20 per cent KUK rule, and is a convenient way of discharging the obligation. Since the decision to concentrate the expansion of the program on rural banks, the numbers of groups and loans outstanding are reported to have been growing at a compound rate of 10 per cent per month. While the rural banks have shown the capacity to develop and manage SHGs for themselves, NGOs and other ‘self-help promoting institutions’ will continue to have a role, especially in the Outer Islands where BPRs are much less common. One of the themes which emerges from this survey is the need to allow NGOs in Indonesia a greater role in microfinance provision, principally through their support of the self-help group movement. The resistances to this arise partly from the limitations of NGOs themselves but also from political factors. The PHBK has proved a significant mechanism to serve the credit needs of those who are generally bypassed by formal banking institutions. However, it does not specifically target those below the poverty line. Intensive technical inputs, training and guidance provided by GTZ have contributed greatly towards the introduction and strengthening of the PHBK program in Indonesia. Present plans call for the expansion of the PHBK mechanism to all 27 provinces of Indonesia by the year 2000, but the program of technical assistance provided by GTZ will cease in 1999, so that sustainability will become an important issue at that time. Both the PHBK and the P4K programs are carefully crafted models of sustainable microfinance service delivery, with the former operating since 1987 and the latter since 1979. P4K, as we have seen, has reached about 10 per cent of the eligible population in the social groups which it targets. It is perhaps understandable, therefore, that given the large absolute number of the poor remaining (some 22.5 million in 1996) that larger scale, more ‘broad brush’ approaches to the eradication of poverty have emerged in recent years. In the process, considerations of financial institution development, sustainability and the like are being given much less priority than mass outreach. However, the value of continued expansion of sustainable programs such as P4K and PHBK should be recognised. 2.3 Other major programs Reflecting political concern with the problem of the hardcore poor, the Government of Indonesia has introduced two mass programs during the current Repelita (1993–1998). The first of these is the Inpres Desa Tertinggal (IDT) which was a scheduled program of Repelita VI and commenced in 1993. The second major campaign, the Prosperous Family Program, was introduced as an emergency measure in 1996. Both programs reflected a decision that direct intervention was necessary to overcome problems of residual poverty in Indonesia. In previous Repelitas the government had made considerable progress in meeting basic needs in education and health, in the development of rural financial services, and in maintaining an overall rate of economic growth which distributed benefits to all income classes. However, issues of relative poverty, and the persistence of regional and subregional concentrations of poverty, were felt to call for a more direct approach. Inpres Desa Tertinggal (IDT) Inpres Desa Tertinggal means ‘presidential instruction relating to backward villages’. As a presidential program, the IDT calls upon an interdepartmental effort, coordinated by BAPPENAS, the national development coordination authority. The program commenced with the identification of some 28,000 backward (literally, ‘left behind’) villages. While the chosen villages represent 44 per cent of the national total, only 26 per cent of villages on Java were chosen for the program, whereas 68 per cent of villages on the Outer Islands other than Java and Sumatra qualified for assistance. This indicates the thrust to redress regional income inequalities. The assistance to these villages under the IDT contains three basic components:
The capital injection of $600 million was spread over three years (1994–97) to stimulate economic activity in the chosen villages. The program of infrastructure development is phased over a longer period, and involves multilateral loans as well as Indonesian government funding. In the previous Repelita, the thrust of central government programs to reduce regional inequalities had been very largely towards physical infrastructure development, a process to which the World Bank and other agencies had contributed. The new thrust is designed to be more direct, providing village people with the financial resources and technical assistance to increase their productivity and earnings. Infrastructure provision is a secondary measure. The capital injections for income generation have been allocated to self-help groups (Kelompok Masyarakat or ‘people’s groups’) in the chosen villages as outright grants. Groups are free to decide the terms on which this capital will be loaned to members. This is essentially a revolving fund scheme, although the longer run objective is for the SHGs in villages to be linked with BPRs, small financial institutions and other sources of commercial funds. The outreach of the IDT has been impressive. At the end of 1996 some 107,000 self-help groups had been created, involving almost 2.9 million people. By March 1997 this number was reported to have grown to more than 120,000 groups and 3.3 million persons. A high degree of freedom has been given in relation to the use of funds, which are employed as seed capital for ventures in agriculture, horticulture, livestock rearing, fisheries, artisanal trades, and petty trading. Approximately 3 million poor households had received seed capital averaging $85 per household by mid-1997. An evaluation of groups in eleven provinces, conducted in 1996, came to the conclusion that after three years of IDT funding some 31. 