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Division 41 Financial Systems Development Section The Challenge of Sustainable Outreach 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 Outreach How can Public Banks Contribute to Outreach in Rural Areas? 5 Case Studies from Asia Eschborn 2003 Publisher: Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) GmbH Postfach 51 80 65726 Eschborn - Germany Internet: http://www.gtz.de Editors: Dr. Dirk Steinwand Martina Wiedmaier-Pfister Redaction: Saliya Kanathigoda Responsible: Dr. Dirk Steinwand Acknowledgements Acknowledgements 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 i Table of Content Table of Content List of Abbreviations and Acronyms 1 Foreword 1 1. Synopsis Report: The Challenge of Sustainable Outreach Dirk Steinwand 1 1.1 Introduction 1 1.2 Can Public Banks Contribute? 3 1.3 1.3.1 1.3.2 1.3.3 Five Cases from Asia Why Asia? The Financial Landscape The Banks 6 6 8 11 1.4 1.4.1. 1.4.2. 1.4.3 1.4.4 1.4.5 Critical Issues Ownership and Governance Funding and Economic Viability Decentralisation Restructuring and Good Management Customer Orientation and Products 18 18 20 23 24 27 1.5 Conclusions 29 1.6 References 32 2. Case Study: Kakathiya Grameena Bank, India 2.1 2.2 2.2.1 2.2.2 2.2.3 2.2.4 2.2.5 2.2.6 Harishkumar R. Dave 35 Introduction: Outreach vs. Sustainability - a Dilemma for Indian Banks? 35 The Financial Sector in India The Financial Infrastructure Public Sector Banks (PSBs) Private Sector Banks Foreign Banks Regional Rural Banks (RRBs) The Cooperative Sector 37 37 38 38 38 39 39 1 The Challenge of Sustainable Outreach 2.2.7 Apex Financial Institutions and Development Finance Institutions 2.2.8 NABARD 41 41 2.3 2.3.1 2.3.2 2.3.3 2.3.4 2.3.5 2.3.6 2.3.7 Regional Rural Banks: outreach without sustainability The Mandate Ownership and Governance Board of Directors Outreach Impediments to profitability RRB reform Impact of Reforms 41 41 42 42 42 43 43 45 2.4 SHG Banking: How to Overcome the Dilemma of Outreach to the Poor vs. Sustainability 48 2.5 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 50 50 52 55 56 57 63 64 65 68 73 2.6. Annex 75 2.7 References 77 3. Case Study: Bank Rakyat Indonesia, Indonesia Wolfram Hiemann 79 3.1 Introduction 79 3.2 3.2.1 3.2.2 3.2.3 Financial Sector Brief description of the main features and developments Key financial institutions Non-bank financial institutions 82 82 84 88 3.3 PT Bank Rakyat Indonesia (Persero) 3.3.1 General data 2 89 91 Table of Content 3.3.2 3.3.3 3.3.4 3.3.5 3.3.6 Ownership and Governance Economic Viability Decentralization Good Management Customer Orientation 94 99 117 122 129 3.4 Summary and Conclusions 138 3.5 Annexes 143 3.6 References 149 4. Case Study: Agricultural Development Bank, Nepal Marc Oliver Jünemann, Ulrich Wehnert, in cooperation with Jalan Kumar Sharma 151 4.1 Introduction 151 4.2 4.2.1 4.2.2 4.2.3 The Financial Sector of Nepal Regulatory and Supervisory Framework Financial Institutions The Armed Conflict and Its Adverse Effects on the Banking Sector 152 153 154 4.3 4.3.1 4.3.2 4.3.3 4.3.4 4.3.5 4.3.6 The Agricultural Development Bank of Nepal Background Ownership and Governance Economic Viability Decentralisation of Banking Operations Bank Restructuring and Good Management Products and Customer Orientation 157 157 160 163 169 177 186 4.4 Summary and Conclusions 190 4.5 Annexes 194 4.6 References 208 5. Case Study: The People’s Bank, Sri Lanka 5.1 156 Richard Gant, Steve Durrant 211 Introduction 211 5.2 The Financial Sector in Sri Lanka 5.2.1 Macro Assessment 5.2.2 Financial Sector Assessment 212 212 216 3 The Challenge of Sustainable Outreach 5.3 5.3.1 5.3.2 5.3.3 5.3.4 5.3.5 5.3.6 The People’s Bank of Sri Lanka General Data Ownership and Governance Economic Viability Decentralisation Good Management Customer Orientation 221 221 221 223 231 234 239 5.4 Summary and Conclusions 245 5.5 References 248 6. Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand Marie Luise Haberberger, Luck Wajananawat, Nipath Kuasakul 249 6.1 Introduction 249 6.2 Thailand’s Financial Sector 250 6.3 6.3.1 6.3.2 6.3.3 6.3.4 6.3.5 6.3.6 The Bank for Agriculture and Agricultural Cooperatives (BAAC) General Ownership and Governance Economic Viability Decentralization Good Management Customer Orientation 253 253 254 257 266 269 274 6.4 Summary and Conclusions 284 6.5 References 288 7. The Way Forward Dirk Steinwand, Anke Wolf 289 7.1 The New Paradigm 289 7.2 New Challenges 291 7.3 New Roles 292 4 List of Abbreviations and Acronyms List of Abbreviations and Acronyms ACTI ADB ADBN ATM BAAC BDN BI bn BNI BOT BPR CAMEL CAR CBSL CCPI CEO DGM EC EDA EMI FC FCBU FINCO GDP GHB GM GNP GSB HDI HRM IBRA IDP IDR 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 1 The Challenge of Sustainable Outreach IFIs IPTW ISA IT JBIC KGB KKPA KLBI KUT LLR LSB MIS m MoF MSME NABARD NBL NGO NIDC NPL NRB NRFC NRs OPEC OSA P4K PACS PLDB PSB PC PMS PPP PSD RBB RBI 2 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 million 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 Kecil 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 RBIP RDB RO(A)A ROE RRB RRDB RTC RUFIN SAARC SBI SFCL SFDP SFI SHG SIDBI SKBB SLDB SLR SME SOE SPC SPO SRR tn TPS TRIS US$ 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 3 Foreword Foreword 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 1 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 countries. 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 conference. Dr. Dirk Steinwand GTZ, Head of Section Financial Systems Development 2 Martina Wiedmaier-Pfister Consultant Synopsis Report: The Challenge of Sustainable Outreach 1. Synopsis Report: The Challenge of Sustainable Outreach Dirk Steinwand 1.1 Introduction 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 1 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.” 1 2 2 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 branches. 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 microfinance”. 1.2 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- 3 4 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. 3 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 IFAD. 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 4 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 areas. 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 manner. 5 The Challenge of Sustainable Outreach 1.3 Five Cases from Asia 1.3.1 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 enormous. 5 6 7 6 With the exception of the members of the CGAP working group chaired by GTZ on that topic. 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 America. 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. 8 9 Malhotra (1997) differentiates between „the state led and controlled capitalist state“ and „the centrally planned and led Communist or Socialist Command states currently in transition“. This of course changed for the South East Asian countries during the financial crisis of 1997/98. 7 The Challenge of Sustainable Outreach 1.3.2 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) 10 11 8 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 societies. 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 12 13 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). 9 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 years. 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. 14 10 Which, on the other hand, left India virtually unaffected by the financial crisis of 1997/98. Synopsis Report: The Challenge of Sustainable Outreach 1.3.3 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 point: 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 15 See: Patten/Rosengard 1991, Patten 1999, Charitonenko, Patten, Yaron 1998, M. Robinson 1992, 1994, 2001, Maurer 1999. 11 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 salaries. 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 16 12 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 13 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. 14 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 17 18 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). 15 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. 16 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. 19 20 21 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). 17 The Challenge of Sustainable Outreach 1.4 Critical Issues 1.4.1. 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 18 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 22 23 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. 19 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. 1.4.2. Funding and Economic Viability 1.4.2.1 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 identified: No government intervention in lending policy and no programme loans. A very low loan loss ratio (below 2%). High efficiency and staff productivity (530 active borrowers per employee). 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 25%. 20 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 versa. 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 21 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. 1.4.2.2 Funding 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 discipline. 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 24 25 22 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. 1.4.3 Decentralisation 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. 26 27 See Miller (2001). The so-called “house-banking approach”. 23 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 mechanisms. 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. 1.4.4 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. 24 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 staff). Introduction of performance based salaries and other staff incentive systems. New promotion policies, e.g. promoting the most talented and not the most senior staff. 25 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. 26 Synopsis Report: The Challenge of Sustainable Outreach 1.4.5 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. 27 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. 28 Synopsis Report: The Challenge of Sustainable Outreach 1.5 Conclusions28 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 28 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. 29 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 business. 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 Nepal). 29 30 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. 31 The Challenge of Sustainable Outreach 1.6 References APRACA/GTZ (ed.) (1997): The Linkage Banking in Asia. Volume I: The Assessment of Linkage Projects; Volume II: Country Papers on Selected Topics, Bangkok. Adams, Dale W. & Douglas H. Graham & John D. v. Pischke (ed.) (1984): Undermining Rural Development with Cheap Credit, Boulder. AFRACA (ed.) (2002): Agricultural Development Banks in Africa. The Way Forward, Nairobi. BRI & John F. Kennedy School Government, Harvard University (2001): BRI Micro Banking Services: Development Impact and Future Growth Potential, Jakarta. Central Bank of Sri Lanka (2001): Annual Report, Colombo. 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, Eschborn. Gant, Richard & Dulan de Silva & Anura Atapattu & Steve Durrant (2002): National Microfinance Study of Sri Lanka. survey of Practices and Policies, Aus AID & GTZ, Colombo. Gonzalez-Vega, Claudio & Douglas H. Graham (1995): State-Owned Agricultural Development Banks: Lessons and Opportunities for Microfinance, Economics and Sociology Occasional Paper No. 2245, The Ohio State University, Columbus. Gurley, John G. & Edward S. Shaw (1960): Money in a Theory of Finance, Washington DC. Holloh, Detlef (2001): PROFI Microfinance Institutions Study, Bank Indonesia & GTZ, Denpasar. Malhotra, Kamal (1997): The Role of the State in East and Southeast Asia, Chulalongkorn University Social Research Institute, Bangkok. 32 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 Microsavings Mobilization - Concepts and Views from the Field, GTZ, Eschborn. Maurer, Klaus (1999): IFAD Rural Finance Working Paper No. 6, Rome. McKinnon, Ronald I. (1973): Money and Capital in Economic Development, Washington DC. Microcredit Summit Campaign (2002): State of the Microcredit summit Campaign Report 2002, Washington DC. Miller, Margaret (2001): Credit Reporting Systems Around the Globe: The State of the Art in Public Credit Registries and Private Credit Reporting Firms, World Bank, Washington DC. Narayan, R.K. (1952): The Financial Expert, first published in Great Britain by Methuen & Co. Ltd., London. NENARACA(ed.) (2002): Restructuring of Agricultural Development Banks-Perspectives and Prospects, Limassol, Cyprus. Patten, R. H. & J. K. Rosengard (1991): Progress with Profits. The Development of Rural Banking in Indonesia, International Center for Economic Growth and Harvard Institute for International Development, San Francisco. Patten, Richard H. (1999): The East Asian Crisis and Micro Finance. The Experience of Bank Rakyat Indonesia through June 1999, Jakarta, mimeo. Robinson, Marguerite S. (1992): Lessons from Indonesia, Part Rural Banking, 1970-1991, No. 434, Harvard Institute Cambridge, MA. Rural Financial Intermediation: One: The Bank Rakyat Indonesia. Development Discussion Paper for International Development, 33 The Challenge of Sustainable Outreach Robinson, Marguerite S. (1994): Financial Intermediation at the Local Level: Lessons from Indonesia, Part Two: A Theoretical Perspective, Development Discussion Paper No. 482, Harvard Institute for International Development, Cambridge, MA. Robinson, Marguerite S. (2001): The Microfinance Sustainable Finance for the Poor, Washington D.C. Revolution. Wittvogel, K.A (1957).: Oriental Despotism, New Haven/London. Seibel, Hans Dieter (2001): Reaching hundreds of millions of the rural poor with sustainable savings and credit services: The role of rural & agricultural banks and their reform in Asia, paper presented at the Asia and Pacific Region Microcredit Summit Meeting of Councils, 1-5 February 2001, New Delhi. Seibel, Hans Dieter & Harishkumar R. Dave (2002): Commercial Aspects of SHG Banking in India, SHG Bank Linkage Programme Seminar, 25-26 November 2002, New Delhi. Sinha, Sanjay (2002): The Performance of rated Microfinance Institutions in South Asia, in: Small Enterprise Development, Vol. 13, No. 2. Steinwand, Dirk (2001): The Alchemy of Microfinance. The Evolution of the Indonesian People’s Credit Banks (BPR) from 1895 to 1999 and a Contemporary Analysis, Berlin. Wehnert, Ulrich & Roshan Shakya: Are Small Farmer Cooperatives Ltd. Viable Financial Institutions? ADBN/GTZ Rural Finance Nepal, Working Paper No.1, Kathmandu. World Bank (1989): World Development Report 1989. Financial Systems and Development, Washington D.C. World Bank (2002): Rural Financial Services: Implementing the Bank’s Strategy to Reach the Rural Poor, Draft Version, Washington D.C. Yaron, 34 Jacob (1994): What Makes Rural Finance Institutions Successful?, The World Bank Research Observer, Vol. 9, No. 1, pp. 49-70. Case Study: Kakathiya Grameena Bank, India 2. Case Study: Kakathiya Grameena Bank, India Harishkumar R. Dave 2.1 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 2000.30 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): 30 Source - National Human Development Report 2001. 35 The Challenge of Sustainable Outreach nationalized commercial banks with 30,000 rural and semi-urban branches 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 characteristics: a rural financial sector with the following 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. 