FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT APPRAISAL DOCUMENT ON A PROPOSED GRANT

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT APPRAISAL DOCUMENT ON A PROPOSED GRANT IN THE AMOUNT OF SDR 32.6 MILLION (US$50 MILLION EQUIVALENT) TO THE ISLAMIC REPUBLIC OF AFGHANISTAN FOR A ACCESS TO FINANCE PROJECT November 4, 2013 Afghanistan Country Unit South Asia Finance and Private Sector Development Report No: AF 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 CURRENCY EQUIVALENTS (Exchange Rate Effective September 30 th, 2013) Currency Unit = AFN = US$1 US$1.53 = SDR 1 FISCAL YEAR December 21 December 20 ABBREVIATIONS AND ACRONYMS ACGF AFN AMA ARDS ARTF BMZ BPHS CDC CGAP CHW CSOs CSPI DAB DDA DEG DIME DMFI EA EIA ESMF FM FMA FP GoA IDA IEC IFC IP Afghanistan Credit Guarantee Foundation Afghani Afghanistan Microfinance Association Afghanistan Reconstruction Development Service Afghanistan Reconstruction Trust Fund German Federal Ministry for Economic Cooperation and Development Basic Package of health care Services Community Development Council Consultative Group to Assist the Poor Community Health Worker Civil Society Organizations Community-based Savings Promotion Institutions Da Afghanistan Bank District Development Assembly Deutsche Investitions- und Entwicklungsgesellschaft mbh World Bank Development Impact Evaluation Unit Deposit taking MFI Environment Assessment Environment Impact Assessment Environment and Social Management Framework Financial Management Financial Management Adviser Facilitating Partner Government of Afghanistan International Development Association Information, Education, Communication International Finance Corporation Implementing Partners

3 IUFR M&E MFIs MISFA MOF MSEs MSMEs NGO NPPs PAR PEFA PFIs PFM PO PRA PWR SDU SMEs TUP US$ Interim Un-Audited Financial Reports Monitoring and Evaluation Microfinance Institutions Microfinance Investment Support Facility for Afghanistan Ministry of Finance Micro and Small Enterprises Micro, Small and Medium Enterprises Non-Government Organizations National Priority Programs Portfolio at Risk Public Expenditure and Financial Accountability Partner Financial Institutions Public Financial Management Program Organizers Participatory Rural Appraisal Participatory Wealth Ranking Special Disbursement Unit Small and Medium Enterprises Targeting the Ultra Poor United States Dollar Regional Vice President: Philippe H. Le Houerou Country Director: Robert J. Saum Sector Director: Sujata Nitin Lamba Sector Manager: Henry K. Bagazonzya Task Team Leader: Guillemette Jaffrin

4 AFGHANISTAN Access to Finance Project TABLE OF CONTENTS I. STRATEGIC CONTEXT...11 A. Country Context B. Sectoral and Institutional Context C. Higher Level Objectives to which the Project Contributes II. PROJECT DEVELOPMENT OBJECTIVES...16 A. PDO B. Project Beneficiaries C. PDO Level Results Indicators III. PROJECT DESCRIPTION...16 A. Project Components B. Project Financing C. Lessons Learned and Reflected in the Project Design IV. IMPLEMENTATION...22 A. Institutional and Implementation Arrangements B. Results Monitoring and Evaluation C. Sustainability V. KEY RISKS AND MITIGATION MEASURES...26 A. Risk Ratings Summary Table B. Overall Risk Rating Explanation VI. APPRAISAL SUMMARY...27 A. Economic Analysis B. Technical C. Financial Management D. Procurement E. Social (including Safeguards) F. Environment (including Safeguards)... 33

5 ANNEX 1: RESULTS FRAMEWORK AND MONITORING...34 ANNEX 2: DETAILED PROJECT DESCRIPTION...41 ANNEX 3: IMPLEMENTATION ARRANGEMENTS...47 ANNEX 4: ORAF...84 ANNEX 5: TUP PROGRAM...91 ANNEX 6: CREDIT GUARANTEE FACILITY ANNEX 7: ECONOMIC AND FINANCIAL ANALYSES ANNEX 8: IMPLEMENTATION SUPPORT PLAN...131

6 .. AFGANISTAN Access to Finance Project Project Appraisal Document Basic Information Project ID EA Category Team Leader P F - Financial Intermediary Assessment Lending Instrument Fragile and/or Capacity Constraints [ ] Specific Investment Loan Financial Intermediaries [ ] Project Implementation Start Date 15-Dec-2013 Expected Effectiveness Date 15-Dec-2013 Joint IFC No Series of Projects [ ] Project Implementation End Date 31-Dec-2018 Expected Closing Date 31-Dec-2018 Guillemette Sidonie Jaffrin Sector Manager Sector Director Country Director Regional Vice President Henry K Bagazonzya Sujata Nitin Lamba Robert J. Saum Philippe H. Le Houerou Borrower: Islamic Republic of Afghanistan Responsible Agency: MISFA Contact: Bahram Barzin Title: Acting Managing Director Telephone No.: bahram.barzin@misfa.org.af Responsible Agency: Ministry of Finance Contact: Adris Walli Title: Aid Coordination Officer Telephone No.: adris.walli@budgetmof.gov.af

7 Project Financing Data(in USD Million) [ ] Loan [ ] Grant [ ] Guarantee [ ] Credit [ X ] IDA Grant [ ] Other Total Project Cost: Total Bank Financing: Financing Gap: 0.00 Financing Source Amount BORROWER/RECIPIENT 0.00 IDA Grant Total Expected Disbursements (in USD Million) Fiscal Year Annual Cumulati ve Proposed Development Objective(s) The proposed Project Development Objective is to build institutional capacity to improve access to credit of micro, small and medium enterprises. Components Component Name Improving access to financial services for micro and small enterprises Improving access to financial services for small and medium enterprises Cost (USD Millions) Sector Board Financial Inclusion Practice Institutional Data Sectors / Climate Change Sector (Maximum 5 and total % must equal 100) Major Sector Sector % Adaptation Co-benefits % Finance Microfinance 45 Finance SME Finance 45 Finance General finance sector 10 Mitigation Co-benefits %

8 ..... Total 100 I certify that there is no Adaptation and Mitigation Climate Change Co-benefits information applicable to this project. Themes Theme (Maximum 5 and total % must equal 100) Major theme Theme % Financial and private sector development Micro, Small and Medium Enterprise support Financial and private sector development Other Financial Sector Development 10 Total Policy Compliance Does the project depart from the CAS in content or in other significant respects? Yes [ ] No [ X ] Does the project require any waivers of Bank policies? Yes [ ] No [ X ] Have these been approved by Bank management? Yes [ ] No [ ] Is approval for any policy waiver sought from the Board? Yes [ ] No [ X ] Does the project meet the Regional criteria for readiness for implementation? Yes [ X ] No [ ] Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 X Natural Habitats OP/BP 4.04 X Forests OP/BP 4.36 X Pest Management OP 4.09 X Physical Cultural Resources OP/BP 4.11 X Indigenous Peoples OP/BP 4.10 X Involuntary Resettlement OP/BP 4.12 X Safety of Dams OP/BP 4.37 X Projects on International Waterways OP/BP 7.50 X Projects in Disputed Areas OP/BP 7.60 X Legal Covenants Name Recurrent Due Date Frequency ACGF Agreement 31-Dec-2015 Description of Covenant The Government of Afghanistan (Ministry of Finance) shall enter into a partnership agreement with the

9 . Afghanistan Credit Guarantee Foundation (ACGF) under terms and conditions approved by the Association. Name Recurrent Due Date Frequency Safeguards X CONTINUOUS Description of Covenant The Government of Afghanistan, through Ministry of Finance shall, and shall cause DEG, ACGF and MISFA, to carry out the Project in accordance with the ESMF, including the screening and mitigation measures set forth therein, in a manner satisfactory to the Association. Conditions Name Project Operational Manuals Description of Condition Type Effectiveness Both the MISFA's Operational Manual and the Guarantee Facility Operational Manual shall be submitted to the Association and found to be satisfactory. Name Subsidiary Agreement Description of Condition Type Disbursement The Subsidiary Agreement shall be executed between the Government of Afghanistan (Ministry of Finance) and MISFA Name DEG Agreement Description of Condition Type Disbursement An agreement shall be executed between the Government of Afghanistan (Ministry of Finance) and DEG, under terms and conditions approved by the Association. Bank Staff Team Composition Name Title Specialization Unit Chau-Ching Shen Senior Finance Officer Senior Finance Officer CTRLN Juan Carlos Alvarez Senior Counsel Senior Counsel LEGES Asha Narayan Asta Olesen Asif Ali Guillemette Sidonie Jaffrin Sr Financial Management Specialist Senior Social Development Specialist Senior Procurement Specialist Senior Private Sector Development Specialist Sr Financial Management Specialist Senior Social Development Specialist Senior Procurement Specialist Team Lead SARFM SASDS SARPS SASFP Naila Ahmed Operations Officer Operations Officer SASDL

10 . Mohammad Arif Rasuli Nazir Ahmad Parwana Wawreena Nasiri Senior Environmental Specialist Private Sector Development Specialist Senior Environmental Specialist Private Sector Development Specialist SASDI SASFP Program Assistant Program Assistant SASFP Shiori Onishi E T Consultant E T Consultant SASFP Mihasonirina Andrianaivo Non Bank Staff Financial Sector Specialist Financial Sector Specialist SASFP Name Title Office Phone City Locations Country First Administrative Division Afghanistan Kunduz Kunduz X Afghanistan Kandahār Kandahār X Afghanistan Kabul Kabul X Afghanistan Jowzjān Wilāyat-e Jowzjān X Afghanistan Herat Herat X Afghanistan Badakhshan Fayzabad X Afghanistan Balkh Province Balkh Province X Location Planned Actual Comments Afghanistan Wilāyat-e Baghlān Wilāyat-e Baghlān X

11 I. STRATEGIC CONTEXT A. Country Context 1. Afghanistan will experience a major security, political and development transition over the next years. At the Kabul and Lisbon Conferences in 2010, NATO and the Afghan government agreed that full responsibility for security would be handed over to the Afghan National Security Forces by the end of Presidential elections are scheduled for April The country now faces the drawdown of most international military forces over the coming several years with an expected accompanying decline in civilian aid as international attention shifts elsewhere and aid budgets come under increasing fiscal pressure. The decline in external assistance is likely to have widespread ramifications for Afghanistan s political and economic landscape well beyond Falling aid flows in Afghanistan will have the most impact on public spending as present levels of expenditure will be fiscally unsustainable for Afghanistan once donor funds decline. The main issue is how to manage this change, mitigate impacts, and put aid and spending on a more sustainable path. At the Tokyo Conference on July 8, 2012, the international community committed to US$16 billion of aid to Afghanistan (annual average of US$4 billion over the next four years) and agreed to the Tokyo Mutual Accountability Framework with the Government of Afghanistan (GoA) that focuses on (i) Representational Democracy and Equitable Elections, (ii) Governance, Rule of Law and Human Rights, (iii) Integrity of Public Finances and Commercial Banking Systems, (iv) Government Revenues, Budget Execution and Sub-National Governance, and (v) Inclusive and Sustained Growth and Development. 2. The GoA s 22 National Priority Programs (NPPs) identified private sector development as one main driver of a diversified growth strategy. 1 The private sector is currently dominated by micro, small and medium enterprises (MSMEs) both in urban and rural areas, with 91 percent of enterprises employing 5 workers or less and half of the private firms have been operating for 4 years or less. 2 Self-employment is also preponderant reaching 43 percent in rural areas and 50 percent in urban areas. These MSMEs are labor intensive, and have the potential to absorb part of the growing labor force, estimated at 400,000 to 500,000 new entrants per year. Moreover, they could also help address the significant under employment of Afghans, which is six times larger than unemployment rate at 48 percent in Afghanistan, especially in rural areas, due to seasonality of farming GoA has recognized that MSMEs face several challenges in access to finance and that it is one of the main business constraints hampering firms growth. Only 3.4 percent of firms in Afghanistan held a bank loan or line of credit in 2008 compared to 30 percent in South Asia on 1 Islamic Republic of Afghanistan, 2012, Towards self-reliance, Strategic Vision for the Transformation Decade. Tokyo conference on Afghanistan. 2 The dominant activities are (i) trade and repair (29 percent), (ii) manufacturing (22 percent), and (iii) accommodation and food services (10 percent). Central Statistics Organization, Integrated Business Enterprise Survey National Risk and Vulnerability Assessment 2007/8. 11

12 average, and only 1.4 percent of Afghan firms use banks to finance their investments, compared to a south Asian average of 15 percent. 4 Capacity development of MSMEs through improved access to finance is one of the key objectives of the Integrated Trade and SME Support Facility in NPP. B. Sectoral and Institutional Context 4. Commercial banks and the microfinance sector have the potential to provide increased access to finance to SMEs and MSEs respectively 5, but the underdevelopment and the fragility of the financial system in Afghanistan have prevented them to do so on a significant scale. An overall weak commercial banking sector shaken by the Kabul Bank crisis 5. The banking sector is composed of 3 state-owned banks (including the newly created bank following the Kabul Bank crisis, New Kabul bank, currently under privatization), 9 private full-fledged banks and 4 branches of foreign commercial banks. The assets of the banking system have grown tenfold since 2005, from US$388 million in March 2005 to US$4.32 billion in July 2013, although from a very low base. Total outstanding loans amount to US$818 million in July 2013 with loans mainly concentrated in the trade and service sectors (29 and 19, percent respectively) and geographically concentrated in Kabul (81 percent). The banks sustain high liquidity, with US$3.72 billion in deposits as of July The banking sector registered US$8.75 million of profits between July 2012 and July 2013, resulting in a Return on Assets of 0.36 percent. The regulatory capital ratios of all but one (New Kabul Bank, under privatization) commercial banks are above the minimum regulatory threshold (12 percent of risk-weighted assets), as of July The banking sector 7 is still dealing with the aftermath of the Kabul Bank crisis, which was the result of fraud and money laundering activities as the bank s shareholders and top management manipulated the bank s loan books. The crisis threatened the overall stability of the banking sector (as the bank held about one-third of the system s assets of US$4 billion) and has raised concerns regarding the capacity of the Central Bank to adequately supervise the banking sector. The government had to shoulder US$825 million for the cost of the lender-of-last-resort facility loans that covered the deposit guarantee (about 5 percent of GDP). Kabul Bank was subsequently put into receivership, revoking shareholders rights altogether. Kabul Bank has been split up into a good bank and a bad bank. The bank s deposits and good assets were transferred to a bridge bank, New Kabul Bank (NKB, owned by the Government of Afghanistan). NKB privatization is on-going. About US$935 million (principal and interest) in the asset portfolio are sought for recovery. However progress on asset recovery has been slow, with cash recoveries amounting to US$173 million out of US$935 million total receivables. A 4 WBG Enterprise Surveys, The microfinance sector focuses on the lower end of the market (microenterprises) and has the potential to reach small enterprises through upscaling, while commercial banks which focus on the higher end of the market have the potential to reach SMEs through downscaling approaches. 6 DAB, Financial Supervision Department, Summary Analysis of Condition and Performance of the Banking Sector (February 2013) 7 The financial sector is dominated by commercial banks, as the NBFI (Non-Bank Financial Institutions) sector is still underdeveloped in Afghanistan. 12

13 detailed report of the public inquiry into the Kabul Bank crisis was released in November 2012 by the Independent Joint Anti-Corruption Monitoring and Evaluation Committee. The conclusions are severe and highlight critical weaknesses in governance in the financial sector and more broadly (including the judiciary). 7. Audits of ten commercial banks 8, financed under the World Bank s Financial Sector Rapid Response Project (FSRRP), revealed serious weaknesses at all levels: governance, skills, internal controls, accounting, credit analysis, risk management, compliance with regulations (related parties, single obligor limit). In addition, while branches of foreign banks largely serve the donor and the international sector, many local banks were established around business groups where lending tends to be based on relationships and with the interests of the groups superseding those of depositors when investments go wrong (IMF, 2011). 8. With a banking sector still fragile and underdeveloped, SMEs remain financially underserved and only few banks have specialized SMEs financing window, most notably First Microfinance Bank (FMFB, a commercial bank), which focuses on the SME market segment. An SME Credit Guarantee Facility (with initial funding from USAID and the German Government) has been operating in Afghanistan since 2006 and is showing promising results: the Facility has guaranteed loans of a total value of US$108.2 million to more than 3,000 businesses (cumulatively), as of July This Credit Guarantee Facility has been implemented and managed by DEG, a German Government-owned development financial institution, part of KfW Group (the operations of the Guarantee Facility are detailed in Annex 6). A microfinance sector emerging from a major consolidation phase 9. MSEs (the lower end of the market) also suffer from limited access to finance as the microfinance sector went through a boom and bust cycle, with a steep consolidation of the sector since It is expected that, with the exit of BRAC and ASA from the microfinance sector by March 2013 (see paragraph 12 and Figure 1 below), the consolidation of the sector would be completed. 10. The World Bank has supported the development of the microfinance sector in Afghanistan since 2003 (with both ARTF and IDA funding), through the establishment of a microfinance apex institution: MISFA (Microfinance Investment Support Facility for Afghanistan). The ARTF funded project (US$168 million disbursed) provided on-lending funds to microfinance institutions (MFIs) as well as grants for capacity building of MFIs. The IDA funded project (US$16 million disbursed) provided further on-lending funds to MISFA. 11. From , growth of the microfinance sector was steady with 373,080 active borrowers (and around 450,000 clients) reported by March 2008 and a cumulative US$204 million of loans disbursed by MISFA s 16 microfinance partners. During that period, the main focus was to scale outreach of MFIs. The microfinance experience in Afghanistan was considered a unique success as it had managed to build a microfinance sector from scratch in five years. 8 Selected by DAB because of their weak CAMEL ratings. 13

14 12. However, the extremely rapid growth of the sector with fragile institutions led to a repayment crisis in 2008 (which is not unique to Afghanistan and also happened in countries such as Nicaragua, Bosnia and Herzegovina and Pakistan). The rapid client outreach had come at the expense of proper due diligence in lending, compliance with internal control processes and internal monitoring of performance. These factors, combined with cost inflation and a deteriorating security environment, contributed to a decline in portfolio quality of most MFIs. 13. Following this crisis, MISFA focused more attention on direct monitoring and supervision of MFIs to verify the accuracy of their reporting and supported a consolidation of the sector, as it appeared that a number of small MFIs were not viable. As of 2011, from the initial 16 MISFA partner institutions, 2 of the weakest institutions exited the sector, 1 merged with FMFB a sister organization, 2 institutions remained in country, but discontinuing as MISFA partners 9, 6 of the small MFIs had their operations merged into Mutahid (a new entity created by MISFA 10 ), 5 MFIs remained as independent institutions: FMFB, BRAC, ASA, Oxus and HFL. However, in 2012, it emerged that BRAC and ASA had serious difficulties, which led to their exit (by March 2013) of the sector. MISFA currently has four partner MFIs: FMFB (which is a commercial bank), Oxus, HFL and Mutahid, representing 148,111 clients and 81,970 borrowers with US$93.4 million in loans outstanding 11. Figure 1 below shows the evolution of the microfinance sector (represented by MISFA partners) between 2003 and The sharp contraction in the number of clients in 2012 is caused by the exit of the microfinance sector of BRAC. Figure 1: Evolution of Afghan microfinance sector Thousands $ 140 $ 120 $ 100 $ 80 $ 60 $ 40 $ 20 $ 0 Millions Gross Loan Portfolio (right) Number of active borrowers (left) Source: MISFA and AMA 9 FINCA and IIFC repaid in full their loan capital obligations. FINCA Afghanistan counts 19,305 clients and IIFC counts 89,848 clients. 10 And held as a wholly-owned subsidiary. 11 FMFB is the leading institution, representing 88 percent of clients and loans outstanding. 14

15 14. A few financial institutions are not MISFA partners: FINCA, Islamic Investments and Finance Cooperatives (IIFC Group) and Afghanistan Rural Finance Company. In addition, the microfinance sector also includes Community-based Savings Promotion Institutions (CSPIs), which promote savings groups. Altogether, these institutions (including MISFA s partners) represent 362,968 clients and 156,203 active borrowers, with US$137.3 million in outstanding loans (as of June 2013). 15. The proposed project supports and complements the Government of Afghanistan s efforts to develop and implement a financial sector development strategy that focuses on increasing access to finance moving beyond the Kabul Bank crisis. Such a strategy would also aim at ensuring a stronger coherence between the various ongoing efforts to increase access to finance in Afghanistan. The project would complement other World Bank initiatives and other donors programs focusing on increasing access to financial and non-financial services to MSMEs (such as, Afghanistan Rural Enterprises Development Project, Afghanistan New Market Development Project, IFC Business Edge program). The project will also complement the on-going and planned IFC activities in the microfinance and SME finance sector. IFC is a shareholder of FMFB and is considering further investments in MFIs and Non-Bank Financial Institutions 12. IFC also plans to support the development of mobile money as a means to increase access to financial services, leveraging its investments and technical assistance in the financial and telecom sectors. 16. This project will also take into account the lessons learnt from over ten years of efforts to develop the financial sector in Afghanistan. The recent crises in both the banking and microfinance sectors have shown the need for an incremental and long term approach towards financial sector development. In particular, learning from the MISFA experience (as described in paragraphs 10 and 12), it will be important to avoid a too heavy focus on increasing outreach and disbursements, at the expenses of building solid and sustainable institutions, offering financial products that meet the need of the Afghan populations and MSMEs. This project would aim at better positioning the financial sector at large to seize opportunities post transition. C. Higher Level Objectives to which the Project Contributes 17. The World Bank Group recognizes the importance of supporting the Government of Afghanistan in implementing the National Priority Programs. Considering the ongoing conflict and uncertainty, the Bank s strategy strives to maintain flexibility to adjust to events through an Interim Strategy Note (ISN) for the period FY12-FY The ISN has three pillars, and the proposed project would directly support the third pillar, focused on inclusive growth and jobs. This pillar is concentrating on foundational investments for growth as one of GoA s main priorities during the transition period is to build domestic sources of growth and jobs in order to replace donor and military assistance. Aside from the Bank s engagement around resource corridors, this pillar speaks to addressing the constraints to enterprise development including a weak financial sector (...). 12 Pending the approval of the leasing law. 13 World Bank Group, 2012, Interim Strategy Note for the Islamic Republic of Afghanistan for the period FY12- FY14. 15

16 18. The current World Bank s strategy in Afghanistan is consistent with the World Development Report 2011 on conflict affected countries. More specifically, short-term or partial solutions are insufficient, and strengthening legitimate institutions and governance in order to provide citizen security, justice and jobs is crucial to break cycles of violence. The importance of job creation in economic development is reinforced in the World Development Report Putting in place an environment that will favor private sector (especially SMEs) led job creation, is critical. II. PROJECT DEVELOPMENT OBJECTIVES A. PDO 19. The proposed Project Development Objective of the project is to build institutional capacity to improve access to credit of micro, small and medium enterprises. B. Project Beneficiaries 20. The ultimate project beneficiaries are Afghan micro, small and medium enterprises (MSMEs). The project aims at increasing MSMEs access to financial services to facilitate their growth and increase their job creation potential. The project includes a sub-component focusing on ultra-poor households. Under this sub-component (Targeting the Ultra Poor), households identified as ultra-poor will benefit from a package of support, including access to financial services, to allow them to develop sustainable income generating activities. C. PDO Level Results Indicators 21. The PDO level results indicators are as follows: Outstanding microfinance loan portfolio of MISFA s partner institutions Outstanding SME loan portfolio of partner institutions of the Afghanistan Credit Guarantee Facility Graduation rate of TUP beneficiaries III. PROJECT DESCRIPTION A. Project Components Component 1: Improving access to financial services for micro and small enterprises (US$32 million) 22. This component aims to provide continuing support to the microfinance sector through MISFA, as well as, supporting MISFA to take on a broader role as a catalyst for innovations to increase access and usage of financial services from the lower end of the market (notably micro and small enterprises) as per its new strategic plan (see details in Annex 2). It should however be 16

