Completion Report. Project Number: Loan Number: 2224-KGZ December Kyrgyz Republic: Banking Sector and Capital Market Development Program

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1 Completion Report Project Number: Loan Number: 2224-KGZ December 2010 Kyrgyz Republic: Banking Sector and Capital Market Development Program

2 CURRENCY EQUIVALENTS Currency Unit som (Som) At Appraisal At Program Completion 19 November November 2009 Som1.00 = $ $ $1.00 = Som Som ABBREVIATIONS ACPCM Advisory Committee on Privatization through the Capital Market ADB Asian Development Bank GDP gross domestic product IAS international accounting standards JSC joint stock company KSE Kyrgyz Stock Exchange MOF Ministry of Finance MOU memorandum of understanding NBFSA Nonbank Financial Services Agency NBKR National Bank of the Kyrgyz Republic PCR Program Completion Report SAFSR State Agency for Financial Supervision and Reporting SCFRA State Commission on Financial Reporting and Auditing SCSM State Commission on Securities Markets SDR special drawing rights SOE state-owned enterprise TA technical assistance USAID United States Agency for International Development NOTE In this report, $ refers to US dollars. Vice-President X. Zhao, Operations 1 Director General J. Miranda, Central and West Asia Department (CWRD) Director D. Kertzman, Financial Sector, Public Management, and Trade Division, CWRD Team leader Team members W. G. Settle, Senior Financial Sector and Public Management Specialist, CWRD R. Barreto, Young Professional (Economics), CWRD M. Marcelino, Associate Operations Analyst, CWRD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

3 CONTENTS Page BASIC DATA i I. PROGRAM DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 1 A. Relevance of Design and Formulation 1 B. Program Outputs 2 C. Program Costs 6 D. Disbursements 6 E. Program Schedule 6 F. Implementation Arrangements 7 G. Conditions and Covenants 7 H. Related Technical Assistance 8 I. Consultant Recruitment and Procurement 8 J. Performance of Consultants, Contractors, and Suppliers 9 K. Performance of the Borrower and the Executing Agency 9 L. Performance of the Asian Development Bank 10 III. EVALUATION OF PERFORMANCE 10 A. Relevance 10 B. Effectiveness in Achieving Outcome 11 C. Efficiency in Achieving Outcome and Outputs 11 D. Preliminary Assessment of Sustainability 11 E. Institutional Development 12 F. Impact 12 IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 12 A. Overall Assessment 12 B. Lessons 12 C. Recommendations 13 APPENDIXES 1. Design and Monitoring Framework Historical Status of Compliance with Second Tranche Release Conditions Details of Estimated Adjustment Costs Training Workshops, Seminars, and Round Table Discussions Conducted on Securities Regulation, Supervision, and Enforcement Topics Assessment of Program Performance 51 SUPPLEMENTARY APPENDIX (available on request) National Bank of the Kyrgyz Republic Letter

4 BASIC DATA A. Loan Identification 1. Country 2. Loan number 3. Program title 4. Borrower 5. Executing agency 6. Amount of loan 7. Program completion report number Kyrgyz Republic 2224-KGZ Banking Sector and Capital Market Development Program Kyrgyz Republic Ministry of Finance SDR10,900,000 PCR: KGZ 1229 B. Loan Data 1. Appraisal Date started Date completed 2. Loan negotiations Date started Date completed 3. Date of Board approval 4. Date of loan agreement 5. Date of loan effectiveness In loan agreement Actual Number of extensions 6. Closing date In loan agreement Actual Number of extensions 7. Terms of loan Interest rate Maturity (number of years) Grace period (number of years) 8. Terms of relending (if any) Interest rate Maturity (number of years) Grace period (number of years) Second-step borrower 19 October October November November December May August August 2006 one 30 June November 2009 Two (31 October 2009, 30 November 2009) 1% per annum during grace period and 1.5% per annum thereafter 24 8 Not applicable Not applicable Not applicable Not applicable

5 ii 9. Disbursements a. Dates Initial Disbursement 27 October 2006 Effective Date 31 August 2006 Final Disbursement 20 November 2009 Original Closing Date 30 June 2009 Time Interval 37 months Time Interval 34 months b. Amount ($ million) Category or Subloan Original Allocation Last Revised Allocation Amount Canceled Net Amount Available Amount Disbursed Undisbursed Balance Total The total amount disbursed was more than the original allocation due to exchange rate fluctuation between $ and SDR. C. Program Data 1. Program cost ($ million) Cost Appraisal Estimate Actual Foreign exchange cost Total Financing plan ($ million) Cost Appraisal Estimate Actual Implementation costs ADB financed First tranche Second tranche Total ADB = Asian Development Bank. 3. Cost breakdown by program component ($ million): Not applicable 4. Program schedule Item Appraisal Estimate a Actual Release of first tranche January October 2006 Release of second tranche June November 2009 a ADB Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance Grant to the Kyrgyz Republic for the Banking Sector and Capital Market Development Program. Manila (Loan 2224-KGZ).