36 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 2008. 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. 2.2 The Financial Sector in India 2.2.1 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 31 Recent poverty estimates, because of different methodologies adopted, have arrived at figures of the poor population in the range of 260m to 300m. 37 The Challenge of Sustainable Outreach other financial institutions. Commercial banks comprise public, private and foreign banks. 2.2.2 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 outstanding. 2.2.3 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). 2.2.4 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. 38 Case Study: Kakathiya Grameena Bank, India 2.2.5 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$3.87 billion). 2.2.6 The Cooperative Sector The Cooperative Sector is very complex in India and comprises the following: a) 30 State Co-operative Banks at the Province Level b) 367 Central Co-operative Bank sat the district level c) 98,843 village-based Primary Agriculture Credit Societies d) 20 State Land Development Banks at the state level e) 732 Primary Agricultural Development Banks at district level f) Urban Co-operative Banks, mostly at urban and metropolitan centers. The cooperative credit structure is broadly divided into short-term and long-term credit institutions. The short-term structure has three tiers in most of the states with Primary Agricultural Credit Societies (PACSs) as the base unit, District Central Cooperative Banks as federations of PACSs operating in a district and State Cooperative Banks as apex banks of District Cooperative Banks in each state. The long-term cooperative credit structure comprise of Primary Land Development Banks (PLDBs) at district level and State Land Development Bank (SLDBs) as apex bank at state level. The rural banking structure in India as on 31 March 2002 is presented in Table 1 below: 39 The Challenge of Sustainable Outreach Table 1: Rural Banking Structure in India (31 March 2002) Cooperative Financial Institutions (Short Term Structure) Primaries (3/2001) District Banks State Coop Banks 369 Regional Rural Banks Public Commercial Banks 30 20 SLDBs + 732 Primary LDBs 196 27 14,350 46,316 (30,151 rural & semi urban32) No. of institutions 98,843 Coop Financial institutions (Long Term Structure) No. of units or branches: 98,843 12,120 1,515 1,249 SLDBs 726 Primary LDBs Depositors (in millions) 100 33 - - - 50 378 (82 m rural) Borrowers (in millions) 46.5 - - - 12 40 (10.3 m rural) Deposits: (billion Rs.) 135 649 359 7.9 443.3 (303 rural) 8,467 (1,212 rural) (billion US$) 2.8 13.5 7.5 0.2 9.2 176.4 (6.31 rural) (25.3 rural) Loans outstanding (billion Rs.) 345 565 327 230 186 (132 rural) 4,954 (498 rural) (billion US$) 7.2 11.8 6.8 4.8 3.9 (2.8 rural) 103.2 (10.4 rural) Gross NPAs n.a. 18% 13% 22% 16.00% 11.10% Source: 32 33 40 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 2.2.7 Apex Financial Institutions and Development Finance Institutions 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 capitalisation. 2.2.8 NABARD 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. 2.3 Regional Rural Banks: outreach without sustainability 2.3.1 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 41 The Challenge of Sustainable Outreach to bring down the cost of providing credit in rural areas. 2.3.2 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. 2.3.3 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. 2.3.4 Outreach 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. 42 Case Study: Kakathiya Grameena Bank, India 2.3.5 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 action. 2.3.6 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: 2.3.6.1 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. 43 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. 2.3.6.2 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. 2.3.6.3 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. 44 Case Study: Kakathiya Grameena Bank, India 2.3.7 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$561 million as on 31 March 2002. Sustainability was not attained at the expense of compromising their original mandate. During the initial phase of liberalization, during which the RRBs were permitted to also finance non-target group clients, the outstanding loans increased at a significant annual average growth rate of 22% between 1995 and 2000. Subsequently, the growth rate stabilized at a healthy 18-20% range. The drop in the number of loan accounts from 12.6 million in 1995 to 11.5 million in 2000 was primarily due a vigorous recovery drive to reduce the levels of NPA and the writing off of large numbers of small bad accounts. However, the Credit-to-Deposit ratio of RRBs declined substantially from 56% in 1995 to 41% in 2000 where it has almost stabilized till 2002, indicating that the resources mobilized from the rural areas are not being ploughed back. This is an area of concern since the RRBs have access to credit lines from NABARD and the sponsor bank for enhancing the flow of credit in rural areas. The performance of RRBS over the years is presented in Table 2 below: 45 The Challenge of Sustainable Outreach Table 2: Performance of RRBs - 1975-2002 (Amounts in US$ million) Year No. of No. of Deposits Loans Credit to RRBs RRBs RRBs Accu- NPA in RRBs branche deposit earning with without mulated % s ratio in current current accu- losses % profits losse mulated losses 1975 6 17 0.04 0.02 n.a. n.a. n.a. n.a. n.a. 1980 85 3,279 41.6 50.7 n.a. n.a. n.a. n.a. n.a. 1985 188 12,606 267.9 293.3 n.a. n.a. n.a. n.a. n.a. 1990 196 14,443 654.7 740.4 n.a. n.a. n.a. n.a. n.a. 1995 196 14,509 2,323 1,311 56 32 164 n.a. n.a. 46.0 2000 196 14,301 6,709 2,747 41 162 34 55 621 22.6 2001 196 14,313 7,973 3,295 41 170 26 80 582 18.8 2002 196 14,350 9,279 3,875 42 167 29 86 561 16.0 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 below: 46 Case Study: Kakathiya Grameena Bank, India Table 3: Saver, borrower and SHG outreach of RRBs, 1995-2002 Year No. of deposit accounts (in million) No. of loan accounts (in million) Credit to Deposits Ratio in % Cumulative No. of SHGs financed by RRBs No. of SHG members in millions 1995 37.4 12.6 56 2000 47.2 11.5 41 38,998 0.7 2001 47.8 11.6 41 97,824 1.7 2002 50.0 11.9 42 188,738 3.2 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 volume. 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. 47 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. 2.4 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 34 48 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 49 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. 2.5 Kakathiaya Grameena Bank (KGB) 2.5.1 Overview 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. 50 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 financed. The outreach profile of the bank can be seen from the table 4 below: Table 4: Outreach profile of KGB (Amount in US$ million) 1999-00 Number 2000-01 Amount Number Amount 2001-02 Number Amount Number of Borrowers and loans outstanding 79,178 12.66 83,659 16.18 84,244 20.58 Number of savers and deposits outstanding 119,343 19.40 121,258 23.54 123,484 28.26 Source: Annual Reports of KGB 51 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. 2.5.2 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. 2.5.2.1 Mandate 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 government-sponsored income and employment generation 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. 35 52 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 2.5.2.2 The relationship between management of the bank the owner and the 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 53 The Challenge of Sustainable Outreach are placed before the Board of Directors and also sent to the controlling authorities of the respective Directors. 2.5.2.3 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” sector. 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. 54 Case Study: Kakathiya Grameena Bank, India Table 5: Loans under government programs, 2000-2002 (in Rs. million) 1999-00 % 2000-01 % Integrated Rural Dev. Prog. 25.7 4.0 28.4 3.6 32.5 3.1 Integrated Tribal Dev. Prog. 9.0 1.4 10.2 1.3 6.5 0.6 Scheduled Castes Action Plan 8.0 1.3 6.8 0.9 5.4 0.8 Backward Classes Action Plan 5.0 0.8 6.4 0.8 8.5 0.8 Minority Corporation Prog. 3.0 0.5 4.0 0.8 5.2 0.5 3.7 0.2 61.8 6.0 Others 50.7 Total 8.0 55.8 7.0 2001-02 % Source: Annual Reports of KGB 2.5.3 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 following: 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 branches) Surprise visits by HO functionaries 55 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 mechanism. 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. 2.5.4 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 56 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. 2.5.5 Economic Viability 2.5.5.1 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 57 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. 2.5.5.2 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. 2.5.5.3 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, 36 58 Share capital includes the recapitalisation funds of Rs. 93.8m (US$1.95m) lying as share capital deposits. Case Study: Kakathiya Grameena Bank, India backed by technical assistance for project formulation, appraisal and monitoring. Such refinance helps the bank providing term finance to key sectors of the rural economy and avail of concomitant technical assistance. Table 6 below presents the status of refinance availed by the bank and cost of average refinance borrowings in last three years: Table 6: Amount of refinance and costs of borrowings, 2000-2002 (Amount in US$ million) Lender 31/03/2000 31/3/2001 31/03/2002 Sponsor Bank 1.6 1.2 1.3 NABARD 2.4 3.8 6.2 Total 4.0 5.0 7.5 6.8% 6.2% 8.3% 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 decline. Table 7: Investments and their returns, 2000-2002 (Amount in US$ million) Investments outstanding Return on avg. investments 31/03/20 31/3/2001 31/03/2002 10.8 14.0 17.1 11.2% 10.9% 10.3% 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 37 Includes the investments in approved securities and money at call & short notice, term deposits with sponsor bank. 59 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 1999-2000 2000-01 2001-02 Return on average assets in % 1.0 0.9 -1.7 Return on average loans in % 2.2 1.8 -3.6 11.3 12.9 -30.8 Return on equity in % 2.5.5.4 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. 60 Case Study: Kakathiya Grameena Bank, India Table 9: Repayment performance of different loan products On-time repayment rates, 2000-2002 (in %) Type of loan 38 1999-00 2000-01 2001-02 Agri Cash Credit (ACC) 60 70 66 Agri Term Loan (ATL) … 34 54 53 Term Loan (TL) 36 46 58 Cash Credit (CC) 52 65 63 Self Help Group (SHG) 100 93 96 Total 58 67 68 Source : Annual Reports of KGB Table 10: Non-performing assets, 2000-2002 (Amount in US$ million) Total Loans NPA % NPA to Total Loans 1999-2000 2000-01 2001-02 13.21 16.62 21.48 2.13 1.71 2.06 16.00 10.30 9.60 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. 38 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. 61 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. 39 62 Commercial Aspects of SHG Bank Linkage Programme by H.D. Seibel and H.R. Dave, Nov. 2002. Case Study: Kakathiya Grameena Bank, India 2.5.5.5 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. 2.5.6 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. 63 The Challenge of Sustainable Outreach 2.5.7 Decentralisation 2.5.7.1 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 Population/unit 40 2 38 202 37 15,000 Number of staff (including four from the sponsor bank) 185 Number of officers 107 Number of loan officers 48 Service radius (km to furthest customer) 35 Source : Annual Reports of KGB 2.5.7.2 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. 64 Case Study: Kakathiya Grameena Bank, India 2.5.7.3 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. 2.5.7.4 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. 2.5.8 Good Management 2.5.8.1 Major restructuring programmes implemented in the past 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 40 41 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. 65 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. 2.5.8.2 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. 2.5.8.3 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 66 Case Study: Kakathiya Grameena Bank, India NPA reports. The bank has introduced a comprehensive monthly statement, now computerized, which captures the branch performance in totality. 2.5.8.4 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 Year Number of training programmes No. of employees deputed for training Training expenditure Rs. 1999-00 6 37 92,500 (US$1,927) 2000-01 5 14 56,000 (US$1,167) 2001-02 12 35 140,000 (US$2,917) Source: Annual Reports of KGB 2.5.8.5 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 67 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. 2.5.9 Customer Orientation 2.5.9.1 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 deposits: Table 13: Deposit product structure of KGB (in US$ million) 1999-00 2000-01 2001-02 4.67 4.77 5.18 Time deposits 13.96 18.77 23.09 Total Deposits 18.63 23.54 28.27 % of Time deposits to total deposits 74.90 79.70 81.70 Demand Deposits Source: Annual Reports of KGB 42 68 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. 2.5.9.2 Loans 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 1999-00 2000-01 2001-02 Short term crop loans 4.11 6.35 7.85 Agricultural term loans 1.47 1.46 1.29 0.5 0.34 0.29 Non-farm term loans 0.39 0.42 0.40 Cash Credits for business 0.83 0.86 0.75 Two-year loans to SHGs 0.22 0.75 1.24 Other types of loans 5.70 6.45 9.65 13.22 16.63 21.47 Loans for converting of crop loans into medium term loans Total 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. 43 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 69 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. 2.5.9.3 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. 70 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 employees. 2.5.9.4 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. 2.5.9.5 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. 2.5.9.6 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 71 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 40 37 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) 98,835 Source: Annual Reports of KGB 2.5.9.7 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. 72 Case Study: Kakathiya Grameena Bank, India 2.5.10 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 all, 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 are: 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 between institutional sustainability and Absence of representation of private sector on the board 73 The Challenge of Sustainable Outreach Restricted real autonomy since the chairman comes from the sponsor bank 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 and perks of the staff 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. 