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1.

German Technical Cooperation (GTZ)

Reconstruction and Development of the Microfinance System

in Nanggroe Aceh Darussalam (NAD), Indonesia

Cooperative Outreach Component:

Report on Preparations

for the Establishment of Pilot Savings & Credit Cooperatives (BQs)

in the Districts of Aceh Utara and Bireun

by Hans Dieter Seibel

December 2005

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Economic Recovery and Microfinance in NAD, Indonesia

Project brief: The microfinance component

From relief to rehabilitation and reconstruction. The Tsunami flood disaster of December 2004 and the earthquake preceding it caused unseen devastation among people and infrastructure in Nanggroeh Aceh Darussalam (NAD). They also led to widespread destruction of financial and other institutions, already weakened by decades of conflict. As most relief actions are coming to an end, the emphasis is now shifting to sustainable rehabilitation and reconstruction. Financial institutions will have a crucial role to play, expanding services to those 80% of the population beyond the reach of banks. Bank Indonesia (BI) and GTZ as partners in microfinance. In June 2005 an appraisal mission prepared a technical assistance project with a focus on microfinance including microbanking. The project is geared to the rehabilitation of rural banks (BPR/S) and the reconstruction and development of non-bank microfinance institutions (MFIs), particularly Islamic savings and credit cooperatives (Baitul Quirad, BQ). BI is the legal partner of GTZ. Implementing partners include the rehabilitation and reconstruction agency BRR, the cooperative agency Dinas Koperasi and PNM, the former small credit division of BI.

Strengthening the microfinance sector in Aceh. GTZ supports BI in strategies of developing the microfinance sector and in donor coordination. Upon the request of BRR GTZ has organized the mapping of MFIs throughout the province as a basis for the activities of all stakeholders. In this context GTZ, in cooperation with PNM, has also carried out an assessment of those 73 financial cooperatives which were recently recapitalized by BRR. To alleviate the severe shortage of qualified personnel, GTZ is considering to support Syiah Kuala University in Banda Aceh in establishing a microfinance training program.

The rural banking component. The main emphasis is on the strengthening of five private rural banks (BPR/S) in Banda Aceh and Aceh Besar and the establishment of a new BPR/S in Aceh Utara. Among the project inputs are the rating of rural banks in cooperation with Mercy Corps; a business planning workshop; designing and introducing a new cash-flow lending product, using resources from the BPR and from Allianz AG; on-the-job training of loan officers in the new product; and the strengthening of Perbarindo, an association of BPR.

The cooperative component. Together with its partners GTZ has prepared a strategy for establishing sustainable savings and credit cooperatives (Baitul Quird, BQ) following Islamic financial principles and a support structure of secondary cooperatives (BQ Centers). GTZ’s support will focus on 15 new BQs and a BQ Center at the east coast and on strengthening the existing BQ Center in Banda Aceh. In cooperation with PNM GTZ has helped establishing two new BQs, one in Muaru Batu in Aceh Utara and one in Jeunib, Bireuen. In July 2006 PNM and GTZ took initiatives to establish BQs in Seneddon, Tanah Pasir and Lhoksukon. To increase its effectiveness, GTZ integrates the contributions of several German organizations into its approach: the German Development Service (DED) provides professional inputs into the day-to-day operations of the BQs and BQ Centers; the German Raiffeisen and Cooperative Federation (DGRV) will assist in the building of a sustainable cooperative sector, with an adequate apex structure and effective supervision; CIM, a subsidiary of GTZ, will place an expert in the cooperative agency of Aceh.

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Table of contents

1. From relief to reconstruction and development: the role of microfinance 1

2. The GTZ Microfinance Project in Aceh and its cooperative component

2.1 June 2005: preparing a technical assistance project

2.2 September 2005: Identifying locations for new savings and credit cooperatives (BQ)

2.3 December 2005: Initiating two pilot BQ

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3. Establishing pilot BQs

3.1 Cooperation partners

3.2 Service providers

3.3 Initiating the establishment of two pilot BQ

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4. Towards a sustainable system of savings and credit cooperatives (BQ) in Aceh

1. Background: The Aceh Microfinance Program (AMF)

2. Cooperation between ADB and GTZ in support of the AMF Program

3. Challenges and opportunities for enhancing the BQ sector in Aceh

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1.1. From relief to reconstruction and development: the role of microfinance

