PPK Program Pengembangan Kecamatan KDP Kecamatan … · KDP Microcredit System Review i Review of...

P P K P r o g r a m P e n g e m b a n g a n K e c a m a t a n

K D P K e c a m a t a n D e v e l o p m e n t P r o g r a m

Financi

K D P M

R e v i e w o f t h e i c r o c r e d i t A p p r o a c h

al Management Unit UPK Telagasari, West Java

Consultancy Report

prepared for

World Bank, Jakarta Office

by

Dr. Detlev Holloh

Jakarta, September 2001

KDP Microcredit System Review i

Review of the KDP Microcredit Approach Dr. Detlev Holloh, September 2001

CONTENTS

Introduction 1

1. KDP Objectives, Strategy and Instruments 3

1.1 Context and Objectives of the First Kecamatan Development Program (KDP I) 4

1.2 KDP Organization, Technical Assistance and Implementation Responsibilities 6

1.3 KDP I Project Strategy and Implementation Process 9

1.4 KDP I Microcredit System and Revolving Fund Management 12

1.5 Project Appraisal of the Second Kecamatan Development Program (KDP II) 22

2. KDP Credit Performance and Experiences 28

2.1 KDP Credit Performance: What Do Databases and Reports Say? 28

2.1.1 Availability and Quality of Information 28

2.1.2 General Performance and Allocation of Funds 29

2.1.3 Credit Repayment Performance 31

2.1.4 Credit and Financial Management Problems 32

2.2 Findings of KDP Economic Studies 35

2.2.1 Microcredit Approach and Management 35

2.2.2 Governance and Management of Loan Funds 36

2.2.3 Borrower Characteristics, Loan Use and Impact 37

2.2.4 Reasons for Poor Repayment Performance 38

2.2.5 KDP Relations to Banks and other Credit Programs 39

2.2.6 Recommendations of the Economic Studies 40

2.3 Field Visit Findings: Yogyakarta, Lampung, Karawang 43

2.3.1 General Performance 43

2.3.2 UPK Organization and Management 45

2.3.3 Outreach and Financial Performance 47

2.3.4 Financial Administration and Management 49

2.3.5 Credit Management 51

2.3.6 Project Support 55

2.3.7 Preparing the Future of UPKs 56

KDP Microcredit System Review ii

3. Major Issues and Conclusions 58

3.1 KDP Microcredit Performance: Design Matters 58

3.2 Terminating Microcredit or Phasing-out ‘Old’ Sub-districts? 59

3.3 Alternatives to Managing Loan Funds by UPKs? 60

3.4 Should Microcredit be Continued in KDP II? 62

3.5 KDP Strategy and Process Vs. Sound Credit Management 63

3.6 Microcredit & Revolving Funds Expertise and Consultancy Inputs 64

3.7 Objectives-Oriented Planning for Microcredit & Revolving Funds 65

3.8 Manuals and Instruments for Microcredit & Revolving Funds Management 66

3.9 Training and Consultancy Systems for Microcredit & Revolving Funds 67

3.10 Information and Supervision Systems for Microcredit & Revolving Funds 68

3.11 Governance and Future of UPKs 69

3.12 Target Groups, Credit Eligibility and Access to Credit 70

4. Towards a New KDP II Microcredit Approach: A Proposal 71

4.1 Principles for the New KDP II Microcredit Approach 71

4.2 Proposal for a Preparatory Technical Taskforce 73

Annexes

A. Detlev Holloh, ProFI Microfinance Study, Bank Indonesia and GTZ, Denpasar, March 2001.

B. Regional Income Generation Project (RIGP-P4K): Information Materials

C. Presentation of Preliminary Results of the Review Mission, 19 September 2001

KDP Microcredit System Review iii

CURRENCY EQUIVALENTS

Note: The report provides information in Rupiah only, as the exhange rate has been extremely volatile during the last years and the US Dollar does not reflect local financial intermediation exclusively done in Rupiah.

End of Year

Currency Unit: US Dollar

Currency Unit: Indonesian Rupiah (Rp.)

1997 $ 1 = Rp. 4,650

1998 $ 1 = Rp. 8,025

1999 $ 1 = Rp. 7,100

2000 $ 1 = Rp. 9,675 August 2001 $ 1 = Rp. 8,925

September, 22, 2001 $ 1 = Rp. 9,420

FISCAL YEARS

Until March 31, 2000: April 1 to March 31

Until December 31, 2000: April 1 to December 31

From January 1, 2001: January 1 to December 31

KDP Microcredit System Review iv

ABBREVIATIONS AND ACRONYMS

BPD Bank Pembangunan Daerah: Regional Development Bank BPR Bank Perkreditan Rakyat: People’s Credit Bank BRI Bank Rakyat Indonesia: People’s Bank of Indonesia, commercial state bank FD Fasilitator Desa: Village facilitator FK Fasilitator Kecamatan: Sub-district facilitator GTZ German Agency for Technical Cooperation IDR Indonesian Rupiah IDT Inpres Desa Tertinggal: Presidential Instruction on Backward Villages KDP Kecamatan Development Project (PPK) KM-Kab KDP District Management Consultants KM-Prop KDP Provincial Management Consultants LKMD Lembaga Ketahanan Masyarakat Desa: village administrative body NMC KDP National Management Consultants P2KP Proyek Penanggulangan Kemiskinan di Perkotaan: Poverty Alleviation Project

in Urban Areas P4K Proyek Peningkatan Pendapatan Petani-Nelayan Kecil: Small Farmers'

Income Generating Project PDM-DKE Pemberdayaan Daerah dalam Mengatasi Dampak Krisis Ekonomi: Local

Empowerment by Overcoming the Impact of the Economic Crisis PHBK Proyek Hubungan Bank dengan Kelompok Swadaya Masyarakat: Project

Linking Banks and Self-help Groups, also: linkage project P3DT Pembangunan Prasarana Pendukung Desa Tertinggal : Village Infrastructure

Project (VIP) PjAK KDP sub-district administrator PjOK KDP sub-district project manager PMD BPM

Pengembangan Masyarakat Desa: Village Community Development Agency, Ministry of Home Affairs (Now: Badan Pengembangan Masyarakat)

PPK Program Pengembangan Kecamatan: Sub-district Development Program ProFI Promotion of Small Financial Institutions RIGP/P4K Rural Income Generation Project, 3rd phase of P4K TPK KDP village implementation team UDKP Sub-district Council of Village Heads, includes more village representatives as

the KDP planning and decision-making body. UED-SP Unit Ekonomi Desa-Simpan Pinjam: Village Economic Unit-Savings and CreditUPK Unit Pengelola Keuangan: Financial Management Unit of PPK USD US Dollar VIP Village Infrastructure Project

KDP Microcredit System Review v

EXECUTIVE SUMMARY

The Kecamatan Development Program (KDP) aims at alleviating poverty, improving local governance and strengthening local government and community institutions. KDP allocates block grants to poorer sub-districts for financing village infrastructure and economic activities through participative local planning and decision-making mechanisms. A Financial Management Unit (UPK) at the sub-district level provides either grants for infrastructure projects to villages or loans to community groups. UPKs use loan repayments to build up revolving funds managed.

This report reviews KDP’s current microcredit system to come up with recommendations for the second KDP project to be implemented between January 2002 and June 2006. The review focuses on examining the supply side of KDP’s microcredit system. If credit management and services are wrong, loan use will most likely not be achieving the expected impact.

Design Matters. KDP has been successful in involving communities in local planning and decision-making, making governments more responsive to local needs, and building low-cost infrastructure by participative planning and self-help. This success was based on a tailor-made project design. In contrast to this success, KDP’s microcredit and revolving fund component has been performing poorly. The major conclusion of this review is that the very same design that brought about project success doomed KDP’s microcredit component to failure.

KDP Strategy Incompatible with Sound Credit Management. The core of the project is a participative planning and decision-making process by which funds are competed for between villages. This process is good for allocating funds earmarked for public goods. It is incompatible with the sound management of credit and revolving funds. Both participative forums and local government institutions are governed by logics other than required for good credit governance.

Special Microcredit Planning and Inputs Matter. KDP did not make microcredit a focus of strategic planning. Consequently, the project has not been providing the inputs required for a successful microcredit program. There are no comprehensive financial & credit management manuals and instruments. Financial & credit management training modules do not exist. Neither training and consultancy systems nor effective information and supervision systems were established for both the UPK as the lender and the community groups as the borrowers. KDP financial intermediaries lack financial and credit management capabilities. Common bonds, internal control, organization and financial administration of community groups have been weak. Group members lack business planning and management capabilities.

Alternatives? Executing program credit through banks, linking community groups to banks, or decentralizing revolving funds to the village level were discussed as alternatives to managing KDP loan funds by UPKs. This report comes to the conclusion that these alternatives are not viable, do not necessarily improve credit services to low-income households, do increase rather than decrease project burdens, or do not provide a generalized solution for all project areas. UPKs should be encouraged to graduate bankable borrowers to banks. However, the scarcity of both bankable KDP groups and banks able and willing to provide credit services to KDP’s target groups, leaves no general option other than managing loan funds by UPKs.

KDP Microcredit System Review vi

Continue Microcredit Operations? KDP II stakeholders are advised to continue credit and revolving fund operations only, if they are willing to make substantial changes to the current system. Elements of such substantial changes are:

Targeting Low-income Households with Prudential Credit Services

SEPARATE CREDIT MANAGEMENT. Credit management must be made subject to prudential banking principles. KDP’ process-oriented strategy needs to be maintained, but credit management should add output orientation and be separated from the overall process. The lender (UPK) should take and manage credit risks by commanding all credit procedures.

DEMAND-DRIVEN AND SUPPLY-CONTROLLED CREDIT. KDP has been applying an approach driven by expressed needs. A demand-driven approach looks to effective credit demand, absorption and repayment capacity. Identifying real demand requires a supply-controlled approach. The lending institution rather than community forums has to appraise credit feasibility and to determine loan amounts, terms and conditions.

CREDIT ALONE IS NOT ENOUGH. UPKs, community groups and individual borrowers must be trained before credit operations start, and they must have access to continued technical assistance and supervision services.

NO FAST CREDIT. Credit operations must be prepared. Require sub-districts to finalize preparations before credit operations are started.

NO EASY CREDIT. Access to credit is not a matter of course. Groups have to meet credit eligibility criteria. Borrowers have to pledge guarantees, measurable efforts of self-help and joint responsibility, to get access to credit; they must prove willingness to repay, to collect savings and to learn from KDP training.

NO INSTANT CREDIT. One-time access to credit is not what low-income households need and what make borrowers repaying credit. Guarantee repeated and sustained access to credit for well-performing borrowers by thoroughly planning the allocation of UPK loan funds.

NO CHEAP CREDIT. Interest rates should not undermine sustainable banking operations. The setting of interest rates has to take cost of funds, loan loss costs and credit risks, operating and inflation costs into account. Interest rates must cover costs and sustain the net value of loan funds.

Making Self-help Groups and UPKs the Focal Points of the Microcredit Approach

GROUP FOCUS. Make self-help groups the focal point for strengthening the demand side of the microcredit approach. Their capability of planning and managing microbusinesses, managing savings and credit activities, and bargaining and networking with third parties is a crucial factor for making the KDP microcredit program a success. Strengthening groups has to be accompanied by requiring borrowing groups and members to pledge self-help and guarantees, and to meet credit eligibility criteria.

KDP Microcredit System Review vii

Credit eligibility develops. KDP II should apply a gradual approach to providing credit access. This includes, i.e., limiting individual loan sizes and making higher loan sizes dependent on repayment performance and the members’ business planning and management capabilities. This approach should also guarantee repeated and sustained credit access for well performing borrowers.

UPK FOCUS. Make the UPK the focal point for strengthening the supply side of the microcredit approach. The proper setup of the UPK system and the training of UPK staff is crucial for ensuring prudential financial and credit management. The new UPK governance should be based on:

o Full credit management responsibilities. o Direct relationships of UPKs to borrowing groups. o By-laws that determine objectives, operations, supervision, liability

of managers. o Staffing with capable and motivated persons. o UPK staff graduating from KDP training. o Setup of accounting & financial management system before

starting credit operations. o Village credit officers as UPK staff and responsible to the UPK. o Effective supervision and auditing. o UPK association building for cooperation and networking with

service providers. o UPK cooperation with special local consultants.

Preparatory Steps for the KDP II Microcredit Approach

Designing basic approach and policy decision.

Objectives-oriented planning of the microcredit component.

Developing UPK accounting system / financial management instruments and manual.

Designing credit management instruments and manual.

Designing training manuals and training management system.

Designing UPK consultancy system.

Preparing procurement of local trainers and consultants.

Designing microcredit/UPK information and supervision systems.

Designing credit eligibility and group development concept.

Preparing the setup of the KDP II long-term microcredit consultancy team.

Ensuring Preparations and Enabling Preparations to Become Effective

To ensure fast preparation of the new microcredit system, an independent small technical task force of microcredit experts should be assigned.

Sub-districts should prepare phasing-in plans that include all preparatory steps and requirements for starting microcredit operations.

Sub-districts should be required not to start credit operations before preparations are finalized, UKPs are set up, and UPK staff and groups are trained.

The Kecamatan Develolocal governance and sallocating block grants infrastructure and economaking processes. A spmanages KDP funds. Tgrants and economic acrepayments flow back through the project’s pla

The First Kecamatan DAugust 1998. Its third aplanned to end on 31 Away and loan repaymenappraisal of the SeconMay 2001. KDP II impleuntil June 2006.

The consultant was asobjective to prepare a pwas carried out betweeweeks of field travel in Wbased on field findingsreports and studies, mand intensive discussiomanagement team. Theand Economic Monitorisupporting his field visit

Project studies in the fithe demand side of Kimportant sources of imicrocredit system. Exmatters and its transforcrucial for either projecwrong, loan use will mo

KDP Microcredit System Review

Introduction

pment Program (KDP) aims at alleviating poverty, improving trengthening local government and community institutions by

to poorer sub-districts as sources of funds for financing village mic activities through participative local planning and decision-ecial Financial Management Unit (UPK) at the sub-district level he UPK finances village infrastructure projects in the form of tivities of community group members in the form of loans. Loan to the sub-district level to be managed as revolving funds nning and decision-making mechanisms.

evelopment Program (KDP I) has been implemented since nnual cycle of local project planning and implementation was ugust 2001, but preparations for the third cycle are still under t of the third disbursement cycle may reach well into 2003. The d Kecamatan Development Program (KDP II) was finalized in mentation is planned to commence in January 2002 and to last

signed to review KDP’s current microcredit system with the roposal for the KDP II microcredit approach. The consultancy n 2 August 2001 and 21 September 2001. It included three est Java, Yogyakarta and Lampung. The consultancy report is

, the review of current project designs, formats, databases, eetings with various project stakeholders and related parties, ns with the National Management Consultant’s (NMC) financial consultant is greatly indebted to Mr. Azlim Fitra, NMC Social

ng Expert, and Mr. Agung H. Budi, NMC Credit Specialist, for s and providing valuable inputs for his report.

eld of microcredit have been focusing on loan use and impact, DP’s microcredit approach. While these studies are used as nformation, this report focuses on the supply side of KDP’s perience from other microcredit programs shows that design mation into practice through project instruments and inputs are t success or failure. If credit management and services are

st likely not be achieving the expected impact.

Introduction KDP Microcredit System Review 2

One of the first observations of the consultant was that project stakeholders and various project documents communicate different objectives and expectations with regard to KDP’s microcredit and revolving fund approach. Assuming that project objectives and design determine the strategies and instruments applied in local project implementation, the consultant placed much emphasis on examining the relationship between the KDP’s credit and revolving fund management approach as reflected in its design, strategy, guidelines and instruments, on the one hand, and KDP’s credit and revolving funds performance, on the other hand.

This report consists of four chapters:

The first chapter describes KDP’s project design, strategy and instruments. What does the project want to achieve, which strategy is applied to achieve project objectives, and which inputs and instruments are provided in support of the project strategy? Special attention is given to examining KDP’s credit and revolving fund management system.

The second chapter looks to the output side of KDP’s microcredit system. Findings presented here are based on a) national databases and local reports, b) economic and microcredit studies carried out by the project, and c) the consultant’s field visits to West Java, Yogyakarta and Lampung.

The third chapter presents the major issues and conclusions of the consultancy. The major conclusion is that microcredit has become KDP’s problem child because of the very same design that made the project successful in improving participative local planning and decision-making processes for infrastructure investments. KDP II is advised to continue credit and revolving fund operations only, if substantial changes to the current system are made.

The fourth chapter presents principles that may guide KDP towards a new microcredit approach and proposes setting up a microcredit technical taskforce that can is capable of preparing the KDP II microcredit and revolving fund system. The consultant refrained from providing a detailed proposal, because technical preparations are highly dependent on policy decisions to be taken for substantially changing the current KDP microcredit approach.

KD

This review of KDP’s mrationale as documenteachieve, which strategyinstruments are providethe KDP I project desigfor the discussion of KD

A. The World Bank, Ru

Country DepartmentLoan in the Amount Development Projec

B. Departemen Dalam Kecamatan: PetunjuTahun Anggaran 19

C. National ManagemeDevelopment Progra

D. Departemen Dalam Pusat: Kebijakan PeOperasional Program(Collection of circulaThis document inclu

a. Menteri DalamPetunjuk Tekn

b. Menteri DalamPenegasan Pr1999.

E. Departemen Dalam Pusat: Formulir Isian2001. (Collection of

F. The World Bank, EnRegion: Project AppMillion and ProposedEquivalent) to the ReWorld Bank Report N


1. P Objectives, Strategy and Instruments

icrocredit system starts from the current project design and its d in various project documents. What does the project want to is applied to achieve project objectives, and which inputs and d in support of the project strategy? This chapter summarizes n and the KDP II project appraisal document as far as relevant P’s microcredit system. It is based on the following references:

ral Development and Natural Resources Sector Unit, Indonesia , East Asia and Pacific Region: Project Appraisal Document on a of US$ 225 Million to the Republic of Indonesia for a Kecamatan t, World Bank Report No.: 17397 IND, April 21, 1998.

Negeri Republik Indonesia, Tim Koordinasi Program Pengembangan k Teknis Operasional Program Pengembangan Kecamatan (PPK), 99/2000 - 2000, Jakarta 2000. (Implementation guidelines)

nt Consultants for the KDP National Secretariat: Kecamatan m. Second Annual Report 1999/2000, Jakarta, September 2000.

Negeri dan Otonomi Daerah Republik Indonesia, Tim Koordinasi PPK nyempurnaan Petunjuk Pelaksanaan dan Petunjuk Teknis Pengembangan Kecamatan (PPK) Tahun 2001, Jakarta 2001.

r letters improving provisions made in the implementation guidelines) des guidelines for KDP’s revolving fund:

Negeri Republik Indonesia, Surat Edaran Nomor 414.2/1098/PMD, is Perguliran Dana PPK, Jakarta, 5 Agustus 1999.

Negeri Republik Indonesia, Surat Edaran Nomor 412.2/1663/PMD, insip-prinsip Teknis Perguliran Dana PPK, Jakarta, 27 Desember

Negeri dan Otonomi Daerah Republik Indonesia, Tim Koordinasi PPK Program Pengembangan Kecamatan (PPK) Tahun 2001, Jakarta instruments and forms applied in project implementation)

vironment and Social Development Unit East Asia and Pacific raisal Document on a Proposed Loan in the Amount of US$ 208.9 Credit in the Amount of SDR 87.5 Million (US$ 111.3 Million public of Indonesia for a Second Kecamatan Development Project, o. 22279-IND, May 23, 2001.

Objectives, Strategy and Instruments KDP Microcredit System Review 4

1.1 Context and Objectives of the First Kecamatan Development Program (KDP I)

The formulation of development objectives and project strategies depends on the perception and analysis of problems the target population or institutions are exposed to. The project documents available to the consultant do not include a systematic problem analysis with regard to microcredit, but they describe the strategic context from which the project and its microcredit intervention emerged.

The IDT and P3DT Projects as KDP Predecessors

With the issuance of Inpres Desa Tertinggal (IDT), or Presidential Instruction on Backward Villages, in 1993 poverty alleviation was made a political top priority. IDT became an ambitious poverty alleviation program that targeted 44% of Indonesia’s villages in three financial years (1994/1995 to 1996/97). As of March 1997, the program had injected IDR 1.3 trillion into 28,376 villages and 123,000 community groups.

The IDT design already included the major KDP components: a) capital grants to be used as revolving funds for income-generating activities of the poor; b) capital grants to be used for improving the physical infrastructure of poor villages, and c) technical support provided by program facilitators. As a crash program that hastily formed community groups to channel loans at highly subsidized interest rates, however, IDT represented a break with good practices of developing viable self-help groups of the poor and sustainable microfinance systems accessible by the poor. Focusing on distributing money in short time rather than on the self-reliance of community groups and the sustainability of microcredit services, and lacking a proper monitoring and supervision system, about half of credit channeled was not repaid.

Pembangunan Prasarana Pendukung Desa Tertinggal (P3DT) or the Village Infrastructure Project (VIP) was added to the IDT program and, financially and technically assisted by the World Bank, has been working through one-time block grants to poor villages and has been. Launched in the financial year 1995/96, the project is reported to have been successful in introducing participative mechanisms for planning, building and maintaining low-cost village infrastructure.

