Indonesia: Rate Caps Counterproductive

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Feb 2016
Indonesia, February, 17 2016 - Imposing Interest rate ceilings would undermine the ability of these lending institutions to cover their costs. Many would be driven out of business and even those surviving will struggle. The poor, who are the recipients of microfinance, would be the losers.

Governments all over the world have used credit schemes as a way to transfer resources to specific populations. This approach has not always produced the desired effect, and the negative impact of these schemes has led many experts to advocate for governments to disengage from the micro-financing business.

However, it is increasingly clear that governments have a constructive role to play in building financial systems that work for the poor. They must focus on developing sound policy frameworks and encouraging vibrant and competitive microfinance, rather than directly providing financial services.

Appropriate interventions are crucial for microfinance development in Indonesia. Why?

Because Indonesia has established itself as a global leader in the commercial microfinance business. But, except for microfinance experts, too few people know about this.

The microfinance industry (MFI) would benefit significantly if Indonesia took a more active role in global industry leadership. At the national level, Indonesia enacted a specific law for microfinance institutions in 2013 that was expected to create a more conducive regulatory environment that encouraged market entry and competition in microfinance.

The Indonesia Financial Services Authority or OJK has been assigned to regulate, assist, and supervise the MFI in Indonesia.

In undertaking this responsibility, OJK, working with the Ministry of Finance, has produced one government regulation and three OJK regulations.

Government Regulation No. 89/2014 is dedicated to regulating interest rates and business coverage of microfinance institutions. The question is: Is interest rate control justifiable?

OJK has been very careful in setting interest rates for microfinance businesses. Today, they are free to determine the rate they charge on their micro-credit clients. Why?

Interest rate ceilings and the provision of credit at the retail level have been identified as the two types of intervention that could undermine the development of microfinance.

The other two kinds of interventions that have a negative impact are subsidized lending programs and political interventions. These two types of interventions come in the form of social assistance programs run by various ministries.

Imposing Interest rate ceilings would undermine the ability of these lending institutions to cover their costs. Many would be driven out of business and even those surviving will struggle. The poor, who are the recipients of microfinance, would be the losers.

Faced with an interest rate ceiling, many microfinance institutions have withdrawn from markets, those who remain experience slow growth. They become less transparent about their loan costs, and many cut back on their rural operations and costly markets.

A cap on interest rates can block the microfinance institution’s role as one of the most effective instruments to increase financial inclusion among low-income and vulnerable people as it limits their ability to provide credit schemes for micro and small enterprises.

As a result, their operation will not be able to optimally support Indonesia’s economic growth and efforts to overcome development challenges such as poverty, unemployment, and wealth and income disparity.

The OJK is fully aware that too-high interest rates charged by microfinance institutions can reduce access to microcredit loan and therefore has relaxed its regulations on interest rates.

Today, all microfinance institutions are only required to regularly report their interest rate dynamics and after five years OJK will use these reports to try to recognize the most appropriate and comfortable interest rates for microcredit schemes.

A new interest rate policy will be developed in conjunction with OJK’s other efforts in providing incentives for microfinance development in Indonesia

These efforts, including capacity building, product development, and a financial report system, have been announced by OJK Chairman Muliaman Hadad on many occasions.

He has also stated clearly that “the supervision of microfinancial institutions is one of the most important indicators of OJK’s reputation.”

The interest rate requirement is also related to the future policy on a deposit insurance corporation for microfinance. OJK is mandated by Law No. 1/2013 to undertake this action.

The existence of this corporation will secure public funds managed by microfinancial institutions and reduce the role interest rates as a tool for competition and strategy in the micro-lending business.

 



Source : The Jakarta Post
 

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