Completion Report. Project Number: Loan Numbers: 2291, 2292 December Pakistan: Improving Access to Financial Services (Phase I) Program

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1 Completion Report Project Number: Loan Numbers: 2291, 2292 December 2009 Pakistan: Improving Access to Financial Services (Phase I) Program

2 CURRENCY EQUIVALENTS Currency Unit Pakistan rupee/s (PRs) At Appraisal At Program Completion 31 October June 2008 PRs1.00 = $ $ $1.00 = PRs60.57 PRs67.85 ABBREVIATIONS ADB Asian Development Bank ADF Asian Development Fund ATM automated teller machine CBR Central Board of Revenue CGAP Consultative Group to Assist the Poor CIB credit information bureau CWCD Centre for Women's Cooperative Development DFID Department for International Development (U.K.) FIP Financial Inclusion Programme (of DFID) FMFB The First MicroFinance Bank GIS geographic information system IAFSP Improving Access to Financial Services (Phase I) Program ILO International Labour Organization ISF Institutional Strengthening Fund IT information technology LIBOR London interbank-offered rate MFB microfinance bank MFI microfinance institution MIOP Microfinance Innovation and Outreach Program MOF Ministry of Finance MOIT Ministry of Information Technology MSDP Microfinance Sector Development Program NBP National Bank of Pakistan NEC National Economic Council NGO nongovernment organization NRSP National Rural Support Programme OCR ordinary capital resources OSS operational self-sufficiency PCIU Program Coordination and Implementation Unit PMN Pakistan Microfinance Network PPAF Pakistan Poverty Alleviation Fund PRISM Program for Increasing Sustainability and Outreach in Microfinance PTA Pakistan Telecommunications Authority QCBS quality and cost-based selection ROA return on assets ROE return on equity RRP report and recommendation of the President RSP rural support program SBP State Bank of Pakistan SDR special drawing rights TA technical assistance

3 NOTES (i) (ii) The fiscal year (FY) of the Government ends on 30 June. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2008 ends on 30 June In this report, "$" refers to US dollars. Vice President X. Zhao, Operations Group 1 Director General J. Miranda, Central and West Asia Department (CWRD) Director R. Subramaniam, Financial Sector, Public Management, and Trade Division, CWRD Team leader Team member N. P. Knoll, Financial Sector Specialist, CWRD C. Nazario, Associate Project Analyst, CWRD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

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5 CONTENTS Page BASIC DATA I. PROGRAM DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 1 A. Relevance of Design and Formulation 1 B. Program Outputs 2 C. Disbursements and Program Schedule 8 D. Implementation Arrangements 8 E. Conditions and Covenants 8 F. Related Technical Assistance 10 G. Consultant Recruitment and Performance 10 H. Performance of the Borrower and the Executing Agency 10 I. Performance of the Asian Development Bank 11 III. EVALUATION OF PERFORMANCE 11 A. Relevance 11 B. Effectiveness in Achieving Outcome 11 C. Efficiency in Achieving Outcome and Outputs 12 D. Preliminary Assessment of Sustainability 12 E. Impact 12 IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 13 A. Overall Assessment 13 B. Lessons Learned 13 C. Recommendations 14 i APPENDIXES 1. Status of Compliance with Loan Covenants Pakistan Microfinance Sector Data Annotated Design and Monitoring Framework 26

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7 BASIC DATA A. Loan Identification 1. Country 2. Loan Numbers 3. Program Title 4. Borrower 5. Executing Agency 6. Amount of Loans 7. Program Completion Report Number Pakistan 2291-PAK; 2292-PAK (SF) Improving Access to Financial Services (Phase 1) Program Islamic Republic of Pakistan Ministry of Finance $300 million (OCR) SDR million (ADF) $20 million equivalent PCR: PAK 1138 B. Loan Data 1. Appraisal Date Started Date Completed 2. Loan Negotiations Date Started Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness In Loan Agreement Actual Number of Extensions 6. Closing Date In Loan Agreement OCR Loan ADF Loan Actual OCR Loan ADF Loan Number of Extensions 7. Terms of Loan OCR Loan Interest Rate Maturity (number of years) Grace Period (number of years) ADF Loan Interest Rate Maturity (number of years) Grace Period (number of years) 16 October November November November December December March January December March June January London interbank offered rate % % during grace period; 1.5% thereafter 24 8

8 ii 8. Disbursements a. Dates i. OCR Loan Initial Disbursement 12 January 2007 ii. Effective Date 10 January 2007 ADF Loan Sole Disbursement 12 January 2007 Effective Date 10 January 2007 Final Disbursement 27 June 2008 Original Closing Date 31 December 2008 Original Closing Date 31 March 2007 Time Interval 17.5 months Time Interval 24 months Time Interval 3 months Category or Subloan b. Amount ($) i. OCR Loan Original Amount Net Amount Amount Allocation Canceled Available Disbursed million million 300 million 0 Category or Subloan ii. ADF Loan (SDR) Undisbursed Balance Original Amount Net Amount Amount Allocation Canceled Available Disbursed 01 13,425, ,425,000 13,425,000 0 C. Program Data 1. Program Cost ($) ADB Portion Cost Appraisal Estimate Actual Foreign Exchange Cost OCR Loan 300,000, ,000,000 ADF Loan 20,000,000 20,078,712 Total 320,000, ,078, Program Performance Report Ratings (OCR and ADF) Undisbursed Balance Ratings Development Implementation Progress Implementation Period Objectives 31 December 2006 Satisfactory Satisfactory 31 January 2007 to 31 December 2008 Satisfactory Highly Satisfactory D. Data on Asian Development Bank Missions Name of Mission Date No. of Persons No. of Person-Days Specialization of Members a Consultation Fact-Finding 6 17 June July a, b, g a, b, c Appraisal 16 October 7 November a, b, c, d, e Loan Review 8 14 April f a a = principal financial sector specialist, b = financial economist, c = project implementation specialist, d = economic officer, e = senior counsel; f = financial sector specialist, g = director.

