Creating Inclusive Financial Services for Economic Growth and Poverty Reduction in Indonesia

1. Creating Inclusive Financial Services for Economic Growth and Poverty Reduction in Indonesia Presented at the 1st International Islamic Financial Inclusion Summit Solo, July 17th, 2012 P.S. Srinivas, Lead Financial Economist Financial and Private Sector Development Unit World Bank Jakarta Office

2. Outline of Presentation: Financial Inclusion contributes to poverty reduction Indonesia’s relative position on Financial Inclusion World Bank’s engagements related to Financial Inclusion in Indonesia How Islamic Finance links to Financial Inclusion

3. What is Financial Inclusion ? How does it contribute to economic growth and poverty reduction?

4. How does Financial Inclusion relate to poverty reduction? Poverty Reduction Social inclusion (Access to Basic Services ) Promote empowerment among the poor (e.g., Health & Education, Social mobilization) Economic inclusion Increase access to the income generating opportunities for the poor (e.g., MSME development) Financial inclusion (Access to Finance) Expand the financial capacity of the poor • Without inclusive financial systems, poor individuals and small enterprises will have to rely on their personal wealth or internal resources to invest in their education, become entrepreneurs or take advantage of promising growing opportunities

5. Importance of Financial Inclusion for Poverty Reduction • Asset & income expansion • Regular Access to Formal Services • Asset/life protection (insurance) Escape from poverty • Asset Building & business start up • Start Accessing Broader Formal Financial Services ( Saving, Credit, remittance etc) • Financial management & Planning Skills • NEEDS: • Asset Building • Entry point for Formal Financial Services (saving) Economic Inclusion Economic Inclusion Economic Inclusion Financial Inclusion Financial Inclusion Financial Inclusion • KUR Program (partial guaranteed credit) • KUBE program (joint business group program for productive poor) Poor (Cluster 3) • almost graduate (still vulnerable) Poorer (Cluster 2) • with sources of income Poorest • (Cluster 1)with limited assets Social Inclusion Social Inclusion Social Inclusion • i.e. PNPM Program: • MandiriRural-Urban, Revolving Loan Fund (RLF) • PISEW (regional infrastructure development) • P2DTK (enhancing the development of underdeveloped region) • PKH (CCT program) • Scholarship & school operational assistance • Jamkesmas (health assistance) • Raskin (rice assistance)

6. Financial Inclusion goes beyond credit / microcredit Transactions & Technological Support Financial Education/Entrepreneurship

7. Financial inclusion isfour dimensional 7

8. Financial Inclusion in Indonesia: Where are we? What is happening?

9. Indonesia’s access to finance is behind other emerging economies • Bank Deposit Value • (% of GDP) • Bank Loan Value • (% of GDP) • ATM per 1,000 sq km • Bank Branches per 1000 sq km • Bank Branches per 100,000 adults • ATM per 100,000 adults Source: IMF FAS 2011, data as 2010

10. Formal financial sector is dominated by banks, and the poor segment is excluded from access to finance Source: World Bank Study, Improving Access to Financial Services in Indonesia 2010

11. The poor have much less access to formal financial services (Savings slightly better than credit but still limited) Source: World Bank Study, Improving Access to Financial Services in Indonesia 2010

12. Informal sector has larger share than banks in credit

13. Reasons for financial exclusion • 1. Do not have money • 2. Do not have a job Saving (Bank account) • 3. Donot see advantages of having a bank account • 1. Not creditworthy Credit • 2. Do not want to borrow • 3. No collateral • 1. Do not have money Insurance • 2. Know nothing about insurance • 3. Do not need insurance Source: World Bank Study, Improving Access to Financial Services in Indonesia 2010

14. World Bank’s engagements in Financial Inclusion in Indonesia

15. Who does the World Bank work with?

16. The Range of Financial Inclusion Engagements in Indonesia • 2012 NSFI development • Two Diagnostics Studies Reform on GoI funded PNPM Mandiri RLFs Scheme Fin Literacy ToT for GoI Pilot Project (Research on Fin. Literacy Assessment on MWs) Microinsurance Regulatory Framework Microinsurance Marketplace Review on MW Microinsurance Islamic Finance for MSMEs Assessment on KUR (GoI Credit Guarantee Program) Strengthening Savings & Loans Cooperatives Branchless Banking regulatory review Evaluation of TabunganKu (Basic bank account) Collaborative partnership

