Restructuring of State-Owned Financial Institutions: Lessons from Bank Rakyat Indonesia

Despite the trend toward fi nancial sector liberalization in recent years, state ownership of fi nancial institutions remains widespread in the developing world. However, in general, state-owned fi nancial institutions have underperformed their private sector counterparts, and governments have sought to restructure them. This case study reviews the transformation of Bank Rakyat Indonesia from a loss-producing, overstaffed state-owned bank to the most profi table bank with the largest microbanking network in Indonesia. From the bank’s experience, the study seeks to draw decisive lessons for the successful transformation of other state-owned fi nancial institutions. For Bank Rakyat Indonesia, the key driver of successful reform was the government’s commitment to allow it the autonomy to restructure itself—including an emphasis on good corporate governance, supported by appropriate regulations and effective supervision.

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OF STATE-OWNED FINANCIAL INSTITUTIONS

Hans Dieter Seibel • Mayumi Ozaki Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org ISBN 978-971-561-797-0 Publication Stock No. RPT090538 Printed in the Philippines

BRI spread tyl final no spine.indd 1 10/5/09 2:57 PM RestRuctuRing OF state-Owned Financial institutiOns lessOns FROm Bank Rakyat indOnesia

Hans Dieter Seibel Mayumi Ozaki

September 2009 © 2009 Asian Development Bank

All rights reserved. Published 2009. Printed in the Philippines.

ISBN 978-971-561-797-0 Publication Stock No. RPT090538

Cataloging-In-Publication Data

Seibel, Hans Dieter and Mayumi Ozaki. Restructuring of state-owned financial institutions: Lessons from Bank Rakyat Indonesia. Mandaluyong City, Philippines: Asian Development Bank, 2009. 1. Financial institutions. 2. Bank Rakyat Indonesia. 3. Indonesia. I. Asian Development Bank.

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For orders, contact Department of External Relations Fax +63 2 636 2648 [email protected] Contents

Abbreviations and Acronyms iv

Currency Equivalents v

Notes v

Foreword vi

Introduction vii

Restructuring of Bank Rakyat Indonesia Microbanking Units 1 Origin of Bank Rakyat Indonesia Microbanking Units 1 New System of Bank Rakyat Indonesia Microbanking Units 2 Bank Rakyat Indonesia Microbanking Units and the 1997/1998 Asian Financial Crisis 3 Challenges and Decisive Factors in Restructuring 5

Restructuring of Bank Rakyat Indonesia 9 Pre-Restructuring Period 9 Crisis-Driven Restructuring 11 Post-Restructuring Period 14 Decisive Factors in Restructuring 19

Conclusions and Lessons Learned 22

References 25

Appendix 1: The Evolution of Bank Rakyat Indonesia: In Search of the Most Effective Inclusion 27 Prehistory, 1895–1945 27 Postwar History, 1945–1983 28

Appendix 2: Finance Sector in Indonesia 32 Policy Framework 32 Financial Institutions 35 Contents iii Abbreviations and Acronyms

AVB – Algemeene Volkscredietbank Bimas – Bimbingan Masal (mass guidance) BKD – Badan Kredit Dasa BRI – Bank Rakyat Indonesia BPR – Bank Perkreditan Rakyat (people’s credit bank) BOC – board of commissioners BOD – board of directors BKTN – Bank Koperasi Tani dan Nelayan (cooperative farmers’ and fishermen’s bank) CAR – capital adequacy ratio CEO – chief executive officer GDP – gross domestic product GTZ – Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ) GmbH (German Agency for Technical Cooperation) IMF – International Monetary Fund IPO – initial public offering Kupedes – Kredit Umum Pedesaan (general rural credit) NPL – nonperforming loan ORP – operational restructuring plan PAKTO27 – Paket 27 Oktober 1988 Simpedes – Simpanan Pedesaan (rural savings) SME – small and medium-sized enterprise SOFI – state-owned financial institution Abbreviations and Acronyms iv (Previous Years) Currency Equivalents Year End (As of 23 December 2008) 1984 1,074 Currency Unit – Rupiah (Rp) 1985 1,125 $1.00 = Rp10,893 1986 1,641 Rp1.00 = $0.0001 1987 1,650 1988 1,731 1989 1,793 1990 1,877 1991 1,992 1992 2,062 1993 2,110 1994 2,200 1995 2,308 1996 2,383 1997 4,650 1998 8,025 1999 7,100 2000 9,595 2001 10,400 2002 8,940 2003 8,425 2004 9,285 2005 9,830 2006 9,393 2007 9,419

Notes

(i) Until 1999, the fiscal year (FY) of the Government of Indonesia ended on 31 March; for 2000, FY was 1 April 2000 to 31 December 2000; and from 2001 on, FY coincides with the calendar year, 1 January to 31 December. (ii) In this report, $ refers to US dollars. (iii) Currency amounts in this report are generally stated in $. Rupiah amounts are converted into $ using official end-of-year exchange rates. In some cases, corresponding rupiah amounts are added, e.g., to demonstrate the wide fluctuations in the value of the rupiah during 1997 and 1998. of Contents Table v Foreword

Despite the trend toward finance sector liberalization in recent years, state ownership of financial institutions is still widespread in the developing world. In general, the establishment of state-owned financial institutions, particularly banks, was advocated to correct market failures and provide resources to underserved or high-priority sectors of the economy, thus facilitating equitable economic growth. However, on the whole, government ownership of financial institutions has not necessarily been conducive to achieving those objectives. Weak governance and susceptibility to political influences have reduced the incentives for these institutions to focus on long-term viability. The implicit government guarantee limited these institutions’ effort to achieve sustainability. Faced with the massive budgetary burden to sustain state-owned financial institutions, governments have been forced to decide to either close or restructure them.

A number of state-owned financial institutions have been restructured, yet important questions remain, such as:

• What are the factors that will lead to successful restructuring of state-owned financial institutions? • How can poorly performing state-owned financial institutions become sustainable organizations?

This study examines Bank Rakyat Indonesia (BRI), the oldest and largest commercial bank in the country, which was successfully restructured twice— one after the interest rate deregulation of the finance sector in Indonesia in the early 1980s, and the other after the Asian financial crisis in the late 1990s. We hope that this study will provide some insights into how state-owned financial institutions can be transformed into viable financial institutions that are instrumental in achieving greater financial intermediation and economic development in developing countries.

Kunio Senga Director General South Asia Department Asian Development Bank Foreword Foreword vi Introduction

From the 1960s to the 1980s, developing countries—with the assistance of international development agencies—encouraged the establishment of state- owned financial institutions (SOFIs), including banks. The rationale for operating an SOFI was (i) to correct for market failures so that the poor could obtain financial services, and (ii) to ensure a flow of investment to specific sectors of the economy to which the government attached high priority.

However, over the years, and in many countries, SOFIs have generally underperformed compared with their private sector counterparts. Faced with the economic instability to which these failed financial institutions have contributed, governments were often forced to restructure them. Various efforts have been made, sometimes tied to budget support by international development agencies, to restructure SOFIs into sound financial institutions through such actions as privatization, divestiture, or external management contracts. This restructuring often required substantial capital injections, either from the government budget or through external borrowing. However, the outcomes of these efforts have varied, and there have been very few systematic studies analyzing the results and drawing conclusions.

This case study reviews Bank Rakyat Indonesia (BRI) and its transformation from a loss-producing, overstaffed state-owned bank to the most profitable bank with the largest microbanking network in Indonesia. The study is based on historical documents; previous studies of BRI units by Hans Dieter Seibel since 1987; BRI annual reports; and information generously provided by BRI in March 2008. The evolution of BRI from 1895 to 1983 is presented in Appendix 1, and the development of the institutional environment from 1983 to 2008 is presented in Appendix 2. The success of BRI was achieved in two separate restructuring phases. The first was the reform of the BRI microbanking units—unit desa (village units)—in 1984.1 The second was the restructuring of BRI as a whole, from 1999 to 2003, immediately after the 1997/1998 Asian financial crisis. This study aims to extract, from these two phases, decisive lessons for the successful transformation of other SOFIs.

The experience of BRI suggests that an unprofitable SOFI can be transformed into a profitable organization with significantly expanded outreach. In 1983, BRI began the transformation of unit desa from dispensers of subsidized agricultural credit to a self-financed microbanking network with ever-growing deposits, loan portfolios, profits, and outreach to the lower market segment. This transformation established BRI as the world’s most successful large-scale commercial microfinance provider, even though microfinance represented just a fraction of its loan portfolio. In 1997–1998, the fallout from the Asian financial crisis destroyed much of the commercial sector in Indonesia and almost wiped out the country’s banking industry.2 However, BRI was one of the state-owned

1 The unit desa network was established by BRI in 1969 to implement a government-subsidized Introduction vii microcredit program in rural areas. After the restructuring of the unit desa, BRI eventually changed their name to BRI units, also referred to as microbanking units. In this study, the term unit desa refers to the BRI village unit network for the bank’s subsidized microcredit programs until 1983; thereafter, they are called BRI units or simply units. 2 Also referred to in Indonesia as the monetary crisis, or krisis moneter (Krismon). Protocol at the Asian Development Bank viii banking sector’srestructuring. effective supervisionbythecountry’scentralbank,wasacrucialelementin corporate governance.Thisemphasis,supportedbyappropriateregulationsand government’s interferenceinbankinghasbeenreplacedbyanemphasisongood through long-termtechnicalassistance.Sincethestartofreforms, Development didplayacrucialroleinthereformandrestructuringofunitdesa that transformation,althoughHarvardUniversity’sCenterforInternational nor acontractwithanexternalmanagementgroupwasdecisivefactorin factor tothebank’ssuccessfultransformation.Neitherexpatriatemanagement deregulation ofSOFIinterestratesinJune1983,wasanimportantcontributing An evolvingpolicyframeworkconducivetosuchautonomy, startingwiththe the GovernmentofIndonesiatoallowBRIautonomyrestructureitself. The keydriveroftheBRIreformswaspoliticalwillandcommitment portfolio size. in Indonesia.SinceApril2008,ithasbeenthelargestbanktermsofloan market inIndonesia2003.In2007,BRIbecamethemostprofitablebank recapitalization effortin2000,anditmadeitsinitialpublicofferingonthestock banks thatwereexemptedfromclosure.Itwasrestructuredthroughamassive 2 1 1982, resultinginheavylosses.Likemostsubsidized programsatthetime, credit discipline.ThedefaultratesofBimasborrowers surgedtoabove50%asof loans, farmerslackedincentivestorepay, andBRIstaffwasunabletoenforce 17.5% oftheBimasportfolio.Withgovernment’simplicitguaranteethese In 1971,one-thirdofBimasclientswereinarrears,resultingalossratio The portfolioqualityofthesesubsidizedlendingprogramsdeterioratedrapidly. and MidiCreditformedium-sizedones. subsidized lendingprogramsthroughBRI:MiniCreditforsmallruralbusinesses the mainsourceoffinancing.In1974,too,governmentinitiatedadditional were authorizedin1974tomobilizesavings;butgovernmentfundsremained 1970 andto3,600in1983.To strengthentheirownresourcebase,theunits supported byagovernmentsubsidy, grewrapidlyfrom18in1969to537 rice-growing areas,mostlyonepersubdistrict.ThenumberofBRIunitdesa, To managetheBimasprogram,BRIestablishedanetworkofunitdesain (Bimas) (massguidance)programofsubsidizedcredittofarmers’groups. revolution” andintegratedruraldevelopmentthroughtheBimbinganMasal with financingtheproductionofimprovedcropvarietiespromotedby“green it asacommercialbankwithbroadermandate.ThegovernmenttaskedBRI government separatedBRIfromBankKoperasi Tani danNelayan,reestablishing cooperatives offarmersandfishermenwithsubsidizedlending.In1968,the nationalized DutchbanktoformBankKoperasi Tani danNelayan,supporting state-owned BankTani Nelayan (afarmers’andfishermen’sbank)a government’s socialagenda.In1960,thegovernmentmergedBRIwith During the1960s,BRIunderwentseveralstructuralchangestopromote sector, e.g.,agriculture,industry, trade,andsalariedindividuals. the jurisdictionofotherfinancialinstitutions.Creditwasmadeavailabletoany government programs;and(iv)actasaspecialbankforgroupsthatwerebeyond other services;(ii)guideandsupervisecooperativesvillagebanks;(iii)handle were to(i)conductbankingbusinessingeneral,includingsavings,credit,and In 1951,BRIwasdeclaredagovernment-ownedbank,anditsbroadmandates only emergedafterIndonesia’sofficiallyacknowledgedindependencein1950. Although BankRakyatIndonesia(BRI)datesbacktothe1890s,itspresentform Origin ofBankRakyatIndonesiaMicrobankingUnits financial institutions. small enterprisesandmicroenterprises,aswellsupervisingcloseto6,000local government alsomadeBRIresponsibleforservingagriculturalestatesandrural the termBPR,isreservedforthose thataresupervisedbyBankIndonesia. financial Since the 1988reforms, credit bank.Theirhistorygoesbacktothe early 1900s. people’s and villagesavings andloaninstitutions,broadlyreferredtoasbankperkreditanrakyat(BPR),or There aredifferenttypesofsmall financial institutions, including village-owned creditorganizations production. Science Dictionary.Heritage for intensificationofrice Bimas programwasinitiallyintended The fertilization, irrigation, mechanization, and soilconservation techniques,” according to theAmerican and improved use ofpesticides, effective breeding ofhigh-yieldvarietiesgrains,the including the The “greenrevolution”encompassesincreasing agricultural “theapplicationofsciencetoproductivity, 2 Restructuring ofBankRakyatIndonesia Microbanking Units 1 The

