Deutsche Gesellschaft für

Technische Zusammenarbeit (GTZ) GmbH

INDONESIA

Post-Preparation Report (“ProFI Component 5”)

Microfinance for Post-Disaster Support in the

Earthquake Affected Areas of Yogyakarta (D.I.Y.) and Central Java

06 January 2007

prepared by Dr. Rauno Zander GTZ Consultant

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ABBREVIATIONS AND ACRONYMS

ATMI - Akademi Tehnik Mesin Industri, Academy of Industrial Machinery

Technology

BAI - Bankakademie International

BAPPENAS - Badan Perencanaan dan Pembangunan Nasional,

National Development and Planning Body

B.I. - Bank Indonesia (Central Bank)

Bn - billion

BPR - Bank Perkreditan Rakyat (“People´s Credit Bank”)

CAR - Capital Adequacy Ratio

EMI - Equal Monthly Instalments (housing finance)

GoI - Government of Indonesia

ICT - Information and Communication Technology

IDR - Indonesian Rupiah (national currency)

MFI - Microfinance Institution

MICRA - Microfinance Innovation Center for Resources and Alternatives

Mn. - million

NPL - Non-performing loan

PERBARINDO - Persatuan Bank Perkreditan Rakyat Indonesia Association of Indonesian BPR

PHBK - Pengembangan Hubungan Bank dengan Kelompok Swadaya Masyarakat (Project Linking Banks and SHGs)

PNM - PT. Permodalan Nasional Madani (Persero)

POKMAS - Kelompok Masyarakat, local govt. organised self-help groups

PPP - Public Private Partnership

ProFI - GTZ Program Strengthening of Small Financial Institutions

QUICK - Quick Impact Capacity Development & Knowledge Transfer Centre for Microfinance

RED - Regional Economic Development

RoA - Return on Assets

RoE - Return on Equity

SHG - Self-Help Group

SME - Small and Medium Enterprises

SOP - Standard Operating Procedure

ST - Short Term

TA - Technical Assistance

USD - United States Dollar

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CURRENCY EQUIVALENTS Interbank Rates:

As of 15 November 2006

1 EURO = 11,675.68 IDR 1 USD = 9,107 IDR As of 31 December 2005 1 EURO = 11,633.20 IDR 1 USD = 9,832.18 IDR

FISCAL YEAR

1 January to 31 December

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CONTENTS EXECUTIVE SUMMARY vi I. BACKGROUND AND INTRODUCTION 1 II. THE EARTHQUAKE AND ITS CONSEQUENCES

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A. Facts 2 B. Damages and Losses 2 C. Policy Responses 4 D. Emerging Medium-term Strategy 6 III. PEOPLE´S CREDIT BANKS (BPRs) IN YOGYAKARTA AND CENTRAL

JAVA

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A. People´s Credit Banks (BPR) in Yogyakarta 8 B. People´s Credit Banks (BPR) in Central Java 8 C. BPR Earthquake Damages 9 D. Bank Indonesia Exemption Directives for Affected BPRs 9 IV. THE PROPOSED PROFI PROGRAMME COMPONENT FIVE

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A. Rationale and Design Considerations 10 B. Proposed Project Activities in Summary 12 C. Loan Fund Support to People´s Credit Banks 14 D. Technical Assistance for Involved Financial Institutions 17 E. Proposed Centre for Quick Impact in Capacity Development and

Knowledge Transfer (QUICK) 21

F. Docking Points for Other Donors 24 V. COMPONENT MANAGEMENT

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A. Component Costs 25 B. Proposed Staffing 26 C. Monitoring and Evaluation 27 D. Connectivity to Other ProFI and GTZ Components and Activities 28 E. Summary Risk Assessment 29

VI. ANNEXES

Annex 1: Terms of References for Appraisal Mission

Annex 2: Draft Specimen Contract between PNM and Apex BPRs

Annex 3: Proposed Design Parameters for Housing Finance Product

Annex 4: Bank of Indonesia Regulation for Post-Disaster BPR Loan Classifications dated 7 June 2006

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TABLES

Table 1: International comparison of disasters 3

Table 2: Summary of damage and losses main sectors 6

Table 3: Financial details on all 19 BPRs in Klaten District 9

Table 4: Differences between mainstream and low-cost housing finance 20

Table 5: Sub-component summary cost table 26

Table 6: Three main outcomes proposed for component 5 28

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EXECUTIVE SUMMARY Latest figures from the National Coordinating Board for the Management of Disasters1 indicate that the earthquake that struck the Indonesian island of Java on 27 May took the life of 5,778 people and completely destroyed 139,859 houses. A further 468,149 were heavily damaged, and it is estimated that 2,111,872 people were made homeless. With damages and losses amounting to as much as an estimated USD 3.13 billion, this earthquake ranks high among the aggregate damage caused by all the major natural calamities of the past decade. Total damage and losses significantly exceed the tsunami damages suffered by Sri Lanka, India and Thailand individually, and are comparable in the scale of damage and material loss to the recent devastating quake in Pakistan. Even tsunami damages in Indonesia are not much higher with an estimated USD 4.45 billions. The Government of Indonesia reacted quickly after the quake and the army aided the immediate disaster relief. A three-month state-of-emergency was declared and among other commitments, considerable expectations for non-repayable grants to aid earthquake victims were built up. Domestic relief agencies and international donors provided substantial emergency relief support. Some of the NGOs and larger bi- and multilateral donors are now beginning to shift to reconstruction and development activities in the earthquake affected areas.

Against this background, the main problem to be addressed by activities under this new component of the ProFI Programme is the precarious state of large parts of the population affected by the May 2006 quake. While salaried people and those with positions in government or large private sector employers have managed to secure some support or are able to borrow against their employer certificates, self-employed small and micro entrepreneurs can not easily access funds for recovery and income generation. At the same time, the small financial institutions operating in the area are not yet fully equipped to respond to the various different service needs of earthquake affected small and micro entrepreneurs. Precisely when microfinance institutions and their credit resources are required most to rebuild productive assets, both the service mix within these institutions and the refinancing capital are not at hand to meet the needs in earthquake affected areas. The local population has no illusions about the promised government hand outs, but expects the Government and international community to facilitate the reconstruction of institutions and resumption of financial services to help micro and small entrepreneurs make a living again out of their own initiative.

There is therefore a compelling rationale for making small financial institutions in earthquake affected areas more responsive to the needs of affected people. The focus is on strengthening structures that provide quick responses to capacity development requirements in post-disaster environments. At the level of the affected micro or small entrepreneur, it is necessary to kick-start the process of providing financial services that are responsive to the specific post-disaster needs of the affected population. These services should be provided by institutions that are both fully integrated into the formal financial system and regulated by the central bank, but that are also close to the people suffering from the consequences of the tremor. The main goal of the proposed project is to increase the number and volume of microfinancial services accessible above all to the self-employed and lower income segments of the population affected by the earthquake of May 27, 2006. At the same time, financial institutions in the earthquake affected areas would benefit from capacity development and the transfer of technical skills related to areas such as special loan 1 Badan Koordinasi Nasional Penanganan Bencana (BAKORNAS PB), July 2006 Bulletin No.32

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services for lower income groups and people without tangible collateral; low-cost housing finance, working capital and investment loans to micro entrepreneurs and insurance, money transfer and leasing facilities. This type of support is normally slow to come forward after natural calamities. Case examples of successful financial services would be financed out of a small experimental loan fund to support the capacity development. This two-pronged approach – supporting a tightly defined segment of the productive low-income population with loan funds for recovery and development, while making proximity based financial institutions more robust, effective and client oriented – would produce the results necessary for strengthening financial institutions’ capacity and without compromising on service quality. To this end, the central bank, the Bank Indonesia and the GTZ will carry out a microfinance promotion component in Yogyakarta and Central Java provinces to facilitate economic development and sustainable institution building. This 24 months quick response component to natural calamity would address the three important levels in financial systems development, the macro, meso and micro level:

1) Full compatibility with the nationally operating ProFI programme components to strengthen the service quality and the skills of BPRs, the People´s Credit Banks that are the main partners also for this post disaster initiative (macro level); 2) The effectiveness and service orientation of BPRs in the two affected provinces would be increased. This would be done through a new research and knowledge management facility with the specific objective of providing technical and capacity development services to small financial institutions in Indonesia in post-disaster scenarios. QUICK, the Quick Impact Capacity Development & Knowledge Transfer Center for Microfinance, would be a one-stop shop for disaster affected small financial institutions. Services would be offered in product development with a particular emphasis on savings mobilisation, and IT platforms and expansion (meso level); 3) Both the reach and quality of services to affected micro and small entrepreneurs should be improved to rebuild their livelihoods and assist in the re-integration of persons now still in tents or other temporary shelters (target group & micro level)

Three sub-components would translate this service approach into measurable component activities: First an experimental loan fund of EUR 500,000 would be on-lent to 8 to 10 BPRs who are assessed as sound and signal a specific demand for loan fund resources through one of two selected provincial apex banks. Second, technical assistance and capacity development measures would be provided at the level of PNM, the apex banks, recipient BPRs and group leaders of borrowing self help groups (SHGs). A third sub-component deals with the establishment and functioning of QUICK, the Quick Impact Capacity Development & Knowledge Transfer Centre for Microfinance in Yogyakarta. The initiative would start at end November with a phase 1 that – for the larger part - has already been implemented: (i) the identification of potential partnering microfinance institutions for a first round of credit fund disbursements, (ii) preparation of contract documents for the different on-lending levels, (iii) selection of focal institutions among the large group of BPRs that would over time assume different types of wholesaling functions for retail BPRs, (iv) preparation of an office in the disaster affected area for quick coordination of component activities, and (v) recruitment and posting of a sub-component management team in this special office in Yogyakarta. Phase II, the pilot phase for the component, would then commence with (vi) an initial credit fund transfer and the soliciting of concrete finance proposals from BPRs that received a positive rating from Bankakademie and MICRA, and (vii) the start of capacity development and on-lending activities to these BPRs.

Bank Indonesia / GTZ Microfinance for Post-Disaster Support in the

Earthquake Affected Areas of Daerah Istimewa Yogyakarta (DIY) and Central Java

POST PREPARATION REPORT

I. BACKGROUND AND INTRODUCTION 1. Within the context of the Bank Indonesia (BI) GTZ Programme for the Promotion of Small Financial Institutions (ProFI), a quick response to the earthquake that hit the central part of Java on 27 May, 2006 was conceptualised immediately after the catastrophe struck. Following preparations by the ProFI Programme Office, a post-preparation mission visited Jakarta and the earthquake affected areas of Yogyakarta and Klaten from 27 October to 27 November 2006. The mission consisted of a technical spearheading team of Bank Appraisers: two from the German Bankakademie International (BAI) and a further three from the Indonesian Microfinance Innovation Center for Resources and Alternatives (MICRA). Their appraisal work was conducted in 18 People´s Credit Banks (BPRs) from 30 October to 10 November. The team leader with report writing responsibility joined the team together with other team members from 6 to 27 November. A consolidated first draft mission report and recommendations was presented to GTZ and the Bank Indonesia in a Wrap-Up Seminar on 27 November 2006 in Jakarta, Indonesia. 2. The appraisal team consisted of Willemien Libois and Constanze Kreiss, both BAI and Lintang Nugroho, Budhi Siswoadji and Surya Agung Meranga from MICRA. This team was completed by Ms. Wulandari from the GTZ ProFI Office in Jakarta and Rauno Zander, GTZ Team leader (consultant). Dr. Michael Hamp, the GTZ ProFI Programme team leader and Ms. Eva Michler, GTZ Attorney at Law and Executive Assistant joined the team selectively in Yogyakarta and Klaten. 3. The team is indebted to the Bank Indonesia for its lead and guidance provided in particular by Mrs. Libraliana Badilangoe, Manager of Rural Bank Licensing, Research and Regulation Division of Directorate of Rural Bank Supervision, and Messrs. Djarot Sumartono, Director and Dalil Subagya, PUML Consultant in the Bank Indonesia Regional Office in the Yogyakarta Province. 4. Dr. Michael Hamp, team leader from the GTZ ProFI Programme Office in Jakarta, drafted the terms of references, briefed and de-briefed the mission and provided guidance and advice to the mission at all stages of the assignment. 5. Apart from several detailed discussions with the regional central bank office in the Yogyakarta Province, the mission met with representatives of PT. Permodalan Nasional Madani (Persero)/PNM2, with PERBARINDO as the association of BPR in Indonesia, and with the management of the two selected apex banks in Semarang and Gunung Kidul. The team also met most of the People’s Credit Banks in the two provinces of Yogyakarta and Klaten that were affected by the disaster, as well as representatives from other commercial banks. Local and village level authorities were

2 PNM is a parastatal financial institution engaged in providing capacity building assistance to Indonesian financial institutions, and also permitted to lend to them: PNM branched off from the central bank more than a decade ago, and now operates as a non-bank financial institution.

