Document of The World Bank FOR OFFICIAL USE ONLY FILE COPy Report No. 2563 PROJECT PERFORMANCE AUDIT REPORT INDONESIA - BANK PEMBANGUNAN INDONESIA (CREDIT 310-IND) June 27, 1979 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY PROJECT PERFORMANCE AUDIT REPORT INDONESIA - BANK PEMBANGUNAN INDONESIA (CREDIT 310-IND) TABLE OF CONTENTS Page No. Prefaceai Basic Data Sheet ii Highlights iii PROJECT PERFORMANCE AUDIT MEMORANDUM 1 A. BAPINDO - Design of the Project 1 BAPINDO and the Indonesian Financial System 1 - 3 The Pre-Negotiation Phase 3 - 6 The Negotiation Phase 6 - 7 The Pre-appraisal Phase 7 - 8 The Appraisal Stage 8 - 9 B. Assessment of the Bank Design 9 Time Spent 9 - 10 Attitude Towards Financing Government DFCs 10 Progress on Reforming BAPINDO 11 Framework for BAPINDO's Operations 11 - 13 C. Objectives and Expectations 13 D. BAPINDO Operations 14 Use of Bank Funds 14 - 15 Overall Operations 15 - 16 Arrears and Profitability 16 - 17 E. Institutional Development 17 Role of Special Advisors 17 - 18 Appraisal and Supervision Practices 18 - 19 Accounting Systems 19 Branch Offices and Personnel 19 - 20 Autonomy in Operations 20 - 21 BAPINDO's Developmental Role 21 - 22 Present Organization Set-up 22 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. -2- Page No. F. Bank Supervision 22 G. Summing up and Conclusions 23 Annexes: I.1 Summarized Balance Sheets, December 31, 1974-77 (Audited) and December 31, 1978 (Unaudited) 25 - 26 1.2 Summarized Income Statements 1974-77 (Audited) and 1978 (Unaudited) 27 II.1 Bank Pembangunan Indonesia Organization Chart (1972) 28 11.2 Bank Pembangunan Indonesia Organization Chart (as of December 31, 1978) 29 III. Comments received from the Borrower 30 - 31 Attachment: Project Completion Report 1. Introduction 32 2. Objectives of the Credit 32 3. Accomplishments of the Credit 34 BAPINDO's Role as a Term Lending Institution 34 - 35 BAPINDO's Policy Statement 35 BAPINDO's Organizational Structure 35 - 37 Financial Aspects of BAPINDO 38 - 40 4. Utilization of Credit 310-IND 41 Rate of Utilization 41 Subprojects Financed 41 - 42 5. Operational and Financial Results 42 Level of Operations 42 - 43 Profitability 43 Financial Position 43 6 Overall Evaluation 44 Annexes: 1. Estimated and Actual Disbursement of Credit 310-IND 45 2. List of Subprojects Approved Under Credit 310-IND 46 3. Characteristics of Subprojects Financed Under Credit 310-IND 47 -3- Page No. 4. Status of Implementation of Subprojects Approved Under Credit 310-IND 48 5. Forecast of Operations 1972-75, and Actuals 1972-76 49 6. Operational and Economic Data of Subprojects Financed Under Credit 310-IND 50 7. Projected Balance Sheets 1972-75, and Actuals /a 1972-76 51 8. Projected Income Statements 1972-75, and Actuals 1972-76 52  PROJECT PERFORMANCE AUDIT REPORT INDONESIA - BANK PEMBANGUNAN INDONESIA (CREDIT 310-IND) PREFACE This is an audit of performance under Credit 310-IND for US$10 million, made to the Government of Indonesia for onward lending to Bank Pembangunan Indonesia (BAPINDO), a Government-owned development finance company. The credit was approved in May 1972 and became effective in August 1972. It was disbursed to an amount of US$9.55 million by August 1977 when, after a cancellation of US$0.45 million, it was closed. An OED mission visited the country in February 1979 and discussed various aspects of the project, particularly Government-BAPINDO relation- ship and the institution-building role of the Bank, with BAPINDO officials, representatives of banks and industry, and Government officials. The mission also visited one project financed under the credit. Assistance rendered by Government and BAPINDO officials and representatives of banks and industry during the mission is gratefully acknowledged. The audit memorandum is based on the Project Completion Report (PCR) prepared by the East Asia and Pacific Regional Office, study of files and discussions with the Bank staff and during the OED mission. The PCR describes adequately the project experience, particularly after the approval of the credit. In view of the long pre-negotiation phase and the measures taken to upgrade the institution prior to credit approval, the Audit Memorandum analyses in detail the role of the Bank Group during this phase, and the institutional development of BAPINDO during the period of the credit. The PPAM also updates information in the PCR. Comments received from the borrower have been taken into account in preparing this report, and are reproduced as Annex III to the Audit Memorandum.  - 11 - PROJECT PERFORMANCE AUDIT REPORT INDONESIA - BANK PEMBANGUNAN INDONESIA (CREDIT 310-IND) BASIC DATA SHEET Amounts (in US$ m1n) As of 4/30/79 Original Disbursed Cancelled Repaid Outstanding Credit 310-IND 10.00 9.55 0.45 - 9.55 Cumulative Credit Disbursement 1972 1973 1974 1975 1976 1977 (i) Planned 0.30 4.10 8.10 9.70 10.00 10.00 (ii) Actual 0.10 1.70 7.60 8.60 9.30 9.55 % of (ii) to (i) 33.0 41.5 93.8 88.7 93.0 95.5 Project Data Actual or Original Estimate Re-Estimate Conception in Bank June/69 June/69 Board Approval 5/30/72 5/30/72 Credit Agreement 6/07/72 6/07/72 Effectiveness 8/10/72 8/10/72 Credit Closing 12/31/76 8/31/77 Mission Data * No.of No. of Month,Year Weeks Persons Manweeks Date of Report Reconnaissance Nov. 1968 3 2 6 Jan. 29, 196Q Preappraisal Dec. 1969 3 3 9 Aug. 7, 1970 Appraisal Sept. 1971 3 4 12 May 8, 1972 Subtotal 9 9 27 Supervision I May 1973 3 3 9 July 3, 1973 Supervision II Aug. 1975 3 2 6 Feb. 23, 1976 Supervision III April 1976 3 3 9 June 29, 1976 * In addition, short missions were taken between 1969 and 1971 for discuss sions and negotiations on related issues. Follow-on Projects Loan 1054-IND of US$50.00 million, signed November 20, 1974. Loan 1437-IND of US$40.00 million, signed June 6, 1977.  - iii - PROJECT PERFORMANCE AUDIT REPORT INDONESIA - BANK PEMBANGUNAN INDONESIA (CREDIT 310-IND) HIGHLIGHTS Credit 310-IND was the first credit made by the Bank Group to the Government of Indonesia for on-lending to Bank Pembangunan Indonesia (BAPINDO), a Government financial intermediary. BAPINDO was one of the earliest institutions to seek to take advantage of a new direction in Bank Group policy making Government-owned DFCs eligible for Bank financing. It took the Association four years to approve the credit to BAPINDO. A part of this rather excessive time was taken to assess BAPINDO's portfolio and upgrade its accounting system and procedures. The Association also helped in obtaining technical assistance for BAPINDO in the areas of project appraisal, technical assessment and accounts keeping. BAPINDO's appraisal and supervision practices improved during the period of the credit. BAPINDO also reduced its branches and staff, though not to the same extent as the Association expected owing to local difficulties. Sub-project performance in the initial years was below expectation. BAPINDO carried out some operations at the instance of the Government, reflecting its inability to maintain autonomy. On the whole, the Association brought about significant reforms in the accounting and operational procedures and practices of BAPINDO during the period of the credit, laying auseful basis for future Bank Group operations. The Bank instituted, at the time of the 1977 loan, a system of managed funds to insulate BAPINDO from the consequences of operations undertaken at the instance of the Government. Other points of interest are: - institution of accounting reforms (paras. 16, 34, 65 of PPAM); - provision of technical assistance (paras. 17, 22, 60-61 of the PPAM, and paras. 2.04, 3.06 of PCR); and - continuance of high arrears and low profitability (paras. 54-55 of PPAM and paras. 3.14 and 3.17 of PCR).  - 1 - PROJECT PERFORMANCE AUDIT MEMORANDUM INDONESIA - BANK PEMBANGUNAN INDONESIA (CREDIT 310-IND) 1. The Association approved in May 1972 to Government of Indonesia a credit for US$10 million for onward lending to Bank Pembangunan Indonesia (BAPINDO), a Government-owned development finance company in Indonesia. The credit became effective in August 1972, and was fully committed by February 1975, as projected. It was closed, after two extensions, by December-end 1977, with a total disbursement of US$9.55 million, an amount of US$0.45 million having been cancelled. 2. Bank Pembangunan Indonesia (BAPINDO) was formed in 1960 as a wholly Government-owned bank for providing finance to industry, and, soon after, absorbed Bank Industri Negara which was the earlier industrial lending institution in Indonesia. Soon after this, the Government of Indonesia and BAPINDO first made an approach to the Bank for a DFC loan. In 1967, the contact between BAPINDO and the Bank was renewed, for the first time on a consistent and continuous basis. In the initial phase of this set of contacts, the DFC Department, then forming part of the IFC, while retaining the communication line, indicated to BAPINDO its ineligibility for a Bank loan on the ground that the Bank financed only privately-owned DFCs. When, in July 1968, the Bank issued a policy statement widening the scope of its DFC lending operations to include Government-owned DFCs (and, in consonance with this approach, later also transferred the DFC Department to the Bank), BAPINDO became eligible for Bank lending and was quick to stake a claim for a Bank loan to supportits operations. In order to appreciate the subsequent course the negotiations took, it is necessary to narrate, though in brief, the early history of BAPINDO and the institutional financing system as it had evolved in Indonesia. A. BAPINDO - DESIGN OF THE PROJECT BAPINDO and the Indonesian Financial System 3. Bank Industri Negara (which BAPINDO later absorbed) was set up in 1951 to provide finance to industry which was then mainly in the State sector. The financial system was specialized according to sectors, that is, each Bank was allocated a sector (agriculture, industry, mining and so on) which formed its exclusive field of operations. There was, more- over, only one bank for each sector, so that the borrower's access to a - 2 - bank was determined by the sector in which its operations lay. At the same time, there was little differentiation in the scope and extent of functions and operations of the sector banks, that is, each sector bank was expected to meet all the financial needs--whether short- or midium-term, whether for working capital or fixed assets--of enterprises in its sector. The sector banks obtained their resources from deposits, from the central banking authority (through a program which came to be called INVESTASI or the Joint Financing Scheme) and from budgetary allocations made by the Government. The Government and the central banking authority determined the extent of financing to be provided by a sector bank to an eligible borrower according to a priority- scale laid down by them (the balance being required to be met by the borrowing unit from its own resources), and also laid down the terms (the rate of interest and the maturity structure) on which the funds were to be provided by the sector banks. 4. Bank Industri Negara, reflecting the stage of Indonesia's industrialization at the time, was one of the smaller of the sector banks. In 1960, the Government constituted, by statute, BAPINDO, and, soon after, merged Bank Industri Negara into it. The BAPINDO statute was in consonance with the Government's thinking on the organization of the financial system in Indonesia, and gave wide powers to BAPINDO, including collection of deposits, access to central banking and Govern- mentfunds, raising of loans and providing funds, on short- and medium- term, in the development field. Moreover, BAPINDO was required to undertake such specific functions on behalf of the Government as the Government directed. Thus, the scope and volume of its actual operations were determined by the Government. 