The Tsunami flood disaster and the earthquake preceding it, with its epicentre off the coast of North Sumatra, caused not only unseen devastation among people and infrastructure, but also led to widespread destruction of financial and other institutions. Of all areas affected in various countries, the province of Nanggroeh Aceh Darussalam (NAD), commonly referred to as Aceh Province, suffered the most. 167,000 people died or are missing from tsunami, and 500,000 were internally displaced. Directly or indirectly, most financial institutions in the area were affected. Among them are the regional development bank (BPR) which suffered a loss of EUR 85.5m, People’s Credit Banks (BPR), commercial banks and savings and credit cooperatives. Of about 20 savings and credit cooperatives reported as functioning before the tsunami, half were simply washed away; 6,000 borrowers stopped repaying because they had become victims of the deadly waves or lost their business. This is all the more serious as the financial sector of the province has been poorly developed, due to three decades of political conflict.

As most relief actions are coming to an end within this year (2005), the emphasis is now shifting to sustainable rehabilitation and reconstruction measures. Financial institutions with adequate services to all segments of the population will have a crucial role to play. In larger towns such services are provided by the units of government-owned Bank Rakyat Indonesia which runs one of the most successful microfinance schemes in the developing world, the ailing regional development bank (BPD), a few commercial bank branches with microfinance programs and some rural banks (BPR). The majority of the population, however, perhaps as many as 70-80%, are beyond the reach of banking institutions. Here is a big potential for small financial institutions organized on the basis of self-help and self-management, particularly savings and credit cooperatives under cooperative law. The crisis has thus opened a window of opportunity: seemingly the decades-old political conflict has been settled; and there is a strong urge for reconstruction and development.

The Rehabilitation and Reconstruction Agency for Aceh and Nias (BRR) estimates that there is a potential for up to 1000 savings and credit cooperatives in 335 subdistricts of the province, ie three per subdistrict on average. It is expected that the large majority of them, if

not all, will be Islamic cooperatives, referred to in Aceh as Baitul Qirad (BQ). It is conceivable that within a time period of around five years, up to 500 BQ may be established, provided the required resources can be mobilized and the recently concluded peace accord is sustained. The reconstruction agency BRR is in the process of initiating, with the assistance of consulting firms, the establishment of 73 new BQ during 2006, to be followed by about 100 in each of the two subsequent years. As a result of the political conflict in Aceh, of 43 BQ established since 1995 only 21 were functioning in 2004; of these only 10 are left after the Tsunami. PNM, an agency carved out of the central bank in 1999 with the mandate of financial and technical assistance to small financial institutions with services to small and microenterprises, has recapitalized three BQ in 2005 through its regional office in Medan and its provincial office in Banda Aceh. PNM has also helped to establish a secondary BQ for back-up services to the BQ sector in Aceh.

2. The GTZ Microfinance Project in Aceh and its cooperative component

2.1 June 2005: preparing a technical assistance project

In June 2005 a Bank Indonesia-GTZ Appraisal Mission visited Aceh province and prepared a technical assistance project to be implemented over a period of 36 months. The objective of the proposed project is the „Rehabilitation of the BPR/BPRS (Bank Perkreditan Rakyat/Bank Perkreditan Rakyat Syariah) industry and the reconstruction and development of non-bank microfinance systems”, including savings and credit cooperatives.

Formatted: Bullets and Numbering

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2.2 September 2005: Identifying locations for new savings and credit

cooperatives (BQ)

During September 8-20, 2005, a mission was fielded to Indonesia, with the main objective of identifying locations for the establishment of new savings and credit cooperatives and preparing a plan of action for the establishment of two pilot cooperatives. The mission in Aceh province during September 12-20, 2005, was jointly carried out with PNM, the agency mandated to support institution-building of People’s Credit Banks and savings and credit cooperatives nationwide, with a provincial office in Banda Aceh. A detailed report was presented to the reconstruction agency BRR and discussed on 20 September (App. 1). A representative of UNDP was also present. Prior to the meeting the report was forwarded to PNM in Jakarta for comments. BRR and GTZ expressed their intent to coordinate procedures for the establishment of new cooperatives (BQ). For the identification of additional locations beyond the scope of the GTZ project it was suggested to follow the procedure tested in our mission and to use the rapid appraisal instrument attached in Annex 3 of the report. The desirability of coordinating the activities of GTZ with those of other donors was also discussed.