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likewise met to be apprised of concrete progress of different post-disaster support initiatives. Thanks are likewise due to Herman Susmanto and Father Andree Sugiyopranoto of the ATMI on presenting different technical options for low-cost housing and shelter constructions. II. THE EARTHQUAKE AND ITS CONSEQUENCES A. Facts 6. The quake: In the morning hours of May 27, 2006 an earthquake struck Yogyakarta and Central Java. These two regions are not normally affected by major seismic distortions. The quake lasted for 52 seconds and measured 6.3 on the Richter Scale. The epicentre was located 3 kilometres south of the Bantul District in the open sea. Because the earthquake was relatively shallow under ground, shaking on the surface of the sea was more intense than deeper earthquakes of the same magnitude, resulting in major devastation, in particular in the districts of Bantul in Yogyakarta Province and Klaten in Central Java Province. 7. The earthquake took 5,778 lives, about 40,000 were still injured six weeks after the event; the homes and livelihoods of hundreds of thousands of people were destroyed. As if the devastation of the earthquake was not enough, the disaster may not be over. The increase in Mount Merapi’s volcanic activity, which began in March 2006, is producing lava flows, toxic gases, and clouds of ash, prompting the evacuation of tens of thousands of people. 8. Both of these natural disasters are a stark reminder that the island country of Indonesia is at a permanent high risk of different types of natural calamities. Tsunami damages in the Aceh Province and Nias were not even fully repaired when the two new disasters struck. It therefore also seems timely to evolve the ad hoc approaches for reconstruction and development after each disaster into a more structured approach for joint learning and sharing of the experiences of different stakeholders in post disaster scenarios. This report contains some proposals in this regard, specifically for the areas of microfinance and development of small financial institutions. B. Damages and Losses 9. Earthquake impact: As a first damage and loss assessment indicated3, the impact from this earthquake is much greater than initially believed. While major infrastructure remained largely intact, the damage and losses to housing and other buildings that were constructed without proper reinforcement (small enterprises, schools, clinics, etc) were staggering. The overall damage and loss of the earthquake, estimated at Rp 29.1 trillion (US$3.13 billion), places this as a more costly disaster than the tsunami impact on Sri Lanka in 2004, and at a scale similar to the Gujarat earthquake of 2001 and the recent earthquake in Pakistan. 10. Damage and Loss in Comparison: Table 1 illustrates the extent of damage and loss of human life. The earthquake catastrophe in Central Java is put in comparison with other major earthquakes of the past decade. It is also compared to the costs for 3 Preliminary Damage and Loss Assessment, Yogyakarta and Central Java Natural Disaster. The 15th Meeting of The Consultative Group on Indonesia Jakarta, June 14, 2006, A joint report of BAPPENAS, the Provincial and Local Governments of D.I.Yogyakarta, the Provincial and Local Governments of Central Java, and international partners, June 2006

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each country affected by the Tsunami of end 2004. The reason for the comparatively high figure of estimated damage has to be explained by the comparatively high housing damage and losses. Equally, small-scale private and cottage industries took a severe blow as a result of the quake. Table 1: International Comparison of Disasters Country Disaster

Event Date No. Victims Loss,

Damage USD mn. 2006 constant prices

Turkey Earthquake 17 Aug 1999 17,127 10,281 Indonesia (Aceh)

Tsunami 26 Dec 2004 165,708 4,747

Indonesia Yogya; Klaten

Earthquake 27 May 2006 5,716 3,134

Pakistan Earthquake 08 Oct 2005 73,338 2,942 India (Gujarat) Earthquake 26 Jan 2001 20,005 2,958 Thailand Tsunami 26 Dec 2004 8,345 2,345 Sri Lanka Tsunami 26 Dec 2004 35,399 1,551 India Tsunami 26 Dec 2004 16,389 1,306 Sources: Asia Disaster Preparedness Center, Thailand; ECLAC, EM-DAT, World Bank 11. Composition of Losses by Ownership Status: With most of the physical damage to housing and small and micro enterprises, more than 90 percent of the total damage was assessed to be to private owners. Damage and loss to the state and public property on the other hand, was relatively small with just 9% of the total.

12. Housing damage: An estimated 140,000 houses were completely destroyed. 260,000 houses were damaged or severely damaged. 74% of the households with

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houses completely destroyed continue to live in temporary shelters on their existing home sites. Water and sanitation has to be restored, but on the other hand, there are still raw materials secured from the rubble that can be used for reconstruction. 13. Geographical impact: The districts of Bantul in the Yogyakarta Province and Klaten in the Central Java Province were worst affected: together, destruction there constituted more than 70% of the total damage. 14. Damage for small and micro enterprises: The affected regions are known as centres for artisanal and other producing micro and small enterprises. These reach from furniture producers and small handicraft and ceramics producers to small specialised agricultural and livestock producers. Many of these cottage industries were severely damaged or completely destroyed. As a consequence, the already precarious poverty level in earthquake-affected areas is expected to rise: from 880,000 people before the earthquake to about 1 mn. with an additional 66,000 people having fallen into poverty and 130,000 losing their job or main source of livelihood as a result of the earthquake4. C. Policy Responses 15. Official Reactions: The central Government of Indonesia (GoI) reacted quickly. The army was moved to central Java to aid relief operations, and the Vice President announced a grant of IDR 30 million to each family whose house was destroyed or severely damaged in Yogyakarta and Central Java. In the case of those with minor damages, the compensation level announced was IDR 10 million. These grant payments to aid housing reconstruction have been delayed, but considerable expectations for non-repayable grants to aid earthquake victims with destroyed houses were thus built up among the affected population. It seems that the now required shift from the emergency phase into rehabilitation and recovery still poses challenges for governments at central and district level. 16. Following the official end of the emergency response period, the president of Indonesia issued a presidential decree to establish a reconstruction and rehabilitation team consisting mainly of the Governors of Central Java and Yogyakarta. Budget provisions were made for rehabilitation and reconstruction until 2007. In spite of these agreeable arrangements at higher level, the proof of effectiveness of the government relief policy remains the degree to which budgeted support measures actually reach the affected population in the earthquake stricken areas. At the time of the field mission in November 2006, most of this distribution challenge still needs to be met by official channels. 17. Total of houses damaged and government reductions on earlier pledges5: Following the discussion on the housing assistance package, the Government stated that a total of 303,000 houses are identified as being beyond repair and qualifying for assistance: 206,000 in Yogyakarta and 97,000 in Central Java. The policies that were then issued by the Provincial Government are as follows:

4 Preliminary Damage and Loss Assessment, June 2006 5 This summarises a report of Jesuit Relief Services of August 2006 which contains detailed information on this aspect (Final Report: Merapi and Earthquake Response Programme in Yogyakarta and Central Java, Indonesia IDN06/MERP/02), pp. 6 ff.

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GRANT PAYMENTS BY PROVINCIAL GOVERNMENT IN YOGYAKARTA The Yogyakarta Provincial Government plans to grant all affected households (destroyed of heavily damaged houses) with IDR 15 million in three stages. The grants will be dispersed to ‘community groups ’ or POKMAS (Kelompok Masyarakat) between 1-15 households. As the first funding covers only approximately 30% of all the affected families (47,000 families), each group must decide which are the most vulnerable families and should receive the fund first. Community groups will receive the grants in three stages as well. The provincial government recruited 514 technical facilitators who will provide advice to local communities on housing reconstruction, planning and budgeting. 18. The situation is similar in the Central Java Province. Here as well the total commitments are halved, and disbursements staggered over three payout dates. The delay in these payments up to November 2006, the time of compiling this report, or beyond means that families enter the rainy season that starts in late October and early November in their tents, bamboo shelters and other temporary constructions. These are not water-proof and offer little protection against wind and humidity, diseases and rodents.

GRANT PAYMENTS BY PROVINCIAL GOVERNMENT OF CENTRAL JAVA 19. The provincial government in Central Java plans to provide all 97,000 affected households with IDR 12 to 15 million per family. This housing compensation will be disbursed in three stages: IDR 4.1 million in the first round (planned for up to end November), followed by the second allocation of IDR 4.4 million (planned in early 2007) and the last stages in 2007. A compensation package of IDR 500,000 per household is also provided to families who have been classified as having 'lightly damaged' houses. The government has recruited 774 technical facilitators to provide advice to local communities on group formation, etc. 20. Impact: Before the earthquake struck, the Human Development Index of the Yogyakarta Province was among the highest in Indonesia. Central Java was still above the Indonesian average. In addition to high quality health facilities, Yogyakarta is also a centre for learning and higher education. The destruction of social and health facilities was largest in Yogyakarta and Bantul City. In terms of housing destruction, the largest damages were suffered in the four rural districts of Bantul, Klaten, Sleman and Gunung Kidul. Between these four districts, 91% of total housing destruction took place. With most of the basic infrastructure like roads, energy and water and sanitation still intact or quickly repaired, the bulk of the damage of this earthquake falls on private households, micro and small businesses operating out of small workshops or home premises. 21. The following table 2 presents all types of damage and loss caused by the earthquake in separate categories and in line with different strata of economic activity. The overriding importance of house destruction in terms of overall damages suffered is only too apparent:

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Table 2: Summary of Damage and Losses Main Sectors (in IDR billions) Disaster Effects Ownership Damage Losses Total Private Public Housing 13915 1382 15296 15296 0Productive Sectors 4348 4676 9025 8854 170Industry 4063 3899 7962 7962 0Social Sectors 3,906 77 3982 2112 1870Education 1683 56 1739 584 1154Health and Social Prot. 1569 21 1590 1030 560Infrastructure 397 154 551 76 476Other n.a. n.a. n.a. n.a. n.a. Total IDR billions 25979 10265 40145 35914 4230Source: Damage and Loss Assessment Report, p.40, summarised and abridged D. Emerging Medium-term Strategy 22. Tactical and strategy guidance from BAPPENAS and donors: Different from Aceh, the damage to public infrastructure, also in rural areas (water and sanitation, energy) is limited. No large-scale infrastructure re-development initiative is required or needs to be coordinated by public authorities. Rather, the main thrust of the damage is to private houses and artisanal and small-scale industry. Reconstruction of damaged or totally destroyed houses constitutes the main challenge after this calamity. Also, compared to Aceh, the affected area is smaller. The scale of the damage however is much larger in the case of this quake6. The IDR 15 billion of damages and losses in the housing sector constitute the largest share of the total. The scale of the damage to houses can easily be prevented in future by housing reconstruction that includes earthquake resistant design. In this context, the Preliminary Damage and Loss Assessment Report calls for “…financing mechanisms to rehabilitate and rebuild private houses and homesteads since they comprise more than 80% of all destroyed buildings”7). 23. Resulting Challenge - Support for Micro Enterprises Damaged or Destroyed to Provide New Livelihood Perspectives: The pattern of destruction and the distribution of affected economic groups both indicate that the key challenge for livelihood support is to assist this micro sector in regaining and developing their damaged or destroyed businesses and the necessary premises for these. Two functional areas for development support are therefore (i) working capital loans, and investment loans to micro entrepreneurs, and (ii) support for repair of damaged or destroyed houses and business premises. Financial technologies adjusted to lower income segments of the population with a temporary shortness of pledgeable assets should be employed where appropriate. These would be (i) group loans or (ii) small or micro individual loans.

6 Klaten and Bantul districts have population densities exceeding 1,600 people per square kilometer. The population density in Aceh amounts to only about 72 persons per square kilometer. 7 ibid, p. 40

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III. PEOPLE´S CREDIT BANKS (BPRs) IN YOGYAKARTA & CENTRAL JAVA 24. Context: Bank Perkreditan Rakyat (BPR) or People’s Credit Bank are secondary banks that operate as legal entities, either as limited liability companies, regional government enterprises or cooperatives8. They operate under the Indonesian Banking Law, Act No.7 of 1992, subsequently revised by Act No.10 of 1998. BPRs are supervised as secondary banks by the central bank and operate with much lower capital than commercial banks, but also with a number of banking restrictions, such as prohibition to engage in foreign exchange transactions, etc. Aiming at a sound BPR industry with consolidated and larger BPRs, the minimum capital requirements were increased and layered according to the density of the urban setting in which these BPRs are located (highest capital requirements for BPRs in Jakarta, medium levels for provincial capitals and lowest capital requirements in rural or economically less favoured areas). In his history of BPRs in Indonesia, Steinwand points to the fact that BPRs originated under the Dutch colonial administration in Central Java9 in the town of Purwokerto, where the Hulp-en Spaar Bank der Inlandsche Bestuurs Ambtenaren was founded in 1895. Interestingly, Steinwand informs (on p. 76 of ibid.) also that right from the early phase of establishment of this bank, it was intended to transform this bank into a cooperative bank as the hub for the simultaneously emerging village level savings and credit cooperatives. 25. Current Strength of BPR System in Indonesia: The total number of BPRs in Indonesia was given by the central bank as 1955 in June 2006 with an additional 403 branches10. This is down from 2,427 in 2000 and in line with attempts of the central bank to consolidate and stabilise the BPR Industry. BPRs can be found in all parts of the island country. No other type of bank has the same outreach also into more remote and rural areas. Consequently, the client profile of BPRs penetrates far more into middle and lower income segments of the population, and also covers self- employed micro and small entrepreneurs in rural Indonesia and their essential banking requirements. 26. Proposed Development Options for Next Generation BPRs: Provincial or regional apex structures of BPRs were formed early. Up to recently however, their main focus was on managing finance facilities between attached BPRs with fund surpluses and those with deficits. As the BPRs develop and require more comprehensive services from their representative apexes, the medium to long-term strategy for BPR development foresees a deepening and widening of the functions of provincial apex BPRs. The Blueprint11 refers to this broadening of apex functions, and this encompasses mainly complementary non-financial functions such as up-to-date financial assessments and ratings, in particular of deficit BPRs approaching the apex for financing support. Also, the apex would in future be more engaged in managing the training and capacity development of member BPRs.

8 Holloh, Detlev: Microfinance Institutions Study, GTZ ProFI, 2001 (information from Mr. Holloh), pp. 61 ff. 9 Steinwand, Dirk: The Alchemy of Microfinance – Evolution of the People`s Credit Banks (BPR) from 1895 to 1999 and a Contemporary Analysis, p.64 10 Nama dan Alamat Bank Pekreditan Rakyat Di Seluruh Indonesia, Bank Indonesia Direktorat Pengawasan Bank Perkreditan Rakyat, Juni 2006 11 Cetak Biru Bank Perkreditan Rakyat, Bank Indonesia Direktorat Pengawasan Bank Perkreditan Rakyat, 2006

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A. People´s Credit Banks (BPR) in Yogyakarta 27. The 18 BPRs visited by the Bankakademie and MICRA team as part of component preparation differ from each other in ownership, management, size and development. This is in line with the different origins of the BPR. The district government owns four of the 18 BPRs visited (BP Karanganyar, BP Kulonprogo, BKK Tulung, BKK Pedan), while the others belong to private owners, mostly prominent business families in the location. 28. Altogether there are 63 non-Syariah BPRs12 operating in the province. As many as 57 were affected by the earthquake, either through asset impairment as a consequence of clients in distress, or through direct damage on buildings and property. 29. Out of the 13 BPRs rapidly appraised in Yogyakarta Province, one was located in Gunung Kidul district, two were located respectively in Bantul and Kulon Progo districts and a further 8 in Sleman district. B. People´s Credit Banks (BPR) in Central Java 30. In the much larger Central Java province, 452 BPRs are in operation. Of these, 19 are located in the district of Klaten, which was gravely destroyed because of the quake. In total, the Association of BPRs reports that a total of 27 BPRs were affected directly or through client distress by the earthquake. Most of these (15) are located in the district of Klaten (see table 3 below). A further 8 are in Sukoharjo, three in Boyolali and one in the district of Solo. 31. Specifically for the district of Klaten, a separate survey provides details on post-earthquake scenario13 and the degree to which the economically active population was affected. 48 out of 87 village markets were destroyed, significantly reducing the revenue of government and trading posts for locally produced goods. The estimated loss for the agricultural sector alone amounts to 21.6 bn. IDR only in the district of Klaten. For small producing enterprises, the loss in the 10 sub-districts of Klaten adds up to 18.9 billion. The loss for the banking sector as a whole in the district is estimated at 47.625 bn., mostly stemming from client impairment, but to a smaller degree also from direct damage to the banking infrastructure. 32. The following table provides data on key financial indicators of the total of 19 BPRs in Klaten, the district that suffered most of the damage from the quake in the Central Java Province. 15 of these or 79% suffered direct or indirect (borrowers) damage on account of the earthquake.

12 In the earthquake affected districts of both provinces, Syariah based BPRs do not play a role according to PNM sources consulted. 13 Laporan Penelitian Dampak Gempa Bumi 27 Mei 2006 terhadap aktivitas perekonomian di Kabupaten Klaten, Kerjasama Kantor Bank Indonesia Semarang dengan CEMSED FE UKSW Salatiga, October 2006

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Table 3: Financial Details on All 19 BPRs in Klaten District (in IDR mn.)

