consolidated assessment of upk revolving loan...

PNPM Mandiri:

Consolidated Assessment of UPK Revolving Loan Funds

in

Indonesia

for their financial performance and capacity building needs

Commissioned by the Access to Finance Team

Financial and Private Sector Development Department The World Bank, Indonesia

May 2012

Micro‐Credit Ratings International Limited 602 Pacific Square, 32nd Milestone NH8

Gurgaon 122001 INDIA

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WB406484

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WB406484

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Consolidated report on 508 UPK RLFs in Indonesia

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Table of Contents Page

Preface iv Glossary of Technical Terms v Abbreviations vii Executive Summary ix

S1 Overview of the assessed rural UPK RLFs ix S2 Quality Assessment xS3 Main performance indicators xiv S4 Main findings and key recommendations xvi

S4.1 Operational performance xvi S4.2 Competition, liquidity and financial performance xvii S4.3 Data and accounting issues xix S4.4 Facilitation xx S4.5 Capacity building needs xx

S5 Conclusions xxi Action Plan xxii MAIN REPORT 1 Introduction and background 1

1.1 The PNPM Revolving Loan Funds 11.2 Background on the needs assessment 2 1.3 Scale and scope of the assessment of UPKs 21.4 Specific objectives expected to be achieved 3

2 Description of the assessment methodology used 4

2.1 Process map of the assessment visit 52.2 Analysis and reporting 5

3 Main Findings 6

3.1 Operational performance 6 3.1.1 Outreach 6 3.1.2 Operational structure and roles 8 3.1.3 RLF policies 9 3.1.4 Competition 12 3.1.5 Poverty targeting 14 3.1.6 Misappropriation 15 3.1.7 Group management 17 3.1.8 Financing of UPK RLFs 17


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3.2 Financial performance& cost analysis 18

3.2.1 Financial performance ratios – distribution across UPK RLFs 21 3.2.2 Liquidity analysis 23 3.2.3 Credit performance and portfolio quality 24

3.3 Data issues – reliability, quality and transmission 28

3.3.1 Accounting system and internal control/audit 28 3.3.2 Tracking of overdues 29 3.3.3 Management information systems (MIS) and data reliability 30

3.4 Institutional capacity 33 3.4.1 Staff – qualifications and capacity 33 3.4.2 Loan appraisal and approval 34 3.4.3 Dealing with delinquency 35 3.4.4 Facilitation 36 3.4.5 Issues of programme structure 36 3.4.6 Training of facilitators and UPK RLF staff 37

3.5 Future directions 40 3.5.1 Institutional 40 3.5.2 Financial – bank linkage 41

4 Conclusions and Recommendations 42

4.1 Operational performance & institutional capacity 424.2 Financial performance 44 4.3 Data issues 44

4.3.1 Accounting system – better practice needs to be ensured 44 4.3.2 MIS and data reliability/quality 45

4.4 Future directions 46

6 Best practices and critical issues 48

Annex 1 M‐CRIL’s rating grades 50

Annex 2 Checklist for rural UPK RLF and urban UPK assessments in Indonesia 51

Annex 3 Summary of the MIS and reporting system at UPK RLFs 57

Exchange rate used throughout this document:9,000 Indonesian Rupiah = one dollar

(Rp9,000=US$)


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Preface

This is the final consolidated report of an extensive programme to assess the financial performance and capacity building needs of the UPK Revolving Loan Funds under the PNPM Mandiri project. As explained in the report, the assessmentprogramme covered 508 rural and urban UPKs in the provinces of Central Java, Yogyakarta, Nusa Tenggara Timor and West Sumatra. The aim was to cover 30% of rural UPK RLFs in these four provinces and 10% of the urban UPKs in order to establish the achievements and determine areas of improvement to enable these UPKs to provide a better service to the low income families in their operational areas. This report covers all 267 rural UPK RLFs and 241 urban UPKs identified for the purpose in the four provinces. The M‐CRIL team undertook this work in conjunction with and using the support of its local partner, MICRA, based in Jakarta, Indonesia. We would like to thank the World Bank for assigning the work to us. In particular, we would like to thank Yoko Doi, Financial Specialist, other members of the team consisting of Kiyotaki Tanaka, Cynthia Clarita Kusharto, Eric Tamaela Wattimena, Muhammad Asway Pulungan and Fajar S. Pane for their support,and of course, P Srinivas, Head of the Financial and Private Sector Development Unit, for his guidance. We would also like to thank the entire MICRA team for their highly effective support. The members of the diligent team that undertook this work are as follows

M‐CRIL MICRA

Swetan Sagar, Director, Studies Surya Agung Meranga Berenice da Gama Rose, Senior Analyst Wishnuhardjo

Kajal Arora, Senior Analyst Rionaldo Matondang Pankaj Kumar, Senior Analyst Didi Hartono Rudy Tomasoa, Senior Analyst Indra Alfonso Mursid

Tirupathaiah Namani, Senior Analyst Edwin Benyamin Linnga

Avishek Sarkar, Analyst Rini Sadikun Neelmani Gupta, Analyst Yeni Fitriyani Saurabh Rastogi, Analyst Fitri Utami Ningrum

Revathy S, Analyst Andriyani Hapsari Satish Gupta, Analyst Philips Marbun Rupal Patel, Analyst

Alok Misra, CEO Micro‐Credit Ratings International Limited Sanjay Sinha, Managing Director Gurgaon, INDIA

May 2012


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Glossary of Technical Terms 1 APR – Annual percentage rate: Effective rate of interest charged by the RLF on its loans.

APR differs from the Effective Interest Rate (EIR) paid by borrowers since the amount received by the RLF is different from the amount paid by the client

2 Average loan disbursed: Total portfolio disbursed over the year divided by the number of loans disbursed during the year

3 Average loan portfolio: This represents the average loan outstanding for the year computed on a monthly basis

4 Average total assets: This represents the average total assets for the year calculated on an annual basis

5 CCR/OSS (Current Cost Recovery/Operational Self Sustainability): Actual revenue earned from operations as a proportion of total cost incurred in operations. For an organization to be sustainable it should be greater than 1 (or >100%)

6 Cost per borrower: Total cost of operations (staff cost and other expenses but not

financial or loan loss expenses) divided by number of borrowers served by the RLF

7 Collectability (Kolektibilitas): Aging categories for amounts overdue from borrowers –the first category (Kolektibilitas I) being current loans (principal outstanding in loans being paid on time) and the last category (Kolektibilitas V) being loans not recoverable (actual age of overdue for each category is shown in the body of the report, Table 4.2.6)

8 Block grant (BLM): Grant provided annually by the national government (80%) and

provincial governments (20%) for the PNPM programme

9 EIR – Effective interest rate: Total cost of the loan to the borrower calculated as a proportion of the borrower’s expected average loan portfolio for the year (as determined by the loan terms)

10 FER – Financial expense ratio: All financial expenses incurred by the UPK as a proportion

of average portfolio during the year. FER is different from the cost of funds which is the average cost of borrowing money from other institutions. The denominator for the calculation of FER is “portfolio” whereas that for cost of funds is “borrowed funds”.

11 LAR – Loans at risk: The number of loans with portfolio at risk (PAR – see below) as a

proportion of the total number of loans

12 Liquidity: Cash in hand plus money in bank accounts as a proportion of total assets at the end of the financial year/period (31 December). Average liquidity (for the year) = total of month‐end cash & bank balances for each month from 31 December of the previous year to 31 December of the current year (average of 13 month‐end balances


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since using 12 months leaves out January of the year as the data starts on 31 January) divided by average assets calculated as the average of 13 month‐end figures for assets

13 LLP – Loan loss provisioning ratio: Total loan loss provisioning expense for the year divided by the average portfolio

14 Net operating margin: Difference of (yield on portfolio+ yield on other income) and (loan loss provisioning) – also known as spread on portfolio

15 NMC – National Management Consultant: Advisory and technical support agency for the PNPM programme – supports the work of the Regional Management Consultants (RMC)

16 OER – Operating expense ratio: Ratio of salaries, travel, administrative costs and

depreciation expenses to the average loan portfolio

17 PAR – Portfolio at risk (PAR (>0day)): Ratio of the principal balance outstanding on all loans with overdues greater than or equal to 1 day to the total loans outstanding on a given date. It is often stated by degree of risk – PAR30 = principal outstanding in loans with overdues for more than 30 days or PAR90 principal outstanding in loans with overdues for more than 90 days and so on

18 RoA – Return on assets: Ratio of profit earned (or loss) to average total assets. RoA is a

measure of an organisation’s profitability relative to the total funds deployed in all its activities (not just operations). In the financial sector RoA is usually in the 1‐3% range

19 RoI – Return on investment: Ratio of profit/net income to capital investment.

Depending on how capital investment is defined, this could be the same as RoA

20 RMC – Regional Management Consultant: Provincial level consultant to the PNPM for coordinating and supporting the work of facilitators at the district level (Faskab) and UPK level in the rural programme, and of Korkots and facilitators at the kelurahan level (Faskel) in the urban programme.

21 Sustainable (self‐sustainable): In a financial context, a sustainable institution is one that

is able to generate sufficient revenues to cover all its operational expenses as well as its capital investment needs. An institution that has become sustainable is said to have achieved sustainability. In terms of indicators, an operationally sustainable financial institution has an OER (see above) of 100% and a financially sustainable institution covers its capital expenses as well (RoA greater than zero).

22 SOP – Standard Operating Procedures: The set of rules framed by the programme to

determine the normal operating procedures in UPKs

23 Yield on portfolio: Actual interest income on lending by the RLF divided by the average loan portfolio for the year


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Abbreviations Askot Assistant Korkot (see below) Bendahara Treasurer/accountant at the UPK RLF level BKAD Badankerjasama antar desa (Inter‐village coordination body) BKK Badan Kredit Kecamatan (Sub‐district Credit Board) BKM Badan Keswadayaan Masyarakat (Community Self Reliance Body) BLM Block Grant from Indonesian Government/Provincial Government to UPK BMT Baitul Mal Wal Tamwil (syaria savings and credit cooperative) BPD Bank Pembangungan Daerah (Regional Development Bank) BPKP Badan Pengawasan Keuangan dan Pembangunan (Finance and Development

Audit Agency) BPR Bank Perkreditan Rakyat (Rural Bank) BP‐UPK Badan Pengawas UPK (Supervisory Board of Activity Management Unit) BRI Bank Rakyat Indonesia (People’s Bank of Indonesia) BUMDES Badan Usaha Milik Desa (Village owned enterprise) Faskel Fasilitator Kelurahan – Facilitator based in the Kelurahan (city ward) Faskeu Fasilitator Keuangan – Facilitator Financial, responsible for the RLF Faskab Fasilitator Kabupaten – Facilitator based in the Kabupaten (district) IPTW Insentif Pembayaran Tepat Waktu (Incentive for Timely Repayment) Korkot Koordinator Kota, city coordinator (in this case for the facilitation of

urban UPKs) KJKS Koperasi Jasa Keuangan Syariah – Islamic syariah cooperatives KMP Konsultan Managemen Pusat (National Management Consultant) KMW Konsultan Manajemen Wilayah (Regional Management Consultant) KSM Kelompok Swadaya Masyarkat (e.g. Group Borrowers) M‐CRIL Micro‐Credit Ratings International Limited MFI Microfinance Institution MICRA Microfinance Innovation Center for Resources and Alternatives MIS Management information system MIX Microfinance Information Exchange (www.mixmarket.org) NPL Non‐Performing Loan NTT Nusa Tenggara Timur (Island province of Indonesia) PKK Pemberdayaan Kesejahteraan Keluarga (Family Welfare Empowerment) PNPM Program Nasional Pemberdayaan Masyarakat (National Community

Empowerment Program) P2SPP Program Pengembangan System Pembangunan Participative (Community

Participative Program for System Development) PS2 Pemetaan Swadaya 2 – self mapping by the communityof households living in

poverty PUAP Pengembangan Usaha Agribisnis Perdesaan (Rural Agri‐business Development

Program) RLF Revolving Loan Fund Rp Indonesian rupiah RTM Rumah Tanga Miskin (list of families with incomes below the poverty threshold) TV Tim Verifikasi (Verification Team) PTO/SOP Petunjuk Teknis Operasional (Standard Operating Procedures)


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UPK Unit Pengelola Keuangan (Financial Management Unit) in Urban PNPM Unit Pengelola Kegiatan (Activity Management Unit) in Rural PNPM


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Executive Summary

This is the final consolidated report of an extensive programme to assess the financial performance and capacity building needs of the UPK Revolving Loan Funds (UPK RLFs) under the PNPM Mandiri project in Indonesia. As explained in the report, the assessment programme covered 508 rural UPK RLFs and urban UPKs in the provinces of Central Java, Yogyakarta, Nusa Tenggara Timor (NTT) and West Sumatra. The aim was to cover 30% of rural UPK RLFs in these four provinces and 10% of the urban UPKs in order to establish the achievements and determine areas of improvement to enable these UPK RLFs to provide better credit services to the low income families in their operational areas. As the programme was not designed as a traditional microfinance program, this assessment looks at whether the UPKs could continue providing loans to the community without continuing direct Government support and under what conditions individual UPK RLFs could become self‐sustainable. This report covers all 267 rural UPK RLFs and 241 urban UPKs identified for the purpose in the four provinces. S1 Overview of the assessed UPK RLFs –loans outstanding per borrower are quite small at $100‐150; urban UPKs serve fewer people and their portfolios are a fraction of rural UPK RLF portfolios

The coverage of the sample of 267rural UPK RLFs in the four provinces of Central Java, Yogyakarta, West Sumatra and Nusa Tenggara Timor (NTT) amounts to 30% of all rural UPK RLFs in these provinces. The 241 urban UPKs covered are 10% of the total number of urban UPKs in these provinces at the end of 2010. The 36 rural RLFs and 52 urban UPKs not covered in 2009, as indicated by Table S1.1are mostly new UPKs established in 2010. In the case of 5 urban UPKs, the exclusion is because data is not available for 2009 due to the malfunctioning of the UPK. The average coverage of both rural UPK RLFs and urban UPKs off Java is between half and one‐third that of those in Java – partly a reflection of the high density of population in Java.

The portfolio size of rural UPK RLFs (Table S1.2) varies from Rp1.86 billion (~$200,000) in Central Java to just over Rp1 billion (~$110,000) in NTT at the end of 2010. The average loan outstanding per borrower in UPK RLFs is quite small at around Rp1.2 million (~$132) for rural UPK RLFs across 3 provinces; rural borrowers in Yogyakarta have even smaller loans of Rp0.86 million ($100) outstanding. Urban UPK portfolios are a fraction (3‐7%) the size of rural UPK RLF portfolios, ranging from an average of just Rp35 million ($4,000) in West Sumatra to Rp94 million ($10,500)in Central Java where these are most numerous. Yogyakarta urban UPK portfolios are much larger at Rp256 million ($28 million) or 15% of Yogyakarta rural UPK RLFs. Individual borrower portfolios outstanding are around Rp300,000 to Rp400,000 ($33‐44) but much higher in Yogyakarta, Rp99,000 ($110). In Yogyakarta the average loan outstanding per borrower is actually larger in urban UPKs than in rural UPK RLFs.


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Table S1.1 Outreach of the sample

Location UPK RLFs RLF Borrower

Groups Active borrowers–

total Borrowers per

UPK 2009 2010 2009 2010 2009 2010 2009 2010

Rural UPK RLFs Central Java 119 133 17,029 22,669 141,402 199,556 1,188 1,500Yogyakarta 17 17 2,895 3,165 31,447 34,413 1,850 2,024West Sumatra 37 43 1,493 2,793 23,026 40,946 622 952NTT 58 74 3,361 6,010 32,284 54,247 557 7334 Provinces 231 267 24,778 34,637 228,159 329,162 988 1,233 Urban UPKs Central Java 144 179 5,598 7,283 30,057 40,098 209 224Yogyakarta 17 18 800 904 4,015 4,647 236 258West Sumatra 21 33 317 554 1,935 3,227 92 98NTT 7 11 114 292 685 1,694 98 1544 Provinces 189 241 6,829 9,033 36,692 49,666 194 206

Table S1.2 Loan amounts given by the sample – outstanding with borrowers

Location

UPKs Total portfolio

Average Portfolio per UPK

Average Portfolio per borrower

(Rp billion) (Rp billion) (Rp million) Rural 2009 2010 2009 2010 2009 2010 2009 2010C Java 119 133 175.7 247.5 1.48 1.86 1.15 1.20Yogyakarta 17 17 25.2 31.6 1.48 1.86 0.75 0.86West Sumatra 37 43 28.7 48.6 0.78 1.13 1.25 1.19NTT 58 74 43.0 74.8 0.74 1.01 1.33 1.384 Provinces 231 267 272.7 402.5 1.18 1.51 1.05 1.19Urban (Rp billion) (Rp million) (Rp million) C Java 144 179 12.81 16.88 89.0 94.3 0.43 0.42Yogyakarta 17 18 3.87 4.62 227.5 256.5 0.96 0.99West Sumatra 21 33 0.71 1.16 34.1 35.1 0.37 0.36NTT 7 9 0.34 0.50 49.1 55.3 0.50 0.294 Provinces 189 239 17.74 23.15 93.8 96.9 0.48 0.47 S2 Quality Assessment – relatively few RLFs, 28% rural and 9% urban1, were found to operate at a level comparable with operationally sustainable, independent micro‐finance institutions; the overall performance of UPK RLFs is quite good in Central Java and Yogyakarta, moderate in West Sumatra and weak in NTT. Both rural and urban UPK RLFs submit operational and financial reports to the district (Kabupaten) level on a monthly basis. However, the accuracy of the data depends on the

1 See Table S2.1


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level of commitment of the staff and UPK RLF facilitator and their level of understanding of the need for accuracy and of the accounting system itself. There are also sometimes differences between what is reported and the data with the UPK RLF. M‐CRIL has gone out of its way to correct the data whenever possible; in the case of profitability calculations, M‐CRIL has made its own estimates which are presented alongside the UPK RLF’s calculations in the tables in this report. Nevertheless, the data limitations mean that M‐CRIL’s calculations should also be treated as estimates rather than the definitive final results. The latter can only be established on the basis of a thorough audit of each UPK RLF. Figure S2.1presents the distribution of the assessed RLFs by quality of governance, management and financial performance in the 4 provinces covered. Details of the methodology are provided in Section 2, below. The rating grades assigned, based on the assessment, use a standard set of criteria applicable to UPK RLFs across types. Thus, an RLF with a good performance (and an “a minus”rating) is judged to be functioning as well as an independent financial organisation (such as an MFI) with the same rating grade. The range of rating grades and the meaning of each rating grade are presented in the table in Annex 1. This assessment methodology applies a standard set of ratios but, with variations in the types of institution,

Figure S2.1 Governance grading of rural UPK RLFs in pilot provinces

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No. of U

PKs

C Java Yogyakarta West Sumatra NTT

Management grades of rural UPK RLFs in pilot provinces

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M‐CRIL makes some adjustments; thus, for instance, since UPK RLFs do not pay any financial expenses for their funds, the return on assets these institutions must earn are benchmarked using averages for each type – for rural UPK RLFs and urban UPKs – rather than comparing their performance with the typical 2‐3% returns on assets of MFIs. As Figure S2.1shows, the UPKs have a better performance on management (mode b+) and financials (mode b+ and a‐) than on governance (mode b).Financial performance is the best of the three categories except in NTT where it is significantly worse than for the other two categories. Overall, the performance of rural UPK RLFs is quite good in central Java, moderate in West Sumatra and weak in NTT.

It is apparent from this analysis that UPK RLFs are able to do reasonably for a few years on the strength of high disbursements (which mask portfolio quality by increasing the denominator of the non‐performing loan, NPL, measure) and some management ability (which facilitates application of financial principles specified by the government and enables appropriate borrower selection) as in Central Java and Yogyakarta. The effects of weak governance are felt

more gradually as borrowers (and staff) increasingly realise that collection efforts are not reinforced and misappro‐priation does not result in meaningful penalties. The performance of UPK

Figure S2.2 Governance grading of urban UPKs in pilot provinces

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Management grades of urban UPKs in pilot provinces

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RLFs in NTT is particularly affected by this but the impact is also felt in the other provinces (resulting in governance being weaker than management and financial performance). These comments apply to urban UPKs as well, see graphs in Figure S2.2. These show the mode slipping to the right of the graphs: b for governance, b to b‐ for management and b‐ for financial performance. Here the governance and management grades are very similar in all the provinces but the financial performance grades are significantly worse in Central Java and more distributed over the range of grades in the other provinces. Again the performance of NTT is substantially weaker than the other provinces.

For the purpose of institutionalisation, the performance of the assessed UPK RLFs has been categorised in Table S2.1as follows Leaders: 18 rural UPK RLFs and 6 urban UPKs (albeit with a marginally lower performance) that record “very good” performance and, in M‐CRIL’s opinion, could be encouraged to become independent community financial institutions immediately. Progressives: Another 57 rural UPK RLFs and 15 urban UPKs that could become independent institutions with some handholding support to enable them to raise lending resources from banks and to improve their functioning to the level of the “Leaders”. Possibles: Another 39 rural UPK RLFs and 14 urban UPKs with reasonable performance (Possibles‐1) and 31 rural and 31 urban with moderate performance (Possibles‐2) that could become independent

institutions with extensive support, training and handholding over a two year period. Laggards: The remaining 119 rural UPK RLFs and 125 urban UPKs that were graded but were found to be too weak under the present institutional conditions to justify additional support.

