Financial Inclusion

Financial Inclusion in
Indonesia
Financial Inclusion in
Indonesia
July 2013
This publication was produced by DAI/Nathan Group for review by the United States Agency for
International Development (USAID). It is made possible by the support of the American people. Its contents
are the sole responsibility of the author or authors and do not necessarily reflect the views of USAID or the
United States government.
Acknowledgments
This study was prepared by the International Center for Applied Economics and Finance
(InterCAFE) at the Bogor Agricultural University for the office of the Deputy Minister for the
Economy of Bappenas. The authors of this study were Nunung Nuryartono, Parulian Hutagaol,
Sahara, Triana Anggraenie, Rima Rosita, Ade Holis, and Nuning K. The authors would like to
acknowledge the assistance of Made Sanjaya, Sigit Yusdianto, Deviyantini. Constructive feedback
and comments from Peter McCawley and Pungki Sumadi are gratefully acknowledged. The study
was funded by the United States Agency for International Development (USAID) through the
Support for Economic Analysis Development in Indonesia (SEADI) project.
Contents
v
Abbreviations
vii
Glossary
1. Overview
1.1 Study Background and Rationale
1.2 Study Objectives
1.3 Conceptual Policy Framework for Financial Inclusion System in Indonesia
2
12
2. Methodology
2.1 Research Stages
13
2.2 Data Collection Methods
14
2.3 Method of selection UPK for transformation
16
17
3. State of Financial Inclusion

3.1 International Practices in Financial Inclusion
17
3.2 Financial Inclusion in Indonesia
23
3.3 Gap between Current and Desired State of Financial Inclusion
29
31
4. PNPM UPK System

4.1 Background
Error! Bookmark not defined.
4.2 Evaluation of UPK Performance Based on National Data
33
4.3 Evaluation of UPK Performance in the Study Area
42
4.4 Opportunities and Constraints
53
4.5 Summary
5. Transforming Sustainable UPKs into Legal Microfinance Institutions
57
5.1 The Need
57
5.2 Conceptual Approach
57
5.3 Legal Business Form Options
58
5.4 Factors to Consider in Deciding Legal Structure
61
5.5 Operational Implications of Transformation
62
6. Pilot Project
6.1 Background
63
6.2 General Description of Project
65
6.3 Project Funding
69
6.4 Monitoring and Evaluation Plan
69
II
References
73
Appendix A. Maya Declaration on Financial Inclusion
Appendix B. System of PNPM
PNPM Rural
PNPM Urban
Appendix C. Literature Review of Microfinance Performance Indicators
Appendix D. Measuring Outreach
Appendix E. Measuring Financial Sustainability
Illustrations
Figures
Figure 1-1. Financial Inclusion Policy Frameworks

10
Figure 2-1. Important Results at the End of the Study
12
Figure 2-2. Stages of the Study
13
Figure 2-3. Numerical Breakdown of Household Survey Respondents
16
Figure 3-1. Percentages of Respondents by Average Monthly Income Classes
27
Figure 3-2. Respondents Knowledge and Use of Basic Financial Products
27
Figure 3-3. Respondents Knowledge and Ownership of Insurance
28
Figure 3-4. Use of Banking Products in General Based on Saving Account Ownership
29
Figure 4-1. Sustainability of Urban UPKs
38
Figure 4-2. Sustainability of Rural UPKs
38
Figure 4-3. Household Distribution by Profession
47
Figure 4-4. Household Distribution by Financial Manager
48
Figure 4-5. Distribution of Saving Account Ownership
49
Figure 4-6. Household Distribution by Financial Planning
49
Figure 4-7. Importance of Continuing Borrowing from UPKs
50
Figure 4-8. Reasons for Repayment
50
Figure 4-9. Strategies for Dealing with Repayment Problems
51
Figure 4-10. Nonmember Respondents Who Know about UPKsError! Bookmark not defined.
Figure 5-1. Minimalist and Integrated Approaches to Microfinance
58
Figure 6-1. Minimalist and Integrated Approaches to Microfinance
64
Figure 6-2. General Framework of the Study Support on Financial Inclusion
66
Tables
Table 1-1. Numbers, Capital, Assets, and Loan Portfolios of UPKs in 2012
Table 2-1. Key Issues in the Study
Table 2-2. Sample UPKs in the Selected Research Area
Table 3-1. BIs Activities to Implement Financial Inclusion in Indonesia
Table 4-1. Financial Sustainability Performance Indicators
Table 4-2. Financial Performance of Urban and Rural UPKs (percentage)
Table 4-3. Other Operational and Financial Indicators of Urban UPKs
Table 4-4. Other Operational and Financial Indicators of Rural UPKs
Table 4-5. Logistic Regression of Sustainability Model of UPK
Table 4-6. Financial Performance of Urban UPKs in the Selected Research Areas
11
14
15
24
35
40
40
40
41
43
III
Table 4-7. Other Financial and Operational Performances of Urban UPKs in the
Selected Research Areas
Table 4-8. Financial Performances of Rural UPKs in the Selected Research Areas
Table 4-9. Other Financial and Operational Performances of Rural UPKs in the
Selected Research Areas
Table 4-10. Financial Performance of Sample Urban UPKs in the Selected
Research Areas
Table 4-11. Other Financial and Operational Performance of Sample Urban UPKs in
the Selected Research Areas
Table 4-12. Financial Performances of Sample Rural UPKs in the Selected
Research Areas
Table 4-13. Other Financial and Operational Performances of Sample Rural UPKs in
the Selected Research Areas
Table 4-14. Regulations to Increase UPK Repayment Performance
Table 4-15. Training Materials Provided by Urban and Rural UPKs
Table 4-16. Causes of Loss of Quality in UPK Performance
Table 5-1. Percentage of UPKs That Do and Do Not Want to Become Legal
Microfinance Institutions
Table 6-1. Program Logic of Pilot Project Activity
Table 6-2. Number of UPKs in the Pilot Project Location
Table 6-3. Approaches and Tools for Monitoring / Measuring Output and Outcome
Evaluation
44
45
45
45
46
46
47
52
53
53
57
69
69
70
Abbreviations
ACA
AD/ART
ATM
Bappeda
Bappenas
BFI
BI
BKAD
BKM
BLM
BPD
BPR
BPUPK
BSP
BUMDes
CAMEL
CAR
CGAP
DAI
EDC
FGD
FINGOs
FSAC
GDP
GON
GTZ
HNB
IDR
IFI
IPTW
KSM
KUR
LKM
MAD
M-CRIL
MFDB
Asuransi Central Asia

Anggaran Dasar/Anggaran Rumah Tangga (Association bylaws)
Automatic teller machine
Badan Perencanaan Pembangunan Daerah (Regional Development
Planning Agency)
Badan Perencanaan Pembangunan Nasional (National Development
Planning Agency)
Banking finance institution
Bank Indonesia (Central Bank of Indonesia)
Badan Kerjasama Antar Desa (Inter-Village Coordination Body)
Badan Keswadayaan Masyarakat (Community Empowerment Body)
Bantuan Langsung Masyarakat (Direct Assistance for Communities)
Badan Permusyawaratan Desa (Village Consultative Agency)
Bank Perkreditan Rakyat (Community Credit Bank)
Badan Pengawas UPK (Supervisory Board for Activity Management
Unit)
Bangko Sentral ng Pilipinas
Badan Usaha Milik Desa (Village-owned Enterprises)
Capital, asset quality, management, earning, liquidity
Capital adequacy ratio
Certified government auditing professional
Development Alternatives, Inc.
Electronic data capture
Focus group discussion
Financial intermediary nongovernmental organizations
Financial sector adjustment credit
Gross domestic product
Government of Nepal
Agency for Technical Cooperation (Government of Germany)
Hatton National Bank
Indonesian Rupiah (Indonesian currency)
Index of Financial Inclusion
Insentif Pengembalian Tepat Waktu (Incentive for Timely Repayment)
Kelompok Swadaya Masyarakat (Community Self Help Group)
Kredit Usaha Rakyat (Peoples Business Credit)
Lembaga Keuangan Mikro (Micro Finance Institution)
Musyawarah Antar Desa (Inter-Village Discussion)
Micro-Credit Ratings International Limited
Microfinance development bank
VI
MFI
MIS
MSMEs
NBFI
NGO
NPA
NPL
PAD
PAMP
PJOK
PNPM
PT
PT. ASABRI
PT. ASKES
PT. JAMSOSTEK
PT. TASPEN
RFP
RLF
Rp
Rural UPK
SACCOs
SEWA
SHG
SME
SPP
UEP
UNDP
UPK
UPL
UPS
Urban UPK
FINANCIAL INCLUSION IN INDONESIA
Microfinance institution
Management information system
Micro, small and medium enterprises
Nonbanking finance institution
Nongovernmental organization
Nonperforming assets
Nonperforming loan
Pendapatan Asli Daerah (Local Revenue)
Alleviation Microfinance Projects
Penanggung Jawab Operasional Kegiatan (Responsible Person for
Operational Activities)
Program Nasional Pemberdayaan Masyarakat (National Community
Empowerment Program)
Perseroan Terbatas (Limited Company)
Limited Liability Company (Limited) of the Armed Forces Social
Insurance Republic of Indonesia
Limited Liability Company (Limited) Health Insurance Indonesia.
Limited Liability Company (Limited) Social Security Workers
Limited Liability Company (Limited) Savings and Insurance Fund
Servants
Request for proposals
Revolving loan fund
Rupiah (Indonesian currency)
Unit Pengelola Kegiatan (Activity Management Unit) in Rural PNPM
Savings and credit cooperatives
Self-Employed Womens Association
Self-help group
Small and medium enterprises
Simpan Pinjam Perempuan (Womens saving and loan program)
Usaha Ekonomi Produktif (Productive Economic Activities)
United Nations Development Program
Unit Pengelola Keuangan (Financial Management Unit)
Unit Pengelola Lingkungan (Environmental Management Unit)
Unit Pengelola Sosial (Social Management Unit)
Unit Pengelola Keuangan (Financial Management Unit) in Urban PNPM
Glossary
Average loan portfolio. This represents the average loan outstanding for the year computed on a
monthly basis.
Average total assets. This represents the average total assets for the year calculated on an annual
basis.
Badan Kerjasama Antar Desa (BKAD). A BKAD (inter village cooperative agency) coordinates
inter village activities. Numerous BKADs have been established at the local level in Indonesia.
Bank Perkreditan Rakyat (BPR). Rural banks dedicated to serving groups of micro, small, and
medium enterprises. Usually situated close to customers.
Camat. The head of a subdistrict (Kecamatan); a Camat is a civil servant who reports to the head
of a regency (Bupati) or a mayor (city).
Collectability. Aging categories for amounts overdue from borrowers.
Current cost recovery (CCR)/operational self-sustainability (OSR). Actual revenue earned
from operations as a proportion of total costs incurred in operations. For an organization to be
sustainable it should be greater than 1 (or >100%)
Earning asset. Loan portfolio/total assets.
Facilitator. A technical person who assists the community in the PNPM program.
Financial asset. Earning assets + liquidity.
Financial inclusion. The process of ensuring access to appropriate financial products and services
needed by vulnerable groups, such as weaker sector and low-income groups, at an affordable cost
in a fair and transparent manner by mainstream institutional players.
Financial institution. An establishment that focuses on dealing with financial transactions, such
as investments, loans, and deposits. Conventionally, financial institutions are organizations such as
banks, trusted companies, insurance companies, and investment dealers.
Financial viability. The ability of an MFI to cover costs with earned revenue.
Insurance. The equitable transfer of the risk of a loss from one entity to another in exchange for
payment. It is a form of risk management primarily used to hedge against the risk of a contingent,
uncertain loss.
VIII
Kabupaten/Kota. In Indonesia, the regency or district (kabupaten) and city (kota) have the same
administration level and their own local government and legislative body. The main difference
between lies in demography, size, and economic activities. Generally, a regency is a rural area
physically larger than a city. A city usually has nonagricultural economic activities. Regencies are
headed by a regent (bupati), while a city is headed by a mayor (walikota).
Kecamatan. In Indonesia, a kecamatan or subdistrict is a subdivision of a regency or city. A
subdistrict is in turn divided into kelurahan, or administrative villages.
Kelompok Swadaya Masyarakat (KSM). KSM is a citizens group of beneficiaries of
independent direct grants from the government and/or borrowers of revolving funds and/or
implementing activities that are intended to alleviate poverty.
Kelurahan/Desa. Though Desa and Kelurahan are part of a district, a Kelurahan has less power
than a Desa. A Kelurahan is headed by a "Lurah, a civil servant directly responsible to the head
of a subdistrict (Camat). A Kelurahan is part of a regency/city government bureaucracy, while
Desa is led by the "Head of Desa" (Kepala Desa), who is elected by popular vote.
Leverage. Assets/equity.
Liquidity. Cash in hand plus money in bank accounts as a proportion of total assets at the end of a
financial year/period (31 December). Average liquidity (for the year) = total of month-end cash
and 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 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 the 13
month-end figures for assets
Loan. Loans that are distributed from creditor to debtor.
Loan loss provisioning ratio (LLP). Total loan loss provisioning expense for the year divided by
the average portfolio.
Loan portfolio. This represents loans outstanding for the year computed on a monthly basis.
Market leverage. The gain that the MFI has achieved with the donations given.
Operating expense ratio (OER). Ratio of salaries, travel, administrative costs, and depreciation
expenses to the average loan portfolio.
Portfolio at risk (PAR). The 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. This ratio is often
stated by a 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.
(Portfolio at risk (PAR (>0day).
Program Nasional Pemberdayaan Masyarakat (PNPM). The PNPM (National Program for
Community Empowerment) is a framework for community-oriented poverty reduction and
programs of community based-need for systemic change. There are PNPM activities in urban and
rural areas.
GLOSSARY
IX
Return on assets (RoA). A measure of an organizations profitability relative to total funds

deployed in all activities (not just operations). In the financial sector, RoA is usually in the 1-3%
range.
Return on investment (RoI). Ratio of profit/net income to capital investment. Depending on how
capital investment is defined, this could be the same as RoA
Saving. The portion of disposable income not spent on consumption of consumer goods, but
accumulated or invested directly in capital equipment.
Sustainable (self-sustainable). In a financial context, a sustainable institution is one that is able to
generate sufficient revenue to cover operational expenses and 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).
Tanggung Renteng (joint liability). Where parties act together in a contract as partners they have
joint and several liability. In addition to all partners being responsible together, each is also liable
individually for the entire contract - so a creditor could recover a whole debt from any one of them
individually, leaving that person to recover their shares from the rest of the partners.
Total assets. This represents total assets for the year calculated on an annual basis.
Unit Pengelola Kegiatan (UPK). An UPK is a part of the PNPM Rural program. An UPK is a
management unit established by BKAD and legally certified by the inter-village meeting forum
(MAD). A UPK has two roles. It manages basic functions for revolving and technical management
programs and development, such as group coaching and handling troubled loans. It also manages
the funding of the Rural PNPM in a district (kecamatan).
Unit Pengelola Keuangan (UPK). This UPK is exists in PNPM urban areas. UPK is formed
under Badan Keswadayaan Masyarakat (BKM) in urban areas, and manages all funding of Urban
PNPM in the subdistrict (Kelurahan), not to manage the technical management program.
Yield on portfolio (YoP). Actual interest income on lending by the RLF divided by the average
loan portfolio for the year.
1. Overview
1.1 STUDY BACKGROUND AND RATIONALE
Indonesias financial sector is growing. Its commercial banks are liquid, solvent, and profitable,
and the economy has been doing quite well for the past decade. Indonesia is also home to various
forms of microfinance institutions (MFIs) that meet needs for loans, savings, and insurance. With
more than 94,000 MFIs, Indonesias microfinance sector is one of the largest in the world (Mercy
Corp 2011) and Indonesia has been a global leader in microfinance outreach and innovation for the
past 25 years. But some scholars, including Rosengard (2011), find that two paradoxes
characterize Indonesias financial sector:
About 50 percent of Indonesians still have only limited access to affordable formal financial
services, particularly in semi-urban and rural areas. Forty million low-income people still lack
access to financial services, and more than 70 percent live on less than $1 per day.
Small and medium enterprises (SMEs) still face a credit crunch, although commercial banks are
liquid, solvent, and profitable.
Many scholars have found that access to finance can help reduce urban and rural poverty, as the
poor use small loans to expand their businesses, which generates income to build up their asset
base. The financial sector, particularly MFIs, can do more to serve more low-income families and
SMEs, and thereby support the development of micro and small businesses in various sectors, such
as agriculture, trading, and small industries.
Haughton and Khandker (2009) determined that a key cause of poverty is capital inadequacy.
Therefore, one of the largest roles of access to finance in local economies is helping low-income
and poor families achieve financial stability. Access to finance gives people an opportunity to
generate enough income to pay for basic needs, build assets, protect against risks, invest in
income-generating projects, and finance enterprise development. Access to finance provides
stability and opportunities to families and businesses, and supports the economy as a whole.
Families and business need access to affordable, safe, secure, and reliable financial infrastructure,
the same way that they need access to physical infrastructure for transport, power, and
telecommunications. Giving these families the opportunity for long-term financial stability can
reduce the number of people on public assistance programs, which benefits local and national
economies. In providing better tools to manage such financial needs, financial inclusion supports
balanced and pro-poor economic growth, and helps alleviate poverty. Inclusive finance is
particularly important for disadvantaged groups: the poor, women, youth, and rural communities.
For these reasons, financial inclusion has gained prominence in recent years as a policy objective
to improve the lives of the poor.
1.2 STUDY OBJECTIVES

To ensure the provision of financial services to vulnerable and disadvantage groups at an
affordable cost, financial regulators from more than 20 countries have made financial inclusion
commitments under the Maya Declaration(see Appendix A). These commitments are to (1)
create an enabling environment that increases access and lowers costs of financial services,
including through new technology; (2) implement a proportionate regulatory framework that
balances financial inclusion, integrity, and stability; (3) integrate consumer protection and
empowerment as a pillar of financial inclusion; and (4) use data to inform policies and track
results. A comprehensive approach to financial inclusion addresses at least three things: access to
financial services and products; use of financial services and products; and quality of financial
services and products, defined by the consumers ability to benefit from new financial services and
products (and linked to consumer protection and financial capability) (World Bank 2012).
Therefore, our main research question is How can financial inclusion be promoted in Indonesia?
Related to the existing community empowerment and anti-poverty program, PNPM (see Appendix
B), another question we hope to answer is How could this program be improved to make a
significant contribution to financial inclusion?
The two main objectives of the study are to (1) assess the state of financial inclusion in Indonesia,
and identify constraints, opportunities, and priorities for significantly improving access to finance;
and (2) explore how the PNPM can be expanded for greater financial inclusion. To answer our
main research questions, we also attempt to answer the following questions:
What is the gap between the current state and desired end state of financial inclusion in
Indonesia? The desired end state can be explained qualitatively and quantitatively and the
research team will analyze backwards to assess where Indonesia stands now and what ground
still needs to be covered. It covers demand and supply issues.
What is the gap between Indonesia and other countries (including several countries such as
India, Sri Lanka, and the Philippines) in financial programs and products to promote community
development and pro-poor growth? This will be explained by international best practices on
financial inclusion.
What are the system, current practices and performances of PNPM UPKs (UPK is Unit
Pengelola Keuangan, which manages community grants for PNPM beneficiaries) and their
rotating loan funds?
What are the possible options for PNPM UPKs to permit them to play a larger role in financial
inclusion?
What are the possibilities for expanding linkages between rural and urban programs, such as the
PNPM program, in order to improve financial inclusion in Indonesia? This will be explained by
project design for a pilot project that is complemented by an M&E system.
1.3 CONCEPTUAL POLICY FRAMEWORK FOR FINANCIAL

INCLUSION SYSTEM IN INDONESIA
Background
In a market economy, where money plays a key role in economic transactions, having access to
reliable and affordable financial services is critical in improving ones quality of life. However, the
current formal financial system does not provide such services to everyone who needs them, but
only to those who can meet transaction requirements. This is regrettable given that a large segment
of the population of developing countries, including Indonesia, cannot meet these requirements
because they are poor. The exclusion of these people, who range from small farmers, landless
OVERVIEW
laborers, and small traders to urban workers and handicapped persons, from the formal system has
suppressed their opportunities to improve their lives through the market economy. And the cost of
being excluded from the formal financial system can be severe. Desperate for financial support to
run their businesses, many small farmers and traders turn to local moneylenders whose usurious
interest rates push poor borrowers into indebtedness. Perpetual indebtedness opens the way for
further exploitation by lenders. In many developing countries, including Indonesia, excluded
people are the prey of local moneylenders.
In Indonesia, the government has long recognized the problem of accessibility to formal financial
markets. Accordingly, it has attempted to improve accessibility for otherwise excluded groups.
From the era of the Suharto regime to the present, many government-sponsored credit schemes
have attempted to help low-income families improve their finances. Recently, the government has
been encouraging and facilitating microfinance institutions, banking and nonbanking, to grow
rapidly and serve small borrowers demand for credit, which the existing banking system cannot
make available. Indonesia is now a global leader in microfinance outreach and innovation, with
over 94,000 MFIs (Bappenas 2011).
This achievement, however, is far from sufficient. Financial exclusion is still a serious problem.
Rosengard (2011) found that around 50 percent of Indonesians still have only limited access to
affordable formal financial services, particularly in semi-urban and rural areas. Most of these
excluded people have a daily expenditure of less than US$1 per person. In addition, SMEs are still
facing a credit crunch, although commercial banks are liquid, solvent, and profitable.
Financial inclusion is viewed as a critical precondition for simultaneous achievement of growth
and equity (inclusive growth), previously considered impossible. Sarma and Pais (2008) have
identified two potentially positive effects of financial inclusion on an economy. First, by helping to
allocate resources efficiently, inclusion reduces the cost of using capital and helps an economy
grow rapidly. Second, it suppresses the growth of informal sources of credit, such as moneylenders
who charge high interest rates and whose borrowers are mostly poor households. This suppression
should then bring down interest rates charged on informal loans, so that the poor borrowers can
make better use of their informal borrowing to raise their income. Therefore, financial inclusion
can promote both economic growth and equity.
Others emphasize the impact of financial inclusion on poverty. Haughton and Khandker (2009)
claim that lack of capital is a key factor in poverty. Providing better access to financial markets
through inclusive policy would presumably help people escape poverty. Meanwhile, citing
examples of poor Indian farmers, Kelkar (2010) makes an even stronger point: financial inclusion
can drastically reduce indebtedness, the same indebtedness that drives many farmers to suicide.
With an average growth rate of more than 6 percent per annum, Indonesias economy has grown
quite rapidly over the past 10 years. This enduring and high growth rate has not been accompanied
by a high rate of poverty reduction: more than 30 million people in Indonesia remain poor. Thus,
the high economic growth of Indonesia is not yet inclusive. Making high economic growth
inclusive mean providing these poor people with better access to the formal financial market.
Accordingly, the government should design and implement inclusive financial policy, which
promotes this low-income groups financial interests.
Theory
Before discussing basic considerations for developing an inclusive financial system, we outline the
theory of credit market operation in developing countries. In Indonesia and elsewhere, credit
markets are segmented into the formal and informal. They co-exist, but their operating procedures
are distinct. The government often intervenes in these credit markets in various ways, such as by
implementing its own programs including the increasingly popular group-lending schemes.
Formal Credit Market

One characteristic of credit transactions is the length of time between the signing of a contract and
loan repayment. It can be a month, six months, or even longer. A long interval provides an
opportunity for borrowers to be opportunistic they may later fail to fulfill repayment commitment
for the loan repayment when it is due, so that the loan becomes outstanding.
The borrowers denial may be due to its inability to make the repayment because of business
failure, which may be due to either mismanagement or miscalculation of business risks
(involuntary default). However, there is another possibility. The borrower may be not willing to
repay his loan not because he cannot afford to make the repayment that he promised. He can,
indeed, make the repayment but he just does not want to make it (strategic default). Such strategic
default is possible when law enforcement is weak, which is common in developing countries (Ray
2000).
Such behavior is not possible in a spot market characterized by brief transactions. Consider the
following case. Suppose two trading agree to exchange IDR 50,000 for a sack of 5 kg rice.
Suppose also that the seller of the rice acts first, that is, he hands the rice to the buyer before the
buyer hands the agreed payment to the seller. If the buyer then tries to cheat the seller by simply
taking the handed rice package away before paying the agreed price, the seller will act quickly to
solve this problem, either by shouting to attract his neighbors to help him catch the buyer, or by
directly fighting with the buyer to have his rice back. Hence, the buyer would not be successful in
his attempt to cheat the seller of rice.
Credit transactions are quite vulnerable to a hold-up strategy by the borrowing party. In
anticipation of this, the lending party requires the borrowing party to pledge collateral against the
applied loan. To make this pledge of collateral effective in keeping the borrower from acting
opportunistically in the use of the loan, the monetary value of the collateral must be much higher
than that of the loan. Thus, credit transactions are characterized by an exchange of hostages
between the lending party and the borrowing party.
The formal markets requirement for collateral in any credit transaction makes it accessible only
for those who can meet the requirement. Poor people, such as small farmers, landless laborers,
urban workers and small traders, who cannot pledge collateral are excluded from the formal
market.
Transaction costs also hinder the poor from entering the formal credit market. Before being
granted a loan, borrowers normally have to follow some processing activities, such as drafting a
loan application, interviewing with bank staff, and field verification. After succeeding, the
borrowers are still involved in activities with the bank, such as monitoring, making repayments,
and administration. All these activities impose costs on both sides. These costs are subject to
economies of scale, whereby the transaction cost per rupiah on a loan declines as the size of the
loan increases up to a certain level. This implies that transaction costs are cheaper for larger
OVERVIEW
packages of loans than smaller ones. Therefore, the lending institution will prefer to serve a big
borrower rather than a small one. Small borrowers like poor farmers whose borrowing is small
would prefer not to borrow from formal banks because the transaction costs are high because their
loans are typically small.
Informal Credit Market

