Comments on Indonesias

Microfinance Institutions Act

RIZKY WIRASTOMO

MASSACHUSETTS, USA
SPRING 2014

I
Indonesia has commendable record in the field of microfinance: it is one of the first
countries to develop commercial microfinance in Asia, and its BRIs Unit Desa have
been widely characterized as an international best practice. 1 Behind this recognition,
however, the absence of specific legislation governing non-bank microfinance
institutions (NBMFIs) forced them to operate in a legal limbo. Pre-2013, practically
all type of financial service industries2 fell under the Indonesian banking laws. 3 Critics
say that the problem with this situation is that the banking laws do not offer NBMFIs
an ideal climate in which they can optimally generate sustained growth, which
resulted to semi-formal and informal financial institutions 4 having much less

Joselito Gallardo, A Framework for Regulating Microfinance Institutions: The Experience in

Ghana
and
the
Philippines,
THE
WORLD
BANK,
2
(2001),
http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-2755.
See also: Yoko Miyashita,
Microfinance and Poverty Alleviation: Lessons from Indonesias Village Banking System, 10 PAC.
RIM L. & POLY J. 147, 147-8 (2000).

2 Except credit and savings cooperatives, which fall under a special cooperative law.
See, Act No. 17 of 2012 on Cooperatives. [State Gazette No. 212 of 2012, Supplement
No. 5355 (Oct. 29, 2012)].
3 Act No. 7 of 1992 on Banking as amended by Act No. 10 of 1998. [State Gazette No.
31 of 1992, Supplement No. 3472 (Mar. 25, 1992); State Gazette No. 182 of 1998,
Supplement No. 3790 (Nov. 10, 1998)].
2

dominant force5 in Indonesian microfinance industry as opposed to formal financial

institutions.6
Under the banking laws, NBMFIs must convert into either commercial bank, rural
bank, or cooperative in order to provide financial intermediation services and
mobilize deposit. This is problematic. Converting into banks are generally considered
an onerous process because banks are subject to heightened prudential regulation
which incurs compliance cost that most small institutions find prohibitive, while
converting into cooperatives only allows them to provide certain financial services to
members, as opposed to offering services to the general public. What this means to
NBFMIs is that they do not have access to deposits, which represents a cheap source
of funding that also protects them against foreign exchange risks. 7 This regulatory
4 Such as cooperatives and non-governmental organization.
5

Another explanation is that under Soehartos authoritarian regime, the brewing of independent
social movements was heavily discouraged for fear of opposition culture. Soehartos infamous
administration was effectively a complex structure of authoritarian institutions deliberately
designed to curtail political participation.
See, Jamie Bedson, The Microfinance Industry
Report: Indonesia, BANKING WITH THE POOR AND SEEP NETWORK, 16 (2009),
http://www.bwtp.org/MF_Industry_Report_Indonesia_ELECTRONIC.pdf.; and R. William
Liddle, Regime: The New Order, in INDONESIA BEYOND SUHARTO: POLITY, ECONOMY, SOCIETY AND
TRANSITION 39, 40 (Donald K. Emmerson ed., 1999).

Such as such as large commercial banks and smaller regulated financial institutions. In fact, 90%
of microcredit in Indonesia is provided by commercial banks. See, Global Microscope on the
Microfinance Business Environment 2010, ECONOMIST, 21 (2010), http://idbdocs.iadb.org/wsdocs/getdocument.aspx?docnum=35379430.

7 Eugenia Macchiavello, Microfinance Regulation and Supervision: A Multi-Faced

Prism of Structures, Levels and Issues, 9 N.Y.U. J. L. & BUS. 125, 146 (2012).
3

framework is said to have made it very difficult for NBMFIs to maintain sustainable
operation.
Believing that the unfavorable regulatory structure may have inhibited NBMFIs from
operating as well as it should, the Indonesian government decided to draft a statute
that recognizes the unique mission, structure, and needs of NBMFIs. After getting
forestalled for more than a decade 8 in the House of Representatives, the Indonesian
President finally signed into law the Microfinance Institutions Act (the MFI Act or
the Act) on January 8, 2013. 9 This is truly the first comprehensive law that targets
NBMFIs that have for a long time been operating without clear legal basis. 10 Under the
8 Banking authorities must have thought that regulating microfinance NGOs were
just not worth the effort from prudential standpoint (they also had the same thoughts
with regards to department-store credit cards). The trend has changed: there are a
great number of countries that have become convinced that microfinance must be
regulated.
9 Act No. 1 of 2013 on Microfinance Institution. [State Gazette No. 12 of 2013,
Supplement No. 5394 (Jan. 8, 2013)].
10 Prior to the enactment of the MFI Act, the Minister of Finance, Minister of Home
Affairs, Minister of Cooperative and SMEs, and the Governor of Bank Indonesia
promulgated a joint decree that basically contains the four high-ranking agencies
commitment to transform unincorporated MFIs into legal entities, to provide
financial literacy education, and in general to advance and develop micro, small, and
medium enterprises as well as microfinance service providers.
4