Based on field visits in five districts, 41 locations in 26 subdistricts were proposed. An additional 6 subdistricts were proposed by the Dinas Koperasi in Aceh, but not visited due to

time constraints, bringing the total to 47 locations. Out of five potential pilot locations, three

start-up locations were proposed for immediate action: Keude Mane in Aceh Utara, Keude Jeunib in Bireuen and Krueng Raya in Aceh Besar. As a special location, Pasar Lamno at the west coast in Aceh Jaya, was also proposed: one of the most severely affected areas where the need for assistance is greatest. It is there where the mission met with great enthusiasm, but cautioned that during the rainy seasons road conditions are difficult.

There is consensus in Aceh that newly established cooperatives should follow the principles of Islamic finance. Aceh uses a unique terminology for its Islamic savings and credit

cooperatives: Baitul Qirad (BQ). A summary of Principles and Products of Islamic

Finance is given in App. 2.

Note should be taken that GTZ commissioned a study of Islamic Microfinance in

Indonesia in 2004; an abstract is attached in App. 3, the chapter on Islamic savings and credit cooperatives in App. 4

1. One of the conclusions of the study was that the poor

performance of many savings and credit cooperatives in Indonesia, including those following Islamic principles, is due to the historical absence of effective supervision. In the same vein, the September 2005 mission identified an urgent need for effective supervision of savings and credit cooperatives in Aceh, presumably through PNM as the mandated government agency in cooperation with the Cooperative Agency (Dinas Koperasi).

The possibility of assisting BRR and implementing agencies in the establishment of a sustainable system of financial cooperatives in Aceh with up to 500 BQ will have to be examined in further detail.

2.3. December 2005: Initiating two pilot BQ

Based on the results of the above mentioned Identification Mission in September 2005 steps for the establishment of savings and credit cooperatives in the more remote parts of the province were to be taken. The following activities were to be initiated during the available time frame, 28 November to 17 December 2005:

Facilitating the establishment of two pilot savings and credit cooperatives (Baitul Quirad, BQ) in two locations at the east coast of Aceh Province:

o Muara Batu Subdistrict in Aceh Utara District

1 The full version can be requested from seibel@uni-koeln.de.

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o Jeunib Substrict in Bireun District Coordinating (in Jakarta and Banda Aceh) the strategy and procedure of establishing

BQs with Bank Indonesia as the national project partner, BRR as the coordinating agency in Aceh Province, the Ministry of Cooperatives and its local cooperative office as the registration authority, and PNM as the presumed implementing agency for field initiatives including capacity-building and capitalization.

Initiating the establishment of financial cooperatives in two pilot locations in cooperation with a partner agency (PNM)

Making preparations for the capitalization of pilot cooperatives Discussing preparations to be made by PNM for effective supervision

3. Establishing pilot BQs

3.1 Cooperation partners

BRR and Dinas Koperasi: In December 2005 GTZ has signed a cooperation agreement (MOU) with the Reconstruction and Rehabilitation Agency (BRR) and the cooperative agency Dinas Koperasi (Annex 1).

BRR, originally in charge of planning and monitoring only, has now taken command of the

reconstruction and development of savings and credit cooperatives, in partnership with Dinas Koperasi. Total budget allocations in 2005 (to be carried over into 2006) and 2006 amount to Rp 165bn ($16.5m), with the objective of rehabilitating or establishing a first set of 73 BQ and a second set of approx. 100 BQ until the end of 2006, to be followed by perhaps another 100 BQ during 2007. BRR has defined for itself two functions in microfinance: (1) overseeing and directing the whole microfinance sector in Aceh, including smaller NGOs, through the Aceh Microfinance Forum (AMFF); (2) rehabilitating or establishing MFIs, especially BQ, referred to by BRR as its Aceh Microfinance (AMF) program. BRR considers as its main governmental partners Dinas Koperasi and PNM; main cooperating donor agencies are ADB and GTZ as well as ILO.

BRR has prepared plans and program guidelines2 for an initial set of 73 MFI and has

selected Jasa Konsultansi for the implementation of its program. Notes of BRR’s presentation to GTZ on 29 and 30 November (Annex 3) as well as the presentation by the consulting firm (App. 5) are attached. The key element of the program, the establishment of SHG/KSM as embryo MFIs/BQ, is presented in a separate document

3; the translation into

English (by Iman Budi) is attached as Annex 4. ADB and GTZ have discussed with BRR the need to revise the strategy and focus on the establishment of new full-fledged savings and credit cooperatives in the form of BQ, instead of establishing SHGs without a legal status and with an uncertain institutional future (see below).