9 I. PROGRAM DESCRIPTION 1. The Improving Access to Financial Services (Phase I) Program (IAFSP) for the Islamic Republic of Pakistan was approved on 14 December The program consisted of a $300 million program loan (Loan 2291-PAK) from ADB's ordinary capital resources (OCR), an SDR-denominated loan (Loan 2292-PAK) equivalent to $20 million from ADB s special funds resources (ADF loan), and a $2 million technical assistance (TA) grant (TA 4894-PAK). The entire proceeds of the ADF loan were used to establish a 20-year endowment fund managed by the State Bank of Pakistan (SBP) and administered by a committee composed of representatives of five stakeholders SBP, the Pakistan Microfinance Network, the Pakistan Banks Association, the Pakistan Poverty Alleviation Fund (PPAF), and academia. (ADB acted as an observer to the committee.) The Japan Fund for Poverty Reduction financed an additional grant of $2 million to support the program s objectives (JFPR 9105-PAK), 2 although this grant was not implemented and was cancelled in The IAFSP aimed to reduce poverty; build a more inclusive, competitive, and efficient financial sector; and promote sustainable economic growth. Its objective was to ensure access to sustainable institutional financial services at competitive prices for poor and low-income households and their microenterprises. Under the program, the Government of Pakistan agreed to enact an enabling policy, legal, and regulatory framework, and to implement other actions to remove constraints to the growth of microfinance institutions. These actions included (i) promotion of technology and applications to achieve a national scale of microfinance services at reduced cost; (ii) expansion of the range and quality of financial products and services provided by microfinance institutions (MFIs); (iii) development of public private partnerships to expand outreach; (iv) development of reliable business and credit information and systems; (v) provision of fast, reliable, and lower cost remittance services for overseas workers; and (vi) financial literacy and capacity building. 3. The IAFSP had four components: (i) development of policy, legal, and regulatory frameworks for microfinance; (ii) microfinance product diversification and innovation; (iii) capacity building, institutional strengthening, and restructuring of MFIs; and (iv) financial and basic microfinance literacy. The first two components were to be addressed by the program loan conditions, while the third and fourth components were to be addressed by grants from the endowment fund created under the ADF loan. II. A. Relevance of Design and Formulation EVALUATION OF DESIGN AND IMPLEMENTATION 4. At present, only 14% of Pakistanis are using a financial product or the services of a formal financial institution, compared with 32% of Bangladeshis, 48% of Indians, and 59% of Sri Lankans. 3 In recent years, Pakistan has been moving to cultivate an inclusive financial sector 1 ADB Report and Recommendation of the President to the Board of Directors on Proposed Loans and a Technical Assistance Grant to the Islamic Republic of Pakistan for the Improving Access to Financial Services (Phase I) Program. Manila. 2 ADB Grant Assistance to the Islamic Republic of Pakistan for Microfinance for the Poorest (Financed by the Japan Fund for Poverty Reduction). Manila. 3 T. Nenova, C. T. Niang, and A. Ahmad Bringing Finance to Pakistan's Poor: Access to Finance for Small Enterprises and the Underserved. Washington, DC: World Bank. pp. xv-xvi. More than half of the population saves, and more than one-third borrow, but only 8% and 3% of the population, respectively, use formal financial institutions to do so (p. xvi). Compared with Bangladesh, there are fewer loan accounts (22 per 1,000 people, compared with 55) and fewer deposit accounts (192 per 1,000 people, compared with 229) (p. 10). An inclusive financial sector does not imply 100% penetration, however. Nineteen percent of the population does not see the usefulness of being financially served, and an additional 16% are unemployed and probably could not be profitably served (p. 32). Moreover, there is a strong aversion to debt (p. 49).

