FOR OFFICIAL USE ONLY

Transcription

1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No: XK Public Disclosure Authorized Public Disclosure Authorized PROJECT PAPER ON A PROPOSED ADDITIONAL CREDIT IN THE AMOUNT OF SDR 4.30 MILLION (US$6.85 MILLION EQUIVALENT) TO THE REPUBLIC OF KOSOVO AND RESTRUCTURING FOR FINANCIAL SECTOR STRENGTHENING AND MARKET INFRASTRUCTURE PROJECT (FORMERLY TITLED FINANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT) Public Disclosure Authorized May 16, 2011 This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Bank s Policy on Access to Information. i

2 CURRENCY EQUIVALENTS (Exchange Rate Effective April 30, 2011) Currency Unit = Euro Euro 0.68 = US$1 US$1.62 = SDR 1 FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS AF AMIK BDs BCC BIS CA CBK CMU CPSS CSD DIFK DvP EICS EU FIRST FSSMIP FSTA GoK HR IADI IBRD IDA IMF ISN ISR KBA KfW MoF MFIs NBFIs NPLs NPS PDO P-RAMS PMT RTGS SDR ToRs TPL USAID Additional Financing Association of Microfinance Institutions in Kosovo Bidding Documents Business Continuity Center Bank of International Settlements Credit Agreement Central Bank of Kosovo Country Management Unit Committee on Payment and Settlement Systems Central Securities Depository Deposit Insurance Fund of Kosovo Delivery versus Payment Electronic Interbank Clearing System European Union Financial Sector Reform and Strengthening Initiative Financial Sector Strengthening and Market Infrastructure Project Financial Sector Technical Assistance Project Government of Kosovo Human Resources International Association of Deposit Insurers International Bank for Reconstruction and Development International Development Association International Monetary Fund Interim Strategy Note Implementation Status and Results Report Kosovo Bankers Association Kreditanstalt für Wiederaufbau / German Development Bank Ministry of Finance Microfinance Institutions Non Banking Financial Institutions Non-performing loans National Payment System Project Development Objective Procurement Risk Assessment Management System Project Management Team Real Time Gross Settlement Special Drawing Rights Terms of Reference Third Party Liability United States Agency for International Development Vice President: Country Director: Country Manger: Sector Director: Sector Manager: Task Team Leader: Philippe H. Le Houerou Jane Armitage Ranjit Nayak Gerardo M. Corrochano Lalit Raina Isfandyar Z. Khan i

3 KOSOVO FINANCIAL SECTOR STRENGTHENING AND MARKET INFRASTRUCTURE PROJECT Contents I. Introduction... 1 II. Background and Rationale for Additional Financing... 1 III. Proposed Changes... 3 IV. Appraisal Summary... 6 A. Technical... 6 B. Partnerships... 8 C. Procurement... 8 D. Financial Management E. Post Project Safeguards for Component 6 (Provision of Seed Funding to the DIFK) F. Environment and Social G. Implementation Arrangements Annex 1: Results Framework and Monitoring Annex 2. Revised Project Results Framework Annex 3: Kosovo Financial Sector Snapshot Annex 4: Detailed Description of Components 4, 5 and Annex 5: Summary Procurement Plan Annex 6. Operational Risk Assessment Framework (ORAF) ii

4

5 KOSOVO FINANCIAL SECTOR STRENGTHENING AND MARKET INFRASTRUCTURE PROJECT (FORMERLY TITLED FINANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT) PROJECT PAPER EUROPE AND CENTRAL ASIA ECSPF Basic Information (Original Project) Project ID: P Project Name: Kosovo, Financial Sector Technical Assistance Team Leader: Isfandyar Zaman Khan Expected Closing Date: June 30, 2011 Environmental category: C Lending Instrument: Technical Assistance Loan Joint IFC: Joint Level: Basic Information (Additional Financing) Date: March 30, 2011 Team Leader: Isfandyar Zaman Khan Country Director: Jane Armitage Sectors: General finance sector (45%); Country Manger: Ranjit Nayak Payment systems, securities clearance and Sector Director: Gerardo M. Corrochano settlement (30%); Banking (25%) Sector Manager: Lalit Raina Themes: Standards and financial reporting (40%); Regulation and competition policy (40%); Other financial and private sector development (20%) Project ID: P Lending Instrument: Technical Assistance Loan [ ] Loan [X ] Credit [ ] Grant [ ] Guarantee [ ] Other: Environmental category: C Additional Financing Type: Scale Up and new activities Joint IFC: Joint Level: Project Financing Data For Loans/Credits/Others: Total Bank financing (US$m): 6.85 Proposed terms: IDA credit with a final maturity of 20 years including a grace period of 10 years Financing Plan (US$m) Source Local Foreign Total RECIPIENT IDA Credit Total: Recipient: Republic of Kosovo Responsible/Implementing Agency: Central Bank of Kosovo (CBK) iii