17. Results of collaborative partnership • 2012 • Broader Awareness of Importance of Fin Incl among policy makers and regulators ASEAN Financial Inclusion Seminar Commitment at G20 Mexico • GoI Mid-Term Dev Plan (2010-2014): Improving Access to Finance for MWs National Strategy of Fin Inc ideveloped Bappepam-LK Master Plan 2010-2014 Facilitation of Microinsurance Development No frills account (TabunganKu) introduced in Feb 2010 has reached more than 2.5 million accounts KUR introduced and offered to previously unbanked MSMEs & TKIs • Awareness of Importance of Sustainability of GoI funded Fin Inc Program • Reform of GoI funded PNPM Mandiri RLFs Scheme • Improving KUR scheme

18. Islamic Finance and Financial Inclusion for MSMEs in Indonesia

19. Islamic Finance in Indonesia: A fast growing industry with strong potential Source: BI, Bapepam LK, WB estimates What the World Bank has done • The World Bank commissioned a study to look at access of Islamic finance for SMEs which include the following activities: • Reviewed current Indonesian Islamic finance industry (products, clients, etc.) • Conducted surveys: demand- supply side, covering 1,100 MSMEs and 100 Islamic Financial Institutions (IFIs) • Developing strategy to enhance access SMEs to Islamic finance

20. Sharia Banks and MSMEs: Key Messages from the Study (1) Sharia bank believe their products better serve the needs of MSMEs and their simple process for granting financing provides competitive advantage over conventional banks Sharia banks have been providing higher access to financing for SMEs - at 70%, compared to convential banks – at around 50% Cost (margin/interest), simple process and quality of services are the main considerations for choosing Sharia financing over conventional. Not much different factors seen in conventional. Source: WB estimates Sharia financing to MSMEs has been mostly used for productive uses – additional working capital for current business or expanding the business Source: WB estimates

21. Sharia Banks and MSMEs: Key Messages from the Study (2) Lack of understanding of Sharia products appears to be a significant hindrance for higher access of Sharia products by MSMEs More than half of MSMEs surveyed said that they would use Sharia banks’ products, if they have enough understanding. Awareness can play a significant role in increasing the usage of Sharia financing Most MSMEs use murabahah for Akad (73.79%) – there is a room for product diversification Only a small share of MSMEs surveyed claimed to know Sharia banks and their products well Source: WB estimates

22. Sharia Banks and MSMEs: Key Messages from the Study (3) Micro-Sharia financial institutions such as the BMT seems to be very popular source of financing by MSMEs, much higher than conventional cooperatives and rural banks. A significant portion of MSMEs respondents (30%) indicated that do not have access to financial institutions. A more prevalent for Micro enterprises MSMEs’ source of financing by type of institutions There are around 4,000 BMTs in Indonesia. With their current presence in rural areas, these institutions have the potential to serve more productive poor at grass root level. Empowering Micro Sharia financial institution such as the BMT is an effective strategy in enhancing financial inclusion (access to finance) for the productive poor and help them escape poverty. Source: WB estimates

23. CONCLUSION

24. Conclusion • Financial inclusion is means to achieve poverty reduction and local economic growth • A more “inclusive” Indonesia is an overall policy goal for the country • Financial sector should be inclusive as well • Less than 50% of Indonesians have access to the formal financial sector • Less than a fifth have ever borrowed from a bank • Much lower for poor • Enhancing Access to Islamic Financing for SMEs in Indonesia • The Islamic finance industry has been growing strongly in Indonesia, but it is still relatively small. Like its conventional peers, sharia banks dominate the industry. • Currently Sharia banks are already more inclined to served MSMEs. • Building awareness can play a significant role in increasing the use of Sharia financing by MSMEs. • Empowering the micro sharia financial institutions can potentially increase financing for productive poor who run micro enterprises.

