Financial Sector Lending Instrument. Government of Sierra Leone Implementing Agency

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Project Name PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: AB6433 (The report # is automatically generated by IDU and should not be changed) Financial Sector Development Plan Support Project Region Africa Country Sierra Leone Sector Financial Sector Lending Instrument Grant Project ID P Parent Project ID Borrower(s) Government of Sierra Leone Implementing Agency Bank of Sierra Leone Environmental Screening { }A { }B { }C { }FI Category Date PID Prepared February 2, 2011 Estimated Date of Appraisal February 28, 2011 Completion Estimated Date of Board April 7, 2011 Approval Decision Project authorized to proceed to negotiations upon agreement on any pending conditions and/or assessments. I. Country Context Following the 2002 end of a decade-long civil war, peace has been consolidated in Sierra Leone and democratic transition of government has been achieved. Despite progress, particularly with economic growth and a fall in poverty, Sierra Leone s economic recovery remains fragile. Postconflict growth was robust but thereafter slowed to 5.5 percent in 2008 and then down to 4 percent in The global recession challenged the economy as demand for the country s mineral exports slowed down. The 2010 Joint Country Assistance Strategy emphasizes that there is a real risk that the progress made thus far will be undermined unless economic growth can be sustained and employment opportunities increased. The two major challenges are the development of new engines of growth to diversify away from reliance on mineral exports and maintaining productivity growth. Both challenges can only be met if efficiency in financial intermediation is increased, access to financial services is expanded, transaction costs are lowered and scarce resources are channeled to productive investments. A growth diagnostic undertaken in 2006 has identified finance as the binding constraint for growth: A low supply of credit to the private sector, but high returns to economic activity result in a high unsatisfied demand for finance and high interest rates compared to regional peers 2. 1 Sierra Leone Joint Country Assistance Strategy. World Bank. March Hornberger et al, Sierra Leone Growth Diagnostics: What is holding back growth in Sierra Leone?, 2006

2 Based on the 2003/2004 Integrated Household Survey, the 2006 growth diagnostic study finds that 83% of respondents quote access to funding as the biggest obstacle to starting a business and that 85% of those who tried were unsuccessful in securing a loan. The 2006 FSAP finds - based on the same data set - that the majority of those households who obtained a loan (primarily from traders or informal sources), indeed, used its proceeds to invest in productive capacity. II. Sectoral and Institutional Context Financial sector development in Sierra Leone is characterized by the trade mark contradictions of post-conflict financial sector development and Government faces a dual challenge: On the one hand, the sector has starting from very low levels experienced significant growth in the past years, which is challenging the institutional framework charged with safeguarding this growth. On the other hand, growth in credit supply has not yet reached the majority of households and firms. Access to finance by MSMEs and households remains a key challenge to facilitate private sector growth. Figure 1: Sierra Leone Financial Depth Private Sector Credit (PSC) and M2 as % GDP June Congo, 2010 e DR 1 Liberia 1 Mozambique income 1 Low SSA 1, 2 PSC/ GDP 4.5% 5.3% 7.1% 9.3% 10.3% 7.1% 12.5% 18.4% 23.5% 57.3% M2/GDP 20.9% 21.7% 22.7% 26.3% 26.2% 12.6% 27.8% 30.3% 35.4% 37.4% Source: WDI, Bank of Sierra Leone, World Bank staff calculation 1 latest available, 2 all income levels, e World Bank staff estimate Significant financial sector deepening Starting from very low levels after the conflict period, considerable financial sector deepening has taken place. Banks are mobilizing desposits (M2 steadily increased to 26.2% of GDP) and, more importantly, an increased share of funds is intermediated to the private sector. Private sector credit as a share of GDP has grown rapidly from below 4% just after the conflict period to 10.3% in June 2010 (nominal credit supply to the private sector increased by an average of 47% per year between 2006 and 2009). This development mirrors similar growth experiences in other post-conflict country in the region. The peace dividend and economic opportunities have attracted a significant number of new entries to the banking market (in 2010, following a merger of Ecobank and ProCredit Bank, 13 commercial banks were operating in the country), many of them subsidiaries of regional, predominantly Nigerian, banks. In 2009 alone, the branch network expanded from 57 to 75 branches. Active donor support resulted in significant growth in the supply of microfinance. The Microfinance Technical Assistance Facility (MITAF), which covers most of the microfinance sector, reported an increase in clients of supported institutions from 13,000 to 120,000 since The entry of international MFIs like BRAC, LAPO and the acquisition of ProCredit Bank by Ecobank, a large regional bank, testify to the increasing professionalization of the microfinance sector. puts pressure on stability.