Informal credit marketsin which moneylenders, landlords, and other individuals, such as rural
middlemen, supply loansare quite different. Lenders do not require collateral. The credit
application procedure is simple, with no documentation and taking very little time. The transaction
costs are much smaller when compared to the same package from a bank in the formal credit
market. These characteristics make the informal credit market attractive to low-income families
excluded from the formal market. These conveniences, however, are balanced by interest rates
much higher than in the formal credit market (Hoff and Stiglitz 1993). The absence of collateral in
credit transactions in the informal market does not mean that lenders and borrowers do not care
about the risk of credit default. They do, but loan repayment is ensured in other ways. A bank
follows a tedious selection process and uses collateral to help ensure loan repayment. Informal
lenders use methods suited to the local socio-economic environment.
Three Types of Problems in Money Lending

Hoff and Stiglitz (1993) have identified three types of problems in any lending transaction: (1)
screening problems, (2) incentive problems, and (3) enforcement problems. These problems
emerge out of imperfect and costly information embodied in lending transactions, and this
provides the opportunity for borrowers to capitalize on their possession of information regarding
their actions in using the loan to their own benefit at the expense of lenders. It is therefore rational
for a lender to avoid providing loans to applicants who might abuse this information asymmetry, or
to follow a proper screening process. Accordingly, screening borrowers is the first problem that
lenders have to solve in making loans.
Even if a proper screening process is followed there is no guarantee that a loan will be used as
described on an application. Any guarantee of behavior will require an incentive to ensure that the
borrowers take actions that make loan repayment possible (Hoff and Stiglitz 1993). The lender
must then solve the problem of incentive.
Loan repayment is problematic not simply because business failure makes it impossible for the
borrower to repay the loan, but also because borrowers may not want to repay (Ray 2000). Such
misbehavior is possible when law enforcement is weak, as is common in developing countries.
This implies that the lenders must ensure enforcement to increase the likelihood of repayment by
those able to repay (Hoff and Stiglitz 1993). Thus, enforcement of contracts is another problem
that the lenders have to confront.
Two Types of Mechanisms to Manage Money Lending Problems

According to Hoff and Stiglitz (1993), lenders can manage the problems of screening, incentives,
and enforcement indirectly or directly.
Indirect Mechanisms. To manage problems indirectly, lenders may design contracts in such a way
as to make borrowers unintentionally reveal information about their riskiness, encourage them to
take proper actions in using the loan increase the likelihood of repayment, and to make repayment
when they can afford to do so. This mechanism may be integrated into the credit contract (in loan
terms, such as the interest rate or size of the loan). For example, loans with high interest rates can
only be repaid if the business for which the loan is used can generate high profitsbut a business
with high potential for high profit is usually also high risk. Thus, the interest rate imposed on a
loan can be used to detect the riskiness of potential borrowers.
An indirect mechanism can be also integrated into the terms of other related contracts, such as land
or marketing contracts. For example, a trader who buys products produced by a farmer may grant
the famer a production credit package consisting of fertilizers and pesticides at a low interest rate
production credit. The trader is motivated to grant such a nice production credit since he knows
that the use of fertilizers and pesticides will lower the probability of farming failure, which reduces
the probability of loan default.
The interlinking of credit and land rent contracts is another indirect mechanism often used by
landlords-cum-moneylenders to manage the problems of screening, incentives, and enforcement.
The threat of contract termination embodied in interlinking contracts can be effective in making
borrowers discipline themselvesbut such self-discipline occurs only if the borrowers earn some
economic surplus from the interlinked contracts.
Direct Mechanisms. These consist of two types of lending action. First, lenders screen credit
applications to ensure that undesirable borrowers do not get loans, and enforce the terms of the
contract to ensure repayment by those who can afford it. This activity consumes lenders
resources, the costs of which are then often passed on to borrowers in the form of higher interest
rates. Second, lenders can confine their credit provision services to specific people with whom
they have sort of influence in managing the problems of screening, incentives, and enforcement
(e.g., members of a particular kinship group, residents of a region, and individuals with whom they
trade).
It can be concluded that the informal credit market is not truly helpful for low-income families that
struggle to improve their income. Since the market is very selective in allocating credit, credit
exclusion is still a serious problem for this group. But this is not the worst aspect of the informal
credit market. More serious for poor families is that their involvement in this market can make
their familys lives even worse. The high interest rates charged can force poor families into a
vicious circle of poverty. Kelkar (2010) argues that financial inclusion could reduce the incidence
of farmer suicide in rural India where indebtedness is a major cause of such suicides.
Credit Program
Given the prevalence and pitfalls of informal lending, it is no surprise that the governments of
many developing countries have long tried to end them by providing cheap credit to low-income
families. The expectation is that such cheap credit provides competition for the informal lenders
and hurts their businessbut reality is far from the expectation. Government-sponsored credit
schemes often fail not only to eradicate informal lending but also to lower interest rates (Hoff and
Stiglitz 1993). This implies that instead of correcting market failures, government intervention
sometimes makes them worse.
Government-sponsored credit programs would have achieved their goal if they had reached lowincome groups effectively (Braverman and Guash 1993). The programs usually transferred income
from the government to the target group. The possibility of income transfer stimulated demand for
credit among poor families and attracted applicants from groups other than the target group
causing a surge in demand that outstripped supply and intensifying competition for sponsored
OVERVIEW
credit. Rich families, such as large landowners, are much more able to win this market
competition, not only because they can pledge the required collateral but alsoand more
importantlybecause they can exert political power over credit administrators.
Sponsored credit schemes in developing countries also have an adverse effect on rural formal
credit institutions (Braverman and Guash 1993). They force down interest rates in the formal
market in rural areas. Low rates discourage savings/deposit mobilization among low-income
families. Meanwhile, banking institutions are sustained by local community savings. If they use
government funds in lending their commitment to business-like operations is diminished. This is
because normally outstanding loans are handed to the government to manage. This is in contrast to
these lending institutions relying on their own ability to mobilize savings from local communities
for their lending activities. Their responsibility to repay the mobilized savings, together with the
charged interest rate, would force them to work hard to make their businesses solvent and
profitable.
Group Lending Schemes

Group lending schemes have attracted much attention from scholars and governments in many
developing countries after the success of Grameen Bank, a group lending scheme of Professor
Mohammad Yunus, a Bangladeshi Nobel laureate. Grameen Bank made material collateral
requirements and high cost transaction irrelevant when a banking institution provides credit to the
poor. The strength of this group-lending scheme is its inclusion of joint liability into a group of
borrowers (Braverman and Guash 1993). Joint liability makes the formation of a group crucial
because the group becomes a self-policing instrument. Proper selection of members by a group is
important. Misbehavior by any member would lead to the termination of group lending until the
moral problem is fixed. Accordingly, group members must be selected with a great care to ensure
that their interests match. The group should have no difficulties in applying this selection principle
since they belong to the same community, where members have interacted intensively for a long
period of time. As a result, a solid lending group with a great commitment to success is realized.
Basic Considerations
The development of an inclusive financial system has attracted much attention from government
leaders and academia. Financial inclusion involves not only the demand side of the credit market,
but also supply, yet scholars have focused on inclusion from the demand side of the market. This
trend is likely a response to what Gardwe and Elizabeth (2011) call lack of attention to client
needs. This lack of attention is a major cause of exclusion of low-income families from the
formal market. Hence, looking to the future, from one point of view there is a need for scholars to
give more attention to client needs in their efforts to assist the development of inclusive financial
systems in developing countries.
A single-mined focus of academic attention on client needs would not appear appropriate,
however. Improving access of clients to financial services would not be possible without due
attention to consequences on the side of the supplier, since any change in the demand side will
affect the supply side. Thus, any attempt to improve access to formal financial services will require
suppliers to make adjustments. With this point in mind, we will discuss some basic considerations
in developing inclusive financial systems in Indonesia.
Type of Clients
Which type of client should be given top priority in an inclusive financial system? Most scholars
suggest that low-income families should have top priority (AFI 2012; Kelkar 2010; Reyes at al.
2011; Rangarajan Committee 2008; Sharawat 2010). This suggestion is reasonable given that
members of this group are the ones who have been excluded from formal services. This exclusion
has made their lives worse since they are now dependent on informal credit with its exorbitant
interest on loans.
As mentioned, more than 50 percent of the population in Indonesia has only limited access to the
formal financial market. A majority of this group are poor families with daily expenditure less than
US$1 per person. Developing an inclusive financial system in which they are priority clients will
have three kinds of positive effects on the economy of Indonesia. First, they will be released them
from dependence on moneylenders who exploit them by the charging excessive interest on loans.
Second, inclusion will help them to improve their economic activities, generating jobs and family
income, and improving family welfare. Third, improved economic activity by a large population of
low-income families will result in their being included in the formal financial system. This will not
only directly stimulate the national economy but will also create a many jobs. In short, the
development of an inclusive financial system will push the Indonesian economy to grow faster and
will create inclusive growth. This would be in keeping with the governments attempt to promote
pro-growth and pro-poor development in Indonesia.
Type of Financial Products, Terms, and Conditions

What types of financial products should be provided, and what terms of contractual conditions
should inclusive financial institutions impose on their products? Demirguc-Kunt and Klapper
(2012) suggest that inclusive systems should serve all vital purpose financial needs (e.g., savings,
credit, payment and risk management products) and that products should be accessible without
price or non-price barriers. As previously discussed, collateral requirements and costly
administrative processes are major constraints on low-income families in the formal financial
system. Therefore, eliminating these constraints is a rational precondition for implementing an
inclusive financial system.
The success of Grameen Bank scheme demonstrates that poor families can be brought into the
formal lending system without requiring them to follow conventional administrative banking
procedures or pledge material collateral. This can occur by developing a group-lending scheme in
which a joint liability rule is imposed whenever any individual members of the group fail to fulfill
the agreed loan contract. This type of group lending scheme may be one option for an inclusive
financial system in Indonesia.
As discussed previously, an inclusive financial system will improve the economic growth rate and
reduce poverty. To encourage such externalities up to a socially optimum level, the government
should provide subsidies for operation of an inclusive system (Stiglitz 2000). The subsidy could be
implemented in various forms, such as subsidization of interest rates charged on inclusive financial
products and payment of insurance fee for the products. The first type of subsidy does not appear
appropriate. Braverman and Guash (1993) argue that subsidizing interest rates makes the inclusive
scheme flow to groups other than low-income families and slows the mobilization of saving from
the local community, savings that are crucial for the sustainability of a financial institution.
The government, through the KUR scheme, has implemented the second type of subsidy. Under
this scheme, borrowers pledge no collateral. The lender need not to worry about repayment since
OVERVIEW
the government has insurance contracts with an insurance company. This type of subsidy seems
appropriate for financial inclusion products. This means that low-income families that borrow
from inclusive institutions do not need to pledge collateral since the government will assume
responsibility for repayment in the case of business failure. But the government does not need to
make a direct repayment for this failure. It can transfer its repayment responsibility to an insurance
company by making a contractual insurance agreement with the company for which the
government will pay some fees.
Interest Rates
The interest rate charged on inclusive financial products is another important issue. Some scholars
recommend that products be offered to low-income families at an affordable cost but do not
define affordable cost (Rangarajan Committee 2008; Ferando 2009). Meanwhile, the
government seems to hold the view that interest rates for loans supplied to this group should be
lower than market rates. This view is reflected in the governments provision of credit to this
group at subsidized rates. The assumption underlying this subsidy seems to be poverty prevents
this group from every repaying their loans if they are charged interest at the market rate. But, as
Braverman and Guash (1993), argue subsidizing interest rates will make an inclusive scheme flow
to groups other than low-income families and slow the mobilization of savings from local
communities. This implies that inclusive financial products should be made available to lowincome families at the market interest rate, not lower than it.
Financial inclusion is helpful for low-income families. It can help them avoid indebtedness,
improve their economic activities, raise family income, and escape poverty. This can occur only
when they have good knowledge about use of financial services and products. Members of this
group generally have little formal education and the sound financial knowledge that usually
develops with it. Thus, if an inclusive financial system is to help reduce poverty, the government
must promote financial literacy for this group.
Policy Framework for Financial Inclusion System

The conceptual policy framework for developing an inclusive financial system in Indonesia is
shown in Figure 1-1, below. The ultimate goal is to promote high growth with equity, or inclusive
economic growth. While Indonesia has experienced high economic growth for more than a decade,
the high growth of the economy has failed to bring the national poverty rate down substantially.
Poverty is still a major economic problem. Better economic policy is desirable to ensure that the
growth of the national economy alleviates poverty.
One may conclude that a major constraint in Indonesia turning its high economic growth into
inclusive growth is a formal financial system ill suited to the task. The present financial system is
exclusive; about 50 percent of the population is excluded from using its servicesand most of the
excluded are poor people with daily expenditures of less than US$1 per capita (Rosengard 2011).
Haughton and Khandker (2009) claim that a major cause of poverty is lack of access to capital.
Improving access to financial markets through inclusive financial policy would reduce poverty and
spur economic growth by facilitating efficient allocation of resources and reducing the cost of
capital (Sarma and Pais 2008). Thus, financial inclusiveness will promote inclusive economic
growth. Accordingly, the main target of the system must be low-income households. To make
financial products accessible to them, price and non-price barriers must be removed (e.g.,
provision of material collateral, costly borrowing procedures). Training to improve financial
literacy is also desirable because most of the poor have very little formal education and very little
10
knowledge of financial products. To ensure such training is applied, the government should also
provide business-related assistance. Only with these two provisions can poor families maximize
the benefits of their involvement in an inclusive financial system.
Figure 1-1
Financial Inclusion Policy Frameworks
Ultimate
Objective
Intermediate
Objective
High Growth with Equity

(Inclusive Growth)
Constraint
Access
Low Income Household
Suppy side Constraint:

Colateral High Administrative cost
Usage
Demand side Constraint:

Lowfinancial literacy Lack of market opportunity
Non-conventional financial services practices:

Without price and non price barriers
Financial education programs
Business assistency Franchises model
Approach
Channeling
Institution
Financial
Stability
Inclusive Financial System
Financial Inclusion
Target Group
Poverty
Reduction
Income
Equality
Non-Bank Financial Institutions:

MFI Non MFI
Banking
UPK
Inclusiveness
Pillars:
Knowledge and Skills:

Capacity Buliding
Improved Behaviour
Custumer Protection
Access:
Eligibility
Affordable Products
Improved Accsess
Risk Mitigation
Usage:
Financial Literacy
Business Asistency
Chanelling institution
sustainability:
Sound and sustainable
business practices
Such a system will impose more complex tasks and more responsibility on formal financial
institutions. They will have to design products to fit the needs of customers, especially low-income
families, help low-income households become financially literate, and assist them in developing
and operating businesses that use borrowed money. The institutions themselves will may need help
from the government in preparing to offer such client care. All these activities will be costly.
11
OVERVIEW
Accordingly, financial institutions will be interested in taking on extra tasks if the benefits of doing
so offset the costs, in addition to their ordinary costs of serving this group.
Legal structures of financial institutions vary. These can be for banking or nonbanking financial
institutions. Banking financial institutions do not appear easily adaptable to inclusive financial
service concepts. Nonbanking institutions are much easier to transform, since their operations are
not conventional but instead adapted to the social-economic conditions of customers, most of
whom are poor (e.g., MFIs generally accept ownership certificates of a moveable asset as
collateral).
Of nonbanking financial institutions, UPKs are of special interest. UPKs have long served the
financial needs of very poor communities in Indonesia and are accustomed to tailoring financial
products to match the needs of poor customers. UPKs also provide loans to poor families without
requiring a pledge of material collateral by individual borrowers; instead, they require joint
liability collateral. These arrangements occur through group lending schemes. Thus, UPKs in
Indonesia have good experience with and knowledge of innovative financial service practices
required by an inclusive financial system. UPKs have also developed networks and cultivated trust
in their communities. This gives them an advantage in realizing the inclusiveness concept.
Nevertheless, formal banking institutions may collaborate with UPKs in implementing an inclusive
approach. In such a collaboration, UPKs can be used as channeling agents for banks wishing to
reach out to and serve low-income households.
Table 1-1
Numbers, Capital, Assets, and Loan Portfolios of UPKs in 2012
Number of
Items
UPKs
(Units)
Capital
(Billion Rupiah)
Asset
(Billion Rupiah)
Loan Portfolio
(Billion Rupiah)
Urban UPKs
10, 114
1, 071
1, 168
760
Rural UPKs
5, 311
4, 160
4, 187
3, 136
5, 231
5, 355
4, 896
Total
15, 425
SOURCE: Own calculation from Financial Reports of Rural and Urban UPKs
The concept of a financial inclusion system may be rewarding to implement, but the extent of the
reward depends on the extent to which the four pillars of inclusiveness(1) knowledge and skills,
(2) access, (3) usage, and (4) sustainability of channeling institutionare in fact implemented.
Developing and maintaining these pillars is critical to the success of any inclusive financial
system.
2. Methodology
Our research focuses on a central issue that must be addressed when considering how to promote
financial inclusion in Indonesia:
How might PNPM, the well-known community empowerment and anti-poverty
program, working through the UPK management units (Unit Pengelola Keuangan in
urban and rural areas) that are part of the PNPM, be improved so as to make a
significant contribution to financial inclusion?
We examine the effectiveness of UPKs in providing financial services to the poor and recommend
how they can be improved. As part of our recommendations, we present a rationale and design for
a pilot project that would model the delivery of financial inclusion services in Indonesia through
UPKs. As per the Request for Proposal (RFP), the study is the first part of a two-part program. The
output of the first part is this preliminary study presenting baseline data to be used to guide the
pilot project in the second part. The second part, not covered by the RFP and to be financed
through other means, will be a pilot project to be conducted in at least four regions associated with
the well-known and established PNPM activity. Our proposed design for a pilot project sets out
possibilities for expanding linkages between rural and urban programs, such as the PNPM
program, to improve financial inclusion in Indonesia.
Figure 2-1
Important Results at the End of the Study
Option for improving UPK

legality:
UPKs, Cooperatives, BKD,
Banks, etc.
Criteria:
Health, Sustainable,
Technology, human
resources
Typology or Classifications of
UPKs based on some criteria
Umbrella Institutions
Well established finance

institutions
Wider network to ensure
the sustainability of the
program
Road map of each typology

Proof of concept testing for
each typology
Pilot Project
13
METHODOLOGY
2.1 RESEARCH STAGES

We conducted a literature review on the state of programs and products provided to improve
financial inclusion in Indonesia; the status of international best practices on financial inclusion; the
target and the end state of Indonesias financial inclusion; and a review of the PNPM UPK system.
We defined the scope of research activities by breaking them into components and steps, and
developed research methods in detail. Source of information included a literature survey, policy
and regulatory reviews, and practices (program and product) that support financial inclusion. There
are two main outputs: (1) documentation of literature on financial inclusion in Indonesia and
elsewhere, including PNPM UPK in Indonesia; and (2) a list of issues and indicators to be covered
by primary data collection (e.g., surveys, interviews, and focus group discussions).
To begin answering our research questions we collected and then conducted qualitative and
quantitative analysis of secondary and primary data. Secondary data came mainly from urban and
rural UPK periodical reports. Primary data were collected through a quick survey, household and
UPK surveys, interviews, and focus group discussions in four provincesJawa Tengah, DI
Yogyakarta, Sumatera Barat, and Nusa Tenggara Timurwith data drawn from two districts in
each of these four provinces. The data provide information on the gap, potential and challenges of
financial inclusion, and baseline data for the planned pilot project.
Figure 2-2 summarizes the stages of this study; Table 2-1 explains the types of issues and the
information gathered for it.
Figure 2-2
Stages of the Study
Stage 1. Prepare
Literature review and
secondary data exploration:
Best practices in Indonesia
and other countries
Policy and regulatory
framework for financial
Inclusion
Stage 2. Implement
Collecting Primary Data
Methods (field survey, focus
group discussion)
Stage 3. Report
Analysis legal options for the

PNPM UPKs
Project design for a Pilot

Project
Respondents or Source if
Information
Location
Program and product

currently provided in
Indonesia
PNPM UPKs System
Objectives
To define the scope of research
activities by breaking down into
components and steps and
develop research method in
more detailed fashion. Find out
some answers
Objectives
To find out the answer to the
research questions
Objectives:
To formulate a set of
implementable strategic
frameworks that can better
foster financial inclusion in
Indonesia particularly the role of
PNPM UPKs in the financial
inclusion.
14
Table 2-1
Key Issues in the Study
Issue
Unmet needs in
Indonesia: Demand and
Supply issues
Respondent
Question
UPK
Supply:
Households have access to

financial services/PNPM
and Households do not
have access
ability to manage risk, provide infrastructure,

provide a suitable range of products supplied,
human resources, and IT systems
Purposes
Answer how is the gap
between supply and
demand
Demand:
Accessibility, financial literacy
Evaluation of the PNPM

UPKs system, current
practices, performance
and possible option to
improve of role UPK
PNPM UPKs
The use of existing funds
Household have access to

financial service/PNPM
Practices
Constraints
Performance
Provide data for

baseline to find scope
for improvement
Policy and legality aspect
PNPM UPK
Household:
Experience and opinion
Benefit
Constraints
Accessibility
Timeline
Coverage
PNPM UPKs
Rotating loan funds
Types of businesses supported
Payment records from clients receiving loans
Interest rates charged
Profits from various activities
Other financial data from the UPK
2.2 DATA COLLECTION METHODS

Survey of UPKs
The survey of UPKs gathered information about the following aspects of their operations:
Current practices of the PNPM UPK system

Constraints
Performance and future direction
Policy and legal aspects and options for improving the role of UPKs
Use of rotating loan funds in the UPKs, such as
Types of businesses supported
Payment records of clients receiving loans
Interest rates charged
Profits from various activities
Other financial data.
The number of UPKs chosen as samples and their distribution by province and districts is shown in
Table 2-2. A total of 113 UPKs were studied, 68 sustainable and 45 unsustainable. Our sampling
procedure reflects the total population of UPKs in each province studied. Thus, the total number
studied in Central Java (78) is much larger than the number in Nusa Tenggara Timur (NTT) since
the total in Central Java is higher than the total in NTT.
We study more sustainable UPKs (68) than unsustainable ones (45), even though there are in fact
fewer sustainable than unsustainable ones in all four provinces. This is because we are focused on
15
METHODOLOGY
the transformation of sustainable UPKs into MFIs; the sample of unsustainable ones is used as a
control.
Table 2-2
Sample UPKs in the Selected Research Area
Urban UPK
No
Location
Sustainable
Unsustainable
Rural UPK
Total
Sustainable
Unsustainable
Total
DI Yogyakarta
Kab. Bantul
Kab. Sleman
44
19
63
15
Jawa Tengah
1
Kab. Brebes
Kab. Klaten
25
10
35
Kab. Pati
10
17
Kab. Wonosobo
Kab. Demak
Sumatera Barat
12
Kota Padang
12
Sawahlunto/Sijunjung
Nusa Tenggara Timur
Kota Kupang
Kab. Kupang
57
28
85
11
17
28
TOTAL
Household Survey
We conducted household surveys in each of the four provinces to collect information about factors
contributing to demand for financial services (e.g., accessibility, financial literacy, usage, need).
Respondents included people who have, and do not have, have access to financial services or the
PNPM program (Figure 2-3). Respondents were asked about the following:
Experience and opinion on benefits, constraints, and accessibility to the financial services
including from PNPM UPKs
Financial literacy and usage of financial services
Their needs for financial services.
Quick Survey
A quick survey was conducted to examine the accessibility of financial services from formal and
informal institutions for the community. Ten people represented respondents from each UPKs
operational area. The method used to select the respondents was the convenience survey method.
The survey used a short questionnaire.
Focus Group Discussions

Focus group discussions (FGDs) were conducted in four provinces Jawa Tengah, DI Yogyakarta,
Sumatera Barat, and Nusa Tenggara Timur. FGDs were conducted twice: during the study and
then after running the data and writing the first draft report, in order to inform the main findings of
16
the study to the stakeholders. Discussants were representatives of institutions that work closely
with PNPM UPKs programs, including BI, BPD, NGO, BAPEDA, the PNPM national
management team, regional management consultants, PU, UPK staff, and members of group
borrower/KSM.
Figure 2-3
Numerical Breakdown of Household Survey Respondents
15 households
(members of UPK)
Case Study
30 in each rural UPK
1 rural UPK and 1 urban

UPK in each province
60 respondents in each
province
15 households
(nonmembers of UPK)
15 households
(members of UPK)
30 in each urban UPK
15 households
(nonmembers of UPK)
2.3 METHOD OF SELECTION UPK FOR TRANSFORMATION

To support the roles of UPKs in promoting financial inclusion among poor families in Indonesia, it
is important to transform UPKs into MFIs. MFIs are different from UPKs. The role of UPKs is
simply to facilitate the distribution and collection of loans to the poor. MFIs, as independent
financial institutions, can design and provide a variety of financial services. This means that MFIs
have a much greater capacity to promote financial inclusion than UPKs.
In Indonesia, there are more than 15,000 UPKs. It is unlikely that all have performed sufficiently
well to facilitate their transformation into MFIs. Hence, it is important to have criteria for selecting
UPKs that are ready to become MFIs. These criteria are explained in Chapter 4.
.
3. State of Financial Inclusion