10 2 one that serves all of the country's population, including the poor. Under ADB's Microfinance Sector Development Project (MSDP), a lead microfinance bank Khushhali Bank was established in 2000 as a strategic way to promote microfinance. 4 MSDP also promoted the establishment of six additional microfinance banks. However, total outreach remained relatively small, with most of the poor having no access to basic banking services. The IAFSP was designed to help the Government of Pakistan implement reforms that would help expand the delivery of financial services to the poor. The program's design was relevant to its objectives. 5. The IAFSP was also consistent with ADB's microfinance strategy, with its country strategy and program for Pakistan, and with the government's Medium-Term Development Framework and Strategic Directions to Achieve Vision B. Program Outputs 6. The program identified eight key issues, constraints, and opportunities facing the development of an inclusive financial sector (Table 1). Item Table 1: Key Issues, Constraints, and Opportunities Facing the Development of an Inclusive Financial Sector Lack of a national strategy for an inclusive sustainable financial sector Overdependence on donor funds for both wholesale finance and operating costs Technical challenges and high transaction costs because of an absence of infrastructure and a lack of mobility of clients, in particular women and people living in rural areas Lack of reliable business and credit information that impedes the access of credit and increases delivery costs Lack of diverse financial services and products to meet local needs and priorities Action Proposed Under the IAFSP Adopt a national strategy None Adoption of a model agreement for using Pakistan Post to provide services to financial institutions Create a credit information bureau Promote Islamic banking, branchless banking, and mobile banking Current Results of Action Taken Strategy adopted; limited results (e.g., Khushhali Bank operating under 2001 Ordinance). N/A Pakistan Post is disbursing loans for two microfinance banks. None; a pilot project has not yet been implemented. Islamic banking: The promulgation of regulations has not resulted in the provision by financial institutions of new Islamic products for the poor. Mobile banking: Six mobile branch offices were established by the end of Branchless banking: Several initiatives have recently been launched. 4 ADB Program Completion Report on the Microfinance Sector Development Program in Pakistan (Loan 1805-PAK). Manila; ADB Project Completion Report on the Microfinance Sector Development Project in Pakistan (Loan 1806-PAK). Manila. 5 ADB Finance for the Poor: Microfinance Development Strategy. Manila; ADB Country Strategy and Program for Pakistan, Manila. p. ii; ADB Pakistan: Country Strategy and Program Update, Manila. p. 3; Government of Pakistan Pakistan Interim Poverty Reduction Strategy Paper (I-PRSP), Islamabad. paras. 117, ; Government of Pakistan Accelerating Economic Growth and Reducing Poverty: The Road Ahead (Poverty Reduction Strategy Paper), Islamabad. paras scan_d4a612cf62fe9576=0&bcsi_scan_filename=cr0424.pdf

11 3 Item Unequal treatment of microfinance banks, including different legal status Lack of education and literacy (basic and financial), especially among women and in rural areas Capacity building of financial services providers and authorities Action Proposed Under the IAFSP Place Khushhali Bank under same legal regime as other microfinance banks Promote basic and financial literacy initiatives using income from the endowment fund created under Loan 2292-PAK Promote capacity building of financial services providers and authorities using income from the endowment fund created under Loan 2292-PAK Current Results of Action Taken Done; there has been no effect on Khushhali Bank or the microfinance sector. None; the endowment fund has not yet disbursed any grants to support literacy initiatives. None; the endowment fund has not yet disbursed any grants to support capacity building initiatives. 1. National Strategy for Inclusive Financial Sector 7. Pakistan's national strategy, which was issued in February 2007, established a goal of reaching 3 million borrowers by To achieve this goal, the strategy propounded a threepronged approach: (i) require microfinance providers to operate on a sustainable (costrecovery) basis; (ii) raise private domestic capital for microfinance providers; and (iii) build the human resource base of microfinance providers. The national strategy also recommended changes in the operations of Khushhali Bank, PPAF, and the National Rural Support Programme (NRSP). Most of the recommendations of the national strategy have not yet been implemented. For example, Khushhali Bank has not been sold to a strategic investor, PPAF has not diversified its operations, and NRSP has not completed the transformation of its microfinance lending operations into a microfinance bank. Although the national strategy has only achieved limited results thus far, it is a good step in the right direction. Greater progress can be expected during its contemplated 5-year implementation period. 2. Overdependence on Donor Funds 8. The report and recommendation of the President (RRP) (para. 18) identifies an overdependence on donor funds as a key issue because (i) such overdependence can result in complacency and discourage efforts to offer savings products to clients, (ii) it can "crowd out" private sector development, and (iii) it can discourage the commercialization of microfinance (which can help to achieve the scale necessary for national outreach). Although a few notable private sector microfinance investments have occurred in Pakistan in the last 3 years, 7 donors continue to be a large source of funds for microfinance in Pakistan. 8 Domestic loans for microfinance have not been forthcoming, principally because local lenders perceive unprofitable microfinance providers to be poor credit risks. 6 The strategy is not contained in a document whose title includes the words "national strategy," but in a PowerPoint presentation entitled "Expanding Microfinance Outreach in Pakistan." updates/emo-presentation-pm.pdf 7 E.g., Telenor's $12.5 million investment in Tameer Microfinance Bank and Deutsche Bank's $500,000 loan to Asasah, an NGO MFI. 8 E.g., World Bank Project Information Document (PID): Appraisal Stage for Third Pakistan Poverty Alleviation Fund Project. Washington, DC. para. 29 ($40 million loan); International Fund for Agricultural Development President's Report: Proposed Loan to the Islamic Republic of Pakistan for the Program for Increasing Sustainable Microfinance. Rome. p. iv ($35 million loan); International Finance Corporation Summary of Proposed Investment: Kashf MFI. Washington, DC ($22.5 million in loans/ guarantees and equity).

