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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 PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF EUR 47.8 MILLION (US$70 MILLION EQUIVALENT) TO BOSNIA AND HERZEGOVINA FOR A Report No: BA ENHANCING SMALL AND MEDIUM ENTERPRISES ACCESS TO FINANCE PROJECT November 6,2009 Finance and Private Sector Development (ECSPF) South East Europe Country Unit (ECCU4) Europe and Central Asia (ECA) 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 BOSNIA AND HERZEGOVINA - GOVERNMENT FISCAL YEAR January 1 - December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of September 30,2009) Currency Unit Bosnia and Herzegovina Mark (BAM) US$l.oo BAM 1.33 Metric System ABBREVIATION AND ACRONYMS (As applicable, plus others) ABBREVIATIONS AND ACRONYMS AR BAM BiH CAS CDP CEE CL CLS CPS DA EA EBRD EC ECA EDSGF EF EMP EU EUR FBiH FDI FIL, FIRR FMET FM FMM FMS FYR GDP IBRD ICA ICB IFAC IFC IF1 Accounts Receivable Bosnia and Herzegovina Mark Bosnia and Herzegovina Country Assistance Strategy Community Development Project Central and Eastern Europe Credit Line Credit Line Section Country Partnership Strategy Designated Account Environmental Assessment European bank for Reconstruction and Development European Commission Europe and Central Asia Economic Development Strategy Global Framework Environmental Safeguard Review Framework and Management Plan Environmental Management Plan European Union Euro Federation of Bosnia and Herzegovina Foreign Direct Investment Financial Intermediary Loan Financial Internal Rate of Return Federal Ministry of Environment and Tourism Financial Management Financial Management Manual Financial Management System Former Yugoslavian Republic Gross Domestic Product International Bank for Reconstruction and Development Investment Climate Assessment International Competitive Bidding International Federation of Accountants International Finance Corporation International Financial Institution 2

3 IFR JICA KfW LCS LDP LIBOR LOC LT MCO MIS MoF MoFT MoFTER MoU M&E NPL NPV NGO OM OdRaz PAD PFI PHRD PIU PRSP PTAC QCBS ROE RS RSIDB SEE SFA SME SOE SPA ST TI USAID VPE VSL WB WBG FOR OFFICIAL USE ONLY Interim Unaudited Financial Report Japan International Cooperation Agency Kreditanstalt fur Wiederaufbau (German Rehabilitation Credit Institute) Least-Cost Selection Local Development Project London Interbank Offered Rate Line of Credit Long Term Microcredit Organization Management Information Systems Ministry of Finance Ministry of Finance and Treasury Ministry of Foreign Trade and Economic Relations Memorandum of Understanding Monitoring & Evaluation Non Performing Loans Net Present Value Non-Governmental Organization Operationa Manual Foundation in the Federation Project Appraisal Document Participating Financial Institution Policy and Human Resource Development Project Implementation Unit Poverty Reduction Strategy Paper Privatization Technical Assistance Credit Quality and Cost Based Selection Return On Equity Republika Srpska Republika Srpska Investment- Development Bank Southern Eastern Europe Subsidiary Financing Agreement Small and Medium Enterprise Statement of Expenditure Special Project Account Short Term Transparency International Unites States Agency for International Development Voucher Privatized Enterprise Variable Spread Loan World Bank World Bank Group Vice President: Country Director: Country Manager Sector Manager: Task Team Leader: Philippe H. Le Houerou Jane Armitage Marco Mantovanelli Lalit Raina Irina Astrakhan This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

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5 BOSNIA AND HERZEGOVINA ENHANCING SME ACCESS TO FINANCE CONTENTS I Page. STRATEGIC CONTEXT AND RATIONALE I1 A. B. C. Country and sector issues Rationale for Bank involvement Higher level objectives to which the project contributes PROJECT DESCRIPTION A. B. C. D. E. I11. A. B. C. D. E. F. IV. A. B. C. D. E. F. G. Lending Instrument Project Development Objectives and Key Indicators Project Description Lessons learned and reflected in the project design Alternatives considered and reasons for rejection IMPLEMENTATION Partnership Arrangements Institutional and implementation arrangements Monitoring and evaluation of outcomeshesults Sustainability Critical risks and possible controversial aspects Loadcredit conditions and covenants APPRAISAL SUMMARY Economic and Financial Analyses., Technical Fiduciary., Social Environment Safeguard policies Policy Exceptions and Readiness Annex 1: Country and Sector or Program Background Annex 2: Major Related Projects Financed by the Bank and/or other Agencies

6 Annex 3: Results Framework and Monitoring Annex 4: Detailed Project Description Credit Line Component - EUR Project Management and Monitoring Component - EUR 408, Attachment to Annex 4: Pre-Qualification Process of Participating Financial Institutions (PFI) Annex 5: Project Costs Annex 6: Implementation Arrangements Annex 7: Financial Management and Disbursement Arrangements Annex 8: Procurement Arrangements Annex 9: Economic and Financial Analysis Annex 10: Safeguard Policy Issues Annex 11: Project Preparation and Supervision Annex 12: Documents in the Project File Annex 13: Statement of Loans and Credits Annex 14: Country at a Glance Annex 15: Map. IBRD 33375R

7 BOSNIA AND HERZEGOVINA ENHANCING SME ACCESS TO FINANCE PROJECT APPRAISAL DOCUMENT EUROPE AND CENTRAL ASIA ECSPF Date: July 27,2009 Country Director: Jane Armitage Sector ManagedDirector: Lalit Raina Project ID: P Lending Instrument: Financial Intermediary Loan Team Leader: Irina Astrakhan Sectors: General finance sector (60%); General industry and trade sector (20%); Micro- and SME finance (20%) Themes: Small and medium enterprise support (75%); Other financial and private sector development (25 YO) Environmental category: Financial Intermediary Assessment Joint IFC: Joint Level: [XI Loan [ ] Credit [ 3 Grant [ ] Guarantee [ ] Other: For Loans/Credits/Others: Total Bank financing (EUR m.): 47.8 Proposed terms: an IBRD Flexible loan at 6 month LIBOR for Euro plus variable spread, with a 25 year maturity and 10 years of grace, with level repayment of principal. Financing Plan (EUR) Source Local Foreign Total BORROWEFURECIPIENT International Bank for Reconstruction and Development Total: Borrower: Government Bosnia and Herzegovina Responsible Agency: Ministry of Finance and Treasury Bosnia and Herzegovina Ministry of Finance of the FBiH Ministry of Finance of RS 6

8 FY 4nnual Zumulative Estimated disbursements (Bank FY/EUR) FYll FY12 FY13 FY Project description [one-sentence summary of each component] Ref: PAD ILD., Technical Annex 4 The project has two components. They are: 1. The Credit Line component will comprise a credit line of EUR 46,972,200 to be extended through PFIs to creditworthy private enterprises for viable projects. 2. The Project Management and Monitoring Component in the amount of EUR 408,300 would finance costs of project management, monitoring, financial management, audits and other activities related to overall project management in the Federation of Bosnia & Herzegovina. There will be EUR 300,000 of unallocated funds which will serve as a contingency for this component, and the decision on its allocation will be taken at the project s mid-term review. Which safeguard policies are triggered, if any? Re$ PAD IK F., Technical Annex 10 The only safeguard policy which is triggered is OP/BP A summary of the Environmental Safeguard Review Framework describes procedures for the Participating Financial Institutions (PFIs) to apply to sub-projects which will be financed under the Project with regard to Environmental Assessment (EA) issues. These procedures include eight elements, i.e. (i) Compliance with FBiH/RS EA requirements; (ii) Screening; (iii) Documentation; (iv) Public Consultation; (v) Disclosure; (vi) Review and Approval; (vii) Conditionality; and (viii) Monitoring and Reporting. There will be four categories of subprojects from low risk (Category I) to sub-projects or enterprises involved in the manufacture or use of dangerous or illegal materials (Category IV). Only projects of Category I (low risk) and Category I1 (intermediate risk) will be eligible for financing. 7

9 Significant, non-standard conditions, if any, for: Re$ PAD III.F. Board presentation: None Loan effectiveness: A Project Agreement has been executed on behalf of the Bank and an Entity on terms and conditions satisfactory to the Bank; For the Entity referred to in paragraph (a) of this Section 5.01 of the Loan Agreement, a Subsidiary Loan Agreement has been executed on behalf of the Borrower and the Entity concerned, on terms and conditions satisfactory to the Bank; For the Entity referred to in paragraph (a) of this Section 5.01 of the Loan Agreement, a Project Implementation Agreement has been executed on behalf of said Entity and the PIU concerned, on terms and conditions satisfactory to the Bank; The PIUs have each established accounting and reporting mechanisms satisfactory to the Bank; The PIUs have each identified at least two (2) qualified PFIs and submitted to the Bank the related draft Subsidiary Financing Agreements, on terms and conditions satisfactory to the Bank; and The Entities have adopted the Operational Manual in form and substance satisfactory to the Bank. Implementation covenants: The Project shall be implemented under the overall responsibility of the Federation PIU in the Federation, and the RS PIU in RS. To this end, the Borrower shall cause the Entities to each enter into a Project Implementation Agreement with their respective PIU, on terms and conditions satisfactory to the Bank and setting forth, inter alia, the respective PIU s responsibilities for Project management, implementation and monitoring, including the provision of Subsidiary Financings to their respective PFIs, reporting, disbursement, procurement and financial management arrangements. The Borrower shall cause the Entities to each maintain their respective PIU at all times during Project implementation with terms of reference and resources satisfactory to the Bank, and with competent staff in adequate numbers. The Borrower shall, and shall cause the Entities, through their respective PIU, to: (a) duly perform all obligations under the Operational Manual and the Environmental Safeguard Review Framework in a timely manner and in accordance with their respective terms, and apply and implement, as the case may be, the actions, criteria, policies, procedures and arrangements therein set forth; and (b) not amend or waive, or permit to be amended or waived the Operational Manual or the Environmental Safeguard Review Framework or any provisions of any one thereof, except with the prior written approval of the Bank. The Borrower shall, and shall cause the Entities, through their respective PIU and PFIs, to ensure that no land acquisition or resettlement shall be required under the Project. To facilitate the carrying out and financing of Part 1 of the Project, the Borrower shall make the amount of twenty eight million six hundred eighty thousand Euros (EUR 8

10 28,680,000) out of the proceeds of the Loan available to the Federation under a subsidiary loan agreement between the Borrower and the Federation ( Federation Subsidiary Loan Agreement ), under the same terms and conditions as the Loan, approved by the Bank and including the Anti-Corruption Guidelines, for on-lending by the Federation to its Participating Financial Institutions on terms and conditions set forth in Part C of this Section I. To facilitate the carrying out and financing of Part 2 of the Project, the Borrower shall make the amount of nineteen million one hundred twenty thousand Euros (EUR 19,120,000) out of the proceeds of the Loan available to Republika Srpska under a subsidiary loan agreement between the Borrower and Republika Srpska ( RS Subsidiary Loan Agreement ), under the same terms and conditions as the Loan, approved by the Bank and including the Anti-Corruption Guidelines, for on-lending by RS to its Participating Financial Institutions on terms and conditions set forth in Part C of this Section I. The ODRAZ and RSIDB will maintain a financial management system acceptable to the Bank. The project financial statements, including SOEs and DA Statements as well as RSIDB entity financial statements will be audited by independent auditors acceptable to the Bank and on terms of reference acceptable to the Bank. The annual audited financial statements and the audit report will be provided to the Bank within six months of the end of each fiscal year. The OdRaz and RSIDB shall also prepare and furnish to the Bank not later than forty five (45) days after the end of each calendar semester, Interim Unaudited Financial Reports (IFRs) for the Project covering the semester, in form and substance satisfactory to the Bank. 9

11 I. STRATEGIC CONTEXT AND RATIONALE A. Country and sector issues Country Background 1. BiH had experienced rapid growth in recent years and was in a relatively stable position at the on-set of the global financial crisis. In the years after the postwar reconstruction, BiH has achieved double-digit growth rates and has made substantial progress in a wide range of social and economic areas. Much of this initial growth was driven by privatization, economic restructuring, and postwar reconstruction efforts, supported by credit growth and financial sector development. 2. Growth rates have declined in the past few years, but remained between 4 to 7% since However, much of the recent growth was consumption driven, and has been fueled by capital inflows from the parent banks of the foreign banks operating in BiH, as well as by other capital inflows. This has led to substantial credit growth that has been dependent on foreign banks, creating a significant vulnerability if parent banks were to decrease their support for their BiH subsidiaries. Other factors that have led to this substantial growth also include high metal prices, growth of remittances, strong export growth and increase of private investment. 3. The credit expansion, combined with a pro-cyclical fiscal policy and rising commodity prices have resulted in a substantial current account deficit that has amounted to 12.7% of GDP in 2007 and 14.5% in In addition, the economy has been highly dependent on exports to the EU, commodities, and a significant inflow of remittances. These conditions implied significant vulnerabilities that made BiH sensitive to the global financial crisis. 4. The global financial crisis has impacted BiH significantly since late Growth estimates for 2009 now project a 3% decline in Unlike many other countries, banks operating in BiH had no exposure to toxic mortgage-backed securities or other types of instruments that have led to financial instability in other parts of the world. However, BiH felt the impact of international financial and economic crises via three transmission mechanisms: slow-down of FDI and capital inflows; reduced demand for exports; and lower commodity prices. 5. Although the financial system has fared well so far, financing for new loans to enterprises and households has greatly decreased. Much of the recent growth in capital flows has been driven by foreign banking groups that have been supporting their local operations in BiH. With the onset of the international financial crisis, these foreign banking groups have become more risk-averse, resulting in parent banks decreasing support for their operations in BiH, thus credit growth has declined substantially. Credit growth for the first two months of 2009 was slightly negative (-0.2%), compared to a growth of 3.8% in the first two months of 2008l. In the second quarter on 2009, credit growth experienced further deterioration and a continued negative trend. This decreased credit growth is impacting investment across a ' Credit growth was 27.3% in 2005,23.4% in 2006,28.4% in 2007, and 21.8% in

12 number of sectors of the economy, as enterprises face decreased access to credit and higher rates of interest. 6. The enterprise sector has not only been impacted by the decreased access to finance, but also by decreased domestic consumption and exports. Exports have declined significantly (see figure 1) as BiH's main trading partners have experienced slowdowns in growth due to the financial crisis2. The year-on-year growth of exports slowed dramatically in the fourth quarter of 2008 and recorded a 21% decline in January (yoy). As economic prospects of the enterprise sector has declined, banks have become more risk averse and have increased interest rates for both short term and long term credit. Interest rates in BiH in June 2009 were some 15% higher than in June Although NPLs have remained relatively low, they could increase if the crisis persists. Overall growth in BiH is expected to decrease substantially from the 6% rate of 2008, and could be close to zero if these conditions persist. In addition, public revenue is declining, which has dropped 5% in January and 17% in February of 2009, when compared to the same months last year. 7. SMEs are particularly hit by the insufficient amount of available working capital, medium term investment financing, and liquidity. Credit growth has slowed down, bringing a sharp decline in short-term lending. Performance of SMEs has deteriorated notably in 2008, and it can be expected that the trend will continue in Liquidity is in jeopardy, as sales on credit significantly increased, with collection of accounts receivable (AR) remaining at the same level. At the same time, suppliers are not extending payment periods and payables are not increasing at the same pace as AR. Furthermore, interest expense is significantly increasing (by 23% in the sample of 870 SMEs analyzed3), accounting for the increased interest rates. These factors are particularly evident in smaller companies, while the trend is also visible in larger ones. 8. The enterprise sector is further hit by unfavorable regulatory environment, and increased costs and risks of doing business. The business environment in BiH is probably the most unfriendly in the region, coupled with large and complex public administration and layers of administrative approval authorities. The maze of authorizations and approvals needed, overlapping competencies and lack of harmonization among laws give rise to the increased costs and risks of doing business. This complexity, coupled with negative credit growth, increase in interest rates, and decrease in consumption make it very difficult for SMEs to operate in BiH. And while the business environment reforms are being implemented, the pace of these reforms has been slow. There' is much more that needs to be done in this respect in the coming years. The European Union accounted for approximately 90% of exports in 2008, where the World Bank and other agencies have predicted negative growth for The analysis looked at publicly listed companies in Sarajevo and Banja Luka stock exchange for the period of Sample companies include state-owned enterprises, voucher-privatized enterprises and private companies. In total, data for 1008 companies from two stock exchanges in BiH were collected, 646 from BLSE exchange, and 362 from SASE. Out of this, 870 companies were officially listed and had their records for 2007 and 2008, while 750 companies were officially listed and had their records since The difference is caused by some companies de-listing, going bankrupt, new companies being added, etc. There are total of 698 SMEs with their records

13 Decreasing Credit, Exports and Imports in BiH I 3.0%, _._._.._ % 40% 2 0% 30% 1 5% 20% I f 1 0% 10% 0 5% 0 % 0 0% -10% -0 5% -20% -1 0% L -30% credit (prevous month) &exports -imports Banking Sector Background- Pre and post crisis 9. The financial system in BiH is dominated by the banking system. In 2008, banking systems assets amounted to about 8 1 % of the total financial sector assets. The development of BiH banking sector has been driven by privatization led by several large European banking groups, which bought banks in both entities. The privatization phase was followed by consolidation, as several European banking groups merged their BiH banks in the two entities and a number of small state-owned banks in the FBiH were closed. Foreign banks now account for over 95% of the total banking system assets and about 88.4% of its equity capital. Almost 60% of the foreign ownership is related to investors from Austria. Other large investors are from Germany and Italy, although investments are often made through their subsidiaries from Slovenia and Croatia. In the Federation, there are also investors from the Middle East countries. 10. Large and competitive foreign-owned banks have grown at a very rapid rate during the past four years, far faster than their smaller rivals, steadily increasing their market share. The five largest banks now account for well over two-thirds of total assets in the banking sector4 in both entities. Mergers among banks created opportunities for reducing administrative costs and improving coverage through larger branch networks. Competition and access to both know-how and funding of large parent banks has had positive effects on access to finance for both the enterprise sector and the population. The availability and diversity of financial services and loan products in BiH is now similar to that of the new EU member states. 11. As of June 2009, there were 20 banks licensed in the Federation (and additional two banks with a temporary banking license) and 10 in RS, although a number of banks in the two entities actually belong to the same international banking groups. The market is well 4 The largest banking groups by total assets include: Unicredit/HVB through the merger of HVB Central Profit Banka, Unicredit Zagrebacka Banka and Nova Banjalucka Banka; Raiffeisen Bank; Hypo Alpe-Adria-Bank (HAAB) Group created by merging HAAB from Mostar and HAAB in RS; Nova Ljubljanska Banka Group created by merging CBS Banka, Tuzlanska Banka, Razvojna Banka Jugoistocne Evrope and LHB Banka; and Intesa-UP1 Bank. 12