Act, microfinance industry is no longer perceived as a mere species of the banking

industry genus, it is no longer a niche product, a subset of financial industry: it is
instead a separate sector that deserves a regulatory framework specifically tailored to
adapt to the characteristics and specific risks of the microfinance industry.
The MFI Act classifies as microfinance institutions (MFIs) 11 all non-bank financial
institutions that specialize in the provision of services in loans or financing to microscale businesses, in fund saving management, and in business consultancy. In
addition to placing bans on certain activities,12 the Act also imposes limits on the
geographic and social concentration of MFIs. For the most parts, the MFI Act
incorporates essential provisions such as ownership structure, licensing, list of
permissible activities, geographic scope, supervisory and regulatory control,
consumer protection, and transformation. Most of these provisions are to be further
implemented by the Financial Services Authority (the FSA). In fact, the House of
Representatives grants the FSA an extensive power and wide latitude to carry out the

11 In light of the numerous definition of MFIs used by different countries and institutions, we would
like to stress that the term microfinance institution or MFIs throughout this paper should be
understood in the context of the MFI Act.
For a brief list of several MFI definitions, See, Eugenia
Macchiavello, supra note 7 at 129, note 11.

12 Impermissible activities are: offering checking account services, taking part in the
payment systems, engaging in foreign currencies transaction, insurance underwriting,
acting as guarantor, and providing loans to other MFIs (MFI Act, art. 14).
5

mandate of the MFI Act. Practically almost every chapter in the Act is ended with the
phrase further provisions shall be regulated by the FSA. 13
The MFI Act allows government agencies and microfinance institutions a two-year
transitional period. The FSA has until January 2015, approximately seven months
from today, to promulgate implementing regulations concerning capital adequacy
requirement, licensing, merger, acquisition, dissolution, consumer protection,
supervisory activities, and administrative sanction. Because draft FSA regulations are
not made publicly available via internet,14 the scope of this papers discussion is to
certain extent limited.
The rest of this paper is organized as follows: Section II briefly comments on the
Indonesian governments decision to craft a special regulatory framework for MFIs.
Section III discusses some provisions of the Act, specifically form of entity and
restriction on capital structure. Section III concludes the paper.

***

13 Perhaps the best way to explain this is that most of the supervisory regulation is the
domain of the executives, which subject to political influence, for example: capital
adequacy requirements, interest rate cap, and lending practices.
14 And the authors request to access draft FSA regulations went unanswered.
6

II
Is Special Regulatory Window for Indonesian MFIs Necessary?
There is a rush to regulate in microfinance today. 15 The CGAP warns that regulators
should be cautious when deciding whether to draft a separate regulatory window for
MFIs.16 Governments tend17 to enact excessive regulation that hampers the organic
development of the very industry they seek to regulate. The CGAP report 18 outlines
key policy questions to assist the government in drafting special legal regime for
MFIs. The present section of this paper refers heavily to CGAPs findings and policy
suggestions.
To understand the intent behind the enactment of MFI Act, we need to look at the
Acts legislative history. While knowing that studying transcripts of legislative
15 Robert Christen & Richard Rosenberg, The Rush to Regulate: Legal Frameworks
for Microfinance, CGAP, 2 (2000), http://www.cgap.org/sites/default/files/CGAPOccasional-Paper-The-Rush-to-Regulate-Legal-Frameworks-for-Microfinance-Apr2000.pdf.
16 Christen & Rosenberg, Id.
authors, e.g.:

Similar words of caution has also been expressed by various other

17 Macchiavello, supra note 7 at 149.

18 Christen & Rosenberg, supra note 12.
7

hearings and meetings is important in deciphering the legislators intent,

unfortunately the only document that was available to the author is an Academic
Draft19 which accompanied the introduction of the MFI Bill in the House.
A reading of the Academic Draft reveals the main problems that the drafters sought to
resolve: exclusion of the poor from financial services, exploitation of small borrowers
by usurious loan sharks, the weak structure of existing MFIs that impedes their
growth, and the lack of a special regulatory window for MFIs which results in the
recent prosecution of MFIs management for conducting illegal deposit-taking
activity.20 After repeatedly lamenting the lack of clear legal foundation, the Draft
states that a special regulatory window (a third window) for MFIs must be instituted
to provide legal certainty for existing microfinance service providers, and to symbolize
the states firm commitment in poverty reduction. 21 Microfinance institutions, the
drafters argued, must be given a conducive regulatory framework that relieves them of
19 In Indonesia, a bill must be accompanied by an academic document. An academic draft usually
contains identification of issues and problems the bill seeks to address; philosophical, sociological,
and juridical justification for its enactment; comprehensive survey of all pertinent legislations; and
a detailed explanation of how the bill deals with the issues. A complete clause-by-clause bill and
elucidation are usually attached as appendices to the academic draft. Academic draft is only an
initial step in the legislative process. Subsequently, the draft along with the appended
bill/elucidation is brought to the House, which will appoint a subcommittee to deal with it. Rounds
of discussions, meetings, and hearings with stakeholders will result in a compilation of issues
(Daftar Inventarisasi Masalah, DIM). The bill should resolve all issues in the DIM.
If the subcommittee is satisfied that the bill resolves all issues listed in the DIM, the bill is presented
to the Houses plenary session for formal acceptance. The bill is then passed to the president to be
signed. The president cannot veto a bill that the House passed.
Act No. 12 of 2011 on Formulation of Laws and Regulations. [State Gazette No. 82 of 2011.
Supplement No. 5234. (Aug. 12, 2011)].

20 MFI Act Academic Draft at 18.

21 Id.
8

the restraints imposed by conventional banking laws regime. 22 The Draft suggests a
minimum capital requirement of Rp10 millions (approximately $870) for MFIs, 23
indicating a vision that barriers to entry for MFIs should be lower than that for
banks.24
This tells us that the logic of the drafters of MFI Act is very similar to that of the
legislators in other countries. The CGAP report identifies that in many countries, the
argument for licensing MFIs commonly run along the following lines:
The commercial banks wont serve poor customers. Most of the
institutions reaching a poor clientele right now are NGOs. Since these
institutions do not have financial licenses, they cannot leverage their
resources by capturing deposits, and they cannot provide a savings
service to their clients. The requirements for a regular banking license
are too high for the institutions interested in poor clients. Thus we
need a separate window for MFIs, with lower barriers to entry and
standards better suited to microfinance. The existence of such a
window will improve the performance of the NGOs trying to qualify
for it, and will draw forth solid new entrants who are not yet on the
microfinance scene.25

22 Id. at 30.
23 Id. at 31.
The final version of the bill as approved by the House does not contain such
numerically definitive minimum capital requirement.

24 In Indonesia, the current minimum capital requirement for commercial banks is

Rp100 billion (approximately $8.7 million) and for rural banks is Rp3 billion
(approximately $260,000).
25 Christen & Rosenberg, supra note 15 at 12.
9

The CGAP report cautions that that policy line is probably too premature for some
countries. Creating a special third window for MFIs means the government vouches
for the soundness and safety of the licensed institution. The question then becomes:
how many microfinance service providers out there are actually prepared to be
licensed? The Draft has neglected to carry out a study to assess whether these MFIs
are structurally prepared to get licensed. Are Indonesian MFIs really suitable for
licensing?
Perhaps a good way to answer that question is by looking at market share statistics.
According to the Draft, there are approximately 8,239 banks; 37,820 cooperatives;
and 31,363 NGOs that provide microfinance services in Indonesia. 26 However, the
Draft offers no explanation whether that so-and-so number of microfinance service
providers actually have the potential to grow into a profitable MFI. We think this is
problematic: Indonesias microfinance industry is predominantly serviced by formal
financial institution, i.e. the rural banks and the microfinance unit of larger
commercial banks. Let us now examine some numbers. Of the aggregate outstanding
microfinance loan portfolio, 82.8% is provided by commercial banks. About 12.6% is
provided by rural banks. This means roughly 95.4% of microloans in Indonesia is
funded by licensed banks. Similarly, about 97.5% of the total micro-deposits collected
nationwide is collected by licensed banks (both commercial and rural). 27 While this
26 MFI Act Academic Draft at 13.
27 All data is collected from the Credit Bureau division of Bank Indonesia (date stamped Sept. 2005).
Sumantoro Martowijoyo, Indonesia Microfinance at the Crossroads: Caught Between
Popular and Populist Policies, ESSAYS ON REG. & SUPERVISION 5-6 (No. 23, 2007).
This situation perhaps can be explained by the Indonesian central banks (Bank Indonesia, or
BI) continuous effort to encourage commercial banks to lend to micro, small, and medium

