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Division 41
Financial Systems Development
The Challenge of Sustainable
How can Public Banks Contribute to
Outreach in Rural Areas?
5 Case Studies from Asia
Division 41
Financial Systems Development Section
The Challenge of Sustainable
How can Public Banks Contribute to
Outreach in Rural Areas?
5 Case Studies from Asia
Eschborn 2003
Deutsche Gesellschaft für
Technische Zusammenarbeit (GTZ) GmbH
Postfach 51 80
65726 Eschborn - Germany
Dr. Dirk Steinwand
Martina Wiedmaier-Pfister
Saliya Kanathigoda
Dr. Dirk Steinwand
This collection of case studies on achieving the sustainable provision of
financial services to rural areas was only made possible by the efforts of
a considerable number of people and institutions to whom we are deeply
indebted. We wish to thank Fiona Musana and Saliya Kanathigoda for
their continuous support in organising and coordinating this research.
We are also grateful to Hans-Dieter Seibel for his sage inputs during the
editing phase.
Many thanks are due to our GTZ projects in each of the five countries for
their contribution in financing the individual studies. We would like to
express our appreciation to each of the long-term advisors - Brigitte
Klein, Dominique Gallmann, Ulrich Wehnert, Armin Hofmann and
Marie-Luise Haberberger - without whose significant efforts this
publication would not have been possible.
Lastly, and most importantly, our thanks go to the five financial
institutions represented in the case studies - NABARD in India, BRI in
Indonesia, ADBN in Nepal, People’s Bank in Sri Lanka and BAAC in
Thailand - who kindly and openly shared their rich experiences with us.
Dr. Dirk Steinwand
Martina Wiedmaier-Pfister
Eschborn, 2003
Table of Content
Table of Content
List of Abbreviations and Acronyms
Synopsis Report: The Challenge of Sustainable
Dirk Steinwand
Can Public Banks Contribute?
Five Cases from Asia
Why Asia?
The Financial Landscape
The Banks
Critical Issues
Ownership and Governance
Funding and Economic Viability
Restructuring and Good Management
Customer Orientation and Products
Case Study: Kakathiya Grameena Bank, India
Harishkumar R. Dave
Introduction: Outreach vs. Sustainability - a Dilemma for
Indian Banks?
The Financial Sector in India
The Financial Infrastructure
Public Sector Banks (PSBs)
Private Sector Banks
Foreign Banks
Regional Rural Banks (RRBs)
The Cooperative Sector
The Challenge of Sustainable Outreach
2.2.7 Apex Financial Institutions and Development Finance
2.2.8 NABARD
Regional Rural Banks: outreach without sustainability
The Mandate
Ownership and Governance
Board of Directors
Impediments to profitability
RRB reform
Impact of Reforms
SHG Banking: How to Overcome the Dilemma of Outreach
to the Poor vs. Sustainability
Kakathiaya Grameena Bank (KGB)
2.5.1 Overview
2.5.2 Ownership and Governance
2.5.3 Supervision and control
2.5.4 Assessment and Conclusions
2.5.5 Economic Viability
2.5.6 Assessment and conclusions
2.5.7 Decentralisation
2.5.8 Good Management
2.5.9 Customer Orientation
2.5.10 Summary and conclusions
Case Study: Bank Rakyat Indonesia, Indonesia
Wolfram Hiemann
Financial Sector
Brief description of the main features and developments
Key financial institutions
Non-bank financial institutions
PT Bank Rakyat Indonesia (Persero)
3.3.1 General data
Table of Content
Ownership and Governance
Economic Viability
Good Management
Customer Orientation
Summary and Conclusions
Case Study: Agricultural Development Bank, Nepal
Marc Oliver Jünemann, Ulrich Wehnert, in cooperation
with Jalan Kumar Sharma
The Financial Sector of Nepal
Regulatory and Supervisory Framework
Financial Institutions
The Armed Conflict and Its Adverse Effects on the
Banking Sector
The Agricultural Development Bank of Nepal
Ownership and Governance
Economic Viability
Decentralisation of Banking Operations
Bank Restructuring and Good Management
Products and Customer Orientation
Summary and Conclusions
Case Study: The People’s Bank, Sri Lanka
Richard Gant, Steve Durrant
The Financial Sector in Sri Lanka
5.2.1 Macro Assessment
5.2.2 Financial Sector Assessment
The Challenge of Sustainable Outreach
The People’s Bank of Sri Lanka
General Data
Ownership and Governance
Economic Viability
Good Management
Customer Orientation
Summary and Conclusions
Case Study: Bank for Agriculture and Agricultural
Co-operatives, Thailand
Marie Luise Haberberger, Luck Wajananawat,
Nipath Kuasakul
Thailand’s Financial Sector
The Bank for Agriculture and Agricultural Cooperatives
Ownership and Governance
Economic Viability
Good Management
Customer Orientation
Summary and Conclusions
The Way Forward
Dirk Steinwand, Anke Wolf
The New Paradigm
New Challenges
New Roles
List of Abbreviations and Acronyms
List of Abbreviations and Acronyms
Agricultural Credit Training Institute
Asian Development Bank
Agricultural Development Bank of Nepal
Automatic Teller Machine
Bank for Agriculture and Agricultural Cooperatives
Bank Dagang Negara
Bank Indonesia
billion or 1,000 million or 109
Bank Negara Indonesia
Bank of Thailand
Bank Perkreditan Rakyat
Bank rating based on capital, assets,
management, earnings, liquidity
Capital Adequacy Ratio
Central Bank of Sri Lanka
Colombo Consumer Price Index
Chief Executive Officer
Deputy General Manager
European Community
Extended Deposits Account
Equal Monthly Interest
Finance Company
Foreign Currency Banking Unit
Registered Finance Company
Gross Domestic Product
Government Housing Bank
General Manager
Gross National Product
Government Savings Bank
Human Development Index
Human Resource Management
Indonesian Bank Restructuring Agency
Institutional Development Programme
Indonesian Rupiah
The Challenge of Sustainable Outreach
International Financial Institutions
Insentif pembayaran tepat waktu
International Standard Association
Information Technology
Japanese Bank for International Cooperation
Kakathiya Grameena Bank
Kredit Koperasi Primer untuk Anggota
Kredit Liquiditas Bank Indonesia
Kredit Usaha Tani
Lender of Last Resort
Licensed Specialised Bank
Management Information Systems
Ministry of Finance
Micro, Small, Medium Enterprises
National Bank for Agriculture and Rural Development
Nepal Bank Limited
Non-Governmental Organisation
Nepal Industrial Development Corporation
Non-Performing Loans
Nepal Rastra Bank
Non Resident Foreign Currency Account
Nepalese Rupees
Organization of Petroleum Exporting Countries
Ordinary Savings Account
Pembinaan Peningkatan Pendapatan Petaninelayan
Primary Agricultural Credit Societies
Primary Land Development Bank
Public Sector Banks
Personal Computer
Personal Management System
Purchasing Power Parity
Postal Savings Bank
Rastriya Banijya Bank
Reserve Bank of India
List of Abbreviations and Acronyms
Rural Banking Innovations Project
Regional Development Bank
Return On (Average) Assets
Return On Equity
Regional Rural Bank
Regional Rural Development Bank
Regional Training Center
Rural Finance Nepal
South Asian Association for Regional Co-operation
Sertifikat Bank Indonesia
Small Farmer Cooperative Ltd.
Small Farmer Development Programme
Specialized Financial Institution
Self-Help Group
Small Industries Development Bank
Sana Kisan Bikas Bank
State Land Development Bank
Sri Lanka Rupee
Small and Medium Enterprises
State Owned Enterprise
Savings Center
Sub-Project Office
Statutory Reserve Ratio
trillion or 1 million x 1 million or 1012
Transfer Pricing System
Thai Rating and Information Service
United States Dollar
The discovery of microfinance as an efficient and effective tool for
fighting poverty, creating employment, and improving the overall living
conditions of the poor is one of the most remarkable success stories in
the history of development cooperation. Over recent years the
microfinance industry has displayed impressive growth, the increasing
professionalisation of its practitioners (as well as of the donors
supporting them!), and the rapid diversification of its techniques,
instruments and services.
However, observing the international debate on microfinance, it becomes
obvious that there is a strong bias towards small NGO-like microfinance
institutions - commonly referred to as MFI. Most attention is devoted to
them, while other players, such as the large public banks in Asia and
their rural lending operations, have been shunted into the background.
Given that the majority of MFI have only limited outreach to rural areas
and that many of them still struggle with the viability and sustainability of
their operations, we raised the question of whether large public banks
and their impressive networks of branches are in a position to contribute
to expanding the outreach of financial services to the rural population in
a sustainable manner.
The liberalisation of the financial sector, which has resulted in increased
competition, forces public banks to substantially reform their operations.
Some of these banks have already developed very exciting instruments
for providing rural areas with financial services and, by this, have not
only achieved impressive outreach but also considerably improved the
viability and sustainability of their operations.
Against this background GTZ together with APRACA and supported by
IFAD held an international conference in Colombo, Sri Lanka from
January 27 to 29, titled
“The Challenge of Sustainable Outreac: How can Public Banks
Contribute to Outreach in Rural Areas?”
In preparation for this conference, case studies on five large public
banks from India, Indonesia, Nepal, Sri Lanka, and Thailand have been
conducted. The case studies look into the innovative tools and
instruments of these banks used for serving rural areas; and they look
The Challenge of Sustainable Outreach
into the reform measures the banks have undertaken in order to respond
to an increasingly competitive financial sector in these respective
In volume I of “the Challenge of Sustainable Outreach” we present the
five case studies, preceded by a synopsis report which summarises the
major findings of the case studies and discusses the critical issues for
success. The final chapter of volume I contains a reflection on the
challenges for the way forward, based on the results of the conference.
Volume II (available as CD ROM only) contains the proceedings of the
Dr. Dirk Steinwand
GTZ, Head of Section
Financial Systems Development
Martina Wiedmaier-Pfister
Synopsis Report: The Challenge of Sustainable Outreach
Synopsis Report:
The Challenge of Sustainable Outreach
Dirk Steinwand
As early as the 1960s Gurley and Shaw (1960) and later McKinnon
(1973) stressed the importance of a functioning financial system for
development and criticised so-called financial repression, i.e. the strict
regulation of the financial sector, which was common at that time.
Throughout the 1960s and 1970s, most Third World governments,
following traditional growth theory, intervened in their economies on a
massive scale. A cornerstone of this growth strategy was the channelling
of domestic and - even more importantly - donor money through
specialised development banks at concessional rates to priority areas
such as the agricultural sector. Outreach was the challenge here, with
sustainability of little concern.
The famous Spring Review, research funded by USAID in South Korea
and Taiwan in the 1970s, influential publications like “Undermining Rural
Development with Cheap Credit” (Adams et. al. 1984) and tighter
development aid budgets finally resulted in a shift in policy. From the
mid-1980s, target lending programmes were gradually replaced by a
financial systems approach focussing more on the sustainability and
viability of the financial system and its institutions rather than on the
number of priority clients served. International Finance Institutions (IFIs)
pushed structural adjustment programmes (SAP) in partner countries
and capped their refinancing lines for development banks. Many of the
The Challenge of Sustainable Outreach
notorious loss-making development banks, particularly in Latin America
and Africa, were closed down. It was hoped that lending business would
be taken over by commercial banks. This development is well
documented in literature and does not need to be discussed in more
detail here.1
At the same time a new star was born. First experiences in Indonesia,
Bangladesh, Bolivia and some other countries demonstrated that
banking with the poor is not only viable, but indeed has a strong positive
developmental impact on clients (income, employment, health, etc.). This
was the beginning of what M. Robinson (2001) recently called the
Microfinance Revolution. Within a decade microfinance projects
mushroomed all over the world, leading to a large and diverse
microfinance industry by the end of the century. Although there are
thousands of different players active in the field of microfinance, each
with their own strategies and beliefs, it is still possible to roughly
separate them into two groups. The first group, we might call the
“sustainability fraction”. It perceives the existence of microfinance
services as an integral part of a strategy for financial systems
development which gives priority to the viability and sustainability of its
institutions. The other group is the “outreach fraction”, which has poverty
alleviation as its main agenda, the number of poor gaining access to
microfinance services its main criteria for success.
Although there are now many successful examples of microfinance
institutions (MFI) which have achieved sustainability, some of which also
have impressive outreach in terms of both quantity and quality, from a
global perspective sustainable outreach - particularly to rural areas remains an unsolved problem:
The majority of MFIs are NGO-like, small financial institutions which
operate in urban or semi-urban areas. Rural areas, especially in large
countries, are seriously underserved.2
Only a small fraction of MFIs have managed to achieve operational
self-sufficiency. Recent surveys on the performance of MFIs draw
attention to the rather weak condition of the majority of MFIs. For
example, Sanjay Sinha (2002: 25) concludes from a recent survey of
MFIs in South Asia that: “microfinance in the region has a long way to
go before it can achieve any form of commercial viability.”
FAO/GTZ (1998/1999), Steinwand (2001), World Bank (1989).
CGAP presentation at the CGAP Annual Meeting 2000.
Synopsis Report: The Challenge of Sustainable Outreach
To increase outreach by creating an adequate number of new
microfinance institutions of the type mentioned above would result in
an unmanageable number of institutions for those supervising the
financial sector.3
On the one hand, we hence have a dynamic and fast growing
microfinance industry still, however, lacking substantial outreach on a
global basis. On the other hand, we still have - at least in some areas the oft-derided development banks of the 1960s, which, with the shift in
paradigm to a financial systems approach, disappeared from the radar of
the development community or have simply been ignored (Seibel 2001).
Nevertheless, many of them are still living and breathing, operating
mainly in rural areas and serving millions of clients through thousands of
It was against this backdrop that Gonzalez-Vega and Graham (1995)
raised the question of whether state-owned (agricultural) development
banks4 could potentially play a significant role as a “source of
Can Public Banks Contribute?
While everybody was discussing upgrading NGOs, GonzalezVega/Graham asked if there was “any hope to transform state-owned
agricultural development banks into valuable financial intermediaries that
can provide microfinancial services” (1995: 20). Given the large number
of failed development banks and their previous poor performance - which
certainly could not be interpreted as being suited to a financial systems
paradigm - their approach was rather sceptical: “Why bother to
restructure organisations with such a stubbornly flawed past history?
What services could they offer that are not being satisfactorily supplied
by private banks, non-bank intermediaries, and NGOs? What benefits
and costs are involved?” (1995: 23).
As a precondition for any restructuring efforts, they identified, amongst
others, the following issues: at least a moderate degree of macro-
Assuming that these institutions have to mobilise savings in order to raise sufficient
funds to attain large scale outreach in a given country.
Gonzalez-Vega/Graham focussed on agricultural development banks. Here we will
discuss the role of public banks with operations in rural areas in general.
The Challenge of Sustainable Outreach
economic equilibrium in the respective countries, government
commitment to financial reform, an effective framework for the prudential
regulation and supervision of deposit taking intermediaries, and a sound
fiscal system.
Given these supportive framework conditions, Gonzalez-Vega/
Graham advanced several arguments in favour of dealing with
development banks rather than closing them down: “It may be argued
that some of these organisations possess valuable information capital,
human capital, and an infrastructure (i.e. branch network) that can reach
further down towards lower income clientele than private commercial
banks can and, at the same time, service rural (agricultural and nonfarm) clientele better than most NGOs do. Moreover, such a bank may
be able to mitigate the consequences of covariant income risks through
enterprise and geographical diversification due to possession of a
branch network with a national scope as well as through access to
liquidity markets and lenders of last resorts.” (1995: 23)
However, over the ensuing years, development banks generally seemed
to have made little progress towards transforming themselves into viable
and efficient providers of financial services to rural areas. They have, at
least, remained little-known to the public. Correspondingly, donor interest
in these banks has remained marginal. In 1999, a CGAP working group
on agricultural development bank reform was established, but its
activities concentrated mainly on one single, active member, namely
In Latin America, most of the development banks were closed down
during the course of the 1990s.
In Africa, AFRACA, with the support of IFAD, conducted several regional
workshops on “the role of agricultural development banks in rural finance
in liberalised economies: the way forward” (2000) and commissioned
several case studies (AFRACA 2002). However, apart from the BNDA in
Mali, only a few promising efforts at reform can up to now be identified.
In the Near and Middle East, most public banks are still in a quite
miserable condition. In 2002, NENARACA, with the support of IFAD,
conducted a workshop on the “Restructuring of Agricultural Development
Banks - Perspectives and Prospects”. Although participants acknowledged the importance of reform, they also emphasised “the difficulties
the banks would encounter in restructuring themselves to comply with
sound banking principles. Of special prominence would be problems
Synopsis Report: The Challenge of Sustainable Outreach
created by pressure groups that may oppose or impede restructuring.
Hence, banks must implement restructuring gradually, without media
provocation, and with due consideration to the situation of small
producers.” (NENARACA 2002: 8 - 9)
As yet no dramatic restructuring initiatives from Near and Middle East
development banks have become known to the public.
Which leaves us with Asia. Seven years have passed since GonzalezVega/Graham’s initiative. Asia experienced dramatic cycles of boom and
bust during this period and faced a complete restructuring of the financial
sector in those countries hit by the 1997/98 crisis. In Asia, financial
sector reforms have been more substantial, and it appears that the
potential for further reform is stronger than in the other regions
mentioned above. Public banks are still in place in all countries of the
region and once again play - due to the crisis - an important role in the
financial sector. As Seibel (2001) points out, the volume of assets and
number of customers served by these banks, give them a weight in the
financial sector, which makes it inadvisable to simply ignore them. The
fact that the only two examples of public banks with successful
microfinance operations frequently mentioned in international literature namely BRI and BAAC - are both from Asia, raises the question of
whether other public banks in the region can follow this path.
This book tries to find an answer to this question. It contains case
studies on five Asian banks and their microfinance operations in rural
areas: ADBN of Nepal, BAAC of Thailand, BRI of Indonesia, the
Regional Rural Bank, KGB, of India, and the People’s Bank of Sri Lanka.
All of them, with the exception of BRI, have been receiving Technical
Assistance through the GTZ over the last five to ten years. All the studies
have the same structure. After a short overview of the financial sector of
the respective country, they discuss how these banks handle the most
decisive critical issues in order to achieve sustainable outreach to rural
The following pages give a synthesis of the five case studies and draw
some more general conclusions, which might be useful for public banks
intending to increase their outreach to rural areas in a sustainable
The Challenge of Sustainable Outreach
Five Cases from Asia
Why Asia?
When we initially planned to take a closer look into the recent
development and current performance of some of the Asian public
banks, we received only muted interest from the international
microfinance community.5 Public banks are definitely not in vogue at the
present time. A typical response from a renowned microfinance expert at
the frontier was: “Thank you for the invitation. Please describe precisely
what you mean by ‘public banks.’ Are these the same old state-owned
banks that led the agricultural and SME credit disasters in so many
countries in the past because of their inherent governance problems, or
do you have in mind other types of institutions that may be unique to
Germany and other European countries?” However, we decided to have
a more benevolent look at these banks, since, measured against the
original goal for which they have been set up, namely the financing and
implementation of the green revolution, they have been relatively
successful.6 Whether they will be able to survive under a new
development paradigm within the context of competitive markets in a
global economy remains to be seen.
Moreover, particularly in Asia, the topic of public banks is of high
relevance to development: When addressing the problems of outreach,
poverty alleviation and the millennium goals, one has to talk about Asia.
The majority of poor people live in this region of the world. India alone
has an estimated 250 million poor people, China some 130 million.7
Correspondingly, the largest public banks operate in Asia, many of them
with millions of clients and extensive branch networks all over the
country. The five banks we will discuss here have together nearly 40
million customers! However, according to the Microcredit Summit (2002),
only some 14% of poor families in Asia have access to microfinance.
Hence, the potential leverage to be gained by transforming these
institutions into viable providers of financial service in rural areas is
With the exception of the members of the CGAP working group chaired by GTZ on that
Although, with the benefit of hindsight, one could argue that there would have most likely
been more cost efficient approaches to implement the green revolution.
According to the CIA World Factbook 2002.
Synopsis Report: The Challenge of Sustainable Outreach
When talking about public banks, one cannot avoid looking at Asia
either. Asian countries have the highest share of state-owned banks in
their respective financial sectors. In India and China, both amongst the
largest economies in the world (measured against PPP), the financial
sectors are dominated by public banks, and there is little indication that
this will change in the near future.
While many countries in Africa and Latin America have bowed to the
pressure of the International Financial Institutions (IFIs), undergoing
major structural adjustment programmes and privatising their state
enterprises, this policy was by and large resisted by South and East
Asian countries. This can be attributed to several factors:
Traditionally, the state plays a more active role in economic
development in most Asian countries and views itself as an active
agent of development. The dominant and often patriarchal character
of Asian states8 - according to Wittvogel (1957), a reflection of the
hydraulic mode of production of Asian economies - permeates all
aspects of the economy and stands in sharp contrast to the more
Anglo-American influenced laissez-faire states in Africa and Latin
Secondly, due to their economic weight and low levels of international
indebtedness, Asian governments have stronger bargaining power
with respect to the IFIs.9
Thirdly, until the outbreak of the financial crisis, it was believed that
the fundamentals of the Asian economies were in good condition and
that there was little need for intervention through the IFIs.
Finally, as Gonzalez-Vega/Graham (1995) pointed out, a prerequisite for
addressing the issue of public banks is the existence of supportive
framework conditions. In many Asian countries, these conditions have
improved considerably over the last decade. Important financial sector
reforms have been at least initiated, particularly in the aftermath of the
financial crisis. This offers new opportunities to redefine the future role of
public banks in a more efficient and stable financial sector.
Malhotra (1997) differentiates between „the state led and controlled capitalist state“ and
„the centrally planned and led Communist or Socialist Command states currently in
This of course changed for the South East Asian countries during the financial crisis of
The Challenge of Sustainable Outreach
The Financial Landscape
The two South East Asian countries of the case studies, Thailand and
Indonesia, were hit strongly by the Asian crisis 1997/98, whereas the
three South Asian countries, Nepal, Sri Lanka, and India, were affected
only very moderately. Despite various structural differences in the
respective financial sectors of these countries, there is one common
feature: all of them are characterised by the rather strong presence of
public banks and/or public specialised financial institutions; and all of the
countries have begun to liberalise their financial sectors, allowing more
competition and at least starting the reform of their public banks.
However, scope, time frame, and the level of success of these reforms
differ substantially from country to country.
Indonesia was among the countries worst hit by the crisis. Indonesia
liberalised its financial sector with a series of reform measures from 1983
to 1992. As a result, the share of public banks declined from almost 90%
before 1988 to only 30% before the crisis. However, after the crisis, the
government had to take over some large, collapsed private banks,
pushing the share of public banks again to over 50%. Financial
deepening (using the ratio M2/GDP) remained stable at nearly 60%.
Although restructuring of the financial sector, as a response to the crisis
is under way, the scope and pace of reforms is still not sufficient.
Indonesia is an outstanding example of a country with a diversified
microfinance sector.10 Its microfinance sectors has over 100 years of
history,11 the main actors being the BRI, rural banks (People’s Credit
Banks, BPR) various community-owned MFIs (LDKP), and cooperatives.
Due to the strong presence of those institutions and political suppression
during the Soeharto era, the typical NGO-MFI plays only a subordinate
role in Indonesia.
Thailand was the first country to be hit by the crisis. Much has been
done to stabilise the financial sector since then, although international
observers still demand more comprehensive action (The Economist
2002). Among the sample countries, Thailand has the lowest share of
public financial institutions, most of them with the status of specialised
financial institutions (BAAC, Government Savings Bank, Government
Housing Bank). The banking sector is dominated by private Thai (13)
See Holloh 2001.
See Steinwand 2001.
Synopsis Report: The Challenge of Sustainable Outreach
and foreign banks (18). At 105% the financial deepening ratio indicates a
comparatively high-developed financial sector.
Thailand’s microfinance sector is dominated by one public bank,12 the
BAAC. Neither NGOs nor other MFIs play a major role, a situation that is
especially stark in rural areas.
Sri Lanka has the most dynamic and liberal financial sector of the South
Asian countries, which have traditionally been tightly regulated. Over the
last two decades, the civil war has severely harmed the economy, also
damaging the financial system badly. Nevertheless, the financial sector,
supported by reform measures throughout the last decade, is still one of
the most vibrant sectors of the economy. Compared to 23 private banks,
there are only two public banks (Bank of Ceylon, People’s Bank).
However, these two banks dominate the banking landscape, accounting
for over half of all deposits in Sri Lanka. Both banks are striving to
become efficient and competitive commercial banks. At 39%, the
financial deepening ratio is somewhat lower than those of its South East
Asian neighbours.
Similar to Indonesia, Sri Lanka enjoys a highly diversified microfinance
sector.13 Major players include private and public commercial banks,
NGOs, foundations, and more than 8,000 thrift and credit cooperative
In Nepal, prior to the liberalisation of the financial sector in 1984, all
commercial banking activities were principally concentrated in the hands
of two state banks, namely the Nepal Bank Ltd. and the Rastriya Banijy
Bank. Despite the establishment of a substantial number of private
banks since the mid-1980s, the sector is still dominated by the two
largest public banks, which have a combined market share of 50% of all
banking transactions. Both banks are technically insolvent and have
serious shortcomings in all aspects of their governance. The Central
Bank has assigned foreign management teams to eventually prepare
these banks for privatisation. There are a further seven public
development banks with a market share of 7.5% and the financial
deepening ratio is 45%. The whole economy, particularly the banking
sector, has suffered from the armed conflict with Maoist Guerrillas which
For convenience, we refer to the BAAC in this paper as a „bank“ and avoid the awkward
term „specialized financial institution“.
See Gant (et. al.) (2002).
The Challenge of Sustainable Outreach
started in 1996. Consequently, for the fiscal year that ended in July
2002, Nepal has had to register its first negative GDP growth rate for 19
Nepal has a vibrant microfinance industry reaching an estimated
1.2 million households. In terms of outreach, the five state-owned and
two privately-held Grameen Bank replicators have had the most
success. In the last couple of years, many former NGO-MFIs have
transformed themselves into development banks as part of their
commercialisation strategies. The Small Farmer Cooperatives Ltd.
(SFCLs) system is one of Nepal's fastest growing microfinance models.
In India, policymakers have always put a strong emphasis on outreach
of financial services to rural areas, albeit sometimes ignoring the viability
and sustainability aspects. The Indian banking sector is still dominated
by public banks, which hold more than 80% of total commercial bank
assets. Rural areas are served by about 33,000 rural branches of 91
commercial banks, 14,350 branches of 196 Regional Rural Banks as
also by the cooperative banking system, with more than 400 banks and
nearly 100,000 primaries. These systems are chiefly government-owned.
Until the early 1990s, the (rural) financial sector was strictly regulated.
For example, under the so-called service area approach, certain regions
have been assigned to single banks that have been obliged to serve
targeted clients with regulated interest rates, eliminating any semblance
of competition. As a consequence, banks incurred substantial losses.
Since 1992, the financial sector is being gradually liberalised and various
reform efforts undertaken in the public banking sector, which has
resulted in the early improvement of banks’ performance. However,
compared to the other countries included in this study, India is still the
country with the most strictly regulated financial sector.14
While the profitability of public banks is improving, their lending activities
- especially in the microfinance sector - have declined as a result of
liberalisation. The rural poor are primarily served through the NABARD
SHG (self-help group) banking programme, in which some 450 banks
presently participate and by several hundreds NGOs.
Which, on the other hand, left India virtually unaffected by the financial crisis of 1997/98.
Synopsis Report: The Challenge of Sustainable Outreach
The Banks
All the banks of the sample were established during the 1960s, with the
exception of the KGB in India which was founded in 1982. They were
true children of their time. In line with the dominant development
paradigm of that decade, the purpose of the banks was not financial
intermediation but the channelling of money into the agricultural sector.
Funding stemmed mainly from governments and international donors.
Only the PBS had, from its inception, the dual tasks of development and
commercial banking. Like their fellow banks in other countries, these
banks were mostly loss-making, requiring governments to re-inject
additional equity on several occasions.
Meanwhile, as indicated above, the financial sectors of all the sample
countries underwent major liberalisation measures (only India still lags
behind), easing the access of new private banks, and thereby initiating
competition in the sector. Although there are differences from country to
country regarding the scope of reforms and the impact on the respective
banks, some similar developments of the sample banks are identifiable,
for example, the diversification of lending operations and the funding
structure, measures to improve efficiency etc. which will be dealt with in
the following chapter. Although the sample banks find themselves at
different stages of the reform process and differ considerably in terms of
viability, efficiency, market share, strategy and overall performance, all
five of them have developed some interesting strategies targeting
sustainable outreach in the provision of financial services to rural areas.
Bank Rakyat Indonesia, one of the large Indonesian state banks, has
achieved international recognition within the microfinance community for
its Unit Scheme. Its development and history has been well
documented:15 in international discussion, BRI is often quoted as an
example of a development bank that successfully reformed its
operations, becoming one of the largest microfinance providers in the
world. In fact, this picture is somewhat misleading and misses the salient
Firstly, BRI did not reform its agricultural lending operations (BIMAS); it
completely terminated them and replaced them with an entirely different
business. The remaining agricultural programme loans were transferred
See: Patten/Rosengard 1991, Patten 1999, Charitonenko, Patten, Yaron 1998,
M. Robinson 1992, 1994, 2001, Maurer 1999.
The Challenge of Sustainable Outreach
to its branch offices. Instead, the BRI Units launched a general credit
business with only one product (KUPEDES), targeting mainly those
members of the semi-urban and rural population with a regular income.
Secondly, the BRI Units do not explicitly address the lowest income
segment with their loans. Although average loan size is small (US$550),
a recent survey (BRI et. al. 2001: 18) indicated “the (median computed
and average computed) income of regular BRI Unit borrowers is more
than double those of respondents in the sample who were not BRI Unit
customers.” Nevertheless, the BRI Units provide very valuable services
to the general Indonesian population.
Thirdly, while the BRI Units, with close to 3 million borrows, nearly 27
million savers and high profitability, are a convincing example of
sustainable outreach, the bank, without its microfinance operations,
would still be a loss making enterprise. Hence, BRI is an interesting
example of a bank introducing a new, viable microfinance system without
restructuring its whole banking operations. Year after year, the profit of
the BRI Units subsidises BRI’s general banking operations. There is too
much liquidity in the system, which, according to BRI officials, stems
mostly from urban rather than rural units.
The literature on BRI mentioned above intensively discusses the
success factors of the model of sustainable outreach used by BRI Units.
Besides a favourable environment, there are several other major factors
for success: the designing of the BRI Units as profit centers; the focus on
a few, flexible and attractive products, founded upon the mentality of the
target groups; incentives for supervisors, staff, and clients; simple and
clear procedures; strict transparency and close supervision; and
substantial investment in human resources coupled with competitive
Alongside the BRI Units in Indonesia, the BAAC of Thailand is the other
microfinance celebrity among public banks. In the latest rural finance
strategy of the World Bank (2002), for example, the BAAC is the only
public bank (positively) mentioned. Like BRI, its case has been well
documented.16 The BAAC initially concentrated on wholesale lending to
agricultural cooperatives. As early as 1966, the BAAC developed its
Joint Liability Group scheme (JLGs) - a channelling group scheme
through which individual farmers were served. The stark contrast
See Yaron 1994, Maurer 1999.
Synopsis Report: The Challenge of Sustainable Outreach
between the poor performance of cooperative loans and the favourable
performance of individual lending business led the BAAC to shift its
focus in the late 1970 from wholesale to individual lending. Although the
BAAC has hundreds of different products, some 80% of its loans are to
individual farmers, the majority of them organised in JLGs. Over recent
decades, the BAAC has established its dominance in rural Thailand and
covers 92% of rural households (5.2 million registered farm household
and 2.7 million active borrowers). Thus, unlike the BRI Units, the BAAC
occupies a dominant position in rural areas with very few competitors in
this specific market. Until very recently, the BAAC’s mandate was purely
to finance agricultural activities. However, given the fungibility of money,
this regulation was easily circumvented and is gradually being phased
out. The BAAC has been allowed to finance farming-related activities
since 1993, with financing to farmers for non-farming activities business
permitted since 1998. Final abolition of the current lending regulations is
expected by mid-2003. The BAAC will then have completed its
transformation from an agricultural development bank into a provider of
rural financial services.
While for BRI the outstanding success factor for sustainable outreach
was the concept of village units functioning as profit centers, for the
BAAC it was the JLG scheme, which created low default rates and high
staff productivity (440 loans/loan officer). Only recently, the BAAC
followed the example of the BRI Units and started to transform its branch
network into profit centers.
Another major development in its almost 40 year history has been a shift
in the BAAC’s funding structure. In 1967, the BAAC’s funding was 66%
through equity, 19% through borrowings and only 11% through deposits
from the public. In 2001, deposits from the public accounted for 76% of
total assets, offering the BAAC greater autonomy from the government.
Nevertheless, from time to time, the BAAC is still a victim of political
intervention, as demonstrated by its recent implementation of a
temporary debt relief programme.
Of all the banks in the sample, the People’s Bank of Sri Lanka (PBS) is
definitely the one currently undergoing the most radical reform. In 2001,
for the first time professional managers from the private sector became
directors of the management board and replaced former board
members. In contrast to the profitable BRI Units and the BAAC, the PBS
has made substantial losses throughout its history. The main problems
are not caused by minor defaulters but rather by large, politically
motivated loans. Loans to 25 large defaulters constitute some 40% of the
The Challenge of Sustainable Outreach
bank’s non-performing balance! The PBS has twice been recapitalised
by the government during the last decade and is at present being
completely restructured (or “rejuvenated”, as the bank management calls
it). This includes, for example, the launch of new successful products
such as foreign currency accounts for migrants to the Middle East, and a
multi-purpose microfinance loan product. Like all the other banks in the
sample, the PBS is in the process of transforming its branch network into
profit centers, following the example of the BRI Units. In 2001, the bank
returned to profit, which might be hailed as evidence that the painful
process of restructuring is beginning to reap rewards. However, with its
negative equity, the bank is still carrying a large burden.
In terms of its outreach to rural areas, the PBS’s credit business has
been dominated by programme lending. Throughout most its life, the
PBS has offered some 20 different programme loans at fixed terms and
with moderate performance. Only recently did the PBS introduce a
modern, flexible, cash-flow based microfinance loan product in some
branches. However, it is still to gain a substantial market share.
Nevertheless, the PBS has more than 3 million active borrowers with an
average loan size of some 60% of GDP per capita.
Most impressive is the deposit business of the PBS. With more than
8 million savings accounts, PBS reaches 44% of the population, which
means that the average Sri Lankan household has two savings accounts
with the PBS.
Including the PBS in the sample of institutions with successful
instruments for sustainable outreach is less for its programmedominated, loss-making lending business than for its pawning services.
The PBS operates some 587 units with pawning and savings services in
rural Sri Lanka, most of them attached to branches of the bank. Pawning
services have been part of the bank’s operations since its inception and
are mainly used by farmers to buy seeds and other agricultural inputs,
which are then reclaimed post-harvest. With some 2.8 million customers,
pawning clients not only clearly outnumber loan clients, but it is also by
far the most important single source of income for rural branches, since
pawning is highly profitable for the bank. Despite its importance, until
recently, pawning was underestimated by the PBS. It was completely
separated from the loan business, mostly hidden in some corner of the
branch, and hardly mentioned in the bank’s literature. Only after the
recent rejuvenation process has pawning been given a prime role in
branches and linked to the other services to encourage rural customers
to use a broader range of products.
Synopsis Report: The Challenge of Sustainable Outreach
Until the mid-1980s, the Agricultural Development Bank of Nepal
(ADBN) was a typical agricultural development bank. In 1984, the bank
introduced commercial deposit business and, in 1991, commercial
lending operations to complement its development business. The results
have been very surprising: around 97% of the bank’s borrowers are
served through the programme loans of the development section, while
97% of its depositors originate from the commercial section. Since
commercial operations are generally restricted to urban areas and
development operations to rural areas, there is, in fact, a transfer of
funds from urban to rural areas.17
Reform of the ADBN started in 1987, but initially had marginal impact.
Only after the ADBN completely ceased to provide funding in 1996, did it
implement more serious and extensive reform measures to improve
service delivery, the quality of lending and loan performance and to
reduce operating costs, amongst other objectives. In 2001, the ADBN
launched another reform programme, which included proper loan loss
provisioning and the transformation of the ADBN’s extensive branch
network into profit centers. Despite the relative improvement in key areas
resulting from these reforms, the ADBN’s true financial position cannot
be assessed with absolute certainty. An overdue loan ratio of near 20%,
low capitalisation, a write-off policy clearly below international standards
and an uncertain volume of bad loans give clear reason for concern. If
we also take into consideration the current difficult banking environment
in Nepal, we can assume that the ADBN’s real challenge in achieving
sustainability lies ahead.
With its 527 branches, the ADBN is the bank with the largest network in
Nepal. However, the ADBN's management recognised at an early stage
that the microfinance operations conducted by its sub-project offices
under the Small Farmer Development Programme were not viable.
Subsequently, in 1993 it began to outsource "microfinance" through the
transformation of its SPOs into Small Farmer Cooperatives Ltd. (SFCLs).
SFCLs have now captured a 7 - 8% share of the rural financial market
and combine both outreach to the poor and financial viability.18 The
ADBN will transform most of its remaining SPOs into SFCLs. Through
Deposit taking public banks with large outreach in rural areas (like the PBS) are often
criticised for draining capital from rural areas. However, in the case of the ADBN this is
not the case. (BRI officials also argue that the bulk of the surplus liquidity of the BRI Unit
system is generated in urban areas).
See Wehnert/Shakya (2001).
The Challenge of Sustainable Outreach
the transformation process, the ADBN has managed to reduce its
operating costs to the tune of an estimated US$1.2 million. Encouraged
by this process, the ADBN and 21 SFCLs established the Sana Kisan
Bikas Bank (Small Farmer Development Bank) in 2001. This new apex
bank became operational in November of 2002 and will take over the
entire portfolio of ADBN loans to SFCLs. The largest shareholder at
present is the ADBN, however, the majority of shares will be offloaded to
the SFCLs in due course. The emergence of the Sana Kisan Bikas Bank
will allow the ADBN to concentrate more on its core commercial and
development banking reforms. The Sana Kisan Bikas Bank is expected
to further advance the development of the SFCL system and to offer
demand-oriented refinancing services to SFCLs and similar organisations.
Thus, in the specific case of Nepal, a successful model of sustainable
outreach of microfinance services has been achieved, not by the reform
of banking operations, but by a) spinning off all microfinance operations
to autonomously managed small farmer cooperatives and b) creating a
separate, lean and professional refinancing institution to cater for the
needs of its clients.
The Kakathiaya Grameena Bank (KGB), included here as a case
study, is one of nearly 200 Regional Rural Banks (RRBs) established
since 1975 in rural India. RRBs have common ownership with 50% of
equity owned by the Government of India, 15% by the respective state
governments and 35% by a “sponsoring bank” - usually a public
commercial bank. Together the RRB system manages around 50 million
deposit accounts and 12 million loan accounts through their network of
14,350 branches. During their first 20 years of existence, RRBs followed
a “pro-poor focus”, with targeted clients in targeted areas and regulated
interest rates. As a result, RRBs amassed huge losses and had to be
recapitalised several times.
Since 1992, the government has launched major reform programmes for
RRBs, which include deregulating interest rates, allowing them to finance
the non-farming sector, and to relocate loss-making branches from
remote areas to better business locations. As a result, the number of
loss-making RRBs declined to 15% in 2002 and non-performing assets
dropped from 45% in 1995 to 16% in 2002. In 2001, the government set
up a ‘Working Group to Suggest Amendments to the Regional Rural
Banks Act’. This committee has made wide-ranging recommendations
relating to ownership, structure, governance, regulation & supervision,
and personnel policies currently under review.
Synopsis Report: The Challenge of Sustainable Outreach
The Kakathiaya Grameena Bank was established in 1982 and operates
in the southern state of Andrha Pradesh. Poverty is widespread and the
district is classified as one with serious problems of law and order, a
grave constraint to all banking operations. Like most other RRBs, the
KGB has incurred losses for most of its life. After introducing reform
measures (in 1995) and being recapitalised, the bank earned profits for
the first time in its history in 1998/99. However, due to the payment of
wage arrears for 10 years imposed by a court order and increased
provisions for bad and doubtful debts, the bank incurred losses again in
2001. With accumulated losses exceeding its share capital, the KGB is
technically bankrupt.
From the RRBs, the KGB is a pioneering bank in microfinance. It was
one of the first banks in the district to participate in the SHG banking
programme launched by NABARD in 1996. While similar SHG banking
programmes in other countries had rather mixed results19 and often
suffered under low outreach, the Indian experience appears relatively
impressive. By the end of 2002, the programme had reached more than
500,000 SHGs and some eight million households.20 A recent study21
revealed that SHG banking in India is highly profitable, due mainly to
excellent loan performance. For example, the KGB, one of the sample
banks in this study, has an average on-time repayment rate of only
around 60% for individual loans compared to 96% for SHG loans in
2002. Its SHG portfolio generated direct profits, while the bank as a
whole incurred losses.
To conclude, the five sample banks each developed different, but
successful approaches to rural microfinance. This does not automatically
imply that the banks themselves are already both efficient and profitable
providers of financial services. In fact, in most cases a sustainable and
financially viable microfinance business exists in stark contrast to the
mainstream business of these banks. In the following chapter, we
highlight some critical issues vital to attaining sustainable outreach in the
rural microfinance operations of public banks.
See APRACA/GTZ (1997).
These are accumulated figures. The existing monitoring system of the SHG banking
programme does not provide sufficient data for a profound assessment of the
performance of the programme. NABARD together with the GTZ is presently working on
a more sophisticated monitoring system.
Seibel/Dave (2002).
The Challenge of Sustainable Outreach
Critical Issues
Ownership and Governance
In the past, the operations of the state banks have not always been
based on commercial criteria and this has resulted in certain
inefficiencies in their operations…Hence there is an urgent need to
improve the operations of these...banks. An important step in this
process would be to ensure that their future dealings with the
government are at arms length…
(Central Bank of Sri Lanka, Annual Report 2001)
In plain language, governance, directly related with ownership, is the
most crucial issue affecting the success or failure of public banks. The
vast bulk of the loan losses of public banks, as much today as in the
past, does not result from defaulting minor borrowers, but from political
interference in banking business.
For all the examples, the respective governments were responsible for
appointing the board of directors in charge of steering the banks’
operations. Generally, board members are recruited from various
government institutions and represent the stakeholders’ interests (e.g.
the Ministry of Agriculture etc.). Explicit banking knowledge and a
profound understanding of the bank’s business have rarely been criteria
for selection. As a result, all of the banks are confronted with public
intervention. Interventions by politicians are generally short-termist and
either a direct result of corruption or instigated to pursue certain
development goals. Particularly in South Asia (although recently also in
Thailand), so-called loan waivers and temporary debt relief measures
have proved popular. As a matter of fact, these interventions seriously
harm banks’ loan business, negatively effect borrower discipline and
conflict with the longer-term targets of banks’ management.
However, there are signs of improvement. As pressure on the profitability
of public banks increases, so increases their bargaining power to obtain
at least compensation for these government interventions (BAAC). BRI
managed to strictly segregate all programme loans from the profitable
BRI Unit business. The PBS has probably made the most serious efforts
to differentiate between ownership and management by replacing nearly
all its board members with managers from the private sector.
Some banks have tried to optimise governance structures by distributing
shares to its targets groups (ADBN, BAAC), and, in the case of the
Synopsis Report: The Challenge of Sustainable Outreach
BAAC, going as far as to give them a place on the board. However, the
volume of these shares is primarily symbolic - in reality, it has neither
created “ownership” among clients, nor improved governance structures.
Besides an unhealthy mix of public ownership and direct influence on
management, there is also a conflict of interest where owners are (as is
usually the case) also responsible for the regulation and supervision of
these banks. Until now, many public banks have operated under a
special, less stringent development bank regulation. There is, however,
the clear trend towards “mainstreaming” public development banks, i.e.
imposing upon them the same strict regulations which apply to
commercial banks. This has become a matter of urgency as, over the
last two decades, most of the public banks operating in rural areas
(applicable to all the banks of the sample) have managed to dramatically
restructure their funding base from lending to mobilising deposits from
the public (see following chapter).
Another challenge all banks are confronted with regards aspects of
internal governance. Beyond the question of internal supervision and
control faced by banks, the banks of the sample have to address an
additional problem. All of them operate large branch networks often in
remote and inaccessible areas.22 Appropriate internal control
mechanisms and regulations are required in order to avoid fraud within
this decentralised structure. For example, BRI has set up very clear and
simple procedures that are easy to supervise. It has also established a
well-staffed BRI Unit supervision section, which tightly controls the Units’
operations and restricts all its services to the Unit offices (i.e. it does not
offer the more complex door to door services of its main competitors).23
The supervision costs of the Unit system amount to more than 10% of
total transaction costs or more than 30% of personnel costs!
Obviously, governments are still satisfied with the performance of public
banks. Only BRI shall be going public in 2003. However it is unknown
whether this will be in the form of a single bank or whether, as some
rumours seem to indicate, it will split into two: on one side, the profitable
microfinance business (BRI Units) and, on the other, its remaining (less
profitable or loss-making) operations. The PBS first has to become
profitable before any thought can be given to changing its ownership
See the following chapter on decentralisation.
In fact, the most important comparative advantage of BRI competitors like the BPR is the
convenience of their door to door service.
The Challenge of Sustainable Outreach
structure. For the other banks, no immediate privatisation plans are in
the pipeline. The crucial question is whether the banks can maintain their
public mandate of outreach to rural areas (for example, it is explicitly
stipulated for BRI “to maintain a basic network for financial services in
remote areas”) while at the same time being profitable enough to attract
investors. This directly addresses the question of economic viability,
which will be discussed in the next chapter.
Funding and Economic Viability Economic Viability
An essential precondition for the sustainability of microfinance operations
is their economic viability. With a RoA of between 3% and 6% over the
last few years, the BRI Units have been highly profitable and, as already
mentioned, helped BRI to remain in the black. The other banks in the
sample are either loss making or operating very small positive net
returns. The success factors of the BRI Unit system can be easily
No government intervention in lending policy and no programme
A very low loan loss ratio (below 2%).
High efficiency and staff productivity (530 active borrowers per
Freedom to set its own loan interest rates resulting in a gross interest
margin of more than 15% and an environment that allows these rates.
Cost efficiency and profitability have become issues of concern for the
other banks as well and important reform measures have been launched
in order to improve economic viability. However, there are two main
factors currently impeding higher profitability:
The regulation of interest rates (BAAC, formerly KGB) by the
government or the setting of maximum margins (as used to be the
case for the ADBN).
High costs for loan provisioning due to unsound lending practices in
the past (PBS) and high current loan loss ratios of between 10 and
Synopsis Report: The Challenge of Sustainable Outreach
Particularly in regard of the first aspect, governments have to realise that
if, for political reasons, they are not willing to accept higher loan interest
rates and/or margins and interfere in lending, they must continue to
subsidise their banks, either by concessional funding (BAAC and ADBN
in the past), by regular recapitalisation (KGB, PBS) or by direct
compensation for certain activities. However, since the microfinance
revolution, it is common knowledge that poor clients, at least in the nonfarm sector, are willing and able to pay cost-covering interest rates. If
governments feel the need to subsidise certain economic activities,
alternatives should be sought which are more transparent and less
harmful for the financial sector. Perhaps it is the very level of this high
outreach which prevents governments from unpopular actions like
raising interest rates. Several million loan customers are, after all, also
several million voters.
In terms of other efficiency-related aspects, there are already signs of
improvement. All the banks in the sample have managed to increase
staff productivity and decrease operational costs over the last years.
However, as the BAAC example shows, there is a trade-off between
reducing administrative costs and the quality of the loan portfolio. Over
the last decade the BAAC’s administrative expenses sank from 3% to
2.1% before rising again to again in 2001. The decline in these costs
was mirrored, however, by a deterioration in loan performance. As a
matter of fact, it has to accepted that serving rural areas implies higher
costs and thus that urban business cannot be used as a benchmark.
While all banks of the sample already accomplish high outreach in rural
areas, the challenge of sustainability concerns how to cover the
comparatively high costs and share these costs between borrowers and
lenders in an optimal way. The case studies demonstrate that there is no
single solution to sustainability. What works in one case might
completely fail in another (group lending, cooperatives etc.) and vice
For example, increasing efficiency may form the basis of a particular
strategy (BAAC, BRI), but it is recognised that it may not be sufficient by
itself or, if over-emphasised, actually damage loan performance. By
working through self-help groups (KGB) and channelling groups (BAAC),
banks have successfully managed to shift some of their internal
transaction costs to the borrowers, but in many other countries group
lending schemes have failed. All these efforts might not suffice in any
particular environment. In the case of the ADBN, it transpired that, with
its given cost structure, the bank was simply not able to reduce costs
The Challenge of Sustainable Outreach
substantially and thus decided to externalise its microfinance operations
to the newly established farmer cooperatives. In the Nepalese case, the
specific governance structure of cooperatives proved to be the optimal
solution for making rural microfinance operations sustainable within a
short period of time.
One of the most fundamental changes experienced by the banks of the
sample over the last two decades was the complete shift in their funding
structure. With the exception of the PBS (which was always strong in
savings mobilisation), all the banks started as specialised credit
institutions with non-existent or marginal deposit business. Since this
time, deposits mobilised from the public constitute more than 70% of the
total assets of these banks, transforming those credit institutions into
genuine financial intermediaries. In most cases, lending to rural clients
can be financed entirely from these deposits24 and deposit accounts
significantly outnumber loan accounts.
By collecting deposits from the public, these banks not only offer
important financial services to the rural population,25 they also make
public banks less dependent on government funds. This gives them a
stronger bargaining position when faced with prospective government
interference and increases the autonomy they have with their lending
policies (BAAC). Moreover, it reduces the banks’ need for external,
foreign currency nominated loans and thus reduces their exposure to
currency risks, which, as the Asian Financial Crisis so clearly
demonstrated, can cause the complete capitulation of a bank. Following
the cold money/hot money theorem, a replacement of government
money by locally collected deposits should also change the perception of
the bank in the eyes of the banks’ clients and boost repayment
While the strong overall drive towards deposit mobilisation implemented
by public banks over the last years is a very positive development, that
this often happens outside the purview of the respective central banks
(for example, in the case of the ADBN) is of major concern. This is due
to the fact that many public banks are registered under their own act or
Although in the case of the ADBN, deposits are mobilised in urban areas and lent to
rural areas.
Meanwhile, it is widely acknowledged that there is substantially higher demand for
deposit services than credit in rural areas.
Synopsis Report: The Challenge of Sustainable Outreach
under a development bank act, which is often less strict than commercial
banking acts. Immediate action appears to be necessary to bring public
banks under the supervision of central banks to provide the banks'
customers with a degree of protection.
Two prerequisites for high outreach in rural areas are a) a decentralised
branch structure and b) decentralised decision making. In contrast to
America - where scoring card based credit technologies, enabling
anonymous centralised decision making, are gaining popularity26 - in
most part of Asia, as in Europe, where the mobility of the (rural)
population is much lower, the cost of information is reduced by
establishing close long-term personal relationships between bank and
client.27 In fact, the high levels of staff efficiency of the BRI Units can be
largely explained by the fact that an estimated 90% of its clients are
repeat borrowers. Given that the cost of information within the existing
environment of rural Asia is directly related to spatial proximity, it is
essential that banks are close to their clients. It is also essential for rural
clients to be close to their bank, in order to allow them to keep their
transaction costs low.
Since their inception the banks have continuously increased the size of
their networks in rural areas. Currently, they operate between 520 (PBS)
branches and more than 3800 (BRI) units. Divided by the number of rural
households, one branch covers between 3,000 and 10,000 rural
households for each respective country! Additionally, some of the banks
operate sub-branches, village posts (BRI) or extension services, they
work through village groups (BAAC, KGB) or cooperatives (ADBN), as
channelling or wholesale agents and have even established a separate
apex institution with which to entrust their microfinance activities (ADBN).
During the early years of their existence, banks’ decision-making was
centralised and loan processing was cumbersome and time consuming.
Moreover, the staff in rural branches with access to the relevant client
information was generally not involved in decision-making and had no
incentives to screen and select good customers. As a result, loan
performance was poor.
See Miller (2001).
The so-called “house-banking approach”.
The Challenge of Sustainable Outreach
In recent years, all the banks in the sample have followed the BRI Unit
example in transforming their branches. Indeed it is surprising that very
similar reform measures took place more or less simultaneously in four
different Asian countries: decision-making was decentralised, branches
were transformed into profit centers and performance-based incentives
for branch staff introduced. As a reflection of the increasing importance
of deposit business, the banks also introduced a so-called transfer price
for liquidity exchange between branches and head office. By setting
appropriate interest rates for this transfer price, the banks are able to
influence the volume of deposit mobilisation and the direction of the flow
of funds between branches and head offices.
It must be noted that the establishment of a more efficient and
sustainable decentralised structure has been the result of several closely
interrelated measures: the delegation of decision-making, the
introduction of cost transparency, incentive systems, and, finally, the
introduction of clear and simple procedures and efficient internal control
In our sample banks (except for BRI), the transformation of branches into
profit centers only recently started, and, in most cases, has not yet been
completed. Thus, it is too early to measure the impact of the
transformation. However, if this transformation is comprehensive and the
incentives set correctly, one can assume a substantial improvement of
performance will occur within a short period. The recent development of
such indicators as loan performance, efficiency and the increase of
business volume clearly point in this direction.
Restructuring and Good Management
In international discussion there is an ongoing debate as to whether it is
worthwhile reforming badly performing banks or, as advocates of the
“Greenfield Approach” recommend, more effective to simply close them
down and replace them with new institutions. The Latin American
experience showed that closing these banks down is an uncomplicated
exercise. However, establishing alternatives to serve the rural area is
another matter entirely and one which still remains to be completed.
In chapter two, Gonzalez-Vega/Graham gave three arguments in favour
of considering the “Brownfield Approach”: taking advantage of existing
information capital, human capital, and the infrastructure of these banks,
within a supportive political environment.
Synopsis Report: The Challenge of Sustainable Outreach
The case studies show that all of our sample banks took important steps
in the right direction, albeit with differing levels of success. South Asian
banks in particular are still lagging behind and are only gradually
adopting international best practice standards in microfinance.
Moreover, it has also become apparent that the transformation of a
government institution into an efficient competitive bank can be a
painfully slow process. Take the case of the ADBN: this bank has been
“under reconstruction” for nearly half of its lifetime. However, only after
the discontinuation of support from the ADB, which since 1970 had
repeatedly refinanced the ADBN with concessional loans, and which
confronted the management with a severe liquidity crisis, was the bank
willing to commit to serious structural reform measures.
Another lesson to be learned is that extensive reforms can only be
successful given both a stable macro-economic environment and
harmony between the efforts of management and owners. For example,
the ADBN's reforms could have had more impact, had various
governments shown more support for these objectives. In contrast, the
reform of the PBS is moving at a fast pace, due to the government fully
supporting the bank’s transformation.
The major challenge in the transformation process from a bureaucracy
into an enterprise is not management but the bank’s “human capital”. In
the case of the PBS: the replacement of top management with
experienced professionals from the private sector was a purely political
decision. To change the mentality of more than 11,000 staff and to adjust
personnel structure to meet the new requirements, however, is an almost
impossible task. Generally this implies:
the replacement of elder staff with younger qualified professionals.
the reduction of the total number of staff and competitive salaries for
those remaining. (As long as public banks pay public sector salaries,
they cannot compete with the private banking sector for qualified
Introduction of performance based salaries and other staff incentive
New promotion policies, e.g. promoting the most talented and not the
most senior staff.
The Challenge of Sustainable Outreach
Changing the remuneration structure is a particularly sensitive issue and,
as the PBS case demonstrates, often evokes fierce opposition from
trade unions.
Other elements of a professional human resource policy are staff
recruitment procedures that ensure the employment of the best qualified
rather then the best connected (which, in the past, has often not been
the case for public institutions) and sufficient investment in training and
education of staff.
A crucial element in enabling management to fulfil its mandate is the
implementation of an appropriate MIS, which includes a customer
information system (CIS). All of the banks invested in upgrading their
MIS, but, with the possible exception of BRI, have not yet sufficiently
adjusted these systems in light of recent decentralisation measures.
These MIS have not yet achieved the appropriate and timely provision of
information to managers at the operational level.
Comparing the different strategies of the sample banks in creating
systems to achieve sustainable outreach in rural areas, it is interesting to
observe that the banks realising the fastest and most impressive results
were those which built completely new microfinance operations from
scratch, either clearly separating them from normal banking operations
(BRI) or externalising them (ADBN). By doing this, they established
viable microfinance services with impressive outreach long before an
end to the painful restructuring process of the banks themselves was in
sight. This system seems to capitalise on the benefits of a Greenfield
Approach, while, at the same time, making use of the infrastructure and
resources of the bank.
Synopsis Report: The Challenge of Sustainable Outreach
Customer Orientation and Products
Once upon a time…in India…
One of the proudest buildings in Malgudi was the Central Co-operative Land Mortgage
Bank, which was build in the year 1914 and named after a famous Registrar of Cooperative Societies, who had been knighted for his devotion to Co-operation after he had,
in fact, lost his voice explaining co-operative principles to peasants in the village at one
end and to the officials in charge of the files at the Secretariat end…
All the principles of co-operation for which he had sacrificed his life were dissolving under
his eyes, if he could see beyond the Portals of the bank itself, right across the little stretch
of lawn under the banyan tree, in whose shade Margayya sat and transacted his business.
Margayya commanded the respect of those who sat before him. He was to them a wizard
who enabled them to draw unlimited loans from the co-operative bank. If the purpose of
the co-operative movement was the promotion of thrift and the elimination of middlemen,
those two were just the objects that were defeated here under the banyan tree: Margayya
didn’t believe in advocating thrift: his living depended upon helping people to take loans
from the bank opposite and from each other.