6 Pristina Kosovo Contact Person: Mr. Gani Gerguri (Governor) Telephone No.: , ext Estimated disbursements (Bank FY/US$m) FY Annual 1,013,331 5,270,000 1,186,669 1,380,000 Cumulative 1,013,331 6,283,331 7,470,000 8,850,000 The disbursement schedule is for both the original project and the proposed additional credit Project implementation period: Start September 1, 2011 End: June 30, 2014 Expected effectiveness date: September 1, 2011 Expected closing date: June 30, 2014 Does the project require any exceptions from Bank policies? Have these been approved by Bank management? Does the project include any critical risks rated substantial or high? Project development objective [ ]Yes [X] No [ ]Yes [X] No [X]Yes [ ] No Original project development objective: The objective of the Project is to enhance the stability and development of Kosovo s financial system by supporting stronger prudential regulation and supervision by the Central Bank of Kosovo (CBK) for banks and non bank financial institutions, supporting the institutional strengthening of the CBK, and strengthening the banking and microfinance industry through capacity building. Revised project development objective: The objectives of the Project are to (i) enhance the stability and development of the financial sector; and (ii) strengthen the financial sector s underlying market infrastructure. Project description Component 1: Assistance to the CBK Component 4: Establishment of a Real Time Gross Settlement System (RTGS) Component 5: Establishment of a Business Continuity Center (BCC) Component 6: Provision of seed funding to the DIFK Components 2 and 3 exist in the original project Which safeguard policies are triggered, if any? None iv

7 I. INTRODUCTION 1. This Project Paper seeks the approval of the Board of Executive Directors to: (a) provide additional financing (AF) in the form of an additional credit of US$6.85 million to the Kosovo Financial Sector Technical Assistance Project (P108080); and (b) restructure the Project to make the accompanying amendments to the Original Project s legal documents. 2. The proposed additional financing would both help to scale up activities under the Original Project and support new activities as part of the project restructuring due to the enhanced scope of the Project. The changes to the Project as part of the additional financing and restructuring include: (i) expanding the project development objective (PDO) and title of the Project to reflect the broadened scope of the Project; (ii) adding three new components that build on the technical capacity that was developed as part of the Original Project; and (iii) modernizing the results matrix to reflect the revised scope. 3. The additional financing would enhance the financial sector market infrastructure and make the financial sector more efficient and resilient by: (a) scaling up the technical assistance provided under the Original Project to support the Central Bank of Kosovo (CBK); (b) financing the costs associated with the implementation of the CBK s Strategy for the Development of a National Payments System (NPS) and establishing a Real Time Gross Settlement (RTGS); (c) establishing a Business Continuity Center (BCC) for the CBK; and (d) providing seed funding to the Deposit Insurance Fund of Kosovo (DIFK). The restructuring is necessary to make changes to the Original Project that reflect the impact of the additional financing. II. BACKGROUND AND RATIONALE FOR ADDITIONAL FINANCING 4. The Original Project, supported by an IDA grant of SDR 1.3 million (US$2 million equivalent), was a technical assistance grant and was approved by the Board of Executive Directors on December 13, 2007 and became effective on January 3, It consisted of three components: Component 1 - Assistance to the CBK aimed at strengthening its institutional framework and sustainability and improving the regulatory and supervisory framework for the banking and non-banking financial institutions (NBFI) sectors; Component 2 - Assistance to the Association of Microfinance Institutions of Kosovo (AMIK) aimed at strengthening the microfinance industry; and Component 3 - Assistance to Kosovo s Bankers Association (KBA) aimed at building capacity within banks. 5. The Original Project has achieved impressive results to date, especially when considering the nascent stage of development of the legal and regulatory framework for the financial sector in Kosovo, the overall weak capacity, and challenges of dealing with a relatively new Central Bank. The CBK s institutional capacity has substantially been strengthened thanks to the preparation and implementation of a medium-term development strategy. This has led to the recruitment and retention of high quality staff. The Original Project has also enhanced the legal and regulatory framework under which the Kosovo financial sector operates. Specifically, it has helped to create conditions for a viable insurance sector by assisting the Government of Kosovo (GoK) to establish the legal framework for third part liability and for compulsory insurance. In 1

8 addition, a detailed actuarial assessment of life insurance activities and products was carried out and the sector adopted the recommendations made there under. 6. As of March 2011, the Original Project had disbursed the equivalent of US$735,033 (36 percent of the total grant amount), with commitments of US$894,000 (45 percent of total amount). By May 2011 it is expected that further contracts for US$460,000 will be signed, bringing the committed amount to 67.7 percent of the total project cost. The Original Project Closing Date was extended by one year to June 30, 2011, to provide sufficient time to implement the planned activities. Disbursement delays were initially encountered due to weak capacity and unfamiliarity with Bank procedures. This was compounded by departure of the CBK governor and the Project Management Team (PMT) head last summer, which further slowed down disbursement. This led to a downgrade of the Original Project from Satisfactory to Moderately Satisfactory in the last Implementation Status and Results Report (ISR) in January However, quickly a well-qualified acting CBK Governor and a new PMT head were appointed and the Original Project has proceeded at a satisfactory pace since then. The acting Governor has now been confirmed as the new Governor by the Parliament in April The initial lack of familiarity with Bank procedures has been largely overcome as PMT staff gained implementation experience. Components 2 and 3 of the Original Project are expected to be fully completed by June 2011 and component 1 is expected to be 47 percent disbursed. The Original Project is in full compliance with the loan covenants and has no outstanding Financial Management Reporting (FMR) or procurement issues. Table 1: ISR Ratings in the last 12 months ISR Ratings ISR #3 ISR #4 ISR #5 12/8/2009 6/29/2010 1/13/2011 Progress towards PDO MS S MS Overall Implementation Progress S S MS Financial Management S MS S Procurement S S S Counterpart Funding S S S M&E S S S Note: MS is for Moderately Satisfactory, S is for Satisfactory 7. Since the Original Project was approved by the Board of IDA, Kosovo declared its independence and subsequently became a member of the World Bank Group and the International Monetary Fund (IMF) in June As an independent country, Kosovo needs a basic infrastructure to support its financial sector, such as a real time payment system. Under United Nations Interim Administration Mission in Kosovo, the Central Bank operated an electronic interbank clearing system. While the system is effective in clearing payments, settlements do not occur in real time. Considering increasing volume and value of transactions this is not in line with international best practices as it gives rise to settlement risk. Under RTGS the payee banks and their customers have certainty regarding receipt of funds during the day, thus enabling them to use the funds immediately without exposing themselves to this risk. Finally, as a fully fledged central bank, the CBK needs to have a back-up system to ensure that it can continue to perform its functions in case of a disaster. 2

