Document of The World Bank

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank PROJECT APPRAISAL DOCUMENT ONA PROPOSED LOAN IN THE AMOUNT OF US$50.0 MILLION TO THE BANK OF THE NORTHEAST FOR A NORTHEAST MICROFINANCE DEVELOPMENT PROJECT April 27, 2000 Report No: BR Brazil Country Management Unit Environmentally and Socially Sustainable Development Sector Management Unit Latin America and Caribbean Region

2 CURRENCY EQUIVALENTS (Exchange Rate Effective April 1, 2000) Currency Unit = Real (R$) R$ = US$ 0.57 US$ I = R$ 1.74 FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS AROA Adjusted Return on Assets LCSES Environmentally and Socially Sustainable Development Sector Management Unit Latin America and the Caribbean Region ATM Automatic Teller Machine MIS Management Information System BN Banco do Nordeste (Bank of the Northeast) NBF Non-Bank Financed BNDES Banco Nacional de Desenvolvimento Econ6mico e NCB National Competitive Bidding Social (National Bank for Economic and Social Development) BRI Bank Rakyat of Indonesia NE Northeast CAS Country Assistance Strategy NGO Non-Governmental Organization CDI Certificado de Deposito Interbancdria (Inter-Bank PIRD Japan's Policy and Humaai Resources Development Certificate of Deposit) Fund CGAP Consultative Group to Assist the Poorest PMR Project Management Report CQS Consultant's Qualifications Selection QBS Quality Based Selection CY Calendar Year QCBS Quality and Cost Based Selection ETENE Escrit6rio Tecnico de Estudos Economicos do RFP Request for Proposal Nordeste - (Technical Office for Economic Studies of the Northeast) FENAPE Federa~,co Nacional de Apoio aos Pequenos ROA Retum on Assets Empreendimentos (National Federation for Assistance to Small Enterprises) FNE Fundo Constitucional do Nordeste (Constitutional SDI Subsidy Dependence Index Fund for the Northeast) FY Fiscal Year SEBRAE Servi,o Brasileiro de Apoio as Micro e Pequenas Empresas (Brazilian Service for Assistance to Microand Small Enterprises) GDP Gross Domestic Product SIL Specific Investment Loan ICB International Competitive Bidding SME Small and Medium Enterprises IDA International Development Association SOE Statement of Expenditures IDB Inter-American Development Banik SPC Servico de Prote,co do Credito (Credit Protection Service) IFC Intemational Finance Corporation TA Technical Assistance LACI Loan Administration Change Initiative UNDP United Nations Development Program LCS Least Cost Selection Vice President: Country Director: Sector Director: Task Team Leader: Mr. David de Ferranti Mr. Gobind T. Nankani Mr. John Redwood Mr. Steven N. Schonberger

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5 BRAZIL NORTHEAST MICROFINANCE DEVELOPMENT PROJECT CONTENTS A. Project Development Objective Page 1. Project development objective 2 2. Key performance indicators 2 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2 2. Main sector issues and Government strategy 3 3. Sector issues to be addressed by the project and strategic choices 5 C. Project Description Summary 1. Project components 6 2. Key policy and institutional reforms supported by the project 7 3. Benefits and target population 8 4. Institutional and implementation arrangements 8 D. Project Rationale 1. Project altematives considered and reasons for rejection 9 2. Major related projects financed by the Bank and other development agencies Lessons leamed and reflected in proposed project design Indications of borrower commitment and ownership Value added of Bank support in this project 11 E. Summary Project Analysis 1. Economic Financial Technical Institutional Environment Social Safeguard Policies 23 F. Sustainability and Risks 1. Sustainability Critical risks Possib]e controversial aspects 24

6 G. Main Loan Conditions 1. Effectiveness Condition Other 25 H. Readiness for Implementation 26 I. Compliance with Bank Policies 26 Annexes Annex 1: Project Design Summary 27 Annex 2: Project Description 34 Annex 3: Estimated Project Costs 64 Annex 4: Cost Benefit Analysis Summary 65 Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary 68 Annex 6: Procurement and Disbursement Arrangements 83 Annex 7: Project Processing Schedule 89 Annex 8: Documents in the Project File 90 Annex 9: Statement of Loans and Credits 91 Annex 10: Country at a Glance 95 Annex 11: Framework for Microfinance in Brazil 97 MAP(S)

