Documentof The WorldBank FOROFFICIALUSEONLY ReportNo: 38861-VN PROJECTAPPRAISAL DOCUMENT ONA PROPOSED CREDIT INTHEAMOUNT OF SDR 127.7MILLION (US$200 MILLIONEQUIVALENT) TO THE SOCIALIST REPUBLIC OF VIETNAM FORA THIRDRURALFINANCE PROJECT April 28,2008 RuralDevelopment, Natural ResourcesandEnvironment Sector Unit SustainableDevelopment Department East Asia andPacific Region This document has a restricted distribution and may be used by recipients in the performance o f their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCYEQUIVALENTS (ExchangeRateEffectiveNovember2007) CurrencyUnit = VietnamDong VND16,200 = US$1 US$ = SDR1 FISCALYEAR January 1 - December31 ABBREVIATIONSAND ACRONYMS ATM Automated Teller Machine AAA Analytical and Advisory Assistance BIDV Bank for Investmentand Development of Vietnam CAR Capital Adequacy Ratio CAS Country Assistance Strategy CFAA Country Financial Accountability Assessment CEP Capital Aid Fundfor the Employment of the Poor CFC National Chloro-fluoro-carbons Trust Funds CQS Consultants Qualification Selection DATC DebtandAsset TradingCompany DA Designated Account EL4 Environmental ImpactAssessment ED Environment Division ERR Economic Rate of Retum FI Financial Intermediary FIL FinancialIntermediary Loan FRR Financial Rate of Return FM Financial Management FMM Financial Management Manual GDP Gross Domestic Product GEF Global Environment Facility HCMC Ho Chi MinhCity I A S InternationalAccounting System ICB InternationalCompetitive Bidding IDA InternationalDevelopment Association IDP InstitutionalDevelopmentPlan IEG IndependentEvaluation Group IFC InternationalFinance Corporation IFRS InternationalFinancialReporting Standard JSBs Joint Stock Banks MLF Micro Finance Loan Fund OED Operations EvaluationDepartment M&E Monitoring and Evaluation MSME Micro and Small to MediumSized Enterprise MSE MediumSizedEnterprise MFI Microfinance Institution MOF MinistryofFinance FOR OFFICIAL USE ONLY MONRE MinistryofNaturalResourcesandEnvironment M P I MinistryofPlanningandInvestment MPDF Mekong Private Sector DevelopmentFacility NGO Non-Government Organizations NPL Non Performing Loan ODA Official Development Assistance OP OperationalPolicy PCF People's Credit Funds PDO Project Development Objective PER-FA Public Expenditure Review-IntegratedFiduciary Assessment PFI Participating Financial Institution PIM Project Implementation Manual P M Policy Manual PMO Project Management Office Ph4SJ Project Management Unit QCBS Quality and Cost Based Selection RFI FirstRuralFinance Project RFII Second RuralFinanceProject RFIII ThirdRuralFinance Project RDF RuralDevelopment Fund ROA Returnon Assets ROE RetumonEquity SBV State Bank ofVietnam SEDP Socio-Economic Development Plan SLA Subsidiary Loan Agreement SOCB State-Owned Commercial Bank SOE State-Owned Enterprise SME Small and MediumEnterprise SWOT Strength, Weakness, Opportunity, Threat TA Technical Assistance TA2 SecondPhaseo f a Comprehensive Technical Assistance TC3 Transaction Center I11 VNIBOR Viet NamInter-Bank Offered Rate USD UnitedStatesDollar VAS Vietnamese Accounting Standard VBARD Vietnam Bank for Agriculture and RuralDevelopment VND Vietnam Dong WAIR WeightedAverage Interest Rate WB World Bank WBO Wholesale BankingOperation WHO World Health Organization Vice President: James Adams Country Director: Ajay Chhibber Sector Director: Christian Delvoie Sector Manager: RahulRaturi Task Team Leader: Xiaolan Wang 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. SOCIALIST REPUBLICOFVIETNAM THIRD RURALFINANCEPROJECT CONTENTS Page A. STRATEGICCONTEXTAND RATIONALE ............................................................. 1 1 Country and sector issues........................................................................................ 1 2 Rationale for Bankinvolvement............................................................................. 3 3 Higher level objectives to which the project contributes ........................................ 4 B. PROJECTDESCRIPTION ............................................................................................. 5 1 Lending instrument ................................................................................................. 5 2 Project development objective andkey indicators.................................................. 5 3 Project components................................................................................................. 6 4 Lessons learned andreflected inthe project design................................................ 8 5 Alternatives considered and reasons for rejection.................................................. 9 C. IMPLEMENTATION .................................................................................................... 10 1 Partnership arrangements., .................................................................................... 10 2 Institutional and implementation arrangements .................................................... 10 3 Monitoring and evaluation o f outcomes/results .................................................... 11 4 Sustainability......................................................................................................... . . . 11 5 Critical risks andpossible controversial aspects ................................................... 13 6. Loadcredit conditions and covenants ................................................................... 14 D. APPRAISAL SUMMARY ............................................................................................. 15 1 Economic and financial analyses .......................................................................... 15 2 Technical............................................................................................................... 16 3 Fiduciary ............................................................................................................... 16 4 Social..................................................................................................................... 17 5 Environment.. ........................................................................................................ 18 6 Safeguard policies................................................................................................. 19 7 Policy Exceptions andReadiness .......................................................................... 19 Annex 1: Country and Sector Background .............................................................................. 20 Annex 2: Major RelatedProjectsFinancedby the Bank andor other Agencies ...................25 Annex 3: ResultsFramework andMonitoring .......................................................................... 26 Annex 4: DetailedProject Description ....................................................................................... 32 Annex 4.1: Alternative Project DesignOptions Considered .................................................... 45 Annex 4.2: Appraisal of the APEX Bank .................................................................................. 48 Annex 4.3: Eligibility Criteriafor Participating FinancialInstitutions ................................. 55 Annex 4.4: Compliancewith Financial Intermediary LendingPolicies ................................. 60 Annex 5: Project Costs ................................................................................................................. 63 Annex 6: ImplementationArrangements .................................................................................. 74 Annex 7: FinancialManagementandDisbursementArrangements ...................................... 75 Annex 8: Procurement Arrangements ....................................................................................... 85 Annex 9: EconomicandFinancial Analysis ............................................................................... 91 Annex 10: SafeguardPolicy Issues ............................................................................................. 93 Annex 11:Project Preparation and Supervision ..................................................................... 101 Annex 12: Documentsinthe ProjectFile ................................................................................. 103 Annex 13: Statementof Loansand Credits ............................................................................. 104 Annex 14: Country at a Glance ................................................................................................. 107 Annex 15: Map IBRD35972 ..................................................................................................... 109 SOLIALIST REPUBLIC OF VIETNAM THIRD RURALFINANCEPROJECT PROJECTAPPRAISAL DOCUMENT EASTASIA AND PACIFIC EASRE Date: April 28, 2008 Team Leader: Xiaolan Wang CountryDirector: Ajay Chhibber Sectors: Micro- and Sh4E finance (100%) SectorManagerDirector: RahulRaturi Themes: Small andmediumenterprisesupport /ChristianDelvoie (P);Other financial andprivatesector development(S) ProjectID: P100916 Environmentalscreeningcategory: Financial IntermediaryAssessment LendingInstrument: Financial Intermediary Loan [ ]Loan [XICredit [ ] Grant [ ] Guarantee [ ] Other: ForLoandCredits/Others: Total Bankfinancing: IDA Credit: SDR 127.7 million (US$200.0 million equivalent) Proposedterms: StandardCredit with 10-yeargrace periodand40-year maturity Borrower: SocialistRepublicof Vietnam Responsible Agency: Bankfor InvestmentandDevelopmentof Vietnam(BIDV) 1lthFloor,Tower A, Vincom City Towers 191BaTrieu Street, Hanoi Vietnam Tel: 84 4 2200571 Fax: 84 4 2200569 sgd3@bidv.com.vn Estimateddisbursements (Bank FY/US$m) FY 09 10 11 12 13 14 Annual 20.00 40.00 40.00 40.00 40.00 20.00 Cumulative 20.00 60.00 100.00 140.00 180.00 200.00 Does the project depart from the CAS incontent or other significant respects? Ref. PAD A.3 [ ]Yes [XINO Does the project require any exceptions from Bank policies? Ref. PAD 0.7 [ ]Yes [XINO Have these been approved by Bank management? [ ]Yes [XINO I s approval for any policy exception sought from the Board? [ ]Yes [XINO Does the project include any critical risks rated "substantial" or "high"? Ref. PAD C.5 [XlYes [ ] No Does the project meet the Regional criteria for readiness for implementation? Ref. PAD 0.7 [XIYes [ ] N o Project development objective Ref. PAD B.2, TechnicalAnnex 3 The development objective of the proposed RFIIIwould be to increase economic benefits to rural private enterprises and households by increasing their access to finance. The expected outcomes would include: (i) improved access to financial services for rural entrepreneurs; (ii) increased capital investment made by the rural entrepreneurs as well as increased employment; (iii)increased lending, particularly term lending to the rural private sector for capital investment by all participating financial institutions (PFIs) on market-based terms. Project description Ref. PAD B.3, TechnicalAnnex 4 Component I.Increase Capital Investment by Rural Enterprises - the "Rural Development Fund"(US$ 175millionIDA financing). This component is designed to addressthe term financing constraints of financial institutions to provide funding to rural enterprises for longer- term investment needs. Component II.Increase Access to Microfinance inthe Rural Economy - the "Micro-finance Loan Fund" (US$ 10million IDA financing). This component will provide a small line of credit to demonstrate the commercial viability of lending to micro-enterprises and household businesses. Component III.Build Institutional Capacities and New Products (US$ 15 million IDA financing.) The technical assistance (TA) component i s a core element to the success of the RFIIIproject. This component is designed to help buildthe financial institutionsparticipatingin the project and showing a credible strategy for expanding access to finance inrural areas of Vietnam. The component i s also designed to help demonstrate that new commercially viable markets can be found. These new markets can come inthe form of new customers, new products and services, and new institutions participating inthe project. Which safeguard policies are triggered, if any? Ref. PAD D.6, TechnicalAnnex 10 This Proiecthas a safeguards classification of FI(Financial Intermediarv). As with all FI classifiedprojects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis duringthe course of project implementation. The project triggers the Environmental Assessment andPest Management Safeguards. By design, the project will not finance sub-projects that would trigger safeguard policies on i)natural habitats; ii)involuntary resettlement; iii)forests; iv) cultural physical resources; vi) safety of dams vii) projects indisputed areas; and viii) international waterways. Sub-projects that would trigger these safeguards policies are includedinthe negative list of sub-projects that may not be financed under the Project. The safeguard policies triggered are: OP/BP 4.01 (Environmental Assessment); and OP 4.09 (Pest Management) Significant, non-standard conditions, for: Ref. PAD C.6 Credit effectiveness: The On-lending Loan Agreement has been executed between the Borrower and BIDV under terms and conditions satisfactory to IDA, and it has been authorized or ratified. BIDV has adopted the Policy Manual, the Project Operational Manual and the implementation Guideline, all acceptable to IDA. BIDV has adopted the revised Environmental Guidelines, in a manner satisfactory for IDA. BIDV has strengthened a sub-unit within the PMU with sufficient and competent staff under terms of reference acceptable to the IDA to manage the Institutional Strengthening component. Covenants applicable to project implementation: (a) The recipient shall ensure that the Project i s carried out in accordance with the provisions of the Anti-Corruption Guidelines on Preventing and Combating Fraud and Corruption in Projects Financedby IBRD and IDA Credits and Grants, dated October 15,2006. (b) PMU at BIDV should be maintained at all times during project implementation with staffing functions, andresponsibilities acceptable to IDA. [c) An annual training program including budget and procurement plan for activities related to Institutional Strengthening Component should be furnished to IDA for review by December 31of the preceding calendar year. :d) Quarterly progress reports should be furnished to IDA no later than two months after the end of each quarter commencing from the first quarter with actual disbursement. (e) A mid-term report on the implementation progress and proposed adjustment plan if there i s any should be furnished to IDA by June 30, 2011. The report should include results of the first impact evaluation. (f) All sub-projects financed carried out in accordance to the Environmental Guidelines prepared for this Project. A. STRATEGIC CONTEXT AND RATIONALE 1 COUNTRYAND SECTORISSUES 1. Introduction. Vietnam's estimated annual development growth rate for 2006-2010 i s estimated between 7.5% - 8%. Based on its latest growth and poverty reduction strategies, the Government o f Vietnam estimates that the total investment needs for the rural economy will be in the order o f VND300,OOO billion, or on average around US$4billion per annum, for this five year period. Inaddition, about 75% o f Vietnam's population i s still living in rural areas with agriculture as their main source o f livelihood. With continued growth, there is risk o f growing disparity between rural and urban areas. There are two main challenges facing the rural areas; first, target the issue o f lagging regions and the pockets of high poverty; second, diversification o f agriculture and also more broadly rural economic activities, and create more rural employment. The proposed Third Rural Finance Project (RFIII) tackles the second challenge. The continued support through the proposed Project would assist more private enterprises and individuals in the rural areas to invest in assets, expand their production capacity, create employment opportunities, generate rural economic growth, and hence contribute to narrowing the rural-urban income gap. Private enterprises, whose activities were negligible in 1993, now account for over half of the investments made each year. In order to improve the quality o f the investments, the Government o f Vietnam intends to increasingly rely on private investments, which i s viewed as more efficient than state-led investments. Even ifthe share o f private investment inthe rural economy is kept at the same level as in recent years, contributing about 50% o f total investment on average, private investment inthe rural economy would have to be in the order o f about US$2 billion per annum. While the proposed RFIII Project would finance less than 1% o f the total expected credit demand, most o f which would be for medium- and long-term investment, it is expected to have a significant demonstration and catalytic effect through further strengthening bank and further solidifying the existing initial foundation for a sustainable rural finance system in Vietnam. 2. Financial Sector Reform. The Government o f Vietnam's strategies for poverty reduction, financial sector development, and growth inrural areas all emphasize the importance o f greater access to finance services to facilitate economic growth. The financial sector reform process, which began in earnest around 2001,has produced some significant results. The State Owned Commercial Banks (SOCBs), which make up over 70% o f the banking sector, have been under restructuring processes, policy lendinghas beenformally removed from the SOCBs into specialized entities, the regulatory framework for banking has moved towards international standards, the presence o f foreign financial institutions has increased competition inthe sector, the market infrastructure is rapidly developing with a robust payment system in place, and a capital market has been evolving with two trading centers. This progress i s all the more remarkable considering that barely more than a decade ago Vietnam's financial sector was largely a "window" to channel government 1 resources to State OwnedEnterprises (SOEs) and there was no real bankingsystem in place. The private banking sector is also growing rapidly. For example, the equity in 22 private commercial banks participating in the Rural Finance I1project has increased almost ten fold between 2002 and2007. 3. Access to Finance. Vietnam has also made impressive gains in expanding access to finance for households, with an estimated 70-80% o f the poor with access to some form o f financial services both formal and informal. However, the quality o f services offered is weak, the market i s highly fragmented, and often the services do not meet the needs o f the customers. Access to finance for private, particularly small and medium sized enterprises (SMEs), is very limited. In fact, the 2005 (unpublished) World Bank Investment Climate Assessment found that access to finance is the number one constraint facing businesses inVietnam. The investment survey results shows that it i s the access to finance, rather than the cost o f finance, that concerns firms most. Inaddition, all SOEs, especially 100% state-owned, have much greater access to commercial and developmental financing sources than private firms, many o f which are smaller scale and located in rural areas. Private firms finance close to 75% o f their new investments from non-commercial sources, such as (non-market) equity investments, and family and friends, in addition to internal funds (retained earnings). This high dependence on non-market financial sources substantially limits the rate and degree to which private firms can grow in size and expand into new markets. Beyond these factors, if an enterprise does obtain bank financing, it i s usually relatively short-term and thus, not well suitedto medium- and long-term investments. A combination o f factors have led to this situation, including weak business plans, a lack o f audited accounts and credit history, insufficient collateral, etc. from the enterprises, and an aversion among financial institutions to smaller-scale, potentially more risky (compared to SOEs), less well-known companies 4. Barriers to Access. However, the primaryreason i s the lack o fmedium- and long- term funds available to banks, particularly medium- and long-term deposits, which they can use for on-lending as medium and long term loans. Based on the information provided by State Bank o f Vietnam (SBV), only one-third o f the deposits raised in the banking sector in Vietnam are longer than 12 months. As such, short-term sources have been used to finance term-loan needs creating a maturitymismatch and potential liquidityproblems. Due to the increasingdemand for term-financing, SBV has issued a new decision to allow financial institutions increase the ratio o f using short-term fund to finance term-loan from maximum of 25% to a maximum o f 40%. One other dimension o f the limitations in access to finance for firms is geographic. H o Chi MinhCity is the clear center o f gravity for banking activity, comprising 29% o f all loans and 34% o f all savings in Vietnam. Interestingly, Hanoi has an equally high rate o f savings, with 32% o f all funds mobilized coming from businesses and individuals inHanoi. The four major cities, HCMC, Hanoi, Danang, and Haiphong, receive 52% o f all credit by banks and 70% o f all savings are mobilized from these cities. Thus, a conclusion that can be drawn from this data is that the areas outside o f these four main urban centers (60 provinces) may not have adequate access to financial services. 2 5. Experience with Rural Finance. The Bank has a decade o f experience working to improve access to finance for rural enterprises inVietnam. There has been a steady improvement in the banking sector during that period, some of which can be attributed to a series o f two rural finance projects financed by the Bank. The first Rural Finance Project (RFI) closed in 2001 with an internal World Bank ex-post analysis rating of satisfactory, with recognitionthat the overall impact o f the project had been substantial. Seven banks were Participating Financial Institutions (PFIs) under this Project, having met the accreditation criteria set under the project. The RFII became effective in 2003 and is expected to close in 2008. Twenty four financial institutions have joined RFII, o f which 22 are private banks (JSBs). The line o f credit i s managed by an SOCB, the Bank for Investment and Development o f Vietnam (BIDV), which performs a wholesale banking function indisbursingthe funds to the PFIs. Under these two rural finance operations, the Bank has provided a total $310 million o f IDA resources for on-lending and capacity building purposes. 6. While the aggregate IDA rural finance credits represent less than 1% o f the total formal credit outstanding inthe domestic market today, these operations have had a far reaching impact on advancing the development of the rural finance system through the active engagement form the World Bank. The first internal and external ex-post and independent assessments o f these operations confirm that they have contributed to development o f the rural economy and improvement o f the living conditions in the rural areas. This was achieved through encouraging investments of farm households and private rural entrepreneurs, by extending additional medium and long term financial resources; strengthening the banking system's capacity to better serve the rural economy; and increasing access of the rural poor to financial services. 2 RATIONALEFORBANKINVOLVEMENT 7. The Government o f Vietnam's strategies for poverty reduction, financial sector development, and growth in rural areas all emphasize the importance o f greater access to finance services to facilitate economic growth. Vietnam's Socio- Economic Development Plan (SEDP) to 2010 emphasizes the importance o f greater accessibility to rural finance services for agricultural growth, non-farm employment generation andrural poverty reduction. Despite the impressive reform progress and increasing formalization o f the financial sector during last decade, Vietnam still lags in the efficiency and outreach o f financial services. Rural private enterprises face serious challenges in accessing financing of medium- and longer-term nature for investment purposes. The World Bank is uniquely positioned to help the Government address these challenges through the Third Rural Finance Project. The Bank has intensively engaged with the Government on the broad agendas o f poverty reduction, rural development and diversification, and strengthening the financial sector. This i s being done through a variety o f modalities, fiom policy dialogue and analytical work to technical advisory assistance and lending operations. Interms o f the specific to the challenges for access to finance for rural enterprises, the Bank is assisting the three primary stakeholder groups: (i) assisting the financial institutions through restructuring technical assistance, (ii) the helping government in financial sector policy reforms, and (iii) providing term financing to rural enterprises. The evaluated impact o f these assistance efforts has been very positive andthe Bank now has accumulated a long history o f experience, trust, and access to the key financial institutions active in the rural space and to the Government entities involved in setting relevant policies. The RFI and RFII projects yielded a number o f lessons interms o f both the most effective operational and policy designs to meet the challenges in catalyzing term financing for rural enterprises. The RFIIIproject will build on these successes and on the operational experiences in Vietnam under the first and second Rural Finance projects. In addition, the Bank i s leading the donor community globally in operational best practices in financial intermediary lendingto support rural enterprises and the RFIII will applyingthese practices underthe project inVietnam. 3 HIGHER LEVEL OBJECTIVES TO WHICH THE PROJECT CONTRIBUTES 8. The Project supports Government's goal o f economic growth, employment creation opportunities, rural development acceleration through the financing o f rural micro and small private investments, and subsequent income generation improvement of a significant proportion o f the population by promoting broad-based, private sector- led growth inrural areas. 9. The Project is consistent with the World Bank Vietnam Country Assistance Strategy (CAS), and the overall World Bank PRSC program o f broader financial sector reform and improvement o f the rural sector. This operation, as well as the previous RF projects, has benefited by past financial sector operations, such as the Payment System and Bank Modernization Projects I& 11, which have provided support to the largest banks in Vietnam in developing their core information systems to international standards. The APEX bank andPFIs also benefited from a series o f comprehensive financial sector technical assistance programs to assist in their restructuringprocesses and assistanceprovided to the State Bank o f Vietnam- the bank supervisor - to improve the regulatory framework and its effectiveness. The sum o f this financial sector work has resulted in elevating the safety, soundness, and performance of the banks participating in the RFII project, as well as those that will potentially participate in the RFIII operation. At the same time, the proposed Project will contribute to the overall financial sector reform by providing technical assistance, training and supporting implementation o f the participating banks' institutional development plans. This Project i s well integrated into the Bank's overall rural development strategy. For example, the Land Development Project supports improved property rights particular in rural areas, enabling farmers to use landas collateral as a basis for financial services which this Project supports. The Agriculture Competitiveness Project encourages the introduction o f new technologies, marking arrangements and organization structures so that players can enter into more profitable value chains. This Project would be available to meet increased demand for financial services including reviewing business plans from various players inthe value chains. 4 B. PROJECTDESCRIPTION 1 LENDING INSTRUMENT 10. The proposed lending instrument i s a Financial Intermediary Loan (FIL). The IDA credit will be made to the Socialist Republic o f Vietnam for on-lending to BIDV, which is acting as the wholesale institution (APEX Bank) o f the project. BIDV will be responsible to accredit the interested participating financial institutions (PFIs) and micro-finance institutions (MFIs) based on the agreed accreditation criteria. BIDV will then on-lend IDA credit to the accredited PFIsMFIs inaccordance with subsidiary loan agreements signed between BIDV and these PFIsMFIs indicating the obligations o f each party and the on-lending terms. The on-lending term will be formula-based which is acceptable to the IDA and all stakeholders participating in this Project. In turn, the PFIs/MFIs will make loans with market rates to end- borrowers for sub-projects that meet the eligibility criteria. 2 PROJECT DEVELOPMENTOBJECTIVEAND KEY INDICATORS 11. The development objective o f the proposed RFIII would be to increase economic benefits to rural private enterprises and households by increasing their access to finance. The expected outcomes would include: (i) improved access to financial services for rural entrepreneurs; (ii) increased capital investment made by the rural entrepreneurs as well as increased employment; (iii) increased lending, particularly term lending to the rural private sector for capital investment by all participating financial institutions (PFIs) on market-based terms. 12. Key Performance Indicators 13. The following are selected outcome and output indicators for the Project. A detailed list i s presented inAnnex 3, Outcome Indicators: Increased amount o f capital investments made by the rural entrepreneurs (a proxy for increased direct economic returns as a result o f the project); 0 Incremental increase in employment (a proxy for social and secondary economic returns o f the project); Output Indicators: 0 Volume o fterm loans (a proxy for access to credit resources) Numbero fborrowers (a measure o fthe effectiveness o ftargeting SMEs) Compliance of BIDV and PFIs with minimum accreditation criteria or time bound institution development plans (IDPs) agreed with IDA. 0 Number o f new microfinanceborrowers, particularly women. 0 Number o f training courses for bankers. 