Document of The World Bank Report No: 20330-BR PROJECT APPRAISAL DOCUMENT ONA PROPOSED LOAN IN THE AMOUNT OF US$50.0 MILLION TO THE BANK OF THE NORTHEAST FOR A NORTHEAST MICROFINANCE DEVELOPMENT PROJECT April 27, 2000 Brazil Country Management Unit Environmentally and Socially Sustainable Development Sector Management Unit Latin America and Caribbean Region CURRENCY EQUIVALENTS (Exchange Rate Effective April 1, 2000) Currency Unit = Real (R$) R$ = US$ 0.57 US$ I = R$ 1.74 FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS AROA Adjusted Return on Assets LCSES Environmentally and Socially Sustainable Development Sector Management Unit Latin America and the Caribbean Region ATM Automatic Teller Machine MIS Management Information System BN Banco do Nordeste (Bank of the Northeast) NBF Non-Bank Financed BNDES Banco Nacional de Desenvolvimento Econ6mico e NCB National Competitive Bidding Social (National Bank for Economic and Social Development) BRI Bank Rakyat of Indonesia NE Northeast CAS Country Assistance Strategy NGO Non-Governmental Organization CDI Certificado de Deposito Interbancdria (Inter-Bank PIRD Japan's Policy and Humaai Resources Development Certificate of Deposit) Fund CGAP Consultative Group to Assist the Poorest PMR Project Management Report CQS Consultant's Qualifications Selection QBS Quality Based Selection CY Calendar Year QCBS Quality and Cost Based Selection ETENE Escrit6rio Tecnico de Estudos Economicos do RFP Request for Proposal Nordeste - (Technical Office for Economic Studies of the Northeast) FENAPE Federa~,co Nacional de Apoio aos Pequenos ROA Retum on Assets Empreendimentos (National Federation for Assistance to Small Enterprises) FNE Fundo Constitucional do Nordeste (Constitutional SDI Subsidy Dependence Index Fund for the Northeast) FY Fiscal Year SEBRAE Servi,o Brasileiro de Apoio as Micro e Pequenas Empresas (Brazilian Service for Assistance to Micro- and Small Enterprises) GDP Gross Domestic Product SIL Specific Investment Loan ICB International Competitive Bidding SME Small and Medium Enterprises IDA International Development Association SOE Statement of Expenditures IDB Inter-American Development Banik SPC Servico de Prote,co do Credito (Credit Protection Service) IFC Intemational Finance Corporation TA Technical Assistance LACI Loan Administration Change Initiative UNDP United Nations Development Program LCS Least Cost Selection Vice President: Mr. David de Ferranti Country Director: Mr. Gobind T. Nankani Sector Director: Mr. John Redwood Task Team Leader: Mr. Steven N. Schonberger )X -7 t£1A2 BRAZIL NORTHEAST MICROFINANCE DEVELOPMENT PROJECT CONTENTS A. Project Development Objective Page 1. Project development objective 2 2. Key performance indicators 2 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2 2. Main sector issues and Government strategy 3 3. Sector issues to be addressed by the project and strategic choices 5 C. Project Description Summary 1. Project components 6 2. Key policy and institutional reforms supported by the project 7 3. Benefits and target population 8 4. Institutional and implementation arrangements 8 D. Project Rationale 1. Project altematives considered and reasons for rejection 9 2. Major related projects financed by the Bank and other development agencies 10 3. Lessons leamed and reflected in proposed project design 10 4. Indications of borrower commitment and ownership 11 5. Value added of Bank support in this project 11 E. Summary Project Analysis 1. Economic 12 2. Financial 13 3. Technical 14 4. Institutional 15 5. Environment 20 6. Social 21 7. Safeguard Policies 23 F. Sustainability and Risks 1. Sustainability 23 2. Critical risks 23 3. Possib]e controversial aspects 24 G. Main Loan Conditions 1. Effectiveness Condition 25 2. Other 25 H. Readiness for Implementation 26 I. Compliance with Bank Policies 26 Annexes Annex 1: Project Design Summary 27 Annex 2: Project Description 34 Annex 3: Estimated Project Costs 64 Annex 4: Cost Benefit Analysis Summary 65 Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary 68 Annex 6: Procurement and Disbursement Arrangements 83 Annex 7: Project Processing Schedule 89 Annex 8: Documents in the Project File 90 Annex 9: Statement of Loans and Credits 91 Annex 10: Country at a Glance 95 Annex 11: Framework for Microfinance in Brazil 97 MAP(S) BRAZIL Nortieast Microfinance Development Project Project Appraisal Document Latin America and Caribbean Region LCSER Date: April 27, 2000 Team Leader: Steven N. Schonberger Country Manager/Director: Gobind T. Nankani Sector Manager/Director: John Redwood Project ID: P050776 Sector(s): BI - Institutional Development, FY - Other Finance Lending Instrument: Specific Investment Loan (SIL) Theme(s): Rural Development; Poverty Reduction; Financial Sector Poverty Targeted Intervention: Y Project Financing Data R Loan El Credit Oi Grant Cl Guarantee Li Other (Specify) For LoanslCredits/Others: Amount (US$m): $50.00 Proposed Terms: Variable Spread & Rate Single Currency Loan (VSCL) Grace period (years): 5 Years to maturity: 15 Commitment fee: 0.75% on undisbursed balance, beginning 60 days after signing. GOVERNMENT 0.00 0.00 0.00 IBRD 48.50 1.50 50.00 IDA OTHER 50.00 0.00 50.00 Total: 98.50 1.50 100.00 Borrower: BANK OF THE NORTHEAST Responsible agency: BANK OF THE NORTHEAST Estimated disbursements ( Bank FY/US$M): Annual 3.7 6.1 9.8 13.4 12.1 4.9 Cumulative 3.7 l 9.8 19.6 33.0 45.1 50.0 Project implementation period: 12/01/99 to 6/30/05 Expected effectiveness date: 07/01/2000 Expected closing date: 12/31/2005 OCa PAD F.ni Rev M,f. 200 A. Project Development Objective 1. Project development objective: (see Annex 1) The proposed project is part of the Bank's program of targeted assistance to the Northeast Region which constitutes the largest concentration of poverty in Brazil. The project addresses the lack of access of the poor to financial services, an important constraint to improved productivity and incomes. The project would build on a successful two-year pilot program, financed by the Government of Brazil with technical assistance from the Bank and preparation assistance financed by a Japanese PHRD Grant. The overall objective of the project is to improve the access of microenterprises throughout the Northeast Region to sustainable, fonnal financial services by supporting expansion of the program known as "CrediAmigo" in Brazil. 2. Key performance indicators: (see Annex 1) Progress towards achievement of the project objective would be monitored using the following indicators: (i) Extent of outreach: At least 120,000 additional active clients. (ii) Depth of outreach: Average outstanding loan balance less than 65% of Northeast per capita GDP. (iii) Breadth of outreach: Number of municipalities in Northeast with CrediAmigo clients. (iv) Financial sustainability: Subsidy dependence index of zero: adjusted return on assets greater than 3%. (v) Operational efficiency: Operational costs (annualized) less than 24% of average net outstanding portfolio. (vi) Institutional independence: Equity to earning assets ratio of at least 15%. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 16582-BR (CAS), R98-116 (Progress Report), SecM98-943 (Framework Paper) Date of latest CAS discussion: 12/01/98 The project would support achievement of the CAS regional growth goals to (i) reduce rural and urban poverty in the Northeast Region of Brazil; and (ii) increase the sustainability of poverty reduction activities. The importance of self-employment and micro-enterprise activities to the incomes of the poor (discussed below) suggests that activities which support the growth of those activities can improve their employment and incomes. The Bank has supported Government programs which provide grant financing to poor communities, particularly in rural areas, to develop their productive assets. Govemnment wishes to "graduate" many of these communities from grant-based assistance. However, limited access to financing for working capital and complimentary investments limits full utilization of the improved asset base. The proposed project would develop, in the Northeast Brazil environment, products and delivery systems, designed on the basis of international and local experience, for provision of financially sustainable microfinance services to poor communities in urban and rural areas. Relevant CAS indicators: (i) Declining poverty gap for poor, client households in the Northeast; (ii) Declining subsidy requirement per beneficiary The proposed project is consistent with the CAS strategy to improve access to, and reduce the cost of capital by using innovative lending technologies to lower financial internediation costs. To the extent the - 2 - project is able to provide savings services, it will also support increased domestic savings mobilization. Emphasis on asset quality is consistent with the Bank's support of improvements in the soundness of the financial system. Regulatory and supervisory issues particular to development of the microfinance industry which are identified during the preparation and implementation of the proposed project are being integrated into the Bank's dialogue with the Central Bank of Brazil in coordination with the Bank-financed Central Bank Modernization Technical Assistance Loan, and through non-lending services. Experience in support of commercial microfinance development in Brazil is being shared with the International Finance Corporation (IFC) which places mobilization of resources for small and medium enterprises through credit lines amongst its major priorities for development of capital markets. 2. Main sector issues and Government strategy: See Annex llfor a more thorough review of the framewvork for microfinance in Brazil) Poverty in Northeast Brazil The Northeast Region, consisting of the states of Maranhao, Piaui, Ceara, Rio Grande do Norte, Paraiba, Pemrnambuco, Alagoas, Sergipe, and Bahia, constitutes the largest concentration of poverty, particularly rural poverty, in Brazil. While the Northeast accounts for less than 30% of Brazil's population (45 million), it contains over 55% (14.6 million) of Brazil's poor, a poverty rate over twice that of the rest of the country. Almost half the Northeast population is rural and 60% of the poor in the Northeast live in rural areas. According to the Brazil Poverty Assessment (Brazil: A Poverty Assessment, World Bank Report No. 14323-BR)., 37.4% of all poor household heads are self-employed, reaching almost 50% in rural areas. Economic and Sector Work (Brazil: the Management ofAgriculture, Rural Development and Natural Resources, World Bank Report No. 11783-BR) has identified skewed access to land and financial services, inter alia, as major constraints to improved productivity and incomes in the Northeast. Government is piloting the use of market-based mechanisms to improve the quality and efficiency of its services targeted to the poor. While the introduction of demand-driven programs has improved the efficiency and effectiveness of some social investments targeted to the poor, programs to facilitate access to land and credit have been less successful, requiring high, ongoing public subsidies while reaching a limited number of beneficiaries. Government is now piloting the use of market-based, alternative mechanisms to improve access to both land and financial services. -3 - Microenterprises Despite their important role in the economy, microenterprises have very limited access to business support services. The most recent available enterprise statistics indicate that the microenterprises account for over 90% of all finns in Brazil and over 35% of total employment in services, commerce and industry ( Coletanea Estatistica da Micro e Pequena Empresa, Brazilian Service for Assistance to Micro- and Small Enterprises (SEBRAE)). Not surprisingly, given its economic profile, the Northeast Region has the highest percentage of its labor force, 81% working in enterprises with up to five employees. A recent survey of microentrepreneurs in the Northeast Region (Demanda PorMicrocredito No Nordeste Brasileiro, Technical Office for Economic Studies of the Northeast (ETENE), indicates that most microentrepreneurs have not completed secondary schooling, have little training in business management and have virtually no access to lending from banks and other fonnal financial intermediaries. Private banks, unable to meet the demand for lower-cost lending services to medium and large enterprises, have little incentive to develop the market knowledge and technology required to profitably provide financial services to microenterprises. The surveys carried out in urban centers and rural market towns, indicate that guarantee requirements, transactions costs and inappropriate loan products discourage microenterpreneurs from accessing government-sponsored directed credit programs. Limited informal finance is available from suppliers and moneylenders at effective interest rates as high as 200% per annum. Government has recognized the importance of supporting the development of microenterprises as part of its poverty reduction strategy and has identified improved access to technical and financial services as a priority development activity (Brasil em Accao, Ministry of Planning). Access to Formal Financial Services Access to formal financial services in Brazil is uneven. Using the rough indicator of population per bank branch, access to banking services in Brazil (just under 10,000 people per branch) is comensurate with other upper middle income countries in Latin America, though this number is much higher than in OECI) countries. However, this masks important regional disparities. The Northeast (approximately 19,000 per branch) and the North (20,000 per branch) are the most under-served regions in Brazil. In addition, using GDP per branch ($50,000 per branch for Brazil) as an indicator of potential business volume, the Northeast ($47,000) provides little incentive for private bankers to increase their coverage relative to other regions (i.e.: in the North where GDP per branch is $60,000). This disparity in coverage and lack of incentives for increased coverage by private banks is one of the primary justifications for continued support of publicly-owned banks (which account for 46% of bank branch infrastructure and 55% of financial sector assets in Brazil) and directed credit lines which generally have high defaults and administrative costs. However, survey data from SEBRAE and ETENE indicates that few microenterprises have access to financial services, particularly lending services, from either public or private banks, despite attractive cash-flow characteristics, payment of interest rates to moneylenders and suppliers which are several times those offered by directed credit lines, and a demonstrated willingness to utilize savings services. While access to savings and deposit services is more common, this occurs mostly in large, urban centers and even in those cases reaches less than a quarter of microentrepreneurs. As a result, Govemment is seeking altemative mechanisms for deepening access to financial services, which require limited and declining subsidies to initiate, and which could potentially be provided by the private sector on commercial basis, reducing or eliminating the need for public interventions such as directed credit lines. -4 - Microfinance Services The development of microfinance services in Brazil has lagged behind that of other countries in Latin America, due in part to the former period of high inflation, restrictions on the ability of NGOs to serve as financial intermediaries and mobilize foreign donor funding, and lack of Government support for industry development - all impediments which have been removed in the past two years. More recently, a number of Brazilian programs have demonstrated that Brazilian microentrepreneurs are willing and able to borrow and repay loans at relatively high rates of interest, but these programs are all quite small relative to the potential market for these services. It is important to note that the existance of directed credit lines has not been an impediment to the rapid growth of these programs despite the fact that they charge interest rates several times that of the credit lines for loans of much shorter term and have had very low arrears rates. Noting the success of microfinance programs in other countries, such as Indonesia, Bangladesh and Bolivia, the Brazilian Government has embarked on an amnbitious program to promote the development of microfinance services in Brazil as a cost-effective mechanism for addressing the public policy goal of reducing disparities in access to financial services. Consistent with the experience in these countries where governments and donors played a critical role during the initial development phase of the microfinance industry, the Brazilian Government, working with donors, has taken several important initiatives over the past two years to provide an appropriate legal frarnework as well as financial and technical assistance to microfinance programs. A high-level commission attached to the Office of the President (Comunidade Solidaria) has been working with the Central Bank to provide a new institutional context for development of microfinance institutions ( Law No. 9.790 of March 23, 1999; Central Bank Circular and Resolution No. 002915; and Presidential Provisionary Measure No. 1.9414-4 of July 28, 1999). In addition, the National Bank for Economic and Social Development (BNDES), with support from the Inter-American Development Bank (IDB), provides technical assistance and loans to existing Non-Governmental Organization (NGO) lenders and NGO/municipal start-ups, located primarily in the urban centers of the Southeast Region of Brazil. In the Northeast Region, the World Bank has assisted Govemment in the development of an alternative strategy, similar to the approach taken in Indonesia and Chile, where microfinance services were developed in public development banks. Through the Northeast Rural Poverty Alleviation Program, a Japanese PHRD Grant and the Consultative Group to Assist the Poorest (CGAP), the Bank has financed technical assistance for the development of a pilot microfinance program (CrediAmigo) in the Bank of the Northeast (BN), a regional development bank with branches throughout all nine Northeastern states and the northern areas of Minas Gerais. The pilot, which was initiated in November 1997, had over 37,000 active clients and an outstanding portfolio of almost US$10 million by December 31, 1999. Portfolio quality, measured as 30-day portfolio-at-risk was 2.4%. 3. Sector issues to be addressed by the project and strategic choices: The proposed project would build on the twvo-year pilot for development of CrediAmigo to provide sustainable financial services to microenterprises throughout the Northeast Region. The program represents the most important effort to develop a sustainable microfinance program within a commercial bank in Brazil. While supporting the expansion and institutional development of the CrediAmigo program, emphasis would be placed on progress towards full financial sustainability of service provision in order to permit eventual phase-out of public or donor assistance. The micro-finance program is being developed with BN, a development bank with majority govemment ownership. The initial focus on a public bank, with its inherent risk of political intervention, was based on - 5- the commitment of BN management to development of a sustainable, microfinance program and important potential support service network provided by BN's 176 branches throughout the Northeast Region. BN's financial and institutional support systems and banking know-how have provided an important platform for CrediAmigo's initial development. Though initially focused on lending services in urban areas and market towns, the program will introduce savings and other financial services, consistent with the high demand indicated by the ETENE surveys and their potential as a source of sustainable funding for the program. Consistent with intemational experience, savings services will be introduced following thorough legal, regulatory and institutional evaluation, and market surveys will be carried out to ensure savings products are designed for the target clientele. The project will also pilot mechanisms to cost-effectively reach isolated clients through the use of post offices as service windows, mobile branches, smart cards and ATMs. By demonstrating the viability of a sustainable microfinance program, based on intemational best practices, CrediAmigo is expected to have an important spill-over effect on the development of microfinance in Brazil. Through.CrediAmigo, BN is the first bank in Brazil to provide unsecured loans based on solidarity group guarantees. In addition, the program has emphasized sustainability and is demonstrating the willingness of microentrepreneurs to borrow and repay at interest rates substantially higher than those charged under directed credit lines. By the end of the project period it is expected that further financing ifor CrediAmigo will be obtained commercially, at least for its more profitable market segments, while any further Bank support would be limited to technical and financial assistance to extend the program's outreach to increasingly isolated, under-served communities or to pilot financial products for special categories of activities. Once the profitability of CrediAmigo is well established, it is expected that privalte banks will begin to enter the microfinance market as has occurred in other countries. C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): .. . .a v.._. ... . Expanded Microfinance Loan Financial Sector 85.50 85.5 47.00 94.0 Portfolio (subloans) Development Strengthened Capacity to Support Institutional 13.70 13.7 2.20 4.4 Sustainable Growth of CrediAmigo Development (TA, training, equipment, incremental loan officers) Impact Evaluation (TA) Cross-sectoral 0.30 0.3 0.30 0.6 Economic Analysis Fee Other Non-sector 0.50 0.5 0.50 1.0 Specific Total Project Costs 100.00 100.0 50.00 100.0 Total Financing Required 100.00 100.0 50.00 100.0 -6 - 2. Key policy and institutional reforms supported by the project: While CrediAmigo continues to benefit from BN's operational support, the World Bank appraisal mission and BN agreed that the program should evolve into a financially and legally distinct institution so as to provide a governance and management structure focused on the needs of a sustainable microfinance institution. In order to initiate this process, it was agreed that CrediAmigo will utilize an independent accounting framework (including the estimated value of services provided by BN) to monitor operational efficiency and profitability. In addition, BN management is working with the Central Bank to establish the regulatory framework for a "trust fund"-type institutional arrangement which would permit CrediAmigo to formally separate its accounts within BN and retain earnings in a capitalization fund to serve as future equity. Additional studies under the project will identify options for increased institutional independence and issues to be addressed with the Central Bank, including minimum capital requirements, restrictions on branch operations, and the ability to provide savings and other financial services. Credit and Savings Policies Government-funded or guaranteed subsidized credit lines remain an important financial and sectoral policy instrument in Brazil. The pilot experience with CrediAmigo has demonstrated superior repayment performance relative to these credit lines despite the much higher interest rates and shorter terms of the microfinance loans. As a result, BN is reviewing its current mechanisms for management of subsidized credit lines. BN has raised this discussion with the Ministry of Finance and the Central Bank. By demonstrating that a microfinance program can provide financial services more effectively to the target groups without subsidy, CrediAmigo can provide Government with an option to distortionary, subsidized credit lines. Savings policies are also influenced by Brazil's strong reliance on directed credit. The Central Bank imposes restrictions on the application of demand and savings deposits beyond the normnal reserve requirements to fund special rural and housing lending programs. As a result, only 10% of demand deposits and 25% (45% in the case of national, public banks) of savings deposits are available for unrestricted lending by the mobilizing institution. In addition to the policy distortions in credit allocation, this policy creates strong disincentives for deposit mobilization, particularly for institutions which are uninterested or unable to utilize the funds withing the program restrictions. While this policy, like many in Brazil is avoided by the private banks by having clients assign their funds to money-market or investment CDs, these instruments are rarely attractive for the small savers typical of microfinance institutions, for whom instant accessibility to the funds is second only to security. The Central Bank has indicated that it is not opposed to easing these restrictions if alternative mechanisms, such as microfinance, can be found to meet the needs of the some of the market segments served by the special programs. As part of its current efforts to develop savings services in CrediAmigo, BN is seeking exemptions from these restrictions for qualified institutions which utilize the deposits to finance their microfinance portfolios. - 7 - 3. Benefits and target population: The primary benefit of an expanded program would accrue to the urban and rural microenterprises throughout Northeast Brazil which would have improved access to sustainable, lower-cost financial services. Microenterprises are defined as owner operated firms with gross receipts of up to five minimum salaries, and firms with employees with gross receipts of up to 10 minimum salaries. Based on this criteria, CrediAmigo has estimated its potential market in the Northeast Region at over 2.2 million microenterprises of which the program expects to serve at least 150,000 during the project period. Review of a sample of the microenterprise financial statements prepared by loan officers indicates that client businesses have average returns on assets of 34% per month with a median of 15%. CrediAmigo clients currently pay 5% per month for credit services with minimal transactions costs, compared to the 10% or more charged by informal lenders. While the financial benefits of microfinance programs on microenterprises in terms of lower financial costs and high returns to economic activities is relatively straightforward to evaluate, the eventual impact in terms of reduced poverty and improved standard of living at the household level is more difficult to measure. Nonetheless, the program will utilize information from the MIS, the social assessments and a formal impact evaluation focused on the microenterprise household to assist BN and Government in assessing to what extent and through what mechanisms access to microfinance services improves household welfare. The program, consistent with successful programs worldwide, relies on self-targeting mechanisms based on relatively small loans and high interest rates, as well as membership in a solidarity group. Using the proxy commonly used for estimating poverty outreach in microfinance programs worldwide, CrediAmigo's current average outstanding loan balance of US$241 is equivalent to 5.2% of per capita GDP in Brazil. Even using the proportion of the much lower per capita GDP of the Northeast Region (17%), CrediAmigo's depth of outreach is superior to that of programs such as BancoSol in Bolivia (8 1%) or even Grameen in Bangladesh (48%). The social assessment carried out during project preparation confirms the program's strong poverty orientation with over 80% of surveyed households reporting incomes below the poverty line. Participation of the poor is facilitated by a dissemination program carried out in conjunction with community organizations which work in street markets and poor neighborhoods, and as most new clients discover the program through word-of mouth, particular attention is paid to providing a clear message to current clients. Monitoring and impact evaluation activities will review client characteristics to check consistency of beneficiary definition and targeting mechanisms with program and CAS objectives which will be reviewed in-depth during the project's mid-term review. 4. Institutional and implementation arrangements: The project would be implemented by the CrediAmigo Program in BN. The CrediAmigo Technical Unit would have overall responsibility for implementation of project activities, working in conjunction with relevant areas of BN. Individual branches would be responsible for lending under the Microfinance Loan Portfolio Component. The CrediAmigo Technical Unit would have direct responsibility for implementation of the Institutional Development Component of the project, and ETENE would manage implementation of the Impact Evaluation Component. Due to the importance of the expected demonstration and learning aspects of the program, the project includes a number of mechanisms to promote review and evaluation by both primary (BN, Government, CrediAmigo clients, Bank) as well as secondary (Central Bank, other microfinance institutions, other commercial banks) stakeholders. The program includes an annual due diligence review which will be conducted by an outside agency to thoroughly evaluate the program's progress towards commercial viability according to several financial sector criteria. The due diligence will be reviewed jointly by BN, Government and the Bank each year and a report prepared for general dissemination. - 8 - The program MIS will provide a framework for on-going analysis of client benefits at the enterprise level. A mid-term review will be carried out no later than 30 months after loan effectiveness, during which BN, Govemment and the Bank will review, inter alia, progress toward the program's financial sustainability objectives, institutional evolution, results of the impact evaluation, environmental mitigation program, and the effectiveness of dissemination activities. D. Project Rationale 1. Project alternatives considered and reasons for rejection: The principle altematives for supporting the development of microfinance services in Northeast Brazil are: (i) financing NGOs; (ii) financing a private bank; (iii) financing an apex operation with private and other public banks; and (iv) immediately creating an administratively and financially independent subsidiary or similar entity. NGOs, while important sources of innovation in microfinance, rarely achieve substantial outreach, particularly in rural areas. In Brazil, the oldest and largest NGO programn - National Federation for Assistance to Small Enterprises (FENAPE) - has approximately 26,000 loans outstanding in its affiliate programns with urban branches located in 12 states throughout Brazil after more than ten years of operation. By contrast, BN's network of 174 branches in the Northeast represent substantial potential outreach, including relatively isolated rural communities. The private banking sector (including finance corporations) in Brazil is still in the process of consolidation, and low domestic savings and high spreads and administrative costs in credit intermediation contribute to the limited interest and ability of private-sector banks to serve even the small- and medium- enterprises (SME) demand for financial services (Brazil CAS, op.cit.). IFC credit lines to support SME lending under US$100,000 by private banks are not disbursing. Consistent with international experience, it is expected that demonstration by CrediAmigo that provision of microfinance services can be profitable in the Brazil environment may attract private banks into the market. International experience with apex operations has demonstrated that these are most suited to addressing a funding constraint in countries where significant microfinance retail capacity already exists. The Inter-American Development Bank (IDB) has financed apex operations with public and private banks to facilitate the development of microfinance services in other countries. While some of these programs have induced banks to expand their small-scale loan portfolio, these loans are generally at the upper limits or exceed the definition of micro-lending. In addition, banks have generally failed to expand their micro-lending programs beyond the resources under the projects. While the President of BN has expressed his desire to see CrediAmigo evolve into a financially and administratively independent entity, the program currently derives significant benefits from operating as a program of BN. The CrediAmigo program does not yet have sufficient scale to independently support the high quality "back-office" services, including cash handling, security, promotions and communications and logistical services including training which it can access through BN. In addition, its close association with an important, regional, commercial bank is seen as an attractive attribute by its clients, most of whom have never before had access to formal financial services. However, to anticipate its eventual independence, the program has developed an independent accounting framework which includes imputed prices for all services received from BN. Further institutional independence will depend in large part on the relative advantages and lost privilages negotiated with the Central Bank. -9- 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned). Implementation Development Bank-financed Progress (IP) Objective (DO) Economic development of poor, rural Northeast Rural Poverty S S communities in the Northeast. Alleviation Program (Projects in all 10 states) Market-based land reform. Land Reform and Poverty S S Alleviation Pilot Project (BR-PE-6475)) Financial sector strengthening. Central Bank Technical S S Assistance Loan (BR-PE-48357) Other development agencies Grants to microfinance NGOs. IDB Small Grants Facility Apex lending to on-going NGOs and IDB Global Multi-sector start-up municipal microfinance Financing Program institutions. IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: The strong interest in microfinance as a tool to alleviate poverty provides numerous lessons regarding "best practices" and errors to avoid. These lessons have been tested in the Brazil context during the pilot phase. In addition, the Bank has facilitated visits by BN senior management and CrediAmigo staff to many of the leading microfinance programs in Indonesia, Bolivia, Chile, Peru and Colombia. Amongst the most important lessons reflected in the CrediAmigo program and the proposed project design are: (i) Focus on sustainability as a goal from the outset of program development. The pilot phase was designed to minimize operational costs while charging a high enough interest rate to permit fairly rapid achievement of profitability. New products and delivery systems will be subject to feasibility studies to determine their potential profitability, piloted to test critical business assumptions, and evaluated to determine their contribution to overall program sustainability; (ii) Provide appropriate incentives to program staff and clients. During the pilot phase, CrediAmigo introduced an incentive system based on repayment performance and portfolio growth, which can account for as much as 50% of loan officer salaries. Clients who repay promptly receive an interest rebate and can renew their loans for a greater amount within 24 hours of their final loan payment. Access to additional products, such as individual loans and payment services, can serve as additional incentives to clients with good repayment records; - 10 - (iii) A management information system (MIS) which can provide real-time information on portfolio quality and clear procedures to react to repayment problems is essential to avoid rapidly accumulating portfolio deterioration. CrediAmigo, with financial assistance from a Japanese PHRD Grant, has installed an MIS which is on-line in all CrediAmigo branches. An operational manual provides clear guidance for loan officers, and the Technical Unit monitors and assists branches with repayment difficulties. (iv) The ability to mobilize funds through savings and direct access to financial markets is an essential element of longer-term sustainability. In addition, savings and payment services can be as valuable to the poor as credit and significantly expands the potential client base. Under the Institutional Development component of the proposed project, CrediAmigo's development into an independent institution will address internal (BN) and extemal (Central Bank) constraints to service expansion and resource mobilization. As has been done in other successful microfinance programs (BRI, BancoSol) market studies will be carried out for the design of savings products tailered to the target clientele. Funds will be transferred internally by BN to CrediAmigo branches at the inter-bank lending rate (CDI) so as maintain financial incentives to reduce costs and seek alternative sources of financing. The cost of funds used for monitoring the program's SDI is based on the rate which CrediAmigo would have to pay to mobilize deposits from the public. (v) Rapid growth early in the pilot phase demonstrated the importance of developing institutional capacity prior to rapid growth. As a result, the pilot program has focused on developing the capacity of support systems including recruitment, training, information and management. During the first two years of the loan period, CrediAmigo's capacity to support growth will be consolidated and this is reflected in the loan's disbursement profile. Substantial program expansion from the current 213 loan officers will not begin until the third year, following establishment of the capacity required to support an additional 400 loan officers. 4. Indications of borrower commitment and ownership: The current program was initiated by the President and Board of Directors of BN who requested technical assistance from the World Bank to develop an altemative mechanism for providing financial services to the poor. BN has devoted significant resources, including funds for loans under the pilot program as well as staff and senior management effort for program development. Study tours to successful microfinance institutions in other countries have been followed by presentations to senior management as well as the Board of Directors of BN. Perhaps most importantly, BN has emphasized its goal to develop a sustainable institution as indicated by its decision to charge an interest rate which is higher than most NGO programs in order to accelerate achievement of profitability. 5. Value added of Bank support in this project: The proposed project fits well within the Bank's focused poverty reduction program in the Northeast Region. Provision of financial services to microenterprises complements activities to reduce urban and rural poverty through projects which improve the quality, cost-effectiveness and accessibility of education, land reform and infrastructure services. The Bank's experience working with farmers' groups and community associations through the Northeast Rural Poverty Alleviation Program provides the basis for developing outreach strategies for solidarity group lending in rural areas. World Bank financing would provide a reliable source of funds to the microfinance program during a period of financial sector volatility in Brazil. Worldwide experience has demonstrated that liquidity constraints during program expansion can severely undermine client willingness to repay, as the expectation of access to new and possibly larger loans is an important, if not the primary, incentive for repayment. As indicated above, the project includes assistance to CrediAmigo to identify and evaluate alternative sources of funding for its continued expansion beyond the project period. - 1 1 - In addition, the World Bank's international expertise in microfinance, gained initially through its experience in Indonesia in support of BRI, and later through its sponsorship of Sustainable Banking for the Poor and CGAP provides a reference point for relevant experience which BN can readily access for program development. CrediAmigo's experience can also provide the Bank with important lessons in the development of commercial microfinance in large banking institutions. Finally, the Bank can draw on its multi-sectoral experience in Brazil and international experience with microfinance to assist BN and Government with dissemination of the results of the CrediAmigo program from the perspectives of both poverty reduction and commercial sustainability. The Bank's on-going loans and sector work in Brazil provide excellent linkages for reviewing microfinance in the context of cost-effective poverty reduction and discussion of legal and regulatory impediments with Central Bank authorities. In coordination with the IFC, the Bank can establish a credible forum for discussing microfinance as a commercial, rather than donor-driven, activity with Brazil's private banking sector. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): O Cost benefit NPV=US$ million, ERR = % (see Annex 4) 3 Cost effectiveness 0 Other (specify) The proposed project provides a means for Govemment to build upon the pilot phase to demonstrate financial viability with extended outreach in terms of numbers of clients and depth of outreach in terms of reaching microenterprise owned and operated by the poor. The project is expected to provide substantial public benefits. First and foremost, demonstration that financial services can be profitably provided to the poor in a poor region such as the Northeast would provide Govemment with an alternative to directed credit lines which have both high fiscal costs and whose funding mechanisms result in substantial distorticin of credit allocation in Brazil. The project will attempt through its monitoring and impact evaluation activities to determine both the effectiveness in targetting as well as the impact of access to financial services on poor households; information which is vital for Government to evaluate its increasing financial and legal and regulatory support for development of microfinance. The development of an appropriate environmental screening and mitigation mechanism for microenterprises will be an important innovation which can be utilized by other microfinance and SME lenders in Brazil to implement Brazil's Green Protocol. Economic evaluation of the provision of these expected benefits requires both calculation of a measure of the efficiency with which the services are provided, as well as confirmation that (i) the benefits are being provided to the target group, and (ii) the nature of the benefits in terms of income gains and improved household welfare. In order to evaluate the CrediAmigo's cost-effectiveness, the program's actual and projected subsidy dependence index (SDI) was calculated based on operational results and the CrediAmigo business plan. The SDI indicates the interest rate which the program would have to charge, after adjustment for inflation and all explicit and implicit subsidies, in order to break-even. In the case of the pilot phase of CrediAmigo, the SDI has declined rapidly from 239% in December 1998, to 10% in December 1999 as portfolio has grown rapidly relative to overhead costs. An SDI at or below zero indicates that the program is subsidy independent, and as such does not depend on public funding to survive. As a result of continued increases in clients and outstanding portfolio per loan officer, according to its business plan, CrediAmigo's SDI is projected to become negative by December 2000 and remain so over the remaining project period, although increasing costs associated with servicing more remote markets - 12 - and increasing competition with resultant reductions in interest rates are expected to put pressure on the program to improve productivity and efficiency to maintain its subsidy-free sustainability. Benefits to clients are less easily calculated with accuracy, due to the fungability of the use and benefits of the financing and the complex survival strategies employed by poor families. The main expected project benefits to clients results from the support of about US$400 million (estimated cumulative disbursements of short-termn micro-loans during the project period) of investment under the Expanded Financing of Microenterprises Component of the project. Microenterprises are likely to use part of the loans to finance new investments and to expand their operations. Prior to loan approval, CrediAmigo evaluates all loans to microenterprises to determine their repayment capacity. Only microenterprises with solid ex-ante capacity to repay the CrediAmigo lending rate will be financed. For example, in the CrediAmigo branch in Caixas, which ranks fourth and sixth in terms of outstanding loan portfolio and active clients, respectively, the average return on assets of active clients was 34% per month, and the median was 15% per month. CrediAmigo's high repayment and renewal rates verify the ability of microenterprises to eam sufficiently high retums to pay real, effective interest rates of 4% per month. Monitoring activities will attempt to isolate the net economic benefits of improved access to credit to the program's clients in order to verify the actual, as opposed to perceived, benefits at the enterprise level, and the impact evaluation will attempt to measure and identify the mechanisms for improved household welfare resulting from access to financial services. 2. Financial (see Annex 5): NPV=US$ million; FRR = % (see Annex 4) Banco do Nordeste (BN): The project is expected to contribute to BN's profitability to the extent that CrediAmigo's profits are recorded as BN profits or as returns on contributed equity in the event of CrediAmigo's partial or complete spin-off. In terns of its role as the pass-through mechanism of Bank loan funds to CrediAmigo, the project is expected to have a neutral or positive effect on BN's profitability, although this will depend on actual exchange rate movements of the real. BN is expected to charge an internal transfer interest rate for accounting purposes to CrediAmigo that takes into account the foreign exchange risk and would explore different alternatives to hedge itself from currency devaluation. BN will charge CrediAmigo branches an on-lending rate equal to or above the Inter-Bank Certificate of Deposit (CDI) rate which averaged 13 percentage points above the real Bank US$ lending rate from 1996 to 1998. As the CDI rate is market determined, it is expected that the spread vis a vis the Bank's variable, libor-based US dollar lending rate will be sufficient to cover foreign exchange risk. CrediAmigo: The project would contribute towards the profitability of CrediAmigo. CrediAmigo has developed an independent accounting framework for the microfinance program to facilitate monitoring of progress toward full financial sustainability. The accounting framework includes assignment of costs of the CrediAmigo Technical Unit, estimations of the value of services received from BN and explicit identification of goods and services received on a subsidized or grant basis. The framework and the financial results will be reviewed on as part of an annual due diligence to be carried out by a firm specialized in analysis of microfinance programs, according to guidelines developed by CGAP. Based on CrediAmigo's business plan, the contribution to profitability is estimated to total R$184 million (US$106 million) over five years with an annual contribution to profits of over R$75 million (US$43 million) at full development. After tax return on assets (ROA) is forecast at 27% at the end of the five year project period. - 13 - Fiscal Impact: The project is expected to have a positive impact on Government finances based primarily on taxes on CrediAmigo's incremental profits. Govemment will guarantee the loan but BN will be responsible for repayment and for providing counterpart funding from its commercial sources. Government has chosen to wave guarantee fees in return for partial financial guarantees and project financing of activities with high public goods components such as the impact evaluation, legal and regulatory studies and development of an environmental screening and mitigation program appropriate to microenterplises. Based on the CrediAmigo business plan, taxable net operating income is estimated to generate R$ 148.5 million (US$ 85.3 million) in tax revenues to Government over the five years of the project. Additional taxes are expected to be received from the incremental net income of microenterprise clients, however given the high level of informality, expected tax revenues from microenterprises were not estimated. 3. Technical: The CrediAmigo program reflects intemational best-practices and lessons learned during the pilot phase Study tours and international technical assistance have been used effectively by BN and CrediAmigo management to build a prograrn which reflects the stated objective of full financial sustainability. This includes: (i) designing a simple loan product based on market research; (ii) setting the interest rate high enough to fully cover the high operational costs associated with a. start-up; (iii) recruiting new loan officers at salaries substantially below those of regular BN staff; (iv) providing performance incentives to loan officers and clients consistent with institutional objectives. The most important lesson learned during the pilot phase resulted from the decision to expand from five to fifty branches after less than six months of operational experience. Management and training capacity was not sufficient to provide the required oversight for the more than 200 new loan officers, and methodological deviations and a focus on volume over quality generated high arrears which resulted in loan losses of 9% on an annualized basis over the first nine months of the program. CrediAmigo management responded by halting new lending for two months in order to retrain loan officers and focus on recovery of outstanding loans. As a result of this costly experience, CrediAmigo has placed emphasis on portfolio quality in its staff training and incentives with the consequence that over the past five months, loan losses have run at an annualized rate of less than two percent. The proposed loan will support CrediAmigo's expansion consistent with its business plan. The pre-appraisal mission's analysis of the business plan indicated that it's assumptions are consistent with recent performance in terms of loan officer productivity, portfolio quality, average loan sizes and costs and reflects lessons leamed during the pilot phase. Nonetheless, the loan size is based on a more conservative assumption of average active clients per loan officer (280 per loan officer rather than 400) as the program has not yet demonstrated the ability to support higher numbers of clients program-wide without increases in arrears and/or client desertion. In order to realize its high growth goal, prior to any further significant expansion of its program, CrediAmigo will have to: (i) consolidate staff training and monitoring to reduce variability in productivity amongst loan officers and branches; (ii) develop staff productivity and outreach mechanisms which permit increased market penetration without substantial increases in overhead costs; 14 - (iii) implement strategies to balance portfolios across loan officers without impeding productivity of top performers; (iv) strengthen recruiting, training and management systems to support planned expansion from 250 to 600 loan officers beginning in two years. In order to address these needs, CrediAmigo will draw upon technical assistance and training resources included in the Strengthened Capacity to Support Sustainable Growth of CrediAmigo Component. 4. Institutional: 4.1 Executing agencies: Bank of the Northeast (Borrower) (see Annex 5) Although BN has limited responsibility for implementation and the proposed project is focused on CrediAmigo, rather than BN's institutional development, CrediAmigo remains dependent on BN's central services and ability to manage repayment of the Bank loan. Accordingly, a due diligence review of BN was carried out by a private, Brazilian rating agency and reviewed by the appraisal mission. BN, established under Law No. 1649 of July 19, 1952, is one of four federal Govemment development banks and is the 22nd largest bank in Brazil in terms of assets. BN's mission is to contribute to the sustainable development of the Northeast region of Brazil. BN has its headquarters in Fortaleza in the State of Ceara, and operates 176 branches in the nine states of the Northeast as well as the northem part of Minas Gerais and Espirito Santo. BN is a mixed capital corporation with limited liability and unlimited duration under the laws of Brazil. As of December 31, 1999, the Federal Govemment owned, directly and indirectly, 90.63% of BN's voting stock and 90.82% of its total capital. Since 1989, BN has been placed under the control of the Ministry of Finance who designates the chairman of the bank's board of directors. The President of BN is chosen by the President of Brazil. BN's management conducts business independently to achieve and maintain reasonable profitability. A major thrust of reforms being undertaken by BN's current president are to create a more professional, results-oriented corporate culture which is better insulated from political interventions at the operational levels. No single individual can approve a loan, and all loans are approved in committees according to technical criteria. BN operates primarily as a development bank, but as a multiple service bank, BN provides a range of banking and financial services, including deposit accounts, lending to the rural, commercial and industrial sectors, trade financing, foreign exchange brokerage and pension fund management. BN initiated an important institutional reform program in 1995 to increase efficiency and outreach. Overall staff was reduced from 5,468 in 1995 to 3,832 at the end of 1999, with the share of administrative staff as part of total staff declining from 29% to 10% over the same period. From 1995 to 1999, loan assets grew from R$2.6 million to over R$6.0 million, and the number of credit operations approved each year grew from 68,000 in 1995 to over 404,00 in 1999, reflecting the bank's increasing focus on smaller borrowers. As a result, BN's market share has increased from 35% of all loans granted to the Northeast region in 1995 to 78% at the end of 1999. Loan approval was also decentralized so as to reduce the - 15- average time required for loan approval from 217 days in 1995 to the current mandated limits of 21 to 60 days, depending on loan amount. Resources and Assets: BN's total funding of just over $14.0 billion (US$8.0 billion) consists primarily of repassed Government funds (77.6%), complemented by repassed foreign funds - including loans from IDB (8.2%), deposits (7.4%) and equity (6.8%). The Constitutional Fund for the Northeast (FNE), a constitutionally guaranteed Government fund administered by BN, accounts for 47% of BN's funding. BN's assets consist of net loans (78%), treasury - limited to highly liquid federal government securities (17%), and permanent and other assets (5%). According to BN's December 31, 1999 financial statement, current assets over current liabilities are a strong 152.2%. Porfolio Composition: Approximately 90% of BN's outstanding loans are development loans based on Federal Govemment financing, of which about half are to the agricultural sector. Remaining loans are general credit to the private sector which consist mainly of short-term working capital loans funded through BN's own resources - including deposits and repassed foreign funds, and trade financing. Financing of public agencies has declined from over 37% of net loan assets in December 1995 to less than 7% in December 1999. Concentration of the loan portfolio in the 10 largest borrowers has been reduced from 322% of net worth in December 1995 to just under 200% in December 1999. Concentration in the largest 100 borrowers has been reduced from 606% to 436% of net worth over the same period. Portfolio Quality: The quality of BN's portfolio has improved since 1995. Net non-performing loans improved from 12.1% in December 1996 to 11.2% in June 1999. However, this measure includes FNE loans which are not subject to Central Bank rules on provisioning, but by less stringent rules approved by the Brazilian Congress. Excluding FNE lending, net non-performing loans increases to 19.5% of total loans in June 1999. While better than other large public banks such as Banco do Brasil (21.9%) or BANESPA (22%), this is still well above the average of 2.4% for the fifty largest banks in Brazil in 1999. BN management indicated that a large proportion of non-performing loans were contracted prior to the 1995 reorganization, and that loans contracted since then have performed much better, with non-performing loans representing about 6% of the post-1995 portfolio. Foreign Exchange Management Capacity and Impact of Recent Devaluation of the Real: BN's direct exposure to foreign exchange risk is minimal since most of its funding is in reals BN's policy is to match foreign exchange funding with foreign exchange loans, with no money or time gaps. Nevertheless, some of the bank's customers are heavily dependent on imports and may result in increased past dues. For the proposed loan, BN plans to utilize the Bank's hedging instruments. Profitability, Liquidity and Solvency: BN has reported increasing nominal profits every year since 1995, reaching R$75.4 million (US$ 43.3 million) in December 1999. Return on average equity increased from 5.2% in 1995 to 8.2% in 1999, compared to 16% for the fifty largest banks in Brazil. Return on average assets was 1.0% in 1999 compared to 1.6% for the fifty largest banks. Net interest income before provisioning expenses has increased steadily since 1995 and totaled R$572.6 million in 1999, which well exceeds the R$308.4 million earned in 1998. Much of this income came from gains with the securities portfolio, which benefited from increasingly higher interest rates imposed by the Central Bank since October 1997. Administrative and personnel expenses have decreased drastically since 1995 and in December 1999 only accounted for 18.9% of intermediation revenue, down from 95.5% at year end 1995. It is difficult to evaluate BN's performance without taking into account the effect of FNE. BN receives an - 16 - administrative fee of 3% on the value of assets lent from FNE which is recorded as "other income". These fees account for over 35% of BN's gross income. Concurrently, the administrative expenses of managing FNE are included in BN's overall administrative expenses. While BN would not be profitable without the FNE administrative fees, BN feels that this is a secure source of income as it is constitutionally guaranteed and would require a constitutional amendment to eliminate or change significantly. Nonetheless, recent Government studies have suggested alterations to the basis of renumeration for public banks administering Government funds. Given the importance of these funds to BN's solvency, the World Bank team will continue to monitor this issue throughout project implementation. BN's capital adequacy has averaged 12.3% over the past five years, consistent with private banks. This is above the average of 10.4% for the fifty largest banks in Brazil. BN's BIS ratio stood at 11% on December 3 1, 1999. Adjustment of BN's stated net worth to reverse special Central Bank dispensations for provisioning for past due loans reduces BN's capital adequacy ratio to 8.6%, which while less than the fifty bank average, is consistent with large, private banks such as Bradesco, Lloyds and BankBoston, and significantly better than Banco do Brasil (5.5%). Outlook: Since 1995, BN has taken important steps to improve the efficiency of its operations and reduce the concentration of its portfolio in government lending and large loans. The main issues which it will face in the coming years are: (i) addressing the historic problem of large, non-perforning loans booked prior to 1995 which affects portfolio concentration and effective yield on portfolio as well as casting doubt on the quality of published financial information; (ii) increase equity to point where adjustments to net worth do not undermine capital adequacy; (iii) provide a clearer link between real intermnediation costs and retums for specific financial services (i.e.: calculation of SDI); (iv) continue to incorporate private-sector banking practices which contribute to increased administrative efficiency and improvement of portfolio quality; and (v) maintain its insulation from political pressures which might undermine the important advances made since 1995. CrediAmigo (Microfinance Lending and Institutional Strengthening Components) (See Appendix 2.a and 2.b.II to Annex 2) Background: The CrediAmigo microfinance program was initiated when BN's President, Dr. Byron Quiroz, requested World Bank assistance to launch a program to better reach poor entrepreneurs in the informal sector. The World Bank facilitated the transfer of funds from a loan to the State of Maranhao to BN for study visits by senior management to successful microfinance institutions in Latin America and Asia, to design and implement a market study, and to hire international technical assistance to assist with the design of the program. The pilot phase of CrediAmigo was formally launched in five branches in late November 1997 with assistance from ACCION Intl., an international NGO with substantial experience in development of sustainable microfinance institutions in Latin America. Organization: CrediAmigo exists as a program within BN. The program works within the matrix management structure of BN with each of CrediAmigo's current 51 branches responding directly to BN's regional superintendents. CrediAmigo has a dedicated staff of 302, of which 186 are loan officers, 51 are branch managers, 14 are sub-regional coordinators, and 51 are in the CrediAmigo Technical Unit or are client training coordinators in the branches. CrediAmigo has distinct office space, disbursement and repayment windows, MIS, salary incentive system and field staff. Technical support is the responsibility of the CrediAmigo Technical Unit under the Chief of Cabinet of BN's President. Financial Services CrediAmigo currently provides a single loan product based on formation of solidarity groups of four to seven borrowers. Maximum loan size is R$3,000, with no minimum. Maximum size of - 17 - the first loan is R$700. Loans normally have tenms of 90 days though some groups with good repayment records have received 120 day loans. Repayments are made every 15 days to the CrediAmigo branch and there is no grace period. Loans have an interest rate of 4% which is charged against the original disbursed amount, resulting in an effective interest rate of 7.3% per month. An interest rebate of 15% of the total interest due is discounted from the final repayment for clients with a perfect on-time repayment record. Groups which repay on-time are eligible to receive new their loans for higher amounts within 24 hours of receipt of the last repayment. There are no other charges, deposit requirements or guarantee requirements. CrediAmigo intends to provide more flexible terms for its solidarity group loans, increasing the maximum loan amount of R$4,000 and the maximum first loan to R$1,000. Loans would also have a maximum tenn of six months, and payments could be made weekly, every 15 days or monthly depending on the specific cash-flow characteristics of the group. CrediAmigo is currently piloting an individual loan for clients who have perfect on-time repayment records for at least two loan cycles. The individual loan is intended for those clients whose capacity to borrow exceeds that of the rest of the group. Terms for the individual loan (interest rate, repayment period and maximum loan amount) are similar to group loans. CrediAmigo is also reviewing other loan products, such as investment loans and one-month special events loans. It is also introducing insurance against non-repayment due to death. A savings product with a minimum balance of R$50 is also being reviewed, though its introduction will depend in part on Central Bank regulatory approval. Non-financial Services CrediAmigo has initiated a business training program for clients through its branch offices. Clients must pay for training which is not a requirement to access the loans. CrediAmigo charges R$9 to R$18 for each course and offers a 30% discount to its loan clients. CrediAmigo is also developing an environmental mitigation program which will assist microenterprises to reduce their environmental risks, the majority of which directly affect microenterprise workers, their families and neighbors. Loan Application and Qualification Process Borrowers must meet the following qualifications: Member of group of 4 to 7 eligible borrowers; Present identification card; Proof of residence; Over 18 years old; Established in business at least one year; Not be recorded in the credit reporting service (SPC). Borrowers normally attend one orientation meeting, after which they are visited by a loan officer in their place of business. The loan officer assists the potential clients with developing a simplified balance sheet, income statement and cash flow estimate. The group then submit their credit application which is reviewed by the loan officer who also checks if they are listed in the SPC and submits the application to the credit committee. The branch-level credit committee meets daily to approve or rejects applicants and adjusts loan amounts in relation to the estimated repayment capacity. The group then attends a final consolidation meeting at which the terms and conditions of the loan are again explained, the loan contract is signed, and the group receives its disbursement and a booklet with dated repayment slips. First loans are normally disbursed within 7 days of the orientation meeting and renewals for groups which repaid their loan on-time are disbursed within 24 hours. - 18- Repayments are made biweekly to CrediAmigo branches. While loans are made to individuals, repayment is a group responsibility. Partial group repayments are not accepted, so if a single group member does not make a repayment on-time, the entire group's repayment is delinquent unless the other members of the group provide the missing repayment. Loan officers normally follow-up with individual clients at least once every two weeks and more frequently in the case of actual or potential repayment problems. Resources and Assets: CrediAmigo lending during the pilot phase has been solely financed by R$24 million of BN funds. CrediAmigo's R$8.2 million in earned losses have been booked as negative equity. CrediAmigo's $17.3 million in assets consist of microfinance loans (90%), cash (4%), deferred expenses (3%/o), fixed assets (3%). Portfolio: All outstanding CrediAmigo loans are working capital loans of 90 days with repayments every 15 days. Loans carry a flat interest rate of 4% per month with no additional fees or deposit requirements. Loans are based on solidarity group guarantees for groups of three to seven borrowers. As of December 1999, CrediAmigo had 37,683 active borrowers with an outstanding balance of R$17.2 million (US$9.6 million). Portfolio Quality: As of December 31, 1999, CrediAmigo had a 30-day portfolio-at-risk measure of 2.4%. After climbing to over 4.2% in September 1998, this measure of portfolio quality has fluctuated between 1.3% and 4%. Profitability: CrediAmigo has steadily improved its profitability over the past two years. The program incurred large losses during its first year of operations associated with high overhead costs and rapid growth. However, steadily increasing loan officer productivity and reductions in administrative costs have resulted in a decline in the unadjusted quarterly losses from R$1.4 million (US$1.4 million) in March 1998, to a small, nominal profit of R$280,000 (US$161,000) in December 1999. Impact of Recent Devaluation: As the goods and services produced by its microenterprises are largely of domestic origin and most microenterprises have rapid tum-over of inventory, foreign exchange fluctuations have little impact on either the costs or volume of business of CrediAmigo's clients. This was demonstrated in late 1998 and early 1999 when the substantial devaluation of the real had virtually no impact on the program's portfolio quality, renewal rates or demand for new loans. Outlook: Assessments of the CrediAmigo program were carried out with CGAP in November 1998 and April 1999. The November 1998 assessment identified a number of areas for improvement in the central management of the program and the focus and design of loan officer incentives and training which accounted, in part, for the high variability in results across branches and loan officers and the program's low loan officer productivity. The follow-up visit in April 1999 verified that a number of important steps had been taken to strengthen the program, including creation of the CrediAmigo Technical Unit with specialists in each of the operative areas, promotion of experienced loan officers to branch managers to replace BN staff, and an institution-wide focus (reflected in the incentive system and training program) on increased productivity measured as growth in new clients per month. While operating results have begun to reflect improvements in productivity and reduced variability between branches, additional time will be required to determiine to what extent these measures are sufficient. While acknowledging the improvements made in its institutional structure, the April 1999 assessment recommended further consolidation of key centralized functions to support future program growth: (i) Accountability mechanisms, including incentives and punitive actions; -19- (ii) Human resources development, including staff recruitment, supervision, evaluation and promotion; (iii) Training, including initial staff training and reiterative training to maintain motivation and professionalism; (iv) Ex-post monitoring of loan portfolio including field reviews to identify potential methodological drift and fraud, and statistical risk analysis; (v) Overall loan portfolio management system for administering portfolio quality and growth, including intervention strategies in case of poor performance; (vi) Strategic planning and product development based on market research, design, simulation and testing. (vi) Development of institutional structures which permit increasing financial and managerial independence from BN. The Strengthened Capacity for Sustainable Growth Component of the proposed loan includes intemational technical assistance, training and equipment to support CrediAmigo's institutional strengthening program. ETENE (Impact Evaluation Component) (See Appendix 2.c to Annex 2) ETENE (Impact Evaluation Component): ETENE's legally mandated mission is to promote and disseminate research findings financed by BN and its partners with the-objective of generating sustainable economic development in the Northeast Region. ETENE operates with a staff of 22 employees, the majority of whom have post-graduate degrees, including four Ph.Ds. ETENE has numerous collaborative arrangements with Brazilian and international universities and research institutions. ETENE, working with independent researchers, designed and implemented the initial market survey and social assessments for the CrediAmigo program. 4.2 Project management: Project management will be the responsibility of the CrediAmigo Technical Unit working with the relevant specialized areas of BN. Technical assistance will be provided under the loan to support punctual project management tasks as required. 4.3 Procurement issues: BN has a dedicated procurement unit which will work with the CrediAmigo Technical Unit in all procurement matters. The project's procurement plan, including a description of all procurement responsibilities and expected modalities was reviewed by the World Bank procurement specialist and found to be sufficient. The procurement specialist also provided training to the BN procurement unit regarding Bank guidelines and use of standard Bank bidding documents and contracts. 4.4 Financial management issues: Rated "B" Ineligible for PMR-Based Disbursements BN's capacity to manage the loan funds, including assuming the foreign exchange risk and accounting for use of funds, has been reviewed by the Bank's financial management specialist. The specialist determineid that the project satisfies the Bank's minimum financial management requirements. However, the project financial management system cannot currently generate quarterly project management reports (PMRs). An action plan was prepared and agreed for the implementation of the project-specific financial management system able to generate PMRs within six months after project effectiveness. 5. Environmental: Environmental Category: B 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis. - 20 - BN's Environmental Development Unit is adopting its environmental screening and mitigation tools for general BN loans to the particular requirements of the CrediAmigo microfinance program (See Appendix 2.b.II to Annex 2). The appraisal mission reviewed the proposed environmental policy, flow-chart and institutional responsibilities and found it acceptable. Based on these initial documents, the Environmental Development Unit is working with CrediAmigo's training staff to prepare a training program for the training agents in each branch who will integrate environmental mitigation training for businesses with potential environmental damage identified through the loan application process. 5.2 What are the main features of the EMP and are they adequate? Activities currently financed are very small-scale, focused on service activities, and all are on-going. Based on intemational experience with microfinance, this profile is not expected to change significantly as the program expands. As some on-going activities which would be supported could have environmental impacts (tanneries, mechanical shops) which could be fairly easily mitigated, all loans will be screened to identify those businesses with potential adverse environmental impacts. Those identified will be visited by the training agent to prepare a simple mitigation plan with the microentrepreneur in the context of improved, overall business management. Businesses which fail to implement simple mitigation activities will not be eligible for follow-up loans. 5.3 For Category A and B projects, timeline and status of EA: Date of receipt of final draft: September 15, 1999 (See Appendix 2.b.II to Annex 2 5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted? During project preparation, meetings were held with loan officers in each state to identify the types of activities engaged in by microfinance clients. Based on these meetings, field visits were conducted to the business locations of a sample of microfinance clients to identify the types of actual and potential environmental risks associated with the different business activities. Meetings were also held with the relevant national and state government environmental agencies regarding existing environmental information and programs related to microenterprises. The proposed screening and mitigation mechanisms developed on the basis of these consultations were then reviewed with operational personnel at all levels of the microfinance program in order to determine their operational practicality. A follow-up workshop with the participation of personnel from the microfinance program, national and state environmental agencies, microfinance clients and NGOs will be undertaken in August to review the implementation of the program and these consultations will be repeated as part of the annual evaluation of the environmental screening and mitigation measures. 5.5 What mechanisms have been established to monitor and evaluate the impact of the project on the environment? Do the indicators reflect the objectives and results of the EMP? BN's Environmental Development Unit will provide oversight for the program, but annual extemal evaluations, financed by the loan, will be conducted to review the information base developed on microenterprises and to verify the effectiveness of mitigation actions. Overall project monitoring and evaluation includes specific indicators to highlight the effectiveness of environmental mitigation activities. 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social - 21 - development outcomes. As agreed during the identification mission, in 1999, ETENE in BN performed an evaluation of CrediAmigo clients (Trabalho de Avaliacao Social CrediAmigo) in order to identify client characteristics and determine their satisfaction with CrediAmigo financial services. For this evaluation, ETENE carriedl out a survey of 518 clients from five branches (Sio Luis, Teresina, Fortaleza, Limoeiro do Norte and Recife). These branches accounted for 18% of CrediAmigo's total portfolio. The survey was complemented by interviews with individual clients and loan officers. CrediAmigo's clients generally live in urban neighborhoods that have minimal infrastructure, poor housing, and low family incomes. CrediAmigo's clients have five or more years of experience running their enterprises (61 percent), are illiterate (51 percent), are between 39 and 46 years old (44 percent). Microentrepreneurial activity constitutes the principal activity, in terms of time, for most of CrediAmigci's clients. CrediAmigo's MIS indicates that 75% of clients are engaged in commerce, 15% in services, and the remaining 10% in manufacturing. Female headed businesses had lower incomes and education levels. Although the program's design (use of solidarity groups, low initial loan amounts and short terms) favors the participation of poorer clients and particularly women who tend to be most active in commercial and service activities, the program's clients are less than 50% women. Follow-up interviews have indicated that this is due to: (i) many male clients are, in fact, borrowing for their wife's businesses; and (ii) loan officers have concentrated their promotional efforts on shops and markets while many women-owned enterprises operate from homes. Overall, clients appear to be extremely satisfied with CrediAmigo's services, as is evinced by CrediAmigos' high loan renewal rate, about 85% of the loans are renewed. Low transaction costs for borrowers may explain the high degree of client satisfaction. The survey shows that 93% of clients received their loans without delays. Although CrediAmigo charges a slightly higher interest rate than other microfinance programs, a small share of its clients (5%) complains about high interest rates. About 57% of clients are not satisfied with the repayment periods on their loans. This is because the loan terms tend to depend more on the number of loans taken by the borrower than on their cash flows. Borrowers may incur substantial transaction costs in travel and time. CrediAmigo is planning to accept payments at post-offices, which will reduce transaction costs to clients During implementation, the appropriateness of the program and product design to meet the needs of the targeted client group will continue to be reviewed with clients and community informants as part of marketing studies and new product development. An impact evaluation study will be carried out during implementation to attempt to measure program impact on client households. 6.2 Participatory Approach: How are key stakeholders participating in the project? The key stakeholders are the microentrepreneurs in urban and rural areas throughout the Northeast Region of Brazil and potentially all small savers unable to access formal financial service providers. During initial program development, market surveys were carried out with microentrepreneurs in urban markets, poor., urban neighborhoods, markets in intermediate towns and largely rural communities. Loan product design, including term, interest rate and repayment frequency, were based, in part, on the survey results. 6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations? Not applicable - 22 - 6.4 What institutional arrangements have been provided to ensure the project achieves its social development outcomes? Not applicable 6.5 How will the project monitor performance in terms of social development outcomes? The impact evaluation component will focus specifically on measurement of social impacts. Specific social impact indicators are part of the projects overall monitoring and evaluation framework. 