3.1 INTERNATIONAL PRACTICES IN FINANCIAL INCLUSION
Asli Demirguc-Kunt and Leora Klapper (2012)1report that the use of formal accounts varies widely
across regions, economies, and individual characteristics. Analysis of Global F-index data concluded
that account penetration is higher in economies with higher national income, as measured by GDP per
capita. But national income explains much less of the variation in account penetration for low- and
lower-middle-income economies. Indeed, at a given income level and financial depth, use of financial
services varies significantly across economies, suggesting an important role for policy.
Poor people juggle complex financial transactions every day and use sophisticated techniques to
manage their finances, whether they use the formal financial system or not. We cannot assume that all
those who do not use formal financial services are somehow constrained from participating in the
formal sectoraccess and use are not the same thing. But the recent success of mobile money in subSaharan Africa shows that innovations can dramatically change how people engage in financial
transactions. To allow a better understanding of the potential barriers to financial inclusion, the Global
F-index survey includes novel questions on the reasons for not having a formal account. The
responses provide insight about where policymakers might begin to expand the use of formal financial
services.
The Global F-index indicators measure the use of financial services, which is distinct from access to
financial services. Access most often refers to the supply of services, while use is determined by
demand as well as supply. Use refers to the levels and patterns of use of different services among
different groups, such as poor people, youth, and women.
Indicators are in four sets for each objective. The first focuses on formal accounts, such as frequency
of use, mode of access, personal or business purpose, receipt of payments, government or family
purpose, barriers to account use, and alternatives to formal accounts (e.g., mobile money). The second
focuses on savings behavior, which relates to the use of accounts as people often save at formal
financial institutions. The third focuses on sources of borrowing (formal and informal) such as
mortgages for emergency or health purposes, and use of credit cards. The last focuses on use of
insurance products for health care and agriculture.
How the required information is obtained varies from one country to another. In economies where
telephone interviewing is employed, random digit dialing or a nationally representative list of phone
numbers are used. In selected economies where cell phone penetration is high, a dual sampling frame
is used. Random respondent selection is achieved by using either the latest birthday or the Kish grid
Measuring Financial Inclusion the Global F-index (2012)
18
method. At least three attempts are made to reach a person in each household, spread over different
days and times of day.
The most important in the study by Demirguc-Kunt and Leora Klapper (2012) is about data
weighting. Data weighting ensures a nationally representative sample for each economy. First, base
sampling weights are constructed to account for oversamples and household size. If an oversample
has been conducted, the data are weighted to correct the disproportionate sample. Weighting by
household size (number of residents age 15 and above) is used to adjust for the probability of
selection, as residents in large households will have a disproportionately lower probability of being
selected for the sample. Second, post stratification weights are constructed. Population statistics are
used to weight the data by gender, age, and, where reliable data are available, education or
socioeconomic status. Finally, approximate study design effect and margin of error are calculated.
The average country-level margin of error for the account penetration indicator is plus or minus 3.9
percent.
Exhibit 3-1
Financial Inclusion and Development: Cross-Country Analysis
Using the index of financial inclusion, [this exhibit] attempts to identify factors associated with financial inclusion. Human
development and financial inclusion level in a country move closely with each other, although a few exceptions exist.
Among socio-economic factors, income is positively associated with the level of financial inclusion. Going beyond income,
inequality, literacy, and urbanization are other important factors. Physical infrastructure for connectivity and information are
also significantly associated with financial inclusion.
The banking sector variables, NPA and CAR, are negatively associated with financial inclusion. Government ownership of
banks is not significantly associated with financial inclusion, while foreign ownership is found to be negatively associated.
The interest rate does not seem to be significantly associated with financial inclusion.
= 1
1 !
+ 0.5 !
1.5
+ 0.5 !
The index of financial inclusion (IFI) is a measure of inclusiveness of the financial sector of a country. It is constructed as a
multidimensional index that captures information on various aspects of financial inclusion (banking penetration, availability
of banking services and usage of the banking system). The IFI has a range between 0 to 1, where 0 denotes complete
financial exclusion and 1 indicates complete financial inclusion in an economy. There are three basic dimensions of financial
inclusion: (1) Accessibility represented by number of bank per 1000 population, (2) Availability represented by number of
bank branches and number of ATMs per 100,000 people, and (3) Usage represented by the volume of credit plus deposits
relative to the GDP.
Philippines
The Philippines embraces m-banking to deepen financial inclusion. Although there are almost 8,000 bank branch offices,
some 6,000 financial cooperatives, and around 7,700 ATMs in the Philippines, facilities are concentrated in urban areas, and
a significant proportion of the low-income population remains underserved. In response, the Bangko Sentral ng Pilipinas
(BSP), the central bank, is expanding multi-channel institutions to deliver a wider range of financial services to more people.
Existing branch networks will be expanded, technology employed to find new ways to deliver financial services, and nonbank retail institutions used to extend service networks.
BSP has sanctioned two e-money products. The first, Smart Money, was approved in 2004. It is the product of a major
commercial bank and so did not require any new regulations. The second, G-cash, was approved in 2005, though it was
not a bank product and thus posed a more difficult regulatory challenge. Following the examination of issues of consumer
STATE OF FINANCIAL INCLUSION
19
protection, money laundering, and the soundness of the product, the provider was licensed as a remittance agent.
BSP has since worked through a range of issues arising from the electronic banking (e-banking) phenomenon, and has issued
circulars on registration for AML compliance, technology risk management, and consumer protection, as well as
comprehensive and generalized regulations for issuance of e-money. The impact of e-money has been substantial, with some
eight million people using one of the two products and growing numbers of banks involved. Some banks have lowered
interest rates on microfinance loans administered via the phone repayment platform, and lower-cost remittance channels
have resulted in a marked fall in remittance costs.
These advances are opening the way for an integrated regulatory framework for e-money, which will require the
convergence of mobile technology, e-money, and the traditional brick-and-mortar networks of financial institutions, and
involve both bank and non-bank partnerships. The act of creating e-money will be decoupled from banking transactions and
non-exclusive third party agent networks will be enabled to handle all transactions other than retail deposits, which will
remain the province of regulated banks.
The Philippines experience shows that simple and convenient payment and fund-transfer products that can mature into morevalue-generating relationships can deepen financial inclusion. The reach of banking services can be increased by the
combination of a liberalized branching regime, m-banking technology, and strategic partnerships with non-bank agent
networks.
Proportionate and appropriate regulation and supervision are required to encourage innovation and market growth while
ensuring that e-banking does not challenge the integrity of the financial system or the rights of consumers. There is a need
for clear delineation between deposit-taking transactions and the receipt of funds for other purposes, each requiring
proportionate regulation. Sound internal controls and governance arrangements for all players are also essential to maintain
order and discipline. However, BSP has preferred to avoid heavy regulation for low-value payments, as these are not likely
to be used for money laundering.
A National microfinance strategy was built to encourage growth of micro-insurance in the Philippines. The Philippines has
an embryonic micro-insurance sector covering little more than 5 percent of the adult population. Of those covered, about 60
percent have coverage from formal institutions, such as banks, mutual funds, and credit-associated life insurance providers,
with the rest covered by informal sources, such as cooperatives and unincorporated mutual funds. The strong infrastructure
of service providers and a conductive regulatory and political environment have supported the growth of micro-insurance
institutions and products, simplified documentation and KYC requirements, and permitted major banks to market insurance
products on bank premises.
The national microfinance strategy has prompted the Insurance Commission of the Philippines to take a proactive stance in
regard to micro-insurance. The explicit inclusion of insurance in the regulatory regime has stirred awareness in the industry,
and the successes of mainstream microfinance have encouraged operators to branch into insurance. Regulatory flexibility has
also allowed space for innovation.
Remaining barriers include the absence of an effective regulatory environment for cooperatives, many of which have
unregulated in-house insurance schemes and are prone to failure, and the regulatory ambiguity affecting pre-need and health
care plans. There is also a lack of incentives to persuade large commercial insurers to offer micro insurance, and rural banks
are still prohibited from selling micro insurance on their premises.
France
Although it is a statutory right to have a bank account in France, and 99 percent of the households have a bank account,
people find it is difficult to use the financial services. Often customers do not possess a clear understanding of the banking
system, deterring the use of various banking services and the repayment of credit. Banks often seek to limit their risks and
costs, and may charge fees from the clients. This scenario of misunderstanding and insecurity prevents people from utilizing
20
banking services. The narrow perception of financial inclusion to merely the ability to access to a bank account presents a
rather skewed view of the problem. Mere access doesnt allow the presumption of successful usage.
Thus, it is a must to remember that the huge financial inclusion discourse of the current time must not be only limited to
opening up of a bank account or a bank branch in the vicinity of a village. Further, it must be noted that fear and insecurity
toward the banking process is prevalent in society to a large extent. Thus schemes must concentrate on awareness and the
ability of usage as much as on mere access.
Bangladesh
Bangladesh has its own products and services, targeting criteria, system of credit delivery, and recovery. Its underlying
philosophy is that credit is a fundamental right. Grameen Bank is a trust-based bank, which offers loans without any
collateral. It has friendly clientele and flexible credit delivery and recovery mechanisms. As of September 2008, Grameen
has 40,016 centers, 98,038 groups, and about 7.6 million members. Ninety-seven percent of its members are women.
Grameen has mobilized more than US$ 826 million as deposits, including US$ 373 million from non-members (Sept. 2008).
Deposits as a percentage of outstanding loans is 136 percent. The interest rate charged on loans by the Grameen Bank is
lower than the rate of interest fixed for the government-run microcredit programs. Yet, the Grameen Bank has earned a profit
in every year except 1983, 1991, and 1992. The bank has a decentralized system, and it follows a participatory approach. At
the same time the entire system is made transparent by strict monitoring through a strong Management Information System
(MIS). It also has a strong internal audit system. Thus in the case of financial inclusion the objective of poverty reduction
should be made crystal clear. Special strategies must be made to effectively target the poorest.
Sri Lanka
According to a 2009 GTZ study on financial inclusion in Sri Lanka about 82.5 percent of households have access to financial
institutions. The National Development Trust Fund is the biggest wholesale lender for MFIs in Sri Lanka. Poverty
Alleviation Microfinance Projects (PAMP I and II) were started to establish a sustainable microcredit delivery system for the
poor. Further, The Hatton National Bank (HNB) in Sri Lanka uses the concept of the Barefoot Banker to set up a number of
village-level schemes to distribute loans. Loans up to LKR 15,000 (US$165) can be approved without formal collateral.
Over 600,000 students have been a part of the saving system through HNBs network of 200 student banking units, and the
bank holds savings deposits up to nearly US$ 40 million from these students. In addition, National Saving Banks youth
savings program reached nearly 390,000 youth with a total savings of LKR 3.4 billion (US$30 million) by the end of 2005.
Despite many drawbacks, Sri Lanka is doing relatively much better in the field of financial inclusion. This may be due to
many factors. Due to the lower incidence of poverty (about 15 percent), microfinance is more viable. In India, programs may
be modeled as poverty alleviation microfinance programs. The literacy rate is about 92 percent. A better literacy rate can
be linked to better awareness of financial services and an open mindset toward using them. In Indonesia, an impetus to
financial literacy is a must, along with financial inclusion. Women are actively involved in the economy.
From 2003-2007, of the estimated worker contracts abroad, on average, 65 percent have been females. Around 80 percent of
exports have been dependent largely on the fortunes of the garment industry in which over 90 percent of employees are
women. Financial policy should be designed to specifically empower women. The network of schools is quite wide and can
be harnessed as a tool for propagating financial literacy and usage of services. Youth form a major chunk of the population,
and inculcating in them financial habits can be a crucial step for the future. Similarly, post offices can also be used for the
purpose of financial inclusion.
India
SEWA (the Self-Employed Womens Association) is a membership organization a movement rather than a program. Its
objective is to empower poor women working in the informal sector, so that they can achieve secure employment and selfreliance. As a membership organization with firmly democratic procedures and based explicitly on Gandhian principles, all
other SEWA activities have emerged and evolved in direct response to members needs. Members are rural and urban poor
21
women working in the informal sector, who have empowered themselves by organizing into a labor union to struggle for
their rights, and into 100 cooperatives to improve their economic security.
SEWA members see themselves first and foremost as workers, and identify their primary need as gainful and secure
employment. Large numbers of members have increased their incomes through both the collective pressure that organizing
allows them to exert and the creation of alternative employment opportunities. They have gained access to markets through
information campaigns, assistance with product improvement, and SEWA-run marketing services; they have gained access
to services that are essential to a secure livelihood; and they have gained access to banking facilities that allow them both to
save and to borrow in small amounts and on reasonable terms and so gradually build up assets. At the same time, large
numbers of members have achieved self-reliance. By organizing poor women and providing training and capacity building
of various kinds, SEWA has developed their leadership abilities, their self-confidence, and their life skills.
SEWAs successful efforts have mobilized large numbers of poor self-employed women for empowerment. From small
beginnings in 1972, as a group of poor, illiterate women working as casual laborers in the wholesale textile markets,
SEWAs membership has grown to 535,000 in its home state of Gujarat, and to around 700,000 throughout India. The
annual rate of membership growth has averaged between 25 percent and 35 percent in each of the past three five-year
periods.
A structure has evolved that gives SEWA great flexibility to grow and respond to members needs. Apart from the formal
election and governance arrangements, there are three main ways in which members are engaged:
A union, with both urban and rural branches, that helps members in their collective struggle for fair treatment and access to
justice, to markets, and to services. The urban branch represents over 70 occupations or trades and has focused on upgrading
skills in changing markets and seeking better wages and benefits. The rural branch targets alternative employment creation
including handicrafts and some high value crops, reversing a trend toward declining agricultural wages and leading to a
noticeable decline in seasonal migration of female agricultural workers.
Cooperatives help members produce and market the fruit of their labor and build their assets. The largest cooperative is
SEWA Bank whose deposits total $13.9 million, with $3 million loans outstanding (average loan size of around $60). The
World Bank is a major source of SEWA strength, and an innovative source of microcredit. The other more than 100
cooperatives help women improve the marketing, quality, and design of their handicraft and woven items to ensure
consistency, timely delivery, and salability. Cooperatives also promote new agricultural products, and techniques that add
value to traditional products. Other cooperatives include a rural marketing organization and a Trade Facilitation Center.
Member services that are financed partly by user charges, but also in part by donors, and by government departments have
been unsuccessful in providing the services for which they are responsible by statute. SEWA concentrates its member
services in the key areas of health care, childcare, insurance, and housing.
The main lessons of SEWAs experience in mobilizing and empowering poor self-employed women can be summarized into
four headings:
Organizing members (as distinct from offering services at the outset) helps to ensure ownership, and having subsequent
activities that are based on members needs, while providing a firm foundation for future growth. In making poor women
better informed about their rights, it increases the accountability of various organizations. In helping members articulate their
needs, it ensures that SEWA activities are demand-driven. In identifying potential activists and leaders among new recruits,
it lays the ground for SEWAs future growth.
Values at the core of an organization help establish consistency in its purpose, and serve to attract and retain highly
motivated staff and members. They also underpin the patience and perseverance needed to influence the policy environment.
From its inception, SEWA has been steeped in Gandhian beliefs and practices. Perseverance, egalitarianism, inclusion, and
22
participation are actively incorporated into meetings and organizational practices.

Flexibility in an organizations style and structure encourages experimentation and learning, a willingness to take advantage
of partnerships with others, and an ability to recognize crises as opportunities. Flexibility induces innovation and risk-taking;
a capacity to grow; a decentralized style that promotes a highly motivated, energetic and committed staff; and a focus on
ideology rather than dogma.
Leadership is crucial not only in defining an organizations vision, but also in establishing management and behavioral
practices that reduce social distance between corporate management and grassroots members. Moreover, effective leadership
skills can be taught to and learned by poor and uneducated women.
SEWA has overcome many challenges. Initially it encountered great resistance in even registering as a union, since the
authorities questioned whether self-employed women were legally entitled to form a trade union. Later the banking
authorities were reluctant to sanction a bank that lent to self-employed women without collateral. In overcoming these and
many similar challenges, SEWA has shifted the policy environment in India, and in that way it has had an impact far beyond
its membership. The challenges of rapid growth have been successfully met up to now, thanks in part to SEWAs flexible
structure, but they are a continuing preoccupation as membership continues to increase. And the long-run financial viability
of various enterprises remains a concern: while SEWA has a clear policy that all such activities should be self-sustaining,
actually making them so, and deciding when initial subsidies have gone on long enough, is always difficult. Moreover, some
of SEWAs newer initiatives, such as insurance, require more financial expertise and discipline than traditional activities.
Mongolia
Mongolia has a population of 2.66 million, and may be considered as a city state, as 40 percent of the population lives in
the capital city of Ulaanbaatar, where about 60 percent of gross domestic product (GDP) is generated. Poverty is higher in
rural areas, especially in the western regions, and there are indications that the poverty gap continues to widen (IFC & KfW
2009).
Today, Mongolias largest and most profitable bank, with offices in every village and neighborhood, is the Khan Bank of
Mongolia. Khan Bank is an example of a former public bank that has ultimately been reformed into a model of financial
inclusion. While it was privatized in 1991 as the Agricultural Bank of Mongolia, it was not separated from the government
and there was no real change in its operations (ADBI 2009).
The bank failed in 1996. It was recapitalized by donors, but, since there was no change in its operations, was placed in
receivership in 1999 and accepted a compromise remediation plan under the World Bank Financial Sector Adjustment Credit
(FSAC) program, where the government re-acquired 100 percent ownership, but the bank was run by external management,
Development Alternatives, Inc. DAI, and supervised by an independent board. The bank was renamed Khan Bank
(ADBI 2009).
After generating its first profit in 2001, the Bank was sold to Japans HS Securities in 2003, but DAI was retained as
manager. HS Securities resold 40 percent to Mongolian partners, and another 13 percent to DAI and IFC in 2004. The
successful privatization and restructuring of the state bank has resulted in high performance (ADBI 2009). It has become a
successful turnaround of a state bank, which increased the number of deposit accounts by over 1.4 million since 2006, and
reached 62 percent of all households in 2010 (Hannig & Jansen 2010).
The key to the Banks turnaround and current success has been the successful development and implementation of new
products throughout the country. The current menu of credit and deposit products is carefully tailored to be responsive to the
unique demands of the market. For example, the Banks herder loans were specifically designed to meet the unique needs of
nomadic Mongolian herders. Available on terms of up to one year, they help cover living and operating expenses in the
months when herders are not generating income or wish to purchase herd-related goods. Because herders have substantial
cash at certain times of the year, penetration of the herder market with comprehensive training and banking services is a
23
priority (Gutin & Young 2005).
Nepal
Nepal has significantly unequal development across social groups. Ensuring equitable growth is one of the key priorities of
the Government of Nepal (GON). In light of these challenges, the Government has understood the substantial importance of
financial inclusion and the role of microfinance for poverty alleviation and economic development. The national interest to
expand financial services to low income households is held as a high priority for the Government. As a consequence of this,
GON adopted microfinance as one of the poverty reduction approaches and introduced a National Microfinance Policy in
2007 to promote rapid sectoral growth and increase the outreach of MFIs to low-income groups in remote areas.
Due to these favorable policies, Nepals financial sector has grown rapidly over the past two decades; increasing the number
of financial institutions from only two in 1980 to 264 in 2010. Currently, there are 31 Commercial Banks, 87 Development
Banks, 79 Finance Companies, 21 Microfinance Development Banks (MFDBs), 16 Savings and Credit Cooperatives
(SACCOs) with limited banking licenses, and 37 Financial Intermediary Non-Governmental Organizations (FINGOs)
operating in the country. In addition, there are hundreds of cooperatives providing financial services all over the country.
Despite the expansion of retail providers, the microfinance sector in Nepal has not yet met the growing needs of low-income
households, especially in rural areas.
Nepal is stretched from the highest altitudes in the world to the low plain lands. The geographical pluralism of Nepal
adversely affects large areas of hill and mountain regions, which remain out of reach of roads, causing impediments to
development programs, including access to financial services.
Access to financial services in Nepal is particularly hard in rural areas or areas with limited infrastructure. Institutions have
struggled to extend financial services beyond some populated areas especially in rural Nepal, but building a physical network
of branches is costly. Transportation costs, opportunity costs, and lack of financial providers remain major impediments to
access financial services for many people in rural areas, some have to walk for hours to access a branch. High costs of
obtaining basic infrastructure services, such as energy, appear to impose significant constraints to enterprise development
and thus limit demand for financial services.
Low population density in the hills and mountains coupled with difficult terrain and limited infrastructure provides
challenges for MFIs to reach those areas. Moreover, limited economic activities and high operational costs make hills and
mountains unattractive for MFIs. Not surprisingly, reaching hills and mountains remains a challenge for most MFIs.
Therefore, households are still very much dependent on loans from relatives, friends, and neighbors.
SOURCE: Mandira Sarma -Indian Council for Research on International Economic Relations- and Jesim Pais Institute for Studies in
Industrial Development (2008).
3.2 FINANCIAL INCLUSION IN INDONESIA

Indonesian Support of Financial Inclusion
The government (i.e., Bank Indonesia), the financial industry, and communities are Indonesias
financial inclusion stakeholders. Each plays a different role. The government is a regulator and
supervisor; the financial industry, including MFIs, supplies services; and the communityparticularly
the low-income poor, working poor, and near poorare targeted by financial inclusion programs.
Table 3-1 explains Bank Indonesias activities in financial inclusion in Indonesia.
24
Table 3-1
BIs Activities to Implement Financial Inclusion in Indonesia
Approach
Financial education
Objective
To increase the knowledge and awareness of consumers
on financial products and services
Product/Activities
Scope of financial education program
Financial products and services
Risk management
Consumer protection
Financial management
MSME development
MSMEs are a core target for the fostering of local

economic development and the reduction of poverty
To highlight initiatives that can contribute directly to
MSME development
To encourage MSMEs in strengthening their eligibility
and capability in order to increase MSME access to
finance
People Business Credit (KUR)

To accelerate MSME bankability: land
certification, livestock insurance
Regional credit guarantee corporation
MSMEs rating system
Linkage program for technical assistance
and financing
Technical assistance and training
Saving
To increase the access to saving as a gateway for

consumer to access other financial products
Tabunganku
Government-to-Person (G2P)
To design flexible, cheap, and convenient products

Financing
To encourage the development of saving and credit

bundling initiatives
CSR Program
Government credit program
To support the financing from CSR program

Payment system
To create greater access to financial services, particularly

related to transfer payments
To expand financial transactions
Insurance
Focus on promoting insurance products for the poor
Implementing information and

communication technology as an
instrument for payment system
JAMKESMAS
Insurance for migrant workers
Note: Based on definition of micro-insurance, JAMKESMAS cannot be categorized as a micro-insurance institution because of its premium
obligations. In this paper, JAMKESMAS is viewed as an implementer of the social security agenda.
SOURCE: Alamsyah, Halim. 2012.
Saving mobilization in supporting financial inclusion in Indonesia is conducted through a range of

programs including those listed below.
Bank and Self-help Group Projects

Program Hubungan Bank dan Kelompok Swadaya Masyarakat (KSM) (PHBK) is a group-lending
program sponsored by the Central Bank of Indonesia (BI) and the German governments Agency
for Technical Cooperation (GTZ). The program has been in existence since 1989.
Each member of a self-help group (SHG) must first put money in with the SHG manager before
obtaining a loan (save first, credit next).
Savings mobilization is integral to all financial linkages.
Joint liability and blocked saving accounts are alternatives to physical collateral.
My Saving Program/TabunganKu
In February 2010, 70 commercial banks and more than 900 rural banks launched a savings product
for individuals TabunganKu, to enhance the savings culture and improve public welfare. The main
25
features are no monthly administration fees, low initial deposit (IDR 20,000/US$ 1.8 for
commercial banks and IDR 10,000/US$ 0.9 for rural banks), and low interest rates
One service is transport by TabunganKu Cars, which take people to open TabunganKu accounts and
run from areas where people gather, such as schools, markets, office buildings, and residential
areas. The service with cooperation of the banking industry.
As of August 2012, TabunganKu had 2,667,897 accounts valued at IDR 2,778,576.29.
Rural Bank Saving/TAPRINDO

The main features are door-to-door fund collection, open market area services, a personal approach,
use of the electronic data capture machine, and rural banks joint cooperation on lottery prize
As of May 2011, rural banks had 8,246,578 accounts with an average savings of IDR 1,200,000
Simpedes (Saving in rural areas)

After a subsidized credit program called BIMAS performed poorly in the 1980s, Indonesias
government rural bank, Bank Rakyat Indonesia (BRI), stared the BRI Unit Desa System. Bank
branches offer simple savings and microenterprise credit services to the self-employed. The system
now serves tens of millions of clients.
Other Microfinancial Products