17 underlined that the role of MISFA is primarily a role of market facilitator, rather than direct technical assistance provider. 23. This component will support: (i) the strengthening of the microfinance sector through MISFA, (ii) the scale up of the Targeting the Ultra Poor Program and (ii) further strengthening of MISFA to support the implementation of its new business plan and project implementation. It will include the following activities (further details are provided in Annex 2). Sub-component 1.1: Strengthening of the microfinance sector through MISFA (US$13 million) 24. Capacity Building Fund (US$10 million). This Capacity Building Fund will have two windows: (i) Innovation Window and (ii) Systems Strengthening Window. The Innovation Window will allow MISFA to support innovations to improve access to and usage of financial services proposed by MFIs and other institutions which have a focus on access to finance. As such, this fund would cover the testing and piloting of new financial products (small enterprise finance, agricultural credit, savings, sharia-compliant products, insurance, etc.) as well as the use of technology to improve access to financial services. The Systems Strengthening Window will support efforts from MFIs and CSPIs to strengthen their systems and their human resources (MIS, internal control, risk management, etc.) based on a detailed capacity strengthening plan. This fund will also support systems strengthening of MFIs aiming to become Deposit taking MFI (DMFI), once the regulation is approved. In addition, the Capacity Building Fund could cover support to the establishment of new financial institutions, to strengthen the supply side 14 of the microfinance sector, which counts a limited number of institutions following the consolidation process. The Capacity Building Fund will not include on-lending funds as MISFA has currently enough resources for on-lending (which could be mobilized in parallel by the applying institutions, if needed). 25. Support to Policy, Regulation and Advocacy (US$3 million): this sub-component will provide support to agencies in charge of policy, regulation and advocacy, namely: the Ministry of Finance, which has the responsibility to set the policy direction for financial sector development in Afghanistan; the Central Bank of Afghanistan (DAB) which once the Deposit taking MFIs regulation will be approved will be responsible for regulating these institutions and the Afghanistan Microfinance Association (AMA) which is the representative body for the microfinance sector. For the activities described in this paragraph, MISFA will be the conduit to provide financial support to these institutions which play an essential role in financial sector development and financial inclusion. Sub-component 1.2.: Targeting the Ultra Poor (TUP) Program (US$15 million) 26. This sub-component will support the scale up of the Targeting the Ultra Poor (TUP) program piloted by MISFA in Bamyan and Badakshan. The TUP program aims at graduating participants from safety nets programs to income-earning activities, linking them with 14 The MISFA Operations Manual will clarify the eligibility criteria as it is important to learn the lessons from the past uncontrolled growth of the microfinance sector in Afghanistan with a large number of weak institutions, the majority of which collapsed. Such support might be considered post 2014, once the political situation has stabilized in Afghanistan. 17

18 microfinance programs. Building on the lessons learned from the pilots and from international experience, the program will provide TUP beneficiaries a three-year package of inputs which includes the transfer of productive assets (such as livestock) as well as training (classroom and hands-on); a subsistence support (monthly stipend, as short term income support); and basic healthcare through community-based health workers. The total cost of this package (including its delivery) is estimated at US$2,000 per household. It is envisaged that this Program will be replicated in 20 districts (across 5 provinces) and will reach 7,500 households (representing an estimated 52,500 household members). Sub-component 1.3: Strengthening of MISFA (US$4 million) 27. This sub-component will provide support to MISFA to implement its new business plan. This sub-component will in particular support the establishment of a Research and Development Department within MISFA to develop innovative programs, as an incubator, to better support under-served groups, notably women and youth. Under its new strategic plan, MISFA intends to develop a Women Empowerment Program as well as a Youth Entrepreneurship Program (combining financial and non-financial services). This component will also support the establishment of a Knowledge Management Department at MISFA to document best practices, lessons learned, and provide timely and relevant information to stakeholders by commissioning research and studies. This Department would also be tasked to implement the Progress out of Poverty Index (based on international experience) to better track microfinance impacts. MISFA will also strengthen its Client Profile database to have more accurate information on clients and avoid multi-lending to clients and over-indebtedness. This sub-component will also strengthen project implementation capacity at MISFA (with a focus on fiduciary aspects). It will in addition support coordination efforts between various initiatives with a focus on access to finance supported by development partners (notably USAID, with FAIDA and ABADE) and the World Bank (such as Financial Sector Rapid Response Project, New Market Development Project, Rural Enterprise Development Project, Skills Development Project, Non Formal TVET Project and Justice Service Delivery Project). Component 2: Improving access to financial services for small and medium enterprises (US$18 million) 28. The aim of the component is to increase commercial bank and MFI lending to SMEs in Afghanistan and thus facilitate access to financial services for SMEs. It will support the expansion of the Afghanistan Credit Guarantee Facility implemented and managed by DEG, which has supported SME lending in Afghanistan since The Facility has a strong track record. It will also support technical assistance to commercial banks to strengthen their SME lending capacity (also referred as downscaling ). This component will include support to the Credit Guarantee Facility to provide coverage to MFIs lending to the lower end of the SME market (also referred as upscaling ). 18

19 Sub component 2.1: Supporting the expansion of the Afghanistan Credit Guarantee Facility, (US$13 million) 29. This component will provide US$13 million to the Afghan Credit Guarantee Facility (the current capital stock of the guarantee fund of US$8 million as of June 2013 is fully committed and will reach its maximum leverage in the near future). The Afghanistan Credit Guarantee Facility has been managed, since 2006, by DEG, a member of the KfW Group and one of the largest European development finance institutions with a focus on financing and structuring investments of private companies in developing and transition countries. 30. It will support the expansion of the Credit Guarantee Facility generated by its organic growth and by additional initiatives, e.g.:, (i) volume growth with existing partner institutions (the Facility currently works with 3 partner institutions); (ii) cooperation with additional partner institutions (an increasing number of commercial banks and MFIs have expressed an interest for support to develop SME lending); (iii)regional expansion; (iv) new product development. Sub component 2.2: Providing technical assistance to the Afghanistan Credit Guarantee Facility and partner financial institutions (commercial banks and MFIs) (US$5 million) 31. In general, the Facility provides technical assistance on best practice SME lending to partner financial institutions (banks and MFIs), until the Facility considers that the partner institutions no longer require technical assistance. More specifically, this sub-component will finance the following activities by the Afghanistan Credit Guarantee Facility: (i) Technical assistance on new product development such as rural SME credit, Islamic finance, trade finance, credit technology improvements for larger SME loans, women entrepreneurs, supply chain finance, other products as per individual need, knowledge sharing and management capability; (ii) Support for management information system (MIS) for the Credit Guarantee Facility and Partner Financial Institutions (PFIs); (iii) Support to the geographical expansion of the Credit Guarantee Facility, with the opening of offices in the North (e.g. Mazar-e Sharif) and possibly Herat and, (iv) Strengthening of the Credit Guarantee Facility capacity including human resources (training) and systems. The Credit Guarantee Facility systems will continue evolving to strengthen its reporting and planning capacity as well as risk management (portfolio rating and credit scoring), (v) Impact evaluation. Collaboration with IFC 32. Building on the experience of the IDA financed Financial Sector Strengthening Project where the World Bank and the IFC Advisory Services are closely working together (in particular on the establishment of a Public Credit Registry and of a Collateral Registry), the Access to Finance Project will strive to identify areas of joint interventions with the IFC. The IFC has 19

20 invested in First Microfinance Bank (FMFB), which is also a key partner financial institution of this project. This could be perceived as a Conflict of Interest for the World Bank Group 15. To mitigate the potential Conflict of Interest risk, the World Bank project team will not include any IFC Investment Officer dealing with FMFB. 33. IFC is also looking at further investments in the microfinance sector in Afghanistan. One of the objectives of the Access to Finance project is to strengthen partner financial institutions which could then facilitate their access to IFC investments and advisory services. B. Project Financing 34. Project Cost and Financing Table 1: Project Cost and Financing Project Components Project cost IDA Financing % Financing $32 million $32 million 100% 1. Improving access to financial services for micro and small enterprises 1.1. Strengthening the microfinance sector through MISFA 1.2. Targeting the Ultra Poor Program 1.3. Strengthening of MISFA $13 million $15 million $4 million $13 million $15 million $4 million 2. Improving access to financial services for small and medium enterprises $18 million $18 million 100% Total Costs Total Project Costs Front-End Fees Total Financing Required $50 million $50 million $50 million $50 million 100% 100% 35. While the table above only shows IDA financing, it should be noted that the institutions supported by the project (MISFA and Afghanistan Credit Guarantee Facility) are also using their own resources to finance their day-to-day operations, as both institutions have been operating for several years in Afghanistan and are generating revenues through the management of their capital base. C. Lessons Learned and Reflected in the Project Design 36. Lessons learned from support to microfinance apex institutions internationally and from support to the microfinance sector in Afghanistan since 2003, as well as support to credit guarantee facilities have been incorporated in the design of this Project. The section below highlights key lessons on which the design of the project is built. 15 The World Bank and the IFC will jointly formally inform the Government of Afghanistan of this potential Conflict of Interest. 20

21 Lessons learned from support to microfinance apex institutions Large disbursement pressure in early years does not lead to a healthy growth of the microfinance sector. The experiences in Afghanistan, Egypt and Mali have shown that too aggressive disbursement and early outreach by apex institutions are less likely to achieve sound results. In Afghanistan, as the emphasis was given on rapid disbursements and outreach and less focus on a long-term impact and capacity building, the microfinance sector experienced a steep decline in portfolio quality and repayments in It is important to take into account the required time for apex institutions to build their own capacity with a sound governance structure. 38. Apex institutions supporting early stage microfinance markets need a different strategy than those operating in mature markets. In early stage microfinance markets, apex institutions play a key role in developing the quality of partner MFIs through close hand-holding and extensive capacity building, with aims at strengthening the usually weak supply side of microfinance, through both existing and new MFIs. In such settings, apex institutions need appropriate financial instruments for capacity building, typically through grants, as well as dedicated staff with expertise in microfinance operations. 39. Establishing regular and transparent reporting of MFIs will help improve the accountability and performance. Apex institutions can play a significant role in building early market infrastructure and reporting framework for MFIs. This can involve setting up standards in reporting systems for audit and governance. Apex institutions can also be a center for sharing client credit information. Lessons learned from the Bank s engagement in the microfinance sector in Afghanistan 40. International microfinance models may not necessarily warrant success without adjustment to country context. At the initial stage of the Bank s engagement in developing the microfinance sector in Afghanistan, it was hoped that microfinance models that had worked in other countries, notably in Bangladesh, could be transferred to Afghanistan. The exit of BRAC and ASA from the microfinance sector in Afghanistan has indicated that sole replication of external microfinance models may not lead to sustainable microfinance operations in the country and that adaptation to country circumstances is critical. 41. Governance structure and effective capacity building of MFIs are crucial for success. The microfinance crisis and sector consolidation have highlighted that the microfinance sector remains fragile, and effective capacity building is required for better governance and risk management for MFIs. Tailored interventions to effectively build sustainable capacity need to be developed. 42. Building a strong apex institution requires building strong institutional capacity before expanding its portfolio. In the initial phase of the Bank s previous projects, MISFA was in the process of building up its own capacity, and had limited capacity to effectively monitor MFIs activities. Through the consolidation phase of the sector, MISFA significantly enhanced 16 CGAP (2012) A New Look at Microfinance Apexes. 21

22 its capacity based on the lessons learned from the microfinance crisis, and has evolved into a competent and sustainable apex institution. Lessons learned from the Credit Guarantee Facilities 43. Technical Assistance to Partner Institutions is critical for developing new business model and credit process for SME finance. Bank s projects such as in Papua New Guinea and Mali have shown that technical assistance to Partner Institutions is a crucial factor to support SME lending, as it allows banks to develop new lending practices suited to SMEs. 44. The commitment of Partner Institution s senior management to SME market development and a clear vision of market positioning are critical. The commitment of the top management to SME lending is critical. In addition, the structure of the financial institution needs to allow for effective SME lending: SME lending departments need to be developed with the ability to make loan decisions. 45. DEG s experience with Credit Guarantee Facilities identified the following lessons: Focus on individual guarantees: portfolio guarantee can create elevated net losses/moral hazard. Therefore, the Credit Guarantee Facility only uses portfolio guarantees with partner institutions after a proven track record and successful implementation of best practice SME credit technology; Apply risk adequate guarantee fees, as high subsidizes can distort the market. The Credit Guarantee Facility has elaborated a guarantee fee formula that includes PAR 30 (portfolio at risk over 30 days), claims ratio and refunds ratio to adequately cover the risk of individual bank s performance; Insufficient SME-credit-technology with local banks (because of no or limited technical assistance) creates higher defaults/claims. The Credit Guarantee Facility puts high emphasis on technical assistance to implement best practice SME credit technology; International experience shows that a minimum capital stock for a financially sustainable credit guarantee scheme is at or above US$20 million. IV. IMPLEMENTATION A. Institutional and Implementation Arrangements 46. The project will be implemented by two implementing entities: MISFA, for Component 1, and the Ministry of Finance, for Component 2. The following paragraphs will provide further details on the implementation arrangements. MISFA: implementing entity for Component MISFA has been a long term partner of the World Bank, first through an ARTF funded project (Microfinance for Poverty Reduction Project, P091264, closed in June 2010) and then through an IDA funded project (Expanding Microfinance Outreach and Improving Sustainability Project, P104301, closed in June 2012). MISFA has evolved into a strong institution, recognized 22

23 as being de facto regulator of the microfinance sector. In recent years, MISFA took on the difficult task of cleaning and consolidating the microfinance sector in Afghanistan and should be commended for these efforts. MISFA is established as a limited liability non-profit company wholly owned by the Ministry of Finance. It has a robust governance structure, with the Minister of Rural Rehabilitation and Development as Chairman of the Board. The members of the Board include the Deputy Minister of Finance (as Vice-Chair), the CEO of the Afghanistan Chamber of Commerce and Industry and three international microfinance experts. MISFA is currently competitively recruiting a new Managing Director and the former Operations Director has been named Acting Director. 48. MISFA will be responsible for component 1 of the Project: Improving access to financial services for micro and small enterprises. As per the previous IDA project, a Project Agreement will be signed between MISFA and the World Bank and a Subsidiary Agreement will be signed between the Government of Afghanistan (MOF) and MISFA. MISFA, as the Project Implementing Entity, will have fiduciary responsibility for the overall component. Ministry of Finance: implementing entity for Component Component 2 will be implemented by the GoA Ministry of Finance which will enter into a contractual arrangement with the Afghanistan Credit Guarantee Facility. As a first step, the contractual arrangement will be between the GoA Ministry of Finance and DEG, which is currently managing the Afghanistan Credit Guarantee Facility. Under this first step, DEG will therefore be an implementing partner. DEG intends to institutionalize the Afghanistan Credit Guarantee Facility through the establishment of the Afghanistan Credit Guarantee Foundation (described in the paragraph below) in the near future. Once the Foundation will be established, the contractual arrangement will be reviewed, so that the contractual arrangement will be between the GoA Ministry of Finance and the Afghanistan Credit Guarantee Foundation. Under this second step, the Afghanistan Credit Guarantee Foundation will become the implementing partner (thus replacing DEG). 50. The Afghanistan Credit Guarantee Facility has been managed, since 2006, by DEG, a member of the KfW Group and one of the largest European development finance institutions with a focus on financing and structuring investments of private companies in developing and transition countries. The Afghanistan Credit Guarantee Facility has received funding from USAID and BMZ (the German Federal Ministry for Economic Cooperation and Development). DEG, BMZ and the Government of Afghanistan have recently agreed to institutionalize the Afghanistan Credit Guarantee Facility and to establish the Afghanistan Credit Guarantee Foundation (ACGF). The Foundation will be registered in Germany and operate under German law. It will be governed by a Board of Trustees that will include a representative of DEG, of BMZ and of the Afghanistan Ministry of Finance. The Foundation will be managed by a Board of Directors, including a Chief Executive Officer and a Chief Financial Officer. The Foundation, once established, will rely on the staff who have been working for the Facility. 51. As described above, in a first phase, DEG will be the implementing partner for Component 2: Improving access to financial services for small and medium enterprises. A contract will be signed between the Ministry of Finance and DEG, which will stipulate the legal 23

24 and fiduciary conditions of the partnership. DEG will (i) manage, on behalf of GoA, the capital contribution financed by IDA to the Guarantee Fund (as it currently does with BMZ) through the Afghanistan Credit Guarantee Facility Trust Fund and (ii) manage the technical assistance provided to the Credit Guarantee Facility and partner financial institutions. Annex 6 provides a detailed description of the operations of the Credit Guarantee Facility. The Project Document will refer to the Afghanistan Credit Guarantee Facility as a generic term as the Facility will be managed, in a first phase by DEG, and in a second phase, by the Foundation. 52. The institutional and implementation arrangements will be carried out according to the rules and procedures agreed in the Operations Manuals of each component. The Operations Manuals will be subject to periodic reviews. Draft Operations Manuals are already available for both components and will be finalized before effectiveness (their finalization is a condition of effectiveness). Further details on implementation arrangements are given in Annex 3. B. Results Monitoring and Evaluation 53. MISFA and the Credit Guarantee Facility will be responsible for monitoring and evaluation (M&E) for their respective components. Both institutions have already developed strong M&E systems. The two institutions will make limited adjustments to be able to regularly report on the project s indicators. 54. MISFA produces a Monthly Performance Report for internal purposes, which gathers key financial information on MISFA partner institutions (building on international good practices in microfinance): income statement, balance sheet, portfolio summary (with detailed information on the loan and savings portfolio of each institution with geographical and gender data). In addition, MISFA provides public information on the performance of its partner institutions on its website: MISFA will however need to strengthen the M&E mechanism for the TUP program, considering its significant scale up. Support from the World Bank Development Impact Evaluation Unit (DIME) has been sought, during project preparation, to conduct a robust impact evaluation of this program, with support from the CGAP (Consultative Group to Assist the Poor) which has been conducting in-depth research on Targeting the Ultra Poor programs internationally ( 56. The Credit Guarantee Facility already tracks detailed financial information on the performance of its partner financial institutions. For each financial institutions, it tracks on a monthly basis (and on a cumulative basis) the following: loan disbursement, guarantees issues, loans outstanding, guarantees outstanding, write-offs, claims disbursed, claims refunded, Non- Performing Loans (over 30 and 90 days). Furthermore, a financial scorecard shows the revenues/expenses and gives operational as well as total financial results for the Facility. It also tracks the number of jobs created by the SMEs benefiting from the guarantees. The Credit Guarantee Facility intends to undertake a thorough impact assessment during project implementation to further measure the impact of increased access to finance on SMEs. 24

25 C. Sustainability 57. MISFA was created with the view to become a sustainable microfinance apex institution. The World Bank (through ARTF) has provided the bulk of MISFA s on-lending capital. MISFA s equity (share capital and reserves) amounts to US$123.8 million as of December MISFA has been able to develop into a sustainable institution, in spite of recent difficulties of the microfinance sector over the last five years. The current challenge of MISFA is to be able to make an effective use of its on-lending resources (MISFA has an outstanding portfolio to MFIs of US$34 million, but has an additional US$85 million it could use for on-lending). In addition, MISFA s role is to support the development of sustainable microfinance institutions. As of March 2013, only one partner institution (First Microfinance Bank) has reached Operation Self Sufficiency (while a second institution is close to reaching Operation Self Sufficiency). The Targeting the Ultra Poor Program also aims at providing the required support to ultra-poor households to ultimately reach sustainable livelihoods after 24 months of support (further details on TUP are provided in Annex 5). 58. A well-managed Credit Guarantee Facility can also be financially sustainable, as risk and market oriented guarantee fees, up-front fees, refunds from claims payment, interest income on the capital stock and grant Technical Assistance (TA) funding should be able to cover the operational costs, such as claims paid, local operating expenses and TA activities provided by the Guarantee Facility to PFIs. Generally, TA should be grant funded or (partially) co-financed by PFI. The challenge for the Afghanistan Credit Guarantee Facility is to balance sustainability and risks. A Guarantee Facility can be too conservative and take very limited risks, therefore limiting its development impact, but safeguarding its sustainability (as long as partner financial institutions find the coverage it offers useful). Conversely, a Guarantee Facility can take too many (uninformed) risks and therefore rapidly erode its sustainability (as many state-run Credit Guarantee Facilities). So far the Afghanistan Credit Guarantee Facility has been able to manage risks adequately and has a strong financial position. However the Facility recognizes the challenges of operating in an uncertain and high risk environment, such as Afghanistan in the forthcoming years. In addition, the Credit Guarantee program supported under this project aims to demonstrate to commercial banks that lending to SMEs can be profitable. As such it is expected that commercial banks will become interested in lending to SMEs, even in the absence of a guarantee mechanism, once they have become more familiar with the characteristics of this market. 25

26 V. KEY RISKS AND MITIGATION MEASURES A. Risk Ratings Summary Table Table 2 Risk Rating Summary Table Risk Category Stakeholder Risk Rating S Implementing Agency Risk - Capacity S - Governance M Project Risk - Design M - Social and Environmental M - Program and Donor S - Delivery Monitoring and Sustainability S Overall Implementation Risk S B. Overall Risk Rating Explanation 59. The main risk relates to the on-going transition process with the withdrawal of international combatting troops in 2014 and the elections planned for April The transition and the scheduled elections will increase uncertainties in the operating environment in the country, and is likely to impact the delivery of programs. A deteriorating security environment would affect project implementation (including the ability to supervise activities properly). 60. Another risk relates to the current situation of the microfinance sector. Since 2008, the sector went through a period of consolidation. With the exit of two additional institutions of the sector (BRAC and ASA) in early 2013, it is now considered that the consolidation of the sector has been completed, with a limited number of institutions remaining in operation in Afghanistan (6 microfinance institutions and 5 Community-based Savings Promotion Institutions report financial information to the Afghanistan Microfinance Association). The sector can again focus on a careful growth, with strong governance and systems, while maintaining a cautious approach during the Transition period. 61. A third risk relates to the health of the banking sector, which has been severely shaken by the Kabul Bank crisis. While recognizing there is a critical need to strengthen banking supervision, it is not proposed to address this issue under the present project as the focus of the project is on supporting financial institutions to increase access to financial services. This project therefore complements two on-going World Bank financed projects (Financial Sector 26

27 Strengthening Project and Financial Sector Rapid Response Project 17 ) which have a focus on strengthening the capacity of the Central Bank. 62. The overall implementation risk is considered Substantial mostly because of the very uncertain environment in Afghanistan. The Project will provide support to scale up initiatives (MISFA and Afghanistan Credit Guarantee Facility) that have been operating in Afghanistan for several years, which limits, to some extent, Implementing Agency and Project Risks. However, while the security situation of the country and the transition period have been taken into account while designing the project, the project could still suffer from a significant deterioration in the security environment. VI. APPRAISAL SUMMARY A. Economic Analysis 63. The Project includes investments to improve access to finance for MSMEs. The economic analysis of this Project is built as a financial analysis with the estimated difference in cash flows to beneficiaries (ultra-poor households and MSMEs, including new jobs created) accounted for as cash flows to the Project. The costs and benefits that are expected to accrue from sub-components 1.2 (Targeting the Ultra Poor) and 2.1 (Supporting the expansion of the Afghanistan Credit Guarantee Facility) have been estimated and the Net Present Value (NPV) and the Economic Rate of Return (ERR) for the investments in these components were calculated. Details on these calculations are provided in Annex 7. The economic analysis of subcomponents 1.1 (Strengthening of the microfinance sector through MISFA), 1.3 (Strengthening of MISFA) and 2.2 (Providing technical assistance to Credit Guarantee Facility partner financial institutions) presents a special challenge due to the indirect relationship between the capacity building supported under the Project and the stream of benefits that it is expected to trigger. Nonetheless, literature has demonstrated the positive effects of access to finance and capacity building on business creation, SME development and growth. A brief survey of this literature is provided in Annex Overall Project NPV is estimated at US$12.3 million at a 10 percent discount rate (with costs and benefits based on only component 2), with a 16 percent ERR. The data and the assumptions are based on field research that estimates the impact of similar programs on SMEs growth and productivity rates, and changes in wages. 10 and 12 percent discount rates are used for different scenarios, in line with World Bank guidelines. Further details on these are provided in Annex Targeting the Ultra Poor. The Project will support the national scale up of the Targeting the Ultra Poor (TUP) program piloted by MISFA in Bamyan and Badakshan. The TUP Program 17 An Additional Financing to the Financial Sector Strengthening Project (FSRRP) is under preparation. This Additional Financing is part of the restructuring of the Financial Sector Strengthening Project (FSSP). Under this restructuring, FSSP will be closed and an Additional Financing is provided to FSRRP to pursue selected activities initiated under FSSP (establishment of a public credit registry and targeted capacity building activities towards Da Afghanistan Bank, the Central Bank of Afghanistan). 27