Both the unsatisfactory IDT performance and the satisfactory VIP performance contributed to rethinking future project designs. The World Bank’s project appraisal document used the lessons learned from VIP, but enabled greater decision-making, especially by (a) introducing block grants at the sub-district level to accommodate differing local needs; (b) establishing an open menu policy for funding proposals from the village level; and (c) aiming at strengthening local government capacity and developing a sustainable local mechanism for participative fund management.

KDP as a Reaction to the Financial Crisis, Poverty and Bad Governance

The long-term financial and economic crisis since mid-1997, accompanied by the El Nino drought, revealed that the majority of the Indonesian population had remained highly vulnerable to expenditure poverty. It was estimated that the poverty incidence in the second half of 1998 was more than two times the estimated pre-crisis low, and that, taking into account the various dimensions of poverty, that poverty confronted more than half of all Indonesians.


KDP was designed under the impression of this crisis and poverty incidence. In line with Government and World Bank policies, the project intended to address these problems with labor-intensive work programs and fast cash transfers to the poor. The project appraisal stated: “KDP is expected to become the government's umbrella for community-based poverty relief.”

The rapid transformation of the financial into a political crisis also highlighted that decades of authoritarian centralized rule had undermined local initiative, planning and decision-making, the accountability of the local administrative system and its responsiveness to the needs of the poor. While bad governance had become a major constraint for economic recovery and poverty alleviation, in general, the KDP design recognized that the effective delivery of services to the poor and the village level requires improving the capacity, transparency, and responsiveness of local government and strengthening community institutions through participative planning and decision-making processes.

The KDP project design may be regarded as a response to the inter-related problems of poverty and bad governance. This response fitted into the reform and stabilization program the Government embarked upon in 1998, which included a range of social safety net and credit programs in order to cushion the impact of the crisis as well as efforts to improve public accountability and local decision-making.

Risks and Assumptions Related to the Strategic Project Context

The project appraisal rated the risk of fast project scale-up high. Facing the pressure of mass poverty, however, it opted for covering 725 sub-districts within two years, also because it assumed that the VIP had provided a successful test of basic project mechanisms: “Once a tested system of this type is in place, the success of any one village/kecamatan is independent of the number of kecamatans in the program.“

The project appraisal pointed to the persisting risk of unaccountable and unresponsive local governments. It also pointed to the lesson that government should concentrate on providing adequate frameworks rather than direct involvement in local project implementation. Nonetheless, it opted for providing financial resources through local administrative structures, especially LKMDs, “the village councils that have managed VIP programs with such success”.

Project Objectives and Expected Outputs

The project appraisal defines KDP’s development objectives as to a) raise rural incomes, b) strengthen kecamatan and village government and community institutions, and c) build public infrastructure through labor-intensive methods. Direct financing of community activities through participatory planning and decision-making mechanisms at the sub-district and village levels is thought to shorten the lag between planning requests and funding availability, to ensure implementation of local priorities, and to improve local transparency and ownership. KDP’s implementation guidelines define the general project objective as to accelerate the alleviation of poverty and strengthen community and government institutions via the provision of funds for the development of productive businesses and infrastructure in rural areas.


Specific project objectives/outputs mentioned are:

• To increase community participation in planning, implementation and sustaining rural economic activities.

• To increase business activities, employment opportunities and income sources of the rural population.

• To provide infrastructure for developing the people’s economy in rural areas.

• Increase the capacity of community and government institutions at the village and sub-district level for facilitating people’s empowerment in implementing development programs.

The project appraisal formulates the following project outputs that are supposed to contribute to KDP’s development objectives: a) improved planning of villages, b) public infrastructures proposals implemented, and c) economic investments proposals implemented. Key performance indicators mentioned are a) participation of 350 sub-districts in the first and of 725 sub-districts in the second financial year; b) 2000 new villages participating each of the three financial years; funds disbursed per financial year (IDR 227 billion, 450 billion, 450 billion); economic returns on sub-projects higher than 20% per financial year; loan repayment rates better than 80% per financial year; and a percentage of revolving funds with increased capital higher than 80% per financial year.

Note: The project objectives imply funding of infrastructure and microbusinesses. However, microcredit and revolving loan funds were not directly made an integral part of project objectives and outputs. Sustainability of microcredit services was did not become a focus of the project design, though one if the key performance indicators mentioned expects that revolving funds will be growing. While the project appraisal assumes that KDP will phase out credit activities after three years of project implementation, the project’s implementation guidelines explicitly mention the necessity of sustaining the revolving fund. After the general presentation of the project concept in the appraisal document, KDP appears not to have developed a comprehensive logical framework through which the role of its microcredit system is clearly defined through a hierarchy of objectives, outputs, and indicators.

1.2 KDP Organization, Technical Assistance and Implementation Responsibilities

At the national level, KDP is currently carried out under the responsibility of the Community Development Agency (PMD) of the Ministry of Home Affairs. PMD’s Project Secretariat, headed by the national project manager and assisted by an advisory team, manages the project budget, contracts consultants, determines the project policy, and issues project regulations and guidelines. A National Management Consultant (NMC) team provides technical assistance. Currently, it consists of 42 consultants but has only one recently employed credit specialist.

At the provincial and district level, KDP secretariats and coordination teams are responsible for project coordination. Technical assistance comes through provincial management consultants (KMProp) and district management consultants (KMKab),


which were contracted through various consulting firms. The project currently employs 20 provincial and 215 district consultants. These consultants have general project implementation and monitoring responsibilities. Microfinance or credit experts are not hired at the provincial and district levels.

Project Implementation at the Sub-district Level

The locus of project implementation is the sub-district level. The sub-district head has the overall responsibility for project implementation, legitimizes fund allocation to villages based on decisions taken the sub-district development forum (UDKP), and legalizes the latter’s financial management unit (UPK). Operational responsibility is assigned to a sub-district project manager (PjOK), a local PMD official assisted by another civil servant responsible for project administration (PjAK). Both officials cooperate with project staff in facilitating the functions of the UDKP and UPK.

UDKP – Sub-district Development Forum. The allocation of KDP funds to selected sub-districts given, the UDKP becomes KDP’s core decision-making body. The UDKP is originally a forum headed by the sub-district head and made up of village leaders and sub-district officials in order to communicate local development issues. In the framework of KDP, UDKP participants are additionally made up of project personnel and three members per village who were elected in or chosen from the village meeting. Other community members and the public in general are also invited to participate in the forum.

Though the UDKP is its final decision-maker, KDP’s implementation guidelines do not specify its institutional role and functions, especially with regard to supervising the financial and credit management of UPKs, as it does for other stakeholders. Expected outputs and procedures of the forum are explained as part of KDP’s planning process. There are two UDKP meetings during each project cycle. The first meeting takes place after information on KDP had been disseminated to the villages. Outputs expected from the meeting are: selecting participating villages, fixing rules and sanctions for project implementation, planning of village meetings and village facilitator training. The second meeting is the place where competition between villages takes place, and funding proposals of villages are discussed and decided upon. The meeting is also responsible for forming a financial management unit (UPK) and electing its staff members based on proposals of each participating village.

UPK – Sub-district Financial Management Unit. The Unit Pengelolaan Keuangan (UPK) or Financial Management Unit is formed by and responsible to the UDKP forum. An appointment letter of the sub-district head legitimizes its operation. The UPK is usually a small room, either provided by the sub-district government or rented in a private house, which is equipped with tables, chairs, white boards displaying project information, a typing machine or computer. UPK staff usually consists of a chairperson, an accountant and a secretary. For covering its operational costs the UPK receives 2% (maximum) of KDP funds allocated to the sub-district.

The UPK is the central body through which the revolving funds of sub-districts are managed. KDP’s implementation guidelines make it responsible for the entire administration of the project as well as for credit administration and supervision,


ensuring repayment, and providing technical support to LKMDs, village implementation teams and community groups. A more detailed description of the UPK can be found in the following chapters.

FK - Sub-district Facilitators. Technical assistance at sub-district level is provided by sub-district facilitators (FK), which were procured through consulting firms other than those of the management consultants. KDP currently employs 1,329 of these facilitators. Besides general communication and facilitation functions, the project’s implementation guidelines assign the following tasks relevant for microcredit activities to FK:

• Identify local sources of funds and credit as alternative choices. • Carry out training for village facilitators in cooperation with the PjOK. • Assist village facilitators in facilitating the collection of funding ideas. • Monitor the preparation of funding proposals, ensuring the preparation of

loan repayment schedules for groups and members. • Provide technical assistance to village implementation teams in cooperation

with the PjOK. • Carry out and facilitate training for UPK in cooperation with the PjOK. • Assist UPK, LKMD and village implementation teams with respect to credit

management and repayment. • Assist UPK with respect to business development and revolving fund

management.

Recently, FK have been provided with assistants, who share the general burden of socialization and facilitation functions, and are also supposed to assist villages with regard to microcredit activities and loan repayment.

Project Implementation at the Village Level

The village head has the overall responsibility for project implementation at the village level. According to KDP’s implementation guidelines the village head has to stimulate group meetings, hamlet meetings and community participation in preparing funding proposals as well as to supervise project implementation and the use of funds. The LKMD is made responsible for project steering through village meetings. It is given the tasks to disseminate project information, carry out village meetings, prepare project administration documents, and to record loan repayments as well as to collect loan installments, if they were not paid on time. For covering operational costs during project implementation LKMD receive 3% (maximum) of KDP funds allocated to the village. A special village implementation team (TPK) is set up to assist the LKMD in project administration and to manage the entire project planning and implementation process at the village level.

Note: The LKMD is given a core function in project implementation. Originally, it is a body of village leaders and officials who had to assist the village head in implementing governmental village development programs under the centralistic rule of the New Order Government. As this institution has usually not been responsive to community needs, villagers usually regard it as part of the government machinery. Though times


are slowly changing, this feature is more persistent than apparently assumed by the project design and guidelines, which refer to LKMDs as community institutions.

Village Development Forum. The major decision-making power at the village level is given to the Village Development Forum (Musbangdes), in which village officials, project staff, group representatives and other community members are supposed to participate. The project’s implementation guidelines do not specify its institutional role and functions, but they mention outputs expected from three village meetings during a planning and implementation cycle. The first meeting elects the village facilitator and agrees upon a schedule for collecting funding ideas from hamlets and groups. The second meeting is to agree upon funding proposals to be forwarded to the UDKP, elects three village representatives (besides the village head and the chairman of the LKMD) for the UDKP meeting, and forms a team responsible for preparing funding proposals. The third meeting discusses the results of UDKP decisions, elects the village implementation team, and should agree upon sanctions and loan repayment schedules.

Community groups. The ultimate target population of the project is poor community members organized in groups that should have been existent for one year. It is important to note that the project’s implementation guidelines have not established clear eligibility criteria and responsibilities for community groups, although KDP credit funds are channeled to and loan repayment is expected from them.

Village Facilitators and Engineers. Technical assistance at the village level is to be provided through two Village Facilitators (FD) and one Village Engineer (TTD) per village. Village engineers are employed by the LKMD for preparing technical proposals and supporting the technical implementation of funding proposals, mainly for infrastructure activities. Village Facilitators are elected by the village meeting and have to members of the village community.

KDP’s implementation guidelines assign the following tasks to the village facilitators:

• Participate in training provided by FK and PjOK. • Stimulate community participation in group meetings and activities. • Collect funding ideas from the community and groups. • Assist community groups in preparing proposals. • Assist LKMD in carrying out village development meetings. • Assist in preparing reports of groups and village implementation team. • Assist groups in developing cooperation with respect to economic activities. • Assist FK in facilitating community groups and timely loan repayment.

1.3 KDP I Project Strategy and Implementation Process

Project Principles. According to the project’s implementation guidelines, the KDP strategy is guided by the principles of decentralization, transparency, participation of the poor and women, healthy competition for funds between villages, self-help and self-reliance, sanctions and sustainability. KDP’s annual project report emphasizes community participation and empowerment of the poor, transparency and sustainability as key principles of project implementation. Empowerment is defined as community ownership in all aspects of the project. Transparency is explained as open decision-


making and financial management shared with the entire community. Sustainability refers to community self-reliance and village management of all activities.

The project documents do not clarify the substance and implications of these principles for KDP’s microcredit system. Are participation and competition between villages really elements of managing revolving funds according to good practice standards? What is the substance of self-reliance, empowerment and sustainability with regard to finance and microenterprise development?

Target Population and Targeting. The implementation guidelines state that project’s main target group and beneficiaries are the poor. It is important to understand that the project does not directly target the poor. Targeting is limited to the selection of sub-districts with high proportions of poor villages. The project appraisal suggests that sub-districts are relatively homogenous in terms of poverty, and thus form a good basis for project targeting. Self-targeting mechanisms such as wages at local rural minimum for works and repayment with interest for economic activities are supposed to orient project funds towards the poor. This assumption is based on experiences of the Village Infrastructure Project. Note that requiring loan repayment with interest is most probably not a sufficient condition to reach the poor with credit services through mechanisms applied for infrastructure services.

Direct Fund Transfer and Open Menu Policy. KDP starts with selecting eligible sub-districts and disbursing annual block grants over a three-years period to them through direct transfers from the national level through the local treasury office to a collective village account at a local bank. Depending on population size annual block grants ranged from IDR 350 million to IDR 1 billion per sub-district for the first two financial years. In order to strengthen local decision-making and choice KDP applies an open menu policy allowing funding proposals for infrastructure and economic activities except those on a negative short list. The Open Menu policy is an important element of KDP. It allows villagers themselves to decide what they want. The minimum amount per proposal is IDR 15 million for women groups or otherwise IDR 35 million, and the maximum amount approved per proposal is IDR 150 million.

Project Cycle, Planning and Decision-making Process. The allocation of funds to villages either in the form of grants for infrastructure proposals or in the form of loans provided to community groups is result of a long planning and decision-making process that takes at least four months until final decisions are taken by the UDKP forum and funds are released by the UKP to villages and community groups. This process is preceded by a phase in which KDP information is disseminated at all project levels and is followed up by implementation, supervision and evaluation phases.

One project cycle consists of the following phases and activities as documented in the project’s implementation guidelines and annual report:

• Socialization and dissemination of Information: Provincial and district workshops; Selection and training of sub-district facilitators; UDKP I meeting to select participating villages and plan project implementation; First village development forum (Musbangdes I) to elect village facilitators and prepare a schedule for collecting funding ideas; Training of village facilitators.


• Socialization in hamlets and collection of funding ideas: Hamlet and group meetings to disseminate KDP information and encourage submission of ideas; Special meetings with women's groups to discuss women's proposal ideas; collection of funding ideas.

• Selection and preparation of village proposals: Second village development forum (Musbangdes II) to discuss and agree upon funding proposals, elect village representatives for UDKP II, and form the team responsible for preparing funding proposals; Technical preparation and application of village proposals.

• Feasibility / Verification Stage: Formation of verification teams; Examination of completeness of proposals; Crosscheck by district consultant; Field visit to all applicants to assess feasibility of proposals, preparation of recommendations.

• Funding Decisions: Second UDKP meeting to discuss and select village proposals for funding; Election of UPK staff members.

• Preparations for Implementation: Third village development forum (Musbangdes III) to discuss results of UDKP II meeting, elect the village implementation team, agree upon sanctions and loan repayment schedules; Recruitment of village technical assistance; Training for implementation teams, UPK, village engineers; Transfer of funds from the state treasury to collective village bank accounts.

• Implementation: Mobilization of village laborers; Procurement of materials and equipment; Withdrawal of funds from collective village bank account and loan disbursements; Implementation of village activities; Supervision, monitoring, and reporting.

• Post Implementation Stage: Maintenance of infrastructure; Hand-over of completed projects; Collection of loans with a maximum maturity of 18 months; Sustainability and growth of revolving fund; Strengthening of UPK, LKMD and village implementation team as well as of community institutions at the sub-district and village levels.

Project Training Services. The project has not developed a comprehensive system of planning, implementing and evaluating training for its stakeholders, especially in the fields of financial management, microcredit, self-help group development and microenterprise development. Training modules in these fields are not available. The implementation guidelines hold that the project strategic training consists of technical skill training and project planning training for UPKs, village facilitators, village implementation teams and village engineers.

UPK training is to comprise financial administration and management, loan collection, business development, networking and other not specified topics. The duration of training should be 5 days. Training for Village Facilitators should comprise information on KDP, responsibilities and tasks of FD, techniques for collection of funding ideas, use of flip charts, and work planning. Training materials consist of the project guidelines and a FD handbook. The training is to be carried out by FK and PjOK during 5 days.


Training for the village implementation teams and engineers should comprise KDP principles, organization, administration, and reporting. Further specifications are not made. Neither training for community groups and their members, the users of KDP funds, nor training for sub-district facilitators, who are supposed to provide training to UPK, to FK assistants and at the village level, are subjects of KDP’s implementation guidelines. The annual KDP report mentions that the national management consultants carried out a needs assessment and have begun to organize financial management training for UPK. There is, however, no training plan and manual available, and training implementation seems not to make great strides.

Project Monitoring. Both involved government institutions and the consultants and facilitators at each project level carry out project monitoring. The project has a large monitoring and data processing team at the national level regularly paying monitoring visits to project areas and handling the KDP reporting system. The project’s monitoring and reporting forms book consists of 164 pages comprising short guidelines and 65 forms to be used from the first step of collecting funding ideas to the monitoring of maintenance activities. Monthly reports on the basis of these forms are to be prepared at the kecamatan, district and province level, and to be forwarded to the national project secretariat.

The project’s implementation guidelines and forms book specify local monitoring and reporting requirements. They neither include a description of the monitoring system nor do they specify the tasks of the national monitoring team. Special reference to credit monitoring requirements and procedures are not made. The project has also not developed a special financial and credit management manual. Credit and revolving fund monitoring forms included in the forms book will be discussed in the next chapter.

1.4 KDP I Microcredit System and Revolving Fund Management

KDP has not developed a comprehensive manual for revolving fund and credit management. The project’s implementation guidelines are structured according to KDP’s project cycle with special emphasis on the participative planning process. Provisions made for revolving funds and credit management are scattered through various chapters such as the introduction, preparation and verification of funding proposals, and the notes on sustainability. Technical guidelines for revolving funds, comprising only 14 pages, were issued separately and focus on general process guidelines without establishing good quality standards and including standard instruments for financial and credit management. Forms to be used for revolving fund activities are included in a book containing all forms used for project implementation.

1.4.1 General Provisions and Objectives

Objectives. KDP’s implementation and revolving fund guidelines define the objectives of revolving funds as to increase capital accumulation and to sustain the poor’s access to credit for economic activities. Outputs expected are: a financial institution that is easily to access; the growth of microbusinesses; and increased decision-making capabilities of the community with regard to the management of business capital. Circular letter 138/1047/SJ of the Ministry of Home Affairs states that the UPK may be developed into a unit capable of managing various development funds for the


socioeconomic development of the rural population. The project documents stress that achieving these objectives requires repaying loans to UPKs with market-oriented interest rates, strengthening the management capacities of UPKs and community institutions, and establishing appropriate planning, monitoring and control systems.

Use of Revolving Funds. A circular letter (414.2/1663/PMD) issued by the Ministry of Home Affairs in December 1999 makes two provisions that may not support the objective of sustaining credit access through growing revolving funds:

• The provision that the open menu principle (including grants for infrastructure) applies also for loan installments tends to diminish the loan fund available for re-lending.

• The provision that loans can be provided to individuals, if they are members of a group (it is assumed that this implies joint responsibility for repayment) tends to cause moral hazard problems and neglects that joint liability is only seldom to be found in KDP groups.

Note: KDP revolving funds are not necessarily pure revolving loan funds and that KDP generally does not separate infrastructure and loan fund management. Infrastructure may be financed, i.e., by allocating part of UPK profits to a special village development fund. Financing infrastructure from loan (principal) repayments rather than from income, however, will sooner or later lead to the end of KDP operations. Combining the two different logics of grant and credit services may cause severe governance problems for the UPK as a financial institution.

Lender - Borrower Relationship. KDP’s implementation guidelines make the UPK responsible for collecting loans from groups and do not define financial intermediation functions of the LKMD. The introduction chapter states that KDP funds are channeled from the collective bank account managed by the UPK to the LKMD, and are provided to the community via the LKMD. The revolving fund guidelines establish a two-level system, in which the UPK disburses loans to the village implementation team (TPK) and the TPK provides loans to community groups. Loans are repaid from groups to the TPK and from the TPK to the UPK. Circular letter 412.2/1663/PMD of the Ministry of Home Affairs emphasizes that the LKMD does not receive loan repayments and that installments have to be paid directly to the UPK. At the same time the letter allows both the UPK and the LKMD chairpersons to sign repayment receipts.

Note: Clear, close and trustful relationships between lenders and borrowers are a major element of good quality credit management. The lack of clarity in project documents regarding lender - borrower relationships as well as the two-level system through which UPKs have no longer direct access to group information may cause governance problems for the UPK and may lead to inconsistent interpretations of KDP’s revolving fund and credit management approach.

Revolving Fund Level and Ownership. Project documents make conflicting statements on revolving funds level and ownership. The project’s implementation guidelines clearly define the sub-district as the level at which funds are revolving, and the UPK is regarded as the institution through which these funds are managed,


sustained and developed. The revolving fund guidelines make the provision that funds revolve at both the sub-district and village levels.

