Document ofThe World Bank

Report No: 19596-BD

PROJECT APPRAISAL DOCUMENT

ONA

PROPOSED CREDIT'

IN THE AMOUNT OF SDR 34.5 MILLION

(US$46.9 MILLION EQUIVALENT)

TO THE

PEOPLE'S PEPUBLIC OF BANGLADESH

FORA

FINANCIAL INSTITUTIONS DEVELOPMENT PROJECT (FIDP)

August 24, 1999

Bangladesh Country DepartmentSouth Asia Regional Office

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CURRENCY EQUIVALENTS

(Exchange Rate Effective August 1, 1999)

Currency Unit = Taka49.5OTaka = US$1

ITaka= 0.020202 USD

FISCAL YEAR

July I - June 30

ABBREVIATIONS AND ACRONYMS

AAE Accounts and Audit ExpertADB Asian Development BankBB Bangladesh BankBOD Board of DirectorsBSB Bangladesh Shilpa BankBSRS Bangladesh Shilpa Rin SangsthaC&AG Comptroller and Auditor GeneralCAS Country Assistance StrategyCBSF Credit, Bridge and Standby FacilityCDC Commonwealth De,;elopment CorporationCLO Collateralized Loan or Lease ObligationsCEO Chief Executive OfficerDCA Development Credit AgreementDD Deputy DirectorDFI Development Financing InstitutionDMD Deputy Managing DirectorDNS Directorate of National SavingsDO Development ObjectiveDOAFAP Directorate of Audit-Foreign Aided ProjectsDOE Department of EnvironmentEDP Export Development ProjectFl Financial InstitutionsFIDP Financial Institutions Development ProjectFAA Facility Advisory AgreementFSAC Financial Sector Adjustment CreditGDFI Gross Domestic Fixed InvestmentGDP Gross Domestic ProductGOB Government of BangladeshIDA International Development AssociationIDLC Industrial Development Leasing Company of Bangladesh Limited

Vice President: Mieko NishimizuCountry Director: Frederick Temple

Sector Director: Marilou UyTeam Leader: Joseph Pernia

Task Leader: Alfredo Dammert

IFC International Finance CorporationIP Implementation ProgressIPDC Industrial Promotion and Development Company of Bangladesh Ltd.IT Information TechnologyLACI Loan Administration Change InitiativeLC Law CommissionMD Managing DirectorMFA Master Facility AgreementMOF Ministry of FinanceMOL Ministry of LawNBFI Non-Bank Financial InstitutionNCB Nationalized Commercial BanksNPBIT Net Profit Before Interest and TaxesNSS National Saving SchemesOD Operational DirectivesPMRs Project Monitoring ReportsPSIC Private Sector Industrial CreditQBS Quality-Based SelectionREPO Repurchase AgreementROE Return On EquitySA Special AccountSEC Securities Exchange CommissionAA Administration AgreementTA Technical AssistanceTAPP Technical Assistance Project ProformaTB Treasury Bond/ BillTOR Terms of ReferenceULC United Leasing Company

BangladeshFinancial Institutions Development Project (FIDP)

CONTENTSPage No.

A. Project Development Objective 2

B. Strategic Context 2

1. Sector-related CAS goal supported by the project 22. Main sector issues and Government strategy 23. Sector issues to be addressed by the project and strategic choices 4

C. Project Description Summary 5

1. Project components 52. Key policy and institutional reforms supported by the project 73. Benefitsandtargetpopulation 84. Institutional and implementation arrangements 8

D. Project Rationale 10

1. Project alternatives considered and reasons for rejection 102. Major relatedprojects financed by the Bank and/or other development agencies 113. Lessons learned and reflected in proposedproject design 124. Indications of borrower commitment and ownership 125. Value added of Bank support in this project 13

E. Summary Project Analysis 13

1. Economic 132. Financial 143. Technical 144. Institutional 145. Social 146. Environmental assessment 147. Participatory approach 158. Checklist of Bank Policies 15

F. Sustainability and Risks 15

1. Sustainability 152. Critical risks 163. Possible controversial aspects 18

G. Main Loan Conditions 18

1. Effectiveness conditions 182. Other 18

H. Readiness for Implementation 18

I. Compliance with Bank Policies 19

Annexes

Annex 1. Project Design Summary 20Annex 2. Detailed Project Description 23

2a Methodology to Estimate Funding under CBSF 262b Highlights of the CBSF 282c Terms of Reference for Manager of the CBSF 33

Annex 3. Estimated Project Costs 40Annex 4. Cost-Benefit Analysis Summary 41Annex 5. Financial Summary 43Annex 6. Procurement and Disbursement Arrangements 44

Table 6.1 Project Costs by Procurement Arrangements 45Table 6.2 Thresholds for Procurement Methods and Prior Review 46

Annex 7. Project Processing Budget and Schedule 47Annex 8 Letter of Sector Policies 48Annex 9 Eligibility Criteria for Financial Institutions 52Annex 10 Summary Appraisals of Financial Intermediaries 55Annex 11. Documents in Project File 60Annex 12. Status of Bank Group Operations in Bangladesh 61Annex 13. Country at a Glance 62Map 64

BangladeshFinancial Institutions Development Project (FIDP)

Project Appraisal Document

South Asia Regional OfficeBangladesh

Date: August 27, 1999 Task Leader: Alfredo DammertTeam Leader: Joseph Pernia

Country Director: Frederick Temple Sector Director: Marilou UyProject ID: BD-PE- Sector: Industrial/IDF Program Objective Category: Private Sector Development44811Lending Instrument: Financial Intermediary Loan Program of Targeted Intervention: [ ] Yes [X3 No

Project Financing Data [] Loan [X] Credit [I Guarantee [ Other [Specify]

For Loans/Credits/Others:

Amount (US$m/SDRm): 46.9/ 34.5Proposed terms: [X] Multicurrency [ Single currency, specify

Grace period (years): 10 [I Standard Variable [ Fixed [ LIBOR-basedYears to maturity: 40Commitment fee: 0.5%

Service charge: 0.75%

Financing plan (US$m):Source Local Foreign Total

Government 0.41 5.00 5.41IDA 0.92 45.98 46.90IMF - 0.30 0.30Financial Intermediaries - 5.08 5.08

Total 1.33 56.36 57.69

Borrower: People's Republic of BangladeshGuarantor: Government of BangladeshResponsible agencies: Ministry of Finance (MOF), Bangladesh Bank (BB), Securities Exchange Commission (SEC).

Estimated disbursements (Bank FY/US$m): 1999/00 2000/01 2001/02 2002/03 2003/04Annual 11.25 9.77 8.98 8.50 8.40

Cumulative 11.25 21.02 30.00 38.50 46.90

Expected effectiveness date: 10/20/99 Expected closing date: 8/30/05

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A: Project Development Objective (refer to Annex 1 for the Project Design Summary)

The objective of the project is to promote the development of non-bank financial institutions (NBFIs), inparticular, and investment financing, in general, on a sustainable basis contributing to improvements inthe quality of intermediation, and the speed and efficiency of industrial growth in Bangladesh.The proposed project forms part of a number of Government initiatives to strengthen the financial sector:(i) a proposed Central Banking Technical Assistance from IDA (section D2); and (ii) a recently approvedcapital development program loan from ADB for the expansion and deepening of equity markets (sectionD2).

B: Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project (see Annex 1):

CAS document number: 17453-BD. Date of latest CAS discussion: July 20, 1999

IDA supports the Government's poverty reduction strategies of: (i) promoting rapid, job-creatingeconomic growth; and (ii) interventions that directly assist the poor.

The assistance strategy for FY98-00 onwards considers the need to improve financial intermediation inbanks, nonbank institutions, and capital markets. Concerning commercial banks, IDA's strategy is tohelp the government rebuild the three institutional pillars of sound banking -- corporate governance,strong regulatory systems, and an effective court system. In this regard, an IDA-led initiative is helping todefine the needed banking reforms and considering adjustment lending support for bank restructuring andprivatization together with technical assistance for strengthening supervision and legal reforms. While aprogram for restructuring the banking sector is agreed upon with the Government, our strategy in thenear- to mid-term is to support expansion of NBFIs which represent the sounder and more efficient partof the financial sector. As such, the project will promote the development of NBFIs in order to: (i)provide alternative opportunities for savers; and (ii) increase on a sustainable basis the supply of termfunds for competitive projects which generate growth and employment. These two outcomes contributedirectly with the CAS poverty reduction strategy.

2. Main sector issues and Government strategy:

(a) Unsatisfactory Intermediation by Nationalized Commercial Banks (NCBs) and DevelopmentFinancing Institutions (DFIs): In the past NCBs accounted for 50-60 percent of term loandisbursements. However, the NCBs have largely failed in investment financing and a potentially difficultsituation has arisen for the following reasons: (i) Maturity mismatch. Average maturity of deposit fundsof NCBs stands at 9.5 months while maturity of the loan portfolio is about 20.4 months, (ii) Non-performing loans. 40-50 percent of their term loans are non-performing, though the performance ofrecent loans is improving, and (iii) Inefficiency. Interest rates charged by NCBs for term lendingaverage 13.5 percent, do not cover the cost of funds (7 percent), administrative costs (3 percent) and thecost of bad debts. Performance of the two public industrial DFIs is also highly unsatisfactory given that:(i) about 80 percent of the loan portfolio of BSB and 60 percent of the loan portfolio of BSRS are non-performing, (ii) collection ratios are very low, and (iii) both institutions depend fully on governmentfunds for financing new projects as most donors have ceased to provide any credit lines and these DFIshave failed to mobilize alternative resources, domestically and overseas.

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In order to stem the flow problem, the Government of Bangladesh (GOB) is encouraging NCBs to restricttheir term lending activities. As a result NCBs' disbursements fell in FY96-97 to only 40 percent of thosein the previous FY. This GOB initiative is a positive step and constitutes a reversal from past policies inwhich NCBs were encouraged to provide excessive term lending. However, due to its concern forincreasing funds for term lending, the GOB announced in April, 1999 the issuing of IndustrialDevelopment Bonds through two NCBs (Sonali and Agrani) both in the international and domesticmarkets. Although these NCBs are the bond issuers they will onlend a large part of these proceeds toother financial institutions for project financing. The GOB has indicated to IDA that these funds will notlead to an increase in the NCBs' term lending portfolio, but principally a restructuring of balance sheetsthrough improved maturity matching of assets and liabilities, thereby abiding with their Statement ofReform Policy for the Non-Bank Financial Sector (para D.4 and Annex 8).

(b) Weak Regulatory System for NBFIs: NBFIs are regulated by the Financial Institutions Act of1993 and the rules of 1994. The existing regulatory framework is inadequate since it does not distinguishbetween deposit and non-deposit takers. IDA has proposed to the Government that the basic principle forNBFI regulations should be the classification into deposit and non-deposit takers, according to which: (i)NBFIs that are deposit takers should be regulated as banking institutions, but with lower minimum capitaland liquidity requirements since these are allowed to take only term deposits, do not participate in foreignexchange operations, and do not have access to BB discount facility, (ii) NBFIs' functions of obtainingfunds through public offerings of securities should be under the regulatory jurisdiction of the SEC, and(iii) NBFIs not perfoming any of the above functions, i.e. not affecting the public interest, should beregulated as corporations including the requirement that these follow adequate accounting and auditingprocedures.

BB has agreed to review NBFI regulations and operating standards in accordance with IDA mission'srecommendations of November 26, 1997 and to undertake an institution building program for its NBFIDepartment in the context of the Central Banking TA project. With IFC participation, IDA iscoordinating with SEC the development of procedures for the issuance of market traded instruments.Strengthening of the SEC is being carried out under the ADB's Capital Market Development AdjustmentLoan.

(c) Inadequate Legal Framework for NBFIs: The inadequate legal framework, leading inter-alia tolong drawn out foreclosure procedures, constitutes a major constraint in term finance and imposesadditional costs to lenders and borrowers. As a result leasing companies lend against liquid collateral(cash, CDs, shares) rather than the assets being financed.

The Government is taking steps to strengthen the legal framework under an IDF Grant. Further IDAsupport is being considered under the proposed Judicial and Legal Reform Project, which would includestreamlining court procedures for loan recoveries and establishing alternative dispute resolutionmechanisms for NBFIs. However, the additional costs to lenders and borrowers are expected to continuefor sometime until capacity building through such a project will have an effect. This is a commonproblem to projects involving the private sector since such projects are vulnerable in an environmentwhere the legal and regulatory frameworks are still nascent.

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(d) Underdeveloped Funding Mechanisms for Term Lending: Term loans provided by the financialsystem in Bangladesh amount to only about US$250-300 million per year, equivalent to about 1.5 percentof GDP, while private and public investment amounts to about 16 percent of GDP. A major constraint tothe provision of term loans is the lack of a well developed long-term savings market. NCBs fund theirterm loans mainly with their deposits creating a maturity mismatch (see 2 (a) above). Also, publicdevelopment finance institutions - Bangladesh Shilpa Bank (BSB) and Bangladesh Shilpa Rin Sangstha(BSRS) -- which have reduced their lending to insignificant levels since the 1990s depend fully onGovernment and Multilateral Funds for their operations, which the latter are no longer providing. NBFIs,which have shown to be the most dynamic and efficient sources for project financing in Bangladesh,have until now secured funds mainly through multilateral lenders and commercial banks. Experiencefrom Pakistan and other countries suggests that a major source for NBFI funding are debentures sold toboth institutions and individuals. However, during project preparation a number of constraints wereidentified that prevented the development of the bond markets in Bangladesh, including: (i) restrictions toinstitutional investors - life insurance companies and provident funds were not allowed to purchaseprivate bonds, (ii) issuance costs for corporate bonds are significantly higher than in Pakistan and othercountries ( e.g. issuance cost in Bangladesh is about 5 percent -- including a 2 percent stamp duty onbond issues --compared to only 3 percent in Pakistan) due mainly to taxes, (iii) there are no benchmarkinterest rates, (iv) government saving rates -- the National Saving Schemes (NSS) -- are not marketdetermined, (v) there is a lack of a comprehensive set of guidelines by the Securities and ExchangeCommission (SEC) for issuing bonds and debentures, an.d (vi) there is no secondary bond market.

The Government has already taken important steps to address the above issues both under the proposedand other projects. On June 7, 1999, the Cabinet approved the amendment to the Trust Act to allowpension and insurance funds to invest up to 25 percent in the capital market. The Government has alsoagreed to reduce the stamp duties and other taxes affecting the issuance cost of bonds. Since end 1998,the BB started issuing Treasury Bonds of up to two years maturity (previous maturities were up to 180days), which will provide a benchmark for interest rates. Furthermore, the Government has recentlyimposed a 10 percent tax on interest income arising from NSS saving certificates (interest income belowUS$500 equivalent is exempted from this tax in order to protect small savers) in order to create a levelplaying field with bonds and other debt instruments. Although, a secondary market for TBs has not yetbeen created, IMF assistance has been secured by the Government aiming at the development of thismarket.

(e) Potential Risk of Contagion of NBFIs: A potential problem is the risk of contagion of NBFIs bythe non-performing loans in the financial sector. Main measures to avoid this risk will be: (i) rigorousproject analysis by FIs participating in the proposed project will ensure that borrowers have ensuredadequate working capital financing; (ii) to the extent possible NBFIs will finance permanent workingcapital as part of project financing; (iii) cofinancing of investment projects will be limited to performingFIs; and (iv) clients of weak banks (defined as banks with CAMEL rating of 4 as rated by BB) will not beeligible for CBSF financing through eligible FIs. More broadly, through investments in NBFIsbonds/CLOs by NCBs, the proposed project will support the flow of funds from inefficient NCBs to theefficient FIs.