0 Preparation o f training courses for SMEs. 5 3 PROJECTCOMPONENTS 14. The following three primarycomponents are envisaged for the RFIIIproject: a Increase Capital Investment by Rural Enterprises - the "Rural Development Fund"(US$ 175 million IDA financing) * Increase Access to Microfinance in the Rural Economy - the "Micro- finance Loan Fund" (US$ 10 millionIDA financing) a Build Institutional Capacities and New Products (US$ 15 million IDA financing) 15. Component I: Increase Capital Investment by Rural Enterprises - Rural DevelopmentFund(US$175 millionIDA financing). This component, the Rural Development Fund (RDF), is designed to address the term financing constraints o f financial institutions to provide funding to rural enterprises for longer-term investment needs. The goal i s to enable rural private entrepreneurs to access medium- to long-term financing for capital investments, such as equipment andnew technologies, which will enable opportunities for efficiency gains and business expansion. The Vietnamese economy and the banking sector have developed rapidly since the RFI and RFII projects were prepared. As a result, medium and large scale enterprises have increased access to financial services. Since IDA funds are scarce and they shouldbe usedfor development and poverty reductionpurposes, thus the funds should be used in those segments o f the market where there is a financing gap and inthose segments o f the market that have the greatest potential to reduce poverty. Under the current economic conditions inVietnam, it is the micro and small enterprise segment o f the market that does not have sufficient access to medium- and long-term funds. Providing medium- and long-term funds to this enterprise segment o f the market would also result in the largest development impact. The line o f credit operation would mirror the ones under the ongoing RFII interms ofthe processingterms, as ithasbeenfound that the credit fromthe APEX bank (BIDV) to the PFIs, and from the PFIs to the end borrowers, is currently in line with market rates and i s not causing any market distortions. The PFIs will have to meet specific accreditation criteria to participate in the project. These accreditation criteria are structured to reflect the core areas o f a financial institution -managementandcorporate governance, assetquality, capitaladequacy, liquidity, profitability, and efficiency - and are primarily aimed at setting a basic standard o f financial health and soundness for eligible PFIs and encouraging other financial institutions to reach these standards. (see Annex 4.3 for details). If a financial institution does not meet all the accreditation criteria, it can still participate in the line o f credit and select elements o f the technical assistance component o f the RFIIIproject if it agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit will finance up to 70% o f each sub-project cost, and the rest 30% will be financed by the PFIs and the contribution 6 from each end-borrower. The following eligibility criteria will be applied to sub- loans andprojects financed underthe RDFby the PFIs: Sub-projects to be financed shouldbe physicallylocated outside the four big cities inVietnam, includingHanoi, H o ChiMinhCity, Danang, andHaiphong. Sub-loans should be for capital investments in productive assets and associated working capitalneeds. Sub-loans should be targeted at micro and small enterprises with less than 50 employees. For Sub-loans larger than $80,000 will be subject to BIDV's prior review. Sub- loan largerthan $80,000 per sub-project could be approved providedthat it can be demonstrated that they are located outside Tier I1cities (reference indicated inthe Policy Manual) and inrural areas and will have a large incremental impact on the rural economy interms o f employment creation. Sub-projects financed will be subject to environmental compliance requirements based on the Environment Guideline developed for this Project and the funding will be aimed at sustainable investments that do not produce negative environmentalimpacts. Component 11: Increase Access to Microfinance in the Rural Economy - Micro-financeLoan Fund (US$ 10 million IDA Financing). This component, the Micro-finance Loan Fund (MLF), will provide a small line o f credit to demonstrate the commercial viability o f lending to micro-enterprises and household businesses. These may be defined as formal andinformal businesses employing 2-3 employees outside o f their immediate families. The MLF will also be aimed at encouraging the participating o f financial institutions, as well as eligible non-bank PFIs such as rural People's Credit Funds (small rural financial cooperatives) and licensed microfinance institutions, to develop more robust microfinance services in rural areas. These institutions will be subject to accreditation criteria (see Annex 4.3). Ifa financial institution does not meet all the accreditation criteria, it can still participate in the line o f credit and select elements o f the technical assistance component o f the WIII project if it agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit will finance up to 70% o f each sub-project cost, and the rest 30% will be financed by the PFIs and the contribution from each end-borrower. Eligibility criteria for sub-loans under this component are as follows: a As with the RDF, sub-projects financed under the MLF should be physically located outside the four big cities inVietnam including Hanoi, H o Chi MinhCity, Danangand Haiphong. Sub-loans are for short-term financing, as well as medium- to long-term financing where demanded, would be available only for new customers (household or micro-enterprises). 7 Sub-loan size would be limited to a maximum o f $500. 0 Sub-projects financed will be subject to environmental compliance requirements based on the Environment Guideline developed for this Project and the funding will be aimed at sustainable investments that do not produce negative environmental impacts. 17. Component 111: Build Institutional Capacities and New Products (US$ 15 millionIDA financing). The institutionalbuildingcomponent is a core element to the success o f the RFIII project. This component is designed to help strengthening the financial institutions participating in the project and demonstrating a credible strategy for expanding access to finance inrural areas o f Vietnam. The component i s also designed to help demonstrate that new markets can be found and that these can be commercially viable. These new markets can come in the form o f new customers, new products and services, and new institutions participating in the project. This component will be supported bytwo sources o f funding. The first i s a $5 million IDA credit that will be transformed into a grant from the Government budget for activities considered to be public goods, such as new banking product development, strengthening the People's Credit Funds, and supporting micro- and small- to medium-sized enterprises (MSMEs). The second source o f funding i s a $10 million IDA credit will be on-lent to the PFIs at IDA terms to cover PFIs to improve credit processes for rural lending, strengthenPFIs that do not yet meet the accreditation criteria, enhancing the largest rural lendinginstitution, and supporting the APEX Bank (BIDV). It is envisaged that the entire TA facility will be managed by the Project Management Unit o f the APEX Bank for efficiency o f administration. The specific elements that will be funded under this component are detailed inAnnex 4. 4 LESSONS LEARNEDAND REFLECTEDINTHE PROJECTDESIGN 18. There i s a substantial body o f knowledge that has been accumulated by the Bank on line-of-credit operations. A recently completed report by the Independent Evaluation Group (IEG) "World Bank Lending for Lines o f Credit", provided some key lessons relevant for this project which are; i)a stable macroeconomic environment i s a necessary condition for a successful line o f credit operation; ii)the requirements o f the World Bank policy on financial intermediary loans (OP 8.30) should be met, which includes, clear accreditation criteria for participating banks, backed up by institutional development plans for those banks that do not meet all the criteria, and established procedures for environmental safeguards; iii)a conservative estimate o f the disbursement rates for the line o f credit based on an assessment o f the demand for credit under the prevailing interest rate regime; and iv) non-distortionary interest rates shouldbe usedwith any subsidy documented and justified. This loan incorporates all o f these recommendations. The regional Line o f Credit coordinator concluded that this proposed Project complies with the requirements o f OP 8.30 and highlighted the success o f the collaborative cross- sectoral team in preparing the project to meet both the rural and financial sector 8 objectives in the design. Annex 4.4 provides a detailed compliance comparison with the OP8.30 policies. 19. This project would be the third in a series o f rural credit operations. Four main lessons were learned from these earlier operations. First, the combination o f a line- of-credit facility, technical assistance, minimum accreditation criteria and institutional development plans has proved more effective ininducing change inthe banking sector than focusing the project on any one o f these factors alone. This design has provided the basis for an open dialog with participating banks, suggesting improvements in their operations, raising the importance o f better environmental screening, and funding for implementation. This project retains this core design from earlier projects but, since it i s the third project in the series, has enhancements such as add fimding for developing and testing new products. Second, based on the monitoring and evaluation results for these two projects, small andmediumsize enterprises have had a greater incremental impact onjob creation that other segments o f the market, as a result the project would tighten the targeting o f loans to focus on the SME sector. Third, the first and second projects have successively reduced their dependence on VBARD as the only vehicle to obtain coverage in remote areas. Under the first loan 75 % o f the loan was disbursed through VBARD, under the second project the disbursement share i s currently at less than 50 %. Assuming VBARD meets the minimum criteria as a participating financial institution, it i s thought that the total share i s expected to reduce further under the third project as private banks grow and gain market share. However, VBARD is still the only operator inmanyremote locations, andthus, it is expected that the third project will rely on VBARD to provide broad geographic coverage provided it can meet the minimum accreditation criteria or make positive progress with an acceptable institutional development plan. Finally, the second project has made an important contribution to improving the operation o f PFIs, however, the institutional reform objectives set by the project were too high. The third project should set more realistic institutional objectives given that the Project is not designed to be a financial sector reform project but focusing on increasing access to finance. 5 ALTERNATIVESCONSIDEREDAND REASONSFORREJECTION 20. Alternative Project Design Options: Four options for onlending arrangements were considered in the design, including: (a) Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected APEX Bank, the Bank for Investment and Development of Vietnam (BIDV), that would bear the full credit risk; (b) Modified Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected Agent Bank, BIDV, that would only administer the line o f credit without taking the credit risk; (c) Semi-Competitive - several pre- determined participating financial institutions (PFIs) would be selected based on the accreditation criteria to receive a line o f credit for on-lending to their respective clients; (d) Competitive - bidding out the WBO to the market to select an APEX bank for the line o f credit. Option (a), Status Quo, was selected over option (b) because it was considered to provide a better incentive structure for PFI 9 accreditation and sub-loan collection and make use o f a well established project management unit at BIDV. Both the Semi-competitive and competitive models were rejected because there were not enough private commercial banks in the system with the capacity or the interest to play a wholesale financing role. More details o f the specific risks and advantages o f each o f these options are discussed in Annex 4.1, C. IMPLEMENTATION 1 PARTNERSHIPARRANGEMENTS 21. The International Finance Corporation (IFC) was consulted closely on the design o f the RFIII project and the intention i s to partner with the IFC's advisory institution, the Mekong Private Sector Development Facility (MPDF), to deliver specific elements o f the training activities proposed under this project. Related to this project, the IFC i s committed to providing two $50 million lines o f credit in Vietnam, through two joint stock banks partially owned by the IFC (Asia Commercial Bank and Saigon Thuong tin Commercial Bank), to support housing finance. 2 INSTITUTIONALAND IMPLEMENTATIONARRANGEMENTS 22. The IDA credit o f US$ 200 million would be made to the Socialist Republic of Vietnam for on-lending and grant to BIDV. Out o f this credit, the Ministry o f Finance will then on-lend the funds to BIDV based on an on-lending agreement for US$ 195 million, including the Rural Development Fund and Micro-finance Loan Fund, and capacity building for the financial institutions. BIDV would assume overall responsibility for project implementation. BIDV will on-lend the proceeds to eligible PFIs based on the terms and conditions o f Subsidiary Loan Agreements (SLAs) signed between BIDV and PFIs. The PFI, will inturn, extend sub-loans to eligible borrowers. In accordance with the draft MOF circular on Financial Management applicable to Official Development Assistance projects and programs to support the implementation o f Decree no. 131/2006/ND-CP, dated 9 November 2006, by the Government on ODA Management, BIDV will be responsible for expenditure verification (kiem soat chi) for both credit activities and non-credit components under the on-lending agreement. 23. The remaining US$5 million (under Component 111: Build Institutional Capacity and New Product Development) will be allocated to the SBV in the form as grant from state budget. In accordance with the Official Letter no. 4072BKH-KTDN dated 12 June 2007 from MPIto the Prime Minister, SBV will be responsible to the Prime Minister for the management and efficient and effective usage o f this US$ 5 million grant for the intended purposes, in compliance with current governmental regulations, and ensuring no overlap with other funding sources for training activities of the banking sector. In accordance with the draft MOF circular on Financial Management applicable to Official Development Assistance projects and programs to support the implementation o f Decree no. 131/2006/ND-CP on ODA 10 Management, the State Treasury or an ornanization desiwated bv the MOF will be responsible for expenditure verification for this grant from state budget. 24. BIDV has already established a Project Management Unit under the Second Rural Finance Project, which i s part o f the BIDV's core transaction center. This PMUhas equipped with committed and capable staff and they are the champion in achieving the Project development objectives and ensure the compliance the IDA'Ssafeguard policies. It i s decided this same PMU will be the PMU managing the proposed Project with one Division which will manage the Institutional Strengthening sub- component o f this new Project. The PMU has several units including: Accreditation Division, in charge o f financial analysis o f the interested financial institutions; Appraisal Division, in charge o f eligibility o f sub-projects financed; Environment Division, in charge o f compliance o f the IDA'S safeguard policy; Finance and Accounting Division, in charge o f funds flow and bookkeeping; and the Project Monitoring and Evaluation Division, responsible for institutional strengtheningcomponent andproject reportingand evaluation activities. 3 MONITORINGEVALUATIONOFOUTCOMEShESULTS AND 25. BIDV has set up a system to maintain all data on project inputs and outputs to monitor and evaluate progress made with project implementation. Functional divisions o f the PMU will collect and analyze PFIs financial statements, audit reports, uses o f sub-loans and information related to the end-borrowers combined with field trip observations. The Project Monitoring and Evaluation Division will be responsible for consolidation o f all information and will provide quarterly progress report to IDA and the decision makers. 26. Each PFI will be required to keep all the information based on clearly identified performance indicators, and they will provide data on project outcomes and results on a regular basis in an agreed format. This will include quarterly progress reports coveringboth sub-loan information on MSEs as well as specific technical assistance andtraining to each PFI. BIDV will beresponsible for overseeing andcoordinating this process. 4 SUSTAINABILITY 27. This project and the other projects in this series o f line-of-credit operations is designed as an interim intervention in commercial loan markets for rural areas during a period when the bankingsystem is inthe process o f reform. During this period o freform, a lack o f confidence inthe bankingsystem results ina shortage of deposits which inturn results ina shortage o f funds available for on-lending. Inthe first project there was a shortage o f liquidity across all deposit terms. Over time short term liquidity has increased, but there is still a shortage o f liquidity in the medium and long term deposit market which inturn results ina shortage o f medium or long term loans or a highrisk o f term mismatch inthe banks. The provision o f a medium and long term lines o f credit to PFIs under the proposed loan offers them an opportunity to overcome this market failure until such time as confidence inthe 11 bank system increases. The project will encourage the development o fmediumand long term deposit instrumentsthrough Component 111. It i s also expected to reduce the length o f the transition process by providing f h d s for training, information system upgrades for PFIs, and new product development. At the end o f this series o f line of credit projects, there would be enough reliable and efficient commercial banks with experience in lending to rural areas, and generating enough medium term deposits to ensure sufficient medium and long term lending to rural areas on a sustainable commercial basis. Also, the project will continue to integrate environmental considerations into small credit activities and encourage the financial sector to adopt the same approach beyond the rural finance project, without causing a high cost to the commercial banks. Thus, the project also has an environmental sustainability element to and should help to facilitate more "green" investments into the future. 12 5 CRITICAL RISKS AND POSSIBLE CONTROVERSIAL ASPECTS' I Rating Risks - Rating before RiskMitigationMeasures With Mitipation Mitigation To Project ~~~ Development Objective Macro economic or M Macroeconomic and banking system M banking system conditions will be monitored. Moderate instability. levels o f instability will be absorbed through interest rate adjustments which PFIs are free to make. Ifthere are major shocks, the appropriate actions would needto be evaluated Number o fjobs created S The project i s designed to focus on M by subprojects is medium and long term investments micro insignificant and small enterprises which have been demonstratedto have highemployment generation rates. Employment rates will To Component Results Low demand for S Dialogue with the government and build M mediumor long term partnership with the donor community credit from PFIs due to government or donor funded subsidized interest rates. Inadequate number o f M Accreditation criteria set at project start M accredited PFIs take into account the level o f development o f the banking system. An acceptable IDP would allow banks to participate even ifthe entire set o f I accreditation criteria i s not met. There are at least 22 PFIsthat would be eligible. Efforts would be made to enhance PFIs' M hstitutional appreciation for institutional Strengthening activities strengthening activities; new products development will be made relevant; discuss with MOF to standardize and streamline the approving procedure 3verall risk rating S M 'The fiduciary risks are not critical. For detailed analysis please see Annexes 7 & 8. 13 6 LOAN/CREDIT CONDITIONSAND COVENANTS EffectivenessConditionsare: 28. The On-lending Loan Agreement has been executed between the Borrower and BIDV under terms and conditions satisfactory to IDA, and it hasbeen authorizedor ratified. 29. BIDV has adopted the Policy Manual, the Project Operational Manual and the ImplementationGuidelines, all acceptable to IDA. 30. BIDV has adopted the revised Environmental Guidelines, in a manner satisfactory for IDA. 31. BIDV has strengthened a sub-unit within the P M U with sufficient and competent staff under terms o f reference acceptable to the IDA to manage the Institutional Strengthening component. ImplementationCovenantsare: 32. The Borrower shall ensure that the Project is carried out in accordance with the provisions o f the Anti-Corruption Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD and IDA Credits and Grants, dated October 15,2006. 33. P M U at BIDV should be maintained at all times duringproject implementationwith staffing functions, andresponsibilities acceptable to IDA. 34. An annual training program including budget and procurement plan for activities related to Institutional Strengthening Component should be furnished to IDA for review byDecember 31o f the preceding calendar year. 35. Quarterly progress reports should be furnished to IDA no later than two months after the end o f each quarter commencing from the first quarter with actual disbursement, 36. A mid-term report on the implementationprogress andproposed adjustment plan if there i s any should be furnished to IDA by June 30, 2011. The report should include results o fthe first impact evaluation. 37. All sub-projects financedcarried out inaccordance to the Environmental Guidelines prepared for this Project. 14 D. APPRAISAL SUMMARY 1 ECONOMIC FINANCIAL ANALYSES AND 38. Because this i s a credit project, with no advanced determination o f the precise investments to be made, it is only possible to estimate the project's economic impact in a very general way. There are a number o f key factors that indicate that the project would be likelyto have a sound economic impact. 39. Contributionto Economic Growth and Poverty Reduction. While progress on reducing poverty has been impressive inVietnam, rural poor are still vulnerable to both internal and external shocks. The project would primarily focus the accumulation o f productive assets inrural areas and on the creation o f employment opportunities. This will be achieved primarilythrough financing medium and long term credit to micro, small and mediumenterprises (MSMEs). MSMEs have been shown in RF1 and RFIIto generate high levels o f employment per dollar o f funds invested. The project will also finance individual households, which would use the resources to enhance their productivity and incomes. 40. Contributionto the LongTermInvestmentNeedof Vietnam. Vietnam is going through a period o f rapid growth with targeting investment levels at 30% o f GDP for the economy. The Project will contribute to the effective provision o f these resources and inparticular term resources, which at present are not easily mobilized inthe bankingsystem. 41.Applicable Rates of Return. Uses o f Project funds will be demand-driven, there i s no ex ante estimate o f the economic or financial rate o f return for individual sub- project or for the project as a whole. However, the eligibility criteria for sub- project financing would be set so that project with an expected Economic Rates o f Return(ERR) o f less that 15% would not be financed. Therefore the ERR for the whole project should be in excess o f 15%. For sub-projects with sub-loans greater that US$ 200,000 an ex-ante economic analysis will be required and a minimum ERRo f 15 %will be required. For sub-projects with sub-loans betweenUS$15,000 and US$200,000 an ex-ante financial rate o f return will be calculated, and a minimum 15% Financial Rate of Return (FRR) will be required. Market interventions in Vietnam have largely been dismantled and the policy induced divergence between economic and financial values for commercial loans is not presently substantive. Because the shadow wage rate is below the financial wage rate in rural areas for most o f the year, it i s likely that ERRSwill be higher than FRR. Thus, for smaller projects, the use o f a minimumFRR o f 15 % will largely eliminate any projects with an ERR o f less than 15%. Inaddition, projects that result in significant negative environmental externalities would be automatically ineligible as a result o fthe implementationo f environmental safeguards. 15 2 TECHNICAL 42. There are no major technical issues in this Project. BIDV, the PFIs and the end- borrowers would all be operating in areas core to their business and technology i s known. A network o f private suppliers is well developed and it is expected that MSEs and farmer households will purchase well know brands o f equipment through well established dealerships. The new product develop activities will bringthe best international practices to Vietnam by taking into consideration the progress made bythe financial institutions duringcourse o fproject implementation. 3 FIDUCIARY 43. This Project will be a follow on operation from the on-going RFII Project. The financial management (FM) arrangements of RFII are operating satisfactorily and there are adequate financial internal controls and systems operating together with timely reporting and auditing. The RFIII's financial management arrangements will be based on the RFII's FM arrangements with some required improvements to overcome weaknesses identified in RFII. For RFIII, the FM risk i s assessed as moderate. The moderate inherent risk relates to the financial environment weaknesses and the nature o f the project which involves a large number o f PFIs/MFIs's sub-branches at provincial, districts, and commune level participating intheproject with lack of integrated financial information system; and a significant amount o f training, study tours, seminars and workshop expenditure. The project control risk is assessed as moderate primarily due to: (i) weak or insufficient internal audit function especially at PFIs/MFIs for project activities which result in weaknesses in sub-loan initiation and monitoring procedures; (ii) o f errors and risk mistakes arising from the manual consolidation process o f quarterly financial reports for PFIs/MFIs' branches and sub-branches; (iii)inefficient expenditure verification procedures by State Treasury which may result indelay indisbursement for the USDS million grant component. 44. To mitigate the risks, PFIsNFIs are encouraged to consider integrating project financial report format into their current accounting system. More trainings and capacity building on internal audit objectives, functions, procedures, and best practices should be organized. The Accounting Division o f BIDV- Transaction Center I11(TCIII) should actively participate insupervisions to PFIsMFIs. Inorder to avoid possible serious delays experienced in many projects due to cumbersome approval procedures, MOF, SBV and BIDV would meet together to work out an efficient mechanismto effectively use the fund for its intendedpurposes. 45. Proiect Procurement. An assessment o f the capacity o f the Project Implementing Unit (PMU) ofthe wholesale bank was conducted. Discussions were heldwith the project management and procurement staff. An action planhas also been discussed and agreed. The project hnds would be mainly used for on-lending to intermediary financial institutions. The project procurement i s rather modest consisting o f several small value contracts for shopping o f vehicles and office equipment for the PMUand a number o f consulting services including seven QCBS 16 packages and the remaining are CQS packages. The P M U o f the wholesale bank will manage the procurement process o f institutional strengtheningcomponent for all the PFIs. The wholesale bank has involved in implementation o f the second Rural Finance Projects and has gained adequate knowledge and experience to implement theproject procurements which are basically similar to those under the previous projects. However, giventhe potential larger value andcomplex nature of the foreseen consulting services couple with a potential shortage o f staff, the PMU o f the wholesale bank will undertake a number o f actions to increase their procurement capacities required for a successful implementation o f the project procurement. Since the Project is a financial intermediary loan where the credit will be passed on to the intermediary institutions to be on-lent to rural private end- borrowers, an assessment o f the procurement practices normally used by these end- borrowers were also conducted. The typical end-borrowers mostly include private households who borrow small loans ranging from several hundreds to several thousands US dollar equivalent for procurement o f wide range ofproducts required for their family business such as seeds, fertilizers, hand tools, animals, boats, etc. These products are readily available inthe local market at competitive prices. It i s also expected that there might be some larger sub-loans ($100,000 to $150,000) on- lent to small private enterprises to procure small trucks, machine tools or constructionmachines such as excavators and concrete mixers. The most commonly used procurement practice is similar to shopping which is appropriate and acceptable. 4 SOCIAL 46. No negative social implications are envisaged. 47. This is a demand driven project and as such is "a bottom up" operation, based on financing needs from the end-borrowers. 48. The Project would contribute directly to the improvement of the social-economic state o f about 50,000 rural households and small business. The Project is expected to create more employment opportunities and better access to financial services to the ruralpopulation. Basedon an IndependentProject Impact Assessment report on Second Rural Finance Project, it indicates 30 % o f the end-borrowers accessed to formal financial services first time and 60 % had opened a savings account with the formal financial institutions for the first time. 49. The World Bank's OED's Beneficiary Assessment and survey confirmed that women benefited equitably from the first Rural Finance Project. This impact is further strengthened during the implementation o f Second Rural Finance Project, where all PFIs were required to keep records and report information on women borrowers. This i s the first operation in Vietnam that the banking sector obtained gender disaggregated data for project monitoring and evaluation. 50. The project will not finance any land purchase transactions. The resettlement safeguard is therefore not triggered. The indigenous people safeguard policy is also 17 not triggered. This Project is market-based demand-driven line o f credit, the indigenous people are free to apply for loans on equal basis with other population groups. However, in Vietnam the government has various subsidized credit programs for indigenous people, including through the Vietnam Bank for Social Policies, andtherefore the uptake o f this RFIII loan facility by indigenous people i s expected to be low. 5 ENVIRONMENT 51. This Project has a safeguards classificationo f FI(Financial Intermediary). As with all FI classified projects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis during the course o f project implementation. The project triggers the Environmental Assessment and Pest Management Safeguards. By design, the project will not finance sub-projects that would trigger safeguard policies on i)natural habitats; ii) involuntary resettlement; iii)forests; iv) cultural physical resources; vi) safety of dams vii) projects indisputedareas; and viii) internationalwaterways. Sub-projects that would trigger these safeguards policies are included inthe negative list o f sub- projects that may not be financed under the Project. Appraisal o f the Projects compliance with IDA's environmental and pest management safeguard policies i s discussed below and inmore detail inAnnex 10. 52. The environment assessment required for the purpose o f appraising the RFIII project i s based on an independent review o f the implementation o f environmental compliance under RFII, the ongoing rural finance project inVietnam. Based on an analysis o f the types o f projects financed under RFII, the MI11i s considered to pose a low level risk. An independent environment audit on RFIIhas been carried out inMay 2007 and the final report confirms the low level risk and positive efforts made by the participating banks and the end-borrowers. The lessons learned have beenincorporated into the draft environmentalguidelines for RFIII. 53. Since this i s a follow-on operation to the Rural Finance I1project, using the same implementation agency, TC3, an environmental procedure has already been prepared entitled "Guidelines o f Environment Impact Assessment and Monitoring for Subprojects Financed RFII." This guideline includes procedures for appraisal, evaluation and monitoring environment and pest management safeguard compliance by the proposed sub-projects. These environmental compliance procedures are reviewed at least once a year in the course o f IDA's supervision cycle. The same arrangement including environmental audit schedule will be applied out under the RF I11Project, at mid-term and the end o f the project. The project management unit inTC3 already has an established environment unit staffed with specialists for the purpose of monitoring environmental compliance under RFII. It has one full time environmental specialist on staff. This unit would be responsible for environmental compliance under RFIII. There i s also sufficient environmental consultant capacity in Vietnam to carry out independent environmental audits o f sub-projects. In addition, under RFIII Project, the Government will allocate fimd to carry out specific trainings catering to 18 environment compliance activities and prepare and distribute environment compliance pamphletto all the end-borrowers. 54. The Second Rural Finance Project i s recognized as a first ever banking sector project in Vietnam that integrates the environmental considerations into the small- scale credit lending activities. Now it is acknowledged by all the PFIs that environmental compliance by sub-projects financed is an important consideration duringthe loan appraisal process. There is strong interest from MPI, MONRE and SBV to disseminate good practices o f RFII which integrates environmental considerations into small-scale credit activities and encourage the financial sector to adopt the same approach beyond the rural finance project, without generating a high cost for commercial banks. 