ICRR 10028
                                                                                               Report Number : ICRR10028
                    ICR Review
                    Operations Evaluation Department




1. Project Data :
             OEDID :
             OEDID:     C2250
         Project ID :   P010374
      Project Name :    Fourth Small and Medium Industries Project
            Country :   Sri Lanka
             Sector :   Other Finance
       L/C Number :     C225O
  Partners involved :   Asian Development Bank and Japanese JGF
       Prepared by :    Robert Buckley, OEDCR
      Reviewed by : Patrick Grasso
    Group Manager : Ruben Lamdany
       Date Posted : 04/03/1998

2. Project Objectives, Financing, Costs and Components :
This financial intermediation credit, for US$ 45 million, was approved in FY91 and closed in FY98 with 1.6
percent of of the orginal credit canceled . Objectives: deepen policy dialogue with GOSL on financial sector
issues; support the GOSL to improve : Customs and Excise Duties, environmental protection, and SMI
policies and institutions; and to provide credit, through the banking sector, for long -term capital investment
by eligible enterprises. The ICR was prepared by the South Asia Region and includes a Borrower's
assessment of the credit as an appendix .

3. Achievement of Relevant Objectives :
The project objectives were fully accomplished in important areas : the institutional development of the participating
credit institutions, particularly in terms of their debt recovery practices, was improved; the credit supported SMI
enterpreneurs in their subproject implementation; and the credit advanced in policy development in both the financial
and trade sectors. The delay in disbursement of the credit occurred because the Credit's terms made two large state
banks (SCBs) ineligible to participate in the program for a portion of the credit period . However, both institutions
ultimately improved sufficiently to become eligible again . Nevertheless, even though they have improved, problems
remain with both institutions. The project played a catalytic role in strengthening environmental regulatory policy, but
the performance of the technical assistence programs was mixed : the modernization of the Customs and Excise
Department was implemented satisfactorily, but little was done on the issues of the non -bank financial sector.

4. Significant Achievements :
The second tier lending institution that served as the credit's implementing agency was privatized during the
project, and the strength and performance of the banking sector were significantly improved . Accessibility of
credit is now not a problem in Sri Lanka, although high real interest rates are .

5. Significant Shortcomings :
Both the Bank and the GOSL underestimated the complexity and political difficulty of fundamental
restructuring of the two large state -owned banks. Even though improvements have occurred, their
performance still distorts and impedes the functioning of the financial sector . Bank research indicates that
this slower than anticipated financial reform process is a frequent occurrence . Evidence indicates that
financial reform is rarely accomplished over the course of one project . Hence, the follow up work proposed
on broader financial sector issues, and proposed work on financial reform seems appropriate and well
targeted. As the ICR shows, an additional shortcoming of the intermediation process used in the credit is
the continued reliance on a government -run guarantee scheme that penalizes good performance by lenders .




6. Ratings :             ICR                       OED Review                Reason for Disagreement /Comments
               Outcome : Satisfactory              Satisfactory
    Institutional Dev .:   Substantial             Substantial
        Sustainability :   Likely                  Likely
   Bank Performance :      Satisfactory            Satisfactory
      Borrower Perf .:     Satisfactory            Satisfactory
       Quality of ICR :                            Satisfactory


7. Lessons of Broad Applicability :
The importance of seeking financial viability and strenghtening the internal efficiency of participating credit
institutions is difficult to exaggerate, and should be a component of credit lines such as this one .
Well-functioning financial institutions can effectively and productively distribute Bank credits in productive
ways. However, it is important that such loans focus on the sources of imperfection which prevent lenders
from carrying out effective intermediation in the first place . In addition, Bank research on the need for a
long-term commitment for fundamental financial reform is supported by the experience of this credit .

8. Audit Recommended?           Yes       No

9. Comments on Quality of ICR :
The ICR is of satisfactory quality . It effectively summarizes an extensive amount of information on a
complex, multi-faceted project in a lucid, coherent way .