His tin box…contained practically his entire equipment. a bottle of ink, a pen, and a blotter,
a small register,…and above all – the most important item – loan application forms of the
co-operative bank. These last named were his greatest assets in life, and half his time
was occupied in acquiring them…Sometimes a villager arrived who did not have a form
and who could not succeed in acquiring one by asking for it in the bank. On such
occasions Margayya charged a fee for the blank form itself, and then another for filling in
the relevant details.
The clerks of the bank had their own methods of worrying the villagers. A villager who
wanted to know his account had to ask for it at the counter and invariably the accounts
clerk snapped back, “Where is your pass-book?” A pass-book was a thing the villager
could never keep his hand on. If it was not out of sight it was certain to be out of date. This
placed the villager fully at the mercy of the clerk, who would say:” You will have to wait till I
get through all the work I have now on hand. I’m not being paid to look after only your
business here.” And then the peasant would have to hang about for a day or two before
getting an answer to his question, which would only be after placating the clerk with an
offering in cash or kind…
R.K. Narayan, The Financial Expert, (1952)
During the good (or bad) old days of banking in (particularly South-)
Asia, a client was regarded more as a necessary evil, who disrupted the
bank’s administrative procedures, than a customer to be taken care of
(see box). Most office space was occupied by back-office administration
and the teller often operated through a small hole in the wall in front of
his desk, at which the farmers had to bow down after endless queuing or
fighting with other ‘customers’. Competition was definitely something
experienced by customers rather than banks.
The Challenge of Sustainable Outreach
Fortunately, these times have now changed. With the deregulation of the
financial sector, competition grew and banks had to begin to concern
themselves with their customer base. Although competition was
focussed predominantly on urban areas, a general shift towards greater
customer orientation also had a positive spill-over effects on rural
branches. However, those banks with less competition in their specific
market segment (ADBN, BRI Unit) clearly placed less emphasis on
customer orientation than those facing stronger competition such as the
PBS. For example, under the framework of its “rejuvenation” strategy
(see above), the PBS undertook a shift to “front-office thinking”, involving
the adjustment of opening hours to meet the needs of the customers of
specific areas, new décor and furniture for branches, and a complete
reversal in space allocation - the customer now being allocated three
quarters of the physical space available in the banking halls.
The most important changes in this context are the streamlining of
products, the introduction of new products and services beyond
agricultural loans (savings, time deposits etc.), and the diversification of
lending operations:
None of the banks exclusively lends to the agricultural sector any more.
Some of them have simply added additional commercial products to their
programme loans (ADBN), while some of them have considerably
reduced the volume of programme loan lending in favour of other
products (PBS). Some banks have gone as far as to completely
terminate programme loan lending, preferring to concentrate on a single
“one size fits all” loan product (BRI Units). Even the BAAC, which has
hundreds of different products on its books(!), recently identified its socalled “core products” and now concentrates on those products with the
most transactions.
Hence, there is a clear tendency towards substantially reducing or
eliminating the old targeted programme loans with their fixed interest
rates by offering more flexible products at cost-related prices. At the
same time, banks have started to change their lending technologies and
shifted from collateral based to cash-flow based lending (as is already
common in many MFIs). Only the BRI Units are sticking to a more
conservative, strictly collateral backed lending policy. Additional features
introduced by these banks are the well-known and oft-imitated BRI Unit
lottery system for savings products and various monetary and nonmonetary customer incentives, such as discounts for timely repayment or
privilege cards for well-performing customers.
Synopsis Report: The Challenge of Sustainable Outreach
All five banks discussed here have undergone substantial changes over
the last decade. With one exception, they were set up in the 1960s,
typically as institutions refinanced by governments and donors, offering
programme loans for agricultural purposes at fixed terms and losing
substantial sums of money for most of their lifetime. The shift in
paradigm from a supply led development strategy to a financial systems
approach resulted in financial sector reform and financial market
liberalisation in each of these countries (although this took place with
varying scope and speed from country to country).
Increased competition in the financial sector (as a result of liberalisation),
pressure from donors, and tighter development budgets forced the old
public development banks and their governments to adjust to this new
environment: while governments relaxed or abolished policies imposed
on banks regarding interest rate regulation and lending to priority
sectors, the banks diversified their lending operations, introduced new
flexible products and credit technologies, and started to give (more)
emphasis to customer orientation. At the same time, they completely
shifted their refinancing structure from government and donor sources to
predominantly locally mobilised deposits. Thus, they are involved in a
process of transformation from specialised lending institutions into fullyfledged financial intermediaries.
However, although things have improved considerably, there is still a
considerable way to go. Governments still occasionally interfere in
banks’ operations. Most of their portfolios still contain a high share of
non-performing assets and even current loan performance remains
unsatisfactory. MIS have to be adjusted to suit new operational
procedures and the more decentralised decision-making structure.
Turning to the microfinance operations of these banks and the challenge
of sustainable outreach, we can observe the following:
Sustainable outreach still remains a challenge, due to the inherent tradeoff between the two objectives. Focussing on sustainability might easily
have a negative impact on outreach. For example, in order to strengthen
Since all five sample banks underwent similar changes but also show substantial
differences regarding specific aspects, conclusions made here do not always necessarily
apply to all banks to the same extent.
The Challenge of Sustainable Outreach
their profitability, RRBs in India have closed down remote rural branches
with insufficient business volume. Furthermore, the highly profitable BRI
Units are often criticised for not putting enough emphasis on serving the
lower market segments of clients who cannot provide physical collateral.
The BAAC on the other hand, with its remarkable outreach to more than
90% of rural households, has always had to struggle with the profitability
of its operations.
To overcome this trade-off and move the frontier of sustainable outreach
both horizontally (i.e. to remote areas) and vertically (i.e. to the poor),29
these banks are applying different strategies. Besides general principles
of sound banking, which apply to any kind of banking operations, the
most important issues for achieving sustainable outreach to rural areas
is that appropriate financial technologies are available provided through
a cost efficient delivery structure. All the banks of the sample have
decentralised their operations. They have consequently increased the
number of branches, transformed them into profit centers, and given
branch staff more autonomy in management decisions.
However, a bank branch inevitably has a certain cost structure, requiring
a sufficient volume of business to keep operations profitable. Hence, in
order to further narrow the spatial (and social) gap between banks and
the rural population, all banks have applied additional instruments:
The establishment of sub-branches, village units, satellites or any
other kind of outlets with limited scope of operations, and products
specifically designed for their respective target group (e.g. pawning in
Sri Lanka). Often they have limited opening hours and other features,
which allow the cost structure to be adjusted to the volume of
The use of “agents” between the bank and rural customers which help
to reduce transaction and information costs, e.g. the self-help groups
in India which are (mainly) acting as financial intermediaries or the
joint liability groups in Thailand, acting as channelling agent for
individual loans to group members.
The externalisation of microfinance operations through the
establishment of a new institutional infrastructure (e.g. SFCLs in
Actually both targets often coincide, since generally those living in the most remote
areas are in the poorest segment of society.
Synopsis Report: The Challenge of Sustainable Outreach
While each of the five samples has its own “best practice” we should be
careful in treating them as generally applicable best practices. Each of
them is successful because it found its niche in a specific environment
and has been supported by certain framework conditions and other
external factors. What works very well in one place might be a complete
failure when replicated in a different environment. For example, the
Indian SHG-banking model is successful only because of the
groundwork of hundreds of NGOs, which establish and strengthen the
SHGs. In Thailand, where this NGO infrastructure does not exist, this
model could not be applied. On the other hand, the Thai JLG-model
would most likely fail in India due to the substantially lower level of
education of the Indian rural population. Contrast the incredible success
of the SFCLs in Nepal with the list of countries who can look back on
failed cooperative banks programmes?
Finally, it is important to add one remark to the “close them or reform
them” debate. One side argues that, given the existing infrastructure and
human capital, it is worth reforming public banks and transforming them
in efficient providers of financial services to rural areas. The other argues
that the reform of a rotten bank is a hopeless endeavour and that it is
better to close it and start from scratch with a new institution. While,
globally, we can find strong arguments for both approaches - depending
on the prevalent local conditions - our cases point towards the
emergence of a third alternative, beyond the close vs. reform options.
The examples of BRI, the PBS, and the KGB all demonstrate that it is
possible to operate profitable microfinance activities while the remaining
business is still making a loss. Thus, it is not necessary to completely
restructure an existing bank before commencing microfinance activities.
On the contrary, profitable low risk microfinance activities can help to
stabilise banking operations in general.
Moreover, it is interesting to observe, that the banks which achieved the
fastest and most impressive results were those building microfinance
operations completely from scratch, either clearly separating them from
normal banking operations (BRI) or externalising them (ADBN). By doing
this, they established viable microfinance services with impressive
outreach, long before an end to the painful restructuring process of the
bank itself was (or, indeed, is) in sight. This approach seems to
capitalise on the benefits of the Greenfield Approach, while, at the same
time, making use of the infrastructure and resources of the bank.
The Challenge of Sustainable Outreach
APRACA/GTZ (ed.) (1997): The Linkage Banking in Asia. Volume I: The
Assessment of Linkage Projects; Volume II: Country Papers on
Selected Topics, Bangkok.
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(1984): Undermining Rural Development with Cheap Credit,
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BRI Micro Banking Services: Development Impact and Future
Growth Potential, Jakarta.
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Charitonenko, Stephanie. & Richard H. Patten & Jacob Yaron (1998):
Bank Rakyat Indonesia Unit Desa 1970 - 1996, Sustainable
Banking with the Poor, The World Bank, Washington DC.
FAO/GTZ (1998-99): Agricultural Finance Revisited, No. 1-6, Rome,
Gant, Richard & Dulan de Silva & Anura Atapattu & Steve Durrant
(2002): National Microfinance Study of Sri Lanka. survey of
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Synopsis Report: The Challenge of Sustainable Outreach
Maurer, Klaus (1999): Bank Rakyat Indonesia (BRI), Indonesia (Case
Study), in: Hannig, Alfred, Sylvia Wisniwski (ed.): Challenges of
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Banks-Perspectives and Prospects, Limassol, Cyprus.
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Development of Rural Banking in Indonesia, International Center
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The Challenge of Sustainable Outreach
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Case Study: Kakathiya Grameena Bank, India
Case Study:
Kakathiya Grameena Bank, India
Harishkumar R. Dave
Introduction: Outreach vs. Sustainability a Dilemma for Indian Banks?
Nearly 63% (680m) of India’s population of 1.08 billion lives in rural
areas. While the incidence of poverty has declined from 44.5% in 1983
to 26% (rural: 27%) in 2000, the absolute number of poor, as a result of
population growth, has only declined from 323m in 1983 to 260m in
Most of the poor - particularly those in marginal areas -remained outside
the fold of formal finance. Studies indicated that opportunities for
depositing their small savings and access to loans for emergencies and
micro-investments were among their most urgent needs. In an effort to
counteract perceived market failures, the government took responsibility
over the financial system in 1969 by nationalizing commercial banks.
During the 1970s and 1980s, in a tradition of social banking, it placed a
major emphasis on outreach at the expense of institutional viability.
It expanded the rural financial infrastructure and supplied cheap credit to
farmers and the rural poor through three networks (3/2002 data):
Source - National Human Development Report 2001.
The Challenge of Sustainable Outreach
nationalized commercial banks with 30,000 rural and semi-urban
Regional Rural Banks (RRBs), introduced in 1975, with 14,000
branches aiming at the rural poor
cooperative system, comprising 100,000 farmer cooperatives, over
13,000 cooperative bank branches for short term finance and 2000
branches for long-term finance.
This resulted in
Public ownership of a highly differentiated rural financial infrastructure, combined with government control over primary cooperatives
Massive outreach to farmers and the rural poor, comprising 232m
savers and 69m borrowers as of 3/2002
Unsustainable financial intermediation, combining vigorous deposit
mobilization with directed credit at subsidized rates within an inverted
interest rate structure.
The emphasis on outreach at the expense of institutional viability
resulted in two major challenges:
extreme default rates and bank losses
restriction in outreach to the better-off, effectively barring 300 m of the
very poor in rural areas (= 60m families) from sustainable access to
deposit and credit services.
Policymakers confronted two options for the public banks: closing them
or reforming them. They opted for latter. In 1992, the authorities began
addressing both challenges:
The Reserve Bank of India started liberalizing the financial system by
deregulating interest rates.
The National Bank for Agriculture and Rural Development (NABARD)
started a pilot project, establishing self-help groups (SHGs) of the very
poor as informal local financial intermediaries with access to bank
services, followed by implementation on a national scale after 1996.
Case Study: Kakathiya Grameena Bank, India
As of 2002, the problems are far from being resolved; but remarkable
progress has been achieved:
Rapid improvements in performance of RRBs (no information
available on other banks): Non-performing assets declined to 16%
(compared to 46% in 1995); the number of RRBs with losses during
2001-02, out of 196 RRBs, declined to 29 (=15%); the number of
RRBs with accumulated losses to 86; total accumulated losses
decreased by 3.5%, down to 14.5% of loans outstanding.
Rapid increase in outreach of banks to SHGs of the very poor on
commercial terms, with 461,000 SHGs of the very poor as of
31/3/2002, comprising 8m SHG members and a population of 40m,
linked to 17,000 bank branches; and extraordinarily high profit rates of
SHG banking due to virtually zero NPA. About one-third of India’s
300m31 poor are expected to be reached through SHG banking by
This paper reviews the impact of the reform process initiated during
nineties on the Regional Rural Banks in general, supplemented with a
case study of one of the 196 RRBs operating in India, i.e. Kakathiya
Grameena Bank (KGB) with focus on outreach vs. sustainability.
The Financial Sector in India
The Financial Infrastructure
The Indian financial system comprises commercial banks, regional rural
banks, cooperative banks and societies, term-lending institutions,
investment institutions, specialized development banks, non-bank
finance companies and other market intermediaries such as the stock
brokers, pawn-shops and moneylenders. Some of the NGOs and
Microfinance Institutions have taken up financial intermediation, but in
absence of proper regulatory and supervisory mechanism, their outreach
is quite insignificant compared to the formal banking system. Reserve
Bank of India (RBI) is the central banking authority in the country with
wide ranging powers for regulation, supervision & control of banks and
Recent poverty estimates, because of different methodologies adopted, have arrived at
figures of the poor population in the range of 260m to 300m.
The Challenge of Sustainable Outreach
other financial institutions. Commercial banks comprise public, private
and foreign banks.
Public Sector Banks (PSBs)
PSBs have either the Government of India or Reserve Bank of India as
majority shareholder. As part of the financial sector reforms, some of the
public banks have issued equity shares and are listed on the various
stock exchanges. Currently there are 27 PSBs in India operating through
46,316 branches spread over the country. Of these, 30,151 were rural or
semi-urban branches. These banks dominate the Indian banking system
with a share of more than 80% of total commercial bank assets. As on
31 March 2002, the outstanding deposits of PSBs stood Rs. 8,467 billion
(US$176.4 billion) and outstanding loans at Rs. 4,954 billion (US$103
billion). The PSBs were in the forefront of social banking since early
years of nationalization. However, with intensification of financial sector
reforms, the small loan accounts of PSBs (<Rs. 25,000 or US$520) are
showing declining trends. Such accounts aggregated at 39.3 million in
2000, down from 55.4 million in 1994 with the share of small loans in
total loans down from 19.8% in 1994 to 7.9% in 2000. Rural deposits and
loans of these banks accounted for 14% and 10.6% of total deposits and
loans, respectively. Agricultural loans formed 10% of total loans
Private Sector Banks
Private Sector Banks have been active in India for a very long time. The
amendment to Banking Regulation Act in 1993 paved the way for the
entry of new private banks. Currently there are 31 private banks with
5,376 branches, constituting the second largest group in the Indian
banking sector with a share of around 10% of deposits and loans. As on
31 March 2002, the outstanding deposits of private sector banks stood at
Rs. 1,499 billion (US$31 billion) and outstanding loans at Rs. 1,198
billion (US$25 billion).
Foreign Banks
Foreign banks have been active in India in their chosen niches.
However, during the phase of nationalisation, few new foreign banks
ventured into the countryside. Since the amendment to the Banking
Regulation Act in 1993, the banking sector has gradually opened to
foreign banks. Currently there are 40 foreign banks operating through
203 branches in the country.
Case Study: Kakathiya Grameena Bank, India
Regional Rural Banks (RRBs)
RRBs came into existence with the specific objective of providing deposit
and credit facilities to small and marginal farmers, agricultural labourers
and small entrepreneurs. The 196 RRBs operate through 14,486
branches spread over all provinces of the country. Their operations are
normally restricted to 1 - 3 districts. RRBs currently have a marginal
share in the deposits and loans of Scheduled Banks at around 4% and
2.7%, respectively. As on 31 March 2002, the outstanding deposits of
RRBs stood at Rs. 443 billion (US$9.24 billion) and outstanding loans
and advances stood at Rs. 186 billion (US$3.87 billion).
The Cooperative Sector
The Cooperative Sector is very complex in India and comprises the
a) 30 State Co-operative Banks at the Province Level
b) 367 Central Co-operative Bank sat the district level
c) 98,843 village-based Primary Agriculture Credit Societies
d) 20 State Land Development Banks at the state level
e) 732 Primary Agricultural Development Banks at district level
f) Urban Co-operative Banks, mostly at urban and metropolitan
The cooperative credit structure is broadly divided into short-term and
long-term credit institutions. The short-term structure has three tiers in
most of the states with Primary Agricultural Credit Societies (PACSs) as
the base unit, District Central Cooperative Banks as federations of
PACSs operating in a district and State Cooperative Banks as apex
banks of District Cooperative Banks in each state. The long-term
cooperative credit structure comprise of Primary Land Development
Banks (PLDBs) at district level and State Land Development Bank
(SLDBs) as apex bank at state level. The rural banking structure in India
as on 31 March 2002 is presented in Table 1 below:
The Challenge of Sustainable Outreach
Table 1: Rural Banking Structure in India (31 March 2002)
Cooperative Financial
Institutions (Short Term
20 SLDBs +
Primary LDBs 196
rural &
semi urban32)
No. of
(Long Term
No. of units or
1,249 SLDBs
726 Primary
(in millions)
100 33
(82 m rural)
(in millions)
(10.3 m rural)
(billion Rs.)
(303 rural)
(1,212 rural)
(billion US$)
(6.31 rural) (25.3 rural)
Loans outstanding
(billion Rs.)
(132 rural)
(498 rural)
(billion US$)
(2.8 rural)
(10.4 rural)
Gross NPAs
Various RBI and NABARD publications
Most of the semi-urban branches also finance in rural areas.
Represents total members of primary cooperative credit societies. Figures of depositors
not available, though many of the primaries accept deposits.
Case Study: Kakathiya Grameena Bank, India
Apex Financial Institutions and Development Finance
Apex Financial Institutions and Development Finance Institutions
normally provide long term capital for industries and agriculture. In 1949,
after independence, the government established the Industrial Financial
Corporation of India to finance industrial development. The National
Bank for Agriculture and Rural Development (NABARD), the Small
Industries Development Bank (SIDBI) and the National Housing Bank
followed as all-India apex development banks. In recent years public
mutual funds were added. The capital market has experienced
tremendous growth in terms of resource mobilisation, listings and market
The apex development bank of India for agriculture and rural
development established in 1982, supports the Indian banks in
expanding their outreach in a sustainable manner through the
instruments of (i) policy guidelines; (ii) credit for agriculture, allied
sectors, and the rural non-farm sector; (iii) institutional development
assistance; (iv) rural credit innovations and (v) supervision of cooperative
credit structure and RRBs. It also provides rural finance policy inputs to
the financial authorities. In recent years, it has piloted and supported the
largest and fastest growing microfinance programme in the world, the
SHG Bank Linkage Programme.
Regional Rural Banks: outreach without sustainability
The Mandate
The mandate of the RRBs as spelled out in the Regional Rural Banks
Act of 1976 is:
to take banking to the doorsteps of rural masses, particularly in
marginal areas
to make available cheaper institutional credit to the weaker sections of
the society
to mobilise rural savings and channel them into productive activities
to generate employment opportunities in rural areas and
The Challenge of Sustainable Outreach
to bring down the cost of providing credit in rural areas.
Ownership and Governance
The RRBs have a common ownership pattern, with 50% of equity owned
by the Government of India, 15% by respective state government and
35% by a sponsoring bank, usually public commercial banks. They
started with a moderate capital base of Rs. 2.5 million (US$52,083).
Over a period of time, the paid-up share capital of each of the RRBs was
raised to Rs. 10 million (US$210,000), as against an authorized share
capital of Rs. 50 million (US$1.04 million). Subsequently, as a part of the
financial sector reforms, additional total share capital assistance of
Rs. 2.2 billion (US$45.8 million) was injected. Pending amendments to
the RRB Act, these capital injections are included in the balance sheets
as share capital deposits.
Board of Directors
The direction and management of RRBs is vested in the Board of
Directors, consisting of the chairman as CEO appointed by the sponsor
bank, two non-official directors, and six directors of the sponsor bank,
State Government, RBI and NABARD. The board is expected to act on
business considerations with due regard for the public interest. At the
same time, it is expected to conform to the advices issued by the
Government of India in matters relating to public interest, which include
areas such as personnel policies, recruitment, promotions, and wages.
Starting with 6 RRBs in 1975, their number had reached 85 by 1980,
with mere 210,000 borrowers in 144 districts. In next five years, growth
was phenomenal. By 1985, 188 RRBs provided credit to 7 million
borrowers in 333 districts. A large number of branches of RRBs were
opened in remote areas without banking services. After their exclusive
pro-poor focus during the first 20 years of existence, the RRBs were
allowed in 1995 as part of reforms process to finance ‘non-target group’
clients. As of March 2002, 196 RRBs were providing banking services in
500 districts through 14,350 branches. The number of deposit and loan
accounts of these banks had grown to 50 million and 11.9 million,
respectively. As of March 2002, RRBs accounted for 23.8% of the total
rural branch network of the formal banking system, 4% of total deposits
and 2.7% of total loans outstanding of Scheduled Banks.
Case Study: Kakathiya Grameena Bank, India
Impediments to profitability
The Working Group on Rural Banks in 1975 had laid emphasis on
viability of rural banks; but this was not followed up. During the first ten
years, 152 out of 188 RRBs accumulated losses of Rs. 3.4 billion. The
amount of losses went up sharply in 1992 on account of nation-wide debt
relief and the introduction of an adjusted salary scheme. Their financial
viability was overstretched by policy rigidities coupled with poor loan
repayment, a low capital base and recurrent political interferences.
Structural impediments include limitations in the area of operation and
choice of clientele, small loan sizes rates, directed lending, and
regulated interest rates. This eroded not only their capital, but in many
cases also ate into their deposits. By 1993 - 94, the losses of RRBs
mounted to more than US$625 million, forcing the authorities to take
RRB reform
The winds of financial sector reforms, which started blowing in India in
1992, also swept the RRBs. Major reforms included broad basing the
business activities of RRBs, deregulation of interest rates, greater
freedom of investment to improve earnings, retraining of employees,
application of prudential norms along those of the International Basle
Committee, strengthening the capital base, introduction of annual
preparation of Development Action Plans aimed at viability, and including
bank professionals in the Board of Directors. The focus of reforms in
RRBs since 1994 was to turn them into strong financial intermediaries
and enable them reaching their full potential. Policy, structural and
financial reforms included the following: Policy Measures
To attain viability and self-reliance, RRBs were permitted to finance
the non-farm sector non-target group borrowers, first up to 40% and
subsequently up to 60% of their portfolio.
RRBs were given complete freedom in deciding the rates of interest
on loans and deposits.
Income recognition and asset classification norms were introduced in
1995 - 96, provisioning norms in 1996 - 97. In 2003 - 04, the norms
for classification of Non Performing Assets will be further tightened
from presently 180 days to 90 days.
The Challenge of Sustainable Outreach
RRBs were required to prepare a plan for achieving viability within a
specific time frame and sign Memorandum of Understanding (MoU)
with their sponsor bank on annual basis. The Board of Directors
reviews the progress on a quarterly basis.
In order to reduce NPAs, a one-time settlement scheme was
introduced to improve the recovery of loans.
RRBs were encouraged to adopt the Self-Help Group Banking
approach for channeling credit to the poor on sustainable basis.
Product innovations in form of Credit Cards for farmers were
introduced for facilitating provision of adequate and timely credit to the
farming community.
Barred by RBI to provide financial performance incentives, a new
training intervention known as Organizational Development Initiatives
was launched in order to improve staff motivation.
Structural Measures
RRBs were permitted to relocate loss-making branches from remote
areas to better business location or convert them into satellite offices
with a reduced staff.
Professionals such as economists, agricultural scientists, chartered
accountants and other financial experts were included as non-official
directors in the board.
Sponsor banks were entrusted with full managerial responsibility,
relegating RBI and NABARD to regulation and supervision.
Financial Measures
RRBs were recapitalized in three phases, injecting Rs. 21.88 billion
(US$446 million) in 187 RRBs during 1995 - 2000.
RRB business was diversified, including the issuance of bank
guarantees, the purchase and discounting of cheques, Rupee
Traveler's Cheques, Drafts and Money Transfers, locker facilities and
housing loans.
In order to broad base their investments and provide access to
profitable avenues for investment of its non-statutory liquidity funds,
RRBs were provided enhanced freedom.
Case Study: Kakathiya Grameena Bank, India
Impact of Reforms
The unshackling of the RRBs had a very positive impact. NPAs dropped
from 46% in 1995 to 16% as in 2002. The number of profit-making RRBs
grew from 32 RRBs in 1995 to 162 in 2000, despite a sharp increase in
losses during 1997 on account of new prudential provisioning norms.
The number of RRBs, which had wiped out all their accumulated losses
increased significantly, reaching 55 in 2000 and 86 in 2002. The
aggregated net profit of RRBs amounted to US$150 million in 2002, an
increase of 19% over the previous year; while the accumulated losses of
RRBs declined from US$582 million as on 31 March 2001 to US$561
million as on 31 March 2002.
Sustainability was not attained at the expense of compromising their
original mandate. During the initial phase of liberalization, during which
the RRBs were permitted to also finance non-target group clients, the
outstanding loans increased at a significant annual average growth rate
of 22% between 1995 and 2000. Subsequently, the growth rate
stabilized at a healthy 18-20% range. The drop in the number of loan
accounts from 12.6 million in 1995 to 11.5 million in 2000 was primarily
due a vigorous recovery drive to reduce the levels of NPA and the writing
off of large numbers of small bad accounts.
However, the Credit-to-Deposit ratio of RRBs declined substantially from
56% in 1995 to 41% in 2000 where it has almost stabilized till 2002,
indicating that the resources mobilized from the rural areas are not being
ploughed back. This is an area of concern since the RRBs have access
to credit lines from NABARD and the sponsor bank for enhancing the
flow of credit in rural areas. The performance of RRBS over the years is
presented in Table 2 below:
The Challenge of Sustainable Outreach
Table 2: Performance of RRBs - 1975-2002
(Amounts in US$ million)
No. of No. of Deposits Loans Credit to RRBs RRBs RRBs Accu- NPA in
RRBs branche
deposit earning with without mulated %
ratio in current current accu- losses
profits losse mulated
Source: Various annual publication of RRB data by NABARD
With healthier loan portfolios, the RRBs have taken up expansion of
outreach in a sustainable manner through the Self Help Group-Bank
Linkage Programme. As may been seen from the table below, the
number of rural poor women accessing the financial services from the
RRBs through their own self managed Self Help Groups has increased
manifold in last three years. With near zero NPAs under the loans given
to SHGs, the RRBs have found a sustainable way of outreach expansion
among the rural poor. Including the outreach achieved to the rural poor
through financing of SHGs, the RRBs increased their credit outreach
from 12.6 million clients in 1995 to 15.1 million in 2002. The details of
outreach profile of RRBs between 1995 and 2002 is presented in Table 3
Case Study: Kakathiya Grameena Bank, India
Table 3: Saver, borrower and SHG outreach of RRBs, 1995-2002
No. of
(in million)
No. of loan
(in million)
Credit to
Ratio in %
No. of SHGs
financed by
No. of SHG
in millions
Source: Annual publications on RRBs by NABARD
Issues which need to be addressed: In 2001, the government set up a
Working Group to Suggest Amendments to the Regional Rural Banks
Act, chaired by NABARD, which presented the following critical issues:
High-risk exposure on account of limitations in area of operation,
restricted business activities and clientele.
Continued perceptions of RRBs as a bank for the poor in the mind of
the public and of RRB staff.
The roadmap for structural change of RRBs has not been properly
designed; over the past ten years, there has been little development
of the branch network.
Capital and asset limitations have restricted the growth of business
Confusion between the social and commercial objectives persists.
Some of the RRBs have adopted an investment rather than the
mandated loans route to viability.
RRBs are not adequately integrated into the financial markets, relying
on their respective Sponsor Banks instead, which is a competitor.
Narrowly defined policy directives and dependency on sponsor banks
even in small matters have restricted the power of the board and
added to the governance problems of RRBs.
Despite pressures of credit expansion, profit orientation and
compliance with banking norms and widely differing work situations in
the various parts of the country, uniform personnel policies have been
imposed and caused highly disruptive period staff unrest.
The Challenge of Sustainable Outreach
The committee has made wide-ranging recommendations, relating to
ownership, structure, governance, regulation & supervision, and
personnel policies that are currently under review.
SHG Banking: How to Overcome the Dilemma of
Outreach to the Poor vs. Sustainability34
NABARD’s programme Linking Banks and Self-Help Groups aims at
providing sustainable access to financial services to the rural poor,
focusing on those who had been considered unbankable. By using the
existing rural financial infrastructure of 150,000 banking and cooperative
retail units and linking them to savings and credit groups with joint
liability, there are economies of scale and scope, resulting in
substantially lower transaction costs. National implementation started in
1996, after four years of pilot-testing. Due to massive support from
governmental and non-governmental agencies and the banking sector,
the programme grew rapidly and, by March 2002, encompassed 461,000
self-help groups (more than 500,000 by September 2002) with 8m
members, covering 40m household members. Average loan sizes are
Rs. 22,240 (US$463) per SHG and Rs. 1,300 (US$27) per member.
With its balanced emphasis on both savings and credit, it is the largest
non-directed microsavings and microcredit programme in the developing
world. By 2008, it is expected to cover a population of 100m, which is
one-third of India’s rural poor. 209 commercial banks, 191 regional rural
banks and 44 commercial banks are involved as banking partners, with
17,085 participating branches. There can be no doubt about the
programme’s outreach to the poor; but is it viable for the banks? Is SHG
Banking a poverty-lending program, which may be of immense benefit to
the poor, but only thrives on subsidies; or is it a commercial proposition
that can be recommended to all banks as an instrument of both outreach
and institutional viability?
There are two outstanding aspects to the programme: massive outreach
at lowest interest rates, fluctuating around 7% in real terms. Seven units
of three banks were studied in October 2002. The study applied average
cost analysis, attributing all costs duly to each product; and marginal cost
analysis, in response to the advice of bank managers to ignore
Studies, papers and training materials on SHG Banking are available from Micro Credit
Innovations Department, NABARD, Mumbai ([email protected]).
Case Study: Kakathiya Grameena Bank, India
personnel costs of SHG banking because of existing idle capacities.
Main performance indicators are non-performing loans, return on
average assets, and operational self-sufficiency.
Non-performing loans to SHGs were 0%, testifying to the effectiveness
of group lending to the very poor. In contrast, consolidated NPL ratios of
the banking units ranged from 2.6% to 18%; and of Cash Credit and
Agricultural Term Loans up to 55% and 62%, respectively.
Returns on average assets (ROA) of SHG Banking ranged from 1.4%
to 7.5% by average and 4.6% to 11.8% by marginal cost analysis,
compared to -1.7% to 2.3% consolidated. The operational selfsufficiency of SHG banking ranged from 110% to 165% by average and
142% to 286% by marginal cost analysis, compared to 86% to 145%
consolidated. In contrast, ROA of Cash Credit varied from -10.2% to
-0.5% and of ATL from -6.3% to 0.2%; OSS ratios from 54% to 102%.
SHG Banking was found to be a robust financial product, performing well
in healthy as well as in distressed financial institutions.
Self-reliance of SHGs based on internal savings and retained earnings
were found to be rapidly growing, exceeding in older groups the volume
of bank refinance by an increasing margin. In addition, SHGs deposited
substantial amounts of savings voluntarily in banks as reserves.
In addition to direct effects on bank profits, SHG Banking has indirect
commercial effects on banks in terms of improved overall vibrancy in
banking activities. Indirect benefits at village level include the spreading
of thrift and financial self-reliance and of a credit culture among villagers,
micro-entrepreneurial experience, growth of assets and incomes, the
spreading of financial management skills, and the decline of private
money lending. Intangible social benefits are reportedly many:
self-confidence and empowerment of women in civic affairs and local
politics, improved school enrolment and women’s literacy, better family
planning and health, improved sanitation, reduction of drinking and
smoking among men, and a decline in adherence to local extremism.
The future sustainability of SHG Banking hinges on five factors: (a) A
sound self-supporting institutional framework is in place, (b) Despite
exceptionally low interest rates, linkage banking was found to be viable
and profit-making for all financial institutions and SHGs; however, many
rural banks require restructuring. (c) SHGs have substantially increased
their level of self-reliance and deposited reserves, while banks are
constrained by high statutory liquidity requirements. (d) Given the low
The Challenge of Sustainable Outreach
inflation rate, preservation of the value of resources is no major issue,
except in distressed banks. (e) With continually increasing internal funds,
effective supervision of SHGs through a delegated system, together with
the enforcement of prudential norms in banks and cooperatives,
emerges as a major challenge to the long-term sustainability of SHG
banking and rural finance in India.
SHG banking in India has exceeded its predecessors in Asian and other
countries by a wide margin both in terms of outreach and profitability.
Three challenges remain:
expansion to the total rural banking network in India to reach 300m
rural poor with access to savings and credit;
incorporating some of the good practices of SHG banking in other
financial products to eliminate NPAs, invigorate banks and
cooperatives, and consolidate the reform process;
offer the lessons of good SHG banking with the poor and the poorest
to SHGs and banks all over the developing world.
Kakathiaya Grameena Bank (KGB)
KGB was established in 1982. Sponsor bank is the State Bank of India.
The bank has only one district as area of operation viz. Warangal in the
southern state of Andhra Pradesh. The economy of the district is mainly
agricultural, with animal husbandry as a secondary activity. There is very
little industry. Of the 3.2 million population of the district (about 0.64m
families), 82% live in 1,003 villages. The agriculture is mainly monsoondependent. The erratic monsoons in last few years have affected the
economy badly. More than 56% of land holdings are less than 1 hectare,
accounting for 19% of privately held land, while 24% of land holdings are
between 1 to 2 hectares, covering 24% of land.
Poverty is widespread and has made the district- classified as one of 19
districts with serious problems of law and order - a breeding ground for
armed insurgence. This has posed serious constraints for all banks
activities in the district, with loan defaulting - amounting up to 50% at one
time - considered as a form of unarmed insurgence.
Case Study: Kakathiya Grameena Bank, India
KGB is one of the 20 banks operating in the district and with 40
branches, it has 25% share in terms of total bank branches and 29%
share among the rural bank branches (39 rural branches). As against a
Credit-to-Deposit ratio of 47% of the commercial banks in the district,
KGB had a better ratio of 70%, meaning higher amount of the deposit
mobilized from the district was being invested back in the district. As a
late entrant to the district banking market, it had to contend itself with
hitherto un-banked and remote areas.
Out of 1,098 revenue villages in the district, the bank offers its services
in 202 villages under the service area approach, plus 50 non-service
area villages, constituting more than 25% of the banking outreach in the
district. For focused planning and development through credit, identified
clusters of villages are allotted to different bank branches of RRBs and
commercial banks, forming their service areas, assigning specific
responsibilities to them to provide banking services in the assigned
service areas.
The bank primarily extends credit facilities to the lower income strata of
the rural area. Right from the inception, the bank has taken a lead in
implementing various government-sponsored income and employment
generation programmes benefiting largely the weaker sections of the
rural society.
The bank is also the pioneering bank under microfinance. It was the first
among the banks in the district to take up SHG banking in 1997-98 and
continues to occupy first rank in the district in terms of number of SHGs
The outreach profile of the bank can be seen from the table 4 below:
Table 4: Outreach profile of KGB
(Amount in US$ million)
Number of Borrowers
and loans outstanding
83,659 16.18
Number of savers and
deposits outstanding
121,258 23.54
Source: Annual Reports of KGB
The Challenge of Sustainable Outreach
Despite its good efforts in reaching out to the rural masses and
specifically the rural poor, the bank went on incurring losses for nearly
17 years of its establishment. The reforms process that started around
1994 started making an impact on the performance of the bank.
KGB, like all the rest of the RRBs underwent the reform process.
Beginning in 1995 - 96, the KGB benefited on account of interest rate
deregulation, recapitalisation, branch relocation, extending credit to
hitherto non-target group clients, etc.
Ownership and Governance
The Bank carries on and transacts the business of banking as defined
under the Banking Regulation Act. KGB has been sponsored by the
largest commercial bank of India, i.e. the State Bank of India. The Bank's
authorized share capital is Rs. 50 million (US$1.04m) and paid up share
capital is Rs. 10 million (US$0.21m).This is contributed by the
Government of India, State Bank of India and the Government of Andhra
Pradesh in the ratio of 50:35:15. As part of the revitalization effort, the
three shareholders infused additional capital of Rs. 93.8m (US$1.95m)35
in the same proportion between 1996 - 97 to 1998 - 99.
At the time of its establishment, the bank was supposed to be a small
man’s bank in rural areas. Though the pressures of attaining
sustainability have led to dilution of the original mandate, the focus still
remains on outreach to the lower income strata.
Right from inception, the bank took a lead in implementing various
programmes. However, it failed to earn profits for the first 17 years! With
the newly won freedom of selecting borrowers from the non-target
groups, semi-urban and urban areas, and relocating some of its
branches from inaccessible villages to rural market centers, the bank has
been able to deploy its surplus resources in high value advances such
as small scale industries, trade & services and transport sectors.
Additional share capital is shown as share capital deposits in the balance sheet pending
amendments to the RRB Act.
Case Study: Kakathiya Grameena Bank, India The relationship between
management of the bank
Each shareholder is represented on the Board of Directors. Given that
the sponsorship and consequent responsibility of running the bank rests
with the sponsor bank, a senior official of the Sponsor Bank is appointed
as the Chairman of the bank, with tenure of three years. The functions of
the sponsor bank include providing management personnel, facilitation
of cash management and money transfer, monitoring, overall guidance
on loan policies, documentations, supervision, investments of surplus
funds, providing audit facilitation and staff training.
The state government appoints two district officials as directors, one of
them being the Project Director of the District Rural Development
Agency, the nodal government agency for undertaking district
developmental activities. The Government of India, the majority
shareholder, is represented by four directors chosen from RBI, NABARD
and the area of operation of the RRB. Although, there was an in-principle
national level policy view to induct professionals in the Board, the KGB
did not have the benefit of presence of any professionals on the Board.
The day-to-day functioning of the bank is carried out under the
supervision of the Chairman and under overall guidance of the Board of
Directors. Personnel policies on recruitment, promotions, salaries and
industrial relations are generally decided by the Govt. of India in
consultation with NABARD and are generally applied uniformly among all
RRBs. The bank has no say in deciding the personnel policies, except
transfers. There is no system of individual performance incentives.
Increasingly, as per the policy views taken at national level, the sponsor
bank is expected to guide the bank in some of the operational matters
relating to staff matters such as promotions and staff allowances.
RBI delegated the responsibilities of supervision to NABARD. The
Directors from RBI and NABARD ensure governance of KGB within the
overall policy, regulatory and supervisory framework laid by the RBI and
GOI. The directors from the state government help KGB in
implementation of poverty alleviation programmes and in the resolution
of repayment problems.
The functioning of the Board of Directors is reviewed during the biannual inspections of the bank by NABARD as also the periodic
management audits carried out by the sponsor bank. The observations
The Challenge of Sustainable Outreach
are placed before the Board of Directors and also sent to the controlling
authorities of the respective Directors.
Priority lending and directed credit
A distinction needs to be made between priority sector financing and
government-directed subsidized poverty alleviation credit programmes.
The “priority sector” includes loans for entire agriculture (including short
term loans for crop production, medium to long term loans for
investments such as irrigation, farm mechanization, land development,
animal husbandry, poultry, horticulture, etc.), loans to small scale
industries, artisans, cottage industries, handlooms, small retail trade and
services, housing, education, small road transport operators, etc. The
categorization of such loans as “priority” has not much practical meaning
for RRBs since their mandate was for financing such loans, which any
way fall under “priority” status. Initially, there was a focus on small loans
within the “priority” sector loans, which has now been relaxed to include
bigger size loans, the bulk of which even now qualifies as “priority”
However, there are expectations from KGB regarding loans to be given
under the government directed poverty alleviation programmes. Targets
used to be allocated to KGB depending upon the number of villages
serviced. The selection of borrowers used to be done by the
“sponsoring” government development agencies, with little say of the
branch. The subsidies also gave such loans the character of a
“government gift”. Mismatches between loan size and investment
capacity of borrowers were common, resulting in low repayment rates.
Over a period of time, with mounting NPAs, the bank became reluctant to
provide loans under directed credit programmes. Over time, pressures
on participation in the Government’s poverty alleviation programmes
have relented. The bank used to be one of the major financiers of the
largest credit linked poverty alleviation programme, the Integrated Rural
Development Programme, which along with a few similar programmes
has now been merged into “Swarna Jayanti Gram Swarozgar Yojna”
(Golden Jubilee Village Self Employment Programme). In addition, the
bank has participated in programmes for minorities and scheduled tribes
and castes. The proportion of directed credit has declined from 8% of
loans outstanding to 6% over the past three years. Table 5 below
presents the share of loans outstanding under various directed lending
programmes over the last three years.
Case Study: Kakathiya Grameena Bank, India
Table 5:
Loans under government programs, 2000-2002
(in Rs. million)
Integrated Rural Dev. Prog.
Integrated Tribal Dev. Prog.
Scheduled Castes Action Plan
Backward Classes Action Plan
Minority Corporation Prog.
Source: Annual Reports of KGB
Supervision and control
Three types of external supervision and audit systems exist in the
bank. The statutory audit is carried out annually by governmentapproved Chartered Accountants. The Sponsor Bank conducts
management audit of the Bank once in two years. The Sponsor Bank
reviews the performance of KGB vis-a-vis MOU signed with it and
examines the systems and procedures and advises for improvements
wherever necessary. NABARD, on behalf of RBI, conducts inspection of
the Bank under the Banking Regulation Act once every two years. The
inspection focuses on policies, systems and procedures adopted by the
bank and comments on the compliance to various instructions of the
Government of India and the Reserve Bank of India. Apart from the
periodic on-site supervision, NABARD also has put in place an earlywarning system of off-site supervision through periodic returns to be
submitted by the bank.
The internal control systems put in place by the bank comprise of the
Periodical Returns submitted by branches
Snap Audit (a quick and surprise audit system)
Audit and Inspection (regular audit of the branches done by the
inspectors of the bank)
Cash Audit (done during the surprise visits of the HO officials to
Surprise visits by HO functionaries
The Challenge of Sustainable Outreach
The audit and internal control systems have been based on the practices
prevailing in the sponsor bank and has been able to minimize fraud.
Further, the bank has recently computerized all its branches on a standalone basis and is now making preparations to network its branches with
Head Office, which also expected to further tighten the internal control
The branches are monitored through weekly reports, comprehensive
monthly statements including balance sheets and quarterly profit and
loss accounts. Budgeting for the bank and the branches is done
annually; the performance of the branches against the budgets is
reviewed monthly. As part of the restructuring process, the bank is
required to prepare a development action plan with the objective of
attaining operational profitability and cleaning up its accumulated losses.
On that basis, annual business projections are prepared and entered into
a MOU with its sponsor bank.
Assessment and Conclusions
The government ownership and the sponsorship by the largest bank of
the country helps this small-sized bank gain the respectability and public
imagerequired for mobilization of public deposits. It also helps the bank
in integrating with the wider financial sector of the district. The support of
the sponsor bank helps in cash management, money transfers and
internal control. With a 25% share in total rural bank branches, the bank
has a good coverage of the rural district. The cooperative banking
system in the district is weak and does not pose much competition.
The relatively small area of operation (only one district) has limited the
number of branches and increased systemic risks in a district with rainfed agriculture. These have been further aggravated by local radicalism,
depressing repayment morale. With is low capital base and capital
adequacy ratio, KGB is poorly equipped to withstand these risks.
Strength could also be a weakness, as is the case with government
ownership and sponsorship by a commercial bank, which is a competitor
and a control agency rather than a partner. After 25 years of regional
rural banking, the ownership pattern and the resulting micromanagement
interference is due for a review. Key management positions are still
occupied by the officials of the sponsor bank, barring KGB staff from
promotion into management. The lack of autonomy and operational
freedom in staff and management hampers the growth of the bank; in
fact, the number of staff declined from 185 to 181 over the last three
Case Study: Kakathiya Grameena Bank, India
years. Little progress has been made in infusing bank professionals in
the board. There are no staff performance incentives. Staff training is
inadequate. All this does not help KGB to evolve as a bank of the 21st
century. The bank feels it would be more successful in attaining its dual
objectives of sustainability and outreach under NABARD ownership.
Economic Viability Performance overview
Riding on the reform wave, the bank was able to improve business
significantly over the last few years. On account of higher-than-averagemarket-rates of interests on deposits, it succeeded in mobilizing deposits
at a 57% growth rate in 1998-99, tapering off to 21% in 2000-01 and
stabilizing around 20% in 2001-02 (compared to 16% in 2001-02 in the
district as a whole). The performance of the bank in credit expansion
was also significant at an average annual growth of 28% for the last
three years.
Branch productivity increased from Rs. 28.3 million (US$0.6m) in
1998-99 to Rs. 59.7 million (US$1.24m) in 2001-02. Total working assets
of the bank increased from Rs. 668 million (US$13.92m) in 1998-99 to
Rs. 1.44 billion (US$30m) in 2001-02, a growth rate of 115% over three
years. Similarly, with declining number of staff and increasing business
levels, staff productivity increased from Rs. 6.3m (US$0.13m) in 1998-99
to Rs. 13.2m (US$0.28m) in 2001-02, registering a remarkable growth of
112% over the three-year period.
As of March 2002 KGB has mobilized resources through various deposit
products from 123,484 depositors to the tune of Rs. 1.36 billion
(US$28.3m) and extended credit to 102,484 borrowers to the tune of
Rs. 1.03 billion (US$21.5m).
While the bank was successful in expanding its outreach and volume of
business, the bank earned its first modest profits of Rs. 2.7m
(US$0.06m) in 1998-99, which increased to Rs. 12.9m (US$0.28m) in
2000-01. But in 2001-02 it again incurred losses of Rs. 31.9m
(US$0.66m). This was due to a 47% rise in the wage bill on account of a
court directive to all RRBs; enhanced provision of Rs. 24.2 m (US$0.5m)
for bad and doubtful debts during 2001-02 against a provision of Rs.
5.7m (US$0.12 m) in the previous year. With accumulated losses of
The Challenge of Sustainable Outreach
Rs. 120.3 m (US$2.50m), its share capital of Rs. 103.8m36 (US$2.16m)
was fully eroded as on March 2002, which made the bank technically
bankrupt. The details of KGB’s financial statements for the last three
years are given in Annexure I. Interest rates
The Reserve Bank of India gave complete freedom to RRBs for
determining their own deposit and lending rates in 1996. Observing
market trends, KGB utilized the freedom by offering higher interest rates
on deposits as of October 1996. At the same time, it increased interest
rates on small loans up to Rs. 25,000 from 12% to 15%, medium loans
up to Rs. 100,000 from 13.5% to 17% and loans above Rs. 100,000 up
to Rs. 200,000 from 13.5% to 18%, still apparently adhering to social
banking expectations of charging lower interest rates on costlier small
loans. Until June 2000, KGB charged 22.5% on loans for consumer
durables and on loans against gold ornaments or government securities.
At the higher rates, the bank found it difficult to get good new clients,
which resulted in a shift of the portfolio to high-risk borrowers. As of July
2000, the bank reduced the highest lending rate from 22.5% to 17%.
Deposit rates fell to a range of 7.5% to 12% in 1999 and 5% to 8.75% in
2002, reflecting changes in monetary policy of the central bank. To cover
the costs of computerization, the bank also decided to charge Rs. 50
(US$1) annually per loan account. Cost of funds and margins
Despite an overall fall of interest rates, average costs of deposits during
last three years went up from 9.8% to 10.94%, reflecting a substantial
increase in the share of time deposits. Similarly, after initial
improvements from 12.62% in 1999-00 to 13.63% in 2000-01, the yield
on loans declined to 13.23% in 2001-02. Accordingly, the spread (2.82%
in 1999-2000, 3.04% in 2000-01 and 2.29% in 2001-02) continued to be
under pressure.
In addition to the deposits, KGB has also facilities available for
refinancing its loan portfolio at near market rates from its sponsor banks
and NABARD. While the sponsor bank and NABARD provide refinance
to the bank for short term loaning operations, NABARD also provides
refinance to the bank for medium and long term credit operations also,
Share capital includes the recapitalisation funds of Rs. 93.8m (US$1.95m) lying as share
capital deposits.
Case Study: Kakathiya Grameena Bank, India
backed by technical assistance for project formulation, appraisal and
monitoring. Such refinance helps the bank providing term finance to key
sectors of the rural economy and avail of concomitant technical
Table 6 below presents the status of refinance availed by the bank and
cost of average refinance borrowings in last three years:
Table 6: Amount of refinance and costs of borrowings, 2000-2002
(Amount in US$ million)
Sponsor Bank
Average cost of borrowings
Source: Annual Reports of KGB
Apart from the statutory cash reserve requirements, which are to be
maintained as balances in non-interest bearing current account with the
RBI, KGB invests its minimum statutory liquidity reserve requirements
with its sponsor bank either in interest bearing current account and short
term deposit accounts, besides investing its other surplus liquidity in
short term deposits with sponsor bank and in government approved
securities. The income from such investments is also a major source of
income for the bank. Table 7 below presents the outstanding position of
investments37 and return on average investments, indicating a steady
Table 7: Investments and their returns, 2000-2002
(Amount in US$ million)
Investments outstanding
Return on avg. investments
On aggregate operations, the return on average assets showed a
decline from +1.0% in 1999-2000 to -1.7% in 2001-02, reflecting the
Includes the investments in approved securities and money at call & short notice, term
deposits with sponsor bank.
The Challenge of Sustainable Outreach
influence of external factors, particularly court-imposed payment of wage
arrears (Table 8 below).
Table 8: Return on average assets, loans and equity, 2000-2002
Return on average assets in %
Return on average loans in %
Return on equity in % Loan recovery
The bulk of the loans of KGB are towards agriculture. The due dates for
payments of both short and medium term loans coincide with the
harvesting seasons. Short-term crop loans are recovered in one
instalment; medium term loans for irrigation and farm mechanization
have semi-annual repayment schedules. Loans for dairy animals are
generally recovered on a monthly basis. The loans for rural non-farm
activities such as village and cottage industries, artisans, retail trade and
small business, etc., have repayment schedules worked out according to
cash flows.
It is only since computerization in 2002 that the branches are now in a
position to quickly generate information on overdues, which is expected
to help in improving loan recovery. The repayments of loans were
hitherto measured as actual collection of loans against what was due i.e.
the demand. A Demand Collection Balance (DCB) register has being
prepared annually on every 30 June as a basis for sector- and villagewise loan monitoring and follow-up. The sector wise details of% of ontime repayment of loans for the last three years are given below. Except
for SHG loans, on-time repayment rates are abysmally low. It is only
recently, with the introduction of prudential norms, that the concepts of
NPA and NPL are being increasingly used for loan monitoring, resulting
in a significant decline in gross NPA rates from 16% to 9.6%. Table 9
below presents the repayment performance of various loan products,
while the NPA details are presented in Table 10.
Case Study: Kakathiya Grameena Bank, India
Table 9: Repayment performance of different loan products
On-time repayment rates, 2000-2002 (in %)
Type of loan
Agri Cash Credit (ACC)
Agri Term Loan (ATL) …
Term Loan (TL)
Cash Credit (CC)
Self Help Group (SHG)
Source : Annual Reports of KGB
Table 10: Non-performing assets, 2000-2002
(Amount in US$ million)
Total Loans
% NPA to Total Loans
Source: Annual Reports of KGB
For inculcating habits of on-time repayment of loans among clients, the
bank has given priority to Farmers’ Clubs of 15-20 members supposedly
comprising farmers with good investment and repayment performance.
Through Farmers’ Clubs, the bank initiates a process of “development
through credit”, facilitating interactions with agricultural scientists and
technologists and spreading word about the benefits of on-time
repayments. The credit extension propagated by KGB through 45
Farmers Clubs under Vikas Volunteer Vahini Programme has the
potential of ensuring a good customer base and a healthy loan portfolio.
In fact, the volunteers and their clubs could be converted into extended
arms, legs and ears of the bank, at low cost. The bank could be well
advised to emulate the experiences of other RRBs, which have adopted
the Farmers’ Club approach for the marketing of financial products.
Prospects are good for the bank to attain current viability within the next
two years.
ACC: crop loan of 12 months for two seasons, due upon maturity; ATL: 36-60 months,
payments due quarterly or (mostly) yearly; TL: 36 months, payments due monthly or
quarterly; CC: Overdraft facility or composite term and working capital loans; SHG: 24-36
months, monthly repayment.
The Challenge of Sustainable Outreach
The branch staff, using village-wise repayment records, undertakes field
visits to problem villages to forewarn the defaulters and persuade them
to clear their loans, followed by legal notice under special recovery acts.
The District Collector as the administrative head of the district to enforce
legal action, which KGB has found too cumbersome to actually utilize.
This has left the bank with the option of persuading defaulters to repay
their loans: a difficult mission in an area of drought and social turbulence.
The bank has provided motorcycles to branches and set up a special
recovery cell in the Head Office during the recovery season, manned by
a few senior officials to assist the branches allocated to them.
SHG banking has helped the bank improving the general repayment.
The group peer pressure enables the bank to finance collateral free
loans to groups of poor women. The repayment morale of these 3,350
SHGs of the poor has built pressure on the non-poor in the villages
prompting them to repay their loans. The branches have demonstrated
that if “relationship banking” is maintained with the SHGs, these women
could turn out to be effective brand ambassadors of the bank. A good
number of instances were observed where SHGs and their members
directly helped the bank recovering non-performing loans. The thrust laid
on banking with the poor, the core of KGB ’s mandate, under the SHG
Banking Programme has the potential of a major impact on the
profitability of the bank. A recent study of profitability of SHG Bank
Linkage Programme39 in KGB has shown that the SHG portfolio in fact
generated direct profits of Rs. 1.52 million (US$0.03m) in 2002, when the
bank as a whole incurred losses of Rs. 31.93 million (US$0.66m). Apart
from the direct benefits, banking with SHGs also led to several indirect
benefits such as recoveries of past dues with the help of SHG members,
generation of good-will for the branches leading to faster deposit
mobilization. The SHG business of KGB has already assumed significant
scale with more than 6,500 SHGs maintaining deposits of Rs. 19.6
million (US$0.41m) and more than 3,300 SHGs accessing loans of Rs.
59.7 million (US$1.24m) with near zero NPAs. The experience shows
that with the passage of time, the credit demands of SHGs increase
substantially. Coverage of 110,000 families under the SHG Bank
Linkage programme by the bank means a large part of the rural poor
population of the district was willing to bank with KGBon commercial
basis. In fact, the study also observed that the poor women were willing
to pay higher rates of interest for value added banking services.
Commercial Aspects of SHG Bank Linkage Programme by H.D. Seibel and H.R. Dave,
Nov. 2002.
Case Study: Kakathiya Grameena Bank, India Improving efficiency
Given the stop on recruitment of new staff, the bank opted for
computerizing all its branch level operations and many of the HO level
operations. KGB is the only RRB in India, which has computerized all its
branches. This has enabled the branches to focus more on business
development and loan quality. The reduction in transaction costs and risk
costs is expected to improve its margins significantly. The thrust on
banking with SHGs is another major initiative aimed at improving the
efficiency of delivery. Simultaneously, KGB stepped up its investments in
human capital development in last two years. During the preceding three
years, 37, 14 and 35 employees, respectively, participated in training. To
improve customer services, all the branches have been provided with
note counting machines. The branches have been given a facelift with
good furniture, cash counters, offices for the branch manager and diesel
operated generators.
Assessment and conclusions
KGB presents a classic case of rural banks where the battle for survival
is a day-to-day affair with adversities such as erratic monsoons, antigovernment agitations, largesse being given to the masses through the
bank in form of subsidized loans and political promises of debt waiver,
and interference in staff recruitment, promotions and wages. The reforms
have brought in a hope for economic revival. Though the three
shareholders put in additional equity as part of the financial package,
KGB has not been able to retain its nominal, not to speak of real, net
worth. The interest rate freedom led it to overprice deposits and loans,
leading to accumulation of high cost deposits. Interest rates are now
being adjusted more frequently, to ensure a reasonable spread without
loosing the best clients. All these odds are being countered in different
ways. The branch relocation to market centers, face-lifts to branches and
emphasis on computerization of all branches and building IT based MIS
has already started paying off in terms of better market image and
productive use of its overstrained manpower. The inclusion of SHGs as
the thrust area in the corporate policy has already established its
relevance for improving the profitability and will continue to contribute
increasingly larger share in the banks business and its quality.
The Challenge of Sustainable Outreach
Decentralisation The delivery structure
Starting with 5 branches in 1982 - 83, 18 more branches were opened in
1983 - 84, followed by another 20 branches in 1984 - 95. Thus, within
three years, KGB spread 43 branches throughout the district, including
backward areas. With RBI permission, KGB merged three loss-making
branches during 1997 - 99 and added two satellite offices in 1999 and
2001, respectively. An average branch has three staff, comprising a
branch manager, a cashier-cum-clerk and an ancillary staff. The table 11
below presents the delivery structure of KGB.