6 per cent, or almost one third, were adequately prepared for entry to the Bank Indonesia linkage project, the PHBK (Sajogyo 1997). This is another alternative under consideration. Although it would require a substantial increase in the resources allocated by Bank Indonesia for technical assistance under the PHBK, such an increase appears justified. This may be an opportunity for external assistance; such assistance should focus on achieving transition to commercial operation by groups which, under present IDT operating practices, benefit from substantial subsidies. The Prosperous Family program As mentioned in section 1.2, a second mass program was launched by the government in 1996 as an emergency response to political concerns about income inequality. Apart from its having been launched outside the framework of Repelita VI, it has several other unusual features. It is financed by a levy of 2 per cent on the incomes of persons and corporations in excess of Rp100 million ($42,700) per year. This levy is collected and administered by a foundation created by the former President Soeharto. The levy raises revenue outside the normal taxation framework and gives the impression of being a populist response to resentment of the wealth of the ‘conglomerates’. The Prosperous Family Program is implemented by BKKBN (the National Family Planning Coordination Board). BKKBN is an agency of the government of Indonesia with an international reputation for the sustained effectiveness of its family planning program, which is credited with substantially reducing the rate of population growth over the past quarter century. In the process, it has built up an infrastructure in practically every village in Indonesia, giving it almost unrivalled outreach. This capacity has been deployed in disseminating contraceptive knowledge and supplies, and in influencing the attitudes of two generations of Indonesians. Women’s groups set up as the vehicles for these activities enrol a high proportion of the cohort of Indonesian women of child-bearing age. They provide a ready-made organisational structure for the Prosperous Family program. The program is directed by State Minister for Population Haryono Suyono who is quoted (Kompas, 28 June 1997) as stating that up to April 1997 some 9.8 million Indonesian families had received funding. This is an extraordinary administrative and logistic achievement, accomplished in just 12 months. Funds are channelled to the groups via Bank Negara Indonesia, a state bank, or via post offices where there are no bank branches, and administered on the ground by government field staff. Beneficiaries of the program are women. They are divided into classes according to their economic status. The poorest groups are enrolled initially in the Takesra (Prosperous Family savings scheme). Each woman receives a tiny initial grant of Rp2,000 (85 cents) to commence a savings account. She is encouraged to put aside Rp100 (4 cents) each month for 6 months, at which time she receives a bonus of Rp2,000 in the account. If these women can accumulate Rp25,000 ($11), they then become eligible for loans under the Kukesra (Prosperous Family credit scheme) which also has a savings component. Much criticism has been directed at the small size of the initial loan under this scheme, Rp20,000 ($9), which is loaned at a concessional rate of 6 per cent. In press interviews Haryono has defended the scheme on the basis that it is designed to effect social change, and that the poorest of the poor lack confidence to handle larger sums; they must be brought up to the point where they are capable of managing their finances. The program is undoubtedly huge and operates on a subsidised interest rate indicating that financing under the program is not sustainable. Secondly, doubts remain whether the groups of family planning acceptors, accustomed to outright grants and organised originally with quite different objectives, will be able to convert themselves into successful savings and credit groups. Similar doubts must be raised about the capacity of family planning and family health field staff to implement an essentially economic or ‘livelihood’ program. Comment Considering the IDT and Prosperous Family programs, it is clear that both represent a substantial break from the pattern of careful expansion of sustainable financial activity in rural Indonesia. The IDT provides outright grants which initiate revolving funds. Groups are not required to set terms of lending which would cover costs and compensate for inflation. The Prosperous Family program provides credit in amounts which might be thought too small to finance significant economic activities for borrowers, at the highly concessional interest rate of 6 per cent. Both programs depend on intensive inputs from government field staff, and there are real questions concerning the capacities of the staff concerned to nurture economic, as distinct from social, activities. Finally, although IDT and Prosperous Family are not supposed to overlap geographically, in some cases they do, as well as coinciding to some degree with P4K which is attempting to cover costs