3 However, most of the credit growth is concentrated on urban clients and the limited number of established firms. There are significant concerns that these narrow market segments are already overbanked and overheating. Absolute levels of non-performing loans are on the rise (although they are declining relative to the growing asset base) and at risk to be compounded by fast credit growth. Profitability in the banking sector, which carries a high number of banks and microfinance institutions given the size of the economy, has come under pressure. Returns on assets (RoA) and equity (RoE) have decreased significantly from 2006 to Competition has reduced average interest income and margins. Commercial banks are still highly capitalized, which provides a considerable stability cushion but also increases pressures to generate return on capital and increase risk exposures. Figure 2: Selected Banking Sector Indicators Bank Capital / Total Assets 17.7% 18.5% 18.8% Capital Adequacy Ratio 38.7% 43.5% 34.0% Non-Performing Loans (SLN 000) 88,442, ,864, ,963,450 as % of Total Advances 31.69% 23.39% 16.54% Interest Income/Interest Earning Assets 15.8% 15.9% 12.4% Net Interest Income/Interest Earning Assets 12.5% 12.2% 9.2% Return on Assets (RoA) 1.6% 1.2% 0.5% Return on Equity (RoE) 8.8% 6.3% 2.9% Source: Bank of Sierra Leone, Commercial Bank Annual Reports, World Bank staff calculation The banking sector has potential for further growth The banking sector remains highly liquid and has further potential to expand credit to the private sector: While the share of assets directed as credit to the private sector has increased steadily to 29% of overall banking assets in June 2010, the Sierra Leonean banks still hold the majority of funds in liquid assets. Investments in treasury bills, foreign exchange deposits with foreign banks and reserves held with the BSL accounted for almost half of all assets (48%) in June Figure 3: Banking Sector Asset Composition Source: Bank of Sierra Leone which is needed to alleviate substantial constraints in access to financial services. Despite the deepening, levels of financial sector depth remain substantially below that of lowincome country peers and regional averages (see Figure 1) resulting in significant constraints to access to financial services by firms and households.

4 A 2008 survey of 2500 households confirms the significant access gap 3. Overall, 56.5% of all surveyed households were excluded from any type of financial services (credit, savings, money transfer, insurance etc.), 30% were served only by informal and semi-formal financial service providers (money lenders, family, supplier credit, cooperatives) and only 13.5% had access to formal financial services (banks and MFIs). There is a substantial need to expand the entire range of financial services: Savings mobilization: Only 24% of urban and 8% of rural households reported any monetary savings in formal or informal savings products. Savings mobilization by the formal financial sector is weak. Just 8% of respondents saved with a bank or MFI, which corresponds to the low number of accounts held in banks and MFIs as a share of population. Access to Credit: 90% of respondents did not have a loan outstanding (63% never borrowed at all). Of the 10% that had a loan, the large majority borrowed informally (81%) or semiformally (10%). Only 9% of borrowers - less than 1% of all respondents had a loan from a commercial bank or MFI. Access to Insurance: 97.8% of all respondents were never insured, 65% were not familiar with the concept. Money transfer is the most widely used financial service: 31% of respondents sent or received money through some form of money transfer system. However, 92% of the households that sent money and 71% that received money (indicating a higher prevalence of remittances received via international money transfer operators) used informal mechanisms, which are often costly and not secure. Growth in private sector credit has not yet reached important sectors in the economy. Further steps need to be taken to facilitate access to finance by SMEs and households and enable banks and microfinance institutions to reach new client segments, including in rural areas. The agricultural sector, which accounts for 44% of GDP is only attracting 6% of bank funding, while the construction sector is overweight with 17% of bank funding (but only 7% of GDP). Most bank funding goes to commerce and trading activities and does not support productive investments. The mining sector is funded primarily from abroad and local bank funding is limited to small credit lines (2% of bank funding). Figure 5: Sectoral distribution of commercial bank credit, 2002 June Field Survey on the Microfinance Demand in Sierra Leone, EU BizClim, 2008