7. Safeguard Policies 7.1 Do anv of the following safeguard uolicies aMDl to the project? ,@:t@<-,7 2 Po-.y , 7 e ty l Environmental Assessment (OP 4.01, BP 4.01 GP 4.01) 1 Yes El No E Natural habitats (OP 4.04, BP 4.04, GP 4.04) O Yes 1 No l Forestry (OP 4.36, GP 4.36) O Yes E No El Pest Management (OP 4.09 LI Yes NI No El Cultural Property (OPN 11.03) O Yes 1 No Ii Indigenous Peoples (OD 4.20) l Yes 1 No O Involuntary Resettlement (OD 4.30) E Yes E No El Safety of Dams (OP 4.37, BP 4.37) El Yes 1 No El Projects in International Waters (OP 7.50, BP 7.50. GP 7.50) O Yes LI No El Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60) O Yes LI No 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies. See Section 5. Environment above. F. Sustainability and Risks 1. Sustainability: Development of a sustainable microfinance institution has been a primary objective of the CrediAmigo program since its inception. Sustainability is defined as profitability after adjustment for inflation and any subsidies received. Experience in other countries has indicated that this can be achieved if (i) the program prices its services at a level which allows it to cover its full financial costs as well as contribute to its equity base; (ii) arrears are maintained at a very low level through staff incentives and an aggressive collections policy; (iii) operational costs are constantly reduced through incorporation of new technologies and management techniques in response to internal incentives and extemal market pressures; and (iv) the institution and its products evolve so as to meet the needs of new as well as its historic client base. 2. Critical Risks (reflecting assumptions in the fourth column of Annex 1): Risk I :Risk Ratinig Risk inimization Measure From Outputs to Objective - 23 - 1. BN management does not maintain S 1. Agreed policies in Loan Agreement on focus on low arrears, sustainability maintenance of portfolio quality (arrears and objectives. loan losses), restrictions on re-aging, refinancing, parallel financing and non-cash paydowns, and development of institulional structures which provide CrediAmigo with increasing independence and transparency. 2. BN's subsidized credit lines limit S 2. CrediAmigo product and client service market for microfinance loans and/or differentiated from BN credit lines. Client and undermine repayment discipline of clients. staff incentives focused on repayment. 3. Central Bank and/or BN Directors do M 3. Continuous informational effort by not approve institutional structures CrediAmigo, supported by Bank to demonstrate consistent with program independence. advantages and intemational experience. 4. Brazilian macroeconomic/financial S 4. Provision of high-quality information on sector conditions serve as disincentive to financial performance of CrediAmigo through external equity investors and/or published operating results and annual, extemal commercial lenders. due diligence. From Components to Outputs 1. Lack of counterpart funds. N 1. BN, rather than Govemment, fully responsible for provision of counterpart funds. 2. Unable to attract and retain suitable M 2. Performance-based compensation allows loan officers at salary levels consistent CrediAmigo to tie pay more closely to with program profitability. contribution to program profitability. Strong staff training program provides additional compensation. 3. Insufficient client demand for loan M 3. Products and service delivery systeims product. developed based on results of client surveys and pilots. Overall Risk Rating S Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk) 3. Possible Controversial Aspects: (i) The relatively high interest rate charged by CrediAmigo has raised concems with some NGOs which work with poor communities. However, there is growing public awareness in Brazil of the advantages of sustainable microfinance programs, and several NGO microfinance programs have followed CrediAmigo in increasing their interest rates on loans. (ii) CrediAmigo's evolution into a legally and financially independent entity is controversial due to the program's positive contfibution to BN's work environment and public image, and the issues raised regarding Central Bank regulations on the operation of bank branches and the forrn of financial institutions. BN's top management has indicated its support for CrediAmigo's development into an independent subsidiary or similar arrangement. The Central Bank has agreed to review proposals for reforms to - 24 - provisions of the regulatory framework which may impede development of sustainable microfinance institutions. G. Main Loan Conditions 1. Effectiveness Condition Loan Implementation Manual and CrediAmigo Credit Regulations, acceptable to Bank, formally adopted by BN Board of Directors. 2. Other [classify according to covenant types used in the Legal Agreements.] Financial Covenants (a) Annualized loan losses (the sum of the unpaid balance of loans in arrears over 90 days) incurred in any quarter will not exceed 4% of the outstanding portfolio at a date 180 days prior to the end of the quarter for which loan losses are measured. (b) Portfolio quality, measured as the average of the daily value over the quarter of the sum of payments overdue up to 30 days plus the the balance of loans overdue 30 days or more, divided by the outstanding portfolio at the end of the quarter, will not exceed 8%. Additional Covenants (a) Capacity to generate quarterly PMRs acceptable to the Bank within six months of loan effectiveness. (b) Any modification of CrediAmigo's current policies with respect to the following will require prior consultation and agreement with the Bank and modification of the relevant sections of the Implementation Manual and CrediAmigo Regulations: * Change of current policy which prohibits refinancing and rescheduling of loans; * Introduction of new loan products and policies regarding parallel loans; * Changes in the basis for measurement of program arrears; * Changes in the reference interest rate used for accounting purposes for the transfer of funds to CrediAmigo branches. (c) Any modifications of CrediAmigo's current policies with respect to the following will require a priori notification of the Bank and modification of the relevant sections of the Implementation Manual and CrediAmigo Regulations: * Management and operational structure of CrediAmigo; * Changes in terns, interest rates, grace periods and repayment frequency for loan products; * Basis for calculation of staff incentives; * Changes in the accounting framework for CrediAmigo. Event of Default Bank will be authorized to suspend disbursements in the event that the Govemment of Brazil has enacted legislation or the Central Bank has issued regulations which establish interest rate ceilings, or require debt rescheduling or debt forgiveness which materially and adversely affect CrediAmigo's ability to perform its - 25 - obligations under the Loan Agreement. H. Readiness for Implementation [G 1. a) The engineering design documents for the first year's activities are complete and ready for the start of project implementation. 1 1. b) Not applicable. 1 2. The procurement documents for the first year's activities are complete and ready for the start of project implementation. 1 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. Z 4. The following items are lacking and are discussed under loan conditions (Section G): 1. Compliance with Bank Policies El 1. This project complies with all applicable Bank policies. G 2. The following exceptions to Bank policies are recommended for approval. The project complies with all other applicable Bank policies. Steven N. Schonberger hn Redwood u#* T. Xanicm Team Leader Sector Manager/Director County ManageDirnctor - 26 - Annex 1: Project Design Summary BRAZIL: Northeast Microfinance Development Project Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission) Increase sustainability of (i) Poverty headcount declines. Evaluation of impact of Fiscal savings of sustainable poverty reduction activities program on household programs results in increased targeted to Northeast Region. welfare. coverage for poor as well as increased GNP through more efficient utilization of Brazils resources. (ii) Higher levels of cost Brazil Poverty Assessment recovery/lower levels of direct subsidy per program dollar spent compared to on-going programs. Project Development Outcome / Impact Project reports: (from Objective to Goal) Objective: Indicators: Improved access of Extent of Outreach Annual, external due diligence Loans go to poor households. microenterprises throughout At least 150,000 active clients. reviews. the Northeast Region of Brazil to sustainable, formal financial services. Depth of Outreach Annual, external due diligence Financial services result in Average outstanding balance reviews. measurable improvement in less than 65% of Northeast household Region GNP. consumption/income. Financial Sustainability Annual, external due diligence Subsidy Dependence Index reviews. zero, and Adjusted Return on Assets greater than 3% after factoring all direct headquarters expenses and estimations of related indirect costs of services from BN. Operational Efficiency Annual, external due diligence Operational costs less than reviews. 24% (annualized) of average outstanding portfolio during last two quarters of program. Establishment of Independent Annual, external due diligence Institution reviews. Retention of earnings and mobilization of external equity result in 15% equity to earning assets ratio. - 27 - Output from each Output Indicators: Project reports: (from Outputs to Objective) component: 1. Increased portfolio of 1.1 Increase in outstanding 1. PMR BN management maintains microfinance subloans. portfolio program-wide, per program focus on lowv arrears branch, per loan officer. and sustainability objjectives. 2. Strengthened Capacity to 2. PMRtSupervision Missions BN's subsidized credit lines do Support Sustainable Growth of not interfere with growth CrediAmiigo and/or undennine repayment discipline of clients. 2.1 Marketing Studies (10 2.1 Market studies result in 2.1 PMRtBank supervision Central Bank and BN studies and staff training in new promotional mechanisms missions Directors approve institutional promotional techniques) structures consistent with program independence. 2.2 Risk Management Unit 2.2 Reduced level and 2.2 PMR Brazilian Established (risk model variation of arrears and loan macroeconomic/financial operational and staff training losses program-wide, per sector conditions permit in use of system) branch and per loan officer. CrediAmigo to attract external investors. 2.3 Loan Officer Productivity 2.3 Higher level and reduced 2.3 PMR Tools (Evaluation studies and variation in new clients per pilots for introduction of palm loan officer per month pilots, etc. Staff training in program-wide, per branch and use of productivity tools, per loan officer. including time management.) 2.4 Tools/Mechanisms to 2.4 Program expands coverage 2.4 PMR Expand Geographic Coverage to at least 150 municipalities. (Evaluation studies and pilots for new branches/posts, postal service windows, mobile branches, smart cards, etc. Hiring of 400 new loan officers. Equipment and staff training.) 2.5 Identification of Viable 2.5 New product evaluations 2.5 PMiR/Bank supervision New Products (At least five result in profitable missions evaluations and pilots, introduction without undue including investment loans, disruption to existing services. special events loans, savings and staff insurance). 2.6 Environmental 2.6 Environmental screening 2.6 PMRs/Annual Management Program identifies risky Evaluations/Bank supervision (screening process, client microenterprises and missions training, evaluation) mitigation program results in effective reduction of risks. - 28 - 2.7 Basic components of 2.7 Establishment of 2.7 PMR/Bank supervision independent status within BN Independent Accounting missions (legal studies, due diligence Framework, CrediAmigo reviews, dissemination Trust Fund, Published activities.) Program Results certified by due diligence, dissemination seminars and publications. 2.8 Loan management 2.8 Difference between 2.8 PMR services (annual financial planned and actual results in audits, maintenance of project PMRs < 20%. Project reporting system, project mid-term review. mid-term review, procurement assistance for bidding documents and contracts). 3. Socio-Economic Impact 3. Evaluation provides 3. Bank supervision missions Evaluation (TA for survey statistically reliable design, field testing and assessment of impact of access training, field work, data to CrediAmigo services on analysis, interpretation) microenterprise development, income growth and client household welfare. Project Components / Inputs: (budget for each Project reports: (from Components to Sub-components: component) Outputs) 1. Expansion of CrediAmigo 1. $85.5 million Procurement and Availability of counterpart (Increase in subloans and disbursement reports from funds. incremental microfinance loan project and Bank. portfolio) 2. .Strengthened Capacity for 2. $13.7 million Suitable loan officers hired at Sustainable Growth low salary levels. 2.1 Marketing (TA, training) 2.1 $1,130,000 Sufficient client demand for loan product. 2.2 Risk Management (TA, 2.2 $120,000 training) 2.3 Increased Loan Officer 2.3 $230,000 Productivity (TA, equipment, training) 2.4 Geographic Coverage 2.4 $11,170,000 (equipment, TA, training, incremental loan officers) 2.5 New Financial Products 2.5 $330,000 (TA, training, equipment) 2.6 Environmental 2.6 $110,000 Management (TA, training) - 29 - 2.6 Institutional Independence 2.7 $310,000 (TA, training) 2.7 Loan Administration (TA) 2.8 $300,000 3. Socio-Econonic Impact 3. $0.3 million Evaluation (TA) 4. Fee 4. $0.5 million Appendix l.a. Monitoring and Evaluation Framework As presented in the project logical framework, the project will have four sets of indicators: (i) impact indicators; (ii) development objective indicators; (iii) output indicators; and (iv) input indicators. In addition, indicators have been identified for the risks associated with the critical assumptions specified in the logical framework. Impact Indicators Specific indicators to measure the impact of access to the CrediAmigo program on client business development, income and household welfare will be identified and benchmarks established as part of the design of the impact evaluation study during the first year of the project (see appendix A). Development Objective Indicators The following indicators and annual benchmarks have been identified to track progress toward achieving the CrediAmigo program's objective of "providing sustainable financial services accessible to microentrepreneurs throughout the Northeast Region." These indicators will be calculated annually as part of the due diligence review and form part of the report provided to BN and the World Bank. The indicators may be calculated more frequently as desired by BN or the World Bank. Indicator Actual CY2000 CY2001 CY2002 CY2003 CY2004 1. Financial Sustainability: 1.1 AdjustedReturnon 1.1 -17% 1.1 0% 1.1 1% 1.1 2% 1.1 3% 1. IAtleast Assets (before taxes) 3%, 1.2 SDI 1.2 Less than 1.2 10% 1.2 0% 1.2 -5% 1.2 -10% 1.2 -10% -1(% - 30 - 2. Operational Efficiency: 2.1 Administrative costs 2.1 53% 2.1 40% 2.1 35% 2.1 30% 2.1 25% 2.1 Less than over outstanding loan 24% portfolio 3. Extent of Outreach: 3.1 Number of active clients. 3.1 37,683 3.1 40,000 3.1 55,000 3.1 75,000 3.1 105,000 3.1 150,000 4. Depth of Outreach: 4.1 Average loan size over NE Brazil Per 4.1 20% 4.1 Less 4.1 Less than 4.1 Less than 4.1 Less than 4.1 Less than Capita GDP than 35% 50% 65% 65% 65% 5. Breadth of Outreach: 5.1 Number of municipalities in NE 5.1 52 5.1 81 5.1 100 5.1 120 5.1 140 5.1 150 Brazil with CrediAmigo clients. 6. Establishment of Independent Institutional Framework: 6.1 Institutional Status (subject to approval of 6.1 6.1 Fully 6.1 Trust 6.1 Direct 6.1 External 6.1 Spin-off BN Board of Directors Program independent Fund Legally commercial equity funds plan approved and Central Bark of within BN accounting Established borrowing. mobilized. by Board of Brazil) without framework. Directors. formal 6.2 Ratio of equity from distinctions. retained earnings and external investors to 6.2 0% 6.2 At least 6.2 At least 6.2 At least 6.2 At least earning assets: 6.2 0% 5% 20%. 15%. 15%. - 31 - Output Indicators Indicators and annual benchmarks have also been defined to measure progress in achieving the planned loan-financed outputs and associated outcomes. These indicators will be calculated by the MIS and reported to the World Barik at least quarterly as part of the PMRs, and verified by the due diligence and external evaluation of the environmental program. Descriptions of new promotional programs, new loan and non-loan financial producis and new geographic outreach and productivity mechanisms will be provided by the CrediAmigo Technical Unit as part of the comments sections of the PMRs. The following table provides an indicative subset of the output indicators which will be monitored under the project Output Indicators 1. Increase in outstanding gross portfolio: 1.1 Program-wide portfolio. 1.2 Average branch portfolio 1.3 Average loan officer portfolio 1.4 Program-wide active clients 1.5. Average active clients per branch 1.6 Average active clients per loan officer 2.1 Marketing 2.1.1 Number of marketing studies completed 2.1.2 Description of new promotional programs 2.1.3 Number of staff trained in marketing 2.2 Risk Management 2.2.1 Program arrears (Portfolio at risk 15 days at end of period) 2.2.2 Program loan losses (Quarterly losses annualized divided by outstanding portfolio at date 180 days previous) 2.2.3 Variability of program arrears 2.2.4 Average arrears at branch level 2.2.5 Variability of arrears at branch level (Standard deviation divided by mean) 2.2.6 Average loan officer arrears 2.2.7 Variability of loan officer arrears 2.2.8 Number of staff trained in risk management 2.3 Loan officer productivity (Only loan 2.3.1 Average productivity New clients per loan officer per month. at officers with at least 9 months experience program level. used for construction of indicator) 2.3.2 Variability at program level 2.3.3 Average at branch level 2.3.4 Variability at branch level 2.3.5 Number of staff trained in productivity enhancement 2.4 Expansion of Geographic Coverage 2.4.1 Number of loan officers 2.4.2 Number of loan officers with more than 9 months experience 2.4.3 Number of new loan officers 2.4.4 Number of branches 2.4.5 Number of posts 2.4.6 Number of mobile units 2.4.7 Number of ATMs 2.4.8 Number of non-CrediAmigo disbursement/payment windows (i.e.: postal service, shops, etc.) 2.4.9 Number of staff and others trained to use outreach technology 2.5 New Financial Products 2.5.1 Description of products piloted 2.5.2 Number of staff trained in new products 2.6 Enviromnental Management 2.6.1 Percentage of microenterprises with potential environmental risks captured by screening process 2.6.2 Percentage of microenterprises identified for mitigation which fully implement mitigation program 2.6.3 Numb;;of enviromnental officers trained 2.6.4 Numbff of microentrepreneurs trained in mitigation 4. BN management does not 4.1 Annualized loan losses 4.1 More than 3% PMR/supervision maintain CrediAmigo's in quarter divided by missions/due diligence focus on low arrears, outstanding portfolio lagged 4.2 Policies relaxed to sustainability objectives. by 180 days. permit these activities. 4.2 Program policies 4.3 Less than 1% regarding refinancing, re-aging, parallel loans and non-cash paydowns. 4.3 Adjusted Return on Assets. 5. BN's subsidized credit 5.1 Program arrears. 5. 1 Greater than 6%. PMR/supervision lines do not interfere with missions/due diligence growth and/or undermine 5.2 Outstanding portfolio 5.2 Less than 10% in repayment discipline of growth. quarter. clients. 6. Central Bank and/or BN 6.1 Formal Central Bank 6.1 No approval by July PMRlsupervision Directors do not pennit approval for CrediAmigo" 2000. missions/due diligence. institutional forms trust fund". consistent with program 6.2 No approval by independence. 6.2 BN Board of Directors December 2000. approval for CrediAmigo" trust fund". 7. Brazilian macroeconomy 7.1 Quarterly net investment 7.1 Greater than 0 Due diligence/supervision creates disincentives to flow into Brazil.. missions outside equity investment in 7.2 Greater than % in real CrediAmigo 7.2 Financial sector growth terms. rate in Brazil. Impact (Development Objectives to CAS Goal) 8. Loans do not go to poor 8. Clients household 8. Above poverty line. Impact evaluation. households. consumption/income level. 9. Financial services do not 9. Change in household 9. Insufficient to close Impact evaluation. result in significant incomes/consumption due to poverty gap. improvement of client CrediAmigo financial incomes/consumption. services. - 33 - Annex 2: Project Description BRAZIL: Northeast Microfinance Development Project By Component: Project Component I - US$85.50 million Expanded Microfinance Loan Portfolio Component This component will be implemented by CrediAmigo branches with oversight from the CrediAmigo Central Technical Unit. The component would provide funds for CrediAmigo to make loans for working capital and investment to solidarity groups and individual solidarity group clients who have "graduated" by virtue of a good loan repayment record. Financial management of the funds received from the Bank will be carried out by BN, while implementation of the microfinance loan program will be carried out by CrediAmigo (see appendix 2.a for description of CrediAmigo program) BN will be responsible for overall financial management and repayment of World Bank loan funds. Loan funds will be provided in Reals by BN to CrediAmigo branches at a market rate equal to or greater than the current inter-bank funds rate (CDI). The spread between the World Bank lending rate and the rate charged to CrediAmigo by BN will be allocated by BN to cover the foreign exchange risk. The Central Government's guarantee is being provided without charge to BN in return for the studies and evaluations which will be financed under the loan (see Strengthened Capacity to Support CrediAmigo Expansion Component and Impact Evaluation Component) and which are expected to generate substantial public goods in terns of the development of the policy and regulatory framework for microfinance in Brazil. Transfer of the funds to CrediAmigo will be recorded in CrediAmigo's accounting framework. Operating results will be reflected in CrediAmigo's income statement and any loan losses will be charged against CrediAmigo's accumulated profits. Net profits will be reflected as retained earnings, and net losses in excess of equity will be covered by BN and reflected as outstanding liabilities to BN or paid-in equity by BN on CrediAmigo's balance sheet. T he microfinance loans supported by the World Bank funds will be identified by their code number in ithe CrediAmigo MIS and this list will be available for review by Bank supervision missions and extemal auditors and evaluators. Assessment criteria and terms of the microfinance loans will be according to CrediAmigo's credit manual which will be agreed with the Bank. CrediAmigo assessment criteria include: (i) cash flow analysis of each microenterprise, including construction of a balance sheet and income statement; (ii) guarantees consisting of formation of a solidarity group comprised of at least three co-guarantors or presentation of a legal guarantor (co-signer); (iii) not found in credit reporting system; (iv) acceptable repayment performance for previous CrediAmigo loans. Demand is expected to be high given the limited availability of formal loan products designed for the microenterprise sector in the Northeast. During the project period, CrediAmigo is expected to reach at least 200,000 microentrepreneurs or less than 10% of the 2.5 million estimated microenterprises in the - 34 - Northeast. Competition from NGO lenders is restricted to a few large cities and these institutions have not pursued aggressive growth strategies. Informal lenders provide loans whose characteristics are as or more convenient for microenterprise borrowers but at interest rates at least twice that of CrediAmigo. As a result of the component, CrediAmigo's loan portfolio should have expanded from approximately $10 million to $105 million and active clients from 37,000 to 150,000. Project Component 2 - US$13.70 million Strengthened Capacityfor Sustainable Growth of CrediAmigo This component will be implemented by the CrediAmigo Technical Unit working with the appropriate areas of BN and outside agencies (Central Bank, state environmental agencies) as relevant. (See appendix 2.b.I for institutional action plan.) Marketing (US$1,130,000): Consultants will be hired to assist CrediAmigo in develop promotional and marketing strategies for the CrediAmigo program and products. Technical unit and branch staff will be trained to implement the strategies which are adopted. As a result of the component, CrediAmigo will have developed and implemented at least 10 new marketing strategies for the overall program, specific markets and specific products and branch staff trained accordingly. Risk-Management (US$120,000): Consultants will be hired to assist CrediAmigo in the development of its risk management unit within the Technical Unit. The Technical Unit will develop and utilize a neural systems model for portfolio analysis and credit scoring, and Technical Unit and branch staff will be trained to utilize more sophisticated risk management techniques. As a result of the component, portfolio quality will improve and variability in portfolio quality between loan officers and branches decline. Loan Officer Productivity (US$230,000) Consultants will be hired to assist the Technical Unit in development of mechanisms to enhance loan officer productivity in terms of gaining new clients and management of larger numbers of active clients. These mechanisms will include training in time management and purchase of equipment, such as palm pilots. As a result of the component the level of staff productivity will increase and variability between loan officers and branches decline. Geographic Coverage (US$11,170,000) Consultants will be hired to assist CrediAmigo in the identification of mechanisms which provide cost-effective outreach to clients in lower-density areas. Approximately 400 incremental loan officers will be added in the second, third and fourth years of the project. Based on feasibility studies prepared, equipment will be purchased to pilot the technology and staff trained. As a result of the subcomponent, CrediAmigo will have feasibility studies and pilot evaluations of several outreach technologies, including financial projections, legal and regulatory requirements and staff training and support needs. Govemment will benefit from identification of legal and regulatory constraints and suggested solutions. New Financial Products (US$330,000): Consultants will be hired to assist CrediAmigo in the identification and design of new loan and savings products. The consultants will assist CrediAmigo in the design of product design and testing and development and evaluation of pilots. Staff training and equipment will also be financed. As a result of the subcomponent, CrediAmigo will have feasibility studies and pilot evaluations of several loan and savings products, including financial projections, legal and regulatory requirements and staff training needs. Government will benefit from the identification of legal and regulatory constraints and suggested solutions. - 35 - Environmental Management (US$110,000): Consultants will be hired to work with BN's Environmental Development Unit and CrediAmigo Technical Unit to carry out annual, independent evaluations of CrediAmigo's environmental mitigation program for at-risk microenterprise clients. (See appendix 2.b.I]: for description of BN's environmental development program and mission assessment of CrediAmigo environmental management program.) CrediAmigo's business management/environmental officers in the branches will receive updated training based on the results of the evaluations. As a result of the component, CrediAmigo will have an effective screening system to identify microenterprise activities with potential environmental risks and a follow-up client orientation program which results in effective mitigation of identified risks. Government environmental agencies will have information on the types and geographical locations of microenterprises which pose environmental risks. Public and private agencies which assist microenterprises will have access to information and educational materials for distribution to microenterprises, and microenterprises will have access to the materials and training. Institutional Independence (US$3 10,000) Consultants will be hired to undertake legal and regulatory studies, develop public reporting mechanisms and to cany-out annual due diligence reviews. (See appendix 2.b.1I for description of due diligence review.) CrediAmigo staff and BN management will also receive training through study tours and participation in conferences focused on institutional development of commercial microfinance institutions. As a result of the component, BN will be able to establish institutional structures consistent with increasing the managerial, financial and legal independence of CrediAmigo, and publish annual statements of program results based on extemal due diligence reviews which assess the program in terms of its viability as an independent financial institution. Program results and on-going lessons learned will be disseminated through seminars and publications. Loan Administration (US$300,000) Funds will be provided to contract short-term consultants to assist in punctual activities in support of loan administration, including extemal loan audits and assistance with development of bidding documents for procurement. As a result of the subcomponent, BN should have annual, extemal financial loan audits and bidding documents acceptable to the Bank, increasing consistency between projected and actual implementation performance as reflected in the quarterly PMRs, and a comprehensive mid-term evaluation carried out jointly with BN, Government and the Bank to review project performance relative to objectives, lessons learned and any required adjustments in the program. Project Component 3 - US$ 0.30 million Impact evaluation Component This component would be implemented by ETENE working in conjunction with universities and other Brazilian and international researchers. Technical assistance will be hired to assist ETENE in the design, implementation and analysis of statistical surveys to evaluate program impact on client households. (See appendix 2.c for description of ETENE and design parameters for impact evaluation.) As a result of the component, CrediAmigo, BN and Government will be able to identify the relationship between access and use of formal microfinance services, how credit is actually used, the impact on microenterprise growth and profitability, and the broader benefits for the household. This will assist Government in determining the public welfare aspects of microfinance in relation to other potential poverty reduction tools. - 36 - Appendix 2.a Appraisal of CrediAmigo Microfinance Program Mission CrediAmigo's mission is to "Contribute to the development of the microenterprise sector through the offer of financial services and training, which are sustainable, relevant, adequate and easy to access, assuring new opportunities for employment and income in the Northeast Region of Brazil." Background The program was initiated when BN's President, Dr. Byron Quiroz, requested World Bank assistance to launch a program to better reach poor, entrepreneurs in the informal sector. A seminar was held at BN's headquarters in Fortaleza, Brazil in November 1996 at which the World Bank staff presented the lessons learned from sustainable microfinance institutions in Asia and Latin America. A set of basic principles for development of sustainable microfinance services, and a follow-up World Bank/CGAP mission in February 1997 carried out an assessment of BN's suitability as a platforrn to pilot a microfinance program. The World Bank facilitated the transfer of funds from a loan to the State of Maranhao to BN for study visits by senior management to successful microfinance institutions in Latin America and Asia, to design and implement a market study, and to hire international technical assistance to assist with the design of the program. In late November 1997, with assistance from ACCION Intl., an international NGO with substantial experience in development of sustainable microfinance institutions in Latin America, CrediAmigo was formally launched in five pilot branches. CrediAmigo's first major challenge occurred in May 1998, when BN management decided to expand the program to 46 more branches throughout the Northeast. Insufficient support systems, loan officer and branch manager training, and emphasis on rapid growth resulted in a rapid deterioration in the quality of the loan portfolio. The President of BN instructed all managers to reduce or stop new microfinance lending until arrears were brought under control and loan officers retrained. The rapid expansion cost the CrediAmigo program an estimated $3 million in loan losses, lost productivity and rehiring and retraining costs. However, the experience did provide an important examnple of the dangers of over-rapid expansion and setting of ambitious growth targets without sufficient controls and attention to portfolio quality. As a result, CrediAmigo has suspended any further expansion in favor of program consolidation. CrediAmigo and BN management have focused on reducing overhead costs, and increasing loan officer productivity and portfolio quality through training, incentives and better monitoring, a process which is being supported by technical assistance from CGAP and ACCION, Intl. Program Description Legal Structure and Ownership. CrediAmigo is a program fully within BN and as such has no distinct legal standing. BN management is currently working with the Central Bank of Brazil in the definition of a trust find-type entity which would permit CrediAmigo to have a financially independent status for the - 37 - purposes of accounting. BN is also examining options for increased institutional independence consistent with the program's requirements and capacities. Organizational Structure. CrediAmigo works within the matrix management structure of BN. Loan officers are organized into 51 CrediAmigo branches which are both physically and administratively distinct from BN. Though in most cases they share physical facilities and security arrangements with BN branches, CrediAmigo has separate offices and separate, dedicated tellers for disbursement and repayment of microfinance loans. CrediAmigo branches are directly accountable to BN's regional superintendents, who appoint sub-regional coordinators to oversee and support the activities of up to five branches. The regional superintendents report directly to the President of BN. The CrediAmigo Technical Unit, housed in the Office of the President of BN, provides technical support services to the branches and the superintendents, including training, assistance with human resources management, promotional support and resolution of particular problems with portfolio management or growth. The Technical Unit is also responsible for program oversight, policy development, MIS development and support, and strategic planning. The Technical Unit provides program results and performance comparisons to all levels of the program and reports directly to the President of BN through the Chief of Cabinet who is also the General Manager of CrediAmigo. Geographic Coverage. CrediAmigo currently has 51 branches spread throughout the nine states of the Northeast Region (Alagoas, Bahia, Ceara, Maranhao, Paraiba, Pernambuco, Piaui, Rio Grande doNorte and Sergipe) as well as the northem portion of Minas Gerais. CrediAmigo is testing innovative means to extend its geographic coverage without incurring the overhead expense of new branches through introduction of service posts, mobile units and use of non-bank transactions points such as post offices. Source of Funds BN has provided CrediAmigo with R$24 million for on-lending which are "transfered" for accounting purposes at the inter-bank lending rate (CDI). CrediAmigo also received $400,000 of non-reimbursable funds from a World Bank loan to the State of Maranhao, and a $996,000 PHRD Grant to support staff training, MIS development and technical assistance. Financial Services CrediAmigo currently provides a single loan product based on formation of solidarity groups of four to seven borrowers. Maximum loan size is R$3,000, with no minimum. Maximum size of the first loan is R$700. Loans normally have terms of 90 days though some groups with good repayment records have received 120.day loans. Repayments are made every 15 days to the CrediAmigo branch and there is no grace period. Loans have an interest rate of 4% which is charged against the original disbursed amount, resulting in an effective interest rate of 6% per month. An interest rebate of 15% of the total interest due is discounted from the final repayment for clients with a perfect on-time repayment record. Groups which repay on-time are eligible to receive new their loans for higher amounts within 24 hours of receipt of the last repayment. There are no other charges, deposit requirements or guarantee requirements. CrediAmigo intends to provide more flexible terms for its solidarity group loans, increasing the maximum loan amount of R$4,000 and the maximum first loan to R$1,000. Loans would also have a maximum term of six months, and payments could be made weekly, every 15 days or monthly depending on the specific cash-flow characteristics of the group. CrediAmigo is currently piloting an individual loan for clients who have perfect on-time repayment records for at least two loan cycles. The individual loan is intended for those clients whose capacity to borrow exceeds that of the rest of the group. Terms for the individual loan are similar to group loans, though CrediAmigo intends to require a co-signatory to the loan. - 38 - CrediAmigo is also reviewing other loan products, such as investment loans and one-month special events loans. It is also introducing insurance against non-repayment due to death. A savings product with a minimum balance of R$50 is also being reviewed, though its introduction will depend in part on Central Bank regulatory approval. Non-financial Services CrediAmigo has initiated a business training program for clients through its branch offices. Clients must pay for training which is not a requirement to access the loans. CrediAmigo charges R$9 to R$18 for each course and offers a 30% discount to its loan clients. CrediAmigo is also developing an environmental mitigation program which will assist microenterprises to reduce their environmental risks, the majority of which directly affect microenterprise workers, their families and neighbors. Loan Application and Qualification Process Borrowers must meet the following qualifications: Present identification card; Proof of residence; Over 18 years old; Established in business at least one year; Not be recorded in the credit reporting service (SPC). Borrowers normally attend one orientation meeting, after which they are visited by a loan officer in their place of business. The loan officer assists the potential client with developing a simplified balance sheet, income statement and cash flow estimate. The group then submit their credit application which is reviewed by the loan officer who also checks if they are listed in the SPC and submits the application to the credit committee. The branch-level credit committee meets daily to approve or rejects applicants and adjusts loan amounts in relation to the estimated repayment capacity. The group then attends a final consolidation meeting at which the terms and conditions of the loan are again explained, the loan contract is signed, and the group receives its disbursement and a booklet with dated repayment slips. First loans are normally disbursed within 7 days of the orientation meeting and renewals for groups which paid their loans paid on-time are disbursed within 24 hours. Loan officers normally follow-up with individual clients at least once every two weeks and more frequently in the case of actual or potential repayment problems. Human Resources CrediAmigo has a dedicated staff of 302, of which 186 are loan officers, 51 are branch managers, 14 are sub-regional coordinators, and 51 are in the CrediAmigo Technical Unit or are client training coordinators in the branches. CrediAmigo loan officers are recruited and contracted through a third party due to union restrictions on hiring and pay scales in BN. (The proposed trust fund arrangement is intended, in part, to permit CrediAmigo to contract staff directly outside the BN union restrictions). Loan officers are typically recent university graduates with some business experience. Branch managers are selected from amongst loan officers. Sub-regional coordinators are BN employees, although CrediAmigo expects to eventually replace them with CrediAmigo staff that entered as loan officers, both to further institutionalize the CrediAmigo culture and microfinance focus, and to reduce staff costs. The staff of the CrediAmigo Technical Unit comes from within BN. In addition to capitalizing on the banking experience of its staff, BN is placing high quality staff in the sub-regional coordinator