6 iii 5. Program performance report ratings Implementation Period Development Objectives Ratings Implementation Progress From 1 January 2006 to 31 December 2006 Satisfactory Satisfactory From 1 January 2007 to 31 December 2007 Satisfactory Satisfactory From 1 January 2008 to 31 October 2008 Satisfactory Satisfactory From 1 November 2008 to 31 December 2008 Satisfactory Partially Satisfactory From 1 January 2009 to 24 November 2009 Satisfactory Partially Satisfactory D. Data on Asian Development Bank Missions Name of Mission Date No. of Persons No. of Person-Days Specialization of Members Reconnaissance 3 13 Nov a, b, c Fact-finding 2 5 Mar a, c, d Fact-finding 2 12 Aug a, c, d Appraisal October a, a, c Program review Oct a Program review 7 14 Jun a Program review 27 Sep 4 Oct a Program review 31 Jan 4 Feb a Program review April a Program review Sep a Program review 27 Jan 10 Feb a Program review Jun a Program completion review a = economist/program officer, b = banking sector specialist, c = economics officer, d = counsel, e = project analyst.

7 I. PROGRAM DESCRIPTION 1. In December 2005, the Asian Development Bank (ADB) approved a program loan of $15.5 million 1 to the Kyrgyz Republic for the Banking Sector and Capital Market Development Program, and a capacity building technical assistance (TA) grant of $600,000 from the Japan Special Fund. 2 The program loan was disbursed in two equal tranches. The first tranche was released on 27 October 2006 after completion of all tranche release conditions. The second tranche was released on 20 November 2009, after full compliance of 11 core conditions and a waiver of full compliance of one condition. 2. The TA was designed to provide legal and technical advice and institutional development in the banking sector and capital markets. In the banking sector, the TA was designed to support the staff of the National Bank of the Kyrgyz Republic (NBKR) in implementing policy reforms, including the drafting of guidelines and protocols of enforcement and supervision. In the capital markets (stock and bond markets), the aim was to strengthen the capacity of the State Service on the Supervision and Regulation of the Financial Market 3 to apply international best practices in the regulation of capital markets and the nonbank financial sector. In addition to providing policy, legal, and technical advice to the new financial market agency, the TA advised the Financial Sector Regulatory Working Commission and the Advisory Committee on Privatization through the Capital Market (ACPCM) on privatization of state-owned enterprises (SOEs). 3. The impact of the program was expected to be more sustainable economic growth through improvements in financial intermediation. The expected outcome was a more efficient and balanced financial sector. The program included three components: (i) banking sector supervision, (ii) securities market supervision, and (iii) policy distortions in capital markets. The design and monitoring framework is in Appendix 1. II. EVALUATION OF DESIGN AND IMPLEMENTATION A. Relevance of Design and Formulation 4. The design of the program was generally consistent with the strategic plans of the government of the Kyrgyz Republic and ADB s country strategy. The Kyrgyz Republic s Comprehensive Development Framework and Poverty Reduction Strategy highlighted the role of the financial sector in ensuring high and inclusive economic growth. The government s main directions for Medium-Term Development of the Banking Sector and the Comprehensive Program for Securities Markets Reforms defined the objectives and strategies of further financial sector reforms, including (i) consolidating the banking system and increasing its competitiveness, (ii) strengthening risk management, (iii) introducing new banking and nonbanking financial products and services, and (iv) strengthening the transparency and efficiency of securities markets. The program was in line with ADB s country strategy and program update for the Kyrgyz Republic for , which emphasized the importance of 1 The US dollar amounts approved refer to the SDR equivalent at the time. 2 ADB Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance Grant to the Kyrgyz Republic for the Banking Sector and Capital Market Development Program. Manila (Loan 2224-KGZ). 3 The original policy matrix used the term NBFSA, which stands for Nonbank Financial Services Authority. This is essentially another name for the State Agency on Financial Supervision and Reporting (SAFSR) and its successor organization, the State Service on the Supervision and Regulation of the Financial Market (SSSRFM) collectively referred to herein as the financial market agency.

