CHAPTER 8 THE DYNAMIC PRESENCE OF BMT IN YOGYAKARTA …
8.2. General Attribute of BMT Institution
8.2.5. BMT Supervisory and Governance System
As for its generic counterparts, the supervisory and governance framework is very important for BMT. It is obvious that a sound and healthy BMT sector is determined by how the management performs daily operations. Sound governance is necessary to ensure that the operation complies with laws and regulations.
The general practice in the BMT sector is that the board of management is overseen by internal and external supervisory bodies.
The Cooperatives Law states that the primary role of the government toward the cooperatives sector is as a regulator, supporter and facilitator. However, the MENEGKOP-UKM policy demonstrates that the government has a limited role in daily monitoring of the management of the cooperatives including the BMT sector.
The BMT supervisory mechanism is regulated in the MENEGKOP-UKM decrees:
No.35.2/Per/M.KUKM/X/2007 and No.35.3/Per/M.KUM/X/2007. These regulations outline the supervisory and monitoring procedures and also specify the main roles, duties and responsibilities of the official government supervision of the cooperatives sector, including the BMTs. The decrees specifically stipulate a compulsory audit for all BMTs with a total loan portfolio over IDR 1 billion; the annual financial audit must be carried out by a public accounting office or registered cooperative audit agency.
The internal supervisory framework of the BMT system is embedded in the institutional structure. The self-monitoring function is carried out by a supervisory board on a daily basis and by the collective monitoring of the members. The supervision of BMT operations comprises of a management supervisory board and a Sharia supervisory
board. These boards are appointed by the board of management with endorsement of the members at the AGM.
The management supervisory board (DPM) consists of three members competent to perform supervision and monitoring including audit functions. The DPM monitors the BMT’s operations regularly by conducting offsite and on-site inspections of the overall operation, management performance and financial sustainable.
The Sharia supervisory board (DPS) is set up to oversee BMTs’ operations, specifically whether it is consistent with Islamic financial transaction jurisprudence (Fatwa of MUI), including to what extent the institution is run according to the general socio-religious norms of the community (see also Section 8.2.1.). The DPS comprises one to three members who should have sufficient knowledge both in Sharia law and economic areas. The role of DPS is to independently examine the compliance of financial contracts, the accounting system and the entire scope of the BMT’s operations. If the BMT management breaches a Fatwa, the DPS should respond immediately and suggest the manager take appropriate corrective action.
In relation to the internal BMT supervisory mechanisms, the functions of the DPM and the DPS are clearly delineated and both are under the coordination of the management board. This board is responsible for examining the monthly monitoring reports from DPM and DPS, and at the end of financial year, the report should be approved by the members at the AGM. Then, the approved annual report, including the financial statement, is submitted to the government agency where the BMT is registered for further assessment.
The BMT supervision methodology (the MENEGKOP-UKM decree No. 35.3/Per/M.KUM/X/2007) explains the nature of the assessment process that can be performed through on-site and off-site supervision. On-site visits and interviews are conducted with the board and management, while the off-site techniques involve an examination of the main financial reports, including the balance sheet and profit and loss statement.
The core of the BMT assessment comprises eight financial and non-financial indicators:
capital, asset quality, management capability, efficiency, liquidity, self-sufficiency and growth, cooperative identity, and Sharia-compliance. Five of those elements – capital,
asset quality, management capability, efficiency, liquidity performances – are examined through the CAMEL assessment that is adopted from commercial banking practice.
Self-sufficiency and growth indicators are examined using the quantitative assessment method that was developed by the MENEGKOP-UKM. The other indicators (management capability and Sharia-compliance) are carried out by using a qualitative approach through a list of questionnaires, whereby each indicator is weighted and scored proportionally and, at the end, the scores are tabulated to determine an overall classification. The four categories of the BMT performance are described in Table 8.3.
Table 8.3. Composite Classification of BMT Institution Performance
Management and financial assessment
Score Explanation
Sound 81 ≤ 100 Indicates BMT performance is superior.
Fairly sound 66 ≤ 81 Depicts a performance above average, strong operation and sustainable.
Less sound 51 ≤ 66 Represents a lower performance that is below average with several areas of weaknesses hence in the long-term perspective could threaten the sustainability of the BMT institution.
Unsound 0 ≤ 51 Suggests a lowest performance and critically vulnerable, with a high ratio of NPF, inefficient, unprofitable, breach the rules etc.
therefore it need immediate actions to improve the performance.
Sharia Compliance
Complies 7.51 – 10 Demonstrates the BMT operation fulfills all relevant Fatwa and the Sharia principles.
Satisfactory compliance
5.01 – 7.5 Suggests that BMT institution need to carry out further correction toward specific transactions as stated in the Fatwa.
Less compliance 2.51 – 5 Implies BMT institution to some extent violates the Fatwa and strongly advised to review the operation procedures.
Does not comply 0 – 2.5 Indicates BMT institution substantially breaches the Fatwa and the Sharia principles.
Source: MENEGKOP-UKM, decree No. 35.3/Per/M.KUM/X/2007
As previously mentioned, the current BMT evaluation model is a mixture of the Islamic banking assessment methodology (CAMEL and Sharia compliance module) and the general cooperative assessment procedure. However, the method does not fully
encompass the nature of BMT both as a faith-based financial cooperative and community-based microfinance institution because of several limitations.