12 4 3. Lack of Infrastructure and Limited Mobility of Clients 9. Two other constraints which the RRP identifies (paras ) are technical challenges and high transaction costs resulting from a lack of infrastructure and the limited mobility of some microfinance clients, especially women. To help alleviate these problems, the program contemplated the use of alternative delivery channels namely, Pakistan Post and mobile banking. Thus far, however, these alternative delivery channels are being utilized only to a small extent. a. Use of Pakistan Post to Deliver Services 10. The program required a model agreement to be prepared pursuant to which Pakistan Post would deliver microfinance services, such as disbursing loans to clients. Thus far, however, only two financial institutions First MicroFinance Bank (FMFB) and Khushhali Bank have entered into arrangements with Pakistan Post. 9 In addition, the existing agreements with FMFB and Khushhali Bank encompass only a small number of Pakistan Post's more than 13,000 branches (of which approximately 7,500 provide financial services such as money orders). The volume of Pakistan Post's financial services business remains small, "mainly due to [its] poor management, inability to track funds transparently, limited capacity to deal with complex services, as well as little initiative and vision in broadening the product range in cooperation with private financial outfits." 10 Nevertheless, over many years and with a great deal of effort Pakistan Post could occupy an important role in delivering expanded financial services to the poor, in the same way that the post office delivers financial services to the poor in some other countries. It is therefore inferred that the decision to involve Pakistan Post in the chain was correct. b. Adoption of Branchless Banking Regulations 11. "Branchless banking is defined as the delivery of financial services outside conventional bank branches using information and communications technologies [e.g., mobile telephones] and nonbank retail agents." 11 The IAFSP required SBP to adopt regulations or guidelines to support the use by banks of technologies such as those for mobile money transfers. In March 2008, SBP adopted "branchless banking regulations." 12 Pursuant to these regulations, Tameer Microfinance Bank and its majority owner, Telenor, launched a product to deliver banking services using mobile phones in October Three months earlier, MCB Bank initiated a mobile banking service; in addition to improving service for its existing, mostly non-poor clients, the bank expressed hope that the service would reach people who currently have mobile phones but not bank accounts. 14 United Bank's "Orion" service allows mobile phone owners to pay bills and transfer funds. 15 Customers of Atlas Bank, Citibank, and KASB Bank can pay bills 9 Footnote 3, p Footnote 3, pp Footnote 3, p The branchless banking regulations do not permit telecom operators to provide financial services without a bank partner, an innovation that has proved successful in increasing rural outreach of remittances in countries such as the Philippines and Kenya. Footnote 3, p. 19. Although SBP believes that its current stance is appropriate, it will consider non-bank-led models after the market matures In another pilot project, "Tameer Bank has partnered with local retail outlets including pharmacies, telecom outlets, and post offices to install point of sale devices closer to the customers.... [, who] can visit these registered outlets to withdraw and make deposits, repay loans, pay utility bills, and remit money." Footnote 3, p

13 5 through mobile phones that utilize Mobilink as the service provider. 16 Pakistan Post and Mobilink also introduced a money transfer service in the last 12 months. Other banks have also applied, but have yet to receive permission, to begin services under the branchless banking regulations. These initiatives reflect the significant potential of mobile phone banking to scale up financial services in Pakistan, where about 90% of the population has mobile phone coverage The program also required the Ministry of Information Technology (MOIT) to issue rules and regulations to support mobile money transfers and remittances. MOIT issued regulations in May However, by requiring telecom operators to allow any other telecom operator to utilize their network to deliver a mobile banking product, telecom operators are less likely to promote the product than they would be if they could require users to utilize their own networks in order to obtain the product. c. Sales Tax Exemption 13. In order to promote the adoption of new technologies, the IAFSP required the Federal Board of Revenue to enact a sales tax exemption for certain equipment. Although it is difficult to determine what impact this exemption has had, the impact appears to have been minimal given that financial institutions have adopted few new technologies to serve the poor. Expansion of existing technology applications e.g., ATMs could also help increase access to financial services. Pakistan has fewer than 0.53 ATMs per 100,000 people, compared with 4 per 100,000 in Sri Lanka and a world median ratio of 10 per 100, Absence of Credit Bureau 14. The fourth issue identified in the RRP (pp ) was the absence of reliable credit histories for microfinance borrowers. Because few microfinance borrowers have credit histories, 19 prospective borrowers who have previously repaid obligations to other creditors cannot utilize their favorable payment histories to help persuade new lenders to give them credit (or to give them credit on more favorable terms than those offered to borrowers without favorable credit histories). In addition to helping borrowers obtain credit, accurate and complete credit histories would also help lenders. First, it would reduce the cost of evaluating the creditworthiness of prospective borrowers. Second, it would reduce loan losses by helping lenders avoid extending credit to: (i) prospective borrowers with poor credit histories and (ii) prospective borrowers with outstanding loan(s) who may not have the capacity to repay both the pre-existing loan(s) and the proposed new loan. Under the IAFSP, a pilot project to utilize an existing consumer finance credit bureau (DataCheck) is being developed. 20 The pilot project, which will include approximately 188,000 borrowers from 12 microfinance organizations in Lahore, is expected to commence in January 2010 (2 years beyond the program's target date) Footnote 3, p. xxi. 18 Footnote 3, p The existing private credit bureaus currently cover less than 1.4% of adults, and of course an even lower percentage of microfinance borrowers. Footnote 3, p. 8. However, credit histories of clients of microfinance banks are submitted to SBP for inclusion in the ecib (electronic credit information bureau) database. Footnote 3, p Footnote 3, p. 100.

