By Sahil Sondhi, Jakarta Globe -

When Nobel laureate Muhammad Yunus was first exposed to microfinance in East Java he could not have predicted that he would go on to spark a revolution in commercializing microfinance.

Microfinance improves the lives of the poor in a variety of ways. It provides access to savings and loan services that are fundamental to the expansion, diversification and enrichment of economic life.

And with the accompanying rise in incomes, nutrition, access to health care, education and housing all improve as well. And with any luck, microfinance users eventually transcend poverty and emerge as new members of the mainstream economy.

Most of the world’s early microfinance programs were supported by donors and were carried out by nonprofits. As the scale and scope of activities expanded, it became imperative for commercialization and institutionalization to occur.

This is due to several factors. First, many microfinance institutions (MFIs) were becoming too large and profitable for their nonprofit roots and the donor community would inevitably stop funding them.

At the same time, MFIs were realizing that getting bigger necessitated funding and options that were not available in the nonprofit sector. Access to mainstream capital markets would be essential.

Similarly, the nonprofit incorporation of these institutions precluded them from distributing their profits to shareholders and, in turn, from becoming serious investment options for capital markets.

Indeed, many of the most successful and prominent MFIs encountered this reality during their evolution. Bolivia’s highly regarded BancoSol began as a nonprofit in 1986 and switched to the legal and financial structure of a commercial bank in 1992.

Similarly, India’s largest MFIs, including SKS, Spandana, Share and Bandhan, all underwent the same transition. When the need for the shift became clear, the MFIs began to construct and employ models that were commercially self-sustainable.

A notable shift has taken place, from microfinance being discussed as a new and innovative poverty-alleviation strategy to a new and innovative profitable venture.

As a result, the mainstream finance industry has shown increasing interest in large-scale commercial microfinance.

When the Accion microfinance network invested $1 million in Banco Compartamos, for example, the increase in value to $300 million was a watershed event.

Today, equity has poured into the microfinance industry from the gamut of mainstream finance, including from such entities as the International Finance Corporation, Standard Chartered Bank and even Temasek Holdings, Singapore’s sovereign wealth fund.

Indonesia has a special place in the history of commercial microfinance. The world’s first commercial microfinance venture was practiced by the former Bank Dagang Bali before spreading to East Java and subsequently to the world.

Additionally, Indonesia was the first country where several crucial elements of today’s commercial forms were employed on a national scale: outreach, methodology of loans and savings, high microloan repayment rates and institutional and financial self-sustainability.

And yet today’s global commercial microfinance industry has surged ahead of Indonesia’s, far outstripping the world’s fourth most populous country in terms of outreach, scale, market penetration and rate of growth.

In fact, the recent Forbes list of 50 Top Microfinance Institutions did not include a single Indonesian name, which is especially disappointing given the moderate estimates suggesting the existence of more than 100 million potential microcredit clients across the archipelago.

While Bank Rakyat Indonesia is world-renowned and commonly cited as being the largest MFI, boasting 30 million clients and serviced by more than 4,000 branches, only 10 percent of its clients are active borrowers, making BRI a much smaller microlender than the world-class MFIs with which it is often compared.

Furthermore, even as the commercialization of microfinance has taken place in Indonesia, competitive pressure and efficiency in the market remain low.

BRI is still majority state-owned and has monopolistic power, holding about two-thirds of the savings and 40 percent of the loans in the microfinance sector.

BRI’s microfinance units also alienate the majority of potential microcredit clients by restricting the provision of credit to borrowers with fixed income or collateral.

Moreover, BRI’s dominance has often rendered it a price-maker and has made it expensive for the industry to mobilize deposits and provide demand-driven and cost-effective financial services to the poor.

One of the notable aspects of the potential of microfinance in Indonesia is the high proportion of economically active people among the country’s large impoverished population.

Yet even with some of the world’s most fertile soil, favorable climate conditions and an abundance of natural resources, the capacity of Indonesia’s productive poor segment remains largely untapped.

It is conventional wisdom that poverty is best tackled through the provision of institutional financial services.

This is not to say that commercial microfinance alone is sufficient. While microfinance can empower certain segments of the poor it is not a poverty cure-all.

The argument holds that charitable funds are limited and would be better spent on the extremely poor, leaving commercial MFIs to channel mainstream finance to the more productive poor.

Nonetheless, commercialization can deliver financial services to those demanding it.

In Indonesia there is ample evidence of unfulfilled demand — an Asian Development Bank study in villages across five provinces surveyed 120 rural households with an equal mix of non-poor, poor and extremely poor and found that half of them did not have a savings account and more than 60 percent had no access at all to institutional credit.

That this demand remains largely unfulfilled is partially attributable to an overwhelming lack of interest on the part of policy makers and of the finance industry as a whole.

The majority of MFIs are plagued by poor performance, which stems from a combination of lack of expertise, poor practices, a prohibitive supervisory and regulatory environment, and a serious shortage of skilled managers and specialists.

An ADB report on the commercialization of microfinance in Indonesia reveals several deficiencies: government-subsidized programs providing cheap credit impede commercial microfinance initiatives from gaining traction; there is no credit bureau to manage and share data; and there is no centralized local institution providing microfinance training of international best practices and principles.

What is needed is a strategy to address these deficiencies. Such a strategy could borrow from international successes, such as the Indian Task Force on Supportive Policy and Regulatory Framework for Microfinance, which acted as a centralized national policy framework for Indian microfinance.

Factors that were studied by the task force included organizational and regulatory issues, inter-institutional coordination, independent legislation for microfinance and support mechanisms for emerging MFIs.

An Indonesian version of such a task force must also include public education on the genuine impact of microfinance so that public perceptions can be matched with the experience of practitioners.

The proposed strategy can only work through the cooperation between the three pillars of government, private sector and civil society.

More collaboration is required between practitioners, policy makers, central banks, finance ministries, development agencies, knowledge networks and donors if Indonesia’s microfinance industry is to fulfill its promise.

Muhammad Yunus witnessed the vast potential for microfinance in Indonesia, learned the tools of the trade and polished them to create his esteemed Grameen Bank.

It is time for Indonesia to make an earnest effort toward realizing the potential of microfinance that it introduced to the world.

Sahil Sondhi is an associate consultant at Strategic Asia, a Jakarta-based consultancy promoting cooperation among Asian countries. He can be contacted at sahil.sondhi@strategic-asia.com.