Fear and loathing in Jakarta

Working in Asia is different from working in the US. Ok, that's a huge understatement. But I didn't really feel it until I experienced living there. Here are a couple of quirks about life as an intern in Jakarta.

1. Irony. In this case, of living in one of the most advanced banking economies in the developing world and not having a bank account. The IFC pays me in cash. Specifically, IDR 18,426,000 of it every month. It comes in a Manila envelope, which I put in a plastic bag to bring home, much like how I carry broccoli back from Whole Foods. I keep my money under my mattress (literally) and use MS Money to manage my "account". It's not too bad; I bought everything from plane tickets to Nasi Goreng with it, and always make sure to carry an "inch" with me wherever I go. And the best part, it's tax free!

2. Karaoke. In America, we schmooze clients on the golf course. Out here, it's karaoke. And we're not talking about a bunch of drunkards spilling 40's of beer (or worse) over a mike in a noisy bar. The karaoke club my boss and a couple of colleagues went to was one of the classiest joints I've seen, with ferrari's lining the red-carpeted entrance and a dedicated karaoke room for us with two large screens, surround sound, 4 mikes, a full course menu with wine, and (get this) our very own live backup singers. Someone please tell me how one goes about talking business in a place like this.

3. Nasi Goreng. It's everywhere. Really. You can get it for 50 cents on the sidewalk, or you can pay over $8.00 for exactly the same thing at a nice hotel. Its noodle counterpart, Mie Goreng, has become my staple, as all you need is noodles, egg, and "ketchup manis", a sweet soy sauce. Isn't it great when even the simplest things taste so good?

Indonesian Microfinance Sector

My thoughts on the intriguing Indonesian microfinance sector:

Indonesian Microfinance Sector

Microfinance Sector / Trends
1.1. Indonesia is one of the most celebrated cases in microfinance today, with 44 million depositors, 30 million borrowers (individuals and micro-enterprises), and a total asset size of $141 Billion.[1] Commercialization and privatization are growing trends; over the past two years several Indonesian banks have been sold to foreign investors and the government has sold significant stakes of its own banks through IPOs, namely Bank Mandiri (30%) and Bank Rakyat Indonesia (41%). Today over 80% of Indonesia’s microloans come from commercial sources. Table 1 shows the progress of commercialization, relative to other countries.

Table 1: Comparison of MFI commercialization in Asia (*** = large extent, * = lesser extent)[2]

1.2. A BRI survey with 1426 respondents showed that 62% of households without a viable enterprise did not have savings accounts and 68% did not have credit from any financial institution. In households with a viable enterprise, 52% did not have a savings account and 58% did not have a loan from a financial institution.[3] A similar study consisting of surveys, interviews, and focus groups conducted by the Asian Development Bank in 2003 echoed these results. Surveys also showed greater demand for microsavings than microcredit.[4]

1.3. The amount of micro-loans given out by commercial banks has increased steadily as well (graph 1). Furthermore, the share of the micro segment (defined as loans less than $5000 as defined by Bank Indonesia) of outstanding loans of commercial banks in the last three years is fairly impressive – 18.8% in 2001, 22.4% in 2002, and 23.3% in 2003.[5] The average loan size from a commercial bank is $983[6].

Graph 1: Outstanding micro credits (Rp.Billions) by commercial banks[7]
1.4. The quality of assets, as measured by non-performing loan (NPL) rate is promising for Indonesian microfinance institutions. Table 2 shows NPLs for the most prominent commercial MFIs:

Table 2: Non-Performing Loans (2004)[8]

Competitive Landscape
2.1. As shown in table 3, the Indonesian microfinance sector is currently comprised of a large variety of public and private institutions and government programs.