8 2 creating a conducive environment for private investment and the need to further strengthen the financial sector and deepen financial intermediation The rationale for the program was also supported by ADB s continuous commitment to develop the financial sector in the Kyrgyz Republic. ADB support has included substantial staff resources, loans, and TA. In 1997, the Corporate Governance and Enterprise Reform Program supported (i) enterprise efficiency, (ii) financial discipline in enterprises, (iii) domestic and international competition, (iv) the legal framework for insolvency and insolvency proceedings, (v) transparency in financial accounting and reporting, and (vi) mitigation of transition and social adjustment costs. 5 In 1999, the Financial Intermediation and Resource Mobilization Program helped to establish a legal and regulatory environment for the banking sector and resolved a number of problem banks. 6 The second phase of the Corporate Governance and Enterprise Reform Program, in 2001, addressed corporate governance and judicial reforms Building on the achievements of the above programs and other reforms undertaken by the government, the program aimed to further strengthen the financial sector through a holistic approach that addressed policy, legal, regulatory, and institutional impediments to higher levels of capital market activity. 8 B. Program Outputs 7. The program was designed to achieve eight outputs within the scope of three components: (i) banking sector supervision, (ii) securities market supervision, and (iii) capital market development. The eight outputs in the design and monitoring framework were: (i) facilitated enforcement of banking sector legislation and regulation, (ii) strengthened risk management and cross-border banking supervision, (iii) enhanced competition and innovation in the banking sector, (iv) strengthened institutional framework for financial sector supervision, (v) strengthened legal framework for securities markets, (vi) strengthened governance of securities markets, (vii) reduced distortions in the tax system that discriminate against corporate securities, and (viii) strengthened privatization policies. These outputs were the result of policy actions covered in section G, below (Conditions and Covenants). The core conditions for release of the second tranche are in Appendix There were 18 performance targets and measures related to outputs in the original program design and monitoring framework. Of the 18 targets, nine were achieved, five were not achieved, and four were indeterminate at program completion. Of the nine targets achieved, four were in the banking-sector component, two were in the securities market supervision ADB. Country Strategy and Program Update: Kyrgyz Republic, Manila. 5 ADB Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance Grant to the Kyrgyz Republic for the Corporate Governance and Enterprise Reform Program. Manila (Loan 1546-KGZ[SF], approved on 25 September, for $40 million). 6 ADB Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance Grant to the Kyrgyz Republic for the Financial Intermediation and Resource Mobilization Program. Manila. 7 ADB Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance to the Kyrgyz Republic for the Second Phase of the Corporate Governance and Enterprise Reform Program. Manila. 8 These previous ADB programs and TA supporting the financial sector have been deemed successful as per internal and independent reviews; see: ADB Completion Report: Financial Intermediation and Resource Mobilization Program in the Kyrgyz Republic. Manila; ADB Completion Report: Capacity Building in Corporate Governance and Insolvency Procedures in the Kyrgyz Republic. Manila; ADB Validation Report: Capacity Building in Corporate Governance and Insolvency Procedures in the Kyrgyz Republic. Manila; and ADB Technical Assistance Completion Report: Financial Sector Reforms in the Kyrgyz Republic. Manila.

9 3 component, and three were in the capital markets component (Appendix 1). The sector assessment undertaken at the time of this program completion report (PCR) notes that of the eight outputs expected, five were fully achieved in letter as well as spirit. The three other outputs have been partially achieved at the time of the PCR. Of these, two outputs promoting innovation and competition in the financial sector, and increasing transparency and disclosure need to be supported on an ongoing basis. The third output aimed to promote regulatory independence, defined as direct accountability to legislators. In this area, the program action had to be modified to conform to the Constitution of the Kyrgyz Republic. Hence, in terms of spirit, this output is reported as partially achieved at the time of this PCR. A summary of the salient program activities and inputs is presented below, along with a brief assessment of the outputs. 1. Component 1: Banking Sector Supervision 9. Output 1: Facilitated enforcement of banking sector legislation and regulation. This output has been achieved and sustained at the time of the PCR. The policy actions were quite relevant, and they were fulfilled in a satisfactory manner. Specifically, the following program inputs/actions contributed to the successful achievement of output 1: (i) (ii) (iii) NBKR structured institution-specific supervision plans for each commercial bank, and adopted and executed them; NBKR institutionalized targeted credit inspections in vulnerable banks, those with high risk ratings or fast credit growth; and credit and operational risk management of banks was improved, through fairly well-structured improvement programs. 10. Output 2: Strengthened risk management and cross-border banking supervision. The program inputs included the following: (i) (ii) cross-border agreements on consolidated supervision were implemented with home country supervisors of parent banks; and agreements incorporating all the necessary elements of the Basel Committee s recommendations on supervision of cross-border banking were put in place with the People s Republic of China, Kazakhstan, Pakistan, the Russian Federation, and Turkey. 11. Assessment: Output 2 was achieved, and it has been effectively sustained at program completion. The policy actions were comprehensive, relevant, and completed. They are also sustainable, as the NBKR continues to expand the scope of cooperation. It is in the process of signing a memorandum of understanding (MOU) with the Austrian Financial Market Authority on banking supervision. NBKR is also preparing a framework of crisis management measures with the Commission for Banking Supervision in the People s Republic of China Output 3: Strengthened competition and innovation in the banking sector. The program supported this output through the following actions: (i) NBKR institutionalized conservatorship and liquidation for banks that failed to meet capital adequacy requirements; 9 NBKR letter to ADB regarding progress after program completion dated 15 September 2010.