with an effective interest rate of 22 per cent. The expansion of small commercial financial institutions such as the rural banks could also be inhibited to the extent there is an overlap with their potential client base. Such distortions should be avoided so far as possible. For both IDT and Prosperous Family it is intended that groups will graduate to relationships with commercial funding sources (be they rural banks, the PHBK program, or small financial institutions). The success of these programs, in terms of substantial expansion of access of the poor to microfinance, will only be assured if this loop can be closed. The judgement of Hans Dieter Seibel (1977), made with respect to the IDT, could equally well apply to both of these mass campaigns: ‘. . . IDT will only be successful to the extent that concerns for institutional viability and sustainability will outweigh the concern for short-term political gains from liberal disbursement of funds’. The ‘graduation’ of the best groups emerging from the IDT and Prosperous Family programs to a more rigorous commercial environment along the lines of programs such as PHBK and P4K should be encouraged, but will need resources for technical assistance. This is an area where NGOs are capable of making a greater contribution than at present. Bambang Ismawan has attempted to calculate the human resource and financial requirements necessary to achieve Indonesia’s share of global targets set at the Microcredit Summit in Washington in February 1997. Of a global target of one hundred million families to be provided with sustainable microfinance services by the year 2005, Bambang estimated Indonesia’s share at seven million families or approximately thirty million people. (Bambang 1997a). This would ultimately require the formation of 280,000 SHGs and the services of 11,200 ‘facilitators’, together with coordinators and administrative staff employed in 2,240 SHG facilitation centres. He estimated the annual operational expenses of these centres at Rp138 billion ($59 million) and saw a major role for NGOs in the process. 3 Regulation of non-bank microfinance institutions 3.1 The broad regulatory framework This survey of microfinance in Indonesia has emphasised the importance of small financial institutions which provide microfinance services to the poor as part of their more general outreach. These include the Unit Desa of BRI, BPRs and a range of ‘small financial institutions’. Our approach has been to describe institutions which provide microfinance, without necessarily describing them as microfinance institutions. BRI is a very clear case of a banking institution which provides microfinance services; the regulatory environment in which it operates is described under section 4 below. The other category of regulated bank in Indonesia is the BPRs or rural banks. The regulatory framework for BPRs is also described in section 4. It will be useful at this point to distinguish between BPRs and the generic category of ‘rural banks’ of which they are a part. These consist of:
All three categories (BPRs, LDKPs and BKDs) provide microfinance services to a greater or lesser extent. The functioning BPRs are regulated banks while LDKPs and BKDs are regarded for our purposes as non-bank MFIs and are therefore discussed in this section of the Indonesia survey. These latter institutions and their transition to BPR status are comprehended in the 1992 Banking Act. As we have seen, NGOs play a relatively subdued role in the provision of microfinance in Indonesia, whereas in other countries they underpin much of the microfinance sector. As explained in section 1.4, effective local administration in Indonesia and the widespread networks of cadres employed by line agencies give government considerable capacity to implement policies and programs. When combined with reservations held by officials towards NGOs, particularly at the local level, this can lead to programs being conducted without them. For example, while it is IDT policy to involve NGOs so far as possible in the preparation of self-help groups, local-level officials charged with implementing the program are sometimes less willing to involve the NGOs from their districts. The procedures for creating and registering an NGO are simple and straightforward. NGOs take the form of a Yayasan, a legal entity similar to a foundation. Yayasan are established for social objectives, and may conduct economic activities in pursuit of those objectives. A great many Yayasan are established in Indonesia for a wide range of purposes, such as Yayasan Dana Sejahtera Mandiri set up by the former President Soeharto to collect the levy on high-income earners and operate the Prosperous Family program. Some Yayasan control assets worth hundreds of millions of dollars and their activities can only be described as opaque. There are no reporting requirements, nor any provision for the taxation of the income of a Yayasan, although taxation liability on income derived from the business activities of a Yayasan is a grey area. To form a Yayasan/NGO requires the services of a notary and the drafting of Articles of Association and rules. The Yayasan is established by a letter from the notary certifying it. It is apparently advisable to register the Yayasan with the Directorate General of Social and Political Affairs within the Department of Home Affairs, but not obligatory. Registration with the Directorate General, at a cost of Rp25,000 ($11), will establish that the objectives