14 covered by branch offices: Federation-licensed banks have 658 branch offices (of which 58 in RS) and RS-licensed banks 441 (of which 59 are in the Federation). 12. Similar to many other countries in the region, BiH experienced rapid financial deepening and a credit boom in recent years. Although this started later than with its regional peers, BiH has caught up quickly with regional trends, both in terms of assets and credit growth. Assets increased from BAM 9.4 billion at end-2004 to BAM 19.5 billion at end-2007, showing a growth trend in the range of 2530% per year. Real credit growth averaged well over 20% from 2001 to 2007, during which time the credit to GDP ratio more than doubled. Reported average profitability of BiH banks has normally been around 051% for return on assets (ROA) and around 6-lO% for return on equity (ROE), but there were significant differences between larger and smaller banks, as well as between banks licensed in the Federation versus RS. ROE of largest international banks subsidiaries has normally been in the range of 15-20%. On the other hand, most small banks active locally had ROE of around 5%, and some were barely able to stay with positive returns. 13. The increased demand for credit from enterprises and households was driven by favorable macroeconomic conditions, including substantial economic growth, low inflation and wage growth. Interest rates in both entities were freely determined and subject to strong competition. In general, the interest rate levels were significantly lower than in the regional economies in BiH neighborhood (e.g., Croatia, Serbia). Beyond competition, this could be explained by the smaller cost of compliance to prudential regulations imposed by the regulatory authorities in BiH. In general, interest rates for households were basis points higher than the rates for the enterprise sector. 13

15 Average Interest Rates5 on Loans to Private Enterprises and Cooperatives,%ages Short (ST) and Long Term (LT) " " -Interest Rates on KM Loans ST -interest Ratcs on KM Loans LT - interest Ratcs on KM loans indexed to EUR ST -Interest Rates on KM loans indexed to EUR2 IT - fntercst Rates on EUR Loans ST - Interest Rates on EUR Loans LT, ' 14. Assets and credit growth began to reverse in September 2008, due to the impact of international financial and economic crisis. Overall, banking sector assets grew by approximately 9.2% from December 2007 to September However, reflecting the reversal in asset growth in the last quarter, overall annual asset growth in 2008 was approximately 7.6%. The trends in the two banking systems had stabilized in the first quarter of 2009, with total assets remaining at the end-2008 level in the Federation and reduced by 3% in RS. Capital increase in 2008 was at the level of about 8%, much smaller than in earlier years. In the first quarter of 2009, total capital in the Federation increased by about one% to about BAM 1 billion; in RS, the total capital remained at the end-2008 level of BAM 597 million. The effects of financial crises on key banking sector risk and performance indicators are shown in the table below Capital Adequacy Profitability Liquidity Risk-weighted CAR Tier 1 capital to risk-weighted assets Return on assets Return on equity Net interest income to total income Net interest expense to total income Liquid assets to total assets Liquid assets to ST liabilities The interest rate levels show averages of interest rates extended by commercial banks, on annual basis. The base for calculation of the weighted average are amounts of loans which were, with associated interest rates, realized in the respective month. 14

16 Asset Quality Forex Risk ST liabilities to total liabilities NPL to total loans NPA to total assets Forex and indexed loans to total loans Forex liabilities to total liabilities Net open position o After years of over 20% credit growth, it slowed-down in the last quarter of As of end-march 2009 credit remained at the end-2008 level in RS, and decreased by about one% in the Federation. There were practically no changes in the credit volume as of mid It is not yet clear if and when the credit growth trends would change, but the change will be significantly affected by the ease and quality of funding available to banks. On the positive side, as indicated in Table 1, changes in the reported quality of credit portfolio were not dramatic: in the Federation, credits classified as substandard and doubtful accounted for 2.9% of the total portfolio as of end-march 2009 (2.4 as of end-2008); in RS, the ratio was 3% for both. Credit quality in BiH is substantially better than for the peer countries in the region. 16. Liquidity in the system has also declined due to a drop in banking sector deposits. Overall, deposit levels fell by about 8.3% from September to December 2008, driven primarily by a slow-down in remittance transfers and negative rumors from abroad. The level of deposit withdrawals was uneven, affecting some banks more than others. As remittances continue to fall and the economy remains under pressure, deposit withdrawals are expected to continue, albeit at a slower pace. In the Federation, deposits remained the same as of end- March 2009, while in RS the level has dropped by additional 5%. However, with high levels of overall liquidity, the banks have been able to withstand the pressure to date and liquidity ratios of most banks continue to be significantly higher than the minimum level set by banking regulatiom6 17. As much of the recent growth in credit was driven by subsidiaries borrowing from parent banks, the fact that the financial crisis and the resulting global liquidity squeeze have effectively blocked external borrowing for banks in most financial markets is of concern. Most internationally active EU banks, which dominate the banking sector in BiH, are in the process of re-building capital and liquidity in their home markets. Many of these banks are decreasing their emerging market exposure, and could call upon subsidiaries for dividend payments, reduce credit lines, or in the worst case, prematurely call in the existing credit lines. Another trend was to increase the cost of funding to subsidiaries, although there are significant differences among banks. ti The Central Bank of BiH tried to help increase banks liquidity by reducing reserve requirements from 18 to 14% for demand deposits and 10% for tem deposits. 15

17 Short Term Funding Trends 900,000, - Short-term - correspondent =counts of 400,000 nonresident banks 300,000 - short-term deposits and credits from nonresident s3 - Other 0 Long Term Funding Trends ~- - I 1 - Long-term liabilitles - Ions-term time deposits of nonresidents 4, t I lonp-term credits from nonresidents - Other 18. Funding has become an increasing challenge since the on-set of the crisis. As illustrated in Chart 1, short-term liabilities have decreased by about BAM 340 million from their peak in July The total short-term commercial bank deposits dropped almost BAM 800 million (12%) since their peak in summer of 2008, and enterprise short-term deposits dropped by 13%. Long-term liabilities have grown until November 2008, and remain at about the same level. On the other hand, the portfolio of long-term deposits dropped by about BAM 440 million (or 7%) from their peak last year, almost entirely due to drops in long-term deposits of various government institutions and (to a lesser degree) households. With much of the enterprise sector already facing worsening operating conditions, this combination of events has led to more difficult access to short term and long term credit available to enterprises. On the positive side, the reduction of reserve requirements from 18 to 10% has increased the share of funds that can be lent, as well as has reduced the cost of lending. 19. With much of the enterprise sector already facing worsening operating conditions, this combination of events has led to decreased short term and long term credit available to enterprises. Since August 2008, credit has become more difficult to obtain, maturities have 16

18 become shorter and costs have increased, as the banks have faced problems with deposit structure and stability as well as with access to funding sources. Background on the SME Sector - Pre andpost crisis 20. The enterprise sector is growing as a share of the economy but many firms operate below potential. The private sector contribution to GDP is estimated at 50% in BiH. Infusion of new investor funding in the sector coupled with corporate restructuring is key for future BiH's growth, but structural reforms in this area have been delayed. 21. With concessional funding to BiH on decline, future capital sources for investment will remain scarce. Financial intermediation with the real sector is not very high, while FDI levels remain one of the lowest in the region. The situation is compounded by a negative trade balance, with imports continuing to outstrip exports, and high levels of foreign and domestic debt. Although there is a movement in "green-field" private sector enterprises, these are mainly micro and small enterprises. 22. The enterprise sector has been an important source of job creation and increased productivity in BiH. In particular, growth of SMEs is seen as a potential source of economic growth in BiH. Encouraging this growth has been a priority for the government which recently introduced a number of business environment reforms to promote SME development. However, comparative studies have demonstrated that BiH still lags behind other countries in the South Eastern and Central Europe in creating and sustaining SMEs. With less than 10 SMEs per 1,000 inhabitants, small and medium enterprises represent an untapped source of growth in BiH. Number of SMEs per 1,000 inhabitants in SEE and CEE Number of SMEs per 1,000 inhabitants Source: European Bank for Reconstruction and Development (EBRD) 23. Prior to the crisis, in the period SME companies in the sample improved their performance7. Sales increased by about 40%, while profitability increased two-fold. Accounts receivable increased by about 25%, while accounts payable - by about 40%. Companies were collecting sales revenues faster and paying suppliers slower (through the second half of 2008). Current asset ratio remained steady at 1.2, and companies were in a better financial situation in 2008, compared to previous years. Assets were growing steadily ' This section is based on the data provided by a recently completed Investment Climate Assessment (ICA) for BiH. 17

19 and interest expense remained stable, with notable increase in Gross salaries grew, while the number of employees was reduced. Companies started to undertake certain restructuring measures to improve their performance. Leverage increased from 23% to 30%, but was not a major threat yet, as there was no immediate liquidity problem. With secured access to finance and increasing consumption and exports, BiH companies were looking at further improvements in their performance. 24. In the context of the global economic crisis, decreased private consumption and limited exports have created an extremely difficult operational environment for almost all firms in BiH. However, the deterioration in access to finance is impacting SMEs more than other borrowers, as they traditionally can offer the least collateral to secure a loan. If this trend were to continue, the loss of access to finance would exacerbate the ability of BiH to maintain the recent growth pattern. In addition to securing financing, SMEs will also need to ensure that they are able to reorient their operations to deal with the changing economic situation by, for example, focusing on new markets or modifying their products. 25. Beginning in 2008, companies started to experience liquidity problems due to interest expenses increase, payment terms deterioration, and drop in their liquid assets. In addition, exports have shrunk and domestic consumption has fallen. Under these circumstances, working capital, even for short-term needs, has become a serious constraint for regular business operations. B. Rationale for Bank involvement 26. The rationale for the proposed project is to help address difficulties with SME access to term finance, which was identified as one of the major impediments to growth in the enterprise sector. While a number of barriers to growth and competitiveness enhancement of the enterprise sector existed prior to the current global financial crisis, the crisis has put access to finance issue as a key vulnerability for the economic future of BiH. 27. The reduced availability of external financing and remittances is likely to affect banks liquidity, profitability, and ability to extend new credits. As banks rollover or re-financing risks have been substantially magnified in the past months, and access to parent-bank or external funding becomes very difficult, banks are likely to become averse to any sort of maturity mismatches and to significantly reduce lending, especially towards SME borrowers, who traditionally can offer the least collateral to secure a loan. Thus, it is imperative that the Bank be promptly involved in addressing the shortage of medium term funding sources and stagnation in capital flows by making available additional medium and long-term funding to ensure sustained development of enterprise sector, and SMEs in particular. While other sources are possible, the Bank can provide support on a systemic level more effectively, and in the broader context would help to also address other shortcomings that may negatively affect growth perspectives. C. Higher level objectives to which the project contributes 18

20 28. The BiH authorities Medium-Term Development Strategy (MTDS) for stipulated three main policy goals: creation of conditions for sustainable and balanced economic development, reduction of poverty by 20%, and acceleration of EU integration. The Government is preparing a new medium-term Country Development Strategy (MCDS), which was delayed by local elections and cumbersome consultation processes at State and Entity levels, but should be completed by the end of Strengthening the competitiveness of the economy and increasing the employment rate comprise two of the six strategic objectives that have been identified. The Country Partnership Strategy (CPS) for the period FY08-FYI 1 supports the country s priorities by focusing on improving the environment for private-sector-led growth and convergence with Europe as one of its two key pillars. The CPS Progress Report (April 15, 2009) underscored negative impact of the global financial crisis on the enterprise sector, exports in particular, and pointed to the stagnation of capital flows. 29. Bosnian authorities are taking actions to mitigate the impact of the financial crisis, including the recently completed negotiations of a Stand-By Agreement with the IMF. They have also requested the World Bank s support in increasing credit to the private sector. The proposed project is designed to address one of the key targets under the first pillar of the CPS - expand business activity and increase economic opportunities - through stimulating SME development and access to finance in the context of the global financial crisis. By making medium term finance available through local banks, SMEs can maintain their current level of activities and invest in new technology and capacity so as to encourage, inter alia, job expansion and strengthening of market position. 11. PROJECT DESCRIPTION A. Lending Instrument 30. The proposed lending instrument is a Financial Intermediary Loan (FIL). The FIL will be a Variable Spread Loan (VSL) in the amount of EUR 47.8 million (US$70 million equivalent). 31. The IBRD loan will be extended to the Ministry of Finance (MoF) of B&H which will make the respective portions of the loan proceeds available to the MoF of the Federation and the MoF of Republika Srpska through Subsidiary Loan Agreements. The two MoFs will sign Project Agreements with the IBRD and, in turn, enter into Project Implementation Agreements with corresponding Project Implementation Units (OdRaz Foundation in the Federation and the Investment Development Bank of the Republika Srpska). The PIUs will, in turn, enter into Subsidiary Financing Agreement with each pre-qualified eligible Participating Financial Intermediaries (PFIs). The terms and conditions of all the abovementioned legal agreements should be acceptable to the Bank. 32. The BiH MoF (the Borrower) shall make part of the proceeds of the Loan available to the Federation and Republika Srpska under a Subsidiary Loan Agreement between the Borrower and the Federation ( Federation Subsidiary Loan Agreement ), and the Borrower and Republika Srpska ( RS Subsidiary Loan Agreement ), under the same terms and conditions 19

21 as the Loan, approved by the Bank and including the Anti-Corruption Guidelines, for onlending by the Federation and Republika Srpska to its Participating Financial Institutions through their corresponding PIUs. 33. The Borrower shall exercise its rights under the Subsidiary Loan Agreements in such manner as to protect the interests of the Borrower and the Bank and to accomplish the purposes of the Loan. Except as the Bank shall otherwise agree, the Borrower shall not assign, amend, abrogate or waive the Subsidiary Loan Agreements or any provision thereof. B. Project Development Objectives and Key Indicators 34. Although there are long term structural issues that need to be addressed to improve the business environment and competitiveness of the enterprise sector, the current global financial instability implies a focus on dealing with the access to term finance, as the most critical short-term vulnerability for the SME sector. 35. The project development objective is to enhance access to finance for small and medium enterprises in Bosnia and Herzegovina in the context of global financial crisis. Primary beneficiaries of the project would be small and medium enterprises contributing to growth of regional economy and export, which would benefit from improved access to finance. The project would also help the banking sector in Bosnia to withstand the global economic downturn that has triggered financing difficulties for the enterprise sector. 36. The outcomes of the project will be measured by three groups of key indicators: (i) number of loans and the amount of medium and long-term credit extended to SMEs in BiH, including exporters, (ii) the payment performance of the sub-borrowers in the project - the number and volume of non-performing sub-loans, and (iii) the investment and export performance of the sub-borrowers, and the impact on their employment level. Performance indicators of SMEs - final beneficiaries would be monitored throughout the project to offer lessons which may be helpful in designing future crisis response schemes for SMEs in Bosnia and elsewhere. C. Project Description 37. The project consists of the following two components: (i) Credit Line Component; and (ii) Project Management and Monitoring Component. Credit Line Component 38. The Credit Line (CL) component will include funding of EUR 46,972,200 to be extended through PFIs to creditworthy private enterprises for viable projects. The eligible financing will cover investments and/or incremental working capital in industry, agro-processing and the related service sectors. Loan funds will be on-lent by the Entities' MoFs via their respective PIUs to participating financial institutions (PFIs). The sub-loans to PFIs will be extended back-to-back to PFIs' loans to final borrowers and under the similar terms and conditions. The decision to extend a sub-loan to final borrowers will be left to PFIs. The PFIs will bear the full credit risk. The credit decisions would be based on thorough financial 20

22 appraisal of borrower s financial condition and prospects. The sub-loans would be available in EUR or in BAM referenced to EUR. 39. Subsidiary financing to PFIs will be extended on a variable interest rate basis adjusted semi-annually. Interest rates will be market determined, based on preceding six-months LIBOR rates plus a spread for a selected IBRD loan product. The entities Ministries of Finance will add a spread needed to cover the cost of project implementation and the related risks which will be reflected in Subsidiary Financing Agreements with PFIs. The spread will be reviewed, from time-to-time, and could be adjusted in line with market dynamics. 40. PFIs will determine the principal, amortization and interest payment schedules for subloans to final borrowers on a case-by-case basis, based on cash-flow projections. PFI subloans to final borrowers will be extended at domestic credit market rates, and will include a PFI spread sufficient to accommodate the associated credit risk. Sub-loan service payments by borrowers to PFIs would generally be made according to typical repayment schedules used by the respective PFI. There will be no sub-loan prepayment penalties, and interest will be charged on a declining balance formula. 41. SME Eligibility. The final beneficiaries must be privately owned and duly licensed and registered with the tax authorities. They should be active in manufacturing, food production or agro-processing, or in related services. Enterprises will be required to demonstrate prior operating experience in the activity to be financed and should be in a sound financial condition. The creditworthiness of final borrowers will be assessed by the PFIs. The final borrowers will also have to comply with the environmental requirements described in Annex Eligibility of Projects. Sub-loans would finance investments, repair or modernization, and/or incremental working capital. Sub-loans proceeds could be used for the equipment and raw materials, repairs to facilities and only minor construction. Each credit application would be accompanied by a viable business plan, financial statements before and after the project, and cash-flow projections. Further details are provided in Annex Eligibility of PFIs. Interested PFIs will be able to participate if they are able to meet eligibility criteria, as required by Bank s OP To be eligible, a bank should be licensed and at least two years in operations; be in good standing with the respective Banking Agency (ie., meet all pertinent prudential and other applicable laws and regulations) and remain in compliance; maintain at least the minimum capital and the risk-based capital adequacy of at least 12%; maintain adequate liquidity; classify its assets and off-balance sheet credit risk exposures and make adequate provisions; be profitable and maintain the value of its capital. It must have qualified and experienced management (i.e., adequate governance), well defined policies and written procedures for management of all financial risks, adequate internal audits and controls and management information systems. More details on PFI eligibility and the selection process is provided in Annex In accordance with the BiH MoFTER s definition, SME is an enterprise which employs fewer than 250 persons and which has an annual turnover not exceeding EUR 50 million, and/or its annual balance sheet does not exceed EUR 43 million. 9 Private ownership should be more than 50% 21

23 Project Management and Monitoring Component 44. The component in the amount of EUR 408,300 would finance costs of the project management and monitoring, including financial management, audits, procurement, environmental compliance supervision and other activities related to a project management and coordination in the Federation of Bosnia & Herzegovina. As regards to the project management and monitoring in Republika Srpska, the RS MoF decided that the cost related to administration, management and supervision of the credit line component will be financed by setting an interest margin to be charged on the funds provided to PFIs. D. Lessons learned and reflected in the project design 45. The project reflects lessons learned from recent analytical work on SME development which indicated that the SMEs are more seriously affected by business environment constraints than are larger firms; have less access to credit (finance constraints); and have less access to information, advisory services, technology and innovation (knowledge constraints) lo. Given the spill-over from the current economic crises in the EU, the quality of SME access to finance has worsened. Without focused support during a crisis period, real sector economic activity by SMEs would significantly contract. And this will have serious consequences for employment and income of major segments of the population. Taking these lessons into account, the project proposes to help mitigate access to finance constraints by providing a credit line specifically targeting SMEs. 46. The project has also benefited from lessons learned from other credit line financing operations in ECA and other regions (e.g., Ukraine, Bosnia, Poland, Turkey, India). Specifically, a lesson learned from previous credit lines is that implementation problems have stemmed mainly from weak borrower accountability and management capacity, lack of clearly defined and transparent indicators for monitoring of the financial performance of concerned financial intermediaries, as well as poor monitoring of the overall project impact, inadequate demand from ultimate beneficiaries and lack of bankable sub-projects, and inflexibilities in project design that make it difficult to adjust design to reflect changing ground realities. 47. The proposed project design and implementation plan tackles each of the perceived and real issues upfront: (i) the PIU has been assigned clear responsibilities for project implementation; (ii) the financial intermediation capacity of interested banks has been independently evaluated and the banks identified that are able to implement the operation (see Annex 6); (iii) the credit line facilities have been available for both investment as well as working capital financing, thus increasing flexibility; (iv) the team has defined clear project performance indicators; (v) the pricing of SME loans has been left to the PFIs, based on their assessment of on-lending risks; and (vi) a majority of banks in country have expressed strong demand for medium term credit". In addition, the success of the credit lines has been lo For an overview of constraints facing SMEs, see IFC "SME Strategy," With respect to demand, during project pre-appraisal, the World Bank team estimated that the total financing demand by banks under the proposed credit line would exceed US$300 million, based upon preliminary indications of interest expressed by most banks in country. 22