5. BAPINDO's history till 1968 was chequered, being determined by industrial, economic and political developments in the country. During the period 1961 to 1966, BAPINDO financed development projects out of funds made available directly from the Government budget. In 1966 BAPINDO was allowed to operate in the general banking field, earlier prohibited. In mid-1966, BAPINDO became inactive in long-term lending, and was confined to short-term loans to medium and small industry. In 1967, the Government assumed direct responsibility for providing long- term finance to industry. Moreover, following a tight money policy and budgetary stringency, BAPINDO was not allowed to accept deposits nor provided Government allocations. BAPINDO was thus confined to managing old loans. 6. By 1968, BAPINDO had built up 20 branches and a staff of 1,370, including 838 as the Head Office staff. The branch offices processed applications directly, and sent them to the head office for appr-ival. BAPINDO had also undertaken operations under Government's directives, as in allocating raw cotton imports to textile mills under - 3 - U.S. PL 480 aid and import of rubber crumb machinery for allocation to entrepreneurs under U.S. and French aid. As the inflationary situation gradually began to come under control and the Government's budgetary position improved, a budgetary allocation was made to BAPINDO in 1968 to finance industrial projects, mostly in the State Sector. 7. BAPINDO's organization and accounts at the stage were ap- parently not in proper shape. While BAPINDO prepared and provided summaries of its accounts (balance sheets and profit and loss accounts), these had not been subjected to external audit duly. An external audit, carried out in 1969-70 for the first time by a private independent auditing firm appointed by BAPINDO at the World Bank's instance, showed deficiencies in ledger-maintenance, in periodicity of reconciliation of accounts and in accounting practices. Moreover, while BAPINDO had provided Rp 412 million (1.6% of the total portfolio) for bad debts, it appeared that a sizeable part of its loans to industrial units in the State sector might not be recoverable. 8. In the meanwhile there had been some evolution in the sectoral system of providing finance, and the structure that had emerged provided financing responsibilities of the banking system as follows: Bank Pembangunan Indonesia: Industry, Transportation. Bank Negara Indonesia 1946: Industry, Transportation, Agricultural/cattle- breeding. Bank Rakjat Indonesia: Agricultural/cattle breeding. Bank Impor/Expor Indonesia: Production of export goods, Estates sector. Bank Bumi Daya: Production of export goods, Estates sector, Mining. Bank Dagang Negara: Production of export goods, Mining. The Pre-Negotiation Phase 9. While the DFC.Department had till 1968 kept nominal relation- ship with BAPINDO and had maintained contact with the Government, central banking and BAPINDO officials regarding BAPINDO's resource problem, it had not made any serious attempts to study BAPINDO's operations or its current role and future potential in the country's financial system. These began when BAPINDO approached the Bank for financing under the Bank's new eligibility criteria. 10. Within the next two years to June 1970, there were three Bank missions, mounted at intervals of about nine months, and intended to provide the Bank with a detailed picture of BAPINDO to enable it to determine its DFC financing strategy in Indonesia: the first, an internal (DFC Department) acquaintance mission in December 1968 to determine the policy options for the Bank; the second, a set of con- sultant (October 1969) and internal DFC Department (December 1969) missions, combined with initiation of an external audit process (commencing September 1969) to determine the scope for private sector development in Indonesia and BAPINDO's role and position in it; and the third, a Bank mission (in June 1970) to discuss the policy options and the strategy of the Bank's DFC lending in Indonesia. 11. The terms of reference of the first mission, in December 1968, were not to appraise BAPINDO but to ascertain and assess the financial system in Indonesia and BAPINDO's role and potential in it. The mis- sion's assessment was that BAPINDO had yet to find a role in Indonesia's economic life and a capability to fulfill it. Apparently the idea of setting up a private development bank or to transfer the Government- owned company into a private development bank seemed premature for lack of private capital, private projects and inflationary trends. The mission recognized that BAPINDO could play an important role as an institutional source of medium- and long-term finance for both State- owned and private enterprises in Indonesia. It also expected BAPINDO, in all probability, to continue its short-term lending and general banking operations though gradually term-lending would become more important. Therefore, the mission ruled out setting up a new privately- owned DFC or converting BAPINDO into a privately-owned DFC. Instead, it recommended improving RAPINDO's technical competence--its organization, project appraisal and follow-up techniques and accounting systems. The mission believed that, considering BAPINDO to be the only institution in Indonesia capable of providing medium- and long-term financing, this (improving BAPINDO's capability) was a practical means of helping the public and private sectors in Indonesia. It then recommended a specific technical assistance program (seconding of experts and provision of training), and suggested an appraisal of BAPINDO for Bank/IDA financing after it had received the technical assistance. 