74 Case Study: Kakathiya Grameena Bank, India 2.6. Annex Financial performance of Kakathiya Grameena Bank, 1999-2000 - 2001-02 (Amount in US$ million) Balance Sheet (adapted) Liquid assets Investments Net loans outstanding (loans - loan loss reserve) Net fixed assets Other assets Accumulated losses* Total Assets Average total assets Savings deposits + Current deposit Time deposits Borrowings Other liabilities Total Liabilities Paid up capital Retained earnings Reserves Others Total Equity* Total Liabilities and Equity 1999-2000 11.74 0.45 12.82 0.12 0.60 2.11 27.84 24.17 4.67 13.96 3.92 3.13 25.68 0.21 0.00 0.00 1.95 2.16 27.84 2000-01 15.30 0.45 2001-02 19.05 0.45 16.18 0.13 0.38 1.84 34.28 30.79 4.77 18.77 4.97 3.61 32.12 0.21 0.00 0.00 1.95 2.16 34.28 20.58 0.14 0.31 2.50 43.03 38.55 5.18 23.09 7.53 5.07 40.87 0.21 0.00 0.00 1.95 2.16 43.03 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. 75 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 1999-00 1.02 1.43 0.29 2.74 1.82 0.63 0.51 0.00 0.00 0.00 0.05 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 (%) 1999-00 2.13 4200 16.63 0.12 0.02 2000-01 1.71 3840 10.57 0.47 0.06 2001-02 2.06 3920 10.01 0.13 0.01 Ratios Equity/liabilities (%) Deposits/liabilities (%) Capital adequacy (%) Performance Return on average assets (%) Return on average loans (%) Return on equity (%) Sustainability Operational self-sufficiency (%)* Financial self-sufficiency (%) Self-sufficiency in funds (%) Efficiency Number of active borrowers/loan officers Value of loans outstanding/loan officers 1999-00 8.4 72.5 7.8 2000-01 6.7 73.3 6.3 2001-02 5.3 69.2 5.0 1.0 2.2 11.3 0.9 1.8 12.9 -1.7 -3.6 -30.8 109.6 108.6 85.8 145.3 145.5 137.4 1650 0.3 1743 0.3 1755 0.4 2.50 0.24 2000-01 1.27 2.05 0.22 3.54 2.43 0.65 0.53 0.00 0.00 0.12 0.06 3.26 0.28 2001-02 1.40 2.47 0.19 4.06 3.18 0.97 0.77 0.01 0.00 0.50 0.07 4.73 -0.66 * The OSS is calculated according to the CGAP formula Operational Income/Operational Expenditure, which includes interest expenses among operational expenditure. 76 Case Study: Kakathiya Grameena Bank, India 2.7 References 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 Experience. 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, 1975. Annual Reports and Audited Statement of Accounts of Kakathiya. 77 Case Study: Bank Rakyat Indonesia, Indonesia 3. Case Study: Bank Rakyat Indonesia, Indonesia Wolfram Hiemann 3.1 Introduction 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. 79 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 44 80 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 average Exchange rate to US$: [Local currency = IDR indon. Rupiah] end of period **) average Financial deepening (M2/GDP) in % 1999 140,659 206.5 2000 152,227 209.6 about 60%*) 681 726 2001 145,307 211.2 688 1.9% 20.5% 9.4% 3.7% 12.6% 11.5% 7,085 7,855 9,595 8,422 10,400 10,261 58% 58% 57% Source: The Economist Intelligence Unit Ltd. 2002, Country Risk Service May 2002 *) Some observers stated a 2-3% increase in the rural population as a result from the financial crisis when many people lost their job in urban areas and returned to their villages. Meanwhile the trend reversed. **) The exchange rate slipped from 1,650 in 1986 to 2,350 in June 1997. Since then, it is not a one-way road as the figures may suggest: The rate peaked at more than 15,000 in 1998. End of 2002, the rate is below 9,000. 81 The Challenge of Sustainable Outreach Reduced subsidies on basic commodities and ongoing exchange rate adjustments pushed the inflation rate to 12.6% in 2001. It will most probably decrease to below 11% in 2002 and decline further as a result of Bank Indonesia’s (BI) tight money policy and a stabilized exchange rate. Bank Rakyat Indonesia (BRI), the bank this study deals with, was heavily hit by the financial and banking crisis. The following shows that the crisis provoked major changes in the way BRI is managed. At the same time BRI’s Micro Banking arm, the Unit system was not negatively affected by “krismon”, the monetary crisis. 3.2 Financial Sector 3.2.1 Brief description of the main features and developments In the late 60ies, Indonesia Foreign exchange rate policy received a new Rupiah, a new Banking Act, a new Central Bank 1968 – 1986: fixed US$ 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 45 82 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 repercussions. 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 95.5 - 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$1 on BI passed the parliament (1999) the banking industry started adopting international standards on prudential banking. Compulsory “fit and proper” tests evicted a number of politicians and non-bankers from influential posts. Banks appointed compliance directors and disclosed their portfolio on risk and risk management strategies. Transparency is high on the agenda. All these measures are expected to result eventually in a behavioral change in the way banks are managed. 46 For more details on the financial crisis see Annex 1, on banking system reforms see Annex 2. 83 The Challenge of Sustainable Outreach Table 2 Banking indicators (US$bn) Exchange rate IDR/US$ Total assets47 Credits Deposits Capital Net interest margin Profit before tax NPL gross NPL net 1999 2000 2001 7,085 9,585 10,400 142.1 39.1 87.2 -5.8 107.5 33.4 72.9 5.5 105.7 34.5 76.7 6.0 -5.4 2.4 3.6 -12.9 1.1 1.3 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. 32.8% 7.3% 18.8% 12.1% 5.8% 3.6% 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. 3.2.2 Key financial institutions 3.2.2.1 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 47 84 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$1bn scheme for farm businesses (Kredit Usaha Tani, KUT), the management of which was transferred to BRI (see Annex 3). The 1999 Act on BI charges this institution as monetary authority with the responsibility for payment systems, stable exchange rates and low inflation. BI steers money supply through open market operations. The institution is still supervising banks and multifinance companies (the latter ones in cooperation with Ministry of Finance/MoF) until end of 2002 and afterwards during a transitional period until a still to be created institution for supervising the financial services sector takes over this task. Another main mission of BI’s management is the improvement of the institution’s image and rebuilding its credibility as it influences international confidence in the country. 3.3.2.2 Banks The 1992 Act on Banks distinguishes between Commercial Banks (Bank Umum) and BPR (Bank Perkreditan Rakyat), literally “People’s Credit Banks” or, according to BI’s translation, “Rural Credit Banks”, a confusing term as almost half of these banks operate in cities or close to city borders. 48 “PAKJAN” or January (1990) package. 85 The Challenge of Sustainable Outreach Table 3: Classification of banks (2001) Classification of banks No. of banks No. of offices/ branches Assets US$bn Loans US$bn Commercial banks BRI Bank Rakyat Indonesia, SOE 1 399 7.3 3.2 3,823 240 + BRI Units + BRI Unit Service Posts State owned banks49, others 4 1,407 41.2 12.2 Private national banks 80 3,988 35.3 10.4 Regional Development Banks 26 857 4.3 1.6 Joint venture banks 24 53 4.2 2.8 Foreign banks 10 60 10.4 4.3 145 6,765 103.0 34.5 0.6 0.4 Total commercial banks Rural credit banks 50 BPR Bank Perkreditan Rakyat 2,358 BKD Badan Kredit Desa 5,345 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). 49 50 86 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 scarce. 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$5 55) short-term (three months) multi-purpose loans for about one million people in rural areas. They are regarded as banks and supervised by BRI on behalf of BI. BRI extends loans for the operation of a number of viable BKDs. 87 The Challenge of Sustainable Outreach Table 4 Financial Sector Assessment 1999 2000 2001 No. of private financial institutions (commercial banks) *) 132 120 114 No. of public financial institutions (commercial banks) *)+) 32 31 31 142.1 107.5 103.6 Assets of a l l banks (US$bn) **) Assets of p r i v a t e banks 53% Assets of p u b l i c banks 47% Lending interest rate in % (12 mth working capital, commercial banks) 20.7% 17.7% 19.2% Deposit rates (3 mth demand deposits) in % (BI Certificates, SBI) 12.8% 14.3% 17.6% *) 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. 3.2.3 Non-bank financial institutions The table below informs about prominent non-bank financial institutions. Table 5 Type 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 88 Assets (US$m) 640 574 3,000 6,200 30,700 150 600 300 Case Study: Bank Rakyat Indonesia, Indonesia 3.3 PT Bank Rakyat Indonesia (Persero)51 Literally “People’s Bank of Indonesia”, abbreviated “Bank BRI” or “BRI”, the country’s third largest state bank is also the fourth largest commercial bank. In addition to a common branch and sub-branch system BRI operates nationwide the “BRI Unit” system, the bank’s “Micro Banking” arm with separate outlets and products. The Unit system is managed by BRI’s Micro Business Division. BRI Units use the same company logogram but the public can differ between the modest Unit premises and more generous branch offices. The following tries to describe both, the entire BRI organization and the Unit system that made BRI known worldwide. 51 BRI was established based on a government act. Since 1992, BRI is a shareholder company (“Persero”) based on the Act 1/1995 on Perseroan Terbatas (PT, or Limited Liability Corporations) with 100 percent of its shares still owned by the state. This opened BRI more opportunities to expand in the large-scale and business sector. 89 The Challenge of Sustainable Outreach BRI Organisation Chart Shareholder Assembly Audit Committee Commissioners President Director Director Micro and Retail Business Division Micro Business (BRI Unit) Division Retail Business Director Medium-scale -, General -, and Agribusiness Division Agribusiness Division General Business Division Program loans (channeling) Four other directors Internal Audit Loan portfolio 946 Deposits 2,115 1,338 940 3,439 715 (In US$m) BRI Network 2001 {Dec. 2002} Head Office 11 Inspection Offices ----- ----------- ----------Micro Division, Monitoring 3,823 {3,902} BRI Unit Offices 240 {na} Village Service Posts 90 12 {15} Regional Offices New York Hong Kong 323 {320} Branch Offices 64 Sub Branch Offices Case Study: Bank Rakyat Indonesia, Indonesia 3.3.1 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 programs. 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$1,000), a test field for the successful “Kupedes53” loan scheme. BRI participated and still participates in the channeling and administration of program or project based loans, in particular those related to rural areas, agriculture and fishery. Starting in the mid-70s and until 1990, BRI, along with other state and private banks, offered KIK/KMKP, a long term investment and permanent working capital scheme for SMEs. In 1989 BRI introduced the Unit system to cities, including Jakarta, and abandoned the word Desa (“village”). Now, even the word “Unit” disappears from the billboards. 52 53 The Unit Desa, established based on a Presidential Decree, operated as a window to the BRI branch. They did not maintain complete financial statements. The loan products carried a 12% interest rate, well below the inflation rate in a number of years and also below the deposit interest rate (15%) (from: www.cgap.org/html/p_focus_notes10.html). For details see chapter 2.6.7. 91 The Challenge of Sustainable Outreach Table 6 Bank Rakyat Indonesia (consolidated) Balance Sheet (adapted) Liquid assets 1999 2000 2001 US$m US$m US$m 1,004 1,038 1,355 0 2,952 2,616 3,168 2,528 2,843 98 79 79 Other assets 108 316 433 Total Assets 4,378 6,913 7,326 Savings 2,586 2,367 2,551 Time Deposits 2,548 2,180 2,574 Borrowings 1,362 456 470 Other liabilities (incl. demand deposits) 1,532 1,486 1,266 Total Liabilities 8,028 6,489 6,861 244 180 166 -3,977 -2,811 -2,508 0 0 0 83 3,055 2,807 -3,650 424 465 4,378 6,913 7,326 Investments (government recapitalization bonds) Net loans outstanding (loans ./. loan loss reserve) Net fixed assets Paid-up capital Retained earnings Reserves 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$3bn) (see shaded figures in table 6 above). In 2000, a new management took over and declared discarding the corporate market and focusing on the micro, retail, and SME market. In 2001, international rating agencies considered BRI a better risk than the country risk (BBB versus C). 92 Case Study: Bank Rakyat Indonesia, Indonesia Today, BRI employs about 38,000 people, some 31,000 fixed, in about 4,400 locations. The BRI Unit system accounts for about one third of the assets but two thirds of the employment. The unrivalled outreach through its more than 4,000 outlets and with more than 28 million savings accounts and some 3 million loan accounts makes BRI’s Micro Division Indonesia’s “bank” with the highest number of clients. The table below is an attempt to establish a balance sheet for a separate BRI Unit system. Not all Units mobilize more funds than required for their lending operation. Some Units borrow funds from the branch system. All profits of the Unit system are used to cover deficits of the branch system so that no funds are available for reserves. Table 7 BRI U n i t System 1999 2000 2001 US$m US$m US$m 193 159 169 Investments (placements with BRI branch system) 1,719 1,356 1,361 Net loans outstanding (loans - loan loss reserve) *) 807 759 885 Net fixed assets (less than 1% of total assets) 27 21 21 Other assets 87 70 75 Total Assets 2,832 2,366 2,511 Savings *) 1,835 1,673 1,802 Deposits *) 573 319 313 Borrowings (received intrabank placements: 15% of loans) 121 114 133 44 53 53 2,573 2,159 2,307 92 85 98 167 121 112 - - - 259 206 210 2,832 2,366 2,511 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$. 93 The Challenge of Sustainable Outreach 3.3.2 Ownership and Governance 3.3.2.1 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 BRI); 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 stake-holders. 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 agribusiness. • To be one of the best go public banks. • To do good corporate governance consistently. Source: www.bri.co.id 94 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 operations protected some 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. 3.3.2.2 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$5,50054) and strict operating procedures kept certain high risk borrowers, including local politicians, away. Superiors encouraged Unit managers to perform cautious and prudent lending. The state, represented by the MoF as the only shareholder and the State Minister for State Owned Enterprises55 (SOE) as the supervisor, employs BRI’s management and defines the general business policy. The government had to appoint a new management for BRI to meet the prerequisite of the bank’s recapitalization process as laid down in a Letter of Intent with the International Monetary Fund (IMF). In July 2000 a new board of commissioners and board of directors commenced their assignments. Four persons form BRI’s Board of Commissioners. The Indonesian President proposed the board’s president but the candidate did not pass BI’s fit and proper test. The President Commissioner appointed by the MoF, a former University President, resigned after one year without replacement.56 The three commissioners have in common that they studied in USA and attended various (non-formal) professional development programs abroad. One of them worked 31 years with the 54 55 56 The US$-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 graduated. 95 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. 3.3.2.3 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. 57 58 96 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. 3.3.2.4 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 59 Other state banks added also Audit Committees to their organization chart. 