14 6 5. Lack of Diverse Financial Services a. Islamic Microfinance 15. Next, the RRP (pp ) discussed the IAFSP's expected impact to increase the diversity of financial services products to meet local needs and priorities. The RRP assumed, for example, that for religious reasons some people in Pakistan would not utilize conventional financial services, but that these individuals would utilize financial services that adhered to Islamic principles. At present, however, almost no one in the two poorest quintiles has access to Islamic finance, 21 in part because "[c]ommercial and Islamic banks do not generally focus on serving underserved populations." In order to facilitate the provision of Islamic microfinance services to the poor, the IAFSP required SBP to issue guidelines or regulations to support the provision of such services by financial institutions (commercial banks, Islamic banks, and microfinance banks). 23 This was done in September 2007, 24 and Pakistan's basic Islamic banking regulations are considered outstanding. 25 However, no financial institution has apparently provided any new Islamic banking services to poor clients in the 2 years since the guidelines were issued. Three non-bank microfinance organizations not subject to the guidelines Akhuwat, Centre for Women's Cooperative Development (CWCD), and NRSP currently offer one or more Islamic finance products. 26 b. Microfinance Banks Authorized to Handle Foreign Remittances 17. A substantial body of literature supports the conclusion that remittances help reduce poverty. For example, one study concludes that each 1% increase in remittances' share of GDP reduces poverty in Pakistan by 0.15%. 27 However, because Pakistanis working abroad generally come from the less poor and middle classes, rather than the poorest families, "remittances do not appear to make [up] a significant portion of household income for the poorest quintile." 28 Therefore, in Pakistan increasing access to remittances will not benefit the poorest as much as in some other countries. 29 Nevertheless, since microfinance banks operated in some areas (especially rural areas) that were not well served by banks and other existing providers of formal remittance services, the IAFSP required that the law be changed to allow microfinance banks to handle remittances from abroad. 30 The law was amended in June 2007, Footnote 3, p Footnote 3, p. 88. According to a survey of 10,305 households, "[o]nly a fifth of the population is willing to pay more for Islamic products than [for] conventional banking product[s]." Footnote 3, p "As of December 2007, there were 18 banks involved in Islamic banking with a network of 288 branches in the country. Of these, 6 are full-fledged Islamic banks with 185 branches and 12 of the existing commercial banks have 103 branches that are offering Islamic banking services." Footnote 3, p. 9 (citing State Bank of Pakistan, Islamic Banking Department Industry Progress and Market Share. Islamic Banking Bulletin July September 2007.). 24 State Bank of Pakistan Islamic Banking Department Circular No. 05 of Karachi. 25 Footnote 3, p Akhuwat has been providing interest-free loans since CWCD has been working with an Islamic approach since Akhuwat and CWCD are both based in Lahore. NRSP's initiative started in Between December 2007 and April 2009, NRSP concluded 792 Islamic financing transactions (murabaha) all in the Mardan district of North-West Frontier Province. 27 R. Amjad Remittances and Poverty in Pakistan: Does It Matter Who Sends These Remittances, Who Receives Them and How They are Sent? A Note. Unpublished. p Footnote 3, p Only 2.3% of the population send or receive domestic or international remittances. Footnote 3, p International remittances to Pakistan total $9 billion annually. Footnote 3, p. xx. Although an ILO study estimated that only 57% of total remittances flow through official channels, there is a general view that the large increase in remittances sent through official channels since 2001 reflects stricter controls imposed after 9/11. Footnote 27, pp.