and technical unit positions in order to facilitate communication with other areas of BN and to ensure that the lessons learned from the microfinance operation, particularly in portfolio management, human resources management and client services, are transferred to the rest of the bank. BN also considers CrediAmigo as a source of staff with a stronger commercial focus for the larger bank. - 39 - CrediAmigo staff at the loan officer and branch levels receive a base pay of about R$400 (US$230) per month which can be doubled through an incentive system based on productivity (new clients per month) and portfolio quality (low arrears). The average loan officer received R$724 (US$416) in base salary and incentive payments in June 1999. Staff receive quarterly evaluations which review performance, attitude, teamwork and skills and career development. Although not formally employees of BN, CrediAmigo loan officers and branch managers are considered as such in terms of all BN activities and access to recreational facilities. Training Staff receive intensive training in microfinance credit methodology, business management and communications. Training modules have been developed with the assistance of ACCION, Intl., an intemational NGO with extensive experience in the development of sustainable microfinance institutions throughout Latin America. Training modules are continually updated in response to identified program needs. Training is provided through formal courses conducted by BN, apprenticeships with experienced loan officers, staff exchanges between CrediAmigo branches, study visits to other microfinance institutions in Latin America, and on-line lessons. Management Information Systems (MIS) BN has invested substantially in CrediAmigo's MIS. All 51 branches are on-line with the Central Technical Unit, regional coordinators and the regional superintendents. The MIS consists of two main systems - the managerial system which is "open", and the accounting system which is "closed" and which interacts with BN's main MIS. Virtually all CrediAmigo systems and processes are computerized and available through the MIS, including loan applications, loan. officer scheduling, disbursement and repayment information, basic data on clients, incentives calculations and performance rankings. Delinquency management The current incentive program rewards, portfolio growth and delinquency control. Under this scheme, loan officers' remuneration varies according to a score calculated on the basis of their sales performance (new loans plus renewed loans); they lose points for any loan in their portfolio that is behind in its payments. The loan officer is responsible for following up on portfolio at risk of up to 0.5% of his/her portfolio. The branch coordinator will intervene if default is between 0.5% and 2%, with involvement of the regional manager when portfolio at risk exceeds this amount. CrediAmigo's technical unit will monitor and/or intervene branches when portfolio at risk raises above 4% in the branch. CrediAmigo's policy is to never refinance any loan. Program Promotion BN has also invested substantially in promotion of the CrediAmigo program through television, radio, and promotional posters, pamphlets and t-shirts. A recent market study indicates that the most important promotional tool has become CrediAmigo's satisfied clients who tell others about the program. Second in importance are the individual visits of loan officers to potential clients. Operational Results In table 1 the performance of CrediAmigo is compared against data published by the MicroBanking Bulletin for large Latin America microfinance institutions which have attained at least 95% full financial sustainability. The microfinance institutions included in this category are: BancoSol (Bolivia), Los Andes, Financiera Calpia (El Salvador), CM Arequipa, Prodem, FIE, MiBanco, Genesis Empresarial (Guatemala), Finamdrica, FWWB Cali (Colombia). Comparing a young microfinance institution like CrediAmigo to older microfinance institutions may have some drawbacks. Nonetheless, the comparison highlights areas such as administrative costs which inhibit CrediAmigo's sustainability, while identifying areas, such as outreach, where CrediAmigo is performing better that its peer group. - 40 - Table 1 Comparison of CrediAmigo with other large Latin American Microfinance Institutions MARKETINDICA TORS Rate of Consumer Price Inflation (per year) 3.2% 4.9% 8.9% Market Reference Rate (per year): 36.5% 34.1% 15.2% Exchange Rate (ReaislUS Dollar): 1.2 1.8 NA GDP per capita (USS, Northeast) 2,170 1,388 1,938 KEY FINANCIAL PERFORMANCE RA TIOS Subsidy Dependence Index 239.1% 25.5% NA Return on Assets (ROA) -516.4% -16.8% 5.5% Adjusted Retum on Assets -705.7% -147.2% 4.2% Operational Self-Sufficiency (excluding cost of funds) 35.9% 123.4% 120.5% CREDITRISKRA TIOSa Portfolio at Risk (>90 days, after write-offs) 0.0% 0.0% 1.2% Portfolio at Risk (> 30 days, after write-offs) 1.3% 2.4% NA FINANCIAL MARGINRATIOS Interest Expense / Avg. Assets 28.3% 24.0% 8.6% Portfolio Yield = Interest Income / Avg. Loan Portfolio 76.5% 77.9% 36.8% Real Portfolio Yield 71.0% 69.6% 25.8% Adj. Profit Margin= Adj. Net Income/Total Operating Income -201.0% -5.4% 13.4% Asset Utilization= Interest Income / Avg. Assets 64.2% 78.3% 30% PRODUCTIVilTY RA TIOS Personnel Costs / Avg. Assets 113.3% 39.5% 9.1% Personnel Costs/ Avg. Loan Portfolio 137.1% 40.7% 12% Administrative Cost / Avg. Loan Portfolio 193.8% 55.5% 19% Active Loan Clients per Staff Member (end of period) 55 121 147 HUMAN RESOURCES Total Staff (end of period) 345 311 188 Loan Officers 243 186 NA Average Salary per staff / GDP per capita 70% 60% 6.4% REGIONAL DISTRIBUTION Branch Offices 50 57 20 Average no. of Employees per Branch 6.9 5.5 9.4 O UTREA CH INDICA TORS Avg. Loan: Loan Portfolio/ Clients (US$) 336 254 714 Avg. Loan/ GDP 16% 26% 50% Active Clients 21,024 37,683 27,420 % women clients 45% 45% 65% LoanPortolio (USS '000s) 7,067 9,558 17,222 Sources: CrediArnigo's Finianicial Statenments andMicroBankingBulletin Issue No. 3, July 1999 a CrediAmigo write off bad loans after 90 days of the initial delinquency, which is more aggressive than the I year policy of the peer-group. *CrediAmigo writes off bad loans after 90 days of th e initial delinquency, which is more aggressive than the 1 year policy of the peer-group, but these delinquencies remain in the portfolio at risk figures indefinitely so that they are not directly comparable with the figures for the peer group. Outreach Despite its early difficulties, CrediAmigo has achieved impressive growth. Its loan portfolio has grown an average of 40% per quarter in real terms. After 18 months, its outstanding loan portfolio of - 41 - R$16.6 million (US$9.6 million) and 37,683 active clients compares to US$17.2 million and 27,420 active clients for its peer group, all institutions which have been in business for at least three years and in most cases over five years. Profitability. Adjusted return on assets (AROA) summarizes CrediAmigo's overall financial performance. As shown in Table 1, CrediAmigo is pursuing a rapid path to profitability. Although CrediAmigo's adjusted ROA has been negative all quarters, consistent with a relatively new program, it has shown impressive improvements, growing from negative 705.7% in December 1998 to negative 147.2% in December 1999. This improvement results from controlling operating expenses and increasing loan officer productivity. At this pace, CrediAmigo management hopes to achieve positive adjusted ROA by December 2000. Overall, most microfinance programs take five to seven years to become fully sustainable, but CrediAmigo may achieve full sustainability faster due to its relatively higher lending rates.. Decomposing the Return on Assets. The retum on assets can be decomposed into the product of CrediAmigo's adjusted profit margin (adjusted net income / interest income) and asset utilization (interest income / avg. assets). In December 1998, CrediAmigo showed an adjusted profit margin of negative 201%. By December 1999, CrediAmigo presented an adjusted profit margin of negative 5.4%, representing a significant improvement. CrediAmigo has achieved this by controlling the growth of adjusted operating expenses and by producing substantial interest income. CrediAmigo's asset utilization, which represents the gross yield on assets, was 48 percentage points above the peer group. CrediAmigo's portfolio yield (interest income /avg. loan portfolio) reached 77.9% in Decemberl999. Controlling Adjusted Non-Interest Expenses. Adjusted non-interest expenses as a share of total operating income, excluding grants, have fallen every single quarter since CrediAmigo's inception from negative 1,404% in Q 1/98 to negative 92% in Q2/99. A determining factor has been a reduction of the average monthly salary per staff from R$2,058 in Q1/98 to R$1,415 in Q2/99, reflecting in large part the transfer of branch management responsibilities from regular BN staff to promoted loan officers. Nonetheless, relative to GNP, CrediAmigo pays its staff more than what average staff at peer group institutions earn. In December 1999, its average staff salary was equivalent to 60% of GNP per capita in the Northeast, compared to 6.4% for its peers, and administrative costs as a share of average loan portfolio were 56%, or almost three times higher than the average for other large microfinance programs in Latin America. Loan Officer Productivity. Productivity, measured as average new clients per loan officer per month has increased dramatically from 2 in June 1998 to 14 in December 1999. This is CrediAmigo's key challenge as its current 121 active clients per staff member and average loan balance of US$254 per loan compares unfavorably to 147 clients per staff member and an average loan balance of US$ 714 for its peer group. CrediAmigo's management has also had some success in reducing the large disparities in productivity between loan officers. In February 1999, 57% of loan officers had 10 or less new clients per month, whereas four months latter, this percentage declined to 43 percent. Portfolio Quality. (Figure 1) Following high delinquency associated with the early expansion of the programn, CrediAmigo has been able to manage delinquency relatively well considering its growth push. Portfolio at risk (30 days) reached 2.4% in December 1999. Netting out loans which would be excluded from the 90 day portfolio at risk indicator for its peer group, CrediAmigo's performance is comparable to its peer group (1.2%). The program's recent emphasis on increased loan officer productivity has resulted in the rapid increase in delinquency, but this has remained within the program's target limits and is currently declining. CrediAmigo's management is implementing preventive actions to control future delinquency while monitoring trends of portfolio at risk by branch and developing an action plan to solve delinquency problems. As of July 1999, twelve branches had a portfolio at risk (15 days) above seven percent. - 42 - 1. Figure 1 Portfolio Quality - PtboUo at Rtsk p.30 days) -PwfoIO atRsk Rp60 days) -PbWt aotatR1sk (15daysJ --+ Wrta-offs IAvg. Loan Ptofoo Lagged 180 days (Rlght-tdaSea)e) C% ~ .......... 20% Oi?:¢:>~~~~~~~~~~~~~~~~~~~~ . .: ... .:?: .+ ~~~ ~~18% 5% -E r7..7-Q- ........ ---.--n-:--;---.r......... --- -., .. -----,- - -m. .. . . .... 1---r- 14% 4%~~~~~~~~~~~~~~~~~2 ...a. .-:....-.- ...... {.?:.-l....................... :';126 3% ~~~~~~~~-10% 6% 1% ---ti-- f 2% 0% - 0% 12/7 3/98 6/8 9/98 12/98 39 &W99 Capital Adequacy. For the purpose of the analysis, CrediAmigo's equity was defined as retained profits (losses), which implies that CrediAmigo has negative equity. However, a wider definition will include all of BN's transfers, resulting in 100% equity funding from BN. For this reason, capital adequacy issues are not relevant for CrediAmigo as part of BN. Creation of a CrediAmigo trust fund is intended to pernit the program to retain any future profits as contributions to equity as well as seek extemal investors. CrediAmigo S Subsidy Dependence Index An import indicator of CrediAmigo's sustainability is the subsidy dependence (SDI). The SDI is the percentage by which the yield obtained on loan portfolio would need to be raised, over the interest rate actually collected, in order to fully cover the cost of both explicit and implicit subsidies. CrediAmigo receives subsidies from the following sources: * Implicit subsidies from concessional liabilities. A market reference rate serving as a shadow price for CrediAmigo is derived using the interest rate for 30 days deposits, a reserve requirement of 15 percent, and an administrative cost of mobilizing and servicing deposit of three percent per year. * Implicit subsidies related to opportunity cost of equity. Because CrediAmigo's liabilities are greater than accumulated earnings and BN has not made equity contributions to the program, its equity is negative. Hence, CrediAmigo has a "negative" subsidy from equity, which is subtracted rather than added to the total subsidies. * Explicit Donations for Operating Expenses as reflected in the income statement. The calculation of the Subsidy Dependence Index, or SDI is presented in Table 2. CrediAmigo's SDI has been improving since its inception. According to the estimation, the amount of subsidies amounted to R$0.3 million in Q4/99 (or R$11 per client), a significant reduction from Q2/98, when subsidies reached R$2. 1 million (R$143 per client). In Q4/99, CrediAmigo had a SDI of 10%, which indicates that the annual yield on the loan portfolio would have to increase from 74.2% to 81.7%. - 43 - This SDI calculation provides a lower bound estimate of CrediAmigo path towards sustainability. For example, Brazil's Central Bank regulations require an equity assignment when opening a new branch. As part of BN, CrediAmigo has been able to open branches without the corresponding equity contribution, which constitute an additional implicit subsidy not accounted for in the SDI. Table 2 Calculation of the Subsidy Dependence Index for CrediAmigo Market Indicators Rate of Consumer Price Inflation (per year): 4.7% 3.7% 2.6% 1.8% 2.3% 3.3% 5.5% 8.4% CPI (Jun-99=l) 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 Interbank lending rate (CDI) 35.2% 26.7% 28.1% 21.2% 20.3% 19.9% 21.3% 18.2% Discount Ratel 38.5% 29.4% 42.3% 39.4% 46.0% 24.5% 21.8% 21.4% Derivation of the Market Reference Rate a. Deposit Rate(per year) 32.3% 22.7% 23.8% 33.3% 40.0% 25.4% 19.9% 18.9% Administrative Cost of Mobilizing and Servicinig Deposits (per b. month) 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% c. Reserve Requirement 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% d. Rate of Interest on Required Reserves 0.0% 0.00/s 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% e. Market Reference Rate (per year) = [a+bl/[I-cl: 41.5% 30.2%/o 31.5% 42.7% 50.6% 33.4% 26.9% 25.7%/ Identification of the Sources of Subsidy f. Interest Expense 79 264 385 760 889 1,153 849 711 g. Liabilities (mothfy avg.) 2,633 7,388 10,417 15,142 19,001 23,070 23,944 24,862 h. Subsidiy on Concessional Liabilities=Ie*g03-fl: 12 293 435 857 1.513 772 761 888 i. Opportunity Cost of Equity 41.5% 30.2% 31.5% 42.7% 50.6% 33.4% 26.9% 25.7% l Accounting Cost of Capital 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% k. Equity (monthly avg.) -707 -2.866 -4.637 -6.343 -7.281 -8.002 -7.946 -7.558 1. Subsidy on Equity =[i*k*31: -24 -216 -365 -677 -921 -668_ -534 486 m. Miscellaneous Grants and Benerits: 0 0 471 261 239 218 78 206 Calculation of the SDI n. Total Subsidy Received by CrediAmigo [h + I + m] -12 77 541 440 832 322 305 608 o. Profit (Loss) -1,383 -2,027 -1,736 -1,639 -738 -497 322 280 p Net Subsidy = [n - o] 1,371 2,105 2,276 2,080 1,570 820 -18 328 a. Interest Income: 110 773 1.036 1.405 2.015 QJ 7691 3,345 3.228 r. Subsidy Dependence Index = [p / ql: 1248% 272% 220% 148% 78% 30% -1% 10% Requisite Interest Rate Adjustment s. Real Yield on Portfolio (per year): 31.2% 75.8% 80.6% 70.9% 72.1% 72.6% 73.1% 60.7% t. Current Yield on Portfolio (per year): 37.3% 82.4% 85.3% 74.0% 76.1% 78.2% 82.6% 74.2% Increase in the On-Lending Rate Required to Eliminate u. Subsidy Dependence= [r*t]: 465.0% 224.2% 187.6% 109.6% 59.2% 23.1% -0.4% 7.5% Lowest Subsidy Free On Lending Rate (per month) = [t + v. ul: 502.3% 306.6% 272.90/o 183.6% 135.3% 101.3% 82.2% 81.7% Subsidy per Borrower (Rs) Source: CrediAmigo's Financial Statements and Table _ I D)iscowit Rate Rate darged by di Central Barik of Brazil on loans to financial iransittiors collateralized by federal securities. 2 Deposit Rate:Aveage Rate offered by banks on certificates of deposit of 30 days or tongeT - 44 - Financial Projections - Assumptions As part of project preparation, CrediAmigo prepared a five-year business plan using the CGAP Microfin Model. The appraisal mission reviewed the following assumptions with CrediAmigo staff: Loan Products. For the financial projections, CrediAmigo plans to continue with solidarity group loans and to add three new loan products: individual working capital loans, individual investment loans, and special event loans. Investment loans would be available to good standing clients that have repaid two solidarity group loans. Special event loans would satisfy the demand of current clients to expand their operations due to seasonal festivities in the region. These loans would be targeted to clients that have received at least three loans from CrediAmigo. As shown in Table 3 all assumptions regarding solidarity group loans are consistent or more conservative than current practices. Assumptions for individual, investment, and special event loans were provided by Accion Intemational based on intemational experience. Table 3 Characteristics of Loan Products for Financial Projections .... .- - - - ........... . . .- ..... . . . . - . . - --- . - . . ......................................... .. .. . .............. . Solidary eGoup Investtent Individud a - -WSci r:&aHe--: :- - -. :-- Actual -- Proiected. Proieced- .i*oededa F jiectI Average loan anount (RS) First loan 716 550 1,352 2,000 680 Second loan 914 825 2,028 3,000 Third loan 1131 990 3,785 3,600 Fourth loan 1349 1,139 7,435 4,140 Fifth loan 1521 1,252 7,435 4,761 Sixth and subsequent loans 1,628 7,435 5,951 Loan size linked to inflation? No Monthly No Yearly Repayment Term (months) First loan 3 3 12 3 1 Second loan 3 3 15 3 Third loan 4 4 18 4 Fourth loan 4 4 18 4 Fifth loan 5 5 24 5 Sixth and subsequent loans 5 5 24 6 Repayment frequency Every two Every two Monthly Monthly End-term weeks weeks Grace period? No No Yes No No Fees and Compulsory Savings No No No No No Interest Rates Interest rate method Flat Flat Declining Flat Flat Interest rate, Month 1 79.6% 79.6% 79.6% 101.2% 125.2% Month 60 42.6% 60.1% 69.6% 125.2% Effective yiedd First loan, Month 1 NA 99.8% 66.3% 128.0% 108.5% Effediveyield; Sixth loan, Month 1 NA 107.9% 66.3% 137.1% NA Client Retention Rate Overall Rate (monthly average) 83% Second loan NA 85% 50% 85% 0% Third loan NA 90% 30% 90% Fourth loan NA 90% 25% 90% Fifth loan NA 90% 20% 90% Sixth and subsequent loans NA 90% 10% 90% Source: CrediAmigo 'sBusiness Plan 'End-of-projections Interest Rates. The business plan assumes that lending rates would decrease for all loan products except - 45 - special event loans. For exarnple, the nominal interest rate for solidarity loans would diminish from its original 5% per month to the current 4% and eventually to 3%. It is expected that CrediAmigo may fuirtler reduce its lending rate with reductions in the market price of funds and the entry of new competitors, aifer having achieved its consolidation. Client Retention Rates. CrediAmigo's business plan assumes a client retention rate ranging from 85-90 percent, which is slightly higher than the overall retention rate for solidarity loans. This assumption may be reasonable for solidarity loans, as CrediAmigo is focusing its incentive system towards client retention. In the case of individual loans, the business plan assumes a similar retention rate than that of solidarity loans, which is consistent with CrediAmigo's policy of graduating solidarity group borrowers to individual loans. If this is the case, individual loan clients will consist of individuals that have borrowed from CrediAmigo for various loans, and thus, are more likely to stay. In the case of investment and special event loans, the business plan is more cautious regarding retention rates. Table 4 Loan Officer Productivity Assumptions Solidarity Group -nvestment Individual Social Total-: Characteristic Actual Projected Projected Proiected Projected Loan Officer Productivity New Clients per month 13 14 2 3 NA 19 Clients per loan officer 203 3301 10 561 6 402 Source: CrediAmigo's Business Plan Loan Officer Productivity. The business plan assumes that loan officers will attract 14 new clients per month for solidarity loans, which is consistent with CrediAmigo's past perfornance. A point of concem. is the capacity of loan officers to manage an average of 402 active clients in five years compared to the present average of 203 clients per loan officer. CrediAmigo plans to focus on developing adequate training and support systems over the next 12 months to ensure that loan officers will be able to manage 400 clients without significant increases in loan delinquency and decreases in customer satisfaction. Portfolio Quality. The projections assume that portfolio at risk (30 days) will increase from its current level of 2.4% to 50/oat the end of five years. The experience in Latin America with solidarity group suggests that the portfolio at risk ratio increases when the portfolio is growing rapidly in terms of number of clients. This increase would not jeopardize the financial performance of the program, as lending rates should cover those expenses. The assumption regarding loan loss provisioning categories was unrealistic in assuming a reserve for loan losses equal to zero, and thus, adjusted using 10% for loans with up to 30 days late, 50' % for loans with 31-60 days late, and 100% for the remainder. With this modification, CrediAmigo's adjusted and projected financial statements present comparable figures regarding write-off policy and reserve for loan losses. - 46 - Table 5 Portfolio Quality and Interest Rate Assumptions :-n Year 1 Year2 Year 3 Year-4 Year 5 Portfolio Ouality Portfolio at risk (30 davs) 2.4% 3.0% 4 0% 4.0% 5.0c 5.0% Annual Loss rate 1.9% 2.4% 2.1% 2.6% 2.6% Inflation I 8.4%. 8.0%. 8.0% 8.0% 8.0%1 8.0% Yield on Loan Portfolio 74.2%1 110.0% 95.0% 84.5% 81.0%1 81.8% Interest rate on Liabilities 25 .7% 24.1%1 24.8% 20.7%. 19.91 19.2%1 Source: CrediAmigo 's Business Plan Interest Rate on Liabilities Interest rate on liabilities is projected to fall from 24% to 19% during five years. The projected cost of debt is consistent with CrediAmigo's current level of 15.7%. To calculate the projected market rate, the cost of debt is adjusted to take into account the costs of mobilizing deposits and reserve requirements. Inflation is projected to be constant at 8 percent per year. Financial Projections and Sensitivity Analysis In this section, CrediAmigo's financial projections are presented with its actual performance (Table 6) and standard ratios to assess operational and financial performance. For these projections, some of the initial assumptions of CrediAmigo were modified using MICROFIN to provide more conservative estimations of portfolio growth. Namely, (a) provision for loan losses and (b) average loan size of individual loans. The latter assumption was modified to present an average loan size of US$1,154 at the end of five years. After these changes, CrediAmigo's projected loan portfolio will increase from US$9.6 million to US$151.2 million, of which US$89.3 million correspond to solidarity lending and US$ 46.8 million to individual lending (Table 7). At the projected level of performance, CrediAmigo's adjusted ROA will continue its upward trend, reaching 38 percent at the end of five years, despite reductions in lending rates (Table 8). - 47 - Table 6 Actual and Projected Financial Results BALANCE SHEET ACTUAL_ p PROJCTE 1 (RS ) Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 De_ _4 Current Assets Cash & Banks 0 731 741 879 1,766 3,153 4,075 4,960 Net Loan Portfolio 36 7,577 15,608 38,057 75,907 129,506 176,244 224,772 Gross loan portfolio 40 8,519 17,614 43,636 87,980 150,769 206,307 263,113 less: reserve for loan losses 4 -941 -2,005 -5,579 -12,073 -21,264 -30,063 -38,341 Short-term Investments 0 0 0 9,133 13,816 19,373 Pernanent Assets Net Fixed Assets 648 434 356 277 198 120 4l1 Net Deferred Expenses 494 500 557 445 334 223 111 28 Total Assets 529 9A57 17.340 39.737 78.284 142.214 194.366 249174 Liabilities Banco do Nordeste 553 16,266 24,782 Short-tern Commercial Loans 1,185 1,185 100,128 98,588 74,946 Long-term Commercial Loans 41,577 66,181 0 0 0 Equity Accumulated retained earnings/losses -24 -6,809 -8,183 -3,765 10,177 41,345 95,037 173,487 Accumulated Donated Equitv 741 741 741 741 741 741 Total Liabilities and Equity 529 .9,457 17.340 1397 3717.2824 142.214 194.366 249.1,14 Source: CrediAmigo's Financial Statements and Projections Financial projections were generated using Microfmi model. Note that total assets and total liabilities and equitv are not equal for 6/98-6/99. however the difference is very small. INCOME STATEMENT ACTUAL_____P_____ ROJECTED __ WRS '000s) Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 DecO4 Interest Income 1 3,323 11,357 30,274 57,715 100,872 149,865 197,308 Interest Expenses -3 -1,488 -3,602 -8,047 -13,015 -17,186 -19,856 -17,406 Gross Financial Margin -2 1,835 7,755 22,227 44,700 83,686 130,009 179,902 Provision for Loaui Losses 4 -983 -1,433 4,127 -8,002 -11,747 -13,453 -14,349 Net Financial Margin -6 852 6,321 18,100 36,698 71,940 116,556 165,552 Non-interest Income 0 783 1,147 0 0 0 0 0 Total Operating Costs -17 -8,421 -8,101 -9,498 -10,968 -14,892 -18,554 -22,592 Administrative Expenses -17 -8,239 -7,875 -9,687 -11,158 -15,082 -18,743 -22,754 Salaries and Benefits -17 -5,956 -5,939 -6,932 -8,308 -11,541 -14,763 -18,349 Other Operational Expenses 0 -2,283 -1,936 -2,756 -2,850 -3,541 -3,980 -4,405 Amortization and Depreciation 0 -182 -226 190 190 190 190 162 Net Operating Income (before taxes) -24 -6,786 -632 8,602 25,730 57,048 98,003 142,960 Amount of taxes paid -3,805 -11,408 -25,501 43,930 -64,186 Net income (after taxes) -24 -6,786 -632 4,797 14,322 31,547 54,072 78,774 Total Adjusted Operating Profi t (Loss), -209 -9,273 -5,528 Pf-w t- "I IIIIIa Source: CrediAmigo 's Finantcial Statements and Projections Financial projections were generated using Microfin model. aAdiusted by Subsidies and Iiflation. - 48 - Table 7 Outreach and Productivity Indicators .__ACrUAL PROJECTED Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 MARKET INDICATORS 777M Rate of Consumer Price Inflation (per year): 4.9% 3.2% 4.9% Market Reference Rate (per year): 34.1% 36.5% 34.1%:; Exchange Rate (Reais/US Dollar): 1.81 1.16 1.74:~ . 7 7 7 GDP per capita (US$, Northeast) 1,387.5 2,169.7 1,387.5 t 1, . 3 l8 OUTREACH INDICATORS Clients Solidarity Group Clients 80 21,024 37,683 '~O6 0~k 4~s 6 2I Individual Clients 80 21 0 2 37, J X --- 9 Total Clients 80 21,024 37,683 Loan Portfolio (US$ '000s) Solidarity Loan Portfolio 35 7,067 9,558 .20 88 3S dI 47 .I . 8 Individual Loan Portfolio ~3$~ ~ ~) Total Loan Portfolio 35 7,067 9,558 Z 1 0 r 6 Average Loan Size (USS) Solidarity Group Loans 444 336 254 3 r 3 3 395 Individual Loans66 I Q I19 Average Loan ..~ .47 0 1 PRODUCTIVITY & OPERATIONAL MANAGEMENT RATIOS r Loan Officers 20 243 186 w 2 6 , Personnel Costs /Monthly Avg. Assets -3% -113% -40%- ,. 9 w 5 W9% Personnel Costs/ Monthly Avg. Loan Portfolio -44% -137% -41% 1 " 1 % Administrative Cost (excluding provision for loan losses)/ Monthlv Avg. Loan Portfolio 44% -194% -56% % N 1 10% 10. Active Loan Clients per Loan Officer (end of period) z A58 450 . 45 Solidarity Group Clients 4 78 203 . % . 5 Individual Loan Clients 2 SI 5 61- Outstanding portfolio per loan officer (USS, end of period) Solidarity Loan Portfolio 1,774 26,540 51,388 3 4 3( 4 £ Individual Loan Portfolio .~ 9 04 4916~I5.*2,1 Total Loan Portfolio S 1 4 2 2 Net Income per: Loan Officer (RS) -1,176 -27,926 -3,399 Z3 82~3 2 0,3 .S~7 Client (R$) -294 -323 -17 9 9 . . 3 Iz5 Source: Credinmizo's Business Plan -49 - Table 8 Financial Performance Indicators ACTUAL PROJECTED Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 FINANCIAL MARGIN RATIOS Annual Yield on Portfolio 2% 76% 78% X i N S . Annual Average cost of debt 1% 17% 16% W g . KEY PERFORMANCE RATIOS SDI Index 5367% 239% 26% G 0 -. Return on Assets (after taxes) - 2z% i2% 3 ; Return on Assets (before taxes) -18% -516% -17% Adjusted Return on Assets (before taxes) -158% -706% -147% M X Adjusted Return on Assets (after taxes) _ 1 v 21% 0 23 zz% Assets 0% 64% 78% w 6 ' 9 Profit Margin (before taxes)=Net Income / total operating income -3537% -201% -5% , V . taxes)=Adjusted Net Income /total operating income -3 1481% -275% -47%;.24A 4W 4% S%' Interest Expense I Interest Income 434% 45% 32% 2 % X W A Net Loan Portfolio / Total Assets 7% 80% 90% 7 W '9 ..91% CREDIT RISK RATIOS Portfolio at Risk > 30 days 0.0% 1.3% 2.4% . X Loan Write-off Ratio -: 19 24% 21% -{ 6 26X Source: CrediAmizo 's Business Plan Sensitivity Analysis. A simplified approach incorporate more realistic assumptions is presented in Table 9, which shows the effect of changing loan officer productivity, number of loan officers, the average loan size of individual loans, and the exchange rate. Because solidarity group loans and individual loans account for most of the loan portfolio the simplified projections are limited to these two loan products. As presented in Tables 9, the most conservative scenario, which assumes 650 loan officers with an average productivity of 280 clients and an average individual loan of US$1,154 shows that CrediAmigo will experience substantial growth. On average, its portfolio will grow 62 percent per year, which is consistent with programs such as BancoSol and BRI at similar stages of their development. -50- Table 9 Sensitivity Analysis - 0 ~~~Sensitivity Analysis (end of 5 vears) End o End o Individua Total Clients per No. Loan Jun-98 Jun-99 .o I Loan Loan Officer Officers Group Lending 3.43 8.28 92.95 78.87 67.60 58.50 Individual Lending 00 8 42 42 00 Total FX 1.8 8.28 4 Total FX 1.6 8.28 Ttal 8X228 Assumptions Avg. Group Loan (RS) 233 254 X 380 380 380 375 Avg. Individual Loan 0~ ~ ..Ž. 1.1541 1154 1154 Group Lending 59 153 S 3 4 330 d>2 Productivity Individual Lending Producti vity0 56 Group Loan Clients 14.733 32 594 4 244.845 Individual LQan Clients M 41m553 FX 51 FX16 FX2 Loan Officers2174 71 71 Retention Rate Portfolio at Risk (30 davs) 2____ _29__ ___ Annual Growth Rate (S years) Group Lending Poryfolio ~i Total FX 1.8 142% ~ ~.~ >.A62% 57% 52% 48% Total FXl. 1~~.6 66% 61% 56% 51% Total FX 2.0 . $59% 54% 49% 45% Group Lending Clients 121% 50% 45% 40% 37% Total Lending ~ .. Total FX 1.8 77% 69% 65% 61% Total FX 1.6 __ 81% 73% 69% 64% Total FX 2.0 73% 65%, 62%. 57%, 'As presented in CrediAmigo's business plan. b Changing average loan size for individual loans in Microfin's assumptions. - 51 - Appendix 2.b Institutional Strengthening Action Plan Environmental Management Program Due Diligence Review L Institutional Strengthening Action Plan Goal Current Status Strengthening Need Action 1. Increased market Good client retention but Revised Technical assistance to analyze penetration for existing low penetration in markets promotion/marketing current and potential markeling loan product with dense potential client strategy. tools and messages to identifiy populations. more efficient and effective means to reach potential clients. Training of all project staff to improve marketing message. 2. Sophisticated risk Portfolio quality/risk Introduction of improved Technical assistance to develop and test analysis to better target analysis is rudimentary risk analysis mechanisms risk models. lending and reduce the and loan officer an branch for Teclhical Unit and overall level and perfonnance higlhly branch staff. Training of dedicated risk management variability of arrears variable. unit and branch staff in use of models. performance. 3. Increase loan officer Average new clients per Introduce teclniques and Technical assistance to identify and productivity in terms of loan officer per month of equipment which increase evaluate mechanisms to improve new clients per month 14 not increasing and loan the productivity of loan productivity. and canying capacity of officers canying average of officer time as well as active clients. Reduce 165 active clients. High techniques such as transfer Equipment for loan officers. variability between loan variability in perfonnance of active clients from officers and branches. of loan officers and higher productivity to Training of loan officers in lime branches. lower productivity loan management and use of officers. equipment. 4. Cost-effective Outreach limited Identify and implement Technical assistance to identify, pilot and expansion of geographic municipalities within alternative mechanisms to evaluate alternative outreach coverage of program. proximity of 51 branches. economically service mechanisms such as posts, rnobile clients in municipalities branches, ATMs and non-BN service and zones with lower client windows. density. Training and equipment for implementation of accepted outreach mechanisms. Incremental staff, equipment and training for new loan officers. - 52 - 5. Introduction of new, Single solidarity loan Development, testing of Technical assistance to design, pilot and profitable financial product which constrains new financial products and evaluate new products such as products for current and client growth and may not modification in Central longer-term investment loans, housing new clients. be attractive to many Bank regulations. loans, savings, insurance. potential clients. Existing client base and servicing Technical assistance to work with mechanisms represents Central Bank in evaluation of legal and well-known market for regulatory issues associated with these other financial products products. which could be serviced at low marginal cost. Central Equipment and staff training for Bank restrictions impede servicing of new products. introduction of these products. 6. Effective mnitigation of No environmental Program wlich effectively Technical assistance for design of enviromnental risk in mitigation program in screens client activities and educational materials and training of client microenterprises. place. provides mitigation business management/environmental support to identified, risky mitigation agents. activities. Annual, external evaluations of operation of environmental mitigation program. 7. Increased financial Fully dependent on BN. Institutional fonn and Study of institutional options including and management Central Bank regulations management which legal and technical characteristics and independence from BN. provide few options for facilitates CrediAmigo's constraints. development of ability to operate and be transparent, fonnal evaluated as an Implementation of new, transparent distinctions of CrediAmigo independent entity. structure acceptable to Central Bank. program. Annual, extemal due diligence reviews to assess CrediAmigo as independent financial entity. Publication of audited, operating results. Retention of earnings to build-up own equity. Identification and mobilization of altemative sources of equity and borrowings. 