97 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 alone. 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 microfinance. 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 60 61 98 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. 3.3.3 Economic viability 3.3.3.1 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$178m (RoA about 3% - 6%) for the years 1993-2001. Without these profits BRI would have had to report losses in every one of the past nine years.62 With other words, BRI’s branches produced continuously losses. BRI’s Unit system provided constantly profits, also throughout the economic crisis. In 1998, BRI had to offer high interest rates for deposits. The interest payments exceeded interest income, the main reason for the loss. BRI could more than halve its administrative costs in two years. Interest on investments (including from government bonds) doubled in 2001 whereas interest revenues from loans increased only in line with a cautious expansion of the loan portfolio. Higher interest rates for time deposits in 2001 are reflected in higher costs. Personnel costs decreased compared to 1999 and 2000 when allocations were made for pensions and severance payments. For more details see the table below (8). 62 It could be that BRI’s branch system generated already small profits in 2001 and most probably in 2002. 99 The Challenge of Sustainable Outreach Table 8 BRI (consolidated) 1999 2000 2001 Profit & Loss Account US$m US$m US$m Interest on investments 1.189 193 400 581 632 156 91 132 Total Income 1.345 865 1.164 Interest expenses (and other financing charges) 1.339 497 574 Administrative costs 608 353 280 thereof personnel expenses 253 258 189 0 -60 85 -361 39 114 5 1 2 1.591 830 1.055 Net Profit/Loss (before tax, minority interest) -246 35 109 BRI (consolidated) 1999 2000 2001 Interest on loans Other operating income (and non-op. income) (Loan) Earning assets loss provision Other operational costs (incl. gain/ losses from sale/change in value of securities) 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. 100 Case Study: Bank Rakyat Indonesia, Indonesia Table 9 BRI Unit system 1999 2000 2001 US$m US$m US$m Interest on (intrabank) investments/placements 436 148 196 Interest on loans (2001: 33% p.a.) 280 244 262 - - - Total Income 716 392 457 Interest expenses (and other financing charges) (2001: 10% - 14%) 391 152 212 Administrative costs (about 6% of earning assets) 152 117 127 89 77 92 Loan loss provision (difference to previous year) 6 3 7 Other operational costs - - - Non-operational costs - - - Total Expenses 549 271 345 Net Profit/Loss (before tax, minority interest) 167 121 112 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. 63 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. 101 The Challenge of Sustainable Outreach 3.3.3.2 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. 64 65 102 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$0.11) monthly administration fee aiming at increasing fee based income. This compares with fees of IDR3,000 or more charged by dominant banks for savings accounts with ATM access. Case Study: Bank Rakyat Indonesia, Indonesia BRI’s deposit interest rates p.a. in October 2002 are as follows: Table 10 Balance 0 (IDR’000 / US$) 10 25 50 1.000 2.000 50,000 >50,000 >100,000 1 2.5 5 110 220 5,500 >5,500 >11,000 Product IDR demand deposits Tabanasbri 10% 5% 5% 5% 10% 10% 10% 10% 10% 10% 10% Simpedes 6% 6% 8% 8% 9.5% 9.5% 9.5% Simaskot 7% 7% 9% 9% 11% 11% 11% 7% 7% 9% 9% 11% 11% 12,75% 12,75% 12,75% 13.5% BritAma Time deposit 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$800) applies. For more details see section 3.3.6. Table 11 Interest rates and deposit balances at BRI Units Year Savings Time deposits Comments 1997 7,633 1,203 Pre-crisis interest rates 1998 9,822 6,234 savings earn about 20%, time dep. more than 50% 1999 13,001 4,060 time deposit rates below 40% and decreasing 3,062 savings earn about 8%, time deposits about 11% 2,936 time deposits earn 15%, balance down 4%, but total industry +17%! 2000 16,053 2001 18,738 figures in IDR bn The interest rates for time deposits are frequently adjusted according to the development in the money market and the demand for BRI’s branch system. Interest rates climbed to 15% and attracted 17% more time deposits in 2001, exactly in line with the industry. Normally, time deposit interest rates exceed inflation rates. Regarding BRI’s Units, the rise and fall of interest rates for time deposits from 1997 until 2000 is directly reflected in the fluctuation of the amount kept in term accounts. For some months during 1998, interest rates exceeded 50% p.a., when 20% were earned on savings accounts and the inflation rate 103 The Challenge of Sustainable Outreach was 77%. A 4% interest rate increase for time deposits in 2002 did not draw new deposits unlike for the branch system. The amount placed in savings accounts grows steadily (see table above), roughly in line with inflation. Loan interest rates In 2001, BRI could realize 21% interest income on the average loan portfolio. BRI’s branch system realizes an average interest income of about 16% (see table below) as a mix of commercial lDR loans (19-24%), US$ 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 BRI BRI BRI (in IDRbn) total 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., Average 29,363 8,613 20,749 outstanding such as those offered by cooperatives or applied by Average interest 21% 31% 16% rate savings and credit groups: loan *) IDR1,000,000 and 12 estimated 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 66 104 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. 3.3.3.3 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 67 68 69 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. 105 The Challenge of Sustainable Outreach were mostly from 16% to 24% whereas for savings and time deposits about 8% to 15% were paid. 3.3.3.4 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) Year Loans 2000 2001 2,819.9 3,223.9 Write-off 243.2 61.7 - in % of loans 8.6% 1.9% Recovery 57.5 55.3 - in % of write-off 24% 90% 164% 51% - 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 Restructuring Agency 70 Loan recovery (IBRA) . became the task of another organization with a different policy. The table on 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 3.3.6.7). 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. 70 106 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$m) no repeat loan for frequently repayments, Total Current Cur. in % delayed Type loans loans of Total persuasion and enforcement Micro business according to local conditions, 946.3 924.1 97.7% (Kupedes/Unit) i.e. through the family or Retail village elders in rural areas 1,337.8 1,282.7 95.9% business and through sale of collateral Medium, in those cases that are corporate 939.8 252.0 26.8% promising and allow doing so. business BRI’s loan recovery performance improved as can be seen from the table below: Table 15 BRI: Loan Recovery Performance 1999 2000 2001 Loans in arrears (in US$m) na 727 660 Loans in arrears (number of loans) na na na 25.80% 20.50% 8.62% 1.91% Portfolio at risk (= non-current) Loan Loss Ratio 0 The following figures for the BRI Unit system reflect their superior performance. 71 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). 107 The Challenge of Sustainable Outreach Table 16 BRI Unit: Loan Recovery Performance 1999 2000 2001 26 22 22 75,455 68,162 60,826 3.05% 2.71% 2.33% 1.43 1.45 0.18% 0.15% Loans in arrears (in US$m) Loans in arrears (number of loans) 72 Portfolio at risk (collectibility 2-5 ) Loans written off (in US$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 Collectibility 1: General reserve Special reserve: 2: Special mention 3: Substandard 4: Doubtful 5: Loss *) BRI Branch BRI Unit loans (Kupedes) Definition for Kupedes installment loan 1% 3% 5% 25% overdue installment, loan not yet due 50% overdue up to 3 months after due date 100% overdue 3 to 9 months after due date 100% overdue more than 9 month after due date 15%*) 50% *) 100% *) net of deductible collateral; NPL = collectibility 3, 4, 5 72 108 For the loan classification, refer to the following table. Case Study: Bank Rakyat Indonesia, Indonesia Table 18 fBRI Unit (“Kupedes”) loans (US$m) Collectibility Reserve Current 2000 2001 3% 794.6 924.1 Special mention 25% 12.0 12.4 Substandard 50% 4.0 3.8 100% 4.3 4.1 Doubtful The necessary loan loss provision (according to above definition) amounts to 4.1% of the outstanding amount at BRI Units (see table left). This amount is almost twice compared to loans at risk (2.3%). For comparison, reserves for bad debt total more than Total 816.6 946.3 10% of BRI’s entire Loans at risk 2.7% 2.3% outstanding loan amount in Reserve requirement 34.9 38.6 2000 and also in 2001, despite IBRA already - in % of Total 4.3% 4.1% taking over bad corporate debt (compare table 9: loan loss provision; and table 6: balance sheet). This stresses again the superior Kupedes loan quality. Loss 100% 1.8 1.8 3.3.3.5 Efficiency improvements The financial crisis with abrupt changes of exchange rates, inflation, and business activity makes an analysis of actual efficiency improvement (versus idle capacity) almost impossible although certain ratios indicate that improvements may have taken place. For example, from 1999 to 2001, expenditures for overheads decreased if measured by local currency, by US$, or as a percentage of assets (see table below). Table 19: Overhead expenses (personnel, general and administrative costs) Overheads Year Assets IDR tn IDR tn % of assets US$m 1998 34.0 2.24 6,6% 224 77,6% 1999 30.5 4.38 14,4% 558 2.0% 2000 65.7 3.35 5,1% 398 9.4% 2001 75.7 2.97 3,9% 290 12.6% Inflation US$ 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. 109 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 incidences. 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. 73 74 110 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 92%. 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 1997 2000 2001 527 534 533 202,926 160,521 185,056 4,220 6,181 6,344 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$100m in communication hardware and software for the establishment of an on-time on-line system linking 75 For example, one Unit with 6 staffs, 750 borrowers and 8,000 savers might be split into two units with 8 staffs (minimum). A Unit manager has more incentives to pick only the borrowers with lowest risks than to expand the Unit’s business. His income is higher if he manages 500 loans with 99% collectibility rather than a small post split Unit with 375 loans with 97% collectibility. This may also be a reason for the Unit system expanding very slowly. 111 The Challenge of Sustainable Outreach all Units with branches and head quarters. This will give Unit managers access to SME Information centers that the bank is setting up, on-time online connections and ATM. 3.3.3.6 Sources of funds BRI is financed as follows (2001): Table 21 % of bal. sheet Source of funds US$bn Current deposits 0.72 Savings deposits 2.55 34.8% 9%-11% Time deposits 2.28 31.1% 12.5%-18.4%; 87.5% due within one month 0.29 13.5%-14,75% for IDR deposit certificates LIBOR + 1.2% for foreign currency deposit 4.0% cert. 8%-28% for inter bank call money Fund borrowings 0.48 0% for construction of certain BRI Unit offices 6.6% 3%-16% for BI liquidity loans to be re-loaned 22%-24% for capital lease (vehicles, computers) Others (various allowances) 0.53 7.2% Equity 2.96 40.4% Deficit -2.50 - 34.2% Deposits from banks Net equity 0.46 Total 7.32 Interest rates for funds or other costs 9.9% 5% Mostly no cost (i.e. short-term liabilities and allowances) 0,55% dividend paid for 2000 on paid-in equity 6.2% 9.7% dividend paid for 2000 on net equity 100.0% 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 76 112 Government decentralization decreased central budgets and increased district budgets. Districts keep these funds with Regional Development Banks because they are shareholders. 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 Year 1998 1999 2000 2001 Ratio: Third party funds/ assets 125% 133% 74% 76% 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) Type US$m Interest rate or other costs n.a. [<2%] BRI Units do not offer current account facilities to the general public 1,802 71.8% 8%-9%, + about 1% for prizes Time deposits 313 12.5% 11% - 14.5% Other liabilities 187 7.7% e.g., for on-time repayment incentive 98 3.9% about 10% on loans and fixed assets 112 4.2% 2,511 100.0% Current accounts Savings Equity Retained profit Total 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). 3.3.3.7 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. 113 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 quality.78 77 78 114 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 extension. 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 115 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 1999 Equity/liabilities in % CAR in % Loan to Deposit Ratio in % 2000 2001 -45.5 6.5 6.8 -118.35 14.35 13.32 62.3 53.6 56.1 -4.77 0.68 1.62 average equity negative 30.36 Performance RoAA in %79 RoAE in % Efficiency Number of active borrowers / loan officers Value of loans outstanding/loan officers (US$) 445 471 480 617.608 435.593 494.318 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. 79 116 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) 1999 2000 2001 10.1 9.5 8.8 Third party deposits / liabilities in % 94 92 92 Capital adequacy in % (Capital + 50% profits) / (net loans and other risk assets) 19 17 15 RoAA in % 6.1 5.4 4.8 RoAE in % 202 159 127 Equity / liabilities in % Performance 3.3.4 Decentralization 3.3.4.1 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 1998 Number of branches Number of sub-branches 1999 171 322 322 50 146 44 64 3,694 3,724 3,823 394 286 240 4,405 4,377 4,450 3,238 3,135 3,145 47,657 47,449 29,957 30,935 17,997 18,426 18,809 6,340 6,474 6,522 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) 2001 323 Number of BRI Units Number of “permanent” staff (“non-permanent” supporting staff: about 7,000) 2000 Total 1997: >44,000 in particular remote areas > 80 km 117 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 4000 branches and they became subService branches. This decision was revised in 3000 Posts 2000 (see table). Services for branch clients (and eventually for Unit clients) 2000 are also rendered through own ATM Units 1000 and an ATM network. Since 2001, BRI (urban) (urban) offers also telephone banking services. 0 The costs of electronic decentralization 1984 1994 2001 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), 80 118 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. 3.3.4.2 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. 81 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 network. 119 The Challenge of Sustainable Outreach 3.3.4.3 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. 3.3.4.4 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 profitable.82 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 82 120 In Indonesia, mobile banking is normally not profitable, if a bank would fulfill all regulations. 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 banking). 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 added. The market is saturated and opening new Units would only result in cannibalising in the business of those Units in the neighbourhood. 83 84 85 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. 121 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. 3.3.5 Good Management 3.3.5.1 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 86 87 88 122 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 27%. 