3. Sector issues to be addressed by the project and strategic choices:

As part of the proposed project, the Government has prepared a statement of Reform Policy for the Non-Bank Financial Sector (Annex 8). The project components described below will assist the Government in

4

implementing such policies. In particular, the project will address the following sector issues: (a) it willstrengthen the high performing part of the FIs by funding only those that meet stringent eligibility criteria;and (b) it will assist eligible FIs to develop their own funding mechanisms for term financing through: (i)supporting FIs efforts through the bridge and standby component of the project, (ii) ensuring that theGovernment takes the adequate steps to eliminate constraints to the development of markets for bondsand other debt instruments (i.e. reducing advantages of GOB saving certificates, reducing issuance costfor bonds), and (iii) strengthening the institutional framework for issuing bonds and debentures (i.e.improving regulations, creating appropriate benchmarks) with IFC participating in the development of theregulatory and legal framework for bond issues, promotion of credit rating firms and development ofunderwriting and structuring capabilities of its investee companies. A strategic choice has been made toleave the recommended improvements of the regulatory framework for NBFIs - provided under projectpreparation -- to the proposed Central Bank Technical Assistance Loan given the commonality ofregulations required for banks and non-banks. Similarly, streamlining of court procedures for loanrecoveries and establishing alternative dispute resolution mechanisms would be considered under theJudicial and Legal Reform project which is under preparation. These choices would allow a sharperfocus for the proposed NBFIDP while assigning two important related activities to those projects underwhich they constitute the main focus of their operation.

C: Project Description Summary

1. Project components (see Annex 2for a detailed description and Annex 3for a detailed costbreakdown).

The project comprises two main components: The Resource Mobilization component will address theexternal factors that delay or constrain resource mobilization from the market. It will aim atsimplifying/streamlining regulations for market traded instruments to facilitate bond and security issues,creating an even playing field for individual investors between market traded instruments andgovernment saving schemes, and developing market oriented mechanisms for raising funds by thegovernment through strengthening government treasury bond markets (which will also create abenchmark for bonds issuance). The component to Strengthen Financial Institutions cons;sts on creatinga Credit, Bridge and Standby Facility (CBSF) that would encourage the development of term financingby the more efficient and healthy part of the financial system. The CBSF will provide funding from IDAto FIs through a variety of mechanisms that would increase their funding while enabling and encouragingthem to mobilize medium to long term resources from the local market. One subcomponent of the CBSFwill provide term financing as a regular credit line up to a predeternined amount. The Bridge andStandby component will encourage FIs to raise their own funds by facilitating their issuance ofbonds/debentures and the securitization and sale of their loan/lease portfolios. This will be accomplishedthrough the provision of temporary bridge financing to allow FIs to accumulate assets, and of standbysupport as commitments to purchase the unsold balances of bonds/debentures and CLOs that underwritersare unable to place in the market. A liquidity fund (not financed by IDA) will provide temporaryfinancing to institutional investors who want to liquefy temporarily their holdings of bonds/CLOs under arepurchase agreement (REPO) mechanism. Funding of the CBSF for US$49 million (including GOB'sand FIs' contributions) is justified based on an analysis of FI requirements (Annex 2a). Three FIs --United Leasing Company (ULC), Industrial Promotion and Development Company (IPDC) and IndustrialDevelopment Leasing Company (IDLC), - already qualify according to the eligibility criteria (Annex 9),with their final eligibility subject to the presentation of their audited 1998 financial statements. Another

5

four FIs are being considered for eligibility under the proposed project. It is expected that between fourand seven FIs would ultimately qualify.

Diagram of the CBSF

Sale of Assets - -. - - - -.CBSF …… ~ ~ ~ ~ ~ ~ ~ ~ ~ , ~ n Facility . _ .

Master Facility - Advisor -Agreement II

----------------- --- --

Vanous Agency and II/ \ / \ / \ I + Service Agreements ;

< Credit > <Bridge > <Standby > I;

\ / \ / 1. | +g CLO --+ 4 Servicingj ' i | \ / I ~~~~~~~~~Agent !j

Financial Sale of)ssets r- PayingInstitution I Agent

B;onds! I.Sub-Loan/| I ~ ~ ~ < Debent. -? I i | Custodial

LeaseAgreement \- - IiI ~~~Agent '

Issuance Tr1Investment IEnterprise

Underwriters/Dealerset-

Sbroect Liquidity Deer

6t,__

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Project Components and Cost Summary

Component Cate- Indicative % of Bank % ofgory Costs Total Financing Bank

(US$M) (US$M) Finan-cing

I. Resource Mobilization for NBFIs and otherFIs through:(i) Development of issue rules for IB 0.27 0.47 0.26 96.3bonds/debentures.(ii) Implementation of procedures for IB 0.08 0.14 0.08 100.0bonds/debentures.(iii) SEC training on debt instruments. IB 0.05 0.09 0.05 100.0(iv) BB training on debt instruments. IB 0.05 0.09 0.05 100.0(ii) Reform of GOB's National Saving Schemes. POL/IB 0.67 1.16 0.57 85.0(iii) Development of procedures for secondary TB IB 0.40 0.69 - -

market.Resource Mobilization Subtotal 1.52 2.6 1.01 66.4

II. Strengthening of Private NBFIs and otherFIs through:(i) Development of a credit, bridge and standby IB 1.30 2.25 1.10 84.6facility (CBSF) to fund eligible FIs and facilitatetheir raising funds.(ii) Management of CBSF. IB 2.50 4.33 2.50 100.0(iii) Funding of CBSF. CR 49.00 84.94 40.0 81.6(iv) Capacity enhancement of FIs business IB 2.30 3.99 1.22 52.2planning, resource management and MIS.(v) Resource mobilization for FIs' IB 0.43 0.74 0.43 100.0(vi) Revision of CBSF Mechanism IB 0.64 1.11 0.64 100.0

Strengthening NBFIs/FIs Subtotal 56.17 97.36 45.89 81.7Total 57.69 100.0 46.90 81.3IB: Institution Building. POL: Policy. CR: Credit. OT: Other.

2. Key policy and institutional reforms supported by the project.:

The project focuses on providing support to the private sector and addressing only those policy reformsnecessary to strengthen financial intermediation for investment projects. For that reason the project willsupport the following policy measures: (a) aligning Government NSS to market conditions; (b) allowingpension and insurance funds to invest in private bonds and debentures; and (c) issuing TBs of maturitiesof up to five years and allowing a secondary market for these instruments thus creating a benchmark formedium term private securities. Concerning institutional development, the project will focus mainly onthe strengthening of FIs in the private sector through the activities performed under the CBSF andtechnical assistance under the project. IFC will collaborate with IDA in strengthening the market for

Success fee will be paid by FIs.

7

bonds and debentures through providing advice to SEC and participating in the establishment of creditrating agencies and underwriters.

3. Benefits and target population:

The proposed project is expected to generate the following benefits:

(a) For the financial sector. It will support expansion of the sounder and more efficient part of thefinancial sector while the rest is being restructured. It will support the availability of term financingon a sustainable basis through strengthened FIs, increased availability of funds for term lending, anddevelopment of the bond and securities markets.

(b) For the overall economy. It will promote increased efficient private investment in competitiveprojects that would generate economic growth and employment and provide the population withadditional saving opportunities.

4. Institutional and implementation arrangements:

(a) Organization Responsible for the Project. The Bangladesh Bank (BB) will be responsible forimplementation of the project. Management of the Project would be as follows:

(I) Policy and Overall Coordination A project steering committee headed by the Secretary of Financeand representatives of ERD, IRD, SEC and the Finance Division will meet periodically to decide onpolicy and major implementation aspects of the project. The Deputy Governor of BB in charge of theFinancial Institutions (FI) Department will act as Secretary of the Committee.

(II) Implementation The Deputy Governor BB in charge of the Fl Department will be the ProjectDirector. He will monitor implementation of the project components and will draw upon the assistance ofthe following when required: Joint Secretary Banking, Joint Secretary ERD, Director General for theDirectorate of National Savings (DNS), and Member SEC. The Chairman SEC and the Director GeneralDNS will be responsible for day to day implementation of the project in their areas of concern. TheDeputy Governor of BB will be responsible for establishing and implementing the Credit, Bridge andStandby Facility (CBSF).

(b) Role of IDA During Project Implementation. IDA's participation in project implementation will besubstantial. First, it will assist the Government in organizing workshops and seminars during projectpreparation and implementation. Second, it will assist the Government, when required, on policy designand implementation. Third, the innovative approach under the CBSF will require that IDA provideextensive advice for its establishment and functioning. Fourth, it will execute the disbursements forsubproject financing if the CBSF is not put in place immediately by project effectiveness. Fifth, it willprovide support for the implementation of the technical assistance components including selection ofconsultants, advice and participation in monitoring implementation of each component, and assisting theGovernment in taking any corrective measures when necessary. Sixth, it will undertake periodicsupervision missions, including two term reviews during implementation.

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(c) Administrative Arrangements for Project Implementation.

(I) Procurement. The Deputy Governor of BB will be responsible for procurement of goods, consultantservices and training for project component I. He will also be responsible for contracting the facilitymanager and training of GOB/BB personnel under component II. Financial Intermediaries will procuregoods and services financed under the CBSF and consultants for their institutions under projectcomponent II.

(I) Financial Management and Reporting Arrangements. BB will maintain a computerized financialmanagement, accounting, disbursement and reporting system for the project in accordance with generallyaccepted accounting principles and practices. The accounts and records will be capable of disclosing atrue and fair view of the financial position and of facilitating progress monitoring. To facilitate this BBwill engage a full-time Accounts and Audit Expert (AAE) external to BB, reporting to the Projectdirector, and supervising an Accounts Officer and the Unit's support staff. They will prepare quarterlyand annual accounts and generate quarterly reports, to ensure consistency with IDA's requirements underOP/BO 10.02. Annual financial statements will be audited by a private audit firm acceptable to IDA.Internal controls will include a separate Project Audit Committee, proper segregation of functionalresponsibilities, signing of checks after clearance by the AAE, verification of procurement proposals,monthly reconciliation of bank accounts, and regular detailed reporting.

Participating FIs will submit annual audit reports to BB/CBSF management and IDA within four monthsof the end of the year.

A special account will be opened with BB. Disbursements will be made by BB to the beneficiaryagencies on reimbursement basis directly from the Special Account. After initial advance in the SpecialAccount, quarterly disbursements would be made on the basis of submission of quarterly ProjectMonitoring Reports (PMRs), the form of these reports is to be agreed during negotiations with theBorrower.

(III) Monitoring and Evaluation Arrangements. The project has set forth benchmarks and performanceindicators (Annex 1) to evaluate progress on individual components. These have been agreed duringnegotiations and will be periodically reviewed to see their effectiveness against performance standardsand implementation schedules.

BB will present the following reports to IDA:

* For the CBSF (prepared by the CBSF Advisor): (a) monthly reports with key data on utilization andstatus of its components and financial statements; (b) quarterly reports on the implementation of theCBSF component; (c) semi-annual assessments of the FIs' demand for the three CBSF components;and (d) annual projection of the CBSFs cash flow and balance sheet.

* For the technical assistance sub-components: quarterly reports on the progress of each sub-component

The participating FIs will: (a) verify the status of subprojects supported under the CBSF by on-siteinspection at least quarterly; (b) prepare sub-loan portfolio management and progress reports covering

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operations under the credit to be submitted to BB/CBSF management and IDA within thirty days of eachsemester; and (c) undertake quarterly and annual assessments of the demand for funds from the CBSF tobe presented to BB/CBSF management.

IDA will undertake two term reviews during project implementation. BB will be responsible for ensuringthat the above audits and reports are prepared and submitted on time. It will also prepare theGovernment's contribution to the Implementation Completion Report (ICR) at the end of the projectaccording to IDA guidelines.

Project Structure

CBSF Project Steering OversightBoard Committee

Project Management UnitDeputy Governor, NBFI

Supervisor/Coordinator

Deputy DirectorSupport Staff

National Savings Bangladesh Bank Securities andCBSF Agent Directorate GFl Exchange Implementation

Director General Commission

D: Project Rationale

1. Project alternatives considered and reasons for rejection:

(a) A more ambitious project covering capital markets was rejected because ADB has recentlyapproved a Capital Market Development Adjustment Operation for Bangladesh. Moreover,experience in Bangladesh has shown that focused operations have a much higher chance ofsucceeding. As an example, the recently closed Private Sector Industrial Credit (PSIC) has beensuccessfully completed because it focused on a limited number of activities that were easy to reviewand strengthen when problems arose.

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(b) Although a pure technical assistance operation could achieve some of the project objectives, a termfinancing facility is being considered under the project since it would take time to develop the longterm savings markets, particularly the shifting of investor preference from the safety of fullygovernment backed saving schemes and bank deposits to the non-guaranteed term paper of privatefinancial institutions. The proposed project will provide term financing and a bridge and standbyfacility that would support efforts by eligible NBFIs and FIs to issue bonds and collateralized loanand lease obligations in order to raise funds from the market.

2. Major related projects financed by the Bank and/or other development agencies (completed, ongoingand planned):

Sector Issue Project Latest SPN (Form 590) RatingsBank Financed Projects

Implementation DevelopmentProgress Objective

(IP) (DO)Bank-financedImproving regulations and supervision Financial Sector S Sof the banking sector; liberalizing Adjustment Creditinterest rates; and recapitalizing NCBs. (FSAC)Improving availability of export credit; Export Development S Sstrengthening capacity of export credit Project (w/USAID)guarantee and duty drawback (EDP)institutions.Promoting private sector development Private Sector S Sby strengthening term lending by private Industrial CreditFIs; and supporting reforms under FSAC (PSIC)for interest rate liberalization and loanrecoveries.Ensuring strong regulatory framework Central Bank Planned Plannedfor banks by strengthening BB; Technical Assistancestrengthening the legal environment -- Projectlaws, court procedures, and judicialcapacity - to restore financial discipline;and improving governance in BB andNCBs and private banks throughrestructuring and privatization of NCBs.Improving the efficiency of the legal and Judicial and Legal Planned Plannedjudicial system through reform of the Reformlegal and regulatory framework,strengthening the Ministry of Law(MOL) and Law Commission (LC),improving legal education, strengtheninginstitutional and physical infrastructure,and improving access to justice.

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Other Development AgenciesADB: Accelerating the development of Capital Marketthe domestic capital market by Developmentstrengthening market regulations and (Approved insupervision, developing capital market December 1997)infrastructure, modernizingCapital market support facilities,increasing the limited supply ofsecurities, developing institutionalsources of capital, and strengtheningpolicy coordination. . -

IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

3. Lessons learned and reflected in the project design

(a) Focusing on Main Activities. Experience in Bangladesh has shown that focused operations have amuch higher chance of succeeding (see DI(a)). Therefore the proposed project focuses on a limitednumber of activities considered necessary and sufficient for achieving its objectives.

(b) Addressing Institutional Capacity Issues. Due to the complexity and innovative nature of theCBSF and its transitional nature, which does not require GOB institutional strengthening, the projectwill finance an independent manager with international experience to administer the CBSF facilitythat will report to BB.

(c) Ensuring Sustainability. In spite of success of the PSIC, beneficiary FIs in Bangladesh achievedlimited increases in their own sources of funding, since there was no explicit mechanism toencourage/support FIs development of funding sources. The proposed project will enhance thepossibility that participating FIs would raise funds from the market by: (i) supporting thedevelopment of sources of funds for term lending through its bridge and standby components, (ii)increasing FIs fund raising capabilities through technical assistance and training, and (iii) assisting --through IFC participation -- in developing regulations for bond markets and creating supportinstitutions such as credit rating agencies and bond underwriters.

(d) Developing a Realistic Timetable. Although efforts would be made to shorten the implementationtimetable through technical assistance and the choice of government agencies committed to theproject, a realistic timetable will be developed based on past experiences taking into account theprocedures required to implement government actions in Bangladesh (e.g. selection of consultants,issuing of decrees).