“The people/community” is usually regarded as the owner of the revolving fund. Up to now, however, KDP has not defined who “the people/community” are and has not clarified the legal ownership of its funds. Project documents and circular letters of the Ministry of Home Affairs state that KDP funds are government grants provided to sub-district and are owned by the sub-district population. This seems to contradict with circular letter 413.1/233/V of the Ministry of Home Affairs, which requires sub-districts to return funds to the state treasury they are not able to absorb.

Note: Lack of clarity with regard to revolving fund level and ownership may lead to the following governance problems:

• “Community ownership” is still a slogan and not backed up with legal ownership of revolving funds and the UPK. This may undermine community sense of ownership and will most likely lead to unsound competition for funds after termination of project support.

• Ownership defined on the basis of all embracing administrative or social entities (village, sub-district, community, the people) conflict with the project’s objective to target revolving funds to the poor.

• The expectation of village ownership may motivate to withhold loan funds and to block UPK access to borrowers. Moral hazard and misallocation of funds will become an in-built factor, if the project lacks credit management and supervision capacity at the village level.

• Funds revolving at the village level undermine UPK operations and functions, decrease financial intermediation between villages, and prevent funds from revolving to poor borrowers in other villages.

1.4.2 Governance and Financial Management of UPK and LKMD/TPK

KDP funds and credit are managed by the UDKP’s financial management unit (UPK) at the sub-district level. The UDKP approves loans and determines policies of revolving fund management and UPK organization. The UPK disburses initial funds for infrastructure and loans, collects and revolves loans.

KDP’s implementation guidelines mention the following UPK functions:

• Record, document, and monitor activities. • Receive and approve fund requests from LKMDs. • Record the use of funds. • Ensure loan repayment according to loan agreements with groups/LKMD. • Provide project progress reports and financial records to the UDKP. • Provide technical assistance with respect bookkeeping, reporting and loan

repayment to LKMDs, village implementation teams and groups. • If necessary, carry out on-site supervision of village/group bookkeeping. • Identify potential linkages to third parties (marketing, technical assistance). • Open collective KDP bank account in cooperation with LKMDs and FK.


• Open two bank accounts for UPK operational funds and loan repayment. • Prepare an operating fund use plan to be approved by the UDKP. • Prepare fund disbursement schedules in cooperation with FK and PjOK. • Participate in UPK training. • Collect loan installments from beneficiary groups through regular field visits.

The implementation guidelines specify the following responsibilities of revolving fund management:

• The UPK provides monthly information on revolving funds available for lending.

• Special UDKP meetings determine revolving fund regulations and decide on funding proposals in line with the process valid for the UDKP II meeting.

• The UPK management is responsible for credit monitoring and supervision.

For covering the costs of these operations the UPK receives 2% (maximum) of KDP funds allocated to the sub-district. Operating costs can also be covered by interest income. The revolving fund guidelines stress that interest income is also to be used for capital accumulation. The LKMD/TPK is directly involved in financial transactions. KDP guidelines either provide forms for loan contract between the UPK and LKMD chairmen (forms book) or state (revolving fund guidelines) that loan contracts are to be made between the UPK and TPK chairmen as well as between the TPK chairman and the group members. The LKMD receives 3% (maximum) of KDP funds allocated to the village for covering its operating costs.

Circular letter 414.2/1663/PMD of the Ministry of Home Affairs makes the additional provision that debt collectors at the village and sub-district level may receive up to 2% of interest payments collected. It is not clarified who these debt collectors are. It further makes the provision that the UDKP has to agree upon the use of interest income without, however, specifying good standard practice. Note that project documents speak about using and distributing interest income rather than about the allocation of profit. This may lead to unsound financial management practice.

Besides the provision that UPKs are formed by and responsible to the UDKP forum, the project documents do not specifically deal with the governance and supervision of UPKs. UPK ownership, vision, mission and liability are not clarified. The project has not prepared UPK statutes or does not require the UDKP to establish such statutes. The UPK management is not made liable for losses incurred by mismanagement and fraud. The UDKP is supposed to control the UPK and to express community ownership of KDP funds. However, the project has not established a supervisory body and internal control guidelines though which “owners” can effectively control the UPK management. The same is true for the relationship between the village meeting and the LKMD/TPK. There are no guidelines that explain how the village community can effectively inspect and control the financial management of LKMD/TPK. Though LKMD/TPK take loans from the UPK, neither loan contracts nor other regulations make them liable for loan loss incurred at the village level.

External control is supposed to come from the local government and consultants. The project prepared forms for the inspection of UPK (Form IX.15) and LKMD (IX.14)


administration that look into the completeness and consistency of project documents and forms, and are to be completed by facilitators and consultants. However, the project has not developed inspection rules and financial management standards for assessing the soundness of UPKs and LKMD/TPKs. Enforcement, as part of effective supervision, is not made a subject of project regulations. While the UPK is supposed to undergo regular audits, the project has not prepared audit regulations and guidelines.

Financial administration instruments prepared by the project for UPK, LKMD/TPK and groups comprise:

• A journal for chronologically recording bank transactions (Form VII.1). • A journal for chronologically recording daily cash transactions (Form VII.2). • A journal for monthly recapitulation of daily cash transactions (Form VII.3).

The LKMDs were additionally provided with:

• A ledger for recording monthly receipts according to the following accounts: KDP funds, loan installments, loan interest, loan penalties, community contribution, donations and operating funds received (Form VII.5).

• A ledger for recording monthly disbursements and expenses according to the following accounts: disbursements made to TPK, loans disbursed to groups, and expenses for administration, transport, fees and inventory.

Additionally, the project’s forms book includes a financial statement format for UPK that comprises:

• A balance sheet format (Form VII.4) that includes the following accounts: Cash, Bank deposits, loan portfolio, office inventory on the assets side; Liabilities, Initial capital, current profit on the liabilities side.

• Rather than providing a standard income statement the form indicates how profit and loss should be calculated.

The financial administration instruments provided in the project’s forms book are not accompanied with guidelines that explain their use and systematic relationships. A short guideline is provided for filling out the UPK balance sheet. The guidelines, however, do not include information on the use of financial statements for the purpose of financial analysis and management. Some explanations conflict with prudential financial administration and management standards. I.e., the loan portfolio account is explained to include the outstanding loan principal and credit interest.

The financial administration instruments prepared by the project do not add up to a complete and consistent system of accounts and accounting. They do not provide a systematic approach that makes it easier for UDKPs/UPKs to prepare financial statements and understand their own financial situation. They do also not facilitate supervisors in examining the UPK’s accuracy of accounting and assessing their soundness. Instruments required for financial analysis and management, in general, and for loan portfolio analysis and management, in particular, are missing. The absence of these instruments as well as the absence of a comprehensive financial management manual may negatively affect the quality of policy decisions taken by the UDKP and of operational decisions taken by the UPK.


1.4.3 KDP Credit Management

Credit Eligibility. Circular letter 413.1/204/V of the Ministry of Home Affairs makes the provision that funding proposals can only be made by groups that have been existing for at least 1 year, because KDP applies the joint liability system. Note: joint liability does not simply exist. It must be internally generated through common bonds and interests, member participation and ownership, and must be externally reinforced through adequate approaches and regulations. Group and membership qualities as well as poverty and business indicators are not considered as criteria applied for controlling access to credit.

Loan Application. Loan applications are result of a planning process that starts with village facilitators collecting funding ideas from community groups and through meetings at the hamlet level. The village facilitators prepare and sign a list of funding ideas (Form I.1). The village meeting discusses these ideas and selects those to become part of village funding proposal. A special team consisting of the two village facilitators, the village engineer, one LKMD member and one group representative prepares the funding proposal. The community group has to approve and the LKMD has to ratify the proposal.

The first part of the proposal format (Form II.2) asks for general information on the number of groups and beneficiaries covered by the proposal, group establishment, activities, credit access and assets. The second part consists of a table summarizing proposal costs, including LKMD and UPK costs. The village head, the chairman of the LKMD and a group representative, signs the final proposal. Note: The proposal is a budget plan for economic activities at the village level rather than a loan application. The proposal format may include several group loans and does not whether the loan applicant is the group or the village/LKMD. Note further that group members are not actively involved in business planning and loan application preparation. Real ‘empowerment’, one of KDP’s key principles, would require enabling individual borrowers to increase their self-reliance also in these respects.

Attachments to the proposals should comprise a) a list of individual borrowers per group, b) a credit feasibility analysis on the basis of the group members’ economic activities and/or the groups’ on lending activity, c) a cash flow plan and d) a repayment schedule approved by each group member. Note: The cash flow example shown in the project’s forms book is misleading as it relates business expenses to the loan amount received (as incoming cash) rather than to income expected from the business. The format for the calculation of business profits does not specify whose business is analyzed. It assumes that the business is a collective business or that all borrowers make investments in the same business type. The format for calculating profits of group on lending to members shows the header “Savings and Credit Feasibility Assessment”, although it only deals with the on lending of the KDP loan. Furthermore, the format is misleading as it includes loans disbursed to members as costs and loan repayment as income. Both feasibility formats have a footnote explaining that costs may include technical assistance fees of up to 10% of total costs. As the loan amount was made a cost item, this would increase the annual effective interest rate of KDP group loans to almost 60%!!!


Loan Appraisal. After being sent to the UDKP funding proposals are appraised by a special verification team that is formed by decision of a meeting of government officials and project personnel under the chairmanship of the sub-district head. According to the project’s implementation guidelines the team should consist of local technically qualified people such as loan officers of local banks. The team provides recommendations to the UDKP II meeting. Note: the verification team is an ad-hoc group that is not liable for credit decisions. Note further that the loan appraisal function is disintegrated from revolving fund and credit management functions.

KDP’s implementation guidelines assign the following tasks to the verification team:

• Examine whether proposals include investments mentioned on KDP’s negative list or are funded by other government programs.

• Examine the completeness of funding proposals. • Assess the technical, financial, economic viability as well as the

environmental impact of investments proposed. • Assess the need for technical assistance. • Recommend improvements of funding proposals. • Provide verification results to the UDKP forum.

KDP’s implementation guidelines mention that the verification process takes at least three to four weeks. Funding proposals are first examined at the sub-district level and returned to the village if they have to be improved. The team is also supposed to visit each community group covered by the proposals. For this purpose the project has designed a standard 5-page verification form (Form III.1) checking general group characteristics, the feasibility of the village’s budget planning, the feasibility of the business investments proposed, and the appropriateness of repayment schedules proposed. Note: The form assesses proposals of one village and covers both infrastructure and loan proposals. It is a checklist that applies no feasibility assessment instruments other than already used for preparing funding proposals. The form does not include a specific credit risk analysis.

Loan Terms and Conditions. Funding proposals are finally approved during the second UDKP meeting. It is, however, important to understand that the borrower’s business planning function and the lender’s function to determine loan amount, term, installments and interest rate are not clearly distinguished. Loan amount, term and repayment schedule are subject to the planning process and part of the loan application. Project documents lack clarity by making the provision that either the village forum or the UDKP forum determines loan terms, repayment schedules and interest rates.

Most loan decisions are delegated to bodies central to the project’s planning process. Project guidelines make the following limited provisions with regard to loan terms and conditions:

• Loan amounts may range from IDR 15 to IDR 150 million. Note: the project does neither determine nor recommend loan ceilings for individual borrowers, thus not making maximum loan amounts an instrument to target the poor.


• The maximum loan term is set at 18 months, whereas no provisions are made with regard to installment systems. Note: Loans with a maturity of 18 months and full repayment made only at the end of the term would disrupt loan revolving as intended by the project.

• Provisions made with regard to interest rates have been erratic. According to KDP’s implementation guidelines interest rates are to be calculated on declining balance and should reflect local BRI market rates. A 20% interest rate on declining balance is used in interest calculation examples. Note: The guidelines stress that credit interest is relevant for sustaining the value of revolving funds, but they do not explain how revolving fund managers can reflect interest rates as a function of financing costs, operating costs and profit expectations. Note further that a 20% interest rate on declining balance is far below the currently prevailing local market rates.

The revolving fund guidelines state that interest rates should be below rates of local financial institutions or should at least not be higher than these rates. Circular letter 413.1/204/V of the Ministry of Home Affairs declares that the annual interest rate is no longer fixed at 20%, but should at least be equivalent to the currently prevailing local market rate. Note: Local market rates vary considerably between financial institutions and reflect different policies of and intermediation costs incurred by these institutions.

• The guidelines stress that KDP lending banks on joint liability and do not require collateral, because this would restrict outreach to the poor. Note: This does not reflect good microfinance practices. Collateral may take the form of household items or blocked savings as partial collateral, or collateral can be substituted by group guarantees. Rather than assuming that joint liability simply exists, a mix of collateral and collateral substitutes is required to reinforce joint liability and reduce credit risks. Note further that the first borrower of KDP loans is the LKMD/TPK on behalf of the village rather than directly the poor.

• The guidelines determine the following sanctions and penalties for late payments: a) groups have to pay a monthly penalty calculated as 1/12 x annual interest rate x arrears (note: this is only applicable for interest rates on declining balance: a 24% annual flat rate is not equal to a monthly rate of 2%); b) villages are eligible for further KDP funding only if group loans are fully repaid at final due date. Circular letter 412.2/1663/PMD of the Ministry of Home Affairs stresses that revolving funds are made available to villages without arrears. Note: Circular letter 413.11/260/PMD of the Ministry of Home Affairs states that groups and villages in arrears are not eligible for further funding, whereas group members or groups with good repayment records are to get priority access to revolving funds. It is likely that this provision contributes to inconsistent local decision-making.


Loan Approval. Loan approvals are part of the decision-making process during the UDKP II forum or special revolving fund UDKP meetings. The meetings approve village funding proposals rather than single loan applications from groups. The project has prepared a standard format (Form IV.1) that documents proposals approved by the meetings. The form contains group and funding information per village. It is to be prepared by the sub-district facilitator, signed by the head and LKMD chairman of each village receiving funds, and has to be approved by the sub-district head. The sub-district head then issues a decision letter (Form V.1) on the basis of which funds can be disbursed from the state treasury. Note: This UDKP process takes the form of competition between villages. As loan applications are part of the village proposal it is likely that this competition for approvals also will be guided by criteria and interests other than those specifically required for making good loans.

Loan Contracts and Disbursement. Making contracts for fund disbursement is the first activity where the UPK comes into KDP’s financial administration and credit management. Note: The UPK is established by the UDKP only after completion of business planning, loan application and loan approval. Thus, the institution made responsible for loan disbursement, supervision and collection, the actual credit provider, is separated from the vital functions of selecting customers, analyzing credit feasibility, and determining loan terms and conditions.

The disbursement process involves several written agreements or contracts. In a first step the UPK chairperson and the local project manager (PjOK) sign a fund disbursement agreement (Form V.2) that requires the UPK to disburse funds from a collective bank account to villages in accordance with UDKP decisions. In a second step the UPK and LKMD chairpersons sign an assistance agreement (Form V.5) that includes information on funds to be disbursed in accordance with UDKP decisions. Amounts of funds are mentioned separately for infrastructure grants and loans. The following provisions are made for loans: a) the obligation of the LKMD chairperson to repay the loan; b) the loan term (number of months); c) the annual interest rate; d) the total amount of loan principal and interest to be paid until the final due date; e) the requirement to disburse loans to groups on receipt; and f) the sanction that chance for further funding will be missed in case of non-repayment. As already explained earlier, the revolving fund guidelines also establish a two-step loan for which loan contracts should be made between the UPK and village implementation team (TPK) as well as between the TPK and community groups. The loan contract formats mentioned in these guidelines, however, are not included in the project’s forms book.

Note: The technical provisions made by and the instruments included in project documents show that the LKMD/TPK is regarded as a financial intermediary. Thus, it is the LKMD/TPK rather than the groups that has to be made liable for loan repayment to UPK. It is also important to note that the standard contract between UPK and LKMD only mentions the time until when loans have to be repaid. The lack of clear provisions with regard to loan installments allows the LKMD to withhold loan repayments of groups for up to 18 months. The project documents do not include loan contracts directly made between the UPK and community groups. Depending on the local interpretations of project regulations, however, loan contracts are made by the UPK either with the LKMD/TPK or directly with community groups.


Loan Collection, Monitoring and Supervision. While KDP guidelines make the UPK responsible for directly collecting loans from groups and carrying out on-site credit supervision, and circular letter 412.2/1663/PMD of the Ministry of Home Affairs states that installments have to be paid directly to the UPK, it was shown that other provisions made by the project require the direct involvement of the LKMD/TPK in loan collection and monitoring. It was also emphasized that this lack of clarity as well as the broken relationship between the UPK lender and the group borrower may predicate problems in loan collection and governance of the KDP credit management.

The project prepared three almost identical credit-monitoring forms for the LKMD (Form VIII.2), UPK (Form VIII.4) and PjOK (Form VIII.6). The latter form recapitulates the UPK form and serves to provide quarterly information to the district head. The other forms are monthly monitoring sheets. The LKMD has to make the first form available to the UPK and FK, and the FK team leader is responsible for sending the form to the district and national level. The UPK has to prepare the second form and to make it available to the district and national level via the FK team leader.

The LKMD and UPK forms differ only in that the UPK form is used for more than one village. Both forms have a tabular format comprising the following columns: ‘type of activity’; ‘loan disbursement date’; ‘loan amount’; ‘loan term’; ‘interest amount’; ‘total loan amount’; ‘installments (principal and interest) made until end of previous months’; ‘installments (principal and interest) made in current month’; ‘installments (principal and interest) made until end of current month’; ‘installments (principal and interest) made up to 30 days past due’; ‘installments (principal and interest) made between 31-90 days past due’; ‘installments (principal and interest) made more than 90 days past due’; ‘amount of penalty until end of current month’; ‘accumulative amount of arrears’; ‘amount of loans outstanding’; ‘number of groups’; number of beneficiaries’; ‘number of female beneficiaries’; ‘number of male beneficiaries’.

Note: The credit monitoring forms reflect project information needs rather than credit management needs. They are partly difficult to fill out by the UPK and LKMD, and they even divert attention from information required for proper credit monitoring:

• The forms monitor financial transactions per ‘type of activity’. Credit monitoring, however, requires information per borrower (group).

• Interest is regarded as part of loans disbursed. Interest is income and has to be recorded separately from loan installments.

• The form does not allow calculating proper repayment rates, arrears rates and the loan portfolio at risk. Arrears are a position at the end of a period, not an accumulated amount.

• Repayments made after they had fallen due are not relevant information. What is required and may be intended is the ageing of arrears required for assessing loan portfolio quality.

• Repayment and loan portfolio information can be easily prepared only, if it can be derived from a proper loan accounting system. This system has not been prepared by the project.


1.5 Project Appraisal of the Second Kecamatan Development Project (KDP II)

The Project Appraisal Document for the Second Kecamatan Development Project (KDP II) was finalized in May 2001. It provides a strategic outline for the new project strategy and for the preparation of project plans and manuals. The document states that results of various studies such as in the fields of participation, local governance, village infrastructure and microcredit will be used for fine-tuning the project design and making local adaptations.

1.5.1 Project Objectives and Targets

The second Kecamatan Development Project will be implemented from January 2002 to June 2006. Initially, the project will cover about 1,000 of the 3,500 sub-districts of the country. Project budgets assume that 200 sub-districts will be added each year. The number of participating villages is expected to increase to about 10,000.

The KDP II development objectives are:

• Support participatory planning and development management in villages.

• Support a broad construction program of social and economic infrastructure in poor villages.

• Strengthen local formal and informal institutions by making them more inclusive, accountable, and effective at meeting villagers' self-identified development needs.

The twin purposes of KDP II are to support better governance in rural villages and to provide rural communities with public goods and the development infrastructure that will raise the incomes of the poor. Stressing the link between local governance reform and poverty alleviation, the documents regards the promotion of local-level participation as the core of project implementation. The heart of the project is seen in activities that increase communities' abilities to make assessments of their development needs and involve local governments and other stakeholders in solving them.

1.5.2 The KDP I and KDP II Approaches Compared

By and large, the KDP II design maintains the strategy, planning and decision-making process of KDP I. The appraisal documents mentions the following strategic features of the new approach:

• An increasingly explicit governance-poverty linkage. Strong focus on decision-making by elected village and sub-district councils.

• A renewed focus on project quality rather than just quantity.

• A wholesale portfolio shift into demand-responsive project design. Budgets, planning, financial management will be further decentralized to the village level.

• A higher emphasis on developing local technical capacities for design, management, and maintenance.


Major implementation-related differences between the two projects are:

• While KDP I provided competitive fund at the sub-district level only, KDP II will add flat village allocations, particularly as investment budgets for rehabilitating infrastructure.

• While KDP I worked through local government structures (UDKP and LKMD), KDP II will involve elected village councils (BPD) and replace the UDKP with an inter-village forum elected by each village and ratified by official letter.

• While KDP I provided open menus to all sub-districts, KDP II will limit economic (credit) activities to sub-districts meeting repayment standards and promoting links to banks.

• While KDP I planning focused on developing funding proposals, KDP II will begin with a long-term village planning vision.

• While KDP I promoted women's participation in existing institutions, KDP II will involve an equal number of men and women in the inter-village forum, and will provide women with autonomy through separate planning and decision-making structures.

• While KDP I provided basic training and initial experience in funds management, KDP II will provide training in budgetary administration and project management for all village funds, and will focus on training village facilitators and local government.