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 3.3.2.3). 89 90 91 92 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. 123 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 account all current technological advancements. The 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. 3.3.5.2 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. 124 Case Study: Bank Rakyat Indonesia, Indonesia Table 27: Structure of staff expenses (BRI 2001) Item Salaries, wages, allowances US$m Share US$ p.a./ employee 106.0 61.0% 3,534 Bonuses, incentives 39.0 22.4% 1,301 Pension costs 13.2 7.6% 440 Medical allowances 6.0 3.4% 199 Gratuity benefits 5.3 3.1% 177 Training 4.3 2.5% 144 173.8 100.0% 5,795 Total 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 Units. The Unit manager and the Unit staff receive an annual profit-related bonus. They thus have an interest in loan performance. They earn 10% of the Unit’s profits, capped at 1.5 times of their monthly salary. The debtor receives 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. 93 94 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. 125 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. 3.3.5.3 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. 95 96 126 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 3.3.5.4 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 3.3.4.1, 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. 97 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. 127 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 expenditures. 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. 3.3.5.5 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’ premises. 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. 128 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. 3.3.6 Customer Orientation 3.3.6.1 Products BRI offers 29 products. The following is an overview reflecting their importance. Table 28: Overview of products Type No. Name, sub-type, characteristics Demand deposits 1 Giro, current or cheque account Savings 5 Simpedes, the savings product of BRI Units Loans Others 3 13 7 723 share 100% 1,526 60% BritAma and Tabanasbri, ATM access 767 30% Simaskot, offered also in urban BRI Units 249 10% 8 0% Pilgrim savings account, no interest but presents Deposits US$m On-call, time deposits, deposit on call 2,280 00% - of which 1-month time deposits 1,888 83% - of which deposits in foreign currency 235 10% Kupedes, BRI Unit’s micro loans 946 29% Working capital loans 892 28% Consumption loans 745 23% Other loans, incl. government program loans 626 20% 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. 129 The Challenge of Sustainable Outreach Table 29 BRI: Products and Services BRI total BRI Unit Number of loan products 13 1 Number of savings products (5) and other deposits (4) 9 3 Number of other financial services 7 2 The following provides details on some of the products. For more information on interest rates compare also section 3.3.3.2. 3.3.6.2 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. 3.3.6.3 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% 98 99 130 Regulations on public administration require government agencies to have demand deposits. Savings accounts are only for individuals, including owners of non-corporate SMEs. 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$190) recorded in 1997.100 Higher interest rates for higher balances did obviously not motivate account holders to increase the balance. Nevertheless, Simpedes remained the most popular savings deposit product in Indonesia because BRI as a state bank offers the by far safest heaven for savings, and BRI offers an additionality, an “opportunity”, “dream”, or “hope”, namely to win one of the major lucky draw prizes in a country where lotteries are prohibited. The following are details on the development of savings deposits at BRI Units: Table 30 Number of savings accounts at BRI Units (million) Year Simpedes Tabanas, Simaskot Total Growth 1995 8.90 5.49 14.39 million % 1996 10.10 5.94 16.04 1.65 11% 1997 11.67 6.34 18.01 1.97 12% 1998 13.88 6.95 20.83 2.82 16% 1999 15.79 7.94 23.73 2.90 14% 2000 17.60 7.93 25.53 1.80 8% After almost 20 years BRI Units can still expand the number of savings account holders although since 1998, the growth rate decreases constantly and became single-digit for the first time. The market in the vicinity of the Units shows perhaps signs of saturation. The average balance of Tabanas accounts was 2001 24.20 2.57 26.77 1.24 5% traditionally less than half of those on Simpedes accounts. “Regarding to the focused and efficient strategy of BRI”101, the product Tabanas was discontinued and the balance transferred to Simpedes and Simaskot accounts. 100 101 Taking the US$ 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. 131 The Challenge of Sustainable Outreach 3.3.6.4 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. 3.3.6.5 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. 3.3.6.6 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 3.3.3.2). 3.3.6.7 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 132 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 3.3.3.2). 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). Age Borrowers Therefore, it makes sense that the loan comes -39 13.4% together with a “free” life insurance that covers the 40-49 39.5% outstanding amount. The customer is also not 50-59 26.1% charged with provisions or administration costs that >60 21.0% 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. 102 103 Figures based on a survey; see: BRI micro banking services..., p. 22. Women’s World Banking, www.swwb.org. 133 The Challenge of Sustainable Outreach 3.3.6.8 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. 3.3.6.9 Services BRI offers a full scope of modern banking products from telephone banking and foreign trade support facilities to a full range of custodial operations. 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). 3.3.6.10 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 published.106 104 105 106 134 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. 3.3.6.11 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$78). Table 32 Loan Portfolio BRI (consolidated) 2001 1999 2000 2001 2,821 3,052 3,133 2,425 2,662 2,734 of which are rural (000's) (estimated) 1,818 1,996 2,051 1,818 1,996 2,051 Number of accounts (000's) (estimated) 2,939 3,179 3,264 2,474 2,716 2,790 Outstanding gross portfolio in US$m 3,916 2,820 3,224 841 816 949 Average loan balance in US$ 1,332 887 988 340 300 340 Average outstanding loan size/per capita income in % 195.6 122.1 143.5 50 41 49 Number of active borrowers (000's) (assuming 96% x loan accounts) Average loan processing time (depending on type of loan and others) 1999 2000 BRI Unit system from less than one week to more than one month % of rural population served first time borrower: about 3 weeks, repeater: < 1 week 1.5 1.6 1.6 Market share in rural lending (amount, based on assets) . >60% % of rural borrowers served by financial institutions nationwide >35% 135 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$0.5m for Units. This allows the conclusion that BRI is the bank of small people not only in rural but also in urban areas. Table 33 Savings Portfolio BRI (consolidated) BRI Unit system 1999 2000 2001 1999 2000 2001 23,834 27,272 28,444 21,812 23,241 24,341 17,450 18,593 19,472 17,450 18,593 19,472 26,482 30,303 31,604 24,236 25,823 27,045 2,586 2,367 2,551 2,408 1,992 2,115 Average deposit balance in US$ 97.7 78.1 80.7 99 77 78 Average deposit balance/per capita income in % 14.3 10.8 11.7 14.6 10.6 11.4 % of rural population served (‘000) 14.1 14.9 15.6 (21,812) (23,241) (24,341) Market share in rural deposits >80% >80% >80% (17,450) (18,593) (19,472) % of rural savers served by financial institutions nationwide >65% >65% >65% No. of of active savers (000's): assumption: Savings accts x 90%) 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 3.3.6.11 24,236 25,823 27,045 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. 136 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 107 108 109 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 accounts. 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. 137 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. 3.4 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 lines: 110 138 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: www.ADBTASME.or.id). 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. 111 112 113 114 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 obstacles: 139 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 services. 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 products. The profit center approach is coupled with an internal MIS that allows self-monitoring that simultaneously motivates and warns Unit managers. Successful positive incentive systems are in place for superiors, Unit managers and their staff, as well as for clients. - 140 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 living); no system exists for binding collateral; legal enforcement would be non-existent, collateral could not be seized; no loans are allowed for civil servants and pensioners with automatic deduction from the payroll, and/or salaries are transferred in cash and irregularly; 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 141 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$). Some of the Unit’s larger loan or deposit clients might look for an alternative bank if they cannot directly communicate and negotiate with the decision maker. BNI, a state bank with focus on manufacture, tries to capture a share of the profitable rural market for financial services. The bank started in 2002 with opening some 60 rural sub-branch offices. 142 Case Study: Bank Rakyat Indonesia, Indonesia 3.5 Annexes Annex 1 The financial crisis The Asian crisis started with pressure on the Thai currency in 1997. In Indonesia, the speculative boom in the construction industry prompted BI in July 1997 to order that banks stop extending more loans in this sector. This was the start of a traumatic financial crisis. In August 1997, BI abandoned the currency band. A 30% devaluation raised concern about the repayment capacity of enterprises that obtained low interest short term US$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$of this aid remained unaccounted for.) Auditors passed a non-opinion verdict on BI and its governor was imprisoned several months for involvement in a banking scandal but meanwhile, he resumed his duty. Bank balance sheets showed negative equity, interest payments exceeded income. In 1999, another 38 banks were closed. The government offered a bank equity recapitalization scheme that allowed bank owners with 20% participation to repurchase a simultaneous public 80% equity injection within three years. This offer met no response. Finally, the government issued bonds that replaced bad loans and reinstated equity. The loans were transferred to the Indonesian Banking Restructuring Agency (IBRA). It is IBRA’s mission to recover loans and liquidate related, mostly insufficient, collateral. The proceeds, and tax income, shall enable the government to pay interest In order to keep the banking system afloat for the bonds and eventually repurchase the government gave a blanket guarantee them. Bailing out the banks will burden a for deposits. At the same time, forest fires generation. and draught affected agricultural The IDR became the strongest currency with production and prices soared. The inflation about 100% gain (decline to 7,000) against rate, typically hovering below 10% p.a., the US$. 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. 143 The Challenge of Sustainable Outreach Annex 2 Major reforms in the Indonesian banking system 1983 1988 1989 1990 1991 1992 1993 1995 1996 1997 1998 1999 2000 2001 2002 144 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. 145 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 Volume IDRbn Volume US$m KUT (seasonal small farm credit) BRI (state bank) 8,000 720 5,500 500 2,900 260 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) 146 Case Study: Bank Rakyat Indonesia, Indonesia Annex 4 Characteristics of selected commercial banks a) Characteristics of state banks Assets US$bn Rank Name Characteristics 1 Bank Mandiri Merger of four bankrupt state banks: Bank Export Import, Bank Dagang Negara, Bank Bumi Daya, Bank Pembangunan Indonesia; 25.2 2 BNI Went public in 1996 and was even listed at the New York Stock Exchange; following recapitalization, the government’s share increased from about 75% to more than 99%; 12.4 4 BRI The state bank for agriculture and micro finance covering rural areas; most extensive network: more than 4,400 outlets all over the country; 7.3 7 BTN Bank Tabungan Negara, Special savings bank for housing loans; 2.5 19 BEI Special bank founded in 1999 to support export financing; 1.1 Total 5 banks 48.5 Others 140 banks 54.5 Total Indonesia 145 banks 103.0 (based on InfoBank 7/2002, figures per December 2001, exchange rate 10,400) b) Indonesia’s largest private commercial banks (2001) Rank 3 Assets US$bn Name Type, characteristics BCA TO (taken over by government), a substantial part was already sold to investors 9.9 TO, merging with other banks, 71% for sale 5.1 Negative equity, under BI surveillance 3.0 6 Bank Danamon BII 8 Citibank Foreign 2.5 9 Bank Panin National 2.3 10 Bank Niaga Government TO, to be sold in 2002 2.2 5 (Rank 1, 2, 4, and 7 are state banks, see above) (based on InfoBank 7/2002, figures per December 2001, exchange rate 10,400) 147 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%. 148 Case Study: Bank Rakyat Indonesia, Indonesia 3.6 References 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, Rome. 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. 149 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, Paper. 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. 2000. 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 2001. The Economist Intelligence Unit Ltd. (2002): Country Risk Service May 2002. 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 www.bri.co.id www.swwb.orf/English/1000/Address/gnbi/add_gnbi_rakyat.htm www.org/waicent/faoinfo/agricult/ags/AGSM/banks/indonbri.htm www.org/assets/images/bri.pdf www.harvard.edu/cbg/asia/research.htm 150 Case Study: Agricultural Development Bank, Nepal 4. Case Study: Agricultural Development Bank, Nepal Marc Oliver Jünemann, Ulrich Wehnert, in cooperation with Jalan Kumar Sharma 4.1 Introduction 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 115 UNDP (2002). 151 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. 4.2 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.116 116 152 For an overview, see Table A1 in the annex. Case Study: Agricultural Development Bank, Nepal 4.2.1 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 standards. 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. 153 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 microfinance. 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. 4.2.2 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 117 118 154 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 Kathmandu. 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 155 The Challenge of Sustainable Outreach financial services to their members in rural and very remote areas of the country. 4.2.3 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 donations; 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 2002.120 119 120 156 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. 