Table 3: Microfinance Institutions in Indonesia (as of 2005)[9]
The major microfinance institutions are described as follows:

Commercial banks. BRI’s microbanking outlets (called BRI Units) account for the majority of micro-loans in Indonesia. Though other commercial banks (such as Bank Mandiri) have followed BRI´s example, they have had limited success due to (1) expensive business model, (2) poorly defined strategy, and (3) lack of fit with industry in terms of organizational skill and human resources. The only other successful bank is Danamon which focuses on urban areas and provides higher-end micro-loans (average size $2000).

BPR. BPRs (Bank Perkreditan Rakyat) are rural banking units created by the Central Bank. Though they have been experiencing CAGR of 35%, they are highly regulated and are not allowed to accept any foreign investment. Of these, BKDs are village banks that are set up locally and funded by a combination of village landowners, village treasury, government organizations, and/or the Ministry of Finance. They also have a harder time competing with commercial banks for savings and tend to have lower-income clients.

Non-bank non-cooperative. Also called LDKPs, these are established by provincial governments as microfinance providers. They are government owned and receive seed capital from the local and central government.

Credit cooperatives. Most cooperatives are small, local institutions with up to 5 staff and mo more than 1,000 clients. They are often set up by a group of individuals who pool their funds and create a cooperative as an investment option. They provide individual loans, including some that do not require collateral.

S & L units. These are cooperatives that deal inclusively with saving and lending. A common form of S&L cooperative is the Islamic-lending cooperatives called Baitul Maal wat Tamwil (BMT) or Baitul Qirat that uses traditional profit-sharing schemes instead of charging an interest rate on their loans.

Pawnshops. All pawnshops in Indonesia are state-owned and run by Perum Pegadaian. There are 744 branches and 14 regional head offices. As of 2004, total loan asset of these pawnshops are $0.7 Billion. The lending is based on collateral which includes jewelry, precious metal, electrical devices and even clothing. To customers, pawnshops have advantages of simple and fast procedure.

2.2. Bank Rakyat Indonesia is the world’s first, largest, and most profitable commercial microfinance institution. Over the last four years the number of savings accounts at its BRI units increased by 1 million per year on average, the number of units increased from 325 to 4046, and the percentage of profitable units increased to 96%.[10]. BRI’s growth and success, combined with the as yet unmet demand for microbanking services, shows that there are still significant opportunities for growth in this sector.

Regulatory Environment
3.1. Indonesia’s approach to regulating microfinance has been one of trying to make optimal use of its diversity of small financial institutions – mainly sponsored by the state or locality – while commercializing microfinance in line with the liberalization of the Indonesian economy and banking system.

3.2. Regulations on BPRs have been revised several times; a 1999 regulation stipulated that BPRs may not have foreign shareholders and could only open one new branch per year, prior to which it must meet a minimum CAR requirement of 15% and be defined as a sound BPR for 2 years in a row by Bank Indonesia. A 2004 regulation changed the capital requirement to the following (table 4):

Table 4: Capital requirement for BPRs as of 2004[11]
3.3. A 2001 law stipulates that by 2008, foundations such as the one owned by Parasahabat Group can no longer engage in commercial and lending activities and must be purely dedicated to social activities.

3.4. Bank Indonesia uses the CAMEL system (a criteria to assess the performance of financial institutions through Capital, Assets, Management, Earnings, and Liquidity) to determine the soundness of BPRs and sets the following prudential requirements with which BPRs must comply.

Table 5: BI’s Prudential Requirements[12]
Table 6: CAMEL Supervision Tool[13]

3.5. Recent government focus on formulation of policies and strategies to develop microfinance is also creating more opportunity in this sector:
· Government has proposed the establishment of a supervisory body (Otoritas Jasa Keuangan – OJK) by 2010 that will supervise, under one roof, all financial institutions including banks and finance companies. If established, the quality of supervision is expected to improve.
· In 2005 the government created the National Committee for Microfinance Development, consisting of high officials and headed by a Deputy of the Coordinating Minister of Economic Affairs. The group’s mission is to (1) eliminate all restrictions to the development of microfinance, (2) recognize the existence of various non-bank non-coop MFIs, and (3) legalize these MFIs.
· Establishment of a microfinance Apex institution – essentially to link the BPRs to liquidity management and eventually to foreign funding and the payment system – with provincial apexes operating around the country.