• While KDP I worked with one sub-district facilitator, KDP II will employ two (social, technical) facilitators to put emphasis on skill transfer.

1.5.3 Project Components and Inputs

KDP II will consist of four components: a) sub-district grants, b) community capacity building, c) implementation support, and d) monitoring and evaluation studies. The total indicative project costs amount to USD 421.5 million, of which IBRD and IDA loans will finance USD 320.2 million.

Component A: Kecamatan Grants Program

Sub-district grants over the four-years project period will make up 74% (USD 310.6 million) of the total project budget. Annual grants per sub-districts will range from IDR 750 million to IDR 1.5 billion, depending on population size. Grants will be channeled directly to a collective bank account at the sub-district level and will be made available to all villages within a selected sub-district.

The appraisal document states that each sub-district grant normally has two windows (note that the missing 20% are not explained):

• 70% for infrastructure, economic activities, and social services allocated on a competitive basis to proposals from villages; and

• 10% to be allocated for pre-existing, successful (verified on audit) savings-borrowing schemes being operated by women's groups.


The component opens also a new window for pilot programs aiming at expanding outreach to the poor. These programs “work with local leadership and organizations on intra-village targeting of the most vulnerable groups using the basic KDP grant mechanism but involving more specialized kinds of facilitation and technical support.“

Component B: Community Capacity Development

The longer-term impact of the project is to be sustained by developing community abilities to plan, manage, and maintain their own projects. The project intends to focus on sustaining input of training and practical experience rather than providing one-time training only. The component has a budget amounting to USD 65.5 million.

Component C: Implementation Support

Implementation support will be financed by a budget amounting to USD 40 million. The project will hire and train approximately 30,000 villagers and 2,000 facilitators who will work at the sub-district level. They are referred to as the training infrastructure of the project. The training program is to consists of:

• Basic skills in development planning and management (procurement, financial management, participatory design, technical skills).

• Cross-village programs in cooperative planning, ex post quality review, and conflict resolution.

• Village linkages to the government and private sector at the district level through monitoring, long-term development planning, and community participation in district contracting.

• District level participatory poverty assessments and dialogue on sustainability.

Component D: Monitoring and Evaluation, Studies

This component has a budget of USD 2.9 million and intends to support Bappenas and PMD's efforts to track impacts from the KDP II program and to seed pilot programs in a number of areas that have to do with local governance and poverty.

1.5.4 Rationale of KDP II Revolving Funds and Microcredit Approach

The project description of the appraisal document makes only scarce references to the role of revolving funds and microcredit in KDP II. Explanations and provisions are mainly made in Annex 4 (Cost Effectiveness Analysis Summary) of the document.

Summary of explanations and provisions made with regard to KDP II microcredit:

• Microcredit in KDP I was meant as transitional support during the financial and economic crisis. KDP I met all performance indicators except for loan repayment. Though repayment performance in the second year improved, it is estimated that repayment does not exceed 60%.


• Over time KDP I revolving funds moved from the kecamatan to the village level, where social controls and relationships functioned more effectively as incentives for repayment and continued revolution. Interest rates provide a filter on subproject proposals, but the group proposal process does not require collateral and eliminates the regressive screen that blocks poor people from access to formal credit elsewhere.

• Economic activities in KDP II continue this system but with some technical refinements to improve longer-term connections to the private banking system. KDP II will limit credit activities to sub-districts meeting repayment standards and promoting links to banks.

• As in KDP I, there is no objective of developing a microcredit institution. The purpose of economic activities is stretch resources for community development through cost sharing and the use of revolving funds with community sanctioned repayment. The incentive for repayment is that the resources will stay at the community level.

• Revolving funds of this sort have an important financing role without taking anything away from "real" microcredit institutions. No government program should be competing with privately run credit, and allocations to kecamatans and villages are given as grants.

• KDP II makes the following improvements: (a) all proposals must be verified by a consultant hired from a local bank; (b) communities that are eligible for credit must show year-to-year repayment improvements of 20% or more (or already be at >80%); (c) funds revolve at the village rather than kecamatan level, to increase social pressure for repayment; (d) communities adopting the credit option must use a portion of their TA budget to contract a consultant who will train the village in basic bookkeeping.

• The document further states that the benefit of including economic activities in KDP II is deemed to outweigh the costs of dropping the open menus.

Further reference to KDP’s revolving funds and microcredit interventions are made under “Main Loan Conditions”. Provisions made for the Government of Indonesia are to ensure that:

• A revolving fund is established and maintained by the UPK in the Project Kecamatans in accordance with procedures agreed with the Association and set forth in the Project Manual.

• Payments on the principal of and interest on sub-loans are deposited into the respective Kecamatan account established for such revolving funds.

• The UPK has been provided with technical assistance and training in bookkeeping and financial management.


• The verification team for proposed sub-projects includes at least one member from a commercial bank.

• Where the Project Kecarnatan has provided sub-loans under the Borrower's Kecamatan Development Project

- the annual average repayment on principal under sub-loans calculated over the twelve preceding months is equal to or more than 80% of the total amount of repayment due during such twelve-month period, or

- the repayment has improved during the same twelve-month period by at least 25% in the aggregate.

1.5.5 Project Design Summary and Planning

The following table provides an excerpt of objectives and indicators of the project design summary as provided by the project appraisal document. The table shows that explanations and provisions made with regard to KDP II revolving funds and microcredit approach have not yet been used to elaborate project objectives, outputs and indicators in more detail. The project design summary does not relate revolving funds and microcredit activities to objectives such as “reducing poverty”. Revolving funds or microcredit has not been made part of project components or outputs. Indicators for objectives and outputs related to revolving funds and microcredit have not yet been developed.

A logical framework such as the one provided in the appraisal document serves to outline the basic project strategy and interventions required to achieve project objectives via project outputs supported by clearly defined indicators. Such an outline of the project strategy is is usually the basic document on the basis of which project implementation and work plans are prepared. Therefore, it should also clearly define the role of revolving funds and microcredit as well as of related project interventions for achieving project objectives.

The continuation and improvement of the project’s microcredit component would require additional planning and its integration into the logical framework of project objectives, outputs and activities.


Project Design Summary of the Project Appraisal Document (Excerpt of Objectives and Indicators)

Hierarchy of Objectives Key Performance Indicators

Sector-related CAS Goal: Sector Indicators:

Reducing Poverty

% of poor

Improving local governance

Satisfaction with leadership rises

Project Development Objective: Output / Impact Indicators:

Component A: Kecamatan Development Grants

Providing broad-based resource access to villages

Min # participating villages: Year 1: 7,500 / Year 2: 10,000 / Year 3: 10,000

Reducing poverty in rural areas HH expenditure to rise 1% each year

Providing low-cost, quality infrastructure 20% less than current costs from line agencies, 10,000 km feeder roads, 2,000 units clean water, 2,000 village markets, 1,000 school rehabs.

Improved maintenance 70% of infrastructure built by KDP ranked as satisfactory

Component B: Community Capacity Development

Ability of villages to carry out long term planning

50% of all villages have finished plans by Year 3

Villages able to meet audit standards in FMS&D

Completed courses in 80% of villages

Corruption is reduced 70% resolution rate of all cases in corruption database

Decision meetings made more inclusive Annual 10% increase in active participation rates with at least proportional growth by women & poor

Legislature to monitor and review KDP implementation

15% annual increase in number of UDKP-DPRD joint monitoring teams

Component C: Implementation Support

Facilitators deployed in kecamatans 90% of kecamatans have TA present before UDKP I

Field problems are resolved 75% of technical problems are fixed 75% of corruptions cases reported are resolved

Technical Training courses are completed

50% of villages participate

Governance training programs are completed

75% of DPRD programs are completed

Component D: Monitoring and Studies

Assessing village revenue Report listing options

Outputs from each Component: Output Indicators:Improved planning # desas with project proposals (80%)

Public infrastructure # sub-projects implementation agreements (> 80%) O&M groups formed (70%) Roads, canals, bridges, etc built or rehabilitated

KD

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A. National ManagemeDevelopment Progra

B. Tim Studi Ekonomi, Pengembangan Kec

C. Melissa Day: Microc

D. Ismah Afwan and AzMalang dan Lamong

E. Azlim Fitra: Laporan

F. Monthly Reports from

2.1 KDP Microcredit Pe

2.1.1 Availability and Q

KDP made large invesavailable at the nationalsteering KDP’s revolvinteam has not been abledisbursements and loancovered only part of thyear, while credit perfavailable at all. The probeen sent to the natiotransactions reports hacomparison of data annational level suffers alchapter 1) as well as Measures and reportingrevolving funds have no

The national project oconsulting firms. Thescomparable microcredit


2. P Credit Performance and Experiences

KDP’s microcredit performance and experiences. Findings d on a) national databases and local reports, b) economic and

ed out by the project, and c) the consultant’s field visits to West ampung. Findings other than those made during the field visits ng references:

nt Consultants for the KDP National Secretariat: Kecamatan m. Second Annual Report 1999/2000, Jakarta, September 2000.

Konsultan Manajemen Pusat: Laporan Studi Ekonomi Program amatan, Jakarta, Juli 2001.

redit Report (no title), Jakarta, June 2001.

lim Fitra: Laporan Kunjungan Lapangan Jawa Timur Kabupaten an, 22 - 27 Januari 2001.

Awal Studi Ekonomi 21 Mei - 21 Juli 2001.

Consultants in West Java, Yogyakarta, and Lampung.

rformance: What Do Project Databases and Reports Say?

uality of Information

tments in its monitoring and reporting system. Information level, however, lacks the completeness and quality required for g funds and microcredit component. The national consultants to produce complete and consistent information on both loan repayment. Credit statistics made available to the consultant

e sub-districts with loan funds allocated in the second project ormance data for the first project year could not be made ject’s annual report mentions that credit-monitoring forms have nal level by only 34% to 70% of the sub-districts. Financial ve been reported in different forms, making aggregation and almost impossible task. The reliability of information at the so from the weak design of the revised monitoring forms (see from the lack of standard measures of credit performance. formats for supervising the financial soundness of UPKs and t been developed.

ffice has been piling up monthly reports of the many local e reports were not standardized and do also not provide data. The quality of these reports varies extremely. They may

Credit Performance and Experiences KDP Microcredit System Review 29

consist of 200 pages, of which 180 pages are filled with tables. The description of project performance focuses on project process rather than project outputs. ‘Stories’ from the field are often not backed up by hard data. Problems are shortly listed but not analyzed. Credit failures are usually perceived as problem of others rather than as problems probably also predicated by the own approach. The consultant even found one report in which credit was referred to as grant.

2.1.2 General Performance and Allocation of Funds

KDP outreach and success. According to the second annual project report, KDP has been implemented in 20 provinces, 116 districts, 727 sub-districts, and in 11,325 of Indonesia’s 67,925 villages. The project experienced a rapid scale-up during its first year, with the number of participating sub-districts (501) exceeding the planned number (350) by far. A sub-district survey of August 2000 estimated the total number of beneficiaries at 8.7 million. Most of them participated in infrastructure projects.

According to the KDP II appraisal document, the project met or surpassed all its performance indicators except for loan repayment. It was most successful in getting funds effectively to poor villages, and in establishing a participative planning and decision-making process for meeting local needs for useful investments. During the project's first two years, 74% percent of the funds were used to build economic infrastructure, with average rates of return between 30% and 40%, and costs as much as 30% less than in prevailing approaches. Some five million poor people received wages in KDP's first year.

Share of Microcredit in KDP Funds Fund Allocation a) Progress a) Microcredit Share a)

Region No. Sub-

districts IDR

(Billion) No.

Sub-districts

IDR (Billion)

No. Sub-

districts% IDR

(Billion) % % > b) 50%

Sumatra 144 159.5 144 149.7 98 68.1 34.3 22.9 13.9 Year 1 109 77.0 87 67.2 74 67.9 18.5 27.6 22.9 Year 2 87 82.5 109 82.5 53 60.9 15.8 19.2 13.8 Java 261 329.3 261 328.2 253 96.9 78.6 23.9 11.1 Year 1 187 125.5 187 123.9 127 67.9 25.3 20.4 12.3 Year 2 226 204.3 226 204.3 223 98.7 53.1 26.0 12.4 Sulawesi 86 95.3 85 92.9 62 72.1 15.7 16.9 10.6 Year 1 60 39.3 59 36.9 38 64.4 5.8 15.8 8.5 Year 2 54 56.0 54 56.0 43 79.6 9.9 17.7 13.0 Other * 109 118.3 103 106.8 100 91.7 51.1 47.8 48.5 Year 1 82 53.5 70 42.3 67 95.7 16.7 39.5 38.6 Year 2 77 64.8 77 64.5 76 98.7 34.4 53.3 57.1 Total 600 702.3 593 677.6 513 85.5 179.5 26.5 18.2 Year 1 438 294.8 425 270.4 306 72.0 66.3 24.5 18.8 Year 2 444 407.5 444 407.2 395 89.0 113.2 27.8 20.5

Source: NMC Database * Includes East Nusa Tenggara, Papua, Central and South Kalimantan. a) Note that the database is not complete for both allocation of KDP funds to sub-districts

and progress of fund allocation to villages. Microcredit share relates to progress data. b) Percentage of sub-districts with microcredit share in KDP funds higher than 50%.


Fund allocation and microcredit. Data made available by the NMC covers 600 of the 727 sub-districts to which KDP funds were allocated during the first two project years. These 600 sub-districts received IDR 702 billion. Progress data, which are based on decisions taken by the UDKPs, were available for 593 sub-districts. These sub-districts had allocated IDR 678 billion to villages either in the form of infrastructure grants or in the form of loans for economic activities.

During the project's first two years, 86% of the 593 sub-districts allocated 26.5% of KDP funds to loan purposes. More than 25% of the sub-districts in Sumatra and Sulawesi placed their funds in infrastructure investment only, whereas almost all sub-districts in Java and other provinces (East Nusa Tenggara, Papua, Central and South Kalimantan) opted for both types of investment. The sub-districts of the latter four provinces allocated almost half of their funds to microcredit. This is somewhat surprising as one may expect that infrastructure development is a particular need of eastern regions. The share of microcredit in total funds varies considerably between sub-districts. 27% of all sub-districts allocated 25% to 50%, and 18% of them allocated more than half of KDP funds to loan purposes.

Loan purposes. According to another NMC source, which probably includes a larger number of sub-districts, 27% (IDR 239 billion) of funds allocated to sub-districts (IDR 877 billion) went into loans. These statistics report a total number of 25,471 ‘activities’ financed, 10,749 (41%) of which were loans. The definition of ‘activities’ in reports and monitoring forms is not explained. Most probably, it is the number of proposals selected by the UDKP that is reported. The number of 10,749 loan activities would then refer to the number of group loan proposals approved. Loan purposes in the agricultural sector, with high concentration to livestock, contributed 27% to both the number of proposals and the total loan amount disbursed. 50% of the proposals and 54% of the total loan amount are classified as ‘savings and credit’. Note that this designation is used to classify proposals that cannot be classed with economic sectors. Most of these groups do not have savings activities. The remaining loans went into small-scale trading, home industries and microenterprises.

Outreach to the poor. A survey carried out through 317 sub-district facilitators in August 2000 found that 77% of the loan beneficiaries were perceived as poor community members. Local reports, however, often emphasize that local project implementers do not effectively target the poor. Both groups and village leaders tend to be reluctant to include poor community members, because they assume that the poor are not creditworthy and will most likely fail to repay. Apart from the fact that this assumption does usually not hold true, it must be stressed that the project does not apply clear measures of poverty, neither in surveys such as the one mentioned above nor in its targeting instruments. Questions such as the one included in funding proposals, asking for the percentage of poor approximately involved, will not produce reliable information. The self-targeting approach is most likely to fail, when villages and village leaders rather than the poor compete for getting access to KDP funds.


2.1.3 Credit Repayment Performance

National project documents and reports rely on guessing repayment performance. According to the most recent estimate of the NMC and the Economic Study Report, about 40% of loans due from Year 2 disbursements have been repaid. The KDP II project appraisal document estimates a repayment rate of between 50% and 60% for Year 1 loans, all of which have fallen due since several months.

All project documents hold that repayment has improved between Year 1 and Year 2 of project implementation. This, however, is difficult to back up with the NMC database. The following table summarizes Year 2 repayment data made available to the consultant. Year 1 repayment data were not available. Data as of June 2001 comprise only 40% of the sub-districts with microcredit. Data as of March 2001 are derived from a different (old) reporting format and cover 64% of these sub-districts. The analysis and interpretation of these data is difficult, because they come from different sources of information, and definitions of loans disbursed, repayment and overdues as well as of repayment performance measures vary locally. Repayment and overdues reported include interest payments. Repayment and repayment rates include repayments that were not due. Thus, repayment rates reported from sub-districts may be 100%, although groups and villages are in arrears. Sub-districts reported repayment rates as high as 400%.

Repayment Performance of KDP Year 2 Loans

(In IDR Million) Sumatra Java Sulawesi Other * Total

End of June 2001 Sub-districts (available data) 3 139 6 11 159 % of all with microcredit 5.7 62.3 14.0 14.5 40.3 Loan amount disbursed 1,070 20,430 354 3,904 25,759 Repayment a) 0 29 21 0 51 Overdues a) 260 1,020 96 261 1,637 Repayment rate (%) b) 0.0 2.8 17.9 0.0 3.0 End of March 2001 Sub-districts (available data) 19 221 12 1 253 % of all with microcredit 35.8 99.1 27.9 1.3 64.1 Repayment rates c) % sub-district < 10% 63.3 19.5 - 100.0 22.1 % sub-district 10 - < 25% 31.1 59.7 58.3 - 56.5 % sub-district 25 – 50% 5.3 15.4 41.7 - 15.8 % sub-district > 50% 10.5 5.4 0.0 - 5.5

Source: NMC Database, based on Form VIII * Includes East Nusa Tenggara, Papua, Central and South Kalimantan. a) Includes interest payments b) Assumes that repayment + overdues = repayment due. c) Average repayment rates cannot be calculates as repayment includes loans that were paid but not

due. The forms show repayments rates as high as 400%. Also repayment rates below 100% are not much reliable as they also include early payments and interest payments. It is likely that forms are filled out based on different interpretations of loans due, overdues, and repayment rate calculation.


Provided the data are reliable, only 7% of the total loan amount (IDR 25.8 billion) covered by the first database had fallen due as of June 2001. Disbursement of Year 2 loans commenced in August (Java) and October 2000. This indicates that most loans have long maturities, and that repayment schedules do not require frequent installments and repayment discipline. Despite the low loan amount due, 97% of this amount was overdue. According to the second database, which records amounts of ‘repayment planned’ and ‘repayment made’, 79% of the sub-districts had repayment rates lower than 25% as of March 2001. Repayment rates higher than 50% were reported for only 6% of the sub-districts. It is assumed that the amount of ‘repayment planned’ is equal to the loan amount due.

Reliable calculations of repayment rates and loan portfolio quality cannot be made on this basis. Data available do not indicate improving repayment performance between Year 1 and Year 2. Long maturities and lacking installment requirements do certainly not provide hope for improvement. It can also not be expected that sub-district not reporting to the national level are better credit performers.

2.1.4 Credit and Financial Management Problems

Reasons of bad repayment performance. The consultant checked some of the many reports prepared by local consultants, especially with regard to their analysis of problems in the fields of revolving fund management and credit performance. The following reasons for KDP’s bad credit performance were mentioned:

• Business failure. Reports often mention ‘business failure’ as causes of non-repayment, usually without analyzing what caused the business to fail. In part of the cases market conditions such as the drop of agricultural prices require loan restructuring or rescheduling. Experience, however, also shows that ‘business failure’ is used to cover up improper loan use. Inadequate business planning as well as inadequate loan terms and conditions may also contribute to business failure. The reports indicate lacking capabilities with regard to both business planning and setting of adequate loan terms and conditions.

• Government-led credit perceived as grants. Many reports mentioned that PPK has not yet been sufficiently ‘socialized’ and that ‘the people’ still regard KDP loans as grants. This is difficult to believe as KDP applies an intensive standard process of communicating the project purpose through participative forums and involving potential borrowers in preparing loan proposals. While it may be true that KDP is perceived as just another government program where non-repayment has been the norm, it should be analyzed whether this is not a pretended perception. Some reports also indicate that this misinformation has been intentionally disseminated.

• Lack of loan collection, supervision and enforcement. The reports indicate that loans disbursements lack consistent and resolute follow-up action. Delinquent borrowers are threatened with sanctions, but sanctions are not enforced. This links up to the experience that


non-repayment of government loans has been the norm and points to governance problems of credit providers who do not bear the risk of loan loss. If borrowers perceive that lenders are not serious in collecting loans and do not expect sanctions, then they will perceive loans as grants irrespective of what had been communicated earlier.

• Loan use deviates from loan application. The reports mention some cases where loans were used for purposes other than planned and documented in loan proposals. One of the characteristics of money is its fungibility. Lack of credit monitoring and supervision is a direct predicator of this problem. There is another reason for diverting loan use. If the lender is not able to disburse loans on time, investment in planned loan uses are often not anymore profitable.

• Unwillingness to pay and instant/bogus groups. Some sub-districts appear to have serious problems with borrowers unwilling to pay, although their businesses show high rates of return. Many sub-districts report that borrowing groups were formed only for the purpose of getting access to KDP funds and lack common bonds that support loan repayment. In some cases groups even exist only on paper. These problems point to weaknesses in KDP loan appraisals. The borrower’s character and the group’s eligibility are major indicators for minimizing credit risks, especially when collateral and other guarantees are not required.