Table 11: Delivery structure of KGB, 3/2002
Number of branches
Number of satellite offices
of which are rural
Number of service area villages allotted by the central bank
Number of units with SHG banking activities
Number of staff (including four from the sponsor bank)
Number of officers
Number of loan officers
Service radius (km to furthest customer)
Source : Annual Reports of KGB Decision-making structure
The delegation of power in KGB emanates from the board of directors.
The chairman sanctions expenditures and loans. The board also
approves periodic revision in the delegation of powers to the
administrative officer, who is the deputy in the bank, the manager of
advances and branch managers. Branch managers are authorized to
sanction loans up to Rs. 25,000 (US$520), which comprise 90% of
loans, the manager of advances up to Rs. 50,000 (US$1,041, the
administrative officer up to Rs. 200,000 (US$4,167) and the chairman
above Rs. 200,000 (US$4,167), within the limits of single exposure
norms of 15% of net own funds. The sponsor bank is not involved in
lending decisions.
Case Study: Kakathiya Grameena Bank, India Branches as profit centers
Each is monitored for its profits and losses. Only the branch level
expenditure and income are taken into account; the investment of
surplus funds by HO is excluded. In line with its sponsor bank, KGB has
adopted a Multiple Transfer Price Mechanism pertaining to funds lent to
HO40 and borrowed from HO.41 This mechanism is biased towards
transferring low-cost deposits to the HO. Assessment and conclusions
KGB is a relatively small bank among the RRBs of India. It is limited to
one district, of which it covers nearly 25%. Branches are profit centers;
yet there is no remuneration for individual performance. Delegation of
lending authority is basically adequate, but might be extended for
managers of branches in market centers. A transfer price mechanism is
in place, biased towards mobilization of low cost deposits, which are
transferred to HO.
Good Management Major restructuring programmes implemented in the
Since 1995, the bank has undergone restructuring as part of the financial
sector reform. Under guidance by NABARD’s district development
manager (DDM) with a seat on the RRB board, KGB worked out its
development action plan for attaining current profits in the shortest
possible time and wiping off accumulated losses in medium term. A
restructuring process was initiated, involving (i) recapitalisation, (ii)
relocation of branches, (iii) revision of interest rates on deposits and
loans, (iv) strategies for financing non-target groups, and (v) NPA
management. The process of moving towards sustainability is still going
The branches are entitled for interest on funds lent to Head Office as under:
Savings bank deposits: 200% of interest paid during the year
Current account deposits: 6% of weekly average balances during the year
Time deposits: 110% of interest paid during the year
Protested bills: 5% of cash recoveries during the year (excluding write-offs)
The branches are required to pay interest on funds borrowed from Head Office as under:
Agricultural gold loans: 50% of interest received during the year
All other advances: 70% of interest received during the year
Protested bills: 5% of outstanding on monthly averages
Cash balance: 10% of weekly average.
The Challenge of Sustainable Outreach
on. The bank was recapitalized with an injection of Rs. 93.8m
(US$1.95m) in six different instalments during the period 1996 - 97 to
1998 - 99: interest rates were readjusted, and the branch network was
restructured, merging three loss-making branches and reducing their
total number to 40. The bank gradually moved away from directed
lending to increase its market penetration, making use of the freedom to
allocate up to 60% of fresh lending to non-target groups and the nonpoor. A development action plan was prepared for its turn-around
strategy, to improve its current viability (earning profits in the current
year) and sustainable viability (wiping out its accumulated losses). A new
pricing policy was introduced in 1998, charging higher interest rates (with
average term deposit rates of 13%, 1% above other banks). Taking
effect in 1999 as the turning year, this led to an increase in the number
of savers from 87,190 in 1998-99 to 123,500 in 2001-02, generating
substantial excess liquidity. Branches were computerized between
January 1999 and October 2002. After having repositioned itself in the
market and having made the necessary technological preparations
through branch computerization, the bank finally started making use of
the authorization of 1994 to diversify into non-target areas and opened
up the retail business with wage and salary earners. Technology offered
an integrated solution for salary transfers. The bank is now free to cover
all sectors in the district including Warangal city. In 1998-99, the bank
earned profits for the first time in its history. Staff incentives
Public banks in India are prevented by RBI regulation from providing
financial incentives for individual performance. KGB honours individual
performance in various non-financial ways, such as training in renowned
institutions and postings in preferred places. Every year, the nine bestperforming branches are awarded of Rs. 1500 (US$31) , Rs. 1000
(US$21) and Rs. 750, (US$17) respectively: three each in terms of
growth in deposits, reduction in amount of non-performing assets, and
percentage reduction. The incentive payments are used in a social affair.
Management Information System (MIS)
All the branches and H.O. were computerized between 1997 and 2002,
using locally developed software. The newly introduced MIS focuses on
liquidity management, monitoring of deposits and loans, NPA
management and branch profitability. In accordance with central bank
requirements, detailed weekly reports are generated at branch and bank
level such as benchmark reports, shuttle memos, Protested Bills and
Case Study: Kakathiya Grameena Bank, India
NPA reports. The bank has introduced a comprehensive monthly
statement, now computerized, which captures the branch performance in
Recruitment and human resource development
The KGB has total staff strength of 185, which include 4 officials on
deputation from the sponsor bank. KGB is not free to select its own staff.
All recruitments were carried out through the public sector “Banking
Services Recruitment Board”. Staff was recruited from candidates
domiciled in the state familiar with the local culture. As part of the
financial sector reforms the recruitment board has now been dismantled.
While commercial banks are now free to recruit their own staff, RRBs are
still under the decade-old recruitment ban. This has constrained the
bank’s ability to respond to changing market conditions in the wake of
liberalization. Industrial relations have been substantially improved since
the Supreme Court awarded RRB staff equal status with that of sponsor
banks, instead of the government staff.
The bank has been taking advantage of the training facilities offered by
the sponsor bank and NABARD. During the current year, the bank
greatly intensified its investments in staff training, increasing its training
budget from an average of Rs. 100,000 (US$2,083) to Rs. 500,000
(US$10,400). Training includes computerized MIS, fund and investment
management, agro-industrial project finance, managerial effectiveness
and self-development. Table 12 below presents the training initiatives of
the bank in last three years.
Table 12: Training Initiatives in last three years
Number of
No. of employees
deputed for training
Training expenditure
92,500 (US$1,927)
56,000 (US$1,167)
140,000 (US$2,917)
Source: Annual Reports of KGB
Assessment and conclusions
KGB is the first RRB in the country to computerize all its branches. KGB
was given the benefit of an infusion of fresh capital. However, some of
the restrictions still persist such as a ban on recruitment of staff, lack of
The Challenge of Sustainable Outreach
financial incentives for individual performance, external salary setting,
and allocation of managerial staff by the sponsor bank. The restructuring
process has motivated management and staff to work hard towards
sustainability and to address bottlenecks such as target group
restrictions, interest rates, lack of investment avenues, and branches in
low business potential areas.
Customer Orientation Financial products and services
KGB offers a wide range of deposit, loan, money transfer, guarantee
services and safe deposit facilities to its clients.
Deposits: Given the rural focus of the bank, the deposit products are
simple and client friendly. They range from non-interest bearing current
account deposits to passbook savings at 4% interest and term deposits
at 6.5% to 10% p.a. interest.42 The bank reaches out to all economic
strata of the rural and urban population comprising farmers, salary
earners, self-employed, traders, professionals and the poor. Being a
regional bank, it faces strong competition from the big public sector
banks, finance companies, and small-savings schemes of the
Government sold through a network of agents and post offices and
insurance companies. Therefore, the interest rates offered on deposits
have to be competitive. The strength of the bank lies in its outreach in
remote areas and in the quality of service. The deposit products popular
in rural areas of the bank are long-term deposits and constitute a large
proportion of total deposits. Table 13 below presents the composition of
total deposits, indicting a substantial increase in the share of time
Table 13: Deposit product structure of KGB (in US$ million)
Time deposits
Total Deposits
% of Time deposits to total deposits
Demand Deposits
Source: Annual Reports of KGB
Reduced to 5.5% to 8.0% from October 2002.
Case Study: Kakathiya Grameena Bank, India
One of the reasons for dramatic change in composition of deposits in
favour of time deposits lies in the higher rates of interest paid by the
bank on term deposits compared to other banks in the area. However, to
stem the influx of deposits, the bank is initiating corrective measures
during 2002-03, offering 8% on deposits with a maturity of 2 - 3 years
and 7% to 7.5% on deposits of more than three years.
The bank offers a variety of loan products ranging from short term loans
for crop cultivation to purchase of household goods and consumer
durables, which increased from 15 products in 2000 to 25 in 2002.
Details are presented in Table 14 below.
Table 14: Loan products of KGB (in US$ million)
Type of loan
Short term crop loans
Agricultural term loans
Non-farm term loans
Cash Credits for business
Two-year loans to SHGs
Other types of loans
Loans for converting of crop loans
into medium term loans
Source: Annual Reports of KGB
Agricultural loans continued to be the major component of the banks
advances basket, increasing in absolute terms, from US$6.8m in
1999 - 2000 to US$9.43m in 2001 - 02, but decreasing in relative terms
from 46% to 44%. The substantial increase in crop loans was due to
their better repayment performance compared to term loans. A
significant portfolio diversification has come from the consumer durables
segment. The bank is also aggressively marketing its salary loans and
loans against the government securities to higher income clients. While
the bulk of loans was made in Service Area43 Villages, the bank has also
embarked on quality loans in semi-urban and urban areas.
RBI introduced the service area approach in late nineties under which each rural branch
and a few semi-urban branch of commercial banks and RRBs were designed to cater to
the ‘priority sector’ credit needs of specific group of villages called ‘Service Area’. The
credit planning and monitoring system was geared up focusing on these Service Area
The Challenge of Sustainable Outreach
While the reforms have enabled the bank to finance the non-target group
clients, it also found a new way of banking with it’s mandated target
group through the SHG Bank Linkage Programme spearheaded by
NABARD. The poor, mostly women, are organized by NGOs,
government development agencies and, at times, bank staff into small
informal self-help groups (SHGs) with up to 20 members. The groups
save small amounts of money, use them for small loans to members,
and after a period of six months to one year, gain access to bank
refinance. The first interface of the poor with the bank is by way of
opening a savings account. For the first six months the women learn the
virtues and processes of savings, loan examination, determining loan
terms, account keeping and managing group dynamics. The necessary
facilitation and capacity building support to the SHGs is provided by the
agencies promoting them. The reliance on savings and peer pressure
ensures that about 95% of the bank loans are repaid on time, as is
shown by nearly 3,300 SHGs financed by the bank. The share of these
high quality loans in total loans has steadily increased from 1.7% in 2000
to 5.8% in 2002.
The bank also participates in various government sponsored poverty
alleviation and self-employment programmes, but due to poor repayment
performance on a declining basis and without undue pressure from the
local administration. With nearly 70% of its loans towards the priority
sector, the bank still exceeds its stipulated target of 40%.
Interest rates on loans ranged from 13% to 17% p.a., reduced in April
2002 to 12.5% to 16%. In addition, the bank decided to charge a service
charge of Rs. 50 (US$1) on all loan accounts for the better services
offered on account of computerization.
Other services
The bank has experimented with personal accident insurance linked to
term deposits in cooperation with a public insurance company. The
scheme was discontinued when the insurance company increased its
premium. Within the district, the banks issues banker’s cheques for
Villages. For financing outside the ‘Service Area’, a bank branch was required to take a
no-objection certificate from the designated branch catering to a particular service area.
A nation-wide computerized system of credit planning and monitoring called ‘Service
Area Monitoring and Information System’ was developed by NABARD and implemented
through the Lead Banks. Usually, a commercial bank with highest number of bank
branches in a district was assigned the responsibility of implementing Lead Bank
Scheme in a district.
Case Study: Kakathiya Grameena Bank, India
money transfer; outside the district, it offers money transfer services
through its sponsor bank. The bank also offers bank guarantees against
100% cash margins: a non-fund based business, which helps generating
additional income. The bank has entered into agreements with some
government departments and agencies for payment of salaries to their
Non-financial services
The bank provides safe-deposit facilities to prime customers in all its
branches. In addition, through its 45 Farmers’ Clubs promoted under the
Vikas Volunteer Vahini Programme, the bank spreads the message of
development through credit. The bank provides agricultural extension
services to the farmers in club villages at no extra costs through
agricultural universities, government agencies and agricultural input
marketing companies.
Autonomy in customer selection
Within limits, the bank is autonomous in selecting its customers and
determining its loan products. The government agencies implementing
various poverty alleviation or employment generation programmes
sponsor applications of the selected borrowers to the bank branch. To
that extent, the branch has to select borrowers from among the
applications sponsored to it, but with due care.
New initiatives in customer orientation
The bank tries to attain a balance between mandated clients and others.
On one side, it focuses increasingly on quality business from among the
non-poor; on the other hand, it has been a pioneering bank in banking
with the poor through SHG linkages. The massive outreach achieved
through SHGs has indeed made it a people’s bank. It has about 85,000
active borrowers, 3,300 of which are SHGs with more than 50,000
members. Its borrowers thus number more than 100,000 (covering a
population of half a million), more than 90% of them poor. Further, there
are nearly 3,200 other SHGs, which have opened savings accounts and
were in different stages of graduation to be eligible for availing loans.
The number of poor women members of these SHGs accessing only the
savings services is over 50,000. Thus KGB serves a total of over
200,000 depositor clients. The SHGs are turning out to be key brand
ambassadors of the bank, increasingly utilized for spreading banking
information in the rural areas. The regular meetings of the SHGs in
The Challenge of Sustainable Outreach
villages attended by the branch staff also help in bringing transparency
to the business of the bank among its clientele. Similarly, the thrust on
opening new Farmers’ Clubs and seeking the help of the Club
Volunteers in canvassing quality business also exhibits the willingness of
the bank to become transparent in its operations and dealings with the
clients. Computerization and a facelift to the branches have further
contributed to improving customer relations. Outline of the client profile
of KGB is given in Table 15 below.
Table 15: KGB client profile, 31/3/2002
Number of branches
Number of units with SHG Banking
Total number of loan accounts
Among them: SHGs loan accounts
(with outstanding)
84,244 (90% rural)
3,350 (100% rural)
Total number of deposit accounts
Among them: SHGs deposit accounts
123,484 (80% rural)
6,589 (100% rural)
Number of SHG members (estimated)
Source: Annual Reports of KGB
Assessment and Conclusions
With its limitations on recruitment, the bank was forced to look at the
information technology option to increase its outreach and efficiency.
The time saved on account of the computerization has freed the staff
from banking drudgery to focus on business development. The large
scale coverage of the lower income strata through the SHG linkage
approach has created a dedicated mass of trustworthy clients. With over
200,000 deposit clients (including SHG members), the bank reaches one
third of the families in the district. The volume of deposit and loan
business mobilized by the bank through the SHGs is still small, but
profitable. As the age of SHGs grows, both their savings with the bank
and loan requirements would grow significantly. Many of the more
enterprising and disciplined members of the SHGs are expected to start
accessing bigger loans directly from the bank. Thus, the policy decision
of the bank to build long term relationship with the poor as “the middle
income class of tomorrow” has already started paying dividends.
As a legacy of regulated banking, product innovation in public banks has
been a slow process. Encouraging product innovations to increase
consumer satisfaction and bank profitability is an area that NABARD
needs to focus on for public banks like KGB.
Case Study: Kakathiya Grameena Bank, India
Summary and conclusions
KGB represents the case of a public bank set up to provide banking
services in rural areas to the lower income strata, trying now to attain
sustainability in the liberalized environment. It illustrates the struggle of
overcoming the legacy of social banking and finding new ways of
sustainable banking with the poor. Rating the bank on the parameter of
outreach, its coverage of over 150,000 families out of 640,000 in the
district, mostly rural poor, should get it full score. On the parameter of
sustainability, however, the bank is struggling. While it is on the way to
earning current profits, it still has a long way to go to wipe out losses
accumulated over nearly 20 years of social banking. The reforms have
enabled KGB in:
relocating its branches to better and more accessible centers
determining its own rates of interests on deposits and loans, and
thereby its margins
opening up to non-target group high value business
launching computerization of its branch and HO operations
diluting the thrust on unviable clients and subsidized loans
getting recapitalisation support from the owners
planning its revitalization in a structured and orderly manner through
Development Action Plans and MoU with sponsor bank, and above
evolving a vision of first attaining sustainability and then continuing to
serve the client group for which it was set up, thereby winning the
commitment of the entire staff.
However, some of the critical factors still remain to be addressed. These
Expanding the area of operation and thereby allowing KGB to reach
the economics of scale and to spread its risks
Lack of clarity on relationship with sponsor bank, Govt. of India, RBI
and NABARD, particularly in terms of social vs. commercial banking
Conflicting demands
mandated outreach
Absence of representation of private sector on the board
The Challenge of Sustainable Outreach
Restricted real autonomy since the chairman comes from the sponsor
Infringement on autonomy by the state government through its
directors on the Board who may compel the bank to finance unviable
clients under poverty alleviation programmes
Inability to recruit any staff for the last 10 years
Inability to determine the salaries
commensurate with their performance
Absence of a rewards and punishment system in the bank
Need for developing managerial competence and awareness among
the senior officials selected from the KGB ’s own staff
Inadequate investments in skill development of the staff, specifically in
fund management and investments, product innovations, and
information technology
The increasingly stringent application of prudential norms would
require substantial change in the minds of the staff and clients, who
still are bound in the old world of rural finance.
Case Study: Kakathiya Grameena Bank, India
Financial performance of Kakathiya Grameena Bank,
1999-2000 - 2001-02
(Amount in US$ million)
Balance Sheet (adapted)
Liquid assets
Net loans outstanding (loans - loan loss
Net fixed assets
Other assets
Accumulated losses*
Total Assets
Average total assets
Savings deposits + Current deposit
Time deposits
Other liabilities
Total Liabilities
Paid up capital
Retained earnings
Total Equity*
Total Liabilities and Equity
With accumulated losses of Rs. 120.3m (US$2.50m), its share capital of Rs. 103.8m
(US$2.16m) was fully eroded as on March 2002, resulting in a negative net worth.
The Challenge of Sustainable Outreach
Profit & Loss Account
Interest on investments
Interest on loans
Other operating income
Total Income
Interest expenses
Administrative costs
thereof personnel expenses
thereof direct SHG social mobilisation cost
thereof SHPI social mobilisation cost
Loan loss provision
Other operational costs
Non-operational costs
Total Expenses
Net Profit/Loss
Loan Recovery Performance
Non-performing loans (Amount)
Number of non- performing loan accounts
Non- performing loans to net loans (%)
Loans written off (During 2001-02)
Loan Loss Ratio (%)
Equity/liabilities (%)
Deposits/liabilities (%)
Capital adequacy (%)
Return on average assets (%)
Return on average loans (%)
Return on equity (%)
Operational self-sufficiency (%)*
Financial self-sufficiency (%)
Self-sufficiency in funds (%)
Number of active borrowers/loan officers
Value of loans outstanding/loan officers
* The OSS is calculated according to the CGAP formula Operational Income/Operational
Expenditure, which includes interest expenses among operational expenditure.
Case Study: Kakathiya Grameena Bank, India
National Human Development Report 2001 (Planning Commission of
India - 2002).
Annual Report of the Reserve Bank of India / 2002.
Trends and Progress in Banking - Reserve Bank of India Publications for
2000, 2001/2.
Report of the Working Group to suggest amendments in the Regional
Rural Banks Act, 1976 - 2002.
Report of the Working Group on Regional Rural Banks - 1984.
Report of the Agriculture Review Committee - 1989.
Report of the Committee on Restructuring of RRBs - 1994.
Report of the Committee on Banking Sector Reforms - 1998.
Report of the Expert Committee on Rural Credit - 2001.
Nanda Y.C., 1992 - Informal sector and micro Finance - NABARD
Nanda Y.C., 1991 - Banking with the poor - NABARD Experience.
NABARD and micro Finance - 2002.
Various publications of NABARD on financial data of RRBs and
Cooperatives for 2000, 2001, and 2002.
Seibel H.D. and Dave H.R., Commercial Aspects of SHG Banking in
India, Nabard, Mumbai - 2002.
Seibel H.D. and Khadka S., SHG banking: a financial technology for very
poor microentrepreneurs. NABARD’s program of promoting local
financial intermediaries owned and managed by the rural poor in
India. Savings & Development (Milan) 26/2 (2002): 133-150.
Report of the Government of India’s Working Group on Rural Banks,
Annual Reports and Audited Statement of Accounts of Kakathiya.
Case Study: Bank Rakyat Indonesia, Indonesia
Case Study:
Bank Rakyat Indonesia, Indonesia
Wolfram Hiemann
The promoters of microfinance acknowledge Bank Rakyat Indonesia
(BRI) with its more than 4,000 outlets scattered all over the country to
operate the largest profitable microfinance system, the BRI Unit system,
reaching more than 25 million customers. This introduction describes the
general environment in which it operates.
Indonesia’s archipelago with 17,506 islands covers 1.9 million sq km.
They stretch from West to East over a distance of about 4,500 km. Her
ethnic diverse population of some 210 million speaks over 250 regional
languages. Close to 60% of the population live on Java with the density
approaching 1,000 persons per sq km. Papua (once called Irian Jaya) in
the East is the largest province (422,000 sq km) and the least populated
one with just 5 persons per sq km. The capital Jakarta, the main
government and business center, registers about 8.5 million people
(growing to 11 million during workdays). Jakarta is surrounded by a
heavily industrialized belt of smaller cities.
The Challenge of Sustainable Outreach
On August 17, 1945, after 350 years as a colony of The Netherlands and
three years under Japanese military rule, Indonesia’s first president
Soekarno declared the country independent. In 1949, after years of
fighting Indonesia’s independence was internationally acknowledged.
Following were years of political instability and economic decline leading
to the nationalization of foreign firms in 1957, armed secession
movements, and a policy that looked for an alternative to the capitalist
and communist system at a time when the Vietnam war unfolded in the
neighborhood. In 1965, the military resumed power. The economy
collapsed and inflation reached 600%. In March 1966, General Soeharto
was pronounced Indonesia’s second president. He established the “New
Order” and remained in office for 32 years in which Indonesia’s annual
economic growth of about 6% by far outpaced a declining population
growth rate. Investment in education and health facilities effected a
substantial decrease in illiteracy (39% in 1969, 10% in 199944) and
increase in live expectancy (1967: 46 years, 1996: 65 years). Poverty
decreased substantially, although not evenly. The financial crisis of
1997/98 triggered public unrest and the fall of Soeharto, “Father of
Development”, in May 1998. Today, this country with the largest Muslim
population (almost 90%) is led by its fifth president, Ms. Megawati
Soekarnoputri, a daughter of the country’s founder.
Indonesia, a member of OPEC, is rich in natural resources. It is the
world’s largest producer of LNG (liquefied natural gas). Huge coal fields
are exploited. Wood and fish are other prominent natural export
EIU Country Profile 2001, The Economist Intelligence Unit Limited, 2001.
Case Study: Bank Rakyat Indonesia, Indonesia
resources. Its plantation commodities have a prominent share in the
world market and include tea, palm oil, rubber, coffee, cacao and spices
that made these islands famous. Textile and shoes industries became
the largest foreign exchange earner. Since 1996, exports of electrical
appliances and machinery grew about 100%. During the past 20 years
the country increased the share of manufactured exports from 15% to
78% of the total export volume. From 1986 to 1995 tourist spending
increased 8-fold. The entire economy was booming until 1997. Only few
were concerned about untamed speculative construction activities.
Despite the 60% to 80% devaluation from mid 1997 until mid 1998, the
export volume grew on average by less than 1% annually between 1997
and 2001 (US$51.1bn). The dominant destinations are USA (17.7%), EC
(17.0%) and Japan (15.7%).
In the aftermath of the crisis and various subsequent financial and
political maneuvers, confidence is still weak and economic recovery is
very slow (2001: 3.3% growth, 2002: below 3%) and mainly driven by
private consumption (+6.2%). In constant prices, the 2001 GDP
(US$145.3bn) is only 95% of the 1997 GDP. After the Bali incident in
October 2002, the government cut the 2003 growth rate projection from
4% to 3.5%.
Table 1
Macro Sector Assessment
GDP in millions US$ (at market prices)
Population (million)
Rural population (%)
GDP per capita in US$
Inflation in %
end of period
Exchange rate to US$: [Local currency = IDR indon.
end of period **)
Financial deepening (M2/GDP) in %
about 60%*)
Source: The Economist Intelligence Unit Ltd. 2002, Country Risk Service May 2002
Some observers stated a 2-3% increase in the rural population as a result from the financial crisis
when many people lost their job in urban areas and returned to their villages. Meanwhile the
trend reversed.
The exchange rate slipped from 1,650 in 1986 to 2,350 in June 1997. Since then, it is not a
one-way road as the figures may suggest: The rate peaked at more than 15,000 in 1998. End of
2002, the rate is below 9,000.
The Challenge of Sustainable Outreach
Reduced subsidies on basic commodities and ongoing exchange rate
adjustments pushed the inflation rate to 12.6% in 2001. It will most
probably decrease to below 11% in 2002 and decline further as a result
of Bank Indonesia’s (BI) tight money policy and a stabilized exchange
Bank Rakyat Indonesia (BRI), the bank this study deals with, was heavily
hit by the financial and banking crisis. The following shows that the crisis
provoked major changes in the way BRI is managed. At the same time
BRI’s Micro Banking arm, the Unit system was not negatively affected by
“krismon”, the monetary crisis.
Financial Sector
Brief description of the main features and
In the late 60ies, Indonesia
Foreign exchange rate policy
received a new Rupiah, a new
Banking Act, a new Central Bank 1968 – 1986: fixed US$ exchange rate, three
Act, and free currency conversion. 1987 – 1997: “dirty” floating (tar-get band),
Seven nationwide operating state Since August 1997: free market;
banks were established, among Indonesians are allowed to own, export
import foreign exchange in cash and
them BRI, the bank described in and
on/via bank accounts.
the following. They dominated the
sector for 20 years. Private banks
and joint venture banks played a major role in Jakarta.
Triggered by falling oil revenues and inspired by a new cabinet the
banking reform process started in 1983 with the removal of control on
credit ceiling and both lending and deposit interest rates, which
exceeded the inflation rate in every year (except 1998).45 BI regulated
the market through its function as a lender of last resort, and the creation
of discount instruments such as promissory notes (SBI Sertifikat Bank
Indonesia) and money market securities (SBPU Surat Berharga Pasar
Uang) to steer liquidity (“Open Market Operation”).
Barriers for the establishment of new banks and bank branches were
removed in 1988. Mighty conglomerates founded banks aimed at almost
This refers to time deposit. Interest rates for savings are often below the inflation rate.
Case Study: Bank Rakyat Indonesia, Indonesia
uncontrolled mobilization of cheap funds for the expansion of their
diversified activities. Indonesia observed an “explosion” of bank services,
which were not backed by the availability of respective numbers of
qualified staff. In 1990, a first set of prudential banking standards was
launched. In the following years, BI introduced tighter international
standards on capital adequacy ratio (CAR), legal lending limits and
foreign exchange net open positions. BI closed only one out of 239
banks before the Asian crisis hit the country in 1997.46
The crisis hit Indonesia severely because, among others, deregulation in
the financial sector was not accompanied by effective control and
immediate sanctions. Regulations were too lenient and contained
loopholes. BI’s policy aimed at tightening the regulations and
implementing them through persuasion rather than risking confrontation
and bank closures. BI and the government were afraid of the
Since the outbreak of the crisis, the
state closed (68), merged (14) and “took
over” or “nationalized” (12) banks. By
the end of 2001 only 8 banks out of 145
missed the target of an 8% CAR. The
process of rehabilitating the banking
system is not yet entirely finished.
Costly bank restructuring
(in IDR tn)
Government bonds in banks 435.3
Government revenues 2001 299.9
Interest payments
- Domestic interest 66.3
- Overseas interest 29.3
Source: BI 2001, Government
Since international auditors reviewed all Revenues and Expenditures 2001;
commercial banks (1998) and a new Act IDR9,000 = US$1
on BI passed the parliament (1999) the banking industry started adopting
international standards on prudential banking. Compulsory “fit and
proper” tests evicted a number of politicians and non-bankers from
influential posts. Banks appointed compliance directors and disclosed
their portfolio on risk and risk management strategies. Transparency is
high on the agenda. All these measures are expected to result eventually
in a behavioral change in the way banks are managed.
For more details on the financial crisis see Annex 1, on banking system reforms see
Annex 2.
The Challenge of Sustainable Outreach
Table 2
Banking indicators (US$bn)
Exchange rate
Total assets47
Net interest
Profit before
NPL gross
NPL net
The banking sector in Indonesia
remains highly competitive. Before
1997, commercial banks were eager
offering corporate loans for reason
of low relative transaction costs and
alleged loan quality (repayment
capacity). Now, based on the crisis’
experience and due to lack of credit
demand from large enterprises,
many banks concentrate on the
promising market of loans to viable
SMEs and for consumer loans.
There are signs of economic
improvement, but the general
conditions still continue to be
Source: BI, Annual Report 2001
affected by significant uncertainties.
The loan/deposit ratio is still low (45%) indicating weak intermediation.
This is not caused by recapitalization, i.e. government bonds substituting
bad loans (about 40% of total assets), alone.
18.8% 12.1%
Figures in IDR show signs of recovery, but the US$ equivalent points to
the banking sector not growing in real terms. In fact, the inflation rates for
2000 and 2001 exceeded sector growth. Contrasting the overall
development, banks in rural areas showed a high degree of resilience
during and after the crisis. From 1999 until 2001, the assets of rural
credit banks increased by 74%.
The sector reform is ongoing with the establishment of a bank
superintendence, a deposit insurance system, a credit bureau, and
preparations for the Basel II Accord.
Key financial institutions The central bank: Bank Indonesia (BI)
Asia’s financial crisis triggered the review of BI’s tasks. Formerly, BI was
a government tool. BI supported the government’s development policy
with credit lines at interest rates below market rates (“subsidized”). This
Total assets expressed in local currency are increasing.
Case Study: Bank Rakyat Indonesia, Indonesia
so-called “Bank Indonesia Credit Liquidity” (KLBI Kredit Likuiditas Bank
Indonesia) financed priority sectors and activities. Low interest seasonal
funds and long-term loans were channeled as “program loans” through
commercial banks, for rural areas in particular through BRI. In 1990 a
deregulation package48 stopped most of these schemes but new credit
programs with below market interest rates were offered, for example in
1998, a US$1bn scheme for farm businesses (Kredit Usaha Tani, KUT),
the management of which was transferred to BRI (see Annex 3).
The 1999 Act on BI charges this institution as monetary authority with
the responsibility for payment systems, stable exchange rates and low
inflation. BI steers money supply through open market operations. The
institution is still supervising banks and multifinance companies (the
latter ones in cooperation with Ministry of Finance/MoF) until end of 2002
and afterwards during a transitional period until a still to be created
institution for supervising the financial services sector takes over this
Another main mission of BI’s management is the improvement of the
institution’s image and rebuilding its credibility as it influences
international confidence in the country. Banks
The 1992 Act on Banks distinguishes between Commercial Banks (Bank
Umum) and BPR (Bank Perkreditan Rakyat), literally “People’s Credit
Banks” or, according to BI’s translation, “Rural Credit Banks”, a
confusing term as almost half of these banks operate in cities or close to
city borders.
“PAKJAN” or January (1990) package.
The Challenge of Sustainable Outreach
Table 3:
Classification of banks (2001)
Classification of banks
No. of
No. of
Commercial banks
BRI Bank Rakyat Indonesia, SOE
+ BRI Units
+ BRI Unit Service Posts
State owned banks49, others
Private national banks
Regional Development Banks
Joint venture banks
Foreign banks
Total commercial banks
Rural credit banks
BPR Bank Perkreditan Rakyat
BKD Badan Kredit Desa
Source: Bank Indonesia, Annual Report 2001
Commercial Banks
Until 1988, state owned banks dominated the market and accounted for
80-90% of the outstanding bank loans. Their importance declined and
just before the crisis they accounted for about 30% of deposits and 35%
of loans. The recapitalization of private banks made the state the owner
or majority owner of 16 banks, including the country’s five largest banks
(as measured by assets) in which BRI is number 4. For more details see
Annex 4. Nowadays, the five state banks together with the regional
banks are leading the market again if measured by their loan portfolio
(51%) and by their assets (47%, see table above). Those private banks
in which the government keeps a majority share account for about 20%
of the market.
A number of Regional Development Banks compete increasingly with
BRI in the field of small loans, in particular to fixed income earners
(government employees, pensioners).
This includes BNI, a bank that started establishing 60 rural sub-branches in 2001.
BPR = “People’s Credit Bank” or “non-rural BPR”, BKD = “Village Credit Agency” or
“rural BPR”; BPR managers dislike this name because: “It makes mobilizing funds
difficult and expensive. The people come only to ask for loans. They are surprised that
deposit facilities are also offered.”
Case Study: Bank Rakyat Indonesia, Indonesia
24 banks are listed on the Jakarta Stock Exchange, most of them far
below their IPO (initial price offering), some trade almost as non-valeur
(less than US$0.01/share).
Only one sharia bank, a financial institution following Islamic principles,
operated before the crises but recently a number of large private and
state banks established sharia affiliates. Together, they serve clients at
49 outlets and account for about 1% of the market.
Rural credit banks
The government supports actively the role of small financial institutions
as they deliver competitively financial services to millions of low-income
people in a sustainable (profitable) way. However, their supervision is
costly, and requires educated and specialized manpower, which is
By end of 2001, BI registered 2,358 BPRs, which might be categorized
as “secondary banks”. The assets of these legally independent
institutions vary from less than US$50,000 to more than US$2m
(average assets: about US$250,000). Some 15 staffs administer about
500 to 1,000 loan accounts and some 2,000 savings accounts. Doorstep services are a feature of many BPRs. Their products are, with few
exceptions, limited to loan products, savings and time deposits.
BKDs or “rural BPR”, were established only on Java and on Madura, an
adjacent island, from 1895 until 1922. The 5,345 BKDs are owned by the
village and run by village authorities. Many of them open only once or
twice weekly. BKDs are in many places the only formal financial
institution and as such part of the infrastructure. They offer a place to
deposit liquidity (with little public acceptance) and to obtain small (US$5 55) short-term (three months) multi-purpose loans for about one million
people in rural areas. They are regarded as banks and supervised by
BRI on behalf of BI. BRI extends loans for the operation of a number of
viable BKDs.
The Challenge of Sustainable Outreach
Table 4
Financial Sector Assessment
No. of private financial institutions (commercial banks) *)
No. of public financial institutions (commercial banks) *)+)
Assets of
a l l banks (US$bn) **)
Assets of p r i v a t e banks
Assets of p u b l i c banks
Lending interest rate in % (12 mth working capital,
commercial banks)
Deposit rates (3 mth demand deposits) in %
(BI Certificates, SBI)
The total number of both private and public financial institutions (commercial and rural
banks, multifinance companies, insurance companies, cooperatives) exceeds 5,000
each; the number of private financial institutions includes those in which the state owns a
majority as a result of recapitalization.
**) The consolidated assets of all financial institutions amount to less than 120% of total
bank assets. The decrease is a result of exchange rate fluctuations. Assets increase
from year to year if measured in IDR.
Most of the 26 Regional Development Banks operate in only one province.
Non-bank financial institutions
The table below informs about prominent non-bank financial institutions.
Table 5
Cooperatives, more than 37,000 units, about 11 million members,
strong competitors in the micro finance sector
Pawning, one state-owned company, 714 branches, 15.7 million
transactions in 2001, total disbursement 2001:
Multifinance companies (MFC: leasing, factoring, credit card,
consumer loans), 245 registered MFCs, about 50 MFCs are active,
including PT Sanwa BRI
Insurance companies (IC), 104 general ICs, 60 life ICs (including
BRInginLife, 90% owned by BRI’s pension fund), 27 million people
insured through group insurance, 3.5 million bought individual cover
Stock exchange, 328 companies; BRI is slated to join 2003
Venture capital companies (VCC), 59 companies: 28 state owned
financing some 6,000 SMEs in form of 3-5-year profit sharing;
BRI participation in PT Sarana Bersama Pembiayaan Indonesia
PT Permodalan Nasional Mandani, a special state owned financial
institute to administer former BI (state) program loans
State owned enterprises, 2%-5% of profits to support SMEs
Assets (US$m)
Case Study: Bank Rakyat Indonesia, Indonesia
PT Bank Rakyat Indonesia (Persero)51
Literally “People’s Bank of Indonesia”, abbreviated “Bank BRI” or “BRI”,
the country’s third largest state bank is also the fourth largest
commercial bank. In addition to a common branch and sub-branch
system BRI operates nationwide the “BRI Unit” system, the bank’s “Micro
Banking” arm with separate outlets and products. The Unit system is
managed by BRI’s Micro Business Division. BRI Units use the same
company logogram but the public can differ between the modest Unit
premises and more generous branch offices.
The following tries to describe both, the entire BRI organization and the
Unit system that made BRI known worldwide.
BRI was established based on a government act. Since 1992, BRI is a shareholder
company (“Persero”) based on the Act 1/1995 on Perseroan Terbatas (PT, or Limited
Liability Corporations) with 100 percent of its shares still owned by the state. This
opened BRI more opportunities to expand in the large-scale and business sector.
The Challenge of Sustainable Outreach
BRI Organisation Chart
Shareholder Assembly
President Director
Director Micro and Retail
Division Micro Business (BRI
Division Retail Business
Director Medium-scale -, General -, and
Division Agribusiness
Division General Business
Division Program loans
Four other directors
(In US$m)
BRI Network 2001 {Dec. 2002}
11 Inspection
----------- ----------Micro
3,823 {3,902} BRI Unit
240 {na} Village Service
12 {15} Regional
New York
323 {320} Branch
64 Sub Branch Offices
Case Study: Bank Rakyat Indonesia, Indonesia
General data
The history of BRI dates back to 1895 when “The Assistance and
Savings Bank for Native Government Employees” was established. After
independence BRI was declared the first state owned bank. Its name
was changed into Bank Rakyat Indonesia Serikat (“People's Bank of the
Indonesia Union”) in 1949. BRIS was merged with the Cooperative Bank
for Farm and Fishermen in 1960. The resulting bank was integrated into
Bank Indonesia in 1965, with the new name of “Bank Indonesia for
Farmers and Fishermen Cooperatives”. Only one month later the
independent Bank Negara Indonesia was established in which the
business of the former BRI was integrated as Bank Negara Indonesia
Unit II Rural Division. Following the establishment of Bank Indonesia as
a central bank in 1968, BRI was reborn as a commercial bank for its
traditional clients, namely government employees, farmers and
fishermen, and as agent of development to implement government
From 1969 until its halt in 1983, BRI channeled loans as part of the
government’s “Mass Guidance” (BIMAS), a national program with
technical and financial aid to achieve rice self-sufficiency. For reaching
the farmers, BRI established more than 3,600 field posts52 or village
units (Unit Desa). Since 1974, the Unit Desa attracted the informal sector
with non-agricultural MIDI and MINI loans (up to about US$1,000), a test
field for the successful “Kupedes53” loan scheme. BRI participated and
still participates in the channeling and administration of program or
project based loans, in particular those related to rural areas, agriculture
and fishery. Starting in the mid-70s and until 1990, BRI, along with other
state and private banks, offered KIK/KMKP, a long term investment and
permanent working capital scheme for SMEs. In 1989 BRI introduced the
Unit system to cities, including Jakarta, and abandoned the word Desa
(“village”). Now, even the word “Unit” disappears from the billboards.
The Unit Desa, established based on a Presidential Decree, operated as a window to
the BRI branch. They did not maintain complete financial statements. The loan products
carried a 12% interest rate, well below the inflation rate in a number of years and also
below the deposit interest rate (15%) (from:
For details see chapter 2.6.7.
The Challenge of Sustainable Outreach
Table 6
Bank Rakyat Indonesia (consolidated)
Balance Sheet (adapted)
Liquid assets
Other assets
Total Assets
Time Deposits
Other liabilities (incl. demand deposits)
Total Liabilities
Investments (government recapitalization bonds)
Net loans outstanding (loans ./. loan loss
Net fixed assets
Paid-up capital
Retained earnings
Others (incl. “Additional paid-in capital”)
Total Equity
Total Liabilities and Equity
Source: Bank BRI Annual Report 2001
BRI’s balance sheet reflects the changes from a bank with a high
negative equity in 1999 to a bank with a modest profit the following
years. BRI was recapitalized in 2000. Government bonds replaced bad
debt (assets) and balanced negative retained earnings. The government
bonds earn interest and reduce the necessity for borrowing.
BRI’s financial performance was never particularly strong. The bank
provided services and covered costs. In 1998, BRI belonged to the
banks most severely hit by the crisis. Huge corporate loans turned bad.
The bank had to spend more on interest than it earned from debtors. BRI
was technically bankrupt. The government had to inject IDR28tn (about
US$3bn) (see shaded figures in table 6 above). In 2000, a new
management took over and declared discarding the corporate market
and focusing on the micro, retail, and SME market. In 2001, international
rating agencies considered BRI a better risk than the country risk (BBB
versus C).
Case Study: Bank Rakyat Indonesia, Indonesia
Today, BRI employs about 38,000 people, some 31,000 fixed, in about
4,400 locations. The BRI Unit system accounts for about one third of the
assets but two thirds of the employment. The unrivalled outreach through
its more than 4,000 outlets and with more than 28 million savings
accounts and some 3 million loan accounts makes BRI’s Micro Division
Indonesia’s “bank” with the highest number of clients.
The table below is an attempt to establish a balance sheet for a separate
BRI Unit system. Not all Units mobilize more funds than required for their
lending operation. Some Units borrow funds from the branch system. All
profits of the Unit system are used to cover deficits of the branch system
so that no funds are available for reserves.
Table 7
BRI U n i t System
Investments (placements with BRI branch system)
Net loans outstanding (loans - loan loss reserve) *)
Net fixed assets (less than 1% of total assets)
Other assets
Total Assets
Savings *)
Deposits *)
Borrowings (received intrabank placements: 15% of
Balance Sheet (estimated)
Liquid assets: cash, BI reserve requirement
(3% + 5% of deposits)
Other liabilities, incl. timely-payment-incentive
Total Liabilities
Paid-up capital and accumulated reserves:
10% x (loans + fixed assets + and other assets)
Retained earnings (profit current year)
Reserves (none, used up by BRI branch system)
Total Equity
Total Liabilities and Equity
It is a hallmark of the Unit system that the amount of mobilized funds is
regularly twice as high as outstanding loans. The decline in US$ valued
assets in 2000 is the result of currency depreciation from IDR7,085 to
IDR9,595 against one US$.
The Challenge of Sustainable Outreach
Ownership and Governance Public mandate
The following are BRI’s officially declared mandates:
Assist the government as agent of rural development;
Channel program loans (repayment risk covered by government);
Extend program loans (low interest loans but repayment risk with
Support the agricultural, plantation, fishery and forestry sector with
commercial loans;
Maintain a microfinance system without subsidy;
Maintain a basic network for financial services in remote areas;
Generate employment;
Earn profit.
BRI Vision
• To be a leading commercial bank placing
utmost priority on customer satisfaction.
BRI Mission
• To perform the best banking activities by
delivering services mainly to micro, small
and medium enterprises in order to support the economic development.
• To provide excellent services to its
customers through widely distributed network supported by professional human
resources and to conduct good corporate
governance practices.
• To provide optimal profit and benefit to its
BRI Goals
• To be the biggest and the best bank in
helping micro, small and medium enterprises.
• To be the biggest and the best bank in
• To be one of the best go public banks.
• To do good corporate governance consistently.
BRI was designed to be a
commercial bank with the main
mission of being an agent of rural
development. After the 1983
deregulation BRI was required to
improve its work program as a
commercial bank without surrendering its development role. The
continuation of Village Unit
14,000 working places and
secured basic financial infrastructure in rural areas.
In 2000, after the recapitalization
of state banks, BRI retained its
focus on agriculture, forestry and
fishery. According to the 20012003 business plan at least 80%
of the loan portfolio shall be
disbursed to micro, retail and
medium-scale businesses.
Case Study: Bank Rakyat Indonesia, Indonesia
The government plans to go public with BRI in 2003. Therefore, it is now
perhaps BRI’s most important public mandate to increase profitability.
The Micro Business Division fulfills this demand. Relationship between bank owner and management
BRI was an instrument of the government to implement its policies.
Simultaneously, the government (until 1999) also controlled the central
bank. This situation allowed carrying out imprudent transactions. BRI’s
management was not independent.
It is of remarkable significance that the BRI Unit system could almost
entirely evade political influence. None of the government’s loan
schemes was channeled through BRI Units. The small individual loans
(maximum US$5,50054) and strict operating procedures kept certain high
risk borrowers, including local politicians, away. Superiors encouraged
Unit managers to perform cautious and prudent lending.
The state, represented by the MoF as the only shareholder and the State
Minister for State Owned Enterprises55 (SOE) as the supervisor, employs
BRI’s management and defines the general business policy.
The government had to appoint a new management for BRI to meet the
prerequisite of the bank’s recapitalization process as laid down in a
Letter of Intent with the International Monetary Fund (IMF). In July 2000 a
new board of commissioners and board of directors commenced their
Four persons form BRI’s Board of Commissioners. The Indonesian
President proposed the board’s president but the candidate did not pass
BI’s fit and proper test. The President Commissioner appointed by the
MoF, a former University President, resigned after one year without
replacement.56 The three commissioners have in common that they
studied in USA and attended various (non-formal) professional
development programs abroad. One of them worked 31 years with the
The US$-amount decreased due to devaluation: maximum IDR25m (at the time of
introduction more than US$12,000), since 2000: IDR50m (approximately US$5,500).
Menteri Badan Usaha Milik Negara (BUMN); in recent years, status and responsibilities
of the management of state owned enterprises changed several times.
Prof. Dr. Sukadji Ranuwihardjo was President of University Gajah Mada, Yogyakarta,
with its highly appreciated Faculty of Economics where also BRI’s President Director
The Challenge of Sustainable Outreach
state development bank Bank Pembangunan Indonesia.57 His final
position was President Director. Another commissioner worked five
years with the tourist state enterprise, as commissioner of a local state
owned airline, and as lecturer for accounting at the state university. The
third commissioner had 31 years BI experience. His final position was
General Manager Internal Audit.
BRI is managed by a President Director and six directors aged 46 to 62.
BRI’s President Director gained almost 30 years experience at BDN, a
former state bank with emphasis on financing trade.58 He held positions
such as General Manager of the New York branch and finally as BRI
director. The vitae of the other directors are similar: One of them started
his career also with the state bank BDN (1964), another one with the
state bank BNI (1980). Four of them worked in BRI since 1976 and 1980,
respectively. Their educational background includes attending
universities and seminars in the USA and working abroad. There is no
private sector experience represented on the board. Supervision, control and audit
The multi-level supervision, control and audit system of BRI consists of
BI supervision (external)
Public accountant (external)
Audit Committee (mixed internal and external)
Internal Audit department (internal)
Inspection Offices (internal)
BRI is supervised by BI until 2002 and by a new still to be established
financial superintendence starting 2003. An international registered
public accountant performs the external audit (2001: Andersen). The
audit follows the standards established by the Indonesian Institute of
Accountants, in particular the rules on “Accounting for Banking” and BI’s
“Accounting Guidelines for Indonesian Banking” revised in 2000.
This bank experienced heavy losses and was merged with three other state banks to
become Bank Mandiri (see Annex 4).
Through merging with three other state banks the bankrupt BDN (Bank Dagang Negara)
became part of state owned Bank Mandiri (see Annex 4).
Case Study: Bank Rakyat Indonesia, Indonesia
The Audit Committee, a new achievement, assists and reports to the
Board of Commissioners. It is composed of a commissioner, two
consultants, and a former auditor with the Supreme Audit Agency. The
team evaluates the adequacy of overall internal control (management
task), compliance with BRI’s Good Corporate Governance Policies, the
Code of Ethics, the competence and independence of the external
auditors and so on.59 The Audit Committee meets with the Internal Audit
department twice monthly, and twice with either commissioners, external
auditors, or others. The Internal Audit department reports to the
President Director (see BRI Organization Chart).
BRI established a supervision and audit scheme with 11 Inspection
Offices (internal audit and management supervision) and 12 Regional
Offices for its 323 branches.
BRI developed a multi-layer supervision and audit scheme for its Units.
The branch manager is responsible for the result of the Units in his/her
area. It became part of his overall performance assessment. An
Assistant Manager for Unit Business is in charge for about ten Units with
supporting the Unit manager and approving larger loans.
BRI branches employ also full-time supervisors for permanently running
audits on four to six Units. They supervise all aspects of the Unit’s
activities, including reconfirmation balances with customers so as to
ensure the correctness of loan and deposit records at the Unit level.
They also maintain a dialogue with borrowers in arrears. This serves the
double purpose of assisting in loan collection and preventing collusion
between Unit staff and borrowers. The Micro Business Section of the 12
Regional Offices supports Unit activities, in particular with regard to
whether the branch managers perform their tasks regarding Units,
namely support, facilitation and supervision.
At Head Office monitoring and supervision of the Unit system is
executed by the Micro Business Division. Assessment and conclusions
BRI’s clear public mandate includes expressively micro finance services
in remote areas. The change from a company based on a Government
Act to become a bank based on company law in 1992 was already an
Other state banks added also Audit Committees to their organization chart.
The Challenge of Sustainable Outreach
anticipation of the likelihood to go public. This is not a new experience.60
It will not change the bank’s mandate. However, if one looks at the box
with BRI’s “Vision, Mission, Goals” the financial health of the bank
becomes the new focus.
External pressure (IMF) prompted a new formation of the board of
commissioners and board of directors in 2000. BI’s fit and proper test
resulted in BRI being managed by persons who are qualified
professionally and by their character. The membership in the board of
commissioners is not a full-time task. To improve internal control, the
commissioners are therefore supported by a newly created Audit
Committee in order to add to the board’s competence so that for decision
making commissioners need not relying on information from the directors
The approach to keep microfinance activities separate from other
businesses is not reflected in the composition of the Board of Directors
(see: organization chart). The set-up with one Director being responsible
for the Micro Business (Unit system) and the Retail Business Division
(Branch system) simultaneously may result in synergies but a conflict of
interest may also emerge, e.g. not enough priority may be put on
The financial crisis prompted profound changes with regard to the bank’s
governance. These are reflected in a new organization (only few years
after introducing 1997 SBUs or “Strategic Business Units”), a new
leadership, reformulated goals and targets, more transparency and a
new set of committees, of which the Audit Committee assisting the Board
of Commissioners underlines the efforts to effectively control the
management. A new ownership structure after going public in 2003 could
result in a new organizational arrangement again.
MoF and the Ministry of SOEs appointed commissioners and directors.
The private sector is not represented on the Board. In contrast to some
national private banks, no foreigner ascended the position as a member
of the Board of Commissioners or as a member of the Board of Directors
at a time, when the owner plans to go public (in 2003) and the bank
intends to mobilize foreign currency funds.61
The government went public with the state bank BNI in 1996.
The Act on BRI (1968) reserves membership of BRI’s Board of Commissioners or Board
of Directors to Indonesian nationals.
Case Study: Bank Rakyat Indonesia, Indonesia
Albeit costly, in particular for Units, the multi-layer structure of external
audit, internal audit and lines of supervision has a positive effect on the
performance of Units. The Unit system did not need organizational
adjustments after the financial crisis.
Economic viability Present economic performance of the bank
The economic performance of the entire BRI (branches and Unit system)
was already weak before the crisis (1993-1997) with published profits
varying from US$57m to US$145m (RoA about 0.5% to 1%). The heavy
US$3,308m loss (RoA -49%) in 1998 could only be managed when the
government swapped bad loans against bonds. For 1999, BRI reported
still a loss, the following year a tiny profit (US$35m) which more than
tripled to US$109m in 2001 (see table below). The RoAA achieved 1.6%.
(BI considers >1.2% healthy) Until July 2002 BRI realized profits of
US$150m. For 2002, an RoAA exceeding 2.5% is realistic. It could be
BRI’s best year.
BRI’s Unit system recorded profits ranging from US$66m to US$178m
(RoA about 3% - 6%) for the years 1993-2001. Without these profits BRI
would have had to report losses in every one of the past nine years.62
With other words, BRI’s branches produced continuously losses. BRI’s
Unit system provided constantly profits, also throughout the economic
In 1998, BRI had to offer high interest rates for deposits. The interest
payments exceeded interest income, the main reason for the loss. BRI
could more than halve its administrative costs in two years. Interest on
investments (including from government bonds) doubled in 2001
whereas interest revenues from loans increased only in line with a
cautious expansion of the loan portfolio. Higher interest rates for time
deposits in 2001 are reflected in higher costs. Personnel costs
decreased compared to 1999 and 2000 when allocations were made for
pensions and severance payments. For more details see the table below
It could be that BRI’s branch system generated already small profits in 2001 and most
probably in 2002.
The Challenge of Sustainable Outreach
Table 8
BRI (consolidated)
Profit & Loss Account
Interest on investments
Total Income
Interest expenses (and other financing
Administrative costs
thereof personnel expenses
Net Profit/Loss (before tax, minority
BRI (consolidated)
Interest on loans
Other operating income (and non-op.
(Loan) Earning assets loss provision
Other operational costs (incl. gain/
losses from sale/change in value of
Non-operational costs
Total Expenses
Some figures on the BRI Unit system are published; a profit/loss
statement of this profit center is not. Based on various assumptions the
table below describes how the P/L account of the BRI unit system might
look like. Bank-internal figures might differ due to another system of cost
allocation, in particular regarding staff costs.
Case Study: Bank Rakyat Indonesia, Indonesia
Table 9
BRI Unit system
Interest on (intrabank)
Interest on loans (2001: 33% p.a.)
Total Income
Interest expenses (and other
financing charges) (2001: 10% - 14%)
Administrative costs (about 6% of
earning assets)
Loan loss provision (difference to
previous year)
Other operational costs
Non-operational costs
Total Expenses
Net Profit/Loss (before tax, minority
Profit & Loss Account (estimated)
Other operating income (and non-op.
income) e.g. for money transfer, tax
collection, negligible
thereof personnel expenses (avg.
US$4,038 / employee)
incl. related branch and HQ staff
(supervision etc.)
Before 1997, operational costs of Units were spent as follows: about
40-50% for staff, about 10-15% for supervision, less than 10% for loan
loss provision, and 30-35% for other expenses. The year 1999 was
particularly profitable for the Unit system because of the income from
high interest bearing loans and placements during the first half of the
year providing an interest margin of US$325m against about US$240m
in 2000 and 2001.63 Interest income on placements declined due to a
rapid interest rate fall on the local money market in 1999. Interest
expenses decreased, too, because of shifts from time deposits to
savings accounts.
The deposit interest rates in Table 9 are those recorded at the end of the year. They are
not indicative for the year’s average.
The Challenge of Sustainable Outreach Interest rate setting
All interest rates for non-program loans and deposits are set by
headquarters nationwide for all branches and Units.
Deposit interest rates
The interest rates on SIMPEDES, the most important savings product of
the units, were calculated in 1983 on the basis of a thorough study of all
costs. At that time the national savings book (Tabanas) earned a higher
interest rate (15%) on small deposits up to IDR200,000 (approximately
US$300), additional deposits earned less (only 9%) thus contradicting
economic common sense.
The interest rates for savings products are set with regard to the general
long-term competitive situation, costs of other benefits for savers (lucky
draw prizes, accident insurance64), transaction cost considerations (a
lower interest rate is applied for low balances in order to reflect fixed
costs, see table below) but not without entirely considering effects on the
poorer saver (e.g. no monthly account fee for low balances on special
products65). Depositors have an incentive to increase their deposits.
The adoption to interest rate changes in the money market is slow when
interest rates rise, and fast once the market interest rates decline.
People in rural areas have not many alternatives to store their excess
funds in a safe and liquid place that can be approached at reasonable
transaction costs. Savings account interest rates below the inflation rate
are accepted.
The BRI pension fund is owner of the insurer BRInginLife.
Since 2002, rural savings accounts (Simpedes) with a balance of more than IDR1 million
are charged with an IDR1,000 (US$0.11) monthly administration fee aiming at increasing
fee based income. This compares with fees of IDR3,000 or more charged by dominant
banks for savings accounts with ATM access.
Case Study: Bank Rakyat Indonesia, Indonesia
BRI’s deposit interest rates p.a. in October 2002 are as follows:
Table 10
(IDR’000 /
IDR demand
12,75% 12,75%
Interest income is added monthly and capitalized for the following month. A
20% tax on interest for accounts with a balance of > IDR7.5m (about US$800)
applies. For more details see section 3.3.6.
Table 11
Interest rates and deposit balances
at BRI Units
Year Savings
Pre-crisis interest rates
savings earn about
20%, time dep. more
than 50%
1999 13,001
time deposit rates
below 40% and
savings earn about
8%, time deposits
about 11%
time deposits earn
15%, balance down
4%, but total industry
2000 16,053
2001 18,738
figures in IDR bn
The interest rates for time
deposits are frequently adjusted
according to the development in
the money market and the
demand for BRI’s branch
system. Interest rates climbed
to 15% and attracted 17% more
time deposits in 2001, exactly in
line with the industry. Normally,
time deposit interest rates
exceed inflation rates.
Regarding BRI’s Units, the rise
and fall of interest rates for time
deposits from 1997 until 2000 is
fluctuation of the amount kept in
term accounts. For some
months during 1998, interest
rates exceeded 50% p.a., when
20% were earned on savings
accounts and the inflation rate
The Challenge of Sustainable Outreach
was 77%. A 4% interest rate increase for time deposits in 2002 did not
draw new deposits unlike for the branch system. The amount placed in
savings accounts grows steadily (see table above), roughly in line with
Loan interest rates
In 2001, BRI could realize 21% interest income on the average loan
BRI’s branch system realizes an average interest income of about 16%
(see table below) as a mix of commercial lDR loans (19-24%), US$ loans
(8%-10%), program loans (3%-16%) and classified loans (0%). The
individual (market) interest rate for commercial loans depends on
purpose, maturity, collateral, and negotiation. When the interest rate for
BI’s certificates increased from 12% to 17% loan rates increased only by
about 2%. The average rate is probably about 1% to 2% above those
published by BI for the industry (see also table 12). BRI is not regarded
as a price-aggressive competitor.