4. Indications of borrower commitment and ownership:

Responding to the Ministry of Finance's concern about the lack of sources for financing investments bythe private sector in Bangladesh an IDA team prepared a Non-Bank Financial Markets Sector Reportoutlining the measures needed for the development of term financing. The MOF agreed to follow-up therecommendations and requested IDA's assistance through a project (letter of June 29, 1997) to whichIDA agreed. The MOF followed-up on the various recommendations and agreements of IDA'spreparation and appraisal missions that are reflected in the GOB's Statement of Reform Policy for the

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Non-Bank Financial Sector (Annex 8). The actions agreed cover: (i) implementing IDA'srecommendations for Establishing a Sound and Competitive Banking Sector (report of June 1998), (ii)discouraging NCBs from increasing their term lending activities until governance and management areadequately reformed, (iii) eliminating restrictions to institutional investors (pension and life insurancefunds) to purchase private bonds, (iv) reducing/eliminating the stamp duties for issuance of corporatebonds (implemented), (v) revising the National Saving Schemes to align their returns to those available inthe market (implemented), (vi) developing guidelines by SEC for issuance of bonds/debentures, and (vi)developing a secondary market for TBs.

5. Value added of Bank support in this project:

IDA's participation in the proposed project is important because:

(a) It possesses in-depth knowledge of the NBFI markets in Bangladesh through its involvement inprevious projects and its preparation of the recent overview report on "Developing Non-BankFinancial Markets."

(b) It has gained additional experience with the recently implemented PSIC in Bangladesh.

(c) It will provide different kinds of international expertise within and outside the Bank necessary for thedevelopment of term financing.

(d) It will complement the actions being pursued under the proposed Central Bank Technical AssistanceProject and the Capital Markets Development Program recently approved by ADB.

(e) Its participation will provide assurance to FIs and other private institutions that the appropriateconditions and market mechanisms for the development of term lending will be in place.

E: Summary Project Analysis (Detailed assessments are in the project file, see Annex 11)

1. Economic (supported by Annex 4):

[x] Cost-Benefit Analysis: NPV=US$ 5.49 million; ERR= 14%

The overall economic benefit of the project would be its support of the expansion of the sounder andmore efficient part of the financial sector, providing alternative opportunities for savers and an increasedsupply of term funds for competitive projects. Since the project is designed to have a catalytic role insupporting NBFIs' and other FIs' efforts to raise term funds for investment lending it is difficult toquantify its long term impact. This long term impact would consist in the additional benefits to theeconomy arising from the more efficient use of savings to finance investment projects (increase inconsumer's and producer's surplus) during and beyond the project's life when FIs continue to raise fundswithout the project's support. However, an attempt has been made to quantify the short term impactduring the project's life based on a projected stream of gross income for the potential subprojects (usingdata from the previous operation - the PSIC) minus the cost of funds. As shown above this has yielded apositive NPV and an ERR of 14% on IDA's credit. The long term effects are expected to be muchhigher.

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2. Financial

(a) Financial performance of FIs will be addressed by revision of the regulatory framework for NBFIsunder the proposed Central Bank Technical Assistance Project, incorporation of prudential standards inthe eligibility criteria for participating FIs under the facility, and development of institutionaldevelopment plans for those institutions that do not meet the eligibility criteria; (b) financial performanceof subprojects will be addressed by agreeing with eligible FIs on the evaluation methodology and follow-up of sub-projects; (c) financial management capacity will be ensured through the contracting of amanager for the CBSF and technical assistance to the eligible FIs.

3. Technical:

None.

4. Institutional:

(a) Institutional capacity weakness of GOB will be addressed through hiring specialized expertise formanaging the CBSF; and (b) the need to strengthen financial intermediaries capabilities to diversify theirsources of funding and appraise projects would be addressed through technical assistance and training.

5. Social:

None.

6. Environmental assessment:

(a) Issues: Industrial development has an impact on the environment. To address this, three types ofactions would be taken: (i) as criteria of eligibility for participation under the proposed CBSF, FIsmust prove that their subproject approval procedures include verification of the Department ofEnvironment (DOE) clearance and must assign a suitably trained member of staff to perform thefunction of environmental compliance officer; (ii) processing of the subprojects under the proposedcredit facility would depend on whether these fall under the red, orange or green industrial categoriesas established by the Department of Environment (DOE). Applications for subproject disbursementwould require clearance from DOE for those subprojects which fall under the orange and redcategories, which will be the principal responsibility of the environmental compliance officer; and(iii) to ensure that appropriate training is available for Fl staff to fulfill the role of environmentalcompliance officer, the project includes in its Fl capacity building component the establishment of anenvironmental compliance course at the Bangladesh Institute for Bank Management or anotherappropriate institution. The project will support the training of trainers so that the environmentalcompliance course can be offered on an ongoing basis.

(b) Environmental category: B

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(c) Justification/Rationale for category rating: Individual sub-loans have not been identified, butgiven the fact that some are likely to fall into the orange or red categories of industries (as defined by theDOE), a "B" rating has been given in line with prevailing practice and precedents.

(d) Proposed Actions: Based on OD 4.01, no separate Environmental Analysis or EnvironmentalManagement Plan is needed for the reason that any potentially polluting subloans will require a separateclearance from the DOE. Some subloans may also require an environmental assessment, based oncurrent DOE regulations.

(e) Status of any other environmental studies: "Setting Environmental Priorities in Bangladesh"(white cover report, May, 1997) is the strategy document guiding IDA's environmental agenda inBangladesh. Both IDA and CIDA are currently initiating activities to improve the monitoring andenforcement of industrial pollution guidelines.

7. Participatory approach:

Collaboration (COL) with potential financial intermediaries to: (a) identify major problems affecting theirdevelopment and propose means to address these problems; (b) determine the potential demand for termlending and their needs; (c) address any institutional issues of BB for the processing of subprojectapplications under the proposed financing facility; (d) review IDA/GOB proposed terms and conditionsand eligibility criteria under the proposed financing facility; (e) discuss their needs for technicalassistance to strengthen their capabilities; and (f) develop and implement seminaries and workshops.

& Checklist of Bank Policies

This project involves:[x] Environmental impacts (OP 4.01) (BP 4.01) (GP 4.01)[x] Financial management (OD8.30) (OP 10.02) (BP 10.02)

F: Sustainability and Risks

1. Sustainability:

Sustainability of the project beyond implementation depends on three factors: (a) Capacity of NBFIs/FIsfor term lending and fund raising. The availability of a financing facility linked to stringent eligibilitycriteria would encourage NBFIs and other FIs to strengthen their project evaluation and term lendingcapabilities, while the bridge and standby facilities provided under the proposed project would promotefund raising by NBFIs and FIs from the market. The development of an appropriate regulatoryframework for NBFIs under the proposed Central Bank Technical Assistance Project would ensure thehealth of the NBFI system; (b) Development of market sources of funding for term lending. Necessaryactions required under the project were that the Government revise the conditions of its saving certificatesto reflect market conditions already implemented, and eliminate the stamp duties on issuance ofbonds/debentures so that financial institutions can become competitive in raising long term funds. Thedevelopment of the bond/debentures and CLO markets under the project would provide appropriateinstruments to raise funds from the market; and (c) Supply of funds by institutional investors. Allowinginsurance and pension funds to invest in bonds and securities would enhance the supply of funds for termlending.

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2. Critical Risks (reflecting assumptions in the fourth column ofAnnex 1):

Risk Rating Risk Minimization MeasureAnnex 1, cell "from Outputsto Objective"

Lack of interest for bonds of M Liberalization of Govt. savinghigher term maturity. schemes already implemented

and other policies will makethese bonds attractive.

NBR may not reduce stampduties and taxes on bonds. N GOB has announced its

decision to eliminate/reducethe stamp duty on bondsduring 1999.

Lack of investors interest for In-depth analysis has beencredit under project. N made showing investors

interest. Experience underPSIC shows that there issubstantial demand.

FIs may not be interested in Potential FIs have beenparticipating in the proposed N consulted during credit designfinancing facility. and shown substantial

interest.

NCB's do not reduce their The GOB has confirmed itsexposure to term loans. M strategy to discourage NCBs

to increase their term lendingactivities until governance andmanagement are adequatelyreformed. Progress hasalready been made during thecurrent Government.

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Annex I, cell "fromComponents to Outputs"

MOF and SEC may not N Participation of bothcoordinate adequately on institutions under the projectDeveloping the Bond Market will ensure full coordination.

The private sector may show M The CBSF subcomponents areinsufficient response to designed to reduce this riskinfrastructure improvements through the standby andin bond/debenture and CLO liquidity mechanisms.markets.

Credit rating agencies may M IFC participation will ensurenot be established. their establishment.

Private investors may show N Creation of a level playinglittle interest in purchasing field among these instrumentsbonds/debentures and CLOs. and development of a strategy

by NBFIs will minimize thisrisk.

There may be insufficient M The size of the CBSF hasnumber of NBFIs that qualify been determined based on thefor the CBSF. NBFIs that could potentially

qualify as determined duringappraisal.

A pipeline of sound industrial N During project preparation anprojects may be lacking. assessment has been made

showing that a potentialpipeline of sound projectsexists.

Management capacity at M IDA will coordinate withNBFIs may be inadequate. potentially eligible Fl to

ensure the development ofadequate managementcapacity, which will beincluded in the eligibilitycriteria.

Overall Risk Rating MRisk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk)

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3. Possible Controversial Aspects: (Project Alert System):

Risk Type of Risk Risk Minimization MeasureRisk Rating

Impact on the government G and S M Any revenue lost from NSSbudget and on beneficiaries sales will be more than offset by(Mainly government retirees gains from Tbills, which carry aand small savers) of reducing market rate and are not taxinterest rates on the certificates exempt. Truly small savers willunder the NSS to market rates continue (if they wish) toand recent imposition of taxes purchase certificates under theon interest income. NSS and any interest lost will

be more than offset bygovernment revenue gainswhich can help cover socialexpenditures. These savers areexempt from taxes on interest

______________ _ ___ = __ - income under the NSS.Type of Risk - G(Governance), S(Social). Risk Rating - H(High), S(Substantial), M(Modest), N(Negligible).

G: Main Loan Conditions

1. Effectiveness Conditions:

(a) Standard legal conditions; (b) GOB and BB to sign the Administration Agreement; (c) BB and CBSFAdvisor to sign the Facility Management Agreement; (d) BB to issue the Operational Directives for theCBSF; and (e) Government to have contributed the equivalent of US$3.0 million to the CBSF.

2. Other:

(a) MOF and BB will conduct with IDA two reviews during project implementation, in particular theCBSF performance and will take any corrective actions, if necessary, to enhance its performance; (b)GOB should, within 30 days of effectiveness of the Credit, reduce stamp duties on issuance of bonds anddebentures and reform the National Saving schemes to reduce distortions in the demand for market tradedinstruments by either imposing income tax on the returns over a ceiling or by reducing the nominal rates(already implemented); (c) GOB to contribute the remaining US$2 million within three months of therequest made by BB for the proper functioning of the liquidity mechanism; and (d) any actions by theGOB concerning lending or resource mobilization activities of FIs that may adversely affect theachievement of the project objectives would be a cause for suspension and/or cancellation of the project.

H. Readiness for Implementation

[x] The Project Implementation Plan has been appraised and found to be realistic and of satisfactoryquality.[] The following items are lacking and are discussed under loan conditions (Section G):

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I. Compliance with Bank Policies

[x] This project complies with all applicable Bank policies.

[signature] lA-Task Leader: 1ed lammert

[signature] tTeam Leader - - Josepl Pefnia

[signature]Sector Director: 0Uy "'Jy

[signature]Country Director: Frederick Temple

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Annex 1Bangladesh

Financial Institutions Development Project (FIDP)Project Design Summary

Narrative Summary Key Performance Indicators Monitoring and Critical AssumptionsEvaluation

Sector-Related CAS Goal:

To support the Government's poverty 1. Measures on increase in 1. Political and investment climate in Bangladeshreduction strategy of promoting investment financing. improved or maintained.rapid, job creating economic growth 2. GOB commitment to implement financial sectorby fostering the development of reforms and avoid policies that distort fnancialinvestment financing on a sustainable markets.basis.

Project Development Objectives: (Objective to CAS Goal)

Promote the development of 1. Increased term financing by Monitoring by BB. Requires:investment financing on a sustainable eligible NBFIs and other FIs. Supervision mission 1. Continued eligibility of FIs.basis and improve the quality of 2. Increased share of market reviews. 2. Savings increase or remain constant.intermediation. sources of funds for eligible

NBFIs and other Fls.

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Narrative Summary Key Performance Indicators Monitoring and Critical AssumptionsEvaluation

Project Outputs: (Outputs to Objective)

I. Facilitating resource mobilization 1. Periodic bond auctions BB with review from Depends on adequate market interest.

by NBFIs/FIs (semiannual or annual) for supervision missions.maturities of up to five years.

2. Reduction of advantage of MOF with IDA reviews Assumes that (large) investors would consider buying

Government National Saving during project appraisal bonds/debentures and or CLOs from qualified FIs as an

Schemes (NSS) over market and supervision. alternative to National Saving Certificates.traded fnancial instruments.

II. Increasing NBFIs/FIs Institutional 1. Cumulative disbursements of BB with review from Assumes stable economic situation.Capacity for Term Lending credit subcomponent to eligible supervision missions.

FIs: Yr.l 30%, Yr. 2 70%, Yr. 3100%.2. Participating FIs increase BB with review from Assumes sufficient investors response.market sources of funding by: supervision missions.Yr.2 10%, Yr.3 25%, Yr. 4 50%,Yr. 5 100% (expressed aspercentage of IDA's Fundsprovided under the CBSF).3. Plans by FIs to develop/ BB with review from Assumes adequate management capacity at FIs.strengthen appraisal and fund supervision missions.raising capabilities:(i) design required for eligibilityunder project;(ii) implementation duringproject.

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Project Components and Subcomponents Project Inputs (Budget) Monitoring and Evaluation Critical Assumptions(Components to Outputs)

L Resource Mobilization(i) Development of Issue Rules for SEC: US$0.0Im SEC with IFC/IDA supervision. Positive response by the private sector.Bonds/Debentures IDA: US$0.26m

(ii) Implementation of Procedures for IDA: US$0.08m SEC with IFC/IDA supervision. Positive response by the private sector.Bonds/Debentures(iii) SEC Training on Debt Instruments IDA: US$0.05m SEC with IFC/IDA supervision. SEC active participation.(iv) BB Training on Debt Instruments IDA: US$0.05m BB/SEC with IFC/IDA BB active participation.

supervision.(v) Reform of Government Saving Schemes IDA: US$0.57m MOF with IDA supervision. Interest by investors to switch to commercial

GOB: US$0.Im paper and bonds.

(vi) Development of Procedures for GOB: US$0. Im BB with IMF supervision. Cooperation between MOF and BB.Secondary TB Market IMF: US$0.3m

IL Strengthening of Private NBFIs andOther FIs(i) Development of CBSF IDA: US$1.lm BB/CBSF with IDA BB active participation.

GOB: US$0.2m supervision

(ii) Management of CBSF IDA: US$2.50m [----do.----] Positive response by consulting companies

(iii) Funding of CBSF IDA: US$40.Om [----do.----] Adequate pipeline of sound industrialGOB: US$5.Om projects. Development of capabilities by FIsFIs: US$4.Om for issuing bonds and CLOs.

(iv) Capacity Enhancement of FIs Business IDA: US$1 .22m [----do.----] Appropriate management capacity at FIs.Planning, Resource Management and MIS FIs: US$1.08m

(v) Resource Mobilization for FIs IDA: US$0.43 [----do.----] Appropriate management/technical capacity atFIs: success fee Fls.