4.3 The Agricultural Development Bank of Nepal 4.3.1 Background 4.3.1.1 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 accordingly.121 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; 121 For a more detailed elaboration of this topic, see section 2.5.1. 157 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) Description Amount Total Assets 435.52 Loan Portfolio 290.60 - Developing Banking 200.00 - Microfinance (SFDP) 12.05 - Commercial Banking 77.56 Shareholder Funds 23.51 Borrowings 68.98 Public Deposits 241.01 Outreach - Number of Creditors 430,000 - Number of Depositors 800,000 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. 4.3.1.2 Operational Areas of the Bank (1) Development Banking 122 158 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 159 The Challenge of Sustainable Outreach loans, guarantee and remittance services are provided to a limited extent. 4.3.2 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. 4.3.2.1 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, shareholders, one representative from the Ministry of Food/Agriculture and Irrigation, 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 160 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. 4.3.2.2 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 well: Banks are required to have a 12% Capital Ratio of risk-weighted assets. 123 124 See ADBN Act, Article 15. World Bank (2002), p. 63; at present, another NRB inspection of ADBN is underway. 161 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 Divisions. 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 162 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. 4.3.2.2 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. 4.3.3 Economic Viability 4.3.3.1 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$435 million). This increase was mainly due to an increase in agricultural loans funded by a substantial growth in deposits. Since around 90% of all deposits are generated in urban areas, and 70% in Kathmandu alone, ADBN is shifting a large part of its financial resources from urban areas to rural regions. The following chart gives an overview of some essential balance sheet developments over the last decade. 163 The Challenge of Sustainable Outreach Figure 1 B alan ce Sh eet D evelo pm en t 3 50 00 3 00 00 To ta l A s s et s De p os its Nrs mio. 2 50 00 B o rro wing 2 00 00 Ca p ita l 1 50 00 To ta l L o an P ortfo lio 1 00 00 - Ag ricu lt ural L oa n s 50 00 - Co m m ercia l Lo a ns 0 91 World 1 99 3Bank 19 9 5 Source: ADBN 19 and 1 9 97 1 99 9 20 0 1 Capital Adequacy After a severe shortage in equity at the beginning of the nineties, ADBN's capital ratio came down to 4.9%. Despite a substantial increase of capital by several hundred percentage points in the following years,125 the capital increments could not keep up with the significant increase in total assets. The state as owner of the bank did not provide the required means on the one hand, and the internal equity generation of ADBN was insufficient due to its low level of profitability, on the other. Hence, the equity position has worsened over recent years, standing at 5.4% in 2001. Table 2: Equity (US$million) 1991 1993 1995 1997 1999 2001 3.7 4.0 13.3 17.1 23.1 23.5 Total Assets 75.6 108.9 175.1 230.5 361.6 435.5 Equity Ratio 4.9 3.7 7.6 7.4 6.4 5.4 Capital Source: ADBN and World Bank 125 164 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 1998/1999 1 Overdue Loans /Loans Outstanding (1) 23.0 1999/2000 2000/2001 21.4 20.7 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$4 million) to compensate the bank for up to 75% of old and non-performing loans to cooperatives. The reluctant approach of ADBN towards cleaning up its balance sheet has resulted in a negative impact on liquidity and interest income. It puts the bank under pressure to provide costly funding for a growing share of assets which are not generating sufficient cash flow in the form of principal and interest payments. 165 The Challenge of Sustainable Outreach Profitability The bank has generated positive returns over the last 3 years, but profitability as measured by the return on average assets (ROAA) and average equity (ROAE) is still low. The major issue that needs to be addressed before profitability can be improved is a substantial reduction of administrative expenses, which currently account for 36% of total costs. Table 4: Profitability 1999 2000 2001 ROAA 0.2 0.3 0.3 ROAE 4.3 6.1 6.3 Source: ADBN Efficiency and Productivity Over the last three years staff productivity has improved. Table 5 indicates an increase of about 15% on the number of borrowers per loan officer between 2000 and 2001. Measured by the value of loans handled by each loan officer, the ratio has improved by about 13% over the same period. Table 5: Efficiency and Productivity 1999 2000 2001 Number of borrowers/loan officers and assistants 247 235 268 Value of loans outstanding/loan officers (In US$´000) 130 150 170 Source: ADBN 4.3.3.2 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. 166 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%. 4.3.3.3 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: 126 See section 2.6.1 for further details. 167 The Challenge of Sustainable Outreach Figure 2 S o u rc e s o f F u n d s 100% 80% E q u it y 60% B o rro w in g s 40% D e p o s it s 20% 0% 1991 1993 1995 1997 1999 2001 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. 127 168 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 (%) 8.5 9.3 9.1 8.4 7.7 Revenue Rate (%) 14.9 17 17 16.3 15.1 Interest Margin 6.4 7.7 7.9 7.9 7.4 Source: ADBN 4.3.3.4 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. 4.3.4 Decentralisation of Banking Operations 4.3.4.1 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. 128 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. 169 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. 129 170 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. 4.3.4.1 Outsourcing Microfinance Cooperatives Ltd. (I): The Small Farmer 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 farmers.131 130 131 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). 171 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 required.133 132 133 172 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 134 135 136 137 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 (2003). 173 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 SPOs transformed in the period Tentative No. of Estimated years of cost annual saving operating costs per SPO (in USD) Total Savings in operating costs due to transformation process (in USD) 1993/94 4 8.5 2,900 98,600 1994/95 3 7.5 2,900 65,250 1995/96 4 6.5 2,900 75,400 1996/97 23 5.5 2,900 366,850 1997/98 23 4.5 2,900 300,150 1998/99 20 3.5 2,900 203,000 1999/00 7 2.5 2,900 50,750 2000/01 17 1.5 2,900 73,950 2001/02 6 0.5 2,900 8,700 2002/03 15 0 2,900 0 Total Source: GTZ/ADBN 174 1,242,650 Case Study: Agricultural Development Bank, Nepal 4.3.4.2 Outsourcing Microfinance (II): The Sana Kisan Bikas Bank 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 175 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. 4.3.4.3 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 176 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. 4.3.5 Bank Restructuring and Good Management 4.3.5.1 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 177 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 138 178 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. 179 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 1996/1997 2000/2001 2.5 4.7 Repayment Rate 53.9 73.5 Overdue Loans/Loans Outstanding 30.1 21.1 Share of Deposits of Funding 59.3 72.3 7.4 5.3 Total Assets (in NRs million) 17,266 32,141 Total Assets (in US$million) 230.5 435.5 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. 180 Case Study: Agricultural Development Bank, Nepal The introduction of a Transfer Pricing System (TPS).139 4.3.5.2 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 14 139 140 141 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. 181 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 employees Total training Total training No. of Total no. of expenses expenses per training days training days (thousand) employee per employee 1996/97 4,735 65.39 13.81 6,851 1.45 1997/98 4,697 189.13 40.27 8,232 1.75 1998/99 4,798 274.93 57.30 13,319 2.78 1999/00 4,957 87.24 17.60 13,789 2.78 2000/01 4,547 113.14 24.88 9,658 2.12 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 142 143 182 See Table A5 in the annex. Exceptions to this rule are only made for specific positions such as chartered accountants. 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 employees. 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 leaders. 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; 144 145 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). 183 The Challenge of Sustainable Outreach Periodical reviews and interaction on the major issues of the reform programme. 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. 4.3.5.3 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 abroad. 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. 4.3.5.4 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. 184 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. 4.3.5.5 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 146 About 73% of ADBN transactions are computerised. 185 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. 4.3.6 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.147 147 186 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% 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 4.3.6.1 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 facilities; 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. 187 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 148 149 150 188 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. 4.3.6.2 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 maintained. 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. 4.3.6.3 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 151 Real interest rates are positive due to a low inflation level of 2.4% in 2001. 189 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. 4.3.6.4 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. 4.4 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 190 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 191 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 activities. 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. 192 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. 152 Nurkse, R. (1966): Problems of Capital Formation in Underdeveloped Countries (reprinted), first publication 1953, Oxford. 193 The Challenge of Sustainable Outreach 4.5 Annexes Table A1: Consolidated Financial Assets July 2001 Banks US$million % Nepal Rastra Bank 1,524.52 27.5 Commercial banks 3,020.03 54.5 Development banks (ADBN, NIDC) 418.50 7.5 Provident Fund 280.35 5.1 Finance Companies 211.09 3.8 Others (see breakdown below) 88.61 1.6 Regional Rural Development Banks 26.66 0.5 Other development banks 34.71 0.6 0.21 0.003 27.04 0.5 Microfinance NGOs Cooperatives 5,543.09 Total Sources: Calculations of World Bank (2002) based on Nepal Rastra Bank Exchange rate 1 US$= 74,904 NRs Table A2: Capital Requirements for Commercial and Development Banks Types of Bank With Head Office in Kathmandu Valley With Head Office Outside Kathmandu Valley Authorised Capital Paid-up Capital Authorised Capital Paid-up Capital Commercial Banks NRs 1 billion NRs 500 million NRs 500 million NRs 250 million Development Banks NRs 640 million NRs 320 million NRs 20 million 100 million NRs 10 million 50 million Source: ADBN 194 Case Study: Agricultural Development Bank, Nepal Table A3: Level of Authority for Collateral and Loan Evaluation (in Thousands of NRs) Individual Board of Directors Deputy General Manager Group above 10,000 10,000 4,500 5,000 Section Chief 2,000 2,500 Section/Loan Officer 1,000 1,900 Main Branch Manager 3,000 3,500 Manager/Section Chief 1,500 1,800 Section/Loan Officer 800 1,000 Office/Loan Assistant 500 600 Manager 600 800 Office/Loan Assistant 400 500 300 500 Divisional Chief Level Supervision Office Main Branch/Branch Sub-Branch Depot Manager Source: ADBN, Loan Division 195 The Challenge of Sustainable Outreach Table A 3a: Level of Authority for Collateral and Loan Evaluation (in US$) Individual Board of Directors Group above Deputy General Manager 133,511 133,511 60,080 66,756 - - Section Chief 26,702 33,378 Section/Loan Officer 13,351 25,367 Main Branch/Branch - - Main Branch Manager 40,053 46,729 Manager/Section Chief 20,027 24,032 Section/Loan Officer 10,681 13,351 Office/Loan Assistant 6,676 8,011 - - Manager 8,011 10,681 Office/Loan Assistant 5,340 6,676 - - 4,005 6,676 Divisional Chief Level Supervision Office Sub-Branch Depot Manager Table A4: Training I Training Days 1998/99 1999/2000 2000/01 1996/97 1997/98 4,192 8,232 39,403 16,372 13,838 - - 4,669 2,583 4,180 4,192 8,232 34,734 13,789 9,658 Total training days for farmers 23,462 62,937 35,553 67,057 21,828 Total 27,654 71,169 74,956 83,429 35,666 Total training days for staff External Internal Source: ADBN 1. 2. 3. 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. 