Optimal Interest Rates and Subsidy Dependence in Microfinance:
Lessons from the BRI-Unit Desa, Indonesia

Jacob Yaron, Rural Finance Advisor

        The challenge for microfinance institutions around the world remains achieving financial sustainability, and few institutions have been very successful in this respect. One of the most successful institutions is the Unit Desa (BRI-UD) or Village Bank. BRI-UD was established as an independent profit-center of the Bank Rakyat Indonesia (BRI), a State-owned rural bank, in 1984. While charging a real interest rate of 21.1 percent in 1994 (32.9 percent nominal), the Subsidy Dependence Index (SDI) of BRI-UD is negative (-43 percent), which is an extremely rare situation. This means that the BRI-UD could lower its real lending rate to 8.2 percent (nominal 18.7 percent) while maintaining sustainability. For now, the surplus income generated by this program is used to subsidize other activities BRI carries out, in particular, lending to richer classes in urban areas. This situation is of course not ethically satisfying.

        BRI-UD is an example of efficiency--it's operating costs account for 14 percent of the average outstanding loan portfolio in 1994. These costs also cover mobilizing savings, the volume of which is about twice the value of the outstanding loan portfolio. This demonstrates that higher efficiency can be achieved in microfinance than was ever believed. Success was attained by:

  • focusing on rural financial intermediation rather than credit to agriculture alone;
  • focusing on increasing access to financial services and not on targeting poor people or resolving gender issues;
  • mobilizing and servicing 12.2 million savings accounts ($2.1 billion) that make dependency on State and donor funds redundant;
  • stressing profitability, management autonomy and adequate management information systems (MIS): village banks have specific targets to achieve subsidy independence; staff incentives are linked to branch profitability;
  • introducing incentive schemes for clients: significant interest rate rebates are offered for prompt loan repayments; flexible savings products are offered;
  • introducing highly positive on-lending interest rates.

        BRI-UD is faced in most areas with little competition and therefore little incentive to lower the on-lending rate. However, as commercial banks and other private organizations become aware of the profitability of rural financial intermediation, these institutions are more aggressively entering the market and BRI may react by lowering its rate. An issue arises: should the State intervene to ensure that the lending rates are not too high? There are two ways the State could take action: either speed up the competition by auctioning the entry of new banks into rural areas and small municipalities (as will be done in Mexico under a World Bank Technical Assistance loan); or regulate the interest rate directly since the State is the owner of BRI.

        While in the case of BRI-UD it can be argued that the interest rate charged to poor clients of the Unit Desa is too high, this is rarely the case in most microfinance programs. BRI-UD's case is particular for a number of reasons. First, the Village Banks were created out of existing bank branches and took advantage of elements of the existing infrastructure. Second, BRI-UD benefited from a very favorable context : high density of population, hospitable macro and financial policies, and a very high rate of growth of GDP. Third, given the size of the program (2.2 million loans and 12.2 million depositors in 1994), important economies of scale have been achieved. Therefore it would be unreasonable to believe that most microfinance institutions can reach the same results as BRI-UD. However, there are many lessons of efficiency and successful savings mobilization that can be drawn from BRI-UDís experience.

Contact Information:
    Rustam Dachlan
    Managing Director
    Unit Division
    Jl. Jend. Sudirman No. 44-46
    P.O. Box 1094
    Jakarta 10210 INDONESIA
    Tel 62-21-251-0312
    Fax 62-21-251-0313
    Email ivp@bri.co.id

    Jarot Eko Winarno
    Product development manager, Unit Division
    International Visitor's Program.
    Email: briunit@ibm.net

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