and activities of the Yayasan are consistent with Pancasila, the state ideology. An NGO intending to conduct lending activities does not require permission to do so; however, it is forbidden to mobilise savings from its members, other than by placing deposits on their behalf in a regulated financial institution. In fact, some savings mobilisation by NGOs appears to be tolerated, so long as the volume is small. This limitation on their capacity to mobilise resources for lending from their membership is one factor driving NGOs to consider creating rural banks. The situation of microfinance NGOs would be improved if ambiguities were removed concerning their right to collect compulsory savings from clients in connection with the provision of other microfinance services. NGOs should be free to do so. Self-help groups are completely informal organisations in Indonesia. Seibel (1997) notes that hundreds of thousands of informal SHGs with savings and credit activities exist in Indonesia. Many are spontaneous groupings, based on traditional forms of association. Many others have been founded by government and community organisations in connection with government programs, or have been created by NGOs. The expansion and capacity building of self-help groups is a field which could benefit from greater involvement of NGOs, if a more positive attitude to their involvement were adopted by officials, especially at the local level. Cooperatives are regulated by the Ministry of Cooperatives and can accept the savings of members. Because of their functions, cooperatives are perceived more as agents of the government than as people’s institutions. As suggested in section 1.3, they are of relatively little significance for microfinance. 3.2 Interest rates MFIs in Indonesia are free to set interest rates on deposits and loans. It is interesting to note that even before 1983 the myriad of small financial institutions in rural areas had been able to operate largely without restraint on their interest rates. This was a factor in establishing this system even before the liberalisation of 1983. Where MFIs operate within the framework of a government program they may be constrained by the policies of that program in regard to maximum lending rates. In some cases also, the availability of subsidised credit from the Koperasi Unit Desa, the IDT or the Prosperous Family program can affect the ability of MFIs to charge full cost interest rates. Such distortions inhibit private responses to the need for microfinance. The overlap of programs which leads to such distortions should be avoided. 3.3 Prudential regulation and supervision NGOs engaged in lending are subject to no external prudential regulation or supervision. When engaged on one or another of the government microfinance programs (for example, P4K or PHBK) they are subject to supervision by the relevant agency in each case. However, in the great majority of cases NGOs do not conduct financial intermediation, but instead serve as social intermediaries, working with self-help groups to prepare them for microfinance. BKDs, as mentioned, now have BPR status under licence from the Ministry of Finance. As such, they are subject to the supervision of Bank Indonesia. They are continuing to function as rural credit agencies under the field supervision of officers of BRI. They have not yet commenced mobilising savings, although in principle they are entitled to do so. BRI staff visit BKDs on a weekly basis and assist management to compile weekly reports on the volume of credit outstanding and the quality of credit, applying BRI criteria. These reports are compiled at BRI branches, and aggregated reports are filed quarterly with Bank Indonesia. These institutions will make the transition to full operation as BPRs in due course. LDKPs (rural fund and credit institutions) are in a different situation, having been established by decision of various provincial governments, by which they are registered. Responsibility for their supervision is not as clear-cut as in the case of the BKDs above; the provincial government banks (BPD) provide technical assistance and collect some data on their operations. This is not forwarded to Bank Indonesia, nor does Bank Indonesia have the authority to require reporting. Since the expiry of the October 1997 deadline to upgrade to BPR status, those institutions remaining are no longer entitled to mobilise savings. They must upgrade or wither away; stronger institutions with the necessary capital, office premises and appropriate leadership will become BPRs. One path to this could involve LDKPs using their capital base to establish a ‘new’ BPR (as permitted under the 1988 reforms) and then to go into liquidation. These 2,000 institutions are a resource for microfinance, especially since some are located outside Java. Every effort should be made to bring them up to the standards required for operation as BPRs. 3.4 Performance and reporting standards of second tier institutions There are no second tier institutions in Indonesia equivalent to PKSF in Bangladesh or PCFC in the Philippines. However, BRI has responsibility for field supervision of BKDs, the rural banks which are not yet functioning as such. It can play a very important role in advancing BKDs to full operational status as rural banks. BRI is also the channelling bank for government microcredit programs, including the P4K. It is thus in a strategic position to set performance and reporting standards for the institutions