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LESSONS:

Microcredit Project

sector: Finance | country: Indonesia

Bank Perkreditan Rakyat (BPRs or village banks) can benefit from continued assistance. BPRs are well suited to microfinance because the average loan size of most BPRs is below 150% of GNP per capita. BPRs are confined geographically and cannot easily expand deposit-taking activities to expand loans. They cannot move up market because of competition from larger financial institutions (such as commercial banks), legal lending limits, and funding constraints that limit lending outreach. They are, however, well positioned to move down market. BPRs’ competitive advantage is in their closeness and attentiveness to their customers, who are generally individuals, microenterprises, and small businesses. BPRs, however, often lack the desire or the funds to invest in computer systems and software, and they have no easy way to link with the payments system or wider payment networks. Negative implications for asset/loan portfolio diversification is that in some cases they are not well equipped to design new products that might facilitate moving down market to serve poorer clients with smaller loans. BPRs need to develop appropriate new products, diversify and better manage asset and loan portfolio risk, and improve their information technology. External interventions targeting BPRs might consider creating more formal linkages of BPRs and commercial banks – where a marketing/product channelingsymbiosis is likely – and strengthening of supporting institutions that help BPRs enhance their competitiveness or reduce their risks by providing treasury management services.

Commercial microfinance has arrived in the country, highlighting new possibilities for private-sector operations. The project demonstrates that with the proper oversight, a portfolio of loans to Bank Perkreditan Rakyat (BPRs or village banks) – established, profitable, well-capitalized businesses – can carry low risk and earn a commercial yield. At the very least, it is possible to reduce the scope of public-sector activity in future microfinance projects/loans. Future ADB funding should further catalyze private-sector participation in microfinance, meaning that ADB funds should be leveraged with private funding.

Expansion of microfinance activity does not necessarily contribute to creation of new wage earning jobs. With access to loans, a microentrepreneur can spend more time developing her/his business, and perhaps support the participation of additional family members in the business. The impact of microfinance on employment is mainly indirect, therefore, and the most significant impact of microfinance can expected to be on family incomes.

If challenged, and with access to effective technical assistance, many financial institutions can move down market and adopt new methods of reaching poorer clients. The key factors were the fact that (i) the small financial institutions (SFIs) set their own interest rates to charge clients; and (ii) the project did not limit lending to a certain sector, only a certain size. Maximum loan sizes were attractive mainly to poorer clients, and also helped serve large numbers of microenterprises run by poor and near-poor women because they matched the size of their businesses. Client selection is the microfinance’s business and should not be interfered with by any project or agency.

In most cases, small financial institutions (SFIs) were allowed to borrow no more than 5% of their overall funding. The project created no dependency on the part of SFIs; BPRs (village banks)needed to continue gathering funds in the form of savings and time deposits from traditional customers. Sustainability of microfinance depends upon microfinance institutions’ (MFIs’) ability to attract and retain readily available commercial sources of funding. Credit line availability should be strictly limited so as not to create dependence on the part of the MFI. The success of a credit line intervention might best be measured in lending outreach to new borrowers combined with a substantial increase in the amount of local funding gathered by the MFI.

Since incomes are subject to various unquantifiable externalities, success or failure of microfinance is best measured by outreach and financial sustainability. Loan size can serve as a useful proxy for depth of outreach to poor clients. It is important to gather survey data related to poverty and incomes of project participants. It is necessary to understand poverty in all its dimensions – not simply in terms of income – so well-designed social impact surveys should rightfully be incorporated into microfinance projects. Still, an increase or decrease in income by participating microenterprises should not be considered the central indicator of success of a microfinance project. There is solid evidence to suggest that a well-designed microfinance intervention will benefit those who were hitherto denied access to affordable financial services. Project frameworks should elevate sustainable financial deepening to the outcome or impact level.

There is a natural limit to how far down market small financial institutions (SFIs) can go with lending without (i) increasing operating expenses to such a point that the lending business is no longer attractive, or (ii) finding insufficient demand for such small loan amounts. This level will be different for each SFI. There was friction between ADB, the executing agency (Bank of Indonesia), and the SFIs during the project over the maximum initial loan size; the project performed a constant and difficult balancing act to push downward the frontiers of microcredit while keeping the SFIs interested in exploring those frontiers. Microfinance projects should determine a range for commercial microlending, challenge SFIs to move down market, provide proven new methodologies to assist SFIs to move down market, and allow SFIs some leverage to push back from the bottom end of the range to ensure commercial sustainability. The project demonstrates that ADB can successfully expand the frontiers of microfinance.

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