12. The report of the mission was followed by a debate within the Bank on its strategy for DFC lending in Indonesia. Apparently doubts were expressed about improving the capability of BAPINDO by itself, and a suggestion made to create a wholly-owned subsidiary of BAPINDO, to carry on DFC operations and handle Bank Group funds. The Bank also seemed to be averse to using BAPINDO as it had branches. - 5 - On the other hand, the Government opposed the idea of setting up a new DFC and suggested that BAPINDO could be converted from a Government channel (as the Bank considered it to be) to a DFC (as the Bank wanted it to be). Moreover, the Government also suggested that other com- mercial banks be given access to Bank finance. In the meanwhile, the Bank continued to keep up a dialogue with BAPINDO; an internal note made an assessment of the financial system in Indonesia. 13. Under the system of joint financing under which BAPINDO obtained funds from the Government and from Bank Indonesia, the decisions on financing were taken either outside BAPINDO or with a minimal participation by BAPINDO. In either case, control by other Government agencies appeared to be firm and clearly defined. Towards October 1969, the Bank was still open-minded on whether it could be more effective in providing finance through BAPINDO or through other institutions, existing or yet to be created. 14. In the meanwhile, in response to requests for action from the Government and the Resident Mission, the Bank appointed a consultant to examine the role of, and scope for, private enterprise in Indonesia and suggest changes in the legal framework to encourage it; asked the Government and BAPINDO to appoint, from a list of four auditing firms, a firm of external auditors to review its accounts and accounting practices; and agreed to send, in December 1969, a mission to assess BAPINDO's capability of being made a suitable channel for Bank finance, and if so, to propose the necessary changes and improvements. 15. The one-man consultant mission visited Indonesia in November 1969. It assessed the role of, and scope for, private enterprise in Indonesia. On the question of the DFC structure in Indonesia, the consultant suggested reorganizing BAPINDO and strengthen- ing regional development banks through Bank Indonesia. As regards the specific issue of the agency for channeling Bank funds, the consultant felt that the Development Bank for Indonesia (a joint venture promoted by Bank Indonesia and the Netherlands Finance Company for Developing Countries, with majority holding by the Dutch Government and its head office in the Netherlands at the time), properly established and staffed, might become a medium for World Bank Group financing even earlier than BAPINDO. 16. The reports issued by an audit firm, appointed by BAPINDO, were highly critical of the state of account-keeping practices of BAPINDO, and made detailed recommendations for setting them right. The auditors were unable to satisfy themselves independently concerning substantial loans from the Government for investment needs as also from Bank Indonesia for refinancing loans plus what appeared to be serious doubts concerning the collectibility of past loans due for - 6 - recovery. Therefore, as regards the accounts ending December 31, 1969 the auditors were unable to give an opinion on the fairness of the financial statements taken as a whole. One consequence of the auditors' reports was that the Bank recognized that any technical assistance package for reorganizing and strengthening BAPINDO would need to include an accounts expert. 17. Finally, the Bank mission in December 1969 examined BAPINDO's organization and operations in great detail (para 2.04 of the PCR). Its main recommendation was to transform BAPINDO into an institution specializing in providing term finance mainly to small- and medium- scale enterprises. The institution would have a sound capital structure and possess wide range of expertise and experience, and sound operational, technical and accounting procedures. It was to be autonomous in its decision-making, and capable of taking initiatives in its field of operations. The report made recommendations on the nature of technical assistance needed by BAPINDO and identified areas in which it should be provided. 18. The first six months of 1970 were devoted to a consideration of these various findings and the basis for undertaking discussions with the Government. The Bank appeared to have come to the conclusion that BAPINDO, at that stage, was not capable of using capital effectively or a viable financial institution. In the discussion on the preliminary draft of the consultant's report, the Government, while recognizing the need for more development finance institutions, had not supported the idea of re-constituting the (Dutch-sponsored) Development Bank of Indonesia; the Bank, therefore, favored setting up a traditional type of development finance company associated with the World Bank Group. The Bank was thus gradually pushing towards a three-tier DFC structure: (i) regional DFCs; (ii) BAPINDO concentrating on financing small- and medium-scale industries, mainly in the field of rehabilitation and modernization; and (iii) a new multinational DFC in which foreign shareholders and the Government (directly or through BAPINDO) were each to take minority shareholdings. The Negotiation Phase 19. It was with this package that a Bank mission went to Indonesia to discuss a program for Bank lending to the DFC sector in Indonesia. In the discussions the Bank suggested a revision in BAPINDO's charter and the need for BAPINDO to shed commercial banking activities and to close the branches (and, consequently, to reduce staff). The Government was reluctant to change BAPINDO's basic law or reduce its operations or branches. The Bank representatives affirmed their conviction that there would be need for a new development finance company even after BAPINDO's successful reorganization. - 7 - 20. At this stage it was apparent that