As a key component of Indonesias national strategy for financial inclusion, micro-insurance provides
insurance to low-cost broad market segments and the underserved. Low-income households are the
center-stakeholder of any micro-insurance scheme.
Social security and micro insurance. Micro-insurance, according to Churchill (2006), is the
protection of low-income people against specific perils in exchange for regular premium payments
proportionate to the likelihood and cost of the risk involved. Micro-insurance provides a safety net in
the event of accident or injury that prevents the poor from working, thereby protecting their capital.
The difference between social security and micro insurance is mainly in premiums. Social security is
guaranteed by the government, while micro insurance is paid by clients.
Government social security programs. The government provides two main types of social security
and assistance programs, one for formal economy workers and their families and the other for workers
in the informal economy, the self-employed, marginal groups, and the poor. Program details are set
forth in the Act of Republic Indonesia Number 40 of 2004 on the National Social Security System.
The national social security system aims to guarantee the fulfillment of the basic needs of living for
every participant and/or family members and provide a public good for formal workers and informal
workers.
For workers in the formal economy, the Social Security Board consists of (1) Limited Liability
Company (Limited) Social Security Workers (PT. JAMSOSTEK); (2) Limited Liability Company
(Limited) Savings and Insurance Fund Servants (PT. TASPEN); (3) Limited Liability Company
(Limited) of the Armed Forces Social Insurance Republic of Indonesia (PT. ASABRI); and (4)
Limited Liability Company (Limited) Health Insurance Indonesia (PT. ASKES).
Micro-insurance provided by insurance industry, NGOs, and development organizations.
Various insurance companies in Indonesia have run microinsurance pilot projects. Given the size of
26
the potential market, private insurance companies are now trying to develop products of interest to
various market segments. The field is promising, but faces several challenges.
Several organizations offer micro-insurance products, although most only offer (more often require)
credit life insurance to protect the portfolios of microfinance providers. Several large institutions are
pursuing micro-insurance products. Allianz Life Indonesia is a pioneer in Indonesia. In August 2006,
it started to offer micro-insurance for low-income households. Its micro-insurance is promoted by
means of a partnership between the public and private sectors (Allianz, GTZ, and UNDP). Memberowned insurers, such as Bumiputera, Jiwasraya, Asuransi BRIngin Life, Takaful, and Asuransi
Central Asia (ACA), offer an array of products. Other than credit, there are limited micro-insurance
schemes provided by the insurance industry, such as micro-insurance for Demam Berdarah (DB) from
ACA. ACA and Allianz are preparing to offer micro-insurance for fires and earthquakes. PT Chartis
Insurance Indonesia provides health micro-insurance.
Microfinance includes loans, savings, insurance, and pension products crafted to meet the needs of
poor people. All microfinance products, microcredit/microloans, micro-savings, micro-insurance, and
micro-pensions are important in helping the poor to safely accumulate and protect wealth. Until
recently, the focus was on providing microcredit to individuals or communities as an alternative to
informal moneylenders. But several studies of the impact of these services on the lives of the poor
have shown that microcredit is not a panacea; it often helps to generate extra income, but doesnt help
smooth the consumption over time. The focus on savings, insurance, and pensions is relatively new,
and savings and insurance schemes are starting to gain some popularity among MFIs.
Micro-pensions are designed for the people with low income. They combine the elements of a
standard pension scheme with the features of microfinance. They help clients grow their capital so it
can be used when they are no longer earning income. From the perspective of the microfinance
industry, money transfers as a fee-based activity can generate revenue for MFIs. Moreover, through
money transfer activity, MFIs can have access to migrant and remittances receiver savings, which
could be longer term than other clients savings (Ponsot 2007). One can easily imagine that migrants
need to save for long-term purposes that initially motivated their decision to migrate (e.g., building a
house or buying land). By cross-selling money transfer services with adapted financial products, MFIs
can transform remittance receivers into clients, and have access to this medium and long-term
resource at a relatively low cost (Ponsot 2007). The question then is: is there a significant increase in
savings for MFIs involved in the remittance market?
State of Financial Literacy

We conducted a quick survey of 1,040 respondents who live around the working areas of UPKs to
ascertain what financial services are used and the state of financial literacy in general. Survey results
indicate that about 92 percent of respondents are poor, living on less than IDR 2.5 million per month
(Figure 3-1). Only 1 percent have income equal to or above IDR 5 million per month. This condition
influences their knowledge of and access to financial service institutions.
Some financial productsincluding savings, credit, features, and insuranceare well known among
respondents. Respondents, however, make little use of products except for credit and savings; more
than 50 percent have used credit and savings services (see Figure 3-2). When respondents decide to
save, they consider the benefits and services provided by the savings products to respondents families
(48 percent) and the conditions of respondents income (29 percent). Formal financial institutions
(banks) are the most popular places for savings. Respondents choice of a particular bank is
influenced by distance from home and the benefit of the savings products (27 percent).
27
Figure 3-1
Percentages of Respondents by Average Monthly Income Classes
1%, 7 obs
7%, 73 obs
50%, 524 obs
> Rp 5 million
42%, 436 obs
Rp 2.5-5 million
Rp 1-2.5 million
< Rp 1 million
Figure 3-2
Respondents Knowledge and Use of Basic Financial Products
Used
Used, Others, 1%
Known
Known, Others, 55%

Used, Insurance, 17%
Known, Insurance, 80%
Used, features, 29%
Known, features, 83%
Used, pension fund, 3%
Known, Pension fund,

69%
Used, Credit, 56%
Known, Credit, 94%
Used, Remittance, 12%

Known, Remittance, 65%
Used, Saving, 73%
Known, Saving, 99%
Notes:
Saving product: saving account, Gyro, and bank deposit

Credit product: Credit, car purchase loan, credit card, housing loans
Features (banking features): ATM and mobile banking
Insurance: life, health, and education
Others: Mutual fund, stock, bond
Number of sample: 1040
Savings. Although the majority of respondents in our survey had heard the term "saving," only 73
percent have ever had savings accounts. This is because their income is low and they must spend most
of their money on consumption.
28
Credit. Among respondents who have ever heard of credit, only about 56 percent of them have ever
had credit. Formal financial institutions are the preferred sources of credit (76 percent), since they can
provide larger loans than informal institutions. Only about 13 percent of respondents have credit from
an informal financial institution and the rest have credit from both. In choosing a credit program,
respondents consider the benefit of the program (31 percent), distance from home to the institution
(31 percent), and the credit application process (21 percent).
Insurance. Our survey revealed that take-up rates for insurance are still low in Indonesia. Among 80
percent of respondents who have ever had insurance, only 21 percent of them currently have
insurance. The most popular insurance plans are health and life insurance, as stated by 33 percent of
respondents (Figure 3-3). Only a few respondents have owned education insurance (6 percent).
Banking Features. Although 73 percent of respondents know about banking services only 22 percent
have ever used such services (Figure 3-4). About 26 percent of these respondents decided not to use
banking services. About 60 percent know about services for remittance and pension funds. But only
12 percent and 3 percent of these respondents have used remittance and pension funds. With respect
to remittances, respondents say that they prefer to use formal financial institutions because the
facilities and networks are better than those of informal institutions.
Figure 3-3
Respondents Knowledge and Ownership of Insurance
100%
20%
80%
21%
79%
29
Figure 3-4
Use of Banking Products in General Based on Saving Account Ownership
100%
Sample
(1040)
100%
None, 62%
466 obs
80%
1%
Do not Have
Saving Account
(10)
99%
Have Saving
Account
(1130)
60%
40%
Mobile
Banking
1%, (5 obs)
20%
27%
Not
used
(276)
Used
(754)
73%
Both, 4%
(27 obs)
ATM 34%
(256 obs)
0%
Saving Account Ownership
Note: Banking Products: ATM and Mobile Banking
Respondents living around the working areas of UPKs have good knowledge of automatic teller
machines (ATMs) and mobile banking services. Still, the use of these services is limited. Respondents
who have savings account usually also have ATM cards. Only a few respondents who have savings
accounts use mobile services. About 55 percent of respondents know about other financial services
(i.e., mutual fund, stocks, and bonds) but few use such services.
3.3 GAP BETWEEN CURRENT AND DESIRED STATE OF FINANCIAL

INCLUSION
How to deliver a wider range of financial services to more people, particularly low-income groups, is
an emerging issue around the world. Many developing countries are using various programs to
improve financial inclusion. The Central Bank of Philippines uses a combination of a liberalized
branching regime, m-banking technology, and strategic partnerships with nonbank agents to increase
access to financial institutions. In Bangladesh, Grameen Bank, a trust-based bank, offers loans
without any collateral requirement. Sri Lanka has a sustainable microcredit delivery system through
poverty alleviation microfinance projects. The purpose of Indias Self-Employed Womens
Association (SEWA) is to empower poor women working in the informal sector. Mongolias Khan
Bank has offices in every village and neighborhood to support financial inclusion. The Government of
Nepals national microfinance policy in intended to increase the outreach of MFIs to low-income
groups in remote areas.
Indonesia is following this trend, with the government, BI, the financial industry (banks), launching
programs and other MFIs helping the poor access financial institutions. Together, they provide a
supply of financial services in Indonesia. Credit programs for low-income groups include the People
Business Credit (KUR), Linking Bank and Self Help Group Project, SIMPEDES from Indonesias
government rural bank (Bank Rakyat Indonesia, BRI) and other government credit programs (e.g.,
credit for inputs for farmers). To increase the access of the poor to savings program, the government
and BI have designed flexible, cheap, and convenient products (i.e., Tabunganku, or My Saving;
SIMPEDES from BRI, and Government-to-Person). Meanwhile, to promote insurance for the poor,
BI and the financial industry have designed JAMKESMAS and an insurance program for migrant
workers.
30
While supply side measures in the financial sector are developing rapidly in Indonesia, demand is also
increasing. This means that there is a gap between demand and supply of financial services,
particularly for low-income groups. Again, about 50 percent of Indonesians still have only have
limited access to affordable formal financial services, an observation supported by our survey, which
found that while people know about savings, credit, and insurance services, they tend not to use them
for variety of reasons (e.g., little money for savings, limited access to credit, and distance between
home and formal and informal institutions).
To fill the gap between supply and demand and to promote financial inclusion, the Government of
Indonesia established the National Program for Community Empowerment (Program Nasional
Pemberdayaan Masyarakat) in 2007. PNPM is focused on poverty reduction at the community level.
Its Units Pengelola Keuangan (UPKs) manage community grants. Details about PNPM-UPK are
provided in Chapter 4.
4. PNPM UPK System

4.1 BACKGROUND
Program Nasional Pemberdayaan Masyarakat (PNPM) is the national program for community
empowerment established in 2007. Earlier community empowerment programs included
Program Pengembangan Kecamatan (PPK), a district development program that conducted basic
community empowerment in rural areas, and
Program Penanggulangan Kemiskinan di Perkotaan (P2KP) a poverty alleviation program in urban
areas that undertook basic urban social development.
Since 2008, PNPM Mandiri has expanded by involving Program Pengembangan Daerah Tertinggal
dan Khusus (P2DTK), a program for disadvantaged and special areas in the development of
disadvantaged, post-disaster and conflict areas; and Program Pengembangan Infrastruktur Sosial
Ekonomi Wilayah (PISEW) to integrate centers of economic growth with surrounding areas. Various
empowerment programs by various departments of the sector also strengthen the PNPM.
The PNPM is a national policy framework and a process for reducing poverty at the community level.
PNPM Mandiri was implemented by harmonizing systems and mechanisms that provide mentoring
and funding incentives for community involvement in poverty reduction. PNPM implementation
through empowerment enhances the capacity of communities to solve problems and improve living
standards and requires involvement of the local government and other stakeholders to ensure
sustainability. A board manages community activities through the Unit Pengelola Keuangan (UPKs),
which manages local financing and grants to PNPM beneficiaries. The implementation of PNPM
Mandiri in achieving PNPM objectives illustrates these basic principles. Community empowerment
starts at the planning stage of the provision of food, health, and education services, expansion of
employment opportunities, etc. and goes through implementation, monitoring, and evaluation.
PNPM procedures must be simple, flexible, easy to be understand and manage, and accountable to the
community. All activities must be oriented to the poor and involve the community. This means that
individuals or groups with simple technology, low risk, and without an expert, are included in
decision-making and activities. All parties interested in reducing poverty are encouraged to cooperate.
Effective and efficient implementation requires localizing programs, at the subdistrict level for rural
PNPM and the village level for urban PNMP.
Rural PNPM
The Ministry of Home Affairs oversees the Coordinator of Team Controller of PNPM Mandiri at
every level: central, provincial, district (kabupaten/kota) and subdistrict (kecamatan). Each subdistrict
has a community organization known as Badan Koordinasi Antar-Desa (BKAD), based on the
mechanism of Musyawarah Antar Desa (MAD), which consists of the following: Unit Pengelola
Keuangan (UPK), Badan Pengawas-UPK (BP-UPK), verification team and local assistance, which is
32
drawn from the local community. At the subdistrict level, a district facilitator and technical facilitators
educated as civil engineers oversee activities.
Revolving loan funds (RLF) can give the poor access to financing. UPKs were established to assist
with RLFs. UPKs are expected to support activities during the program and post-program periods, and
to maintain the sustainability of programs as a revolving fund management institution. .
UPKs support community activities through the provision of revolving fund services and technical
management programs. Reflecting the goal of promoting financial inclusion, UPKs have a strategic
role in the implementation of rural PNPM programs. In the process of supporting the provision of
revolving loan funds and technical management programs UPKs manage all of the relevant PNPM
funds. The PNPM funds are distributed to the poor through so-called "productive" activities
(revolving fund activities) such Usaha Ekonomi Produktif (UEP, or Productive Economic Activities)
and Simpan Pinjam Perempuan (SPP, or Women's savings and loans programs), and through
"nonproductive" activities, such as direct community assistance (BLM, or Direct Assistance for
Communities) and the provision of development funds (infrastructure, education, health).
In the rural PNPM activities, revolving funds are used for UEP and SPP programs. The UEP is a
capacity building activity designed to encourage skill development in mixed social groups (with a
composition of both women and men). These activities are carried on by poor households. The UEP
program does not provide additional capital, but provides finance in the form of revolving funds and,
also, provides training programs designed to foster the involvement of group members in business
activities. This means that communities that are actively involved in businesses activities often use the
revolving funds provided in the UEP program for training. SPP activities (Simpan Pinjam Perempuan,
or Women's savings and loans programs) provide capital for womens groups that support savings and
loan activities. SPP activities aim to help support needs of business or social funding through giving
opportunities to women, improving household economic activities through venture capital funding,
and encouraging the strengthening of savings and loans programs by women. Loan recipients of SPP
activities are generally groups of borrowers whose members are poor but productive. Borrower
groups are generally groups that receive revolving loan funds from the rural PNPM programs which
are managed directly and distributed to the beneficiaries (through a "channeling" process). It is
intended that Women's groups will implement "Tanggung Renteng" arrangements (joint liability
mechanisms) to pay for the installments of one or more members who fall into in arrears (and, indeed,
some UPKs require Savings Group arrangements for candidates who will make a loan to the UPK).
Urban PNPM
The Ministry of public works manages the urban PNPM. At the provincial and district level, it
oversees the Team Controller and Bappeda. While the rural PNPM is under the authority of
BKAD/MAD and UPK, the urban PNPM is under the authority of Camat and Penanggung Jawab
Operasional Kegiatan (PJOK) (which controls administration of the subdistrict works area, including
inspections of funds disbursed for the community in accordance with proposals approved by
facilitators).
In the urban PNPM, village implementers are the Badan Keswadayaan Masyarakat (BKM), or
Lembaga Keswadayaan Masyarakat (LKM). BKMs involve the community in order to develop selfreliance, reduce poverty, and support general development. Also, the BKMs role in the BLM is to
establish policies and to monitor the use of funds managed by UPK.
PNPM UPK SYSTEM
33
Communities that benefit from the urban PNPM are Kelompok Keswadayaan Masyarakat (KSM).
KSMs are managed by volunteers and assisted by facilitators from villages that have a common bond
and share certain objectives. KSMs are passive beneficiaries and implement activities related to
poverty alleviation, for which BKM raises funds.
Urban PNPM manages RLFs to create business and job opportunities, increase the income of the
poor, and support other productive activities. RLF success depends on the ability to manage funds and
to support borrowers (KSMs and members).
The BKM is a village-level organization whose members are selected on the basis of their humanity
and leadership abilities. It establishes managerial units to execute policy in economic, environmental,
and social realms. These are Unit Pengelola Keuangan (UPK), which manages RLFs; Unit Pengelola
Lingkungan (UPL), which manages infrastructure relief assistance; and Unit Pengelola Sosial (UPS),
which manages social relief assistance (education, health). The units make independent operational
decisions but are responsible to the BKM. The legal position of BKMs reflects the decision-making
process of the local community. The results of community agreements, formulated in village
meetings, are normally authorized through registration and notarized by a Notary.
The main difference between rural and urban UPKs is that rural ones are formed by communities
through MAD and channel funds to communities for the construction and improvement of public
facilities, as well for RLFs at the subdistrict level. UPKs in urban areas implement the activities of the
unit BKM, particularly for RLFs for self-help groups at the village level.
4.2 EVALUATION OF UPK PERFORMANCE BASED ON NATIONAL

DATA
Achieving an inclusive financial system is a concern of government and academia. Inclusion,
however, involves the demand and the supply sides of the financial market. Access to financial
services cannot be improved without attending to supply side consequences as any change in demand
side will affect supply. Thus, any attempt to improve access to formal financial services will require
adjusment on the supply side.
Developing an inclusive financial system that overcomes the constraints of formal financial markets
and that gives priority to low-income groups will have positive effects on the economy. UPKs have
experience serving the financial needs of the very poor members and in innovative financial practices.
In providing loans to poor families, for example, they require joint liability collateral, realized through
group lending schemes, rather than material collateral. But before UPKs can take on a bigger role in
improving access to financial services for excluded communities, they must be strong and
sustainable. To judge the strength of UPKs we set out to examine their operations and financial status
by
Collecting reports on rural and urban UPKs,

Reviewing literature review on microfinance performance indicators,
Checking UPK reports for data related to such indicators,
Selecting indicators, and
Measuring the performance of rural and urban UPKs.
Collecting Reports on Rural and Urban UPKs

The study team collected UPK reports from various institutions handling national data on rural and
urban PNPM. Data sources for urban UPKs were 10,114 reports from December 2010 through March
34
2013. Data sources for rural UPKs are reports submitted from September 2010 through June 2012 but
the number of UPKs varied by each reporting period.
Literature Review of Microfinance Performance Indicators

The research team has summarized the literature review of microfinance performance indicators in
Appendix C.
Data from UPK Reports

The study team then checked UPK data for availability and consistency in indicative performance
indicators. The database of urban UPKs reports on the following:
Balance sheet
Income statement (income and cost)
Rotating loan fund indicators
Number of borrower groups (KSM)
Collectability
Turnover
The database of rural UPKs has reports on the following:
Collectability of SPP
Collectability of UEP
Accounts reconciliation
Operational of program
Operational of microfinance activity
Balance sheet of program
Loans for female borrower groups (SPP/womens saving and loan program)
Balance sheet of microfinance activity
Cash flow
Health condition of UPKs
Pilot cash flow
Mapping of UPKs
Loans for productive economic activities (UEP)
Performance Indicators for Rural and Urban UPKs

Because rural and urban UPKs have and report on different data and in different formats, the study
team developed performance indicators as follows:
Selected indicators from literature and data in UPK reports.
Used a modified CAMEL (capital-asset-management-earning-liquidity) approach to assess UPK
sustainability and performance.
Compared the performance of urban and rural UPKs by mapping and selecting variables.
Used indicators to quantify UPK sustainability.
Table 4-1 presents performance indicators for assessing the financial sustainability of UPKs.
35
PNPM UPK SYSTEM
Table 4-1
Financial Sustainability Performance Indicators
Type
Indicator
Code
Definition
Cap
Leverage
LEV
Asset/equity
Asset
Loan portfolio
ALP
Loans outstanding for the year computed on a monthly basis
Total assets
ATA
Total assets for the year calculated on an annual basis
Earning asset
EA
Loan portfolio/total asset
Financial asset
FA
Earning asset + liquidity
Portfolio at risk (>0day)
PAR
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
Sustainable (selfsustainable): Sustainability

Index
SUS
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 value above 10
percent.
Management
SI=YoP-OER-PAR
Earning
Liquidity
Current cost
recovery/operational self
sustainability
CCR/OSS
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 percent)
Operating expense ratio
OER
Ratio of salaries, travel, administrative costs and depreciation expenses

to the average loan portfolio
Return on assets
RoA
Ratio of profit earned (or loss) to average total assets. RoA is a measure
of an organisations 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 percent range
Yield on portfolio
YoP
Actual interest income on lending by the RLF divided by the average

loan portfolio for the year
Liquidity
LIQ
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 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
Development of UPK Performance Measurement

Researchers propose several methods for calculating the financial sustainability of MFIs (Appendixes
D and E). This study calculates a sustainability index for UPKs. In a financial context, a sustainable
institution is one that generates enough revenue to cover operational expenses and capital investment
needs. In terms of indicators used by M-CRIL and the World Bank, an operationally sustainable
financial institution has an operating expense ratio (OER) of 100 percent, and a financially sustainable
institution covers its capital expenses as well (ROA greater than zero). Some characteristics of UPK
operations are as follows:
UPK operating costs are relatively low because they do not have to cover some expenses for
internal control, governance, and support systems, including facilitation.
Costs associated with rotating loan funds are low because the government is the source and UPKs
do not pay interest on the funds.
36
Some UPK reports do not calculate loan loss provision. For UPKs with weak portfolios, as
indicated by a high number of nonperforming loans, this condition may reduce real profits.
But considering operating expenses and low RLF costs, UPKs should be very profitable based on
higher values in profitability indicators, including return on assets. Therefore, using profitability
indicators to assess sustainability will not provide accurate information. The research team needs a
new indicator to examine UPK sustainability.
Another consideration is that deposit savings institutions provide fees/interest for customers at about 5
percent per annum. As UPKs are expected to have improved roles in their activities, for example,
when they become deposit takers, they have to be able to pay interest. Therefore, the interest provided
by other formal institutions provides a threshold value for a new indicator, the Sustainability Index
(SI). The formula is as follows:
Yield on Portfolio - Operating Expense Ratio - Portfolio at Risk
(YoP OER PAR)
Based on such criteria, an operationally sustainable financial institution has an SI value of above 10
percent.
Evaluation Results
Indonesias poor communities have about 15,425 UPKs, 65 percent in urban areas (10,114) and 35
percent in rural areas (5,311). UPKs are expected to improve access to financial services for the poor.
But whether they can provide even better access and advance financial inclusion depends on the
sustainability of their financial and operational performance. Drawing on UPKs reported data, we
discuss UPKs sustainable performance as precondition for their contributing to progress in financial
inclusion.
Figure 4-1 shows the percentage of sustainable and unsustainable urban UPKs. At the national
aggregate level, considering the SI threshold value of 10 percent or above, approximately 16 percent
of urban UPKs are sustainable. Some provinces have a greater percentage of sustainable of UPKs than
the average, with the highest percentage in Kalimantan Tengah Province (more than 40 percent are
sustainable). However, no urban UPKs in Papua, Papua Barat, and Maluku provinces are sustainable.
The percentages of sustainable urban UPKs in the selected research areas are as follows, DI
Yogyakarta, 14 percent; Jawa Tengah, 13 percent; Sumatera Barat, 10 percent; and Nusa Tenggara
Timur 7 percent.
With the same threshold at the national aggregate level, the percentage of sustainable rural UPKs is 16
percent (Figure 4-2). The provinces of Kepulauan Riau and DI Yogyakarta have the highest
percentages of sustainable UPKs (greater than 40 percent). In contrast, no rural UPKs in Nusa
Tenggara Barat province are sustainable. In Jawa Tengah 20 percent of rural UPKs are sustainable
and Sumatera Barat 7 percent are. No data are available for Nusa Tenggara Timur.
These findings imply that 16 percent of UPKs in urban and rural area could be transformed to further
improve financial access for the community. In a financial context, the sustainable UPKs are
relatively ready, but additional steps are required to transform UPKs, as explained in Chapter 5.
PNPM UPK SYSTEM
37
38
Figure 4-1
Sustainability of Urban UPKs
Figure 4-2
Sustainability of Rural UPKs
PNPM UPK SYSTEM
39
Referring to the Sustainability Index, the key financial performances of urban and rural UPKs are
presented in Table 4-2. Tables 4-3 and 4-4, below, show the operational and financial indicators of
UPKs.
Capital. One indicator for capital is leveragethe ratio of assets divided by equity. The asset/equity
ratio indicates the relationship of the total assets of the MFI to the part owned by shareholders
(owners equity). Usually, this ratio is an indicator of the companys leverage (debt) used to finance
the firm. There is no ideal ratio, but it is valuable in comparing businesses. A high ratio (indicating
lots of assets and little equity) may indicate that the company has taken on substantial debt merely to
remain in businessor is wisely trading on equity. In other words, there is a high asset/equity ratio
because the return on borrowed capital exceeds the cost of that capital. But UPK assets are not
financed by debt so UPKs have low cost of capital. These asset/equity ratios simply indicate return on
received capital and the ability of UPKs to manage capital.
Assets. There are two indicators to assess the assets of UPKs, portfolio at risk (PAR) and earning
assets. PAR is the ratio of the principal balance outstanding on loans overdue more than or equal to 1
day to total loans outstanding on a given date. It is often stated by degree of risk PAR30 = principal
outstanding in loans with overdue for more than 30 days, or PAR90 principal outstanding in loans
overdue for more than 90 days, and so on. Earning assets are calculated from the loan portfolio
divided by total assets.
Table 4-2 shows that sustainable UPKs have lower PAR90 than unsustainable ones. The value of
PARs of sustainable UPKs is less than 1 percent, while for the unsustainable urban UPKs it is more
than 40 percent, and about 19 percent for unsustainable rural UPKs. This indicates that sustainable
UPKs are better able to manage risk. For earning assets, there is no significant difference between
sustainable and unsustainable UPKs. About 70 percent of their assets are delivered as loans to
members.
Earnings. UPK earnings can be assessed by the indicators of operational self sustainability (OSS),
operating expense ratio (OER), return on assets (ROA), and yield on portfolio. OSS is actual revenue
earned from operations as a proportion of total cost incurred in operations. For an organization to be
sustainable, its OSS should be greater than 1 (or >100 percent). Operating Expense Ratio is the ratio
of salaries, travel, administrative costs, and depreciation expenses to the average loan portfolio. OSS
and OER values are proxies for the efficiency (ratio) in the operation of UPKs. The efficiency ratio
measures the cost of providing services (loans) to generate revenue.
ROA is the ratio of profits earned (or lost) to average total assets. ROA is a measure of profitability
relative to total funds deployed in all activities (not just operations). In the financial sector, ROA is
usually in the 1-3 percent range. Yield on portfolio is actual interest income on lending by the RLF
divided by the average loan portfolio for the year.
Table 4-2 explains the values of earning indicators and shows that sustainable UPKs have the ability
to manage their operations. The value of OSS, ROA, and yield on portfolio is higher for sustainable
UPKs than unsustainable ones. The other ratio of efficiency is OER, and, as expected, sustainable
UPKs have lower OERs compared to unsustainable ones. Since the operational cost of UPKs is very
low, the value of OSS is very high and the OER is also low. The costs are mainly used for the salary
of UPK staff. Some activities such as monitoring and facilitation in the UPKs are mainly financed by
other sources of the PNPM program.
40
Table 4-2
Financial Performance of Urban and Rural UPKs (percentage)
Urban UPKs
Indicator
Sustainable
Rural UPKs
Unsustainable
Total
Sustainable
Unsustainable
Total
124.1
101.9
102.1
102.0
CAPITAL
Leverage
136.9
121.5
ASSET
Portfolio at risk
Earning asset
0.7
40.6
34.0
0.7
18.8
15.8
70.4
73.4
72.9
71.3
71.7
71.6
EARNING
Operational self sustainability
647.0
338.0
389.2
396.4
263.6
286.0
7.2
12.3
11.4
3.7
5.3
5.0
Return on asset
12.1
0.2
2.2
6.0
3.1
3.6
Yield on portfolio
24.0
10.3
12.6
11.6
7.6
8.2
26.7
27.0
26.1
26.3
Operating expense ratio
LIQUIDITY
Liquidity
29.4
26.2
Table 4-3
Other Operational and Financial Indicators of Urban UPKs
Indicator
Sustainable
Unsustainable
Total
Percentage of RLF to Equity of Microfinance Activities
96
77
81
Avg. loan portfolio/UPK (mn IDR)
91.1
106.3
103.8
Avg. loan portfolio/group (mn IDR)
3.6
4.5
4.3
584.2
975.8
910.4
Percentage of UPKs with > 50 percent of collectability 5
21
18
Percentage of UPKs with 100 percent of collectability 5
Avg. of total cost (mn IDR/month)
6.7
9.1
8.7
Avg. loan portfolio/member (th IDR)
Avg. of salaries /total cost (percent)