10 4 (ii) (iii) details of fees and charges for standard sets of products and services were made available on the NBKR website; and NBKR-mandated capital adequacy requirements for existing commercial banks were set at Som60 million and Som300 million for new banks, and the minimum levels were raised again in 2010 to Som100 million and Som600 million for existing and new banks, respectively. 13. Assessment: The discrete and targeted actions constitute essential building blocks for achieving competition and innovation in the sector, which is a continuous process. All the actions have been sustained at the time of the PCR. 2. Component 2: Securities Market Supervision 14. Output 4: Strengthened institutional framework for financial sector supervision. The program supported two specific actions: (i) (ii) Signing of two memoranda, on (a) cooperation and coordination arrangements among the members of the Financial Sector Regulatory Working Commission, and (b) information exchange between the NBKR and the financial market agency, which incorporate the Basel Committee s recommendations on key elements of a statement of cooperation between supervisors; and Adoption of regulatory guidelines on credit management and operational risk, and standards on market management and transfer risks. 15. Assessment: This output is also of an ongoing nature. The program actions all of which were fully completed and sustained on program completion formalized and helped institutionalize relations between the relevant authorities. Building on the actions, NBKR and the financial market agency are expected to strengthen policy and regulatory coordination. Adequate capacity is a key ingredient for sound institutional framework for supervision. The banking sector regulatory and supervisory framework has been improved since the transition, while the non-bank financial sector has continued to be small and nascent in the Kyrgyz Republic. Hence, continued advisory support will be required to bolster the sustainability of the program s achievements thus far. 16. Output 5: Strengthened legal framework for securities markets. The inputs under the program were: (i) (ii) enactment of legislation aimed at establishing the new financial market agency with independent and autonomous status in a manner comparable to NBKR; and improvement in the legal framework for the securities market, in line with International Organization of Securities Commissions recommendations. 17. Assessment: This output has been partially achieved. It was supported with the passage of two laws, one a framework type of law on the new financial market agency, and the other on the securities market itself. The original intent of the program was two-fold, to: (i) consolidate all non-bank financial sector regulatory and supervisory functions in one agency; and (ii) confer that agency with autonomy, resources and stature comparable to that of the NBKR, including accountability to Parliament. By establishing the new financial market agency with consolidated functions, the Government will conserve public resources significantly. However, as per the Kyrgyz Constitution, only five core bodies in the following areas are mandated to report to

11 5 Parliament: supreme audit, elections monitoring, prosecutorial services, ombudsman, and central banking. Hence, the legislation enacted provides for nomination of the head of the new financial market agency by the Prime Minister, and appointment by the President for a fixedterm of 5 years with clearly defined dismissal procedures. Remuneration levels of the agency staff will be on par with the Ministry of Finance, which will provide adequate incentives for them to perform effectively. Against this background, the agency will require support over the medium-term to attain autonomy in a practical and operational sense. The new securities law enacted under the program is judged to be adequate, and will help advance the objective of output Output 6: Strengthened governance of securities markets. The inputs were: (i) (ii) facilitating the adoption of, and adherence to, international accounting standards; and improvements in financial disclosure for listed companies. 19. Assessment: The objective behind output 6 has been partially achieved, in the sense that good governance in financial markets is a continuous process. A dedicated Board on Accounting and Auditing has been established, with clear authority to set national accounting and auditing standards and guidelines. Kyrgyz has long had a tradition of continuously aspiring for conformity with international accounting standards. The program actions have resulted in greater regulatory clarity. The full intent of this output will be achieved when the actions are implemented effectively. In the interim, the new board on accounting and auditing standards will ensure compliance with regulatory requirements, while the financial market agency will monitor disclosure. The actions will pave way for self-regulation over time. Yet, effective self-regulation is evolving gradually in the country. Hence, the program s focus on and support for greater regulatory clarity is an essential step. 3. Component 3: Policy Distortions in Capital Markets 20. Output 7: Reduced distortions in the tax system that discriminate against corporate securities. The policy action was the adoption of a new tax code, to bring about a rationalized tax regime for government and corporate securities by establishing a zero tax rate for interest on both government and corporate securities and for dividends and capital gains from investments in listed companies. 21. Assessment: Output 7 was fully achieved, and progress has been sustained at the time of the PCR. This action is a major step, since the zero rate will also eliminate complications in compliance and costs of enforcement. If sustained, the action will have a significant beneficial impact on capital market development. 22. Output 8: Strengthened privatization policies. The inputs included: (i) (ii) amendments made to the privatization law to establish the government as the approval authority for privatization programs; and a privatization program, which foresees the listing of selected SOEs, that was submitted to the government by the State Committee for Privatization was approved. 23. Assessment: Output 8 was achieved. After initial delays, ACPCM began to meet regularly to discuss privatization of SOEs through the capital markets. Its focus has been on the