the Government was keen on developing BAPINDO into an effective industrial financing insti- tution, and was seeking the Bank's help for this purpose; as the Bank noted, the Government was determined not to abandon BAPINDO, but to reconstruct it. Following the discussions, the Bank advised the Government that it was desirable the Government should take no signi- ficant action on BAPINDO without prior consultation with the Bank (later amended to read that the Government had agreed that it would advise the Bank of any significant action it intended to take on matters concerning BAPINDO); that the Bank would prepare a detailed commentary on the requirements of an amended BAPINDO law; and that the Bank would commence work on the preparations for setting up a new development finance company along the lines of other such institutions financed by the World Bank Group. The Pre-appraisal Phase 21. The next one year, approximately from August 1970 to August 1971 was devoted to determination and commencing of implementa- tion of steps to reorganize and strengthen BAPINDO and attempts to promote interest in the traditional Bank-style DFC. Almost each mission and each visit by Bank staff to Indonesia was devoted to discussion of these two issues. 22. With the receipt of the auditors' report, the Bank's attention was turned to determining the quality of BAPINDO's portfolio, reorgan- izing its capital structure, and finding advisors for it. A Bank mission, mounted in November 1970, made a fairly detailed study of BAPINDO loans to privately-owned projects and arrived at broad estimates of likely losses on these loans. As a result of the mission's work, the Government agreed to a revised capital structure for BAPINDO by taking off BAPINDO's balance sheet its old loans to State enterprises and increasing its equity. The Bank also asked the Government to bring about changes in the BAPINDO law to bring it in line with the Bank's concept of BAPINDO's activities and operational scope. The Bank's search for advisors led to the recommendation, accepted by the Government and BAPINDO, of three advisors for BAPINDO--one as advisor to the President, one as advisor on development banking and one on accounts. By July/August 1971, these advisors were in position, except that the advisor on development banking left almost immediately to take up a senior position in his home country. 23. In the meanwhile, in August 1970, the Government, concerned about BAPINDO's financial position, asked it to stop term-lending operations. At the same time, the Government gave BAPINDO a substantial emergency line of credit to enable it to meet cash withdrawals in case these came about. In November 1970, the Government issued a directive - 8 - to BAPINDO to segregate its commercial banking and development banking operations, to confine itself to development banking and to do com- mercial banking only in relation to its long-term borrowers. External auditors had carried out an audit of the 1970 accounts, but refused to certify them as internal controls and accounting systems were found to be too unreliable to certify the balance sheet without qualifica- tions. Early in 1971 the Government appointed a new President of BAPINDO. 24. The attempts to promote a new DFC, in the mould the DFC Department had been used to, seemed to make less progress. A steering committee was set up in the latter half of 1970 to stir up interest in and initiate design of the new DFC. The November 1970 mission reported little progress on the subject. Visits by Bank representa- tives showed that there were problems in raising the local part of the share capital. Ideas canvassed to allow IFC participation as local capital to supplement it, seemed to make little progress. 25. Moreover, the attempt to broaden the shareholding in the Development Bank of Indonesia and to shift its headquarters to Indonesia also did not seem to get off the ground. In the meanwhile, two commercial banks proposed, independently of each other, setting up wholly-owned subsidiaries for medium- and long-term lending. The respective spheres of medium-term lending operations, demarcated by Bank Indonesia, were thus not strictly adhered to by the State commercial banks and the commercial banks were competing with each other in the same fields. The Appraisal Stage 26. With these developments, the Bank sent in September 1971 a mission to appraise BAPINDO and to report on progress made on the new DFC. The Appraisal Mission reported that in the case of BAPINDO progress was not sufficient to justify the Bank proceeding with the credit, and suggested a new appraisal mission for BAPINDO in January 1972, with possibly an interim visit earlier to review progress. As regards the new DFC, the Mission found that nobody was enthusiastic about the proposal, the Steering Committee had neither been expanded nor made any progress, and the local feeling was that the process to set up the new DFC would be long drawn out and the Bank was pushing too hard. 27. The findings of the mission set off a major debate within the Bank. The Bank had indicated to the Government of Indonesia that on its and BAPIND,0's undertaking the reforms suggested by the Bank, BAPINDO would be eligible for Bank financing. The Resident Mission and the Region felt that the Government and BAPINDO had acted on Bank advice and the Bank had committed itself to financing BAPINDO. The Region felt that it was not always possible to achieve in Indonesia - 9 - the degree of institutional readiness attainable elsewhere, and the Bank had, as a matter of strategy, in a number of cases, provided funds to agencies in Indonesia as that was the only way of bringing about, within a reasonable period, the changes which were so vital for the progress of Indonesia. On the other hand, the DFC Department felt that the progress made by BAPINDO was not sufficient, and a further delay of four months (the time needed to mount the next mission) was justified. After discussion, it was agreed that the DFC Department would go ahead with the preparation of an appraisal and negotiations based on it, on the assumption that progress made during this process would justify Board presentation in March 1972. 