BRR has expressed a keen interest in an exposure visit to Germany with the objective of studying the German system of cooperative banking development and supervision. A note of intent is attached as Annex 5. Before entering into the process of establishing or revitalizing savings and credit cooperatives, BRR plans to establish a rating system. BRR is aware of the long and very successful historical experience of Germany with savings and credit cooperatives, which includes effective delegated supervision and associated performance rating. BRR requests assistance from GTZ to support a visit by a team of approx. three from BRR to Germany to examine its cooperative banking system with particular emphasis on rating and supervision. The proposed exposure visit comprises the following objectives:

2 BRR: Petunjuk Teknis. Program Rekonstruksi dan Rehabilitasi Sub Bidang Pemberdayaan UKM

melalui Lembaga Keuangan Mikro. 3 Dinas Koperasi dan PKM & BRR: Panduan Penyiapan Kelompok Swadaya Masyarakat (KSM)

Sebagai Lembaga Lokal Penguat Embrio Koperasi LKM.

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Examining the multi-tier structure of an autonomous, self-financed and self-contained sector of savings and credit cooperatives, including the services provided at each tier to the respective lower tier

Examining how supervision and rating are organized in the cooperative banking sector

Learning how supervision and rating have emerged historically before the cooperatives were brought under the banking law in 1934

Drawing conclusions for the establishment of a healthy sector of financial cooperatives in Aceh and the organization or rating and supervision.

On the basis of this visit GTZ, together with other donors, may provide technical assistance for the implementation of BRR’s program of microfinance development. The time frame proposed by BRR is “as soon as possible”, preferably during the 2

nd week of January 2006

The proposed visit is given high priority by BRR:

The result of this mission may fundamentally shape the building of Acehnese savings and credit cooperatives

BRR has to start rating cooperatives within the immediate future as a first step to cooperative restructuring and reform.

Donor coordination: GTZ has also participated in the first meeting of the Aceh Micro Finance Forum in September 2005 and in donor coordination meetings. Notes are attached as App. 9. Note should be taken of the following:

Next donor coordination meeting: Wed 18 Jan. 14:00 h at Dinas Koperasi, Banda Aceh

Coordination meeting of ADB, BRR and PNM, 16-18 Jan in Jakarta. GTZ is being asked to participate.

3.2 Service providers

Permodalan Nasional Madani, GTZ’s pilot implementation partner: PNM is considered the best service provider in the field of promoting Islamic savings and credit cooperatives. Its branch office is in Jakarta; it has a branch office in Banda Aceh. In December 2005 GTZ has signed a cooperation agreement (MOU) with PNM, a state-owned corporation (ISO 9002-certified by TÜV) with the mandate of refinancing and capacity-building of small financial institutions with services to the small, medium and microenterprise sector (Annex 2).

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that basis PNM has submitted to GTZ a proposal for the establishment of two pilot BQ , which GTZ has accepted (Annex 6). It has also agreed to submit to GTZ its copyright-

protected Standard Operational Procedure (SOP) for BMT/BQ.

Dompet Dhuafa as a potential service provider: Dompet Dhuafa is an NGO funded from Islamic sources, providing a variety of social services (such as health and education). Among them are institutional development and capacity-building services for Islamic cooperatives. Its head office is in Jakarta. It has seven branch offices and a total staff of 400. Since 2000 it has a branch office in Banda Aceh with a staff of four. It has been instrumental in establishing some 60 Islamic savings and credit cooperatives (BMT) on Java; with a concern for quality it has recently focused on six BMT. Dompet Dhuafa has provided some of the personnel to the consulting firm which has been selected by BRR for the implementation of its BQ program. Upon request Dompet Dhuafa has submitted a proposal to GTZ. The proposal, based on a sample package of 16 BQ to be established in Aceh, and a review of activities in Aceh are attached as App. 6 and 7, the budget as Annex 7.

4 While Bank Indonesia’s functions, after the financial crisis of 1997/98, were refocused on monetary

policy, its various development banking functions have been divested in various other institutions, among them PNM as a replacement for BI’s Liquidity credit program, KLBI, since June 1999.

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3.3 Initiating the establishment of two pilot BQ

Based on the visits to the respective locations and the proposal of September 2005 (see App. 1, pp. 5, 11-16, 31)

5, two initial pilot locations in areas affected by the tsunami were

selected: Muara Batu Subdistrict in Aceh Utara District; and Jeunib Substrict in Bireun

District. The team involved in the start-up activities comprised GTZ (Iman Budi, Seibel),

Dinas Koperasi Banda Aceh (Syamsurizal) and PNM Banda Aceh (Abdy Irawan).

