Investing in Bangladesh

Two days ago I attended a conference on untapped investment opportunities in Bangladesh. It was structured as a panel discussion and less interactive than the PE round table due to the large audience size, but insightful nevertheless. The panel included the MD of a large Bangladeshi corporation, economists from leading investment and development banks, and private equity investors. With the recent growth in Bangladesh, I was curious about its drivers and needs. Here are some of my realizations from the conference.

Drivers and Opportunities
Road to political stability. The caretaker government that was put in place on Oct.29,2006 following a period of violence and volatility has since instituted several reforms, including reconstitution of the Elections Committee. The government also recently created the Better Business Forum to improve interaction between the business community and government and establish the need for public private partnerships (PPP) for infrastructure projects. The impending election and government emphasis on business should decrease risk and attract foreign investment.

Investment climate. Bangladesh has a favorable investment climate with the government allowing 100% FDI and joint ventures with the private and public sectors. The government has also instituted no ceiling on investment, tax holidays, duty-free imports of machinery, etc. for export-oriented industries, and multiple entry visas for foreign investors among other incentives.

Economic indicators. A 7% growth in GDP is further bolstered by a shift to new industries such as services, which now accounts for 50% of GDP, and an increased shift of the informal sector to the formal which results in value that was previously not being recognized now counting towards the national output. The Dhaka Stock Exchange is also up 66% this year, making it Asia’s top performer after China.

Isolation. With a foreign investment being 1% of GDP and only 20% of GDP being exported outside its borders, Bangladesh’s market is decoupled from the rest of the world and thus, relatively uncorrelated. The government is also promoting self-sufficiency by encouraging foreign investment in sectors that will help import substitution, such as high-tech. Foreign investors seeking to diversify their emerging markets footprint should find opportunity here, though the correlation will increase over time as Bangladesh continues to integrate with the rest of the world.

Favorable demographics. With a population median of 22.5 years in 2007 and 33% of Bangladeshis being under 15 years age, the next generation will dramatically increase the number of consumers and demand for consumer products. Arif Dowla, MD of ACI Ltd. (leading provider of pharmaceuticals, FMCG, and others) even commented that it could be difficult for businesses to keep up with the demand growth. Further, a growing cadre of tech savvy and entrepreneurial Bangladeshis, many educated abroad, are fueling new business growth and remittances from an increasing number of non-resident Bangladeshis are increasing stability.

Barriers and Needs
Lacking infrastructure. Repeatedly prioritized by several panelists as the leading area for reform, including electricity which is only available to 15% of villages (World Bank), roads, railroads, and telecommunications. The government also needs to go to market for investments in infrastructure through public private partnerships.

Marketing and branding. David Fernandez, head of emerging Asia economic and sovereign research at JP Morgan, made a point repeatedly that what Bangladesh needs (but is starting to build) is a credible story for investors. This includes developing a brand for the country and promoting opportunities to the global investment community. The country also lacks a credit rating as the government has yet to decide when the right time to establish that would be.

Fiscal reforms. Peter Berezin, senior global economist for Goldman Sachs, pointed out the need for greater fiscal reforms, underscoring the need for tax collection reforms. Unless the country is able to significantly increase its tax collection, through better tax administration or expanding the tax base, it will not be able to meet fast economic growth without increasing the fiscal deficit.

Any App, Any Device

In a surprising move that has potential to significantly reshape the US wireless ecosystem, Verizon Wireless announced this week that it will open its network in 2008 by allowing users to use non-Verizon phones and applications on its network. The company, which users have long recognized as one of the most restrictive, plans to make the open network available to customers by end of 2008. It will publish the technical standards the development community will need to design products to interface with the network by early 2008. Though Verizon has not yet hinted at the minimum requirements to meet its technical standards or certification fee for the open network, leading some to speculate on how restrictive these requirements could potentially be, the wireless ecosystem will never be the same.

FCC and Google: Can You Hear Me Now?
Verizon has little choice today as the wireless industry moves towards the open access model which has long been accepted in Europe and Asia. Political and competitive pressure mounts as customers are increasingly dissatisfied with the US carrier oligopoly. That Verizon moved first is beneficial as it gives the operator an edge over traditional competitors in the new era of wireless services.

Political pressure. The FCC’s Kevin Martin has been advocating “open access” requirements on the upcoming 700 MHz spectrum and may even lock out bidders who don’t support the paradigm. Further, Washington is seeing legislation supporting net neutrality and granting more power to the FCC. Finally, the possibility of a democratic win in the 2008 elections and statements in Senator Obama’s recent position paper on tech promoting net neutrality and even further competition within the 700 MHz spectrum will only turn up the heat on carriers to open up.