• Misappropriation of loan installments. Local reports describe many cases where loan installments were misappropriated. Installments made by group members were appropriated by group leaders and not passed on to the LKMD/TPK or UPK. Installments made by groups were misused by the LKMD chairperson, the village head or the village facilitator, and not passed on to the UPK. Installments made to UPKs were misused by UPK staff and not deposited in the project’s repayment account. Several examples point to bad UPK governance, but most of the problems seem to occur at the village level. The village is not the place of social control, and LKMDs/TPKs appear to be part of the problem rather than part of the solution when they are involved in credit transactions.

Problems of Loan Funds Governance and Management. Local reports indicate several problems that relate to the governance and management of loan funds. Problems identified are summarized in the following:

• Misappropriation of KDP funds. Bad governance of financial intermediaries is not only a factor predicating non-repayment. The reports also indicate misappropriations of funds before being allocated or disbursed. There are some examples where sub-district heads or LKMD chairpersons deducted part of the amount to be disbursed, or where UPK staff appropriated KDP funds.


• Political power versus prudential credit management. Some reports mention that the village elite or LKMD has been monopolizing the making of loans. Loan proposals were pushed through, though they were not feasible. Loans were provided to bogus groups, people who are not members of the target groups, or people closely related to the village head and LKMD. LKMD disbursed loans to groups without loan contracts and receipts. Borrowers were required to pledge house certificates or motorcycle ownership papers against loans. UPKs disbursed loans to LKMD via the sub-district head, and are to weak to refuse interventions from sub-district officials.

• Lack of effective supervision. The problems described above points to another weakness in the governance of KDP’s financial intermediaries. The reports indicate that many UPK and LKMD lack effective supervision. The village and sub-district level forums are apparently not capable of exerting control. Community monitoring seems to fail because of existing power structures and domination of decision-making forums by the village elite. Note that KDP has neither established supervisory bodies nor prepared instruments required for effective supervision.

• Weak financial administration and management. Many UPKs are reported to lack complete and consistent financial administration. Human resources available do not match requirements for managing huge KDP funds. This finding cannot be surprising, because the project has not yet provided the financial administration and management instruments as well as the training required for improving UPK management.

• Governance of loan funds by logics external to good microcredit standards. Consultants and facilitators appear to feel both helpless and innocent, because village and sub-district development forums are free to take loan decisions, also those that do not reflect prudential credit management. The project seems to communicate that decisions made on the basis of expressed (and infinite) local needs are good decisions. Whether decision-making forums express the democratic will of communities or are dominated by the elite, they do not work according to logics required for good financial and credit management.


2.2 Findings of the KDP Economic Studies

KDP recently carried out two Economic Studies (see references at the beginning of this chapter). The first study report was prepared by the ‘Economic Study Team’ and will be referred to as the EST Report. It is based on surveys conducted in 15 sub-districts of West Java, East Java, South Sulawesi, Central Sulawesi, and West Sumatra. The study aimed at examining credit procedures, credit impact, reasons for low repayment performance, and implementation of credit monitoring forms. The study team also interviewed bankers and discusses alternative models for the future development of the UPK and KDP’s cooperation with local banks. The second study report was prepared by Melissa Day and will be referred to as the MD Report. The study looked at KDP microcredit from the perspective of borrowers, loan use and impact. Findings were derived from interviews with 79 borrowers, 11 potential borrowers, 30 community leaders, and several local banks in 15 sub-districts of West Java, East Nusa Tenggara and Lampung.

2.2.1 Microcredit Approach and Management

Group quality and support. Both reports show that groups were usually established for the purpose of getting access to KDP funds. Internal bonds and control as well as group organization and financial administration are weak. Group activities other than related to KDP loans do often not exist. The MD Study found that 77% of its sample groups did not exist before, and 3% didn’t exist at all. Preexisting groups recorded better repayment and delivered more support to borrowers. 62% of the borrowers said that their groups were not helpful in any way.

Training and continued support for strengthening the organization and financial administration of the groups as well as for strengthening their members’ business planning and development are not provided. The MD Report is right to argue that successful microcredit interventions are usually preceded by group guidance and training, especially with regard to internal savings mobilization and business planning. The capability of KDP field staff and the village bureaucracy to provide these support services is highly limited.

Loan proposal and verification. The process of collecting funding ideas, preparing loan proposals and verifying the feasibility of loan proposals does not ensure the quality of these proposals. Loan amounts proposed do often not reflect real credit demand and absorption capacities. Groups or other parties involved in determining loan amounts tend to distribute KDP funds ‘fairly’, thus all borrowers getting the same loan amounts irrespective of their loan uses. Loan terms and repayment schedules do often not correspond to loan uses and business cycles. Verification has been weak as time for feasibility studies is highly limited and qualified members of the verification team are difficult to find. (EST Report)

Loan amounts, terms and conditions. Loan amounts per individual borrower range from IDR 200,000 to IDR 3 million. Loans have usually maturities of 12 or 18 months, while installments are made monthly, quarterly, semi-annually or even with lower frequencies. Loans with a 12-months term and monthly installments have the best repayment rates.


Annual interest rates on group loans were 20% flat for the first loan cycle and 20% on balance for the second loan cycle. (See first chapter: while KDP provisions require market interest rates, the implementation guidelines include examples of how calculating a 20% interest rate on declining balance; this has obviously led UDKPs and LKMDs to fix a standard interest rate far below locally varying market rates.)

Many village development forums require groups and their members to pledge physical collateral against loans. This, however, did not improve repayment performance. (EST Report)

Credit monitoring and reporting. Accounting systems applied at both the village and sub-district levels are not standardized and do not support easy control, financial analysis, and even recording increases in the number of borrowers. Financial transaction reports (Forms VIII.2 and VIII.4) are not properly prepared and difficult to analyze. The new forms were not yet socialized, old forms were partly modified, and the contents of the forms were differently interpreted. The study team could not find even one village where Form VIII.2 was used. Respondents mentioned that they have difficulties in understanding and filling out the form. They also lacked sense for its usefulness. (EST Report)

2.2.2 Governance and Management of Loan Funds

Financial and credit management. All financial intermediaries, groups, LKMDs/TPKs and UPKs, were found to focus on distributing funds and to lack capabilities with regard to financial administration, revolving fund management and credit feasibility analysis. Direct credit supervision to members is missing. Credit monitoring and reporting seems to be regarded as formal requirements rather than as useful means for taking timely and corrective action in cases of arrears. The EST Report suggests that institutional strengthening of financial intermediaries is crucial for avoiding the well-known failures of other credit programs. The MD report sees a great need of training in the fields of credit and portfolio risk management.

Project support. District consultants and sub-district facilitators were found to concentrate on KDP process implementation rather than on institutional strengthening. (EST Report) This finding is related to the fact that the qualifications of consultants and sub-district facilitators are usually to be found in fields other than financial and credit management.

Governance of financial intermediaries. The MD Report emphasizes that financial intermediaries and credit decisions are governed by logics other than required for effective and sound microcredit programs. KDP credit comes from the government and credit management involves local officials and village leaders who do not apply prudential banking criteria. Honest leaders often tend to distribute credit equally, thus neglecting the real credit demand of the borrowers’ businesses. Unfavorable local power structures lead to concentrating credit to the powerful rather than to the poor. 42% of the study's respondents reported corruption or missing funds. In all but two cases corruption could be traced back to village leaders and their cronies.


2.2.3 Borrower Characteristics, Loan Use and Impact

Borrower characteristics. 61% of the individual borrowers covered by EST Study were women. The study found some evidence that the poor were partly reached by credit services. However, the report states that poverty data for borrowers are almost not available. UPKs usually only record the number of groups served. Forms that are supposed to include poverty information are often not complete or consistent. (See first chapter: the only source of borrower information is the funding proposal; the proposal team is simply asked to mention an ‘approximate’ percentage of benefiting poor households; this approach can by no means deliver reliable data.)

Lending decisions and outreach to the poor. The EST Report provides several examples where KDP loans went to borrowers (with large newly built houses; with large bank deposits, with monthly household income far above any poverty standard) other than the poor. The report indicates that KDP lenders and village leaders tend to believe that better-off villagers are more likely to repay the loans.

Economic potentials of a great part of the poor given, neither KDP experiences nor experiences from microcredit programs directly targeting the poor can support this argument. The poor are usually more eager to repay loans as they highly depend on sustained credit access. The MD Study found that KDP credit was a virtually risk free option for non-poor borrowers, whereas poor borrowers lack alternatives and were more likely to repay than borrowers with monthly incomes over IDR 600,000.

The lack of clear targeting instruments and responsibilities provides scope for arguments such as the one above and seems to undermine outreach to the poor. The MD Study sample included many non-poor and found evidence of targeting the powerful rather than the poor.

Loan use. The MD Study found that the majority (51%) of loans were used to save or consume in a way that did not immediately increase income:

• 33% of the loans were saved for future use, either in kind such as inventories or in cash.

• 18% of the loans were used for immediate consumption, school fees, outstanding debts, house improvements, especially by borrowers with higher household income.

• 31% of the loans were used to start new businesses, especially by farmers as an additional income source.

• 26% of the loans were used to expand existing businesses, especially home industries. These borrowers showed the best repayment performance.

Economic impact. The MD Study made the following findings with regard to the economic impact of KDP credit:

• 33% of the borrowers, usually those who started or expanded businesses, reported a net increase in their incomes.

• 45% of the borrowers reported an increase in household savings, however, usually because loans were used as household savings.


• 14% of the borrowers reported that their overall household debt level will or has increased at the end of their loan terms. If borrowers did not have a stable income or economic activity, taking loans added to their debt without increasing their ability to repay.

The main constraints of business growth as identified by borrowers are a) access to market information; b) lacking business strategy and long term planning; c) lacking marketing vision to expand beyond current operations; and d) risk adversity and unwillingness to expand.

The EST Report identified three categories of borrowers and economic impact:

• Borrowers who could not improve business profits and household income, because they could not expand sales, production and employment. Loans were often used for consumptive purposes and most of the borrowers failed to repay loans. The report estimates that this group makes up 50% of all borrowers.

• Borrowers who succeeded to improve business profits and household income by business expansion or diversification. Most of them were non-poor borrowers and repaid on time. The report estimates that this group makes up 30% of all borrowers.

• Borrowers who succeeded to stabilize or improve their businesses without increasing household income. They were usually poorer and female borrowers and showed a good repayment performance. The report estimates that this group makes up 20% of all borrowers.

Note: These results have to be carefully read. The report does not clarify how poverty, business profit, and household income were measured. Estimates seem to be backed up by passing observations rather than hard data. Third, the sample of the study is too small and not representative enough to allow for general conclusions.

2.2.4 Reasons for Low Repayment Performance

Improved loan repayment. The EST Report states that repayment performance improved during the second loan cycle. The report mentions increased efforts to educate borrowers and the threat of suspending village funding as factors contributing to this improvement.

The report mentions the following reasons for low repayment performance without, however, assessing their relative importance:

• Bad attitude and character of the borrower. • Loan is perceived as grant; assumes that bad debts will be written off. • Low economic impact of the loan; Failure of the borrower’s business. • Force mayeure. • Inadequate debt collection. • Snowball effect: not repaying because the neighbor doesn’t repay. • Lack of enforcement and sanctions.


Note: The study pointed structural weaknesses in KDP’s credit management that may also be regarded as potential predicators of loan loss:

• Business planning does not involve each borrower and is not supported by training borrowers how to plan their businesses.

• Groups cannot enforce joint liability, because they often do not have common interests other than getting access to KDP funds.

• Loan proposals often do not reflect real credit demand, absorption capacities and repayment capacities.

• The present form of verifying loan proposals does not prevent bad targeting, over-financing, and inadequate loan terms and conditions.

• Decision-making forums do not apply good microcredit standards. • All financial intermediaries lack credit management capability.

The MD Report emphasizes that KDP credit is perceived as a soft credit option with below market interest rates and without collateral requirements and effective enforcement of sanctions. Only 19% of the respondents were aware of sanctions. Furthermore, KDP credit is perceived a just another government program where non-repayment is the norm. 62% of the borrowers had taken part in past credit programs. 88% of the borrowers did not fully repay their loans and 92.5% of those were behind by two months or more in payment to KDP. According to these borrowers, KDP credit is to be repaid if possible but it’s not really expected. The report concludes that responsibility for repayment seems to end when the proposal process proved to be a formality.

2.2.5 KDP Relation to Banks and other Credit Programs

Access to other credit sources. The MD Study found that 10% of its respondents had current loans outstanding to banks, and 23% had access to bank credit during the last eight years. All of these loans were or are being repaid. 61% of the respondents had taken credit from another government program during the last eight years, and 88% of these loans went unpaid. The most common reason for taking KDP credit was that is was easily available and apparently also to repay loans from other sources.

Competition. The EST reports some findings with regard to the completive situation with banks and other credit programs:

• KDP does not contribute to over-supply of microcredit as banks and other credit programs have different target groups. Note: This may not be true where P4K Project of BRI and the Ministry of Agriculture, the Kuskesra program of the Family Planning Board, and the Linking Banks and Self-Help Group approach have been implemented.

• KDP credit did not lead to lowering locally prevailing market rates. Note: Why should they? Other than in KDP, bank interest rates have to reflect cost of funds, intermediation costs, risk and profitability.

• KDP credit does not take customers away from local banks. Note: Why should customers not switch to KDP, when they get access to


cheaper loans and they expect that non-repayment is likely not to affect them negatively? Furthermore, the question of competition is not only whether KDP borrowers do already have access to bank credit. It is also important to assess whether credit programs with low interest and repayment rates undermine access of financial institutions to potential borrowers.

Perception of local bankers. The study team interviewed local bankers on how they perceive KDP and the problem of debt collection. Findings of the study are:

• Bankers regard KDP’s credit risk as very high, because a) the village assemblies, which neither bear the risk nor have the necessary qualifications, select borrowers; b) the number of borrowers and the costs of credit supervision are high; and c) collateral is not required and executable.

• Bankers do not believe that involvement of bank officers in KDP’s proposal verification teams improves loan quality, because verification team members do not bear credit risks and are not liable for wrong decisions.

• Bankers do not see adequate efforts of debt collection, because UPK do not bear credit risks; debt collectors (loan officers) are not sanctioned for bad collection performance; and KDP/UPK staff does not risk losing permanent employment.

• All bankers concluded that they would not be interested in cooperating with KDP neither as channeling nor as executing agencies.

2.2.6 Recommendations of the Economic Studies

The MD Report makes the following recommendations:

Building bridges to sustainable credit sources. The current KDP microcredit system should be improved in such a way that it enables KDP borrowers to get future access to more sustainable credit providers. Pre-requisites for this approach are: a) to strengthen the financial management and credit services of the UPK; and b) to depart from fallacies of past governmental credit programs. Good UPKs, which have developed close and trustful relationships of trust with KDP borrowers, would graduate good borrowers to financial institutions, and could then continue to identify and serve new borrowers with out access to sustainable credit sources.

Improving outreach to the poor. KDP credit should be limited to low income entrepreneurs without current access to sustainable microcredit. It should not be forced upon poor people but made available as one option. To improve access to low income borrowers, KDP should a) limit first time individual loan size to IDR 500,000; b) apply above market (BRI) interest rates; c) train project staff on improving outreach depth; and d) increase participation of poorer villages.


The EST Report makes the following recommendations:

Selective and cost covering credit approach. The EST report concludes that continuing KDP as is would be financially unsound. In order to sustain credit operations, the report argues, that the program should bear the costs of credit administration, bad debts, and inflation.

The report recommends improving KDP’s microcredit interventions as follows:

• KDP should adopt a selective credit approach. Borrowers should be able to improve business profits or to use credit for stabilizing and sustaining their business. KDP should only provide credit on the basis of ‘real need’ rather than ‘expressed need’ and on the basis of ‘effective demand’ rather than ‘absolute demand’.

• To improve credit management, KDP should train UPK staff, FKs, LKMDs and FDs, especially with regard to evaluating business prospects of loan applicants and preventing loan loss. All parties directly involved in financial transaction should bear credit risks.

• KDP’s credit system should progress from ‘formal participation’ to ‘real participation’. Real participation would include savings and bearing the risk of any loss.

Cooperation with banks and the future of the UPK. The economic study report discusses three alternatives: continuing UPK operations, transferring the KDP credit program to a bank, and converting UPK to BPR. Note: The alternative of converting UPK to BPR is not considered, because both BPR regulations (paid-up capital requirements, management capacities) and Bank Indonesia’s restrictive licensing practice make this alternative irrelevant.

The economic study opts for transferring the KDP credit program to either BRI or the Bank Indonesia Microcredit Program executed through BPRs. The main arguments for this option are:

• Percentage of loan loss is low. • Attracts borrowers with real credit demand and willing to repay. • Motivates borrowers to come up with realistic business planning. • Credit program is sustainable.

The main arguments made against continuing KDP credit through UPKs are:

• Continuation violates the Banking and Central Bank Act. • Economic lifetime of UPK is limited. • Loan loss is high. • Number of borrowers with increased business profits is low. • Distracts borrowers from following normal banking procedures. • Part of the village elite benefits from KDP loan distribution.


Note: Future options for the KDP microcredit system will be discussed in later chapters of this report. It is, however, useful to point to some problematic assumptions underlying the recommendations and arguments summarized above.

• The Central Bank Act provisions refer only to Bank Indonesia. The Banking Act (article 16) requires only parties mobilizing funds from the public to obtain a bank license. Revolving fund management by the UPK is not subject to the Banking Act.

• All other arguments against UPK continuation may describe the current situation. The arguments are valid only, if the KDP revolving fund and credit management approach is not revised and improved.

• Arguments for transferring the KDP credit program to BPRs and/or BRI refer to experiences from the Microcredit and P4K Projects (see following chapter). These projects provide intensive technical support to both executing banks and self-help groups. The support services required would increase rather than decrease the burden to be carried by KDP. Second, BPRs operating in rural areas outside of Java are scarce, and there are also not too many rural BPRs in Java that are able to carry out the approach without project support. Third, BRI is the executing bank of P4K, but BRI program credit does not involve their sub-district units. P4K implementation and much of BRI’s banking tasks rely on agricultural extension workers.


2.3 Field Visit Findings: Yogyakarta, Lampung, West Java

The consultant visited participating sub-districts in Yogyakarta, Lampung and West Java. The major findings of these field visits are summarized in the following.

Province District Sub-district

Yogyakarta Gunung Kidul Paliyan and Tepus Kulon Progo Kalibawang and Girimulyo

Lampung Central Lampung Seputih Banyak and Rumbia West Lampung Balik Bukit

West Java Karawang Rengasdengklok and Talagasari

2.3.1 General Performance

Yogyakarta is regarded as one of KDP’s most successful project areas. The following table shows why. During the project’s first two years, the 15 participating sub-districts in the province allocated IDR 6.4 billion to loans funds. In several cycles they revolved an additional loan amount of IDR 2.9 billion. Their loan repayment performance has been excellent compared to other project regions and in most sub-districts by any standard.

Yogyakarta: Loans Disbursed and Repayment Performance (as of June 2001)

Initial Loan Fund Revolving Loans (In IDR Million)

Year 1 Year2 Year 1 Year2 Year 1+2

Gunung Kidul District Number of sub-districts 5 8 5 3 Number of villages 23 49 28 16 Number of groups 214 389 243 52 Loan amount disbursed 647.9 2,065.5 974.0 204.5 Loan amount due 647.9 626.1 412.4 26.0 Loan amount repaid a) 658.0 626.3 404.5 26.0 Repayment rate 97% 100% 98% 100% No. villages 100% 11 43 18 16 No. villages < 80% 1 - - - Kulon Progo District Number of sub-districts 5 7 4 Number of villages 14 40 23 Number of groups 103 421 206 Loan amount disbursed 1,128.6 2,578.5 1,690.9 Loan amount due 1,128.6 1,322.0 986.2 Loan amount repaid a) 1,014.5 1,242.7 926.5 Repayment rate 89% 94% 94% No. villages 100% 5 14 6 No. villages < 80% 3 5 4 Source: District Management Consultants a) Includes payments of loan amount not due


Note: The table shows that IDR 1.869 billion of Year 2 loans were collected in Yogyakarta, with an aggregated repayment rate of 100% in Gunung Kidul and 94% in Kulon Progo. The national data presented in the previous chapter do not record any repayment for Year 2 loans in Yogyakarta! Thus, the KDP’s overall collection performance may be better than nationally reported!

Lampung can be regarded as one of KDP’s poorer performing areas. The collection rates of sub-districts visited ranged from 4% to 66%. The overall repayment rate Year 1 loans in Central Lampung was 45.5% as of July 2001, with a total loan amount disbursed of IDR 2 billion. Year 2 loans amounting to IDR 3.2 billion have not yet fallen due. Loans disbursed to LKMD usually have 18-months terms without intermittent installments. Note: The UPKs report the total loan amounts outstanding as arrears. This has led to wrong calculations of their collection rates also at the national level.