Table S2.1 UPKs RLFs classified by performance

b+ or above in “x” categories…

Total – 4 provinces

*

Category

Rural UPK RLFs All a‐ 18 Leaders All 3 categories (b+ or above) 57 Progressives 2 categories (b+ or above) 39 Possibles‐1 1 category (b+ or above) 31 Possibles‐2 None (b+ or above) 119 Laggards 264

Too new to be graded 3 New Total 267

Leaders/progressives 28% of total Urban UPKs Two a‐+ one b+ 6 Leaders All 3 categories (b+ or above) 15 Progressives 2 categories (b+ or above) 14 Possibles‐1 1 category (b+ or above) 31 Possibles‐2 None (b+ or above) 125 Laggards 191

Too new to be graded 40 Non‐functional 10

Total 241 Leaders/progressives 9% of total *province‐wise information in main report Table 4.2.1


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Ungraded: 3 rural UPK RLFs and 40 urban UPKs were not graded because these were established too recently (started functioning after 1st January 2010) to justify a grade. Ten Urban UPKs were found to be non‐functional at the time of the assessment, so these too have not been graded (since these effectively fall below the c grade in M‐CRIL’s grading table; an institution to be functional in order to be graded).

These findings are discussed further in the Action Plan in Section S5.

S3 Main performance indicators – reported profitability is good but does not account for voluntary inputs, facilitation, financial expenses and accurate loan loss provisioning

The financial performance of UPK RLFs in the four provinces is presented in Table S3.1. The table shows that the reported financial performance in terms of profitability (Return on Assets, RoA) is good. However, this profitability calculation excludes a provision for the voluntary inputs of the community in appraisal and internal control, the inputs of the facilitation team as well as loan loss provisioning expenses. Thus, it does not present an accurate picture. The financial statements of rural UPK RLFs do not include provisions for loan losses but rather use the calculation of the provision for determining allocation of surplusafter the calculation of profit. After correcting the provisioning for loan losses in accordance with PNPM guidelines and incorporating it in the income statements, the return on assets (‘estimated by M‐CRIL’ in the table) is just 3.5% for rural UPK RLFs. The liquidity ratio is relatively high at nearly 20%, compared to a best practice range of 10‐15% for small community finance institutions. In some rural UPK RLFs, BKADs become wary of further lending of recycled funds once the portfolio quality deteriorates. There are similar issues in the urban UPKs but the financial performance of these is lower anyway, resulting in an overall loss of 0.2% of assets before accounting for financial expenses and for the voluntary inputs of the community and the work of the facilitation team which is not paid for by the UPK RLFs. Liquidity in the urban programme is high also because of a policy of suspending disbursements in UPKs not attaining minimum performance levels.

Table S3.1 Financial performance of UPK RLFs

2010 see footnotes to table for full form of acronyms

Province Cost per borrower

OER, % RoA* estimated by M‐CRIL#

Yield Yield/APR Liquidity@

Rural Central Java 89,175 8.6% 15.3% 6.5% 25.3% 82.2% 15.5%Yogyakarta 91,964 11.3% 15.7% 8.5% 29.3% 88.3% 17.2%West Sumatra 63,319 6.6% 8.0% ‐2.2% 15.7% 84.2% 23.3%NTT 117,694 12.4% 3.7% ‐8.7% 14.6% 47.3% 26.0%

Total 95,044 9.3% 13.7% 3.5% 22.7% 76.1% 19.8%Urban Central Java 27,976 7.5% 6.1% 1.1% 21.0% 61.6% 17.8%Yogyakarta 60,557 8.8% 6.9% ‐1.3% 16.1% 46.6% 11.3%West Sumatra 21,606 6.5% 6.4% 4.0% 19.1% 63.2% 39.8%NTT 19,318 6.6% 1.9% ‐35.3% 8.4% 27.2% 37.7%

Total 31,718 7.7% 6.1% ‐0.2% 19.6% 57.8% 18.5%* as calculated by the UPK; # calculated by M‐CRIL using specified provisioning for bad debt; @ end‐of month average for the year. OER = Operating Expense Ratio; RoA = Return on Assets (profitability); APR = annual percentage rate (expected yield); yield = actual gross income from loans as % of portfolio


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The portfolio quality of assessed rural UPK RLFs in December 2010 mirrors the overall performance of UPK RLFs, Figure S3.1, with non‐performing loans (Kol‐V as per rural UPK

Figure S3.1 Collectability of Rural UPK RLFs – operational

88.8% 86.4%93.8% 90.1%

77.8% 81.8%

54.9% 53.3%

6.0% 6.3%1.2% 3.6%

6.2%6.2%

3.8% 4.4%

4.4%

2.6% 3.9% 3.4% 3.3%13.0% 8.9%

37.2% 34.4%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2009 2010 2009 2010 2009 2010


Kol‐I Kol‐II Kol‐III Kol‐VI Kol‐V

Figure S3.2 Collectability of urban UPKs – operational

42.1% 38.9%

62.5%53.3% 54.0%

46.3%

13.7% 11.6%

21.8%22.8%

9.1%

10.5%15.1%

22.4%

33.9%

21.4%

8.7%7.5%

4.5%

5.9%6.9% 8.8%

21.7%

19.7%

3.0%4.1%

2.7%5.3%

3.7% 5.5%12.6%

4.8%

24.3% 26.6%21.2% 25.1% 20.4% 17.0% 18.0%

42.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2009 2010 2009 2010 2009 2010



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RLF guidelines) ranging from 3.9% in Central Java and 3.3% in Yogyakarta in 2010 to 8.9% in West Sumatra and as high as 34.4% in NTT. This is essentially a proxy for the relative performance of the PNPM programme in the provinces covered by this assessment. Small improvements in the non‐performing loans (NPL) ratios from 2009 to 2010 are attributable more to increases in overall portfolio outstanding than to any significant recoveries of previous NPLs. With a worsening trend from 2009 to 2010 a further decline in quality can be expected in 2011. In the case of urban UPKs, NPLs are defined as Kol III‐V and Figure S3.2 shows that this ranges from 38.2% in Central Java, 36.3% in Yogyakarta and 31.3% in West Sumatra to as much as 67.0% in NTT. This also is a reflection of the relative performance of the UPKs in each province and (when compared with the NPLs of rural UPK RLFs) of the large difference in performance between urban UPKs and rural UPK RLFs. A consideration of the collectability2 categories used by PNPM Rural and PNPM Urban shows that rural uses stricter definitions and reserves for overdue loans than urban PNPM (details in Table 3.2.8 of the main report). If used correctly the reserves thus created would be sufficient in both cases to cover actual loan losses. However, as indicated above, this is not being done at present. UPK RLFs finance their portfolios with block grants (BLM) contributed by the national and provincial governments. Rural UPKRLFs have received an average of around Rp8 billion ($0.9 million) in block grants (BLM)from the government since inception while urban UPKs have received Rp400‐700 million ($44,000‐77,000) in the 4 provinces with an overall average of Rp531 million ($59,000). The amount allocated per rural UPK RLF is Rp1.42 billion ($160,000) and to urban UPKs Rp97 million ($11,000). In the long run, the two types of UPK RLF have allocated roughly the same proportions of their block grants to RLF, particularly in Java, though off Java the urban UPKs have received a lower proportion of the total grant – details in Table 3.1.5 of the main report. S4 Main findings and key recommendations S4.1 Operational performance – UPK RLFs have reached substantial numbers of people Both the rural UPK RLFsof the PNPM programme and the urban UPKs areaimed at delivering credit to low income families through community governed structures. Extrapolating the outreach of the sample UPK RLFs over all the UPK RLFs in the four

provinces covered, it is apparent that theprogrammes have reached substantial numbers of people/ borrowers in the 4 pilot provinces (Table S4.1). As discussed in the previous section above, however, portfolio quality and profitability/ sustainability are challenges.

2 Collectability (Kolektibilitas, Kol) is the term used in Indonesia to describe the “aging” of portfolio dues and to distribute the overdues into age categories.

Table S4.1 Programme outreach in the pilot provinces

end‐December 2010 Four provinces Borrowers Portfolio Rp bn $ mnPNPM Rural 1,100,000 1,340 150.0PNPM Urban 500,000 231 25.7


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The key problem with operations in both rural and urban PNPM RLFs is that there is a lack of understanding in much (but not all) of the community about the objectives of the programme. In most locations, the perception that “loans” provided under this programme are effectively a grant from the government (rather than revolving funds) is strong both amongst the borrowers and the community leaders who are members of the sub‐district level BKADs and town ward level BKMs that form the governing bodies of rural UPK RLFs and urban UPKs respectively.3 This perception is fuelled essentially by the fact that UPK RLFs are financed by government funds but it is reinforced by the money being provided as a grant to each RLF; members of the community are conscious that it does not have to be paid back to anyone outside the community. Discussion at the UPK RLFs shows that community leaders and members alike feel they can manage each other and that the matter of loan repayments need not be an issue of concern to anyone else. This could be seen as an indicator of “ownership” if not of concern for conserving the resources provided to the community for its own benefit. As a result, the revolving of funds has been reduced considerably in many UPKs and has stopped altogether in a few where urban UPKs have been suspended on account of poor portfolio quality.4 Neither BKAD/BKMs nor UPK RLF staff is always committed to loan recovery and, partly as a result, loan appraisal (prior to disbursement) is done in an indifferent manner. The perception of government grant funds as hand‐outs to the community, discussed above, is compounded by the fact that there is also a skill and motivation problem. The internal control function, to be undertaken by BP‐UPKs, is highly deficient with members of these voluntary committees usually not understanding any of the technicalities of internal audit. This could be greatly improved both through a better choice of members and greater commitment of resources to transfer skills to them. Whether or not this can be achieved in the PNPM programme is discussed later in this report (Section 5.1). In the urban programme, while the staff is paid for its work, that work is part‐time. The assessment of remuneration for this part‐time work varies between urban UPKs because the workload is different. However, the payment of Rp30,000‐200,000 ($3.30 to $22) is not substantial in absolute terms and, despite the limited time requirement, surrounds the job undertaken with an aura of voluntarism. This has the effect of reducing the motivation of staff in urban UPKs to lower levels than that of rural UPK RLF staff. S4.2 Competition, liquidity and financial performance – limited competition is combined with relatively high liquidity and not so good, if not weak, financial performance Since the loan size is quite small (mostly Rp0.5 million to Rp5 million, $55 to $550)in rural UPKRLFs and only up to Rp 2 million,$220 in urban UPKs) and no collateral is required, UPKs do not face much competition from the wide range of community level financial institutions in existence in Indonesia. The only real competitors are cooperative/credit union programmes, the KUR programme of BRI and the ubiquitous moneylenders. The loan size, however, is a limiting factor in the demand for credit and sometimes poor portfolio quality

3See glossary for the full form of BKAD and BKM. 4Poor portfolio quality has greatly hampered the revolving of funds at the 119 rural UPK RLFs and 125 urban UPKs classified as “laggards” in Table S2.1, in some cases to near standstill. Ten urban UPKs have stopped functioning altogether.


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limits the willingness of BKAD/BKMs to authorize lending (as it affects their standing with the government) – particularly off‐Java. While liquidity levels are high (at an average of 18‐20% and more over the year 2010, this is higher than the 10‐15% international norm for small MFIs) it is largely on account of inefficiencies in operations and not because of a lack of demand for loans. Although interest rates are lower than commercial institutions in Indonesia, the APR levels of UPK RLFs (28‐36%) are still very much in line with international microfinance practice. Since these RLFs pay no interest on their funds and receive an implicit subsidy by outsourcing their internal control, the support of facilitators and (partly) the loan appraisal mechanism to the community, they could be highly profitable institutions. However, their

poor portfolio quality results in the loan loss provisioning requirements being very large. The low (under 3%)average returns on assets (calculated by M‐CRIL after correcting the provisioning in their accounts and excluding outliers) are well below the 1‐3% return (after accounting for all financial charges and internal control expenses) normally seen in sustainable RLF institutions in Asia. The distribution of performance grades assigned by M‐CRIL to the UPK RLFs assessed and the financial performance grades are shown to be correlated with the calculated financial ratios in Figure S4.1. The figure shows the consistent correlation between financial performance ratios and good performance. [The yield to APR ratio is the actual income received by the RLF – yield – compared

Figure S4.1 Correlation of financial performance grades of rural UPK RLFs with

financial ratios

Correlation of financial performance grades of urban UPKs with financial ratios

0%

20%

40%

60%

80%

100%

120%


Yield/APR NPL RoA

‐20%

0%

20%

40%

60%

80%

100%


Yield/APR NPL RoA


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with the income that should have been received by the RLF – APR. Ideally it should be close to 100%. A low yield/APR ratio means that the portfolio is performing poorly]. Figure S4.2 correlates the average age of UPK RLFs (in months) with each financial performance grade. The rural programme does not demonstrate a clear correlation of financial performance with the age of an RLF. This cross‐sectional analysis indicates that over time the RLFs’ characteristics, good or bad, are reinforced and the RLFtends to move away from the average of b+ towards very good performance (a or even, in very few cases, a+)or very poor performance lower down the scale. But the fact that there are more RLFs at the lower end of the scale (75 RLFs do better than b+ but 132 do worse) means that there is a tendency overall for the financial performance of rural UPK RLFs to get worse as the RLF gets older. In the case of urban UPKs, however, there is a clearer correlation between age and financial performance. Just 18 UPKs are above the b+ level, and these are only 29 months old, whereas 147 are below that level with age increasing up to 68 months for c graded urban UPKs. The difference is partly because rural UPK RLFs have received more grants in recent years (especially 2010) enabling continued growth whereas the urban UPK growth has been arrested by the policy of reducing or stopping funds to those seen to be performing particularly poorly.

S4.3 Data and accounting issues – show significant discrepancies

The maintenance of the MIS of UPK RLFs in the PNPM programme is moderate. The overall management of UPKs affects their information status. In this there are some issues around the numbers of borrowers and actual portfolio

Figure S4.2 Correlation of financial performance grades of rural UPK RLFs with

average age (in months)

Correlation of financial performance grades of urban UPKs with

average age (in months)

322

50 52

42 39

2922

81

69 63

56

80 76

80

96

0

20

40

60

80

100

120


Number of RLFs Age (in months)

0 0

18

2631

48

35 33

‐ ‐

29

45 43

53 54

68

0

10

20

30

40

50

60

70

80


Number of UPKs Age (in months)


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at risk (since loan records are not always well maintained).5 There is a lack of data security within the UPK RLF and the lack of understanding and commitment of staff and (of facilitators) is compounded by discrepancies between monthly reports and data in the UPK RLF records. Changes can be made at any time in the MIS without any record of why and by whom the changes were made. Add to this the fact that the MIS presently entails the production of information that is not used at the operational level and this leads to a lack of understanding of the need for it. There is a lot of repetition of information and consequent carelessness of UPK staff/facilitators in completing formats (either leaving information blank or casually filling numbers without checking). While accounts at the UPK RLF level are moderately well maintained, the calculations of loan loss provisioning remain a problem. Provisioning is not correct in many of the UPK RLFs visited(350 of the 508 assessed) and in most of the urban UPKs (see Table 3.2.9 of the main report).This means that the assessment of financial performance at the UPK level is a poor indication of its actual financial status and, as a result, there is a general lack of understanding of the financial condition of the programme.

S4.4 Facilitation – is sometimes useful but affected by sub‐optimal skill levels

Facilitation of the rural UPK RLFs and urban UPKs is an issue. Facilitators are, in theory, there to advise the UPK (both staff and BKADs or BKMs) as well as transfer skills to improve the functioning of the UPKs. In practice, the facilitators are constrained in their task because their skill level needs improvement and also their turnover at the UPK RLF level (changed every 18 months, on average) is greater than is desirable. Neither low skill levels nor high turnover are conducive to performing the task well, so facilitator motivation also tends to be low. Their other key function is to ensure that the principles of the programme set out in the guidelines are adhered to; given the perception of the programme as a government handout, they are able to ensure the sustainability aspect of this only in small measure. While as an independent team of observers their presence does, to some extent, ensure the continuation of regular programme operations, there is substantial room for improvement. While there is a need for facilitators in the programme, more work needs to be done to ensure their efficacy. A more effective facilitation mechanism will contribute to more sustainable UPK RLFs that will, thereby, be in a better position to internalise the costs of the facilitators.

S4.5 Capacity building needs – are substantial, especially for delinquency and group management As discussed above, the perception problem amongst the community is the most important factor affecting the performance of the UPKs RLFs. This needs to be addressed urgently. At the same time, however, there are areas of the functioning of the RLFs that can be addressed through a capacity building effort. The key areas of capacity building across the programme are delinquency management including the tracking of overdues, and the broad area of group management and supervision (Table S4.2).

5Around 33% of all UPK RLFs are unable to provide correct borrower numbers though this relatively simple to work out and M‐CRIL analysts were able to do so in all but 25 (5%) of RLFs. Loan records are poorly maintained by 32% of rural UPK RLFs and 19% of the smaller, easier to manage, urban UPKs.


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Table S4.2 Intensity of capacity building needs for various groups of participants in the programme

Capacity Building Areas UPK Staff BKAD/BKM BP‐UPK Verification

Team* Facilitators Groups

Role clarity Operational/loan procedures Accounting Cash and financial planning Overview Documentation/recording MIS Loan appraisal and approval Internal control Overview Tracking of overdues Delinquency management Process & skill building Group mgmt. & supervision Group cohesion

KEY Low Medium High *rural UPK RLFs only

There is also a considerable need to strengthen the skills and operations of facilitators and staff at the sub‐district (rural UPK RLFs) and town ward (urban UPK) level. There is already a systematic training and mentoring programme (through the facilitation mechanism) in place but it is not functioning as effectively as is needed. The table summarises the capacity building needs of various types of participants in the programme and provides M‐CRIL’s overall view of the intensity and urgency of the need for further capacity building of each type of participant. Specific needs are discussed in more detail in Section 4of the main report.

S5 Conclusions While PNPM’s approach to microcredit through the UPK RLFs in the four provinces covered by this assessment has achieved significant outreach, there are challenges in ensuring long term sustainability and independence of operations. These are, particularly, issues with the repayment performance, and lack of a clear strategy for ensuring the proper institutional development and sustainability of the RLFs. These issues need to be addressed in order to reinforce the gains the PNPM has achieved in access by the community to affordable credit. One of the key obstacles to the strong performance of RLFs identified by this assessment is lack of clarity about the role of UPK RLFs and some misperception by the community (including UPK RLF staff) about the function these funds are supposed to perform. Since considerable work will be required to turn this situation around, an action plan to revamp the programme and remedy its weaknesses follows.


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Action Plan proposed by M‐CRIL

1 Institutionalisation: Many of the UPK RLFs – particularly rural RLFs – are handling

quite large sums of money (over Rp2 billion or $220,000) and yet operating without a legal framework. This extra‐legal operation, in itself, runs the risk of undermining the institutional governance system of the country. Also, on the assumption that government subsidies would not continue to be available in the long run, the UPK RLFs would need an appropriate institutional framework to ensure that the experience of the PNPM is not lost and that there continues to be a local mechanism for providing small loans within the community. Institutional options for the future of the UPK RLFs would include conversion to (a) a cooperative, (b) a government‐owned company, or (c) some other form of institution in conformity with Indonesian law. The results of this in‐depth assessment of the representative sample of UPK RLFs were summarised in Table S2.1 and the discussion in Section S2. It shows that

Leaders: 18 rural and 6 urban UPK RLFs could be launched immediately as independent financial institutions, while Progressives: another 57 rural and 15 urban would need a small amount of assistance, intensively over a 6‐12 month period, to become independent after these are registered under an appropriate legal framework. Of the remainder, Possibles: 39 rural and 14 urban reasonable performers and 31 rural and 31 urban moderate performers should receive intensive handholding support for two years to enable them to reach, if possible, a level where their launching as independent institutions could be considered. Finally, Laggards: the remaining 119 rural UPK RLFs and 125 urban UPKs should be shut down immediately with the residual resources recovered from these institutions being applied to other activities of community benefit. The 10 non‐functional UPKs also belong to this category. New, ungraded institutions could be included in the list of possibles for intensive handholding to enable them to develop into independent institutions within 2 years. The planned capacity building programme has the potential to play an important role in supporting more UPK RLFs to reach levels of efficiency in operation that would enable these to become independent financial institutions. Most important, if this plan is to work, however, is for the government to undertake a programme of financial education which emphasizes the sustainability objectives of the UPK RLFs. This would not only be an integral part of the capacity building programme, it would also need to be accompanied by a strong political message from the national government, perhaps through a campaign of public addresses and media interviews


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and radio‐TV messages. The aim of the message would be to emphasise that the national/provincial governments are serious about the sustainability of the programme and that the funds provided are not intended to be a hand‐out. Without this, the technocratic sustainability and institutionalization efforts (discussed in this box) are unlikely to be successful.