Based on the contract with PNM (Annexes 2 and 6), PNM as GTZ’s implementation partner applies its proven and tested methodology and procedure (Standard Operating Procedures, SOP), which is now in the process of being transmitted to GTZ. The procedure as presented to the prospective founding members in the two locations is attached as App. 8 (Bahasa Indonesia) and Annex 8 (English).

A report on the procedure and results on the start-up activities in Muaru Batu is attached as Annex 9 (para 1-3). This also includes notes on visits to potential clients of the BQ (para 4). Two issues evoked particular interest during the discussion: sources of loanable funds and methods of preventing defaulting (Annex 9, p. 1).

A report on the procedure and results on the start-up activities in Jeunib is attached as Annex 10 (para 1-4). This also includes notes on GTZ Emergency Aid activities in Jeunib Subdistrict to tsunami victims as potential BQ members (para. 5). Issues that evoked particular interest during the discussion included sanctions against defaulters, life insurance as a loan protection component, autonomy and quality of management, and concern over GTZ’s promise of prividing start-up assistance.

Follow-up meetings to finalize the initial steps during the week of December 12 had to be postponed due to flooding in both locations. GTZ (Iman Budi) and PNM (Abdy Irawan) plan to visit the two areas during the last week of December.

4. Towards a sustainable system of savings and credit cooperatives (BQ) in Aceh:

challenges and opportunities

GTZ’s support to the cooperative microfinance sector in Aceh is geared to the establishment of a sustainable system. This will ultimately have to comprise three tiers: primary cooperatives owned by their members; secondary cooperatives owned by primary cooperatives with service functions to the primaries; and an upper tier with apex functions such as regulation & supervision and liquidity exchange & refinancing. Organizations exist in Aceh at the primary and secondary level, but not at the tertiary level. During an initial phase, the apex functions may be carried out by secondary organizations.

The team has visited two older BQs in Lhokseumawe serving mainly as channelling agencies for charitable program funds (Annex 11-1), a BQ in Bireun which serves as a BRR reform model (Annex 11-2), a BQ in Lambaro revitalized by PNM an serving as PNM’s reform model (Annex 12) and a secondary BQ in Banda Aceh recently established by PNM as a BQ center owned by the BQs established or revitalized by PNM. ADB participated in the visit to the BQ center and also visited other BQ. Reviewing BRR’s plans for rehabilitating and establishing savings and credit cooperatives and the cases visited. GTZ and ADB agree that they must cooperate closely in their support to BRR and Dinas Koperasi. As a first step they

jointly identified a number of challenges and opportunities for enhancing the BQ sector

in Aceh which must be met if the sector is to evolve into a sustainable system that may

5 The questionnaire, Rapid participatory appraisal of potential locations for the establishment of Baitul

Qirad/Islamic savings & credit cooperatives, may also be used by BRR and cooperating agencies for the identification of additional locations (see App. 1, pp. 26-28).

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serve as a model for reform in Indonesia. One issue needs to be highlighted which will be of crucial importance to the development of a sustainable cooperative microfinance sector:

Prudential regulation and effective supervision by an autonomous financial authority, comparable to Bank Indonesia’s role for the banking sector.

BRR realizes that the establishment of a sustainable cooperative microfinance sector is a complex task and that much may be gained from the experience of other countries, particularly Germany where cooperative banking has evolved over 150 years and now constitutes a major part of the banking sector. It is in that vein that BRR has proposed an exposure visit to the German cooperative banking sector (Annex 5).

The following presentation of challenges and opportunities6 may serve as a living document

to be updated on the basis of the experience of the cooperating governmental, private and donor agencies.

1. Background: The Aceh Microfinance Program (AMF)

Promotion of savings and credit cooperatives by BRR and Dinas Koperasi The Reconstruction and Rehabilitation Agency (BRR) and local government represented by the Office of Cooperatives and Small Enterprises (Dinas Koperasi) in the province of Nanggroe Aceh Darussalam (NAD) have jointly decided to promote access of small enterprises and the general public including Tsunami victims to financial services through microfinance institutions, with a particular focus on savings and credit cooperatives (Koperasi Simpan Pinjam, KSP). They have jointly formed a task force (SATKER), which is attached to the Dinas Koperasi.

Promotion of savings and credit cooperatives by PNM The concern for developing sustainable savings and credit cooperatives is shared by Permodalan Nasional Madani (PNM), a government-owned corporation which has taken over from Bank Indonesia the mandate of refinancing and strengthening small financial institutions with services to small enterprises.