24 achieved through comprehensive project supervision and monitoring throughout the life of the project. E. Alternatives considered and reasons for rejection 48. The proposed project design was chosen based on lessons learned from successful projects, the needs of the enterprise sector, and the Bank s internal assessment of the best mechanism to place these funds in a Bosnian context. The proposed design, focused on providing funding to banks with demonstrated competency and capacity in corporate lending, stems from discussions that the World Bank team had with the Central Bank, Banking Agencies of both entities, the Ministries of Finance, IFIs, banks and business membership organizations. 49. There was an option not to support the Government s efforts related to the financial crisis. Nevertheless, it was decided to proceed with the current operation to confirm the Bank s commitment to the authorities to support reforms of the enterprise and banking sectors, to stimulate growth and to provide technical assistance, if and where needed. Private sector and banking sector sustainable growth are critical to the development of Bosnia and Herzegovina, which in turn may play a critical role for the continuing peace in the region. 50. The alternative of facilitating private sector access to term finance through guarantees, or similar instruments, was also rejected. Guarantees are useful as a credit enhancement tool when funding is available but collateralhepayment guarantees are insufficient. This approach would not have allowed Bank s active assistance to the banking sector and the involvement with the Banking Agencies. For private sector growth, banks must become capable of providing a range of cost-effective services needed by private enterprises. It is also critical to maintain the public confidence in banks, and maintain capacity for resource mobilization. At this point, due to increasing difficulties in access to funding, the lack of access to finance cannot be effectively addressed through guarantees or similar Bank instruments The option of having a separate lending window for Microcredit Organizations (MCOs) was also considered, and was initially included in the project concept note, but was eventually rejected. The MCOs in Bosnia have been the main funding source for micro enterprises and a key factor supporting regional growth and employment creation. Bosnian MCOs expanded and grew tremendously in the last few years: as of September 2008, total assets of the largest MCOs were KM 1.16 billion. However, with the current liquidity squeeze they started to experience problems in securing access to external sources of funding required to at least maintain the existing level of lending to microenterprises and entrepreneurs. While recognizing importance of raising adequate external funds for MCOs, the team decided against including them in the project. It was viewed that the available loan amount would not be sufficient to effectively address the existing demand for external financing from the banking sector and MCOs, to make a meaningful impact on lending to SMEs and microenterprises. The opportunities for cooperation with other donors were also explored, and it was concluded that the IFC and EBRD current and planned equity investments and credit lines to some of the MCOs would complement the Bank s efforts in providing additional funds to the banking sector. 23

25 52. There was also an option to include a matching grant component to facilitate SME access to external expertise, based on the accumulated experience of the World Bank projects with the matching grants facilities. Nevertheless, given the final loan amount, significant added complexity of the project implementation, and existing similar programs funded by other donors (USAID and EBRD), the decision was made not to include this component into the project IMPLEMENTATION A. Partnership Arrangements 53. The project was designed in close cooperation with the BiH, FBiH and RS ministries of finance and the BiH Central Bank. The Central Bank provided statistical data and analysis on demand throughout the project preparation period; the data available through the Central Bank s Central Credit Registry will be used to improve and strengthen M&E process. The BiH Employers Association and the Foreign Trade Chamber were consulted in the project design and will remain involved both in the promotion of the project and in the monitoring of its effects. 54. During project development, intensive consultation and coordination efforts were made to improve targeting and minimize overlap with ongoing and planned operations of international financial and aid organizations. In close communication with EBRD and IFC, which have substantial portfolios of loans and equity investments in large enterprises and MCOs, the team opted to focus the project on the small and medium enterprises, where the substantial demand for credit lines is not fully met yet, and invited participation of interested qualifying banks. With IFC s regional microfinance facility about to become active and EBRD and KfW continuing to focus on support to microfinance institutions, it became obvious that the project s resources would not contribute significantly to improving the MCO s position and the sole focus on SMEs would considerably simplify the project design and implementation. Two new US AID projects, targeting agribusiness and several industrial sectors, will come on-stream in the fall and they will offer participating companies technical assistance which can usefully complement the kinds of interventions the project aims to support. 55. The Japanese PHRD grant was used to support the project preparation, particularly to analyze the current situation in the real sector enhance the capacity of the PIUs and assess demand and possible options for implementing the matching grants component. B. Institutional and implementation arrangements 56. The project will be implemented by two Project Implementation Units (PIU), one in the Federation (FBiH) and the other one in the RS. OdRaz Foundation will become the PIU for the Federation. The RS Investment Development Bank (RSIDB) will become the PIU of Republika Srpska. Both PIUs will utilize the Operational Manual (OM) and Financial Management Manual (FMM) developed for the project. The OM and FMM will be the same for both entities. Further details on implementation arrangements and the PIUs are provided in Annex 6. 24

26 57. The key functions of the two PIUs will include financing PFI sub-loans to final beneficiaries; maintaining the Special Project Accounts, arranging disbursements and collecting interest and principal repayments from the PFIs; monitoring and administering the use of resources, and the PFI compliance with terms and conditions of their Subsidiary Financing Agreements; preparing, in a format acceptable to the Bank, semi-annually written progress reports and making arrangements for external audits of the project related accounts and records. More detailed description is provided in Annex As the OdRaz and RSIDB would be the implementing units of the project, they will have full responsibility for all aspects of project implementation; including financial management. In order to improve the financial management capacity of the project, it was recommended that OdRaz Foundation upgrade its accounting software. 59. The PFIs responsibilities will include promotion and building of the project pipeline; appraisal of the sub-project to be financed and of the creditworthiness and financial condition of the potential borrowers; assisting borrowers in the application of efficient procurement practices; performing an environmental review of sub-loan requests which incorporates the procedures described in the Environmental Safeguard Review Framework; making sub-loan related payments in a timely manner against appropriate documents (to evidence use of funds, procurement aspects) and ensuring that payments of interest and principal to the PIUs are made as due; preparing annual external audits and keeping all necessary records and payment evidence, as specified in legal documents; and providing periodic reports to the respective PIUs. C. Monitoring and evaluation of outcomes/results 60. The PFI related monitoring functions will include: (i) a-priori review and clearance of PFIs' appraisals of eligibility and creditworthiness of final borrowers for subprojects above the free limit and of the first three presented by a newly qualified PFI; (ii) review on a sampling basis of subprojects below the free limit; (iii) a-priori clearance of minimum three procurements under the commercial practices for each new PFI; (iv) supervision of all other commercial practice procurements on a sampling basis; (v) supervision of subprojects on a sampling basis during subproject implementation; (vi) collecting information needed for monitoring that the qualified banks continue to meet the qualification criteria. 61. The Bank will evaluate progress on the proposed outcome indicators as part of supervision missions and through regular project related reporting by the PIUs. The PIUs will conduct quarterly activities' reviews and produce semi-annual reports to the Bank, as mandated by IFRs, based on information collected by the PIU and from regular reports provided by the PFIs to the PIU. The PIUs will also submit detailed annual reports including all output and all agreed outcome indicators. D. Sustainability 62. Project benefits are expected to be sustainable. For the private sector subprojects, sustainability will be addressed through appraisal of creditworthiness of individual private sector borrowers and of financial viability of subprojects. Clients who are not creditworthy 25

27 and subprojects which are not financially viable will not be financed. Sustainability of the revolving credit line beyond the first sub-loan cycle will depend on timely and full repayment of sub-loans by borrowers and participating banks, which would be achieved through close supervision and follow-up by the PIUs. The biggest threat to sustainability of subproject benefits would be the deterioration of regional stability. 63. The PFIs will be selected based on their interest, their financial condition and capital adequacy, their risk management capacity and overall institutional readiness. From such a starting point, facilitating access to funding during project implementation and the availability of technical assistance, if needed, are expected to result in improved clients confidence and safer banking institutions. Sustainability of advances to be accomplished by participating banks seems good, for as long as the political situation remains stable and the Government remains committed to market reforms. E. Critical risks and possible controversial aspects 64. Risks and related mitigation measures to address such risks are summarized below. After mitigation, the overall risk is assessed as moderate. Risk factors Financial Sector Risks Technical Design Implementation Capacity And Sustainability Description of Risk Financial condition of banks may deteriorate due to international financial crises. Deposits may fall. due to falling remittances and/or confidence issues. Banking system is owned by well recognized foreign banks. Banks are generally well capitalized and profitable, albeit with significant differences across banks. Economic slowdown: Developments in the local and global economy may reduce the SME credit demand. Implementation arrangements will include two project implementation units (PIUs), one for the Federation and one for Republika Srpska. The PIUs would: (i) assist with PFIs qualification; (ii) review and approve loans; (iii) disburse Bank sub-loans; (iv) supervise sub-loan utilization and subproject implementation; (v) collect sub-loan repayments from PFIs; (vi) maintain Bank loan related accounts; (vii) prepare financial management and project implementation related reports as requested by the Bank; and (viii) assist in Bank s Mitigation measures The impact of tightening international liquidity conditions would mostly come through banks inability to borrow from abroad to fund lending. This will impact bank liquidity, earnings and banks ability to extend new credits. Bank project will address this lack of funding. The SME demand for medium term financing appears to be high. An economic slowdown might affect the demand. To facilitate project implementation, Bank funding will be made available on the first-come7 first served basis. The selected PIUs are familiar with Bank requirements as there were prior Bank projects in both entities administered by the same PIUs. Both are staffed by experienced officers familiar with bank policies and requirements. Nevertheless, needed training and capacity building will be organized before effectiveness. Rating of Risk after Mitigation Moderate Moderate Moderate 26

28 Financial Management triggered in regards to the PIU implementation capacity, as related to World Bank fiduciary and safeguard requirements. Despite well-documented familiarity with World bank procedures and previous experience, Banks may be unfamiliar with certain aspects of WB procedures. Moderate Procurement Social And Environmental Safeguards Overall Risk The proposed sub-loan sizes (EUR million) would generally not trigger mandatory international bidding on the presumption that there may be more than a single contract. Nevertheless, a low risk exists of issues relating to the use of commercial practices and ensuring that these are acceptable to the Bank. As the sub-projects are not yet known, there is a possibility of negative environmental impacts, although the risk is relatively low because no new construction involving land acquisition and/or resettlement will be financed. transactions. An assessment of the commercial practices used in Bosnia and Herzegovina and their description in the POM will be used to ensure compatibility with Bank practices. Additionally, during preparation, based on the commercial practices, a threshold will be established (per contract) above which International Competitive Bidding will be made mandatory and thus, in accordance with the Guidelines. The project has been assigned Environmental Category (FI), and an Environmental Safeguard Review Framework document acceptable to the World Bank was prepared and disclosed by the Borrower. This framework includes screening of sub-projects to exclude sub- projects which would entail significant environmental risk or involve land acquisition and/or resettlement. Low Low Moderate 65. Another set of risks that has received close attention and that has been addressed in the project design is the risk of adverse selection that can materialize in two forms: (i) as adverse selection of intermediaries (i.e., banks that are not adequately capitalized and in sound financial condition, which are more likely to make adverse selection of final beneficiaries and which will not be able to service sub-loans in arrears); and (ii) adverse selection of final beneficiaries (i.e., extending loans to businesses that are not viable and/or for subprojects that are not financially sound). Both risks have been specifically addressed. 66. A due process has been established to ensure that only sound banks will be allowed to participate. PFIs will be accepted for participation based on strict eligibility criteria. PFIs will be re-appraised annually and subject to continuous scrutiny by the supervisory authorities, which are expected to report on problems experienced by participating banks. PFIs that stop meeting the eligibility criteria will be disqualified. 27

29 67. There are also criteria that address the risk of adverse selection of final beneficiaries. The eligibility criteria for beneficiaries specifically require that the beneficiaries are in sound financial condition and that the subprojects are financially viable. The due process of subloan appraisal is described in the Operations Manual and includes full appraisal of final borrowers' financial condition, their market position, sources of competitiveness and their business and growth plans. The PFIs are expected to appraise each final borrower and subproject. A due process has also been established to ensure that the appraisal actually takes place and that it is sound. The PIUs has been charged with responsibility to ensure that the PFIs have done a solid quality appraisal and to check the key parameters. All initial subprojects and all larger subprojects will also be reviewed by the Bank. 68. Adequate mitigation measures are incorporated in the project, and the Bank staff will closely monitor performance during implementation. Specific procedures are developed by the project to secure proper financial accountability of this project and to minimize project financial management risks. Additional financial management arrangements in the project will include the audit of project financial statements in OdRaz Foundation and RSIDB and RSIDB entity financial statements by independent auditor acceptable to the Bank, and on the terms of reference acceptable to the Bank. F. Loadcredit conditions and covenants 69. Effectiveness Conditions: A Project Agreement has been executed on behalf of the Bank and an Entity on terms and conditions satisfactory to the Bank; For the Entity referred to in paragraph (a) of this Section 5.01 of the Loan Agreement, a Subsidiary Loan Agreement has been executed on behalf of the Borrower and the Entity concerned, on terms and conditions satisfactory to the Bank; For the Entity referred to in paragraph (a) of this Section 5.01 of the Loan Agreement, a Project Implementation Agreement has been executed on behalf of said Entity and the PIU concerned, on terms and conditions satisfactory to the Bank; The PIUs have each established accounting and reporting mechanisms satisfactory to the Bank; The PIUs have each identified at least two (2) qualified PFIs and submitted to the Bank the related draft Subsidiary Financing Agreements, on terms and conditions satisfactory to the Bank; and The Entities have adopted the Operational Manual in form and substance satisfactory to the Bank. 28

30 70. Covenants applicable to project implementation. 0 The Project shall be implemented under the overall responsibility of the Federation PIU in the Federation, and the RS PIU in RS. To this end, the Borrower shall cause the Entities to each enter into a Project Implementation Agreement with their respective PIU, on terms and conditions satisfactory to the Bank and setting forth, inter alia, the respective PIUs responsibilities for Project management, implementation and monitoring, including the provision of Subsidiary Financings to their respective PFIs, reporting, disbursement, procurement and financial management arrangements. The Borrower shall cause the Entities to each maintain their respective PIU at all times during Project implementation with terms of reference and resources satisfactory to the Bank, and with competent staff in adequate numbers. 0 The Borrower shall, and shall cause the Entities, through their respective PIU, to: (a) duly perform all obligations under the Operational Manual and the Environmental Safeguard Review Framework in a timely manner and in accordance with their respective terms, and apply and implement, as the case may be, the actions, criteria, policies, procedures and arrangements therein set forth; and (b) not amend or waive, or permit to be amended or waived the Operational Manual or the Environmental Safeguard Review Framework or any provisions of any one thereof, except with the prior written approval of the Bank. 0 The Borrower shall, and shall cause the Entities, through their respective PIU and PFIs, to ensure that no land acquisition or resettlement shall be required under the Project. To facilitate the carrying out and financing of Part 1 of the Project, the Borrower shall make the amount of twenty eight million six hundred eighty thousand Euros (EUR 28,680,000) out of the proceeds of the Loan available to the Federation under a subsidiary loan agreement between the Borrower and the Federation ( Federation Subsidiary Loan Agreement ), under the same terms and conditions as the Loan, approved by the Bank and including the Anti-Corruption Guidelines, for on-lending by the Federation to its Participating Financial Institutions on terms and conditions set forth in Part C of this Section I. To facilitate the carrying out and financing of Part 2 of the Project, the Borrower shall make the amount of nineteen million one hundred twenty thousand Euros (EUR 19,120,000) out of the proceeds of the Loan available to Republika Srpska under a subsidiary loan agreement between the Borrower and Republika Srpska ( RS Subsidiary Loan Agreement ), under the same terms and conditions as the Loan, approved by the Bank and including the Anti-Corruption Guidelines, for on-lending by RS to its Participating Financial Institutions on terms and conditions set forth in Part C of this Section I. The OdRaz Foundation and RSIDB will maintain a financial management system acceptable to the Bank. The project financial statements, including SOEs and DA Statements as well as RSIDB entity financial statements will be audited by independent auditors acceptable to the Bank and on terms of reference acceptable to the Bank. The annual audited financial statements and the audit report will be provided to the Bank within six months of the end of each fiscal year. The OdRaz 29

31 and RSIDB shall also prepare and furnish to the Bank not later than forty five (45) days after the end of each calendar semester, Interim Unaudited Financial Reports (IFRs) for the project covering the semester, in form and substance satisfactory to the Bank. IV. APPRAISAL SUMMARY A. Economic and Financial Analyses 71. Direct measures of the cost-benefit or cost-effectiveness are not applicable to the project itself. Sub-loans are expected to be subject to sound credit analysis at entry, including a' financial and economic rate of return. Financial analysis will be performed on a subproject by subproject basis. In case of significant macroeconomic distortions (which is currently not the case, as the market environment is liberal and the Currency Board is in place), the economic rate of return will also be calculated for each subproject to be financed. 72. Financial appraisal will be performed on a subproject-by-subproject basis as part of the appraisal of eligibility of individual final borrowers and subprojects. Financial soundness of subprojects will be based on financial analysis including: (i) financial rate of return; and (ii) incremental financial benefits and costs to the final beneficiary based on "with-subproject" and "without-subproject" analysis. Assumptions underlying financial benefits and forecasts (such as prices for key inputs and outputs, market outlooks for projections, or inflation) are specified in Operations Manual and will be reviewed and adjusted from time to time. To assess the risk, sensitivity analysis will be performed for each subproject, including sensitivity to exchange rate devaluation, to price decreases in the expected productlservices market and to increase in operating cost. Implementation risks will also be assessed for each subproject. 73. In addition, financial soundness will be assessed for each final beneficiary. This will include assessment of beneficiary's financial condition based on historical and projected financial statements, using financial ratio analysis and comparisons with relevant industry standards. It will also include assessment of his business plan and investment programs, assessment of market position and the sources of competitiveness and of stability in the respective market. In addition, there will also be an assessment of leverage offered to the bank, in terms of participation of the final borrower in the total cost of the project and if pledged collateral. 74. The analysis of financial soundness will be carried out for each PFI. Banks will be appraised on the basis of their risk-weighted capital adequacy, which should be minimum 12% of which at least half as Tier 1 capital. Banks' asset quality, including off-balance sheet exposures, will be reviewed regularly to ensure that the banks correctly classify their assets and that they make adequate provisions. Banks must have acceptable risk profile and positive profitability and they must maintain adequate liquidity. Appraisal of participating banks will be carried out each year to ensure that they continue to meet the participation criteria. OP 8.30 Compliance Review 30