Positions and Ratios 19 BPR aggregate IDR mn.

In EUR

Total Assets 160,408 14,493,162 Total Loans Outstanding 132,646 11,984,814 Savings, of which 104,398 9,432,554 - on sight and demand savings 37,257 3,366,239 - term deposits 67,141 6,066,315 Loan-to-Deposit Ratio (LDR) 127.06% Non-performing Loans (NPL) 7.93%

Source: PNM, as of 30 April 2006, EUR exchange rate as per same date, interbank rate. 33. The table illustrates the comparatively small aggregate sums involved for the BPRs. However, their outreach into the rural and lower income population translates into a more direct impact on economically weaker small and micro entrepreneurs than other banks lending against land and property or against a salary certificate. 34. It is clear from these data on BPRs from one of two worst hit districts that BPRs are small and proximity based financial institutions. External funds should not be smaller than 5% of total assets or about EUR 32,000 equivalent and not exceed a 15% ceiling or EUR 97,500. This holds true in particular in post disaster environments where the existing (or remaining) staff is under stress and possibly also personally affected by the natural calamity. C. BPR Earthquake Damages 35. Physical Damage: The effect of the earthquake on the BPR and its clients is determined by the location of the BPR and the distance to the epicenter of the earthquake. Some of the BPRs had to relocate their operating office due to the fact that their own business premises collapsed, while others had hardly been affected. 36. Portfolio Impairments: Most BPRs undertook actions to prevent potential losses because of an impending inability of borrowers to repay after the earthquake. Bank Indonesia gave permission to the BPRs to reschedule loans to borrowers affected by the earthquake. Most BPRs have used this opportunity for roll-over of loans, provided grace periods and reduced the interest rates. In some cases the loans have been rescheduled to the tune of up to 100% of the original principal sanctioned. 37. Excessive loan restructuring after earthquake: It was reported by the appraisal teams of BAI and MICRA that the quoted NPLs are not always a reflection of real portfolio quality, which was worse than could be deducted from the NPL figures. It is likely that some BPRs have used the opportunity provided by the central bank to reschedule loans after the earthquake to roll over a larger part of the loans than only those affected by the earthquake, as observed by BAI and MICRA Consultants on their preparatory study for this report. D. Bank Indonesia Exemption Directives for Affected BPRs 38. Permission to reschedule impaired parts of the loan portfolio that derive from borrowers affected by the quake is based on two regulations issued by the Bank Indonesia. The central bank issued these special regulations with regard to the

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treatment of bank credits in the areas affected by the earthquake. These are regulations No. 8/10/PBI/2006 and 8/15/PBI/2006. 39. Regulation 8/10/PBI/2006: This first regulation applies to all funds disbursed to debtors with project locations or places of business in Yogyakarta and in the nearby areas in Central Java (Art. 2 (5)). It stipulates the possibility to restructure loans through the end of June 2009, i.e. up to 3 years after the earthquake (Art. 3 (1)). The conditions for the eligibility of clients for having a loan restructured are however kept vague: the customer must have “difficulties in repayment of loan principal and/or interest” or these difficulties must be “likely to arise by reason of the impact of the natural disaster in Yogyakarta” (Art. 4 (b)). With this broad definition, almost all customers in affected areas become eligible for restructuring. Moreover, the regulation states the possibility to refinance loans (Art. 6 (1)).With regard to the determination of the quality of loans the regulation refers to “applicable Bank Indonesia regulatory provisions”, without mentioning specific regulations. In the supplementary explanation to the regulation, the possibilities of rescheduling, reconditioning and restructuring are explicitly mentioned as a means of debt rescue. Here, the regulation refers to “regulatory provisions concerning Earning Assets Quality and Allowance for Earning Asset Losses” (BAI and MICRA Study, p.15). 40. Regulation 8/15/PBI/2006: This second regulation refers to all areas in Indonesia hit by natural disaster in the past. It also defines a validity period of max. 3 years for this regulation after the natural disaster for restructuring. The areas covered are mostly the same as in the regulation for the Central Java quake mentioned above (BAI and MICRA Study, p.15). 41. Other regulations: BI issued new minimum capital requirements for BPRs in August 2004. The minimum capital will continue to depend on the location of the BPR:

BPR in a provincial capital: IDR 2 billion (about EUR 182,000)

BPR in a district capital: IDR 1 billion

BPR outside of district: IDR 500 million 42. Existing BPRs are granted a transition period until 2010 to comply with the new regulation and increase the capital as necessary. By the end of 2006 BPRs should have at least 60% of the required capital paid in and in 2007 it should be 70%. 43. Regarding maximum capitalization for BPRs, the Indonesian Banking Architecture mentions14 in its unified vision of the Indonesian banking landscape, that BPRs may grow up to a maximum of IDR 100 bn. or about EUR 9 mn. Capital levels exceeding IDR 100 bn would then require a different type of banking license. 44. Two new regulations will become effective in December 2006, concerning minimum capital requirement (8/18/BPR2006) and asset quality (8/19/BPR2006). 45. Field visits to a sample of BPRs also confirmed that in many BPRs the owners occupy senior or management positions such as president, director, internal auditor, etc.) in the bank. This practice is no longer allowed within commercial banks, but still permitted for BPRs by the Bank Indonesia15. 14 (on p.15, see http://www.bi.go.id/NR/rdonlyres/2853A950-8B65-4D35-9A21-540111515BFE/845/action.pdf ) 15 as detailed in the BAI / MICRA Preparatory Study, vide p.5

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IV. THE PROPOSED PROFI PROGRAMME COMPONENT FIVE A. Rationale and Design Considerations 46. Response to Support Requirements of Micro and Small Entrepreneurs: The first chapters of this report highlighted both the enormous damage caused by this particular quake, and also the fact, that micro and small entrepreneurs with their mostly producing micro and small industries were particularly hard hit by the quake. Other than earthquake victims in government employment or people working for large private companies, there is no perspective for small self-employed people and their families to access relief funds or take out loans for reconstruction. Considering the limited amount of support funds available under ProFI component 5, it is recommended to focus on supporting small and micro entrepreneurs in re-building their livelihoods. The definition as to what exactly falls under the term micro enterprise would follow the standard definition in Indonesia, contained in the MoF Decree No. 12/PMK.06/2005 with respect to the net worth or annual sales proceeds and ownership criteria. With regard to small businesses, these are defined here as specified in Act No. 9 of 1995 as a small scale people’s economic activity, again defined by net worth, or annual sales proceeds and ownership criteria. 47. Capacity Development of Earthquake-Affected BPRs: BPRs are geographically highly restricted. They operate either as single unit banks with branches or have permission to open cash counters only within the same district (Kabupaten). For this reason, a temporary cross-subsidization in post disaster scenarios, which was observed for example in the case of commercial banks in the Aceh Province after the Tsunami, can not be expected from within the BPR structure. Mutual support is presently restricted to a limited amount of borrowing and lending between liquidity surplus and deficit BPRs, intermediated through the local apex BPR. Training, skills and capacity development initiatives to enable BPRs to continue their business are not organised from within the system. A focus on capacity development is therefore recommended. 48. Support of In-Country Strategies for BPR Capacity Development and Apex Structures: Within the BPR network, an important strategic reorientation process towards a deepening and widening of local apex bank functions has recently begun16. This is a welcome development enabling retailing BPRs to source financial (liquidity management functions) as well as in future also non-financial functions (training, skills development, rapid appraisals and ratings of attached BPRs) to their BPR members. Only the capacity to organise for the conduct of quick BPR appraisals will enable apex BPRs to base their lending and liquidity management decisions on a sound data footing17. However, Heupel (2005, pp. 85, and also p. 35 for practice in Ghana) emphasise that these ratings should be outsourced and not be conducted by the apex banks themselves. 49. An enhanced support functionality of local apex BPRs is all the more important in post-disaster situations where this dispersed and decentralised type of financial institution has at present no central support structure to help them back on their feet after calamities struck. 16 Heupel, W.: Recommendations and Critical Issues for the Way Forward towards a BPR APEX Institution in Indonesia; GTZ ProFI Publication.Jakarta and Accra, Ghana, 2005. 17 The Bank Indonesia supervision and related data are updated only once every three months.

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50. Promotion of Proven Microfinance Technologies in Post-Disaster Environments: After completion of a first emergency and relief phase with the provision of temporary shelter and transitional infrastructure and sanitation facilities, the focus is now shifting to reconstruction and development support. Even though it is welcome in principle to furnish all families with serious damages or losses with non-repayable grants, the budget provisions are not near enough to fulfil this ambitious undertaking. 51. Creation of a Facility to Promote Best Practice Dissemination for Microfinance in Post-Disaster Environments: New tragedies and natural calamities follow close on the heels of each other. Indonesia with its more than 18,000 islands along the Pacific “ring of fire” of active volcanoes and tectonic faults is in permanent danger of natural perils and calamities. It is unrealistic not to expect major natural disasters in Indonesia in the near future. After quite a few ad hoc responses and development initiatives for microfinance in different parts of Indonesia affected by natural calamities, it seems appropriate to manifest and consolidate this experience now and pool the emerging experiences and best practices into a special facility to maintain and manage these emerging promising practices and approaches to post-disaster responses for microfinance development. These could initially focus on the interplay between loans and non-repayable grants, quick liquidity provident type of loans, semi formal and locally adjusted types of financial technologies such as linkage banking, and also housing finance, in particular specific forms of low-cost housing finance. 52. Emerging Component Objective: Out of the above design considerations, the following objective for the implementation of ProFI component 5 can then be deduced: To “provide sustainable access to financial services for the rehabilitation and reconstruction of businesses” production capacities and enhance the self-help capacity of small-scale entrepreneurs”. B. Proposed Component Activities in Summary 53. The new component 5 of the GTZ Programme for the Promotion of Small Financial Institutions (ProFI) is proposed to consist of three sub-components. These would be implemented in Yogyakarta and Central Java Provinces under a decentralised component management. 54. First an experimental loan fund of EUR 500,000 would be used for on-lending. Resources out of this fund would be made available to BPRs who are assessed as sound and signal a specific demand for loan fund resources through one of two provincial apex banks. This credit fund is not meant for comprehensive coverage of earthquake affected families, but rather as an experimental tool to test promising practices in providing a package of different financial services in disaster-prone areas. For this reason, the fund will finance only one clearly defined sub-group among victims of the quake: self-employed micro and small entrepreneurs in search of re-starting their livelihood activities. Financial technologies used will again be pilot tested with a view to possible up-scaling in future events of post-disaster support to microfinance. 55. Second, technical assistance and capacity development measures would be provided at the level of PNM, the apex banks, recipient BPRs and group leaders of borrowing self help groups (SHGs). The objective is again to take stock of experience

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gained so far in post-disaster environments that are unfortunately quite common in Indonesia18. Specifically, technical assistance would be used to derive a pool of promising practices and experiences in two critical areas of microfinance support following natural calamities:

(i) a short-term tactical approach to microfinance capacity development: This includes concrete support for areas most needed after primary emergency assistance, such as building repair, provision of working capital or of small investment loans to affected micro enterprises, but also reconstruction and back-office support to microfinance institutions damaged or partly physically destroyed by natural calamities.

(ii) a medium term strategy for microfinance development after calamities.

This strategy would focus on development of adequate savings and loan products to aid people damaged by natural disasters. Accompanying financial services would include micro insurance, development or strengthening of lending technologies with an outreach wide into more remote and disaster affected areas through intermediate levels such as self-help groups and employing the group lending methodology. At the level of the damaged financial institution, back office support specifically for recovery and management of records and IT would be provided, as well as training to new or existing staff.

56. As a result, it is even possible that certain BPRs and other small financial institutions re-orient their entire business operations away from urban and salaried clients and undertake a focused re-bundling of services with new and emerging market opportunities. 57. Competitive financial services globally are information- and knowledge-intensive, and training and advisory functions become more essential for institutions striving to secure market niches in new and rapidly changing market environments. Against this background, a third sub-component deals with the establishment and functioning of QUICK, the Quick Impact Capacity Development & Knowledge Transfer Center for Microfinance in Yogyakarta. This center would collect, manage and generate specific tools and good practices related to a small and well defined field: the application of microfinance tools and technologies as a part of coordinated responses to natural calamities once primary emergency assistance and early recovery measures have been successfully completed. 58. The objective of QUICK would be to distil quick response applications and technical material for microfinance institutions of different kinds that would use microfinance as a tool for post disaster rehabilitation and development. QUICK would distil the specific responses in terms of short-term tactical responses and more strategically oriented medium to long-term responses to post-disaster microfinance. Experience gained and lessons learned under sub-component 2, the technical assistance and capacity development activities would enter into the good practices pool, just as the experience of other domestic and international microfinance experience in post-disaster environments. 59. QUICK would be operated during the first 12 months after its establishment out of the premises of the management team for component 5. The team would oversee 18 Within the six-months after the quake and up to the compilation of this report, there were two further unfortunate events, flooding in the coastal areas of Central Sulawesi and further volcanic eruptions in Central Java.