12 6 following: (i) adopting a privatization program for ; (ii) draft legislation on the privatization of SOEs through the stock exchange; (iii) revaluation of SOE assets in light of existing market prices; (iv) listing of companies with state-shareholding of more than 30%; (iv) transformation of SOEs in open joint stock companies; and (v) the step-by-step divesture of SOEs over a 3 5-year period that were not of strategic importance, had been profitable in 2 of the past 3 years, and could be sold through the stock exchange at fair market prices. Although no transactions have taken place, the policy and laws are in place. Further policy dialogue will be required to sustain the progress made thus far. C. Program Costs 24. The SDR10.90 million ($15.50 million) loan was from ADB s Special Fund resources, with a term of 24 years, including a grace period of 8 years and an interest charge of 1% per annum during the grace period, and 1.5% per annum for the remaining period. The actual amount disbursed was $16.73 million, nearly 8% more than the $15.50 million original US dollar equivalent. The difference in US dollar values was due to changes in the US dollar exchange value in SDRs at the time of disbursement. 25. The advisory TA (see section H below), of $600,000, was financed by the Japan Special Fund. The amount utilized was $561,042 or 94%. The government s contribution was $110, ADB staff resources in support of the program totaled 170 person-days. Implementation required 76 person-days and preparation required 99 person-days of staff resources. These quantities underestimate the actual resource costs because they do not include person-days spent on the program by staff at headquarters. 27. The cost of reforms was expected to include certain adjustment costs to the government, estimated at $35 million. These costs were in addition to the political costs of implementing the reforms and costs to the private sector for compliance. The report and recommendation of the President outlined elements of the adjustment cost in detail (see Appendix 3). D. Disbursements 28. The first tranche of SDR5.45 million ($8.01 million) was disbursed on 27 October The second tranche of SDR5.45 million ($8.72 million equivalent on date of disbursement) was disbursed on 20 November 2009, a delay of 29 months from the original expected release date of June Since the loan signing was substantially delayed (the loan was approved on 20 December 2005, but was not signed until 23 May 2006), the timing of loan effectiveness and disbursals shifted from initial expectations. E. Program Schedule 29. As per the original design, the overall program period was to be 3 years (from December 2005 to November 2008). The loan became effective on 31 August 2006, 8 months after the loan was approved on 20 December The policy reforms supported under the program included 23 first-tranche conditions, 21 of which were completed prior to loan approval. The government complied with the two remaining conditions in April Although the conditions for the first tranche had been met by the government, the loan only became effective 4 months after the first tranche conditions had been met, because the Ministry of Finance (MOF) submitted the required documentation late (i.e., the government s legal opinion following ratification of the loan agreement by the President of the Kyrgyz Republic).

13 7 30. The second tranche was disbursed 29 months after the original expected date of June 2007 due to constitutional issues, legal reviews, reshuffling of personnel in key implementing agencies, and volatile political and economic conditions 31. The TA was approved on 20 December 2005 and signed on 12 January 2006; consultants were fielded on 1 March The completion date for the TA was expected to be 31 December 2007; the actual date was 30 September This was primarily due to the delayed application of TA resources in meeting conditions under the loan agreement because of political uncertainty and frequent changes in government leadership. Therefore, despite intensive policy dialogue and awareness- and capacity-building efforts, the pace of technical support did not proceed as quickly as anticipated. F. Implementation Arrangements 32. The MOF was the executing agency for the program loan, while NBKR and the SAFSR were the implementing agencies. The government established a coordinating commission under the Regulatory Working Commission comprising representatives from the MOF, the NBKR, and the Service. The roles of the Regulatory Working Commission were to: (i) facilitate and coordinate the development, regulation, and supervision of the financial sector; and (ii) act as a steering committee for the program s implementation. The coordinating commission was to meet every quarter to ensure the effective implementation of the proposed reforms and was to be supported by the Regulatory Working Commission s Secretariat. 33. The Secretariat was responsible for monitoring and reporting implementation, supporting the activities of the Regulatory Working Commission in coordinating the program, and participating in the working groups it established. The secretariat was largely inactive until 2008 due to a lack of leadership and ownership of the monitoring responsibility. ADB review missions would normally trigger actions. G. Conditions and Covenants 34. All 23 first-tranche conditions were completed. Of the 12 core second-tranche release conditions, 11 were fully complied with. 10 The government partially complied with the remaining action under output 5 (S17 in Appendix 2). Of the 19 monitorable actions under the second tranche, the government fully complied with 14, while substantial work was achieved toward compliance of the remaining actions ADB staff s assessment in October 2009 was that the government has partially complied with the action on establishing a nonbank financial services agency as an independent regulatory and supervisory body with authority, status, and governance similar to that of the central bank (NBKR). The framework law provided for the establishment of the new agency as a separate entity, but not with the same stature enjoyed by NBKR. While the government remained committed to regulatory autonomy for the securities market regulator, a 2007 amendment to the Constitution of the Kyrgyz Republic stipulated that only five core bodies had this level of autonomy and a mandate to report to Parliament. 12 This numerical limit effectively excluded the new agency from this level of autonomy. Further, the government was concerned Core conditions are actions required by the loan agreement for tranche release. Monitorable actions are used to indicate the level of progress and to alert the government and ADB to possible needed adjustments to improve implementation. The existing five core bodies are: (i) supreme audit, (ii) elections monitoring, (iii) prosecutorial services, (iv) ombudsman, and (v) central bank.