28 provides beneficiaries with a package of inputs over a three year period including the transfer of productive assets, training, subsistence support, and basic health care. The aim of the program is to graduate beneficiaries out of safety net programs to income earning activities as well as linking them with microfinance programs. As a result, income within the beneficiary groups is expected to increase in addition to overall wellbeing such as health. Impact of this investment has been estimated with a range of scenarios. 66. The ERR of this sub-component is expected to be 15 percent, and the NPV is expected to be about US$2.7 million with a discount rate of 10 percent. 67. Credit Guarantee Facility. The Project will support continued implementation of the Afghanistan Credit Guarantee Facility which provides guarantees for SME lending. As a result, individual enterprises will be able to expand their business and/or improve efficiency, thereby increasing profits. The impact on individual businesses of different sizes and associations has been estimated as part of the economic analyses with a number of different scenarios. 68. The number of beneficiaries for the Guarantee Program is estimated at 5993 based on current operations of the AGCF. The ERR of this sub-component is expected to be 17 percent, and the NPV is expected to be about US$9.8 million with a discount rate of 10 percent. 69. Other project activities. Activities under sub-components 1.1, 1.3, and 2.2 are expected to result in improvements in the capacity of local financial institutions and MISFA, thereby improving access to finance, a relationship established in previous empirical studies (listed in Annex 7). Public Rationale 70. As discussed in paragraph 3, Afghanistan has one of the lowest rates of access to financial services, a critical constraint raised by the private sector, whatever its size (from micro to large enterprises). There is therefore a need for public intervention to increase access to financial services to MSMEs (which represent the bulk of the private sector), to help them grow and create jobs. Under this Project, the Government of Afghanistan, recognizing that increasing access to financial services is a priority, will provide funding to autonomous institutions which will in turn facilitate MSMEs access to a wide range of financial services, in a sustainable manner. World Bank s value added 71. The World Bank has played a leading role in the development of the microfinance sector in Afghanistan. It has been a long term partner of MISFA, having first supported its establishment in 2003 and developed a long term relationship which has allowed MISFA to emerge as a stronger institution following the microfinance consolidation that occurred from Through its proposed support to the Afghanistan Credit Guarantee Facility, the World Bank will also leverage its international experience on credit guarantee facilities and access to finance programs to support a wider range of financial institutions (including commercial banks) to provide financial services to a broader range of enterprises. 28

29 B. Technical 72. The project supports existing initiatives (MISFA and the Afghanistan Credit Guarantee Facility), with the view to scale up their activities. As such, it relies on significant existing technical capabilities. 73. As explained in section IV. A., MISFA has been a long term partner of the World Bank and has developed into a widely recognized microfinance apex institution. This project will support MISFA s recently approved strategic plan. The strategic plan (and the project) benefits from significant lessons learnt in the microfinance sector in Afghanistan since 2003 (as documented, in particular, in the two recently completed ICR, P and P104301). The TUP sub-component builds on MISFA s experience in two provinces and aims to scale up this initiative. It also builds on international experiences with such programs 18 and on the experience of the World Bank with the National Solidarity Program. Annex 5 provides a detailed description of the proposed TUP Program. 74. During project preparation, a Microfinance Sector Scan 19 was commissioned to validate the World Bank and MISFA s assessment of the status and potential of the microfinance sector. The sector scanning confirmed that the consolidation of the sector should now be finally completed and that there is potential for measured growth of the sector, while learning the lessons from the past, despite the political uncertainty in Afghanistan. 75. The project will also support the expansion of the Afghanistan Credit Guarantee Facility. This Facility has been operating since 2006 with funding from USAID and BMZ and has a strong track-record (see Annex 6). C. Financial Management 76. A Public Financial Management (PFM) performance rating system has been developed for Afghanistan by the Public Expenditure and Financial Accountability (PEFA) multi-agency partnership program, which includes the World Bank, IMF, European Commission and other agencies. Afghanistan s ratings against the PFM performance indicators portray a public sector where financial resources are, by and large, being used for their intended purposes as authorized by a budget that is processed with transparency and has contributed to aggregate fiscal discipline. 77. Financial management and audit functions for the proposed project will be undertaken at the central level through the agents contracted under the IDA-financed Public Financial Management Reform Project II. These are the primary instruments for continuing to strengthen the fiduciary measures put in place for ensuring transparency and accountability of funds provided by the Bank and other donors. Under these contracts, two advisers Financial Management and Audit are responsible for working with the government and line ministries to 18 The CGAP has conducted significant analytical work on TUP programs internationally. See in particular: Reaching the Poorest, Lessons from the Graduation Model, Technical Note # 69, March 2011, CGAP and 19 Present and future picture of the microfinance sector, Joyce Lehman, June

30 carry out these core functions. The former, the Financial Management Adviser (FMA), is responsible for helping the MoF maintain the accounts for all public expenditures, including IDA/ARTF-financed projects and for building capacity within the government offices for these functions. The latter, the Audit Agent is responsible for providing technical assistance to the Supreme Audit office in the performance of annual audits. 78. Implementation arrangements. At the project level, there will be two project implementing entities: MISFA will implement component 1 of the project, as such will also be responsible for the financial management aspects. Component 1 of the project will be undertaken as a conventional World Bank project with MISFA as the project implementing entity. 79. Ministry of Finance will implement Component 2 through a contractual arrangement with DEG initially, thereafter with the Afghanistan Credit Guarantee Foundation once it is established. DEG and ACGF will be considered as implementing partners. The contract will specify the legal and fiduciary obligations of the partnership. 80. A Designated Account (DA) will be opened at Da Afghanistan Bank (DAB, Central Bank) in the name of the project, for Component 1 implemented by MISFA, on terms and conditions satisfactory to IDA. The DA will be maintained by the MoF. Withdrawal applications for new advances and submission of expenditure reporting will be done monthly. Though no segregated Designated Account will be opened for Component 2 implemented by the Ministry of Finance, through DEG (and ACGF when established), payments under Component 2 will be made directly by the World Bank to a bank account or bank accounts designated by DEG/ ACGF and agreed to by the Government of Afghanistan. 81. Funds flow. Funds flow arrangements will follow existing procedures. As with all public expenditure, all payments under the project will be routed through MoF. The FMA will assist the MoF in executing and recording project payments. In keeping with current practices for other projects in Afghanistan, the DA will be operated by the Special Disbursement Unit (SDU) in the Treasury Department of MoF. Requests for payments from DA funds will be made to the SDU by MISFA. In addition to payments from DA funds, MISFA can also request the SDU to make direct payments to consultants or consulting firms. Such requests will follow World Bank s procedures. 82. For Component 2, as stated above, disbursements by the Bank will be made directly to a bank account or bank accounts designated by DEG/ACGF and not through a segregated designated account. Payment requests will be prepared by the FM focal point in RIMU (Reform Implementation and Management Unit) of MoF. All withdrawal applications to IDA, including advances, reimbursement, and direct payment applications, will be prepared and submitted by MoF. 83. Accounting and Reporting. For component 1, MISFA will maintain essential project transaction records using computerized accounting system and generate required monthly, quarterly and annual reports. For component 2, MoF will be responsible for the accounting and reporting. For Component 1, Quarterly Interim Financial Reports (IUFRs) will be prepared by MISFA every quarter and submitted to the Bank within 45 days from the end of the quarter. For component 2, quarterly IFRs will be prepared by MoF. For the guarantee funds received by 30

31 DEG/ ACGF, the responsibility for accounting and periodic reporting to MoF will primarily rest with DEG/ ACGF, and will be defined in the contract and the operational manual. 84. Financial Management Manual. There will be two financial management manuals under the project, to be part of the operational manuals for components 1 and 2 respectively. MISFA will prepare a Financial Management (FM) manual relating to Component 1 of the Project. The FM Manual will include: (i) roles and responsibilities for all FM staff; (ii) financial management aspects relating to each of the sub components, and documentation and approval procedures for payments; (iii) project reporting requirements; and (iv) quality assurance measures to help ensure that adequate internal controls and procedures are in place and are being followed. The financial management manual for component 2 will be prepared by DEG and will specifically include the funds flow, reporting and audit arrangements for the guarantee facility sub component, and also details relating to the TA component. 85. The FM Manuals will define project financial management arrangements in accordance with standard Afghan government policies and procedures as well as IDA requirements, including use of the Government Chart of Accounts to record project expenditures. Overall project accounts will be maintained centrally in SDU in AFMIS (Afghanistan Financial Management Information System), which will be ultimately responsible for recording all project expenditures and receipts in the Government s accounting system. Reconciliation of project expenditure records with AFMIS records will be carried out monthly by MISFA and RIMU of MoF. 86. Disbursement Method. Disbursements from the IDA grant will be made using advances, reimbursement, direct payment, including records or against reports, in the form of Summary Sheet or Statements of Expenditures, as appropriate. 87. Audit of Project Funds. The Supreme Audit Office, supported by the Audit Agent, is responsible for auditing the accounts of all IDA and ARTF-financed projects. Annual audited project financial statements will be submitted within six months of the close of GoA s fiscal year. Special audits will be required for the funds contributed to the Guarantee Facility; these requirements will be stated in the agreement between the Ministry of Finance and DEG, in the first phase, and between the Ministry of Finance and ACGF, in the second phase. 88. Audit-Responsible Entity. The responsible entities for the project audit report are MISFA and Ministry of Finance. There are no overdue audit reports, no overdue IFRs nor any ineligible expenditures for these entities. D. Procurement 89. Procurement for the project will be administrated in accordance with the World Bank s Guidelines: Procurement under IBRD Loans and IDA Credits dated January 2011, Guidelines: Selection and Employment of Consultants by World Bank Borrowers dated January 2011, and the provisions stipulated in the Financing Agreement. In addition, the World Bank s Guidelines on Preventing and Combating Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants dated October 15, 2006 and revised in January 2011 has 31

32 been shared with the recipient. The World Bank s Standard Bidding Documents, Requests for Proposals, and Forms of Consultant Contract will be used. Goods following National Competitive Bidding (NCB) procedures shall be procured using the agreed Standard Bidding Documents (SBDs) for Afghanistan. In case of conflict/contradiction between the World Bank s procurement procedures and any national rules and regulations, the World Bank s procurement procedures will take precedence as per the Article 4(2) of the Procurement Law July 2008 (Amendments in January 2009 incorporated) of the GoA. The general description of various procurements under different expenditure categories are described in Annex 3. A detailed procurement plan has been prepared for the project as part of the Procurement arrangement. 90. Component 1 of the Project will be implemented by MISFA. Project procurement mainly comprises the purchases of consultant services and goods. MISFA will undertake small value procurement. All large value procurement of goods (NCB/ICB) and consultant services will be carried out with the assistance of the Afghanistan Reconstruction Development Service (ARDS) as per the Afghan Procurement Law. A Procurement Manual will be prepared by MISFA, as part of its overall Operations Manual. The World Bank approval of MISFA Operations Manual is a condition of effectiveness for the project. 91. Component 2 of the project will be implemented, in a first phase, through an agreement between MOF and DEG, which is considered an implementing partner. This agreement will therefore not be governed by World Bank procurement rules. E. Social (including Safeguards) 92. The Project is not expected to have any negative social impact on the contrary, it is expected to generate considerable positive social impact through provision of financial services to under-served groups (MSMEs), with a focus on the poorer section of the population (including ultra-poor households through the TUP Program), women and youth. 93. Social Safeguards. The project is not expected to trigger any of the World Bank social safeguards policies. See further details in Annex Environment and Social Management Framework (ESMF). MISFA has implemented two projects, one financed by ARTF and one financed by IDA. For the implementation of the IDA financed project, an ESMF was prepared in accordance with the World Bank OP/BP 4.01 Environmental Assessment and the Afghan laws and regulations to make sure the microcredit subprojects are environmentally and socially sound. MISFA also provided several training and awareness raising events on social and environmental safeguards to partner MFIs. The ESMF prepared for MISFA was adapted to address the activities of the Afghanistan Credit Guarantee Facility. So far, DEG has implemented the European Development Financial Institutions (EDFI) based Environmental and Social Management System (ESMS) which covers environmental and social standards compliance in the Facility and corresponding legal commitments by PFIs. Moving forward, the Credit Guarantee Facility will implement the approved ESMF. 95. The project Environment Category is: Financial Intermediary Project. 32

33 F. Environment (including Safeguards) 96. The Project is also not expected to have any significant negative environment impact. The Project will build on the mechanisms established by MISFA under the previous IDA-funded project to ensure that the MSMEs supported by both MISFA and the Credit Guarantee Facility do not have significant harmful impacts on the environment. 97. Environment Safeguards. The Project triggers Environmental Assessment OP/BP As indicated in the section above, under the previous IDA financed project, MISFA developed an ESMF, which has been revised to address the activities supported by the Afghanistan Credit Guarantee Facility. 98. MISFA, the Credit Guarantee Facility and the partner institutions will assume overall responsibility for compliance with pertinent Afghan laws and regulations on environmental protection and with the requirements of the World Bank. For this purpose, MISFA and the Credit Guarantee Facility will take necessary steps to encourage environmental due diligence during project implementation. Commitment to ensuring environmental soundness would be included in the cooperation agreements between MISFA and its partner institutions, as well as between the Credit Guarantee Facility and its partner institutions, as per the ESMF. The ESMF also includes a list of ineligible activities. Further details are provided in Annex As mentioned in the section above, the project is categorized as Environment Category FI Financial Intermediary Project. 33

34 ..... ANNEX 1: RESULTS FRAMEWORK AND MONITORING AFGHANISTAN Access to Finance Project (P128048) Results Framework Project Development Objectives PDO Statement The proposed Project Development Objective of the project is to build institutional capacity to improve access to credit of micro, small and medium enterprises. These results are at Project Level Project Development Objective Indicators Indicator Name Outstanding Microfinance Loan Portfolio Percentage of projectsupported institutions that are reporting on this indicator Core Unit of Measure Amount(US D) Percentage Sub-Type Supplemental Cumulative Target Values Baseline YR1 YR2 YR3 YR End Target Frequency Data Source/ Methodolog y Responsibility for Quarterly MISFA MISFA Data Collection Quarterly MISFA MISFA 34

35 . Outstanding SME Loan Portfolio Percentage of projectsupported institutions that are reporting on this indicator Graduation rate of TUP beneficiaries (graduation criteria: stabilized and diversified income) Amount(US D) Percentage Sub-Type Supplemental Quarterly Quarterly Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Percentage Annually MISFA MISFA Intermediate Results Indicators Indicator Name Volume of Bank Support: Institutional Development - Microfinance No of active loan accounts - Microfinance Core Unit of Measure Amount(US D) Cumulative Target Values Baseline YR1 YR2 YR3 YR Number End Target Frequency Data Source/ Methodolog y Responsibility for Quarterly MISFA MISFA Data Collection Quarterly MISFA MISFA 35

36 Percentage of projectsupported institutions that are reporting on this indicator % active loans to women - Microfinance Percentage of projectsupported institutions that are reporting on this indicator No of active loan accounts - SME Percentage of projectsupported institutions that are reporting on this indicator Percentage Sub-Type Supplemental Quarterly MISFA MISFA Percentage Quarterly MISFA MISFA Percentage Sub-Type Supplemental Quarterly MISFA MISFA Number Quarterly Percentage Sub-Type Supplemental Quarterly Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Portfolio at Risk - Microfinance Percentage Quarterly MISFA MISFA Percentage of projectsupported institutions that are reporting on this indicator Percentage Sub-Type Supplemental Quarterly MISFA MISFA 36

37 Direct project beneficiaries Number Quarterly MISFA MISFA Female beneficiaries Portfolio at Risk - SME Percentage of projectsupported institutions that are reporting on this indicator Number of PFIs working with the Afghanistan Credit Guarantee Facility Pay Out Rate of the Afghanistan Credit Guarantee Facility Percentage Sub-Type Supplemental Quarterly MISFA MISFA Percentage Quarterly Percentage Sub-Type Supplemental Quarterly Number Quarterly Percentage Annually Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility Afghanistan Credit Guarantee Facility 37

38 .. Project Development Objective Indicators Indicator Name Outstanding Microfinance Loan Portfolio Percentage of project-supported institutions that are reporting on this indicator Outstanding SME Loan Portfolio Percentage of project-supported institutions that are reporting on this indicator Graduation rate of TUP beneficiaries (graduation criteria: stabilized and diversified income) Description (indicator definition etc.) Provide the outstanding (i.e., not yet repaid or written off) amount of the micro-finance loan portfolio for each PFI or CMLF promoter receiving Bank support. Report the entire portfolio of the institution as of a reasonably recent date, not just the Bankfinanced portion. No description provided. Provide the outstanding (i.e., not yet repaid or written off) amount of the SME loan portfolio for each PFI or CMLF promoter receiving Bank support. Report the entire portfolio of the institution as of a reasonably recent date, not just the Bank-financed portion. No description provided. No description provided. Intermediate Results Indicators Indicator Name Volume of Bank Support: Institutional Development - Microfinance No of active loan accounts -Microfinance Percentage of project-supported institutions that are reporting on this indicator Description (indicator definition etc.) Institutional development financing relates to capacity building at institutions including technical assistance, training, fixed assets etc. Report the cumulative amounts disbursed as of most recent date available. If a split by micro and SME is not available or possible, please use 50% for each as proxy. Provide the total number of active microfinance loans for all institutions supported by the Bank. Do not report the cumulative number of loans over the life of the project. Report on the entire microfinance portfolio of the PFI/CMLF, not just the Bankfinanced portion. If number of loan accounts is not available, use number of borrowers as a proxy. The optional "breakdown" tab can be used to report by institution. No description provided. 38

39 % active loans to women - Microfinance Report on the percentage of total loan accounts noted above that were made to women. Percentage of project-supported institutions that are reporting on this indicator No of active loan accounts -SME Percentage of project-supported institutions that are reporting on this indicator Portfolio at Risk - Microfinance Percentage of project-supported institutions that are reporting on this indicator Direct project beneficiaries Female beneficiaries Portfolio at Risk - SME No description provided. Provide the total number of active SME loans for all institutions supported by the Bank. Do not report the cumulative number of loans over the life of the project. Report on the entire SME portfolio of the PFI/CMLF, not just the Bank-financed portion. If number of loan accounts is not available, use number of borrowers as a proxy. The optional "breakdown" tab can be used to report by institution. No description provided. Portfolio at Risk = Outstanding (or not yet repaid) balance of all loans where payment is late by > 30 days / Gross outstanding loan portfolio Provide the Portfolio at Risk (PAR) for the PFI's entire microfinance portfolio. Do not report on the PAR for just the Bank-funded portion. Loans that have been rescheduled or renegotiated should also be included in the numerator of the PAR. Weight each institution's PAR by its outstanding Microfinance portfolio to calculate the average PAR for the project. The optional "breakdown" tab can be used to report by institution. No description provided. Direct beneficiaries are people or groups who directly derive benefits from an intervention (i.e., children who benefit from an immunization program; families that have a new piped water connection). Please note that this indicator requires supplemental information. Supplemental Value: Female beneficiaries (percentage). Based on the assessment and definition of direct project beneficiaries, specify what proportion of the direct project beneficiaries are female. This indicator is calculated as a percentage. Based on the assessment and definition of direct project beneficiaries, specify what percentage of the beneficiaries are female. Portfolio at Risk = Outstanding (or not yet repaid) balance of all loans where payment is late by > 90 days / Gross outstanding loan portfolio. Report the Portfolio at Risk (PAR) for the PFI's entire SME portfolio. Do not report on the PAR for just the Bankfunded portion. Loans that have been rescheduled or renegotiated should also be 39

40 Percentage of project-supported institutions that are reporting on this indicator Number of PFIs working with the Afghanistan Credit Guarantee Facility Pay Out Rate of the Afghanistan Credit Guarantee Facility Operational Self Sufficiency of MISFA partners included in the numerator of the PAR. Weight each institution's PAR by its outstanding SME portfolio to calculate the average PAR for the project. The optional "breakdown" tab can be used to report by institution. No description provided. No description provided. (value of claims paid out over a year / average outstanding guarantee amount that year) No description provided. 40

41 ANNEX 2: DETAILED PROJECT DESCRIPTION AFGHANISTAN: Access to Finance Project Component 1: Improving access to financial services for micro and small enterprises (US$32 million) 1. This component aims to provide continuing support to the microfinance sector through MISFA, as well as, supporting MISFA to take on a broader role as a catalyst for innovations to increase access to financial services to the lower end of the market (notably micro and small enterprises) as per its new strategic plan. It should be underlined that the role of MISFA is primarily a role of market facilitator, rather than direct technical assistance provider. Key data on the microfinance sector is provided in the appendix to this Annex. 2. MISFA new strategic plan for is developed around two key guiding principles: Leadership: The development of strong leadership principles and capacity as the foundation for providing innovative access to financial programs, which involves the following objectives: o Maintain MISFA s credibility as a leading institution; o Develop strategic alliances and partnerships with key organizations in financial sector; o Strengthen advocacy function to promote inclusive development finance sector; o Establish concrete capacity development mechanism to promote Afghan leadership within MISFA and across the sector. Financial Inclusion: The deepening of MISFA s core business to expand access to financial services throughout Afghanistan; and develop activities that will complement and maximize outreach in the market to reach underserved target populations. MISFA therefore aims to support the development of a viable and inclusive financial sector for the poor and under served by supporting a range of innovations, products and services with a focus on the financial and social betterment of clients. This rests on the following priorities: o Core Business: Continue supporting the creation of stronger and more effective microfinance institutions (MFIs); o Research and Development: Implement R&D function to conduct market driven sector research on new products, innovations, and investigate new ways to use technology for greater efficiency in serving clients; o Knowledge Management: Develop a knowledge based resource center within MISFA to document lessons learned, implement the credit registry and social performance management initiatives, and provide access to sector knowledge. 3. This component will support: (i) the strengthening of the microfinance sector through MISFA, (ii) the scale up of the Targeting the Ultra Poor Program and (ii) further strengthening of MISFA to support the implementation of its new business plan and project implementation. It will include the following activities. 41

42 Sub-component 1.1: Strengthening of the microfinance sector through MISFA (US$13 million) 4. Capacity Building Fund (US$10 million). This Capacity Building Fund will have two windows: (i) Innovation Window and (ii) Systems Strengthening Window. The Innovation Window will allow MISFA to support innovations to improve access to financial services proposed by MFIs and other institutions which have a focus on access to finance. As such, this fund would cover the testing and piloting of new financial products (small enterprise finance, agricultural credit, savings, sharia-compliant products, insurance, etc.) as well as the use of technology to improve access to financial services. The Systems Strengthening Window will support efforts from MFIs and CSPIs to strengthen their systems and their human resources (MIS, internal control, risk management, etc.) based on a detailed capacity strengthening plan. This fund will also support systems strengthening of MFIs aiming to become Deposit taking MFI (DMFI), once the regulation is approved. During the preparation of the project microfinance institutions and CSPIs have confirmed their interest in such a Capacity Building Fund and preidentified the type of support they would be interested to receive. In addition, the Capacity Building Fund could cover support to the establishment of new financial institutions, to strengthen the supply side 20 of the microfinance sector, which counts a limited number of institutions following the consolidation process. 5. The mechanism for this Capacity Building Fund will be detailed in the MISFA Operations Manual for this component. This Capacity Building Fund would finance consultancy services, incremental operating costs and goods 21 (works would not be covered) to institutions whose applications have been accepted by MISFA. A transparent application process will be developed by MISFA (and posted on its website), with clear eligibility criteria and selection process. The consultancy services and goods financed under this Capacity Building Fund will need to be procured following World Bank procurement rules. MISFA s procurement unit will undertake the procurement process in coordination with the selected applicants to ensure World Bank procurement rules are properly followed. 6. The Capacity Building Fund will not include on-lending funds as MISFA has currently enough resources for on-lending (which could be mobilized in parallel by the applying institutions, if needed). 7. Support to Policy, Regulation and Advocacy (US$3 million): this sub-component will provide support (consultancy services, training, workshops, operating costs and goods) to agencies in charge of policy, regulation and advocacy, namely: the Ministry of Finance, which has the responsibility to set the policy direction for financial sector development in Afghanistan; the Central Bank of Afghanistan (DAB) which once the Deposit taking MFIs regulation will be approved will be responsible for regulating these institutions and the Afghanistan Microfinance Association (AMA) which is the representative body for the microfinance sector. For the 20 The MISFA Operations Manual will clarify the eligibility criteria as it is important to learn the lessons from the past uncontrolled growth of the microfinance sector in Afghanistan with a large number of weak institutions, the majority of which collapsed. Such support might be considered post 2014, once the political situation has stabilized in Afghanistan. 21 The MISFA Operations Manual would specify the types of goods that could be financed through the Capacity Building Fund. For example, vehicles would not be eligible. Eligible goods would include Management Information Systems or technological solutions to improve financial institutions operations. 42

43 activities described in this paragraph, MISFA will be the conduit to provide financial support to these institutions which play an essential role in financial sector development and financial inclusion. 8. Support to the Ministry of Finance (via MISFA as the Project Implementing Entity for this component) will mostly consist of consultant services, training (focused on tashkeel staff) and goods (such as computers). This sub-component would provide support to the Ministry of Finance to elaborate a financial sector development strategy for Afghanistan, which would set the vision for the future of the financial sector in Afghanistan, moving beyond the Kabul Bank crisis and its resolution. Support to DAB would also mostly consist of consultancy services, training (for DAB staff) and goods (such as computers). This sub-component would help ensure that DAB staff have the required technical capacity when the Deposit taking MFIs regulation is approved and once DAB is required to supervise Deposit taking MFIs. 9. This sub-component will also provide support to the Afghanistan Microfinance Association, which represents the microfinance sector (MFIs, as well as CSPIs) in Afghanistan. The capacity of AMA has improved and it is playing an increasing role in the provinces in Afghanistan, clarifying the role of microfinance 22 and bringing together a wide range of actors involved in increasing access to financial services. Support to AMA would mostly consist of consultant services, goods, training and operation costs and would focus on the following priorities: financial literacy for microfinance clients via MFIs and CSPIs, social performance management for MFIs, coordination between microfinance and business development services at the provincial level, information management on the microfinance sector (quarterly statistics, annual report, newsletter, website improvements). Sub-component 1.2.: Targeting the Ultra Poor (TUP) Program (US$15 million) 10. This sub-component will support the scale up of the Targeting the Ultra Poor (TUP) program piloted by MISFA in Bamyan and Badakshan. The TUP program aims at graduating participants from safety nets programs to income-earning activities, linking them with microfinance programs. Building on the lessons learned from the pilots and from international experience, the program will provide TUP beneficiaries a three-year package of inputs which includes the transfer of productive assets (such as livestock) as well as training (classroom and hands-on); a subsistence support (monthly stipend, as short term income support); and basic healthcare through community-based health workers. The total cost of the package (including its delivery) is estimated at $2,000 per household. This Program will be replicated in 20 districts (across 5 provinces) and the program will reach 7,500 households (representing an estimated 52,500 household members). 11. A detailed description of this sub-component (objective and implementation) is provided in Annex AMA s legal awareness meetings (as part of its functions in advocacy and lobbying) aiming at increasing awareness among policymakers, government officials and community elders are important to increase government and community s support to microfinance, which can be a challenge in the Afghanistan environment. 43