Spectrum auction changes. The upcoming 700 MHz spectrum auction gives the FCC and open access advocates such as Google and eBay the opportunity to increase competition in the market. Google has even backed its assertion with a $4.6 billion commitment for next January’s auction if the FCC agrees to its conditions of (1) open applications, (2) open devices, (3) open wholesale services, and (4) open network access, though Google's aim is likely to sway the auction process to this end rather than actually win spectrum for itself. Verizon’s announcement also comes amidst fears that the FCC may lock out bidders who are not willing to “provide a platform that is more open to devices and applications”.[1]

Disruptive technology threats. Verizon’s shift is also a response to recent technology advancements including Google’s recent announcement of Android, its open-source open-access mobile software platform that allows developers and users to customize and create applications for mobile phones. The expectation that Android will, in a fashion similar to Facebook’s application creation platform, result in a myriad of innovative phone applications shifts power from the operators to the application developers. Sprint and T-Mobile have already declared support for Android in an effort to support more innovative phones than their larger competitors, leading AT&T to consider it as well. Similarly, Apple’s iPhone and the decoupling of the handset from the service are signals of value migration from the carrier to the device and application developer.

The Empire Strikes Back
Though a reactionary measure, Verizon’s announcement will have far-reaching implications across the value chain:

Verizon. Being the first carrier to truly declare support for open access in their own network, Verizon benefits in the short term from positive press and first mover advantage in developing partnerships with Google and application developers. In the medium term Verizon may also be able to seize first mover advantage in mobile advertising, a market expected to reach over $19 billion by 2011[2]. On the flip side, Verizon diminishes its ability to force exclusivity on new handsets and lock customers into contracts, making it more open to competition. Verizon will still give consumers the option of signing a contract, but will now have to provide them with a rebate on their phone purchase to do so. Finally, expect Verizon to see an increasing amount of business from wholesale capacity as new gadgets that require connectivity emerge, for example Amazon’s Kindle e-book reader which uses wholesale capacity from Sprint to connect a portable gadget at no cost to the consumer.

Competitive war games. Verizon’s move is a cross parry against smaller operators such as Sprint and T-Mobile which had no choice but to embrace open access. The move will severely diminish their chance of outflanking Verizon and further increase the subscriber gap between the rivals. The announcement is also well timed to blunt Sprint’s spring 2008 launch of its new Xohm service. AT&T, though temporarily safe because its GSM phones won’t work on Verizon’s CDMA network, has also taken steps to open access through the iPhone for which it pays Apple a portion of recurring service revenues. Expect AT&T to further embrace open access now that the floodgates have opened.

Device manufacturers. Device decoupling will give manufacturers more freedom to develop innovative products and obtain higher margins, similar to what is done in Europe and Asia today. Expect handset manufacturers to aggressively promote their brands through advertising and showcase their technologies using their own retail presence, similar to the Apple store. Devices will also start to provide other forms of connectivity (e.g. IP) such as Europe’s 3 Skypephone which lets users make free calls via Skype as well as regular network calls.

Retail channel. The ecosystem shift could breathe new life into consumer electronics stores such as Best Buy or Radio Shack as the handset becomes a gadget in consumer eyes. Though operator owned stores will retain some business from mid-market consumers that want to subsidize their handsets with contracts, this could be the death knell for independent dealers who thrived on symbiotic and exclusive relationships with carriers.

Application developers. Players in the software and application segment will get a boost as the open network allows their operating systems and applications to move between networks. As handsets come into the limelight, expect client software to be a key point of differentiation for them. Microsoft, seeking to grow its mobile OS share, will benefit from Verizon’s software agnostic approach and Google is already seeding application innovation for Android with two $10 million contests.

Devices, Networks, and Applications: The New DNA of Wireless
As the ecosystem evolves and reshapes, expect a pivot around one or more of the following pivot points: devices, networks, and applications. The diagram shows this change, with the dark circle indicating the pivot point and the white circle indicating the least influential point at that phase.

Pivoting around each of the three could take an ecosystem in different directions, resulting in the following effects.

Network based. Today’s ecosystem pivots around the network operators. With open access on the horizon, mid-market and less affluent customers will still have the option of subsidizing their handset through contracts while customers interested in open access will be lured to network operators through rebates and loyalty programs. This scenario will also see growth of MVNOs as new applications for data services emerge.