15 7 and since then three microfinance banks (FMFB, Rozgar, and Tameer) have begun handling remittances, although the number of transactions has been relatively small (around 5,000 per month). 32 Thus, the change in law required by IAFSP has had some positive impact. 6. Unequal Treatment of Microfinance Banks 18. The RRP identified the unequal treatment of microfinance banks as a "key issue for more rapid development of financial services in remote and rural areas" (para. 29). Specifically, the RRP criticized (i) the disproportionate amount of resources dedicated to Khushhali Bank, (ii) the fact that Khushhali Bank operated under a different ordinance than the other microfinance banks, 33 and (iii) the substantial ownership interest in Khushhali Bank held by a state-owned institution, the National Bank of Pakistan (NBP). Ironically, ADB through the lowcost credit line provided under the MSDP 34 was the source of most of the "disproportionate" resources. Although ADB considered addressing the resource allocation issue by (i) discontinuing the credit line to Khushhali Bank 35 and (ii) providing a credit line to other microfinance banks, ultimately these options were not contained in the IAFSP. However, the IAFSP did address the other two issues by requiring (i) Khushhali Bank to operate under the same ordinance as the other microfinance banks and (ii) NBP to offer to sell its shares of Khushhali Bank. (Actual divestiture of the shares was not required.) 19. SBP successfully arranged for Khushhali Bank to be reconstituted under the Microfinance Ordinance, Khushhali Bank thereby came under the same legal regime as the other microfinance banks. During the program period, NBP also offered to sell its shares of Khushhali Bank. However, the hoped-for divestiture did not occur, perhaps in part because an unprofitable financial institution is not usually considered an attractive investment Basic and Financial Literacy 20. Another key issue identified in the RRP (para. 30) was the poor's lack of education and basic and financial literacy, especially among women. Two surveys identified in the RRP found that household heads participating in microfinance had significantly higher literacy rates than household heads not participating in microfinance. 37 To address this concern, IAFSP created an endowment fund and mandated that a minimum of 10% of the income of the fund be spent on 7 8 (citing ILO/ARTEP Impact of Out and Return Migration on Domestic Employment and Labour Market in Pakistan. Bangkok.). 31 Finance Act, para. 21(1). 32 The IAFSP also recognized SBP's issuance, before the start of the program, of an instruction directing commercial banks to establish "Home Remittance Cells" (Footnote 1, para. 27). 33 For example, under the ordinance applicable only to Khushhali Bank, (i) SBP rather than Khushhali Bank's board appointed the bank's first president and (ii) Khushhali Bank's shareholders were not eligible to receive any dividends. 34 ADB Report and Recommendation of the President to the Board of Directors on Proposed Loans to the Islamic Republic of Pakistan for the Microfinance Sector Development Program. Manila. 35 Since most of the credit line had been disbursed by the time the IAFSP was designed in 2006, its discontinuance would not have had a significant impact. 36 According to statistics published on over the past 5 years ( ), Khushhali Bank's adjusted return on assets has ranged from 5.1% to 2.9%, while its adjusted return on equity has ranged from 14.9% to 10.6%. 37 These were small surveys and their conclusions are not universally held. For example, "empirical evidence from Indonesia suggests that financial literacy has very little if any impact on the use/uptake of financial services among households." Footnote 3, p. 100 (citing S. Cole, B. Zia, and T. Sampson Evaluation [of] the Impact of Bank Accounts on Households Welfare Outcomes in Indonesia. Unpublished.).

16 8 literacy programs. 38 However, since the endowment fund has yet to award a single grant (para. 30), the program has had no impact on improving literacy Capacity Building of Financial Services Providers and Government 21. The final issue identified in the RRP (paras ) was the need to strengthen the capacity of financial services providers and government authorities (including SBP). The IAFSP identified three ways to fulfill this need. 22. First, SBP officers would receive training "in new management information systems for on-site and off-site surveillance and in applications of new technologies and systems for money transfer and remittances" (RRP, para. 33). This was accomplished. 23. Second, the program contemplated training provincial and local officials in Sindh in automated land registration, records systems, and reporting. The program also called for installing a computerized revenue management information system in 23 districts in the province by These objectives were not accomplished because, among other things, the preconditions for implementing a pilot automated land registration system were not in place. Legal reforms, for instance, would be required before an automated land registration system could be implemented. In addition, existing land records, which were entirely paper-based, would need to be digitized a time-consuming process. 24. Third, the IAFSP called for the creation of an endowment fund to support capacity building initiatives for financial services providers. This too has not been accomplished because although the endowment fund was created, it has yet to award any grants (para. 30). C. Disbursements and Program Schedule 25. The IAFSP was approved on 14 December The first tranche ($100 million) of the OCR loan was disbursed on 12 January 2007, 2 days after loan effectiveness. The second tranche ($200 million) was scheduled for disbursal within 24 months thereafter and was actually disbursed on 27 June months ahead of schedule. The ADF loan was disbursed in a single tranche of SDR13,425,000 on 12 January All of the proceeds of the ADF loan were transferred by the government to SBP on a grant basis to create an endowment fund. However, SBP did not receive the funds from the government until February 2008, a 13-month delay for which the government has not provided any justification. D. Implementation Arrangements 26. The Ministry of Finance (MOF) was the executing agency. The implementing agencies were SBP, the Federal Board of Revenue, the Ministry of Information Technology, Pakistan Post, and the Board of Revenue of the Sindh government. SBP consulted regularly with MOF to ensure that policy actions were taken promptly. These implementation arrangements were satisfactory. E. Conditions and Covenants 27. The program was supported by two loans: (i) a $300 million loan from ADB's ordinary capital resources repayable in 24 semiannual installments beginning 1 June 2010 and ending 38 Rules of the Improving Access to Financial Services Fund. para. 8(ii). 39 "[SBP] with the support of its two principal training institutions, National Institute of Banking and Finance (NIBAF) and the Institute of Bankers Pakistan (IBP), is implementing [another] initiative for financial literacy and capacity building." Footnote 3, p. 21.