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the conduct of special studies, transfer of data from other experienced microfinance operators and collation of the material with final processing into a registry or document centre. A separate website and a monthly e-newsletter would keep interested practitioners informed about recent developments. After a mid-term review meeting for QUICK, proposed to be held in October 2007, future options for institutional development would then be explored. At this moment, the preferred option would be the continuation of QUICK operations in a separate office and as an independent legal entity. Sources of funds could in principle be derived from three sources: (i) fees for utilisation of services, or a possible membership structure19 (ii) donations sourced domestically or internationally, and (iii) non-operational income deriving from endowment fund proceeds or similar financial mechanisms. 60. As one of the recently emerging developments the GTZ ProFI Team Leader informed that other projects within the focal area now think of knowledge facilities similar to QUICK. If these ideas are indeed carried forward to concrete implementation within the next two years, with focal areas that would complement the thrust of QUICK which is up and about to be running within the next coming months without the need for duplication, then component management should check the feasibility of bringing these facilities together in a second step. C. Loan Fund Support to People´s Credit Banks 61. Under this component, resources for a credit fund would be made available. This fund would support microfinance development activities undertaken in sub-components two and three. The fund would be available to selected BPRs. The People´s Credit Banks are proximity based single unit banks. They do not have the possibility to quickly access liquidity and other essential post-disaster support from other regions or a capital based head office. This is an option open to nationwide commercial banks, and as the Tsunami events in the Aceh Province showed, liquidity within nationwide operating large financial institutions is available within hours if the back office structure supports the transfer and was not damaged. The vicinity to a lower income target group, but with operations under full supervision of the central bank constitutes the main plus point of the BPRs. In the aftermath of natural calamities they however require more support than larger banks. 62. Flow of Funds. The overview on the following page summarises the proposed flow of funds under this sub-component. The funds originate from the German Ministry for Development Cooperation and are made available by GTZ to a financial institution in Indonesia, that is legally permitted to receive and transact these foreign currency funds. GTZ – PNM: A Financing Agreement and a Special Agreement govern the financial relations and duties of PNM as the first domestic recipient of Credit Fund proceeds. The Financing Agreement stipulates the total amount of EUR 500,000 as a financial and non-repayable contribution. It defines the general obligations of PNM as the recipient. The Special Agreement first stipulates the two apex BPRs (“Project Executing Agencies”) that were appointed based on advise from the Bank Indonesia as GTZ’ principal partner, (i) the PT. BPR Agra Artaka Mulya in Gunung Kidul, Yogyakarta Province, and the PT. BPR Gunung Kawi in Semarang, Central Java. 19 consisting of MFIs and financial institutions, but also other stakeholders such as domestic and international donor agencies and possibly also other non-conventional stakeholders such as local governments

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63. PNM – 2 Apex BPRs: The proposed contractual relations between PNM at national level are governed in a contract that is currently under review between the central ProFI office and PNM. It would be useful to focus the contractual obligations of PNM in this context strictly to its role as an apex finance institution, and not mix loan and technical assistance provision. Also, it is advisable to keep out of the contract any obligations of financial institutions at lower levels of the financial chain vis-à-vis PNM or a separate coordinating mechanism (“committee”). It has to be recalled that each institution apart from PNM at the apex received the funds on a repayable basis, be it as a deposit or be it as a line of credit. It is therefore up to the institution taking the credit risk at each level of the structure to take responsibility for lending decisions and apply its own tested business procedures. 64. Apex BPRs – Retailing BPRs: In detailed discussions with the two apex BPRs proposed by Bank Indonesia, it was clarified that the contractual relation between apex and retailing BPRs would be governed by standard operating procedures and that no separate specimen contract would be required for this purpose. 65. Retailing BPRs – Members: Loan contracts between retailing BPRs and the final borrowers (“sub-borrowers”) would follow the standard contract forms used by these BPRs in the dealings with their clients. 66. Funds Disbursement in Summary: After receipt of funds from GTZ, PNM (“the Recipient”) awards Special Loans over a period of 5 years to each of the two apex BPRs (“Executing Agencies”). These two apex BPRs place time deposits in earthquake affected rural credit banks (BPRs) after an initial rapid appraisal and rating of these banks, and receipt of financing proposals from the sub-sample that is considered to be sound enough for immediate receipt of loan funds (“first round BPR recipients”). These funds would be granted with a maturity period of up to 2 years with optional roll-over facility. Such scheme would have the advantage, that these funds are not exposed to a full credit risk, since they are partially covered by the Indonesian Deposit Guarantee System (LPS), do not negatively affect the capital adequacy ratio (CAR) of a BPR and, therefore, comply with Bank Indonesia’s regulations. The earthquake affected BPR shall on-lend the fund to end users (“sub borrowers”) as working capital or investment financing for up to 2 years with optional roll-over facility. In the case of low-cost housing finance, the loan tenor could exceed 24 months. 67. Spreads: The initial spread for PNM is illustrated in the overview on the next page. Funds are granted from PNM to the apex BPRs at 2% p.a. PNM shall derive no other income from fees etc. from the transfer of these funds to the two apexes. It has also been recommended that the interest rate for sub-borrowers shall not exceed 10% p.a. and a maximum of 1% up front fees (instead of the usual 2% fee charged in BPRs). The 10% would be charged on a reducing balance basis for all types of loans offered under this facility. The apex BPR is proposed to lend to retailing BPRs at 5% p.a. (3% spread) and the retailing BPRs to borrowers at 10% with a one percent upfront fee (5% spread). 68. Credit Risk: The risk for repaying funds from higher levels of the intermediating chain would rest with each level of this chain. This means precisely that the retailing BPRs have to repay to the two apexes and take the full credit risk for funds borrowed. The two apex BPRs in turn have to retransfer funds back to PNM. These funds would come out of credit repayments from the retailing BPRs. Again, the two BPRs assume a de facto credit risk. Since the risk is spread over the different levels, final decisions as well as fine-tuned lending terms and conditions plus underlying

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documentation would be left to the financial institutions concerned and not centrally governed by an apex institution. 69. Selection Criteria for First Round Recipients: Based on a sample of 18 BPRs considered sound in principle, the BAI and MICRA conducted rapid appraisals and ratings in order to determine, which BPRs could be recommended for inclusion into this Loan Fund mechanism. Eight out of this sample were rated immediately recommendable for being considered in the scheme. These potential first round recipients will now be approached by the two apex BPRs with a request for concrete credit proposals in order to derive volumes and terms of the requested lines of credit.

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70. End Use of Funds: The Special Agreement stipulates that “…priority shall be given to businesses organized in savings and credit self-help groups following the linkage banking approach and other productive enterprising. Furthermore, the credit line shall be used preferably for granting loans for earthquake resistant low-cost housing finance.” Added to these special types of loan products should be the investment and small working capital loans to micro and small-scale entrepreneurs. 71. However, credit transactions will not be linked to one particular supplier arrangement, such as the provision of low cost permanent housing through one particular contractor or company. On the contrary, the levels of contractors from the production or trading sphere (as opposed to financial services providers) will be kept to a minimum. Instead, initiative and self-help of earthquake victims will be promoted. Experience from Aceh shows that housing reconstruction does not only move faster and more efficiently when the family constructs the major part of the house themselves; it also reduces frictions and delays of various kinds that are a regular occurrence with contracted building companies. 72. Sunset Clauses: The decision about the final beneficiary of the recollected funds will be taken by GTZ based on a mid-term review meeting to be held in October 2007. GTZ will analyse the performance of the Loan Fund and explore different options for the final utilisation of reflow proceeds from the Loan Fund. At this juncture, the preferred option is to converse the Loan Fund proceeds into equity participations in the two selected apex BPRs, respectively of the shareholders, i.e. member BPRs of the apex banks. D. Technical Assistance for Involved Financial Institutions 73. An important part of sub-component activities consists in the focused provision of institution building and capacity development for BPRs, their regional apex banks and to a very limited degree also, to the national level recipient of funds from GTZ, PNM. Direct training or capacity building activities at the level of the sub-borrower or final recipient of loans is not foreseen by GTZ-ProFI. It may be rendered by the other projects in the region, i.e. mainly the regional economic development program (red), and with that creating synergy effects amongst the GTZ program for economic recovery and development. However, in the case of PHBK self-help groups, non-regulated micro-savings and credit self-help organizations that operate in the earthquake affected areas, small provisions can be made for refresher trainings of group leaders, if BPR loan officers and the component management specialists from GTZ see a scope for it. Principally, the TA activities would focus on areas similar to those that would be offered for services by QUICK:

• Product development, in particular as it relates to group lending activities through SHGs, micro insurance and low-cost housing

• Product refinement for the entire area of savings mobilisation and diversification of sources of funds

• Development of adapted solutions in the area of information and communication technology, possibly in the form of public private partnerships with domestic or international IT providers/software developers.

74. Important progress within Indonesia and for microfinance development in some of the above areas has already been made. In others, product development and service

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provision are just at the beginning. This is in spite of the particular importance in post-disaster environments and as part of medium-term stabilisation strategies at the small-scale or microenterprise level. Without insurance services, financial savings and specially developed products in the areas of low-cost housing, effective microfinancial intermediation is not possible presently. 75. Group Lending and Linkage Banking: Since 1988, GTZ in partnership with the Bank Indonesia promoted a financial technology for improving the depth of outreach to lower income borrowers. This so-called linkage banking approach had its origins in informal finance arrangements that operate in Indonesia and many other parts of the world, as well as in the then emerging microfinance institutions such as the Village Banking concept of John Hatch and FINCA, etc. This Program was called the Pengembangan Hubungan Bank dengan Kelompok Swadaya Masyarakat (PHBK) Project. The first phase was wrapped up in 1989. It ran as a pilot in 4 Provinces, Yogyakarta, Central Java, North Sumatra and Bali. From 1992 to 1996 the second and full implementation phase was carried out and extended the approach from the four pilot to all the other 27 provinces of Indonesia at that time20. From 1996 to 1999 the phasing-out of PHBK was implemented to mainstream the linkage approach. The project finally closed in 2000. 76. Since this time, the financial technology has been consolidated and further fine-tuned without outside support to this effect. A recent example in this regard is the conduct of a field study in the Solo area financed and supervised by the Bank Indonesia21. In the next section, group lending and linkage banking is taken as a concrete example for the structuring of work of QUICK. Further details can be found there. 77. Micro insurance: It is obvious that different types of insurance products would play a major role in the medium term economic development of micro and small enterprises damaged or destroyed by natural calamities in Indonesia. There is an ongoing initiative in the form of a Public Private Partnership (PPP) between ProFI and the German Allianz planned for the Aceh Province. Successful experimental activities in microinsurance also involving the Development Program of the United Nations (demand assessment study) have been under implementation in the Greater Jakarta (capital region) since 2006. 78. Low-cost Housing Finance: On the initiative of private housing finance institutions in India, and also as a result of government settlement and rehabilitation programmes in Bangladesh, there has been a largely invisible emergence of specialised types of loans adapted to the needs of asset poor people and small-scale entrepreneurs in post-disaster situations. The overview below summarises the – rather significant – differences between mainstream housing finance programmes in India and similar products with a low-cost focus. These include labour contribution of the beneficiary and the beneficiary family in order to keep total cash costs low as well as substitutes to a formal individual land title issued by local government and treated as an acceptable collateral in lieu of a formal title. This is in spite of the fact that there are however no possibilities to monetize these titles in case of default.

20 Indonesia now has 33 provinces. 21 Penerapan Sistem Kredit Kelompok Sebagai Alternatif Strategi Penyaluran Kredit kepada Usaha Mikro, conducted by Pak Saptono under the supervision of Kantor Bank Indonesia Solo.

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79. The overview below summarises the differences and shows some of the more important technical parameters guiding low-cost housing finance as a response to post-disaster financial services. 80. ATMI has designed appropriate technology low-cost housing models that are earthquake proof. The component management team is requested to collect different similar types of houses and the total costs of constructing these, plus time required and the highlighting of any obligations with single contractors or a group of contractors that may ensue from this. It is recommended to support house models that (i) respond to the requirements of the household or small-scale enterprise, (ii) provide the possibility to input labour as an in-kind contribution from the recipient household, (iii) have the contractor for the specific type of house approved by BPR and by the component office in Yogyakarta, and (iv) request references from the offering company of housing construction work recently completed (preferably in Aceh or similar difficult circumstances) as proof of timely and robust delivery prospects for the recipient. Table 4: Differences between Mainstream and Low-cost Housing Finance

Source: Rauno Zander: Internal HDFC Consultant Report for Indian Housing Development Finance Corporation (HDFC), Mumbai, 2003.22 81. In this more challenging innovation area for small financial institutions, low-cost housing finance, transacting significant volumes under this ProFI component is not the key issue. Rather, the component managers should make sure that 2 or 3 BPRs are selected which recognise this market segment as strategically important and are willing to spend extra staff time and resources to do the necessary learning and training. The capacity development process should be carried out mainly by domestic consulting expertise, but with an initial input of an international specialist to draft an

22 For a good introductory reader on low-cost housing, see: Innovative and Effective Approaches to Housing. United Nations Center for Human Settlements http://72.14.253.104/search?q=cache:v9EarAnqIp8J:www.blpnet.org/learning/tools/housing.pdf+Innovative+and+Effective+Approaches+to+Housing&hl=id&gl=id&ct=clnk&cd=1

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overall training and capacity development plan related to TA for this purpose of low-cost housing finance. 82. Savings mobilisation: Different events were used in Yogyakarta (“Socialisation Seminar” of this mission with BPRs of the Province) and Central Java (central bank seminar with both BPRs and mission invited) to get the views and preferences / needs of BPRs with respect to capacity development, training, and skills development of staff. Somewhat surprisingly, on these and other one-to-one occasions the need to improve the attractiveness of savings mobilisation products was repeatedly pointed out by BPRs. There is adequate literature available – chiefly from GTZ and its different best practice publications for savings mobilisation23 – and it is not required to further elaborate on technical aspects in this area in this report. 83. Development of Information and Communication Technology: The medium term development of BPRs affected by natural calamities is to a significant degree a function also of the underlying IT solutions, both for back-office accounting and administration, but also for client data management and other front office tasks. One of the common expressed wishes of small financial institutions that were damaged by natural disasters is to use any recovery work and input to update and modernise the existing IT: In particular the two apex banks that are planned to operate as guides to other apex BPRs in terms of broadening and deepening the menu of services to attached members would have requirements for new Information and Communication Technology solutions that existing softwares may not be able to satisfy. In addition to an accounting platform, issues at stake are supervision and loan enforcement support, and the possibility for a larger degree of harmonisation and standardization of business processes on which IT solutions would then be built. This would at the same time also address the new BI on-line reporting requirements for BPRs. 84. Existing problems and barriers concern mainly high initial investment and subsequent maintenance costs for individual software solutions in BPRs. To some extent, asymmetries of information about the market, its suppliers and new products at hand (including useful IT solutions from other Asian countries for small financial institutions, notably India) also play a role. BPRs with large business interests located in the capital Jakarta will ultimately have easier access to information about new technologies than a single unit bank owned by the local community in a more remote area of the country. This aspect only adds to the other well-known problems such as lack of after sales support, need for high initial investment and subsequent maintenance costs, etc. A uniform solution offered by a large domestic or international provider from the private sector could reduce costs significantly and the scope for synergies would be considerable. GTZ could act as liaison and “honest broker” in the early phases of vetting suitable private sector partners and assessing their delivery potential in the concrete context of supporting BPRs. During implementation, the ProFI office could also take the neutral role of a supervisor of processes and make sure that the PPP is adequately balanced in its many different elements. With Bank Indonesia in the lead, updated accounting frames (risk categories, risk adjustments for capital, identification of shareholders, etc.) could be introduced per decree together with new ICT solutions.