25. ANNEX: World Bank Engagement on Financial Inclusion in Indonesia

26. Financial Services for Migrant Workers (PPP)Partners: BI, Commercial bank, PPTKIS • WB with BI + Private Sector Number of MWs is significant MWs have specific financial needs • MWs have financial needs along the stages of migration, but lack of knowledge in financial literacy and financial credibility hinder their access. • Steady growth in the number of legal MW: around 520,000 in 2011 (drop in recent years was due to GoI moratorium policy) • Remittance growing: 6.9 USD billion in 2010 (about 1% as share of GDP) What we are doing Assist BI to develop a business model that integrate a financial scheme covering each stage of migration process and providing MWs (and their families) with a wide range of financial services and products including credit, savings, remittances and financial literacy training to both MWs and their family

27. Regulatory review on Branchless BankingPartners: IFC, BI, Banking Association, Telco Association • Supporting Government Initiatives • WB Initiatives • Comparing cell phone penetration with access to finance, Indonesia has the highest potential for branchless banking implementation, (reaching 83 million individuals). What we are doing • Assisting BI in assessing the regulatory environment for branchless banking development in Indonesia which consisted of 3 components: • Industry assessment • Legal and regulatory review • Oversight framework

28. Improving microcredit scheme under PNPM MandiriPartners: Menko Kesra, Bappenas, MoHA, Min. Public Works • Supporting Government Initiatives What we are doing Project Title: PNPM Mandiri Revolving Loan Fund Capacity-Building and Sustainability Project Project Area : 4 provinces (Central Java, Yogyakarta, NTT and West Sumatra) Activities: • Restructure and improve performance of RLF operations (through needs assessment & technical trainings & capacity building ) • Determine the legal structure of RLFs • Establish linkage with commercial banks and other formal financial providers • Develop a long term strategy for revitalizing PNPM Mandiri RLFs

29. Pilot Project on Financial Literacy Training for Indonesian Overseas Migrant Workers and Their FamiliesPartners: CMEA, BNP2TKI,Disnakertrans Malang, PPTKIS • WB Initiatives Output and Outcome Activities • Modules: Training Guidelines, Trainer’s Guide for Migrant Workers, Trainer’s Guide for Migrant Workers’ Family; and supporting training tools: poster, comic book, financial book, and brochure • Overall, 432 migrant workers and/or their families from Greater Malang area have been trained • Currently, the pilot is analyzing all the data collected from the monitoring stage. Report on the results are expected to be published in mid June 2012. • Preliminary analysis of the monitoring data shows that there is a positive correlation between financial literacy training and opening savings account. • This pilot is a randomized research. The main objective is to evaluate the impact of financial literacy training for migrant workers and their families and to explore the effective ways to improve their knowledge in managing their remittances • Development of financial literacy training modules for migrant workers and migrant workers’ families, and development of training supporting tools • Providing financial literacy training: trainings are conducted for migrant workers who have registered to recruitment agencies (PPTKIS) to work overseas and/or their families. • Phone and face to face monitoring were carried out to assess how the training affected the household’s financial behavior.

30. TA to Support GOI’s Financial Literacy Initiatives for Indonesian Overseas Migrant Workers and their FamiliesPartners: CMEA, BNP2TKI, BP3TKI, Disnakertrans, Government-owned Banks • Supporting Government Initiatives Activities Output • ToTon financial literacy for staffs of BNP2TKI, BP3TKI (regional office of BNP2TKI, in 19 provinces across Indonesia) & Govt-owned banks; 2 batches in 2011 & 1 batch in 2012 • Mentoring and monitoring during BNP2TKI – BP3TKI financial literacy trainings to MWs and MWs families: 17 provinces in 2011 (April – November 2011) and 9 provinces in 2012 (March – July 2012) • ToT implementation: March 29 – April 8, 2011, 58 staffs from 19 BP3TKIs, Bank BRI, Bank BNI, Bank Mandiri, TIFA Foundation, and SahabatWanita Foundation participated in the training. March 5 – 8, 2012, 37 staffs from 19 BP3TKIs, Bank BNI and Bank Mandiri participated in the training. • Monitoring tools formulated: checklist, pre test/post test questionnaire, time keeping form, mentoring & monitoring form • Overall, 1,287 people were trained in 2011 (542 MWs, 723 MW’s families, 22 ex MWs) • Mailing list established (for BNP2TKI & BP3TKI staff) as a media to discuss, learn, and share experience in conducting FL training • FL advocacy video produced, and FL training tutorial video in production process • Website on MWs financial education is under construction Outcome • BNP2TKI staff gained competency as mentor & Master Trainer during ToT in 2012 • Banks (BRI, BNI and Mandiri )committed to provide support to BNP2TKI by involving their trainers in the ToT • Bank Mandiri committed to expand FL training as part of its CSR activities