17 9 on 1 December 2021 and (ii) a loan of SDR13,425,000 ($20 million equivalent) from ADB's special funds resources, repayable in 32 semiannual installments beginning 1 June 2015 and ending on 1 December The $300 million loan bears an interest rate to be determined in accordance with ADB's London interbank offered rate (LIBOR)-based lending facility, while the SDR-denominated loan carries an interest rate of 1% until 1 June 2015 (the end of the grace period ) and 1.5% thereafter. There were no delays in meeting the conditions of effectiveness. The loan agreements became effective 21 days after signing. 28. The OCR loan was designed to be released in two tranches. The first tranche ($100 million) was to be released upon effectiveness, and the second tranche ($200 million) was to be released upon the fulfillment of nine conditions (Table 2). These conditions were fully or substantially complied with and the second tranche was released on 27 June Policy Action Table 2: Second Tranche Release Conditions Government approval of a national strategy for an inclusive financial sector and a 5-year implementation plan Issuance by SBP of regulations regarding disclosure by microfinance banks of costs to borrowers ("truth-in-lending") Submission to Parliament of a bill to license and supervise Khushhali Bank under the same legal and regulatory framework as other microfinance banks Adoption of reduced import duties and sales taxes on certain capital goods including technology machinery and equipment Issuance by MOIT of rules and regulations to support technical implementation of mobile money transfers and remittances Rationalization by PTA of registration and annual license fees on VSAT and other technologies Completion by Khushhali Bank of actions (through 2008) under its 5-year operational plan Issuance by SBP of guidelines and/or regulations to support the provision of Islamic microfinance services and products by financial institutions Submission to Parliament of a bill to allow microfinance banks to directly receive international remittances Compliance Status Full X X X X X X X X Substantial MOIT = Ministry of Information Technology, PTA = Pakistan Telecommunications Authority, SBP = State Bank of Pakistan, VSAT = very small aperture terminal. Source: ADB Progress Report on Tranche Release: Pakistan: Improving Access to Financial Services (Phase I Program). para. 11 (Table 1). 29. Formally, compliance with the program's limited reporting requirements was not good. Quarterly reports on program implementation were not submitted to ADB, nor were audited financial statements of the endowment fund prepared. 40 However, the need for quarterly reports was obviated by ADB's participation as an observer on the endowment fund's governing committee (minutes of whose meetings were prepared), while the absence of disbursements by the endowment fund (para. 30) meant that audited financial statements would not be very meaningful. X 40 A firm has recently been selected to conduct audits of the fund's accounts for the fiscal years ended 30 June 2008 and 30 June 2009.

18 Covenant compliance was generally satisfactory (Appendix 1). The only covenants that were not complied with (in addition to the reporting deficiencies mentioned in para. 29) involved the endowment fund. The endowment fund was not established until February 2008, well beyond the deadline of 31 March 2007, and the fund's activities were also implemented slowly. For example, the first meeting of the fund's governing committee was not held until April In addition, the committee has yet to award any grants and therefore no progress has been made on achieving the program's capacity building or literacy objectives (paras. 20, 24). Although SBP has been taking positive steps, especially since December 2008, 41 these delays constitute serious deficiencies. In effect, the purpose of the ADF loan to fund grants for capacity building and financial literacy initiatives has not been accomplished at all. 31. One significant impediment to using the endowment fund to realize the capacity building objectives of the IAFSP is that, in 2008, SBP and the Department for International Development of the United Kingdom (DFID) announced a 50,000,000 Financial Inclusion Programme (FIP). As part of FIP, a 10,000,000 Institutional Strengthening Fund (ISF) was established. Grants for capacity building of the microfinance sector can be made from both the ISF and the endowment fund established under the IAFSP. Since the ISF has a much shorter duration than the endowment fund (5 years as opposed to 20 years), it is reasonable for SBP to utilize the ISF rather than the endowment fund for capacity building grants during the life of the ISF In addition, many microfinance organizations are also eligible to receive capacity building grants from PPAF under two programs sponsored by the International Fund for Agricultural Development: the Microfinance Innovation and Outreach Program (MIOP), which was designed in 2005, and the Program for Increasing Sustainability and Outreach in Microfinance (PRISM), developed in F. Related Technical Assistance 33. The program, which was not designed using project preparatory technical assistance, was supplemented by a $2 million technical assistance grant (TA 4894-PAK) that was approved at the same time as the two loans. This grant funded work on a number of topics, including topics related to disbursement conditions (e.g., branchless banking). The contract with the consultancy firm hired to deliver the work was signed in July 2007, and the work was completed in September The technical assistance completion report will be prepared after the financial closing of the grant. G. Consultant Recruitment and Performance 34. Sixteen international consultants and 13 local consultants were engaged by the firm selected by ADB (using the quality-and-cost-based selection (QCBS) method) to deliver the work under the technical assistance grant. All consultants performed satisfactorily. H. Performance of the Borrower and the Executing Agency 35. Overall, the performance of the borrower and the executing agency (MOF) was partly satisfactory. An excellent job was done in achieving 7 months ahead of schedule most of the conditions set out in the program loan. However, the borrower's performance in achieving the goals of the ADF loan was poor. While the loan was disbursed in January 2007, the counterpart 41 E.g., State Bank of Pakistan SBP Governor Launches Key Microfinance Sector Development Initiatives. Karachi. 19 December When the IAFSP was being processed, FIP had yet to be considered by DFID. DFID and SBP did not consult with ADB when FIP was being processed.