9 8. Although the banking sector has come out of the crisis relatively unaffected (see Annex 3 for a brief analysis of the financial sector), the crisis has highlighted the importance of deposit insurance schemes in ensuring orderly bank resolution and maintaining public confidence in the sector. Furthermore, the crisis has brought to the fore the importance of having well functioning bank resolution frameworks that ensure transparent, cheap and fast resolution. Against this backdrop Kosovo has introduced a deposit insurance scheme and is reforming the existing bank resolution framework. The existence of a deposit insurance scheme is also a requirement for EU accession. 9. The additional financing is seen as the most appropriate way to scale up the Original Project s impact and development effectiveness and support Kosovo in introducing a real time settlement system, a business continuity center for its Central Bank and a deposit insurance scheme. The Financial Sector Strengthening and Market Infrastructure Project (FSSMIP) will build upon: (i) the technical capacity of the CBK built under the Original Project; (ii) the Bank s other technical assistance work with the CBK; and (iii) the fact that the CBK will remain the main implementation partner. The fiduciary capacity of the CBK will also be enhanced since the scaled up activities require more sophisticated procurement processes. 10. The proposed additional financing and restructuring of the Original Project is consistent with the Kosovo Interim Strategy Note (ISN) for FY10 and FY11. The additional financing for the Original Project was specifically mentioned in the ISN as part of the first pillar that aimed to improve macroeconomic stability. In particular, strengthening the capacity of the CBK to supervise financial institutions and modernizing the payment systems were identified as key priorities. 11. In addition to the FSSMIP, the Bank is supporting the development of the banking and insurance sectors via two FIRST grants focusing on the legal and regulatory framework of the sectors and the capacity of the regulator. Moreover, the Bank has supported the CBK through the Western Balkans Technical Assistance Facility, which has financed development of the payment system and Business Continuity strategy and supported a crisis management preparedness assessment. Further technical assistance to the Deposit Insurance Fund will be provided under the Western Balkans Technical Assistance Facility to develop an institution building plan to reach compliance with the Core Principles for Effective Deposit Insurance System adopted by the Basel committee and the International Association of Deposit Insurers (IADI). III. PROPOSED CHANGES 12. The Additional Financing involves: a. Broadening the project development objectives; b. Updating the title of the Project; c. Expanding activities that scale up the original Project s impact and development effectiveness and adding three new components; d. Extending the project timeline; e. Updating the results matrix to reflect the enhanced scope of the Project that now includes financial infrastructure in addition to technical assistance; f. Updated implementation arrangements for the additional financing. 3

10 13. A level one restructuring is required because the Project s Development Objectives (PDOs) are being broadened for the AF. As a consequence of the AF, the proposed restructuring involves: a. Broadening the project development objectives; b. updating the title of the Project; c. updating the results matrix to reflect the enhanced scope of the Project that now includes financial infrastructure in addition to technical assistance; d. updating references to the Central Bank of Kosovo from CBAK as it was formerly known to CBK ; e. Modifying the Procurement and Consultant guidelines to be used for the Original Project from the Procurement and Consultant Guidelines published by the World Bank in May 2004 and revised in October 2006 to the Procurement and Consultant published by the World Bank in May 2004 and revised in October 2006 and May 2010; and f. Extending the closing date of the Project. 14. PDO. The development objective is being changed to recognize the inclusion of components to improve the financial market infrastructure. The original development objective was to enhance the stability and development of Kosovo s financial system by supporting stronger prudential regulation and supervision by the CBK for banks and non bank financial institutions, supporting the institutional strengthening of the CBK, and strengthening the banking and microfinance industry through capacity building. The new development objectives will be to (i) enhance the stability and development of the financial sector; and (ii) strengthen the financial sector s underlying market infrastructure. 15. Project Name. The name of the Project is revised to Financial Sector Strengthening and Market Infrastructure Project (FSSMIP) because of the additional focus on financial infrastructure following the additional financing and restructuring. 16. Results Matrix. The results matrix has been strengthened from the Original Project (Annex 1) and the additional activities that focus on strengthening the financial sector market infrastructure have been incorporated. 17. Scaling up of components from the Original Project. The Original Project had three components that focused on technical assistance to the CBK, AMIK and KBA. No additional financing is planned for the AMIK and KBA. For component 1, additional financing for technical assistance will be provided for: a. Supporting the implementation of the CBK s training as identified in the training needs analysis that CBK conducts regularly. 18. Three new components. Building on the success of the Original Project, and the engagement of the World Bank through other activities, three new components will be added as part of the project restructuring and additional financing: 4