Focus on Islamic savings and credit cooperatives (Baitul Qirad, BQ) There is agreement that the savings and credit cooperatives in Aceh should follow the principles of Islamic law (syariah). Within the specific legal and social framework of Aceh (Qanan), these cooperatives have taken their own identity and are referred to as Baitul Qirad (BQ).

2. Cooperation between ADB and GTZ in support of the AMF Program

Coordination through the Aceh Micro Finance Forum It is expected that coordinated support will lead to the rapid growth and development of a healthy and sustainable BQ sector that may serve as a model of cooperative reform. Government and donor agencies have therefore agreed to coordinate their strategies and support. One of the instruments of communication and coordination is the Aceh Micro Finance Forum (AMFF).

Cooperation between ADB and GTZ In this context ADB and GTZ have agreed that they will cooperate in their support to the BQ sector and the relevant agencies. GTZ have signed agreements with BRR and Dinas Koperasi as well as with PNM. ADB, based on its Grant Agreement with Government of

6 Prepared by Mariano Cordero (ADB), Iman Budi Utama (GTZ) and Hans Dieter Seibel (GTZ) and

submitted to BRR and PNM.

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Indonesia (GA 0002-INO), has committed consultants and resources to work with BRR. It has also signed an agreement to closely coordinate with PNM. On the basis of their examination of existing new or revitalized BQs and the broader sector of savings and credit cooperatives in Aceh, ADB and GTZ have identified a number of challenges and opportunities for enhancing the BQ sector in Aceh, which they propose to address jointly in support of BRR, Dinas Koperasi and PNM.

3. Challenges and opportunities for enhancing the BQ sector in Aceh

3.1 Establishing new BQs as single-purpose savings and credit cooperatives:

a strategy of sustainable institution-building

Focus on the establishment of new BQs Most of the existing savings and credit cooperatives or cooperative units carry with them a load of bad debts and bad habits. Their restructuring and reform exceeds the capacity of the cooperating agencies with the given human and financial resources. They may also contaminate efforts at establishing healthy new BQs. We therefore propose:

The cooperating agencies should focus on the establishment of new sustainable BQs.

An exception may be made in the case of BQs destroyed by the Tsunami, which may be revitalized (provided these were operational before the Tsunami)

BQs as single-purpose savings and credit cooperatives (KSP) BQs established by the cooperating agencies should be autonomous single-purpose financial institutions with the legal status of registered savings and credit cooperatives (Koperasi Simpan Pinjam, KSP). Cooperative units (USP) which are only units of larger “multi-purpose” cooperatives cannot be autonomous and are thus under great risk of undue influence on their lending decisions. Also these USPs are likely to suffer from improper governance and management due to doubtful capability of the governing boards or management to engage in diverse business activities. The legal status of cooperative (KSU) or savings and credit unit of a cooperative (USP) is therefore not acceptable as this would undermine the autonomy of the institution.

The proper legal status for a BQ is that of a Koperasi Simpan Pinjam (KSP). In the framework of Qanan, preparations may be made for their registration by the

Dinas Koperasi in Aceh under the name of Baitul Quirad (BQ).

Incorporation of SHGs/KSM Self-help groups (Kelompok Swadaya Masyarakat, KSM) are widespread in Aceh. Many are rotating savings and credit groups of indigenous origin (arisan, julo-julo) for different purposes, mostly with monthly but also with weekly or daily cycles. Other SHGs focus on marketing or production.

Establishment of financial SHG/KSM as an alternative strategy to BQ/KSP should be discouraged, since these thrive well under own-initiatives of local folks and do not need external push which often destroy the essence of their creation

However, these SHG/KSMs may be jumping-off points for creating or enlarging the BQs (e.g., by incorporating them to the BQs)

Self-help groups may become members of a BQ by acquiring a share (simpanan pokok), possibly in the name of the chairperson of the KSM

BQ and SHG/KSM should encourage full BQ membership of the individual members of the SHG/KSM.

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3.2 Promoting member ownership of BQs: a strategy of broadening outreach

How to increase membership outreach BQ should have a broad membership of shareholders. They should make every effort of broadening their membership. Confining membership to a core of 20 or 25 shareholders with voting and profit-sharing rights and relegating large numbers of savers and borrowers indefinitely to the status of “future” or “associate” members (pra-anggota) is contrary to cooperative principles and the objective of broad ownership within the community.