Restructuring of Bank Rakyat Indonesia (BRI) Microbanking Units 1 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank (BRI) 2 Microbanking Units 2 introduced inFebruary 1984. A newunitdesasystemdesignedbythetechnicalassistanceteamwas Development andtheCenterforPolicy andImplementationStudiesinJakarta. Development, supportedbytheUnitedStatesAgencyforInternational long-term technicalassistancefromHarvardUniversity’sCenterforInternational in Indonesia.ThenewBRImanagementrevampedtheunitdesasystemwith total of14,300staffmemberswithintheunits—thelargestloandeliverynetwork the loss-makingunitdesanetwork.In1983,BRIhad3,617oftheseunits,witha reform-oriented managementatBRItotakeimmediateactionsrestructure state-owned banks.Inanotherreforminitiative,thegovernmentinstalledanew were removedandthegovernmentreduceditscontrolovermanagementof government’s broaderbankingsectorliberalization,inwhichinterestrateceilings subsidized programs—Bimas,Mini,andMidi.Thisactionwaspartofthe abolish subsidizedcreditaltogether, thegovernmentdiscontinuedthreemajor subsidizing suchapoorlyperformingcreditprogram.In1983,ratherthan lending program.Atthatpoint,thegovernmentbecameunabletocontinue and forcedthegovernmenttowithdrawfromexpensivesubsidized The oilpricedeclinein1982sharplyreducedIndonesia’soil-relatedrevenue food self-sufficiency. targets; thus,negatingitspurposeofimprovingfarmproductivityandincreasing and restrictionsofallowableloanpurposestoproduction-orientedagricultural frequent delaysbeyondthetimeofplanting,whenfarmersneedcreditmost, Bimas programwasburdenedwithillegalextracharges,onerousprocedures, such aspettytrading,agriculture, andagricultureinputtrade,industry, services, providing credittoanycreditworthy personforanyincome-generatingactivity and seasonalloans.Instead,theunitsadoptedaso-called incomeapproach, previous commodityapproach,whichemphasizedfarmers, cropagriculture, At thecustomerormarketsegmentlevel,units moved awayfromthe the unitsbutwereconfinedtobranches. and creditdisciplineattheunits,subsidizedprograms werenotimplementedat equip themwithcomprehensivebankingskills.To maintainthefinancialhealth strengthened andorganizedinregionalBRIeducation andtrainingcentersto other noncashtransactionsinonestop.Training andretrainingofunitstaffwere various transactionssuchasmoneytransfers,check clearing, billpayment,and “one-stop servicemethod”wasintroduced,inwhich atelleratunithandled posts orclosed.During1987and1988,anewoperatingsystemcalledthe areas tobusinesscenters;unprofitableunitsweredowngradedvillageservice in turnreducetheirchancesforpromotion.Unitsweremovedfromriceplanting lowered to3%),unitmanagerswouldlosetheirlendingauthority, whichwould If loanarrearsexceeded5%foracertainperiod(thisbenchmarkwaslater incentives werematchedbypenaltiesformanagersofpoorlyperformingunits. with substantialprofit-sharingincentivesforthemanagementandstaff. These regional offices.Allunitswerereorganizedasself-sustaining profitcenters their ownadministrativestructure,supervisedbybranches,andaudited Under thenewsystem,atorganizationallevel,unitswereplacedunder New SystemofBankRakyatIndonesiaMicrobankingUnits covering theircosts,andearningaprofit(Table 1). have beencompletelyfinanciallyself-reliant inmobilizingtheirownresources, 3 to generateprofitsevenduringthemonetarycrisis. During 1998–1999,the merged orclosed.However, theBRIunits showedstrongresilienceandcontinued in Indonesia.VirtuallyallbanksIndonesiawereaffected, andmanywere resulted ininflationandcurrencydevaluation,which ledtoamonetarycrisis Indonesia washithardbythe1997/1998Asianfinancial crisis.Thiscrisis Asian FinancialCrisis Bank RakyatIndonesiaMicrobankingUnitsandthe1997/1998 1989, theygeneratedexcessliquidityof$63million. the unitssoonbecameindependentofexternalfunding,andbyDecember Simpedes savingsproduct,whichprovidedpositiverealreturnstodepositors, and $97millionin1989forliquiditysupport.However, giventhesuccessof $102 million,distributedasfollows:$5millionin1987fortechnicalassistance liquidity forloansandinitialadministrativecosts;(ii)aWorld Bankloanof of Rp210billionseedcapitalin1984fromthegovernmentasstart-up received fundsfortheunitdesareformfromtwomajorsources:(i)aninjection The BRIunitshavebeenfinanciallyself-sufficient since1989.BRIinitially loans ontime,aproportionwhichincreasedto98.8%in2007. for arrearsprevention,asapproximately95.0%oftheborrowersrepaidtheir if allinstallmentswerepaidontime.Thisturnedouttobeapowerfulinstrument amount ofinterestdue,and(ii)theexpectationrepeatloansincreasingsize repayment oftheloans,withtwocomponents:(i)arefund25% loans, ruralaswellurban.BRIalsointroducedanincentivesystemfortimely away frommainlyagriculturalloansandtowardvariousbusinessconsumer borrowers foranypurpose.Kupedes enabledtheunitstodiversifytheirportfolio (Kupedes), whichprovided formonthlyinstallmentpaymentsandwasopentoall other innovationwasageneralruralcreditproduct,KreditUmumPedesaan outperforming timedepositsandothersavingsproductsbyawidemargin.The public events.SimpedeshasbecomeBRI’smostattractivesavingsproduct, any time,andhadalotterycomponent,withprizesawardedatwell-publicized doing businessinruralareas.Thisproductprovidedforunlimitedwithdrawalsat called SimpananPedesaan (Simpedes),wasasavingsproductforthoselivingor and twonewsavingsloanproductswereintroducedattheunits.One, At theproductlevel,innovationsinsavingsandloanproductswereemphasized, potential unitcustomer. well asconsumercredit.Anyonewhowasabletosaveandrepayaloan horticulture, operationofsmallplantationsandlivestock-relatedactivity, as the liquiditywasinjectedinto branches. million wasreleasedbytheWorldAt thetime$97 Bank,the unitswerealreadyself-reliant, and 3 Sincethattime,BRIunits

Restructuring of Bank Rakyat Indonesia (BRI) Microbanking Units 3 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank (BRI) 4 Microbanking Units 4 level during1997–1999. increase theirborrowing,thenumberofborrowersstoodatanalmostconstant general expectationthatsincethepoorwereshortoffundsandwouldneedto throughout 1997–1999. moderate increaseinloandelinquency, theloanlossratioremainedbelow2.2% crisis hadlittleeffectonloanrepaymentattheunits.Althoughtherewasa because ofuncertaintyoverthefutureandbehavedcautiously. Themonetary number ofdepositaccountsattheunitsgrewby3.6%. 6 5 4 1998 (Table 1). and intocorporatelending.Thus,itwastheseunitsthatultimatelysavedBRIin (ii) throughthetransferofsavingsmobilizedatvillageleveltobranches (i) throughthecontinualtransferofprofitsfromunitstoBRIasabank,and banks. Inamoretechnicalsense,theunitscross-subsidizedBRIintwoways: If notfortheresilienceofunits,BRIwouldhaveclosedormergedwithother unprecedented negative1-monthloan–lossratioof–0.21%. savings; rather, microborrowersrushedtorepaytheirloans early, resultinginan peaked, theunitsexperiencedoppositeofarunonbanktowithdraw development duringthisperiod.InAugust1998,rightafterthemonetarycrisis low of0.5%as2001. remained low,to an all-time declining thereafter but in 1997, to 2.2% in 1996 increasingfrom1.6% declining 4.7% in1997andto5.7%1998, steadilythereafter. Butthe12-monthloan–loss ratio in repayment, indicatedbyan increase of thearrears ratio (1 dayor more) from 3.7% in 1996 to units andthecreditcultureofmicroenterprisesfarmer customers. There weresomedelays The crisishadonlyamoderateeffectonloanrepayment,testifying totheresilienceofbothBRI 2003–2004. turn of was onlyreachedatthe The recoverytothepre-crisislevel billion in1998. to alowof$0.6 falling billion in1997, to $1.0 billion in1996 substantial declineinloansoutstanding:from$1.7 In USdollarterms,duetothecollapseofrupiah,therewasa trillion inMay 1998. Rp4.55 slightly from Rp4.41 trillioninAugust1997toRp4.75January anddeclining 1998, to future. Theamount ofloansoutstandingremainedalmostconstantinnominalterms,increasing poor concerninganuncertain among the a cautiousattitude to related demand, a lackof to but banking system, in the case elsewhere to ashortageoffunds,aswasthe This wasnotdue 1999. and fell to2.5millionin1998 the numberofborrowers,whichhadstoodat2.6millionin1997, In contrasttotheexpectationsofmanydonorsthatwerewillingprovideextrafundsforpoor, in 1996to$1.9billion1997.Ittookuntil2003reach,andsurpassthepre-crisislevel. deposits intheunitsfellfrom devaluation oftherupiah,picturewasquitedifferent;$3.0 In USdollarterms,duetothe in nominaltrillion1998. terms,from to Rp16.2 Rp8.8 trillionin1997 On ayear-to-yearperiod. inflation rateforthe 56% the 83.8% units surgedby in the basis,deposits and anincreasewellabove trillion, agrowthrateof96.9%, to Rp35.17 trillion rose fromRp17.86 Rp15.13 to trillion inAugust1997 in theBRI unitsincreasedfromRp7.98 Deposits in BRIalmostdoubled. total savingsdeposits to August1998, 1997 from September initial 12-monthcrisisperiod, the units; andanmillion) additional Rp2.84trillion($354 wasInnominal deposited. terms, during in the accounts wereopened million newdeposit financial crisis,1.3 a droughtandthe both by 3-month peakcrisiswhenIndonesiahadbeenmostbadlyhit period, June1998toAugust 1998, During the 1999. December to number ofaccounts fromJanuary1998 increase inthe a 33.6% The figuresshow million in1999. and 24.2 million in1998, 21.7 million in1997, to 18.1 1996 resilience. Growthinthenumberofdepositaccounts continued, from 16.1million accounts in impact ontheunits,whichshowedextraordinary The monetarycrisishadastronglypositive trillion in August 1998, an increase Forin August1998,of89.6%. trillion thesameperiod,inallofBRI,deposits 6 5 Microborrowerpsychologyshowedaninteresting Thisimpliesthatthepoorwerereluctanttoborrow 4 Incontrasttothe billion a keyroleinthedecisionto recapitalizeBRIatthetimeof1997/1998Asian a majorcontributortoBRI’s profitability. Theunits’successpresumablyplayed BRI unitsarehighlyprofitable,morethananyother business segmentofBRI,and loan portfolioareoutsideofJava.Withareturnon assets of9.4%in2007,the (Figure 1).Geographically, 37.7%oftheunits’borrowersand49.1% disbursed bytheunitsmonthlyin2007,asteadyincrease from196,200in2003 of theunits’outreachhasbeenunabated;onaverage, 225,000loanswere 4,228 unitsand117villageservicesposts,oratotal of4,345outlets.Thegrowth The restructuredBRIunitsare,attheendof2008,in their25thyear, comprising Challenges andDecisiveFactors inRestructuring b a savingsaccounts. inactive Cleaningof 2006–2007: crisis(hyperinflation); Asianfinancial 1997–1998: Note: number. ()=negative available; =not n.a. Source: Bank Rakyat Indonesia (BRI), Laporan Statistik BRI Unit. BRI LaporanStatistik (BRI), Indonesia BankRakyat Source: End-of-year exchange rates. exchangerates. End-of-year off. excludingloanswritten loansoutstanding, total overdueonedayormorein%of payments Total 072,2,8 ,4. ,1,1 ,6. 6 ,8. . . . 9,419 9.4 1.2 0.9 2,185.1 163 3,461.3 3,515,812 5,646.4 21,229,085 2007 063,0,6 ,5. ,5,2 ,0. 6 ,5. . . . 9,393 8.5 1.3 1.2 1,754.9 160 2,904.8 3,455,528 4,659.7 30,907,566 2006 053,5,4 ,4. ,1,3 ,1. 6 ,2. . . . 9,830 7.0 1.4 1.3 1,424.8 161 2,317.9 3,313,532 3,742.7 32,252,741 2005 043,7,5 ,4. ,1,7 ,6. 7 ,7. . . . 9,285 6.8 1.9 1.3 1,474.4 171 2,067.0 3,210,678 3,541.4 31,271,553 2004 032,6,9 ,3. ,0,5 ,8. 1 ,5. . . . 8,425 5.7 2.5 1.9 1,854.8 210 1,683.4 3,100,358 3,538.2 29,869,197 2003 022,6,7 ,2. ,5,0 ,4. 9 ,8. . . . 8,940 6.4 1.6 1.7 1,283.0 195 1,343.4 3,056,103 2,626.4 28,262,073 2002 012,4,8 ,1. ,9,9 4. 2 ,6. . . . 10,400 5.8 2.2 0.5 1,165.1 223 949.4 2,790,192 2,114.5 27,045,184 2001 002,2,2 ,9. ,1,0 1. 4 ,7. . . . 9,595 5.7 2.5 1.1 1,176.5 244 815.7 2,715,609 1,992.2 25,823,228 2000 992,3,8 ,0. ,7,2 3. 8 ,6. . . . 7,100 6.1 3.1 1.7 1,564.1 286 839.0 2,473,923 2,403.1 24,235,889 1999 982,9,9 ,1. ,5,5 8. 4 ,2. . . . 8,025 4,650 4.9 4.7 5.7 4.7 1.9 2.2 1,426.6 892.8 344 585.3 189 2,457,652 1,007.6 2,011.9 2,615,679 21,698,594 1,900.4 1998 18,143,316 1997 961,4,6 ,7. ,8,3 ,1. 7 ,6. . . . 2,383 5.7 3.7 1.6 1,265.4 174 1,710.5 2,488,135 2,975.9 16,147,260 1996 951,8,6 ,0. ,6,6 ,8. 8 ,2. . . . 2,308 6.5 3.5 1.1 1,223.7 188 1,382.7 2,263,767 2,606.4 14,482,763 1995 941,6,5 ,7. ,5,1 ,1. 1 ,6. . . . 2,200 5.1 4.5 0.7 1,260.9 213 1,117.3 2,053,919 2,378.2 13,066,854 1994 931,3,7 ,4. ,9,6 2. 2 ,2. . . . 2,110 3.3 6.5 2.2 1,122.2 221 927.7 1,895,965 2,049.9 11,431,078 1993 9299324168418172795268893491262,062 2.6 9.1 3.4 848.9 206 799.5 1,831,732 1,648.4 9,953,294 1992 9185782125418759708145464986271,992 2.7 8.6 1,074 4.9 n.a. 544.6 5.4 174 1.0 730.8 (64.1) 1,837,549 1,275.4 38 8,587,872 1991 103.4 640,746 39.3 2,655 1984 907225992918318762131672041301,877 1,793 3.0 1,731 n.a. 1,650 4.1 1,641 n.a. 5.4 1,125 n.a. 7.4 n.a. 2.0 n.a. 2.3 5.8 4.5 4.6 166.7 2.1 62.8 3.0 2.7 (28.5) 123 1.8 (86.2) 113 (96.6) 736.2 91 (128.1) 472.1 67 1,893,138 53 313.3 37 902.9 1,643,980 260.4 534.9 1,386,035 203.7 7,262,509 203.6 284.8 1,314,780 1990 6,261,988 1,231,723 1,034,532 174.2 1989 4,998,038 107.1 75.5 1988 4,183,983 418,945 1987 36,563 1986 1985 erSavings Year Accounts Accounts (Number) al : FinancialPerformance ofBRIMicrobankingUnits,1984–2007 Table 1: ($ million) Savings Accounts Accounts (Number) Loan ($ million) Loans to-Loans Savings- Ratio (%) ($ million) Liquidity Surplus Loan–Loss 12-Month Ratio (%) Arrears Ratio (%) a