5 Source: Bank of Sierra Leone In addition to broadening access to finance to key sectors, there is a need to lay the foundations for the intermediation of long-term funding. The majority of loans are short-term, frequently with less than 6 months maturity, which limits the ability of firms and households to invest in productive capacity and housing or crop-cycle aligned borrowing in the agricultural sector. Government borrowing is restricted to treasuries with maturities of less than one year. There are no corporate bonds and capital market activity is limited to one stock traded on a manual capital market platform run by the Bank of Sierra Leone. Figure 6: Financial System Assets Commercial bank loans 658,966,802,000 MFI loans 49,177,520,000 Commercial bank other assets 1,303,433,231,000 NASSIT total assets 302,636,748,000 Insurance investment assets 70,198,800,000 Source: Bank of Sierra Leone, MITAF, NASSIT, SLICOM (latest available data) Given the developmental state of the sector and the predominance of the credit market the shortterm focus lies on expanding commercial bank and MFI activities (see Figure 6). But the pension sector (dominated by the National Social Security Investment Trust (NASSIT)) and a strengthened insurance sector can provide a source of long-term savings in the medium term and first steps to expand the Government yield curve should be undertaken. Priorities for financial sector development reforms In a nutshell, the Sierra Leone financial sector has demonstrated its ability to grow, attract new entries and fund private sector growth. But without a strengthened operating environment to safeguard financial sector stability and without the market infrastructure and product capacity that enables financial institutions to reach beyond their limited existing client base, current levels of credit growth are not sustainable. The most immediate concerns are to safeguard the positive growth trend, mitigate the stability risks associated with fast growth and strengthen the framework and market infrastructure to allow more diversified and sustainable financial sector development to take place. From a stability perspective, the priorities are a strengthening of the Bank of Sierra Leone s oversight capacity and the legal and regulatory framework as well as the establishment of credit information infrastructure to help the banks manage credit risk adequately. From a growth perspective, it will be important to enable the banks and microfinance institutions to use funds productively, access new market segments and expand the range of financial services available to firms and households, including money transfer services. Adequate financial products (like leasing, secured lending or value chain finance) need to be introduced to enable the banking sector to address the needs of MSMEs, especially in agrobusiness. Sierra Leone Financial Sector Development Plan (FSDP) The Sierra Leonean authorities have made financial sector development a key pillar of their economic development strategy. Building on the 2006 FSAP and FIRST-funded follow-up