11 a. Component 4 - Establishment of a Real Time Gross Settlement System. An effective financial sector infrastructure contributes to the provision of affordable financial services to underserved populations. The NPS of a country encompasses everything that is concerned with the movement of money from payer to payee, covering all phases of payment from initial offer of a payment instrument to final settlement. The payment system in Kosovo is relatively underdeveloped. Weaknesses include: the lack of interoperability between commercial banks' card networks leading to inefficiency and cost increase for users and delayed settlement of payments. This also results in a high percentage of payment transactions in cash. In September 2009, the CBK approved a strategy document and an action plan for implementation of NPS. Component 4 will enable implementation of the action plan by establishing an RTGS. This will reduce operating costs for banks, increase the speed, and shorten execution times for the high value payments. Above all, the system will minimize the payment risk and increase confidence in the banking sector. b. Component 5 Establishment of a Business Continuity Center: In 2007, the Bank provided the CBK with technical assistance for the development of its Business Continuity Strategy in line with the Bank of International Settlements (BIS) Core principle VII. The Strategy identifies the business processes supporting the key operational functions within the CBK in the event of a disaster, establishes a Business Continuity Management Team, develops and documents an IT disaster recovery plan to facilitate the proper and timely recovery of IT operations, and establishes recovery locations to be used based on the disaster classification. The Strategy recommends establishing a Business Continuity Center outside Pristina, which will be a 'hot' stand-by site and will contain continuously-updated live data from all the CBK's critical systems. Such a back up site for the CBK would ensure stability of the financial sector in the event of a disaster. The additional financing will assist in establishing such a center and will include the renovation of a building site. The site has already been chosen and is located in the city of Prizren and owned by the CBK. c. Component 6 - Provision of seed funding to the DIFK. An efficient deposit insurance scheme is essential to ensure orderly bank resolution. Moreover, the existence of such a scheme is critical to maintaining public confidence in the banking sector, as the financial crisis has illustrated. The presence of such a fund is also a requirement for the EU accession. Introduction of a Deposit Insurance scheme in Kosovo was initiated by the CBK in 2007 with technical assistance from KfW. The Law on Deposit Insurance was approved by the Parliament in October 2010 and is now in force after being made effective in December Through the additional financing IDA will provide seed funding to the DIFK. The KfW and IMF are key partners in this component. The DIFK is expected to build reserves of approximately 15 million over time. The DIFK funding will include premiums from financial institutions, GoK contribution, and grant capital of 4.5 million from KfW. 5

12 (a) Original Table 2: Project costs by component (in USD) (b) Disbursed (03/2011) Original (c) Committed (03/2010) (d) Undisbursed (a)-(b) (f) Additional Financing (g) Total undisbursed (d)+ (f) (h) Project Total (a)+(f) Component 1: 1,540, , ,623 1,046, ,000 1,176,,277 1,670,000 Assistance to CBK Component 2: 240, ,722 80, , , ,000 Assistance to AMIK Component 3: Assistance to KBA 220, ,800 32,000 51,000-51, ,000 Component 4: ,870,000 1,870,000 1,870,000 Establishment of a RTGS Component 5: , , ,000 Establishment of a BCC Component 6: Provision of seed funding to the DIFK ,000,000 4,00,000 4,000,000 Total 2,000, , ,623 1,213,755 6,850,000 8,063,755 8,850, Implementation and Procurement Schedule. The revised plan for all activities under the additional financing to be implemented in three years and the accompanying procurement plan are included in Annex Project Timeline and Disbursements: The estimated disbursement schedule for the Grant and Credit would be as follows: Table 3: Revised disbursement estimates for the Project (including the Grant and Credit) FY FY12 FY13 FY14 Total Component 1: Assistance to CBK 724, , , ,000 1,670,000 Component 2: Assistance to AMIK 240, ,000 Component 3: Assistance to KBA 220, ,000 Component 4: Establishment of a RTGS - 520, , ,000 1,870,000 Component 5: Establishment of a BCC - 150, , , ,000 Component 6: Provision of seed funding to the DIFK - 4,000, ,000,000 Total 1,013,331 5,270,000 1,186,669 1,380,000 8,850, The large disbursement foreseen in FY12 is attributable to the disbursement of seed funding for the DIFK in that year. A. TECHNICAL IV. APPRAISAL SUMMARY 22. For Component 1 (Assistance to the CBK), initial delays occurred because of the minimal experience of the PMT with World Bank procurement and financial management procedures. 6

13 This was compounded by the departure of the CBK Governor and the PMT head in July A new acting Governor and PMT head were quickly appointed and the Original Project has proceeded at a reasonable pace since then. Two fiduciary reviews of the CBK were conducted in recent months. The World Bank has done a review of the project arrangements and found the CBK procurement and financial management capacity to be adequate. The IMF conducted a safeguard assessment and found the legal structure and independence, financial reporting framework, internal audit mechanism, system of internal controls and external audit by independent auditors to be adequate. Over the course of the Original Project, the capacity of the PMT was also enhanced; the financial management system is fully operational and the staff well trained and project staff have gained experience, albeit relatively modest, with procurement requirements as well. The procurement plan for this component has been revised in light of the fast development of the financial sector that has taken place in the past three years. In April 2011, the acting Governor was appointed as the new Governor and thus there is continuity in the top management of the CBK. 23. For component 4 (Establishment of an RTGS), the RTGS working group has been established within the CBK, and it is responsible for drafting bidding documents to procure and implement the RTGS. Consultations have been carried out with other regional central banks, and draft bidding documents to procure and implement RTGS have been prepared. 24. For component 5 (Establishment of a business continuity center), a team within the CBK has been established to support the implementation. The establishment of the BCC will require the procurement of a contractor for refurbishment work of an identified CBK-owned building in Prizren followed by installment of backup servers. Terms of Reference (ToRs) will be developed by the CBK with assistance from IDA and will be advertised shortly after approval. In addition, procurement will be required for hardware, networking connections and software to equip the BCC to support the business-critical systems, which will be established in the BCC, with the exception of the RTGS system. Procurement for back-up software will also be required. 25. For Component 6 (Provision of seed funding to the DIFK), the Law on Establishment of Deposit Insurance System for Financial Institutions in Kosovo has been adopted and came into force in December Furthermore, the process of creation of the DIFK as an independent legal entity has been completed on May 3 rd, 2011 with the: (i) appointment of the Management Board through a decision of the CBK; (ii) approval by the Management Board of the TORs and selection process for the recruitment of the DIFK director; (iii) opening of two accounts for the DIFK in the CBK (one account will be used for the DIFK operational expenditures and one for the DIFK s funds); and (iv) appointment of an interim Director. 26. Finally, to make the DIFK effective, the following needs to be achieved: (i) Approval by the Management Board of a directive on governance (Management Board decisions making process and structure of the DIFK); (ii) Approval by the Management Board of a directive adopting the human resources, financial management and procurement procedures of the CBK; (iii) Signing of a binding agreement between the DIFK and CBK on outsourcing of human resources, financial management and procurement functions to the CBK; (iv) Approval by the Management Board of a directive on payout form; (v) Approval by the Management Board of a directive on criteria for payee banks; and (vi) A decision by the Management Board that an amount equivalent to the IDA contribution (US$4 million) will be sufficient to initiate coverage 7

14 of depositors. In addition, material explaining coverage will need to be developed prior to the DIFK being effective. These will be included as disbursement conditions in the Financing Agreement. 27. Under operational policy 6.00 (Bank Financing), the World Bank may finance expenditures that are productive from loan proceeds. IDA contribution to the DIFK in the amount of US$4 million will enable the DIFK to commence provision of deposit insurance services. Like any insurance business, a deposit insurance fund does not hold resources equivalent to the insured amounts. However, for a deposit insurance fund to be credible and inspire confidence in the population, it is crucial that the DIFK has some capital reserves to demonstrate ability to pay-out. Against this backdrop, up-front disbursement of IDA resources is a critical component of the support to the DIFK as it will strengthen its balance sheet and these reserves will provide a buffer in the event of a crisis. The provision of seed capital to the DIFK will raise confidence in the banking system. Heightened confidence in the banking sector backed by a deposit insurance scheme will in turn increase the mobilization of domestic savings, thus increasing on-lending resources for banks operating in Kosovo. Domestic savings mobilization is crucial for growth in Kosovo in light of reduced capital inflows to Eastern Europe after the crisis. Therefore, the provision of capital to the DIFK constitutes a clear productive purpose and hence meets the requirements of operational policy The DIFK is expected to build reserves of approximately 15 million over time. DIFK funding will include premiums from financial institutions, GoK contribution, and grant capital of 4.5 million from KfW. B. PARTNERSHIPS 29. The development of the financial sector in Kosovo is supported by a number of donors. Specifically, with respect to the said Project, the World Bank is working with the US Treasury to ensure that the RTGS platform funded under this Project is fully integrated by the Central Securities Depository (CSD) system being supported by the US treasury. In addition, The World Bank under the Western Balkans Technical Assistance Facility will, together with the IMF and KfW, provide technical assistance to the DIFK to support preparation of, annual updates to and implementation of an institutional building plan to ensure compliance with Basel/IADI principles. KfW will also provide seed funding to the DIFK and the IMF is supporting the introduction of a new bank resolution framework. While the funding and partnership support provided by the US Treasury, KfW, IMF and the GoK is useful, the FSSMIP is not dependent on the same and may proceed independently of such funding and support. C. PROCUREMENT 30. A procurement capacity assessment of the CBK to undertake necessary procurement actions under the AF was conducted using the web-based Procurement Risk Assessment Management System (P-RAMS). At the project level, the CBK has acquired some procurement experience under the Original Project thus far. However, procurement under the additional financing is of a more complex nature involving International Competitive Bidding (ICB), which requires a relatively high degree of technical capacity, particularly with respect to procurement 8

