Provisional Manual for the Credit Business

SMALL-SCALE AND

MICRO-FINANCE

INDONESIA

PROVISIONAL MANUAL FOR THE CREDIT BUSINESS

OF THE GENERAL POPULAR CREDIT BANK

by Th. A. Fruin

Original title (Dutch):

"Voorlopige Handleiding voor het Credietbedrijf der Algemeene Volkscredietbank"

edited by

Klaas Kuiper

Development Cooperation Information Department of

the Ministry of Foreign Affairs, The Hague, Netherlands

1994, 2000

` Development Cooperation Information department (DVL/OS)

PO Box 20061, 2500 EB The Hague, Netherlands

July 1994 ( printed version), August 2000 (electronic version)

Permission is granted for the reproduction in part of this material for educational, scientific or development related purposes except those involving commercial sale, provided that full citation of the source is given. For all other purposes prior written consent of the copyright holder is required.

The opinions expressed in this publication are the sole responsibility of the authors.

CONTENTS

PREFACE AND ACKNOWLEDGEMENTS

Klaas Kuiper, editor

PROVISIONAL MANUAL FOR THE CREDIT BUSINESS OF THE GENERAL POPULAR CREDIT BANK

Th. A. Fruin

GLOSSARY

REFERENCES

PREFACE AND ACKNOWLEDGEMENTS

The year 1995 marked the centenary of the founding of the first popular credit bank in Purwokerto, Indonesia.

It was also sixty years since the publication of Th. A. Fruin's "Voorlopige Handleiding voor het credietbedrijf der Algemeene Volkscredietbank", in Jakarta, or Batavia as it was known at the time. Fruin's book reflects his fifteen years of experience with credit schemes, a period marked by a series of major reorganizations in the institutional structure of credit facilities, which culminated in the establishment of the "Algemeene Volkscredietbank" (AVB) in 1934, the predecessor of today's Bank Rakyat Indonesia (BRI).

The various types of credit facility granted at village level mainly served the needs of those with limited or no access to commercial banks, such as small farmers, merchants and small entrepreneurs or, in short, one-man businesses and households. The credit system consisted of popular banks and thousands of village banks, lumbungs (village rice banks) and pawnshops that provided small, usually short term loans to millions of households. And the interesting thing is that they managed to do so at a profit!

For a number of reasons this is an opportune moment to produce a translation of Fruin's manual:

-Many countries are interested in small-scale credit facilities and are seeking ways to tackle the problems such loans entail. They could benefit from examples from other countries and eras which demonstrate that it is possible to channel numerous small loans to relatively poor clients in a sustainable manner. Anyone in the field of credit today would do well to examine the factors which made those programs successful.

-The history of credit extension in Indonesia, which was still under Dutch colonial administration at the time, was chronicled in a monthly journal published since 1913. These documents contain detailed accounts of the many experiments carried out at village level and the debates and studies surrounding them. An English translation of these publications will make this wealth of information available to a far wider public and hopefully facilitate further research.

-Rural credit systems typically featured a bottom-up approach with a clear role set aside for government. They were generally based on wide-ranging social and economic surveys of village life concerning income flows and the role of informal loan providers, and consequently the most suitable form of credit. In addition, comparative studies were conducted of bank branches so that the less successful could learn from those that did well. These studies provide detailed information on the numbers, sizes, costs and performance of the loans, and show how problems were solved.

-Over the years a shift took place in the relationship between head offices and the local banks. For further information on this subject the reader is referred to Schmit's history of the popular credit system (1). Nevertheless, the popular credit banks always had a large measure of freedom in interpreting the general guidelines issued by headquarters.

-Another reason for translating the manual is that it is not merely a summary of precepts, but a detailed record of people's experience in the field, from which Fruin distilled strategic and operational principles applicable to a wide range of types of credit for entirely disparate groups. Today, the work would be called a "best practices manual", and much of the information is still valid.

In short, Fruin's manual is not simply of historical interest. In 1969, when I was involved in planning the "unit desa" (village units) project for Bank Rakyat Indonesia, extensive use was made of this and other publications by Fruin, particularly those describing approaches and costs in greater detail. (2)

In the period between 1920 and 1930 it was possible to extend millions of small loans on a profitable basis to the same target groups (small farmers, traders and small and micro enterprises) as the BRI was trying to reach. The results of the pilot project in 1969/72 confirmed that these credit schemes could be repeated. Losses were incurred in the 1970's, when the unit desa scheme was too rapidly expanded and some of the guidelines developed during the pilot project were abandoned. Nevertheless, BRI's current KUPEDES program, which has replaced the units desa, has some of the features of both the earliest unit desa and of the pre-war AVB. In addition, the program has been yielding a profit.