196 Case Study: Agricultural Development Bank, Nepal Table A5: Training II NRs Million 1996/97 1997/98 1998/99 1999/2000 2000/01 Training Exp. (source: ADBN) 4.90 14.17 20.59 6.53 8.47 Training Exp. (other sources) 6.80 7.50 3.34 6.62 5.51 11.70 21.67 23.93 13.15 13.98 Training Expenses Total 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 Deposits Number of Borrowers Number of Loan Account Development Banking 213,0 11,2 418001 515003 Commercial Banking 77,6 229,8 11592 11951 290,6 241,0 429593 527954 Total Source: ADBN 197 The Challenge of Sustainable Outreach Table A7 Maturities for Loan Products in Development Banking Production Credit 6 months to 1.5 yrs. Irrigation 3 to 5 yrs. Farm Mechanisation 3 to 5 yrs. Livestock and Fisheries 1 to 5 yrs. Agriculture and Cottage Industry 5 yrs. Marketing 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 Various Source: ADBN Table A8 Development Banking Tea Plantation Tea/Coffee Processing Housing & Land Development Cold Storage Horticulture Godown Cereal Crops Cash/Special Crops Irrigation Biogas & Energy Fishery Livestock Poultry Livestock (Other) Working Capital/Marketing Agri-tools Agro/Cottage Industries Source: ADBN 198 Interest Rate Structure in % 2001/2002 1999/2000 1998/99 10 13 12 12 12 13 15 14 15 15 15 15 16 15 16 16 12 14 12 12 14 13 15 15 15 15 15 16 16 15 16 16 12 12 12 12 14 14 15 15 15 15 15 16 16 16 16 16 1997/98 1996/97 14 14 15 14 14 14 15 16 16.5 16 17 17 17 17 17 16 15 15 16 15 15 15 16 17 17.5 17 18 18 18 18 18 17 Case Study: Agricultural Development Bank, Nepal Table A9: Conditions and Products in Commercial Banking 2001/2002 1999/2000 1998/99 1997/98 1996/97 Loans Overdrafts: Individuals 17 17 19 19 19 Overdrafts: Institutions 15.5 15.5 18 18 18 Demand Loans 15.5 15.5 17 17 17 Contract Loans 14.5 14.5 17 17 17 Business Loans 15.5 15.5 17 17 17 Hire Purchase 15 15 17 17 17 Industrial 14 14 16 16 16 Service 14 14 16 16 16 Hotel/Resorts 14 14 Business Complexes 15 15 Housing & Equipment 14 14 Educational Institutions 14 14 Health Clubs, Nursing Homes 14 14 Entertainment & Equipment 15 15 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% Deposits Savings 5.25 5.50 7.00 8.00 8.00 Up to 1 Year 6.50 7.25 8.50 9.50 9.50 Up to 2 Years 6.75 7.50 8.75 9.75 9.75 Up to 3 Years 6.75 7.50 9.00 10.00 10.00 Up to 5 Years 6.75 7.50 9.25 10.25 10.25 Fixed Source: ADBN 199 The Challenge of Sustainable Outreach Table A10: Agriculture Development Bank (Figures in NRs) Macro Sector Assessment GDP (billions) Population (millions) 1998/99 1999/2000 2000/01 342.04 379.52 410.19 22.37 22.80 23.20 Rural Population (%) 85.80 Income per Capita in US$ 220 220 Inflation in % 11.3 3.5 2.4 Exchange Rate (NRs to US$1) 67.9 69.1 73.8 45 49 52 Financial deepening (M2/GDP) in % Financial Sector Assessment 1998/99 1999/2000 No. of Financial Institutions (private) 2000/01 126 No. of Financial Institutions (public) 9 Assets of Private Financial Institutions (millions) 150,954 Assets of Public Financial Institutions (millions) 264,259 Lending Interest Rate (12 months) in % 7.5 - 19 7.5-18 7.0-18 Deposit Rates (3 month fixed deposits) in % 4.0 - 7.5 4.0 - 6.0 2.5 - 6.0 Decentralisation 1998/99 1999/2000 2000/01 Branch Network 659 640 592 - Development Banking 239 241 251 Main branches/branches 86 91 101 Sub-branches/Depots 153 150 150 - Small Farmer Development Programme units 385 357 294 35 42 47 Main branches/branches 23 26 27 Sub-branches/Depots 12 16 20 Population/branch outlets n.a. n.a. n.a. Number of staff 4,794 4,957 4,547 Number of loan officers 1,564 1,595 1,603 34,734 13,789 9,658 n.a. n.a. n.a. - Commercial Banking Number of staff training days Service radius (km to furthest customer) 200 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 1998/99 1999/2000 2000/01 13 8 13 9 13 10 2 3 3 1 3 2 3 3 1 3 2 3 3 1 3 386,869 377,792 9,077 530,815 521,457 9,358 16,270 12,178 1,132 4,092 30,651 23,354 437,273 n.a. n.a. n.a. n.a. 375,472 364,988 10,484 499,877 489,069 10,808 18,545 13,852 1,263 4,693 37,099 28,323 434,215 n.a. n.a. n.a. n.a. 429,593 418,001 11,592 527,954 516,003 11,951 21,447 15,722.3 1,434 5,724.3 40,622 30,469 478,981 n.a. n.a. n.a. n.a. 353,543 12,526 439 12,087 369,987 15,105 719 14,387 379,729 17,786 826 16,960 34,188 n.a. n.a. n.a. 38,884 n.a. n.a. n.a. 44,663 n.a. n.a. n.a. * estimated 201 The Challenge of Sustainable Outreach Balance Sheet (in millions) 1998/99 Liquid assets (Cash and bank, T. Bills) 4,207.64 4,856.70 4,679.81 341.42 479.40 598.00 15,921.47 18,013.80 21,029.80 461.28 607.90 663.30 Other assets 3,622.72 4,081.80 5,170.49 Total Assets 24,554.53 28,039.60 32,141.40 Deposits 12,526.25 15,105.47 17,786.20 Borrowings 4,838.48 4,714.70 5,090.90 Shareholders’ equity 1,568.22 1,615.15 1,735.10 Other liabilities and provisions 5,621.58 6,604.28 7,529.20 24,554.53 28,039.60 32,141.40 6,925.27 10,065.33 12,587.72 11,548.78 12,451.73 13,898.48 of which long-term 4,512.26 3,907.39 3,920.10 Total Equity 1,568.22 1,615.15 1,735.10 Total Liabilities and Equity 24,554.53 28,039.60 32,141.40 Profit & Loss Account (millions) 1998/99 1999/2000 2000/01 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 1999/2000 2000/01 25.00 80.85 91.94 2,427.12 2,672.58 2,894.29 63.57 94.71 136.99 Total Income 2,515.69 2,848.14 3,123.22 Interest expenses 1,489.86 1,556.12 1,640.69 Administrative costs 786.30 879.09 1113.63 of which personnel expenses 618.35 676.06 914.67 Loan loss provision 127.65 269.38 217.67 7.83 11.48 12.09 43.72 43.58 45.92 Total Expenses 2,455.36 2,759.65 3,030.00 Net Profit/Loss 60.33 88.49 93.22 Interest on loans Other operating income Other operational costs (Bonus expenses) Non-operational costs (Income tax) 202 Case Study: Agricultural Development Bank, Nepal Loan Recovery Performance Loan recovery performance in % Loans written off (millions) Value of loans outstanding (millions) Ratios Equity/liabilities in % 1998/99 1999/2000 2000/01 68.9% 73.9% 75.4% 68.00 33.29 32.91 14,933 17,366 20,349 1998/99 1999/2000 2000/01 6.8% 6.1% 5.7% Deposits/liabilities in % 51.0% 53.9% 55.3% Capital adequacy in % 9.8% 9.0% 8.3% Return on assets in % 0.2% 0.3% 0.3% Return on equity in % 4.3% 6.1% 6.3% Number of borrowers/loan officers and assistants 247 235 268 Value of loans outstanding/loan officers (in millions) 9.55 10.89 12.69 Portfolio Quality 23.0% 21.4% 20.7% Portfolio at risk in % 16.0% 14.7% 18.5% Loan loss ratio in % 0.46% 0.19% 0.16% Performance Efficiency 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 capital 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 203 The Challenge of Sustainable Outreach Table A11: Agriculture Development Bank (in US$) Customer Orientation Loan Portfolio Number of borrowers 386,869 375,472 429,593 - Development Banking 377,792 364,988 418,001 - Commercial Banking* 9,077 10,484 11,592 Number of accounts 530,815 499,877 527,954 - Development Banking 521,457 489,069 516,003 9,358 10,808 11,951 Total Loan Portfolio (millions) 239.62 268.38 290.60 Development Banking Loan Portfolio 179.35 200.46 213.04 of which non-farm lending 16.67 18.28 19.43 Commercial Banking Portfolio 60.27 67.92 77.57 Average portfolio size 451.41 536.88 550.43 - Development Banking 343.94 409.88 412.86 - Commercial Banking 6439.95 6283.87 6490.26 353,543 369,987 379,729 184.48 218.60 241.01 6.47 10.40 11.20 178.01 208.20 229.81 503.50 562.72 605.19 - 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 204 Case Study: Agricultural Development Bank, Nepal Balance Sheet (in millions) 1998/99 1999/2000 2000/01 61.97 70.29 63.41 5.03 6.94 8.10 234.48 260.69 284.96 6.79 8.80 8.99 Other assets 53.35 59.07 70.06 Total Assets 361.63 405.78 435.52 Deposits 184.48 218.60 241.01 Borrowings 71.26 68.23 68.98 Shareholders’ equity 23.10 23.37 23.51 Other liabilities and provisions 82.79 95.58 102.02 361.63 405.78 435.52 of which short-term 101.99 145.66 170.57 of which medium-term 170.09 180.20 188.33 66.45 56.55 53.12 23.10 23.37 23.51 361.63 405.78 435.52 Liquid assets (Cash and bank, T. Bills) Net Investments (Share + Fixed Deposit) Net loans portfolio (loan portfolio-loan loss reserve) Net fixed assets Total Liabilities of which long-term Total Equity Total Liabilities and Equity Profit & Loss Account(in millions) 1998/99 1999/2000 2000/01 0.37 1.17 1.25 35.75 38.68 39.22 0.94 1.37 1.86 Total Income 37.05 41.22 42.32 Interest expenses 21.94 22.52 22.23 Administrative costs 11.58 12.72 15.09 9.11 9.78 12.39 Loan loss provision 1.88 3.90 2.95 Other operational costs (Bonus expenses) 0.12 0.17 0.16 Non-operational costs (Income tax) 0.64 0.63 0.62 Total Expenses 36.16 39.94 41.06 Net Profit/Loss 0.89 1.28 1.26 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) 1998/99 1999/2000 2000/01 68.9% 73.9% 75.4% 1.00 0.48 0.45 219.93 251.31 275.73 Source: ADBN 205 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 206 Deputy General Manager Internal Control Deputy General Manager Service Regional Training Center Deputy General Manager Implementation SFDP Offices Field Office Supervision Office General Manager Board of Directors Commercial Banking Offices Deputy General Manager Training/SFDP/SFCL Organisational Structure of ADBN Deputy General Manager Banking 207 Case Study: Agricultural Development Bank, Nepal The Challenge of Sustainable Outreach 4.6 References 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, Kathmandu. 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, Kathmandu. 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. 208 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. 209 Case Study: The People’s Bank, Sri Lanka 5. Case Study: The People’s Bank, Sri Lanka Richard Gant, Steve Durrant 5.1 Introduction 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 211 The Challenge of Sustainable Outreach 5.2 The Financial Sector in Sri Lanka 5.2.1 Macro Assessment Table 1: Sri Lanka Macroeconomic Data (1999-2001) Indicator GDP (US$Million)154 Population (Million) 155 Rural Population(%) 156 GDP per Capita (US$) Inflation (%) 157 158 Exchange Rate (US$1=SLR) 159 Financial Deepening (%) (M2/GDP) Financial Deepening (%) (M2b/GDP) 160 FY1999 FY2000 FY2001153 15,712 16,600 15,700 18.208 18.467 18.732 N/A N/A 80 865 901 841 4.7 6.2 14.2 70.39 75.78 89.36 32.355 32.218 32.125 38.702 38.488 39.14 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, 2002b).161 153 154 155 156 157 158 159 160 161 212 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 countries. 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 (ibid.). 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).163 162 163 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 213 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$841 since 1999 (CBSL, 2001a). Negative growth was accompanied by a 8 percent rise in inflation to 14.2 percent in 2001. The Colombo Consumer Price Index has risen by 9.5 percent since 1999. The exchange rate against the US Dollar has also slipped significantly with the Rupee depreciating by over 25 percent since 1999 (ibid.). Table 2: Key Economic Indicators 1999-2001 Indicator 1999 2000 2001 Public Debt % of GDP 95.1 96.9 103.6 Gov. Revenue as % of GDP 17.7 16.8 16.5 0.218 0.201 0.279 External Debt (US$billion) 9.08 9.03 8.56 External Debt as % of GDP 59.2 57.5 57.0 External Debt Service % of GDP 12.4 12.6 10.6 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). 214 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.). 215 The Challenge of Sustainable Outreach Table 3: Interest Rates 1999-2001 Type of Interest Rate,% 1999 Treasury Bill Primary Yield - 3 month 2000 2001 11.79 17.77 12.90 9.25 17.00 12.00 Treasury Bill Reverse Repo - overnight 13.48 20.00 14.00 Treasury Bonds - 2 year 12.88 18.97 14.94 Commercial Banks Prime Lending 15.16 21.46 14.3 Call Money 10-14 20-32 12-14 15.9 21.5 14.3 9.2 8.4 8.4 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.). 5.2.2 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 216 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 1999 2000 2001 Assets (US$million) 8,110 8,943 8,294 Liquid Assets (US$million) 2,247 2,292 2,300 Liquid Assets/Total Deposits in % 40.6 39.0 39.6 Cash in Hand/Total Deposits in % 3.0 2.4 2.1 Loans & Advances/Total Deposits in % 78.2 80.0 72.9 Statutory Reserve Ratio in % 11.0 11.0 10.0 Excess Reserves/Total Deposits in % -0.5 0.2 0.4 33,264 33,476 33,230 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 164 165 166 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. 217 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) 1999 2000 2001 23 23 23 4 4 6 - Private FINCOs 25 25 25 Total Number of Private Financial Institutions 52 52 54 2 2 2 - Public Licensed Specialised Banks 10 10 12 Total Number of Public Financial Institutions 12 12 14 Total Number of Formal Financial institutions 62 63 64 Institutional type Private Financial Institutions - Private Commercial Banks - Private Licensed Specialised Banks Public Financial Institutions - Public Commercial Banks Source: CBSL, 2001a 167 218 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 Companies. Table 6 - Banking Branches in Sri Lanka Financial Institution 1999 2000 2001 1,013 1,051 1,082 42 45 46 1,055 1,096 1,128 Regional Development Banks 177 181 187 National Savings Bank 100 100 101 20 20 22 3 3 5 11 11 12 311 315 327 1,366 1,411 1,455 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 168 169 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 systems. 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. 219 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 percent. 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.170 171 170 171 220 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 5.3 The People’s Bank of Sri Lanka 5.3.1 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). 5.3.2 Ownership and Governance 5.3.2.1 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.). 5.3.2.2 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 172 173 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. 221 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 management. 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. 5.3.2.3 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. 174 175 222 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 5.3.2.4 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 management. 5.3.3 Economic Viability 5.3.3.1 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 223 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 (adapted) 1999 US$‘000s 2000 US$‘000s 2001 US$‘000s Assets Liquid Assets 173,755 327,681 76,971 Investments 479,790 536,844 553,414 Net Loans 896,985 1,063,549 959,362 41,832 38,662 31,718 Other Assets 210,665 236,403 254,056 Total Assets 1,803,027 2,203,139 1,875,521 - - - 1,487,268 1,517,640 1,427,302 Borrowings 176,226 524,465 317,466 Other Liabilities 203,046 244,292 197,907 1,866,539 2,286,397 1,942,674 710 660 560 - - - (80,574) (99,119) (80,604) 16,366 15,202 12,892 (63,498) (83,258) (67,153) 1,803,041 2,203,139 1,875,521 Net fixed Assets Liabilities Savings Deposits Total Liabilities Equity Paid up capital Retained Earnings Reserves Other Total Equity Total Liabilities & Equity 224 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 Profit/loss (Adapted) 1999 US$‘000s 2000 US$‘000s 2001 US$‘000s Income Interest on Investments 55,070 52,090 52,843 120,191 160,363 193,412 27,359 31,021 35,732 202,620 243,473 281,987 149,488 138,690 170,742 Administrative Costs 62,049 70,248 61,560 Loan Loss Provision 94,713 20,741 9,041 Other Operating Costs 19,063 38,070 37,192 Non-operational Costs - - - 325,313 267,750 278,535 (122,693) (24,276) 3,452 1,391 - - (121,302) (24,276) 3,452 Interest on Loans Other Operating Income Total Income Expenses Interest Expenses Total Expenses Profit/loss Taxation Net Profit/Loss Source: People’s Bank Annual Reports 1999-2000 & 2001177 In terms of operations, the bank’s gross earnings have risen steadily over the past decade, apart from a small dip in 1998. Earnings have increased 176 177 US$ 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. Ibid. 225 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. 5.3.3.2 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. 178 179 180 226 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 5.3.3.3 Margins Table 9 - People’s Bank Financial Ratios 1999-2001 Ratios Equity/Liabilities 1999 181 Deposits/Liabilities 182 183 Capital Adequacy -3.64% -3.46% 79.68% 66.38% 73.47% 0.062% 0.058% -7.079% -7.828% -7.000% 185 n/a -11.300% -10.500% 84% 103% 89% 22.7% 18.9% 20.9% -6.0% -1.10% 0.18% -193.2% -29.10% 5.13% 186 Non-performing portfolio to advances Return on Total Assets Return on Equity -3.40% 0.079% Capital Adequacy(c) 189 2001 184 Capital Adequacy(b) Cost to Income ratio 2000 188 187 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. 181 182 183 184 185 186 187 188 189 People’s Bank Annual Report 2001. Ibid. 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. Ibid. bid. 227 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. 5.3.3.4 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. 228 Case Study: The People’s Bank, Sri Lanka 5.3.3.5 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. 5.3.3.6 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 government.192 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. 190 191 192 193 Average annual exchange rate for 1993 was US$1 = SLR 48.25 on a SLR 10.5 billion loan. Average annual exchange rate for 1996 was US$1 = SLR 55.27 on a SLR 10 billion loan. 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. 229 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). 5.3.3.7 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. 