Device based. As the ecosystem pivots around devices, there will be more cases like the iPhone where a manufacturer is able to sell the device separately from the service, dictate the features, software, and interface for the device, and even take a portion of the carrier’s recurring service revenue for users of the device. There will also be a proliferation of devices that cater to particular segments, for example an ESPN-themed device with game tracking software for sports enthusiasts. Devices will continue to become fashion statements, consumers will buy devices without knowing who the network provider is (e.g. Kindle), and innovations will get to consumer hands faster.

Application based. Pivoting around applications will result in a pairing of the device with software, with the device being less pronounced to consumers. Applications will come from three sources: (1) individual programmers who will create and share simple applications, similar to Facebook’s application platform, (2) software companies which will provide complex applications for purchase or custom applications for businesses, and (3) businesses which will provide mobile extensions of their services, for example TD creating a real-time trading application or Amazon allowing users to take a picture of an item and search for it on Amazon mobile. Consumers will purchase them from through a forum similar to AppExchange by Salesforce.com. As applications proliferate into embedded devices such as home appliances and cars, the cell phone will become a ubiquitous feature rather than a tangible product.

[1] FCC News Release: FCC Revises 700 MHz Rules to Advance Interoperable Public Safety Communications and Promote Wireless Broadband Deployment. July.31.2007
[2] ABI Research. Mobile Marketing and Advertising. April.2007

Private equity and economic development in Africa

Last night I had a chance to join a round table discussion hosted by the Harvard Private Equity club on "Private Equity and Economic Development", featuring Roberto Mizrahi of the South North Development Institute (http://www.southnorth.org/). Though I was the only person there without a finance background, I was early to the event and had a chance to speak with Roberto in person about his work. As with others of similar stature in the world of investing for development, I found him to be a fountain of wisdom while maintaining a warm, inviting, and down-to-earth demeanor. And with a unique sense of humor; upon finding out about my experience in microfinance he made it a point, during the group discussion, to point at me every time he mentioned micro-credit. The discussion focused on Africa and Latin America as that was the focus of his work; here are some of my recollections on private equity, investing, and development.

1. Africa is going through an economic growth phase (GDP growth in 2006: 5.7%, 2007: 6.1%, expected 2008: 6.8%), primarily driven by the booming oil and commodities markets. It was pointed out that countries such as Nigeria and Kenya have active stock exchanges and have seen strong IPOs in recent history. Financial access to individuals has also been increasing.

2. Emerging markets private equity is a local game. One of the first points made by Roberto in the discussion was the importance of local talent in investing. True, there will always be a crucial role for US-based investors in developing countries because of the need for foreign capital, but local partnerships are necessary to build relationships, navigate the regulatory framework, and bridge cultural gaps.

3. Africa is not a country, it's 53 countries. And not only are there 53 countries, but these countries differ vastly in level of economic development, opportunities for local investment, and regulatory framework. Egypt and South Africa, for example, have more developed capital markets and some oil exporting countries are attracting significant investment, while in some parts of Sub-Saharan Africa, raising debt is still expensive and medium to large sized investment opportunities are few and far between. Hence, investors should look regionally for opportunities.

4. Private equity as a tool for development. PE itself won't solve the world's problems, especially in large parts of Africa where many key issues related to disease, AIDS, malnutrition, and poverty have yet to see market-based solutions. To this Roberto described PE as a vehicle for wealth generation, and that wealth allowing for the creation of foundations which can better address these fundamental development issues. In Africa PE can also be a direct tool towards development, with oil and gas, mining, infrastructure, and telecommunications being the most lucrative. And the poorest countries? Well, there may be a trickle down or halo effect, but that's more up to governments than the PE firms.

5. Innovation is still the key to double-bottom line investing. I've been saying it for years (ok, so I started saying it after I heard CK Prahalad say it...), but Roberto said it again. Standard business models for delivery of products and capital cannot be replicated in emerging economies. Instead, traditional models have to be redefined in order to be effective while profitable. He gave a great example in microfinance (while pointing at me); it isn't profitable to replicate the consumer bank loan model in a low-margin high-volume system (because of high unit cost). However, if one is able to create a system to approve a hundred loans in aggregate, it might be profitable.