10

number does not prove that Indonesian microfinance NBMFIs are not suitable for
licensing, they do prove that NBMFIs have a very small market share compared to
commercial and rural banks. Perhaps this should be taken as a red flag: is there a
problem in NBMFIs marketing strategy, in their daily operations, or in their
management that makes them unable to seize bigger pie of microfinance industry
market share?
Even if we were to accept that the minuscule market share is caused precisely by the
lack of accommodating regulatory framework,28 which eventually justifies the
establishment of a special licensing regime, one should be worried that forcing
NBMFIs (cooperatives and NGOs) to fit into the new regime will only do more harm
than good. The MFI Act mandates the Financial Services Authority (FSA) to
examine the institutions organizational structure, capital structure, ownership, and
work program viability prior to issuing MFI business license. This is clearly an
attempt to filter out weak MFIs from the stronger ones. However, in the event that
very few MFIs are in fact able to pass the FSAs screening procedures (remember:
NBMFIs only make up 4.6% of microloans and 2.5% of micro-deposits nationwide),
the FSA might be politically pressured to pass out licenses to MFIs who can only

enterprises (MSMEs).
Latin American microcredit data present very similar figures. About 95% of Latin American
microcredit is provided by licensed institutions. See, Christen & Rosenberg, supra note 12 at 16.

28 Lack of specific regulatory framework means inability to mobilize deposits, which

means limited access to cheap form of funding, which means less competitiveness.
11

promise future instead of actual profitability.29 This grim prediction is not

unfounded: as we have discussed earlier, the decade-long authoritarian regime may
have crippled the development of Indonesian NGOs. Also, Indonesias microfinance
industry is so dominated by state-run microfinance intermediation or program, 30
government officials have been said to be reluctant to nurture and develop NGO
activities in microfinance services because that might shift political energy and
influence away from the states own agencies.31

29 Christen & Rosenberg, supra note 15 at 15.

30 Notable government microfinance programs are subsidized loan programs such as
BIMAS, Instruksi Desa Tertinggal, and Kredit Usaha Tani.
31 Miyashita, supra note 1 at 173.
12

Figure 1. Microfinance Institutions in Indonesia

To sum up, the main issues that we have been discussing right now is whether after
the new regulatory window kicks off, there will be any microfinance service providers
that can pass the FSAs licensing requirement; and if there are some, whether they can
be profitable under the new regime. Statistics shows that in Indonesia, NBMFIs
constitute only a very small fraction of the microfinance industry market share. More
than 95% of the microfinance industry is already serviced by licensed banks. Yes it is
true that there are tens of thousands of small non-governmental organizations and
cooperatives that faithfully cater to poor people in remote areas but are now operating
13

in legal limbo. And yes, it is true that there is a burgeoning demand to allow these
small institutions to mobilize deposits. But licensing them probably is not the only
solution.
One possible solution is to simply refrain from regulating. Instead of creating an MFI
regulatory window, the government implicitly treats certain select leading
microfinance service providers as equal to deposit-taking institutions. This means
these providers are to be exempted from some prudential regulations such as
minimum capital requirement or limits on unsecured lending. This way, regulators
can respond to NBMFIs demand to have legal certainty without having to establish
a special framework, which carries (hefty) supervisory costs for both the regulator (in
this case, the FSA) and for the industry. Another solution is to permit unlicensed
MFIs to team up with licensed banks in extending services to the poor. This strategy
has been reported successfully implemented in Burkina Faso, Ghana, Mali,
Madagascar, and the Philippines.32
Having said that, the author does not mean to say that it is wrong for the government
to construct a third window for microfinance service providers. However, there is very
little experience around the world with supervision of microfinance, 33 it is perhaps
more prudent to not rush to regulate the industry and instead take a wait and see
strategy. After all, a poorly-drafted regulation might result in regulatory arbitrage 34

32 Christen & Rosenberg, supra note 15 at 18.

33 Id. at 15.
14

where financial institutions can abusively take advantage of the less stringent
prudential regulations reserved for MFIs.

34 ROBERT CHRISTEN

ET AL.,

MICROFINANCE CONSENSUS GUIDELINES: GUIDING

PRINCIPLES ON REGULATION AND SUPERVISION OF MICROFINANCE, (2003) at 5-6.