Interest rates for Kupedes loans
(see section 3.3.6) are set to
Realized loan interest rates
account for all costs and to offer
villagers a cheap alternative to
Figures for 2001
(in IDRbn)
Unit branch traditional sources of funds, in
Interest from loans
6,109 2,711*)
3,398 particular money lenders. BRI
adopted popular schemes, e.g.,
8,613 20,749
such as those offered by
cooperatives or applied by
Average interest
savings and credit groups: loan
installments repayment, each
IDR100,000, or: 10 installments each IDR120,000. Repaying 20% more
than the initial loan amount (or about 2% per month flat, i.e. on the initial
loan amount) is considered socially still acceptable. Due to the
decreasing outstanding amount of installment loans, a 2% monthly flat
rate translates into an effective 44% p.a. rate. BRI applies the 2% flat
rate nationwide. BRI returns 25% of the interest amount to most
borrowers for not paying late.66 Thus, the effective rate arrives at 33%.
Table 12
For 2001, BRI paid its borrowers “on-time repayment incentive” (IPTW) amounting to
IDR769bn (US$74m). IPTW could be explained as refunding a penalty charged upfront
but it proved to be very effective. Surprisingly, no other bank copied this approach.
Case Study: Bank Rakyat Indonesia, Indonesia
Some time ago interest rates for higher loan amounts were lower but
meanwhile this policy was reversed. Charging different interest rates for
working capital loans and investment loans (1985: 1.5%, respectively 1%
flat per month) was also abandoned. During the peak of the financial
crisis the interest rate was raised. Kupedes interest rates are fixed until
full loan repayment.
Internal transfer rates
The interest rate for internal transfers of surplus funds from Units to
branches is slightly(0.5% to 1%) lower than the rate which Units could
obtain if they would place the funds in the market. BRI Units receiving
internal transfers have to pay more than they would receive for
placements. Previously, both rates were equal. Margins: lending rates and cost of funds
The net interest margin as published by BRI is 7.64% (2000: 6.60%)
compared with an industry average of 6.77%.67
BRI experienced a critical time in 2001 when the bank received 12%
from fixed interest government bonds (37.3% of BRI’s assets) but the
market rate for deposits was 16% or more. With interest rates
decreasing BRI’s profitability will improve.
The branch system’s margin is about 7%: 16% earned on assets minus
9% paid for liabilities. The margins of the BRI Unit system amount to
about 11% as a result from loans and placements earning 21% and third
party fund costs of about 10%.68
Commercial interest rates for loans and deposits (and resulting margins)
did not show erratic fluctuations, seen apart from the crisis year 1998.69
For the past two decades, BRI’s loan interest rates charged by branches
BRI Annual Report 2001; Rating 145 Bank di Indonesia, InfoBank July 2002, p. 27.
In the context of Indonesia’s rural financial intermediation this is not an exceptional high
rate. It is rather one of the lower side. For example, loans at cooperatives cost also 2%
flat per month but are often accompanied by a processing or administration fee plus a
penalty for late payments, by membership fees and sometimes compulsory savings
contribution. The gross margin of these institutions exceeds regularly 25% p.a.
When interest rates peaked in 1998, some banks offered more than 60% p.a. for time
deposits (more than 100% were quoted on the interbank market) and charged less than
50% for loans. A negative interest spread was not uncommon.
The Challenge of Sustainable Outreach
were mostly from 16% to 24% whereas for savings and time deposits
about 8% to 15% were paid. Loan recovery policy, relevance, and importance
BI required all banks to comply with a 5% non-performing loan limit. BRI
achieved this target in 2000 and 2001 (4.93%) whereas this ratio was
19.9% in 1999. BI advised all banks to undertake efforts to restructure
loans based on the management’s evaluation of the debtor’s business
prospect, financial condition and ability to repay. For BRI loan recovery is
relevant: Income from loans written-off (more than US$50m, see table
below) exceeds the year 2000 profit and still exceeds 50% of the year
2001 profit.
Table 13
Loan write-off and recovery (US$m)
- in % of loans
- in % of write-off
- in % of profit
Recoveries of loans that were already written off
are added to the loan loss reserves.
BRI’s loan portfolio quality
improved after the bad loans
(in particular business and
corporate loans) were moved
to the Indonesian Bank
(IBRA) .
became the task of another
organization with a different
collectibility (below) shows
that end of 2001 still only
26.8% of medium and
corporate loans are current.
Since its introduction, a high
loan recovery rate is a hallmark and pillar of success of BRI’s Unit
system with its Kupedes loans (see section The table below
shows that 97.7% of the micro loans are current. The internal staff
incentive system coupled with strict internal rules on loan loss reserves
and write-offs contribute to a high recovery rate: Losses would erode
profits and reduce the bonus for the staff, and even the working place:
Non-profitable Units are closed.
Badan Penyehatan Perbankan Nasional (BPPN).
Case Study: Bank Rakyat Indonesia, Indonesia
Loan recovery policy starts with the right lending policy and credit risk
management.71 Lending is based on clearly identifiable income sources.
Collateral is compulsory as it underlines the borrower’s commitment to
repay the loan. Enforcement
Table 14
is executed in several steps:
smaller subsequent loans or
Loans collection (2001) (US$m)
no repeat loan for frequently
Current Cur. in % delayed
of Total
persuasion and enforcement
Micro business
according to local conditions,
i.e. through the family or
village elders in rural areas
and through sale of collateral
in those cases that are
promising and allow doing so.
BRI’s loan recovery performance improved as can be seen from the
table below:
Table 15
BRI: Loan Recovery Performance
Loans in arrears (in US$m)
Loans in arrears (number of loans)
Portfolio at risk (= non-current)
Loan Loss Ratio
The following figures for the BRI Unit system reflect their superior
Prudent management principles include: using principles of credit risk management,
establishing target markets, selecting criteria for tolerable risk (negative sector, black-list
debtors [applicable for loans > IDR50m]); credit granting procedures (prescreening,
analysis), monitoring and maintenance; early warning system and managing nonperforming loans; policy regarding group lending (legal lending limit, loans to
subordinated companies); policy regarding collectibility and provision for losses on
productive assets; policy on monitoring for expansion of credit facility and policy on
write-off; limitations on business segments/industry/unit with high risk that needs to be
avoided and should not be financed. (BRI Annual Report 2001, p. 146/147).
The Challenge of Sustainable Outreach
Table 16
BRI Unit: Loan Recovery Performance
Loans in arrears (in US$m)
Loans in arrears (number of loans)
Portfolio at risk (collectibility 2-5 )
Loans written off (in US$m)
Loan Loss Ratio
Monitoring arrears is another part of the loan recovery policy. It was
already implemented for the BRI Unit system several years before the
present loan quality concept (see tables below) was introduced. The
classification of loans as stipulated by BI depends on an individual
assessment. This is not a suitable procedure if it concerns almost 3
million loans. Based on BRI’s request, BI agreed to a special
classification for BRI Unit loans as described below.
Table 17
Guidelines for the recognition of allowances for possible losses
and estimated losses
1: General
Special reserve:
2: Special
3: Substandard
4: Doubtful
5: Loss
BRI Branch BRI Unit
Definition for Kupedes installment loan
overdue installment, loan not yet due
overdue up to 3 months after due date
overdue 3 to 9 months after due date
overdue more than 9 month after due date
net of deductible collateral; NPL = collectibility 3, 4, 5
For the loan classification, refer to the following table.
Case Study: Bank Rakyat Indonesia, Indonesia
Table 18
fBRI Unit (“Kupedes”) loans (US$m)
Special mention
The necessary loan loss
provision (according to
above definition) amounts
to 4.1% of the outstanding
amount at BRI Units (see
table left). This amount is
almost twice compared to
loans at risk (2.3%).
For comparison, reserves
for bad debt total more than
946.3 10%
Loans at risk
2.3% outstanding loan amount in
Reserve requirement
38.6 2000 and also in 2001,
- in % of Total
taking over bad corporate
debt (compare table 9: loan loss provision; and table 6: balance sheet).
This stresses again the superior Kupedes loan quality.
1.8 Efficiency improvements
The financial crisis with abrupt changes of exchange rates, inflation, and
business activity makes an analysis of actual efficiency improvement
(versus idle capacity) almost impossible although certain ratios indicate
that improvements may have taken place. For example, from 1999 to
2001, expenditures for overheads decreased if measured by local
currency, by US$, or as a percentage of assets (see table below).
Table 19:
Overhead expenses (personnel, general and
administrative costs)
IDR tn
IDR tn
% of assets
US$ based on average exchange rates
In 2001, BRI’s business was characterized by minimal lending activities if
compared to pre-crisis years whereas crisis management (and not
efficiency improvement) was certainly the topic from 1998 through 2000.
The Challenge of Sustainable Outreach
BRI’s cost efficiency increased: The cost efficiency ratio fell from 97%
(2000) to 50% (2001).73 BRI undertook efforts to increase the bank’s
efficiency through
investment in technology, such as ATM and real-time on-line systems;
early pension offers to adjust the number of personnel;74
review of internal procedures and products.
For 2001, personnel costs declined from IDR2,475bn to IDR1,962bn.
General and administrative costs increased less than 5% (from
IDR910bn to IDR950bn) thanks to lower costs for rents, depreciation on
fixed assets and communication.
The situation is somewhat different for BRI’s Units that were less
affected by the crisis. The Unit system has been efficient from its
inception: no door-to-door service, no high technology (costly,
maintenance problems, technical back-up), simplicity and transparency
of procedures combined with a system of consultancy and supervision
through appointed branch office staff contribute to low arrears rates and,
subsequently, a high loan to loan officer ratio and relatively few fraud
The typical BRI Unit employs four to six persons: one or two tellers, a
desk man, one or two account officers and a Unit manager. For safety
and other reasons financial transactions outside the office are
discouraged. Efficiency improvements are realized when more services
are rendered and at the same time no additional staff is employed.
Efficiency improvement by reducing staff is hardly possible due to the
staff minimum.
Ratios for 1998 and 1999 are not available (BRI: ”not applicable due to negative net
revenue”). They must have been higher than 100%. BI’s benchmark for healthy banks is
Pension-related costs declined from US$98.1m in 2000 to US$14.4m in 2001, but the
number of employees increased from 29,957 to 30,935 (3.3%).
Case Study: Bank Rakyat Indonesia, Indonesia
Table 20
BRI Unit: Staff efficiency
Number of active borrowers/loan officers
Value of loans outstanding/loan officer (US$)
Deposit accounts per teller
Within four years the efficiency of tellers improved from about 150 to
some 250 transactions or more than 60% per day after introducing
Personal Computers (PCs) (see table above).
From 1997 to 2001, the number of outstanding loans rose from 2.62
million to 2.79 million whereas the number of loan officers increased
from about 4,960 to about 5,100. The number of borrowers per loan
officer, about 530, remained almost the same whereas the efficiency did
not increase. This number is high if compared with door-step microfinance systems (less than 200) and low if compared to banks that just
revolve loans to government employees (up to 2,000).
In future, automated reporting on real-time on-line facilities in all Units
might increase the efficiency of loan officers and desk men by about
10% to maximum 30% respectively.
The BRI Unit system applies a principle that makes it difficult to realize
efficiency gains. Once a Unit has reached its highest point of efficiency a
new Unit will be established and the business of the original Unit(s) will
be split. The efficiency of the former Unit decreases and the new Unit will
also start at a lower efficiency level.75
The BRI Unit system invests heavily in training and supervision, the latter
accounting for about 15% to 20% of the Unit’s personnel costs.
In 2000 and 2001, BRI invested US$50m in premises and equipment,
out of this US$35m (70%) for computers and peripherals. For 2002 and
2003 it is planned to invest about US$100m in communication hardware
and software for the establishment of an on-time on-line system linking
For example, one Unit with 6 staffs, 750 borrowers and 8,000 savers might be split into
two units with 8 staffs (minimum). A Unit manager has more incentives to pick only the
borrowers with lowest risks than to expand the Unit’s business. His income is higher if he
manages 500 loans with 99% collectibility rather than a small post split Unit with 375
loans with 97% collectibility. This may also be a reason for the Unit system expanding
very slowly.
The Challenge of Sustainable Outreach
all Units with branches and head quarters. This will give Unit managers
access to SME Information centers that the bank is setting up, on-time
online connections and ATM. Sources of funds
BRI is financed as follows (2001):
Table 21
% of bal.
Source of funds
Current deposits
Savings deposits
34.8% 9%-11%
Time deposits
31.1% 12.5%-18.4%; 87.5% due within one month
13.5%-14,75% for IDR deposit certificates
LIBOR + 1.2% for foreign currency deposit
8%-28% for inter bank call money
Fund borrowings
0% for construction of certain BRI Unit
6.6% 3%-16% for BI liquidity loans to be re-loaned
22%-24% for capital lease (vehicles,
Others (various
- 34.2%
Deposits from banks
Net equity
Interest rates for funds or other costs
9.9% 5%
Mostly no cost (i.e. short-term liabilities and
0,55% dividend paid for 2000 on paid-in
6.2% 9.7% dividend paid for 2000 on net equity
More than 70% of BRI’s funds are short-term and can be withdrawn
within 30 days. This ratio is typical for banks in Indonesia where a
medium term bond market just starts to develop.
In 2001, BRI has a very low ratio of low-cost current account funds
(9.9%) which, ideally, should exceed 25% of total liabilities.76 The
Government decentralization decreased central budgets and increased district budgets.
Districts keep these funds with Regional Development Banks because they are
Case Study: Bank Rakyat Indonesia, Indonesia
development of the ratio: third party funds (deposits) to total liabilities
and equity (= assets) reflects the monetary crisis and recapitalization
(see section 3.3.1, table 6: 1998/99 liabilities exceed assets):
Table 22
Ratio: Third party funds/ assets
About 70% of BRI’s savings deposits are mobilized by its Units. The BRI
Unit system’s source of finance might look approximately as follows
(data estimated for 2001, no balance sheet is published):
Table 23
Funding the BRI Unit system (estimate)
Interest rate or other costs
BRI Units do not offer current account
facilities to the general public
8%-9%, + about 1% for prizes
Time deposits
11% - 14.5%
Other liabilities
e.g., for on-time repayment incentive
about 10% on loans and fixed assets
Retained profit
The table above tries to describe the approximate structure of liabilities
and equity should the Unit system work as a separate bank. For
1998/99, when interest rates for time deposits were above 30%, the
percentage of this expensive source of fund amounted to more than
34%, in 2001 it is only 12.5% (see table above). Assessment and conclusions
Until 1998, BRI was active in the field of commercial banking, fulfilled the
task as the government’s agent of development, operated a microfinance
institution with outreach to remote areas and generated profits. As an
SOE, BRI contributed profits to the state coffers. About 4,000
microfinance Units generated these profits during the past decade and
covered BRI branch losses. It is not known to what extend these losses
are resulting from program loans to peasants. The rural Unit debtors
might cross-subsidize loans to fellow villagers.
The Challenge of Sustainable Outreach
It would have required about 20 years of Unit profits to balance the
branch system’s 1998 loss. In contrast, BRI’s Unit system could even
increase margins and profits in the crisis year 1998. A slight increase in
loan delinquency could be managed and the performance is nowadays
even better than before the crisis.
Since recapitalization in 2000, BRI’s profits (RoAA) increased steadily
and achieved a level that earns the bank highest CAMEL scores
possible. The profitability will improve further with interest rates on the
money market retreating. Based on preliminary data for 2002, BRI’s
branch system will provide profits, just in time for going public in 2003.
BRI is threatened by few low-cost demand deposits and maturity
mismatch. Most of the funds are short-term and susceptible to interest
rate fluctuations whereas almost half of its assets (Government bonds,
micro loans) earn fixed interest.
It was seen that is not required to offer passbook savers interest rates
above the inflation rate. Savers accepted 20% interest when the inflation
was 77% (1998) and their net return after tax is below 8% with inflation
at more than 10% (2001, 2002). People accept for small installment
loans interest rates twice as high as those charged to urban companies
as long as they are lower than those charged by traditional lenders.
The Unit system broke even three years after inception.77 It was
financially self-sufficient after six years. BRI Units earn probably about
80% of their profit from loans and not from passing on deposits to
branches (seen apart from the exceptional year 1998). Thus, BRI Unit
debtors finance the financial infrastructure from which in particular
millions of small savers benefit. The Unit system would still break even
when loan interest rates were lowered from 33% to 22%, and the Units
would still be profitable when lending all funds at 18%. However, it is an
unresolved question whether more lending would have the potential to
further increase profitability or rather endanger the high portfolio
It is common that also BPRs, small private banks, break even after two or three years.
Other small financial institutions such as BPRs charge often higher loan interest rates
and an additional administration fee or a provision which gives them a return of more
than 50% p.a. Their cost of funds is higher, some offer more than 20% p.a. for deposits,
others take up a commercial bank loan (19%-22%) for on-lending or they receive a
program loan (16%). But this still allows them earning a higher margin, which is
estimated to exceed 20% despite a higher ratio of delinquencies.
Case Study: Bank Rakyat Indonesia, Indonesia
Transfer prices are a prerequisite for calculating the fair profit of Units
and their products. It is questioned whether transfer prices result in
substantial funds mobilization. So far, savings deposits increase when
interest rates are high and low. High transfer prices compete with loan
Throughout the years, the Indonesian market offered banks, including
BRI, a generous gross interest margin of more than 5% for commercial
loans and about 20% for micro loans. BRI experienced a negative
interest spread in 1998 and 1999, a result of the financial crisis, but
certainly also accountable to loan decisions made many years ago.
Today, the question is whether there is enough loan demand from low
risk clients because BRI’s competitors view the same segment at a time
when corporate debtors are not yet eligible (unresolved bad debt with
IBRA) or do not need loans.
BRI’s portfolio has been discharged of a considerable amount of bad
debt as a result of the transfer to IBRA. Now, the bank is focusing on
cautious and prudent lending to low risk consumer and SME clients so
that, hopefully, loan recovery as a main activity becomes an activity of
the past.
Efficiency improvements result from computerization. Urbanization and
higher incomes supported by marketing efforts (advertisements,
products) contributed to a higher demand for financial services and
improved the bank’s efficiency. The efficiency of Unit loan officers
increased only marginal. Efficiency gains are small and one should
attribute this to that the BRI Unit system is efficient already from its initial
set-up. Connecting all Units on-line will increase efficiency, but maybe
most of all costs.
BRI proved that a state bank has a particular advantage when mobilizing
funds in rural areas. These funds are one pillar for a viable and
independent micro finance system, in particular, if access to other lowcost funds is limited. The other pillar is the acceptance of high interest
rates for low risk loans on which the profitability and sustainability is
founded. Rural people and small debtors in urban areas accept “high”
loan interest rates (if compared to corporate loans) as long as they are
regarded competitive.
Despite its profitability no other commercial bank tried to cut into BRI’s
share of the micro loan market so that the sustainability of the Unit
The Challenge of Sustainable Outreach
system was never endangered. However, without a disciplined high
quality portfolio BRI Units might not have been successful. Absence of
government intervention, no participation in government programs and
special “development” loans (which could harm the business and result
in moral hazard) etc. are further key factors. The ambitious on-time online connection of all outlets will cut into the profits of a number of Units.
The profitability of rural micro business has captured the attention of BNI,
another state bank with a focus on manufacturing enterprises, including
SMEs. About 60 rural sub-sub branches shall operate in 2002.
Table 24
Ratios of the BRI
Equity/liabilities in %
CAR in %
Loan to Deposit Ratio in %
average equity negative
RoAA in %79
RoAE in %
Number of active borrowers / loan officers
Value of loans outstanding/loan officers (US$)
Ratios as reported by BRI
The figures above mix BRI’s micro, retail and corporate business
activities. The figures below give details on BRI’s micro banking
business and its performance. They are based on published data,
calculations based on these data and own assumptions.
Based on figures in US$, the respective RoAA figures for the years 2000 and 2001 are
0.62% and 1.53%.
Case Study: Bank Rakyat Indonesia, Indonesia
Table 25
Ratios of the BRI Unit system (estimate)
Third party deposits / liabilities in %
Capital adequacy in %
(Capital + 50% profits) / (net loans and other risk assets)
RoAA in %
RoAE in %
Equity / liabilities in %
Decentralization Development of the delivery structure
BRI delivers its services to corporations through 12 Regional Offices, its
services to retail customers and SMEs through 323 Branch Offices and
64 Sub-branch Offices whereas microfinance services are offered
through the BRI Unit system with its 3,823 Units and 240 Service Posts
some of which operate only some days or hours per week.
Table 26
Degree of Decentralization
Number of branches
Number of sub-branches
Number of Service Posts
Total number of outlets
of which are rural (estimated)
Population / total number of outlets
of which are staff of Units and Service
Posts incl. staff for supervision
Number of loan officers (estimated)
Service radius (km to furthest customer)
Number of BRI Units
Number of “permanent” staff
(“non-permanent” supporting staff: about
in particular remote areas > 80 km
The Challenge of Sustainable Outreach
BRI’s delivery network does almost not grow. It reflects the government
structure: one branch in every district
No. of BRI Units
capital and one Unit in most sub-district
and Service Posts
capitals. In the wake of the financial
crisis BRI downgraded almost half of its
branches and they became subService
branches. This decision was revised in
2000 (see table). Services for branch
clients (and eventually for Unit clients)
are also rendered through own ATM
and an ATM network. Since 2001, BRI
offers also telephone banking services.
The costs of electronic decentralization
amounted to US$35m or 70% of the
2000 and 2001 investment in premises and equipment. IT investments
for 2002 and 2003 are planned to amount to US$100m.
Changes in the delivery structure occurred after 3,617 BIMAS field posts
were transferred to become BRI Village Units in 1983. It required a
special BI regulation for operating these below branch level offices.
About one third of these Units started as Service Posts, a number of
these posts and Units in remote and less prospective areas were closed
or resettled from production centers to rural economic business centers
(market places). These Units are highly decentralized semiautonomous
entities with their own balance sheet and profit/loss account.
It was and it still is a concern that BRI covers continuously losses in
other divisions by using the profits of the Unit system instead of
expanding the profit generator. By 1984, a network of 3,617 outlets
operated and the number stood at 3,616 in 1997, and 3,823 end of 2001.
The Unit system would certainly have extended outreach (and so would
the services to the people, and the profits) if one would have left a
prudent 50% of the profits with this division.
The total number of Units and Service Posts increased only very slowly
(see Chart). The Unit System expanded to urban areas and their outlets
can be found in particular in places where many small traders run their
businesses. As of December 1990, about 20% of the Units had their
domicile in urban areas.80 Eleven years after inception, in 1994, the
number of outlets reached 3,887 (3,365 Units and 522 Service Posts),
Robinson, M., 1992.
Case Study: Bank Rakyat Indonesia, Indonesia
an increase of 270 (7.5%). Until 2001, more Service Points were
upgraded. The number of Units grew by 448 (13.3%) to 3,832 and the
number of Service Posts declined by 282 to 240. The aggregate number
of Units and Service Posts increased by 180 to 4,063, a meager 4.5%
over seven years. The number of new opening Units is higher as nonprofitable Units are either downgraded to become Service Posts or
closed altogether.81
On Java, one BRI Unit services an average area of about 8 x 8 sq km
and, probably, more than 80% of the population lives at a distance of
less than 3 km to a Unit.
Mobile banks (there were six units in 1994) or motorcycle units are not a
regular feature of the delivery structure. The customers visit BRI Units for
savings services, loan application, loan disbursement and other cash
transactions. The credit officer visits loan applicants (verification) and
borrowers with repayment problems. Transactions outside the Unit’s
premises, such as selected door-to-door services, are only tolerated in
thinly populated, remote areas where customers live far apart from the
Unit office and public transport is expensive and not reliable. Decision-making structure
As a measure to manage the financial crisis, BRI downgraded about half
of their branches to become sub-branches in 1999. The respective
managers lost the credit-granting authority which they (or their
successors) regained afterwards. At present, Branch managers are
authorized to sign up to IDR2bn (US$220,000). The actual amount
depends on the size of the branch and is adjusted according to inflation
and experience of the branch manager. Regional Offices decide on
loans up to IDR15bn.
BRI Unit loan officers have no authority to grant loans. The authority of
BRI Unit managers is based on a capacity assessment. It is common
that they sign for up to IDR5m (US$550) or, increasingly, IDR10m. Loans
with higher amounts, up to the maximum of IDR50m, require branch
office approval (Assistant Manager). This structure, a key element for
high loan repayment rates, did not change.
Opening of new bank offices “below the branch level” was the competence of MoF and
was transferred to BI. The regulations allow only “healthy” banks extending their branch
The Challenge of Sustainable Outreach BRI Units as profit centers
BRI Units are profit centers. Every Unit writes its own balance sheet and
profit/loss statement. The MIS software of the Units’ PCs informs the
manager daily about the development of assets and liabilities, and
income and costs. Expenditures for which the Unit manager doesn’t sign
are charged as overheads to the Micro Business Division, for example,
costs for supervision, product promotion and training.
The profit center approach allows BRI to state that by end of 2001, 150
Units were not profitable, up from 86 in 2000. Quite a number of these
Units went into operation only recently (not yet reaching break even
point), a few maintain the financial infrastructure as cashiers of local
administration in remote areas and will probably remain unprofitable for
some time, and others were affected by the conditions in riot-torn areas.
Generally, Units that do not provide profits will be downgraded to
become Village Service Posts without lending authority, or BRI leaves
the place altogether.
The Unit managers are not the only ones responsible for the success of
the Unit. They have to cooperate with the branch manager who is also
held responsible for the result of the Units and, as it is part of the branch
managers’ evaluation scheme, will influence their chances to be
promoted. The Inspection Offices facilitate between both. The profit/loss
accountability becomes opaque. Assessment and conclusions
The network reflects the government structure. The four-tier system,
Headquarters (capital), Regional Offices (provinces), Branches (districts)
(and Sub-branches), and Units (with Service Posts) (sub-district), exists
since two decades with few changes. The total number of outlets
remained quite stagnant. Neither sub-branches, nor service posts or
mobile services developed to play a prominent role in BRI’s delivery
structure. It can be assumed that mobile services turned out to be not
BRI did not add to its network at a time when private banks doubled and
tripled the number of their outlets in order to mobilize funds. BRI closed
In Indonesia, mobile banking is normally not profitable, if a bank would fulfill all
Case Study: Bank Rakyat Indonesia, Indonesia
Units in rural areas and re-opened them in urban areas where they offer
deposit services and loans.
There were not many reasons to invest in branch network expansion
when its business did not provide profits. Furthermore, the density of
Indonesia’s banking services is regarded rather high. There are not
many places left for a bank to open a new branch unless it operates in a
market niche or it wants to take market share from competitors (i.e., the
smaller ones attack the big). The actual economic situation does also not
favor opening sub-branch offices. However, BRI keeps abreast with
technological developments (decentralization through ATM, phone
In 1983, BRI transformed disbursement centers for low interest loans
into almost independent microfinance intermediaries. The Unit system
was revolutionary83 at that time due to its transparency, simplicity and
low costs (four staff, four products, rented premises). By not integrating
the Unit system into the branch system, e.g. separate outlets, it was
easy to pursue a profit center approach. There was no need for profound
adjustments during the past two decades. The total number of offices,
the area covered (the entire country), the type, kind and manner of
services rendered, and the products did not change remarkably over the
years. New tools, e.g. introduction of PCs, substituted type writer and
abacus or pocket calculator and improved efficiency but the bank did not
change the products or marketing strategies in an obvious way.84
Despite its high profitability, it seems that few efforts and investments
were made to increase the number of Units and expand outreach. The
following are assumptions which may explain the modest growth of the
number of outlets:
In fact, BRI invests in the Unit system. For example, BRI set up about
97 Units in 2001. The number of Units increased by 99, the number of
Service Posts decreased by 46.85 Statistically, only 53 outlets were
The market is saturated and opening new Units would only result in
cannibalising in the business of those Units in the neighbourhood.
Reportedly, BI would not have permitted other banks to extend their network with
Unit-like facilities.
E.g., BRI just omitted the words “Unit” and “Desa” (=village) from the billboards.
BRI Annual Report 2001, p. 40, p. 44.
The Challenge of Sustainable Outreach
However, based on a recent survey, 61 of 64 Unit managers
contradict this supposition.86
Competition is too strong and conquered the sector growth. For 19992001 BPRs could grow much faster than BRI Units. However, the
Units continued to grow, too.87
The former BRI management discouraged expansion of the Unit
system despite its profitability. The management found it perhaps
more prestigious to engage in other activities.
No funds were available to expand the Unit system as the profits were
needed to cover losses in the bank’s other businesses.
Good Management Major restructuring programs
A major restructuring program was the transformation of BIMAS field
offices to become BRI Unit Desa with new products in 1983. The
financial administration of the BIMAS rice intensification program
employed about 14,000 non-bank staffs. Training these people was a
major HRD investment with a remarkable drop-out rate.
The repayment rate for BIMAS loans deteriorated to about 50% and
gave reason to reducing lending to small scale farming (now only 22% of
the portfolio). The fixed, punctual and secure income of government
employees and pensioners, as well as the ease of credit appraisal, made
them a preferred target. They are second with a 30% share now,
whereas loans to trade dominate with a 42% share. Offering a multipurpose loan to the general public (not to certain professions only) was
crucial for achieving a portfolio that generated profits very fast.88
After the year 2000 recapitalization, BRI needed to undergo a major
restructuring program. International consultants (Price Waterhouse
Coopers) were hired to develop a concept of good corporate governance
PT BRI and Center for Business and Government and J.F. Kennedy School of
Government, Harvard University, BRI micro banking services: development impact and
future growth potential, October 2001.
Loan portfolio growth: Units 31%, BPRs 48%; savings deposit growth: Units 12%, BPRs
World Bank provided a US$102 million program (US$97 million, disbursed in 1989, for
on-lending, US$5 million for TA and training) only in 1987.
Case Study: Bank Rakyat Indonesia, Indonesia
to “reflect BRI’s commitment to adopting international standards in its
daily operations.”89 There were fundamental changes in the structure of
organization (based on a new definition of business fields) and in the
way the bank is managed and internally monitored and supervised. What
BRI presents as “continuously improving the structure of organization”90
has the potential to restructure minds and behavior.
The owner decided that BRI restructures the loan portfolio by focusing
on micro, retail (small) loans and medium-scale businesses while
maintaining below 20% the portion of loans for the corporate segment,
specifically those engaged in the agro-business.
The following aspects to implement the principles of good corporate
governance were reviewed and implemented starting in 2000:91
Structure and composition of Board of Directors including scope of
individual duties and responsibilities;
Strategy planning and control mechanism;
Formation of the Compliance and Risk Management Division headed
by a newly appointed Compliance Director:92 This division handles
compliance issues and has to manage integrated risks as well as
operational risks;
Issues regarding transparency and disclosure;
Assessment of ethics, environment and social obligations;
Expansion of the responsibilities of the Commissioners.
The following committees were set up at Head Quarters:
Audit Committee: The duties and responsibilities of the
commissioners were expanded to include monitoring of the quality
and acceptability of the bank’s financial reports, including ensuring
adequacy of internal as well as external audits (i.e. an auditor audits
auditors). The Audit Committee supports the commissioners so that
they can professionally fulfill their duties (see section
BRI Annual Report 2001, p. 29.
BRI Annual Report 2001, p. 29.
Restructuring after recapitalization was not unique to BRI but to all re-capitalized banks.
BI requires all banks to appoint a compliance director.
The Challenge of Sustainable Outreach
Risk Management Committee (RMC) under the auspices of the
Director of Credit Control: With the formation of this unit, the credit
risk control function was separated from the marketing (customer
relation management) function. The latter now falls under the
auspices of the Director of Medium-scale Business and the Director of
Micro and Retail Business. The purpose of the separation was to
facilitate the application of the four-eye principle in risk control and
adherence to prudent banking principles. The RMC is responsible for
the formulation and improvement of the strategies and policies
required in order to achieve optimal profitability. The right strategy and
policies will provide the management with a more focused direction
that can be justified based on existing economic conditions.
Asset and Liability Committee (ALCO): This committee is responsible
for the management of the bank’s assets and liabilities in addition to
its liquidity. ALCO is responsible for gap (mismatch) management,
e.g. regarding maturities and currencies.
Credit Committee: The main duty of this committee is giving loan
approval after consultation with ALCO.
Information and Technology Committee: This committee deliberates
and formulates policies regarding any technology risk by taking into
recommendations of the IT commission have to consider not only the
bank’s operation but also the customers’ needs.
It is too early to account rising profits in 2002 to the functioning of the
new organization.
It was not necessary to restructure the BRI Unit system after the crisis.
Policy and technical advice have been provided by international
consultants from the Harvard Institute for International Development
(HIID) sponsored by the World Bank and USAID since its inception. Incentive systems
The following describes incentives that are in place for the Unit system.
Positive incentives are found on all levels and all participants benefit.
The performance assessment of BRI branch managers takes into
account the performance of Units in the area of supervision. Thus he
is interested in profitable and trouble-free Units.
Case Study: Bank Rakyat Indonesia, Indonesia
Table 27:
Structure of staff expenses (BRI 2001)
Salaries, wages,
US$ p.a./
Pension costs
Gratuity benefits
173.8 100.0%
Personnel expenses in % of total income: 14.9%95
The Assistant Manager
oversees some 10 or
more Units. His further
career depends on the
performance of these
The Unit manager and the
Unit staff receive an
bonus. They thus have an
performance. They earn
10% of the Unit’s profits,
capped at 1.5 times of
their monthly salary.
IPTW, a bonus for on-time
loan repayment.
The savings account depositor receives a higher interest rate for higher
account balances and the chance to win a lottery prize is also a function
of the savings account balance.
The employment with BRI offers in itself a number of incentives. In the
first place, the major incentive to perform is the relative safe employment
with a state owned company. Second comes an over average salary in
the banking industry if one considers all fringe benefits The average
expenses for one staff amounts to 7 times per capita GDP.93
The table below shows that BRI pays bonuses and incentives benefits
amounting to more than 60% of the basic salary.94 Additional cash
awards are given for achieving particular goals referring to deposit and
loan portfolio expansion decrease in arrears, and quality of
administration. Cash incentives and bonuses can exceed 40% of salary
payments. Severance payments are generous.
This is low if compared with many other banks but not very low when considering that
61% of the staff works in BRI Units. Unit salary levels are lower than the average.
This amount is in line - or even on the lower side - if compared with figures from other
private and state banks (BNI: US$8,300 per average employee). Salaries and other
benefits common in BPRs are much lower: about US$1,000 to 1,500 per employee.
The Challenge of Sustainable Outreach
Various forms of recognition within the bank are regarded as a reward,
such as being sent to one of the company’s five Training Centers,
participating in courses, field visits and other events like conferences,
also abroad.
A special incentive applies for BRI Unit managers. They can be
promoted to become BRI Branch staff, in particular supervisor or
assistant manager in charge for the Units. Management information system (MIS)
BRI’s Technology and Information System division is in charge for data
management. To complement the core banking system, BRI is currently
developing a new integrated MIS that shall meet the need for information
of both external parties (e.g. regulatory reports), and the needs of
internal management to support decision making and risk management.
The development is carried out in stages. It is expected to be completed
by the end of 2003.
By end of 2001, the development of BRINets on-line on-time system
included also 11 BRI Units. This internal integrated network system
allows access to various data, including data on customers in other
branches and Units, with the purpose to improve services, increase
efficiency and anticipate business competition.
The stand-alone PCs in the Units are equipped with software that
provides not only financial data but also a range of relevant management
ratios like, e.g., portfolio composition, arrears, etc. At the end of the day,
the Unit managers receive printouts on all relevant developments based
on the Units’ financial transactions. The MIS data are a management tool
and therefore disclosed to the staff.
More IT investment amounting to US$100m96 is planned for 2002/2003
to back up the upcoming privatization process of BRI.
The 2001 ratio of 14.9% is low if compared with a number of other banks in Indonesia.
Commonly, the ratio is above 20% (e.g. state bank BNI: 25%, private mid-size bank
Buana: 24% and NISP 18%, selected major Regional Development Banks: 23%-36%).
This compares with BRI’s total net fixed assets of US$79m in 2001 (see Chap. 2.1,
Table 6).
Case Study: Bank Rakyat Indonesia, Indonesia Human resources development
BRI employs almost 31,000 permanent staff, those who enjoy all fringe
benefits of a state company, and about 7,500 non-permanent staff, those
with non-essential tasks like night guards (see section, table 26).
These figures include 18,809 (61%) permanent employees of BRI Units,
a 4.5% plus since 1999. Reportedly, this is still about 1,000 short of the
target.97 Outsourcing (canteen, cleaning and transport services) was
used to improve staff efficiency ratios.
About ten years ago, and again in 1999, BRI offered its staff the
opportunity to leave the bank with a “golden hand shake” in efforts to
reduce the number of employees. Already in 2001 the bank added 978
personnel (3.3%) again.
The personnel for BRI Units are recruited locally. Local people
understand the local language and they are familiar with prevailing
traditions. Employment with BRI Units is in high demand and the bank
can select among hundreds of applicants. Candidates are invited to
apply at a branch office for an initial test. The best will be invited to
further exams at the Regional Office that is also in charge for deciding on
the number of additional employees. Few BRI Unit managers develop to
become an employee at a branch office. They can, however, even
advance to be appointed at Headquarters.
BRI set up five Training Centers across the country with a combined
capacity of 780 students for both branch and Unit employees. The bank
developed its own training material and employed professional full-time
lecturers. After an initial introduction of about four weeks the staff will
return to classes approximately once a year for about one to two weeks
fresh-up or upgrading. The syllabus encompasses fields others than
purely bank-technical ones. One course, for example, refers to the
diverse characters of the different ethnics, their behavioral pattern and
how to respond to them. The leadership development course addresses
also the topic of corporate culture and good corporate governance. BRI
offers for some 20 employees (about 0.07%) the opportunity to earn a
Master’s degree at local and international universities.
Since about four years, it has been proven difficult to convince the management to hire
new Unit staff while at the same time retiring BRI employees at the branch level.
The Challenge of Sustainable Outreach
BRI spent US$4.3m on human resource development, about 2.5% of
total personnel expenses. BI suggests observing a 5% target for training
BRI is proud to become the first bank in Indonesia to implement the
Human Resource Management System program, software developed by
SAP AG. The system shall be deployed at Headquarters and all
Regional and Branch Offices to improve staff management, allocation
and control. It is the objective to ensure service excellence and a high
degree of customer satisfaction. Assessment and conclusions
Within less than four years BRI’s organization was reviewed twice. In the
aftermath of the financial crisis, BRI underwent profound changes with
the transfer of bad debt to IBRA and a new start with releasing staff,
recapitalization, a new organizational chart, a number of new committees
and a new management, i.e. new members in the Board of
Commissioners and the Board of Directors. Some observes draw
parallels to the restructuring when BRI revamped the Units. They
question whether the remaining BRI branch employees can adapt to the
new management and new operational environment in due time. It is
obvious that restructuring does not only mean re-training. It comes
always with restructuring the personnel, i.e. costly dismissals (about 20%
of the staff) and employment of new staff.
It is a common feature of Indonesia’s SOEs that the employees share in
the profit. It is not common that the success of small economic units is
measured, monitored and attributed to particular persons as it happens
with regard to BRI Units. For this, the management, including the Unit
manager, receives information which is relevant for decision making. The
information is also generated by those PCs that operate in the Units’
Since its inception, BRI’s Micro Business Division overseeing the Unit
System did not burden the employees (and clients) with restructuring
programs. It was not necessary. The Unit system is uncomplicated and
clear and without obvious overlapping authorities. An incentive system is
in place and it is transparent as it is based on figures which the
beneficiaries, the Unit staff, can follow-up thanks to a kind of MIS system
to which they have access, namely the PC in the office.
Case Study: Bank Rakyat Indonesia, Indonesia
BRI embarked on a professional staff training system. The efficiency of
running five training centers and investment in a Human Resource
Management System is based on the high number of BRI staff out of
which 61% work in Units. However, with only few simple products and a
set of clear and easy to understand instructions, it is questioned whether
it is necessary to employ skilled or just disciplined people.
Incentives are also a common attribute of the Units’ products. Within
certain limits the customers decide on how much interest they earn on
deposits or how much they pay for loans as well as the amount of a
follow up loan.
Customer Orientation Products
BRI offers 29 products. The following is an overview reflecting their
Table 28: Overview of products
Name, sub-type, characteristics
Giro, current or cheque account
Simpedes, the savings product of BRI Units
BritAma and Tabanasbri, ATM access
Simaskot, offered also in urban BRI Units
Pilgrim savings account, no interest but presents
On-call, time deposits, deposit on call
- of which 1-month time deposits
- of which deposits in foreign currency
Kupedes, BRI Unit’s micro loans
Working capital loans
Consumption loans
Other loans, incl. government program loans
Transfers, guarantees, traveler cheques, safe deposit box, etc.
BRI offers the full range of products whereas the Unit system is famous
for its single loan product and few other products.
The Challenge of Sustainable Outreach
Table 29
BRI: Products and Services
BRI total
BRI Unit
Number of loan products
Number of savings products (5) and other
deposits (4)
Number of other financial services
The following provides details on some of the products. For more
information on interest rates compare also section GiroBRI
The BRI branch system offers the common demand deposits or current
(cheque) accounts, for which the account holder can earn up to 5%
(3% for US$accounts) p.a. interest depending on the account’s balance.
In 1996, BRI Units administered about 60,000 current accounts, about
10 to 20 per Unit, mostly for sub-district and village governments and
their agencies.98 The Units do not offer cheque accounts. Simpedes
Simpanan Pedesaan (Rural Savings) accounts are only offered at BRI
Units. After about two years testing Simpedes was introduced nationwide
in 1986. Its quite revolutionary (at that time) features are:
unrestricted with drawal facility: no limit to time, number and amount
of withdrawals;99
free participation in an attractive lucky draw offering quarterly prizes
like various kinds of electrical appliances and even motorcycles. The
prizes are financed with an about 1% lower interest rate compared to
other savings products;
“competitive” interest rates (in several years below the inflation rate).
By the end of 2001, the balance of US$1.5bn belonged to 24.2 million
accounts (more than 6,000 per Unit), a plus of more than 100%
Regulations on public administration require government agencies to have demand
deposits. Savings accounts are only for individuals, including owners of non-corporate
Remote Units require a two-day advance withdrawal request for amounts exceeding
US$1,100 for liquidity planning and because of maximum cash insurance limits.
Case Study: Bank Rakyat Indonesia, Indonesia
compared to end of 1997. The average balance of IDR652,000 (US$63)
in 2001 is much smaller in real terms than the average balance of
IDR457,000 (US$190) recorded in 1997.100 Higher interest rates for
higher balances did obviously not motivate account holders to increase
the balance. Nevertheless, Simpedes remained the most popular
savings deposit product in Indonesia because
BRI as a state bank offers the by far safest heaven for savings, and
BRI offers an additionality, an “opportunity”, “dream”, or “hope”,
namely to win one of the major lucky draw prizes in a country where
lotteries are prohibited.
The following are details on the development of savings deposits at BRI
Table 30
Number of savings accounts at BRI
Units (million)
Year Simpedes
After almost 20 years BRI
Units can still expand the
number of savings account
holders although since
1998, the growth rate
decreases constantly and
became single-digit for the
first time. The market in the
vicinity of the Units shows
The average balance of
Tabanas accounts was
26.77 1.24
traditionally less than half
of those on Simpedes
accounts. “Regarding to the focused and efficient strategy of BRI”101, the
product Tabanas was discontinued and the balance transferred to
Simpedes and Simaskot accounts.
Taking the US$ as a proxy, the nominal 43% balance growth hides a dramatic 67%
purchase power decrease. The poor savers had to foot the bill for the economic crisis.
Debtors, normally better off, gained. Interest is added to the account monthly based on
the lowest balance during the month. The accounts’ IDR growth is approximately
equivalent to the interest amount. The average saver did not add but did also not
withdraw money. A more detailed analysis on the behavior of the Indonesian small saver
would certainly reveal interesting information.
BRI Annual Report 2001, p. 41.
The Challenge of Sustainable Outreach BritAma
BritAma is a new product and substitutes Tabanasbri. This savings
product is marketed through BRI’s branch system. It offers on-line,
telephone and ATM access. Periodical payments for electricity and
telephone are possible through ATM. The account holder is covered by
an accident insurance and participates in a lucky draw. The annual
prizes are equivalent to about 0.2% of the total balance of this product.
For BritAma accounts, BRI charges a monthly fee of about US$0.40, an
amount that also competitors demand for similar facilities. Simaskot
This savings product was introduced about a decade ago for depositors
with urban BRI Units. Simaskot is the abbreviation for Simpanan
Masyarakat Pekotaan (Urban People’s Savings Account). The product
offers a 1% to 1.5% higher interest rate compared to Simpedes to attract
the more interest-minded urban saver. The average balance on these
accounts is more than 50% higher than those of Simpedes accounts.
This reflects the higher degree of monetarization in urban areas. Deposito
Time deposits offer an alternative to earn higher interest rates as
investing in the bond market is not yet popular. The deposit contracts for
1-month (most popular with automatic roll-over) and up to 24 months are
also offered to rural BRI Unit customers who account for 13.7% of all
time deposits. This product allows the rural investor to participate in
higher yields that develop on the money market in the capital. The
administration process is somewhat awesome (paperwork) and involves
frequently duty stamps for all kinds of documents so that it is not a
choice for clients with less than IDR5m (US$550) to invest for a short
period only. End of 2001, the average amount for 2.7 million BRI Unit
time deposits was IDR12m (US$1,150). (see also section Kupedes
Since 1984, Kupedes (Kredit Umum Pedesaan or general village loan) is
the only loan product of BRI’s Unit system. It is a multi-purpose “one fits
all” micro credit for “the working poor and those with a regular income.” It
is not a loan for the very poor and destitute and those who cannot prove
their commitment with collateral. Kupedes is a consumption loan for fixed
Case Study: Bank Rakyat Indonesia, Indonesia
income earners. For entrepreneurs it is a working capital loan (maturities
up to two years) or an investment loan (up to three years).
The common loan amounts range from IDR1m to IDR10m (US$110 to
US$1,100). People are not encouraged to take up loans below
IDR500,000 whereas IDR50m is the maximum. End of 2001, the
2.7 million borrowers owe on average IDR2.8m, the average new loan
approval is IDR5m. Repayment terms range from 3 to 36 months.
Installments can be made monthly, 3-monthly, 4-monthly, 6-monthly,
9-monthly and annually. A grace period of up to 9 months is offered.
However, the most common Kupedes loan is the 12-month or 36-month
monthly installment loan.
Nationwide, the monthly interest rate is 2% flat for all purposes and
maturities (see also section When the client repays this loan
without delay the bank returns every six month 25% (= 0.5%) of the paid
interest amount. With other words: It works as if borrowers pay an
upfront fine for late payment which is returned if proven unnecessary.
This incentive is regarded as a success key for punctual repayment and
high repayment rates. In Indonesia it is socially acceptable (or almost a
trade principle) to charge high and to return (as a gift or in another form)
a part of the income. This creates satisfied clients rather than negotiating
low and asking afterwards for additional compensation or even
“penalties” (creating ill feelings).
The credit policy is very cautious. Due to the co-signature requirement
almost all borrowers are married. Between
Table 31
11%-25% are women.103 Less than 2% of the
Kupedes borrowers102 borrowers are below 30 years. Many borrowers
achieved already pension age (50-55 years).
Therefore, it makes sense that the loan comes
together with a “free” life insurance that covers the
outstanding amount. The customer is also not
charged with provisions or administration costs that
competitors usually ask for. However, he has to
take over expenses for securitization (notary: US$4-45). He has to
provide (or buy) duty stamps (about US$2 for three documents).
Usual processing time for a Kupedes loan is about three weeks for the
first loan and less than one week for repeat loans.
Figures based on a survey; see: BRI micro banking services..., p. 22.
Women’s World Banking,
The Challenge of Sustainable Outreach Government program loans
Government program loans are those for which the bank receives
liquidity at preferential interest rates from BI104. For a number of these
programs (e.g. KKPA, a scheme used to finance plantations for farmers
in a cooperative) the repayment risk remains with the bank, for others
BRI is channeling agent105 and receives fees. Several of these programs
address people who would not be eligible for a loan with BRI Units, such
as the poverty alleviation program for small groups of farmers and
landless (P4K) with individual loan amounts of below US$50. These
programs are administered by BRI’s branch system. Services
BRI offers a full scope of modern banking products from telephone
banking and foreign trade support facilities to a full range of custodial
BRI Units offer payment services for telephone and electricity bills,
sometimes through automatic deduction from the savings account. The
Units receive also land tax payments. The teller will also accept transfer
orders which are sent to, and executed by, the closest BRI branch office.
This service is quite expensive (US$1.60). Customer orientation
Fundamental changes took place since the economic and financial
crises enhancing. All banks, including BRI exercise transparency and
disclosure of the banks’ business data to a remarkable extent. However,
these efforts may help banking analysts but not the clients. Consumer
protection is still very weak and it is not a field in which BRI is particularly
engaged. For example, until today, effective loan interest rates are not
The government did not subsidize interest rates but ordered BI to extend liquidity at
below market rates to banks so that they could offer loans at below market rates.
Micro loans channeled through BRI branches amount to about IDR2.6bn or US$250m.
Citing the loan contract as another example, borrowers will hardly read the four page
loan contract before signing it. Several applicants would need new glasses because of
small print. Supposedly, quite a number of Unit heads are unable to explain all
paragraphs in it. Few, if any, Unit heads will hand out a blank form to the prospective
customer for studying it carefully at home before signing the contract.
Case Study: Bank Rakyat Indonesia, Indonesia
Customer orientation is an issue, however not a priority issue, for the
BRI Unit system. BRI understands customer orientation as (i) presence
in rural areas, (ii) offering easy to understand standardized products and
procedures and (iii) generating a climate in which clients don’t feel
embarrassed to enter a BRI Unit. BRI chooses staff from the area in
which the Unit operates so that local languages can be spoken. There is
no immediate pressure to engage in more customer orientation. In most
rural areas of the country, Units do not have a competitor or at least not
a serious one.
Comparison BRI and BRI Unit system
Comparison of BRI’s whole operations with its microfinance arm shows
that about 474,000 BRI accounts (nearly 15% of total accounts)
constitute more than thirds of BRI’s total outstanding loan portfolio,
namely US$2,275m. The average BRI branch loan is much higher than
its aggregate average loan, but, at US$4,800, is still quite low. This
underlines BRI’s role as a bank for rather small enterprises. This
becomes even more evident from the comparison of the average
balance of savings accounts. The average balance of all savers with BRI
(US$80.7) is only slightly higher than the average balance of BRI Unit
savers (US$78).
Table 32
Loan Portfolio
BRI (consolidated)
2,821 3,052
of which are rural (000's)
1,818 1,996
Number of accounts (000's)
2,939 3,179
Outstanding gross portfolio in US$m
3,916 2,820
Average loan balance in US$
Average outstanding loan size/per
capita income in %
195.6 122.1
Number of active borrowers (000's)
(assuming 96% x loan accounts)
Average loan processing time
(depending on type of loan and
BRI Unit system
from less than one
week to more than one
% of rural population served
first time borrower:
about 3 weeks,
repeater: < 1 week
Market share in rural lending (amount, based on assets) .
% of rural borrowers served by financial institutions nationwide
The Challenge of Sustainable Outreach
The customer orientation of the BRI Unit system is described below. This
allows several comparisons. For example, the average outstanding
loanportfolio for the entire bank is US$988 per account. For Units it is
only about one third, namely US$340. The average deposit balance for
the entire organization is estimated to be about US$80.7 and for the Unit
system US$78. The average urban branch could only mobilize US$2.3m
compared to an average of almost US$0.5m for Units. This allows the
conclusion that BRI is the bank of small people not only in rural but also
in urban areas.
Table 33
Savings Portfolio
BRI (consolidated)
BRI Unit system
Average deposit balance in US$
Average deposit balance/per
capita income in %
% of rural population served
15.6 (21,812) (23,241) (24,341)
Market share in rural deposits
>80% (17,450) (18,593) (19,472)
% of rural savers served by
financial institutions nationwide
No. of of active savers (000's):
assumption: Savings accts x
of which are rural (000's)
Savings accounts (000's)
(average per branch = 2 x
average Unit or about 14,000)
Portfolio size in US$m
Assessment and conclusions
The BRI branch system offers a complete range of common modern
bank products. The bank follows the market leaders. There is no obvious
product or service that differentiates this bank from competitors.
Case Study: Bank Rakyat Indonesia, Indonesia
BRI reduced the number of savings products to increase efficiency.107 It
seems that it does not make sense to promote new products, be it a loan
or a deposit product, with new gimmicks. The BRI branch system earns
about 90% of the income from general working capital, consumption and
investment loans. The contribution of the other loan products is
negligible. It is to be questioned whether new products would really
improve the overall performance of the bank.
The state bank BRI attracts attention thanks to its unique Unit system
and the Unit’s products. Simplicity and target group adaptation are the
key elements and success factors.108
BRI Units offer the fundamental products that most people, including
small entrepreneurs, request from a bank. The two basic products, the
loan facility Kupedes and the deposit facility Simpedes come with
specific and unique features: on-time repayment incentive together with
a “free” life insurance cover and “free” participation in a lucky draw.109
The additional benefits have a high value for the clients and they regard
them as an extra because they do not (directly) pay for them. These
features take very carefully into account the psychology of the target
group, the incentives on which the hard working poor people respond.
They get something in return for their efforts. For the loan it is a reward
for compliance, for Simpedes the by-product, the “free” participation in a
lottery, it is “hope”, which is so important for not “well-connected” low
income people. The lottery offers an equal and fair opportunity of a
return that is much higher than the common interest income.
The data (see table 2.8, Customer Orientation) reveal that BRI is not the
only but the leading financial institution for peasants. At present Units are
to be found in only one out of about 16 villages. It serves about 15% of
the rural population, probably more than 50% of the households, with
savings products. But only 1.6% or less than 8% of the households enjoy
the loan product. This reflects a common judgment: The rural population
saves with BRI but they obtain loans mostly from other sources.
However, all the other sources provide more loans, but on average much
Several years ago BRI promoted a savings account based on 50% Rupiah and 50%
US$ value. BRI had to withdraw this product because regulations allow only IDR savings
Despite complicated loan contracts for which the unreliable juridical system in Indonesia
is responsible.
This feature was unique and it still is in rural areas where few competitors embarked in
offering prizes for deposits.
The Challenge of Sustainable Outreach
smaller loans to Indonesia’s about 40 million micro and SMEs.
Unfortunately, the percentage of households not seriously interested in
obtaining a loan remains unknown. For politicians it seems it is 0%.110
Government credit programs are often characterized by high arrears.
BRI protects the Unit system and all losses from those loans become the
losses of the branch system.
Summary and Conclusions
The state bank BRI demonstrates that over the long term a public bank
can provide financial services without subsidy, i.e. sustainable, on a
nation-wide scale to lower-income and even poor clients at local level.
The bank is not known for outstanding service, customer care, or highly
competitive interest rates. BRI carries the image of a state bank: The
money is safe, but procedures are bureaucratic, and flexibility is low. But
BRI is known for its presence, and for few but right products.
Additionally, many regard BRI as the commercial bank where small
people are respected most. BRI is the first choice of SMEs.
BRI’s strength is the unparalleled outreach through its Units. The
multilayer system of control, supervision and guidance is expensive but
these costs are balanced by low costs for bad debt reserves. The
management gives high priority to accountability, transparency and
simple procedures rather than flexibility and a wide range of decision
making that would, in the Indonesian context, too often invite misuse
than exploiting more business opportunities.
Since 2000, a new management has introduced good governance
principles and international standards for bank management. Under its
business plan 2000-2003 BRI’s targets the market for rural and urban
micro businesses, SME, and corporations in the sector agricultures,
forestry and fishery, those with low growth rates.
BRI fulfills the public mandate to support development goals without
requiring subsidies.111 This commercial bank operates along two different
A 2001-survey on more than 400 SMEs revealed that more than 30% are not at all
interested in obtaining a bank loan, only 30% actually applied for one. (see: Another survey on 1,066 respondents found: 81% run an
enterprise, 16% are Kupedes customers, 44% viable enterprises that did not apply for a
loan and 21% non-viable enterprises. (See BRI micro banking services, p. 14.
Case Study: Bank Rakyat Indonesia, Indonesia
The BRI branch system delivers program loans and extends loans to
other institutions (e.g. cooperatives) that provide micro finance for low
income people. The bank finances (or subsidizes) this task with
income from commercial operations and from the Unit system. There
are several reasons why the branch system did not provide profits, for
example losses associated with program loans.
The BRI Unit system with its separate outlets offers basic financial
products for low income people and maintains the financial
infrastructure in rural areas. Income from nearly 3 million commercial
micro loans is the main source to finance the network from which
about 25 million savers benefit. The system is efficient and was
profitable in every of the past 15 years.
The profitability of the Units is based on both, a relatively high loan
interest income and low costs for funds.112 With regard to deposits BRI
cashes in on the trust people have in state banks. The high demand for
deposit services is noteworthy. With regard to small loans BRI picks
raisins. BRI’s Unit system does not fulfill the demand for micro loans
because many applicants do not fulfill the selectivity criteria. The Units’
loan interest rates could be lowered from 33% to 25% and the RoA
would still comply with BI’s “healthy” criteria. The high interest rate and
the selectivity have positive repercussions regarding Indonesia’s
financial infrastructure. It allows private competition from which several
millions of small savers and debtors benefit in addition.113
There are a number of advantages114 when a state bank, and not a
private institution, develops and runs a microfinance institution such as
better (access to) infrastructure, government support, and clients.