6 SAFEGUARD POLICIES Safeguard Policies Triggered by the Project Yes N o Environmental Assessment (OPBP 4.01) [XI [I Natural Habitats (OPBP 4.04) [I [XI Pest Management (OP 4.09) [XI [I Physical Cultural Resources (OP/BP 4.11) [I [XI InvoluntaryResettlement (OPBP 4.12) [I [XI IndigenousPeoples (OPBP 4.10) [I [XI Forests (OP/BP 4.36) [I [XI Safety o fDams (OPBP 4.37) [I [XI Projects inDisputed Areas (OPBP 7.60)* [I 1x3 Projects on International Waterways (OPBP 7.50) [I [XI 7 POLICY EXCEPTIONS READINESS AND 55. The Project complies with all applicable World Bank policies. There is no policy exception identified. 56. This is a follow-up Project which will be managed by the same APEX Bank. The institutional arrangements for project implementation are already in place. The Policy Manual, the Project Operational Manual have been prepared and will be adopted by Project effectiveness. The Project meets the Regional criteria for readiness for implementation. * By supporting theproposedproject, the Bank does not intend toprejudice thefinal determination of theparties' claims on the disputedareas 19 Annex 1:Country andSector Background Vietnam: Third RuralFinance 1. Macroeconomic Background. Vietnam is one o f the best-performing developing economies inthe world interms o f macroeconomic growth and stability. It is going through a far-reaching transformation from an inward-looking plannedeconomy to one that i s globalized and market-based. Vietnam has been on a sustained path o f economic reform since the launching o f its D o i M o i (renovation) process, in 1986. The overall principle guiding the reform process has been the increased reliance on market mechanisms, as well as international integration, while maintaining a socialist orientation. The latter can be interpreted as focusing on social inclusionwhile preserving a leading role for the state. Beyond this general principle, the process has involved a systematic piloting o f reforms, followed by some form o f evaluation, an effort to forge consensus among relevant stakeholders, and finally the scaling up o f reportedly successful initiatives. Comprehensive economic reforms have led to rapid economic growth andremarkable progress on development outcomes. Vietnam has been among the fastest-growing economies in the world for almost two decades and the country acceded to the World Trade Organization in January 2007, which was a major milestone in Vietnam's integration into the global economy. GDP per capita has increased at roughly 6.9% per year inreal terms. Real income has grown 7.3% per year over the last 10 years. When the World Bank reengaged with Vietnam in 1993, income per capita was US$170. Today it is US$620. Despite this rapid growth, inequality has remained relatively stable. The Gini index increased from 0.34 in 1993, the year o f the first representative household expenditure survey, to 0.37 in 2004. Based on a consumption basket o f food and non- food items sustaining an intake o f 2,100 calories per person per day, the poverty headcount declined from 58 percent in 1993 to less than 20 percent in2004. Other social indicators, including child maternity, have shown equally remarkable improvements and Vietnam appears able to reach most o f the MillenniumDevelopment Goals. Emerging from massive poverty less than two decades ago, the vision now i s to attain middle- income status by 2010. Ifcurrent growth trends were to continue, GDP per capita could cross the US$lOOObenchmark inthree years time. 2. FinancialSector Reform Process. The Government o f Vietnam's strategies for poverty reduction, financial sector development, and growth inrural areas all emphasize the importance o f greater access to finance services to facilitate economic growth. The financial sector reform process, which beganin earnest around 2001, has produced some significant results. The State Owned Commercial Banks (SOCBs), which make up over 70% o f the banking sector, have been under restructuring processes, policy lending has been formally removed from the SOCBs into specialized entities, the regulatory framework for banking has moved towards international standards, the presence o f foreign financial institutions has increased competition in the sector, the market infrastructure i s rapidly developing with a robust payment system inplace, and a capital market has been evolving with two trading centers. This progress is all the more remarkable considering that barely more than a decade ago Vietnam's financial sector 20 was simply a "window" to channel resources to State Owned Enterprises (SOEs) and there was no real bankingsystem inplace. 3. ReformResults. These reform improvements have beenreflected inthe rapidly rising level of formal financial intermediation and efficiency o f finance. The banking system inVietnam has moved from a structure with only the Government was involved, to a system with five SOCBs, 36 joint stock banks(JSBs), 30 foreign banks, 919 People's Credit Funds (PCFs), and a variety o f informal microfinance providers. Confidence in the bankingsystem has grown rapidly as evidenced by the rapid growth in deposits from 24% o f GDP in 2000 to close to 70% in 2006. In addition, credit to the economy has grown at a similarly rapid pace, also averaging a growth rate o f close to 30% per annum since 2000, reaching 67% o f GDP by 2006. Research also indicated that in 1992,73% o f rural credit was provided by the informal sector-in 2002, that figure had dropped to 11%. Finally, the bankingpayment system, based on international standards, has vastly improved payment services by reducing float (from up to 30 days in 1995 to less than 24 hours today), accelerating circulation o f funds and increasing efficiency o f funds transmission. Inaddition, the payment systemhas facilitated over 20% growth in formal remittances to Vietnam, reaching over $4 billionin2005. There are now more than 1,100 Automated Teller Machines (ATMs), 2.1 million cards (Le., credit, debit, etc.), and 17 banks offering credit cards. More recently, the stock market has shown phenomenal growth. During 2006, the number o f companies listed has increased by nearly fivefold2 while the market capitalization increasingby more than tenfold to surpass 22% o f GDP, already well surpassing the Government's original target o f 15% by 2010. The largest enterprises, including the SOCBs, have yet to list shares on the markets. The insurance sector also has registered healthy growth, accounting now for 2% o f GDP in 2005, up from 0.4% in 1993. 4. Future Reform Challenges. Despite the impressive progress in Vietnam, important weaknesses remain in the financial sector, including a still rudimentary approach to monetary policy, relatively poor quality o f banking credit, insufficient surveillance o f the stock market, and still limited access to formal finance for private businesses. These weaknesses may lead to financial instability if Vietnam is confronted with an unexpected slowdown. While the probability o f this happening in the coming years i s low, financial crises are among the most devastating blows an economy can experience, which justifies devoting special attention to the regulation o f this sector. Even assuming the absence of major turbulence, Vietnam needs to expand access to financial services to more citizens and the rapidly emerging business sector. Aware o f these challenges, the Government has launched both a roadmap for the reform o f the banking sector and a strategy for the development o f capital markets. Combined with the international commitments made to accede to the WTO, full implementation o f the roadmap and the strategy shouldleadto a larger and more efficient financial sector. 5. LimitedAccess to Financefor Enterprises. Vietnamhas also made impressive gains in expanding access to finance for households, with an estimated 70-80% of the '192including 106at H o Chi MinhCity Securities Trading Center (STC) and 86 at the Hanoi STC as of January 16,2007. 21 poor with access to some form o f financial services. However, the quality o f services offered i s weak, the market is highly fragmented, and often the services do not meet the needs o f the customers. However, access to finance for private, particularly small and medium sized enterprises (SMEs), i s very limited. Infact, the 2005 (unpublished) World Bank Investment Climate Assessment found that access to finance is the number one constraint facing businesses in Vietnam. The investment survey results shows that it i s the access to finance, rather than the cost o f finance, that concerns firms most. In addition, all SOEs, especially 100% state-owned, have much greater access to commercial and developmental financing sources than private firms, many o f which are smaller scale and located inrural areas. Private firms finance close to 75% o f their new investments from non-commercial sources, such as (non-market) equity investments, and family and friends, in addition to internal funds (retained earnings). This high dependence on non-market financial sources substantially limits the rate and degree to which private firms can grow insize and expand into new markets. Beyond these factors, ifanenterprise does obtainbankfinancing, itisusuallyrelatively short-term andthus, not well suited to medium- and long-term investments. A combination o f factors have led to this situation, including weak business plans, a lack of audited accounts and credit history, insufficient collateral, etc. from the enterprises, and an aversion among financial institutions to smaller-scale, potentially more risky (compared to SOEs), less well-known companies. 6. However, the primary reason is the lack o f medium- and long-term funds available to banks, particularly medium- and long-term deposits, which they can use for on-lending as mediumand long term loans. Based on the information provided by State Bank o f Vietnam (SBV), only one-third o f the deposits raised in the banking sector in Vietnam are longer than 12 months. As such, short-term sources have been used to finance term-loan needs creating a maturity mismatch and potential liquidity problems. Due to the increasing demand for term-financing, SBV has issued a new decision to allow financial institutions increase the ratio o f using short-term fund to finance term- loan from maximum o f 25% to a maximum o f 40%. One other dimension o f the limitations in access to finance for firms i s geographic. H o Chi Minh City i s the clear center o f gravity for bankingactivity, comprising 29% o f all loans and 34% o f all savings in Vietnam. Interestingly, Hanoi has an equally high rate of savings, with 32% of all funds mobilized coming frombusinesses andindividuals inHanoi. The four major cities, HCMC, Hanoi, Danang, and Haiphong, receive 52% o f all credit bybanks and 70% o f all savings are mobilized from these cities. Thus, a conclusion that can be drawn from this data i s that the areas outside o f these four main urban centers (60 provinces) may not have adequate access to financial services. 7. Expanding Rural Finance through Rural Finance Projects. The Bank has a decade o f experience working to improve access to finance for rural enterprises in Vietnam. There has been a steady improvement inthe bankingsector duringthat period, some o f which can be attributed to a series o f two rural finance projects financed by the Bank. The first RuralFinance Project (RF I) in2001 with aninternal World Bank closed ex-post analysis rating o f satisfactory, with recognition that the overall impact o f the project hadbeen substantial. Seven bankswere Participating Financial Institutions (PFIs) 22 under this Project, having met the accreditation criteria set under the project. The RFII became effective in 2003 and i s expected to close in 2008. Twenty four financial institutions havejoined RFII, o f which 22 are private banks (JSBs). The line o f credit i s managed by an SOCB, the Bank for Investment and Development o f Vietnam (BIDV), which performs a wholesale banking fimction indisbursing the finds to the PFIs. Under these two rural finance operations, the Bank has provided a total $310 million o f IDA resources for on-lending andcapacity buildingpurposes. Box 1. Summary Statistics: Second RuralFinance Project As of August 2007, US222millionequivalent hadbeendisbursedfrom IDA.All sub-loans are made based on commercial terms. The project has two distinct lines o fcredit, the Rural Development Fund, which has disbursed$192 million, and the Micro-LoanFund, which has disbursed $24 million. The average size o f the projects under the Rural Development Fund (RDF) was $3,500, with the RDF providing on average $2,047 (54%), the PFIs providing 34% andthe borrowers contributing 12% to the investment. o The proportion o f medium-to long-term financing under the RDFwas 78%, which is much almost twice the average share o f term-loans made by the banking systeminVietnam. o O f all sub-loans, 44% fmance activities inMekong River Delta which i s most active economic development region, and about 37% o f the end-borrowers are female. o Close to halfofthe finds are going towards direct investment inthe agricultural sector (46%). The averagesize o fthe sub-loans to households underthe Micro-Loan Fund (MLF) was $545 andthe MLF providing $316, and to micro-enterprises at $1,038 with the MLFproviding $600. o All the sub-loans under the MLFwere short-term, inaccordancewith the objectives. o More than 30% ofthe sub-loans went to end-borrowers livinginpoor northernmountainous areas. o About 45% ofthe end-borrowers are female. Therehave beenabout 300,000 sub-projects spreadacross 60 provincesthroughout the country, except the four largest cities (HCMC, Hanoi, Danang, Haiphong). Incrementaljob creation has beenreported to be as high as 160,000. The collection rate from Participating Financial Institutions (PFIs) to the APEX bank, BIDV,is loo%, and the averagepast due loans from end-borrowers to the PFIs is about 0.3%. About 30% o f clients under the project are first time borrowers who were able to establish their credit history for subsequentaccess to loans. About 60% o fthe clients have opened savings accounts for the first time. 8. BuildingSustainableInstitutionsfor RuralFinance. While the aggregate rural finance credits represent less than 1% o f the total formal credit outstanding in the domestic bankingmarket today, these operations have had a lasting impact on advancing the development o f the rural finance system. The first internal and external ex-post and independent assessments o f these operations confirm that they have contributed to 23 development o f the rural economy and improvement o f the living conditions in the rural areas. This was achieved through encouraging investments o f farm households and private rural entrepreneurs, by extending additional medium and long term financial resources, strengthening the banking system's capacity to better serve the rural economy, andincreasing access ofthe rural poor to financial services. Inaddition, the series o fRF projects has encouraged increased banking competition in the rural areas, with the number o fPFIs growing from seven in2000 to 24 by 2007. Such increased competition pushes greater outreach and efficiency among the competitors andresults in better quality products andservices for rural enterprises (andhouseholds). 9. However, for rural finance to expand on a sustainable path, the institutions must also be strong and the series o f rural finance projects has contributed to the banking sector development in Vietnam. One way this i s achieved i s through the accreditation process and capacity building support for the PFIs. The accreditation process sets out minimumstandards for the PFIs to meet. Ifthe PFIs do not meet all o f the accreditation criteria, they must have Institutional Development Plans (IDPs) put into place. These IDPs provide performance benchmarks that the PFIs commit to meet in order to participate in the RFII project and the PFIs meet these targets through utilizing RFII funding, as well as their own funding, to undertake internal restructuring andoperational enhancements. As a result, PFIs are improving both their financial performance and overall transparency. Finally, the APEX bank for the operation, BIDV, has shown improvement since it became the APEX bank for RFII three years ago through the engagement in the project and the efforts BIDV has made to meet its IDP targets. BIDV's financial performance has shown improvements over the course o f the RF projects and the bank is making strides to improve its financial health based on recommendations made by the World Bank and outside experts. Ultimately, this will enable BIDV to provide wholesale banking services to a wide range o f banks inVietnam that need additional liquidity to expand their operations into rural locations and to serve rural customers. Annex 4.2 contains an in-depth appraisal o f BIDV. 24 Annex 2: Major RelatedProjectsFinancedby the Bank and/or other Agencies Vietnam: Third RuralFinanceProject 1. Portfolio Size and Composition. The Vietnam portfolio consisted of 36 active operations (including stand alone GEF and CFC) with net commitments o f about US$ 3.6 billion by the end o f January 2007. The portfolio size has slightly declined from December 2006 as three projects exited the portfolio in December 2006 (Agriculture Diversification Project, Rural Energy Project and PRSC V). Amongst the sector units, Rural Development (23%), Energy(22%) and UrbanDevelopment (21%) are the largest. These units account for two third of our total commitments. 2. Delivery of Investment Projects. The Coastal Cities Environment and Sanitation Project (US$125 million) was approved by the Board on December 19, 2006. Inaddition, negotiations for the Vietnam Avian and HumanInfluenza Control Project (US$20 million) and Program 135 - Phase I1were completed in February and these two projects are scheduled for Board approval in February 2007 and March respectively. Negotiations for the Mekong Transport InfrastructureDevelopment Project are scheduled for March 12,2007. FY07LendingDeliveries ProjectName Deliveryto Client Skllls for Growth & 30-May-07 Tertiary Education 06 Health Financing & 30-May-07 Higher Education II 58 08-May- Strategy Work 07 Mekong Transport Infra. 207 05-Apr-07 Country Gender 25-Oct-06 Hanoi Urban Transport 132 28-Jun-07 Assessment I Program 135 Phase II - I 50 II20-Mar-07 Environment Monitor 04-May-07 CY06 PRSCVI 200 21-Jun-07 ~ Country Environment 16-Jun-07 Analysis Avian & Human Influenza 20 na Water ResourcesSector 31-May-07 Review HlFU Development 50 28-Jun-07 Land Policy Stocktaking 15-Jun-07 Mekong Transport Supp 20 21-Jun-07 Expressway Investment 01-Jun-07 Tax Administration (stand-by) 80 26-Jun-07 Strategy Medium Cities 23-Feb-07 Total 862 Transportation Total (incl. stand-by) 942 InvestmentClimate 03-Jan-07 Assessment VDR 2007 22-01-07 25 Annex 3: ResultsFrameworkandMonitoring Vietnam: RuralFinanceProject ResultsFramework PDO ProjectOutcomeIndicators Use ofProjectOutcome Information The Project Development i)Cumulativeinvestmentsmade This willbe measuredex post in Objective would be to increase by rural entrepreneurs as a result order to evaluate the impact o f economic benefits to rural private o f the project (proxy for increased the project on investment and enterprises and households by direct economic returns as a result employment creation, as a proxy increasing access to finance. ofthe p r ~ j e c t ) . ~ for economic growth as a result o f this project. ii)Incrementalincreasein employment as a result o f sub- project investments (proxy for social and secondary economic IntermediateOutcomes Use ofIntermediateOutcome Monitoring Component 1. Rural i)Volumeofmediumorlong These would be reported inthe Development Fund. Improved term loans (a proxy for access to Project progress report, mid-term access to mediumterm credit for credit resources) review report submits both to the rural entrepreneurs and shareholders including key individuals. ii)Numberofborrowers(a government agencies and the measure o f the effectiveness o f World Bank, inorder to monitor targeting SMEs) the effectiveness o f the line o f credit inreaching the target iii)Collectionrates(measuring beneficiaries. the effectiveness o f financial i)volumewillindicatewhether intermediation) the line o f credit is appropriately priced relative to the market in order to be useful to target beneficiaries. ii)Number of borrowers will determine whether banks are effectively targeting the SMEborrowers which have been identified as an under served segment o f the credit market. The number o f borrowers is estimated basedon an average expected loan size o f US$5000. iii)Collectionrateswillbeused to monitor the effectiveness o f financial intermediation. Total investment i s equal to total subproject costs including sub-loan amounts and equity contributions bybeneficiaries 4 Incremental employment is the difference between with and without project level o f employment inthe fumor household. 26 Component 2. .Microfinance Loan i)No.ofnewcustomers This will contribute to the impact Fund. Enhance rural poor access borrowing from PFIs and MFIs assessment and project evaluation to the financial services through report to be reported to the key micro finance find ii)Shareofwomenborrowers government agencies including M P I and MOF. Component 3. Bank Capacity APEX Bank (BIDV) BIDVscompliance with its BuildingandNew Products institutional development plan Development. Strengthened i)Compliancewithaccreditation willbe monitoredannually. capacity o f financial institutions criteria or with a time bound IDP to provide better financial agreed with IDA. For eachPFI, compliance will be services to the rural areas. measured o n a four point scale ii)ComplianceofPFIswith Unsatisfatory, Marginally accreditation criteria or with time Unsatisfactory, Marginally bound IDPs. Satisfactory or Satisfactory. A PFIwill receive a satisfactory iiiTrainingprovidedtobankers rating if it meets all accreditation (person days) criteria or the conditions o f its IDP. The project will receive a iv)Training curriculum and satisfactory rating if all PFIs material developed for SMEs, receive a satisfactoryrating or have not had a less than satisfactory rating for more than a year. This would allow PFIs time to correct any non compliance withthe IDP or be excluded from the program. The project rating o f marginally satisfactory, marginally unsatisfactory, and unsatisfactory will be used to reflect varying degrees to which this condition i s not met. Arrangementsfor resultsmonitoring 1. InstitutionalArrangements The implementingagency for the project, BIDV has already has a well established Project Management Unit (PMU) set up for the RFI and RFIIprojects. The PMUis an integral part o f the BIDV's core transaction center. This PMU is equipped with committed and capable staff and they are the champion in achieving the Project development objectives and ensure the compliance the IDA'S safeguard policies. The PMU has several units one o f which i s the Project Monitoring andEvaluation Divisionresponsible project reporting and evaluationactivities. 2. Data Collection PFIs will be required to submit quarterly reports to BIDV on their compliance with accreditation criteria and their respective sub-projects. This data will be aggregated by BIDV. The process for collecting this data is well established. In addition, outside consulting companies will be hired to carry out environmental audits of the project. 3. CapacityThe PMUis committed andhas capable staff with experience inproject monitoring and IDA'Ssafeguard policies. Inaddition, experience with RFIIproject has 27 shown that there are a number of consulting companies or research institutions which are capable of carrying out environmental audits. 28 * i;: a s53 w" 53 I 0 N P 0 I 2 9 - 8m 0 00 m 0 m l v 0 ?4N -1 00 N z1 0 c W c I 0 N 0 0 0 0 Y I Y - fL c .C 5 eteE 0 c E c c + 0 M E N Annex 4: DetailedProjectDescription Vietnam: Third RuralFinanceProject 1. Project Objective. The development objective o f the proposed RFIII would be to increase economic benefits to rural private enterprises and households by increasing their access to finance. The expected outcomes would include: (i) improved access to financial services for rural entrepreneurs; (ii) increased capital investment made by the rural entrepreneurs as well as increased employment; (iii) increased lending, particularly term lendingto the rural private sector for capital investmentby all participating financial institutions (PFIs) on market-based terms. 2. Project Rationale. The Government o f Vietnam's strategies for poverty reduction, financial sector development, and growth in rural areas all emphasize the importance o f greater access to finance services to facilitate economic growth. Vietnam's Socio-Economic Development Plan (SEDP) to 2010 emphasizes the importance o f greater accessibility to rural finance services for agricultural growth, non- farm employment generation andrural poverty reduction. Despitethe impressive reform progress and increasing formalization o f the financial sector during last decade, Vietnam still lags in the efficiency and outreach o f financial services. Rural private enterprises face serious challenges in accessing financing o f medium- and longer-term nature for investment purposes. The 2005 (unpublished) World Bank Investment Climate Assessment found that access to finance i s the number one constraint facing businesses in Vietnam. 3. The private firms finance almost 75 percent o f their new investments from non- commercial sources, such as internal funds (retained earnings), (non-market) equity investments, and family and friends. This highdependence on non-commercial financial sources substantially limits the rate and degree to which private firms can grow in size and expand into new markets. Beyond these factors, if an enterprise does obtain bank financing, it is usually relatively short-term and thus, not well suited to medium- and long-term investments. It is thought that a combination o f factors have led to this situation, including weak business plans, a lack o f audited accounts, insufficient collateral, etc. from the enterprises, and an aversion to smaller-scale, more risky (compared to SOEs), less well-known companies. However, the primary reason is the lack o f medium- and long-term funds available to banks, particularly medium- and long- term deposits, which they can transform into medium- and long-term loans. Based on the information provided by the SBV, only one-third o f the deposits raised in the banking sector in Vietnam are longer than 12 months. As such, short-term sources have been used to finance term-loan needs creating a maturity mismatch for the banks and limiting the ability of the banksto meet the demands by enterprises for such funding. The project therefore intends to provide term financing to micro and small enterprises for investment inproductive assets through the Rural Development Fund (RDF) to be financed by the IDAcredit. 4. Despite the general availability o f short-term liquidity in the banking system, the rural poor and rural households and micro-enterprises in some regions still do not have 32 access to financial services due to absence o f viable micro finance institutions. Based on a recent Micro Finance Study managedby the Financial Sector o f the World Bank, there are still exists great demand for improved quality and targeting o f the micro finance services (both credit and savings), especially in more remote areas that are more costly for the formal banks to reach. The project will provide a small amount o f fundingunder the Micro-finance Loan Fund (MLF) to demonstrate the profitability of microfinance lending, as well as to encourage the participation of banks as participating financial institutions. 5. Lending Instrument and On-lending Arrangement. The proposed lending instrument i s a Financial Intermediary Loan (FIL). The Government has proposed that the Bank for Investment and Development o f Vietnam (BIDV) be the APEX bank and the institution responsible for the implementation o f this project and on-lending to the accredited participating financial institutions (PFIs). BIDV has performed well as the APEX bank under RFII and is interested in implementing the RFIII project. IDA has agreed to the Government's proposal based on the continued improvement in BIDV's financial performance, the audited IAS accounts for 2006, and progress on its strategic plans, including its business strategy, equitization and Non-Performing Loan resolution plans (an appraisal o f BIDV i s contained inAnnex 4.2). The Bank will continue to work with BIDV duringthe project implementation andmonitor BIDV's financial performance closely. Alternative options were considered and are described inAnnex 4.1. 6. Participating Financial Institutions. The accreditation criteria for the Participating Financial Institutions (PFIs) under the Rural Finance I11 (RFIII) project have been developed based onpast experience under the previous Rural Finance projects, as well as best practices in World Bank line o f credit operations worldwide. The criteria set out standard financial performance benchmarks for PFIs to meet in order to participate in the project. These benchmarks are structured to reflect the core areas o f a financial institution - management and corporate governance, asset quality, capital adequacy, liquidity, profitability, and efficiency - and are primarily aimed at setting a basic standard of financial health and soundness for eligible PFIs and encouraging other financial institutions to reach these standards. Secondarily, the criteria are designed to protect the on-lending bank from the potential credit risks o f the PFIs and to enable the on-lending bank to better determine the appropriate level o f the size o f the line o f credit. Finally, the criteria are designed to provide a standardized, comparable monitoring tool to measure the progress made by the PFIs. It i s envisaged that for the Micro-finance Loan Fund, the PFIs participating in the RDF will be eligible to participate in the MLF. In addition, non-bank PFIs will also be eligible for andparticipate inthe MLFline o f credit. The non-bank PFIs that would qualify to participate inthe MLF would include primarily some select number o fthe best performing o fthe 955 People's Credit Funds (PCFs). The criteria for these non-bank PFIs under the MLFwill be similar to those for PFIs, but with some key differences. The full details on the accreditation criteria are attached inAnnex 4.3. 