15

III
This section is dedicated to discuss the form of entity, capital requirement, and
ownership structure of MFIs as regulated in Arts. 5 to 8 of the MFI Act. The articles
read as follows:
Article 5

(1) The forms of the legal entities as intended by Article 4

letter a shall mean:
a. Cooperative; or
b. Limited Company.
(2) Limited Company as intended by paragraph (1) letter
b, shall have a minimum of 60% (sixty percent) of its shares
owned
by
regent/municipality
governments
or
village-/subdistrict-owned enterprises.
(3) The remaining portion of the shares of the Limited
Company as intended by paragraph (2) may be owned by:
a. Indonesian nationals; and/or
b. Cooperatives.
(4) The ownership of every Indonesian national of the
share of Limited Company as intended by paragraph (3) letter
a shall be at the maximum of 20% (twenty percent).

Article 6
MFI shall not be owned, either directly or indirectly, by
foreign nationals and/or legal entities which are partially or
entirely owned by foreign nationals or foreign legal entities.
Article 7

(1) The sources of capital of MFI are adjusted to the

terms of the laws and regulations depending on its legal entity.
(2) Terms about the amount of the capital of MFI shall be
regulated in the Regulation of the Financial Services Authority.

Article 8

MFI shall only be owned by:

a. Indonesian nationals;
b. village-/subdistrict-owned enterprises;
16

c. regency/municipality government; and/or

d. cooperatives.

Form of Entity
In

Indonesia,

financial-service-oriented

non-governmental

organizations

are

commonly formed in a wide variety of entities: cooperative, foundation, partnership,

and even limited liability. Some organizations were even formed under an obsolete
colonial law35 that no living soul remembers, or under indigenous unwritten law. 36 The
multifariousness of MFI entities makes it insensible to create a regulatory framework
that mainly refers to institutional forms rather than activities. 37 Indeed, many scholars
35 See, e.g., Badan Kredit Desa (Village Banks), which was formed under Staatsblad
No. 357 of Sep. 14, 1929. The Staatsblad has been repealed by Indonesias modern
banking statutes.
36 The customary adat law is respected, recognized, and to some extent is
enforceable in Indonesia. For more information how this indigenous law interacts
with statutory law, see, e.g. MICHAEL BARRY HOOKER, ADAT LAW

IN

MODERN

INDONESIA (1978).
37 However, choice of entities does influence the way an MFI behaves. For example, Indonesian
incorporated association law is a remnant of the colonial era that has not been repealed yet is so
distantly detached from the Indonesian modern legal system, if an MFI were to be formed as an
incorporated association, it would not be able to operate for lack of governing regulations. Also,
Indonesian foundation law prohibits foundations from engaging in commercial activities, which
clearly runs counter to the reality that in order to be sustainable, MFIs is pushed to be profitable.
Staatsblad 1870 No. 64 on Associations with Legal Person Status. [Rechtspersoonlijkheid van
Vereenigingen. Royal Order dated 28 Mar. 1870].
Act No. 16 of 2001 on Foundations as amended by Act No. 28 of 2004. [State Gazette No. 112 of
2001, Supplement No. 4132 (Aug. 6, 2001); State Gazette No. 115 of 2004, Supplement No. 4430
(Oct. 6, 2004)].

17

believe that functional-based regulatory framework is more desirable than

institutional-based regulatory framework.38
The MFI Act specifically prescribes that MFI license is only available to cooperatives
or limited liability companies. The Elucidation to MFI Act does not provide
explanation why specifically these form of legal entities are chosen. 39 The author
believes that the decision might have been driven by the demand of many credit-andsaving cooperatives who were concerned that the establishment of a special MFI
regulatory framework would diminish the role of cooperatives in providing
microfinance service. Under Indonesian cooperative laws, cooperative can only fund
their loan portfolio with member deposits (as opposed to external, non-member
financing). This has been pointed out as a major weakness because of the relative
familiarity of poor people with cooperatives. Allowing cooperative to mobilize public
savings to finance their operations will arguably result in more widespread financial
inclusiveness.40
38 See, e.g., Eugenia Macchiavello, supra note 7 at 149; and Christen & Rosenberg,
supra note 15.
39 However, the Academic Draft deliberates five possible legal entities: incorporated
association, cooperative, (private) limited liability company, company owned by
regional government, and company owned by autonomous village. See, MFI Act
Academic Draft, at p. 31.
40 However, recall that in the past cooperatives have been used as political vehicle
and they are still susceptible to political influence. It is uncommon for cooperatives to
18