with which it works. The new DABANAS Foundation will provide technical assistance to rural banks as well as loanable funds; to the extent it accepts the development of microfinance as an appropriate goal for the rural banks it could grow to exercise second tier functions also. 3.5 Self-regulation With respect to NGOs, attempts have been made to achieve an organisational framework for those NGOs involved in Bank Indonesia’s PHBK project. Since 1994, several meetings have been held, to form an organisation (given the acronym ALTRPAKU) which might provide a forum for communication between NGOs, and between them as a group and Bank Indonesia. The association has not yet functioned. Grameen replicators in Indonesia are associated with the Grameen Trust and CASHPOR, the network of replicators, which fulfils self-regulatory functions. BKDs, while not yet functioning as rural banks, will be eligible to join Perbarindo, the Association of Indonesian Rural Banks. Although it is not clear to what extent this organisation sees itself as responsible for self-regulation, the potential exists. 4 Regulation of banks Some elements of the regulatory environment for banks have already been discussed in section 1.3 and elsewhere. Banks within the Indonesian financial system are regulated by Bank Indonesia, while the licensing of banks is done by the Ministry of Finance, acting under recommendation from the central bank. The current legislation is the Banking Act of 1992 which defines two categories of banks in Indonesia: commercial banks and rural banks. It is worth noting that the Act (Article 12) mandates all banks to support government programs; this is potentially a very significant obligation. 4.1 Licensing and minimum capital requirements Banking licences are issued in consideration of an application satisfying certain criteria. These are described by Bank Indonesia as:
Bank Indonesia judges applications according to these criteria and recommends accordingly to the Minister of Finance (Bank Indonesia 1996). The minimum capital requirements are currently Rp50 billion ($21.4 million) for a commercial bank and Rp100 billion ($42.7) for a joint venture bank (with maximum 85 per cent foreign ownership). Minimum capital required for a rural bank is only Rp50 million ($21,000). Under the 1992 Banking Act, rural banks are permitted to accept deposits only in the form of time deposits and savings. The category includes both the ‘new’ rural banks registered after the reform package of 1988 (of which there were around 1,350 in March 1997) and those registered before the 1988 reforms (of which there were some 640 in March 1997). The Act recognises the existence of the array of small rural financial organisations (of which as mentioned in section 3.1 there are currently somewhat more than 7,300) subdivided between LDKPs (rural fund and credit institutions) and BKDs (rural credit agencies). The Act empowers the government to set rules for changing their status. It provides for these small institutions ultimately to upgrade to meet the requirements for licensing as rural banks (Cole & Slade, p.129). Cole and Slade note a number of key differences between commercial banks and rural banks. The latter are restricted both in their scope of operations and where they may locate. Rural banks are not part of the payments system, neither can they offer cheque accounts, or deal in foreign exchange. They must be wholly ‘Indonesian owned’ by individuals or an Indonesian legal entity. Cole and Slade comment that: . . . the Law actually changed the original expected role of these new BPRs from providing just rural finance to also ‘providing services to economically weak groups and small-scale businessmen in urban areas’. The Law broadened the location opportunities for BPRs . . . New BPRs located outside cities could open branches in capital cities of districts, municipalities, provinces and in Jakarta . . . The low minimum capital requirements and the relaxation of restrictions on location of BPRs have contributed to their flexibility and capacity to provide microfinance services. Their ability to operate in cities has spurred substantial growth in their activities in major urban areas. Jakarta alone now has more than 300 BPRs. It should be noted, however, that the current financial crisis has led to the closure of a number of rural banks, and may also lead to a tightening of the requirements for the establishment of rural banks. 4.2 Interest rates The financial reforms of 1983, as described in section 1.3, included the freeing of interest rates on deposits and loans throughout the banking system. Since then real interest rates in the banking system (adjusted for inflation) have been strongly positive. This has stimulated a surge in savings mobilisation which contributed to shifting the balance between private and state banks in Indonesia. Seibel notes that the effect of deregulating interest rates ‘has been more pronounced on savings proper, an instrument of the poorer sections of the population, than on time deposits, an instrument of the non-poor’ (1997, p.21). BRI’s capacity to set interest rates on advances high enough to cover the costs of lending underpinned the expansion of rural credit (including microfinance) through the Unit Desa system of BRI. Substantial increases in both interest rates and inflation are now occurring in Indonesia, however, and it is difficult to judge their impact at the time of writing. BRI has a standard 1.5 per cent monthly flat rate