High losses and subsequent recapitalization in 2000 was more a function of bank size
than bank ownership.
Compared with competitors, loan interest rates are low and so is cost of funds.
The BRI Unit system has not the target to occupy and monopolize rural or micro banking
although the Units take the bulk of the easy and safe business and leave the niches to
competitors. Units will be closed if competition results in losses. Thanks to the Unit’s
loan interest rate level, various small financial institutions can compete, survive and offer
products (and loans) to people that BRI Units do not offer. This competition improves the
financial services for the low income population.
Investment in financial infrastructure has additional returns for the government that are
not reflected in the balance sheet, e.g. less disparities between rural and urban areas.
The government would therefore consider an investment feasible at a lower rate of
return compared to a private investor. The private investor would also face the following
The Challenge of Sustainable Outreach
Profits do not find their way into private hands. This allows charging
“high” interest rates without social sanctions.
The state as bank owner is regarded as guarantor for deposits.
A number of clients require accounts with a state bank, for example
government offices. These accounts cover some of the fixed costs.
A state bank has easier access to facilities than a private investor who
might be charged much higher for various government and private
State banks can easier obtain special regulations, such as those
issued by BI for BRI’s Units.
As a state bank BRI sets benchmarks, which influence the entire
micro finance market. This can be regarded as a kind of open market
operation (similarities to the central bank’s activities) in contrast to
administered interest rates and ceilings.
Synergies from which the branches and the Units profit relate to a higher
capacity use (e.g. training facilities). The bank’s branches offer the Units
easy and efficient liquidity planning and placements of excess liquidity.
The proximity allows frequent supervision and consultation. The Unit
system benefits from the strength of BRI’s image whereas BRI has
access to relative cheap funds.
Other success keys worth mentioning are:
The government refrained from intervention in Unit issues.
The Units offer few, but the right products, those that offer positive
incentives for debtors and for savers, instead of a variety of similar
The profit center approach is coupled with an internal MIS that allows
self-monitoring that simultaneously motivates and warns Unit
Successful positive incentive systems are in place for superiors, Unit
managers and their staff, as well as for clients.
Depositors would not trust a private bank in the same way they trust a state bank.
A number of clients have to have their accounts with a state bank.
A private investor would fear to face restrictions, e.g. on interest rate setting.
The initial investments to set up a network until it works efficiently and profitable are
high and it takes time in particular with regard to human resource development.
Case Study: Bank Rakyat Indonesia, Indonesia
Contrary to assumptions of several observers, the BRI micro finance
system works
despite negative real interest rates for savings deposits;
despite high total transaction costs (here: costs for clients living at a
distance from the BRI office, the bank does not operate a mobile
service or door-to-door service);
despite an economically stagnant and even declining environment
(financial crisis);
despite an environment with some lack of a social ethic because
almost no unsecured loans are made;
despite low population density, even below 30 per km2, if supported
by modest infrastructure such as all weather roads;
with people with an average level of formal education as products and
procedures are kept as simple as possible;
The Unit system would not work as successful in an environment where
people and their families are not registered (identity and place of
no system exists for binding collateral;
legal enforcement would be non-existent, collateral could not be
no loans are allowed for civil servants and pensioners with automatic
deduction from the payroll, and/or salaries are transferred in cash and
bank regulations would not allow to set up smallest units;
responsibilities for profit and loss cannot be accounted to small units;
no performance related incentives are allowed, e.g., bank staff are
government employees;
business limitations exist, e.g., no consumption loan.
Serious challenges and threats lie ahead:
The Unit system accounts for about one third of BRI’s business and
(in the past) more than 100% of its profits. However, the Unit system
has not “its own” director. The superior of the Micro Business Division
The Challenge of Sustainable Outreach
(profitable) is also responsible for the branch network (in the past loss
making). When competing for scarce investment budgets it seems
that quite often the Unit system was the victim as no efforts were
obvious to invest a noteworthy amount for expanding its network.
It will be a major and costly effort to bring more than 4,200 offices online, to operate on the same system, and to provide the same level of
services to its customers across Indonesia. The investment and
operational costs will be a heavy burden for many Units whereas only
the minority of the rural Unit’s clientele may benefit.
Before, the BRI management has allowed the Unit system to operate
without major interference. After BRI being stripped of the prestigious
corporate business the management may be tempted to extend the
outreach of the branch system in order to lift its profitability. For
example, the Unit’s excess funds transferred to the branch system
may earn interest below the market rate, or IT-costs may be
accounted to Units in an unfavorable way.
In the end Units may loose their special status as a low cost system
with simple procedures and clear accountability. Units may finally
become a kind of sub-sub branch.
The authority of Unit managers to decide on loans declined
considerably if measured in real terms (proxy: US$). Some of the
Unit’s larger loan or deposit clients might look for an alternative bank
if they cannot directly communicate and negotiate with the decision
BNI, a state bank with focus on manufacture, tries to capture a share
of the profitable rural market for financial services. The bank started in
2002 with opening some 60 rural sub-branch offices.
Case Study: Bank Rakyat Indonesia, Indonesia
Annex 1
The financial crisis
The Asian crisis started with pressure on
the Thai currency in 1997. In Indonesia,
the speculative boom in the construction
industry prompted BI in July 1997 to order
that banks stop extending more loans in
this sector. This was the start of a
traumatic financial crisis. In August 1997,
BI abandoned the currency band. A 30%
devaluation raised concern about the
repayment capacity of enterprises that
obtained low interest short term US$loans
but invested it into property and did not
hedge against the currency risks. The
government called for IMF assistance. As
a first step 12 banks were closed in early
November and the government replaced
only deposits up to IDR20m (about
US$6,000 then). The trust in the banking
sector could not be restored and until end
of December 1997, the Indonesian Rupiah
(IDR) slipped from 2,450 to 4,650 against
the US$. In January 1998, more than
IDR15,000 bought one US$. The rate
recovered to 7,000 only few weeks later.
The volatile exchange rates prevailed
resulting from the lack of confidence in the
country’s banking system. Many US$financed banks and companies could not
service their tripled debt.
Assisted by IMF programs, all banks and the
entire banking system were reviewed with the
result that most of the large loans turned out
to be bad and commissioners and manager
of a number of large banks not fit and proper.
BI avoided the collapse of the banking
system by providing unsecured liquidity.
(Reportedly, more than ten billion US$of this
aid remained unaccounted for.) Auditors
passed a non-opinion verdict on BI and its
governor was imprisoned several months for
involvement in a banking scandal but
meanwhile, he resumed his duty. Bank
balance sheets showed negative equity,
interest payments exceeded income.
In 1999, another 38 banks were closed. The
recapitalization scheme that allowed bank
owners with 20% participation to repurchase
a simultaneous public 80% equity injection
within three years. This offer met no
response. Finally, the government issued
bonds that replaced bad loans and reinstated
equity. The loans were transferred to the
Indonesian Banking Restructuring Agency
(IBRA). It is IBRA’s mission to recover loans
and liquidate related, mostly insufficient,
collateral. The proceeds, and tax income,
shall enable the government to pay interest
In order to keep the banking system afloat for the bonds and eventually repurchase
the government gave a blanket guarantee them. Bailing out the banks will burden a
for deposits. At the same time, forest fires generation.
The IDR became the strongest currency with
production and prices soared. The inflation
about 100% gain (decline to 7,000) against
rate, typically hovering below 10% p.a.,
the US$. Now it was the exporters’ turn to be
reached 78%. Public dissatisfaction
hit in this rollercoaster ride. Inflation came to
resulted in riots that forced President
a stop and prices in December 1999 were
Soeharto to resign. The intimate
only 2% higher than 12 months earlier.
relationships between politicians and
Meanwhile IBRA sold some of the assets,
businessmen disrupted. This caused a run
including shares in large national banks.
on “well-connected” banks and the
These transfers were plagued by many
exchange rate to see 15,000 again and
interventions and finally low share prices.
more windfall profits for producer of export
Meanwhile the banking sector recovers
goods, including many cash crop farmers
slowly but without interest income from the
on the Outer Islands. The economy
government bonds many large banks would
contracted by 13%.
have to close.
The Challenge of Sustainable Outreach
Annex 2
Major reforms in the Indonesian banking system
Deregulation of loan and deposit rates, elimination of credit ceilings;
Relaxed requirements for establishing a bank and to open branches and subbranches; Presidential Decree on multi-finance companies;
Regulating off-shore banking business;
Abolishing almost all interest-subsidized loan schemes (in particular those for
small farmers, micro and small entrepreneurs); introduction of a compulsory
20% loan allocation to farmers, small and medium enterprises (SME);
Time table to meet BIS’s (Bank for International Settlement, Basel (Suisse))
8% capital adequacy ratio (CAR);
New banking law with two types of banks: commercial banks and rural banks;
Setting deadlines for banks to meet the legal lending limits;
Introduction of tax incentives for bank merger and consolidation, BI
announces plan for deposit protection (still unresolved); minimum paid-up
capital for foreign exchange license triples from IDR50bn to IDR150bn
(US$67m then);
Minimum reserve requirement rises from 3% to 5% of third parties deposits;
In July, BI forbids banks to loan to property development; the financial crisis
unfolds; first agreement with the IMF: 16 banks closed without deposit
protection. The government bails out small depositors (up to IDR20m or
about US$6,000);
BI announces a blanket guarantee for the national banks’ deposit liabilities;
suspension of the compulsory 20% loan portfolio allocation for farmers and
SME; a number of emergency regulations that were shortly afterwards
revoked, e.g., those on minimum capital for banks, or on foreign exchange
transaction tax (revoked after only few hours);
“Freezing” the assets of 38 domestic private banks (closing banks);
recapitalization starts and the first bond issue costs IDR157.6trn
(US$19.4bn); four state banks merge to become Bank Mandiri, the countries
biggest institute; a new Law on Bank Indonesia gives this institution
independence; Law on Foreign Exchange; bank supervision shall be moved
to an institution to be established until end of 2002; rules on prudent banking,
“fit and proper” tests for commissioners and directors;
BI demands CAR = 4% for 2000 and 8% for 8%;
Legislators discuss the status of BI and propose an amendment to the 1999
Law on BI that would jeopardize the institute’s independence; legislators
discuss a Draft Law on Small Financial Institutions and a polarizing Draft Law
on Credits proposing among others a 40% allocation of loans to SME;
BI extends the blanket guarantee for deposits in banks and stipulates the
minimum CAR requirement of 12% until 2003.
Case Study: Bank Rakyat Indonesia, Indonesia
The above list is indicative. The sector reform is continuing: For
example, BI issued 25 regulations in 2001 alone. In implementation of
the Master Plan for Bank Supervision (to fulfill the Basel Core Principles
and enhance prudential regulations) BI issued regulations concerning (i)
Transparency in Banks Financial Condition, (ii) Requirements to Provide
Minimum Capital; and (iii) Determination of Banks Status and Delivery to
IBRA. Major pressing issues on the agenda are the establishment of an
institution to supervise banks and other financial institutions, rules and
the implementation of a deposit insurance system, and the establishment
of a credit information system or credit bureau.
The Challenge of Sustainable Outreach
Annex 3
Program loans
Before the new Act on Bank Indonesia limited the tasks of the central bank (1999) the
government did not provide for interest subsidies. BI channeled low interest liquidity (KLBI),
additional money, to handling banks for on-lending to their clients.
KLBI was dominant in financing long term loans for small and medium enterprises and for the
development of farming, in particular rice self-sufficiency and the plantation sector (export
commodities). Quite a number of loan schemes benefited village cooperatives (regulated and
founded by the government) and members of these cooperatives. The misuse of the KLBI
facility became obvious when a son of the former president received a loan at only nominal
interest for his business.
In 1990, BI stopped a number of low interest program loans, the so-called PAKJAN or
January package. The interest rate of these loans were rather low and it was profitable to
invest proceeds in time deposits for effortless and risk free income.
In 1999, the execution of domestic and donor funded credit programs was transferred to
other institutions. BI is the owner of the liquidity credit (KLBI), which finances the credit
programs mentioned below. PNM (see section 3.2.3) and state owned Bank Tabungan
Negara (BTN) are allowed to re-lend credit program principal repayments without any
interest cost until the final principal repayment date of each credit program. BI is still
monitoring re-lending of credit program funds to monitor that the re-lending is implemented in
accordance with the regulations of each credit program.
Transfer of credit programs from BI to BRI, PNM and BTN
Credit programs
Managing institution
KUT (seasonal small farm credit)
BRI (state bank)
11 loans schemes for cooperatives PNM (non bank, state
and members of cooperatives
owned financial institution)
KPR (two housing loan programs)
BTN (state bank)
Current schemes: BI
Domestic and donor funded SME
credit programs
New schemes: Ministry of Finance
Export schemes: BEI (state bank)
Case Study: Bank Rakyat Indonesia, Indonesia
Annex 4
Characteristics of selected commercial banks
a) Characteristics of state banks
Merger of four bankrupt state banks: Bank Export
Import, Bank Dagang Negara, Bank Bumi Daya, Bank
Pembangunan Indonesia;
Went public in 1996 and was even listed at the New
York Stock Exchange; following recapitalization, the
government’s share increased from about 75% to more
than 99%;
The state bank for agriculture and micro finance
covering rural areas; most extensive network: more
than 4,400 outlets all over the country;
Bank Tabungan Negara, Special savings bank for
housing loans;
Special bank founded in 1999 to support export
5 banks
140 banks
Total Indonesia
145 banks
(based on InfoBank 7/2002, figures per December 2001, exchange rate 10,400)
b) Indonesia’s largest private commercial banks (2001)
Type, characteristics
TO (taken over by government), a substantial part
was already sold to investors
TO, merging with other banks, 71% for sale
Negative equity, under BI surveillance
Bank Panin
Bank Niaga
Government TO, to be sold in 2002
(Rank 1, 2, 4, and 7 are state banks, see above)
(based on InfoBank 7/2002, figures per December 2001, exchange rate 10,400)
The Challenge of Sustainable Outreach
c) Regional Development Banks
The provinces and districts own “their” bank. 26 BPDs (Bank
Pembangunan Daerah, Regional Development Bank) act as cashiers of
local governments and source of regional income. Its main business, up
to 90% of the credit portfolio, is granting small loans to government
employees. Few of these banks extended their branch network beyond
provincial boundaries. Some of them engaged in financing micro and
small traders and housing. Their experience with lending to medium size
enterprises is limited. As a result of regional autonomy and government
decentralization the local communities have more funds available which
they keep on demand accounts with BPDs. Subsequently, in 2001, these
banks expanded their business volume: growth in loans achieved 48%.
Case Study: Bank Rakyat Indonesia, Indonesia
Bank BRI: Annual Report 2001.
Bank Indonesia: Annual Report 2001.
BRI & John F. Kennedy School Government, Harvard University (2001):
BRI Micro Banking Services: Development Impact and Future
Growth Potential, Jakarta.
Charitonenko, Stephanie. & Richard H. Patten & Jacob Yaron (1998):
Bank Rakyat Indonesia Unit Desa 1970 - 1996, Sustainable
Banking with the Poor, The World Bank, Washington DC.
Jarot Eko Winarno (1997): Designing Products for the Microfinance
Market, Workshop on Institutional Commercial Microfinance for
the Working Poor, Jakarta.
Maurer, Klaus; Seibel, H. D. (2001): Agricultural Development Bank
Reform: The Case of Unit Banking System of Bank Rakyat
Indonesia (BRI), IFAD Rural Finance Working Paper No. B 5,
Maurer, Klaus (1999): Bank Rakyat Indonesia (BRI), Indonesia (Case
Study), in: Hannig, Alfred, Sylvia Wisniwski (ed.): Challenges of
Microsavings Mobilization - Concepts and Views from the Field,
GTZ, Eschborn.
Patten, Richard H.; Rosengard, Jay K.; Johnston Jr., Don E. (2001):
Microfinance Success amid Macroeconomic Failure: The
experience of Bank Rakyat Indonesia during the East Asia Crisis,
Harvard University, Cambridge (USA).
Patten, Richard. H.; Rosengard Jay K. (1991): Progress with Profits. The
Development of Rural Banking in Indonesia, International Center
for Economic Growth and Harvard Institute for International
Development, San Francisco.
Report of the High Powered Team (1995): Rural Financial Institutions in
Indonesia, Reserve Bank of India, Rural Planning & Credit
Department, Mumbai.
Rhyne, E. (1997): Remarks, Workshop on Institutional Commercial
Microfinance for the Working Poor, Bank Rakyat Indonesia
International Visitor Program, Jakarta.
The Challenge of Sustainable Outreach
Robinson, Marguerite S. (1992): Rural Financial Intermediation: Lessons
from Indonesia, Part One: The Bank Rakyat Indonesia. Rural
Banking, 1970-1991, Development Discussion Paper No. 434,
Harvard Institute for International Development, Cambridge, MA.
Robinson, M. S. (1997): Sustainable Microfinance at the Bank Rakyat
Indonesia: The Economic and Social Profits, Workshop on
Institutional Commercial Microfinance for the Working Poor,
Rosengard, Jay K. (2000): Doing well by doing good: the future of
microfinance via regulated financial institutions, contribution to: III
Interamerican Forum on Microenterprise, Barcelona (Spain), Oct.
Sugianto, Robinson, M. S. (1997): Commercial Banks as Microfinance
Providers, Workshop on Institutional Commercial Microfinance for
the Working Poor, Bank Rakyat Indonesia, Jakarta.
Sugianto (1997): Sustainability of Commercial Microfinancial Institutions,
Workshop on Institutional Commercial Microfinance for the
Working Poor, Bank Rakyat Indonesia, Jakarta.
The Economist Intelligence Unit Limited, (2001): EIU Country Profile
The Economist Intelligence Unit Ltd. (2002): Country Risk Service May
Yaron, J.; The World Bank (1998): Comparisaon: BAAC-Thailand and
BRI-UD Indonesia, Performance under Crisis, Second Annual
Seminar on New Development Finance, Frankfurt, Paper.
Other sources
Case Study: Agricultural Development Bank, Nepal
Case Study:
Agricultural Development Bank, Nepal
Marc Oliver Jünemann, Ulrich Wehnert,
in cooperation with Jalan Kumar Sharma
The Agricultural Development Bank of Nepal (ADBN) is mandated by His
Majesty’s Government to provide financial services to the rural
population to stimulate income and generate employment in remote
areas. In a country in which one third of all districts are still inaccessible
by road, whose level of human development is ranked below that of
Bangladesh,115 and which is presently facing one of its biggest
challenges, a Maoist insurgency (resulting in the first negative GDP
growth rate for 19 years), sustainable outreach, understandably, might
not seem very high on the immediate agenda.
Despite the present non-conducive environment for rural banking
activities in Nepal, ADBN’s past and present management team is aware
that the future of the bank does indeed depend on the institution’s
capacity to deliver its services on a cost-covering basis. Small reform
steps have been initiated in the past to turn this government-owned bank
into a more efficient provider of rural financial services, and some initial
results are already visible. Yet, both in and outside the country, ADBN is
still mostly known for its strong support of the Small Farmer Cooperative
UNDP (2002).
The Challenge of Sustainable Outreach
System, which has emerged over the last decade as an example of how
to achieve outreach to the poor and be financially sustainable at the
same time.
Section 4.2 provides the reader with a brief overview of Nepal’s financial
sector, touching on its structure, the regulatory and supervisory
framework and the present general non-conducive banking environment.
Section 4.3 deals exclusively with the ADBN, starting in section 4.3.1 by
familiarising the reader with ADBN’s mandate and main operational
areas. Section 4.3.2 deals with ADBN’s ownership and governance
structure. The relevant question of the bank’s financial viability is
addressed in section 4.3.3. The focus in section 4.3.4 is on ADBN’s
trademark approach, the “Small Farmer Cooperatives”, as a potential
model for the outsourcing of costly microfinance activities. ADBN’s
reform measures are analysed in detail in section 4.3.5. The issue of
customer orientation forms part of section 4.3.5. Finally, section 4.3.6
three concludes this study with a short summary of the main issues
related to the subject of sustainable outreach.
The authors would like to thank ADBN, for fully supporting this study
right from the beginning. Mr. Manohar Shrestha, Section Chief at ADBN,
was always ready to respond in a timely way to our queries and to
comment on the various drafts of this study.
The Financial Sector of Nepal
Although Nepal, according to the World Bank, is categorised as a Low
Income Country with an average annual income of about US$220, the
country has a broad and diversified financial system, with a great
number of institutions. In January 2002, the banking system comprised
16 commercial banks, 10 development banks, 10 rural microfinance
development banks, 49 finance companies, 34 cooperative societies and
16 NGOs. All of these institutions are licensed by the central bank, the
Nepal Rastra Bank (NRB). Furthermore, there are thousands of savings
and credit grassroots organisations in the informal financial sector which
are not licensed by the NRB.116
For an overview, see Table A1 in the annex.
Case Study: Agricultural Development Bank, Nepal
Regulatory and Supervisory Framework
The Nepal Rastra Bank is the country’s central bank. It was founded in
1956, based on the NRB Act, and is responsible for monetary policy as
well as the regulation of banking institutions. The issuance and
management of the currency falls under its purview. The Nepalese
Rupee (NRs) has been effectively pegged to the Indian Rupee (IRs)
since 1991, at a rate of NRs 1.6: IRs 1.
In terms of its regulatory responsibility, the central bank oversees the
functioning of the entire banking system to ensure and maintain financial
stability. Furthermore, it engages directly in the development and
distribution of credit facilities and partakes in corporate holdings in the
financial sector. Essentially, the bank is charged with the responsibility of
regulating and supervising the operations of commercial and
development banks as well as finance companies and microfinance
institutions, which are licensed by the NRB. As a clearing facility, it also
provides the infrastructure for inter-bank transactions.
A study carried out in 1999 with the purpose of determining how well the
bank’s regulations conform to the Basel Core Principles of Banking
Regulation highlighted numerous weaknesses. Some of the major
problem areas include an inadequate administrative legal framework as
well as a lack of independence in pursuing regulatory objectives. It was
noted that the regulatory mechanism is marred by political influence and
conflicts of interest.
A new act which came into effect in May 2002 aims at strengthening the
independence of the central bank. It is supposed to set different
regulations for various institutional groups on an individual basis, and
aims at adapting banking regulatory rules to internationally recognised
The basis for the regulation of the financial system is articulated and
constituted in the Nepal Rastra Bank Act of 2002. The following acts
were devised to lay down concrete regulations for the respective banks
and financial institutions:
The Commercial Banking Act of 1974 contains guidelines for the
regulation of commercial banks.
The Development Banking Act of 1996 regulates development banks.
The Challenge of Sustainable Outreach
The Finance Companies Act of 1985 regulates finance companies
and merchant banks (investment banks).
The Financial Intermediary Act of 1998 regulates NGOs in the field of
Further guidelines relevant to financial intermediaries can be found in the
Cooperative Act and in the Society Registration Act. Also of importance
for the financial sector is the Companies Act, which sets and articulates
the basis for economic relations in the economy.
Financial Institutions
Commercial Banks
With a share of 54.5% of the total assets of the banking system, the 16
commercial banks constitute the driving force behind Nepal’s banking
system. Within this segment, the two state banks, Rastriya Banijya Bank
(RBB) and Nepal Bank Ltd. (NBL), are the dominant players, accounting
for 50% of all commercial banking transactions. The other 14 commercial
banks are privately owned. Nine of these banks are run as joint ventures
with foreign part-ownership, while national shareholders control the
remaining 5 banks.
Based on the size of its total assets, RBB is the largest bank in Nepal. It
was founded in 1966. With a network of over 210 commercial branches,
it provides a great array of financial services to different levels of the
population. At the end of the fiscal year (2000/2001),117 the bank had
assets worth US$858 million and capital in the region of US$20 million.
The institution employs about 6,000 workers.118 Next in size to RBB is
Nepal Bank Ltd. This bank’s service-outreach is provided by 235
branches around the country. With a workforce similar to that of RBB,
this institution has assets valued at US$695 million and capital of around
US$15 million.
However, both RBB and NBL are facing an economic crisis. A study
conducted by KPMG Barents in 2000 on behalf of the Nepalese
Government concluded that both banks are technically insolvent and are
suffering serious shortfalls in all aspects of governance, management
The fiscal year in Nepal usually runs from mid-July (year 0) to mid-July (year 1).
For figures, see NRB (2001): Banking and Financial Statistics, Mid-Oct. 2001, No. 38.
Case Study: Agricultural Development Bank, Nepal
and customer orientation. Given the importance of RBB and NBL to
Nepal’s financial system, NRB has assigned foreign management teams
to the banks to eventually prepare them for privatisation.
Development Banks
The seven development banks in Nepal have a market share of 7.5%,
with transactions mainly dominated by the two state-owned banks, the
Agricultural Development Bank of Nepal (ADBN) and the Nepal Industrial
Development Corporation (NIDC). ADBN has the primary task of
developing the agricultural sector, whereas NIDC’s mandate is to
support the industrial sector. While ADBN’s market share in terms of
total assets is less than the share of RBB or NBL, ADBN nevertheless
has the highest outreach in terms of customers in rural areas. This
explains why ADBN is playing the principal role in the country’s rural
financial sector.
Other Financial Institutions
Besides the commercial and development banks, there are a great
number of other institutions in Nepal’s financial sector. Finance
companies offer a broad range of credit facilities and other services.
Refinancing is facilitated through fixed investments and bank loans.
Their share of the consolidated amount of assets in the banking system
is around 3.8%. Business activities are limited to the urban centers: of
the 49 finance companies licensed in 2001, 35 were established in
Nepal has a vibrant microfinance industry based on a wide variety of
models. In terms of outreach, the five Regional Rural Development
Banks (RRDB), modelled upon the Grameen Bank approach, are in the
lead. However, the financial viability of these state-owned institutions,
with one exception, is reportedly very poor. Two privately-owned
Grameen Banks appear to be more sustainable. In the last couple of
years, many former NGO microfinance institutions transformed
themselves into development banks as part of their commercialisation
strategy. The Small Farmer Cooperatives Ltd. (SFCL) is one of Nepal’s
fastest growing microfinance models. While the above-mentioned formal
and semi-formal institutions potentially reach an estimated 1.2 million
households, very little is still known about the estimated 26,000 cooperative societies and community-based organisations, which provide
The Challenge of Sustainable Outreach
financial services to their members in rural and very remote areas of the
The Armed Conflict and Its Adverse Effects on the
Banking Sector119
Since February 1996, Maoist insurgents have been waging a war against
Nepal’s government. Up to July 2002, the conflict had claimed more than
7,000 victims. The fighting so far has been confined to the remote
districts of the country, although 46 of Nepal’s 75 districts have been
classified as “highly affected” and another 20 (including Kathmandu) as
“affected” by the insurgency.
The main causes of the conflict are attributed by observers to bad
governance and corruption, inequitable socio-economic and political
access and resulting widespread poverty. Until recently the conflict was
treated by the government as a law and order problem that was mainly
dealt with by the police force. However, due to the deteriorating situation,
the army has now been called in to quell the insurrection.
The conflict has serious negative implications for the country, such as:
The spread of insecurity and fear in affected areas;
Impaired government services;
An increase in criminal activities, such as extortion in the form of
An adverse economic impact on the poor.
The main economic sectors (agriculture, tourism, textiles and carpet
manufacturing) are suffering due to increased insecurity and the
resulting impairment of economic activities. The ongoing conflict and the
state of emergency are having a serious negative impact on the
country’s development prospects. Development services in affected
areas have in many cases already been stopped or substantially
reduced. As a result, Nepal registered for the first time in 19 years a
negative GDP growth rate for the fiscal year ending July 2002.120
This section draws on the GTZ Nepal Country Study on Conflict Transformation and
Peace Building. For more details, see Kievelitz, U. (2002).
Kathmandu Post, 12 December 2002.
Case Study: Agricultural Development Bank, Nepal
The banking sector is particularly heavily affected by the conflict.
Between 20 and 30% of the branch networks of the three largest banks
(RBB, NBL and ADBN) have been vandalised by the insurgents. This is
resulting in a withdrawal of banking services from affected areas. Even
“pro-poor” providers of rural financial services such as SFCLs or
Grameen Banks have become targets of the Maoists. Banks and
customers now have to cope with a weakened outreach due to a
diminished branch network. Financial institutions are facing higher costs
due to reconstruction efforts and, last but not least, branch staff are often
fearful and subject to continuous tension due to security concerns. Thus,
to move towards or to even achieve sustainable outreach in the present
context represents a veritable challenge for all financial institutions.
The Agricultural Development Bank of Nepal
Background Introduction
ADBN was established in 1968 on the basis of the ADBN Act, with the
objective of improving production and productivity in the agro-sector
through organised credit distribution. The bank inherited the assets and
liabilities of the Cooperative Bank, which was established in 1963. In
1973, the Land Reform Savings Corporation was merged with the
bank.ADBN is an "autonomous" organisation under the governance of
the Ministry of Finance. In 1997 the bank embarked on an ambitious
reform programme, a reconsideration of the policies pursued so far
prompted by the bank’s inadequate financial situation. In successive
years, several measures were implemented and policies changed
On the basis of the ADBN Act, the bank now operates in three market
segments simultaneously:
development banking, providing credit for the improvement of
production and productivity in the agricultural sector, and for the
development of rural areas;
microfinance for poverty alleviation through the Small Farmer
Development Programme (SFDP). SFDP was the first major poverty
alleviation programme in the country, and was launched in 1975;
For a more detailed elaboration of this topic, see section 2.5.1.
The Challenge of Sustainable Outreach
limited commercial banking activities, primarily with the goal of
mobilising urban savings to channel them into rural areas.122
The development banking segment, with an outstanding loan portfolio of
US$200 million, is the principal focus of ADBN’s activities. As a special
microfinance programme, the loan portfolio under the SFDP amounts to
US$12.05 million. The following table provides an overview of ADBN's
main business activities:
Table 1: Business Activities of ADBN 00/01 (in US$million)
Total Assets
Loan Portfolio
- Developing Banking
- Microfinance (SFDP)
- Commercial Banking
Shareholder Funds
Public Deposits
- Number of Creditors
- Number of Depositors
Source: ADBN
Measured on the basis of its branch network, ADBN is the largest bank
in Nepal. It supports a network of 546 branches that are spread out
among the 5 regions of Nepal. The organisational structure comprises
three layers: a central layer at its Headquarters in Kathmandu, branches
at the field level, and supervision offices in the middle. In July 2002, the
bank employed around 4,600 workers. Measured in terms of total assets,
ADBN is the third largest bank in Nepal. Operational Areas of the Bank
(1) Development Banking
ADBN’s commercial banking operation does not carry out certain activities, such as
letter of credit or foreign exchange business.
Case Study: Agricultural Development Bank, Nepal
The bank provides short, medium and long-term loans to individuals,
groups, cooperatives and corporate bodies to carry out activities in
agricultural production, marketing, farm mechanisation, storage,
livestock, agro processing, irrigation and non-farm activities such as
tourism, alternative energy and housing. In addition, savings facilities in
the form of the Client Security Fund are offered. Further non-financial
services are confined to the provision of a livestock insurance product.
The development banking segment also includes other microfinance
programmes for which ADBN has received a management mandate from
the government. ADBN’s outstanding loan portfolio to the Small Farmer
Cooperatives Ltd. (SFCLs) now totals US$10 million.
(2) Microfinance - Small Farmer Development Programme (SFDP)
SFDP was initiated in 1975 to improve economic conditions for small
farmers and entrepreneurs. Particular emphasis was placed on the
promotion of women. In the mid-nineties ADBN, supported by GTZ,
developed a new vision to transfer more responsibility and autonomy to
small farmers in the execution of the programme. The objective was to
transform an unsustainable credit programme into healthy memberowned financial institutions. In order to facilitate this change, ADBN’s
Sub-Project Offices, which were used as executing units for the SFDP,
were subsequently transformed into SFCLs. Given the good results with
the transformation process, ADBN decided to transform all of its
remaining Sub-Project Offices into SFCLs. More details on the SFDP
and the transformation process into SFCLs are provided in section 2.4.2.
(3) Commercial Banking
The bank started commercial banking operations in 1984. Up to that
point, the main sources of funding were multilateral development banks
and the central bank. Prior to 1984 the bank was prone to liquidity
problems due to occasionally volatile decision-making in the respective
funding organisations. Hence, the bank intended to stabilise and
diversify its funding base. Consequently, commercial banking activities
were initiated, mainly with the goal of mobilising urban resources and
redirecting them to development banking-related lending activities. In
view of the success of the operation, the number of commercial
branches gradually increased to 54 by July 2002. As a result, public
deposits now provide over 70% of all funding. Additionally, commercial
banking loan services were developed gradually. In July 2001, 26.7% of
all loans were generated in the commercial banking area. In addition to
The Challenge of Sustainable Outreach
loans, guarantee and remittance services are provided to a limited
Ownership and Governance
The bank is majority-owned by the Government of Nepal. Since 1978,
the Government has exercised its ownership rights through the Ministry
of Finance (93.2%). before then, the bank was under the supervision of
the Ministry of Agriculture. The rest of the shares are held by Nepal
Rastra Bank (around 2.0%) and farmers, including cooperatives (4.8%).
Farmers and other groups taking out loans from the bank exceeding NRs
10,000 (US$128) were required to purchase at least one share in the
bank. This system was meant to transfer part of the ownership to small
farmers, as the bank’s main target group. Governance Structure
ADBN is governed and supervised by a board of seven directors. The
basic tasks and duties of the board are to formulate policies and
strategies to develop the business policies of the bank and to provide
internal supervision and control of the general administration.
The board of directors comprises seven members, consisting of:
one representative nominated by NRB,
one representative nominated by the Ministry of Finance from
cooperative institutions,
one representative nominated by the Ministry of Finance drawn from
the individual,
one representative from the Ministry of Food/Agriculture and
one representative from the Ministry of Land Reform,
one representative from the Ministry of Finance,
the General Manager of ADBN.
The chairman is nominated by the government. The Ministry of Finance,
which exercises the ownership rights of the government, appoints three
of the seven representatives. Only two members are non-bureaucrats.
According to the ADBN Act, there are no formal requirements regarding
Case Study: Agricultural Development Bank, Nepal
the formal qualifications of the board members. Since all board members
are appointed by the government, the board consists mainly of the
respective decision-makers within the various ministries.
The General Manager is the chief executive officer of the bank. He is
supposed to make major business decisions, to execute day-to-day
operations and to represent the bank externally. The board appoints the
General Manager for a period of five years.123
The composition of the board has two important effects:
Board members are representatives of the concerned ministries and
therefore might follow their respective interests. Politically motivated
decision-making with regard to the operational aspects of the bank
and its organisation are thus very likely.
Due to the lack of formal requirements by the ADBN Act regarding the
qualifications of board members, it is doubtful that the board can fully
comply with its supervisory obligations vis-à-vis the management. Supervision, Control and Auditing
Unlike other development banks in Nepal, ADBN has its own Act, and
thus is not governed by the Development Bank Act or the Commercial
Bank Act. Despite the fact that ADBN has become a major deposit
mobiliser (see the following section for details), this is to a large extent
happening outside the direct supervision of the Nepal Rastra Bank. As a
result, NRB has carried out only one formal inspection of ADBN, some
thirteen years ago.124
In its efforts to strengthen the banking system, NRB has issued some
prudential standards for the commercial banks. The below-mentioned
standards are some of the most prominent and significant reforms in the
recent past that should apply to ADBN's commercial banking activities as
Banks are required to have a 12% Capital Ratio of risk-weighted
See ADBN Act, Article 15.
World Bank (2002), p. 63; at present, another NRB inspection of ADBN is underway.
The Challenge of Sustainable Outreach
Exposure to a single borrower or group of related borrowers is
restricted to 25% of core capital.
Loans that are overdue for a period of over two years must be treated
as lost assets and 100% provisioning is required. From the next
financial year, this period is further curtailed to one year.
All banks are required to prepare their financial statements following
prescribed formats and to have them audited within five months of the
end of the fiscal year.
However, it is not fully clear to what extent ADBN is really following these
norms, since the mobilised funds are primarily used for the loan business
in the development banking segment, which is less strictly regulated and
supervised by NRB.
Internally, the Board of Directors and the General Manager are in charge
of controlling and supervising the activities of the bank, based on the
stipulations of the ADBN Act. The task of auditing and inspection is
entrusted to various controlling units established for this purpose under
the Internal Control Department. Within this entity there are three
separate divisions, namely the Internal Audit, Inspection and Legal
The Internal Audit Division conducts, supervises and monitors the
internal audit function on a regular basis. Due to ADBN's vast branch
network, five Internal Audit Units have been set up in different parts of
the country, in addition to a central audit unit at the head office. Today,
the Internal Audit Division consists of 67 employees who carry out
internal audits on an annual basis.
The Inspection Division was established about two years ago. Its main
tasks are to ensure that rules and regulations are implemented and
followed properly and to prevent fraud. The internal control system is
based on 13 supervision offices at the regional level and on district
controlling offices in all 75 districts of the country. Commercial banking
inspection and development banking inspection are treated separately in
two different sections. Inspections are conducted on a regular basis and
through surprise visits. During the last year, 86 inspections were carried
out by this division, 26 of them in commercial banking offices. 55 staff
members currently work for the Inspection Division at the head office.
The Legal Division was established to support and supervise the legal
processes related to collateral assessment and investment procedures in
Case Study: Agricultural Development Bank, Nepal
general. According to ADBN officials, this division contributes
significantly to the containment of fraud through the enforcement of the
respective rules and regulations. Further action might be required to train
loan officers and branch managers in legal matters to raise awareness of
the importance of proper documentation and fraud control in the bank. Assessment and Conclusions
Like many other public banks, ADBN also faces the challenge of political
intervention in its day-to-day business. Given Nepal's past history of
rapidly changing governments with equally swiftly changing priorities, it
would be difficult for any institution to be able to operate within a
relatively constant framework. With all board members nominated by the
government, the task of building a lasting institution to deliver
professional services to its customers remains extremely challenging.
Thus, more autonomy for the bank's management in decision-making
and day-to-day management appears to be key to future success.
Due to its unique legal status, ADBN is not supervised in the same way
as other commercial banks are by Nepal Rastra Bank. While NRB has
the mandate to take a potentially tough stance regarding ADBN, it is
presently not yet doing so. A separate NRB Directive on ADBN's
commercial banking activities would certainly be in the interests of the
bank as well as its depositors, who would benefit from some sort of
protection through an improved supervisory policy.
Economic Viability Economic Performance
Total Assets
The bank's operations have increased significantly over the last decade.
Total assets have grown six-fold since the beginning of the nineties and
doubled in size since the beginning of reforms in 1997 to reach NRs 32
billion (US$435 million). This increase was mainly due to an increase in
agricultural loans funded by a substantial growth in deposits. Since
around 90% of all deposits are generated in urban areas, and 70% in
Kathmandu alone, ADBN is shifting a large part of its financial resources
from urban areas to rural regions. The following chart gives an overview
of some essential balance sheet developments over the last decade.
The Challenge of Sustainable Outreach
Figure 1
B alan ce Sh eet D evelo pm en t
3 50 00
3 00 00
To ta l A s s et s
De p os its
Nrs mio.
2 50 00
B o rro wing
2 00 00
Ca p ita l
1 50 00
To ta l L o an P ortfo lio
1 00 00
- Ag ricu lt ural L oa n s
50 00
- Co m m ercia l Lo a ns
91 World
1 99 3Bank
19 9 5
Source: ADBN 19
1 9 97
1 99 9
20 0 1
Capital Adequacy
After a severe shortage in equity at the beginning of the nineties, ADBN's
capital ratio came down to 4.9%. Despite a substantial increase of
capital by several hundred percentage points in the following years,125
the capital increments could not keep up with the significant increase in
total assets. The state as owner of the bank did not provide the required
means on the one hand, and the internal equity generation of ADBN was
insufficient due to its low level of profitability, on the other. Hence, the
equity position has worsened over recent years, standing at 5.4% in
Table 2: Equity (US$million)
Total Assets
Equity Ratio
Source: ADBN and World Bank
This is mainly due to a capital injection by the government of NRs 600 million
(US$8 million).
Case Study: Agricultural Development Bank, Nepal
Quality of Loan Portfolio and Recovery Performance
The quality of the portfolio at the beginning of the reforms in 1997 was
unsatisfactory. Since then, the new policy has resulted in successive
improvements in financial indicators between 1997 and 2000 (details of
the reform programme can be found in section 4.3.5). In 2001 the ratio of
impaired assets increased again, mainly due to the deteriorating internal
security situation. Table 3 illustrates how the quality of loans measured
by the ratio of overdue loans has improved over the last three years:
Table 3: Quality of Loan Portfolio
Overdue Loans /Loans Outstanding
1999/2000 2000/2001
Defined as overdue payments from day one
Source: ADBN
The introduction of client incentives such as rebates for timely interest
and principal repayments, the launch of a monthly interest rate system
and the levying of penalties of up to 4% on overdue payments, have all
contributed to improving ADBN's recovery performance. Nevertheless,
by international standards, the overall level of overdue loans (at around
20%) remains unsatisfactory.
The bank has not yet established a stringent write-off policy. Bad loans
are basically not written off. There is only one guideline for loans
provided by the bank in the development banking segment (including
SFDP): up to a limit of NRs 5,000 (about US$66), loans are written off
after an overdue period of 5 years. Consequently in 2001, only NRs 32.9
million (US$450,000) were written off. In 1995 the government
established a fund of NRs 300 million (US$4 million) to compensate the
bank for up to 75% of old and non-performing loans to cooperatives.
The reluctant approach of ADBN towards cleaning up its balance sheet
has resulted in a negative impact on liquidity and interest income. It puts
the bank under pressure to provide costly funding for a growing share of
assets which are not generating sufficient cash flow in the form of
principal and interest payments.
The Challenge of Sustainable Outreach
The bank has generated positive returns over the last 3 years, but
profitability as measured by the return on average assets (ROAA) and
average equity (ROAE) is still low. The major issue that needs to be
addressed before profitability can be improved is a substantial reduction
of administrative expenses, which currently account for 36% of total
Table 4: Profitability
Source: ADBN
Efficiency and Productivity
Over the last three years staff productivity has improved. Table 5
indicates an increase of about 15% on the number of borrowers per loan
officer between 2000 and 2001. Measured by the value of loans handled
by each loan officer, the ratio has improved by about 13% over the same
Table 5: Efficiency and Productivity
Number of borrowers/loan officers and assistants
Value of loans outstanding/loan officers (In US$´000)
Source: ADBN Interest Rate Policy
ADBN's board of directors is in charge of determining the interest rates
on savings and loans. The following items are considered when
determining interest rates:
The market rate offered by other banks and financial institutions.
The cost of funding and other operating costs.
The competitive position in certain loan segments.
Case Study: Agricultural Development Bank, Nepal
The economic performance of the borrower.
The macroeconomic environment.
Guidelines and directives issued by Nepal Rastra Bank.
Government policy on priority sectors of development. In the priority
lending sector, the bank is offering rates on a cost coverage basis
plus a margin of about 1.5%.
In addition, the borrower's performance may also have an impact on
individual interest rates: a good repayment record and monthly interest
payments can further reduce loan rates.126
In a nutshell, ADBN is taking relevant components regarding costs and
the market environment into consideration when calculating interest
rates. A strain on profits is incurred by priority lending sector activities,
which only permit a margin of about 1.5%. Sources of Funds and Margins
Borrowings and deposits are the main items that refinance the bank's
lending operations. The composition of the funding base has changed
significantly over the last decade, with deposits largely substituting for
borrowings. The share of borrowings in the total funding mix decreased
from 45.5% in 1991 to 20.7% in 2001. During the same period the
deposit share increased from 48.8% to 72.3%. The following figure
emphasises this change in the funding mix:
See section 2.6.1 for further details.
The Challenge of Sustainable Outreach
Figure 2
S o u rc e s o f F u n d s
E q u it y
B o rro w in g s
D e p o s it s
Source: ADBN
The government is the largest equity holder of ADBN (93.2%). Minor
contributions are provided by Nepal Rastra Bank (2.0%), and by
individual farmers and cooperatives (4.8%).
The deposits are divided into fixed deposits, savings and current account
deposits. In the financial year 1995/96 the composition of the deposit mix
was 48%, 45% and 7% respectively. In the financial year 2000/01, the
composition had changed to 31%, 62% and 7%, with an increment of
17% in savings and a decline of 17% in fixed deposits. A very marginal
increment of only 0.1% occurred in the current account. These changes
imply shorter maturities.
Borrowings are primarily provided by the central bank, national banks
and external donors. The commercial banks provide funds under the
mandatory priority sector scheme, which only cost the bank 3.5%.127
Over the financial year 2000/2001 the bank operated at an average
interest margin of 7.4%. Funding costs have decreased since 1998 due
to the increment of deposits in the funding mix and the shift towards low
yield savings accounts in the deposit mix.
12% of the loan portfolio of each bank operating in Nepal has to be allocated to the socalled priority sectors. In order to fulfill their individual quotas, banks can alternatively
resort to providing the equivalent funds to ADBN, instead of providing the required loan
business themselves.
Case Study: Agricultural Development Bank, Nepal
Table 6: Cost of Funding
1996/1997 1997/1998 1998/1999 1999/2000 2000/2001
Cost of Funds (%)
Revenue Rate (%)
Interest Margin
Source: ADBN Assessment and Conclusions
Without a doubt, ADBN’s overall financial performance has improved
over the last few years. Major indicators such as total assets and deposit
mobilisation show impressive growth rates. Despite the dramatic
expansion of the loan portfolio, it proved possible to reduce the overdue
loan ratio. As section 5 will demonstrate, this achievement can be
attributed to the reform measures initiated by the bank’s management
since the mid nineties.
ADBN’s determination to become more independent from external
lenders through an exemplary deposit mobilisation drive is certainly one
of its greatest achievements so far. Unlike many other banks, ADBN is
shifting its financial resources from urban to rural areas and is thus a net
investor in Nepal’s countryside.
Despite the relative improvement in key areas, the bank’s real financial
position cannot be assessed with any certainty. An overdue loan ratio of
around 20%, a low level of capitalisation, a write-off policy clearly below
international standards and an uncertain amount of bad loans give
enough reasons for concern.128 If we add Nepal’s present difficult
banking environment to this picture, we can assume that the real
challenge of making the bank sustainable still lies ahead.
Decentralisation of Banking Operations Branch Network and the Introduction of Profit Centers
In terms of its branch network, ADBN is the largest bank in Nepal. It
operates from 546 offices located in all 75 districts of the country.
This is why ADBN and ADB agreed to prepare a "diagnostic study" through a special
Technical Assistance project. The results of this study will possibly become available
during the first half of 2003.
The Challenge of Sustainable Outreach
Operations are carried out by a three-tier organisational structure,
consisting of the head office at the central level, branches at the field
level and supervision offices in-between. Branches at the field level are
sub-divided into main branches, branches, sub-branches and depots
according to their size. Currently the organisation consists of 256
developing banking branches, 217 sub-project offices (SPO), which are
the executing bodies for the Small Farmers Development Programme,
54 commercial banking branches, 13 supervision offices, 5 regional
training centers and the head office. The number of development and
commercial banking branches increased between 1999 and 2001 from
239/35 to 251/47 respectively.
The total number of employees totalled 4,547 as of July 2001, of which
1,603 are loan officers (35%), and the remainder bank assistants and
support staff. On average 5 to 6 loan officers, depending on the size of
the branch, are located in one field office. Managers of branches have to
be at least “officers”, which means that they must have obtained an
academic degree before joining the bank. Sub-branch officers are 3rd
class officers, branch officers are at least 2nd class officers, and main
branch officers are usually 1st class officers. Only non-graduate officers
can occupy a management positions at depot level.
The decision-making process with regard to loan approvals and
collateral evaluations has been decentralised over the last decade.
Depending on the status of the branch, branch managers can approve
individual loans up to an amount between US$8,000 and 40,000. Tables
A3 and A3a in the annex give an overview of the level of competencies
granted to the respective operational levels.
Since the beginning of the second reform phase in 2001, the bank has
introduced the concept of “responsibility centers” (profit centers) for
branches129. The branches are supposed to record every expense and
item of income on their account to ensure transparency in their cost and
income structure. The implementation of a transfer pricing system is an
essential ingredient of the profit center concept. Regarding the transfer
pricing mechanism, a transfer price is applied on funds transferred
between head office and the branches. If a branch needs additional
funding to cover lending operations, it is charged a transfer price
(currently 8%). On the other hand, the accounts of branches are credited
with the transfer price when they transfer surplus funds to head office.
For a detailed examination of the reforms, see section 2.5.1.
Case Study: Agricultural Development Bank, Nepal
Branches are now charged for the use of vehicles and computers, and
have to take personnel expenses and provisions for bad loans onto their
branch profit/loss account. Additionally, they share different sorts of head
office expenses, such as administrative expenses, costs for supervision
offices and training centers in their respective regions.
The new system is supposed to lower costs and generate efficiency
gains, by making branch staff more sensitive towards expenditures and
income. An annual ranking of branches supports the profit center
concept. A set of selected indicators is used to measure performance.
Since the system was only implemented a year ago, it is too early to
discuss the final outcome or any shortcomings; nevertheless, initial
results appear to show an improvement in efficiency.130
The ongoing Maoist insurgency is adversely affecting the performance of
ADBN’s branch network. Since the beginning of the conflict about 6
years ago, 166 bank premises have been vandalised and looted,
including 61 bank offices and 81 SPOs. These incidents caused physical
damage valued at about NRs 10.6 million (US$135,000), and the loss of
NRs 28.7 million (US$370,000) in looted cash. Consequently, bank
activities in the affected districts are severely impeded, and field staff
movement is very limited at present. Outsourcing Microfinance
Cooperatives Ltd.
In 1975, ADBN started to form joint liability groups of small farmers
through its Sub-Project Offices (SPOs). In line with the prevailing
development thinking of that time, “cheap” money, meant for productive
purposes, was channelled to group members. The high overheads and
low collection rates of the SPOs, however, led experts to question the
sustainability of this approach. In 1987, the ADBN introduced an action
research Institutional Development Programme (IDP) with the support of
GTZ. The objective of the new direction taken was to transfer the ADBNrun SPOs into fully self-administered and managed cooperatives of small
Between 2001 and 2002 staff productivity measured by staff per loans outstanding
increased from 4.7 million to 4.9 million, and staff per public deposits increased from 3.8
to 4.6 million.
Lamsal, P.P., Sejuwal, C.B. and R. Shakya (2001).
The Challenge of Sustainable Outreach
In 1993, as a result of the IDP, the first four SPOs were transformed into
Small Farmer Cooperatives Ltd. (SFCLs). Since then, 121 SFCLs have
been established in 34 districts of the country. Currently, the Small
Farmer Cooperatives Ltd. in Nepal comprise a total of 68,000 rural
households with outstanding loans of US$11.5 million and internally
generated resources of US$2.5 million. Female membership stands at
38% and is increasing.
A Small Farmer Cooperative Ltd. is a multi-service cooperative designed
to deliver primarily financial, but also non-financial services to its
members in rural areas. SFCLs are civil society organisations which pool
their joint resources to meet basic needs and to defend their members’
interests. They are member-owned and controlled and have an open
membership policy towards “poor” farmers.
An SFCL is a three-tiered organization with small farmer groups, intergroups and the main-committee as the three pillars. Small farmer groups
are formed as joint liability groups at the village level, usually consisting
of 5 to 12 members. These bodies allow members to start and operate
financial and non-financial services required by the group and/or group
members. From each small farmer group within a defined area, one
representative joins the so-called inter-group. The inter-group further
validates specific group requests and gives approval recommendations
to the main committee. It also functions as an intermediary between the
groups and the main committee. One representative of each inter-group
joins the so-called main committee at the VDC132 level. The nine member
main committee approves the programme of the SFCL and decides on
the implementation of any other projects such as office building
construction, livestock insurance schemes, consumer stores, etc. To
handle the daily operations of the organisation, a chief manager, an
assistant manager and a helper are employed by the SFCL. Either the
chief manager or the assistant manager should be female. The general
assembly is the main body of the SFCL. It takes place once a year in
order to elect the main committee and to approve the audit and progress
reports. In special situations, the general assembly can meet as
Village Development Committee (the smallest administrative unit in Nepal).
For more detailed information on SFCLs, their organisation and products, see Staschen,
S. (2001).
Case Study: Agricultural Development Bank, Nepal
Through the above-described organisational set-up, SFCLs deliver
various financial and non-financial services. Financial services include
various forms of voluntary and compulsory savings products, a variety of
loan products as well as a livestock insurance scheme. Non-financial
services include the construction of irrigation channels, establishment of
milk collection centers, nursery programmes or women empowerment
programmes. New products are continuously added. A prominent
example is the design of a savings product addressed to children and
their parents.
An impact study conducted during November 2000134 was able to
demonstrate that both the economic and the social living conditions of
members had improved after joining the cooperative organisation. In
particular, dependency on moneylenders had decreased significantly.
More than 50% of the farmers reported that their children now had easier
access to schools due to improved income levels.
By July 2000, SFCLs had captured a significant share of the
formal/semi-formal rural financial market, serving 6% of the total
borrowers.135 The market share of SFCLs is estimated to have increased
since then by another 1-2%. For many years the SFCLs followed a
strong path towards profitability with impressive growth rates in terms of
deposit mobilisation and increases in revenue. An ADBN/GTZ study in
2001136 showed that from a sample of 33 SFCLs, the average financial
self-sufficiency ratio had increased from a poor 39% by mid-July 1997 to
118% by mid-July 2000, putting SFCLs in the category of successful
microfinance institutions. Over the last couple of years, however, the
business climate and security situation have deteriorated due to the
Maoist conflict, adversely affecting the performance of SFCLs. 34 SFCLs
have so far been attacked by extremists, and documents, furniture and
buildings have been burnt down. The average financial self-sufficiency
ratio therefore dropped to 89% by July 2001 and further decreased to
83% by July 2002.137
The question as to why SFCLs are being attacked by the Maoists has
often been raised. Apart from the fact that the Maoists appear to attack
Sharma, S., Bhattachan, K.B. and R. P. Shreshta (2001).
Calculated from data provided by ADB (2001).
Wehnert U. and R. Shakya (2001).
The calculation is based on a sample of 77 SFCLs. For more details on SFCLs and the
armed conflict in Nepal, see the upcoming publication by Wehnert, U. and R. Shakya
The Challenge of Sustainable Outreach
any kind of development infrastructure, it is possible that SFCLs are
perceived by the Maoists as still being closely associated with ADBN
even after the transformation process. ADBN and its branch structure
has long been a prime target of the Maoists because it is a governmentowned institution and a symbol of capitalism. However, while most of the
attacked SPOs had to be closed or merged with the sub-branches,
almost all SFCLs quickly resumed operations after the incidents. Today,
32 out of 34 attacked SFCLs are again providing services to their
members. There could be no better sign of true people’s ownership.
Due to the relative progress made with the SFCL programme, ADBN
decided in the 1997/98 fiscal year to completely outsource its remaining
SPO microfinance operations into independent local grassroots
organisations in the form of SFCLs. The estimated savings in terms of
operational costs through the outsourcing of its microfinance operations
appear to have been significant. Table 7 shows the number of SPOs
transformed in the respective fiscal years. Given the annual operational
costs of NRs 225,000 (US$2,900) for one SPO, the total savings in
operating costs due to the transformation of SPOs into SFCLs are
estimated to be around US$1.2 million, a quite significant amount.
Table 7:
Fiscal year
Estimated Savings in Operational Costs of ADBN by
Transforming SPOs into SFCLs
Number of
transformed in
the period
Tentative No. of Estimated
years of cost
operating costs
per SPO (in
Total Savings
in operating
costs due to
(in USD)
Source: GTZ/ADBN
Case Study: Agricultural Development Bank, Nepal Outsourcing Microfinance (II): The Sana Kisan Bikas
Even after the transformation of SPOs into SFCLs, the relationship
between the bank and the SFCLs usually remains very strong. ADBN
provides not only refinance facilities to the cooperatives, but also delivers
regular technical support and supervisory services through its
supervisory and controlling offices. These support activities still affect the
bank’s bottom line; the increasing capacity of SFCLs demands more
sophisticated technical and financial support services from ADBN, too.
However, ADBN felt increasingly uncomfortable in responding to these
demands since it was increasingly focusing on reforming its core
commercial and developing banking business. Thus, the idea of setting
up a separate apex bank to completely outsource the bank’s
microfinance operations under the Small Farmer Development
Programme emerged. The hundreds of refinance lines to SFCLs were
supposed to be bundled and channelled in future only through the Sana
Kisan Bikas Bank (Small Farmer Development Bank). The objective of
the new bank is:
to create a specialised, professional and lean rural finance institution
to refinance SFCLs and similar institutions in rural and remote areas
to encourage SFCLs to become majority shareholders of this bank in
a 5-10 year time-frame.
Thus, the vision of the new bank was not to create merely a subsidiary of
ADBN, but to establish a refinance institution which should be driven and
guided in the long run through its members, i.e. SFCLs and similar
organisations. However, in the start-up phase, ADBN assumed the role
of strong promoter and main shareholder. The total paid-up capital at
present is almost NRs 100 million (US$1.3 million). The biggest
shareholder is ADBN with NRs 70 million (US$900,000), followed by the
Ministry of Finance with NRs 20 million (US$255,000) and two
commercial banks with a total share holding of NRs 7 million
(US$90,000). The initial 21 SFCL promoting agencies have a joint
holding of US$22,000. Another 31 SFCLs have already deposited NRs
1.4 million (US$17,500) to buy respective shares. This amount is
expected to increase significantly over the coming years. Despite being
the smallest shareholder, SFCLs are represented on the seven-member
board with two representatives. The remaining seats are shared by
The Challenge of Sustainable Outreach
ADBN with three representatives and by the Ministry of Finance and the
Nepal Bank Ltd. with one representative each.
The Sana Kisan Bikas Bank (SKBB) was registered in July 2001 with the
company registrar office. The bank received its operating license from
the Nepal Rastra Bank in March 2002 and started its lending operations
from three area offices in November 2002.