2 Capacity building support planned by the World Bank needs to be designed to focus on the priorities identified in Table S4.2above. As the table shows, all direct participants – members of community institutions, UPK staff, facilitators and borrowers – need capacity building to generate awareness of the objectives of the programme, understanding of what needs to be done and to create and hone skills that will usefully serve the needs of the programme. This entails not only training but also hand‐holding (on the job training) at the UPK level and exposure visits to “best practice” urban UPKs, rural UPKs, MFIs and cooperatives that are run well. Part of this will function to generate role clarity and awareness of the potential for community institutions(BKAD/BKM, BP‐UPK and Verification Teams) to perform effectively. The development of training as well as financial skills of facilitators would be an important part of this component; but it may also entail some re‐thinking (and enhancement)of the minimum qualifications of the personnel engaged as facilitators at the sub‐district/town ward level. Equally, it is apparent from interaction with Regional Management Consultant (RMC) and district facilitators (Faskabs) as well as assistant coordinators (Askots in the urban programme) that there is a need for a substantial overhaul of the training techniques currently employed – an immediate reduction in lectures as a training method and a focus on exercises and case studies would greatly enhance the rate of skills transfer to staff and communities, and improve the likelihood of trainees retaining and using those skills in their work.[See more on facilitation in Point 4, below].

3 Best practice guidelines for rural UPK RLFs& urban UPKs: A series of improvements are required in the guidelines that exist to align these with international best practice. These are set out in Section 5 of this Action Plan (below). The immediate reinforcement of accounting rules with measures such as the creation of a financial expense reserve would help to inject a dose of reality into the financial results of the UPK RLFs. To begin with, this requires the correct calculation and then posting of loan loss provisions into the income (profit & loss statement). Then it would be necessary to include the full cost of funds (interest on borrowed funds + tax on interest, if applicable) and a better understanding of operational subsidies and expenses. The financial expense calculation is needed to understand what expenses the UPK would have to incur if it were required to borrow, at commercial rates, most of the funds currently provided as grants by the government. This is an essential complement to the financial skills that should be developed as part of the capacity building programme. An enhanced (and better designed) incentive system for community “volunteers” who give their time to the governance and management of the UPK RLFs would ideally be included in the guidelines. Expenses incurred on the facilitation system should also be worked out and ideally used to determine the performance of the UPK RLFs at “full cost”. This is an exercise that could be carried


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out at the project level to enable the project management to get a better sense of the progress of the UPK RLFs to sustainability and to commercial viability – a factor that could be important in the long term if the RLFs are to become independent entities with full relationships with commercial banks.

4 MIS & internal audit: Finally, in addition to the strengthening of internal audit that

will result from a more practical approach to the training of BKAD/BKM, BP‐UPK and Verification Team, both the MIS and the external audit procedures (including audit by the government auditor, BPKP) need to be strengthened. This should include:

• A thorough review of the MIS and reporting formats– this is less a matter of software and more a matter of the requirements and accuracy of the data uploaded, the utility of the actual information generated, and the analytical use made of the reports at all levels from the UPK RLF through the District and Province to the National level. Appropriate software would, nevertheless, be useful with built in queries and safeguards to ensure consistency, accuracy and data security. Presently, the MIS entails the production of information that is not used at the operational level and this leads to a lack of understanding of the need for it, causing carelessness and inaccuracy. The role of the supervisory levels of the facilitation system (RMC and National Management Consultant, NMC) seems to be limited to collating the information without anything more than the most cursory of checks for consistency. This approach needs to change.

• Once a streamlined reporting system is in place, an intensive effort not only at training UPK staff in completing the formats but also in developing their technical skills so that they understand what information is required, why it is important and, above all, how to calculate operationally useful information like borrower numbers, average disbursements/outstandings, OER, RoA, Collectability and loan loss provisions. The number of active borrowers and the Collectability of UPK portfolio are both numbers that are important to a programme such as this. Yet, borrower numbers are largely ignored and Collectability, which is completed, is neither fully understood by staff nor by facilitators resulting in incorrect calculations at a majority of UPK RLFs.A goal would be to have this generated automatically with the new MIS, so it is important that staff/facilitators understand what comes out of the system from their inputs and how it is used. Training alone is usually not enough, it needs to be accompanied by on the job support (hand‐holding) and also careful accuracy checks. A complete overhaul of the functioning of the facilitation mechanism may be necessary to make it more purposeful and accountable. One of the observations of the assessment team is that a leaner and more technically proficient facilitation team (of 5‐6 facilitators) at the district level working directly with UPK RLF staff rather than having financial facilitators dedicated to particular UPK RLFs is likely to be more


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useful for skill transfers to the staff. In the rural programme, the present system of having large numbers of facilitators only dilutes responsibility and (the sheer number of persons employed as facilitators)makes it more difficult to ensure that they have the skills and commitment necessary for effective financial services delivery. The urban programme needs a rationalisation too with greater technical proficiency and, perhaps, fewer UPKs to supervise.

• Overall, an additional effort is needed to ensure that the MIS runs in a technically competent manner and that critical data quality glitches (such as differences between assets and liabilities on the balance sheet from some UPKs) are not allowed to continue indefinitely. This approach not only causes confusion by allowing incomplete and incorrect information to go unchecked, it also means that a culture of unprofessional behaviour could creep through the entire system.

5 Indicators: The urban programme is currently using the indicators PAR, RoI and CCR

based on the recommendations of earlier World Bank missions. These are defined as:

LAR = Loans at risk “SHGs in arrears >= 3 months divided by total number of SHGs” comment: SHG (self‐help group) is an inappropriate term for KSMs (borrower groups in the urban programme); SHGs have internal savings rotated within the group, but this is not how KSMs function; knowing the number of loans at risk could be marginally useful but does not add much information when one knows that, say, 63% of the portfolio is at risk (PAR). PAR = Loans> 3 months overdue/actual loan balance; comment: this is a useful indicator which needs to be emphasized and the staff trained properly to calculate it correctly – this is not being done at present with staff assuming that loans with, say, two instalments overdue continue to be 2 months overdue even if many months have elapsed after the end of period of the loan – the problem is in the definition of overdue by instalments rather than time. It would also be useful to add PAR30, overdue more than 30 days as an early warning indicator.

ROI, return on investment = Net income/capital investment; comment: raises the question of the definition of capital – is it the BLM allocated to RLF or is it BLM + retained earnings (total equity). In any case, this is a relevant indicator for properly constituted institutional entities – cooperatives or companies – it is not appropriately applied to public investment. RoA, return on total assets would be more appropriate. It is a well recognized financial sector indicator (worldwide) for which benchmarks are easily available across sub‐sectors of the financial system – banks, non‐bank financial institutions, cooperatives, MFIs amongst others.

CCR (OSS) = total revenue/total cost, the Cost Coverage Ratio; comment: as discussed in Section S3 above CCR is not a very useful indicator in this case since it does not include loan loss provisions which (in theory) need large allocations in the case of the UPK RLFs; so CCR of 230% means nothing if 150% has then to be


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allocated to provisions for loan losses. The calculation of OSS is no longer favoured in the world of microfinance which has moved to more commercially acceptable functioning than was the case when this indicator was first introduced in the mid‐1990s.

For the rural programme, PTO X provides a long list of indicators none of which appear to be in use for operational decision making. Ratios are routinely calculated, as provided for by the MIS, and passed on to the next level with relatively little attention paid to the calculated numbers. It is a passive system of limited practical value (see Section 4.3 for suggested improvements to the PTO).


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Main Report 1 Introduction and background 1.1 The PNPM Revolving Loan Funds The PNPM Revolving Loan Funds (RLFs) have evolved from earlier community lending programmes of the government of Indonesia. The funds are operated via two separate community institutions, the Unit Pengelola Kegiatan (UPK – Activity Management Units) established by the Ministry of Home Affairs for rural areas and the Unit Pengelola Keuangan (UPK – Financial Management Units) established as part of Badan Keswadayaan Masyarakat (BKM – Community self‐supporting agencies) by the Ministry of Public Works in urban areas. The key distinctions between the two types of UPKs are as follows Rural UPK RLF Urban UPK Activities/programmes managed

Community infrastructure programme Revolving Loan Fund

Manages an RLF as one component of the BKM programme; the other two components are UPL (Environment Management Unit) and UPS (Social Management Unit), each with their own separate programmes

Established 2007 2007 Borrowers Women, productive poor only Minimum 30% women, at least 5

member groups; all in PS2 list Predecessor programme

UEP (productive economic activities) for mixed men’s/women’s groups

UPP(urban poverty project)

Financed by Block grant provided on an annual basis to UPKs with (80:20) contributions from the national and provincial governments

Block grant provided on an annual basis to BKMs with contributions from the national and provincial governments

Budget allocation Community infrastructure, >80% of block grant to UPK RLF, maximum 25%, cumulative <20% of block grant, varies, decision by UPK

UPK receives a maximum of 20% of the block grant provided to the BKM, cumulatively have received <20% of block grant; current allocations, below 15%.

Staff 3+ on a full time, professional basis; relatively well paid by minimum wage standard

1‐3 on a part time, partly voluntary basis, with small remuneration

Loan cycle No limit on nr. of loan cycles Maximum 4 loan cycles/borrower Loan size Max Rp5 million ($555) Max Rp2 million ($222)


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1.2 Background on the needs assessment This series of assessments is the first step in a programme that aims to improve the quality and sustainability of the PNPM’s UPK revolving loan funds (RLFs). This project is endorsed by the Government of Indonesia (GOI) as well as donor communities supporting the PNPM‐MANDIRI programme, PNPM Support Facility (PSF);it is implemented by the World Bank Financial and Private Sector Development Department in close coordination with the Sustainable Development Department in Indonesia.

The Project has four key components:

a) Develop and implement a strategy to support the capacity building and

institutionalization of the PNPM UPK RLFs. b) Strengthen linkages between the UPK RLFs and the commercial financial sector

so as to help ensure growth and sustainability in the provision of financial services to the poor.

c) Develop and establish a monitoring and supervision system to provide fiduciary oversight of the microfinance operations and to track the institutional development and performance of the UPK RLFs.

d) Develop a clear policy and strategy for the phasing‐out of Government’s direct support of the RLFs by supporting the transition of the UPKs from being a government‐backed scheme to becoming operationally and financially independent microfinance institutions.

A critical first step of the project is to understand and verify the real financial performance and identify the potential and options for further development of the UPK‐managed RLFs and the consequent capacity building and training needs. This is the final consolidated report of the assessment of rural and urban UPK RLFs undertaken during the assessment programme. It includes the assessment of 150 rural UPK RLFs in Central Java and Yogyakarta,197 urban UPKs in the same region, 11 urban UPKs and 74 rural UPK RLFs in NTT as well as 33 urban UPKs and 43 rural UPK RLFs in West Sumatra. Thus it covers 267 UPK RLFs of PNPM Rural and 241 UPKs of PNPM Urban, a total of 508 assessments. Capacity building needs and recommendations for strengthening the PNPM UPK RLFs emerging from this exercise will be used to design capacity building interventions that are to be rolled out in later phases of the programme. 1.3 Scale and scope of the assessment of UPKs The 508UPK assessments were distributed by province as shown in Table 1.3.1. The sample was selected to cover 30% of the rural UPK RLFs and 10% of the more numerous urban UPKs in the provinces selected for the assessment. The sample was stratified based on loan repayment performance and location within the province to ensure an even spread. The aim of this stratification was to ensure that when compared with the total data from the MIS, the results would be fairly representative of the overall sample.


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Table 1.3.1 Distribution of the UPK sample for assessment

Province Rural Urban Total

Number of RLFs

Assessed Number of UPKs

Assessed Assessed

Central Java 444 133 1,795 179 312 Yogyakarta 56 17 168 18 35

Java sub‐total 500 150 1,963 197 347 West Sumatra 141 43 327 33 76 NTT 245 74 110 11 85 Off Java sub‐total 386 117 437 44 161

Total pilot 886 267 2,400 241 508

1.4 Specific objectives expected to be achieved As specified in the Terms of Reference for the assignment, this assessment was expected to achieve the following objectives:

1) Provide an assessment of the operational and financial performance of the UPKRLFs from a good practice microfinance perspective based on key performance indicators.

2) Review the current information and data flow (financial information, financial

reporting) and its data collection mechanism from each UPK RLF and BKAD level to district, regional and central level and identify areas for improvement. Conduct an independent verification of the financial data from UPK RLFs. In case RLFs are “phased out” or a rural UPK has moved under the UPP project, the close review and assessment on how the transition from Rural to Urban was made, and collect the information on issues/challenges faced by such UPK RLFs. How borrowing groups from RLF under Rural were treated when it is moved from Rural to Urban, and any best practices should also be noted.

3) Assess the current institutional capacity of UPK RLFs (organization, management

and human resources) for microcredit service provision including formal and informal mechanisms (including groups and individuals) which provide any type of support for UPK’s microcredit service operations. Review current relationships with other microcredit programmes (provided by central and local government), local banks and graduation of bankable clients.

4) Assess their capacity building and training needs for sustainability and future growth of their operations by reviewing the current training program offered to UPK staff and any supporting system/individuals (i.e. financial facilitators, sub‐district facilitators, consultants of the PNPM) whether on a formal or informal basis (i.e. formal trainings, day to day on‐the‐job training). The information should include the current training providers, the level of capacity, and frequency of the training.


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5) Gain an understanding of the direction that the UPK staff and its stakeholders would like to take in the future regarding the future development of the RLF operation, its legal status and functions (e.g. credit, savings, business support).Then question needs also to be raised for the kinds of training of financial facilitator/consultant/KMW/etc. and about their knowledge to build/facilitate networks especially to other forms of access to capital.

2 Description of the assessment methodology used

In the assessment of UPK RLFs the methodology used by M‐CRIL has been based on its comprehensive rating tool consisting of three categories of indicators

(a) Governance and strategy: The assessment depends on the quality and appropriateness of the management, its role, process of making strategic decisions and overall client targeting and growth strategy in the local context of the UPK.

(b) Management systems: Rating on the quality of human resources, loan disbursement and collection processes, strength of critical systems like accounting, management information, monitoring and internal audit/control. The performance of the UPK on staff productivity and ensuring compliance was also assessed. Group dynamics and awareness about UPK loan procedures and terms are integral parts of the exercise.

(c) Financial performance: Presentation of microfinance financial statements for 2010 as available at the UPK, along with statements for one or two previous years (2009 and information until June for 2011). The financial statements were used to assess the financial strength of the RLFs based on aspects like repayment performance, asset quality, liquidity, profitability and sustainability.

In keeping with the objectives of this assignment, the above exercise has been augmented with a specific

(d) Capacity building assessment: Evaluation of the capacity building needs of

the UPK RLFs with regard to current capacities and future requirements based on the above framework.

The assessment process including credit/financial rating is mapped in the following diagram

Preliminary analysis of UPK’s RLF information

Travel to UPK


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2.1 Process Map of the Assessment Visit

Client interaction(while undertaking field visits)

Focus group discussions with clients • Relationship between staff and clients

• Spot check of MIS reports • Maintenance of specified documents

• Feedback on products – suitability to client needs – application of terms & conditions

2.2 Analysis and reporting

At UPKs • Discussions with staff– strategy & goals of the UPK • Review of policies • Understanding loan origination, disbursement,

MIS, portfolio tracking, internal control systems • Capacity building needs assessment

Visit duration: 2 days

Interaction with BKAD/BKM, BP‐UPK, Verification Team, Facilitators

and borrower groups • Understanding of policies, practical difficulties in applying

Return to M‐CRIL office

At M‐CRIL: Data analysis & report writing

by rating team followed byinternal review

Report sent to World Bank

‐ Field portfolio tracking ‐ quality of accounts ‐ viability of the UPK


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Duration of visit to each UPK: 1‐2 days by an experienced M‐CRIL analyst (excluding travel time) accompanied by an analyst from the Indonesian MICRA team. Assessments off‐Java were budgeted on an average of 2.0‐2.5 days per UPK since access and logistics were expected to be more difficult. The interview structure used for the purpose of the assessment is detailed in the checklist provided as Annex 2. The interview approach at each level followed an informal method so that respondents were relaxed and willing to talk about their work in an environment of cooperation. The aim was, nevertheless, to cover all the aspects detailed in the checklist as thoroughly as possible in the time available. The coverage of the interviews at rural UPK RLFs and urban UPKs incorporated discussion at each UPK with members of

1 BKAD or BKM/LKM 2 BP‐UPK 3 Verification Team (rural only) 4 UPK staff 5 Empowerment facilitator and Faskab 6 KSMs – at least two.

The findings of the assessment are presented in a report on each UPK RLF along with a capacity building needs assessment matrix specially designed for the purpose – provided in the Executive Summary (above). 3 Main Findings 3.1 Operational performance 3.1.1 Outreach As shown in Table 3.1.1 the outreach of the 267 rural UPKs assessed in Indonesia extends to nearly 35,000 groups (KSMs) with around 337,500 borrowers. The 241 urban UPKs serve over 9,000 groups/KSMs with nearly 50,000 borrowers. Since 30% of rural UPK RLFs were covered this suggests an overall coverage of 1.125 million borrowers in the four provinces where the assessment was undertaken. Similarly, since 10% of urban UPKs were covered, the outreach of urban UPKs in these four provinces amounts to nearly 0.5 million borrowers. The urban UPKs are less than one‐sixth of the size of rural UPK RLFs in terms of borrowers, with an average of around 200 borrowers compared to 1,264 for rural. Off‐Java UPKs assessed are less than half the size of those on Java. The support provided to these borrowers in terms of loan funds outstanding is presented in Table 3.1.2. Total portfolio outstanding to borrowers in the 267 sample rural UPK RLFs on 31 December 2010 was Rp402.5billion ($44.7 million) translating (on the same basis as the calculations above) to a total portfolio of Rp1,340 billion ($150 million) in rural UPKRLFs in

Presentations at World Bank office in Jakarta on completion of various parts of the assessment


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the 4 provinces. Portfolio in urban UPKs was Rp23.1billion ($2.6 million). The average outstanding loan size per borrower is shown in Table 3.1.2at $133 for rural UPKRLFs and just $52 for urban UPKs. While there was an increase of 13.6% in the average outstanding loan size amongst rural UPK RLF borrowers, urban UPKs registered a small decline in this figure.

Table 3.1.1 Outreach of the assessment sample

Location

UPKs Groups (KSMs) Active borrowers Borrowers/UPK2009 2010 2009 2010 2009 2010 2009 2010

Rural Central Java 119 133 17,029 22,669 141,402 199,556 1,188 1,500Yogyakarta 17 17 2,895 3,165 33,412 36,564 1,965 2,151West Sumatra 37 43 1,493 2,793 23,026 40,946 622 952NTT 58 74 3,361 6,010 32,284 54,247 557 733

Total 231 267 24,778 34,637 228,159 329,162 988 1,233 Growth rate‐annualised 15.6% 39.8% 44.3% 24.8%Urban C Java 144 179 5,598 7,283 30,057 40,098 209 224Yogyakarta 17 18 800 904 4,015 4,647 236 258West Sumatra 21 33 317 554 1,935 3,227 92 98NTT 7 11 114 292 685 1,694 98 154

Total 189 241 6,829 9,033 36,692 49,666 194 206 Growth rate‐annualised 27.5% 32.3% 35.4% 6.2%

Table 3.1.2 Portfolio outstanding

Location UPKs

Total portfolio Portfolio per UPK Portfolio per borrower (Rp billion) (Rp billion) (Rp million) Rural 2009 2010 2009 2010 2009 2010 2009 2010C Java* 119 133 176.0 247.7 1.48 1.86 1.24 1.24Yogyakarta 17 17 25.2 31.6 1.48 1.86 0.75 0.86West Sumatra 37 43 28.7 48.6 0.78 1.13 1.25 1.19NTT 58 74 43.0 74.8 0.74 1.01 1.33 1.38

Total 231 267 273.0 402.7 1.18 1.51 1.20 1.22$ 30.3 mn 44.7 mn 131,153 167,495 117 133

Urban (Rp million) (Rp million) (Rp thousand) C Java 144 179 12,810 16,878 89.0 94.3 426.0 421.0Yogyakarta 17 18 3,868 4,617 227.5 256.5 963.0 994.0West Sumatra 21 33 715 1,159 34.1 35.1 370.0 359.0NTT 7 9 344 498 49.1 55.3 502.2 294.0

Total 189 239 17,737 23,152 93.8 96.9 483.4 466.2$ 1.97 mn 2.57 mn 10,427 10,763 54 52


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The average outstanding portfolio per rural borrower, $133 is very low (4.6%) in relation to Indonesia’s GDP per capita of $2,900 for 2010. Even in relation to the Gross Regional Product (GRP) per capita of West Sumatra ($1,650) it is only slightly better at around 8%. For NTT, the figure of $153 is much better especially in relation to its GRP per capita of $600 (25.5%). Average loans disbursed to individual borrowers, of the order of $220, Rp2 million amount to just 7.6% of the GDP per capita of Indonesia and 13.3% of the GRP per capita of West Sumatra. This amount can make only a small supplementary contribution to the economic lives of the low income borrowers such loans are intended to support. Micro‐loans of the order of 15%‐20% of GDP per capita are more normal in low income countries. 3.1.2 Operational structure and roles

The operational structure and roles of various kecamatan (rural UPKRLFs) and kelurahan (urban UPKs) community institutions in the programme are outlined in Table 3.1.3below.