Return Assets (%) on Exchange (Rp) Rate $ b

Restructuring of Bank Rakyat Indonesia (BRI) Microbanking Units 5 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank (BRI) 6 Microbanking Units 6 to investscarcefinancialresourcesborrowedatrelatively highinterestrates credit andtheopportunityofsafelydepositingsavings, farmhouseholdsprefer increase. been decliningovertime,theportfolioofrestructured unitscontinuedto flagship ofruralmicrofinance”(Seibel2005). most advancedexampleofthemicrofinancerevolution”(Robinson2001)and“a well-trained staffmembers;and(iv)theirinternationalreputation,laudedas“the the largenumberof their vastoutreach;(iii) (ii) excellent performancesince1984; financial crisis.Decisiveaspectsofthissuccessincluded:(i)theunits’continually 8 7 1984 to$692millionin2007. of agriculturalcreditextendedbytheunitsincreased from$21millionin loans aredirectlyinvestedinagriculture.Usingthis percentage, theamount has beenestimatedthatabout20%ofthenonsubsidized,all-purposeKupedes was reduced;onthecontrary, agriculturalcreditincreasedinabsoluteterms.It replaced bycommercialmicrobanking,doesnotmeanthatagriculturalcredit The restructuringoftheunits,inwhichsubsidizedagriculturalcreditwas Source: Bank Rakyat Indonesia. BankRakyat Source:

1,000 2,000 $ million3,000 4,000 5,000 6,000 that partofamountflowed intononagriculturalactivities. per yearwasdisbursedovera14-year period.Giventhefungibilityofmoney, itmustbeassumed Under thesubsidizedBimas program, an handled bytheunits until1983, average of $101million or approximately$252millionin termsofdisbursements. the annualamountofagricultural Over the24-yearperiod,loansoutstanding averaged$224 0 Figure 1: 9418 9618 9818 9019 9219 9419 9619 9819 0020 0220 0420 062007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 8 Inaddition,thereisanecdotalevidencethatwithunrestricted useof ($ million) Indonesia MicrobankingUnits,1984–2007 Savings DepositsandLoansOutstandingofBankRakyat 7 IncontrasttotheBimasportfolio,whichhad Deposits Loans million, microbanking business: factors ofrestructuringcanbedrawnfromtheexperiencereformBRI’s (iii) areallowedtomobilizeresourceslocally. Severallessonsconcerningdecisive to focusonsustainabilityandoutreach,(ii)areadequatelysupervised, be commerciallyviableiffinancialinstitutions(i)aregivenproperincentives Overall, therestructuringofBRIunitsdemonstratedthatmicrofinancecan by linkingwithothermicrofinanceinstitutions. new institutionalarrangements.Atpresent,BRIistakingstepsinthatdirection depositors, andthecostsavingswouldbelargerthanrequiredfor theory, sucharrangementswouldreducetransactioncostsofborrowersand in extendingservicestounservedorunderservedpopulations.Accordingthe the lendingoperationstocommunity-levelinstitutionsincreasesoverallefficiency strategies? Onetheoryisthat“takingthebanktopeople”bybringingdown financial institutions?Orhasthetimecometodevelopmore-inclusiveoutreach with theirsavingspotentialanddemandforsmallerloansto 50% oftheruralpopulation.Shouldunitsleavemoreremotevillages savings mobilizedlocally, despiteanunmetdemandforcreditbyestimated subdistrict townsandtheirvicinity, theunitshavenotbeenabletorecycle lending technologyandnospecialoutreachmechanismtovillagesbeyondthe 10 9 place thesurpluswithinBRIbranchsystem. 1984–1988 andhasbeenstronglypositivesince1990.Theunitsarerequiredto Figure 1representstheamountofsurplusliquidity, whichwasnegativeduring produced surplusliquidity. Thespacebetweenthedepositandloancurvein recycling thesavingswithinvillageeconomy. Since1989,theunitshave The units’successinsavingsmobilizationhascreatedanewchallenge: resource allocationandinvestmentsamongthefarmhouseholds. the discontinuationofsubsidizedagriculturalcreditpromotedmoreefficient activities, andtofinanceagriculturefromtheirownresources.Thisimpliesthat in activitieswithhighreturns,suchaspettytradingandothermicroenterprise co.id, [email protected] 013 orthrough +62 212513e-mailivp@bri. Micro 644, at Banking, atfaxnumber+62212511 and training program. For moreinformation, please contacttheInternationalVisitorProgram, SBU BRI ispreparedtosharethisexperience withothersthroughexposurevisit an institutionalized 1.6–1.7 timesasmuchsavingsloansoutstanding). (mobilizing and 2007 2004 between times asmuchsavingsloansoutstanding),to163%–171% the unitshavesucceededinloweringtheirsavings-to-loans (mobilizing 3.4 ratio from344%in1998 billion. Overthelast10years, surplus liquidityamountedto$2.19 provide freshcreditlines.In2007, billion, respectively—atatimewhenbanksran out ofloanablefundsanddonorsrushedinto monetary crisis andthefollowing year 1998 year, surplus liquidity wasbillionand$1.56 $1.43 Since 1993, surplus liquidity has been consistentlyabove$1billion exceptin 1997. During the ii Thepoorneedsavingsproductsmorethancredit.Ifboth (iii) Thepoorandnear-poor cansave,andruralfinancialinstitutions (ii) Withattractivesavingsandcreditproducts, appropriatestaff (i) services effectivelyexceedsthedemandforcreditby awidemargin. and creditservicesareoffered,thedemandforsavings deposit mobilize theirsavingscost-effectively. supervision, ruralmicrofinancecanbehighlyprofitable. incentives, andaneffectivesystemofinternalregulation 10

9 Withitsindividualunit-based

Restructuring of Bank Rakyat Indonesia (BRI) Microbanking Units 7 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank (BRI) 8 Microbanking Units 8 vi Financesectorpoliciesthatarefreeofdistortivepoliticalinterference (vii) Cateringtoboththepoorandnonpoorenablesfinancialinstitutions (vi) Inmicrofinance,outreachtovastnumbersofpoorpeopleistheway (v) Rigorousmonitoring,promotionofgoodcreditculture,and (iv) are conducivetofinancialinnovations. volume oftransactions. while atthesametimeincreasingprofitabilitywithincreased to loweraveragetransactioncostsaswellinterestratesonloans, to viability, self-reliance, andfinancialself-sufficiency. microfinance. incentives fortimelyrepaymentarethekeytosuccessful enforcement power. regulation andsupervisionbyBankIndonesia,whichlackedindependence However, theexpansionoffinancesectorwasnotaccompaniedbyeffective concomitant lossofmarketsharebythestate-ownedbanks. central bank.Thisledtoarapidexpansionoftheprivatebankingsectorand 13 12 11 Bank Perkreditan Rakyat(BPR) provided alegalframeworkfortheestablishmentofregulatedruralbanks— the establishmentofnewcommercialbanksandbankbranches.Thelawalso policy of1983wascontinuedin1988byalaw(PAKTO27) designedtoease 20% smallandmedium-sizedenterprise(SME)lendingquota.Thederegulation largest remainingsubsidizedcreditprogramswerephasedoutandreplacedbya placing aheavyburdenonitsbranches;itwasonlyin1990that32ofthe36 1 and2).Atthattime,BRIstillhandledmorethan300governmentprograms, of thebank’stotalloanportfolioand14.6%itsdepositbalance(Tables and theotherstate-ownedbanks.By1989,unitsaccountedforamere8.1% commercial microbankingunits,buthadlittleeffectonthemainbusinessofBRI from theBRIvillageunits.Thisledtotheirtransformationintohighlyprofitable the interestrateregimeofstate-ownedbanks,andwithdrewitsliquiditysupply by theGovernmentofIndonesia.InJune1983,governmentderegulated exports, initiatedaneraofliberalizationandgradualwithdrawalsubsidies The declineinoilprices1982,andtheresultinglossofincomefrom Pre-Restructuring Period collapse ofthebankingsector, andthedownfallofpoliticalregime. the monetarycrisisin1997–1998,whichledtoastandstillofeconomy, the The processofexpansionarygrowththebankingsectorwasinterruptedby sector waspracticallyoutofcontrol. which wasthusunabletoenforceprudentbankingsupervision,andthe under politicalinfluence.Until1999,thegovernmentcontrolledBankIndonesia, of theirparentconglomeratecompanies.Lendingdecisionsstatebankswere markets andcompetedvigorouslyfordomesticdepositstofinancetheexpansion by bigbusinessconglomerates.Thesebanksborrowedcheaplyoninternational Indonesia. 1997, many, including the World Bank, continued tobelieve in the robustness of the economy of soundness so as to create an efficient, solidlyestablishedbanking system.” Even by theendof reporting years, banksmaintainedtheireffortstopromote favorable economicin the developments Bank Indonesiareportedthat,”against (p. 62),thebackdropof In itsannual report 1996–1997 in 1995,and(iv)anincreaseofminimumreserverequirementsfrom 3%to5%. 8% andsettingdeadlinesforbankstomeetlegallendinglimits,(iii) taxincentivesforbankmergers taking Rp8.1trillionfrom (i) atightmoneypolicyin1991state-owned banks,(ii)raising the CARto effect: take slow to were but to 1996, from 1991 instituted positions, anumberofmeasureswere open adequacy (capitalratiosorCARs),legallendinglimits andforeignexchangenet Following the establishmentofa timetable for the introduction of prudentialstandards of capital Indonesia. AllLembagaDanaKreditPedesaanweresupposedtobetransformed into regulated Kredit Pedesaan as LembagaDana to also referred which were under provincial law), (most ofthem institutions PAKTO27passage of the before “BPR” wasused term The for nonbankfinancial as agenericterm continue tocoexistwithBPRslicensedbyBankIndonesia. opposition intheprovinces.Asaresult,ruralfinancial institutions licensedunderprovinciallaw BPRs; butBankIndonesiawasunabletoenforcethistransformation process becauseofstrong . Since PAKTO27,. Bank by and supervised BPRs licensed “BPR” refersonlyto the term 12 Manyofthenewprivatecommercialbankswereowned Restructuring ofBankRakyatIndonesia 11 —under thesupervisionofBankIndonesia, 13

ProtocolRestructuring at the of Asian Bank Development Rakyat Indonesia Bank 9 9 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank 10 10 BRI becametechnicallybankrupt, butittookthegovernmentuntil1999to surged to52.98%,andthe netlossamountedto$3.3billion(Tables 2and5). fell by0.6%comparedwith1996;thegrossnonperforming loans(NPLs)ratio By 1998,duetohighinflationanddevaluation,BRI’s assetsinUSdollarterms depositor andcreditorrunsonthebanks. to copewiththesurgeinexchangeandinflation rates,capitalflight,and of adequatesupervision.Asthecrisisunfolded, banking sectorwasunable expansion. Allofthesefactorswereexacerbatedby weak regulationandalack mismatches; and(iii)alackofmarketdisciplineafter yearsofrapideconomic including insiderlendingandpoliticalinterference;(ii) currencyandmaturity the commercialbankingsectorhadbeenlargelydue to(i)poorgovernance, foreign exchangeandcorporateexposure,wereless affected.Thefragilityof The monetarycrisismostseverelyaffectedcommercialbanks,butBPRs,without borrow $10billion. approved a3-yearstandbyagreementunderwhichthegovernmentwasto support.InNovember1997,theIMF committed toimplementundertheIMF’s sector reformwasoneofthreemajorinitiativesthatthegovernment Monetary Fund (IMF)describingits3-yeareconomicreformprogram.Finance In October1997,thegovernmentsignedaletterofintentwithInternational Indonesia. BankRakyat Source: Year-endfigures. Note: (%) deposits ratio Loans-to- equity (%) Return on assets (%) Return on Financial Ratios tax ($million) Income after ($ million) income Net interest Profit/Loss ($ million) Equity ($ million) Deposits ($ million) Loans (gross) ($ million) Total assets Item al : BankRakyatIndonesiaFinancialHighlights, Table 2: ,7. ,5. ,3. ,0. ,7. ,0. ,7. 8,101.1 6,970.1 6,802.7 6,970.1 6,807.0 5,836.3 5,150.2 3,674.3 ,3. ,4. ,4. ,8. ,7. ,5. ,7. 11,225.3 9,775.1 8,757.3 9,070.6 8,886.0 7,945.3 7,841.8 5,834.4 ,5. 05531,4. 21051,6. 16271,7. 14,440.2 12,376.9 11,682.7 11,863.0 12,130.5 10,648.6 10,565.3 7,758.5 9919 9119 9319 951996 1995 1994 1993 1992 1991 1990 1989 5. 5. 3. 3. 3. 2. 4. 138.6 140.2 128.7 130.1 130.5 136.1 152.3 158.8 5. 0. 3. 6. 8. 1. 8. 672.3 681.1 618.2 487.7 468.5 437.8 505.1 355.3 6. 8. 0. 5. 3. 2. 1. 759.5 711.0 621.4 535.5 453.9 200.3 185.4 160.6 663. 33 .264 .857 5.26 5.74 5.28 6.44 6.12 13.39 31.0 26.6 .505 .537 .103 .20.70 0.62 0.33 4.51 3.74 0.25 0.54 0.55 295. 662. 463. 63101.1 76.3 38.2 34.6 27.6 26.6 57.5 42.9 Pre-RestructuringPeriod, 1989–1996 as collateral. micro borrowerstohavetheir housingplotsregisteredandtoofferthem centers andinaprogramoflandcertification,which enablessmalland subsequently participatedintheestablishmentof18 of 80%itsportfolio.Insupportthemicroand SMElendingfocus,BRI and reconfirmeditscommitmenttomicroSME lending,withatarget sector, whichwasthemostproblematicportfolioduringmonetarycrisis, of theportfoliocomposition.BRIdrasticallyreduced itslendingtothecorporate The restructuringofnonperformingassetswasaccompanied byarestructuring in January1998totakeoverinsolventbanksandabsorb nonperformingassets. Indonesian BankRestructuringAgency, whichwascreatedbythegovernment ($2.2 billion)ofNPLsinvolving190major, mostlycorporate,badloanstothe BRI restructureditsproblemloansandtransferreda totalofRp15.66trillion banking servicesforindividualclients. (Britama) withautomatedtellermachineaccess.BRIalsoimproveditsinvestment product diversificationandinnovation,introducedanonlinesavings among thebank’sbusinesssegments(Table 4).Furthermore, BRIinitiated expanded itsmicroandconsumerlending,whichhadthelowestNPLratios and operatedwithoutgovernmentsubsidies.Underthenewstrategy, BRI For severalyearsbeforethecrisis,BRI’sunitswerehighlyprofitablebusinesses overcome thecrisisalonglineslistedinBox1. Immediately aftertheformulationofORP, BRItookshort-termmeasuresto system, and(vi)managementinformationsystem(MIS)enhancement. operating costsandefficiencyimprovement,(v)reorganizationoftheaccounting business strategy,enhancing riskmanagement,(iii) portfolios, (ii) (iv)reductionof ORPs weremainlyfocusedon(i)resolutionofNPLsandrestructuring committee forpreparingORPs forthreestate-ownedbanksincludingBRI. In February 1999,theMinistryofState-OwnedEnterprisesestablisheda and (iii)partialprivatization. implementation ofanoperationalrestructuringplan(ORP),(ii)recapitalization, BRI restructuringduring1999–2003encompassedthreephases:(i)the weight ofthebank’sloss-generatingcorporatesector. Subsequently, the a focusonSMEsincludingthoseinruralareas,whiledecreasingtherelative restructure insolventbutpoliticallyimportantbanks.ItkeptBRIalive,with launched bythegovernmentinAugust1998,decidedto Under theForward StepsforBankImprovementandRestructuringProgram, Crisis-Driven Restructuring keep thebankfrominsolvency. still toosmall(andtheperformanceofotherbusinesssegmentspoor)to 1996 (slightlylowerin1997),theunits’shareofbank’stotalbusinesswas but at15.2%ofthebank’stotalportfolioand36.7%itsdepositbalancein renown ofBRI’smicrobankingunitsplayedanimportantroleinthatdecision; amalgamation ofseveralfailedstatebanks.Theperformanceandinternational bank andtomergetheremainderofwithnewBankMandiri,an decide whethertorestructureBRI,orseparatetheunitsinanewmicrofinance SME businessdevelopment

