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Document of The World Bank Report No. 15431-BD STAFF APPRAISAL REPORT BANGLADESH POVERTY ALLEVIATION MICROFINANCE PROJECT August 14, 1996 Private Sector Development and Finance Division Country Department I South Asia Region Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized

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Document of

The World Bank

Report No. 15431-BD

STAFF APPRAISAL REPORT

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

August 14, 1996

Private Sector Development and Finance DivisionCountry Department ISouth Asia Region

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CURRENCY EQUIVALENTS

(July 29, 1996)

Currency Unit = Bangladesh Taka (Tk.)Tk 1.00 = US$ 0.0239US$ 1.00 = Tk 41.9

ABBREVIATIONS AND ACRONYMS

ASA - Association for Social Advancement

BB - Bangladesh BankBRAC - Bangladesh Rural Advancement Committee

CAS - Country Assistance Strategy

FY - Fiscal Year

GOB - Government of Bangladesh

HES - Household Expenditure Survey

MFI - Microfinance Institution

NCB - National Competitive BiddingNCBs - Nationalized Commercial Banks

NGO - Non-Governmental Organization

PKSF - Palli Karma Sahayak FoundationPOs - PKSF's Partner Organizations

RNF - Rural Non-Farm

SLA - Subsidiary Loan AgreementSOE - Statement of Expenditures

TORs - Terms of Reference

GOB FISCAL YEAR

July I - June 30

Vice President: Mr. D. Joseph WoodDirector: Ms. Mieko NishmizuDivision Chief: Ms. Marilou UyPrincipal Operations Officer: Mr. Abid Hasan

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

TABLE OF CONTENTSPage No.

CREDIT AND PROJECT SUMMARY ..................................................... i

CHAPTER 1: THE SECTOR ..................................................... I

CHAPTER 2: FINANCE AND THE POOR .................... ................................. 2

Overview ..................................................... 2The Formal Financial Sector ..................................................... 2The Semiformal Sector ..................................................... 3The Palli Karma Sahayak Foundation (PKSF) ................................................... 4

CHAPTER 3: MICROFINANCE PROGRAMS AND INSTITUTIONS .............. .................... 6

Operational Features ..................................................... 7Financial Aspects ..................................................... 8Institutional Capacity ............ 1......................................... 1Accounting and Auditing ..................................................... 12Socioeconomic Impact ..................................................... 12Constraints to Expansion of the MFIs' Financial Services .............. .................... 13

CHAPTER 4: THE PROJECT ..................................................... 14

Country Assistance Strategy Objectives ..................................................... 14Project Concept ..................................................... 14Project Objectives ..................................................... 14Rationale for IDA Involvement ..................................................... 15Lessons from Previous IDA/Bank Operations ................................................. 16Coordination with Other Donors ..................................................... 16Project Scope and Description ..................................................... 16Project Costs and Financing Plan ............................ ......................... 16Credit Component ..................................................... 17

Credit Size ..................................................... 17Credit Use ..................................................... 18Institutional Eligibility Criteria ..................................................... 18Credit Terms and Conditions ..................................................... 19Rationale for Lending Terms and Conditions ........................................ 20

Institutional Development Component ..................................................... 21PKSF's Institutional Development Program ..................... .................... 21Strengthening Regulation and Promotion ............................................. 23

CHAPTER 5: IMPLEMENTATION ARRANGEMENTS ................................................. 23

Credit Institutions ..................................................... 23Procurement Arrangements ..................................................... 24Disbursement ..................................................... 25Monitoring and Reporting Requirements ..................................................... 26IDA Supervision ..................................................... 27

Page No,

CHAPTER 6: PROJECT JUSTIFICATION AND IMPACT ............................................. 27

Rationale for Publicly provided Concessional Funding ...................................... 27Project Impact ........................................................ 29Risks ........................................................ 32

CHAPTER 7: AGREEMENTS AND RECOMMENDATIONS .......................................... 35

ANNEXES:

1. THE DIMENSIONS OF POVERTY ...................................... 6................ ....... 362. FINANCE AND THE POOR .393. THE APEX AGENCY: PKSF .494. SOCIOECONOMIC IMPACT OF MICROFINANCE PROGRAMS:

A SUMMARY OF FINDINGS .625. INSTITUTIONAL DEVELOPMENT COMPONENT .686. IDA DISBURSEMENT SCHEDULE .717. MONITORING AND EVALUATION PLAN AND PROJECT

PERFORMANCE INDICATORS .738. DOCUMENTS IN PROJECT FILE .77

LIST OF TABLES

TABLRS

2.1 Microcredit Programs: Annual Disbursements. 2

3.1 Viability Analysis of MFI's Credit Programs .103.2 Welfare effects of Grameen Bank Loans .12

4.1 Project Costs and Financing .17

5.1 Procurement Arrangements .255.2 Disbursement by Category .26

6.1 PKSF's Projected Financial Performance .31

This report is based on findings of an appraisal mission to Bangladesh in October 1995. Project team membersincluded: Mr. A. Hasan (Principal Financial Specialist, SAIPF), Task Manager; Ms. Sona Varma (Economist,SAIPF); Mr. T. Ahmed (ACTDR); Ms. S. Sharmin (Consultant); and Mr. Reazul Islam (Program Officer,RMB). The project is endorsed by Ms. Mieko Nishimizu, Director, Country Department 1, South Asia Region,and Ms. Marilou Uy, Chief, Private Sector Development and rinance Division. The Peer Reviewers comprisedMessrs./Mmes. S. Khandker (PSP), M. Ravallion (PRDPH), L. Bennett and C. Cuevas (ASTHR), and M.Malhotra (CGAP). The Report was processed by Annie Andrianasolo and Soon-Won Pak, with assistance fromAgnes Evidente, Ceny Sauz and Anthony Stanley.

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BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

CREDIT AND PROJECT SUMMARY

Borrower: People's Republic of Bangladesh

Implementation Agencies: Palli Karma Sahayak Foundation (PKSF), a quasi-governmental apexfinancing intermediary for NGOs in Bangladesh; and Bangladesh Bank(BB).

Beneficiaries: NGO-based Micro-Finance Institutions (MFIs) and about 1.2 millionpoor, mostly rural women.

Poverty Category: The Project is included in the program of targeted intervention forpoverty alleviation, given its focus on the poor.

Amount: SDR 72.7 million (US$105 million equivalent)

Terms: Standard, with 40 years' maturity

Commitment Fee: Standard (a variable rate between 0 and 0.5% of the undisbursed creditbalance set annually by the Executive Directors of IDA).

On-lending Terms: GOB will onlend IDA funds to PKSF at 1 % for 20 years, with 5 years'grace. PKSF will relend to its Partner Organizations (Pos)-eligibleMFIs-at interest rates ranging from 3-5 %. The POs will be free to setthe final lending rate to the beneficiaries (expected to be in the 25-30%range).

Financing Plan: See para 4.10

Financial Returnto Final Beneficiary: Annual financial return of the final beneficiary, after payment of loan

and cash inputs, is expected to range from 100-150% of the amount ofmicro-loan. This is mostly return to own labor.

Map: Not applicable

Project Identification No: BD-PA-40985

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1. THE SECTOR

1.1 With a 1995 per capita income of US$230 per annum, Bangladesh is among the poorestcountries in the world. About half the people are below the poverty line, with over 80% in the ruralareas (Annex 1). The poverty situation has deteriorated in the last decade, primarily due to the rapidincrease of the working age population, increasing landlessness, and slow growth in productive non-farm employment. The burden of poverty falls disproportionately on women, who on average had88% of nutritional intake of males and 40% of the wage rate earned by males; also declining homesteadbased activities have exposed women to serious economic pressures.

1.2 The present production structure, accompanied by sound macro-economic and incentivepolicies can help increase GDP growth rate above 5 %; but even this will be insufficient to productivelyemploy all new entrants to the labor force. Robust growth in agriculture could probably absorb about25 % of new entrants, and industry and services another 40%. The remainder would have no choicebut to turn to the rural non-farm (RNF) sector for employment opportunities and involve themselves inmarginal activities; this would swell the ranks of the very poor, unless action is taken to diversify therural economy and expand targeted efforts to help the landless. However, the ability of the landless toengage in productive non-farm employment is severely limited by their illiteracy, lack of skills andinadequate financial resources.

1.3 Poverty alleviation and rural employment are top priorities in the development agenda ofGovernment of Bangladesh (GOB). The GOB has adopted a broad based approach to povertyalleviation, that emphasizes macroeconomic stability and economic liberalization, and supports anumber of targeted programs. It has also assigned top priority to increasing foodgrain production, andmore recently to developing labor-intensive export industries in order to increase employment andincomes. A salient feature of many such targeted programs is the provision of microcredit for self-employment, by a number of government agencies as well as by various non-government organizations(NGOs). In most instances good progress has been made in implementing these microcredit schemes,and the scope for efficient expansion is enormous. The proposed Project is the result of a participatoryinitiative between GOB, IDA and the NGOs, and is based on detailed studies and reviews of successfulpoverty-oriented microfinance programs.

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2. FINANCE AND THE POOR

Overview

2.1 Bangladesh's financial sector comprises the formal financial institutions (15 commercial andspecialized banks, and two cooperative networks), the semi-formal institutions (over 150 NGO-basedmicrofinance institutions), and the informal institutions (family, friends and money lenders). For themost part, these institutions have operated in segmented markets. The informal sector dominates ruralfinance in Bangladesh, with the semi-formal sector occupying second place and the formal sector third.In FY94, Grameen Bank and other NGO-based Microfinance Institutions (MFIs) provided about Tk 17billion in microcredit, compared with Tk 11 billion of rural credit provided by the agricultural banksand nationalized commercial banks (NCBs) combined. Table 2.1 below provides estimates ofmicrocredit disbursements, in recent years, by the different institutions.

Table 2.1: Microcredit Programs: Annual Disbursements(Tk million)

1990-91 1991-92 1992-93 1993-94 1994-95 No. ofborrowers,1994 (000)

1. Formal SectorGrameen Bank 2,642 5,200 10,622 13,912 15,000 1,861BRDB* 205 352 688 878 1,647 521NCBs 53 43 52 80 104 n.a.

11. Multi-purpose NGOsASA* 19 195 573 887 1,156 386BRAC* 421 605 733 1,368 2,035 706Proshika* 121 127 224 303 423 417PKSF POs* n.a. 44 198 399 675 290Swanirvar 45 44 62 109 132 598

Total 3,506 6,610 13,152 17,936 21,172 4,779In million US$ 98 173 336 448 520

Source: MFIs and Staff Estimates.* ASA-Association for Social Advancement; BRAC-Bangladesh Rural Advancement Committee;

BRDB-Bangladesh Rural Development Board; PKSF's POs: PKSF's Partner Organizations or MFIs.

The Formal Financial Sector

2.2 This comprises the public sector financial institutions (NCBs and specialized banks), privatebanks and the Grameen Bank. Apart from the latter, few other institutions in the formal sector havebeen a major source of microfinance. Although the NCBs and specialized banks have a large rural

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credit program and some have initiated microcredit programs, for the most part their rural creditprograms are neither targeted to the poor nor do they reach the poor. Their programs are mainly forsmall rural enterprises and farmers, rarely include the landless, and their average microcredit loan sizeis 3-5 times that of MFIs. Also, when NCBs have provided microcredit. their rather low lending ratesof 16% compared to MFIs' rates to the final borrower (para 3.4) suggests that these banks are makingsuch loans perhaps to fulfill their social obligations and provide work for underutilized staff in ruralbranches. While they have high collection rates (90% +) on their microcredit portfolios, overall theportfolio quality of these institutions has been very unsatisfactory because of pervasive "defaultculture"; a recent World Bank study indicates that non-performing loans (according to internationalstandards) are over 50 % of the total portfolio. Private banks have largely stayed away from the ruralcredit sector, due to the high cost of intermediation and perceived risk.

2.3 Several factors militate against lending by commercial banks to MFIs or directly to the poor;these include the predilection of commercial banks to shy away from the asset-less, and their operatingculture and procedures which are geared to the relatively well off, well connected and more vocalsegments of rural society. While there are no regulatory or interest rate barriers to voluntary lending,getting commercial banks involved in MFI financing would require the "heavy hand' of government, inaddition to offering credit guarantees.' The banking sector would also have to undergo a sea-change tolend on an uncollateralized basis, given that collateralized lending is the norm; in the interim it wouldrequire forcing banks to relax their collateral requirements which would be imprudent in the presentenvironment of "default culture". Commercial banks, thus, are unlikely to become a major player inmicrofinance in the foreseeable future.

2.4 The most important and internationally well-known example of a formal sector institutionproviding microfinance is the Grameen Bank. It began as an NGO, but was formally established as aspecialized bank under a special charter in 1983. Grameen's shareholders are its' borrowers and theGovernment. It is the largest provider of microcredit in Bangladesh and has so far disbursed about Tk48 billion to around 2 million poor.

The Semi-Formal Sector

2.5 The semi-formal sector comprises largely NGOs which operate microfinance programs targetedto the rural poor. There are over 150 NGOs in Bangladesh offering regular financial services-microcredit and savings, and majority of these programs are less than 5 years old. Most of these NGO-based MFIs are social welfare non-profit organizations formed to provide nonlending services such associal empowerment, education, family planning, relief, sanitation, and health. Recognizing theimportance of stable income and capital accumulation for a permanent escape from poverty, theseNGOs initiated targeted savings and credit programs for income generating self-employment activities.Over time, these institutions also recognized that provision of nonlending services was not, in itself,leading to alleviation of poverty and that lending and nonlending services sustain and reinforce eachother. MFIs see financial services as a vehicle to achieve multiple objectives: enhance the poor'sconsumption; empower them to access health and education services; as a social safety net for the verypoor; and as a means to establish a permanent income-generating asset base for the poor. Theseprograms have grown rapidly and are a major source of finance for the poor (Annex 2). During thelast five years, these MFIs have disbursed, on a cumulative basis, about Tk II billion to over 2.5

In early 1995, through moral suasion, GOB made NCBs buy Tk 6 billion of Grameen Bank bonds. Thesewere underwritten by GOB and were also eligible securities to meet statutory liquidity requirements.

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million borrowers. 80% of credit recipients are women and repayment rates are mostly above 95%;this is a stark comparison to the pervasive loan "default culture" in the formal system. In addition tothe NGO-based MFIs, the Bangladesh Rural Development Board (BRDB) has a well performingmicrocredit program financed by external donors.

2.6 The microfinance market structure is bipolar; almost 95% of the market is serviced byGrameen Bank and a few large national MFIs, such as BRAC, ASA, and Proshika, with annual creditprograms ranging from Tk 0.4-2.0 billion. These institutions are professionally managed and staffed,and have so far received a majority of their funds as grant from overseas donors. The large MFIsoperate on the basis of 3-5 year business plans, which are fully funded at commencement of the plan.The remaining 5% share of the market is serviced by small, local MFIs with annual credit programsranging from Tk 1-100 million. They have flexible organizational structures and have grown accordingto the availability of funds; most of these rely on PKSF (para 2.7) for financial support. Despite thebipolar market structure, there is increasing competition among service providers as the number ofinstitutions increase. With some of the large MFIs (e.g. Grameen and BRAC) slowing down theirexpansion in new areas, the small/medium MFIs are expected to become the major institutions forincreasing outreach in areas not covered currently.

The Palli Karma Sahayak Foundation (PKSF)

2.7 A major institutional innovation in Bangladesh was the establishment in FY90 of the PalliKarma Sahayak Foundation (PKSF), an apex financing institution to assist promising small and mediumNGOs expand their poverty targeted microcredit programs. Detailed institutional and financial analysisof PKSF is given in Annex 3. The PKSF is registered under the Companies Act of 1913 as a privatenon-profit organization. It has a General Body of 15 people, of which majority are from outside theGovernment and are leading personalities and social workers of national and international repute. TheGeneral Body, which meets a few times a year, provides broad policy direction. In addition, there is aseven member Governing Body, comprising the Chairman, Managing Director and five othermembers. The Governing Body meets more frequently and is responsible for overall policies andoperations (including loan approvals). The Chairman and two other members are appointed by theGovernment; the former, however, cannot be a serving official. In the past the Managing Director wasappointed by the Government, but in late-1995 PKSF's Articles of Association were changed to givethis authority to PKSF's Governing Body. The other three Board members are selected by the GeneralBody from private sector, and represent knowledge professionals with interest in the field of NGOactivities and poverty alleviation. The Governing Body currently includes Professor Yunus of GrameenBank.

2.8 PKSF's Governing Body has full autonomy on staff compensation and recruitment/termination.PKSF's salaries are higher than those of government and large national NGOs. Importantly, it hasrigorous staff selection criteria-professional staff must have masters degree with above average grades(i.e., First Class). It has a staff of 72 of whom 37 are professional staff.

2.9 As of December 1995, PKSF has financed 124 Partner Organizations (POs)2, almost all ofwhich started as social service organizations, adding microcredit subsequently as a new service to theirnonlending activities. PKSF proactively solicits new POs but maintains tight entry standards as

2 PKSF uses the term "Partner Organization" (PO) for MFIs borrowing from PKSF.

reflected by its very high rejection rate-of the 690 NGOs who have applied for loans, PKSF hasapproved only 124. To be eligible to borrow from PKSF., POs are required to have a demonstratedtrack record of microfinance or a potential capacity; while PKSF does not exclude POs with newlyestablished credit activities, it gives priority to those with on-going programs. Thus of the 18 new POsit accepted in FY95, 15 had been operating a credit/savings program for over 2 years. while all theremainder had credit operation for one year. So far, PO's borrowing from PKSF have mnobilized 1.2mnillion poor women into groups; however, only 25% of these have been provided microcredit becauseoffinding shortages and cautious lending policies.

2.10 PKSF makes uncollateralized fixed-rate loans, at rates ranging from 3-4.5% p.a.. with amaturity period of three years. It periodically reviews its rate structure and raised rates by 0.5-1.0% inend-1994. Even though POs need long-term funds (para 3.8), PKSF provides three-year loans toensure adequate accountability and monitoring of fund use: at the same time, it has a policy ofautomatically providing repeater loans of higher amounts, as long as the repayment rate is satisfactory(i.e. 95% +) and PO continues to have good manag.ment.

2.11 PKSF's overall operating policies and procedures are quite satisfactory. Its credit approvalpolicies are sound and conservative, credit supervision intensive, accounting/MIS systems reasonablysatisfactory and its own external audit quite comprehensive. PKSF's main focus of attention withregard to its POs is on loan collections (which have been over 99.8% since inception), satisfactorybookkeeping of disbursements and repayments, routing of PKSF-financed transactions through banks.and ensuring that microcredits are made to the target group. POs are required to conduct alltransactions of PKSF-funded programs through banks and submit monthly bank statements and MISreports. Loans are approved on the basis of POs' annual needs, but disbursed generally at intervals of1-2 months after field supervision and bank statements confirm that the earlier tranche has beensatisfactorily used. To further strengthen its monitoring and internal accountability capabilities, PKSFhas recently established an Internal Audit Cell which would undertake compliance audit of each POtwice a year.

2.12 PKSF has established a prudent exposure limit; maximum loan to a PO generally canlot exceed10% of available funds. In addition, it follows a conservative policy for first-time POs by starting witha small loan and gradually increasing loan sizes. For example, in regard to the 18 POs approved inFY95, the loan size ranged from Tk 100,000 (for 12 POs) to Tk 1.2 million. As of June 1995. theaverage loan outstanding per PO amounted to about Tk 24 million, while the size distribution was asfollows: 57% of loans, by number, were below Tk 2 million, 34% between Tk 2-5 million andremainder 9% higher. Loans in the last category accounted for 60% of outstandilng loans with themaximum loan outstanding being Tk 80 million.

2.13 PKSF encourages its POs to at least fully cover the recurring credit administrative/fundinigcosts from interest income; it also imposes a minimum lending rate of 16% to ensure that POs do notlend below commercial bank rates and to promote cost recovery from operations. PKSF alsoencourages POs who have outside sources of income to set aside a portion of interest income asreserves. PKSF mandates that all POs must have a member savings program and generally requiresthat these savings be kept in a regular bank; only for those POs which have a good track record andhigh standards of financial accounting does PKSF allow them to use savings in credit programs. Itfollows this strict policy to protect savings of the poor. In general, it does not impose any specificperformance or sustainability target. PKSF's main objective is to ensure accountability of its funds andmember savings. As long as POs meet its stringent requirements for targeted lending, repayment and

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accounting, PKSF neither monitors nor imposes its view on: (a) PO's product mix; (b) cross-subsidization of nonlending services from lending profits or lending services from grants and otherincome: (c) loan pricing and loan loss reserve policies; (d) level of mandatory savings; and (e)separation of accounts for different services, etc. Considering the pervasive loan default culture, thehiglh priority PKSF attaches to loan collections is well-placed and should remain as its predominantconcern. In addition, but without sacrificing the above noted emphasis. it needs to pay attention toissues of sustainability and its own role as an apex financial institution. Thus, a major institutionaldevelopmenit objective of the Project is to enhance PKSF's financial planning and monitoringcapabilities, incorporate forward looking performance targets in PKSF's credit policies, and strengthenfield-level financial accountability including accounting/auditing standards of POs.

2.14 PKSF has so far been fully funded on a grant basis by GOB, which has provided it with Tk 750million: of this, over half was provided a year ago. PKSF's annual disbursement increased from Tk 3million in FY 90, to an estimated Tk 500 million in FY 96. PKSF's assets increased from Tk 239million in 1991 to Tk 844 million as of June 30, 1995. Loans outstanding increased during the sameperiod from Tk 3 million to Tk 456 million, or about 55% of assets. The remaining 45% of assets aremostly investments in term deposits which yield about 6% compared to a yield of about 3.5% on loans.With expansion of loan portfolio. PKSF's operating costs, as % of loans, declined from 10% in FY93to 2.7% in FY95. Since inception, PKSF has been profitable, mostly on account of interest incomefrom term deposits and has pursued a policy to project itself as a sustainable institution-for staffmorale and to the POs, and to avoid decapitalization. The high percentage of assets in investments is,thus, partly a reflection of the profitability objective and partly on account of its conservative lendingpolicies. While this policy has obviously led to sacrificing the poverty objective, i.e. higher lending,for the reasons noted earlier it seems appropriate. With the profitability objective now well ensured,the share of loans in assets is expected to increase to 80% in five years (Table 6.1). Beginning FY96,PKSF intends to start making loan loss provisions amounting to I % of annual disbursements; with closeto 100% recovery rate, this level of provisions appears satisfactory. However, with the impendingexpansion, and associated potential risks, PKSF needs to adopt a provisions policy appropriate for itscontingent risks; a new policy wouid be developed under the Project (para 4.33).

2.?15 Overall, PKSF's independent and autonomous governance structure and prudent operatingpolicies provide a good foundation for rapid and sustainable expansion of its lending to POs. It hasnurtured over 120 MFIs whose financial service programs have good potential for becoming financiallyviable, and as a result significantly increased access of the poor and competition among MFIs.

3. MICROFINANCE PROGRAMS AND INSTITUTIONS

3.1 All MFIs are multipurpose, providing both credit and non-credit services. Not only there is awide range in the scope of services offered by each MFI, but there is also large variation in themicrocredit programs pursued by each. While the key operational and financial features of the creditprograms are similar and credit is usually multi-dimensional (i.e., combined with skills development,marketing assistance, etc.), MFIs operate with differing objectives, methodologies and scope of multi-dimensionality in credit. At one end of the spectrum there are institutions like Grameen Bank andASA, where credit activities dominate the institutions' business. At the other end are MFIs like BRACand Proshika, which believe that an integrated strategy focused on community and human resource

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development is necessary to assist the landless; for these institutions credit is only about half of theiractivities with the remaining accounted for by social sector programs, livestock/fisheries, socialforestry, social empowerment, etc. Institutions at both ends of the spectrum have experiencedtremendous success in terms of horizontal (i.e., new borrowers) and vertical outreach (i.e. larger loansize) and repayment performance, though the MFIs which are "credit-only" and whose credit hasfewer multi-dimensional elements have lower operating costs.

WHO ARE THE BORROWERS?

The target group includes:

I . Landless women such as Bedana, age 35, who initially received Tk 1,000 to purchase goats and chickens.This enabled her to improve her four children's diet, and earn some income from the sale of eggs and chicken. In thefollowing years, she received larger loans, and was able to purchase and operate a small grocery shop. Adevelopment education class taught her basic skills in math, and also increased her awareness of the impact of health,nutrition, and the environment on her family's well-being.