Table 3.1.3 Summary of the structure and roles in the operations of UPK RLFs

[*issues presented here for summary purposes only; details in the body of the report]

Level/[orientation] Description Issues* Rural UPK RLFs MAD – inter‐village meeting

Voluntary: community leadership role

Six people per village (10‐15 villages) • Four meetings a year + need‐based ad hoc meetings

• Allocates funds for RLF and infrastructure • Determines loan conditions • Appoints UPK staff, BKAD, BP‐UPK, Verification Team

• Sets UPK (including RLF operational priorities)

• Focussed mainly on infrastructure;

• Financial planning largely dependent on recommendations of UPK staff

BKAD – inter‐village coordination body (termed BKAN – inter town coordination body in W Sumatra) Voluntary: UPK leadership

2‐12 members from MAD:• Monthly meeting; approves infrastructure projects assessed by Verification Team (TV)

• Overall management of UPK; ensures community cooperation and participation

• In most UPKs involved in monitoring and follow up of RLF overdues also;

• For some RLFs does not sanction loans; regards TV verification as the loan sanction

Verification Team (TV) Voluntary: Borrower appraisal

1‐3 members: • Verifies RLF loan applications, undertakes appraisal and recommends loans for sanction

• Assesses/recommends infrastructure projects from the community (prepared with the support of UPK staff/technical facilitator)

• Verification of group members done mainly at the village hall, not by visiting members’ homes; most RLFs have a reporting format but some do not


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Level/[orientation] Description Issues* BP‐UPK Voluntary:Internal audit and control

2‐3 members: • Monthly visits to UPK to verify RLF cash flows, check bank reconciliation statements, account books

• No operational audit or standard format for reporting;

• Does not usually check entries on UPK computer

UPK staff – 3 + support staff Professional full time: Operational role

3 persons + 1‐2 assistants:• Manager (ketua), Secretary (sekretaris) and Bendahara (accountant)

• Group acquisition, project preparation, loan disbursement & collection of repayments, cash handling, MIS and record keeping

• Discussed at length in the report.

Urban UPKs BKM – community self‐reliance body Voluntary UPK leadership

Usually 13 members representing all town wards – 3 member sub‐committee for supervision of UPK • Overall management of UPK; ensures community cooperation and participation

• In most UPKs involved in monitoring and follow up of RLF overdues also;

• Undertakes loan verification and sanction since there is no TV

• Similar issues to TV above

BP‐UPK Voluntary: Internalaudit and control

2‐3 members:• Monthly visits to UPK to verify RLF cash flows, check bank reconciliation statements, account books

• No operational audit or standard format for reporting;

• Does not usually check entries on UPK computer

UPK staff – 2 + collectors Partly voluntary, part‐time: Operational role

Usually 2 persons• Manager (ketua), and Bendahara (accountant)

• Group acquisition, project preparation, loan disbursement & collection of repayments, cash handling, MIS and record keeping

• Discussed at length in the report.

In relation to the RLF, the system at each UPK is supported by a financial facilitator(sometimes referred to as the empowerment facilitator) who is supposed to ensure that the arrangement functions well with the support of the office of the district‐level facilitator. The district facilitators are supported, in turn, at the provincial level by the office of the Regional Management Consultant, who guides them in their support of the effective implementation of the programme. The system is discussed further later in this report. 3.1.3 RLF policies Standard operating procedures: The policies and processes to be followed by the RLFs are set out in separate documents for the purpose. The PTO X (ten) (“Explanation X Revolving Loan Fund Operations – Technical Operation Manual) sets out the operational guidelines to be followed for rural UPK RLF operations. This PTO is a comprehensive document


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containing everything from general policy and operational mechanisms (including the handling of non‐performing loans) such institutional ideas as UPK Network Development. It also covers all technicalities related to the assessment mapping and performance rating of UPK RLFs. So comprehensive is the document that relatively few people (including UPK managers) have read it all and most have not fully understood it. This is partly because it goes much further in its scope (such as the scored rating of every aspect of an UPK RLF’s performance) than is perhaps justified by the present, relatively moderate capabilities of staff implementing the programme. It could be considerably simplified and reduced to make it more accessible in terms of reading and comprehending. For urban UPKs, there is a much sketchier document that sets out the structure, stages, accounting and management, ratio analysis of the UPKs’ performance. It is accompanied by a much simpler format (than the rural assessment format) of criteria for running UPKs setting out a hierarchy of ranges for satisfactory performance. It also has a detailed checklist for the assessment of an UPK. In M‐CRIL’s view, this document too needs some more thought. In this case a little more explanation of some of the brief bullet points would be useful and the ratios in particular need more thought. These have been discussed in the Action Plan above. RLF policies (as practised by UPKs) Loans are provided by the rural RLFs to individual women organised in groups of 5‐20 under the SPP (women’s savings and loan) programme. Many rural UPK RLFs still have amounts outstanding in the UEP (RLFs for productive economic activities) programme through mixed men’s and women’s groups, essentially as a legacy from earlier versions of the PNPM; 125 of the 267 (47% of the total) UPK RLFs assessed have outstanding UEP portfolios. Urban UPKs have groups of 5‐10 people, with a minimum of 30% women as specified in the SoP. Loans are disbursed in cash to members at the village office (rural UPKs) or in the house of the group leader (urban UPKs). The disbursement period is usually from the 5th to the 20th of each month for urban UPKs or on specified days in the case of rural UPK RLFs. If any member is absent during disbursement the cash is brought back to the UPK office. There is a Loan Card for groups but no individual loan cards at any of the UPK RLFs. In rural UPKs there is a “Form 49” to be used as loan cards but the distribution of these cards as well as completion of the form is not regularly observed by most of the RLFs. Collections are made by the group leader, or another member in the group leader’s absence, and deposited at the UPK office or at a staff member’s home. In some UPKs in Central Java and West Sumatra the staff visit the groups for collection purposes. Overall, the UPK’s group record management has some weaknesses as adequate attention is not paid to individual loan cards and, in the urban programme which has no provision for this in the SoP, only informal notebooks containing individual outstandings is the best that some UPKs are able to achieve. The UPK staff’s interaction with groups is very limited, which affects their loan appraisal capabilities and also weakens the follow up of overdues. Group interaction by staff is limited by the view that group management is the group leader’s responsibility. This has become a part of the culture of the programme in both


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rural and urban areas. In general, the community as a whole views the programme as an indirect subsidy resulting in nobody (including the staff) appreciating the need to conduct operations in a systematic manner so long as roughly the right sort of people benefit from it. Loan products UPKs usually offer only one loan product to their borrowers (apparently) for income generation.6 Details of the loan products are provided in Table 3.1.4 which follows.

Table 3.1.4 Details of loan products offered by UPK RLFs

Product features

Rural UPK RLF loans Urban UPK loans

Loan amount Central Java & DIY:Rp 1‐5 million; varies between RLFs West Sumatra: 0.5‐5 million, some UPKs up to Rp15 mn NTT: 0.5‐5 million; a few loan up to Rp10 mln; Rp1mln in 1st cycle loan in most cases

Rp 0.5‐2 million per borrower (significant number of UPKs have maximum loan size of Rp1million in Sumatera Barat)

Number of members

C Java & DIY: Minimum 5 members per groupW Sumatra: 5‐30 members per group (few UPKs have more than 30 members per group) NTT: 5‐20 members per group

C Java, DIY & NTT: up to 7 members per group/KSM W Sumatra: 4‐10 members per group

Security deposit

C Java & DIY: 10% joint liability savings are required up front in many RLFs; it is not recorded as an RLF liability W Sumatra: None NTT: Small amounts kept either in a group bank account or simply not collected in NTT since borrowers plead inability to provide a deposit

10% joint liability savings are required up front in many UPKs or 5% upfront and another 0.5% collected monthly over a ten‐month period

Loan period C Java & DIY: 10 or 12 monthsW Sumatra: 10‐12 months; mostly 12 months NTT: 10‐12 months; mostly ten months

C Java & NTT: 10 or 12 months; mostly ten months W Sumatra: 10‐12 months

Repayment frequency

Monthly principal and interest payments

Monthly principal and interest repayments

Collateral None NonePre‐payments

Pre‐payment is usually allowed but interest is collected in full; it happens in very rare cases.

Pre‐payment is usually allowed but interest is collected in full

Incentive C Java & DIY: IPTW is an incentive given to groups with an on‐time repayment record amounting to 10% of total interest W Sumatra: Ranges from 0%‐2% of total interest collection (but there are very cases in

Some UPKs provide an incentive given to groups with an on‐time repayment record (“IPTW”). The IPTW usually amounts to 10% of total interest.

6This is a reference to the fungibility of money. The micro‐loans are usually given only for income generation whereas people will cite an income generation activity they are already engaged in for getting the loan and will then use the money for e.g. ceremonies, if they want to.


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Product features

Rural UPK RLF loans Urban UPK loans

which such a payment has been made)NTT: The IPTW usually amounts to 10% of total interest for most UPKs. It is usually adjusted from the last instalment due from the group.

Interest rate [*APR excludes group fees since it measures income to the financial institution; EIR includes group fees since it measures cost to the client]

C Java& DIY: 1%‐2% per month on a flat basis; 0.5% also collected in many groups to meet group expenses and to cover late payments. EIR to client: 32%‐42% W Sumatra: 0.75%‐1% per month, flat basis NTT: 1%‐2% per month, flat basis

Distribution of interest rates – rural UPK RLFs

APRs* No. of UPK RLFs C

Java DIY West

Sumatra

NTT

<15% 5 15‐18% 11 18‐21% 16 21‐24% 6 1 10 24‐27% 2 1 1 8 27‐30% 12 20 30‐33% 98 7 35 33‐36% 4 7 7 >36% 11 1 4

Total 133 17 43 74 Average 30.9% 33.1% 18.7% 30.8%

C Java, DIY& NTT: 1%‐2% per month on a flat basis W Sumatra: 0.75%‐1% per month on a flat basis

Distribution of interest rates – urban UPKs

APRs No. of UPK RLFs

C Java DIY West Sumatra

NTT

<30% 7 0 4 1 30‐35% 133 16 26 9 35‐40% 14 1 3 >40% 25 1 1

Total 179 18 33 11

Average 34.1% 34.6% 30.2% 30.9%

3.1.4 Competition Given the number of local level financial institutions in Indonesia, it would be reasonable to expect rural UPK RLFs and urban UPKs to face a fair amount of competition in their locations. The main competitors to rural UPK RLFs in Central Java and Yogyakarta are listed in Figure 3.1.1. These are (in order of importance) local

Figure 3.1.1 Main competitors of PNPM Rural UPK RLFs ‐ Java

[multiple responses, total 281]

7365

47

29

15 13 12 128 7

0

10

20

30

40

50

60

70

80


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branches of Bank Rakyat Indonesia – famous worldwide for the microfinance orientation of its Unit Desa (“village bank”) system – the sub‐district (kecamatan) level local banking system (BKK), cooperative banks, other BPRs, the provincial government’s bank (BPD) and from the Islamic syariah cooperatives (BMT). There are also some branches of commercial banks and other financial service providers as well as the ubiquitous money lenders. Urban UPKs in this region were found to have a similar pattern of competition. In both West Sumatra and NTT, however, competitor institutions are limited in number and the main institutions mentioned by UPK RLFs as competitors are cooperatives. Moneylenders are also seen as offering competition by some UPKs, though the short term and high interest rate of moneylender loans means that they meet a very different type of demand for funds. UPKs take at least two weeks and up to two months to disburse loans while moneylenders are able to disburse instantly. Similarly, many cooperatives charge significantly more for loans and have shorter terms. Government programmes like Anggur Merah in NTT and cooperatives such as KJKS (Koperasi Jasa Keuangan Syariah – syariah cooperatives) are also seen as competition in some UPKs but were not consistently mentioned by UPKs because the geographical coverage of the former is limited – Anggur Merah is available in just one sub‐district per district – while KJKS has mostly larger loan sizes. The strengths and weaknesses of the UPK RLFs and urban UPKs vis‐à‐vis their main competitors are Strengths of UPK RLFs • Collateral free loans – not provided by any banking institution but also provided by

cooperatives and moneylenders • Lower monthly interest rate – mostly 1.25%,1.5% or 2% flat (see distribution of interest

rates charged in Table 3.1.4)compared to 2% usually charged by competitors and up to 5% or more by moneylenders

• No administration fee unlike competitor institutions that charge around 2‐5%. • As community institutions UPKs command a high degree of loyalty from borrowers

Weaknesses • Loan size is relatively small so provides a small amount of supplementary capital to

borrowers but is not appropriate for a fresh investment in production enterprises • Due to the general perception of the programme as a government hand‐out, there are

serious delinquency problems in many UPK RLFs – some in Central Java, Yogyakarta and West Sumatra and many in NTT; on account of these portfolio quality problems, many UPKs have become reluctant to (or are not allowed by the provincial authorities to) release funds so the prospects of getting loans are not very good.

The overwhelming response to this issue, however, is that while there are a few competitor institutions in their areas, there is no lack of demand for loans; the issue of high liquidity in some UPKs is not on account of potential clients preferring competitors but rather because, in some places, BKADs and BKMs have become conservative about lending due to fears of


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increasing portfolio delinquency or in the case of urban UPKs, because their lending has been suspended by PNPM regulations which require a reasonable portfolio quality to be maintained. The real competition to UPKs comes from cooperatives (as these serve the same market segment in similar conditions). In no case did the assessment team encounter concerns about competition being the reason for inadequate deployment of UPK funds. At best, the UPK RLF loan is a supplementary source of funds for existing businesses. In practice, it is more a way getting access to cheap funds likely to amount in the long run to an implicit grant from the government. As such, for those who are able to get access to UPK RLF “loans” there is no real competitor institution. The key question for the average family classified as poor (on the RTM/PS2 lists)7 is whether or not they can get access given the limited funds available and given the occasional reluctance of BKADs/BKMs to disburse funds. Sometimes, on account of rising delinquency and poor financial performance, UPKs are suspended from disbursing new loans until their performance improves. This is particularly so in the urban programme where, since 2008, there has been a suspension policy in place for poorly performing UPKs.

3.1.5 Poverty targeting The PNPM‐Rural programme is implemented by the Ministry of Home Affairs and is a women’s saving and loan programme (SPP) as the successor to the PPK, a Kecamatan (sub‐district) development programme that was originally started in 1995‐6. The PNPM‐Urban (Mandiri Perkotaan)programme is implemented by the Ministry of Public Works and is the successor to the Urban Poverty Programme (P2KP) that was originally started in 1999. As these are poverty reduction programmes, the need to target the poor is generally understood by the BKADs and BKMs. While recognizing this, some BKADs/BKMs do not put in place the processes necessary to ensure that the programme is fully focused on the poor. Indeed, there does not appear to be adequate awareness of the guidelines on this

7 These are lists prepared by local government institutions to identify poor members of their communities eligible for special assistance from the government. The RTM (Rumah Tangga Miskin) list is prepared in rural areas and the PS2 (Pemetaan Swadaya) is prepared in urban areas.

Figure 3.1.2 Status of poverty targeting by UPKs for RLF

Rural UPK RLFs

Urban UPKs

30% 29%

88% 80%

53%

70% 71%

12% 20%

47%

0%10%20%30%40%50%60%70%80%90%

100%

C Java DI Yogya WestSumatra

NTT Overall

No

Yes

74% 67%88%

45%

74%

26% 33%12%

55%

26%

0%10%20%30%40%50%60%70%80%90%

100%

C Java DI Yogya WestSumatra

NTT Overall

No

Yes


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with BKADs, in the rural programme in particular, giving precedence to their own views in relation to the sustainability objective. Members of the UPK governance bodies argue that it is better to have a number of borrower group members from non‐poor families so as to ensure income stability for (and, therefore, an assurance of repayment by) the group. By and large this formula is applied through the informal knowledge of UPK staff, Verification Team members (in the case of rural RLFs) and BKM member (in the case of urban UPKs) from the potential borrower members’ locality. Since the verification team is in place, BKAD members in rural UPKs do not usually play a significant role in this process. Figure3.1.2 shows around 70% of rural UPK RLFs in C Java and Yogyakarta do not have a formal process of giving priority to groups with a high proportion of members in the RTM or PS2 lists. In the case of urban UPKs the proportions are lower (over 25% in Java and over 50% in NTT). The other UPKs do have such processes and random verification by the M‐CRIL teams suggests that around 60‐90% of borrowers in these UPKs are on the poverty lists. In practice, there is no clear evidence in international microfinance on the relationship between the income levels of borrowers and the sustainability of microfinance programmes. The issue is more one of perception and willingness than of the income levels of borrowers. Therefore, the only way to improve sustainability and obtain results is to alter the perception that the programme is intended to be an indirect hand‐out from the government. 3.1.6 Misappropriation Misappropriation includes

• loans to borrowers without their knowledge (ghost loans), • mismatch in cash and other assets between the accounts of the UPK RLF and the

actual amounts available to the RLF, • cash collections from borrowers (by group head/UPK staff) not deposited in RLF, • security deposits not returned after loan closure, • payment of salaries of inactive staff, • defalcation by BKM/staff with substantial amounts of money (no details available).

Incidences of such misappropriation are difficult to detect in short assessment visits. Yet, UPKs are community institutions and people do sometimes talk about such matters even with strangers (especially if the strangers have the responsibility of assessing the UPK). Table 3.1.5 (next page) shows the number of instances of alleged misappropriation reported to or detected by the assessment team. As the table shows, more than 30% of the rural UPK RLFs and 48% of the urban UPKs have been found to have been affected by instances of potential misappropriation. In most of these cases it was allegedly a few groups in an UPK that were affected. It often entailed repayments collected by group leaders, or by UPK staff not being deposited correctly (or at all). There were also a few cases of loans being provided to non‐existent people (ghost loans) and collusion between the staff and BKAD/BP or BKM to misappropriate the funds. Most such cases are settled informally if the fraud is of a minor nature. More serious cases where the amount is large, of which there are a few cases, are


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subject to more stringent action with police cases being registered and pursued in rural UPK RLFs in West Sumatra, in particular, but elsewhere there is a more relaxed approach to such instances. In the other provinces – particularly in the urban programme – the lack of stringent action by the UPKs has the result of effectively encouraging more such activity. Controls and vigilance in relation to money is important in any financial institution and stringent action taken in PNPM Rural in West Sumatra helped to limit the number of cases occurring there.

Weaknesses in the BP‐UPK audit could mean that there are considerably more cases of alleged misappropriation that have either not been detected or go unreported because of the system of informal settlement. It is difficult to quantify the actual amount of loss incurred on this account. It ranges from a few percentage points of the total UPK portfolio up to as much as 40‐50% in a few cases. In some UPKs, the assessment has identified that a

misappropriation has happened without being able to say exactly how much. M‐CRIL emphasizes that the team is not confident of having identified all instances of loss on account of fraud and cannot claim to have quantified the amount in cases where the misappropriation was identified –a detailed audit would be necessary to do that.

Clearly the strengthening of BP‐UPKs will play a major role in reducing misappropriation. Greater motivation of BP‐UPK members and transfer of skills to them (through basic training in accounting and internal audit) along with an increase in the frequency and coverage of the BPKP audit will strengthen the control environment (including the integrity of the MIS and greater clarity about the need for the UPK governance to assume ownership of the funds) in the entire PNPM system. The external audit, in particular, would play a major role in improving the professional orientation of the entire programme, particularly if it is accompanied by rewards for good performance along with penalties for UPKs being careless in the management of PNPM funds. In order to reinforce this there needs to be a clear statement from the government that while the funds now belong to the community the BKADs and BKMs must still bear the burden of managing the funds in a responsible manner (fiduciary responsibility). A higher provision of funds for UPK RLFs performing well and less

Table 3.1.5 Instances of alleged misappropriation

Status – Rural UPK RLFs

C Java DIY WestSumatra

NTT Total

Group 32 2 5 18 59Staff 9 2 5 12 28Faskec 1 0 1 0 4BKAD/BP 1 0 0 2 2Total 43 4 11 32 93UPKs 35 3 8 27 82% of total 26% 18% 19% 36% 31%Urban UPKs Group 40 3 5 3 44Staff 21 3 7 4 63Faskec 1 0 0 0 7BKAD/BP 30 1 2 27Total 92 7 9 7 115UPKs 89 5 8 5 107% of total 50% 28% 24% 45% 44%


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for those not doing so well would be an immediately implementable measure of rewards and punishment. A specific monetary incentive and disincentive system for staff/BKAD/ BKMs at the UPK level would help to reinforce the impact.

In the context of misappropriation, it is also worth noting that the urban PNPM has a well functioning complaints handling system that is web‐based and which produces quick and helpful responses. The rural complaints‐handling system is more difficult to use and, based on the feedback from the assessment, seems to be less responsive. While the rural system is backed up by a telephone number posted at UPKs, the system is much less user‐friendly. The rural web‐based system is difficult to use and it is only potential complainants with a relatively high degree of initiative who tend to use telephone‐based systems. 3.1.7 Group management

The rural UPK RLF groups have largely been carved out of existing revolving savings and loan groups (arisan), prayer groups or groups formed for other government programmes. While this ensures affinity amongst group members it also reinforces collusion not to repay or to collude with the group leader in misappropriating funds. This could be one of the reasons for the high instance of alleged misappropriation reported to the assessment team. Urban UPK borrower groups are usually formed specifically for the programme and tend to be much more tenuous in their links with each. As a result, group leaders are often bolder in misappropriating funds because the lack of affinity between members means no one has much concern about what happens to the funds.