31. Formal insurance industry WEALTH Informal insurance Insurable, without access Uninsurable through market mechanisms POPULATION Promoting Micro-insurancePartners: BNP2TKI, Bapepam-LK, Min. of Manpower & Transmigration • Supporting Government Initiatives Review of Mandatory TKI Insurance • Support on Micro-insurance Development Despite of its mandatory features critical problems still exist : its effectiveness to provide protection for MWs has been increasingly questionable. Background • The insurance industry in Indonesia is relatively small compared to the overall financial sector • Bapepam-LK’s master plan for 2010-2014 includes the development of micro insurance in Indonesia: • a) expansion of the overall insurance market, particularly given the low levels of penetration; and • b) as a tool for social protection/safety net Background • Conduct a review on the existing MWs insurance product and mechanism • Gather information on type of data collected by any institution related to MWs What the we are doing What we are doing • Support microinsurance marketplace • More details in the following page • T.A. for Insurance Bureau of BapepamLK: • to develop regulation for microinsurance to support enabling environment in Indonesia 31

32. Promoting Micro-insurancePartners: Bapepam-LK, the Indonesia Insurance Council, Institute of Risk Management and Insurance (STIMRA), IFC, Global Index Insurance Facility (GIIF) • WB w/ Private Sector + GoI • Microinsurance Marketplace Event (October 2011) What we are doing • Two days event consisting of plenary session and exhibition of existing micro insurance product • Plenary session was used to share international and local best practices • Exhibition was used to promote micro insurance product and services • Around 370 people participated in the event coming from both insurance and non-insurance sector 32

33. Basic no frills accounts: TabungankuPartners: BI, Commercial Banks, BPR • Supporting Government Initiatives Overview of TabunganKu Basic bank account initiative led by Bank Indonesia along with 70 commercial banks and more than 1,000 BPRs/Sharia with main features: free monthly administration fee, low minimum account balance & low opening balance. What we are doing • Assist Bank Indonesia to evaluate TabunganKu: • Has it met costumer’s demand? • Has it enhance access to formal savings? • Is it commercially sustainable?

34. Credit Guarantee Scheme for MSMEs: KURPartners: CMEA, BI, State Owned Bank, Credit Guarantee Companies • Supporting Government Initiatives • In 2007, the GoI launched KUR program to give access to credit for unbanked MSMEs by providing partial credit guarantees to selected state owned banks • In a few years KUR has grown into one of the largest credit guarantee programs in the World. As of April 2012, total disbursements were IDR 72 trillions with 6.3 million borrowers • Due to the size of KUR, the GoI decided to review the KUR’s effectiveness in order to maintain performances and prepare its scaling up in the coming years Background What we have done • The World Bank assists CMEA to evaluate the KUR program’s achievements to date and develop recommendations on how to strengthen the program • Main findings: • There was evidenced that KUR has helped to increase access to credit to MSMEs • KUR has encouraged banks to lend to small enterprises and especially to microenterprises • However further changes to improve the KUR scheme’s effectiveness are still needed