2. It also includes women such as Sokhina, age 27, whose family lost everything in the 1988 floods. An initialloan of Tk 500 helped her family survive and resume their business of paddy husking. The family also purchased agoat for fattening, and profits from its sale and from paddy husking enabled Sokhina's husband to buy a rickshaw,and further increase the family's sources of livelihood. A second loan of Tk 1,000 helped Sokhina start a matbusiness. Finally, a Tk 3,000 loan, combined with Sokhina's personal savings, allowed the family to purchase land,which was used for jute-cropping.

3. Often, the recipients of these loans are poor, young widows. Such was the case of Rahima Begum, age 31.After her husband's death, Rahima learned sewing in an effort to sustain herself, but was unable to get credit topurchase a sewing machine. An initial loan of Tk 1,000, combined with personal savings, permitted her to buy abasic sewing machine. She began a tailoring business, which gradually expanded. With a further loan of Tk 2,000,Rahima bought another sewing machine and employed an assistant. Profits from the business financed much neededrepairs in the house and Rahima's tailoring business is now worth Tk 6,000.

Source: "Voices from the Lower Depth: Impact Assessment through Case Analysis," Association for SocialAdvancement (ASA), Dhaka.

Operational Features

3.2 The MFIs' credit model has the following key features : (a) it is targeted to the landless/asset-less; (b) all borrowers have to be part of a group, and groups meet regularly once a week; (c) womenborrowers are given preference. In fact, most MFIs only lend to women, and overall womenborrowers make up over 80% of the total borrowers; (d) loans are collateral-free, and generally have amaturity of 50 weeks with weekly repayments; (e) savings is an integral part of the program; (f)borrowers have full freedom to choose the activity to be financed by the loan; (g) all financialtransactions are recorded in individual passbooks and done in presence of the entire group to enhancetransparency and self-monitoring; (h) all MFIs start with a small loan (Tk 1-3 thousand) and providerepeater loans of increasing amounts as long as repayment of earlier loan is satisfactory. This repeaterfeature is critical to the excellent repayment performance, but more importantly the basic premise isthat the poor need to have continuous access to credit, in increasing amount, for 8-10 years toaccumulate enough savings/assets (net of debt) to escape from the poverty trap and maintain reasonable

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consumption once loan is withdrawn; (i) most MFIs have maximum loan limits of Tk 8-12 thousand.but few have a policy to "graduate" a borrower from the program since borrowers with large loans arelow risk-having been in the system for several years-and provide ability for cross-subsidy (para 3.4);() most of the credit provided by MFIs finances rural non-farm production. This includes activitiessuch as poultry farming, petty trade and shopkeeping, cow fattening, pottery, and other relatedactivities-mainly activities with short gestation and daily sales; and, (k) MFIs use fairly comprehensiveloan forms to select beneficiaries. In the absence of land records and objective means test, the selectionis largely subjective. However the following features of the program provide a reasonable degree ofassurance that only the poor get the loans: self-selection process; very small loan sizes and highinterest rates; rigorous enforcement of repayment; weekly meetings; MFI staff's knowledge of localcommllunities and unlikelihood of the better-off to subject themselves to the rigors of the program andbe seen sitting with the poor in open meetings.

Financial Aspects

3.3 Following from their overriding poverty and social welfare objectives, most institutions operateon a non-profit basis and emphasize increasing borrowers' incomes rather than making profits. Withinthe constraints imposed by the resource envelope comprising grants, concessional funds and voluntaryservices of key organizers, MFIs' attempt to maximize nonlending services and horizontal outreach,minimize interest rates, and pursue a loosely defined goal of achieving financial sustainability on theircredit programs. There is wide variation among MFIs on the relative priority attached to each of theseobjectives. The usual pattern is described below.

3.4 Iiiterest rates. These are much higher than rates in the formal sector. Effective interest ratesrange from 25-30%3 per annum; this is 15-20% in real terms and 50-100% higher than the highestlending rates of private banks. Interest rates are set such that within 3-5 years of initiating lending to agroup, interest revenues from each group fully cover the operating costs (administrative costs, interestcost on borrowed funds and borrower savings, and 2-3% loan loss provisions). By this time averageloans are around Tk 5-6 thousand and 80-90% of the group members are borrowing. Beyond thispoint, and as loan sizes increase, interest income exceed costs which enables the MFI to cross subsidizenew groups. MFIs charge a uniform rate for all borrowers which allows them to cross-subsidize loss-making first time borrowers through profits originating from mature borrowers who have been in thesystem for several years and whose loan size is generally 2-3 times that of a first time borrower. Theavailability of low-cost funds enhances the ability for cross-subsidization, and hence horizontaloutreach. While loan pricing is generally on a cost-plus basis, the interest rates fall within the aboveband because of: (a) pricing policies of market leaders like Grameen/BRAC; (b) "social consensus" onthis rate band; (c) MFIs' poverty objectives and reluctance to charge higher interest rates which theyconsider usurious; and (d) increasing competition and a growing pattern of beneficiaries switchingbetween MFIs. This latter behavior has also put pressure on MFIs to enhance cost effectiveness.

3.5 Credit Delivery Costs. These usually range from 10-20% of loan amount, and varyconsiderably; for example, per borrower, they are annually Tk 330 (Grameen), Tk 400 (Proshika). Tk

Most institutions charge a nominal rate of 12-15% with interest due calculated on the basis that the principalamount is outstanding for the entire 50 week period; e.g., at an interest rate of 12%, interest collected on aloan of Tk 100 would be Tk 12, even though because of weekly repayments, average loan outstanding isaround Tk. 50. Because of this feature and other fees (e.g. emergency fund, etc.), the effective interest rateamounts to around 25-30%.

380 (BRAC) and Tk 240 (ASA). They are higher for smaller MFIs and whose credit is more multi-dimensional and lower for larger MFIs and those which provide limited nonlending services as part ofcredit; also they decline over time with increase in volume of lending.

3.6 Credit Risk Management. Most MFIs incorporate a 2-3 % loan loss provision in theirinterest rate. Many also operate mandatory credit insurance schemes to enable borrowers to repayloans in case of natural disasters, death, sickness, etc. The grants and the mandatory savings alsoprovide MFIs adequate cushion to absorb credit risks over and above the 2-3 % provisions.

3.7 Funding Strategy. The MFI's strategy has been to seek low cost and long term funds. Roughestimates indicate that grants, concessional loans and borrower savings account for 37, 30 and 33 %respectively, of the MFIs' total funding base at end-1994. MFIs basically act as "pass-through"institutions in terms of the benefits of the lower cost funds.

3.8 MFIs prefer grants (or interest-only borrowings) rather than borrowings which require regularprincipal repayments, as this enables them to pursue an important feature of the program-assuredrepeater loans-without fear of a break in the cycle. Prior to a situation where all of MFIs' borrowershave completed the 8-10 year cycle (para 3.2), withdrawal of funds from the MFIs in form of principalrepayment would necessitate withdrawal of an equivalent amount from the final beneficiary-this wouldbreak the virtuous cycle of higher consumption/savings accumulation and push the poor back intopoverty. Moreover, withdrawal of principal would also diminish MFIs' capacity to increase outreach.

3.9 The use of borrower savings by the MFIs falls into two categories. Those MFIs (e.g. Grameenand ASA) which tend to emphasize lending services use borrower savings for this purpose and paydeposit rates equal to rates on savings accounts at NCBs; borrowers are not allowed to withdrawsavings until their loans are fully paid. Other MFIs, such as Proshika, do not use borrower savings forcredit, though they mandate that borrowers regularly save and monitor savings which are kept by theborrowers in a bank. PKSF's POs are required to follow this latter policy (para 2.13). Althoughaccurate data is not available, there is a definite pattern for the savings mobilized by MFIs. As MFIsbegin operations, savings are quite high as proportion of loans outstanding and range from 40 to 60%.With credit expansion this ratio drops to around 15-20%, and then starts to increase as voluntarysavings increase for borrowers who have been in the system for several years. For mature MFIs, likeGrameen, savings are about 30% of loans outstanding.

3.10 So far retained earnings have not been a major source of funding. MFIs prefer to maximizeborrower income rather than build up equity and believe that until the time their horizontal outreachobjectives are met, and mature borrowers exceed new first time borrowers, they would not have theability to build up equity from operations.

3.11 Determinants of Viability and Sustainability. Table 3.1 on the next page highlights for arange of MFIs, key operational information and the MFIs' financial evolution with respect to thefollowing three broad viability indicators: (a) operational viability , i.e. interest income exceedsadministrative costs; (b) financial viability, i.e. interest income exceeds administrative, loan loss andsubsidized financial costs; and (c) economic viability, i.e. interest income exceeds administrative, loanloss and market-priced financial costs. Because of the lack of good accounting information separatingcosts of lending and nonlending services, and unaudited financial statements of small/medium MFIs,Table 3.1 is, at best, rudimentary and indicative

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Table 3.1: Viability Analysis of MFI's Credit Programs

Loan Dis- Borrowers Average Savings/ Viability Ratios (%)bursement Loan Size Loan

Outstanding Operational4 Financial5 Economic.6(Tk M) ('000) (Tk '000) %

I. Mostly Credit

LargeGrameen 1992 5,200 1,280 4.1 34 89 88 56

1993 10,622 1,680 6.3 27 114 93 661994 13,912 1,861 7.5 30 137 98 75

(0.22)MediumASA 1992 195 86 1.9 22 160 160 121

1993 573 198 2.9 34 143 139 1011994 887 262 3.4 41 145 113 102

SmallSUS 1992 0.1 0.1 0.7 18 -- -- --

1993 1.6 0.8 2.0 14 148 115 981994 3.7 1.4 2.6 18 166 109 109

11. Multi-12urpse

Proshika 1992 224 272 0.7 -- 61 61 381993 303 368 0.8 -- 58 58 361994 423 495 0.9 -- 74 74 41

(3.16)BRAC 1992 733 287 2.5 32 111 89 69

1993 1,368 476 2.8 29 90 73 601994 2,035 706 2.8 30 120 96 72

(1.06)

Source: MFIs and staff estimates. Figures in parenthesis are Subsidy Dependency Index (SDI) for 1994estimated by another study. An SDI of 1.0 implies that interest rates would have to increase by 100% to eliminateall forms of subsidy.

3.12 From the above table, the general pattern that emerges is that as loan portfolio increases,financial viability improves and dependence on external funds declines while economic subsidyprevails. Thus, in case of Grameen, financial viability indicator was 98% in 1994, having increasedfrom 88% in 1992. Similarly, in case of Proshika, the financial viability indicator increased from 61 %in 1992 to 74% in 1994. The "mostly credit" institutions (e.g., Grameen, ASA) are financially viable,

4 Interest Income as % of non-financial operating costs (total non-financial costs for "mostly-credit" MFIs andestimated credit-related costs for "multi-purpose" MFIs).

5 Interest Income as % of operating cost including financial expenses.

6 Interest Income as % of operating cost plus imputed economic cost (10% p.a.) of entire funding basecomprising grant funds, concessional loans, and borrower savings.

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albeit on the basis of subsidized funding; on the other hand, the multipurpose institutions (e.g.,Proshika) are loss making on account of their emphasis on horizontal outreach and greater multi-dimensionality in their credit program. Few of the institutions would be profitable if opportunity costwas imputed to grants/ concessional funds; thus, in 1994, interest income as percentage of economiccosts was 75% (Grameen), 102% (ASA), 41% (Proshika), and 72% (BRAC).

3.13 Overall, most MFIs currently operate at or below operational viability stage because they are ofrecent origin (para 2.5); very few are economically viable. They use grants from donors and incomefrom commercial activities (e.g. fish ponds, handicrafts) for providing nonlending services, financingup-front costs of establishing new groups and initial losses incurred until the lending volume builds upto a break-even level. The time frame for an MFI to move from one viability stage to the nextdepends on the following factors, many of which result from development choices made by MFIs:

* Volume of lending, with viability improving as the portfolio expands.

* Unit loan size, per beneficiary, is also a critical determinant. Those MFIs which emphasizevertical outreach tend to move faster along the viability continuum compared to those thatemphasize horizontal outreach. MFIs optimize this trade-off (Annex 2, para 22) based onavailability of grant/own funds to cover losses. In general, for a typical MFI having multi-dimensional credit and operating cost (para 3.5) like Grameen, it appears that the MFIattains operational, financial, and economic viability once unit loan reaches Tk 3-5thousand, Tk 4-6 thousand, and Tk 7-9 thousand respectively.

- Scope of multi-dimensionality of credit and other nonlending services provided has adirect impact on viability. MFIs whose credit does not include non-lending services (e.g.,ASA) has much better ratios than MFIs whose credit is more multi-dimensional (e.g.,Grameen). Similarly "mostly credit" MFIs (e.g., Grameen and ASA) have higher viabilityratios compared to multi-purpose MFIs (e.g., BRAC and Proshika).

- Wage level of staff is an important determinant of operating costs. Wages paid by smallMFIs are much lower than large MFIs like Grameen or BRAC. As MFIs' lending volumeincreases, wage costs (as % of loans) decrease; beyond a certain scale the wage costs startto increase as they have to compete with the large MFIs for better qualified staff.

* Standardization of products. Those MFIs, like ASA, which follow rigid productstandardization-all loans in multiples of Tk 1000 and savings in multiples of Tk 5-havelower administrative costs compared to those which offer borrowers a choice.

* Percentage of group members borrowing. MFIs which are able to finance a highpercentage of group members have lower unit costs.

Institutional Capacity

3.14 So far institutional capacity has not been a constraint to lending, as evidenced by the rapidhorizontal and vertical expansion of these programs without any adverse effect on repayment. Thelarge/medium MFIs, in particular those which have had generous access to funds have been able toexpand rapidly due to the simplicity of the system, tried and tested credit model and the large pool ofunemployed college graduates available to work at the field level. Thus, over the last five years, each

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of the large institutions-BRAC, Grameen, ASA and Proshika-have expanded their programs fivetimes (Table 2.1). PKSF's POs have experienced even higher growth rates. Most MFIs are dependenton dynamism of original organizer and lack depth of management. Evidence indicates that over timeinstitutional viability improves-there is well developed organization and professional management.

Accounting and Auditing

3.15 The accounting, MIS and external audit policies and standards followed by the large MFIs,particularly those funded by external donors, are good and comprehensive. While PKSF monitors veryclosely the credit programs of small/medium MFIs financed by it. for the most part the latter'saccounting, MIS and audit systems need to be substantially upgraded. MFIs can, to some degree,separate cost of credit delivery from costs of nonlending services; few have a cost allocation systemwhich accurately tracks these costs or is able to differentiate the direct cost of credit delivery fromassociated costs, i.e., group mobilization, training, empowerment, etc. An important objective to bepursued under the Project is improving the financial and cost-accounting systems, while recognizing thegenuine concerns of MFIs about the administrative/reporting burdens of even a rudimentary costaccounting system.

Socioeconomic Impact

3.16 There have been several studies to measure the impact of microfinance on the socioeconomicstatus of the beneficiaries (Annex 4). The quality, coverage, independence and analytical robustness ofthese vary considerably. Most however, do indicate that households which received microcredit havebetter living standards, higher human development status and greater assets. A more rigorous study byBank staff shows that MFIs place their programs in poorer areas and that program participation amongthe poor is self-selective. The study also shows that microfinance programs, such as those of GrameenBank, have desirable impact on the poor, program impact is statistically different for male and femaleborrowers, women benefit from program participation, and the larger the loan the more significant thesocioeconomic impact.

Table 3.2: Welfare effects of Grameen Bank Loans(percentage change)

Indicators Effect of male borrowing Effect of female borrowing

Participation rates

- Boys' schooling 7.2 6.1- Girls' schooling 3.0 4.7

Weekly Per capita expenditure 1.8 4.3Recent fertility of women aged -7.4 -3.5

15-49 yearsWomen's labor supply to cash- 0 10.4

income earning activitiesWomen's nonland assets 0 19.9

Source: Pitt and Khandker, 1995

3.17 The above table, based on the Bank's study, highlights the welfare effects for those Grameenborrowers who have been receiving loans for about four years and whose average loan is about Tk

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3500; a 1 % increase in their loan size would: (a) increase per capita consumption (a weekly increaseof 4.3 % among female borrowers and 1.8 % increase among male borrowers); (b) enhance schoolparticipation rate for boys (7.2 % increase among male borrowers and 6. 1 % increase among femaleborrowers) and girls (3.0 % increase among male borrowers and 4.7 % increase among femaleborrowers); and (c) reduce recent (over the last five years) fertility of women aged 15-49 (7.4 %reduction for male borrowing and 3.5 % reduction for fema!e borrowing).

3.18 The Bank study also indicates that: (a) earnings, from microcredit, of an average femaleborrower of Grameen Bank can take the family out of poverty (i.e. per capita consumption exceedspoverty level consumption) within five years of continuous borrowing; (b) the total assets of a borrowerare about 140- 240% higher in 4 years compared to asset holding prior to participation in the program;(c) women benefit from program participation mainly through increasing labor supply to cash-incomeearning activities (by 10.4%) and holding more nonland assets (by 19.9%); (d) these programs havecreated positive externality in the village economy. The nonfarm income of an average household is14.8 % higher in Grameen Bank villages than nonprogram villages, with a resulting 10.2% increase ofaverage household total annual income; (e) rural wage workers also benefit from program placement.The average daily wage rate is at least 5.2% higher in Grameen Bank villages than in non-programvillages: and (f) the credit programs have generated positive externality in the case of both informallendinig (reduction of 54.5%) and informal interest rate (a reduction of 8.0%).

3.19 Due to the MFIs' active involvement in social issues, differentiating the impact of credit versusthe impact of other nonlending services that they provide is difficult. According to one study, as muchas 75 % of the increase in income can be attributed to nonlending services7 . However, it is important torecognize that the credit and non-credit activities are an integral part of a development paradigmfocused on poverty alleviation and that microfinance programs should not be viewed in isolation merelyas a financial intermediation activity. In comparison to other targeted programs in Bangladesh forpoverty alleviation (e.g., Food-for-Work, etc.) experience is gradually revealing that microfinanceoffers much greater potential for poverty reduction as it has a proven track record, is the mosttransparent method of reaching the poor, especially rural women, and results in positive externalities atthe village level.

3.20 Despite the positive contributions of these programs at the individual, group and village levels,the enormous magnitude of poverty in Bangladesh has dwarfed this contribution in aggregate statistics.With only a low percentage of the poor being covered so far under these programs, the highly positiveimpact has not led to a drop in aggregate levels of the poor. Also, the impact has been masked by theincrease in the ranks of the poor. Any meaningful and observable change would require both aquantum increase in the size of these programs and higher growth of the rural economy, and overalleconomic growth.

Constraints to Expansion of MFI's Financial Services

3.21 The potential demand for credit is enormous (para 4. 11). The main constraint facing MFIs inexpanding outreach and attaining economic viability is funds, particularly concessional funds. Asexternal grant funds shrink, even large MFIs like BRAC and Proshika with strong connections toexternal donors face funding constraints. While the large MFIs have developed their credit

Impact of Micro-Credit Program: Signe-Mary McKernan, Brown University 1995.

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management, monitoring and evaluation capabilities in tandem with their rapid expansion, theaccounting and credit management skills of smaller MFIs is weak. These institutions and PKSF need todevelop this capacity, if they are to continue expanding as they have over the last few years.

4. THE PROJECT

Country Assistance Strategy (CAS) Objectives

4.1 IDA's overriding objective in Bangladesh is to support the country's efforts to accelerate therate and improve the pattern of growth, so as to reduce the absolute number of people living inpoverty. The CAS envisages a two pronged approach that comprises: (a) direct support for programswhich benefit the poor, and (b) programs which support overall economic growth particularly thatoriginating in labor-intensive economic activities. Within these themes, the CAS gives priority tofostering the participation of the poor in the growth process, and supporting the emerging collaborationbetween the Government and the NGOs. In particular, it places emphasis on increased involvement ofthe communities and stakeholders in the design and monitoring of development programs.

Project Concept

4.2 The basic concept behind the Project is to enable successful MFIs to expand their financialservices programs through increasing the level of resources available to them, and to assist them inattaining financial and institutional sustainability of these programs. Resources will be providedthrough the apex intermediary, PKSF, which will onlend the funds to small, medium and large POs.The Project was conceived by a GOB Task Force comprising key stake-holders-GOB, PKSF andMFIs, and its design incorporates the recommendations of the Task Force and the results of a Bankresearch project (RPO-676-59) under which detailed institutional and financial sustainability studieswere undertaken for three large MFIs: Grameen Bank, BRAC and BRDB's RD-12 program. TheProject design is based on a tested approach and has strong ownership features resulting from: (a) theactive involvement of key stakeholders in project preparation; (b) the high priority attached by GOB tosupporting such programs (as evidenced by its Tk 750 million grant contribution to PKSF, andunderwriting of Tk 6 billion of bonds of Grameen Bank); and (c) wide acceptance by the finalbeneficiaries of the credit component's key features.

Project Objectives

4.3 The Project has two key objectives: (a) reduce poverty through expanding horizontal andvertical outreach of on-going successful microfinance programs; and (b) enhance institutional andfinancial sustainability of PKSF and PO's credit programs through (i) financing expansion of lending;(ii) enhancing the role of PKSF from being a financier of small and medium POs to becoming an apexorganization that lends funds to POs of all sizes, and acts as a catalyst in mobilizing enhanced levels offinancial support from other donors and eventually from the market; (iii) assisting in institutionalstrengthening of PKSF and its borrowers by providing resources for training and institution building;(iv) providing insight and possible solutions to several issues/problems (e.g., strengthening linkagesbetween MFIs and the formal financial sector) currently facing the microfinance system in Bangladeshby conducting a range of special studies and associated training; and (v) disseminating best practices forincreasing cost effectiveness of these programs.

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Rationale for IDA Involvement

4.4 The proposed Project supports the twin CAS objectives of poverty alleviation and broad basedeconomic growth. Recognizing microfinance's potential as an instrument for poverty reduction, theproposed Project is part of IDA's comprehensive poverty alleviation strategy comprising this initiativeand investments in social sectors and rural infrastructure. It will be the first of its type for IDA'stargeted assistance to the poor in Bangladesh. While the Project would benefit people from all layers ofthe poverty pyramid, the majority of the clients would be rural women. The Project would thus have asignificant impact on women's economic status and empowerment, with its attendant benefits on healthand education status of children and fertility rates.

4.5 The Project is also an important element of IDA's overall strategy for the financial sector. Theoverarching objective for the sector is to establish an efficient and sound financial system in order toachieve the economic growth goals. IDA has a three pronged strategy for the sector. Thefirst is toreform the commercial banking system which is repressed, facing enormous portfolio problem andwhere loan defaulters and irresponsible bank managers/owners have so far avoided any penalties. Thekey elements of the strategy involve privatization of NCBs, strengthening of regulations, andenforcement of sanctions to overcome the "default culture" and irresponsible governance behavior.The second is to deepen the financial system through supporting non-bank financial institutions and thecapital market, which are insignificant at present. Finally, the third is to establish a financiallysustainable market-based mechanism for provision of financial services to the poor. This would beachieved through assisting the credit programs of the MFIs become financially sustainable and fosteringthe development of linkages between the formal and informal systems. Achieving these objectiveswould, of necessity, take a long time on account of: (a) the deep seated institutional problems facingthe formal financial system (para 2.3); and (b) balancing the difficult trade-off between enhancingconsumption/asset build up of the poor and removing concessionality in funding, the latter beingnecessary to establish a market based microfinance system. The above not withstanding, IDA'sunderlying strategy is to establish an integrated and seamless financial services market over the longrun. IDA's vision on the Project-induced evolution of the MFI sector is discussed in paras 6.13-6.17.

4.6 IDA support will also: (a) bring about a fundamental shift from a grant based system to a loanbased system. As a result of this Project, GOB has decided that all future budgetary funding to PKSFwould be in the form of loans, not grants. In addition, two large MFIs (Proshika and BRAC) would beusing loan funds for the first time; (b) enable GOB to significantly enhance its financial support toNGO-based microcredit programs, (c) play an important institution building and dissemination role(para 4.3); (d) assist grassroots institutions to strengthen their credit operations, as a means to sustainand enhance nonlending services to the poor and to support those willing to move along theorganizational continuum from informal social service organizations to full service formal financialinstitutions; and (e) establish an efficient mechanism to transfer subsidized funds without penalizing thebanking system. Provided Project objectives are met and achievement of outcomes is as envisaged,IDA support for the microcredit programs is expected to continue over the foreseeable future as part ofIDA's poverty assistance strategy.