Central/West Lampung: Loans Disbursed and Repayment Performance

Central Lampung a) West Lampung (In IDR Million)

Seputih Banyak Rumbia Total C.L. Bukit Balik b)

YEAR 1 Loan amount disbursed 561.7 712.5 1,980.0 263.6 Number of groups 50 9 129 Number of ind. borrowers 867 594 2,910 Average ind. loan amount 0.65 1.2 0.68 Maximum ind. loan amount 2.8 1.5 2.8 Loan amount overdue 561.7 712.5 1,980.0 240.7 Loan amount repaid 167.7 471.1 869.9 11.2 Repayment rate 29.9 66.1 45.5 4.4 YEAR 2 Loan amount disbursed 789.0 801.7 3,213.0 224.8 Loan amount overdue *) *) *) *) Number of groups 71 97 473 22 Number of ind. borrowers 1,082 990 7,705 235 Average ind. loan amount 0.73 0.81 0.42 0.96 Maximum ind. loan amount 3.0 4.1 4.7 3.0 Loan amount repaid 167.7 - 390.9 **) 84.7 **) Repayment rate ? ? ? ? a) Source: Konsultan Manajemen Propinsi, Laporan Bulanan, Juli 2001 and UPKs b) Source: UPK Bukit Balik *) Loan amounts overdue reported are equivalent to loan amounts outstanding. This is not possible as field findings showed that most Year 2 loans have not yet fallen due and are often to be repaid in one installment at final due date. **) Includes interest payments.

The Karawang district in West Java is, with an overall collection rate of 73% for initial loan funds, a medium-performing project area. While the sub-district Rengasdengklok (including three villages of the newly formed Jayakerta sub-district) has been performing relatively poorly, though still better than most sub-districts in Lampung, the UPK in Telagasari is one of KDP’s better performing UPKs.


Karawang District: Loans Disbursed and Repayment Performance (as of July 2001)

Rengasdengklok Telagasari Karawang (In IDR Million)

Initial Revolving Initial Revolving Initial Revolving

Number of villages 9 * 6 7 7 39 Number of groups 75 14 25 23 Number of ind. borrowers 2,475 141 1,064 Loan amount disbursed 460.7 31.7 239.6 133.6 1,385.5 Loan amount due 341.5 9.5 158.8 28.7 827.6 141.1 Loan amount repaid a) 209.7 7.5 153.8 27.2 610.7 134.7 Repayment rate a) 61% * 79% 96% 94% 73% 95% Sources: District Management Consultant, UPKs a) Includes payments of loan amount not due * Includes 3 villages which joined the newly established sub-district Jayakerta, where the UPK has heavy collection problems: Repayment rate Jayakerta = 39%, Rengasdengklok = 72%.

2.3.2 UPK Organization and Management

UPKs usually operate from a small office room equipped with not more than three to four desks and chairs, one typing machine and/or computer, and boards displaying project information. None of the offices visited had a phone. Records are usually not kept in a filing cabinet, but pile up on the accountant’s desk. UPK offices open in the morning, while the afternoon is usually used for field visits. UPK staff usually consists of a chairperson, a bookkeeper and a secretary. In some cases additional staff was added to support field operations.

UPK Paliyan was established in April 1999 and is operated by four employees. The UDKP has approved funds for moving to a permanent office. UPK assets include one motorcycle and one computer. The accountant brought in financial administration experience as a former UEDSP (tiny village financial body promoted by PMD) employee. The additional field staff brought in experience from managing savings and credit groups and building up bank linkages in the framework of the PHBK program. Though he failed to be appointed as UPK staff during the UDKP II meeting, he is definitely the UPK’s most capable and talented person. He was the only one being able to provide immediate response and to discuss problems with an analytical touch. Most strikingly, the UPK chairman turned out to be totally ignorant and unmotivated. Also this finding indicates that UDKP decisions follow logics other than required for financial and credit management. In general, UPK management seems to be highly dependent on the sub-district facilitator. The consultant could not sense training impact or transfer of knowledge.

UPK Tepus was also established in April 1999 and operates from a rented office, which is located in the sub-district center close to the BRI unit. The UPK is staffed with three persons and owns one motorcycle and one computer. The office makes a good impression and, contrary to other offices visited, looks like a real service place. Books are kept properly with staff being able to provide prompt information and having basic knowledge of financial administration. The accountant acquired this knowledge during his work in a cooperative.


UPK Girimulyo was established in May 1999 and operates from a room in the sub-district government complex. Since May 2001, it operates only with the chairman and the accountant. The UDKP decided that additional staff is not yet required (the UPK serves 58 groups with 1,500 borrowers!). The statistical board has not been up-dated because of time constraints. The accountant, a woman with UEDSP experience and accounting background, made an informed and motivated impression. She prepared balance sheets on her own initiative: Recently, she stopped this initiative because the FK and PjOK found the activity unnecessary. The chairman did not show that he is supposed to manage the UPK, though he was a teacher and former LKMD accountant. Neither UPK staff nor the PjOK and FK were able to provide prompt information about key indicators such as the repayment rate. The dominant PjOK answered all questions put to UPK staff, and emphasized several times that there are no problems, although the UPK has been facing severe repayment problems from some villages.

UPK Kalibawang is one of KDP’s success stories. The UDKP took the policy decision to allocate all KDP funds to loans and to finance infrastructure projects from interest income. The UPK has a large and well-equipped rented office. It employs five staff, of which two are permanent employees. One staff is a special training officer providing business training to borrowers. He has carried out 17 trainings with the budget of IDR 4.8 million financed by interest income. All UPK staff, mainly university graduates, appeared to be well informed, motivated and capable. The Kalibawang model has a special feature. It is highly dominated by energetic PjOK and FK with their own vision. The priority is to strengthen local government in alleviating poverty. Much of the interest income goes to the village and hamlet administration. The LKMD is enabled to hold routine meetings with the help of project funds and is entirely responsible for project implementation. Credit is regarded as adequate and timely intervention as local infrastructure has been sufficiently developed by other projects. Formalizing and professionalizing the UPK is seen as the major task for the near future.

UPK Seputih Banyak was established in October 1998 and disbursed the first loans in December 1998. The rented office consists of two simply equipped rooms and is operated by three persons. Both the chairman and the accountant were part-time teachers before they joined the UPK. The management team made a motivated impression. However, records were not complete and the real reasons for default were only partially known. It took considerable time to calculate the total loan amount overdue. The team was trained for one week in bookkeeping and preparation of reports. Nonetheless, they stressed to urgently need additional bookkeeping and financial management training.

UPK Rumbia was established in late 1998 and started to disburse loans in April 1999. Four UPK staff, including one field staff, operates a rented two-room office for five hours in the morning. Prior to their assignment to the UPK, they worked as administrative staff of schools (chairman, accountant) or in an insurance company (secretary). The management team was not aware of their monthly operating costs and was not able to answer question related to the causes of loan defaults. The accountant needed about 30 minutes to calculate the number of groups served in Year 2. The chairman even didn’t know the members of the verification team. The team had participated in a five-days training once and felt an urgent need for further training.


UPK Balik Bukit operates from a small room in the office complex of the sub-district government. The chairwoman is the wife of a PjOK of another sub-district and made a motivated but frustrated impression, especially because the UPK has no direct access to borrowers and does not know how to improve is collection performance. The UPK makes a generally weak impression and its management team lacks all kind of training.

UPK Rengasdengklok operates from a tiny rented office (about 8m²) since November 2000. The office is equipped with three tables, two white boards and a computer. The infrastructure of the sub-district is well developed, and all villages can be easily accessed. After office hours (8.00-13.00) UPK staff visits borrowers often until the evening. The UPK management makes generally a good and motivated impression, and has detailed knowledge about villages and borrowers. All three management members brought in valuable experience from their previous work in private companies or cooperatives. The accountant had been a BPR employee for 5 years. All UPK staff received short-term training from KDP, but emphasized that they urgently need additional training, especially for improving credit analysis and management. Staff salaries range between IDR 300,000 and IDR 350,000 per month.

UPK Telagasari operates from an office in the sub-district’s government complex since November 2000. The office is also equipped with three tables, two white boards and a computer. As in the case of Rengasdengklok villages are easy to reach and UPK staff pay regular visits to borrowers during and after office hours (8.00-14.00). All three women managing the UPK were recently graduated from universities and brought in accounting and economic competency. All are highly motivated and able to communicate independently from the FK and PjOK. They have not yet received and asked for financial management training. As the UDKP has not yet agreed upon financing operating costs from interest income, the UPK lacks operational funds, especially for financing transport to the villages. With monthly salaries of IDR 275,000 or IDR 300,000, the UPK managers are considerably underpaid, especially if their qualification and performance is compared to that of other UPKs.

2.3.3 Outreach and Financial Performance

UPK Paliyan has already provided credit services to 7 villages and 1,567 borrowers organized in 188 groups. The UPK had disbursed a total loan amount of IDR 982.4 million, of which IDR 421.3 million were revolved from initial loan funds. As of July 2001, the UPK managed a total fund of IDR 680 million, of which IDR 428.4 million were loans outstanding to 177 groups. 105 of these groups consist of small traders. With a total accumulated loan amount due of IDR 557.3 million and overdues amounting to IDR 13.2 million, the UPK achieved an overall collection rate of 97.6%.

UPK Tepus has been serving 10 villages, 184 groups and 2,038 group members. It disbursed a total loan amount of IDR 678.8 million, including IDR 279.7 million revolved from initial loan funds. Loan uses are highly concentrated in the livestock and home industry sectors. As of June 2000, loans outstanding amounted to IDR 314 million (70% of total funds), of which IDR 12.7 million were in arrears. With IDR 375 million of accumulated loans due, the UPK achieved an overall collection rate of 96.6%.


UPK Girimulyo has been serving 58 hamlet groups in 4 villages. Initial loan funds during the first two years amounted to IDR 352 million. As of April 2001, the UPK had total assets of IDR 416 million and a total loan amount outstanding of IDR 328 million. Profits were recorded at IDR 64 million, but did not consider loan loss costs, purchase of one computer and part of operating costs. As of July 2001, the arrears amounted to IDR 65.5 million with an accumulated loan amount due of IDR 368.1 billion. While two of the four villages recorded collection rates of 96%, the UPK had serious collection problems in the other two villages where collection rates were not higher than 60%. UPK staff referred to the impact of former credit programs as causes for these problems, but had apparently no intimate knowledge about the groups affected.

UPK Kalibawang has been serving 4 villages, with 1,481 members of 126 groups receiving loans from initial loan funds and 1,512 members of 207 groups receiving loans from revolving funds. As of July 2001, the UPK had disbursed a total loan amount of IDR 2,991 million, of which IDR 1,803 million were revolved through 26 disbursements. Loans outstanding to 155 groups amounted to IDR 885 million. As of June 2001, the total amount overdue was IDR 81.9 million and, based on an accumulated loan amount due of IDR 2,032 million, the UPK achieved a collection rate 96%. With 9% of its loan portfolio (IDR 929 million) in arrears at that time, the UPK’s loan portfolio at risk (including the total balance of loans in arrears, which could not be produced by the UPK) may point to problems that cannot be detected by the accumulated repayment rate.

UPK Seputih Banyak provided Year 1 loans amounting to IDR 562 million to 9 villages and Year 2 loans amounting to IDR 789 million to 8 villages. LKMDs disbursed these loans to 53 groups in Year 1 and to 65 groups in Year 2. All Year 1 loans had fallen due until April 2001. The amount of loans overdue as of July 2001 was IDR 394 million. The UPK recorded IDR 169 million of overdue interest payments. The final due month for Year 2 loans will be October 2001. Most of Year 2 loans had not yet fallen due, but there is not much hope that repayment of Year 2 loans will be much better than that of Year 1 loans. The UPK has not yet revolved loan funds. IDR 225 million of idle funds were deposited in the BRI account.

UPK Rumbia disbursed IDR 712.5 million to 9 LKMDs in Year 1 and IDR 812 million to 11 LKMDs. According to UPK statistics these loans went to only 9 groups with 594 borrowers (501 men) in the first year and to 57 groups with 1,234 borrowers in the second year. The repayment rate for Year 1 loans was 66% as of July 2001. The UPK had revolved loans paid three times with a total amount of IDR 538 million revolving.

UPK Balik Bukit disbursed IDR 264 million to 5 LKMDs in Year 1 and IDR 225 to 5 new LKMDs in Year 2. Based on the UPK’s aggregated statistics it had an overall collection rate of 4% for Year 1 loans. According to disaggregated statistics, however, the repayment rate per village ranged from 4% to 49%. For Year 2 loans that had not yet fallen due the UPK reports total loans outstanding as arrears.

UPK Rengasdengklok has been serving 9 villages, 75 groups and 2,475 borrowing group members from initial loan funds amounting to IDR 461 million. It revolved funds to 6 villages, 14 groups and 141 borrowing members. The overall collection rate for


initial loan funds was 61% and the collection rate for revolving funds was 79 % as of July 2001. Major collection problems occurred in three villages that became part of the newly formed Jayakerta sub-district after Year 1 loans were disbursed. The collection rate for these villages was only 39%. According to the UPK management, their collection problems were mainly caused by four factors: a) approval of loans for groups without common bonds and established only for the purpose of getting access to KDP funds; b) the fact that the verification team examined only a sample of all loan proposals; c) the lack of training and support for group members, especially with regard to business planning and management; and d) several cases in which loans or loan installments were misappropriated by either group leaders or local officials.

UPK Telagasari has been serving 7 villages, 25 groups and 1,064 borrowing members from initial loan funds amounting to IDR 240 million. It revolved IDR 134 million to 7 villages and 23 groups. As of July 2001, the collection rates for both initial loan funds (96%) and revolving funds (94%) were among the best in West Java. Collection problems are limited to a few cases where group members have been unwilling to pay, came into conflict with each other, or group leaders misappropriated loan installments of members. Two groups visited were weak in both administration and internal coherence. Both group leaders have been trying their best, but they appeared rather frustrated with their unpleasant role as debt collectors. They, however, experienced collection problems with only 7 of their 43 members.

2.3.4 Financial Administration and Management

Accounting system and financial management. In Yogyakarta, the UPK financial administration makes a good impression, if the measure is the standards and accounting instruments provided by KDP. The previous chapter showed that this project input is highly inadequate for institutions that are supposed to manage large loan funds. The standards and instruments provided are inconsistent and sometimes simply wrong, are not based on a complete chart of accounts, do not enable UPKs to proceed from chronological to systematic accounting, and thus are not helpful for analyzing the UPKs’ financial situation and loan portfolio quality.

The situation in Yogyakarta is better than in most other project areas. UPKs and other project stakeholders have been improving UPK accounting on their own initiative. This was necessary as the project did not provide the necessary input. This improvement of accounting instruments, however, highly depends on individual capabilities and has not resulted in a standardized and consistent system. The UPKs’ accounting is usually limited to cash and bank journals. None of the UPK had prepared complete and consistent financial statements. The instruments are not available and financial statements cannot be easily prepared as the basic accounting system is not in place.

The UPK Paliyan prepares a sort of financial statement that confuses balance sheet and income statement items. The accountant of UPK Girimulyo tried to prepare balance sheet, but this is regarded as her hobby. Important cost items are not accounted for. The monthly reports of UPK Kalibawang, an institution with a loan portfolio of IDR 1 billion, does not enable the reader to figure out its assets, loan portfolio and net worth. It contains loan information no other than accumulated


payments measured against to total loan principal disbursed. The consultant experienced several times that information requested could not be provided or only be provided after a long search through books. This search had usually to be assisted by the sub-district facilitator. UPK staff focus on recording and reporting as a formal requirement, but they do not analyze what they are recording and reporting. Financial management in UPKs is virtually non-existent.

The UPKs in Lampung have not yet been using financial statements and management instrument. Records were often not complete and did nor allow monitoring repayment performance of groups. UPK Balik Bukit does not separate between loan principal and interest payments. It is only assumed that 20% of incoming payments from villages were interest payments. The UPK does not know whether LKMDs have appropriate records. There is no monitoring from the sub-district level at all. Transactions of the loan repayment account were mixed up with transactions for infrastructure projects. The books did partly not allow identifying to whom payments were made.

Both UPKs in Karawang keep their books properly. They have developed accounting and financial management systems beyond the limited instruments made available by the project, which they regard as less useful for their own purposes. UPK Telagasari was the only UPK visited that had prepared an accounting system based on a systematic chart of accounts. It also prepared financial statements and had loan ledgers providing information per group. Also in this case, however, there is room for considerable improvement, and the UPK management is eager to find the consultancy input required for this improvement.

Distribution of interest income. The project has not developed standards how interest income should be accounted for and how profits can be allocated. It provides grants for covering costs of operating KDP funds, while interest income does not have to cover costs of financial intermediation. This opens up opportunities to ‘distribute’ interest income to activities and people external to financial intermediation. Sub-districts and UPKs in Yogyakarta have been highly creative in developing various systems how interest income rather than profit should be allocated. UPK Kalibawang allocates almost all interest income to infrastructure development, while operating costs are financed by KDP grants. UPK Paliyan and UPK Tepus uses 50%/45% of its interest income to capital, 25%/20% for paying incentives for on-time loan repayment, 15%/23% for UPK operating costs, 6%/8% to LKMDs, and 2% each to UPK staff and village coordinators. Other UPKs allocate up to 25% to LKMDs at the expense of either capital accumulation or their own operating funds.

These systems mix up real operating cost, the purpose of increasing personal income, and the finance of funds (capital, village development) that are usually a function of profit rather than income. Interest rates have to cover operating costs and may include profit margins that are used to finance agreed upon purposes. Operating costs and allocation of profit should be clearly distinguished. Usually, either shareholders or members of member-based organizations should agree upon profit allocation. Borrowers in KDP are neither shareholders nor members of the UPK.


Credit monitoring forms. All UPKs in Yogyakarta complain about the new credit monitoring forms (Forms VIII.2/VIII.4). These forms are perceived as an additional and unnecessary burden, because they do not fit to real needs of credit monitoring and would require revising the internal bookkeeping system developed by UPKs in Yogyakarta. As shown in the previous chapter, the forms do not allow monitoring credit performance per borrower, do not separate loan principal and interest payments, do not include the loan amount due, do not separate between due and non-due payments, and thus do not allow calculating correct repayment rates. Other parts of the form are simply, and most understandably, not understood. People in Yogyakarta understand that arrears are not an accumulated amount as formulated in the forms. Nobody understands how and why payments that had been in arrears but were repaid should be aged as suggested by the forms. Consequently, the forms are not used and not forwarded to the national level. These findings are also valid for most of the other project areas visited.

Another issue raised was that these form VIII.2 assume a direct role of LKMDs as financial intermediaries, while the project’s implementation guidelines do not foresee this role. Especially the sub-districts and UPKs in Gunung Kidul insist to having direct relationships with borrowing groups. Sub-districts and UPK in Kulon Progo, however, promote the direct involvement of LKMDs as financial intermediaries (see below.)

2.3.5 Credit Management

Selection of and relationship to borrowers. Direct targeting and eligibility criteria are not part of the project approach. In Yogyakarta, the UPKs in Paliyan and Tepus have made good experiences with groups that have internal savings and have elected trustworthy and capable managers. Prioritizing these sorts of groups minimizes credit risks. Both UPKs care much about developing and sustaining direct relationships with borrowing groups, and they see this as a reason for their success. Both UPKs have installed field staff at the village level to sustain these relationships, supervise credit use, and collect installments. UPKs in Gunung Kidul, in general, prefer the direct linkage model because of experiences where group, hamlet and village leaders proved not to be capable and trustworthy financial intermediaries.

Girimulyo and Kalibawang, where UPKs do not have direct relationships to borrowing groups, are the opposite examples. Especially, the UPK in Kalibawang stressed that it does not link with groups at all. The UPK signs loan agreements with LKMDs, and the LKMDs are independent financial intermediaries that deal with borrowing groups. Group leaders are responsible to the LKMD. The PJOK and sub-district facilitator emphasized that LKMDs in Kalibawang are trustworthy and capable institutions, and that this is one important factor of their success. Strengthening the LKMDs is the major objective of KDP in Kalibawang. While UPK Kalibawang is quite successful with this approach, the credit performance of UPK Girimulyo is much less convincing.

Most UPKs in Lampung apply a similar model, although generally they appear not to rely on capable LKMDs. Usually LKMDs or hamlet heads select borrowers. UPK Seputih Banyak reports that lot even selected borrowers, as credit demand exceeded the amount of loan funds allocated. The UPKs relationship to final borrowers is broken.


Sometimes they even do not know who borrows. UPK Balik Bukit reports that they are prevented from directly accessing borrowing groups and members. They feel helpless as they depend on decisions taken by others and they cannot take the responsibility for collecting loans from the groups.

The decision-making process in village assemblies and UDKPs does often not result in sound credit decisions. Villages often take the decision to apply for loan funds only, because loan funds rather than infrastructure investments are thought to ‘benefit everyone’. At the sub-district level, villages compete for funds without considering credit eligibility and risks, and seem not to accept monitoring functions of the PjOKs and FKs. In the framework of decentralization, the sub-district tends to become a powerless level trapped between the district and the villages as new power centers. Especially in West Lampung, sub-district staff both from the government and the project felt helpless towards the rising self-confidence of the village administration. They feel that LKMDs are simply uncontrollable.