7. On-LendingInterestRates. Interms ofthe interest rates charged throughout the line o f credit, from the Ministry o f Finance to BIDV, and from BIDV to the PFIs, it has 33 been determined that the calculation used by Second Rural Finance Project will be a reasonable basis for the RFIIIproject (see Box 1 below for further details). The RFIII will continue to use the formula-based approach to setting the pass-on rate and the fixed margincharged by the APEX bank, BIDV, to the PFIs o f at least 2% as this is the best approach at the current time due to the limitations o f the inter-bank market. Inter-bank interest rates are reported daily as VNIBOR o f (on the Reuters information system), with twelve banks contributing, which i s supposed to represent the benchmark rate for short- term financing (overnight to 6 months) for banks. However, the market i s highly segmented with different rates paid by the different types o f institutions and depending on whether or not the transaction i s collateralized. Consequently, inter-bank deals actually negotiated one at a time inan over-the-counter manner between individual banks andthe VNIBOR rate is indicative only and not utilized as a benchmark by banks inthe market. The proposed interest rate calculation will be re-assessed within one year o f implementation o f the project to determine if a more suitable, market-based on-lending interest rate can be applied instead. For instance, if in the future the inter-bank market matures sufficiently to provide for a standardized and reliable benchmark interest rate or a more streamlined calculation methodology can be developed, then the pass-on rate will be adjusted accordingly. The on-lending rates from PFIs to end-borrowers would continue to be market based and at the full discretion o fthe PFIsto determine. Box 1. On-LendingInterest Rate Calculation under the SecondRuralFinance Project The Socialist Republic o f Vietnam would be the Borrower o f IDA Credit. The proceeds o f the Credit would be made available to BIDV under an On-lending Loan Agreement (OA), satisfactory to IDA, to be entered between MOF and BIDV. Under this OA, which would be built into the Rural Development Fund(RDF) and Micro-enterprise Development Fund(MDF) policy manuals, would be lent to BIDV for a period o f 25 years with a grace period o f 8 years on the principal. The interest rate charged by MOF to BIDV would be such as to give BIDV a 2% spread to cover its operating costs, risks, and a slight margin. This should be adequate to make the project attractive to BIDV and to encourage it to promote the flow o f resources into the lines o f credit. Finance for the RDF and the MDF credit lines would be made available to the Participating FinancialInstitutions under subsidiary loan agreements (SLAs) between them and BIDV. The on-lending rates from BIDV to the PFIs, under these SLAs, would be adjustable periodically based upon criteria that reflect market interest rates. BIDV would manage the two funds and would bear the credit risk at the level o f the PFIs. Funds would be on-lent to PFIs in local currency, in line with their clients needs. They would bear a variable rate o f interest adjusted monthly and intended to be equal to the adjusted cost o f commonly available deposits. This rate would be calculated by the SBV based o n the Weighted Average Interest Rate (WAIR) for 3, 6 and 12 months deposits inthe banking system inVietnam from a sample o f 24 banks, adjusted for the reserve requirement imposed by the SBV. The on-lending rate would largely reflect the market deposit rates on a quarterly basis. The PFIs would be free to set their interest rates to the end-borrowers to fully reflect market forces, and their associated costs, risks, and profit requirements. The Government would bear the foreign exchange risk against a 'fee' - the difference between the on- lending rate to BIDV and the cost o f IDA funds. This is because: (i) the small sub-borrowers would not be inapositionto bear the foreign exchange risk, andtherefore, BIDVwouldnotbeable to pass onthis risk to the PFIs; and (ii) the US$ o f IDA proceeds would actually remain with the Government who in return would provide BIDV with the equivalent local currency for on-lending to the PFIs. 8. Project Components. The following three primary components are envisaged for the RFIIIproject: 34 a Increase Capital Investment by Rural Enterprises - the "Rural Development Fund" (US$ 175 million IDA financing) e Increase Access to Microfinance in the Rural Economy - the "Micro- finance LoanFund" (US$ 10 million IDA financing) a Build Institutional Capacities and New Products (US$ 15 million IDA financing) 9. Component I: Increase Capital Investment by Rural Enterprises - Rural Development Fund (US$ 175 million IDA Financing). This component, the Rural Development Fund (RDF), i s designed to addresses the term financing constraints o f financial institutions to provide funding to rural enterprises for longer-term investment needs. The goal i s to enable rural private entrepreneurs to access medium- to long-term financing for capital investments, such as equipment and new technologies, which will enable opportunities for efficiency gains and business expansion. The Vietnamese economy and the banking sector have developed rapidly since the RFI and RFIIprojects were prepared. As a result, medium and large scale enterprises have increased access to financial services. Since IDA funds are scarce and should be used for development and poverty reduction purposes, the funds should be used at those segments o f the market where there is a financing gap. Inparticular, finds should be used at those segments o f the market the have the greatest potential to reduce poverty. Under the current economic conditions in Vietnam, it i s the micro and small enterprise segment o f the market that does not have sufficient access to medium- and long-term funds. Providing medium- and long-term funds to this enterprise segment o f the market would also result in the largest development impact. The line o f credit operation would mirror the RFII interms o f the processing, terms, as it has been found that the credit from the APEX bank to the PFIs, and from the PFIsto the endborrowers, is inline with marketrates andis not causing any market distortions. The PFIswill have to meet specific accreditation criteria to participate inthe project (see Annex 4.3 for details). Ifa financial institution does not meet all the accreditation criteria, it can still participate inthe line of credit and select elements o f the technical assistance component o f the RFIII project if it agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit will finance up to 70% o f each sub-project cost, and the rest 30% will be financed by the PFIs and the contribution from each end-borrower. The following eligibility criteria will be applied to sub-loans and projects financed under the RDF: e Sub-projects to be financed should bephysically locatedoutside the four big cities inVietnam, includingHanoi, Ho ChiMinhCity, Danang,andHaiphong. e Sub-loans should be for capital investments in productive assets and associated working capital loans. a Sub-loans should be targeted at micro and small enterprises with less than 50 employees. e For Sub-loans larger than $80,000 will be subject to wholesale bank's prior review. Sub-loan larger than $80,000 per sub-project could be approved provided 35 that it can be demonstrated that they are located outside Grade I1towns and in rural areas andwill have a large incremental impact on the rural economy interms o f employment creation. a Sub-projects financed will be subject to environmental compliance requirements based on the Environment Guideline developed for this Project and the funding will be aimed at sustainable investments that do not produce negative environmentalimpacts. 10. Component 11: Increase Access to Microfinance in the Rural Economy - Micro-finance Loan Fund (US$ 10 million IDA financing). This component, the Micro-finance Loan Fund (MLF), will provide a small line o f credit to demonstrate the commercial viability o f lending to micro-enterprises and household businesses. These may be defined as formal and informal businesses employing 2-3 employees outside o f their immediate families. The MLFwill be aimed at also encouraging the participating o f financial institutions, as well as eligible non-bank PFIs such as rural People's Credit Funds (small rural financial cooperatives) and licensed microfinance institutions, to develop more robust microfinance services inrural areas. The institutions will be subject to accreditation criteria (see Annex 4.3). If a financial institution does not meet all the accreditation criteria, it can still participate inthe line o f credit and select elements o f the technical assistance component o f the RFIII project if it agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit will finance up to 70% o f each sub-project cost, and the rest 30% will be financed bythe PFIs andthe contribution from each end-borrower. The participation ofthe PFIs is subject to the availability o f funds. It i s expected that sub-loans for short-term financing, as well as medium- to long-term financing where demanded, would be available only for new customers (household or micro-enterprises). These sub-loans would be limited to $500. As with the RDF, sub-projects financed under the MLF should be physically located outside the four big cities in Vietnam including Hanoi, H o Chi Minh City, Danang and Haiphong and the sub-projects will be subject to environmental compliance requirements and the MLF funding will be aimed at sustainable investments that do not produce negative environmental impacts. 11. Component 111: Build Institutional Capacities and New Markets (US$ 15 million). This institutional building component is a core element to the success o f the RFIII project. This component is designed to help build the financial institutions participating in the project and demonstrating a credible strategy for expanding access to finance inrural areas o f Vietnam. The component i s also designed to help demonstrate that new market can be found and are financially viable. These new markets can come in the form o f new customers, new products and services, and new institutions participating inthe project. The component will be supported by two sources of funding - (i) $5 a million IDA loan that has been transformed into a grant from the Government budget, and (ii)$10 million IDA loan that is passed on to the PFIs at IDA credit terms. a It is envisaged that the entire TA facility will be managed by the Project Management Unit o f the APEX bank, BIDV, for efficiency o f administration. The specific elements that will be finded under this component are follows with the approximate estimates for the resources associated with each component: 36 SubcomponentA. Meeting Emerging Demand for Rural Financial Services - GrantBasedAssistance (US$5 million) 12. A. 1. Supporting SMEs - SME Association (US$ 0.94 million): In order to prepare the SMEs to access to financial services and overcome the constraints they are facing, this sub-component will focus on supporting SMEs via the SME Association. Most o f the SMEs will need assistance in terms of creating business plans, developing accounts, finding sales markets, conducting marketing, meeting export standards, and a wide variety o f other training needs. This will also include capacity buildingto produce the required documentation for bank loans and other training specific to the lending process. The training will be provided through the Small and Medium Business (SME) Association andthe activities would include TA to develop a training strategy and model, curriculum and prepare training material for the end borrowers, including carrying out a train-the-trainers program. The subject o f the training to the SME ownerdmanagers would include how to improve their efficiency and profitability, how to prepare the business plan which is better linked to the requirement from the financial institutions. The training will also include marketing, human resources management, production & Operations development, finance & accounting skills. The IFC Mekong Private Sector Development Facility has launched BusinessEdge, which offers management training product and services to the SME sector inVietnam. 13. A. 2. SustainingPCFs and Non-BankMicrofinance InstitutionsOperations to Better Service Rural Populations (US$ 1.74 million): Component I1o f the RFIII project i s a small line o f credit designed to demonstrate the commercial viability o f lending to micro-enterprises and household businesses. It will be aimed at also encouraging the participating o f financial institutions, as well as eligible rural People's Credit Funds (small rural financial cooperatives) and licensed microfinance institutions, to develop more robust microfinance services in rural areas. The PCFs and non-bank microfinance institutions would be new institutions to the rural finance lending programs o f the past and thus, this New InstitutionDevelopment sub-component would be aimed at exclusively at them. This sub-component would include four inter-related elements o f TA support: 0 Supporting the Selected Non-Bank PFIs (US$ 0.5 million): The non-bank PFIs, the PCFs and MFIs, selected to participate in the MLF line o f credit would be supported by this sub-component. These PCFs and MFIs may need TA interms o f institutional strengthening, credit risk management, and lendingtechniques for micro-enterprises as part o f their use o f the MLF funding. This may be limited given that these non-bank PFIs will be selected based on rigorous accreditation criteria and assessment by the APEX Bank, BIDV, before the determination o f participationinthe MLF line o f credit i s made. 0 Strengthening the Vietnam Association of People's Credit Funds (US$ I.24 million): The People's Credit Funds (PCFs) network is a form o f cooperative credit organization that must ensure its growth and self-sustainability for 37 development. This network has gone through important stages since its foundation in 1993 including a fast-development stage (1993-1999), a consolidation phase under the guidance o f the SBV (2000-2003) and a return to a more secure organizational development since 2003. This approach has moved the PCF network to gradually set up a national organization to link the 955 PCFs and the Central Credit Fund(CCF), which is a sort o f credit cooperative bank to the PCF network. The idea has emerged to improve the security o f the entire network and begin to free the State Bank o f Vietnam from its direct support for the PCF network. The creation o f the new Association (VAPCF) inlate 2005 is a first step forward towards this new national approach and VAPCF has been officially operating since January 2006. The VAPCF has a number o f core objectives, including: guiding the members to implement the regulations and laws concerning the operation o f PCFs, supporting the PCFs in transferring technologies and management experiences, setting standards for the operations o f PCFs (i.e., reporting, accounting, credit, internal control, etc.), and organizing professional training courses for the PCFs. The VAPCF i s a relatively new organization and i s still struggling to establish itself as an effective tool for the PCF network. The Association i s receiving technical assistance, but there will be substantial follow-up that will be required to continue the VAPCF capacity building. Given that it is expected that 10-20 PCFs will participate in the MLF line o f credit and the aim is to show a demonstration effect, the VAPCF is a logical organization to spread the lessons o f the pilot lending under the MLF across the entire PCF network. Some o f the key areas o f need that can be supported by this TA sub-component are expected to be: (i)building the supervision, external auditing, and internal control fhctions within the PCF network, (ii) rolling out a standardized credit manual across the PCF network, (iii) supporting the development o f management information, banking software, accounting, and reporting systems across the PCF network, (iv) implementingthe organizational and business planfor the VAPCF, (v) improving the funding o f the VAPCF, (vi) strengthening the humanresources o f the VAPCF, and (vii) training the PCFs on the standardized operational procedures in various areas, such as credit risk management. Some limited support will be provided under this sub- component to the State Bank o fVietnam. The purpose will be to include the SBV inthe capacitybuildingofthe VAPCF so that the SBV, as the supervisory agency o f the PCF network, understands the developments and begins to gain a level o f comfort with the VAPCF. 14. A. 3. New Financial Services Development- PFIs (US$ 1.9 million): This sub-component i s designed to encourage PFIs to develop new products, particularly to serve the rural economy inVietnam. The basic idea behind this component would be to allow for innovations in the provision o f rural financial services and supporting those PFIs that are interested in offering new products to rural enterprises and households. There will be four distinct elements to this New Market Development component as follows: 38 0 Cash Flow-Based Lending (US$ 0.83 million): One critical barrier to access to finance i s the stringent use by banks o f collateral to back loans, which for small rural enterprises with little in the way o f valuable (or acceptable) collateral, this necessarily limits their ability to grow their businesses through a bank loan. However, because most banks do not provide non-collateralizedloans, substantial training o f staff, as well as new standardized systems and policies would be required to effectively undertake cash-flow based lending by the PFIs to rural enterprises. This component will enable the PFIs to design cash flow-based credit technologies that would provide the PFIs with simple, client-responsive, standardized loan product designs with built-in specialized accounting, monitoring, risk management and management information systems designed specifically for small-scale loans. The credit technologies would allow the PFIs to better judge the borrower's ability to pay based on a variety o f input factors, which would not be totally reliant upon collateral availability and valuation, and would allow them to better price their products based on the risks and costs identified by the system. The success o f such technologies would require that they be paired with training to loan officers, managers, etc. to better understand their application. The TA provided could support feasibility studies for any new technologies requiredfor implementation, as well as for training to the PFIs. This will be coordinated with the IFC's Mekong Private Sector Development Facility (IFC-MPDF) Vietnam Bank Advisory Project to help Vietnam's commercial finance institutions provide more and better services to micro, small and medium enterprises, as well as individual consumers. e Insuring Against Agricultural Risks (US$ 0.5 million): Another key area requiring new innovative approaches is risk mitigation for agricultural lending. The agricultural sector in Vietnam i s regularly subjected to a variety o f risks, including weather (floods, droughts, typhoons, etc.) and disease (avian flu, etc.), but there are virtually no products available to the banks to hedge their exposures to the agricultural sector. Insurance penetration in Vietnam i s very low, in common with other countries in the region, but it i s growing. However, most insurance coverage i s not geared towards agricultural risks. Therefore, the innovations that will be supported under this sub-component would include supporting the PFIs with TA to explore new insurance products. One example o f such an innovation could be weather-indexed insurance coverage for agricultural businesses. The country, particularly the rural areas, i s particularly prone to adverse weather, which mainly manifests itself in the form o f floods at regular intervals. VBARD, the biggest bank which serves rural areas has to send its credit officers after each flood to check the impact and often has to reschedule loans made to those who were impacted by the floods. This causes major problems for both the enterprises and the banks, and thus a new type o f weather- based insurance product could greatly mitigate the risks associated with lending to certain types o f businesses in particular locales in Vietnam. In addition, there appears to be demand from agricultural-relatedbusinesses for insurance products to mitigate the risks of disease in fish, livestock, poultry, etc. Thus, the PFIs 39 could be provided TA to build these services in partnership with insurance companies. e Generating Long-Term Funding (US$ 0.5 million): A key financing constraint that the RFIII project attempts to address i s the lack o f medium- and long-term financing in the banking system. At the moment, the majority o f banks raise funds via mobilizing relatively basic deposits from individuals and corporations andthere are very few alternative savings products offered by the banks. As was mentioned in Annex 1, only about one-third o f all deposits are longer than 1year inmaturity and thus, much of the longer-term lending is being fundedby short- term money. This is a significant barrier to the investment needs o f the growth businesses in Vietnam. Therefore, this sub-component would provide TA to the PFIs to assist in designing, marketing, and managing new longer-term savings products, including varied deposit account structures, Certificates o f Deposit, and other products such as bonds. 15. A. 4. EnvironmentalCompliance in Lending-PFIs (US$ 0.4 million): Given that environmental safeguards are an important innovation inthe RFIIIproject - no other lending operations in Vietnam have factored in environmental concerns - emphasis will be given to this area. This sub-component will provide training to the PFIs on the environmental guidelines and manual prepared for lending under the RDF (and MLF). The PFIswill receive training on the procedures for appraisal, evaluation, and monitoring o f compliance with environmental assessment and pest management safeguards, as well as on the restricted and negative lists o f environmentally (and socially) sensitive sub- projects. This will cover two times environment audit during the project implementation for the sub-projects financed. This will also cover the costs o f developing and printing thepamphlets for the end-borrowers on the environmentalrequirements o fthe project. Subcomponent B. Strengtheningthe Participating Financial Institutions - Loan BasedAssistance (US$ 10million) 16. B. 1. Strengtheningthe APEX Bank BIDV (US$ 1.5 million): Assistance will - be needed to continue the restructuring o f BIDV on organizational change, corporate governance, and many operational areas o f the bank. This TA would follow-on the previously provided assistance to BIDV in these areas and would also include a significant proportion o f training andhands-on implementation assistance. Inaddition to the general issues related to the bank restructuring, specific assistanceto BIDV related to the project administration could include support to enhance its credit risk analysis and determination o f the credit line exposures for the PFIs. Support to the PMU for the project, TCIII, will be included inthis component. Such support will cover strengthened analytical review o f the PFI strategies, methods o f capital increase, shareholder structure and corporate governance issues, accounting standards and qualifications, and implications o f the trends inthe financial ratios. This support will also cover a variety o f training for BIDV management and staff, as well as the relevant goods required to support the implementation o f the project such as computers, printers, a supervision car, etc. BIDV will be requiredto borrow to access this sub-component o f TA services. 40 17. B. 2. Building the Capacities of the PFIs (US$ 8.5 million): The PFIs have varied needs for technical assistance and training, from the broader range o f institutional strengthening to credit appraisal and risk management specific to the RFIII lending operation. The emphasis o f the TA to PFIs under this sub-component would be on those needs specific to the provision of financial services to rural micro-enterprises and SMEs, as well as ruralhouseholds. This particular sub-component will be an on-demand facility that will work towards the various PFIneeds based on their specific demands given that the PFIswillbe requiredto borrow to support this TA. However, it is expected that there willbe the following elements to this sub-component: e Strengthening Rural SME Lending PFIs (US$ 0.5 million): The PFIs would - likely needtraining managing credit risk to these customer segments, pricing the loans to incorporate the full risk, cost, and profit considerations, effectively engage inmore unsecured lendingand lendingto small-sized rural enterprises and households, usingthe movable assets registry, marketingto new market segments, and other issues surrounding rural enterprise business development. The TA could also include strategic advisory services on branch expansion in rural areas and methods o f outreach into these areas and businesses in the rural economy. Some o f the assistance could be provided through existing facilities, such as the Bank Training Center and the Vietnam Banker's Association, and some training may have to be customized and tailored for eachPFI. Improving Potential PFIs (US$ 1 million): Those banks that do not fully meet the accreditation criteria set forth inAnnex 4.3 can also participate inthis specific sub-component. These banks can access this facility to develop a time-bound action plan, or Institutional Development Plan (IDP), to reach the performance benchmarks o f the accreditation criteria. The IDP would be specific to each PFI given that each PFIwill have unique strategies, strengths, and weaknesses, but all IDPswould be aimed at reaching the same targets. Upon such time the PFImeets the criteria, it will be eligible for an allocation o f the RDF and/or MLF line o f credit. The aim o f this sub-component i s to assist the ineligible PFIs inimproving their performance, and ultimately, to encourage their participation in the RDF and/or MLFlines o f credit to expand access to finance inthe rural economy. e Enhancing the Largest Rural Financial Institution - VBARD (US$ 7.0million): The Vietnam Bank for Agriculture and Rural Development (VBARD) i s the largest bank in Vietnam by branches (about 2,200 nationwide) and by total assets (approximately US$ 12billion), as well as by employees (over 30,000). VBARD began its history as a specialized lending institution to support agricultural lending. Since the banking reforms in the late 1990s, VBARD began shifting toward more commercialized banking operations. By 2001, as with all o f the State Owned Commercial Banks (SOCBs), VBARD began shifting its strategy towards a more diversified, universal banking model aimed at increased private sector lending and retail bankingthrough its branch network, but still the core o f the bank's operations is inrural household and SME lending. As with all o f the 41 SOCBs, VBARD i s also tryingto expandits non-interest income through offering new products and services. The overall restructuring o f VBARD has yielded some positive results and the bank has historical strengths, but the bank still faces weaknesses and threats inthe near term. The key institutional weaknesses o f the bank include inefficient and decentralized organizational design with limited built-inaccountability for risks and systems for accurate accounting o fthe bank's position. These inefficiencies have resulted inlagging financial performance with inadequate capital adequacy, unknown asset quality and insufficiency o f loan loss provisions, low liquidity with possible maturity mismatches, and limited profitability. As such, VBARD today would not be able to participate inthe RDF and MLF as it would not meet the minimum accreditation criteria. VBARD drafted an Institutional Development Plan (IDP) in late-2007, which when finalized, will be the basis for financial performance enhancement andprovide the roadmap for meeting the RFIII eligibility / accreditation criteria. By agreeing to an IDP mutually acceptable to the bank and IDA, VBARD would be eligible to participate in the above-mentioned sub-component to build the institutional strengths to enable the bank to meet the accreditation criteria and participate in the RDF and/or MLF lines o f credit. In addition, because VBARD has such a wide network presence inrural areas, it is essential to enhance the performance o f this institution to better serve the rural-based businesses. Therefore, this particular sub-component would be focused expressly on helping VBARD implement its institutional development plan, but with particular emphasis on those areas directly connected to the activities o f the project, namely household and MSME lending. Therefore, some areas that this technical assistance component would support include: o Diagnostic review of the bank - In order to establish a benchmark for financial performance under the IDP, as well as for the restructuring and planned equitization o f VBARD, a full diagnostic review o f the bank will be required. Such a review would be broader than a routine audit, which is based on a sampling, and would cover the entire branch network and all aspects o f the bank's business with particular focus on the loanportfolio. o Detailed Appraisal of Rural Branch Operations and Development of Future Structure - VBARD needs to carry out a detailed assessment o f the effectiveness and efficiency o f its entire branch network operations and following this to put inplace the most efficient and effective network to serve its customer requirements profitably. For purposes o f this project, the focus will largely be on the rural branch network o fVBARD. o Building a comprehensive business strategy - Based on the diagnostic review and assessment o f the bank's branch operations, both o f which should reveal the strengths that VBARD should build on and the weaknesses VBARD should address, the bank will need assistance in developing a comprehensive business strategy for the next five year period. This strategy should cover the future direction o f the bank in terms o f objectives, operations, organization, and ownership. 42 o Establishing a human resource capacity building program - A critical element o f the success o f VBARD's fbture strategy will adequate human resource capacities to implement it effectively. Therefore, the bank will need to build on assessments and strategic plans developed (under a separate assistance program to VBARD under the RFII project) to carry out the training programs. The training programs developed will cover areas specifically geared to household and MSME lending operations, including: . Develop an extensive training program for credit ofjcers - All credit officers should attend a major training program at least every two years. The bank should develop a range o f programs with assistance from an international organization covering credit assessment, control o f credit, problem loans, SME lending, financial and planning assessment, programs specific to particular industrysegments. Leaders - Lending groups are an important element ina significant Develop a series of training programs for Lending Group proportion o f household lending and they carry out an analysis o f the customer and their requirements before the customer approaches the bank. It is inthe interest o f VBARD to ensure that the leaders o f these groups receive some training on a periodic basis from VBARD on credit assessment and risks associated with credit as well as with VBARD's overall approach to risk. o Developing a risk based approach to credit - VBARD will need to develop and put in place a modem risk based approach to household and SME lending. This will include putting in place the systems and procedures so that the risks associated with its various markets can be continuously assessedandupdated. o Put in place a modern credit assessment and controlprocess -VBARD has a credit assessment and monitoring process in place which is largely based on the existing credit manual. This i s a manual-based system with no reliance on modem technology for the analysis o f the information, control o f the lending, and follow up processes. As the bank has significant numbers o f small loans to family households it needs to implement a modem system with good use o f technology to make the processing o f these loans more efficient and to facilitate the introduction o f automatic control and follow up procedures. Credit Scoring should be put inplace for some smaller loans andthebankshouldhave a control and monitoring system that focuses the effort on where the key problems arise rather than across the total portfolio as i s the case at present with household lending. o Develop a mechanismfor the overall quality control of lending -This is necessary for controlling non performing loans by the credit and risk function at head office and in the provinces. VBARD does not have any 43 clear system for controlling the overall quality o f its portfolio at present. Their primary effort i s focused on collecting the necessary information on non performing loans. The bank needs to put in place a mechanism whereby the information requirements can be provided automatically by the information system and that the bank develops the important skills o f managing the problem loans successfully so that the bank achieves a high repayment rate andresolutiono f these accounts inthe shortest timescale. 44 Annex 4.1:AlternativeProjectDesignOptions Considered A numbero foptions were considered for on-lending arrangements under the proposed project, including the following: 1. Alternative Options for Project Design: In designing the Rural Finance I11 project, various options were considered interms o f structuring the line of credit. Under the RFIIproject, BIDV was selected unilaterally as the wholesale bank to administer the line o f credit. This was done at the early stages o f the bankingreform program, in2001, andthe choices ofpotential wholesale bankswere very limited. The bankingsector has since evolved, however the range o f realistic choices for project design has not dramatically changed since the design o f the RFII. Four basic options were considered in the design, including: (a) Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected APEX Bank, the Bank for Investment and Development of Vietnam (BIDV), that would bear the full credit risk; (b) Modified Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected Agent Bank, BIDV, that would only administer the line of credit without taking the credit risk; (c) Semi-competitive - several pre-determined participating financial institutions (PFIs) would be selected based on the accreditation criteria to receive a line o f credit for on- lendingto their respective clients; (d) Competitive -bidding out the WBO to the market to select an APEX bank for the line o f credit. The advantages and disadvantages o f the four options are summarized below. 