35. Support to KUR’s Policy Committee (CMEA) to develop KUR’s Monitoring & Evaluation (M&E) Framework Partners: KUR Policy Committee (CMEA) • Supporting Government Initiatives • Supporting Government Initiatives KUR program has been expanding strongly in respects of disbursement, number of participating banks and debtors. The Government has indicated continued supports on KUR and it has increased the target of disbursement of KUR. There is absent of an integrated M&E framework of KUR which is important if GoI wants to review/assess impacts of the KUR program. M&E is required by KUR related regulations (KUR’s MOU, Inpres No. 5/2008, PP No. 39/2006). Background • Organized discussions with related stakeholder (BPKP, BI, Guarantee Company, Banks) to understand existing monitoring systems in each institutions. • Identified the gap/areas for improvements and currently on the process of drafting a proposed framework of M & E. • Expected completion by December 2012. What we have been doing:

36. Enhancing Access to Islamic Financing for SMEs in Indonesia: Partners: BI, Bapepam LK and Ministry of SMEs & Cooperative • Supporting Government Initiatives • Supporting Government Initiatives • WB Initiatives Background The Islamic finance institutions (banking and NBFI) - have been growing strongly In Indonesia. The Sharia banking assets has increased by around 40% annually but it only accounts 5% of total banks’ asset. It suggest the potential for further growth is strong. On the other hand, MSME also shows strong growth of number of entities and business volume However, access to financing is still known as one constraint. There is a growing interest in the World Bank to work on supporting Islamic finance to complement the MSME finance works but its knowledge on level of access of MSMEs to Islamic financing is limited hence it commissioned this project. The results also expected to Indonesia has the potential to have a vibrant Islamic finance industry. What we have done • The project had a number of activities: • Conducted an review of current Indonesian Islamic finance industry (products, clients, etc) • Conducted demand and supply –side surveys • Develop an assessment tools on how to assess level of access to Islamic finance • Prepare a concept of financing facility for the World Bank to consider supporting in Indonesia.

37. Enhancing Access to Islamic Financing for SMEs in Indonesia: Partners: BI, Bapepam LK and Ministry of SMEs & Cooperative • Supporting Government Initiatives • Supporting Government Initiatives • WB Initiatives What we have found: • The survey results suggest the perception of Micro-SMEs toward Islamic Financial Institutions (IFI) is positive and Sharia finance is well received by the Micro-SMEs. • A majority of Micro-SMEs surveyed indicated the simple process of Sharia financing is an important factor for their decision to use Sharia financing and Sharia finance products do serve their needs. • The lack of understanding of Sharia products appears to be a significant hindrance for higher access of Islamic finance for Micro-SMEs in Indonesia.

38. National Strategy of Financial InclusionPartners: TNP2K, Bank Indonesia, Bappepam-LK • Supporting Government Initiatives • Supporting Government Initiatives • a “People-Centered” strategy approach with the mission • “to Achieve a Financial System that is Accessible by all Layers of the Community to Promote Economic Growth, Poverty Reduction and Income Equality in Indonesia” Strategy designed with a mutually reinforcing fit between these three components: Financial Inclusion Targeting the poor Promoting Enabling Regulation & Consumer Protection What we are doing • Assisting the Vice President office to develop the National Strategy for Financial Inclusion • Accomodate socialization / discussion between the VP office with Bank Indonesia (regulator of banks) and Bappepam-LK (regulator of NBFI) • Assisting VP office in providing a better understanding to the other ministries on their role & involvement in the strategy • Promoting Local Economic Development

39. Strengthening and Empowering the Saving and Loan Cooperative Sector : Increasing Access to Finance for Micro-SMEs Partners: Bappenas, Ministry of SMEs & Cooperative • Supporting Government Initiatives • Supporting Government Initiatives KSP /USP shows strong growth of business and plays important roles in providing financing for Micro and Small enterprises. GoI’s policy to strengthen and empower KSP/USP to increase the above roles whilst maintaining the value of Cooperatives. Need to have a through analysis of issues, challenges and prospects of the KSP/USP before formulating policies. Background What we will do • The activities will be divided into two components: • Component 1: Conduct a KSP/USP study: • Phase 1designing and preparing the study (literature review, write case studies, prepare research tools. (March – June 2012) • Phase IIComplete the study, will include surveys/interviews (July 2012 – June 2013) • Component 2: Follow up of Study:Technical Assistant & Capacity Building