28. By January 1972, progress was made in the sense that a term-lending advisor was identified, a draft BAPINDO Act was submitted to the Bank for comments, and BAPINDO was permitted to resume term lending. There were further discussions on interest rate structure, BAPINDO's accounting system, and disbursement, pre-payment and termination issues in relation to Bank financing. The credit proposal, presented to the Board on May 30, 1972, was viewed as marking the culmination of efforts, over a period of three years, in establishing a broad-ranging scheme of Bank Group assistance to financial insti- tutions in Indonesia. B. ASSESSMENT OF THE BANK DESIGN 29. By the time the Bank fielded, in September 1971, the mission to appraise BAPINDO for possible Bank Group financing, a period of four years had elapsed since the initiation of contact between BAPINDO and the Bank and a period of more than three years had passed since BAPINDO became formally eligible for Bank Group financing as a result of the revised policy of financing State-owned DFCs. During this period, besides a large number of visits by Bank representatives and discussions, both in the U.S.A. and in Indonesia, between the Government and BAPINDO officials and Bank representative, the Bank, as described above, carried out three major missions (one of them, including a consultant), to determine its DFC lending strategy and the agency for channelling its funds. Time Spent 30. The lack of knowledge about the local situation in Indonesia, where the Bank was then just initiating the lending process, made it necessary to obtain an understanding of the local economy, its laws and the envisaged role of the private sector in the country's industrial development. The state of BAPINDO, at the time it made its first approaches to the Bank, provided a natural argument 'for considering potential and possible channels for Bank Group's DFC lending. Even then, it appears that the time taken to arrive at the actual decision was inordinately long. - 10 - 31. In the first one year, counting from the time when public sector DFCs became eligible for Bank financing and BAPINDO made the first formal approach to the Bank (that is, from July 1968), the main action taken by the Bank was to arrange a visit to BAPINDO, which led to an identification of the issues involved in providing industrial finance in Indonesia and suggestions for an approach to such financing. Over the next three years, the progress made com- prised initiation of an audit process, reform in accounting systems and procedures, assessment of the portfolio, and appointment of advisors; three years was a long time to bring this about. Moreover, at the end, the solution found (reform and financing of BAPINDO) was the same as recommended after the first (December 1968) Bank visit on the lines suggested after it, and the subsequent efforts, while enormous in terms of manpower devoted and visits undertaken, represented, in fact, little change in terms of the final decision taken. Attitude Towards Financing Government DFCs 32. The DFC Department had, in the past, been sponsoring, and providing finance to, privately-owned DFCs, which depended, for their viability, on substantial support from the Government and continued financing by the Bank and other official lending agencies. When at first BAPINDO approached the Bank for assistance, this was the model (later, often referred to as "the traditional Bank-type DFC") which the Bank sought to support. Given this background and the state in which BAPINDO was in July 1968 when the Bank extended the scope of its DFC lending policy, it appeared natural to seek an alternative channel for Bank lending to industry in Indonesia. It was thus that, despite the recommendations of the first Bank mission, the DFC Department initiated the process for locating or promoting a DFC in the Bank's traditional mould. 33. This led to the Bank's second set of missions (including that of a consultant) which sought to identify an alternative channel and, subsequent attempts by the Bank, through visits and discussions, to set up a new DFC in the traditional mould. While the Bank con- tinued its dialogue on the shortcomings of BAPINDO and the need to set them right, it made serious and persistent efforts, including encouraging the formation of a steering group, to promote a privately- owned DFC. These efforts, despite the Government and Central Bank support, came to nought for reasons identified by the first Bank mission: lack of private capital and scope for private investment made such efforts premature at that stage. For the same reasons, the Bank's attempts to turn the Development Bank of Indonesia into a privately-owned local DFC by broadening its shareownership also failed to make any headway. The situation in Indonesia at the time was not receptive to such an institution. - 11 - Progress on Reforming BAPINDO 34. The Bank's preoccupation with promoting a new DFC also led to a gradualist approach to up-grading BAPINDO to meet Bank lending criteria. External auditors were appointed in the second half of 1969. However, thereafter, progress was painfully slow: an analysis of BAPINDO portfolio was initiated only at the time of the December 1970 Bank mission; a framework for reorganizing the capital structure was determined, and agreed to with the Government, and advisors were in position only by mid-1971. The shortcomings of BAPINDO--in the areas of organization and accounts-keeping, in project appraisal and supervision capability--had been identified in the first (1968) Bank mission