Lessons from Previous IDA/Bank Operations

4.7 This would be IDA's first microfinance operation in Bangladesh. A somewhat similaroperation in the late 1980s was aborted at negotiations after IDA was informed that PKSF's GoverningBody declined to borrow IDA funds, partly because it found IDA's conditions too onerous. At that

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time, the GOB was also not as entlhusiastic about channeling IDA funds to NGOs. Now GOB is verykeen on supporting microcredit programs in light of their success and the enormous need for funds. Toavoid a repetition of the past. and recognizing the importance of participation of key stake-holders tosuccessful design and ownership, PKSF and MFIs were involved in, and extensively consulted by, theGOB Task Force and IDA. In a recent communication to IDA, the NGO Association of DevelopmentAgencies in Bangladesh praised this Project as a "historical initiative" by IDA. The Projectincorporates the emerging lessons-importance of good credit information/supervision and emphasis onachieving financial sustainability-of successful microfinance programs in Bangladesh and othercountries.

Coordination with Other Donors

4.8 During project preparation, IDA staff liased closely with official bilateral donors andinternational NGOs who have generously supported these programs. Their views and experience havebeen reflected in Project design. With grants shrinking and all donors emphasizing financialsustainability and greater accountability, they see the Project as a path breaker in shifting microcreditaway from a grant based system and in sharpening the emphasis on financial sustainability. Since IDAfunds would be at higher cost and in form of loans, IDA would be the lender of last resort andtherefore not displace available donor funds. Moreover the continued provision of low-cost funds bydonors would not pose any problem of underutilization of Project funds given the enormity of the need.

Project Scope and Description

4.9 An IDA credit of US$105 million and GOB loan of US$10 million is to be provided under theProject for: (a) a line of credit (US$109 million) for loans to the poor through POs that meetpredetermined criteria; and (b) technical assistance (US$6 million) for capacity and institution buildingof the POs, PKSF and Bangladesh Bank (BB). The GOB loan of US$10 million and US$100 million ofIDA funds will be on-lent to PKSF on terms and conditions acceptable to IDA (para 4.17). The GOBwill provide US$5 million of IDA funds, on a grant basis, to PKSF and BB to implement the variouscomponents for institution building and for deepening and broadening the microfinance market.

Project Costs and Financing Plan

4.10 The proposed IDA credit of US$105 million will finance 77% of the total Project cost ofUS$137 million, with GOB contributing 7% (US$10 million) and POs/beneficiaries the balance of 16%(US$22 million) . The Project costs and financing plan are summarized in Table 4.1. GOB has alreadyprovided to PKSF its initial contribution of US$5 million.

With the inclusion of large POs and expected institutional improvements in small/mediulIl POs as a result ofthe Project, it is estiniated that about S22 million of meniber savings is likely to be used for credit programs(para 2.13).

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Table: 4.1 Project Costs and Financing

Local Foreign Total Local Foreign Total %

(Tk billion) (US$ million)Project Costs

Credit Component 5.47 -- 5.47 131 -- 131 96Institutional Development 0.21 0.04 0.25 5 1 6 4

Total 5.68 0.04 5.72 136 1 137 100

Financing Plan

IDA 4.34 0.04 4.38 104 1 105 77GOB 0.42 -- 0.42 10 -- 10 7PO/Beneficiaries 0.92 -- 0.92 22 -- 22 16

Total 5.68 0.04 5.72 136 1 137 100

Credit Component

Credit Size

4.11 The size of the credit component is only about 10% of the estimated potential demand forcredit. A recent study indicates that only 18% of the target group (all landless poor in the rural areas)has been covered so far by MFIs. Bringing the remaining 82% into the program would require almostUS$1.5 billion9. Looked at another way, it would require over US$200 million to extend loans togroup members who have already been mobilized by POs borrowing from PKSF, but have not beenprovided credit. The large difference in average loan size per borrower-Grameen (Tk 7500), ASAand BRAC (Tk 2900), small POs (Tk 1500-2000)-for recipients having generally similar abilities andmarket opportunities, provides an indication of the large room for credit expansion. The size of thecredit component is also much smaller than the total amount, about US$250 million, included in the1996-2000 business plans presented to the appraisal mission by PKSF, BRAC, Proshika and ASA. Onan aggregate basis, the Project will not result in a significant increase in the availability of total funds,given the total volume of microcredit disbursed by all institutions (US$492 million in FY95). Annex 2,Table 1 shows the projected annual disbursements of the major MFIs between FY96 and FY2000,roughly the period of the IDA Project. In relation to these, IDA funds will finance approximately 12%of total annual microcredit disbursements in Bangladesh by FY2000. The Project's overall impact oncredit availability will be modest, which is prudent; however, the Project's potential impact onstrengthening PKSF and the small/medium POs and enhancing sustainability and accountability of theircredit programs, is large. In addition, the Project should significantly increase coverage of newborrowers over the four-year implementation period.

4.12 As a result of the Project, PKSF's annual disbursements would increase from Tk 0.5 billion inFY96 to about Tk 2.4 billion in FY2000. This growth is not out of line with past pattern (para 2.14).

9 Assuming average loans of US$ 150 per family to 10 million target families which are yet to be covered.

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Moreover, PKSF's past low disbursement level is a reflection of both scarcity of loanable funds and itspolicy of gradually increasing loan size in line with PO's absorptive capacity. Thus, the POs have notonly had to limit lending to no more than 25% of group members already mobilized but also had tolower unit loan size to expand horizontal outreach. PKSF's borrowers, and in turn PKSF, could easilytriple their lending in 2-3 years just by increasing coverage to 70-75% of the existing group members-the norm for Grameen/BRAC is 85-90%-without much risk of poor lending, lowering of PKSF'sappraisal standards or creating a "disbursement" mentality. The simplicity of the system permits itsrapid replication; moreover, the enhanced monitoring and accountability arrangements proposed underthe Project should reduce the above risks further.

Credit Use

4.13 Under the Project, funds will be channeled as follows. GOB will lend IDA funds (and its own)to PKSF which in turn will re-lend these to eligible POs; the latter will on-lend to the beneficiaries.Recognizing the segmentation of the market into a few large institutions and numerous small/mediumPOs, the various aspects - credit allocation, eligibility criteria, terms and conditions-have been tailoredto suit this market structure.

4.14 About half of the credit component is notionally earmarked for the small/medium POs, with theremaining for the large POs. This would ensure that the large POs, who have better access to externalfunds, do not crowd out the equally efficient and promising small/medium POs. At the same time, apredetermined allocation for the large POs would assure them of stability of funding for their medium-term business plans and encourage them to use available scarce grant resources for mobilizing newgroups. In anticipation of the Project, PKSF has recently approved loans to two large POs-a loan ofTk 1.4 billion (US$34 million) to BRAC and Tk 0.8 billion (US$19 million) to ASA. The allocationsbetween small/medium and large POs would be reviewed at mid-term, taking into account actualexperience.

4.15 The Project funds will enable POs to expand both horizontal and vertical outreach; except forBRAC, all other POs will use the funds for general portfolio expansion. BRAC intends to use Projectfunds exclusively for expanding its credit program for women participating in its Vulnerable GroupDevelopment Program (Annex 1, para 10). By supporting this particular program, IDA funds wouldreach the poorest segments of the rural population.

Institutional Eligibility Criteria

4.16 The eligibility criteria described below would apply to institutions implementing the Project.

4.17 PKSF would need to meet the following criteria to be eligible to borrow IDA (and GOB)funds: (a) continue to have an independent Governing Body, professional management and staff andsound operating policies; (b) maintain a strong and transparent accounting, MIS and internal auditsystem; (c) continue to have its accounts audited by reputable external auditors on annual basis; and (d)maintain a loan recovery rate of 98% on a continuous basis.

4.18 Small/Medium POs borrowing from PKSF. The following criteria, currently used by PKSF inselecting POs, will be used under the Project: (a) the PO has a demonstrated track record of running asuccessful microcredit program, or in the view of PKSF demonstrates the potential to do so aftertechnical assistance and capacity building; (b) the minimum loan recovery rate is 95%; (c) the PO

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possesses adequate skilled, salaried staff for intensive supervision, and has a good managementcommittee; and (d) the PO is using a standard double entry accounting system, or is willing to adopt itwith PKSF's assistance.

4.19 Large POs (such as BRAC, ASA, etc.) would be eligible to borrow from PKSF provided:(a) the institution has been operating a successful microcredit program for a minimum of 5 years; (b) ithas at least 100,000 borrowers with a strong potential for expansion; (c) the institution has at least Tk100 million of equity (including foreign grants, retained earnings etc.) of its own in the program; (d)the debt-equity ratio does not exceed 2.5:1 to avoid excessive leveraging. This would not apply toGrameen Bank or POs which become banks and which would need to meet prudential capital adequacystandards established by the central bank; (e) the institution maintains a strong and transparentaccounting, MIS and internal audit system; (f) the institution has its accounts audited by reputableexternal auditor on an annual basis; and (g) it maintains a loan recovery rate of 95 %.

4.20 At present, while PKSF mandates savings mobilization and financial viability, it has notestablished any targets that POs should meet for their credit programs in the short, medium or longterm in respect of sustainability indicators such as: savings mobilization, coverage of credit operatingcosts from interest income, profitability, equity build-up, etc. Under the Project, PKSF will study andincorporate forward-looking financial indicators in the eligibility criteria (para 4.33) to ensure that POs'credit programs are moving along the continuum to full financial sustainability.

Credit Terms and Conditions

4.21 GOB Loan, and IDA funds, on-lent to PKSF would have an interest rate of 1 %, and amaturity period of 20 years (including a 5-year grace period).

4.22 PKSF Loan to Small/Medium POs would have a maturity of three years and differentiatedinterest rates (referred to as service-charge by PKSF) as follows: (a) 3% for POs with cumulativeborrowing from PKSF of Tk 5 million; (b) 4% for POs with cumulative borrowing from PKSF of Tk5-75 million; (c) 4.5% for POs with cumulative borrowing from PKSF above Tk 75 million.

4.23 PKSF Loan to large POs would carry an interest rate of 5 %, and PKSF would decide on thematurity and grace period, based on review of the PO's ability to repay from its income and reflows.These loans will have the following features: (a) they will be approved on the basis of medium-termbusiness plans submitted by the POs to provide a firm planning horizon for them, since their programsare large-scale and require considerable up-front preparation; (b) the loans will be of longer maturity(10-14 years including grace) in line with needs of the program, with PKSF deciding on the final termsof each loan based on the PO's overall cash flow projections. Unlike PKSF's small/medium POs whichrequire much tighter control and monitoring over fund flow (and hence the three-year funding cycle),the large POs do not need to be subjected to this policy because they have a sound track record andwell developed internal controls/MIS; (c) disbursement will be made at a minimum on a quarterly basisto these POs since they are dealing with larger volumes and more borrowers and, after the firstadvance, disbursement would only be made provided the institution continued to meet eligibility criteria(para 4.19).

4.24 During the Project period, it is conceivable that a large PO (e.g., Grameen) may issue bonds.While PKSF's policies do not allow it to subscribe to bonds, it might decide to change this policy infuture. If PKSF does so, and subject to prior consultation with IDA, it would be allowed to use Project

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funds, up to $10 million, to subscribe to PO bonds provided that: (a) the bonds are intended to financeexpansion of inicrocredit portfolio; (b) institution meets the above eligibility criteria; and (c) the interestrate on bonds is not lower than prevailing interest rate on loans to large POs.

4.25 PO Loans to the Final Borrowers. Interest rates will be market determined, and the POs willhave full autonomy to set their loan maturity periods (usually 52 weeks) and onlending rates; theeffective interest rates are expected to range between 25 and 30% (para 3.4). With the greateravailability of funds, competition among POs will increase which could possibly result in a reduction ofrates.

4.26 Currency of Loans. All loans-from GOB to PKSF, from PKSF to POs and from POs to thepoor-will be denominated in local currency, with GOB bearing the exchange risk without any fee(para 6.18).

Rationale for Lending Terms and Conditions

4.27 The interest rates at the beneficiary level are much higher than interest rates in the formalsector; however, they have an element of subsidy resulting from GOB providing IDA funds to PKSF atless than market rates. The proposed project financing strategy-low cost, long maturity externalfunds-is appropriate and fully justified on account of the poverty objective and is necessary to allowthese well functioning poverty oriented institutions sufficient time to enhance the financial viability oftheir financial services, while at the same time pursuing their outreach goals and nonlending services.The rate structure would enable GOB to cover foreign exchange risks (up to 5% p.a., para 6.18) and,avoid the need for PKSF/PO to raise current onlending rates.

4.28 A significant part of the high operating costs, which necessitates large margin to POs, is onaccount of bringing banking to the poor and "non-commercial" operating costs-group mobilization,nonlending services provided to groups, costs incurred on group members who do not borrow.Largely for administrative ease and partly for inability to easily allocate costs between "normal costs"of providing credit and these costs, GOB and donors have financed these costs mainly throughsubsidized funding. Donors and POs have explored the possibility of providing grants fornoncommercial costs, and market-priced loans for regular lending. There is a consensus that thepresent approach is working very well, and that changing to a loan-cum-grant system would imposelarge administrative and reporting burden on POs, require changing the whole operating andmonitoring system built around the present method of financing, and possibly lead to abuse.Importantly, PKSF does not want to be seen as a grant giving agency since it believes that this wouldundermine financial discipline. That is why it strongly rejected the GOB Task Force proposal that thepilot program for funding equipment acquisition (e.g., computers) by POs (para 4.34) be on a grantbasis and insisted that it be a loan even if is interest free.

4.29 It is proposed to continue the present fixed interest rate policy considering that neither POs norborrowers have the ability to manage interest rate risks. In addition, it is proposed to follow PKSF'sdifferentiated interest rate policy-lower rate for small POs and higher rate for larger POs-under theProject. This "ability-to-pay" pricing policy is meant to promote newer POs and lower their costswhile their lending volume builds up. While the best policy would be to have a risk-differentiated ratestructure combined with a grant for smaller POs, the current approach is easier to manageadministratively and avoids the risk of abuse. With operating costs amounting to 3 % of loans

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outstanding in FY96, and expected to decline to 1.6% in FY99, PKSF would have a positive operatingmargin even at its lowest lending rate of 3 %.

4.30 While the proposed relending interest rate structure is fully justified, nevertheless it should becomprehensively reviewed periodically (Para 4.33), to assess the appropriateness of the rate structurein light of poverty and sustainability objectives and prevailing rates in the formal sector. The firstcomprehensive rate review would be undertaken prior to mid-term (para 5.13).

Institutional Development Component

4.31 The Project includes a US$6 million institutional development component, of which US$5.85million has been allocated for strengthening institutional capacity within the PKSF and its POs and theremaining US$0.15 million to Bangladesh Bank. PKSF is a well run, autonomous and efficientorganization; however, it will need further institutional strengthening and changes in its operatingpolicies to enable it to effectively handle a large increase in its loan portfolio. It also needs institutionaldevelopment to effectively handle its mandate as the apex financial institution with responsibility fornurturing and monitoring POs. For the most part, Project-supported training and institution buildingwould be focused towards PKSF and small/medium POs. The institutional development needs of thelarge POs are covered under their donor-financed programs, which have a large staff development andinstitution building components; therefore, they would not need technical assistance resources fromPKSF for expansion of Project financed lending. Of the US$5.85 million, US$0.5 million will used byPKSF to provide interest free loans to its POs for consultants and hardware for program expansion, andthe remaining US$5.35 million for its own institutional development including capacity to assistsmall/medium POs borrowing from it.

PKSF's Institutional Development Program

4.32 This will include measures to enhance financial sustainability of PKSF and POs, strengthenaccountability, improve staff skills and assess socioeconomic impact of POs' programs, as discussedbelow with details in Annex 5. At negotiations, agreement was reached with GOB and PKSF that thisprogram would be initiated in tandem with the credit component.

4.33 PKSF would undertake studies and thereafter change its policies in the following two areas: (a)to enhancefinancial sustainability, PKSF would: (i) establish a policy that the level of PKSF supportto all POs in the future would also depend, among other factors, on the POs' progress towards financialsustainability of their credit operations. To implement this policy, PKSF would establish forwardlooking financial performance standards that it would use to measure POs' progress in regards tosustainability; (ii) establish a loan classification and provisioning policy for itself, and guidelines for thePOs, taking into account past experience and potential future risks; and (iii) periodically reviewingappropriateness of it's relending rate structure; (b) to strengthen accountability, PKSF would: (i)establish audit standards/requirements for POs and (ii) formulate guidelines for its POs on uniformaccounting policies, particularly those for reporting repayment rates, arrears, rescheduling, portfolioquality, etc. Another aspect on which guidelines would be developed is a better cost accounting systemto separate and measure the costs of delivering lending and nonlending services for the multipurposePOs, without imposing excessive burden/cost on them. Terms of Reference (TORs) for all the abovestudies were agreed at negotiations.

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4.34 PKSF would also undertake the following Institution Building programs/measures to strengthenskills of PKSF/PO staff and institutional capacity:

(a) Establish a new unit-large PO Window-to enable PKSF to appraise and superviselarge POs. PKSF has recently established the new unit, which would enable it toeffectively and efficiently handle the special characteristics of these large organizations,and avoid diluting the needed attention to small/medium POs.

(b) Strengthen MIS and expand coverage of the system to: (i) quickly identify POs facingunsatisfactory repayment rates at the field level; (ii) enable PKSF to track repaymentperformance of entire credit operations of those POs (e.g., ASA) that have othersources of funding; (iii) and enable it to evaluate financial performance, on a regularbasis, of all its POs and monitor their evolution.

(c) Establish a small training unit which would develop and undertake comprehensivetraining programs for PKSF and PO staff. It would use PKSF's own center, to beestablished under the Project, and existing training centers of large POs.

(d) Recruit staff to strengthen its own financial planning capacity.

(e) Strengthen financial accountability at PO level through: (i) expanding its own internalaudit cell. The cell staff would audit each PO twice a year and would visit POs, fieldoffices, and borrowers, on a representative sample basis, to review: use of funds;integrity and quality of accounting/MIS records at the field level and those submitted toPKSF; loan collection rates, etc.; (ii) expanding TORs of PKSF's statutory externalauditor and require it to audit one-third of the POs each year; and (iii) requiring allPOs, with loans over Tk 3 million, to have audits according to TORs, and by auditfirms, acceptable to PKSF.

(f) Establish a Technical Assistance Fund to: (i) initiate a pilot program of interest-freeequipment loans (e.g., for computers, motorcycles, etc.) to help successful POs with agood track record expand their operations. These interest-free loans would bechanneled along with loans that PKSF would provide for the POs' microcreditprogram; and (ii) finance technical assistance needs (e.g., accounting/MIS consultants)of individual POs.

(g) Establish Impact Evaluation Program. Many POs periodically assess socioeconomicimpact of the programs. Except for large institutions, like BRAC and Proshika, theimpact evaluation capacity and quality is, at best, rudimentary. While PKSF's Charterrequires it to periodically undertake impact evaluation, it does not have a systematicand regular program; under the Project this capacity would be developed. It isenvisaged that PKSF would enter into a contract with a local socioeconomic researchinstitute which would establish, in consultation with POs, base line surveys and regulardata collection and analysis.

(h) Undertake external training and study tours, for PKSF and PO staff, to study andreview microfinance related matters. One area of emphasis would be to review

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experience of MFIs in other countries which have become formal financial sectorinstitutions.

(i) Construct a head office/training center, with covered area of about 40,000 sq. ft.PKSF currently operates out of a residential house.

Strengthening Regulation and Promotion

4.35 Measures need to be taken to proactively promote economically viable MFIs graduate to formalfinancial institutions, and to regulate MFIs raising deposits, particularly those raising deposits fromnonmembers. These initiatives would be developed and managed by Bangladesh Bank (BB), and forthis an amount of US$150,000 has been allocated to it. Specifically BB would undertake the followingstudies in collaboration with PKSF and POs, and upon completion initiate a program including stafftraining and study tours to implement recommendations of the studies: (a) regulatory reforms andproactive measures to enhance linkage of MFIs with formal financial sector (e.g. developing market forsecuritization of MFI assets, voluntary lending to MFIs by commercial banking system, etc.), andmeasures to promote interested MFIs become formal financial institutions along with guidelines thatshould be used by GOB/BB for determining their readiness; (b) appropriate regulatory framework andinstitutions for regulating and monitoring MFIs engaged in deposit taking, while recognizing: (i) thespecial nature of these institutions; (ii) the inherent strong self regulation in the system, whichminimizes the need for regulatory oversight; and (iii) that unlike formal financial institutions, depositorsof MFIs are usually net borrowers from the system which obviates the need for depositor protection.TORs for these studies were agreed at negotiations.

5. IMPLEMENTATION ARRANGEMENTS

Credit Institutions

5.1 The PKSF would be the apex financial intermediary onlending IDA funds to the POs. It hasrecently entered into a Subsidiary Loan Agreement (SLA) with GOB, under which IDA/GOB fundswould be on-lent to it; the SLA spells out PKSF's responsibilities under the Project, the lending termsand conditions, reporting and auditing requirements and details of PKSF's institutional developmentprogram. In all, around 130 MFIs are currently eligible to borrow IDA funds through PKSF.

5.2 Small/Medium POs. Presently there are 124 small/medium POs which meet the eligibilitycriteria and are borrowers of PKSF in good standing. Over the next four years, PKSF envisages that nomore than 60-70 additional NGOs (out of existing 200-250 NGOs who are non-borrowers of PKSF andprofess to have credit operations) are likely to meet the eligibility criteria. Thus, in all, the Project islikely to finance about 200 POs.

5.3 Large POs. At present there are four institutions, Grameen Bank, Proshika, BRAC and ASA,which potentially meet the eligibility criteria for large POs. Grameen's medium-term program does notenvisage any borrowings from PKSF, as it has recently received a loan from Japan OECF (US$30million at I % for 30 years). In addition, BRDB's successful microcredit program is a potentialprogram that appears to meet a number of the large-PO criteria. While BRDB as an institution isexcluded from the Project in light of chequered performance of its general rural credit programs

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through cooperatives, its group-based microcredit scheme under the Canadian funded RD-12 programhas been operating successfully. However, access to Project funds would be conditional on theprogram's institutional arrangements being changed (i.e. RD-I' becoming a legally independent MFI)in accordance with measures outlined by Canadian CIDA and the program meeting the Project'sinstitutional/financial eligibility criteria. CIDA has been the main financier of the program and hasindicated that while it would be willing to support RD-12's institutional strengthening program, itcannot support the credit component any longer because of unavailability of funds.

Procurement Arrangements

5.4 The procurement arrangements for goods and services would be undertaken in accordance withstandard World Bank Procedures as follows (Table 5.1).

5.5 Credit Component. The final borrower's use of loans will be determined by the borrower inconsultation with the PO providing these loans. POs' procedures, high interest rates on loans, stringentrepayment requirements and borrower's self-interest all ensure that the procurement is economic andefficient. Most loans will be used for non-farm activity. Goods and services purchased with loanproceeds will all have close to 100% local content. Through its own supervision and strengthening offield level financial accountability arrangements, PKSF would ensure that the microcredit loans areused productively.

5.6 Civil Works. The estimated cost of the civil worKs for the Head Office building and trainingcenter, is about $3.0 million. This contract would be awarded through national competitive bidding(NCB), using bid documents and procedures satisfactory to IDA.

5.7 Goods and Equipment. These are expected to cost about $1.05 million, spread over fouryears. No contract is expected to exceed $75,000, and most contracts will range from $5-20 thousand.These include items such as office furniture, motorcycles, personal computers and training equipmentin small quantities which would not attract the interests of foreign suppliers, and therefore would beprocured on the basis of prudent shopping (at least three priced quotations). For all contracts over$20,000, these would be procured through national competitive bidding, using bid documents andprocedures satisfactory to IDA.

5.8 Consultancies. The estimated costs of consultant contracts and training study/tours is about$1.95 million. Consultancies would be procured in accordance with the World Bank Guidelines forUse of Consultants.

5.9 Prior Review. Each individual contract over $100,000 (for civil works) and $75,000 (forgoods and equipment) would be subject to IDA's prior review. About 80% of the total estimated civilworks and goods procurement would be subject to IDA's review. Consultant assignments exceeding$100,000 (for firms) and $50,000 (for individuals) would be subject to prior review. Post reviewwould be undertaken of the remainder.