32 75. The OP 8.30 review concluded that the project is compliant with the requirements of OP 8.30, related to objectives, coordination with the IFC, policy framework, on-lending rates, subsidies, eligibility criteria for PFI and use of Bank funds. There is no additional work envisagedheeded to make this project compliant with OP Project Objective. The principal objective of the project is to provide $70 million (equivalent) to enhance SME access to medium and long term finance in BiH. The project need arose as a result of the impact of the current financial crisis, which has created liquidity pressures at the same time as there is a demand for medium and long term funding. Most internationally active EU banks, which dominate the banking sector in BiH, are in the process of re-building capital and liquidity in their home markets. Many of these banks are decreasing their emerging market exposure and could call upon subsidiaries for dividend payments, reduced credit lines or prematurely call in existing credit lines. This has created a decrease in medium and long term credit for SME borrowers in particular who traditionally can offer the least collateral to secure a loan. The project s objectives, i,e., jnancing investment needs of real sector are consistent with OP Coordination with IFC. Both the Bank and IFC use lines of credits to help member countries achieve their development objectives, and the two institutions need to coordinate effectively on the use of LOCs to ensure that the appropriate Bank Group financing instrument is used. The task team has already initiated consultations with the relevant staff in the IFC. 78. Policy Framework. This aspect of OP 8.30 covers (a) macroeconomic environment; (b) financial sector framework; (c) interest rate regime in the country; (d) rationale for directed credit; and (e) justification for subsidy. 79. Macroeconomic Environment. A stable macroeconomic environment is critical for the success of a line of credit, as distorted or disturbed macroeconomic environment could undermine the realization of project objectives. There is currently global turmoil due to the international financial crisis. The external economic environment for developing countries has deteriorated markedly since The Project Appraisal Document notes that BiH is at risk from declining international liquidity. The project team has assessed the adequacy of BiH s macroeconomic environment and notes the risks inherent in the current situation. However, it also notes that the economy in general and the banking sector in particular are have remained generally resilient and that demand for medium term finance remains high at the same time there is a potential reduction of credit lines by parent banks and the shortening of maturities being offered to the corporate sector. Therefore, actions to ease liquidity and provide medium term funds such as the proposed loan make sense. Therefore, the updated assessment of BiH s macroeconomic environment and its adequacy for the project meets OP 8.30 requirements in this regard. 80. Financial Sector Framework. OP 8.30 requires that financial sector framework should be considered for a line of credit operation. This is necessary for two reasons. The prospects for the success of a line of credit operation are significantly stronger if the project uses strong and capable PFIs and such intermediaries are usually found in a competitive, liberalized, well-supervised, and reasonably strong financial sectors. Moreover, the state of the 31

33 development of the financial sector provides a basis for a decision supporting a directed credit program. A well-developed financial sector also contributes to the success of a directed credit program of the kind supported by the project. The PAD provides comments on the proactive steps taken by the authorities to maintain a healthyjkancial sector. 81. On Lending Rate. The level and structure of interest rates are critical determinants of the economic efficiency with which resources are allocated in an economy and of financial sector viability. OP 8.30 states that Bank funds are priced to be competitive with what the participating FIS and the sub borrowers would pay in the market for similar money, taking into account, as relevant, maturities, risks, and scarcity of capital. The PAD states that the on-lending rate will be on market terms. In this regard, the project is in compliance with this requirement of OP Subsidies. There is no subsidy envisaged in this project. 83. Eligibility Criteria for Financial Institutions. OP 8.30 requires an assurance that financial institutions acting as on-lenders are viable. The World Bank needs to ensure that the entity has the necessary capacity and knowledge to perform the assigned apex role, including especially the capacity to assess competence and creditworthiness of borrowers. The PSD provides details on eligibility criteria for the participating FIs and details on PFI assessments. (Full details are available in project files). 84. Use of Bank Funds. OP 8.30 requires that line of credits be used to finance investments in subprojects for increased production of goods and services. The project is in compliance with OP 8.30 in this regard. 85. Monitoring. OP 8.30 requires provisions to be made for the effective monitoring and evaluation of the project s progress towards its objectives and development impact throughout the life of the loan. The effective monitoring of the quality of the portfolio is detailed in the PAD. B. Technical 86. Technical analysis will be performed on a subproject-by -subproject basis. It will address technical, production and other relevant aspects specific for each subproject. 87. Provisions are included in the project to ensure that the lending rate charged by PFIs reflects the cost of intermediating funds, including an appropriate credit risk margin, as required by OP Moreover, the lending rate charged by PFIs will be subject to adjustment two times per annum to reflect market conditions then in effect. C. Fiduciary 88. The OdRaz and RSIDB will be responsible for the financial management (FM) function of the project including disbursements, flow of funds, budgeting, accounting, project designated accounts management, reporting, and auditing. 32

34 89. Fiduciary Risk at the Project Level. The FM arrangements of OdRaz and RSIDB have been reviewed during the financial management assessment conducted in July 2009 and have been found moderately satisfactory and meeting the Bank s minimum financial management requirements, particularly, (i) Internal Audit Department has been established in RSIDB; (ii) the project s designated account will be maintained in a commercial bank acceptable to the World Bank (iii) procedures for the flow of funds, monitoring and supervision of the participating commercial banks by the OdRaz and RSIDB would be documented in detail in the project financial management manual. 90. The overall financial management risk for the project before mitigation measures is substantial and after mitigation measures, the risk is moderate. 91. As the project will be implemented in an environment where corruption can be perceived as an important issue, adequate mitigation measures have been put in place and will be closely monitored to ensure that the residual project risk is acceptable, including: (a) a formal internal control framework described in the financial management manual; (b) the flow of funds mechanism agreed with the Borrower will be enforced; (c) the project financial statements and RSIDB financial statements will be audited by independent auditors and on terms of reference acceptable to the Bank; and (d) regular FM supervision and procurement prior and post reviews will be conducted to monitor and assess the corruption risk. D. Social 92. The project does not entail any social risks. The project will not involve job losses/relocations. On the contrary, the project will make entrepreneurial activities easier to pursue and will likely increase demand for labor in more competitive enterprises. 93. The project has been initiated the request of authorities of Bosnia and Herzegovina. Consultations with stakeholders, including other donors, business associations and think tanks, banking community have been held during the identification and preparation phases of the project. Consultations will continue on a regular basis during the implementation phase. E. Environment 94. In accordance with World Bank policy on Environmental Assessment (OP/BP 4.01) the project has been assigned Environmental Category FI, and an Environmental Safeguard Review Framework (hereafter Framework ) follows World Bank policies on consultations and disclosure. An English language version of the Framework was disclosed in the Infoshop on September 18, 2009 and a local language version was disclosed on the BiH MoF s website on September 18, 2009 and is available to the public. 95. The Environmental Safeguard Review Framework will be incorporated in the Operating Manual of the PFIs. In essence, the Framework addresses procedures and responsibilities of the PIUs and PFIs for the key elements of the environmental review process, namely: (a) compliance with FBiH/RS EA requirements, (b) screening, (c) documentation, (d) public consultation, (e) disclosure, (f) review and approval, (g) conditionality, and (h) monitoring and reporting. Sub-projects will be categorized into four categories. Only sub-proj ects with 33

35 assigned Category I (Low Risk) and Category I1 (Intermediate Risk) will be eligible for financing under the project. 96. The Loan Agreement provides a covenant that the Borrower shall cause the Entities, through their respective PIU, to ensure that no private land shall be affected by the Project and that no land acquisition or resettlement shall be required. PIUs and PFIs have substantial capacity and prior experience in screening of potential sub-projects and monitoring their compliance with the requirements of the Environmental Safeguard Review Framework. Additional environmental capacity building has been provided to PIUs and PFIs in the course of the project preparation under the PHRD grant. 97. A summary of the Environmental Safeguard Review Framework is presented in Annex

36 F. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP 4.01) [XI [I Natural Habitats (OP/BP 4.04) [I [XI Pest Management (OP 4.09) [I [XI Physical Cultural Resources (OP/BP 4.1 1) [I [XI Involuntary Resettlement (OP/BP 4.12) [I [XI Indigenous Peoples (OP/BP 4.10) [I [XI Forests (OP/BP 4.36) [I [XI Safety of Dams (OP/BP 4.37) [I [XI Projects in Disputed Areas (OP/BP 7.60)* [I [XI Projects on International Waterways (OP/BP 7.50) [I [XI G. Policy Exceptions and Readiness 98. The Project requires no exceptions from standard policies and is ready for implementation. * By supporting the proposedproject, the Bank does not intend to prejudice thefinal determination of the parties claims on the disputed areas 35

37 Annex 1: Country and Sector or Program Background BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance 1. The SME sector has been an important source of job creation and increased productivity in BiH. Encouraging its growth has been a priority for the government as SMEs potential contribution to the economy is much higher than is currently being delivered. Business environment reforms have helped to encourage the sector s growth, but recent studies have indicated that BiH lags behind other countries in the region in terms of the contribution that SMEs make to overall growth. 2. The private sector contribution to GDP is estimated to be at 50% in BiH. This is quite low for the region, with Hungary and the Czech Republic at ap roximately SO%, Bulgaria and Poland at 75%, FYR p2 Macedonia at 65% and Croatia at 60%. The private enterprise sector initially developed following the privatization program that started in This involved privatizing the majority of state owned enterprises using voucher privatization. 3. In addition to privatized enterprises and the remaining SOEs, the enterprise sector consists of a small but growing number of SMEs. However, Voucher Privatized Enterprises (VPEs) still dominate the enterprise sector in BiH. Early attempts at privatization have resulted in diluted ownership and weak governance, and large-company divestiture has been slow. Some privatized companies, however, have become major contributors to real sector growth. There are over 900 VPEs, and their assets are estimated at 40% of GDP and their total liabilities are estimated to be 16% of GDP in BiH lags behind other countries in the South Eastern and Central Europe in creating and sustaining SMEs, as shown in figure and table below. With less than 10 SMEs per 1,000 inhabitants, SMEs represent an untapped source of growth in BiH No of SMEs/l,OOO 1 & Source: European Bank for Reconstruction and Development (EBRD) 12 Much of the material in this section (including all of the data) is based on the recently completed ICA for BiH. 36

38 Number of SMEs in Bosnia and Herzegovina Albania I Montenearo Serbia Croatia Slovenia FYR Macedonia BiH 64,650 I 11,000 75,000 70,000 88,340 44,500 34, In BiH, there are some 34,000 SMEs and 80,000 crafts and entrepreneurs (see Table below). If we look into breakdown of SME sector by entity, it is evident that Federation BiH has about 60% of SMEs and crafts compared to 40% in Republika Srpska. 5. Comparing contribution to overall employment by SMEs in BiH and the region, BiH lags behind in this respect, but the situation is improving. In Slovenia, SMEs contribute 65% to the overall employment, while in Serbia this is even higher at 67.2%. In BiH, this indicator amounts to 67%. Also, in terms of employment, SMEs in FBiH employ about 75% of the total employees in this entity, compared to 55% in Republika Srpska. 6. Comparative analysis of productivity of SMEs, SOEs, and VPEs underscores the overall potential of the SME sector. Private small and medium enterprises are more productive than SOEs or VPEs, and provide an indication of the SME sector potential to fuel growth in BiH. VPEs represent potential for growth as well, as they are primarily SMEs. Through active restructurings they can add more value to share of private enterprises in GDP. In addition, SMEs are showing growth in numbers of registered companies (RS growth 5% and Federation BiH growth 3% in 2008 compared to 2007), which is an encouraging sign. 7. Furthermore, analysis shows that small companies are experiencing more liquidity problems than medium and large ones, but that they are less leveraged than medium and large ones. Large companies are increasing their leverage more rapidly, and they are the ones to first experience problems in the near future. There is a general problem with liquidity, especially in small companies. In the sample companies (870 SME companies in the analysis done in June 2009), sales increased by 21% in 2008, while accounts receivable increased by 19.5% in the same year. This differs from previous years. Dangerously low liquidity has slightly improved to 0.81, which is 4% better than in However, such a substantial increase in AR distorts liquidity ratio, since the collection of AR did not improve (AR days on hand remained constant at 90 days, therefore making most of the sales as sales on credit). This makes liquidity of SMEs even more questionable. 8. Detailed comparison of sample of SMEs performance over the two years ( ) shows that these companies have potential. At the same time, a smaller sample of 698 SMEs studied over five year period ( ), shows similar trends. As the Figure below shows, productivity did increase in some sectors. This corresponds to the increase in capacity utilization 37

39 for medium and large companies in these sectors. The evident decline in several sectors is also linked to the decline in capacity utilization in these sectors. In general, medium companies are the most efficient in terms of capacity utilization. Figure 2 shows that there is definitely a potential for SME development in some sectors. Productivity per worker ( ) in BAM I C c- Agriculture Blanufartlire of appliances -t~- Manufacture of chemicals - Mantifartitre of transport equipment xx w"," Manufacttire of wood arid wood proclucts 0 ' C Construction -4- Electricity, gar and water rupply 9. At the same time, accounts payable didn't increase at the same rate (by 11% only), therefore indicating that payments are made faster than collection of AR. Finally, stock of inventory increased by 3% in 2008, which further contributed to distorted liquidity ratio. Overall, the deterioration of companies' liquidity requires more liquid assets for working capital and short and medium term investments. While large companies have more current assets to offset this impact, general problems with monetizing current assets in the market and lack of liquid resources will also affect large companies. This will further deepen liquidity problems of SMEs. In general, small and medium companies are in a desperate need for financing, including working capital. 10. Analysis of the banking sector data shows negative credit growth and lack of available resources for SMEs financing. SMEs have been growing in number (7% growth in registered SMEs in 2008; 8.3% growth in employment in 2008), but credit growth is not following this trend. Credit dynamics was negative from December 2008 till March 2009, and almost 0% by July 2009 (see the figure on Private Sector Credit Growth below), which corresponds to the sharp decline in lending to the private sector. Moreover, companies are facing increased interest rates and difficulties in servicing the debt with poor liquidity. Interest expense increased by 23% in 2008 in the sample SMEs compared to

40 Private Sector Credit Growth Private sector credit growth in terms of maturity (short and long term loans) 35% 30% 25% 20% 15% 10% 5% \\ z 0 0 i -Short- term - Long- term These facts show that BiH has a long way to go in creating a private sector comparable to that in other CEE and SEE countries, and due attention has to be paid in improving ownership and restructuring the existing private sector, as a main channel of growth. SMEs need more liquid capital and investments to fuel growth. Export oriented SMEs 12. The output of private enterprises has been expanding in recent years, with much of the growth in export related industries. BiH had the highest export growth in the region, with growth totaling 64% in (export growth was 36% in 2006, 15% in 2007 and 13% in 2008). However, export remains dominated by traditional low-skill and resource intensive industries. Analysis of manufacturing industries by factor inputs indicated that the share of resource intensive products increased from 48% in 2003 to 56% in The largest increase in export growth from 2003 to 2008 was in metal ores and non-ferrous metals, both of which benefited from the rapid growth in worldwide commodity prices. Machinery and mechanical appliances also experienced a significant increase during this time period. Light manufacturing in areas such as furniture, apparel and apparel manufacturing has declined, partially due to high wage costs relative to other countries that dominate these sectors. High technology industries accounted for less than 4% of total exports. 13. The global financial crisis has hit exporters extremely hard, as export growth across sectors has declined significantly (see Figure below). Nominal exports have dropped by 21% and imports - by 24% during Q While the nominal drop partly reflects a drop in the prices of traded products, it also indicates the drop in economic activity. Resource intensive industries, which dominate the export market, have been hit particularly hard as commodity prices have declined worldwide. Export oriented SMEs are in a particularly precarious position as they tend to be the less diversified and have the least financial capacity to handle significant losses. Industrial production shrank by 10% in the Federation during Q1 and Q period, while it 39

41 was up in Republika Srpska around 17%. The growth of industrial production in Republika Srpska is largely due to the launch of production in the Brod refinery, but in other important industries, production indexes are down by 40%. In addition, as trade finance has become particularly difficult for smaller firms to obtain, access to finance in general has become a major constraint for these enterprises. Credit growth has stopped and, in fact, bank credit portfolio slightly shrank between March and April (0.3%). BiH export growth (2008, year on year) 70% - Business Environment Issues 14. Improving the business environment will also be critical for the SME growth. Although, substantial progress has been made during the past few years in improving the business enabling environment, significant issues remain. As noted in the recently completed ICA, progress has been achieved in a number of areas, including business registration, inspections, licensing and bankruptcy procedures. However, substantial areas of reform remain, as BiH ranks 105 out of 178 countries in the 2008 Doing Business report. 15. Notwithstanding these achievements, substantial economic challenges remain in BiH. Privatization has progressed slowly, FDI is limited, and the extent of the informal economy, while not quantified exactly, remains extensive by general consensus. A fragmented economic space has made it difficult to make a significant dent in the high unemployment or poverty figures. Even so, as mentioned earlier, there has been substantial progress. How far that progress has translated into making it easier for businesses to operate on the ground is a topic for further investigation. 16. First stage reforms to improve BiH s business environment have largely been completed. Now, the country should be moving to more advanced and demanding second phase reforms. BiH has to be able to attract more brown-field investment in order to fuel private sector growth. To the extent that the government s regulatory infrastructure makes it easy for firms to start or stop operating, the likelihood of more business activity will improve. 17. The ICA highlighted several top priorities for reform, including business licensing procedures, business start up requirements, and mechanisms for business closure to facilitate restructuring. It is important that administrative costs for businesses are reduced and that regulatory reform, in particular regulatory simplification of licenses and permits, is done in the near future, to create smart regulations and to reduce costs and risks of doing business. 40

42 SME data on Interest TOTAL sample ,322 Banking Sector Development 18. Financial system in BiH is dominated by the banking system. In 2008, banking system assets amounted to about BAM 20.1 billion, or 81% of the total financial sector assets. The framework structure of the banking sector in BiH is similar to the rest of the economy - there are two licensing and supervision authorities, one in the Federation and one in Republika Srpska and, practically, two separate banking markets. Since 2004, development of BiH banking sector has been driven by privatization led by several large European banking groups, which bought banks in both entities. There are practically three models: 0 One bank with headquarters in one of the entities, with branch network covering the whole territory of BiH. The most prominent example of this model is Raiffeisen Bank, which is the largest bank in BiH with an integrated market structure. As of mid-2009, it accounted for about 21% of BiH banking sector assets. Other larger banks that use the same approach are IntresaSanPaolo from SarajeGo (5.3% of total BiH banking sector assets) and Nova Bank from Banja Luka (3.6% of total assets). Two banks, one licensed in each entity, and each focusing on businesses in the respective territory, with the same governance structure and active cooperation at the senior management level stimulated by the foreign bank headquarters. There is also exchange of information in the risk management process. Typically for this model, one of the.two subsidiaries accounts for a significant market share in one of the two entities. Maintenance of this significant market share was probably the key reason that this model persists. The most prominent cases using this model are HypoAlpeAdria Group (with subsidiaries in Mostar and Banja Luka. RS subsidiary accounts for 32% of the RS credit market), UniCredit Group (subsidiaries in Mostar and Banja Luka. FBiH subsidiary accounts for about 20% of the FBiH credit market) and Nova Ljubljanska Bank Group (subsidiaries in Tuzla and Banja Luka. RS subsidiary accounts for 23% of the RS credit market). A typical objective of mother banks utilizing this model is to ultimately integrate the two subsidiaries. 41

43 A bank active only in one entity, or even focusing on one canton, is a model typically utilized by small banks in local ownership (e.g., Bobar Bank in Bijeljina) or by some non-eu foreign banks interested to develop business relationships focusing on enterprises in one region (e.g., Komercijalna Bank from Belgrade is focused on RS; Bosnia Bank International from Arab Emirates is focused on the Federation). Again, it should be expected that, over time, this model will also migrate towards covering the whole BiH territory. 19. Regulatory and Supervisory Framework. The two entities also maintain separate licensing, regulatory and supervisory authorities, with Banking Agencies in Sarajevo and Banja Luka. After a challenging start in the late 1990~~ the two agencies have developed high levels of cooperation and coordinate issuance of prudential regulations which are, in the case of banking sector, practically identical. Moreover, prudential regulations in most cases follow international standards and are enforced in a similar way, thus preventing regulatory arbitrage 42