Both UPKs in Karawang have direct relationships to borrowers. The UPK in Rengasdengklok, however, works through the TPK and relies on close contacts to group leaders. The key role of these leaders could be observed during the visits. Two women had organized groups in their hamlets and visit and guide their members regularly. Both women have intimate knowledge about their members’ households because of their occupation as small-scale traders selling their goods directly to households of the village. They succeeded to organize monthly group meetings that are also attended by members currently not borrowing. This active approach and the asset of borrower information contributed to repayment rates of 95% in both groups

Loan amounts and terms. Individual loan sizes in the four sub-districts of Yogyakarta ranged from IDR 50,000 to IDR 5 million. The most frequent loans size in Kalibawang was IDR 1.5 million. This is high above normal loan sizes in poverty-oriented microcredit projects such as UPPKS or P4K. Loan sizes above IDR 1 million may not reach the project’s target group. One exception is cattle farming. Purchase of young stock may require up to IDR 3 million. These loans are not too risky as cattle or other livestock may be regarded as a sort of savings or collateral. The consultant observed that these investments are often fully credit-financed. Relatively large loans for cattle farming, and investment loans in general, should require partial self-finance. Loan terms range from 10 months to 18 months. Two thirds of the loans disbursed by UPK Paliyan had terms not longer than 12 months. The UPK prefers monthly installments as longer repayment frequencies proved to carry higher risks. UPK Girimulyo made loans with monthly, quarterly and semi-annual installment system.

In Lampung, individual loan sizes ranged from IDR 50,000 to IDR 4.7 million. The average loan size per member was higher than IDR 1 million in two of the six sub-districts. In Padang Ratu it exceeded even IDR 1.5 million for Year 1 loans. There were no Year 1 loans disbursed in Rumbia and Padang Ratu lower than IDR 1 million. Loan sizes are considerably higher than in poverty-targeting microcredit programs. This leads to misallocation of loan funds, and exposes the UPKs to high credit risks, especially when loans go into fixed assets and are not partly matched with borrower equity. One but not the only example was that a group of 12 members invested KDP


loans of about IDR 35 million into two large sheds for raising chickens and went into a contract with a large firm supplying all inputs and paying only IDR 500 per chicken raised. A rough calculation showed that they would not be able to repay the loan and to make any profit during the 18-month loan term, even if all chickens service and the supplier does not interrupt supply. Investments are often entirely credit-financed.

UDKPs/UPKs in Lampung often effect standard terms for loans provided to LKMDs. With the exception of UPK Seputih Banyak, all loans had a standard term of 18 months with full repayment only required at the end of the term. With the relationship to borrowing groups and members broken and funds revolving (?) at the village level, UPK staff is more or less rendered jobless. In answering the question why these loan sizes and amounts are provided UPK staff usually refers to what LKMDs and groups requested. Verification of proposals does often not function, and the UDKPs/UPKs do not take an active role in determining loan amounts, terms and conditions. In Balik Bukit LKMDs even extended loan terms without the consent of the sub-district.

In Karawang, loan amounts ranged from IDR 100,000 to IDR 1 million. The average loan size was about IDR 200,000. Groups visited in Rengasdengklok tend to distribute loans equally. One group disbursed IDR 200,000 to each member irrespective of his/her loan use. Loans are usually used for microbusinesses. The UPK in Telagasari provided also loans to groups of becak drivers. Loan terms range from 5 months to 12 months. Installments are usually made monthly. Lower loan amounts, shorter maturities and regular installment systems seem to have contributed to better repayment performance, especially in Telagasari.

Verification teams play an important role in fixing loan amounts, terms and conditions. The UPK in Telagasari reported that the sub-district’s verification includes loan officers from BKPD (a special form of BPR in West Java) and has done a good job. The UPK in Rengasdengklok, however, apparently suffered from inadequate verification of loan proposals. The UPK informed that the team did not include a banking and microenterprise development specialist and, because of loans from initial loan funds were disbursed fast and at the same time, did not carry out field checks for all loan proposals. The UDKP did not correct this weakness, because villages competing for funds have not been focusing on assessing credit risks and the feasibility of proposals.

Interest rates. In Yogyakarta, interest rates for group loans were 18% or 20% flat per year. The consultant noticed that sub-districts other than those visited had decreased the interest rate to 15%, and that ‘communities’ asked for decreasing interest rates to 10% to 12%. The consultant further observed that the discussion of interest rates lacks a rationale foundation. The setting of interest rates should consider prevailing local market rates to prevent borrowers with access to banks or other sustainable credit sources from taking program credit. The target groups visited included several examples of this kind. This criterion, however, would be less important, if the project strictly target only borrowers that do not have and, for the time being, will not have access to sustainable credit sources. In this case, it would be sufficient but also absolutely necessary that interest rates reflect cost of funds, loan loss risks, imputed capital costs (inflation), operating costs and a profit margin for sustaining revolving funds and access to credit.


Annual interest rates in Lampung were usually 18% per year for loans disbursed to LKMDs and 20% for loans disbursed to groups. In Balik Bukit, the annual interest rate for Year 2 loans was decreased to 10% to the LKMD and 12% to the groups, allegedly because this would contribute to improve repayment performance. Note: The same provincial consulting firm, namely PT. Indomas Mulia, that refers to loans as grants (see: Laporan Triwulanan II, April - June 2001) calls for lowering interest rates to the level of subsidized KUT loans (see: Laporan Bulanan, Juli 2001). This does not only violate project rules, but it further undermines the soundness of KDP microcredit operations in Lampung. The qualification of this firm to carry out microcredit programs should be immediately evaluated.

In both sub-districts of Karawang, the interest rate for loans disbursed to groups was 18% flat per year and the monthly interest rate for loans disbursed from groups to members was 24% flat per year.

Loan agreement, disbursement and collection. In Yogyakarta, loan procedures vary with the models of financial intermediation applied by the sub-districts and UPKs. The UPKs in Paliyan and Tepus sign direct loan agreements with group chairpersons. The PjOK and LKMD sign as witnesses. This loan agreement states the loan amount, loan term, and frequency of installments. The loan agreement has two attachments: a) a repayment schedule for the group; and b) a list signed by each borrowing group member, including their names, loan purposes, and loan amounts. Loan disbursements as well as loan installments are made in public, usually in the village hall, and are witnessed by all concerned parties. The BPD is actively involved in both loan disbursements and loan collection. In Girimulyo and Kalibawang the LKMD chairperson is responsible for signing the loan agreement with the UPK, taking the loan from the UPK, and paying installments to the UPK. Financial transactions at the village level are independently made between the LKMD and chairperson and the group leader.

In Lampung, loan agreements are made between UPKs and LKMDs, and between LKMDs and the groups’ chairpersons. It was reported, however, that LKMDs sometimes do not make formal loan agreements with groups. The LKMD-group relationship seems to be limited to the groups’ chairpersons, who are often hamlet leaders rather than elected group leaders. The UPKs use the standard loan agreement form provided by the project, which only mentions the term and the final due date.

Except of UPK Seputih Banyak, UPKs are not involved in loan disbursements. All UPKs do not feel responsible for loan supervision and collection, and they passively wait for the LKMDs making installments. In Balik Bukit, UPK staff was even afraid that they would be replaced by the UDKP, if they would actively try to collect loans at the village level. LKMDs make installments without providing information about the identity of groups that have made installments and without distinguishing between principal and interest payments. A special problem is that LKMDs sign loan agreements without taking responsibility for repaying loans when groups fail to pay. Reports from Lampung describe many cases where LKMDs misappropriated loan installments from groups.

In Karawang, UPKs disburse loans in public and directly at the village level. UPK Telagasari collects loans directly from groups or group leaders deposit installments


directly to the UPK. Group members make installments between the 15th and 20th of each month, and the group leader is responsible to make payments to the UPK at latest on the 25th of each month. In one village, women group leaders used the loudspeaker of the mosque to call members for paying their installments. Depending on the model preferred by the villages, UPK Rengasdengklok collects loans either directly from group leaders or via the TPK. Both UPKs visit group members with late payments directly and are well informed about the reasons for late payments.

2.3.6 Project Support

Credit eligibility and development. Similar to other project regions, the credit eligibility of groups and individual borrowers has also become a major issue in Yogyakarta. There are examples where groups were established only for the purpose of getting access to KDP credit. Entire hamlets are sometimes referred to as community groups, and the head of the hamlet becomes a financial intermediary. Entities called groups do not carry out routine group meetings outside of the KDP process. Many groups are referred to as ‘simpan-pinjam’, but they do not have internal savings. The capacity of groups to assist members planning their household economy and businesses is low. The function of the group as an institutional intermediary is not developed. Joint responsibility or even joint liability for KDP credit is non-existent in such groups.

Yogyakarta is different, also because the types of groups described above are much less often to be found here than in other project regions. Yogyakarta is a lucky draw, because it has a long history of non-governmental programs focusing on the development of self-reliant self-help groups with high emphasis on savings and continuous education. Yogyakarta is also the place where the Linking Banks and Self-help Group Program started some 12 years ago. The consultant himself was involved in this start and knows some of the KDP groups from that time. Many people met during the field visit have been involved in the program. One example is a group in Paliyan, which has sustained business relationships to a local NGO and the BPD since 10 years. Meanwhile it has also established a primary cooperative. It still has loans outstanding to the BPD and its members have four different sources of credit, including KDP. In other places BRI customers moved or wanted to move from BRI to KDP credit. In Kalibawang BRI lowered collateral requirements as an impact of KDP credit. These are all credit-worthy customers with long and good credit histories. They are also good borrowers of KDP credit. Only, they are most probably not the ones covered by the project’s target group definition.

Project support and guidance. Groups such as the one mentioned above do not require extensive support. However, these groups are a minority in Yogyakarta and are definitely a small minority outside of Java. The project in general is not equipped to provide the support services required for them with regard to both self-reliant group development and the development of their members’ businesses. The tendency to transfer this task to village facilitators or the village bureaucracy can by no means cope with the well-tried standards set by NGOs. When project stakeholders at the village and sub-district level speak about group guidance, the substance of this guidance stays in the dark. Support, guidance and participation are usually limited to the group leader.


UPKs are supposed to manage IDR 500 million or even IDR 1 billion, a size of loan funds that often cannot be found in rural BPRs. Persons who manage them had never to think about managing IDR 1 million before becoming UPK staff. The project has neither prepared the necessary management instruments nor an adequate training system for them. The need for training in accountancy, financial management and credit management is obvious and also expressed by almost all UPK staff. Yogyakarta may be a lucky draw also in this case, because the human resources required are more readily available here than in other project regions, and the project stakeholders can search for the necessary expertise in close-by universities and other institutions. The UPKs in Gunung Kidul have established a coordinating forum that also organized training for its member UPKs. However, even the UPKs in Yogyakarta are weak financial managers. They often depend on project consultants and sub-district facilitators that do not have the capability to transfer the knowledge and skills required. They were simply not hired for this purpose.

2.3.7 Preparing the Future of UPKs

Yogyakarta is one of the few project regions that have made progress in preparing the past-project period and the future of the UPKs. The starting point has been the objective to sustain revolving fund activities and the unclear legal status of UPKs. The question is how community ownership in UPK funds, which has been not more than a slogan, can be materialized and legally protected. The sub-districts in Gunung Kidul have established a joint team that is supposed to develop the future model of the UPK as a “Badan Perkreditan Masyarakat Kecamatan”, a credit institutions owned by the sub-district community.

The preliminary result of this working group was discussed with the consultant. The team suggests to establish the UPK as an association as bank licensing requirements cannot be fulfilled and the community would not accept the form of a cooperative. Qualified personnel should manage the institution independently and the sub-district government should only be involved as the supervisory authority. The institution, called UPK-PPK, aims at the same objectives as the project. Village representatives via the UDKP will establish it. All sub-district people may become members.

It is not clear what kind of legal security the form of an association can provide. Associations at the sub-district level, like secondary cooperatives, can only be democratically organized, if they have functioning sub-structures. If these sub-structures are groups, these groups would have to be represented in decision-making assemblies of the association. The UDKP forum cannot guarantee this democratic representation of members. Furthermore, if ownership covers all people in one sub-district, the institutions mission of providing microcredit to the poor will be undermined.

This basic concept is not yet consistent. However, the UDKPs, UPKs and their working group are highly determined to find ways of sustaining KDP’s revolving funds through a well-managed and independent sub-district financial institutions with the mission to contribute to poverty alleviation through microcredit. They should prioritize strengthening the management capacities of the UPK rather than focusing on formalizing the institution only. This requires training and consultancy systems available to UPKs. Well-performing UPKs able to follow this approach will be a small


minority. If basic conditions are given, the project should organize this training and consultancy. The unclear legal status of community ownership in revolving funds should also find immediate response from the project. Investments over three years were not made to see them vanish into thin air or the pockets of those most powerful after the project has withdrawn its consultants, facilitators and supervision systems.

The sub-districts in Lampung have not yet taken such initiatives. The UPKs have not an idea of their future. Considering the lacking viability of current operations, it is rather ridiculous when some UPKs are talking about developing into micro banks.

Both sub-districts in Karawang had not yet developed a vision for the future of their UPKs. The UPK in Rengasdengklok would like to diversify its activities, i.e., by assisting its borrowers in marketing their products. The women managers of the UPK in Telagasari can imagine setting up a shop as an additional activity.

3.1 KD

Issue

KDP has been succescommunities in local pdecision-making; makimore responsive to locbuilding low-cost infrasparticipative planning a KDP’s microcredit-revocomponent has not besuccess. The NMC cuthat the overall repaym40%, while complete arepayment data are no Findings suggest that UPKs will be able to sufund operations on the Findings also suggest microcredit has only ptarget groups and condeveloping microbusinincreasing household Unsound credit managperception of credit asmisallocation and misaloan funds have been for KDP’s poor credit cperformance.


3. Major Issues and Conclusions

P Microcredit Performance: Design Matters

s Conclusions

sful in involving lanning and ng governments al needs; and tructure by nd self-help.

lving funds en a great rrently estimates ent rate is about nd consistent t available.

only a minority of stain revolving ir own.

that KDP artly reached its tributed to esses and income.

ement, the grants, and the ppropriation of systemic reasons ollection

Why has KDP been successful in its non-credit components, and at the same time failed to carry out a sound microcredit-revolving fund program? The KDP success was based on a project design that was tailor-made for achieving its non-credit objectives:

• Open menu policy; • Process-oriented and needs-

oriented participative planning; • Allocation of funds by participative

decision-making forums; • Administrative units as focal points

of planning and decision-making; • Involving local government

institutions in the project process; • Stressing accountability of cash

flows and fund use. The major conclusion of this review is that the very same design that brought about project success doomed KDP’s microcredit component to failure. The special requirements of a successful microcredit program have not been taken into consideration by the project strategy, process, instruments and inputs. (See below)

Major Issues and Conclusions KDP Microcredit System Review 59

3.2 Terminating Microcredit or Phasing-out ‘Old’ Sub-districts?

Issues Conclusions

The poor performance of KDP’s microcredit component and the lacking viability of UPKs/revolving funds suggest abandoning credit operations. The KDP II Project Appraisal Document limits continuation of credit activities to sub-districts that meet repayment standards and promote links to banks. There are well-performing sub-districts/ UPKs that can succeed to sustain revolving fund operations. Others have the potential but require additional assistance to do so. The majority of revolving funds seem not to be viable. How many of the UPKs fall into the categories mentioned above is not known. KDP has no information about the quality and financial viability of UPKs/revolving funds. Large investments made into revolving loan funds are at risk, because their legal ownership and continuation has not yet been clarified. KDP has not yet prepared phasing-out plans, which determine the necessary actions to be taken in ‘old’ sub-districts.

KDP has to take responsibility for poor credit performance and to try rescuing or sustaining revolving funds wherever possible, especially because its own microcredit design and approach contributed to the situation. Repayment rates, especially unreliable ones reported at the national level, should not be the sole indicator for determining follow-up actions. This requires information about each sub-district’s/UPK’s potential to sustain revolving funds and to improve collection performance. KDP needs to prepare an inventory and performance classification of UPKs/sub-districts that takes into account:

• UDKP policies and performance; • UPK financial statements, loan

portfolio quality, staff quality; • Information on where the money is

and whether it is recoverable; • Information on who caused loss at

which level. Sub-districts with no potential to improve and sustain revolving funds should terminate credit operations. UPKs with potential to sustain revolving funds should receive technical assistance. Well performing sub-districts may request support for preparing the future of their UPKs. A special study should show in which form revolving funds could be legally protected and express community ownership after project termination. Such actions should be made part of a phasing-out plan, though which each sub-district clarifies how revolving funds will be used and managed in the future, and which preparatory steps and inputs are required for this.


3.3 Alternatives to Managing Loan Funds by UPKs? (1)

Issues Conclusions

KDP’s poor credit performance and the lacking viability of UPKs suggest to looking for alternative and more professional managers of KDP’s loan funds. Alternatives discussed are transferring loan funds to BRI, the only bank with a national network of sub-district units, to BPDs, the regional development banks, or working through BPRs, people’s credit banks operating at the local level. Note: The following assessment of alternatives for managing KDP’s loan funds is based on the consultant’s microfinance sector study and his work in three Indonesian microfinance sector projects: Linking Banks and Self-help Groups (PHBK), Rural Income Generation Project (RIGP/ P4K) and Promotion of Small Financial Institutions (ProFI). (See annexes) The KDP II Project Appraisal Document stresses that KDP has no objective of developing microcredit institutions. Instead, it requests sub-districts to promote links with banks, and it suggests that loan funds are to revolve at the village level, because social control and relationships function would be effective here rather than at the sub-district level. In contrast to this position, both project guidelines and project stakeholders have been promoting the idea of developing the UPK into a sustainable financial institution. Several sub-districts have been preparing by-laws and legal status for their UPKs as independent credit institutions.

The Rural Income Generation Project (RIGP/P4K), carried out by the Ministry of Agriculture and BRI, is the only larger microcredit project being executed by a bank with national outreach, and targeting the poor with a group approach. P4K develops small groups with inputs over several years and facilitates credit from BRI’s district branches. BRI does not provide program credit through its sub-districts units, which only provide individual loans. Project implementation and success depends highly on the large network of agricultural field extension workers, who have to carry the burden of both group development and banking functions, as BRI lacks the staff to directly access target groups at the village level. P4K’s methodology of developing self-help groups and teaching them how to become bankable could also be an asset for KDP. Working through BRI, however, is not realistic, as it would require BRI to provide program credit through its units and KDP to provide the infrastructure of field workers with the necessary capabilities. This would increase rather than decrease KDP’s credit management burden. The idea of promoting linkages to BPRs is not applicable for most of the areas outside of Java, where rural BPRs are scarce. Even most of the BPRs in Java/ Bali do not have a significant outreach to the village level. The number of BPRs willing and able to link up with groups is even lower. Groups and their members must be qualified and meet eligibility criteria for getting access to bank credit. BPRs must be qualified and need to be trained in expanding their outreach to low-income households at the village level. These requirements and the low density and limited outreach of BPRs do not allow making this model a general KDP microcredit approach.


3.3 Alternatives to Managing Loan Funds by UPKs? (2)

Issues Conclusions

The KDP II Project Appraisal Document stresses that KDP has no objective of developing microcredit institutions. Instead, it requests sub-districts to promote links with banks, and it suggests that loan funds are to revolve at the village level, because social control and relationships function would be effective here rather than at the sub-district level. In contrast to this position, both project guidelines and project stakeholders have been promoting the idea of developing the UPK into a sustainable financial institution. Several sub-districts have been preparing by-laws and legal status for their UPKs as independent credit institutions.

Revolving funds at the village level are most likely not viable. The village as an administrative unit is not the place of social integration and control. KDP and other experiences show that projects are subject to power relations and the goodwill of the village elite. Much of KDP’s collection problems can be traced back to the village level. Problems at the sub-district level have been due to the lack of effective supervision. Effective supervision would even be more difficult to achieve at the village level. Furthermore, KDP will not be able to establish the required fund and credit management capability in thousands of villages. The project does not intend to establish village banks, and LKMDs and village councils are governed by other logics than required for sound credit management. They should focus on developing their public functions rather than becoming financial intermediaries. KDP has not the objective of developing microcredit institutions. This is good so, as financial institutions development requires a new project that is able to provide the long-term inputs required for this development. However, the UPK can also not be treated as an administrative unit. Managing credit and large revolving funds requires more than recording inflows and outflows earmarked for public investments. Thus, UPKs have to be provided with the training, technical assistance and supervision required for managing loan funds successfully. This has to be the focus during the three years of project implementation. If sub-districts decide independently to sustain their loan funds by developing the UPK into a financial institution after project termination, KDP may facilitate legal advice and technical assistance on request and based on phasing-out plans.


3.4 Should Microcredit be Continued in KDP II?

Issues Conclusions

The poor performance of KDP’s microcredit component has also raised the question whether KDP II should continue credit and revolving fund activities in new sub-districts. The KDP II Project Appraisal Document maintains the open menu policy, thus providing the opportunity for credit operations also to new sub-districts entering KDP II. Should this opportunity be taken in the light of KDP’s past credit performance? The discussion of alternatives indicated that KDP as no general option other than managing loan funds by UPKs. The high variety of local conditions, including the availability of sustainable financial institutions willing to cooperate with KDP/UPKs, does not allow coming up with one replicable model for sustaining revolving funds.

KDP’s inadequate microcredit design, instruments and inputs rather than borrowers and local project implementers have to take the blame for the KDP’s poor credit performance. Where UPKs have been successful, this was due to individual persons and local conditions rather than to the project approach. This conclusion implies that changing the project approach and learning from successful microcredit programs and UPKs may greatly contribute to improving KDP microcredit operations. KDP faces a basic alternative and has to take a fundamental policy decision:

Either KDP is serious about changing its microcredit design and approach or it should not continue providing microcredit.