(vi) Revision of CBSF Mechanism IDA: US$0.64m [----do.----] Adequate response by BB to CBSFmanagement proposals.

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Annex 2Financial Institutions Development Project (FIDP)

Project Description

Component 1 Resource Mobilization - US$1.52 million (total cost of component)

This component will address the external factors that delay or constrain resource mobilization from themarket. It aims at simplifying/streamlining regulations for market traded instruments to facilitate bondand securities issues, creating an even playing field for individual investors between market tradedfinancial instruments and government saving schemes -- the latter being more advantageous but restrictedto individual investors and pension funds --, and developing benchmarks for issuing term paper throughstrengthening government bond markets. Given the nature of this component and comparative advantageamong institutions, implementation of its subcomponents will be undertaken by IMF, IFC and IDA.

(a) Development of Issue Rules for Bonds and Debentures. The various decrees and circulars directly orindirectly related to the issuance of market traded instruments will be reviewed, modifications will besuggested as appropriate and a comprehensive circular will be issued by SEC. IFC will provideassistance to the SEC in coordination with IDA and the ADB. (Cost: US$0.27m. Funding: SEC -US$0.01 m; IDA - US$0.26m)

(b) Implementation of Procedures for Market Traded Instruments. Consultant assistance to SEC toimplement the issue rules under (a). (Cost: US$0.08m. Funding: IDA- US$0.08m)

(c) Training of SEC on Debt Instruments. SEC's main expertise is on equity instruments. Thissubcomponent will finance travel expenses for SEC staff to learn about security exchange commissionsabroad in regulating debt instruments. (Cost: US$0.05m. Funding: IDA - US$0.05m)

(d) Training of BB on Debt Instruments. Given that the CBSF will be under BB's responsibility, thissubcomponent will finance travel of BB staff together with SEC staff to learn about experiences inregulating/supporting debt market development. (Cost: US$0.05m. Funding: IDA-US$0.05m)

(e) Reform of National Saving Schemes (NSS). Aimed at reducing distortions that repress potentialdemand for market traded instruments caused by the GOB's NSS. This will be accomplished by bringingbenefits of NSS closer to market oriented instruments. The subcomponent will finance an implementationplan to facilitate access for small savers including the establishment of a computerized system and ananalysis on the impact on GOB's revenues with recommended measures if needed. (Cost: Consultantsand GOB counterparts- US$0.3m;Computers - US$0.37m. Funding: IDA - US$0.57m; GOB -US$0.lm)

(f) Development of Procedures for Secondary Treasury Bond(TB) Market. Establishment of a secondaryTB market will increase liquidity of TBs thus promoting the development of a government bond market.This task is being done by BB with assistance from the IMF. Although this subcomponent is not fundedby IDA, the project will benefit from its implementation. (Cost: US$0.4m. Funding: GOB - US$0. lim;IMF -US$0.3 m).

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Component 2. Strengthening of Financial Institutions - US$56.17 million (total cost of component)

This component consists on creating a Credit, Bridge and Standby Facility (CBSF) that would encouragethe development of term financing by the more efficient and healthy segment of the financial system.The CBSF will provide funding from IDA to FIs through a variety of mechanisms that would increasetheir funding while enabling and encouraging them to mobilize medium to long term resources from thelocal market. The eligible FIs will obtain funds from the CBSF as a regular credit line on a back to backbasis up to an individual maximum of US$4 million. After this amount has been reached, the FIs wouldhave to mobilize resources from the capital market to obtain additional funds from the credit line. A totalof US$49 million of CBSF funding (including GOB's and FIs' contribution) is justified since it represents6% of the estimated demand for term loans by potentially eligible FIs (see Annex 2a). The FIs canaccomplish the resource mobilization objective in two ways:

* The first method involves the securitization and sale of its assets (credits). Under thismethod, the FIs spin off accumulated quality earning assets and sell participation on these assets, in amanner similar to loan syndications that are already practiced in Bangladesh. These participations will besold to investors in the forrn of certificates in a pool of loans or lease contracts called collateralized loanor lease obligations (CLOs). A holder of participation certificates in a CLO has a share and undividedinterest in the payments on loans or lease payments on leases. Two or more FIs may combine theirsubloans/leases into a CLO pool to be issued by he CBSF on behalf of the FIs.

* The second method is for the FIs to issue secured bonds or unsecured debentures. For thisthe FIs would enter into a "firm" agreement with acceptable underwriters to underwritebonds/debentures. Alternatively, acceptable major financial institutional investors, such as banks,insurance companies and pension funds, could provide a take-out agreement.

An advisory group (firm with international experience) will assist BB in managing the CBSF.

Support under the CBSF

The following types of support will be provided:

- Credit Finance. Credit line in local currency priced at market rates to be determined fromtime to time. It will be provided to those FIs that meet the eligibility criteria under the project .

- Bridge Finance. After the maximum amount permitted under the credit line has beenreached, FIs may require additional financing to accumulate earning assets to sell as CLOs. The CBSFwill provide bridge financing with a maximum period for the take-out, i.e. for the repayment of the bridgefinance by some other funding source. The CBSF would pre-approve the take-out arrangements.

* Standby Support. Under the standby support, the CBSF would commit to purchase thebonds/debentures or CLOs of the FIs that these are not able to sell into the market. However, only in theevent that the underwriters are unable to successfully market the bonds/debentures or CLOs will theCBSF purchase the unsold balances. There will be a system of incentives and/or disincentives to inducethe underwriters to successfully place the bonds/debentures or CLOs.

* Liquidity Mechanism. The CBSF will also have a mechanism to provide liquidity toinvestors who have purchased CLOs and bonds/debentures. Under a Repurchase Agreement or "Repo",the CBSF will purchase the bonds/debentures or CLOs at discount below their fair market value, 1 asdetermined by the CBSF in its ownjudgment. The CBSF will not absorb the credit, market or interestrate risks associated with the Fl's CLOs or bonds/debentures. The investors holding these instrumentscontinue to carry these risks. The investors must agree to repurchase the instruments within apredetermined period.

' The CBSF may elect to impose a lower percentage purchase value depending on financial market conditions, thequality of the Bonds/debentures or CLOs and the fnancial standing of the counterpart to the "Repo".

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Development/implementation of the CBSF will require:

(a) Development of the CBSF. This subcomponent will consist of: (i) implementation of the CBSF'sorganizational structure including role of Government and Facility Advisor; (ii) development/implementation of accounting and MIS systems; (iii) training GOB/BB staff; and (iv)development/implementation of a communications programfor the CBSF. (Cost: Accounting System andSoftware Development - US$0.45m; Computers and Hardware - US$0.45m; Training of GOB/BBpersonnel US$0.2m; GOB counterparts and contribution in kind - US$0.2m. Funding: IDA - US$1.1m;GOB US$0.2m)

(b) Management of the CBSF (see Annex 2cfor Terms of Reference). A CBSF advisor (firm) will berequired to: (i) advise and assist BB with the operation of the CBSF; (ii) develop details of the operatingsystem of the CBSF; (iii) advise FIs on use of the CBSF; (iv) manage development of systems asnecessary; (v) handle documentation for formation of the CLOs of the FIs; (vi) implement the availmentsunder the CBSF; (vii) handle the servicing of the CBSF; (viii) recommend modifications of CBSF'spolicies and procedures;' and (ix) submit reports and audits of the CBSF. (Cost: Expatriate and LocalConsultants and Staff- US$2.27m; Office Expenditures - US$0.20m; Computers and Equipment-US$0.03m. Funding: IDA US$2.50m)

(c) Funding of CBSF. This will be divided as follows: (a) Credit line for US$28m; and (b) Bridge,Backstop and Liquidity Mechanism for US$17m. (Cost: Subproject cost is estimated at least at US$49m.Funding: IDA will finance US$40m through the CBSF, GOB US$5m, and FIs direct contribution to thesubprojects US$4m)

(d) Capacity Enhancement of FIs Business Planning, Resource Management and MlS. Assistance toeligible FIs in: (i) enhancing their capacity to develop strategic and business plans to enable them toadjust to economic, policy changes and environmental compliance1 , (ii) strengthening their risk andresource management in particular credit assessment and management and asset liability management,and (iii) modernizing support systems in treasury operations, accounting, internal audit, legal and humanresource management. (Cost: Consultants for Systems Development US$0.8m; Training US$0.8m;Computers and Related Hardware - US$0.7m.. Funding: IDA US$1.22m; FIs US$1.08m)

(e) Resource Mobilization for FIs. Assistance to FIs (including merchant banks) to develop their capacityto mobilize medium to long term resources through issuance of bonds/debentures and CLOs. Assistancewill be provided in two steps: (i) preparation of internal systems for issuing bonds/debentures and CLOs,and (ii) advice and close coordination in actual issuance of these instruments. (Cost: ConsultantsUS$0.43m plus success fee. Funding: IDA US$0.43m; success fee paid by FIs)

69 Revision of CBSF Mechanism. Tasks: (i) preparation of business plan (BP) and financial model for theCBSF, (ii) review of the liquidity mechanism, and (iii) strengthening of FI certification process. (Cost:Consultants US$0.62m, Software for BP US$0.02m. Funding: IDA US$0.64m)

'The component will assist in establishing capacity in Bangladesh to teach environmental compliance courses, withthe objective of ensuring that each participating Fl includes a staff member suitably trained to verify appropriateDepartnent of Environment clearance of loan requests.

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Annex 2aMethodology to Estimate the Funding under the CBSF

1. Introduction. The estimation methodology covers the following aspects: (a) potential demand for termfinancing; (b) funding requirements by potentially eligible FIs; and (c) investors' capacity to support Fl's fundingrequirements. As shown below, the CBSF which is composed of a line of credit for US$20 million and a bridge andstandby facility for US$25 million (with the objective of supporting an equivalent amount of bonds/debenturesCLOs) can be justified from these estimates (in addition to FIs own funds).

2. Potential Demand for Term Financing. Table I shows, past and projected macroeconomic figures for GrossDomestic Product (GDP), Gross Domestic Fixed Investment (GDFI), Gross Private Fixed Investment (GPFI) andprivate investment in construction, machinery and equipment, and transport equipment and fixed assets. Keyassumptions based on historical data and recent developments are: (a) GDP growth in real terms of 5.5% between1995-1999 and 5.6 % between 2000-2003; (b) ratios of GDFI to GDP of 17.4% between 1997-1998 and 17.6%between 1999-2003; (c) 37.9% share of private investment in GDFI; and (d) private investment as a component ofGDFI broken down into 80% for construction, 14% for machinery and equipment, and 6% for transport equipmentand other items. GPFI is projected to reach US$3.75 billion over the three year period 1999-2001 and US$6.62billion over the five year period 1999-2003.

Table 1. Macroeconomic Data on Investment(US$ million)

1997 1998 1999 2000 2001 2002 2003GDP 15,930 16,806 17,730 18,723 19,772 20,879 22,048GDFI 2,772 2,924 3,121 3,295 3,480 3,675 3,880Public 1,720 1,815 1,937 2,045 2,160 2,281 2,409Private 1,051 1,109 1,184 1,250 1,320 1,394 1,472Constr. 841 887 947 1,000 1,056 1,115 1,178Mach. 147 155 166 175 185 195 206Other 63 67 71 75 79 84 88

Source of data: World Bank. Bangladesh: Annual Economic Update 1997 - Economic Performance, Policy Issues and Priority RefonnsOctober 1997. Mission's projections.

3. Funding Requirements by Potentially Eligible FIs. The historical and projected medium to long termfmancing requirements by six potentially eligible FIs (four NBFIs and two commercial banks)' are shown in Table2. Total medium to long term financing (funding) requirements for the period 1999-2003 amount to US$796million. As shown in the same table, four FIs have indicated their interest to raise funds under the CBSF throughissuing bonds/debentures as follows: (a) over 3 years US$79.1 million (not shown); and (b) over 5 years US$233.7million.

Table 2. Funding Requirements and Resource Mobilization Prospects(US$ million)

FIs Funding Requirements Resource Mobilization ProspectsOver 5 Years

1995/96 1996/97 1997/98 1999/00- CLOs Bond/ Total2000/03 Debent.

NBFIs 2 37.6 47.9 70.8 617.5 121.0 103.7 224.7Com- 11.0 19.6 43.4 178.5 8.5 0.5 9.0mercialBanks 3

TOTAL 48.6 67.5 114.2 796.0 129.5 104.2 233.7

'Based on questionnaires and follow-up interviews with the FIs' CEOs.'Includes IPDC, IDLC, ULC and PLCL.3Prime Bank and South East Bank.

26

4. Sources of Funding. The sources of medium to long-term debt capital, i.e. potential buyers of bonds/debenturesand CLOs, include three general groups: some commercial banks, non-bank institutional investors and high networth individual investors. By far the largest group consists of banks, including nationalized commercial banks(NCBs). Non-bank institutional investors consist of life insurance and pension /provident funds, and non-profitorganizations. High net worth individuals are major buyers of capital market debt instruments who have shiftedtheir investments to govermment saving schemes. Based on direct interviews with NCBs and insurance companiesit is estimated that banks have an annual flow of investable medium to long term resources of over US$535 million,while insurance companies have a flow of about US$44 million (Table 3).

Table 3. Annual Flow of Medium to Long Term Investable Resources of Selected Institutions(US$ million)

Institution Annual FlowBanks 535

Nationalized Commercial 460Banks

Agrani Bank 110Janata Bank 20Rupali Bank NegligibleSonali Bank 330

Private Commercial Banks 75Pubali Bank 75

Insurance Companies 44Life Insurance 24

Non-Life Insurance 20TOTAL 579

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Annex 2bHighlights of the Credit, Bridge, and Standby Facility

(CBSF)

Background

I. The International Development Association (IDA) is preparing a long-term credit line, under its FinancialInstitutions Development Project (FIDP), to the Government of Bangladesh (GoB). IDA funding is placed atUS$40 million.' This Project supports Financial Institutions (Fls), consisting of eligible non-banks and banks,which engage in medium/long-term lending to private sector enterprises. An important objective of the Project isto develop the capability of the FIs to raise medium/long-term resources. The GoB proposes to provide co-financing for the Project. The Project will establish the Credit, Bridge, Standby Facility (CBSF) to implement thefinancing program for private sector enterprises through the FIs. Bangladesh Bank (BB) will act as the Agent ofthe GoB and actively interface with the Facility Advisor.

Credit Component

2. The CBSF is designed to provide the customary IDA credit line to FIs, while enabling them to mobilizemedium to long-term resources on a sustainable basis consistent with the enabling environment and requisiteinstitutional infrastructure. While the GoB will take the IDA loan in foreign currency, the CBSF facilities will bedenominated in local currency and priced at a market rate, ensuring that the IDA subsidy is captured by the GoBas intended.

3. The maximum Credit Component without any resource mobilization will be the equivalent of US$4million per Fl. The FIs can accomplish the resource mobilization objective in two ways. The first method involvesthe securitization and sale of its credits. The second method is to issue the FIs' secured bonds/debentures.Resource mobilization, as defined, includes CLOs covering the securitization of outstanding and new credits andthe primary issuance of bonds or debentures. After an Fl uses US$4 million of credit component, there will be a1:1 ratio between resource mobilization and Credit Component. Under this formula, an Fl may use an additionalUS$1 of the Credit Component for every US$1 of resource mobilization, until the maximum of US$28 million inCredit Component is reached. Thereafter, only resource mobilization will be allowed. All availments will be on afirst come, first serve basis. The Facility Advisor will consider other forms of acceptable resource mobilization inaddition to those already identified.