6 technical assistance, Government has developed the Sierra Leone Financial Sector Development Plan (FSDP), a comprehensive long-term strategic plan to address financial sector challenges, which was approved by Cabinet in October The authorities devised a best practice interagency and sector-wide reform governance structure, including a high-level Financial Sector Consultative Forum (FSCF), the Financial Sector Steering Committee (FSSC) and an FSDP Secretariat to coordinate and implement this complex reform program. The Bank of Sierra Leone is charged with coordinating and supporting the implementation of the FSDP and has developed a detailed implementation plan, which provides a robust foundation for implementing reforms and coordinated donor support. It constitutes the framework for activities under this project. Given the complexity and technical demands of financial sector reforms and the need for coordinated approaches by policy makers, private sector and development partners it will be important to develop the capacity of the Bank of Sierra Leone as a champion of financial sector development. The development state of the financial sector needs a strong apex institution that formulates adequate policies to enhance access to finance, coordinates stakeholder activities and takes a pro-active leadership role in advancing sector reforms and the provision of shared infrastructure such as credit information and payment systems 4. In order to meet this challenge, the Bank of Sierra Leone has drawn up an Institutional Development Plan with the objective to increase its capacity to formulate and implement monetary and supervisory policies to foster a sound and economic and financial environment. III. Project Development Objectives The project development objective is to strengthen the capacity of the Bank Sierra Leone and contribute to improving efficiency in financial intermediation, safeguarding financial sector stability, reducing transaction costs and expanding access to financial services. The proposed PDO derives directly from the objective of the Financial Sector Development Plan (FSDP). IV. Project Description The project will finance two major components, aimed at: 1) Enhancing access to financial services; and 2) Building financial sector reform and oversight capacity of the Bank of Sierra Leone. The activities under these components derive directly from the priorities of the Sierra Leone Financial Sector Development Plan (FSDP) and the activities outlined in the corresponding project implementation plan. Component 1: Enhancing access to financial services (US$ 1.6 million) 1. This component will support activities that improve efficiency in financial intermediation, reducing transaction costs of money transfer and expand access to financial services. It complements technical assistance and financial support to the microfinance sector provided by the Sierra Leone Microfinance Investment and Technical Assistance Facility (MITAF) funded by KfW, UNCDF, UNDP, CORDAID and the Bank of Sierra Leone, the IFC 4 Beck, T. and Honohan, P. Making Finance Work for Africa, 2007

7 Doing Business Reform Action Plan, IFC technical assistance on leasing and secured lending to support MSME finance, Investment Climate Facility technical assistance as well as the African Development Bank WAMZ payment system support project. 2. Specific activities include: i. Credit information infrastructure: This activity will include two phases: the first phase of the project will support the development of a basic bad debtor database operated by the Bank of Sierra Leone, which utilizes non-performing loan information reported by Sierra Leone banks. In the second phase, the development of a comprehensive credit information bureau including negative and positive credit information funded either entirely by the private sector or in a public-private partnership model including negative and positive credit information, adequate regulation and capacity development for BSL oversight will be supported. ii. Implementation of payment systems and remittances policy framework: Activities will support the (i) drafting of required payment systems regulation and policies, (ii) training, technical assistance and capacity development for payment system and mobile payment supervision, and (iii) the drafting of mobile payment regulation and design adequate oversight mechanisms iii. SME / value chain finance capacity development of commercial banks: This activity will include the (i) analysis of product development needs and enabling environment constraints to support MSME finance and agricultural finance, (ii) development of sector policies and support for sector dialogue on enhancing access to financial services, (iii) pilot product development in cooperation with selected commercial banks (secured lending, leasing, value chain finance) and capacity development for selected commercial banks, (iv) drafting of secured lending law and regulation to support MSME finance. Component 2: Building financial sector reform and oversight capacity of the Bank of Sierra Leone (US$ 2.4 million) 3. This component will strengthen the Bank of Sierra Leone s capacity to supervise the growing financial sector effectively, lead the financial sector reform process and develop its organizational capacity to undertake its key functions within the Sierra Leone financial sector. It complements technical assistance support from Gesellschaft for Internationale Zusammenarbeit (GIZ) on banking supervision and reform capacity, IMF technical assistance on banking supervision, legal framework and organizational development as well as the African Development Bank WAMZ payment system support project. The component will focus on the implementation of the Institutional Development Plan of the Bank of Sierra Leone, including banking supervision, strengthening the legal environment of the financial sector and build BSL capacity to lead implementation of the Financial Sector Development Plan (FSDP). 4. The component will include the following specific activities: i. Financial Sector Legal Environment: This activity will (i) review and update the financial sector legal framework, including the Other Financial Services (Amendment)