15 of the IT inputs. Given that the Project coordinator is relatively new, and the procurement officer s experience on Bank procurement requirements is still modest, the CBK was found to have only limited experience and knowledge for the preparation of the technical requirements and Bidding Documents (BDs) for the RTGS IT package under the AF. This in turn could lead to delays in bidding process/contracting. Moreover, there is some concern that potential interference by officials in the procurement process, including selection and contract award, may negatively impact project implementation. 31. In view of the above assessment, and to avoid procurement delays and potential political interference in the tendering process, the following mitigation measures have been agreed upon: (a) an international IT expert will be hired to support the CBK in the procurement of RTGS main IT system; in particular, the consultant will help with BDs preparation (including technical specifications/functionality) in the evaluation process, and also during delivery and acceptance of the IT system. The process of preparation of ToRs will commence prior to effectiveness of the Project however the IT expert only needs to be on hired prior to evaluating the technical requirements and preparing the bidding documents for procurement under the RTGS component; (b) IDA will continue to conduct prior reviews of all contracts (as is the case under the current Original Project); (c) the World Bank's procurement specialists will conduct regular and need based training in World Bank's procurement policies and procedures; (d) regular support, guidance, and supervision by the World Bank's procurement specialist during project supervision; and (e) a procurement plan covering the first 18 months of the project implementation has been prepared and will be discussed and approved by IDA. 32. Procurement Risk and Mitigation Measures: The overall project risk for procurement is high before mitigation measures, and with the agreed mitigation measures described above, the residual risk for procurement is judged to be substantial. The table below summarizes the project procurement risks, the mitigation measures proposed and the oversight and monitoring arrangements for procurement. Table 4: Procurement Risk and Mitigation Measures Procurement Risks Modest procurement capacity within the CBK and inadequate knowledge of Bank s procurement and consultant guidelines. Lack of capacity on IT/technical side of respective IT department for preparation of technical specifications/ functionalities for RTGS main IT package. Mitigation Measures during Preparation The CBK procurement officer will continue to increase his procurement knowledge in current FSSMIP Project. Mitigation Measures by Effectiveness Prepare ToRs for an information technology expert, to assist the CBK in evaluating the technical requirements and preparing the bidding documents for the RTGS IT system. Mitigation Measures during Implementation Hiring of IT expert to be done prior to evaluating the technical requirements and preparing the bidding documents for procurement under the RTGS component (component 4) of the Project. Regular and adhoc training in the Bank procurement policies and procedures by the Bank s Procurement Specialist 9

16 The CBK does not have a procurement planning process. Potential interference by officials in the procurement process, including selection and contract award. Prepare draft procurement plan. Assurance that no interference in procurement and agreement on who will sign the contract. Update the detailed procurement plan for the first 18 months of the Project. Follow up closely and discuss anticorruption guidelines and include provisions related to disclosure of conflict of interests, code of ethics for evaluation committee. (PS). Project coordinator and procurement officer to attend procurement training offered. Implementation of the procurement plan will be closely monitored by the Bank s task team. Regular support, guidance, supervision by the Bank s procurement specialists during the project implementation. Follow closely through prior and post review of contracts to be alerted of any red flags. 33. Applicable Guidelines: Procurement for the proposed Project will be carried out in accordance with the World Bank s "Guidelines: Procurement under IBRD Loans and IDA Credits" published in May 2004 and revised in October 2006 and May 2010 (Procurement Guidelines); and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" published in May 2004 and revised in October 2006 and May 2010 (Consultant Guidelines); and the provisions stipulated in the Financing Agreement (FA). D. FINANCIAL MANAGEMENT 34. Financial Management Arrangements. The ongoing Original Project is implemented by the CBK. The project implementation team comprises of staff of the CBK supported by a local financial management consultant located at the Grant Unit within the Ministry of Finance. There are no outstanding interim financial reports or audit reports under the ongoing Original Project. Although the existing financial management arrangements for the implementation of the Original Project are considered adequate, the scaled up FSSMIP comprises more complex components including establishment of a payment system, business continuity center, and seed funding to the DIFK. These components will be subject to the World Bank financial management requirements, including satisfactory financial control mechanism and independent financial audit 1. To mitigate fiduciary risk that credit proceeds will not be used for purposes intended, and to further strengthen existing financial management arrangements, disbursement conditions as outlined in paragraph 26 have been established. 1 OP/BP Financial Management 10