Resource Mobilization

4. Under the first method of resource mobilization, the FIs spin off accumulated quality earning assets andsell participations on these assets, in a manner similar to loan syndications that have become popular amongbanks. The participations to the quality earning assets of the FIs that are sold to investors will be in the form ofParticipation Certificates in a pool of either loans or lease contracts. These loan or lease receivables that arepooled are called either "Collateralized Loan Obligations" or "Collateralized Lease Obligations", or "CLOs" forshort. A holder of Participation Certificates in a CLO pool of loans or leases, in effect, has an undivided share inthe interest and principal payments on loans or lease payments. Two or more FIs may combine their sub-loans orleases into a CLO pool to be issued on behalf of the FIs. CLOs will be issued through single-purpose trusts.

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Bridge Loans

5. To enable FIs to accumulate earning assets to sell, the CBSF will provide "bridge" financing to the FIs tofund the periodic disbursements on sub-projects to be financed. The "bridge" financing agreement would stipulatethe period for the take-out, i.e., for the repayment of the "bridge" finance by some other source. The maximumcontemplated allowable period for bridge loans is 18 months. The Facility Advisor will recommend to BB the pre-approval of the take-out arrangements.

Standby Component

6. Under its Standby Component, the CBSF would purchase the CLOs or bond/debentures of the FIs.However, there should be a prior firm agreement from acceptable underwriters (merchant banks) to underwrite theCLOs or bond/debentures to be purchased by the CBSF. If the underwriters are unable to market the CLOs orbonds/debentures, the CBSF will purchase the unsold balance of the CLOs or bonds/debentures. There will be asystem of incentives and/or disincentives to induce the underwriters to market the CLOs or bonds/debentures andutilize the Standby Component only as a last resort.

Liquidity Mechanism

7. The CBSF will also have a mechanism that will provide short-term liquidity to the CLOs and thebonds/debentures that are purchased by investors. The Fl, whose CLOs or bonds/debentures are to be used bytheir holders to gain access to the liquidity mechanism, must continue its status as an eligible institution under theFIDP. The CBSF will not absorb the credit, market or interest rate risks associated with the Fl's CLOs orbonds/debentures. The investors holding these instruments continue to carry these risks. The CBSF will, under aRepurchase Agreement or "Repo" (the equivalent of a rediscounting facility), purchase the CLOs orbonds/debentures at prices based on guidelines defined in the CBSF Operational Directives (OD). (The OD spellout specific guidelines that will govern the actions of BB and the Facility Advisor on various CBSF components.)The investors agree to repurchase the instruments after a short period to provide the CBSF a rate of return thatreflects prevailing market conditions and the quality of the Fl's CLOs or bonds/debentures. The Facility Managerwill determine the holding period for the "Repo" and the underlying yield.

IDA's Role

8. IDA's role will include, among others, the appraisal of the FIs to determine their eligibility, the periodicsupervision of the Project (including the periodic review and modifications of the Operational Directives), andassistance in the resolution of other critical issues essential to the effectiveness of the CBSF and the success of theProject.

GoB' Role

9. The GoB's role consists of: (a) the adoption of the sector strategy, policies and reform agenda supportiveof the Project, in close consultation with the IDA; (b) relending and co-financing mechanisms; (c) Projectoversight for (i) CBSF policies, and (ii) CBSF operations review; and (d) operational control procedures for CBSFfunds, exercised by Bangladesh Bank, consisting of co-signing, together with the Facility Advisor, sub-project/lease disbursement documents.

Facility Advisor

10. A Facility Advisor will assist BB in implementing and managing the operational procedures of the CBSFin a manner consistent with the GoB's Financial Sector Policy Statement. The objective of the work of theConsultant is to: (a) develop details of the operating systems of the CBSF, defined in the Terms of Reference(TORs) and formalized in the Facility Advisory Agreement; (b) assist BB in carrying out with prudence, diligenceand care the operations of the CBSF; (c) actively coordinate or assist in the coordination of Technical Assistance(TA) components relating to the development of CBSF internal system, business plan and financial model, and

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various institution building programs for the benefit of FIs; (d) define the implementation issues that may impedethe achievement of the objectives of the Project and recommend appropriate actions therefor; and (e) recommendamendments and/or refinements in the CBSF so as to achieve the Project's objectives to the fullest extent possible.

Operational Directives

11. The BB and IDA will adopt an Operational Directive (OD) that contains the basic policies andprocedures governing the operations of the CBSF. In particular, the OD covers: (a) the policies governing the (i)different components of the CBSF and (ii) the management of temporary investments under its InvestmentManagement Account; (b) the eligibility criteria for Fls; (c) the reporting and monitoring system to be followed bythe Facility Advisor; and (d) the periodically-updated estimate of demand for CBSF components.

CBSF Component Pricing

12. The CBSF will operate on the basis of market pricing commensurate with the appropriate cost of funds tothe FIs under the different CBSF components. The pricing for these CBSF components will be as follows:

Document PricingFixed interest rate equal to the pricing for the weighted average of the latest

Credit Access issue of Treasury Bills of all maturities using the amounts of each maturity asAgreement the weights plus an appropriate margin spelled out in the OD. The Facility

Manager will fix the rate upon formalization of the Credit Component.Until such time as Treasury Bills with maturities longer than one month are

Bridge Loan fairly regular and substantial the benchmark will be the one-month TreasuryAccess Agreement Bill rate and the margin 50 basis points. When BB and IDA consider that TBs

with maturities longer than one month would be deemed appropriate they canmutually agree on using as benchmark longer maturity TBs..

Standby Support Standby commitment fee specified in the OD, commensurate with the overallAccess Agreement cost of underwriting the CLOs or bonds/debentures of FIs.

Repurchase Cost of funds commensurate with money market conditions and the quality ofAgreement the FIs' CLOs or bonds/debentures, subject to additional guidelines in the OD.

On-lending Arrangements

13. Under a Development Credit Agreement (DCA), IDA will lend the proceeds of the credit to the GoB inUS dollars at the standard IDA terms. The GoB will enter into an Administration Agreement (AA) with the BB onbehalf of the CBSF, providing for the same back-to-back grace and repayment periods. Given that local investorsare allowed to invest only in local currency investment instruments, it would be appropriate to denominate theCBSF components in local currency. In view of the fact that the grace and repayment periods under the DCA arelonger than the servicing periods for the CBSF components made available to the FIs, the CBSF will have theopportunity of recycling collections for the same components to deepen the attaimnent of the objectives of theProject.

14. To enable IDA to effectively monitor and supervise the Project, it is further proposed that IDA priorwritten consent be sought for: (a) Fl eligibility; and (b) changes in (i) the Facility Management, (ii) theOperational Directives that will guide the operations of the CBSF; (iii) the CBSF Chief Executive, and (iv) theMaster Facility Agreements with various FIs.

Downstream Agreements

15. The CBSF will enter into a Facility Advisory Agreement (FAA) with a qualified international FacilityAdvisor to provide advice and operational assistance to BB for handling the main components of the CBSF,namely, the Credit Component, Bridge Component, and Standby Support Component. In addition, the Facility

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Advisor will assist and provide operational assistance to BB for administering the CBSF's Liquidity Mechanism.In turn, BB with advice from the FA will enter into a Master Facility Agreement (MFA) with eligible FIs coveringthe standard terms and conditions, except those that will apply to specific transactions. Specific availments by FIsof CBSF funding will require the formalization of transaction-specific terms, such as the pricing and the tenor ofthe funding made available. Access to the Liquidity Mechanism will require the formalization of a "Repo"covering the instruments eligible for liquidity funding.

Overview of Relevant Documents and Agreements

16. The table below lists the important documents and agreements formalizing the Project and itsimplementation:

FIDP Documents and Agreements

Document/Agreement Parties CoverageDevelopment Credit a. IDA

Agreement b. GoB (a) Loan from IDA to GoB(b) Project execution requiring, amongothers, prior GoB/IDA consent for: (a) Fleligibility; and (b) changes in (i) theFacility Management, (ii) the OD, (iii) theCBSF Chief Executive, and (iv) MFAswith different FIs.

Administration a. GoBAgreement b. BB/CBSF Administration of Funds by BB/CBSF

(a) Policies on (i) CBSF components andOperational Directives a. IDA (ii) Investment Management Account; (b)

b. CBSF FI eligibility criteria; (c) supportc. Facility Advisor functions for CLOs and bonds ord. Financial Institution debentures; (d) reporting and monitoring;

and (e) CBSF demand assessment.Facility Advisory a. BB Provision of Advice and Assistance to BB

Agreement b. Facility Advisor in Operating the CBSFMaster Facility a. BB General Conditions

Agreement b. Financial Institution of the CBSFFacility Access

AgreementsCredit Line a. BB Access to CBSF

Access Agreement b. Financial Institution Credit ComponentBridge Loan a. BB Access to CBSF

Access Agreement b. Financial Institution Bridge Component

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a. BBStandby Support b. Financial Institution Access to CBSF

Access Agreement (agreed to by Standby Componentunderwriters)

Standard a. Financial InstitutionSub-Loan Agreement e. Investment Enterprise Sub-Project/Loan Financing

Standard a. Financial InstitutionLease Agreement b. Investment Enterprise Lease Financing

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Annex 2cTerms of Reference, Selection Method and GuidelinesFor The Financial Proposal Of The Facility Advisor'

Background

1. The International Development Association (IDA) is preparing a long-term credit line, under its FinancialInstitutions Development Project (FIDP), to the Government of Bangladesh (GoB). IDA funding is placed atUS$40 million.. This Project supports Financial Institutions (FIs), consisting of eligible non-banks and banks,which engage in medium/long-term lending to private sector enterprises. An important objective of the Project isto develop the capability of the FIs to raise medium/long-term resources. The GoB proposes to provide co- -

financing for the Project. The Project will establish the Credit, Bridge, Standby Facility (CBSF) to implement thefinancing program for private sector enterprises through the FIs. Bangladesh Bank (BB) will act as the Agent ofthe GoB and actively interface with the Facility Advisor.

Objectives and Role of the Facility Advisor

2. An International Consultant will be selected as the Facility Advisor for the CBSF. In that capacity, theFacility Advisor will implement and manage the operational procedures of the CBSF in a manner consistent withthe GoB's Financial Sector Policy Statement. The objective of the work of the Consultant is to: (a) develop detailsof the operating systems of the CBSF as defined in these Terms of Reference (TORs) and formalized in theFacility Management Agreement; (b) assist BB in carrying out with prudence, diligence and care the operations ofthe CBSF; (c) actively coordinate or assist in the coordination of Technical Assistance (TA) components relatingto the development of CBSF internal system, business plan and financial model, and various institution buildingprograms for the benefit of FIs; (d) define the implementation issues that may impede the achievement of theobjectives of the Project and recommend appropriate actions therefor; and (e) recommend amendments and/orrefinements in the CBSF so as to achieve the Project's objectives to the fullest extent possible. During the initialstages of operations, CBSF earnings generated on the use and recycling of IDA funds are not expected to fullycover the Facility Advisor's fees. TA funding drawn by the GoB would have to cover the deficiency during theinitial period.

3. In particular, the Facility Advisor will:

(a) advise BB and provide operational support for the efficient operation of the CBSF in accordance with theobjectives of the Project and the instructions of BB/IDA;

(b) handle the documentation for the structuring of the CLOs of the FIs;

(c) implement the availments under the CBSF and handle the underlying documentation, as appropriate;

(d) cause the Fl that issues the CLO to contract for the services of a qualifiedTrustee2 to represent CLO holders in all matters and, in such capacity:

Revisions to these notes will include provisions for: (a) the cancellation of the contract between the CBSF andthe Facility Advisor in the event of a cancellation of the Project by the IDA; and (b) the role of the GoB in thecontrol procedures relating to the use of CBSF funds originating from the GoB and collections from sub-loans/leases. Bangladesh Bank, as the agent of the GoB, will co-sign, together with the Facility Advisor, sub-project/lease disbursement documents for each Fl.

2 In the event there is no qualified private sector party that could act as the Trustee, the Facility Advisor may serveas the Trustee.

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(i) establish an internal system to review compliance of covenants by all parties to the CLO orbond/debenture issue;

(ii) in the event of default or dispute, pursue all remedies and take all legal actions that are necessaryto protect and advocate the interest of the securities holders; and

(iii) perform all fiduciary duties and responsibilities as detailed in the Trust Indenture of the CLO orbond/debenture issue;

(e) cause the Fl that issues the CLO to serve as the CLO's Servicing Agent' to:

(i) issue timely billing invoices to borrowers/lessees of sub-loans/leases that have been pooled intoa CLO;

(ii) maintain accurate records of payments and outstanding principal balances;(iii) monitor and seek immediate collection of delinquent payments;(iv) monitor the conditions and status of all assets financed by the sub-loans/leases that are securing

the CLO; and(v) perform all fiduciary duties and responsibilities;

(f) cause the Fl that issues the CLO to contract for the services of a qualified Custodial and Paying Agentto:

(i) provide safekeeping for all collateral pledged to the CLOs;(ii) expedite the settlement and transfer of securities or certificates representing ownership interest

in the CLOs; and(iii) perform all fiduciary duties and responsibilities;(iv) maintain various accounts and records of the CLO or bond/debenture issue;(v) maintain a registry of holders of the CLO or bond/debenture issue;(vi) make proper and timely payments to CLO or bond/debenture holders;(vii) invest surplus or idle cash balances; and(viii) send pertinent notices to CLO or bond/debenture holders.

(g) submit regular reports on the operations, financial performance and financial condition of the CBSF;

(h) prepare, as needed, updated projections of the future operations, financial performance and financialcondition of the CBSF;

(i) assist the BB/IDA in determining the eligibility of Fls to participate in the CBSF;

(j) actively coordinate or assist in the coordination of TA components relating to the development of CBSFinternal system, business plan and financial model, and various institution building programs for thebenefit of FIs;

(k) recommend possible modifications of the CBSF's policies, products and procedures to ensure theattainment of the Project's objectives and the sustainability of the CBSF; and

(1) arrange the audit of the CBSF according to International Accounting Standards and InternationalAuditing Standards.

I Normally, the FI wouldfunction as the Servicing Agent for the sub-loans/leases it originates so as to (a)maintain the ongoing relationship between the Fl and the client, and (b) reduce the administrative burden for theCBSF. Where FIs have pooled assets into a CLO, the participating FIs will act as the Servicing Agents for theirrespective clients.

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General Features of the Facility

4. Credit Component. The CBSF is designed to provide the customary IDA credit line to FIs, whileenabling them to mobilize medium to long-term resources on a sustainable basis consistent with the enablingenvironment and requisite institutional infrastructure. While the GoB will take the IDA loan in foreign currency,the Credit Component of the CBSF will be denominated in local currency and priced at a market rate, ensuringthat the IDA subsidy is captured by the GoB as intended.

5. The maximum Credit Component without any resource mobilization will be the equivalent of US$4million per Fl. The FIs can accomplish the resource mobilization objective in two ways. The first method involvesthe securitization and sale of its credits. The second method is to issue the FIs' secured bonds/debentures.Resource mobilization, as defined, includes the issuance of CLOs covering the securitization of outstanding andnew credits and primary issuance of bonds or debentures. After the first US$4 million of credit component, therewill be a 1:1 ratio between resource mobilization and Credit Component. Under this formula, an Fl may use anadditional US$1 of the Credit Component for every US$1 of resource mobilization, until the maximum of US$28million in Credit Component is reached. Thereafter, only resource mobilization will be allowed. All availnentswill be on a first come, first serve basis. The Facility Advisor will consider other forms of acceptable resourcemobilization in addition to those already identified.