44 Sub-component 1.3: Strengthening of MISFA (US$4 million) 12. This sub-component will provide support to MISFA to implement its new strategic plan. This sub-component will in particular support the establishment of a Research and Development Department within MISFA to develop innovative programs, as an incubator, to better support under-served groups, notably women and youth. Under its new strategic plan, MISFA intends to develop a Women Empowerment Program as well as a Youth Entrepreneurship Program (combining financial and non-financial services). This component will also support the establishment of a Knowledge Management Department at MISFA to document best practices, lessons learned, and provide timely and relevant information to stakeholders by commissioning research and studies. This Department would also be tasked to implement the Progress out of Poverty Index (based on international experience) to better track microfinance impacts. MISFA will also strengthen its Client Profile database to have more accurate information on clients and avoid multi-lending to clients and over-indebtedness. This sub-component will also strengthen project implementation capacity at MISFA (with a focus on fiduciary aspects). It will in addition support coordination efforts between various initiatives with a focus on access to finance supported by development partners (notably USAID, with FAIDA and ABADE) and the World Bank (such as Financial Sector Strengthening Project, Financial Sector Rapid Response Project, New Market Development Project, Rural Enterprise Development Project, Skills Development Project, Non Formal TVET Project and Justice Service Delivery Project). 13. This sub-component will mostly finance consultancy services, incremental operating costs and goods. As described above this sub-component will have a strong market research angle. In its strategic plan, MISFA identified the following areas of research: Cluster-wise research needs assessment of SMEs 23 Feasibility of trade finance products for SMEs Women entrepreneurship development Youth entrepreneurship development Analysis of the potential of technology in the context of the Afghanistan microfinance sector Impact evaluation of microfinance in Afghanistan Component 2: Improving access to financial services for small and medium enterprises (US$18 million) 14. The aim of the component is to increase commercial bank and MFI lending to SMEs in Afghanistan and thus facilitate access to financial services for SMEs. It will support the expansion of the Afghanistan Credit Guarantee Facility implemented and managed by DEG, which has supported SME lending in Afghanistan since The Facility has a strong track record. It will also support technical assistance to commercial banks to strengthen their SME lending capacity (also referred as downscaling ). This component will include support to the Credit Guarantee Facility to provide coverage to MFIs lending to the lower end of the SME market (also referred as upscaling ). Further details on the operations of the Facility are provided in Annex MISFA focuses on the lower end of the SME market. 44

45 Sub component 2.1: Supporting the expansion of the Afghanistan Credit Guarantee Facility (US$13 million) 15. This component will provide US$13 million to the Afghan Credit Guarantee Facility (the current capital stock of the guarantee fund of US$8 million as of June 2013 is fully committed and will reach its maximum leverage in the near future). It will support the expansion of the Credit Guarantee Facility generated by its organic growth and by additional initiatives, e.g.:, (i) volume growth with existing partner institutions (the Facility currently works with 3 partner institutions); (ii) cooperation with additional partner institutions (an increasing number of commercial banks and MFIs have expressed an interest for support to develop SME lending); (iii) regional expansion; (iv) new product development. Sub component 2.2: Providing technical assistance to Credit Guarantee Facility and partner financial institutions (commercial banks and MFIs) (US$5 million) (i) (ii) (iii) (iv) (v) 16. In general, the Facility provides technical assistance on best practice SME lending to partner financial institutions (banks and MFIs), until the Facility considers that the partner institutions no longer require technical assistance. More specifically, this sub-component will finance the following activities by the Credit Guarantee Facility: Technical assistance on new product development such as rural SME credit, Islamic finance, trade finance, credit technology improvements for larger SME loans, women entrepreneurs, supply chain finance, other products as per individual need, knowledge sharing and management capability (US$1,500,000); Support for management information system (MIS): improvement to the Facility s and the PFIs Management Information System (portfolio reporting module, loan tracking and appraisal module, projection and risk management module, workflow management module) (US$550,000); Support to the geographical expansion of the Credit Guarantee Facility, with the opening of offices in the North (e.g. Mazar-e Sharif) and possibly Herat, as well as capacity improvement (US$2, ); Risk management improvements (credit rating system, credit scoring system, risk management toolbox) (US$450,000) Impact evaluation (US$250,000) 17. A detailed breakdown of this budget is provided in the appendix of Annex 6. 45

46 Appendix: key data on microfinance sector 46

47 ANNEX 3: IMPLEMENTATION ARRANGEMENTS AFGHANISTAN: Access to Finance Project Project Institutional and Implementation Arrangements 1. The project will be implemented by MISFA and the Afghanistan Credit Guarantee Facility. MISFA will be a Project Implementing Entity, while, in a first phase, DEG, which manages the Credit Guarantee Facility, will be a Project Implementing Partner. The following paragraphs will provide further details on the implementation arrangements. The implementation capacity of both institutions is considered satisfactory. MISFA 2. MISFA was established by the Government of Afghanistan in 2003, as the vehicle to channel resources supporting the establishment and growth of the microfinance industry. The key objectives for MISFA were to: (i) coordinate donor funding ensuring that conflicting priorities endemic in post conflict situations do not duplicate efforts and distort markets; (ii) help start-up microfinance institutions that would scale up rapidly and eventually become sustainable; and (iii) build systems for transparent reporting and instill a culture of accountability. MISFA is established as a limited liability non-profit company wholly owned by the Ministry of Finance. 3. Until 2008, MISFA was in the process of building up its own capacity which limited its ability to effectively supervise MFIs activities and performance. Building on lessons learned from the microfinance crisis and the subsequent sector consolidation, MISFA strengthened its capacity and transformed into a competent, sustainable and independent apex institution. MISFA has been a long term partner of the World Bank, first through an ARTF funded project (Microfinance for Poverty Reduction Project, P091264, closed in June 2010) and then through an IDA funded project (Expanding Microfinance Outreach and Improving Sustainability Project, P104301, closed in June 2012). 4. MISFA has a robust governance structure, with the Minister of Rural Rehabilitation and Development as Chairman of the Board and the Deputy Minister of Finance as Vice-Chair. Other Board members include the CEO of the Afghanistan Chamber of Commerce and three international microfinance experts. MISFA organization chart is presented below. It should be noted that MISFA is currently recruiting a new Managing Director. The transition process has been soundly managed. The Acting Managing Director is the former Operations Director. 47

48 Graph 1: MISFA organization chart 5. MISFA will be responsible for component 1 of the Project: Improving access to financial services for micro and small enterprises. As per the previous IDA project, a Project Agreement will be signed between MISFA and the World Bank and a Subsidiary Agreement will be signed between the Government of Afghanistan (MOF) and MISFA. MISFA, as the Project Implementing Entity, will have fiduciary responsibility for the overall component. 6. The implementation mechanism for Component 1 will be further detailed in the Operations Manual for Component 1, which will be subject to periodic reviews. The Operations Manual for Component 1 will detail in particular the implementation mechanisms of the Capacity Building Fund and of the TUP Program (a draft manual is already available for the TUP program and will need to be updated). MISFA already has a draft Operations Manual for its activities. This Operations Manual will be updated in light of the activities financed under the project and the ESMF by effectiveness (condition of effectiveness). 48

49 Afghanistan Credit Guarantee Facility 7. The Afghanistan Credit Guarantee Facility has been managed, since 2006, by DEG, a member of the KfW Group 24 and one of the largest European development finance institutions with a focus on financing and structuring investments of private companies in developing and transition countries. The Afghanistan Credit Guarantee Facility has received funding from USAID and BMZ (the German Federal Ministry for Economic Cooperation and Development). DEG, BMZ and the Government of Afghanistan have recently agreed to institutionalize the Afghanistan Credit Guarantee Facility and to establish the Afghanistan Credit Guarantee Foundation (ACGF). The Foundation will be registered in Germany and operate under German law. It will be governed by a Board of Trustees that will include a representative of DEG, of BMZ and of the Afghanistan Ministry of Finance. The Foundation will be managed by a Board of Directors, including a Chief Executive Officer and a Chief Financial Officer. The Foundation, once established, will rely on the staff who have been working for the Facility. 8. In a first phase, DEG, which manages the Credit Guarantee Facility, will be responsible for the implementation of Component 2: Improving access to financial services for small and medium enterprises. An agreement will be signed between the Ministry of Finance and DEG, which will stipulate the legal and fiduciary conditions of the cooperation. DEG will (i) manage, on behalf of GoA, the IDA funds to the Credit Guarantee Facility and (ii) manage the technical assistance budget extended to the Facility. In a second phase, once the Afghanistan Credit Guarantee Foundation is established, the contractual arrangements will be reviewed and the contractual arrangements will be between the Ministry of Finance and the Foundation. The Financing Agreement provides further details on the proposed agreements, referred to DEG Agreement, in the first phase, and to Implementing Partner Agreement, in the second phase. 9. Once the Foundation is established and before closure of the project, the Ministry of Finance and the World Bank will need to agree on the future utilization of the funding provided to the Guarantee Fund. The following options have been identified for the remaining balance of funding: (i) be retained by ACGF during the remaining period of any partial credit guarantee for which any portion of the proceeds of the financing remains committed; (ii) be retained by ACGF, at the request of the Ministry of Finance, for the duration of the existence of ACGF; (iii)be transferred back to the Ministry of Finance, including upon its request for dissolution of ACGF, to be used for the purposes agreed to between the Ministry of Finance and the World Bank (iv) in the event that the Ministry of Finance and the World Bank are unable to reach agreement in writing before project closing, then the balance remaining shall be refunded by ACGF to the Ministry of Finance to be refunded to the Association. 10. The implementation mechanism of the Credit Guarantee Facility is described in the Operations Manual (version 1.2, dated March 2012). This Operations Manual will be updated by 24 KfW was established in 1948 as a public law institution, KfW is owned 80% by the Federal Republic of Germany and 20% by the federal states. With a balance sheet total of more than EUR 450 billion, KfW is one of Germany s three largest banks. 49

50 Project effectiveness to take into account the contribution from the Project and the related safeguards requirements, as described in the ESMF. 11. Annex 6 provides a detailed description of the operations of the Afghanistan Credit Guarantee Facility. Financial Management Country Issues 12. The World Bank has gained substantial experience and understanding of the financial management environment in Afghanistan through the large number of projects under implementation over the past years. The Public Financial Management Reform Project II is the primary instrument to continue and enhance the fiduciary measures put in place during the past years to help ensure transparency and accountability for the funding provided by the Bank and other donors. 13. A PFM performance rating system using 28 high-level indicators that was developed by the Public Expenditure and Financial Accountability (PEFA) multi-agency partnership program was applied in Afghanistan in June 2005, and updated in A current update in 2013 is in progress, the results of which have not been published yet. PEFA is comprised of the World Bank, IMF, EC, and several other agencies. The system is structured around six core dimensions of PFM performance: i) budget credibility, ii) comprehensiveness and transparency, iii) policybased budgeting, iv) predictability and control in budget execution, v) accounting, recording, and reporting, and vi) external scrutiny and audit. Afghanistan s ratings against the PFM performance indicators generally portray a public sector where financial resources are, by and large, being used for their intended purposes. This has been accomplished with very high levels of support from international firms; this assistance will continue to be needed over the medium term if these ratings are to be maintained. There is also much room for improvement. 14. In spite of undeniable gains made in reconstruction since the end of 2001, the challenges facing Afghanistan remain immense; not least because of the tenuous security situation in the region and continued prevalence of a large illegal and illicit economy. The policy framework benchmarks have not yet been fully estimated so various priorities are funded through the annual budgeting process. The rising costs of the security sector constitute the major constraint on attainment of fiscal sustainability. With regard to executive oversight, the national assembly will play an increasingly active role. All in all, the new national strategy has created high expectations of the executive which could prove to be quite difficult to meet. 15. The public sector, in spite of considerable efforts to reform its core functions, remains extremely weak outside of Kabul. The lack of qualified staff in the civil service and the absence of qualified counterparts in the government after 30 years of war and conflicts is still a binding constraint. Delays in reforming the pay structure and grading of civil servants have severely crippled the public administration of the country. Domestic revenues lag behind expenditures significantly. Large-scale corruption could emerge to undermine the government s efforts to enhance aid flows through national accounts. Capacities to track expenditures and monitor 50

51 expenditure outcomes have improved, but they need rapid and substantial strengthening if progress toward the attainment of national development targets is to be monitored. 16. The World Bank is financing a Financial Management Advisor to assist the Ministry of Finance, an Audit Advisor to assist the Supreme Audit Office, and a Procurement Advisor to assist in Procurement-related activities. Also an Internal Audit function is being developed within the Ministry of Finance with World Bank financing. The activities carried out under the series of Public Financial Management Reform projects have helped the Government to ensure that appropriate fiduciary standards are maintained for public expenditures, including those supported by the Bank and the donor community. 17. Progress has been slower than expected in shifting from operations support provided by the three Advisors to capacity development and knowledge transfer to the civil servants. Given that, is expected that the Advisors will continue to be required for the medium term. Challenges still remain in attaining the agreed upon fiduciary standards and also to further enhance them. And to make matters more complex, the regulatory environment in Afghanistan has advanced significantly in the past three years. Unfortunately, even mastery of basic skills in the early environment does not fully qualify the civil servants to work effectively in the new emerging environment. Risk Assessment and Mitigation 18. The table below identifies the key risks that the project may face and indicates how these risks are to be addressed. The overall FM risk rating is High but the residual risk rating after application of the mitigating measures is Substantial. Risk Risk Rating Risk Mitigation Measures Inherent Risk Country H Afghanistan is a country in conflict with improving, but still extremely fragile, state and civil society institutions. The 2008 PEFA ratings related to internal and external audits remain low. According to the 2009 ROSC- AA, there is no approved body representing the Audit profession in Afghanistan nor is there a corporate regulator. Afghanistan is still ranked as one of the highest countries in terms of perceived level of corruption. Implementing S Both MoF and MISFA have significant experience Agency in implementing Bank projects. Project H MISFA will implement component 1 of the project. Component 2 which is the partial risk guarantee facility will be implemented by MoF through an implementing partner contractual arrangement. The contract for component 2 and the operations manuals for both components will define in detail the necessary fiduciary arrangements Residual Risk H M S Condition of negotiations or effectiveness (Y/N) N N N 51

52 Overall H Inherent Risk Control Risk Budgeting S MoF and MISFA will ensure that project funds are allocated in the annual Government Development Budget, the approved carried forward budget is used at the beginning of the new year, and that disbursements are made while waiting for the Parliament s approval of the new year s budget. Both MoF and MISFA will be responsible for the preparation of annual work plans and the derivation of annual budget there from for the project. Accounting S International accounting standards will be followed. Project accounting procedures and detailed financial management arrangements will be defined in the FM manuals for each of the components that will be part of the operations manual. The accounting, reporting and audit arrangements for the guarantee funds will be stated in the implementing partner contract and the operational manual. At the central level, MoF system AFMIS will be used for accounting, the project will also follow MoF chart of accounts. Internal H MISFA FM staffing is qualified and adequate, and Control MoF will utilize existing staff in RIMU. MISFA including MoF s internal audit department will review Internal Audit project internal control systems through periodic internal audit. MISFA will facilitate the internal audit function through an outsourced arrangement with an audit firm. Relevant controls exist at central and the implementing agency level, and allow for segregation of duties, these controls will be reviewed periodically for effectiveness. The TORs for the internal audit and the frequency will be defined in the FM manual Funds Flow S The project will follow standard funds flow arrangements being utilized by other projects in Afghanistan. A designated account will be set up for component 1, this DA will be maintained at DAB and managed by MoF. For Component 2, Bank disbursements will be made to bank accounts designated by DEG/ACGF. Financing Reporting H Strengthening the SDU is a priority under the FM Advisor contract, to provide required information to facilitate project reporting. Project reporting will be done MISFA and RIMU for components 1 and 2 respectively. This will be facilitated by the accounting system maintained by MISFA, and excel records maintained by RIMU and AFMIS Auditing S Project will be audited by the Supreme Audit Office with support from Audit Advisor S M N M Y 25 S N M N S N M N 25 The FM manuals will be part of the operational manuals for the two components, the operational manuals being a condition of effectiveness. 52

53 Overall Control Risk Overall FM Risk Rating Risk rating: H=high risk; S=substantial risk; M=modest risk; L-low risk H H S S Strengths and Weaknesses 19. Strengths. The Government provides assurance to the Bank and other donors that the measures in place to ensure appropriate utilization of funds will not be circumvented. The Government strongly supports reforms through the Public Financial Management Reform Projects I and II to enhance financial management in Treasury operations, public procurement, internal audit in the public sector, and external audit by the Auditor General. MISFA has developed into a strong institution, with strong financial management capacity. The proposed implementation partner to carry out activities under component 2 through a contractual arrangement with MoF has experience in carrying out similar activities in Afghanistan. 20. In Afghanistan, there is weak capacity among FM staff. However, MISFA has a finance department staffed with adequate FM staff, and led by an international Finance Director. MoF will utilize the existing FM staff in RIMU that also supports PFMR II. Action Plan - To be reviewed at Initial Supervision Significant Weaknesses Project internal controls and procedures need to be defined Interim reports need to include required information Action Responsible Agent Completion Date Financial Management Manuals MISFA and DEG By effectiveness developed for components 1 and 2 26 respectively Interim financial report formats IDA/MoF/MISFA Before confirmed negotiations Implementing Entities 21. The project will be implemented by two implementing entities: MISFA and MoF will implement component 1 and 2 of the project respectively. MoF will implement the component through a contractual agreement with DEG initially and subsequently with Afghanistan Credit Guarantee Foundation after the latter s establishment. All fiduciary aspects relating to the accounting, reporting and audit arrangements for the guarantee funds will be defined in the contract. In MoF, the FM focal point in RIMU (Reform Implementation and Management Unit) will be responsible for the financial management aspects. 26 The Financial Management Manuals to be developed for Component 1 and 2 respectively by MISFA and DEG before effectiveness will be incorporated into the Operations Manuals of the project. 53

54 22. MISFA shall be staffed with qualified and experienced financial management staff to carry out day-to-day financial management operations of the project as well as overall contract and project management. The finance department of MISFA is headed by an International Director Finance and Administration, who is a Chartered Accountant with significant years of experience. He is supported by experienced national finance staff, one pursuing post-graduation and another pursuing graduation. MISFA is also in the process of hiring a qualified and experienced national Finance Manager to further support the department. Detailed FM reporting requirements, staffing, systems, internal control procedures, and other FM arrangements will be included in the Financial Management Manuals. 23. Project coordination and monitoring. MISFA has the responsibility for implementation, coordination, and monitoring of Component 1 and to ensure steady progress of execution in accordance with an implementation schedule reviewed and approved by the World Bank. For Component 2, the Economic Governance Sector Manager of the MoF Budget Department will be the technical focal point, while RIMU will be the focal point for financial management and disbursement arrangements. 24. Project oversight. Oversight function for MISFA for component 1 will be performed by the Board of MISFA. Oversight function of the overall project will be undertaken by the Deputy Minister for Finance of the Ministry of Finance. 25. Budgeting. A budget committee within MISFA will coordinate the preparation of annual work plan and the derivation of annual budget, prior to review by the Board. The Committee shall also coordinate quarterly budget reviews to ensure adequate budget discipline and control. The committee will be responsible for ensuring that project expenditures for each fiscal year are captured in the Governmental Development budget of that fiscal year and that carry forward budgets are used during the first few months of the new fiscal year while waiting for Parliament s approval of the new year s budget. The budgeting process and the key roles of budget committee on periodic budget reviews will be detailed in the FM Manual. 26. Accounting. Government follows IPSAS cash basis of accounting and at the central level, uses a computerized accounting system, AFMIS, to record/ report all project disbursements, to exercise controls and generate financial statements. MISFA utilizes Quick Books for its accounting and reporting, and MISFA will reconcile its records with AFMIS records on a monthly basis. Differences identified will be resolved within a reasonable period of time. MISFA s finance department will be responsible for preparation of relevant documents to facilitate projects, including B27 allotment forms and M16 payment request forms. RIMU/ MoF will be responsible to perform similar functions for component 2 related payments and will maintain basic books of records using excel. While original copies of required supporting documents are attached to the Form M16, MISFA and RIMU are required to keep photocopies of these documents for records retention and audit purposes. 27. The FM Manuals will be prepared by MISFA and DEG by effectiveness, and will be approved by the Bank. The MISFA FM Manual will include: (i) roles and responsibilities for all FM staff; (ii) financial management aspects relating to each of the sub components, and documentation and approval procedures for payments; (iii) project reporting requirements; and 54

55 (iv) quality assurance measures to help ensure that adequate internal controls and procedures are in place and are being followed. The financial management manual for component 2 will be prepared by DEG and will specifically include the funds flow, reporting and audit arrangements for the guarantee facility sub component, and also details relating to the TA component. 28. Internal Control including Internal Auditing. Adequate internal controls exist at the central and the implementing agency level, the effectiveness of these controls will be periodically reviewed by the internal audit function and also the Bank. Project specific internal control procedures for requests and approval of funds will be described in the FM Manual including segregation of duties, documentation reviews, physical asset control, asset verification, reconciliation and cash management. 29. The internal audit function at MoF will be carried out by its own internal audit department. The capacity of the IAD department in MoF continues to be strengthened under the PFMR II project. The internal audit function will be carried out by MISFA through an outsourced arrangement with an audit firm. This will also be supplemented by the Monitoring and Supervision department of MISFA for the technical aspects. The TOR for the MISFA internal audit function will be reviewed by the Bank to ensure that it captures all relevant aspects of components 1. The frequency of the internal audit exercise should be preferably quarterly, and at least semiannual. The Bank also reserves the right to conduct an external review of the project activities and financial flows. 30. Funds Flow. The standard funds flow mechanism in Afghanistan will be followed for the project. For component 1, IDA funds will be deposited in the Designated Account (DA) to be opened and maintained at the Da Afghanistan Bank (DAB). The DA, in keeping with current practices for other projects in Afghanistan, will be operated by the Special Disbursement Unit (SDU) in the Treasury Department of MoF. Requests for payments from the DA will be made to the SDU by MISFA when needed. Further advances from the DA may be taken by MISFA, subject to periodic and timely acquittal. MISFA s controls for management of such advances has been assessed and found satisfactory. All the bank accounts of MISFA are closely monitored by finance director and finance officer, monthly reconciliations are prepared and all payments out of those accounts require dual signatures as per the signature matrix of MISFA. All these details will be captured in the FM manual. 31. In addition to payments out of DA funds, MISFA can also request the SDU to make direct payments from the Grant Account to consultants, consulting firms or suppliers, These payments will follow World Bank procedures. All project payments will be made to either international firms or local firms that have bank accounts in DAB, a local commercial bank, or an overseas bank. All payments will be made either through bank transfers into the account of such firms or by check. 32. No segregated designated account will be established for component 2. IDA disbursements under this component are the following: 55