8. Implementation of Limited experience with Capacity to manage Tecluical assistance for project reporting Bank loan with minimal multi-lateral loans through disbursement and and ICB procurement. delays in procurement or IDB financed project. procurement processes disbursements. consistent witlh Bank External financial audits of loan funds. guidelines and procedures and implementation needs of project. - 53 - IL Environmental Management Plan Assessment of Environmental Management Program BN considers environmental concerns to be an integral component of its sustainable development mission in the Northeast Region of Brazil. As such, in addition to strictly applying the relevant Brazilian environmental legislation in reference to financial institutions (Law 6.938/81 and Decree 99.274/90), BN has a number of proactive environmental programs focused on conservation and preservation of natural resources in the Northeast Region. It has also integrated environmental screening and mitigation into its standard lending evaluation, approval and evaluation processes. BN is adapting its environmental management procedures to the specific requirements of the CrediAmigo program through development of a proactive mitigation program which assists those few microenterprises which may have significant environmental impacts (mainly focused in the workplace or neighborhood) to reduce or eliminate these impacts through more efficient productive processes and/or management and storage of inputs and products. The project will finance external technical assistance to work with BNWs Environmental Development Unit and CrediAmigo in the development of communications materials and training programs for CrediAmigo staff and microenterpreneurs, and to carry-out annual external evaluations of the effectiveness of screening mechanisms and promoting adoption of mitigation measures where risks are identified. BN's environmental policy BN's environmental policy states that it will: (i) Assist its clients with compliance with the environmental requirements imposed by the law and markets; (ii) Dissemination and education of its staff and clients regarding environment as an integral factor in the quality and continuity of life; (iii) Support prevention and reduction of negative environmental impacts in productive activities; (iv) Provide economic incentives to businesses which are "eco-efficient" (reduce their effluents) and activities which are ecologically healthy; (v) Encourage the use of Environmental Accounting by BN clients as a means of improving their competitiveness and the differentiation of their products and services in the market. BN's Environmental Focus Project includes: (i) Insertion of the environmental variable in the policies, directives and programs of BN; (ii) Creation of mechanisms and instruments consistent with the implementation and development of BN's environmental policy; (iii) Identify, diffuse and provide incentives for the development of businesses based in sustainable development alternatives (green markets); (iv) Develop and support inter-institutional actions focused on rational resources use and combating the principal negative environmental impacts in the region. Principal Actions to date include: - 54 - (i) Training courses, workshop and seminars for over 700 BN staff; (ii) Development of an environmental communication network including public officials, consultants and private sector businesses; (iii) Application of environmental accounting by the Bank management and branches; (iv) Development of a line of credit to support environmental conservation, including financing of projects for reforestation, organic agriculture, solid waste recycling, altemative energy generation and protected area management; (v) Protocols with national (IBAMA) and state agencies to simplify and speed-up environmental permits; (vi) Participation in programs with IBAMA, UNDP, universities and state agencies to promote reforestation, sustainable agriculture and reduce desertification. BN's Environmental Development Unit The Environmental Development Unit is housed within the Development Policies area of the Bank but works closely with the Superintendent of Operational Procedures. The unit has primary responsibility for development of environmental screening and mitigation procedures which are integrated into BN's credit processes, as well as staff training. The unit is also responsible for evaluating implementation of the procedures at the credit analyst and branch levels. The Environmental Development Unit's permanent staff consists of two full-time professionals and five part-time professionals with post-graduate training in geography, engineering and business administration - all with specialization in environmental impact assessment and mitigation. In addition, the unit draws upon a group of 70 environmental specialists in national and state environmental agencies, consulting firms and NGOs located throughout the Northeast Region. Integration of environmental mitigation into BN's standard credit processes BN has fully integrated environmental screening, development of mitigation plans and impact evaluation into its standard credit processes. An environmental procedures manual describes the procedures which must be carried out by each administrative and operational unit of BN, as well as any external agents, in the process of design, analysis, approval and supervision of each loan. These requirements are reflected in the various applications and forms which document the loan process and are incorporated in BN's computerized loan documentation system (SEAP) which automatically identifies environmental risks and mitigation activities associated with the primary industrial and agricultural activities in the region. BN has also prepared an environmental guide for rural producers which allows producers to self-evaluate their environmental practices as related to water and soil conservation, use of agro-chemicals and energy, waste disposal and relationship with biodiversity conservation. Application of BN's en vironmental policy and mitigation procedures to tIhe CrediAmigo Program Consistent with BN's mission of sustainable development, the environmental unit has defined an environmental screening and mitigation program consistent with the client profile and credit technology of CrediAmigo. The program consists of: (i) A specific policy statement for environmental mitigation in CrediAmigo; (ii) A flow diagram indicating how environmental screening and mitigation will be integrated into the microfinance loan identification, preparation, approval, supervision and renewal processes; (iii) Preparation of pamphlets based on market tests with microenterprises which effectively communicate environmental risks, reasons to take mitigating actions and how to obtain assistance; - 55 - (iv) training of environmental/business education agents in branches to provide assistance to identified high-risk micro-enterprises to define and carry-out improved environmental business management plans; (v) annual, published descriptions and evaluations of effectiveness of mitigation program in terms of screening, follow-up and implementation of mitigation plans. The environmental screening and mitigation process will be integrated into the standard CrediAmigo loan process according to the flow diagram which also identifies institutional responsibilities: Project Support of the Environmental Management Program BN's Environmental Development Unit and CrediAmigo staff are working with the World Bank and PHRD financed consultants in the final design of the informational pamphlets and development of the training course for environmental agents. The loan will finance the training of environmental/business education agents and contracting of external consultants for annual evaluations of the environmental management program based on Terms of Reference and selection criteria approved by the World Bank. The annual evaluations will assess: (i) the effectiveness of the screening process in identifying potentially risky activities; (ii) consistency of follow-up where risks are identified; (iii) the quality of environmental orientation/training provided to microentrepreneurs; (iv) the effective implementation and maintenance of mitigation measures; and (v) enforcement of restrictions on new loans to microenterprises which do not carry-out mitigation activities. In addition, CrediAmigo will evaluate any positive or negative impacts of the environmental management program on loan officer and branch productivity and client retention. Based on its review of BN's existing activities, the appraisal mission was confident of BN's ability to develop these activities successfully by December 1, 1999. Approval of the overall program as part of the final project implementation manual is a condition of effectiveness of the loan. - 56 - CREDIAMIGO POLITICA AMBIENITAL 0 CREDIAMIGO reconhece a gestao ambiental como uma das prioridades do Programa e como um fator-chave para o desenvolvimento sustentavel das atividades produtivas. Dessa maneira, estabelece principios e praticas que fundamentam sua Politica Amiibienltal para a realizac,o de neg6cios e apoio aos clientes, comprometendo-se a: 1. Conduzir suas operaq6es de acordo com as leis ambientais e regulamentac,es aplicaveis, cuidando para que as atividades apoiadas sejam desenvolvidas de maneira ambientalmente responsavel; 2. Apoiar somente atividades geradoras de produtos e servicos seguros, tanto em rela,co aos envolvidos nas atividades comno em rela,ao aos consumidores e sociedade em geral; 3; Elaborar e aplicar manual de procedimentos indicando as ac,es e os responsaveis pela implementa,cao e condu,co do Programa Ambiental do CREDIAMIGO; 4. Elaborar cartilha educacional contendo os impactos ambientais negativos potenciais e as medidas preventivas, mitigadoras e corretivas que devem ser adotadas pelos clientes, em suas atividades, para combater esses impactos; 5. Capacitar gerentes, funcionarios e subcontratados para implementa,cao e condu,co do Progranma Ambiental; 6. Orientar os clientes no que se refere ao uso racional e protecao dos recursos naturais; combate ao desperdicio de materias-primas, agua, energia e demais insumos; reduc,o, reutiliza,ao, reciclagem e disposi,co adequada de residuos; e ado,co de medidas de seguran,a no desenvolvimento de suas atividades; 7. Adotar medidas para melhoria continua dos procedimentos do Programa Ambiental; 8. Monitorar o progresso e publicar anualmente relat6rio de desempenho do Programa Ambiental. Esta Politica e aceita pelos gerentes, funcionarios e subcontratados do CREDIAMIGO, que assumem a responsabilidade por sua implementa,ao diaria. Maria Rita da Silva Valente Coordenadora do CREDIAMIGO - 57 - III. Due Diligence Description of Annual Due Diligence Reviews of CrediAmigo CGAP is preparing specialized guidelines for due diligence for microfinance institutions which are expected to provide the basis for the due diligence reviews. As the guidelines are not expected to be ready until July 2000, a general description of due diligence issues and procedures is provided based on the CGAP Handbooklfor External Audits ofMicrofinance Institutions. Objective: The due diligence is intended to provide a complete review of CrediAmigo's performance and operations consistent with the requirements of potential private sector investors and lenders. Since its inception, BN's senior management has expressed interest in the program developing its institutional independence so as to have direct access to equity and the capital markets based on its financial performance. The due diligence review is intended to provide BN and CrediAmigo management, potential investors and lenders, and supervisory and regulatory authorities, with a clear evaluation of the quality of CreidAmigo's portfolio, operational systems and financial results, and identify and risk factors to be addressed by management. Skills Required: Substantial knowledge of microfinance institutions, banks, management information systems, accounting and auditing, bank supervision, Brazilian regulations, Portuguese (ideal) or Spanish. Background: CrediAmigo is a microfinance program within BN, headquartered in Fortaleza, Ceara, Brazil. CrediAmigo began its operations in November 1997 with five pilot branches. In April 1998, CrediAmigo expanded to its present total of 51 branches. In order to better track its performance, an independent set of accounts has been established by CrediAmigo which are used to generate quarterly aLnd annual financial statements. CrediAmigo has a technical unit responsible for technical support and oversight of the program, including policy development, MIS support, financial management, training, monitoring, operational support, strategic planning, product development and program-wide reporting. The auditors will coordinate their activities with the General Manager of the CrediAmigo Technical Unit, XXXXXX, who will facilitate their access to staff and information as needed. Objective: The objective of the extemal due diligence of CrediAmigo is to: * Enable the auditor to express a professional opinion on the financial position of CrediAmigo at the end of the two semesters prior to the review and on the funds received and expenditures for that twelve month period; * Obtain an extemal review of CrediAmigo's loan portfolio systems; - 58 - Obtain an external review of CrediAmigo's management information system; Obtain a review of CrediAmigo's internal controls. Scope of the external due diligence: * The external audit will be carried out in accordance with International Standards on Auditing (ISAs) and will include such tests and controls as the auditor considers necessary under the circumstances. The auditor should pay special attention to key account balances, particularly the loan portfolio and loan loss provisions, cash and equivalents, and fund balances. Given CrediAmigo's large number of loans, the auditor is encouraged to use statistical smpling methods to ensure that a representative sample is tested. * As part of the audit process, the auditor should visit a representative number of branches each year. It is expected that the auditor will have visited all branches in a two-year period. * For the purposes of testing, the auditor is required to visit a representative number of clients. Use of CGAP handbook: The auditor must become familiar with both volumes and annexes of the Estemal Audits of Financial Institutions: A Handbook, produced by CGAP which cover key issues relevant to audits of microfinance institutions. The auditor will be required, before executing the engagement agreement, to specify in writing any major elements of the handbook's guidance that the auditor does not believe should be implemented. Financial Statements and othler information: CrediAmigo prepares its financial statements according to Brazilian accounting standards. CrediAmigo will provide the suditor with the following financial statements: Income statement Balance sheet Cash-flow statement The auditor will be given access to all leval documents, correspondece and any other information associated with CrediAmigo and deemed necessary by the auditor. Prior year audits: CrediAmigo has not been audited in previous years. Thus it is crucial that the external auditor closely examine all of the opening balances for this fiscal year. Audit Opinion: The extemal auditor is required to provide an opinion on the financial statements of CrediAmigo in accordance with ISAs. Management Letter: In addition to the audit report and opinion, the auditor will be required to prepare a management letter. In the management letter the auditor should: Comment on the accounting records, systems, and controls that were examined during the auidt, including but not limited to systems for handling and recording cash; adherence to policies and procedures in the loan approval and disbursement process; segregation of duties in loan and cash areas; procedures for 59 - loan loss provisions; proper recording and cut-off of payables and accruals; and so on. * Comment on other specific systems and processes, such as the administration system and management information system, particularly at the branch level. * Recommend improvements where specific weaknesses are identified in any of the above systems and controls. * Communicate any other matters identified during the audit what might significantly affect the future implementation of CrediAmigo's function, or that that auditor considers pertinent. * Comment specifically on the appropriateness, and consistency of application, of policies for loan loss provisioning, loan write-offs, allocation of indirect costs between financial and nonfinancial services, and where applicable, cessation and reversal of accrued but unpaid interest on nonperforming loans. Agreed-upon procedures: In addition to the financial statement audit, the extemal auditor is required to perfornn the following agreed-upon procedures according to annexed terms of reference and submit a special report: Test the loan portfolio delinquency report with respect to real status and amounts of overdue loans, and- the degree to which stated loan balances reflect actual cash paydown. Determine the extent of compliance with loan policy and procedures with respect to key credit risk factors. * Prepare an appraisal report of CrediAmigo according to the CGAP Format for Appraisal of Microfmance Institutions plus calculation of CrediAmigo's Subsidy Dependence Index for each quarter during the previous year according to "Assessing Development Finance Institutions: A Public Interest Analysis" World Bank Discussion Paper no. 174. Timing of the audit: The audit report and opinion, management letter and the report on agreed upon procedures should be received by BN/CrediAmigo no later than two months after initiation of the due diligence activities. The auditor should submit the report to CrediAmigo's General Manager and to directly to the World Bank. - 60 - Appendix 2.c CrediAmigo Economic and Social Impact Evaluation Design Summary BN will implement an impact evaluation of CrediAmigo to assess its effectiveness in promoting development of the microenterprise sector, raising household incomes, and thus reducing poverty. The evaluation, which will be implemented in the third year of the loan, is expected to contribute to the Brazilian Government's understanding of the socio-economic benefits of investing in improved access to financial services for low-income households. The design of the impact evaluation will be the responsibility of the Economic Studies Unit (ETENE) of BN, working with technical assistance financed by the loan. ETENE will also be responsible for contracting and managing technical assistance for implementation of data collection, analysis and interpretation. Although the detailed design of the impact evaluation is expected to be carried out during the first year of the loan, the appraisal mission reviewed with ETENE the broad parameters of the study -in order to assess institutional capacity, technical assistance requirements and expected costs. ETENE ETENE's legally mandated mission is to promote and disseminate research findings financed by BN and its partners with the objective of generating sustainable economic development in the Northeast Region. ETENE's activities in support of this mission include: development of economic databases for the Northeast, economic analysis of the Northeast Region, and design and analysis of surveys. ETENE operates with a staff of 22 employees, the majority of whom have post-graduate degrees, including four Ph.Ds. ETENE has been involved in numerous research projects, such as a market research and evaluation studies for CrediAmigo, construction and update of an input-output matrix of the Northeast region, evaluation of support strategies to increase competitiveness of agro-industries, among other studies. ETENE leverages its resources through partnership arrangements with Brazilian and intemational universities and intemational organizations, including Universidade Federal do Ceara, Massachussets Institute of Technology, University of Chicago, lCA, and PNUD. Issues to be Addressed in Microfinance Impact Evaluation There is substantial controversy regarding whether it is possible to estimate the impact of microfinance prograns on client businesses and households. The fungability of funds and the complexity of household survival strategies, particularly amongst the poor, are among the factors which make the positive or detrimental impacts of access to credit difficult to isolate. - 61 - Objective The overall objective of the impact evaluation is to assess the costs and benefits of CrediAmigo as an instrument for poverty reduction. Within this overall objective, study design will consider measurement of various potential benefits such as increasing household income, increasing overall and individual factor productivity, reducing income fluctuations. To assess costs, it is important to include not only CrediAmigo' s costs, but also borrowers' transaction costs, such as travel costs and time spent soliciting and repaying loans. The welfare effects of application of increased or more stable cash flow and/or income within the household and any distinctions resulting from client gender will also be examined. Unit of Analysis. Because microenterprise and household decisions are intertwined, the proposed unit of analysis is the household. Most microenterprises are a means of survival, and are important elements of household diversification strategies. Also, using the household as unit of analysis is consisted with CrediAmigo's lending technology, which relies on evaluating cash flows not only of the microenterprise, but also of the overall household. Geographical Coverage. The impact evaluation will cover the areas of operation of the CrediAmigo program throughout the Northeast Region. Data Collection ETENE has proposed two approaches for data collection. The first approach, which will be implemented in the first year of the loan, will follow the evolution of CrediAmigo' clients from program entry through the various loan cycles based on the changes observed and recorded by loan officers in CrediAmigo's MIS system and borrowers' dossiers. The sampling design will consider generating a random control group to calculate the impact of the program using quasi-experimental strategies. This sampling scheme and the data collection will be implemented in coordination with CrediAmigo. While the data will not control for self-selection of participating in the program, and thus will not provide the basis for isolating the contribution of the program or the impact on general household welfare, it does provide an inexpensive source of data for analysis of client behavior according to different socio-economic criteria. The second approach to data collection will rely on household surveys, creating a control group of non-participants. ETENE will work with contacted specialists to evaluate sample design options such as a panel versus cross-sectional, and design of the survey instrument. Depending on the sampling strategy selected relative to ETENE's in-house database, ETENE or a contracted service provider will provide lhe sample-frame for the survey. Training of the survey team and field implementation will be contracted out with ETENE oversight and data provided in an agreed format. Methods of Data Analysis The proposed impact evaluation will use a combination of quantitative and qualitative methods to provide a range of the cost and benefits of CrediAmigo. Econometric models have been used extensively to analyze data gathered using quasi- and non-experimental methods. The literature on impact of credit uses a variety of econometric models to control for sample selection issues, and providing an answer to the question wvhat would have been the behavior of this microenterprise/household in the absence of credit? Depending on the - 62 - sampling design and the nature of the data (cross-section versus panel), switching regression models, limited dependent variable models, and quartile regressions could be used for this purpose. ETENE will work with contracted specialists in the design of analytical models and evaluation of quantitative and qualitative data. Estimated Cost of the Study Based on its experience with household surveys, ETENE estimates that the contracted technical assistance services for the proposed impact study would cost approximately US$250,000. - 63 - Annex 3: Estimated Project Costs BRAZIL: Northeast Microfinance Development Project 1. Expanded Financing of Microenterprises 85.50 0.00 85.50 2. Strengthened Capacity to Support Sustainable Growth 10.50 0.70 11.20 3. Impact Evaluation 0.20 0.10 0.30 4. Fee 0.00 0.50 0.50 Total Baseline Cost 96.20 1.30 97.50 Physical Contingencies 0.00 0.00 0.00 Price Contingencies 2.40 0.10 2.50 Total Project Costs 98.60 1.40 100.00 Total Financing Required 98.60 1.40 100.00 Goods 0.70 0.20 0.90 Microfinance Subloans 85.50 0.00 85.50 Technical Assistance 0.80 0.80 1.60 Training 0.20 0.10 0.30 Incremental Recurrent Costs 11.20 0.00 11.20 Fee 0.00 0.50 0.50 Total Project Costs 98.40 1.60 100.00 Total Financing Required 98.40 1.60 100.00 -64 - Annex 4: Cost Effectiveness Analysis Summary BRAZIL: Northeast Microfinance Development Project Indicators of Cost-Effectiveness: The project includes several indicators of cost-effectiveness of provision of microfinance services through CrediAmigo consistent with monitoring progress in achieving its sustainability objective. The primary indicator is the subsidy dependence index (SDI) which calculates the required increase in the nominal interest rate which the CrediAmigo program would have to charge in order to achieve break-even after adjusting for inflation and implicit and explicit subsidies. The SDI permits: (i) monitoring of the progress made by an institution in reducing its dependence on subsidies; (ii) comparison of performance with other microfinance institutions which provide *similar services; (iii) comparison of the cost of the program with other poverty reduction measures by providing a basis for estimating the "cost" of the program to society, or amount of subsidy transfer, by simply multiplying the SDI by the amount of funds disbursed. The lower the SDI, the lower the required interest rate subsidy. A negative SDI indicates that the program is profitable in real terms even if all subsidies were eliminated. The CrediAmigo business plan indicates that the current SDI of 10% will become negative by December 2000. Experience in other countries in Latin America suggests that increasing costs of reaching clients in less dense areas will increase costs considerably, and/or competition from other micro-lenders will force the program to reduce its real rate of interest. Nonetheless, the program is expected to maintain an SDI of at least -10% after the second year of the project. In the event that, due to a sharp decline in the CDI and/or lack of competitive pressure to reduce onlending rates to microenterprises, the SDI falls below -20%, CrediAmigo and the Bank will review the pricing policy for CrediAmigo lending products. Operational efficiency will also be monitored through calculation of the ratio of Operating Costs to Average Earning Assets. This ratio is currently at 56% and is likely to remain relatively high given CrediAmigo's aggressive expansion plans. However, consistent with other large microfinance programs operated by banks in Latin America, this ratio is expected to decline to less than 24% by the end of the project. Financial Impact on Participants Sub-borrowers: The project would provide credit assistance to microenterprises in supporting their working capital and investments, contributing to strengthen their operations and/or incomes. Market studies of microenterprises in the Northeast suggest that less than five percent of microentrepreneurs have access to bank credit. Loans from informal money lenders (ajiotas) or suppliers, while often convenient in terms of access or flexibility of terms, typically charge real effective interest rates of over ten percent per month, or over 200 percent per year. Microenterprises which do not access credit often incur high costs associated with time away from their business for daily or weekly purchases of inputs and merchandise. The main financial impact of the project results from the support of about US$400 million (estimated cumulative micro-loan disbursements during the project period) of investment under the Expanded Financing of Microenterprises Component of the project. Loan terms under CrediAmigo would normally be short-term, ranging between 3-6 months. Microenterprises are likely to use part of the loans to finance new investments and to expand their operations. Prior to loan approval, CrediAmigo evaluates all loans to microenterprises to determine their repayment capacity, pricing loans at market-based interest rates. Solidarity group loans are priced at 4% - 65 - per month on the original loan amount, leading to a portfolio yield of 74.2% per year. Consequently, only microenterprises with solid ex-ante repayment capacity will be financed. For example, in the CrediAmigo branch in Caixas, which ranks fourth and sixth in terms of outstanding loan portfolio and active clients, respectively, the average return on assets of active clients was 34% per month, and the median was 15% per month.. CrediAmigo's high repayment and renewal rates verify the ability of microenterprises to earn sufficiently high retums to pay market-based interest rates. Banco do Nordeste (BN: The project is expected to contribute to BN's profitability to the extent that CrediAmigo's profits are recorded as BN profits or as returns on contributed equity in the event of CrediAmigo's partial or complete spin-off. In terms of its role as the pass-through mechanism of Bankc loan funds to CrediAmigo, the project is expected to have a neutral or positive effect on BN's profitability, although this will depend on actual exchange rate movements of the reals. BN is expected to charge a transfer interest rate to CrediAmigo that takes into account the foreign exchange risk and would explore different alternatives to hedge itself from currency devaluation. BN will charge CrediAmigo branches an on-lending rate equal to or above the inter-bank CDI rate which has averaged 13 percent per year above the real Bank US$ lending rate from 1996 to 1998. As the CDI rate is market determined, it is expected that the spread will incorporate market expectations regarding foreign exchange risk consistent with past behavior. (Table 1) Table 1: Actual and Projected Annual Interest Rate Differential 1996 1997 19981 2000 2001 2002 2003 2004 a Rate from BNB to CrediAmnigo (Interbank-CDI 26% 24% 28% 25.00% 22.00% 20.00% 18.00% 18.00% b Brazil inflation rate 16% 7% 3% 8.00% 8.00% 8.00% 8.00% 8.00% c Real CDI interest rate: (a-b)/(1+b) 8.62% 15.89% 24.27% 15.74% 12.96% 11.11% 9.26% 9.26% d Bank Rate (JS$ variable) 5.87% 6.04% 5.70% 6.00% 6.00% 6.00% 6.00%/o 6.00% e. US inflation rate 2.93% 2.34% 1.55% 3.00% 3.00% 3.00% 3.00%/0 3.00% f. Real Bank Rate (US$ variable): (d-e)/(l+e) 2.86% 3.62% 4.09% 2.91% 2.91% 2.91% 2.91%/ 2.91% g Interest Rate Differential: (c-f) 5.76% 12.27% 20.19% 12.83% 10.05% 8.20% 6.35% 6.35% Source: CrediArniigo's Butsiness Plan and International Financial Statistics CrediAmigo: The project would contribute towards the profitability of CrediAmigo. Based on CrediAmigo's business plan, the contribution to profitability is estimated to total R$183.5 million (US$121 million) over five years with an annual contribution to profits of over R$75 million (US$43 million) at full development. After tax return on assets (ROA) is forecast at 27% at the end of the five year project period. Fiscal Impact The project is expected to have a positive impact on Goveniment finances. Fiscal impact will be determined by: (i) Government counterpart funding requirements; (ii) Govemment guarantee; (iii) taxes on net income of BN/CrediAmigo; (iv) taxes on the incremental net income of microenterprise clients. Counterpart Funding: The loan will be made to BN, a self-financing Government owned entity, with a Govemment guarantee. All counterpart funding will be the responsibility of BN, based on its commerciial funding, rather than Govemment. - 66 - Guarantee Fee: Govemment has chosen to wave guarantee fees from BN in return for the project's financing of several activities expected to produce significant benefits to Government in its efforts to establish an appropriate framework for development of the microfinance industry in Brazil. Specifically, the socio-economic impact evaluation is expected to provide Govemment with indications of the cost-effectiveness of microfinance services as a poverty reduction instrument. Legal and regulatory studies are expected to benefit all actual and potential providers of microfinance services in Brazil. Development of an environmental screening and mitigation program appropriate to microenterprises will be shared with other institutions, permitting extension of Brazil's Protocol Verde to this segment of the economy. Taxes on Net Income of CrediAmigo: The most important fiscal impact from the project is expected to be the taxes received by Government on the incremental net income generated by the CrediAmigo program. Based on the CrediAmigo business plan, taxable net income is estimated to generate R$148.5 million (US$ 85.3 million) in tax revenues to Government over the five years of the project (Table 2). Taxes on Net Income of Microenterprises: Since most of CrediAmigo's clients are informal microenterprises, they may not contribute to increase tax revenues initially. Nonetheless, it is expected that a proportion of CrediAmigo's clients would expand their operations and become "formal" microenterprises that are registered with tax authorities. The resulting tax revenues were not estimated, but suggest that the results of the calculations in table are a lower-bound estimate of fiscal financial benefit. Table 2: Estimated Cash Flow to Government Projected ($ '000) _ l CY2000 CY2001 CY2002 CY2003 CY2004 1. Taxes on CrediAmigo Net Income 4,797 11,408 25,501 43,930 64,186 2. Taxes on incremental NA NA NA NA NA microenterprise profits I Total 4,797 11,408 25,501 43,930 64,186 Summary of benefits and costs: NA Main Assumptions: NA Cost-effectiveness indicators: NA - 67 - Annex 5: Financial Summary BRAZIL: Northeast Microfinance Development Project Financial Summary for Bank of the Northeast (Banco do Nordeste) Balance sheet, income statement and financial ratios based on BN's Audited, Non-Consolidated Published Financial Statements without adjustment for inflation. (Consistent with Intemational Accounting Standard IAS 29 which states that restatement of financial statements is necessary when "the cummulative inflation rate over three years is approaching or exceeds, 100%".) - 68 - BALANCE SHEET - RS thousands Disclosure Disdosure Disdosure Disdosure Disclosuwe Disclosure Interbank Placmenb 361,999 4.7 312,326 4.2 444,804 6.4 366,799 6.9 430,891 9.8 212,532 6.3 Securites (Net of Compulsry Reserves) 565,318 7.3 270,998 37 533,477 7.6 201,934 3.8 97,614 2.2 72,269 2.1 Compulsory Reserves 123,327 1.6 268,885 3.6 242,793 3.5 88,913 1.7 176,644 4.0 73,691 2.2 InterbankTransactions 127,145 1.6 178,904 2.4 167,624 2.4 264,565 5.0 221,582 5.1 213,062 6.3 CreditOperations (Netof Provisions) 1,625,194 20.9 1,939,716 26.3 1,581,221 22.6 1,523,320 28.7 1,137,688 26.0 964,145 28.5 Foreign Exchange Portfolio 57,795 0.7 42,553 0.6 U,990 0.6 75,008 1.4 100,055 2.3 93,570 2.8 Provisions 83,299 1.1 70.492 1.0 48,133 0.7 118,317 2.2 75,422 1.7 23,104 0.7 OtherCurentAuets 36,251 0.5 38,570 0.5 20,570 0.3 26,283 0.5 24,536 0.6 15,103 0.4 Total CurrentAssts 2,897,029 37.3 3,052,452 41.3 3,035,479 43.5 2,546,822 48.0 2,189,010 50.0 1,644,372 48.6 Interbank Placements 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 Securites(NotofCompulsoyReserves) 260,201 3.4 346,304 4.7 127,009 1.8 195,252 3.7 5,618 0.1 0 0. Compulsr,y Reserves 18,609 0.2 17,055 0.2 16,202 0.2 0 0.0 0 0.0 0 0.0 InterbankTransactions 4,399 0.1 3,355 0.0 6,851 0.1 5,748 0.1 2,907 0.1 5,934 0.2 CreditOperatlons (Net of Provisions) 4,371,755 56.3 3,743,153 50.7 3,559,619 51.0 2,293,863 43.3 1,937,399 44.2 1,515,954 44.8 Foreign Exchange PortfolIo 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 Provisions 1,042,183 13.4 737,127 10.0 716,091 10.3 455,342 8.6 285,122 6.5 100,118 3.0 Other Long Term Assets 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 Total Long Term Assets 4,654,964 60.0 4,109,867 55.7 3,709,681 53.1 2,494,863 47.0 1,945,924 44.4 1,521,888 45.0 PermanentAssets 206,400 2.7 222,477 3.0 238,778 34 261,472 4.9 245,446 5.6 218,277 6.4 Investments 2,044 0.0 1,752 0.0 1,682 0.0 1,284 0.0 792 0.0 796 0.0 PremisesandEquipment 160,799 2.1 166,227 2.3 171,806 2.5 175,772 3.3 177,842 4.1 181,503 5.4 Deferred Charges 43,557 0.6 54,498 0.7 65,290 0.9 84,416 1.6 66,812 1.5 35,978 1.1 TOTAL ASSETS 7,758,393 100.0 7,384,796 100.0 6,983,938 100.0 5,303,157 100.0 4,380,380 100.0 3,384,537 100.0 Deposds 804,450 10.4 661,822 9.0 1,207,533 17.3 1,167,836 22.0 959,334 21.9 810,676 24 MoneyMarketRepwrchaseCommitments] 27,303 0.4 10,207 0.1 27,619 0.4 41,398 0.8 175,227 4.0 105,488 3.1 InterbankTransactions 14,564 0.2 61,521 0.8 18,703 0.3 11,573 0.2 31,113 0.7 16,249 0.5 ShortTerm Borrowings 145,703 1.9 179,121 2.4 101,813 1.5 123,261 2.3 184,625 4.2 212,938 6.3 Onlendfng - Foreign and Domestic 705,494 9.1 363,025 4.9 327,433 4.7 277,435 5.2 232,395 5.3 176,201 5.2 Other Current Liabities 205,437 2.6 263,632 3.6 450,583 6.5 211,128 4.0 389,146 8.9 238,681 7.1 Total CurrentUabilMtes 1,902,951 24.5 1,539,328 20.8 2,133,684 30.6 1,832,631 34.6 1,971,840 45.0 1,560,233 46.1 Deposits 235,003 3.0 349,992 4.7 15,785 0.2 1,709 0.0 181,706 4.1 0 0.0 InterbankTransactions 0 00 0 0.0 5,439 0.1 15,071 0.3 23,387 0.5 32,579 1.0 LongTermBorrovings 118,449 1.5 68,269 0.9 90,390 1.3 56,496 1.1 48,128 1.1 34,139 1.0 Onlending-ForeignandDomestic 4,031,298 52.0 1,979,522 26.8 1,694,176 24.3 1,154,506 21.8 884,692 20.2 856,821 25.3 Other Long Term Liabilties 514,396 6.6 2,533,738 34.3 2,157,419 30.9 1,504,989 28.4 813,800 18.6 484,048 14.3 Total Long Termn Usbiltes 4,899,146 63.1 4,931,521 66.8 3,963,209 56.7 2,732,771 51.5 1,951,713 44.6 1,407,587 41.6 Deferred Income 562 0.0 661 0.0 792 0.0 2,461 0.0 2,749 0.1 2,580 01 Minoty Interest 0 0.0 0 0.0 0 0.0 0 0.0 0 0o0 0 0.0 Capital 831,000 10.7 831,000 11.3 772,000 11.1 624,000 11.8 366,000 8.4 347,383 10.3 Reserves 68,646 0.9 82,286 1.1 114,253 1.6 111,294 2.1 88,078 2.0 66,754 2.0 Retained Earnings 56,088 0 7 0 0.0 0 0.0 0 0.0 0 0.0 . 0 0.0 Net Worth 955,734 12.3 913,286 12.4 886,253 12.7 735,294 13.9 454,078 10.4 414,137 12.2 TOTAL LIABIUTIES 7,758,393 100.0 7,384,796 100.0 6,983,938 100.0 5,303,157 100.0 4,380,380 100.0 3,384,537 100.0 - 69 - Intermediation Revenue 2,317,963 100.0 1,451,798 100.0 1,113,514 100.0 825,118 100.0 778,879 100.0 805,945 100.0 Intermediation Expenses -1,749,211 -75.5 -1,182,508 -81.5 -805,006 -72.3 -558,375 -67.7 -591,490 -75.9 -606,454 -75.2 Provision Expenses -473,971 -20.4 -170,712 -11.8 -283,535 -25.5 -252,935 -30.7 -243,238 -31.2 -74,666 -9.3 Gross Profit from Intermediation 94,781 4.1 98,578 6.8 24,973 2.2 13,808 1.7 -55,849 -7.2 124,825 15.5 Total Non-interest Income & Expenses -27,721 -1.2 -45,677 -3.1 85,395 7.7 86,782 10.5 133,747 17.2 -96,255 -11.9 Service Fees 143,221 6.2 70,538 4.9 143,580 12.9 123,537 15.0 129,533 16.6 77,949 9.7 Earnings from Affiliates 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 -2,566 -0.3 Administrative and Personnel Expenses -483,332 -20.9 -236,534 -16.3 -464,350 -41.7 -412,930 -50.0 -406,403 -52.2 -374,968 -46.5 OtherOperating Incomeand Expenses 312,390 13.5 120,319 8.3 406,165 36.5 376,175 45.6 410,617 52.7 203,330 25.2 Operating tncome 67,060 2.9 52,901 3.6 110,368 9.9 100,590 12.2 77,898 10.0 28,570 3.5 Non-Operafing Income 2554 0.1 294 0.0 -2,139 -0.2 310 0.0 -540 -0. 1 -1,431 -0.2 Translaton Gains & Losses 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 Income before Taxes 69,614 3.0 53,195 3.7 108,229 9.7 100,900 12.2 77,358 9.9 27,139 3.4 Income Taxes and Social Contributions 5,761 0.2 -24,854 -1.7 -34,034 -3.1 -33,703 -4.1 -34,912 -4.5 -5,622 -0.7 Statutory Profit Sharing Distribution 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 -431 -0.1 Minority Interest 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0 NET INCOME (LOSS) 75,375 3.3 28,341 2.0 74,195 6.7 67,197 8.1 42,446 5.4 21,086 2.6 (+)Depreciabon 35,333 1.5 17,811 1.2 35,197 3.2 29,377 3.6 20,631 2.6 10,731 1.3 (-) Dividends 11,650 0.5 7,065 0.5 18,236 1.6 16,595 2.0 5,904 0.8 9,600 1.2 (=) CASH GENERATION 99,058 4.3 39,087 2.7 91,156 8.2 79,979 9.7 57,173 7.3 22,217 2.8 Dec/I 999 Dec./1998 Dec./1997 Dec./1996 Dec./1995 L%AnnualInflaion 8.40 1.65 5.22 9.56 22.41 FX-rateR$IUS$l 1.7695 1.2087 1. 