Unlike in UPK RLFs generally, group management is an area that receives some attention in a 5‐6 of the rural UPK RLFs West Sumatra. The staff in these award winning UPKs, pay particular attention to ensuring the good management of groups and in counselling the group leader about her responsibility in this regard. The perception of the programme as an instrument of community solidarity and economic support is more pronounced in these UPK RLFs where, by a combination of circumstances, there are enlightened BKM members as well as competent staff and facilitators. This applies to a very few UPK RLFs in C Java and Yogyakarta as well. In other RLFs, group management has been seen by staff, BKAD/BKMs and facilitators as purely the responsibility of the group leader and not an activity to which they need to pay any attention. This too weakens the sense of joint responsibility within the group, i.e. if one member defaults the others do not see it as their responsibility to encourage repayment. This hurts the overall efficacy of the programme.

3.1.8 Financing of UPK RLFs

The proportion and amount of funds allocated to RLFs and UPKs from block grants (BLM) is provided in Table 3.1.6. The rural programme has seen a fairly even average allocation of BLM since inception of 17.5‐18.4% across the provinces with funds of the order of Rp1.4 billion ($155,000) per UPK RLF. The urban programme has a substantial difference between provinces, about 20% on Java and just over 12% off‐Java with cumulative funds of around Rp100 million ($11,000) on average. In the urban programme, the allocations during 2010 are much lower than the long term average. This seems to be part of the response of the


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national government to the poor performance of the urban UPK RLF programme. While in theory the decision to allocate funds to the UPK is that of the BKM, in practice poorly performing UPKs are suspended from receiving additional funding until they improve their portfolio quality; if NPL is greater than 10% no more BLM allocation to RLF is allowed and if NPL exceeds 20% fresh disbursements to borrowers are also suspended.

Table 3.1.6 Allocation of BLM funds to RLFs

Province During 2010 Since inception*

(1999‐2010)Block grants

(BLM) received per UPK location since inception

Allocated perRLF since inception

Rural Rp billion Rp billionCentral Java 16.0% 18.4% 7.87 1.45Yogyakarta 16.0% 17.8% 7.62 1.36West Sumatra 19.6% 17.5% 8.06 1.41NTT 18.4% 17.7% 7.87 1.39

Average 17.3% 17.9% 7.88 1.42Urban Central Java 15.2% 19.4% 0.529 0.102 Yogyakarta 14.2% 21.4% 0.699 0.149 West Sumatra 7.6% 12.1% 0.419 0.051 NTT 4.8% 12.4% 0.621 0.077

Average 13.5% 18.3% 0.531 0.097* While some UPK RLFs may have been established before 1999, this has been treated as the inception year for the older UPK RLFs for the purpose of this report – most were established much later. For the older UPK RLFs, in many cases information even for1999 and later is not available. 3.2 Financial performance and cost analysis

The key financial ratios emerging from the UPK RLF assessments are presented in Table 3.2.1 for 2009 and 2010.8

8Data for 2009 has been presented here because some information was available and data for 2011 has not been presented since the process of annualisation creates a high margin of error in income/expense statements. A number of lumpy expense categories, in particular, such as “meeting” expenses or transport expenses incurred on a special repayment collection drive are not incurred steadily through the year and can create substantial distortions in the process of annualisation.


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Table 3.2.1 Key financial ratios of rural UPK RLFs and urban UPKs (averages weighted by the denominator of each ratio:

Number of borrowers, portfolio (OER), assets (RoA), portfolio (Yield & APR)) Negative ratios in red font

2009 Rural UPK RLFs, Province

Rp Cost borrower

OER,% RoA, % Yield, % APR, %calculated estimated9

Central Java 85,667 9.4% 12.3% n.a. 23.6% 30.5%Yogyakarta 77,188 11.8% 13.4% n.a. 28.1% 33.1%West Sumatra 91,389 9.4% 3.2% ‐9.4% 13.3% 18.6%NTT 130,043 16.2% 2.7% ‐34.8% 15.0% 30.9%

Total 95,449 10.7% 12.5% n.a. 21.6% 29.6%Urban UPKs Central Java 31,558 9.0% 5.6% ‐18.8% 17.9% 34.1%Yogyakarta 85,609 14.7% 6.8% ‐16.7% 14.6% 34.6%West Sumatra 17,011 5.4% 6.8% ‐10.3% 15.4% 30.2%NTT 24,378 7.4% 3.0% ‐17.7% 10.2% 30.8%

Total 41,364 10.1% 6.2% ‐17.9% 16.9% 34.0% 2010

Rural UPK RLFs Province

Rp Cost borrower

OER,% RoA, % Yield, % APR, %calculated estimated

Central Java 89,175 8.6% 15.3% 6.5% 25.3% 30.9%Yogyakarta 91,964 11.3% 15.7% 8.5% 29.3% 33.1%West Sumatra 63,319 6.6% 8.0% ‐2.2% 15.7% 18.7%NTT 117,694 12.4% 3.7% ‐8.7% 14.6% 30.8%

Total 95,044 9.3% 13.7% 3.5% 22.7% 29.6%Urban UPKs Central Java 27,976 7.5% 6.1% 1.1% 21.0% 34.1%Yogyakarta 60,557 8.8% 6.9% ‐1.3% 16.1% 34.6%West Sumatra 21,606 6.5% 6.4% 4.0% 19.1% 30.2%NTT 19,318 6.6% 1.9% ‐35.3% 8.4% 30.8%

Total 31,718 7.7% 6.1% ‐0.2% 19.6% 34.0%

9Calculated returns are based on official balance sheet information for each UPK RLF. Estimated RoA incorporates M‐CRIL’s estimates of correct loan loss provisioning using the provisioning norms specified in the respective SoP.


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For institutions that incur no expenses on internal controls, limited expenses on appraisals, no financial expenses and undertake no or very limited loan loss provisioning, returns on assets of 8.0% in West Sumatra and 3.7% in NTT are still very low. Correct loan loss provisioning of around 2.5% (to compensate for the bad loans in the UPKs’ portfolio) would still result in a loss even before (and certainly after) allowing for expenses on tasks that are covered by voluntary community institutions (BKAD/BKM, TV and BP‐UPK and the support of facilitators) in this programme. Not surprisingly, the cost per borrower of around Rp95,000 ($10.50) for Rural UPKs and Rp32,000 ($3.50) for urban UPKs is very low compared to the norm of $27 for full service MFIs in Southeast Asia and $12 even in South Asia – the lowest in the rest of the world.

Table 3.2.2 presents a comparison of the performance of MFIs in Southeast Asia with the current performance of rural and urban UPK RLFs as well as a notional calculation of the estimated cost structure if UPK RLFs were required to survive as independent community financial institutions with no government support. The notional calculation which allows for expenses to be incurred if UPK RLFs were to be independent has

• an additional 50% of operating expenses to cover internal control, governance and support systems including facilitation expenses

• a slightly higher financial expense ratio than MFIs assuming less efficient fund management

• the full loan loss provision as calculated by M‐CRIL based on the UPK guidelines. As the table shows, on these assumptions the rural UPK RLFs would lose some 0.6% of their assets on an annual basis even before any allowance was made for inflation. The urban UPKs would lose a very substantial 5.8%. By comparison, MFIs earn a profit (RoA) of 2.5% of assets in Table 3.2.2 and typical commercial banks in the Asian region earn a profit of 1.5% of assets (as shown in the table).

Table 3.2.2 Notional comparison of UPK performance with sustainability parameters

Financial ratios as % of portfolio

Banks in SE Asia* (typical for the region)

MFIs, SE Asia

(www.mixmarket.org)

Rural UPK RLFs, current

Rural UPK RLFs

notional#

Urban UPKs current

Urban UPKs notional#

Operating Expense Ratio, OER 4.0% 19.5 9.3 13.5 7.7 11.5Financial expense ratio, FER 8.5% 5.6 6.0 6.0 Loan loss provision 1.2% 1.2 4.0 2.5 7.0

Total expense ratio 26.3 9.3 23.5 10.2 24.5 Yield on (average) portfolio 16.0% 29.6 22.7 22.7 19.6 19.6 Profit as % of portfolio 2.3 3.3 13.4 ‐0.8 9.7 ‐4.9 Portfolio as % of assets 65% 75% Return on assets (RoA) 1.5 2.5 3.4* ‐0.6 ‐0.2 ‐5.8 *including additional provisioning calculated by M‐CRIL based on UPK RLF guidelines #see text below for implications of the term “notional”


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Adding the effects of inflation, which in Indonesia averaged 13.3% during the period 1997‐2011 and averaged around 5.5% during the period of this study of UPK RLFs by M‐CRIL (January 2009‐May2011, according to Badan Pusat Statistik Indonesia), means that the UPK RLFs (rural and urban) should have earned a minimum of 5.5% during this period in order to retain the real value of their assets. In practice, therefore, with an average notional RoA of minus 0.6%, the inflation‐adjusted RoA of rural UPK RLFs in Indonesia would be minus 6.1% in 2010.Urban UPKs would have an inflation adjusted RoA of minus 11.3% of the value of

their assets. 3.2.1 Financial performance ratios – distribution across UPK RLFs Efficiency: In the tables alongside, the operating expense ratio (OER) is mainly in the 5‐10% range, below the 10‐20% common for MFIs in Asia – with the MIX median around 15%.10 As Table 3.2.3shows, just38.6% of the

operational rural UPK RLFs and 23.0% of the urban UPKs have OER in excess of 10%. As discussed above, the reason for this is that a substantial part of the governance and control functions are performed by community institutions(BKAD, BP‐UPK and Verification Team) that cost very little since those institutions operate on a voluntary basis (though travel honoraria are usually paid by both rural and urban UPKRLFs).As a result, the average OER of around 9.3%for rural UPK RLFs is moderate by microfinance standards and 7.7% for urban UPKs is a low figure. The difference between the two types of UPK RLFs is on account of the higher salaries and more intensive staff orientation of the rural RLFs compared to the urban UPKs. Profitability: In addition to having low operating expense ratios,

• Both rural and urban UPK RLFs incur no financial expenses since additions to the revolving loan fund are via grants provided by the government or through accruals of profits from previous periods.

10MIX = Microfinance Information Exchange (www.mixmarket.org), an international platform for information on the operational, financial and social performance of MFIs worldwide. The MIX median is the median of the information on each indicator presented by the MIX separately for each sub‐continental region of the world.

Table 3.2.3 Distribution of operational UPK RLFs by OER, 2010

OER interval Rural UPK RLFs


NTT Total % of total

< 5% 7 0 9 17 33 12.5%5%‐10% 82 5 22 20 129 48.9%10%‐15% 39 10 4 7 60 22.7%15‐20% 5 2 5 11 23 8.7%20‐30% 2 8 10 3.8%>30% 1 8 9 3.4%Total 133 17 43 71 264 100.0%Urban UPKs < 5% 48 12 14 6 80 33.5%5%‐10% 90 3 10 1 104 43.5%10%‐15% 27 2 9 2 40 16.7%15‐20% 14 1 15 6.3%Total 179 18 33 9 239 100.0%


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• Rural UPK RLFs do not include loan loss provisioning in the income statement (P&L) as specified by the SoP; it is calculated only for determining the allocation of surplus after the profit calculation has been completed.In urban UPKs, loan loss provisioning is supposed to be included in the income statement (P&L) but here there is under‐provisioning partly because staff and facilitators have a very limited understanding of the calculation and also because BKMs would like to show profits; often an accurate calculation of the loan loss provision (LLP) would result in losses or significantly lower

profits for the urban UPK. As discussed above, the LLP has been adjusted by M‐CRIL in the calculations used to assess profitability (discussed further in Section 3.2.3, Credit Performance and Portfolio Quality).

Before correction, average RoA (profit generated from assets) in the 4 provinces covered by this study are 13.4%

for rural UPK RLFs in 2010 and 6.1% for urban UPKs. These are much higher than the apparent profits of MFIs as shown by the MIX RoA benchmark of 2.5% for MFIs in Southeast Asia and are also much higher than the 2‐3% RoA for BPRs in Indonesia. Table 3.2.5 presents the retained earnings of UPK RLFs in the 4 provinces for 2009 and 2010. It shows that surpluses of over 25% of equity have been generated by rural UPK RLFs and 19% by urban UPKs from retained earnings. However, this information needs to be viewed in the context of the accounting issues relating to loan loss provisioning that have been raised at various places in this report. Thus the numbers are indicative rather than accurate reflections of performance.

Table 3.2.4 Distribution of operational UPK RLFs

by RoA, 2010 (number of units)

RoA interval Rural UPK RLFs

C Java/ Yogya

DIY West Sumatra


<‐5% 3 3 1.1%‐5%‐0% 3 15 18 6.8%0%‐5% 1 0 7 33 41 15.5%5%‐10% 15 1 23 11 50 18.9%10%‐15% 41 6 9 4 60 22.7%> 15% 76 10 1 5 92 34.8%

Total 133 17 43 71 264 100.0%Average RoA 15.3% 15.7% 8.0% 3.7% 13.4% Urban UPKs

<0% 14 2 2 1 64 26.8%0%‐5% 33 4 10 5 36 15.1%5%‐10% 54 4 8 4 48 20.1%10%‐15% 49 6 11 60 25.1%> 15% 29 2 2 31 13.0%

Total 179 18 33 10 239 100.0%Average RoA 6.1% 6.9% 6.4% 1.9% 6.1%

MIX median for MFIs in SE Asia 2.5% BPRs in Indonesia 2%‐3%


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Using the “adjusted” LLPs calculated by M‐CRIL analysts, the surpluses decline to 10% for rural UPK RLFs. Urban UPKs, on the other hand, have lost some (3.7%) of their assets on this basis making them unsustainable. Given the accounting problems in the balance sheets, however, these numbers still need to be viewed with caution; each year’s surplus is not always clearly transferred into next year’s balance sheet with some room for concern about the possibility of the statement having been adjusted to create a balance when the facilitators and staff were unable to find the related error in the accounts. 3.2.2 Liquidity analysis The issue of excess liquidity at UPK RLFs has been a matter of concern in the overall PNPM programme. The concern is that either UPK RLFs do not have an adequate demand for funds from the local population (due to the saturation of credit from various sources) or that there are inefficiencies in the systems of some RLFs resulting in a stagnation of resources. It is apparent from Table 3.2.6 that the 20% average liquidity of rural UPK RLFs in the 4 provinces for 2010 is somewhat higher than the Southeast Asia MFI median of 18.4% for 2009 (as available on the MIX). Even the 18.4% figure is high by global microfinance standards where 7‐10% liquidity is regarded as best practice for non‐deposit taking MFIs. As Table 3.2.6 shows, about 45% of the sample rural UPK RLFs have over 20% liquidity while only 26% come within the 10% international best practice norm. For the urban UPKs, even fewer (23%) are within the international best practice norm of 10% while 57% have over 20% liquidity. Based on M‐CRIL’s assessment of the rural UPK RLFs it appears that it is inefficiencies in disbursement and, also caution on the part of UPK managements in relation to portfolio

Table 3.2.5 Retained earnings of UPK RLFs (% of total funds)#

Province

2009* 2010Rp bn 2010 2009 2010

Rp mn 2010

Rural UPK RLFs Urban UPKs before correcting LLP

Central Java 24.7% 28.5% 85.1 13.3% 13.6% 2,866 Yogyakarta 29.5% 34.8% 13.6 51.1% 47.5% 2,510 West Sumatra 11.9% 16.2% 10.72 8.8% 9.5% 174 NTT 16.5% 14.8% 8.32 8.8% 8.1% 82 Total/Average* 25.6% 117.74 20.4% 19.3% 5,632

after correcting LLP Central Java 24.7% 28.5% 85.1 ‐7.2% ‐7.8% (1,712) Yogyakarta 29.5% 34.8% 13.6 30.9% 22.6% 1,196 West Sumatra 0.0% 14.6% 9.65 ‐7.4% ‐3.8% (76) NTT ‐27.0% ‐25.3% ‐20.43 ‐25.6% ‐29.9% (238) Total/Average* 10.1% 87.92 0.2% ‐3.7% (831)

# Total funds = total assets but retained earnings are an equity item which is part of funds not assets *2009 data is error prone and, therefore, purely illustrative – the average for all provinces has not, therefore, been presented.


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quality that is the bottleneck in the use of funds. This has resulted in a slowdown in portfolio expansion and leads to further disappointment amongst the community about the availability of PNPM loan funds, thereby depressing demand for the funds available.

“Inefficiencies in disbursement” refer to the fact that it takes UPK staff and Verification Team(in the case of rural RLFs) 2‐3 months to carry out appraisals and BKAD/BKM to approve loans, far longer than it seems to take their main competitors (cooperatives and moneylenders). Also a number of urban UPKs have the policy of disbursing only once in 2‐3 months, sometimes even 6 months, leading to a building up of liquidity in their accounts. This emphasizes the weakness in liquidity management and is a part of the various issues in financial management that exist in PNPM both rural and urban.

In a number of cases, a poorly performing portfolio makes the BKAD/BKM cautious and unwilling to disburse further funds leading to a form of gridlock. Thus, UPK does not disburse because borrowers do not repay and borrowers do not repay because the UPK is not disbursing and so they do not expect to get another loan. This is a well known phenomenon in microfinance. In addition, a significant number of urban UPKs with high overdues have been suspended by government policy from making additional loans. The “saturation of credit” has not emerged as an issue. 3.2.3 Credit performance and portfolio quality

As specified in the project documents, portfolio quality is measured in rural UPK RLFs and urban UPKs using a loan collectability framework as follows

Table 3.2.6Liquidity distribution of UPKs, 2010

Liquidity level – rural UPK RLFs



<5% 17 3 0 0 20 7.6%5%‐10% 33 4 5 5 48 18.2%10%‐20% 44 4 12 17 77 29.2%20%‐30% 30 4 10 21 65 24.6%30%‐40% 7 2 8 18 34 12.9%40%‐50% 2 0 5 8 15 5.7%>50% ‐ 0 3 2 5 1.9%Total 133 17 43 71 264 100.0%Avge liquidity 15.5% 17.2% 23.3% 26.0% 19.8% Urban UPKs <5% 33 0 1 34 14.1%5%‐10% 19 3 0 22 9.1%10%‐20% 44 3 1 48 19.9%20%‐30% 35 7 3 45 18.7%30%‐40% 18 11 4 33 13.7%40%‐50% 25 4 0 29 12.0%>50% 23 5 2 30 12.4% 197 33 11 241 100.0%Avge liquidity 16.5% 39.8% 29.4% 18.5%


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Table 3.2.7 Specified framework for the calculation of loan loss provision

Collectability Classification Conditions – Rural Reserve, %

I Current loans 1 II 1‐2 months past due 10 III 3‐4 months past due 25 IV 5‐6 months past due 50 V More than 6 months past due 100 Conditions – Urban I Current loans 1 II <3 months past due 5 III 4‐6 months past due 15 IV 7‐9 months past due 50 V More than 9 months past due 100

This framework is used to calculate the loan loss reserve (referred to in the rural SOP as “loan loss provision”) for each rural UPK RLF and urban UPK. In practice there are significant issues in the calculation of collectability. Thus 18 of the rural UPK RLFs in West Sumatra,96 in C Java& 11 in Yogyakarta have calculated loan loss provisions correctly on the basis of the age classification of overdues in the collectability statement. In most of the remaining 142 (58.1% of cases) understanding of how to undertake aging is limited. Amounts in various collectability categories are incorrectly categorized with the assumption that the payment of a current instalment makes the loan current in spite of earlier instalments remaining unpaid.