ProtocolRestructuring at the of Asian Bank Development Rakyat Indonesia Bank 11 11 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank 12 12 a riskmanagementcommittee atthebank’shighestlevel,consistingof introduced aspartofthedue diligenceprocess.InMarch2002,BRIestablished Aligned withthenewoperational strategy, theratingofsmallbusinesses was Various enhancementsweremadeinrisk managementandprudentialbanking. Sources: Bank Rakyat Indonesia. BankRakyat Sources: Management InformationSystemandAccountingImprovement 6. Organizational EffectivenessandEfficiency 5. OperationalEfficiencyandCostReduction 4. BusinessStrategyRedefinition 3. RiskManagementInitiatives 2. LoanRecoveryEfforts 1. • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • Box 1: Information technologyrestructuring Management informationsystemandaccountingrestructuring Voluntary staffretirement Closing ormergingsomeregionalofficesand auditoffices Implementing ahub-spokebranchofficeconcept Control improvement Office automation Reviewing relationshipwithsubsidiarycompanyandpensionfunds transit andothercosts Reviewing thirdpartyservice,travel,education,insurance,cashin Reviewing maintenanceandrepairpolicy Minimizing expeditioncost Reviewing purchasingpolicy Reconstruction ofbusinessstrategy Redefining businessconcept Computerized assetliabilitymanagementplanningmodel Asset liabilitymanagementimprovement Establishment ofaloanadministrationdivision improvement Dynamic monitoringsystemandportfoliomanagementcapability Analysis andriskratiostandardizationformedium-sizedbusinesses Risk ratingsystemforsmallbusinesses Loan applicationformsimplification Early warningsystem Consumer loandatacollectiontomonitorquality Restructuring 20largestobligorsamountingtoRp8.9trillion Restructuring 42debtorsamountingtoRp3.0trillion Strengthening loanrestructuringdepartmentinregionaloffices accurate andtimelyinformation Improving managementinformationsystemstoprovidemore Setting portfolioanalysisconcept Training inloanrestructuring Adding loanrestructuringstaff Setting loanrestructuringpolicy Restructuring Program,Completedasof30September1999 First PhaseofBankRakyatIndonesiaOperational

14 government kept59.5%ofthesharecapitaland publictook40.5%. shares wereoversubscribedby15.4times.Afterthe partialprivatization,the listed ontheIndonesianStockExchanges.Atinitial publicoffering(IPO), In November2003,BRIbecameapartiallyprivatized publiccompanyandwas requirements ofBankIndonesia(Table 5). BRI startedyieldingaprofit.Allotherfinancialindicators mettheregulatory The NPLratiowasatahistoricallylowlevel.After2 years ofmassivelosses, The resultsoftheserestructuringactivitiesbecamevisible bytheendof2000. government inNovember2001. (CAR) of4%.AnexcessRp0.9trillion,plusinterestearned,wasreturnedtothe Rp8.7 trillioninOctober2000,toachieveastipulatedcapitaladequacyratio to berepaidinduecourse;andRp20.4trillionwastransferredJuly2000 of Rp29.06trillion($3.0billion)ingovernmentbondswasinjectedintothebank, immediately followedbyrecapitalizationofthebankgovernment.Atotal The installationofthenewboarddirectorsandcommissionerswas investment effectiveness. operational riskmitigation,efficiency, andinformationtechnology services, real-timeonlineinformationaccess,automatedtellermachinesharing, structures; and(v)theintroductionorimprovement,respectively, ofonline redefinition oftheaccounting,supervision,financialreporting,andauditing relations liability, duediligence,andcompensationprogramimprovement;(iv)a procedures; (iii)anorganizationaldiagnosisforcreditriskmanagement,human establishment ofintegratedsettlementandtreasuryoperationguidelines platform, includingsystemredefinition,separationoffrontandbackoffice, relationship management;(ii)improvementstotheinformationtechnology introduction oftheprincipleseparatingcreditriskmanagementfrom for BRIincluding(i)establishmentofaloanrestructuringdivisionandthe management performanceagreementstipulatedfurtherrestructuringsteps performance targetsandtimeframesupto31December2003.Theinvestment requiring managementtodevelopandimplementabusinessplanwithspecific into aninvestmentmanagementperformanceagreementwiththegovernment, and commissionersinJuly2000.ThenewBRImanagementwasaskedtoenter A keyaspectofBRI’srestructuringwastheinstallationnewboarddirectors agents, andmotivators. them whohaveexceptionalperformancerecordstoserveasrolemodels,change a workethicsprogramforabout35,000employeesbyappointing1,000of reputational (BRIAnnualReport2003:25).Since2001,hasalsoimplemented eight risks:operational,market,credit,liquidity, compliance,legal,strategy, and Management, whichwasresponsibleforintegratedriskmanagementcoveringall management organizationinasingleunit,theDivisionforComplianceandRisk of newregulationsbyBankIndonesia,BRIsubsequentlyconsolidateditsrisk board ofdirectorsandseniormanagement.Following theimplementation ownership atthetimeofIPOwas44.7%domestic and55.3%foreign;by government maygiveupitsmajority ownership. is noindicationthatthe this stage,there At 2008. in September The publicsharewas43.17% 14 Public

ProtocolRestructuring at the of Asian Bank Development Rakyat Indonesia Bank 13 13 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank 14 14 length ofthepreviousreports. two volumes,oneinEnglishandBahasaIndonesia,atmorethantwicethe in theorganization’sannualreports,whichsince2003havebeenpublished shareholders. Thebank’snewattitudetowardpublicrelationsisdemonstrated crucial forBRItocomplywithcapitalmarketregulationsandgainthetrustof foreign. GoingpublichasrequiredaparadigmshiftforBRI.Itbecome changed thepublicownershipcompositionto20.9%domesticand79.1% 31 December2003,mostofthedomesticownershadsoldtheirshares,which portfolios, 30.0% of BRI’s loan portfolio reportedly is in rural and portfolios, 30.0%ofBRI’sloanportfolioreportedlyis inruraland medium loans(upto$5million)were5.7%(Table 4).Intermsofruralandurban 1.7%, whiletheNPLratiosforsmallcommercialloans (upto$500,000)and 2007, theNPLratioofmicroloans(upto$5,000)was 1.2%andconsumerloans, portfolio ofsmallloanshasperformedmuchbetter than itsbiggerloans.In incentive andriskmanagementstructuresinmicro consumerlending,BRI’s and SMElendinggrewfrom65.5%to82.6%(Table 3).Duetomoreeffective sector wascutinhalffrom34.5%1998to17.4% in2007,whilemicro substantially changedBRI’sportfoliocomposition.Lending tothecorporate SME sectors,thelatterincludingagriculture.Thereform during1999–2003 BRI owesitssuccessafterthecrisistoemphasison theurbanandmicro terms ofloansoutstanding,andthebestinprofitability. the thirdlargestbankintermsoftotalassetsanddeposits,second As ofApril2008,BRIhadthemostextensivedeliverynetworkinIndonesia,was useful. Corporateloansarebyfartheriskiest,butatadecliningrate. analysis ofrisksbyloansizeinthesmallcommercialsegmentwouldbe range ofloansupto$5millionarenotyetmanagedwell;amoredetailed loans upto$20,000haveperformedbest.Therisksofthesmallandmedium variance overtimeoftheNPLratio,segmentsmicroandsmallconsumer a goodbusinessdecisionforthetreasuryofIndonesia.Intermsleveland recapitalization, BRIpaid$1.03billionintaxes,makingtherestructuringof net profitof$513.6million.Duringthe7yearssince2001,yearafter increasing by87.5%from$440.6millionto$826.0million,yieldinganafter-tax the industry’snetinterestmarginof5.7%;profitbeforetaxmorethandoubled, margin increasedfromanalreadyremarkablyhigh9.5%to10.9%,farabove to 69.8%,betterthanthebankingindustryratioof84.1%;netinterest expenditure asapercentageofoperationalincomedecreasedfrom79.8% With thecostoffundsloweredfrom7.9%in2003to4.5%2007,operational in 2007,betterthanthebankingindustryat4.1%(Figures2and3). from agrossNPLratioof6.0%in2003,aboveBankIndonesia’s5%limit,to3.4% by 113.9%from$5.6billionto$12.1billion.Portfolio qualityimprovedmarkedly, grew by92.3%from$11.2billionto$21.6billion.Grossloansoutstanding showed impressivegrowth.From 2003–2007,totalassets inUSdollarterms During theslightlymorethan4yearsafterIPO, untilDecember2007,BRI Post-Restructuring Period Source: Bank Rakyat Indonesia. BankRakyat Source: Source: Bank Rakyat Indonesia. BankRakyat Source: loan. NPL=nonperforming adequacyratio, CAR =capital

-140 -120 -100 % $ million iue3 BankRakyatIndonesiaCapitalAdequacyRatio,Nonperforming Figure 3: 25,000 20,000 15,000 10,000 –5,000 -80 -60 -40 -20 5,000 20 40 60 80 0 0 iue2 BankRakyatIndonesiaTotal Assets,LoansOutstanding, Figure 2: Loan Ratio,ReturnonAssets,andEquity, 1996–2007 9619 9819 0020 0220 0420 062007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 9619 9819 0020 0220 0420 062007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 CAR Deposits, andEquity, 1996–2007 Total assets Total NPL (gross) ($ million) Loans (gross) Loans (%) Return onassets Deposits Total equity Total Return onequity

ProtocolRestructuring at the of Asian Bank Development Rakyat Indonesia Bank 15 15 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank 16 16 further improveitsriskmanagementinagriculturallending. loans ishigherthantheratioforoverallportfolio—achallengeBRIto agricultural loanproviderinIndonesia.Theratioofnonperforming and accountsforalmost30%ofthetotalportfolio.ThismakesBRIlargest 70% inurbanareas.BRI’sagriculturallendingamountstoabout$3.5billion c b a Source: Bank Rakyat Indonesia. BankRakyat Source: loansoutstanding. total valueof loansto nonperforming dollarvalueof of =ratio loan(NPL)ratio Nonperforming Source: Bank Rakyat Indonesia. BankRakyat Source: (%) Segment Business Micro (%) ml osmr pt 0 ilo 0002329 1. 1.67 19.3 2,332.90 20,000 Upto200million Small Consumer ml omrilU o5blin50003299 2. 5.71 5.67 27.3 7.3 3,299.91 882.39 500,000 500,000–5million 5billion–50billion Upto5billion Medium–Scale Small commercial Commercial Small Corporate ir % 111. 033. 073. 103. 0228.6 30.2 30.4 31.0 30.6 30.7 30.8 30.3 18.2 11.1 Micro (%) Total cl % ...... 7.3 8.3 6.3 4.7 4.4 3.9 4.9 6.7 5.4 4.2 Scale (%) Medium- Consumer Small (%) Corporate oa % 0. 0. 0. 0. 0. 0. 0. 0. 0. 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Total (%) R rlin 21 24 57 19 90 75 19 49 02 113.85 90.28 74.90 61.98 47.53 39.03 31.98 25.79 32.45 42.16 (Rp trillion) Total $blin .545 .930 .756 .876 .112.09 9.61 7.62 6.68 5.64 4.37 3.07 2.69 4.57 5.25 ($ billion) Total ae(p ,2 ,0 ,9 0408908459259809339,419 9,393 9,830 9,285 8,425 8,940 10,400 9,595 7,100 8,025 rate (Rp) Exchange Business segment Small commercialloansincludeprogramandSharialoans. Small consumer loans include salary-based, car, mortgage, and credit cardloans. andcredit mortgage, car, Small consumerloansincludesalary-based, Highlights. inFinancial reported those from slightly 1998–2005differ inrupiahanddollarsfor Totals b

c

9819 0020 0220 0420 062007 2006 2005 2004 2003 2002 2001 2000 1999 1998 294. 751. 412. 762. 7027.3 27.0 27.9 27.6 26.6 24.1 19.2 17.5 46.8 42.9 451. 372. 691. 351. 3317.4 13.3 13.3 13.5 14.6 16.9 20.8 23.7 18.6 34.5 al : BankRakyatIndonesiaLoansOutstanding Table 3: . 102. 432. 382. 212. 19.4 21.2 22.1 23.2 23.8 24.4 24.3 21.8 11.0 7.3 al : BankRakyatIndonesia Nonperforming Table 4: pt 0mlin5003470 2. 1.19 28.6 3,457.05 5,000 Up to50million 5 ilo 5mlin2132 1. 4.62 17.4 2,103.24 >5million >50 billion Rupiah

by BusinessSegment,1998–2007 Loan RatiosbyBusinessSegment Loan Size $ 2075 0. 3.44 12,087.59 100.0 ilo % $ million Portfolio 31December2007 a NPL Ratio(%) Table 5: Bank Rakyat Indonesia Financial Highlights, 1996–2007 (Year-End, $ million)

Item 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Total assets ($ million) 14,440.2 8,809.5 4,252.3 4,368.3 6,913.4 7,326.4 9,658.3 11,241.5 11,528.3 12,489.9 16,472.4 21,616.3 Loans (gross) ($ million) 11,225.3 6,817.6 5,410.1 3,929.7 2,817.1 3,223.9 4,404.1 5,649.7 6,717.1 7,683.9 9,611.7 12,087.6 Government recapitalization bonds ($ million) 0.0 0.0 0.0 0.0 3,020.5 2,734.2 3,176.1 3,275.6 2,443.3 1,802.8 1,963.7 1,934.7 Deposits ($ million) 8,101.1 5,417.8 5,324.2 5,801.0 5,129.4 5,553.7 7,788.3 9,058.3 8,874.5 9,872.4 13,251.3 17,568.2 Total equity ($ million) 759.5 395.1 (3,083.7) (3,702.4) 422.4 462.9 648.1 1,003.4 1,340.9 1,358.4 1,797.0 2,063.7 Profit/Loss Net interest incomea ($ million) 672.3 422.8 (203.6) (149.0) 291.1 477.1 680.1 952.8 1,212.5 1,267.2 1,466.0 1,772.7 Income before tax ($ million) 144.8 29.9 (3,308.5) (235.4) 35.0 109.7 164.4 440.6 617.2 570.5 628.9 826.0 Income after tax ($ million) 101.1 12.0 (3,308.5) (235.4) 35.3 102.3 170.6 306.1 391.3 387.5 453.3 513.6 Financial Ratios Total Capital Adequacy Ratio (%) 8.69 8.10 (61.54) (118.35) 14.35 13.32 12.62 18.94 16.19 15.29 18.82 15.84 Nonperforming Loan Ratio (Gross) (%) 10.60 11.40 52.98 19.94 4.96 4.93 6.74 6.03 4.19 4.68 4.81 3.44 Return on assets (%) 0.70 0.14 (77.80) (4.77) 0.68 1.62 1.83 4.02 5.77 5.04 4.36 4.61 Return on equity (%) 5.26 3.04 n.a.b n.a.b n.a.b 30.36 38.81 43.41 42.76 37.92 33.75 31.64