If KDP is serious about changing its microcredit design and approach, it should:

• Provide sufficient time and expertise for thoroughly preparing the new microcredit design, instruments and inputs;

• Ensure that sub-districts prepare phasing-in plans that include all preparatory steps and requirements for starting microcredit operations;

• Require sub-districts not starting credit operations before preparations are finalized and conditions are met.

The necessary preparations, conditions, and changes to KDP’s current microcredit approach are discussed in the following.


3.5 KDP Strategy and Process Vs. Sound Credit Management

Issues Conclusions

The core of the project is a participative planning and decision-making process by which funds are competed for between villages. The process aims at improving local governance and meeting local needs by involving both communities and local government. This process is good for allocating funds earmarked for public goods and for improving local governance. It is incompatible with good governance of credit and revolving funds management. Credit management is scattered all over the project process and is given into many hands. Neither verification teams nor decision-making forums analyze and bear credit risks. As the UPK becomes involved only after loan decisions were taken, the lending institution is separated from its vital functions of selecting customers, analyzing credit feasibility, and determining loan terms and conditions. In many cases UPKs lack direct and close relationships to borrowers, as the project strategy focuses on the village as an administrative unit and LKMDs or village councils are made financial intermediaries. Separating the UPK from these functions and cutting it off from direct customer contact, leads to severe credit governance problems. Village competition and the involvement of participative forums, local government and village councils in credit decisions and supervision have not led to improving credit performance and outreach to the poor.

Credit management functions are given into too many hands that usually do not bear credit risks. Good credit governance requires that the lender takes and manages credit risks by commanding all credit procedures. KDP II needs to reallocate credit management responsibilities into one hand (UPK). Bodies that are governed by logics other than required for sound credit management take credit decisions. Credit is not about democratic distribution of money on the basis of infinite needs, nor is it a public good to be managed and allocated by governments. Local governments and councils are not borne to become financial intermediaries. KDP II needs to make credit governance subject to prudential banking principles. One feature of the KDP strategy has been to make the village as an administrative unit the focal point of its planning and decision-making process. KDP II needs to make the group rather than the village the focal point of the microcredit approach. The overall problem is that all credit procedures have been integrated into the general project planning and decision-making process. The process-oriented KDP strategy must be maintained, but successful microcredit approaches require an output-oriented strategy. KDPII needs to separate all credit management functions from the overall project process. This separation applies to credit procedures and the financial administration of KDP funds as well as to the project inputs required: planning, training and technical assistance, manual and instruments, monitoring and evaluation.


3.6 Microcredit & Revolving Funds Expertise and Consultancy Inputs

Issues Conclusions

KDP I has been suffering from lacking credit and revolving fund management expertise at all levels. Preparations for KDP II have not yet included the design and planning of its microcredit component. KDP II will not be serious in improving credit performance, if it does not employ the expertise required for the successful design, planning and implementation of its microcredit component. .

KDP should immediately assign a small short-term technical task force of microcredit and financial management experts to prepare the new KDP II microcredit component. This team would have the following tasks:

• Assist in preparing a financial performance classification of ‘old’ sub-districts.

• Recommend project inputs required for the phasing-out of these sub-districts.

• Prepare a planning workshop for determining KDPs future microcredit and revolving funds strategy.

• Prepare manuals and instruments required for credit and revolving funds management.

• Prepare criteria and guidelines that determine eligibility of a) groups and their members to get access to credit, b) UPKs to manage credit and revolving funds, and c) sub-districts to allocate loan funds.

• Prepare training and technical assistance systems for a) groups, b) UPKs, and c) project staff.

• Prepare credit information and UPK supervision system.

During project implementation KDP II should have a special long-term microcredit consultancy team, capable of a) assisting sub-districts in preparing phasing-in plans for microcredit operations, b) organizing local consultancy inputs, c) organizing and evaluating training, d) managing technical assistance for UPKs, e) managing the credit information and UPK supervision system, and f) assisting sub-districts in preparing phasing-out plans and sustaining revolving funds operations.


3.7 Objectives-Oriented Planning for Microcredit & Revolving Funds

Issues Conclusions

KDP I as a reaction to the economic crisis started up fast and without making microcredit and revolving funds management a central element of its strategic planning. KDP I had no logical framework clarifying the objectives, outputs and activities of KDP’s microcredit interventions and serving as a basis for project guidelines and implementation. As a consequence, KDP I has not been providing the inputs required for making its microcredit intervention a success. The KDP II appraisal keeps the menu open, but it has not yet integrated KDP’s credit component into a comprehensive logical framework and strategic plan.

It is of utmost importance that KDP II implementation will be based on a strategic plan that defines the target group, objectives and outputs of its microcredit component as well as the activities and inputs required for achieving these objectives and outputs. This strategic plan has also to include output indicators that define the substance and quantitative targets of each output, and have to become the core of the microcredit information system. KDP II should apply an objectives- and output-oriented planning approach for its microcredit component. A comprehensive example of this sort of strategic planning (developed for the P4K project) is attached to this report. A tentative example can be found in the consultant’s presentation of preliminary review results (also attached to this report). Planning has to take place at all project levels. The formulation of a strategic plan at the national level is most urgent, as it serves as a framework for lower level planning and provides the parameters that have to be taken account by each sub-district. Sub-districts will be responsible to prepare both phasing-in and phasing-out plans for their microcredit operations during the project implementation period. The cooperation with local banks and local alternatives to managing KDP credit may be examined and planned. UPKs have to prepare their own plans that reflect institutional development to sustain revolving funds, and strategies to meet the borrowers’ demand for repeated and continuous access to credit.


3.8 Manuals and Instruments for Microcredit & Revolving Funds Management

Issues Conclusions

KDP I has not been implemented on the basis of comprehensive and separate manuals for credit and revolving funds management. Provisions made by guidelines and circular letters are not consistent and have caused credit governance problems. KDP I has also not developed a comprehensive set of financial and credit management instruments. Many of the instruments introduced by the project conflict with prudential standards for managing credit and revolving funds. Accounting formats provided to UPKs do not enable them to easily prepare financial statements. Adequate instruments required for financial management and loan portfolio analysis are missing.

Apart from the overall project manual, KDP II should develop and train separate revolving funds and credit management manuals for:

• UPK management to manage revolving funds and other KDP funds, including a comprehensive accounting system as well as instruments for financial management and loan portfolio analysis.

• UPK loan officers to carry out all credit management procedures.

This manual should be based on a comprehensive set of financial and credit management instruments. Credit management instruments have to comprise:

• Group eligibility check format • Loan application format • Loan appraisal format • Loan agreement format • Guideline to fix interest rates, loan

terms and conditions. • Loan supervision format • UPK management to manage

revolving funds and other KDP


3.9 Training and Consultancy Systems for Microcredit & Revolving Funds

Issues Conclusions

KDP financial intermediaries lack financial administration and management as well as credit management capabilities. The project has not developed a system of planning, implementing and evaluating training for its stakeholders, especially groups, UPKs and field facilitators. Training modules for financial and credit management were not developed. Special training for community groups and their members is not provided. UPK training is limited to a 5-days workshop that focuses on explaining how simple bookkeeping and reporting formats should be prepared rather than transferring financial and credit management skills. KDP has also not provided the consultancy services required for improving the UPKs’ financial and credit management. Provincial and district consultants usually do not have the necessary expertise. The major qualifications of FK and their assistants are general communication and facilitation. Most of them are not able to provide technical assistance to UPKs. Their capability to support community groups in developing their organization and financial activities is also limited.

KDP II should have a properly designed training management system that includes training needs assessment, procurement of quality trainers, evaluation of training, and evaluation of training impact. Its purpose is to control the quality of training and support the transformation of individual learning into the institutional practice of UPKs and community groups. The future training system should consist of three components:

• Training of local consultants and facilitators;

• Training of UPK staff; • Training of community groups. This requires three preparatory steps:

• Design of the training management system;

• Preparation of training modules; • Procurement of local quality trainers

carrying out training based on these modules and clear terms of reference.

Standard training is not able to solve specific institutional problems, especially of the UPKs. UPKs need intermittent attention that can only be secured through special UPK consultants. It is assumed that this function cannot be taken over by project consultants.

Preparatory steps are to:

• Develop clear terms of reference for special UPK consultants at the local level;

• Procure local UPK consultants that visit each UPK at least once a month and are able to assist solving problems on request.


3.10 Information and Supervision Systems for Microcredit & Revolving Funds

Issues Conclusions

Information is the most valuable assets for steering both the project and the UPKs. The national database is not complete, consistent and reliable. Return of credit-monitoring forms from local levels has been low. Reliable repayment rates cannot be calculated. Information on credit impact is not part of the credit monitoring system. The project has no information on the financial soundness of UPK operations. Systematic credit supervision of groups and members is missing. Credit monitoring and reporting seems to be regarded as formal requirements rather than as useful means for taking timely and corrective action. UPKs are not subject to effective supervision neither by its ‘owners’ (note: legal ownership is not clarified) nor by independent or project supervisors. There are no performance standards on the basis of which effective supervision can be carried out. Audits have been carried out for part of the UPKs. Their impact on improving the financial performance of UPKs id not clear. UPK audit standards and terms of reference do not exist.

KDP II should establish a comprehensive credit and revolving fund information system. Monitoring formats should be developed on the basis of information available from UPKs rather than adding new burdens for UPK staff. They should be comprehensive enough to serve project management purposes, but also realistic enough to produce quality data that reach the national level. Few but good data are better than many but bad data. Credit management instruments prepared by KDP II have to include an instrument for directly supervising credit use and impact at the levels of borrowing groups and members. KDP II needs to develop an UPK supervision system that allows controlling the financial soundness of UPK operations. UPKs should have their own supervisory boards that reflect ownership. External supervision should be carried out by the project and/or by special UPK consultants. Depending on the UPK development model, these consultants can also be used to strengthen the supervision capability of sub-district governments. UPKs should be required to be audited once a year by independent private auditors.


3.11 Governance and Future of UPKs

Issues Conclusions

KDP has not been aiming at developing UPKs into microcredit institutions and, therefore, has not focused on strengthening their financial and credit management capacities. The open menu policy and local initiatives, however, have practically led to the establishment of a new sort of financial institution, and in most cases to a scaring one: Without legal status and effective supervision, UPKs manage funds larger than that of many BPRs, with financial management capacities often lower than that of informal savings and credit associations Financial administration is basic and accounting systems are not complete. Few UPK prepare (inadequate) financial statements and none analyzes loan portfolio quality. UPK staff lacks financial and credit management capabilities, and has not sufficiently been trained. UPK staff often appears to be selected for reasons other than their experience and capability. Most UPKs depend heavily on project staff and seem not to be able to maintain autonomy. Though the UPK is made responsible to collect loans, it is separated from vital credit management functions such as selecting customers, analyzing credit feasibility, and determining loan terms and conditions. Credit management functions are taken over by parties that do not bear credit risks and can be made liable for unsound loan approvals. UPKs do often not have direct and close relationships with borrowers, and cannot enforce repayment from LKMDs. UPKs do not have by-laws, a clear ownership and legal status, on the basis of which staff can be made personally liable for loss and fraud. They are not subject to effective supervision based on financial performance standards.

KDP is not a financial institutions development project. But, UPKs cannot be treated as project administration units. KDP II has to focus on strengthening the financial and credit management capacities of UPKs. Sub-districts may want to sustain revolving funds by developing their UPKs into financial institutions. KDP II can only organize legal advice and technical assistance for this purpose in the context of preparing phasing-out plans.

To improve UPK governance:

• Give UPKs full credit management responsibilities.

• Establish direct relationships of UPKs to borrowing groups.

• Require UPKs to have by-laws that determine objectives, operations, supervision, liability of managers.

• The UPK objective is to servicing low-income households according to prudential banking practice.

• Guarantee UPK staffing with capable and motivated persons.

• Require UPK staff to graduate from KDP training.

• Require UPKs to set up trained accounting & financial management system and to separate accounting of loan and other funds before starting credit operations.

• Require UPKs to have village credit officers, to ensure close and trustful customer relations. These officers must be responsible to the UPK.

• Require UPKs to have an ownership based supervisory board.

• Require UPKs to be inspected at least once a year by both a KDP supervisor and a private auditor.

• Assist UPKs to form district associations for cooperation and networking with service providers.

• Facilitate UPK cooperation with banking consultants (bank, firm, university, NGO, individual).


3.12 Target Groups, Credit Eligibility and Access to Credit

Issues Conclusions

KDP uses a group approach. The initial policy to work through existing groups has not been successful, because necessary group qualities were not defined and there are not too many existing groups able to manage credit. Many groups were formed only for the purpose of getting access to KDP funds. Internal control, group organization and financial administration have been weak. Members often do not regard their groups useful for purposes other than getting access to credit. Group members lack capability of planning and managing their businesses/ household economy, and they were not trained to increase this capability. UPKs have made best experience with groups that have internal savings, elected and trustworthy managers, and activities other than related to KDP credit. Targeting low-income households through village leaders and self-targeting mechanisms has not generally been effective. Increasing outreach to the poor with business potentials is not actively pursued. KDP has often provided credit to groups and individuals that already have access to banks or other sustainable sources of credit. KDP has been spreading credit to as many people as possible. Low-income households, however, need sustained access to credit.

KDP I has been applying an approach driven by expressed needs. KDP II should apply a demand-driven and supply-controlled approach. A demand-driven approach looks to effective credit demand, absorption and repayment capacity. Identifying real demand requires a supply-controlled approach. The lending institution rather than community forums has to appraise credit feasibility and has to determine loan amounts, terms and conditions. KDP II should define credit eligibility criteria. (See P4K example attached to this report) Credit should not come fast and easy. Groups and their members have to be eligible for credit and to learn how to become bankable. Groups must pledge self-help and guarantees to get access to credits. Members must be able to plan and manage their businesses. Credit eligibility develops. KDP II should apply a gradual approach to providing access to credit. (See P4K example) This approach includes, i.e., limiting individual loan sizes and making higher loan sizes dependent on repayment performance and the members’ business planning and management capabilities. This approach should also guarantee repeated and sustained credit access for well performing borrowers. KDP II needs a targeting approach to increase outreach to low-income groups. The point is to actively and gradually increase this outreach rather than to apply narrowly defined and difficult to measure poverty lines. People who a) have access to sustainable sources of credit and b) do not have business opportunities and potentials should be excluded from credit access. An upper limit of assets and savings may also be applied for determining credit access.

Towards a

4.1 Principles for the N

Targeting Low-income

NO ‘BANTUAN’the perception obanking terminol

NO UNDERMINof small financiato serve potentiafinancial institutio

NO MULTIPLE Pcurrently involvmicrocredit progr

NO FAST CREDdistricts to finaliproject staff, setbefore credit ope

NO CREDIT WCredit alone is borrowers must have access to c

NO EASY CREDand their membeto pledge guaresponsibility, torepay credit, copledge.

NO INSTANT CRhouseholds neerepeated and suthoroughly plann


4. New KDP II Microcredit Approach: A Proposal

ew KDP II Microcredit Approach

Households with Prudential Credit Services

CREDIT. Linguistic confusion has been contributing to f credit as aid or relief that has not to be repaid. Use ogies. Credit is no aid but a financial service.

ING CREDIT. Do not provide program credit to customers l institutions or where small financial institutions are ready l KDP customers. Cooperate with locally existing small ns where KDP credit may undermine their growth.

ROGRAM CREDIT. Do not provide credit to groups are ed in other microcredit programs. Cooperate with ams such as P4K.

IT. Credit operations must be prepared. Require sub-ze preparations (procurement of consultants, training of up and training of UPKs, training of community groups) rations are started.

ITHOUT TRAINING AND TECHNICAL ASSISTANCE. not enough. UPKs, community groups and individual be trained before credit operations start, and they must ontinued technical assistance and supervision services.

IT. Access to credit is not a matter of course. Groups rs have to meet credit eligibility criteria. Borrowers have rantees, measurable efforts of self-help and joint get access to credit; they must prove their willingness to llect savings and learn from KDP training; they must

EDIT. One-time access to credit is not what low-income d and what make borrowers repaying credit. Guarantee stained access to credit for well-performing borrowers by ing the allocation of UPK loan funds.

Proposal: KDP II Microcredit Approach ProFI Microfinance Institutions Study 72

NO CHEAP CREDIT. Interest rates should not undermine sustainable banking operations. However, local market rates vary and the setting of interest rates has to be rationalized by taking cost of funds, loan loss costs and credit risks, operating and inflation costs into account. Interest rates must cover costs and sustain the net value of loan funds.

Linking Credit to Savings

Savings is the core of financial self-help and self-reliance. Savings habits should be encouraged as a value in itself. Loans should not fully finance larger investments. Collateral savings blocked in a bank account may encourage joint responsibility for repayment. Incentives for timely repayment as part of the interest rate may also be regarded as collateral savings. Especially for savings and credit groups, external finance should not replace internal savings mobilization. Credit eligibility should include at least the introduction of group savings instruments. This has to be studied in more detail as the vast majority of KDP groups have been channeling groups rather than savings and credit groups.

Making Self-help Groups and UPKs the Focal Points of the Microcredit Approach

GROUP FOCUS. Make self-help groups the focal point for strengthening the demand side of the microcredit approach. The capability of groups and their members to plan and manage microbusinesses, to manage savings and credit activities, and to bargain and network with third parties is a crucial factor for making the KDP microcredit program a success. Strengthening of groups also fits into the community capacity building objective of the project. Community capacity building funds are part of the KDP II design.

UPK FOCUS. Make the UPK the focal point for strengthening the supply side of the microcredit approach. The proper setup of the UPK system described in the previous chapter as well as the training of UPK staff is crucial for ensuring prudential financial and credit management. Direct bank-like business relationships between the UPK and eligible self-help groups supports groups and their members in learning how to become bankable.


4.2 Proposal for a Preparatory Technical Taskforce

The new KDP II microcredit design and approach is not about making minor corrections to the current approach. The new system has to be designed from scratch. The overall strategy, manuals, instruments, training and consultancy systems, information and supervision systems, group and UPK development concepts, and phasing-in plans for sub-districts have still to be prepared. All has to start with developing a logical framework for the microcredit approach and agreeing upon this framework with project stakeholders during objectives-oriented planning sessions.

This situation did not allow the consultant to come up with a ready-made design within a few weeks. The necessary preparations for KDP II require more consultancy inputs and a team of microcredit experts. As KDP II is supposed to start in early 2002, this consultancy inputs should be made available as soon as possible.

To ensure a fast but comprehensive preparation of the new microcredit system, it is proposed to assign an independent small technical task force of microcredit and financial management experts.

These experts should bring in extensive experience in microbanking, poverty-oriented program credit, linkage banking, financial self-help group development, and training and consultancy practice in these fields rather than academic knowledge. Experience in objectives-oriented planning of microcredit programs would also be helpful.

The microcredit consultancy team would work for up to six months and would have to cooperate with both the KDP secretariat and selected members of the NMC.

The consultancy team should work on the basis of the conclusions and guidelines elaborated in this report.

The tasks of the consultancy team may include:

Preparing an objectives-oriented planning workshop for determining the basic microcredit and revolving funds strategy of KDP II. The results will be logical framework on the basis the team can continue with subsequent preparations.

Preparing an implementation plan for the new microcredit approach that distinguishes between ‘old’ and ‘new’ sub-districts.

Preparing a system and approach for local planning and microcredit phasing-in plans at the sub-district level on the basis of the national framework.

Preparing a system and approach through which UPKs can prepare their own revolving funds development and credit service plans. This includes strategies to meet the borrowers’ demand for repeated and continuous access to credit

Preparing an accounting system and financial management instruments, including loan portfolio analysis instruments, for UPKs.


Preparing an UPK accounting and financial management manual on this basis.

Preparing credit management instruments, including formats for group eligibility checks, loan application, loan appraisal, loan agreement, loan supervision as well as guidelines for fixing interest rates, loan terms and conditions.

Preparing a credit management manual for UPKs/UPK loan officers on this basis.

Preparing a training management system, including training needs assessment, procurement of quality trainers, evaluation of training, and evaluation of training impact.

Preparing training modules for the training of local consultants and facilitators, training of UPK staff, and training of self-help groups.

Preparing the procurement of local quality trainers, which will carry out training based on these modules and clear terms of reference.

Preparing an UPK consultancy system to ensure intermittent advice and specific problem solving at the local level.

Preparing the procurement local UPK consultants that visit each UPK at least once a month and are able to assist solving problems on request.

Preparing a comprehensive but easy to implement credit and revolving fund information system. Emphasis should be given to improving data quality by reducing data quantity.

Preparing an UPK supervision system that allows effectively controlling the financial soundness of UPK operations.

Preparing an institutional development concept through which the governance, service quality and performance of UPKs can be improved.

Preparing a targeting and group development concept that clearly defines credit eligibility criteria and applies a gradual approach in providing access to credit.

Preparing the setup of the KDP II long-term microcredit consultancy team, capable of a) assisting sub-districts in preparing phasing-in plans for microcredit operations, b) organizing local consultancy inputs, c) organizing and evaluating training, d) managing technical assistance for UPKs, e) managing the credit information and UPK supervision system, and f) assisting sub-districts in preparing phasing-out plans and sustaining revolving funds operations.

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