14 8 that given the nascent state of the Kyrgyz Republic s nonbank financial sector, the agency would not have resources comparable to those of the NBKR. Based on these justifications and a consideration of the progress made within the context of the current state of development of the Kyrgyz Republic s financial sector, the government sought a waiver of full compliance. H. Related Technical Assistance 36. The program included a TA grant of $710,000 (government share $110,000, ADB share $600,000) to assist the government in implementing the reforms under the program. The TA was designed to (i) strengthen regulation and supervision of the banking sector in the areas of risk management and cross-border supervision, (ii) strengthen governance of the securities markets, (iii) support the establishment and build the capacity of a consolidated nonbank financial services regulator, and (iv) increase the efficiency and effectiveness of tax and privatization policies. 37. TA support to the new agency was substantially affected by delays in the preparation and consideration of the draft revised Law on the Securities Market and the Nonbank Financial Services Agency Framework Law. The bulk of the work on revising existing statutory provisions, regulations, bylaws, and orders was expected to be carried out by national legal experts. However, the national legal experts had little time to focus on such tasks due to ongoing efforts on the revision of, and advocacy related to, these two laws Overall, the quality of TA outputs was satisfactory and sufficiently guided by reforms called for under the program. The TA s design was consistent with ADB and government priorities. The quality of TA inputs and capacity-building activities was also satisfactory. Implementation of the nonbank financial sector component was delayed for reasons outlined earlier. The TA was rated successful in a TA completion report submitted to the ADB Board of Directors on 22 December I. Consultant Recruitment and Procurement 39. The implementation arrangements were appropriate and the terms of reference for consultants were comprehensive. The TA supported 12 person-months of international consultants and 85 person-months of national consultants. The consulting team comprised a financial regulatory and policy team leader, a banking supervision expert, legal experts, securities market experts, and an accounting and audit expert. Technical qualifications included expertise in banking regulation and policy, banking supervision, banking and securities law (international and domestic), the securities market, and accounting and audit. There were no issues regarding selection, recruiting, and fielding of consultants. A list of the training activities in the capital markets is in Appendix Selection and engagement of consultants were carried out through individual consultant selection. There was no significant divergence from the approved consultant skill mix, while there was a shift in the focus of the consultants in the capital market component. The 13 To facilitate discussions, the national legal experts prepared briefing materials for the benefit of members of Parliament and their staffs and the relevant Parliamentary committee. The consultants made themselves available to staff and members of Parliament to answer questions about the revised draft securities law, as appropriate. The national legal experts also prepared an implementing regulation for the Service to give effect to the requirements of this law with respect to its inspection and supervisory obligations under the laws and regulations it administers. 14 ADB Technical Assistance Completion Report: Supporting Banking Sector and Capital Market Development Program in the Kyrgyz Republic. Manila (TA 4747-KGZ).

15 9 consultants had to reprioritize from capacity building within the new agency to promotion and training of government officials on the merits of the proposed changes in law. This shift in focus was necessary, yet only partially successful. J. Performance of Consultants, Contractors, and Suppliers 41. All TA reports were delivered on time and were of good quality. The TA emphasized capacity building of the NBKR and the Service, as well as of market participants. Several workshops and seminars were held throughout TA implementation. Capacity-building programs were developed based on staff interviews in order to determine skill levels and experience. K. Performance of the Borrower and the Executing Agency 42. The quality of preparation and degree of involvement of the borrower and executing agency was satisfactory, even though there was an initial delay in program effectiveness, as described in para. 29. The performance of the implementing agencies overall was partially satisfactory, while the adequacy of monitoring was unsatisfactory. 43. A summary of the performance of each agency involved in implementation is presented below: (i) (ii) NBKR s performance is rated highly satisfactory. NBKR showed strong initiative and ownership. High-level commitment and allocation of adequate staff resources facilitated policy and technical discussions, and resulted in timely implementation of the reforms under the banking sector component. The effective implementation of the banking sector component is attributable to a large extent to NBKR s strong commitment and ownership of the proposed reforms. In contrast, the capital market component was dependent on government sponsorship and lacked a champion within the government, partly due to political developments. The SAFSR s performance was partly satisfactory. Frequent changes in government during led to several revisions of the legal status and organizational structure of various institutions. This, together with serious capacity constraints, slowed the pace of reforms under the capital market component. The uncertainty surrounding SAFSR s status also affected its ability to play a meaningful role in promoting structural and institutional reforms in the operation of the securities market. 15 Still, it continued to make positive strides within the scope of its mandate on the reform program embodied in the policy matrix and the TA project, subject to the ongoing legal and political constraints mentioned above. In particular, the chairman and members of the Service actively participated in the TA project s training programs, and they were readily available to work with the consultants. The chairman also chaired and actively participated in three high-level seminars that focused on the regulatory reform agenda and the proposed new Law on the Securities Market. Further, the Service established internal working groups to consider the proposed new Law on the Securities Market and the Nonbank Financial Services Agency Framework Law. 15 The status of the SSRFM changed several times in as a result of government reorganization and the adoption of a new constitution. These changes affected not only the status of the Service, but also its ability to have legislation introduced to Parliament in a timely manner.

