Indonesia is renowned for its large scale microfinance sector, with a range of commercial banks and over 60,000 MFIs reaching more than 50 million people (CGAP). There are $11.2 billion USD loans disbursed, 722,249 borrowers and $13.1billion USD in deposits as of 2013 (MIX Market). Indonesia has more than 50 million MSMEs, representing some 97% of all enterprises and contributing no less than 30% of GDP growth in 2012 (OECD). Currently, however, many of these do not have adequate access to the bank financing they need to grow their businesses, particularly in rural areas. To that end, Bank Indonesia issued a rule that requires banks to have at least 20% of their loan portfolio dedicated to micro loans by 2018 opening up new opportunities to further grow the sector.

Indonesia’s banking sector is diverse (See Opportunities in Indonesia’s Banking Sector). Regulated banks are either general commercial banks (Bank Umum) or Bank Perkreditan Rakyats (BPRs). Of 128 commercial banks, 31 are either 100%government-owned or majority-controlled, including 26 regional development banks (BPDs). The regulated microfinance providers, commercial banks, and BPRs follow commercial principles and cover mostly the upper levels of the micro-enterprise market, with loans of more than 3 million Rupiah ($300 USD).

Among private sector banks, Bank Tabungan Pensiunan Nasional (BTPN) has been expanding into microfinance since a buyout by the private equity firm Texas Pacific Group in 2008, followed by loan financing from the IFC in 2009 and 2012. In 2012, BTPN turned an ROE of 32.6% and its SME loan portfolio grew 33% yoy to 9 trillion Rupiah ($900 million USD), with its NPL steadily brought down to 2.1% (BTPN). Sumitomo-Mitsui Financial Group announced in 2013 that it plans to acquire a 24% stake of BTPN at a 14% premium to its last traded price pre-announcement and is looking to acquire up to 40% for about $1.5 billion pending regulatory approval, providing investors with a lucrative partial exit. Typically thought of as a key micro player, BRI has long been dominant in the microfinance space. But now, BRI’s position is being challenged by a range of competitors, such as Bank Mandiri, the largest state-owned bank in Indonesia that has built up a microbanking business of scale and Bank Danamon; a private sector bank that has also built a strong foothold in the sector.

While lenders like BRI offer low-cost microloans, lending regulations (which require customers to have proof of a permanent job, income and collateral) shut out the majority of Indonesia’s laborers. Commercial lenders and microfinance cooperatives have tried to meet the demand, but a combination of strict regulations and too-high thresholds have hampered efforts and given rise to a murky black-market of motorcycle-riding lenders and unscrupulous loan sharks. Inadequate outreach to rural communities has also contributed to unmet demand. Most micro lending has been located in the urban areas of Java and Sumatra, where the Indonesian population is concentrated. For microfinance operations to remain sustainable, it needs to cover its operational costs. This is achieved by ensuring that there is ample customer base to spread its expenditures and that it is located closer to the customers’ homes and workplaces.  

In light of the challenging economics of expanding outreach, the emergence of mobile banking has been gaining attention as a new delivery model that addresses such cost barriers. In Indonesia, there are 260 million mobile subscribers, with 143 million unique mobile subscribers (See An Overview of Indonesia’s Telecommunication Sector), enabling the poorest people to have access to reliable financial transactions (CGAP). Mobiles and point-of-sale devices have now created an opportunity to reach more unbanked people than ever before without relying on the traditional bricks-and-mortar branches model which entails high costs. The number of branchless banking services has grown rapidly, but the vast majority of registered customers are not actively transacting.

Islamic microfinance or Sharia-compliant microfinance (which is structured in line with Islamic law) plays an important role in Indonesia as the largest Muslim majority market in the world (See The Outlook for Indonesia’s Islamic Banking Sector). Since interest cannot be charged, the lender purchases assets for the client and sells them at a predetermined profit margin. Between 2008 when the government issued the Sharia Banking Law and 2012, Islamic banking assets tripled, increasing by an average of 31.5% annually (Bank Indonesia). Despite this growth, a 2012 World Bank survey showed fairly low levels of awareness amongst MSMEs about the various financing products offered by Sharia-compliant banks (CGAP). With Sharia-compliant financial service providers accounting for only 4.5% of total banking sector assets and financing in need for millions of MSMEs, raising awareness and increasing outreach remains key to continued growth.

The slow pace of reform in the regulatory and legal environment also deters growth in the microfinance sector. In 2012, the government created new laws to increase minimum paid-up capital requirements to set up new BPRs and minimum capital assets for existing ones, which may well lead to many BPRs reducing services for rural areas (e.g. BKDs). Rising protectionism has also been an investor concern. In 2012, Singapore based DBS Bank made an offer to purchase a controlling stake of Bank Danamon. The purchase was valued at $6.8 billion, and could amount to Indonesia’s largest-ever foreign investment, if executed. The deal has been held up for more than a year, however, following rule changes capping foreign ownership of Indonesian lenders at 40%, adding that any further increase in stakes will need another set of approvals. Investors could be less interested in buying Indonesian banks if they are not guaranteed a controlling stake, as the economics may be challenging in terms of integration with existing investor business in Indonesia.

Looking ahead in 2013 and beyond, the microfinance industry has a lot to gain by developing technologies and working with regulatory bodies to tap into the Indonesian microfinance market’s huge unmet demand. Smaller enterprises are less exposed to the global economy and hence, they are more resilient in the face of general downturns, leaving little or no impact on the microfinance industry during economic slowdowns. Indonesia’s banks are targeting this micro segment based on predictable future growth of the country’s economy and the source of its domestic consumption. While there are certain conditions that need to be met in order to achieve expansion into less populated areas, recent innovations such as mobile banking make it increasingly feasible to provide services to rural regions which were once considered too costly to serve in order to maintain commercial sustainability.