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47 Results Framework Annex 3: Results Framework and Monitoring BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance come To maintain and improve access to finance for small and medium enterprises in BiH Intermediate Outcomes Outcome 1: Access to medium term loans funded under this project The total amount of medium term credit granted and the number of firms supported through line of credit Intermediate Outcome. Indicators Total amount disbursed to private sector f m s Target: Disbursement projection Design of new credit lines. Use of Intermediate Outcome Monitoring Determine if loan products/ maturities need to be revisited Outcome 2: Outreach Outcome 3: Quality of the Portfolio Number of loans disbursed Target: disbursement projections Non - performing loans measured as number of loans and volume Tarnet < 5% NPL Determine if adjustments to project design are required Based on performance determine if criteria for selection of borrowers needs to be adjusted 46

48 gg g 88 a dd 2 m i n E? E in u u B e z e m v ) in a a a 33 3 inin m ee E aa a 6.I c C e i c e r I b 5 c U e ;.i e n b \o\o $ 8 g g 5 r g w G 00 a

49 ANNEX 4: DETAILED PROJECT DESCRIPTION 1. The proposed EUR 47.8 million (US$70 equivalent) Enhancing SME Access to Finance Loan is a two-component project consisting of a credit line component (in the amount of EUR 46,972,200) and a project management and monitoring component (in the amount of EUR 408,300). Also, there will be EUR 300,000 of unallocated funds which will serve as a contingency, and the decision on its allocation will be taken at the project s mid-term review. 2. The credit line will be extended to the Ministry of Finance (MoF) of B&H which will make the respective portions of the loan proceeds available to the MoF of the Federation and the MoF of the Republika Srpska through Subsidiary Loan Agreements. The two MoFs will sign Project Agreements with the IBRD and, in turn, enter into Project Implementation Agreements with corresponding Project Implementation Units (PIUs) (OdRaz Foundation in the Federation, and the Investment Development Bank of the Republika Srpska (RSIDB). The PIUs will, in turn, enter into a framework Subsidiary Financing Agreements with each eligible Participating Financial Intermediary (PFI) and a separate PFI Sub-loan agreement for refinancing of each subloan to be extended to a final borrower. 3. The project will be implemented during FY under the overall responsibility of the Ministry of Finance (MoF) in the Federation, and the Ministry of Finance (MoF) in the RS. As a PIU for the Federation, OdRaz Foundation will be responsible for implementation of the project in the Federation, including procurement and financial management. As a PIU for RS, RSIDB will be responsible for project implementation in Republika Srpska, including procurement and financial management. The PIUs will be staffed with qualified personnel and capable of satisfactorily implementing all aspects of the project. Further details on implementation arrangements and the PIUs are provided in Annex 6. 48

50 4.1 Credit Line Component - EUR 46,972, The main component of the project is a line of credit to be extended through participating financial institutions (PFI) to creditworthy private enterprises for viable projects. The financing will include working capital finance; and/or investments plus incremental working capital loans for the SME sector. The targeted SMEs should be active in manufacturing, agro-processing and the related service sectors. Loan Terms and Conditions between PIUs and PFIs 5. Subsidiary-loans will be made based on an application of a PFI, which wishes to extend a subloan for eligible private beneficiary and eligible sub-project. Subsidiary-loans to PFIs will be extended back-to-back to PFIs sub-loans to final borrowers with the same amount, maturity and grace period. The decision to extend a sub-loan will be made by a PFI based on analysis of client s creditworthiness and project viability. In practical terms, financial risk taken by the PFIs is the credit risk taken on the final borrower and his sub-project. The credit risk comprises the commercial risk inherent in the enterprise and the project being financed, enlarged by the interest rate that are carried by the final borrower. In principle, a final borrower should be in a financial position that would allow him to meet all existing and projected financial obligations in a timely manner. The projected financial position should show that the final borrower will maintain its profitability and adequate liquidity once the PFI sub-loan is extended, and that his leverage will remain reasonable. 6. The PIU s Credit Line Section (CLS) will evaluate each application to ensure that the PFI s sub-loan appraisal and approval conform with the Operations Manual (OM) and the principles of sound banking. For the first three subsidiary-loans extended to each PFI and for all subsidiaryloans above an agreed amount specified in the OM, a prior review and a no-objection by the Bank will be required. The Bank may establish, in cooperation with the PIUs, a free limit for experienced PFIs which: i) are familiar with Bank procedures; and ii) have a proven track record of sound credit decisions. The subsidiary-loans below the free limit will not require any prior reviews. 7. PFIs will determine principal amortization and interest payment schedules on a case-by-case basis, based on cash-flow projections, but payments would generally be made monthly. Payments from enterprises to PFIs and from PFIs to the PIUs would be required to be current at the time of approval of additional subsidiary-loans. There would be no sub-loan prepayment penalties, and interest could be charged on a declining balance formula. 8. Interest Charges. Sub-loans to PFIs and PFI sub-loans to final borrowers will be extended at variable rates that are adjusted semi-annually. Interest rates for sub-loans to PFIs will be based on 6 months EUR-LIBOR reference rate plus an applicable margin for the selected IBRD loan product. The entities Ministries of Finance will add a spread needed to cover the cost of project implementation and the related risks. Interest rates for PFI sub-loans to final borrowers will also include a PFI margin. The PFIs should be free to set a margin that is market-based and covers their credit risk. 49

51 9. Currency Risk, Credit Risk. Subsidiary-loans to PFIs would be denominated in EUR, or in BAM equivalents referenced to EUR, as selected by the final beneficiary. PFIs will assume the full credit risk on all sub-loans that they have financed. The MoFs will assume credit risk on subsidiary-loans to PFIs. 10. Repayment of PFI Sub-loans. PFI Subsidiary Loan amount will be equivalent to the aggregate amount of principals of all PFI Subsidiary-loans made by the respective PFI. The PFIs are required to repay interest and principal of PFI subsidiary-loans semiannually. The PFIs will be required to make payments to PIUs regardless of whether or not they have received payments from their final borrowers. 11. A PFI that is delinquent in its payments will be charged penalty interest on the full outstanding balance of interest and principal, until payments are again current. Payment arrears are a ground for suspension of participation. PFIs which fail to make payments to PIUs and remain delinquent for 90 days will be referred to regulatory authorities and legal counsel for appropriate action. 12. At the time of interest and principal payments, PFIs will also report to the PIUs the payment history for all PFI sub-loans. If a principle or interest due on a PFI sub-loan idwas late, or the PFI has classified the respective sub-loan as substandard, doubtful or loss, the PFI will be required to provide to the PIUs a report on the performance of the sub-loan, the reason for adverse classification and the subsequent developments, and the up-dated financial condition of the final borrower. The PFI would agree to keep the credit history of the final borrower on file and to furnish it to any authorized central credit reporting agency. Participating Financial Institutions (PFI) - Eligibility and Qualification Process 13. Banks licensed in both the Federation and RS have been invited to express interest for participation in the project. Banks that wish to be considered for participation are requested to confirm that they: Allow to the Bank access (on a need-to-know basis) to privileged information necessary to appraise whether the interested financial institution meets and/or continues to meet the agreed qualification criteria; Agree to follow the rules as prescribed in Operations Manual and to undertake annual external audits by reputable auditors satisfactory to the Bank and according to international accounting and auditing standards; and Agree to devote adequate resources to the project, including to appoint specific staff for the Bank project implementation, with all necessary technical profiles and to provide the necessary training. 14. Banks that wish to be considered for participation are requested to meet eligibility criteria that are fully compliant with the Bank s OP Eligibility criteria used for banks qualification for participation are the following: The bank must be duly licensed and at least two years in operation. 50

52 0 The bank s owners and managers must be considered fit and proper. It must have qualified and experienced management, adequate organization and institutional capacity for its specific risk profile. The bank must be in good standing with its supervisory authority (Le., it should meet all pertinent prudential and other applicable laws and regulations) and remain in compliance at all times. The bank must have well defined policies and written procedures for management of all types of financial risks (liquidity, credit, currency, interest rate and market risk, as well as risks associated with balance sheet and income statement structures). The bank must maintain capital adequacy prescribed by prudential regulations, with the minimum risk-based capital adequacy of 12%. The bank must have adequate liquidity and meet the minimum liquidity prescribed by prudential regulations. The bank must have positive profitability and acceptable risk profile. It must maintain the value of its capital13. The bank must classify its assets and off-balance-sheet credit risk exposures (at least four times per year) and make adequate provisions. It must have adequate portfolio quality. The bank must have adequate internal audits and controls for its specific risk profile. The bank must have adequate management information systems. 15. The check of compliance with prudential regulations of the Central Bank of BiH and the two Banking Agencies (Le., if a bank is in a good standing ) includes capital adequacy, a set of risk exposure limits, and asset classification and provisions practices, as summarized in the table below. Compliance with Prudential Regulations I Risk Related Concerns Capita I Adequacy Related Party Exposures I Prudential Reaulations Risk Weighted Capital Adequacy Ratio (CAR) should be minimum 12% of the total value of bank s risk weighted assets. At least 50% of capital shall be Tier 1 (core) capitall4. The maximum amount of unsecured credit to a single related borrower or a group of related borrowers may not exceed the equivalent of 5% of the bank s core carital: Aggregate amount of credits extended to insiders/connected parties must not I exceed 30% of the bank s core capital. I 13 Maintaining the value of its capital means that the bank is adequately provisioned for the level of risk it is taking and that the bank s retained earnings are at least at the level of inflation. 14 Law defines three types of capital: Tier 1 is core capital, Tier 2 is supplementary capital and Tier 3 is additional capital that serves as coverage for market risk. The total risk represents the sum of multiples of appropriate risk rates and asst and off-balance sheet items that include credit risk. The risk multipliers are: 0% for cash funds, claims of BiH Governments and the Central Bank, and of central banks and banks with head offices in zone A. Zone A includes original 15 EU members, USA. Australia and New Zealand, Canada, Japan, Switzerland, Nordic countries, and Turkey; 20% for claims of enterprises and Governments from countries of zone A, banks with head offices in zone B and international development banks; 50% claims from banks in BiH; 100% for all other assets and credit equivalents and off balance sheet liabilities. 51

53 I Credit Exposure and Concentration limits liquidity Ratio Foreign Exchange Exposure loan Loss Provisioning Risk Management Structures Outstanding principal amount of all credit from a bank to a single borrower or a group of related borrowers may not exceed the equivalent of 40% of the bank s core caoital. I Any amount of credit to a single borrower or a group of related borrowers exceeding the equivalent of 25% of the bank s core capital must be fully secured by readily marketable collateral; The bank s total aggregate outstanding principal amount of all large credit exposures may not exceed the equivalent of 300% of the bank s core capital. Maintenance of average 10-day minimum liquidity in cash funds15 up to at least 20% of short term fund sources according to the book value at the last day of previous month. The level of cash funds cannot be less than lo%, even for one dav. Maximum to 30% of core capital (FC position of the bank) Maximum to 20% (30% in EUR) of core capital (for individual FC overnight position) Asset classification is obligatory at least every quarter. The calculated risk must be fully covered by provisions. A bank should have an Asset/Liabilities Management Committee, a Credit Risk Management Committee and a Liauiditv Management Committee. I 16. The pre-qualification of all interested institutions will be continued in order to establish whether they indeed meet the eligibility criteria. 17. Once the eligibility has been confirmed, a PFI will sign a framework Subsidiary Financing Agreement (SFA) with the respective PIU. The SFA will specify terms of access to Bank finance, mutual responsibilities and terms and conditions of participation of the PFI in the project. Once signed, it will allow eligible PFIs access to finance on specified terms for eligible beneficiaries and eligible projects. The PFI Subsidiary Loan amount will be equivalent to the aggregate amount of the principal of all PFI Sub-loans made by the respective PFI. The Ministries of Finance of the Entities with the Bank s consent may set a limit on the total funding made available to an individual PFI. 18. A PFI is expected to continue to meet the eligibility criteria in order to maintain access to bank funds. A PFI that does not follow the rules or experiences financial problems may be suspended. Suspension denotes an act where a PFI loses its right to utilize Bank funds for future commitments. The PFI may be re-accepted once the problems that have prompted its suspension have been adequately addressed. The reasons to cancel the PFI eligibility are as follows: 0 If a PFI is found to breach the established eligibility criteria or other participation rules, its further participation will be suspended until such time when the problem has been addressed. 0 If a PFI is delinquent on its payment of interest and principal due. 15 Cash funds include: cash in BAM and foreign currency in bank s treasury; balance of the reserve account at the CBBiH, balance in BAM and foreign currency demand deposits with correspondent banks. Short term (ST) hnds include bank s demand deposits; ST liabilities on time and savings deposits; St liabilities based on money market funds; ST liabilities based on bonds and limited deposits. 52

54 0 If a PFI utilizes Bank funds for ineligible expenditures or does not obey Bank procedures, the erring PFI would be asked to clean its mistakes by a certain deadline, or else refund to the Special Account all Bank-financed amounts that have been improperly used. Eligibility of Final Borrowers 19. The final beneficiaries must be privately owned (private ownership should be more than 50%) and duly licensed and registered with the tax authorities. They should be active in manufacturing, food production or agro-processing, or in related services. Enterprises will be required to demonstrate prior operating experience in the activity to be financed and should be in a sound financial condition. The creditworthiness of final borrowers will be assessed by PFIs. 20. Per the definition provided by the BiH MoFTER, the category of micro, small and mediumsized enterprises (SME) is made up of enterprises which employ fewer than 250 people and which have an annual turnover not exceeding EUR 50 million, and/or an annual balance sheet not exceeding in total EUR 43 million. Eligibility of Sub-projects 21. In principle, a final borrower should be in a financial position that would allow him to meet all existing and projected financial obligations in a timely manner. The projected financial position should show that the final borrower will maintain its profitability and adequate liquidity once the PFI sub-loan is extended, and that his leverage will remain reasonable. More specifically, sub-projects will be requested to meet the following criteria: Subprojects should be technically feasible and economically, financially and commercially viable. Subprojects should be in compliance with applicable environmental standards and in compliance with all applicable regulations relating to health, safety and environmental protection. Goods and works on the Bank s negative list will not be eligible for financing. The Bank policy on environmental assessment must also be complied with. 22. For the first three sub-loans of each PFI, prior review by the Bank will be required. All subloans not subject to prior review can be subject to ex-post review by the PIUs or the Bank in order to verify compliance with the sub-loan agreement terms, including market interest rate provisions. Final borrowers must comply with the World Bank s procurement procedures for the procurement of goods and works to be financed under project sub-loans (see Annex 8). 53

55 4.2. Project Management and Monitoring Component - EUR 408, The component in the amount of EUR 408,300 would finance costs of the project management and monitoring, including financial management, audits, procurement, environmental compliance supervision and other activities related to an overall project management and coordination in the Federation of Bosnia & Herzegovina. As regards to the project management and monitoring in Republika Srpska, the RS MoF decided that the cost related to administration, management and supervision of the credit line component will be financed by setting an interest margin to be charged by the RS MoF on the funds provided to PFIs. 24. OdRaz Foundation will become the Project Implementation Unit (PIU) for the Federation, and the RS Investment Development Bank (RSIDB) will become the Project Implementation Unit (PIU) for Republika Srpska. Overall project management would therefore be the responsibility of these PIUs, which already have experience in implementing IF1 funded projects and will be responsible to the World Bank for disbursement, project reporting, administration of the Designated Account, authorization of withdrawal applications, and project accounting including financial reporting filing and auditing of project accounts, and general procurement. Since the PIUs already have the capacity for World Bank project administration, these arrangements will significantly speed up the project implementation. Detailed functions and responsibilities of the PIUs are described in Annex The component will finance incremental operational costs to be incurred by the Federation PIU (OdRaz Foundation) related to the management of the project implementation. This will include, inter alia: (i) salaries paid to the staff working on the Project, other than civil servants salaries; (ii) travel costs and per diem; (iii) depreciation, maintenance and operation of equipment and vehicles procured or used for the management of the project; (iv) office supplies; (v) rent of an office space; (vi) translation and interpretation; (vii) communications cost; (viii) public awareness activities, including web-page maintenance, local media publications, etc.; (ix) acquisition of financial management software; and (x) bank charges and other miscellaneous costs as may be agreed with the Bank. 26. In addition, this component would cover, inter alia: (i) audits; (ii) training of relevant staff in financial management and procurement; (iii) monitoring and impact evaluation activities; (iv) consulting services to support creditworthiness analysis and sub-project appraisal; and other incremental cost as necessary which would be financed by the project as per annual budget acceptable to the Bank. 54

56 Attachment to Annex 4: Pre-Qualification Process of Participating Financial Institutions (PFI) 27. At the start of project preparation, larger banks licensed in Bosnia and Herzegovina, which accounted for roughly 80% of the credit market in both entities, have been invited to express interest for participation in the project. Of the Federation-licensed banks, four banks confirmed their interest in participation including Raiffeisen Bank (Sarajevo), Intesa-SanPaolo Bank (Sarajevo), Hypo-Alpe-Adria (Mostar) and UniCredit (Mostar). Of the RS-licensed banks, four banks confirmed their interest, including NLB-Razvojna Bank (Banja Luka), Nova Bank (Banja Luka), Hypo-Alpe-Adria (Banja Luka), UniCredit (Banja Luka). 28. Banks pre-qualification already started in April The process focused on a detailed assessment of whether a bank meets the standard eligibility criteria (described above in Annex 4). The pre-qualification included interviews with senior management covering bank s business strategy, ownership and governance (structure of the Board and bank s management and supervisory bodies, governance policies and practices, Board meeting agendas, Board reports, follow-up reports), review of all key banking and risk management functions and review of key documentation, including externally audited financial statements as of end-2008, interim financial statements as of end-march 2009, capital adequacy calculations, licensing information, written policies and procedures related to the lending and management financial risks (cash and liquidity risk management, credit risk, currency risk, interest rate risk, price risk), internal controls manual and sample of internal audit reports (detailed reports, as well as reports prepared for the Supervisory Board, follow-up reports) and review of IT systems used by the bank. 29. In the Federation, the pre-qualification process was completed for Raiffeisen Bank and Intesa-SanPaolo Bank. Both banks meet the eligibility criteria. In RS, the pre-qualification process was completed for NLB-Razvojna Bank, Nova Bank, Hypo-Alpe-Adria (Banj a Luka), UniCredit (Banja Luka). The four banks all meet the eligibility criteria. The pre-qualified institutions have been informed in writing about the results of the. process. Since prequalification, all six banks continue to meet the eligibility criteria, and remain in a stable financial condition. Signing of the Subsidiary Financing Agreement (SFA) by at least two banks in the Federation and RS will be a condition of effectiveness. 30. The table below summarizes banks that have been pre-qualified and meet the eligibility criteria. 55