The translation

Translating the manual has been an onerous task involving a number of choices. A lawyer by profession, Fruin sought accuracy of expression in complicated phraseology and convoluted sentences. His original text has been simplified where necessary to make the English version more readable. Moreover, his Dutch is now slightly archaic. Some of the terms he used have acquired a different meaning or simply have become obsolete. His vocabulary is larded with numerous Indonesian and Javanese words, and geographical names are spelt according to the orthographic rules of his day. Such usage has generally been preserved in the English. If possible, an English equivalent or explanation follows the first time a local word is quoted. Some terms, however, mostly referring to specific local contract forms, have not been translated. Many of them are strictly regional and are defined in purely local terms. Reference is made to the glossary containing the most frequently used foreign terms. We have opted for an unabridged translation of the manual and have therefore included a number of passages which may seem irrelevant today. The reader should be aware that the manual was written when Indonesia was still a Dutch colony. The term "government" thus refers to the colonial administration, while Fruin himself was a colonial civil servant, of the social-democratic school and with no ambition to be a commercial banker!

Acknowledgements

Many people have put time and effort into producing this version of the manual. In particular, I would like to thank the author's son, R. Fruin, for his permission to translate the work and to consult the family archives at the "Rijksarchief" (General

State Archives) in The Hague. I am also deeply grateful for his advice and suggestions.

I am grateful too to Dr Leo Schmit for studying the archive and summarizing the history of the first 40 years of credit extension in Indonesia, published together with this manual in its printed version. (1) The historical framework he has thus provided makes the manual easier to understand. His earlier research for his own dissertation placed him in the best position to do this.

Thanks are also due to the English Section of the Ministry of Foreign Affair's Translation Department for the translation of the manual.

The project was funded by the research program of the Directorate-General for Development Cooperation (DGIS-DST/SO).

Finally, I would like to thank my secretary, Desiree Sackman, for her assistance with the editing and lay-out, and the Development Cooperation Information Department for their help in liaising with the printers.

Klaas Kuiper, editor

The Hague, July 1994

The electronic version

Because the printed version of Fruin's manual has been sold out but requests for it still remain, it has been decided to make an electronic version available, especially for the various virtual libraries that are being set up.

This electronic version differs in some aspects from the printed version:

-The article by Schmit on the history of the popular credit system (1895-1935), which was part of the book, is not part of this electronic version but has been given its own electronic copy. (1)

-Due to the different formats of the book and this version page numbers do not correspond.

-The text notes and footnotes in the printed version have been moved to a list of references at the end of this version.

-Text references to Dutch language publications have been translated into English in this electronic version; the original Dutch title appears in the references at the end. The name "AVB" has been used throughout for the "General Popular Credit Bank".

-Some errors in the printed version have been corrected and some Indonesian terms have been translated into English. They have been added to the glossary.

-The lay-out has been changed too, however, this is still an unabridged version of

Fruin's original text. With the above we have attempted to make the reading more

pleasant.

I would like to thank Maaike Manten and Johan Leestemaker for the assistance provided in making this electronic version possible.

Klaas Kuiper, editor

August 2000

PROVISIONAL MANUAL FOR THE CREDIT BUSINESS
OF THE POPULAR CREDIT BANK

by Th. A. Fruin

Published by the General Popular Credit Bank

in Jakarta, March 1935

CONTENTS

CHAPTER I INTRODUCTION

CHAPTER II THE CAPITAL OF THE AVB

Capital stock
Net assets
Total equity capital
IGCI reserves
Village assets
Total IGCI and village investments
The AVB as investment institution for the local councils and their institutions
The AVB working primarily with capital from the indigenous community
The AVB as a savings bank
Indefinite-term deposits
Current account funds
Relationship with the general banks
Conclusion

CHAPTER III NATURE, SIZE AND LIMITS OF THE AVB's CREDIT BUSINESS

Three principal characteristics
Subsidiary characteristics
The bank's socio-economic responsibilities
The AVB is not a philanthropic institution
The commercial basis
No direct influence on the part of Government
The limits of the AVB's credit operations
The AVB does not accept other banks' leavings
The AVB as an agent for the major banks
Credit for all, irrespective of racial origin or class
The AVB as an intermediary for government credit
Guarantees for the AVB
AVB subsidiaries
Geographical area covered by the AVB
Advantages of the multi-faceted nature and geographical spread of the AVB
Long-term credit justified from the point of view of liquidity and socio-economic considerations
The risks associated with long-term credit
Business credit on liquid assets
Business credit secured by immovable property
The extension of loans secured by pensions in combination with life insurance
The danger of becoming a sleeping partner
Personal credit
Credit to one-man businesses