Summary
With 30 million current borrowers and 58% of households not having any form of loan from a financial institution, an estimated 41 million households have yet to benefit from microcredit services. With approximately half of the 30 million receiving funds from commercial sources, if we assume (conservatively) that 20 million of the untapped households will receive loans from commercial sources and an average loan size of $983, the market opportunity for commercial microfinance can be estimated to be $20 billion. Combined with a diverse set of competitors and a regulatory environment that is removing restrictions on microfinance, commercial microfinance institutions can thrive in Indonesia’s microfinance market.

[1] Meagher, Campos, Christen. Microfinance Regulation in Seven Countries: A Comparative Study. Iris Center, 2006
[2] Charitonenko, Campion, Fernando. Commercialization of Microfinance: Perspectives from South and Southeast Asia. Asian Development Bank, 2004
[3] BRI Microbanking Services: Development Impact and Future Growth Potential. Jakarta BRI, Harvard University, 2001
[4] Fernando. Commercialization of Microfinance – Indonesia. Asian Development Bank, 2003
[5] Bank Indonesia. Annual Report 2003.
[6] Meagher, Campos, Christen. Microfinance Regulation in Seven Countries: A Comparative Study. Iris Center, 2006
[7] Bank Indonesia statistics. http://www.bi.go.id/
[8] Hammerich, Hamp. Joint GTZ-KfW Fact-Finding Mission Report. March 2005
[9] Meagher, Campos, Christen. Microfinance Regulation in Seven Countries: A Comparative Study. Iris Center, 2006
[10] Robinson. Why the Bank Rakyat Indonesia has the World’s Largest Sustainable Microbanking System. BRI 2005
[11] Bank Indonesia. http://www.bi.go.id/
[12] Bank Indonesia. http://www.bi.go.id/
[13] CAMEL supervision tool. http://www.gdrc.org/icm/rating/rate-2.html; Bank Indonesia, http://www.bi.go.id/

The Holy Grail of Old-School

The chance to work at the IFC was too good to be true, if even just for a 3 month internship. I was assigned to a team working on a deal memorandum for IFC's first microfinance venture in Jakarta: project financing for a Java-based commercial bank to extend microloans to aspiring micro-entrepreneurs. I was surprised that it was the first; after all Indonesia had arguably the most mature and differentiated microfinance sector in the developing world. Bank Rakyat Indonesia (BRI), the largest local bank, was known the world over as a bank that revolutionized rural microfinance (even in 2001, its microbanking division accounted for 34% of its total assets, 31% of loans outstanding, and 41% of deposits); the microbanking unit was profitable even though the bank as a whole was loss making. With several types of MFIs, including BRI rural banking units, independent rural banks (BPRs), as well as non-bank MFIs such as financial cooperatives, village MFIs, and pawnshops, it was also one of the most diverse.

A few pleasant surprises came my way in the first week of working here:

1. Analytic rigor. This was the real thing, worlds apart from how we used to fund projects at AID (let's see... does it look like it'll help people someday? have we met or worked with the NGO before? might this lead to a people's movement of some sort?). In the first few days I was pouring over financial statements, calculating NPL, NIM, interest spreads, and ROA ratios, and talking to experts to build accurate projections for the model. What better way to learn finance than to get thrown in the deep end with a cause I could be passionate about?

2. Strategic mindset. Even more surprisingly, the whole process seemed more like a consulting case than a valuation exercise. I realized, as PE folks back at Wharton had always told me, that valuation is just a piece of the puzzle. The real question of whether IFC should finance this project or not depended on (here come the 3 buckets!!!) opportunity size / market demand, macro-economic / regulatory / environmental influences, and alignment with IFC goals (which would include the financial ROI analysis). Hmm, maybe there is more to the IFC than finance.