Besides the refinance facilities provided through the SKBB, SFCLs still
need technical assistance and guidance in the future. In order to achieve
full autonomy from external support, SFCL federations will provide nonfinancial services to their members such as training, consultancy,
supervision and auditing. ADBN, SKBB, SFCLs and GTZ are working at
present on a sustainable federation concept. Assessment and Conclusions
ADBN has organised its operations into a fairly decentralised
organisational structure. The branch network, which extends to every
district of Nepal, serves areas of the country where access to financial
services is in scarce supply. Due to the comprehensive devolvement of
decision-making, regional and local level entities appear to have been
granted sufficient competencies to deal with day-to-day business. The
recently implemented profit center concept is expected to produce some
more efficiency gains.
The outsourcing of ADBN’s microfinance operations certainly represents
a genuine innovation. In phase one, ADBN is transforming its mostly
unsustainable sub-project offices into member-owned and managed
SFCLs. So far, ADBN has managed to reduce operating costs by an
estimated US$1.2 million. Even more important, the newly established
microfinance institutions have regularly managed to exceed the 100%
financial self-sufficiency ratio in only a couple of years. However,
although SFCLs are one of the fastest growing microfinance systems in
Nepal, observers have criticised the slow pace of ADBN’s transformation
process. It took the bank almost ten years to transform 120 SPOs into
SFCLs. The transformation of the remaining 200+ SPOs into SFCLs will
only succeed if this process becomes more efficient.
With the start of stage two of the microfinance outsourcing process,
ADBN is preparing to completely disconnect itself from the SFCLs. The
establishment of the Sana Kisan Bikas Bank in 2001 is designed to allow
ADBN to concentrate on its core commercial and development banking
reforms. The new apex bank is expected to further advance the
Case Study: Agricultural Development Bank, Nepal
development of the SFCL system and to offer demand-oriented
refinance services. The vision of an SFCL-owned bank appears to be
fully in line with the philosophy of the Small Farmer Development
Programme of giving ownership to the people. However, given Nepal’s
highly politicised environment and a board on which the private sector is
not well represented, the SKBB faces clear obstacles in implementing
this well-thought out business plan.
The Maoist insurgency constitutes at present certainly one of the biggest
challenges for ADBN in the light of the frequent attacks on its branch
network. An expansion into rural areas seems unwise at this point.
Against this background, the Sana Kisan Bikas Bank and the SFCLs
need to develop an image that is distinctly different from that of ADBN.
The fact that 95% of the attacked SFCLs have been rebuilt and
revitalised by the members themselves after the attacks shows the
“sustainability” of ADBN’s microfinance outsourcing concept, even in
times of armed conflict.
Bank Restructuring and Good Management Reforms in ADBN
Institutional development and reform activities at ADBN can broadly be
distinguished into four periods:
1968-1987 Development Oriented Policy Approach
Prior to 1987, ADBN was committed to a solely development bankingoriented approach. The bank was primarily responsible for acting as the
executive organ of the government, translating policy guidelines
regarding the development of rural areas into practical reality. Hence the
bank mainly concentrated on activities related to providing rural/
agricultural credit to rural areas of the country. In 1975 the SFDP was
initiated as a pilot project. After the successful implementation of initially
two sub-project offices (SPOs), the SFDP gradually expanded to over
400 SPOs at the beginning of the nineties.
During this time the bank’s performance was measured by indicators
such as loan disbursement, expansion of branch network, implementation of the government’s targeted priority programmes and dissemination
of rural technology. Loans were extended on the basis of a subsidised
interest rate. In line with these policies, the loan delivery approach was
The Challenge of Sustainable Outreach
clearly supply-led. The mobilisation of savings was neglected and played
no role at that time in the policy of the bank.
The first four credit lines provided by the Asian Development Bank (ADB)
supported this policy. Sustainability was not an issue. Consequently, the
efficiency of bank operations was low and the operational costs
disproportionably high. The bank’s share of non-performing loans
consistently rose, and frequent liquidity crises occurred.
The main sources of funding during this period were external loans from
international donors and refinancing facilities from the central bank. Due
to volatility affecting these sources of funds, high funding costs and
inadequate size, the bank started commercial banking operations at the
beginning of 1984, primarily for deposit collection in urban areas.
1987-1996 A Gradual Policy Shift towards Institutional Viability
Since 1987 the bank has changed its policy gradually. Due to ADB’s
strategic policy shift giving greater consideration to aspects of
institutional viability, ADBN introduced financial indicators and
accounting policies in line with the conditions of the fifth agricultural
credit agreement with ADB. The sixth credit agreement with ADB put
further emphasis on issues related to institutional sustainability138.
During this period, developing banking operations expanded to non-farm
activities in rural areas. To improve its funding base, the bank gradually
increased its commercial banking operations. As outlined in section 2.2,
the bank has been quite successful in this regard and has managed to
increase the total share of deposits to its financial resources to over 70%
by 2002.
To address the problem of non-performing loans, the bank adopted
policies to concentrate loan disbursement to sectors and regions with an
economic potential. However, the adopted measures did not significantly
The Asian Development Bank has been supporting ADBN since 1970 through six lines
of credit projects and sectoral projects. Between 1970 and 1995 it provided US$118
million for the implementation of these projects. Associated with the fifth and sixth
Agricultural Credit Agreements was technical assistance meant to develop manpower
and provide inputs for the modification of ADBN’s strategies, procedures and policies.
ADB did not provide additional assistance after the expiry of the sixth agricultural project,
indicating inadequate collection performance. However, in 2002 ADB resumed
cooperation by providing technical assistance in carrying out a review of ADBN’s
financial and operational performance.
Case Study: Agricultural Development Bank, Nepal
improve the economic situation of the bank. Problems related to the loan
portfolio quality, high overhead costs, tight liquidity and a still low
collection performance remained on the reform agenda.
1997-2001 Reform Programme (First Phase)
In 1996 structural reforms became inevitable. The improvement of the
financial situation during the previous years was inadequate according to
the expectations of donor agencies and ADBN's own management. In
1996/97, also due to the discontinuation of support from ADB, ADBN’s
management anticipated a liquidity crisis and embarked on an ambitious
reform programme to improve the overall financial situation of the bank.
The reform programme was initiated in October 1997. The reform
strategy basically consisted of continuing with the reform path as laid
down by ADB at the beginning of the nineties, but with an indigenous
design and following the ADBN’s own methods.
The main objectives of the reform were
To improve the service delivery mechanism for loan operations.
To strengthen the capability of internal resource mobilisation to further
diversify the funding base and to prevent liquidity shortages.
To reduce overdue loan and interest receivables.
In order to attain these objectives, the bank implemented various
measures in the following areas: 1. Monthly interest payments, 2. Rural
savings mobilisation, 3. Restructuring of the existing loan portfolio.
The monthly payment system is at the heart of the reform programme.
This system was introduced to encourage borrowers to repay interest
due on a monthly basis. A 10% interest rebate as an incentive for
monthly interest repayments was established to support the
implementation of this measure. The system provides significant
advantages for the clients and the bank: 1) borrowers only have to pay a
relatively small amount monthly, 2) borrowers will be more aware about
the rate of loan repayment from the very beginning, 3) the bank - client
relationship will be improved through the regular contact each month on
the interest payment date, 4) frequent opportunities exist to discuss the
progress of projects financed and to identify potential problems at an
early stage. Depending on the branches, between 30% and 50% of the
loan recipients have to date chosen a monthly interest payment scheme.
The Challenge of Sustainable Outreach
After four years, the reform endeavour is beginning to bear fruit, as can
be seen in Table 8. The repayment rate, the ratio of overdue loans to
loans outstanding and the share of non-performing loans have improved
over time. With reference to the funding base, the share of deposits has
increased to over 70%. However, the capital position of the bank has
deteriorated considerably. This can be mainly traced back to the 90%
growth of assets in the period under examination.
Table 8: Comparison of Selected Figures
Before and After the Reform
Repayment Rate
Overdue Loans/Loans Outstanding
Share of Deposits of Funding
Total Assets (in NRs million)
Total Assets (in US$million)
Staff Productivity/Loans Outstanding (in NRs million)
Equity Ratio
Source: ADBN
Reform Programme 2001 (Second Phase)
While the first-phase reforms were able to reverse the negative trends
and stabilise, to some extent, the economic situation of the bank, the
objective of the second-phase reforms is to improve the economic status
quo through increased efficiency and better transparency. In order to
achieve these goals, more stringent accounting policies and the concept
of the “responsibility center” have been introduced in the field offices.
The bank management considers three policies essential for the secondphase reforms:
The introduction of a more conservative provisioning policy. This
policy is meant to make the field offices more aware of the impact of
performing and non-performing assets.
A substantial tightening of the income recognition policy.
Case Study: Agricultural Development Bank, Nepal
The introduction of a Transfer Pricing System (TPS).139 Human Resource Development
A recently conducted study by ADBN's Policy Research Division on the
role that human and physical resources play in the performance of larger
branch and sub-branch offices of ADBN concluded that human
resources are a critical factor in the overall performance of these
offices.140 It was pointed out that well-educated staff are essential if
improved individual performance, which is of particular importance in the
context of the second phase reforms, is to be achieved.
The Human Resource Management Division, which comes under the
Deputy General Manager “Service”, is in charge of human resource
development. It selects appropriate candidates for further training
seminars and has to identify the specific training needs of the bank.
Capacity-building for Staff and Client Training
The seminar and training sessions are given in the bank’s training
centers, as well as at the Nepal Rastra Bank for advanced commercial
banking training or abroad, if necessary. The bank's own training
institutions provide several different types of courses, such as a basic
training programme designed to provide pre-employment preparation,
and advanced programmes on specific technical fields such as loans,
supervision, collection and management.
In addition, the training centers are also concerned with the training
programmes of SFDP and SFCL. The major types of training and
seminars organised for this target group are institutional development,
gender development, credit operation, financial management and SFCL
operations. The training of small farmers is an important component in
the transformation of SPOs into SFCLs.141
Total ADBN expenditures on training peaked after the initiation of the
first reform phase in 1997, with NRs 23.9 million (US$319,000) spent in
the 1998/1999 financial year. The current level is at around NRs 14
For more details on the transfer pricing system, see section 2.4.1.
See ADBN (2002).
Table A4 in the annex shows the significance of client training for farmers through the
ADBN training centers.
The Challenge of Sustainable Outreach
million (US$187,000),142 of which NRs 8.5 million (US$113,484) was
spent on training employees. The remaining part was used to cover
expenses for clients' training. Even though training expenses for
employees increased between 2000 and 2001 by about 30%, the
amount spent per employee is still substantially lower than in 1999.
While in 1999 NRs 4,290 (US$57) was spent on average per employee,
these expenditures declined in 2001 to NRs 1,860 (US$25). The
relatively low expenditure on training accompanies a decrease in the
total number of training days to 9,658 in 2001.
Table 9: Employees’ Training
Total Personnel Expenses and Training Days per Employee
in 2000/01 (in US$)
No. of
Total training Total training
No. of
Total no. of
expenses expenses per
training days
training days
per employee
Source: ADBN
Recruitment Policy
The recruitment policies and procedures of ADBN are developed and
supervised by a recruitment committee consisting of a chairman and five
members. The chairman is the General Manager. The other members
are from related ministries, the Human Resource Management Division
and the shareholders.
There are 8 levels of professional bank staff in the bank: special, first,
second and third class officers and, at the assistant level, first to fourth
class assistants. External recruitment is normally only conducted for
positions for third class officers and at the assistant level. Vacancies on
other levels are exclusively filled by internal recruitment.143 An essential
See Table A5 in the annex.
Exceptions to this rule are only made for specific positions such as chartered
Case Study: Agricultural Development Bank, Nepal
requirement for an officer position is a university degree. To move up
one level, a candidate has to have worked for at least 5 years at his or
her current position. Skipping levels is not possible. The seniority
principle is in general an important aspect for promotion to higher levels.
Training Facilities
The Bank has its own training center located at the central office (CTI),
and five regional training centers.144 The CTI (Central Training Institute)
was established in 1977 with the objective of concentrating training
efforts in a more independent entity.145 Due to the fact that it is very
difficult to acquire well-qualified development banking staff in Nepal, the
foundation of the training center represented a first step for ADBN
towards developing working skills and bank expertise among its
Its main area of operation includes the organisation of workshops and
seminars for bank staff and clients. CTI can be considered as a key
functional building block in human resource development. It provides
staff training in the following areas: loan operation and management,
project appraisal, irrigation and energy development, training of trainers,
financial management, human resource development, internal audit and
inspection, gender issues, etc. Client training is mainly provided on
microfinance, office management and agricultural development, but
issues such as health, sanitation, and family planning are also covered.
The target groups for this type of training are small farmers and group
In the above-mentioned study, a particular demand for training was
discovered for managers, loan officers and loan assistants in the
following areas:
Project appraisal training for loan officers and loan assistants;
Management training for managers and potential managers;
Specific training in the field of poultry, livestock, tea, agro-based
industries and microfinance;
Due to its extensive branch network, ADBN decentralised its training facilities and
established 5 Regional Training Centers (RTCs), to provide better access for staff and
clients to the training facilities.
The name of the training institute has been changed recently from ACTI (Agricultural
Credit Training Institute) to CTI (Central Training Institute).
The Challenge of Sustainable Outreach
Periodical reviews and interaction on the major issues of the reform
Additional courses for the above-mentioned staff are recommended by
the inspection division on legal matters, particularly in terms of dealing
with collateral in order to improve fraud control. Incentive Systems
In the course of the reforms, incentives to motivate bank staff became
particularly important. ADBN had adopted an incentive system, which
provided about NRs 6 million (US$80,106) to the staff of the
approximately 100 best performing field offices. For the fiscal years
1998/99 and 1999/2000, ADBN provided premiums to staff from the 24
best performing branches and SFDP offices. The amount of the premium
was between one month’s and 15 days’ salary. Besides this, central level
supervisors of supervision offices also provide small incentives to the top
performing staff members.
Branch performance is measured on the basis of financial indicators
such as loan investment, principal and interest collection, over dues,
repayment rate, loans outstanding and total profit. Branches are ranked
accordingly to identify the best performing units. Regarding individual
staff performance, senior officers regularly evaluate branch employees.
The evaluation follows a standard format. Further incentives include
better promotion prospects and special training courses in Nepal and
A problem regarding top performing staff is the salary level: this is linked
to public sector wages and does not meet the levels paid by private
banks. This means that well-qualified staff can earn between 100 and
300% more in private banking institutions, which results in a brain drain
of motivated and qualified employees. Management Information System (MIS)
The MIS at ADBN is broadly separated into two different components:
The first component comprises an information system that provides
the middle and top management of the bank with essential
management information necessary for all aspects of bank
management. Information is provided on a monthly, quarterly, semiannual and annual basis.
Case Study: Agricultural Development Bank, Nepal
The second component encompasses a client information system that
provides branch staff with client information.
Within the first component, each month MIS provides a set of 7
indicators that are forwarded to the management of the bank in a
progress report. Indicators include monthly developments in
disbursement, principal collection, interest collection, outstanding and
overdue amounts, interest receivable and the recovery rate.
The supervision offices gather information with the assistance of the field
offices. Depending on the degree of computerisation in branches and the
branches’ general accessibility, one person needs between 2 hours and
6 days to collect the required information. About 50% of the development
banking branches are computerised.146 This means that in certain
branches a substantial part of the available working time has to be
utilised for the preparation of reports. The data is available to
management about 7 days after the end of each month.
The second component relates to the availability of client information for
branch staff. Currently client information is only directly available at the
branch outlet where the clients' files are kept. It can take between 2 to 5
days to provide specific client data to other branches as a computer
network has yet to be established. Additionally, the current system is not
integrated, which means that information on loans and deposits is still
kept in different systems.
One shortcoming of the first component is that the system is not
sufficiently flexible to provide data on time when required. The set of
seven indicators is insufficient to meet all the information demands of
management. An integrated client information system providing
combined information on savings and loans would definitely improve the
bank’s efficiency. In another step to achieve efficiency gains, the
information systems of the branches and the headquarters could be
linked together to provide immediate access to client data from any
branch. Assessment and Conclusions
The reforms initiated by ADBN were clearly designed to improve the
bank's institutional viability. Key elements in this strategy were to focus
on savings mobilisation, to introduce monthly repayment systems, to
About 73% of ADBN transactions are computerised.
The Challenge of Sustainable Outreach
improve loan collection and to incorporate incentives to staff for good
performance. These reforms have significantly contributed to the
improvement of ADBN's financial position over the last few years (see
section 2.3 for details of the economic analysis). It is important to note
that these reforms were initiated mainly from within the organisation.
Unlike in many other public banks, where reform is imposed from the
outside, ADBN has acknowledged and reacted to the need for reforms at
an early stage. These reforms could have had even a larger impact if the
various governments over the past five years had been more supportive
of this mission. A key lesson learned from ADBN's reform process is that
extensive reforms will only be successful if management and owners pull
in the same direction.
To maintain ADBN's growth path in the near future, further investments
in its staff and MIS systems appear to be a priority. The linkage of
ADBN's salary structure to the public sector's low wages might cause a
brain drain effect, since ADBN's salaries cannot compete with the levels
paid by the private banks.
Products and Customer Orientation
ADBN was founded with the goal of enhancing productivity and
production in rural areas. Since the implementation of commercial
banking deposit activities in 1984, there has been a gradual policy shift
away from pure development banking towards a more commercial
approach. The organisational and financial structure of ADBN reflects
these developments. Nevertheless, the roots of ADBN are still in the
development banking segment. The following diagram compares
development banking (including SFDP) and commercial banking
activities with regard to the outstanding loan portfolio, the deposits, the
number of accounts and borrowers.147
See Table A6.
Case Study: Agricultural Development Bank, Nepal
Figure 3
Sh are o f D e v e lop me n t an d C o mme rcial B a n kin g
2000 /2 001
1 0 0%
8 0%
6 0%
Co m me rc ia l B a nk in g
De ve lop m e nt B an kin g
4 0%
2 0%
L o an
P ort fo lio
Dep o sit s
Numb e r o f Nu m b er o f
B o rro wers Ac c ou n ts
Source: ADBN Development Banking (including SFDP)
Loan Products
ADBN's loan products are broadly composed of loans to individuals
(development banking) and loans to solidarity groups (under the SFDP
Programme). The following list provides a short overview of the
development banking credit segments:
Production loans covering different types of cereal and cash crops;
Irrigation loans for underground and surface irrigation;
Farm mechanisation loans for the financing of tractor, thresher and
other types of machinery and tools;
Livestock and fishery loans;
Agriculture and cottage industry loans;
Alternative energy loans for biogas, solar and micro-hydropower
Tea, coffee, horticulture and herb farming loans;
Marketing and trading loans;
Warehouse and other cold storage loans;
Non-agricultural / Tourism sector loans for trading in industrial and
daily consumer goods, service business and tourist sector
development in specific areas.
The Challenge of Sustainable Outreach
Each loan product comes with a specific term or time period. While tea
and coffee in the horticultural product segment have terms of up to 15
years, production loans for cereal and cash crops are limited to a
maximum of 1.5 years.148 Additionally, the rate of interest depends on
the respective loan segment. Accordingly, the interest rate fluctuates
between 10 and 16%.149 Principal payment periods are related to the
productivity of the investment or product cycle and can be monthly, every
three or four months, or yearly. Regarding the interest payments,
different payment intervals can be fixed. On the basis of the bank’s
preference for monthly interest payments, a creditor who embarks on
such a repayment scheme receives a 15% discount on the respective
interest rate. With an interest rate of 15%, for example, a total interest
rate reduction of 2.25% can be achieved, which brings the effective
interest rate to 12.75%.
Owners of “green cards” are duly entitled to a further reduction in the
interest rate of another 1%.150 The “green card” is an incentive for
creditors with a good economic repayment record, i.e. who have not
delayed payments within a period of 3 years. Besides the already
mentioned 1% discount on the rate of interest, owners of “green cards”
can access loans of up to NRs 50,000 (US$640) at any time without
further formalities.
Savings Products
The Client Security Fund is the only available savings product within the
scope of the development banking segment. The product contains two
components: 1) In terms of credit acceptance, the borrowers must place
a deposit ranging from 1% to 5% of the borrowed sum as an obligatory
savings investment with a maximum limit of NRs 100,000 (US$1,282).
The investment is subject to 7% interest and will only be made available
when the loan has been fully repaid. The interest payments on the loan
can be made from this investment, which can help to bridge interest
servicing in case debtors experience liquidity problems. Hence, besides
the idea of savings formation, it also serves as a security buffer against
possible difficulties in making the monthly interest payments. 2) Apart
from being an obligatory investment scheme in order to access a loan,
the Client Security Fund also serves as a limited savings account. The
Table A7 provides an overview of the respective maturities of individual credit products.
See Table A8.
About 1,200 of the banks’ clients are Green Card holders.
Case Study: Agricultural Development Bank, Nepal
total deposits in the development banking segment amount to NRs 826
million (US$11.2 million).
Other Financial Products
In addition to the above-mentioned loan and savings products, ADBN
also provides a popular livestock insurance product. Other products or
services like payment transfers and cash transactions are not offered in
the context of development banking. Commercial Banking
In the commercial banking segment, ADBN offers fixed term deposits,
savings and current account deposits. Fixed term deposits are available
for periods between 1 and 5 years. At present, however, only deposits of
up to 2 years are offered with an interest rate of 6.5% (1 year) and
6.75% (2 years). Savings deposits offer a rate of 5.25%.151 The funds are
available at anytime, but only withdrawals up to a certain amount within a
certain period can be made. ADBN does not provide clients with any kind
of interest on its current accounts. However, withdrawals can be made at
any time for any amount, and only the minimum balance has to be
ADBN started commercial lending in 1991. In addition to the provision of
loans, commercial branches deliver the following services as well:
Issue of bank guarantees;
Issue of bank drafts by fax and mail;
Collection of cheques, drafts and bills;
Issue of bank drafts and money transfers to selected places in India. Customer Orientation
Customer orientation is in general not yet a priority issue for ADBN.
ADBN has no broad strategy or policy to systematically come closer to
its customers or even to anticipate future customer needs. Nevertheless,
measures are undertaken on a discretionary basis. In order to improve
its product and service performance, the bank tries to create regular
contact between branch staff and clients and to obtain feedback through
Real interest rates are positive due to a low inflation level of 2.4% in 2001.
The Challenge of Sustainable Outreach
customer surveys. New products and instruments are hereby discussed
with customers prior to their introduction. Products, interest rates and
special offers are made accessible to the public via the mass media
(television and newspapers). The main driving force behind these efforts
is competition with other banks. This is why customer orientation attracts
more attention in the field of commercial banking than in the
development banking segment, in which ADBN is, in certain districts and
for certain loan segments, the only provider of financial services. Assessment and Conclusions
ADBN offers a broad range of financial products. While the number of
programme loans in the development banking business is rather
extensive, voluntary savings products for rural customers are still
unavailable. It appears that ADBN’s customer orientation is only slowly
changing from the more traditional perception that rural customers are
poor and thus do not require safe and liquid savings products. This
would explain ADBN’s continued focus on programme loans and the
non-cash function of its development banking offices. In contrast, ADBN
has designed successful savings products in the commercial business
segment, which shows the bank’s potential for innovation.
To reduce its development banking offices (those which are not
transformed into SFCLs) to mere “loan outlets” does not appear to be a
winning strategy for either the bank or its customers in the long run.
ADBN might have to consider abandoning the artificial separation
between development and commercial banking segments and to offer
financial services to urban and rural customers alike. The launch of
savings products by experienced Small Farmer Cooperatives shows the
demand of the rural poor for these products. Moreover, the integration of
services will help the bank to reduce operational costs and to strengthen
its relationship with its customers.
Summary and Conclusions
This study has aimed at unveiling some of the critical issues facing the
Agricultural Development Bank of Nepal on its path towards achieving
sustainable outreach. Following a predetermined structure in the
analysis section, the paper has focused on five key areas, i.e.
governance, viability, decentralisation, good management and customer
orientation. It should again be noted that the external environment in
Nepal is at present non-conducive to sustainable banking due to the
Case Study: Agricultural Development Bank, Nepal
ongoing Maoist insurgency. The review or assessment of any financial
institution and its results therefore need to be seen and evaluated
against this background.
Let us start by recalling what ADBN has achieved in the past, and what
could differentiate this bank from other public banks with regard to the
subject of sustainable outreach. ADBN should certainly be credited with
some achievements:
ADBN's management recognised at an early stage that its smallest
business segment, i.e. microfinance delivered through its sub-project
offices under the Small Farmer Development Programme, was not
viable. Subsequently, it began in 1993 to outsource "microfinance" by
transforming its SPOs into Small Farmer Cooperatives Ltd.
(SFCLs). SFCLs today have captured a significant share of the rural
financial market and combine outreach to the poor and financial
viability. ADBN plans to transform most of its remaining SPOs into
SFCLs. ADBN has so far managed to reduce operating costs through
the transformation process by around US$1.2 million.
Encouraged by the transformation process, ADBN and 21 SFCLs
established the Sana Kisan Bikas Bank (Small Farmer Development
Bank) in 2001. The new apex bank will take over the complete loan
portfolio provided by ADBN to SFCLs. The emergence of the Sana
Kisan Bikas Bank allows ADBN to concentrate more on its core
commercial and development banking reforms. The Sana Kisan Bikas
Bank is expected to further advance the development of the SFCL
system and to offer demand-oriented refinance services to SFCLs
and similar organisations.
The reforms initiated by ADBN's management since the mid 1990s in
particular have been designed to improve the bank's institutional
viability. Key elements of the reform programme include the
introduction of a monthly repayment system, measures to improve
loan collection, a profit center concept for branches, and the
incorporation of incentives to staff and clients for good performance.
The bank's determination to become more independent from external
lenders through the deposit mobilisation drive is certainly one of its
greatest achievements so far. Unlike many other banks, ADBN is
shifting its financial resources from urban to rural areas and is thus a
net investor in Nepal's countryside.
It is worth mentioning that these reforms were initiated mainly from
within the organisation. Unlike other public banks, where reform is
often imposed from the outside, ADBN has acknowledged and
The Challenge of Sustainable Outreach
reacted to the need for reforms at an early stage. The reforms could
have had an even larger impact had the various governments over
the past five years been more supportive of this mission.
However, there is a darker side of the coin. Some of the bank' s major
weaknesses can be summarised as follows:
Despite the relative improvement in key areas due to its reform
programme, ADBN's real financial position cannot be assessed with
any certainty. An overdue loan ratio of nearly 20%, a low level of
capitalisation, a write-off policy clearly below international standards and
an uncertain amount of bad loans provide enough reasons for concern. If
we add Nepal's present difficult banking environment to this picture, we
can assume that the real challenge of making the bank sustainable still
lies ahead.
In this context, after the successful outsourcing of its SFDP microfinance
segment, ADBN might consider lifting the artificial separation of its
two main business segments, development and commercial
banking, with the aim of providing financial services to its urban and
rural customers alike. The launch of savings products by experienced
Small Farmer Cooperatives shows the demand of the rural poor for
these products. Moreover, the integration of services could help the bank
to reduce operational costs and to strengthen its customer relationships.
Given Nepal's highly politicised environment, with frequent government
interference in state-owned institutions, more autonomy for the bank's
management in decision-making and day-to-day management appears
to be another priority. Thus, operational autonomy and the containment
of political interference need to be key elements in the ongoing reform
Due to its unique legal status, being incorporated under its own Act,
ADBN is not supervised in the same way as other commercial banks are
by Nepal Rastra Bank. While NRB has the mandate to take a potentially
tough stance on ADBN, it is presently not yet adequately doing so. A
separate NRB Directive on ADBN's commercial banking activities
would certainly be in the interests of the bank and its depositors, who
would benefit from some sort of protection through an improved
supervisory policy.
Case Study: Agricultural Development Bank, Nepal
In conclusion, we can say that ADBN has successfully outsourced the
smallest of its three main business segments. The Small Farmer
Cooperatives do combine outreach to the rural poor customers with a
financially viable service delivery system. However, sustainable outreach
in the two remaining business segments, i.e. commercial and
development banking, despite initial successful reform measures, seems
to be a long way down the road. To further advance its overall financial
prospects, ADBN needs to address some of the governance issues for
more autonomy, to strengthen its capital base, to continue cost-cutting
measures, to improve its supervisory framework jointly with NRB, and
generally to push on with its reform agenda. As Ragnar Nurske puts it,
"capital is made at home”.152 By pursuing an ambitious reform path,
ADBN could further consolidate its contribution to the formation and
allocation of capital, and thus promote the provision of sustainable
financial services to customers in rural Nepal.
Nurkse, R. (1966): Problems of Capital Formation in Underdeveloped Countries
(reprinted), first publication 1953, Oxford.
The Challenge of Sustainable Outreach
Table A1:
Consolidated Financial Assets July 2001
Nepal Rastra Bank
Commercial banks
Development banks (ADBN, NIDC)
Provident Fund
Finance Companies
Others (see breakdown below)
Regional Rural Development Banks
Other development banks
Microfinance NGOs
Sources: Calculations of World Bank (2002) based on Nepal Rastra Bank
Exchange rate 1 US$= 74,904 NRs
Table A2:
Capital Requirements for Commercial and Development Banks
Types of Bank
With Head Office in
Kathmandu Valley
With Head Office Outside
Kathmandu Valley
Commercial Banks
NRs 1 billion
NRs 500
NRs 500 million
NRs 250
Development Banks
NRs 640
NRs 320
NRs 20 million 100 million
NRs 10
million 50 million
Source: ADBN
Case Study: Agricultural Development Bank, Nepal
Table A3:
Level of Authority for Collateral and Loan Evaluation
(in Thousands of NRs)
Board of Directors
Deputy General Manager
Section Chief
Section/Loan Officer
Main Branch Manager
Manager/Section Chief
Section/Loan Officer
Office/Loan Assistant
Office/Loan Assistant
Divisional Chief Level
Supervision Office
Main Branch/Branch
Source: ADBN, Loan Division
The Challenge of Sustainable Outreach
Table A 3a: Level of Authority for Collateral and Loan Evaluation
(in US$)
Board of Directors
Deputy General Manager
Section Chief
Section/Loan Officer
Main Branch/Branch
Main Branch Manager
Manager/Section Chief
Section/Loan Officer
Office/Loan Assistant
Office/Loan Assistant
Divisional Chief Level
Supervision Office
Table A4:
Training I
Training Days
1998/99 1999/2000 2000/01
Total training days for farmers
Total training days for staff
Source: ADBN
Total training days =sum of training days * number of participants
Internal training consists of training/seminars conducted by ADBN’s training centers
External training consists of training/seminars carried out by various institutes in Nepal
and abroad
External training days for FY 1996/97 and 1997/98 are currently not available.
Case Study: Agricultural Development Bank, Nepal
Table A5: Training II
NRs Million
Training Exp. (source: ADBN)
Training Exp. (other sources)
Training Expenses
Source: ADBN
Notes: Training expenses include only the variable costs which are directly related to
training, such as training materials, allowances to trainers, allowances to trainees,
etc. Training expenses of a fixed nature are not included in the above expenses.
Table A6
Comparison between Development Banking and Commercial Banking 2001
(USD mio)
Loan Portfolio
Number of
Number of
Loan Account
Source: ADBN
The Challenge of Sustainable Outreach
Table A7
Maturities for Loan Products in Development Banking
Production Credit
6 months to 1.5 yrs.
3 to 5 yrs.
Farm Mechanisation
3 to 5 yrs.
Livestock and Fisheries
1 to 5 yrs.
Agriculture and Cottage Industry
5 yrs.
1 yr.
Alternative Energy
3 to 5 yrs.
Horticulture, Tea, Coffee and Herbal
2 to 15 yrs.
Godown/Cold Storage
10 yrs.
Non-agricultural Sector
Source: ADBN
Table A8
Development Banking
Tea Plantation
Tea/Coffee Processing
Housing & Land Development
Cold Storage
Cereal Crops
Cash/Special Crops
Biogas & Energy
Livestock Poultry
Livestock (Other)
Working Capital/Marketing
Agro/Cottage Industries
Source: ADBN
Interest Rate Structure in %
2001/2002 1999/2000 1998/99
Case Study: Agricultural Development Bank, Nepal
Table A9: Conditions and Products in Commercial Banking
2001/2002 1999/2000 1998/99
Overdrafts: Individuals
Overdrafts: Institutions
Demand Loans
Contract Loans
Business Loans
Hire Purchase
Business Complexes
Housing & Equipment
Educational Institutions
Health Clubs, Nursing Homes
Entertainment & Equipment
Loans Against Fixed Deposit
Extra 2% Extra 2% Extra 2% Extra 2% Extra 2%
Loans Against Govt. Securities
Extra 2% Extra 2% Extra 2% Extra 2% Extra 2%
Up to 1 Year
Up to 2 Years
Up to 3 Years
Up to 5 Years
Source: ADBN
The Challenge of Sustainable Outreach
Table A10:
Agriculture Development Bank (Figures in NRs)
Macro Sector Assessment
GDP (billions)
Population (millions)
Rural Population (%)
Income per Capita in US$
Inflation in %
Exchange Rate (NRs to US$1)
Financial deepening (M2/GDP) in %
Financial Sector Assessment
No. of Financial Institutions (private)
No. of Financial Institutions (public)
Assets of Private Financial Institutions (millions)
Assets of Public Financial Institutions (millions)
Lending Interest Rate (12 months) in %
7.5 - 19
Deposit Rates (3 month fixed deposits) in %
4.0 - 7.5
4.0 - 6.0
2.5 - 6.0
Branch Network
- Development Banking
Main branches/branches
- Small Farmer Development Programme units
Main branches/branches
Population/branch outlets
Number of staff
Number of loan officers
- Commercial Banking
Number of staff training days
Service radius (km to furthest customer)
Case Study: Agricultural Development Bank, Nepal
Customer Orientation
Number of loan products
- Development Banking
- Commercial Banking
Number of savings products
- Development Banking
- Commercial Banking
Number of other financial services
- Development Banking
- Commercial Banking
Loan Portfolio
Number of borrowers
- Development Banking
- Commercial Banking*
Number of accounts
- Development Banking
- Commercial Banking
Total Loan Portfolio (millions)
Development Banking Loan Portfolio
of which non-farm lending
Commercial Banking Portfolio
Average portfolio size
- Development Banking
- Commercial Banking
Average loan size/per capita income in %
Average loan processing time
% of rural households served
Market share in rural lending
Savings Portfolio
Number of active savers/accounts
of Commercial Banking
Portfolio size (million)
- Development Banking
- Commercial Banking
Average deposit balance in NRs
of commercial banking
Average deposit income/per capita income in %
% of rural households served
Market share in rural lending
1999/2000 2000/01
* estimated
The Challenge of Sustainable Outreach
Balance Sheet (in millions)
Liquid assets (Cash and bank, T. Bills)
Other assets
Total Assets
Shareholders’ equity
Other liabilities and provisions
of which long-term
Total Equity
Total Liabilities and Equity
Profit & Loss Account (millions)
Net Investments (Share + Fixed Deposit)
Net loans portfolio (loan portfolio-loan loss reserve)
Net fixed assets
Total Liabilities
of which short-term
of which medium-term
Interest on investments
Total Income
Interest expenses
Administrative costs
of which personnel expenses
Loan loss provision
Total Expenses
Net Profit/Loss
Interest on loans
Other operating income
Other operational costs (Bonus expenses)
Non-operational costs (Income tax)
Case Study: Agricultural Development Bank, Nepal
Loan Recovery Performance
Loan recovery performance in %
Loans written off (millions)
Value of loans outstanding (millions)
Equity/liabilities in %
Deposits/liabilities in %
Capital adequacy in %
Return on assets in %
Return on equity in %
Number of borrowers/loan officers and assistants
Value of loans outstanding/loan officers (in millions)
Portfolio Quality
Portfolio at risk in %
Loan loss ratio in %
Source: ADBN
Capital adequacy =
Operational self-sufficiency =
Financial self-sufficiency =
Portfolio at risk =
Loan loss ratio =
Portfolio quality =
Capital/ Net loan portfolio
Income/ Operational cost (administrative cost + loan-loss
provision) + cost of funds
Income/ Operational cost + cost of funds + imputed cost of
for 1998/99 and 1999/2000, loan arrears over 9 months and,
for 2000/01, loan arrears over 3 months to loans outstanding
(as per the income recognition policy of the bank)
Loans written off/ Loans outstanding
Overdue loans/ Loans outstanding
The Challenge of Sustainable Outreach
Table A11:
Agriculture Development Bank (in US$)
Customer Orientation
Loan Portfolio
Number of borrowers
- Development Banking
- Commercial Banking*
Number of accounts
- Development Banking
Total Loan Portfolio (millions)
Development Banking Loan Portfolio
of which non-farm lending
Commercial Banking Portfolio
Average portfolio size
- Development Banking
- Commercial Banking
- Commercial Banking
Savings Portfolio
Number of active savers/accounts
of Commercial Banking
Portfolio size (million)
- Development Banking
- Commercial Banking
Average deposit balance in US$
of commercial banking
Case Study: Agricultural Development Bank, Nepal
Balance Sheet (in millions)
Other assets
Total Assets
Shareholders’ equity
Other liabilities and provisions
of which short-term
of which medium-term
Liquid assets (Cash and bank, T. Bills)
Net Investments (Share + Fixed Deposit)
Net loans portfolio (loan portfolio-loan loss
Net fixed assets
Total Liabilities
of which long-term
Total Equity
Total Liabilities and Equity
Profit & Loss Account(in millions)
Total Income
Interest expenses
Administrative costs
Loan loss provision
Other operational costs (Bonus expenses)
Non-operational costs (Income tax)
Total Expenses
Net Profit/Loss
Interest on investments
Interest on loans
Other operating income
of which personnel expenses
Loan Recovery Performance
Loan recovery performance in %
Loans written off (millions)
Value of loans outstanding (millions)
Source: ADBN
The Challenge of Sustainable Outreach
Capital adequacy =
Capital/ Net loan portfolio
Operational self-sufficiency =
Income/ Operational cost (administrative cost + loan-loss
provision) + cost of funds
Financial self-sufficiency =
Income/ Operational cost + cost of funds + imputed cost
of capital
Portfolio at risk =
for 1998/99 and 1999/2000, loan arrears over 9 months
and, for 2000/01, loan arrears
over 3 months to loans outstanding (as per the income
recognition policy of the bank)
Loan loss ratio =
Loans written off/ Loans outstanding
Portfolio quality =
Overdue loans/ Loans outstanding
Deputy General
Internal Control
Deputy General
Training Center
Deputy General
SFDP Offices
Field Office
General Manager
Board of
Banking Offices
Deputy General
Organisational Structure of ADBN
Deputy General
Case Study: Agricultural Development Bank, Nepal
The Challenge of Sustainable Outreach
ADB (2001): Agricultural Sector Performance Review, TA
No. 3536-NEP.
ADB (2002): Outlook 2002, Manila.
ADBN (2002): The role of Human and Physical Resources on the
Performance of Larger Branch and Sub-Branch Offices of ADBN,
EIU (2001): Country Profile Nepal, London.
IMF (2001): Nepal - Recent Economic Developments, IMF Country
Report 01/173, Washington DC.
Kievelitz, U. (2002): Nepal Country Study on Conflict Transformation and
Peace Building, GTZ Eschborn.
Lamsal, P.P., Sejuwal, C.B. and R. Shakya (2001): Innovations in
Development Finance: How the Agricultural Development Bank of
Nepal Transformed an Unsustainable Credit Programme into Selfreliant Local Financial Intermediaries Owned and Managed by the
Poor, ADBN/GTZ, Rural Finance Nepal, Kathmandu.
Nepal Rastra Bank (2001a): Banking and Financial Statistics No. 38,
Nepal Rastra Bank (2001b): Quarterly Economic Bulletin, Mid-July 2001,
No. 3 & 4.
Nurkse, R. (1966): Problems of Capital Formation in Underdeveloped
Countries (reprinted), first publication 1953, Oxford.
Sharma, S., Bhattachan, K. B. and R. P. Shreshta (2001): Institutional
Sustainability and Impact of Small Farmer Cooperatives Ltd.,
ADBN/GTZ, Rural Finance Nepal, Kathmandu.
Staschen, S. (2001): Financial Technology of Small Farmer
Cooperatives Ltd. - Products and Innovations, ADBN/GTZ, Rural
Finance Nepal, Working Paper No. 2, Kathmandu; IFAD Rural
Finance Working Paper C5, Rome.
UNDP (2002): Nepal Human Development Report, Poverty Reduction
and Governance, Kathmandu.
Case Study: Agricultural Development Bank, Nepal
Wehnert U. and R. Shakya (2001): Are Small Farmer Cooperatives Ltd.
Viable Financial Institutions? ADBN/GTZ, Rural Finance Nepal,
Working Paper No. 1, Kathmandu; IFAD Rural Finance Working
Paper B12, Rome.
Wehnert, U. and R. Shakya (2003): Microfinance and Armed Conflict in
Nepal: The Adverse Effects of the Maoist Insurgency on the Small
Farmer Cooperatives Ltd., ADBN/GTZ, Rural Finance Nepal,
Working Paper No. 3, Kathmandu.
World Bank (2002): Nepal - Financial Sector Study, prepared by Private
Sector Finance Division, Washington DC.
Case Study: The People’s Bank, Sri Lanka
Case Study:
The People’s Bank, Sri Lanka
Richard Gant, Steve Durrant
This study of the People’s Bank of Sri Lanka was conducted during
October 2002. It provides a brief overview of the macroeconomic
environment and financial sector in Sri Lanka before going on to look at
the Bank in more depth. The second section overviews general
background data and looks at issues related to ownership and
governance, economic viability, management and customer orientation.
The qualitative information contained herein has been gained from news
clippings, informal discussions with external stakeholders and the Bank’s
own Annual Reports. The views contained herein are those of the
authors and do not necessarily reflect those of the sponsor GTZ/RBIP.
The authors would like to thank Frank Mueller, Anke Wolf and all the
others at RBIP who gave so generously of their time during the
preparation of the report.1. The Financial Sector in Sri Lanka
The Challenge of Sustainable Outreach
The Financial Sector in Sri Lanka
Macro Assessment
Table 1: Sri Lanka Macroeconomic Data (1999-2001)
GDP (US$Million)154
Population (Million)
Rural Population(%)
GDP per Capita (US$)
Inflation (%)
Exchange Rate (US$1=SLR)
Financial Deepening (%) (M2/GDP)
Financial Deepening (%) (M2b/GDP)
Source: CBSL 2001a, CBSL 2001b
Sri Lanka is a medium developed country located at the southern tip of
the Indian sub-continent. Among SAARC member countries, Sri Lanka
has the second highest HDI rating after the Maldives. Literacy Rates are
high at 94 percent for males and 89 percent for females (CBSL 2001b,
Financial data for the year 2001 are latest provisional estimates from the Central Bank of
Sri Lanka.
GDP figures are market prices as listed in Economic and Social Statistics of Sri Lanka
2001, Vol. XXIII. CBSL, Colombo.
Figures are revised Mid-Year estimates based on the provisional findings of the 2001
National Census, which estimates that the population has risen by over 500,000 in the
past three years. Population growth averages 1.2 percent per annum. Population density
is estimated at 342 persons per square kilometre.
Year-on-year population by sector statistics are not tracked by the CBSL. 1981 Census
figures estimate the rural population at 72.2%, 2001 Census estimates it at 80%, a 7.2%
increase over the last 20 years.
Recent Economic Developments - Highlights, CBSL, March 2002, Colombo.
Inflation figures are based on CCPI, as listed in Sri Lanka Socio-Economic Data 2002,
Vol. XXV, CBSL. Colombo.
Exchange Rate figures are based on annual averages, as opposed to year-end data.
Figures based on M2b Broad Money data inclusive of FCBUs, CBSL Annual Report
2001, Table 112.
If one considers per capita GNP on a PPP basis however, the gap between India and
Pakistan lowers to 30-40% respectively and remains the same with other SAARC
Case Study: The People’s Bank, Sri Lanka
Per capita GNP ratios are around 80 percent higher than in India and
Pakistan, more than twice the levels of Bangladesh, three times the level
of Nepal and four times the level of Bhutan. However when compared
against its East Asian counterparts it ranks poorly against all but
Indonesia, with Thailand and the Philippines being its closest peers
Poverty estimates vary according to definition, but conservative
estimates are around 26 percent of the population. This is equivalent to
the poverty levels in India, but significantly lower than in Pakistan,
Bangladesh, Nepal or the Maldives. Poverty is most widespread in
remote rural areas, with ‘pockets’ of intense poverty persisting in the
plantations sector, ‘dry zone’ areas and urban slums (ibid).
However, the country has been involved in a protracted secessionist
conflict for the last 20 years and, not withstanding the present,
encouraging, ceasefire agreement, poverty levels in the North and East
Region are as perhaps as high as 90%. The Sri Lankan economy is thus
simultaneously on both a recovery and development footing.
The Sri Lankan economy is presently in a fairly precarious position,
currency reserves are low, inflation is high, fiscal borrowing is high, the
public sector is huge and the economy has until perhaps most recently,
supported unsustainable levels of military spending (c.f. ADB 2001,
World Bank, 2001).162
The economy is comprised of services (54%), Industry (27%) and
Agriculture (19%). This reflects an increased growth in the services and
industrial sectors over the last decade. However, the agricultural sector
has continued to grow in real terms and remains the mainstay of
employment in rural areas (CBSL 2002a).163
The armed forces are a huge source of employment with over 250,000 In the event of a
prolonged peace settlement the issue of de-mobilisation will create huge problems
economically. One estimate, for example, claims that the rural poor in the ‘south’ are
three times more dependent on ‘military remittances’ than the state welfare programmes.
The agriculture sector employs 36 percent of the labour force and contributed 20.5
percent of the GDP in 2000. Overall growth has dropped from 4.5 percent in 1999 to 1.8
percent in 2000, the lowest level since 1996. National policy has gradually lessened
state intervention with a view to improving efficiency and competitiveness. This approach
has been most effective in plantation agriculture. However, restrictions on the sale and
use of land combined with poorly targeted agricultural subsidies, the availability of more
attractive off-farm labour opportunities and poor management of irrigation systems have
hindered productivity. In addition, inconsistent tariff policies have generated long-lasting
unhealthy results. Reviving Sri Lanka's agricultural productivity is critical to improving the
The Challenge of Sustainable Outreach
The economy experienced negative growth during 2001. From a peak of
7.3 percent in the second quarter of 2000, economic growth dropped to a
low of -3.7 percent in the third quarter of 2001 leading to reduced
investment. The real GDP growth rate was -1.4 percent in 2001, in
contrast to a projected growth rate of 4.5 percent at the start of the year.
This is the first time the Sri Lankan economy has recorded annual
negative growth since independence in 1948 with per capita GDP falling
by over US$60 to US$841 since 1999 (CBSL, 2001a).
Negative growth was accompanied by a 8 percent rise in inflation to 14.2
percent in 2001. The Colombo Consumer Price Index has risen by 9.5
percent since 1999. The exchange rate against the US Dollar has also
slipped significantly with the Rupee depreciating by over 25 percent
since 1999 (ibid.).
Table 2: Key Economic Indicators 1999-2001
Public Debt % of GDP
Gov. Revenue as % of GDP
External Debt (US$billion)
External Debt as % of GDP
External Debt Service % of GDP
External Assistance (US$billion)
Source: CBSL 2001a, 2002a
The public debt to GDP ratio increased 8.5 percent during the last three
years from 95.1 percent in 1999 to 103.6 percent at the end of 2001.
Government revenue as a percentage of GDP decreased by 1.2 percent
during the same period while external debt as a percentage of GDP
decreased by 2.2 percent to 57 percent. Servicing external debt as a
percentage of GDP decreased by 1.8 percent from 12.4 percent in 1999
to 10.6 percent in 2001 (CBSL 2001a, 2002a).
The domestic savings to GDP ratio declined 15.3 percent in 2001 from
17.4 percent in the previous year. The investment to GDP ratio declined
to 22.1 percent in 2001 from 28 percent in 2000 reflecting widespread
decreased investor confidence. At current market prices GDP increased
by over 11 percent to 1.4 trillion rupees in 2001(ibid).
incomes of some of Sri Lanka's poorest communities and to boosting broad economic
growth (Charitonenko & de Silva, 2001).
Case Study: The People’s Bank, Sri Lanka
The present state of the Sri Lanka economy needs to be placed in the
context of the most widespread global economic slowdown for half a
century with G7 nations repeatedly revising down their growth
projections over the past two years. The global economy started to
decelerate during the latter half of 2000 and throughout 2001, with global
economic growth falling to 2.5 percent in 2001 from 4.7 percent in 2000
(CBSL 2001a).
The slowing of growth has been accompanied by a sharp increase in oil
prices in 2000 and a sharp reduction in trade volumes, with goods and
services down to -0.2 percent in 2001 from over 12 percent in 2000. In
addition, international commodity prices deteriorated significantly, as did
private capital flows to emerging markets. Overall, growth in exports from
developing countries is estimated to have dropped from 15 percent to 3
percent during the same time period (ibid.).
External shocks aside, economic performance in 2001 was adversely
affected by the secessionist conflict; particularly the terrorist attack on
the international airport, which badly affected the tourist sector. The
economy also suffered from a prolonged drought which reduced
agricultural growth to -2.5 percent across the sector, including rice, tea,
rubber and coconut production as well as most subsidiary agricultural
crops (ibid.).
In addition, chronic national power shortages and subsequent power
cuts from June 2001 to December 2001 drastically reduced economic
activity. Growth in the Industrial Sector was -3.8 percent while growth in
the Services Sector was -0.7 percent, with services accounting for 54
percent of GDP and industry accounting for 26.5 percent. Within the
industrial sector, only the mining, quarrying and construction industries
that account for 9 percent of the sector showed modest growth during
the year (ibid.).
The Challenge of Sustainable Outreach
Table 3: Interest Rates 1999-2001
Type of Interest Rate,%
Treasury Bill Primary Yield - 3 month
Treasury Bill Reverse Repo - overnight
Treasury Bonds - 2 year
Commercial Banks Prime Lending
Call Money
7.5 - 11.5
7 -17
7.5 - 14
Treasury Bill Repo - overnight
Lending Interest Rate (12 month)
National Savings Bank Savings Rate
Deposits (3 month fixed deposits)
Source: CBSL 2002b
Consumption levels in Sri Lanka remain high and have risen slightly in
the past three years from 76 percent of GDP in 2000 to 79.3 percent in
2001. The National Savings to GDP ratio has fallen from 23.5 percent in
1999 to 19.5 percent in 2001. The Domestic Savings to GDP ratio has
fallen by similar levels to 71.6 percent in 2001, largely due to
government ‘dissavings’ reflected by a larger current account deficit.
Private Sector Savings to GDP have remained more or less constant at
around 20 percent of GDP (CBSL 2001a, 2002b).
Interest rates moved down significantly in 2001 from the previous year.
This was a result of downward adjustments in monetary policy by the
CBSL, increased Rupee liquidity, reduced taxation levels and reduced
international rates. The lending rates of the commercial banks fell less
resulting in high lending rates in real terms. High levels of public sector
borrowing also slowed the decline as did a national non-performing
portfolio of some 17 percent and a consumer preference for fixed
deposits savings accounts (ibid.).
Financial Sector Assessment
The government started deregulating the financial sector in 1977. The
sector has grown and diversified in the last three decades but remains
dominated by the two state-owned commercial banks, namely, the Bank
Case Study: The People’s Bank, Sri Lanka
of Ceylon and the People’s Bank. Together, these two banks still
account for some 55 percent of national banking assets.164
Significant regulatory, supervisory, and institutional reforms were
initiated in the 1990s. These included improved disclosure requirements
and loan recovery mechanisms.165 In 2000, the limits on foreign
ownership of commercial banks and insurance companies was raised to
60 percent and 90 percent respectively, with a view to further improving
their capital base and encouraging modernisation.
Table 4: The Commercial Banking Sector in Sri Lanka (1999-2001)
Commercial Banking Sector
Assets (US$million)
Liquid Assets (US$million)
Liquid Assets/Total Deposits in %
Cash in Hand/Total Deposits in %
Loans & Advances/Total Deposits in %
Statutory Reserve Ratio in %
Excess Reserves/Total Deposits in %
Total Employment (No. of Staff)
Source: CBSL 2002
Today, finance is one of the most dynamic and vibrant sectors of the
economy.166 Services continue to improve and the sector is becoming
increasingly competitive. Numbers of bank branches have expanded and
been accompanied by an increased density of customers served per
The state banks have had to be assisted twice in the past to meet their emerging deficits
arising largely by directed (e.g. political) lending. It appears that further strengthening of
the two state banks is necessary to reduce intermediation costs and improve financial
sector stability by increasing their capital base.
For example, a Credit Information Bureau has been in operation for twelve years.
Presently however it only serves formal lending institutions that are its members and
currently doesn't address the needs of semi-formal financial institutions or their
customers. For the bureau to more usefully serve the needs of the rural poor it would
need to include reliable information on loans in the US$500-1000 range and expand its
market to include large microfinance wholesale and retailers. The ADB is presently
proposing to work with the bureau in this regard.
There are some cautious signs for optimism regarding future macro-economic stability
for the year 2003. The new government is continuing to encourage competition and
reform. The ceasefire agreement has lasted for nearly one year, water catchement areas
have received healthy quantities of rain and power-cuts have largely stopped. Overall,
the economy seems better poised going into 2003 than it did going into 2002.
The Challenge of Sustainable Outreach
branch. The availability of modern services such as automated teller
machines, credit cards, and telephone banking services continues to
increase rapidly. This has encouraged financial intermediation and
increased financial deepening in the economy, i.e. reaching lower
income clients. Broadly, there have also been improvements to rural
banking and credit facilities including the expansion of private forward
sales contract facilities for agricultural products.
The banking, insurance and real estate sector has increased from 8.1
percent of GDP in 1999 to 8.4 percent in 2001. Accounting for
depreciation against the Dollar, total assets in the commercial banking
sector increased by US$200 million from US$8.1 billion to US$8.3 billion
during the period 1999 to 2001. However, in Rupee terms, assets grew
by over 20 percent in the same period.
Liquidity in the commercial banking sector has increased from US$2.2
billion to US$2.3 billion during the period 1999 to 2001. In Rupee terms,
liquidity has grown by over 20 percent in the same period, in part
reflecting policy pressure from the Central Bank.167
The formal financial sector is comprised of: commercial banks, merchant
& investment banks, savings banks, finance companies, development
finance companies, mortgage banks, leasing banks, insurance
companies, venture capital companies and equity and pension funds.
Table 5 - Formal Financial Institutions in Sri Lanka (1999-2001)
- Private FINCOs
Total Number of Private Financial Institutions
- Public Licensed Specialised Banks
Total Number of Public Financial Institutions
Total Number of Formal Financial institutions
Institutional type
Private Financial Institutions
- Private Commercial Banks
- Private Licensed Specialised Banks
Public Financial Institutions
- Public Commercial Banks
Source: CBSL, 2001a
The CBSL does not presently provide a detailed break-down of the commercial banking
sector into public and private; nor does it break-down activity into urban and rural.
Case Study: The People’s Bank, Sri Lanka
The Central Bank of Sri Lanka (CBSL) is the apex financial institution in
the financial system. The CBSL is responsible for regulating and
supervising commercial banks, licensed specialised banks, and licensed
finance companies as set forth in the Monetary Law Act, the Banking Act
and their amendments.168 169 The Central Bank demarcates formal
financial institutions into three main categories, namely: Licensed
Commercial Banks; Licensed Specialised Banks and Registered Finance
Table 6 - Banking Branches in Sri Lanka
Regional Development Banks
National Savings Bank
No. of Commercial Bank Branches
- Domestic
- Foreign
No. of Commercial Bank Branches
No. of LSB Branches
Long-term Lending Institutions
Housing Finance Institutions
Private Savings and Development Banks
Total Number of LSB Branches
Total Number of Banking Branches
Source: CBSL, 2001a
Commercial banks require a minimum initial capital of approx. US$4.5
million each, the RDBs were launched with initial capital of approx.
US$1.5 million each, and savings and development banks require
approx. US$1 million initial capital (ADB, 2000). Standard international
Action has been taken to restructure the Ministry of Finance and to modernise the CBSL
including the introduction of some external contracted senior managers and consultants
setting up a management development center and real-time payment and settlement
The regulatory and supervision practices of the CBSL have been strengthened in recent
years with regard to the entities under its jurisdiction. However, the bank has not kept up
with the growth of semi-formal financial service provision and does not effectively
supervise or protect the assets of the relatively poor.
The Challenge of Sustainable Outreach
directives apply to regulated entities, covering areas such as loan
classification, provisioning and reporting requirements as well as auditing
standards. The Statutory Reserve Ratio was recently lowered to 10
At the end of 2001, there were a total of 64 formal financial institutions in
Sri Lanka. There are also co-operative societies registered under the Cooperative Societies Law (No. 5) of 1972 and building societies registered
under the National Housing Chapter, which can accept deposits. At
present NGOs are not allowed to accept savings, although in practice
many do.
The total number of commercial banks operating in Sri Lanka in 2001
changed from 26 to 25. Of these, two, the Bank of Ceylon and the
People’s Bank are publicly owned and the remaining 23 are private
banks. The two public banks dominate the banking landscape
accounting for over half of all deposits in Sri Lanka.
The total number of licensed bank branches increased by 73 since 1999
from 1,055 to 1,128 branches in 2001. The increase was due mainly to
expansion of domestic banking services rather than international ones.
This figure of branches is equivalent to a banking density of 0.60
(number of branches per 10,000 people). The number of LSB branches
increased by 10 from 177 in 1999 to 187 in 2000, giving a total of 1,455
bank branches throughout the country. These figures exclude
information on pawning centers and student savings units.