Avg. of salaries and benefits to average outstanding portfolio (percent)
Avg. financial revenue/total revenue (percent)
54
41
43
95
83
83
Table 4-4
Other Operational and Financial Indicators of Rural UPKs
Indicator
Sustainable
Unsustainable
Total
Percentage of RLF to Equity of microfinance activities
97
78
81
91
106
104
584
976
910
Avg. of total cost per UPK per month (mn IDR)
21
18
Avg. of operational/total cost (percent)
Avg. of salaries of UPK staff/operational cost (percent)
54
41
43
Percentage of UPKs with > 50 percent of collectability 5

Percentage of UPKs with 100 percent of collectability 5
Avg. of salaries and benefits to average outstanding (percent)

Avg. revenue from SPP/total revenue (percent)
41
PNPM UPK SYSTEM
The same holds true for ROA. Because UPKs do not have financial expenses, ROA will be higher as
compared the typical MFI. Table 4-2 shows that ROAs in sustainable UPKs are higher than in
unsustainable one. Yield of portfolio in sustainable UPKs is also higher than in unsustainable UPKs.
Liquidity
Liquidity is cash in hand plus money in bank accounts as a proportion of total assets. Table 4-2 shows
that urban and rural UPKs have a liquidity value of about 27 percent. There is no significant
difference between the sustainable and the unsustainable UPKs. This is an indication that UPKs hold
some idle money, around one-third of their assets. As discovered in focus group discussions, liquidity
is relatively higher in UPKs for several reasons, including problems with loan disbursements and the
high incidence of nonperforming loans hindering UPKs in delivering loans and keeping assets in a
bank account.
Relationship Between Sustainability and Regional Indicators

We use a logistic regression to investigate the relationship between regional indicators and
sustainability of UPKs in Indonesia. Regional indicators are treated as independent variables in the
model, while the variable of UPK sustainability is a dependent variable (1=sustainable, 0=not
sustainable). The model is estimated by using maximum likelihood estimation. Table 4-5 presents the
coefficients and odds ratios from the logistic model. Four out of eight independent variables have a
significant influence on the probability of UPK sustainability. These variables are (1) proportion of
local revenue (PAD), (2) education level of the village chief, (3) number of small enterprises, and (4)
number of cooperative institutions. The estimated coefficients of these independent variables are
statistically different from zero, between 1 percent and 5 percent levels of significance. It would be
useful to utilize the values of odds ratios since the regression coefficient in the logistic model is only
used to predict probability values of a dependent variable with respect to all independent variables.
Table 4-5
Logistic Regression of Sustainability Model of UPK
Odds
Independent Variable
Coeff.
Ratio
Std. Err.
P>z
Proportion of agricultural households
0.40
1.51
0.26
1.58
0.11
Proportion of local revenue (PAD)
0.55
1.80
0.26
2.14
0.03
Village chief education
0.25
1.35
0.11
2.36
0.02
Number of small industrial enterprises
0.00
1.00
0.00
2.17
0.03
Number of formal education institutions
0.00
1.00
0.00
0.60
0.55
Number of Commercial bank
0.01
1.03
0.02
0.39
0.70
-0.02
0.99
0.02
-1.56
0.12
0.02
1.02
0.00
4.22
0.00
0.60
-5.82
0.00
Number of Rural Bank

Number of Cooperative Institution
Constant
-3.48
Note: Dependent variable is sustainability of UPK (sustainable=1)
Proportion of Local Revenue. The sign on the proportion of local revenue (PAD) is positive;
suggesting that a higher proportion of PAD is associated with sustainability. The odds ratio 1.80
implies that the probability of UPK sustainability increases by 1.80 percent when the proportion of
PAD increases 1 percent. This means that a higher proportion of local revenue in certain regions
42
generates income activities increasing the revolving fund of UPK in the region. If it is assumed that
credit default is lower, the probability that UPK is sustainable increases.
Education of Village Chief. Education levels are elementary, secondary, tertiary, and university. The
odds ratios suggest that increasing the education level of the village chief can increase the probability
of UPK sustainability 1.35 times. Village chiefs that have higher levels of education tend to be
innovative, which in turn may facilitate the speed of UPK programs in their regions.
Number of Small Industrial Enterprises. The number of small industrial enterprises is significant and
positively related to UPK sustainability. The value of odds ratios indicates that if numbers of small
industrial enterprises increases by 1 unit, the probability of UPK sustainability increases 1.0001 times.
As outlined previously, UPKs provide small loans to the poor who have small businesses. This means
that the larger the number of small enterprises, the higher the absorption rate of UPK funding. This
result suggests that the more local firms there are, the more likely it will be that a UPK can make good
loans.
Number of Cooperatives. Similarly, a unit increase in the number of cooperative results in a 1.0
percent increase in the probability of UPK sustainability. The existence of cooperatives in a certain
area must be supported by economic activities, particularly small industrial enterprises. Cooperative
clients can borrow money from UPKs to expand their business. In this situation, there is no
competition between the two institutions, the UPK and the cooperative. In fact, they are
complementary.
Table 4-5 also shows that the coefficients of the remaining independent variablesproportion of
agricultural households, number of formal education institutions, number of commercial banks, and
number of rural banksdo not have any significant effect on the probability of UPK sustainability.
4.3 EVALUATION OF UPK PERFORMANCE IN THE STUDY AREA

The study team also analyzed micro level data of four provinces: DI Yogyakarta, Jawa Tengah,
Sumatera Barat and Nusa Tenggara Timur. Findings are presented below.
Financial and Operational Indicators

To become MFIs, UPKs must be sound and sustainable. This section discusses the financial and
operational performance of urban and rural UPKs in Sumatera Barat, Jawa Tengah, DI Yogyakarta,
and Nusa Tenggara Timur.
Urban UPKs
The financial and operational performance of urban UPKs can be distinguished on the basis of
sustainability (Tables 4-6 and 4-7). Sustainable ones have better value than unsustainable ones,
indicating relative ability to manage performance given their characteristics and resources. Other
observations of urban UPK performance in the selected research areas are as follows:
PAR90 measures the principal outstanding in loans overdue more than 90 days and indicates risk
management ability. Unsustainable UPKs have high value of PAR90, particularly in Nusa Tenggara
Timur (57 percent) and Sumatera Barat (42 percent). Sustainable ones have a PAR90 value of about
1-2 percent.
Yields on portfolio in sustainable UPKs are higher than those in unsustainable UPKs. Ability to
manage loans is a key to generating revenue.
43
PNPM UPK SYSTEM
Liquidity is an indicator of fund availability. Sustainable UPKs in Sumatera Barat and Nusa
Tenggara Timur are more liquid than those in Jawa Tengah and DI Yogyakarta. To improve
financial access, there should be a way to promote the appropriate delivery of funds.
Unsustainable urban UPKs tend to provide bigger loans per member and serve more members than
sustainable UPKs. In preparing UPKs for transformation, this aspect needs attention. Loan size and
number of members influences performance. To be a sustainable institution, there should be an
optimal economic of scale in the operations of UPKs. This will influence the market coverage and
outreach of transformed UPKs.
Except in Nusa Tenggara Timur, average salaries of UPK staff to total costs is more than 50
percent. In Nusa Tenggara Timur, the average salary of UPK staff to total costs is less than 20
percent. This raises a question: do incentives influence UPK quality?
All urban UPKs rely on loan delivery to generate revenue.
Table 4-6
Financial Performance of Urban UPKs in the Selected Research Areas (percentages)
Sumatera Barat
Jawa Tengah
DI Yogyakarta
S
136
123
136
124
42
OSS
911
530
OER
Return on assets
Nusa Tenggara Timur
140
118
123
118
40
27
57
779
319
649
451
659
452
10
13
13
Yield on portfolio
29
26
12
21
12
20
Liquidity
46
41
29
24
17
19
59
36
Earning asset
55
61
72
81
84
82
41
65
Leverage
PAR90
Note: S is sustainable; U is unsustainable
44
Table 4-7
Other Financial and Operational Performances of Urban UPKs in the Selected Research Areas
Sumatera
Jawa
DI Yogya-
Nusa Tenggara
Barat
Tengah
karta
Timur
RLF to equity microfinance activity (percent)
75
74
97
95
117
95
50
76
32
48
114
128
312
335
20
60
469
607
627
785
866
2901
479
430
69
101
204
245
357
312
42
151
UPKs with 100 percent of collectability 5 from

its loan portfolio (percent)
10
28
Total cost (mn IDR/month)
24
18
Salaries/total cost (percent)
64
66
57
50
44
53
15
20
95
85
94
87
98
92
93
48
Avg. number of borrowers/group (number)
UPKs with > 50 percent of collectability 5

from its loan portfolio (percent)
19
18
45

Avg. number of borrowers/UPK (number)
Salaries and benefits to average outstanding

portfolio (percent)
Financial revenue/total revenue (percent)
Notes: S is Sustainable; U is Unsustainable
Rural UPKs
Tables 4-8 and 4-9 present data on the financial and operational performance of rural UPKs
differentiated by sustainability in the selected research areas. The estimates show that sustainable
rural UPKs have better value than unsustainable ones, indicating relative ability to manage
performance given their characteristics and resources. Other observations of rural UPK performance
in the selected research areas are as follows:
There is no database for rural UPKs in Nusa Tenggara Timur.
Loan sizes cannot be calculated because there are no outreach variables (e.g., number of members)
in the database of rural UPKs.
Yield on portfolio in rural UPKs is lower than in urban UPKs.
Liquidity in rural UPKs seems to be better than in urban UPKs. Liquidity is highest (32 percent) is
in Sumatera Barat.
Salaries of UPK staff to total cost are around 40 percent in Jawa Tengah and DI Yogyakarta, and
about 50 percent in Sumatera Barat. For urban and rural UPKs, total costs are mainly for salaries,
but this does not necessarily mean that UPK staff are highly paid. The total cost of UPKs is
relatively low because some microfinance activities are financed by other government sources or
the PNPM.
All rural UPKs rely on loan delivery to generate revenue.
45
PNPM UPK SYSTEM
Table 4-8
Financial Performances of Rural UPKs in the Selected Research Areas (percentage)
Sumatera Barat
Jawa Tengah
DI Yogyakarta
101
101
104
102
103
103
15
10
OSS
351
239
416
315
312
264
OER
Return on assets
Yield on portfolio
10
12
10
Liquidity
33
33
23
19
16
19
Earning asset
67
66
76
79
82
79
Leverage
PAR90
Note: S: Sustainable; U: Unsustainable
Table 4-9
Other Financial and Operational Performances of Rural UPKs in the Selected Research Areas
Sumatera Barat
S
68

Average of loan portfolio/UPK (bn IDR)
1.0
UPKs with > 50 percent of collectability 5 (percent)
UPKs with 100 percent of collectability 5 (percent)
66
79
81
DI Yogyakarta
S
84
81
1.9
2.3
2.1
Average of monthly total cost / UPK (mn IDR)
30.5
42.0
44.5
47.9
87.2
Operational cost/total cost (percent)
98
95
96
96
98
96
Salaries of UPK staffs/operational cost (percent)
54
53
38
40
37
43
91
80
90
76
86
76
Salaries and benefits to outstanding loan portfolio (percent)

Financial revenue from SPP/total revenue (percent)
1.2
Jawa Tengah
2.0
79.4
Notes: Notes: S: sustainable; U: unsustainable
Table 4-10
Financial Performance of Sample Urban UPKs in the Selected Research Areas (percentage)
Sumatera Barat
D.I. Yogyakarta
Jawa Tengah
Nusa Tenggara Timur
136
128
152
127
133
122
166
123
70
38
37
89
369
639
731
496
662
353
396
215
RoA
11
13
13
YOP
29
12
19
16
26
11
34
LIQ
38
50
12
23
30
23
79
42
Earning Asset
63
52
88
79
71
85
21
59
Leverage
PAR90
OSS
OER
Notes: S: sustainable; U: unsustainable
46
Table 4-11
Other Financial and Operational Performance of Sample Urban UPKs in the Selected Research Areas
Sumatera
Jawa
D.I. Yogya-
Barat
Tengah
karta
Nusa Tenggara
Timur
85
66
93
84
134
88
35
71
38
61
91
78
118
254
30
47
591
673
632
1119
571
888
326
310
UPKs with > 50 percent of collectability 5 from its

loan portfolio (percent)
35
16
80
UPKs with 100 percent of collectability 5 from its

loan portfolio (percent)
13
60
Avg. of total cost (mn IDR per month)
20
71
62
46
45
35
36
31
15
Financial revenue/total revenue (percent)
98
83
93
87
98
83
89
32
Salaries of UPK staff/Total Cost (percent)
71
63
46
45
35
37
32
16
Avg. loan portfolio/UPK from its loan portfolio

(mn IDR)
38
63
91
96
119
272
30
47
591
673
632
1119
571
888
326
310
81
129
207
247
188
307
92
147
Avg. of salaries / total cost (percent)

Salaries and benefits to average outstanding
portfolio (percent)

Avg. loan portfolio/borrower (th IDR)
Avg. number of borrowers/group (number)
Avg. number of borrowers / UPK (number)
Notes: S sustainable; U unsustainable
Table 4-12
Financial Performances of Sample Rural UPKs in the Selected Research Areas (percentage)
Sumatera Barat
S
Leverage
Jawa Tengah
DI Yogyakarta
100
104
103
102
104
101
17
309
375
422
271
285
165
OER
RoA
YOP
14
12
10
LIQ
30
20
12
21
Earning Asset
69
92
79
86
92
79
PAR90
OSS
Note: S: sustainable; U: unsustainable
47
PNPM UPK SYSTEM
Table 4-13
Other Financial and Operational Performances of Sample Rural UPKs in the Selected Research Areas
Sumatera Barat
S
Jawa Tengah
DI Yogyakarta
69
96
81
88
95
80
Monthly total cost/UPK (mn IDR)
50
57
49
78
58
64
Operational cost/total cost (percent)
98
91
97
95
100
99
Salaries of UPK staffs/operational cost (percent)
43
48
41
35
48
54
88
97
79
69
99
97
RLF to equity microfinance activity (percent

Average of loan portfolio/UPK (bn IDR)
Salaries and benefits to average outstanding portfolio (percent)

Financial revenue from SPP/total revenue (percent)
Note: S: sustainable; U: unsustainable
Nonfinancial Indicators
The study team also surveyed two types households around UPK working areas, those that are already
members of UPKs and those that are not. The survey found that the majority of household
respondents around urban UPK are entrepreneurs. The proportion of UPK members that are working
as entrepreneurs is slightly higher than nonmember samples. Meanwhile, in rural UPKs, household
respondents, members and otherwise, work mainly as farmers, and only a small proportion are
entrepreneurs.
In Indonesia, women are important in managing household income. For all households in the sample,
more than 50 percent of women have control of household income (Figure 4-4). In urban areas,
around 72 percent of women in the UPK member sample have managed household income, compared
to 58 percent in the nonmember sample. It is different in rural areas where the proportion of women
from nonmember samples having control over income is slightly higher than those in member
samples (71 percent versus 58 percent). In such situations, it would be useful if revolving funds from
the PNPM were allocated to SPP since women can manage household income. And have fewer
problems with repayment than men.
Figure 4-3
Household Distribution by Profession
60%
53%
Gov. Employee
Entrepreneur
Employee
Retired
Others (Student, drivers, etc)
50%
48%
50%
40%
35%
33%
27%
30%
22%
20%
20%
10%
Farmer
7%
15%
12% 12%
10% 10%
0%
23%
0%
2%
6%
2%
2%
6%
5%
2%
0%
Member
Non-Member
Urban
Member
Non-Member
Rural
48
Figure 4-4
Household Distribution by Financial Manager
80%
Husband
72%
70%
Wife
Husband and Wife

58%
58%
60%
71%
50%
42%
40%
30%
20%
18%
18%
23%
20%
10%
9%
10%
0%
0%
Member
Non-Member
Urban
Member
Non-Member
Rural
Similar patterns prevail in financial literacy and access to and use of financial services. Age and
education influence knowledge and saving habits of household respondents. Respondents 30 to 50
years old have similar behavior with regard to saving and credit (Figure 4-5). Women have a higher
proportion of saving than men (74 percent versus 72 percent), while men have a higher share of credit
than women (63 percent versus 56 percent). This may be because men, as heads of households,
usually submit applications of credit to formal institutions and those institutions require creditors to
own income-generating activitiesand generating household income is the responsibility of men in
Indonesia. Savings accounts in rural UPKs are slightly higher than in urban UPKs (78 percent versus
72 percent).
Household respondents in rural and urban areas have the same behavior and attitudes about managing
money and income. Generally, they rarely if ever plan the management of their income (Figure 4-6).
UPK members, however, have done some financial planning (32 percent in urban and 30 percent in
rural areas). They may decide to do planning because UPKs require groups to provide a financial plan
before they receive credit. Less attention to financial planning may influence their behavior regarding
savings, credit, insurance, and pension funds.
49
PNPM UPK SYSTEM
Figure 4-5
Distribution of Saving Account Ownership
100%100%
94%
90%
87%
83%
83%
75%
73%
57%
54%
59%
58%
57%
72%
78%
74%
72%
63%
58%
61%
56%
54%
48% 50%
36%
0%0%
< 20 20 - 30 30-40 40 - 50 > 50

years years years years years
Never
Second
Primary
High Universi
UPK
go to
ary
Male Female
school
school
ty
Kota
school
school
Age
Education
Gender
UPK
Desa
UPK Type
Respondents who Have Account Have Savings
54%
87%
90%
100%
0%
36%
50%
73%
83%
94%
72%
74%
72%
78%
Respondents who Have Account Have Credit
57%
57%
83%
100%
0%
48%
58%
59%
58%
75%
63%
56%
61%
54%
Figure 4-6
Household Distribution by Financial Planning
65%
60%
58%
45%
32%
30%
28%
27%
15%
12%
9%
5%
3%
3%
Member
3%
3%
Non-Member
Member
Urban
Non-Member
Rural
Continuously
5%
3%
15%
3%
Regularly
3%
3%
9%
12%
Occasionally
32%
28%
30%
27%
Never
60%
65%
45%
58%
When household respondents were asked about their intentions in continuing to borrow from the
UPK, about 34 percent said that credit extensions are very important and 58 percent said they are
important (Figure 4-7). Ninety-one percent said that UPKs are an important source of business
support funds. About 39 percent suggest that UPKs provide credit above IDR 2 million/credit cycle.
Only 2 percent need credit below IDR 500,000. Currently, the first credit that can be submitted by a
group member is only IDR 500,000, and values of credit can double for the next period. The
maximum amount of credit that a UPK can provide is IDR 5 million per group member. On average,
each group member has already borrowed IDR 2 million.
50
Figure 4-7
Importance of Continuing Borrowing from UPKs
continue borrowing to
UPK
Very important
34%
Important
58%
Ordinary
6%
Less important
2%
Much less important

0%
Credit repayment is an important to ensure that revolving funds go to UPKs in other poor
communities. Respondents gave several reasons for ensuring repayment: responsibility to the group
(42 percent), ensuring more loans (28 percent), debt settlement (16 percent), and intention to stay in
the groups (14 percent) (Figure 4-8).
Figure 4-8
Reasons for Repayment
Responsibility to group,
42%
For further loans
28%
Want to be in the group,
follow the rules
14%
Debt settlement, 16%
Respondents have various strategies for complying with repayment schedules. If they do not have
cash for repayment, they borrow from other sources (39 percent), friends or relatives (15 percent), or
use savings or deposited money (15 percent) (see Figure 4-9). In repaying loans, then, respondents
still depend on other sources instead of their own business profits.
51
PNPM UPK SYSTEM
Figure 4-9
Strategies for Dealing with Repayment Problems
Borrow money, 39%
15% ask friends or

relatives for money
Use savings or deposit

money, 15%
Others, 13%
No answer, 15%
Sell or mortgage assets,

3%
Insurance claim, 0%
This study also captures the perceptions of nonmembers of UPKs. Around 58 percent of respondents
know about revolving PNPM funds that are distributed through UPKs (Figure 4-10). Among these,
only a few apply to UPKs for credit. About 29 percent of respondents say that they do not know how
to apply for RLF from UPKs. Other reasons include, not sure whether they can repay the credits (24
percent), do not have any groups to apply credits (13 percent), and not included as a targeted
group (10 percent).
Figure 4-10
Nonmember Respondents Who Know about UPKs
Yes
58%
%, 5, 29%
No
%, 4, 24%
42%
%, 3, 19%
%, 2, 13%
%, 1, 10%
A
Note:
Figure A : Question: Do you know about RLF in UPK?
Figure B :the reason why respondent didnt take the UPKs RLF?
0: No answer
1: I am not include in those who can apply RLF
2: I dont have any group (not member of a group)
3: I doubt I can pay the credit
4: I dont know how to apply for RLF
5: Others (No information, afraid to have credit, doesnt know the existing of UPK, etc.)
%, 0, 6%
52
UPK Product Features

UPKs in urban and rural areas provide 10 months of credit with monthly payments. UPK regulations
state that each group member may receive credit for a maximum of four cycles. But some UPKs
provide credit for more than four cycles. For the first cycle, a group member may borrow a maximum
of IDR 500,000. Currently, the average amount borrowed in rural UPKs is IDR 1.78 million and in
urban UPKs IDR 1.48 million; maximum amounts in rural UPKs is IDR 5 million and in urban UPKs,
IDR 7 million. Interest rates are about 1.5 percent per month. UPK staff are willing to provide other
services, such as savings and billing services for electricity and water bills, but regulations prevent
them from doing so.
Certain regulations are intended to improve the performance of UPK credit programs (see Table 414). To encourage timely repayment, UPKs provide the incentive for paying on schedule (IPTW), the
values of which vary among UPKs and are usually are taken from revolving loan services.
Administrative costs for group members are low, about IDR 10,000-15,000 per KSM. Some UPKs
require security deposits for avoiding repayment problems. The proportion of security deposits is 10
percent of the loans and is refundable at the end of a credit cycle. UPK staff rarely impose penalties
on borrowers. If a group member cannot repay on time, UPK staff give a verbal warning and ask the
borrower to provide double repayment the next period (next month). If the borrower cannot provide a
payment UPKs will ask the group to use a joint liability fund to cover the delayed payment. In certain
circumstances (i.e., the borrower has died) credit may be canceled, particularly when heirs cannot
afford to make repayments.
Table 4-14
Regulations to Increase UPK Repayment Performance (percentage)
Rural UPK
Operational
Urban UPK
Yes
No
Yes
No
UPK requires groups to have deposits
43
58
64
36
Having other saving product
100
95
IPTW
50
50
44
56
Penalty overdue
35
65
36
64
Administrative cost in UPK
50
50
43
57
Security deposit
89
12
82
19
Training (implemented)
96
84
16
Training frequency (routine) once a year
62
39
48
52
Reserve for loan needed
54
46
72
28
Some UPKs provide training to group members annually (Table 4-15). The most popular training
covers mechanisms or procedures for borrowing and repayment. Other training is provided but in
limited amounts.
53
PNPM UPK SYSTEM
Table 4-15
Training Materials Provided by Urban and Rural UPKs (percentage)
Purpose
Rural
Urban
Regarding the mechanism or procedures for borrowing and repayment
64
85
Planning and managing of household finances or business
Technical guidance to create and manage a product
16
Marketing strategy
Others
Institution
Most UPKs are managed by a director, a treasurer, and a secretary. Usually only one person has good
knowledge of and experience in financing. Support staffsuch as facilitators, verification teams, and
BPUPKare available on a temporary basis. UPK managers and support staff communicate and
coordinate every three months.
UPK performance is important to the continuity of the PNPM. Staff say that a number of things can
diminish UPK performance (Table 4-16). In rural and urban areas, inadequate number of staff affects
UPK quality; and in urban areas staff competence in managing activities is the main cause of
diminished quality. This is an important finding. Given the perception that the government usually
spends too much on salaries, increasing the number of staff might simply increase UPK expenditure.
But all institutions need competent staff, so improving staff ability to manage activities may be the
best way to improve overall performance.
Table 4-16
Causes of Loss of Quality in UPK Performance
Cause
Rank Rural UPK*
Rank Urban UPK*
Number of staff in UPK
Staff competence in managing activities
Administrative completeness (SOP, etc.)
Availability of operational costs
Activeness and motivation of the group members
Activeness facilitators
Note: * from 1 = most important to 6 = least important.
4.4 OPPORTUNITIES AND CONSTRAINTS