First, in the microfinance sector, ideally the assessment should consider a three- dimensional microfinance context – sustainability, outreach and impact (Zeller and Meyer 2002). In fact the current assessment only focuses on financial and managerial issues.
Second, given that in the BMT sector there are subsidised government funds in the BMTs’ lending portfolios, it is important to measure the effect of the subsidy on the sustainability of the BMT institution. This is not considered in the MENEGKOP-UKM supervisory system (see further discussions in Chapter 9).
Finally, as BMT financial operations consist of minuscule transactions, its Sharia compliance should be more specifically designed, instead of using the Islamic banking model. In this regard, the MENEGKOP-UKM and the Indonesian Islamic Council (DSN-MUI) should design a Sharia-compliant module which is suitable for BMT.
The conceptual framework of the BMT supervisory system emphasises that the MENEGKOP-UKM or the cooperatives government authority is the main institution responsible for the supervision of the soundness of the BMT sector. Within the MENEGKOP-UKM organisational structure, there is a section responsible for supervision. However, field observations suggest that the government has relinquished this monitoring role to the BMTs themselves.
This study confirms previous research that the government agencies do not adequately oversee the BMT sector; this lack of supervision applies not only to the BMTs but also to the entire cooperative sector (Seibel 2008). The main problem is the lack of competent supervisors to perform routine monitoring of cooperatives. Even though the BMT system is less complicated than the banking system, there is a need for specific supervisory knowledge and skills to understand the nature of the financial transactions especially those conducted using the Islamic financial model.
Government supervision has become even more complicated since the regional autonomy regime has been implemented in the early 2000s. The MENEGKOP-UKM and the local authorities have encountered a shortage of experienced and skilled
supervisors because many of them have been moved to positions in other government agencies. Another critical issue is the insufficient budget allocation to support the government monitoring function, as stated by Bambang Harimurti and Titik. They state that since the role of the government is mainly as a facilitator, hence the budget allocation is focused more on strengthening the capital and liquidity of the BMT sector, in particular after the earthquake disaster, and to improve quality of the BMT management and staff by conducting regular training programs (interviewed on 8 June 2009).
Accordingly, to deal with limited resources for competent supervisors and an adequate budget, the supervisory agency is likely to employ a minimalist strategy of off-site supervision) by requiring BMTs to submit their AGM reports to be used as a database to carry out the institutional assessment, instead of conducting regular on-site supervision.100 It is obvious that this minimalist monitoring approach is usually unable to detect internal managerial problems and fraudulent activities, and thus there is a failure to undertake immediate and appropriate actions whenever there is problem in a BMT.
Within the BMT, supervision problems arise because most members of the supervisory board have little or no experience and knowledge regarding the general nature of Islamic banking and Islamic microfinance, especially BMT financial operations. As discussed in the previous section, many of the board members are clerics and others who have no expertise in finance. Most board members are not qualified to occupy the position and carry out a supervisory role.
From the surveys conducted and discussions with key informants, the findings show that in many BMTs, the internal monitoring function does not work effectively as specified in the supervision guidelines. The DPM position seems only a formal structure because, in practice, the manager is the key person responsible for managing and monitoring the entire BMT operation. It can be seen from the AGM reports that the boards are likely only to issue a normative statement rather than a monitoring report to portray the factual condition of BMT. There have been several cases of mismanagement
100 The MENEGKOP-UKM decree stipulates that the BMT institution must submit its annual general meeting report and, more specifically for BMT, which manages over IDR 1 billion, its financial statement must be audited by a public accountant.
and fraud in BMTs that were not reported until they were exposed to the public by staff and members101, i.e. the case of BMT Amartani (see further discussion in Section 9.5.1).
Similarly, the research findings reveal several shortcomings relating to the Sharia- compliance issue. Referring to Muhamad (a member of the DPS of several BMT institutions), the problems arise because the DPS function in the BMT organisational structure was ineffective (if any) or absent since in the beginning. The majority of DPS members do not have an adequate knowledge of Islamic banking and financial standards and practice (interviewed on 15 July 2009). Totok Suparwoto, a BMT activist in Yogyakarta, recognises the problem:
In the beginning we encountered tremendous challenges because the background of the majority of BMT personnel was in Islamic teachings and social sciences. In other words, when we established the BMTs, the religious spirit and motivation to promote Islamic values was more dominant than the banking and microfinance practical knowledge (interviewed on 23 June 2009).
A study of the Islamic Development Bank Research and Training Institute (IRTI) suggest a similar finding – that the Sharia governance practices within the Islamic microfinance sector, i.e. the BMT sector, is not standardised and therefore it is difficult to assess the level of compliance (IRTI 2008). Not surprisingly, Muslim scholars who have scrutinised the operations and practices of BMTs have expressed concerns about the governance and compliance of their Sharia modus operandi (Karim et al. 2008).
This concern is also highlighted by Suryadarma Ali, the Minister of Cooperative, Small and Medium Enterprises for period of 2004–09. He criticised the practices of some BMTs that fail to satisfy the Sharia compliance regulations (Eramuslim 2007), for instance the cases of 22 BMTs in the Serang District of Banten province (BPK 2006).
Hartarska and Nadolnyak (2007) point out that ineffective regulation, supervision and governance framework has been costly for BMTs and the entire microfinance sector.
101 In beginning of the study there were several BMTs involved as samples, but without explanation reason the BMTs withdrew as they did not submit financial reports. An informal confirmation mentions that the BMTs faced financial problem due to mismanagement and fraud.