7 Date: April 27, 2000 Country Manager/Director: Gobind T. Nankani Project ID: P Lending Instrument: Specific Investment Loan (SIL) BRAZIL Nortieast Microfinance Development Project Project Appraisal Document Latin America and Caribbean Region LCSER Team Leader: Steven N. Schonberger Sector Manager/Director: John Redwood Sector(s): BI - Institutional Development, FY - Other Finance Theme(s): Rural Development; Poverty Reduction; Financial Sector Poverty Targeted Intervention: Y Project Financing Data R Loan El Credit Oi Grant Cl Guarantee Li Other (Specify) For LoanslCredits/Others: Amount (US$m): $50.00 Proposed Terms: Variable Spread & Rate Single Currency Loan (VSCL) Grace period (years): 5 Years to maturity: 15 Commitment fee: 0.75% on undisbursed balance, beginning 60 days after signing. GOVERNMENT IBRD IDA OTHER Total: Borrower: BANK OF THE NORTHEAST Responsible agency: BANK OF THE NORTHEAST Estimated disbursements ( Bank FY/US$M): Annual Cumulative 3.7 l Project implementation period: 12/01/99 to 6/30/05 Expected effectiveness date: 07/01/2000 Expected closing date: 12/31/2005 OCa PAD F.ni Rev M,f. 200

8 A. Project Development Objective 1. Project development objective: (see Annex 1) The proposed project is part of the Bank's program of targeted assistance to the Northeast Region which constitutes the largest concentration of poverty in Brazil. The project addresses the lack of access of the poor to financial services, an important constraint to improved productivity and incomes. The project would build on a successful two-year pilot program, financed by the Government of Brazil with technical assistance from the Bank and preparation assistance financed by a Japanese PHRD Grant. The overall objective of the project is to improve the access of microenterprises throughout the Northeast Region to sustainable, fonnal financial services by supporting expansion of the program known as "CrediAmigo" in Brazil. 2. Key performance indicators: (see Annex 1) Progress towards achievement of the project objective would be monitored using the following indicators: (i) Extent of outreach: At least 120,000 additional active clients. (ii) Depth of outreach: Average outstanding loan balance less than 65% of Northeast per capita GDP. (iii) Breadth of outreach: Number of municipalities in Northeast with CrediAmigo clients. (iv) Financial sustainability: Subsidy dependence index of zero: adjusted return on assets greater than 3%. (v) Operational efficiency: Operational costs (annualized) less than 24% of average net outstanding portfolio. (vi) Institutional independence: Equity to earning assets ratio of at least 15%. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: BR (CAS), R (Progress Report), SecM (Framework Paper) Date of latest CAS discussion: 12/01/98 The project would support achievement of the CAS regional growth goals to (i) reduce rural and urban poverty in the Northeast Region of Brazil; and (ii) increase the sustainability of poverty reduction activities. The importance of self-employment and micro-enterprise activities to the incomes of the poor (discussed below) suggests that activities which support the growth of those activities can improve their employment and incomes. The Bank has supported Government programs which provide grant financing to poor communities, particularly in rural areas, to develop their productive assets. Govemnment wishes to "graduate" many of these communities from grant-based assistance. However, limited access to financing for working capital and complimentary investments limits full utilization of the improved asset base. The proposed project would develop, in the Northeast Brazil environment, products and delivery systems, designed on the basis of international and local experience, for provision of financially sustainable microfinance services to poor communities in urban and rural areas. Relevant CAS indicators: (i) Declining poverty gap for poor, client households in the Northeast; (ii) Declining subsidy requirement per beneficiary The proposed project is consistent with the CAS strategy to improve access to, and reduce the cost of capital by using innovative lending technologies to lower financial internediation costs. To the extent the - 2 -

9 project is able to provide savings services, it will also support increased domestic savings mobilization. Emphasis on asset quality is consistent with the Bank's support of improvements in the soundness of the financial system. Regulatory and supervisory issues particular to development of the microfinance industry which are identified during the preparation and implementation of the proposed project are being integrated into the Bank's dialogue with the Central Bank of Brazil in coordination with the Bank-financed Central Bank Modernization Technical Assistance Loan, and through non-lending services. Experience in support of commercial microfinance development in Brazil is being shared with the International Finance Corporation (IFC) which places mobilization of resources for small and medium enterprises through credit lines amongst its major priorities for development of capital markets. 2. Main sector issues and Government strategy: See Annex llfor a more thorough review of the framewvork for microfinance in Brazil) Poverty in Northeast Brazil The Northeast Region, consisting of the states of Maranhao, Piaui, Ceara, Rio Grande do Norte, Paraiba, Pemrnambuco, Alagoas, Sergipe, and Bahia, constitutes the largest concentration of poverty, particularly rural poverty, in Brazil. While the Northeast accounts for less than 30% of Brazil's population (45 million), it contains over 55% (14.6 million) of Brazil's poor, a poverty rate over twice that of the rest of the country. Almost half the Northeast population is rural and 60% of the poor in the Northeast live in rural areas. According to the Brazil Poverty Assessment (Brazil: A Poverty Assessment, World Bank Report No BR)., 37.4% of all poor household heads are self-employed, reaching almost 50% in rural areas. Economic and Sector Work (Brazil: the Management ofagriculture, Rural Development and Natural Resources, World Bank Report No BR) has identified skewed access to land and financial services, inter alia, as major constraints to improved productivity and incomes in the Northeast. Government is piloting the use of market-based mechanisms to improve the quality and efficiency of its services targeted to the poor. While the introduction of demand-driven programs has improved the efficiency and effectiveness of some social investments targeted to the poor, programs to facilitate access to land and credit have been less successful, requiring high, ongoing public subsidies while reaching a limited number of beneficiaries. Government is now piloting the use of market-based, alternative mechanisms to improve access to both land and financial services. -3 -