3. Development impact. I know the skeptic in me will be back to argue on this one later, or maybe it's just the IFC kool-aid (which, in southeast Asia, comes in all natural flavors with real fruit), but I really feel like this project will have social impact while achieving ROI. I went for a walk on Friday evening in the Kuningan area where my corporate housing was and saw people lining up outside a "Pegadaian" (state-owned pawnshop). Pegadaian itself had over 12.5M customers in 2005, with banks reluctant to lend to potentially high-risk customers after the economic crisis of the late 90s. However, droughts and adverse situations would force people to use valuable items, such as farm equipment, as collateral, leading to a downward spiral if they couldn't pay back the loan (with interest). Commercial microbanking units, such as the project we were financing, would give these people another option, a more structured and formal way to take microloans. I was moved by what I saw; behind our market sizing and deal structure was this story of real people who would be affected by what we do. Is that what we should call development?

Meeting Bill

There are two people I've been dying to meet for over a decade, and this was my chance to meet one of them (the other is Bono). And not only was I going to meet Bill himself, but I was going to meet him a week after his announcement that he would, in 2 years, shift focus from Microsoft to the Gates Foundation, an announcement that shook tech world and development community alike. Of course in a group of 50 MBA interns I would probably get at most 1 question off, so I had to have a good one. Should I ask about Africa's most pressing issues? Or the role of technology in development? Or whether the foundation is a more effective vehicle for development than the private sector? I realized, though, that I could find these opinions elsewhere. What I really wanted to know was: what is his plan, and what does he see as his role in the grand scheme?

Questions from the group fell fairly equally into 3 categories: Microsoft, technology, and the foundation. In fielding questions from our group, he touched upon the GF's thrusts in Africa, including health-care, education, poverty alleviation, access to finance, and governance, and reminded us that though a developed country, the US has its own "development" needs as well. To my question about his plan and vision, he simply reminded me of the role of foundations in development and some of the issues which the private sector cannot yet address, because there is simply no profit model (yet). He also talked about innovation as a key driver for development whether it be through technology / computers, innovative health-care models, financial services, or others. To this I asked further about his thoughts on projects such as One Laptop Per Child (http://laptop.org/) and was surprised to find him less bullish than I would have hoped. Otherwise nothing too ground-breaking, but it was good to know we're all on the same page.

For me the big takeaway was this other avenue towards development, which is to keep development as a hobby or interest at my early stage, create wealth for myself (whether through entrepreneurship, finance, or whatever), and come back to development in a non-profit / foundation capacity much later on. Of course amassing that kind of wealth is not easy (and takes luck), but maybe it can be done to a smaller scale. Or perhaps, a group of people deciding to pitch in together to create a foundation. Instead of "doing well through doing good", it's "doing well then doing good". Until then, we'll see where the GF goes.

Making a Name for Themselves

The Philadelphia Inquirer wrote a nice article summarizing our GCP project for a small Peruvian sauce company entering the US.

Making a Name for Themselves
by Stacey Burling, Inquirer Staff Writer

Do Americans really want more sauce? Jorge Lam Sr., a Peruvian chef famous in his home country in an Iron Chef sort of way, might have wondered this week as he toured Trader Joe's, Whole Foods and DiBruno Bros. groceries in Philadelphia with a team of student marketing consultants from the Wharton School and Universidad del Pacifico in Lima.

As students pointed from one intriguing sauce to another, one thing quickly became obvious: There are an awful lot of sauces. Shelves were loaded with them near the produce and the pasta and the meat and the chips. There were red curry and Cuban mojito, red pepper spread and marinara, chipotle-citrus barbecue and Baja seafood.

Lam, who wants to begin exporting his company's sauces to the United States, was
undaunted. Full of energy and ideas at 72, he thinks Americans will like his blend of
Chinese and Peruvian flavors. There is room here for more, he said through an
interpreter. "The market is for all."