Perhaps the most simple and straightforward reason is that cooperative and limited
liability company offers a well-established and rigid organizational structure and both
are legally allowed to engage in profit-seeking activities. This helps ensuring effective
governance, which is one of the key ingredients for a sustainable and profitable MFI.
Business structure, organization, and management have been said to have great
impact on the stability of a financial entity. 41 In fact, the Basel Committees survey
reveals that the majority of countries either require the corporate form or cooperative
form in order to be permitted to conduct deposit mobilization activities. 42
Mission Statement
The MFI Act provides that MFIs must increase access to micro-sale funding for the
people; help promote the empowerment of the economy and productivity of the
people; and help improve the income of the people and promote the welfare of the
people.
be used to deliver governments subsidized loan programs. After the political turmoil
that followed the demise of the Soehartos authoritarian government, much of the
authority of the central government was devolved to the regions, resulting in a big
bang of decentralization that in turn caused confusion over which has the
responsibility for overseeing cooperatives: the central government or regional
government. These must be taken into account when considering to charter an MFI as
a cooperative.
41 Macchiavello, supra note 7 at 175.
42 Id.
19

Local Government as Majority Shareholder and Locality of MFIs

The MFI Act further stipulates that an MFI that elects to be chartered as a limited
liability company should be majority-owned (60%) by the local government. This is
predictable: local government might want to assert control over important financial
institution. After all, the people might perceive microfinance industry as a sensitive
and strategic industry that should not be privately-owned. Furthermore, by being the
majority shareholder of an MFI, the local government will be able to ensure that most
microfinance initiatives and strategies will be tailored according to the situation of the
specific region or to the specific characteristics of the local population (locally-driven
strategies). This 60% rule is perhaps also motivated by the mandate of Art. 1 of the
MFI Act, which prescribes that MFIs should not merely seek profit at the expense of
their social mission.43
On the other side, this ownership structure might incite the local government to
politicize the MFI. In Peru, a local government (which was the sole shareholder of an
MFI) reinvested a large portion of the MFIs profits into social projects, jeopardizing
the MFIs capitalization.44 Also, there were administrative hurdle because the MFI was
100%-owned by government. In other words, the MFI Acts 60%-ownership rule

43 However, this explanation is unlikely; because that will mean the drafters had
assumed that local government is more faithful with MFIs social mission than private
investors. This is way too overgeneralizing.
44 Ccile Lapenu & Dorothe Pierret, Handbook for the Analysis of the Governance
of Microfinance Institutions, IFAD 48, (2006).
20

presents a risk of conflict of interest (the local government may be tempted to

politicize the MFIs mandate at the expense of credit outflows), over-dependency risk,
and red-tape risk. In addition, the 60% rule presents a barrier to entry for newcomers
that might be more innovative than the local government. The rule also may restrain
development of existing network.
The MFI Act imposes a strict geographic limitation against MFIs. Microfinance
institutions are not to operate outside the boundaries of one regency or one
municipality and it can be compelled to convert its charter into bank if it conducts
microfinance activity outside its prescribed area.
Prohibition of Foreign Ownership
The MFI Act explicitly prohibits foreign nationals or entities from owning a
microfinance institution. The main reason behind this prohibition is that foreign
investment injection can easily affect the competition among domestic financial
providers.45 Foreign fund typically offer MFIs much larger sums of money, often
bundled with additional products and services. By instituting foreign ownership
prohibition, the government also avoids dependence on foreign fund and preserves
national financial sovereignty.46 The presence of foreign national in the shareholder
composition means that foreigner can have a say in the strategic decisions concerning
an MFI and can have catalytic effect, which may not necessarily be aligned with that
of the locals. This mission drift argument basically says that foreign influence may
45 Macchiavello, supra note 7 at 176.
46 Christen & Rosenberg, supra note 15 at 18.
21

distract the commitment of the MFIs to cater to the needy and the poor. Assuming,
arguendo, that foreign infiltration definitely results in mission drift, this argument
neglects to acknowledge that mission drift can and does happen perhaps more
quickly and effectively through the influence of a foreign member of the board of
director.
There is, however, a downside of this prohibition. We are afraid this might be
counterintuitive to the reality in microfinance industry where international donors
play an important role in injecting additional capital funds and offering expanded
outreach for an MFI. In addition, there is a contemporary trend toward foreign
ownership in MFIs, where the proportion of foreign equity increased by 384% over
the five-year period (2002 2007), compared to 154% increase of local equity. 47
Today, local equity is often unavailable, and local MFIs are forced to find foreign
funding.48
Local Deposit Insurance Company
Article 19 of the MFI Act sets forth a provision on participation of MFIs in deposit
insurance scheme.49 In Indonesia, all prudentially-regulated banks must participate in
47 Axel de Ville, et al., Does Foreign Ownership in Microfinance Interfere with Local
Development? Discussion Paper No. 1, ADA (2009) at 11.
48 Id.
49 Indeed, if the government permits MFIs to mobilize public savings, it ought to
think about protecting depositors savings. Deposit insurance scheme can either
provide reimbursement in the event of failure or operate a stabilization fund that
22