56 a) For Component 2.1 (credit guarantee facility): Based on withdrawal applications from the Government of Afghanistan, IDA funds for this sub-component 27 will be advanced in a number of tranches 28 to a bank account designated by DEG in Germany. This account will be a pooled account for IDA disbursement purposes, and IDA funds will be co-mingled with guarantee funds from other donors. Such disbursement arrangement will be clearly captured in the agreement to be entered between GoA (MoF) and DEG, and also documented in the Credit Guarantee Facility Operations Manual. Expenditures under this sub-component will be recognized (and corresponding amounts will be documented against advance made) on the basis of guarantees issued. DEG will be required to report on a regular basis to GoA (MoF) on the guarantees issued, so that GoA (MoF) through submission of withdrawal applications, can properly account for the advance made by IDA. A pro rata formula will be established (and documented in the Credit Guarantee Facility Operations Manual and in the agreement to be entered between GoA and DEG) to determine the amount of IDA s share in the combined pool of funds at a given time. The treatment of unutilized IDA funds lying in the pooled bank account with DEG at project closing date will be agreed to between GoA and the Association four months prior to project closure. However, once ACGF is established, one option is that contributions to the Foundation for guarantee purposes be capitalized and such contributions would be treated as eligible expenditures 29. b) For Component 2.2 (TA activities): Based on withdrawal applications to be submitted by the Government of Afghanistan, through MOF, IDA funds for this sub-component will be advanced in an amount up to US$750,000 to a separate bank account designated by DEG and set up in Germany. This bank account so designated by DEG will be treated as a segregated Designated Account for IDA disbursement purposes, i.e. IDA funds in this bank account will not be co-mingled with other funds from other donors or DEG, and DEG will be required to account for the receipt and use of IDA funds in this bank account under sub-component 2.2. DEG, on a semi-annual basis, will provide relevant documents supporting the use of IDA funds to GoA, so that through submission of withdrawal applications by MOF/RIMU, IDA funds under this sub-component can be accounted for and the bank account properly replenished. Unlike IDA funds for sub-component 2.1, IDA funds advanced and remaining un-utilized at the project s closing date needs to be refunded back to IDA. The above disbursement arrangements for sub-component 2.2 will be captured in both the Credit Guarantee Facility Operations Manual and in the agreement to be entered between GoA and DEG. Similar arrangement will be followed for ACGF once it is established. 27 Under phase I to be implemented by DEG. 28 To be defined in the agreement between MoF and DEG. 29 Guarantees and capital contribution for the purposes of issuing guarantees are recognized as eligible expenditures as they meet the conditions of paragraph 2 of O.P : they are productive and necessary to meet the development objectives of the Project, the impact of the Project on the member country s fiscal sustainability is acceptable, and acceptable oversight arrangements, including fiduciary arrangements, are in place to ensure that Investment Project Financing proceeds are used only for the purposes for which the financing is granted, with due attention to considerations of economy and efficiency. 56

57 Funds flow chart World Bank / IDA Component 2 Direct payments DEG/ ACGF Provides SOEs with supporting documentation, reconciliations, & requests replenishment transfers to Designated Account, OR requests Direct Payments IDA Replenishes Designated Account for component 1 SDU (MOF) Designated Account Consultants/ Suppliers/ Firms & Associations, etc Invoices MISFA Finance Dept 33. Financial Reporting. Relevant financial reports will be prepared by MISFA and MoF (RIMU) on monthly, quarterly and annual basis as required. Financial Statements and Project Reports will be used for project monitoring and supervision. These reports will be produced based on records from three sources: (i) MISFA s accounting system and excel records maintained by RIMU; (ii) expenditure statements from SDU (as recorded in AFMIS) and reconciled with MISFA/ RIMU; and (iii) bank statements from DAB. The annual project accounts to be prepared from AFMIS after due reconciliation to records maintained at MISFA and RIMU, will form part of the consolidated Afghanistan Government Accounts for all development projects. This is done centrally in the Ministry of Finance Treasury Department, supported by the Financial Management Advisor. 34. Quarterly Interim Financial Reports (IFRs) will be prepared and submitted to the Bank within 45 days from the end of the quarter. The project will follow GoA s fiscal year for accounting and reporting. The quarterly IFRs will be prepared and submitted by MISFA and MoF for components 1 and 2 respectively. The IFRs will show: (i) sources and uses of funds by project components and activities; (ii) reconciliation of DA advance; and (iii) reconciliation of project disbursements to Bank disbursements. The government and IDA have agreed on a pro forma report format for all Bank projects; a final customized format for the project will be provided before project negotiation. 57

58 35. With regard to the guarantee funds provided to DEG/ ACGF, detailed reporting arrangements (formats and periodicity) will be specified in the contract and the operational manual. As the funds will be deposited into a pooled account in which other guarantee funds are maintained, the reporting formats will provide for segregation of funds and guarantee claims from/to different donors based on a pro rata formula agreed to in the contract. 36. Auditing. The project accounts will be audited by the Supreme Audit Office of Afghanistan, with the support of the Audit Advisor, with terms of reference satisfactory to the Association. The audit of project accounts will include an assessment of the: (a) adequacy of the accounting and internal control systems; (b) ability to maintain adequate documentation for transactions; and (c) eligibility of incurred expenditures for Association financing. The audited annual project financial statements will be submitted within six months of the close of fiscal year. All agencies involved in implementation and maintaining records of expenditures would need to retain these as per the IDA records retention policy. 37. The following project audit reports will be required under the project and monitored each year: Responsible Agency/ ies Audit Auditors Due Date MISFA/ MoF SOE, Project Accounts and Supreme Audit June 20 Designated Account Office 38. The Bank-funded projects already or currently being implemented by MoF or MISFA have no overdue audit reports, no overdue IFRs nor any ineligible expenditures. 39. The audit requirements for the funds given to DEG/ACGF for the guarantee facility including the periodicity will be defined in the FM/operations manual as well as in the agreement to be entered between GoA and DEG/ ACGF. 40. Financial Management Covenants: MISFA and MoF shall submit audited financial statements for the project within six months of the end of each fiscal year. The Project s audit report will cover the financial statements, the Designated Account, and SOEs, in accordance with terms of reference agreed with the Association. Project interim financial reports will be submitted by MISFA and MoF (for components 1 and 2 respectively) on a quarterly basis to the World Bank and a copy to SDU-MoF within 45 days after the end of each quarter. The implementing entities will ensure that key FM staff are retained throughout the duration of the project in order to ensure smooth project disbursements. 41. Regular Supervision Plan. During project implementation, the Bank will supervise the project s financial management arrangements. The team will: Review the project s quarterly interim financial reports as well as the project s annual audited financial statements and auditor s management letter. Review the project s financial management and disbursement arrangements (including a review of a sample of SOEs and movements on the Designated Account and bank reconciliations) to ensure compliance with the Bank's minimum requirements. 58

59 Review agencies performance in managing project funds to ensure that it is timely, accurate, and accountable. Review project Internal Audit reports and internal controls. Review of financial management risk rating, compliance with all covenants, and follow up on the action plan. 42. The FM arrangements, including the systems, processes, procedures, and staffing are adequate to support this project- subject to implementation of the action plan. During the process of FM assessment, the designated Procurement Specialist in the Bank was consulted as needed. 43. Disbursement Arrangements. The project will be 100% financed by the IDA grant, inclusive of taxes. Table 1 below shows the allocation of IDA proceeds in two expenditure categories. The first category is for Goods, non-consulting services, consulting services, training and incremental operating costs for Component 1 implemented by MISFA. Successful signing of a Subsidiary Agreement between GoA (through MOF) and MISFA is a condition for disbursement under component 1 or disbursement category 1 in Table 1. The second category is for the support to the guarantee facility, Component 2, implemented by Ministry of Finance through a contractual arrangement to be entered between GoA (through MOF) and DEG (and subsequently with ACGF). Signing of this contractual agreement between GoA (through MOF) and DEG is a condition for disbursement under component 2 or disbursement category 2 in Table A standard 4-month grace period is provided for the project. During this four-month grace period, project-related expenditures incurred up to the closing date are eligible for disbursement or documentation against advances to the designated account. Disbursements procedures will follow the World Bank procedures described in the World Bank Disbursement Guidelines and the Disbursement Handbook for World Bank Clients (May 2006). Table 1: IDA Financing by Categories of Expenditure (US$ million) Category 1. Goods, non-consulting services, consulting services, training, workshops and incremental operating costs under Part 1 of the Project 2. Guarantees under Part 2.1 of the Project, and goods, non-consulting services, consultants services, training, workshops and incremental operating costs under Part 2.2 of the Project Amount (US$) Summary Reports. Summary sheet with records evidencing eligible expenditure should be provided for payments against contracts for i) goods and non-consulting services valued at US$200,000 equivalent or more per contract; ii) consulting firms valued at US$100,000 equivalent or more per contract; and iii) individual contractors valued US$50,000 equivalent or more per contract; and reports in the form of Statements of Expenditure (SOE) will be used for all other contracts or expenditures regardless of whether Bank procurement prior review is required or not. 46. Designated Account. A segregated designated account (DA) for MISFA, for the purpose of Component 1 of the project, will be opened at DAB in US dollars for a ceiling of advance up to four (4) months worth of eligible expenditures to be paid out of the funds in the DA. The 59

60 SDU in MOF will manage payments from and new advances/replenishments to this account. Other transfers in the form of cash advances may be taken from the Designated Account, and held and managed by MISFA. This agency s controls, holding, accounting, and preparation of Statement s of Expenses (SOEs) have been satisfactorily assessed. New cash advances will only be made when all other prior cash advances have been justified through submission of SOEs to the SDU. Expenditure reporting on the designated account will be submitted on a monthly basis and requests for fresh advances will be made as needed. 47. No segregated Designated Account will be established for Component 2 to be implemented by DEG 30 through a contractual agreement between GoA/MOF and DEG. Instead, a bank account to be designated by DEG will be used to receive IDA funds for Component 2.1 and this bank account so designated by DEG will be treated as a pooled designated account for IDA disbursement purposes. DEG (and ACGF when it is established) will be required to report on a regular basis to MOF on the use of IDA funds under credit guarantee facility, so that through withdrawal applications submitted by MOF, IDA funds under Component 2.1 can be properly accounted for on a timely manner, i.e. on a quarterly basis or a period not to exceed six months. For the TA funds under component 2.2, DEG will set up a separate bank account to receive IDA funds and this separate bank account to be so designated by DEG will be treated as the segregate designated account for IDA disbursement purposes. 48. Direct Payments. Third-party payments (direct) will be permitted for amounts exceeding 20 percent of the advance in the Designated Account. All such payments require supporting documentation in the form of records (copies of invoices, bills, purchase orders, etc.). Component 2 will be implemented through Direct Payments to DEG and the Afghanistan Credit Guarantee Foundation. 49. Preparation of Withdrawal Applications. For Component 1, MISFA will prepare Summary Reports and forward those reports to the SDU for further processing into withdrawal applications. For component 2 related payments, RIMU in MoF will facilitate the process. The SDU will review withdrawal applications for quality and conformity to Treasury procedures, and then obtain signature. Selected MISFA, RIMU and SDU finance staff will be registered as users of the World Bank Web-based Client Connection system, and take an active hand in managing the flow of disbursements. 50. Legal requirements for authorized signature. Ministry of Finance has authorization to disburse funds from the Grant. If necessary, specimen signatures of authorized signatories in MoF will be submitted to the Bank prior to commencing disbursements. Procurement 51. The Bank has gained substantial experience and understanding of the procurement environment in Afghanistan through its involvement in the interim procurement arrangements put in place under the Emergency Public Administration Project (2002) and though working with the institutions currently responsible for procurement functions, including the Afghanistan Reconstruction and Development Services. As part of the broader review of Afghanistan s 30 Subsequently by ACGF after it is established 60

61 Public Finance Management (PFM) system, the Bank carried out two assessments, in June 2005 and September 2007, of the procurement environment in the country based on baseline and performance indicators developed by a group of institutions led by the World Bank and OECD/DAC. 52. The first key issue identified through the procurement assessments was lack of ownership and lack of a procurement champion in the Government, which is a serious impediment to reform and to inter-ministerial dialogue. A second, related issue is the lack of capacity in the line ministries, as evidenced by their inability to define and communicate effectively their desired functional specifications/terms of reference in their procurements. The lack of capacity is also evident in the local private sector while the number of bids is reasonably high, there is a lack of understanding about how to apply public procurement rules. 53. Government Reforms. A new Procurement Law (PL) was adopted in November 2005 that radically transforms the legal and regulatory framework. In accordance with the law, GoA established a Procurement Policy Unit (PPU) under the Ministry of Finance to provide oversight for the PL s implementation. PPU has issued several circulars regarding implementation of the PL including Rules of Procedures for Public Procurement (Circular: PPU/C005/1386 of April 12, 2007) and Procurement Appeal and Review Mechanism (Circular: PPU/N001/1385 of March 18, 2007). PPU and MOF have developed several standard bidding documents (SBDs), standard requests for proposal (SRFPs), standard requests for quotation (RFQs) for national and international procurement of goods/works and consulting services following national procedures as per the PL s Glossary of Procurement Terms in English and Dari. MOF has now mandated the use of: (i) SBDs for Goods and Works (Circular PPU/C024/1388 of June 10, 2009); (ii) SRFQs (Circular PP/C026/1388); and (iii) SRFPs (Circular PPU/C029/1388 of January 13, 2010). A Procurement Management Information System (PMIS) has been developed and is being piloted in three line ministries. In addition, a PPU Web site will facilitate publication of procurement notices and contract awards in addition to similar action being done under the ARDS-Web site and the Web sites of the line ministries, as applicable. 54. In the absence of adequate capacity to manage procurement activities effectively, a central procurement facilitation unit (ARDS PU) has been established under Ministry of Economy to support line ministries and project implementing agencies. The Bank and the Government have agreed on a program for country-wide procurement reform and capacity building, leading to the transition from centralized to decentralized procurement services. The above was implemented by an international consultant under the supervision of PPU/MOF and financed under the Public Administration Capacity Building Project (PACBP) and the Public Finance Management Reform Project (PFMRP). The consultant has conducted several basic, intermediate, and advanced level training programs. The implementation of the procurement reform component of the PACBP/PFMRP should be considered with due priority to ensure that fiduciary standards are further enhanced and that capacity is developed in the Government to maintain these standards. 55. The Procurement Law has been revised in July 2008 and amended in January 2009 and issued as a new Law by the Ministry of Justice and was published in the Official Gazette 61

62 Number 957, (18 January 2009). The revised Rules of Procedures for Public Procurement have been issued as circular PPU/C027/1387 of November 18, General Procurement for the Project 56. Procurement for the project will be administered in accordance with the World Bank s Guidelines: Procurement under IBRD Loans and IDA Credits, dated January 2011; Selection and Employment of Consultants by World Bank Borrowers, dated January 2011 and the provisions stipulated in the Financing Agreement. In addition, the World Bank s Guidelines on Preventing and Combating Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants dated October 15, 2006 and revised January 2011 has been shared with the recipient. The World Bank s Standard Bidding Documents, Requests for Proposals, and Forms of Consultant Contract will be used. Civil works and goods following National Competitive Bidding (NCB) procedures shall be procured using the agreed Standard Bidding Documents (SBDs) for Afghanistan. It has been agreed by both parties that in the event of a conflict between IDA Procurement/Consultant Guidelines, as per Article 4 (2) of the Procurement Law July 2008 (Amendments in January 2009 incorporated) of the GoA, the IDA Procurement/Consultant Guidelines shall prevail. 57. Procurement of Works. The project will not finance civil works. 58. Procurement of Goods and Non Consulting Services. Procurement of the goods will be done using Bank s SBD for Goods for all contracts following International Competitive Bidding (ICB) procedures. National SBDs agreed with IDA, or satisfactory to IDA, will be used for the procurement of goods following National Competitive Bidding (NCB) procedures. Shopping shall be in accordance with paragraph 3.5 of the Bank s Guidelines. Any contract estimated costing more than US$200,000 shall be procured following ICB procedures. Any contract estimated to cost more than US$50,000 equivalent and less than US$200,000 shall be procured following NCB procedures. Any contract estimated to cost less than US$50,000 equivalent shall be procured following shopping procedures. Goods that meet the requirements of paragraph 3.7 of the World Bank Procurement Guidelines may be procured following direct contracting procedures with prior agreement with IDA. 59. Selection of Consultants. The proposed grant would finance several consultancy assignments (as per the attached procurement plan). Short lists of consultants for services estimated to cost less than US$100,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. The selection methods applicable for consultants are QCBS, QBS, CQS, LCS, FBS, and SSS for firms as per Section V of the Bank s Guidelines for Individuals. The threshold for CQS will be less than US$300,000 equivalent per contract. 60. Operating Costs. The cost which would be financed by the project would be procured using the implementing agency s administrative procedures such as Procurement Law, which were reviewed and found acceptable to the Bank. The operating costs will include operations and maintenance of equipment and vehicles, hiring of vehicles, office rent, costs of consumable, fuel, office utilities and supplies, bank charges, and advertising expenses but exclude any salaries and allowances of civil servants. 62

63 61. Contracting and selection of TUP Program Implementing Partners. MISFA as the implementing agency will contract and finance several consultancy assignments under the TUP sub-component 31. This will involve hiring the services of NGOs (Facilitating Partners) to (a) rollout the project to cover all the provinces and districts under the program; and (b) carry out the planning at the household levels so as to provide appropriate technical assistance and transfer of benefits as required of the three-year package to beneficiary households. For the TUP subcomponent a competitive Fixed Budget Selection or Single Source Selection method will be followed under the following 2 categories: Category 1: Hiring the services of an existing Facilitating Partner (FP) of the National Solidary Project (NSP) under the Ministry of Rural Rehabilitation and Reconstruction on a Sole Source Selection (SSS) basis, if they are working in the same district and/or province and have a satisfactory performance and implementation capacity (based on an assessment done by MISFA, using information from the NSP FP database and other sources). The selected FP would be requested to submit a Short Technical Proposal (STP) and negotiate a separate contract with MISFA; Category 2: Selection of a Facilitating Partner based on a competitive process, following preparation of a shortlist based on expressions of interest (EOI) 62. MISFA will make payments to the NGOs based on set milestones (e.g. completion of participatory wealth ranking, completion of planning process at household level, trainings, transfer of assets/subsistence allowances, final payment at graduation of household etc.). Depending on the type, cost and availability of the assets to be transferred the procurement can be community participatory procurement or done by the hired FP. 63. Assessment of MISFA s Capacity to Implement Procurement. MISFA will have overall responsibility for all procurement under Component 1. Component 2 will be implemented by Ministry of Finance, through a contract with the Afghanistan Credit Guarantee Foundation. An assessment of the capacity of MISFA to implement procurement actions for the project has been carried out by Samson Omodele Idahosa, Procurement Specialist, in June The assessment reviewed the organizational structure for implementing the project. 64. To mitigate risks, the following measures will be taken: A competent procurement specialist will be hired by MISFA by end November 2013 (candidate identified, under contract negotiations) To ensure compliance with the World Bank policy and procedure, procurement documentation for complex and large value of goods and consultancy contracts will be carried out through ARDS, in conformity with Afghan Procurement Law. 65. With the above arrangements in place, the risk is rated as Moderate. 66. Governance and Accountability (GAC) agenda. All the contract opportunities and contract awards will be widely published in the internet, ARDS website, PPU/MOF website and when required in UNDB World Bank external website. MISFA will set up a system to ensure 31 FPs could also be recruited through Non Consulting Services Contracts. 63

64 that the staff/consultants who handled the procurement process/contract management/contract execution do not join the consultants/contractors. This will be reviewed during supervision missions. 67. Procurement Plan. The Borrower, at appraisal, developed a Procurement Plan for project implementation that provides the basis for the procurement methods. This plan has been agreed between the client and the IDA Task Team on October 2 nd, 2013 and is available at MISFA. It will also be available in the Project s database and on the Bank s external website. The Procurement Plan will be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. 68. Frequency of Procurement Supervision. In addition to the prior review supervision shall be carried out from Bank offices. There will be two Implementation Support Missions per annum. 69. Procurement Audit. In addition to prior review, Bank staff or Bank appointed consultant shall carryout post procurement audit once per annum. 64

65 Table 1 Procurement Risk Mitigation Monitoring Plan S No Procurement Process/step General Procurement Notice REOI/Invitation for Bids and Bidding process Preparation of Bid Documents/RFPs GPN Published Process Indicator Number of responses received against GPN REO/IFB Published Minimum bidding time provided [4 weeks in NCB and RFP and 6 weeks in ICB and RFP with complex assignments] Attention of the firms/individuals who expressed interest against GPN while issuing REOI/SPN was called Number of Bid Documents sold and Number of firms confirmed participation against RFP issued Clarifications/addendums issued Cleared by IDA without seeking clarifications/comments 4 Bid Submission Bid opening minutes sent to all bidders Sources of Information and means of verification Documentary evidence filled within MISFA Existence of updated responses registration file within MISFA Copy to be available in the file. 10% of the procurement files will be verified Deviations to be collected from procurement files Copy to be available in the file. 10% of the procurement files will be verified Sale of bid documents register and confirmation from consultants about receipt of RFP. 10% procurement files will be verified Copy to be available in the file. 10% of the procurement files will be verified Number of cases to be collected from procurement files Timeliness to be verified from procurement files 10% of the procurement files will be verified Use of information for risk mitigation To ensure GPN is widely published to increase transparency Performance target to be achieved 100% To increase competition. 100% To ensure SPN/REOI is widely published to increase transparency 100% To ensure competition 100% To ensure competition 100% To ensure competition 100% To ensure transparency 100 % Capacity building measures initiated by international procurement specialist Continued progress To ensure transparency 100% 65

66 S No 5 6 Procurement Process/step Bid Evaluation/REOI and proposal evaluation Bid Evaluation Report and Technical Evaluation Report 7 Contract Award 8 Delivery/ Completion Process Indicator Formation of bid evaluation committee before bid closing. Timeliness of Evaluation: (a) 5-7 working days following shopping procedure; (b) working days following NCB/ICB procedures; (c) 10 working days for individual consultants; and (d) 15 working days for firms for REOI evaluation, 21 working days for TER and 20 working days to conclude the contract negotiations after commencement of contract negotiations. Sources of Information and means of verification Deviations to be collected from procurement files Deviations to be collected from Procurement Activity Schedule Number of Re-bids Procurement files Cleared by IDA without seeking clarifications/comments Contract award within the original bid validity (a) Contract award published within 14 days of NOA (b) Average time taken for publication of award (c) Number of cases award not published Delivery time: Percentage of Contracts completed/ delivered within the original schedule as mentioned in Contract Liquidated damage: Percentage of Contracts having liquidated damage imposed for delayed delivery/completion Data to be collected from procurement files Deviations to be collected from Procurement Activity Schedule Data to be collected from procurement files Data to be collected from procurement files Data to be collected from procurement files Use of information for risk mitigation To expedite finalizing of bids/proposal evaluation. Finalizing of bids/proposal evaluation in timely manner. To improve procurement process. To improve procurement process. Performance target to be achieved 100% Compliance and continuous improvement for reduction in timelines for all activities continuous improvement for reduction in number of rebiddings 100% To ensure transparency 100% To improve procurement process. To improve procurement process. 60% 66

67 S No 9 Payment Procurement Process/step 10 Complaints Contract dispute resolution Procurement Capacity Building Process Indicator Completion rate: Percentage of Contracts fully completed and accepted Average number of days taken to release payment Late payment: Percentage of cases (considering each installment as a case) with delayed payment Procurement complaints pending over 60 days Resolution of complaints resulted in modification of contract award Resolution of complaints within 15 working days Complaints forwarded to MOF for independent review Sources of Information and means of verification Data to be collected from procurement files Data to be collected from procurement files Data to be collected from procurement files Use of information for risk mitigation To improve procurement process. To improve procurement process. To improve procurement process. Performance target to be achieved 90% 15 days 20% Complaint register To ensure transparency 90% Complaint register and Procurement files To ensure transparency 0% Complaint register To ensure transparency 70% Complaint register To ensure transparency 100% Unresolved Disputes over 60 days Procurement files To ensure transparency 10% Number of procurement staff trained in Civil Service Institute Number of staff trained outside Afghanistan Procurement training plan To improve procurement process. To improve procurement process. 80% staff to be trained during first year and 100% by second year. One staff during first 18 67

68 Attachment 1. Details of Procurement Arrangements Involving International Competition List of contract packages which will be procured following ICB and Direct Contracting procedures: Table 1: Procurement Packages with Methods and Time Schedule Ref. No. Contract Procurement Comments (Description) Method Estimated Cost (in million USD) Prequalification (yes/no) Domestic Preference (yes/no) Review by Bank (Prior / Post) Expected Bid- Opening Date G1 Software of PPI Index 50,000 Direct contracting No No Post January 20, 2014 G2 Software for AMA (MIS) 50,000 Direct contracting No No Post January 20, 2014 Obtain support from Grameen Foundation Obtain from PMN (Pakistan) Table 2: List of Consulting Assignments with Shortlist of International Firms or Individuals Ref. No. C1 C2 C3 Description of Assignment Technical assistance on report generation and analysis of the PPI Index Cluster-wise research needs assessment of SMEs Research on Sharia Lending product development Estimated Cost (USD) Selection Method Review by Bank (Prior / Post) Expected Proposals Submission Date 60,000 CQS Prior May 30, ,000 CQS Prior January 31, ,000 CQS Prior February 28, 2014 Comments 68

69 C4 C5 C6 C7 C8 C9 C10 C11 C12 C13 C14 Research on feasibility of SME trade finance product Qualitative Research on the impact of current MF client Research on the needs of current female clients (segmentation) and development of gender appropriate financial products WED (Women Entrepreneurship Development) program launch value chain linkage Research on global best practices in use of technology, and analysis on the potential of technology use in the context of Afghanistan microfinance sector Market research on youth entrepreneurship initiatives Development of appropriate financial products for youth Research on savings opportunities and existing programs Development of appropriate savings solutions for the poor Individual consultant to provide assistance for the spin-off of Mutahid (about 3 months) Support to MISFA for knowledge management department set up 150,000 CQS Prior March 15, ,000 CQS Post February 15, ,000 CQS Post March 15, ,000 CQS Post May 15, ,000 CQS Post June 15, 2014 [Might also try through IC if CQS does not lead good results] 200,000 CQS Post March 1, ,000 CQS Prior June 1, ,000 CQS Post March 1, ,000 CQS Prior June 1, ,000 IC Post December 30, ,000 IC Post December 30,