17 35. Overall financial management risk has been assessed as substantial before mitigation measures and moderate after mitigation measures. Specifically for component 6, in addition, there is a fiduciary risk related to the short implementation period that may not be sufficient to allow for the FM arrangements to be tested and therefore provide assurance that funds will not be diverted from their intended purpose after the closing date. In addition, US$4 million allocated to the DIFK component will be disbursed up-front, therefore, even during the term of the Project, conventional remedies such as suspension (of future disbursements) will have little value in case of a breach by the Recipient. It is likely that the funds disbursed from the IDA credit will not be "used" by project Closing Date, unless there is a financial crisis, and depositors payout takes place. This risk is mitigated by ensuring the DIFK has a strong and effective governance structure and oversight mechanisms in place by effectiveness, in addition to the annual audit and public disclosure of its financial statements beyond closing date. Additionally there are a number of post project closing measures including right to audit after project closing which are detailed in section E below (paragraphs 42-45). 36. The CBK s legal framework as defined in the Law on the Central Bank of the Republic of Kosovo, July 2010, provides a high degree of autonomy to the CBK, with principal objective to foster and maintain a stable market based financial system, including a safe, sound and efficient payment system and management of official international reserve. Based on the IMF Safeguard Assessment of CBK dated November 4 th, 2010, the legal structure and independence, financial reporting framework, internal audit mechanism, system of internal controls, external audit by independent auditors are considered adequate, and place reliance on use of the CBK s systems and controls for implementation of the proposed scaled-up Project. 37. As far as fiduciary arrangements in the DIFK are concerned, the DIFK will de-facto rely on the CBK for fiduciary arrangements. All DIFK s back office functions will be outsourced to the CBK upon payment of a reasonable fee. Moreover, the DIFK will adopt HR, financial management and procurement procedures of the CBK (see disbursement conditions in paragraph 26). Finally, the DIFK will have two accounts established with the CBK (one account for the operational expenses of the DIFK and one for the deposit insurance fund). 38. Disbursements and Auditing Arrangements. The World Bank Group disbursement procedures for loan/credit proceeds will be followed. The additional financing Credit proceeds for the establishment of the Business Continuity Center and the establishment of RTGS system components will be disbursed under existing arrangements for the Original Project whereby the GoK pre-finances all project expenditures and requests reimbursements from IDA. Direct method of disbursement for large contracts will also be available. Regarding disbursements into the DIFK, a one-time up-front deposit will be made from the Credit Account through the Ministry of Finance to a segregated Deposit Account maintained at the CBK. Such disbursement will not be supported by invoices on expenditures incurred. Both the project financial statements and the DIFK will be audited annually by independent auditors. 39. Under the World Bank s operational policies and 6.00, the World Bank may advance loan proceeds into an account that is held in a financial institution acceptable to the World Bank and operated on terms and conditions acceptable to the World Bank to finance eligible expenditures as they are incurred. Since the capitalization of the DIFK is an eligible expenditure, up-front disbursement for the DIFK is financing an expenditure as it is actually 11

18 incurred and meets the requirements under the World Bank s policies. The funds will pass through the Ministry of Finance and credited to the DIFK account at the CBK. Therefore, the financing for this component can be advanced accordingly. 40. Financial covenants for the FSSMIP will include: Maintenance of a financial management system and preparation of project financial statements in accordance with consistently applied accounting standards acceptable IDA, adequate to reflect the operations, resources and expenditures related to the Project. Annual audit of the project financial statements and of the DIFK carried out by an independent auditor, and under terms of reference acceptable to IDA. The audit reports will be submitted to IDA no later than six months after the end of period audited. The Recipient will make the annual audited financial statements of the Project publically available in a timely fashion. The Recipient shall prepare and furnish to IDA not later than forty five (45) days after the end of each calendar quarter, interim unaudited financial reports for the Project covering the quarter, in form and substance satisfactory to IDA. 41. Financial covenants specifically for component 6 (Provision of seed funding to the DIFK) are as follows: The Recipient shall, at all times, ensure that the DIFK maintains governance arrangements and a financial management system adequate to reflect the operations, resources and expenditures of the DIFK, both acceptable to IDA. The Recipient shall, at all times, ensure that the DIFK: (i) prepares and maintains annual financial statements in accordance with consistently applied accounting standards acceptable to IDA; (ii) has such financial statements annually audited by independent auditors in accordance with consistently applied auditing standards; (iii) prior to the Project Closing Date, makes such audited financial statements publicly available and furnishes to IDA copies of such audited financial statements not later than six months after the end of the financial year; (iv) after the Project Closing Date, makes such audited financial statements publicly available within one month of such reports becoming available and furnishes to IDA, upon its request, copies of such audited financial statements, as IDA may require; (v) performs a special audit upon IDA s request, and makes the reports and findings of such special audit available to IDA; and (vi) if a payment under the Deposit Insurance Scheme is made out of the DIFK Fund to an entity, provides to IDA, at IDA s request, evidence that the payment was made on account of an Insured Event. 12

19 E. POST PROJECT SAFEGUARDS FOR COMPONENT 6 (PROVISION OF SEED FUNDING TO THE DIFK) Closing Assessment 42. The Recipient shall review and assess with IDA no later than March 30 th, 2014, the operations of the DIFK and the Deposit Insurance Scheme (the Closing Assessment ). In making the Closing Assessment, the following factors will be considered: (i) the governance arrangements for the DIFK are satisfactory to IDA; (ii) the financial management system of the DIFK is satisfactory to IDA; (iii) the DIFK and the Deposit Insurance Scheme are operating in accordance with the provisions of the DIFK Legislation and the Financing Agreement; (iv) the DIFK, in the opinion of IDA, has sufficient resources for the continued operation of the Deposit Insurance Scheme and the GoK transferred a minimum of 3.3 million resources to the DIFK (other than the IDA contribution under component 6); (v) the DIFK s audit reports are unqualified; (vi) the DIFK has adopted by-laws and an operating manual satisfactory to IDA; and (vi) any other factors considered relevant by IDA. The goal will be to ensure that Kosovo is complying with international best practices as identified in the Basel/IADI Core Principles for Effective Deposit Insurance and that the DIFK has robust fiduciary management and governance systems that make it sustainable in the long run. 43. As part of the Closing Assessment, IDA may require the Recipient, in consultation with the CBK and the DIFK, to: no later than April 30 th, 2014, prepare a plan (the Plan ) designed to ensure the continued achievement of the DIFK s objectives, and the continued operation of the DIFK and the Deposit Insurance Scheme; and afford IDA a reasonable opportunity to exchange views with the Recipient on the Plan. The Recipient shall immediately repay into the Credit Account for cancellation an amount equal to the proceeds of the Credit provided by IDA under component 6 of the Project, if the Closing Assessment or the Plan is, in the opinion of IDA, unsatisfactory. After Project closing and until the IDA credit is paid in full, the Recipient would maintain a strong and effective governance structure, strong oversight arrangements and fiduciary arrangements. 44. The Recipient will, after closing date, continue to make the annual audited financial statements of DIFK publically available through publishing or posting on its website within one month of receipt of such reports from the auditors. 45. IDA reserves the right to conduct a special review/audit of the DIFK in the event that IDA becomes aware of any irregularities subsequent to the closing date. F. ENVIRONMENT AND SOCIAL 46. Project Components 1, 2, 3, 4 and 6 will have no impact on the environment. Project component 5 (and in particular the renovation of the building that will host the business 13

