Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No: 38861-VN

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 127.7 MILLION (US$200 MILLION EQUIVALENT)

TO THE

SOCIALIST REPUBLIC OF VIETNAM FOR A

THIRD RURAL FINANCE PROJECT

April 28,2008

Rural Development, Natural Resources and Environment Sector Unit Sustainable Development Department East Asia and Pacific Region

This document has a restricted distribution and may be used by recipients in the performance o f their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective November 2007)

ATM AAA BIDV CAR CAS CFAA CEP CFC CQS DATC DA EL4 ED ERR FI FIL FRR FM FMM GDP GEF HCMC I A S ICB IDA IDP IEG IFC IFRS JSBs MLF OED M&E MSME MSE MFI

Currency Unit = Vietnam Dong

US$ = SDR1 VND16,200 = US$1

FISCAL YEAR January 1 - December31

ABBREVIATIONS AND ACRONYMS Automated Teller Machine Analytical and Advisory Assistance Bank for Investment and Development o f Vietnam Capital Adequacy Ratio Country Assistance Strategy Country Financial Accountability Assessment Capital Aid Fund for the Employment o f the Poor National Chloro-fluoro-carbons Trust Funds Consultants Qualification Selection Debt and Asset Trading Company Designated Account Environmental Impact Assessment Environment Division Economic Rate o f Retum Financial Intermediary Financial Intermediary Loan Financial Rate o f Return Financial Management Financial Management Manual Gross Domestic Product Global Environment Facility Ho Chi Minh City International Accounting System International Competitive Bidding International Development Association Institutional Development Plan Independent Evaluation Group International Finance Corporation International Financial Reporting Standard Joint Stock Banks Micro Finance Loan Fund Operations Evaluation Department Monitoring and Evaluation Micro and Small to Medium Sized Enterprise Medium Sized Enterprise Microfinance Institution

MOF MONRE M P I MPDF N G O NPL O D A OP PCF PDO PER-FA PFI P I M P M P M O Ph4SJ QCBS RFI RFII RFIII RDF R O A ROE SBV SEDP SLA SOCB SOE SME SWOT TA TA2 TC3 VNIBOR USD V A S VBARD VND WAIR WB WBO WHO

Ministry o f Finance Ministry o f Natural Resources and Environment Ministry o f Planning and Investment Mekong Private Sector Development Facility Non-Government Organizations Non Performing Loan Official Development Assistance Operational Policy People’s Credit Funds Project Development Objective Public Expenditure Review-Integrated Fiduciary Assessment Participating Financial Institution Project Implementation Manual Policy Manual Project Management Office Project Management Unit Quality and Cost Based Selection First Rural Finance Project Second Rural Finance Project Third Rural Finance Project Rural Development Fund Return on Assets Retum on Equity State Bank o f Vietnam Socio-Economic Development Plan Subsidiary Loan Agreement State-Owned Commercial Bank State-Owned Enterprise Small and Medium Enterprise Strength, Weakness, Opportunity, Threat Technical Assistance Second Phase o f a Comprehensive Technical Assistance Transaction Center I11 Viet N a m Inter-Bank Offered Rate United States Dollar Vietnamese Accounting Standard Vietnam Bank for Agriculture and Rural Development Vietnam Dong Weighted Average Interest Rate World Bank Wholesale Banking Operation World Health Organization

FOR OFFICIAL USE ONLY

V i c e President: James Adams Country Director: A j a y Chhibber

Sector Director: Christian Delvo ie Sector Manager: Rahul Ratur i

Task Team Leader: Xiaolan Wang

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not be otherwise disclosed without Wor ld Bank authorization.

SOCIALIST REPUBLIC OF VIETNAM THIRD RURAL FINANCE PROJECT

A . 1

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B . 1

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C . 1

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D . 1 2

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CONTENTS

Page

STRATEGIC CONTEXT AND RATIONALE ............................................................. 1 Country and sector issues ........................................................................................ 1

Rationale for Bank involvement ............................................................................. 3

Higher level objectives to which the project contributes ........................................ 4

Lending instrument ................................................................................................. 5 Project development objective and key indicators .................................................. 5 Project components ................................................................................................. 6 Lessons learned and reflected in the project design ................................................ 8

Alternatives considered and reasons for rejection .................................................. 9

IMPLEMENTATION .................................................................................................... 10 Partnership arrangements., .................................................................................... 10

Institutional and implementation arrangements .................................................... 10

Monitoring and evaluation o f outcomes/results .................................................... 11

Critical r isks and possible controversial aspects ................................................... 13

Loadcredit conditions and covenants ................................................................... 14

Economic and financial analyses .......................................................................... 15

Technical. .............................................................................................................. 16

Fiduciary ............................................................................................................... 16

Environment.. ........................................................................................................ 18

Safeguard policies ................................................................................................. 19 Policy Exceptions and Readiness .......................................................................... 19

PROJECT DESCRIPTION ............................................................................................. 5

. . . Sustainability ......................................................................................................... 11

APPRAISAL SUMMARY ............................................................................................. 15

Social ..................................................................................................................... 17

Annex 1: Country and Sector Background .............................................................................. 20

Annex 2: Major Related Projects Financed by the Bank andor other Agencies ................... 25

Annex 3: Results Framework and Monitoring .......................................................................... 26

Annex 4: Detailed Project Description ....................................................................................... 32

Annex 4.1: Alternative Project Design Options Considered .................................................... 45

Annex 4.2: Appraisal of the APEX Bank .................................................................................. 48

Annex 4.3: Eligibility Criteria for Participating Financial Institutions ................................. 55

Annex 4.4: Compliance with Financial Intermediary Lending Policies ................................. 60

Annex 5: Project Costs ................................................................................................................. 63

Annex 6: Implementation Arrangements .................................................................................. 74

Annex 7: Financial Management and Disbursement Arrangements ...................................... 75

Annex 8: Procurement Arrangements ....................................................................................... 85

Annex 9: Economic and Financial Analysis ............................................................................... 91

Annex 10: Safeguard Policy Issues ............................................................................................. 93

Annex 11: Project Preparation and Supervision ..................................................................... 101

Annex 12: Documents in the Project F i le ................................................................................. 103

Annex 13: Statement of Loans and Credits ............................................................................. 104

Annex 14: Country at a Glance ................................................................................................. 107

Annex 15: Map IBRD 35972 ..................................................................................................... 109

SOLIALIST REPUBLIC OF VIETNAM

THIRD RURAL FINANCE PROJECT

PROJECT APPRAISAL DOCUMENT

EAST ASIA AND PACIFIC

EASRE

Date: April 28, 2008 Team Leader: Xiaolan Wang Country Director: Ajay Chhibber Sector ManagerDirector: Rahul Raturi /Christian Delvoie

Project ID: P100916

Lending Instrument: Financial Intermediary Loan

Sectors: Micro- and Sh4E finance (100%) Themes: Small and medium enterprise support (P);Other financial and private sector development (S) Environmental screening category: Financial Intermediary Assessment

[ ]Loan [XI Credit [ ] Grant [ ] Guarantee [ ] Other:

For LoandCredi ts/Others : Total Bank financing: IDA Credit: SDR 127.7 million (US$200.0 million equivalent) Proposed terms: Standard Credit with 10-year grace period and 40-year maturity

Borrower: Socialist Republic of Vietnam

Responsible Agency: Bank for Investment and Development of Vietnam (BIDV) 1 lth Floor, Tower A, Vincom City Towers 191 Ba Trieu Street, Hanoi Vietnam Tel: 84 4 2200571 sgd3 @bidv.com.vn

Fax: 84 4 2200569

Estimated disbursements (Bank FY/US$m) FY Annual Cumulative

09 10 11 12 13 14 20.00 40.00 40.00 40.00 40.00 20.00 20.00 60.00 100.00 140.00 180.00 200.00

[ ]Yes [XINO

[ ]Yes [XINO [ ]Yes [XINO [ ]Yes [XINO

[ X l Y e s [ ] N o

[XIYes [ ] N o

Does the project depart from the CAS in content or other significant respects? Ref. PAD A.3 Does the project require any exceptions from Bank policies? Ref. PAD 0 .7 Have these been approved by Bank management? I s approval for any policy exception sought f rom the Board? Does the project include any critical r i sks rated “substantial” or “high”? Ref. PAD C.5 Does the project meet the Regional criteria for readiness for implementation? Ref. PAD 0 . 7 Project development objective Ref. PAD B.2, Technical Annex 3 The development objective o f the proposed RFIII would be to increase economic benefits to rural private enterprises and households b y increasing their access to finance. The expected outcomes would include: (i) improved access to financial services for rural entrepreneurs; (ii) increased capital investment made by the rural entrepreneurs as well as increased employment; (iii) increased lending, particularly term lending to the rural private sector for capital investment b y all participating financial institutions (PFIs) on market-based terms.

Project description Ref. PAD B.3, Technical Annex 4 Component I. Increase Capital Investment by Rural Enterprises - the “Rural Development Fund” (US$ 175 mi l l ion IDA financing). This component i s designed to address the term financing constraints o f financial institutions to provide funding to rural enterprises for longer- term investment needs.

Component II. Increase Access to Microfinance in the Rural Economy - the “Micro-finance Loan Fund” (US$ 10 mi l l ion IDA financing). This component w i l l provide a small l ine o f credit to demonstrate the commercial viability o f lending to micro-enterprises and household businesses.

Component III. Build Institutional Capacities and New Products (US$ 15 mi l l ion IDA financing.) The technical assistance (TA) component i s a core element to the success o f the RFIII project. This component i s designed to help build the financial institutions participating in the project and showing a credible strategy for expanding access to finance in rural areas o f Vietnam. The component i s also designed to help demonstrate that new commercially viable markets can be found. These new markets can come in the form o f new customers, new products and services, and new institutions participating in the project.

Which safeguard policies are triggered, i f any? Ref. PAD D.6, Technical Annex 10 This Proiect has a safeguards classification o f FI (Financial Intermediarv). As with al l FI

classified projects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis during the course o f project implementation. The project triggers the Environmental Assessment and Pest Management Safeguards. By design, the project w i l l not finance sub-projects that would trigger safeguard policies on i) natural habitats; ii) involuntary resettlement; iii) forests; iv) cultural physical resources; vi) safety of dams vii) projects in disputed areas; and viii) international waterways. Sub-projects that would trigger these safeguards policies are included in the negative l i s t o f sub-projects that may not be financed under the Project.

The safeguard policies triggered are: OP/BP 4.01 (Environmental Assessment); and OP 4.09 (Pest Management)

Significant, non-standard conditions, for: Ref. PAD C.6

Credit effectiveness:

The On-lending Loan Agreement has been executed between the Borrower and BIDV under terms and conditions satisfactory to IDA, and i t has been authorized or ratified.

BIDV has adopted the Policy Manual, the Project Operational Manual and the implementation Guideline, all acceptable to IDA.

BIDV has adopted the revised Environmental Guidelines, in a manner satisfactory for IDA.

BIDV has strengthened a sub-unit within the PMU with sufficient and competent staff under terms o f reference acceptable to the IDA to manage the Institutional Strengthening component.

Covenants applicable to project implementation:

(a) The recipient shall ensure that the Project i s carried out in accordance with the provisions o f the Anti-Corruption Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed b y IBRD and IDA Credits and Grants, dated October 15,2006.

(b) PMU at BIDV should be maintained at all times during project implementation with staffing functions, and responsibilities acceptable to IDA.

[c) An annual training program including budget and procurement plan for activities related to Institutional Strengthening Component should be furnished to IDA for review by December 3 1 o f the preceding calendar year.

:d) Quarterly progress reports should be furnished to IDA no later than two months after the end o f each quarter commencing from the first quarter wi th actual disbursement.

(e) A mid-term report on the implementation progress and proposed adjustment plan if there i s any should be furnished to IDA b y June 30, 201 1. The report should include results o f the f i rst impact evaluation.

(f) All sub-projects financed carried out in accordance to the Environmental Guidelines prepared for this Project.

A. STRATEGIC CONTEXT AND RATIONALE

1 COUNTRY AND SECTOR ISSUES

1. Introduction. Vietnam’s estimated annual development growth rate for 2006-2010 i s estimated between 7.5% - 8%. Based on i t s latest growth and poverty reduction strategies, the Government o f Vietnam estimates that the total investment needs for the rural economy will be in the order o f VND300,OOO billion, or on average around US$4 bi l l ion per annum, for this five year period. In addition, about 75% o f Vietnam’s population i s s t i l l living in rural areas with agriculture as their main source o f livelihood. With continued growth, there is r isk o f growing disparity between rural and urban areas. There are two main challenges facing the rural areas; first, target the issue o f lagging regions and the pockets o f high poverty; second, diversification o f agriculture and also more broadly rural economic activities, and create more rural employment. The proposed Third Rural Finance Project (RFIII) tackles the second challenge. The continued support through the proposed Project would assist more private enterprises and individuals in the rural areas to invest in assets, expand their production capacity, create employment opportunities, generate rural economic growth, and hence contribute to narrowing the rural-urban income gap. Private enterprises, whose activities were negligible in 1993, now account for over hal f o f the investments made each year. In order to improve the quality o f the investments, the Government o f Vietnam intends to increasingly rely o n private investments, which i s viewed as more efficient than state-led investments. Even if the share o f private investment in the rural economy is kept at the same level as in recent years, contributing about 50% o f total investment on average, private investment in the rural economy would have to be in the order o f about US$ 2 bi l l ion per annum. While the proposed RFIII Project would finance less than 1% o f the total expected credit demand, most o f which would be for medium- and long-term investment, i t is expected to have a significant demonstration and catalytic effect through further strengthening bank and further solidifying the existing init ial foundation for a sustainable rural finance system in Vietnam.

2. Financial Sector Reform. The Government o f Vietnam’s strategies for poverty reduction, financial sector development, and growth in rural areas al l emphasize the importance o f greater access to finance services to facilitate economic growth. The financial sector reform process, which began in earnest around 2001 , has produced some significant results. The State Owned Commercial Banks (SOCBs), which make up over 70% o f the banking sector, have been under restructuring processes, pol icy lending has been formally removed from the SOCBs into specialized entities, the regulatory framework for banking has moved towards international standards, the presence o f foreign financial institutions has increased competition in the sector, the market infrastructure i s rapidly developing with a robust payment system in place, and a capital market has been evolving with two trading centers. This progress i s a l l the more remarkable considering that barely more than a decade ago Vietnam’s financial sector was largely a “window” to channel government

1

resources to State Owned Enterprises (SOEs) and there was no real banking system in place. The private banking sector i s also growing rapidly. For example, the equity in 22 private commercial banks participating in the Rural Finance I1 project has increased almost ten fold between 2002 and 2007.

3. Access to Finance. Vietnam has also made impressive gains in expanding access to finance for households, with an estimated 70-80% o f the poor with access to some form o f financial services both formal and informal. However, the quality o f services offered is weak, the market i s highly fragmented, and often the services do not meet the needs o f the customers. Access to finance for private, particularly small and medium sized enterprises (SMEs), is very limited. In fact, the 2005 (unpublished) World Bank Investment Climate Assessment found that access to finance is the number one constraint facing businesses in Vietnam. The investment survey results shows that i t i s the access to finance, rather than the cost o f finance, that concerns firms most. In addition, al l SOEs, especially 100% state-owned, have much greater access to commercial and developmental financing sources than private f irms, many o f which are smaller scale and located in rural areas. Private f i r m s finance close to 75% o f their new investments from non-commercial sources, such as (non-market) equity investments, and family and friends, in addition to internal funds (retained earnings). This high dependence on non-market financial sources substantially limits the rate and degree to which private firms can grow in size and expand into new markets. Beyond these factors, if an enterprise does obtain bank financing, i t i s usually relatively short-term and thus, not wel l suited to medium- and long-term investments. A combination o f factors have led to this situation, including weak business plans, a lack o f audited accounts and credit history, insufficient collateral, etc. from the enterprises, and an aversion among financial institutions to smaller-scale, potentially more r isky (compared to SOEs), less well-known companies

4. Barriers to Access. However, the primary reason i s the lack o f medium- and long- term funds available to banks, particularly medium- and long-term deposits, which they can use for on-lending as medium and long term loans. Based on the information provided by State Bank o f Vietnam (SBV), only one-third o f the deposits raised in the banking sector in Vietnam are longer than 12 months. As such, short-term sources have been used to finance term-loan needs creating a maturity mismatch and potential liquidity problems. Due to the increasing demand for term-financing, SBV has issued a new decision to allow financial institutions increase the ratio o f using short-term fund to finance term-loan from maximum o f 25% to a maximum o f 40%. One other dimension o f the limitations in access to finance for firms is geographic. H o Chi Minh City is the clear center o f gravity for banking activity, comprising 29% o f al l loans and 34% o f al l savings in Vietnam. Interestingly, Hanoi has an equally high rate o f savings, with 32% o f al l funds mobilized coming from businesses and individuals in Hanoi. The four major cities, HCMC, Hanoi, Danang, and Haiphong, receive 52% o f al l credit by banks and 70% o f al l savings are mobilized from these cities. Thus, a conclusion that can be drawn from this data is that the areas outside o f these four main urban centers (60 provinces) may not have adequate access to financial services.

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5. Experience with Rural Finance. The Bank has a decade o f experience working to improve access to finance for rural enterprises in Vietnam. There has been a steady improvement in the banking sector during that period, some o f which can be attributed to a series o f two rural finance projects financed by the Bank. The f i rst Rural Finance Project (RFI) closed in 2001 with an internal World Bank ex-post analysis rating o f satisfactory, with recognition that the overall impact o f the project had been substantial. Seven banks were Participating Financial Institutions (PFIs) under this Project, having met the accreditation criteria set under the project. The RFII became effective in 2003 and i s expected to close in 2008. Twenty four financial institutions have joined RFII, o f which 22 are private banks (JSBs). The l ine o f credit i s managed by an SOCB, the Bank for Investment and Development o f Vietnam (BIDV), which performs a wholesale banking function in disbursing the funds to the PFIs. Under these two rural finance operations, the Bank has provided a total $310 million o f IDA resources for on-lending and capacity building purposes.

6. While the aggregate IDA rural finance credits represent less than 1% o f the total formal credit outstanding in the domestic market today, these operations have had a far reaching impact on advancing the development o f the rural finance system through the active engagement form the World Bank. The first internal and external ex-post and independent assessments o f these operations confirm that they have contributed to development o f the rural economy and improvement o f the living conditions in the rural areas. This was achieved through encouraging investments o f farm households and private rural entrepreneurs, by extending additional medium and long term financial resources; strengthening the banking system’s capacity to better serve the rural economy; and increasing access o f the rural poor to financial services.

2 RATIONALE FOR BANK INVOLVEMENT

7. The Government o f Vietnam’s strategies for poverty reduction, financial sector development, and growth in rural areas al l emphasize the importance o f greater access to finance services to facilitate economic growth. Vietnam’s Socio- Economic Development Plan (SEDP) to 2010 emphasizes the importance o f greater accessibility to rural finance services for agricultural growth, non-farm employment generation and rural poverty reduction. Despite the impressive reform progress and increasing formalization o f the financial sector during last decade, Vietnam s t i l l lags in the efficiency and outreach o f financial services. Rural private enterprises face serious challenges in accessing financing o f medium- and longer-term nature for investment purposes. The World Bank i s uniquely positioned to help the Government address these challenges through the Third Rural Finance Project. The Bank has intensively engaged with the Government on the broad agendas o f poverty reduction, rural development and diversification, and strengthening the financial sector. This i s being done through a variety o f modalities, f i om pol icy dialogue and analytical work to technical advisory assistance and lending operations. In terms o f the specific to the challenges for access to finance for rural enterprises, the Bank is assisting the three primary stakeholder groups: (i) assisting

the financial institutions through restructuring technical assistance, (ii) helping the government in financial sector pol icy reforms, and (iii) providing term financing to rural enterprises. The evaluated impact o f these assistance efforts has been very positive and the Bank now has accumulated a long history o f experience, trust, and access to the key financial institutions active in the rural space and to the Government entities involved in setting relevant policies. The RFI and RFII projects yielded a number o f lessons in terms o f both the most effective operational and pol icy designs to meet the challenges in catalyzing term financing for rural enterprises. The RFIII project wil l build on these successes and on the operational experiences in Vietnam under the first and second Rural Finance projects. In addition, the Bank i s leading the donor community globally in operational best practices in financial intermediary lending to support rural enterprises and the RFIII wil l applying these practices under the project in Vietnam.

3 HIGHER LEVEL OBJECTIVES TO WHICH THE PROJECT CONTRIBUTES

8. The Project supports Government’s goal o f economic growth, employment creation opportunities, rural development acceleration through the financing o f rural micro and small private investments, and subsequent income generation improvement o f a significant proportion o f the population by promoting broad-based, private sector- led growth in rural areas.

9. The Project is consistent with the World Bank Vietnam Country Assistance Strategy (CAS), and the overall World Bank PRSC program o f broader financial sector reform and improvement o f the rural sector. This operation, as wel l as the previous RF projects, has benefited by past financial sector operations, such as the Payment System and Bank Modernization Projects I & 11, which have provided support to the largest banks in Vietnam in developing their core information systems to international standards. The APEX bank and PFIs also benefited from a series o f comprehensive financial sector technical assistance programs to assist in their restructuring processes and assistance provided to the State Bank o f Vietnam - the bank supervisor - to improve the regulatory framework and its effectiveness. The sum o f this financial sector work has resulted in elevating the safety, soundness, and performance o f the banks participating in the RFII project, as well as those that wil l potentially participate in the RFIII operation. At the same time, the proposed Project wil l contribute to the overall financial sector reform by providing technical assistance, training and supporting implementation o f the participating banks’ institutional development plans. This Project i s wel l integrated into the Bank’s overall rural development strategy. For example, the Land Development Project supports improved property rights particular in rural areas, enabling farmers to use land as collateral as a basis for financial services which this Project supports. The Agriculture Competitiveness Project encourages the introduction o f new technologies, marking arrangements and organization structures so that players can enter into more profitable value chains. This Project would be available to meet increased demand for financial services including reviewing business plans from various players in the value chains.

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B. PROJECT DESCRIPTION

1 LENDING INSTRUMENT

10. The proposed lending instrument i s a Financial Intermediary Loan (FIL). The IDA credit wil l be made to the Socialist Republic o f Vietnam for on-lending to BIDV, which i s acting as the wholesale institution (APEX Bank) o f the project. BIDV will be responsible to accredit the interested participating financial institutions (PFIs) and micro-finance institutions (MFIs) based on the agreed accreditation criteria. BIDV will then on-lend IDA credit to the accredited PFIsMFIs in accordance with subsidiary loan agreements signed between BIDV and these PFIsMFIs indicating the obligations o f each party and the on-lending terms. The on-lending term wil l be formula-based which is acceptable to the IDA and al l stakeholders participating in this Project. In turn, the PFIs/MFIs wil l make loans with market rates to end- borrowers for sub-projects that meet the eligibility criteria.

2 PROJECT DEVELOPMENT OBJECTIVE AND KEY INDICATORS

11. The development objective o f the proposed RFIII would be to increase economic benefits to rural private enterprises and households by increasing their access to finance. The expected outcomes would include: (i) improved access to financial services for rural entrepreneurs; (ii) increased capital investment made by the rural entrepreneurs as well as increased employment; (iii) increased lending, particularly term lending to the rural private sector for capital investment by al l participating financial institutions (PFIs) on market-based terms.

12. Key Performance Indicators

13. The following are selected outcome and output indicators for the Project. detailed l i s t i s presented in Annex 3,

A

Outcome Indicators:

Increased amount o f capital investments made by the rural entrepreneurs (a proxy for increased direct economic returns as a result o f the project);

0 Incremental increase in employment (a proxy for social and secondary economic returns o f the project);

Output Indicators:

0 Volume o f term loans (a proxy for access to credit resources) Number o f borrowers (a measure o f the effectiveness o f targeting SMEs) Compliance o f BIDV and PFIs with minimum accreditation criteria or time bound institution development plans (IDPs) agreed with IDA.

0 Number o f new microfinance borrowers, particularly women. 0 Number o f training courses for bankers. 0 Preparation o f training courses for SMEs.

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3 PROJECT COMPONENTS

14. The following three primary components are envisaged for the RFIII project:

15.

a Increase Capital Investment by Rural Enterprises - the “Rural Development Fund” (US$ 175 mi l l ion IDA financing)

* Increase Access to Microfinance in the Rural Economy - the “Micro- finance Loan Fund” (US$ 10 mi l l ion IDA financing)

Build Institutional Capacities and N e w Products (US$ 15 mi l l ion IDA financing)

a

Component I: Increase Capital Investment by Rural Enterprises - Rural Development Fund (US$175 million IDA financing). This component, the Rural Development Fund (RDF), is designed to address the term financing constraints o f financial institutions to provide funding to rural enterprises for longer-term investment needs. The goal i s to enable rural private entrepreneurs to access medium- to long-term financing for capital investments, such as equipment and new technologies, which wil l enable opportunities for efficiency gains and business expansion. The Vietnamese economy and the banking sector have developed rapidly since the RFI and RFII projects were prepared. As a result, medium and large scale enterprises have increased access to financial services. Since IDA funds are scarce and they should be used for development and poverty reduction purposes, thus the funds should be used in those segments o f the market where there is a financing gap and in those segments o f the market that have the greatest potential to reduce poverty. Under the current economic conditions in Vietnam, it is the micro and small enterprise segment o f the market that does not have sufficient access to medium- and long-term funds. Providing medium- and long-term funds to this enterprise segment o f the market would also result in the largest development impact. The line o f credit operation would mirror the ones under the ongoing RFII in terms o f the processing terms, as i t has been found that the credit from the APEX bank (BIDV) to the PFIs, and from the PFIs to the end borrowers, is currently in l ine with market rates and i s not causing any market distortions. The PFIs will have to meet specific accreditation criteria to participate in the project. These accreditation criteria are structured to reflect the core areas o f a financial institution - management and corporate governance, asset quality, capital adequacy, liquidity, profitability, and efficiency - and are primarily aimed at setting a basic standard o f financial health and soundness for eligible PFIs and encouraging other financial institutions to reach these standards. (see Annex 4.3 for details). If a financial institution does not meet al l the accreditation criteria, i t can s t i l l participate in the l ine o f credit and select elements o f the technical assistance component o f the RFIII project if it agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit will finance up to 70% o f each sub-project cost, and the rest 30% wil l be financed by the PFIs and the contribution

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from each end-borrower. The following eligibility criteria will be applied to sub- loans and projects financed under the RDF by the PFIs:

Sub-projects to be financed should be physically located outside the four big cities in Vietnam, including Hanoi, H o Chi Minh City, Danang, and Haiphong.

Sub-loans should be for capital investments in productive assets and associated working capital needs.

Sub-loans should be targeted at micro and small enterprises with less than 50 employees.

For Sub-loans larger than $80,000 wil l be subject to BIDV’s prior review. Sub- loan larger than $80,000 per sub-project could be approved provided that i t can be demonstrated that they are located outside Tier I1 cities (reference indicated in the Policy Manual) and in rural areas and will have a large incremental impact on the rural economy in terms o f employment creation.

Sub-projects financed wil l be subject to environmental compliance requirements based on the Environment Guideline developed for this Project and the funding wil l be aimed at sustainable investments that do not produce negative environmental impacts.

Component 11: Increase Access to Microfinance in the Rural Economy - Micro-finance Loan Fund (US$ 10 million IDA Financing). This component, the Micro-finance Loan Fund (MLF), wil l provide a small line o f credit to demonstrate the commercial viability o f lending to micro-enterprises and household businesses. These may be defined as formal and informal businesses employing 2-3 employees outside o f their immediate families. The MLF will also be aimed at encouraging the participating o f financial institutions, as wel l as eligible non-bank PFIs such as rural People’s Credit Funds (small rural financial cooperatives) and licensed micro finance institutions, to develop more robust microfinance services in rural areas. These institutions will be subject to accreditation criteria (see Annex 4.3). If a financial institution does not meet al l the accreditation criteria, i t can s t i l l participate in the line o f credit and select elements o f the technical assistance component o f the WIII project if i t agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit w i l l finance up to 70% o f each sub-project cost, and the rest 30% will be financed by the PFIs and the contribution from each end-borrower. Eligibility criteria for sub-loans under this component are as follows:

a As with the RDF, sub-projects financed under the MLF should be physically located outside the four big cities in Vietnam including Hanoi, H o Ch i Minh City, Danang and Haiphong.

Sub-loans are for short-term financing, as wel l as medium- to long-term financing where demanded, would be available only for new customers (household or micro-enterprises).

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17.

4

18.

0

Sub-loan size would be limited to a maximum o f $500.

Sub-projects financed will be subject to environmental compliance requirements based on the Environment Guideline developed for this Project and the funding wil l be aimed at sustainable investments that do not produce negative environmental imp acts.

Component 111: Build Institutional Capacities and New Products (US$ 15 million IDA financing). The institutional building component is a core element to the success o f the RFIII project. This component is designed to help strengthening the financial institutions participating in the project and demonstrating a credible strategy for expanding access to finance in rural areas o f Vietnam. The component i s also designed to help demonstrate that new markets can be found and that these can be commercially viable. These new markets can come in the form o f new customers, new products and services, and new institutions participating in the project. This component wil l be supported by two sources o f funding. The first i s a $5 million IDA credit that wil l be transformed into a grant f rom the Government budget for activities considered to be public goods, such as new banking product development, strengthening the People’s Credit Funds, and supporting micro- and small- to medium-sized enterprises (MSMEs). The second source o f funding i s a $10 mi l l ion IDA credit will be on-lent to the PFIs at IDA terms to cover PFIs to improve credit processes for rural lending, strengthen PFIs that do not yet meet the accreditation criteria, enhancing the largest rural lending institution, and supporting the APEX Bank (BIDV). I t i s envisaged that the entire TA facility wil l be managed by the Project Management Unit o f the APEX Bank for efficiency o f administration. The specific elements that will be funded under this component are detailed in Annex 4.

LESSONS LEARNED AND REFLECTED IN THE PROJECT DESIGN

There i s a substantial body o f knowledge that has been accumulated by the Bank on line-of-credit operations. A recently completed report by the Independent Evaluation Group (IEG) “World Bank Lending for Lines o f Credit”, provided some key lessons relevant for this project which are; i) a stable macroeconomic environment i s a necessary condition for a successful l ine o f credit operation; ii) the requirements o f the World Bank policy on financial intermediary loans (OP 8.30) should be met, which includes, clear accreditation criteria for participating banks, backed up by institutional development plans for those banks that do not meet al l the criteria, and established procedures for environmental safeguards; iii) a conservative estimate o f the disbursement rates for the line o f credit based on an assessment o f the demand for credit under the prevailing interest rate regime; and iv) non-distortionary interest rates should be used with any subsidy documented and justified. This loan incorporates al l o f these recommendations. The regional L ine o f Credit coordinator concluded that this proposed Project complies with the requirements o f OP 8.30 and highlighted the success o f the collaborative cross- sectoral team in preparing the project to meet both the rural and financial sector

8

objectives in the design. Annex 4.4 provides a detailed compliance comparison with the OP8.30 policies.

19. This project would be the third in a series o f rural credit operations. Four main lessons were learned from these earlier operations. First, the combination o f a line- of-credit facility, technical assistance, minimum accreditation criteria and institutional development plans has proved more effective in inducing change in the banking sector than focusing the project on any one o f these factors alone. This design has provided the basis for an open dialog with participating banks, suggesting improvements in their operations, raising the importance o f better environmental screening, and funding for implementation. This project retains this core design from earlier projects but, since i t i s the third project in the series, has enhancements such as add fimding for developing and testing new products. Second, based on the monitoring and evaluation results for these two projects, small and medium size enterprises have had a greater incremental impact on j ob creation that other segments o f the market, as a result the project would tighten the targeting o f loans to focus on the SME sector. Third, the f i rs t and second projects have successively reduced their dependence on VBARD as the only vehicle to obtain coverage in remote areas. Under the first loan 75 % o f the loan was disbursed through VBARD, under the second project the disbursement share i s currently at less than 50 %. Assuming VBARD meets the minimum criteria as a participating financial institution, it i s thought that the total share i s expected to reduce further under the third project as private banks grow and gain market share. However, VBARD i s s t i l l the only operator in many remote locations, and thus, it i s expected that the third project wil l rely on VBARD to provide broad geographic coverage provided it can meet the minimum accreditation criteria or make positive progress with an acceptable institutional development plan. Finally, the second project has made an important contribution to improving the operation o f PFIs, however, the institutional reform objectives set by the project were too high. The third project should set more realistic institutional objectives given that the Project is not designed to be a financial sector reform project but focusing on increasing access to finance.

5 ALTERNATIVES CONSIDERED AND REASONS FOR REJECTION

20. Alternative Project Design Options: Four options for onlending arrangements were considered in the design, including: (a) Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected APEX Bank, the Bank for Investment and Development o f Vietnam (BIDV), that would bear the full credit risk; (b) Modif ied Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected Agent Bank, BIDV, that would only administer the line o f credit without taking the credit risk; (c) Semi-Competitive - several pre- determined participating financial institutions (PFIs) would be selected based on the accreditation criteria to receive a l ine o f credit for on-lending to their respective clients; (d) Competitive - bidding out the WBO to the market to select an APEX bank for the l ine o f credit. Option (a), Status Quo, was selected over option (b) because it was considered to provide a better incentive structure for PFI

9

accreditation and sub-loan collection and make use o f a well established project management unit at BIDV. Both the Semi-competitive and competitive models were rejected because there were not enough private commercial banks in the system with the capacity or the interest to play a wholesale financing role. More details o f the specific r isks and advantages o f each o f these options are discussed in Annex 4.1,

C. IMPLEMENTATION

1 PARTNERSHIP ARRANGEMENTS

21. The International Finance Corporation (IFC) was consulted closely on the design o f the RFIII project and the intention i s to partner with the IFC’s advisory institution, the Mekong Private Sector Development Facility (MPDF), to deliver specific elements o f the training activities proposed under this project. Related to this project, the IFC i s committed to providing two $50 mi l l ion lines o f credit in Vietnam, through two joint stock banks partially owned by the IFC (Asia Commercial Bank and Saigon Thuong tin Commercial Bank), to support housing finance.

2 INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS

22. The IDA credit o f US$ 200 mi l l ion would be made to the Socialist Republic o f Vietnam for on-lending and grant to BIDV. Out o f this credit, the Ministry o f Finance wil l then on-lend the funds to BIDV based on an on-lending agreement for US$ 195 million, including the Rural Development Fund and Micro-finance Loan Fund, and capacity building for the financial institutions. BIDV would assume overall responsibility for project implementation. BIDV will on-lend the proceeds to eligible PFIs based on the terms and conditions o f Subsidiary Loan Agreements (SLAs) signed between BIDV and PFIs. The PFI, wil l in turn, extend sub-loans to eligible borrowers. In accordance with the draft MOF circular on Financial Management applicable to Off icial Development Assistance projects and programs to support the implementation o f Decree no. 131/2006/ND-CP, dated 9 November 2006, by the Government on O D A Management, BIDV will be responsible for expenditure verification (kiem soat chi) for both credit activities and non-credit components under the on-lending agreement.

23. The remaining US$ 5 mil l ion (under Component 111: Build Institutional Capacity and N e w Product Development) wil l be allocated to the SBV in the form as grant from state budget. In accordance with the Off icial Letter no. 4072BKH-KTDN dated 12 June 2007 from MPI to the Prime Minister, SBV will be responsible to the Prime Minister for the management and efficient and effective usage o f this US$ 5 mil l ion grant for the intended purposes, in compliance with current governmental regulations, and ensuring no overlap with other funding sources for training activities o f the banking sector. In accordance with the draft MOF circular o n Financial Management applicable to Off icial Development Assistance projects and programs to support the implementation o f Decree no. 131/2006/ND-CP on ODA

10

Management, the State Treasury or an ornanization desiwated bv the MOF will be responsible for expenditure verification for this grant from state budget.

24. BIDV has already established a Project Management Unit under the Second Rural Finance Project, which i s part o f the BIDV’s core transaction center. This PMU has equipped with committed and capable staff and they are the champion in achieving the Project development objectives and ensure the compliance the IDA’S safeguard policies. I t i s decided this same PMU wil l be the PMU managing the proposed Project with one Division which wil l manage the Institutional Strengthening sub- component o f this new Project. The PMU has several units including: Accreditation Division, in charge o f financial analysis o f the interested financial institutions; Appraisal Division, in charge o f eligibility o f sub-proj ects financed; Environment Division, in charge o f compliance o f the IDA’S safeguard policy; Finance and Accounting Division, in charge o f funds f low and bookkeeping; and the Project Monitoring and Evaluation Division, responsible for institutional strengthening component and project reporting and evaluation activities.

3 MONITORING AND EVALUATION OF OUTCOMEShESULTS

25. BIDV has set up a system to maintain al l data on project inputs and outputs to monitor and evaluate progress made with project implementation. Functional divisions o f the PMU will collect and analyze PFIs financial statements, audit reports, uses o f sub-loans and information related to the end-borrowers combined with field trip observations. The Project Monitoring and Evaluation Division wil l be responsible for consolidation o f al l information and will provide quarterly progress report to IDA and the decision makers.

26. Each PFI will be required to keep al l the information based on clearly identified performance indicators, and they will provide data on project outcomes and results on a regular basis in an agreed format. This will include quarterly progress reports covering both sub-loan information on MSEs as well as specific technical assistance and training to each PFI. BIDV will be responsible for overseeing and coordinating this process.

4 SUSTAINABILITY

27. This project and the other projects in this series o f line-of-credit operations i s designed as an interim intervention in commercial loan markets for rural areas during a period when the banking system is in the process o f reform. During this period o f reform, a lack o f confidence in the banking system results in a shortage o f deposits which in turn results in a shortage o f funds available for on-lending. In the f i rst project there was a shortage o f liquidity across al l deposit terms. Over time short term liquidity has increased, but there is s t i l l a shortage o f liquidity in the medium and long term deposit market which in turn results in a shortage o f medium or long term loans or a high risk o f term mismatch in the banks. The provision o f a medium and long term lines o f credit to PFIs under the proposed loan offers them an opportunity to overcome this market failure until such time as confidence in the

11

bank system increases. The project will encourage the development o f medium and long term deposit instruments through Component 111. I t i s also expected to reduce the length o f the transition process by providing f h d s for training, information system upgrades for PFIs, and new product development. At the end o f th is series o f line o f credit projects, there would be enough reliable and efficient commercial banks with experience in lending to rural areas, and generating enough medium term deposits to ensure sufficient medium and long term lending to rural areas on a sustainable commercial basis. Also, the project wil l continue to integrate environmental considerations into small credit activities and encourage the financial sector to adopt the same approach beyond the rural finance project, without causing a high cost to the commercial banks. Thus, the project also has an environmental sustainability element to and should help to facilitate more “green” investments into the future.

12

5 CRITICAL RISKS AND POSSIBLE CONTROVERSIAL ASPECTS'

T o Project Development Objective Macro economic or banking system instability.

Risks

~~~

M

Rating before Mitipation -

Number o f jobs created by subprojects i s insignificant

To Component Results L o w demand for medium or long term credit f rom PFIs due to government or donor funded subsidized interest rates.

accredited PFIs Inadequate number o f

S

S

M

need to be evaluated The project i s designed to focus on

I

M

hstitutional Strengthening activities

are at least 22 PFIs that would be eligible. Efforts would be made to enhance PFIs' appreciation for institutional strengthening activities; new products development will be made relevant; discuss with MOF to standardize and streamline the approving procedure

M

M

Risk Mitigation Measures

3verall r isk rating

I

S

Rating With

Mitigation

Macroeconomic and banking system conditions will be monitored. Moderate levels o f instability will be absorbed through interest rate adjustments which PFIs are free to make. I f there are major shocks, the appropriate actions would

M

medium and long term investments micro and small enterprises which have been demonstrated to have high employment generation rates. Employment rates will

Dialogue with the government and build partnership with the donor community

Accreditation criteria set at project start take into account the level o f development o f the banking system. An acceptable IDP would allow banks to participate even if the entire set o f accreditation criteria i s not met. There

M

M

' The fiduciary r isks are no t critical. For detailed analysis please see Annexes 7 & 8.

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6 LOAN/CREDIT CONDITIONS AND COVENANTS

Effectiveness Conditions are:

28.

29.

30.

31.

The On-lending Loan Agreement has been executed between the Borrower and BIDV under terms and conditions satisfactory to IDA, and it has been authorized or ratified.

BIDV has adopted the Policy Manual, the Project Operational Manual and the Implementation Guidelines, a l l acceptable to IDA.

BIDV has adopted the revised Environmental Guidelines, in a manner satisfactory for IDA.

BIDV has strengthened a sub-unit within the P M U with sufficient and competent staff under terms o f reference acceptable to the IDA to manage the Institutional Strengthening component.

Implementation Covenants are:

32.

33.

34.

35.

36.

37.

The Borrower shall ensure that the Project is carried out in accordance with the provisions o f the Anti-Corruption Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD and IDA Credits and Grants, dated October 15,2006.

P M U at BIDV should be maintained at al l times during project implementation with staffing functions, and responsibilities acceptable to IDA.

An annual training program including budget and procurement plan for activities related to Institutional Strengthening Component should be furnished to IDA for review by December 3 1 o f the preceding calendar year.

Quarterly progress reports should be furnished to IDA no later than two months after the end o f each quarter commencing from the f i rst quarter with actual disbursement,

A mid-term report on the implementation progress and proposed adjustment plan if there i s any should be furnished to IDA by June 30, 2011. The report should include results o f the f i rst impact evaluation.

All sub-projects financed carried out in accordance to the Environmental Guidelines prepared for this Project.

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D. APPRAISAL SUMMARY

1

38.

39.

40.

41.

ECONOMIC AND FINANCIAL ANALYSES

Because this i s a credit project, with no advanced determination o f the precise investments to be made, i t i s only possible to estimate the project’s economic impact in a very general way. There are a number o f key factors that indicate that the project would be likely to have a sound economic impact.

Contribution to Economic Growth and Poverty Reduction. W h i l e progress on reducing poverty has been impressive in Vietnam, rural poor are s t i l l vulnerable to both internal and external shocks. The project would primarily focus the accumulation o f productive assets in rural areas and on the creation o f employment opportunities. This will be achieved primarily through financing medium and long term credit to micro, small and medium enterprises (MSMEs). MSMEs have been shown in RF1 and RFII to generate high levels o f employment per dollar o f funds invested. The project wil l also finance individual households, which would use the resources to enhance their productivity and incomes.

Contribution to the Long Term Investment Need of Vietnam. Vietnam is going through a period o f rapid growth with targeting investment levels at 30% o f GDP for the economy. The Project wil l contribute to the effective provision o f these resources and in particular term resources, which at present are not easily mobilized in the banking system.

Applicable Rates of Return. Uses o f Project funds will be demand-driven, there i s no ex ante estimate o f the economic or financial rate o f return for individual sub- project or for the project as a whole. However, the eligibility criteria for sub- project financing would be set so that project with an expected Economic Rates o f Return (ERR) o f less that 15% would not be financed. Therefore the ERR for the whole project should be in excess o f 15%. For sub-projects with sub-loans greater that US$ 200,000 an ex-ante economic analysis wil l be required and a minimum ERR o f 15 % will be required. For sub-projects with sub-loans between US$15,000 and US$200,000 an ex-ante financial rate o f return wil l be calculated, and a minimum 15% Financial Rate o f Return (FRR) will be required. Market interventions in Vietnam have largely been dismantled and the pol icy induced divergence between economic and financial values for commercial loans i s not presently substantive. Because the shadow wage rate is below the financial wage rate in rural areas for most o f the year, i t i s l ikely that ERRS will be higher than FRR. Thus, for smaller projects, the use o f a minimum FRR o f 15 % will largely eliminate any projects with an ERR o f less than 15%. In addition, projects that result in significant negative environmental externalities would be automatically ineligible as a result o f the implementation o f environmental safeguards.

15

2 TECHNICAL

42. There are no major technical issues in this Project. BIDV, the PFIs and the end- borrowers would al l be operating in areas core to their business and technology i s known. A network o f private suppliers is well developed and it is expected that MSEs and farmer households wil l purchase wel l know brands o f equipment through well established dealerships. The new product develop activities wil l bring the best international practices to Vietnam by taking into consideration the progress made by the financial institutions during course o f proj ect implementation.

3 FIDUCIARY

43. This Project will be a fol low on operation from the on-going RFII Project. The financial management (FM) arrangements o f RFII are operating satisfactorily and there are adequate financial internal controls and systems operating together with timely reporting and auditing. The RFIII's financial management arrangements wil l be based on the RFII's FM arrangements with some required improvements to overcome weaknesses identified in RFII. For RFIII, the FM risk i s assessed as moderate. The moderate inherent risk relates to the financial environment weaknesses and the nature o f the project which involves a large number o f PFIs/MFIs's sub-branches at provincial, districts, and commune level participating in the project with lack o f integrated financial information system; and a significant amount o f training, study tours, seminars and workshop expenditure. The project control risk is assessed as moderate primarily due to: (i) weak or insufficient internal audit function especially at PFIs/MFIs for project activities which result in weaknesses in sub-loan initiation and monitoring procedures; (ii) risk o f errors and mistakes arising from the manual consolidation process o f quarterly financial reports for PFIs/MFIs' branches and sub-branches; (iii) inefficient expenditure verification procedures by State Treasury which may result in delay in disbursement for the USDS mi l l ion grant component.

44. To mitigate the risks, PF IsNFIs are encouraged to consider integrating project financial report format into their current accounting system. More trainings and capacity building on internal audit objectives, functions, procedures, and best practices should be organized. The Accounting Division o f BIDV- Transaction Center I11 (TCIII) should actively participate in supervisions to PFIsMFIs. In order to avoid possible serious delays experienced in many projects due to cumbersome approval procedures, MOF, SBV and BIDV would meet together to work out an efficient mechanism to effectively use the fund for i t s intended purposes.

45. Proiect Procurement. An assessment o f the capacity o f the Project Implementing Unit (PMU) o f the wholesale bank was conducted. Discussions were held with the project management and procurement staff. An action plan has also been discussed and agreed. The project hnds would be mainly used for on-lending to intermediary financial institutions. The project procurement i s rather modest consisting o f several small value contracts for shopping o f vehicles and office equipment for the PMU and a number o f consulting services including seven QCBS

16

packages and the remaining are CQS packages. The P M U o f the wholesale bank will manage the procurement process o f institutional strengthening component for al l the PFIs. The wholesale bank has involved in implementation o f the second Rural Finance Projects and has gained adequate knowledge and experience to implement theproject procurements which are basically similar to those under the previous projects. However, given the potential larger value and complex nature o f the foreseen consulting services couple with a potential shortage o f staff, the PMU o f the wholesale bank wil l undertake a number o f actions to increase their procurement capacities required for a successful implementation o f the project procurement. Since the Project is a financial intermediary loan where the credit will be passed on to the intermediary institutions to be on-lent to rural private end- borrowers, an assessment o f the procurement practices normally used by these end- borrowers were also conducted. The typical end-borrowers mostly include private households who borrow small loans ranging from several hundreds to several thousands US dollar equivalent for procurement o f wide range o f products required for their family business such as seeds, fertilizers, hand tools, animals, boats, etc. These products are readily available in the local market at competitive prices. I t i s also expected that there might be some larger sub-loans ($100,000 to $150,000) on- lent to small private enterprises to procure small trucks, machine tools or construction machines such as excavators and concrete mixers. The most commonly used procurement practice is similar to shopping which i s appropriate and acceptable.

4 SOCIAL

46. No negative social implications are envisaged.

47. This i s a demand driven project and as such i s “a bottom up” operation, based on financing needs from the end-borrowers.

48. The Project would contribute directly to the improvement o f the social-economic state o f about 50,000 rural households and small business. The Project is expected to create more employment opportunities and better access to financial services to the rural population. Based on an Independent Project Impact Assessment report on Second Rural Finance Project, it indicates 30 % o f the end-borrowers accessed to formal financial services first time and 60 % had opened a savings account with the formal financial institutions for the f i rs t time.

49. The World Bank’s OED’s Beneficiary Assessment and survey confirmed that women benefited equitably from the f i rst Rural Finance Project. This impact is further strengthened during the implementation o f Second Rural Finance Project, where al l PFIs were required to keep records and report information o n women borrowers. This i s the f i rst operation in Vietnam that the banking sector obtained gender disaggregated data for project monitoring and evaluation.

50. The project wil l not finance any land purchase transactions. The resettlement safeguard is therefore not triggered. The indigenous people safeguard pol icy is also

17

not triggered. This Project is market-based demand-driven l ine o f credit, the indigenous people are free to apply for loans on equal basis with other population groups. However, in Vietnam the government has various subsidized credit programs for indigenous people, including through the Vietnam Bank for Social Policies, and therefore the uptake o f this RFIII loan facility by indigenous people i s expected to be low.

5 ENVIRONMENT

51. This Project has a safeguards classification o f FI (Financial Intermediary). As with al l FI classified projects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis during the course o f project implementation. The project triggers the Environmental Assessment and Pest Management Safeguards. By design, the project wil l not finance sub-projects that would trigger safeguard policies on i) natural habitats; ii) involuntary resettlement; iii) forests; iv) cultural physical resources; vi) safety o f dams vii) projects in disputed areas; and viii) international waterways. Sub-projects that would trigger these safeguards policies are included in the negative l i s t o f sub- projects that may not be financed under the Project. Appraisal o f the Projects compliance with IDA’s environmental and pest management safeguard policies i s discussed below and in more detail in Annex 10.

52. The environment assessment required for the purpose o f appraising the RFIII project i s based on an independent review o f the implementation o f environmental compliance under RFII, the ongoing rural finance project in Vietnam. Based on an analysis o f the types o f projects financed under RFII, the MI11 i s considered to pose a low level risk. An independent environment audit on RFII has been carried out in M a y 2007 and the final report confirms the low level risk and positive efforts made by the participating banks and the end-borrowers. The lessons learned have been incorporated into the draft environmental guidelines for RFIII.

53. Since this i s a follow-on operation to the Rural Finance I1 project, using the same implementation agency, TC3, an environmental procedure has already been prepared entitled “Guidelines o f Environment Impact Assessment and Monitoring for Subprojects Financed RFII.” This guideline includes procedures for appraisal, evaluation and monitoring environment and pest management safeguard compliance by the proposed sub-projects. These environmental compliance procedures are reviewed at least once a year in the course o f IDA’s supervision cycle. The same arrangement including environmental audit schedule wil l be applied out under the RF I11 Project, at mid-term and the end o f the project. The project management unit in TC3 already has an established environment unit staffed with specialists for the purpose o f monitoring environmental compliance under RFII. I t has one full time environmental specialist on staff. This unit would be responsible for environmental compliance under RFIII. There i s also sufficient environmental consultant capacity in Vietnam to carry out independent environmental audits o f sub-projects. In addition, under RFIII Project, the Government will allocate fimd to carry out specific trainings catering to

18

environment compliance activities and prepare and distribute environment compliance pamphlet to al l the end-borrowers.

54. The Second Rural Finance Project i s recognized as a f i rst ever banking sector project in Vietnam that integrates the environmental considerations into the small- scale credit lending activities. Now i t i s acknowledged by al l the PFIs that environmental compliance by sub-projects financed is an important consideration during the loan appraisal process. There is strong interest from MPI, M O N R E and SBV to disseminate good practices o f RFII which integrates environmental considerations into small-scale credit activities and encourage the financial sector to adopt the same approach beyond the rural finance project, without generating a high cost for commercial banks.

6 SAFEGUARD POLICIES

Safeguard Policies Triggered by the Project Yes N o Environmental Assessment (OPBP 4.01) [ X I [I Natural Habitats (OPBP 4.04) [I [ X I Pest Management (OP 4.09) [ X I [I Physical Cultural Resources (OP/BP 4.1 1) [I [XI Involuntary Resettlement (OPBP 4.12) [I [ X I Indigenous Peoples (OPBP 4.10) [I [XI Forests (OP/BP 4.36) [I [XI Safety o f Dams (OPBP 4.37) [I [ X I Projects in Disputed Areas (OPBP 7.60)* [I 1x3 Projects on International Waterways (OPBP 7.50) [I [XI

7 POLICY EXCEPTIONS AND READINESS

55. The Project complies with al l applicable World Bank policies. There is no pol icy exception identified.

56. This i s a follow-up Project which will be managed by the same APEX Bank. The institutional arrangements for project implementation are already in place. The Policy Manual, the Project Operational Manual have been prepared and wil l be adopted by Project effectiveness. The Project meets the Regional criteria for readiness for implementation.

* By supporting the proposedproject, the Bank does not intend to prejudice thefinal determination of the parties' claims on the disputed areas

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Annex 1: Country and Sector Background

Vietnam: Third Rural Finance

1. Macroeconomic Background. Vietnam is one o f the best-performing developing economies in the world in terms o f macroeconomic growth and stability. I t is going through a far-reaching transformation from an inward-looking planned economy to one that i s globalized and market-based. Vietnam has been on a sustained path o f economic reform since the launching o f its D o i M o i (renovation) process, in 1986. The overall principle guiding the reform process has been the increased reliance on market mechanisms, as well as international integration, while maintaining a socialist orientation. The latter can be interpreted as focusing on social inclusion while preserving a leading role for the state. Beyond this general principle, the process has involved a systematic piloting o f reforms, followed by some form o f evaluation, an effort to forge consensus among relevant stakeholders, and finally the scaling up o f reportedly successful initiatives. Comprehensive economic reforms have led to rapid economic growth and remarkable progress on development outcomes. Vietnam has been among the fastest-growing economies in the world for almost two decades and the country acceded to the World Trade Organization in January 2007, which was a major milestone in Vietnam’s integration into the global economy. GDP per capita has increased at roughly 6.9% per year in real terms. Real income has grown 7.3% per year over the last 10 years. When the World Bank reengaged with Vietnam in 1993, income per capita was US$170. Today i t is US$620. Despite this rapid growth, inequality has remained relatively stable. The Gini index increased from 0.34 in 1993, the year o f the f i rst representative household expenditure survey, to 0.37 in 2004. Based on a consumption basket o f food and non- food items sustaining an intake o f 2,100 calories per person per day, the poverty headcount declined from 58 percent in 1993 to less than 20 percent in 2004. Other social indicators, including chi ld maternity, have shown equally remarkable improvements and Vietnam appears able to reach most o f the Millennium Development Goals. Emerging from massive poverty less than two decades ago, the vision now i s to attain middle- income status by 2010. If current growth trends were to continue, GDP per capita could cross the US$lOOO benchmark in three years time.

2. Financial Sector Reform Process. The Government o f Vietnam’s strategies for poverty reduction, financial sector development, and growth in rural areas al l emphasize the importance o f greater access to finance services to facilitate economic growth. The financial sector reform process, which began in earnest around 2001, has produced some significant results. The State Owned Commercial Banks (SOCBs), which make up over 70% o f the banking sector, have been under restructuring processes, pol icy lending has been formally removed from the SOCBs into specialized entities, the regulatory framework for banking has moved towards international standards, the presence o f foreign financial institutions has increased competition in the sector, the market infrastructure i s rapidly developing with a robust payment system in place, and a capital market has been evolving with two trading centers. This progress i s a l l the more remarkable considering that barely more than a decade ago Vietnam’s financial sector

20

was simply a “window” to channel resources to State Owned Enterprises (SOEs) and there was no real banking system in place.

3. Reform Results. These reform improvements have been reflected in the rapidly rising level o f formal financial intermediation and efficiency o f finance. The banking system in Vietnam has moved from a structure with only the Government was involved, to a system with five SOCBs, 36 joint stock banks (JSBs), 30 foreign banks, 919 People’s Credit Funds (PCFs), and a variety o f informal microfinance providers. Confidence in the banking system has grown rapidly as evidenced by the rapid growth in deposits from 24% o f GDP in 2000 to close to 70% in 2006. In addition, credit to the economy has grown at a similarly rapid pace, also averaging a growth rate o f close to 30% per annum since 2000, reaching 67% o f GDP by 2006. Research also indicated that in 1992,73% o f rural credit was provided by the informal sector-in 2002, that figure had dropped to 11%. Finally, the banking payment system, based on international standards, has vastly improved payment services by reducing float (from up to 30 days in 1995 to less than 24 hours today), accelerating circulation o f funds and increasing efficiency o f funds transmission. In addition, the payment system has facilitated over 20% growth in formal remittances to Vietnam, reaching over $4 bi l l ion in 2005. There are now more than 1,100 Automated Teller Machines (ATMs), 2.1 mi l l ion cards (Le., credit, debit, etc.), and 17 banks offering credit cards. More recently, the stock market has shown phenomenal growth. During 2006, the number o f companies listed has increased by nearly fivefold2 while the market capitalization increasing by more than tenfold to surpass 22% o f GDP, already wel l surpassing the Government’s original target o f 15% by 2010. The largest enterprises, including the SOCBs, have yet to l i s t shares on the markets. The insurance sector also has registered healthy growth, accounting now for 2% o f GDP in 2005, up from 0.4% in 1993.

4. Future Reform Challenges. Despite the impressive progress in Vietnam, important weaknesses remain in the financial sector, including a s t i l l rudimentary approach to monetary policy, relatively poor quality o f banking credit, insufficient surveillance o f the stock market, and s t i l l l imited access to formal finance for private businesses. These weaknesses may lead to financial instability if Vietnam is confronted with an unexpected slowdown. While the probability o f this happening in the coming years i s low, financial crises are among the most devastating blows an economy can experience, which justifies devoting special attention to the regulation o f this sector. Even assuming the absence o f major turbulence, Vietnam needs to expand access to financial services to more citizens and the rapidly emerging business sector. Aware o f these challenges, the Government has launched both a roadmap for the reform o f the banking sector and a strategy for the development o f capital markets. Combined with the international commitments made to accede to the WTO, full implementation o f the roadmap and the strategy should lead to a larger and more efficient financial sector.

5. Limited Access to Finance for Enterprises. Vietnam has also made impressive gains in expanding access to finance for households, with an estimated 70-80% o f the

’ 192 including 106 at H o Chi Minh City Securities Trading Center (STC) and 86 at the Hanoi STC as o f January 16,2007.

21

poor with access to some form o f financial services. However, the quality o f services offered i s weak, the market is highly fragmented, and often the services do not meet the needs o f the customers. However, access to finance for private, particularly small and medium sized enterprises (SMEs), i s very limited. In fact, the 2005 (unpublished) World Bank Investment Climate Assessment found that access to finance i s the number one constraint facing businesses in Vietnam. The investment survey results shows that i t i s the access to finance, rather than the cost o f finance, that concerns f i r m s most. In addition, al l SOEs, especially 100% state-owned, have much greater access to commercial and developmental financing sources than private f irms, many o f which are smaller scale and located in rural areas. Private firms finance close to 75% o f their new investments from non-commercial sources, such as (non-market) equity investments, and family and friends, in addition to internal funds (retained earnings). This high dependence on non-market financial sources substantially limits the rate and degree to which private firms can grow in size and expand into new markets. Beyond these factors, if an enterprise does obtain bank financing, i t i s usually relatively short-term and thus, not wel l suited to medium- and long-term investments. A combination o f factors have led to this situation, including weak business plans, a lack o f audited accounts and credit history, insufficient collateral, etc. from the enterprises, and an aversion among financial institutions to smaller-scale, potentially more risky (compared to SOEs), less well-known companies.

6. However, the primary reason is the lack o f medium- and long-term funds available to banks, particularly medium- and long-term deposits, which they can use for on-lending as medium and long term loans. Based on the information provided by State Bank o f Vietnam (SBV), only one-third o f the deposits raised in the banking sector in Vietnam are longer than 12 months. As such, short-term sources have been used to finance term-loan needs creating a maturity mismatch and potential liquidity problems. Due to the increasing demand for term-financing, SBV has issued a new decision to allow financial institutions increase the ratio o f using short-term fund to finance term- loan from maximum o f 25% to a maximum o f 40%. One other dimension o f the limitations in access to finance for f i r m s i s geographic. H o Chi Minh City i s the clear center o f gravity for banking activity, comprising 29% o f al l loans and 34% o f al l savings in Vietnam. Interestingly, Hanoi has an equally high rate o f savings, with 32% o f al l funds mobilized coming from businesses and individuals in Hanoi. The four major cities, HCMC, Hanoi, Danang, and Haiphong, receive 52% o f al l credit by banks and 70% o f al l savings are mobilized from these cities. Thus, a conclusion that can be drawn from this data i s that the areas outside o f these four main urban centers (60 provinces) may not have adequate access to financial services.

7. Expanding Rural Finance through Rural Finance Projects. The Bank has a decade o f experience working to improve access to finance for rural enterprises in Vietnam. There has been a steady improvement in the banking sector during that period, some o f which can be attributed to a series o f two rural finance projects financed by the Bank. The f i rst Rural Finance Project (RF I) closed in 2001 with an internal World Bank ex-post analysis rating o f satisfactory, with recognition that the overall impact o f the project had been substantial. Seven banks were Participating Financial Institutions (PFIs)

22

under this Project, having met the accreditation criteria set under the project. The RFII became effective in 2003 and i s expected to close in 2008. Twenty four financial institutions have joined RFII, o f which 22 are private banks (JSBs). The l ine o f credit i s managed by an SOCB, the Bank for Investment and Development o f Vietnam (BIDV), which performs a wholesale banking fimction in disbursing the finds to the PFIs. Under these two rural finance operations, the Bank has provided a total $310 mi l l ion o f IDA resources for on-lending and capacity building purposes.

Box 1. Summary Statistics: Second Rural Finance Project

As of August 2007, U S 2 2 2 mil l ion equivalent had been disbursed from IDA. All sub-loans are made based on commercial terms.

The project has two distinct l ines o f credit, the Rural Development Fund, which has disbursed $192 million, and the Micro-Loan Fund, which has disbursed $24 million.

The average size o f the projects under the Rural Development Fund (RDF) was $3,500, with the RDF providing on average $2,047 (54%), the PFIs providing 34% and the borrowers contributing 12% to the investment.

o The proportion o f medium- to long-term financing under the RDF was 78%, which i s much almost twice the average share o f term-loans made by the banking system in Vietnam.

O f al l sub-loans, 44% fmance activities in Mekong River Delta which i s most active economic development region, and about 37% o f the end-borrowers are female.

Close to half o f the finds are going towards direct investment in the agricultural sector (46%).

o

o

The average size o f the sub-loans to households under the Micro-Loan Fund (MLF) was $545 and the MLF providing $316, and to micro-enterprises at $1,038 with the MLF providing $600.

o

o

o

All the sub-loans under the MLF were short-term, in accordance with the objectives.

More than 30% o f the sub-loans went to end-borrowers l iving in poor northern mountainous areas.

About 45% o f the end-borrowers are female.

There have been about 300,000 sub-projects spread across 60 provinces throughout the country, except the four largest cities (HCMC, Hanoi, Danang, Haiphong).

Incremental job creation has been reported to be as high as 160,000.

The collection rate from Participating Financial Institutions (PFIs) to the APEX bank, BIDV, i s loo%, and the average past due loans from end-borrowers to the PFIs i s about 0.3%.

About 30% o f clients under the project are f i r s t time borrowers who were able to establish their credit history for subsequent access to loans.

About 60% o f the clients have opened savings accounts for the first time.

8. Building Sustainable Institutions for Rural Finance. Whi le the aggregate rural finance credits represent less than 1% o f the total formal credit outstanding in the domestic banking market today, these operations have had a lasting impact on advancing the development o f the rural finance system. The f i rst internal and external ex-post and independent assessments o f these operations confirm that they have contributed to

23

development o f the rural economy and improvement o f the living conditions in the rural areas. This was achieved through encouraging investments o f farm households and private rural entrepreneurs, by extending additional medium and long term financial resources, strengthening the banking system's capacity to better serve the rural economy, and increasing access o f the rural poor to financial services. In addition, the series o f RF projects has encouraged increased banking competition in the rural areas, with the number o f PFIs growing from seven in 2000 to 24 by 2007. Such increased competition pushes greater outreach and efficiency among the competitors and results in better quality products and services for rural enterprises (and households).

9. However, for rural finance to expand o n a sustainable path, the institutions must also be strong and the series o f rural finance projects has contributed to the banking sector development in Vietnam. One way this i s achieved i s through the accreditation process and capacity building support for the PFIs. The accreditation process sets out minimum standards for the PFIs to meet. If the PFIs do not meet al l o f the accreditation criteria, they must have Institutional Development Plans (IDPs) put into place. These IDPs provide performance benchmarks that the PFIs commit to meet in order to participate in the RFII project and the PFIs meet these targets through utilizing RFII funding, as well as their own funding, to undertake internal restructuring and operational enhancements. As a result, PFIs are improving both their financial performance and overall transparency. Finally, the APEX bank for the operation, BIDV, has shown improvement since i t became the APEX bank for RFII three years ago through the engagement in the project and the efforts BIDV has made to meet i t s IDP targets. BIDV's financial performance has shown improvements over the course o f the RF projects and the bank i s making strides to improve its financial health based on recommendations made by the World Bank and outside experts. Ultimately, this wil l enable BIDV to provide wholesale banking services to a wide range o f banks in Vietnam that need additional liquidity to expand their operations into rural locations and to serve rural customers. Annex 4.2 contains an in-depth appraisal o f BIDV.

24

Annex 2: Major Related Projects Financed by the Bank and/or other Agencies

Project Name

Skllls for Growth &

Vietnam: Third Rural Finance Project

Delivery to Client

30-May-07

1. Portfolio Size and Composition. The Vietnam portfolio consisted o f 36 active operations (including stand alone GEF and CFC) with net commitments o f about US$ 3.6 bi l l ion by the end o f January 2007. The portfolio size has slightly declined from December 2006 as three projects exited the portfolio in December 2006 (Agriculture Diversification Project, Rural Energy Project and PRSC V). Amongst the sector units, Rural Development (23%), Energy (22%) and Urban Development (2 1 %) are the largest. These units account for two third o f our total commitments.

Tertiary Education

Health Financing & Strategy Work

2. Delivery of Investment Projects. The Coastal Cities Environment and Sanitation Project (US$125 million) was approved by the Board on December 19, 2006. In addition, negotiations for the Vietnam Avian and Human Influenza Control Project (US$20 million) and Program 135 - Phase I1 were completed in February and these two projects are scheduled for Board approval in February 2007 and March respectively. Negotiations for the Mekong Transport Infrastructure Development Project are scheduled for March 12,2007.

30-May-07

FY07 Lending Deliveries

Higher Education II

Mekong Transport Infra.

Hanoi Urban Transport

06 58 08-May-

07 207 05-Apr-07

132 28-Jun-07 I I

Program 135 - Phase II 50 I 20-Mar-07 I

Country Gender Assessment Environment Monitor CY06 Country Environment Analysis Water Resources Sector Review Land Policy Stocktaking

Expressway Investment Strategy Medium Cities Transportation Investment Climate Assessment VDR 2007

25-Oct-06

04-May-07

16-Jun-07

31-May-07

15-Jun-07

01-Jun-07

23-Feb-07

03-Jan-07

22-01 -07

~

PRSC VI

Avian & Human Influenza

HlFU Development

Mekong Transport Supp

Tax Administration (stand-by)

Total

Total (incl. stand-by)

200 21-Jun-07

20 na

50 28-Jun-07

20 21-Jun-07

80 26-Jun-07

862

942

25

Annex 3: Results Framework and Monitoring

Vietnam: Rural Finance Project

Results Framework

PDO

The Project Development Objective would b e to increase economic benefits t o rural private enterprises and households by increasing access to finance.

Intermediate Outcomes

Component 1. Rural Development Fund. Improved access to medium term credit for rural entrepreneurs and individuals.

Project Outcome Indicators

i) Cumulative investments made by rural entrepreneurs as a result o f the project (proxy for increased direct economic returns as a result o f the p r ~ j e c t ) . ~

ii) Incremental increase in employment as a result o f sub- project investments (proxy for social and secondary economic

i) Volume o f medium o r long term loans (a proxy for access to credit resources)

ii) Number o f borrowers (a measure o f the effectiveness o f targeting SMEs)

iii) Collection rates (measuring the effectiveness o f financial intermediation)

Use of Project Outcome Information

This wil l b e measured ex post in order to evaluate the impact o f the project o n investment and employment creation, as a proxy for economic growth as a result o f this project.

Use of Intermediate Outcome Monitoring

These would be reported in the Project progress report, mid-term review report submits both to the shareholders including key government agencies and the Wor ld Bank, in order to monitor the effectiveness o f the l ine o f credit in reaching the target beneficiaries. i) volume wi l l indicate whether the l ine o f credit is appropriately priced relative to the market in order to be useful to target beneficiaries. ii) Number o f borrowers wil l determine whether banks are effectively targeting the SME borrowers which have been identif ied as an under served segment o f the credit market. The number o f borrowers i s estimated based o n an average expected loan size o f US$5000. iii) Collection rates wil l be used to monitor the effectiveness o f financial intermediation.

Total investment i s equal to total subproject costs including sub-loan amounts and equity contributions

Incremental employment is the difference between with and without project level o f employment in the by beneficiaries

fum or household. 4

26

Component 2. .Microfinance Loan Fund. Enhance rural poor access to the financial services through micro finance f ind

Component 3. Bank Capacity Building and N e w Products Development. Strengthened capacity o f financial institutions to provide better financial services to the rural areas.

i) No. o f new customers borrowing f r o m PFIs and MFIs

ii) Share o f women borrowers

APEX Bank (BIDV)

i) Compliance with accreditation criteria or with a time bound I D P agreed with IDA.

ii) Compliance o f PFIs with accreditation criteria or with t ime bound IDPs.

iii Training provided to bankers (person days)

iv)Training curriculum and material developed for SMEs,

This will contribute to the impact assessment and project evaluation report to be reported to the key government agencies including M P I and MOF. BIDVs compliance with its institutional development p lan wil l be monitored annually.

For each PFI, compliance wil l be measured o n a four point scale Unsatisfatory, Marginal ly Unsatisfactory, Marginal ly Satisfactory o r Satisfactory. A P F I wil l receive a satisfactory rating if it meets a l l accreditation criteria or the conditions o f i ts IDP. The project will receive a satisfactory rating if a l l PFIs receive a satisfactory rat ing or have no t had a less than satisfactory rating for more than a year. This would al low PFIs time to correct any non compliance with the I D P or be excluded f rom the program. The project rating o f marginally satisfactory, marginally unsatisfactory, and unsatisfactory will be used to reflect varying degrees to wh ich th is condition i s not met.

Arrangements for results monitoring

1. Institutional Arrangements The implementing agency for the project, BIDV has already has a wel l established Project Management Unit (PMU) set up for the RFI and RFII projects. The PMU i s an integral part o f the BIDV’s core transaction center. This PMU i s equipped with committed and capable staff and they are the champion in achieving the Project development objectives and ensure the compliance the IDA’S safeguard policies. The PMU has several units one o f which i s the Project Monitoring and Evaluation Division responsible project reporting and evaluation activities.

2. Data Collection PFIs wil l be required to submit quarterly reports to BIDV on their compliance with accreditation criteria and their respective sub-projects. This data wil l be aggregated by BIDV. The process for collecting this data is well established. In addition, outside consulting companies wil l be hired to carry out environmental audits o f the project.

3. Capacity The PMU is committed and has capable staff with experience in project monitoring and IDA’S safeguard policies. In addition, experience with RFII project has

27

shown that there are a number o f consulting companies or research institutions which are capable o f carrying out environmental audits.

28

* i;: a

s 53

w" 53 I

0 P N

0 2

I 8 m

- 0

?4 N

9

0 m l 00 m 0 v

-1 z1 00

N

0 W

c c I 0 N

0 0 0 0

Y I Y

L f c 5

0

.C - E e t e c

E c c

+ 0 M

E N

Annex 4: Detailed Project Description

Vietnam: Third Rural Finance Project

1. Project Objective. The development objective o f the proposed RFIII would be to increase economic benefits to rural private enterprises and households by increasing their access to finance. The expected outcomes would include: (i) improved access to financial services for rural entrepreneurs; (ii) increased capital investment made by the rural entrepreneurs as wel l as increased employment; (iii) increased lending, particularly term lending to the rural private sector for capital investment by al l participating financial institutions (PFIs) on market-based terms.

2. Project Rationale. The Government o f Vietnam’s strategies for poverty reduction, financial sector development, and growth in rural areas al l emphasize the importance o f greater access to finance services to facilitate economic growth. Vietnam’s Socio-Economic Development Plan (SEDP) to 20 10 emphasizes the importance o f greater accessibility to rural finance services for agricultural growth, non- farm employment generation and rural poverty reduction. Despite the impressive reform progress and increasing formalization o f the financial sector during last decade, Vietnam s t i l l lags in the efficiency and outreach o f financial services. Rural private enterprises face serious challenges in accessing financing o f medium- and longer-term nature for investment purposes. The 2005 (unpublished) World Bank Investment Climate Assessment found that access to finance i s the number one constraint facing businesses in Vietnam.

3. The private f i rms finance almost 75 percent o f their new investments f rom non- commercial sources, such as internal funds (retained earnings), (non-market) equity investments, and family and friends. This high dependence on non-commercial financial sources substantially limits the rate and degree to which private f i rms can grow in size and expand into new markets. Beyond these factors, if an enterprise does obtain bank financing, i t i s usually relatively short-term and thus, not wel l suited to medium- and long-term investments. It i s thought that a combination o f factors have led to this situation, including weak business plans, a lack o f audited accounts, insufficient collateral, etc. from the enterprises, and an aversion to smaller-scale, more r isky (compared to SOEs), less well-known companies. However, the primary reason is the lack o f medium- and long-term funds available to banks, particularly medium- and long- term deposits, which they can transform into medium- and long-term loans. Based o n the information provided by the SBV, only one-third o f the deposits raised in the banking sector in Vietnam are longer than 12 months. As such, short-term sources have been used to finance term-loan needs creating a maturity mismatch for the banks and limiting the ability of the banks to meet the demands by enterprises for such funding. The project therefore intends to provide term financing to micro and small enterprises for investment in productive assets through the Rural Development Fund (RDF) to be financed by the IDA credit.

4. Despite the general availability o f short-term liquidity in the banking system, the rural poor and rural households and micro-enterprises in some regions s t i l l do not have

32

access to financial services due to absence o f viable micro finance institutions. Based on a recent Micro Finance Study managed by the Financial Sector o f the World Bank, there are st i l l exists great demand for improved quality and targeting o f the micro finance services (both credit and savings), especially in more remote areas that are more costly for the formal banks to reach. The project will provide a small amount o f funding under the Micro-finance Loan Fund (MLF) to demonstrate the profitability o f microfinance lending, as wel l as to encourage the participation o f banks as participating financial institutions.

5. Lending Instrument and On-lending Arrangement. The proposed lending instrument i s a Financial Intermediary Loan (FIL). The Government has proposed that the Bank for Investment and Development o f Vietnam (BIDV) be the APEX bank and the institution responsible for the implementation o f this project and on-lending to the accredited participating financial institutions (PFIs). BIDV has performed wel l as the APEX bank under RFII and is interested in implementing the RFIII project. IDA has agreed to the Government’s proposal based on the continued improvement in BIDV’s financial performance, the audited I A S accounts for 2006, and progress on i t s strategic plans, including i t s business strategy, equitization and Non-Performing Loan resolution plans (an appraisal o f BIDV i s contained in Annex 4.2). The Bank will continue to work with BIDV during the project implementation and monitor BIDV’s financial performance closely. Alternative options were considered and are described in Annex 4.1.

6. Participating Financial Institutions. The accreditation criteria for the Participating Financial Institutions (PFIs) under the Rural Finance I11 (RFIII) project have been developed based on past experience under the previous Rural Finance projects, as well as best practices in Wor ld Bank l ine o f credit operations worldwide. The criteria set out standard financial performance benchmarks for PFIs to meet in order to participate in the project. These benchmarks are structured to reflect the core areas o f a financial institution - management and corporate governance, asset quality, capital adequacy, liquidity, profitability, and efficiency - and are primarily aimed at setting a basic standard o f financial health and soundness for eligible PFIs and encouraging other financial institutions to reach these standards. Secondarily, the criteria are designed to protect the on-lending bank from the potential credit risks o f the PFIs and to enable the on-lending bank to better determine the appropriate level o f the size o f the line o f credit. Finally, the criteria are designed to provide a standardized, comparable monitoring tool to measure the progress made by the PFIs. I t i s envisaged that for the Micro-finance Loan Fund, the PFIs participating in the RDF will be eligible to participate in the MLF. In addition, non-bank PFIs wil l also be eligible for and participate in the MLF l ine o f credit. The non-bank PFIs that would qualify to participate in the MLF would include primarily some select number o f the best performing o f the 955 People’s Credit Funds (PCFs). The criteria for these non-bank PFIs under the MLF will be similar to those for PFIs, but with some key differences. The full details on the accreditation criteria are attached in Annex 4.3.

7. On-Lending Interest Rates. In terms o f the interest rates charged throughout the l ine o f credit, from the Ministry o f Finance to BIDV, and from BIDV to the PFIs, it has

33

been determined that the calculation used by Second Rural Finance Project wil l be a reasonable basis for the RFIII project (see Box 1 below for further details). The RFIII wil l continue to use the formula-based approach to setting the pass-on rate and the fixed margin charged by the APEX bank, BIDV, to the PFIs o f at least 2% as this i s the best approach at the current time due to the limitations o f the inter-bank market. Inter-bank interest rates are reported daily as VNIBOR o f (on the Reuters information system), with twelve banks contributing, which i s supposed to represent the benchmark rate for short- term financing (overnight to 6 months) for banks. However, the market i s highly segmented with different rates paid by the different types o f institutions and depending on whether or not the transaction i s collateralized. Consequently, inter-bank deals actually negotiated one at a time in an over-the-counter manner between individual banks and the VNIBOR rate is indicative only and not utilized as a benchmark by banks in the market. The proposed interest rate calculation wil l be re-assessed within one year o f implementation o f the project to determine if a more suitable, market-based on-lending interest rate can be applied instead. For instance, if in the future the inter-bank market matures sufficiently to provide for a standardized and reliable benchmark interest rate or a more streamlined calculation methodology can be developed, then the pass-on rate wil l be adjusted accordingly. The on-lending rates from PFIs to end-borrowers would continue to be market based and at the full discretion o f the PFIs to determine.

Box 1. On-Lending Interest Rate Calculation under the Second Rural Finance Project

The Socialist Republic o f Vietnam would be the Borrower o f IDA Credit. The proceeds o f the Credit would be made available to BIDV under an On-lending Loan Agreement (OA), satisfactory to IDA, to be entered between MOF and BIDV. Under th is OA, which would be built into the Rura l Development Fund (RDF) and Micro-enterprise Development Fund (MDF) policy manuals, would b e lent to BIDV for a period o f 25 years with a grace period o f 8 years o n the principal. The interest rate charged by MOF to BIDV would b e such as to give BIDV a 2% spread to cover i t s operating costs, risks, and a slight margin. This should be adequate to make the project attractive to BIDV and to encourage i t t o promote the f l ow o f resources in to the lines o f credit. Finance for the RDF and the MDF credit lines would be made available to the Participating Financial Institutions under subsidiary loan agreements (SLAs) between them and BIDV.

The on-lending rates f r o m BIDV to the PFIs, under these SLAs, would be adjustable periodically based upon criteria that reflect market interest rates. BIDV would manage the t w o funds and would bear the credit r isk at the level o f the PFIs. Funds would be on-lent to PFIs in local currency, in l ine with their clients needs. They would bear a variable rate o f interest adjusted monthly and intended to be equal to the adjusted cost o f commonly available deposits. This rate would b e calculated by the S B V based o n the Weighted Average Interest Rate (WAIR) for 3, 6 and 12 months deposits in the banking system in Vietnam f r o m a sample o f 24 banks, adjusted for the reserve requirement imposed by the SBV. The on-lending rate wou ld largely reflect the market deposit rates o n a quarterly basis. The PFIs would be free to set their interest rates to the end-borrowers to fully reflect market forces, and their associated costs, risks, and prof i t requirements.

The Government would bear the foreign exchange risk against a 'fee' - the difference between the on- lending rate to BIDV and the cost o f IDA funds. This is because: (i) the small sub-borrowers would not b e in a position to bear the foreign exchange risk, and therefore, BIDV would no t be able to pass o n t h i s r isk to the PFIs; and (ii) the U S $ o f IDA proceeds would actually remain with the Government who in return would provide BIDV with the equivalent local currency for on-lending to the PFIs.

8. Project Components. The following three primary components are envisaged for the RFIII project:

34

a Increase Capital Investment by Rural Enterprises - the “Rural Development Fund” (US$ 175 mi l l ion IDA financing)

Increase Access to Microfinance in the Rural Economy - the “Micro- finance Loan Fund” (US$ 10 mi l l ion IDA financing)

Build Institutional Capacities and New Products (US$ 15 mi l l ion IDA financing)

e

a

9. Component I: Increase Capital Investment by Rural Enterprises - Rural Development Fund (US$ 175 million IDA Financing). This component, the Rural Development Fund (RDF), i s designed to addresses the term financing constraints o f financial institutions to provide funding to rural enterprises for longer-term investment needs. The goal i s to enable rural private entrepreneurs to access medium- to long-term financing for capital investments, such as equipment and new technologies, which wil l enable opportunities for efficiency gains and business expansion. The Vietnamese economy and the banking sector have developed rapidly since the RFI and RFII projects were prepared. As a result, medium and large scale enterprises have increased access to financial services. Since IDA funds are scarce and should be used for development and poverty reduction purposes, the funds should be used at those segments o f the market where there i s a financing gap. In particular, finds should be used at those segments o f the market the have the greatest potential to reduce poverty. Under the current economic conditions in Vietnam, it i s the micro and small enterprise segment o f the market that does not have sufficient access to medium- and long-term funds. Providing medium- and long-term funds to this enterprise segment o f the market would also result in the largest development impact. The l ine o f credit operation would mirror the RFI I in terms o f the processing, terms, as it has been found that the credit from the APEX bank to the PFIs, and from the PFIs to the end borrowers, i s in line with market rates and i s not causing any market distortions. The PFIs wil l have to meet specific accreditation criteria to participate in the project (see Annex 4.3 for details). If a financial institution does not meet al l the accreditation criteria, i t can s t i l l participate in the l ine o f credit and select elements o f the technical assistance component o f the RFIII project if it agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit wil l finance up to 70% o f each sub-project cost, and the rest 30% will be financed by the PFIs and the contribution from each end-borrower. The following eligibility criteria will be applied to sub-loans and projects financed under the RDF:

e Sub-projects to be financed should be physically located outside the four big cities in Vietnam, including Hanoi, H o Chi Minh City, Danang, and Haiphong.

Sub-loans should be for capital investments in productive assets and associated working capital loans.

Sub-loans should be targeted at micro and small enterprises with less than 50 employees.

For Sub-loans larger than $80,000 wil l be subject to wholesale bank’s prior review. Sub-loan larger than $80,000 per sub-project could be approved provided

e

a

e

35

that i t can be demonstrated that they are located outside Grade I1 towns and in rural areas and wil l have a large incremental impact on the rural economy in terms o f employment creation.

Sub-projects financed wil l be subject to environmental compliance requirements based on the Environment Guideline developed for this Project and the funding wil l be aimed at sustainable investments that do not produce negative environmental impacts.

a

10. Component 11: Increase Access to Microfinance in the Rural Economy - Micro-finance Loan Fund (US$ 10 million IDA financing). This component, the Micro-finance Loan Fund (MLF), wil l provide a small l ine o f credit to demonstrate the commercial viability o f lending to micro-enterprises and household businesses. These may be defined as formal and informal businesses employing 2-3 employees outside o f their immediate families. The MLF will be aimed at also encouraging the participating o f financial institutions, as wel l as eligible non-bank PFIs such as rural People’s Credit Funds (small rural financial cooperatives) and licensed microfinance institutions, to develop more robust microfinance services in rural areas. The institutions will be subject to accreditation criteria (see Annex 4.3). If a financial institution does not meet al l the accreditation criteria, i t can st i l l participate in the line o f credit and select elements o f the technical assistance component o f the RFIII project if it agrees to a time-bound Institutional Development Plan (IDP), to reach the performance benchmarks. The IDA Credit wil l finance up to 70% o f each sub-project cost, and the rest 30% will be financed by the PFIs and the contribution from each end-borrower. The participation o f the PFIs i s subject to the availability o f funds. I t i s expected that sub-loans for short-term financing, as wel l as medium- to long-term financing where demanded, would be available only for new customers (household or micro-enterprises). These sub-loans would be l imited to $500. As with the RDF, sub-projects financed under the MLF should be physically located outside the four big cities in Vietnam including Hanoi, H o Chi Minh City, Danang and Haiphong and the sub-projects will be subject to environmental compliance requirements and the MLF funding wil l be aimed at sustainable investments that do not produce negative environmental impacts.

11. Component 111: Build Institutional Capacities and New Markets (US$ 15 million). This institutional building component is a core element to the success o f the RFIII project. This component i s designed to help build the financial institutions participating in the project and demonstrating a credible strategy for expanding access to finance in rural areas o f Vietnam. The component i s also designed to help demonstrate that new market can be found and are financially viable. These new markets can come in the form o f new customers, new products and services, and new institutions participating in the project. The component will be supported by two sources o f funding - (i) a $5 mil l ion IDA loan that has been transformed into a grant from the Government budget, and (ii) a $10 mi l l ion IDA loan that i s passed on to the PFIs at IDA credit terms. I t i s envisaged that the entire TA facility wil l be managed by the Project Management Unit o f the APEX bank, BIDV, for efficiency o f administration. The specific elements that wil l be finded under this component are follows with the approximate estimates for the resources associated with each component:

36

Subcomponent A. Grant Based Assistance (US$5 million)

Meeting Emerging Demand for Rural Financial Services -

12. A. 1. Supporting SMEs - SME Association (US$ 0.94 million): In order to prepare the SMEs to access to financial services and overcome the constraints they are facing, this sub-component will focus on supporting SMEs via the SME Association. Most o f the SMEs wil l need assistance in terms o f creating business plans, developing accounts, finding sales markets, conducting marketing, meeting export standards, and a wide variety o f other training needs. This will also include capacity building to produce the required documentation for bank loans and other training specific to the lending process. The training wil l be provided through the Small and Medium Business (SME) Association and the activities would include TA to develop a training strategy and model, curriculum and prepare training material for the end borrowers, including carrying out a train-the-trainers program. The subject o f the training to the SME ownerdmanagers would include how to improve their efficiency and profitability, how to prepare the business plan which is better linked to the requirement from the financial institutions. The training will also include marketing, human resources management, production & Operations development, finance & accounting skil ls. The IFC Mekong Private Sector Development Facility has launched BusinessEdge, which offers management training product and services to the SME sector in Vietnam.

13. A. 2. Sustaining PCFs and Non-Bank Microfinance Institutions Operations to Better Service Rural Populations (US$ 1.74 million): Component I1 o f the RFIII project i s a small l ine o f credit designed to demonstrate the commercial viability o f lending to micro-enterprises and household businesses. It wil l be aimed at also encouraging the participating o f financial institutions, as wel l as eligible rural People’s Credit Funds (small rural financial cooperatives) and licensed microfinance institutions, to develop more robust microfinance services in rural areas. The PCFs and non-bank microfinance institutions would be new institutions to the rural finance lending programs o f the past and thus, this N e w Institution Development sub-component would be aimed at exclusively at them. This sub-component would include four inter-related elements o f TA support:

0 Supporting the Selected Non-Bank PFIs (US$ 0.5 million): The non-bank PFIs, the PCFs and MFIs, selected to participate in the MLF line o f credit would be supported by this sub-component. These PCFs and MFIs may need TA in terms o f institutional strengthening, credit risk management, and lending techniques for micro-enterprises as part o f their use o f the MLF funding. This may be limited given that these non-bank PFIs wil l be selected based on rigorous accreditation criteria and assessment by the APEX Bank, BIDV, before the determination o f participation in the MLF line o f credit i s made.

0 Strengthening the Vietnam Association of People’s Credit Funds (US$ I .24 million): The People’s Credit Funds (PCFs) network is a form o f cooperative credit organization that must ensure i t s growth and self-sustainability for

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development. This network has gone through important stages since i t s foundation in 1993 including a fast-development stage (1993-1999), a consolidation phase under the guidance o f the SBV (2000-2003) and a return to a more secure organizational development since 2003. This approach has moved the PCF network to gradually set up a national organization to link the 955 PCFs and the Central Credit Fund (CCF), which i s a sort o f credit cooperative bank to the PCF network. The idea has emerged to improve the security o f the entire network and begin to free the State Bank o f Vietnam from i t s direct support for the PCF network. The creation o f the new Association (VAPCF) in late 2005 is a first step forward towards this new national approach and VAPCF has been officially operating since January 2006. The VAPCF has a number o f core objectives, including: guiding the members to implement the regulations and laws concerning the operation o f PCFs, supporting the PCFs in transferring technologies and management experiences, setting standards for the operations o f PCFs (i.e., reporting, accounting, credit, internal control, etc.), and organizing professional training courses for the PCFs. The VAPCF i s a relatively new organization and i s st i l l struggling to establish i tself as an effective tool for the PCF network. The Association i s receiving technical assistance, but there will be substantial follow-up that wil l be required to continue the VAPCF capacity building. Given that i t i s expected that 10-20 PCFs wil l participate in the MLF line o f credit and the aim is to show a demonstration effect, the VAPCF is a logical organization to spread the lessons o f the pi lot lending under the MLF across the entire PCF network. Some o f the key areas o f need that can be supported by this TA sub-component are expected to be: (i) building the supervision, external auditing, and internal control f hc t i ons within the PCF network, (ii) roll ing out a standardized credit manual across the PCF network, (iii) supporting the development o f management information, banking software, accounting, and reporting systems across the PCF network, (iv) implementing the organizational and business plan for the VAPCF, (v) improving the funding o f the VAPCF, (vi) strengthening the human resources o f the VAPCF, and (vii) training the PCFs o n the standardized operational procedures in various areas, such as credit risk management. Some limited support wil l be provided under this sub- component to the State Bank o f Vietnam. The purpose wil l be to include the SBV in the capacity building o f the VAPCF so that the SBV, as the supervisory agency o f the PCF network, understands the developments and begins to gain a level o f comfort with the VAPCF.

14. A. 3. New Financial Services Development - PFIs (US$ 1.9 million): This sub-component i s designed to encourage PFIs to develop new products, particularly to serve the rural economy in Vietnam. The basic idea behind th i s component would be to allow for innovations in the provision o f rural financial services and supporting those PFIs that are interested in offering new products to rural enterprises and households. There wil l be four distinct elements to this New Market Development component as follows:

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0 Cash Flow-Based Lending (US$ 0.83 million): One critical barrier to access to finance i s the stringent use by banks o f collateral to back loans, which for small rural enterprises with little in the way o f valuable (or acceptable) collateral, this necessarily limits their ability to grow their businesses through a bank loan. However, because most banks do not provide non-collateralized loans, substantial training o f staff, as well as new standardized systems and policies would be required to effectively undertake cash-flow based lending by the PFIs to rural enterprises. This component wil l enable the PFIs to design cash flow-based credit technologies that would provide the PFIs with simple, client-responsive, standardized loan product designs with built-in specialized accounting, monitoring, risk management and management information systems designed specifically for small-scale loans. The credit technologies would allow the PFIs to better judge the borrower’s ability to pay based on a variety o f input factors, which would not be totally reliant upon collateral availability and valuation, and would allow them to better price their products based on the r isks and costs identified by the system. The success o f such technologies would require that they be paired with training to loan officers, managers, etc. to better understand their application. The TA provided could support feasibility studies for any new technologies required for implementation, as wel l as for training to the PFIs. This will be coordinated with the IFC’s Mekong Private Sector Development Facility (IFC-MPDF) Vietnam Bank Advisory Project to help Vietnam’s commercial finance institutions provide more and better services to micro, small and medium enterprises, as well as individual consumers.

e Insuring Against Agricultural Risks (US$ 0.5 million): Another key area requiring new innovative approaches is risk mitigation for agricultural lending. The agricultural sector in Vietnam i s regularly subjected to a variety o f risks, including weather (floods, droughts, typhoons, etc.) and disease (avian flu, etc.), but there are virtually no products available to the banks to hedge their exposures to the agricultural sector. Insurance penetration in Vietnam i s very low, in common with other countries in the region, but it i s growing. However, most insurance coverage i s not geared towards agricultural risks. Therefore, the innovations that will be supported under this sub-component would include supporting the PFIs with TA to explore new insurance products. One example o f such an innovation could be weather-indexed insurance coverage for agricultural businesses. The country, particularly the rural areas, i s particularly prone to adverse weather, which mainly manifests itself in the form o f floods at regular intervals. VBARD, the biggest bank which serves rural areas has to send its credit officers after each flood to check the impact and often has to reschedule loans made to those who were impacted by the floods. This causes major problems for both the enterprises and the banks, and thus a new type o f weather- based insurance product could greatly mitigate the risks associated with lending to certain types o f businesses in particular locales in Vietnam. In addition, there appears to be demand from agricultural-related businesses for insurance products to mitigate the r isks o f disease in fish, livestock, poultry, etc. Thus, the PFIs

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could be provided TA to build these services in partnership with insurance companies.

e Generating Long-Term Funding (US$ 0.5 million): A key financing constraint that the RFIII project attempts to address i s the lack o f medium- and long-term financing in the banking system. At the moment, the majority o f banks raise funds via mobilizing relatively basic deposits from individuals and corporations and there are very few alternative savings products offered by the banks. As was mentioned in Annex 1, only about one-third o f al l deposits are longer than 1 year in maturity and thus, much o f the longer-term lending is being funded by short- term money. This is a significant barrier to the investment needs o f the growth businesses in Vietnam. Therefore, this sub-component would provide TA to the PFIs to assist in designing, marketing, and managing new longer-term savings products, including varied deposit account structures, Certificates o f Deposit, and other products such as bonds.

15. A. 4. Environmental Compliance in Lending - PFIs (US$ 0.4 million): Given that environmental safeguards are an important innovation in the RFIII project - no other lending operations in Vietnam have factored in environmental concerns - emphasis wil l be given to this area. This sub-component will provide training to the PFIs o n the environmental guidelines and manual prepared for lending under the RDF (and MLF). The PFIs wil l receive training on the procedures for appraisal, evaluation, and monitoring o f compliance with environmental assessment and pest management safeguards, as wel l as on the restricted and negative lists o f environmentally (and socially) sensitive sub- projects. This wil l cover two times environment audit during the project implementation for the sub-projects financed. This wil l also cover the costs o f developing and printing the pamphlets for the end-borrowers on the environmental requirements o f the project.

Subcomponent B. Based Assistance (US$ 10 million)

Strengthening the Participating Financial Institutions - Loan

16. B. 1. Strengthening the APEX Bank - BIDV (US$ 1.5 million): Assistance will be needed to continue the restructuring o f BIDV on organizational change, corporate governance, and many operational areas o f the bank. This TA would follow-on the previously provided assistance to BIDV in these areas and would also include a significant proportion o f training and hands-on implementation assistance. In addition to the general issues related to the bank restructuring, specific assistance to BIDV related to the project administration could include support to enhance i t s credit risk analysis and determination o f the credit line exposures for the PFIs. Support to the PMU for the project, TCIII, wil l be included in this component. Such support wil l cover strengthened analytical review o f the PFI strategies, methods o f capital increase, shareholder structure and corporate governance issues, accounting standards and qualifications, and implications o f the trends in the financial ratios. This support wil l also cover a variety o f training for BIDV management and staff, as well as the relevant goods required to support the implementation o f the project such as computers, printers, a supervision car, etc. BIDV wil l be required to borrow to access this sub-component o f TA services.

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17. B. 2. Building the Capacities of the PFIs (US$ 8.5 million): The PFIs have varied needs for technical assistance and training, from the broader range o f institutional strengthening to credit appraisal and risk management specific to the RFIII lending operation. The emphasis o f the TA to PFIs under this sub-component would be on those needs specific to the provision o f financial services to rural micro-enterprises and SMEs, as well as rural households. This particular sub-component wil l be an on-demand facility that wil l work towards the various PFI needs based on their specific demands given that the PFIs wil l be required to borrow to support this TA. However, i t is expected that there wil l be the following elements to this sub-component:

e Strengthening Rural SME Lending - PFIs (US$ 0.5 million): The PFIs would likely need training managing credit risk to these customer segments, pricing the loans to incorporate the full risk, cost, and profi t considerations, effectively engage in more unsecured lending and lending to small-sized rural enterprises and households, using the movable assets registry, marketing to new market segments, and other issues surrounding rural enterprise business development. The TA could also include strategic advisory services on branch expansion in rural areas and methods o f outreach into these areas and businesses in the rural economy. Some o f the assistance could be provided through existing facilities, such as the Bank Training Center and the Vietnam Banker’s Association, and some training may have to be customized and tailored for each PFI.

Improving Potential PFIs (US$ 1 million): Those banks that do not fully meet the accreditation criteria set forth in Annex 4.3 can also participate in this specific sub-component. These banks can access this facility to develop a time-bound action plan, or Institutional Development Plan (IDP), to reach the performance benchmarks o f the accreditation criteria. The IDP would be specific to each PFI given that each PFI wil l have unique strategies, strengths, and weaknesses, but al l IDPs would be aimed at reaching the same targets. Upon such time the PFI meets the criteria, i t wil l be eligible for an allocation o f the RDF and/or MLF l ine o f credit. The aim o f this sub-component i s to assist the ineligible PFIs in improving their performance, and ultimately, to encourage their participation in the RDF and/or MLF lines o f credit to expand access to finance in the rural economy.

e Enhancing the Largest Rural Financial Institution - VBARD (US$ 7.0 million): The Vietnam Bank for Agriculture and Rural Development (VBARD) i s the largest bank in Vietnam by branches (about 2,200 nationwide) and by total assets (approximately US$ 12 billion), as well as by employees (over 30,000). VBARD began its history as a specialized lending institution to support agricultural lending. Since the banking reforms in the late 1990s, VBARD began shifting toward more commercialized banking operations. By 2001, as with al l o f the State Owned Commercial Banks (SOCBs), VBARD began shifting i t s strategy towards a more diversified, universal banking model aimed at increased private sector lending and retail banking through its branch network, but st i l l the core o f the bank’s operations i s in rural household and SME lending. As with al l o f the

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SOCBs, VBARD i s also trying to expand i t s non-interest income through offering new products and services. The overall restructuring o f VBARD has yielded some positive results and the bank has historical strengths, but the bank sti l l faces weaknesses and threats in the near term. The key institutional weaknesses o f the bank include inefficient and decentralized organizational design with limited built-in accountability for r isks and systems for accurate accounting o f the bank’s position. These inefficiencies have resulted in lagging financial performance with inadequate capital adequacy, unknown asset quality and insufficiency o f loan loss provisions, l ow liquidity with possible maturity mismatches, and limited profitability. As such, VBARD today would not be able to participate in the RDF and MLF as it would not meet the minimum accreditation criteria. VBARD drafted an Institutional Development Plan (IDP) in late-2007, which when finalized, will be the basis for financial performance enhancement and provide the roadmap for meeting the RFIII eligibility / accreditation criteria. By agreeing to an IDP mutually acceptable to the bank and IDA, VBARD would be eligible to participate in the above-mentioned sub-component to build the institutional strengths to enable the bank to meet the accreditation criteria and participate in the RDF and/or MLF lines o f credit. In addition, because VBARD has such a wide network presence in rural areas, i t is essential to enhance the performance o f this institution to better serve the rural-based businesses. Therefore, this particular sub-component would be focused expressly on helping VBARD implement i t s institutional development plan, but with particular emphasis on those areas directly connected to the activities o f the project, namely household and M S M E lending. Therefore, some areas that this technical assistance component would support include:

o Diagnostic review of the bank - In order to establish a benchmark for financial performance under the IDP, as wel l as for the restructuring and planned equitization o f VBARD, a full diagnostic review o f the bank wil l be required. Such a review would be broader than a routine audit, which is based on a sampling, and would cover the entire branch network and al l aspects o f the bank’s business with particular focus on the loan portfolio.

o Detailed Appraisal of Rural Branch Operations and Development of Future Structure - VBARD needs to carry out a detailed assessment o f the effectiveness and efficiency o f i t s entire branch network operations and following this to put in place the most efficient and effective network to serve its customer requirements profitably. For purposes o f this project, the focus wil l largely be on the rural branch network o f VBARD.

o Building a comprehensive business strategy - Based on the diagnostic review and assessment o f the bank’s branch operations, both o f which should reveal the strengths that VBARD should build on and the weaknesses VBARD should address, the bank wil l need assistance in developing a comprehensive business strategy for the next five year period. This strategy should cover the future direction o f the bank in terms o f objectives, operations, organization, and ownership.

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o Establishing a human resource capacity building program - A critical element o f the success o f VBARD’s fbture strategy wil l adequate human resource capacities to implement i t effectively. Therefore, the bank wil l need to build on assessments and strategic plans developed (under a separate assistance program to VBARD under the RFII project) to carry out the training programs. The training programs developed wil l cover areas specifically geared to household and MSME lending operations, including: . Develop an extensive training program for credit ofjcers - All

credit officers should attend a major training program at least every two years. The bank should develop a range o f programs with assistance from an international organization covering credit assessment, control o f credit, problem loans, SME lending, financial and planning assessment, programs specific to particular industry segments.

Develop a series of training programs for Lending Group Leaders - Lending groups are an important element in a significant proportion o f household lending and they carry out an analysis o f the customer and their requirements before the customer approaches the bank. I t is in the interest o f VBARD to ensure that the leaders o f these groups receive some training on a periodic basis from VBARD on credit assessment and r isks associated with credit as wel l as with VBARD’s overall approach to risk.

o Developing a risk based approach to credit - VBARD will need to develop and put in place a modem risk based approach to household and SME lending. This will include putting in place the systems and procedures so that the r isks associated with i t s various markets can be continuously assessed and updated.

o Put in place a modern credit assessment and control process - VBARD has a credit assessment and monitoring process in place which is largely based on the existing credit manual. This i s a manual-based system with no reliance on modem technology for the analysis o f the information, control o f the lending, and fol low up processes. As the bank has significant numbers o f small loans to family households i t needs to implement a modem system with good use o f technology to make the processing o f these loans more efficient and to facilitate the introduction o f automatic control and fol low up procedures. Credit Scoring should be put in place for some smaller loans and the bank should have a control and monitoring system that focuses the effort on where the key problems arise rather than across the total portfolio as i s the case at present with household lending.

o Develop a mechanism for the overall quality control of lending - This i s necessary for controlling non performing loans by the credit and risk function at head office and in the provinces. VBARD does not have any

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clear system for controlling the overall quality o f i t s portfolio at present. Their primary effort i s focused on collecting the necessary information on non performing loans. The bank needs to put in place a mechanism whereby the information requirements can be provided automatically by the information system and that the bank develops the important sk i l ls o f managing the problem loans successfully so that the bank achieves a high repayment rate and resolution o f these accounts in the shortest timescale.

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Annex 4.1 : Alternative Project Design Options Considered

A number o f options were considered for on-lending arrangements under the proposed project, including the following:

1. Alternative Options for Project Design: In designing the Rural Finance I11 project, various options were considered in terms o f structuring the l ine o f credit. Under the RFII project, BIDV was selected unilaterally as the wholesale bank to administer the line o f credit. This was done at the early stages o f the banking reform program, in 2001, and the choices o f potential wholesale banks were very limited. The banking sector has since evolved, however the range o f realistic choices for project design has not dramatically changed since the design o f the RFII. Four basic options were considered in the design, including: (a) Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected APEX Bank, the Bank for Investment and Development of Vietnam (BIDV), that would bear the full credit risk; (b) Modif ied Status Quo - a Wholesale Banking Operation (WBO) to be carried out by a pre-selected Agent Bank, BIDV, that would only administer the line o f credit without taking the credit risk; (c) Semi-competitive - several pre-determined participating financial institutions (PFIs) would be selected based on the accreditation criteria to receive a l ine o f credit for on- lending to their respective clients; (d) Competitive - bidding out the WBO to the market to select an APEX bank for the l ine o f credit. The advantages and disadvantages o f the four options are summarized below.

2. (a) Status Quo - This option would maintain the structure under Second Rural Finance Project, with BIDV as APEX taking the credit risk. There are some clear advantages in selecting this option: (i) it allows more banks to participate in the project, thus increasing banking competition in the rural areas (one o f project objectives); (ii) this option would allow the project to diversify project's beneficiaries as each PFI wil l accommodate i t s own clientele; (iii) this option would better fit the basic concept o f a demand driven operation, as it allows potential PFIs to join the project at their choice; (v) social and economic impact o f the project i s spread, through the wholesale operation, throughout the country. BIDV has performed well in managing the Rural Finance I1 (RFII) project, in particular, staff from BIDV has carried out the credit risk assessment o f the participating financial institutions (PFIs) with professionalism and strived to ensure that the subprojects financed by the PFIs were in l ine with the project the objectives. The repayment rate from the PFIs to BIDV under the project has been 100% and the %age o f past due loans from end-borrowers to the PFIs has been close to zero - only 0.3% by August 2006. BIDV has made progress in institutional strengthening under the project and various technical assistance programs. All o f the RFII project audits have been unqualified and the financial management system has been judged to be sound. The Government supports this option and BIDV i s interested in maintaining i t s role as the APEX bank under the RFIII and i s making serious efforts to implement i t s business strategy, equitization, and Non-Performing Loan (NPL) resolution plans. The Government o f Vietnam i s committed to support BIDV's ambitious equitization plan which wil l make BIDV a much stronger financial institution.

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3. (b) Modified Status Quo - This option would essentially have the same pros and cons o f the Status Quo option (a), but with a few key exceptions. O n the positive side, using BIDV as an agent bank would limit the potential risks to the World Bank (WB) and the Government in terms o f the exposure with the l ine o f credit managed by an SOCB with weak financial performance. This would also reduce the reputational risk to the WB in terms o f being seen as endorsing an SOCB in poor financial health. The credit risk would be borne by the Government (Ministry o f Finance) and BIDV would simply administer the l ine o f credit on behalf o f the Government through a contract and on a fee or commission basis. This option would expect MOF to carry out the credit r isk assessment function, which i t does not have the capacities to do (nor should it). However, if the MOF outsources this function, the line o f credit is de facto the same as Option A, but with less ownership and motivation on the part o f BIDV to perform the credit risk function and intensely monitor the performance o f the PFIs given they do not take the credit risk and reap the benefits (interest earned) in doing so. The costs might also be higher as BIDV could not cover i t s costs through the revolving funds o f the project, but instead would charge higher fees that would compensate. In addition, the M O F might be enticed to become more directly involved in the banking sector, including possibly directing credit and influencing PFI management and banking operations. The potential for such actions i s unknown, but if realized would constitute a major set-back for the banking reform process. The Government has not expressed support for this option.

4. (c) Semi-Competitive - This option would allow the Government and WB to pre- select PFIs based on agreed upon accreditation criteria. The criteria would be set to include the PFIs with the strongest financial health, as well as sound strategies and abilities to expand access to credit in the rural economy. This would have the added advantage o f limiting the credit and reputational risks by pre-selecting the PFIs. However, the MOF would have to perform some form o f the APEX banking function, would carry some o f the attendant risks as mentioned in Option (b). This option would also be an expensive one in terms o f project preparation and supervision as i t would involve the appraisal o f several banks and later o n routine supervision o f the performance o f each o f the selected financial institutions and the way they were implementing the project. The main disadvantage i s that such a design i s inflexible, specifically i t would: (i) prevent other financial institutions from joining the project in a later stage; and (ii) limit the number of PFIs that are able to participate under the project, thus limiting project impact on enhancing banking competition in the rural areas and diversification o f i t s beneficiaries. Experience in other countries has indicated that there are often problems in making desirable re-allocations o f committed funds from institutions which are unable to disburse funds quickly to those which could use them. This 'predetermined' option, if selected, would reduce the likelihood that the project would fully meet al l i ts objectives.

5. (d) Competitive - This option would essentially be the same as the Option (a) with the many o f the same pros and cons, but instead o f pre-selecting the APEX bank, the role would be bid out the WBO to the market. This would allow al l o f the interested banks in Vietnam to compete for the APEX bank role based on their terms and ability to

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meet predetermined accreditation criteria set by the Government and WB. This would enable the Joint Stock Banks to compete directly with the SOCBs and would potentially bring in a more financially sound bank to be the APEX bank, provide a lower cost option, and enable more efficient management and administrative capabilities to the WBO. However, al l o f the PFIs (private joint stock banks) under the RFII project are al l o f a small-scale in terms o f assets (averaging US$286 million) and have strategies to be retail lenders, therefore these banks have not expressed interest in taking the wholesale banking role. The remaining three SOCBs also have not expressed strong interest in the wholesale banking role given their strategies, with the agricultural bank seeking to act as a PF I under the project and the other two banks pursuing strategies that are not aligned to performing a wholesale banking function. Finally, the bidding process would be very time-consuming and expensive and carries the risks that there are no banks interested, the bids are expensive and not suited for the project needs, and the project reverts to the status quo. The Government has not expressed support for such an option.

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Annex 4.2: Appraisal of the APEX Bank

Bank for Investment and Development of Vietnam

1. Choice of On-lending Bank. The Government proposed that the Bank for Investment and Development o f Vietnam (BIDV), a State Owned Commercial Bank (SOCB), be the APEX bank and the institution responsible for the implementation o f this project, including managing the credit risk o f the l ine o f credit. BIDV has performed wel l in administering the Rural Finance I1 (RFII) Project, in particular, staff from BIDV has carried out the credit risk assessment o f the participating financial institutions (PFIs) with professionalism and strived to ensure that the subprojects financed by the PFIs were in line with the project the objectives. The repayment rate from the PFIs to BIDV under the project has been 100% and the percentage o f past due loans from end-borrowers to the PFIs has been close to zero - only 0.3% by August 2007. BIDV has also met al l o f the disbursement targets under the RFII project and administered the project in compliance with al l o f the World Bank guidelines and requirements, including the separate technical assistance component. All o f the RFII project audits have been unqualified and the financial management system has been judged to be sound.

2. Beyond the proven project management capacities o f BIDV, another consideration for selecting BIDV as the APEX bank was that most o f the PFIs (private joint stock banks) under the RFII project are al l o f a small-scale in terms o f assets (averaging US$286 million) and have strategies to be retail lenders, therefore these banks did not express interest in taking the wholesale banking role. The remaining three SOCBs also have not expressed strong interest in the wholesale banking role given their strategies, with the agricultural bank seeking to act as a PFI under the project and the other two banks pursuing strategies that are not aligned to performing a wholesale banking function. BIDV i s keen to maintain i t s role as the APEX bank under this RFIII and i s making serious efforts to implement i t s business strategy, equitization, and Non- Performing Loan (NPL) resolution plans. BIDV has made progress in institutional strengthening under the project and various technical assistance programs and the overall financial health o f the bank has shown significant improvement. Therefore, the role o f BIDV as the APEX bank for the project has been confirmed.

3. However, BIDV does not meet al l o f the financial performance accreditation criteria required for participating financial institutions and as such, BIDV has prepared a newly updated Institutional Development Plan (IDP) that includes a time bound schedule for meeting al l accreditation criteria that i t does not currently meet. BIDV has also submit to IDA an update on its strategic plans (business, equalization, NPL, IDP, etc.). Based on information from BIDV management and staff, it is expected that BIDV should have met most o f the PFI accreditation criteria by end-2007 and this wil l be verified by the 2007 IFRS audit report. This Annex describes this progress, as well as the overall financial health and performance o f the bank.

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4. History of the Bank. The Bank for Investment and Development o f Vietnam began its history as a specialized lending institution to finance large-scale capital and infrastructure projects in the country. BIDV was established in 1957 as the Bank o f Construction o f Vietnam, and re-established in 1996 as an independent state owned commercial bank. BIDV i s the second largest bank in Vietnam by assets and a relatively large bank in terms o f physical presence, with 103 main branches and 202 sub-branches and transaction offices across al l 64 provinces o f Vietnam and 10,000 employees as o f September 2006.

5. Since the banking reforms in the late 1 9 9 0 ~ ~ BIDV lost its monopoly position in the area o f large-scale financing and the bank, as with al l o f the SOCBs, began shifting its strategy towards a more diversified, universal banking model aimed at increased private sector lending and retail banking through i t s branch network. Despite the shift, lending to State Owned Enterprises (SOEs) s t i l l represents the majority o f the BIDV’s portfolio with the bank s t i l l maintaining strong relationships the large SOEs engaged in construction activities. As with al l o f the SOCBs, BIDV i s also trying to expand its non-interest income through offering new products and services. The new business lines the bank i s expanding into include leasing, securities, insurance, cards, and ATMs. BIDV i s the third largest o f the four main SOCBs by branches and total assets. The overall restructuring of BIDV has yielded some positive results and the bank has some inherent strengths, but the bank s t i l l faces weaknesses and threats in the near term.

6. Overall Financial Performance. BIDV’s financial performance is showing significant improvements in a number o f areas, but the bank i s s t i l l struggling with the legacy loans o f i t s past role as a directed lending institution. BIDV has been one o f the most aggressive banks in the Vietnamese market to pursue International Accounting Standard ( IAS) audited accounts and the bank has published them in their Annual Reports since 2004, side-by-side to i t s Vietnamese Accounting Standard (VAS) audits. Based on the 2006 I A S accounts, one can see an improvement in the income statement with an increase in interest income o f 17% implying an increase in the interest margin. The bank also maintained relatively strong performance on the measures o f efficiency - expenses to loans and assets - and the bank’s net prof i t also rose during the period to reach 613 bi l l ion Vietnamese Dong, or VND, (US$ 38.6 million) in 2005. This allowed the bank to record a Return on Equity (ROE) o f 16% and Return on Assets (ROA) o f 0.4%. Whi le this is an improvement over previous years and BIDV is continually making strong improvements in performance, BIDV compares unfavorably against many international performance benchmarks in East Asia and among developed country banks for performance. BIDV’s profitability i s increasing, but i t is s t i l l relatively l ow when compared with the benchmarks for banks operating in East Asia and in developing economies. BIDV’s capital adequacy i s also wel l below the 7.2% average in East Asia, as i t s liquidity, and the asset quality i s also lagging. BIDV has also been reviewed in M a y 2007 by an international rating agency, Moody’s, and received a l o w Bank Financial Strength Rating o f E+ (on a scale f i om A to E, with A being the best), which was a slight improvement over the October 2006 rating o f E. The rating was given because o f the bank’s “significant asset quality problems, its weak funding profile, and modest liquidity,” however, Moody’s provided a positive outlook for BIDV due to the bank’s “strengthening profitability, ongoing restructuring, and recapitalization.” Below i s a

49

comparative table showing BIDV’s performance on a number o f key metrics compared with the average in East Asia and developed economies worldwide.

Performance Indicators

Table 1 : Benchmarking BIDV’s Financial Performance

East Asia Developed Country BIDV’ Average** Average” *

Sources: * 2006 IAS Audit Data for B ID V, Ernst & Young Vietnam. * * 2005 DatafFom the I F C derivedfiom Banh-scope. East Asia data based on an average of 25 banks across 7 countries and Developed Country data based on an average of 43 banks across 12 countries.

7. Overall Asset Quality. The asset quality o f BIDV has been increasing on a slow and steady trajectory over the past five years, but has witnessed a sudden rapid improvement in 2006. Although the exact quality o f the loan portfolio before 2003 i s difficult to ascertain on an international standard basis, the broad trends can be described. BIDV initiated a re-orientation o f i t s asset profile. BIDV brought its level o f N P L s down to 9.6% from a level o f over 33% in 2002, slowed lending from a growth rate o f 37% in 2002 to 19% by 2006, and increased the level o f provisions to cover 60% o f N P L s by 2006. In addition, BIDV has increased i t s holdings o f government securities and placements with other banks by 167% since 2002, and these holdings constituted 21% o f total assets by 2006. The shift in the portfolio represents part o f the bank’s strategy o f gradually moving into less risky asset holdings and focusing on asset quality over growth.

8. Management and Corporate Governance. The management o f BIDV, under the strong and committed leadership o f the bank’s General Director, has taken many aggressive steps since 2005 to improve the performance o f the bank. Under the direction o f the bank’s management, BIDV has completed the second phase o f a comprehensive technical assistance program (“TA2”) with an international advisory partner, ING Bank. The project was supported and managed by the World Bank and was focused on strengthening BIDV’s strategic planning, organizational model (including corporate governance), restructuring the head office organization and member units, improving the

50

credit risk, asset and liability management, internal audit, and other key operational functions in line with international best practices in banking operations. The bank has already incorporated many elements o f the technical assistance, including in the strategic planning process, and i s contracting the next phase o f assistance to fully implement many o f the recommendations provided under the TA2 project.

9. Strategy. The bank has drafted the strategy to 2010 and i t has been approved by the Board o f Directors and Board o f Management. This strategy includes new product development and IT modernization approaches. BIDV has also taken steps to centralize the operations o f the branch network and i s planning a regional hub structure, including setting lower credit approval limits and rol l ing out the core banking and management information systems to the branch network (144 branches and subsidiaries). BIDV has activated the Risk Management Unit to implement its risk management policies, guidelines, and tools. This Unit i s also developing the Operational Risk Framework and the Manual for Credit Risk Management. The bank i s also pushing training programs to i t s staff on a range o f issues, including credit risk management, with the support o f the World Bank. In the f i rst 4 months o f 2006, BIDV had already conducted 45 courses for 2,133 staff across the bank under the Project’s budget. Finally, BIDV is a market leader in publishing their I A S accounts in the bank’s Annual Reports and was the first bank in the market to complete its 2005 I A S audit. Related to this move towards greater transparency, the bank also invited Moody’s to provide a rating o f the bank in April 2006 and again, invited Moody’s back to update the rating in M a y 2007.

10. The strategic plans o f the bank (business, equalization, NPL, IDP, etc.), which in the past did not appear to be inter-related, now are highly inter-active. In fact, the April 2007, “Brief Report on the Implementation o f BIDV’s Strategic Plans,” brought the various strategic plans together in one coherent explanation o f the future targets and actions the bank plans to take to 2010. The financial performance targets in these strategic plans seem to be much more realistic and fact-based than in the past, the sequencing o f the actions appear to be logical, and the ambitions in the strategies appear to be largely aligned with the strengths o f BIDV. ,

11. In addition, in spite o f al l o f the positive progress over the past year and a half, BIDV, as with al l o f the SOCBs, faces a fundamental corporate governance and incentives challenge. This i s due to the uncertainty surrounding who has the responsibility to provide management oversight from a shareholder point o f view and hence, who has the power to act. The SBV plays the shareholder role and i s often involved in management-level decisions through regulatory mandates, while the Ministry o f Finance (MoF) has little real power in the SOCBs. SOCB managers need SBV approval for many business decisions and the bank faces other government imposed constraints, such as expenditure limits and profi t targets. The shareholder role in putting pressure on management to perform i s largely absent in the SOCBs and there i s no independent reporting to shareholders on performance o f the SOCBs, nor to the Board o f Directors (BOD) on the performance o f the managers. Thus, the performance incentives based on profit maximization and delivering value to shareholders i s largely absent. All o f this may change in the near term with the planned “equitization,” or partial privatization, o f BIDV in 2008.

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12. Equitization of the Bank. BIDV plans to equitize, or partially privatize, the bank by selling shares and on January 2, 2007, the Prime Minister directed the bank to complete the process by 2008. Details o f the equitization plan were finalized by end o f November 2006 and the Steering Committee for the equitization was established in January 2007. BIDV has hired an international investment bank to help in the advisory process to seek out a foreign strategic investor, as wel l as to help in valuing the bank and developing the share sale strategy - the bidding and short l i s t o f international f i r m s has already taken place. I t i s expected that an international investor wil l take a minimum 15% stake in the bank and another 15% wil l be sold via an init ial public offering process on the domestic stock markets. BIDV i s seeking to accomplish the following objectives through the equitization proces: (a) enhance financial performance; (b) improve management capabilities by attracting international management experience; (c) facilitate BIDV’s international integration; (d) become more competitive and further increase market share; and (e) update technology and develop new products. N o other state- owned commercial banks in Vietnam have actually undertaken the equitization process to date, but it i s expected that BIDV will be the third to do so (after the Bank for Foreign Trade, or “Vietcombank,” and the Mekong Housing Bank). Once BIDV does undergo an initial public offering o n the market, presumably the Ho Ch i Minh Stock Exchange, i t wil l be subject to al l o f the listing standards o f the exchange, including importantly those for disclosure and corporate governance.

13. Recommended Restructuring and Progress. BIDV has made aggressive efforts towards improving the operational and managerial performance o f the bank. In mid-2006, the World Bank reviewed this progress (under the supervision process o f the Rural Finance I1 project) and made recommendations for continued reform and restructuring. BIDV showed impressive initiative in meeting the recommendations in a short period o f just six months. The table below provides an approximate measurement o f the progress to date. Three notable developments shown in Table 2 below should be highlighted. First, BIDV has developed and i s now implementing an NPL resolution plan that sets out ambitious targets for achieving a l ow level o f N P L s by end-2007, aiming at a 5% or below. Second, BIDV has developed, with the help on an international auditing firm (Ernst & Young), an Internal Credit Rating System (ICRS) to evaluate and classify al l o f i t s loans more accurately which was put into operation in November 2006 that covers 68% o f the loan portfolio. Finally, as mentioned above, BIDV developed and is implementing an equitization plan that envisages BIDV becoming a publicly held bank, including significant share holdings by strategic international investor(s).

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Table 2: Recommendations and Restructuring Progress by BIDV

World Bank Recommendations

(June2006)

Rapidly reduce lending to the industries, sectors, geographic locations, and enterprises identified as being high risk and generating NF’Ls (Categories 3, 4, 5 loans) for the bank and address the portfolio o f Category 2 (special mention) loans.

Aggressively pursue the NPL resolution plan with greater emphasis on selling the N P L s to the Debt and Asset Trading Company (DATC) and resolution through Government recapitalization.

0 Get the strategic plans o f the bank, including the overall plan to 20 10 and the equitization plan, approved and adopted.

Fully implement and enforce the new credit manual and procedures across the bank network and implement a system o f rewards and penalties for performance for credit officers.

Also, implement the plan to develop a customer ratings system and move the internal reporting and loan classification systems to the international standard and pilot test the systems.

Make additional progress in pricing credit to reflect the full

BIDV i s implementing an Internal Credit Rating System (ICRS) to evaluate and classify al l o f its loans more accurately. The ICRS has been approved by the SBV and now covers 68% o f the bank’s loan portfolio. The bank i s now taking action to reduce the lending to the poorly performing customer segments.

A detailed NPL resolution plan has been developed and BIDV i s targeting a level o f N P L s o f 5% by end-2007 through aggressive collection, and resolution through provisioning, sales to the DATC, and recapitalization by the Government. Based on new ICRS, the NPLs within the bank in 2006 (based on the I A S audit report) were 9.6% o f total loans outstanding.

BIDV has prepared an equitization plan, which has been approved by the Government, and BIDV i s contracting an international strategic advisor for the valuation o f the bank and developing the equitization strategy for the share sale by the end o f 2007. BIDV also has an Institutional Development Plan, which appears to be in line wi th its overall strategic plan for the bank.

Thisis still a work in progress.

As ofNovember, the ICRS has been built and i s now being put into place across the bank, including the branch network. The ICRS monitors approximately 68% o f total loan portfolio. Loans to individual borrowers are not included under ICRS yet. The SBV, by official letter No. 9745/NHNN-CHN dated November 14,2006, approved the adequacy o f BIDV’s ICRS as per Art. 7 o f SBV Decision 493.

This i s a work in progress. The ICRS should help in differentiating customers

53

costs and risks associated with the loans with a resulting larger interest income and increased profitability ratios.

Reverse the trends in medium-to long-term fund mobilization to better align the assets and liabilities o f the bank and provide for increased opportunity to undertake longer te rm investments and loans.

Continue to provide high quality training to the bank staff involved in the credit decision making process, as well as in other areas o f the bank critical to risk management.

Accelerate the centralization o f the credit function f rom the branches, along with the installation o f more robust internal controls and segregation o f duties.

Prepare for a third phase o f comprehensive technical assistance for the bank to build on the recommendations and processes developed under the Technical Twinning project with ING Bank, which closed in 2006.

54

based on risk and thus, should help in pricing the products and services.

BIDV signed a 5 year loan agreement wi th RFZ Bank (Austria) on November 6 for $200 mil l ion in an effort to restructure its liabilities, thus improving the profile o f its long-term assets which now are partially financed by short-term liabilities. Other efforts are also being made.

BIDV conducted training on trainers nationwide in 3 geographical regions. Training courses on credit operations have been implemented for branches nationwide. As o f the end o f September, 7 out o f 8 planned courses have been carried out under Rural Finance I1 project. In addition, BIDV intends to develop a human resources strategy and training programs through a projecl to be funded under the RFII project.

BIDV has reduced the credit approval limits o f branches. The f u s t restrictions have been on medium and long-term lending and the handling o f customers o f Group B and customers wi th Category 3,4, and 5 loans.

BIDV i s in the process o f contracting the project to be funded under the Rural Finance I1 project.

e

Annex 4.3: Eligibility Criteria forparticipating Financial Institutions

1. The eligibility criteria for the Participating Financial Institutions (PFIs) in the Rural Finance I11 (RFIII) project have been developed based on past experience under the previous Rural Finance projects, as well as best practices in World Bank line o f credit operations worldwide. The criteria set out minimum standards o f financial performance benchmarks for PFIs to meet in order to participate in the project. These benchmarks are structured to reflect the core areas o f a financial institution - management and corporate governance, asset quality, capital adequacy, liquidity, profitability, and efficiency - and are primarily aimed at setting a basic standard o f financial health and soundness for eligible PFIs and encouraging other financial institutions to reach these standards. Secondarily, the criteria are designed to protect the on-lending bank from the potential credit r isks o f the PFIs and to enable the on-lending bank to better determine the appropriate level o f the size o f the line o f credit. Finally, the criteria are designed to provide a standardized, comparable monitoring tool to measure the progress made by the PFIs.

Purpose of Eligibility Criteria.

2. Background on the Financial System. Vietnam’s financial system i s st i l l in transition from serving a centrally planned economy to serving an increasingly liberalized, market-oriented economy. Since the reform program began in 2000, there have been significant improvements, such as an increase o f bank credit to GDP from 35% in 2000 to 66% in 2005 and deposits to GDP from 39% to 67% respectively. In addition, the growth rate o f both credit and deposits has been rapid, averaging close to 30 % on an annual basis. Importantly for this project, there i s now increased domestic competition, with 36 joint stock (semi-private) banks (JSBs) holding 15% o f the market share, although the four large State Owned Commercial Banks (SOCBs) have maintained their dominance o f the market, holding a steady 70-75% market share. Despite this progress, the level o f financial performance o f the banks has historically been weak, which would be expected at Vietnam’s stage o f transition and economic development. Although some o f the banks are now solid performers, attracting the major international banks as partners and investors, and recent evidence suggests that many o f the JSBs in particular are reaching towards international standards o f performance. Therefore, i t is important to establish financial eligibility criteria that are in line with the direction o f the progress within the banking system and to provide realistic, but achievable benchmarks for PFIs under the RFIII project.

3. General Criteria. In order to participate in the project, a financial institution wil l need to meet a set o f management and financial criteria that have been agreed with the World Bank, and to have signed a Subsidiary Loan Agreement with the on-lending bank for the project. The Agreement will, inter alia, reflect the PFI’s management interest in and commitment to servicing the rural market, willingness to strictly adopt and adhere to prescribed policies and procedures o f the project, commitment to hire and train new loan officers, and to utilize the Technical Assistance Facility o f the project. In addition, the

55

PFI would have to provide i t s full business strategy and plan for the future and the rationale for its participation in the RFIII project. This would include the institution’s plan for outreach and expansion into rural areas, including in the various business segments, and would provide some indication o f how the RFIII i s in l ine with the overall business strategy. As Table 1 below indicates, the financial institution would also have to be in substantial compliance with al l the prudential and regulatory requirements o f State Bank o f Vietnam (SBV) and acceptable to the World Bank, with no pending supervisory actions against the institution. The financial institution would also have to be licensed in Vietnam to undertake banking operations and have an appropriate corporate governance structure that complies with the appropriate regulations, with independence and capacity to provide adequate supervision to management and control over the bank’s lending decisions. This would also include verification o f the PFI management that the bank meets the fit and proper standards and other requirements o f Vietnamese banking laws and regulations. Finally, the financial institutions must have (and provide) financial reports for the past two years under VAS, audited by a reputable auditing firm that i s acceptable to the SBV. In cases where the I A S audit reports are available, the PFIs shall provide the I A S audit reports immediately. Otherwise, the PFIs shall provide I A S audit reports within 2 years after receiving a credit l ine o f USD 3 mi l l ion and above from the project or at the discretion o f the APEX Bank. The audit reports should not contain any serious qualifications and if they do, i t wil l be at the discretion o f the APEX Bank, in agreement with the World Bank, as to whether the audit reports wil l be accepted as compliant with the eligibility criteria and whether the bank can participate in the project.

4. Financial Criteria. As mentioned above, financial eligibility criteria are structured to reflect the core areas o f a financial institution. The criteria included in Table 1 cover standard ratios for asset quality, capital adequacy, liquidity, and profitability. These financial criteria are designed to capture the key performance issues, such as rapid business expansion (loan growth ratio), robustness o f r isk management practices (non-performing loans ratio), ability to cover losses (provisions, capital adequacy ratios), and the sufficiency o f income generation (profitability ratios). In sum, these indicators should provide a clear picture o f the overall health o f a financial institution and in a time-series, will provide picture o f the positive and negative trends within the institutions. I t would also be useful to monitor other standard financial ratios o f the PFIs, such as those for efficiency (operating expenses to assets, loans, and income) to gauge the operational strength and others that are not criteria, but would be indicative, such as the provisions to non-performing loans, net interest margin, and various liquidity measures. Wherever possible, the criteria are benchmarked to the East Asia region based on the International Finance Corporation’s (IFC) due diligence process for its investments in banks. However, the performance benchmarks for Vietnam are adjusted to account for the lower level o f economic and financial development as compared to the other six mostly middle income countries used in the F C benchmarks. In addition, the methodology for calculating the ratios is consistent with existing SBV regulations where applicable.

5. Meeting the Criteria. All potential PFIs would have to apply to participate in the RFIII project and the on-lending APEX bank, BIDV, along with the World Bank would determine the eligibility o f a financial institution. Given that the APEX bank i s taking

56

the full credit risk o f on-lending to the chosen PFIs, i t wil l then conduct i t s own in-depth due diligence on each PFI to determine creditworthiness and the specific allocation o f the l ine o f credit for each PFI based on this due diligence assessment. The APEX bank wil l also conduct regular monitoring o f the performance o f the PFIs to ensure continued eligibility throughout the project implementation. If a financial institution can not meet the minimum criteria o f Table 1, i t wil l not be eligible to participate in the RDF and/or MLF l ine o f credit under the FWIII project." Such a financial institution would pose a sufficiently high risk to the on-lending bank and to the project. If a financial institution does not meet al l the criteria, then it can s t i l l participate in the l ine o f credit and select elements o f the technical assistance component (Component 111) o f the RFIII project if it agrees to a time-bound action plan, or Institutional Development Plan (IDP), to reach the performance benchmarks. The IDP would be specific to each PF I given that each PFI wil l have unique strategies, strengths, and weaknesses, but al l IDPs would be aimed at reaching the same targets. The IDP wil l be done to the satisfaction o f and subject to approval by the APEX bank, BIDV, and the World Bank. The IDP would be monitored on an annual basis by the on-lending bank and the World Bank to ensure progress is being made. If a financial institution meets al l o f the eligibility criteria, then i t would not need an IDP and would immediately become a PFI in the project and would receive an allocation o f the line o f credit based on the assessment made by the APEX bank, BIDV.

6. Non-Bank Participating Financial Institutions. I t i s envisaged that for the Micro-enterprise Development Fund, the PFIs participating in the RDF will be eligible to participate in the MDF. In addition, non-bank PFIs wil l also be eligible for and participate in the MDF line o f credit. The non-bank PFIs that would qualify to participate in the MDF would include primarily some select number o f the best performing o f the 955 People's Credit Funds (PCFs). The PCFs are governed by the Law on Credit Institutions and associated regulations and they are supervised directly by the State Bank o f Vietnam. The PCFs are a network o f member-owned credit cooperatives that provide savings and credit products. The PCF network serves 1 mi l l ion members with loans o f an average value o f US$ 700-800. Due to their small size, private (member) ownership, and closeness to borrowers, PCFs can usually provide more varied loan products, albeit at higher interest rates, than banks. The interest rates on loans vary significantly from 8.4 - 17.4% p.a., but loans to poorer members cost an average o f 9% p.a. The non-bank PFIs that would be eligible to participate in the MDF would also possibly include a l imited number o f Microfinance Institutions (MFIs) that are licensed by the State Bank o f Vietnam under Decree 28 o f 2005." At the moment, no MFIs have been licensed to operate under this Decree and the implementing guidelines and regulations have not been finalized. Most potentially licensable MFIs are non-governmental organizations that are supported by international donors o f some form and most programs use a solidarity-group methodology, either o f the village bank or Grameen Bank-type, whi le a few (including the largest MFI, the CEP Fund in Ho C h i Minh City) also

lo Based on September 2007 data from BIDV, 15 joint stock banks out o f 24 PFIs under the RFII project meet al l of the proposed criteria and it i s expected that by end-2007, many more w i l l reach the targets as well. l1 Decree of the Government Number 28/2005/ND-CP of March 9, 2005, "On organization and operation o f micro finance institutions in Vietnam."

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provide individual loans and housing loans. The size o f outreach by these institutions i s very small, with only about 142,200 loan accounts. Interest rates range between 0.8 - 2% per month, calculated o n a flat or declining balance. The overall average loan size reported i s VND 1.5 m i l l i on (US$ 95). M a n y o f the schemes offer financial services as part o f an integrated package o f other activities. The criteria for these non- bank PFIs under the MDF will be similar to those for PFIs as outlined in this section and in Table 1 below. However, the underlying methodologies (and associated regulations) governing the criteria, such as those for liquidity, asset quality, etc., listed in Table 1 wil l be different because these institutions are regulated differently than banks. In addition, there are no standard international benchmarks for performance for these non-bank institutions and the benchmarks used to judge these non-bank PFIs may differ than those l isted in Table 1. Therefore, the performance benchmarks wil l largely be in l ine with Table 1, but can be modified at the discretion o f the APEX bank according to market conditions for these non-bank PFIs.

......................................... 2

4

5 ........................

Table 1 : Eligibility Criteria for Participating Financial Institutions"

PFI " i s licensed to operate' 1 >=3 years I NIA

1 SiA Level o f compliance with i banking laws and regulations' 1 Compliance with management :

and corporate governance 1 regulations' ~ "

Audited Accounts Asset Quality Non-Performing Loans to ! !

.......................... ............................. f.. .................................................................. " .... ................................................. " ........... " ................................. " ................................ i ............ " ................................................ I 1 Nopending 1 j

I supervisory ~

actions I j

i ................................................................................ ......................................... ...................... ................................. ............... ........ .............. .............................................

Full I i NIA

I NIA

t " ~ _ " " " "

........................ .............................................................

1 <=6% ~ 3.2% Total Outstanding Loans4 i

capital^ Adequacy Owner's Equity to Total Risk Weighted Assets' 6.8% I 1 >=8% i i

Eligibility Criteria

...................... 9 10

........................................................................ ....................... .... ................................................. ................... ............................................................................................................ 15.9% ...... " .... ̂. ! >= 10% ReturnonEquity ._." 1 *" "" ...." ~ _ Return on Assets , >= 0.5% 1

Note that for non-bank PFIs, such as the People's Credit Funds and Microfinance Institutions, the underlying methodologies and regulations governing the criteria l isted in Table 1 wil l be different. In addition, there are no international benchmarks for performance and the benchmarks used to judge these non-bank PFIs may differ than those listed in Table 1.

12

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A s per the L a w o n Credit Institutions (1997) and associated S B V regulations.

As per the requirements o f S B V Decree 49/2000MD-CP o f September 12, 2000 (and any subsequent revised versions o f th is regulation).

Audited Accounts required to b e done by a reputable accounting fm. The Audit should be basedon I A S if the P F I has total assets above U S D 500 mil l ion. Otherwise, the accounts wil l be prepared under V A S with an action p lan to produce IAS-compliant accounts.

As per the requirements o f S B V Decision 49312005lQD-NHNN o f April 22, 2005 and any subsequent amendments, which outlines the five category classification system for loans, required level o f provisions for each category, and the general level o f provisions.

As per the requirements o f S B V Decision 457/2005/QD-NHNN o f April 19, 2005 and any subsequent amendments.

F rom the 2005 performance benchmarks o f the International Finance Corporation (IFC) derived f r o m Bankscope based o n the median data o f 25 banks across 7 countries in East Asia, including Vietnam.

3

4

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Annex 4.4: Compliance with Financial Intermediary Lending Policies

World Bank Operational Policy 8.30

1. The following table provides an overview o f the Third Rural Finance (RFIII) project’s compliance with the World Bank operational policies on financial intermediary lending (FILs). The compliance assessment i s based on the main criteria set forth under OP 8.30 and provides a brief explanation o f the justification for rating the proposed RFIII compliant with the policies.

Interest Rates

Directed Credit

The Project supports one or more o f the fol lowing Objectives:

(a) supporting reform programs in the financial sector or related real sectors;

(b) financing real sector investment needs;

(c) promoting private sector development;

(d) helping to stabilize, broaden, and increase the efficiency o f financial markets and their allocation o f resources and services;

(e) promoting the development o f the participating Financial Institutions (PFIs); and

(0 supporting the country’s poverty reduction objectives.

Bank funds are priced to be competitive with what the participating PFIs and their sub-borrowers would pay in the market for similar money, taking into account, as relevant, maturities, risks, and scarcity o f capital

Bank-supported F ILs also a im to remove o r substantially reduce the use o f directed credits, wh ich are akin to interest rate subsidies, as they lead to resource allocation outside market mechanisms. A Bank FIL may support directed credit programs to promote sustained financing for such sectors, provided the programs are accompanied by reforms to address the underlying institutional infrastructure problems and any market imperfections that inhibit the market-based f l ow o f

investments in the real sector - capital investments by micro- and s m a l l enterprises (MSEs) in rural areas. I t will also support private sector development as the borrowers wil l a l l be privately held, and it wil l encourage the participating o f the private financial institutions. The project wil l provide fund for technical assistance and training to the PFIs. The project will also help to enhance and catalyze P F I term lending to the MSEs in rural areas o n a commercial basis. Ultimately, the project wil l contribute to new investment and income generation by supporting broad-based, private sector-led growth in rural areas.

The h d s f r o m the Bank wil l be provided f r o m the PFIs to the sub- borrowers at h l ly commercial rates. The finds on-lends to the PFIs f rom the APEX will be based o n market rates, with an agreed formula with weighted deposit rate discussed between the Wor ld Bank and the key stakeholders in Vietnam.

The credit will focus o n addressing the impediment o f MSEs’ access to finance especially those private enterprises with less than 50 employees, who generate most o f the employment but have most dif f iculty in access to finance. The credit appraisal and on-lending terms wil l be done o n a market- basis and wil l promote increased

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Subsidies

Accreditation Criteria

Appraisal

credit to these sectors.

In some cases (e.g., poverty reduction programs), subsidies may be an appropriate use o f public funds.

The Bank requires an assurance that PFIs acting as on-lenders in FILS and other investment operations are viable institutions, having:

(a) adequate profitability, capital, and portfol io quality, as c o n f i e d by financial statements prepared and audited in accordance with accounting and auditing principles acceptable to the Bank

(b) acceptable levels o f loan collections;

(c) appropriate capacity, including staffing, for carrying out subproject appraisal (including environmental assessment) and for supervising subproject implementation;

(d) capacity to mobil ize domestic resources;

(e) adequate managerial autonomy and commercially oriented governance (particularly for state-controlled PFIs);

(f) appropriate prudential policies, corporate structure, and business procedures.

Note: New and existing PFIs that do not meet al l the accreditation criteria for being intermediaries may participate in an FIL ifthey agree to an institutional development plan that includes a set of time-bound monitorable performance indicators and provides for a periodic review ofprogress.

The Bank's appraisal o f a proposed FIL:

(a) determines if it wil l achieve the desired objectives with due regard to the sustainability o f the financial sector;

(b) establishes the economic justif ication o f the operation;

(c) confirms, for a FIL justif ied by its poverty- reduction goals, that it i s a practicable, cost- effective way o f achieving them;

(d) confirms the accreditation o f PFIs proposed for inclusion; and

(e) ascertains that implementing the FIL i s unl ikely to undermine the financial condition o f participating PFIs.

term financing for these enterprises in the rural economy by PFIs. The project will also have extensive assistance to help address the underlying barriers to finance for rural MSEs.

There are n o subsidies built in to the project.

The project sets out standard financial performance benchmarks for the APEX bank, as we l l as the PFIs to meet in order to be selected to participate in the project. These benchmarks are structured to reflect the core areas o f a financial institution - management and corporate governance, asset quality, capital adequacy, liquidity, profitability, and efficiency - and are primarily aimed at setting a basic standard o f financial health and soundness for potential PFIs. In addition, provision i s made for those PFIs that j o i n the project and may for some reason not meet the criteria. These provisions include the mandatory implementation o f an institutional development plan.

The Project has taken a l l these appraisal elements in to consideration, not only promotes rural growth and bring economic benefit t o the rural private enterprises, but also aims to help strengthening the APEX and PFIs and support the broader financial sector re form in Vietnam. The project builds in a process for the appraisal o f the APEX bank and the PFIs at the in i t ia l accreditation stage, as we l l as o n an ongoing basis as the project is under implementation.

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Use o f Funds

Monitoring

FILS are used to finance investments in subprojects for increased production o f goods and services and that meet eligibility and development criteria agreed with the Bank.

The FIL has effective monitoring and evaluation (M& E) o f the project’s progress toward i ts objectives and development impact throughout the l i f e o f the project. The variables for the PFIs include, inter alia, adequacy o f capital, quantity and quality o f earnings, quality o f assets, sufficiency o f liquidity, extent o f subsidy dependence, effectiveness o f FI loan administration, and adequacy and timeliness o f preparation o f audited financial statements.

The funds w i l l be used for financing the financial and environmental variable sub- projects in Vietnam except the four cities in Vietnam (Hanoi, H o Chi Min City, Danang and Haiphong) and sub-loans w i l l be used to finance capital investments in productive assets and associated working capital loans.

The project will have an integrated set o f monitoring and evaluation indicators to report during the course o f Project implementation. This wil l also include variables for the participating PFIs. The accreditation criteria will represent the basic framework for t h i s FI monitoring. In addition, project- specific variables are also included into the M&E process. The APEX w i l l monitor the performance o f PFI and carry out the analysis and follow up on the IDP implementation on regular basis.

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Annex 5: Project Costs

Vietnam: Third Rural Finance Project

Table 1. Components Project Cost Summary

Vietnam Third Rural Finance Project Components Project Cost Summary

A. Increase Capital Investments by Rural Enterprises B. Increase Access to Microfinance in Rural Economy C. Build Institutional Capacities and New Products

1, Strengthening APEX Bank 2. Building Participating Financial Institutions 3. Expanding into New Markets

New Product Development New Customer Development New Institution Development New Environmental Standards in Lending

Subtotal Expanding into New Markets Subtotal Build Institutional Capacities and New Products

Total BASELINE COSTS Physical Contingencies Price Contingencies

Total PROJECT COSTS

(US$ '000) Local Foreign Total

175,000.0 75,000.0 250,000.0 14,285.7 14,285.7

409.7 865.9 1,275.6 2,575.7 5,033.4 7,609.0

175.1 1,575.9 1,751 .o 145.9 708.8 854.7 160.4 1,447.3 1,607.7 36.9 332.1 369.0

51 8.3 4,064.1 4,582.4 3,503.6 9,963.4 13,467.0

192,789.3 84,963.4 277,752.7 175.2 498.2 673.4 474.6 384.5 859.1

193,439.2 85,846.0 279,285.1

Table 2. Legal Categories and IDA Funding

Disbursement Category (US$ '000) IDA

Amount %

RDF eligible sub-loans disbursed (component 1) 175,000 100.0

MLF eligible sub-loans disbursed (component 2) 10,000 100.0 IDA-term Capacity Building eligible expenditures and taxes (component 3.A & 3.8, including Goods and Works, Consultant and Training) 10,000 100.0

Grant Capacity Building eligible expenditures and taxes (component 3.C, including Goods and Works, Consultant and Training) 5,000 100.0

63

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Annex 6: Implementation Arrangements

Vietnam: Third Rural Finance Project

1. The credit would be made to the Socialist Republic o f Vietnam for on-lending to BIDV. The Ministry o f Finance wil l then on-lend the h d s to BIDV based o n an on- lending agreement. BIDV would assume overall responsibility for project implementation. BIDV will on-lend the proceeds to eligible PFIs based on the terms and conditions o f Subsidiary Loan Agreements (SLAs) signed between BIDV and PFIs. The PFI, will, in turn, extend sub-loans to eligible MSEs and households borrowers.

2. BIDV has already established a Project Management Unit which i s part o f the BIDV’s core transaction center. This PMU has equipped with committed and capable staff and they are the champion in achieving the Project development objectives and ensure the compliance the IDA’s safeguard policies. The PMU has several un i t s including Accreditation Division in charge o f financial analysis o f the interested financial institutions; Appraisal Division in charge o f eligibility o f sub-proj ects financed; Environment Division in charge o f compliance o f the IDA’s safeguard policy; Finance and Accounting Division in charge o f hnds f low and bookkeeping; Training Division responsible for the training activities for both the staff from PMU, BIDV and the PFIs; and the Project Monitoring and Evaluation Division responsible for institutional strengthening component and project reporting and evaluation activities.

3. Project Operating Policies and Procedures. Under the proposed project BIDV would develop i t s capabilities as the APEX bank. The credit operation would be carried out on the basis o f policies and procedures established in a Policy Manual (PM) for each o f the Funds. The P M would be periodically updated to reflect necessary pol icy changes. The adoption and implementation o f the PM, satisfactory to IDA would be a condition o f Credit effectiveness. The PM would include: interest rate structure and foreign exchange coverage fee; PFIs accreditation criteria; eligibility criteria for subprojects financed; sub- projects appraisal procedures, sub-project review and disbursements; sub-loan rescheduling; sub-loan maturities; environmental protection; and arrangement o f monitoring and supervision; accounting and audit procedures. The PM would not be revised without prior consultation with and approval o f IDA.

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Annex 7: Financial Management and Disbursement Arrangements

Financial Management Assessment

Vietnam: Third Rural Finance Project

1. An assessment o f the project’s financial management arrangements was conducted in October - November 2006, June 2007, September 2007, and during the Appraisal mission in October 2007 and i t i s concluded that with the completion o f the Action Plan as tabled in this Financial Management Assessment, the Project wi l l meet the minimum requirements o f the Bank’s OP/BP10.02.

2. The Third Rural Finance Project (TRFP) i s a fol low on project from the Second Rural Finance Project (SRFP). The financial management (FM) arrangements o f the SRFP are acceptable and the FM Risk i s considered to be low as there are good financial internal controls and systems operating together with timely reporting and auditing. Unqualified audit reports have issued annually in relation to the SRFP. The TRFP’s financial management arrangements therefore are based on the current FM system o f SRFP with some required improvements to overcome weaknesses identified in the SRFP.

A. Country Issues

3. Over the past several years, Vietnam has taken significant steps in improving institutions, laws and regulations and practices to ensure greater financial accountability and transparency in public expenditure. A large number o f recommendations o f the Country Financial Accountability Assessment (CFAA) and P E R - F A have been implemented, or else are in the process o f being implemented. For example, oversight by the National Assembly and the provincial People’s Councils over public finances has been substantially increased. Audit reports on public expenditures are now published. Public access to financial information continues to improve. Nevertheless, challenges remain. Public sector accounts need to be made more timely, accurate and consistent with international standards.Oversight by the National Assembly over public finances and the effectiveness o f the State Audit o f Vietnam need further strengthening. Financial accountability and transparency at the sub-national level also need to be fbrther strengthened.

B. Risk Analysis and Mitigating Measures

4. The project inherent risk i s assessed as moderate primarily due to: (i) risks that funds may not be used for intended purposes especially under Component I11 - Strengthening Institutional Capacity and Meeting Merging Demands for Rural Finance Services - where many trainings, study tours and seminars will occur, (ii) the large number o f PFIs/MFIs’ sub-branches at provincial, district and commune level participating in the project with the lack o f integrated financial information system.

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5. The project control r isk is assessed as moderate with strengths in the implementing agencies having prior experience with Bank funded operations and adequate financial management capacity and acceptable external audit arrangements. FM risks primarily relate to weaknesses identified through the SRFP in the areas o f (i) insufficient internal audit function especially at the PFIs/MFIs for project activities which result in weaknesses in sub-loan initiation and monitoring procedures; (ii) risk o f errors and mistakes arising from the manual consolidation process o f quarterly financial reports for PFIs/MFIs’ branches and sub-branches; and (iii) inefficient expenditure verification procedures by State Treasury which may result in delay in disbursement for the USD5 mi l l ion grant component.

r Risk Risk

Rating

Inherent Risk Country level: Overall Moderate Fiscal Environment

6. To mitigate the risks, more training and capacity building o n internal audit objectives, functions, procedures, and best practices wil l be organized with a focus on governance and the Accounting Division o f BIDV- Transaction Center I11 i s to more actively participate in supervisions o f PFIs/MFIs during project implementation. The PFIs/MFIs wil l be encouraged to consider integrating the project financial report format into their current accounting system. To avoid possible serious delays experienced in many projects due to cumbersome approval procedures, the MOF, SBV and BIDV will meet together regularly to work out an efficient mechanism to effectively use the fund for i t s intended purposes and the procedures will be documented in the Financial Management Manual for this project.

Moderate Entity and Project level: Large number o f participating PFVMFI and significant resources allocated for

1. Budgeting Moderate

Weaknesses at participating PFI/MFI could compromise

Risk Mitigation Measures Incorporated into Project Design

Capacity building in Med ium Term Expenditure Framework (MTEF), urban planning and budgeting, implementation and monitoring, commitment control and debt management; (i) Annual financial audit by external auditor, (ii) enhanced internal audit arrangements (iii) enhanced oversight for sofi expenditures (iv) smart procurement o f training services

Training for PFVMFI o n internal audit. Additional staffing for P M U so that PMU can participate in internal audit missions conducted by the Appraisal divison o f the APEX Bank.

Risk After Mitigation Condition of Negotiation, Board or Effectiveness

Moderate

Moderate

Moderate

L o w

Moderate

76

e o f a specific system. To n o f FMR PFI/MFI w i l l

not negate the need for manual production and I consolidation.

Overall Control Risk I Moderate 1 I Moderate

D. Implementation arrangements

7. As for the SRFP, the TRFP’s APEX Bank (BIDV), wil l be responsible for the project’s overall financial management, and other project implementing institutions, including PFIs/MFIs, SME Association and PCF Association, wil l be responsible for the financial management o f the project resources to which they wil l have access under their respective project components. All project implementing institutions wil l have adequate financial management and accounting systems in place before they can use proceeds o f the IDA Credit.

US$195 million on-lending credit

8. The IDA credit o f US$ 200 mi l l ion would be made to the Socialist Republic o f Vietnam for on-lending and grant to BIDV. Out o f this credit, the Ministry o f Finance wil l on-lend the funds to BIDV based on an on-lending agreement for US$195 million, including the Rural Development Fund and Micro-finance Loan Fund, and capacity building for the financial institutions. BIDV will assume overall responsibility for project implementation. BIDV will on-lend the proceeds to eligible PFIs based on the terms and conditions o f Subsidiary Loan Agreements (SLAs) signed between BIDV and PFIs. The PFI, wil l in turn, extend sub-loans to eligible borrowers. In accordance with Circular no. 108/2007/TT-BTC dated 7 September 2007 by MOF o n Financial

77

Management applicable to Official Development Assistance projects and programs to support the implementation o f Decree no. 131/20O6/ND-CPy dated 9 November 2006, by the Government on ODA Management, BIDV will be responsible for expenditure verification (kiem soat chi) for both credit activities and non-credit components under the on-lending agreement.

US$5 million grant from state budget

9. The remaining U S $ 5 mi l l ion (under Component 111: Strengthen Institutional Capacities and Meet Emerging Demands for Rural Finance Services) will be allocated to BIDV in the form o f grant from the state budget. In accordance with the Official Letter no. 1794/TTg-QHQT dated 22 November 2007 by the Prime Minister, the BIDV was delegated to be the APEX Bank for the whole IDA funds including US$195 mi l l ion on- lending and U S $ 5 mi l l ion grant. SBV wil l be responsible to ensure that BIDV develops an efficient mechanism for the fund management and coordination among concerned parties for the implementation o f the US$ 5 mil l ion grant. In accordance with Circular no. 108/2007/TT-BTC dated 7 September 2007 by MOF on Financial Management applicable to Official Development Assistance projects and programs to support the implementation o f Decree no. 13 1/2006/ND-CP on ODA Management, the State Treasury will be responsible for expenditure verification for this grant from the state budget, this provides an additional safeguard over the use o f the grant.

10. In line with this arrangement, MOF will allocate the budget o f the U S $ 5 mi l l ion grant directly to BIDV. BIDV will be responsible for the implementation o f the grant including budgeting, accounting, internal controls, reporting, and auditing. M O F wil l approve total and annual financial budgets with the State Treasury or an organization desinnated bv the MOF performing expenditure verification. SBV will approve total and annual procurement and training plans and supervise BIDV’s compliance with government regulations during their implementation o f the grant activities.

11. This arrangement will exploit BIDV’s experience and expertise in preparing TORS for consultants and technical assistance, in designing training plans and in supervising training courses while s t i l l ensuring SBV’s overall approval and oversight hnction. I t also ensures one focal point - BIDV - in budgeting, accounting, internal controls, and reporting for the whole IDA Credit o f USD 200 mi l l ion (including both the on-lending and grant components). I t will help ensure consistency and achievement o f project development objective and wil l facilitate supervision o f project implementation.

12. To address concerns o f possible serious delays experienced in many projects due to cumbersome approval procedures, and MOF, SBV and BIDV will work together to develop efficient mechanisms to effectively use the grant finds for i t s intended purposes and to avoid any implementation delays. BIDV i s exploring the possibility o f contracting out provision o f training and other activities on a lump s u m contract basis (rather than in house organization) which would have the benefit o f reducing the number o f transactions and therefore quicken the expenditure verification process by the State Treasury.

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13. Based on the agreement among MOF, SBV and BIDV for the US$5 mi l l ion grant, BIDV wil l develop a detailed implementation arrangements between BIDV and the beneficiaries which are the SMEs Associations (for sub-component 111.1 - enhance MSEs capacity to access rural finance services), the PCF Association (for sub-component 111.2 - enhance PCFs capacity in providing rural finance services), and PFIs (for sub-component 111.3 - introduce new rural finance products and services). The current arrangements proposed by BIDV i s that BIDV will be responsible for budgeting, implementing, accounting, and reporting with detailed tasks to include:

Consolidating and developing work plans for al l sub-components for Component 111; Coordinating with the two associations and PFIs to implement work plans,

including developing TORS for consultants and selecting consultants/training providers; Monitoring consultants’ work and training results;

-

-

- Receiving and evaluating consultants’ finished work (reports, training plans, etc); Funds management for the Component; Recording and accounting, internal controls; Evaluating results achieved and consolidating reports.

- - - -

Regarding training, SBV will approve total and annual training plans. After that, BIDV will implement the approved training plans with support from the participating Associations.

14. The implementation arrangements will be clearly documented in the Implementation Guidelines for RFPIII and will be the binding document for a l l parties participating in the implementation o f the project.

E. FMStaffing

15. Currently there are two accountants in the Accounting Division o f Transaction Centre 111, which i s part o f the BIDV’s core transaction centre, who are directly responsible for RFPII (one i s responsible for the credit component, the other for the training component). Under TRFP, in addition to the on-lending credit and training components o f US$195 million, the Transaction Centre will implement the US$5 mi l l ion grant for which State Treasury i s the expenditure verification agency. However, i t i s noted that in 2006 and 2007, the Accounting Div is ion could not j o i n the Appraisal Division in supervision visits to PFIs due to their heavy workload (these supervisions normally include staff from both the Appraisal Division and Accounting Division o f the Transaction Centre 111). To ensure adequate financial management resource o f TRFP, the TCI I I has recently appointed one more accountant to ensure smooth FM operations o f the project and allow more time for project accountants to participate in internal audit visits to PFIs organized by the Appraisal Division. The accounting and financial management staff (including the Chief Accountant) o f the project must be acceptable to the Bank.

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E. Budgeting

16. The TRFP’s P M U at BIDV wil l be responsible for the total project budget including al l components (for both on-lending credit and grant). For Component I and Component 11, the annual budget wil l be prepared based on approved credit limits for PFIs/MFIs. For Component I11 - Strengthen Institutional Capacities and Meet Emerging Demands for Rural Finance Services (US$15 mi l l ion IDA financing) the annual budget wil l be prepared based on actual need and annual training plans from BIDV, SMEs Association, PCF Association and PFIs/MFIs.

17. Annual training plans wil l cover the period from 1 April to 31 March. This allows PFIs to prepare their training plan during the first quarter o f the year when the work load i s reduced. At the same time, i t allows for some training to take place in the beginning o f the year when staff have more available time to attend. Current practice i s that the PMU issues instruction to PFIs on the preparation o f training plan on an annual basis. The P M U will issue a training plan template as a reference for al l PFIs and include the template in the FM Manual.

18. For the US$10 mi l l ion on-lending credit under Component I11 (sub-component Strengthening the Participating Financial Institutions), PFIs wil l prepare their training plans and submit them to the PMU, the management o f BIDV and WB for approval. The P M U and BIDV’s management wil l be responsible for providing assurance to SBV that the training plans are suitable, SBV wil l not be involved in approving total and annual training plans o f PFIs.

19. For the US$5 mi l l ion grant, BIDV will prepare total and annual training plans in coordination with the SMEs Association, the PCF Association, and PFIs. SBV wil l then approve these total and annual training plans and supervise BIDV’s compliance with government regulations during their implementation o f the grant activities.

20. TRFP’s Financial Management Manual.

The budgeting procedures and approval processes are to be clearly documented in

F. Accounting policies and procedures

21. Under SRFP, the accounting policies and procedures are governed by various directives issued by MOF and SBV and are documented in the project’s Financial Management Manual (FMM). A revised FMM which i s part o f the Project Operational Manual (POM) for TRFP will be prepared taking into account the TRFP requirements and recommendations from the WB and the auditors for improvements in financial management arrangements.

G. Internal Controls

22. The current internal controls o f SRFP are operating effectively for the Credit Component and therefore, are proposed to be used for TRFP. However, the SRFP

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internal controls for the Institutional Strengthening Component have some weaknesses and i t i s recommended that more detailed instructiodguidance with reference templates (both training plan and expenditure acquittaVdisbursement dossier templates) for Component I11 be developed. The instructions/guidance wil l be incorporated into the FMM in order to make one complete set o f guidance for PFIs.

23. In accordance with Circular no. 108/2007/TT-BTC dated 7 September 2007 by M O F on Financial Management applicable to Off icial Development Assistance projects and programs to support the implementation o f Decree no. 131/2006/ND-CP on O D A Management, the State Treasury wil l be responsible for expenditure verification for the US$5 mi l l ion grant from the state budget, while BIDV will be responsible for expenditure verification (kiem soat chi) for both credit activities and non-credit components under the on-lending agreement. The expenditure verification processes wil l be clearly documented in the FMM.

H.

Funds Allocation

Funds Flow and Disbursement Arrangements

Box 1. The table below details the allocation of IDA Credit

Categorv

(1) Sub-loans

(a) under Part A o f the Project

(b) under Part B o f the Project

(2) Goods, consultants’ services, and training

(a) under Parts C( 1) and (2) o f the Project

(b) under Part C(3) o f the Proiect

Total Amount

Amount of the Financing Allocated (exDressed in SDR)

1 17,700,000

6,380,000

6,380,000

3,240,000

127,700,000

Percentage of Expenditures to be

Financed (inclusive o f Taxes)

100% o f Sub-loan Amount disbursed

100%

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Fundsflow

24. The credit will be made to the Socialist Republic o f Vietnam for on-lending to BIDV which i s acting as the wholesale institution (APEX Bank) o f the project. The funds flows for the project Under Component I and I1 wil l be: BIDV on-lends to PFIsMFIs in accordance with subsidiary loan agreements between BIDV and PFIsMFIs. These loans are called subsidiary loans. PFIsMFIs make loans to end-borrowers for sub-projects which have three financing sources, the one from IDA Credit is called sub-loans which finance up to 70% o f the total estimated sub-project cost, 15% from PFIs and the rest 15% from the end-borrower’s equity contribution. The current practice i s that PFIsMFIs select from their loan portfolios sub-projects which meet RFP’s requirements, present these eligible sub-loans in the Statement o f Expenditure (SOE) and ask for a subsidiary loan for the total amount o f the SOE from BIDV. I t is encouraged that PFIs actively seek suitable end-borrowers and offer them with sub-loans from the project source.

25. Under the on-lending sub-component o f Component I11 - Build Institutional Capacity and N e w Product Development, PFIs/MFIs submit payment dossiers for approved trainings which are already carried out using their own sources o f funds. Upon checking and approval from the Project M&E Division, Accounting Division, and PMU’s Director, funds wil l be disbursed from the DA to PFIsMFIs.

26. For the US$5 mi l l ion grant for Component 111, BIDV will submit payment dossiers to State Treasury or a designated organization by M O F for expenditure verification before submitting withdrawal applications for DA.

27. Disbursing from the Designated Account (DA) - DA (A) for Credit Line:

1. PFIsMFIs consolidate the eligible sub-loans and transmit the request for payment to BIDV Appraisal Division;

2. BIVD Appraisal Division reviews and approves eligibility o f the sub - projects and passes to the Accounting Division;

3. The Accounting Division checks the funds request and passes to the Director;

4. Director approves and funds are then withdrawn from the designated account and transferred to the PFI/MFI.

(A similar process for requesting payments for training from P F I M F I s i s followed except that the payment request does not pass through the Appraisal Division).

28. Disbursing from the Designated Account (DA) - DA (B) for Grant: 5. PFIsMFIs consolidate training payment requests and transmit the request

for payment to BIDV; 6. For al l expenditure requests from the Grant DAY BIVD submits the request

to the State Treasury for approval;

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7. After approval i s received, the BND disburses f inds from the Grant DA.

29. Withdrawal Application Process: 8. The BIDV prepares the withdrawal application and supporting documents

and send to the World Bank; 9. IDA disburses monies to the Designated Accounts.

Disbursement methods

30. TFWP will use the following disbursement methods: Reimbursement - The Bank may reimburse the borrower for expenditures eligible for financing pursuant to the Credit Agreement (“eligible expenditures”) that the borrower has prefinanced from i t s own resources. Advance - The Bank may advance loan proceeds into a designated account o f the borrower to finance eligible expenditures as they are incurred and for which supporting documents wi l l be provided at a later date.

0 Direct Payment - The Bank may make payments, at the borrower’s request, directly to a third party (e.g. supplier, contractor, and consultant) for eligible expenditures.

31. the project.

The Disbursement Deadline Date will be four months after the Closing Date o f

32. Withdrawals from the Credit wil l be made on the basis o f Statements o f Expenditures for: (a) contracts with consulting f i r m s cost less than $100,000 equivalent each, (b) contracts with individual consultant cost less than $50,000 equivalent each, (c) goods costing less than $100,000 equivalent per contract, (d) training, ( f ) sub-loans. Documentation supporting SOE disbursements wil l be kept by the BIDV for the l i fe o f the project and one year after the receipt o f the audit report for the last year in which the last disbursement was made. These documents wil l be made available for review by the auditors and IDA supervision missions. All other expenditures above the SOE thresholds will be submitted to IDA o n the basis o f full documentation.

The project w i l l use traditional disbursement method.

Designated Accounts and Ceilings

33. Two Designated Accounts (DAs) wil l be opened for the BND Transaction Centre I11 who is responsible for the project funds in a commercial bank with terms and conditions satisfactory to the IDA. One DA will be for the US$195 mi l l ion on-lending credit, the other DA for the US$5 mi l l ion grant.

34. The ceiling for the Credit DA (A) account (for disbursement category la , lb and 2a) wi l l be US$20 million. The ceiling for the Grant DA (B) account (for disbursement category 2b) wil l be US$500,000.

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35. regular basis, e.g. monthly.

BIDV will report on the use o f the loan proceeds advanced to the D A s on a

Counterpart Funds

36. BIDV and PFIs are assessed as having the capacity to mobilize the counterpart funds needed for the project. N o counterpart funds are required for the US$5 mi l l ion grant (1 00% financing by the grant).

I. Financial Reporting

37. The current computerized accounting system and project management systems at the Transaction Center I11 are operating effectively and therefore, i t i s proposed that TRFP will continue to use these systems.

Under SRFP, the PMU’s financial reports in accordance with the project FMM are submitted to the Bank on a quarterly basis and in a timely manner. Progress reports are submitted as required for the Bank’s missions. The financial reporting system o f the project i s effective and wil l continue for TRFP. Quarterly financial report templates for TRFP will be agreed upon between the PMU and the Bank by negotiation.

38. At PFIs, quarterly financial reports consolidated from their branches are manuallv prepared using excel. This practice creates more manual work for accountants in preparing financial reports for the projects and increase risks o f errors and mistakes. PFIs are encouraged to consider integrating the project report format into their current accounting system based on their own cost and benefit analysis.

J. Internal Audit

39. Under SRFP, the Internal Audit Departments o f each PFIsMFIs i s required to perform internal audits o f loans financed by SRFP as part o f their internal audit o n a

semi-annual basis. In addition to this, the Appraisal Division and Accounting Div is ion under Transaction Center I11 are responsible for internal auditing and supervising o f a l l PFIs/MFIs every six months. These practices wil l be continued in the TRFP.

40. In order to enhance the internal audit function at PFIs, more training on internal audit objectives, functions, procedures, and best practices wi l l be organized during project implementation. I t i s also recommended that the PFIs’ internal audit annual work plan and semi-annual internal audit reports be sent to the PMU o f BIDV for review and approval. These requirements wil l be clearly documented in TRFP’s Financial Management Manual. The focus o f the enhanced internal audit function will be improved governance.

K. External Audit

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41. The BIVD will be responsible for preparation o f annual financial statements for the Project. The financial statements o f the project wi l l be audited on an annual basis in accordance with international auditing standards and terms o f reference acceptable to IDA. The annual financial statements and audit report must be submitted to IDA within six months o f the end o f each fiscal year. The auditor who is acceptable to the IDA will be required to express a single audit opinion covering the Project Accounts, the use o f Statements o f Expenditures and the Designated Account. A management letter addressing any internal control weaknesses o f the implementing agencies (PMU and PFIsMFIs) wil l also be provided by the auditor together with the audit opinion report.

L. Financial Management Action Plan

Actions Date of Completion Responsibility

I PFIs/MFIs Appoint the project accounting staff with qualifications acceptable to the IDA

I I I

By Accreditation

Revise and adopt an acceptable Financial Management Manual, as part o f the overall Project Operation Manual

APEX Bank Effectiveness

M. Supervision Plan

APEX Bank/PFIs/MFIs

Develop training and capacity building programs including trainings on internal audit

42. Supervision o f project financial management wil l be performed on a risk-based approach at least once a year with field visits to the PMU and selected PFIs/MFIs to review their financial management arrangements, funds flows, budgeting, accounting records and internal controls. The supervision wil l review the project’s financial management system, including but not limited to the operation o f Designated Account, Project accounts, internal control and financial reporting. The supervision visits to the project implementing agencies will be supplemented by reviews o f the internal control supervision reports, review o f the quarterly IFRs, and the annual audit reports o f the project. Financial management supervision will be conducted by IDA’S financial management specialist(s).

3 months after effectiveness

Annex 8: Procurement Arrangements

Vietnam: Third Rural Finance Project

A. General

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1. Procurement for the proposed project would be carried out in accordance with the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated M a y 2004 (Revised October 2006) (Procurement Guidelines); and "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers'' dated M a y 2004 (Revised October 2006) (Consultants Guidelines), and the provisions stipulated in the Financing Agreement. The various items under different expenditure categories are described in general below. For each contract to be financed in whole or in part by the Credit, the different procurement methods or consultant selection methods, the need for pre- qualification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank in the Procurement Plan. The Procurement Plan wil l be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity.

2. Procurement of Works. N o procurement o f works i s foreseen in this Component.

B. Procurement Arrangement for Component 111 : Build Institutional Capacities and New Products (US$15 million IDA Financing)

3. Procurement of Goods. Goods procured under this Component would include two vehicles and office equipment for the project implementing units. The procurement wil l be done using the Bank's sample documents for shopping.

4. services i s foreseen in this Component.

Procurement of non-consulting services. N o procurement o f non-consulting

5. Selection of Consultants. Consulting services foreseen in this Component include major assignments such as development o f strategic business plan, strengthening SME lending, business advisory services for SMEs, development o f new financial services and technical assistance for strengthening institutional capacity o f participating banks and other financial institutions. These major consulting services would be procured using QCBS. Smaller assignments would be procured using CQS. Short lists o f consultants for services estimated to cost less than $200,000 equivalent per contract may be composed entirely o f national consultants in accordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines. The most updated version o f the Bank's Standard Request for Proposals will be mandatory to hire consulting f i r m s for contracts estimated at more than USD 200,000 per contract financed by the IDA Credit.

6. Operating Costs. No operating costs which would be financed by th is Component.

7. foreseen in this Component.

Others. Some in-country training activities such as workshops and seminars are

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8. The Bank’s Procurement Prior-review Requirements. The Bank will conduct prior review o f procurement documents and actions, in accordance with the Procurement Guidelines and Consultants Guidelines, as follows: 0 Procurement plans. The Bank shall review the procurement arrangements proposed

by the Borrower, including contract packaging, applicable procedures and scheduling o f the procurement process. Goods. Each contract estimated to cost US$lOO,OOO or more; and all contracts procured through the Direct Contracting method shall be subject to the Bank’s prior-review. Consulting services. All contracts that exceed US$ 100,000 per contract for f i r m s and US$ 50,000 per contract for individuals; and al l contracts procured on the basis o f Single Source Selection shall be subject to the Bank’s prior-review.

0

0

9. enterprises or households, through PFIs. The IDA Credit wil l finance up to 70% o f each

These two Components wil l provide sub-loans to end-borrowers, being rural

C. Procurement Arrangement for Component I: Increase Capital Investment by Rural Enterprises - Rural Development Fund (US$175 million IDA financing); and Component I1 : Increase Access to Microfinance in the Rural Economy - Microfinance Loan Fund (US$ 10 million IDA Financing)

10. Sub-project cost, and the rest wil l be financed by the PFI and the contribution from each end-borrower. These two Components are demand-driven; any goods, civil works or services that meet the Project’s requirements can be considered to be financed out o f these two Components. The ceiling amount for a sub-loan i s US$500 in Component I1 but there i s no limit for sub-loans in Component I.

11. Goods and works estimated to cost US$l,OOO,OOO or more per contract will be procured in accordance with the International Competitive Bidding procedures specified in Section I1 o f the Procurement Guidelines. Domestic preferences in accordance with paragraphs 2.55 and 2.56 o f the Procurement Guidelines and Appendix 2 thereto shall apply to goods manufactured in the territory o f Vietnam. All goods and works contracts estimated to cost US$l,OOO,OOO or more per contract shall be subject to the Bank’s prior- review in accordance with paragraphs 2 and 3 o f Appendix 1 to the Procurement Guidelines.

12. Goods and works estimated to cost less than US$l,OOO,OOO per contract wil l be purchased at a reasonable price following the established private sector/commercial practices. Other factors should also be taken into account such as: (i) in the case o f goods, timely delivery and efficiency and reliability o f the goods and availability o f maintenance facilities and spare parts; and (ii) in the case o f works, the technical quality and the competitive cost. All goods and works contracts estimated to cost less than US$l,OOO,OOO per contract shall be subject to the Bank’s post-review in accordance with paragraph 5 o f Appendix 1 to the Procurement Guidelines. 13. For small consulting services contracts (i,e,, below VND500 mi l l ion or US$30,000 equivalent), single source selection (but usually based on a comparison o f qualifications o f several candidates or previous experience with the firm) would be used (to certain extent, this procedure is similar to the Bank’s CQS method). For larger

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contracts, consultants would be selected through a competitive process similar to the Bank’s QCBS or LCS methods. All consulting services contracts under these two Components wil l be subject to the Bank’s post-review in accordance with para 5 o f Appendix 1 to the Consultants Guidelines.

14. The list o f items to be procured and estimated cost o f those items under the sub- loans larger than $100,000 wil l be specified in the sub-loan proposal which will be reviewed by the respective PFI. For sub-loans which contain contracts larger than US$l,OOO,OOO/contract, in addition to review by the respective PFI and the wholesale bank BIDV, sub-loan proposals and thus the procurement plans o f the sub-loans wil l be subject to prior-review by the Bank.

15. Procurement under these two Components wil l be carried out by end-borrowers (rural enterprises and households). PFIs will be primarily responsible for monitoring the adherence to sub-loan proposals and procurement plans by end-borrowers. The PMU under the wholesale bank BIDV will be responsible for provide training on the Bank’s procurement procedures to end-borrowers who have contracts o f more than US$l,OOO,OOO per contract.

D. Assessment o f the agency’s capacity to implement procurement

16. established under the wholesale bank.

Procurement process wil l be managed by the Project Management Unit (PMU)

17. An assessment o f the capacity o f the PMU to implement procurement actions for the project has been carried out by Thang Chien Nguyen, Senior Procurement Specialist on August 22 and October 11, 2007. The assessment reviewed the organizational structure for implementing the project and the interaction between the project’s staff responsible for procurement.

18. The key issues and risks concerning procurement for implementation o f the project have been identified and include (i) potential understaffing since the current PMU procurement staff i s part-time with inadequate capacity for evaluation o f major consulting services; and (ii) the PMU to be established under other PFIs may not have adequate capacity to support the procurement o f their respective components. The main corrective measures which have been agreed include:

- -

Appoint other key PMU staff to help the procurement officer World Bank Workshop on procurement and selection o f consultants (completed in June 2007) Procurement training at project launch. Ad hoc training on I C B and QCBS for the PMU o f BIDV and PFIs. The Bank procurement supervision and technical assistance.

- - -

19. The overall project risk for procurement i s medium.

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E. Procurement Plan

20. The Borrower, at pre-appraisal in August 2007, developed a procurement plan for Component I11 which provides the basis for the procurement methods. This plan has been updated during the appraisal on October 11 , 2007 and i s available at the PMU Office, Vincom Tower A, 191 B a Trieu Hanoi. I t will also be available in the project’s database and in the Bank’s external website. The Procurement Plan wil l be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity.

F. Frequency of Procurement Supervision

2 1. In addition to the prior review supervision to be carried out from Bank offices, the capacity assessment o f the P M U has recommended annual supervision missions to visit the field to carry out post review o f procurement actions.

G. Details o f the Procurement Arrangements Involving International Competition under Component I11

22. Goods, Works, and Non Consulting Services

(a) List o f contract packages to be procured following I C B and direct contracting:

No I C B or direct contracting procurements are foreseen in the project.

(b) I C B contracts estimated to cost above U S $ 100,000 per contract and al l direct contracting if any would be identified at later stage wil l be subject to prior review by the Bank.

23. Consulting Services

(a) List o f consulting assignments with short-list o f international firms.

USD 1,000

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I l l 2 I 3 l 4 1 I I ’ I Ref No.

Bank Review Expected Description of Assignment Proposals Comments Estimated Selection

Cost Method (PriodPost) Submission Date

1

2

3

4 I I i I I I

5 IProject Audit I 125.01 LCS I Postreview I 2008-2012 I 6 IBusiness advisory services o SME borrowers I 840.01 QCBS I Priorreview I 2008-2009 I

Strategic business pian and iDP 240.0 QCBS Prior review 2008-2009

Credit Appraisal 108.0 CQS Prior review 2008-2009

Credit Risk Management 144.0 CQS Prior review 2008-2009

Other core banking operations 162.0 CQS Prior review 2008-2009

7

8

institutional strengthening 340.0 QCBS Prior review 2008-2009

Strengthening Vietnam Association of PCFs 600.0 QCBS Prior review 2008-2009

(b) Consultancy services estimated to cost above US$lOO,OOO per contract for f i r m s and US$50,000 for individuals and all single source selection o f consultants wil l be subject to prior review by the Bank.

9

10 11

12

13

(c) Short l i s ts composed entirely o f national consultants: Short l is ts o f consultants for services estimated to cost less than US$200,000 equivalent per contract may be composed entirely o f national consultants in accordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines.

improving supervision by the SBV 160.0 CQS Prior review 2008-2009

Supporting implementation of MLF operations 160.0 CQS Prior review 2008-2009 introducing cash-flow based lending techniques 600.0 QCBS Prior review 2008-2009

Developing agricultural insurance products 380.0 QCBS Prior review 2008-2009

Generating new long-term saving products 380.0 QCBS Prior review 2008-2009

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Annex 9: Economic and Financial Analysis

Vietnam: Third Rural Finance Project

1. Because this i s a credit project, with no advanced determination o f the precise investments to be made, or even the sub-sectors l ikely to be involved, i t i s only possible to estimate the project’s economic impact in a very general way. There are a number o f key factors that indicate that the project would be l ikely to have a sound economic impact. These are set out below.

2. Contribution to Economic Growth and Poverty Reduction. Vietnam GDP per capital has increased at about 6.9% per year in real terms. Although the share o f the population living below the poverty line has fallen dramatically, the remaining areas o f poverty are concentrated in rural areas. There i s a widening gap between rural and urban wealth and incomes, which could have longer term social and political consequences. While progress on reducing poverty has been impressive, rural poor are s t i l l vulnerable to both internal and external shocks. The project would primarily focus the accumulation of productive assets in rural areas and on the creation o f employment opportunities. This wil l be achieved primarily through financing medium and long term credit to micro, small and medium enterprises (MSMEs). MSMEs have been shown in RF1 and RFII to generate high levels o f employment per dollar o f funds invested. The project wil l also finance individual households, which would use the resources to enhance their productivity and incomes.

3. Contribution to the Long Term Investment Need o f Vietnam. Vietnam i s going through a period o f rapid growth with targeting investment levels at 30% o f GDP for the economy. The Project wil l contribute to the effective provision o f these resources and in particular term resources, which at present are not easily mobilized in the banking system.

4. Applicable Rates o f Return. The Access to Credit Component would finance economically and financially viable investments in rural areas, including both agricultural and other types o f activities. The use o f f inds wil l be driven by demand. There would be no ex-ante allocation by crop, type o f industry or individual project. As a result, there can be no ex ante estimate o f the economic or financial rate o f return for individual sub- project or for the project as a whole. However, the eligibility criteria for sub-project financing would be set so that project with an expected Economic Rates o f Return (ERR) o f less that 15% would not be financed. Therefore the ERR for the whole project should be in excess o f 15%. For sub-projects with sub-loans greater that US$ 200,000 an ex- ante economic analysis will be required and a minimum ERR o f 15 % will be required. For sub-projects with sub-loans between US$15,000 and US$200,000 only an ex-ante financial rate o f return will be calculated, and a 15% FRR will be required.

5. Market interventions in Vietnam have largely been dismantled and the pol icy induced divergence between economic and financial values i s not presently substantive. Because the shadow wage rate below the financial wage rate in rural areas for most of the

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year, it is l ikely that ERRS will be higher than FRR. Thus, for smaller projects, the use o f a minimum FRR o f 15 % will largely eliminate any projects with an ERR o f less than 15%. There s t i l l remain, however, some sub-sectors where there are considerable prices distortions (eg sugar) that could result in projects that are financially viable but not economically viable. To avoid the financing o f uneconomic projects, a negative list, to be finalized at negotiations, would be drawn up and those sub-sectors would not be eligible for financing under the project. In addition, projects that result in significant negative environmental externalities would be automatically ineligible as a result o f the implementation o f environmental safeguards.

6. Increasing the Efficiency o f Bank Intermediation. Investments under this project related to the bank capacity building and new product development would result in broad based economic benefits to the economy through a long term reduction in the cost o f intermediation. However, these benefits are too disbursed and too difficult to attribute to these specific investments.

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Annex 10: Safeguard Policy Issues

Vietnam: Third Rural Finance Project

A. Summary

1. This Project has a safeguards classification o f FI (Financial Intermediary). As with al l FI classified projects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis during the course o f project implementation. By design, the project wil l not finance sub-projects that would trigger i) natural habitats; ii) involuntary resettlement; iii) forests; iv) cultural physical resources and v) safety o f dams, vi) disputed areas; or vii) international waterways. Sub- projects that would trigger these safeguards policies are included in the negative l i s t o f sub-projects that may not be financed under the Project. The indigenous people safeguard policy is not triggered. The only safeguard policies that are triggered by this project are the environmental assessment and pest management safeguards. Appraisal o f the projects compliance with IDA’S environmental assessment and pest management safeguard policies i s discussed in detailed below.

2. In order to anticipate and deal with any environmental issues that may arise, the following measures have been designed into the project: (i) a fully staffed and trained environmental unit has been established in BIDV, TC3, the management unit for the project; ii) an environmental guideline (manual) has been prepared; iii) restrictions, including a negative l i s t o f sub-projects with potentially high risks; iv) an independent audit o f environmental procedures will be carried out at mid-term and at the end o f the project, v) there wil l be ongoing training for BIDV staff, and PFIs in the area o f environmental appraisal and monitoring; vi) consultation with potential beneficiary groups or their representatives.

3. Based on the experience o f RF 11, the environmental risk associated with this project would be low. As with RFII, most o f the sub-borrowers under RFIII would be rural individuals with an average loan size o f US$3,000 and small proportion o f small rural-based entrepreneurs with the sub-loans estimated to average about US$20,000. Given most o f these sub-projects would be involved in agricultural production, processing, and trading services in rural economies, and most o f these sub-projects are managed within households or small enterprises, i t i s very likely that most o f them would have no negative environmental impact. Under RFII, al l sub-projects received an environmental screening, and are classified by risk category. O n this basis, 70 % o f were exempted from any environmental procedures and 29 % required an Environmental Compliance Commitment submitted by the borrower to the PFI. Only 1 % o f projects were required to undergo a l imited environmental assessment to be cleared by provincial DONREs. None o f the sub-projects under RFII were required to have a full EIA under Vietnamese environmental regulations. The same pattern o f l ow environmental risk is expected under RFIII.

4. As part o f the preappraisal process for RF 111, the following actions were taken. i) existing national regulations were reviewed to determine their compatibility with IDA’S

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environmental safeguards; ii) the performance o f environmental monitoring under RFII was reviewed and the lessons learned have been incorporated into the environmental compliance procedures for RFIII; (iiii) the draft environmental guidelines for RFIII and implementation responsibilities were reviewed and cleared by IDA..

B. Protection

Appraisal of Existing Legal Framework and Institutions for Environmental

The New Laws on Environmental Protection effective since July 1,2006

5. N e w laws on environmental protection effect on July 1, 2006, and were followed up in September by a new Government Degree and Circular providing detail implementation guidance (Degree 80/2006/ND-CP and Circular 08/2006/TT-BTNMT). The major changes in resulting from this new law and degree are i) the environmental management responsibility has been fbrther decentralized to l ine ministries and to district & commune level in the MONRE/DONRE system; ii) a much more detailed project environmental classification, with clear guidelines on which categories are subject to different environmental review procedures (full EIA, Environmental Registration, Environmental Compliance Commitment); and iii) an explicit requirement o f public consultation and document disclosure during the environmental assessment process. These improvements close the main gaps that existed in the old laws between the WB environmental safeguards and Government environmental policies.

6. This new decree provides good platfonn for updating the current project environmental guideline. The updated environmental guidelines for this project reflects the changes in the regulations including i) a different sub-proj ect classification system matching those o f the new regulations; and ii) institutional arrangements for increased coordination between PFI’s credit officers and local government environmental bodies in sub-project appraisal and supervision; iii) procedures for increased public consultation.

C. Appraisal o f DONREs Capacity for Environmental Assessment and Licensing

7. Based on the experience under RFII, provincial leve l DONRE offices have demonstrated their capacity to carry out environmental assessments and approvals for the limited number o f Category B sub-projects (those requiring limited environmental assessments) that were financed. The primary weakness o f the provincial DONRE system in the past i s that i t has been under staffed, on average each province has about 4- 5 staff looking after a l l the environmental aspects o f the whole province, so they can only focus on major environmental hotspots or big investment projects which have high environmental risks. The next level o f priority i s to issue environmental permits or licenses. They tend to place a lower priority on monitoring o f post licensing environmental compliance for smaller projects such as those financed under this project. One o f the objectives o f the new environmental regulations i s to f ir ther decentralize environmental management to district and commune levels, thus reducing the workload o f provincial DONRE and mobilizing more human resources at grass-root level. This i s

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expected to increase the coverage o f the environmental management activities in the provinces, particularly the monitoring o f post licensing monitoring o f environmental compliance.

D. Performance of Environmental Monitoring under RF 11.

8. In order to understand the current status o f the environmental monitoring system to be used under RFIII we provide a br ief summary o f the performance o f the environmental monitoring system under RFII.

9. The RFII Project i s recognized as a f i rs t banking sector project in Vietnam that integrates environmental appraisal and monitoring into the small-scale credit activities. As a result o f the RFII project, al l PFIs are aware o f the importance o f environmental safeguards compliance by sub-projects. There i s also a strong interest from MPI, M O N R E and SBV to disseminate the good practices o f RFII and encourage the financial sector to adopt the same approach beyond the project. Incorporating environmental safeguards into the appraisal o f projects has been an important part o f the institutional capacity building activities supported by RFII.

10. The Environmental Guideline was cleared by IDA and issued in March 2004, shortly after project effectiveness. This environmental guideline was based on the environmental law in place at that time, Circular 490/1998/TT-BKHCNMT (Guidance on Setting Up and Appraising the Environmental Impact Assessment Report for Investment Projects) that the Government issued in 1998, and on the Bank’s safeguard policies. The Environmental Management Guideline provides a screening mechanism, environmental review procedures, supervision and enforcement requirements, and a list o f sub-projects not eligible for funding. Under this environmental guideline, al l sub-projects are screened and classified into three groups, based on their environmental risk. Category C sub- projects are exempt from government environmental clearance. Within the Project, Category C sub-projects are further classified into those with no environmental risk that are exempt from any environmental requirements, and those that have low environmental risk. For those sub-projects that have low environmental risk, the sub-borrower i s required to s i g n an Environmental Compliance Commitment with the PFI verifying familiarity with the environmental impacts o f the sub-proj ect and with the appropriate mitigation measures. Category B sub-projects are subject to a limited environmental assessment to be cleared by provincial DONREs. Category A sub-projects are those that have high environmental risk are subject to a full environmental impact assessment and clearance by the relevant government agencies.

1 1. All o f participating PFIs are required to implement the environmental guidelines, and as a result al l sub-projects applying for funds are screened on environmental aspects. The average size o f a RDF I1 sub-project was U S $ 3,780, the average size o f a RDF I1 sub-loan was about US$ 2,000. Dividing by economic sectors, these financed sub- projects include; livestock raising (20.7%); trade & service (28.7%); aquacultures (7.6 %); processing (7.5%); small craft production (2.4%); cultivation (1 7.2%); and others (14.9%). Between March 2004, when the project environmental guideline was put into

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effect, and December 2006, 81,587 sub-projects were financed. O f these there were 56,886 (70%) were Category C sub-projects that were exempt from any environmental procedures, 24,145 (29%) were Category C sub-projects which required an ‘%Environment Compliance Commitment” with PFIs. There were 556 (1%) Category B sub-projects that required a l imited environmental assessment and review and clearance by provincial DONREs. O f the 556 Category B sub-projects, 190 were for agricultural cultivation, 136 for animal husbandry, 116 for processing, 26 for fisheries and 88 for other sectors. None o f the sub-projects under RFII were classified as Category A, which would have required a full environmental review cleared by MONRE and/or the IDA.

12. Since the WIII project i s likely to have the same lending patterns as RFII, it i s also expected to have a similar environmental risk profile. With the expectation that only 1 % o f the sub-projects would be classified as Category B and very few or no sub- projects classified as Category A the Project would be considered to have a l ow underlying environmental risk (Le. the type o f projects being financed have a l ow environmental risk). The other source o f environmental risk for the project i s environmental compliance risk. Below, we examine the performance o f RF I1 on environmental compliance.

13. Sub-projects classified as Category C and requiring a signed environmental compliance commitment with PFIs are primarily in the primary agriculture sector (agriculture cultivation, livestock raising, aquaculture farming, agricultural product processing) and managed by households. For these subprojects the environmental compliance is subject to the supervision o f PFI’s credit officers. Based o n field visits and direct interviews with sub-project borrowers, the assessment is that the environmental compliance in this group is moderately satisfactory. There i s increasing awareness in rural areas in terms o f applying good production methods as a result o f good agricultural and aquaculture extension services being provided in almost al l rural areas in Vietnam.

14. Subprojects classified as Category B and subject to limited environmental review and clearance by DONRE are mainly in small rural based industrial production & processing (craft metal melting, paper pulp recycling, plastic recycling, foodstuff processing. According to environmental regulations these sub-projects are also subject to regular supervision by provincial DONRE during implementation. Most o f these projects are for expansion o f production or increasing productivity. N o issues were identified in the area o f natural habitat encroachment or biodiversity. Most o f the environmental certifications issued were related to liquid & solid waste control and disposal, air emission control, health protection measures for laborers. Field visits to these sub-project sites during supervision identified some specific cases o f non-compliance with environmental certificates issued by DONRE. Actions were taken to correct these specific cases, and in one case the sub-loan was recalled. In addition, environmental audits were introduced to monitor compliance more closely. These environmental audits have been structured to sample a higher proportion o f Category B sub-projects.

15. Lending to villages identified as “environmental hotspots” by DONREs are restricted. Environmental hotspots are villages and towns that have high concentrations

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o f craft production such as craft paper recycling, craft plastic & metals melting, textile production with manual dyeing, using outdated equipment and without any treatment facilities. PFIs are restricted from making sub-loans for projects in environmental hot- spots, unless i t can be demonstrated that the sub-loan i s used to improve technology which help to minimize and control emissions. In addition to restrictions on lending for environmental hot-spots, the environmental guidelines have a clearly defined negative l i s t o f sub-project types that cannot be financed under the Project. During the implementation o f RFII no violation o f the environmental hot-spot or negative list restrictions have been identified.

16. In order to monitor environmental compliance under RFII, project officers are required to monitor the performance o f PFIs in following the environmental procedures established in the guidelines. Periodic checks are also carried out by IDA during supervision field visits. In addition the project has financed an environmental audit at mid-term and wil l finance another audit at project completion. The mid-term project audit will be based on a stratified random sample o f about 600 observations. The stratified random sample wil l ensure higher sampling rates for sub-projects in high risk categories (Categories A and B) and wil l also ensure adequate sample coverage for al l banks. The idea o f environmental audits i s new to Vietnam, so this exercise, which i s being carried out by local institutes i s important for knowledge transfer.

17. In summary, the risk resulting from the types o f projects financed under RF I1 i s low. The mechanisms used to restrict financing o f sub-projects with high environmental risk have worked well. These include a wel l documented environmental manual, which includes a negative l i s t o f high risk project types and restrictions on lending to environmental hot-spots. The key area for attention under RF I11 i s on ensuring environmental compliance o f approved Category B projects. This wil l be best achieved through increased training, monitoring and environmental audits. The key recommendations for RFIII based on the performance o f RFII are:

Prepare a revised environmental guideline for RFIII, incorporating the new regulations passed in 2006 and add the Pest Management Plan Prepare and disseminate pamphlets regarding environment compliance to the end- borrowers Environmental training should be extended to include al l members o f the Environmental Division (ED) o f the PMU; related BIDV and PFI staff, including those in the provincial and district branches, as well as associated DONRE staff. The environmental training program for PFI management and their credit officers administered through RF I11 should be upgraded and integrated into a national environmental capacity building initiative. Training o f trainers could be administered at the provincial level by appropriate Vietnamese environmental teaching and research institutions. RFIII should retain the same restrictions on lending in areas classified as environmental hot-spots and should retain an updated negative l is t o f environmentally risky projects.

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A hll environmental audit wil l be carried out at mid-term and at the end o f the project period. This audit wil l place a heavier weighting on the sampling o f higher risk projects, such as projects categorized as Category B.

E. Appraisal of Environmental and Social Safeguard Arrangements for RFIII

18. This Project has a safeguards classification o f FI (Financial Intermediary). As with al l FI classified projects, exact investments to be carried out under the Project cannot be identified a priori, but are selected on a competitive basis during the course o f project implementation. Since this i s a follow-on operation from the Rural Finance I1 project the institutional arrangements and procedures for managing environmental and social safeguards are already in place. These wil l be upgrades under RFIII.

19. Environment Compliance Unit in BIDV. The project management unit in BIDV TC3 already has an established environment unit staffed with specialists assigned to monitoring environmental compliance under RFII. This unit will continue to be responsible for managing compliance with environmental safeguards under RFIII. The unit has one full time environmental technical specialist on staff and has trained i t s other staff on issues related to environmental compliance and monitoring. There i s also sufficient environmental consultant capacity in Vietnam to carry out independent environmental audits o f sub-projects.

20. Consultation during; Preparation. A workshop was held as part o f the mid-term review for RFII to review the environmental monitoring system. This workshop included representatives o f government, academic institutions, and NGOs involved in environmental issues and also included PFIs. The workshop was based on a review o f the environmental management system under the project and sought feedback from the broader community on the how the system could be improved. Feedback from this workshop has been incorporated into the revised environmental guidelines. Since this project is a financial intermediary project i t does not identify any sub-projects before implementation. Any public consultation on individual projects wil l be done during implementation. Requirements for public consultation are included in the new law and regulations for environmental management.

2 1. Environmental Guidelines. An environmental procedure manual has already been prepared entitled “Guidelines o f Environment Impact Assessment and Monitoring for Subprojects Financed RFII.” This guideline includes procedures for appraisal, evaluation and monitoring o f compliance with environmental assessment and pest management safeguards. These environmental compliance procedures wil l be reviewed at least once a year in the course o f IDA’S supervision cycle. The procedures wil l also be updated on the basis o f lessons learned from periodic environmental audits (discussed below).

22. Pest Management Plan. The Pest Management Plan for the project wil l be a part o f the environmental guidelines. Project sub-loan funds may be used for the purchase o f fertilizers by small-scale farmers. Since the pesticide purchases under the project wil l be

98

l imited to small amounts o f pesticide for on farm use, purchased on a commercial basis from local suppliers. The P M O will produce a pamphlet that wil l include lists o f pesticides that not eligible for financing under the project (the negative list), i t wil l also include list o f pesticides in other categories and instructions for their safe use. This pamphlet wil l be distributed by PFIs to al l sub-borrowers who could potentially use the sub-loan for the purchase o f pesticides. Monitoring o f pesticide use will be part o f the regular environmental monitoring and audit.

23. Classification System for Sub-proj ect Tmes. The updated environmental guidelines wil l include l is ts o f sub-project types typically found in each environmental risk category. The environmental risk categories used would match those in the new environmental law and regulation.

24. Negative L i s t o f Environmentally and Socially Sensitive Sub-Projects. The Project's environmental guidelines include a l i s t o f types o f subprojects that would be precluded from borrowing. This would exclude financing for any subprojects i) that would destroy natural habitats; ii) that involve forest extraction , iii) that could damage physical cultural resources o f archaeological, paleontological, historical, architectural, religious, aesthetic, or other cultural significance, iv) involve the construction o f dams higher than 18 meters; v) subprojects in disputed areas and vi) international waterways. In addition, the guideline includes l i s t o f ineligible subprojects which have a) Fishing methods that result in over fishing or are banned in Vietnam b) that result in land erosion; land slides, or destroy wetlands or mangroves. c) the location where determined by the Government as environment-sensitive d) sub-proj ects that would trigger the pesticides safeguards by purchasing pesticides classified by WHO as Class 1A or lB, or the use o f Class 2 pesticides by unqualified individuals. The l i s t o f pesticides banned in Vietnam and WHO'S "Recommended Classification o f Pesticides by Hazard and Guidelines to Classification" (IOMC, 2000-2002) wil l be attached to the Guidelines

25. Restricted Sub-Proiects. The Project's environmental guidelines restrict the financing o f projects in villages identified as environmental hot-spots, unless the financing i s used for installing clean technologies approved by the Government.

26. Environmental Audits. An environmental audit was completed in July o f 2007 for the on-going Second Rural Finance Project. The environmental audit schedule wil l be applied out under the RF I11 Project, at mid-term and the end o f the project.

27. Environmental Training Proaam. The environmental training program for PFI management and their credit officers administered through RF I11 will be upgraded and integrated into a national environmental capacity building initiative. Training o f trainers would be administered at the provincial level by appropriate Vietnamese environmental teaching and research institutions. Environmental training would include al l members o f the Environmental Division (ED) o f the PMU, related BIDV and PFI staff, including those in the provincial and district branches. Periodic workshops and seminars would be held by the Project to promote knowledge sharing across regions and between PFIs.

99

These workshops could also be used to promote the importance o f environmentally responsible lending by commercial banks.

100

Annex 11: Project Preparation and Supervision

Vietnam: Third Rural Finance Project

Planned Actual PCN review 11/06/2006 11/08/2006 Initial PID to PIC 11/20/2006 11/20/2006 Initial ISDS to PIC 11/20/2006 11/20/2006 Appraisal 10/10/2007 10/02/2007

Board/RVP approval 0312 812008 Planned date o f effectiveness 612 812008 Planned date o f mid-term review 6/28/20 1 1 Planned closing date 06/28/2014

Negotiations 0 1 /20/200 8

1. Key institutions responsible for preparation of the project:

The State Bank o f Vietnam 49 Ly Thai To Hanoi, Vietnam Tel: 84 4 9343 361; Fax: 84 4 825 0612 Email: fdsbv@fpt.vn

2. Bank staff and consultants who worked on the project included:

Name Title Unit Xiaolan Wang Task Team Leader EASRE Iain Shuker Lead Agricultural Economist EASRE James Seward Financial Sector Specialist EASFP The Dzung Nguyen Operations Officer EACVF James Lacey Senior Banking Specialist Consultant Mei Wang Senior Counsel LEGES Hiet Thi Hong Tran Procurement Specialist EACVF Thang Chien Nguyen Senior Procurement Specialist EACVF Edward Daoud Senior Finance Officer LOAFC Jennifer Thomson Senior FM Specialist EAPCO Pham Thi Mong Hoa Senior Social Development EACVF

Trang Phuong Thi Nguyen Environment Specialist EACVF Quyen Thi My Nguyen Financial Management EACVF

Evelyn Bautista Laguidao Program Assistant EASRE Thu Thi L e Nguyen Senior Program Assistant EACVF

Specialist

Specialist

3. Bank funds expended to date on project preparation: 1. Bank resources: US$212,000 2. Trust hnds: US$20,000 3. Total: US$232,000

101

4. Estimated Approval and Supervision costs: 1. Remaining costs to approval: US$87,000 2. Estimated annual supervision cost: US$120,000

102

Annex 12: Documents in the Project File

1.

2.

3.

4. 5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

Vietnam: Third Rural Finance Project

Project Concept Note, October 2006

Draft PCN at QER Stage, October 2006

draft Environmental Safeguards Annex to PAD, January 2007

Detailed Cost Tables, October 2007 Project Operational Manual

Policy Manual

Financial Management Assessment, January 2007

Financial Management Assessment, October 2007

Procurement Assessment, October 2007

Diagnostic Review o f Vietnam Bank for Agriculture and Rural Development by Miguel Sanchez de Pedro, November 2006

Assessment o f Vietnam Bank for Agriculture and Rural Development by James Lacey, June 2007

BIDV's financial performance and IDP implementation letter, January 2007

Report on Microfinance Development StudiesReports

Mission Aid Memoire 0

0

e e 0

June 2006. Aide-Memoire Reconnaisance Mission August 2006. Aide Memoire Identification Mission January 2007. Aide-Memoire Preparation Mission July 2007. Aide-Memoire Pre-Appraisal Mission November 2007, Aide-Memoire Appraisal Mission

103

Annex 13: Statement of Loans and Credits

Vietnam: Third Rural Finance Project

Difference between expected and actual

disbursements Original Amount in US$ Millions

Project ID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev’d

PO86361 PO75407 PO85071 PO73361 PO84871 PO77287 PO79344 PO79663 PO74688 PO66051 PO73763 PO80074 PO82604 PO82627

PO74414

PO85080 PO85260 PO88362

PO701 97 PO65898

PO59663 PO7101 9

PO75399

PO44803

PO73778

PO73305 PO72601 PO66396

PO59936

PO51838

PO42927

PO52037 PO62748

2006 2006 2006 2006 2006 2006 2006 2006 2005 2005 2005 2005 2005 2005

2005 2005 2005 2005

2004 2004

2004 2003

2003

2003

2002

2002 2002 2002

2002

2002

2001

2001 2001

VN-PRSC v VN-RT3 Customs Modernization VN -Natural Disaster Risk Mngt Project VN-TRANS & DISTRIB 2 VN-RRD RWSS VN -1CT Development VN-Mekong Regional Health Support Proj VN-RURAL ENERGY 2 VN -Forest Sector Development Project VN-WATER SUPPLY DEV. VN-GEF-RURAL ENERGY 2 VN-HIV/AIDS Prevention Project Payment System and Bank Modernization 2 VN - GEF Forest Sector Development Proj VN-ROAD SAFETY VN-EFA Support Program VN-Avian Influenza Emergency Recovery Pr VN-URBAN UPGRADING VIETNAM WATER RESOURCES ASSISTANCE VN-ROAD NETWORK IMPROVT VN-GEF DEMAND SIDE MGMT & ENERGY Public Financial Management Reform Proj .

DISADVANTAGED CHILRE VN-GEF-System Energy Equitization- Renewa VN-Regional Blood Transfusion Centers VN - Rural Finance I1 Project

EQUITIZATION & RENEWAB VN -Northem Mountains Poverty Reduction

DEVELOPMENT

VN-PRIMARY EDUC FOR

VN-SYSTEM ENERGY,

VN-PRIMARY TEACHER

VN-MEKONG TRANSPORTELOOD PROT. VN-HCMC ENVMTL SANIT. VN - COMMUNITY BASED RURAL

0.00 100.00 0.00 106.25 0.00 65.90 0.00 86.00 0.00 200.00 0.00 45.87 0.00 93.72 0.00 70.00 0.00 220.00 0.00 39.50 0.00 112.64 0.00 0.00 0.00 0.00 0.00 105.00

0.00 0.00 0.00 31.73 0.00 50.00 0.00 5.00

0.00 222.47 0.00 157.80

0.00 225.26 0.00 0.00

0.00 54.33

0.00 138.76

0.00 0.00

0.00 38.20 0.00 200.00 0.00 225.00

0.00 110.00

0.00 19.84

0.00 110.00

0.00 166.34 0.00 102.78

104

0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.00

0.00 0.00

0.00

0.00

0.00

0.00

0.00 0.00

0.00

0.00

0.00

0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 5.25 0.00

0.00

9.00 0.00 0.00 0.00

0.00 0.00

0.00

5.50

0.00

0.00

4.50

0.00 0.00

0.00

0.00

0.00

0.00

0.00 0.00

~

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00

0.00

0.00 0.00 0.00

0.00

0.00

0.00

0.00 0.00

100.74 108.92 66.58 81.73

200.79 45.75 90.43 70.29

217.36 49.03

109.10 4.95

28.40 99.57

8.50 29.26 46.04 2.68

202.04 148.42

211.89 3.00

51.86

175.20

3.58

38.39 40.61

187.01

38.92

12.36

55.59

149.08 56.18

0.00

1 .oo -0.25 -3.06 6.67 1.69 0.97

-1.97 34.19 3.23 5.05 0.20

-1.42 28.83

1.83 2.47

15.00 2.24

2.93 18.36

83.52 0.60

29.63

44.15

3.58

26.29 -60.29 145.06

4.78

9.29

39.33

84.32 29.55

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.47 0.00 0.00 0.00

15.67

1.32 0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00

0.00

0.00 0.00

25.65

0.00

4.96

-6.13

77.07 0.00

PO56452 2000 PO42568 2000 PO51553 1999 PO04845 1999 PO04828 1999 PO45628 1998 PO04844 1998

INFRA. VN-RURAL ENERGY VN - COASTAL WetWProt Dev

VN-3 CITIES SANITATION

VN - MEKONG DELTA WATER VN-HIGHER EDUC.

VN-TRANSMISSION & DISTR VN-AGRIC. DIVERSIFICATION

0.00 0.00

0.00 0.00 0.00 0.00 0.00

150.00 31.80 80.50

101.80 83.30

199.00 66.90

0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

8.82 0.00

0.00 0.00

0.00 39.69 0.00

22.42 4.99

38.19 31.10 22.96 47.44 11.00

25.17 3.08

32.58 26.44 16.54 79.36

9.34

7.26 3.08

20.54 -15.45 17.16 18.07 6.45

Total: 0.00 3,815.69 0.00 24.25 48.51 2,912.35 750.28 176.12

Vietnam: Third Rural Finance Project

STATEMENT OF IFC’s Held and Disbursed Portfolio

In Millions o f U S Dollars

Committed Disbursed

IFC IFC

FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic.

2003 2002 2002 2002 2005 1998 1997 2004 2005 200 1 2006 2003 2004 2005 2006 2002 2003 2007

ACB-Vietnam

CyberSoft

Dragon Capital F-V Hospital

K h a i Vy

MFL Vinh Phat

Nghi Son Cement Olam

Paul Maitland RMIT Vietnam

SABCO Sacombank

Sacombank

Sacombank Sacombank

VEIL

VEIL VEIL

0.00 0.00 0.00 5.00 6.00 0.13 10.09 20.00 7.20 7.25 20.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00

5.02 0.06 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00 2.77 2.31 2.05 3.05 0.00 7.41 6.15

0.00 0.00 1.05 3.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 2.00 0.00 0.00

0.00 0.00 5.02 0.00 0.00 0.06 0.00 0.00 0.00

0.00 5.00 0.00 0.00 0.00 0.00 0.00 0.13 0.00 1.88 10.09 0.00

0.00 20.00 0.00 0.00 7.20 0.00 0.00 3.50 0.00 0.00 0.00 0.00 0.00 0.00 2.77 0.00 0.00 2.3 1 0.00 0.00 2.05 0.00 0.00 3.05 0.00 0.00 0.00 0.00 0.00 7.41 0.00 0.00 6.15

0.00 0.00 0.00 0.00 1.05 0.00 3 .OO 0.00

0.00 0.00

0.00 0.00 0.00 1.88 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 2.00 0.00 0.00 0.00 0.00 0.00

Total portfolio: 75.67 28.82 6.05 1.88 45.92 28.82 6.05 1.88

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic.

2000 MFL-AA

2006 CCS-Asia

2000 Interflour

2006 CII-Vietnam

0.00 0.00 0.00 0.00 0.02 0.00 0.00 0.00 0.01 0.00 0.00 0.01 0.00 0.00 0.00 0.00

105

2000 MFL Mondial 0.00 0.00 0.00 0.00 2002 F-V Hospital 0.00 0.00 0.00 0.00 1999 MFL Minh Minh 0.00 0.00 0.00 0.00 1999 MFL Chau Giang 0.00 0.00 0.00 0.00

Total pending commitment: 0.03 0.00 0.00 0.01

106

Annex 14: Country at a Glance

Vietnam: Third Rural Finance Project

POVERTY and SOCIAL E a r t

Aala 8 Low. Vletnam Pacl f lc Income

2005 Po pulat lo n, mid-year (millions)

ON1 (Atlas method, US$ bilhons)

Average annual growth, 1999.05

83 0

514 GNlpercapIta (Atlasmethod, US$) 820

Population (%) 11 Laborforce(%) 2 1

M o s t recent eat lmate (lateat year avallable, -99-05)

Povert y (% o f populatlo n M o w natb nal po verty line) 29 26

Life expectancyat birth (pars) 70 Urban population (%of total population)

Infant mortality(per lO0Olivebirths) n Child malnutrltlon (%of childrenunder5) 28 Access to an improvedwatersource (%ofpopulation) Llteracy(%ofpopulation age E+J 90

Male ni

85

Gross pnmary enrollment oof school-agepopulation) 98

Female 94

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1985 1996

GDP (US$ billions) 141 207 Gross capital fornatlon1GDP 27 1 Exports of goods and servIceslGDP 32 8 Gross domestic savingsIGDP 8 0 Gross national savings/GDP P2

Current account balance1GDP -38 -735 Interest payments1GDP 00 0 4 Total debtlGDP 0 4 P28

Present valueof debtIGDP Present valueof debtleqmrts

Total debt servlcdexports 4 7

198545 1995-05 2004 (average annuel gro Mh) GDP 6 5 6 9 7 7 GDP percapita 4 3 5 6 6 6 Exports of goods and services 252 158 279

1885 1827 3,087

0 9 13

41 70 29 15

79 91 16 18 114

2004

45 2 35 8 86 4 28 3 322

-3 8 0 7

39 4 2 8

341 504

2,353 E80

1384

19 2 3

30 59 80 39 75 82 n 4 la 99

2005

52 4

2005 2005.09

8.4 7.5 7.4 6.4 15.0 15.0

Development dlamond.

Life expectancy

Gross primary

capita enrollment

1

Access to improvedwatersource

-Vietnam Lo wincome group

Economic ratloa.

Trade

Indebtedness

-Vietnam Lowincome aro UD

107

STRUCTURE o f the ECONOMY

(%of GDPj Agriculture industry

Services

Household final consumption expenditure Genera gov't final consumption expenditure imports of goods and sewices

Manufacturing

40

30

20

10

(average annual gm vdh) Agriculture industry

Services

Household final consumption expenditure General gov't final consumption expenditure Gross capital formation Imports of goods andservices

Manufacturing

1985 I995

40.2 27.2 27.4 28.8 20.5 15.0 325 44.1

.. 73.8

.. 8.2

.. 419

1985-95 1995-05

3 5 4 1 7 3 0 0 4 3 110 8 4 5 7

5 2 3 8

258 9 8 242 8 5

2004

218 40.1 20.3 38.2

65.3 8.4

73.6

2004

3.5 0 2 0 1 7.5

7.1 7.8 m.5

25.2

2005

2005

/G rowth o f capi ta l and GDP (Oh)

Growth o f exports and imports (Oh)

W 01 02 03 W 1 -Exports - .9 - lmpOrtS O5 I Note: 2005 data are preliminaryestimates. This table was producedfmm the Development Economics LDB database. 'Thediamonds showfourkeyindicators in thecountry(in boid)comparedwithits income-groupaverage. lfdataare missing,thediamond~il

be incomolete.

Vietnam

PRICES and GOVERNMENT FINANCE

Domes t i c p r i ces (%change) Consumer prices implicit GDP deflator

Government finance (%of GDP, includes current grantsj Current revenue Current budget balance Overall surpius/deficit

I985

TRADE

(US$ millions) Totalexports (fob)

Rice Fuel Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export pnce index(2000=WO) Import price index(2000=00) Terms of trade (2000=60)

1985

507

930

1995

7 . 0

23.3 6.0 0.7

1995

5,88 547

1063 1785

7.543

858 2,097

0 8 0 3 m6

2004

7.8 7.9

23.1 6.6 -14

2004

26,503 950

5.671 14,842 31954

3.574 8,624

137 TI6 m i

2005

8.3 8.4

2005

Inf lat ion (%) I

---GDP deilator - . o -CP i

Export and import levels (US$ mill.)

40,000 T

30 000

20 000

10.000

0

I I 99 00 01 02 03 M 05

exports imports

108

BALANCE of P A Y M E N T S

(US$ millions) Eports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

1985

-496

-90 52

Current account balance -534

Financing items (net) Changes in net reserves

265 269

M e m o : Reserves including gold (US$ millions) Conversion rate (DEC. local/US$) 8.3

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

1985

61 IB RD 0 IDA 54

Total debt service IBRD IDA

2 0 0

Composition of net resource f l o w Official grants 38 Official creditors 7 Private creditors 0 Foreign direct investment (net in f low) 0 Portfolio equity(net inflows) 0

World Bank program Commitments Disbursements Principal repayments Net f l o w Interest payments Net transfers

1995

7,607 n.603 -2,996

-279 474

-2,801

3,301 -500

1,376 11038.3

1995

25,428 0

23 1

364 0 2

348 58

356 0 0

265 47

1 46 2

45

2004

30,363 33,808 -3,245

-940 2.484

-t701

2,395 -694

6,314 25,772.3

2004

l?,825 0

3,039

781 0

37

387 1278

r) 1,6r)

0

711 444

8 436 29

407

2005

-1261

7,575 25,987.1

2005

0 3,187

0 44

391 14

378 31

347

Current account balance to GDP (Oh)

G 2 , t X m . 1 " Q O

E. 9,249

A - IBRD E- Bilateral 8 - IDA D. Other mltilaterd F - Private C - I M F G. Short-terr

Note This table was producedfrom the Development Economics LDB database 81 '(3106

109

MAP SECTION

8

10

1112

1516

17

1819 20

212223

33

36

37

40

43

41

4446

47

50

51

1314

24

48

7

25

29

30

31

32

34

35

38

39

45

49

2627

28

42

5254

55

56

64

58

60

6263

53

5759 61

2

39

1

4

5

6 HÀ NÔI

Phong Tho Lào Cai

Hà Giang

˘ ` Cao Bang

' Son La

Yên Bái

Tuyên Quang

˘ ̀ Bac Can

' Lang Son

Viêt Trì

˜ Vinh Yên

Thái Nguyên

˘ ̀ Bac Giang

Ha Long ˘ ̀ Bac Ninh

Hà Dông

_ ' Hung

Yên ' ' Hai Duong

Hai Phòng Hòa Bình

Hà Nam Thái Bình

Ninh Bình _ Nam Dinh

Thanh Hóa

Vinh

˜ Hà Tinh

` ' _ Dông Hói

_ Dông Hà

Hue

˘ ˜ _ Dà Nang

` Tam Ky

Quang Ngãi

Kon Tum

Plei ku ' Quy Nhon

Tuy Hòa

Buôn Ma Thuôt

˜ Gia Nghia Nha Trang

` _ Dong Xoài

_ Dà Lat

Phan Rang- Tháp Chàm

Tây Ninh

` Thu Dau Môt

Biên Hòa ' Phan Thiêt

` Hô Chí Minh City

˜ Vung Tàu

Tân An ˜ My Tho

Cao Lãnh

' Bên Tre Long Xuyên

˜ Vinh Long

Trà Vinh

Rach Giá

` ' Cân Tho

Vi Thanh

˘ Sóc Trang

Bac Liêu Cà Mau

_ Diên Biên Phu

Gulf

of

Tonkin

Gulf of

Thailand

Mekong

Mekong

Phu Quoc

Hainan I. (China)

C H I N A

C A M B O D I A

T H A I L A N D

LAO PEOPLE'S

DEMOCRATIC

REPUBLIC

104 102

20

22

16

18

12

10

14

20

22

16

18

12

14

10

108 110 106

104 106 108 102

323334353637383940414243444546474849505152535455565758596061626364

Thùa Thiên HuêDà Nang Quang NamQuang NgãiKon TumGia LaiBình DinhPhú YênDak LakDak NôngKhánh HòaBình Phuóc Lâm DongNinh ThuanTây NinhBình DuongDông NaiBình ThuanHô Chí Minh CityBà Ria – Vung TàuLong AnTiên GiangDông ThápBên TreAn GiangVinh LongTrà VinhKiên GiangCân ThoHâu Giang Sóc TrangBac LiêuCà Mau

12345678910111213141516171819202122232425262728293031

Lai ChâuDiên Biên Lào Cai Hà Giang Cao Bang Son La Yên Bái Tuyên Quang Bac Can Lang Son Phú Tho Vinh PhúcThái NguyênBac Giang Quang Ninh Hà NoiBac NinhHà Tây Hung YênHai DuongHai PhòngHòa BìnhHà NamThái BìnhNinh BìnhNam DinhThanh Hóa Nghe An Hà TinhQuang Bình Quang Tri

PROVINCES:

_

˘

˘

`

`

`

`

`

`

˘˘ ˘

'

'

˘

˘

˘

˘̀

' '

'

'

'

˜

˜

˜

˜

˜

_

_

_

_

_

_

__

VIETNAM

0

0 50 100 Miles

50 100 150 Kilometers

The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries.

PROVINCE CAPITALS

NATIONAL CAPITAL

PROVINCE BOUNDARIES

INTERNATIONAL BOUNDARIES

IBRD 35972

FEBRUARY 2008

VIETNAM

THIRDRURAL FINANCE

PROJECT