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Table 5.1: Procurement Arrangements(US$ million)

Procurement MethodsProject Elements International National Other* Total

Competitive CompetitiveBidding Bidding

Credit ComponentGoods and works 131.00 131.00

(100.00) (100.00)Institutional DevelopmentComponent

(i) PKSF Head Office/TrainingCenter

Civil Works 3.00 3.00(2.23) (2.23)

Equipment 0.10 0.05 0.15(0.08) (0.04) (0.12)

Transport 0.10 0.10(0.08) (0.08)

(ii) PKSF/BB StrengtheningComputer Equipment (PKSF) 0.40 0.40

(0.31) (0.31)Studies & Evaluation (PKSF) 1.40 1.40

(1.40) (1.40)Studies & Training (BB) 0.15 0.15

(0.15) (0.15)Ext. Trng., Study tours 0.30 0.30(PKSF). (0.30) (0.30)

(iii) POs Inst. StrengtheningEquipment 0.40 0.40

(0.31) (0.31)Consultancies 0.10 0.10

(0.10) (0.10)Sub-total Component 3.60 2.40 6.00

(2.70) (2.30) (5.00)

Grand Total (0.00) (2.70). (102.30) (105.00)Norim;ia shopping prilcficc of crodit receivcrs, anod IDA Guidelines for Consulancies.

Noc: Arniouniis in parenlhesis are IDA finianiced

Disbursement

5.10 Disbursement would largely be made on the basis of Statement of Expenditures (SOE) alongthe lines indicated in Table 5.2 below.

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Table 5.2: Disbursement by Category

Category Amount of Credit Allocation % of Expenditures to be(US$ million) Financed

Microcredit Loans 100.0 92% of credit disbursed.

Civil Works 2.2 75% of expenditures

Goods and Equipment 0.8 100% of foreign expenditures,or 100% of local expenditures(ex-factory) and 80% of localexpenditures for other itemsprocured locally.

Technical 2.0 100% of expendituresAssistance/Consultancies

5.11 To facilitate disbursements a Special Account with an authorized allocation of US$8 millionwould be opened in BB, into which IDA funds would be disbursed. PKSF would be responsible formanaging the Special Account and handling all disbursement matters. SOEs would be used for: (a) allexpenditures under the microcredit component; (b) civil works below $100,000; (c) goods below$75,000; and (d) consultant contracts below $100,000 (firms) and $50,000 (individuals). The basis forreimbursement on account of the microcredit component would be the net increase (i.e. increase in loanoutstanding) in POs microcredit loans financed from funds provided by PKSF; Annex 6 provides theSOE format that PKSF would use for this purpose. GOB has already provided $5 million of itscontribution (US$10 million) to PKSF and would provide the remainder at the beginning of FY97/98.The Project funds are expected to be fully disbursed in about four years, by June 30, 2000 (Annex 6).

Monitoring and Reporting Requirements

5.12 PKSF has a well-developed monitoring system; its monthly report to its Governing Body andthe Annual report it publishes are sufficient to monitor the IDA credit, given a few additions to thesereports. PKSF will submit the following reports to Ministry of Finance (and through them, to IDA):(a) a quarterly report detailing progress of IDA credit and review of Project's performance indicators(Annex 7); (b) an Annual Report, including review of evolution of the MFI system and progress of itsPOs towards increasing borrower outreach and enhancing their financial sustainability; (c) an externalaudit report within 6 months of the close of the financial year. The auditor's report would includeauditor's opinions on: quality of PKSF's general accounting practices, adequacy of MIS and internalaudit/control systems, adequacy of loan classification and provisioning policies, accuracy of loanrecovery rates and overdues reported in the quarterly reports, and accuracy of SOEs submitted to IDAfor fund withdrawal; and (d) at the beginning of each year, it's business plan outlining detailedfinancial, operational, and institutional plans for the following year and broad goals in these areas forthe following 3-4 years.

5.13 Annex 7 details the Project monitoring and evaluation plan and performance indicators whichwere agreed at negotiations. These indicators will enable tracking of the Project's twin objectives-poverty reduction and financial sustainability of credit programs. A mid-term review will be held inJuly 1998 or after 50% of the funds are disbursed (whichever is earlier) to review overall progress of

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the Project and lessons learned, and agree on changes, if any, to Project scope and design. Prior tomid-term, PKSF would prepare a comprehensive review report.

IDA Supervision

5.14 The project is expected to require, on average, about 18-20 staff weeks per year of supervision,or about 90 weeks over the four year implementation period, including the time for project launchworkshop and mid-term review. This reflects: (a) the innovative nature of the project; (b) thelogistical challenges of the dispersed area of operations of POs; and (c) that this is IDA's first project inthe sector. A supervision plan, including the project launch workshop, formal reviews, and regularsupervision missions is shown in Annex 7. Given the nature of the Project, in due course supervisionresponsibility would be devolved to the resident mission.

6. PROJECT JUSTIFICATION AND IMPACT

6.1 As discussed below, the Project is justified on the following grounds: (a) it would beinstrumental in furthering the paramount economy-wide objective in Bangladesh-namely alleviation ofpoverty-by enabling the poor to undertake micro-investments that have a high return and fosteringsocial empowerment; (b) traditional sources for expanding microcredit programs-donor grants andmember savings-are inherently limited; and (c) it promotes institutional and financial sustainability ofthe microcredit program and the institutions.

Rationale for Publicly Provided Concessional Funding

6.2 Overall, microcredit programs have demonstrated their potential for being a successfulintervention and NGO-based institutions as effective and efficient delivery vehicles for: (a)overcoming failure of the formal financial sector to provide financial services to the poor; and (b)reducing poverty and correcting gender inequality (paras 3.16-3.18). Therefore, scaling up of NGO-based microcredit programs is fully warranted within the context of a comprehensive povertyalleviation strategy comprising other complementary investments.

6.3 Traditional sources of financing-mandatory savings by borrowers and grants frombilateral/NGO donors-will continue to be a funding source for the program; however, there arelimitations to these sources and there is growing uncertainty about the availability of donor funds in theamounts available in the past. Thus, for the programs to expand significantly and reach a largepercentage of the poor in Bangladesh, majority of the funding would have to come from other sourcesoutside the system-market and/or publicly provided funding. Voluntary market-based provision offunding from the financial system-in form of POs borrowing from the banking system, raisingdeposits from non-members or banks lending directly to the poor-could potentially provide largeamounts of funding, and would be promoted under the Project (para 4.35). However, they are onlylikely to materialize in any significant way, over the long term, for the following reasons: (a) theurgent priority for the banking system is to complete much needed sector reforms, restore the system'sfinancial health and overcome the pervasive default culture before encouraging banks into new lines ofbusiness which require uncollateralized loans; (b) commercial banks are unlikely to voluntarily get intomicrocredit business on account of their predilection to shy away from the asset-less, and theiroperating culture and procedures which are geared to the relatively well off, well connected and more

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vocal segments of rural and urban society; (c) allowing POs to raise deposits from non-members wouldgive rise to a host of regulatory and supervision issues which the central bank is not in a position todeal with at the present time; (d) most POs are not keen to raise deposits from non-members as theyperceive that this shift could lead to diversion of staff efforts away from social and human developmentto deposit mobilization, and (e) using market-based mechanism would raise final lending rates andadversely affect consumption/asset build up of the poor. Thus over the foreseeable future, pendingfundamental reforms and "institutional culture" change in the financial sector to overcome marketfailure, rapid expansion of POs' microcredit programs can only be sustained through publicly providedloans through the well functioning PKSF apex mechanism.

6.4 Concessional funding is needed to support the following objectives: (a) enable POs to bringbanking to the doorsteps of the poor, and pursue their credit-cum-social empowerment approach topoverty alleviation; (b) provide PKSF and POs the ability to build up their equity base, and hence thelong-run financial sustainability of their lending services; (c) increase profitability of PO's financialservices, thereby enabling them to provide multidimensional credit, nonlending services and pursue thecostlier strategy of horizontal outreach expansion; and (d) increase the poor's consumption and savingssince the POs are mostly pass-through organizations. Given the incidence and depth of poverty andgender inequality, a policy of leaving money in the hands of the poor, particularly women, as againstgenerating reflows back to the government through higher relending rates, is fully justified.

6.5 It is unlikely that there will be a direct fiscal cost arising from the concessional funding ( para.6.18), even though it will result in an economic subsidy. The size of the subsidy depends on what isconsidered an appropriate benchmark rate. If all the POs were allowed to raise deposits from thegeneral public, their average cost of funds would be the same as that of commercial banks, i.e. 6-7%.On this basis, the economic subsidy ranges from 1-2% (for large POs) to 3-4% (for small POs) of loanamount. For those POs that cannot raise funds from the market because of perceived risks and had torely on a wholesaler like PKSF, the costs of funds would be higher. Thus if PKSF had to raise fundsfrom the market for onlending, the cost to the POs would be about 8-9%. POs would also face thisinterest rate if they borrowed from commercial banks. On this basis, the economic subsidy amounts to5-6%. Assuming an eight year lending cycle-with initial loan of Tk 2,000 increasing to Tk 9,000 ineight years-and implicit subsidy of 5 %, the lifetime subsidy would amount to about US$55 perbeneficiary or about US$7 per annum. In aggregate the annual economic subsidy would amount toabout US$5 million, once the credit is fully disbursed.

6.6 There has not been a comprehensive cost-benefit or welfare analysis of whether the implicitsubsidy in the microcredit mechanism is the most appropriate and cost-effective mechanism to achieveobjectives identified in para 6.4. However, if government programs were taken as alternatives, a studyis not needed to convincingly demonstrate that the multi-dimensional MFIs are much better at servicedelivery-quality and client responsiveness-and importantly have low levels of abuse. The Food-for-Work program, which is single dimensional, has significant leakages amounting to about 40-45 % offood provided to the program.

6.7 The desirability and level of concessional public funding needs to be regularly revisited, in linewith the changing poverty status of beneficiaries, improving financial position of POs and PKSF anddevelopment of linkages between the POs and the formal financial system. The comprehensive impactevaluation system, to be established under the Project, and the PKSF's monitoring of financialevolution of the PO system would enable GOB and IDA to review this issue periodically.

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Project Impact

6.8 The impact of the Project has been assessed in five ways: (a) impact on program outreach andthe beneficiaries; (b) impact on sustainability of microfinance programs of POs; (c) impact on thebudget; (d) impact on the RNF sector; and (e) environmental impact.

6.9 Impact on Program Outreach and Poor. As a result of the Project., POs would be in aposition to increase their lending, thereby increasing coverage of the poor who are eligible for credit.It is difficult to estimate with any degree of accuracy how many people will be covered by the Project,given that some part of the funds will be used for vertical as opposed to horizontal outreach; however,rough estimates based on past pattern of outreach growth suggest that the Project funds would benefitroughly 1.2 million borrowers-over 90% of whom would be women. Most of them would need creditsupport beyond the Project period to move out of poverty. The average loan of current borrowers ofPKSF's POs is about Tk 2,500. By the end of the Project the average loan is expected to be about Tk6-7 thousand, compared to minimum loan of Tk 8-10 thousand that a borrower needs to have for a fewyears to cross the poverty line. Thus, as long as Project beneficiaries continue to receive loans ofincreasing amounts and rural economy grows as in the past, majority of them should be moving out ofpoverty in about 4-6 years after the Project period.

6.10 The financial returns to Project beneficiaries are expected to be substantial. Based on a surveyof beneficiaries by the appraisal mission and impact evaluation studies by PKSF and MFIs, the annualnet income (after payment of loan and costs of cash inputs) is expected to range from 100% to 150% ofthe loan amount, on activities such as basket weaving, poultry and livestock rearing, street vending andretail trade, rickshaw plying, rice husking, etc. These are returns to own labor and non-cash inputsand are typical in service and low capital intensive activities. Moreover, the 95 % + repayment rates atvery high interest rates are also an indication of the high profitability of these activities; whilerepayments may be coming from other activities (and payments by group members in case of inabilityto pay), the consistently high repayment rates year-after-year and low drop-out rates from theprograms is a clear indication that microcredit financed activities must be yielding returns much higherthan interest rates. While the returns are high, in percentage terms, they do not account for risks suchas natural disasters, sickness, etc. Also, given the small size of loans, in absolute amounts the cashincomes resulting from these investments are very small. They are, however, a major supplement tothe household income of those who live below the poverty line. Thus the additional income from atypical microcredit financed activity may bring in up to Tk 3,500, raising the household income of thelandless by 15% annually; with loan amount increasing over time, the income would grow at aroundthis rate annually.

6.11 Impact on Sustainability of PKSF and its POs. The Project would significantly increasePKSF's profitability and long-term sustainability, and will be instrumental in moving the PO systemtowards financial and economic viability stages ( para 3.11). The Project will also push the frontiers ofmicrofinance by supporting studies on various issues affecting microfinance in Bangladesh, identifyappropriate regulatory framework for prudential supervision, increasing knowledge on depositmobilization, and improving understanding of the impact of program design on sustainability.

6.12 POs. All available evidence clearly indicates that the basic microcredit model is intrinsicallyviable and that availability of concessional funding should enable the POs to move along the viabilitycontinuum (para 3.11). At present, majority of the PKSF's POs are at or below the operational viabilitystage. As highlighted in para 3.13, the time frame for financial maturity of these POs and the duration

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for providing subsidy and budgetary funding would depend upon several factors, many related to theirdevelopment objectives. As an example, it has taken Grameen Bank over a decade to reach financialviability stage as it pursued a rapid horizontal outreach objective. In addition, PO's sustainability isclosely linked to poverty status of the borrower. Thus, as long as most borrowers are below thepoverty line and institutions are in the rapid horizontal outreach phase where new loss-makingborrowers far outstrip profit yielding borrowers, concessional funding would be needed. Once averageloans for all borrowers reach Tk 8-10 thousand, their incomes will have crossed the poverty line andjustification for providing concessional funding to POs on poverty grounds would no longer remain.

6.13 The following Project-induced evolution-which is at best very tentative given the largenumber of POs with wide differences in their initial conditions, policies, outreach objectives and scopeof services-is envisioned for the PO system, and would be nurtured and tracked by PKSF. While afew small POs might wither away because of weak management and/or poor lending, most POs willgrow and are likely to follow two distinct institutional tracks: (a) the Project's focus on financialsustainability will wean many institutions towards the "mostly-credit" mode, many of whom may wellbecome full fledged financial institutions once they reach economic viability stage for the creditprogram as well as the institution as a whole; and (b) a large number of POs will continue to emphasizemulti-dimensional credit and retain their multi-faceted quasi-commercial and quasi-formal character-and for good reason. While these institutions will have profitable credit programs, the institutions as awhole will be loss making on account of substantial nonlending services and in some cases (e.g.Proshika) totally dependent on outside funds because their development model requires borrowers tokeep savings outside the institutions. Considering that the development model of these institutionsresults in similar, if not better, poverty reduction and social empowerment achievements, continuedpublic support would be fully warranted even if the institutions as a whole are loss making or rely onoutside funding.

6.14 By the end of the Project period, average loans are expected to be around Tk 6-7 thousand perbeneficiary, and the two track evolution (para 6.13) is likely to be as follows: (a) POs having loans ofPKSF's above size or higher (i.e. those emphasizing vertical outreach) would have reached thefiinancial viability stage, albeit on the basis of subsidized funding. A selected few such POs would beeconomically viable and ready, and should be allowed, to become regular or specialized banks; thesetting of PKSF's onlending interest to these POs at close to the average cost of deposits of the bankingsystem and the mechanism for periodic rate review should prepare them for becoming banks. By thistime, the initiatives to correct market failure as well as the efforts to establish a sound regulatoryframework and prudent eligibility guidelines (para 4.35) would also be in place. Moreover, theProject's efforts to improve financial sustainability of these POs would enhance the confidence of thebanking system to lend to the POs on a voluntary basis and to their ability to securitize their loans; and(b) majority of those POs emphasizing horizontal outreach and greater multi-dimensionality in creditwill have operationally viable credit programs, but most will continue to be loss making as institutions.

6.15 In 4-6 years after the Project, if continued concessional funding is provided, average loansshould reach Tk 9-10 thousand and incomes of the majority of the Project beneficiaries would havecrossed the poverty line. By this time: (a) majority of the "mostly credit" POs emphasizing verticaloutreach would be close to becoming economically viable, have a favorable capital structure-maiilygrants/long term concessional funding-and a portfolio comprising mostly profit-yielding borrowers;this should provide them with the ability to borrow commercial funding for incremental increase invertical outreach, and consequently concessionality and public funding for these POs could be graduallyreplaced by market-based and market-provided funding. Also by this time the "market correction"

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initiatives would start having a significant impact and reach a point which would enable the level ofpublic support to be phased out; and (b) most POs emphasizing horizontal outreach and multi-dimensionality, would have financially viable credit programs.

6.16 PKSF. As a result of the Project, PKSF's annual disbursement would increase from Tk 0.5billion in FY96 to about Tk 2.4 billion in FY2000; during the same period, its assets would increasefrom Tk 1.0 billion to Tk 6.0 billion, while net income from Tk 65 million to Tk 46 million. Thefollowing table highlights key financial indicators for the period FY95-FY2005. Detailed analysis isprovided in Annex 3.

Table 6.1: PKSF's Projected Financial Performance(Tk million)

FY ending FY95 FY96 FY97 FY98 FY99 FY2000 FY2005

June 30 Actual Estimated Projected Projected Projected Projected Proiected

Loans Disbursed 302 497 856 1337 1851 2362 5728Loans Outstanding 456 735 1242 2151 3414 4914 13509Total Assets 844 1009 1495 2575 4037 6023 14587Long-Term Debt 0 0 436 1462 2853 4730 12486DebfEquity 0 0 0.4 1.3 2.4 3.7 5.9As % of Average AssetsTotallncome(%) 3.8 4.9 4.1 4.1 4.1 4.1 5.6Operating Costs (%) 1.4 2.0 2.4 2.1 1.5 1.1 0.6Int. & Provision Expe.(%) 0.4 1.3 1.2 1.5 1.8 1.7 3.5Net Income (%) 2.0 1.7 0.6 0.5 0.8 1.3 1.5

6. 17 PSKF is projected to maintain a reasonable profitability and a sound financial position. Thedrop in profitability during FY97 and FY98 is a combination of the following factors: a shift fromhigher yielding investment assets into lower yielding loan assets; an increase in loan loss provisionsfrom 1 % to 2 %; and increase in administrative expenses on account of scaling up of operations.PKSF's long term sustainability is closely tied to that of its POs and their borrowers. Longer termprojections indicate that after FY 2000, it should be possible to gradually phaseout concessionality ininterest rate (both on the borrowing and lending side) in line with the following: the evolution of thePO sector with a large number of POs having crossed financial viability stage; and PKSF having builtup a large pool of concessional funds. Thus, PKSF could start to pay higher rates on incrementalborrowings and by FY 2015 it could pay 8% interest rate (7% higher than at present and 2% higherthan average cost of funds of the banking system) on all its borrowed funds and earn a satisfactory1.9% return on assets, while raising the average lending rate only 4% points-from the 4.4% in FY2000 to 8.5% in FY 2015. Because of higher cost of funding, the average interest expense (as % ofborrowed finds) increases from 1.0% in FY 2000 to 6.3% in FY 2015. The favorable debt:equityratio, which hovers around 7:1 beyond FY 2005, would enable PKSF to operate on a thin interestmargin and yet earn a satisfactory return on assets. By FY 2015, PKSF would be earning a return onequity of about 15%, which should be sufficient to attract private capital.

6.18 Impact on the Budget. While most of the grant element of IDA resources is passed on to thePOs, and in turn to the poor, there is unlikely to be a direct fiscal cost of providing IDA funds at belowmarket rates. The grant element of GOB loan to PKSF is 55%, at an opportunity cost of capital of 8%,compared to grant element of about 85 % in IDA loan to GOB. The grant element that GOB retains-by charging 0.25% higher than IDA rate and having a shorter maturity of loan to PKSF-is adequate to

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compensate it for incurring the foreign exchange risks, unless the annual rate of depreciation of theTaka against the US dollar exceeds 5%, p.a. and as long as GOB could earn a 8% return on reflowsfrom PKSF. A potential fiscal cost, over and above exchange rate depreciation exceeding 5%, wouldresult from the possibility of default; i.e., PKSF is not able to repay the GOB loan as per the agreedterms and maturity. This in turn may arise due to a default by the POs. PKSF's and POs' loanprovisioning policies, present and to be developed under the Project, and other risk managementmeasures (para 6.21) would ensure that default risks remain within acceptable limits and do not getpassed on to GOB.

6.19 Impact on the Rural Economy: The Project is expected to have a positive impact (para 3.18)on the rural economy by increasing participation in productive non-farm activities and increasing laborforce participation rates, particularly employment of women. By supporting and expanding POprograms, the Project will increase participation in activities which are dynamic and productive andthat typically yield returns that are higher than the prevailing unskilled wage rate. Based on a WorldBank study that estimated capital-output ratios for representative MFI programs (Khandker, 1996), theProject should lead to an increase in RNF output by US$250 million a year; this would amount to about3 % of current output in the RNF sector. The high rates of return in RNF activities also suggest thatthere is no evidence of a demand constraint for rural non-farm products. This implies that there will bea continuing strong demand for microcredit in the rural areas.

6.20 Environmental Impact. The Project will have a beneficial impact on the environment byreducing the pressure of agricultural activity on land, which is slowly leading to environmentaldegradation in Bangladesh. As people move from agriculture to non-farm activity, this pressure will belessened; none of the major RNF activities promoted by the POs are known to have a negative impacton the environment. The Project will, indirectly, also promote activities like sanitation, health andfamily planning; this would have a positive impact on the environment. Moreover, the Project wouldprovide support to many POs who are conscious about preserving the environment; one such PO isPKSF's third largest borrower and is managed by women. This institution lists protection for theenvironment as an important objective, and implements this through its social forestry programs.

Risks

6.21 The Project is building upon success, a system that works and a program that has tremendousownership of all stakeholders-government, institutions and beneficiaries. Nevertheless, the programfaces two potential major risks: higher loan default risk, and risk of poor socioeconomic impact. i.e.,the anticipated increase in socioeconomic and empowerment indicators does not materialize. So far,loan default risks have remained less than 4-5 % for the system as a whole. Moreover all impactevaluation studies conducted to-date, attest to the positive socioeconomic impact of the developmentmodel pursued by the Bangladesh MFIs. Nevertheless as the program is scaled up, particularly for thesmall/medium POs, many of the factors contributing to keeping the above two risks at acceptable levelscould diverge from the past pattern. These contributing factors and potential risks are:

(a) horizontal expansion risk, which could increase because of inclusion of greater numberof vulnerable borrowers who live on the edge;

(b) institutional risks, considering that many of the small/medium POs, and even largePOs, are dependent on the motivation and dynamism of one person and there is nomanagement succession plan;

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(c) marketing risks, in that the local markets are unable to absorb the increased level ofproduction for the typical products produced by the beneficiaries;

(d) concentration of risk, in that 3-4 POs would be absorbing over half the credit amount;

(e) governance risks, which would result from appointment of poor management at PKSFand/or politicization of the P0 selection and loan approval/disbursement processes;

(f) under-disbursement risks, which could result from lower than expected demand forcredit and/or POs face capacity constraints or are unable to meet eligibility criteria on acontinuous basis; and

(g) proliferation risks, which happened in many countries when availability of credit led toproliferation of new institutions whose main goal was gaining access to cheap fundsrather than poverty alleviation.