Table 3.2.8 Status of loan loss provisioning calculations in sample UPKs

Number of UPKs Rural UPK RLFs Overestimated Correct Underestimated No information Total C Java 96 37 150 Yogyakarta 11 6 Sumatera Barat 1 18 21 3 43 NTT 5 0 60 9 74

Total 6 125 124 12 267 Urban UPKs C Java 50 20 109 197 Yogyakarta 5 13 Sumatera Barat 1 1 31 33 NTT 11 11

Total 56 21 164 241


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Figure 3.2.1Colectibility of Rural UPK RLFs – operational

88.8% 86.4%93.8% 90.1%

77.8% 81.8%

54.9% 53.3%

6.0% 6.3%1.2% 3.6%

6.2%6.2%

3.8% 4.4%

2.6% 3.9% 3.4% 3.3%13.0% 8.9%

37.2% 34.4%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2009 2010 2009 2010 2009 2010

C Java Yogyakarta Sumatera Barat NTT


Figure 3.2.2 Colectibility of urban UPKs – operational

42.1% 38.9%

62.5%53.3% 54.0%

46.3%

13.7% 11.6%

21.8% 22.8%

9.1%

10.5%15.1%

22.4%

33.9%

21.4%

8.7% 7.5%

4.5%5.9%

6.9% 8.8%

21.7%

19.7%

3.0% 4.1%2.7%

5.3%3.7% 5.5%

12.6%

4.8%

24.3% 26.6% 21.2% 25.1% 20.4% 17.0% 18.0%

42.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009 2010 2009 2010 2009 2010 2009 2010

C Java Yogyakarta Sumatera Barat NTT



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In the case of urban UPKs, loan loss provisions have only been calculated correctly by 20 UPKs in C Java and 1 in West Sumatra. In 164 out of 241 UPKs (68%) loan loss provisioning has been underestimated and in 56 UPKs (23%) it has been overestimated due to a lack of understanding of the calculation. Following international best practice, M‐CRIL analysts attempted to correct the collectability classification at each RLF and to calculate the correct figure for loan loss provisioning. The status of the portfolio quality calculation is set out in Table 3.2.8. While this has been done reasonably accurately in some cases, in others it was not possible to do this accurately due to the lack of information. The resulting portfolio quality performance is presented in Figure 3.2.1. The actual quality is weak by microfinance standards. Rural UPK RLF portfolio in overdue loans in 2010 amounts to 18.2%in West Sumatra and around 13% in C Java, an improvement from the 22.2% in West Sumatra December 2009 but based on a 69% increase in overall portfolio size – meaning that the absolute amount overdue had actually gone up by 38%.In Central Java there was actually a slight decline in portfolio quality from 11% in the previous year. Since the portfolio had increased by 63% during 2010, this means that the actual amount overdue increased by 92% during 2010. The NTT portfolio with 47% overdues is in a very bad condition. Urban UPK portfolios have significantly higher levels of risk than the rural UPK RLFs with 61% of the portfolio in Central Java, 47% in DIY, 54% in West Sumatra and as much as 88% in NTT overdue. The portfolio quality of assessed rural UPK RLFs in December 2010 mirrors the overall performance of UPKs, with NPL (Kol‐V as per RLF guidelines) ranging from 3.9% in Central Java and 3.3% in Yogyakarta to 8.9% in West Sumatra and as much as 34.4% in NTT. This is essentially a proxy for the relative performance of the PNPM programme in the provinces covered by this assessment. Small improvements in NPL ratios from 2009 to 2010 are attributable to increases in overall portfolio outstanding rather than to any significant recoveries of previous NPLs. In the case of urban UPKs, NPLs are defined as Kol III‐V and Figure 4.2.2 shows that this ranges from 38.2% in Central Java, 36.3% in Yogyakarta and 31.3% in West Sumatra to as much as 67.0% in NTT. This also is a reflection of the relative performance of each province.

Impressionistically, comparing just Kol‐V in rural UPK RLFs with Kol‐V for urban UPKs is a good reflection of the relative performance of the two programmes. Despite the stricter definition of Kol‐V in the rural programme, it performs substantially better than the urban one. As discussed earlier, the main reason for the better performance of rural UPK RLFs appears to be that it is more professionally oriented with full time staff on reasonable remunerations rather than a part‐time activity managed on a, sometimes, casual basis. Nevertheless, it needs to be borne in mind that the rural UPK RLF portfolios are, on average, more than 15 times the size of urban UPK portfolios thus, potentially, posing a higher fiduciary risk. While the risk posed by the worst performing urban UPKs is limited by the policy of suspending new funds to them, the risk in rural UPK portfolios appears to be constantly diluted by new (BLM) funds.


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3.3 Data issues – reliability, quality and transmission 3.3.1 Accounting system and internal control/audit The maintenance of income and expense accounts by staff at rural UPK RLFs is not very good – though better in Java (both Central Java and Yogyakarta) than elsewhere. Table 3.3.1 shows that the need for training is largely high in the UPK RLFs – both rural and urban. As discussed earlier,

The process is not helped by the fact that there are multiple accounting books to be updated monthly at the UPK RLF level – 16 in the urban programme – generating information that is not used at the operational level and this leads to a lack of under‐standing of the need for it, causing carelessness and inaccuracy. A rationalisation of the accounting system would not only reduce the accounting burden, it would lead to greater accuracy of information if UPK staff understood the need for each item being collated. Responsibility for internal audit rests mainly with the BP‐UPK. But as Table 3.3.1shows,as many as 41 of the 241 urban UPKs do not even have an auditor(BP) and in others accounting knowledge and skills are quite weak making it difficult for the BP teams to do their job. This applies to rural UPK RLFs as much as to urban UPKs. In many cases the accounting knowledge of the facilitators also needs to be improved if internal audit is to be undertaken adequately.

…knowledge of the guidelines and understanding of accounting for overdues and for the collection of overdues are areas that need to be addressed through communication and training of UPK RLF staff. In particular, there is lack of clarity in the calculation and accounting for collectability and making loan loss provisions.

Table 3.3.1 Need for capacity building in accounting

(number of UPKs)

High Medium Low Total High Medium Low No BP Total

Rural UPK RLF Staff Rural BP‐UPK C Java 30 56 47 150 62 46 25 133Yogyakarta 5 6 6 17 9 4 4 17West Sumatra 24 18 1 43 35 4 3 1 43NTT 63 9 2 74 59 4 1 10 74

Total 122 89 56 267 165 58 33 11 267 Urban UPK staff Urban BP‐UPK C Java 85 60 34 179 134 13 4 28 179Yogyakarta 8 10 0 18 11 1 1 5 18West Sumatra 15 14 (4) 33 10 1 22 33NTT 5 2 (4) 11 3 8 11

Total 113 86 34 241 158 15 27 41 241


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There is a “high” requirement for training in accounting and the specific skills required for internal audit. Essentially, the voluntary nature of the BP‐UPK arrangement means that, often, inappropriate people (including homemakers and teachers with no previous knowledge of accounting) or people with very little time to spare for the work are appointed as members resulting in gaps in understanding and/or execution of the internal audit and control task allocated to the team.

3.3.2 Tracking of overdues Due to the nature of this programme, the tracking and follow up of overdues is an important task to be performed by UPK RLFs. Given the status of portfolio quality as measured by Kolektibilitas (collectability, Figure 3.2.1 & Figure 3.2.2), the follow up and collection of overdues is naturally a major task to be performed by staff and BKAD/BKMs. Partly because PNPM is seen as a subsidy‐based government programme, staff are not motivated to follow up with borrowers. In the urban programme, the volunteer status of staff is a factor affecting both their motivation and their authority. Members of BKAD/BKM, who are supposed to be responsible for the functioning of the UPK are also sometimes ambivalent in their approach to the tracking of overdues – partly on account of their own time constraints. Many borrowers too have the attitude that the money is a government grant, so they do not see the imperative to repay.

The loss incurred on account of late payments is significant but not fully quantifiable due to deficiencies in the quality of the MIS. Wherever, rural UPK RLFs have attempted to impose penalties for late payments (which could be another way of tracking late payments), borrowers have resisted the attempt and the penalty has either been withdrawn or has simply not been implemented. This is another indication of the social welfare rather than financial services orientation of the community’s approach to both the programmes – though it is even stronger in the urban programme than in the rural one and is apparently responsible for the difference in the relative quality of the portfolio in the two programmes.

Table 3.3.2Need for improvement in the tracking of overdues

(number of UPKs) Rural UPK RLF staff High Medium Low

No staff Total

BKAD High Medium Low

No BP Total

C Java 45 49 39 133 49 53 31 133DI Yogyakarta 6 5 6 17 9 2 6 West Sumatra 10 19 14 43 20 16 6 1 43NTT 53 18 3 74 59 15 0 74

Total 114 91 62 267 137 86 43 1 267Urban UPK staff BKM C Java 100 62 35 197 105 71 21 197DI Yogyakarta West Sumatra 10 17 2 4 33 19 11 2 1 33NTT 4 3 4 11 6 3 2 11

Total 114 82 37 8 241 130 85 23 3 241


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3.3.3 Management information systems (MIS) and data reliability

Through the work of the national and regional management consultants, the programmes have systematic sets of formats in MS Excel at the UPK RLF level and in special software with the UPK level sub‐district facilitator (Faskel) and assistant coordinators (Askot) in urban UPKs. There is also a detailed monthly reporting system provided by the management consultants that would provide all the information necessary for monitoring the programme, if completed properly. This is essentially a staff responsibility but the monthly reports are mostly prepared with the support of the facilitator for consolidation with other UPK RLFs at the district level and with the Faskel in urban UPKs for consolidation and onward transmission by the Askot to the main office of the regional management consultant. The RMC consolidates it further (at the provincial level) for submission to the national management consultant. A summary of the MIS at UPK RLFs is provided in Annex 3. The MIS function is moderately performed in both programmes, though again the rural programme performs better overall than the urban – as is apparent from the proportion of UPKs with “high and medium” need for improvement in the rural programme (67%) compared with those in the urban programme (85%) – see Table 3.3.3. There are

nevertheless many UPK RLFs with significant issues. The M‐CRIL assessment teams compared the UPK level MIS data with information in monthly reports and also matched the collectability statement with repayment information from selected group loan cards during field visits. Information is also triangulated for consistency by comparing information on loan cards with copies of receipts issued. Often the information reviewed from various sources does not match; if it does broadly appear to match, the data is accepted by M‐CRIL as relatively reliable. The M‐CRIL analysts’ assessment of the

need for UPK level training in the MIS function is set out in Table 3.3.3. Facilitators of both rural UPK RLFs and urban UPKs tend not to be fully skilled to perform the relatively simple information functions required of them, though in the rural UPK RLFs they are better in Java than elsewhere. In this case, the facilitators also need considerable additional orientation to ensure that data is accurately recorded as an input to the monitoring of the programme. If this is seen as a routine task of no importance to management it tends to be done without due care and attention.

Data security is an important issue at the UPK level, as the printed monthly report of the UPK sometimes does not match records maintained in the computerized MIS in the rural UPK RLFs. Staff can make changes in the MIS at any time and such modifications after the submission of the monthly report cause confusion if there is no record of how and why the change was made. Equally important, many RLFs have inadequate information because the

Table 3.3.3 Need for improvement in the MIS function

(number of UPKs) Rural High Medium Low Total C Java 23 45 65 133DI Yogyakarta 6 4 7 17West Sumatra 16 14 13 43NTT 61 11 2 74

Total 106 74 87 267Urban

C Java 77 70 32 179DI Yogyakarta 10 6 2 18West Sumatra* 20 5 4 29NTT* 7 7

Total 114 81 38 229* 4 urban UPKs in each province have no staff so no MIS


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MIS and accounts simply are not being adequately maintained. When the data does not exist, the facilitator and staff estimate the information to as reasonable a degree of accuracy as possible. This provides impressionistic information which becomes accepted as the reality as it moves up the chain. In most of the rural UPK RLFs, staff do not even have copies of the report sent to the district facilitator’s office (Faskab). Similar comments apply to the urban UPK system which is even more prone to errors and changes as it is maintained manually and not always efficiently since the staff are part‐time, essentially volunteer, workers with this as their subsidiary occupation. There is some checking of the monthly report filed by the facilitator from each urban UPK. As long as the data is found to be broadly consistent by the Faskab/Askot, it is passed on to the provincial level for consolidation. There is very little checking of the MIS when the Faskab/Askots visit an UPK. Thus basic errors like the reporting of the cumulative number of borrowers rather than the number of borrowers with currently outstanding loans can become institutionalized. The consistency method accepts data if, say, December 2010 showed 136 borrowers and then June 2011 data shows 153 with a concomitant increase in portfolio. The fact that the number of loans outstanding should have been 57 in December 2010 and then 69 in June 2011 can be missed altogether.

In the absence of adequate monitoring at the UPK level by the supervisory levels – Faskabs and Askots – and the virtual lack of any form of external audit, data reported by them is simply accepted by RMC as correct. Since at the urban UPK, Askots and Faskabs are supposed to check the performance reports prepared, they do take a brief look at accounts also during their very occasional visits to the UPK. However, the M‐CRIL team has not found them to be very familiar with UPK level information since they do not put much effort into verifying it or ensuring its accuracy. RMCs have established a system of reporting responsibility, successively for UPK Facilitators, Askot, Faskab and provincial Financial Management Specialist but, in practice, this is being routinely (but dispassionately) followed without significant checks that could ensure the accuracy of the information. The NMC sees itself as the user of the data and does not regard verification or validation as its responsibility. Based on this assessment exercise, it was also found that the random audit by the national government audit agency (BPKP)is very infrequent since the agency has many responsibilities and only does a sample audit of each programme funded by the central government. Just 2‐3% of the assessed UPKs reported having had any such audit within the past two years. There is supposed to be a 20% audit at the provincial level but there was no indication during the assessment field visits about the actual occurrence of such audits – only the national BPKP audits were mentioned. The only audits that were reported by rural UPK RLFs were the BPKP audit. Urban UPKs are required to be audited annually by local auditors but due to lack of funds some do not conduct the audit whereas others use very low cost firms resulting in a very poor quality of audit.

Some of the specific issues arising in the MIS are listed in Table 3.3.4.Not all the shortcomings in the table may be applicable in all UPKs but all the points in the table apply to a majority of the type of UPK stated.


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Table 3.3.4 Specific issues arising in the maintenance of MIS (applicable to both rural and urban unless otherwise stated)

Common MIS Issues 1 Regular back‐ups of MIS are not taken. (earlier data often erased from UPK records) 2 [Rural UPK RLFs] Links in the MIS file are not protected, resulting in casual changes being

made by staff or facilitators at UPK RLF level, causing significant difficulties in tracing inaccuracies when the reasons or nature for the changes cannot be traced

3 No report on rescheduled loans available4 No group wise loan records, including loan status report, loan cards 5 Some groups with overdues not mentioned in the portfolio statement 6 Group‐wise tracking. UPKs could not give the number of active borrowers for 2009 (and

sometimes even for 2010); often this data is reported on a cumulative basis but can be easily be computed by a knowledgeable analyst

7 Interest rate mentioned in many loan documents different from the actual loan product (what is actually collected from the groups)

8 Disbursement register has some dates missing9 Reporting to Faskabonly contains a summary collectability report not a group‐wise report

10 Groups names do not tally with namesrecognized by the groups11 MIS report on group‐wise outstanding loans shows negative balances implying incorrect

entries for advance collections It is standard procedure in any assessment undertaken by M‐CRIL, to check the reliability of data provided. In all RLFs, therefore, data provided by staff has been cross‐checked at various levels by • comparing manual financial and

operational information with that maintained in the MIS

• randomly matching client/group level loan records with RLF loan ledgers

• checking consistency of data between one year and the next and across KSMs and UPKs (ensuring there is a good reason for variations in both time series and cross‐sectional data).

Table 3.3.5 summarises M‐CRIL’s assessment of the reliability of data available in the records of the UPK RLFs – when data was unavailable it was classified as “weak”. By and large, the

Table 3.3.5 Data reliability at UPKs

(number of UPKs)

Rural UPK RLFs Good Moderate Poor TotalC Java 66 52 15 133DI Yogyakarta 8 3 6 17West Sumatra 18 15 10 43NTT 5 14 55 74

Total 97 84 86 267% of total 36% 32% 32% 100%

Urban UPKs Good Moderate Poor TotalC Java 88 62 29 179DI Yogyakarta 7 6 5 18West Sumatra 16 11 6 33NTT 3 1 7 11

Total 114 80 47 241% of total 47% 33% 20% 100%

* Good = reasonably accurate and complete Moderate = with some gaps in data for 2009 and earlier, problems with calculation of collectability due to lack of understanding of staff and facilitators Weak = substantial errors in 2010 data, no information on numbers of borrowers, imbalanced accounts, riddled with inaccuracies; includes UPKs with data unavailable


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two types of UPK RLF, rural and urban, have similar quality data and as with a number of other parameters of assessment, there is considerable room for improvement in both. Excluding the especially weak performance of both rural and urban programmes in NTT, around 50% of both rural and urban UPK RLFs have reasonably good data quality. Both rural and urban UPKs are supposed to submit operational and financial reports to the district (Kabupaten) level on a monthly basis and this is done in virtually all cases. However, the accuracy of the data depends on the level of commitment of the staff and UPK facilitator and their level of understanding of the need for accuracy and of the accounting system itself. There are also sometimes differences between what is reported and the data with the UPK. This is because each level of the reporting chain demands complete information (even if accuracy is not always fully checked); so, as indicated earlier, facilitators/staff sometimes just estimate the number of borrowers, for instance, if the data does not seem to match. At other times portfolio data is misrepresented to cover up deficiencies that the staff perceives as temporary. As in any financial system, the under‐reporting of payment difficulties can become permanent as the “temporary” payment problem persists. Overall the rural information available appears to be significantly better than the urban. This seems to be because rural UPK RLFs have permanent, full time staff with information maintained at an established office. Urban UPKs have “volunteer” part‐time staff with records often kept at home resulting in a mix up of household responsibilities with the UPK responsibilities of the staff. While rural RLFs have a dedicated facilitator to support their reporting, urban have one facilitator for 9 UPKs (usually) resulting in diluted knowledge and understanding of each unit, albeit for much simpler operations. 3.4 Institutional capacity 3.4.1 Staff – qualifications and capacity In general the UPKs have hired staff based on their availability and willingness to undertake the work required. Though the qualifications of UPK staff are moderate (see Figure 3.4.1), the undemanding nature of the written work means that they mostly have a reasonable level of competence for

Figure 3.4.1 Staff qualifications UPK RLFs

Staff numbers All rural UPK RLFs assessed

Total staff 853Staff per UPK 3.19

Staff numbers All urban UPKs

assessedTotal staff 498Staff per UPK 2.07

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Ketua Bendahara Sekretaris

Graduate High School Diploma

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Manager Bookkeeper Cashier

Graduate High School Diploma


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undertaking the functions assigned to them. Most rural UPK RLFs have just 3 staff members (full time) – the Manager (Head of the UPK team), Accountant (Bendahara) and secretary (Sekretaris). Salaries – ranging from Rp1 million to Rp2 million per month – are well above the minimum wage of around Rp1 million per month but compare with the Rp2‐3 million per month paid to facilitators. Urban UPKs mostly have just 2 part‐time staff members with honoraria in the range Rp25,000 to Rp300,000. While this is for part‐time employment, the small amount in relation to the minimum wage naturally affects the individual’s perception of and motivation in the job. Most focus on their primary occupations to the detriment of the UPK. The capacity of staff to handle the tasks required of them and the need for enhancing that capacity through training (capacity building) have been assessed by the M‐CRIL analysts for various functions. The need for improvement is presented in Table 3.4.1. The most important issues that emerge from the table are accounting, MIS, delinquency management, cash/financial planning, on the one hand, and the related issue of the tracking of overdues as well as group management and supervision, on the other. In general, staff were found to have reasonable knowledge and understanding of operational and loan procedures. Loan appraisals were found to need some attention but not as much as in some of the other functional areas. As expected, the head of an UPK (or sometimes the accountant/bendahara in the case of rural UPK RLFs) is typically the most knowledgeable and skilful member of staff and plays the most important role in guiding the UPK team. Facilitators in rural UPKs tend not to have an equivalent level of skills and act mainly as a conduit of information down the chain from the RMC through the district facilitator to the UPK RLF staff. In urban UPKs, facilitators do sometimes have a similar if not superior level of skills compared to the staff but this still needs considerable enhancement in many cases to reach a satisfactory level. 3.4.2 Loan appraisal and approval

Staff does the primary work of identifying and forming borrower groups followed by working with the borrower groups to generate the proposal documents and the verification of borrower identities. The appraisal of group projects in

Table 3.4.1 UPK staff capacities & skills – need for improvement

(number of UPKs)

Intensity Required Rural UPK RLFs High Med’ LowOperational/loan procedures 31 88 148Accounting 122 89 56Cash and financial planning 107 87 73Documentation/record keeping 77 74 116MIS 106 74 87Loan appraisal and approval 75 109 83Tracking of overdues 114 91 62Delinquency management 145 75 47Group mgmt. & supervision 126 116 24 37.6% 33.4% 29.0%Urban UPKs Operational/loan procedures 44 67 122Accounting 113 86 34Cash and financial planning 128 79 26Documentation/record keeping 69 85 79MIS 114 81 38Loan appraisal and approval 96 95 42Tracking of overdues 114 82 37Delinquency management 163 54 16Group mgmt. & supervision 145 76 12 47.0% 33.6% 19.4%


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UPK RLFs is undertaken by the verification team (TV) occasionally along with the BKAD representatives in the locality of the borrower. In urban UPKs it is done by staff with support from BKM members and RT members in the town ward (kelurahan). M‐CRIL’s assessment of the appraisal activity is summarized in Table 3.4.2. The role of the TV/BKMs

as well as the availability of the skills necessary to undertake loan appraisals and the lack of time of team members to perform the task properly are key factors. In this, the issues arising are the same as those for the BP‐UPK; the Verification Team/BKMs need additional motivation and skill building for the function to be performed as well as necessary. 3.4.3 Dealing with delinquency The discussion in Section 3.2.3 showed the extent to which loan delinquency is an issue in the programme, more in urban than in rural and more acute in NTT than in other provinces. It is an issue even in rural UPK RLFs in Yogyakarta which have the best quality of portfolio but the PAR60(portfolio at risk/overdue more than 60 days) still exceeds 6%, a high level compared to other small community financial institutions where this level is regarded as acceptable below 5% and good only below 3%. An important “rule of thumb” here is that, in M‐CRIL’s experience, the annual loan loss rate is likely to be 50% of PAR60 so a 3% level of PAR60 would lead to a 1.5% loan loss provision – which is the maximum tolerable provision expense for small financial institutions to be normally

profitable. It is apparent that there is a need for a substantial effort to deal with the level of delinquency in the programme, both rural and urban. The arrangements in the programme for dealing with delinquency are

Table 3.4.2 Need for capacity building for loan appraisal

(number of UPKs)

Verification Team (TV) in rural UPK RLFs High Medium LowC Java 51 43 39Yogyakarta 4 6 7West Sumatra 9 24 9NTT 37 28 7Intensity of capacity building required 38% 38% 23%BKM in urban UPKs C Java 81 69 29Yogyakarta 8 8 2West Sumatra 16 13 4NTT 6 3 Intensity of capacity building required 42% 35% 13%

Need for improving role clarity (number of UPKs)

Verification Team in rural UPK RLFs High Medium LowC Java 21 23 89Yogyakarta 2 5 10West Sumatra 3 14 25NTT 19 29 24Intensity of capacity building required 17% 27% 56%BKM in urban UPKs C Java 37 53 89Yogyakarta 3 6 9West Sumatra 9 11 13NTT 6 2 1Intensity of capacity building required 21% 27% 42%


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Rural: Follow up by staff and BKAD; delinquent groups do not receive another loan until the previous one is paid off. In extreme cases Loan Remedial Teams must be established for follow up of delinquent groups and borrowers. Urban: Follow up by staff (including, in some cases, loan collectors) and the BKM’s sub‐committee for the UPK; also, no subsequent loan for delinquent KSMs. In practice, as discussed in various places in this report, follow up is very limited due to the grant perception of the funds disbursed by UPK RLFs, both rural and urban. Even on Java, where the programme runs more smoothly than elsewhere, there is a degree of casual treatment of overdue loans due to this grant perception. Overall, there were only 42 cases of functioning Loan Remedial Teams amongst the 267 UPK RLFs, of which as many as 86 have PAR60 in excess of 10% and 66 have NPLs (overdue more than 9 months) greater than 10%.The comparable figure for urban UPKs is PAR60 (same as NPL) 146 out of 241. There is no provision for Loan Remedial Teams in PNPM Urban but there is a ban on the provision of BLM for UPKs where NPL exceeds 10%.