1164 1.0394 0.9725 Source: IPCA - 70 - Financial Projections BALANCE SHEET - RS thousands Actual Projected Projected Projected Projected Current Assets 2,897,029 3,872,000 4,259,200 4,685,120 5,153,632 Long Term Assets 4,654,964 5,502,986 6,018,324 6,594,983 7,240,243 Permanent Assets 206,400 253,000 278,300 306,130 336,743 TOTALASSETS 7,758,393 9,627,986 10,555,824 11,586,233 12,730,618 Current Liabilities 1,902,951 2,029,500 2,232,450 2,455,695 2,701,265 Long Term Liabilties 4,899146 6,610,230 7,271,253 7,998,376 8,798,216 Future Income 562 770 847 932 1,025 Net Worth 955,734 987,486 1,051,274 1,131,228 1,230,112 TOTAL LIABILITIES 7,758,393 9,627,986 10,555,824 11,686,233 12,730,618 Gross Operating Revenue (') 3,600,445 3,015,095 3,463,933 3,980,021 4,588,201 Taxes on Gross Operating Revenue (45,696) (57,055) (65,428) (75,246) (86,739) NET OPERATING INCOME 3,554,749 2,958,040 3,398,505 3,904,775 4,501,462 Intermediation Expenses (2,576,082) (1,948,631) (2,336,857) (2,802,578) (3,361,279) FINANCIAL MARGIN 978,667 1,009,409 1,061,648 1,102,197 1,140,183 AdninistrativeExpenses (161,943) (137,791) (136,726) (138,187) (139,664) Personnel Expenses (275,693) (243,662) (239,453) (233,485) (225,306) Other 2,554 Amnorization of Deferred Expenses (21,684) (21,684) (21,684) (21,684) Provisicins for Doubtful Loans (473,971) (537,600) (589,824) (630,374) (663,552) NET OPERATING MARGIN 69,614 68,672 73,961 78,487 89,977 Non Operating Income/Expenses - - - Income before Taxes and Contributions 69,614 68,672 73,961 78,467 89,977 Income Taxes and Contributions 5,761 (8,455) (8,239) (9,909) (13,232) NET INCOME 75,375 60,217 65,722 68,558 76,745 () RECONCILIATION WITH HISTORICAL DATA FROM PREVIOUS WORKSHEET FNE Incoma 1,139,261 FNE Expenses (826,871) Net Other Operating Income/Expenses on 312,390 Intermeciation Revenue 2,317,963 Service Fees 143,221 Revenue from FNE 1,139,261 Gross Operating Revenue shown above 3,600,445 - 71 - Premises BNB used in preparing projections The projectons submilted by the bank are based on the following premises: a) Assets will grow at an average rate of 10°b. b) Gains from the securites portfolio will generate 16% of intermediabon revenue. c) Personnel expenses: there will be no salary increases. Retirements are included. d) Other administrative expenses will increase at a rate of 2% for the years 2000 and 2001 and 1% for the years 2002 and 2003. e) Brazil's GOP will grow at an annual rale of 4°%. f) The Northeast region's GDP wilt grow at an annual rate of 4.49%. g) The interest rate on Interbank CDs (CDI) will be 16% in 2000; 14% in 2001, 13% in 2002; and 11.5% in 2003. h) TheLong Term Interest Rate (TJLP) will be 12% in 2000; 11% in 2001; 10% in 2002; and8.5% in 2003. i) The US dollar exchange rate will fluctuate 8% in 2000 and 2001, 6% in 2002 and 4% in 2003. D Resources from FNE will average R$447 million per year, based on Brazil's GDP. k) FNE's equity is accounted for offbalance sheet. The only FNE values that are included in BNB's liabilities are the funds that are about to be disbursed to borrowers. NOTE: In April 2000, BNB submitted revised projections for revenues and expenses. The projected balance sheet and the premises were left unchanged from whal was submitted in August, 1999. - 72 - BANCODO NORDESTE DOB RASIL - COMPARATIVE RATIOS BNB Projected Historical Performance Performance Loan Assets / Deposits (Net of Interbank Ptacements) 337.5% 317.8% 381.8% 486.4% 704.6% NA NA NA NA Cunent Aets / Current Liabilities 105.4% 111.0% 139.0% 142.3% 152.2% 190,8% 190,8% 190,8% 190,8% Lor Ten Assets / Long Term Provisions- (Past Due+Non-Performing Loans)) I Loan Assets -4,8% -7.0% -1.7% -3.9% -3.8% NA NA NA NA rovisions / (Past Due + Non- erforming Loans) 48.8% 59,4% 88.3% 76,8% 80.3% NA NA NA NA Past Due + Non-Performing Loans) I Net Worth + Provisions) 47.0% 74,5% 49,6% 60,3% 67.3% NA NA NA NA Renegotiated Loans / Total Loan et WorthlTotalAssets 12.2% 10,4% 13,9% 12,7% 12.3% 10.3% 10,0% 9,8% 9.7% NetWorth/LoanAssets 15,4% 128% 165% 14,9% 13.3% NA NA NA NA Return on Average Assets 0.5% 1.1 % 1.4% 1.2% 1.0% 0.7% 0,6% 0.6% 0.6% Retum on Average Equity 5.2% 9,8% 11.3% 9.2% 8.2% 6,2% 6,4% 6,3% 6.5% Administrative & Personnel Expenses I Operatang Revenue _ 78.4% 69.2% 65.84h 63.1% 35.10 41.6% 39.3% 36.8% 34.1% Mission BN is one of four Federal Government development banks in Brazil, the others being Banco Nacional de Desenvolvimento Econ6mico e Social (BNDES), Banco da Amaz6nia (BASA), and Banco Regional de Desenvolvimento do Sul (BRDES). BN operates in the Northeastern states of Maranhao, Ceara, Piaui, Rio Grande do Norte, Paraiba, Pemambuco, Alagoas, Sergipe and Bahia, as well as in Northern Minas Gerais. BN's mission is to contribute to the sustained development of the Northeast region of Brazil, to promote the region's economic integration with the Brazilian and international economies and to work towards reducing regional and social inequality. The bank's primary function is that of a development bank. Its commercial activities play an auxiliary role in fulfilling the BN's development mission. Signif cant Milestones since Founding Established under Law No. 1649 of July 19, 1952, BN began operations in June 1954 through one branch in Fortaleza. From the bank's foundation until 1967, it was principally funded by a fixed percentage of federal taxes as provided under Article 198 of the Brazilian Constitution of 1946. This source of funding ended in 1967, and the bank came to rely on new sources, principally from Government entities, "repassed funds", as well as its own equity, deposits and commercial borrowing from the private sector. The latter source of funds enabled the bank to build up its commercial banking activities. In 1974, BN also began acting as operating agent for FINOR (Investment Fund for the Northeast), which provided an additional - 73 - source of revenues and funding. The Brazilian Constitution of 1988 provided for the creation of a Constitutional Fund for Financing the Northeast - FNE, which was implemented with Law No. 7827 of 1989. This law establishes that the objective of this fund is to promote social and economic development in the Northeast through financial programs to productive sectors, giving priority to small rural producers (annual revenues below R$80,000). Since then, FNE has provided not only the primary but also a secure and rapidly growing source of long-term funding for the bank.. BN's main focus has always been on the rural sector, which in 1999 received 52.1% of the bank's applied resources. Ownership and Management Structure BN is a mixed capital corporation with limited liability and unlimited duration under the laws of Brazil. It is the primary government-owned financial agent for the implementation of development policies in the Northeast region of Brazil, however, as a multiple service bank, BN provides a range of banking and financial services as well, including deposit accounts, lending to the rural, commercial and industrial sectors, trade financing, foreign exchange brokerage and fund management. As of June, 1999, the Government owned, directly and indirectly, 90.63% of the bank's voting stock and 90.82% of its total capital. Government ownership is reflected in the govemance structure of BN. Since January, 1989, the bank has been placed under the control of the Ministry of Finance. The bank is run by a Board of Directors and an Executive Board. The Board of Directors is comprised of a Chairman, a Deputy Chairrnan and four other members who represent the shareholders and are elected by the General Assembly for renewable three-year terms. The Chairmnan is a representative of the Ministry of Finance. The Deputy Chairman is the President of the bank who is nominated by the President of Brazil. One representative from the Management and Budget Ministry (Ministerio de Gestao e Oracamento) and one from the Superintendency for the Development of the Northeast (SUDENE) also are entitled to seats on the Board. The Board of Directors normally meets once a quarter or more frequently if required and is responsible for setting overall operational and administrative guidelines. It also approves the bank's financial statements. Day to day running of the bank is the responsibility of the Executive Board, which nonmally meets weekly. In addition to the President and the four official board members, the Executive Board includes BN's seven superintendents who function as executive vice-presidents. Each superintendent is either responsible for operations in two of the ten states in BN's geographical region, or for the major functional areas of the bank (business and financial controls, human resources or strategic support). By providing each member with votes of equal weight, the Executive Board's structure is intended to provide a focus on the Bank's operational, rather than political objectives by ensuring that the votes of the career bankers outnumber those of the political appointees, however the bank must follow the broad guidelines set by the federal government for the application of federal resources, which comprise 80% of its funding base. These guidelines are: * To maintain a stable economy; To create conditions for sustained growth; * To improve living conditions. BN's management conducts business independently to achieve and maintain reasonable profitability. A major thrust of reforms being undertaken by BN's current president are to create a more professional, results-oriented corporate culture which is better insulated from political interventions at the operational - 74 - levels. No single individual can approve a loan, and all loans are approved in committees according to technical criteria. Significant Changes since January, 1995 New management took office in March, 1995 and embarked on a thorough restructuring of the bank's operations, including its personnel policies, product development, lending policies and outreach. Personnel Policies * The bank's administrative structure was reduced. Administrative and personnel expenses dropped from 78.4% to 35.1% of operating revenue. General overtime expenditures were eliminated, and top management's drive to transfer the majority of administrative employees to branches throughout the region encouraged many employees to retire. Overall headcount decreased from 5,468 employees in 1995 to 3,832 at the end of 1999, and headquarters staff was sliced from 1,562 in 1995 (29% of total staff) to 390 employees at end of 1999 (10% of total staff); the remainder either retired or were re-trained and sent out to branches throughout the Northeast. * A performance incentive program is being incorporated into the payroll policy. The incentives program, were introduced for the insurance and certificate of deposit products, and are being extended for recovery of fully provisioned, past-due loans as well as for general loan portfolio quality. Product Development * As the bank shifted from being product-driven to being customer-driven, the process of product development was reversed and is now bottom-up, with the input for the identification and prioritization of financial needs filtering up from clients and communities to branches, and from branches to general management. Lending Policies * The bank, consistent with restrictions imposed by the Central Bank and Congress since 1988, has significantly reduced its lending to the public sector. BN is placing increasing focus on micro, small and medium enterprises. * The credit approval process was redesigned. The bank now employs a decentralized loan approval system which is codified in the form of policy manuals and updates. The bank uses a committee structure with increased involvement of senior managers as the size of the credit increases. Decisions are made on majority vote. No singular individual has credit authority in the bank; proper committee approval is required for all loans. * Previously the time span between loan request and loan approval averaged 217 days. Today loans are approved within mandated time limits ranging from 21 to 60 days depending on the amount involved. Outreach * A new, more modem marketing image was created and branches were remodeled. Operations were automated so that today all 176 branches are on-line. - 75 - * Mobile branches were introduced to reach distant communities. The mobile units (staffed vans) spend on average one day in each of 473 remote communities. During the first half of 1999, 31,555 loans out of a total of 125,400 were channeled through these mobile units. The impact of these reforms on BN's operations is summarized in the table below. Performance Indicators (R$ thousands) Dec.l1999 Dec./1998 Dec./1997 Dec./1996 Dec./1995 Dec./1994 Deposits per Employee 271 306 254 222 156 99 BNB+FNE Assets/ Employee 3,716 3,036 2,137 1,549 1,070 697 BNB+FNE Assets/Branch 81,852 69,788 53,418 41,893 30,954 21,103 Admin. Exp./ BNB+FNE Assets 3.1% 3.7% 4.3% 5.3% 6.6% 7.9% No. of New Loan Approvals 404.5 517.4 286.8 144.4 68.0 27.4 No. of Clients 1,016.9 720.3 399.1 200.9 94.6 78.2 No. of approvals of new loans in excess of R$10 million 1 3 7 4 5 0 Public Sector/ Total Loan Portfolio 6.7% 9.0%o 11.0% 13.5% 17.2% 21.6% Private Sector / Total Loan Portfolio 93.3% 91.0% 89.0% 86.5% 82.8% 78.4% Weighted Average term of Long Tenn 8.1 years 8.3 years 8.6 years 9.8 years 6.4 years 6.5 years Assets Weighted Average tenn of Long Term 8.5 years 10.7 years 9.8 years 7.6 years 6.5 years 6.3 years Liabilities Exchange Rate R$/US$1. 00 1.7890 1.2087 1.1164 1.0394 0.9725 0.8500 (*) Annualized expenses Operating Results Return on assets (ROA) has improved from 0.5% in 1995 to an annualized rate of 1.0% during 1999. Net interest income before provisioning expenses has increased steadily since 1995 and totaled R$572.6 million for the year ended December 31, 1999, which well exceeds the R$308.4 million earned in - 76 - 1998. Much of this income came from gains with the securties portfolio, which benefited from increasingly higher interest rates imposed by the Central Bank since October 1997. Administrative and personnel expenses have decreased drastically since 1995 and in December 1999 only accounted for 18.0% of intermediation revenue, down from 95.5% at year end 1995. Overall administrative expenses (personnel and others) shrunk 28.1% between 1994 and 1998, while personnel expenses shrunk an impressive 49.2% during the same period. However, it is difficult to evaluate BN's performance with out taking into account the effect of FNE. BN receives an administrative fee of 3% on the value of assets lent from FNE which is recorded as "other income". These fees account for over 35% of BN's gross income. The administrative expenses of managing FNE are included in BN's overall administrative expenses. Interest income and the FNE adnninistative fee account for 93% of BN's income. While BN would not be profitable without the FNE administrative fees, BN feels that this is a secure source of income as it is constitutionally guaranteed and would require a constitutional amendment to eliminate or change significantly. Nontheless, recent Government studies have suggested alterations to the basis for renumeration for public banks which administer Govemment funds. Some proposals, such as paying fees only for those funds actually disbursed by the banks rather than the current practice of providing fees on all funds administered could substantially reduce BN's fee income. Asset Composition BN's asset base grew 129.2% between DecenTber 1995 and December 1999. Most of this increase was due to a growth of 135.2% in the loan portfolio, including foreign exchange operations. The treasury portfolio increased 132.6% during the same period. Asset growth for the 18-month period between December 1997 and June 1999 totaled 46.3%. The consolidation of both BN and FNE balance sheets results in a total asset base of R$ 14.3 billion, evidencing the importance of FNE to the bank's activities. FNE assets are lent through BN, even though the operations are accounted for on a separate balance sheet. Treasury Portfolio: BN's policy limits its treasury activities to investments in highly liquid federal government securities. As such, BN does not make use of market opportunities, as do other private banks, to benefit from fluctuations in interest rates that can increase profits and asset liquidity. BN is exempted from govemment pressures to "load" its securities portfolio with unmarketable paper. Between December 1995 and December 1999, the treasury portfolio as a percentage of total assets has varied between 17% and 21%. This small participation translates into liquidity ratios that are below average when compared to the majority of private banks operating in Brazil. Liquidity Liquid Assets / Total Assets: BN's low liquidity ratio of 5.8% in December 1995 improved steadily through the following years and reached its peak of 15.7% in December 1998 which is low relative to an average liquidity ratio of 37.2% for the 50 largest banks in Brazil. CurrentAssets 7CurrentLiabilities. The correlation of BN's current assets and current liabilities is another measure of the bank's liquidity. The good performance of the current ratio (105.4% as of December 1997, rising to 152.2% in December 1999) is due to the fact that the bank borrows long term - 77 - foreign funds to finance long term projects, and the proceeds from these long term borrowings are accounted for as current assets until they are disbursed to the client. However, BN's current liquidity would still be at a good level even if the bank's current assets were adjusted accordingly. Loan Portfolio - BN plus FNE Approximately 90% of the bank's outstanding loans are development loans with typical maturities of five to eiqht years; the remainder are short term commercial loans (under one year) which, though not directly linked to investment projects, are normally a by-product offered to BN's existing customers. General credit consists largely of short term loans to the private sector for working capital purposes. These loans are made primarily to industrial and commercial borrowers. The principal forms of lending are overdrafts (including an overdraft facility for corporate credits), direct advances and discounting trade bills. The bank's own funds, principally its repassed funds, provide the funding sources for these loans. The average maturity of general credit loans is between 90 days and 18 months. In the case of trade financing, the bank extends trade credit to customers which is matched by specific funding from a foreign bank or the foreign branch of a Brazilian bank. Maturities average 150 days for export financing, and 180 days for import financing. In the case of free funding, the bank principally uses dedicated trade financing lines with major international banks or foreign branches of Brazilian banks. Trade financing is only conducted with private sector clients. - 78 - LOAN PORTFOLIO (BNB + FNE) (R$ thousands) 12131/1999 e 12131/1998 eA 1213111997 Rural 6.997.263 52.1 4.261.274 39.1 3.604.139 Crop financing and storage 986.669 7, 660.077 6,1 339.757 Investment 6.010.594 44. 3.601.197 33.C 3.264.382 groindustrial 403A57 3.0 765.315 7.0 273.675 ndustrlal 3.402.572 25, 3.553.242 32.6 2.334.951 nfrastructure 1.287.180 9,6 1.133.449 10,4 1.111A89 Electrification 315.150 2, 477.686 4.4 588.184 Road building and repairs 335.475 2. 85.417 0.E 51.235 Water and sewage 47.656 0. 24.476 0.2 132.356 Highways 175.570 1, 135.463 1, 115.295 Other 413.329 3.1 410.407 3,. 224.419 General Credit 1.024.946 7.6 943.857 8.7 825.533 Industrial production 832.579 6. 462.084 4,2 574.401 Commerce 98.276 0. 33.342 0. 20.672 Public Sector 53.863 0. 64.567 0;6 44.894 Other 40.228 0. 383.864 3.5 185.566 Trade financing 197.563 1.5 143.255 1.3 143.790 Export 86.875 0. 42.188 0.4 77.272 Import 91.385 0, 60.076 0.6 39,361 Other 19.303 0, 40.991 0., 27.157 FNE Repasses to State Banks 109.371 0.8 100.402 0.c 95.858 Rural 98.602 0, 86.980 0, 79.495 Industrial 10.769 0,1 13.422 0,1 16.363 TOTAL LOAN PORTFOLIO 13.422.352 100. 10.900.794 100. 8.389.435 Portfolio Quality BN's net non-performing loans(BN and FNE) improved from 12.1% in 1996 to 11.2% in June 1999. Considering only BN loans, non-performing loans increased from 17.5% to 19.2% over this period. This is still better than other large public banks in Brazil such as Banco do Brasil (21.9%) or BANESPA (22%). On a consolidated basis portfolio quality ratios are somewhat improved, however at 10.5%, BN's loan portfolio quality is still well below the average of 2.4% for the 50 largest banks in Brazil. In addition, FNE has legal authorization to reschedule loans of non-performing borrowers, in which case they are reported as performing loans. BN acknowledges that portfolio quality is a concern and emphasizes that the problem portfolio is composed primarily of large loans contracted prior to 1995, for activities which have proven to be non-viable with stabilization of the economy and which typically carried grace periods of two to three years and so have only come due in the last few years. BN is working with the federal commission which is developing a coordinated strategy amongst the large, federal banks to improve recovery of these loans. - 79 - Non-Perforning Loans / Total Loans BNB BNB+FNE Dec./1995 9.4% 6.3% Dec.f1996 17.2% 12.1% Dec./1997 14.5% 10.9% Dec./1998 16.7% 10.7% Dec./1999 19.5% 11.2% BN's policy for loan provisioning follows Regulation 1,748 of the Central Bank. Loans are classified as overdue when the payment of principal or interest is over 60 days late. In this case, the ban:k must provision 20% of the outstanding balance (50% if the loan is considered to be insufficiently secured or guaranteed). The bank is not permitted to continue to accrue income, above the level of inflation indexing, on loans overdue more than 60 days, but is required to account for any funding costs., whether paid or not. After loans are overdue more than 180 days, or are defaulted, all related income including indexing is accounted for on a cash basis as and when received. Defaulted loans are written off as an expense after 180 days in default, or are rescheduled. The above rule only applies to loans where the credit risk is bome by the bank. In the case of loans where BN has no credit risk, these are never classified as past due regardless of the time that they are overdue. They remain as current loans until they are either collected or written off. Unlike BN, FNE is not subject to Central Bank rules on provisioning. FNE adopts different rules for loans in arrears or in default; these rules are established by the bank as administrator of the fund and approved by the National Congress. For FNE credits with maturities of up to three years, 25% must be provisioned after principal or interest is 180 days overdue, after which three more provisions of 25% each are made in the following 180 days. Therefore after a year the loan is fully provisioned. Loans of over three years are provided for over a period of two years, with no provision made in the first year, a 25% provision made after 180 days into the second year, and three more provisions of 25% each made in the following 180 days. Loans deemed uncollectible must be written off and the principle and interest amount that was for BN's risk must be reimbursed to the FNE within five years, with interest. Funding Mechanisms Until 1997, half of BN's funding was short term in nature, which is not compatible with its developmental role. New management has lengthened the debt profile to better match the long term nature of its lending. Since Dec./ 1997 the bank has done a better job of funding long tenn lending operations with long term funding. - 80 - Funding Mix Prior to 1997, BN relied heavily on time deposits for funding. Since then government funds have played an increasingly important role in the bank's funding base, nearly 46% of which come as FNE funds. Equity BN's capital adequacy ratio is in line with private banks. It has been operating with an average of 12.3% of its own resources over the past five years. Proforma Financials 1999-2004 (year-by-year) based on forecasts provided by BN BN submitted projections for the years 2000-2003 with the premises used by the bank. Analysis of the projections indicates that BN expects an initial dip in its profitability in 2001 and 2002 due primarily to increased provisions for doubtful loans. BN expects profitability to rebound in 2003, more than matching asset growth. Capital adequacy is projected to decline steadily over the period to 9.7%. Outlook Since 1995, BN has taken important steps to improve the efficiency of its operations and reduce the concentration of its portfolio in government lending and large loans. Consistent with its development focus to complement the private banking sector, BN has reoriented its activities to service micro, small and medium enterprises. Nonetheless, BN is faced with continuing challenges over the coming years to translate its improved operational capacity into improved financial results. Specifically, BN will have to address the legacy of large, non-performing loans booked prior to 1995. While Central Bank provisions permit BN to reduce the apparent impact of these loans on its financial statements through rescheduling and special reporting requirements, they nonethleless have a real impact on the quality of the bank's portfolio, its profitability and eventually its solvency. BN is actively working to improve the quality of its portfolio through the introduction of performance-based staff incentives tied to, inter alia, portfolio quality and profitability. BN is also moving ahead of many other public banks in Brazil in the implementation of measures to recover loans which have been provisioned or for which Govemment has delayed provisioning, as a means to strengthen its net worth. BN should also consider working with Govemment on the redifinition of its provisioning policies, particularly in the face of concerns regarding the quality of its loan portfolio as a public bank. While Government guarantees may substantially reduce the risks of loss of principal on a significant proportion BN's overdue loans, large commercial banks in Brazil uniformly fully provision their non-performing loan portfolio, regardless of guarantees, in order to generate a more conservative estimate of true net worth. Central Bank authorizations to avoid liquidation and delay or avoid provisioning for past-due loans distort operational incentives and undermine the increasing commercial focus introduced by BN's recent organizational reforms. Special provisions related to management of portfolio quality should be replaced with explicit, transparent subsidies for development banking activities. As a development bank, BN provides a number of client and regional services which are not offered by private banks. While it receives funds at below market rates, it generally is constrained in the interest rate it can charge final clients, which in turn are well below market rates. As a result, providing a more transparent picture of its true profitability, including provisioning consistent with commercial bank practices, coupled with continued progress in reducing administrative costs and arrears, may provide the - 81 - basis for negotiation of interest rate ceilings to final borrowers which permit sufficient returns given the real risk of development lending. - 82 - Annex 6: Procurement and Disbursement Arrangements BRAZIL: Northeast Microfinance Development Project Procurement Management of the project under the loan will be the responsibility of the CrediAmigo Technical Unit working with the relevant areas of BN. The Technical Unit will be responsible for cariying out procurement of goods and services for the project. A detailed procurement plan has been prepared and the staff responsible to carry out procurement for the project has been trained in World Bank procurement procedure. Consultant Services and Goods financed by the Bank under this project will be procured respectively in accordance with the provisions of the World Bank Guidelines for Selection and Employment of Consultants by World Bank Borrowers (the Consultant Guidelines) published in January 1997 and revised in September 1997, and the Guidelines for Procurement under IBRD Loans and IDA Credits, January 1995, revised January/August 1996 and September 1997. The Request For Proposal (RFP) for selection of consulting firms and contracts issued by the Bank will be used; the bidding documents prepared for Brazil for National Competitive Bidding (NCB) for goods, accepted by the Bank, will be used; shopping procedure will be according to the comparison of at least the quotations. The loan will also provide funds for CrediAmigo to make solidarity group-backed working capital loans, and individual working capital loans to solidarity group clients. BN will follow local commercial practices in accordance with item 3.12 of the World Bank Guidelines, for the disbursement of these funds. BN will be responsible for overall financial management and repayment of World Bank loan funds. Procurement methods (Table A) Consulting Services: the project will finance the employment of consulting services for institutional development activities. Contracts for firms estimated to cost more than US$200,000 will be procured following a Quality and Cost Based Selection (QCBS) in accordance with Chapter II of the Consultant Guidelines for Socio-Economic Impact Analysis, Design of a Risk Management Program, Design and Evaluation of Improved Outreach Mechanisms, and Development of the Accounting System. There will be 3 contracts for firms, estimated to cost more than US$100,000 and less than US$200,000 equivalent, that will be procured following Quality Based Selection (QBS) due to the complexity of the studies which include Due Diligence Reviews, Design and Analysis of Market Studies, and Design and Implementation of a Loan Officer Productivity Enhancement Program. Contracts for firms estimated to cost less than US$100,000 equivalent will be procured following Consultant's Qualifications (QCS) and will include External Evaluation of the Environmental Mitigation Program and Identification and Evaluation of New Financial Products. Individual Consultants will be selected on the basis of their qualifications for Punctual Loan Management Assistance for the CrediAmigo Technical Unit, and Legal Reviews related to Institutional Development: There will be three sole-source contracts all based on continuity of services already being rendered to BN: (a) one contract with Accion Intemacional estimated to cost US$160,000. The firm was selected competitively for the first contract with CrediAmigo to provide technical assistance with transference of the technology used with solidarity credits. The firm assisted in the development of the micro credit technology that is being used by CrediAmigo; the firm will be hired to continue providing technical assistance for the program; (b) one contract with UNYSIS estimated to cost US$80,000. UNYSIS was selected competitively and contracted by BN to provide assistance with their computer system in the development of new systems, adaptation of new programs, etc. To maintain the continuity and compatibility of the services for BN at large, CrediAmigo will sign a separate contract with UNYSIS for the services connected with CrediAmigo program, under the same unit costs contracted for the larger contract with BN; (c) one contract with TREVISAN estimated to cost US$120,000 for the annual external - 83 - auditing of the loan. BN contracted through a competitive selection a firn to do the annual auditing of 13N; this same firm will also do the auditing of the loan under separate terms of reference and a separate contract. Goods: the project will finance the procurement of vehicles, fumiture, computers and printers fcor mobile units that will service distant areas where there are no agencies of CrediAmigo. Contracts for the supply of Goods are estimated below US$350,000 and therefore there will be no ICB procedure in this loan. Contracts estimated to cost US$100,000 to US$350,000 equivalent (with an aggregate amount of US$800,000) will be awarded on the basis of NCB procedures; contracts estimated to cost below US$ 100,000 equivalent (with an aggregate amount of US$400,000) will be awarded on the basis of intemational/national shopping. Table A: Project Costs by Procurement Arrangements (US$ million equivalent) 1. Works 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 2. Goods 0.00 0.70 0.20 0.00 0.90 (0.00) (0.60) (0.10) (0.00) _(0.70) 3. Services 0.00 0.00 1.60 0.00 1.60 Technical Assistance (0.00) (0.00) (1.60) (0.00) (1.60) 4. Training 0.00 0.00 0.30 0.00 0.30 (0.00) (0.00) (0.20) (0.00) (0.20) 5. Microfinance Subloans 0.00 0.00 85.50 0.00 85.50 (0.00) (0.00) (47.00) (0.00) (47.00) 6. Incremental Recurrent 0.00 0.00 0.00 11.20 11.20 Costs (0.00) (0.00) (0.00) (0.00) (0,.00) Total 0.00 0.70 87.60 11.20 99.50 (0.00) (0.60) (48.90) (0.00) (49.50) "Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies v 2. Goods are International/Nationial Shopping. 3. Technical Assistance Services are consulting services (see Table Al). 4. Training includes costs of renting location, training materials and travel and per diem fbr trainees. 5. Microftnance subloans of up to US$ 1000. Procurement by sub-borrowers will be based on connuercial practices, at a reasonable price and taking into account their quality, as repayment requirement provides incentive for procuremnent of goods and services at lowest price. - 84 - Table Al: Consultant Selection Arrangements (optional) (US$ million equivalent) A. Firms 0.54 0.30 0.00 0.10 0.15 0.31 0.00 1.40 (0.54) (0.30) (0.00) (0. 10) (0.15) (0.31) (0.00) (1.40) B. Individuals 0.00 0.00 0.00 0.00 0.20 0.00 0.00 0.20 (0.00) (0.00) (0.00) (0.00) (0.20) (0.00) (0.00) (0.20) Total 0.54 0.30 0.00 0.10 0.35 0.31 0.00 1.60 (0.54) (0.30) (0.00) (0. 1 0) (0.35) (0.31) (0.00) (1.60) 1\ Including contingencies Note: QCBS = Quality- and Cost-Based Selection QBS Quality-based Selection SFB = Selection under a Fixed Budget LCS Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Single source selection (per Section 111, Paragraphs 3.8 to 3.11 of Consultants Guidelines). N.B.F. = Not Bank-financed Figures in parenthesis are the amounts to be financed by the Bank Loan. - 85 - Prior review thresholds (Table B) Table B summarizes the thresholds for procurement methods and prior review by the Bank. Table B: Thresholds for Procurement Methods and Prior Review' 1. Works 2. Goods 100 to 350 NCB All Less than 100 Intl./National Shopping First irrespective of value 3. Services TA Firms More than 200 QCBS All 100 to 200 QBS All Less than 100 LCS, CQ TORs only 4. Services TA Greater than 50 Individual Consultants All Individuals Less than 50 TORs only unless specified as of critical nature in Loan Implementation Manual 5. Subloans Commercial Practices None 6. Training N/A None Total value of contracts subject to prior review: US$4.0 million (4% cf total project expenditures or 50% of non-microfinance loan portfolio expenditures. Overall Procurement Risk Assessment Average Frequency of procurement supervision missions proposed: One every 12 months (includes special procurement supervision for post-review/audits) The above risk assessment and thresholds for prior review was a result of the Procurement Capacity Assessment conducted in the field in August of 1999 by Procurement Specialist, Irani Escolano. 'Thresholds generally differ by country and project. Consult OD 11.04 "Review of Procurement Documentation" and contact the Regional Procurement Adviser for guidance. - 86 - Disbursement Allocation of loan proceeds (Table C) The allocation of loan proceeds by disbursement category is shown in Table C. The proceeds of the proposed loan are expected to be disbursed over a period of 5 years. The project is expected to be completed by June 30, 2005 and the project closing date is December 31, 2005. Retroactive Financing of up to US$5 million (10% of the loan amount) would be provided for eligible expenditures incurred since September 1, 1999 (but not earlier than 12 months before loan signing). Table C: Allocation of Loan Proceeds xpeit-re Categorif--c USn millio n ,- F( F ca . Incremental Microfinance Portfolio 47.00 55% Technical Assistance 1.60 100% Equipment 0.70 80% Training 0.20 80% Fee 0.50 100% Total Project Costs 50.00 Total 50.00 Use of statements of expenditures (SOEs): The financial management systems of BN/CrediAmigo were reviewed by a Bank Financial Management Specialist during pre-appraisal for compliance with OP/BP 10.02 and the Loan Administration Change Initiative (LACI) Implementation Handbook. Based on this review, the project was certified as a "B", indicating that the project satisfies the Bank's minimum financial management requirements. However, the project financial management system cannot currently generate quarterly project management reports (PMRs). Disbursements would be made on the basis of statements of expenditure (SOEs), except for contracts with consulting firms above US$100,000 equivalent: and with individuals above US$50,000. The information required for the compilation of SOEs would be maintained by the CrediAmigo Technical Unit in the MIS data base. An action plan was prepared and agreed for implementation of a project-specific financial management module able to generate PMRs within six months of project effectiveness. The annual financial audit will include a separate opinion on the eligibility of expenditures disbursed on the basis of PMRs. Special account: In order to facilitate project implementation, the Implementing Unit in BN/CrediAmigo will establish a special account in US dollars in a commercial bank acceptable to the Bank with an authorized allocation of US$3.5 million (based on projected disbursements for four months). The initial allocation will be limited to US$1.0 million until the cumulative disbursments from the Special Account total US$3.0 million at which time the authorized allocation of US$3.5 million will be in effect. Upon compliance with the requirements for PMR-based disbursements, the authorized allocation for the Special Account will be US$8.0 million reflecting the expected peak six-month disbursement requirements. The special account will be replenished quarterly on the basis of PMRs submitted by the Implementing Unit and approved by the Bank project team. In the case of a faster than expected draw-down of the special account, an interim PMR may be submitted to request a supplemental disbursement prior to the next - 87 - scheduled quarterly disbursement request. All supporting documentation authenticating the expenditures reported in the PMRs will be maintained by the Implementing Unit in BN/CrediAmigo and made availaLble for review by auditors and Bank missions as requested. The special account will be audited in conjunction with the annual financial audit of the project accounts for the period January 1 to December 31 of the year carried out by a qualified auditor according to terms of reference acceptable to the Bank and selected in accordance with Bank guidelines. The audit report will be submitted to the Bank no later than June 30 in the year following the year for which the project accounts are audited. Selection of a qualified auditor acceptable to the Bank is part of the certification process for use of PMR disbursements and as such is a condition of disbursements. - 88 - Annex 7: Project Processing Schedule BRAZIL: Northeast Microfinance Development Project > . ~ta'° <.',,c;. .tW4uIe Plan d Time taken to prepare the project (months) First Bank mission (identification) 07/15/98 07/15/98 Appraisal mission departure 09/01/99 08/23/99 Negotiations 11/15/99 03/21/2000 Planned Date of Effectiveness 07/01/2000 Prepared by: Bank of the Northeast/CrediAmigo Preparation assistance: Japanese PHRD Preparation Grant Bank staff who worked on the project included: Na0--td gme V==; 0xL =- - X;0 Speciality Steven N. Schonberger Task Manager Irani Escolano Procurement Specialist/Cost Tab Susana Sanchez Financial Economist Carlos Cuevas Principal Financial Economist Robert Christen Senior Microfinance Advisor Fred Levy Principal Economist Tulio Correa Financial Management Specialist Marta Molares-Halberg Senior Counsel Morag van Praag Senior Disbursement Officer Luis Coirolo Portfolio Manager Jacob Yaron Peer Reviewer Khalid Siraj Peer Reviewer Arie Chupak Peer Reviewer Richard Rosenberg Peer Reviewer Beatriz Iraheta Language Program Assistant - 89 - Annex 8: Documents in the Project File* BRAZIL: Northeast Microfinance Development Project A. Project Implementation Plan Manual de Implementacao do Emprestimo BIRD pelo Programa CrediAmigo B. Bank Staff Assessments 1. Trip Report, Banco do Nordeste/CrediAmigo (Technical/Institutional Review) 2. Cost Tables 3. Evaluation of Banco do Nordeste (Due Diligence) 4. Microfinance Prospects in Brazil (Business Environment) 5. Financial and Economic Analysis of CrediAmigo and Business Plan 6. Financial Management Certification 7. Procurement Assessment 8. Environmental Mitigation Assessment 9. Social Assessment 10. Design Issues for Impact Evaluation C. Other 1. Manual Basico CrediAmigo 2. Modelo de Gestao CrediAmigo 3. Piano de Negocios CrediAmigo 4. Projecoes do Resultado Financeiro Programa CrediAmigo 5. Politicas e Acoes de Recursos Humanos do Programna CrediAmigo 6. Gestao de Risco e Controle de Qualidade da Carteira CrediAniigo 7. Projeto de Expansao da Atuacao do CrediAmigo 8. Balanca Social do Banco do Nordeste 1998, 1997, 1996, 1995 9. Demanda por Microcredito No Nordeste Brasileiro 10. Trabalho Avaliacao Social Crediamigo 11. Politica Ambiental e Programa de Mitigacao Ambiental 12. Various Central Bank Laws and Regulations Related to Microfinance Institutions *Including electronic files - 90 - Annex 9: Statement of Loans and Credits BRAZIL: Northeast Microfinance Development Project Difference between expected and actual Original Amount in US$ Millions disbursements Project ID FY Borrower Purpose IBRD IDA Cancel. Undisb. Orig Frm Rev'd BR-PE43874 1999 GOVERNMENT OF BRAZIL DISEASE SURVEILLANCE 100.00 0.00 0.00 96.52 11.52 0.00 BR-PE-48869 1999 FEDERATIVE REPUBLIC OF BR SALVADOR URBAN TRANS 150.00 0.00 0.00 150.00 0 00 0.00 BR-PE-50763 1999 GOV. OF BRAZIL FUNDESCOLA2 202.03 0.00 000 202.03 000 0.00 BR-PE-54120 1999 GOVERNMENTOF BRAZIL AIDS2 165.00 0.00 0.00 14473 19.73 0.00 BR-PE-55386 1999 FEDERAL GOVT OF BRAZIL ANIMAL&PLANT DIS. CO 44.00 0.00 0.00 44.00 0.00 0.00 BR-PE-58129 1999 FEDERAL GOVERNMENT EMER. FIRE PREVENTIO 15.00 000 0.00 15.00 0.00 0.00 BR-PE-35728 1998 STATE OF BAHIA BAHIA WTR RESOURCES 51.00 0.00 0.00 39.36 21.05 0.00 BR-PE-38695 1998 GOVERNMENTOFBRAZIL FED.WTRMGT 198.00 0.00 000 171.58 43.57 0.00 BR-PE-38947 1998 GOVERNMENT OF BRAZIL SC. &TECH 3 155.00 0.00 0.00 137.67 27.67 0.00 BR-PE40033 1998 THESTATEOFMINASGERAIS MGSTATEPRIV. 170.00 0.00 000 170.00 160.00 0.00 BR-PE42565 1998 STATE OF PARAIBA PARAIBA R.POVERTY 60.00 0.00 0.00 45.26 -0.44 0.00 BR-PE-43420 1998 FED. REPUBLIC OF BRAZIL WATER S.MOD 2 150.00 0.00 0.00 150.00 41.51 0.00 BR-PE43421 1998 STATE OF RIO DE JANEIRO RJ M.TRANSIT PRJ. 186.00 0.00 0.00 186.00 93.64 0.00 BR-PE-48357 1998 REPUBLIC OF BRAZIL CEN.BANKTAL 2000 0.00 0.00 16.83 11.33 0.00 BR-PE-50762 1998 GOV. OF BRAZIL FUNDESCOLA1 62 50 0 00 0 00 27.13 -20.36 0.00 BR-PE-51701 199S STATE OF MARANHAO MARANHAO R.POVERTY 80 00 0.00 0.00 59.52 -0.37 0.00 BR-PE-57910 1998 GOVERNMENT OF BRAZIL PENSON REFORM UL 5 00 0.00 0 00 5.00 5.00 0.00 BR-PE-6474 1998 STATEOFSAOPAULO LANDMGT3(SP) 55.00 0.00 0.00 5500 9.50 0.00 BR-PE-6549 1998 TBG GASSCTRDEVPROJECT 13000 000 0.00 130.00 92.00 0.00 BR-PE-6559 1998 THE STATE OF SAO PAULO (BF-R)SP.TSP 45.00 0 00 0.00 45.00 25.00 0.00 BR-PE-34578 1997 RIO GRANDE DO SUL RGS HWY MGT 70.00 0.00 0.00 65.90 25.91 0.21 BR-PE-38898 1997 STATE OF RGN R.POVERTY(RGN) 24.00 0.00 0.00 14.77 4.88 0.00 BR-PE42566 1997 STATE OF PERNAMBUCO R.POVERTY(PE) 39.00 000 0.00 13.51 -0.18 0.°0 BR-PE43668 1997 STATE OF RGS RGS LAND MGTIPOVERTY 10000 0.00 0.00 88.48 21.28 0.00 BR-PE43871 1997 STATE OF PIAUI (PIAUI)R.POVERTY 30.00 0.00 000 8.76 -3.14 0.00 BR-PE-43873 1997 FED.REP.OF BRAZIL AG TECHNDEV. 60.00 0.00 0.00 46.96 16.15 000 BR-PE46052 1997 THESTATEOF MATO GROSSO CEARAWTR PILOT 9.60 0.00 0.00 7.46 7.46 0.00 BR-PE-48870 1997 FED. REP. OF BRAZIL MT STATE PRIV 45.00 0.00 0.00 20.09 20.09 0.00 BR-PE-6475 1997 FEDERAL GOVERNMENT LAND RFM PILOT 90.00 0.00 0.00 58.34 18.84 0 00 BR-PE-6532 1997 STATEOFBAHIA FEDHWY DECENTR 30000 0.00 0.00 252.19 10219 0.00 BR-PE-6562 1997 STATEOFPARANA BAHIAMUN.DV 100.00 000 0.00 9279 3379 -4.21 BR-PE-37828 1996 FEDERATIVE REPUBLIC OF BR (PR)R POVERTY 175.00 000 0.00 13807 95.68 000 BR-PE40028 1996 CVRD RAILWAYS RESTRUCTURG 350.00 0 00 50.00 37 42 47.42 20.00 BR-PE-6512 1996 FED. REP. OF BRAZIL ENV/CONS(CVRD) 50.00 0.00 000 20.75 11.80 0.00 BR-PE-6554 1990 GOVT OF BRAZIL HLTH SCTR REFORM 300.00 0.00 0.00 224.52 147.01 0.00 BR-PE-35717 1995 FED REPUBLIC OF BRAZIL RURAL POV. (BAHIA) 105.00 0 00 0.00 42.13 1615 0.00 BR-PE-38882 1995 GOVTOFBRAZIL RECIFEM.TSP 102.00 0.00 0.00 71.95 48.96 0.00 BR-PE-38884 1995 GOVTOFBRAZIL RURALPOV.- CEARA 70.00 0.00 000 19.31 0.31 0.00 BR-PE-38885 1995 STATE OF CEARA ZIL RURAL POV.