6.22 Together with measures being taken under the Project, the following features of the microcreditmodel, individually and collectively, ensure that the above contributing factors are kept in checkthereby ensuring that the system-wide default risks are kept within the 4-5% range and the risk of poorimpact is minimized:

Borrower Level:

(a) the self-selection of activities, gradual build-up of individual loans, borrowers'closeness to the markets and ability to switch easily among activities reduce themarketing risks. Nevertheless, growth in the rural economy will be a majordetermninant of market opportunities;

(b) very high lending rates and rigors of the program prevent capture by the rural elites,

(c) the transparent incentive of repeater and larger loan linked to full repayment of earlierloans, and inability to get credit in the amount and regularity (and price) from othersources, provides a powerful motivation to maintain high repayments. That is why,even during natural disasters, the loan repayment rates remain high. In fact during the1995 floods, other than a 4-5 week delay in repayments during the flooding period, theMFIs did not experience any significant drop in the repayment rates;

Institutional Level:

(d) PKSF's rigorous selection process, emphasis on proven track record, and starting withvery small loans to new POs provide adequate safeguards against proliferation ofinstitutions. Moreover, even for existing POs the gradual build-up of loans keepsdefault risk manageable;

(e) in case of small/medium POs, PKSF proactively encourages them to have managementsuccession plans, and in fact includes this as a specific factor while making a decisionto expand lending to the P0;

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(f) the large institutions have well-developed governance and management structure, withstrong presence of donors, and sound internal controls and information processes;

(g) Government's ability to politicize management or interfere in PKSF is severelycurtailed by PKSF's independent Governing Body and separation between Governmentand PKSF built into PKSF's Charter. Moreover, Government's ability to influencelending by POs is also very limited. Thus, unlike in the case of its own banks whichhave frequently written off rural loans at Government's request, Government cannotexercise its writ on these NGO-based POs. Even if Government was able to forcePKSF to write off its loans to POs, the latter have so much of their own/donors fundsinvolved that they would not be willing to loan write-off at the beneficiary level. Loanwrite-off is anathema to POs, and they have an unwavering policy of on-timerepayments, except for emergencies;

(h) the emphasis on training and institutional development of PKSF being undertaken underthe Project will enhance its capacity to implement the large credit program;

(i) weekly repayments and good information system provide needed early warning to POsof impending problems. In addition, PKSF's rigorous practice of requiring monthlybank statements and linking disbursements closely to field supervision and repaymentsis a strong safeguard. The strengthening of PKSF's internal audit cell will furtherstrengthen the existing risk minimization mechanisms;

(j) the loan loss provisions in the system-2 % at PKSF level and 2-3% at the PO level-should be able to absorb the expected default risk. Moreover, PKSF's risk of loandefault is reduced by the cushion provided by low debt:equity ratio of many POs;

(k) the razor thin slippage allowance which would make institutions ineligible, e.g. PKSF'scollection rate has to drop from 99.5% to 98% to become ineligible, is an importantrisk minimization measure.

Overall:

(I) the financial risks are diversified over: a million borrowers, a hundred activities and asmany institutions, and geographically all over the country;

(m) the establishment of a comprehensive impact evaluation system would start providing,in 2-3 years, indications about outcomes and benefits of the project. A positive featureof the Bangladesh MFIs is their willingness to incorporate impact results into programdesign;

(n) while there is always the risk of under disbursement, this would be an attestation thatthe safety features-emphasis on repayments, early warning system, rigorous approachof PKSF-are indeed working. Moreover, the credit size has been kept much smallerthan that proposed by PKSF/POs to avoid "disbursement mentality;" and

(o) finally, a major strength of the system is convergence of Project's key goal-povertyalleviation-and raison d'etre of all POs.

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6.23 The most critical factor to Project success and risk minimization is the Governing Body andmanagement of PKSF. As long as PKSF's Governing Body remains independent and continues tocomprise eminent non-government Bangladeshis with interest in poverty alleviation and PKSF hasstrong professional management, probability of Project success is high-credit disbursement will remainclosely linked to absorptive capacity and performance. At negotiations, GOB provided assurances thatPKSF's governance arrangements would remain unchanged and its autonomy protected. During theProject implementation period, this aspect would be a major focus of attention of IDA SupervisionMission. The most likely worst case scenario is that POs' social welfare objectives overshadow thefinancial sustainability goals, and repayments drop significantly. This has not happened so far for thesystem which has disbursed over $1.5 billion, and there is no reason to believe that it would breakdownas a result of a $100 million IDA operation. On balance, the risks of Project-financed PO programsdeviating from the past pattern is highly unlikely.

7. AGREEMIENTS AND RECOMMENDATIONS

7.1 At negotiations, agreements were reached on the following:

(a) The institutional eligibility criteria and lending terms and conditions (paras 4.17-4.26);

(b) The Subsidiary Loan Agreement between GOB and PKSF, under which IDA/GOBfunds would be on-lent to PKSF and which spells out the latter's responsibilities underthe Project and its lending terms and conditions (para 5. 1);

(c) Disbursement mechanisms and procedures (paras 5.10-5.11);

(d) Project Reporting, Accounting and Auditing arrangements and Project PerformanceMonitoring Indicators (paras 5.12-5.13); and

(e) Assurances that PKSF's Governing Body and management would continue to beallowed full autonomy in line with its Charter, and that Governing Body membershipwould continue to comprise eminent non-government persons with experience andinterest in poverty alleviation and microcredit (para 6.23);

(f) PKSF and BB Institutional development component, including the TORs andimplementation timetable (Annex 5);

7.2 Condition of Effectiveness. A special condition of effectiveness is that the Subsidiary LoanAgreement (para 5.1) has been duly authorized or ratified, and is legally binding upon the GOB andPKSF.

7.3 Recommendation. On the basis of the above agreements, the proposed Project is suitable foran IDA Credit of SDR 72.70 million (US$105 million equivalent) to the Government of Bangladesh.

- 36 -ANNEX I

Page 1

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

THE DIMENSIONS OF POVERTY

1. Largely Rural. Bangladesh is predominantly rural; of the 118 million people, over 80% livein rural areas. Of these, close to half are below the poverty line, as highlighted by Table I which isbased on Household Expenditure Survey (HES) data. The table highlights changes in poverty levelsusing two different measures; the Head-Count Index, measuring incidence of poverty, i.e., percentageof population below the poverty line', and the Poverty Gap index, measuring depth of poverty(Ravallion and Sen, 1995)2. Despite problems in measurement of poverty, the HES data clearlydemonstrate that poverty has increased. This was largely due to rising poverty in the rural sector,which saw steadily worsening poverty measures from 1985/86 onwards. More importantly, the sizableincrease in the poverty gap index in rural areas from the mid-1980s suggests falling living standards ofthose near the poverty line and the poorest of the poor. In 1991/92, 53% of the rural and 34% of theurban people lived below the poverty line.

Table 1: Dimensions of Poverty

Urban Pover Rural Poverty NationalHead Count e HaCun Poverty Ga Head Count Pove Gap

1985/86 30.8 7.3 45.9 10.9 43.9 10.41988/89 35.9 8.7 49.7 13.1 47.8 12.51991/92 33.6 8.4 52.9 14.6 49.7 13.6

2. The high growth of population is leading to increasing landlessness, and therefore unequalaccess to the most important means of production. In 1990/91, nearly half the rural households werelandless or near landless (owning less than half an acre of land); 17% of these were completelylandless. Most of the land sales are made by small owners in distress and purchased by large owners.Land is often mortgaged by the poor, which most likely ends up being appropriated. Furthermore, theaverage farm size is also declining. 3

Poverty line is defined as monthly per capita expenditure which permits a daily intake of 2,122 calories; intaka terms, the line was equivalent to a monthly income of Tk 469 and Tk 535 in rural and urban Bangladeshrespectively.

2 For a detailed explanation of these measures, see Ravallion and Sen (1 995) "When Method Matters; TowardA Resolution of the Debate about Bangladesh's Poverty Measures" Policy Research Working Paper No. 1259,The World Bank, Washington D.C.

3 According to the Agricultural Census of 1982, the average farm size had declined from 3.5 acres in 1971 to2.4 acres.

- 37 -ANNEX I

Page 23. The nature of rural poverty masks an important differentiation within the poor who fall intothree distinct bands. Households living just below the poverty line may be characterized as themoderate poor. A major proportion of the rural poor, however, live significantly below the povertyline, by as much as 40% according to the baseline data of 1989/90. These households constitute theextreme poor. The third category of rural poor are technically located above the poverty line. Theseare producers/entrepreneurs, who are not in formal poverty but are highly vulnerable to threats ofincome erosions and consequent descent into moderate or extreme poverty.

4. Mostly Women. The burden of poverty is seen to fall disproportionately on women. In 1989-90, females on average had a nutritional intake only 88 % of that of males, and 40% of the wage rateearned by males. Only 22 % of women were literate compared with 45 % of males. The incomes offemale-headed households is 40% lower than male-headed households; while 8% of the latter fallwithin the category of extreme poor, the corresponding figure for female-headed households is 33%.Female headed households without access to land (nearly 25 % of the landless households) perhapsrepresent the most vulnerable poverty group in Bangladesh. In addition, women have limited access toservices that can equip them for gainful employment.

5. About 86% of women live in rural areas. Women are responsible for most of the post-harvestwork which takes place in the homestead, and keep livestock, poultry and kitchen gardens; many workas part-time or seasonal laborers in the homesteads of others. The economic contribution of women issubstantial, if largely unacknowledged. The rising incidence of landlessness and declining homesteadbased economic activities have exposed women to serious economic pressures. Consequently, womenare moving out of the confines of the household in search of jobs. An estimated 7 million rural womenare seeking employment in a labor market where access has been restricted to date.

Income Generating Opportunities for the Poor

6. GOB has adopted a broad based approach to poverty alleviation, that emphasizesmacroeconomic stability and economic liberalization, and supports a number of targeted programs. Ithas also assigned top priority to increasing foodgrain production, and more recently to developinglabor-intensive export industries in order to increase employment and incomes. The present productionstructure, accompanied by sound macro-economic and incentive policies can help increase GDP growthrate above 5 %; but even this will be insufficient to productively employ all new entrants to the laborforce. Robust growth in agriculture could probably absorb about 25 % of new entrants, and industryand services another 40%. The remainder would have no choice but to involve themselves in marginalactivities, swelling the ranks of the very poor, unless action is taken to diversify the rural economy andexpand targeted efforts to help the landless.

7. With agriculture holding little prospects for employment of the growing rural labor force,which is expected to reach 100 million by year 2000, a larger share of the rural population will turn tothe rural non-farm (RNF) sector for employment opportunities. The RNF sector currently employs39% of the rural population (Labor Force Survey, 1991), up from 34% in 1984, mostly inmanufacturing, fisheries, and livestock. Employment in this sector grew at an average annual rate of4.1 % between 1984 and 1991. Expansion in RNF production and employment is crucial to promotebroad-based economic growth since RNF activity is labor-intensive and generates employment for alarger number of people than urban industry or agriculture. However, the ability of the landless toengage in productive non-farm employment is severely limited by their illiteracy, lack of skills andinadequate financial resources.

ANNEX IPage 3

8. Safety Net and Targeted Programs. GOB is supporting a number of safety net and targetedprograms which provide employment through labor-intensive infrastructure construction programs, andself-employment created through microcredit. These targeted programs for the landless include Foodfor Work (FFW), Vulnerable Groups Development (VGD) and microcredit programs. Rough estimatessuggest that government's average annual expenditures for these programs has been around Tk 6.5billion during the first half of the 1990s. In 1994/95 these programs amounted to about 16% of thetotal budget for the social sectors and human capital development.

9. The FFW program uses food resources to provide relief from severe food shortages andemployment for the landless. Labor is paid in kind to construct needed infrastructure which includesunpaved roads, bridges, embankments, culverts, canals etc.

10. The VGD program is targeted to destitute women who receive 31 kg. of wheat (or rice) permonth for a two year period. A savings system (Tk 25 per month), deposited in the beneficiaries'individual bank account, enables VGD women to draw a lump sum amount anytime after the eighteenmonths of the program and use it for income generating enterprises. Preference is given to poorwomen with young children, who are heads of households.4 The program helps develop the earningcapacity of women by providing training in occupational skills, encouraging savings accumulation, andproviding access to credit. The program is implemented using local government institutions. Between1990 and 1995, 0.8 million metric tons of wheat was distributed among 2.4 million VGD women. TheVGD program has collaborated with BRAC to provide VGD women with training and microcredit, inaddition to the wheat, adding a new dimension to the intervention. BRAC trains women in variousactivities, especially poultry and silk-worm rearing; its annual microcredit disbursements haveincreased rapidly, from Tk 13 million in 1990, to Tk 162 million in 1995, while recovery rates havebeen close to 100%. The program has so far provided loans to 400,000 women, with average loan perborrower of Tk 1,500. Expansion of BRAC's microcredit program for VGD women is an importantelement of the proposed Proiect.

II. While targeting the poorest of the poor, the programs for rural works only provide short-termsuccor to the poor in gaining access to income and employment opportunities. These programs havebeen inadequate in sustaining the productive means of the poor and thus have a limited impact onpermanent escape from poverty. In contrast, the experience of Grameen Bank and other microcreditprograms shows that when lack of access to affordable credit is a major constraint for self-employment,providing credit and other organizational inputs to the poor can help them become self-employed on asustainable basis in familiar income-generating activities.

These women belong to the poorest 5% of the Bangladesh population. A recent study reveal that half thesewomen were unmarried, divorced, widowed or abandoned, and in half the VGD households, there is only oneincome-earning member.

- 39 -ANNEX2

Page I

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

FINANCE AND THE POOROverview

1. Bangladesh's financial sector comprises the formal financial institutions, (15 commercial andspecialized banks, and two cooperative networks), the semi-formal institutions (over 120 NGO-basedMFIs), and the informal institutions (family, friends and money lenders). For the most part, theseinstitutions have operated in segmented markets. While little information is available on loans by theinformal sector, loans outstanding by the formal system amount to Tk 274 billion compared to about Tk13 billion by the semi-formal institutions, at end 1994. However, the semi-informal sector providesfinancial services to over 4 million people, compared to a fraction of that number who have had accessto formal sector credit.

2. The informal sector dominates rural finance in Bangladesh. The semi-formal sector occupiessecond place as providers of rural credit, while the formal sector ranks third. In FY94, Grameen Bankand other large MFIs provided around Tk 16.60 billion in microcredit, compared with a total volumeof Tk 11 billion provided by the agricultural banks and nationalized commercial banks (NCBs)combined. The informal sector has traditionally met a large share of the credit needs of the rural poor;for the most part, the poor borrow to overcome drop in incomes arising from emergencies -- death,sickness, natural disasters -- and for consumption expenditures such as dowry, weddings, etc. The highinterest rates (10 to 15% per month) and the nature of these borrowings -- often in distress and forincome maintenance -- does not provide the rural poor an opportunity to accumulate savings or fixedassets.

The Formal Sector

3. The formal sector comprises of the public sector financial institutions (NCBs and specializedbanks), private banks', and the Grameen Bank; the latter began as an NGO, but was formallyestablished as a specialized bank under a special charter in 1983. Apart from Grameen Bank, fewother institutions in the formal sector have been a major source of microfinance. Although thegovernment owned commercial and specialized banks have a large rural credit program, and some haveinitiated microcredit programs, for the most part their rural credit programs are neither targeted to thepoor nor do they reach the poor. Moreover, the performance of their rural credit programs is absymal.The formal system is under severe strain, due to huge non-performing portfolios, and is unable andunwilling to provide microfinance and/or link to the semi-formal system, which is relatively robust andgrowing rapidly. Private commercial banks have largely stayed away from the rural credit sector, dueto the high cost of intermediation and perceived risk.

4. Nationalized Commercial Banks. While the NCB's main focus is on urban-based lending tothe formal sector, they also provide agricultural credit and microcredit through their rural branchnetwork. Agriculture credit (mostly crop loans) disbursement amounted to Tk 4.5 billion in 1994/95;collection rates have generally been below 20%. NCB's most significant contribution to themicrofinance sector was the purchase of about Tk 15 billion of 3-10 years bonds issued by GrameenBank in early 1995. These have been bought by NCBs, because they are eligible for statutory liquidity

I Private banks largely operate in urban areas, and mainly lend to the corporate sector.

- 40 -ANNEX 2

Page 2

requirements, guaranteed by GOB and provided the banks a partial outlet for their excess liquidity atthat time. Recognizing the immense needs of Grameen and its inability to finance such large amountsfrom the budget, GOB supported this distortionary method of financing.

5. Some NCBs have also teamed up with Swanirvar, Bangladesh's oldest NGO, to provide loansto their members; however, this program is not working well (para 15). Recently, an NCB hasprovided a loan of about US$1 million to a large MFI, after almost two years of protracted processingand only after the MFI offered its premises in Dhaka as collateral and the NCB waived its standardrequirements that the directors of the MFI provide personal guarantees. A few NCBs have started pilotmicrocredit programs; one of them runs a "Special Investment Scheme" under which it provides non-collateralized loans for various non-farm activities, at an annual interest rate of 12% for 3 years.Loans averaging Tk 50,000 have been lent so far to over 6,000 entrepreneurs. Another provides smallloans, largely for the urban poor; as of June 1995, about Tk 3.0 million had been disbursed for 13projects.

6. Several factors militate against NCB's lending directly to the poor: the predilection ofcommercial banks to shy away from the asset-less, and their operating culture and procedures whichare geared to the relatively well off, well connected and more vocal segments of rural society.Moreover, given that collateralized lending is the norm, banks are very hesitant to makeuncollateralized loans to MFIs, without full guarantees from government. When NCBs have providedmicrocredit, their rather low lending rates of 16% to the final borrower suggests that these banks aremaking such loans, perhaps to fulfill their social obligations and use underutilized staff in ruralbranches. While they have well-performing microcredit portfolios, overall the portfolio quality of theseinstitutions has been very unsatisfactory; a recent World Bank study indicates that overdues (accordingto international standards) are about 50% of the total portfolio. These banks are unlikely to become amajor player in microcredit on account of the problems noted above. Moreover, their average loansizes are 3-5 times that of MFIs and really not targeted to the poor. These are mainly for small ruralenterprises and farmers, and rarely include the landless.

7. Specialized Banks. The most important and internationally well-known example is theGrameen Bank. It is a special purpose financial institution with borrowers and the Government as itsshareholders. Government equity and loans from public financial institutions forms the bulk of itsfunding base. Bilateral and international donors have also supported it generously. Grameen is thelargest provider of microcredit in Bangladesh; it has so far disbursed about Tk 48 billion to over 1.9million poor. As of June 1994, total loans outstanding stood at 11 billion, and number of borrowers at1.8 million.

8. The two specialized agricultural banks, Bangladesh Krishi Bank and RAKUB, have not beeninvolved in microcredit lending; their focus has been on larger crop sector loans. Total loansdisbursed, in 1994/95, amount to about Tk 9.6 billion; as in the case of NCBs, recoveries on theseloans are absymal. Almost 50% of the portfolio is in arrears and collection rates are around 25%.Private commercial banks have largely stayed away from the rural credit sector, due to the high cost ofintermediation.

The Semi-Formal Sector

9. The semi-formal sector comprises largely of NGOs which operate microfinance programstargeted to the rural poor. There are over 150 NGOs in Bangladesh offering financial services --microcredit and microsavings. Many of these are social welfare non-profit organizations formed to

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provide non-lending services such as social empowerment, education, family planning, relief,sanitation, and health. Recognizing the importance of stable income and capital accumulation for apermanent escape from poverty, these NGOs initiated, in the 1970's, targeted savings and creditprograms for income generating self employment activities. Over time, these institutions alsorecognized that provision of non-lending services was not, in itself, leading to alleviation of povertyand that lending and non-lending services sustain and reinforce each other. MFIs see financial servicesas a vehicle to achieve multiple objectives: enhance the poor's consumption; empower them to accesshealth and education services; as a social safety net for the very poor; and as a means to establish apermanent income generating asset base for the poor. These programs have grown rapidly and are amajor source of finance for the poor (Table 1). During the last five years, these NGOs have disbursed,on a cumulative basis, about US$280 million to over 2.6 million borrowers. 80% of credit recipientsare women and repayment rates are mostly above 95 %.

10. The microfinance market structure is bipolar; almost 95 % of the market is serviced byGrameen Bank and a few large national MFIs with annual credit programs ranging from US$25 - 50million. These institutions are professionally managed and staffed, and have so far received a majorityof their funds as grant from overseas donors. The remaining 5 % share of the market is serviced bysmall, local MFIs with annual credit programs ranging from US$10 - 50 thousand, with flexibleorganizational structures that can be tailored to the availability of funds. The large MFIs usuallyoperate on the basis of 3 - 5 year business plans, which are fully funded (mostly by grants from donors) at commencement. The small/medium MFIs grow according to the availability of funds. Many ofthe small/medium MFIs rely on the PKSF for financial support, and need to be intensively monitored toensure that they are utilizing funds well. Despite the bipolar market structure, there is increasingcompetition among service providers as the number of institutions increase.

11. While there is diversity in the organization/management style and scope of non-lending servicesbetween large and small MFIs, the basic model of the credit programs is quite similar. A briefdescription of several noteworthy MFIs, some of whom will be participating in the project, is givenbelow:

12. BRAC began as a relief organization in 1972 and has grown to be the largest NGO inBangladesh. In aggregate, BRAC handled over Tk 2.5 billion in 1995; about 57 % of this was onaccount of disbursements of microcredit loans, with the remaining 43 % on account of expenditures forsocial sector programs (non-formal primary education, health programs etc.); commercial activities andrelief work. Around two thirds of funding for these programs came from donors, as grants, with theremaining from interest income, loan-repayments and sales from commercial activities. BRAC has atotal full time staff of 14,000. BRAC's credit program comprises its Rural Development Program(RDP) and Rural Credit Program (RCP). When BRAC initiates a credit program in a new area, itclassifies it as an RDP activity. At the start of RDP, the poor are mobilized, organized and trained;members have to participate in the mandatory savings program, and reach an acceptable level ofreadiness (usually six months after mobilization) before credit is provided. Once a RDP areabranch/unit office reaches breakeven status (i.e., interest income covers all financial and administrativecosts including allocated head office costs, market interest rate2 on funds provided from head office andloan loss premium of 2%), it is classified as a Rural Credit Program (RCP) branch; this usually takesabout four years. In all, there are 115 RDP and 120 RCP branches. Annual credit disbursement of

2 RCP branches are charged 9%, which is close to the rate for 3-year deposit, even though BRAC's own costof funds are close to zero. This enables RCP branches to subsidize RDP branches.

Table 1: Microfrinance Programs: Annual Past and Projected Disbursements (Million Taka)

Name of Cumulative Projected

Organization 1990-91 1991-92 1992-93 1993-94 1994-95 Disbursed % 1995-96 1996-97 1997-98 1998-99 1999-2000

Grameen Bank 2,642 5,200 10,622 13,912 15,000 47,376 76 15,500 16,052 17,087 17,920 18,772

BRAC 421 605 734 1,368 2,035 5,163 8 2,646 3,774 4,591 5,202 5,720

ASA 19 195 573 887 1,156 2,830 5 2,000 2,400 3,000 3,600 4,200

Proshika 121 127 224 303 423 1,198 2 794 864 935 1,007 1,200

PKSF POs* n.a. 44 198 399 675 1,316 2 1,275 2,533 3,909 5,618 8,000

BRDB 205 352 688 878 1,647 3,770 6 3,770

NCBs 53 43 52 80 104 332 1

Swanirvar 45 44 62 109 132 392 1

Total 3,506 6,610 13,153 17,936 21,172 62,377 100 25,985 25,623 29,522 33,347 37,892

In million USD 98 173 336 448 520 1,560 650 641 738 834 947

Additional IDA Credit Disbursement at MFI level, on Account of Project 10 34 67 100

Percent of annual credit disbursement excluding Grameen 4% 12% 18% 25%

Percent of annual credit including Grameen 2% 5% 8% 12%

* These figures are estimates, actual data on field disbursement by POs is not available.

SOurce: F7s and Staff Esnmates

m:\abid\povalIev\sars\graycvr.rpt\anxO2tb1 .xis

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RDP and RCP increased from Tk 421 million in FY90 to Tk 2.0 billion in FY95, to almost 1.3 millionborrowers. Although the recovery rate was around 94% in the early 1990s, it subsequently increasedto above 98% after 1994. From 1994, the RDP and RCP program together are close to financiallyviability stage (Attachment 1), albeit on subsidized funding basis. BRAC expects to expand its RDPand the VGD program (Annex 1, Para 10), and expects that all current RDP branches will reachoperational viability by year 2000. It has initiated a five year (1996-2000) program amounting toUS$135 million. This is funded by donors, and would enable BRAC to expand its credit program byUS$50 million -- from US$90 million in 1995 to US$140 million in 2000 -- and its non-credit programby US$81 million. The proposed Project will help BRAC expand its VGD credit programs.

13. Proshika. This is the second-largest multi-purpose NGO operating in Bangladesh. Inaggregate, Proshika handled over Tk 0.6 billion in 1994. About half of this was accounted formicrocredit disbursement with the remaining on account of expenditures for education, health andlivestock fisheries programs. Around 60% of funding for these programs came from donors, as grants,with the remaining from interest income and loan repayments. Proshika has a staff of 1459. It puts amajor emphasis on its social development program; credit has only recently become an important partof its activities. It provides a variety of services to the poor, both in rural and urban areas, andoperates through village coordination committees. Proshika's lending program is group and projectbased. The viability of these projects is established by Proshika through pilot programs and fieldresearch; often, they consist of pioneering activities such as bee-keeping and silk-worm rearing.Unlike other NGOs, it extends loans to both farm and non-farm activities and provides intensivetraining to its groups before providing loans; loan disbursements have increased from Tk 120 million inFY91 to Tk 423 million in FY95. Recovery rates were low in the early stages of the credit program,since social development and not credit was the main objective of Proshika's operations. Since FY94,recovery rates have been higher, and cumulative recovery as of FY95 was 96 %. Because of its heavyemphasis on training, Proshika's cost of delivery is much higher compared to most MFIs; consequentlyit is unable to fully cover costs from interest income. In FY95, operational viability ratio (interestincome as % of administrative costs) was 74 %, having increased from 61 % in 1992. Proshika hasinitiated a five year (FY95-99) program amounting to US$75 million funded by donors; about 40% ofthis would go towards expansion of its credit program -- from US$10 million in 1995 to US$37 millionin 2000, and the remaining for expansion of the non-credit programs. The proposed Project will helpProshika further expand its overall credit programs, as well as reduce dependence on subsidies forcovering credit delivery costs.