70 C15 C16 C17 C18 Support to MISFA/MFI for agriculture product advisor TA to MISFA/MOF to develop Financial Inclusion policy for Afghanistan TA to MISFA/DAB to develop NBFI regulation for Afghanistan Implementation of TUP Program 200,000 IC Post March 15, 2014 ToR ready 200,000 Individual (international) 200,000 Individual (international) Post May 30, 2014 Prior May 30, ,000,000 FBS or SSS Prior February 25, tenders 70

71 Procurement Plan General Project Information: Country/Borrower: Islamic Republic of Afghanistan Project Name: Afghanistan Access to Finance Project Implementing Agency: Microfinance Investment Support Facility for Afghanistan (MISFA) Grant No: IDA H894 Bank s approval Date of the Procurement Plan: October 3 rd, 2013 Date of General Procurement Notice: October 22 nd, 2013 Period covered by this procurement plan: 18 months A. Goods and Works and Non-Consulting Services Table 1: Procurement Method and Threshold Procurement Method Threshold for Methods (US$) Comment 1. ICB (Works) 5,000,000 Equivalent or more 2. ICB (Goods) 200,000 Equivalent or more 3. NCB (Works) 5,000,000 Equivalent or less 4. NCB (Goods) 200,000 Equivalent or less 5. Shopping (Goods ) 50,000 Equivalent or less 6. Shopping (Works) 100,000 Equivalent or less 7. ICB (Non-Consultant Services) 200,000 Equivalent or more 8 Commercial practices (Goods) 200,000 Equivalent or less Prior Review Threshold: Procurement Decisions subject to Prior Review by the Bank as stated in Appendix 1 to the Guidelines for Procurement: Procurement Method Prior Review Threshold Comments 1. ICB (Goods & Works/non All Contracts consulting services) 2. NCB (Goods & Works) 200,000 Equivalent or more 3 Direct Contracting (Goods& Works/non consulting services) All regardless of value Prequalification: NIL 71

72 Table 2: Procurement Packages with Methods and Time Schedule Ref. No. Contract Procurement Comments (Description) Method Estimated Cost (in million USD) Prequalification (yes/no) Domestic Preference (yes/no) Review by Bank (Prior / Post) Expected Bid- Opening Date G1 Software of PPI Index 50,000 Direct contracting No No Post January 20, 2014 G2 Software for AMA (MIS) 50,000 Direct contracting No No Post January 20, 2014 Obtain support from Grameen Foundation Obtain from PMN (Pakistan) 72

73 B. Selection of Consultants Table 3: Selection Methods and Thresholds Selection Method Threshold Comments 1. CQS for Firms US$300,000 equivalent or less 2. QCBS,QBS, FBS, LCS depending on the nature and complexity of assignment Prior Review Threshold: Selection decisions subject to Prior Review by World Bank as stated in Appendix 1 to the Guidelines Selection and Employment of Consultants: Selection Method Prior Review Threshold Comments 1. Competitive Methods (Firms) US$100,000 or more 2. Competitive methods US$50,000 or more (individuals) 3 Single Source (Firms)/Individuals All regardless of value Short list comprising entirely national consultants: Short list of consultants for services, estimated to cost less than US$100,000 equivalent per contract, may comprise entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. 73

74 Table 4: Consultancy Assignments with Selection Methods and Time Schedule Ref. No. C1 C2 C3 C4 C5 C6 C7 C8 Description of Assignment Technical assistance on report generation and analysis of the PPI Index Cluster-wise research needs assessment of SMEs Research on Sharia Lending product development Research on feasibility of SME trade finance product Qualitative Research on the impact of current MF client Research on the needs of current female clients (segmentation) and development of gender appropriate financial products WED (Women Entrepreneurship Development) program launch value chain linkage Research on global best practices in use of technology, and analysis on the potential of technology use in the context of Afghanistan microfinance sector Estimated Cost (USD) Selection Method Review by Bank (Prior / Post) Expected Proposals Submission Date 60,000 CQS Prior May 30, ,000 CQS Prior January 31, ,000 CQS Prior February 28, ,000 CQS Prior March 15, ,000 CQS Post February 15, ,000 CQS Post March 15, ,000 CQS Post May 15, 2014 Comments 200,000 CQS Post June 15, 2014 [Might also try through IC if CQS does not lead good results] 74

75 C9 C10 C11 C12 C13 C14 C15 C16 C17 C18 Market research on youth entrepreneurship initiatives Development of appropriate financial products for youth Research on savings opportunities and existing programs Development of appropriate savings solutions for the poor Individual consultant to provide assistance for the spin-off of Mutahid (about 3 months) Support to MISFA for knowledge management department set up Support to MISFA/MFI for agriculture product advisor TA to MISFA/MOF to develop Financial Inclusion policy for Afghanistan TA to MISFA/DAB to develop NBFI regulation for Afghanistan Implementation of TUP Program 200,000 CQS Post March 1, ,000 CQS Prior June 1, ,000 CQS Post March 1, ,000 CQS Prior June 1, ,000 IC Post December 30, ,000 IC Post December 30, ,000 IC Post March 15, 2014 ToR ready 200,000 Individual (international) 200,000 Individual (international) Post May 30, 2014 Prior May 30, ,000,000 FBS or SSS Prior February 25, tenders 75

76 Agreed Procedures for National Competitive Bidding: 1. Standard bidding documents approved by the Association shall be used. 2. Invitations to bid shall be advertised in at least one (1) widely circulated national daily newspaper and bidding documents shall be made available to prospective bidders, at least twenty eight (28) days prior to the deadline for the submission of bids. 3. Bids shall not be invited on the basis of percentage premium or discount over the estimated cost. 4. Bidding documents shall be made available, by mail or in person, to all who are willing to pay the required fee. 5. Foreign bidders shall not be precluded from bidding. 6. Qualification criteria (in case pre-qualifications were not carried out) shall be stated on the bidding documents, and if a registration process is required, a foreign firm determined to be the lowest evaluated bidder shall be given reasonable opportunity of registering, without any hindrance. 7. Bidders may deliver bids, at their option, either in person or by courier service or by mail. 8. All bidders shall provide bid security or a bid security declaration form as indicated in the bidding documents. A bidder s bid security or the declaration form shall apply only to a specific bid. 9. Bids shall be opened in public in one place preferably immediately, but no later than one hour, after the deadline for submission of bids. 10. Evaluation of bids shall be made in strict adherence to the criteria disclosed in the bidding documents, in a format, and within the specified period, agreed with the Association. 11. Bids shall not be rejected merely on the basis of a comparison with an official estimate without the prior concurrence of the Association. 12. Split award or lottery in award of contracts shall not be carried out. When two (2) or more bidders quote the same price, an investigation shall be made to determine any evidence of collusion, following which: (A) if collusion is determined, the parties involved shall be disqualified and the award shall then be made to the next lowest evaluated and qualified bidder; and (B) if no evidence of collusion can be confirmed, then fresh bids shall be invited after receiving the concurrence of the Association; 13. Contracts shall be awarded to the lowest evaluated bidders within the initial period of bid validity so that extensions are not necessary. Extension of bid validity may be sought only under exceptional circumstances. 14. Extension of bid validity shall not be allowed without the prior concurrence of the Association (A) for the first request for extension if it is longer than four (4) weeks, and (B) for all subsequent requests for extensions irrespective of the period in case of prior review. 15. Negotiations shall not be allowed with the lowest evaluated or any other bidders. 16. Re-bidding shall not be carried out without the Association s prior concurrence in case of prior review; and 17. All contractors or suppliers shall provide performance security as indicated in the contract documents. A contractor s or a supplier s performance security shall apply to a specific contract under which it was furnished. Environmental and Social (including safeguards) 70. The Environment Assessment (EA) is prepared in accordance with World Bank EA OP4.01 and pertinent to the Afghan laws and regulations. The purpose of the EA is to ensure that all activities that the MSME loans support are environmentally sound and are in compliance with requirements of pertinent Afghan laws and regulations as well as World Bank environmental policies. 71. This section will differentiate between loans for microenterprises (also referred to microfinance) and SME loans, as the potential harmful impact on the environment of SMEs is higher than micro-enterprises (mostly due to their size). 76

77 Microfinance (loans for microenterprises) 72. Microfinance institutions (which provide loans for microenterprises) are supported under component 1 of the project: Improving access to financial services for micro and small enterprises. This component is implemented by MISFA. Micro loans support household level income generating activities. As such income generating activities have no or little environmental impacts and therefore need no formal Environment Assessment. 73. MISFA implemented the IDA financed Expanding Microfinance Outreach and Improving Sustainability Project (P104301), which closed on June 30, MISFA developed and implemented an Environment and Social Management Framework under this Project and the same framework and implementation arrangements will apply for the present project, as described below. 74. MISFA will assume overall responsibility for compliance with pertinent Afghan laws and regulations on environmental protection and with the requirements of the World Bank. For this purpose, MISFA will take necessary steps to encourage environmental due diligence during project implementation. Commitment to ensuring environmental soundness should be included in the cooperation agreements between MISFA and the PFIs. In order to do this, MISFA will include in its contracts with PFIs requirements related to environmental procedures that will be agreed between MISFA and the World Bank. The following basic environmental requirements form the core of this framework: PFIs will conduct their activities with due regard to environmental factors and the principles of environmentally sound and sustainable development. PFIs operations will comply with the World Bank Group s FI Environmental Exclusion List. Activities supported by PFIs shall comply with the applicable health, safety and environmental regulations and standards. PFIs will provide periodic environmental reports to MISFA. 75. In consideration of the fact that the environmental issues involved in the project are generally clear and insignificant, the environmental management of the project is relatively simple and a totally separate environmental management system is not necessary. An environmental management system embedded in the project management system has been established under the previous IDA financed project and will continue to be used. 76. Under the previous IDA financed project, MISFA appointed one member of its Technical Services Department as an Environmental Focal Person to be responsible for the implementation of the agreed ESMF. At the PFI level, focal points have also been designated to be responsible for environmental protection. MISFA has ensured that the PFIs have access to professional environment and/or social advice in case there is a need for this. 77. Environmental laws and regulations in Afghanistan are evolving and are not yet adequate. The National Environmental Protection Agency (NEPA) has developed a few laws and regulations to ensure environmental soundness of the rehabilitation and development activities and projects in the country. Expertise can be sought from this source if necessary. 77

78 78. MISFA will continue to ensure that PFIs put in place environmentally sound policies and procedures to enable credit officers and other staff to adhere to the pertinent Afghan laws and regulations governing environmental screening, assessment and reporting in the process of credit appraisal and administration. The main tool to be used by PFIs is the activity exclusion list developed for the previous project to guide credit officers in their loan decisions. SME finance 79. Both components of the projects aim to encourage loans to SMEs: the first component focuses on the lower end of the market, i.e. small enterprises, while the second component focuses on the higher end of the market (loans up to US$1 million). For SME loans, MISFA and the Credit Guarantee Facility will have to apply the framework proposed below. The analysis of SME loans guaranteed by the Credit Guarantee Facility show that all subprojects have low or no environment or social risks (71.1% of loans guaranteed are in the trade sector and 9.3% are in the service sector, while 8.8% are in the production sector and 0.3% in the agriculture sector, the latter two sectors can represent higher environment risks. 80. The proposed project does not envision to support those subprojects which need preparation of a new full Environment Impact Assessment (EIA) report or a new EIA reporttable (Category A or B projects). Therefore only the following two types of subprojects that do not need new environmental impact assessment will be considered for support: Subprojects that do not require full environmental Assessment; Subprojects that only need filling out of environmental registration and screening forms. In exceptional cases, subprojects of category B with EIA report will be screened and appraisal will be based on defined mitigation measures compiled in a simplified environmental and management plan. 81. MISFA, the Credit Guarantee Facility and the partner institutions will assume overall responsibility for compliance with pertinent Afghan laws and regulations on environmental protection and with the requirements of the World Bank. For this purpose, MISFA and the Credit Guarantee Facility will take necessary steps to encourage environmental due diligence during project implementation. Commitment to ensuring environmental soundness should be included in the cooperation agreements between MISFA and the PFIs and/or between the Credit Guarantee Facility and the PFIs. In order to do this, MISFA and the Credit Guarantee Facility will include in its contracts with PFIs requirements that ensure environmental and social protection and that will be agreed between MISFA, the Credit Guarantee Facility and the World Bank. The following basic environmental requirements form the core of this framework: PFIs will conduct their activities with due regard to environmental factors and the principles of environmentally sound and sustainable development; PFIs operations will comply with the World Bank Group s IFC Environmental Exclusion List; Activities supported by PFIs shall comply with the applicable health, safety and and labour provisions under the pertinent laws and regulations of Afghanistan as well as World bank/ifc policies and guidelines; 78

79 PFIs will provide periodic environmental reports to MISFA and/or the Credit Guarantee Facility. 82. An environmental management system which is embedded in the project management system and makes full use of existing project management resources will be established within the Credit Guarantee Facility (the system is already established within MISFA). 83. The Credit Guarantee Facility will appoint one member of their Technical Departments as an Environmental Focal Person to be responsible for the implementation of the agreed ESMF. At the PFI level (commercial banks), a person will also be designated to be responsible for environmental protection if category B projects occur. If only category C projects occur, the PFI will not be required to designate a person responsible for environmental protection; category A projects will be excluded anyway. MISFA and the Credit Guarantee Facility will ensure that the PFIs have access to professional environment and social assessment advice in case there is a need for this. 84. MISFA and the Credit Guarantee Facility will take necessary steps to ensure that PFIs put in place environmentally sound policies and procedures to enable credit officers and other staff to adhere to the pertinent Afghan laws and regulations governing environmental screening, assessment and reporting in the process of credit appraisal and administration. The main tool to be used by PFIs is an activity exclusion list that will be reviewed to guide credit officers in their loan decisions. Afghan Laws and Regulations 85. The GoA agency in charge of environmental protection is the National Environmental Protection Agency (NEPA). Environmental laws and regulations in Afghanistan are still evolving and not yet adequate, but NEPA has developed few laws and regulations to ensure environmental soundness of the rehabilitation and development activities and projects in the country. The current Afghan laws and regulations on environmental protection mainly deal with construction projects and manufacturing industries. The supplementary local regulations also cover services and trade, with direct applicability to MSME loans (also referred to subprojects ) supported by the Access to Finance project. 86. The Environmental Law, effective 2006 and ratified by the Afghan Parliament in January 2007, is relevant to the proposed Access to Finance project. Article 14 on environmental preliminary assessment states that: A person proposing to undertake a project, plan, policy or activity shall submit to the National Environmental Protection Agency (NEPA) accurate information to allow the National Environmental Protection Agency to determine the potential adverse effects and positive impacts of the project, plan, policy or activity. In addition, Articles 15, 16, 17, 19, 21 and 23 of Environmental Law (2006) require that: a full environmental assessment should be conducted and an Environmental Impact Assessment (EIA) report should be prepared for a project with potential significant environmental impacts; an analysis or a specific assessment should be conducted and an EIA report-table should be prepared for a project which may have light environmental impacts; 79

80 an environmental registration form should be filled out for a project which may have minor environmental impacts and an EIA is not needed. 87. As in the Afghanistan Rural Enterprise Development Project (AREDP), another World Bank financed project in Afghanistan, a proponent of any project, plan, policy or activity that is likely to have a significant adverse impact on the environment shall apply international best environmental impact assessment practices in regard to such activities, in coordination with the National Environment Protection Agency (NEPA). 88. The Guidelines for Land & Asset Acquisition, Entitlement & Compensation is also considered relevant to the proposed Access to Finance project. While the proposed Access to Finance project will not trigger the operational policy for Land Acquisition and Involuntary Settlement, it is deemed appropriate to emphasize that the program checklist will specify that all land transfer be suitably documented and witnessed as per customary deeds (check of title deeds). It is the responsibility of any buyer to ensure that the seller truly has title and right to sell the land: the transfer of the land then becomes a transaction between willing buyer and willing seller. In exceptional cases, minor voluntary land donation may occur in certain sub-projects, but only provided that there are no structures or assets on the land, that the livelihood impact of the donation will be insignificant and the owner is part of the SME to which the land is donated. The voluntary nature of the donation should be fully documented and independently verified. 89. A negative list also excludes any activity which will damage non-replicable cultural property, and in case of chance finds the procedures to be followed are defined in the Law on the Preservation of Afghanistan's Historical and Cultural Heritages (Official Gazette no. 828, 1383/02/3l) specifying the authorities and responsibilities of cultural heritage agencies if sites or materials are discovered in the course of project implementation. This law establishes that all moveable and immovable historical and cultural artifacts are state property. World Bank Policies and Process for Implementation of Environment Safeguards 90. The World Bank operations policy (OP 4.01) requires that For a financial intermediary (FI) operation, the Bank requires that each FI screen proposed subprojects and ensure that sub borrowers carry out appropriate EA for each subproject. The Bank policies also require that In appraising a proposed FI operation, the Bank reviews the adequacy of country environmental requirements relevant to the project and the proposed EA arrangements for subprojects. 91. It should be noted that this requirement was not designed for microfinance projects with hundreds of thousands of micro loans at the household economy level. As mentioned above, for SME loans only the following two types of subprojects that do not need environmental impact assessment will be considered for support: Subprojects that do not require full environmental Assessment; Subprojects that only need filling out of environmental registration and screening forms. Only in exceptional cases, subprojects of category B with EIA report will be screened and appraisal will be based on defined mitigation measures compiled in a simplified environmental and management plan. 80

81 92. In order to begin to introduce this system, at the beginning of the first year of the project, the Credit Guarantee Facility will engage the services of a consultant. This consultant should be familiar with SME finance, with a good knowledge of environment issues affecting SMEs. The consultant will: Finalize the proposed terms of reference for the focal points in collaboration with the Credit Guarantee Facility and the PFIs; Define training and awareness building activities to be undertaken. Generally two types of training are needed: o Awareness programs: sessions for managerial grades of PFIs and the Credit Guarantee Facility o Competence development training: to cover the field experience, sharing the technical capacity needs, hence mainly targeting the field offices of PFIs Establish the user requirements for the reporting related to this ESMF. The implementation will be carried out by the Management Information Systems (MIS) developers / service providers; Finalize the negative lists (and conditional list) and the proposed environmental and registration screening form after reviewing the activities undertaken by SMEs receiving support from the project and taking into account the applicability of Afghan laws, as well as develop systems for the introduction and use of the negative lists. 93. The World Bank supervision team will review progress during the first full supervision mission for this project. 94. Ineligible Activity Lists. The follow activities will be deemed ineligible: activities which: Involves the significant conversion or degradation of critical natural habitats. Including, but not limited to, any activity within: o Ab-i-Estada Waterfowl Sanctuary; o Ajar Valley (Proposed) Wildlife Reserve; o Dashte-Nawar Waterfowl Sanctuary; o Pamir-Buzurg (Proposed) Wildlife Sanctuary; o Bande Amir National Park; o Kole Hashmat Khan (Proposed) Waterfowl Sanctuary. Will significantly damage non-replicable cultural property, including but not limited to any activities that affect the following sites: o Monuments of Herat (including the Friday Mosque, ceramic tile workshop, Musallah complex, Fifth Minaret, Gawhar Shah mausoleum, mausoleum of Ali Sher Navaii, and the Shah Zadehah mausoleum complex); o Monuments of Bamiyan Valley (including Fuladi, Kakrak, Shar-I Ghulghular and Shahri Zuhak); o Archaeological site of Ai Khanum; o Site and monuments of Ghazni; o Minaret of Jam; o Mosque of Haji Piyada/Nu Gunbad, Balkh province; o Stupa and monastery of Guldarra; 81

82 o Site and monuments of Lashkar-i Bazar, Bost; o Archaeological site of Surkh Kotal. Requires: o Chainsaws; o Motorized extraction of groundwater; o Political campaign materials or donations in any form; o Weapons including (but not limited to), mines, guns and ammunition; o Pesticides, herbicides and other chemicals; o Investments detrimental to the environment; o Involuntary land acquisition under any conditions; o Any activity on land that is considered dangerous due to security hazards or the presence of unexploded mines or bombs; o Any activity on land or affecting land that has disputed ownership, tenure or user rights. o Any activity that will support drug crop production or processing of such crops. 95. In addition to the above general list, the following negative list is added from the IFC exclusion list: o Production or trade in any product or activity deemed illegal under host country laws or regulations or international conventions and agreements; o Production or trade in alcoholic beverages; o Gambling, casinos and equivalent enterprises; o Trade in wildlife or wildlife products regulated under CITES (Convention on International Trade in Endangered Species of Wild Fauna and Flora); o Production or trade in radioactive materials; o Production or trade in or use of unbounded asbestos fibers; o Purchase of logging equipment for use in cutting forest; o Production or trade in pharmaceuticals subject to international phase outs or bans; o Production or trade in pesticides/herbicides subject to international phase outs or bans; o Fishing in the marine environment using electric shocks and explosive materials; o Production or activities involving harmful or exploitative forms of forced labor / harmful child labor. o Commercial logging operations for use in primary tropical moist forest; o Production or trade in products containing PCBs (polychlorinated biphenyls); o Production or trade in ozone depleting substances subject to international phase out; o Production or trade in wood or other forestry products from unmanaged forests; o Production, trade, storage, or transport of significant volumes of hazardous chemicals, or commercial scale usage of hazardous chemicals; o Production or trade in any product or activity deemed illegal under host country laws or regulations or international conventions and agreements; o Production or trade in alcoholic beverages; o Gambling, casinos and equivalent enterprises; o Anti-democratic activities like e.g. Nazi propaganda. 82

83 Monitoring & Evaluation 96. MISFA and the Credit Guarantee Facility will be responsible for monitoring and evaluation (M&E) for their respective components. Both institutions have already developed strong M&E systems. The two institutions will make limited adjustments to be able to regularly report on the project s indicators. 97. MISFA produces a Monthly Performance Report for internal purposes, which gathers key financial information on MISFA partner institutions (building on international good practices in microfinance): income statement, balance sheet, portfolio summary (with detailed information on the loan and savings portfolio of each institution with geographical and gender data). In addition, MISFA provides public information on the performance of its partner institutions on its website: MISFA will however need to strengthen the M&E mechanism for the TUP program, considering its significant scale up. Support from the World Bank Development Impact Evaluation Unit (DIME) has been sought, during project preparation, to conduct a robust impact evaluation of this program, with inputs from the CGAP (Consultative Group to Assist the Poor) which has been conducting in-depth research on Targeting the Ultra Poor programs internationally ( The paragraphs below briefly describe 99. The design of the impact evaluation for the TUP component will be finalized by end However, the following key elements that will be incorporated into the evaluation: (i) understanding what characteristics of the TUP model will work best for the Afghan context, and (ii) contributing to unpack the mechanisms through which the TUP model works, a subject that was not extensively developed in impact evaluations undertaken in other countries, which is essential to determine the most cost-effective way of implementing the program. Previous research was limited by the goal of probing the overall impact of the TUP program. The evaluation team will work closely with CGAP, Innovation for Poverty Action (IPA 32 ), and local implementers of the previous pilot to leverage on the already acquired international knowledge on TUP programs The Afghanistan Credit Guarantee Facility already tracks detailed financial information on the performance of its partner financial institutions. For each financial institutions, it tracks on a monthly basis (and on a cumulative basis) the following: loan disbursement, guarantees issues, loans outstanding, guarantees outstanding, write-offs, claims disbursed, claims refunded, Non- Performing Loans (over 30 and 90 days). Furthermore, a financial scorecard shows the revenues/expenses and gives operational as well as total financial results for the Facility. It also tracks the number of jobs created by the SMEs benefiting from the guarantees. The Credit Guarantee Facility intends to undertake a thorough impact assessment during project implementation to further measure the impact of increased access to finance on SMEs. 32 Innovations for Poverty Action is a nonprofit dedicated to discovering what works to help the world s poor. 83

84 ANNEX 4: ORAF. Operational Risk Assessment Framework (ORAF) AFGHANISTAN: Access to Finance Project (P128048) Stage: Board Risks. Project Stakeholder Risks Stakeholder Risk Rating Substantial Risk Description: Project stakeholders include: (i) the Government of Afghanistan and more particularly the Ministry of Finance, the Ministry of Rural Rehabilitation and Development, and the Central Bank, (ii) financial institutions, in particular commercial banks, microfinance institutions (MFIs) and community-based savings institutions promoters, (iii) micro, small and medium enterprises and (iv) development partners with a focus on access to finance (i.e. USAID and DFID). Risk Management: One of the aims of the project is to strengthen the capacity of the Ministry of Finance (MoF) to set policy direction for financial sector development (with a focus on access to finance) in Afghanistan. MISFA is already playing this leadership role on microfinance, the project will support MISFA to take a leading role in the financial inclusion agenda, in coordination with MoF. Resp: Both Status: In Progress Resp: Bank Status: In Progress Stage: Both Recurrent: Stage: Both Recurrent: Due Date: Due Date: Frequency: Quarterly Frequency: Quarterly Increasing access to finance for the private sector and notably MSMEs (which constitute the bulk of the private sector) has been a key concern of the authorities, private sector and development partners. As such, this project is welcome by all stakeholders. Financial institutions also recognize that their capacity to lend to SMEs (for 84