-SERGIPE 36.00 0.00 0.00 957 0.07 0.00 BR-PE-6436 1995 FEDREPUBLICIBRAZIL CEARAURDVIWATERCO 140.00 0.00 0.00 57.34 51.32 -1568 BR-PE-6564 1995 ST.OF ESPIRITO SANTO BELO H M.TSP 99.00 0.00 0.00 41 15 28.68 0.00 BR-PE-6522 1994 ST.OFMINASGERAIS ESPSANTO WATER 154.00 000 4.00 7297 72.56 6.13 BR-PE-B524 1994 GOVERNMENT MINASMNC.DEVELOPMT 150.00 000 500 29.44 34.41 0.00 BR-PE-6543 1994 STATE GOVTS M. GERAISBASC EDUC 15000 0.00 0.00 20.31 16.30 0.00 BR-PE-6555 1994 REPUBLIC OF BRAZIL STE HWY MGT II 220.00 0.00 36.00 374 39.74 3.74 BR-PE-6558 1994 S PAULO/PARANA STS. PARANA BASIC EDUC 96.00 000 000 17.44 12.43 0.00 BR-PE-6541 1993 FED.REP.OF BRAZIL WTR OIPLN(SP/PARANA) 245.00 0.00 930 2561 34.90 1.10 BR-PE-6547 1993 GOVERNMENT METRO TRANSP. RIO 12850 0.00 0.00 0.29 0.30 0 00 BR-PE-6386 1992 GOB WATER SECTOR MODERNI 250.00 0.00 0.00 1.24 1.24 0.00 BR-PE-6454 1992 RONDONIA NTRL RES. M 167.00 0.00 0.00 27.60 27.58 0.00 - 91 - Difference between expected and actual Original Amount in USS Millions d;isbursements Project ID FY Borrower Purpose iBRD IDA Cancel. Undisb. Orig Frm Rev'd BR-PE-6505 1992 GOVERNMENT OF BRAZIL MATO GROSSO NAT RES 205.00 0.00 0.00 53.09 53 06 0.00 Total: 6,103.63 0.00 104.30 3,473.82 1,527.56 11.29 - 92 - BRAZIL STATEMENT OF IFC's Held and Disbursed Portfolio 3 1-Jul-1999 In Millions US Dollars Committed Disbursed IFC IFC FY Approval Compaiy Loan Equity Quasi Partic Loan Equity Quasi Partic 1973/78/83 CODEMIvIN 0.00 0.00 4.34 0.00 0.00 0.00 4.34 0.00 1975/96 Oxiteno NE 22.50 0.00 0.00 0.00 22.50 0.00 0.00 0.00 1980/87/97 Ipiranga 40.00 0.00 6.32 150.00 40.00 0.00 6.32 150.00 1980/88 OPP 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1980/92 DENPASA 0.00 0.12 1.00 0.00 0.00 0.05 1.03 0.00 1981 Brasilpar 0.00 0.00 0.04 0.00 0.00 0.00 0.04 0.00 1982/84/86 PISA 0.00 0.00 3.90 0.00 0.00 0.00 3.90 0.00 1987/92/96 MBR 7.02 10.00 0.00 6.23 7.02 10.00 0.00 6.23 1987/96 Perdigao 26.25 0.00 10.00 12.00 26.25 0.00 10.00 12.00 1987/96/97 Duratex 19.00 3.00 0.00 72.17 19.00 3.00 0.00 72.17 1987/97 SP Alpargatas 25.00 5.00 0.00 0.00 25.00 5.00 0.00 0.00 1989/95 Politeno Ind. 13.15 0.00 0.00 0.00 13.15 0.00 0.00 0.00 1990 ENGEPOL 0.88 0.00 0.00 0.00 0.88 0.00 0.00 0.00 1990 Ripasa 1.43 0.00 5.00 0.00 1.43 0.00 5.00 0.00 1990/91/92 Bahia Sul 7.14 0.00 20.97 0.00 7.14 0.00 20.97 0.00 1991 Bradesco-AL 26.03 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1991 Bradesco-Bahia 3.00 0.00 0.00 0.00 3.00 0.00 0.00 0.00 1991 Bradesco-Eucatex 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.00 1991 Bradesco-Petrofl 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.00 1991 Bradesco-Roini 1.19 0.00 0.40 0.00 1.19 0.00 0.40 0.00 1991 Rhodia-Ster 5.71 0.00 5.95 0.00 5.71 0.00 5.95 0.00 1992 CRP-Caderi 0.00 0.00 1.93 0.00 0.00 0.00 0.68 0.00 1992/93 TRIKEM 0.00 0.00 12.86 0.00 0.00 0.00 12.86 0.00 1993 BACELL 6.00 0.00 15.70 16.20 6.00 0.00 15.70 16.20 1993 Macedo Alimentos 14.50 0.00 0.00 0.00 14.50 0.00 0.00 0.00 1993 Votorantirn 11.71 0.00 0.00 0.86 11.71 0.00 0.00 0.86 1993/96 CEVAL 0.00 0.00 20.00 0.00 0.00 0.00 20.00 0.00 1994 GAVEA 9.38 5.50 0.00 0.00 9.38 5.50 0.00 0.00 1994 GP Capital 0.00 0.00 14.04 0.00 0.00 0.00 14.00 0.00 1994 ParaPigmentos 30.00 9.00 0.00 31.03 25.50 9.00 0.00 25.78 1994 Portobello 12.14 0.00 5.00 0.00 12.14 0.00 5.00 0.00 1994/95/97 Sadia 44.00 9.33 10.00 178.65 44.00 9.33 10.00 178.65 1994/96 CHAPECO 25.00 0.00 0.00 5.00 25.00 0.00 0.00 5.00 1994/96 S.A.I.C.C. 0.00 6.87 7.85 0.00 0.00 6.87 7.70 0.00 1995 Bradesco-Hering 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.00 1995 Brahina - BRA 25.00 0.00 0.00 49.20 25.00 0.00 0.00 49.20 1995 Carrbuhy/MC 16.88 0.00 0.00 0.00 16.88 0.00 0.00 0.00 1995 Lojas Atnericana 24.00 5.00 0.00 12.00 24.00 5.00 0.00 12.00 1995 LATASA - Brazil 13.00 0.00 0.00 2.00 13.00 0.00 0.00 2.00 1995 Rhodiaco/PTA 20.00 0.00 0.00 18.00 20.00 0.00 0.00 18.00 1995/96/98 Globocabo 32.09 0.00 27.97 103.25 32.09 0.00 27.97 103.25 1996 Banco Bradesco 40.00 0.00 0.00 54.36 15.23 0.00 0.00 22.84 1996 Mallory 7.27 0.00 0.00 0.00 7.27 0.00 0.00 0.00 1996 TIGRE 23.08 5.00 0.00 17.09 23.08 5.00 0.00 17.09 1996/97 Lightel 25.00 0.00 18.17 0.00 25.00 0.00 18.17 0.00 1997 Bompreco 25.00 5.00 0.00 0.00 25.00 5.00 0.00 0.00 1997 Copesul 37.50 0.00 0.00 167.14 37.50 0.00 0.00 167.14 - 93 - Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1997 Guilmana-Amorim 28.92 0.00 0.00 81.42 28.92 0.00 0.00 81.42 1997 Rodovia 35.00 0.00 0.00 79.50 33.07 0.00 0.00 75.13 1997 Samarco 16.20 0.00 0.00 13.33 16.20 0.00 0.00 13.33 1997 Sucorrico 15.00 0.00 0.00 0.00 15.00 0.00 0.00 0.00 1997 Wembley 0.00 0.00 10.00 0.00 0.00 0.00 10.00 0.00 1997/93 Coteminas 15.00 0.00 4.00 18.18 15.00 0.00 4.00 18.18 1998 Arteb 20.00 0.00 7.00 20.00 20.00 0.00 7.00 20.00 1998 BSC 14.00 0.00 0.00 7.50 14.00 0.00 0.00 7.50 1998 Dixie Toga 0.00 0.00 15.00 0.00 0.00 0.00 15.00 0.00 1998 Empesca 5.00 10.00 0.00 0.00 5.00 10.00 0.00 0.00 1998 Fosfertil 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1998 Fras-le 10.00 0.00 10.00 0.00 10.00 0.00 6.70 0.00 1998 Icatu Equity 0.00 0.00 30.00 0.00 0.00 0.00 0.28 0.00 1998 Randon 7.00 3.00 0.00 0.00 7.00 3.00 0.00 0.00 1998 Saraiva 15.00 0.00 3.00 0.00 15.00 0.00 3.00 0.00 1998 Tecon Rio Grande 7.50 5.50 0.00 18.00 0.00 0.00 0.00 0.00 1999 Eliane 32.00 13.00 0.00 0.00 0.00 0.00 0.00 0.00 1999 Vulcabras 20.00 0.00 0.00 0.00 20.00 0.00 0.00 0.00 Total Portfolio: 922.97 95.32 270.44 1,133.11 806.24 76.75 236.01 1,073.97 Approvals Pending Commitment FY Approval Companiy Loan Equity Quasi Partic Total Pending Comunitment: 0.00 0.00 0.00 0.00 - 94 - Annex 10: Country at a Glance BRAZIL: Northeast Microfinance Development Project Latin Upper- POVERTY and SOCIAL America middle- Brazil & Carib. Income Development diamond* 1998 Population, mid-year (millions) 165.9 502 588 Life expectancy GNP per capita (Atlas method, US$) 4.570 3.940 4,860 GNP (Atlas method, USS billions) 758.0 1978 2,862 Average annual growth, 1992-98 Population (%) 1.4 1.6 1.4 Labor force (%) 1.7 2.3 2.0 GNP Gross Most recent estimate (latest year available, 1992-98) per primary capita enrollment Poverty (X of population below national poverty line) 17 Urban population (% of total population) 80 75 77 Life expectanev at birth (years) 67 70 70 Infant mortalitv (per 1. 000 live births) 34 32 27 Child malnutrition (% of children under 5) 6 8 Access to safe water Access to safe water (% of population) 69 75 79 Illiteracv (% of population age 15+) 16 13 11 Gross primary enrollment (% of school-age population) 123 113 108 -Brazil Male - Upper-middle-income group Female KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1977 1987 1997 1998 Economic ratios' GDP (US$ billions) 176.2 294.1 820.4 750.8 Gross domestic investmenVGDP 22.1 22.3 21.3 21.2 Exports of goods and serviceslGDP 7.3 9.5 7.6 6.9 Trade Gross domestic savings/GDP 21.4 25.6 18.6 18.8 Gross national savingslGDP 19.7 21.8 16.9 16.6 Current account balance/GDP -2.9 -0.5 -4.1 -4 7 Interest pavmentslGDP 1.2 2.1 1.2 14 Domestic Investment Total debttGDP 23.9 40.7 23.6 28.2 Savings Total debt servicelexports 42.5 41.7 57.4 67.7 Present value of debtlGDP 22.5 Present value of debtlexpouts 277.4 f977-87 1988-98 1997 1998 1999-03 Indebtedness (average annual growth) GDP 3.0 2.4 3.2 0.2 3.0 Brazil GNP Per capita 0.5 0.5 1.9 -1.4 1.0 Upper-middle-income group Exports of goods and services 10.1 4.8 1.8 0.2 6.2 STRUCTURE of the ECONOMY 1977 1987 1997 1998 Growth rates of output and investment 1%) (% of GDP) Aariculture 14.7 10.0 8.1 86 12 . Industry 386 45.9 35.2 375 Manufacturing 29.3 32.0 22.8 24 3 Services 46.7 44.1 567 539 o s s Private consumption 69.2 62.3 63 2 68 5 , 94 SS 26 s7 98 General government consumption 9.4 12.2 181 12.7 GDI e6GDP Imworts of goods and services 7.9 6.2 10.2 9.2 (average annual growth) 1977-87 1988-98 1997 1998 Growth rates of exports and imports (V. Acriculture 3.5 2.5 1.9 0.5 40 - Industrv 2.7 1.8 5.5 0.5 Manufacturing 2.3 0.7 3.8 0.5 20 Services 3.2 2.6 3.5 1.2 Private consumption 3.6 5.3 2.4 -3.4 o 7 9 General government consumotion 4.0 -1.5 8.0 2.1 93 _ss s4 _S _s 97 as Gross domestic investment -1.3 2.1 6.2 0.1 20 Importsofgoodsandservices -2.6 134 139 8.9 Exports .-Imports Gross national product 2.7 2.0 3 3 0.0 Note: 1998 data are preliminary estimates. * The diamonds show four kev indicators in the countrv (in bold) compared with its income-oroup average. If data are missing, the diamond will be incomplete. - 95 - Brazil PRICES and GOVERNMENT FINANCE Domestic prices 1977 1987 1997 1998 Inflation (%) (% change) 3,000 Consumer prices .. 228.3 6.9 2.7 2 .000 Implicit GDP deflator 46.2 204.1 7.8 0.0 1,000) Govemment finance o (9 of GDP, includes cuwentgrants) 0s 96 97 98 Current revenue . 10.4 18.6 21.2 -reon 9 Current budget balance .. -1.4 -1.8 -4.6 GDP deflator OCPI Overall surplusideficit .. -2.8 -2.7 -5.7 TRADE 1977 1987 1997 1998 Export and import levels (USS millions) (US$ migglonsJ Total exports (fob) . 26,225 52,990 47,176 90,000 Coffee .. 2,185 3,094 2,505 Soybeans .. 2,325 5,729 4,580 60,000 Manufactures .. 14,331 32,736 27,601 Total imports (cif) .. 15,053 61,354 53,012 40,000 Food .. 500 3,290 2.961 20,000 Fuel and energy .. 4,674 3,220 3.903 Capital goods er 3,958 26,232 25,262 0 92 93 94 95 96 97 99 Export price index (1995=100) .. 78 96 92 Import price index (1995=100) .. 81 95 84 INExports 0imports Terms of trade (1995=100) .. 97 101 108 BALANCE of PAYMENTS (U5$ millions) 1977 1987 1997 1998 Currentaccount balance to GOP ratio (%) Exports of goods and services 13,003 28,073 56,831 55,479 2 Imports of goods and services 14,646 17,749 74,147 70,517 Resoume balance -1,643 10,324 -17,316 -15,038 0 Net income -3,469 -11,699 -18,331 -21,794 1 9 92 Net currenttransfers 4 -43 2,216 1,886 -2 Current account balance -5,108 -1,418 -33,430 -34,946 Financing items (net) 5,629 363 25,629 26,455 Changes in net reserves -521 1,055 7,801 8,491 .91 Memo: Reserves including gold (US$ millions) 7,256 6,420 51,729 43,366 Conversion rate (DEC, locaYUSS) 5.14E-12 1.43E-8 11 1.2 EXTERNAL DEBT and RESOURCE FLOWS 1977 1987 1997 1998 (US$ millions) Composition of total debt, 1998 (USS millions Total debt outstanding and disbursed 42,037 119,820 193,663 212,069 A: 6,298 IBRD 1,371 9,384 5,743 6,298 c: 5,310 IDA 0 0 0 0 G49,229 D: 5,264 Total debt service 5,737 11,956 38,091 44,049 E:12,644 IBRD 204 1,555 1.428 1.373 IDA 0 0 0 0 Composition of net resource flows Official grants 5 35 63 80 Official creditors 415 10 -1,820 -2,571 Private creditors 5,708 -690 19.890 -268999 Foreign direct investment 1,833 1,225 19,652 23,737 Portfolio equity 0 78 5,300 -1,852 r: 133,324 World Bank program Commitments 319 1,394 1,104 1,291 A -IBRD0 E-Bilateral Disbursements 299 915 1,416 1,240 |8-IDA D-Othermutilateral F-Private Principal repayments 101 867 1,049 995 C - IMF G - Short-termn Net flows 198 48 368 245 Interest payments 104 688 380 378 Net transfers 95 -641 -12 -133 Development Economics 91919EI - 96 - Additional Annex No.: 11 Framework for Microfinance in Brazil (Extractedfrom the Report: "Microfinance Prospects in Brazil" prepared in conjunction with tlhe proposed project.) Background 1. Brazil, the largest country in Latin America in terms of land area, population and Gross Domestic Product, is well behind most other countries in Latin America in the development of its micro-finance industry despite having a large and dynamic micro-enterprise sector. This is particularly surprising given that many micro-finance practitioners point to the city of Recife, in the Northeast Region of Brazil, as the home of the first "modem" micro-finance organization in Latin America, Projeto Uno, an NGO founded in 1971 which was a predecessor of the current CENAPE programs in Brazil.. 2. The most common explanations for the slow growth of micro-finance are: (i) macro-economic instability until fairly recently; (ii) the "crowding -out" effect of subsidized Government credit lines; and (iii) legal and regulatory impediments faced by non-bank institutions. While all of these factors undoubtedly create constraints on micro-finance development, intemational experience suggests that none, in and of itself, is a sufficient impediment to account for Brazil's relative lag in the supply of micro-finance services. However, review of the micro-finance environment in Brazil does point to several factors which warrant attention if Government wishes to provide a more conducive framework for future development of the industry. Basic Indicators 3. Brazil has the world's fourth largest land area, at 8.55 million square kilometers, the fifth largest population, at 164 million people, and the eighth largest economy. It's gross domestic product of over $784 million in 1997, approaches that of China and is well over twice that of Mexico, the second largest economy in Latin America. The Brazilian economy is highly diversified with services and industry representing the highest share of GDP (Table 1). Agriculture, which represents only 10 percent of GDP, contributes 30 percent of the value of total exports and is the basis of Brazil's important agro-processing industry which accounts for a further 20% of GDP. Table 1: Brazil: Sectoral Distribution of GDP and Growth, 1997. Agriculture Industry Services TOTAL % GDP 10.0 38.34 51.6 100 Sectoral Growtlh 0.3% 1.1% 5.3% 3.1% Source: IBGE/BACEN 4. While Brazil is a large and relatively prosperous country in overall terms, it also has the dubious distinction of leading the Latin American region in terms of the number of people below the poverty line, and is a world leader in income inequality (Gini-Index). The poorest 10% of Brazil's population account - 97 - for less than one percent of income, while the top ten percent accounts for almost half (48.9%). While several estimates of poverty exist, the World Bank conservatively estimates that about 24 million Brazilians fell below the poverty line in 1990, equivalent to 17.4 percent of the population. 5. The incidence of poverty is not distributed equally throughout Brazil. The share of population below the poverty line ranges from 6.9 percent in Sao Paulo, to almost a third of the population in the Northeast Region. In fact, the Northeast Region, while accounting for only about a quarter of Brazil's population and 20 percent of its land area, contains over half of Brazil's poor. Despite rapid urbanization, rural and urban areas contribute about equally to national poverty, reflecting the much higher poverty rates in the countryside. 6. Basic education remains a major challenge in Brazil. Per student educational expenditures have varied from US$130 to US$1,000. Although primary enrollments have improved steadily from just over 60 percent in the late 1960s to well over 80 percent at present, high dropout rates result in low school completion. Only 45 percent of children in the relevant age group are enrolled in secondary school, compared to an average of 53 percent for the Latin American Region and 60 percent for all middle-income countries worldwide. Macro-Economic Management 7. Brazil was, for many years, synonymous with high inflation, reaching a peak of 2,668 percent annualized rate in 1994. Better than most countries, Brazil was able to adapt to high inflation rates through widespread indexation of prices. However, the additional costs to the economy of price instability and the inequitable burden of the "inflation tax" on the poor led Government to institute an aggressive stabilization program, the Real Plan, in mid-I 994. The Real Plan introduced an exchange rate anchor within a fairly rigid band, and combined with de-indexation of the economy and tight credit and monetary policies, resulted in a rapid decrease in annual inflation to 10 percent by 1996, a rate which has remained relatively stable to-date despite the recent devaluation. 8. Economic stability contributed significantly to acceleration of the annual growth rate from close to zero in 1992, to an average of almost 4 percent since 1994. International financial markets reacted favorably, with direct foreign investment increasing to US$9.2 million in 1996 compared with US$1.3 million in 1993. Spreads on new public borrowings declined from about 530 basis points over US Treasuries in 1993, to below 200 basis points in 1997, and maturities lengthened significantly. 9. The Real Plan suffered its first serious test in late 1998, when the financial crisis in East Asia and Russia resulted in massive withdrawals of short-tenm foreign capital by investors fearful of a devaluation. In order to stem the capital outflows, Government allowed the real to float outside the band and initiated a number of reforms aimed at reducing Government's fiscal deficit. The swift action on the part of Government appears to have stabilized the real, which lost almost 60 percent of its value in early 1999, from 1.25 to 1.95 realize per dollar. The Informal Sector 10. High poverty rates and an open economy are generally consistent with large numbers of micro-enterprises. Nationwide statistics prepared by SEBRAE estimate almost 9.5 million micro-enterprises, with over two million non-agricultural micro-enterprises located in the Northeast Region alone. According to SEBRAE's relatively broad definition of micro-enterprises as industrial firms with up to 19 employees, and service and commerce firms with up to 9 employees, as much as 90 percent of all - 98 - firms are micro-enterprises, accounting for 35 percent of employment and 16 percent of gross receipts. These "micro-enterprises" are most prevalent in commerce and services, where they represent 94 percent and 91 percent of firms, respectively. Applying a stricter definition of microenterprises as those firms with up to four workers irrespective of sector, micro-enterprises still account for 46 percent of industrial firms, 78 percent of firms in commerce, and 82 percent of service firms. 11. Not surprisingly given its economic profile, the Northeast Region has the highest percentage of its labor force, 61 percent, working in enterprises with up to five employees. This is particularly true in agriculture, commerce and services (Table 2). Table 2: Distribution of Economically Active Population by Sector in Northeast % (figures in parenthesis are for Brazil as a whole) Sector/ Overall Agriculture Manufacturing. Construction Commerce Services Firm Size I to 5 persons 61 77 37 54 74 85 (50) (74) (17) (55) (57) (81) 6 to 10 persons 7 10 10 6 6 5 1(7) (10) (8) (5) (10) (6) Morethan 10 32 13 54 40 21 10 persons (43) (16) (76) (40) (33) (13) 12. There is a little information in Brazil which provides a profile of the microentrepreneurs as well as the micro-enterprises One survey which did cover both was carried out by the Banco do Nordeste in late 1997 as part of market research in preparation of its micro-finance program, CrediAmigo. The survey included 1,381 interviews with micro-entrepreneurs in five locations throughout the Northeast Region, as well as interviews with key community informants (church leaders, police, merchants). The survey locations included two large, state capital cities (Recife and Fortaleza), a smaller state capital city (Sao Luis), a medium-sized commercial town in the interior (Picos), and a smaller commercial town (Limoeiro do Norte), and an agricultural marketing town (Timbauba). The average number of workers, including the owner, in each micro-enterprise was less than two, suggesting that the SEBRAE's larger definition of micro-enterprises may not be at all representative of the informal activities normally supported through micro-finance programs. 13. Table 3 summarizes the main results of the survey as relates to the micro-entrepreneurs, most of whom worked in commerce (77 percent) followed by services (15 percent) and production (8 percent). The survey indicated a surprisingly high proportion of men amongst the sample, which is inconsistent with many other countries where micro-enterprise activity is dominated by women. (This may be explained by the fact that women entrepreneurs often work from home businesses which are not easily identified by an interviewer.) Despite the common perception of the poor as transient in the Northeast Region, Sao Luis was the only location where the majority of those interviewed had migrated from elsewhere. Most micro-entrepreneurs had completed primary and at least part of first grade, although up to 11 percent declared themselves to be illiterate. Educational level did not vary with respect to gender, but there was some positive correlation between educational level and sales volume. Those who had established micro-enterprises tended to have lived in the location for more than five years and generally had close to ten years experience in their business. Table 3: Social Profile of Microentrepreneurs in the Northeast Region - 99 - % Male Avg. Age Family % Native Time in Education Time in Location Size to Local Location Level Business Fortaleza 62.1 35 4 54.1 >5 First 10 lyrs Recife 62.7 33 4 76.4 >5 First 12 yrs SaoLuis 56.9 32 5 43.8 >5 Primary 8 yrs Picos 74.7 34 5 66.0 >5 First 9 yrs Limeiro do 74.2 35 5 76.1 >5 First 8 yrs Norte 7Tmbauba 56.7 45 5 83.1 >5 First 11iyrs 14. The survey also provides information on the origin and frequency of purchases of and payments for stock and raw materials, important detenninants of the potential savings in financial and transactions costs from use of an efficient, microfinance loan product. The majority of micro-entrepreneurs (over 80 percent) purchased their stock and raw materials from commercial suppliers in the same municipality. Only in the case of the rural market town, Timbauba, did a majority of businesses (57 percent) indicate that their purchases came from ariother city or state. 15. The figures in table 4 show that while the frequency of purchases demonstrated some variability between locations, payments for purchases were more consistently done on a cash basis. This suggests th,at supplier credit is unavailable or too expensive for most microentrepreneurs who finance their inventory with their own funds or by borrowing. In addition, as close to half of all micro-entrepreneurs purchase their stock on a daily or weekly basis, access to longer-term financing may reduce the transactions costs represented by the time spent traveling to and from suppliers. Except in the case of highly perishable goods, this time away from the business of selling represents a high, avoidable opportunity cost for the micro-entrepreneur. Table 4: Frequency of Purchases and Payments in % Daily Weekly Bi-weekly Monthly Others Location (Cash) Fortaleza 27.5 35.1 14.25 19.85 3.3 (Purchases) 8.4 6. 3 35.6 1.6 48.2 (Payments) Recife 18.5 25.6 9.4 40.1 6.4 86.0 3.6 2.0 7.4 1.0 Sao Luis 17.4 38.4 9.3 31.1 3.9 81.8 4.4 2.4 7.1 4.4 - 100- Picos 2.7 54.8 12.3 26.7 3.4 100.0 0.0 0.0 0.0 0.0 Limeiro do 4.7 39.5 5.8 48.8 1.2 Norte 1.8 8.2 0.0 4.7 85.9 TImbauba 5.0 43.3 15.0 28.3 8.3 68.4 0.0 5.3 14.0 12.3 16. Frequency of sales and monthly cash-flow provide a good indication of the ability of micro-entrepreneurs to potentially service a formal loan obligation. In the case of the micro-entrepreneurs interviewed, almost all of those in large cities (Fortaleza, Recife, Sao Luis) were able to tum-over their inventory within a week. In the case of Picos, Limoeira do Norte and particularly Timbauba, tum-over tended to be much slower, requiring up to a month or more. In all locations, the months of October, November and December were identified as the months of greatest sales. Access to Formal Financial Services 12s,000 mEE .E 8,000 MI'O. =- Population per Bank Branch 4,000 2,000 XE o~~~~~~~~o Figure 1: Population per Bank Branch 17. Brazil, compared to many of its Latin American neighbors, is a relatively well-banked country both in terms of the geographical coverage of its retail infrastructure and the variety of financial institutions operating in the market. Brazil's financial sector is comprised of 223 banks and a total of 1,936 financial institutions authorized by the Central Bank whose assets are roughly equivalent the country's GDP. Brazil's bank branch density - measured as population per branich - is equal to just under 10,000 inhabitants per branch, which is comparable to other upper middle income countries in Latin America, but well below that of OECD countries (Figure 1). (Bank branch density is becoming a less accurate indicator of access to financial services as banking services are increasingly provided through the internet, smart cards and ATMs throughout both developed and developing countries.) These branches are divided between both private and public commercial and multiple banks, public savings banks, investment banks and development banks (Table 5). Table 5: Number of Banking Institutions and Branches by Type (August 31, 1999) -101 - Type of Bank Institutions Branches Commercial Banks 24 3,923 Federal Govemment-Owned 2 2,986 State Government-Owned 1 256 Brazilian Private 1 1 Brazilian wlForeign Control 3 622 Foreign w/Brazilian Subsidiary 15 53 Cooperative 2 5 Multiple Banks 172 10,735 Federal Government-Owned 4 982 State Government-Owned 11 1,593 Brazilian Private 97 4,905 Brazilian w/ Foreign Control 46 2,446 Brazilian w/ Foreign Participation 14 809 Savings Banks 1 1,692 Federal Govemment-Owned 1 1,692 Development Banks 5 8 Federal Govemment-Owned 1 2 State-Govenmment-Owned 4 6 TOTAL 202 16,358 18. The number of branches has declined from 1994 to 1998, reflecting the on-going consolidation of the banking sector (Table 6). The reduction in branches has been uneven across regions, with the poorer regions of the North, Northeast and Central West accounting for a disproportionate share of reduced - 102 - banking infrastructure Table 6: Bank Branches by Region (December 31 of year indicated) Region 1994 1998 % Change North 704 552 -21.5 Northeast 2857 2360 -17.3 Southeast 8684 8527 -1.8 South 3724 3363 -9.6 Central West 1431 1200 -16.1 Brazil Total 17400 16002 -8.0 19. This has aggravated the inter-regional disparities in banking infrastructure whose presence reflects economic activity more than population density. Figure 5 shows that in terms of the public policy perspective of access to financial services as measured by the rough proxy of population per bank branch, the North and Northeast Regions are significantly under-served relative to other regions of Brazil. However from the commercial banker's perspective of potential funds intermediated as measured by the rough proxy of GDP per bank branch, the North and Central Regions may represent opportunities for profitable expansion of branches relative to the rest of the country, while the Northeast is relatively better served. This suggests that the opportunities for private banks to increase their presence in the Northeast are iimited, unless they can significantly reduce their overhead and operational costs or identify lines of business with superior profitability to those in other regions. 60000 40000-~~ Figue 02 ReginaluopultionpereankBranc 30000^ | 2 g g X | lBranch 20000 0 GDP per Bank 10000 LXL X _lLBranch 0 2 (~~~~ Figure 2: Regional Population per Bank Branch 20. Despite the presence of a dynamic, innovative and retail-oriented private banking sector and increasing privatization, public banks continue to play an important role in Brazil's financial sector. Public banks account for 46 percent of bank branch infrastructure and for 55 percent of financial sector assets. In - 103 - the Northeast Region, the primary Government-owned development bank, Banco do Nordeste, accounls for 86 percent of all bank financing in the region. 21. Credit to the private sector, representing 30.7 percent of GDP in 1996, is equal to or higher than that of most Latin American and middle-income countries, but is well behind high-income and faster - growing lower and middle-income countries. Lending by private banks is concentrated in loans to industry and housing loans with agricultural lending primarily handled by the public banks and individual and commercial lending by non-bank financial and non-financial institutions (supplier and retail credit). Despite the dominant presence of the public sector, and in particular the Caixa Economica Federal, in housing finance, private bank participation is significant, due in large part to incentives provided through requirements on the application of savings. 22. The ability of Brazil's private banking sector to assume an increasing share of financial services provision from the public sector is limited, in the short-run, by the high cost of private credit. Real interbank rates have remained above 16 to 24 percent on short-term borrowings despite macroeconomic stability over most of the past five years. Real-denominated commercial, term lending by private banks is generally limited to sixty days at typical interest rates of over 65% per year. Consumer loan rates (rates for retailer financing, overdrafts and personal loans), while declining, currently average between 95 peircent for personal and direct consumer credit, to 178 percent per year for check overdrafts. This compares to an average funding cost (30-day Certificate of Deposit (CDB)) of 21 percent per year, implying an average annualized spread of 62 percent. Table 7: Operating Costs of Commercial Banks Country Op. Exp./Total Assets Brazil 8.0% Argentina 5.7% Chile 2 to 4% Germany 2 to 3% U.S. I to 2.5% 23. The Central Bank, concerned about the high cost of borrowing for both businesses and individuals, has undertaken a thorough review of the cost of bank credit in the Brazilian financial system. The study has extended the traditional view that large spreads reflected the relative inefficiency of Brazilian banks (Table 7). While the study verified high administrative costs, particularly in the case of individual loans (administrative costs account for 29 percent of the spread for individual loans compared to 19 percent for loans to companies), which in part reflects the low leverage of Brazilian banks (15 percent average capital to asset ratio); the Central Bank review has identified taxes on financial transactions and bank profits, and high default rates as equally significant sources of costs (Figure 3). - 104 - 100% 80% 8 Profit Margin 60%/. | | | | l S @ ¢ g - m L | | S | | W ODefault 40% 0~~~~~~~~~~~~~~ Taxes 20%t * §. l U Administrative Costs 20% Total Individual Business Figure 3: Composition of Banking Spreads for Individual and Business Loans 24. In order to address these issues, the Central Bank announced several measures on October 14, 1999 aimed at reducing the cost of credit. First of all, the tax on financial transactions (IOF) for individual loans was reduced froni 6 percent to 1.5 percent per annum, equivalent with the existing IOF for business loans. Further tax relief through elimination of the turnover tax (COFIN) is included in the general tax reformn program expected to become effective in CY200 1. 25. The Central Bank has also focused on the largest, individual component of banking spreads - the high level of default. Default costs account for an average of 28 percent of the spread on individual loans, and 40 percent of the spread on commercial loans. Past due loans (60 day portfolio-at-risk measure) for the fifty largest banks in Brazil in December 1998 averaged 3.2 percent of loan assets, although in the largest public banks this ratio ranged from 14 percent to 22 percent. (Banco do Brasil, Banco do Nordeste and Banco do Estado de Sao Paulo. The Central Bank is providing banks with greater recourse for credits with real guarantees in the case of client bankruptcy, and the right to continued collection of principal payments during judicial proceedings conceming the interest portion of the loan. 26. Accompanying these efforts to reduce the costs incurred by the banks, the Central Bank has also taken measures to ensure that final borrowers benefit from lower lending rates. The Central Bank intends to facilitate comparison of the cost of credit by disclosing the lending rates charged by each bank on the Internet and requiring banks to post all rates and fees in their branches. Loan contracts will also have to present detailed information regarding the full cost and conditions of the loan. 27. In addition to these efforts to reduce costs directly associated with lending, the Central Bank is also taking measures to reduce the costs associated with mobilizing funds from the public through demand deposits, time deposits and investment funds. The reserve requirements on demand deposits has been reduced from 75 percent to 55 percent. Reserve requirements for time deposits have been reduced from 20 percent to zero. Reserve requirements for investment funds were also reduced to zero from 50 percent for deposits of less than 30 days and 5 percent for deposits of 30 days or more. 28. These measures are not expected to have an immediate impact on availability of funds. Increased savings, particularly for term funds, depends on continued macro-economic stability, on confidence in the banking sector, and on development of attractive, longer-term, contractual savings instruments, which in tum is dependent on developments in the pension, insurance and housing finance sectors. The World Bank is assisting the Central Bank of Brazil in addressing issues of banking supervision and wider financial sector development issues in the context of its Capital Markets Technical Assistance Loan. - 105 - 29. Almost all real-denominated term lending is provided by the public banks, largely through specially-designed lines of credit intended to promote specific economic activities or socio-economic groups. The National Bank for Economic and Social Development (BNDES) provided over US$7.6 billion in termn credit in 1995. Banco do Nordeste lent almost $1.4 billion in 1998 alone on directed credit programs (Table 8) funded by the Constitutional Fund for the Northeast (FNE), the Worker Assistance Fund (FAT), and funds provided by BNDES. Table 8: Banco do Nordeste Credit Lines, 1998 PROGER PRONAF PROTRABALHO PROCERA Cedula (Pilot Total (Development (National (Program to Promote Land Reform Project to Program for Program to Employment and Program Assist Land Employment Strengthen Improve the Quality of (PROCERA-FN Reform) Generation and Family Life of Workers) E) Income) Agriculture) Numberof 44,737 156,343 22,871 35,185 207 259,343 Loans Value (R$ 276,416 671,326 299,783 94,585 30,298 1,372,408 million) 30. PROGER, for example, is targeted to households with annual incomes below R$48,000. PROGER finances working capital for up to two years, and investment capital for up to five years with two years grace period. Borrowing is limited to a total of R$48,000 for both working and investment capital and both are charged a nominal annual rate of 8.75 percent. 31. PRONAF also finances both working capital and investment, but limits borrowing for working capital to R$5,000 per household for up to two years at a 5.75 percent nominal, annual rate. Investmen" loans of up to R$ 15,000 per household are provided for up to eight years, with a two year grace period, at an interest rate of TJLP (Official long-term interest rate) plus 6 percent. Other directed credit programs have similar characteristics in terms of loan size, interest rate, term and grace period. 32. While most private banks and other private financial entities, to the extent they are permitted under their Central Bank charter, provide a broad range of financial services, including savings and payments, public banks tend to have more restricted functions. For example, BNDES works essentially as a second tier bank which supplies funds to public and private institutions at preferable rates consistent with its economic and social development orientation. The Federal Economic Savings Bank (CEF) is the principal lending agent of the national housing system. Banco do Brasil, which is the largest government-owned bank, is the main lender to the agricultural sector in Brazil. While many of these entities offer multiple banking services, they tend to be focused on administration of credit lines, with few incentives to provide customer-oriented savings or payment services. Access of Micro-enterprises to Financial Services 33. Despite Brazil's extensive banking infrastructure and the large number of Govemment sponsored credit lines, few micro-enterprises have access to bank credit. According to SEBRAE statistics, 84 percent - 106 - of micro- and small enterprises in commerce and 88 percent in the service sector do not receive credit. It should be remembered that this definition of micro-enterprises includes firms much larger than the traditional micro-enterprise working in the informal sector. 34. For the smaller micro-enterprises, the Banco do Nordeste study provides a more accurate picture, at least for those operating in the Northeast Region. According to the survey, as little as 2 percent of the micro-entrepreneurs have access to bank credit, depending more on suppliers, family and money-lenders ( ajiotas). In fact, the majority do not borrow at all (Table 9). Table 9: Sources of Financing in the Northeast Area Banks Moneylender Supplier Family No Credit Fortaleza 3.0 9.7 17.9 2.2 63.8 Recife 2.5 2.3 14.0 18.0 63.2 Sao Luis 1.9 0.8 7.8 1.2 88.7 Picos 4.8 2.4 23.0 10.6 58.5 Limoeiro do 5.7 1.1 12.5 10.2 70.5 Norte Timbauba 3.3 3.3 6.7 3.3 83.3 35. Average monthly interest rates paid, primarily to suppliers and moneylenders, are very high in real terms, particularly in relation to the directed credit lines offered by the public banks (Figure 4). The primary reasons given by microentrepreneurs for not obtaining bank credit is their difficulty in meeting documentation and guarantee requirements. In addition, suppliers and moneylenders tend to provide a more flexible lending environment and greater convenience. Ei Fortaleza 25 r .Recife 15 OSao Luis 10 OPicos 0 * Linmoeiro do 0 -Norte E Timbauba Figure 4: Monthly interest rates on loans in the informal sector in the Northeast - 107- 36. While the "intimidation factor" of banks and bank branches is often suggested as a major impediment to micro-entrepreneurs seeking bank credit, the survey indicated that a much higher proportion of micro-entrepreneurs have savings accounts in banks (Figure 5). This suggests that it is the lending service provided, as well as the application requirements which discourage many micro-entrepreneurs frorn seeking bank credit. 25 15 M . 1 1 Loans 10 I E' 5 Fortaleza Sao Luis Limoeira do Norte Figure 5: Percentage of microentrepreneurs interviewed with loans vs. saving accounts with commercial banks in the Northeast Microfinance Programs in Brazil 37. Given the huge, potential market for micro-finance services, the high interest rates paid to inforrial lenders, and the lack of penetration by the formal financial sector, it is not surprising the there are several micro-finance programs operating in Brazil. The list of programs included in Table 10, while representing many of the best-known programs in Brazil, is not exhaustive. The market for micro-finance services is evolving very rapidly in Brazil with new programs emerging almost monthly. With the exception of the Federacao Nacional de Apoio aos Pequenos Empreendimentos (FENAPE) network, the micro-finance programs have been operating for three years or less and so are still developing and refining their methodology. In order to contrast these programs with a mature, "international best-practices" experience in Latin America, similar information is provided for BancoSol in Bolivia (Information for PRODEM is for December 1988 and for BancoSol is for June 1995). Given the short history of most of the Brazilian micro-finance institutions, information for PRODEM (the NGO predecessor of BancoSol) at a similar stage of development (32 months of operation) is provided in parentheses. 