the deposit insurance scheme, Lembaga Penjamin Simpanan (LPS). The MFI Act,
however, only use the modal verb can (which implies that a deposit insurance
scheme is not mandatory). It also specifically separates the MFIs deposit insurance
scheme from the national LPS scheme. The wording of the provision also suggests
that the deposit insurance scheme can either be formed by regional government
alone, by MFIs alone, or by joint cooperation of regional government and MFIs.
Some authors50 (and Bolivian government51) fear that full coverage of deposit
insurance scheme might lead to problems of moral hazard, i.e. the tendency of a
participating financial institution to take on more risk than it would if it were not
participating. Moral hazard can be mitigated by adopting coverage limits and prompt
corrective action policies.
Governance and Accounting
Structure of organization and management is among the minimum requirements to
obtain business license as MFIs and they must make and keep a book in line with the
prevailing financial accounting standard.

provides emergency liquidity.

50 A Guide to Regulation and Supervision of Microfinance: Consensus Guidelines,
CGAP, 37 (2012); and Stefan Staschen, Regulatory Requirements for Microfinance:
A Comparison of Legal Frameworks in 11 Countries Worldwide, GTZ, 64 (2003).
51 Id. at 39.
23

Delegated Supervision
Indonesia spans vast area and consists of more than 18,000 islands. The archipelagic
nature of the country makes centralized supervision very hard. The low net worth
threshold for MFIs registration (the Academic Draft suggested Rp10 millions, which
roughly amounts to $870), combined with the post-Reform spirit of decentralization,
results in the drafters decision to allow the FSA to delegate the bulk of supervision
activity to local government (the municipality or regency governments) or, in case the
local authority declines or incapable, a third party (a decentralized supervisor). Even
though the CGAP says that in most cases, the best supervisor for depository
microfinance is the authority responsible for commercial banks (that is, the FSA), we
do not think that the FSAs scarce resources warrants such huge task. That means,
aside from the local government, the FSA-appointed agent can be either an MFI
federation or an independent entity. There are still many questions to be answered,
ones that we cannot answer before the FSA issues the implementing regulations. For
example, who should pay the cost of supervision 52? Does the FSA have an exit strategy
if the supervision does not work? What are the delegated supervisors powers and
duties? How do you hold regional government as a reliable actor in carrying out the

52 Costs associated with supervisory regulation are likely to be higher for MFIs. Compliance costs
mainly stem from the high need to hire skilled labor (i.e., lawyers).
Robert Cull & Asli DemirgKunt, Does Regulatory Supervision Curtail Microfinance Profitability and Outreach? 39 WORLD.
DEV. 949, 949-50 (2011).

24

supervisory power? Looking at Indonesias past experience,53 we are confident the

delegated supervision can be carried out well.
As shown below in the chart, it is practically impossible for the FSA to supervise MFIs
across the country. The sheer number of supervised institutions presents a major
challenge.

Figure 2. Indonesias MFIs in Number.

