Evaluation of the institutional aspects of the financial institutions development project, Phase I in Indonesia

The project is well-designed, competently implemented, and contains many lessons that may help USAID design future interventions, both in Indonesia and elsewhere. Because of the great variation observable in the different project areas, FID-I exemplifies the importance of deposit mobilization in the provision of financial services to rural smallholders. FID-I and its companion project with the Bank Rakyat Indonesia (BRI) Unit Desa system offer perhaps the clearest evidence available in the developing world of the importance of a credible deposit facility as an essential part of a long-range credit provision strategy. The project succeeded in meeting what, in other contexts, would have been unrealistically optimistic institutional growth targets. It was also very successful in reaching increased numbers of rural poor with improved financial services. Although the optimistic target for number of borrowers served was not achieved, this failure may be due to the project's success in reaching an increased number of savers. Project design failed to anticipate the extent to which small borrowers would substitute the financial service of a good deposit facility for the financial service of credit. If the project design may be faulted on any one issue, it is its failure to appreciate the demand for deposit facilities on the part of the FID-I clients and the potential for institutional development inherent in meeting that demand. The most impressive achievement of FID-I institutions during the life of the project concerned the sharply increased portion of the credit portfolio funded by domestically mobilized resources. According to the most recent statistics, the project achieved 323.1% of the target of 17.3%, with fully 55.9% of the credit portfolio of the original four systems funded out of locally mobilized resources. As of the end of 1989, the Bank Karya Produksi Desa of West Java was able to finance 100% of its rapidly expanding credit portfolio out of locally mobilized resources. The Lembaga Perkreditan Desa of Bali -- not among the original four FID I systems -- should achieve this status by the end of 1991. The report stresses the need for a basic restructuring of the relationship between the BPD and the village units as a means of ensuring a smooth flow of services from the center to the deposit-accepting units at the periphery of the financial system. A model for FID-I systems in this regard is the BRI Unit Desa system, which has solved this problem by forging a close relationship between the village units and the bank as a whole. There is an uninterrupted flow of services from the bank to the Unit Desa -- TA, training, monitoring, and supervision, as well as an array of financial services backed up by an incalculable amount of good will in the form of the image of BRI as an unsinkable ship of state. These services flow to the village units because there is a return flow of both loanable funds and profits to the BRI from the Unit Desa. The development potential that resides in the FID-I systems is great. An enormous amount of human, real, and financial capital has been put in place over the life of the project, much of it from nonproject sources. This capital provides a firm basis for deposit-led growth, provided the organizational and structural problems tied to ownership and control are overcome. In seeking to make the transition to deposit-led growth, established specialized credit institutions face a major stumbling block: as the reliability and convenience of the deposit facility becomes generally recognized by the rural population, there will be relentless pressure for average loan size to increase as former credit customers substitute the deposit facility for credit as a source of liquidity. Institutions that once successfully managed large numbers of small loans are not necessarily prepared to manage the smaller number of larger loans that is the distinguishing characteristic of successful deposit-led financial intermediation, particularly since the larger loans can be made only at sharply reduced loan rates of interest. The reduced average yield on a portfolio of larger loans means that institutions experiencing deposit-led growth must give considerably more attention to loan quality than is currently observable among the specialized credit institutions served by the project. This inescapable concern with loan quality is part of the adjustment to market demand that tends to make village outlets for financial services cash-surplus units. The evaluation reveals that a tendency for successful deposit-based rural institutions to be net suppliers of credit to the financial system constitutes prima facie evidence that the project and institutions respond to the demand for services on the part of the people they serve. The project should be extended until 3/31/94; this would coincide with the national and provincial governmental planning years. A follow-on project is also recommended. Major issues for the immediate future include extending what has been learned about deposit mobilization in Bali and West Sumatra to the other FID provinces and establishing effective systems of external auditing, supervision, and control of the many hundreds of rural financial institutions in the FID provinces. (Author abstract, modified)