Simulating the units' default rates if LKP wrote off 100 percent of its loans in default each year, the volume of loans in default is equal to 5.5 percent of net outstanding loans in 1995 for the system as a whole system~Bad (excluding one unit for which data is not available). Two units have maintained consistently low default rates over the last three years. One

**Table 17** Adjusted Annual Default Rates" for LKP Units in Dompu **District (Percent)**

|**Units**|**1993**|**1994**|**1995**|
|---|---|---|---|
|Total|_11.5_|3.8|5,5D|
|Hu'u|45.8|31.0|NA|
|Montabaru|1.7|**0.3**|**1.1**|
|SanuIu|<br>24<br>|<br>36<br>|06<br>|
|<br>Bada|.<br>2.2<br>|.<br>1.6<br>_____6|.<br>12.6<br>1_|

a/ (Volumc of Loans in Arrcars bv 90 Davs or More in Year I - Volume of Loans in Arrcars by 90 Days or More in Year 0)/ (Outstanding Loan Volumc in Year I - Loan Volume in Arrears by 90 Days or Mores in Year **0).** b/ Excludes the Htu'u uniit for whichi 1995 data were not available.

unit had low default rates in 1993 and 1994, but experienced a significant upsurge in 1995, and one unit experienced default rates in excess of 30 percent for the two years for which information was available (Table 17). The program's default rate is somewhat higher than that which would be considered sound by international microcredit standards.3<sup>5</sup> It is very difficult to estimate unit profitability as income statements and balance sheets provided by the BPD contain some apparent errors, omissions, and inconsistencies. Further, basic earnings measures, such as return on equity and return on assets, are problematic given that the LKPs receive endowment grants and in-kind gifts including supervis.ion by the BPD at a subsidized cost. The units receive an additional implicit subsidy in that they do not pay taxes on income. Finally, the units do not adequately provision for bad debt.

If all of these factors are ignored, the three units for which information is available showed a combined real (above inflation) return on assets of I to 6 percent over the last three years. However, if rough estimates of expenses for depreciation of fixed assets, adequate loan loss provisioning, taxes, reserve requirements, and full supervision costs are made, 36 and the units'

> **35** The Committee of Donor Agencies for Small Enterprise Development (1995) set as an acceptable standard for microenterprisl **e** nding. that lender **s** hould have annual losses from defaults of 4 percent or less of outstanding loan volume. LKP's 1995 rate is above this level and did not include defaults for its most troubled branch.

- **36** There is no need to impute additional interes **t** o LKP liabilities because LKP pays market interest rates on liabilities. For a number of ycars the LKP system had loans from the provincial BPD for which it paid below-market "interest rates"; which also served as fees for supervision. However, these loans were converted to equity in 1995. For the purposes of this analysis. these loans are treated as **equity** for all years and the interest expense/supervision fee is treated as a supervision fee.

The LKP system also funds part of its portfolio from savings accounts required from borrowers. These required savings accounts earn an interest rate below that which the program would have to pay to obtain marginal additional resources from anotlier source. For the purposes of this analysis. this practice is 46