85 commercial banks) and MSEs (for MFIs) need to be strengthened. A potential risk could emerge from Government initiatives to increase access to finance which are not line with good practices. There are on-going Government initiatives (financed by development partners) which support the direct provision by the Government of subsided credit which in most cases have disappointing results (elite capture, non-repayment) and can undermine more sustainable approaches to increasing access to finance. Implementing Agency (IA) Risks (including Fiduciary Risks) Capacity Rating Substantial Risk Description: MISFA: Substantial The World Bank has been working with MISFA since 2003 (through one ARTF funded operation and one IDA funded operation, both closed). MISFA has evolved into a relatively strong institution (having successfully completed an Afghanization strategy, incrementally replacing international staff with national staff) and has learnt a lot from the 2008 microfinance crisis and subsequent consolidation (as well as from the latest collapse of two MFIs). MISFA governance is also relatively strong, with a Board chaired by the Ministry of Rural Rehabilitation and Development and composed of the Deputy Minister of Finance (Vice-Chair), head of the Risk Management: During preparation and implementation, the performance of MISFA will be closely monitored to ensure it remains a strong institution. Special attention will be given to the competitive and transparent recruitment of the new MD during the preparation of the project. A first recruitment process did not yield any strong candidate. Another recruitment process has been launched. The performance of Mutahid will have to be carefully monitored to take early actions if the situations warrants it. The establishment of the Afghanistan Credit Guarantee Foundation will be closely monitored. The governance and the management of the Foundation consist of the current staff of the Afghanistan Credit Guarantee Facility, which should allow a smooth institutionnalization. DEG also indicated that it would remain closely involved (and indicated it could provide a letter of comfort to the World Bank). Resp: Both Status: In Progress 85 Stage: Both Recurrent: Due Date: Frequency: Quarterly

86 Afghanistan Chamber of Commerce and Industry and three international microfinance experts. MISFA leadership in microfinance is widely recognized in Afghanistan. The main risks relate to staff turnover within MISFA and to the recruitment of a new Managing Director. Another risk relates to Mutahid, an MFI created by MISFA following the microfinance crisis, gathering the healthy portfolio of failed MFIs. There are questions on the viability of Mutahid and on how to spin off Mutahid from MISFA. Afghanistan Credit Guarantee Foundation: Moderate The Afghanistan Credit Guarantee Facility has been so far managed by DEG, which is the equivalent of the German IFC. The Facility has been operating in Afghanistan since DEG has recently decided to create the Afghanistan Credit Guarantee Foundation (to be established in Germany) to manage the Credit Guarantee Facility, with the same staff in charge of the Facility so far. The implementing partner of the project will therefore be a newly established institution, which brings some risks (mostly fiduciary risks). Governance Rating Moderate Risk Description: MISFA has a strong governance structure, its Board is chaired by the Minister of Rural Rehabilitation and Development. The Vice-Chair is the Risk Management: The governance of MISFA will be closely monitored during project preparation and implementation: the World Bank has the status of observer during MISFA Board meetings (and has therefore been attending MISFA Board meetings regularly since 2003). The presence of three international microfinance experts should also ensure that MISFA can withstand potential political pressure ahead of 86

87 Deputy Minister of Finance. The Board is also composed of the head of the Afghanistan Chamber of Commerce and Industry and three international microfinance experts. The World Bank is an observer during the Board meetings (held twice a year). The Board meetings are held in a very professional manner and are a great example of good governance in action in Afghanistan. A potential risk relates to increasing political pressure ahead of the elections. the elections. The proposed governance structure of the Afghanistan Credit Guarantee Foundation appears very sound. The establishment of the Foundation and the effectiveness of its governance and management will be monitored during project implementation. Resp: Both Status: In Progress Resp: Bank Status: In Progress Stage: Both Recurrent: Stage: Both Recurrent: Due Date: Due Date: Frequency: Quarterly Frequency: Quarterly The proposed governance structure of the Afghanistan Credit Guarantee Foundation (to be established as a not-for-profit and thus tax-exempt foundation registered in Cologne under German law and supervised by the comptroller office of the foundations and with independently audited accounts) is strong. Its management will comprise a CEO (current person managing the Afghanistan Credit Guarantee Facility) and a CFO. Its board of trustees will comprise a representative of DEG, of the German Ministry for Economic Cooperation and Development (BMZ) and of the Afghanistan MoF (Mr. Hamid Jalil, Director Aid Management). Project Risks Design Rating Moderate Risk Description: The design risks are limited, as the project supports two on-going programs: MISFA and Afghanistan Credit Risk Management: The design risks have been mitigated during project preparation. A microfinance scanning exercise validated the needs of key microfinance partners that could be covered under the capacity building fund. The scale up of the TUP program has also been closely analyzed during project preparation 87

88 Guarantee Facility. drawing on the experience of the National Solidarity Program. For the MISFA component (first component), a key design risk relates to the proposed $10 million capacity building fund, a demand driven funding facility to support financial innovations and systems strengthening. It will be important that MISFA effectively manages this fund (taking into account World Bank procurement procedures) and ensures its design meets the needs of the institutions it targets. MISFA will also need to carefully monitor the impact of the capacity building fund. Another design risk relates to the significant scale up of the Targeting the Ultra Poor (TUP) program ($15 million). For the Afghanistan Credit Guarantee Facility component, the main risk relates to the implementation arrangement with the Afghanistan Credit Guarantee Foundation. Overall design risks are limited as the component aims at scaling up existing activities. A significant deterioration in the security environment might require to review the design of the project. Similarly, the implementation arrangements with the Afghanistan Credit Guarantee Foundation should be agreed by the Decision Meeting. Implementation progress will be carefully monitored to take early action if the design of the project no longer seems appropriate. In term of the security environment, both institutions know how to operate in the present environment. If the security environment were to significantly deteriorate, modifications in the design of the project might be required, with, for example, a focus on the more stable provinces. Resp: Both Status: In Progress Social and Environmental Rating Moderate Risk Description: This project will facilitate the provision of credit to MSMEs. The main risk is that the MSMEs supported under the project engage in activities harmful to the Risk Management: 88 Stage: Both Recurrent: Due Date: Frequency: Quarterly The project will develop an Environment and Social Management Framework (ESMF) that will be applied by MISFA and the Afghanistan Credit Guarantee Facility. MISFA has been a long term partner of the World Bank and has developed appropriate mechanisms to deal with potential (and limited) social and environment risks.

89 environment or with negative social consequences (such as child labor). MISFA has been a long term partner of the World Bank and has developed appropriate mechanisms to deal with potential (and limited) social and environment risks. Resp: Both Status: In Progress Stage: Both Recurrent: Due Date: Frequency: Quarterly It will also be important to ensure that the Afghanistan Credit Guarantee Facility includes appropriate mechanisms to ensure that social and environment risks are mitigated. Program and Donor Rating Substantial Risk Description: A potential risk could come from initiatives financed by donors which are less concerned about sustainability. Such initiatives could undermine the activities of MISFA and the Credit Guarantee Facility which both have a strong focus on sustainability. Delivery Monitoring and Sustainability Rating Risk Description: The main risk relates to a significant deterioration of the security environment which would require changes in delivery mechanisms. Another risk relates to the financial sustainability of MISFA and the credit guarantee facility. Risk Management: The results so far achieved by both MISFA and the Credit Guarantee Facility show that these two institutions and programs have been moderately affecting by donor projects which do not focus on sustainability. In addition, in the context of the transition, there will be a likely significant decrease in free money distributed to MSMEs. Under the project support will be provided to the Ministry of Finance to develop a financial sector development strategy, which should be the guiding principles for donor involvement in the access to finance sphere. Resp: Both Status: In Progress Substantial Risk Management: Stage: Both Recurrent: Due Date: Frequency: Quarterly The security situation of the country will continue to be closely monitored. MISFA and the Credit Guarantee Facility will continue to tailor their activities to the security situation of the country. Should the security situation deteriorates significantly, modifications in the proposed activities (in particular in term of geographical cover) might need to be implemented. With the failure of several MFIs, MISFA has faced financial losses. MISFA has fully provisioned these losses and its balance sheet remains strong. MISFA is fully committed to financial sustainability, both for itself and for its partner MFIs. The World Bank will carefully monitor MISFA on-lending activities to MFIs to ensure that MISFA s financial sustainability is not endangered. 89

90 5. Project Team Proposed Rating Before Review Overall Preparation Risk: Moderate Risk Description: The financial sustainability of Afghanistan Credit Guarantee Facility has so far been extremely strong, as it has only faced a net loss rate of around 1% per annum since As the credit guarantee facility program will take on more risks, with an expansion of its activities with new partner banks, with new products and increased lending beyond Kabul, the loss rate of the guarantee facility might increase slightly. As long as the security situation remains manageable, it will be important to ensure that the net loss rate of the guarantee facility remains low, which in turn ensure the financial sustainability of the guarantee fund. Resp: Both Status: In Progress The risk is considered Moderate as the World Bank and MISFA have a long history of constructive collaboration (since 2003). The Afghanistan Credit Guarantee Facility has been operating in Afghanistan since 2006 and discussions are ongoing to clarify the implementation mechanism with the Afghanistan Credit Guarantee Foundation to be shortly established. 6. Overall Risk Overall Preparation Risk: Moderate Risk Description: Stage: Both Recurrent: Overall Implementation Risk: Risk Description: Due Date: Substantial Frequency: Quarterly The risk is considered Substantial mostly because of the very uncertain environment in Afghanistan. While the security situation of the country and the transition period have been taken into account while designing the project, the project could still suffer from a significant deterioration in the security environment. Overall Implementation Risk: Risk Description: Substantial 90

91 ANNEX 5: TUP PROGRAM AFGHANISTAN: Access to Finance Project Rationale and background 1. This sub-component will support the national scale up of the Targeting the Ultra Poor (TUP) program piloted by MISFA in Bamyan and Badakshan Provinces. The pilot identified 1,200 rural households, through a participatory wealth ranking, who were found to be at the very bottom of the economic ladder. These households often tended to be susceptible to high levels of vulnerability due to a dependence on a weak agriculture sector and to spend household incomes on health care and out of pocket expenses, often leading to further poverty, heavy debt, distress sale of assets and migration. Typically the ultra-poor in Afghanistan are excluded, or exclude themselves, from microfinance services (either savings or loans) as their income is usually too low and unreliable to permit repayment of loans or investment in anything but basic food consumption. 2. There are a few safety net programs in Afghanistan; however they are highly dependent on donor assistance and therefore not sustainable. Safety net programs which usually take the form of cash transfers, food aid, or guaranteed employment help very poor people survive or prevent them from falling further into debt and poverty; however they do not assist the sustainable graduation out of poverty. Under the MISFA pilot it was found that adopting a graduation model which combines support for immediate needs with longer term investments in training, financial services, and business development for a period of at least two to three years equips the ultra-poor to help themselves move and remain out of extreme poverty. 3. Experience globally shows that combining interventions providing safety nets, livelihoods and social development and microfinance services at the household level over a period of 1-3 years results in higher and sustainable graduation rates out of extreme poverty. Safety net programs such as cash or asset transfers, food aid and or public works employment reach the extreme poor, while livelihood and microfinance programs provide an effective and sustainable exit strategy that prepares them for improved income generation and market activities. Findings from the Bamiyan TUP pilot also confirm that this approach works in the Afghanistan context. It was found that in less than a year, 28 percent of household overcame extreme poverty, 92 percent of the household increased access to food after involvement in the program, and an estimated 55 percent reported an increase in value of productive assets. The pilot program which took on a multi-sectoral approach also reported a number of social benefits: for example, 87 percent reported changes in the attitude and behavior of the communities where they live; 65 percent had improved housing conditions, 100 percent household vaccinated their children aged between 0-1 years and 38 percent now use the sanitize stab latrine. Description of the sub-component: Targeting the Ultra-Poor Program (US$15 million) 4. This sub-component aims at sustainably graduating the ultra-poor from a safety net program to income-generating activities and eventually linking them with microfinance programs and savings groups. In order to ensure that the graduation is sustainable the program will (i) provide 91

92 households with a three-year package of assets/inputs and subsistence support; (ii) build their capacity to improve their incomes and achieve financial literacy; (iii) facilitate access to basic health care through community-based health workers; and (iv) link them to existing savings groups and microfinance institutions for access to financial services. The concept of graduation is further explained in the graph and box below. Graph 1: Graduation Model Source: The CGAP-Ford Foundation Graduation Program 92

93 Box 1: The Graduation Model: from Selection to Graduation The Graduation Model: from Selection to Graduation The TUP is implemented through a 36-months cycle, divided into four interim phases. The first phase: comprises of TUP selection, planning and provision of enterprise training and assets transfer for selected members. In this phase the TUP members are also introduced to some key social development and healthrelated issues. Project staff closely monitors and supervise the TUP members, providing individual follow-up (est. month 1-8). Second Phase, training and refresher courses continue. Asset transfer for the members may also continue in this phase. Informal groups are formed during this phase, in which TUP members receive social and health awareness training (month 19-36). In the third phase, informal group discussions continue, and the groups begin to discuss group dynamics, group cohesion, procedures and uses of loans, and savings are introduced. At the end of the third phase, TUP members begin to form their own formal village saving groups or join existing groups (month 19-36). In phase four, TUP saving groups takes the form of a microfinance group where the members join weekly meetings, access credit if they need it and continue accessing savings services (month ). The end point of the 36-month process is that households are expected to have built the skills, capabilities and investments that will enable them to graduate or lift themselves out of ultra-poverty. 5. The sub-component will entrust MISFA to contract services of Non-Government Organization (Implementing Partners) to target eligible households through participatory wealth ranking, deliver the three-year package of assets and subsistence support, build capacity of households in social and economic aspects and closely monitor the various activities over the course of the project. 6. It is estimated that the maximum cost per package per household will be no more than $2,000, inclusive of the direct asset transfers, capacity building to households and Implementing Partner staff salaries, transportation and all other implementation and operating costs over a period of 36 months. An estimated 60 percent of this will be in the form of direct cash and asset transfers, advocacy and capacity building to the household. This also includes the health care assistance which the subcomponent will also finance. This represents a per year health subsidy of AFN 2,000 (US$40) per household for all ultra-poor members, which will go towards covering the costs of mild and severe morbidity, antenatal care, tube well and latrine installation. Table 1: Breakdown (in percentage) of TUP package ($2,000) Activity % Asset / cash transfer to beneficiary 57.0 Capacity building for beneficiaries (outsourced) 3.0 Implementing Partner staff salaries 27.0 Implementing Partner rent, utilities, capital costs, travel costs, communication costs 6.5 Implementing Partner overheads

94 7. Because the graduation model is holistic and intensive, it requires a high level of concerted efforts that come together at the household level at various stages. The key is careful sequencing of development services, along with close monitoring and regular interaction between program staff and participants households. 8. Under the TUP Program: 90% of targeted households are expected to demonstrate increased household incomes 50 % of targeted households are expected to have improved access to finance (through savings groups membership or MFIs). 9. Project locations and beneficiaries. The TUP will be rolled out in an estimated 20 districts in 5 provinces, reaching out to over 52,500 household members, as per the table below. Provinces and Districts covered and estimated number or targeted beneficiaries Province Number of Districts Number of Village Number of households Number of Household members Takhar ,500 10,500 Herat ,500 10,500 Balkh ,500 10,500 Laghman ,500 10,500 Kunar ,500 10, ,500 52, Eligibility criteria. The eligibility criteria for provinces, districts, villages and households will be as follows: Provinces: The selection of the provinces has been carried out based on the following factors: o To maintain a national balance; o The selected provinces are listed in the top category of the poorest provinces in Provincial Briefs June, 2012, a document published by the Ministry of Economy and the World Bank (Economy Policy & Poverty Sector, South Asia Region) o Security was taken into consideration; o Presence of Financial Institutions which is prerequisite for TUP households to be linked with them after their graduation from the project; o Wider existence of social services which is key for the success of the TUP project; o Accessibility to potential and viable markets. Districts and villages: Eligibility criteria of the 20 districts, villages and 52,500 household members will be developed and overseen by the Rural Finance Department of MISFA who will ensure that priority is given to the following: o Poorest districts and villages in each province; o Villages where the implementing partners can have regular assess; o No similar projects are working in/or working with the same households with grants or asset transfers. Households: The selection of households will involve the local community elders and 94

95 Community Development Councils (see Appendix for details on the selection criteria for households). After the household is selected to receive the three-year package of inputs, an assessment will be conducted to determine the mix-of inputs (see appendix) needed to achieve the best results based on their specific needs, capacity and location. Details of this how the assessment will be carried out and the relevant forms will be provided in the operations manual. 11. TUP program activities. The TUP sub-component will provide eligible household a threeyear package of inputs that cover the costs associated with such inputs which will be determined on the need of the specific household. These inputs can include all or some of the following: a. A household level planning process: Before any intervention or dissemination of the twoyear package of inputs begins, a thorough planning process will take place for each household. This is to ensure that there is a comprehensive understanding of the local context, household dynamics, economic, social opportunities and constraints so as to provide the most appropriate package of inputs that will yield the best and sustainable results. The planning process will also include the collection of baseline data for 100 percent of the targeted households. b. Monetary and/or Productive assets: a three-year package of inputs for TUP participants, which includes transfer of productive assets (such as toolkits, small machinery, livestock/poultry etc.) and monetary subsistence support. Larger assets that can be owned by a group of project households will also be considered where appropriate (such as machinery, storage facilities or equipment which they can also rent out for a fee). c. Capacity building: This will include social mobilization, classroom enterprise development training, refresher courses, hands-on training during regular home visits by the implementing agency, exposure visits etc. Once data and specific information from each is collected, households will be grouped in clusters by sector of employment. This will help to focus the technical assistance/capacity building provided. d. Basic health care: The primary objective of the health component is to educate the households regarding the services available in the community by the Ministry of Public Health under the Basic Package of health care Services (BPHS) delivery strategy, so that they know that such services are available which they could avail in cases of severe health conditions. This intervention has been specially designed with the expectation that free services will contribute in large part to preventing or minimizing sudden income erosion due to acute episodes of illness. e. Social development: activities include social mobilization, raising awareness about human rights, gender equity and social issues among the ultra-poor and the wider community. The TUP Program will also create a local volunteer support group to promote awareness and moral support to ultra-poor households and advocacy among officials, elected representatives, influential local elites and members of civil society to mobilize support for the poorest. 95

96 f. Operating costs: This will cover all operational and incremental costs associated with the implementation of this program for MISFA and the facilitating partners, including salaries of staff, transportation, research, Technical Assistance to the project and oversight and reporting of the program as a whole, review and approval of households eligible under this program, exposure visits and any other internal/external evaluations and studies. 96

97 Appendix: TUP Program Implementation Arrangements 1. Household Survey and Poverty Ranking Appropriate selection of ultra-poor households is important because the process and rationale of articulating who the program is targeting allows to create a common understanding of the overall program approach and rationale to a wide range of the community. MISFA, in close consultation with its partners CSOs, will make necessary arrangements for selecting ultra-poor through a comprehensive, participatory and transparent discussion with all relevant stakeholders, such as the Community Development Councils (CDCs), local informed personalities, government representatives and subsequently ranked households into different categories based on their wealth level. A final round of selection will be conducted by using Participatory Rural Appraisal (PRA) techniques which includes: Social Mapping: In the process of targeting the ultra-poor households, the local partner institutions, in consultation with MISFA, will carry out a social mapping of the households, village layout, infrastructure, demography, health pattern and wealth, in the cluster which will be identified for the TUP program. MISFA and the local partner staff will review the information provided by local actors and identify a set of preliminary selected households. Wealth Ranking: Participatory Wealth Ranking (PWR) serves many important functions beyond identifying ultra-poor households. The group discussion of the wealth ranking exercise in the community will give the implementing organization a good understanding of local notions of poverty. Most importantly, it will make the identification process transparent to the community. Eligible households are identified using PWR, a method that engages villagers in creating an economic ranking of all households in a community. After the economic status of eligible families is verified, households are randomly assigned to either a treatment or comparison group. However, in the final visit/assessment by the project team, the six item criteria (described below under Eligibility criteria) will apply. Interview: Semi-structured interviews will be conducted with the community opinion leaders whereas FGDs (Focused Group Discussions) would be conducted randomly from a group of community members. The Project Manager of the Implementing Partner (see further details below) will conduct the PRA in assistance with the Program Organizers. Based on the results of PRA, bottom 20 percent household will be identified for further proceeding. 2. Selection of Household level beneficiaries: From the bottom 20 percent, households would be selected by detailed household survey and poverty ranking. The survey would be conducted with the two-fold objectives to develop a poverty ranking card and for the final selection of ultra-poor households. The survey questionnaire will collect data on socio-economic conditions, education level, health seeking practices; sources of income, total expenditures, assets in house, etc. The questionnaire will be developed jointly by MISFA and the Implementing Partner (see further details below) and will also serve as the baseline questionnaire for TUP. 3. Eligibility: The selection of TUP households will be based on the following criteria: The household is dependent upon female domestic work or begging; Ownership of less than 20 decimals (1 biswa) of land / No homestead land / Living in cave; Age should not be more than 50 years; No male adult active member in the household; Children of school going age have to do paid work; 97

98 No productive assets in the household. 4. As an additional level of verification, and as international experience shows, it will be preferred that at least three of these six criteria will need to be met to be eligible for TUP membership. International experiences indicate that any household which meets at least three of these will be among the ultra-poor. However, to ensure that the very poorest are given top priority, in the first instance, preference will be given to those households which meet all five of the criteria, followed by those who meet four, and finally by those who meet only three. Detailed guidelines and specialized PRA training will also be provided to field staff in order to support the accurate identification of the ultra-poor. 5. Data Collection from Project Beneficiaries. As a next step, the selected beneficiaries data will be extracted from the survey and will be maintained separately. The data will be analyzed across the following dimensions: assets needed, type of employment sought, social ranking, training requirements, etc. 6. Essential Health Care for the Ultra Poor. The primary objective of the health component is to educate the household regarding the services available in the community by the Ministry of Public Health under the Basic Package of health care Services (BPHS) delivery strategy. So they know that such services are available which they could avail in cases of severe health conditions. This intervention has been specially designed with the expectation that free services will contribute in large part to preventing or minimizing sudden income erosion due to acute episodes of illness. The expected outputs of this activity include: The ultra-poor are aware of availability of free basic health services in their respective communities Provision of selected health products being ensured at subsidized rate or cost and Efforts of the government and other organizations will be complemented. 7. MISFA will develop linkages with Ministry of Health to provide essential health care to project beneficiaries, through the existing network of community-based health workers. This will focus on preventing the occurrence of financially-devastating health crises and ensuring basic health care services. A stipend for basic health care will also be provided for eligible households. In order to ensure sustainability of this intervention throughout the graduation process, MISFA will also sign Memorandums of Understanding with the Ministry of Health, Education and Ministry of Women affairs, as the key counterparts. Activities under this strategy will include: Informing ultra-poor household members about Government and other health facilities available locally; Disseminating information among the ultra-poor members about existing common diseases and about changing food habits; Providing identification cards to all ultra-poor household members to facilitate their access to Government hospitals; Facilitate the provision of essential health care services through community based health volunteers; Advocacy information will be provided to households such as education about the importance of vitamin A, its natural resources, and about how to cook vegetables to ensure maximum retention of vitamins, sanitation etc. 98