Microfinance 2.0

Two days ago, I had the chance to meet Premal Shah, the CEO of Kiva.org (http://www.kiva.org/) and ex-Mercer consultant. My thoughts after his presentation on Kiva, how he got involved, and its impact on the developing world:

1. The Internet is game changing in that it brings micro-investing to the average person by creating an accessible and (relatively) transparent channel. It does this through (1) accessibility, as the Internet is ubiquitous, (2) aggregation, allowing a single user to donate a smaller amount and aggregating donations across multiple users, and (3) experience, making it fun for the users to give money through tools such as social networking, blogs, etc. Like eBay in auctions or Kiva in micro-lending, I don't see why the model can't be extended to things like funding projects (a typical AID project required $3000; that's 200 people donating $15 each), micro-VC, or any application that can benefit from the power of masses.

2. Internet development companies are fragile and heavily dependent on press and perception. More specifically, there is a high risk associated with bad press, which on the Internet spreads like wildfire. I experienced this AID, when (during the tsunami relief effort) accusations of donor money being used to fund extremist organizations such as the DYFI and RSS started appearing on blogs and web forums. As chapter coordinator of a highly decentralized organization, it was incredibly difficult to do anything to stop it; only time and repeated public statements quenched that fire. While the Internet can bring people together en masse, it can also turn them away as dramatically; all it could take is one account of fraud, laundering, or a major washout.

3. It's incredibly difficult to make the jump from non-profit to for-profit, so companies should make this call early on. And there are benefits to both... being a non-profit gets you 501(c) status, lets you play the "social good" card with donors, and draws less scrutiny from your investors / users, while being a for-profit makes you (hopefully) financially self-sustainable, increases the scalability of your work, and attracts a larger set of investors who invest in you for returns. But by switching from a non-profit to a for-profit you stand the risk of confusing and alienating your existing user / donor base (which aligned with your social mission) and destroying brand equity.

4. There is tremendous untapped potential in individuals. Kiva itself has over $11 million in loans and 100k lenders to date, and I realized the bottleneck here is the current lack of outlets to connect people with causes they care about. Microlending is just one thing; there are also ways to buy micro equivalent of carbon credits (see Terrapass, http://www.terrapass.com/), among other important causes. What would be nice is if a branded player, such as Google, could create a consolidated forum to connect people with their passions with at least some level of ROI.

5. As stated in Premal's presentation, "Consulting is excellent preparation for the challenges of startup life". I'm loving it.

Touching the sky

I wrote this article for the Wharton Journal after returning from Mt. Cotopaxi in Ecuador: http://media.www.whartonjournal.com/media/storage/paper201/news/2007/04/02/News/Touching.The.Sky.Feeling.The.High-2819292.shtml

Touching the Sky

11.34pm. The snow pebbles sliding gently down the mountain almost sounded like water flowing through a forest brook. For a brief moment I was back on the beach like many other spring breakers, relaxing and listening to the water. Suddenly my peaceful image was broken by the harsh sound of crampons (boots with spikes on the bottom) digging into hard snow; I opened my eyes and forced myself 17,000 feet back to reality. It was almost midnight. I was standing on a steep, dark white glacier, my ice axe planted in the ground for support. Through shadowy gaps in the thick cumulus clouds below I stared at the vast plains of Ecuador and farther, the faint lights of a sleeping Quito. On my left, another 2,500 vertical feet above and eerily lit by the light-blue equatorial moon, the snowcapped summit of Mt. Cotopaxi. The sky was clear tonight and Chris Warner, the legendary mountaineer of Everest and K2 fame who founded EarthTreks and personally led our expedition, announced that the weather was perfect for the climb.

I looked down the icy path that zigzagged up the mountain; a dozen bright spots snaked up slowly like a lost constellation reaching for the dense bed of stars overhead. They were the headlamps of the ten other members of my Wharton Leadership Venture group. A lot had happened over the five days leading to today, and I silently thanked my team for making the choices that kept us together. Extreme situations call for a different form of teamwork and dedication; the last few days convinced me that for a team to maximize its success it’s not enough that members can articulate, understand, and fully buy into the team goal; they must subjugate themselves to the team’s goal over their own and incorporate the goal in everything they do.

My thoughts wandered to our goal: “100% Summit and Back”. Just five days ago the eleven of us met in Quito and decided this would be our objective for the week. It was a self-selected group ripe with marathon runners, triathletes, and experienced mountain climbers (and a few like me, who were new to the very idea of physical exertion and hoped that the weeks of running up the stairs of Franklin Field and the Claridge were worth something). Though the goal was easy to agree on (since everyone’s personal goal was to reach the summit), we discussed its validity when Chris pointed out that no Wharton group had ever placed 100% of its members on the summit. Is it reasonable to have a goal which is seemingly unattainable? How will different individuals react to this?