ProtocolRestructuring at the of Asian Bank Development Rakyat Indonesia Bank 17 17 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank 18 18

Item 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Cost of funds (%) n.a. n.a. n.a. n.a. n.a. 9.14 10.04 7.86 4.60 4.73 6.27 4.52 Net interest margin (%) n.a. n.a. (3.18) (3.41) 6.60 7.60 8.12 9.54 12.16 12.17 11.16 10.86 Operating expenses/ operating income (%) 93.46 97.33 361.98 118.37 96.05 90.81 89.92 79.82 68.86 70.45 74.38 69.80 Loans-to-deposits ratio (%) 138.57 125.84 99.85 62.28 53.61 56.08 56.55 62.37 75.69 77.83 72.53 68.80 Inflation rates, year-end (%) 6.47 11.05 77.54 2.01 9.35 12.55 10.03 5.06 6.40 17.11 6.60 6.59 Rp/$ exchange, year-end (Rp) 2,383 4,650 8,025 7,100 9,595 10,400 8,940 8,425 9,285 9,830 9,393 9,419

0.00 = less than 0.01; ( ) = negative number; n.a. = not available. Note: In cases of discrepancies between different sources, this table contains the latest figures available. a With government recapitalization bonds interest. b Not calculated because of negative capital, including the year of recapitalization. The recapitalization was in October 2000. Source: Bank Rakyat Indonesia (BRI) annual reports; BRI Financial Updates Full Year 2007. compliance withBRI’sgood corporategovernancepolicies,thecodeofethics, audit committeethatreports totheBOC.TheBOCevaluatesinternalcontrol, commissioners, whodonotservefulltime,aresupported byanewlyestablished BRI of1968reservesBODandBOCpositionsfornationals ofIndonesia.The and attendedvariousprofessionaldevelopmentprograms abroad.TheActon third fromastatetourismenterprise.Allthreehadstudied intheUnitedStates came fromBankIndonesia,onethestatedevelopment bank,andthe president; heresignedafter1year. Ofthethreeothercommissioners,one commissioner, appointedbytheMinistryofFinance,wasaformeruniversity Indonesia failedtopassBankIndonesia’sfitandproper test.Thepresident control. Thecandidatefortheboardpresidencyproposed bythePresidentof apex ofathree-tieredsystemexternalaudit,internal audit,andinternal The boardofcommissioners(BOC),whichhasfourmembers, isatthe down byBankIndonesia;onlythethirdwasaccepted. Two candidatesproposedby the PresidentofIndonesiaatthattimewereturned influence whenthenewchiefexecutiveofficer(CEO)ofBRIwastobeappointed. years. Initsnewstrengthenedposition,BankIndonesiawasabletoexercise financing statebank.Ofthesixdirectors,fourhadworkedatBRIfor20–25 BRI andhadpreviouslyworkedfor30yearsatBankDagangNegara,atrade sector experienceontheboard.Thepresidentdirectorhadbeenaat board ofdirectors(BOD)hadastatebankingbackground;therewasnoprivate took over. ItsspecialtaskwastoprepareBRIforitsIPO. Allmembersofthenew were restrictedbyitslackofautonomy. InJuly2000,anewBRImanagement Indonesia isthefinancialsupervisor;butuntil1999,BankIndonesia’spowers employed BRI’smanagementanddefineditsgeneralbusinesspolicy. Bank State-Owned Enterprisesactedasadministrativesupervisor. Thegovernment Indonesia, withtheMinistryofFinanceasonlyshareholder. TheMinisterfor Until 10November2003,BRIwaswhollyownedbytheGovernmentof making, i.e.,tobetterfulfillitsmission,butnotattheexpenseofmissiondrift. successful. Partial privatizationhelped toclarifyBRI’scommitmentprofit lending wasreducedandrestructured.Thisstrategyturnedouttobeimmensely and SMEfinancesinceitsinceptionin1895wasreconfirmed,corporate banks orotherstateinstitutions.Atthesametime,BRI’shistoricfocusonmicro were selectedfromthestateapparatus,havingservedinseniorpositions government didtheopposite.Alldirectors,commissioners,andseniorofficers contract toaninternationalconsultingfirmandredefineBRI’smission.The One mighthaveexpectedthatthegovernmentwouldawardamanagement The restructuringofBRIwasaresponsetoanunprecedentedsystemiccrisis. factors inBRI’sturnaroundtowardgoodgovernanceandcontinualgrowth? turnaround andsteadilyimprovingperformance.Butwhatwerethedecisive restructuring thatthenewmanagementconvincinglydemonstratedasustainable prudential regulation.Itwasduringthe3yearsimmediatelyfollowing to theprinciplesofgoodcorporategovernanceundereffectivelyenforced management, reformulatedtargets,effectiveriskandadherence The BRIreformscomprisedanewmanagementteam,bettercontrolof Decisive Factors inRestructuring

ProtocolRestructuring at the of Asian Bank Development Rakyat Indonesia Bank 19 19 RestructuringProtocol at the of Asian Bank DevelopmentRakyat Indonesia Bank 20 20 were exceededbyaconsiderablemargin. over andabovethoserequiredbythegovernment.Andthesehighertargets business plan.ThenewCEOsetthetargetsforcapitaladequacyandprofits During BRI’srestructuring,ambitioustargetswereatthecoreofbank’s example, andhumanresourceappreciation. culture, namely, integrity, professionalism,customersatisfaction,settingagood and codeofconduct,stipulatingtheprincipaldimensionsitscorporate being publishedintheannualreport.BRIhasdevelopedaworkethicsprogram Attendance atboardandauditcommitteemeetingsisunderpublicinspection, manual, whichdefinesthedutiesandresponsibilitiesofBODBOC. operations. Guidelinesfortheirimplementationarespelledoutinaboard BRI isdeterminedtoapplygoodcorporategovernanceprinciplesallofits multilayer systemfortheunits. audits andmanagementsupervision,12regionalofficesforthebranches,a BRI’s supervisionandauditstructurecomprises11inspectionofficesforinternal reports tothepresidentdirector, meetsregularlywiththeauditcommittee. and theworkofexternalauditors.Theinternalauditdepartment,which 15 more. Inaddition,BRIintroducedamanagementstock optionprogramandan rewarded withtheequivalentofuptofourextramonthly salarypaymentsor combining corporateandindividualincentives;excellent performancewouldbe extra 1monthsalaryperyear. In2002–2003,anewformulawasintroduced, branches; thestaffinprofitablebrancheswouldreceive theequivalentofan in theunits.In2000,anewcompensationprogram wasintroducedforthe October 2000.Until2000,aperformance-basedincentiveschemeexistedonly banks. To motivateBRI’semployees,salarieswereincreasedby20%–30%asof At thetimeofrestructuring,BRIhadlowestsalariesamongstate-owned and ontelevision. public media,withalmostweeklyappearancesinnationalandlocalnewspapers branches. To reach35,000employeesscatteredthroughoutthecountry, heused and managementtocommunicatefreelywithstaffattheheadofficein to allstaffmembersandannounceda“walk-and-talk”strategyfortheboard practical terms,hemadehismobilephonenumberande-mailaddressavailable new CEOconveyedanemphasisondirectcommunicationashisfirstmessage.In in itsplanning,decisionmaking,andcommunication.Comingfromoutside,the communication andincentives.Likeallstatebanks,BRItendedtobebureaucratic culture towardanopenstyleofmanagementandemphasisongreater Implementation ofthenewcorporateplaninvolvedachangein interfering, givingmanagementtheneededindependence. payment farabovetargetsactedasincentivesforthegovernmenttokeepfrom in 2003. and Rp2.58 trillion in2002, Rp1.47 trillion in2001, actual profitsbeforetaxeswere Rp1.14 and Rp2trillionin 2003; Rp1 trillionin2002, billion in2001, increased profittargetstoRp500 the CAR rose to 14.4%and profitsreachedRp336billion,i.e.,30timesthetarget.TheCEOthen and announcedprofitmaximization increased thetargetCARto12.5% as atarget.Within6 at Rp11billion.TheCEO The governmentrequiredaCARof8%andsettheprofittarget for 2000 15 Ever-increasing dividendsandtax months, trillion 16 employee stockownershipprogram. than division. employees; profitmaximizationwouldrequirescaling-up andintegrationrather splits unitsintwooncetheyreachabusinessvolume requiringmorethaneight presently servedoftheapproximately10,000totalsubdistricts. Inaddition,BRI BRI intendstofurtherexpanditsoutreachbeyondthe4,300subdistricts remote areas, requiring branch and unitprofitability, butnotprofitmaximization. maximization atBRIisnotunlimited.For example,thebankcontinuestoserve on profitmaximizationinpreparationforpartialprivatization.However, profit bank havereinforcedthiscommitment.Themainemphasisofthenewplanwas commitment. Inaddition,theprudentialregulationsenforcedbycentral together witheffectiveriskmanagement,playedcrucialrolesindevelopingthis and performanceexcellence.Opencommunicationstaffincentives, both thegovernmentandbankmanagement,togoodcorporategovernance Driven bythecrisis,adecisivefactorhasbeenfirm,newcommitment evaluating theirrespectiverisks. measuring theperformanceofeveryemployeeandorganizationalunit awareness culture,BRIhasalsodevelopedariskself-assessment mechanism, risk, pricing,capitalallocation,andportfoliomanagement.To promotearisk been basictothecalculationofallowancesforpossibleloanlosses,capitalat rating system,whichprovidesinformationtoitsearlywarningsystemandhas written riskmanagementpolicy. Since2002,BRIhasimplementedacreditrisk a singledivisionforcomplianceandriskmanagement,whichimplementsBRI’s regulations byBankIndonesia,riskmanagementatBRIhasbeenintegratedin senior managementmembers.Asof1January2004,followingadoptionnew in turnsupervisedbyariskmanagementcommittee,comprisingtheBODand for creditadministration;andmarketriskbythetreasurydivision.Thesewere by thedivisionofcomplianceandriskmanagement;credit and liquidityrisks.Since2002,operationalintegratedrisksweremanaged comprising credit,market,operational,strategic,compliance,legal,reputation, at BRI.AsrequiredbyBankIndonesiasince2003,BRImanageseightrisks, Risk managementhasmovedtothecenterofattentiongoodgovernance domestic privateownershipfellfrom18.1%to12.1%and4.7%. IPO, 28.4%bytheendof2003,and38.3%at2006;correspondingly, 2008. Foreign institutionsowned22.4%ofthesharecapitalattime to 43%asof2006.Thepublicownershipsharewas43.2%September government’s ownershipdeclinedto57%whilethepublic’sincreased the listingofnewsharesfromBRI’smanagementstockoptionprogram, performance rewardsmadethestafffeelrecognizedandmotivatedthem.With o tlat1ya;tesokoto a nrae oR4mlini 02adR6millionin2003. for atleast1year;thestockoption wasincreasedtoRp4millionin2002andRp6 Before goingpublic,thestaffwere toreceiveRp4millionincashandRp2stocksbeheld 16 Thenewcultureofcommunicationand