Associate or future members (pra-anggota) should participate in regular savings (simpanan wajib) that may be converted into a share (simpanan pokok)

The status of associate or future member (pra-anggota) should be limited to one year; upon request it may be extended by the board or the general assembly for another year.

Assign responsibility for the expansion of the number of share-holding members to a board member or committee and promote expansion actively, eg, through membership drives.

Support capacity building in membership expansion techniques

Designing the size of a share (simpanan pokok) to increase outreach Membership outreach can only be increased if the size of a share is small enough to be afforded by many people in the community:

The value of a member equity share (simpanan pokok) should be kept at a level where it can be afforded by a large number of members (eg, Rp 250,000 to Rp 500,000).

Multiple share ownership should be encouraged. Multiple shares participate in profit sharing, but do not convey additional voting rights in the general assembly.

Relief agencies and NGOs may provide seed funds to tsunami victims to acquire a share and become BQ members (up to 2007 only). However, such seed funds should not be the sole resource of the BQ and should require counterpart funding on an increasing scale from BQ members in pre-determined sharing modalities. By no means should such resources be provided by the agency that supports the establishment or revitalization of a BQ; a BQ is no charity organization.

3.3 Supporting BQs at primary and secondary levels:

a strategy of building a sustainable BQ sector

Establishment costs Establishment costs (over and above the social capital) may be covered by grants. Government agencies and donors may provide grants for office space and

equipment, training, IT, consulting fees and related establishment expenses Contributions to the establishment costs are part of the initial institution building and

should not participate in profit sharing

Investments Investments in working capital by donor and government agencies are encouraged. Investors (eg, Baznas) in working capital employed as loanable funds may share in

the profits (SHU) Investors should define an exit option.

Secondary and tertiary intermediaries Grants, loans and investments may be provided directly to a BQ or a higher-tier organization such as the following:

a secondary BQ or BQ Center (like the existing Aceh Madani Recover) a tertiary BQ yet to be established (Aceh Microfinance Apex)

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PNM (which works through primary and secondary BQs) a mutually agreed upon bank.

Repayment of grants, loans and investments to secondary and tertiary intermediaries Working capital grants and soft loans to BQs as well as investments should not be regarded by the BQs as gifts but should be paid back to a secondary or tertiary intermediary, or a liquidity exchange unit to be established therein in one of the following ways:

Through annual installments after a grace period, eg, of three years From the profits annually accrued to the grant or loan without a grace period. The reflows should be recycled within the BQ sector: through liquidity exchange or

injections into newly established BQ.

3.4 Maintaining institutional autonomy

Autonomy in business decisions Donors, government or private agencies and investors must not unduly interfere in the autonomy of business decisions of primary or secondary BQs. In particular,

They must respect the autonomy of the board and refrain from seeking representation on the board; but may serve as advisors to the board

They must not impose the channeling of loans or grants upon the BQ They must not interfere with the selection of borrowers They must not interfere with the terms and conditions of financial services

Loan channeling Grants, soft loans or other resources provided to a BQ by donors, government or private agencies or investors for particular purposes or on special terms (special programs, loan channeling) must not be mixed up with the regular operations of a BQ:

Donor and government agencies should refrain from using BQs as channels for special programs where the BQ acts as a channeling agency without full rights over client selection and loan terms. They are encouraged to contribute to the outreach of a BQ through portfolio refinancing without strings attached.

BQs should be aware of the great risks of loan channeling on behalf of other agencies, which is likely to pollute their own loan portfolio

Loan channeling of a considerable extent should be handled by a subsidiary of the BQ with its own staff

The operational costs of special programs to the BQ must be fully covered by the provider; they must not be cross-subsidized by the BQ.

Off-balance sheet operations If BQs handle special programs and channel loans on behalf of other agencies, this must not be mixed up with its reporting.

Special funds channeled through a BQ must be reported off-balance sheet and entered into a separate account (with a separate balance sheet and a separate income statement)

Funds administered by a BQ as executing agency, with full rights over client selection and loan terms, are to be reported on the balance sheet.

3.5 Internal control, auditing and supervision:

a strategy of transparency and accountability

Accounting and reporting standards Accounting and reporting practices vary widely among financial cooperatives in Indonesia. The BQ in Aceh require strict standards and the enforcements of such standards within the legal framework for cooperatives. We strongly recommend:

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Adapt the accounting and reporting standards of BQs to those of Bank Indonesia for rural banks (BPR, BPRS) to the extent feasible

Adopt enforcement practices for BQ similar to those of BI for BPR/S Ensure that all BQs have the same accounting and standard reporting system,

including standard performance ratios.