14. ASA. Unlike BRAC and Proshika, ASA, mainly provides financial services to the rural poorand is the third largest MFI in terms of its credit program. In aggregate, ASA handled over Tk 1.2billion in 1995. About 90% of this was accounted for microcredit disbursement with the remaining10% on account of social sector programs, and relief work. Around 10% of funding for theseprograms came from donors, as grants, with the remaining from savings, loan repayments and interestincome. ASA has a staff of 2745, with 425 branches/unit offices. ASA does not provide muchtraining, and believes that its members are best suited to choose income generation activities in whichthey possess skill and perceive market opportunities. ASA members are given loans within 3 - 6months of group organization; its microcredit program has seen phenomenal growth, with annualdisbursements increasing from Tk 19 million in FY91 to Tk 1,156 million in FY95. ASA's microcreditprogram is different from other MFIs, in that: (a) it pursues a strategy of aggressive growth usingsimple, low-cost unit offices that can be easily replicated; (b) it does not offer too much choice and itsloan and saving products are standardized in terms of size. Unit offices are required to be financiallyviable within 9 months and operate using 5 staff where most other NGOs would require 12-15 staff.Heavy emphasis is put on loan recovery, and recovery rates have been close to 100% since inception.

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ASA's financial performance has been commendable - it has been able to generate profit since 1993,largely due to its low-cost operations and, of course low cost of funds. Net surplus is expected to beTk 1 million in 1995, or about 0.5% of loans disbursed. ASA has initiated a five year (1995-1999)US$20 million program, funded by donors, to expand its microcredit program by US$16 million, andits non-credit program by US$4 million. The proposed Project will help it further expand itsmicrocredit programs.

15. Swanirvar Bangladesh, operates its microcredit program in conjunction with NCBs.Swanirvar is responsible for the costs of group mobilization, loan monitoring and collection, while theNCBs provide the finance. However, the bureaucratic procedures and culture of the NCBs has provedto be a severe bottleneck in the system, and loans can take almost 6 months to process, compared to thetwo-week approval time by other MFIs. As of July 1995, NCBs had disbursed Tk 0.3 billion to600.000 Swanirvar beneficiaries. Repayment rates, however, are only 60%.

16. Small/Medium MFIs. These institutions provide both financial and non-financial services; thelatter, though, are not as significant as the large NGOs because of shortage of funds. Their financialservices programs have grown significantly over the past few years, many due to continued supportfrom the PKSF. While there is little difference in design of the financial programs between large andsmall MFIs, there is considerable difference in management structure. A short hierarchy in themanagement structure and low personnel costs help increase cost-effectiveness and facilitate the moveto sustainability. While precise numbers on disbursements by small/medium MFIs are difficult toobtain, PKSF estimates that field disbursements by its MFI borrowers increased from Tk 44 million in1991-92, to Tk 675 million in 1994-95, indicating the high magnitude of growth being experienced bysmall/medium MFIs. Available rough information suggests that most operate at or below operationalviability stage (Attachment 1), because of small size of programs.

17. In addition to the above NGO institutions, there are two cooperative networks operated underthe Bangladesh Rural Development Board (BRDB) and Bangladesh Sambaya Bank Limited; they havemainly provided agricultural credit. In addition, the BRDB operates six income generatingprojects/programs targeted to the landless, for self-employment. These programs have been assuccessful as the NGO programs in terms of outreach and repayment rates. Of these, the RuralDevelopment 12 (RD-12) project, funded by Canadian International Development Agency, is the singlelargest program and has been very successful. As of June 30, 1995, RD-12 provided Tk 2.2 billionto 521,000 members, with recovery rate as high as 95%. Canadian support for expansion is contingenton the program being spun out of BRDB and operated as a separate, autonomous MFI.

Operational Features of MFIs

18. The MFIs' basic model has the following key features:

* it is targeted to the landless/asset-less, specifically those who own less than 0.5 acres ofland. Some MFIs also use an income criteria, including only those people with annualincomes less than Tk 15,000 (US$375).

* all borrowers have to be part of a group whose size ranges from 20-30, with groupmembers guaranteeing each other's loans.

* women borrowers are given preference. In fact, most MFIs only lend to women. Overall,women borrowers make up over 80% of the total borrowers.

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* loans are collateral-free, and have a maturity of 50 weeks, with weekly repayments after 3-5 weeks grace period. Weekly repayments ensure that repeater loans are not paying theprior loan. As a result of the relending opportunity arising from weekly repayment feature,with every additional Tk 100 available to it, an MFI can make loans of about Tk 150-200during the year.

* savings is an integral part of the program. A borrower has to save regularly and mostMFIs have mandatory weekly savings ranging from Tk 5-10 (US$12-20 cents ).

* borrowers have full freedom to choose the activity to be financed by the loan. Some MFIsprovide training to support these activities.

* groups meet regularly once a week. These meetings are used to conduct weeklysavings/loans transaction and are a focal point to ensure tight sense of communityparticipation. Apart from loan transactions, social issues are discussed and training onhealth, basic literacy and other social aspects is often provided.

i all financial transactions are done in presence of the entire group to enhance transparencyand self-monitoring.

* as long as borrowers repay on time, they are assured of repeater loans, generally of ahigher amount. This assurance is critical to the excellent repayment performance. Thebasic premise is that the poor need to have continuous access to credit for a period of 8-10years to accumulate enough savings/assets (net of debt) to escape from the poverty trap andmaintain reasonable consumption once credit is withdrawn. All MFIs start with a smallloan (US$50-75) and provide repeater loans of increasing amounts as long as repayment ofearlier loan is satisfactory. Most MFIs have upper loan limits of US$200-300, but fewhave a policy to "graduate" a borrower from the program; since large loan borrowers arelow risk - having been in the system for a few years - and provide ability for cross-subsidy.

19. Most of the credit provided by MFIs finances rural non-farm production. This includesactivities such as poultry farming, petty trade and shopkeeping, beef fattening, pottery, and otherrelated activities; mainly activities with short gestation and daily sales. Non-farm activities areperformed largely by the landless, especially women. However, a number of agricultural workersundertake non-farm production in the slack seasons, or to supplement their incomes. Some of theseactivities (such as trade and commerce, poultry farming) are highly productive, while others are low-productive activities which provide self-employment and primarily help supplement the family income.These activities require small, short -term loans of the kind provided by MFIs, and their growth hasbeen seriously hindered by the limited availability of this type of finance.

20. MFIs use fairly comprehensive loan forms to select beneficiaries. In the absence of landrecords and objective means tests, the selection is largely subjective. However, the self-selectionprocess ensures that those who enter the program are truly credit constrained, and are unable to tapformal sources of finance. The following features of the program also provide a reasonable degree ofassurance that only the poor get the loans: very small loan sizes and high interest rates; rigorousenforcement of repayment; weekly meetings; NGO staff's knowledge of local communities and lowprobability of the better-off to subject themselves to the rigors of the program and be seen sitting withthe poor in open meetings. Despite these features, the programs often do not reach the very poorest,

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who are usually migrant/destitute, and do not possess the ability to make weekly repayments (which insome cases need to be made from other sources).

21. All MFIs are multipurpose, providing both credit and non-credit services. Not only there is awide range in the scope of services offered by each MFI, there is also significant variation in themicrocredit programs pursued by each. While the basic model is similar, there are a wide range withdiffering objectives and methodologies. At one end of the spectrum there are institutions like GrameenBank and ASA, where credit activities dominate the institutions' business. At the other end of thespectrum are MFIs like BRAC and Proshika, who believe that an integrated strategy, focused oncommunity and human resource development is necessary to assist the landless. Both strategies haveworked well, though the latter has higher costs, and diverse organizations have all experiencedtremendous success in terms of outreach and repayment performance. 3

Sustainability Trade-Off

22. Table 2 below provides on indicative basis trade-offs between key variables of sustainability--unit loan size and horizontal outreach -- for three institutions, namely BRAC, Grameen and ASA. Thetable shows the increase needed in unit loan size for existing borrowers, to maintain breakeven statusunder different scenarios for horizontal outreach and unit loan size of new borrowers. The Tableshows trade-offs among three variables: % increase in unit loan of existing borrowers; % increase innew borrowers; and loan size of new borrower as % of loan size to existing borrower. New loans areusually much smaller, 25-30% of loans of current borrowers.

Table 2: Sustainability Trade-off

Outreach 40% 60%

Grameen BRAC ASA Grameen BRAC ASA

Loan Size ---------------- % increase in unit loan of existing borrower ----------------(Newborrower'sas % ofexistingborrower's)

20% 127 151 115 142 170 12830% 123 147 111 136 164 12240% 119 143 107 130 158 11650% 115 139 103 124 152 110

23. Thus in the case of BRAC, the table shows (in bold numbers) that if BRAC wants to increaseoutreach by 40%, and unit loan size of new borrowers is 20% of loan size of existing borrowers, tomaintain financial breakeven BRAC has to increase unit loan size of existing borrowers by 151 %. Ifoutreach was higher than 40%, BRAC would incur losses unless loan size increases for new and old

3 Outreach refers to the central purpose of microfinance - to provide large number of people with access tocredit.

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borrowers. In general, to maintain breakeven: (a) the higher the unit loan size of new borrowers, thelower unit loan size of existing borrowers has to increase; and (b) the higher the outreach, the higherhas be the unit loan size of existing borrowers. The trade-offs for Grameen and ASA follow similarpattern, except that since they have operating profits, the unit loan size increases are much lower thanBRAC (which has operating losses) for the same changes in other variables.

The Informal Sector

24. Informal markets continue to be the primary source of credit for a large proportion of the ruralpopulation; it is also lender of the last resort for many. Contrary to popular opinion, informal lendingactivity is not dominated by money lenders; a majority of transactions are between friends and relativesat zero or nominal rates of interest. Also, a large part of informal loans are for "productive" purposes,including capital investments. A recent World Bank Survey found that the overall interest rate in theinformal sector was 48%; if only interest bearing loans were counted, the rate was as high as 106%.Not all loans are recovered on time, but almost 100% of the loans are eventually repaid (within 3years). The average recovery rate was estimated to be 62 %, with small borrowers showing better

4repayment.

4 See Gautam, Madhur " Bangladesh: Rural Finance", World Bank (draft) 1996.

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Attachment 1

THE CONCEPT OF SUSTAINABILITY

1. The term "program sustainability" means the ability of a microfinance program to continueoperating as a development finance institution for the rural poor. Since these programs often useloanable funds from various sources to finance productive activities, they can only sustain theiroperations if they remain financially sound. On the other hand, since these programs function asprograms for the poor, they can be sustainable only if the benefits that the poor receive from programparticipation result in a sustainable reduction in poverty. The main determinants of programsustainability are financial, economic, and institutional viability of the MFI as well as of its borrowers.

2. An MFI's credit program is operationally viable once interest income covers direct costs(salaries, administration, etc.) of credit delivery. It isfinancially viable once interest income exceedsdirect costs of credit delivery, bad debt expenses and financial expenses, which are often subsidized. Itis defined as economically viable once interest income exceeds all operating costs including bad debtexpense and the economic cost of funds (the opportunity cost). Finally, an MFI is institutionally viableif it has effective and well-institutionalized procedures for ensuring administration and managementsuccession, so that it is not dependent on the leadership of a particular person. Institutional viabilityalso depends on the viability of the borrowers.

3. MFIs' financial and economic viability depends on the level of subsidies they require. Thereare two types of subsidy - financial and economic. Financial subsidy results when a program is notcost effective (or cannot break even), and is measured by the losses made by the MFI. Economicsubsidy results if the cost of funds is cheaper than the opportunity cost, i.e., the market cost of fundsand one way of measuring it is by calculating the subsidy dependence index. Many credit programsreceive both kinds of subsidy and this is a concern for their long-run sustainability.

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BANGLADESHPOVERTY ALLEVIATION MICROFINANCE PROJECT

THE APEX AGENCY: POVERTY FOUNDATION (PKSF)

A. ORGANIZATION AND MANAGEMENT

History, Legal Framework, and Relationship with the Government

1. The Poverty Foundation (i.e., the Palli Karma-Sahayak Foundation or PKSF) was establishedin May 1990 under the Companies Act of 1913 as an autonomous and non-profit organization chargedwith "helping the poor, the landless, and the assetless in order to enable them to gain access toresources for their productive self-employment, to encourage them to undertake activities of incomegeneration and poverty alleviation for enhancing their quality of life" (PKSF's Memorandum ofAssociation). The formation of PKSF was prompted by the fact that a number of small NGOs wereengaged in promoting income generating activities within their local areas in Bangladesh. While manyof these NGOs were competently managed, they generally suffered from a perennial shortage of funds.Thus, PKSF was formed with a view to financing such NGOs. In support of this objective, PKSFreceived an initial grant of Tk 32 million from the GOB. Since then, it has received additional grantsfrom the GOB for a total of Tk 750 million; very recently, it has received additional Tk 200 million, asGOB's contribution to this Project. The only other source of funds has been net income. At end 1995the total equity of PKSF was Tk 844 million, of which Tk 94 million (or 11 %) was generated by netincome and the remainder from grants from GOB.

2. The principal objectives of PKSF, as mentioned in the Memorandum of Association of theFoundation, are to help the poor by providing them with resources for the creation of productive self-employment opportunities. This is achieved through: (a) provision of credit to various partnerorganizations (POs) that are engaged in promoting such income-generation activities for the poor; (b)institutional strengthening of these organizations; (c) encouraging new ideas, generating newtechnologies for poverty alleviation, and initiating and undertaking research activities; and (d)developing proper management information systems, so that the poverty alleviation activities may bemonitored and evaluated in a regular manner.

Management

3. A General Body provides over-all policy guidance, approves the annual budget, and reviewsthe annual report and audited accounts of PKSF. The General Body may have up to 25 members (withup to 15 members being nominated by government from government employees, NGOs, etc.)appointed on the basis of their record of service with respect to poverty alleviation and incomegeneration activities for the poor; the other 10 members may be from POs and/or private individuals.

4. In addition, there is a seven member Governing Body, comprising the Chairman, ManagingDirector and five other members. The Chairman and two other members are appointed by theGovernment; the former, however, cannot be a serving official. In the past, the Managing Directorwas appointed by the Government, but in late-1995, PKSF's Memorandum of Articles was changed togive its Governing Body the full authority. The other three members are selected by the private sectormembers of the General Body, and represent knowledge professionals with interest in the field of NGOactivities and poverty alleviation. The Governing Body currently includes Professor Yunus, ofGrameen Bank. All the shares of PKSF are held, equally, by the seven Body members. The

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Governing Body reviews progress, set policies, and take decisions as needed on matters related to theregistration of new Partner Organizations, changes in maximum staffing levels, and so on. It alsoreviews and approves the annual budget and the annual report prior to their being presented to theGeneral Body.

5. The General Body and the Governing Body thus provide the control framework within whichthe Managing Director carries out his responsibilities as the Chief Executive Officer of PKSF.

Organization

6. In undertaking his duties, the Managing Director is supported by two General Managers, onefor Operations and the other for Administration. The Operations wing of PKSF is responsible for theinitial screening of organizations applying for registration as POs, the initial screening of loanapplications, for authorizing disbursements, and for tracking scheduled vs. actual repayments. The keyfunctionaries in Operations are the Loan Officers who maintain close linkage with their POs throughregular field visits. The Administration wing includes separate sections for Finance, Administrationand Internal Audit. PKSF has recently established a new unit, "Large PO Window," to handle thelending and suspension related to large POs.

Staff

7. As of December 1995, PKSF had a total of 72 staff, consisting of 37 professional staff (ofwhom 16 are responsible for field visits) and 35 support staff. The compensation package offered byPKSF is geared to attract bright and motivated young graduates, being 50% higher than the publicsector and 20% higher than other large NGOs in the country. Although the salary structure iscompetitive, there is a need to introduce a comprehensive training program for staff.

B. OPERATIONS

Policies

8. The operations of PKSF are governed by written policy guidelines that relate to (a) credit termsand conditions, and (b) rules and modalities concerning final borrowers.

9. With respect to credit terms, the guidelines currently set minimum interest rates charged to thePOs (2%), and rates charged by POs to the final borrowers (16%). PKSF current rates range from 3-4.5 % p.a., with maturity period of three years. Even though POs need long-term funds, PKSFprovides three year loans to ensure adequate accountability and monitoring of fund use; at the sametime, it has a policy of automatically providing repeater loans of higher amounts, as long as therepayment rate is satisfactory (i.e., 95 % +). Loans by POs to the final borrowers are to be repaidwithin one year.

10. With respect to final beneficiaries, the guidelines specify that lending by POs must be basicallydirected towards borrower groups, and also describe the basic rules for these groups. These rules statethat each group must have at least 5 members, and that these members must be basically "assetless-landless" (that is, they must include only people with families having total assets not exceeding oneacre of land in that area). Each group must elect a Chairperson and Secretary who may liaise with thePO on behalf of the group. The group must meet weekly, with attendance required of all members.In addition, potential borrowers must deposit at least two taka as saving deposit in weekly meetings,these being kept in a bank account in the name of the group.

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11. It has established a prudent exposure limit; maximum loan to a PO cannot, usually, exceed10% of available funds. In addition it follows a conservative policy for first-time POs by starting witha small loan and gradually increasing loan sizes once there is a satisfactory track record. For example,in regard to the 18 POs approved in FY95, the loan size ranged from Tk 100,000 (for 12 POs) to Tk1.2 million. As of June 1995, the average loan outstanding per PO amounted to about Tk 24 million,while the size distribution was as follows: 57% of loans, by number, were below Tk 2 million, 34%between Tk 2-5 million and remaining 9% higher; loans in the last category accounted for 60% ofoutstanding loans with the maximum loan outstanding being Tk 80 million.

Activities

12. PKSF's activities in support of it's over-all objectives noted above have to-date largely focusedon ensuring a rigorous screening of applications from various NGOs for registration as PartnerOrganizations, and the subsequent processing of loan approvals, disbursements and repayments. Thiswork involves regular field visits by loan officers. In addition, PKSF has provided technical assistancetowards the institutional strengthening of the POs (this last being primarily focused towards ensuring auniform system of accounting and controls for the credit activities of the POs). There is however aneed to strengthen management information systems to ensure transparency, provide early warning onportfolio problems and information with respect to poverty alleviation activities.

Procedures

13. PKSF's credit operations center around the loan officers in the Operations wing, each of whomhas clear responsibility with respect to individual POs. Organization seeking to register as POscomplete a comprehensive application form, providing information about their own financial status aswell as the status of the borrower groups they service. This is supplemented by field visits by a loanofficer to verify the information provided. The Managing Director and the General Managers controlcredit operations by forming a Loan Committee, which includes the Loan Officer in addition to thesethree senior managers, and which reviews PO registration and loan applications forwarded by the LoanOfficer. Applications approved by the Loan Committee are presented to the Governing Body for finalapproval. POs are required to conduct all transactions, of PKSF funded programs through banks,submit monthly bank statements and MIS reports. Loans are approved on the basis of POs' annualneeds, but disbursed, generally at intervals of 1-2 months, after field supervision and bank statementsconfirms that the latter transaction has been satisfactorily used Loan officers make field supervisionvisits once every two or three months.

Overall

14. PKSF's overall operating policies and procedures are quite satisfactory. Its credit approvalpolicies are sound and conservative, credit supervision intensive, accounting/MIS systems reasonablysatisfactory and its own external audit quite comprehensive. PKSF's main focus of attention withregard to its borrowers is on loan collections (which have been over 99.8% since inception),satisfactory bookkeeping of disbursements and repayments, routing of PKSF financed transactionsthrough banks and ensuring that loans made to the target group. To further strengthen its monitoring,and internal accountability capabilities, PKSF has recently established an Internal Audit Cell.

15. While PKSF encourages its POs to, at least, fully cover the recurring administrative/fundingcosts from operating income, and also imposes a minimum lending rate of 16% to ensure that POs donot lend below commercial bank rates and promote cost coverage from operations, it does not imposeany specific performance or sustainability target. PKSF's main objective is to ensure accountability ofits funds, and as long as POs meet its stringent requirements for repayment, accounting and targeting,

- 52 -ANNEX&3

Page 4

PKSF neither monitors not imposes its view on POs product mix, cross-subsidization of non-lendingservices from lending profits or lending services from grants and other income, loan pricing and loanloss reserve policies, level of mandatory savings, separation of accounts for different services, etc.PKSF encourages, but does not mandate, POs who have outside sources of income to set aside aportion of interest income as reserves. Considering the pervasive loan default culture, the high priorityit attaches to loan collections is well-placed and should remain as its predominant concern. In addition,but without sacrificing the above noted emphasis, it needs to pay attention to issues of sustainability andits own role as an apex institution. Thus, a major institutional development objective of the Project isto enhance PKSF's financial planning and monitoring capabilities, incorporate forward lookingperformance targets in PKSF's credit policies, and strengthen accounting/auditing standards ofsmall/medium POs.

C. PAST AND PROJECTED OPERATIONS

16. The past (FY91-95) and projected (FY96-2005) financial results are given in Tables 1 to 5.

Lending

17. PKSF has so far enlisted 124 POs as borrowers. A brief description of a few representativePOs is given in Attachment 1. PKSF's gross disbursements to POs rose from Tk 3 million in FY91(second year of operations for PKSF) to Tk 26 million in FY92 and to Tk 302 million in FY95. Creditdisbursement grew at an average rate of 63 % between FY93-95. Loans outstanding as a percentage oftotal assets rapidly increased from 1 % in FY91 to 9% in FY92 and stood at 54% in 1995. Theremaining are current assets, mainly term deposits in banks which yield about 6%. As of June 30,1995, loans outstanding (net of a Loan Loss provision of Tk 3 million that was applied for the first timein 1995) was Tk 456 million, or over a three-fold increase from 1993.

18. Disbursement are projected to increase from about Tk 500 million in FY96 to Tk 2.4 billion inFY2000, as a result of the IDA credit, at an average rate of 50% per annum. About 63 % of thedisbursement would be on account of small/medium POs, with the remaining on account of the largePOs, e.g., ASA, BRAC, etc. As a result of this lending, total assets will increase from Tk 1 billion inFY96 to Tk 6 billion in FY2000. Total loan outstanding as a percentage of total assets will grow from73% in FY96 to 82% in FY2000. Loans to large POs are projected to grow from zero, currently, toover Tk 2.3 billion, or about 40% of the total loan portfolio. For the FY2001-2005 it is expected thatthe level of disbursement will increase by 20% a year.

Financial Performance

19. PKSF's total income doubled from Tk 12 million in FY91 to Tk 26 million in FY95. Theshare of interest income in total income grew from 0 in FY92 to 39% (Tk 10 million) by FY95 whilethe share of income from current assets (i.e., interest income on deposits) declined from 100% to 61 %during the same period. Operating expenses as a percentage of average assets came down from 3.5 %in FY91 to 1.4% in FY95. Net income dropped from Tk 29 million to Tk 14 million between FY92-95; this was caused by the drop in income from current assets (resulting from liquidating deposits andincreasing lending ) and a first time loan loss provision of Tk 3 million in FY95.

20. As a result of expanding loan portfolio, 5 % interest rate on loans to large POs, and increasingyield on loans to small POs (as cumulative loans to these increase lending rate shifts to higher rateslabs), total income would increase from Tk 46 million in FY96 to Tk 205 million in FY2000. At the

- 53 - ANXANNEX 3Page 5

same time, total expenses would increase from Tk 30 million in FY96 to Tk 140 million in FY2000; alarge part of the increase is on account of higher loan loss provisioning and interest expense on IDAloans. Total expenses as percentage of assets remains at around 3 % between in FY96 to FY2000.Administrative expenses as percentage of assets declines from 1.2% in FY96 to 0.6% FY2000. Netincome initially drops from Tk 16 million in FY96 to Tk 7 million in FY97, due to higher provision,and scaling - up costs in these years, but thereafter gradually increase to Tk 65 million in FY2000 andTk 204 million in 2005.

21. The IDA credit increases PKSF's debt to equity ratio from 0 in FY96 to 3.7 in FY2000.Return on average assets drops from 2% in FY95 to 1.3% in FY2000, as net income does not grow asfast as the asset base but increases to 1.6% by FY2005. Finally, return on equity increases from 1.6%in FY96 to 5.1 % in FY2000 and reaches 9.7 % by FY2005.

22. Longer term projections indicate that, after FY2005 PKSF could start to pay higher rates onincremental borrowings and that by 2015 it could pay 8% interest rate (7% higher than at present and2% higher than average cost of funds of the banking system) on all its borrowed funds and earn asatisfactory return on assets, while raising the average lending rate only 4% -- from the 4.4% inFY2000 to 8.5 % in 2015. Because of higher cost of funding, the average interest expense (as % ofborrowed finds) increases from 1.0% in FY2000 to 6.3% in FY2015. The favorable Debt:Equity ratiowhich hovers around 7:1 beyond FY2005 would enable PKSF to operate on a thin interest margin andyet earn a satisfactory return on assets.

- 54 - ANINEX 3Page 6

Table 1: PKSF- Fnancial Statements- (Actual)

1990 1991 1992 1993 1994 1995

BALANCESHEhT

Assets

Current Assets 32 230 273 318 258 382

Fixed Assets

Opening Balance: Purchases II

Less: Accumulated Depreciation 5

Plus: Purchases 2

Less. Depreciation Expense I

Fixed Assets (net of drpreciation) 0 5 5 6 5 6

Large PO Loans (gross)

Less: Cumulative Loan Loss ProvisionLarge PO Loans (net)

Small PO Loans 3 29 131 268 459

Less: Cumulative Loan Loss Provision 3

SnallPOLoans(net) 0 3 29 131 268 456

Total Assets 32 239 307 455 530 844

Liabilities

Borrowing IDA credit

Additional Borroving

Equity: Funds and Reserves 32 239 307 459 530 844

Total Uabilities 32 239 307 459 530 844

Performance Ratios

I Debt/Equity 0 0 0 0 0 0

Average lending rate 2% 2% 3% 3%

Interest Margin/Assets 2% 3% 3%

Total income/average assets 9% 9% 10% 8% 4%

Interest expense and provisions /average assets 0% 0% 0% 0% 0%

Administrative Expenses/Average Asmets 0% 3% 2% 2% 1 % l%

Operating costs /Average assets 0% 4% 3% 2% 2% 1 %

Total expense /Average assets 0% 4% 3% 2% 2% 2%

Return on Average Assets 1% 5% 7% 8% 5% 2%

Return on Equity 0% 3% 6% 6% 5% 2%

Loan Portfolio as %Total Assets 0% I % 9% 29% 51% 54%

- 55 - ANX

Page 7

Table 2: PKSF- Financial Statements- (Actual)(Tk million)

1 1990 1991 1992 1993 1994 1995I|. SOURCES AND USES OF FUNDS

Sources of FundsGOB Grant 32 200 50 118 50 300

Institutional Development (IDA grant)

IDA credit

Additional borrowings

Net Income 0 6 18 29 25 13Non-Cash Expenses (Depr-Loan Loss) I 1 I 1 4

Repayment by POs 0 10 49 110

Total 32 2X17 69 159 125 428Uses of FundsPurchase of Fixed Assets:

Institutional Development (IDA grant)

Other 0 5 2 0 2

Disbursements:

Disbursements: Large POs 0 0 0 0 0 0

Disbursements: Srnall POs 3 26 113 185 302

Total Disbursement 302

Repayments:

IDA credit

Additional borrowingsSub-total 0 8 26 114 185 304

Change in Working Capital 32 198 43 45 -60 124Total 32 2Q2 69 15 15 4

II. INCOMESTATEMENT

1990 1991 1992 1993 1994 1995IncomeOperating Income: Interest on Large PO Loans 0.0

: Interest on Small PO Loans 0 0 2 5 10

Other Income: Income from Current Assets 0 12 25 36 32 17

Total Income 12 25 3 3Z 26EcpensesInterest Expense 0 0 0 0 0 0

Interest on IDA credit

Interest on Additional Borrowing

NET INTERST INCOME 37 26

Administrative Expenses 4 6 6 6 7

Other Expenses 0 1 1 1

Training Rbrkshops and Seminars 0 0 0

Research and Publications 0 0 0

Evaluation and Monitoring I 1 I

others 4

Depreciation I I I I I

Loan Loss Provision (Large PO loans) 0

Loan Loss Provision (Snall PO Loans) 3

Total Expense Q _ 7 1a 131 iNet Income 0 7 18 29 25 14

- 56 -ANNEX 3

Page 8

Table 3: PKSF- Disbursement and Requirement of Funds (Tk million)Small POs 96 97 98 99 2000

I NumberofPOs attheendofFY 135.0 155.0 170.0 185.0 2000

2 Numberofborrowers (inMdlon) 0.38 0.41 0.50 0.63 075

3 Average loan/borrower(thousandtaka) 3.00 3.75 4.50 5 50 6.75

4 Targetedloandisbursementat field levelbyPOs (milltaka)2 1125.0 1522.5 2250.0 3437.5 5062.5

5 Fund retuired by POs to meet the tarnet (4/ 1.51 750.0 1015.0 1500.0 229[7 3375.0

5.a Savings (20%of5) 203.0 300.0 458.3 675.0

6 Funds Required this year (5- 5A) 750.0 812.0 1200.0 1833.3 2700.0

7 Borrowings from PKSF-beginningofyear 459 750 812 1200 1833

S. Repayment to P KSF

(i)from previous year 108 174 140 278 414

(ii)From 2years befbre 74 123 S99 159 318

(ii) from 3 years before 28 46 77 124 100

8. Total Loan repayment (during the year) 206 337 407 551 815

9 Annual Disbursement from PKSF (6-7+8) 497 399 795 1184 1682

10 Borrowings from PKSF -endofYear(7-8+9) 750 812 1200 1833 2700

Large P0O

I. Targeted Disbursement by POs to coverdemand 97 9S 99 2000

BRAC 357 830 300 2000

P ROS HlKA 250 475 825 1075

AS A 250 570 1000 1300

11 To tal 857 1875 3125 4375

12. Fund required by POs to meet the dis bursement target (11 1.5)

BRAC 238 553 867 1333

PROSHIKA 167 317 550 717

ASA 67 380 667 867

12 Total 571 1250 2083 2917

13 Savings ( 20%of 12) 114 250 417 583

14 Funds Required this year(12-13) 457 1000 1667 2333

15 Borrowings from PKSF-beginningofyear 0 457 1000 1667

Repayment to P KS F

(i) from previous year 0 0 0 0

(di)From 2years before 0 0 0 0

(iii)from 3years before 0 0 0 0

16 Total Loan repayment (durmg the year) 0 0 0 0

17 Annual Disbursement from PKSF ( 14-15+16) 457 543 667 667

18 Borrowngs from PKSF -endofYear(15-6+17) 457 1000 1667 2333

P KS F:

9S- 96 96- 97 97-'98 98-'99 99-2000

19 Funds Needed to meet Target (LPOs and SPOs- 5 750 1586 2750 4375 6292

19.a LAss Savings of POs (20%of 19) 317 550 875 1258

19.b Funds Needed by POs from PKSF (19-19a) 750 1269 2200 3500 5033

20 L an Outs tanding-- Beginning (7+15) 459 750 1269 2200 3500

21 Repayment (8+16) 206 337 407 551 815

22 Disbursement (19b -20+21)) 497 856 338 1851 2349

23 Loan Outstanding-- Ending (20-21+22) 750 1269 2200 3500 5033

- 57- ANNEX-

Page 9

Table 4: PKSF- Financial statements - projected(Tk million)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005|L SOURCES AND ISES OF FUNDSSources of FundsOBBGrant 150 0 0 0 0 0 0 0 0 0Institutional Development (IDA grant) 43 43 43 43 43IDA credit 0 436 1026 1391 1877Additional borrowings 1200 1700 1700 1700 2600NetIncome 16 7 11 28 65 106 134 148 173 204Non-Cash Expenses (Depr+Loan Loss) 16 21 34 53 67 78 88 99 114 129Repayment by POs 206 337 407 551 815 1348 1908 2436 2927 3276

Total 387 844 1521 2066 2867 2775 3829 4383 4914 6209jUses of FundsPurchase of Fixd Assets:

Instrutional Development (IDA grant) 0 43 43 43 43 43 0 0 0 0Other 32 10 5 5 5

Disbursements:Disbursements:LargePOs 0 457 543 667 680 810 980 1170 1400 1540Disburserrments:SmailPOs 497 399 795 1184 1682 2010 2420 2900 3490 4188

Total Disbursenment 497 856 1337 1851 2362 2820 3400 4070 4890 5728Repayments:

IDA credit 286 286 286 286Additional borrowings

| Sub-total 529 909 1385 1899 2410 2863 3686 4356 5176 6014Change in Working Capital -141 -65 136 167 457 -88 143 27 -262 195

Total 87 844 1521 2 2867 2775 3829 4383 4914 6209IL INCOMESTATE1IENT

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005InconieOperating Income: Interest on Large PO Loans 0 11 36 66 99 156 215 285 376 477

: Intereston SnmallPO Loans 21 27 36 55 84 117 142 163 187 220Otherlncome: IncomeffmmCurTentAssets 25 14 13 15 22 48 38 42 38 49;Total Income 4 84 135 321 395 491 600 746ExpensesInterest Expense 0 2 9 22 38 95 128 193 258 352

jinterest on IDA credit 0 2 9 22 38 47 46 43 40 37Pinterest onAdditional Borrowing 0 0 0 0 0 48 82 150 218 315NETINTERSTINCOME 46 50 75 114 168 226 267 298 342 394iAdministrative Expenses 11 17 23 25 28 31 34 37 41 45(Other Ebpenses 3 4 7 7 8 11 12 13 15 16Training Workshops and Seminars I 2 2 2 2 3 3 4 4 4

'Research and Publications 0 2 2 2 2 3 3 4 4 4i Evaluation and Monitoring 2 4 4 4 5 5 6 6 7 7iDepreciation 4 9 13 16 19 22 20 18 16 14jLoanLoss Provision(LargePOloans) 0 5 5 13 14 16 20 23 28 31Loan Loss Provision (Snall PO Loans) 12 8 16 24 34 40 48 58 70 84

Total Expense L 44 73 107 140 2 2§1 342 427 542Net Incone 16 7 11 28 65 106 134 148 173 204

ANNEX 3Page 10

Table 5: PKSF- Financial statements - projected

(Tk million)1996 1997 1 1999 2000 2001 2002 2003 2004 2-

IIL BALANCESHEET

Assets

Currenit Assets 240 175 310 478 935 847 991 1018 755 950

Fixed Assets

Opening Balance: Purchases 12 44 97 145 193 241 284 284 284 284

L.es3 Accumsulaied Deprecialion 6 /0 19 31 48 6- 89 /08 126 142

P/Nu: Purchases 32 53 48 48 48 43 0 0 0 0

Le.%s: Deprecialioll Expense 4 9 13 16 19 22 20 18 16 14

FixedAssets(netofdepreciation) 34 79 114 146 174 196 176 158 143 128

Large PO Loans (gras.) 0 457 1000 166 234- 315- 413- 530- 6-0- 824-

Les.s. ('uniulaiheLoa,, Los.vPror,isioni 0 5 10 23 3' 53 -3 96 124 155

LargePOLoans(net) 0 453 990 1643 2310 3104 4064 5211 6583 8092

llall PO Loanis -50 812 1200 1833 2700 3362 3873 4338 4901 5813

Le.%%: (nnitulalmieeLoanLovssProvivion 15 23 39 63 96 136 185 243 313 396

Small PO Loans (net) 735 789 1161 1771 2604 3225 3689 4095 4588 5417

Total Assets 1009 1495 2575 4037 6023 7372 8919 10482 12069 14587

Liabilities

Borrowing IDA credit 0 436 1462 2853 4730 4730 4444 4158 3872 3586

Additional Borrowing 0 0 0 0 0 1200 2900 4600 6300 8900

Equity: Funds and Reserves 1009 1059 1113 1184 1293 1442 1575 1723 1897 2101

Total Liabilities 1009 1495 2575 4037 6023 7372 8919 10481 12069 14587

Performance Ratios 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Debt/Equity 0.0 0.4 1.3 2.4 3.7 4.1 4.7 5.1 5.4 5.9

Average lendiig rate 3.5% 3.8% 4.2% 4.3% 4.4% 4.8% 5.1% 5.3% 5.5% 5.6%

Avergae Interest expense 1.0% 1.0% 1.0% 1.0% 1.8% 1.9% 2.4% 2.7% 3.1%

linterest Margin/Average Net Loan Ouststanding 3.5% 3.6% 3.7% 3.6% 3.5% 3.2% 3.2% 3.0% 3.0% 2.8%

iTotalincome/average assets 4.9% 4.1% 4.1% 4.1% 4.1% 4.8% 4.8% 5.1% 5.3% 5.6°o

Iiuterest expense and provisions /average assets 1.3% 1.2% 1.5% 1.8% 1.7% 2.3% 2.4% 2.8% 3.2% 3.5%

lAdminiistrative Expenses /average Assets 1.2% 1.4% 1.1% 0.8% 0.6% 0.5% 0.4% 0.4% 0.4% 0.3%

S0peratingcosts/Averageassets 2.0% 2.4% 2.1% 1.5% 1.1% 0.9% 0.8% 0.7% 0.6% 0.6%

Total expense/Average assets 3.3% 3.6% 3.6% 3.2% 2.8% 3.2% 3.2% 3.5% 3.8% 4.1%

'Return on Average Assets 1.7% 0.6% 0.5% 0.8% 1.3% 1.6% 1.6% 1.5% 1.5% 1.5%

:Retirn oni Equity 1.5% 0.7% 1.0% 2.4% 5.1% 7.3% 8.5% 8.6% 9.1% 9.7%

Loan Portfolio as % Total Assets 72.8% 83.1% 83.5% 84.6% 81.6% 85.9% 86.9% 88.8% 92.6% 92.6%

PROJECTION ASSUMPTIONS

Ilterest received from Small POs 3.5% 3.5% 3.7% 3.8% 3.9°/ 4.0% 4.1% 4.2%1 4.3% 4.4%

Interest received from Large POs 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 6.0% 6.0% 6.5% 6.5%

Interest received on Cuirrent Assets 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5%

Interest paid oni IDA Credit 1.0% 1.0% 1.0% 1.0% 1.0% 4.0% 4.0% 4.0%Y 4.0% 4.5%

- 59 - ANNEX

Attachment IPage l

PROFILE OF PKSF PARTNER ORGANIZATIONS (POs)

PO DESCRIPTION OF OPERATION CREDIT ANDSAVING

OPERATIONThengamara - Established in 1964; Programs extend over 475 villages; it has - Group savings is TkMohila Sabuj organized 35,800 landless-assetless women 7.3 millionSangha - Programs include savings and credit program, education - Cumulative credit(IMSS), program, health and family planning, training, relief and disbursement is TkBogra rehabilitation, agroforestry, pisciculture, nursery, mother and 180 million

child health care, poultry and livestock, sericulture, handicraft,etc.

Association for - Commenced its operation in 1978; Programs include group based - Group savings is TkSocial savings and credit, health, education, training, afforestation and 31 million (PKSF);Advancement post disaster relief and rehabilitation 116 million (other)(ASA), Dhaka - Cumulative credit

disbursement is 226million (PKSF) Tk1. I billion (other)

Rangpur -Initially started relief and rehabilitation in 1972; it is the -Group savings is TkDinajpur Bangladesh chapter of Lutheran World Federation 44 millionRural Service - The activities are now being carried out under: Comprehensive - Cumulative credit(RDRS), Project (CP) and credit program. The comprehensive project disbursement is TkRangpur assists people in developing sustainable new skills in different 210 million

areas like education, agriculture, health, women's' development,environment and disaster preparedness etc.

- Has so far organized 248,289 membersJagorani - Established in 1976; Programs include mass education, health and - Cumulative creditChakra family planning, women's development, development of schedule disbursement is Tk

caste sweepers, income generation and rural credit 56.2 million- It has 13,075 organized members .-

Society for - Established in 1986; Programs include group formation, training, - Group savings is TkSocial Service social afforestation, supply of tube-wells, non-formal child 4.7 million(SSS) education and hygiene program - Cumulative credit

- SSS has organized 13,017 members disbursement is Tk37.5 million

Adarsha Samaj - Established in 1984; Programs include conscientisation, group -Group savings is TkSeba Samity formation, adult education, family planning and health care, and 78.3 thousand(ASSS), providing credit facility for self employment; - Cumulative creditMymensingh - Working area extends over 29 villages disbursement is Tk

-Consists of 1,306 members 2.9 millionKotwai Thana - Established in 1962; Programs include diversified services and - Group savings is TkCentral credit support, training, agricultural extension including technical 1.5 millionCooperatives assistance for mechanized cultivation and irrigation. - Cumulative creditAssociation disbursement is Tk(KTCCA) 16.8 millionLimited,Comilla

- 60 -ANNEX3

Attachment IPage 2

PO DESCRIPTION OF OPERATION CREDIT ANDSAVING

OPERATION

Rural - Established in 1984; Programs include health, education, - Group savings is TkReconstruction women's development, plantation, water and sanitation, savings 3.6 millionCentre Jessore and credit program - Cumulative credit

- The operational area covers eighty villages disbursement is Tk_ 27.9 million

Uttara - Established in 1987; Programs include savings and credit, -Group savings is TkDevelopment education, training, mother and child health care, afforestation 2.3 millionProgramme, etc. - Cumulative creditThakurgaon - Working area covers 248 villages disbursement is Tk

- Consists of 9,724 members 22.4 millionPalli Progoti -Established in 1981; Programs include child education, adult -Group savings is TkShahayak education, training, supply of tubewells and latrines, group 3.7 millionSamity formation, and credit program - Cumulative credit(PPSS), - Working area includes 158 villages disbursement is TkFaridpur - Consists of 10,760 members 31.1 millionSrizony, - Established in 1985; Programs include slum development, model -Group savings is TkJhenaidah village development, adult education, pisciculture, road side 1.1 million

plantation, MCH&FP, mass education, children school attracting - Cumulative creditprogram, group formation saving and credit program disbursement is Tk

-Has 6,540 members 8.9 millionUddipan, - Established in 1984; Programs include group formation, relief - Group savings is TkDhaka and rehabilitation, training of the group members, credit health 5.3 million

and sanitation, and village & farm forestry program - Cumulative credit- Working area extends to 260 villages disbursement is Tk-Consists of 10,500 members 3.8 million

Amra Kaj Kori - Established in 1985; Programs include non-formal primary - Group savings is Tk(AKK), education and adult education 254 thousandFaridpur - Working area extends to over 36 villages - Cumulative credit

- Consists of 1,456 members disbursement is Tk4.4 million

Karmajibi - Established in 1982; Programs include group formation, - Group savings is TkSangstha, conscientisation, child education, savings generation and credit 1.3 millionJessore for self employment of the rural poor - Cumulative credit

- Working area extends to 25 villages disbursement is Tk-Consists of 3,080 assetless female members 6.1 million

Muktipath -Established in 1991; Programs include poultry rearing, cattle -Group savings is TkUnnayan rearing, vegetable and fruit business, grocer's shop, paddy 762 thousandKendra, husking, parched rice, knitting, tailoring -Cumulative creditChittagong - Consists of 1,629 members disbursement is Tk

5.4 million

Samakal - Established in 1979; Programs include group formation, savings - Group savings is TkSamaj mobilization, non-formal education, afforestation, supply of 706 thousandUnnayan tubewells for fresh drinking water, sealed latrine for health and - Cumulative creditSangstha, hygiene and credit support for the rural poor disbursement Tk 7.9Rangpur - Working area extends to over 21 villages million

-Consists of 1,995 members

- 61 -ANNEX 3

Attachment IPage 3

PO DESCRIPTION OF OPERATION | CREDIT ANDSAVING

OPERATIONService - Established in 1988; programs include savings and credit, - Group savings is TkEmergency for education, afforestation, pisciculture, and integrated community 447 thousandRural People, development. - Cumulative creditThakurgaon - Working area extends to over 35 villages disbursement is Tk

- Consists of 2,120 members 3.1 millionShishu - Established in 1985; programs include group formation and - Group savings is TkUnnayan conscientisation, child education, training on handicraft making, 670 thousandsSangstha, adult literacy program, primary health care, charitable dispensary -Cumulative creditDhaka and credit program disbursement is Tk

-Working area extends to over 36 villages 4.8 million- Consists of 2,685 members

Shaldair -Established in 1988; programs include group formation, savings -Group savings is TkRenaissance generation, credit for self employment, education and training on 774 thousandClub (SRC) poultry - Cumulative credit

- Working area extends to over 75 villages disbursement is Tk-Consists of 3,100 members 2.7 million

Grameen Seba - Established in 1990; programs include formation of groups, adult - Group savings is TkSangstha, and child education, livestock development, family planning, 107 thousandManikganj supply of fresh drinking water through tube-wells, sealed latrines, - Cumulative credit

fuel efftcient earthen ovens and primary health education. disbursement is Tk- Working area extends to over 30 villages 1.1 million- Consists of 610 members.

Organization - Established in 1988; programs include group formation, group -Group savings is Tkfor Social based savings and credit, supply of tubewells, training, and 1.2 millionDevelopment education - Cumulative creditand Research - Consists of 2,380 members disbursement is Tk(OSDER), 9.8 millionMunshiganjResource -Established in 1981; programs include leadership training, non- -Group savings is TkIntegration formal education, income generation program, medical 1.8 millionCentre (RJC), assistance, housing assistance, skill development training and - Cumulative creditNarshindi rehabilitation disbursement is Tk

-Working area extends to 319 villages 20.3 million-Consists of 6,625 members

Unnayan, - Established in 1983; programs include group formation and - Group savings is TkKhulna credit, nursery, sanitation, and handicrafts 456 thousand

- Working area extends to 13 villages - Cumulative credit- Consists of 2,000 members, all of whom are women disbursement is Tk

3.3 millionSETU, Kustia - Established in 1983; programs include integrated health and - Group savings is Tk

development, village and farm forestry, non-formal primary 2.4 millioneducation and credit - Cumulative credit

-Working area extends to 168 villages disbursement is Tk-Consists of 6,461 members 6.6 million

- 62 -ANNEX 4

Page 1

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

SOCIO-ECONOMIC IMPACT OF MICROFINANCE PROGRAMS:A SUMMARY OF FINDINGS

1. Most large MFIs have conducted in-depth analyses of the impact of their programs on the

borrowers. Most of these evaluations have been performed by reputed international experts, using a

large sample of the borrowers, and comparing progress in various socio-economic indicators against a

control group of non-borrowers. Some of the findings from these studies, and those done by the Bank

staff, are summarized below. As the MFIs use different approaches, their evaluations are also

different in design and are not comparable. Notwithstanding weaknesses in methodology (e.g.,

endogeneity bias, inability to capture dropouts vs. graduates, difficulties in sampling a suitable control

group, lack of time-series data, etc.), these independent studies have revealed that participation in

microfinance programs yields not only material benefits, but important social benefits to the rural poor.

Bank Study

2. A more rigorous household and individual data-based study has recently been completed by

World Bank and BIDS (Khadker and others, 1996; Khandker and Chaudhry, 1995; Pitt and Khandker,

1995; Rahman and Khandker, 1995). The results show that microfinance programs place their

programs in poorer areas and that program participation among the poor is self-selective. Thus,

Grameen Bank program covers villages where 65.3 % of households belong to target groups (having

less than 50 or less decimal of land) compared to 52.1 % of target households in village without such a

program and that the program participation rate among the target group in Grameen Bank villages is

only 44.3% (Table 1).

Table 1: Extent of target groups and credit programs

Percentage of target households Program participation rate amongtarget households

Grameen Bank villages 65.3 44.3

Non-program villages 52.1 0

Source: Khandker and Chaudhury, 1995.