ProtocolRestructuring at the of Asian Bank Development Rakyat Indonesia Bank 21 21 ConclusionsProtocol at the and Asian Lessons Development Learned 22Bank 22 Conclusions andLessonsLearned be appliedintherestructuringofSOFIs: the countrycontext.However, therearesomefundamentalprinciplesthatshould Effective methodologiesoffinancialinstitutionrestructuringdiffer, dependingon incentives, togetherwitheffectiveriskmanagement. a strongemphasisoncommunication,andambitioustargetsperformance the reformsforwardhaveincludedacorporatecultureofopenmanagement, of reformscoveredallsegmentsthebank.Additionalpositivefactorsmoving highly effectivesystemofinternalcontrolwasputinplace.Thesecondgroup first setofreformswaslimitedtothemicrobankingbusinesssegment,wherea management, togoodcorporategovernanceandperformanceexcellence.The driving forcehasbeenfirmcommitments,fromthegovernmentandbank backgrounds mainlyinstateinstitutionsratherthantheprivatesector. The were implementedbymanagementteamsfromIndonesia,withprofessional context ofanoverallbankingsectorrestructuringprocess.Bothsetsreforms generated thepoliticalwilltoreformBRI,firstinmicrobankingandthen crisis in1982andaseverefinancialaswellpolitical1997–1998, reform. InthecaseofBRI,government,respondingtobothaneconomic crisis toovercomevestedintereststhatstandinthewayofrestructuringand acknowledged andrespondedto.Governmentsoftenneedamajorexternal Crisis isinevitable,andcanresultinpositivechangeswhenproperly Indonesia, resilientagainstthecurrentglobalfinancialcrisis. created whatisnowthemostprofitablebankwithwidestoutreachin of prudentialregulationenforcedbyanindependentcentralbank,whichhas only thetotaltransformationofbankinallitsspheres,underconditions being politicallydominated—andwereunabletowithstandthecrisis.Itwas lending andcorporatefinance.Theseremainedweak—with spillover (ortrickle-up)fromsoundmicrobankingprinciplestosmallandmedium the microbankingunitsremainedisolatedwithinbank,andtherewasno monetary crisishitin1997–1998.Yet, duringthe13yearsprecedingcrisis, business segmentwasanimportantfactorinthesurvivalofBRIwhen microbanking business,freeofgovernmentinterference.Thestrengththis enabled thebanktobuildarapidlyexpandingandincreasinglyprofitable in 1984,precededbyinterestratederegulationandthewithdrawalofliquidity, to partialorcomprehensivetransformation.AtBRI,therestructuringofunits Restructuring mayencompasspartorallofaninstitutionandlead,accordingly, supervision andtheenforcement ofprudentialregulation;deregulationmust However, financesectorliberalization mustbeaccompaniedbyappropriate bank managementarenecessary, alongwithinstitutionalrestructuring. programs (asin1983and1990),thegrantingof operationalautonomyto ceilings (asIndonesiadidin1983),phasingoutsubsidized directedcredit lead toinsolvencyandcostlybailoutsofinstitutions. Eliminatinginterestrate the performanceofinstitutions;suchpoliciesandinterventions couldultimately policies withheavystateinterventionsinfinancialinstitutions negativelyaffect restructuring ofafinancialinstitution.Onthewhole, repressivefinancesector A financesectorenvironmentconducivetochangeis aprerequisiteforthe Policy Framework the bankhassubmittedto stringentriskmanagementstrategies. corporate sector, inwhichBRIhas substantiallyreduceditsinvestmentandwhich and loansizes.Theriskiest sectorisneitherthepoornoragriculture,but both thepoorandnonpoor, giventheir widelydifferingdemandsfordeposit institution andthevolumeofloanablefunds,canbe increasedbycateringto Average transactioncostscanbelowered,andboth theprofitabilityofafinancial compatible with,andinfactcontingentupon,viability andfinancialself-reliance. Outreach ofafinancialinstitutiontovastnumbers low-incomepeopleis for furthercreditoutreachandexpansion.Attention toprofitabilityisimportant. savings canbeextendedtotheruralpoor, whichinturncanbeasourceoffunds more importantthancredit.Withappropriateproducts andmarketingstrategies, since 2002.Especiallyforpoorandotherlow-income clients,savingscouldbe generated bythemicrobankingunitssince1989,and inthebankasawhole foundation offinancialinstitutionself-reliance. AtBRI,surplusliquidityhasbeen focus bothinruralandurbansectorswithdiversifiedproducts.Savingsarethe to expandtheiroutreachothersegmentsofsociety. BRIhasexpandedits specific groupsorsectors.Inthecourseofrestructuring,institutionsneed viability throughmore-inclusiveoutreach.ManySOFIsweremandatedtotarget Successfully transformedstate-ownedfinancialinstitutionsmayimprovetheir Strategy transformation. contract withaforeignconsultingfirm,arenotnecessarilydecisiveforsuccessful majority privateownershipandexpatriatemanagement,oramanagement to concentrateonviabilityandprofitability. TheexperienceofBRIshowsthat in thesecondreformalsobypartialprivatization,enabledBRI’smanagement waivers. Theimplicitguaranteeofnointerferencebythegovernment,driven support toSOFIsforpoliticallymotivatedlending,concessionaryloans,andloan of 1997–1998,madeitimpossibleforthegovernmenttoprovidebudgetary constraint, causedfirstbytheoilcrisisof1982,andthenmonetary own agenda,oftenforgainingconstituencysupport.InIndonesia,thebudgetary institution, itmaybetemptedtousethefinancialinstitutionimplementits to assureunderstateownership.Wheneverthegovernmentownsafinancial state-owned bank.However, theautonomyofboarddirectorsisdifficult as acodeofconductareindispensableforthesuccessfultransformation An independentboardofdirectorsfreegovernmentinterferenceaswell Ownership andGovernance Both reformprocesseswereprecededbyadjustmentsinthepolicyframework. enforcing prudentialregulationsandfitpropertestsforseniormanagement. instrumental inestablishinggoodcorporatecultureandriskmanagementby system. Inthesecondreform,followingmonetarycrisis,centralbankwas of appropriateregulationandeffectiveinternalcontroloveritsmicrobanking assistance oftheHarvardInstituteforInternationalDevelopment,setupasystem enforce prudentialstandards.AtBRI,inthefirstreform,bankitself, withthe Effective supervisionrequiresanautonomousfinancialauthoritywhichcan with poorportfolioquality, asexperiencedinIndonesiaduringthe1980s. is arapid,butuncontrolledexpansionoffinancialservicesandinstitutions be followedbyprudentialre-regulation.Withoutit,thepossibleconsequence

ProtocolConclusions at the and Asian Lessons Development Learned Bank 23 23 ConclusionsProtocol at the and Asian Lessons Development Learned 24Bank 24 Institutional Change any plannedtargets. their effort.ThenewcorporatecultureatBRIhasledtoperformancefarbeyond compliance management,havemotivatedstaffandmanagementtomaximize ambitious targets,andperformanceincentives,togetherwitheffectiverisk governance. For BRI,management’seffortstowardopencommunication, financial institutionneedstoincorporatemeasuresinstallgoodcorporate mindset ofbothmanagementandstaff. Therestructuring ofastate-owned The restructuringofaninstitutionrequireschangesinthecorporatecultureand Kuiper, K.2004. Institute forDevelopmentofEconomicsandFinance Indonesia(INDEF).2005. International MonetaryFund (IMF).2007. Holloh, D.2001. Hiemann, W. 2003.CaseStudy:BankRakyatIndonesia,Indonesia Feekes, F. 1993. ———. 2008. Economist IntelligenceUnit.2007. Consultative GroupforAssistancetothePoor (CGAP).2008. Bank Indonesia(BI). ———. 2008. ———. 1995. Bank RakyatIndonesia(BRI).1990–2006. ———. 2005b.Indonesia:AnAssessmentofCorporateGovernanceandRisk ———. 2005a.Indonesia:AnOverviewofRecentDevelopmentsandPending Asian DevelopmentBank.2003.DraftReportRuralMicrofinanceIndonesia. Indonesia Bank BRI,Keluar dariKrisis (December). Finance, BankIndonesia,GTZ. Development ( (GTZ). Eschborn: DeutscheGesellschaftfurTechnische ZusammenarbeitGmbH Outreach: HowCanPublicBanksContributetoOutreachinRuralAreas? D. SteinwandandM.Wiedmaier-Pfister, eds.TheChallengeofSustainable Microfinance Institutions BRI. 05-2. Management inState-OwnedCommercialBanks Issues intheFinancialSector.SERDOccasionalPaper05-1Manila:ADB. Manila: ADB. Manila:ADB. Country ReportIndonesia BRI FinancialUpdates.Full Year 2007.Jakarta:BRI. One HundredYears: BankRakyatIndonesia1895–1995.Jakarta: Extending SmallCredits:ProfitablyinIndonesia.Enterprise Act orAccident?TheBirthoftheVillageUnitsBank Rakyat . Eschborn:GTZ. Indonesia: MicrofinanceInstitutionsStudy Annual Reports 4) 2:33–38.Cologne. . Washington, DC:CGAP. . Jakarta:INDEF. Country FinanceIndonesia . Jakarta:BI. . London. Annual Reports Banking SectorNote . SERDOccasionalPaper . Jakarta:BRI. . Jakarta:Ministryof Appraisal Guidefor . London. . Jakarta:IMF . In

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Appendix 1 25 ProtocolAppendix at 1 the 26 Asian Development Bank 26 ———. 2005.BankRakyatIndonesia:AFlagshipofRuralMicrofinance ———. 2003.RuralFinance.WorkingPaper, IFAD CountryProgramme ———. 2000.AgriculturalDevelopmentBanks:CloseThemorReformThem? Seibel, H.D.1989.FinancewiththePoor, bythePoor, forthePoor: Financial Steinwand, D.2001. ———. 2008.IslamicMicrofinanceinIndonesia:TheChallengeofInstitutional Maurer, K.2004.BankRakyatIndonesia:Twenty Years ofLarge-Scale Schmit, L.Th.1991. Rudjito. 2003. Robinson, M.S.2001. Patten, R.H.,andJ.K.Rosengard.1991. World Bank.1999. Evaluation Finance &Development. Social Strategies(Basel) Technologies fortheInformalSectorwithCaseStudiesfromIndonesia. of Cologne. Asia (Singapore).(23)1:86–103. Diversity, RegulationandSupervision.JournalofSocialIssuesinSoutheast Bourton-on-Dunsmore andTERIPress. Market: CommercialBanksinMicrofinance In MalcolmHarper&SukhwinderS.Arora,eds.,SmallCustomers,Big Microfinance. Financial SectorNetwork,ScalingupPovertyReduction:CaseStudiesin Microfinance. Leiden DevelopmentStudiesNo.11 the VillageUnitsofBankRakyatIndonesiainSociologicalPerspective. 9–10 April. Bank ConferenceonTransforming PublicSectorBanks.Washington DC, Indonesia inAchievingaSustainableMicrobankingInstitution. Indonesia of RuralBankinginIndonesia (March 29). Wissenschaft undForschung (VWF). Transforming aPublicSectorBank:TheQuestofBankRakyat . Washington DC:World Bank. . Rome:InternationalFund forAgriculturalDevelopment. Indonesia CountryAssistanceNote. Rural CreditbetweenSubsidyandMarket:Adjustmentof InConsultativeGrouptoAssistthePoor&WorldBank The AlchemyofMicrofinance Washington DC:World Bank. The MicrofinanceRevolution,Vol. 2:Lessonsfrom Vol. 3No.2:3–48 Washington DC:IMF. (June:45–48) . San Francisco CA: ICS Press. . SanFranciscoICS CA: Progress withProfits:TheDevelopment . Rijksuniversiteit Leiden, University . RijksuniversiteitLeiden,University . . NewDelhi:ITDGPublishing, . Berlin:Verlag fur Washington, DC:VWF World

in Asia. of thecolonialsystem.Theestablishmentapopular creditsystem(“inclusive cause ofimpoverishment.InIndonesia,thiswasbelieved tothreatenthestability various Europeancountries,usuryandtheresulting indebtedness wereamajor investment banks;and(v)agrowingindebtednessto moneylenders.Asin global commoditycrisisof1884,whichledtothedemise oftheagricultural the fluctuationsofglobalmarkets;(iii)anincreasing landshortage;(iv)the of ChinaafterenactmenttheAgrarianLaw1870, exposingthesectorto opening upoftheruralsectortocapitalsEurope andthePeople’s Republic population duetothecoerciverecruitmentofplantation laboruntil1870;(ii)the combination ofcrisisandpoverty, including(i)theimpoverishmentofrural Historically, the popularcreditsysteminIndonesiaowesitsoriginstoa self-financing, withinterestratesbetween25%and45%annually. highly liquid,relyingalmostentirelyonmobilizationoflocalresourcesand 1 banks (lumbungdesa so-called popularcreditsystem—comprised75districtbanks,12,424paddy taken seriously. By1913,thedecentralizedfinancesectorofIndonesia—the led tomanyclosures—thelatterbeinganindicationthatsupervisionwas elements, wasdeclaredapriority. Thesetwoelementsclashedfrequently, which village creditinstitutions,whichcombinedsocialandcommercialbanking organized bytheMinistryofInteriorAffairs.In1906,growththese State supervisionthroughsupervisorswhowerenationalsofIndonesiawas institutions undercommunitycontrol(today’sBadanKreditDesa,orBKD). establishment ofarapidlygrowingnumberdecentralizedvillagecredit institutions withamorediversifiedclientele.Thiswasparalleledbythe for twotypesofinstitutions: and protectionprovidedbythegovernmentorstate.Itbecamemodel The bankcomprisedelementsofbothself-reliance throughsavingsmobilization expanded toincludesavingsandcreditinkindaswellcash. as wellEuropeancivilservantsintheregencyIndonesia.Itsproductswere owned institution,withoutreachtocreditworthyIndonesiansofanyoccupation, Volksbank (thepeople’sbank).Atthesametime,itwasstructuredasamember- Poerwokertoesche Hulp,SpaarenLandbouwCredietbank,popularlyknownas the Ordinanceof11August1897,bankwasgivenlegalstatusandrenamed de Wolff vanWesterrode, thebankexperienceditsfirstreorganization.Basedon civil servicegentry, orpriyayi,inIndonesia.In1897,underanewmanager, Spaarbank derInlandscheBestuursAmbtenareninDecember1895,forthe and withtheapprovalofhisDutchcolonialsuperiors,hefoundedHulpen others. Inresponsetothecritiquethathewasdivertingmosque’sfunds, local mosque’streasury, whichheusedtoextendloanscivilservantsand Raden BeiAriaWiryaatmadjawasthenentrustedwiththemanagementof a moneylender;theteacherhadtakenloantofinancefamilyceremony. interest loanfromhisownpockettoateacherpaybackusurious Raden BeiAriaWiryaatmadja,viceregentofBanyumas.In1894,hegavealow- The developmentoftheprecursortoBankRakyatIndonesia(BRI)beganwith Prehistory, 1895–1945 pedx1 TheEvolution ofBankRakyatIndonesia: Appendix 1: This chapter is largely based on Schmit (1991) and Bank Rakyat Indonesia (1995). This chapterislargelybasedonSchmit (1991)andBankRakyatIndonesia ), and1,336moneybanks( In SearchoftheMostEffectiveInclusion banksforthepriyayi,andcooperativebanking bank desa ). Thesystemwas 1