report, and the steps taken, over a period of 2 1/2 years, were almost the same as suggested by that mission. The two signi- ficant achievements of the period, subjecting BAPINDO accounts to external audit and analyzing its portfolio, could have been done at least a year earlier, and the latter (as also the positioning of experts) two years earlier, than was actually done. 35. It is argued that the Bank did not have sufficient staff to expedite the process of DFC lending in Indonesia. In fact, some of the work, like external audit, did not need, beyond its identi- fication, Bank action; and some of the advisors were found from outside the Bank. The Bank's appreciation of the task involved, and the final design approved, made no progress beyond that reached under the first (1968-end) Bank mission. The Bank did not devote the additional time to evolving a design for its lending which would be in consonance with, and take full advantage of, the financial system prevailing in Indonesia. Finally, despite its limited staff, the Bank devoted considerable manpower and resources, in terms of missions, visits and consultant time, to the task of arriving at a DFC lending strategy in Indonesia. Framework for BAPINDO's Operations 36. The strategy which the Bank arrived at ultimately was to provide technical support to BAPINDO with a view to appraising it for Bank lending and to continue steps to promote a privately-owned DFC. From the earliest stages of its contacts with BAPINDO, the DFC Department had emphasized its preference for a specialized term- financing institution; in 1969 the Bank pointed out that the other DFCs associated with the Bank did not have branches. The specific design the Bank suggested for BAPINDO was to set it up as a one-unit institution specializing in term finance, thus requiring it to shed most of its commercial banking functions and also its branches. 37. Over the years Indonesia had built up a structure of banking and financial institutions which seemed to be geared to specializing - 12 - banks in various sectors. The result was that the operations of the banks were organized not according to their functions (deposit acceptance, short-term lending) or their maturity (commercial bank- ing, development banking), but according to the activity of the borrower. This was the structure to which Bank Indonesia gave formal recognition in 1969. 38. The Bank's attempts to restrict the scope of BAPINDO's operations did not fit in within this framework. To the extent BAPINDO was required to confine its operations to term financing, it denied BAPINDO commercial banking operations. Moreover, since the other banks (particularly Bank Negara Indonesia 1946 and Bank Dagang Negara) carried on medium-term lending operations (and local currency could be used to make imports), they were able to meet all their clients' needs, leaving little scope to BAPINDO for business from existing units. Both the Government and BAPINDO tried to resist this narrowing of the scope of BAPINDO operations, and the Government referred to the practical difficulty of formally amending the BAPINDO law. The main reason for the Bank's insistence on BAPINDO dropping its commercial banking activities was that till then it was committed to the model of a specialized one-unit DFC operation, unencumbered by commercial banking activities or branches. In the specific case of BAPINDO, this was buttressed by the fact that BAPINDO had proved institutionally weak and the Bank considered it not capable of handling both commercial and development banking activities. Since, however, this concept of functional specialization was not known or practised in Indonesia and commercial banks provided to their clients both working capital and medium-term loans, the Bank's concern about over- loading BAPINDO management seemed to be inappropriate to the local context. 39. BAPINDO had an established set-up--personnel, branches-- for commercial banking, and its staff had experience of it; what was needed was technical support to strengthen it, which BAPINDO had obtained on its own. The Bank's recommendation to the Government and BAPINDO to drop its commercial lending activities (except in relation to its clients) thus imposed upon BAPINDO a greater strain of adjustment, and was not in keeping with the financial system operating and understood in Indonesia. 40. One consequence of this advice was that BAPINDO was required to close its branches and to reduce its staff. In the situation of Indonesia, the first Bank mission had recognized the practical dif- ficulties involved in such a course. The Government, in later discussions, referred to the same problems, and also mentioned that it might slow down the appraisal, supervision and decision-making processes at BAPINDO. However, the Bank insisted upon this being - 13 - done. As experience showed, while BAPINDO made some progress in reducing its branches (mainly by converting them into representa- tive offices) and its staff, this was not to the extent expected by the Bank. 41. Summing up, while the Bank took almost three years to accept BAPINDO as an eligible applicant for appraisal, the actual progress on the reform and strengthening of BAPINDO--except for training BAPINDO personnel and assessment of the quality of its portfolio-- was small. Moreover, the Bank imposed upon BAPINDO a narrow degree of specialization not in keeping with the financial system laid down by the central banking authority and prevailing in the country. The DFC Department thus missed the opportunity of fully utilizing the scope allowed under the Bank's new policy, also of innovating by channelling its term-lending activities through a commercial bank, and of allowing access to Bank funds to more than one financing institution (which, in the form of other commercial banks providing medium-term financing to industry, were available in Indonesia)--all objectives which were also in consonance with the needs and wishes of the borrowing country. C. OBJECTIVES AND EXPECTATIONS 42. BAPINDO having brought about the required changes in its organization, capital structure and operative policies, the Association approved in May 1972 a credit of US$10 million to the Government for on-lending to BAPINDO. It was assumed that there were large invest- ment opportunities and, given resources, there would be adequate scope for business. BAPINDO was expected to emerge as the sole provider of medium- and long-term funds to industry, tourism and transport sectors. It was expected that the funds would be used to finance small- and medium-scale enterprises, and they would be committed over a period of two to three years. 