Review of Financial Linkages in Indonesia Preliminary Case Study Results

1. Review of Financial Linkages in IndonesiaPreliminary Case Study Results

2. Background • FAO’s additional contribution to Ford Study • September 15 – October 15, 2004 • Why Indonesia? Complex and diverse financial landscape with ample linkages for review. • Main objective of study – to help push our reflection on the analytical and methodological frameworks for the global study.

3. Points of Presentations • Overview of Financial Sector Development • Legal and Regulatory Framework • Review of Various Linkages Models • Preliminary Results from Linkage Case

4. Financial Sector Development Strategies • Central bank law enacted with strong ‘development’ mandate in 1968. • Financial sector deregulation began in 1983 with removal of interest rate restrictions • Longer term consequence – BRI village level operations turned around • Further deregulation in 1988 – expansion of local ‘rural banks’ (BPRs) • Liquidity credits through central bank to priority sectors (throughout Soeharto era)

5. Liquidity credits led to gross misallocation and misuse (efforts to curb from 1991) • New 1999 banking law enacted • Channeling credit to priority sectors modified • Require approval of credit subsidies by gov’t budget process • Supervisory role transfer to new entity planned • Increasing trend to preserve central bank’s independence and improve accountability • New banking architecture announced in 2003 • Encourages commercial banks to nurture linkages with rural banks

6. Institutional Landscape of Rural and Microfinance Policy, regulation and supervision. Support for linkages Overall low MF outreach but BI policy encourages links with BPRs. Provincial development banks (BPDs) have multiple linkage relationships with local institutions. Central Bank (BI) Commercial Banks, including BPDS BRI, a rural commercial bank. Retail division links with local institutions. MB Division serves better off micro borrowers via 4000 units. Tight focus precludes unit from linkages Banks BRI Corporate Retail and MB Division BPR/BPR (Shariyah) BPRs total 2123 (incl 86 shariyah). Private (incl cooperative & NGO) ownership, also local gov’t. Multiple linkages with commercial banks to strengthen sector. MF Service Providers BKD Small local organizations. Some 4500 BKDs linked with BRI in supervisory and financial relationships. These century old organizations are liquid and profitable, but static Formal LDKP More than 1600 entities, owned by local or provincial govts. Linked with provincial development banks (BPDs) for purposes of supervision and liquidity management. Non Banks Co-ops 5200 USPs and 1200 KSPs active in rural areas. PN Madani active in linkages. NGOs and MFIs (incl shariyah) have taken advantage of co-op legal status in recent years. Pawnshops Non Formal Efficient and profitable state-owned institutions. Not engaged in linkages Apex Organizations: PN Madani, Bank Mandiri, DABANAS Informal group organizations has traditional roots. New Order government organized millions of households in mass credit schemes. Widespread informal S& L activity continues. MFIs, NGOs, Self Help Groups, ROSCAs Madani is executing agency for former BI liquidity credits. Mandiri is state commercial bank. Both active in credit linkages. DABANAS is a foundation created by private commercial banks to channel working capital credits to BPRs

7. Legal and Regulatory Framework

8. Description of Linkage Models Observable in Indonesia

9. Nature of Linkage Models

10. Five Kinds of Financial Linkages • Savings linkage • Credit linkage • Facilitation linkage • Capacity building and supervision linkage • Equity linkage

11. Simple Bilateral Linkages O-------------------------------------------------O------------> Final borrowers Commercial bank Rural bank O-------------------------------------------------O-------------------> Final borrowers Commercial bank Non-bank financial institution (Credit Fund) Village Credit Board O----------------------------------------------O---------------------> Final borrowers Apex institution Rural Bank Savings and Credit Co-op KSP O-------------------------------------------------O------------> Final borrowers Rural bank Self-help group

12. Agribusiness Financing via Non-financial Entities O----------------------------------O-------------------------------> Final borrowers Commercial Bank Agribusiness entity (Producers)

13. A Case of BPD-LPD Linkage • BPD – Regional Development Bank • LPD – Community Rural Finance Organization at village level • BPD main driver for linkage, provides supervisory services by provincial government statute • LPD deposits excess liquidity with BPD • BPD provides loans to LPD • All products and services are based on market rates of interest

14. Some Key Benefits • Extended financial services at village levels, deposit facilities and loan products • Convenient low-cost and market return liquidity management option for LPD • Convenient access to loans and lines of credit on demand • Technical assistance and supervision by BPD for a fee