Jorvic, the company that Lam and his 40-year-old son, Jorge Lam Jr., run, is one of 11 foreign clients of the Global Consulting Practicum, a Wharton M.B.A. class in its 28th year. The program pairs a team of about five students from the University of Pennsylvania's Wharton School with students in another country to help a company in that country expand in the United States.

Such courses are still unusual, though Temple University requires M.B.A. students to work on similar projects with foreign and domestic companies. The Wharton course is competitive: Only about a quarter of the students who apply are chosen. This academic year, Wharton students in Philadelphia and at the school's West Coast branch in San Francisco worked for companies in Chile, China, Colombia, India, Israel and Peru. Their clients included a winery, a fruit producer, an insurance company, and a carpet manufacturer. The school treats some projects as top secret because of the competition.

Students presented their final expansion proposals to companies this week. Students work for free and get one mere credit despite a workload that is far greater than average, professors said. But they also get valuable real-world practice in marketing, production, international business rules, and pricing. And there are travel perks. The Wharton students, who met their client and Peruvian team members in January in Lima, managed to squeeze in a trip to the famous Incan ruins. "The trip to Machu Picchu is well worth the work," said Pratish Halady, one of the Wharton students.

Then there was the food. Jorge Lam Sr., who is known in Peru for his cooking show broadcast from 1998 to 2000 and for his large cooking school, used his sauces in lavish meals for his guests. "Part of our study was two four-hour meals," said Steve Smolinsky, a marketing consultant and speaker who taught Wharton's Jorvic team.

Companies pay Wharton about $60,000 to cover travel and research expenses. Some companies, such as Jorvic, receive economic-development funding from their countries to offset some of the cost. Wharton absorbs the cost of the very low student-teacher ratio.

"This is still the most costly course that Wharton teaches," said Len Lodish, a marketing professor who started the course, in part, to work with a fellow Wharton professor who moved to Israel. Smolinsky said the Lams got a good deal. "A project like this from a big company would be a half-a-million-dollar project," he said. The school says that students' recommendations have added $300 million to $400 million in annual sales to clients' revenues. For example, one of last year's clients, a maker of Colombian beer, is now one of the fastest-growing in the United States, Lodish said.

Wednesday morning, the Peruvian and Wharton teams, all dressed in suits, convened to present their plan to the Lams. The group itself was evidence of the increasingly international business world. The Wharton team included one U.S. citizen, and he was born in India. His team included students from India, the Philippines, France and China. Their teaching assistant is from Japan. Jorge Lam Sr. is a product of Peru's large Asian community; his businessman father moved to Peru in 1924.

Because Jorge Lam Sr., whose company sells 30,000 bottles of sauce a month in Peru, speaks little English, the Peruvian students did the talking, in Spanish. In preparation, the Wharton students had gone to a fancy-foods trade fair to study the market and competition - 5,000 new sauces a year. They had interviewed Peruvians living in the United States and food distributors.

The teams suggested that the Lams first try selling to Peruvians in the United States. The goal would be to move into the more lucrative specialty market. They suggested getting rid of the Jorvic name and capitalizing on Jorge Lam Sr.'s name recognition - many Peruvians in the United States remember him from the TV show - and the company's unusual Peruvian base. "We want it to be very Peruvian, very him," Halady said before the presentation.

The new name: Chef LAM, El sabor original de Peru - "the original flavor of Peru." And, the students said, the company would need to heighten the flavor of two of its sauces when it expanded to the broader market. After the presentation, Jorge Lam Sr., who had studied bottle shapes and labels at the groceries as only a man with money on the line would, had questions about packaging. Jorge Lam Jr., who is in the same M.B.A. program as the Peruvian students, had detailed questions about pricing and profit, especially the students' projection that the company would not make a profit until the third or fourth year.

The Lams said they planned to accept the students' recommendations, even the part about changing the taste of the sauces. "We are not only chefs," Jorge Lam Jr. said, "but entrepreneurs."