3.4.4 Facilitation

The empowerment/economic facilitator assigned to work at UPK RLFs is responsible for advising rural RLF or urban UPK staff and governance (BKAD/BKM and others) on the effective functioning of the unit. The information in Table 3.4.3shows that, in the assessment of M‐CRIL, there is nearly as much need to train the facilitators as there is to improve the capacity of UPK staff. The capacity and technical skills of facilitators, at a large number of UPK RLFs – both urban and rural – need attention. The facilitators also have the guidance of the district facilitator (Faskab), for rural/assistant coordinator (Askot), for urban, who can be expected to have a higher level of knowledge and understanding of the programme. To that extent the facilitators are under some supervision and able to pass on advice and guidance from people who are better informed about the requirements of the programme. However, as the table indicates, M‐CRIL found there is a need for additional training of the facilitators. This is discussed in detail in Section 3.4.6 There is one empowerment facilitator per rural UPK RLF and that person is available at the office on a daily basis. In urban UPKs it is one economic facilitator for every 9 UPKs. The Faskab/Askot visits an urban UPK about once in two months. 3.4.5 Issues of programme structure The efficacy of facilitation has been greatly reduced by the structure of the facilitation mechanism. The lack of administrative control of the technical teams (NMC/RMC) over their employment causes significant problems in the functioning of the programme. UPK RLF facilitators and their district level supervisors, district facilitator (Faskab, rural) and district coordinator (Korkot, Askot, urban) are employed by the provincial administration (Satker). Their technical support, advice and instructions come from the NMC via RMC. Before this year, coordination between NMC and RMC also could not function properly. This is because NMC was under one private company, and then RMC was under a different private company. The employees of RMC signed their contracts with their own respective


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companies. It was very difficult for NMC to manage and supervise the RMC since complete jurisdiction of the RMC employees were with their own respective companies. To draw an analogy, each RMC was like a kingdom on its own. And some RMC companies were said just to be interested in the profit (using billing rates) without proper concern for the success of the programme. Starting this year this arrangement has been changed. The companies that now run RMC and Province only act as ‘salary payers’ of the employees. The employees of RMC and Province now sign their contracts with the Satker in Jakarta (Direktorat Jendral PMD, Departmen Dalam Negri). So NMC now has control over the employees of RMC and Province. And NMC approval is needed for the recruitment of RMC and Province employees, so that quality can be ensured. Even for the UPK and district facilitators now NMC/RMC approval is needed for recruitment. Feedback from the field, however, suggests that neither NMC nor RMC have functioned satisfactorily and it is apparent that the whole system needs to be sorted out and clear chains of administrative control. NMC and RMC for PNPM Urban do not have a chain of command issue like PNPM Rural. Chain of command from NMC level to UPK facilitator level is relatively clear. But NMC Urban is reported, to often have difficulties in getting cooperation from the Local Government (Governor & Bupati) compared to PNPM Rural since PNPM Rural is under the Ministry of Interior which is considered to have more power with local government than the Ministry of Public Works which runs PNPM Urban. 3.4.6 Training of facilitators and UPK RLF staff In the rural UPK RLFs, District Facilitators train each UPK empowerment facilitator formally once or twice a year and also hold monthly coordination meetings when topics of interest and concern are discussed and explained; this is regarded by the system as another form of training. Training is conducted at district level – each facilitator gets basic, intermediate, advanced plus special training (on accounts, financial management, delinquency management). These are 2‐3 day trainings to enable them to train rural RLF staff in turn.

• Training for UPK RLF staff and community volunteers of UPK (BKAD, TV, BP‐UPK). Emphasis is on their role and functions

o Frequency: as needed o Trainer: Province or Faskab

• Refresher courses. Materials to be covered are discussed in a coordination meeting with RMC and Province. Training coverage depends on the needs of the area

o Frequency: once a year (starting this year it is planned to be twice a year) o Trainer: Province or Faskab

• On the job training/in service training: Conducted during Coordination Meetings. Training coverage: as needed by each area.

o Frequency: Twice a month for UPK facilitators at district level and once a month for Faskab at the provincial level.

All trainings are conducted in the classical (classroom style) or are hands‐on at the UPK directly.


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A facilitator’s/Faskab’s training begins with Pre‐Duty training: This is an introduction to PNPM training for new facilitators. Training covers matters such as introduction of PNPM, PTO, PNPM operations. In recent years this training was of 11 days’ duration. Starting this year the initial training will be delivered for 11 days and then after the facilitator has been in the job for 3 months, he/she will be required to take another 10 days of training. It is considered to be more effective since the new facilitator will then have a pretty good picture of the PNPM programme in practice rather than delivering all 21 days at the start. Since 2010 the empowerment facilitator has received special audit training at the province level. The trainer is from the Province. This training is also attended by Bawasda (the regional government auditor).

Issues in Training for rural UPK RLFs • Before this year, training at the national level was managed by a separate company

called TDC (Training Development Consultant) – different from the NMC. The idea was that the training material was developed by NMC but delivery was managed by TDC. This arrangement had problems since according the people at TDC apparently lacked technical knowledge of the PNPM programme and its regulations. Starting this year, the TDC has been discontinued and training delivery is also now with NMC.

• The Quality of Trainers in the province and Kabupaten also now needs improvement. Even when the training module is good enough if the trainer is not sufficiently good, the training will not be very effective. Training need assessment skills also need to be improved especially since each province/area could have different training needs

The urban UPK economic facilitators’ training has a comprehensive curriculum including

• Basic Training: This is an introduction of PNPM for a new facilitator. Training covers matters such introduction of PNPM, SoP, PNPM Loan Cycles

o Frequency: once o Trainer: Askot or Korkot (must be a certified trainer) o Method: Classical (classroom style)

• Bookkeeping Training: This is a bookkeeping training for the Economic Facilitator.

First year training covers basic/standard items in bookkeeping. The subsequent year training is more in‐depth. Topics in subsequent years are according to need depending on the weakness observed in the programme by Korkots/RMC

o Frequency: once a year o Trainer: Askot Financial Management

• RLF Training: This training is for the Economic Facilitator. It covers the mechanism of RLF in the programme. First year training covers basic/standard items. Subsequent year trainings are more in‐depth. Topics for subsequent year are according to need. Delinquency management is also covered in Year 2 and later trainings

o Frequency: once a year; trainer Askot Financial Management

The Economic Facilitators, in turn, are supposed to deliver training to UPK RLF staff with the support of the Financial Management Askot. This includes


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• Basic Training for UPK staff: Managers, Cashiers, Bookkeepers, Collectors. This training covers bookkeeping and RLF operations

o Frequency: once a year • Strengthening Training for UPK staff. This training covers the same topics as basic

training but it is more in‐depth. Topics are based on need. o Frequency: once a year

• Bookkeeping and Supervision Training for BP‐UPK. This training covers bookkeeping and supervision/internal control. First year training covers basic aspects and subsequent year training is more in‐depth based on need.

o Frequency: once a year

Personal Coaching/on the job training is supposed to be by the Economic Facilitator to UPK staff based on need (especially in the bookkeeping area). Training modules are developed by NMC and adapted by RMC (and sometimes by district facilitators/coordinators). The modules are heavy on detail and are delivered mainly as lectures, with a limited number of exercises/case studies to engage the trainee. Issues in training identified by NMC and RMC include • Due to budget constraints, formal training can only be provided to the facilitators once a

year. The frequency of the training is not considered to be sufficient. • Due to the volunteer nature (or small remuneration) of the UPK staff, their commitment

is quite low. Usually the staff of the UPK prioritise their main occupations; this makes the training less effective.

• Due to low commitment from UPK staff, the facilitator usually has to prepare the UPK financial reports on his/her own rendering the process of learning by the UPK staff ineffective.

As a result,

... absorption of information and skills in these programmes for training facilitators and staff is clearly sub‐optimal and their ability to pass those skills on to UPK staff and BKAD/BKMs is quite limited.

As Table 3.4.3 shows, UPK financial/economic facilitators at many sub‐districts/town wards need significant additional capacity building in the areas of delinquency management and group management and supervision. An additional focus on internal control and guidance to the BP‐UPK would also be useful. The process of facilitation is somewhat weakened by the turnover of UPK facilitators in both types of RLF. Discussion with facilitators during the assessment and with RMC in the provinces covered shows that this can happen every 6‐24 months with an average estimated at 18 months. This is partly due to staff turnover11but, in many cases, is also deliberate to mitigate the possibility of vested interests developing. Either way, it also reduces the possibility of a particular facilitator making a meaningful contribution to the improvement of operations.

11 Facilitators tend to prefer permanent jobs with national, provincial or even local government. As a result there are significant, and unpredictable events of staff turnover when government recruitment takes place.


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3.5 Future directions 3.5.1 Institutional

The predominant reaction of BKAD/BKM members and UPK staff to questions about the future of the UPK in both rural and urban operations is one of surprise. Most have not thought about the possibility of having a say in the matter. Even when pressed, most have no views, but a few do have some understanding of the uncertain future of the programme and thoughts about what should be done. The alternatives put forward are essentially framed by their knowledge and understanding of community level financial institutions in Indonesia. Thus, • conversion to a cooperative similar to some of the competing government sponsored

institutions such as KUBE (kelompok usaha bersama – joint business group)12is the alternative generally suggested. This is a mainly casual response, since the question is asked about possible institutional alternatives. Essentially it is the one type of institution the community is familiar with. There is not much deep thought behind the suggestion. There is, however, some sense that a legal status would enable better tracking and recovery of overdues and, for this reason, the occasional thoughtful BKAD/BKM member suggests a village level bank;

• most have no opinion at all; they either see the UPK RLF/urban UPK activities as a subsidy or are more concerned about dealing with delinquency; the possibility of there being any different model in the future is not something they have thought about.

12 A programme of small loans for farmers, fishermen, small enterprises run by the Social Department of the national government.

Table 3.4.3 Need for capacity building of the facilitators

(number of UPKs)

Rural UPK RLFs High Medium Low Delinquency management 125 76 39 Group mgmt. & supervision 107 100 29 Internal control 110 79 46 Process & skill building 82 109 51 Role clarity 36 84 120 Total 460 448 285 % of total score 38.6% 37.6% 23.9% Urban UPKs Delinquency management 155 69 14 Group mgmt. & supervision 122 102 13 Internal control 90 108 41 Process & skill building 61 114 62 Role clarity 19 59 159 Total 447 452 289 % of total score 37.5% 37.9% 24.2%


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Overall, there is relatively little recognition that the UPKs are performing a useful function in the community. While the UPK teams would “like to continue to cater to the financial needs of the community” there is a degree of confusion about the logic of using government money to give small loans if these are not intended as grants. This creates a fundamental disconnect between the policymakers in Jakarta and the implementers in the field which needs to be resolved if the programme is to serve as an effective tool in the cause of financial inclusion. Clearly there is a need to bring greater institutionalisation to the entire programme at the community level; how to do this is addressed in the Action Plan suggested in the Executive Summary, Section S5 (above).

3.5.2 Financial – bank linkage

One of the strategic objectives in PNPM is launch the UPK RLFs as independent community financial institutions with loan fund support from the banking system (bank linkage). Alternatively, UPK RLFs could help their better borrowers get loans from commercial banks while the RLF continues to serve others with the government funds available to it. UPKs were asked whether they had any formal or informal agreements or relationships with banks or other financial institutions,the vast majority did not; no rural UPK RLF and just one urban UPK has successfully achieved any form of bank linkage.

A few – 7 rural UPK RLFs and 35 urban UPKs – have had some discussion with banks (planning stage in Table 3.5.1) but where there has been interaction, it has been still‐born on one of two grounds

1 The possibility of the RLFs borrowing from banks cannot proceed for lack of a legal status, on the one hand, and for lack of collateral, on the other. The demand for collateral is virtually the first such response of bankers to any such discussion.

2 The possibility of members graduating to borrowing from banks is unpalatable for the BKADs/BKMs because of the concern that they would then lose the only good borrowers they have and, therefore, portfolio quality would deteriorate even further. Only one urban UPK in Central Java has done this so far – for one KSM which has been linked to BRI because the UPK (Gondosuli in Kabupaten Magelang) felt it could no longer meet the borrower group’s needs.

Overall, as Table 3.5.1 above shows, bank linkage is not a priority for most UPKs and even where there has been some discussion, progress has been negligible.

Table 3.5.1Consideration of bank linkage by UPKs

Rural UPK RLFs

C Java Yogya‐karta

Sumatera Barat

NTT Total

Yes 0 0 0 0 0No 131 17 41 70 259Planning 2 0 2 3 7Urban UPKs Yes 1 0 0 0 1No 135 14 30 8 186Planning 25 4 3 3 35


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4 Conclusions and Recommendations 4.1 Operational performance& institutional capacity

As the discussion in this report has shown,

…one of the key findings of the M‐CRIL team is that while significant numbers of people have derived benefit from the programme there is some need for improving its performance at the community level. This includes putting greater emphasis on institutional performance, specifically to consideration of the manner in which the community governance structures (BP‐UPK, TV and BKAD) work…

Including,

• The manner of selection of members of such committees – too many are currently being appointed more on the basis of availability and willingness than on appropriateness to the task to be performed

• Improvement of the incentive system for such community “volunteers”. There are clear indications that the lack of any incentive places a natural limit on the amount of time and effort these voluntary members of governance structures are willing to put into the task. This could include payments based on criteria like meetings attended, time spent, number of applications processed, visits undertaken and so on. Some creative thinking will be required for this purpose. Better functioning will enable the UPK RLFs to generate the additional revenues necessary to cover such payments and could even enhance the (relatively small) surpluses being generated so far. It is a “chicken and egg” situation, if no incentives are paid, the RLFs will continue to function indifferently (if not badly), and will fail to generate the surpluses necessary to pay incentives. The bad portfolio quality in some UPKs will also absorb any funds available into the loan loss reserves (required for prudential purposes). As the discussion above shows (Section 3.2.2), liquidity (and the availability of funds this implies) is not a major concern, whereas profitability certainly is.

• Equally important, the building of the skills of the members selected – through the training envisaged in the capacity building component of the programme and through exposure visits to “best practice” UPK RLFs and to well functioning MFIs, if feasible.

• Even after the proposed capacity building programme is over, ongoing hand‐holding support will be required for the community governance committees. It should be undertaken by trainers/teams who are fully informed about the practical issues in the functioning of such a programme. This should ideally be the role of facilitators but, in the present system, while there are a few good facilitators, overall their knowledge and experience is quite limited. Facilitation at the UPK level is moderate and needs some strengthening to enable it to perform this role as well as necessary.

Facilitation: The high turnover of empowerment facilitators in both the rural and urban programmes needs to be addressed since it reduces their effectiveness in guiding the UPK. By the time facilitators have become familiar with the functioning of the UPK they have been transferred, usually 12‐24 months after taking over responsibility for facilitating a


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particular unit. The support of RMC and ultimately NMC is important but there seem to have been issues in the functioning of these teams (discussed in Section 3.4.5). The accountability of facilitators is also an issue; their remuneration is linked to performance to the limited extent of 10‐15% which does not make an adequate difference. They need to be more action oriented than at present. As discussed along with Table 3.4.3 above, the capacity building of facilitators will make an important contribution to the programme as it is presently constituted. The areas that need to be addressed most urgently are

• Delinquency management • Internal control • Group management & supervision • Skill building

Since the facilitators’ role is to guide the staff and community institutional structures, an understanding of the best ways of building skills is important, so that they can pass on their existing as well as their newly acquired skill base (resulting from the capacity building programme) to the staff and community. For this purpose, it would be useful if all facilitators received a specially designed training of trainers programme – so that they can both conduct some formal training (if necessary) at the UPK level but, more importantly, so that they can learn to communicate their skills in a straight‐forward, uncomplicated manner. All future training efforts need to focus on exercises and case studies, and not on lectures that have been the norm until now. It is only in this way that skill retention can be enhanced. Further, trainings need to be supported by a regular programme of on the job support through field visits by Faskabs/Askots that focus as much on skill development as on monitoring. The three modules on delinquency management, internal control and group management are easily devised from existing modules in the microfinance field though these will certainly need to be modified for the purpose of the UPK RLF programme– particularly to maximize experiential training techniques incorporated in the modules. Overall, there is a need for greater emphasis on group formation as well as management & supervision issues at all levels of the programme as this will help to improve portfolio quality. All of staff, BKAD/BKM members, BP‐UPK and TV need this type of orientation and it is a key feature requiring attention in the programme. The support of some of the good UPK RLFs and urban UPKs, where the governance structures are particularly active, in ensuring the effectiveness of the programme will be crucial for this purpose. This could take the form of field visits by staff and community leaders from not so good UPK RLFs to observe the functioning of good ones – rural and urban – and by the participation of key staff/community volunteers from the good RLFs as resource persons in training programmes. Experiencing the operations of leading institutions and the leaders of such institutions communicating the operating practices and results of their operations can have an important transformative impact on “laggards”.


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Finally, the voluntary aura about the part‐time staff in the urban programme also needs to be addressed. This could be done by fixing specific working hours and a rate per hour rather than the present variable system with flexi‐time working. 4.2 Financial performance It is clear from the discussion in this report that there are significant shortcomings in many UPKs in the management of their finances. Emerging from the discussion from the previous section, the key areas in which capacity building and training is required at various levels are summarized in Table 4.1 below. These include improving understanding of portfolio quality measures, and undertaking loan loss provisioning according to international practice, so that an accurate loan loss reserve is maintained.

Table 4.1

Key capacity building areas for improving financial performance

Functional area Staff BKAD/BKM BP‐UPK TV• Delinquency management • Tracking of

overdues/understanding portfolio quality measures

• Undertaking loan loss provisioning & creation of reserves

• Loan appraisal & approval • Accounting • Cash & financial planning • Internal controls • Group management Again, training in most of these areas can be adapted to the needs of the programme from international training modules on microfinance (which, in turn, are based on experiential adult training methodologies and not on the lecture mode). Training can be combined with exposure visits to best practice UPKs in order to see the systems and skills in practical use in order to reinforce the impact of the learning experience. 4.3 Data issues 4.3.1 Accounting system – better practice needs to be ensured Not all the shortcomings in the accounting for delinquency are attributable to a lack of skills. Some changes to the PTO are also required to ensure that UPK accounting follows international best practice. The most urgent measures required are

1 The correct calculation of the loan loss provision as an expense on the UPK income statement and the calculation of profits after this expense needs to be included


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2 The transfer of the provision to the balance sheet as a loan loss reserve and crucially additions to the reserve of all subsequent provisions made in the income statement. Thus, the total amount of the reserve should cover the expected losses on delinquent loans. Provisions should only be made in the income statement if the reserve requirement exceeds the existing reserve on the accounting date (usually 31 December of each year). Thus, if portfolio quality has improved in a given year there may be no need to make a provision at all. This is not being done at present. Once there is a reserve it will be possible to write‐off NPLs,13 say, some nine months after loans are classified as such. To obtain a good picture of the financial status of the RLF (rural or urban), this should be done.

3 Collection of and accounting for long pending overdue loan payments: Collected amounts should always be allocated to the interest portion of overdue loan payments first and any remaining amount should be allocated to principal. The current practice is almost random and many RLFs allocate funds to principal first which entails a loss of income to the institution.

4 As an additional measure, in order to fully subject the UPKs to financial discipline and to prepare them for graduating to independent institutions, the Government should charge notional interest on the grant support provided to them (as though the money had been borrowed from a bank) and place the interest in a financial expense reserve on the UPK RLF balance sheet.