99 8. Home and Personal Hygiene: At the community level, all Community Health Workers (CHWs) will be supplied with proper Information, Education and Communication (IEC) materials on home and personal hygiene. The material will have promotional messages regarding the importance of safe drinking water and sanitation in daily life. The IEC materials will be used for promotion of simple technologies and right behavior to reduce transmission of waterborne diseases. Issues pertaining to home and personal hygiene will be regularly discussed during the health education sessions. Health Program Organizers will be deployed to establish and maintain liaise and coordinate with BPHS implementers, Provincial Public Health Directors, other national and international entities working on health in the targeted provinces. 9. Financial Assistance for Medical Care: Financial constraints are a major determinant of uptake of health services by the ultra-poor. Even when the need is acute they frequently do not seek health care because of the costs involved. This frequently leads to delays and deteriorates the patients health, so that when treatment is finally sought, it is often very expensive because of implications, or it may even be too late. To address the problem of financial constraints to health care, the TUP model developed a system to provide financial assistance to the ultra-poor for support with accessing medical care. The project will provide a per year health subsidy of AFN 2,000 per household for all ultra-poor members, which will go towards covering the costs of mild and severe morbidity, antenatal care, tube well and latrine installation. 10. Asset Purchasing and Transfer. Project field staff will form a purchasing committee for purchasing of assets. This Committee will include a mix of representatives of beneficiaries, CDC members, representative of local government etc. Depending on the cost of the asset, direct contracting or shopping methods will be used for procurement of assets, by the individual household or implementing partner. The committee will be assigned with the special task of approving quality and validate product specifications. Where relevant the purchased assets after thorough verification by the committee then will be distributed to the TUP household by the committee members in a transparent manner. 11. Overall TUP Program Management. The program will be implemented in five provinces (Takhar, Balkh, Laghman, Kunar and Herat) over five years. Four districts will be selected in each of the five above cited provinces. A total twenty districts will therefore be covered. The TUP Program will be managed by MISFA Rural Finance Department. MISFA s Knowledge Management unit will be responsible for the overall M&E of the TUP Program. The Knowledge Management unit will use standardized reporting formats and collect data through a combination of site visits and electronic reporting from the household, community, district and provincial levels. Reports will be generated for outputs on a weekly and monthly basis and for overall progress, results, key issues and findings on a quarterly and annual basis. Every quarter a sample of around 20 percent of the existing beneficiary/ households will be visited for in-depth monitoring survey that will track changes in consumption, expenditure, behavior changes, assets, debt, etc. The Knowledge Management unit will also conduct a post-implementation monitoring for a sample of 20 percent household after 6 months of graduation to assess sustainability of the program and key lessons learnt. Support from the World Bank Development Impact Evaluation Unit (DIME) will be sought, during project implementation, to conduct a robust impact evaluation of this program. In addition, the project will 99

100 also seek guidance from the CGAP which has been conducting in-depth research on TUP programs internationally. 12. Implementing Partners (IP). MISFA will contract out implementation at the Provincial level to Non-Government Organizations (NGOs) who will each have a presence at the provincial and district levels. It is envisaged that the NGO Program Managers will be assisted by around 4 sector specialists (determined by the local economic opportunities), program organizers, monitoring and accountant officers to implement the TUP program activities. The Sector Specialists for livelihood training and health would be responsible for providing technical and specialized support to the staff (Program Organizers, POs) as well as beneficiaries. The Program Manager will be responsible for planning, staff development, fund management and the overall implementation of the program. He/she will undertake frequent field visits; hold meetings at regular intervals for carrying out supportive supervision for ensuring smooth and efficient implementation of the program. The PM will directly report to the Managing Director of the Implementing Agency. The table below summarizes the implementation mechanisms of the TUP Program. Table 1: TUP Program Implementation Key Functions Time Frame (Est. 36 Months) Responsible Person District Selection and office set up One Month MISFA Partner and Local government Selection of TUP households based on applying the different tools and strategies Three Months IP staff Community elders (CDCs & DDA) MISFA Training for beneficiary in keeping /rearing Three Months IP staff their assets Purchasing and Transfer of assets to TUP households Three Months IP staff MISFA DAIL and MAIL Community elders (CDCs & DDA) IP staff Encourage personal and group saving Provision of Training in Financial Literacy 18 Months One Week Weekly visits from TUP Throughout the project IP Staff (program Organizers, Sector specialist, project manager) MISFA Health services Throughout the project IP staff will introduce TUP households to available health related services Consumption support Up-to 24 Months IP staff Link TUP members with the public services Throughout the project IP staff Enroll TUP kids in formal school Throughout the project IP staff for social development Establish TUP linkage with the market Throughout the project IP staff Link TUP members with available financial institutions 6 Months IP staff 100

101 ANNEX 6: CREDIT GUARANTEE FACILITY AFGHANISTAN: Access to Finance Project 1. Context. This annex summarizes the results of a financial intermediary lending review of Component 2 in accordance with O.P (former O.P review): Improving access to financial services for small and medium enterprises (SMEs) through the Afghanistan Credit Guarantee Facility 33. The proposed grant of US$18 million is intended to support the expansion of the Facility. US$13 million will be allocated to the Facility to provide guarantee coverage, and US$5 million will finance technical assistance for the Afghanistan Credit Guarantee Facility and the Partner Financial Institutions (PFIs) with the following objectives: (i) new product development, (ii) support for management information system (MIS), (iii) support to the geographical expansion of the Foundation, (iv) strengthening of the capacity of the Facility including human resources and systems, and (v) impact evaluation. 2. This intervention has been motivated by the lack of adequate financial services for SMEs in Afghanistan. Commercial banks are usually wary of SME lending, as SMEs are not able to provide the financial information (i.e. audited financial statements, business plans) or sufficient collateral required by commercial banks. The Project will therefore support ACGF to provide technical assistance to PFIs, which will help them to develop new approach in SME lending (appropriate lending methodology and training of staff). As the banking sector sustains high level of liquidity, ACGF will support banks to make a more productive use of their liquidity by providing guarantees, i.e. in investing their resources in the Afghan private sector. 3. The Afghanistan Credit Guarantee Facility was established in 2006 with initial funding contributed by USAID and BMZ. The Facility has been managed by DEG (Deutsche Investitionsund Entwicklungsgesellschaft mbh), a member of KfW group and one of the largest European development financial institutions. DEG and the Afghan authorities have agreed that the Facility will be institutionalized through the establishment of the Afghanistan Credit Guarantee Foundation (ACGF). DEG operations will be transferred to ACGF (DEG will be one of the founders of ACGF). The sections below highlight how the Afghanistan Credit Guarantee Facility has been operating so far. ACGF will operate in a similar manner (as the Credit Guarantee Facility activities will be transferred to ACGF). As the timing of the establishment of the Foundation is unclear, in a first phase, the project will provide support to the Credit Guarantee Facility in its current setting. The implementation arrangements will be reviewed once ACGF is established, with a contractual arrangement between the Ministry of Finance and ACGF (instead of DEG). Policy framework for FILs 4. Macroeconomic environment. Driven mainly by donor grants to fund development and security spending, Afghanistan has experienced robust economic growth with moderate inflation over the past years. GDP growth is estimated to have accelerated to 11.8 percent in 2012, following 33 Component 1: Improving access to financial services for micro and small enterprises does not provide funding for financial intermediary lending. 101

102 7.3 percent in 2011, thanks to the strong performance of agriculture with good weather conditions, as well as the development of mining and telecommunications sector Afghanistan will experience a major security and development transition over the next years, and political and security uncertainty could undermine the country s development prospects. The international military troops will withdraw from Afghanistan by the end of 2014, and the Afghanistan National Security Forces will take over security operations. The decline in external assistance will have the most impact on public spending, as present levels of expenditure will be fiscally unsustainable for Afghanistan once donor funds decline. At the Tokyo Conference in July 2012, the international community committed to US$16 billion of development aid to Afghanistan (annual average of US$4 billion until 2016) to fill the financing gap and continue making progress toward a sustained economic development. 6. Afghanistan s private sector is dominated by MSMEs, engaged mainly in agriculture, trade and small-scale manufacturing. According to the Integrated Business Enterprise Survey 2009 by the Afghanistan Central Statistics Organization, 91 percent of firms have five workers or less, and half of firms have been operating for four years or less. Government of Afghanistan (GoA) identified private sector development as one main driver of the diversified growth strategy in the National Priority Programs (NPPs). Under the private sector development cluster of the NPPs, GoA has set developing resilient and competitive SME and industrial sectors as a core goal. 7. While the medium-term economic outlook for Afghanistan is broadly positive, the transition and transformation process may increase uncertainty and impact on the private sector growth. 8. Financial sector. Since the fall of Taliban regime, the financial sector had grown significantly, from a very low base. However, the financial sector in Afghanistan is still recovering from the Kabul Bank crisis that hit in September The Afghan financial system is dominated by the banking sector. 35 Today, there are 16 commercial banks operating in Afghanistan, which include: (i) three state-owned banks (including the newly created bank following the Kabul Bank crisis, New Kabul Bank, currently under privatization), (ii) nine private banks, and (iii) four branches of foreign commercial banks. These banks together offer 201 full-service and 176 limited service branches in 34 provinces with the largest concentration of branches located in Kabul. Private banks represent the largest portfolio in terms of total assets (60.2 percent), outstanding loans (87.5 percent), and total deposits (59.8 percent). The portfolio of the bank system as of July 2013 is shown in Table World Bank, April 2013, Afghanistan Economic Update. 35 In general, Non-Bank Financial Institutions (NBFIs) in Afghanistan are undeveloped and are yet to play a significant role in providing financial services to the majority of the population. 102

103 Table 1: Banking system in Afghanistan July 2013 (US$ million) Growth from July 2012 Total assets 4, % Private Banks 2,602 State-owned Banks 1,268 Branches of Foreign Banks 455 Outstanding loans % Private Banks 716 State-owned Banks 61 Branches of Foreign Banks 41 Total deposits 3, % Private Banks 2,226 State-owned Banks 1,066 Branches of Foreign Banks 428 Source: DAB, Summary Analysis of Condition and Performance of the Banking System 9. As of July 2013, the banking system earned profits of US$8.75 million in 2013 with return on assets (RoA) of 0.36 percent. The capital of the system amounted to US$332 million, increased by 24.2 percent since July The regulatory capital ratios of all but one commercial bank are above the minimum regulatory threshold (12 percent of risk-weighted assets). Non-performing loans stood at 6.4 percent of gross loans The microfinance sector in Afghanistan has experienced a consolidation phase since 2008, with a decline in number of active borrowers and slower growth of portfolio. Two additional microfinance institutions (BRAC and ASA) exited from the Afghan microfinance sector in early As of March 2013, there are six MFIs and five community-based savings promotion institutions (CSPIs), serving 150,844 active borrowers with US$122 million gross loan portfolio. The sector is dominated by First Microfinance Bank (FMFB), a commercial bank focusing on SMEs, which represents 40.9 percent of active borrowers and 64.5 percent of gross loan portfolio of the microfinance sector Although there has been some progress made in the expansion of SME credit since 2004, there is still significant unsatisfied demand for credit that has inhibited SME growth. According to DAB data, the current portfolio of SME finance stands at approximately US$56 million in March 2013, which accounts for 6.8 percent of total loan portfolio of the banks. As a result, the vast majority of firms rely on internal finance for investment, and access to finance is considered the third largest obstacle to their business Interest rates: The loans covered by the Facility are not subject to any restrictions by the GoA or guarantor (Facility). The interest rate of end borrowers is charged at market rates based on the risk profile of each borrower (SME). 36 Da Afghanistan Bank (DAB), July 2013, Summary Analysis of Condition and Performance of the Banking System. 37 Afghanistan Microfinance Association, Afghanistan Microfinance Sector Update Report as of March World Bank Group, 2008, Enterprise Surveys of Afghanistan. 103

104 13. Directed credit: The Facility is designed to encourage SME lending. As indicated above, SMEs are financially underserved because banks are wary of lending to SMEs mainly due to (i) perceived excessive default risk, (ii) lack of experience in SME lending, (iii) lack of reliable credit information of SMEs, (iv) lack of sufficient collateral provided by SMEs, and (v) perceived high administration costs. The Facility aims to address this market failure through providing guarantee coverage and technical assistance to PFIs. This will encourage the PFIs to increase SME lending. 14. Subsidies: The subsidies proposed by the Project relate to the technical assistance component of the Credit Guarantee Facility. The Credit Guarantee Facility provides free technical assistance on SME lending to PFIs which use the Guarantee Facility. This is a usual approach in downscaling projects. In more mature financial sectors (with stronger competition), co-financing of TA by the banks can be requested. Such co-financing will be further analysed during project implementation (once the Afghan financial sector matures). Coordination with IFC 15. This component complements existing IFC interventions in the financial sector (both Investment Services and Advisory Services). IFC is a shareholder (and lender) of First Microfinance Bank (FMFB), one of the existing PFIs of the Facility. 39 IFC is providing a trade finance facility to AIB, another PFI of the Facility. The overall weakness of the financial sector in Afghanistan (and its governance challenge) hampers the ability of the IFC to directly engage with many commercial banks. However, IFC is considering further investments in Microfinance Institutions (MFIs) and Non-Bank Financial Institutions (NBFI). 12. This could be perceived as a Conflict of Interest for the World Bank Group. Both the World Bank and the IFC will formally inform the Government of Afghanistan of this potential Conflict of Interest. To mitigate the potential Conflict of Interest risk, the World Bank project team will not include any IFC Investment Officer dealing with FMFB. Operations of the Facility 16. The objective is to facilitate access to finance for Afghan SMEs through commercial banks in Afghanistan. Banks benefit from individual guarantees (in form of cash-backed letter of guarantee) provided by DEG, as well as technical assistance package to strengthen their approach to SME lending. A team in Kabul carries out the daily guarantee operations (guarantee appraisal and claim, portfolio and risk management) and provides technical assistance, while DEG in Germany is responsible for overall program implementation, issuing of the letters of guarantee and treasury of the Facility. The Facility has prepared an Operations Manual, which details the procedure of guarantee appraisal, issuance of guarantee, guarantee claim, and portfolio audit/reporting. 17. Financial terms of the Facility: The Facility defines SME loans as a loan between US$5,000 and US$1,000,000, or equivalent in Afghani (AFN). 40 Currently, the guarantee coverage ranges from 36 percent to 72 percent of the default risk, depending on the size and type of loan 39 IFC holds AFN million for equity stake of 16.8 percent and US$5.0 million stand by revolving facility for FMFB. 40 SMEs are defined as firms with up to 500 employees and/or up to US$15 million assets/sales. 104

105 products. Up-front fees and risk adjusted guarantee fees are paid by PFIs. The guarantees can cover loans in US Dollar or Afghani. 18. Mitigation of moral hazard. The guarantee exposure ratio of up to 72 percent (the PFI s risk share is between 28 to 64 percent), and a close linkage between the guarantees and technical assistance to strengthen the institutional capacity of PFIs, as well as detailed guarantee appraisal and close monitoring of loans, mitigates the moral hazard risk of PFIs. In addition, risk adjusted guarantee fees discourage moral hazard behavior. Guarantees are not disclosed to the end borrowers to mitigate moral hazard of borrowers, and to maintain borrower s repayment discipline. 19. Performance of the Facility: Over the past six years, the Facility has shown promising results. As of June 2013, through PFIs, it has mobilized SME loans of US$105.8 million to more than 2,900 businesses with outstanding guaranteed loans of US$22.2 million active in 12 provinces. The Facility has developed a thorough methodology described in its Operation Manual to ensure good credit quality of its portfolio. The Portfolio at Risk (PAR) has been at 1.12 percent (PAR over 30 days) and 0.83 percent (PAR over 90 days) as of June The Facility has disbursed guarantee claims for 48 defaulted loans totaling US$611,853 since The average net pay-out rate stands at a low 0.8 percent per year. 41 Table 2 summarizes the performance of the Facility, and Table 3 and 4 show the Facility s financial statements. Table 2: Performance of the Facility as of June 2013 Cumulative ( ) Jan-13 to June-13 Numbers(#) Amounts ($) # Amounts ($) # Amounts ($) # Amounts ($) Loan Disbursement 2926 $105,758, $20,133, $23,754, $12,374,505 Guarantees Issued 3097 $76,742, $14,058, $16,402, $8,577,543 Loans Outstanding 842 $19,569, $15,881, $19,388, $19,569,967 Guarantee Outstanding 879 $16,928, $11,828, $15,449, $16,928,913 Write-offs 78 $1,111, $138, $233,776 5 $46,850 Claims Disbursed 48 $611, $54, $149,990 6 $91,791 Claims Refunded 24 $64,024 9 $27,693 6 $7,107 6 $10,831 PAR(>30) % % % % PAR(>90) % % % % Source: Afghanistan Credit Guarantee Facility 20. There are various success factors for the good performance: the Facility focuses on training and coaching the PFIs until they have reached the capacity to appraise loans independently. Performance of loan officers is closely monitored and their capacity is appraised through a certification process reviewed bi-annually. Until loan officers are certified, each loan to be guaranteed is physically verified in the field by the Facility s credit analysts. The Facility provides guarantees on individual loan basis; the Facility holds a guarantee committee evaluating the risks of the file for each loan. In case the loan has been appraised by a certified loan officer, no on-site verification is performed but a desk analysis assesses the file prior to the Guarantee Committee. The Facility has started to guarantee loans on a portfolio basis with one of its PFI, for loans from 41 Net pay-out rate is calculated by: (claims-refunds)/average guarantee portfolio of the year. 105

106 US$5,000 to US$10,000. The specific context of Afghanistan, with high risks and low PFIs capacity, calls for such strong implication in the credit process. Nevertheless, the Facility s medium term strategy is to continue withdrawing from the credit process while PFIs gain experience. 21. The fast and predictable claim payment process is also a key success factor of the risk sharing agreement. Once the PFIs master the traditional SME lending methodology, the Facility will continue cooperating with its PFIs through product innovation, supporting the evolution of the SME lending market. Such dual offer of technical assistance and partial credit guarantee brings value to the PFIs ensuring their loyalty toward the program. 22. The high operational involvement has strong impact on the operational and technical assistance expenses incurred by the program. However, the effectiveness of the program has constantly improved thanks to economies of scale achieved through the growth of portfolio as well as constant efforts toward leaner operations. The fees collected represented only 41% of the operating expenses as of Dec. 2009, while they represented 155% as of March The technical assistance has a strong impact on the financials, explaining the quasi stagnation of the Return on Asset (RoA) from -11.4% as of Dec 2010 to -9.8% as of Dec However, once the technical assistance component (expenses and donations) is isolated, the program has shown an operational result of break-even in

107 Table 3: Facility s Balance Sheet BALANCE SHEET ASSETS Cash and Due from Banks 9,616,149 9,373,147 9,341,346 8,678,877 Cash 28,287 28,955 21,198 67,984 Demand Deposits 0 987, ,865 1,610,893 BMZ funding 0 529, ,473 1,038,568 USAID funding 0 457, , ,325 Fixed Term Deposits 9,587,862 8,356,283 8,356,283 7,000,000 BMZ funding 5,587,862 5,656,283 5,656,283 5,000,000 USAID funding 4,000,000 2,700,000 2,700,000 2,000,000 Short Term Financial Investments Receivables 4,944 13, , ,980 Accrued Interest Income Accrued Guarantee Fees , ,645 Other Receivables 4,944 13,457 29,909 23,335 Other Short Term Assets Long Term Financial Investments Tangible Fixed Assets Intangible Fixed Assets Other Long Term Assets Current Assets 9,621,093 9,386,603 9,499,333 8,821,857 Fixed Assets Total Assets 9,621,093 9,386,603 9,499,333 8,821,856 LIABILITIES Accounts Payables and Other Short Term Liabilities 33, , , ,716 Total Liabilities 33, , , ,716 EQUITY Paid In capital 9,688,808 9,688,808 9,688,808 9,688,808 Change in Capital 539, Retained Earnings -578, ,251 42, ,542 Cumulated Retained Earnings -100, , ,125-1,183,667 Total Capital 9,587,862 9,145,612 9,187,683 8,505,141 Total Liabilities & Capital 9,621,093 9,386,603 9,499,333 8,821,857 OFF-BALANCE SHEET LIABILITIES Available allocated guarantee capital 4,783,968 4,702,928 7,685,279 7,430,047 Outstanding guarantee portfolio 7,640,975 6,403,428 11,641,548 15,349,

108 Table 4: CGF Profit and Loss Statement PROFIT & LOSS ACCOUNT Total Operating Income 74, , , ,207 Processing Fee , ,936 Guarantee Fee 140, , , ,085 Other Fee, and Commission Income ,069 Refund 0 18,393 27,693 7,107 Claims 65,294 99,433 54, ,990 Total Operating Expenses 340, , , ,199 Total TA Expenses 794, ,894 1,096, ,162 Change in Provisions Financial Income 34,550 27,714 6,458 11,906 Financial Expenses Net Operating Income before Interest, Taxes and Donations (EBIT) -1,025,555-1,087,129-1,178, ,763 Net Income Before Donations -1,025,555-1,087,129-1,178, ,763 TA Donations 446, ,878 1,220, ,221 Net Income -578, ,251 42, ,542 Source: Afghanistan Credit Guarantee Facility 23. Internal controls and financial management: The Facility s internal control and financial management framework have been assessed during appraisal and is considered to be adequate. The Facility has been managed in accordance with DEG s strict requirements in internal control, financial management, and reporting. The Facility day to day operations are carried out by a team based in Kabul, which is led by a Director, and the team is comprised of three Credit Analysis Managers, one Credit Analyst, one Finance and Administration Assistant Manager, one Administration Officer, one Compliance Officer, and one Senior Logistics Officer. The Operations Manual defines the roles and responsibilities of the staff in managing the Facility. 24. Risk management: The Facility s risk management framework is considered to be adequate for the implementation of the Project. The Facility requires an up-front contribution of the guarantee funds as a precondition for the issuance of guarantees. Experience shows that up-front capitalization (disbursement) of the project funds into a reserve account is the most effective way in which the Facility can function. It creates (i) interest income, and (ii) promotes important bank confidence in validity of guarantee payments in case of SME defaults. In addition, the Facility provides technical assistance to PFIs to strengthen their capacity in SME lending, which reduces the credit risks of PFIs, and helps better portfolio management of the Facility. The Facility also conducts regular portfolio audit in order to mitigate the risk of fraud, and assess the compliance of PFIs. In case of late repayment of end borrowers, the Facility conducts delinquency audit, and provides delinquency management training to PFIs or takes retribution measures, if required. These procedures are detailed in Operations Manual. 25. Eligibility of PFIs. The project requires an assurance that financial institutions participating in this project are viable. The Banking Law of Afghanistan, which was enacted in 2003, sets forth prudential standards: Capital adequacy: DAB requires banks to maintain a minimum capital adequacy ratio of 12 percent of the total value of its assets determined on a risk-adjusted basis. 108

109 Exposure risks: Exposure risk on a single beneficiary is limited to 15 percent of its capital and reserves. The aggregate outstanding amount of loan principal should not exceed 200 percent of its capital and reserves. Risk management mechanisms: Internal control and risk management mechanisms are specified, with a required administrative structure. Banks are required to make adequate provision for depreciation of assets, for discharge of liabilities, and for covering risk of losses; maintain adequate accounting and other records of business; observe effective risk controls; and ensure that their assets are diversified to avoid loss. 26. The Facility sets forth the eligibility criteria for potential PFIs in its Operations Manual, which includes (i) evaluation of the common interest and strategic match in developing a partnership (a series of meetings with PFI s management), and (ii) comprehensive assessments through a CAMELS analysis. 42 The CAMELS analysis includes the review of the Capital Adequacy Ratio (CAR) of the financial institution under due diligence, and the Facility has confirmed that all its PFIs meet the minimum CAR of 12 percent, as required by the Central Bank. It should be noted that a critical aspect of the Facility design is to provide capacity building to potential PFIs in order to be eligible for the guarantees provided by the Facility. To this end, the Facility conducts an evaluation of the technical assistance needs of potential PFIs during the CAMELS analysis, and designs technical assistance program to strengthen the PFIs. 27. Existing PFIs: The Facility currently works with three PFIs: (i) First Micofinance Bank (FMFB), (ii) Afghanistan International Bank (AIB), and (iii) Ghazanfar Bank. The PFIs are licensed with DAB and operate in accordance with DAB s regulation. SME Departments were set up in each of the PFIs, and the Facility has supported, cumulatively: (i) US$52 million loan disbursement to 2,530 businesses for FMFB, (ii) US$40 million loan disbursement to 305 businesses for AIB, and (iii) US$3.7 million loan disbursement to 34 businesses for Ghazanfar Bank (as of February 2013). Summary of indicators for each PFI is given in Table CAMELS stands for Capital Adequacy, Asset Quality, Management, Earning, Liquidity and, Sensitivity to Market Risks 109

110 Table 5: Summary of PFIs Source: Afghanistan Credit Guarantee Facility 28. Potential PFIs: Other commercial banks have approached the Facility to benefit from downscaling support (i.e. support to SME lending). In addition, MFIs have requested the Facility for upscaling support. Monitoring 29. The Facility tracks detailed financial information on the performance of its PFIs (as well as continued adherence of PFIs with the Facility s eligibility criteria). For each financial institutions, it tracks on a monthly basis (and on a cumulative basis) the following: loan disbursement, guarantees issues, loans outstanding, guarantees outstanding, write-offs, claims disbursed, claims refunded, Non-Performing Loans (over 30 and 90 days). A financial scorecard gives an overview of operational income, operational expenses, technical assistance expenses, operational result and total financial result. It also tracks the number of jobs created by the SMEs benefiting from the guarantees. Proposed flow of funds and on-lending terms 30. Flow of funds: The following chart describes the flow of funds for the US$13 million contribution to the guarantee fund and US$5 million for technical assistance. In the first phase, the World Bank financed capital contribution to the Guarantee Fund will be transferred to the Afghanistan Credit Guarantee Facility Trust Fund managed by DEG. Under this component, interest rates will be determined by the PFIs, and will be based on commercial rates. 110