CHAPTER IV CREDIT TO SMALL-SCALE ENTERPRISES

Limits
Retailers and craftsmen
Cooperation with the Industry Department and with craft schools in order to promote crafts
Small-scale enterprises proper
The capital requirements of small-scale enterprises
The credit requirements of small-scale enterprises
Long-term supplier credit
Short-term supplier credit
Customer credit
Supply on credit by small-scale enterprises
The dilemma of credit to small-scale enterprises
The AVB as administrator and accountant to small businesses
Security: mortgages and credit surety
Ceding claims
Fiduciary transfer of ownership
Guarantees
Raising loans on pensions and salaries
Liens on life insurance policies or mixed insurance policies
The ceding of monies involved in contracts; order credit
Raising loans on securities which can be traded on the stock exchange; various forms of security
Forms of credit to small-scale enterprises; discount and loan credit
Short-term loans; seasonal credit
Pseudo current account credit as continuous seasonal credit
Long-term loans for fixed capital or as long-term operating credit
Current account credit
Long wave-length current accounts; continuous seasonal credit
Short wave-length current accounts; permanent operating credit; regularly reduced maximum borrowings
Notice and cover in the case of current account credit
Summary: general conditions for credit to small-scale enterprises
Credit for new and recently established businesses

CHAPTER V CREDIT TO FARMERS

Outline of the indigenous farming community
The role of credit in village communities
The lack of capital formation in the village community
The gross monetary income of the farmer as the basis for the credit to be extended
Tenancies and share-cropping
Bailment and leasing of land
Profiteering
Customer and supplier credit
Other credit
Debt problems
Reasons of the relatively small debt burden of indigenous farmers
Indigenous rural mortgages - an undesirable development
Little need for long-term credit
Credit to finance the purchase of additional land or a family farm
Characteristics of short-term agricultural credit provided by the AVB
Land as security and as a criterion for eligibility for credit
The impossibility of a thorough individual approach
Types of loans in indigenous farming
Repayment dates and rapid succession of loans
Determining the size of loans
Credit for small farmers and indigenous commercial farming

CHAPTER VI CONSUMER AND SEMI-CONSUMER CREDIT

Characteristics of consumer credit
Short-term consumer credit
Credit with which to pay off debts; cooperation with anti-usury associations
Cooperation with trade associations and cooperative associations to keep their members permanently free from usurious debts
Credit for the redemption of pawned goods and the payment of taxes
Credit for the purchase of durable goods (semi-consumer credit)
Credit for the construction of housing on land borrowed by the borrower
Housing credit where construction is to take place on land owned by a third party
Credit for various purposes at once
Guarantees against the misuse of long-term credit

CHAPTER IINTRODUCTION

This manual is both a beginning and an end. It is the author's way of taking his leave of the popular Credit System, an attempt to record, before his departure, his fourteen years' experience of public administration in this field and the knowledge he has gained in that time. It is also a first attempt to provide an overview of the credit system as a whole and to discuss it systematically and with a critical eye.

With the setting up of the "Algemeene Volkscredietbank" (General Popular Credit bank, hereafter referred to as the AVB), the time had come for this to be done. The structure of the popular banking system was wrong, involving as it did a large number of local, insufficiently resourced, small banks, all of which were striving for independence from the beginning and proved to be incapable of effective cooperation. This fragmentation of resources, with the banks being linked only slightly by a management which was permitted as little involvement in the actual business of lending as possible, was badly suited for the development of a theory of the credit business.

After a few attempts in the first few years (cf. for example the interesting articles by Besseling in the "Journal of the Central Fund"(3)) the loans business for years received little attention. Since 1920 the efforts of the management have had to be concentrated primarily on the step by step introduction of better organization; since 1925 they have also been improving internal and external financial control, though by attaching academics to the service especially to conduct economic research (Dr C.L. van Doorn, Dr G.H. van der Kolff, Baron W.E.K. van Lynden in turn) an attempt has also been made to improve the economic side of the business.

The management itself had only occasional opportunity to involve itself intensively in this aspect of the business. The author's articles, "Long-term credit" (4) in the journal "Vollkscredietwezen" (Popular Credit System) in October 1927, "Forms of credit" (5) in January 1929, "The popular mortgage bank" (6) in January 1930 and "Current account credit to the indigenous population" (7) in December 1930 represent his various attempts, all interrupted again and again, to do so.

The "Forms of credit" article did lead to a number of studies by accountants on seasonal loans, some of which were also worked on by management and staff (see also under this heading in the supplement to the file on the Popular Credit System); chapter IV of this manual makes grateful use of those studies.

A full survey of the management's attempts to gain a greater understanding is provided in the author's article "The lending business of the Popular Credit Banks and the Central Fund" in the journal "Volkscredietwezen" of June 1933.

The establishment of the AVB makes a systematic, continuous study of the lending system possible for the first time because this is the first time that the management and the economic affairs department have been able to rely on full cooperation from the local branches or draw up detailed statistics. It is to be hoped that at least one member of staff, freed as far as possible from day-to-day concerns, will now be able to devote himself fully to further developing understanding of the credit system.

In this respect the present manual has been written too soon: the author has not been able to use any of the new statistical material and the year since the establishment of the AVB has not left him with sufficient time to give proper attention to or involve himself intensively in the credit business.