20 continuity center) is likely to have minimal or no adverse environmental impacts. No World Bank environment or social safeguards policies are triggered. Therefore, the Project has been assigned a Category C in accordance with the World Bank safeguard policy OP/BP/GP 4.01 (Environment Assessment). Even though there are no requirements to produce an EMP or an Environmental Assessment for the small-scale renovation of select areas of the Central bank of Kosovo building, a simple Environmental checklist has been prepared and will be included in the bidding documents for the renovation works and the contractor would need to fill that out. The checklist will also be disclosed on the renovation. Beyond initial screening and completing the checklist, no further environmental due diligence is required. G. IMPLEMENTATION ARRANGEMENTS 47. Under the Original Project the PMT was established within the CBK. The team is responsible for overall project management, coordination and procurement. Under the Original Project the PMT included representatives from the CBK, KBA and AMIK. The implementation arrangements remain the same under the additional financing. However, reflecting the design of the additional financing, the PMT will now comprise only two members from the CBK (Head of the Payment Systems, and the current PMT head), and the Director of the DIFK. 48. The PMT will continue to interact closely with the Grant Unit of the Ministry of Finance, which will remain responsible for financial accounts and management of the FSSMIP. In collaboration with the Grant Unit the PMT will be responsible for ensuring that the Project establishes and maintains: (i) adequate accounting systems and procedures; (ii) flow-of-funds mechanisms facilitating timely disbursement of funds and timely payments for goods, works and services; (iii) regular reporting on the use of funds; and (iv) appropriate arrangements for regular financial audits. Same as under the Original Project, all activities will be coordinated by the PMT and the PMT will be responsible for implementing planned technical assistance activities and collecting and reporting progress to IDA. In addition for component 6 (Provision of seed funding to the DIFK), there are special arrangements for implementation and they are referred in detail in section D above. For Component 4, the RTGS working group will assist the PMT in preparing the bidding documentation for procurement and implementation under the component. The PMT and the Grant Unit have experience with financial management under Bank-financed projects and have established sound internal control mechanisms on the application and use of funds. As an additional condition for effectiveness of the Financing Agreement, an inter-agency agreement between the Ministry of Finance and the CBK will be signed for the implementation of the Project which will set out the roles and responsibilities of the respective entities and their obligations vis-a-vis each other in relation to the Project. 14

21 ANNEX 1: RESULTS FRAMEWORK AND MONITORING KOSOVO: FINANCIAL SECTOR STRENGTHENING AND MARKET INFRASTRUCTURE PROJECT Results Framework PDO Revisions to the Results Framework Current (PAD) The objective of the Project is to enhance the stability and development of Kosovo s financial system by supporting stronger prudential regulation and supervision by CBK for banks and non bank financial institutions, supporting the institutional strengthening of CBK, and strengthening the banking and microfinance industry through capacity building. PDO indicators Current (PAD) Component 1 (i) Development by the CBK of a supervision plan for each of Kosovo s main banks and the implementation of such plans; (ii) Development by the CBK of an ongoing supervision plan for insurance companies and for pension funds and the implementation of such plans. Proposed To enhance the stability and development of the financial sector; and strengthen the financial sector s underlying market infrastructure. Proposed change* Revised Status of updated legal and regulatory framework for banks and NBFIs and capacity building in the financial sector. Comments/ Rationale for Change Revised to reflect the outcomes of the new activities added under the additional financing including establishment of the RTGS for delivery of financial services, establishment of a BCC to reduce the impact on the financial sector in the event of a disaster, and establishment of the DIFK to increase confidence in and stability of the financial sector. The two original indicators will be merged into one to better monitor progress towards revised PDO. Component 4 Component 5 Component 6 Intermediate Results indicators Current (PAD) Banking Sector Preparation of a development strategy for the CBK including options to ensure access by the CBK to long term resources Status of operationalization of RTGS. Status of establishment of a fully operational BCC. Status of establishment of the DIFK. Proposed change* Revised: Number of missing and/or outdated regulations and directives drafted for banks and NBFIs, which have been passed recently or to be passed over 15 Additional indicators to reflect the new activities added under the additional financing including strengthening the national payment systems, establishing the BCC and operationalization of the DIFK to increase confidence in and stability of the financial sector. The formulation of these indicators has been modified to reflect the restructuring of the original Project.