10 Microenterprises Despite their important role in the economy, microenterprises have very limited access to business support services. The most recent available enterprise statistics indicate that the microenterprises account for over 90% of all finns in Brazil and over 35% of total employment in services, commerce and industry ( Coletanea Estatistica da Micro e Pequena Empresa, Brazilian Service for Assistance to Micro- and Small Enterprises (SEBRAE)). Not surprisingly, given its economic profile, the Northeast Region has the highest percentage of its labor force, 81% working in enterprises with up to five employees. A recent survey of microentrepreneurs in the Northeast Region (Demanda PorMicrocredito No Nordeste Brasileiro, Technical Office for Economic Studies of the Northeast (ETENE), indicates that most microentrepreneurs have not completed secondary schooling, have little training in business management and have virtually no access to lending from banks and other fonnal financial intermediaries. Private banks, unable to meet the demand for lower-cost lending services to medium and large enterprises, have little incentive to develop the market knowledge and technology required to profitably provide financial services to microenterprises. The surveys carried out in urban centers and rural market towns, indicate that guarantee requirements, transactions costs and inappropriate loan products discourage microenterpreneurs from accessing government-sponsored directed credit programs. Limited informal finance is available from suppliers and moneylenders at effective interest rates as high as 200% per annum. Government has recognized the importance of supporting the development of microenterprises as part of its poverty reduction strategy and has identified improved access to technical and financial services as a priority development activity (Brasil em Accao, Ministry of Planning). Access to Formal Financial Services Access to formal financial services in Brazil is uneven. Using the rough indicator of population per bank branch, access to banking services in Brazil (just under 10,000 people per branch) is comensurate with other upper middle income countries in Latin America, though this number is much higher than in OECI) countries. However, this masks important regional disparities. The Northeast (approximately 19,000 per branch) and the North (20,000 per branch) are the most under-served regions in Brazil. In addition, using GDP per branch ($50,000 per branch for Brazil) as an indicator of potential business volume, the Northeast ($47,000) provides little incentive for private bankers to increase their coverage relative to other regions (i.e.: in the North where GDP per branch is $60,000). This disparity in coverage and lack of incentives for increased coverage by private banks is one of the primary justifications for continued support of publicly-owned banks (which account for 46% of bank branch infrastructure and 55% of financial sector assets in Brazil) and directed credit lines which generally have high defaults and administrative costs. However, survey data from SEBRAE and ETENE indicates that few microenterprises have access to financial services, particularly lending services, from either public or private banks, despite attractive cash-flow characteristics, payment of interest rates to moneylenders and suppliers which are several times those offered by directed credit lines, and a demonstrated willingness to utilize savings services. While access to savings and deposit services is more common, this occurs mostly in large, urban centers and even in those cases reaches less than a quarter of microentrepreneurs. As a result, Govemment is seeking altemative mechanisms for deepening access to financial services, which require limited and declining subsidies to initiate, and which could potentially be provided by the private sector on commercial basis, reducing or eliminating the need for public interventions such as directed credit lines. -4 -

11 Microfinance Services The development of microfinance services in Brazil has lagged behind that of other countries in Latin America, due in part to the former period of high inflation, restrictions on the ability of NGOs to serve as financial intermediaries and mobilize foreign donor funding, and lack of Government support for industry development - all impediments which have been removed in the past two years. More recently, a number of Brazilian programs have demonstrated that Brazilian microentrepreneurs are willing and able to borrow and repay loans at relatively high rates of interest, but these programs are all quite small relative to the potential market for