19 11 funds were not transferred into an SBP account to fund the endowment fund until February 2008; the governing committee of the endowment fund did not meet until April 2008; grant application forms were not available until December 2008; and, as of the date of this report, not a single grant has been awarded. I. Performance of the Asian Development Bank 36. ADB s performance in administering the program was partly satisfactory. Although only one review mission was undertaken, ADB maintained a regular dialogue with the borrower during the program period. Moreover, it does not seem likely that additional review missions would have resulted in faster fulfillment of the conditions precedent to disbursement of the second tranche of the program loan. However, ADB's failure to field any mission before April 2008 (15 months after disbursement of the ADF loan) may have contributed to the borrower's slow disbursement of the counterpart funds, as well as to the slow start-up of the activities of the governing committee of the endowment fund. A. Relevance III. EVALUATION OF PERFORMANCE 37. The program is assessed as relevant. The key implementing agency, SBP, took ownership of policy actions. ADB processing missions were well informed about the microfinance sector, had significant policy dialogue with the government agencies concerned, and consulted broadly with other stakeholders. The program purpose was consistent with the country s development priorities and with ADB's country and sector assistance strategies, both at appraisal and evaluation (para. 5). The lending modality (i.e., program loan) was appropriate in view of the reform momentum and foreign reserves of the country. And the policy matrix was generally realistic 43 and had an appropriate number of program measures. 38. However, the design and monitoring framework did not contain time-specific targets for many outputs. For example, it did not contain any targets on Islamic microfinance clients, on the number of clients covered by credit bureaus, or on the sustainability of the delivery of financial services. These deficiencies make it more difficult to assess the success of the program. In addition, while the program correctly attempted to address the microfinance sector's need for extensive capacity building initiatives, the approach taken transferring the responsibility for managing the capacity building program to SBP and unpaid representatives of stakeholders was a design error. B. Effectiveness in Achieving Outcome 39. The program is assessed as effective. Thus far, the program has not had a measurable impact on expanding outreach and improving access for the poor to diversified and sustainable financial services and products at competitive prices. Although outreach increased between 2006 and 2008 the number of borrowers increased by 73% from 1.00 million to 1.73 million, while the number of savers increased by 66% from 1.13 million to 1.88 million (Appendix 2) 44 there was no connection between these increases and anything in the IAFSP. 43 The implementation of a pilot automated land registration system was the sole significant exception (para. 23). 44 Appendix 2 also shows that the number of microinsurance policyholders increased dramatically from 388,000 in 2006 to 2,242,000 in However, the program did not include anything on microinsurance and thus there is no link between the increase in policyholders and the IAFSP.

20 However, it is unreasonable to expect that regulatory changes made in 2007 or the first half of 2008 would catalyze significant results by the time of this evaluation. The program's effectiveness is anticipated to grow over time. 45 Indeed, long-term expectations for the IAFSP are high because of the potential for initiatives supported by the program to result in increased outreach and access by the poor to a diverse offering of financial services. These initiatives include mobile banking, a functional credit bureau covering microfinance borrowers, Islamic microfinance, and capacity building for financial services providers. C. Efficiency in Achieving Outcome and Outputs 41. The program is assessed as less efficient. The executing and implementing agencies generally acted diligently to accomplish the actions they were tasked to complete. However, the actions of MOF and SBP pertaining to the endowment fund were slow. As a result of these delays, two of the IAFSP's four components (i) capacity building and institutional strengthening of MFIs and (ii) financial and basic microfinance literacy have not been achieved. ADB's administration and supervision of the program essentially followed the same pattern that is, its actions with respect to everything except the endowment fund were performed efficiently. D. Preliminary Assessment of Sustainability 42. The sustainability of the IAFSP is likely despite its lower-than-expected efficacy and lesser efficiency. Most policy achievements such as the adoption of a national strategy, branchless banking regulations, truth-in-lending regulations, and Islamic banking guidelines appear to be sustainable considering (i) the government s continued commitment to the program purpose and (ii) stakeholders support for the program's achievements. 43. The government's commitment is being demonstrated principally by the ongoing activities of SBP. SBP has adopted many new regulations and guidelines, including a microfinance regulation that is "considered to be the most conducive regulation in the region with respect to promoting financial inclusion for poor people." 46 Another promising new regulatory initiative adopted by SBP is the Annual Branch Licensing Policy (2007), pursuant to which commercial banks with at least 100 branches are required "to open up at least 20 percent of their branches outside big cities and set up branches in tehsil 47 headquarters, where no branch of any bank exists." 48 SBP has also created a Development Finance Group to help steer policy implementation and administer financial inclusion programs, such as FIP (para. 31). 49 In addition, the government has introduced a 5-year tax holiday for newly established microfinance banks. E. Impact 44. "Increased access to financial services has a significant effect on poverty." 50 However, as discussed in para. 39, since the IAFSP has not had a measurable impact on increasing 45 Indeed, one might argue that this evaluation should be delayed to allow more time for concrete results to be realized. In this case 5 10 years might be a reasonable delay well beyond the month period after program completion specified as typical in the Project Administration Instructions. ADB Project Administration Instructions. PAI 6.07A. Manila. para Footnote 3, p The second-lowest tier of local government in Pakistan. Each tehsil is subdivided into a number of union councils and is part of a larger district. 48 Footnote 3, p Footnote 3, p Footnote 3, p. 1 (citing S. Claessens and K. Tzioumis Measuring firms access to finance. World Bank manuscript.).