8 ii. iii. iv. v. V. Financing Act, Banking Act and Bank of Sierra Leone Act (ii) support the drafting, amending and implementation of revised sector legislation, including potentially a Microfinance Law, and (iii) fund training and capacity development for the BSL legal department. Implementation of Institutional Development Plan: This activity will support the implementation of the BSL institutional development plan, including (i) review of HR policies and practice and drafting of new HR policy, (ii) staff capacity development: assessment of staff capacity needs, skills/capacity assessment of existing staff and preparation of a staff capacity development plan as a framework for broad-based training and capacity development program, (iii) broad-based training program for BSL staff, (iv) review of functional and business process and support for business and functional process re-engineering, (v) review and development of IT strategy and implementation plan, purchase of IT equipment with a focus on banking supervision, (vi) complement technical assistance support for the implementation of the AML/CFT framework, and (vii) design and implement efficient supervisory processes, including the supervision of the microfinance sector. Support to the FSDP Secretariat: This activity will support (i) project management, M&E and implementation capacity to enable the FSDP Secretariat to coordinate financial sector reforms under the Financial Sector Development Plan (FSDP), the (ii) development of financial management and procurement capacity, and the (iii) purchase of select equipment for FSDP Secretariat. Strategy and analytical support for BSL: This activity will support BSL in further developing financial sector development strategies, including but not limited to the microfinance policy framework and long-term finance, through long-term technical assistance by an international financial sector consultant firm. Source: Borrower/Recipient IBRD IDA Others (specify) US$ 0.2 million US$ 4.0 million Total US$ 4.2 million VI. Implementation Project implementation will be streamlined into the FSDP Secretariat, which is a division with the Office of the Governor of the Bank of Sierra Leone. The FSDP Coordinator/Head of the FSDP Secretariat will report to the Deputy Governor of the Bank of Sierra Leone. Procurement and financial management functions will be carried out by the respective functional departments within the BSL. The head of the FSDP Secretariat, who has been appointed from within the BSL, will be responsible for day-to-day management of the project and be supported by one technical staff and one administrative staff, who will coordinate with the procurement and financial management functions. For an initial period, back-up support by the Integrated Project Administration Unit (IPAU) in the Ministry of Finance and Economic Development will be

9 made available to support procurement and financial management. The project will support the FSDP Secretariat as part of the capacity development for BSL under component 2. The FSDP Secretariat will be responsible for the procurement of consultants, goods and services, as well as M&E in coordination with designated persons within the BSL departments and beneficiary institutions that are implementing the activities. Wherever necessary, timely shortterm technical assistance will be sought to strengthen the team and the project will fund support through an international financial sector consultant on a retainer basis. All project activities support the implementation on the Financial Sector Development Plan and the FSDP Secretariat will report on project activities through the Governor of the Bank of Sierra Leone to the high-level Financial Sector Consultative Forum (FSCF) and the Financial Sector Steering Committee (FSSC) to ensure consistency and coordination of sector reform activities within the FSDP framework. VII. Safeguard Policies (including public consultation) {Same as in last approved ISDS} Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP 4.01) Natural Habitats (OP/BP 4.04) Pest Management (OP 4.09) Physical Cultural Resources (OP/BP 4.11) Involuntary Resettlement (OP/BP 4.12) Indigenous Peoples (OP/BP 4.10) Forests (OP/BP 4.36) Safety of Dams (OP/BP 4.37) Projects in Disputed Areas (OP/BP 7.60) * Projects on International Waterways (OP/BP 7.50) VIII. Contact point at World Bank and Borrower World Bank Contact: Thomas Losse-Mueller Title: Financial Sector Specialist Tel: tmuller@worldbank.org Borrower/Client/Recipient Contact: Ms Andrina Coker Title: Bank of Sierra Leone, Deputy Governor * By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties claims on the disputed areas

10 Tel: Implementing Agencies Contact: Ms Andrina Coker Title: Bank of Sierra Leone, Deputy Governor Tel: I. For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C Telephone: (202) Fax: (202) Web: