PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: 83816 Project Name ENHANCING GOVERNANCE AND STRENGTHENING THE REGULATORY AND INSTITUTIONAL FRAMEWORK FOR MICRO, SMALL, AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT (P147875) Region MIDDLE EAST AND NORTH AFRICA Country THE HASHEMITE KINGDOM OF JORDAN Sector(s) General Finance Sector (100%) Lending Instrument Investment Project Financing Project ID P147875 Recipient(s) THE HASHEMITE KINGDOM OF JORDAN -Central Bank of Jordan (CBJ) Implementing Agency CBJ Environmental Category C-Not Required Date PID Prepared October 20, 2013 Estimated Date of Appraisal October 23, 2013 Completion Estimated Date of Board Approval Concept Review Decision October 2, 2013 Other Decision (as needed) I. Introduction and Context Country Context 1. An inclusive financial system that is operating in a conducive and prudent regulatory and institutional environment can play a pivotal role in job creation, poverty reduction and overall sustainable economic growth. In that context, the proposed Jordan: Enhancing Governance and Strengthening the Regulatory and Institutional Framework for Micro, Small, and Medium Enterprise Development Project aims at setting the regulatory framework for micro finance and non-bank financial institutions (NBFIs), fostering consumer protection, and strengthening credit guarantee schemes, with the ultimate objective of improving micro, small, and medium enterprises (MSMEs) access to finance in a fair and competitive manner, while enhancing the governance and accountability. The project is in response to the request from the Central Bank of Jordan (CBJ), the project implementing entity, and a follow-up on the outcomes of the Arab Funds Coordination Group Meeting, which took place in Kuwait at the Arab Fund for Economic and Social Development 1 (AFESD) on April 7, 2013. This project is done in partnership between the World Bank Group— Bank, International Financial Cooperation (IFC), and Consultative Group to Assist the Poor (CGAP); and AFESD1 to support the Jordanian authorities in developing the MSME sector. 2. The proposed project comes at an opportune time, due to several factors currently in play. There is strong commitment by the Government of Jordan, reflected in making MSMEs development a priority in the reform program, within the overall framework of creating sustainable private sector jobs, and promoting governance, confirming the country’s ownership, as announced by the Jordanian delegation, headed by the Ministry of Planning and International Cooperation at the Deauville Partnership meetings. Another factor is, the competent and reform-oriented leadership in CBJ, which is pushing for transformational, institutional and regulatory reforms aiming at enhancing financial inclusion, and the Minister of Planning and International Cooperation’s commitment for well- coordinated efforts on that front. The rise in employment rates, especially among women and youth that have been compounded by the influx of Syrian refugees, flagging the importance of supporting smaller and younger firms that are the main creators of new jobs through improving the financial institutional infrastructure. Given the overall situation in the region—the revolutions, unrest, and demonstrations, CBJ initiative to promote financial inclusion, consumer protection (including addressing clients’ grievances), and financial literacy, deserves support from development partners, offering international experiences, and in that spirit this operation is proposed. 3. The operation is also timely with regards to fostering partnerships and coordination among donors and stakeholders that are active in MSME development in Jordan, especially AFESD, which has been playing a pivotal role in promoting MSME development in the Arab countries. The operation will complement the on-going and proposed lines of credit, which are supported by the Bank, AFESD, and the European Bank for Reconstruction and Development (EBRD), ensuring that these investment projects have a strong impact on the ground, reaching out to underserved areas and marginalized groups, in a fair, competitive, and transparent way, as well as adequately regulated and supervised to ensure compliance with prudential regulations and best practices, fostering financial inclusion. 4. The regional turmoil has significantly reduced short term growth prospects for Jordan through sharp declines in Foreign Direct Investments (FDI), tourist revenues, and to some extent remittances, while the import bill increased as a result of higher commodity prices, adversely affecting the economic environment. Jordan witnessed sluggish economic growth in the past few years that was marked by the start of the Syrian crisis. Growth in Gross Domestic Product (GDP) per capita averaged at 0.4 percent in years 2011 and 2012, while GDP growth recorded 2.6 percent in both years. 5. The fallout from the Syrian conflict next door, in terms of both inflow of refugees and trade disruptions, is causing new concerns. Almost half a million Syrian refugees have fled to Jordan, while tens of thousands are waiting for authorization to enter. This large number of refugees puts further pressure on the economy in a country with a population of 6.3 million, setting from high unemployment rates, and scarce resources. The weakening economy is further undermined by social challenges, including unemployment and poverty. Unemployment averaged 13 percent in the last decade, with youth unemployment over 30 percent. Hence, it is essential that Jordan promote sustainable and inclusive growth to reduce unemployment, especially among youth and women, as 1 The MSME Arab Fund was launched at the Arab Economic and Social Summit held in Kuwait in January 2009, an initiative led by H.E. Amir of Kuwait to provide US$ 2 billion to support MSMEs development in the Arab countries. The number of participating countries reached 17 by July 2013, where total contribution reached US$ 1.3 billion (with Saudi Arabia and Kuwait being the largest contributors, each US$ 500 million), of which US$ 940 million has been paid out of a total of pledged amount of US$ 1.2 billion. Loans approved as of July 2013, amount to US$ 333 million through 13 financial intermediaries and apex institutions, known for their active operations in the MSME sector. 2 well as in geographically and economically marginalized areas. Job creation and economic inclusion are key priorities for Jordan today—these goals will be advanced by improving the financial system, enhancing competitiveness, promoting governance and transparency, and fostering sustainable private sector-led growth. The Government’s Executive Development Program (EDP) for 2011–13, underscores the importance of private sector development for job creation, and overall economic inclusion through MSME development and attaining a well-developed and diversified financial system. Most recently the Jordanian authorities stressed the need to ensure that the dividends of economic reforms are shared equally and fairly across the country. Sectoral and Institutional Context 6. MSMEs are major contributors to the Jordanian economy and to its competitiveness, and employment potentials. There are around 150,000 registered enterprises in Jordan, of which MSMEs account for more than 99 percent. The majority of jobs are generated through MSMEs, which employ around 71 percent of private sector employees, where SMEs employ 32.7 percent and microenterprises 38.7 percent. This sector is also a leading source of exports and incomes in Jordan. It is playing a key role in the shift to high-value growth sectors, initially through enterprise creation, and subsequently through providing services and inputs, and increasing productivity through adopting and applying innovations. 7. Financial depth is not fully reflected in an improvement in financial access. Loans-to-deposits ratio is 69 percent as of June 2013, reflecting the banks’ conservative lending practices. Private sector credit-to-GDP is relatively low at 80 percent, which is largely allocated to the large corporates (87 percent), often ‘name lending’. Bank financing is relatively common for SMEs in Jordan, where banks are the principal source of external finance for SMEs. However, only 11 percent of bank lending goes to SMEs, compared to 25 percent in emerging markets. SMEs are undercapitalized and predominantly financed through internal funds, as well as, informal sources. Enterprises often resort to the informal sector, family and friends for access to finance. The 2012 Jordan Investment Climate Survey (ICS) shows the large disparities in terms of access to credit by size of firms. Only 27 percent of small firms have a loan versus 38 percent of medium-sized firms and 53 percent of large corporates. 8. High risk perception of MSMEs is one reason behind such low financial intermediation in Jordan. To mitigate the risk associated with MSMEs lending, banks rely primarily on collateral- based lending rather than creditworthiness, leaving creditworthy SMEs unfinanced. Most loans require collateral, equal to about 23 percent more than the loan value. Smaller enterprises do not have sufficient collaterals, and when they do, they are not registered, making foreclosure difficult if not impossible, representing a significant disincentive when lending to MSMEs. Incentivizing banks to lend on cash-flow bases rather than collateral-bases, and to venture into relatively more risky financing to MSMEs could be addressed by strengthening credit guarantee schemes. 9. The credit guarantee schemes in Jordan are underdeveloped. In fact, Jordan is lagging behind many countries. The Jordan Loan Guarantee Corporate (JLGC) contribution to SME lending is currently low. In 2012, only 41 guarantees per one million people were issued (Figure 3). Many countries in the region have used state-owned banks, and partial credit guarantee schemes to increase lending to MSMEs, to tackle the weaknesses of the financial infrastructure. Countries with larger credit guarantee schemes have larger shares of loans to SMEs in total loans, and larger shares of investment lending to SMEs.2 It is critical to strengthen the institutional capacity of JLGC to play a 2 World Bank Finance Flagship Report (2012). 3 more instrumental role in enhancing access to finance. The JLGC’s product offering needs to be improved and its systems modernized in order to enhance its effectiveness. 10. Enhancing access to financial information to MSMEs and protecting their financial rights to avoid being exploited are essential pillars in ameliorating MSMEs’ access to finance. In order to ensure transparency and better informed decisions by MSMEs, banks and financial intermediaries should provide them with timely and accurate information about fees, and effective cost of borrowing. Improving flow of information is essential to foster competition in the sector in addition to decreasing the direct and indirect costs of borrowing for MSMEs (as well as consumers who acquire facilities for non-business purposes). A key aspect of financial inclusion entails protecting consumers and enhancing their knowledge about financial products and services. In that context, the CBJ issued on October 31, 2012, Instruction No. 56 of 2012, adopting the ‘Treating Customers Fairly Instructions’, which replaced the fragmented set of consumer protection rules scattered in different laws and circulars. This regulatory reform reveals CBJ’s commitment to create a reliable and strong consumer protection system. It also flags the importance of disclosure, transparency and recourse system in protecting the rights of financial consumers. 11. The new instructions cover many important areas, such as fair treatment, responsible lending, complaints handling and recourse mechanisms. Moving forward, it is critical to ensure the banking system’s compliance, and to also enforce these regulations on all financial institutions, including NBFIs. Currently, clients of these institutions are not protected and their only recourse mechanism is the lengthy, cumbersome, and expensive court system. The CBJ is planning to establish a Consumer Protection Unit to ensure compliance, and enforcement of financial the consumer protection rules. This requires, among other things, staffing, tailoring an efficient complaint handling system, and building capacity to create a strong and efficient consumer protection team. The unit will also work on promoting public awareness, fostering financial literacy. 12. The overall regulatory and institutional financial infrastructure in Jordan is not conducive to micro enterprises access to finance. Although microcredit is growing in Jordan, a stronger regulatory framework is required to allow for further outreach. Jordan has the highest microfinance coverage of its poor population in the Arab region. Growth of this sector, however, is still constrained by the lack of a supervisor and the consequent enabling microfinance regulatory and legal frameworks. The current framework, for example, does not force any specific legal form. Some of these MFIs are even expanding lending to the small enterprises segment without being supervised by a regulatory body that monitors their compliance. Most MFIs are subject to little or no oversight, limiting their capacity to offer financial services, such as savings, payments, and remittances. The current regulatory framework is unprepared to address non-prudential risks, such as over indebtedness. CBJ is not yet institutionally prepared but is keen on regulating and supervising the microfinance sector in order to create an enabling, and conducive business environment. As the support for regulation and supervision of microfinance institutions is covered by an EU programme implemented by GIZ, this project can provide the necessary additional institutional support to establish the microfinance unit at the CBJ, finance staff positions, and provide the required equipment and infrastructure. Microfinance regulation is important for the protection of customers, and also essential for strengthening the sector and encouraging its growth in a prudent manner. The CBJ also acknowledges the fact that, besides MFIs, there are other NBFIs in the market that are engaged in financial services (e.g. consumer lending, investment funds and financial leasing) and operate without any specialized regulation or supervision. This would be an opportunity to assist the CBJ in adopting a more comprehensive approach of regulating and supervising NBFIs and not only MFIs for the same reasons and concerns mentioned earlier. 13. In that context, it is critical that the CBJ be provided with the sufficient technical assistance, and the required advisory services to support the execution of such an ambitious program, aiming at strengthening the regulatory and institutional financial infrastructure. These are transformational 4 measures that CBJ is committed to pursue, and it would be important for development partners to provide the required know-how, and offer their knowledge and expertise, as well as share international best practices. This would ensure the efficient implementation of essential regulatory and institutional reforms, which would lead to a more inclusive system, catering all segments and serving MSMEs and other consumers, including those in marginalized groups and underserved areas. This will also enhance transparency, accountability, and governance of the sector. II. Proposed Development Objective(s) Proposed Development Objective(s) 14. The project development objective (PDO) is to enhance financial services and products and to strengthen financial protection mechanism for MSMEs, while enhancing governance. III. Preliminary Description 15. The proposed project comprises of three main components: (i) strengthening credit guarantees schemes; (ii) enhancing the consumer protection mechanism; and (iii) developing the regulatory and institutional framework for micro finance institutions. The total cost of the project is US$ 3 million. A. Project Components Component I: Strengthening Credit Guarantees Schemes (US$ 1 million) 16. This component aims at developing the JLGC SME loan guarantee products, and designing new ones that are tailored to SMEs, which are based on proper risk analysis, addressing moral hazard and adverse selection, with the objective of enhancing JLGC operations development and sustainability. This component will focus on assisting JLGC in strengthening its core internal capabilities, expanding its outreach, and increasing the impact of its products, especially those targeting SMEs with a focus on marginalized groups, including women and underserved areas. At the same time, it will support JLGC in designing a guarantee product for micro-lending. Strengthening the credit guarantee mechanism will enhance MSMEs access to finance. 17. It also aims at enhancing JLGC’s internal capabilities to execute the transformation agenda. This component is comprised of seven sub-components, as follows: (i) market research; (ii) risk management; (iii) product development (segmentation and delivery mechanism included); (iv) marketing and outreach; (v) payment rules; (vi) analytics and systems; and (vii) organization and human resources. In order to execute the change initiatives and achieve scale, sustainability and efficiency, the following are the additional areas where support is requested by JLGC: i. Organization and Human Resources. There are significant gaps that need to be addressed for the JLGC to gain required competencies and enhance chances for the successful implementation of the change initiatives, as follows:  People Expertise. JLGC does not have the required internal management expertise in the areas of: (i) product and business development; (ii) risk management; (iii) marketing and outreach; and (iv) payment rules. In this respect JLGC plans to recruit: (i) a risk management resident advisor to implement and manage the risk framework transformation and reform the payment rules; (ii) a product and business development resident advisor to help launch new products and revamp the existing ones, as well as, oversee execution of strategic enablers; (iii) a marketing resident advisor to focus on market coverage, strengthening relationships with Partner Institutions and ensure growth in the volume of guarantees and help refine it. These three resident advisors would be employed over the project lifecycle of four years in order to execute and institutionalize the acquired core competencies so that the targeted 5 outreach and impact can be achieved. In addition these resident advisors would train JLGC staff and improve their technical know-how for changes to be sustained. The total cost of these three advisors over the four year period is estimated at US$ 0.54 million.  Knowledge. JLGC will significantly benefit by learning from best practice guarantee schemes around the world. This would also help avoid typical pitfalls, fast track launch of initiatives and would increase chances of success. Some of the guarantee schemes have achieved success like Kafalat (Lebanon); Small Business Finance Program (Canada); FOGAPE (Chile); OSEO (France); and KODIT (Korea). Hence JLGC can benefit from Study tours to best practice credit guarantee institutions in four different countries to emulate these best practices and continually refine the building blocks. The estimated cost of the four study tours, one study tour planned per year is anticipated at US$ 0.11 million.  Capacity building for banks. There is also a need for building frontline people capacity at banks through training so that the banks are able to understand, bundle and sell the products and schemes that would be launched by JLGC. In this respect JLGC would need to build a training curriculum in order to train and certify relationship managers and team leaders at banks. The cost of building such training curriculum is estimated at US$ 0.05 million. ii. Analytics and systems. There is a significant need for JLGC to: (i) implement an Enterprise Resource Planning (ERP) system; (ii) enhance data warehousing and analytics generating systems; (iii) improve Management Information System (MIS) mechanism through technology based tools and systemized monitoring; (v) increases process automation and building interfaces with banks; and (vi) acquire hardware and software to support all the growth initiatives. This is another significant area of capacity building and is estimated to cost US$ 0.3 million. Component II: Enhancing the Consumer Protection Mechanism (US$ 1.2 million) 18. This component aims at creating a reliable and strong consumer protection system, and at promoting financial literacy in Jordan, which highlights the importance of disclosure, transparency and recourse system in protecting the rights of financial consumers. The objective is to operationalize the Treating Customers Fairly, CBJ Instructions No. 56 of 2012, which aims at promoting financial inclusion and consumer protection. The project will support the establishment of the Consumer Protection Unit at CBJ, as well as, build its capacity to perform its mandate in terms of ensuring financial intermediaries compliance of these instructions, and empowering the unit to enforce such instructions. This component aims to guarantee that MSME clients are receiving timely and appropriate information, and adequate service. It will also ensure that they are not subjected to improper behavior or corruption practices, and that financial intermediaries do not create unnecessary hurdles or discrimination. Furthermore, it will improve transparency, accountability and governance, and will prevent abuse of the illiterate segment of the population, especially in the marginalized areas. 19. This will be delivered through: (i) supporting the establishment of a Consumer Protection Unit at CBJ to supervise compliance with consumer protection laws and regulations (including the new Treating Customers Fairly Instructions) and to handle complaints. This will be done by conducting an assessment of the capacity building, training and resource requirements for the Unit and assisting CBJ in the development of approaches to fulfill these requirements; (ii) providing capacity building to CBJ to undertake these functions, including financing IT equipment (both software and hardware). This will help CBJ to establish appropriate on-site and off-site monitoring systems and procedures, advice on enforcement mechanisms and training on how to use consumer research on a regular basis, and on how to identify financial inclusion barriers created by some financial institutions (such as minimum balance amounts for opening a bank account). The techniques the subject of this training could include surveys, qualitative research (focus groups), mystery shopping, and analysis of 6 complaints data. 20. Furthermore, this component will finance the development of financial literacy programs through public awareness campaign and media programs, on issues, such as the legal rights of clients, understanding different financial products offered in the market and compliant resolution. This component could also include advising CBJ on the Treating Customers Fairly Instructions and related laws, including on any changes which may be considered necessary to fulfill the objectives outlined above; and (iii) conducting two study tours for senior officers of the new Consumer Protection Unit (once it is established) to countries which have well developed systems for financial consumer protection regulation and supervision. 21. Strengthening the capacity of the Consumer Protection Unit will enable it to enforce the following disclosure and accountability requirements reflected in the Treating Customers Fairly Instructions, which include (in summary): (i) mandatory plain-language disclosures of all key prices, terms, and conditions; (ii) requirement that all key information be stated in the contract; (iii) the required disclosure of an effective annual percentage rate (which analytical work has shown to be more comprehensible for many consumers including those with lower levels of education and financial sophistication); (iv) the specific requirements that no additional fees can be charged beyond those that are disclosed; and (v) the requirement that the difference between fixed and variable interest rates is explained clearly to the customer up-front and is based on observable benchmarks in the market. Component III: Supporting the development of the institutional framework for microfinance and non-bank financial institutions (NBFIs) supervision (US$ 0.8 million) 22. This component aims at supporting policy, legal, and regulatory reforms to develop the NBFI and micro finance sector. Recognizing the importance of its role as a financial regulator and supervisor, for not only banks but also for NBFIs, CBJ took the decision to regulate and supervise the microfinance sector. This would entail setting a legal and regulatory framework that is conducive to micro finance and NBFIs, as well as, institutional reforms that would allow CBJ to undertake such mandate. In addition, it would also cover IT, both software and hardware, strengthening the institutional infrastructure. 23. The project will also support the CBJ in gathering all available data about all NBFIs in the market that are engaged in financial services (e.g. consumer lending, unregulated investment funds, factoring, and financial leasing) and operate without any specialized regulation or supervision, to identify the risks, and issues that need to be covered and assist the CBJ in adopting a more comprehensive approach of regulating and supervising NBFIs, and not only MFIs. This will include a comprehensive market study, technical assistance in drafting any needed regulation and building the capacity and training of the staff in charge of supervising these institutions. 24. The upcoming regulations that will be supported by the EU Programme would move all MFIs under the regulatory and supervisory umbrella of the CBJ, and depending on further judgments based on a NBFI market study, there are plans to also include all NBFIs at a later stage. It will comprise of light prudential rules with a focus on fit and proper requirements, strong governance rules, and internal and external controls. The regulation would also adopt general definitions for microfinance, and for the permitted financial services to allow MFIs, pending the approval of CBJ to engage in other financial services such as payments, deposits and remittances. The project will support CBJ in establishing, staffing and equipping a Microfinance Unit, which would be responsible for enforcing rules, ensuring compliance with the regulations, and supervising MFIs. IV. Safeguard Policies that Might Apply 7 Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 X Natural Habitats OP/BP 4.04 X Forests OP/BP 4.36 X Pest Management OP 4.09 X Physical Cultural Resources OP/BP 4.11 X Indigenous Peoples OP/BP 4.10 X Involuntary Resettlement OP/BP 4.12 X Safety of Dams OP/BP 4.37 X Projects on International Waterways OP/BP 7.50 X Projects in Disputed Areas OP/BP 7.60 X V. Tentative financing Financing Source Amount Recipient 0.00 MENA Transition Fund - 3,000,000 Total 3,000,000 VI. Contact point World Bank Contact: Sahar Ahmed Nasr Title: Lead Economist Tel: 5772+215 / 2 Email: snasr@worldbank.org Borrower/Client/Recipient Contact: Dr. Maher Sheikh Hasan Title: Deputy Governor, CBJ Tel: Email: Maher.Hasan@cbj.gov.jo Implementing Agencies Contact: Dr. Maher Sheikh Hasan Title: Deputy Governor, CBJ Tel: +962-6-463-0301 Email: Maher.Hasan@cbj.gov.jo VII. For more information contact: 8 The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-4500 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop 9