Appendix 1 27 ProtocolAppendix at 1 the 28 Asian Development Bank 28 effectiveness eitherasasupervisororanapexbank. on wartimeinvestments,lowinterestrates,andanoveralllackoffunctional into cooperatives.Bycontrast,theCentraleKasstruggled,sufferingfromlosses in sixruralhouseholds—afterhavingresistedeffortstoturnthevillagebanks predecessor ofBRI.By1925,theVolkscredietwezen flourished—servingone voorhetVolkscredietwezen,establishment ofacentralfund,CentraleKas finance), andKoperasi Simpan Pinjam(savinglendingcooperative);and(ii)the credit bank),LembagaDanaKreditPerdesaan (institutionforruralfundingand or cooperativeownership,suchasBKD,BankPerkreditan Rakyat(people’s networks oflocalfinancialinstitutionsinprivate,government,community decentralized people’screditsystem, to adualpolicyformalizedin1913bytwoordinancesdealingwith(i)the At thesametime,centralstateinterventionwasdeemednecessary, leading after 1904. the linchpinofethicalpolicy(“socialbanking,”intoday’sterminology) finance,” intoday’sterminology)appearedasapossiblepanaceaandbecame 2 “inclusive finance”);(iv)politicalagitationandcorruption; (v)thenationalization of collectivist,cooperativist,andKeynesian ideas(i.e.,newideologicalformsof of “guideddemocracy”andeconomy”(introduced in1957);(iii)aclash intervention, comprisingthefollowing:(i)demise ofliberalism;(ii)concepts was followedbyaperiodofpoliticalinstability, economicuncertainty, andstate which wasinternationallyrecognizedonlyafter4years offighting,in1949.This On 17August1945,thenPresidentofIndonesiaSukarno declaredindependence, Postwar History, 1945–1983 banks cametoacompletestandstill;manydidnotrecover. villages wereimpoverished,and,towardtheendofWorld War II,thevillage by theauthorityofbeingoneitsfunctions,loanfundsweresoondepleted, converted intotheSyominGinko(people’sbanking)corporation.Witharequest Species Bank,withgreatlyrestrictedlendingoperations.Thevillagebankswere parts. TheAVB headofficeandbrancheswereintegratedintotheYokohama After theJapaneseoccupationin1942,AVB wasbrokenupintotwo banking system,and(iv)thechannelingofdebtreliefthroughcooperatives. district banksintolocalwelfarecommittees,(iii)theconsolidationofvillage 90 districtbanksintoAVB branches,(ii)transformationoftheboards as aprivatecompany. Amongitsobjectiveswere(i)theconversionof organization (“Credit-Plus,”intoday’sterminology),regulatedandmanaged was establishedin1934.TheAVB wasanonprofitmultifunctionalwelfare attempt tostrengthencentralcontrol,the banks remainedastonishinglyresilient.Despitethatresilience,inapaternalistic restructuring. Thedepressionhitthedistrictbankshard,whilevillage The GreatDepressionwasthenextcrisispresentinganopportunityfor Efforts tocentralizetheVolkscredietwezen An apexbankreferstoasingle servingagroupoffinancialinstitutions. Volkscredietwezen persisted,againststrongopposition. Algemeene Volkscredietbank 2 , whichlivesoninvarious (AVB) a the bankrecovered.In1960, too,BRIandBTNtogetherwithanationalized freezing ofdepositsledBRI toamoney-losingyear;butthefollowingyear, 1960, character ofcooperativesfromtheonset.In1959,a currencyreformandthe formation, guidance,andcontrolofcooperatives;thus, pervertingtheself-help year, a newcooperativelawwaspassed,givingthestateadecisiverolein market segmentthatdidnotseemtobeadequately servedbyBRI.Inthesame created, asthegovernment’sinstrumentofmicrocredit totheruralpoor, a In 1958,thefarmers’andfishermen’sbank,BankTani Nelayan(BTN),was loans. Arrearsstoodat15%.In1956,BRIbecamea foreign exchangebank. fixed-income loans,and17%smallmedium-sized enterprise(SME)business Of thetotalof455,600loansoutstanding,63%were villagemicroloans,20% 19% representedruralloans,14%fixed-income and67%businessloans. disbursements ofBRI’s112branchesamountedtoRp364million.Ofthattotal, due toacontinualstrugglewithnonperformingloans.For example,in1954, individuals. Businessexpandedduringthe1950s,butwithmanyupsanddowns, made availabletoanysector—e.g.,agriculture,industry, trade,andsalaried bank forgroupsthatwerebeyondthereachofotheragencies.Creditwas (vii) extendingcommercialcredittothemiddleclass,and(viii)actingasaspecial communities andotherinstitutions,(vi)handlinggovernmentprograms, and supervisiontocooperativesvillagebanks,(v)managingfundsof savings fromthepublic,(iii)restoringvillagebanks,(iv)providingguidance broad mandate:(i)conductingbankingbusinessingeneral,(ii)collecting class aswellasupervisorofruralbanksandcooperatives,withanextremely On 20April1951,BRIwasdeclaredagovernment-ownedbankforthemiddle which alsoledtothereunificationofBRIandlegalabolishmentAVB. Finally, Indonesiabecameindependentasaunitarynationon15August1950, capacity byawidemargin. sized enterprisesectorintoday’sterminology)—anagendathatsurpassedits (iii) lendingtoenterprisesoftheemergingmiddleclass(thesmallandmedium- government; (ii)lendingtosmall enterprisesintheinformalsector;and the twoentities.SimilarlyconfusingwasBRI’smandate:(i)lendingto in theDutchpart,andaconfusingfluxorganizationalstructurebetween of thecountryaswellBRIintotwoparts:re-establishmentAVB financed byanationalloan.Yet thewarforindependence ledtothepartition 1946, BRIwasformallyestablishedasasuccessortoAVB andSyominGinko, Allied forces,togetherwiththeDutcharmy, inSeptember1945.On22February Ginko withBRI;butthesmoothtransitionwasinterruptedbyarrivalof After independence,anagreementwasreachedwithJapantoreplaceSyomin 11.5% in1996.ThisisthecontextwhichBRIgaineditsnewshape. Asian financialcrisishoveredaround6%;thepovertyratefellfrom60%in1970to and textileexports,paidoff;annualeconomicgrowthratesuntilthe1997/1998 from theproceedsofoilandnaturalgassalesaswellplantationcommodity and development.Investmentsinsocialeconomicdevelopment,financed became president(until1998).His“NewOrder”policycreatedaclimateofgrowth (viii) finally, thecollapseofeconomyandcurrency. In1966,GeneralSuharto communist takeover;(vii)amilitarycoupin1965ledbyGeneralSuharto;and of formerDutchcompanies,plantations,andbanks;(vi)anongoingthreata

Appendix 1 29 ProtocolAppendix at 1 the 30 Asian Development Bank 30 Bank Indonesiasuppliedtherequiredfunds.To handletheBimasprogram,BRI disbursement agencythroughitsbranches.Numerous otherprogramsfollowed; mainly forindustry, tradeandservices,wasintroduced,withBRIasthemain Kredit ModalKerja Permanen, anationalsmallenterprisedevelopmentprogram only bankfortheBimascreditprogram.Thatsameyear, KreditInvestasiKecil/ agencies increasinglydominatedBRI’sagenda.In1969,BRIwasappointedasthe Subsidized targetedcreditprogramsdesignedbygovernmentanddonor for smallfarmersandSMEs. lending accordingtobankingcriteria,and(ii)concessionalspecialloanprograms colonial period,BRIwasthusagaingivenadualfunction:(i)commercialgeneral objective ofriceself-sufficiency. Bimas programofsubsidizedcredittofarmers’groupsinitsearlyphase,withthe to 6,000BPRs,theformerBKTNwasmaintainedasadivisionofBRI,handling serving agriculturalestates,cooperatives,andruralSMEs,supervisingclose financing thegreenrevolutionandintegratedruraldevelopment.Inadditionto government’s mainpolicyinstrumentintheruralsector, withthetaskof Law No.21of1968reestablishedBRIasacommercialbankandthe rehabilitation policies;theinflationratefellfrom650%in1966to9.8%1969. consolidation ofthebankingsectorbenefitedfromsuccessfulstabilizationand Indonesia wasgivenadualfunctionofcentralanddevelopmentbanking.The status of”secondarybanks,”referredtoasBankPerkreditan Rakyat(BPR).Bank former divisionoflabor;thedecentralizedcreditinstitutionsweregiven of 1967reestablishedthestatebanksas“primarybanks”accordingtotheir After thebeginningofNewOrderunderSuhartoin1966,BankLawNo.14 Indonesia, andfinallytothedownfallof“OldOrder”. the economyandcurrency, alsoaffectingthenewlyestablishedBankNegara soaring inflationrates,andadrasticdeclineinincomesledtothecollapseof later intoanewsinglestatebank,BankNegaraIndonesia.Political upheaval, banks, wasintegratedintoBankIndonesia,thecentralbank,andamonth In 1965,furtherexperimentationbythestateensued.BKTN,likeother Agriculture OrganizationoftheUnitedNations. a modelof“supervisedcredit”originallydesignedbyexpertstheFood and cooperatives weretobeservedbyaspecialtargetedcreditprogram,basedon (iii) contributingtobuildingasocialistIndonesiansociety. Fishermenandtheir cooperatives, farmers,andfishermen;(ii)supervising8,000villagebanks; some 500mobileunits.Thenewbankwasgiventhemandateof(i)supporting Bank, BankKoperasi Tani danNelayan(BKTN),comprising165branchesand Dutch bank,weremergedtoformtheCooperativeFarmers’ andFishermen’s 3 Bimas, in1964–1968. The involvementofBRI/BKTNinthedisbursementBimascredit startedduringthefirstphaseof 3 Inthetraditionof“dualeconomy” subdistrict ( established anetworkofso-calledvillageunits(unitdesa),setupmostlyatthe in Indonesia. and becamethelargestmostsuccessfulprovider ofcommercialmicrofinance the optionofeitherclosingorreformingunits,BRI optedforreform in theunits—thelargestdeliverynetworkofanybank inIndonesia.Whengiven branches and3,617villageunits,withatotalof31,777employees,45%them continued tobeprovidedbytheBRIbranches.In1983,comprised292 credit, includingliquiditysuppliedbyBankIndonesiaandinterestratesubsidies, BRI units,puttingthefutureofwholenetworkintojeopardy. Program The year1983markedtheendofdisbursementprogramcreditby as asourceoffundsforBRI’scommercialoperations. Savings mobilizationthroughvariousproductsbecameincreasinglyimportant accounting, (iv)reporting,(v)internalcontrol,and(vi)customerrelations. of areas,including(i)organizationalstructure,(ii)performancerating,(iii) Asian DevelopmentBank(ADB),BRImodernizeditsoperationsinavariety Starting intheearly1970s,withassistancefromvariousagenciesincluding an executingbankwithastrongeroperationalrole. in theagriculturesector, eitherasahandlingbankcompensatedbyfee,or Since 1975,BRIhashandledanincreasingnumberofdonorprojects,particularly economy, butunderminingthecreditculture. to asurgeoflocalandruraldevelopmentgrants,injectingliquidityintothe Guarantee Agency, LembagaJaminanKreditKoperasi. Theoilpriceboomalsoled with theexceptionofcooperativecredit,whichwasinsuredbyaCooperative enforce repayment.CreditwasinsuredbyAscrindo,astateinsuranceagency, reduced todisbursementagencies,withouttheauthorityselectclientsor employees (outofatotal14,564);atthesametime,BRIunitswere instruction in1973,thenumberofunitsincreasedto2,131,with6,079 invest substantialamountsindevelopmentprograms.Following apresidential A surgeintheoilprice1973(andagain1979)enabledIndonesiato institutions). its involvementin5,000BadanKreditDasa(BKDs)(villagecredit finance activitiesthroughitsdistrictoffices,MobileUnitsand micro-finance… BRIwasin1968alreadyfullyengagedmicro- in Indonesia.Therewasalreadymorethan75yearsexperiencewith ….the VillageUnitswere kecamatan ) level.AsKuiper (2004:139)noted: not anattempttointroducemicro-finance

Appendix 1 31 ProtocolAppendix at 2 the 32 Asian Development Bank 32 pedx2 Finance SectorInIndonesia Appendix 2: banking sector, withaminimumcapitalrequirementof$29,000. Bank Perkreditan Rakyat(BPR)(people’screditbank)aspartoftheregulated bank branches.Italsoprovidedalegalframeworkfortheestablishmentof a law(PAKTO27) thateasedtheestablishmentofnewcommercialbanksand In October1988,thegovernmentfurtherliberalizedfinancesectorbypassing 1970 to11.5%in1996(TheWorld Bank,1999). poverty reduction,withadeclineinthepercentageofpoorpeoplefrom60% At thesametime,Indonesiawashailedasoneofmostsuccessfulcountriesin Policy Framework 3 2 1 rapid growth. deepening, rosefrom16%to43%;theeconomyseemedreadyfortakeoffinto percentage ofgrossdomesticproduct(GDP),astandardindicatorfinancial with prudentialregulationduringthe1990s.From 1982to1990,M2asa with anemphasisduringthe1980sonderegulationandincreasingconcern and ruralfinance,thepolicyenvironmentevolvedrapidlytowardconduciveness, important prerequisiteforfinancialmarketliberalization.Incommercialbanking in fiscalyear(FY)1973–1974to5.7%FY1985–1986.Lowinflationratesarean The macroeconomicenvironmentdevelopedasfollows:inflationfellfrom20% market forcesreplacedthegovernmentasprimemoverofdevelopment. supply-driven toademand-drivenfinancialsystemapproach.Intheprocess, oil exportsinitiatedaneraofliberalizationandderegulation,shiftingfroma 1970s, thedeclineofoilpricein1982andresultinglossincomefrom directed credit.Incontrasttotheabundanceoffinancialresourcesinearly banks includingBankRakyatIndonesia(BRI).BRIwasthemainproviderof interest rateswereregulatedandthefinancesectorwasdominatedbystate one ofitstools.Inapolicyenvironmentstatecontrol,orfinancialrepression, country, investedsubstantialamountsindevelopment,usingdirectedcreditas Following theoilpriceincreasesof1973–1979,Indonesia,asanoil-exporting rapid equitablegrowthanddevelopment. of corporateIndonesiaandthepoliticalclassaswelladvocates for BankIndonesiatoenforceprudentialregulationagainstthevestedinterests commercial andruralbanks.Undersuchcircumstances,itprovedimpossible to greatoptimismandarapidexpansionofthebankingsector, comprising development bankingfunctionwas drasticallyreduced. the banker ontheotherhand.Thesetwo objectives conflictedattimes.After1998, development Bank Indonesiahadadualmandate:monetarypolicymakerand regulatorontheonehand,and provinces. Asaresult,old-andnew-typeBPRscoexist. in the against strongopposition enforce this to Bank Indonesiawasunable BPRs; but regulated into BPRs licensed andsupervisedbyBankIndonesia.Allold-typeBPRs were supposedtobetransformed Pedesaan.as LembagaDana Kredit to Since PAKTO27, speaking, refersonlyto BPR, strictly term the referring in 1988,tononbank financial institutions. Mostofthemare under provincial law, referred (BPR)wasusedasagenerictermbeforethepassage of thePAKTO27 law Bank Perkreditan Rakyat the grossdomesticproductpercapita.Ahigherratioindicatesgreater financialsectordepth. relative tothesizeofeconomy. Itisstrongly correlated withthelevelandrateofchange of and non-institutionalmoneymarketfunds.TheratioM2/GDPis ameasureofthemoneysupply savings deposits, includes cash,demanddeposits, that supply is abroadercategory ofmoney M2 1 GDP growth rates averaged 7% per annum during 1979–1996. GDPgrowthratesaveraged7%perannumduring1979–1996. 3 BankIndonesiagenerallylacked 2 Thisled the economyandbanking sectorhaveshownsteadyprogress. nonperforming loans(NPLs) (aratiobelow5%wasrequired).Since2000,both capital adequacy(atleastan8%ratio [CAR]wasrequired)and audit, andregulatorycompliance.In2000,itissued newregulationsconcerning the regulatoryframeworkofbankingsectorfor internal controls, prudential regulationthrougheffectivesupervision. BankIndonesiaupgraded expensive bailoutinglobalbankinghistory);and(ii) theenforcementof by thegovernment,atanestimatedcostof$70billion (atthetime,most policies. Financesectorcrisismanagementwasgeared to(i)bankrehabilitation the supervisionofIMF, wassuccessfulinimplementingmacroeconomic Indonesia’s economicpolicyperformanceover6years from1998to2003,under prudential standards,togetherwiththerestructuring ofthebankingsector. However, thecrisisopenedawindowofopportunityforenforcement programs foralleviatingpoverty, leadingtoadoublingofthenumberpoor. It alsorevealedthefragilityofbankingsectoraswellweaknesses supervision, andtherisksofexcessiveshort-termhard-currencyborrowings. The crisisrevealedthedangersoffinancialderegulationwithouteffective looting, PresidentSuhartowasforcedtostepdown. resulting inheavylossesformostofthebanks.Inmidstriotingand skyrocketed, thenetinterestmarginofbankingsectorturnednegative, lowest valueeverinJune,atRp16,725totheUSdollar. Whileinterestrates inflation soaredtoarateof77%;andwidelyfluctuatingrupiahreachedits The worstyearforIndonesia’seconomywas1998,whenGDPplunged13.7%; government wastoborrow$10billion. November 1997,theIMFapproveda3-yearstandbyagreementunderwhich support.In that thegovernmentcommittedtoimplementunderIMF’s program. Financesectorreformwasoneofthreemajorinitiatives signed aletterofintentwiththeIMFconcerning3-yeareconomicreform (IMF) topreemptafurtherdeepeningcrisis.InOctober1997,thegovernment the governmentofficiallyenlistedsupportofInternationalMonetaryFund Indonesian rupiahmorethananyothercurrency. AsthecrisisreachedIndonesia, the pesoinPhilippines,andringgitMalaysia,thenhitting beginning oftheAsianfinancialcrisis,initiallyaffectingbahtinThailand, banking sector, andthedownfallofpoliticalregime.June 1997markedthe crisis in1997–1998,whichledtoastandstilltheeconomy, thecollapseof The processofsteadygrowthwasunexpectedlyinterruptedbythemonetary supervision, andthebankingsectorwaspracticallyoutofcontrol. Indonesia, whichwasthusunabletoenforceprudentbankingintermsof and adventurouscorporateexpansion.ThegovernmentfullycontrolledBank class furtherexacerbatedtheconflictofinterestbetweenprudentbanking under politicalinfluence.Stronglinksbetweentheandeconomic deposits tofinancetheirexpansion.Lendingdecisionsofstatebankswere international marketsandcompetedvigorouslyforthemobilizationofdomestic conglomerates establishedbanksoftheirown,whichborrowedcheaplyon the rapidlygrowingbankingindustry, especiallyinthelate1980s.Powerful independence andenforcementpower, andcouldnotadequatelyregulate