2. (a) Status Quo - This option would maintain the structure under Second Rural Finance Project, with BIDV as APEX taking the credit risk. There are some clear advantages in selecting this option: (i) it allows more banks to participate inthe project, thus increasing bankingcompetition inthe rural areas (one o fproject objectives); (ii) this option would allow the project to diversify project's beneficiaries as each PFI will accommodate its own clientele; (iii) option would better fit the basic concept o f a this demanddriven operation, as it allows potential PFIs tojoin the project at their choice; (v) social and economic impact o f the project i s spread, through the wholesale operation, throughout the country. BIDV has performed well in managing the Rural Finance I1 (RFII) project, inparticular, staff from BIDV has carriedout the credit risk assessment o f the participating financial institutions (PFIs) with professionalism and strived to ensure that the subprojects financed by the PFIs were inline with the project the objectives. The repayment rate from the PFIs to BIDV under the project has been 100%and the %age o f past due loans from end-borrowers to the PFIs has been close to zero - only 0.3% by August 2006. BIDV has made progress in institutional strengthening under the project and various technical assistance programs. All o f the RFII project audits have been unqualified and the financial management system has been judged to be sound. The Government supports this option and BIDV i s interested in maintaining its role as the APEX bank under the RFIII and is making serious efforts to implement its business strategy, equitization, and Non-Performing Loan (NPL) resolution plans. The Government o f Vietnam is committed to support BIDV's ambitious equitization plan which will makeBIDV a much stronger financial institution. 45 3. (b) ModifiedStatus Quo - This option would essentially have the same pros and cons o f the Status Quo option (a), but with a few key exceptions. On the positive side, usingBIDV as an agent bankwould limit the potentialrisks to the World Bank (WB) and the Government in terms o f the exposure with the line o f credit managed by an SOCB with weak financial performance. This would also reduce the reputationalrisk to the WB in terms of being seen as endorsing an SOCB inpoor financial health. The credit risk would be borne by the Government (Ministry o f Finance) and BIDV would simply administer the line o f credit on behalf o f the Government through a contract and on a fee or commission basis. This option would expect MOF to carry out the credit risk assessment function, which it does not have the capacities to do (nor should it). However, if the MOF outsources this function, the line o f credit is de facto the same as Option A, but with less ownership and motivation on the part o f BIDV to perform the credit risk function and intensely monitor the performance o f the PFIs given they do not take the credit risk and reap the benefits (interest earned) in doing so. The costs might also be higher as BIDV could not cover its costs through the revolving funds o f the project, but instead would charge higher fees that would compensate. In addition, the M O F might be enticed to become more directly involved inthe bankingsector, including possibly directing credit and influencing PFI management and banking operations. The potential for such actions i s unknown, but if realized would constitute a major set-back for the banking reform process. The Government has not expressed support for this option. 4. (c) Semi-Competitive This option would allow the Government and WB to pre- - select PFIs based on agreed upon accreditation criteria. The criteria would be set to include the PFIs with the strongest financial health, as well as sound strategies and abilities to expand access to credit in the rural economy. This would have the added advantage o f limiting the credit and reputational risks by pre-selecting the PFIs. However, the MOF would have to perform some form o f the APEX banking function, would carry some o f the attendant risks as mentioned in Option (b). This option would also be an expensive one in terms o f project preparation and supervision as it would involve the appraisal o f several banks and later on routine supervision o f the performance o f each o f the selected financial institutions and the way they were implementing the project. The main disadvantage i s that such a design i s inflexible, specifically it would: (i) prevent other financial institutions from joining the project in a later stage; and (ii) limit the number of PFIs that are able to participate under the project, thus limiting project impact on enhancing banking competition in the rural areas and diversification o f its beneficiaries. Experience in other countries has indicated that there are often problems in making desirable re-allocations o f committed funds from institutions which are unable to disburse funds quickly to those which could use them. This 'predetermined' option, if selected, would reduce the likelihood that the project would fully meet all its objectives. 5. (d) Competitive This option would essentially be the same as the Option (a) - with the manyo fthe samepros andcons, but insteado fpre-selecting the APEX bank, the role would be bid out the WBO to the market. This would allow all o f the interested banks inVietnam to compete for the APEX bank role based on their terms and ability to 46 meet predetermined accreditation criteria set by the Government and WB. This would enable the Joint Stock Banks to compete directly with the SOCBs and would potentially bringina more financially soundbankto be the APEX bank,provide a lower cost option, and enable more efficient management and administrative capabilities to the WBO. However, all o f the PFIs (private joint stock banks) under the RFIIproject are all o f a small-scale interms of assets (averaging US$286 million) and have strategies to be retail lenders, therefore these bankshave not expressed interest intakingthe wholesale banking role. The remaining three SOCBs also have not expressed strong interest in the wholesale bankingrole giventheir strategies, with the agricultural bank seeking to act as a PFIunder the project and the other two bankspursuingstrategies that are not aligned to performing a wholesale banking function. Finally, the bidding process would be very time-consuming and expensive and carries the risks that there are no banks interested, the bids are expensive and not suited for the project needs, and the project reverts to the status quo. The Government has not expressed support for such an option. 47 Annex 4.2: Appraisalof the APEX Bank Bankfor InvestmentandDevelopmentofVietnam 1. Choice of On-lending Bank. The Government proposed that the Bank for Investment and Development of Vietnam (BIDV), a State Owned Commercial Bank (SOCB), be the APEX bank and the institution responsible for the implementation o f this project, including managing the credit risk o f the line o f credit. BIDV has performed well in administering the Rural Finance I1(RFII) Project, inparticular, staff from BIDV has carried out the credit risk assessment o f the participating financial institutions (PFIs) with professionalism and strived to ensure that the subprojects financed by the PFIswere inline with the project the objectives. The repayment rate from the PFIs to BIDV under the project has been 100% and the percentage of past due loans from end-borrowers to the PFIs has been close to zero - only 0.3% by August 2007. BIDV has also met all o f the disbursement targets under the RFII project and administered the project in compliance with all o f the World Bank guidelines and requirements, including the separate technical assistance component. All o f the RFII project audits have been unqualified andthe financial management system has beenjudged to be sound. 2. Beyond the proven project management capacities of BIDV, another consideration for selecting BIDV as the APEX bank was that most o f the PFIs (private joint stock banks) under the RFII project are all of a small-scale in terms o f assets (averaging US$286 million) andhave strategies to be retail lenders, therefore these banks did not express interest in taking the wholesale banking role. The remaining three SOCBs also have not expressed strong interest in the wholesale bankingrole given their strategies, with the agricultural bank seeking to act as a PFI under the project and the other two banks pursuing strategies that are not aligned to performing a wholesale bankingfunction. BIDV is keen to maintain its role as the APEX bank under this RFIII and is making serious efforts to implement its business strategy, equitization, andNon- Performing Loan (NPL) resolution plans. BIDV has made progress in institutional strengthening under the project and various technical assistance programs and the overall financial health o f the bank has shown significant improvement. Therefore, the role o f BIDV as the APEX bank for theproject has been confirmed. 3. However, BIDV does not meet all o f the financial performance accreditation criteria required for participating financial institutions and as such, BIDV has prepared a newly updated Institutional Development Plan (IDP) that includes a time bound schedule for meetingall accreditationcriteria that it does not currently meet. BIDV has also submit to IDA an update on its strategic plans (business, equalization, NPL,IDP, etc.). Based on information from BIDV management and staff, it is expected that BIDV shouldhave met most o f the PFI accreditation criteria by end-2007 and this will be verified by the 2007 IFRS audit report. This Annex describes this progress, as well as the overall financial health andperformanceo fthe bank. 48 4. History of the Bank. The Bank for Investment and Development o f Vietnam began its history as a specialized lending institution to finance large-scale capital and infrastructure projects in the country. BIDV was established in 1957 as the Bank o f Construction o f Vietnam, and re-established in 1996 as an independent state owned commercial bank. BIDV i s the second largest bank inVietnam by assets and a relatively large bank interms o f physical presence, with 103 main branches and 202 sub-branches and transaction offices across all 64 provinces o f Vietnam and 10,000 employees as o f September 2006. 5. Since the bankingreforms in the late 1 9 9 0 ~ ~ BIDV lost its monopoly position in the area o f large-scale financing andthe bank, as with all o fthe SOCBs, began shiftingits strategy towards a more diversified, universal banking model aimed at increased private sector lending and retail bankingthrough its branchnetwork. Despite the shift, lending to State Owned Enterprises (SOEs) still represents the majority o f the BIDV's portfolio with the bank still maintaining strong relationships the large SOEs engaged in construction activities. As with all o f the SOCBs, BIDV i s also trying to expand its non-interest income through offering new products and services. The new business lines the bank is expanding into include leasing, securities, insurance, cards, andATMs. BIDV i s the third largest o f the four main SOCBs by branches and total assets. The overall restructuring of BIDV has yielded some positive results andthe bankhas some inherent strengths, but the bank still faces weaknesses andthreats inthe near term. 6. Overall Financial Performance. BIDV's financial performance is showing significant improvements in a number o f areas, but the bank i s still struggling with the legacy loans o f its past role as a directed lending institution. BIDV has been one o f the most aggressive banks in the Vietnamese market to pursue International Accounting Standard (IAS) audited accounts andthe bank has publishedthem intheir Annual Reports since 2004, side-by-side to its Vietnamese Accounting Standard (VAS) audits. Based on the 2006 IAS accounts, one can see an improvement in the income statement with an increase ininterest income o f 17% implyingan increase inthe interest margin. The bank also maintained relatively strong performance on the measures o f efficiency - expenses to loans and assets - and the bank's net profit also rose during the period to reach 613 billion Vietnamese Dong, or VND, (US$ 38.6 million) in2005. This allowed the bank to record a Returnon Equity (ROE) o f 16% and Return on Assets (ROA) o f 0.4%. While this is an improvement over previous years and BIDV is continually making strong improvements in performance, BIDV compares unfavorably against many international performance benchmarks in East Asia and among developed country banks for performance. BIDV's profitability is increasing, but it is still relatively low when compared with the benchmarks for banks operating in East Asia and in developing economies. BIDV's capital adequacy i s also well below the 7.2% average in East Asia, as its liquidity, and the asset quality i s also lagging. BIDV has also been reviewed in May 2007 by an international rating agency, Moody's, and received a low BankFinancial StrengthRating o fE+(on a scale fiom A to E, with A being the best), which was a slight improvement over the October 2006 rating o f E. The rating was given because o f the bank's "significant asset quality problems, its weak funding profile, and modest liquidity," however, Moody's provided a positive outlook for BIDV due to the bank's "strengthening profitability, ongoing restructuring, and recapitalization." Below i s a 49 comparative table showing BIDV's performance on a number o f key metrics compared with the average inEast Asia anddeveloped economies worldwide. Table 1: Benchmarking BIDV's Financial Performance Performance Indicators East Asia DevelopedCountry BIDV' Average** Average"* Sources: *** 2005 DatafFom 2006IASAudit Datafor BIDV, Ernst & Young Vietnam. the IFC derivedfiom Banh-scope. East Asia data based on an average of 25 banks across 7 countries and Developed Country data based on an average of 43 banks across 12 countries. 7. Overall Asset Quality. The asset quality o f BIDV has been increasing on a slow and steady trajectory over the past five years, but has witnessed a sudden rapid improvement in 2006. Although the exact quality o f the loan portfolio before 2003 i s difficult to ascertain on an international standard basis, the broad trends can be described. BIDV initiated are-orientationof its asset profile. BIDVbrought its level o fNPLs down to 9.6% from a level o f over 33% in 2002, slowed lending from a growth rate o f 37% in 2002 to 19% by 2006, and increased the level o f provisions to cover 60% o f NPLs by 2006. In addition, BIDV has increased its holdings o f government securities and placements with other banksby 167% since 2002, andthese holdings constituted 21% o f total assets by 2006. The shift in the portfolio represents part o f the bank's strategy o f graduallymoving into less risky asset holdings and focusing on asset quality over growth. 8. Management and Corporate Governance. The management o f BIDV, under the strong and committed leadership o f the bank's General Director, has taken many aggressive steps since 2005 to improve the performance o f the bank. Under the direction o f the bank's management, BIDV has completed the second phase o f a comprehensive technical assistance program ("TA2") with an international advisory partner, ING Bank. The project was supported and managed by the World Bank and was focused on strengthening BIDV's strategic planning, organizational model (including corporate governance), restructuring the head office organization and member units, improving the 50 credit risk, asset and liability management, internal audit, and other key operational functions in line with international best practices in banking operations. The bank has already incorporated many elements o f the technical assistance, includinginthe strategic planningprocess, and is contractingthe next phase o f assistanceto fully implement many o fthe recommendations provided under the TA2 project. 9. Strategy. The bank has drafted the strategy to 2010 and it has been approved by the Board o f Directors and Board o f Management. This strategy includes new product development and IT modernization approaches. BIDV has also taken steps to centralize the operations o f the branch network and i s planning a regional hub structure, including setting lower credit approval limits and rolling out the core banking and management information systems to the branch network (144 branches and subsidiaries). BIDV has activated the Risk Management Unit to implement its risk management policies, guidelines, and tools. This Unit is also developing the Operational Risk Framework and the Manual for Credit Risk Management. The bank is also pushingtraining programs to its staff on a range of issues, including credit risk management, with the support o f the World Bank. Inthe first 4 months o f 2006, BIDV had already conducted 45 courses for 2,133 staff across the bank under the Project's budget. Finally, BIDV is a market leader inpublishingtheir IAS accounts inthe bank's Annual Reports andwas the first bank in the market to complete its 2005 I A S audit. Related to this move towards greater transparency, the bank also invited Moody's to provide a rating o f the bank inApril 2006 and again, invited Moody's back to update the ratinginMay 2007. 10. The strategic plans o f the bank (business, equalization, NPL, IDP, etc.), which in the past did not appear to be inter-related, now are highly inter-active. In fact, the April 2007, "Brief Report on the Implementation o f BIDV's Strategic Plans," brought the various strategic plans together in one coherent explanation o f the future targets and actions the bank plans to take to 2010. The financial performance targets in these strategic plans seem to be much more realistic and fact-based than in the past, the sequencing o f the actions appear to be logical, and the ambitions inthe strategies appear to be largely aligned with the strengths o fBIDV. , 11. Inaddition, inspite of all ofthe positiveprogress over the past year and a half, BIDV, as with all o f the SOCBs, faces a fundamental corporate governance and incentives challenge. This is due to the uncertainty surrounding who has the responsibility to provide management oversight from a shareholder point o f view and hence, who has the power to act. The SBV plays the shareholder role and i s often involved inmanagement-level decisions through regulatory mandates, while the Ministry o f Finance (MoF) has little real power in the SOCBs. SOCB managers need SBV approval for many business decisions and the bank faces other government imposed constraints, such as expenditure limits andprofit targets. The shareholder role inputting pressure on management to perform i s largely absent in the SOCBs and there i s no independent reporting to shareholders on performance o f the SOCBs, nor to the Board o f Directors (BOD)on the performance o f the managers. Thus, the performance incentives based on profit maximization and delivering value to shareholders i s largely absent. All o f this may change in the near term with the planned "equitization," or partial privatization, o f BIDV in2008. 51 12. Equitization of the Bank. BIDV plans to equitize, or partially privatize, the bank by selling shares and on January 2, 2007, the Prime Minister directed the bank to complete the process by 2008. Details of the equitization plan were finalized by end o f November 2006 and the Steering Committee for the equitization was established in January 2007. BIDV has hired an international investment bank to help in the advisory process to seek out a foreign strategic investor, as well as to help invaluing the bank and developing the share sale strategy - the bidding and short list of international firms has already taken place. It i s expected that an international investor will take a minimum 15% stake in the bank and another 15% will be sold via an initial public offering process on the domestic stock markets. BIDV i s seeking to accomplish the following objectives through the equitization proces: (a) enhance financial performance; (b) improve management capabilities by attracting international management experience; (c) facilitate BIDV's international integration; (d) become more competitive and further increase market share; and (e) update technology and develop new products. N o other state- owned commercial banks inVietnam have actually undertaken the equitization process to date, but it i s expected that BIDV will be the third to do so (after the Bank for Foreign Trade, or "Vietcombank," and the MekongHousing Bank). Once BIDV does undergo an initial public offering on the market, presumably the Ho Chi Minh Stock Exchange, it will be subject to all o f the listing standards o f the exchange, including importantly those for disclosure and corporate governance. 13. RecommendedRestructuringand Progress. BIDVhas madeaggressive efforts towards improving the operational and managerial performance o f the bank. Inmid-2006, the World Bank reviewed this progress (under the supervision process o f the Rural Finance I1project) and made recommendations for continued reform and restructuring. BIDV showed impressive initiative inmeeting the recommendations in a short period o f just six months. The table below provides an approximate measurement o f the progress to date. Three notable developments shown in Table 2 below should be highlighted. First, BIDV has developedand is now implementing anNPLresolutionplanthat sets out ambitious targets for achieving a low level o f NPLs by end-2007, aiming at a 5% or below. Second, BIDV has developed, with the help on an international auditing firm (Ernst & Young), an Internal Credit Rating System (ICRS) to evaluate and classify all o f its loans more accurately which was put into operation in November 2006 that covers 68% o f the loan portfolio. Finally, as mentioned above, BIDV developed and is implementing an equitization plan that envisages BIDV becoming a publicly held bank, including significant share holdings by strategic international investor(s). 52 Table 2: RecommendationsandRestructuringProgress byBIDV World Bank Recommendations (June2006) Rapidly reduce lending to the BIDVis implementing anInternal industries, sectors, geographic Credit Rating System (ICRS) to evaluate and locations, and enterprises classify all o f its loans more accurately. The identifiedas beinghighriskand ICRS has beenapproved by the SBV andnow generating NF'Ls (Categories 3, covers 68% o f the bank's loanportfolio. The 4, 5 loans) for the bank and bank i s now taking action to reduce the lending address the portfolio o f Category to the poorly performing customer segments. 2 (special mention) loans. Aggressively pursue the NPL A detailedNPLresolutionplanhas resolution plan with greater been developed and BIDV is targeting a level o f emphasis on selling the NPLs to N P L s o f 5% by end-2007 through aggressive the Debt and Asset Trading collection, andresolutionthrough provisioning, Company (DATC) and sales to the DATC, andrecapitalizationby the resolution through Government Government. Based on new ICRS, the NPLs recapitalization. within the bank in2006 (based on the IAS audit report) were 9.6% o f total loans outstanding. 0 Getthe strategic plans ofthe BIDVhasprepared anequitization bank, including the overall plan plan, which has beenapproved by the to 2010and the equitization Government, and BIDVi s contracting an plan, approved and adopted. international strategic advisor for the valuation o fthe bank and developing the equitization strategy for the share sale by the endo f 2007. BIDValso has anInstitutionalDevelopment Plan, which appears to be inline with its overall strategic planfor the bank. Fullyimplement and enforce the Thisis still a work inprogress. new credit manual and procedures across the bank network and implementa system o frewards andpenalties for performance for credit officers. Also, implement the planto As ofNovember, the ICRShas develop a customer ratings beenbuiltand i s now being put into place systemandmove the internal across the bank, including the branchnetwork. reporting and loan classification The ICRS monitors approximately 68% o f total systems to the international loanportfolio. Loans to individualborrowers standard andpilot test the are not includedunder ICRS yet. The SBV, by systems. official letter No. 9745/NHNN-CHN dated November 14,2006, approved the adequacy o f BIDV's ICRS as perArt.7 of SBV Decision 493. Make additionalprogress in This is a work inprogress. The pricing credit to reflect the full ICRS should help indifferentiating customers 53 costs andrisks associatedwith basedon risk and thus, should helpinpricing the loans with a resulting larger the products and services. interest income and increased profitability ratios. Reverse the trends inmedium-to BIDV signeda 5 year loan long-term fundmobilization to agreementwith RFZBank (Austria) on better alignthe assets and November 6 for $200 million inan effort to liabilities o fthe bank and restructure its liabilities, thus improving the provide for increased profile o f its long-term assets which now are opportunity to undertake longer partially financed by short-term liabilities. term investments and loans. Other efforts are also being made. Continue to provide high quality BIDVconducted training on training to the bank staff trainers nationwide in3 involved inthe credit decision geographical regions. Training making process, as well as in courses on credit operations have other areas o fthe bank criticalto beenimplemented for branches riskmanagement. nationwide. As o fthe end o f September, 7 out o f 8 planned courseshave beencarried out under Rural Finance I1project. In addition, BIDV intends to develop a human resources strategy and training programs through a projecl to be fundedunder the RFII project. Accelerate the centralization o f e BIDVhas reduced the credit the credit function from the approval limits o fbranches. The branches, along with the fust restrictions have beenon installation o f more robust medium and long-term lending and internal controls and segregation the handling o f customers o f o f duties. Group B and customers with Category 3,4, and 5 loans. Prepare for a third phase o f BIDVis inthe process of comprehensive technical contracting the project to be assistance for the bank to build fundedunderthe Rural Finance I1 on the recommendations and project. processes developed under the Technical Twinning project with INGBank, which closed in 2006. 54 Annex 4.3: Eligibility Criteria forparticipating Financial Institutions 1. Purpose of Eligibility Criteria. The eligibility criteria for the Participating Financial Institutions (PFIs) inthe Rural Finance I11(RFIII) project have been developed based on past experience under the previous Rural Finance projects, as well as best practices in World Bank line o f credit operations worldwide. The criteria set out minimum standards o f financial performance benchmarks for PFIs to meet in order to participate in the project. These benchmarks are structured to reflect the core areas o f a financial institution - management and corporate governance, asset quality, capital adequacy, liquidity, profitability, and efficiency - and are primarily aimed at setting a basic standard o f financial health and soundness for eligible PFIs and encouraging other financial institutions to reach these standards. Secondarily, the criteria are designed to protect the on-lending bank from the potential credit risks o f the PFIs and to enable the on-lending bank to better determine the appropriate level o f the size o f the line o f credit. Finally, the criteria are designed to provide a standardized, comparable monitoring tool to measure the progress made by the PFIs. 2. Background on the Financial System. Vietnam's financial system i s still in transition from servinga centrally plannedeconomy to servingan increasingly liberalized, market-oriented economy. Since the reform program began in 2000, there have been significant improvements, such as an increase o fbank credit to GDP from 35% in2000 to 66% in2005 anddeposits to GDP from 39% to 67% respectively. Inaddition, the growth rate o f both credit and deposits has been rapid, averaging close to 30 % on an annual basis. Importantly for this project, there i s now increased domestic competition, with 36 joint stock (semi-private) banks (JSBs) holding 15% o f the market share, although the four large State Owned Commercial Banks (SOCBs) have maintained their dominance o f the market, holding a steady 70-75% market share. Despite this progress, the level o f financial performance of the banks has historically beenweak, which would be expected at Vietnam's stage o f transition and economic development. Although some of the banks are now solid performers, attracting the major international banks as partners and investors, and recent evidence suggests that many o f the JSBs in particular are reaching towards international standards o f performance. Therefore, it is important to establish financial eligibility criteria that are in line with the direction o f the progress within the banking system and to provide realistic, but achievable benchmarks for PFIs under the RFIIIproject. 3. General Criteria. Inorder to participate inthe project, a financial institution will needto meet a set o f management and financial criteria that have been agreed with the World Bank, and to have signed a Subsidiary Loan Agreement with the on-lending bank for the project. The Agreement will, inter alia, reflect the PFI's management interest in and commitment to servicing the rural market, willingness to strictly adopt and adhere to prescribed policies and procedures o f the project, commitment to hire and train new loan officers, and to utilize the Technical Assistance Facility o f the project. In addition, the 55 PFI would have to provide its full business strategy and plan for the future and the rationale for its participation in the RFIII project. This would include the institution's plan for outreach and expansion into rural areas, including in the various business segments, andwould provide some indication o f how the RFIII i s inline with the overall business strategy. As Table 1below indicates, the financial institution would also have to be in substantial compliance with all the prudential and regulatory requirements o f State Bank o fVietnam (SBV) and acceptable to the World Bank, with no pending supervisory actions against the institution. The financial institutionwould also have to be licensed in Vietnam to undertake banking operations and have an appropriate corporate governance structure that complies with the appropriate regulations, with independence and capacity to provide adequate supervision to management and control over the bank's lending decisions. This would also include verification o f the PFI management that the bank meets the fit and proper standards and other requirements o f Vietnamese banking laws and regulations. Finally, the financial institutions must have (and provide) financial reports for the past two years under VAS, audited by a reputable auditing firm that i s acceptable to the SBV. Incases where the IAS audit reports are available, the PFIs shall provide the I A S audit reports immediately. Otherwise, the PFIs shall provide I A S audit reports within 2 years after receiving a credit line o f USD 3 million and above from the project or at the discretion o f the APEX Bank. The audit reports should not contain any serious qualifications and if they do, it will be at the discretion o f the APEX Bank, in agreement with the World Bank, as to whether the audit reports will be accepted as compliant with the eligibility criteria and whether the bank canparticipate inthe project. 4. Financial Criteria. As mentioned above, financial eligibility criteria are structured to reflect the core areas o f a financial institution. The criteria included in Table 1 cover standard ratios for asset quality, capital adequacy, liquidity, and profitability. These financial criteria are designed to capture the key performance issues, such as rapid business expansion (loan growth ratio), robustness o f risk management practices (non-performing loans ratio), ability to cover losses (provisions, capital adequacy ratios), and the sufficiency o f income generation (profitability ratios). Insum, these indicators should provide a clear picture o f the overall health o f a financial institution and in a time-series, will provide picture o f the positive and negative trends within the institutions. It would also be useful to monitor other standard financial ratios o f the PFIs, such as those for efficiency (operating expenses to assets, loans, and income) to gauge the operational strength and others that are not criteria, but would be indicative, such as the provisions to non-performing loans, net interest margin, and various liquidity measures. Wherever possible, the criteria are benchmarkedto the East Asia region based on the International Finance Corporation's (IFC) due diligence process for its investments inbanks. However, theperformance benchmarks for Vietnam are adjusted to account for the lower level o f economic and financial development as compared to the other six mostly middle income countries used in the F C benchmarks. In addition, the methodology for calculating the ratios is consistent with existing SBV regulations where applicable. 