16 10 (iii) The Regulatory Working Commission Secretariat s performance in monitoring and reporting was unsatisfactory. Monitoring was impeded by weak capacity in the Secretariat, which was responsible for submitting quarterly reports to ADB on the various components of the program. It did not fulfill this obligation until the end of the program in The government s ability to implement reforms was hampered by the frequent restructuring and reshuffles, and a major constitutional referendum. Specifically, the submission to Parliament of the Law on Securities Market and the framework law was delayed beyond TA implementation. Following further consultations between ADB and the government, these two laws were adopted in July L. Performance of the Asian Development Bank 45. ADB s performance was satisfactory. There were eight TA review and consultation missions, which were fielded jointly with the program review missions. Consistency in personnel helped ensure continuity in policy dialogue with stakeholders. Close coordination was maintained with other development partners, in particular the International Monetary Fund and German development cooperation through GTZ, as both provided assistance to the NBKR through an in-house advisor and ad-hoc TAs. 46. ADB could have done more to utilize the country knowledge and relationships of staff in the resident mission. This is especially important when the political situation is fluid and there are frequent changes in key personnel of implementing agencies. This was a key lesson that led ADB subsequently to institutionalize closer coordination between sector teams in its headquarters and at the resident mission. 47. The government conveyed its appreciation in a letter in 2010 in which the NBKR stated, [the] availability of technical assistance component of the program of development of the banking sector and capital market has had considerable support in the implementation [by the] National Bank [of] appropriate arrangements for complying with the conditions [of] the policy matrix in a timely manner to achieve its objectives. 16 III. EVALUATION OF PERFORMANCE A. Relevance 48. The program was relevant. Two of the three main components, namely the banking sector and the capital markets components, were highly relevant. While the capital market component was relevant at appraisal, that relevance diminished during implementation. Some of the more sophisticated and ambitious development priorities of the capital market component did not hold up during implementation as institutional and political realities undermined support and called those priorities into question. In the context of a developing country in a state of flux some priorities were questioned by stakeholders during implementation NBKR letter to ADB on progress after program completion, dated 15 September For example, the importance of elevating an autonomous securities regulator to the same level as the national bank is questionable in an environment when the regulator has minimal capacity, the securities markets lack critical mass, and the impact on the economy is questionable.

17 Further, while the program design was consistent with stated government goals and ADB strategy, not all branches of the government and private sector were in agreement with its more ambitious elements. The main impetus of the capital markets component rested on the passage of two pieces of legislation. The legislation, as originally drafted, was in conflict with existing laws and represented a significant shift in political power to an agency with little capacity and no clear rationale as to the benefits. 18 B. Effectiveness in Achieving Outcome 50. The program was less effective. The program was fairly successful in achieving outcomes in two of the three main components. The banking sector component improved the financial sector s effectiveness in intermediating resources for productive investment, financial institutions were less exposed to systemic risks, and depositors and investors were less vulnerable to fraud and misconduct. The program also set the stage for future development and reforms in privatization. While the failure to achieve some outputs in the capital markets component does not undermine the overall achievements in these two areas, the program could have more usefully focused on product and market development areas. 51. There were 14 performance targets and measures related to outcomes in the original design and monitoring framework. These targets were fairly quantitative and access to the data is readily available on the NBKR website. 19 Of the 14 targets, four were achieved, seven were not achieved, and three are indeterminate at completion. All four of the targets achieved were under the banking sector component of the program (Appendix 1). 52. There are signs of progress in the capital markets. Secondary government securities trading is the result of an MOU between the NBKR, the Kyrgyz Stock Exchange, and the Service permitting pilot trading to take place on the stock exchange. While the high concentration of government securities in a few commercial banks continues to limit the depth of that market, there is an active secondary repurchase agreement market on the stock exchange. C. Efficiency in Achieving Outcome and Outputs 53. Given the outcomes in relation to delays, complicated design, and the human and capital resources devoted to implementation, the program is rated less efficient. The capital market component was inefficient with regard to socioeconomic benefits versus costs in the time and effort needed for implementation. The components on banking sector reforms and eliminating policy distortions in the capital markets were both efficient given their contribution and effective implementation. However, the costs and delays reduced efficiency for the program overall. D. Preliminary Assessment of Sustainability 54. Sustainability of the program s outcomes is likely. While the program design was consistent with stated government goals and ADB strategy, the prerequisite sanctity of property rights and the rule of law were not developed to the level required for such an advanced regulatory framework to have a real effect on organized markets for equity securities. However, 18 On 25 July 2009, the President of the Kyrgyz Republic signed the draft Law on the Securities Market. In September 2010, work to bring 85 normative legal acts into accordance with the law was ongoing. 19 The efficacy of these measures is not evaluated in this report. Also, as is the case in all performance measures, attribution is difficult to discern. Potential external factors affecting outcomes included the effects of the global financial market collapse on the increase in nonperforming loans in domestic banks and the introduction of government guarantees on the increase in bank deposits.