If one includes the co-operative banking sector, then the total number of
banking branches throughout the country has risen from 2,740 in 1999 to
2,952 in 2001 (CBSL 2001a). This reflects the huge impact that the
semi-formal financial sector still has on the provision of financial services
to the rural poor and the fact that the main commercial banks have yet to
really grasp the possibility of delivering microfinance services for profitable purposes.170 171
For example, a recent study estimated that in 2001 commercial banking sector (not
including the development banks) as a whole only supplied around 22 percent of microcredit (e.g. loans under US$1,000 in 2001) (Gant, de Silva, Atapattu & Durrant, 2002).
The Commercial Banks have generally become involved in the provision of microfinance
either through their own ‘in house’ microfinance interventions or as vehicles of the state
for wholesaling loans for on-lending as microfinance credit to participating partners in
state and donor community funded microfinance interventions since the 1980s.
However, with a few notable exceptions, such as the Hatton National Bank’s activities
and the People’s Bank Savings and Pawning Centers, the banks have in the main failed
to successfully promote or deliver microcredit to the rural poor (ibid).
Case Study: The People’s Bank, Sri Lanka
The People’s Bank of Sri Lanka
General Data
The People’s Bank (hereafter referred to as ‘the Bank’) was founded by
the People’s Bank Act in 1961, which dissolved the previous Cooperative
Federal Bank of Ceylon. The bank is the second largest commercial
bank in Sri Lanka (CBSL, 1998).
Ownership and Governance Mandate
The public mandate of the bank is twofold, namely:
To develop and assist the co-operative movement, rural banking,
agriculture and industry.
To carry on the business of a commercial bank, pawn broker and
merchant bank.
The bank’s mandate has changed little over time. The bank’s purpose
has always been to provide access to financial services for the rural and
'poor' population of Sri Lanka.172 The bank has always been run as a
commercial entity.173 However, at the same time the bank has also been
used as the vehicle for various development finance initiatives by the
government (ibid.). Ownership and Control
The Bank is wholly owned by the Sri Lanka Government. The bank is
controlled by the Board of Directors. The Board is appointed by the
Government. Under the People’s Bank Act, the board consists of a
maximum of 10 directors appointed by the Minister of Finance, two of
In the early sixties these communities were largely denied access to these services and
relied heavily on traditional unofficial pawning, local lotteries called ‘cheetus’ and the
local money lenders or ‘mudhalalis' who lent cash at usurious rates of interest.
Over the years the bank has developed a wide range of services and products and
created the People’s Bank Group, which contains numerous associate and subsidiary
companies including a travel agency, merchant banking, leasing, property development,
asset management and venture capital investment.
The Challenge of Sustainable Outreach
whom are nominated by the minister in charge of the subject of Cooperatives (ibid.).174
It is written into the Act that the Minister of Finance has the power to
remove a director of the Board without giving reason and no court in Sri
Lanka may question the decision.175 This power delivers the Bank into
the hands of the government, opening its governance, management,
staff and customers deposits to political capture rather than commercial
Profitable day-to-day management of the bank has been constrained in
two main ways: firstly, the owner (e.g. the Minister of Finance) has the
power to intervene in all matters. Secondly, management has been
severely hampered by political interference and directed lending as well
as an over-centralisation of loan granting authority. Supervision and Auditing
The general supervision, control and administration of the affairs and
business of the bank is vested in the Board of Directors and the Board
may exercise all of the powers of the bank.
In terms of auditing, the Auditor General of Sri Lanka is responsible for
directing the audit of the bank and in this is assisted by firms of
accountants in public practice as are the audits of the bank's subsidiaries
and associates who themselves choose the accounting firms for their
audit. The audit is conducted in accordance with Sri Lanka Auditing
Standards. The bank has recently embraced internationally accepted
standards of accounting and has asked a foreign consultant to conduct a
comprehensive internal audit this year with recommendations for
improving the bank’s transparency and accountability.
The Bank appears to have most of the reporting and management
structures required to prevent and detect fraud and/or fraudulent
practice. However no information about the bank’s fraud detection
practices is available.
People’s Bank Act No. 29 of 1961 (incorporating Amendments up to 31.12.1998),
Central Bank of Sri Lanka (CBSL).
Until recently the Minister of Finance was also the State President of Sri Lanka.
Case Study: The People’s Bank, Sri Lanka Assessment and Conclusions
The fact that the state is the owner of the bank and that the Minister of
Finance has the power to appoint and dismiss the Board of Directors
means, that the bank is always potentially open to political capture by the
government of the day. In developing countries such as Sri Lanka control
of the assets of the 'poor' means control of their franchise. With over four
million customers, the potential political leverage gained by state
ownership of the People's Bank is enormous. It is important that the
present day government is seen to remain at arms length from the
bank’s governance.
Historically, appointments to the Board have been made for political
reasons with members not necessarily possessing financial acumen or
banking experience. This has given rise to politicised, directed lending
not necessarily based on sound commercial criteria.
Given the Banks financial state and the advent of a newly elected
government, there has been a high turnover of Directors on the Board
recently and only 2 Directors remain of the 8 who were in place at the
end of 2000. This is encouraging and reflects the new government
commitment to pruning the number of board members, introducing
individuals with more direct industry experience onto the board and
opening the bank’s books up to an international audit.
At the same time however, the powers of the board have not been
changed during the banks recent restructuring and the board would
appear to retain much day-to-day operational involvement (especially
with regard to the authorisation of loans). If the lessons of the recent past
are to be learnt from then there is a strong argument for further
devolution of power away from the Board to the bank’s senior executive
Economic Viability Economic Performance
Observing the history of the People’s Bank, the Central Bank of Sri
Lanka has stated that:
“In the past, the operations of the state banks have not always been
based on commercial criteria and this has resulted in certain
inefficiencies in their operations, which affect the entire banking
industry. Hence there is an urgent need to improve the operations of
The Challenge of Sustainable Outreach
these two banks. An important step in this process would be to ensure
that their future dealings with the government are at arms length and
their business activities are based on commercial criteria.”
(CBSL, 2001: p. 52, added emphasis)
The recent economic performance of the bank is at best mixed. On the
one hand, the Bank has had to be refinanced twice in the past decade
and has made huge pre-tax losses in 1999 and 2000. On the other hand,
the bank’s earnings have increased substantially and the bank made its
highest ever operating profit in 2001, managing to return to the black in
terms of its overall net profit/loss account.
The bank is clearly fighting hard to modernise and making encouraging
efforts to restructure and become more efficient, yet the bank remains
dogged by a huge non-performing loans portfolio, threats of increased
industrial action and a need for refinancing.
Table 7 - Balance Sheet (adapted) - 1999-2001
Balance Sheet
Liquid Assets
Net Loans
Other Assets
Total Assets
Other Liabilities
Net fixed Assets
Total Liabilities
Paid up capital
Retained Earnings
Total Equity
Total Liabilities & Equity
Case Study: The People’s Bank, Sri Lanka
Source: People’s Bank Annual Reports 1999-2000 & 2001176
The bank had a total asset value of US$1.87 billion as of the end of
2001. The bank’s asset value has increased by US$72 million since
1999. In Sri Lanka Rupee terms assets increased by nearly one quarter
since 1999. However this has been offset by a more than 20 percent
Rupee depreciation against the US Dollar during the same period.
Total liabilities were US$1.94 billion for the same period. Total equity
stood at US$-67 million. The bank has maintained a negative equity
position over the past three years.
Table 8 - Profit and Loss (adapted) 1999-2001
Interest on Investments
Administrative Costs
Loan Loss Provision
Other Operating Costs
Non-operational Costs
Interest on Loans
Other Operating Income
Total Income
Interest Expenses
Total Expenses
Net Profit/Loss
Source: People’s Bank Annual Reports 1999-2000 & 2001177
In terms of operations, the bank’s gross earnings have risen steadily over the
past decade, apart from a small dip in 1998. Earnings have increased
US$ exchange rates are based on average yearly amounts rather than year-end
averages. A Rupee based breakdown of the Bank’s financial accounts for the period
1999-2001 is listed in Appendix A.
The Challenge of Sustainable Outreach
dramatically over the last 2 years, rising from approximately US$202 million in
1999 to US$280 million in 2001.
However, recent gains have been offset by net losses of nearly US$150
million during 1999 and 2000. Between 1992 and 2001 the bank’s gross
earnings have topped US$1.57 billion. Overall the bank has posted net
losses of over US$70 million for the same period.178
In 2001 the bank returned to the black with a post-tax profit of 1.22%
against earnings, or US$3.4 million.179 This return to profit is being hailed
as evidence that the painful process of restructuring and reform of the
past two years is beginning to reap rewards. Interest Rates
Interest rates are set by the Central Bank of Sri Lanka. Individual
commercial banks have the discretion to set their own interest rates on
different products as they see fit. When setting a loan banks take a
number of factors into account including: the amount of capital in
question, cost of funds and risk premiums, customer status, degree of
competition, duration of loan, type of securities offered and the rate
offered by other banks.180
With regard to savings, the bank’s rates vary between 6.25 percent on
Ordinary Savings Accounts, to 7 percent on the 5-year savings account,
going up to 8 percent per annum for minors’ savings accounts. Fixed
deposit accounts range from 7 percent on a 1-month account up to 8
percent on maturity of a 12 account.
In terms of loans, rates vary from between 16 percent to 20 percent for
development and government subsidised loans; 20 percent for the
People’s Fast loan product and from 18 percent to 22 percent for other
commercial loan products.
Figures are calculated at US$1 = SLR 89.36 average annual figure for 2001, provided by
the Central Bank.
Adapted from People’s Bank 2001 Annual report (p. 72).
For further details on inflation rates for 1999-2001, please refer to Table 1.
Case Study: The People’s Bank, Sri Lanka Margins
Table 9 - People’s Bank Financial Ratios 1999-2001
Capital Adequacy
Non-performing portfolio to advances
Return on Total Assets
Return on Equity
Capital Adequacy(c)
Capital Adequacy(b)
Cost to Income ratio
As a state-owned financial institution, the People’s Bank operates under
thinner margins than its private sector counter-parts. This is because of
two main reasons, namely:
Lending to the government is high and the return on these loans is
lower than that of lending to the private sector.
The state banks have higher non-performing loans, which lower the
bank’s interest income.
This means that although the interest cost is low in the bank, interest
income is also lower affecting the interest margins (CBSL, 2001a). The
nominal interest spread of the bank is further lowered by the bank’s
recent negative profits. The banks cost to income ratios remains the
highest in the banking industry.
People’s Bank Annual Report 2001.
Paid up Capital * 100, divided by Net Loans.
Total Equity divided by Net Loans.
Statistic is taken from People’s Bank Annual Report 2001 which is calculated as Core
and Supplementary Capital divided by Risk Weighted Assets.
Calculated as cost to income ratio (ibid., p. 4).
Op. Cit., p. 4.
The Challenge of Sustainable Outreach
The source of the bank’s recent troubles stems, essentially, in the size of
it’s non-performing loans portfolio.
The bank has a huge non-performing loan portfolio and in the past has
been seen to be open to ‘political capture’ through the Board who have
the power to intervene in the day-to-day running of operations.
The Bank states that:
“As a result of historic ill-judged lending, at the end of December 2001,
the loans and advances classified as non-performing amounted to Rs.
25.4 Billion [US$284 million]. Provisions required for potential loan losses
represent 12.7% of our loan book.” (p. 5)
In 2001 the non-performing loans ratio stood at nearly 21% of total
advances. Loans and advances to 25 large defaulters and groups
constitute some 40% of the Bank’s non-performing balance (ibid., p.20).
The Bank’s stated target is to reduce non-performing advances to 15
percent by the end of 2003. The weight of the banks NPL portfolio is
clearly shown on the banks capital adequacy. However, the restructuring
and reform efforts made by the bank are starting to show some positive
results with regard to the bank’s operational self-sufficiency and its return
on assets and equity ratios. Loan Recovery
Largely as a consequence of the bank’s huge non-performing loans
portfolio, the bank initiated an accelerated recovery program in 2000.
This program has resulted in the bank making a recovery of over US$22
million in 2001, representing some 8 percent of the bank’s NPL. The
bank has recently appointed a new Credit Controller who has
established a set up an independent credit management unit, called the
Assets and Liabilities Committee (ALCO).
The committee has developed clear guidelines as to the bank’s loan
recovery policies and tightened its credit control procedures. The bank
has also set-down new guidelines and parameters for the management
of liquidity risk and placed clear limits on advances to deposits ratios.
The Treasurer is responsible for managing liquidity on a daily basis.
ALCO is also responsible for overseeing market and interest rate risk.
Case Study: The People’s Bank, Sri Lanka Efficiency
The bank has recently defined new manning levels for each of its
branches and this is resulting in a gradual reduction of the numbers of its
staff. Detailed estimates as to the number of loans per loan officer, or the
ratio of staff to loans issued are not available at present. However, the
positive impact of the restructuring process is shown in that of the banks
324 branches only 18 branches are not showing a profit in 2001.
Overall, the issue of efficiency in relationship to the banks economic
viability is one that permeates the whole organization and lies at the
heart of the bank’s present restructuring strategy and this is discussed
throughout the report, especially in the sections on Good Management
and Decentralization. Financing
The bank has had to be refinanced by the Government twice in the last
ten years. In 1993 the bank received US$217 million.190 This was given
to help refinance bad debt and to provide for increased loan loss
provision. In 1996 the bank received another US$180 million191 issued to
of-set non-performing assets and finance a State Bus Assembly Project.
Both these sets of funds were given in the form of ‘restructuring bonds’
repayable to the Government over 30 years and 10 years respectively.
The Bank receives net annual yields of 9 percent and 10.5 percent from
these bonds, equivalent to approximately US$25 million per annum, with
25 percent of the interest income of the bonds being repayable to the
The bank has been unable to meet its minimum capital adequacy ratio
for the last three years. At the end of 1999 the bank had incurred a loss
of approximately US$121 million193 and possessed a negative net asset
position of US$63 million.
Average annual exchange rate for 1993 was US$1 = SLR 48.25 on a SLR 10.5 billion
Average annual exchange rate for 1996 was US$1 = SLR 55.27 on a SLR 10 billion
People’s Bank Annual Report 2001, p. 59.
Figure calculated using average annual exchange rate of US$1 = SLR 70.39 for 1999 as
provided by the Central. Bank.
The Challenge of Sustainable Outreach
At the end of 2000 the bank incurred a loss of US$24 million194 and
possessed a negative net asset position of US$83 million. At the end of
2001 the bank’s liabilities exceeded its total assets, which resulted in a
negative net asset position of US$67 million.
In April 2001, the Government of Sri Lanka issued a letter of comfort
pledging to make good the deficiency in net assets as at December 31st
2001 and to meet the capital funds requirements stipulated by the
Central Bank. The following April the Government issued another letter
of comfort pledging the same support as at the end of 2001.
As the Auditor General (AG) observes in the Bank’s 2001 Annual Report
the total exposure of the Bank to Government Guaranteed Loans
amounts to over US$212 million at the end of 2001 and facilities given
on comfort letters from the treasury amount to US$235 million. The AG
states that:
“[m]any of these guarantees have an expiry date earlier than the
expected or contracted term of the loan facility. The Bank expects them
to be renewed on a continuing basis as long as they are required.”
(p. 53., added emphasis). Assessment and Conclusions
The figures from 1999 to 2001 show that the bank is doing the right
things to try and make the bank economically viable. The bank has
managed to become operationally profitable and is working hard to
widen its margins by significantly increasing its earnings and deposits,
entering new markets, reducing its borrowings and overheads and
reducing the size of its NPL. At the same time the bank has overhauled
the bank’s risk management systems and has made changes to ensure
that branches and managers are made more responsible for the banks
performance. However, the bank’s main weakness is the sheer size of its
NPL and this is reflected in a debt to earnings ratio of approximately 6 to
1 and negative equity to liabilities ratios. It is still uncertain whether the
bank will be able to meet its capital adequacy requirements in the future.
Figure calculated using average annual exchange rate of US$1 = SLR 75.78 for 2000 as
provided by the Central Bank.
Case Study: The People’s Bank, Sri Lanka
Decentralisation Delivery Structure
Table 10- People’s Bank Branches - 2001
No. of Branches
Number of Staff
No. of Loan Officers
Banking Density per 10,000 people
Source: Peoples Bank Annual Report 2001
The People’s Bank has the largest number of branches in the country,
with over 512 bank branches and some 188 Savings and Pawning
Centers (CBSL, 2001a). The bank has a network of some 90 Automated
Teller Machines. The bank’s branch network is nation-wide with
representation in every district in the country, including the North and
East Region, with the majority of the branches being located in the
Western and Central Regions (People’s Bank, 2001).
The bank had a total of 11,401 employees as at the end of financial year
2001. This represents approx. 1/3rd of the total employment within the
sector. Historically, staff levels have remained fairly constant, fluctuating
in small increments from 10,528 in 1992 to a height of 11,623 in 1999.
Overall, staff levels have increased at average rate of less than 1
percent a year over the least decade. The bank has an employee to
branch ratio of 22 (ibid.).
With over 4 million customers, the bank’s outreach is huge. This is the
equivalent of one customer for every family in the country. Banking
density is 0.6 branches per 10,000 people. The bank’s customer to staff
ratio is approximately one member of staff for every 350 customers
The delivery structure of the bank is becoming increasingly
decentralized. The People’s Fast scheme, supported by GTZ/RBIP,196 for
Information on the number of rural branches or accurate information on service radius
(km to furthest customer) are not available.
Chapter 2.6.1.
The Challenge of Sustainable Outreach
example, is helping to broaden and deepen the bank’s customer
outreach in rural areas by using Field Officers to set-up regular, periodic
mobile savings and credit services in the more remote rural areas where
there are no existing branches or sub-branches. Field Officers perform
marketing, loan enforcement and general liaison functions for the
branch.197 Decision-making Structures
Below the Board of Directors, there are 7 tiers of management from the
CEO down to individual branch managers.198 The CEO heads the Bank’s
corporate management and the bank’s 2001 Annual Report lists 20 other
corporate managers (down 4 on the previous year) and 44 executive
managers (no change, but with an apparent new focus on recoveries,
corporate banking, microfinance and training) (ibid.).
Decision-making structures within the bank have historically been topdown and bureaucratic with branch managers having relatively little
autonomy to authorise loans, with decisions being made by committee.
Not including the Board of Directors, the bank has traditionally
maintained around a dozen different loan approval committees that
authorise advances in progressively higher denominations.
The bank recently reconstituted its Credit Committees in order to try and
increase relevant expertise, decrease delays and become more
innovative in credit evaluation. Steps taken include allowing branch
managers to ‘hand pick’ their own credit personnel. For domestic
advances there are now six levels of credit committee, namely: Branch
level, Assistant Regional Manager level, Regional Manager level, Zonal
The concept is currently being piloted in the Anuradhapura, Matale, Kandy Nuwara-Eliya
and Hambantota districts in the Central, North-Central, Western and Southern Provinces
of Sri Lanka. While the concept of mobile field officers is not new per se, it is an
important step in helping the bank to effectively reach out to the rural populations. The
field officer concept is also helping to improve loan recovery ratios, thus reducing
transaction costs, from its rural customers. For example, the recovery rate in the Kandy
Region has increased from 87 percent to 95 percent within two years of the
operation (Gant, et al.) .
Namely, the General Manager (and additional General manager) followed by: the Senior
Deputy General Manager, Deputy General Managers, Assistant General Managers
(thematic), Assistant General managers (Zonal), Regional Managers and Branch
Managers with varying grades and levels of seniority.
Case Study: The People’s Bank, Sri Lanka
level (Assistant General Manager level), Central Credit Department level
and Deputy General Manager level.199
At least two people are required to sit on any committee at any level.
Generally speaking, individual branch committees have varying degree
of loan authorisation authority broadly ranging up to a maximum ceiling
of US$20,000-60,000, to according to the seniority of the manager and
the type of advance in question. Authorisation levels then increase up to
around US$150,000 at regional level going up to around US$250,000 at
Deputy General Manager level. Loan authorisation above this level is
referred to the General Manager, who can authorise up to around
US$500,000. Authorisation above this level is referred to the Board of
Directors.200 Rescheduling, rehabilitation and wavering activity is stricter
with lower waiver levels than authorisation level and is generally
undertaken at the Regional Manager level or above, with all issues over
US$150,000 being referred to Board. Branches as Profit Centers
During 2001 radical changes to the decision-making structure of the
bank were undertaken. The bank’s central Treasury was transformed
into a profit center, with staff being given intensive training and new risk
management and control procedures implemented (ibid.). Branch
managers were ‘empowered’ to run their branches like independent
business. Responsibility has been devolved to branch level for improved
business performance, productivity and customer service with the
Branch Managers becoming pivotal in the change and overall profitability
of the bank (People’s Bank, 2001).
All branches are now running as profit centers and performance
measurement systems are being introduced. Individual branches are
grouped into regions and ranked. Individual branches are graded into
five different categories, namely: Grades A to D and Corporate and
Super Grade. Regions and individual branches are given yearly and
monthly targets and assessed according to net profit and income and
rate of increase in profitability and profit per employee. Banking regions
and individual branches are then ranked island-wide. The top 100
branches account for over 70 percent of revenues (Ibid.), most of which
There are actually two credit committees at the Deputy General level, namely: i)
commercial and industrial credit and development finance, and, ii) rescheduling and
rehabilitation of non-performing advances.
Does not include government, co-operative or foreign lending or advances secured with
a 100% cash margin or approved staff loans, which have higher or unlimited levels.
The Challenge of Sustainable Outreach
are in the Western Economic Zone or Kandy District. Already over 95
percent of the branch network and sub-branch network is profitable
(ibid.). Assessment and Conclusions
One of the bank’s primary strengths is the fact that it has the largest
network of branches and the largest rural customer base in the country.
The recent expansion of the banks pawn-brokering activities and the
creation of 188 Pawning and Savings Centers, or sub-branches,
provides an excellent platform for increased financial intermediation and
deepening within the rural sector.
The decision to have each branch act as a profit center is key, as is the
decision to encourage Branch managers to move away from micro
management practices and towards delegation of authority so releasing
them for the vital work of business development and building internal and
external relationships.
Good Management Restructuring activity
The bank’s 2001 Annual report states that the People's Bank:
„… is a key financial institution in the country but, over the years
however, theBank grew into a fettered giant, stymied by circumstance
and influence." (p. 1)
In 2001 the bank brought in external expertise by appointing Mr. Derek J.
Kelly as the Chief Executive Officer and General Manager to initiate and
implement a plan of systematic restructuring that would bring the bank
back into profitability and assist it to compete with the private sector
commercial banks.
A strategic plan developed from late 1999 and through 2000 was fully
implemented in 2001. This has been a massive, immensely difficult
undertaking. The plan impacts upon all the areas of the bank including
its management, staff, structures and systems.
The effects of the restructuring plan are referred to at different points
throughout this report, but include: being open about the recent financial
troubles of the bank; increasing the banks financial transparency;
adopting internationally accounting standards; commissioning an
Case Study: The People’s Bank, Sri Lanka
international company to audit the bank’s introducing performance
management systems; improving staff training and introducing ‘fast track’
management recruitment policies; turning branches and offices into profit
centers, codifying bank policies and practices at all levels, focussing on
stabilising and growing the bank’s deposit base, developing new
products, increasing customer loyalty and attracting new customer
groups. Incentive Systems
As part of its ongoing attempt to introduce proper performance
management systems throughout its operations, the bank is in the
process of developing individual training plans as part of wider annual
needs assessment exercises undertaken centrally and at the branch
The bank is attempting to introduce performance-related pay starting at
the corporate and then regional and branch level - that are treated as
profit centers. The Assistant Regional Managers are being trained in
professional development and ‘Management By Objective’ approaches.
New performance management systems are in the process of being
introduced nation-wide.
Incentive bonuses for branch business performance have recently been
put in place at the branch, regional, zonal and HQ level. Incentives
payments are calculated using a ‘performance model’ that takes into
account business performance in relation to net profits earned in excess
of the annual business plan and current and savings deposits targets,
cash recoveries on bad debts and reduction of non-performing loans. All
staff except casual staff qualifies for the scheme. Management Information System
The bank has a national network across cities, towns and remote rural
villages. Devising a comprehensive and systematic computerised MIS
system is a significant challenge for the bank. At present some branches
are located in areas that do not even have access to electricity or
telecommunications. And existing computer systems are frequently in
need of upgrading.
Overall, however, the existing system gives an excellent overview of
activity at the branch level and is focussed on effective financial
monitoring and appraisal. Branch level data is prepared, often manually,
and submitted to HQ where, again often manually, the data is collated.
The Challenge of Sustainable Outreach
However the reporting systems are not identical and differences exist in
the way that provisions and transfer prices are assessed (Huber, 2002).
The MIS tends to be used more as a performance measurement tool
rather than a performance management one. The basic data collected
can potentially be used to develop more detailed analysis in the areas of
profitability, quality and outreach.
The GTZ RBIP project is working on the improvement of the bank’s MIS
and helping the bank to make changes to reporting structures and
develop more effective financial ratios and risk management systems.
This includes introducing more transparent transfer price information and
relative profitability of transaction indicators and incentive related
information that allows for the development of product-based reporting,
allocation and marketing, which is presently largely unavailable. It also
includes assessing portfolio at risk on a 30, 60 and 90-day basis and
introducing provisions at risk and risk use ratios. The project is
introducing these changes based essentially on the bank’s existing
reporting forms in order that they may be introduced throughout the bank
at a later stage with the minimum of difficulty or disruption. Human Resource Development
The bank is undertaking various changes in HR policy under the broad
remit of the Corporate Plan 2001 to 2003 related to the areas of
recruitment, training, transfer, performance management and
professional development.
The bank has no written constitution in this regard and is in the process
of codifying and documenting it’s HR policies; starting with issues related
to staff transferability in which branch locations have been classified
according to the ‘congeniality’ of the location. Under the policy, all staff is
required to spend at least 20% of their time working in locations
classified as high or very high incongeniality, which account for over 1/3rd
of branches nationally. Staff is paid an incentive for working in these
Recruitment policies have also changed significantly in the last couple of
years, and the bank is phasing in ‘fast track’ approaches. Recruitment
takes place through two main streams, namely, Management Trainees
and Banking Assistants. Management Trainees, usually undergraduates,
are given an initial three year contract wherein the first year is spent
largely receiving training in banking, finance and management and the
Case Study: The People’s Bank, Sri Lanka
second and third years is spent gaining on the job experience, frequently
as an Assistant Branch Manager.
At present there is an abundant supply of suitably qualified candidates
and the bank does not feel that there is high competition to attract staff
and does not engage in recruitment fairs at education institutes or similar
activities. As part of wider restructuring, the bank is also in the process of
cutting down its staff levels throughout the organisation. However the
criteria and targets for this have yet to be made public.
Banking Assistants are usually recruited post-A-Level and the bulk of
their training is on-the-job, with a few days initial induction. Banking
Assistants are encouraged to study for internationally accredited banking
exams. Both recruitment streams frequently receive monetary rewards to
cover external training costs upon successful completion, as well as
higher remuneration packages.
Part of the banks new ‘fast track’ policies is to speed up the process of
promotion of the most talented and able staff. Historically, promotion
from Branch Manager to Assistant General Manager or above, could
take as long as 20 years. The bank hopes to make this process much
faster. Fast tracking is being introduced as retirements allow. It is not
clear how quickly fast track candidates will enter into the banks corporate
and executive management as the bank also has a retirement policy that
allows extensions past the age of 55. However, this is somewhat offset
by the high levels of the workforce over the age of 45. Presently, there
are over 100 fast track candidates, recruited last year.
Apart from independent external training, the bank provides two main
types of training, namely, hardware and software. Hardware based
courses concentrate technical training relating to banking, finance,
administration and management and software, relates to transferable
and inter-personal skills development.
The bank recognises that the latter category is an area of relative
weakness in staff, and courses are often sub-contracted externally. Most
in-house training is provided by the bank’s Technical Training College.
However, it is recognised that increased specialisation of training
products is required and that quality can be improved. The overall
training budget for 2001 was approx. SLR 50 million (approx.
US$526,315). Training of senior management is conducted on a more
informal and ad hoc basis.
The Challenge of Sustainable Outreach
Overall, the bank considers its human resource potential as one of its
greatest assets. More effective training and professional development
and recognising the most talented and able individuals within the
organisation and allowing them to rise through the ranks is one of the
banks greatest challenges.
Training is key and the bank has its own Staff Training College that has
been revitalised and offers courses in management skills development,
improving customer service and enhancing credit skills. Sixty-four
managers have been trained as trainers and are now passing on
knowledge and skills throughout the network of branches nation-wide. Assessment and Conclusions
The People's Bank is in the process of massive change in its
management structures and systems. The banks core restructuring
efforts seem largely to have been successful. The drive to adopt
internationally recognised standards of good and best practice needs to
MIS systems are at present designed to provide relatively standardised
information for reporting purposes, the evolution of which appears to be
driven by the implementation of new performance measurement
systems. Information gathering does not as yet appear to particularly
product or customer focussed and is not seen as a key tool for
researching, expanding or developing new or existing business.
Performance measurement systems are still in their infancy. Presently
they are used primarily for purposes of measurement rather than
(strategic) management. Performance management systems can in
theory be extended to SPC sub-units, products and individual staff.
However, the development of such systems requires needs more
complex qualitative as well as quantitative indicators to be developed,
probably leading the use of indexing systems. The setting up of profit
centers and the introduction of performance measurement systems
within the bank in such a short space of time creates much upheaval and
uncertainty. This inevitably creates new sets of problems and conflict,
especially if such systems are imposed rather than evolved.
It is critical that the bank gets the MIS and PMS (Personal Management
System) interface as integrated as possible at an early stage, rather then
leaving it for later. Equally, it is essential that PMS is seen to be
Case Study: The People’s Bank, Sri Lanka
developed and embraced as part of the banks wider Human Resource
Management (HRM) policies.
Customer Orientation Products and Services
Including the government-backed schemes (referred to below) the bank
has some twenty different savings products and over ten loan products.
However, some of these are in effect obsolete and the bank has a
relatively high level of inactive, dormant or defaulted accounts.
Aside from current accounts and overdraft facilities, the bank’s main
savings (and linked loan) products include the Ordinary Savings Account
(OSA), the Extended Deposits Account (EDA), the Jana Jaya and the
Investment Savings Account (ISA),
The OSA is the bank’s standard savings product open to all savers
with no minimum or fixed saving requirements.
The Extended Deposits Account is for people who want to make a
minimum monthly investment or make a fixed deposit.
The Jana Jaya scheme is a savings account linked to loan and
insurance services, including the provision of consumption, education
and housing loans. The scheme requires an initial deposit of around
US$20 and minimum deposits of US$2 thereafter.201
The ISA scheme is a 5 year compulsory general savings product,
linked to (collateralised) loan services. The product accounts for over
60 percent of the bank’s total savings deposits (ibid.).
Re-launched in 2001, the Jaya Sri promotional campaign is linked to the Jana Jaya
scheme. Customers that maintain a minimum balance of around US$100 qualify for a
monthly lottery and the chance to win a gold coin, which are awarded every hour of
every day in monthly and annual prize draws including the chance to win cars,
motorcycles, computers and a house (People’s Bank, 2001). The product has been very
successful, growing by over 18% in 2001.
The Challenge of Sustainable Outreach
Table 11 - Loans and Products 1999-2001
Customer Orientation202
No. of loan products
No. of savings products,
No. of other financial services
No. of accounts
Gross loans portfolio (US$‘000s)
Average loan size in (US$)
Average loan size per capita (US$)
4 weeks
3 weeks
2 weeks
Loan Portfolio
No. of active borrowers (000's)203
Average loan size as a% of GDP per capita
Average loan processing time
Savings Portfolio
No. of savings accounts (000's)
Gross savings portfolio (US$’000s)
Average deposit balance in US$
Average deposit balance per capita
Average deposit balance as a% of GDP per
capita income
Source: People’s Bank Annual Reports 1999-2001
The bank has a number of specialised savings and credit products for
different customer group. These include:
Ethera Isura, an overseas foreign currency savings account for
expatriate Sri Lankan residents living or working abroad; 204
Vedeashika, an overseas foreign currency savings account for female
expatriate workers;
Detailed figures on rural market share and specific number of rural clients are
Estimates provided by the People’s Bank.
Sri Lanka has more than a million of its people living and working overseas with the
majority of them coming from the rural and semi urban communities, the bank has
reached out to this group by offering Non-Resident Foreign Currency Accounts (NRFCs)
that has facilities such as insurance policies, low interest housing loans and credit
facilities for self employment for the spouses of those working overseas. This service
and products increased the bank's NRFC balances by 26% and home remittances by
21% in 2001.
Case Study: The People’s Bank, Sri Lanka
Guru Setha, a savings and credit scheme for teachers;
Suwasetha, a savings and credit scheme for doctors, nurses and
health-care professionals;
Vanitha Vasana, a savings, credit and insurance product for women
only; Isuru Udana, an infants (pre-school) saving scheme;
Sisu Udana, a school children’s savings account;
Wandana, a senior citizens and ‘pilgrimage’ savings, credit and
insurance product.205
The majority of the banks loan products are built into the ‘specialised
savings and loan’ schemes detailed above. These loan products are
referred to as Block Loans or EMIs. Both are offered on a short (1-3
years), medium (3-5 years) or long-term (5 years +) basis. Agricultural
loans are also offered, although generally given as short-term loans over
periods of 3 months, 6 months or 1 year.
Until recently the bank has also had a near monopoly on formal pawn
brokering. The bank has been a formally authorised pawnbroker since its
inception. Pawning has increased substantially as a banking activity
since 1995. The bank has now established some 188 separate Pawning
and Savings Centers (SPCs) with over 2.2 million pawn accounts and an
outstanding pawning loans portfolio of US$177 million, giving an average
loan size of almost US$80 per loan (Grashof, 2002).206 207
A more detailed description of the banks products is not possible. The bank does not
routinely compile business information on a product by product basis or give any more
than a most basic breakdown of customer activity on a sectoral or geographical basis.
The SPC reports to a branch to which it is attached. Some branches are in charge of
more than one SPC, some do not have one at all. The branch managers report to the
respective Regional Manager and they to the Deputy General Manager Branches. A
typical SPC has three staff: a deputy manager, a clerk and a guard. Depending on the
volume of business up to five staff is possible. The deputy manager is equipped with
A-class signing power, which means he/she can approve loan applications up to Rs.
50,000. The clerk has B-class signing power, which is higher than a normal branch clerk.
The four-eye-principle is applied to ensure control. In computerised branches and SPC
each transaction is processed immediately (Grashof, 2002).
In order to apply for a pawn advance the customer needs his or her identification card
and the gold to be pawned. The gold will be and for one Sovereign (i.e. 8 grams) a
maximum of US$40- 50 can be borrowed. The period of the loan is 12 months, but the
customer is allowed to pay back the entire loan at any time. In this case the customers
pay interest only for the time the money was borrowed, but one-month minimum. No
other fee is charged. If the pawn advance is higher than US$50 then the repayment can
be made in instalments. The interest rate is slightly above the commercial lending rate,
but significantly below the informal moneylender rate. Clients in need of higher amounts
The Challenge of Sustainable Outreach
Gold pawning loans represents one of the bank’s fastest growing and
most profitable business activities. Individual SPCs have proved to be
very popular with the poorest segments of urban and rural customers
and the bank is able to use the SPCs as a vehicle through provide and
increase the uptake of some of the banks other main products.
The bank is currently collaborating in micro finance with the German
Technical Cooperation (GTZ) as part of the agency’s Rural Banking
Innovations Project (RBIP). Utilising financial systems approaches, the
project aims to deepen and broaden the bank’s client base and
demonstrate the feasibility of commercially viable, profitable, rural
finance products by developing more relevant, effective and efficient
products aimed specifically at micro, small and medium sized
entrepreneurs and their enterprises.
The innovative features of the ‘People’s Fast’ loan product that was
developed by the project are: (a) Field Officers do most of the loan
processing themselves, (b) borrowers can also be new customers, (c)
loan application procedures are simplified. Since the loan application is
quick and easy, MSME demand for the product is substantial, even
though the loan is offered at a market related interest rates.
Building on the success of the project, the bank is now considering
expanding the product nation-wide and has decided to set up
microfinance business units within branches. The project is continuing to
develop innovative new approaches and products and wants to link
MSME loans to new specialised savings and insurance products and
build up the banks competence in delivering short-term loan products.208 Customer Orientation
The People’s Bank was founded primarily to provide services to the rural
poor. The bank superseded the national Co-operative Federal Bank and
has always been a primary financial service provider to the agricultural
and rural sector. The bank has also frequently been involved in the
(i.e. above US$750 are eligible to negotiate interest rates. The processing of a pawn
loan is extremely fast and takes hardly longer than five minutes, making the product very
cost effective.
The maximum loan amount is Rs. 1,000,000. The interest rate is market oriented but
slightly below the commercial lending rate. The maximum repayment period is three
years (five years in exceptional cases). As security the bank accepts either guarantees
of two people or a mortgage and/or movable assets of the borrower. The product was
pilot tested in the Kandy district and is presently available in five districts. About 1,000
loans were granted up to date. The average loan size is about US$700 (Grashof, 2002).
Case Study: The People’s Bank, Sri Lanka
delivery of state-sponsored development finance initiatives, either as an
on-lender or practitioner. The bank’s savings deposits account for almost
a quarter of all savings deposits in the country.
Successive Sri Lankan governments have introduced various
government and development finance schemes through the Bank as a
tool to alleviate poverty in rural areas.209 Government subsidised or
underwritten schemes that the bank participates in include the Samurdhi,
savings and credit scheme, university loans and various other schemes
including enterprise start-up loans for unemployed youth, a credit
scheme to assist members of Kantha Societies of Womens’ Bureau of
Sri Lanka and subsidised motorcycle loans for local level government
officers. The bank also operates a War Widows Pension Fund.
Various internationally funded projects and programmes, such as the
Integrated Rural Development Programme have tried to use the bank as
participating agencies in delivering development finance components
throughout the 1980s and 1990s.210 This has primarily revolved around
the provision of agricultural loans and credit volumes were low, as were
repayment rates. In general, the two state banks were not keen to
provide credit as a poverty alleviation tool despite attractive interest rates
and did not develop specialised microfinance programmes.
The bank has always maintained a rural focus, with the majority of its
deposits coming from rural areas. However, over the years the bank has
become increasingly commercial and urban oriented and although the
rural savings base is still strong, agricultural loans to rural sectors make
up a small minority of the banks lending portfolio, which is increasingly
focussed on the capital, Colombo, and the surrounding Western
As part of its wider strategic plan, the bank re-launched some of its
flagship products in 2001 and went on a savings drive. This appears to
Successive governments have also indulged in periodic debt forgiveness of mainly
agricultural loans for political purposes which has served to skew the financial landscape
and de-stabilises service providers that supply microfinance services to the poor in Sri
As in many other developing countries, results in directed credit schemes have at best
been mixed, often failing to realise their goals. This is largely due to their supply-led and
subsidy-dependent character.
The western region accounted for 57% of all advances and 31% of deposits in 2001 and
is the only part of the country where the percentage of deposits is lower than the
percentage of advances.
The Challenge of Sustainable Outreach
have been quite successful as deposits increased by over 12 percent
during the year.
There is a programme of rejuvenating the branches themselves, decor,
furniture, fittings and signage all focused on attracting and retaining the
customer through making it easier to 'use the bank' and taking care of
their comfort in the process. As the branches are being re-engineered
there is for example a complete reversal in space allocation with the
customer being allocated three quarters of the physical space available
in the banking halls.
Keeping customers has become a priority and through offering family
niche savings products, housing loans, leasing services and 'fast' short
term credit linked to services such as ATM cards and the People's Visa
Card the bank hopes that customers will more likely 'stick' with the bank.
These changes are portrayed to the public through a broad marketing
and sales drive that uses the whole range of media advertising to reach
the public.
The bank has recently started to focus on the MSME sector as
potentially profitable customer sectors in their own right. In particular this
includes a increased focus on the provision of (largely collateralised)
micro-credit and micro-banking services. At the same time the bank is
looking to substantially increase its deposits base at home and abroad
and to increase its corporate and international portfolios. Assessment and Conclusions
The bank has always had a strong connection with the agricultural and
rural sector. The bank has a huge customer base and the largest rural
outreach of any formal sector financial institution.
The bank has clearly recognised that becoming a more flexible,
customer-focussed organisation is essential to its long-term survival and
profitability. However, while the bank’s rural savings base is well
established and growing, in many parts of the country the bank’s rural
customers do not bank (or borrow) with other formal financial institutions
but rather with semi-formal ones.
The bank has a clear opportunity to try to broaden and deepen its
customer base by growing its savings mobilisation, MSME loans and
Pawning services. The GTZ RBIP project has clearly shown that viable
commercial MSME loan products can be developed. However, the rural
environment of Sri Lanka is very diverse and while concepts can often
Case Study: The People’s Bank, Sri Lanka
be replicated, the successful deployment of products requires that they
be underpinned with effective research, training and product
development processes.
Summary and Conclusions
The long-term economic viability of the People’s Bank is of huge concern
to the Sri Lankan economy at the moment. The People’s bank is the
second largest commercial bank in Sri Lanka after the Bank of Ceylon.
There is a widespread ‘suspicion’ that the bank will be privatised directly
or indirectly through government refusal to refinance above its ongoing
At the same time, the Board was reconstituted last year and the Bank is
in the midst of undertaking a massive reform and restructuring exercise
in an attempt to modernise and become profitable. Industrial action,
including strikes has already commenced and both the Bank and the
Government are keeping very ‘tight-lipped’ about plans for the future.
The bank has clearly taken measures to make ‘better loan decisions’ and
is in the process of introducing a whole raft of new policies and
measures, including introducing more transparency and accountability.
The issue of whether the bank can successfully restructure and become
profitable is one that many see as the key to its long-term survival,
regardless of who the owner is.
The bank has always wrestled with the apparent dichotomy of being a
financially viable commercial bank and maintaining a large rural network.
The trade-off seems largely to have been at the expense of providing
loan services to the rural poor. The bank appears to have been largely
successful in making a break with the past. The restructuring and reform
process undertaken since 1999 seem to be reaping rewards, with the
banking having become operationally profitable, better managed, more
focussed and less politicised. Further reforms to the governance of the
bank seem appropriate at this time.
The bank presently has the largest network of branches and the
broadest and deepest outreach to the rural sector of any formal financial
institution in Sri Lanka. This needs to be considered in light of both the
accomplishments of the sector as a whole and with regard to the extent
that the bank has realised its mandate.
The Challenge of Sustainable Outreach
The bank clearly has the dominant market share of the rural sector
among formal financial institutions but this relates primarily to savings
mobilisation, not the provision or credit services. The lending patterns of
the bank are more oriented towards larger commercial lending in the
urban and most economically developed parts of the country. In
particular, the bank is not providing credit and insurance services to the
poorest sectors of the rural community, who largely still utilise the semiformal sector.
For the bank to effectively realise its mandate it needs to continue to
expand its delivery structures in the most remote rural areas and to
develop innovative new products specifically for the MSME level. The
People’s Fast pilot represents an excellent step in this regard as the
lower transaction-cost approach and experimentation with semicollateralised qualification criteria is demonstrating the viability of such
an approach to the bank itself.
The bank’s recent decision to prioritise microfinance as a growth strategy
is encouraging. At the same time, long term financial deepening depends
upon the bank’s ability to develop more effective (strategic) management
information systems. At present the bank’s inability to systematically
profile business activities by customer, product, geography or even loan
size is a critical hindrance to the ability of the bank to comprehend the
market place or create flexible demand-driven products.
There is much talk within and without the banks walls regarding the need
to privatise the ownership of the bank. This is a highly politically charged
issue (the bank is after all called the ‘People’s Bank’) and one that
warrants very careful consideration. On the positive side, many of the
banks reforms have been successfully implemented and the bank has
come a long way to reforming itself into a modern, successful
commercial bank. The bank has become operationally profitable and
over 80% of its branches are making a profit. Increased financial
intermediation and deepening as well as a continued push to develop the
banks corporate business and deposits base should allow the bank to
realise hitherto unattained stability and competitiveness.
On the negative side, the sheer size of the bank’s 20 percent nonperforming loan portfolio and debt repayment commitments threaten the
ability of the bank to achieve financial sustainability. The bank is working
hard to introduce more effective loan recovery mechanisms and only to
grant loans based on commercial criteria. However, short of further
Case Study: The People’s Bank, Sri Lanka
reform to the banks constitution the threat of further politicisation
Should the bank be privatised there is a need for careful restructuring so
that the key physical network of branches is retained to provide a broad
range of services and products for the rural communities of Sri Lanka.
The Challenge of Sustainable Outreach
ADB (2001).Sri Lanka Socio-Economic Data . Vol. 24. Colombo.
CBSL (2002a) Recent Economic Developments - Highlights. CBSL,
March 2002, Colombo.
(2002b) Sri Lanka Socio-Economic Data 2002. CBSL. Vol. xxv, June
2002, Colombo.
(2001a) Annual Report 2001. CBSL, Colombo.
(2001b) Economic and Social Statistics of Sri Lanka 2001. CBSL, Vol.
xxiii, Colombo.
(1998) People’s Bank Act No. 29 of 1961 (Incorporating Amendments up
to 31st December 1998). CBSL, Colombo Sri Lanka.
Charitonenko, S. and D. de Silva (2001) Sri Lanka Country Study. ADB
Commercialisation of Microfinance Country Workshop. Galle.
Gant, R., D. de Silva, A. Atapattu & S. Durrant (2002) National
Microfinance Study of Sri Lanka. Aus AID & GTZ, Colombo.
Grashof, L. (2002) Reaching the Poor Clients of Sri Lanka: People’s
Bank‘ Pawning and Savings Centers. GTZ. Colombo.
Huber, K. H. (2002) Proposal for an Implementation of a Strategic MIS
based on a Profit Center Approach for Micro-Finance Units and
Branches. Short First Draft Report. GTZ RBIP/Micro-Banking
Competencies Center Frankfurt.
Peoples Bank (2001) Annual Report 2001. Colombo.
(2000) Annual Report 1999-2000. Colombo.
World Bank (2000).Sri Lanka: Recapturing Missed Opportunities. World
Bank Country Report. Washington DC.
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
Case Study: Bank for Agriculture and
Agricultural Co-operatives, Thailand
Marie Luise Haberberger, Luck Wajananawat,
Nipath Kuasakul
Every three to four years it is not only interesting, but also useful, to step
back from the day to day work to rethink the case of the Bank for
Agriculture and Agricultural Cooperatives (BAAC). In 1992, Jacob Yaron
from the World Bank identified BAAC as one of the three most
successful rural finance institutions in the world, while in 1999, Klaus
Maurer analysed the BAAC within the context of agricultural bank reform
for an IFAD working paper. Now, for a third time, the case of BAAC is
addressed, but now, in the context of sustainable outreach. This third
case study is jointly prepared by GTZ’s Marie Luise Haberberger and,
from the BAAC, Luck Wajananawat and Nipath Kuasakul. Previous
studies were of great help and have served as important reference
material for the current assessment.
The BAAC is a “front rider” in outreach: 92% of farm households in
Thailand have been reached directly and indirectly by BAAC. But
outreach is only meaningful, if it remains sustainable. This case study
addresses critical issues that present an on-going challenge to
maintaining sustainable outreach and to face the future.
The Challenge of Sustainable Outreach
Thailand’s Financial Sector
The Thai economy in 2001 has grown by 1.5 percent or slightly higher,
particularly on the back of domestic demand, which was mainly
stimulated by government expenditure. Economic stability remains
satisfactory, as inflation rate was low at 1.6 percent. Liquidity in the
money market remained high in 2001, with deposit growth exceeding
lending growth. This resulted in a reduction in the average bank deposit
and lending rates from the previous year. Meanwhile, the amount of
credits extended by commercial banks rose slightly. At the same time,
commercial banks’ profitability has started to improve in 2001.
Table 1: Macro Sector Assessment
Population (million)
of which rural (million)
GDP per capita in US$
Inflation in %
Bt. 38.4
Bt. 43.5
Bt. 43.8
GDP in millions US$
Rural population (%)
Exchange Rate to the US$ [Local currency =]
Financial deepening (M2/GDP) in %
Source: Bank of Thailand
The formal financial sector in Thailand consists primarily of commercial
banks, non-bank financial institutions, specialized financial institutions
established by the government and cooperatives. As by 2002, there
were 13 (16 before the crisis that began in 1997) Thai commercial banks
and 18 foreign commercial banks, with a total of 3,632 branches
throughout the country. There were also six (12 before the crisis) credit
foncier companies, 19 (91 before the crisis) finance companies and
finance and security companies. The Bank of Thailand supervises the
above institutions.
There are nine specialized financial institutions (four banks and five
companies) supervised by the Ministry of Finance. Most notable among
these are the Bank for Agriculture and Agricultural Cooperatives (BAAC)
with 588 branches and sub-branches; the Government Savings Bank
(GSB) with 577 branches; and the Government Housing Bank (GHB)
with 128 branches. The Bank for Agriculture and Agricultural
Cooperatives (BAAC) as SFI (specialized financial institution) with the
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
primary mandate has been lending to the agricultural sector. Among all
banks, the BAAC has the largest number of branches, holding a market
share in the total assets of 4.3%. The BAAC also has the largest
customer base in Thailand. The Thai government wishes to see BAAC
play a role in community-based enterprise financing while safe guarding
its primary mandate as agricultural bank. The second significant SFI is
the GSB with its large branch network throughout Thailand, but mainly in
Bangkok and in the provincial capitals. Traditionally, this bank operates
as a savings bank since 1947, but has only recently introduced lending
to retail borrowers. The third major SFI, the Government Housing Bank
(GHB) is offering primarily housing loans throughout its mainly urban
branch network.
Table 2: Financial Sector Assessment
No. of Private Financial Institutions
No. of Public Financial Institutions
Assets of Private Financial Institutions(US$million)
Assets of Public Financial Institutions(US$million)
8.25 - 8.5%
7 - 7.5%
Lending Interest Rate (12 mth) in %
Deposit Rates (3 mth fixed deposits) in %
Source: Bank of Thailand
In the past, the grand total of all foreign banks’ branches was restricted
to no more than 20.This was due to the strong influence of the private
owned commercial banks. Enjoying government protection, these banks
were able to continuously increase their branch network.
The financial sector network in Thailand is reasonably well developed.
Bank interest rates on both loans and deposits are positive in real terms
(that is, well above the inflation rate), encouraging financial development.
The banking sector in Thailand shows a high degree of concentration
with five commercial banks holding the largest proportion of the total
assets. The financial system has long been dominated by the
commercial banks, while finance companies have gained importance in
recent years. For its level of income, Thailand had a relatively deep
financial sector. High economic growth and high savings rates, together
with substantial capital inflows, led to rapid growth of financial
institutions’ claims on the private sector in the 1990s (from 83 percent of
GDP in 1990 to 147 percent in 1996, then declining to 102 percent in
2001 - refer to Table 1). By end - 2001, total financial sector assets
The Challenge of Sustainable Outreach
amounted to US$181 billion. Private financial institutions dominate the
financial sector, accounting for 81 percent of the total assets.
The high degree of concentration can be measured on the total assets of
the five largest commercial banks, the Bangkok Bank alone with almost
20 percent. Four (Bangkok Bank, Thai Farmers Bank, Siam Commercial
Bank, Bank of Ayudhya) of the five largest commercial banks are private
owned and one (Krung Thai Bank) is state-owned. The ownership of the
private commercial banks is very much family-based. A few single
families owned the Bangkok Bank, the Thai Farmers Bank, the Bangkok
Metropolitan Bank and the Bank of Asia until the event of the financial
Finance companies were the next largest group of financial institutions,
accounting for 21 percent of total assets at end- 1996. The legal,
regulatory, and supervisory framework was such that finance companies
could not effectively compete for most commercial bank mainstream
businesses. As a result, they were left largely with more risky activities.
Compared to commercial banks, finance companies were restricted from
the businesses of a) mobilizing sight or time deposits, b) offering
overdrafts or credit cards, c) offering credit facilities related to trade
finance, d) providing foreign exchange services, and e) establishing a
branch network in the Greater Bangkok area. Finance companies were
compelled to take greater risks, while being subject to less stringent
prudential requirements than banks.
The Bank of Thailand (BOT) or Central Bank is a lender of last resort
(LLR) through a special credit window for all banks. The BOT has
conducted two financial development plans since 1990, designed to
identify obstacles to financial sector development and to implement
measures to overcome them. Important measures include relaxing
exchange controls, abolishing interest rate ceilings for financial
institutions, introducing greater competition and modernizing the
payment system. Nevertheless the financial crisis in 1997/1998 suggests
insufficient attention has been given to prudential regulation and
supervision. The crisis at least partly reflects financial factors, with banks
incurring significant losses after lending large amounts on the basis of
unsustainable property values. The experience shows that credit risk
management was inadequate. The origins of the weaknesses of the
financial sector fall into two broad categories: a) excessive lending
without prudent management of assets and liabilities, and b) inadequate
regulatory and supervisory frameworks. A considerable erosion of
confidence between banks and clients has developed. The crisis has led
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
the Bank of Thailand to increase its focus on prudential regulation and
Much has been done to stabilize the financial sector since the crisis.
Policies affecting financial institutions during 2001 were aimed at
preventing economic contraction and supporting banks with regulatory
forbearance, stimulating the economy to keep businesses alive and
increasing bank lending. Debt restructuring has been the largest
contributor to the reduction of Non Performing Loans (NPLs) in the
financial system; but the rate of restructuring has been declining. This
declining trend of completed debt restructuring could be explained by the
fact that banks are now restructuring more difficult cases. The pace of
restructuring has been undermined by the backlog of cases in the civil
courts, where mortgages are enforced. The civil courts estimate that
there are more than 65,000 NPL cases awaiting judgment. The existing
legal system lacks a quick mechanism for debt collection and
enforcement of security rights outside the bankruptcy law. Therefore,
measures are needed to develop a sound financial system and ensure
that policies towards the state-owned banks do not conflict with the
medium term objective of developing a sound financial system.
The Bank for Agriculture
Cooperatives (BAAC)
The Bank for Agriculture and Agricultural Cooperatives (BAAC) of
Thailand was established in 1966 as a government owned agricultural
development bank. The mandate of the bank has been to provide
agricultural credit to farm households and agricultural cooperatives.
In the 36 years of operations, BAAC has gradually changed from a
specialized agricultural lending institution to a more diversified rural bank
providing a range of financial services. While this process of change is
still on-going and reforms are far from complete, important lessons can
be learned from the BAAC’s experience.
The Bank for Agriculture and Agricultural Cooperatives (BAAC) in
Thailand has gone through several evolutionary steps. The most
important ones include: developing an innovative credit delivery system
for individual lending to farmers through joint liability groups; expanding
The Challenge of Sustainable Outreach
its lending operations through access to commercial bank and donor
funds and consolidating its operations by reducing loan channelling
through cooperatives; striving for viability and self-reliance, under
conditions of controlled interest rates, through savings mobilization,
improved loan recovery and increased staff productivity. Since 1998, it
has been clear that the financial crises in Thailand did not leave BAAC
unaffected. Therefore, matters concerning prudential regulation by the
central bank and diversifying into non-agricultural lending have become
serious issues. In mid 2001, the BAAC implemented a debt suspension
program for its borrowers with a credit outstanding of less than Baht
100,000 (US$2,300) as one of the urgent policies of the present
Ownership and Governance
The BAAC is categorized as a so-called specialized bank to provide
credit to agricultural producers. Until today, ownership has largely
remained with the government. The Ministry of Finance holds more than
99 percent of the shares in the bank with the remaining balance mainly
in the hands of the agricultural cooperatives. Since 1998, BAAC has
been permitted to sell shares to its employees and to its clients. The
BAAC staff has acquired some shares. A cabinet resolution in 1999
stipulated that BAAC would not go public on a wider scale.
The BAAC operates under the supervision of the Ministry of Finance, as
do all other Specialized Financial Institutions, while the commercial
banks are supervised by the Bank of Thailand (BOT). The State Audit
Office, a government agency, performs the annual external audit. Also,
the BAAC’s performance is annually assessed by the Thai Rating and
Information Service (TRIS) within a framework designed for state-owned
enterprises that is focusing on five aspects (operational effectiveness
and efficiency, stakeholder issues, management, organizational
development, good governance).
The BAAC has a department of Internal Audit for the on-going financial
and management audit of its operations. Periodic reports from the
provincial and branch offices are channelled to the BAAC’s senior
management in order to monitor the sources and uses of funds.
A Board of Directors with its fifteen members governs BAAC. The Board
controls the policies and business operations of the Bank. The
composition of the Board is outlined in the Act of 1966 to include
representatives of the Prime Minister’s Office, the Ministry of Finance,
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
Ministry of Agriculture and Cooperatives, Cooperative Promotion
Department, the Agricultural Land Reform Office, the Bank of Thailand
and one representative from the Agricultural Cooperatives. The president
of BAAC is an ex-officio member of the Board. The Finance Minister is
formally the chairman of the Board, but the Deputy Finance Minister is
assigned to act on his behalf. Overall, the Board has been comprised
mainly of public officials representing the interests of the government. In
general, expertise and experience in banking and financial business has
been scarce.
The Board composition has several important implications. First, it
implies a primarily short-term agenda, which at times may not support
long-term objective of financial health and sustainability of the institution.
Second, major internal policies are based on well-intended and general
development considerations, rather than financial business principles. As
for example, setting of lending rates and restricting BAAC lending
operations to agriculture only. Third, due to its highly emphasized policy
status as the major agriculture arm of the government, the BAAC has to
accommodate the particular interests of ministries and government
agencies by implementing a considerable number of „special projects“, in
addition to its regular lending operations.212
Such “development projects/programs” frequently have had a damaging
impact on the financial viability of the Bank. As a response, the BAAC
has adopted a strategy of „interventions against compensations“ through
negotiations with the government and members of parliament. The latest
and most significant program implemented through BAAC was a debt
suspension for all borrowers with a loan outstanding of less than Baht
100,000 (US$2,300) with BAAC. Under the program, borrowers who
chose the debt suspension are permitted to suspend loan principle and
interest payments for three years.