5. Meeting the Criteria. All potential PFIs would have to apply to participate inthe RFIIIproject and the on-lending APEX bank, BIDV, along with the World Bank would determine the eligibility o f a financial institution. Given that the APEX bank i s taking 56 the full credit risk o f on-lending to the chosen PFIs, it will then conduct its own in-depth due diligence on each PFIto determine creditworthiness andthe specific allocation ofthe line o f credit for each PFIbased on this due diligence assessment. The APEX bank will also conduct regular monitoring o f the performance o f the PFIs to ensure continued eligibility throughout the project implementation. If a financial institution can not meet the minimum criteria o f Table 1, it will not be eligible to participate in the RDF and/or MLF line of credit under the FWIII project." Such a financial institution would pose a sufficiently highrisk to the on-lending bank and to the project. If a financial institution does not meet all the criteria, then it can still participate in the line of credit and select elements o f the technical assistance component (Component 111) o f the RFIIIproject if it agrees to a time-bound action plan, or Institutional Development Plan (IDP), to reach the performance benchmarks. The IDP would be specific to each PFI given that each PFI will have unique strategies, strengths, and weaknesses, but all IDPs would be aimed at reaching the same targets. The IDP will be done to the satisfaction o f and subject to approval by the APEX bank, BIDV, and the World Bank. The IDP would be monitored on an annual basis by the on-lending bank and the World Bank to ensure progress is beingmade. Ifa financial institution meets all o fthe eligibility criteria, then it would not need an IDP and would immediately become a PFI in the project and would receive an allocation o fthe line o f credit based on the assessmentmade by the APEX bank, BIDV. 6. Non-Bank Participating Financial Institutions. It is envisaged that for the Micro-enterprise Development Fund, the PFIsparticipating inthe RDFwill be eligible to participate in the MDF. In addition, non-bank PFIs will also be eligible for and participate inthe MDF line o f credit. The non-bank PFIs that would qualify to participate in the MDF would include primarily some select number of the best performing of the 955 People's Credit Funds (PCFs). The PCFs are governed by the Law on Credit Institutions and associated regulations and they are supervised directly by the State Bank o f Vietnam. The PCFs are a network o f member-owned credit cooperatives that provide savings and credit products. The PCF network serves 1million members with loans o f an average value o f US$ 700-800. Dueto their small size, private (member) ownership, and closeness to borrowers, PCFs can usually provide more varied loan products, albeit at higher interest rates, than banks. The interest rates on loans vary significantly from 8.4 - 17.4% p.a., but loans to poorer members cost an average o f 9% p.a. The non-bank PFIs that would be eligible to participate in the MDF would also possibly include a limited number o f Microfinance Institutions (MFIs) that are licensed by the State Bank o f Vietnam under Decree 28 o f 2005." At the moment, no MFIs have been licensed to operate under this Decree and the implementing guidelines and regulations have not been finalized. Most potentially licensable MFIs are non-governmental organizations that are supported by international donors o f some form and most programs use a solidarity-group methodology, either o f the village bank or Grameen Bank-type, while a few (including the largest MFI, the CEP Fund in Ho Chi Minh City) also loBased on September 2007 data from BIDV, 15 joint stock banks out of 24 PFIs under the RFIIproject meet all of the proposed criteria and it i s expected that by end-2007, many more will reach the targets as well. l1Decree of the Government Number 28/2005/ND-CP of March 9, 2005, "On organization and operation ofmicro finance institutions inVietnam." 57 provide individual loans and housing loans. The size o f outreach by these institutions i s very small, with only about 142,200 loan accounts. Interest rates range between 0.8 - 2% per month, calculated on a flat or declining balance. The overall average loan size reported is VND 1.5 million (US$ 95). Many o f the schemes offer financial services as part o f an integrated package o f other activities. The criteria for these non- bank PFIs under the MDF will be similar to those for PFIs as outlined inthis section and inTable 1below. However, the underlying methodologies (and associated regulations) governing the criteria, such as those for liquidity, asset quality, etc., listed in Table 1will be different because these institutions are regulated differently than banks. In addition, there are no standard international benchmarks for performance for these non-bank institutions and the benchmarks used to judge these non-bank PFIs may differ than those listed in Table 1. Therefore, the performance benchmarks will largely be in line with Table 1, but can be modified at the discretion o f the APEX bank according to market conditions for these non-bank PFIs. Table 1: EligibilityCriteriafor ParticipatingFinancialInstitutions" Eligibility Criteria ......................................... 2 PFI..........................licensed to operate' 1 " i s ............................. 1 >=3 years f.. .................................................................. ..................................................... " " ............................................ " " ................................i " I............ NIA ................................................ Level o f compliance with i Nopending 1 Ij banking laws andregulations' 1 Ii 1 SiA ~ ................................................................................ actions t I " ......................................... ...................... ................................. _ supervisory ......................."........................................................... ~ " " " Compliance with management : j 4 and corporate governance 1 Full I i NIA ........................ regulations' ~ ........................ ............................................................. " 5 Audited Accounts I NIA Asset Quality Non-Performing Loans to ! ! Total Outstanding Loans4 1i <=6% 3.2% ~ capital^Adequacy Owner's Equityto Total Risk 1 I Weighted Assets' i >=8% i 6.8% ...................... 9 ReturnonEquity ._."....................... *"....""................................................. 1 !..................._............................................................................................................ >= 10% 15.9% ...... .... 10 Return........................................................................ on Assets >=0.5% ...." , ~ " ^. 1 12 Note that for non-bank PFIs, such as the People's Credit Funds and Microfinance Institutions, the underlying methodologies and regulations governing the criteria listed in Table 1 will be different. In addition, there are no international benchmarks for performance and the benchmarks used to judge these non-bank PFIs may differ than those listedinTable 1. 58 As per the Law on Credit Institutions (1997) and associated SBV regulations. As per the requirements o f SBV Decree 49/2000MD-CP o f September 12, 2000 (and any subsequent revisedversions o f this regulation). 3Audited Accounts required to be done by a reputable accounting fm. The Audit should be basedon I A S ifthe PFI has total assets above USD 500 million. Otherwise, the accounts will be prepared under VAS with an actionplanto produce IAS-compliant accounts. 4As per the requirements o f SBV Decision 49312005lQD-NHNN o f April 22, 2005 and any subsequent amendments, which outlines the five category classification system for loans, required level o f provisions for each category, and the general level o f provisions. As per the requirements o f SBV Decision 457/2005/QD-NHNN o f April 19, 2005 and any subsequent amendments. From the 2005 performance benchmarks o f the International Finance Corporation (IFC) derived from Bankscopebased on the median data o f 25 banks across 7 countries inEast Asia, including Vietnam. 59 Annex 4.4: Compliancewith FinancialIntermediaryLendingPolicies World BankOperationalPolicy8.30 1. The following table provides an overview o f the Third Rural Finance (RFIII) project's compliance with the World Bank operational policies on financial intermediary lending (FILs). The compliance assessment i s based on the main criteria set forth under OP 8.30 and provides a brief explanationo fthejustification for rating the proposed RFIII compliant with the policies. The Project supports one or more o fthe following Objectives: investments inthe real sector - (a) supporting reformprograms inthe financial capital investments by micro- and sector or relatedreal sectors; small enterprises (MSEs) inrural areas. It will also support private (b) financing real sector investmentneeds; sector development as the (c) promoting private sector development; borrowers will all be privately held, and it will encourage the (d) helping to stabilize, broaden, and increasethe participating o f the private efficiency o f financial markets and their allocation financial institutions. The project o f resources and services; will provide fundfor technical (e) promoting the development o f the participating assistance and training to the PFIs. Financial Institutions (PFIs); and The project will also help to enhance and catalyze PFI term (0 supportingthe country's povertyreduction lending to the MSEs inrural areas objectives. on a commercial basis. Ultimately, the project will contribute to new investment and income generation by supportingbroad-based, private sector-led growth inrural areas. Interest Bank funds are priced to be competitive with what The h d s from the Bank will be Rates the participating PFIs and their sub-borrowers provided from the PFIs to the sub- would pay inthe market for similar money, taking borrowers at hlly commercial into account, as relevant, maturities, risks, and rates. The finds on-lends to the scarcity o f capital PFIs from the APEX willbe based on marketrates, with an agreed formula with weighted deposit rate discussed between the World Bank and the key stakeholders in Vietnam. Directed Bank-supported FILs also aim to remove or The credit will focus on addressing Credit substantially reduce the use of directed credits, the impediment o f MSEs' access which are akin to interest rate subsidies, as they to finance especially those private leadto resource allocation outside market enterprises with less than 50 mechanisms. A Bank FIL may support directed employees, who generate most o f credit programs to promote sustained financing for the employment but have most such sectors, provided the programs are difficulty inaccess to finance. The accompanied by reforms to address the underlying credit appraisal and on-lending institutional infrastructure problems and any market terms will be done on a market- imperfections that inhibitthe market-based flow o f basis and will promote increased 60 credit to these sectors. term financing for these enterprises inthe rural economy by PFIs. The project will also have extensive assistance to help address the underlyingbarriers to finance for rural MSEs. Subsidies Insome cases (e.g., povertyreductionprograms), There are no subsidies builtinto subsidies may be an appropriateuse o f public the project. funds. Accreditation The Bank requires an assurance that PFIs acting as The project sets out standard Criteria on-lenders inFILSand other investment operations financial performance benchmarks are viable institutions, having: for the APEX bank, as well as the (a) adequateprofitability, capital, andportfolio PFIs to meet inorder to be quality, as c o n f i e d by financial statements selected to participate inthe prepared and audited inaccordance with accounting project. These benchmarks are and auditing principles acceptable to the Bank structured to reflect the core areas o f a financial institution- (b) acceptable levels o floancollections; management and corporate (c) appropriate capacity, including staffing, for governance, asset quality, capital carrying out subproject appraisal (including adequacy, liquidity,profitability, environmental assessment) and for supervising and efficiency - and are primarily subproject implementation; aimed at setting a basic standard o f financial health and soundness for (d) capacity to mobilize domestic resources; potential PFIs. Inaddition, provision i s made for those PFIs (e) adequate managerial autonomy and commercially oriented governance (particularly for thatjoin the project and may for state-controlled PFIs); some reason not meet the criteria. These provisions include the (f) appropriateprudential policies, corporate mandatory implementation o f an structure, andbusiness procedures. institutional development plan. Note: New and existing PFIs that do not meet all the accreditation criteriafor being intermediaries mayparticipate in an FIL ifthey agree to an institutional developmentplan that includes a set of time-bound monitorableperformance indicators andprovidesfor aperiodic review ofprogress. Appraisal The Bank's appraisal o f a proposed FIL: The Project has taken all these (a) determines ifit will achieve the desired appraisal elements into objectives with due regard to the sustainability o f consideration, not only promotes the financial sector; rural growth andbringeconomic benefit to the rural private (b) establishes the economic justification o fthe enterprises, but also aims to help operation; strengthening the APEX and PFIs (c) confirms, for a FILjustified by its poverty- and support the broader financial reduction goals, that it is a practicable, cost- sector reforminVietnam. The effective way o f achieving them; project builds ina process for the appraisal o f the APEX bank and (d) confirms the accreditation o fPFIs proposedfor the PFIs at the initial accreditation inclusion; and stage, as well as on an ongoing (e) ascertains that implementing the FIL i s unlikely basis as the project is under to undermine the financial condition o f participating implementation. PFIs. 61 Use o f Funds FILSare usedto finance investments insubprojects The funds will be used for for increased production o fgoods and services and financing the financial and that meet eligibility and development criteria agreed environmentalvariable sub- withthe Bank. projects inVietnam except the four cities inVietnam (Hanoi, Ho Chi MinCity, Danang and Haiphong) and sub-loans will be usedto finance capital investments inproductive assets andassociated working capital loans. Monitoring The FILhas effective monitoring and evaluation The project will have an integrated (M&E)oftheproject's progress toward its set o f monitoring and evaluation objectives and development impact throughout the indicators to report during the life o f the project. The variables for the PFIs course o f Project implementation. include, inter alia, adequacy o f capital, quantity and This will also include variables for quality o f earnings, quality o f assets, sufficiency o f the participating PFIs. The liquidity, extent ofsubsidydependence, accreditation criteria will represent effectiveness o fFIloanadministration, and the basic framework for this FI adequacy and timeliness o fpreparationo f audited monitoring. Inaddition, project- financial statements. specific variables are also included into the M&Eprocess. The APEX will monitor the performance o f PFI and carry out the analysis and follow up on the IDP implementation on regular basis. 62 Annex 5: ProjectCosts Vietnam: Third RuralFinanceProject Table 1. Components ProjectCost Summary Vietnam Third Rural Finance Project Components ProjectCostSummary (US$ '000) Local Foreign Total A. IncreaseCapital Investmentsby Rural Enterprises 175,000.0 75,000.0 250,000.0 B. IncreaseAccess to Microfinance in Rural Economy 14,285.7 14,285.7 C. BuildInstitutionalCapacitiesand New Products 1, Strengthening APEX Bank 409.7 865.9 1,275.6 2. Building ParticipatingFinancialInstitutions 2,575.7 5,033.4 7,609.0 3. Expandinginto New Markets New Product Development 175.1 1,575.9 1,751.o New Customer Development 145.9 708.8 854.7 New InstitutionDevelopment 160.4 1,447.3 1,607.7 New Environmental Standards in Lending 36.9 332.1 369.0 SubtotalExpandinginto New Markets 518.3 4,064.1 4,582.4 SubtotalBuild InstitutionalCapacitiesand New Products 3,503.6 9,963.4 13,467.0 Total BASELINECOSTS 192,789.3 84,963.4 277,752.7 PhysicalContingencies 175.2 498.2 673.4 Price Contingencies 474.6 384.5 859.1 Total PROJECT COSTS 193,439.2 85,846.0 279,285.1 Table 2. LegalCategoriesandIDA Funding IDA DisbursementCategory (US$ '000) Amount % RDF eligible sub-loans disbursed (component 1) 175,000 100.0 MLF eligible sub-loans disbursed (component 2) 10,000 100.0 IDA-term Capacity Building eligible expenditures and taxes (component 3.A & 3.8, including Goods and Works, Consultant and Training) 10,000 100.0 Grant Capacity Building eligible expenditures and taxes (component 3.C, including Goods and Works, Consultant and Training) 5,000 100.0 63 I , , I a h I U 0 8 .-0I: 8 8 .c1 a C w r r r N In -d I-" * P) 6 N s ' 1 ' C QrN m a d N 1 . r ' m m r m CQ F 6 r a N IC 0 6 N m 8 N Y a .- U C 0 a ! t 0 r0 N N P h Y v) u I; 3 a, 2 2 2 hl3 zr: hl 3 3 I I 1 I 2 mv! I I r: t o! 3 2 W 3W W 22 "! 3 h! 2 W 0 2mm r: W 22 2vl 2 2 2 2 vl c1 m I I I I 1 , 0 m vl hl 2 2 W hl 2 W o\ P P vl I I I 3 I I W N W m m N W m b m h l h l h l h l - I I I I I I I I I .I? U .I c;' c) b d a a4 a v1 1 I 9 g .I E c) sd 5 J4 v1 1 E d 0 % t' 2 c? 9 3 Q\ v 3 3 3 3 U 2 2 - I c! 3 c 0 2 2 I I 0 C U c? C d 'c! 3 2 \o 2m .: 2 2 I I .( rU 2m I I I U : U m m 0 m N hl hl N m d I 3 3 3 I I 1 3 1 3 3 3 3 3 3 3 3 3 N 3 N 3 3 3 I I I 3 1 3 3 3 3 3 3 3 1 3 m 1 I I I I G h k- E 6 cc sri 2 2 2 : W v, I I I I 2 I I I W 9 I I I W 3 N z 3 N I I I I 0 N $ 5 5 I I I I I I d d N 3 2 W W I I I 0 3 2 2 2 I I I 3 2 2 2 6 3 6 I I I I I I I I I I 8 g 8 g E8 E8 0 0 f M 22 I! do 0 0 3 B t: 3 8 if E8a e 3 9 9 9 M z I4 -F -F \o ui I I I I I I v! I 3 3 \o CI ii d d M I I 2 2 00 00 x z 2 2 I4 d d I I I I I `? 0 m 0 0 e4 hl z hl hl 5? - 00 00 00 d I I I I I I co I 1 I I I I I I 3 d - d - I I I I I I I I I I I e 0 Y MC .I a .I e C I C d 0 E; CA a - v; 2 I I M I I I os I 3 I- I I I a I I g m m m m 0 o m In I I ' N " 2 I I I I I I I I I I I b N b 2 2 2 I I I I I I I I I I I I m b I I I I d c l Annex 6: ImplementationArrangements Vietnam: Third RuralFinanceProject 1. The credit would be made to the Socialist Republic o f Vietnam for on-lending to BIDV. The Ministry o f Finance will then on-lend the h d s to BIDV based on an on- lending agreement. BIDV would assume overall responsibility for project implementation. BIDV will on-lend the proceeds to eligible PFIs based on the terms and conditions o f Subsidiary Loan Agreements (SLAs) signed between BIDV and PFIs. The PFI, will, in turn, extend sub-loans to eligible MSEs andhouseholds borrowers. 2. BIDV has already established a Project Management Unit which is part o f the BIDV's core transaction center. This PMUhas equippedwith committed and capable staff andthey are the champion inachieving the Project development objectives and ensure the compliance the IDA's safeguard policies. The PMU has several units including Accreditation Division in charge o f financial analysis o f the interested financial institutions; Appraisal Division in charge o f eligibility o f sub-projects financed; Environment Division incharge o f compliance o f the IDA's safeguard policy; Finance and Accounting Division in charge of hnds flow and bookkeeping; Training Division responsible for the training activities for boththe staff from PMU, BIDV and the PFIs; and the Project Monitoring and Evaluation Division responsible for institutional strengthening component and project reporting and evaluation activities. 3. Project Operating Policies and Procedures. Under the proposed project BIDV would develop its capabilities as the APEX bank. The credit operation would be carried out on the basis o f policies andprocedures established ina Policy Manual (PM) for each o f the Funds. The P Mwould beperiodically updated to reflect necessary policy changes. The adoption and implementation o f the PM, satisfactory to IDA would be a condition o f Credit effectiveness. The PM would include: interest rate structure and foreign exchange coverage fee; PFIs accreditation criteria; eligibility criteria for subprojects financed; sub- projects appraisal procedures, sub-project review and disbursements; sub-loan rescheduling; sub-loan maturities; environmental protection; and arrangement o f monitoring and supervision; accounting and audit procedures. The PM would not be revisedwithout prior consultationwith and approval o f IDA. 74 Annex 7: FinancialManagementandDisbursementArrangements FinancialManagementAssessment Vietnam: Third RuralFinanceProject 1. An assessment of the project's financial management arrangements was conducted in October - November 2006, June 2007, September 2007, and during the Appraisal mission in October 2007 and it i s concluded that with the completion o f the Action Planas tabled inthis FinancialManagement Assessment, the Project will meet the minimumrequirements o fthe Bank's OP/BP10.02. 2. The Third Rural Finance Project (TRFP) i s a follow on project from the Second Rural Finance Project (SRFP). The financial management (FM) arrangements o f the SRFP are acceptable and the FMRisk is considered to be low as there are good financial internal controls and systems operating together with timely reporting and auditing. Unqualified audit reports have issued annually in relation to the SRFP. The TRFP's financial management arrangements therefore are based on the current FM system o f SRFP with some required improvements to overcome weaknesses identifiedinthe SRFP. A. CountryIssues 3. Over the past several years, Vietnam has taken significant steps in improving institutions, laws and regulations and practices to ensure greater financial accountability and transparency in public expenditure. A large number o f recommendations o f the Country Financial Accountability Assessment (CFAA) and PER-FA have been implemented, or else are inthe process o f being implemented. For example, oversight by the National Assembly and the provincial People's Councils over public finances has been substantially increased. Audit reports on public expenditures are now published. Public access to financial information continues to improve. Nevertheless, challenges remain. Public sector accounts needto be made more timely, accurate and consistent with international standards.Oversight by the National Assembly over public finances and the effectiveness o f the State Audit o f Vietnam need further strengthening. Financial accountability and transparency at the sub-national level also need to be fbrther strengthened. B. RiskAnalysisandMitigatingMeasures 4. The project inherent risk i s assessed as moderate primarily due to: (i) that risks funds may not be used for intended purposes especially under Component I11 - Strengthening Institutional Capacity and Meeting Merging Demands for Rural Finance Services - where many trainings, study tours and seminars will occur, (ii) the large number o f PFIs/MFIs' sub-branches at provincial, district and commune level participating inthe project with the lack o fintegrated financial information system. 75 5. The project control risk is assessed as moderate with strengths in the implementing agencies having prior experience with Bank funded operations and adequate financial management capacity and acceptable external audit arrangements. FM risks primarily relate to weaknesses identified through the SRFP in the areas o f (i) insufficient internal audit function especially at the PFIs/MFIs for project activities which result in weaknesses in sub-loan initiation and monitoring procedures; (ii) risk o f errors andmistakes arising from the manual consolidation process o fquarterly financial reports for PFIs/MFIs' branches and sub-branches; and (iii) inefficient expenditure verification procedures by State Treasury which may result in delay in disbursement for the USD5 million grant component. 6. To mitigate the risks, more training and capacity building on internal audit objectives, functions, procedures, and best practices will be organized with a focus on governance and the Accounting Division o f BIDV- Transaction Center I11i s to more actively participate in supervisions o f PFIs/MFIs during project implementation. The PFIs/MFIs will be encouraged to consider integrating the project financial report format into their current accounting system. To avoid possible serious delays experienced in many projects due to cumbersome approval procedures, the MOF, SBV and BIDV will meet together regularly to work out an efficient mechanism to effectively use the fund for its intended purposes and the procedures will be documented in the Financial Management Manual for this project. rRisk Risk RiskMitigationMeasures Incorporated RiskAfter Rating into Project Design Mitigation Condition of Negotiation, Board or Effectiveness Inherent Risk Country level: Overall Moderate Capacity buildinginMediumTerm Expenditure Moderate Fiscal Environment Framework (MTEF), urbanplanning and budgeting, implementation and monitoring, commitment control and debt management; Entity andProject Moderate (i) financialauditbyexternalauditor, Annual Moderate level: Large number o f (ii) internalauditarrangements(iii) enhanced participating PFVMFI enhanced oversight for sofi expenditures (iv) and significant smart procurement o f training services resources allocated for Moderate 1.Budgeting Moderate L o w Training for PFVMFIon internal audit. Moderate Weaknesses at Additional staffing for P M U so that PMUcan participating PFI/MFI participate ininternal audit missions conducted could compromise bythe Appraisal divison o fthe APEX Bank. 76 e of a specific system. To nofFMRPFI/MFIwill OverallControlRisk IModerate I1not negatethe needfor manualproduction and consolidation. IModerate D. Implementationarrangements 7. As for the SRFP, the TRFP's APEX Bank (BIDV), will be responsible for the project's overall financial management, and other project implementing institutions, including PFIs/MFIs, SME Association and PCF Association, will be responsible for the financial management o f the project resources to which they will have access under their respective project components. All project implementing institutions will have adequate financial management and accounting systems in place before they can use proceeds o f the IDA Credit. US$195million on-lending credit 8. The IDA credit o f US$ 200 million would be made to the Socialist Republic o f Vietnam for on-lending and grant to BIDV. Out o f this credit, the Ministry o f Finance will on-lend the funds to BIDV based on an on-lending agreement for US$195 million, including the Rural Development Fund and Micro-finance Loan Fund, and capacity building for the financial institutions. BIDV will assume overall responsibility for project implementation. BIDV will on-lend the proceeds to eligible PFIs based on the terms and conditions of Subsidiary Loan Agreements (SLAs) signed between BIDV and PFIs. The PFI, will inturn, extend sub-loans to eligible borrowers. In accordance with Circular no. 108/2007/TT-BTC dated 7 September 2007 by MOF on Financial 77 Management applicable to Official Development Assistance projects and programs to support the implementation o f Decree no. 131/20O6/ND-CPy dated 9 November 2006, by the Government on ODA Management, BIDV will be responsible for expenditure verification (kiem soat chi) for bothcredit activities and non-credit components under the on-lending agreement. US$5million grantfrom state budget 9. The remaining US$5 million (under Component 111: Strengthen Institutional Capacities and Meet Emerging Demands for Rural Finance Services) will be allocated to BIDV inthe form o f grant from the state budget. Inaccordance with the Official Letter no. 1794/TTg-QHQT dated 22 November 2007 by the Prime Minister, the BIDV was delegated to be the APEX Bank for the whole IDA funds including US$195 million on- lending and US$5 million grant. SBV will be responsible to ensure that BIDV develops an efficient mechanism for the fund management and coordination among concerned parties for the implementationo fthe US$ 5 million grant. Inaccordance with Circular no. 108/2007/TT-BTC dated 7 September 2007 by MOF on Financial Management applicable to Official Development Assistance projects and programs to support the implementation o f Decree no. 131/2006/ND-CP on ODA Management, the State Treasury will be responsible for expenditure verification for this grant from the state budget, this provides an additional safeguard over the use o f the grant. 10. Inlinewith this arrangement, MOFwill allocate thebudgetofthe US$5million grant directly to BIDV. BIDV will be responsible for the implementation o f the grant including budgeting, accounting, internal controls, reporting, and auditing. M O F will approve total and annual financial budgets with the State Treasury or an organization desinnated bv the MOF performing expenditure verification. SBV will approve total and annual procurement and training plans and supervise BIDV's compliance with government regulations duringtheir implementation o f the grant activities. 11. This arrangement will exploit BIDV's experience and expertise in preparing TORS for consultants and technical assistance, in designing training plans and in supervisingtraining courses while still ensuring SBV's overall approval and oversight hnction. It also ensures one focal point - BIDV - in budgeting, accounting, internal controls, and reporting for the whole IDA Credit o f USD 200 million (including both the on-lending and grant components). It will help ensure consistency and achievement of project development objective and will facilitate supervisiono fproject implementation. 12. To address concerns o f possible serious delays experienced in many projects due to cumbersome approval procedures, and MOF, SBV and BIDV will work together to develop efficient mechanisms to effectively use the grant finds for its intendedpurposes and to avoid any implementation delays. BIDV i s exploring the possibility o f contracting out provision o f training and other activities on a lump sum contract basis (rather than in house organization) which would have the benefit o f reducing the number o f transactions andtherefore quicken the expenditure verification processbythe State Treasury. 78 13. Based on the agreement among MOF, SBV andBIDV for the US$5 million grant, BIDV will develop a detailed implementation arrangements between BIDV and the beneficiaries which are the SMEs Associations (for sub-component 111.1- enhance MSEs capacity to access rural finance services), the PCF Association (for sub-component 111.2 - enhance PCFs capacity inproviding rural finance services), and PFIs (for sub-component 111.3 - introduce new rural finance products and services). The current arrangements proposed by BIDV i s that BIDV will be responsible for budgeting, implementing, accounting, andreportingwith detailed tasks to include: - Consolidating and developing work plans for all sub-components for Component - 111; Coordinating with the two associations and PFIs to implement work plans, including developing TORSfor consultants and selecting consultants/training - providers; -- Monitoring consultants' work andtrainingresults; Receiving and evaluating consultants' finished work (reports, training plans, etc); -- Fundsmanagement for the Component; Recording and accounting, internal controls; Evaluatingresults achieved andconsolidating reports. Regarding training, SBV will approve total and annual training plans. After that, BIDV will implement the approved training plans with support from the participating Associations. 