6. Resource Mobilization. Under the first method of resource mobilization, the FIs spin off accumulatedquality earning assets and sell participations on these assets, in a manner similar to loan syndications that havebecome popular among banks. The participations to the quality earning assets of the FIs that are sold to investorswill be in the form of Participation Certificates in a pool of either loans or lease contracts. These loan or leasereceivables that are pooled are called either "Collateralized Loan Obligations" or "Collateralized LeaseObligations", or "CLOs" for short. A holder of Participation Certificates in a CLO pool of loans or leases, ineffect, has an undivided share in the interest and principal payments on loans or lease payments. Two or more FIsmay combine their sub-loans or leases into a CLO pool to be issued on behalf of the FIs. CLOs will be issuedthrough single-purpose trusts.

7. Bridge Loans. To enable FIs to accumulate earning assets to sell, the CBSF will provide "bridge"financing to the FIs to fund the periodic disbursements on sub-projects to be financed. The "bridge" fmancingagreement would stipulate the period for the take-out, i.e., for the repayment of the "bridge" fmance by someother source. The maximum contemplated allowable period for bridge loans is 18 months. The Facility Advisorwould assist BB in pre-approving the take-out arrangements.

8. Standby Component. Under its Standby Component, the CBSF would purchase the CLOs orbond/debentures of the FIs. However, there should be a prior firm agreement from acceptable underwriters tounderwrite the CLOs or bond/debentures to be purchased by the CBSF. If the underwriters are unable to marketthe CLOs or bonds/debentures, the CBSF will purchase the unsold balance of the CLOs or bonds/debentures.There will be a system of incentives and/or disincentives to induce the underwriters to move the CLOs orbonds/debentures.

9. Liquidity Mechanism. The CBSF will also have a mechanism that will provide short-term liquidity tothe CLOs and the bonds/debentures that are purchased by investors. The CBSF will not absorb the credit, marketor interest rate risks associated with the Fl's CLOs or bonds/debentures. The investors holding these instrumentscontinue to carry these risks. The CBSF will, under a Repurchase Agreement or "Repo" (the equivalent of arediscounting facility), purchase the CLOs or bonds/debentures at prices based on guidelines defmed in the CBSFOperational Directives. The investors agree to repurchase the instruments after a short period to provide the CBSFa rate of return that reflects prevailing market conditions and the quality of the Fl's CLOs or bonds/debentures.The Facility Manager will determine the holding period for the "Repo" and the underlying yield.

10. IDA's role will include, among others, the appraisal of the FIs to determine their eligibility, the periodicsupervision of the Project (including the periodic review and modifications of the OD), and assistance in theresolution of other critical issues essential to the effectiveness of the CBSF and the success of the Project.

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Report/Documentation Contents and Formats to Develop

11. As part of Project Implementation, the Facility Advisor will develop the content and forrnats forprescribed reports, subject to the approval of the IDA/BB, and prepare/submit them as scheduled. In particular:

(a) The Facility Advisor will prepare a monthly report that will provide a brief narrative of the highlights,together with:

(i) key data on the utilization and status of: (1) the three components of the CBSF, i.e., the CreditComponent, the Bridge Component, and the Standby Component, and (2) the LiquidityMechanism for CLOs and bonds/debentures; and the

(ii) CBSF's financial statements, including the Income Statement, Cash Flow, Balance Sheet (with astatement of the Investment Management Account).

The report would provide the following data for the Credit, Bridge and Standby Components, broken down per Fland consolidated for all FIs:

(a- 1) the summary sub-project/client profile (amount of credit, grace/maturity,pricing, collateral/security, product[s], subsector, project description, project cost and financialplan, use of credit proceeds, principals/management, location, basic issues, and specialconditions);

(a-2) commitments, disbursements, undisbursed commitments, repayments, outstanding amounts, andarrears (if any);

(a-3) credit classification and loss provisions made for sub-loans/leases in CLOs;(a-4) discussion of actions taken or to be taken to resolve any accounts in CLOs that are in arrears,

delinquent, in technical default, or in a bankruptcy court;(a-5) cash reserves and expenses for CLOs;(a-6) a profile of the holders of CLOs and bonds/debentures; and(a-7) for the Liquidity Mechanism for CLOs and bonds/debentures:

(aa) breakdown by FV/underwriter/investor and totals for all Fls/underwriters/investors;(bb) availments, repayments and outstanding amounts for liquidity support for CLOs and

bonds/debentures;(cc) a summary of the underlying instruments and their quality;(dd) the amounts unused under the liquidity mechanism feature of the CBSF;(ee) for securities held by the CBSF through the Liquidity Mechanism, a report showing

market valuation of the underlying collateral;(ff) a management system to immediate notify all parties on margin calls; and(gg) defaults, if any, under the liquidity mechanism and steps being taken to remedy the

defaults.

The Statement of the Investment Management Account will provide information on:

(b-i) asset breakdown consisting of cash and current accounts, short-term deposits, short-termobligations of the GoB, liquidity mechanism receivables from CLO or bond/debenture investors,receivables from each Fl (broken down into current and long-tern portion), and other assets;and

(b-2) the yields on the different earning asset categories.

(b) The Facility Advisor will prepare a quarterly report that narrates the implementation of the FIDP as itrelates to the operations of the CBSF, highlighting relevant implementation issues and the action program toaddress the issues.

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(c) The Facility Advisor will prepare a semi-annual assessment of the FIs' demand for the three CBSFcomponents, providing adequate details for each Fl. The report will be based on a format to be developed by theFacility Advisor and approved by the IDA/BB.

(d) The Facility Advisor will prepare projections, on an annual basis and updated or refined as often asnecessary, of its cash flow and balance sheet with the following time horizons:

(i) for the cash flow projections: daily basis for one week, weekly basis for one month, andmonthly basis for one year; and

(ii) balance sheet projections: monthly basis for one year.

The cash flow projections will include:

(a-i) receipts consisting of estimated collections for sub-loans/leases from each Fl, maturing short-term investments, and fee/investment income; and

(a-2) expenditures consisting of estimated disbursements for sub-loans/leases for each Fl, short-terminvestments to be made, and operational expenses.

The balance sheet projections will include:

(b-1) asset breakdown consisting of cash and current accounts, short-term deposits, short-termobligations of the GoB, liquidity mechanism receivables from CLO or bond/debenture investors,receivables from each Fl (broken down into current and long-term portion), and other assets;and

(b-2) the liability and reserve account consisting of current liabilities, the payables to the GoB onaccount of the CBSF (broken down into current and long-term portion), and accumulatedreserves (representing the excess of income over expenses).

There will be supporting schedules for each Fl, including a breakdown for CLOs and bonds/debentures, asappropriate.

GoB Review of Disbursements

12. BB, as Agent of the GoB, will co-sign CBSF disbursements on the basis ofdocumentation prepared by the Facility Advisor.

Undertakings of the Facility Advisor

13. The Facility Advisor will make the following undertakings, among others: (a) arrangements fortransferring facility management skills to qualified local professionals; (b) an exit strategy for the CBSF, includingthe option of privatization, the proposal for which would be prepared by the end of the second year after signingof the Facility Advisory Agreement; (c) committed engagement of the Facility Advisor's executives for theduration of the contract; (d) BB prerogative to ask for the replacement of any CBSF executive; and (e) BB noobjection required for CBSF executive replacement, in case it becomes necessary.

Contract Cancellation

14. BB may cancel the Facility Advisory Agreement (as provided in the contract) in the event (a) the IDAcancels the Project, or (b) the IDA determines that the financial market reacts differently and/or technical andmanagement skills need change compared with base case scenario expectations.

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Qualifications of the Consultant

15. Since the CBSF Facility Advisor will have access to confidential information on the clients of the FIs, theConsultant serving as the Facility Advisor should not be an Fl operating in Bangladesh or a local group withaffiliation with such an Fl. Therefore, eligible consultants would include (a) local consulting groups withinternational affiliation (but without any affiliation with any FI operating in Bangladesh), (b) international banks,investment banking fimns, or other non-banks not operating in Bangladesh, or (c) international consultants.

16. The Consulting Firn should have expertise in designing and developing capital market financingprograms similar to the CBSF. The Facility Advisor assigned by the Consulting Firm to undertake the workshould have at least five years relevant experience in designing or developing capital market programs similar tothose under the CBSF. Professional exposure of both the Consulting Firm and the Facility Advisor in emerging ordeveloping economies is essential. Assisting the CEO is an Operations Manager who would also be the deputy ofthe CEO. The Operations Manager could be a Bangladeshi with appropriate professional exposure of at least fiveyears in the financial sector. The Operations Manager should be the holder of a Masters Degree in either Businessor Economics. Both the Facility Advisor and the Operations Manager should be fluent in written and spokenEnglish, and computer-literate. Depending on the volume of transactions, the Consultant could have up to twostaff assistants.

Selection Method

17. Quality-Based Selection (QBS) will be the basis for choosing the Facility Advisor from the short list ofconsultants. The responsibilities of the Facility Advisor are highly complex and specialized. They require acombination of the proper expertise and the judicious exercise of developmental and fnancial creativity. TheConsultant and key personnel must demonstrate an understanding of the success metrics of the Project, i.e., actualresource mobilization activities of the FIs measured as a ratio of at least, if not greater than, 1:1 compared to theutilization of the Project's Credit Component. The International Consultant should provide an indicative listing ofdifferent components and related activities, their costs and duration, monitoring strategy and impact indicators, aswell as required local counterpart technical and financial input. The Consultants in the short list should submitonly the technical proposal. The GoB will request the Consultant with the highest ranked technical proposal tosubmit a financial proposal along the lines outlined below.

18. The GoB will evaluate each technical proposal, taking into account several criteria: (a) the Consultant'srelevant experience for the assigmnent and ability to ensure the uninterrupted implementation of the Project; (b)the quality of the methodology proposed; (c) the qualifications of the key personnel proposed (the Chief Executiveand Operations Manager or equivalent); and (d) transfer of knowledge. Each criterion will be marked on a scale ofI to 100. The marks will be weighted in computing the scores. The weights of the different criteria are as follows:

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Criterion Weight Points (1 to 100) Weighted PointsConsultant's specific experience & support 10Methodology 15Key personnel

Chief Executive 50Operations Manager or equivalent 20

Transfer of knowledge 5Total 100

19. Since the key personnel ultimately determine the quality of performance, considerable weight is given tothis criterion. The key personnel will be evaluated on the basis of three sub-criteria:

(a) general qualifications: education and training, length of experience, positions held in variousfirms, time with the International Consultant as staff, experience in developing countries;

(b) adequacy for the assignment: exposure in the financial sector, experience in the development ofcapital market instruments and programs similar to the CBSF, familiarity with regional/localfmancial sector issues and programs, and other specific experience with an important bearing onthe assignment; and

(c) experience in the region: knowledge of the regional/local culture, administrative system, andgovermment structures and policies.

Guidelines for the Financial Proposal

20. The GoB will request the Consultant with the highest ranked technical proposal to submit a detailedfinancial proposal based on these guidelines: The Facility Advisor's compensation will be based on the followingformula:

F = OPE + VI, where:

F Total fee of the Facility Advisor

OPE = Out-of-pocket expenses of the Facility Advisor

VI = variable income.

In turn, OPE operating expenses consisting of personnel compensation andadministrative expenses,

VI = X (total outstanding CLOs, bonds and debentures of FIs floatedthrough the CBSF net of provisions per Bangladesh Bank regulations - CLOs,bonds and debentures of FIs purchased by the CBSF under the StandbyComponent), and

X = 1%or0.01

The cumulative variable income should not exceed 30% of the total out-of-pocket expenses agreed.

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Annex 3Financial Institutions Development Project (FIDP)

Estimated Project Costs

Project Component Local Foreign Total------------------ US $ million--------------------

1. Resource Mobilization 0.21 0.31 1.52(a) Development of Issue Rules for Bonds/Debentures 0.01 0.26 0.27(b) Implementation of Procedures for Bonds/Debentures - 0.08 0.08(c) SEC Training on Debt Instruments 0.05 0.05(d) BB Training on Debt Instruments - 0.05 0.05(e) Reform of National Saving Schemes 0.10 0.57 0.67(f) Procedures for Secondary Treasury Bond Market 0.10 0.30 0.40

2. Strengthening of Financial Institutions 1.12 55.05 56.17(a) Development of CBSF 0.45 0.85 1.30(b) Management of CBSF 0.67 1.83 2.50(c) Funding of CBSF - 49.00 49.00(d) Capacity Enhancement of FIs - 2.30 2.30(e) Resource Mobilization Strengthening for FIs - 0.43 0.43(f) Review/Revision of CBSF Mechanism - 0.64 0.64

Total | 1.33 56.36 57.69

Project Component Government IDA Other Total------------------------------- US $.million-------------------------

1. Resource Mobilization 0.21 1.01 0.30 1.52(a) Development of Issue Rules Bonds/Deb. 0.01 0.26 0.27(b) Implementation Procedures Bonds/Deb. 0.08 0.08(c) SEC Training on Debt Instruments 0.05 0.05(d) BB Training on Debt Instruments 0.05 0.05(e) Reform of National Saving Schemes 0.10 0.57 0.67(f) Procedures for Secondary Treasury Bond

Market 0.10 0.30 0.402. Strengthening of Financial Institutions 5.20 45.89 5.08 56.17

(a) Development of CBSF 0.20 1.10 1.30(b) Management of CBSF 2.50 2.50(c) Funding of CBSF 5.00 40.00 4.00 49.00(d) Capacity Enhancement of FIs 1 .22 1.08 2.30(e) Resource Mobilization for FIs 0.43 0.43(f) Review/Revision of CBSF Mechanism 0.64 0.64

Total 5.41 46.90 5.38 57.69

40

Annex 4Financial Institutions Development Project (FIDP)

Cost Benefit Analysis Summary

Economic Analysis

Benefits Present value of Flows @ 10%Phase 1 LOC US$20', Fl Contribution US$4' $29.49'Phase 2 BS Facility supporting US$ 20' - Disbursing US$10"FIs selling bonds/CLOs US$10' $24.58'Total Annual Gross Income US$13.4' $54.07'

CostsPhase 1 (i) LOC at 0% (2% intermediation) $1.39'

(ii) Fl at 12% (payment to savers)(plus 2%intermediation cost) $4.71'

Phase 2 (i) Project Disbursements from IDA at 0% (2% $0.70'intermediation

(ii)Bond payments at 12% (plus 2% intermediation $11.78'cost)

Total Annual Cost US$1.92' $18.58'

Gross Benefits (over 10 years) $35.49'

II)A Credit (disbursed) $30. 00'

Net Benefits (over 10 years): $5.49'

Economic Rate of Return 14%

Summary of Benefits and Costs:

An overall benefit of the project is that it will support expansion of the sounder and moreefficient part of the financial sector providing alternative opportunities for savers and increasingthe supply of term funds for competitive projects generating economic growth and employment.During the first phase of the project the line of credit will increase available funds for investorsthrough eligible FIs, strengthening the efficient FIs and increasing the number of investmentprojects. During the second phase the bridge and standby component will strengthen FIscapabilities to raise funds from the market benefiting savers and investors. The project benefitsare difficult to quantify since once an efficient system of intermediation for term financing isestablished it is expected to become self sustainable, which will be the main economic benefit.However, a conservative estimate of the project's impact during its implementation phasetaking into account the revenues generated by the investment subprojects minus the cost offunding shows an ERR of 14% (over the IDA funds) and an NPV of US$5.49 million (basecase). The expected benefits over the long run are expected to be substantially higher.

41

Main Assumptions: Benefits assume that projects have a ratio of gross income to investment of0.2 (ratios for similar projects under the PSIC averaged 0.3 ex-ante). To estimate NPV,projects of 10 year lifetime and no scrap value at the end of the project, were considered astypical. Cost of funds was considered as interest on bonds and deposits at 12% plus 2% forintermediation costs. To estimate the ERR, disbursements under the IDA credit wereconsidered at USS30' (i.e. US$10' not disbursed to support bond and CLO issues).