To learn about opportunities for UPK development, and constraints on stakeholders interested in such
development, the study team conducted focus group discussions. The first was on March 21, 2013, in
Semarang, the capital of Central Java. The second was on March 22 in Yogyakarta. The third was on
April 9 in Padang, the capital of West Sumatera. And the fourth was on April 10 in Kupang, the
capital of Nusa Tenggara Timur. Findings are presented below.
Opportunities
Improve the savings habits of group members. Most groups and UPKs encourage members to save
some money in the groups. Accumulated savings can then be used to meet the groups financial
needs. For example, when one or more members cannot make a loan payment, accumulated savings
54
can be used and thereby reduce the incidence of nonperforming loans (NPL). Unfortunately, such
savings must occur at the group level not the UPK level because UPKs are not authorized to take
savings deposits from group members.
Use facilitators to develop the skills of UPK group members. After UPKs make loans to groups,
members use them to support their businesses (usually small). Group members, however, tend to lack
business development skills. Facilitators have provided some business training to group members and
advised members on how to manage and repay loans on time, thereby increasing the repayment rate to
UPKs. After repaying their loan, group members can be assisted in borrowing larger amounts from
banks.
Help members become bankable. Group members tend to have very limited access to commercial
banks. But with training and supervision by facilitators they can meet banks requirements and
become clients of commercial banks.
Introduce the poor to group lending schemes. UPKs apply joint liability principles when group
members borrow money and repay loans. Joint liability schemes can be used to induce mutual
insurance among borrowers. Group members feel a greater responsibility to repay loans than
individual borrowers because they are subject to social sanctions. In this way, group lending schemes
increase repayment rates and build the repayment credibility of borrowers. Group lending schemes
informed by joint liability principles can be useful in improve the poors access to formal banking
sector.
Gender and credit. Female borrowers have higher repayment rates than male borrowers. Female
borrowers may have lower moral hazard risk than male borrowers. For example, when men obtain
credit from UPKs, many of them use it for consumption instead of running small businesses. In most
cases, women are more aware of how best to manage money and loans. Furthermore, many women
realize that they have limited access when enrolling in a credit program compared to men who can
more easily access credit in other formal or informal programs. Therefore, women have to repay to
ensure continued access to credit.
Constraints
The characteristics of urban and rural UPKs influence their management. UPKs in urban and rural
areas differ significantly in terms of working areas. An urban UPK manages its programs at the
village level (kelurahan) but a rural UPK manages them at the subdistrict level (kecamatan) and
therefore manages over a larger areaa difference that has important consequences for human
resources. Rural UPKs need more managers and they work full-time and earn appropriate monthly
salaries. Urban UPK staff are part-time with low monthly salaries. Rural UPK managers perform
much better given these circumstances.
A lot of money sits idle in UPKs. UPKs are to provide small loans to the poor to support their
business activities, but most of the poor have no such activities and not eligible to borrow money.
Therefore, a lot of money in UPKs cannot be absorbed properly.
Bias in the beneficiaries of RLF UPK. As noted, UPK programs are dedicated to the poor engaged in
business activities. Some, however, make loans to the non-poor (e.g., government employers and
large landowners). As a result, the main objective of the UPK programpoverty reductionis still
far from being achieved.
PNPM UPK SYSTEM
55
High number and value of nonperforming loans (NPL). In the UPKs programs, the poor are given
small credit to support income-generating activities. But many have trouble repaying loans. One
reason for the high rate of NPL is a general perception that the RLF is a government-sponsored grant
programand borrowers perceive that they do no need to repay the loans.
Limitations on financial services provided by UPKs. Though UPKs provide loans to the poor
engaged in business activities, their financial services are still limited. The amounts of loans delivered
to borrowers are too small for business expansion. And loans from UPKs are not useable for financing
trade and emergency needs. Repayment schemes are not suitable for agriculture production because
the seasonal nature of the sector means farmers cannot afford to pay back loans on a regular schedule
as required by UPKs.
Lack of human resources. Human resource development in UPKs is a critical need and government
and other stakeholders must work together to meet that need. UPKs do not have enough staff and their
ability to assess creditworthiness is limited. These deficiencies underlie problems with financial
reporting and assessment of financial performance. Training and other programs can build the
capacity of UPK staff.
Lack of legal structure. UPKs have two main roles: social and commercial. However, until now,
UPK does not have a legal structure. In this situation, UPK has banking capacity limitations. For
example, UPKs are not allowed to receive deposits from group members.
Poor selection process of group members and different motives among group members affects
group performance. Many people form groups simply to get loans from UPKs, but dont know each
other very well. A poor selection process of group members by UPK staff exacerbates this situation.
There is guidance on group member selection but it is often not applied. As a result, some people who
are not targeted recipients become group members. Communication problems and emotional
relationships between UPK management and group members have also appeared. This in turn
influences group performance, particularly loan repayment.
Lack of business operation skills. Many group members have little experience managing business
activities. They need training and assistance from UPKs and facilitators to develop business skills.
4.5 SUMMARY
PNPM Mandiri is a community empowerment program intended to improve welfare and increase job
opportunities for the poor. As financial management units of PNPM Mandiri, UPKs are critical to
achieving financial inclusiveness. So far, they have improved inclusiveness for members. For
example, they provide the poor with better access to credit, encourage good savings habits, and
encourage the recording and planning of household income and expenses.
Before UPKs can take on a broader role in providing excluded communities with access to financial
services, their operations and financial business aspects must be sound and sustainable (e.g., the main
duty of UPK administrators is to manage revolving loan funds, and in this regard some UPKs are
more successful than others.) To measure the performance of UPKs, we developed the Sustainability
Index. On the basis of our data analysis, about 16 percent of Indonesias 15,000 urban and rural UPKs
are sustainable and could take on a broader role in improving access to financing. The other 84
percent need to improve their performance in order to become sustainable as UPKs.
56
The sustainable UPKs are ready to move in financial terms, but financial preparedness is a
preliminary step. Other steps are explained in Chapter 5 along with steps for improving the
performance of currently unsustainable UPKs.
5. Transforming Sustainable UPKs

into Legal Microfinance Institutions
5.1 THE NEED
UPKs are not independent financial institutions but instruments for distributing loans to poor
households and for collecting on the loans. UPKs have no legal power to design their own financial
products or services or to reach more people. As instruments of the PNPM, they provide limited types
of financial products and services to only the poor households targeted by the PNPM. This role,
however, is no longer appropriate. Most of the studied UPKs want to become independent formal
microfinance institutions (MFIs). As the data in Table 5-1 show, 72 percent of the studied rural UPKs
and 85 percent of urban UPKs want to become MFIs.
Table 5-1
Percentage of UPKs That Do and Do Not Want to Become Legal Microfinance Institutions
Type of UPK
Want (%)
Not Want (%)
Total (%)
Rural UPK
72
28
100
Urban UPK
85
15
100
Transformation will give them a legal structure and that structure will give them autonomy to design
their own products and services, and the opportunity to broaden the scope of their financial products.
Rural and urban poor families have benefited from UPKs, which makes poor households an exclusive
target group. Having serviced this group for years, UPKs know how to manage and market financial
services to them. They are confident that they can serve a larger segment of the community and
provide more types of services.
UPKs have accustomed many poor families to banking practices and assisted them in developing
small businesses. As their small business develops and their knowledge of financial products and
services improves, these families demand financial products and services beyond what UPKs
currently provide. Confining UPKs to their present legal status will cause them to gradually lose
relevance in their market. Accordingly, many UPKs want to become formal financial institutions. By
becoming MFIs they can maintain market relevance, serve a larger market segment, deliver a variety
of financial products, and better serve poor families and other segments of the financial marketand
serve the goals of financial inclusion.
5.2 CONCEPTUAL APPROACH

There are two views on what MFIs should offer customers. The minimalist view is that MFIs should
provide only financial intermediation services. The integrated view is that MFIs should provide a
58
much broader range of services, not only financial intermediation services, but also social
intermediation, enterprise development, and social services (Figure 5-1).
Figure 5-1
Minimalist and Integrated Approaches to Microfinance
INTEGRATED
Financial and nonfinancial services
MINIMALIST
One missing piece - credit
Financial intermediation
Working capital
Fixed asset loans
Savings
Insurance
Social intermediation
Group formation
Leadership training
Cooperative learning
Enterprise development services

Marketing
Business training
Production training
Subsector analysis
Social services
Education
Health and nutrition
Literacy training
Source: Ledgerwood, 2000

Financial intermediation includes the provision of financial products and services, such as savings,
credit, insurance, credit cards, and payment systems. Financial intermediation should not require
subsidies. Social intermediation is the building of human and social capital required by sustainable
financial intermediation for the poor. Enterprise development services cover nonfinancial services for
micro entrepreneurs: business training, marketing and technology services, and subsector analysis.
Social services include nonnancial services that improve the well being of micro entrepreneurs, such
as training in health, nutrition, and literacy.
The two approaches are not totally different. One can argue that scope of services can develop over
time, starting from the minimal and gradually covering all types. Only MFIs that can compete in the
microfinance market should purse gradual enlargement in service scope.
5.3 LEGAL BUSINESS FORM OPTIONS

Only sustainable UPKs are eligible for transformation, and their participation should be voluntary. It
would be very risky to force a UPK to transform if it is not sustainable and a strong performer. It
would also be best to provide UPKs guidance on transformation well in advance so they can prepare
TRANSFORMING UPKS INTO LEGAL MFIS
59
for competition and managerial upgrades needed for formal institutions. Legal options for those
wishing to become MFIs are BUMDes, cooperatives, Badan Perkreditan Rakyat (rural banks), and
BMT (Shariah cooperatives). The following section describes these options.
LKM UPK
The definition of micro finance institutions or LKM, refers to Law of Republic Indonesia Number 1
of 2013, which regulates financial institutions formed to provide services for business development
and people empowerment, either by providing loans or financing for members micro-scale business,
loan management, or consultation services for business development that does not merely seek
benefits. An LKM is established to increase access to micro-scale funding, to empower people to
become economically productive, and to augment incomes and promote the welfare of the people. If a
UPK wants to become an MFI, it must have a legal identity (cooperative or limited company), capital,
and a business license. A limited company must have a minimum of 60 percent of its shares owned by
regent/municipality regional governments or villages/sub district-owned enterprises.
BUMDs
The organizations known as BUMDs reflect the decision of the Minister of Home Affairs (Number 39
of 2010 for rural enterprises) applying to the capital ownership and management of organizations
handled by village governments and local people. The types of businesses that might be an option for
BUMDs include business services, distribution of the nine basic commodities, agricultural trade, as
well as small and cottage industries. If a UPK wants to become a BUMD, it must meet the following
requirements:
Be a deliberated initiative of the village government and the people.
Have business potential for the village economy.
Be in accordance with the needs of the people, especially fulfillment of basic needs.
Reflect the situation that the availability of village resources has not been used optimally, especially
the overall wealth of the village.
Available local human resources and capable business managers must be judged to be an asset for
economic growth in rural communities.
The business units cover local economic activities
Should be able to increase incomes and revenues for the villagers.
A BUMDes is formed in the following stages:
Village consultation/deliberation leading to an agreement.
Agreements outlined in Anggaran Dasar/Anggaran Rumah Tangga (AD/ART), and covering
organization and working procedures, personnel, accountability and reporting systems, the results
and bankruptcy.
Proposal of agreement material is part of village regulation draft.
Agreement material is published as a village regulation.
Cooperatives
Under Indonesian Cooperative Law No.25 1992, a cooperative is a business enterprise having
individuals or registered cooperative societies as members of which its activities are based on
60
cooperative principles and simultaneously as a peoples economic movement based on the principle of
brotherhood. The principals of cooperative law are as follows:
Voluntary membership
Democratic management
Equal allocation of benefits among members based on their contribution to the cooperative
Distribution of benefits limited to capital
Autonomy
Cooperative education
Partnership among cooperatives.
Cooperatives are supported by regulations:

Indonesian Cooperative Law No. 25, issued in 1992.
Government Regulation No 4, issued in 1994, which states the requirements and procedures for
approval, deed of establishment, and amendment of a cooperative.
Minister Regulation No. 01 of 2006, which covers implementation guidelines formation, ratification
of deeds of establishment, and amendment deeds.
Cooperatives are established to advance the welfare of members in particular and society in general,
and to help realize an advanced, equitable, and prosperous society based on Pancasila and the
constitution of 1945. Cooperatives should
Establish and develop the economic potential and ability of members and society to improve
economic and social welfare;
Enhance the quality of human life and society;
Strengthen the economy as the basis for national economic strength and resilience with cooperatives
as the sokoguru;
Attempt to develop the national economy on the principle of kinship and economic democracy.
Rural Bank
Rural banks (BPR) serve micro, small, and medium enterprises close to the people in need. These
official institutions are regulated by constitution No. 7 1992 about Banking, and as amended by
constitution No. 10 1998. The constitution clearly states that there are two types of banks, commercial
and rural.
The BPR must obtain permission from the Minister of Finance, unless a separate law regulates the
activities of collecting funds from the public. The Minister of Finance grants BPR business licenses,
after consultation with Bank Indonesia. Before getting a license, a BPR must comply with
requirements for organizational structure, capital, ownership, expertise in banking, feasibility work
plan, and other things as determined by the Minister of Finance after consultation with Bank
Indonesia, and meet the requirements regarding the seat of the headquarters of BPR in the district.
A BPR not only supplies credit to micro, small, and medium enterprises, but also accepts deposits
from the public. In lending to the public, BPR uses a 3T principle: Right Time, Right Amount, and
Right on Target. This is due to the credit of the BPR process, which is relatively quick with simple
requirements, and they understand the needs of the customer.
TRANSFORMING UPKS INTO LEGAL MFIS
61
Shariah Cooperatives (BMTs)

BMT stands for Baitul Maal wa Tamwil, which has two main activities: Baitul Tamwil and Baitul
Maal. Baitul Tamwil develops productive business and investment activities to improve the economic
quality of small to medium enterprises, to encourage business activities, to collect funding, and to
distribute funding among the enterprises. Baitul Maal collects and manages funds from zakat (Islamic
religion tax), infaq, and shadaqoh, and distributes them among the poor on the basis of Islamic rules,
namely amanah.2 The main consumers of BMT are Muslims.
The coverage area of BMT can be reached at the district level. The products offered by BMT are quite
varied: mudharabah deposit, financing of leased goods (Al-Ijaroh), financing of working capital
(Murabahah), financing of profit sharing (Mudharabah), financing of partnerships (Musyarakah),
financing of investments (Bai bi tsaman Ajil), and financing of policy (Qhardul Hasan). Considering
that most Indonesians are Muslim, BMT can be an option for UPK transformation.
5.4 FACTORS TO CONSIDER IN DECIDING LEGAL STRUCTURE

When a UPK wants to become an institution with legal status, such as a cooperative or rural bank, it
should consider market positioning, operational coverage, market potential, provision of social
services, and ownership and governance.
Market Positioning
Market position is the position of products or services offered and advantages compared to other
competitors. BPR has a good market position; its products range from funds collected from the public
in the form of time deposits and savings, to the provision of credit in the form of working capital
loans, investment loans, and consumer loans. Cooperatives financial services are more limited,
usually only in the form of savings, or savings and loan products. For the target consumer, there are
differences between cooperatives and rural banks. Rural banks target high society, while cooperatives
target the middle-lower class consumer segment.
Operational Coverage
Operational coverage pertains to region and products. Formal MFIs must have operations in a wider
area. BPRs usually operate in districts and offer a diverse range of products, except for foreign
exchange products and gyro. Cooperatives have smaller operations, usually in a village (e.g., KUD,
Koperasi Unit Desa) and very limited products.
Market Potential
Market potentials are the market opportunities for organizations to operate in a place to market their
products. Experience in serving small communities of UPKs, when a majority of the local UPK
members have a productive business can often create substantial opportunities. Micro, small and
medium enterprises targeted by UPKs often offer sizeable and promising opportunities. In these
2 Amanah (Arabic: ), means fulfilling or upholding trust. Al-Amanah or "The Trust" has a broad Islamic
meaning. It is the moral responsibility of fulfilling one's obligations due to Allah Almighty and fulfilling one's
obligations due to Allah's slaves (other people). It also means "free will." Source:
http://en.wikipedia.org/wiki/Amanah
62
markets, UPKs should be encouraged to continue to develop into more professional institutions (such
as cooperatives and rural banks).
Provision of Social Services for the Community

The original mission of UPKs was to help the poor out of poverty by providing credit. A UPK that
becomes an independent MFI takes on a new orientation. It will no longer receive government funds
and will have to compete for business, which implies that it must be able to maximize profit. This
change in orientation will be problematic if the new MFI must also still provide social services. How
can it do this and remain competitive? It could allocate some portion of profit to social works that
local the government designs and implements to help poor members of the community. The allocated
funds could then be considered a form of corporate responsibility. Or it could help the community
design a financial scheme exclusively for the local poor, covering implementation costs with earnings
from other financial businesses. This cross-subsidization strategy would support its social
responsibility to help poor members of the local community.
Ownership and Governance

Good governance and clear ownership are the two main characteristics of formal legal institutions.
Cooperatives and BPRs are both guided in their objectives by regulations, but BPRs require higher
quality human resources and a larger number of supporting facilities than a cooperative.
5.5 OPERATIONAL IMPLICATIONS OF TRANSFORMATION

An institution is recognized as sound if
It provides services appropriate to its target group. Appropriate services include loans that match
demand with respect to loan size and maturity, collateral requirements, and procedures for granting
loans and ensuring repayment.
It provides a scope of services appropriate to its target group. In some cases, simply offering loans
of a specific type may be all that is needed; in others, an array of loan types may be necessary, or it
may be more important to offer deposit and payment transfer facilities, or a combination of all these
services. (Prices for services are not generally a point of major importance, according to practical
experience.)
Its activities and services are not only in demand but also have a positive impact on the lives of
customers.
It is strong, stable, and financially sound.
6. Pilot Project
6.1 BACKGROUND
The collateral requirements of formal credit transactions exclude the poor who cannot afford such
collateral, which is one reason why Indonesias economy has grown rapidly but it is not yet inclusive.
To improve financial inclusion, most scholars suggest that low-income families be prioritized as
clients of an inclusive financial system (AFI 2012; Kelkar 2010; Reyes at al., 2011; Rangarajan
Committee 2008; Sharawat 2010). Such a system would complement the governments promotion of
pro-poor development. The government should design and implement policy that puts a priority on
the financial interests of low-income groups in order to achieve high growth with equity. And,
because poor families generally have little education and very little knowledge of financial products,
they need business-oriented assistance to maximize the benefit of an inclusive financial system. Under
an inclusive system, formal financial institutions have to carry more responsibility and conduct
complex tasks. In this regard, nonbanking institutions are much easier to transform than banking
institutions. Of the nonbanking institutions, UPKs are of special interest because they have long
served the financial needs of the very poor.
Potential of PNPM UPKs for Financial Inclusion

The government has tried to make financial inclusion as aspect of its poverty alleviation program,
Program Nasional Pemberdayaan Masyarakat Mandiri (PNPM Mandiri), which began in 2007. The
objective of this program is to improve employment opportunities for the poor, and to enable them to
earn enough income to escape poverty. PNPM is a policy framework and a reference for communitybased poverty reduction programs. Such programs provide assistance to foster an environment
conducive to business start-ups among poor households. At the community level, the Unit Pengelola
Keuangan (UPK) manages assistance funds. UPKs are not MFIs, but instruments for channeling loans
to poor families and collecting on those loans. UPKs use revolving loan funds (RLF) to facilitate
financial access; manage community-based activities; and manage revolving and technical
management programs. To support financial inclusion, UPKs help implement rural and urban PNPMs,
particularly fund management programs. There are now 15,274 PNPM UPKs providing financial
services (PNPM 2012). UPKs understand their customers, can connect directly with them, have
massive outreach, and relatively low costs.
PNPM Mandiri has promoted financial inclusion among poor families, and UPKs can promote
inclusion even more once the sustainable ones become formal MFIs with a legal status. As such, they
will be able to provide more types of financial service to poor households in urban and rural areas.
There is much debate as to whether MFIs should be minimalist (that is, offer only nancial
intermediation) or integrated (offer nancial intermediation and other services). Within this
framework are four groups of services that may be provided:
Financial intermediation products and services, such as savings, credit, insurance, credit cards, and
payment systems, that do not require subsidies.
64
Social intermediation services that build human and social capital.

Nonnancial enterprise development services, such as business training, marketing and technology
services, and subsector analysis.
Nonnancial social services to improve the well-being of micro entrepreneurs (e.g., health,
nutrition, literacy training).
Figure 6-1
Minimalist and Integrated Approaches to Microfinance
INTEGRATED
Financial and nonfinancial services
MINIMALIST
One missing piece - credit
Financial intermediation
a. Working capital
b. Fixed asset loans
c. Savings
d. Insurance
Social intermediation
1. Group formation
2. Leadership training
3. Cooperative learning
Enterprise development services

a. Marketing
b. Business training
c. Production training
d. Subsector analysis
Social services
a. Education
b. Health and nutrition
c. Literacy training
Source: Ledgerwood, 2000
It does not seem reasonable to expect that all 15,274 UPKs are in good enough condition to become
MFIs. To make the transition they must be sustainable and be good performers (FSD Kenya 2012;
Portocarrero 2011; and Campionc and White 1999). In addition, transformation poses managerial
challenges and can be very costly and time consuming. According our study, about 16 percent of
Indonesias rural and urban UPKs are sustainable. The rest should not be considered for
transformation until they meet the conditions for performance, feasibility, and sustainability.
Researching the transformation of unsustainable agricultural development banking operations into
MFIs in Nepal, Seibel (1999) found that such operations incurred substantial losses and depended on
donor resources or subsidies to make the transition. Unsustainable UPKs could benefit from guidance,
particularly guidance on management should they wish to eventually become cooperatives or PTs.
65
PILOT PROJECTS
6.2 GENERAL DESCRIPTION OF PROJECT

Title. Strengthening the Roles, Capacity, and Working Procedures of UPKs for Greater Financial
Inclusion
General Objective. To strengthen the roles, capacity and working procedures of PNPM UPKs for
financial inclusion.
Specific Objectives
Roadmap to transform sustainable UPKs into legal MFIs
Improve the financial sustainability of unsustainable UPKs
Advance financial inclusion in Indonesia. UPKs achievement of this goal -to facilitate access to
financial services- has encouraged them to keep growing. One of many solutions is to transform
into a legal MFI, such as a cooperative or limited liability company (Perseroan Terbatas/PT). But
transformation is not easy. Transformation brings economic and social disadvantages as well as
advantages according to Portocarrero (2011) (see Exhibit 6-1).
Exhibit 6-1
Economic and Social Advantages and Disadvantages of UPKs Transformation into Formal MFIs
Economic Advantages to the Organization
Access to a greater and more diverse funding base,
Social Advantages
including deposits and bonds, which will support
broader range of services (savings, micro insurance,
long-term portfolio growth.
remittances) that help them weather shocks and
Savings mobilization can reduce liability
smooth consumption in the absence of social safety
concentration and diminish financial costs.
nets.
Possibility of attaining greater leverage, and thus to
reinforcement of internal controls, all factors in
As portfolios grow rapidly MFIs have economies of
portfolio growth and stable institutional development.
scale, consolidate sustainability, and attain a massive

outreach at the BOP.
competition will drive down interest rates and spur
Social Disadvantages
operational efficiency.
Regulatory compliance costs of regulatory. These
Transformation requires extensive time and resources,

and the level of effort and amount of time are often
underestimated.
Economic Disadvantages to the Organization
Success in attracting external investors and facilitating

growth and M&A.
Lower financial costs thanks to access to lower cost

funds. This evolution and the more intense
Regulation provides a better framework for risk

management, corporate governance, and the
intermediate more resources and expand the portfolio.
Low-income informal sector households are offered a
Many MFIs experiment with cultural change as they
include costs for (1) studies and the consultancies
become commercially driven. Many fear mission drift
required to be licensed; (2) remodelling branches to
away from social vision and that the quest for
meet higher security and infrastructure standards; (3)
profitability will become the top priority. There must
software and hardware for new operations, like
be consensus on the goal of transformation and the
savings; (4) recruiting, training in new financial
governance structure, which should balance the
services, and promotion of old employees; (5) new
imperatives of sustainability and mass outreach.
reports, complex financial management, and

preparing finance and treasury departments to
manage a diverse funding structure and comply with
the regulators financial guidelines.
66
Framework and Technical Description

InterCAFEs 2013 study of financial inclusion provides a general framework (Figure 6-2) for pilot
project inputs. The study sets out a review of the UPK PNPM system, an evaluation of UPK
performance, a discussion of methods of selection for UPK reform to provide legal options for
improving the legal situation of UPKs (depending on the criteria of sustainable and unsustainable
UPKs). These findings of this study provide initial information to be used in evaluating the capacity
of the UPKs to be strengthened to support greater financial inclusion in the future.
The implementation of the suggested pilot project activity might begin by working with established
umbrella institutions which are consistent with each legal option setout in the study. This stage might
be followed by activities in rural and urban UPKs appropriate to their sustainability.
Figure 6-2
General Framework of the Study Support on Financial Inclusion
Option for improving