14. The implementation arrangements will be clearly documented in the Implementation Guidelines for RFPIII and will be the binding document for all parties participating inthe implementation o f the project. E. FMStaffing 15. Currently there are two accountants in the Accounting Division o f Transaction Centre 111, which i s part o f the BIDV's core transaction centre, who are directly responsible for RFPII (one i s responsible for the credit component, the other for the training component). Under TRFP, in addition to the on-lending credit and training components o f US$195 million, the Transaction Centre will implement the US$5 million grant for which State Treasury is the expenditure verification agency. However, it is noted that in 2006 and 2007, the Accounting Division could not join the Appraisal Division in supervision visits to PFIs due to their heavy workload (these supervisions normally include staff from both the Appraisal Division and Accounting Division o f the Transaction Centre 111).To ensure adequate financial management resource o f TRFP, the TCIII has recently appointed one more accountant to ensure smooth FMoperations o f the project and allow more time for project accountants to participate in internal audit visits to PFIs organized by the Appraisal Division. The accounting and financial management staff (including the ChiefAccountant) o f the project must be acceptable to the Bank. 79 E. Budgeting 16. The TRFP's P M U at BIDV will be responsible for the total project budget including all components (for both on-lending credit and grant). For Component Iand Component 11, the annual budget will be prepared based on approved credit limits for PFIs/MFIs. For Component I11- Strengthen Institutional Capacities and Meet Emerging Demands for Rural Finance Services (US$15 million IDA financing) the annual budget will be prepared based on actual need and annual training plans from BIDV, SMEs Association, PCF Association andPFIs/MFIs. 17. Annual training planswill cover the period from 1April to 31 March. This allows PFIs to prepare their training planduring the first quarter o f the year when the work load i s reduced. At the same time, it allows for some training to take place inthe beginning o f the year when staff have more available time to attend. Current practice i s that the PMU issues instruction to PFIs on the preparation o f training plan on an annual basis. The P M U will issue a training plan template as a reference for all PFIs and include the template inthe FMManual. 18. For the US$10 million on-lending credit under Component I11 (sub-component Strengthening the Participating Financial Institutions), PFIs will prepare their training plans and submit them to the PMU, the management o f BIDV and WB for approval. The P M U and BIDV's management will be responsible for providing assurance to SBV that the training plans are suitable, SBV will not be involved in approving total and annual training planso fPFIs. 19. For the US$5 million grant, BIDV will prepare total and annual training plans in coordination with the SMEs Association, the PCF Association, and PFIs. SBV will then approve these total and annual training plans and supervise BIDV's compliance with government regulations duringtheir implementationo f the grant activities. 20. The budgeting procedures and approval processes are to be clearly documented in TRFP's FinancialManagement Manual. F. Accountingpoliciesandprocedures 21. Under SRFP, the accounting policies and procedures are governed by various directives issued by MOF and SBV and are documented in the project's Financial Management Manual (FMM). A revised FMM which i s part o f the Project Operational Manual (POM) for TRFP will be prepared taking into account the TRFP requirements and recommendations from the WB and the auditors for improvements in financial management arrangements. G. InternalControls 22. The current internal controls o f SRFP are operating effectively for the Credit Component and therefore, are proposed to be used for TRFP. However, the SRFP 80 internal controls for the Institutional Strengthening Component have some weaknesses and it is recommended that more detailed instructiodguidance with reference templates (both training plan and expenditure acquittaVdisbursement dossier templates) for Component I11be developed. The instructions/guidance will be incorporated into the FMMinorder to makeone complete set ofguidance for PFIs. 23. In accordance with Circular no. 108/2007/TT-BTC dated 7 September 2007 by M O F on Financial Management applicable to Official Development Assistance projects and programs to support the implementation o f Decree no. 131/2006/ND-CP on ODA Management, the State Treasury will be responsible for expenditure verification for the US$5 million grant from the state budget, while BIDV will be responsible for expenditure verification (kiem soat chi) for both credit activities and non-credit components under the on-lending agreement. The expenditure verification processes will beclearly documented inthe FMM. H. FundsFlow andDisbursementArrangements Funds Allocation Box 1. The tablebelowdetailsthe allocationof IDA Credit Percentageof Amount of the Expendituresto be FinancingAllocated Financed Categorv (exDressed in SDR) (inclusive of Taxes) (1) Sub-loans (a) under Part A of 117,700,000 100%of Sub-loanAmount the Project disbursed (b) underPartB of 6,380,000 the Project (2) Goods, consultants' 100% services, andtraining (a) under PartsC(1) 6,380,000 and(2) ofthe Project (b) under PartC(3) of 3,240,000 the Proiect Total Amount 127,700,000 81 Fundsflow 24. The credit will be made to the Socialist Republic o f Vietnam for on-lending to BIDV which is acting as thewholesale institution (APEX Bank)o fthe project. The funds flows for the project Under Component Iand I1will be: BIDV on-lends to PFIsMFIs in accordance with subsidiary loan agreements between BIDV and PFIsMFIs. These loans are called subsidiary loans. PFIsMFIs make loans to end-borrowers for sub-projects which have three financing sources, the one from IDA Credit is called sub-loans which finance up to 70% of the total estimated sub-project cost, 15% from PFIs and the rest 15% from the end-borrower's equity contribution. The current practice i s that PFIsMFIs select from their loan portfolios sub-projects which meet RFP's requirements, present these eligible sub-loans inthe Statement o f Expenditure (SOE) and ask for a subsidiary loan for the total amount o f the SOE from BIDV. It is encouraged that PFIs actively seek suitable end-borrowers andoffer them with sub-loans from the project source. 25. Under the on-lending sub-component o f Component I11 - Build Institutional Capacity and New Product Development, PFIs/MFIs submit payment dossiers for approved trainings which are already carried out using their own sources of funds. Upon checking and approval from the Project M&EDivision, Accounting Division, and PMU's Director, funds will be disbursed from the DA to PFIsMFIs. 26. For the US$5 million grant for Component 111, BIDV will submit payment dossiers to State Treasury or a designated organization by M O F for expenditure verification before submittingwithdrawal applications for DA. 27. Disbursing from the Designated Account (DA) - DA (A) for Credit Line: 1. PFIsMFIs consolidate the eligible sub-loans and transmit the request for payment to BIDV Appraisal Division; 2. BIVD Appraisal Division reviews and approves eligibility o f the sub - projects andpasses to the Accounting Division; 3. The Accounting Division checks the funds request and passes to the Director; 4. Director approves and funds are then withdrawn from the designated account and transferred to the PFI/MFI. (A similar process for requesting payments for training from PFIMFIs i s followed except that the payment request does not pass through the Appraisal Division). 28. Disbursingfrom the Designated Account (DA)-DA (B) for Grant: 5. PFIsMFIs consolidate training payment requests and transmit the request for payment to BIDV; 6. For all expenditure requests from the Grant DAYBIVD submits the request to the State Treasury for approval; 82 7. After approval i s received, the BND disburses finds from the Grant DA. 29. Withdrawal Application Process: 8. The BIDV prepares the withdrawal application and supporting documents and sendto the World Bank; 9. IDA disburses monies to the Designated Accounts. Disbursement methods 30. TFWP will use the following disbursement methods: Reimbursement - The Bank may reimburse the borrower for expenditures eligible for financing pursuant to the Credit Agreement ("eligible expenditures") that the borrower has prefinancedfrom its own resources. Advance - The Bank may advance loan proceeds into a designated account of the borrower to finance eligible expenditures as they are incurred and for which supporting documents will be provided at a later date. 0 Direct Payment - The Bank may make payments, at the borrower's request, directly to a third party (e.g. supplier, contractor, and consultant) for eligible expenditures. 31. The Disbursement Deadline Date will be four months after the Closing Date o f theproject. 32. The project will use traditional disbursement method. Withdrawals from the Credit will be made on the basis o f Statements o f Expenditures for: (a) contracts with consulting firms cost less than $100,000 equivalent each, (b) contracts with individual consultant cost less than $50,000 equivalent each, (c) goods costing less than $100,000 equivalent per contract, (d) training, (f) sub-loans. Documentation supporting SOE disbursements will be kept by the BIDV for the life o f the project and one year after the receipt o f the audit report for the last year in which the last disbursement was made. These documents will be made available for review by the auditors and IDA supervision missions. All other expenditures above the SOE thresholds will be submittedto IDA on the basis o f full documentation. Designated Accounts and Ceilings 33. Two Designated Accounts (DAs) will be opened for the BND Transaction Centre I11 who is responsible for the project funds in a commercial bank with terms and conditions satisfactory to the IDA. One DA will be for the US$195 million on-lending credit, the other DA for the US$5 million grant. 34. The ceiling for the Credit DA (A) account (for disbursement category la,lb and 2a) will be US$20 million. The ceiling for the Grant DA (B) account (for disbursement category 2b) will be US$500,000. 83 35. BIDV will report on the use o f the loan proceeds advanced to the DAs on a regular basis, e.g. monthly. Counterpart Funds 36. BIDV and PFIs are assessed as having the capacity to mobilize the counterpart funds needed for the project. No counterpart funds are required for the US$5 million grant (100% financing by the grant). I. FinancialReporting 37. The current computerized accounting system and project management systems at the Transaction Center I11 are operating effectively and therefore, it is proposed that TRFP will continueto use these systems. Under SRFP, the PMU's financial reports in accordance with the project FMM are submitted to the Bank on a quarterly basis and in a timely manner. Progress reports are submitted as required for the Bank's missions. The financial reporting system o f the project i s effective and will continue for TRFP. Quarterly financial report templates for TRFP willbeagreeduponbetween the PMUandthe Bankbynegotiation. 38. At PFIs, quarterlyfinancial reports consolidated from their branches are manuallv prepared using excel. This practice creates more manual work for accountants in preparing financial reports for the projects and increase risks o f errors and mistakes. PFIs are encouraged to consider integrating the project report format into their current accounting systembased on their own cost andbenefit analysis. J. InternalAudit 39. Under SRFP, the Internal Audit Departments o f each PFIsMFIs is required to perform internal audits o f loans financed by SRFP as part o f their internal audit on a semi-annual basis. Inaddition to this, the Appraisal Division and Accounting Division under Transaction Center I11are responsible for internal auditing and supervising o f all PFIs/MFIs every six months. These practices will be continuedinthe TRFP. 40. Inorder to enhance the internal audit function at PFIs, more training on internal audit objectives, functions, procedures, and best practices will be organized during project implementation. It i s also recommended that the PFIs' internal audit annual work plan and semi-annual internal audit reports be sent to the PMU o f BIDV for review and approval. These requirements will be clearly documented in TRFP's Financial Management Manual. The focus o f the enhanced internal audit function will be improved governance. K. ExternalAudit 84 41. The BIVD will be responsible for preparation of annual financial statements for the Project. The financial statements o f the project will be audited on an annual basis in accordance with international auditing standards and terms o f reference acceptable to IDA. The annual financial statements and audit report mustbe submittedto IDA within six months of the end o f each fiscal year. The auditor who is acceptable to the IDA will be required to express a single audit opinion covering the Project Accounts, the use o f Statements o f Expenditures andthe Designated Account. A management letter addressing any internal control weaknesses o f the implementingagencies (PMU andPFIsMFIs) will also be providedbythe auditor together with the audit opinion report. L. FinancialManagementActionPlan Actions Responsibility Dateof Completion Appoint the project accounting staff with I qualifications acceptable to the IDA PFIs/MFIs ByAccreditation I I I Revise and adopt an acceptable Financial Management Manual, as part o f the overall APEX Bank Effectiveness Project OperationManual Develop training and capacity building programs including trainings on internal APEX 3 months after audit Bank/PFIs/MFIs effectiveness M. SupervisionPlan 42. Supervision of project financial management will be performed on a risk-based approach at least once a year with field visits to the PMU and selected PFIs/MFIs to review their financial management arrangements, funds flows, budgeting, accounting records and internal controls. The supervision will review the project's financial management system, including but not limited to the operation of Designated Account, Project accounts, internal control and financial reporting. The supervision visits to the project implementing agencies will be supplemented by reviews of the internal control supervision reports, review of the quarterly IFRs, and the annual audit reports of the project. Financial management supervision will be conducted by IDA'S financial management specialist(s). Annex 8: ProcurementArrangements Vietnam: Third RuralFinanceProject A. General 85 1. Procurement for the proposed project would be carried out inaccordance with the World Bank's "Guidelines: Procurement under IBRDLoans and IDA Credits" dated May 2004 (Revised October 2006) (Procurement Guidelines); and "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers'' dated May 2004 (Revised October 2006) (Consultants Guidelines), and the provisions stipulated in the Financing Agreement. The various items under different expenditure categories are described in general below. For each contract to be financed in whole or in part by the Credit, the different procurement methods or consultant selection methods, the need for pre- qualification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank inthe Procurement Plan. The Procurement Planwill be updated at least annually or as required to reflect the actual project implementation needs andimprovements ininstitutional capacity. 2. Procurement of Works. No procurement o f works is foreseen in this Component. B.ProcurementArrangement for Component111:BuildInstitutionalCapacitiesandNew Products(US$15 millionIDA Financing) 3. Procurement of Goods. Goods procured under this Component would include two vehicles and office equipment for the project implementingunits. The procurement willbe done usingthe Bank's sample documents for shopping. 4. Procurement of non-consulting services. No procurement o f non-consulting services i s foreseen inthis Component. 5. Selection of Consultants. Consulting services foreseen in this Component include major assignments such as development o f strategic business plan, strengthening SME lending, business advisory services for SMEs, development o f new financial services and technical assistance for strengthening institutional capacity o f participating banks and other financial institutions. These major consulting services would be procured using QCBS. Smaller assignments would be procured using CQS. Short lists o f consultants for services estimated to cost less than $200,000 equivalent per contract may be composed entirely o f national consultants in accordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines. The most updated version o f the Bank's Standard Request for Proposals will be mandatory to hire consulting firms for contracts estimated at more thanUSD 200,000 per contract financedbythe IDA Credit. 6. Operating Costs. No operating costs which would be financed by this Component. 7. Others. Some in-country training activities such as workshops and seminars are foreseen inthis Component. 86 8. The Bank's ProcurementPrior-reviewRequirements. The Bankwill conduct prior review of procurement documents and actions, in accordance with the Procurement Guidelines and Consultants Guidelines, as follows: 0 Procurement plans. The Bank shall review the procurement arrangements proposed by the Borrower, including contract packaging, applicable procedures and scheduling o f the procurement process. 0 Goods. Each contract estimated to cost US$lOO,OOO or more; and all contracts procured through the Direct Contracting method shall be subject to the Bank's prior-review. 0 Consulting services. All contracts that exceed US$ 100,000 per contract for firms andUS$ 50,000 per contract for individuals; and all contracts procured on the basis o f Single Source Selection shall be subject to the Bank's prior-review. 9. These two Components will provide sub-loans to end-borrowers, being rural enterprises or households, through PFIs. The IDA Credit will finance up to 70% o f each C. ProcurementArrangementfor ComponentI:IncreaseCapitalInvestmentbyRural Enterprises -RuralDevelopmentFund(US$175 I1:IncreaseAccess to Microfinanceinthe RuralEconomy-MicrofinanceLoanFund(US$ millionIDA financing); and Component 10 millionIDA Financing) 10. Sub-project cost, and the rest will be financed by the PFI and the contribution from each end-borrower. These two Components are demand-driven; any goods, civil works or services that meet the Project's requirements can be considered to be financed out o f these two Components. The ceiling amount for a sub-loan i s US$500 in Component I1but there i s no limit for sub-loans inComponent I. 11. Goods and works estimated to cost US$l,OOO,OOO or more per contract will be procured in accordance with the International Competitive Biddingprocedures specified in Section I1of the Procurement Guidelines. Domestic preferences in accordance with paragraphs 2.55 and 2.56 o f the Procurement Guidelines and Appendix 2 thereto shall apply to goods manufactured inthe territory o f Vietnam. All goods and works contracts estimated to cost US$l,OOO,OOO or more per contract shall be subject to the Bank's prior- review in accordance with paragraphs 2 and 3 of Appendix 1 to the Procurement Guidelines. 12. Goods and works estimated to cost less than US$l,OOO,OOO per contract will be purchased at a reasonable price following the established private sector/commercial practices. Other factors should also be taken into account such as: (i) inthe caseofgoods, timely delivery and efficiency and reliability o fthe goods andavailability o fmaintenance facilities and spare parts; and (ii)in the case o f works, the technical quality and the competitive cost. All goods andworks contracts estimated to cost less than US$l,OOO,OOO per contract shall be subject to the Bank's post-review in accordance with paragraph 5 o f Appendix 1to the Procurement Guidelines. 13. For small consulting services contracts (i,e,, below VND500 million or US$30,000 equivalent), single source selection (but usually based on a comparison of qualifications o f several candidates or previous experience with the firm) would be used (to certain extent, this procedure is similar to the Bank's CQS method). For larger 87 contracts, consultants would be selected through a competitive process similar to the Bank's QCBS or LCS methods. All consulting services contracts under these two Components will be subject to the Bank's post-review in accordance with para 5 o f Appendix 1to the Consultants Guidelines. 14. The list o f items to be procured and estimated cost o f those items under the sub- loans larger than $100,000 will be specified in the sub-loan proposal which will be reviewed by the respective PFI. For sub-loans which contain contracts larger than US$l,OOO,OOO/contract, in addition to review by the respective PFI and the wholesale bank BIDV, sub-loan proposals andthus the procurement plans o f the sub-loans will be subject to prior-review by the Bank. 15. Procurement under these two Components will be carried out by end-borrowers (rural enterprises and households). PFIs will be primarily responsible for monitoring the adherence to sub-loan proposals and procurement plans by end-borrowers. The PMU under the wholesale bank BIDV will be responsible for provide training on the Bank's procurement procedures to end-borrowers who have contracts o f more than US$l,OOO,OOO per contract. D. Assessment of the agency's capacityto implementprocurement 16. Procurement process will be managed by the Project Management Unit (PMU) established under the wholesale bank. 17. An assessment o f the capacity o f the PMUto implement procurement actions for the project has been carried out by Thang Chien Nguyen, Senior Procurement Specialist on August 22 and October 11, 2007. The assessment reviewed the organizational structure for implementing the project and the interaction between the project's staff responsible for procurement. 18. The key issues and risks concerning procurement for implementation o f the project have been identified and include (i) potential understaffing since the current PMU procurement staff i s part-time with inadequate capacity for evaluation o f major consulting services; and (ii) the PMU to be established under other PFIs may not have adequate capacity to support the procurement o f their respective components. The main corrective measures which have been agreed include: -- Appoint other key PMUstaffto help the procurement officer World Bank Workshop on procurement and selection of consultants (completed in -- June 2007) Procurement training at project launch. - Ad hoc training on ICB and QCBS for the PMUo fBIDV andPFIs. The Bankprocurement supervisionand technical assistance. 19. Theoverall project risk for procurement is medium. 88 E. ProcurementPlan 20. The Borrower, at pre-appraisal inAugust 2007, developed a procurementplanfor Component I11which provides the basis for the procurement methods. This plan has been updatedduring the appraisal on October 11, 2007 and is available at the PMU Office, Vincom Tower A, 191 Ba Trieu Hanoi. It will also be available inthe project's database and in the Bank's external website. The Procurement Plan will be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs andimprovements ininstitutional capacity. F. FrequencyofProcurementSupervision 21. Inadditionto the prior reviewsupervision to becarried out from Bankoffices, the capacity assessment of the P M U has recommended annual supervision missions to visit the field to carry out post review o fprocurement actions. G. Details of the Procurement Arrangements Involving InternationalCompetition under ComponentI11 22. Goods, Works, andNonConsultingServices (a) List of contract packages to be procured following ICB and direct contracting: No ICB or direct contractingprocurements are foreseen inthe project. (b) ICB contracts estimated to cost above US$ 100,000 per contract and all direct contracting if any would be identified at later stage will be subject to prior review by the Bank. 23. ConsultingServices (a) List o fconsulting assignments with short-list o finternational firms. USD1,000 89 I l l 2 I 3 l 4 1 I I ' I BankReview Expected Ref No. Descriptionof Assignment Estimated Selection Cost Method (PriodPost) Submission Date Proposals Comments 1 Strategic business pian and iDP 240.0 QCBS Prior review 2008-2009 2 CreditAppraisal 108.0 CQS Prior review 2008-2009 3 Credit Risk Management 144.0 CQS Priorreview 2008-2009 4 Othercore bankingoperations CQS Priorreview I I 162.0i I I 2008-2009 I 5 IProject Audit I 125.01 LCS IPostreview I 2008-2012 I 6 IBusiness advisoryservices o SME borrowers I 840.01 QCBS IPriorreview I 2008-2009 I 7 institutionalstrengthening 340.0 QCBS Prior review 2008-2009 8 StrengtheningVietnam Association of PCFs 600.0 QCBS Prior review 2008-2009 9 improving supervisionby the SBV 160.0 CQS Prior review 2008-2009 10 Supportingimplementationof MLF operations 160.0 CQS Prior review 2008-2009 11 introducingcash-flowbased lending techniques 600.0 QCBS Prior review 2008-2009 12 Developingagriculturalinsurance products 380.0 QCBS Prior review 2008-2009 13 Generatingnew long-termsaving products 380.0 QCBS Prior review 2008-2009 (b) Consultancy services estimatedto cost above US$lOO,OOO per contract for firms and US$50,000 for individuals and all single source selection of consultants will be subject to prior reviewby the Bank. (c) Short lists composedentirely o fnational consultants: Short lists of consultants for services estimatedto cost less than US$200,000 equivalent per contract may be composedentirely o fnational consultantsinaccordancewith the provisions ofparagraph 2.7 of the Consultant Guidelines. 90 Annex 9: EconomicandFinancialAnalysis Vietnam: Third RuralFinanceProject 1. Because this i s a credit project, with no advanced determination o f the precise investments to be made, or even the sub-sectors likely to be involved, it i s only possible to estimate the project's economic impact in a very general way. There are a number o f key factors that indicate that the project would be likely to have a sound economic impact. These are set out below. 2. Contribution to Economic Growth and Poverty Reduction. Vietnam GDP per capital has increased at about 6.9% per year in real terms. Although the share o f the population living below the poverty line has fallen dramatically, the remaining areas o f poverty are concentrated inrural areas. There i s a widening gap between rural andurban wealth and incomes, which could have longer term social and political consequences. While progress on reducingpoverty has been impressive, rural poor are still vulnerable to both internal and external shocks. The project would primarily focus the accumulationof productive assets in rural areas and on the creation o f employment opportunities. This will be achieved primarily through financing medium and long term credit to micro, small and mediumenterprises (MSMEs). MSMEshavebeenshown inRF1 and RFIIto generate high levels o f employment per dollar o f funds invested. The project will also finance individual households, which would use the resources to enhance their productivity andincomes. 3. Contribution to the Long Term Investment Need o f Vietnam. Vietnam i s going through a period o f rapid growth with targeting investment levels at 30% o f GDP for the economy. The Project will contribute to the effective provision o f these resources and in particular term resources, which at present are not easily mobilized in the banking system. 4. Applicable Rates o f Return. The Access to Credit Component would finance economically and financially viable investments inrural areas, including both agricultural and other types o f activities. The use o f finds will be drivenbydemand. There would be no ex-ante allocation by crop, type o f industry or individual project. As a result, there can be no ex ante estimate o f the economic or financial rate o f return for individual sub- project or for the project as a whole. However, the eligibility criteria for sub-project financing would be set so that project with an expected Economic Rates o f Return (ERR) o f less that 15% would not be financed. Therefore the ERR for the whole project should be in excess o f 15%. For sub-projects with sub-loans greater that US$200,000 an ex- ante economic analysis will be required and a minimumERR o f 15 % will be required. For sub-projects with sub-loans between US$15,000 and US$200,000 only an ex-ante financial rate o freturnwill be calculated, and a 15% FRRwill be required. 5. Market interventions in Vietnam have largely been dismantled and the policy induceddivergence between economic and financial values is not presently substantive. Because the shadow wage rate below the financial wage rate inrural areas for most of the 91 year, it is likely that ERRSwill be higher thanFRR. Thus, for smaller projects, the use o f a minimum FRR o f 15 % will largely eliminate any projects with an ERR o f less than 15%. There still remain, however, some sub-sectors where there are considerable prices distortions (eg sugar) that could result in projects that are financially viable but not economically viable. To avoid the financing o f uneconomic projects, a negative list, to be finalized at negotiations, would be drawn up and those sub-sectors would not be eligible for financing under the project. In addition, projects that result in significant negative environmental externalities would be automatically ineligible as a result o f the implementation o f environmental safeguards. 6. Increasingthe Efficiency of Bank Intermediation. Investments under this project related to the bank capacity building and new product development would result inbroad based economic benefits to the economy through a long term reduction in the cost o f intermediation. However, these benefits are too disbursed andtoo difficult to attribute to these specific investments. 92 Annex 10: SafeguardPolicyIssues Vietnam: Third RuralFinanceProject A. Summary 1. This Project has a safeguards classification o f FI (Financial Intermediary). As with all FI classified projects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis during the course o f project implementation. By design, the project will not finance sub-projects that would trigger i)natural habitats; ii)involuntary resettlement; iii)forests; iv) cultural physical resources andv) safety o f dams, vi) disputed areas; or vii) international waterways. Sub- projects that would trigger these safeguards policies are included in the negative list o f sub-projects that may not be financed under the Project. The indigenous people safeguard policy is not triggered. The only safeguard policies that are triggered by this project are the environmental assessment and pest management safeguards. Appraisal o f the projects compliance with IDA'Senvironmental assessment and pest management safeguard policies i s discussed indetailed below. 2. Inorder to anticipate and deal with any environmental issues that may arise, the following measures have been designed into the project: (i)a fully staffed and trained environmental unit has been established in BIDV, TC3, the management unit for the project; ii)an environmental guideline (manual) has been prepared; iii)restrictions, including a negative list o f sub-projects with potentially high risks; iv) an independent audit o f environmental procedures will be carried out at mid-term and at the end o f the project, v) there will be ongoing training for BIDV staff, and PFIs in the area o f environmental appraisal and monitoring; vi) consultation with potential beneficiary groups or their representatives. 3. Based on the experience o f RF 11, the environmental risk associated with this project would be low. As with RFII, most o f the sub-borrowers under RFIII would be rural individuals with an average loan size o f US$3,000 and small proportion o f small rural-based entrepreneurs with the sub-loans estimated to average about US$20,000. Given most o f these sub-projects would be involved in agricultural production, processing, and trading services in rural economies, and most o f these sub-projects are managed within households or small enterprises, it i s very likelythat most o fthem would have no negative environmental impact. Under RFII, all sub-projects received an environmental screening, and are classifiedby risk category. On this basis, 70 % o f were exempted from any environmental procedures and 29 % required an Environmental Compliance Commitment submitted by the borrower to the PFI. Only 1 % o f projects were required to undergo a limited environmental assessment to be cleared by provincial DONREs. None o f the sub-projects under RFIIwere requiredto have a full EIA under Vietnamese environmental regulations. The same pattern o f low environmental risk is expected under RFIII. 4. As part o fthe preappraisal process for RF111,the following actions were taken. i) existing national regulations were reviewed to determine their compatibility with IDA'S 93 environmental safeguards; ii)the performance o f environmental monitoring under RFII was reviewed and the lessons learned have been incorporated into the environmental compliance procedures for RFIII; (iiii) the draft environmental guidelines for RFIII and implementationresponsibilitieswere reviewed and cleared by IDA.. B. Appraisal of ExistingLegal Framework and Institutions for Environmental Protection The New Laws on EnvironmentalProtectioneffectivesince July 1,2006 5. New laws on environmental protection effect on July 1, 2006, and were followed up in September by a new Government Degree and Circular providing detail implementation guidance (Degree 80/2006/ND-CP and Circular 08/2006/TT-BTNMT). The major changes in resulting from this new law and degree are i)the environmental management responsibilityhas been fbrther decentralized to line ministries and to district & commune level in the MONRE/DONRE system; ii)a much more detailed project environmental classification, with clear guidelines on which categories are subject to different environmental review procedures (full EIA, Environmental Registration, Environmental Compliance Commitment); and iii)an explicit requirement o f public consultation and document disclosure during the environmental assessment process. These improvements close the main gaps that existed in the old laws between the WB environmental safeguards and Government environmentalpolicies. 