57 Name License No. of Assets Credit Branc (BAMmil) (BAM mil) hes /Offic es Share (%) Share (%) Capital of Total of Credit Adeq. I Assets Market Ratio BiH/Entit Entity (%I Y 06/2009 I Federation BiH Raiffeisen Bank (Sarajevo) FBA I 39/60 4,316 I 2,602 21/ Intesa-SanPaolo Bank FBA I 5/46 1,081 I 805 \ (Sarajevo) I ReDublika Srpska NLB-Razvojna Bank (Banja RSBA 12/54 1, Lu ka) Hypo-Alpe-Adria (Banja RSBA 5/41 1,656 1,314 8/ Luka) L Nova Bank (Banja Luka) UniCredit (Bania Luka) RSBA 11/ RSBA 42/ / Two of the interested banks in the Federation (Hypo Alpe Adria and UniCredit in Mostar) have not been appraisal as both started the process of re-organization of the credit risk management function (moving to a model typical for banks using internal models for credit risk and capital adequacy management) and need to finalize it before they can be ready for appraisal. The process was initiated by their mother-banks in order to bring the banks closer to the group financial risk management standards. Both are expected to be ready for appraisal sometimes in the fall of The model used for the credit line component allows access to all banks that are interested and able to meet the eligibility criteria, as the subsidiary loans will be allocated on a first-come, first-served basis. Banking Associations in both entities organized meetings for interested members. In the Federation, Volks Bank and Bosnia Bank International have already expressed interest for participation; in RS, Balkan Investment Bank (Banja Luka), Pavlovic Bank (Bijeljina) and Bobar Bank (Bijeljina) have asked to be accepted. Appraisal of these banks will be organized in the period before Loan effectiveness. It is likely that there will be more applications, and the interest is to have as many banks as possible, in order to increase coverage and competition for SME clients. 33. The final selection of PFIs will be done based on the confirmation letter from a corresponding Banking Agency which certifies their good standing, and a PFI s readiness to enter into Subsidiary Financing Agreement with a respective PIU. The Bank will review and clear all Subsidiary Financing Agreements to be concluded between the PIUs and PFIs. 56

58 Annex 5: Project Costs BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance Project Cost By Component and/or Activity Local million Foreign Total EUR million EUR million Credit line 46,972,200 46,972,200 Project s management and monitoring 408, ,300 Unallocated 300, ,000 Front-end Fee Total Baseline Cost 47,800,000 47,800,000 Total Project Costs 47,800,000 47,800,000 Total Financing Required 47,800,000 47,800,000 57

59 Annex 6: Implementation Arrangements BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance 1. Financing will be provided through an apex arrangement to allow open access of all interested banks that are able to meet the eligibility criteria, which is one of standard models used for the World Bank credit line operations. Both BiH entities opted for implementation arrangements that would require two development agencies, one supporting lending to enterprises in the Federation, and the other one for enterprises in RS. The related project administration functions will be delegated to these development agencies based on Project Implementation Agreements. The two agencies will establish and maintain project implementation units (PIUs) for the duration of the project s implementation period. Both PIUs will utilize the same Operational Manual (OM) and Financial Management Manual (FMM) developed for the project. 2. A number of options for the PIUs were discussed with the authorities at the BiH level and with both entities. Potential options for PIUs were evaluated based on: (i) institutional background, governance structure and management capacity; (ii) financial condition; (iii) experience with similar World Bank projects; (iv) project implementation capacity and effective cooperation with banks; (v) credit appraisal capacity and existence of active credit risk management bodies (e.g., credit committee); (vi) quality of accounting and bookkeeping and of financial management reporting; (vii) audit practices, including internal controls and external audits; and (viii) information system and IT capacity necessary to support project implementation. After careful evaluation, the following options were selected: For the Federation, the PIU functions will be executed by the Sustainable Development Foundation (OdRaz). OdRaz has ample experience with World Bank projects, including credit lines. It is currently implementing a number of World Bank and other projects. Its accounting, financial management and reporting systems generally meet the World Bank 58

60 requirements, but its credit review/appraisal function will need to be strengthened. To address this issue, OdRaz Foundation will hire a dedicated credit officer16. For RS, the RS Investment and Development Bank (RSIDB) will become the Project Implementation Unit. RSIDB is not involved in direct lending, it administers credit lines funded by the Development and Employment Fund (i.e., the Government) to banks with RS banking license. RSIDB already has all necessary systems and experience, as it has acted as a PIU in a number of World Bank financed credit line projects. Building the PIU capacity for the RSIDB will require only minor efforts. 3. The PIUs will sign a Project Implementation Agreement with their respective Entities (the OdRaz Foundation with the FBiH MoF, and the RSIDB with the RS MoF). The PIUs will also sign a framework Subsidiary Financing Agreement with each Participating Financial Intermediary (PFI), and a separate PFI Sub-loan agreement for refinancing of each sub-loan to be extended to a final borrower. PIU Functions 4. The key functions of the Project Implementation Unit (PIU), i.e., the apex responsible for credit line implementation, will include: Performing an overall management of the project implementation on a daily basis. Signing of framework Subsidiary Financing Agreements with PFIs. Signing PFI Sub-loan Agreements for approved subprojects with PFIs to refinance the PFI loans to their SME clients (Le., back-to-back). Reviewing and approving sub-loan applications received from PFIs. Preparing and disseminating information about the project to eligible beneficiaries. Arranging disbursements and monitoring inflow of interest and principal from the PFIs. Monitoring and administering the use resources and supervising that the PFIs follow the agreed disbursement procedures. Monitoring compliance of PFIs with terms and conditions of Subsidiary Financing Agreement. Maintaining the Special Project Account (SPA), preparing withdrawal applications, maintaining the project account, and maintaining summary records of the flow of resources. Preparing on a cash basis and submitting semiannually Interim Un-audited Financial Statements (IFRs) in a form agreed with the Bank, due within 45 days of the end of each semester, and also preparing and submitting annual project financial statements, in a form acceptable to the Bank. l6 While OdRaz needs to develop the credit review function, the credit appraisal will be primarily the function of PFIs. A well developed credit risk appraisal and management capacity is one of the key eligibility criteria for the PFIs. Moreover, PFIs are expected to get and use the free limits. Therefore, prior and detailed appraisal of projects and clients creditworthiness by the PIUs will not be critical. 17 This will include training of staff in details of the Operational Manual developed for the Project and updating IT system to be able to produce semi-annually reports in the agreed format. 59

61 Ensuring that the obligations and tasks transferred onto the PFIs in the Environmental Safeguard Review Framework are fully implemented; collecting regular reports from PFIs and collating them into the one report for its further submission to the Bank. Making arrangements for external audits of the project accounts and records, including the Special Project Account and Statements of Expenditures. Assisting Bank supervision missions. PFI Responsibilities 5. The PFIs responsibilities will include: a Preparing and disseminating information about the project to eligible beneficiaries. a Review of sub-loan requests from final borrowers (Le., final beneficiaries). e Appraisal of the sub-project to be financed and of the creditworthiness and financial status of the potential final borrowers. a Perform an environmental review of the sub-loan requests which incorporates the procedures described in the Environmental Safeguard Review Framework in order to screen the sub-loans requests into 4 categories with only categories 1 and 2 eligible for the funding under the Project. a Approval of sub-loan application by the Credit Committee once the application has been endorsed by the PIUs/Bank, as applicable. e Assisting final borrowers in the application of efficient procurement practices. e Making sub-loan related payments to final borrowersheneficiaries in a timely manner against appropriate documents (to evidence use of funds, procurement aspects). a Ensuring that payments of interest and principal to the PIUs are made as due. On due-dates of interest and/or principal, the participating bank will provide PIU with a written report on sub-loan performance, deviation of payments of PFIs borrowers from agreed terms, and an updated and credit history of the final borrowers. a Submitting annual external audits (prepared by reputable external auditors satisfactory to the Bank and executed according to international accounting standards) to PIU and forwarded to the Bank no later then six months after the end of each financial year. a Keeping all necessary records and payment evidence, as specified in legal documents. Functional Responsibilities and Arrangements 6. Financial Management. (See Annex 7 for detailed review of financial management arrangements). The two PIUs will be charged with managing contracting and expenditures under the project, as well as the overall financial management. RSIDB has extensive experiences with the many Bank projects, including a number of credit lines. OdRaz also has experience with the number of Bank projects. Financial management capacity and the proposed financial management arrangements for both PIUs have been reviewed in accordance with OP/BP 10.02, to establish if they satisfy Bank s minimum financial management requirements and what else needs to be done. 7. Financial Reporting. The two PIUs will maintain financial records for the Project and will ensure appropriate accounting for the funds provided. The OdRaz and RSIDB will prepare on a cash basis and submit semiannually Interim Un-audited Financial Statements (IFRs) in a form 60

62 agreed with the Bank, due within 45 days of the end of each semester. The OdRaz and RSIDB will also prepare annual project financial statements, in a form acceptable to the Bank, and these will be audited by an external audit firm acceptable to the Bank. 8. PFI Monitoring. The PFI monitoring functions will include: (i) a-priori review of PFIs' appraisals of eligibility and creditworthiness of final borrowers for subprojects above the free limit and of the first three presented by a newly qualified PFI; (ii) review on a sampling basis of subprojects below the free limit; (iii) a-priori clearance of minimum three procurements under the commercial practices for each new participating bank; (iv) supervision of the PFI's performance related to their obligations and tasks transferred onto them in the Environmental Safeguard Review Framework; (v) supervision of all other commercial practice procurements on a sampling basis; (vi) supervision of subprojects on a sampling basis during subproject implementation; (vii) collecting information needed for monitoring that the PFIs continue to meet the eligibility criteria. 9. Monitoring and Evaluation of Outcomes/Results. The Bank will evaluate progress on the proposed indicators as part of supervision missions and through regular project related reporting by the PIUs. The PIUs will produce semi-annual reports to the Bank, as mandated by IFRs, based on information collected by the PIU and from regular reports provided by the PFIs to the PIU. The PIUs will also submit details annual reports including all output and all agreed outcome indicators. 10. Disbursements. Disbursements will be made based on normal disbursement methods of Bank loandcredits (Le., from the Special Account with reimbursements made based on statements of expenditures or full documentation, or direct payments from the Credit Account) as discussed in Annex 7. The proceeds of the World Bank credit will be allocated in accordance with Annex 5. Disbursements will be administered by the two PIUs and PIUs will be responsible for retaining the supporting documentation. The PFIs will be required to furnish the necessary documentation, if and when requested. 11. Repayment of PFI Sub-loans. Two separate Revolving Fund accounts will be opened for repayment of the PFI sub-loans, which would be used for repayment of Bank loan or to extend the new PFI sub-loans. The PFIs should be required to repay interest and principal of PFI subloans semiannually or quarterly. (The semi-annual repayments are easier to administer and should coincide with adjustment of interest rates on sub-loans to PFIs.) The PFIs will be required to make payments to PIUs regardless of whether or not they have received payments from their borrowers. 12. Procurements. Procurements will be the responsibility of the PFI's final beneficiaries. In general, goods should be procured in accordance with good commercial practices. This should involve at least three competitive quotations obtained locally. For somewhat larger procurements, at least one international quote should be required. When applicable, for large procurements, the Bank procurement procedures must be used. Procurements will be supervised on an on-going basis by the PFIs, and by the respective PIUs. They will also be supervised by ' the Bank supervision missions. Further details are provided in Annex 8. 61

63 13. Audits. The audits for the project will include both a project audit, for the two project components managed by the PIUs, and audits of RSIDB. The project audits would include a separate opinion by the auditor on the operation of the related Special Accounts. These audits will include a certification that the PIUs and the PFIs are in compliance with the financial covenants agreed under the project. 14. The project accounts and RSIDB will be subject to an external audit, in accordance with international accounting and auditing standards, on an annual basis. This audit would be carried out by an independent auditor acceptable to the Bank, and the audit reports would be sent to the Bank within six months of the end of the fiscal year. 15. PFIs will be required to provide annual external audits of financial statements (balance sheet and income statement) and of capital adequacy, according to the terms of reference agreed with the Bank, by reputable external auditors acceptable to the Bank and, if applicable, to the respective supervisory authorities. The external audits will form a basis for re-appraisal of financial condition and eligibility of PFIs, in order to confirm their continuous qualification. 62

64 Annex 7: Financial Management and Disbursement Arrangements BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance Risk Inherent Risk Country level. Perceived corruption in the country is high. Compliance on internal controls is weak. Internal audit is lacks experience. Capacity of State Audit Institution is still low Entity level. Weak financial Management structures in the OdRaz and RSIDB that will implement the project. Large infrastructure investments prone to corruption. Risk Risk Mitigation Measures Risk after Rating mitigation S Corruption risk will be mitigated by instituting M additional procedures and strengthening system of internal controls. The internal controls to be applied in practice are described in Financial Manuals. S Semiannual IFRs will be submitted to the Bank. Risk imposed by low capacity of SAI, will be mitigated by using private auditors acceptable to the Bank for the project and entity audits. The risk will be mitigated by instituting additional key M controls to be applied during implementation of the project by dedicated project staff, FM capacity building. Any changes to the RSIDB and OdRaz project financial management staff structure will be agreed with the 3. Internal controls RSIDB. Such manual would describe a detailed 63

65 4. Fundsflow. Risk 5. Financial reporting 6. Auditing. 7. Staffing Overall Control Risk Overall FM Risk Risk Rating M S S S Risk Mitigation Measures commercial banks. The finds would flow from the World Bank to OdRaz and RSIDB, who would then make payments from the designated account to the commercial banks. Any specific procedures would be developed and described in the financial management manual. Both OdRaz and RSIDB are familiar with the World Bank disbursement guidelines. Financial reporting will be based on the current systems used in accordance with project-specific formats agreed at negotiations. Existing software will be adjusted to accommodate these formats, in the RSIDB. OdRaz would continue using a tailor made software for project reporting purposes. No additional mitigation measures needed. A private audit company acceptable to the Bank will perform audit of the project based on existing audit arrangements. In RSIDB the FM staff gained experience with SESP, CDP, and Accelerating Enterprise Restructuring in Bosnia and Herzegovina through Active Portfolio Management of PIFs. In FBiH FM staff in OdRaz has prior experience working on many WB financed projects such as LIC, LDP, PTAC, CDP, Accelerating Enterprise Restructuring in Bosnia and Herzegovina through Active Portfolio Management of PIFs etc. Risk after mitigation Strengths 3. The significant strengths that provide a basis of reliance on the project s financial management arrangements include: - OdRaz - Prior financial and project management experience gained implementing World Bank financed projects such as Community Development Project (CDP), LDP (Local Development Project), PTAC (Privatization Technical Assistance Credit) and Accelerating Enterprise Restructuring in Bosnia and Herzegovina through Active Portfolio Management of PIFs (AERBiH). Audit reports for the concerned projects were received timely, and have been found acceptable to the Bank; and - RSIDB - Prior financial and project management experience gained implementing World Bank financed projects such as Community Development Project (CDP), Second Employment Support Project (SESP) and Accelerating Enterprise Restructuring in Bosnia and Herzegovina through Active Portfolio Management of PIFs (AERBiH). Weaknesses and Action Plan 4. In order to further strengthen the financial management capacity of the project, the following action plan has been recommended and agreed upon: M M M M M M Actions Ensure accounting software upgraded for the new project Responsibility Status OdRaz Under implementation 64

66 FM Implementation Arrangements Implementing agencies 5. In the FBiH, the OdRaz and in the RS RSIDB will be in charge of overall implementation of the project through a designated team of staff. The OdRaz and RSIDB will have overall responsibilities for implementation, including procurement and financial management for the project. 6. Planning and Budgeting. The OdRaz and RSIDB have adequate capacity for planning and budgeting in terms of human resources, availability of quality information and IT system. Staff has experience in budget preparation. Care should be taken that variances of actual versus budgeted figures are monitored on a regular basis, appropriately analyzed and corrective actions taken if required. 7. Accounting Policies and Procedures. Project accounting, on cash basis, will be maintained separately within the OdRaz and RSIDB. Accounting procedures will be set out in detail in a FM Manual for and prepared by the OdRaz and RSIDB. The FM Manual will cover: (a) the FM system proposed under the project, with special emphasis on accounting and auditing policies, standards and internal controls; (b) the role of the FM systems in project management and implementation; (c) the accounting arrangements required for project management, the format for and content of project financial reporting; (d) the auditing arrangements that will be used during project implementation; and (e) budgeting and planning. The FM manual will form an integral part of the project operational manual. 8. Staffing. The OdRaz engages one Financial Management Specialist and one Financial Accountant. This staffing level is satisfactory for the financial management aspects of the project implementation. Similarly, the RSIDB has assigned a person from their accounting department to be in-charge of the project FM arrangements. This person will be assisted by the accounting department staff, as needed. 9. FMManual. Project specific controls and procedures relating to FM will be described in the FM Manuals prepared for the project in each Entity. Key internal controls to be applied include appropriate authorizations, control checks, segregation of duties, reconciliations and documenting transactions. The Manuals will set out the FM and internal control policies and procedures and are intended to guide staff and minimize the risk of errors and omissions, as well as delays in recording and reporting. These written standards will also clarify responsibilities, including level of authority, clear control over assets, cash, and bank accounts, and it ensures timely and accurate financial reporting. The final draft FM manual has been prepared before negotiations. 10. Internal Controls. The OdRaz and RSIDB will on lend the funds under the Project to PFIs, who are selected according to the eligibility criteria agreed with the World Bank, using subsidiary Financing Agreements. All subsidiary Financing Agreements or amendments are subject to prior review by the World Bank. The OdRaz and RSIDB will ensure that complete project file documentation (subsidiary Financing Agreement) is available in OdRaz and RSIDB 65

67 respectively. PFIs shall sign sub-loan agreements with sub-borrowers (SMEs). For all sub-loans not requiring prior review, OdRaz and RSIDB will confirm satisfactory receipt of the sub-loan documentation package referred to above, and inform the PFI accordingly. Such sub-loans will, however, be subject to ex-post review of all Sub-loan documentation by OdRaz and RSIDB and IBRD for verification of compliance with all final borrower, sub-project and sub-loan terms and conditions. All underlying documentation pertaining to sub-loans should be maintained by the PFI for a period of 3 years from the date on which the sub-loan was disbursed and should be made available to OdRaz and RSIDB and/or IBRD. 11. There are regular reconciliations in the OdRaz/RSIDB: semi-annual reports prepared are reconciled with the accounting data and WB client connection disbursement records; DA reconciliation is performed on a monthly basis. Also the consolidated project financial information would be prepared based on semiannual IFRs prepared by participating PFIs. PFIs shall forward such reports to OdRaz/RSIDB, and OdRazRSIDB shall be responsible for consolidating such reports and amending it in order to prepare semiannual IFRs for submission to the IBRD. 12. The OdRaz and RSIDB is regularly submitting acceptable semi-annual financial monitoring reports (now called IFRs) for CDP. SESP (RS DIB only), and AERBiH, and there are no overdue IFRs. 13. The OdRaz and RSIDB shall maintain internal controls ensuring proper segregation of duties, authorization procedures, and regular reconciliations are properly designed and are operating efficiently. OdRaz/RSIDB shall make random visits to sub-borrowers in order to inspect the investments and working capital purchased from such loans. 14. The access in the applications is. restricted by password and there are clear internal procedures in place for creating and changing regularly the users passwords. Any changes in the accounting records are done through adjusting journals. The database is locked at the end of each year; once the year is closed, there is read-only access to the accounting records. 15. RSIDB has internal audit departments and the project related transactions will be subject to its reviews. OdRaz has no internal audit function. Reporting and Monitoring 16. FM Reporting and Monitoring Arrangements. The OdRaz and RSIDB will maintain financial records for the Project and will ensure appropriate accounting for the funds provided. The OdRaz and RSIDB will prepare on a cash basis and submit semiannually Interim Un-audited Financial Statements (IFRs) in a form agreed with the Bank, due within 45 days of the end of each semester. The OdRaz and RSIDB will also prepare annual project financial statements, in a form acceptable to the Bank, and these will be audited by an external audit firm acceptable to the Bank. The IFRs will comprise the following reports presented in the agreed format: - Project Sources and Uses of Funds received, showing the World Bank, Project funds from other donors, and counterpart funds separately; 66