UPK legality:
UPKs, Cooperatives,
BKD, Banks, etc.
Road map of each typology

Umbrella Institutions
Criteria:
Health, Sustainable,
Technology, human
resources
Typology or Classifications
of UPKs based on some
criteria
Well established finance

institutions
Wider network to
ensure the sustainability
of the program
Proof of concept testing

for each typology
Pilot Project
Outputs
The following are the expected outputs to be delivered:
1. Established umbrella institutions of all alternative legal options
Umbrella institutions for each legal option may be banks, BPR, NGOs, cooperatives, nonbank
financial institutions, and partnerships. An umbrella institution for transformed UPKs must have a
clear business plan and meet certain standards. In transforming UPKs, umbrella institutions, in
coordination and collaboration with the implementing partner, will be responsible for the following:
Developing a viable business plan to support UPK and activities within a specified geographic area
Taking over supervision and support for UPKs
Building a sustainable organization, supporting financial activities of UPKs
Providing adequate training and structured methodologies to support improved performance
Rewarding success through additional financing and services
Rolling out products and services based on client needs
PILOT PROJECTS
67
2. Strengthened UPKs sustainability

3. Enlarged UPKs functions
4. Financial services diversification
5. Established nonfinancial business
6. Increased outreach
7. Availability of supporting regulatory framework and appropriate facilities for the effective working
of UPK
8. Readiness of UPKs to hold legal status
During implementation, sustainable UPKs will maintain and improve their sustainability.
(Unsustainable UPKs are also expected to improve their sustainability condition, but this will be the
only output for them.) Sustainability in this context will cover financial and operational aspects,
namely yield on portfolio (YoP), operating expense ratio (OER), and portfolios at risk (PAR). The
YoP is actual interest income on lending by the RLF divided by the average loan portfolio for the
year. It indicates how UPKs can generate income from their core business, which includes delivery of
loans (currently limited to their core business rotating loan funds). To have good YoP, the UPKs
should have capacity to manage their core business. In the case that UPKs and BKM have other
activities (such as nonfinancial activities) to generate income, they should have capacity in both
activities. OER indicates capacity to manage operational costs (e.g., salaries, travel, administrative
costs, and depreciation expenses). PAR indicates capacity to manage credit risk and nonperforming
loans.
To strengthen their sustainability and to have legality to support financial inclusion, UPKs must be
capable in all three of these areas and also be able to do the following:
Provide good financial reports. This can be done through training on financial reports and
supporting infrastructure to produce good financial reports.
Understand financial and operational indicators of their own sustainability.
Manage income sources and operations. To support financial and operational performance,
operational units should provide appropriate support, such as human resources and supporting
facilities (e.g., technology/system information and communication). In term of income, UPKs may
have two sources, financial activities, and nonfinancial (nonfinancial business) activities. Financial
and nonfinancial activities include the following:
Products and services provided: UPKs should be able to manage and maintain their loan
business (currently limited on loans, RLF); in the pilot project there may be some new
financial products based on the clients needs. Local economic activities such as: agricultural
based business, creative industries, and other rural based business are nonfinancial business to
be integrated in UPKs activities.
Number of clients. UPKs should be able to maintain and improve their client base by creating
new delivery channels and entering new markets.
Methodology
Support modalities are as follows:
Baseline and end line studies.
Reviews of UPK capacities. Reviews may take various approaches such as literature/desk studies,
secondary data analysis, field surveys, primary data analysis or a combination of thereof.
68
Workshop: An activity that introduces and provides a medium for brief discussion of policies,
research or survey results and similar activities.
Workshops with follow up training.
Training provided in accordance with a previously designed curriculum.
Modules and SOP development.
Focus group discussions.
Technical assistance that provides continuous guidance to UPKs in conducting activities practiced
during training, or assistance for testing a system/mechanism/tool.
Provision of supporting facilities for an effective working environment of UPK.
Program Logic
Transformation involves a complete makeover of organizational, cultural, and operational structures.
The scope of adjustment required is wide: institutions have to go from being relatively unregulated to
being regulated MFIs. The improved UPKs will try to enlarge their main target groups and provide a
range of financial services. See Table 6-1, below.
Duration, Location, and Participants

Based on InterCAFEs study of financial inclusion, the four-year pilot project will be located in four
provinces: Jawa Tengah (Kabupaten Brebes, Klaten, Pati, Wonosobo, and Demak), Yogyakarta
(Kabupaten Bantul and Sleman), Sumatera Barat (Kota Padang, Sawah Lunto/Sijunjung), and Nusa
Tenggara Timur (Kota Kupang, Kabupaten Kupang).
To have large outreach, additional locations may be added in the pilot project. These additional
locations may be from eastern Indonesia such as East Java, Nusa Tenggara Barat (NTB), Maluku,
West Papua and Papua. The specific districts in these provinces have not been identified.
The selection of districts and UPKs in additional provinces will be based on sustaibility criteria and
potential local economic activities (such as agriculture, creative industry and other rural business).
The objective of differentiating UPKs on the basis of sustainability is to ensure that UPKs can be
transformed and then improve access to financial services for the community.
The target groups of this pilot project activity are around 20 UPKs in each province, except Central
Java will have 40 UPKs as the target group (see Table 6-2). The target groups in the pilot project
consists of: 1) Urban UPK (sustainable & unsustainable) and 2) Rural UPK (sustainable &
unsustainable).
To cover two main interventions (financial and nonfinancial based activities in UPKs), the duration of
the project activity will be run within 4 years and it will be conducted in some stages:
Interventions for Financial Based Activities in UPKs
Stage 1 (1st and 2nd semester): focusing on initiating the prepared interventions for financial
based activities in the UPKs
Stage 2 (3rd-4th semester): focusing on the capacity building of UPKs on financial based
activities
69
PILOT PROJECTS
Stage 3 (4th semester onwards) focusing on the implementation of financial based

interventions for UPK
Interventions for Nonfinancial Based Activities in UPKs
Stage 1 (3rd and 4th semester) focusing on initiating the prepared interventions for non
financial based activities in the UPKs
Stage 2 (5th-6th semester) focusing on the capacity building of UPKs on non financial based
activities
Stage 3 (6th semester onwards) focusing on the implementation of intervention on nonfinancial based activities in UPK
6.3 PROJECT FUNDING

The source of funds is [TBD]; the amount is US$ 8,000,000 for four years.
6.4 MONITORING AND EVALUATION PLAN

Monitoring is the ongoing process by which stakeholders obtain regular feedback on the progress
toward goals and objectives. Evaluation is a rigorous and independent assessment of completed or
ongoing activities to determine the extent to which they are achieving objectives and contributing to
decision making. Through monitoring and evaluation, managers can review progress, identify
problems in planning and/or implementation, and adjust as needed. The M&E Operational Plan will
be the first milestone of the pilot project. This design will discuss key aspects to be used in the
preparation of the M&E Operational Plan in the pilot project.
Table 6-1
Program Logic of Pilot Project Activity
Impact
Outcome
Outputs
Greater financial inclusion

Strengthened roles, capacity and working procedures in UPKs
1.
Establishment of umbrella institutions for all alternative legal options
2.
Strengthened financial sustainabilty of UPKs; for unsustainable UPKs this is the only output will
be achieved during the pilot project
3.
Enlarged UPK functions
4.
Financial services diversification
5.
Establishment of non-financial services
6.
Increased outreach
7.
Availability of supporting facilities for the effective working of UPK
8.
Readiness of UPKs to hold legal status
Activities
OUTPUT 1. ESTABLISHED UMBRELLA INSTITUTIONS OF ALL ALTERNATIVE LEGAL OPTIONS

1.
Taking the steps towards transformation by socialization the PNPM UPK stakeholders, banking and financial
sector, the supervisory and regulatory bodies about planning to transform PNPM UPK
2.
FGD series with the stakeholders
3.
Series meeting with potential and qualifying umbrella instutions
4.
Establishing the umbrella institutions
OUTPUT 2. STRENGTHENED SUSTAINABILTY OF UPKS; FOR UNSUSTAINABLE UPKS THIS IS THE
70
ONLY OUTPUT WILL BE ACHIEVED

1.
Workshop on UPK sustainability
2.
Series of training on financial reports and sustainability indicators
3.
Review on mechanism to manage credit business, including mechanisms to manage NPL and provision of credit
risk
4.
Review on additional indicators to assess broader sustainability of the UPKs such as empowerment
5.
Technical assisstance for sustainable UPK to maintain good portfolio quality and strong growth during the
transformation process and for unsustainable UPK technical assisstance to improve good portfolio quality
6.
Technical assistance for UPK to improve their sustainability, to improve UPK operational efficiency and internal
control by streamlining their operational processes and establish more robust internal control mechanisms.
OUTPUT 3. ENLARGED UPK FUNCTIONS

1.
Review optimal size for effective and efficient operational UPK (including loan size, number of clients, number of
staff, potential and how to merge UPKs, and other relevant aspects)
2.
Review human resources in UPK: evaluate the current organizational structure; review the salary and incentive
structure and recommend changes;
3.
Capacity building for UPK staff for financial and operational aspects in UPK
4.
Review operational policy in UPK, such as innovation to reduce idle money and methods to improve repayment
rates
OUTPUT 4. FINANCIAL SERVICES DIVERSIFICATION

1.
Review on credit/lending business line to be provided by UPK that meet the needs of the clients. The
credit/lending business designed should not have price and non price barriers
2.
A market study to develop savings products or to market other financial services. In the early stages, this can be
done through development and by making available products that are being used/provided by other MFIs to
capture part of the market.
3.
Research and development of appropriate products, piloting and roll-out of new and refined products, positioning
in the market, pricing, process mapping, development of delivery channels for services, and development of
related SOP and manuals.
4.
Workshop training on the implementation of new financal services/products that meet the diversified needs of their
clients based on related SOP and manuals.
5.
Assisstance on the implementation of new financal services/products that meet the diversified needs of their clients
6.
Training in Financial Literacy for UPK members in each location
OUTPUT 5. ESTABLISHED NONFINANCIAL BUSINESS

1.
Study to identify potential local activities to be integrated in UPK activities such as: agricultural based business,
creative industries, and other rural based business.
2.
Need Assessment for rural/agricultural/industry creative based business in the community surrounding UPKs.
3.
Series of workshops and trainings to map the potential economic activity, add value, and expand business in the
agriculture/industry creative sectors.
4.
Establishing new businesses in UPK to support an integrated value chain with local economic activities.
5.
Business assistance or technical services for members to add the value and expand their business in rural/
agriculture or industry creative sectors
OUTPUT 6. INCREASED OUTREACH

1.
Review of the group lending mechanism
2.
Development of delivery channels for services
3.
Workshop training on the penetration of new market segments and delivery channels
4.
Assistance on the group lending mechanism, penetration of new market segments and delivery channels
OUTPUT 7. AVAILABILITY OF SUPPORTING FACILITIES FOR THE EFFECTIVE WORKING OF UPK

1.
Review the hardware and software and determine the changes required to support the new and more complex
operations and reporting requirements
2.
Provision of approriate tecnology/system information and communication to meet the need of improved UPKs (for
operations and reporting);
71
PILOT PROJECTS
3.
Procurement of supporting facilities for UPK Secretariat
4.
Training on data management
OUTPUT 8. READINESS OF UPKS TO HOLD LEGAL STATUS

1.
Regulatory mapping to strengthen general operations/functions of the UPKs
2.
Baseline study on institutional readiness for transformation
3.
Building capacity of the UPKs in readiness for holding legal status
Table 6-2
Number of UPKs in the Pilot Project Location
Urban UPK
No
Location
DI Yogyakarta
Jawa Tengah
Sumatera Barat
Nusa Tenggara Timur
Indonesia
Sustainable
Unsustainable
Rural UPK
Total
Sustainable
Unsustainable
Total
24
144
168
24
32
56
258
1611
1869
54
219
273
28
228
256
126
135
88
94
NA
NA
NA
1270
6389
7659
640
3185
3825
Questions on Outputs and Outcome

The following are questions on monitoring output (including input/activity):
Are the outputs produced as planned, and are they efficient?
What is the quality of each output?
How does activity implementation relate to the achievement of outputs?
What are issues, risks, and challenges faced in achieving the expected results?
If plans change, what, if anything, needs to be done in the next stage? Are there any alternative
strategies that have output with the same quality as expected previously?
Do the outputs strengthen UPK capacity? Are there any unexpected achievements? How can these
be further developed?
What have we learned so far?
The following are key questions for outcome evaluation:
Are the UPKs strengthened roles, capacities, and working procedures related to the delivery of
financial services to the community, and do they encourage financial inclusion?
What outputs support stronger UPK roles, capacity, and systems/working procedures? How do
UPKs apply outputs? Why are some outputs applied but not others?
What factors are helping to strengthen or are constraining UPKs roles, capacities, and systems and
working procedures?
With respect to improving UPKs what have we learned so far? To what extent are outputs and
assistance strengthening roles, capacities, and systems/procedures? How can they be further
developed? Are there any other achievements in addition to those intended?
72
Methodology
Table 6-3 is an overview of approaches and tools for monitoring output and evaluating outcomes.
Table 6-3
Approaches and Tools for Monitoring / Measuring Output and Outcome Evaluation
Objectives
Data and analysis: Analyze the various activity
documentation
Validation: Verification of the activities

that have been carried out
Participation: obtain feedback

from stakeholders
M& E framework
Field visit by expert team
Annual evaluation/review
Annual work plan

Monthly progress report (monthly meeting)
Progress Report (written every 3 months)
Annual progress report
Activity report
Data/information/technical information documentations
from related stakeholders
Rapid assessment (in the 2nd year)
Survey (baseline and end line)
Focus group discussion (FGD)
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Appendix A. Maya Declaration on

Financial Inclusion
We, the Members of the Alliance for Financial Inclusion, a network of central banks, supervisors and
other financial regulatory authorities met in Riviera Maya, Mexico, 28 to 30 September 2011, on the
occasion of the Third AFI Global Policy Forum,
Recognize the critical importance of financial inclusion to empowering and transforming the
lives of all our people, especially the poor, its role in improving national and global
financial stability and integrity and its essential contribution to strong and inclusive growth
in developing and emerging market countries;
Reaffirm the value of peer-to-peer knowledge exchange and learning among financial
regulators and policymakers for the design and implementation of innovative financial
inclusion policy solutions relevant to the developing world;
Recall our efforts over the last two years to strengthen and expand the AFI network and to
identify and explore high-priority areas for financial inclusion policy in the developing
world through AFIs working groups;
Commit as a network of developing and emerging market financial regulators and policymakers to:
a. Putting in place a financial inclusion policy that creates an enabling environment for costeffective access to financial services that makes full use of appropriate innovative
technology and substantially lowers the unit cost of financial services;
b. Implementing a sound and proportional regulatory framework that achieves the
complementary goals of financial inclusion, financial stability, and financial integrity;
c. Recognizing consumer protection and empowerment as key pillars of financial inclusion
efforts to ensure that all people are included in their countrys financial sector;
d. Making evidence-based financial inclusion policy a priority by collecting and analyzing
comprehensive data, tracking the changing profile of financial inclusion, and producing
comparable indicators in the network.
We remain dedicated to making financial inclusion a reality through concerted domestic and global
actions, and actively sharing our knowledge and experience through the AFI network. We commit to
delivering concrete financial inclusion outcomes for the developing world to provide sustainable,
relevant, cost-effective, and meaningful financial services for the worlds financially un-served
populations.
Source: http://www.microfinancegateway.org/p/site/m/template.rc/1.26.19489/
Appendix B. System of PNPM

Indonesias Program Nasional Pemberdayaan Masyarakat (PNPM), a program for community
empowerment, was established on 2007. Before the government implemented PNPM Mandiri in
2007, it started with two community empowerment programs. The District Development Program
(Program Pengembangan Kecamatan or PPK) started as a basic community empowerment program
in rural areas, and Poverty Alleviation Program in Urban Areas (Program Penanggulangan
Kemiskinan di Perkotaan or P2KP) was started for urban society development.
Since 2008, PNPM Mandiri has expanded the program by involving the Development Program for
Disadvantaged and Special Areas (Program Pengembangan Daerah Tertinggal dan Khusus or
P2DTK) for the development of disadvantaged, post-disaster and conflict areas, and Program
Pengembangan Infrastruktur Sosial Ekonomi Wilayah (PISEW) to integrate the centers of economic
growth with the surrounding areas. Various empowerment programs conducted by various
departments of the sector also strengthened PNPM.
The definition of PNPM according the general guidelines is a national program in the form of a basic
policy framework and a reference implementation to poverty reduction programs based on
community. PNPM Mandiri was implemented through harmonization and development of systems
and mechanisms and procedures of the program, providing mentoring and funding stimulants to
encourage initiative and innovation communities in sustainable poverty reduction efforts.
The implementation of the PNPM program is based on community empowerment. This is an attempt
to create / enhance the capacity of communities, both individually and collectively, in solving various
problems related with the efforts to improve the quality of life, independence, and well-being.
Community empowerment requires greater involvement of the local government and other
stakeholders to provide opportunities and ensure the sustainability of the various results. The general
objective of PNPM Mandiri is to improve the welfare and increase job opportunities for poor people.
A board manages the activities of the community through Unit Pengelola Keuangan (UPK), or local
financial management units. UPK management also manages community grants to PNPM
beneficiaries and potentially aids financial inclusion.
Program PNPM improves the welfare of poor community, and community empowerment starts from
the planning process, implementation, through monitoring and evaluation by providing food needed,
health and education services, expansion of employment opportunity, etc. The procedure of PNPMs
program has to be simple, flexible, easy to be understand and to be managed, and can be accountable
to the community.
In the programs, the community is a subject in the effort to alleviate poverty, so all of the activities
have to be oriented to the poor community and the community has to actively participate through selfmanagement. This means that every activity should be done by individuals or community groups with
simple technology, low risks, and without needing an expert, including in the process of decision-
B-2
APPENDIX B
making. For integrity, all parties interested in reducing poverty are encouraged to realize cooperation
and synergy among stakeholders in poverty reduction, not only for this time, but also for the future
(sustainability). To do effective and efficiency activities, and because PNPM is a development activity
with a community base, implementation takes place at the sub-district.
PNPM RURAL
The implementation of Rural PNPM at the central level is coordinated by Ministry of Home Affairs,
which oversees the Coordinator of Team Controller of PNPM Mandiri at every level (central,
province and district (kabupaten/kota). In every district, the initiated and developed community
organization is known as Badan Koordinasi Antar-Desa (BKAD), which is based on the mechanism
of Badan Kerjasama Antar Desa (MAD). It is chosen and set as follows: Unit Pengelola Kegiatan
(UPK), Badan Pengawas-UPK (BP-UPK), Verification team and local assistance, which are entirely
derived from society. On the sub-district (kecamatan) level, to facilitate the implementation of
activities in each kecamatan we placed two facilitators, respectively, the District Facilitator and
Technical Facilitators (with an education background in Civil Engineering).
In providing support to Rural PNPM, whose objective is to accelerate the poverty reduction, revolving
loan funds (RLF) will be one of the activities that facilitate financial access. To assist and facilitate
RLF to the poor, Rural PNPM establishes an organization to manage the activities called Unit
Pengelola Kegiatan (UPK). This organization will manage programs both during the program and
post-program period, and ensure the sustainability of the program. As a revolving fund management
institution whose function is to provide services to the poor, it will keep the public involved in its
implementation under the authority of BKAD/MAD.
The basic functions of UPKs are the management of community-based activities and revolving and
technical management programs. According the objective to support financial inclusion, UPKs have a
strategic role in the successful implementation of Rural PNPM programs, particularly in the fund
management program. As revolving and technical management programs, UPKs are responsible for
managing all of the funds. The funds are distributed to the poor in two activities: productive activities
(revolving fund), such as Usaha Ekonomi Produktif (UEP) and Simpan Pinjam Perempuan (SPP), and
non-productive activities, such as Direct Community Assistance (BLM), development funds
(infrastructure activities, education, and health).
In the Rural PNPM, the revolving funds are used for two main activities, for UEP and SPP. UEP is a
capacity building activity to encourage skills with mixed groups (composition divided by women and
men). This activity is conducted by poor households and gives direct implication against increases in
revenue of poor households to the community business. The UEP program does not provide additional
capital, but provides components of revolving funds for training programs to encourage business and
the capacity of group members. This means that the business community uses the revolving fund in
UEP for training. But some UPK provide the UEP program, RLF, for mixed groups.
SPP is an activity of providing capital for the womens group who has savings and loan activities.
This activity aims to accelerate the process of meeting the needs of business or social funding, giving
opportunities to women by improving household economy through venture capital funding, and
strengthening savings and loans by women. Loan recipients of SPP are a group of borrowers whose
members are poor but productive. Borrower groups are the groups that receive RLF Rural PNPM
managed directly (executing) and distributed to the beneficiaries (channeling). The womens groups
should implement Tanggung Renteng, or joint liability mechanisms, to pay the installments of one or
SYSTEM OF PNPM
B-3
more members in arrears (several UPK requires Savings Group for the candidates who will make a
loan to the UPK).
PNPM URBAN
In the central government, the Department of Public Works is responsible for managing the Urban
PNPM Program. At the province and district level, the Department of Public Works not only oversees
the Team Controller, but also oversees Bappeda. Authority in PNPM Rural at the subdistrict level is
different in PNPM Urban. The PNPM Rural is under BKAD/MAD and UPK, but PNPM Urban at the
sub-district level is under Camat (to support and guarantee for the successful of implementation of
PNPM Urban) and Penanggung Jawab Operasional Kegiatan or PJOK (to controlling the activities of
implementation administration of Urban PNPM at the sub-district works area, including for
inspections against utilize of funds disbursed for the community accordance with the proposal
approved by the facilitators).
In the PNPM Urban, implementing actors in village (kelurahan) is Badan Keswadayaan Masyarakat
(BKM) or also called Lembaga Keswadayaan Masyarakat (LKM). BKM has responsible to guarantee
involvement of all the community in the process of decision making to develop the self-reliance of
community, to alleviate poverty particularly and development of the community and village/kelurahan
as general. Also, BKM role in the BLM is to establishing the policies and monitoring the process of
utilization of fund that has daily managed by UPK.
Communities that get benefits from BLM of Urban PNPM are Kelompok Keswadayaan Masyarakat
(KSM). KSM is manage by volunteer team and assisted by facilitators team consisting
village/kelurahan community who has common bond and struggle to achieve the objectives. The
KSM are not only passive beneficiaries, but also implementers for activities related to poverty
alleviation, proposed to be funded by BKM through various funds that can be raised.
One of the strategic activities of Urban PNPM, which will determined by the community is part of the
allocation of BLM, which will used for revolving loan funds (RLF). RLFs service creates business
opportunities, job opportunities and increasing poor community income, and other productive
activities. The success of the RLF program depends on UPK BKMs ability to manage RLF and also
to support borrower ability (KSM and members).
BKM is a collective leadership community organization in a village, where members are selected
based on their role as community leaders. In performing all policies issued by BKM and maintaining
sustainability in the learning process for community, BKM need to establish management units in the
economic, environmental, and social realms. Management units are Unit Pengelola Keuangan (UPK),
which manages the RLF community; Unit Pengelola Lingkungan (UPL), which manages relief
assistance for the environment (infrastructure); and Unit Pengelola Sosial (UPS), which manages
social areas (education, health, BLM). In their daily tasks, they are independent and make their own
operational decisions. Therefore, each of management unit has responsibility over their work to BKM.
BKMs legality is reflected in the formation process involving the entire community. The results of
the community agreement, which is formulated at the village meeting, will be authorized through the
registration and notarized by the Notary.
The Financial Management Unit is a task force established by the BKM as an independent unit to
implement the policies set by the BKM for revolving loan fund management and financial
administration. The establishment of all implementation units and determination of human resources
B-4
APPENDIX B
decided by BKM member meetings takes into account needs and existing capabilities. In general, the
tasks and functions of UPK BKM are to implement the policies decided by BKM.
In the general, the difference between UPKs in Rural PNPM and UPKs BKM in Urban PNPM is that
UPK in Rural PNPM is a community organization formed by the village community through MAD,
and UPK has the task of channeling BLM funds to communities for the construction and improvement
of public facilities, as well for revolving loan funds (SPP and UEP) at the subdistrict level. While
UPKs in Urban PNPM is included in the implementing unit BKM, particularly for revolving funds for
lending to self-help groups (KSM) at the village level.
Sources:
1. Petunjuk Teknis Pinjaman Bergulir PNPM Mandiri Perkotaan, Kementerian Pekerjaan Umum,
Direktorat Jendral Cipta Karya.
2. Pedoman Umum PNPM, PNPM Mandiri. 2007.
3. Pedoman Teknis Proyek Penanggulangan Kemiskinan di Perkotaan, P2KP - Kementrian Pekerjaan
Umum.
Appendix C. Literature Review of