Sensitivity analysis: (a) Assuming a higher ratio of gross income to investment of 0.3 (similarto ex-ante ratio on projects financed under the PSIC) NPV would be $33.76' and ERR 33%.(b)Assuming that IDA's credit of US$40' is totally disbursed (full backing of bonds and CLOs)both NPV and ERR would be substantially higher due to the low interest rate of the IDA credit,but the long term benefits would be mininum.

42

Annex 5Financial Institutions Development Project (FIDP)

Financial SummaryYears Ending: June 30

(Currency: US$, Unit: Million, Base Year: 1997/98)

Implementation Period

1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 Total

Project Costs

Investment Costs 0.15 13.82 11.98 11.08 10.46 10.20 57.69

Total 0.15 13.82 11.98 11.08 10.46 10.20 57.69

FinancingSources

Government -- 1.31 1.10 1.00 1.00 1.00 5.41

IDA 0.15 11.10 9.77 8.98 8.50 8.40 46.88

IMF -- 0.30 -- -- -- -- 0.30

Financial -- 1.11 1.11 1.10 0.96 0.80 5.10Intermediaries

Total 0.15 13.82 11.98 11.08 10.46 10.20 57.69

43

Annex 6Procurement*

6.1 Table 6.1 summarizes the project items, their related cost estimates and proposedmethods of procurement. Table 6.2 summarizes the thresholds for procurement methods andprior review. Procurement of goods would follow procedures outlined in the Bank's Guidelinesfor Procurement under IBRD Loans and IDA Credits, January 1995 (Revised January andAugust 1996, September 1997 and January 1999). Consultants financed by IDA would berecruited according to the Bank's Guidelines: Selection and Employment of Consultants byWorld Bank Borrowers, January 1977, revised September 1997 and January 1999.

6.2 Equipment (US$ 1.67 million): The project will finance about US$1,670,000 ofcomputers and related equipment. Computers and related equipment for about US$1,400,000will be procured following International Competitive Bidding (ICB) procedure. Urgentlyrequired computers and related equipment costing less than US$20,000 per contract, up to anaggregate amount of US$ 100,000, will be procured following National Shopping procedures(i.e., by soliciting price quotations from at least three qualified suppliers). Software for a totalamount of US$220,000 will be procured through Direct Contracting Method.

6.3 Consultants' Service (US$5.58 million): Consultants' services will be required for:

(a) Consulting firms for (i) Management of CBSF (US$2.51 million plus-success fee)will be selected on Quality Based Selection (QBS), and (ii) Training for FIs CapacityEnhancement (US$0.80 million) will be selected on Quality-and Cost-Based Selection (QCBS)methods. The process of contracting a consulting firm to manage the CBSF has been started.Prior to negotiations, the GOB issued a Request for Proposals (RFP) among previously short-listed firms. Prior to Board, the technical evaluation of the proposals will be presented to IDA.The consulting firm will be appointed as a condition for credit effectiveness.

(b) Individual consultants for (i) Development of Issue Rules for Bonds/Debentures(US$0.26 million), (ii) Implementation of Procedures for Bonds/Debentures (US$0.08 million),(iii) Reform of Government Saving Schemes (US$0.20 million), (iv) Development ofAccounting System Software (US$0.20 million), (v) Resource Mobilization for FIs (US$0.44million), (vi) Revision of CBSF Mechanism (US$0.41 million), (vii) DevelopingCommunication System for CBSF (US$0.20 million), (viii) Contract Processing at BangladeshBank (US$0.03 million), and (ix) Capacity Enhancement of FIs (US$0.45 million) will beprocured on the basis of qualifications and experiences.

6.4 Procurement Plan: Draft Procurement Plan has been prepared by Bangladesh Bankcovering the total project. The final Procurement Plan would be included in the PIP.

* For details on financial management and disbursement arrangements, please see page 9 of theProject Appraisal Document and the Borrower Implementation Plan.

44

6.5 Use of Standard Documents: For ICB procurement, the use of the Bank's StandardBidding Documents (SBD) for goods, modified by the government and agreed by the Bank, ismandatory. The Bank's Standard Bid Evaluation Form for Goods and Works (April 1996,modified by BDO) will be used for submission of evaluation reports to IDA. For requestingproposals from Consulting firms, the Bank's standard Requests for Proposals (RFP) will beused..

6.6 Procurement Capacity Review: Procurement capacity of Bangladesh Bank will bestrengthened for contracting goods and services. A local consultant will be appointed for thispurpose, the cost of which will be supported under the project.

6.7 IDA Prior Review

(a) Goods: IDA will carry out prior review of all contracts for Computers and Accessoriesestimated to cost the equivalent of US$200,000 or more. In addition, IDA will carry out priorreview of the first two contracts for Computers and Accessories under National ShoppingProcedure, irrespective of value. Further, IDA will carry out prior review of ComputerSoftware procured under Direct Contracting method.

(b) Services: There are only two contracts for Consulting firms that will be financed underthe Credit. Since the value of the contract of both the consultants' services is aboveUS$100,000, IDA's prior review will be required for both. Moreover, all individual contractsestimated to cost the equivalent of US$50,000 or more will be subject to prior review by IDA.For other contracts for individual consultants, IDA will review the terms of reference (TOR).

Table 6.1: Project Costs by Procurement Arrangements/a(in US$ million equivalent)

Procurement MethodICB National Others Total Cost

Shopping (includingcontingencies)

1. GoodsComputers and 1.35 0.10 0.22* 1.67

Accessories(1.22) (0.08) (1.30)QBS QCBS

2. Services 2.51 0.80 3.72* 7.03(2.40) (0.75) (2.45) (5.60)

3. CBSF 49.00* 49.00(40.00) (40.00)

TOTAL 3.86 0.90 52.94 56.03(3.62) (0.83) (42.45) (46.90)

/a: Figures in parenthesis are the amounts to be financed by IDA* Includes contribution of FIs.

45

Table 6.2: Thresholds for Procurement Methods and Prior Review

Expenditure Contract Value (Threshold) Procurement Contracts Subject toCategory Method Prior Review

Computers & US$200,00 or more International Prior ReviewAccessories Competitive Bidding

Less than US$20,000 National Shopping Prior Review of firstAggregate US$0.10 million two contracts

Computer All (US$220,000) Direct Contracting Prior ReviewSoftware

Services

Consulting (a) Management of CBSF (US$2.51 Quality -Based (a) Prior ReviewFirms million + Success fee) Selection

(b) Training for FIs capacity Quality- and Cost- (b) Prior Reviewenhancement (US$800,000) Based Selection

Individual All Contracts (US$2.27 million) Qualification and (a) Prior ReviewConsultants (a) Above US$50,000 per contract Experience

(b) Below US$50,000 per contract Qualification and (b) Prior Review -Experience Only terms of

reference

46

Annex 7Financial Institutions Development Project (FIDP)

Project Processing Budget and Schedule

A. Project Budget (US$000) Planned Actual(At final PCD stage)

Regular Budget US$245,000PHRD Grant US$457,000B. Project Schedule Planned Actual

(At final PCD stage)

Time taken to prepare the project (months) 14First Bank mission (identification) 10/27/1997 10/27/1997Appraisal mission departure 9/15/1998 11/01/1998Negotiations 11/15/1998 03/10/1999Planned Date of Effectiveness 02/01/1999 10/20/1999

Prepared by: Additional Secretary of Banking, Ministry of Finance

Preparation assistance: PHRD Grant Funds

Bank staff who worked on the project included:

Name SpecialtyJoseph Pernia Team Leader, Principal Financial Specialist

Alfredo Dammert Task Leader, Sr. PSD SpecialistShamsuddin Ahmad Alt. Task Leader, Financial Specialst

Owaise Saadat Principal Operations OfficerSyed Ahmed Legal Counsel

Carter Brandon Environment SpecialistNurul Alam Procurement Specialist

Mozammal Hoque Financial Management SpecialistGregory Wiratunga Disbursement Officer

Bidishia Islam Project AssistantPaul Bothwell Task AssistantSusan Palmer Task Assistant

47

Annex 8Letter of Sector Policies

Bangladesh: Financial Institutions Development Project (FIDP)

GOB's StatementOf

Reform Policy for the Non-Bank Financial Sector(To be submitted to IDA as a letter of Sector Policy in support of the proposed FIDP)

f the People's Republic of Bangladesh : . 15 JAN rgg-: - t Ministry of Finance .:Sj . -f.-.:,Economic RelationsDivision

>0O ERD/IDA-5 2241Pt.Flle.l/9% 3 C2-January, 19994,.-. , , . . - . , - .,&.k-p, - b

g`GOB's Statement of Reform:Policy for the Non-Bank Financial SectorH :1

ear Mr Teml ... _

Please refer.to your leter of December 22l998'regarding pohcytstatement ontef of thie 1tBank Finandial Sector and otherisuesrelated ite proposed

Financial Ins v elopment Project. ; ',..

2i.' I am pleased to inform you that the Giovernment has examined t osition andhas formulated apolie on Non-Bank Financial Instituton' which is"stated below' Futherbefore the Minister left for Singapore on some personai business,'he isucted me'to,communicate thestatement to the World Bank. I arn'transmitting-the polic1 sttenent as

;instructed by the on ble Finance Minister-.;. -

Oi3. A well functioiing financial system is essential if the country sverall goalsi-regarding savinzgs mvestment, GDP growth and poverty alleviation are to berealized. The function of the funancial'system in anj'countr is to servethe real.sectors and meet people's legitimate needs for financial services. InoSther words,-: the financial system must perform the dual function of mobilization and allocationof resources. The financial system should perform these basic functions at the

*lowest possiblg'cost of intermediation and at' the same time,;offe.the widest-choices to the pr,oyiders'and users of capital:

~4. "Banks are:the principal players in Bangladesh'financial system-.With 6000branches all over the-'country, banking sector 'in Bangladesh'com'prises 4 NCBs,:18 local privat banks,'4 specialized developmeiit.bankss 'and a dozen foreign* banks. Althougi; the banking sector itself has'expanded at a reasonable rate over.;the past two deE'ades, the contribution of the banking sector to .the' ouFY's overall'economic developiment'needs to be improved, especially with respect' the quality.of resource alocation and the strengt of the banksownTinanciaposition. Inparticular, the banks have not performed satisfactortily'the financial intermediation'finiition for the country, as evidenced by the high lievels of rion-performing loans.In the last few yfars the Government has undertaken several reform measures, e.g.

;interest rate liberalization, establishment of money. loan courts' introduction ofprudential regulations, etc. However, much still remains to be done' 'and there isnow an urgentneed to undertake important new measures to strengthen and deepenthe reform process .This 'will require ia"cooperative' effort from all "the principal

48

-:parties involved the Government will need to provide an overall stable and'-positive macro-environment in which the banking industry could'thrive; the

Bahgladesh Bank will need to provide effective supervision and enforcement; the.banking industry will have to improve efficiency, strengthen its financial-condition, and undertake lending more prudently; and the clients of the banking'industry must behave more responsibly, particularly the borro6wers must

-"-'understand that the loans they receive represent contractual obligations-which haveo be repaid diligently.

*5. Considering that in the foreseeable future, the bankingisector:wtIl continueto dominate deposit r4obilization, the GoVernment is committed; trestore the.banking sectoe's 'abilitysto provide -financial intermediation,for the:.economy. The

-:,.Governmnent hase.eviewed tfie-Wdrld Bank's 're i'taEtblihdig a Sounddng Sector, s Jupbft Estblshnga Seorundn-,and CompetitivBanking Sector, June 1998 'that iutn l ieitsf are:trategy, and is;> in the process o taking'ewineasures f9r finial sector*-reforms. But theprobleMns of the banking sector are deep rooted and will require. time and fiscal resources to resolve. There is also~reai.nsk of precipitating a crisis,-if reformns are not well designed and properly sequenced

6. Following`.the Bank's strategy report recommendatio'ns, -the.-;Govt. hasstarted to implement the desired reforn'nmeasures. The government is committed to

* implement the financial sector ref6rms and have already requested the World Bank.for assistance in strengthening the reguplatory and supervisory capacity of theBangladesh Bank and in making it a stronger central bankic Bankruptcy Courtshave been set-up to adjudicate cases under the Bankruptcy Act, 1998. Loans, orleases obtained :from banks and other financial 'institutions must be repaidaccording to contractual agreements. This is the only -way sound banking businesscan be conducted. Therefore, GOB is determined 'to instill strict' financialdiscipline in order to break the 'default culture'. The relevant legal framework-andprocedures are being reviewed and the laws will be'amended and enacted andrelated proc'edures 'modified as necessary.. The' objective' will be to 'niake debtrecovery easier, quicker, and more practical. Various measures are also underwayto improve the governance in the banking 'sector, which'includes issuance of newcirculars defining'-clear-cut and transparent. roles and responsibilitiei'of bankdirectors and management and containnment of laboirunion activities in' bankinginstitutions withii legally defined sphere. Bangladesh'Bank has signed agreementswith problem banks in the private sector to restore theirTiviability. The BangladeshBank is also putting efforts to enforce the prudential'regulations more stringentlyto' ensure financial discipline. -

7. The non-bank financial sector, comprisig'investment and financecompanies, leasing companies and mortgage banks'7'.and the capital markets,constitutes as yet a small but growing component of the financial sector.- FIs as agroup provide Bangladesh with an opportunity to improve financial intermediationfor the economy. Although FIs account forlonly 4% of the assets of the financial

49

. sector, compared to 70% for the NCBs and 25% for the local private.banks, theynow account for -20% of the term financing(FY 1996-97) throughAleasing, projectfinance and me.rchant banking activities. The'-volumeof term`finiance. they*-'provided in the.last four years increased at the rate: of 40% per 'ainnunwhile that -

t4of the NCBs decreased by 40 % compared totheprev year'-Mor,eover NBFls.:-and foreign banlks'are 6nly FIs showing an acceptablr_coilectioni performace. Tee GOB's strategy iso support the expansion of the:halIthya fficient part of the*financial systeni:ie., non-bank sector,'while ratiqna.iing "an orimng theThbanking sector, with a view to achieving a sound aid efficient filnancial system

atht, in the end, isWdiversified and competitive. 'm-r i;- t p ~~* . ,:' - * _.,.J_

The proposed FI Development Project is designed to help 'achive GOB'sstrategy of inQouragi,g the promising and healthy insti6tions ir.h`thfinancial

-sector. With thes-spport: of this projct, mthe Govenmf4il`priote rhe;devel'opment 'of-a .crp.orate.. debt market so':that-Fls can 'havieiaccess to a:sustainable means f'or raising. funds from the market iFanciaVand :technicalassistance under the FIDP wfll be mnade available to' Bngladesh Banka d SEC forinstitutional strengthening and the FIs for developing'their resource mobilization.*and ciedit. appraisal capabilities. For this' purpose,.Werequest IDA' '' provideBangladesh withWa credit to help fiance 'the proposed Financial Inistitutionrsbevelopment Project in the amount of US$ 60.00 (skx) million equivalent.