68 - Uses of funds by loan term; - Uses of funds by loan customer; - Statement of Designated Account; - Project Balance Sheet. 17. FA4 Reporting and Monitoring Capacity. The RSIDB and OdRaz in-charge for the implementation of the SESP (RSIDB only), CDP and AERBiH submit Interim Un-audited Financial Statements on a semi-annual basis. The reports continue to be submitted on time and are acceptable to the Bank. The same arrangements will be retained for the new project. However the format of IFRs has been revised in order to reflect the new sources and uses of funds for the new project. The project interim un-audited financial statements will be prepared in the loadcredit currency. 18. The OdRaz has purchased and has implemented the software that was upgraded by e-line d.o.0. Sarajevo. It is used for all projects currently implemented by OdRaz. The accounting software system uses MS SQL database. It consists of the following modules: financial, procurement and reporting. The financial modules include 4 sub-modules: Payments, Reports, Other Categories, and Reports by Other Categories. The payments are entered into the system based on disbursement categories. The reporting sub-modules allow to print detailed reports and the financial statements. The procurement module enables entering all necessary information on procurement matters. The financial software has adequate security levels. The system meets the Bank s reporting requirements. The system updates needed for the new project will be completed by project inception. 19. RSIDB was applying SCALA software. However the software did not have an option of automatic generation of quarterly or semiannual IFRs or SOEs. Currently, the accounting department is booking the project data in RSIDB accounting system (off balance sheet) and as such it has an option of generating the Project trial balance. The data is then used to fill out the excel forms for IFRs. The formats of semiannual IFRs are attached. External Audit 20. Audit Arrangements. The RSIDB and OdRaz will be responsible for ensuring that project financial statements, designated accounts, and Statement of Expenditures (SOEs) are audited by an independent auditor, acceptable to the Bank, in accordance with standards on auditing that are acceptable to the Bank. The annual project audit will be carried out in accordance with the Chapter V of the FM Practices Manual (November 2005). The audit report shall be in a format in accordance with the International Standards on Auditing promulgated by the International Federation of Accountants (IFAC). The audited project financial statements will be sent to the Bank within six (6) months of the end of the Government s fiscal year. The annual cost of the audits of the project will be covered by the loan funds in the Federation, and out of the margin which RSIDB will charge on the loan funds provided to PFIs in Republika Srpska. There are currently no overdue audit reports of the projects implemented by OdRaz and RSIDB. 67

69 21. The following chart identifies the audit reports that will be required to be submitted by the project implementation unit together with the due date for submission. Audit Report Project financial statements (PFS), including SOEs and Designated account, scope extended to grants. The PFSs include sources and uses of funds by category, by components and by financing source; SOE statements, Statement of designated account, notes to financial statements, and reconciliation statement. The RSIDB and OdRaz shall have its entity financial statements audited in a manner adequate to, reflect its operations and financial condition audited in accordance with consistently applied auditing standards acceptable to the Bank, by independent auditors acceptable to the Bank Due Date Within six months of the end of each fiscal year and also at the closing of the project Within six months of the end of each fiscal year and also at the closing of the project 22. Audit Capacity. There are government-wide audit arrangements covering all Bank financed projects in Bosnia and Herzegovina (with the exception of revenue earning entities). The State Ministry of Finance and Treasury (MoFT) has renewed a one-year contract for the audit of fiscal year 2008 with Price Waterhouse Coopers, Macedonia for the audits of World Bank financed projects. This Project will be included on the list of projects audited under the master audit agreement with Price Waterhouse Coopers, Macedonia. There is an option of contract extension up to two additional years, subject to successful audit performance. The audited financial statements of the current projects implemented by OdRaz (CDP and Accelerating Enterprise Restructuring In Bosnia and Herzegovina through Active Portfolio Management of PIFs) and RSIDB (CDP, SESP, and Accelerating Enterprise Restructuring In Bosnia & Herzegovina through Active Portfolio Management of PIFs) for the FY 2008 have been received by due date and were acceptable to the World Bank. The auditors opinions on the financial statements were unqualified. The management letters contained minor recommendations relating to accounting issues. Although it was not required, OdRaz submitted the PWC auditor s report and audited OdRaz entity financial statements for FY 2007, and such auditor s opinion was unqualified. RSIDB auditor s opinion on the entity financial statements for FY 2007 was unqualified, and the audit was conducted in compliance with ISA and by a local auditor. For FY 2008 the RSIDB selected Deloitte Banja Luka as auditor. The audit fieldwork is underway, and the reports were not completed yet. RSIDB has already concluded a three years contract with the Deloitte Banja Luka which is currently conducting the audit for FY2008 RSIDB financial statements. The audit firm, Deloitte Banja Luka, shall be assessed for the first time by the World Bank as part of the regular audit firms assessment planned for Bosnia & Herzegovina. The standard TOR for the project and entity audit is attached to the Minutes of the Negotiations. 23. In addition to the above requirement for project and RSIDB entity audit, the participating PFI shall be required to submit their annual audited financial statements to OdRaz and RSIDB. OdRaz and RSIDB shall forward such reports to the Bank for a review by the Bank FMS. Funds Flow and Disbursement Arrangements 68

70 24. Disbursement Arrangements. Disbursements from the loan will follow the transaction-based method, i.e., the traditional Bank procedures including reimbursements with full documentation, Statements of Expenditure (SOE), direct payments and special commitments. Disbursements from the loan proceeds would be administered by the RSIDB and OdRaz. The RSIDB and OdRaz are responsible for retaining supporting documentation for SOEs and making them available to supervision missions, as well as to the auditors. The draft CFAA for BiH recommended that report-based disbursements should not be introduced in the BiH portfolio at this stage because of significant risks relating to (i) project FM weaknesses and lack of capacity in PMUs; (ii) the vulnerable banking system; and (iii) the unstable political situation and general governance problems presently affecting Bosnia and Herzegovina. There has been a PHRD grant for the Preparation of Enhancing Small and Medium Enterprises Access to Finance Project - Grant No.TF (US$700,000) used for the preparation of this project. 25. The state Ministry of Finance and Treasury will open two Designated Accounts for each Entity for IBRD loan proceeds. The designated accounts will be denominated in EUR. The funds will be initially transferred from the World Bank to the Designated Accounts and then the RSIDB and OdRaz Foundation will conduct payments from IBRD proceeds to PFIs or suppliers depending on project requirements. 26. The Ceiling for these Designated Accounts will be indicated in the disbursement letters. Applications for replenishment of the Designated Account will be submitted quarterly or when one-third of the amount has been withdrawn, whichever occurs earlier. Documentation requirements for replenishment will follow standard Bank procedures as described in the Disbursement Handbook. Monthly bank statements of the Designated Accounts, which have been reconciled, would accompany all replenishment requests. 27. Disbursement Allocations. The amount of EUR 47.8 million (US$70 million equivalent) will be allocated to the FBiH and RS as indicated in the tables below. These tables set forth the Categories of items to be financed out of the proceeds of the loan, the allocation of the amounts of the loan to each Category and the%age of expenditures for items so to be financed in each Category. Category Amount of the loan I Allocated (in Euros) %age of Expenditures to be financed 1 (1) Sub-loans under Part l.a of the Project (2) Goods, consultants services and Operating Costs under Part 27,900, , % 100% l.b of the Proiect (3) Unallocated under Part 1 of the Proiect 300, I (4) Sub-loans under Part 2 of the 19,072, % Project (5) Front-end Fee 119,500 Amount payable pursuant to Section 2.03 of this Agreement in accordance with Section 2.07 (b) of the General Conditions 69

71 (6) Premia for Interest Rate Caps and Interest Rate Collars TOTAL AMOUNT 0 Amount payable pursuant to Section 2.07(c) of this Agreement in accordance with Section 4.05(c) of the General Conditions 47,800,000 70

72 A. General Annex 8: Procurement Arrangements BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance 1. Procurement for the Enhancing SME Access to Finance will be carried out in accordance with the World Bank s Guidelines: Procurement under IBRD Loans and IDA Credits published May 2004 and revised in October 2006 (Procurement Guidelines) and the provisions stipulated in the Loan Agreement. The procurement arrangements are described below. B. Assessment of the Agency s capacity to implement procurement and Private Sector Procurement Practice in Bosnia and Herzegovina 2. A Country Procurement Assessment Report (CPAR) was prepared in 2002 and updated in September 2006:. The Fiduciary Update on Public Financial Management Bosnia and Herzegovina, concluded that the environment for project implementation in Bosnia and Herzegovina was moderate risk. The following recommendations were provided: (i) Evaluation of Tenders needs to be done on monetarily quantifiable criteria (Clause 7 of tender document for Public Supplies Contract - Open Procedure), (ii) Consultancy services of intellectual nature are not covered appropriately by PPL; (iii) PPL has a limitation period of 1 year for bidder s complaints which is too long and needs to be modified; (iv) An implementing regulation is required to clarify provisions of public procurement law regarding contracts exempted from the law Article 5(1) c) for contracts awarded pursuant to an agreement under which the particular procedure of an international lending or donor organization applies ; (v) Tender document should include General Conditions of Contract, Special Conditions of Contract and Contract Agreement Form; (vi) Tender Document provisions for Qualification criteria: In case of Joint Venture; (vii) Partnership with private sector is missing; (viii) Procurement competence among staff of the procuring entities needs to be improved. However, only minor changes were introduced in revised PPL in February Procurement Capacity Assessment: The project will be implemented by two Project Implementation Units.(PIUS), one for the Federation (FBiH) and one for RS. For the Federation, OdRaz Foundation will function as the Project Implementation Unit. For Republica Srpska, the RS Investment Development Bank (RSIDB) will function as the Project Implementation Unit. 4. An assessment of the PIUs capacity to implement project procurement was conducted by the Bank and it is included in the project file. After completing the assessment summary of the main findings are : At present both PIUs are responsible for on-going implementation of multi projects funded by the World Bank, and they have a record of good knowledge of World Bank procurement rules, procedures and bidding documents that they have acquired during the implementation of previous and current Bank projects. 5. The procurement process under the sub-loans shall be carried out by the relevant final borrowers following their commercial practices, acceptable to the Bank. In case of procurement under sub-loans, OdRaz Foundation and RSIDB will be responsible for ensuring that the procurement rules for sub-loans and leases specified in the Loan agreement and the Operations Manual are followed by the final borrowers. OdRaz Foundation and RSIDB will also be 71

73 responsible for reviewing and monitoring the compliance with the procurement rules by the PFIs and their final borrowers (beneficiary enterprises). Specialists assigned for the procurement arrangements within the PIU teams will be responsible for all procurement oversight for the management of the project. All of them have substantial experience in procurement both in terms of commercial practices, public procurement, and World Bank procurement rules and procedures, as some of them are currently working on another World Bank financed project implemented by OdRaz Foundation and RSIDB. The documents related to the working capital expenditures will be kept by PFIs and these documents will be provided to the Bank whenever requested. The World Bank will conduct regular post reviews of the sub-projects not requiring a prior review. The PIU teams will be responsible for assembling the documentation related to specific procurement transactions from the PFIs and final borrowers in order to facilitate the Bank s reviews 6. The World Bank procurement staff will be in close interaction with the PIU teams at OdRaz Foundation and RSIDB during the implementation of the Project, and will monitor the staffing, document quality, review procedure and archiving of the procurement documents. The World Bank s procurement specialist will arrange procurement trainings to relevant staff in OdRaz Foundation, RSIDB and PFIs upon their request. 7. Commercial Practices: Private Sector Procurement Practice in Bosnia and Herzegovina: It was determined that there are established commercial practices for the procurement of goods, works and services by the private sector enterprises, autonomous commercial enterprises and individuals. Most large companies have procurement or purchasing departments, of which some are subdivided along product lines (raw materials, components, etc) and fixed assets (buildings, manufacturing facilities, etc). The majority of firms have purchasing arrangements and practices, such as corporate ethics, policies and procedures, internal purchasing rules, computerized purchasing management system. Contracts are awarded through comparison of three to five quotations depending on the value of the contracts, based on a combination of evaluation criteria such as price, quality, delivery, maintenance, commercial conditions and reference for past performance. Standard forms of contracts are used. Larger companies source the majority of new suppliers primarily through trade journals, internet, etc. Some companies periodically advertize new tender opportunities in the national press. Smaller companies often favor awarding contracts by direct negotiations without a tender process. In case of goods, the local practice is to prepare the technical specifications and solicit quotations from the local and/or international market. In case of medium and large works, the technical specifications are usually prepared by consultant companies and bids are collected from qualified contractors. Minor works are generally tendered on a lump sum basis by collecting bids from a number of local contractors. When equipment and machinery is needed for expansion of existing facilities, the purchasers usually prefer proprietary goods from a single source for the sake of standardization and minimization of the operation and maintenance cost. Therefore, the local private sector or commercial practices can be considered to be consistent with the World Bank s criteria with respect to economy and efficiency. The general rule in the sector is to procure the least cost goods, works and services consistent with minimum quality requirements. 8. Given the uncertainty of commercial relationships in the aftermath of the war, the prevalence of corruption and the business community s lack of faith in the judiciary to enforce contractual obligations, commercial purchasing practices are characterized by aversion to risk, leading to 72

74 increased value being placed on long-term trading relations with trusted suppliers. Competitive tendering by private companies is rare. C. Procurement risk assessment 9. The overall procurement risk is rated moderate. The risks associated with procurement and the mitigation measures are summarized in the table below: Table 1: Risk Assessment Summarv Description of risk Ratinga of risk Mitigation measures Ratinga of residual risk The final borrowers for the project are entirely private sector entities from different sectors. Commercial practices may vary in sectors and size of the entities. Some entities may not have capacity or experience in carrying out a streamlined procurement process. There is a risk of procurement of second hand goods and/or goods and works from the negative list. Substantial The overall procurement risk can Moderate therefore be mitigated by: (i) Operations Manual to define the threshold for commercial practices and to elaborate in detail the steps and applicable documents for commercial practices, acceptable to the Bank, which will be followed by the final borrowers ; (ii) training the PIUs (at OdRaz and RSIDB), PFIs and beneficiaries in the application of those procedures, as well as the procurement procedures of the Bank which will be followed for contracts above the threshold for commercial practices; (iii) intensified supervision efforts on part of the Bank team during the life of the project; (iv) clear definition of expenses eligible to be financed from the loan; (v) clear definition of the goods and works included in the negative list. vi) Procurement of second hand goods will not be permitted. D. Procurement implementation and arrangements 10. Procurement under the Sub-loans will be carried out by the final borrowers. Detailed procedures, roles and responsibilities to be followed are elaborated in the Operations Manual E. Procurement of Goods and Works Sub-Proiects 11. Procurement of Goods and Technical Services: Procurement of goods and technical services, other than consultant services financed under the proposed project will be according to the World Bank Procurement Guidelines. For contracts below EUR million per contract, 73

75 established local private sector commercial practices will be followed in accordance with paragraph 3.12 of the Procurement Guidelines. Care has to be taken of other relevant factors such as time of delivery, efficiency, quality, reliability and reasonableness of price of the goods and in case of non-consultant services, of the quality and competence of the parties rendering them. Advertising in the local and international press will not be mandatory for contracts up to EUR million per contract. However, International Competitive Bidding (ICB) would be required for individual contracts equivalent and above EUR million per contract for goods and services, other than consultant services in accordance with Section I1 of the World Bank's Procurement Guidelines. Contracts placed by final borrowers on their subsidiary or affiliated companies will not be eligible for financing out of the Loan. The procurement of the second hand goods is not eligible for financing out of the Loan. 12. Procurement of Works: Procurement of works financed under the proposed project will be according to the World Bank Procurement Guidelines. For civil works estimated to cost less than EUR 0.75 million per contract, established local private sector commercial practices will be followed in accordance with paragraph 3.12 of the World Bank's Procurement Guidelines. Care has to be taken of the capacity of the contractors and the cost and quality of the works. Advertising in the local and international press will not be mandatory for contracts up to EUR 0.75 million per contract. For contracts equivalent and above EUR 0.75 million per contract, International Competitive Bidding (ICB) would be required for individual contracts in accordance with Section I1 of the World Bank's Procurement Guidelines. All ICB contracts for works shall be subject to prior review by the World Bank. Contracts placed by sub-borrowers on their subsidiary or affiliated companies will not be eligible for financing out of the Loan. 13. Operating Costs: These expenditures would cover training of staff on financial management and procurement, consultancy services to support creditworthiness analysis and sub-project appraisal, project monitoring and evaluation, operating costs, office equipment, and other incremental cost as necessary which would be financed by the project as per annual budget, approved by the Bank and would be procured in accordance with the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" published May 2004 and revised in October 2006 (Procurement Guidelines), "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated May 2004 and revised in October 2006 (Consultant Guidelines), and ECA thresholds. 14. Also, operating costs means reasonable and necessary incremental expenditures related to the operation of the PIUs, including on account of Project implementation, management, and monitoring and evaluation, as approved by the Bank on the basis of budgets acceptable to the Bank, which would not have been incurred absent the Project and include, inter alia, the costs of (i) maintenance and operation of equipment and vehicles procured or used for the management of the Project; (ii) salaries paid to staff hired for the purposes of the Project, other than civil servants' salaries; (iii) travel costs and per diems; (iv) consumable office supplies; (v) costs of translation and interpretation; (vi) bank charges; and other miscellaneous costs as may be agreed with the Bank. 74

76 F. Procurement Plan and General Procurement Notice 15. Because of the demand-driven nature of the project, it is neither possible to estimate the subborrowers nor their procurement requirements at the appraisal stage. Therefore, it is not possible for the borrower to develop a Procurement Plan which provides the basis for the procurement methods. Similarly, since the contract sizes and the methods cannot be estimated it is not possible to prepare and publish a General Procurement Notice for the Project. It is expected that each sub-borrower will provide a list of procurements planned under the sub-loan in the format indicated in the Operations Manual. In case any sub-project includes ICB, special procurement notice will be published in accordance with the Procurement Guidelines. G. Frequency of Procurement Supervision and Review Procedures 16. The Bank will review the procurement arrangements proposed/performed by the PFIs and supervised by OdRaz and RSIDB every year, including contract packaging, applicable procedures, and the scheduling of the procurement processes, for its conformity with the commercial practices of the PFIs and the World Bank Procurement Guidelines, the proposed implementation program and disbursement schedule. (a) Prior Review: The following procurement action and documentation would be subject to Prior Review by the Bank in accordance with the procedures set forth in paragraphs 2 and 3 of Appendix 1 to the World Bank Procurement Guidelines. For Contracts awarded through ICB; prior review of all Bidding Documents, Bid Evaluation Reports, Recommendations of Contract Award and draft Contract will be conducted. For Contracts awarded through Commercial Practices; prior review of the first two contracts will be conducted by OdRaz and RSIDB for each PFI. (b) Post Review: The procurement documents for all other contracts shall be subject to the World Bank s post review in accordance with the procedures set forth in paragraph 5 of Appendix 1 to the World Bank Procurement Guidelines on a random basis. Post review of the procurement documents will normally be undertaken during the World Bank supervision mission or as the Bank may request to review any particular contracts at any time. In such cases OdRaz and RSIDB shall provide the Bank for its review the relevant documentation. The post review shall be conducted by the Bank s Procurement Specialist. Table 2: Thresholds for Procurement Methods and Prior Review (EUR) Expenditure Category ICB Commercial Practice Thresholds I Sub-1oans I I Goods Civil works Consulting Services (Firms and Individuals) No threshold (apply when needed) No threshold (apply when needed) less than EUR million less than EUR 0.75 million less than EUR million 75