The next day’s practice climb took place on Pichincha, a nearby mountain of 15,500 feet. In the spirit of our goal we decided to work as a team; our “leaders of the day” (each day a different person was assigned to be leader) grouped us into sub-teams of three and required that we stay with our sub-team. The strategy was different from that of past Wharton teams which traditionally used this climb to learn team members’ comfortable pace and categorize them as fast, medium, or slow. Though Pichincha was almost 4,000 feet lower than Cotopaxi and didn’t require us to tread through ice, it had its own perils in the form of precarious terrain and steep inclines. Grey volcanic ash littered the unstable path and a thick shroud of fog frequently blocked our view of the rolling green and brown valley below. At times the clouds would part, revealing the majestic Mt. Cotopaxi in the distance towering over the countryside. The 8-hour hike was tiring, but I was relieved that we were together and working as a team; on several occasions I saw the more experienced climbers helping their less experienced companions navigate a precipice or uneven terrain. We sent periodic reminders to each other to take a sip from our Camelbak water pouches; this not only kept us hydrated, but on Cotopaxi would prevent the water tube from freezing. At times the leaders stayed back and made sure the entire team safely crossed a dangerous area before moving on. I began to realize there were two ways of interpreting our goal; in simple terms it could be translated into each of us committing to do our best to reach the summit, thus achieving 100%. But another interpretation of our goal was that each person’s duty was to make sure that everyone else summitted. I didn’t realize at the time that our collaborative nature this day set a foundation of trust and camaraderie in the team, something that would become invaluable in the days to come.

1.30am. Two hours into climbing Cotopaxi and I was exhausted from the effects of the high altitude; at 18,000 feet the air is almost 25% thinner than at sea level, forcing short frequent breaths. In Quito (10,000 feet) climbing up a single flight of stairs left a person short of breath; I wondered what it would be like at the summit, almost twice as high. I sat by a large serac (ice pillar formed by a moving glacier) next to my rope team.

Possibly the most important (and tense) decision of the entire trip took place just two days ago in the base camp when the group decided how to populate the three rope teams. A rope team connected individuals at the waist with a thick rope to prevent them from falling into a crevasse or cliff. The simplest, almost Darwinist method was by pace; categorize people as fast, medium, or slow and create a team for each. Though this strategy was most often employed by past Wharton groups, it would abandon the slow team and thus, go against our goal. The alternative: balance each rope team with a fast, medium, and slow person. The very idea prompted a heated debate, and the clash between individual goals and the group’s immediately emerged. For example, faster members were afraid that slower people on their team would increase the risk of failure. Indeed this was our group’s crucible moment as we realized that achieving our group’s goal would require every one of us to sacrifice for the team. Faster members would not make the summit as fast as they wanted; slower people would have to push themselves harder to keep up. With some hesitation, we chose the balanced strategy.

5.55am. The first rays of morning broke the night sky in a burst of yellow, pink, and purple, illuminating our final ascent to the summit. The lack of oxygen was giving me hallucinations in the form of bright blue and green spots that occasionally danced in front of me. A fierce freezing wind clung to my down jacket covering it with small icicles. I looked back and saw my entire group behind me. We made it; for the first time an entire Wharton group reached the summit of Cotopaxi.

The next day. As I recovered over a warm tea made from cocaine leaves in the comfortable, heated lodge at the mountain’s foot, I pondered our intense journey. Our team responded to challenges uniquely, but why? What made us sacrifice our egos for people we met just a week ago? How did we make the leap from thinking about the self to thinking about the group? In my observation, it was the fact that throughout the trip we lived and breathed our goal in everything we did. On Pichincha we stayed together. When hiking up to base camp we made sure no one walked alone. Even during a city tour of Quito we used sub-teams to prevent people from losing the group.

This lesson is invaluable as extreme situations in business call for a similar dynamic. A business needs to have a clear, well-defined goal that every member of the management team buys into and incorporates into their daily duties. Furthermore, the team will only truly be successful if members put the collective goal before their own. However, reaching this level of cohesion is difficult and can only happen if team members build trust, and for that the leader must epitomize the team goal from day one and set an example for others. The team should also be careful in choosing, articulating, and quantifying its goal to ensure that it reflects the values of every person in the group.

The more I reflect on this experience, the more I realize that reaching the summit was never the point. Years from now I may forget the sight of the cloud-covered crater from the top, the sound of distant thunder from below, and the icy touch of nature’s breath, perpetual reminder that in the end we were there only because of her kindness. But I won’t forget the people there with me and the journey that brought us there. Looking back, I realize the mountain is but a metaphor for life’s challenges and each of us can touch the sky in our own lives.

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/