43. The process of institutional development initiated prior to the credit approval, as was to be expected, was proposed to be con- tinued during the period of the credit. Further, specific changes and reforms were expected to be carried out in the short run. BAPINDO's operating costs were considered to be on the high side. BAPINDO was expected to close down a large number of branches (transferring its short-term accounts to other State banks), and to reduce its staff substantially. It was also expected that it would shed its commercial banking activities, except those for its clients. A Policy Statement (reproduced in the Appraisal Report No. DB-90a), in line with policy statements adopted by other Bank-associated DFCs, required BAPINDO to carry on its operations on an independent analysis of project viability. BAPINDO was expected to enjoy autonomy in its operations. - 14 - Finally, it was expected that a draft BAPINDO law, discussed with and approved by the Bank and in keeping with the Bank's views on DFC functioning, would be passed soon. D. BAPINDO OPERATIONS Use of Bank Funds 44. It was expected that the Credit would be committed and fully disbursed by December 1976. In fact, the Credit was committed by March 1975, and, disbursed, after two extensions and a cancel- lation of US$0.45 million, by August 1977. The profile of actual disbursement, after showing a lag till December 1975 in relation to projected disbursement, shows a close correspondence with it over the subsequent years. 45. The flow of sub-projects was slow in the initial stages, and the Association's first supervision mission concentrated on the need to expedite this flow and thus the process of disbursement under the credit. As the advisors performed the training job and built up BAPINDO's appraisal capability, the flow of appraisals increased considerably, particularly in 1974. 46. In all, 26 sub-projects were financed out of the Credit, 18 of them for a total amount of US$9.1 million being above the free limit US$100,000. The rather large number of sub-projects above the free limit indicates that the free limit, in relation to the scale of projects coming up in Indonesia and the amount of financing required for them, was on the small side--a cautious approach justified by the past history of BAPINDO and the fact that the Credit represented the Bank Group's first operation with it. 47. The rather large amount of financing involved in sub-projects above the free limit requires further explanation. The average financing per sub-project above the free limit was US$530,000 (or more than five times the free limit) against about US$53,000 for sub-projects below the free limit. Only five sub-projects were above this average, and two sub-projects (one textiles and one cement) accounted for almost 50% of the amount under the Credit. It is apparent that the size distribution of the sub-loans was highly skewed, and the large sub-projects substantially helped in raising the scale of operations of BAPINDO and in the pace of commitment and disbursement of the Credit. 48. The sub-project costs and their characteristics are given in Annexes 1 and 2 of the PCR. They show that, except for the con- centration arising out of the two large sub-loans, the distribution of the Credit in size, industry and geographical area was evenly balanced. Data on the sub-projects is given in Annexes 4 and 5 - 15 - and are analyzed in Section 4 of the PCR. During a visit to one of the sub-projects, an OED mission found that the plant had been operating at about two-thirds capacity and had made its first profit in 1978. It had been facing shortage of raw materials and working capital. BAPINDO had appointed an officer (for a period of three months) to examine its books and bring about improvements in accounting practices. BAPINDO had also required it to appoint, besides the family selling agency, another independent selling agent. Overall Operations 49. The following table gives, on a commitment basis, the projected and actual level of operations of BAPINDO over the years 1972 to 1975: In Rp Billion 1972 1973 1974 1975 Total Term Loans Investment Projected 4.00 6.00 8.00 10.00 28.00 Actual 2.27 7.30 17.04 19.53 46.14 Working Capital Projected 1.00 1.50 2.00 2.50 6.00 Actual 0.70 2.64 5.11 5.13 13.58 Raw Cotton Loans Projected* 10.13 10.13 10.13 10.13 40.52 Actual 14.36 38.54 16.41 - 69.31 * Source: Appraisal of Bank Pembangunan Indonesia (BAPINDO), Report No. DB-90a, Annex XII. In addition, BAPINDO made equity investments and small co-financing loans with regional development banks for which the Bank had not projected any operations, and it made no short-term loans (against a Bank projection of Rp 2.55 b.) over the 1972-1975 period. In respect of all categories of operations (other than short-term loans), Bank projections proved conservative in relation to actual operations. 50. The actual operations to some extent also reflect charac- teristics of BAPINDO's project-financing activities and realities of the investment and financial situation in Indonesia. Apparently, the sharp jump in term-loan operations was due mainly to