The government compensates the BAAC for the interest payments not
made. Borrowers under the debt suspension program cannot borrow
from BAAC during the three-year period. The government expected that
the policy would boost purchasing power of those given temporary relief
from loan repayment. Once the farmer borrowers joined the program,
they are supervised and assisted by the committee to help them improve
and restructure their operations. The program started at the beginning of
2001. With the launch of this program in April, BAAC staffs went out and
Dr. Maurer, Rural Finance, Working Paper No. B 6, IFAD.
The Challenge of Sustainable Outreach
met farmers nationwide to explain the program in detail and assist the
farmers in the submission of their applications. As a result, about 50
percent of eligible farmers opted to avail themselves of the debt relief
and their suspended loans accounted for around 21 percent of the
BAAC’s total loan portfolio. The reason why fewer farmers than expected
showed interest in the program - which was a positive sign that incentive
system against moral hazard is working - was that they were concerned
that they would forfeit the opportunity to borrow more from the BAAC and
so might to turn to the curb market which was much more expensive.
This was encouraging as it meant that farmers who chose to stay out of
the program foresaw a need to borrow more for their next crop cycle or
for future expansion of their businesses. Moreover, farmers who opted
out of the program are entitled to a privilege card, a mark of their good
credit standing. This was a powerful incentive to keep the discipline of
the credit system going, while ensuring that those in real need of the
debt relief were given an opportunity to do so.
In the past, government interventions were mainly confined to the policy
level, while the operational level was kept free from interventions,
thereby ensuring a high degree of operational autonomy. BAAC has
managed to sustain pressures from political interest groups and to resist
interference from local government in borrower selection and lending
decisions. The government-directed debt suspension program in 2001 is
however affecting the autonomy of the BAAC’s operations. The BAAC
monitors thoroughly the existing status of the debt suspension and is
preparing for any eventual moral hazard by establishing adequate
reserves. An on-going dialogue about the preparation of prudential
measures in this regard is conducted with the Ministry of Finance, the
major owner of the bank.
In the wake of the financial crisis, an important and positive change was
initiated in October 1998 when the government decided in principle to
place BAAC under the prudential regulation and supervision of the BOT.
Prudential regulations and banking standards in line with international
standards set out in the Basle Agreement have been developed by the
BOT to take effect in the new Thai Banking Law. However, up to present,
the Ministry of Finance has authorized the BOT only to inspect BAAC. Assessment and Conclusions
The BOT should be the prudential supervisor for the BAAC, while the
Ministry of Finance continues to have oversight through its ownership
and its role as mission regulator. A future modification to put the BAAC
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
under the full supervision of the BOT can be seen as a positive step from
which the BAAC would benefit in the long run. The BAAC would be
supported to operate financially viable and sustainable, at the same time
being protected against damaging interventions.
The outcome of the debt suspension program is uncertain. It certainly
interrupted BAAC’s struggle for viability and presents a potential threat to
its long-term sustainability. An increase in the reserves by BAAC seems
to be unavoidable. It is also likely that the debt suspension would further
support the spread of moral hazard of BAAC borrowers. Therefore,
BAAC should be well prepared for a very challenging time ahead from
2004 onwards.
Economic Viability Financial Performance
The BAAC has generated positive returns on assets and equity in all of
its 36 years of operations. However, since 1975, the level of profitability
has been low, with a return on assets (ROA) of less than one percent. In
the BAAC’s early years, profitability was much higher, because BAAC
was provided with cheap and cost-free funds by the government.
Since 1997, the Bank experienced a decline in loan recovery and higher
provisions for non-performing loans. The financial crisis that hit Thailand
in 1997 led to erosion in loan portfolio quality in the past five years.
Throughout the years, the BAAC was able to cross-subsidize its lending
business with interest income from investments and more recently from
fee-based income to maintain its overall profitability. Only through a
substantial increase in fee-based income was the BAAC able to reach
0.2 percent in return on assets in 2001 (Table 3). The BAAC cannot
always count on cross subsidies, but must rather address the root
causes undermining the profitability of its lending operations.
The BAAC has benefited from various types of hidden incentives and
indirect subsidies, such as an exemption from minimum reserve
requirements and income tax, costless equity from the government and
preferential interest on BOT borrowings.
The Challenge of Sustainable Outreach
Table 3: Ratios
Equity/liabilities in %
Deposits/liabilities in %
Capital adequacy in %
Return on assets in %
Return on equity in %
Number of active borrowers/loan officers
Value of loans outstanding/loan officers (US$000)
Source: BAAC
The ratio of capital to loan portfolio was high during the initial phase of
BAAC’s operations because equity contributions from the government
were the major source of funds at that time. With the diversification of
funds, the ratio gradually declined from 75 percent in 1967 to less than
10 percent in the late 1990s. During the phase of rapid expansion from
1988 until 1995, the BAAC maintained its capital adequacy at between
10 percent and 13 percent of loans outstanding, a level considered
acceptable for a sound rural financial institution. Since 1995, the ratio
has dropped below 10 percent. The most serious decline occurred in the
context of the financial crisis in 1997. BAAC experienced a considerable
loss of Baht 5.6 billion (equivalent to US$223 million at pre-crisis
exchange rate) due to the devaluation of the Thai currency. The bulk of
its foreign debt was unhedged at the time. The deferred loss effectively
wiped out almost half of BAAC’s equity. In 1998, the government
readjusted the Bank’s capital to an adequate level. From 1999 to 2001,
the BAAC’s capital adequacy is in the range from 7.4 percent to 7.3
percent (Table 3) which is insufficient, considering the implementation of
new prudential regulations and provisioning rules.
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
Table 4: Profit & Loss Account (adapted)
in US$000
in US$000
in US$000
Total Income
Interest expenses
Administrative costs
Other operational costs
Non-operational costs
Total Expenses
Net Profit/Loss
Interest on investments
Interest on loans
Other operating income
thereof personnel expenses
Loan loss provision
Source: BAAC
The BAAC’s operational costs have moved up to 4.5 percent (of the
outstanding gross portfolio) in 2001 (Table 4). This seems efficient
considering the nature of the BAAC’s operations with millions of small
loans and deposits that cause high administration costs. The Bank’s
management always pays highest attention to cost control. Over the past
decade, staff expenses were reduced from 3 percent (of the outstanding
gross portfolio) to 2.1 percent, indicating significant gains in productivity.
Office costs were reduced to less than 1 percent of the average loans
outstanding. The decline in these cost aggregates is mirrored, however,
by a deterioration of recovery performance and a resulting increase in
loan loss provisions to the highest level in BAAC’s history. In 1999, loan
loss provisions accounted for 2.7 percent of average loans outstanding,
more than the total staff expenses in the same year. In 2001, loan loss
provisions account of only 1.5 percent of the average loan outstanding
(Table 4). After the implementation of more stringent provisioning rules
that are to be set by the Bank of Thailand, a significant increase in loan
loss provisioning is required most urgently.
The Challenge of Sustainable Outreach
Table 5: Balance Sheet (adapted)
in US$000
in US$000
in US$000
Liquid assets
Net fixed assets
Other assets
Total Assets
Net loans outstanding (loans - loan loss reserve)
Other liabilities
Total Liabilities
Paid up capital
Retained earnings
Total Equity
Total Liabilities and Equity
Source: BAAC Lending Rates
Besides the current recovery problem, the root cause for the BAAC’s
financial situation is rather to be sought in the political restriction on its
lending rates. The cap on lending rates leaves BAAC with a narrow
spread of 3.7 percent to five percent that has been sufficient for the bank
to cover the costs. On the one hand, this policy has in principle ensured
the viability of BAAC’s operations. On the other hand, it has prevented
BAAC from strengthening its capital base through retained earnings and
from providing its shareholders with attractive dividends. The return on
equity (ROE) has been low and in some years even below the rate of
The challenge for BAAC is to convince the government that serving
millions of small customers in rural areas is cost intensive and not like
Dr. Maurer, Rural Finance, Working Paper No. B 6, IFAD.
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
commercial banking in primarily urban areas, which policy-makers see
as a reference point. The scale and scope of BAAC operations,
therefore, require a more realistic pricing of loans. In July 1999, the
BAAC Board approved an important step towards reforming the Bank’s
interest rate policy. The progressive interest rate structure and the
inherent cross-subsidies were abolished and replaced by a minimum
lending rate of 8 percent (3/2002) irrespective of the loan size.(Table 6)
Furthermore, the interest rate is linked to performance, i.e. preferential
rates may be applied for borrowers with good performance and track
record (prime customers). This is certainly a step in the right direction.
Table 6: Interest Rate Structure for Individual Borrowers
of Borrowers
Very good
Record of Debt
15 million Baht
Full and timely
repayments for
consecutive 3
Full and timely
repayments for
consecutive 2
Full and timely
repayments in the
previous year
Past due loans,
Newly registered
Source: BAAC Fund Sources and Costs
One of the results in the BAAC’s process of change has been the
fundamental restructuring in the sources of funds. This restructuring
progressed over a continuous period of many years. By 2001, the Bank’s
source of funds consisted only of 13 percent (Table 7) from borrowing,
out of which 43 percent are from foreign loans (mainly JBIC and ADB),
20 percent from foreign bonds and 37 percent from local borrowing.
The Challenge of Sustainable Outreach
Over the past ten years, the BAAC became increasingly financially selfreliant and was able to significantly reduce its dependence and loans
from domestic and foreign sources. Within only a decade, the deposit-toliability ratio reached 83 percent (Table 3), which is an outstanding
result. In 2001, the BAAC’s cost of loanable funds was 2.8 percent, in
addition 0.5 percent had to be spent on deferred losses for exchange
rate fluctuations. The deposit-to-loan ratio of nearly 100 percent in 2001
can be presented as a most outstanding result achieved by the BAAC.
Table 7:
Change in BAAC’s Sources of Funds Structure 1967 to
Deposits from the public
Mandatory deposits from CBs
Shareholders’ Equity
Other liabilities
Deposit-to-loan ratio
Source: BAAC Loan Portfolio Quality
At a first glance, it appears that arrears would be on a decline (14.5
percent in 1999 to 12.6 percent in 2001 - Table 8). But more analysis is
required. The BAAC has maintained a reserve for doubtful and bad loans
in accordance with loan portfolio quality. With improving portfolio quality,
the reserve declined from more than 7 percent of gross loans
outstanding in the late 1980s to less than 3 percent in the mid-1990s. In
most years, BAAC maintained the reserve at roughly twice the level of
arrears of more than one year. The ratio of reserves to arrears has
declined; and from 1998 to 2000, the reserves appear to be inadequate
against a serious increase in arrears.214
The percentage of total arrears has declined from 14.5 percent to 12.6
percent from 1999 to 2001 (Table 8); however the arrears older than one
year are on the increase from 6.3 percent in 1999 to 9.4 percent in 2001
Microfinance Linkage Project: loan classification and provisioning for BAAC.
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
(Table 9). This calculation includes the (former classified) past due
borrowers who are now under debt suspension.
The Challenge of Sustainable Outreach
Table 8: Loan Recovery Performance
Loans in arrears (number of loans)
% age of arrears
Loans written off in US$(000)
Loans in arrears in US$(000)
Loan Loss Ratio
Source: BAAC
It can be seen here that moral hazard and lack of enforcement are
closely related. BAAC emphasizes on a close supervision, but appears
to be rather hesitant to take legal action against delinquent borrowers. In
April 2000, only one percent of all past-due loan contracts and less than
2 percent of the respective portfolio was under litigation. BAAC rather
takes legal action against a few delinquent borrowers by stating an
example for others. The reason for this is that it is not cost effective to
take legal action against a large number of borrowers with a relatively
small loan size.
Table 9: Reserve for Bad Debt
Gross loans outstanding
Reserve for bad debt
Arrears of more than 1 year
./. Reserve for bad debt
Net loans outstanding
% of loans outstanding:
Source: BAAC. Annual Reports
Until now, annual provisions are made on the basis of past due
principals, according to age. New provisioning rules are currently worked
out by BAAC, the Ministry of Finance and BOT that will be based on
portfolio at risk or non-performing loans, this shall be more in line with
Indicating that 13.4 billion (US$305 million) of past due loans were moved into the debt
suspension program.
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
prudential standards. Discussions and negotiations about the new BAAC
provisioning rules are still on-going among the policy makers, however a
decision is expected in the near future. This measure alone is likely to
require a considerable increase in provisions. Efficiency and Productivity
The successive increases in efficiency and productivity have been key
factors for BAAC’s survival in the past. The increase of staff has closely
followed the growth in output, especially with number of client farmers
The productivity of the credit officers (now called: business development
officers) has increased successively over the years. Today, one credit
officer is responsible for 500 to 550 client farmers, a number which
appears high compared with similar financial institutions elsewhere.
However, only about 75 percent of registered clients are current
borrowers so that a credit officer handles about 430 - 440 active
borrowers (Table 3). Furthermore, individual client farmers are organized
in joint liability groups with an average of 15 members. As the credit
officer primarily deals with the group leader, the credit officer can utilize
economies of scale and scope, as the number of contact persons is
approximately 30. The average loan portfolio per credit officer has
increased at a very fast rate. Over the past eleven years, it has
increased four times in nominal terms from Baht 10 million to Baht 41
million. (US$390,000 to US$940,000)
Similar productivity increases have taken place in the front- and backoffice of the branches. With the rapid expansion of savings mobilization,
the number of deposit accounts per branch employee (excluding credit
officers) increased from 836 in 1995 to 1,800 in 2001.
Overall, BAAC has been remarkably successful in raising staff
productivity over the years, at least in terms of quantity. Whether the
quality of output could simultaneously be sustained or even improved is
to be questioned, especially in the light of the declining quality of the
credit portfolio. Efficiency increases and cost reductions have been the
major guiding principles over the past years.
Administrative cost - combining both staff and office cost declined
between 1993 - 2000 was an opposing trend between administrative
costs and the quality of the credit portfolio. Only since the last year
(2001), could a positive change in this trend be noticed: 2.4 percent (2.1
The Challenge of Sustainable Outreach
percent in 1998) compared to the average gross loan outstanding were
spent on personnel. Assessments and Conclusions
Besides the current recovery problem, the root cause for BAAC’s
financial situation is rather to be seen in the political restriction on its
lending rates. The scale and scope of BAAC operations, therefore,
require a more realistic pricing of loans in the future.
The BAAC’s present capitalization in the range with slightly higher than
7% is not sufficient, considering the declining quality of the loan portfolio
and the urgently-needed implementation of new prudential regulations
and provisioning rules.
The previous (1993-2000) decline in administrative cost - combining both
staff and office cost was a worrying and opposing trend between
administrative costs and the quality of the credit portfolio. The recent
positive change in this trend shows that efforts are made to move from
quantity to more quality of working performance.
Over the years, the BAAC has become increasingly financially selfreliant and has been able to significantly reduce its dependence and
loans from domestic and foreign sources. Within only a decade, the
deposit-to-liability ratio has reached 83 percent, and deposit to loan ratio
of 98 percent which can be assessed as an outstanding result. However,
in 2001, BAAC had to be spent 0.5% on deferred losses for exchange
rate fluctuations. This has caused an attitude change towards borrowing
in foreign currency.
Decentralization Decentralization of Operations
The BAAC conducts its operations through a four-tier organizational
structure: the field offices, the branches, the provincial offices and the
head office. The field offices represent the Bank’s most important
outreach unit, covering all districts of the country. Each field office
employs eight to nine credit officers who are responsible for screening
and selecting borrowers, appraising loans and monitoring repayment.
Field offices are not involved in cash transactions and, thus, do not have
facilities for disbursing loans or for collecting debt repayments and
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
mobilizing deposits. These functions are carried out by the branch to
which the respective field office is affiliated.
Over the years, management and decision-making have been
successively decentralized. Branch managers have far-reaching
authority. They can approve loans of up to Baht one million (US$24,000)
and the provincial directors have a loan approval authority of up to Baht
three million (US$72,000). As 98 percent of all loans extended by BAAC
are generally below these ceilings, lending decisions are almost
completely in the hands of the branch managers.
In 1997, provincial offices - with provincial directors - were established in
an effort to decentralize management control, monitoring and
supervision. A provincial director guides and supervises between six and
10 branches in general, depending on the size of the respective
province. The provincial directors, in turn, report to the head office
(branch administration department) in Bangkok. Expansion of Branch Network
A major factor behind the BAAC’s success in client outreach was the
massive expansion of the retail network over the past decade. For twenty
years, BAAC had maintained only one branch office in each of the
country's 76 provinces. For loan disbursement and repayment farmer
clients had to travel to the BAAC branch office in the provincial capital. For
most of the farmers the distance and the transaction costs involved were
In 1988, BAAC’s management took the major decision to decentralize and
down-scale its banking operations from the provincial to the district level
and issued a policy of upgrading 10 to 25 field offices into sub-branches
and - ultimately - full branches every year. Until 1998, the number of
branches has increased substantially. At the same time, additional field
offices were opened. Today, BAAC has a dense and highly decentralized
network of 588 branches and 888 field offices reaching out to the villages.
(Table 10)
The Challenge of Sustainable Outreach
Table 10: Degree of Decentralization
Number of branches
Number of sub-branches and other units
Number of staff
Number of loan officers
Service radius (km to furthest customer) (if applicable)
30 Km
30 Km
30 Km
of which are rural
Population/(sub-branch+branch outlet)
Source: BAAC
The physical expansion was accompanied by a considerable increase in
human resources up to 1998. The number of branch and field office staff
more than doubled from 5,230 in 1986 to 11,492 by FY 2001. All the
branches and most of the field offices were computerized, thus raising
productivity and efficiency levels. This allowed BAAC to serve an even
larger number of clients.
From 1998 to 2000, the expansion of branches and the hiring of staff was
more or less on hold. This was due to BAAC’s wide outreach in
agricultural credit, which almost reached saturation. However, the number
of credit officers increased 4% in 2001 compared with the previous year.
BAAC clients, in general live within a radius of 30 km or half hour traveling
time from the nearest branch or field unit. Branches as Profit Centers
The BAAC branches have been organized as profit centers since 1994.
This has ensured a high degree of accountability and responsibility
among branch managers and branch staff. Profitability - expressed by
return on assets (ROA) - is becoming an important criteria for measuring
branch performance.
In 1997, the BAAC introduced the transfer price mechanism. The
transfer price is the internal interest rate applied on funds transferred
between the branches and the head office. When a branch requires
funds for its lending operations, it borrows from the head office and is
charged the transfer price, and vice versa: when a branch mobilizes
savings and deposits, then head office pays, based on the transfer price.
In principle, the transfer price is set by the management in accordance
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
with market cost of funds; but it can also be used as an important policy
Branch profits still appear to be overstated and loose some of their
function as precise and early signalling device for branch managers. This
is because branches do not yet allocate the provisioning on a monthly
basis. At present, BAAC - with GTZ and German Bankakademie
cooperation - is testing a new Branch Management Information System
(BMIS) in 29 branches. It provides a complete framework for managing a
branch network, based on a decentralized branch-controlling concept.
This new BMIS includes monthly provisioning, transfer pricing and
realistic cost allocations for the branches. This instrument will support
head office with its central treasury department and the branches in the
implementation of the overall bank strategy. The fully computerized
BMIS is being implemented in all branches and is expected to be fully
operationalized by the beginning of 2003.
Mobile Unit operations can further contribute to improve the
decentralization of operations, especially in regard to savings mobilization
and collection of repayments. The GTZ supported project has promoted
Mobile Unit operations in four branches; the BAAC began replicating
mobile units in 10 provinces at the beginning of 2002. Assessment and Conclusions
BAAC functions in a highly decentralized manner, and its branches are
authorized to handle almost all operations. As a further decentralization
step, implementing of cash transactions in Field Units, respectively using
more Mobile Units is a viable approach.
The planned implementation of the decentralized branch controlling
system, with its BMIS, is a strong tool to delegate more responsibilities
and accountability to branch managers and is a step into the right
Good Management Major Restructuring
One of the core elements of the BAAC’s reform process has been the
fundamental restructuring in the sources of funds. The restructuring of
the liability side progressed over a period of 30 years.
The Challenge of Sustainable Outreach
In its early years, the BAAC operated almost exclusively with
government funds. The major share (about 60 percent) came as equity
contribution and some minor share (about 20 percent) in the form of a
special credit facility on preferential terms from the BOT.
After 10 years, (1975 - 1987), mandatory deposits from commercial
banks became the major source of funds (about 40 percent), following
the agricultural credit policy issued in 1975. At the same time, BAAC
started borrowing from international finance agencies, which made this
source the second most important (about 30 percent) in the 1980s.
Finally, deposit mobilization from the general public started to gain
importance towards the end of the eighties. In 1987, deposits mobilized
by BAAC already accounted for one fourth of BAAC’s funds.
The period from 1988 - 2001 brought another major change in the
funding structure. During the period, BAAC made deposit mobilization a
major activity of its banking operations and as a result, deposits mainly
from the rural areas have evolved into the single most important source
of funds. Due to the liberalization of the agricultural credit policy, the
commercial banks drew down their mandatory deposits with BAAC to an
insignificant volume which caused a substantial stimulation to BAAC’s
mobilization efforts. While borrowings were reduced to as low as 13
percent in 2001, the BAAC suffered considerable losses from exchange
rate fluctuations associated with foreign loans. Thus, it has taken a more
cautious stance towards borrowings from abroad.
By 2001, BAAC’s source of funds consists of only 13 percent from
borrowings which is divided into 43 percent from foreign loans (mainly
JBIC and ADB); while foreign bonds have a share of 20 percent and
local borrowing 37 percent.
Over the past thirteen years, BAAC has increasingly become financially
self-reliant and was able to significantly reduce its dependence on
government funds, mandatory deposits from the commercial banks and
loans from domestic and foreign sources. Within only a decade, the
deposit-to-loan ratio doubled to 98 percent.
Since 1995 is GTZ supporting this major restructuring process of BAAC
by jointly planning and implementing a savings mobilization strategy,
savings product development and a savings delivery system.
As it became clear that the financial crisis didn’t leave BAAC unaffected,
the IMF recommended restructuring studies for all Specialized Financial
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
Institutions, including the BAAC. Consequently a loan for technical
assistance was extended by ADB to prepare a major restructuring study
and plan. This was completed by September 2002 and most meaningful
conclusions and recommendations have been submitted to the Thai
Government. It is now up to the Thai Government and the BAAC to
implement the restructuring recommendations. Management Information System (MIS)
The BAAC’s management information system has only partly kept pace
with the rapid development and fundamental changes that occurred in
recent years. The MIS is centralized and geared towards the middle and
top management in the head office. Accordingly, at the branch level, MIS
is largely perceived as a system of reporting to head office. Branch staff
has to prepare a large quantity of reports to different departments in the
head office every month, many of them seem to be overlapping. The
system has major weaknesses in providing appropriate and timely
management information to managers at the operational level, including
the branch managers, the field unit chiefs and, ultimately, the credit
officers as portfolio managers.
The BAAC has decided to revamp the entire system and to design and
install a new system from scratch. This was completed in April 2001, as
far as the Financial Management Information (FMIS) was concerned. But
the second sub-system, the Customer Information System (CIS) is still in
its planning stage. At present, the BAAC does not have an integrated
customer information system which combines all data on loans, deposits
and other transactions of a particular client in one file. Instead, the
portfolio system is handled by the credit chief and is limited to borrower
clients, while depositors are recorded by the tellers in a separate system.
One of the consequences is, for example, that credit officers have no easy
access to information about the savings performance of their borrower
clients. The under mentioned testing of a new Branch
Management Information System (BMIS) with the support of GTZ and the
German Bankakademie consists of an element of the MIS. Human Resource Management
The BAAC has a Human Resource Management Department that is
responsible for manpower planning, job specification, recruitment and
appointment, personnel administration, performance appraisal,
compensation and benefits, promotion, labour relations and discipline.
The Challenge of Sustainable Outreach
The BAAC has job descriptions for most of its 12,960 staff members
(Table 10). The job descriptions for management include: mission and
responsibilities, while main responsibilities include managing and
monitoring sections and improving subordinates’ ability. Main tasks
include planning, supervising and monitoring performance of the Division
or equivalent, in accordance with agreed objectives, goals, policies and
bank’s corporate plan, coordinating with relevant agencies or individuals,
and undertaking other tasks as assigned.
At present, the implementation of a Performance Management System
(PMS) has been tested and is on-going in 288 branches. The system’s
full roll-out is planned by April 2003. The PMS’s focus is on performancebased planning, performance coaching, performance appraisal and
competencies-based development. Concrete plans are set to replicate
performance standards that provide a bench mark against which working
performance can be evaluated. This performance standard defines how
well the main job functions must be performed in order to meet
expectations. The performance standards are linked to performance
appraisal and include consequent grading. Human Resource Development
The BAAC Human Resource Development (HRD) Department is
responsible for staff development planning, management training, and
the development of training courses. It comprises of two divisions,
Human Resource Development I is mainly responsible for the staff and
executive training, while Human Resource Development II is assigned
mainly with client training. The BAAC’s HRD Department is managing
and organizing training measures in line with staff needs. Most training is
provided by motivated BAAC in-house trainers, who are often branch
managers, section- or division managers in the head office.
Last year, almost 800 executive staff were trained in different subject
matters, mainly in FMIS, staff counselling, performance management. At
the same time, more than 4,000 operative staff participated in technical
training. The most trained subjects are „Service Culture Plus“ (service
competency), staff competency and orientation training. More than 150
BAAC staff (mainly managerial staff) took part in „training of trainer“
(TOT) measures. Another training subject, the so-called „Quality of Life“
was very frequently trained. The HRD Department spent nearly Baht 76
million (US$1.7 million) for the above mentioned staff and executive
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
Staff training plays an important role in the BAAC and contributes
substantially to its service quality. Service culture training, which was
introduced with the assistance of the GTZ- supported Microfinance
Linkage Project in 1997, bears mention here. Within three years, the
BAAC trained more than 10,000 of its staff and established a service
mind-set. Implementing this service culture yielded positive results in the
annual performance appraisal of TRIS (Thai Rating and Information
Services): 90 - 95 percent of the BAAC clients are satisfied to very
satisfied with the BAAC services. The BAAC Service Culture is not just a
training, it has been internalised in the entire Bank as a never ending
subject. The BAAC, with GTZ assistance has further developed its
service competency by offering a „Service Culture Plus“ course which is
addressing three major focus areas: a)service behaviour, b) product
knowledge, c) borrower information.
Another new training program, which is being developed jointly with the
GTZ, is the so-called „Competency-Plus Training“, focussing on cash
flow based lending techniques and developing interviewing skills.
Originally this training was developed mainly for BAAC’s micro credit
operations. However, the Bank realizes that this subject is very essential
for training the entire BAAC credit staff, since the cash-flow based
lending techniques are relevant not only for the non-farm micro-credit,
but simultaneously for short term agriculture credit, as well.
One section under the HRD Department is assigned with client training.
This is a complementary measure extended by the BAAC for improving
customer relationship and simultaneously enhancing the repayment
capacity of the borrowers. The recently-imposed debt suspension
program has sparked an increase in client training. Almost 40,000 clients
were trained by BAAC in 2001. The HRD is regularly requested by the
government to supply non-banking services such as client training to the
rural target group. Assessment and Conclusions
The BAAC has become financially self-reliant and was able to
significantly reduce its dependence on government funds, mandatory
deposits from the commercial banks and loans from domestic and
foreign sources.
The BAAC has expanded its scale and scope of operations substantially
and decentralized its operations. Implementing the FMIS was a major step
The Challenge of Sustainable Outreach
forward; however, the CIS needs to follow suit, as it is an essential need
for all BAAC managers at all levels.
ABAAC Performance Management System (PMS) is very essential and
the bank is taking the right step to strongly emphasize its
implementation. The full role-out is planned by April 2003. The BMIS
should be gradually linked to the PMS.
The BAAC’s HRD Department is very effective in managing and
organizing training measures in line with staff needs. Most training is
provided by motivated BAAC in-house trainers, who are often branch
managers, section- or division managers in the head office. This inhouse approach has the advantage that the training is really tailor-made
for the Bank’s staff, however, the disadvantage is that trainers’ time
capacity is restricted, and the most urgent training needs can not always
be satisfied in a broader context fast enough.
A clear distinction between non-banking operations and other
complimentary operations should be maintained. This is important since
the Bank is facing an increased volume of requests by the government to
supply non-banking services to the rural target group.
Customer Orientation Service-Oriented Mindset and Core Products
The BAAC pays attention to its service quality and stresses continuously
the importance of service-oriented mind set throughout its workforce.
This emphasis reaped positive results in the TRIS (Thai Rating and
Information Services) annual performance appraisal: 90 - 95 percent of
the BAAC clients appreciate the BAAC services. The „BAAC Service
Culture“ has become internalised in the entire bank as a permanent
subject. It has been progressively developed further- initially only
stressing behaviour, but more recently also including competency, such
as product- and customer knowledge. The BAAC has hundreds of
products; but similar to the financial products of many other banks in the
world, the so-called Pareto rule also applies for BAAC: about 20 percent
of the products and services generate almost 80 percent of the business.
That is why focus is on these 20 percent of products, as they produce
enhanced profitability and efficiency. Based on this experience, core
products are identified for which the following criteria apply:
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
High percentage of clients (at least 25 percent of all clients) who use
or will use the product/service
Product is profitable for BAAC
Product/service complies with the mission of BAAC
Widespread knowledge about the product amongst BAAC staff
Key products to establish and strengthen the relationship between
BAAC and the client
High growth potential, especially with new products
Twelve BAAC core-products have been identified which fulfil the above
mentioned criteria. All have been collected and summarized in a hand
book which serves as an easy reference book for the staff. One part of
the hand book details product features such as, target clientele, amount,
conditions, collateral, contact department for further questions. The
second part of the core-product handbook emphasizes sales aspects,
such as advantages for the client and for the Bank.
The BAAC has an outreach of 92 percent in 2001 (direct and indirect) to
farm families. The more direct outreach is that in 46 percent of farm
families in Thailand, there is one active BAAC borrower. In every rural
household, there is a BAAC savings account. The BAAC holds a market
share of 34 percent in rural deposits (Table 11) while 5.5 percent on a
nation-wide basis.
The Challenge of Sustainable Outreach
Table 11: Customer Orientation
Number of loan products
Number of savings products
Number of other financial services
Loan Portfolio
Number of active borrowers (000's)
of which are rural (000's)
Number of accounts (000's)
2 weeks
2 weeks
2 weeks
Average deposit balance in US$
Average deposit balance/per capita income in %
Outstanding gross portfolio in US$(000)
Average outstanding loan balance in US$
Average outstanding loan size/per capita income in
Average loan processing time
% of rural population served
Market share in rural lending
% of rural borrowers served by financial institutions
Savings Portfolio
Number of active savers (000's)
of which are rural (000's)
Number of savings accounts (000's)
Portfolio size in US$(000)
% of rural population served
Market share in rural deposits
% of rural savers served by financial institutions
Source: BAAC Credit Products
BAAC credit services can be divided into two broad categories according
to two delivery channels:
Retail credit to individual farmers (organized in joint liability groups)
accounting for 94 percent of the portfolio
Wholesale credit to farmer institutions (agricultural cooperatives and
farmer associations) accounting to 6 percent of the portfolio
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
Retail credit to individual farmers is again broken down into:
Normal lending which accounts for 87 percent in 2001
Government secured lending which accounted for 13 percent in 2001
Therefore, normal lending to individual client farmers represents the
mainstream credit program of BAAC accounting for about 81 percent of
the total loan portfolio in 2001.
The normal lending can be distinguished by two core credit products:
Working capital loan (1)
Investment loan (2)
Loan Types
The working capital loan is for farmers and family members for
agriculture purpose and for farmers with non-farm loan purpose. The
loan duration is between 12 - 18 months. The investment loans for
medium term and long term periods. A loan can be used to finance
agricultural activities, but also industrial, commercial and services
enterprises are permitted as long as the borrower is also a farmer.
For almost 30 years, the BAAC had been restricted in its lending policy
exclusively to agricultural production. Only in 1993, was the Bank given
permission to extend loans also for farm-related activities, such as agroprocessing and marketing, up to a maximum of 20 percent of its portfolio.
Client Orientation through Credit Technology
The development of the Joint Liability Groups concept dates back to the
foundation of BAAC in 1966. Because few Thai farmers had land title
documents to use as collateral in the 1960s, BAAC adopted joint liability,
as principle form of security for small loans. Joint liability has been at the
heart of the BAAC’s lending ever since.
Joint Liability Groups are formed by people who know and trust each
other. They vary in size from a minimum of 5 to a maximum of 30 and as
average of about 15 members. In general, Joint Liability Groups are
primarily client groups and not what is normally understood as self-help
groups with organization and administration. BAAC Joint Liability Groups
The Challenge of Sustainable Outreach
do not function as financial intermediaries. Individual loans up to Baht
150,000 (US$3,400) are granted on the basis of joint liability. Loans
above this amount must be secured by tangible collateral, usually
through mortgage of land and buildings.216
All transactions are conducted between the BAAC and the individual
members, also the group leader has no role in disbursements or
recovery of loans. The group leader is responsible for distributing
repayment notes and reminding the members of their obligations.
Since in the more recent years, the majority of the BAAC borrowers earn
income from agricultural and non-agricultural activities, the loan
assessment has to become more in line with the total household cashflow of the borrower and not just follow agricultural harvesting schedules.
Shift from Wholesale to Retail Lending
The initial success of direct lending to farmer clients organized in small
Joint Liability Groups on the one hand and the problems experienced in
lending to agricultural cooperatives on the other hand led to a shift in the
lending policy in the late 70s. The BAAC decided to emphasize mainly
on retail lending to farmer clients. From the BAAC’s foundation until
today, the share of wholesale lending through cooperatives dropped
from 70 percent to only 6 percent in 2001.
Latest research findings from the GTZ-supported Micro-finance Linkage Project in
December 2002 indicate that the concept of joint liability group lending has lost
relevance, given today’s situation in rural Thailand. Some major changes have occurred
since the concept was developed and introduced 35 years ago. The basic assumption at
the time has been that most of the farmers cannot provide the conventional type of
collateral such as landtitles. This situation has definitely changed as most farm households have accumulated considerable assets during the boom years of the 1980s and
1990s. The non-farm microcredit pilot project carried out by selected BAAC branches
with GTZ support has adopted cash flow-based lending as a core feature. In future,
much of the current short- and medium-term agriculutral credit could best be treated
under a cash flow-based credit technology of rural microcredit.
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
BAAC’s future market segment - non-farm lending
For many years, BAAC has tried hard to secure amendment of the 1966
Act and to obtain permission to expand its lending operations to nonfarm activities in rural areas. While in 1993, a first window was opened
when BAAC was allowed to provide loans for farm-related activities, as a
second step in the beginning of 1999, the government approved
amendment of the BAAC Act. This allowed the expansion of lending
operations into non-farm activities for farmers, up to 20 percent of the
total portfolio. In 1997, a small grant of Baht 10 million (approximately
US$380,000) was provided by GTZ as part of its technical cooperation
with the BAAC for establishing a revolving fund for non-farm lending. At
the time, BAAC was not allowed to use own funds for this purpose. The
objectives were a) to develop a system and procedures for non-farm
lending and conduct a pilot-test in selected branches and b) to produce a
show-case for supporting BAAC in its policy dialogue with the
government. The abolishment of the final restriction is expected in mid
Government Secured Lending
In addition to its normal lending business, the BAAC grants a large
number of government secured loans or so-called “special agricultural
development projects and policy lending programs”. In 2001, there were
around 200 “special projects and programs”, some nationwide, some of
them regionally concentrated. The outstanding loan volume in 2001
accounted for 13 percent of total loan portfolio. However, the workload
associated with these special projects is heavy. First results from the
decentralized branch controlling (BMIS) of the 29 branches indicate that
they are loss-making products. It also distracts the attention of the credit
officers from their mainstream lending activities which in the current
situation of low recovery, requires full concentration. In addition, most
special lending programs supported by government departments carry
preferential interest rates, which have occasionally led to some
confusion among the clients. BAAC is compensated by the government
in the form of fees and interest compensation. A rationalization and
reduction in these special projects and programs would be urgently
required. “Special loans” with its old supply-driven approach increased to
13 percent of the total net loans in 2001, compared to 10 percent in
The Challenge of Sustainable Outreach Savings- and Deposit Products
During the first twenty years of operations, the BAAC concentrated
almost exclusively on credit services while savings largely remained like in many agricultural development banks elsewhere - the „forgotten
half“ of rural finance. During the early years, the BAAC implemented a
compulsory savings scheme for borrowers, requiring that each borrower
deposit an amount equivalent to 5 percent of the loan value in a savings
account. The scheme was terminated in 1979 because it was costly to
administer, especially since its branch offices were at that time
ill-equipped to manage funds.
Only since the mid-1980s, the BAAC has recognized the importance of
voluntary savings mobilization, not only from its own perspective of
deposits as a stable and reliable source of funds, but also from the
viewpoint of its farmer clients, who need safe, liquid and convenient
deposit facilities. The Bank realized that there is a strong demand for
deposit facilities, especially among farm households that are forced to
synchronize income and expenditure in the course of the agricultural
production cycle. Furthermore, savings act as a buffer against the
uncertainty which governs the rural economy. In the wake of unforeseen
events and emergencies, financial savings perform a basic insurance
Over the past decade, the Bank has campaigned effectively to mobilize
rural savings. The Savings Promotion Division was established in the
head office and assigned the task to develop strategies and designing
appropriate savings products. The branches were instructed to set
annual mobilization targets, and savings mobilization became one of the
major criteria for evaluating branch performance. As a result, the BAAC
has achieved a remarkable success in deposit mobilization. Deposits
from the general public grew at annual rates in average of 17 percent
and increased from only Baht seven billion (US$280 million) in 1986 to
more than Baht 262 billion (US$6 billion) in March 2002.
Demand-Oriented Savings Products
The BAAC offers a range of savings products aimed at different target
groups, as shown in Table 12 below. Standard instruments are the
normal savings passbook on the one hand and fixed deposits for three,
six and twelve months on the other hand. Normal savings carry an
interest rate of 1.75 percent, while fixed deposits are generally higher-
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
yielding, e.g. at 2.5 percent to 3 percent in 2002. Interest rates on both
types of products closely follow the market rates of commercial banks.
Table 12: Product Mix according to Target Group
Target Group
1. Normal Savings (Tamada)
Small Savers
2. Lucky Savings (Thawi Choke)
Small Savers
3. Special Savings (Piset)
Medium to Large
4. Savings Bond (Thawi Sin)
Small to Medium
5. Time Deposits
Source: BAAC
In addition, the BAAC offers a Special Savings facility, which requires a
minimum balance of Baht 10,000 (US$228) and, therefore, addresses
the more well-to-do customers. Interest rates are now only at 2 percent
per annum (2002) and comparable to fixed deposit rates.
The liquidity of this facility is limited as depositors may withdraw only
once a month. However, the feature of this product is that interest
income is exempted from taxation. Only government-owned banks
including BAAC, are entitled to offer this kind of facility, which provides
them with a comparative edge over private commercial banks.
In 1995, the BAAC introduced an innovative savings product, called Om
Sap Thawi Choke or Save and get a Chance, primarily targeted at the
low-income market. This product was developed by BAAC Savings
Promotion Division together with the GTZ-supported Micro-finance
Linkage Project. The minimum opening deposit is only Baht 50
(US$1.15) and, although the interest rate of 0.75 percent paid on
deposits is one percent below the standard rate the BAAC pays for
savings accounts, and the account holder is entitled to participate in
semi-annual tombola-drawing parties offering goods popular in rural
areas as prizes. After successful pilot-testing in selected branches, the
product has been launched nationwide in early 1996 and has so far
attracted more than 2.1 million depositors with an average deposit of
Baht 3,800 per accountholder (US$87) by end of 2001.
The most recent product introduced in 1997, with the objective of
attracting medium-term funds is the BAAC Savings Bond (Thawi Sin).
The savings bonds have a nominal value of Baht 500 (US$11.40) each
and a term of three years. The three-year bonds carry an interest rate of
The Challenge of Sustainable Outreach
only 1.33 percent per annum (2002) but - as a compensation for the low
yield - bond holders participate in a highly publicized prize draw at
national level.
More than 75 percent of BAAC’s deposits are generated mainly through
the four core products, which are mentioned above, while fixed deposits
accounted for less than 25 percent at the end of FY 2001.
Individual and Institutional Depositors
Depositors are broadly classified into (a) private individuals and (b)
institutions.53 percent of the deposits are from individual and 47 percent
are from institutional depositors. The latter include primarily provincial
and district government offices and line agencies and, to a lesser extent,
agricultural cooperatives and farmers’ associations. The BAAC has
benefited from the regulation that local government offices must keep
their budget funds in an account with a government-owned bank. Branch
managers have been lobbying intensively to attract these funds.
Institutional deposits are made up of a relatively small number of
accounts with large amounts. They are held in both savings and fixed
deposits on an almost equal balance. Furthermore, institutional deposit
accounts are subject to considerable fluctuations, depending on budget
allocations and expenditures, which expose the Bank to a considerable
liquidity risk.
Deposits from individuals generally have been much more stable. More
than 90 percent of deposits from private individuals were held in simple
savings accounts including Om Sap Thawi Choke, a pattern which is
typical for rural customers. As of FY 2001, 53 percent of all deposits
originated from individual savings accounts and savings bonds. In the
past, this source has been the most stable and dynamic segment of
BAAC’s deposit market. The number of savings accounts increased from
4.1 million in 1994to 9.5 million in 2002 (Table 11), adding about one
million savings accounts every year.
The size distribution of savings accounts by number and volume reveals
a considerable concentration. The vast majority (97 percent) of the
savings accounts have a balance of less than Baht 50,000 (US$1,140).
This may indicate that the majority of BAAC depositors belong to the
lower-income segment. However, these accounts generate 36 percent of
the deposit volume, while a few large depositors (10,317 clients or 0.1%
in 2001) account for 24 percent of the volume. This concentration has
increased during the past years of the financial crisis and up to present,
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
indicating that a number of investors have resorted to the BAAC as a
safe haven, giving the BAAC high liquidity. As these funds are highly
volatile, the Bank is aware of the liquidity risk from sudden withdrawals. Fee-based and other Products
Since one year, BAAC has been paying greater attention to fee-based
services, similar to what Thai commercial banks have done since the
financial crisis. While Thai commercial banks mainly focus on the urban
and better-off rural customers, the BAAC targets the mass of the rural
people with its extensive branch network. A client who borrows from the
BAAC has also a savings account and normally, he/she needs a life- and
accidental insurance, as well. Fee-based income services are to
complement the cross selling of BAAC core banking products.
Additionally, they also can contribute to reduce credit risk and stimulate
savings mobilization. During 2001, the BAAC collected a substantial
income from fee-based services of U$5.5 million (Baht 238 million).
Table 13: Fee-based Income Products
Name of Product
Target Group
Advantage for the
Life Insurance
All BAAC borrowers
and depositors
Annual Premium
560 Baht per Person
Risk Cover
(insured person)
All BAAC borrowers
and depositors who
own cars
Individual accidental
All BAAC borrowers
and depositors
Annual Premium
150 Baht per Person
Risk cover
Inter-branch money
All BAAC clients
Bill payment
BAAC clients,
general public,
Convenient, safe
government units,
state enterprises
Source: Microfinance Linkage Project Assessment and Conclusions
The streamlining of all BAAC products by identifying the most important
BAAC products or core products are a positive step to accelarate
product knowledge and cross selling among the staff.
The Challenge of Sustainable Outreach
The BAAC’s substantial outreach of 92 percent in 2001 (direct and
indirect) to farm families is outstanding. Even, the more direct out reach
indicates that in 46 percent of farm families in Thailand, there is one
active BAAC borrower. But in every rural household, there is a BAAC
savings account.
In the future, loan products, assessments with repayment schedules
must reflect better the cash flow pattern of the rural households, which
have income from different sources.
Summary and Conclusions
The achievements in client outreach have been extra ordinary. Since the
expansion of the branch network in 1988, the number of borrowers has
doubled. By 2002, 5.2 million farm households are registered as BAAC
direct and indirect clients while 2.7 million of them are active BAAC
borrowers. This represents about 92 percent, respectively 46 percent of
the total farm households in Thailand. This outreach is unique in Asia
and in the developing world as a whole. The outreach to depositors is
equally extra ordinary. The number of savings accounts of almost 9.6
million provide significant proof that rural clients in Thailand have high
demand for the financial services of BAAC.
In the BAAC, reform processes are gradually on-going over a period of
36 years, which is very different from other Agricultural Banks where
reforms are implemented quick and massive. At times, the reform
processes in the BAAC move slowly, but gain momentum in other
In terms of focus and content, reform processes have been directed at
the transition from agricultural credit to rural finance and at the
institutional transformation of BAAC from a specialized credit institution
to a diversified rural bank. The gradual diversification of financial
services provides a clear indication of this evolution. In the early years,
BAAC mainly provided short-term agricultural loans. During the 1980s,
the bank expanded into medium-and long-term farm lending. Since
1993, BAAC has offered loans for farm related activities and most
recently opened the window for non-farm-lending to rural micro and
small enterprises. Since the mid-1980s, BAAC has added savings
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
deposit facilities to the range of financial services offered to its rural
The pro-active rural savings mobilization of the BAAC led to an almost
revolutionary change in the financial resource base. The BAAC has
become financially self-reliant and was able to significantly reduce its
dependence and loans from domestic and foreign sources. Within only a
decade, the deposit-to-liability ratio has reached 83 percent, and depositto-loan ratio of 98 percent, which can be assessed as an outstanding
result. Also, given that a number of large depositors have perceived
BAAC as a safe haven, this has given the Bank high liquidity.
The BAAC has developed a fundamental eagerness for cost
effectiveness, productivity and efficiency. This is achieved by the
constant awareness and attention of the BAAC management in the
assessment of the branch performance. The delegation of authority and
responsibility to managers at all levels and the implementation of profit
centers in the branches contribute to this achievement.
The expansion of the branch network and the decentralization of
operations which significantly increased the physical nearness and
convenience by reducing the transaction costs for the clients. This was
essential for the increased outreach to borrowers and the massive
savings mobilization of the BAAC.
The BAAC developed a financial technology and delivery mechanism, the individual lending to members of joint liability groups. At the same
time, BAAC is reducing its engagement in the field, which was less
successful, the wholesale lending to agricultural cooperatives.
The BAAC’s large and decentralized branch network with its high
outreach to borrowers and savers is an extraordinary achievement.
Furthermore, it can be stated that the BAAC’s products and service
attitude confirm that the Bank is highly customer-oriented which also is
shown by the annual rating of the TRIS (Thai Rating and Information
Service) evaluations.
Dr. Maurer, Rural Finance, Working Paper No. B 6, IFAD.
The Challenge of Sustainable Outreach
Lessons learnt:
Demand-driven approaches to rural financial services offer
opportunities for success. There is a large demand for savings
facilities in rural areas, so that the self financing of rural lending is
entirely possible. Safety and convenience rather than high interest
rates are the main concerns of potential depositors. The success in
small savings mobilization is rooted in BAAC’s ability to provide a
balanced combination of what small savers want and need: safety,
convenience, liquidity and positive yield. BAAC has been successful
to address these four elements in its successful savings mobilization.
The experience with borrowing abroad has been mixed. BAAC was
required to assume the foreign exchange risk on most of the loans
and as a consequence suffered substantial losses due to exchange
rate fluctuations. The losses were severe in the wake of the financial
crisis and the devaluation of the Thai currency when half of the bank’s
equity was wiped out. This is considered a painful lesson.
There is substantial awareness among the dynamic forces of the
BAAC management that a more realistic pricing for BAAC’s loan
operations is essential for the future. A spread of 4 to 5 percent is
insufficient looking at the nature of BAAC’s operations, which consists
of mobilizing small savings and providing small and micro loans.
Commercial banks with higher deposit and loan sizes cannot be used
as an appropriate reference for setting lending rates. There is a
growing awareness in BAAC that borrowers appreciate efficient and
effective credit services and that they are willing to pay a higher
lending rate.
At present, BAAC has an on-going cooperation with GTZ in the
context of the abovementioned Micro finance Linkage Project. The
project serves as a laboratory for developing and testing innovative
features, products and approaches in selected branches. This
cooperation is successful and shows a high leverage in supporting
BAAC in its savings mobilization, improvement of staff competency,
developing a decentralized branch controlling system as well as the
system and instruments for non-farm lending to micro enterprises.
Challenges ahead:
The BOT should be the prudential supervisor for the BAAC, while the
Ministry of Finance continues to have oversight through its ownership
and its role as mission regulator. A future modification to put the
Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand
BAAC under the full supervision of the BOT is urgently needed. The
BAAC would benefit in the long run by being supported to operate
financially viable and sustainable, at the same time being protected
against damaging interventions.
The BAAC’s present capitalization in the range with slightly higher
than 7 percent (Total Equity/Total Assets) is not sufficient, considering
the declining quality of the loan portfolio and the urgently-needed
implementation of new prudential regulations and provisioning rules.
Even though the preliminary outcome of the debt suspension program
showed a positive sign, but it might have a set back in BAAC’s
struggle for viability and presents a potential threat to its long-term
sustainability. An effort to establish a higher level of reserves by
BAAC is appreciated. However, it is likely that the debt suspension
would further support the spread of moral hazard of BAAC borrowers.
Therefore, BAAC should be well prepared for the worst yet to come.
Apart from the current recovery problem, the deep-rooted truth for
BAAC’s financial situation has to be seen in the political restriction on
its lending rates. A more realistic pricing for BAAC’s loan operations is
an important restructuring issue for the future.
Since the BAAC is regularly requested by the government to supply
non-banking services to the rural target group. A clear distinction
between non-banking operations and other complimentary operations
should be maintained in the future.
The Challenge of Sustainable Outreach
6.5 References
BAAC. Annual Report. Various issues.
Fitchett, D. (1997): Agricultural Finance Revisited: Case Study of the
Bank for Agriculture and Agricultural Cooperatives. Draft prepared
for GTZ, Germany.
Fitchett, D. (1998): Bank for Agriculture and Agricultural Cooperatives
(BAAC), Thailand (Case Study). In: Hannig/Wisniwski (eds.):
Challenges of Microsavings Mobilization - Concepts and Views
from the Field. GTZ and CGAP Working Group on Savings
Maurer, K. (1997): Assessment of Linkage Banking Projects in Asia.
Case Study 3: BAAC/GTZ Project Thailand. APRACA. Draft
Maurer, K. (1998): Savings Mobilization in the BAAC: Analysis of past
trends, assessment of performance and recommendations for the
future. BAAC/GTZ Micro-finance Linkage Project.
Maurer, K. (1999): Non-farm Lending in Kalasin and Surin. Internal
Evaluation Report. BAAC/GTZ Micro-finance Linkage Project.
Thailand Development Research Institute Foundation (TDRI) (1998): The
Rural Finance in Thailand 1996.
Yaron, J. (1992a): Successful rural finance institutions. World Bank
Discussion Paper No. 150.
Yaron, J. (1992a): Assessing Development Finance Institutions: A Public
Interest Analysis. World Bank Discussion Paper No. 174.
Maurer, K (1999) Rural Finance Working Paper (1999) No. B 6, Draft for
BAAC-GTZ Micro-finance Linkage Project: Loan Classification and
Provisions for Loan Loss in BAAC (2000).
Marie- Luise Haberberger - Luck Wajananawat, various publications in
the Bangkok Post from 1999 to 2002.
Economic and Financial Statistics of the Bank of Thailand, 2002.
Thailand, Economic Monitor published by the World Bank, May 2002.
The Way Forward
The Way Forward
Dirk Steinwand, Anke Wolf
The New Paradigm
The three days of discussion in Colombo during the International
Conference on “The Challenge of Sustainable Outreach” from January
27th to 29th 2003, which involved more than 130 participants, clearly
indicated a shift in the perception of the role of public banks in a modern
competitive financial sector.218
It was evident that the replacement of the old “Directed Agricultural
Credit Paradigm” with a new “Financial Systems Paradigm” has become
widely accepted, not only among development finance practitioners, but
also among donors, managers of public banks and central bankers in
Asia. Public banks, especially agricultural banks, are at the centre of this
shift of paradigm, which basically constitutes a move from donor-funded
targeted lending to beneficiaries at subsidized terms - with low efficiency,
poor services, high default rate and little emphasis on outreach and
sustainability - to an approach focusing on financial intermediation
(savings mobilization), cost efficiency, loan recovery, and on the
economic viability and sustainability of financial intermediaries.219
For more details see volume II of “The Challenge of Sustainable Outreach”.
See also: Vogel, R.C.; Adams D.W. 1997 (April). “Old and New Paradigms in
Development Finance: Should Directed Credit Be Resurrected?” Cambridge,
MA: Harvard Institute for International Development, CAER Discussion Paper No. 2.
The Challenge of Sustainable Outreach
However, a differentiated and more balanced view on subsidies has
emerged: external incentives, including specific well-designed subsidies,
can help to correct market failures without distorting the private sectorled market development process.
The importance of the five “critical issues”, identified in the case studies
in the previous chapters as the most crucial elements for successful
conversion of old style agricultural banks into modern financial
intermediaries, was confirmed during the discussions of the conference:
Ownership itself is not the issue. Rather, what is fundamental is the way
in which owners interfere in operations. A public bank can be managed
as efficiently as a private one, as long as the owners set the right signals
and install appropriate governance structures. However, the temptation
for politicians to misuse public banks - many of which reach a significant
share of the population (and thus a significant number of potential
voters) - for political purposes are still high, especially ahead of
elections. In order to protect their banks from political intervention,
managers try to establish “firewalls” between their banks and politicians.
However, this is often only possible to a limited extent.
Moreover, many public banks have already made significant progress in
improving their loan performance, their economic viability, and in
putting more emphasis on decentralization, customer orientation and
good management although, in most cases, there is still a long way to
go to fully achieve sustainability.
It is important to note that, for successful reform, none of the issues
mentioned above should be treated as an isolated topic. Rather, as
Marguerite Robinson put it, a new culture is need: a culture of change
which is realised at all levels of staff and management and all fields of
operation of a financial institution.
Meanwhile, best practices in microfinance have been widely
disseminated and are easily available to bank managers in any corner of
the world. Many of these microfinance technologies can also be adopted
by public banks, although further adjustments are needed to improve
coverage in rural areas. Nevertheless impediments to reform are caused
less by a lack of knowledge of how to do it, than by a lack of political will
to push ahead with comprehensive reforms. Or, as one participant put it,
“we know what to do, but how can we do it?”
The Way Forward
New Challenges
The “microfinance revolution”220 has not yet resulted in wide coverage of
the rural population. Hence, sustainable outreach of financial services
remains a major challenge. This is particularly important for agricultural
lending, where new technologies coping with the risk specifically related
to this sector are required. New experiments with weather-based
insurance schemes and instruments to guarantee farmers more stable
prices for their products may lead the way.
The control of interest rates has been largely transferred from governments to the markets. However, where markets do not work - and in
many rural areas there are no functioning financial markets due to the
lack of competition - there is the danger of monopolies arising. This
leads to the question of how to foster competition within rural areas in
order to avoid overpriced products and the offloading of inefficient banks
on rural customers. Governments have to monitor developments in a
deregulated financial sector and have to redefine the role of public banks
and subsidies in cases (or areas) of market failure.
Public banks with a large customer base will always be a source of
temptation for governments. The creation of firewalls between owners
and management might only be a temporary solution - governments
change and with them so do policies towards state banks. A more
sustainable solution would be to hand over control to the markets. As
indicated in the case studies above, there is a clear trend for public
banks to replace government funding with deposits from the public.
Additional funding through capital markets - which are much more
capable of assessing and controlling banks than private households would put substantially more pressure on managers to stick to principles
of sound banking.
Services to remote, sparsely populated rural areas are expensive, a
problem not just relevant for financial services. New technologies such
as satellite based ATMs, Smart Cards, Palmtop based lending etc. and
new delivery structures with low fixed overheads through post offices,
shops etc. are potential solutions for reducing costs. Self-help initiatives
can also play an important role in channeling financial services to rural
See chapter 1.
The Challenge of Sustainable Outreach
New Roles
The shift from a regulated (repressed) rural financial market to a more
liberal, market oriented rural financial system, the microfinance
revolution, the globalization of economies and the persistence of poverty
are all factors urging governments, donors and financial institutions to
adjust their roles in a rapidly changing environment.
Governments should desist from direct involvement in the economic
sector. The major role of government will be to support the private sector
by creating and safeguarding an enabling environment. However, in
cases of market failure or market deficiencies, government involvement
might be justified. In any case, this should be on a subsidiary basis.
Where public financial institutions are still needed, government should
set in place professional management, steer clear of political
intervention, and avoid subsidies that distort the market.
Where they are still needed, public banks should work under a clear
public mandate and function complementary to the private sector. They
have to transform themselves from credit channeling agents into efficient
customer oriented financial intermediaries. Providing a safe deposit
facility for small savers will be of at least equal importance to the
provision of credit. However, shifting the funding base from government
funds to deposits from the public requires the full integration of public
banks into the financial sector of the respective country and the
application of the same tight regulatory and supervisory practices in
place for commercial banks.
Accompanying the paradigm shift has been a change in the need for
donor assistance. The old credit lines provided by bi- and multilateral
donors to development banks are outdated. With an increased domestic
funding base, these banks are less dependent on external funds, while
the recent financial crisis made governments painfully aware of just how
costly the currency risk of accepting foreign loans for domestic lending
can become. However, further donor assistance is needed to support
governments completing the shift from the old paradigm to the new one
and to the public banks striving to transform themselves into efficient
financial intermediaries. Hence, technical cooperation and assistance is
set to play a more dominant role in future development cooperation in
the financial sector than in the past.
Deutsche Gesellschaft für
Technische Zusammenarbeit (GTZ) GmbH
- German Technical Cooperation Dag-Hammarskjöld-Weg 1-5
Postfach 5180
65726 Eschborn, Germany
Tel. +49 (0) 6196 79 0
Fax. +49 (0) 6196 79 1115