on the smaller Kupedes loans which are relevant to microfinance. However, an additional flat 0.5 per cent monthly is added to each payment. If repayment obligations are met in timely fashion over a six-month period, this additional interest charged is returned to the borrower. However, if one or more loan payments is late, the additional charge is forfeited and the annual effective interest rate can exceed 40 per cent. Rural banks charge monthly flat interest rates which can be as high as 3 or 4 per cent. For example, rural banks involved in the PHBK typically charge 2.5 to 3 per cent per month flat. 4.3 Prudential regulation and supervision Prudential requirements are broadly the same for commercial banks and rural banks. The capital adequacy ratio is set at a minimum 8 per cent of risk-weighted assets, following the standards established by the Bank for International Settlements. The reserve requirement imposed by Bank Indonesia applies only to commercial banks which are required to deposit a minimum reserve of at least 3 per cent of ‘third party funds’ in an account with the central bank. Rural banks have no such obligation. The Banking Act does not require that loans be secured against collateral; this has significance for microfinance since there is no legal impediment to non-collateralised lending. However, the required provisioning for loan losses is greater in the case of loans without collateral, since the lending bank is entitled to deduct the value of collateral held from the outstanding balance before making provision. Certain requirements apply to members of the board of directors of a bank. These relate partly to character and reputation, and partly to banking experience. At least 50 per cent of board members must have not less than three years banking experience (for commercial banks) or one year experience (for rural banks). Quite apart from problems of capitalisation, this requirement of banking operational experience is a hurdle for many small financial institutions which might seek to upgrade to rural bank status. Banks are rated by Bank Indonesia as part of the supervisory process. The rating system, which is the same for commercial banks and rural banks, is a qualitative appraisal of various factors which affect the ‘health’ and growth of a bank. It assesses the CAMEL factors, as well as compliance with certain banking regulations. For rural banks this latter evaluation covers only the legal lending limit provision; for commercial banks it is more demanding. In the field of prudential regulation, Bank Indonesia is increasingly emphasising self-regulatory banking principles. Banks are required to have their own written credit policy guidelines; these must be sound and the banks must comply with them once they are established. The reporting requirements of Bank Indonesia are somewhat less onerous for rural banks than for commercial banks. The latter must report weekly in relation to their mandatory reserve requirements and certain foreign exchange transactions. Monthly reporting for all banks includes a balance sheet for each office and reports of any legal lending limit violations. Financial statements are required on a semi-annual and annual basis, together with an annual auditor’s report (from which the smallest rural banks are exempt). There are also some suggestions that the supervision of banks has not always been as rigorous as it could have been, and that this may have contributed to some of the problems currently facing the banking sector. Bank Indonesia’s Banking Regulation and Development Department comments that a more appropriate and helpful system of supervision and reporting needs to be developed for the rural banks. Issues of regulation, supervision and developing the capacity of the rural banking system are being actively considered. Considering the potential for rural banks to expand the availability of microfinance services, such reforms could be helpful. 5 Summary and recommendations With GNP per capita of $980 in 1995, and after experiencing economic growth at an average 6 per cent annually for some thirty years, Indonesia was classified as a lower middle-income economy. This economic growth performance had been accompanied by a rapid decline in the proportion of the Indonesian population living in poverty, from 60 per cent in 1970 to below 12 per cent in 1996. Nevertheless, poverty in its inter-ethnic, interpersonal and inter-regional aspects had become a sensitive political issue in recent years. Moreover, the current economic crisis is likely to lead to a marked increase in the incidence of poverty, at least in the short term. Indonesia has achieved substantial outreach of financial services to the poor through the medium of regulated financial institutions, including Bank Rakyat Indonesia and the rural banks. Together with a myriad of other small financial institutions which are in transition to rural bank status, they have succeeded in providing microfinance services to many of the rural poor in a sustainable manner. A generally favourable policy environment has supported these developments. A number of innovative government programs of microfinance have been conducted with the organisation of borrowers into groups and the involvement of commercial and rural banks. By comparison with many other countries in the region, the role of NGOs in microfinance provision in Indonesia has been relatively limited. More recently, the government has felt the need to respond to concerns about