18 12 it appears that institutional capacity is sufficient to sustain the outcomes achieved, especially within the NBKR. It is too early to judge the Service s sustainability as a regulator, yet there are some positive signs. While the program conditions in this area were not all fully met, the laws passed do set the stage for improvement in the Service s regulatory function. In addition, the new agency appears to have developed a certain critical mass of talented personnel, at least at the higher levels of the organization. E. Institutional Development 55. Institutional development is rated moderate. Governance practices within the capital markets were not improved as expected. Incentive structures were not enhanced and traditional aspects of competition were little changed. Yet, the policy reform process exposed impediments to development of the capital markets and the Service did establish the foundations for improved governance. In the banking sector, the program did contribute to NBKR capacity and its efforts to formulate sound banking oversight. F. Impact 56. The impact of the program was moderate. The banking sector component was instrumental in helping the NBKR establish sound risk management policies and procedures, and overall the program contributed to important reforms in the financial sector. However, the impact of the capital market segment of the program was moderate due to constitutional assessments and legal reviews, reshuffling of personnel in key implementing agencies, and volatile political and economic conditions, as described. Privatization related reforms always take a considerable amount of time. IV. OVERALL ASSESSMENT AND RECOMMENDATIONS A. Overall Assessment 57. The program is rated partly successful based on individual assessments of the program s relevance, effectiveness, efficiency, and sustainability (Appendix 5). Both the banking sector and policy distortion components were successful from beginning to completion of the program. The capital market component overreached and was only partially successful at program completion. B. Lessons 58. Implementation of the program demonstrated that consistent government support is critical to success. The effective implementation of the banking sector component is attributable to the NBKR s strong commitment and ownership of the proposed reforms. In contrast, the capital market component lacked a clear champion as a result of political developments. Therefore, despite intensive policy dialogue, and awareness and capacity-building efforts, the pace of reforms did not proceed as well as anticipated. 59. The ownership and rationale of policy reforms should be carefully assessed at appraisal. In assessing ownership, it is important to remember that policy actions affect many stakeholders, even within the government. In this case, the legislative branch was not enthusiastic about adopting complex new laws pertaining to the regulation of capital markets that would then be interpreted by agencies outside their direct control.

19 The process of translating drafts of the Law on the Securities Market from English into Russian and back into English affected its readability in English. Achieving a reasonable and consistent standard of translation into both Russian and English remained a problem. Once the final version of the draft law has been adopted, it would be desirable if an official English translation could be produced for the benefit of ADB, foreign investors, and other interested parties. In the meantime, an accurate consolidated translation of the final draft of the law should also be produced for the records of the TA. 20 C. Recommendations 1. Program Related 61. Banking and capital markets remain important in the long run and ADB support should focus on consolidating previous gains, prioritizing improvement in the business environment, and taking a more incremental approach to securities markets in the Kyrgyz Republic. ADB should continue policy dialogue with the government and assess the need for further assistance, including capacity building for the NBKR, building on incremental gains of the program, and improving the environment for business and banking. In the Investment Climate Improvement Program, 21 ADB may want to build on certain areas of financial market development. 62. Consultations with the two main implementing agencies (the NBKR and the financial market agency) identified the following reform priorities: (i) (ii) (iii) Unified market. Recent international developments highlight the benefit of a functional approach to regulation, especially in smaller markets. Thus, a functional approach to regulation should be considered for the Kyrgyz Republic. More effective coordination between regulators is also needed. Financial roundtable. Greater coordination between stakeholders (public and private) is needed to promote development of the sector. It may be appropriate to establish a financial markets roundtable to increase the level of discussion of important strategic issues and discuss ideas on moving ahead with financial market development. The roundtable would include the main financial regulators, key private sector participants, representatives of consumers, and development partners. Reconcile conflicts in law and regulations. Recent laws passed as part of the program appear to be in conflict with some 86 laws and regulations. TA support is needed to reconcile these conflicts. During implementation, national legal experts identified existing regulations and bylaws that are likely to be affected by the adoption of the Law on the Securities Market and the types of amendments that are likely to be required ADB Technical Assistance Completion Report: Supporting Banking Sector and Capital Market Development Program in the Kyrgyz Republic. Manila (TA 4747-KGZ). 21 ADB Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster, Grant for Subprogram 1, and Grant Assistance to the Kyrgyz Republic for the Investment Climate Improvement Program. Manila (Grant 0121-KGZ). 22 These discrepancies were anticipated in October ADB Kyrgyz Republic: Supporting Banking Sector and Capital Market Development. Manila (TA 4747-KGZ, consultants final report).