23 Hannig, A. et al, several publications, see www.cgap.org

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E. Proposed Centre for Quick Impact in Capacity Development and Knowledge Transfer (QUICK) 85. New tragedies and natural calamities follow close on the heels of each other. As outlined in the initial chapters of this report, it is unrealistic in Indonesia not to expect major natural disasters in Indonesia in the near future. Disaster preparedness and response time to institutional and capacity development challenges have to be significantly accelerated. Back-to-back with the end of relief and initial emergency rehabilitation measures, development and livelihood support measures have to be set in, managed and coordinated by local institutions that are quickly rehabilitated, and staff needs to be adequately (re)-trained after the distress. In response to this newly emerging need in Indonesia and the wider region, and in order to accelerate this process at least for small financial and microfinance institutions, it is proposed to reduce the negative impact of institutional distress after natural disasters through a special centre where promising practices on Indonesian microfinance are systematically kept and made available in small fact sheets and procedures. These would enable MFIs, BPRs and other small retail oriented financial institutions to be fed with best practices quickly and systematically. This would initially encompass the three areas considered most critical in this process by the concerned institutions: IT platform and development, deposit mobilisation, and new innovative microfinance products such as microinsurance, low-cost housing finance and microleasing. 86. Rationale for building innovative types of partnerships: There is a newly emerging discussion about strategic foci in the traditional government-to-government partnerships and the role of GTZ contained therein. Among the new types of partnerships proposed is for GTZ to be a match-maker and provide a liaison to focus a part of the practical contributions of GTZ. This match making would consist of the building of knowledge platforms for a store, management and exchange of information related to specific institution building aspects. Co-incidentally, the initial promotion of this centre and the possible structured collaboration on different breakthrough areas such as ICT development and application also offers avenues for charting new types of PPP. As mentioned elsewhere in this report, ICT knowledge management through QUICK could involve also bringing in large corporate private sector partners. These could design software solutions for small financial institutions. The introduction, maintenance and after sales support could then be supervised and coordinated through GTZ ProFI again. Altogether, the concept of QUICK responds well to the newly emerging requirements for fast, high quality and flexible responses to rapidly changing operating environments in institutional capacity building. More instruments for steering learning and knowledge generation processes should therefore be in place. 87. The seven-step learning agenda of QUICK: The centre would have a standard strategy for generating information and technical inputs for wider dissemination among BPRs and other microfinance institutions. This approach consists of:

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The 7 Step QUICK Learning and Knowledge Generation Process

1. Analyse, take stock, build empirical base for further work; 2. Locate sources of innovation or technical improvements; 3. Assess wider applicability of new and innovative solutions through forging dialogue with practitioners and front office staff of financial institutions; 4. Accompany learning process through results-based monitoring 5. Produce material relevant for practical application. Academia or development journalism is not the objective of written technical material 6. Promote iterative learning and a continuous improvement and fine-tuning 7. Re-invent yourself according to changing demands and use strategic planning as a tool in the process 88. The example of PHBK Linkage banking is taken to exemplify this approach. In order to meaningfully develop PHBK type of activities in Indonesia, and as a quick and flexible response to post-disaster conditions, it is necessary to promote taking stock and analysing the current status of PHBK experience all over Indonesia. The recent Bank Indonesia empirical study in the Solo area of Central Java is a noteworthy example in this regard. 89. Second is the promotion of innovation and fine-tuning of SHG- Bank Linkage: In order to chart a sustainable way forward for the PHBK, a reconnect to the country of origin of the SHG-bank linkage approach should first of all be promoted. As a response to emerging shortcomings in the Indian SHG-Linkage approach, a number of microfinance institutions from the private sector have taken the original approach promoted by the state agricultural bank NABARD (National Bank for Agriculture and Rural Development) and developed it further. It is recommended to promote a south-south knowledge transfer and exchange of information with these state-of-the-art operators. Indian public institutions cannot at this point provide much any more in terms of further fine-tuning and adapting the approach. It is specifically recommended therefore to establish knowledge channels with NGOs like PRADHAN in Delhi or the DHAN Foundation in Madurai, Tamil Nadu. This latter NGO has significantly brought forward traditional SHG approaches through inclusion of barefoot auditors and additional internal controls and checks and balance technologies at the level of the SHGs. It also promotes a special type of quasi autonomous SHG type of institution, the so called DHAN Federations consisting of many SHGs and providing specific services to them. In the past few years, the many innovations that DHAN has introduced have partly been taken up or copied by public sector institutions. It is still recommended to short circuit with the source of these innovative moves in India and see, what can be adopted and fine-tuned here in Indonesia. 90. Third, and no less important, is the introduction and promotion of specific practitioner exchanges on linkage banking for mutual learning and fine-tuning of the approach. While much of this can be done through QUICK, and in particular its

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website and monthly e-newsletter, the wider strategy of generating meaningful lessons learnt that can then be transported as capacity building assistance to bankers should be outlined in this section already. 91. The approach then consists of a results-based monitoring of pilot projects which include new and innovative adaptations to the original model. The next step consists in the production of technical material in the form of modules, articles in e-newsletters or IT solutions. These are produced and offered to MFIs in post-disaster environments. This QUICK material should be concise, focused, practitioner oriented and avoid any preaching or lengthy generalities. 92. It is also important to conduct the above strategic learning process iteratively and to continuously fine-tune and improve the existing technical material. Finally, major pillars and unquestioned “givens” of particular approaches should be permanently put to the test – the relevance in real life contexts and as value added to a microfinance institution. 93. Governance Options: The centre would initially be managed by the two microfinance advisors posted to Yogyakarta, and under the overall supervision of ProFI. It is however recommended to prepare for eventual independence by setting up internal steering and advisory structures that could later be upgraded to an autonomous governance set up for QUICK. The Steering Committee should consist of one member of affected BPRs, one B.I. representative from the Yogya office, and a representative from ProFI. Alternatively, the option of establishing a separate trust with the steering committee members as Trustees could also be considered. In this case, a Trust Deed would need to be drafted, and the decisive position of the chair of trustees should be held for the time being by the B.I. representative (as an ex-ufficio function). 94. Next Steps: It is proposed to proceed with the establishment of QUICK out of the GTZ ProFI facilities in Yogyakarta. An inception workshop should be held in early 2007 based on a draft budget for the first year developed by the microfinance advisers posted in Yogyakarta. This workshop may also be used to promote and clarify other issues that may come up in this early phase of establishment. At project management level, a so called short term plan needs to be developed to satisfy the new GTZ results based monitoring requirements. January and February 2007 should be used for stock taking, introducing a file system and document centre and developing the website. The first issue of the e-newsletter should be launched in January 2007. The first quarter of 2007 should be used to draft the following important documentation: the Statute or charter of the Centre, assuming its eventual independence from GTZ and B.I., a business planning process including the introduction of quantitative planning tools and participative decisions on future directions and emphases of the centre. F. Docking Points for Other Donors 95. The proposed component structure explicitly foresees collaboration and partnerships with other domestic or international funding agencies. Special docking points are defined in this report. Experience from Aceh and other post-disaster areas shows that smaller domestic and international donors seek a managed and coordinated structure such as the one proposed for component 5 that permits fund utilisation within a broader support context and ensuring accountability in implementation.

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96. There are mainly four types of partnerships feasible, co-financing of the loan fund, supplementing the technical assistance measures, and / or support through other innovative financing mechanisms. 97. Co-financing of the Loan Fund: Participation in the loan fund would usefully complement the limited resources for this facility available to date. Contributions would be channelled via GTZ-International Services and be managed under the same conditions and by the same management team that is in place in Yogyakarta to manage GTZ resources for earthquake affected micro and small entrepreneurs. 98. Supplementing the TA Package: PNM, the two apex banks, the larger number of recipient BPRs and finally, the group leaders of self-help groups would receive support in the form of training for capacity development. Co-financing with other donors would be welcome, and could result in longer support periods for the TA. 99. In-kind or Financial Support for the Running of QUICK: In its second phase after mid term review in October 2007, as QUICK may branch off institutionally from the ProFI structure, financial or in-kind contributions from domestic or international sources would be particularly useful and required to enhance long-term sustainability prospects. 100. Support through Other Innovative Financing Mechanisms: This aspect concerns collaborations with smaller initial sums (from EUR 20,000 upwards) primarily for risk-hedging mechanisms, such as special reserves for anticipated bad debt provisions (“risk funds”) or straightforward guarantee mechanisms that may be launched by the apex banks on a pilot basis and for later up-scaling. The QUICK centre is expected to continuously generate best-practice packages in innovative financing mechanisms that could likewise be tailored to earthquake-affected BPRs. Funds could be managed by GTZ or, in the case of contributions smaller than EUR 50,000 be channelled directly to the concerned institutions by way of parallel financing arrangements, but under one unified component umbrella. This means joint reporting and supervision through the GTZ ProFI management team stationed in Yogyakarta. V. COMPONENT MANAGEMENT A. Component Costs

101. Table 5 contains the necessary details and a breakdown of costs over the two-year implementation period of component 5. 102. For the credit fund, a one-time disbursement from GTZ to PNM as per the Special Agreement and Permission of the German Ministry for Development Cooperation is foreseen. Fund internal management costs are covered from spreads that accrue in the application of this fund. They do not need to be separately costed.

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Table 5: Sub-component Summary Cost Table CATEGORY PY 1 PY 2 Amount Amount Percentage (EUR) (EUR) (EUR) (IDR mn.) Of total1. Credit Fund Credit Fund (lump sum) 500,000 0 500,000 5,837.840 ??? 2. Capacity Development Domestic ST TA 15,000 5,000 20,000 233.514 International ST TA 75,000 25,000 100,000 1,167.568 ICT, other systems development 50,000 35,000 85,000 992.433 3. QUICK Establishment Domestic ST TA 24,000 24,000 48,000 560.433 International ST TA 80,000 20,000 100,000 1,167.568 Production of promo material 12,000 3,000 15,000 175.135 Website development, maintenance 8,000 2,000 10,000 116.757 4. Component Management 2 management staff positions 23,500 23,500 47,000 548,757 Admin, mobility, office exp. etc. 25,000 25,000 50,000 583.784 5. Contingency (5%) 25,000 291.892 TOTAL 1.000000 11.675.680 100,00%/1 at exchange rate of IDR 11,675.68 per EUR (15-11-2006) /2 contingencies for non-credit fund expenditures only. B. Proposed Staffing 103. For the TA and QUICK related activities, the cost breakdown over the envisaged two year period of component implementation assumes that the majority of introductory, set-up and other enabling activities would take place in the first of the two 24 months periods. 104. As far as contingencies are concerned, as per international conventions, they do not cover credit fund proceeds. For the balance EUR 500,000 of total costs, a 5% contingency has been used, since the implementation risks are comparatively low with the GTZ ProFI office and infrastructure already in place. 105. Additional Short-term TA Input: All costs included in table 5 above are total costs, including all additional costs that accrue to the employer. In the case of international short term consultant input, the figures include transfer from and to the country, daily subsistence allowances and over night costs. The all inclusive average amounts budgeted in the project costs is proposed to be 200,000 for a total of 10 months international TA, or EUR 20,000 on average. In the case of domestic ST consulting input, total project costs are projected at about EUR 68,000 or 1,700 EUR per consultant month for 40 months of domestic ST input. 106. A team of two fixed term domestically recruited staff are foreseen to manage all activities related to this component (5 of the ProFI Programme). The team would

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be stationed in Yogyakarta. The terms of references of the Microfinance Advisor (chief of office) and Deputy Microfinance Advisor are attached to this report. It is very useful that the office will be part of a larger office infrastructure, where other well known German GTZ Programmes also have a representation. These are the IGI and the RED Programmes. This makes a short circuit exchange of information on engineering and construction aspects of low-cost housing possible. In fact, IGI supported ATMI in Solo and their low-cost housing solutions developed in collaboration with GTZ IGI are an interesting option for promoting low-cost housing also on the basis of loans to the target group. 107. Component Management Team in Yogyakarta: As a first activity, the team has to come with an information sheet to be distributed to interested BPRs containing (i) a concise summary of possible types of loans supported by the credit fund, and (ii) different options of light or more substantial TA support. The latter is a must for any BPR starting to engage in low-cost housing finance (see section 4 with detailed description of TA measures, above). 108. Administration costs in table 5 may be used to finance one or a part of a general service staff in the office. The sharing arrangements and formulas for general services staff will be worked out between the different GTZ programmes shortly. C. Monitoring and Evaluation 109. As outlined in the strategic outline for QUICK, dynamic environments require fast adaptation and at times even a rigorous re-inventing of the activity and main objectives. Component monitoring would follow the recently agreed on pillars for results-based management and focus in a short and concise way on achievements and milestones. In this context, scope management means assigning planned activities to project objectives. It recommends monthly team meetings to review past performance, roll out short-term plans and discuss risks and opportunities. In addition, bi-annual meetings should assume a wider strategic / mid-term focus by analysing impact and environment information. In the case of component 5, the mid-term review meeting proposed after the initial 12 months of the 24 months implementation period would be an important potential point of strategy and review. It will define the future path and degree of up-scaling (or otherwise, if no adequate in-country ownership for the centre can be built up in the short implementation period). 110. GTZ procedures for results-based monitoring recommend the drafting of an initial short-term work plan. The proposed inception workshop with important stakeholders would be used not only to draft the work plan and budget for the first year, but also to draft a short-term plan to break project activities down to the work package level, and assign milestones and responsibilities at the output level. Work packages / milestones need to be associated with (at least) one indicator defined in the respective project proposal, or justified on other grounds. This short-term plan will serve as a baseline to evaluate project performance. It could also include estimated budgets to enhance cost control. 111. Proposed Measurable Outcomes: The GTZ Proposal to the Ministry of Development Cooperation (BMZ) contains three measurable outcomes for component 5 summarised in the overview below.

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Table 6: Three main outcomes proposed for component 5 BPR Participation BPR Recovery from

Earthquake Damage BPR Client Reach

40 in Yogya and 13 in Central Java

100% in Yogyakarta and Central Java

300% Increase from Beginning of Support Measures

112. The process of confirming and adjusting objectives (“Änderung der Wertbestückung”) could emanate as a result of staff and time resources spent on preparing for and establishing QUICK, a demanding task that was not yet envisaged a the time of drafting the GTZ proposal. 113. In terms of evaluation, the new and more integrated approach of AURA for monitoring and evaluation may be followed. A separate short study may be launched as a prelude to the mid term review and decision as to the future of QUICK. D. Connectivity to Other ProFI and GTZ Components and Activities 114. Connectivity to Component 1: Even though there are comparatively the fewest concrete link ups between the new component 5 and component 1, related to the introduction of a nationwide microfinance policy, there is no doubt that a final agreement on a microfinance policy document could promote the development and growth of microfinance institutions. These would then also be potential users and clients for the services of QUICK, depending on where the next natural disaster will take place in Indonesia. 115. Connectivity to Component 2: There are important areas of cross fertilisation between this component that deals with BPR policies and future development directions and the new component 5. The strategic objective of developing BPR apex structures with a service mix that far exceeds surplus and deficit unit management between single BPRs is a case in point. The two apex BPRs under component 5 would be case examples of what could be achieved on a larger scale nationwide. The two BPRs in conjunction with GTZ are expected to organise for the rating and appraisal services to BPRs as a basis for sound lending decisions to these BPRs. These apexes would also coordinate and steer the main direction of training and technical assistance messages to ground-level BPRs. Even the longer term ownership and governance innovations planned are in a way advanced by the two apex BPRs in component 5. They may be capitalised out of component resources in a way similar to the emergence of BPR owned apex institutions that are envisaged for the future of BPRs. 116. Connectivity to Component 3: Capacity development under this component focused mainly on the highly successful promotion of the CERTIF Institute24. The direct commercial and market oriented outlay of a training and capacity development institute is one further step that would be made in component 5. Commercialisation instead of servicing a captured market can provide interesting insights for the future of CERTIF as well. Capacity building through refresher training of group leaders

24 The ProFI management plans the publication of a best practice publication telling the story of CERTIF and pointing out the lessons learned and technical issues when considering replication of this experience in other countries with similar framework conditions and small financial institutions (agricultural cooperatives, Turkey, Indian cooperative banks, etc.)