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Table 2: Welfare effects of Grameen Bank Loans among borrowers(percentage change)

Indicators Effect of male borrowing Effect of female borrowing

Boys' schooling participation rate 7.2 6.1Girls' schooling participation rate 3.0 4.7Weekly per capita expenditure 1.8 4.3Recent fertility of women aged -7.4 -3.5

15-49 yearsWomen's labor supply to cash- 0 10.4

income earning activitiesWomen's nonland assets 0 19.9

Source: Pitt and Khandker, 1995

3. Microimpact results shown in Table 2 indicate that microfinance program such as GrameenBank has desirable impacts on the poor and that the program impacts are statistically different for maleand female borrowers and that women benefit from program participation. For example, for thoseborrowers with average loan size (about Tk 3,500), a 1% increase in their loan size would: (a)increases per capita consumption (a weekly increase of 4.3 % among female borrowers and 1.8 %increase among male borrowers); (b) boys' schooling (7.2% increase among male borrowers and 6.1%increase among female borrowers), and girls' schooling (3.0% increase among male borrowers and4.7% increase among female borrowers); and (c) reduce recent (over the last five years) fertility ofwomen aged 15-49 (7.4% reduction for male borrowing and 3.5% reduction for female borrowing).Thus, the impact on fertility and boys' schooling is more pronounced for male than for femaleborrowers, while the impact of borrowing on household per capita consumption and girls schooling ismore pronounced for female than for male borrowers. When poverty (measured on the basis of percapita consumption requirement) is evaluated based on the weekly per capita consumption increase offemale borrowing, the results indicates that an average female borrower of Grameen Bank can take thefamily out of poverty within five years of borrowing, provided that the same percentage increase ofconsumption is maintained. This study also shows that women benefit from program participationmainly through increasing labor supply to cash-income earning activities (by 10.4%) and holding morenonland assets (by 19.9%). Also the program participants household assets increased by 140-250% asa result of receiving repeated loans.

4. Microfinance programs have also created positive externality in the village economy (Table 3).Microfinance supports mainly nonfarm production and thus, the nonfarm income of an averagehousehold is 14.8% higher in Grameen Bank villages than nonprogram villages with a resulting 10.2increase of average household total annual income. Rural wage workers also benefit from programplacement. The average daily wage rate is at least 5.2% higher in Grameen Bank villages than in noprogram villages. Grameen Bank's subsidized finance operation through microfinance lending to thepoor has also generated positive externality in the case of both informal lending (reduction of 54.5%)and informal interest (annual) rate (a reduction 8.0%). These results clearly show that a microfinanceprogram such as Grameen Bank has not only reached the poor (more than 2 million borrowers) but alsohelped reduce poverty among the borrowers and generated positive externality in the village economy.Nevertheless, because of some 25 % coverage of poor among the target households in rural Bangladeshby these niicrofinance programs, the overall positive effect of microfinance programs on rural poverty

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reduction is yet marginal. But there is still room for further expansion of microfinancing throughincreased outreach and horizontal program expansion.

Table 3: Village level welfare effects of Grameen Bank

Welfare change Percentage change(Annual)

Household nonfarm annual income 14.8Household total annual income 10.2Individual labor force participation 2.1Average daily wage 5.2Informal lending volume -54.5Informal interest rate -8.0

Source: Khandker and Others, 1996.

5. The above study found that in addition to its financial services, Grameen Bank has devised andimplemented diverse programs to promote social development. It encourages members to open nurseryschools at its centers, distributes seeds and seedlings to promote gardening and planting, and helps itsmembers improve health , nutrition, and productivity by encouraging them to practice "sixteendecisions "'. Overall, the growth recorded for various aspects of this program reflects a remarkableachievement in social development, affecting the living and social conditions of its members and theenvironment ( Table 4).

Table 4: Grameen Bank - Trends in Achievement of Social Development 1985-94

Year Number of schools Number of students Marriage without dowry No. of seeds distributedrun by groups

Women Men Women Men Women Men Women Men

1985 2,23 1,03 39,098 32,369 1,807 931 459,170 322,4581990 10,636 585 236,946 78,862 10,267 1,907 2,534,000 544,5401992 14,894 675 319,817 117,246 14,099 2,144 4,196,928 630,6011994 14,413 391 284,675 111,614 27,798 2,329 6,134,539 724,780Average

Growth 21% -10% 22% 13% 31% 10% 30% 8%*

* Average Annual Growth (1985-1994).Source: Khandker and Others, 1996.

These include guiding rules such as "we will keep our families small", "we will build and use pit-latrines"etc., which define the social behavior expected of all Grameen members.

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Proshika

6. Proshika evaluated its borrowers, using external evaluators, on various social and economicempowerment indicators, that were designed to capture major aspects of the intended impacts ofProshika's empowerment programs. The survey used a random sample from two separate groups:project participants and non-participants. These two groups were surveyed twice over the period.

7. The survey found that female Proshika members tended to have higher levels of literacy thantheir non-Proshika counterparts. Children of these members also demonstrated higher levels ofliteracy, partly due to the Proshika non-formal primary education program. Proshika members weremore likely to consult health practitioners, and received significantly higher levels of health educationand training. They had higher access to pit latrines and water sealed latrines than their counterparts.Female members were more likely to use contraceptives even though they had the same access tosupplies as non-members. Infant mortality rates were lower among Proshika members as the motherswere getting better nutrition, and the percentage of dowryless marriages among Proshika members washigher (Table 5).

Table 5: Social Development Indicators: Proshika vs. Non-Proshika Households (HHs)

Proshika HHs Non-Proshika HHs

Adult literacy (female) 22.5% 17.9%Primary school enrollment (Govt.) 40% 38.8%Use of Thana health complex 12% 3.6%Under one year immunization 68.7% 66.9%Use of Pit Latrines 24.7% 13.2%Percent of contraceptive users 45.7% 38.2%Infant Mortality ( per 1,000 live births) 94 164% of dowryless marriages in last 2 years 22.9% 6.2%

BRAC

8. BRAC's impact assessment conducted in 1993-94 did not use a "before and after" approach;instead it analyzed the economic and social status of different categories of RDP members (Annex 2,para 12) according to their length of membership. The results indicate that BRAC members areconsistently moving along the path to greater wealth and expenditure, according to loan size andmembership age. Moreover, BRAC's RDP is impacting on less well-off households to a comparativelygreater degree than better-off households; and the focus on female members is more effective inbringing benefits to BRAC's target group than would be the case with a higher proportion of malemembership.

9. Changes in nature of household assets, along with increases in the monetary value of capitalsuggest both greater economic security and an improved standard of living for "older" members of theRDP (Table 6). This enhanced security is confirmed by reduced seasonal fluctuations in income,expenditure, food consumption, and stocks, for these members who joined RDP more that two and a

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Page 5

half years ago and have more than Tk 7,500 of cumulative RDP loans. Moreover, there is a tendencyto withdraw from the informal credit market, and the use of loans for consumption or hardshippurposes declines with length of membership.

10. The study reveals that BRAC membership has brought about gradual changes in women's lives.After receiving loans, women's status within the household has increased, and some have experiencedgreater mobility, and have more control over the household income. When BRAC has providedsupport to women close to their homes, they have productively used the loans themselves, without theassistance of male members of the household.

11. A separate survey of the IVGD program revealed that the women in these programs havehigher cash incomes, purchased a higher quantity of consumer and production durables, and tended tosend a higher proportion of their girls to school than women in other targeted programs.

Table 6: BRAC Membership: Indicators of Material Well-being

Indicator BRAC Membership age in Months ( & years)

1- 11 (< 1) 12-29 (1 < 2.5) 30-47(2.5 < 4) 48+ (4+)

Avg. value of gross H/h 10,959 14,037 20,282 23,230assets (taka)Avg. % (and value) of 32.9% 39.1% 31.6% 31.0%revenue-earning assets (3,606) (5,488) (6,409) (7,201)Avg. H/h weekly exp. 419 455 560 528(taka)Avg. per capita weekly 55.5 60.8 63.0 64.1food expenditure

ASA

12. An evaluation of ASA's program in 1993/94 revealed that apart from conducting a profitablecredit operation, ASA has made a significant impact on the lives of its mostly female members. It runsseveral socio-economic programs, such as the Education for Empowerment program, the HumanDevelopment Training program, and the Integrated Health program. For example, the IntegratedHealth Program comprises sub-projects in nutrition improvement, feeding of malnourished children,and traditional birth attendant training. Interviews with participants in these programs revealed thattheir total food consumption increased, the nutritional status of malnourished children improved, andmost of the beneficiaries were aware of maintaining personal hygiene.

PKSF's Small/Medium POs

13. Table 7 shows the results of a study conducted by PKSF that covered 14 POs. Apart fromincreases in incomes to the borrowers, the PKSF study revealed that there is significant improvement incertain social indicators, such as the ability to write names, children's school enrollment, and use ofdrinking water among PO members. While there is a need to put in place an analytically robust systemto regularly track impact of microfinance programs, they have, in general, been successful inexpanding opportunities for self employment, increasing labor force participation of women, andshifting borrowers away from the moneylenders to microcredit programs.

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Page 6

Table 7: Changes in Social Indicators from Membership in PO

Before PO After PO TotalMembership Membership Respondents

Percent of respondents who could:Write their names 53 98 460Use sanitary latrine 30 61 460Are aware of family planning 56 85 315Children attend school 82 99 292Use pure drinking water 68 98 460

Source: Alamgir, 1994.

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Page IBANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

INSTITUTIONAL DEVELOPMENT COMPONENT

A. PKSF COMPONENT

Objective Actions/Steps/Completion Date

Expanding coverage of MIS system to (a) quickly * Approval by Board/Management to enhanceidentify POs facing unsatisfactory repayment rates at MIS - [October 1996]the field level; (b) enable PKSF to track repayment * Engage full time system analyst and/or outsideperformance of entire credit operations of those POs expertise (e.g., Grameen Trust, BRAC, etc.) -

(e.g., ASA) that have other sources of funding, and [November 1996](c) enable PKSF to evaluate financial performance, * Review existing Database - [January 1997]on a regular basis, of all its POs. * Develop Detailed System Design, Reports,

Forms, etc. - [January-March 1997]* Approval of System Design by Management -

[May-June 1997]* Convert Detailed Design into Computerized

System - [July-December 1997]* Staff Training - [October-December 1997]* Make system operational - [February 1998]

Establish and tightening audit * Establish in-house Working Group along withstandards/requirements for medium/large MFIs outside expert (e.g., staff of PKSF external

auditor) - [October 1996]* Draft Guidelines - [October-December 19961* PKSF Governing Body/Management review and

approval of Guidelines - [January 1997]* Issue Guidelines - [January 1997]

Establishing a loan classification and provisioning * Establish in-house Working Group along withpolicy, for itself and POs, taking into account past outside expert (e.g., staff of PKSF externalexperience and potential future risks. auditor) - [October 1996]

* Draft Guidelines - [October-December 19961* PKSF Governing Body/Management review and

approval of Guidelines - [January 1997]* Issue Guidelines - [March 1997]

Strengthening PKSF's financial planning capacity. * Engage staff - [October 1996]* Prepare first medium-term financial projection

- [March 1997]Establish a policy that the level of PKSF support to * Establish in-house Working Group along withall POs in the future would also depend, among outside expert (e.g., staff of PKSF externalother factors, on the POs progress towards financial auditor) - [January 1997]sustainability of their credit operations, and establish * Draft Guidelines - [January-April 1997]financial performance standards that PKSF would * PKSF Governing Body/Management review anduse to measure POs progress in regards to approval of Guidelines - [May-July 1997]sustainability. * Issue Guidelines - [August 1997]

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Page 2

Objective Actions/Steps/Expected Completion Date

Establishing a program for periodically assessing * PKSF Research Committee finalizes TORs -impact of microcredit on social/economic status of [October 1996]borrowers. . Invite proposals from research firms/institutions

- [October 1996]* Establishment of a small research unit within

PKSF - [December 1996]. Award contract - [December 1996]. First Base-Line Survey - [January 1997]

Expanding the training and staff development . Full-fledged small training unit has beenprogram for PKSF and PO staff. established

* Establish staff Working Group to develop, withhelp of outside expert, medium-term trainingprogram for PKSF and PO staff - [September-December 1996]

* PKSF Governing Body/Management review andapproval of program - [January 1997]

* Initiate Program - [April 1997]Establishing a program of interest-free loans to help * Establish in-house Working Group to developsuccessful PO with a good track record to expand Program - [October 1996]their operations. * Formulate Program and Draft Guidelines -

[October-December 1996]* PKSF Governing Body/Management review and

approval of Program/Guidelines - [February1997]

* Initiate Program - [April 1997]Undertaking a study in collaboration with POs to * Establish PKSF/PO Working Group - [Octoberformulate guidelines on uniform accounting policies, 1996]particularly those for reporting repayment rates, * Finalize TORs - [October 1996]arrears, reschedulings, portfolio quality, etc. * Undertake study with help of outside expert

(e.g., PKSF external auditor) - [November1996-January 1997]

* Discuss Draft Guidelines with POs - [February-March 1997]

* Issue Final Guidelines - [April 1997]* POs initiate Implementation - [July 1997]

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Page 3

Objective Actions/Steps Completion Date

Comprehensively review, once a year, PKSF's . PKSF Research Committee review of issues andonlending rate structure taking into account IDA provided guidelines - [July 19971prevailing deposit rates, financial sustainability goals . Establishing PKSF/PO Workingof PKSF/POs and poverty objectives of the Group/Consultant - [August 1997]microcredit program. Review would also cover * Development of Framework and Methodologyexamination of rate structure which is differentiated for review - [September-October 1997]according to average unit loan size of institution, a Approval of methodology/framework byrather than cumulative borrowing from PKSF. Research Committee - [November 19971

a Study Period - [December 1997-March 1998]. Report submitted to PKSF Governing

Body/MOF - [May 1998]a Appropriate changes to rate structure - [July

1988]* Annual Review thereafter

With the help of consultants and PKSF staff,preparation of a comprehensive analysis of projectperformance, prior to mid-term review.

B. BB COMPONENT

Objective Actions/Steps Completion Date

Study, and establish appropriate regulatory * Establishing BB Working Group - [Octoberframework and institutions for regulating NGOs 1996]engaged in deposit taking/lending, while * Finalize TORs - [November 1996]recognizing: the special nature of these institutions; * Engage Consultant - [January 1997]the inherent strong self regulation in the system. and * Study Period - [February-July 1997]that unlike formal financial institutions, depositors of * Report submitted to BB/MOF - [SeptemberMFIs who do not raise funds from non-borrowers 1997]are net borrowers from the system which reduces the * Initiate Program - [December 1997]need for depositor protection.

Study in collaboration with PKSF and MFIs: * Establishing BB/PKSF Working Group -(a) regulatory reforms and proactive measures (e.g., [October 1996]securitization of assets, voluntary lending by * Finalize TORs - [November 1996]commercial banks to MFIs, etc.) to enhance linkage * Engage Consultant - [January 1997]of microcredit institutions with formal financial * Study Period - [February-July 1997]sector; and (b) financial and institutional measures to * Report submitted to BB/MOF - [Septemberpromote MFIs becoming formal financial institutions 1997]and guidelines that should be used by GOB/BB for * Initiate Program - [December 1997]determining their readiness.

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ANNEX 6Page I

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

IDA DISBURSEMENT SCHEDULE

IDA CumulativeFiscal Year Semester Disbursement Disbursement Percent

ending (US$ Million) (US$ Million)

FY97 December 1996 5.0 5.0 5.0June 1997 5.0 10.0 9.0

FY98 December 1997 11.0 21.0 20.0June 1998 13.0 34.0 32.0

FY99 December 1998 18.0 50.0 48.0June 1999 16.0 67.0 64.0

FY00 December 1999 18.0 85.0 81.0June 2000 20.0 105.0 100.0

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ANNEX 6Page 2

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

SOE FORMAT FOR WITHDRAWALS UNDER CATEGORY 1

Period

TK millions

Net Loans Disbursed by POs

off which:(i) Financed from PKSF

(ii) Financed from Other Sources

2. PO Loans Financed by PKSF [same as I (i)]off which:(i) Financed from PKSF's Own Sources

(ii) Financed from Other Sources

3. Loan Disbursement Eligible for IDA financing [same as 2 (i)]

4. Amount Requested for Withdrawal [92% of (3)]

-73 - ANNEX 7Page 1

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

MONITORING AND EVALUATION PLAN AND PROJECT PERFORMANCE INDICATORS

A. MONITORING AND EVALUATION PLAN

1. The proposed Project would be monitored and evaluated from the perspectives of input, outputand impact. Input evaluation would focus on whether the required resources are in place to implementthe program activities and services. Input information would be monitored and assessed continuously(reported quarterly, semi-annually, or annually) to identify problems in the delivery of inputs so thatthey may be resolved before causing significant delays in implementation. Output evaluation wouldfocus on the immediate results of activities, as demonstrated, for example, increase in the number ofborrowers. This evaluation would be undertaken annually or semi-annually (depending on specificoutput indicator). Impact evaluation would focus on program outcomes in terms of the socio-economicimpact on the beneficiaries and non-targeted households. This evaluation would review the program'seffects on indicators such as sustainability of PKSF, POs and borrower viability and well-being. TheProject Launch Workshop would specifically focus on monitoring and evaluation.

2. During negotiations, agreement was reached that: (a) quarterly and annual progress reportswould be prepared by the PKSF and submitted to MOF, who in turn will submit them to IDA; (b) ajoint Government, PKSF and IDA mid-term review would be conducted by July 1998 or when 50 % ofthe funds are disbursed, whichever is earlier. PKSF will prepare a comprehensive report before themid-term review; and (c) an Implementation Completion Report would be submitted by theGovernments to IDA within six months of the closing date of the Project. The scope of the quarterlyand annual progress reports were agreed at negotiations.

3. A summary of performance indicators for the proposed Project is provided in Section B.Except for the impact indicators, the input, output and financial indicators can be monitored withinformation generated by the existing PKSF/POs MIS system. The PKSF would develop detailedguidelines for tracking and performance-monitoring at the PO level. The guidelines would be designedso that the reporting burden on PO is minimized.

4. To monitor impact indicators, baseline surveys would be conducted by POs. Terms ofreference for research studies used for evaluation have been agreed with IDA. Evaluations would beundertaken by using sample surveys, supervisory visits, review of audit/evaluation reports, themanagement information system and drawing upon data already collected by other agencies. Animportant independent source of information, to supplement project statistics, for impact evaluationwould be the Bangladesh Household Expenditure Survey; this is undertaken periodically and wouldhelp monitor levels of poverty in the urban/rural areas.

IDA Supervision Requirements

5. The nation-wide coverage of the project means that standard supervision arrangements,particularly led from headquarters, would not be feasible. In due course, much of the responsibilitywould be taken by IDA's Resident Mission in Bangladesh, supported by local consultants. During the

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Page 2

start up phase, RMB staff would meet with PKSF regularly at least once a month. Formal projectsupervision would be conducted semi-annually. In addition, a mid-term review will be conducted.

6. Table 1 summarizes resource needs for supervision. These inputs are in addition to resourceneeds for the review of progress reports, procurement, supervision report preparation andcorrespondence (which are estimated at six staff weeks per year throughout project implementation).

Table 1: Bank Mission Schedule

Approximate Activity Staff InputDates (Staff Weeks)

HQ RMB

monthly Monthly Supervision - 110/96 Project Launch/initial supervision mission 4 61/97 Mid-year review mission 2 37/97 Annual review mission 3 41/98 Mid-year review mission 2 37/98 Mid-term review mission 4 81/99 Mid-year review mission 2 37/99 Annual review mission 3 41/00 Mid-year review mission 2 35/00 Final supervision/Implementation Completion Report 4 8

mission

7. Formal semi-annual supervision missions would: (a) require at least two weeks of field work,(b) once a year require the services of specialists in microfinance; and (c) review progress of programcomponents and procurement, financial statements and disbursements, loan covenants, and theimplementation of technical assistance,. Specialized skill requirements would be added to the missionsaccording to needs identified by previous supervision missions.

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Page 3

B. SUMMARY OF PERFORMANCE INDICATORS

FrequencyObjective Measure (Performance Targets) of Evaluation

__________________________ A. PROJECT INPUTIncrease funds available to POs Loans disbursed to POs Monthly

Increase funds for Institutional Grant funds disbursed MonthlyDevelopment

B. BENEFICIARIES: OUTPUTS, OUTCOMES AND IMPACTIncrease outreach No. of borrowers reached Quarterly

l__________________________________ (1.2 million by June 2001)Increase loan size Average loan size Annually

Increase in borrower welfare Monthly consumption expenditure Annually; first one by 6/98

Health Indicator Annually; first one by 6/98

Education indicator Annually; first one by 6/98

Increase in income and assets Annually; first one by 6/98(10% increase in family incomeper year)

C. PKSF: OUTPUT, OUTCOMES, AND IMPACTFinancial AspectsEnhance financial sustainability Collection rate (98%) Monthly

Principal and Interest on Loans MonthlyOverdue over 30 days

Principal and interest on loan Monthlyoverdue over 60 daysPrincipal and interest on loan Monthlyoverdue over 90 daysBad debt/loans written off Annually

Administrative costs as % of loans Annuallydisbursed

Interest income on loans as % of Annuallytotal expenses (130% by FY2000)Net income as % of total assets Annually

review on-lending rates Annually

Institutional StrengtheningImprove MIS Conversion of existing database to Semi-annually/Quarterly

computerized system by FebruaryI _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 199 8Tighten audit standards Issuance of audit guidelines by Semi-annually

January 1997Establish loan classification policy Issuance of guidelines by March Semi-annually

1997Strengthen PKSF's financial planning Preparation of medium term Semi-annuallycapacity financial projections

Establish financial sustainability Incorporate performance indicators Semi-annuallyperformance standards for POs in eligibility guidelines by August

______ _____ ______ _____ ______ ____ 1997

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Page 4

FrequencyObjective Measure (Performance Target) of Evaluation

Establish impact evaluation program Periodic Survey reports Semi-annually

Increase training No. of persons trained and type of Semi-annuallytraining imparted

Establish program of interest-free loans to Initiate interest-free loan program by MonthlyPOs, for institution building April 1997

Formulate guidelines on uniform Implementation of guidelines to POs Semi-annuallyaccounting policies by July 1997

Strengthen audit Internal Audit Cell to audit each PO Quarterlytwice a yearExternal auditor to audit one-third AnnuallyPOs each year

D. POs: OUTPUT, OUTCOMES, AND IMPACTFinancial AspectsEnhance Financial Sustainability of Loan collection rates (95%) Monthly

Financial Services Programs Total admin/operating costs as % of Semi-annuallyloan disbursed

Interest income on loans as % of Semi-annuallytotal admin/ operating costsInterest rates charged to AnnuallybeneficiariesNo. of POs attaining financial Semi-annuallyviability (60% by FY2000)Savings as % of loan outstanding Semi-annually

Institutional IndicatorsImprove Accounting and Audit Standards No. of POs meeting accounting Quarterly

standards

No. of POs using external auditors Annually

No of POs following loan Annuallyclassification/ provisioningguidelines

Number of Participating POs AnnuallyE. BANGLADESH BANK

Establish proactive policies and regulatory Complete study by July 1997 andframework for MFIs wanting to be formal initiate implementation programfinancial institutions.

Establish appropriate regulatory framework Complete study by July 1997 andfor deposit-taking NGOs initiate implementation program

- 77 -ANNEX 8

BANGLADESH

POVERTY ALLEVIATION MICROFINANCE PROJECT

DOCUMENTS IN PROJECT FILE

1. Gautam, M. "Rural Finance in Bangladesh." (draft).

2. Islam, Reazul. "Profiles on BRAC, ASA, Proshika, and PKSF."

3. Khalily, M.A. Baqui. "Note on the Sustainability of Large and Small NGOs."

4. Khandker, Shahidur R.. and Baqui Khality. "Credit Programs in Bangladesh: Performanceand Sustainability." World Bank Discussion Paper No. 323, Washington, D.C.

5. Khandker, Shahidur R., and Osman H. Chowdhury, 1996, "Targeted Credit Programs andRural Poverty in Bangladesh" Forthcoming World Bank Discussion Paper, Washington, D.C.

6. Pitt, Mark M., Shahidur R. Khandker. 1996. "Household and Intrahousehold Impacts of theGrameen Bank and Similar Targeted Credit Programs in Bangladesh." World Bank DiscussionPaper No. 320, Washington D.C.

7. Rahman, Rusidan I., and Shahidur R. Khandker. 1995. "Role of Targeted Credit Programs inPromoting Employment and Productivity of the Poor in Bangladesh." The World Bank,Washington D.C.

8. Sen, Binayak. "Rural Non-Farm Growth, Poverty and Inequality in Bangladesh, 1983-84."Background Paper for Rural Non-Farm Sector Study.

9. Syedduzaman, M. 1995. Report on "Poverty Alleviation Microfinance Programs." GOBproject proposal.