77 Annex 9: Economic and Financial Analysis BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance 1. The economic impact at the project level will be measured post-factum, based on evaluation of the expected development results, as elaborated in the Results Framework. 2. Financial analysis on a subproject-by-subproject basis will be performed as part of the appraisal of eligibility of individual subprojects and final borrowers. Financial assessment will also include appraisal of creditworthiness of final borrowers and of their capacity to bear the interest rate and currency risks. The appraisal of final borrower s creditworthiness would include the following: 0 Appraisal of final borrower s business strategy and future perspectives. 0 e e e e 3. In Review of final borrower s major markets, their stability and future perspectives. Assessment of sources of final borrower s competitiveness (for example, if it is price competitiveness, is this based on labor or on cheap raw materials, e.g., wood) and its robustness. Assessment of final borrower s financial condition and profitability. This will specifically include assessment of all outstanding liabilities, including contingent liabilities, and of past payment discipline. Risk directly undertaken by the final borrower, Le., how high is commitment to the project. Nature and value of collateral. addition to project viability and credit risk assessment, sensitivity analysis will be performed for each subproject, including sensitivity to exchange rate devaluation, to price decreases in the expected producthervices market and to increase in operating cost. For the worse-case scenario, whereby the combined negative impact of changes in the three price categories subject to sensitivity analysis adds to 25 (say, simultaneous devaluation of 5%, production cost increase by 10% and output price decrease by lo%), the subproject s financial rates of return is expected to stay over 10%. 4. Financial analysis of participatingfinancial institutions (PFI) was performed in the context of Bank s OP 8.30 appraisal. The appraisal of all interested banks was in the process of project preparation and a simpler version of the appraisal will be repeated annually to ensure the PFIs continue to meet the eligibility criteria. Financial analysis related to the assessment of eligibility (criteria for potential PFIs are described in Appendix 4.2) included assessment of capital adequacy, liquidity, profitability and bank s risk profile (expected that will allow the bank to maintain the value of its capital)18 and the quality of credit portfolio. Eligible banks must have well defined policies and written procedures for management of all types of financial risks (liquidity, credit, currency, interest rate and market risk, as well as risks associated with balance sheet and income statement structures). l8 Maintaining the value of its capital means that the bank is adequately provisioned for the level of risk it is taking and that the bank s retained earnings are at least at the level of inflation. 76

78 Annex 10: Safeguard Policy Issues BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance 1. A summary of the Environmental Safeguard Review Framework (hereafter Framework ) which describes procedures Participating Financial Intermediaries (PFIs) and the Project Implementation Units (PIU s) shall apply to sub-projects to be financed under the Project with regard to Environmental Assessment (EA) issues is presented below: 2. Subproject Environmental Assessment Procedures: The eight elements of sub-project EA procedures are listed below: 0 Compliance with FBiH/RS EA requirements Screening 0 Documentation 0 Public Consultation Disclosure 0 Review and Approval 0 Conditionality 0 Monitoring and Reporting 3. Details of procedures required for each of these elements are subsequently described. 4. Compliance with FBiWRS EA Requirements: The PFI must demonstrate that all FBiH/RS EA requirements have been met. The final borrowers will be responsible for meeting FBiH/RS EA requirements and confirming that any and all environmental clearances, permits, licenses, etc. necessary for the sub-project have been obtained from the relevant authorities as prescribed in FBiWRS legislation. 5. Screening: Sub-projects will be screened by the PFI into one of the following four screening categories: Category I (Low Risk): subprojects whose environmental impacts are expected to be negligible, for which no environmental evaluation will be required. All working capital sub-loans, by definition, are to be considered Category I. Category I1 (Intermediate Risk): sub-projects with impacts that can be readily identified and standard preventative and/or remedial measures can be prescribed without a full EIA. Mitigating measures are standard and are usually just good housekeeping or good engineering practice. Category I11 (High Risk): sub-projects which may have potential and highly significant or irreversible environmental impacts, the magnitude which are difficult to determine at the project identification stage. Furthermore, any sub-project subject to a full EIA under BiH/RS regulations would be regarded as high risk. Category IV: sub-projects or enterprises involved in the manufacture or use of dangerous or illegal materials 77

79 6. The PFI will first determine if the existing enterprise is involved with production or manufacture of certain prohibited industries/products as presented in the IFC Exclusion List. Any existing enterprise or proposed subproject that would involve these industries or products are considered to be Category IV and are ineligible for financing under the Project. 7. Next, the PFI will evaluate the sub-project against Environmental Risk Screening Criteria. If a sub-project is determined to have one or more criteria as High Impact the PFI in close consultations with the PIU will assign the sub-project Category I11 (High Risk). Any subproject assigned Category 111 will be ineligible for financing under the Project. 8. Any sub-project which the PFI determines to have impacts that are modest (of limited extent, temporary and readily managed with conventional construction or operational practices) should be assigned Category I1 (Intermediate Risk) or if the impacts are minor or so negligible that no particular measures for environmental protection are needed the PFI should assign the project Category I (Low Risk). Only Category I or Category 11 Sub-projects would be eligible for Jinancing under the World Bank project. 9. Documentation: Following environmental screening conducted by the PFI, an Environmental Management Plan (EMP) would be required for Category I1 sub-projects. For some subprojects, the PFI in close consultations with the PIU may consider that all the detailed EMP information requirements may be excessive and that certain items are either obvious or inappropriate. For simpler subprojects with few or one item presenting a modest impact, an abbreviated EMP would suffice. In the minimal case, the EMP would only consist of a Mitigation Plan, and the results of the Public Consultation. 10. The sub-borrower is responsible for preparing the EMP 11. If a Preliminary EIA was prepared by the sub-borrower to meet FBiH/RS Environmental Assessment requirements, this documentation should be used to prepare the EMP. The PFI should check the Preliminary EIA and the EMP to insure, as a minimum, consistency in terms of: (a) identifying the same priority environmental issues, mitigating measures and implementing responsibility, (b) monitoring program, (c) institutional arrangements for environmental management. 12. Public Consultations: The final borrower is responsible for the public consultation. FBiH and RS EA regulations include public consultation as part of the procedure for preparing the preliminary EIA. the PFI should review the documentation of the public consultation conducted in the preparation of the Preliminary EIA to assess whether or not that documentation for the public consultation already conducted contains the necessary information 13. In a very few situations, sub-projects may have modest environmental issues, but the PFI in close consultations with the PIU may determine that the existing documentation for public consultation is not adequate. In these situations, the PFI may request the final borrower to repeat and carefully document the public consultation consistent with World Bank requirements. 78

80 14. Disclosure: The final borrower is responsible for disclosing the EMP in a public place near the project site or on the enterprise website. 15. Review and Approval: The PFI is responsible for reviewing and approving the EMP. Only after receiving written EMP approval would subprojects be eligible for Project funds. 16. Conditionality: The PFI will include final borrower commitment to obey requirements set forth in the EMP into any subproject loan agreement. The sub-borrower will be required to ensure that the sub-project is carried out with attention to good environmental management and in accordance with the Environmental Safeguard Review Framework. 17. Monitoring and Reporting: As part of normal supervision activities the PIU will perform supervision functions to assure compliance by the final borrower with environmental obligations specified in the sub-project loan agreement, the EMP and the Environmental Safeguard Review Framework. 18. All PIUs subprojects performance reports will include an environment section. 79

81 Annex 11: Project Preparation and Supervision BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance Planned Acutal PCN review 02/19/ /19/2009 Initial PID to PIC 05/28/ /08/2009 Initial ISDS to PIC 05 /20/ /23/2009 Appraisal 08/05/ /21 /2009 Negotiations 10/12/ /27/2009 Board/RVP approval 12/03/2009 Planned date of effectiveness 05/01/2010 Planned date of mid-term review Planned closing date 07/31 /2014 Key institutions responsible for preparation of the project: The Ministry of Finance and Treasury of Bosnia & Herzegovina; The Ministry of Finance of the Federation of Bosnia & Herzegovina; The Ministry of Finance of the Republika Srpska Bank staff and consultants who worked on the project included: Name Title Unit Irina Astrakhan Lead Private Sector Dev. Spec ECSFl Sonja Brajovic-Bratanovic Financial Sector Specialist ECSFl Rinku Chandra Sr. Strategy and Ops Officer ECAVP Haris Mesinovic Private Sector Dev. Specialist ECSFl Esma Kreso Environmental Specialist ECSS3 Tarik Sahovic Private Sector Dev. Specialist CICRS Goran Tinjic Sr. Operations Officer ECSBA Tatiana Segal Operations Officer ECSF 1 Nikola Kerleta Procurement Analyst ECSC2 Lamija Hadzagic Financial Management Specialist ECSC3 Aha Tourkova Consultant ECSFl Bank funds expended to date on project preparation: 1. Bank resources: US$135, PHRD: US$170, Total: US$305,802 Estimated Approval and Supervision costs: 1. Remaining costs to approval: US$25, Estimated annual supervision cost: US$90,000 80

82 Annex 12: Documents in the Project File BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance Update: PSD JTF093099) for PSD Technical agenda -rest of Enhancing SME Mission - week - all mtgs Access to Enhancing SME confirmed Finance Proiect Access to (P111780) Finance Proiect - The conclusions Aide Memoire from the BE Re: PSD round table AND Technical PSD schedule THE FIRST Mission - SME Access to PSD Preparation DISTRIBUTION Finance Pro-iect, Mission - TO "BOSNIA Feb 12-20,2009 Enhancing BEE TEAM" DL SME signed contract Nermin Oruc Re: Bosnia / PHRD Grant TF / form 384 and related documents - Activity 01 RESENDING WITH CORRECT ATTACHMENT: PSD Preparation Mission - Enhancing SME Access to Finance Proiect - Mission Announcement Letter Request for Comments on the Concept Stage ISDS Re: Technical Mission letter - PHRD Grant Access to Re: PSD mission Finance Proiect - - support related Mission to financial crisis Announcement Re: Minutes of Letter - the PSD mission to Environmental BiH, September Safeguards Framework Mission AM and consultations cover letter today PSD final Re: Fw: Request mission schedule for statistics for - travel BiH Agency for arrangements in Statistics Bania Luka Re: Draft Mission Announcement letter - signed and distibuted PSD: Letter for FBiH commercial banks- proposed credit line for SME/Export support Pro-i ect Information Document (Concept Stage) - Enhancing Competitiveness, Private Sector Development & Reducing Business Regulatory Barriers - P

83 Proiect Information Document (Appraisal Stage) - Enhancing SME Access to Finance - P Proiect Concept Note Data Sheet - Enhancing Competitiveness, Private Sector Development & Reducing Business Regulatory Barriers - P Proiect Concept Note - Enhancing Competitiveness, Private Sector Development & Reducing Business Regulatory Barriers - P Pro-i ect Appraisal Document Data Sheet - Enhancing SME Access to Finance - P Proiect Appraisal Document - Enhancing SME Access to Finance - P Private Sector Development Preparation Mission - Enhancing SME Access to Finance - Aide Memoire Preparation of Enhancing SME Access to Finance Project - Public Consultation on Environmental Safeguards Framework, letter and documents PHRD Grant Approval Monthly Operational Summary- P Jun Monthly Operational Summarv- P Jul Mission agenda, august 17-19, 2009 Minutes of the Environmental Safeguards Framework consultations today Management Letter to Commercial banks for proposed World Bank Credit Line for SME/Export Support Letter:Bosnia & Herzegovina - Enhancing SME Access to Finance proiect-notification of Appraisal Mission Letter to MCO Sunrise Letter from RS MoF, Expression of Interestaction required Letter from RS Ministry of Finance re preparatory mission for PSD- Enhancing SME Access to Finance - Aide Memoire, comments Letter-response to RS MoF on the Enhancing Access to Finance SME Proiect letter fr4om NLB Razvoina Banka Intesa confirms interest for participation in the proiect Integrated Safeguards Data Sheet (Concept Stage) - Enhancing Competitiveness, Private Sector Development & Reducing Business Regulatory Barriers - P Integrated Safeguards Data Sheet (Appraisal Stage) - Enhancing SME Access to Finance - P HYPO Alpe Adria Mostar confirms interest in the proiect 82

84 Fw: URGENT: BiH PHRD application clearance Fw: Re: izvi estai -Hypo Alpe Adria bank BL Doing Business, letter to PM Brankovic Deliverables from Maya Gramenopoulos Decision Package Review Meeting Concept Review Package Comments from LEG re Decision Package Review Meeting - P BOSNIA AND HERZEGOVINA: Minutes of Concept Review Meeting, - Enhancing SME Competitiveness & Access to Finance Proiect (P111780) BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance Project JP ) - Minutes of the Decision Meeting BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance Project JP111780)Terms of Reference - Pre- Appraisal Mission BOSNIA & HERZEGOVINA: Enhancing SME Access to Finance Project JP111780) - Technical Mission; PHRD Grant Enhancing SME Access to Finance (TF093099) - Supervision MissionTerms of Reference Bosnia and Herzegovina: Private and Financial Sector Development JP )Mission TOR Back-to-Office Report for Identification Mission Appraisals for BiH Banks: HYPO BL, Rai ffei sen, Intesa, NLB Razvo-ina, NOVA BL, UNI Credit BL Anteia ECG Re: Bosnia / PHRD Grant TF / form 384 and related documents - Activity 05 PHRD SME access to finance grant - audit request letter Bosnia and Herzegovina: Enhancing SME Competitiveness and Access to Finance - P Safe mards Meeting Minutes (FINAL) 83

85 Annex 13: Statement of Loans and Credits BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance Project ID FY Purpose P Solid Waste Mgmt 2 P ROAD INFRASTRUCTURE AND SAFETY PROJECT P AGRJRURAL DEVELOPMENT P AVIAN FLU - BA PO ECSEE APL3-BiH PO LAND REGISTRATION PO HLT SEC ENHANC PO URB INFRA & SERV DEL PO FOREST DEVTKNSRV TA PO SM SC COM AGRIC PO SOLID WASTE MGMT PO COMM DEVT Original Amount in US$ Millions Difference between expected and actual disbursements IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev d Total: BOSNIA AND HERZEGOVINA STATEMENT OF IFC s Held and Disbursed Portfolio In Millions of US Dollars Committed Disbursed IFC IFC FY Approval Company Bosnalijek Bosnalijek Bosnalijek Energoinvest Enterprise Fund FCL HVB CPB HVB CPB MI-BOSPO Nova Banka Procredit Bosnia Raiffeisen-BOS Raiffeisen-BOS Raiffeisen-BOS SEF Akova SEF Lijanovici Loan Equity Quasi Partic Loan Equity Quasi Partic

86 1977 TKA Cazin Wood Konjuh Total portfolio: Approvals Pending Commitment FY Approval Company Loan Equity Quasi Partic Lukavac MI-BOSPO EKI Bosnia , 2006 Nova Banka Total pending commitment:

87 I_x_ - ~ Lowr-middle-income ~ I_. POVERTY and SOCIAL Annex 14: Country at a Glance BOSNIA AND HERZEGOVINA: Enhancing SME Access to Finance 2007 P 0 pulatio n. mid-year (millions) 3.8 GNIpercapita (Atlas method, US$) 3,790 GNI (Atlas method, US$ billions) M.3 Average annual growth, Population (Sy 0.3 Lab0 r fo rce [%) 0.7 Most recent estlmate (latest year available, 200l-07) Poverty (%of populatio n below natio nal po vertyline) 20 Urban population [%oftotalpopulation) 47 Life expectancyat birth (pars) 75 Infant mortality (per looolive births) 13 Child malnutrition (%of children under5) 2 Access to an improvedwatersource(%ofpopulatlon) 99 Literacy (%ofpopulation age SY Gross primary enroliment (%of school-age population) Male Female KEY ECONOMIC RATIOS and LONG-TERM TRENDS GDP (US$ billions) Gross capital formation/gdp Exports of goods and services/gdp., 27.8 Gross domestic savings/gdp Gross national savings/gdp.. ns Current account baiance/gdp Interest payments/gdp Total debt/gdp Total debt service/exports Present value of debt/gdp Present value of debtlexports (averageannualgrowth) GDP GDP percapita Exports of goods and services Bosnla Europe h Lowerand Central mlddle- Herzegovlna Asla Income 445 6,052 2, D , m m a P.6 D.2 Development dlamond' Life expectancy T 1 Access to improved water source Bosnia andherzegovina group X~WX- Trade 1 Indebtedness Bosnia andhenegovina Lo uer-middle-income group STRUCTURE of the ECONOMY (%of GDP) Agnculture Industry Manufacturing Services D ng Growth of capltal and GDP (Oh) Household final consumption expenditure General gov't final consumption expenditure imports of goods and services OB 07 GCF -GDP [average annuaigrowth) Agriculture Industry Manufacturing Services Growth of exports and Imports (X) T Household final consumption expenditure General gov't final consumption expenditure Gross capital formation Imports of goods and services D l70 Note 2007 data are preliminary estimates This table was producedfrom the Development Economics LDB database 'Thediamonds showfour key indicators inthecountry(in bold) compared withits income-groupaverage K data are missing thediamondmll be incomplete 86

88 Bosnia and Herzegovina PRICES and GOVERNMENT FINANCE Domestic prices (%change) Consumer pnces Implicit GDP deflator DO Government finance (%of GDP. includes current grants) Current revenue Current budget balance Overall surplusldeficit I I GDPdeflator -CPI 1 TRADE (US$ millions) Totalexports (fob) n.a n a. Manufactures Totalimports (cif) Food Fuel and energy Capital goods Export pnce index(2000=00) Import price index(2000=00) Terms of trade (2000=00) , ,834 2, Export and import levels (US$ mill.) T I exports mlmpnrts I BALANCE of PAYMENTS [US$ millions) Exports of goods and services Imports of goods and services Resource balance , , ,518 13,553-5,035 Current account balance to GDP (X) Net income Net current transfers ) Current account balance ,395 Financing items (net) Changes in net reserves , Memo: Reserves including gold (US$ millions) Conversion rate [DEC, iocal/us$) , EXTERNAL DEBT and RESOURCE FLOWS 1987 (US$ millions) Total debt outstanding and disbursed IBRD IDA , Composition of 2006 debt (US$ mill.] Totaldebt service IBRD IDA Composition of net resource flows Official grants Official Creditors Pnvate creditors Foreign direct investment (net inflows) Portfolio equity(net inflows) 258 1) World Bank program Commitments Disbursements Pnncipal repayments Net flows Interest payments Net transfers A. IBRD E- Bilatwd B. IDA D - Other multilatwd F - Private C-iMF G. Short-teri Note This tablewas producedfrom the Development Economics LDB database 9/24/08 87

89 MAP SECTION