Microfinance Performance
Indicators
Measuring the performance of a microfinance institution (MFI) is about examining the progress of
their operations, how well they are doing financially, and determining whether the goals of
microfinance have been achieved. MFIs can use performance indicators to assess their financial and
operational management. The essential goal of microfinance is to improve the standard of living of
the poor and lift them out of poverty. However, the goals can be also different, they can be more
social in nature or more profit oriented.
According to Schreiner (1996), how the performance of an MFI is measured differs by perspective
borrowers, society, donors, MFI staff, and investors. Borrowers measure performance by repeated use
of microfinance products to gain benefits. For example, with microcredit loans, borrowers are able to
improve their businesses, provide healthy food for their families, provide better education for their
children, and also empower their personal life (Schreiner 1996). Society, like borrowers, also
measures the performance of microfinance. Donors, on the one hand, measure performance on the
basis of market leverage, the gain that the MFI achieves with the donations given (Schreiner 2003).
For example, with donations, outreach to the poor will increase and the MFI will be considered more
stable and efficient in delivering services. On the other hand, MFI staff consider financial selfsufficiency an indicator of good performance (Schreiner 2003). Staff are more concerned with
financial self-sufficiency because they feel that they will still have a job when the donors leave.
Lastly, investors see high profitability as a key indicator of MFI performance (Schreiner 2003).
According to Zeller and Meyer (2002), in delivering services MFIs must gauge performance on the
basis of three criteria or objectives: (1) outreach, (2) financial sustainability, and (3) welfare impact.
Zeller and Meyer call this the triangle of microfinance (see Figure C-1). The inner circle represents
the MFIs innovations in technology, policy, organization, and management that affects how well
each objective (outreach, impact, and financial sustainability) is met. But there is a trade-off in
achieving financial sustainability and reaching the poorest while also ensuring a positive impact on
the borrower. Many believe that it is impossible for an MFI to achieve financial sustainability and
reach more of the poorest (Hartarska 2005; Zeller & Meyer 2002; Park & Ren 2001). The basic
judgment about this belief is that reaching the poorest means the MFI charges a low interest rate
because the poorest cannot afford to pay a high rate while the MFI incurs higher transaction costs
(Park & Ren 2001). Hartarska (2005) also stresses that there is no win-win situation for an MFI that
reaches only the poorest while striving for sustainability. The MFI either reaches only the poorest,
charges low interest rates and is subsidized or reaches the not-so-poor, charges higher interest rates,
and achieves financial sustainability.
C-2
APPENDIX C
Figure C-1
The Triangle of Microfinance: Measuring the Performance of Microfinance Institutions
Macroeconomic and sectoral policy
Framework and socioeconomic performance
Impact
Institutional
innovations
Financial
sustainability
Outreach
to the poor
SOURCE: Adapted from Zeller and Meyer (2002, p. 6.)
Based on the CGAP guidelines, five areas need to be taken into consideration when measuring the
performance of MFIs: (1) outreach (how many clients are being served?); (2) client poverty (how poor
are the clients?); (3) collection performance (how effective is the institution in collecting on loans?);
(4) financial sustainability (is the institution profitable enough to maintain and expand its services
without continued support from subsidized donor funds?); (5) efficiency (how well does the
microfinance institution control its administrative costs?) (CGAP 2007, p.1).
According to Ledgerwood (2000), MFI performance indicators are organized into six areas:
1. Portfolio quality. Portfolio quality ratios provide information on the percentage of non-earning
assets, which in turn decreases the revenue and liquidity position of an MFI. This consists of three
indicators:
Repayment rates
Portfolio quality ratios
Loan loss ratios
2. Productivity and efficiency. Productivity and efficiency ratios provide information about the rate
at which MFIs generate revenue to cover expenses. It covers two indicators:
Productivity ratio
Number of active loans per credit officer
Average portfolio outstanding per credit officer
Amount disbursed per period per credit officer.
Efficiency ratio
Operating cost ratio
Salaries and benefits to average portfolio outstanding
Average credit officer as a multiple of per capita GDP
MICROFINANCE PERFORMANCE INDICATORS
C-3
Cost per unit of currency lent

Cost per loan made.
3. Financial viability. Financial viability refers to the ability of an MFI to cover its costs with earned
revenue. To be financially viable, an MFI cannot rely on donor funding to subsidize its operations.
Indicators of financial viability include the following:
Financial spread
Two levels of self-sufficiency, operational and financial
Subsidy dependency index (explained later).
4. Profitability. Profitability ratios measure an MFIs net income in relation to the structure of its
balance sheet. Profitability ratios help investors and managers determine whether they are earning an
adequate return on the funds invested in the MFI. The profitability indicators are
Return on asset ratio
Return on business ratio
Return on equity ratio.
5. Leverage and capital adequacy. Leverage refers to the extent to which an MFI borrows money
relative to its amount of equity. In other words, it answers the question of how many additional dollars
or other currency can be mobilized from commercial sources for every dollar or other currency worth
of funds owned by the MFI. Leverage states the relationship of funding assets with debt versus equity.
It covers two indicators:
Leverage: debt to equity ratio
Capital adequacy standards: capital to risk-weighted assets
6. Scale, outreach, and growth. In addition to financial performance indicators, many MFIs collect
data on their client baseboth the scale of their activities (number of clients served with different
types of instruments) and the depth of outreach (type of clients reached and their level of poverty).
Attempts to establish a set of worldwide microfinance performance standards (Saltzman, Rock, and
Salinger 1998) include the following:
ACCION developed and made public its CAMEL system.
The Private Sector Initiatives Corporation is developing a rating agency.
CGAP and the World Bank are funding the Micro Banking Financial Review.
The UKs Department for International Development (DFID) is funding the development of the
BASE.
Kenyas Micro Finance Institution Monitoring and Analysis System.
USAID funded the PEARLS rating system as used by the World Council of Credit Unions.
Appendix D. Measuring Outreach

According to Ledgerwood (2000), outreach is measured by scale (e.g., numbers of clients served by
different types of instruments) and depth (e.g., types of clients reached and their level of poverty).
This involves determining how many of the poor are served, including the number of women; how
well the MFI reaches the poorest; and the variety of financial services provided. According to CGAP
(1997), outreach indicators are as follows:
Clients and staff
Number of clients or members (percentage women)
Percentage of total target clientele serviced (current)
Number of women as percentage of total borrowers
Number of women as percentage of total depositors
Number of staff
Number of urban branches or units
Number of rural branches or units
Ratio of rural to urban branches or units
Ratio of volume of deposits to volume of outstanding loans
Mobile banking in use
Loan outreach
Number of currently active borrowers
Total balance of outstanding loans
Average outstanding portfolio
Real annual average growth rate of loans outstanding
during the past three years (in real terms)
Loan size
Minimum
Maximum
Average disbursed loan size
Average disbursed loan as a percentage
of GDP per capita
Average outstanding loan size
Average outstanding loan as a percentage of GDP per capita
Average loan term
Nominal interest rate
Effective annual interest rate
Value of loans per staff member (per credit officer)
Number of loans per staff member (per credit officer)
Savings outreach
Total balance of voluntary savings accounts
D-2
APPENDIX D
Total annual average savings as a percentage

of annual average outstanding loan portfolio
Number of current voluntary savings clients
Value of average savings account
Average savings deposits as a percentage of GDP per capita
Value of savings deposits per staff member
Number of savers per staff member
Nominal deposit interest rate (per annum)
Von Pischke (1991) describes a frontier between the formal and informal financial sectors. Those
outside the frontier do not have regular access to formal services. In developing countries, several
categories of people are consistently underserved by financial institutions, including rural inhabitants,
women, the poor, and the uneducated. According to Navajas, Schreiner, Meyer, Gonzales-Vega, &
Meza (2000), there are six measurable dimensions to outreach: breadth, depth, length, scope, cost, and
worth (see Table D-1)
Table D-1
Outreach Dimensions, Definitions and Indicators for Microfinance Institutions
Dimension
Breadth
Definition
The number of clients reached
Indicators
Number of loans to clients
Number of financial accounts
Depth
The value that society

attaches to the net gain of a
given client
Average loan size

Percentage of female clients
Percentage of rural clients
Borrowers' education (less is preferred)
Borrowers' ethnicity (minorities are preferred)
Types of housing (small are preferred)
Length
Assessment of financial
performance-profitability and
portfolio quality
Operational self sufficiency

Financial self sufficiency
Return on assets adjusted
Average loan size to GNP per capita
Real growth portfolio yield
Capital costs to assets
Labor costs to assets
Loans to assets
Donation to loan portfolio
Average loan size
Scope
The number of types of

products and services offered
to clients
Loans
Savings
Insurance
Other
Cost
Worth
The sum of price costs and

transaction costs to clients
Price costs
The value clients place on

products and services
Increase in profits
Transaction costs
The drop-out rate: repeat purchases
MICROFINANCE PERFORMANCE INDICATORS
C-3
Appendix E. Measuring Financial

Sustainability
As discussed, many researchers propose measurements of the financial sustainability of microfinance
institutions (MFIs). Below are some criteria for assessing MFI financial sustainability.
CGAP Indicators
Type
Sustainability/
Code
R1
Ratio
Formula
Return on Equity (ROE)
(Net operating income-taxes)/average equity
Adjusted Return on Equity

(AROE)
(Adjusted net operating income-taxes)/average equity
Return on Assets (ROA)
(Net operating income-taxes)/average assets
Adjusted Return on Assets

(AROA)
(Adjusted net operating income-taxes)/average assets
R3
Operational Self-Sufficiency
Operating revenue/(financial expenses + loan loss provision expenses +

operating expenses
R4
Profit Margin
Net operating income/operating revenue
R5
Financial Self-Sufficiency
Adjusted operating revenue/(financial expenses + loan loss provision

expenses + operating expenses+ expense adjustments
Assets/
R6
Yield on Gross Loan Portfolio
Cash financial revenue from loan portfolio/average gross loan portfolio
Liability
Management
R7
Current Ratio
Short-term assets/short-term liabilities
R8
Yield gap
100%- [cash revenue from loan portfolio/(net loan portfolio x expected

annual yield)]
R9
Funding Expense Ratio
Interest and fee expenses on funding liabilities/average gross loan portfolio
R10
Cost-of-funds Ratio
Interest and fee expenses on funding liabilities/average funding liabilities
R11
Portfolio-at-Risk (PAR) ratio
Portfolio at risk (Xdays)/gross loan portfolio
R12
Write-off Ratio
Value of loans written off/average gross loan portfolio
Adjusted Write-off ratio
Adjusted value of loans written off/average gross loan portfolio
R13
Risk Coverage Ratio
Loan-loss reserve/portfolio at risk > Xdays
Efficiency/
R14
Loan Officer Productivity
Number of active borrowers/number of loan officer
Productivity
R15
Personnel Productivity
Number of active borrowers/number of personnel
R16
Average disbursed Loan Size
Value of loan disbursed/total number of loans disbursed during period
R17
Average Outstanding Loan Size
Gross loan portfolio/number of loans outstanding
R18
Operating Expense Ratio
Operating expense/average gross loan portfolio
R19
Cost Per Borrower
Operating expense/average number of active borrowers
Cost per Client
Operating expense/average number of client
Other Expense Ratios
Any expense/average gross loan portfolio
Profitability
R2
Portfolio
Quality
Number of active client/number of personnel
R20
E-2
APPENDIX E
ACCION CAMEL Indicators

Indicator
ACCION CAMEL
Capital Adequacy (16%)
Formula
Leverage
Adj. risk asset/adj. equity
Adequacy of reserves
Actual loan loss reserve (after write-offs)/adj. loan loss reserve

(after-write-offs)
Portfolio at risk
Adj. portfolio past due>30% days + loans in legal recovery+

rescheduled portfolio 0-30 days/adj. gross loan portfolio
Write-offs/write-off policy
Adj.net write-offs/adj. relevant loan portfolio
Management (23%)
Earnings (24%)
Return on equity
Adj.net income/adj. avg. equity
Operational efficiency
Adj. operational expenses/adj. average Gross Loan Portfolio
Return on assets
Adj.Net Income/adj. avg. assets
Productivity of other current assets
Interest income received on cash and cash equivalent over past 12

months/(avg. monthly cash + cash equiv. balance - liq.
cushion)*(avg. 3months CD rate)+(liq. cushion* avg. saving rate)
Asset Quality (21%)
Liquidity (16%)
WCU PEARLS Indicators

Area
Protection
Effective
Assets
Rates of
Return
& Costs
PEARL
Description
Goal
P1
Allowance for loan losses / allowances required for loans delinquent >12
months
100%
P2
Net allowance for loan losses/allowances required for loans delinquent less than
12 months
35%
P3
Total charge-off of delinquent loans >12 months
100%
P4
Annual loan charge-offs
minimal
P5
Accumulated loan recoveries/accumulated loan charge-offs
100%
P6
Solvency
100%
E1
Net loans/total assets
70-80%
E2
Liquid investment/total assets
Max 20%
E3
Financial investments/total assets
Max 10%
E4
Non-financial investment/total assets
0%
E5
Savings deposits/total assets
70-80%
E6
External credit/total assets
Max 5%
E7
Member share capital/total assets
10-20%
E8
Institutional capital/total assets
Min 10%
E9
Net institutional capital/total assets
Same as E8
A1
Total loan delinquency/gross loan portfolio
5%
A2
Non-earning assets/total assets
5%
A3
Net institutional & transitory capital + non-interest-bearing liabilities/nonearning assets
>200%
R1
Net loan income/average net loan portfolio
Entrepreneurial Rate
R2
Total liquid investment income/average liquid investment
Market Rates
R3
Total financial investment income/average financial investment
Market Rates
R4
Total non-financial investment income/average non-financial investment
Greater than R1
R5
Total interest cost on savings deposits/average savings deposits
Market Rates > Inflation
R6
Total interest cost on external credit/average external credit
Market Rates
R7
Total interest (dividend)cost on shares/average member shares
Market Rates R5
R8
Total gross income margin/average total assets
Variable-Linked to R9,
R11, R12
R9
Total operating expenses/average total assets
5%
E-3
MEASURING FINANCIAL SUSTAINABILITY
Area
PEARL
Liquidity
Signs of
Growth
Description
Goal
R10
Total loan loss provision expense/average total assets
Dependent on delinquent
loans
R11
Non-recurring income or expense/average total assets
Minimal
R12
Net income/average total assets
Linked to E9
L1
S.T. investment + liquid assets - S.T. payables/savings deposits
Min 15%
L2
Liquidity Reserves/Saving Deposits
10%
L3
Non-earning liquid assets/total assets
<1%
S1
Growth in loan to members
Dependent on E1
S2
Growth in liquid investment
Dependent on E2
S3
Growth in financial investment
Dependent on E3
S4
Growth in non-financial investment
Dependent on E4
S5
Growth in savings deposits
Dependent on E5
S6
Growth in external credit
Dependent on E6
S7
Growth in share capital
Dependent on E7
S8
Growth in institutional capital
Dependent on E8
S9
Growth in net institutional capital
Dependent on E9
S10
Growth in membership
>12%
S11
Growth in total assets
>Inflation
Micro rate Indicators

Indicators
Portfolio Quality
Efficiency and
Productivity
Financial Management
Profitability
Ratio
Formula
Portfolio at Risk
(Outstanding balance on arrears over 30 days + total gross outstanding

refinanced (restructured) portfolio) / total outstanding gross portfolio
Provision Expense Ratio
Loan loss provisioning expenses / average gross portfolio
Risk Coverage Ratio
Loan loss reserves / (outstanding balance on arrears over 30 days +

refinanced loans)
Write-Off Ratio
Value of loans written-off / average gross portfolio
Operating Expense Ratio
Operating expenses / average gross portfolio
Cost per Borrower
Operating expenses / average number of active borrowers (excluding

consumer and pawn loans)
Personnel Productivity
Number of active borrowers (excluding consumer and pawn loans) / total

staff
Loan Officer Productivity
Number of active borrowers / number of loan officers
Funding Expense Ratio
Interest and fee expenses / average gross portfolio
Cost of Funds Ratio
Interest and fee expenses on funding liabilities / average funding liabilities
Debt/Equity Ratio
Total liabilities / total equity
Return on Equity
Net income / average equity
Return on Assets
Net income / average assets
Portfolio Yield
Cash financial revenue / average gross portfolio
E-4
APPENDIX E
Microfinance Handbook - MFI Indicators (WB)

Performance
Portfolio quality
Productivity and
efficiency
Indicators
Repayment rate
Formula
Repayment rate
Amount received (including prepayments and past due amounts)/Amount

due (excluding past due amounts)
On-time repayment rate
Collection on current amounts due less prepayments/ total current amounts

due
Repayment rate including

past due amounts
Collection on current amounts due plus past due less prepayments/ total
current amounts due plus past due amounts
Portfolio
quality ratios
Arrears rate
Amount in arrears/ portfolio outstanding (including amounts past due)
Portfolio at Risk
Outstanding balance of loans with payments past due/ Portfolio outstanding

(including amounts past due)
Loan loss ratio
Loan loss reserve ratio
Loan loss reserve for the period/ portfolio outstanding for the period
Loan loss ratio
Amount written off in the period/ average portfolio outstanding for the
period
Number of active loans

per credit officer
Average number of active loans / average number of credit officer
Average portfolio
outstanding per credit
officer
Average value of loans outstanding/ average number of credit officer
Amount disbursed per

period per credit officer
Total amount disbursed/ average number of credit officer
Operating cost ratio
Operating cost/ average portfolio outstanding
Salaries and Benefits to

average portfolio
outstanding
Salaries and benefits/ average portfolio outstanding
Average credit officer as

a multiple of per capita
GDP
Per capita GDP/ average credit officer salary
Cost per unit of currency

lent
Operating cost for the period/ total amount disbursed
Productivity
ratio
Efficiency ratio
Financial
viability
Ratio
Cost per loan made
Operating cost for the period/ total number of loan made in the period
Financial
spread
Spread
(Interest and fee revenue financing costs)/ average loan portfolio
Spread (gross financial

margin)
(Operating revenue financing costs)/ average performing assets
Two levels of
self sufficiency
Operational selfsufficiency (i)
Operating income/ (operating expenses + financing costs+ provision for

loan losses)
Operational selfsufficiency (ii)
Operating income/ (operating expenses + provision for loan losses)
Financial self sufficiency
Operating income/ (operating expenses + financing costs+ provision for

loan losses + cost of capital)
Cost of capital= [(inflation rate x (average equity average fixed assets)]+
[(average funding liabilities x market rate of debt) actual financing costs]
Subsidy
dependency
index
Profitability
Leverage and
capital adequacy
RoA ratio
Total annual subsidies received (S)/ average annual interest income (LP * i )
i= Annual interest earned/ average annual loan portfolio
ROA
Net income/ average assets
ROA adjusted
Net adjusted income/ average total assets
Return on
Business ratio
Return on Business ratio

(adjusted)
Net adjusted income/ average business base
RoE ratio
ROE adjusted
Net adjusted income/ Average equity
Leverage
Debt to equity ratio
Debt/ equity
Capital
adequacy
standards
Capital to risk-weighted
assets
Invested capital + reserves+ retained earnings/ risk-weighted assets
E-5
M-CRILL Indicators
No
Indicator
Formula
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
Average loan disbursed
Total portfolio disbursed over the year divided by the number of loans disbursed during the year
Average loan portfolio
This represents the average loan outstanding for the year computed on a monthly basis
Average total assets
This represents the average total assets for the year calculated on an annual basis
CCR/OSS
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%)
Cost per borrower
Total cost of operations (staff cost and other expenses but nonfinancial or loan loss expenses)
divided by number of borrowers served by the RLF
EIR Effective interest rate
Total cost of the loan to the borrower calculated as a proportion of the borrowers expected average
loan portfolio for the year (as determined by the loan terms)
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.
LAR Loans at risk
The number of loans with portfolio at risk (PAR see below) as a proportion of the total number of
loans
10
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 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
11
LLP Loan loss

provisioning ratio
Total loan loss provisioning expense for the year divided by the average portfolio
12
Net operating margin
Difference of (yield on portfolio+ yield on other income) and (loan loss provisioning) also known
as spread on portfolio
13
OER Operating expense

ratio
Ratio of salaries, travel, administrative costs and depreciation expenses to the average loan portfolio
14
PAR Portfolio at risk (PAR

(>0day))
Ratio of the principal balance outstanding on all loans with overdue 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 overdue for more than 30 days or PAR90 principal outstanding in loans
with overdue for more than 90 days and so on
15
RoA Return on assets
Ratio of profit earned (or loss) to average total assets. RoA is a measure of an organizations
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
16
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
17
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).
18
Yield on portfolio
Actual interest income on lending by the RLF divided by the average loan portfolio for the year
Another measurement for all performance indicators is the Subsidy Dependence Index, particularly
for subsidized MFIs. Conducting a microfinance business is costly because small-scale loans incur
high transaction costs and providing credit poses risks. The poor cannot obtain loans from commercial
financial institutions because they cannot provide collateral. Commercial financial institutions do not
engage in micro lending because of the risks and higher transaction costs. Different to Indonesian
cases, many MFIs in international practices are supported by the government through subsidies and in
their early stages of development, by donations.
E-6
APPENDIX E
Subsidies can be defined as the opportunity cost of the subsidized resource; subsidized resources are
funds that are priced below the opportunity cost of those funds (Schreiner 2003). According to
Schreiner (2003), there are six sources of subsidy: direct grants, public paid-in capital, revenue grants,
discounts on soft debt, discounts on expenses, and discounts on the true profit. Direct grants, such as a
cash gifts, computers, furniture or vehicles, are counted as assets on the balance sheet. Public paid-in
capital comes from the sale of shares to donors, whereas private paid-in capital comes from the sale of
shares to private entities. Revenue grants are cash gifts from government donations and the discount
on soft debt subsidy is the opportunity cost of the soft debt minus what the microfinance institution
paid.
Discounts on expenses are costs absorbed by donors, which the MFI does not record as expenses; for
example, technical help, exemptions from reserve requirements, no deposit insurance, coverage of
organizational costs and feasibility studies, debt guarantees, fees for consultants, training for loan
officers and travel for workers. The true profit, the sixth form of subsidized funds, can be calculated
by subtracting grant profits from accounting profits. Overall, these subsidized resources can be
categorized according to the type of grants, either in cash or noncash forms.
To measure subsidized resources for MFIs, Yaron (1992) introduced the Subsidy Dependence Index
(SDI), which was then expanded by Schreiner (1999). The SDI is a measure of self-sufficiency for
subsidized financial institutions. It is the percentage change in the yield on lending with everything
else held constant, which makes the subsidy equal to zero. The computation of SDI is based on
Shreiner and Yarons (1999) framework, given as:
SDI = Total annual subsidies received (S) / Average annual interest income (LP * i)
= A (m c) + [(E * m) p] + K / (LP * i)
where:
S
S
A
M
=
=
=
=
E
P
K
=
=
=
LP =
i
=
i
Annual subsidy received by the microfinance institution calculated from

A (m-c) + [(E*m) p] + K
Microfinance institution concessionary borrowed funds outstanding
Interest rate that the microfinance institution would assume to pay for borrowed funds if
access to concessionary funds were eliminated
Weighted average annual concessionary rate of interest actually paid by the microfinance
institution on its average annual concessionary borrowed funds outstanding
Average annual equity
Reported annual profit before tax (adjusted for loan loss provisions and inflation)
The sum of all other annual subsidies received by the microfinance institution (such partial or
complete coverage of the microfinance institutions costs by the State or Federal Government)
Average annual outstanding loan portfolio of the microfinance institution
Weighted average yield earned on loan portfolio of the microfinance institution or weighted
average on-lending interest rate earned on the MFI loan portfolio
Annual interest earned / Average annual loan portfolio
A high value indicates low financial sustainability and a low value indicates a higher sustainability.
The index value also suggests how much the average interest rate would have to be increased to
compensate for a complete and immediate elimination of subsidy (Shreiner & Yaron 1999). Mokhrar
(2011) has summarized studies that use SDI values to examine subsidy dependence, as follows:
Schreiner (2003), Morduch (1999b), and Hulme and Mosley (1996a) used the SDI framework to
E-7
examine the subsidy dependence of Grameen Bank. Schreiner (2003) examined the SDI of Banco Sol
Bolivia. In addition, the SDI model has been applied to other institutions, such as cooperative and
NGOs in Nigeria and commercial banks in Fiji, by Sharma Alufohai, (2006) and Uriam (2003),
respectively.
In addition to measuring financial indicators, the Central Bank of Nigeria also uses a dependency ratio
to examine whether MFIs can be self-sustainable, profitable, and meet their social missions. The
dependency ratio is measured by the ratio of donated equity to total capital. This indicator is
combined with ratio of retained earnings to total capital and the combination provides information
about MFIs financial self-sufficiency.

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Financial Inclusion in

1.2 Study Objectives

1.3 Conceptual Policy Framework for Financial Inclusion System in Indonesia

2.2 Data Collection Methods

2.3 Method of selection UPK for transformation

3. State of Financial Inclusion

3.2 Financial Inclusion in Indonesia

3.3 Gap between Current and Desired State of Financial Inclusion

4. PNPM UPK System

Error! Bookmark not defined.

4.2 Evaluation of UPK Performance Based on National Data

4.3 Evaluation of UPK Performance in the Study Area

4.4 Opportunities and Constraints

Error! Bookmark not defined.

5. Transforming Sustainable UPKs into Legal Microfinance Institutions

5.1 The Need

5.2 Conceptual Approach

5.3 Legal Business Form Options

5.4 Factors to Consider in Deciding Legal Structure

5.5 Operational Implications of Transformation

6.2 General Description of Project

6.3 Project Funding

6.4 Monitoring and Evaluation Plan

Appendix A. Maya Declaration on Financial Inclusion

Appendix B. System of PNPM

Appendix C. Literature Review of Microfinance Performance Indicators

Appendix D. Measuring Outreach

Appendix E. Measuring Financial Sustainability

Figure 1-1. Financial Inclusion Policy Frameworks

Asuransi Central Asia

FINANCIAL INCLUSION IN INDONESIA

FINANCIAL INCLUSION IN INDONESIA

Return on assets (RoA). A measure of an organizations profitability relative to total funds

1.2 STUDY OBJECTIVES

FINANCIAL INCLUSION IN INDONESIA

1.3 CONCEPTUAL POLICY FRAMEWORK FOR FINANCIAL

FINANCIAL INCLUSION IN INDONESIA

Formal Credit Market

Informal Credit Market

Three Types of Problems in Money Lending

Two Types of Mechanisms to Manage Money Lending Problems

FINANCIAL INCLUSION IN INDONESIA

Group Lending Schemes

FINANCIAL INCLUSION IN INDONESIA

Type of Financial Products, Terms, and Conditions

Policy Framework for Financial Inclusion System

FINANCIAL INCLUSION IN INDONESIA

High Growth with Equity

Low Income Household

Suppy side Constraint:

Demand side Constraint:

Non-conventional financial services practices:

Inclusive Financial System

Non-Bank Financial Institutions:

Knowledge and Skills:

Option for improving UPK

Well established finance

Road map of each typology

2.1 RESEARCH STAGES

Analysis legal options for the

Project design for a Pilot

Program and product

FINANCIAL INCLUSION IN INDONESIA

Households have access to