Appendix 2 33 ProtocolAppendix at 2 the 34 Asian Development Bank 34 • • • • • • • • • policy frameworksince1983: The followinghighlightssummarizethechronologyofeventsrelatedto 4 • • • • • Bank Indonesiacertificatesarecommonly knownas 1995: legal lendinglimits. 1993: commercial banksandruralbanks. 1992: ($4.1 billion)fromthegovernmentandstatebanks. 1991: positions. standards onCARs,legallendinglimits,andforeignexchangenetopen 1990–1991: quota forcommercialbankswereimplemented. introduction ofa20%smallandmedium-sizedenterprise(SME)lending 1990: commercial banksfrom15%to2%. strengthening banksupervision;and(ii)reductionofreserverequirementsfor expansion ofthebankingsector, thoughwithoutsimultaneously of localruralbanksasparttheregulatedbankingsectorledto(i)rapid opening ofnewprivatebanksandbankbranches,theestablishment 1988: prevent hardcurrencyspeculation. deposits instatebanksintoBankIndonesiacertificateswereundertakento 1987: desa (villageunits)system. reduction ofBankIndonesialiquiditycreditledtothereformBRIunit 1983: ratio wassetatbelow5%. 2000: tests forbankdirectorsandcommissionerswereestablished. agency; rulesonprudentbankingwereenunciated; and “fit-and-proper” government declareditsintentiontoestablishaseparate banksupervision Mandiri; anewlawmadethecentralbank,BankIndonesia, independent;the issue of$19.4billionwassold;4statebanksweremerged tobecomeBank 1999: announced ablanketguaranteeforthedepositliabilities ofnationalbanks. after adiptoaboveRp16,000=$1.00inmid-1998;andBankIndonesia Rp4,650 =$1.00in1997andRp8,0251998(end-of-year rates), 1998: depositors foruptoRp20million($4,300.00)eachoccured. group of16bankswithoutdepositprotection;bailoutbythegovernment 1997: 3% to5%. introduced; andtheminimumreserverequirementswereincreasedfrom 1996: Newregulationsprovidingforbankliquidationprocedureswere Tax incentivesforbankconsolidationandmergersimplemented. TheCARwasraisedto8%anddeadlinesweresetforbanksmeet Anewbankinglawwaspassed,recognizingtwotypesofbanks: Atightmonetarypolicywasimplemented,withdrawingRp8.1trillion Phasingoutof32the36majorsubsidizedcreditprograms;and Anewfinancesectorderegulationpackage,PAKTO27 lawforthe Externaltradeliberalizationandconversionofstateenterprise Full interestratederegulation,eliminationofcreditceilingsanda ThebankCARwassetata4%minimumwhiletheacceptableNPL 38privatedomesticbankswereclosed;firstrecapitalizationbond Therupiahwasdevalued,fromRp2,383=$1.00USdollarin1996to UnfoldingofthefinancialcrisisbeginninginJuly;closurefirst Timetableannouncedfortheintroductionofprudential 4

Sertifikat BankIndonesia . 5 their capitalbase. action hadloweredthequalityofbanks’loanportfolios andhadweakened reserve requirementsfrom15%to2%.Ontheeveof thefinancialcrisis,this credit markets.Commercialbanksalsobenefitedfrom thereductionofminimum in interestrates,bankscompetedever-more-vigorously inboththe depositand ($4.1 billion)fromthegovernmentandprivatebanks, andaresultingincrease the introductionofatightmoneypolicy, thetakingbackofRp8.1trillion to 30%beforetheoutbreakoffinancialcrisis.SinceFebruary 1991,after banks inloansoutstandingdeclinedfromapproximately90%before1988 by privatecompaniesfortheexpansionoftheirbusiness.Thesharepublic to privatebanksasthedominantsubsector, includingmanybanksestablished in 1994,excludingBRI’sunitdesa.Thiswasaccompaniedbyashiftfromstate 1994. Thenumberofbankofficesalmosttripled,from1,728in1988to4,888 banks. Thenumberofbanksmorethandoubled,from111in1988to240 unfettered expansionofthecommercialbankingsector, particularlyofprivate The institutionalliberalizationof1988hadledtoarapidandpractically Financial Institutions • • • • • • • • 1.5%; and(iv)aminimumloan–to–deposits ratioof50%. last 3years;(ii)a capital adequacyratio (CAR) ofatleast 12%;(iii)a minimum return onassetsof billion forthe capital ofatleastRp100 anchor banksasthosewhichhave:(i) Bank Indonesiadefines Rp80 billion($8.7million). 2008: world oilpricesandthesubprimemortgagecrisisinUnitedStates. and macroeconomicpolicywasprudentlymanagedinthefaceofescalating 2007: merger incentives,andgoodgovernancewereimplemented. implemented; newregulationsonearning-assetquality, legallendinglimits, 2006: average NPLratios. 2005: wound up,transferringsomefunctionstootherinstitutions. and toacquireotherbanks;theIndonesianBankRestructuringAgencywas outside theirrespectiveprovince,toengageinforeignexchangetrade, anchor banksthatfulfillcriteriasetbyBankIndonesiaallowedtooperate Indonesian BankingArchitectureplanwaspresented,withonlyso-called Corporation—was established,andbecameoperativeasof2005;the 2004: a financialsafetynetwereannounced. 2003: guarantee forthird-partydepositswasextended. 2002: is stillpending). Lembaga Keuangan Mikro Core Principles;theCARwasincreasedtoaminimumof8%;draftlawon 2001: Minimumcapitalrequirementsofanchorbankswereimposedat Thedepositguaranteethresholdwasslashedby90%to$10,600; Anincentivespackagetopromotebankconsolidationwas Restrictionswereplacedonlendingtobusinesssectorswithabove- LembagaPenjamin Simpanan—theIndonesiaDepositInsurance Preparatorymeasuresfortheestablishmentofdepositinsuranceand TheminimumacceptableCARwasincreasedto12%;andtheblanket AMasterPlanforBankSupervisionannouncedfollowingtheBasel –microfinance institutionswasannounced(thelaw 5

ProtocolAppendix at 3 the 35 Asian Development Bank 35 ProtocolAppendix at 2 the 36 Asian Development Bank 36 foreign exchangeandcorporateexposure,werelessaffected. The monetarycrisisaffectedthecommercialbanksmostseverely. BPRs,without 6 over-liquid, withapreferenceforlow-riskinvestmentsincentralbankpapers, by 19.9%,from$88.7billionin2006to$106.4 in2007.Banksarestill $180.3 billionin2006to$210.92007;and loansoutstandinggrew improved from1.9%in2002to2.8%2007.Total assetsgrewby16.9%from substantially, fromaCARof–8.1%in1999to+19.3%;andreturnonassets From 1999to2007,theperformanceofbankingsectorimproved controlling stakesinBRIandBankTabungan Negara,thenationalsavingsbank. government hadfullstakesinBankMandiriandNegaraIndonesia, divestment programhadbeensoldbacktotheprivatesector. Asof2008,the banks thathadbeennationalizedunderthegovernment’srestructuringand commercial banksand26regionaldevelopmentbanks.By2007,mostofthe number hadfurthershrunkto138,andby2006130,including5state-owned been merged,and12hadtakenoverbythestate.By2004,remaining been reducedbyabout40%,from238to144:68hadclosed,14 By 2001,thenumberofcommercialbanksthathadexistedinmid-1997 (ADB 2005b). outstanding domesticdebtsurgedfrom0%ofGDPin1996to39%2002 the hugerecapitalizationcosts,especiallyforstatebanks,government’s 8 ofthe144remainingbanksmissedtarget8%CARin2001.Asaresult After recapitalization,only indicators showedfurtherimprovementin2001. these to +$1.1billion;andthegrossNPLratiofellsharplyfrom21.8%5.8%.Allof margin rosefrom–5.4%to+2.4%;profitsbeforetaxes–$12.9billion 1999 to2000:capitalwentfrom–$5.8billion+$5.5billion;netinterest those levels.Theperformanceindicatorsdemonstratedtheturnaroundfrom recapitalized BRI.In2001,thebankingsectorhadstabilizedatapproximately The turnaroundbeganduringthelatterpartof2000,whengovernment to $33.4billion;anddepositsdroppedfrom$87.2billion$72.9billion. from $142.1billionto$107.5billion;loansoutstandingfell$39.1 From 1999to2000,thebanking sectorcontinuedtodeclinetotalassetsdeclined state-owned commercialbanksandallmajorprivatewereaffected. exchange andinflationrates,capitalflight,depositorcreditorruns.All crisis unfolded,thebankingsectorfounditselfunabletocopewithsurgein was exacerbatedbyweakregulationandalackofadequatesupervision.Asthe and alackofmarketdisciplineafteryearsrapideconomicexpansion,which insider lendingandpoliticalinterference;currencymaturitymismatches; the commercialbankingsectorhadbeenlargelyduetopoorgovernancei.e., 2006, whileloansoutstandinggrew fromRp8.9trilliontoRp16.9trillion. their totalassetsinrupiah trillion in terms almost to Rp23.0 doubled from trillion in2003 Rp12.6 6 134 rural In 2006,banksweremergedinto14,while second waveofinterventionbeganin2005. A as of2002. 2,141 number ofBPRsdownto bringing the Bank Indonesiabegantointervene, that to enforceprudentialstandards.Itwasonlyin2001 monitored theiractivities,butdidlittle Bank Indonesia Until 2000, as of1999. to 2,427 banks in1996 crisis, from1,987 throughout the number ofBPRscontinuedtogrow the timewhencommercial the At banksweredecimated, were liquidated, bringing their number down to 1,880. Despite the reductionintheirnumbers, Despite bringing theirnumberdownto1,880. liquidated, were 6 Thefragilityof them appliedsoundlendingpractices. microfinance institutionsmobilizedtheirresourcesdomestically, andmostof risk exposureofthebanksandtheircorporatesectorclients.Incontrast, foreignexchange outsideinterferenceinlendingdecisions,and(ii)excessive (i) bythecommercialabsence ofthetwofundamentalproblemsexperienced banks: italsotestifiestothe the public’strustinsector;andonotherhand, and institutionalfoundationsofthemicrofinancesector, itsself-reliance, and 7 them theBRIunits. microfinance institutionsweatheredthecrisisrelativelywell,foremostamong Overall, whilethecommercialbankingsectorvirtuallycollapsed, bringing outboththestrengthsandweaknessesofdifferentsubsectors. The impactofthecrisisoncommercialmicrofinancehasnotbeenuniform, exceptionally high17.1%in2005fallingto6.6%2006and2007. and reached6.3%in2007;inflationratesweremostlysingle-digit,withan finance sector. TheGDPgrowthraterosefrom3.5%in2001to5.0%2004 The favorablemacroeconomictrendalsohelpedtheimprovementsin 1999 to7.0%in2006and4.1%2007,thereisstillroomforimprovement. in 2006.WithregardtothegrossNPLratio,whichdeclinedfrom32.8% but haveimprovedtheirloans-to-depositsratiofrom26.2%in1999to64.7% of themonetarycrisis. results immediate BPR sectorthanthe more along-overdueoverhaulofthe this reflected But 2005. BPRs in to fall2,010 and continued in 2000 As aresult,thenumberofBPRsdeclinedto2,419 that BankIndonesiabegantoenforceitsregulation ofBPRsmorerigidly.It wasonlyin2000 1999. laws. ThenumberofBPRsactuallycontinuedtogrow,BPRs in to 2,427 BPRs in1996 from 1,987 Mainly comprising BRI units, BPRs licensed byBankIndonesia,andBPRs licensedunderprovincial Source: BankIndonesia. NPL =nonperformingloanratio,ROAreturnonassets. ( ) = negative number, n.a. = data not available, CAR = capital adequacy ratio, LDR = loans-to-deposits ratio, al 2 Performance RatiosofCommercialBanks, Table A2: 0719.3 20.5 19.5 2007 19.4 2006 19.4 2005 22.5 2004 20.5 2003 12.5 2002 (8.1) 2001 2000 1999 Year 7 Ononehand,thistestifiestothestrengthoflegal CAR 9920 (%) 1999–2007 O P gos LDR NPL (gross) ROA n.a. n.a. n.a. 2.8 2.6 2.6 3.5 2.5 1.9 12.1 18.8 32.8 4.1 7.0 8.3 5.8 8.2 8.1 66.3 64.7 64.7 61.8 53.7 49.1 33.9 33.2 26.2

Appendix 2 37 Restructuring of State-Owned Financial Institutions: Lessons from Bank Rakyat Indonesia

Despite the trend toward fi nancial sector liberalization in recent years, state ownership of fi nancial institutions remains widespread in the developing world. However, in general, state-owned fi nancial institutions have underperformed their private sector counterparts, and governments have sought to restructure them. This case study reviews the transformation of Bank Rakyat Indonesia from a loss-producing, overstaffed state-owned bank to the most profi table bank with the largest microbanking network in Indonesia. From the bank’s experience, the study seeks to draw decisive lessons for the successful transformation of other state-owned fi nancial institutions. For Bank Rakyat Indonesia, the key driver of successful reform was the government’s commitment to allow it the autonomy to restructure itself—including an emphasis on good corporate governance, supported by appropriate regulations and effective supervision.

About the Asian Development Bank

ADB’s vision is an Asia and Pacifi c region free of poverty. Its mission is to help its developing member countries substantially reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two-thirds of the world’s poor: 1.8 billion people who live on less than $2 a day, with 903 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance.

OF STATE-OWNED FINANCIAL INSTITUTIONS

Hans Dieter Seibel • Mayumi Ozaki Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines www.adb.org ISBN 978-971-561-797-0 Publication Stock No. RPT090538 Printed in the Philippines

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