Internal control Internal control, together with auditing and supervision, is of utmost importance for the maintenance of financial and organizational health of a BQ. Effective internal control must be strictly enforced through:

Clearly defined procedures of internal control by management and board (pengurus) Designated personnel of internal control among the management and the board Dual control by at least two persons, from separate units with separate supervisors

for all financial transactions (four-eye principle), eg., cashiering units/departments must be distinct from accounting units/departments.

Multi-tier lending and procurement limits in approval authority of management and board; no such transactions may be approved and disbursed by only one person

Monthly monitoring by a secondary BQ, PNM branch or other agency during the first year, and for an extended period if deemed necessary

Adequate capacity building of the designated personnel.

Auditing and supervision Auditing and supervision of BQs is essential for the maintenance of their health and a precondition for access to external funds. We propose the following:

Auditing at least once a year by a designated agency, eg, the auditing unit of a secondary BQ, a private auditing firm or PNM

Annual supervision of audited accounts by PNM or a financial authority Regular control of PNM’s monitoring, auditing and supervisory activities by the PNM

head office. Adequate institution and capacity building of service providers such as secondary

BQs and PNM.

Auditing during the start-up phase Auditing services may be provided through independent auditors, the auditing service of a secondary BQ or an auditing federation owned by the BQs or secondary BQs yet to be established. During the initial period we propose:

Establish and support a professional auditing unit in secondary BQs (eg, the BQ Center Aceh Madani Recover)

Examine the feasibility of establishing an auditing federation as soon as possible

Setting up a separate financial authority for BQ supervision Effective supervision includes the right to enforce regulation and to close non-performing financial institutions. The failure of financial cooperatives in Indonesia including Aceh is to a large extent due to the complete lack of effective financial supervision. The Dinas Koperasi is not authorized to enforce standards and to close cooperatives. Effective supervision of BQs by an independent financial authority is indispensable if the BQs in Aceh are to grow into a healthy, self-reliant and sustainable cooperative sector. We strongly recommend:

Establish an independent financial authority for the external supervision of BQ; an institution which may assume this function for a limited period (eg, until 2007) is PNM; donors may contribute to the establishment costs and initial running expenses of the supervision unit

With reference to Aceh’s special authority to create its own legal framework (Qanun), mobilize the necessary political support, eg, by the Governor, Bappeda, BRR and Dinas Koperasi, for establishing an autonomous cooperative supervision authority

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Coordinate donor support and provide the necessary assistance for the establishment, capacity building and initial operational expenses of BQ supervision

BQ Center (Aceh Madani Recover) Strengthen the existing BQ Center Aceh Madani Recover, registered as an Islamic secondary cooperative (Pusal Koperasi Syariah, Poskopsyah)

7, which serves as a

cooperative apex. It is owned by member BQs and financed through member contributions and management fees. We propose to provide coordinated donor support during the start-up and institution-building phase for the following services:

Liquidity exchange Training Monitoring and consultancy Maintenance and problem-solving of IT in member BQs Auditing as long as no separate auditing body has been established.

3.6 Backing up BQs through IT and loan protection

Information technology (IT) The financial software provided by PNM is reportedly superior to that of other BMT/BQ service providers, but needs to be perfected:

Study the experience of BQs with the PNM IT and determine the demand for improvements

Provide the necessary resources for the improvement and development of the IT, eg, its capacity to cover branching by BQs

Provide services to adapt the software to individual needs Assist in the continual updating of the software Ensure the quality of the IT at the level of Islamic banking software.

Loan protection and insurance in BQs Some BQs offer life insurance as loan protection to their borrowers, covering the debt in case of debt. As a loan protection scheme this is of great benefit to the BQ and its members. The premium is minute compared to effective annual margins (interest rates) on loans.

Make loan protection through life insurance mandatory in all BQs. Include the premium in the margin of the loan. Explore opportunities for improving coverage customized to cultural traditions, eg,

mutual benefit payments in case of death of a BQ member or a member of his family.

3.6 Coordination, cooperation and the way forward

Donor coordination and cooperation with government agencies Ensure donor coordination of assistance to BQ and other MFIs (LKM) and cooperation with government agencies, including

Government agencies: BRR, provincial government represented by Dinas Koperasi, PNM

Donor agencies: ADB, GTZ, ILO, MercyCorps, UNDP, others

7 Modeled after the Muamalat Center in Yogyakarta.