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would also link back to a training effort that pre-dates the beginning of ProFI and links with the last phase of the PHBK programme. E. Summary Risk Assessment 117. Total risks for implementation of the proposed activities are assessed to be low to medium scale. The 24 months implementation period is short and manageable, and an experienced management team is in place in the ProFI Program Office in the Bank Indonesia in Jakarta to quickly react to changing circumstances and challenges as they may occur during implementation. 118. Risks related to the absorption and repayment morale of borrowers from the credit fund will exist because of the parallel promised channelling of grant support. As highlighted in detail earlier in this report however, budget allocations and continuing delays into the rainy season make it highly unlikely that even the larger part of seriously affected households will be covered by grant payments. For this reason, the interest rates are set below market rates, and the target group is specified in detail. However, depending on future developments related to the promised government grant payments, unforeseen situation are yet not unlikely to occur. 119. Finally, institution building and generation of lessons learned for wider replication and up-scaling in the specific context of post-disaster microfinance, as it is proposed in this report, bears the risk that the challenging leap from sub-component activity to independent and free standing institution can not be made in the short amount of time available. On the other hand, considering the country background and the expected strong need for this type of knowledge management and transfer facility, it would be wrong not to go ahead and take the risks associated with the establishment of QUICK.

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Annex 1 PROFI Program

PN 2002.2578.9-001.00

Terms of References: Design of ProFI Component 5 in the Context of the Earthquake in D.I. Yogyakarta and

Central Java

Dr. Rauno Zander Background The Yogyakarta (D.I.Y.) and Central Java earthquake on 27 May 2006 has had a devastating effect on the productive sectors of the economy. Large numbers of enterprises, mostly micro, small and medium-sized, shops, traders, and their livelihoods have been destroyed. As a result, the financial sector is also considerably affected. In particular, the 65 BPRs in D.I.Y. and Central Java have been significantly affected, i.e. about half Yogyakarta’s loans might become non-performing and BPRs’ capital adequacy ratio (CAR) may be reduced to negative percentage. Sixty BPRs in D.I.Y. have reported loan losses and will need liquidity support, as repayment of loans will dry up and depositors seek to withdraw funds. Locally owned and operated BPRs that have no business operations outside D.I.Y., Klaten district or affected surroundings are suffering most even damage to banking infrastructure and facilities remained relatively limited. Credit markets have a key role to play in the rehabilitation and restructuring process. Banks, in particular BPRs should extend support to revive economic activities, including reconstruction of houses, in the affected areas. Bank Indonesia (BI), the government and banks have started working to meet emerging needs without dispensing prudent banking regulations and operations. A first rapid impact appraisal of two BPRs in the Klaten district (Central Java), conducted by GTZ-ProFI end of August, comes up with the following findings:

• At BPR Shinta Bhakti many clients were affected by the earthquake accounting for about 4 billion Rupiah in outstanding loans or 20 percent of the total outstanding loan portfolio. The two spot checks with clients revealed that the extend to which clients and their repayment performance is affected varies. The most severely hit clients lost their productive assets / working capital. Future income generation and therefore recovery of outstanding loans is at risk. For those clients access to new finance is crucial to recover business activities. Other clients experienced expenditure shocks because houses or other assets are damaged and will have to be reconstructed. Since for those clients, for example, government employees, income flows are undisrupted or likely to recover quickly, grace periods should be granted to allow for recovery of assets. Those clients will, however, be able to repay loans in the longer run.

• In BPR Shinta Bhakti revenue shortfalls occurred due to (a) restructuring of

repayment schedules (grace periods three months) (b) reluctant provision of new loans. In BPR BKK Pedan, the balance sheets revealed no immediate impact on revenues. On the cost side marginal impacts occurred due to the reconstruction of buildings and infrastructure. However, since operational costs, in particular refinancing costs (interest payments to clients and commercial banks), could not be fully adjusted to falling revenue, BPR Shinta Bhakti has been facing losses in the month after the quake. Some of

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refinancing banks granted grace periods for the interest payments on refinancing loans for a period of three months to cushion the impact. Despite falling profits both BPRs seem to have the financial stability to sustain their businesses.

• Longer term effects will depend on how far the recovery of the portfolio

currently at risk will be achieved. Rough estimates presented by BPR Shinta Bhakti assume that 50% of the portfolio at risk will have to be written off. According to a circular letter issued BI in the wake of the earthquake, the BPRs are granted exemptions to ease the restructuring of the portfolio at risk due to the earthquake. Loan losses and repayment delays due to the earthquake are exempted from capital requirements for a period of three years. Interestingly BPR Shinta Bhakti took a management decision to build up loan loss provisions in order to bolster potential long term effects.

• BPR Shinta Bhakti is keen on receiving financial assistance accompanied by

technical assistance both to contain impact on their own operations as well as to support the clients’ businesses. TA should focus primarily on loan technologies and new products permitting a better monitoring of the use of the loan amount by the client, without boosting the related transaction costs. BPR Shinta Bhakti already introduced a housing finance product to meet the demands of clients arising from post disaster reconstruction efforts. FA is solicited to enable BPRs to move in potentially riskier business (refinancing of productive assets) without making loans prohibitively expensive.

Purpose of the Assignment Based on the rapid appraisal being conducted by Bankakademie International (BAI) in collaboration with Microfinance Innovation Centre for Resources and Alternatives (MICRA), a deeper analysis of the financial impact of the earthquake is suggested to ensure a project design that creates incentives for the BPRs to meet the demand of the earthquake affected clients on a broader scale without distorting markets. Specific questions relate to the appropriate channelling mechanism, terms and conditions for refinancing, better understanding of demands of clients and financial situation of BPRs. The purpose of the assignment is in particular to clarify:

- whether participating BPRs share the vision of GTZ-ProFI to provide financial services to the poorer segment of the population and to those who are in need due to the earthquake;

- how much the BPRs are affected by the earthquake (profit, equity, assets, long-term impact etc.);

- which BPRs are at risk of insolvency; - BPR performances prior to the earthquake; - which are recommended performance/eligibility criteria of BPRs participating

in the GTZ-ProFI support program. Activities of the Assignment

- develop a technical assistance and fine-tune the financial assistance mechanism that takes into consideration that rescheduling, restructuring, and reconditioning of credits enable the clients to recover their livelihood on the one side and that negative impact of loan losses on assets can be minimized. This mechanism must try to avoid the possibility of both moral hazard as well

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as of adverse selection of high risky business financing through channeling of the funds provided;

- outline channeling mechanism of funds from the BPR apex banks to the participating member BPRs and negotiate with the respective stakeholders;

- describe the necessary technical assistance package to be provided by local service providers and experts within the new GTZ-ProFI program component;

- outline future cooperation with local co-financing partners and potential international development agencies, alliances and partners;

- develop an exit strategy proposal for GTZ, including guaranteeing sustainability of the support services provided;

- elaborate a draft implementation plan of the new GTZ-ProFI program component in close cooperation with local stakeholders;

- draft job descriptions for local microfinance/bank experts in connection with the newly established rehabilitation and construction office of GTZ-red/IGI and ProFI.

Amendments of the Terms of Reference These Terms of Reference may be amended in writing only, subject to the agreement of both parties. Duration of the Assignment The assignment will commence not later than on the 01.November.2006 in the field (Central Java and D.I.Y.) and must be concluded by 28 November 2006 (28 days), including preparations in Germany as well as outward and return journey Report/Result The report containing the project design including tentative implementation plan and job descriptions for local microfinance/bank experts (approx. 50 pages) and full documentation shall be submitted as MS file to GTZ-ProFI by 24.11.2006. The report will be in English (except parts of the documentation). Michael Hamp GTZ ProFI Program Advisor

Annex 2 COOPERATION AGREEMENT BETWEEN THE BPR COORDINATOR AND PT. PERMODALAN NASIONAL MADANI (PERSERO) CONCERNING REHABILITATION AND RECONSTRUCTION PROGRAM FOR BPR AND

MSE EARTHQUAKE VICTIMS IN THE REGIONS OF YOGYAKARTA AND CENTRAL JAVA

THROUGH THE APEX INSTITUTION MECHANISM

Number : /K/INS/GK/XI/06 Number : /PKS/PNM/XI/06

On this day.............., date...................., month ......................, year two thousand and six (...........-.................), we the undersigned :

I. Said Hartono, President Director of PT. Bank Perkreditan Rakyat

Gunung Kawi, in this case acting in his capacity, based on Amendment Deed to Statutes No.118 dated 7 July 1999 juncto Minutes of the Extraordinary General Shareholders Meeting of PT. Bank Perkreditan Rakyat Gunung Kawi Number: 10, dated 9 April 2005, executed before Budi Purwanto, S.H., M.Kn., Notary Public in Semarang, is hereby authorized to act for and on behalf of the Directors of PT. Bank Perkreditan Rakyat Gunung Kawi, having domicile and head office in Semarang, with the address, Jalan Imam Bonjol No. 44, Semarang, Jawa Tengah, further called : -----------------------------------

..........................................................THE FIRST PARTY

.......................................... II. Ir. Adil Tobing, M.M., President Director of PT. Permodalan Nasional

Madani (Persero), in this case acting in his capacity, based on the last deed, i.e. Shareholders Decision Statement Deed of Perusahaan Perseroan (Persero) PT. Permodalan Nasional Madani or abbreviated PT. PNM (Persero) Number: 37, dated 27 August 2004, executed before Nanda Fauz Iwan, Sarjana Hukum, Magister Kenotariatan, Notary Public in Tangerang, which deed was approved by the Minister of Justice and Human Rights of the Republic of Indonesia Number: C–27482 HT.01.04.TH.2004, and promulgated in the State Gazette of the Republic of Indonesia Number: 1085, dated 1 February 2005, is hereby authorized to act for and on behalf of the Directors of PT. Permodalan Nasional Madani (Persero), having domicile in Jakarta and address at Gedung Arthaloka Lantai 6, Jalan Jend. Sudirman Kavling 2 Jakarta 10220, further called:------------------------THE SECOND PARTY........................................

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THE FIRST PARTY AND THE SECOND PARTY (together further called ”THE PARTIES”), acting in their abovementioned capacities first of all clarify as follows: 1. Whereas THE FIRST PARTY is a Bank Perkreditan Rakyat with one of its

activities is to provide banking services among others financing facilities for the public.

2. Whereas THE SECOND PARTY is a State Owned Enterprise or Badan Usaha

Milik Negara (BUMN) with activities in the economic and general national development sectors, particularly in the empowerment and development of micro, small, and medium enterprises and cooperatives; among others having actively participated in the formation of Lembaga Dana Apex Bank Perkreditan Rakyat (LEMBAGA APEX BPR) or also called Lembaga Apex BPR.

3. Whereas in the framework of strengthening LEMBAGA APEX BPR functions, it

has been included but not limited to the Rehabilitation and Reconstruction Program for BPR and MSE Earthquake Victims in Yogyakarta and Central Java through the Apex mechanism, hence THE PARTIES intend to enter into a Cooperation Agreement within the regional scope of THE FIRST PARTY through the utilization of a special loan to be granted by THE SECOND PARTY with source of funds originating from GTZ ProFI.

Based on the above, THE PARTIES agree and approve to enter into a Cooperation Agreement concerning the Rehabilitation and Reconstruction Program for BPR and MSME Earthquake Victims in Yogyakarta and Central Java through the mechanism of Lembaga Apex (further called AGREEMENT), with provisions and requirements as follows:

Article 1

DEFINITION

Except otherwise stated in this AGREEMENT, the undermentioned words and terminology have the following meaning : 1. Bank Perkreditan Rakyat (BPR) refers to a bank as mentioned in Act No.7 of

1992 concerning Banking as subesequently revised by Act No.10 of 1998 (Banking Act) which will become a LDA BPR member.

2. Micro and Small Enterprise (MSE) is defined as follows :

a) Micro Enterprise refers to a micro scale people’s economic activity that fulfills the networth or annual sales proceeds and ownership criteria regulated in the Finance Ministerial Decree Number 12/PMK.06/2005 concerning Funding of Credits to Micro and Small Enterprise.

b) Small Enterprise refers to a small scale prople’s economic activity that

fulfills the networth or annual sales proceeds and ownership criteria regulated in Act No.9 of 1995 concerning Small Business.

3. Lembaga Dana Apex BPR (LEMBAGA APEX BPR) refers to an institution that

implements Apex functions, comprising BPR members of THE FIRST PARTY with similar interests in the framework of maintaining liquidity particularly in dealing with mismatch conditions and interlending.

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4. BPR Apex Pilot Project refers to LEMBAGA APEX BPR with implementation in

the regions of Central Java and Yogyakarta. 5. GTZ ProFI refers to an international cooperation agency for sustainable

development with worldwide operations. ProFI refers to a mutual program implemented under the auspices of Bank Indonesia, the Ministry of Finance and GTZ representing the German Government.

6. BPR Coordinator of LEMBAGA APEX BPR refers to a BPR as Perbarindo

member subject to the fulfillment of requirements and election by LEMBAGA APEX BPR members and willing to act as a Coordinator for LEMBAGA APEX BPR and recommended / agreed upon as working partner by THE SECOND PARTY after having consulted the local Bank Indonesia office.

7. A LEMBAGA APEX BPR member BPR refers to a BPR as Perbarindo member

that has already registered and fulfilled the requirements for becoming a LDA participant.

8. A LEMBAGA APEX BPR non-member BPR refers to a BPR as Perbarindo

member that has not yet joined LEMBAGA APEX BPR as a participant but needs LEMBAGA APEX BPR services in the event of mismatch conditions and interlending.

9. Operational Manual and Standard Operating Procedure (SOP) refer to

implementing provisions as Annexes to this AGREEMENT and constitute working guidelines for THE PARTIES in connection with program implementation, as an inseparable unity of this AGREEMENT.

10. LEMBAGA APEX BPR Implementing Unit refers to a working unit within the legal

entity scope of BPR Coordinator for LEMBAGA APEX BPR responsible for executing APEX BPR functions and providing services to LDA BPR members. This Unit is under the leadership of LEMBAGA APEX BPR Unit Leader supervising Analysis and Operational Staff, human resources that for the first time are recommended and determined by THE SECOND PARTY and jointly determined by the Head of DPD PERBARINDO of Central Java and the Director of LDA BPR Coordinator, after that its Unit Leader and staff are appointed and nominated by a Joint Committee based on a recommendation from THE SECOND PARTY.

11. LEMBAGA APEX BPR Joint Committee refers to a committee comprising 3

(three) persons as follows : Head of DPD PERBARINDO of Central Java as the Committee Leader, Branch Office Manager of THE SECOND PARTY, and the BPR Coordinator Director of LEMBAGA APEX BPR as Committee Members. Its task is to make decisions in connection with APEX functions insofar in line with the prevailing laws and regulations. The Joint Committee is responsible to the LDA General Members Meeting.

12. LEMBAGA APEX BPR Monitoring and Evaluation Team refers to a team

comprising 3 (three) persons as follows: one representative from THE SECOND PARTY’s Head Office as Team Leader, one representative from PERBARINDO and one representative from Dewan Pimpinan Pusat (DPP) PERBARINDO as Team members. Its task is to monitor and evaluate implementation of the LEMBAGA APEX BPR Pilot Project in order to keep in line with the prevailing regulations. THE SECOND PARTY, PERBARINDO and DPP PERBARINDO for

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the first time appoint their respective representatives as team members. The Monitoring and Evaluation Team is responsible to the LDA General Members Meeting.

13. LEMBAGA APEX BPR General Members Meeting refers to a general meeting

which at a minimum is held once in 1 (one) year, and for the first phase can be organized in line with the LEMBAGA APEX BPR Pilot Project period.

14. A Funds Mismatch refers to the following conditions :

a) A BPR is experiencing a non-structural financial liquidity problem which does not affect other Bank Soundness Level or Tingkat Kesehatan Bank (TKS) assessment aspects.

b) To overcome temporary liquidity funds problems including but not limited to liquidity problems which will cause a decline in Cash Ratio to the BPR.

c) No intentional elements found based on analysis result by the Joint Committee.

15. LEMBAGA APEX BPR Source of Funds refers to savings from members

comprising Principal Savings, and Voluntary Savings in line with mutual agreements and prevailing regulations.

16. Principal Saving refers to saving from a Member of LEMBAGA APEX BPR

deposited at the beginning of membership, amounting to Rp20,000,000.- (twenty million rupiah) and placed in the form of Saving and or Time Deposit at the BPR Coordinator of LEMBAGA APEX BPR or at the Settlement Bank.

17. Voluntary Saving refers to saving placed by a Member of LEMBAGA APEX BPR

during its participation in LDA, whereas the volume of funds is in line with an agreement concluded with LEMBAGA APEX BPR and placed in the form of Saving and or Time Deposit at the BPR Coordinator of LEMBAGA APEX BPR or at the Settlement Bank.

18. LEMBAGA APEX BPR Utilization of Funds refers to funds invested by LEMBAGA

APEX BPR in the form of Mismatch Funds Facilities, Financing Facilities, Time Deposit Placements, and others insofar in line with the prevailing regulations.

19. LEMBAGA APEX BPR Mismatch Funds Facility refers to placement of a time

deposit from the BPR Coordinator of LEMBAGA APEX BPR at a member BPR of LEMBAGA APEX BPR to meet requirement for mismatch funds of the member BPR concerned as regulated in the Procedure Manual.

20. LEMBAGA APEX BPR Financing Facility (Interlending) refers to a loan granted to

a Member or Non-member of LEMBAGA APEX BPR which has already fulfilled feasibility terms and financing provisions.

21. Working Capital Financing refers to financing of working capital from LEMBAGA

APEX BPR to a Non-member BPR in line with prevailing laws and regulations. 22. Special Loan (SL) refers to a financing product from THE SECOND PARTY to

THE FIRST PARTY in a specific form (including but not limited to financing nominal amount, period, interest rate, objective) and channeled in line with prevailing regulations.

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23. Financing of Earthquake Resistant Simple Houses or Pembiayaan Rumah Sederhana Tahan Gempa (RSTG) refers to financing from BPR Member of LEMBAGA APEX BPR in the regions affected by the earthquake for the earthquake victims to build earthquake resistant houses.

24. Financing to Groups and Productive Activities refers to financing from BPR

Member of LEMBAGA APEX BPR in the regions affected by the earthquake for productive Groups and Micro, Small Business Activities.

25. Interest Income refers to a certain sum or percentage as profit margin obtained

by LEMBAGA APEX BPR derived from providing liquidity funds placement facilities or working capital financing for BPR Members and Non-Members of LEMBAGA APEX BPR .

26. Interest Expense refers to a certain sum or percentage representing cost spent

by LEMBAGA APEX BPR for Principal and Voluntary Savings. 27. LEMBAGA APEX BPR Financial Statements refer to financial statements of the

LEMBAGA APEX BPR Implementing Unit which is produced as of the end of each month and is further consolidated into the financial statements of the BPR Coordinator for LEMBAGA APEX BPR and reported to Bank Indonesia in the form of Monthly Reports.

28. LEMBAGA APEX BPR Profit Sharing refers to profit sharing amounts based on

each respective proportion of THE PARTIES including all LDA Members, that may happen if income obtained by LEMBAGA APEX BPR is in excess of costs spent by LEMBAGA APEX BPR (including but not limited to operational costs, provisioning against losses, insurance fees, interest expenses and taxes) in line with prevailing provisions in the BPR industry.

29. LEMBAGA APEX BPR Loss refers to a situation when expenditure including but

not limited to operational costs, provisioning against losses, insurance fees, interest expenses and taxes, is larger than LDA income, to be borne together by BPR Members of LEMBAGA APEX BPR based on agreement.

30. Collateral refers to assets owned by BPR Members of LEMBAGA APEX BPR or

Non-members which are surrendered to the BPR Coordinator for LEMBAGA APEX BPR in connection with funding facilities received by BPR Members of LEMBAGA APEX BPR or BPR Non-members of LDA.

31. Management Contract refers to a cooperation contract between THE PARTIES in

the form of Technical Assistance from THE SECOND PARTY to THE FIRST PARTY, particularly LEMBAGA APEX BPR Implementation Unit based on LDA requirements.

Article 2 PURPOSE AND OBJECTIVE OF AGREEMENT The purpose and objective of this AGREEMENT is a cooperation between THE PARTIES for the Rehabilitation and Reconstruction Program for BPR and MSE Earthquake Victims in Yogyakarta and Central Java through the Apex Institution mechanism and its development in the framework of revitalizing businesses of the

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BPR and MSE industries based on a sound, secure and mutually profitable cooperation. Article 3 SCOPE OF AGREEMENT The scope of this AGREEMENT is among others : 1. Cooperation between THE PARTIES in the form of a Program and its

development which is based on provisions and requirements as regulated in the Operational Manual as an inseparable unity of this AGREEMENT.

2. THE FIRST PARTY shall mobilize LEMBAGA APEX BPR funds from BPR

members of LEMBAGA APEX BPR in the framework of reaching economies of scale that is sound and flourishing.

3. THE SECOND PARTY shall make available :

a. Financial Assistance in the following shape: i. A Special Loan to the Apex Institution BPR Coordinator for extending

to Member BPR affected by the earthquake, or ii. A Subordinate Loan (SOL) to the LDA BPR Coordinator.

b. Technical Assistance in the form of a Management Contract as follows :

i. Standard Operating Procedure (SOP), ii. Provision and Training of Human Resources and Production of

Information Technology Systems in the interest of LEMBAGA APEX BPR Implementing Unit,

iii. Setting up Common Products / Services, iv. Other activities deemed necessary for the smooth flow of LDA

Implementing Unit operations, which are already approved by THE PARTIES.

c. Additional functional support for Financial Assistance and Technical Assistance shall be provided by the Partner of THE SECOND PARTY which in this case is GTZ ProFI.

d. Implementation of Financial Assistance and Technical Assistance functions is regulated in the Operational Manual as an inseparable unity of this AGREEMENT.

Article 4

AGREEMENT PERIOD 1. This AGREEMENT is valid for a period of 2 (two) years as of the signing date

by THE PARTIES and is subject to extension based on agreement by THE PARTIES.

2. If the period of this AGREEMENT is extended, THE PARTIES agree to conduct

annual reviews and/or evaluation over the implementation of this AGREEMENT. 3. THE PARTIES may terminate this AGREEMENT before its expiry date, provided

that the party wishing to terminate notifies in writing to the other party at the latest 30 (thirty) days before the intended termination date of the AGREEMENT.

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4. If until the intended AGREEMENT termination date referred to in paragraph 3 of this Article, no response has been received from the notification recipient party, the party concerned is believed to have already approved and therefore this AGREEMENT will come to an end.

5. Despite the expiry or termination of this AGREEMENT, THE PARTIES are still

obligated and responsible to settle liabilities which arise and not yet put into effect during the validity and on expiry or termination date of this AGREEMENT.

6. For the purpose of ending this AGREEMENT, THE PARTIES agree to disregard

the provisions stipulated in Article 1266 and Article 1267 of the Indonesian Civil Code.

Article 5

RIGHTS AND OBLIGATIONS OF THE PARTIES 1. Rights of THE PARTIES

a. THE FIRST PARTY is entitled to : 1) Find out about the financial condition and performance of LDA BPR

members. 2) Receive fees for managing LEMBAGA APEX BPR 3) Obtain financial assistance and technical assistance from THE SECOND

PARTY. 4) Receive repayment of collateral sales proceeds from loss member BPR. 5) Become a member of the LEMBAGA APEX BPR Joint Committee.

b. THE SECOND PARTY is entitled to :

1) Find out about the financial condition and performance of the BPR Coordinator for LEMBAGA APEX BPR and LDA BPR Members.

2) Recommend the names of potential BPR Coordinators for LEMBAGA APEX BPR and conduct selection and evaluation for determining the LDA BPR Coordinator.

3) Receive fees for managing LEMBAGA APEX BPR 4) Receive interest compensation in the framework of providing Financial

Assistance and fees in the framework of providing Technical Assistance in line with agreement from THE PARTIES.

5) Receive assistance and cooperation from PERBARINDO in the framework of providing Financial Assistance and Technical Assistance to THE FIRST PARTY.

6) Become a Member of the Joint Committee and the Monitoring and Evaluation Team of LEMBAGA APEX BPR.

2. Obligations of THE PARTIES

a. THE FIRST PARTY has the following obligations : 1) THE FIRST PARTY shall establish a LEMBAGA APEX BPR

Implementing Unit for receiving and managing funds received from the

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members in a secured and profitable instrument not in violation of prevailing regulations.

2) THE FIRST PARTY is obligated to conduct meticulous evaluation on the condition of BPR Members of LEMBAGA APEX BPR to determine mismatch funds facility ceilings in order to refrain from providing excess/lack of facilities.

3) THE FIRST PARTY shall analyze applications for mismatch funds and working capital financing facilities submitted by LDA BPR Members.

4) THE FIRST PARTY together with the Joint Committee Members of LEMBAGA APEX BPR shall make decisions to reject or approve loan applications from LDA BPR Members.

5) If the financing application is rejected, THE FIRST PARTY is obligated to notify the rejection in writing to the Member BPR along with the reasons for rejection.

6) THE FIRST PARTY is obligated to examine, make sure and be responsible for the authenticity and legitimacy of all documents including collateral documents associated with the provision of LDA funding facilities. If it turned out that the data mentioned in the documents were false, THE FIRST PARTY shall be fully responsible for all consequences and losses that may arise and which shall become the burden of THE FIRST PARTY.

7) If a BPR member/non-member of LEMBAGA APEX BPR which has obtained a funding facility from LEMBAGA APEX BPR is in arrears with principal and or interest, the overdue payments shall become the responsibility of THE FIRST PARTY, and PERBARINDO may be requested to provide assistance in demanding loan repayment from the BPR member/non-member of LEMBAGA APEX BPR.

b. THE SECOND PARTY has the following obligations :

1) In its capacity as a Joint Committee Member of LEMBAGA APEX BPR to make Decisions either to approve or to reject Funding facility applications.

2) Channel financial loans with source of funds originating from GTZ Profi in line with financing feasibility and prudential principles determined by THE SECOND PARTY. Financial support in the form of : a. Special financing funds / working capital support at 2% p.a. interest

for a period of 2 (two) years and subject to extensions. b. Subordinate Loan (SOL) support to the BPR Coordinator of

LEMBAGA APEX BPR and BPR members of LEMBAGA APEX BPR that need it insofar in line with prevailing regulations and approval from Bank Indonesia.

3) Together with GTZ ProFi provide technical assistance to the BPR

Coordinator, among others in the form of provision and training of human resources, provision of facilities, information technology, operational systems and procedures, BPR ratings etc., and creation of common products/services for enhancing cooperation among LDA Members.

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Article 6

TASKS AND AUTHORITY OF LDA IMPLEMENTATION UNIT, JOINT COMMITTEE AND MONITORING & EVALUATION TEAM OF LEMBAGA APEX BPR

1. The Tasks and Authority of LEMBAGA APEX BPR Implementation Unit are as

follows : a. Produce management business plans for LEMBAGA APEX BPR

Implementation Unit at the LDA BPR Coordinator, b. Undertake evaluation over Financial Statements of LDA BPR Members, c. Manage funds placement for LEMBAGA APEX BPR in line with prevailing

investment policies based on prudential principles, d. Examine feasibility of BPR Members of LEMBAGA APEX BPR and the

expectation of funds needed, e. Prepare funding facility proposals (mismatch / working capital), f. Examine and sign documents / letters associated with internal and external

parties of LEMBAGA APEX BPR in line with its authority, g. Monitor Joint Committee decisions for follow-up, h. Process implementation of follow-up decisions in line with the Operational

Manual and SOP and notify its results to LDA BPR Members, i. Submit Performance Reports and monthly monitoring results to the Joint

Committee and the Monitoring and Evaluation Team, j. Responsible to the Joint Committee for all implementation aspects of

LEMBAGA APEX BPR comprising activity aspects as follows : • Funding facility application process • Funding facility approval process • Funds inflow and outflow process • Funds (investment) management process • Installment of principal and interest payment process • Administration process • Repayment process • Monitoring process

2. The Tasks and Authority of LEMBAGA APEX BPR Joint Committee are as

follows : a. Conduct committee members joint assessments over proposals for Funding

Facilities (Joint Committee memorandum) submitted by the LDA Implementation Unit.

b. Provide approval or refusal of mismatch funds and working capital facilities ini line with the Operations Manual and SOP,

c. Examine and sign documents / letters associated with internal and external parties of the Joint Committee in line with its authority,

d. Identify problems arising from all LEMBAGA APEX BPR operational activities and determine solution methods,

e. Determine internal policies within the Joint Committee environment, f. Provide input, opinions, ideas, basic concepts to enable improvement of LDA

working Systems and Procedures,

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g. Review and approve LEMBAGA APEX BPR business plans proposed by LEMBAGA APEX BPR Unit for onforwarding to the LDA Monitoring and Evaluation Team,

h. Submit written monthly and annual reports to the Monitoring and Evaluation Team of LEMBAGA APEX BPR regarding targets already achieved,

i. Organize regular / special weekly and monthly meetings with all Joint Committee members for supporting smooth work flow of the Joint Committee,

j. Organize LDA General Members Meetings, k. Responsible to the LEMBAGA APEX BPR General Members Meeting for

generating Joint Committee’s performance.

3. The Tasks and Authority of LEMBAGA APEX BPR Monitoring and Evaluation Team are as follows : a. Examine and evaluate financing proposals periodically determined by the Joint

Committee, b. At any time examine documents / letters already issued by the LEMBAGA

APEX BPR Implementation Unit and Joint Committee, c. Monitor realization of LDA Management Business Plans, d. Assist the LEMBAGA APEX BPR Joint Committee and Implementation Unit

in providing input related to LDA operational policies, e. Verify and recommend operational performance including funds management

improprieties by the BPR Coordinator for LEMBAGA APEX BPR which resulted in losses,

f. Organize periodic meetings with all LDA related parties, g. Responsible to the LEMBAGA APEX BPR General Members Meeting for its

monitoring and evaluation results.

Article 7

LDA GENERAL MEMBERS MEETING 1. A LEMBAGA APEX BPR General Members Meeting is declared valid if

attended by the Joint Committee and at least 2/3 of LEMBAGA APEX BPR members,

2. A Resolution of LEMBAGA APEX BPR General Members Meeting is declared

legal if approved by a minimum of 50%+1 meeting participants present, 3. The LEMBAGA APEX BPR General Members Meeting is held :

a. By the Joint Committee, b. At the region of LDA activity location, c. By sending out invitations from the Joint Committee to all BPR members

of LEMBAGA APEX BPR at the latest one week before an implementation of LDA General Members Meeting.

4. During the LEMBAGA APEX BPR General Members Meeting :

a. The Joint Committee presents a LDA Annual Financial Accountability Report.

b. The Joint Committee presents an Annual Operations Performance Report. c. Resolution on the volume of LDA profit sharing or loss sharing. d. Resolution on other points in line with the prevailing regulations.

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Article 8 FUNDING POLICIES 1. Policies concerning Receipt of Funds

Shall be periodically specified and stipulated by the Joint Committee based on mutual needs and agreements for the benefit of members as large as possible. The specification and stipulation shall be mentioned in the Operational Manual and SOP as an inseparable unity of this AGREEMENT.

2. Policies concerning Investment of Funds

Shall be periodically specified and stipulated by the Joint Committee based on mutual needs and agreements for the benefit of members as large as possible. The specification and stipulation shall be mentioned in the Operational Manual and SOP as an inseparable unity of this AGREEMENT.

Article 9 MANAGEMENT OF LEMBAGA APEX BPR FUNDS

1. Provisions related to mobilization of funds for LEMBAGA APEX BPR and

utilization of LEMBAGA APEX BPR funds are regulated in the Operational Manual and SOP as an inseparable unity of this AGREEMENT.

2. LEMBAGA APEX BPR shall charge interest on mobilization of funds and provision of funding facilities, which is subject to the following provisions : a. Interest rates are reviewed at the latest once in every 6 (six) months

based on market conditions. b. Obeying the Operational Manual and SOP as an inseparable unity of

this AGREEMENT. 3. Fees and administration charges are applied for funding facilities extended to BPR

members/non-members of LEMBAGA APEX BPR, in line with the provisions mentioned in the Operational Manual and SOP as an inseparable unity of this AGREEMENT.

4. Taxes and other charges arising from this AGREEMENT shall abide by prevailing

regulations.

Article 10

NOTIFICATION

1. All correspondence or notifications that should be sent by each respective party to other parties in this AGREEMENT regarding or in connection with this AGREEMENT shall be done by facsimile, registered mail or intrenal/external couriers to the undermentioned addresses :

a. THE FIRST PARTY

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PT. Bank Perkreditan Rakyat Gunung Kawi Jl. Imam Bonjol No.44 Semarang Jawa Tengah Telp (024) 3553682 Faks (024) 3546836

b. THE SECOND PARTY PT. Permodalan Nasional Madani (Persero) Kantor Cabang Semarang Graha HSBC lantai 5 Jl. Gajah Mada no. 135 Semarang 50134 Jawa Tengah Telp. (024) 8453975-77 Faks. (024) 8453978

2. In line with the agreement reached by THE PARTIES, it has been determined

that the Office of LEMBAGA APEX BPR of Central Java is situated at the premises of THE FIRST PARTY, and the Office of THE SECOND PARTY has the following correspondence address :

PT. Bank Perkreditan Rakyat

Gunung Kawi Jl. Imam Bonjol No.44 Semarang Jawa Tengah Telp (024) 3553682 Faks (024) 3546836

PT. Permodalan Nasional Madani (Persero)

Kantor Cabang Semarang Graha HSBC lantai 5

Jl. Gajah Mada No. 135 Semarang 50134

Jawa Tengah Telp. (024) 8453975-77

Faks. (024) 8453978

3. If there is any change to the addresses and or last addresses known to each

respective party, the party wishing to change address has the obligation to notify in writing to the other party in this agreement within a period of 7 (seven) working days at the latest before the address change becomes effective. If no notification has been made, all correspondence or notifications and or requests based on this AGREEMENT are considered having already been sent out as was to be expected, by registered mail or internal/external couriers to the abovementioned addresses or last addresses known to each respective party.

4. All correspondence, notifications and or communication to the

abovementioned addresses are considered as having already been received under the following circumstances :

a. On the same day if hand-delivered as confirmed by the recipient’s signature on

the letter delivery register or another receipt issued by the sender. b. On the fifth day, if the notification is sent by mail as confirmed by the

registered mail delivery receipt.

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c. On the same day, if sent through facsimile with good result.

Pasal 11 STATEMENT AND PLEDGE

1. THE PARTIES promise to carry out all provisions regulated in this

AGREEMENT along with its Operational Manual as best as possible and with full responsibility.

2. THE PARTIES agree and concur that all information and explanation both

written and not written and other information obtained from one of the parties associated with businesses, products, services and data found out or arising based on this AGREEMENT should be treated confidential and not be divulged to PERBARINDO or any irrelevant entity/person with whatsoever reasons during and after the expiry of this AGREEMENT, except :

a. Towards Bank Indonesia and Government Agencies that have the authority to

regulate and issue licenses concerning matters to be agreed upon in this AGREEMENT;

b. By court ruling or by another government agency instruction in connection with written or official law enforcement;

c. Based on prevailing laws and regulations in Indonesia, the information should be provided to another party that is clearly mentioned in the laws and regulations;

d. Already mutually agreed and not of confidential nature.

3. Any violation against confidentiality provisions referred to in paragraph 2 of this Article, specifically concerning Bank Secrecy is subject to the Bank Secrecy provisions regulated in Act Number 7 of 1992 concerning Banking as subsequently revised by Act Number 10 of 1998 along with its operational regulations.

Article 12 TRANSFER OF RIGHTS AND OBLIGATIONS

Each respective party may not transfer any right and obligation arising from this AGREEMENT both wholly and partially to another party without written aprroval from the other party.

Article 13 FORCE MAJEURE

1. No single party shall be pronounced negligent or in violation of the contents of

this AGREEMENT if caused by a Force Majeure. 2. In this AGREEMENT, Force Majeure refers to events or circumstances beyond

human control, including but not limited to natural disasters (floods, earthquakes,

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landslides), riots, wars, epidemics, fire, economic recessions or drastic actions resulting from imposing certain government policies which have concrete and direct consequences against the implementation of this AGREEMENT.

3. In the event a Force Majeure occurs, accordingly at the first possible opportunity,

the party experiencing a Force Majeure should report right away through telephone and facsimile regarding the Force Majeure event and after that should notify in writing to the other party enclosing evidence from the police/authorized agency at the latest within 7 (seven) working days as of the date of the notification through telephone and facsimile.

4. Delay/negligence in reporting existing Force Majeure will result in disavowal of

the event as a Force Majeure by the other party. 5. All and every problem arising from a Force Majeure shall be solved by THE

PARTIES through mutual consensus.

Article 14 SETTLEMENT OF DISPUTES AND LECAL DOMICILE

1. This AGREEMENT and its implementation is regulated and interpreted in

accordance with the prevailing regulations in Indonesia. 2. All and every disparity in opinions, interpretations or disagreements that may

arise between THE PARTIES in implementation of this AGREEMENT shall be settled through mutual consensus.

3. If the mutual consensus method is not achieved, THE PARTIES agree to settle

all differences and interpretations or disagreements that have arisen through the court and for that purpose THE PARTIES choose the general and permanent legal domicile at the Registrar Office of the Central Java District Court in Semarang.

Article 15 OTHER PROVISIONS

1. THE PARTIES agree and concur that further implementation and other requirements still not regulated in this AGREEMENT be further regulated in an Operational Manual and a Standard Operating Procedure (SOP) in force and binding to THE PARTIES.

2. The Operational Manual and SOP may at any time be improved in line with developments and based on agreements of THE PARTIES.

3. If because of any change in the law or government policy/court verdict or because of whatever reason, one or more provisions of this AGREEMENT became or

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declared cancelled, invalid, not binding or could not be implemented by THE PARTIES, THE PARTIES agree to replace the provision (s) with legal provision (s), that is/are binding and implementable both from the objective and the commercial aspects of this AGREEMENT.

4. Other matters still not regulated or insufficiently regulated or in need of changes or additions in connection with the provisions and requirements in this AGREEMENT shall be negotiated together and further regulated in an addendum agreement as an inseparable unity of this AGREEMENT.

Thus is this AGREEMENT established and signed in ………………., on the day and date referred to in the beginning of this AGREEMENT, which is drawn up in triplicate with sufficient stamp duty, and each document having the same legal strength.

THE FIRST PARTY

PT. BANK PERKREDITAN RAKYAT GUNUNG KAWI

Said Hartono President Director

THE SECOND PARTY

PT. PERMODALAN NASIONAL MADANI (Persero)

Ir Adil Tobing, MM President Director

(English Draft as received on 20 November 2006)

Annex 3

Proposals for Design Elements of a Pilot Low Cost Housing Product to be Offered through BPRs in Earthquake-affected Areas Clientele

Households affected by the earthquake with (i) damage to their premises, or (ii) complete destruction of their houses. In view of the ongoing special schemes for housing finance through the state owned mortgage bank with capital provided by the Bank Indonesia, there seems to be adequate housing finance funds for earthquake victims with a fixed income through government or private sector employment. The ProFI supported Housing Finance Pilot scheme should therefore focus specifically on self-employed people, in particular those that use their residential premises as production or service locations for their micro enterprises as well. The definition of a micro enterprise should follow the specifications for Indonesia as contained in the main report. Character and capacity of the prospective borrower are subject to the usual credit appraisal procedures that would be calculated for the entire household and include income contributions from all adult members of the household rather than from the micro enterprise activity alone. In view of the limited available amounts for funding, the prospective borrowers / earthquake victims should be located no farther than 10 kilometres away from a branch or unit office of a participating BPR. Product Design Parameters

Tenor: Sub-borrowers would benefit from a grace period of between 12 to 24 months before commencing principal loan repayment. Interest has to be serviced through three quarterly instalments. Sub-borrowers preferring not to have a grace period for principal loan repayment should receive the housing finance loans as well and without prejudice or maximum quotas. The rationale of the grace period is to support earthquake victims with liquidity when they require it most i.a., immediately and in the first stages of loan repayment. Instalment Design in Equal Monthly Instalments (EMI): The loan repayment period after the initial moratorium on principal repayment would be calculated in equal monthly instalments (including principal and interest). Please note the difference between EMI product design and the flat rate charging of interest rates which is not intended in this pilot activity.

2

Interest Calculation Based on Monthly Reduction of Principal: In housing finance a practice which mixes interest charges on the reducing balance and flat rate charging is common worldwide, the so called “rest”. A six to 12 monthly rest which is the norm in many Asian countries would mean that the interest charge for the underlying principal would not be reduced in line with the monthly repayment, but only once every six months, or – in the case of the 12 monthly rest – even only once in a year. While the interest reduction should transparently reduce in line with increased principal repayments, the domestic mortgage banking consultant would have to determine loan amortisation schedules in line with prevailing legal and banking practice in Indonesia. Hypothecation of the Underlying Real Estate Asset: This is a standard practice and the specific details of mortgaging would have to be designed by a domestic housing finance specialist, possibly even extending to housing finance for extension and repair. In-kind Disbursement: In some countries, the loan amounts are paid directly to the suppliers of house construction materials. The obvious pros and cons of these arrangements would have to be assessed, as well as the comparatively new practice of Equity Participation: Should be waived for earthquake victims, in particular if assets can be easily hypothecated. Appraisal Pointers

Credit and Depositing History: A credit applicant who is known to the participating BPR as a depositor or possibly an earlier borrower should be assessed also with regard to the existing data on credit and depositing history. No Credit Scoring: In view of the emphasis on dynamic loan appraisal parameters, the increasing practice of mortgage finance institutions to develop credit scoring models similar to retail and consumer loans products, should not be promoted in this specific pilot. Parameters for Group-based Low-cost Housing Finance Arrangements: Specific institutional and group based arrangements that characterise new and innovative low cost housing finance schemes in Asia are beyond the scope of this assignment. It should only be pointed out that the appraisal in these schemes should not be limited to the direct borrower alone, but to the group (even though the credit contracts are designed with individuals within the group) and also to the possible institutional intermediary, be it an NGO or an individual group leader that reports directly to the lending bank. Ownership certificates: The situation varies widely between the different earthquake affected districts and provinces. Field visits in Yogyakarta and Central Java provinces showed that workable formal collateral substitutes either exist (leasehold certificates issued by the Sultan´s office in affected areas in Klaten) or can be produced with the help of the village head who can certify past use of a public land plot in question by a loan applicant.

3

Disbursements Depending on the prevailing situation regarding extra commissions to contractors, in kind disbursement may or may not be encouraged. In general , a situation where a borrower under the pilot scheme is tied to only one supplier should be avoided and specifically in case of in-kind disbursements, a minimum choice of two suppliers should always be accessible to the borrower. Disbursements should be direct and without an institutional intermediary involved. Recoveries

EMIs directly to the bank: Equal monthly instalments should be serviced by borrowers directly to the lending bank. Even where intermediary organisations and NGOs are involved, the credit contract is between the individual borrower and the bank and the comparatively tight catchment area stipulated above will permit direct repayment by borrowers and thus reduce commissions and the security concerns involved by exposing cash in transit. Possible Government Grants to be Used for Loan Pre-payments: Earthquake victims with total or partial loss of houses are still awaiting government grants and hand-outs. As detailed in the main body of this report, these may still be forthcoming. A borrower under this pilot scheme should not lose eligibility for the government grants, and should one time grant pay-outs be received, then they should be transferred directly to the loan account in the BPR without pre-payment penalties.