poverty by launching two mass poverty eradication campaigns which focus more on outreach than on capacity building and which are not designed for sustainability. Maintain active role of Bank Indonesia Bank Indonesia does not have policies in regard to microfinance per se, and poverty is seen as a broader government responsibility. The bank sees its core functions as monetary management, guardianship of the payments system and banking supervision. Recent events in Indonesia and the region point to this as an appropriate role for the bank. However, Bank Indonesia has taken a strong incidental interest in microfinance development, considered as an aspect of the broader issue of financial sector development. Its leadership, expressed through programs such as the PHBK and the Microcredit Project, has sent valuable signals to the banking sector as a whole. Bank Indonesia should maintain this position of leadership with respect to microfinance, although current circumstances increase the difficulty of playing such a role. Study success of Bank Rakyat Indonesia The achievements of Bank Rakyat Indonesia in providing rural financial services which encompass substantial numbers of the poor in a professional and sustainable manner is well known. Factors supporting this achievement (at least until the second half of 1997) have been a stable macroeconomic environment, strong leadership, substantial investment in professionalising BRI’s human resource base, clear and transparent financial reporting and accountability. While replicating this success in different political and institutional contexts is difficult, all countries in the region need to consider to what extent and how they may apply the experience of BRI in support of sustainable microfinance services. Arrangements for direct support Expand the role of NGOs There is very little direct support provided for independent microfinance institutions in Indonesia, and the role of NGOs as the operators of independent MFIs is accordingly limited. The limited role of NGOs in microfinance does not mean that private initiative is lacking to promote this approach to poverty alleviation. The proliferation of rural banks, which are small, locally based financial institutions serving the needs of lower income groups, is evidence of a wealth of private initiative, at least in the Inner Islands where these small institutions are concentrated. There is great scope for NGOs to contribute to the extension of microfinance services in other parts of Indonesia, where the rural banks have been slower to become established. And, in all parts of Indonesia, there is scope for NGOs to contribute to the expansion of microfinance by facilitating the formation, training and operation of self-help groups of the poor, which are a culturally congenial form of social organisation. This is shown by the existence of many self-help groups in Indonesia engaged in savings and credit, often informal and based on traditional patterns of behaviour. Reservations are held about NGOs by many officials; suffice to say that one of the costs of this is the failure to maximise the contribution to the Indonesian society and economy of a potentially creative social force. Expand the role of the DABANAS Foundation Even though directed credit schemes are not the best way to secure resources for microfinance, the requirement that 20 per cent of all commercial bank advances must be made to the small industry sector (the KUK scheme) can work to the advantage of MFIs. When commercial banks choose to discharge their obligations under the KUK by funding the lending activities of rural banks, this makes funds available for microfinance to a certain degree. The channelling and rationalisation of this flow through the newly created DABANAS Foundation could increase the loanable funds of rural banks with a microfinance mission, such as are now being established by some NGOs. These NGOs would do well to press their claims to these resources, and Bank Indonesia should exert influence to see that the funding of microfinance is among the new foundation’s priorities. Develop P4K and PHBK programs In terms of programs channelled through the banking system, two programs, the P4K and the PHBK, are of particular significance. Both are carefully crafted models of microfinance service delivery working with SHGs of the poor. The success of the P4K microfinance program in creating successful self-help groups for women suggests the possibility that this program and others could work towards the creation of autonomous local MFIs owned and run by women. Technical assistance and the involvement of Indonesian NGOs will be necessary to achieve this goal. The recent rapid growth of linkages between small rural banks and self-help groups under the auspices of the PHBK linkage program conducted by Bank Indonesia indicates the potential for Indonesia’s rural banks to expand microfinance in direct partnership with SHGs. This approach should be developed further. Bank Indonesia has responsibility for the supervision and development of the rural banking subsector; this potential to develop microfinance as a market niche should be considered in designing a more appropriate and helpful system of supervision and reporting for the rural banks, as suggested below. Make mass government programs more sustainable Unfortunately, the PHBK and P4K have been slow to achieve the necessary outreach. As a consequence, mass campaigns of group-based microfinance (the IDT and Prosperous