6. This new decree provides good platfonn for updating the current project environmental guideline. The updated environmental guidelines for this project reflects the changes in the regulations including i)a different sub-project classification system matching those o f the new regulations; and ii)institutional arrangements for increased coordination between PFI's credit officers and local government environmental bodies in sub-project appraisal and supervision; iii)procedures for increased public consultation. C. Appraisal of DONREs Capacity for Environmental Assessment and Licensing 7. Based on the experience under RFII, provincial level DONRE offices have demonstrated their capacity to carry out environmental assessments and approvals for the limited number o f Category B sub-projects (those requiring limited environmental assessments) that were financed. The primary weakness o f the provincial DONRE system inthe past i s that it has been under staffed, on average each province has about 4- 5 staff looking after all the environmental aspects o f the whole province, so they can only focus on major environmental hotspots or big investment projects which have high environmental risks. The next level o f priority i s to issue environmental permits or licenses. They tend to place a lower priority on monitoring o f post licensing environmental compliance for smaller projects such as those financed under this project. One o f the objectives o f the new environmental regulations i s to firther decentralize environmental management to district and commune levels, thus reducing the workload o f provincial DONRE and mobilizing more humanresources at grass-root level. This i s 94 expected to increase the coverage o f the environmental management activities in the provinces, particularly the monitoring o f post licensing monitoring o f environmental compliance. D. Performanceof EnvironmentalMonitoringunderRF11. 8. Inorder to understand the current status of the environmental monitoring system to be used under RFIII we provide a brief summary of the performance o f the environmentalmonitoring system under RFII. 9. The RFII Project i s recognized as a first banking sector project in Vietnam that integrates environmental appraisal and monitoring into the small-scale credit activities. As a result o f the RFII project, all PFIs are aware o f the importance o f environmental safeguards compliance by sub-projects. There i s also a strong interest from MPI, MONRE and SBV to disseminate the good practices o f RFII and encourage the financial sector to adopt the same approach beyond the project. Incorporating environmental safeguards into the appraisal o f projects has been an important part o f the institutional capacity buildingactivities supported byRFII. 10. The Environmental Guideline was cleared by IDA and issued in March 2004, shortly after project effectiveness. This environmental guideline was based on the environmental law inplace at that time, Circular 490/1998/TT-BKHCNMT (Guidance on SettingUp and Appraising the Environmental Impact Assessment Report for Investment Projects) that the Government issuedin 1998, and on the Bank's safeguard policies. The Environmental Management Guideline provides a screening mechanism, environmental review procedures, supervision and enforcement requirements, and a list o f sub-projects not eligible for funding. Underthis environmental guideline, all sub-projects are screened and classified into three groups, based on their environmental risk. Category C sub- projects are exempt from government environmental clearance. Within the Project, Category C sub-projects are further classified into those with no environmental risk that are exempt from any environmental requirements, and those that have low environmental risk. For those sub-projects that have low environmental risk, the sub-borrower i s required to sign an Environmental Compliance Commitment with the PFI verifying familiarity with the environmental impacts o f the sub-project and with the appropriate mitigation measures. Category B sub-projects are subject to a limited environmental assessment to be cleared by provincial DONREs. Category A sub-projects are those that have high environmental risk are subject to a full environmental impact assessment and clearance by the relevant government agencies. 11. All o fparticipatingPFIs are requiredto implement the environmental guidelines, and as a result all sub-projects applying for funds are screened on environmental aspects. The average size o f a RDF I1sub-project was US$ 3,780, the average size o f a RDF I1 sub-loan was about US$ 2,000. Dividing by economic sectors, these financed sub- projects include; livestock raising (20.7%); trade & service (28.7%); aquacultures (7.6 %); processing (7.5%); small craft production (2.4%); cultivation (17.2%); and others (14.9%). Between March 2004, when the project environmental guideline was put into 95 effect, and December 2006, 81,587 sub-projects were financed. Of these there were 56,886 (70%) were Category C sub-projects that were exempt from any environmental procedures, 24,145 (29%) were Category C sub-projects which required an `%Environment Compliance Commitment" with PFIs. There were 556 (1%) Category B sub-projects that required a limited environmental assessment and review and clearance by provincial DONREs. O f the 556 Category B sub-projects, 190 were for agricultural cultivation, 136 for animal husbandry, 116 for processing, 26 for fisheries and 88 for other sectors. None o f the sub-projects under RFII were classified as Category A, which would haverequired a full environmentalreview cleared by MONRE and/or the IDA. 12. Since the WIII project is likely to have the same lending patterns as RFII, it i s also expected to have a similar environmental risk profile. With the expectation that only 1 % o f the sub-projects would be classified as Category B and very few or no sub- projects classified as Category A the Project would be considered to have a low underlying environmental risk (Le. the type o f projects being financed have a low environmental risk). The other source o f environmental risk for the project i s environmental compliance risk. Below, we examine the performance o f RF I1 on environmentalcompliance. 13. Sub-projects classified as Category C and requiring a signed environmental compliance commitment with PFIs are primarily in the primary agriculture sector (agriculture cultivation, livestock raising, aquaculture farming, agricultural product processing) and managed by households. For these subprojects the environmental compliance is subject to the supervision o f PFI's credit officers. Based on field visits and direct interviews with sub-project borrowers, the assessment is that the environmental compliance in this group is moderately satisfactory. There i s increasing awareness in rural areas interms o f applying good production methods as a result o f good agricultural andaquaculture extension services beingprovided inalmost all rural areas inVietnam. 14. Subprojects classified as Category B and subject to limited environmental review and clearance by DONRE are mainly in small rural based industrial production & processing (craft metal melting, paper pulp recycling, plastic recycling, foodstuff processing. According to environmental regulations these sub-projects are also subject to regular supervision by provincial DONRE during implementation. Most o f these projects are for expansion o f production or increasing productivity. N o issues were identified in the area o f natural habitat encroachment or biodiversity. Most o f the environmental certifications issued were related to liquid & solid waste control and disposal, air emission control, healthprotectionmeasures for laborers. Fieldvisits to these sub-project sites during supervision identified some specific cases o f non-compliance with environmental certificates issued by DONRE. Actions were taken to correct these specific cases, and in one case the sub-loan was recalled. In addition, environmental audits were introduced to monitor compliance more closely. These environmental audits have been structured to sample a higherproportion o f Category B sub-projects. 15. Lending to villages identified as "environmental hotspots" by DONREs are restricted. Environmental hotspots are villages and towns that have high concentrations 96 o f craft production such as craft paper recycling, craft plastic & metals melting, textile production with manual dyeing, using outdated equipment and without any treatment facilities. PFIs are restricted from making sub-loans for projects in environmental hot- spots, unless it can be demonstrated that the sub-loan i s used to improve technology which help to minimize and control emissions. In addition to restrictions on lending for environmentalhot-spots, the environmentalguidelines have a clearly definednegative list o f sub-project types that cannot be financed under the Project. During the implementation o f RFII no violation o f the environmental hot-spot or negative list restrictions have been identified. 16. In order to monitor environmental compliance under RFII, project officers are required to monitor the performance o f PFIs in following the environmental procedures established in the guidelines. Periodic checks are also carried out by IDA during supervision field visits. In addition the project has financed an environmental audit at mid-termand will finance another audit at project completion. The mid-term project audit will be based on a stratified random sample o f about 600 observations. The stratified random sample will ensure higher sampling rates for sub-projects in highrisk categories (Categories A and B) and will also ensure adequate sample coverage for all banks. The idea o f environmental audits is new to Vietnam, so this exercise, which is being carried out by local institutes i s important for knowledgetransfer. 17. Insummary, the risk resulting from the types ofprojects financed under RF I1is low. The mechanisms used to restrict financing o f sub-projects with high environmental risk have worked well. These include a well documented environmental manual, which includes a negative list o f high risk project types and restrictions on lending to environmental hot-spots. The key area for attention under RF I11 i s on ensuring environmental compliance o f approved Category B projects. This will be best achieved through increased training, monitoring and environmental audits. The key recommendations for RFIIIbased on the performance o f RFIIare: Prepare a revised environmental guideline for RFIII, incorporating the new regulations passed in2006 and add the Pest Management Plan Prepare and disseminate pamphlets regarding environment compliance to the end- borrowers Environmental training should be extended to include all members o f the Environmental Division (ED) o f the PMU; related BIDV and PFI staff, including those inthe provincial and district branches, as well as associated DONRE staff. The environmental training program for PFI management and their credit officers administered through RF I11 should be upgraded and integrated into a national environmental capacity building initiative. Training o f trainers could be administered at the provincial level by appropriate Vietnamese environmental teaching and research institutions. RFIII should retain the same restrictions on lending in areas classified as environmental hot-spots and should retain an updated negative list o f environmentally riskyprojects. 97 A hll environmental audit will be carried out at mid-term and at the end o f the project period. This audit will place a heavier weighting on the sampling o f higher riskprojects, such asprojectscategorized as Category B. E. AppraisalofEnvironmentaland Social SafeguardArrangementsfor RFIII 18. This Project has a safeguards classification o f FI (Financial Intermediary). As with all FI classified projects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis during the course o f project implementation. Since this i s a follow-on operation from the Rural Finance I1 project the institutional arrangements and procedures for managing environmental and social safeguards are already inplace. These will be upgrades underRFIII. 19. Environment Compliance Unit in BIDV. The project management unit in BIDV TC3 already has an established environment unit staffed with specialists assigned to monitoring environmental compliance under RFII. This unit will continue to be responsible for managing compliance with environmental safeguards under RFIII. The unithas one full time environmental technical specialist on staff andhas trained its other staff on issues related to environmental compliance and monitoring. There i s also sufficient environmental consultant capacity in Vietnam to carry out independent environmental audits o f sub-projects. 20. Consultation during; Preparation. A workshop was held as part o f the mid-term review for RFIIto review the environmentalmonitoring system. This workshop included representatives o f government, academic institutions, and NGOs involved in environmental issues and also included PFIs. The workshop was based on a review o f the environmental management system under the project and sought feedback from the broader community on the how the system could be improved. Feedback from this workshop has been incorporated into the revised environmental guidelines. Since this project is a financial intermediary project it does not identify any sub-projects before implementation. Any public consultation on individual projects will be done during implementation. Requirements for public consultation are included in the new law and regulations for environmental management. 21. Environmental Guidelines. An environmentalprocedure manual has already been prepared entitled "Guidelines o f Environment Impact Assessment and Monitoring for Subprojects Financed RFII." This guideline includes procedures for appraisal, evaluation and monitoring o f compliance with environmental assessment and pest management safeguards. These environmental compliance procedures will be reviewed at least once a year inthe course o f IDA'S supervision cycle. The procedures will also be updated on the basis o f lessons learned from periodic environmental audits (discussed below). 22. Pest Management Plan. The Pest Management Plan for the project will be a part o f the environmental guidelines. Project sub-loan funds may be used for the purchase o f fertilizers by small-scale farmers. Since the pesticide purchases under the project will be 98 limited to small amounts o f pesticide for on farm use, purchased on a commercial basis from local suppliers. The PMO will produce a pamphlet that will include lists o f pesticides that not eligible for financing under the project (the negative list), it will also include list o f pesticides in other categories and instructions for their safe use. This pamphlet will be distributed by PFIs to all sub-borrowers who could potentially use the sub-loan for the purchase o f pesticides. Monitoring o f pesticide use will be part o f the regular environmentalmonitoring and audit. 23. Classification System for Sub-project Tmes. The updated environmental guidelines will include lists o f sub-project types typically found in each environmental risk category. The environmental risk categories used would match those in the new environmental law and regulation. 24. Negative List o f Environmentally and Socially Sensitive Sub-Projects. The Project's environmental guidelines include a list o f types o f subprojects that would be precluded from borrowing. This would exclude financing for any subprojects i)that would destroy natural habitats; ii)that involve forest extraction ,iii)that could damage physical cultural resources o f archaeological, paleontological, historical, architectural, religious, aesthetic, or other cultural significance, iv) involve the construction o f dams higher than 18 meters; v) subprojects in disputed areas and vi) international waterways. In addition, the guideline includes list of ineligible subprojects which have a) Fishing methods that result inover fishing or are bannedinVietnam b) that result inlanderosion; land slides, or destroy wetlands or mangroves. c) the location where determined by the Government as environment-sensitive d) sub-projects that would trigger the pesticides safeguards by purchasing pesticides classified by WHO as Class 1A or lB, or the use o f Class 2 pesticides by unqualified individuals. The list o f pesticides banned in Vietnam and WHO'S "Recommended Classification of Pesticides by Hazard and Guidelines to Classification" (IOMC, 2000-2002) will be attached to the Guidelines 25. Restricted Sub-Proiects. The Project's environmental guidelines restrict the financing o f projects in villages identified as environmental hot-spots, unless the financing i s used for installing clean technologies approved by the Government. 26. Environmental Audits. An environmental audit was completed in July o f 2007 for the on-going Second Rural Finance Project. The environmental audit schedule will be applied out under the RF I11Project, at mid-termand the end o fthe project. 27. Environmental Training Proaam. The environmental training program for PFI management and their credit officers administered through RF I11will be upgraded and integrated into a national environmental capacity building initiative. Training o f trainers would be administered at the provincial level by appropriate Vietnamese environmental teaching and research institutions. Environmental training would include all members o f the Environmental Division (ED) o f the PMU, related BIDV and PFI staff, including those inthe provincial and district branches. Periodic workshops and seminars would be held by the Project to promote knowledge sharing across regions and between PFIs. 99 These workshops could also be used to promote the importance of environmentally responsible lending by commercial banks. 100 Annex 11: ProjectPreparationand Supervision Vietnam: Third RuralFinanceProject Planned Actual PCNreview 11/06/2006 11/08/2006 InitialPID to PIC 11/20/2006 11/20/2006 Initial ISDS to PIC 11/20/2006 11/20/2006 Appraisal 10/10/2007 10/02/2007 Negotiations 01/20/2008 Board/RVP approval 0312812008 Planned date of effectiveness 612812008 Planneddate of mid-termreview 6/28/2011 Planned closing date 06/28/2014 1. Key institutionsresponsiblefor preparationofthe project: The StateBank ofVietnam 49 Ly Thai To Hanoi, Vietnam Tel: 84 4 9343 361; Fax: 84 4 825 0612 Email: fdsbv@fpt.vn 2. Bankstaffand consultantswho worked on the project included: Name Title Unit Xiaolan Wang Task Team Leader EASRE Iain Shuker LeadAgricultural Economist EASRE James Seward Financial Sector Specialist EASFP The DzungNguyen Operations Officer EACVF James Lacey Senior Banking Specialist Consultant MeiWang Senior Counsel LEGES Hiet Thi HongTran Procurement Specialist EACVF Thang ChienNguyen Senior Procurement Specialist EACVF EdwardDaoud Senior Finance Officer LOAFC Jennifer Thomson Senior FMSpecialist EAPCO PhamThi MongHoa Senior Social Development EACVF Specialist Trang PhuongThiNguyen Environment Specialist EACVF Quyen Thi MyNguyen Financial Management EACVF Specialist EvelynBautista Laguidao Program Assistant EASRE ThuThi LeNguyen Senior Program Assistant EACVF 3. Bankfunds expendedto date on projectpreparation: 1. Bank resources: US$212,000 2. Trust hnds: US$20,000 3. Total: US$232,000 101 4. EstimatedApprovalandSupervisioncosts: 1. Remainingcosts to approval: US$87,000 2. Estimated annual supervision cost: US$120,000 102 Annex 12: Documentsinthe ProjectFile Vietnam: Third RuralFinanceProject 1. Project Concept Note, October 2006 2. Draft PCN at QER Stage, October 2006 3. draft Environmental SafeguardsAnnex to PAD, January 2007 4. Detailed Cost Tables, October 2007 5. Project Operational Manual 6. PolicyManual 7. Financial ManagementAssessment, January 2007 8. FinancialManagementAssessment, October 2007 9. ProcurementAssessment, October 2007 10. Diagnostic Review of Vietnam Bank for Agriculture and Rural Development by Miguel Sanchez de Pedro, November 2006 11. Assessment of Vietnam Bank for Agriculture and Rural Development by James Lacey, June 2007 12. BIDV'sfinancial performance andIDP implementation letter, January2007 13. Report onMicrofinance Development StudiesReports 14. MissionAid Memoire 0 June 2006. Aide-Memoire ReconnaisanceMission 0 August 2006. Aide Memoire IdentificationMission e January 2007. Aide-Memoire Preparation Mission e July 2007. Aide-Memoire Pre-AppraisalMission 0 November 2007, Aide-Memoire Appraisal Mission 103 Annex 13: Statementof LoansandCredits Vietnam: ThirdRuralFinanceProject Difference between expected and actual Original Amount inUS$Millions disbursements ProjectID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm.Rev'd ~ PO86361 2006 VN-PRSC v 0.00 100.00 0.00 0.00 0.00 100.74 0.00 0.00 PO75407 2006 VN-RT3 0.00 106.25 0.00 0.00 0.00 108.92 1.oo 0.00 PO85071 2006 CustomsModernization 0.00 65.90 0.00 0.00 0.00 66.58 -0.25 0.00 PO73361 2006 VN-Natural DisasterRiskMngt Project 0.00 86.00 0.00 0.00 0.00 81.73 -3.06 0.00 PO84871 2006 VN-TRANS & DISTRIB 2 0.00 200.00 0.00 0.00 0.00 200.79 6.67 0.00 PO77287 2006 VN-RRDRWSS 0.00 45.87 0.00 0.00 0.00 45.75 1.69 0.00 PO79344 2006 VN-1CT Development 0.00 93.72 0.00 0.00 0.00 90.43 0.97 0.00 PO79663 2006 VN-Mekong RegionalHealthSupport Proj 0.00 70.00 0.00 0.00 0.00 70.29 -1.97 0.00 PO74688 2005 VN-RURAL ENERGY 2 0.00 220.00 0.00 0.00 0.00 217.36 34.19 0.00 PO66051 2005 VN-Forest Sector DevelopmentProject 0.00 39.50 0.00 0.00 0.00 49.03 3.23 0.47 PO73763 2005 VN-WATER SUPPLY DEV. 0.00 112.64 0.00 0.00 0.00 109.10 5.05 0.00 PO80074 2005 VN-GEF-RURAL ENERGY 2 0.00 0.00 0.00 5.25 0.00 4.95 0.20 0.00 PO82604 2005 VN-HIV/AIDS PreventionProject 0.00 0.00 0.00 0.00 0.00 28.40 -1.42 0.00 PO82627 2005 Payment Systemand Bank Modernization 0.00 105.00 0.00 0.00 0.00 99.57 28.83 15.67 2 PO74414 2005 VN GEFForest Sector DevelopmentProj - 0.00 0.00 0.00 9.00 0.00 8.50 1.83 1.32 PO85080 2005 VN-ROAD SAFETY 0.00 31.73 0.00 0.00 0.00 29.26 2.47 0.00 PO85260 2005 VN-EFA SupportProgram 0.00 50.00 0.00 0.00 0.00 46.04 15.00 0.00 PO88362 2005 VN-Avian Influenza Emergency Recovery 0.00 5.00 0.00 0.00 0.00 2.68 2.24 0.00 Pr PO70197 2004 VN-URBAN UPGRADING 0.00 222.47 0.00 0.00 0.00 202.04 2.93 0.00 PO65898 2004 VIETNAM WATER RESOURCES 0.00 157.80 0.00 0.00 0.00 148.42 18.36 0.00 ASSISTANCE PO59663 2004 VN-ROADNETWORKIMPROVT 0.00 225.26 0.00 0.00 0.00 211.89 83.52 0.00 PO71019 2003 VN-GEF DEMAND SIDE MGMT & 0.00 0.00 0.00 5.50 0.00 3.00 0.60 0.00 ENERGY PO75399 2003 PublicFinancialManagement Reform 0.00 54.33 0.00 0.00 0.00 51.86 29.63 0.00 Proj. PO44803 2003 VN-PRIMARY EDUC FOR 0.00 138.76 0.00 0.00 0.00 175.20 44.15 0.00 DISADVANTAGEDCHILRE PO73778 2002 VN-GEF-SystemEnergy Equitization- 0.00 0.00 0.00 4.50 0.00 3.58 3.58 0.00 Renewa PO73305 2002 VN-Regional Blood TransfusionCenters 0.00 38.20 0.00 0.00 0.00 38.39 26.29 0.00 PO72601 2002 VN RuralFinanceI1Project - 0.00 200.00 0.00 0.00 0.00 40.61 -60.29 0.00 PO66396 2002 VN-SYSTEM ENERGY, 0.00 225.00 0.00 0.00 0.00 187.01 145.06 25.65 EQUITIZATION& RENEWAB PO59936 2002 VN -NorthemMountainsPoverty 0.00 110.00 0.00 0.00 0.00 38.92 4.78 0.00 Reduction PO51838 2002 VN-PRIMARY TEACHER 0.00 19.84 0.00 0.00 0.00 12.36 9.29 4.96 DEVELOPMENT PO42927 2001 VN-MEKONG TRANSPORTELOOD 0.00 110.00 0.00 0.00 0.00 55.59 39.33 -6.13 PROT. PO52037 2001 VN-HCMC ENVMTL SANIT. 0.00 166.34 0.00 0.00 0.00 149.08 84.32 77.07 PO62748 2001VN COMMUNITY BASED RURAL - 0.00 102.78 0.00 0.00 0.00 56.18 29.55 0.00 104 INFRA. PO56452 2000 VN-RURAL ENERGY 0.00 150.00 0.00 0.00 8.82 22.42 25.17 7.26 PO42568 2000 VN COASTAL WetWProtDev - 0.00 31.80 0.00 0.00 0.00 4.99 3.08 3.08 PO51553 1999 VN-3 CITIES SANITATION 0.00 80.50 0.00 0.00 0.00 38.19 32.58 20.54 PO04845 1999 VN MEKONG DELTA WATER - 0.00 101.80 0.00 0.00 0.00 31.10 26.44 -15.45 PO04828 1999 VN-HIGHER EDUC. 0.00 83.30 0.00 0.00 0.00 22.96 16.54 17.16 PO45628 1998 VN-TRANSMISSION & DISTR 0.00 199.00 0.00 0.00 39.69 47.44 79.36 18.07 PO04844 1998 VN-AGRIC. DIVERSIFICATION 0.00 66.90 0.00 0.00 0.00 11.00 9.34 6.45 Total: 0.00 3,815.69 0.00 24.25 48.51 2,912.35 750.28 176.12 Vietnam: Third RuralFinanceProject STATEMENT OF IFC's HeldandDisbursedPortfolio InMillions ofUS Dollars Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. 2003 ACB-Vietnam 0.00 5.02 0.00 0.00 0.00 5.02 0.00 0.00 2002 CyberSoft 0.00 0.06 0.00 0.00 0.00 0.06 0.00 0.00 2002 DragonCapital 0.00 0.00 1.05 0.00 0.00 0.00 1.05 0.00 2002 F-V Hospital 5.00 0.00 3.00 0.00 5.00 0.00 3.OO 0.00 2005 Khai Vy 6.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1998 MFLVinh Phat 0.13 0.00 0.00 0.00 0.13 0.00 0.00 0.00 1997 Nghi Son Cement 10.09 0.00 0.00 1.88 10.09 0.00 0.00 1.88 2004 Olam 20.00 0.00 0.00 0.00 20.00 0.00 0.00 0.00 2005 PaulMaitland 7.20 0.00 0.00 0.00 7.20 0.00 0.00 0.00 2001 RMIT Vietnam 7.25 0.00 0.00 0.00 3.50 0.00 0.00 0.00 2006 SABCO 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2003 Sacombank 0.00 2.77 0.00 0.00 0.00 2.77 0.00 0.00 2004 Sacombank 0.00 2.31 0.00 0.00 0.00 2.3 1 0.00 0.00 2005 Sacombank 0.00 2.05 0.00 0.00 0.00 2.05 0.00 0.00 2006 Sacombank 0.00 3.05 0.00 0.00 0.00 3.05 0.00 0.00 2002 VEIL 0.00 0.00 2.00 0.00 0.00 0.00 2.00 0.00 2003 VEIL 0.00 7.41 0.00 0.00 0.00 7.41 0.00 0.00 2007 VEIL 0.00 6.15 0.00 0.00 0.00 6.15 0.00 0.00 Totalportfolio: 75.67 28.82 6.05 1.88 45.92 28.82 6.05 1.88 Approvals PendingCommitment FY Approval Company Loan Equity Quasi Partic. 2000 MFL-AA 0.00 0.00 0.00 0.00 2006 CCS-Asia 0.02 0.00 0.00 0.00 2000 Interflour 0.01 0.00 0.00 0.01 2006 CII-Vietnam 0.00 0.00 0.00 0.00 105 2000 MFLMondial 0.00 0.00 0.00 0.00 2002 F-V Hospital 0.00 0.00 0.00 0.00 1999 MFLMinhMinh 0.00 0.00 0.00 0.00 1999 MFLChau Giang 0.00 0.00 0.00 0.00 Total pendingcommitment: 0.03 0.00 0.00 0.01 106 Annex 14: Country at a Glance Vietnam: ThirdRuralFinanceProject Eart POVERTY and SOCIAL Aala 8 Low. Vletnam Paclflc Income Development dlamond. 2005 Populatlon,mid-year(millions) 83 0 1885 2,353 GNlpercapIta (Atlasmethod, US$) 820 1827 E80 Lifeexpectancy ON1(Atlas method, US$bilhons) 514 3,087 1384 Average annual growth, 1999.05 Population (%) 11 0 9 19 Laborforce(%) 2 1 13 2 3 Gross primary M o s t recent eatlmate (lateat year avallable, -99-05) capita enrollment Poverty(%of populatlon M o wnatbnalpovertyline) 29 Urbanpopulation(%of totalpopulation) 26 41 30 Lifeexpectancyatbirth(pars) 70 70 59 1 Infantmortality(per lO0Olivebirths) n 29 80 Childmalnutrltlon(%of childrenunder5) 28 15 39 Access to improvedwatersource Access to animprovedwatersource(%ofpopulation) 85 79 75 Llteracy(%ofpopulationage E+J 90 91 82 Gross pnmaryenrollment oof school-agepopulation) 98 16 n 4 -Vietnam Male ni 18 la Lowincome group Female 94 114 99 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1985 1996 2004 2005 Economic ratloa. GDP (US$ billions) 141 207 452 524 Gross capitalfornatlon1GDP 27 1 358 Exports of goods andservIceslGDP 32 8 864 Trade Grossdomestic savingsIGDP 8 0 28 3 Gross nationalsavings/GDP P2 322 Currentaccount balance1GDP -38 -735 -3 8 Interest payments1GDP 00 0 4 0 7 Total debtlGDP 04 P28 394 Total debt servlcdexports 4 7 2 8 Presentvalueof debtIGDP 341 Presentvalueof debtleqmrts 504 Indebtedness 198545 1995-05 2004 2005 2005.09 (averageannuelgroMh) GDP 6 5 69 7 7 8.4 7.5 -Vietnam GDP percapita 4 3 56 6 6 7.4 6.4 Exportsof goods andservices LowincomearoUD 252 158 279 15.0 15.0 107 STRUCTURE of the ECONOMY 1985 I995 2004 2005 (%of GDPj /Growthof capital and GDP (Oh) Agriculture 40.2 27.2 218 industry 27.4 28.8 40.1 Manufacturing 20.5 15.0 20.3 Services 325 44.1 38.2 Householdfinalconsumption expenditure 73.8 65.3 Genera gov't final consumption expenditure 8.2 8.4 imports of goods andsewices ...... 419 73.6 1985-95 1995-05 2004 2005 (averageannualgmvdh) Growth of exports and imports (Oh) Agriculture 3 5 4 1 3.5 40 industry 7 3 0 0 0 2 30 Manufacturing 4 3 110 0 1 20 Services 84 5 7 7.5 10 1 I Householdfinalconsumption expenditure 5 2 7.1 Generalgov't finalconsumption expenditure 3 8 7.8 W 01 02 03 W Gross capitalformation 258 9 8 m.5 -Exports -.9-lmpOrtS O5 Importsof goods andservices 242 8 5 25.2 Note:2005data are preliminaryestimates. This tablewas producedfmm the DevelopmentEconomics LDB database. 'Thediamonds showfourkeyindicators inthecountry(in boid)comparedwithits income-groupaverage.lfdataare missing,thediamond~il beincomolete. Vietnam PRICES and GOVERNMENT FINANCE I985 1995 2004 2005 Domestic prices Inflation (%) I (%change) Consumer prices 7.8 8.3 implicit GDP deflator 7.0 7.9 8.4 Government finance (%of GDP,includescurrentgrantsj Currentrevenue 23.3 23.1 Currentbudgetbalance 6.0 6.6 Overallsurpius/deficit 0.7 -14 ---GDP deilator -.o-CPi TRADE 1985 1995 2004 2005 (US$ millions) Export and import levels (US$ mill.) Totalexports (fob) 507 5,88 26,503 40,000 T Rice 547 950 Fuel 1063 5.671 30 000 Manufactures 1785 14,842 Total imports (cif) 930 7.543 31954 20 000 Food Fuelandenergy 858 3.574 10.000 I I Capitalgoods 2,097 8,624 0 Export pnceindex(2000=WO) 0 8 137 99 00 01 02 03 M 05 Importpriceindex(2000=00) 03 TI6 exports imports Terms of trade(2000=60) m6 mi 108 BALANCE of PAYMENTS 1985 1995 2004 2005 (US$ millions) Current account balance to GDP (Oh) Eports of goods andservices 7,607 30,363 Imports of goods andservices n.603 33,808 Resource balance -496 -2,996 -3,245 Net income -90 -279 -940 Net currenttransfers 52 474 2.484 Current account balance -534 -2,801 -t701 Financing items (net) 265 3,301 2,395 Changes innet reserves 269 -500 -694 -1261 Memo: Reserves includinggold (US$ millions) 1,376 6,314 7,575 Conversion rate (DEC. local/US$) 8.3 11038.3 25,772.3 25,987.1 EXTERNAL DEBT and RESOURCE FLOWS 1985 1995 2004 2005 (US$ millions) Total debt outstanding and disbursed 61 25,428 l?,825 IBRD 0 0 0 0 IDA 54 231 3,039 3,187 G2,tX m . 1 "QO Total debt service 2 364 781 IBRD 0 0 0 0 IDA 0 2 37 44 Compositionof net resourceflow Official grants 38 348 387 Officialcreditors 7 58 1278 Privatecreditors 0 356 r) Foreigndirect investment (net inflow) 0 0 1,6r) Portfolio equity(net inflows) 0 0 0 E.9,249 World Bank program Commitments 265 711 Disbursements 47 444 391 A E- Bilateral 8 IDA -- IBRD D. Other mltilaterd F Private - Principal repayments 1 8 14 C-IMF G. Short-terr Netflow 46 436 378 Interest payments 2 29 31 Net transfers 45 407 347 Note This tablewas producedfrom the Development Economics LDB database 81'(3106 109 MAP SECTION IBRD 35972 102 104 106 108 110 VIETNAM C H I N A 4 THIRD Hà Giang Cao Bang ` 5 RURAL FINANCE Lào Cai Phong Tho 9 PROJECT 1 3 8 22 Bac Can ` 22 Tuyên 7 Quang Thái Lang Son ' Yên Bái Nguyên 10 2 _Diên 13 Viêt Trì 12 14 Biên Phu Son La ' 11 Vinh Yên ~ Bac Giang 15 6 16 Bac Ninh `` HÀ NÔI Ha Long _ 17 Hà Dông PROVINCE CAPITALS 19 20 Hòa Bình Hung Hai Hai Phòng 22 ' 18Yên Duong ' ' 21 NATIONAL CAPITAL Hà Nam 23 24 Thái Bình 25 _Nam PROVINCE BOUNDARIES Dinh26 20 Ninh Bình 20 27 INTERNATIONAL BOUNDARIES LAO PEOPLE'S Thanh Hóa DEMOCRATIC Gulf 28 REPUBLIC Hainan I. of (China) PROVINCES: Vinh Tonkin 1 Lai Châu 32 Thùa Thiên Huê ' 29 2 Diên Biên _ 33 Dà Nang _ ~ Hà Tinh ~ 18 3 Lào Cai 34 Quang Nam 18 4 Hà Giang 35 Quang Ngãi 5 Cao Bang ` 36 Kon Tum Mekong _Dông ` Hói 6 Son La ' ' 37 Gia Lai 30 7 Yên Bái 38 Bình Dinh _ 8 Tuyên Quang 39 Phú Yên 9 Bac Can 40 Dak Lak _ _Dông Hà 10 Lang Son _ ' 41 Dak Nông 31 11 Phú Tho 42 Khánh Hòa Hue 12 Vinh Phúc ~ 43 Bình Phuóc 32 13 Thái Nguyên 44 Lâm_Dong ` 16 33 _Dà Nang ~ 16 14 Bac Giang 45 Ninh Thuan T H A I L A N D 15 Quang Ninh 46 Tây Ninh Tam Ky` 16 Hà Noi 47 Bình Duong 34 17 Bac Ninh 48 Dông Nai _ ` 18 Hà Tây 49 Bình Thuan Quang Ngãi 19 Hung Yên 35 ' 50 Hô Chí Minh City ` 20 Hai Duong ' ' 51 Bà Ria ­ Vung Tàu ~ 36 21 Hai Phòng 52 Long An Kon Tum 22 Hòa Bình 53 Tiên Giang ` 23 Hà Nam 54 Dông Tháp _ ` 38 24 Thái Bình 55 Bên Tre 14 Plei ku Quy Nhon 14 ' 25 Ninh Bình 56 An Giang 37 26 Nam Dinh _ 57 Vinh Long ~ 27 Thanh Hóa 58 Trà Vinh 39 28 Nghe An 59 Kiên Giang 29 Hà Tinh ~ 60 Cân Tho' ` Tuy Hòa C A M B O D I A 40 30 Quang Bình 61 Hâu Giang Buôn Ma Thuôt 31 Quang Tri 62 Sóc Trang 63 Bac Liêu 42 64 Cà Mau 41 Nha Trang Gia Nghia ~ 12 _Dà Lat 12 43 _Dong ` Xoài 44 45 46 Phan Rang- Meko Tây Ninh Tháp Chàm 47 48 49 gn Thu Dau ` ' Môt Phan Thiêt Biên Hòa Gulf 50 54 Hô Chí Minh City ` 52 of 51 56 Cao Lãnh Tân An Thailand Long Xuyên 53 My~ Tho Vinh Long ~ Vung Tàu ~ Phu 55Bên' Tre VIETNAM Quoc 60 10 Rach Giá Cân Tho' ` 57 10 59 61 Trà Vinh Vi Thanh 58 62 Sóc Trang 63 Cà Mau Bac Liêu 0 50 100 150 Kilometers The boundaries, colors, denominations and any other information 64 shown on this map do not imply, on the part of The World Bank 0 50 100 Miles Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. 102 104 106 108 FEBRUARY 2008