53 Indonesia has long used delegated supervision model to supervise approximately

thousands of tiny municipal banks. The central banks supervisory tasks (prior to the
formation of the Financial Services Authority, banking supervision was carried out by
the central bank, Bank Indonesia) are delegated to Bank Rakyat Indonesia (BRI)
branch offices, and the municipal banks pay cost of supervision (approximately 25%
of their operating expenses) to BRI.
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Consumer Protection
All MFIs shall provide open information for the public concerning the authority and
responsibility of the MFI board; the terms and conditions that must be made known
to both depositors and debtors; and the probability of losses due to MFIs transaction
with other parties. The FSA is empowered with the authority to request the MFI to
stop their activities, and the MFI Act mandates the FSA to provide complaints service
which include a dispute settlement.
Sharing of Information and Reporting Requirements
This provision mimics the bank secrecy regulation. The board of MFIs is permitted to
exchange loan and savings information and data with other MFIs, bearing in mind
that the confidentiality of depositors and savings must be kept.
Transitional Provisions
The MFI Acts transitional clause stipulates that certain non-cooperative, non-bank
microfinance service providers54 are to be granted one-year transitional period
counted from January 2015 to adjust to the Acts provisions. After the one-year
transitional period ends, those microfinance service providers are to obtain business
license from the FSA. This means microfinance industry has three years to study the
Act submit questions to the relevant government agency (e.g., the FSA).
54 The Bank Desa, Lumbung Desa, Bank Pasar, Bank Pegawai, Badan Kredit Desa
(BKD), Badan Kredit Kecamatan (BKK), Kredit Usaha Rakyat Kecil (KURK), Lembaga
Perkreditan Kecamatan (LPK), Bank Karya Produksi Desa (BKPD), Badan Usaha
Kredit Pedesaan (BUKP), Baitul Maal wa Tamwil (BMT), Baitul Tamwil
Muhammadiyah (BTM), and other institutions deemed equal to those institutions.
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III
Perhaps we can dub the MFI Act as a statutory mandate for MFIs to be
commercialized. The Act requires all NBMFIs to obtain business license one year after
the Act enters into force, which signifies that there is a movement of microfinance out
of subsidized operations into one in which MFIs manage on a business basis as part of
the regulated financial system. We believe in commercialization of microfinance: it is
a necessary step to provide high quality financial services to the poor by the
introduction of the profit motive.
Unfortunately, the MFI Acts academic study never indicates whether there are
enough number of NBMFIs that can meet the start-up requirement that will be set
forth by the FSA seven months from now. We think this is dangerous. The MFI Act
establishes a new regulatory window aside from banking window. However, statistics
show that 95% of Indonesias microfinance service is actually provided by licensed
banks. That means the new regulatory framework we just created a year ago will only
be filled by, at the most, 5% of the total worth of microfinance industry. If there is only
a few NBMFIs that can actually be licensed, the entire regulatory framework becomes
too expensive to maintain.
The enactment of the Act ends the regime that had for quite a long time put NBMFIs
under banking laws. Even though the Act refrains from regulating the details (such as
lending practice, capital adequacy, loan-loss provision, and interest rate cap), the Act

28

does regulate some of the most critical or sensitive issues: shareholder composition
and regulatory power. Shareholder composition is statutorily mandated to be
dominated by local government. This provision is meant to ensure that MFIs remain
faithful to the need and characteristics of the local people. We welcome the legislators
decision to remove numerical limits (the suggested minimum capital requirement for
MFIs) from the text of the Act. Numerical definition would need periodic revision,
and amending a parliamentary act is much tougher than amending a regulation.
Further study is required as soon as the FSA issues the implementing regulations of
the MFI Act.

***

29

References
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CGAP, 37 (2012)
Axel de Ville, et al., Does Foreign Ownership in Microfinance Interfere with Local
Development? Discussion Paper No. 1, ADA (2009).
Ccile Lapenu & Dorothe Pierret, Handbook for the Analysis of the Governance of
Microfinance Institutions, IFAD 48, (2006).
Eugenia Macchiavello, Microfinance Regulation and Supervision: A Multi-Faced
Prism of Structures, Levels and Issues, 9 N.Y.U. J. L. & BUS. 125, 146 (2012).
Global Microscope on the Microfinance Business Environment 2010, ECONOMIST, 21
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Jamie Bedson, The Microfinance Industry Report: Indonesia, BANKING WITH THE
POOR
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SEEP
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ECONOMY, SOCIETY AND TRANSITION 39, 40 (Donald K. Emmerson ed., 1999).
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ROBERT CHRISTEN ET AL., MICROFINANCE CONSENSUS GUIDELINES: GUIDING PRINCIPLES
ON REGULATION AND SUPERVISION OF MICROFINANCE, (2003) at 5-6.
Robert Cull & Asli Demirg-Kunt, Does Regulatory Supervision Curtail
Microfinance Profitability and Outreach? 39 WORLD. DEV. 949, 949-50 (2011).
Stefan Staschen, Regulatory Requirements for Microfinance: A Comparison of Legal
Frameworks in 11 Countries Worldwide, GTZ, 64 (2003).
Sumantoro Martowijoyo, Indonesia Microfinance at the Crossroads: Caught
Between Popular and Populist Policies, ESSAYS ON REG. & SUPERVISION 5-6 (No. 23,
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Village Banking System, 10 PAC. RIM L. & POLY J. 147, 147-8 (2000).
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