A significant effort is required at both staff and BKAD/BKM level to encourage members to take a stronger interest in the collection of overdue payments. An intensified focus on group management recommended above in Section 5.1 is essential both for the purpose of improving portfolio quality as much as for recovering old overdues. 4.3.2 MIS and data reliability/quality The training and capacity building in the area of internal control recommended above should automatically improve data reliability and quality once better, more focused, internal audit becomes the practice at the UPKs. However, the problem of the software also needs to be resolved. A new software could, of course, add features and help data integrity of the system but what the programme needs is not so much a sophisticated software as an overhaul of the present manual system fed into an MS Excel based report to ensure that 1 All information collected has direct utility to understanding and monitoring UPK

operations – this is not always the case in the present MIS 2 That links are set up correctly and that, once established, these links can only be

changed at the RMC (provincial) level and not at every UPK based on casual perceptions of the need to change the software in order to force it to produce results that match the, often incorrect, manual data input – links should be fully protected from tampering

3 All checking of monitoring reports and balance sheets should be recorded and corrections should be fully communicated to the UPK concerned; the UPK should be

13 NPL = non‐performing loan – otherwise understood as unrecoverable loan – defined in rural UPK RLFs as overdue more than 6 months and in urban UPKs as overdue more than 3 months.


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required to make those corrections within one week and re‐communicate the corrected information up the facilitation chain.

4 After the monthly UPK report has been checked and sent, the system should either not allow changes at the UPK level or should require a record of when, by whom and why the change was made. A more sophisticated MIS with more sophisticated security features than that presently employed may be required for this purpose.

The MIS should also enable the maintenance of individual loan records at the UPK. The SOP and/or guidelines will need to be amended to ensure that these individual records are maintained by all UPKs. This will have an impact, improving the monitoring of loans and follow up of overdues and will also enhance the sense of responsibility of the UPK staff. 4.4 Future directions

As discussed in the Executive Summary and Action Plan UPK RLFs can be classified as follows Rural UPK RLFs • Leaders: There are 18 rural UPK RLFs (17 in Java and one in Sumatra Barat) out of the

267 assessed that were found to be good enough for PNPM Rural to register immediately as independent community finance institutions following Indonesian tradition.

• Progressives: As Table 4.4.1 shows there are 57other such RLFs that have been graded “good” (with at least three b+ grades). These will require a little more handholding for

Table 4.4.1UPK RLFs classified by performance

b+ or above in “x” categories…

C Java/Yogya

DIY West Sumatra

NTT Total Performance

Rural UPK RLFs Number of UPKs All a‐ 14 3 1 18 Very good All 3 categories (b+ or above) 42 4 11 57 Good 2 categories (b+ or above) 29 3 7 39 Reasonable 1 category (b+ or above) 21 2 5 3 31 Moderate None (b+ or above) 27 5 18 69 119 Weak 133 17 42 72 264

Too new to be graded 1 2 3 Total 133 17 43 74 267

Urban UPKs Two a‐+ one b+ 4 2 6 Very good All 3 categories (b+ or above) 12 1 2 15 Good 2 categories (b+ or above) 6 1 7 14 Reasonable 1 category (b+ or above) 26 3 2 31 Moderate None (b+ or above) 106 10 10 9 125 Weak 144 17 21 9 191

Not graded 35 12 2 50 Total 179 18 33 11 241


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the purpose of working with banks to raise financial resources and for improving their governance and management – perhaps for around 6 months – to enable them to function as independent institutions.

• Possibles 1 & 2: The 39 reasonable and 31 moderate performers (in the table) can be continued for two years with government support (as at present) and intensive hand‐holding by facilitators (or with additional expert capacity building support)to enable them to evolve into community finance institutions. Since the responses of staff and community leaders at each UPK RLF to capacity building cannot be predicted, the intensity of this support will need to be determined. However, in order to limit the resource requirements for such a programme it cannot be tailored individually for each UPK RLF; it will need to be worked out across the programme with a process of “trial and error” to establish the right level of intensity.

• Laggards: The 119 rural UPK RLFs below that level would need very substantial capacity building support to try to get them up to an acceptable level. Ideally, these should be considered for shutting down, with the UPK RLF funds redistributed to other forms of community benefit.

Urban UPKs

• Leaders: There are 6 urban UPKs (all in Java) out of the 241 assessed that were found to be good enough for PNPM Urban to seek to register them as independent community finance institutions following Indonesian tradition.

• Progressives: As the above table shows there are 15 other such UPKs that have even been graded “good” (with at least three b+ grades). The latter will require a little more capacity building before they can function as independent institutions. The intensity of capacity building needed for various functions and staff/governance positions are specified in the individual UPK assessment reports.

• Possibles 1 & 2: The 14 reasonable and 31 moderate performers (in the table) amongst

urban UPKs can be continued for two years with government support and intensive hand‐holding by facilitators (or with additional expert capacity building support) to enable them to graduate into community finance institutions.

• Laggards: The 125 urban UPKs below that level need very substantial capacity building support to try to get them up to an acceptable level of financial performance. Ideally, these could be considered for shutting down, with the UPK funds redistributed to other forms of community benefit. This shut down would go beyond the suspension already implemented by urban PNPM.

Linkage (graduation of good borrowers to commercial banks) • On the issue of the graduation of some borrowers to commercial banks: There is

clearly a need to encourage UPKs to allow borrowers who establish their credit‐worthiness with the UPK (and need larger loans) to graduate to borrowing from commercial banks. Some UPKs’ concern that losing their best borrowers to banks would


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result in a deterioration of their overall performance needs to be addressed. One way of doing this could be to add an incentive amount to the amount of BLM available for UPK RLFs that are able to graduate their borrowers to banks: thus, the normal BLM could be increased by the amount graduating borrowers are able to obtain as loans from banks. The idea is that the more such borrowers get from banks, the more funds the UPK will have available to it to lend to other borrowers who are in need. [Though such an arrangement could generate its own set of malpractices and stimulate attempts at institutional fraud, so it would need to be monitored appropriately].

• There is supposed to be a limit of four lending cycles to each borrower in the urban programme but there are very few who have reached this level so far and the limit is, in any case, easily circumvented by lending to other members of the family.

Bank Linkage: The issue is linking UPK RLFs to commercial banks so that the latter provide the on‐lending funds needed by the former. The problem until now is that most UPKs are are simply not engaged with the possibility. This is partly because bankers are not willing to discuss it with them in the absence of institutionalization (registration as a legally recognized entity) and in the absence of collateral. These two issues will need to be addressed – the only real possibility is to persuade the banks to lend with collateral substitutes such as

• hypothecation of loans to individual borrowers – though this is not real collateral, since

banks will never be able to collect from individual borrowers should the MFI default; • personal guarantees or hypothecation of personal property of the promoters or Board

(of MFIs) – but this is not practical with UPK RLFs since it means that BKM or BKAD members’ personal property would need to be collateralized. BKM/BKAD members are highly unlikely to agree to this.

• Retention of 10% of the loan amount to the RLF as collateral – but this merely reduces the loan amount available to the RLF for its lending activities.

[Banks in India have used one or more of these collateral substitutes for their lending to MFIs]. 5 Best practices and critical issues RLF Best practices

• Monthly coordination meeting /BKAD meeting – good minutes lead to greater seriousness in the implementation of decisions rather than with informal meetings and no records

• Preparation of loan demand sheets + implementation of a monthly penalty for overdue loan payments leads to more systematic collection of loans and also greater discipline amongst borrowers

• Loan collection is more effective when UPK RLF staff undertake loan collection and, partly as a result, undertake frequent visits to groups

• Insuring borrowers’ lives with Bumiputra Insurance (amongst others) could be an additional service provided by UPKs to their borrowers – in the short run this could


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be a more beneficial service than the effort to create bank linkages in a situation where the UPKs are seen as weak institutions

• Some UPKsin Java have only heads of villages as members of the BKAD, resulting in more effective operations since they tend to have a more systemic concern for the viability of the institution.

• UPKs could also serve a very useful community purpose if special programmes were routed through them. A few urban UPKs in Java – just 3 out of 197 – have created such links with companies that have established production or service units in their operational areas, using CSR contributions from the companies to bring greater benefit to the local community in the form of education grants or health camps. This example could be followed by both rural and urban UPKs.

Conflicts of interest and fraud/misappropriation

• There are some cases of alleged group and staff fraud amongst UPK RLFs. There are also cases of BKAD/BKM and other influential community representatives taking loans from the RLF; this naturally creates conflicts of interest both in loan appraisal and in the follow up and collection of overdue loan payments. Safeguards should be put in place to prevent those holding UPK positions from deriving direct benefit from its operations.

• The number of alleged misappropriation cases discovered by the assessment team covers 82 of the 267 rural UPK RLFs assessed and 116 of the 241 urban UPKs assessed. Such cases include loan collections by the group leader not deposited with the UPK, cases of fraud/misappropriation by staff and BKAD/BKM or BP members and suspected cases of UPKs where ghost loans were provided in order to collect money fraudulently. This number may be under‐reported as the community tends to settle most such cases informally preferring not to turn them into formal issues. In West Sumatra, the matter is addressed with much stronger measures in some UPKs where the amount of the fraud has been larger; police cases have been registered and pursued there. In other provinces even some quite serious cases have been taken relatively mildly. It may be a good idea to add financial penalties where informal settlement has taken place; this could become a condition for avoiding legal action.


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Annex 1

M‐CRIL’s rating grades

Rating grade Description

a+ Very good performance; a few improvements possible

a Good performance; some room for improvement

a‐ Good performance; significant room for improvement

b+ Moderate performance; significant potential

b Marginal performance; just acceptable

b‐ Marginal, not quite acceptable

c+ Poor performance with some potential for improvement

c Very poor performance


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Annex 2 Checklist for rural UPK RLF and urban UPK assessments in Indonesia

1. General • History of the UPK – when was it formed? • Now how many groups/ borrowers does it have? • How much portfolio? • (Take a quick look at balance sheet, kolektibilitas and ratios/ classification) and get

an idea of performance • Request data 36 months portfolio and cash balances, and balance sheets for 08, 09,

and latest month end report

2. Human resource quality & management First identify the UPK staff and then the facilitators – try to talk to each separately to cross check.

• Method of recruitment ‐ How were they appointed? • Since when have they been working in these positions? • Qualifications of staff – experience, training, educational background

• What are their responsibilities (Ketua, Bendahara, other staff) • Understanding of their roles and operational policies • Test of capacities

• Ability to appraise loan applications • Remuneration and incentives

• Turnover (have any of them left in the recent past, and why?) • Working conditions – temporary/permanent, working hours • Performance appraisal of the staff of UPK – done by whom?

• Trainings undergone • Usefulness of the trainings • Challenges faced • Any legal form which they think is appropriate for UPKs?

3. Facilitation mechanism

• Who is the facilitator? • Since when has facilitator been there • Qualifications, knowledge, experience

• Role of the facilitator – skill transfer, management support, conflict resolution • Interaction with the governance structure • Transfer of skills and knowledge to UPK staff • Salary and incentives earned


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• From which consultant company/ government program does the facilitator’s salary and other remuneration get paid?

• To whom does the facilitator report? What frequency? What reports are prepared?

• Internal auditing role? • Report of internal audit, scope and coverage at client level • Key findings of audit

4. Products and Processes

• What is the process of group formation? • Is there any minimum time that the groups should have been already functioning

together? • Are the groups from PKK, prayer groups, trade associations? Or new groups formed

for PNPM

• What is the process for group verification? • Who sanctions loans (different slabs) • Who decides the proportion of infrastructure and microfinance loans?

• Loan disbursement procedure • Loan disbursement frequency (seasonality) • Collection procedure

• Are prepayments allowed? • Is there any penalty for late payment? • How many groups have savings at an internal level? Are savings showing in the books

of the UPK?

5. BKAD/BKM – Executive Committee of the UPK

• How many members? • How and when were they elected?

Product features Main loan product

Any other products

_____________

____________

Loan amount (min‐max) Security deposit (kept with whom?)

Interest rate to UPK Interest remaining at group level

Loan tenure

Repayment frequency Collateral Grace period?


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• What MAIN job do they do (other than PNPM honorary work)

• What qualification? Verify abilities using documents • What responsibilities? • What minutes of discussions are maintained?

• What about monetary incentives? • Do any of them have a loan from the UPK? (Check for family members also by asking

roundabout questions) • Is there a problem loan sub‐committee in the BKAD/BKM, which tracks overdue

loans? If yes, what is their strategy?

• How much time is spent by BKAD/BKM members per month on UPK activities? • What are the main challenges faced by the UPK? • Do they feel that the UPK should follow any legal form? If yes, then what form?

6. BP‐UPK – supervisory body for UPK

• How and when were they elected? What MAIN job do they do (other than PNPM

honorary work?) • Why were they elected? • What qualification? Verify abilities using documents • What minutes of discussions are maintained? • What are their supervisory responsibilities? • What reports do they analyse when they visit the UPK? • What kinds of weaknesses have they discovered in the UPK? What measures have

they taken to solve these? What is the level of compliance from UPK staff? • What reports do they write, to record their observations?

• How many times have they visited the UPK in the last year? • How much time per month do they spend with the UPK?

• Do any of them have a loan from the UPK? (Check for family members also – tough!) • What about monetary incentives?

• What are the main challenges faced by the UPK? • Do they feel that the UPK should follow any legal form? If yes, then what form?

7. Management Information System

• Who makes the MIS and accounting reports? • How is this data gathered and entered? • Reporting system and flow: Which reports are produced, frequency

• Quality of data and how regularly are reports completed • Flow of data to provincial PNPM coordinator or to facilitator`


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• Data security, reliability (corrections required) • Check for matching of records of UPK and submitted to district • Also for matching of manual and excel

8. Accounting

• All income and expenses are recognised on an accrual basis or cash basis? • Is the interest income is recognised in the income statement as it accrues?

• Depreciation is calculated on what method? • Provisioning and loan write‐off – issues and method of calculation, corresponding

entries in income statement and balance sheet

• Classification of loans according to PAR brackets? • Separate treatment of microfinance balance sheet? • Any training in these aspects for UPK members? If so, what? How useful?

• Check accounts for matching of records with client level data

9. Tracking system for overdues/NPLs

• What is the action taken if the group leader does not come to repay? • How is follow up done? • What are the most common reasons for overdues?

• Do the BKAD/BKM members follow up? • What is the strategy for getting back payment?

• Recovery of overdues over the past one year • Write off –extent and reasons • Overdue report and subsequent follow up • System for loan restructuring and rescheduling • Number of rescheduled loans

10. Internal audit and control systems (conducted by facilitator sometimes)

• Performance of BP‐UPK, reports • Effectiveness of BKAD/BKM in ensuring compliance • Any help from Facilitator for audit functions? • Loan use monitoring and reporting of this • Monitoring system by district and provincial officials • Cases reported – scope, coverage, implementation

11. Planning and Fund mobilisation

• Quality of plans prepared by UPK staff, • Business planning, use of funds, variances


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• Fund shortages and prioritisation?

• Receipt of block grants – when, how much, conditions (rating level, performance of UPK), from whom (central govt, local govt (kabupaten), donation from the community) – reasons for variation in amount received

• What grants are expected in the future? • If grants are over is there any de‐motivation sensed because of this? • Have there been any periods of liquidity crunch? Any borrowers still waiting for loans

because of fund crunch?

• Accounting of RLF vs grant funds received • Check seasonality of disbursement and effectiveness of planning for this • Check high or low cash levels

12. Operating efficiency

• Operating efficiency low or high? What factors behind this? • Expenses allocated between RLF and infrastructure – allocation done how? • How are the block funds received and distributed

13. Member groups

Look out for already formed groups (formed under previous programs, vendors associations, women’s prayer groups)...these are being targeted as easy groups to lend to since they have social cohesion

• Types of groups – women’s groups, mixed groups • New, developing, mature groups

• Savings/loan, joint business, diversified business with poor households • Classification or ranking of groups • Quality and functioning of these different types of groups

• How many clients in the group? What profile? • How much loan size? Loan purpose? • Who checked the group / inspected members for credit assessment? • Was this done in a group or individually at the household?

• Did anyone from UPK, BP‐UPK, BKAD/BKM ever come to see the group members,

check records, etc? • Did any facilitator visit them from UPK or Kabupaten office? • How long was the loan turnaround time?

• Relatives of powerful people? How did the group form? How long have they been

borrowing? • Group leader – how elected, when and why? What incentive does she get?

• Loan terms and conditions? Check awareness.


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• Kind of documentation at group level – accuracy of the same, matching with records in monthly report?

• Check for group constitution and internal agreement

• What are the terms and conditions regarding sharing of interest rebate (shared by leader or distributed as dividend, or kept as group fund in separate bank account?

• Is the group fund collected at the beginning of the loan or at the end?

14. Fixed assets

• Operational assets of the UPK – furniture, computers /office equipment, vehicles • Are infrastructure, community or government assets appearing in the books?

15. Credit performance and portfolio quality

• PAR according to different brackets (to calculate) • Whether LLP reflects in income statements or not

16. Asset, liability and equity composition • Deployment of available funds in loan portfolio • Proportion of funds from deposits (if any) • Retained earnings as % of total funds

17. Profitability and sustainability • Yield relative to OER and loan provisioning ratio • (Yield relative to APR) • RoA, Return on equity

18. Future plans • Biggest strengths, biggest challenges, legal structure.

Kol

Period (months) for rural UPK RLFs

Principal loan o/s for past due loans

PAR, %

I Current II <1‐2 months III 3‐4 IV 5‐6 V >6 Total Kol

Period (months) for Urban UPKs

Principal loan o/s for past due loans

PAR, %

I Current II <up to 3 months III 4‐6 IV 7‐9 V >9 months Total


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Annex 3 Summary of the MIS and reporting system at UPK RLFs

Rural UPK RLFs The operational and financial data is maintained by UPK RLFs both manually as well as in MS Excel. The Facilitator placed with an UPK, updates the data in the excel sheets from the primary manual books and/or MS Excel file maintained by the UPK staff (depending on which is more reliable). From these UPK RLF excel sheets, the district Facilitator enters the data in a system designed in MS Access software or MS Excel. The Excel at the UPK RLF has the following sheets:

a) UEP information – this provides basic operational information for each village (desa) for UEP. Some also maintain it group wise. This includes the total number of groups, disbursements, repayments (principal and interest), overdues and outstanding portfolio.

b) SPP information – similar to the above sheet, this sheet provides information about the women’s programme (SPP) loans.

c) UEP collectability – this sheet provides village wise breakup of the UEP portfolio in Kol‐1 to Kol‐5. Some also maintain it group wise. It also provides the details of loan loss provisioning.

d) SPP collectability – this sheet is similar to the above sheet with a break‐up of SPP loans.

e) Balance sheet for the UPK (all programs). Portfolio details are linked to the UEP and SPP sheets described above.

f) Income and expense statement (or Profit & Loss statement) for the whole UPK. Interest income is linked to sheets for UEP and SPP

g) Microfinance balance sheet for the program of the UPK. Portfolio details are linked to sheets UEP and SPP

h) Income and expense statement for the microfinance program of UPK. Interest income is linked to sheets UEP and SPP

i) Cash flow statement of UPK In addition, while in a majority of sub‐districts a manual one page qualitative check list is used to indicate the health of the UPK, in some areas an MS Access format is used which incorporates scores on various parameters describing the health of the UPK. The broad parameters are:

1. Kapasitas Pengurus, UPK – Capacity of UPK Manager 2. Operasional UPK – Quality of UPK operations 3. Pengelolaan – Quality of management 4. Aturanperguliran – Quality of microfinance policies 5. MAD/BKAD – Capacity of UPK governing bodies 6. BP‐UPK – capacity of internal auditor and quality of internal audit functions 7. Verification Team – Capacity and performance of loan verification team 8. Compliance with the bye‐laws / charter 9. Profitability ratios 10. Fund management, risk management and fund allocation 11. Net output ratios (capital growth, rate of return, portfolio quality,


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Urban UPKs The operational and financial data is maintained by UPKs either manually or in MS Excel. The UPK facilitator uses the UPK data to fill the excel template provided by the RMC. The excel template provided by the RMC; this template has the following sheets which are uploaded on the website

a) Coverage: detailing the UPK’s location and area coverage b) Revolving Fund: The basic data entry sheet that contains operational as well as

financial information c) Balance Sheet, linked to the revolving fund sheet. d) Profit loss/income statement, linked to revolving fund sheet. e) Form PK‐UPK (Performance measurement instrument – UPK), this sheet has

qualitative indicators grouped under three broad heads namely 1) SOP related (2 indicators), 2) Accounting system (6 indicators), and 3) Reporting (1 indicator). The indicators are scored in a binary fashion, either 1 or 0. Other than that, there are six quantitative indicators (Recovery Rate, NPL, Loans at Risk, Portfolio at Risk, Cost Coverage Ratio and Investment Ratio). Each indicator also has a comment column.

f) Form PK‐Sekretariat (Performance measurement instrument – Secretariat), this sheet has eleven qualitative aspects related to the functioning of the BKM like: bank account being maintained in the name of UPK and not in personal name, transactions recorded on the same day, and so on. It is also scored in a binary fashion, either 1 or 0. Each indicator also has a comment column.

consolidated assessment of upk revolving loan...

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