38. The four Brazilian programs can be distinguished into two categories. VivaCredi of Rio de Janeiro, and PortoSol of Porto Alegre, are focused exclusively on their local market. CrediAmigo, which is a program of Banco do Nordeste, and the FENAPE netwvork define their market as regional or national and have pursued high growth strategies accordingly. Unlike BancoSol, none of the programs is leveraged with funds from deposit accounts or private bank loans, though several receive subsidized loans from the; - 108 - National Bank for Social and Economic Development (BNDES). Table 10: Overview of Selected Microfinance Programs in Brazil (Figures are as of July 31, 1999) Program Name CrediAmigo VivaCredi PortoSol FENAPE BancoSol (PRODEM) Institutional Type Bank Division NGO Civil Association NGO Private Bank Includes Municipality (former NGO) of Porto Alegre, State of Rio Grande do Sul, Federation of Commercial Associations and Association of Young Business Owners of Porto Alegre. Operations Began: 11/97 3/97 1/96 5/87 3/87 (32 months) Source of funds Transfers from Equity, IDB, Govt. Grants, Govt. loans, Equity, IDB, Govt. Equity, parent Banco do loans, private international grants loans, UNICEF USAID, Nordeste, IBRD financial company (GTZ, IAF) Government, donation commercial loans, deposits Geographic Area Northeast Region Municipality of Municipality of Porto Urban - South, Urban towns Rio de Janeiro Alegre and suburbs Southeast, throughout Northeast, North Bolivia with Regions focus on La Paz Estimated Market 2.5 million 15,000 19,000 6.8 million 1.0 million No. of branches " 51 3 1 45 42 (2) branches" refers to any permanent physical location used as an operational base by the MFI. Guarantees Solidarity Group Cosigner, Cosigner, collateral or Cosigner or Solidarity collateral, proof of solidarity group solidarity group group salary Avg. term 3 6 6 4 9.6 (4) (months) - 109 - Nominal Interest 5% 3.9% plus 1% 3.5% 5.5% 4.0%/t (4.0%) Rate (monthly) administration fee. Frequency of Every 15 days Weekly, bi-weekly Weekly, bi-weekly and Monthly Mainly repayment and monthly monthly monthly but some weekly and bi-m,onthly Total disbursed US$39.1 million US$2.6 million US$7.8 million US$68.2 million US$448.7 million (US$'3.7 million) No. of loans 121,444 2,798 8,751 152,797 936,953 disbursed (15,245) Outstanding US$8.2 million US$631,000 US$1.2 million US$7.3 million US$67.3 Portfolio million (US$;359,000) No. of loans 34,085 951 1,864 23,310 76,679 (5,288) outstanding Avg. outstanding US$241 US$654 US$660 US$314 US$878 balance (US$131) Portfolio Quality 4.0% 5.1% 3.7% 4.0% 5.0%1, (less than 30 day 2.0%/6) portfolio-at-risk measure. No. of loan 213 6 14 75 246 (20) officers Clients/loan 153 158 133 311 312 (267) officer Loan office Secondary grads Secondary grads Secondary grads College students Secondary education level and college and college grads and students students. college students Base Salary Loan US$211 US$368 US$326 US$289 US$438 Officer (US$275) Incentive (% base Average 40% Average 30%% Average 60% Average 70% Average 15% salary) (none) -110- 38. Based on a comparison of the infomnation presented, several characteristics emerge common to most, if not all programs: * CrediAmigo is the only program within a regulated financial institution with its own disbursement and repayment windows. The other programs, similar to PRODEMIBancoSol are NGOs, and disburse through checks which are cashed at banks which also accept repayments. This is representative of microfinance development to date in Brazil where the dominant institutional model has been the NGO with or without Government participation. Programs are funded primarily by their own equity, based on grant funding, in some cases, by low-interest, long-term loans. CrediAmigo has accessed commercial funds through its parent Banco do Nordeste and VivaCredi has equity investment from Finivest, a financial corporation associated with Unibanco. All programs received grants from intemational institutions for institution building activities, and have benefited from intemational technical assistance in the design of their programs. * PortoSol and VivaCredi define a relatively restricted geographic area based on the area in and around the municipality where they currently operate. This is in contrast to CrediAmigo which is pursuing a market which mirrors that of Banco do Nordeste. FENAPE has developed an interesting strategy to provide NGOs with some of the benefits of the economies of scale enjoyed by banks by linking individual CENAPE NGOs throughout Brazil to ensure consistency in the quality of administration and training support. * All programs emphasize shorter-term (up to 6 months) working capital loans. Solidarity group lending is the dominant means of addressing the absence of "real guarantees" for microlending. VivaCredi, whose lending technology was developed based on an individual loan product, is considering moving into solidarity group lending as there has been greater than expected acceptance of this requirement by the microfinance market in Brazil. Unlike PRODEMlBancoSol which has emphasized solidarity group lending throughout its development, the Brazilian programs all offer or plan to offer individual loans for solidarity group customers and new customers who qualify for larger loans than those of typical group members. * Interest rates, while differing in nominial terms, are similar in real terms once administrative fees, prompt payment rebates and repayment calculation differences are accounted for. These rates are consistent with the 4% real effective monthly rate charged by PRODEM/BancoSol and demonstrate that there is considerable demand for credit at interest rates well in excess of those charged by government-financed lines of credit. Also, similar to PRODEM/BancoSol, all programs currently or plan to provide flexibility in repayment frequency so as to better match client cash-flow. These interest rates are consistent with those charged by Brazilian banks for personal loans to individuals who, unlike microentrepreneurs, can provide proof of adequate, salaried income. (The personal loan program of Banco Fricrisa Axelrod in Porto Alegre, charges an effective interest rate of 81.8% per year (6.8% per month) and does not incur the cost of group formation or evaluation of microenterprise cash-flow.) * The historic volume of funds and number of loans disbursed shows that VivaCredi and PortoSol have approached or far exceeded PRODEM's cumulative volume of lending at a similar point in its development, but have fallen far short in terms of loans disbursed. This reflects an historic average loan size of just over US$900 for these programs compared to US$243 for PRODEM. CrediAmigo's historical average of US$322 is closer to that of PRODEM and well below the US$479 average for BancoSol. FENAPE's much slower growth than BancoSol is reflected in a significantly lower cumulative number of loans and total disbursed, despite a similar average, historic loan size of US$446. The increasing historic average loan size between PRODEM and BancoSol, and between CrediAmigo and FENAPE demonstrate - 111 - the tendency for average loan size to increase as borrowers establish repayment capacity and demand larger loans. The current, outstanding loan portfolios of the Brazilian institutions reinforces the distinctions between the localized NGO programs and the more expansive programs. Both VivaCredi and PortoSol have relatively small portfolios in terms of number of loans relative to PRODEM. Their average outstanding loan balances are equivalent to 14.5% of per-capita GDP in Brazil compared to PRODEM's 17.8% of per capita GDP for Bolivia in 1989. Despite its longer history and much larger historical lending, FENAPE's current lending portfolio is smaller than CrediAmigo's both in terms of the number and value of outstanding loans. The average outstanding balance for FENAPE (6.9% of per capita GDP) and CrediAmigo (5.2%) are much smaller than that of the two localized NGO lenders or BancoSol (81.8% of per capita GDP). Even if adjusted using the much lower per capita GDP of the Northeast Region (Per capita GDP for Brazil according to the Atlas method was US$4550 in 1998, while for the Northeast it wa's US$1,423. Per capita GDP in Bolivia was US$734 and US$1073 in 1989 and 1998 respectively.), the average outstanding balance for CrediAmigo (17 percent) and FENAPE (22 percent) suggest that the Brazilian programs have a greater focus on lending to the poor than BancoSol. (FENAPE is also adjusted using the Northeastern GDP figure as over 70 percent of the portfolio of its affiliates are located in the Northeast Region.) * All of the Brazilian programs lend roughly equally to women and men. This is in sharp contrast to BancoSol whose clients are over 70 percent women. While all of the Brazilian programs emphasized that they consider women clients to be easier to work with and more reliable in repayment, they indicated that iin Brazilian society many women allow their husbands to sign for their loans. All programs are developing strategies to improve their outreach to potential women clients. * Only one Brazilian program, FENAPE, has been able to achieve levels of loan officer productivity consistent with PRODEM/BancoSol. The other three programs have average numbers of clients per loan officer well below both PRODEM and BancoSol for which the PRODEM figure represented an historical minimum. All of the Brazilian programs include new loans per month (new clients and renovations) in their salary incentive formulas. Most programs consider an increase in new clients per loan officer of 15 to 20 per month to be achievable on a regular basis. Low average salaries for loan officers compensate, in part, for the low productivity of staff. CrediAmigo salaries and incentive payments typically amount to US$300 per month or about 80% of Brazil's per capita GDP on an annual basis. The other three programs all typically provide salary and incentives equal to about US$500 per month or 130% of per capita GDP. In the case of FENAPE, the higher salary is due primarily to higher incentive payments resulting from the greater productivity of its loan officers. This compares to a total average monthly salary of US$504 for BancoSol, equivalent to 564% of per capita GDP in Bolivia. Adjusting the average salaries for CrediAmigo and FENAPE using the Northeast Brazil per capita GDP (250% and 420% respectively), the programs' salaries are still low compared to BancoSol. Additional client services in the Brazilian programs are limited to training. With the exception of VivaCredi, the Brazilian programs include training. There is a general belief amongst the Brazilian programs that client training will result in improved management of the microenterprise, resulting in a higher capacity for growth and repayment. Training is not a condition of loan approval or disbursement and, in most cases, clients are required to pay for the training. CrediAmigo, as a program of Banco do Nordeste, is the only regulated financial institution, and as - 112- such is the only one authorized to provide deposit, savings and other financial services in addition to lending. CrediAmigo is currently considering development of a savings product. Voluntary savings has become an important source of funding and loan clients for BancoSol and was a primary motivation for PRODEM's conversion into a regulated financial institution. Government and Donor Support of Microfinance Development 39. Throughout the world, local microfinance initiatives have been dependent on Government and donor support for financing and technical assistance during the initial development period when lending technologies are adapted to specific country contexts and track records are established to attract commercial financing and eventually deposits from the general public. In Brazil, with the exception of the FENAPE network which was supported by UNICEF and is affiliated with ACCION, Intl. this support has only emerged in the past two years. The largest assistance program is the Popular Productive Credit Prograrn of BNDES, supported by a US$300 million loan from the Inter-American Development Bank (IDB). The program has two lines of assistance. The first is BNDES Worker which assists in the establishment of productive credit programs in each interested state or municipality, based on the PORTOSOL mixed public/private institutional model. The program criteria require that at least 40 percent of the funds for establishment of the credit programs come from local govemment and the private sector. The amount of BNDES' participation depends on the numnber of municipalities in the state, varying from R$6 million to R$15 million. BNDES funds are lent to the state government for seven years with nine months grace period at a rate equal to the TJLP. Individual credits to final borrowers must be between R$150 and R$5,000 with a maximum term of 18 months and maximum grace period of 3 months. BNDES monitors portfolio quality and if arrears over 30 days exceeds 6 to 8 percent any two consecutive quarters, or exceeds 8 percent in a single quarter, BNDES can request immediate reimbursement of the funds it lent to the program. 40. BNDES Solidarity is targeted to NGOs which already have at least six months experience in providing micro-credit services. The NGO must demonstrate that it was able to mobilize at least 25% of its capital from Brazilian or international public or private donors. BNDES can provide up to R$3 million per loan limited by the size of the NGO's existing loan portfolio. The loan to the NGO is for eight years with six months grace period with quarterly interest payments equivalent to TJLP. The NGO is required to establish a risk fund by retaining one percent of repayments from final borrowers until the fund reaches a total equal to 15 percent of the funds lent by BNDES. Controls on loan portfolio quality are similar to those for BNDES Worker. 41. The Community Solidarity Program under the direction of the Office of the First Lady has taken a proactive stance in microfinance development in Brazil. This organization recently convoked a high-level panel including the Central Bank, BNDES, Banco do Nordeste, microfinance NGOs and private sector bankers to review the legal and regulatory framework for microfinance development. 42. Amongst international donors, UNICEF was an early supporter of microfinance in Brazil, providing much of the start-up capital to the FENAPE network, the longest running and most successful program to-date. FENAPE has received significant international technical assistance as an affiliate of ACCION, Intl 43. The IDB has also provided support to NGO programs through its small grants program by which US$500,000 equivalent grants are provided to NGOs which have demonstrated superior technical performance. Recipients of the grants include a number of the CENAPEs in the FENAPE network, and - 113- PortoSol. 44. The World Bank has focused its support on development of the CrediAmigo program with the Banco do Nordeste in Fortaleza, Brazil. Through reassignment of funds under an existing loan, Banco do Nordeste was able to undertake study tours to successful micro-finance institutions in Latin America and Asia, and to contract international technical assistance from ACCION, Intl. The World Bank has also assisted Banco do Nordeste in obtaining a Japanese PHRD Grant for training and development of their management information systems in anticipation of loans from the World Bank and IDB. 45. VivaCredi was initiated with private donations and financing from the community assistance foundation of UniBanco. Technical assistance was provided by International Project Consult, a German firm which specializes in the development of microfinance programs. Policy Environment for Microfinance in Brazil 46. There are a number of regulatory and legal issues associated with the development of microfinance institutions. Amongst the most commonly encountered are: * Legal Status oJ'NGOs; * Usery Laws and Interest Rate Restrictions * Financial Sector Entry Requirements; * Prudential Supervision; * 7Loan Loss Provisions; * Capital Adequacy Requirements; * Treatment of Non-traditional Collateral; Frameworkfor Secured Transactions; Loan Documentation Requirements; * Operational Restrictions; * lDeposits and Savings; Credit Reporting. 47. Legal Status of NGOs. NGOs play an important role in the development of a country's microfinance industry. NGOs, as altruistic, non-profit institutions with relatively low overhead costs, are generally more willing to test alternative lending technologies focused on the poor, long before commercial banks or other formal financial intermediaries enter the market. The laws which regulate NGOs, and in particular their ability to mobilize donor funds for lending, can have an important impact, particularly in the early years of microfinance development. Programs which are unable to mobilize funds effectively cannot grow at rates sufficient to demonstrate potential commercial viability and may not be able to even serve the growing requirements of existing clients. Brazil has traditionally restricted the ability of NGOs to receive funds from foreign donors, requiring Central Bank approval on a case-by-case basis which resulted in delays and often loss of funding. 48. Usery laws. Brazil's usery law is often mentioned as the most obvious impediment to development of the microfinance industry. Although the law, which restricts nominal interest rates to 2 percent per month and 12 percent in real terms per year, is not systematically enforced, it does create a climate of uncertainty for actual and potential microfinance service providers and investors. 49. Financial sector entry requirements. Entry regulations, such as minimum capital requirements, serve primarily to establish the formal financial landscape by determining the number, types and sizes of - 114- institutions operating in the market. While many requirements are ostensibly for the protection of those financing new institutions (investors, commercial creditors and depositors), they often function primarily to ensure that the regulatory authorities are able to prudently monitor and regulate the financial sector. Most entry requirements, such as review of the institution's financial and management structure, are generally neutral with regard to the institution's target clientele. However, minimum capital requirements, as opposed to capital adequacy ratio requirements, can be an important impediment in the transformation of an NGO microfinance institution into a bank or finance company, or for a microfinance program to be spun off as a subsidiary or independent organization from the sponsoring public or private bank. 50. In many countries in Latin America, successful microfinance programs which began as NGOs have transformed themselves into formal financial institutions in order to facilitate their ability to mobilize debt and equity from the general public in order to finance their expansion. In most cases, NGOs have first converted to financial companies, with their lower minimurn capital requirements, in order to gain access to commercial equity and debt financing and develop a branch network. As the programs continued to grow, these financeras have applied for banking licenses in order to mobilize savings and expand the financial services offered to clients. 51. Brazil's minimum capital requirements (Table I 1), while not the highest in Latin America, are nonetheless relatively high, particularly for an NGO considering transformation into a bank. Utilizing the weighted average outstanding loan balance of US$286 for the four Brazilian programs in Table 10, suggests that full leverage would require a minimum of over 240,000 clients for a bank, and almost 97,000 clients for a finance company; portfolios many times that of the largest microfinance programs currently operating in Brazil. Adjusting this figure for a lower level of leverage of 1:6, consistent with microfinance institutions in their earlier, high growth stages, still suggests portfolios of over 150,000 clients for a bank and over 60,000 for a finance company. Table 11: Minimum Capital Requirements (Central Bank Resolution No. 2607, dated May 27, 1999) and Required Size of Loan Portfolio Institution Minimum Capital Capital Adequacy Min. No. of Clients Min. No. of Clients Requirement Ratio w/ Avg. Loan of wl Avg. Loan of $500 (Assumes that $1000 70% of institution's assets are in its loan portfolio.) Bank US$9.2 million 1:10 128,800 64,000 Finance Company US$3.7 million 1:10 51,800 25,900 52. A corollary of the barrier presented by minimum capital requirements for the institution, is that required to establish new branches. In Brazil, the Central Bank requires an increase in an institution's minimum capital of one percent for each branch established in the country in addition to the "pioneer" branch. In the states of Rio de Janeiro and Sao Paulo, the increase is two percent for each additional branch. This represents a potentially important impediment to addressing some of the regional imbalances in access to financial services through expansion of microfinance institutions. - 115- 53. Bolivia and Peru have chosen to support the entry of regulated, microfinance-focused institutions through the creation of a distinct type of financial entity. These specialized institutions have lower minimum capital requirements (less than $1 million), but with similar capital adequacy ratios, limitations on maximum loan size (3 to 5 percent of net capital), and additional operating restrictions. In both cases, savings deposits are permitted, but not demand deposits. The above approach is consistent with "tiered banking" in which regulations are adapted to the requirements of the microfinance industry. In a tiered banking approach, the Central Bank defines intermediate institutional forns with generally lower minimum capital requirements, limitations on the services - in particular savings services - which can be offered, and generally more stringent prudential guidelines. 54. The Central Bank of Brazil has indicated that they consider the banking sector in Brazil to be" saturated" and have imposed restrictions on entry of new institutions from abroad. Nonetheless, Central Bank officials have indicated that they have no objections to considering sanctioning new institutional structures to serve markets not currently serviced by the banking sector. However, they would like these to emerge from the peculiar needs of the Brazilian market rather than try to anticipate this through laws or regulations. Undoubtedly, the Central Bank's capacity to carry out off-site monitoring and on-site inspections will be an important factor in determining its willingness to authorize new entrants. 55. Prudential Supervision. Although Brazil does not yet have any regulated financial institutions dedicated to microfinance lending, the rapid growth of CrediAmigo and FENAPE, and their interest in deposit mobilization suggest that the Central Bank may wish to develop supervisory guidelines for microfinance portfolios. Microfinance loan portfolios are generally considered to be less "stable" than banks due to the greater volatility of delinquency rates and the consequent greater threat to equity due to the high operational cost structure (typically 30 to 50 percent of assets) of microfinance institutions. In addition, the microfinance lending technology may require regulatory authorities to develop specialized techniques for their off-site and on-site supervisory activities. 56. Standard loan loss provisioning requirements generally do no not reflect the value at risk in a microfinance loan portfolio. Given their rapid turnover and more frequent repayment periods, standard past-due provisioning requirements often exceed the term of microfinance loans. Brazil's Central Bank regulations require full provisioning for any loan with a payment overdue at least 180 days. Given thal: most micro-loans are for no longer than 90 to 180 days, microfinance lending requires a more aggressive loan loss provisioning policy related both to the time overdue as well as the number of installments missed. However, any new classification system should take into account the variability in the terms and conditions of the loans as well as the potential implications for audits of loan classification of institutions with both micro and standard commercial portfolios. 57. Standard capital adequacy requirements may also be inappropriate for microfinance institutions, particularly during periods of rapid growth. Assuming that an institution has been able to meet the minimum capital requirements to become a regulated financial intermediary, the rapid growth in assets typical in microfinance is likely to quickly undermine the cushion of safety against business risk. As discussed above, the potential volatility of microfinance loan portfolios suggests the need for higher capital adequacy requirements - generally in the range of 15 to 20 percent of risk adjusted assets. 58. Non-Traditional Collateral. The use of non-traditional guarantee mechanisms, in particular solidarity group guarantees, poses a special challenge for regulators. As minimum capital, provisioning and capital adequacy requirements are all based on classification of asset risk, the treatment of non-traditional guarantees by Central Bank authorities can have an important impact on the perceived and actual performance of a microfinance institution. Although many institutions utilize the joint-liability -116 - arrangement to reduce transactions costs and to achieve high repayment rates, most central bank authorities, including Brazil's regard solidarity group-backed loans as equivalent to personal loans and therefore essentially unsecured. The actual classification of these and other non-traditional guarantees should be based on their historic performance. 59. Frameworkfor Secured Transactions. Common to most countries rooted in the civil law tradition, Brazil's framework for the creation, perfection and enforcement of security interests serves as a major impediment to the use of moveable property as collateral. Difficulties in registration and, in particular, repossession significantly reduce the willingness of formnal lenders to provide credit secured by property which could disappear or substantially depreciate during long legal proceedings. Similar to the usery law, the legal provisions which prevent non-judicial repossession are rarely enforced, however they do create uncertainty for both borrowers and lenders, resulting in higher costs and a lower volume of credit transactions secured by non-real estate collateral. These transactions are also, appropriately classified by the Central Bank as unsecured loans as concerns provisioning requirements when such loans become overdue. 60. Limitations in the framework for secured transactions can effectively limit the types of lending services provided to microenterprises and/or significantly increase their cost. Although classical microfinance technology, by focusing on cash-flow based lending and solidarity groups, offers effective means to get around problems associated with the use of physical collateral, most programs microfinance programs eventually expand beyond working capital loans, offering investment loans for the purchase of equipment. As these loans represent significantly greater exposure in the case of default, group lending is generally not a viable means of guaranteeing repayment and most programs attempt to guarantee the loan with the equipment purchased or other household property, such as appliances, which are physically easy to repossess. In addition, Use of stocks and inventory can also increase and lower the cost of credit to suppliers who are often the primary providers of credit to small businesses and farmers. 61. Several Civil Law jurisdictions, including the province of Quebec in Canada and New Orleans in the United States, have effectively incorporated key elements of commercial law from Common Law jurisdictions, in particular, Article 9 of the Commercial Code of the United States. The effectiveness of any legal reforms hinges on the introduction of harmless, or non-judicial, repossession and sale by which the lender is able to repossess and sell the property in the first instance and the borrower is obligated to demonstrate that the repossession was unlawvful. Introduction of harmless repossession requires the simultaneous introduction Qf consumer protection legislation which permnits claims of damages above and beyond the value of the collateral in cases of unlawful repossession. 62. Loan Documentation Requirements: As indicated above, micro-entrepreneurs consider documentation requirements for loans to be a major impediment to accessing bank credit. Few microenterprises have updated accounts or even pay taxes on a regular basis. While Brazilian regulations provide banks with substantial latitude in the definition of documentation requirements, particularly for consumer loans, many banks, due to their lack of familiarity with the microenterprise sector impose onerous loan documentation requirements. As the microfinance industry develops and microfinance institutions become more experienced and sophisticated lenders, development of credit scoring models can greatly reduce the risk to the lender and the transactions costs to both the lender and borrower in qualifying a loan. 63. Operational Restrictions. Regulations which restrict operations of financial institutions are often holdovers from a time when either economic activity was largely restricted to certain period of the week for religious reasons or the requirements for manual bank clearing required that banks close in the aftemoon. - 117 - Given current technology, not only are many of these restrictions unnecessary, they also impede the ability of financial service providers to serve clients in a convenient manner. Brazilian labor laws restrict the operating hours of banks to five days a week and no more than five hours per day. While these restrictions do not apply to NGO lenders, they could restrict the ability of commercial banks to attend to microenterprise clients on important market days, many of which fall on weekends and holidays. Care will also have to be taken not to automatically apply these or other restrictions on client outreach as new institutional forms are defined for emerging microfinance institutions. 64. Regulations pertaining to deposits and savings mobilization, particularly as pertains to restrictions on the application of funds in addition to reserve requirements, will have to be revised if this it to become an attractive source of finding for qualifying microfinance institutions. Brazilian Central Bank regulations require, in addition to reserves required for security of the system which must be deposited with the Central Bank, that a large proportion of demand deposits and savings deposits be used in rural and housing credit programs (Table 12). As a result, only 10 percent of demand deposits and 25 percent (45 percent in case of national public banks) of savings would be free for funding microfinance activities. Table 12: Requirements for Application of Deposits and Savings Deposits/Savings Instrument Reserve Requirement Additional Requirement 1. Demand Deposits 65% without remuneration 25% for rural credit of which: * 40% with ceilings of R$40,000 _ * 60% for specific crop financing 2. Time Deposits None None 3. Investrnent Funds None None 4. Contractual Savings 4a. Banks authorized for mortgage 15% with remuneration 60% for mortgage credit of which lending 80% for SFH 1 0% business real estate 10% percent free of restrictions 4.a. Public Banks not eligible for 15% with remuneration 40% for rural credit programs mortgage lending Aapplies to Banco do Brasil, Banco do Nordeste and Banco Amazonias 65. The rural and housing credit programs financed under these restrictions impose limits on the interest rates charged, amounts lent and other terms to the final borrowers. In the case of demand deposit-financed rural credit, the 60 percent of the funds must be lent through programs in which loan terms are based on the type .of crop as determined by national agricultural priorities, rather than credit risk criteria. The remaining 40 percent must be lent through programs aimed at small farmers with loan ceilings of R$40,000. The majority of these lines of credit are operated by Banco do Brasil, which due to its near monopsony power and the relatively low return on the loans, provides a low rate of interest to the banks which provide the mandated funds. In the case of savings-financed housing finance programs, 80 percent of the funding (48 percent of the deposits) goes to SFH which limits the interest rate to 12 percenrt - 118 - per year above the referential rate (TR) for loans up to R$S180,000, as compared to a market rate of 15 percent above TR for non-SFH loans. 66. This policy creates a number of distortions, not only in the application of Brazil's private capital, but also in the incentives faced by financial institutions and eventually their customers, to mobilize deposits. As indicated above, savings services are important to microentrepreneurs and their families and can be an important source of funds for expansion of the microfinance industry. Thus, the directed credit programs supported by the current policies should be evaluated in terms of their distributional as well as economic benefits to the housing and rural sectors and costs in the form of lower retums to the numerous actual and potential low-income savers in Brazil. Proposals to include microfinance within the eligible applications for mandated rural credit funds are unlikely to result in substantial expansion of microfinance at this stage of the industry's development due to the limited number of microfinance institutions which would qualify for the use of the funds without additional Government guarantees. In any case, the high interest rates charged by the leading Brazilian microfinance institutions suggest that there is no need to subsidize their funding as this would simply further distort credit allocation and may lead to supply driven development of micro-lending capacity with the consequent undermining of financial and operational discipline required for truly sustainable development of the industry. 67. Credit Information. Brazil is fortunate to have a rapidly developing credit reporting industry. SERASA, Servicio de Proteccao do Credito (SPC) and Equifax are examples of services which are widely used by businesses to verify a customer's credit standing. These and similar services draw upon information from a variety of private and public sources, such as the Central Bank's registry of checks presented against insufficient funds and overdue utility and tax payments, to provide up-to-date information on any outstanding delinquent payments owed by a potential client. The wide-spread use of these services by the banking and retail sectors has made them an effective deterrent to delinquency as most Brazilians are very concemed to stay out of the reporting systems. 68. In addition to the current status of clients, these services are increasingly providing centralized information on individual credit histories which document an individual or firm's on-time repayment record as well as developing credit scoring models which provide an estimated likelihood of default. Credit histories and scoring models can help both lenders and borrowers reduce the evaluation costs and uncertainties involved with character-based or cash-flow based lending. It also provides additional incentives for prompt repayment by microfinance clients as the positive credit history can be taken with them and applied to other financing and character verification needs. 69. However, several legal impediments related to consumer protection and privacy laws have created uncertainty as to the rights to collect and utilize this information. Laws which require credit information bureaus to request permission to release information make the sharing of such information overly cumbersome to operate. In addition, these broad protections do not compensate for the absence of specific requirements to provide consumers with access to their credit history and rating as well as to reveal who has requested their credit information. Recent Policy Initiatives in Support of Microfin ance 70. Commensurate with the recent growth of its microfinance industry, Brazil has begun to address legal and regulatory issues which are impeding industry development. The Council of Community Solidarity, which is attached to the Office of the President of Brazil, initiated in 1997 a review of the laws and regulations which may impede development of microfinance in Brazil. A working group was established with participation from the Central Bank to review mechanisms to: (i) facilitate the capture of - 119 - extemal resources bvy NGOs for microfinance; (ii) permit microfinance NGOs to operate outside the restrictions of the usery law which applied to all financial entities not regulated by the Central Bank; and (iii) define an altemative to bank branches which are limited in their operations but are not subject to minimum capital requirements. 71. In March 1999, Law No. 9.790 clearly defined the rights and responsibilities of "Civil Society Organizations", including their right to mobilize external funds for activities which include development of microfinance. In July 1999, Central Bank Resolution No. 002627 defined the rights and responsibilities oif "microenterprise credit societies" (Box 3). Also in July 1999, the Presidency issued provisional measure No. 1.914-4 which redefined Brazil's usery law specifically excluding qualified microenterprise credit societies and civil society organizations from its provisions and permitting the National Monetary Council to identiiy other institutions to which the usery restrictions would not apply. 72. The working group is also reviewing the establishment of trust-fund-type arrangements for microfinance programs within regulated banks. The trust funds, similar to the microenterprise credit societies, are intended to facilitate access to concessional funding by providing a transparent mechanism by which banks can segregate the accounting and equity of their microfinance activities which wvould facilitate: monitoring by donors. It is still being determined if these trust funds will provide the basis for special provisions regarding mi.nimum capital requirements for branches or if branches of microfinance programs can be treated as "service posts", similar to microfinance credit societies. The ability of these branches or posts to mobilize savings and their treatment relative to the parent bank is also under discussion. 73. The above policy measures reflect an expectation of continued NGO-focused and donor-dependeni: provision of microfinance services. This is consistent with the industry's relatively recent development in Brazil and the important role of NGOs in establishing the viability of sustainable microfinance in Brazil. Nonetheless, as the rapid recent growth of the FENAPE network and Banco do Nordeste's CrediAmigo program demonstrate, there is ample scope for commercially-based provision of microfinance services on a broad scale. Similar to other countries, it can be expected that the success of these two programs will attract additional, commercially-oriented entrants with a focus on profitability and provision of a broader array of financial services. Experience in Latin America has demonstrated that regulatory issues become most pertinent to the development of the microfinance industry when institutions begin to "graduate" into regulated financial intemiediaries. As indicated previously, the Central Bank is open to new proposals but does not wish to try to anticipate the regulatory requirements of the emerging microfinance industry based on extemal experience, but instead draw on external and internal experience to develop a framework which responds to the emerging needs of the industry. Conclusions 74. Brazil has a large number of microenterprises which account for a significant share of employment. Not surprisingly, microenterprise employment is most important in the poorest regions of Brazil, and in particular in the Northeast. Using population per branch as a proxy for access to banking services indicates that the Northeast and North are the most under-served regions in Brazil. However, using GDP per branch as an indicator of potential business volume, the Northeast in particular presents little incentiVe for private bankers to increase their coverage in the region. This disparity is the primary justification for continued support of publicly-owned banks and directed credit lines. However, survey data indicates that few microenterprises have access to financial services, particularly lending services, from either public or private banks, despite attractive cash-flow characteristics and payment of interest rates to moneylenders and suppliers which are several times those offered by directed credit lines and a demonstrated willingness to utilize savings services. - 120 - 75. Recently, Government, through an NGO-focused apex program with BNDES, and a pilot microfinance program in Banco do Nordeste, has provided technical and financial assistance, in conjunction with intemational donors and technical assistance providers, to develop microfinance programs throughout Brazil. This initiative is consistent with that taken in other countries to test microfinance technology in the Brazilian context and to demonstrate potential commercial viability. Several of these programs are applying international best practice methodologies and growing rapidly. The programs are making very small loans by international standards which appear targeted to the smaller microenterprises. Administrative costs are low, suggesting that these programs will have to focus on improving the productivity of their loan officers if they wish to attain long-nin, full financial sustainability. 76. Consistent with the industry's early stage of development, the commission formed by Comunidad Solidaria with the pariticpation of the Central Bank, has focused on facilitating the access of these programs to internal and international donor funding. While consistent with the industry's early stage of the development, the ability of microfinance to provide a better targeted and more cost-effective means of providing financial services to an under-served segment of Brazil's economy will require development of a commercially-oriented industry. The rapid development of programs such as Banco do Nordeste 's CrediAmigo, and the FENAPE network suggest that this is an appropriate time to identify potential legal and regulatory impediments to the development of commercially-focused institutions, either commercial banks which move "down-market" into microfinance, or successful NGO programs which wish to convert into formal financial intermediaries such as finance companies or banks. 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