Family programs) have been commenced in recent years. In the process it appears that considerations of institutional development and sustainability may be given less priority than mass outreach, although both programs share the objective of preparing group members to participate in more orthodox microfinance programs in due course. One aspect of the mass campaigns, which may have negative consequences for microfinance more generally, concerns interest rate subsidies. IDT loanable funds are given to groups as a grant, with the group itself determining the terms of on-lending. Prosperous Family loanable funds are available to borrowers at a highly concessional interest rate of 6 per cent. These two programs overlap geographically to an extent, as well as serving the same populations as P4K in some cases. The P4K program is attempting to cover costs with an effective interest rate of 22 per cent. Furthermore, the expansion of small commercial financial institutions such as the rural banks could also be inhibited, to the extent that the mass campaigns overlap with these banks’ potential client base. Such distortions should be avoided so far as possible. Channel IDT groups into PHBK linkage project As against this, an evaluation of the IDT program suggests that some 30 per cent of groups are adequately prepared to enter the PHBK linkage project. Although it would require a substantial increase in the resources needed by Bank Indonesia for technical assistance under the PHBK, such an increase appears justified if the initial benefits flowing from the IDT campaign are to be translated into continuing poverty reduction. The ‘graduation’ of the best groups emerging from the IDT and Prosperous Family programs to a more rigorous commercial environment should be encouraged. The success of these mass programs will only be assured if this loop can be closed. This is another area where NGOs are capable of making a greater contribution than at present. However, the capacity of the banking system to accept this challenge, and Bank Indonesia’s capacity to support any expansion, must both be doubted in the light of events since this judgement was made. The regulatory framework for non-bank MFIs Permit NGOs to collect compulsory savings In principle, the requirements for establishing an NGO are simple to satisfy, and NGOs may freely enter into microcredit activities. Limitations on their capacity to mobilise resources for lending from clients are a constraint on their expansion. The situation of microfinance NGOs would be improved if ambiguities were removed concerning their right to collect compulsory savings from clients. They should be free to do so. Encourage establishment of MFI networks The role of NGOs in microfinance in Indonesia will be strengthened if they are able to organise for purposes of communication, coordination and self-regulation. Efforts to establish an association of NGOs involved in the PHBK linkage program under the sponsorship of Bank Indonesia have so far proved fruitless. This initiative deserves the continuing support of Bank Indonesia. The BKDs (village credit bodies) while not yet functioning as rural banks, will in time be eligible to join the Association of Indonesian Rural Banks (Perbarindo). The potential for this body to act as a mechanism for self-regulation of the rural banks needs to be developed. The expiry of the October 1997 deadline for LDKPs (rural fund and credit institutions) to upgrade to the status of BPRs has left many of these institutions in an ambiguous position. Established by provincial governments and local communities, they have a strong basis of support in a number of provinces, including several outside Java and Bali. Because of their continuing potential to provide microfinance services every effort should be made to bring them up to the standard required for operation as BPRs, rather than allowing them to wither away. The regulatory framework for banks Maintain flexible arrangements for establishment of small banks The regulatory environment permitting the establishment of small banks in Indonesia is a model for other countries in the region. The prudential regulation, supervision and reporting requirements for rural banks are essentially similar to those for commercial banks. However, Bank Indonesia’s Banking Regulation and Development Department believes that a more appropriate and helpful system of supervision and reporting needs to be developed for these smaller banks. The potential for rural banks to develop microfinance as a market should be recognised and facilitated in the process of revising their regulatory environment. The impact of the current banking crisis on the rural bank subsector is unclear at the time of writing. It would be unfortunate if suggestions to raise the minimum capital requirements of banks were applied in an inappropriate way to the rural banks. The DABANAS Foundation has been set up jointly by the associations of private commercial banks and rural banks. It will channel funds to rural banks from those commercial banks which experience difficulty in meeting the 20 per cent small loan obligation. It will also provide technical assistance to the rural banks and has the potential to exercise some of the regulatory and supervisory functions of a second tier organisation. This could be a valuable service, to the extent it accepts the goal of encouraging rural banks to engage in microfinance. References
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