Microfinance Institutions Move Out of Regulatory Black Hole

Microfinance Institutions ("MFIs") play an important role in Indonesia, dispensing financial support to people and small businesses that might not have qualified in the traditional banking system. Until recently MFIs largely operated without a comprehensive regulatory framework to guide their operations, and with little supervision.

After a long wait the Government has issued a framework for MFIs, as provided by Law No. 1 of 2012 (the "MFI Law") regarding Microfinance Institutions, which was enacted on January 8, 2013. The MFI Law governs all aspects of MFIs, from their establishment to their areas of operation and their permitted activities.

The MFI Law is seen as a tool to give these institutions the support they need to provide financial and other types of support to small entrepreneurs. The new law states that MFI activities include providing loans or financing, managing deposits, and providing business consulting services. MFIs, according to the MFI Law, can operate based on a conventional or Shariah basis.

There are a number of prohibitions in the MFI Law. MFIs cannot conduct business outside of their licensed geographical area, either a village, a district or a regency/city. An MFI that engages in business across different regions will be required to transform itself into a bank. Also, the law prohibits MFIs from offering giro, acting as a guarantor, or providing loans or financing to other MFIs unless such financing is designed to save the other MFI from liquidation.

Under the MFI Law, several requirements must be fulfilled for the establishment of an MFI. The MFI must be established in the form of a legal entity that is either a cooperative or a limited liability company ("PT"), and it has to meet the capital requirements. It also must obtain a business license from the Financial Services Authority ("OJK").

Foreign nationals or any entity owned by foreign nationals or a foreign-owned enterprise are prohibited from owning an MFI.

The OJK is given extensive powers under the MFI Law to develop, regulate, and supervise MFIs. The OJK is authorized to approve the restructuring of an MFI through either a merger or consolidation, and it can also approve the liquidation of an MFI.

Rather vaguely, the MFI Law stipulates that the OJK shall support both MFIs and their customers in micro-financing transactions. What this means in practice will be in large part determined by regulations to be issued by the OJK that should contain further details on MFI activities, licensing procedures, and the procedures for dissolving an MFI. The MFI Law does not come into effect until 2015, giving MFIs and small entrepreneurs two years to adjust to the new requirements.

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