194 230 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 5.3.4 Decentralisation 5.3.4.1 Delivery Structure Table 10- People’s Bank Branches - 2001 2001 No. of Branches 195 Number of Staff 512 11,401 No. of Loan Officers 425 Banking Density per 10,000 people 0.6 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 (ibid.). The delivery structure of the bank is becoming increasingly decentralized. The People’s Fast scheme, supported by GTZ/RBIP,196 for 195 196 Information on the number of rural branches or accurate information on service radius (km to furthest customer) are not available. Chapter 2.6.1. 231 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 5.3.6.3 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 197 198 232 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. 5.3.6.3 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 199 200 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. 233 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.). 5.3.4.4 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. 5.3.5 Good Management 5.3.5.1 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 234 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. 5.3.5.2 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 level. 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. 5.3.5.3 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. 235 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. 5.3.5.4 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 areas. 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 236 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. 237 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. 5.3.5.5 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 continue. 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 238 Case Study: The People’s Bank, Sri Lanka developed and embraced as part of the banks wider Human Resource Management (HRM) policies. 5.3.6 Customer Orientation 5.3.6.1 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.). 201 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$100 qualify for a monthly lottery and the chance to win a gold coin, which are awarded every hour of every day in monthly and annual prize draws including the chance to win cars, motorcycles, computers and a house (People’s Bank, 2001). The product has been very successful, growing by over 18% in 2001. 239 The Challenge of Sustainable Outreach Table 11 - Loans and Products 1999-2001 Customer Orientation202 1999 2000 2001 No. of loan products 24 24 25 No. of savings products, 10 11 11 No. of other financial services n/a n/a n/a 3,108 3,800 3,275 No. of accounts 3,108,000 3,800,000 3,275,000 Gross loans portfolio (US$‘000s) 1,071,538 1,246,676 1,123,422 Average loan size in (US$) 345 328 343 Average loan size per capita (US$) 58.8 67.5 60 39.88 36.40 40.78 4 weeks 3 weeks 2 weeks 7,246 7,944 8,336 1,487,268 1,517,640 1,427,302 205 191 171 81 82 76 23.6 21.2 20.33 Loan Portfolio No. of active borrowers (000's)203 Average loan size as a% of GDP per capita income 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; 202 203 204 240 Detailed figures on rural market share and specific number of rural clients are unavailable. 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).206 207 205 206 207 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 241 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 5.3.6.3 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 208 242 (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 Region.211 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 209 210 211 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 Lanka. 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. 243 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. 5.3.6.3 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 244 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. 5.4 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 commitments. 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. 245 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 246 Case Study: The People’s Bank, Sri Lanka reform to the banks constitution the threat of further politicisation remains. 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. 247 The Challenge of Sustainable Outreach 5.5 References 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. 248 Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand 6. Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand Marie Luise Haberberger, Luck Wajananawat, Nipath Kuasakul 6.1 Introduction 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. 249 The Challenge of Sustainable Outreach 6.2 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 1999 2000 2001 124,300 129,272 131,598 Population (million) 61.7 62 62 of which rural (million) 30.8 31.6 32.4 50 51 52 GDP per capita in US$ 2,016 2,088 2,112 Inflation in % 0.3% 0.8% 1.6% Bt. 38.4 Bt. 43.5 Bt. 43.8 105% 102% 102% 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 250 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 1999 2000 2001 No. of Private Financial Institutions 13 13 13 No. of Public Financial Institutions 9 9 9 Assets of Private Financial Institutions(US$million) 160,734 143,765 146,337 Assets of Public Financial Institutions(US$million) 33,992 32,270 35,184 8.25 - 8.5% 7.75% 7 - 7.5% 3.75% 3% 2.25% 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 251 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 crisis. 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 252 Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand the Bank of Thailand to increase its focus on prudential regulation and supervision. 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. 6.3 The Bank for Agriculture Cooperatives (BAAC) 6.3.1 General and Agricultural 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 253 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 administration. 6.3.2 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, 254 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 212 Dr. Maurer, Rural Finance, Working Paper No. B 6, IFAD. 255 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. 6.3.2.1 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 256 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. 6.3.3 Economic Viability 6.3.3.1 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. 257 The Challenge of Sustainable Outreach Table 3: Ratios 1999 Equity/liabilities in % 2000 2001 8.0 7.8 7.9 Deposits/liabilities in % 70.5 75.0 82.7 Capital adequacy in % 7.4 7.3 7.3 Return on assets in % 0.1 0.2 0.2 Return on equity in % 1.4 2.4 2.2 429 442 434 1,000 992 940 Performance Efficiency 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. 258 Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand Table 4: Profit & Loss Account (adapted) 1999 2000 2001 in US$000 in US$000 in US$000 14,938 12,513 17,198 554,959 416,320 365,167 55,391 54,468 64,910 Total Income 625,288 483,301 447,275 Interest expenses 261,512 188,402 159,010 Administrative costs 125,341 115,457 149,638 -109,916 -102,395 -125,221 147,697 86,261 81,673 Other operational costs 31,797 35,364 17,629 Non-operational costs 51,637 45,489 26,670 Total Expenses 617,984 470,973 434,620 Net Profit/Loss 7,304 12,328 12,655 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. 259 The Challenge of Sustainable Outreach Table 5: Balance Sheet (adapted) 1999 2000 2001 in US$000 in US$000 in US$000 Liquid assets 104,851 75,979 41,320 Investments 799,295 841,139 1,243,905 5,884,434 5,602,638 5,592,975 Net fixed assets 129,601 113,213 112,833 Other assets 287,036 468,871 826,782 Total Assets 7,205,217 7,101,840 7,817,815 Savings 2,036,458 1,961,569 2,235,188 Deposits 2,665,703 2,975,034 3,756,232 Borrowings 1,569,869 1,222,597 909,292 397,884 426,130 345,770 6,669,914 6,585,330 7,246,482 440,654 424,562 473,173 94,649 91,948 98,160 Reserves - - - Others - - - 535,303 516,510 571,333 7,205,217 7,101,840 7,817,815 Net loans outstanding (loans - loan loss reserve) Other liabilities Total Liabilities Paid up capital Retained earnings Total Equity Total Liabilities and Equity Source: BAAC 6.3.3.2 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 inflation.213 The challenge for BAAC is to convince the government that serving millions of small customers in rural areas is cost intensive and not like 213 260 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 Classification of Borrowers Prime Very good Symbol Record of Debt Payment Interest Rate Structure Interest Rates% (3/2002) Maximum loanable Amount approved 15 million Baht (US$342,000) AAA Full and timely repayments for consecutive 3 years MLR 8 AA Full and timely repayments for consecutive 2 years MRL+1 9 Good A Full and timely repayments in the previous year MRL+2 10 General B Past due loans, Newly registered borrowers, Restructured loans MRL+3 11 Source: BAAC 6.3.3.3 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. 261 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 2001 1967 1973 1980 1987 1993 1998 2001 Deposits from the public 11% 17% 12% 25% 48% 62% Mandatory deposits from CBs -- -- 39% 39% 7% 1% Borrowings 19% 22% 35% 29% 32% 25% 13% Shareholders’ Equity 66% 57% 12% 6% 8% 7% 7% 4% 4% 2% 1% 5% 5% 5% 100% 100% 100% 100% 100% 100% 100% 14% 19% 21% 38% 66% 83% 98% Other liabilities Total Deposit-to-loan ratio 76% - Source: BAAC 6.3.3.4 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 214 262 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. 263 The Challenge of Sustainable Outreach Table 8: Loan Recovery Performance 1999 2000 2001 906,641 791,356 768,470 Loans in arrears (number of loans) n.a. n.a. n.a. % age of arrears 14.5 13.2 12.6 Loans written off in US$(000) 173 72 178 ---- ---- ---- 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 1999 2000 2001 US$000 Gross loans outstanding 6,257,975 6,007,649 6,120,851 373,541 405,011 527,876 5,884,434 5,602,638 5,592,975 Reserve for bad debt 6.2% 8.6% 8.6.% Arrears of more than 1 year 6.3% 7.2% 9.4% ./. Reserve for bad debt Net loans outstanding % of loans outstanding: (4%)215 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 215 264 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. 6.3.3.5 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 registered. 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 (2.1 265 The Challenge of Sustainable Outreach percent in 1998) compared to the average gross loan outstanding were spent on personnel. 6.3.3.6 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. 6.3.4 Decentralization 6.3.4.1 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 266 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. 6.3.4.2 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 considerable. 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) 267 The Challenge of Sustainable Outreach Table 10: Degree of Decentralization 1999 2000 2001 Number of branches 587 587 588 Number of sub-branches and other units 887 887 888 Number of staff 13,082 12,754 12,960 Number of loan officers 6,256 6,059 6,308 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. 6.3.4.3 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 268 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 instrument. 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. 6.3.4.4 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 direction. 6.3.5 Good Management 6.3.5.1 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. 269 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 270 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. 6.3.5.2 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 6.3.4.3 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. 6.3.5.3 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. 271 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. 6.3.5.4 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 training. 272 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. 6.3.5.5 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 273 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. 6.3.6 Customer Orientation 6.3.6.1 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: 274 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. 275 The Challenge of Sustainable Outreach Table 11: Customer Orientation 1999 2000 Number of loan products Number of savings products 5 Number of other financial services 2001 2 2 5 5 5 5 Loan Portfolio Number of active borrowers (000's) 2,686 2,676 2,738 of which are rural (000's) 2,685 2,676 2,738 Number of accounts (000's) 4,556 4,281 4,413 6,257,975 6,007,649 6,120,851 1,345 1,355 1,321 66.7 64.9 62.5 2 weeks 2 weeks 2 weeks 8.7 8.5 8.5 n.a. n.a. n.a. n.a. n.a. n.a. 8,298 8,633 9,570 2,036,458 1,960,920 2,586,757 Average deposit balance in US$ 245 227 270 Average deposit balance/per capita income in % 12.2 10.9 12.8 27 27 29 31% 33% 34% 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 nationwide 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 nationwide Source: BAAC 6.3.6.2 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 276 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 277 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. 216 278 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 2003. 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 1998. 279 The Challenge of Sustainable Outreach 6.3.6.3 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 function. 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- 280 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 Product 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 Middle-Class/Urban 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 281 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, 282 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. 6.3.6.4 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 Premium Advantage for the Client Life Insurance All BAAC borrowers and depositors Annual Premium 560 Baht per Person Risk Cover Accidental Insurance (insured person) All BAAC borrowers and depositors who own cars Favourable Premium Convenient Individual accidental Insurance All BAAC borrowers and depositors Annual Premium 150 Baht per Person Risk cover Inter-branch money Transferring All BAAC clients --------------------- Convenient Bill payment BAAC clients, general public, --------------------- Convenient, safe government units, state enterprises Source: Microfinance Linkage Project 6.3.6.5 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. 283 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. 6.4 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 periods. 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 284 Case Study: Bank for Agriculture and Agricultural Co-operatives, Thailand deposit facilities to the range of financial services offered to its rural clients.217 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. 217 Dr. Maurer, Rural Finance, Working Paper No. B 6, IFAD. 285 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 286 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. 287 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 Mobilization. Maurer, K. (1997): Assessment of Linkage Banking Projects in Asia. Case Study 3: BAAC/GTZ Project Thailand. APRACA. Draft report. 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 IFAD. 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. 288 The Way Forward 7. The Way Forward Dirk Steinwand, Anke Wolf 7.1 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.219 218 219 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. 289 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?” 290 The Way Forward 7.2 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 households. 220 See chapter 1. 291 The Challenge of Sustainable Outreach 7.3 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. 292 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 http://www.gtz.de