.' t, 7','' 't: ,- r -"^^v,,' ''

-9. To ensure the success of the strategy to strengthen the non-bankYfinancial.sector, the NCBs'would be discouraged to increasei'&eir termI lending activities'until govemanice and management are ad"quiately reied. Infact, NCBs termlending disbursements fell in FY 1996-97 'to only 40%, of those in the'previousyear. '

10. To support the resource mobilization activities of the FIs,.GOB will set up afacility with the a'sistance of the IDA. The Facility, 'called Credit, Bridge and:Standby Facility (CBSF), will provide'funding from IDA'to FIs`through a varietyof mechanisms that-would increase their funding while enabling and encouragingthem to mobilize mediurm to long term resources from the. locail markit GOBwould also contribute USS 5.00 (five) million to the Facility

11. Furthermoe;to remove the constraints faced by e FIs mbilizingresources from th$market, GOB will create an-ena I the'development of th#bond markets. The-specific measures thatwouidb takeniniclude: (i) eliminatin restrictions to 'iiiiitutional ivestors' like 'iisuraxicecodmpanies and prc'ident funds to purclise privateibondsa(iijreducding the'issuance costs for coFrporate bonds by elimi'natin'g 'siampduties or reducingit to anegligible amnount, if'there is a legal requirement; (iii) revising the National-SavingSchemes to align thqir returns to those available in the market providing' certainconcession for small savers;' (iv) developing a comprehensive set of guidelines bythe Securities and''Exchange ComllMission (SECj for-issuance of bonds and

50

I debentures, and,' (v) developing a secondary market for Govermnment Bonds: vfoilowing GOB'sarecent introduction of longer terrn Treasury Bonds.:

1 12. . It is hoped.that the policies enunciated abovyee.yvuld:reduci the potentialrisks of contagoiof FIs by the.non-performing segment of theinanclil system,.

:given that these4policies would ensure that .bothebanking:and. mnon-banking.i:nancial sectorqr effectively regulated andirinsla at e-:sm non-*performing bankiig institutions, and allow. themtopy theirdue ,role in the:4achievement of the country's overall economic developmnt objectivesinc1uding

private sector ceveiopment and poverty allviation

Withreg : S

-.-(Dr. Masihur Rklnan)_L:~ Sere_tar'y~,'ED

Mr Frederick T;Temple.country Director- .'The World BankBangladesh Dhak Office3A Paribagh .Dhaka.

-cc:'i) Secretary, Finance Divisi'On. .n :

ii) secretary, X.iternal Resources ,ivision.-

51

Annex 9Eligibility Criteria for Beneficiaries and Subprojects

ELIGIBILITY CRITER FOR FINANCIAL INSTITUTIONS

Notes: (1) Accounting data on loan classification and provisions would be as per International AccountingStandards (LAS). (2) In addition to the continuing eligibility criteria, Policy Statements and Corporate StrategyStatements acceptable to the IDA will be provided by FIS. (3) The deternination of the eligibility of an Fl underCBSF will consider the totality of the eligibility criteria in a manner that will establish acceptable quality ofmanagement, profitable and sustainable operations, and sound fnancial position. GOB in consultation with IDAmay waive compliance with an eligibility criteria in appropriate cases.

ApplicabilityEligibility Criteria NBFIs KBs

1. compliance with applicable laws and Bangladesh Bank prudential regulations X X2. adequacy of provisions based on International Accounting Standards X X3. positive rate of real return X X4. minimum capital adequacy ratio of 8% (based on Bangladesh Bank regulations) X5. maximum debt/equity ratio of 10 times for NBFIs operating for at least 5 years and X N.A.5 times for NBFIs operating for less than five years (but nor less than three years)'6. minimum current ratio of 1.25 times2 X N.A.7. average life of monetary liabilities should at least be longer than the average life of X N.A.credits8. excess of fixed rate earning assets over fixed rate liabilities not to exceed 5% of X Xcapital 3

_ _ _ _ __ _ _ _ _ _

Debt /equity ratio = long-term mo etary liabilities at the end of a periostockholders' equity at the end of the same period

Long-term monetary liabilities would include the outstanding components maturing after one-year but excludesthe portions maturing within one year.

The maximum debt/equity ratio under Bank projects would not normally exceed 10 times, with a lower ceiling forFIs with a relatively shorter track record.

2 Current ratio = current assets at the end of a periodcurrent liabilities at the end of the same period

Both "current assets" and "current liabilities" should be in accordance with IAS 30.

3 Computed as:

total fixed rate assets at the end of a period minus fixed rate monetary liabilities at the end of same periodstockholders' equity at the end of the same period

X 100 = should not exceed the stated maximum ratio, i.e., 5%.

52

10. mismatched foreign currency position not to exceed 5% of capital' X X11. minimum (total) collection ratio of 80%2 X X (a)12. maximum portfolio infection ratio of 20/%3 X X (a)13. minimum debt service cover ratio of 1.25 times4 X N.A.14. maximum single borrower exposure of 20% of capital5 X X6

15. maximum business group exposure of 20% of capital7 for NBFIs and as per X XBanking Company's Act for Commercial Banking16. maximum insider lending of 25% of capital X X17. maximum industry/sub-sector exposure of 35% X X18. clean auditors' opinion without implied/hidden qualifications' X X19. professional and sound management, as demonstrated in a systematic and X Xcontinual certification process may include: (a) strategic and financial planning,including a well-conceived resource diversification and mobilization plan; (b) risk X Xmanagement policies and guidelines; (c) standardized underwriting standards fororigination, appraisal, documentation, monitoring and servicing; (d) adequateMIS/information technology; and (e) effective intemal audit and control.21. FIs' loan approval procedures include verification of appropriate Department of X XEnvironment clearance.

The "long" or "short" foreign currency position at the end of the period should not exceed the stated ratio inrelation to stockholders' equity at the end of the same period. The "long" or "short" position should be computedfor both the total foreign currency position and the cross currency positions, and the resulting ratios should notexceed the indicated maximum, i.e., 5% of stockholders' equity.

2 Computed as: total cash collections from on balance sheet term credits for a periodtotal receivables from on balance sheet term credits for the same period

"Total cash collections" (a) include current cash collection, i.e., (i) cash collections from receivables due duringthe period, and (ii) cash collections on past due receivables; but (b) exclude reschedulings. "Total receivables"exclude term credits, which are in litigation.

Computed as: on balance sheet term credit portfolio affected by arrears at the end of a periodtotal on balance sheet term credit portfolio at the end of the same period

The word "arrears" is defmed to mean unpaid interest, principal or lease payments of more than 90 days.

4 Computed as:

net eamings before tax + non-cash expenses + cash collections from on balance sheet term creditsinterest expenses and principal payments associated with on balance sheet term credits

Exposure is defined to include both on and off balance sheet exposure.

6 May be lower as legally prescribed for banks.

7 "Business group" is defined to include all interlocking investments, directorships and officer positions.

8 "Hidden or implicit" qualifications are comments in the notes to the fmancial statements which are material andwould have a significantly adverse impact on the financial performance and or fmancial position, if fullyconsidered, but are not explicitly mentioned in the official opinion of the auditors.

53

Legend: NBFIs = non-bank financial institutionsKBs = (private) commercial banksTBD = to be determined

(a) = applicable to the KB's medium to long-tern portfolio

54

Annex 10Summary of Appraisals of Candidate Financial Institutions

1. United Leasing Company Ltd. (ULC)

Established in 1989, ULC is the second largest leasing company, with an estimated market share of 26% in 1997.Its shareholder mix includes a synergistic combination of a diversified business group, and multilateral andbilateral financial institutions. Institutional investors associated with Duncan Brothers (Bangladesh) Ltd. (DBL),whose parent company is Lawrie Group of U.K., holds 48% of company stock, with plans for further increasingthe holdings to 51%. In addition to their equity positions, Asian Development Bank and CommonwealthDevelopment Corporation have provided long-term funding support. Aside from its holdings in ULC, DBL hasinterests in tea production and exports, insurance and bottled water. DBL reportedly accounts for about one-fourthof the Bangladesh tea exports.

There are close business and management relationships between DBL and ULC. DBL provides ULC clientreferrals and local business information relevant to the assessment of lease credits. There are cross-managementlinks between DBL and ULC that constitute an effective subsidiary relationship that could tend to ensure ULCmanagement continuity. Given the small complement of 29 officers and staff, ULC's Executive Committeeprovides a vehicle for hands-on, top-level direction of operations. The company has a senior management teamwith adequate operating experience to cope with a growing level of business. However, there are gaps inprofessional skills that need to be filled or strengthened, especially in the area of credit appraisal, second levelprofessional support, and computer proficiency. The company lacks adequate human resource policies andprocedures concerning staffing requirements, recruitment and performance evaluation.

ULC has formal policies and procedures that guide company-wide operations but there appears tobe no time frame assigned to the attainment of goals and objectives. The company has yet todevelop a formal corporate/business plan that will embody its strategic directions, particularly itsplanned diversification into operating leases and short-term finance, consisting of factoring andcommercial paper issues. ULC is facing competitive pressures that have caused growth rates toslacken and spreads to narrow. ULC's ability to obtain regulatory clearance to open branches, andthus, expand operations is deemed to have been negatively impacted by its resistance toBangladesh Bank policies that prescribe a liquidity ratio for the non-deposit liabilities of non-banks and prohibit cross-directorships between two non-banks.

The company's governance documents include a Policy Statement that is adequate as it takes substantive andrelevant business and operational issues under its purview. The Policy Statement includes various operatingguidelines (e.g., governing laws, liaison with the government, lease appraisal policy, exposure limits, insurance,provisioning policy, dividend policy, lease rates, insider transactions, and lease rates), the responsibility of theBoard of Directors, Executive Committee, the Managing Director, staff, management reports and policy revisions.The company has fairly established policies and procedures governing credit appraisal and disbursements. ULCneeds to strengthen its risk analysis and supervision of clients on a programmed basis, beyond its present systemof payments monitoring and arrears follow-up. It has yet to develop formal policies relating to problem accountresolution.

The company has set policies governing product pricing in a manner that would cover the cost of funds, operatingcosts and provisions and a reasonable return to capital that would enhance shareholder values. Its financialmanagement policies enable the company to cope with normal asset/liability management risks, although there areareas for potential improvement, such as setting targets for key financial parameters, e.g., liquidity, gaping andarrears collections. The company has a long foreign currency position resulting from keeping foreign currencydeposits as security for bank loans, rather than converting them into local currency for Taka-denominated

55

fnancing. A gradual but sustained currency depreciation has enabled ULC to realize positive spreads on thisaspect of its operations, while maintaining a high level of liquidity.

The current rudimentary MIS supports managerial decision-making through a variety of reports, but there is nointernal network. Management plans to strengthen its MIS by developing a database for operations and related ITmodules in collaboration with other leasing companies.

ULC's external auditors, affiliated with a major international auditing firm, audit the company books and assist inthe preparation of financial statements based on the Operating and Financial Methods in accordance withInternational Accounting and Auditing Standards. The opinion issued by the auditors has been unqualified. Thatsaid, the company needs to establish an internal audit unit to provide for checks and balances.

The company financial performance has shown a generally upward trend in terms of operating revenues, after-taxprofit and returns. Audited results for 1997 showed after-tax profit of Tk. 64 million, representing a return onequity of 31% and return on assets of 9%. The after-inflation rates of return figures are significant. However, therehas been a deceleration in the growth of revenues and profit, accompanied by narrowing spreads, owing to aslowdown in lease bookings caused by a combination of political disturbances and competitive pressures. Thestrong financial performance has enabled the company to declare a rising level of dividends, although within adefined maximum payout ratio. At the same time, the company has been able to raise shareholders' equity inrecent years by a growth rate consistently exceeding 20%. Notwithstanding the absence of a formalcorporate/business plan, the company has defined basic goals relating to market share and selective strategicdirections.

The company has attained satisfactory fmancial performance, while maintaining a fairly strong portfolio andfinancial position. Its 1997 collection ratio was 94%, with portfolio infection of 3%, based on a 90-daydefinitional cut-off for arrears. There is no undue concentration of risks other than to one business group and thetextile industry. The 1997 audited reports showed adequate provisions for doubtful accounts. The debt/equity ratiostood at a moderate level of 2.8 times. A detailed rundown of the company's 1997 financials shows overallcompliance with the CBSF eligibility criteria for financial institutions. Unaudited data for 1998 show continuedoverall compliance with the eligibility criteria, although the government's adverse ruling on depreciationallowance negatively impacted earnigs. The financial eligibility of ULC under the CBSF would be validatedupon completion of the audited financial statements for 1998, the positive results of which are expected bymanagement. Final eligibility is premised on: (a) limiting exposure in the loan account with concentration ofcredits; (b) issuance of a Corporate Strategy Statement, acceptable to IDA; (c) setting up of an Internal AuditCommittee; and (d) signing of the FIDP Participation Agreement and compliance with its conditionalities.

2. Industrial Promotion and Development Company Ltd. (IPDC)

IPDC commenced operations in 1983 based on the traditional mold of privately-controlled development financecompanies (DFIs) with a focused product orientation. IPDC's shareholders include the Government of Bangladesh(GoB), which holds the largest single, though minority, block of 30%, International Finance Corporation (IFC),Commonwealth Development Corporation (CDC), German Investment and Development Company (DEG) andthe Aga Khan Fund for Economic Development (AKFED). IPDC's shareholder mix has enabled it to gain ameasure of credibility in the market place, although the equity participation of the GoB has tended to generate aresistance factor in the minds of providers of investible funds. There are plans to divest the GoB holdings in IPDCthrough a rights issue and tap more institutional investors to join its shareholder list. IPDC has benefited from thefunding and technical support of its shareholders, particularly from IFC which has provided long-term foreigncurrency resources to back relending operations.

Affiliation with multilateral and bilateral institutions has enabled IPDC to develop systems and access resourcesassociated with DFIs. Unfortunately, the financial results were disappointing during the initial stages of IPDC's

56

operations. The limiting factors, aside from the global experience of DFIs, included top management discontinuityand ineffectiveness, the absence of a clear strategic vision, restrictive operational policies, and a time-consumingproject approval process. The ascendancy of the current Managing Director and CEO in 1986 has yieldedconsiderable improvements in operational levels, the quality of the portfolio, and the financial performance, withfinancial results and portfolio values showing a credible upward trend. IPDC's strategic plan calls for the phaseddiversification of its operations. In keeping with a gradualist approach to product diversification, IPDC is initiallybranching out only into project leasing and working capital finance.

To cope with the directions for the future, IPDC has restructured a previously unwieldy organizational set-up andestablished two main groups: one handling business origination, the second covering finance and administration.IPDC realizes the need for deepening the in-house skills related to project financing and Information Technology.The company needs to internalize new skills relating to working capital finance and project leasing. But thegreatest organizational challenge facing IPDC is to broaden the skills of senior officers to reduce the operationalburden on the Managing Director who is very much involved in detailed planning, major transactions and keyoperational tasks. IPDC has yet to develop human resource policies.

IPDC governance documents include a business plan that incorporates investment policy, dividend policy andfinancial prudence guidelines. While IPDC does not have a formal document on credit policies, it prescribes amaximum debt/equity ratio of 1.5 times for its clients. The credit appraisal process is fairly detailed coveringvarious aspects of the project. The Business Plan also sets forth the pricing for different product lines, although thefinancial rationale for pricing is unclear. In addition, IFC has stipulated financial covenants covering maximumleverage, interest coverage, and asset/liability average maturity matching. IPDC has been able to maintainmatched average maturities for assets and liabilities, but it continues to incur a significant currency mismatch bykeeping large foreign currency deposits sourced from IFC's financing. IPDC pledges the forex deposits togenerate local currency lending funds. The historical, though gradual, depreciation of the local currency hasenabled IPDC to generate non-operational surplus that supports additional local currency borrowings.

IPDC closely monitors every project, especially the non-performing ones. The company has tended to utilizeamicable settlement as a process of problem account resolution, rather than pursue litigation as the final solution.With respect to regular accounts, the operational staff prepares formal, bi-monthly inspection reports containingqualitative information on the clients (their operations, business, capacity utilized, problems, etc.). Managementcould strengthen the reports by including quantitative information that would facilitate overall performance review(periodic financial statements, bank and cash statements, receivables, etc.).

Independent local auditors, affiliated with a major international auditing firm, handle the audit of IPDC's fmancialstatements based on International Accounting and Auditing Standards. The opinion on the financial statementscertified by the external auditors have been unqualified. To further strengthen its internal systems, IPDCmanagement is aware of the need to install an internal audit unit.

IPDC's financial results have improved substantially over the past few years due to: (a) a sharp increase inoperational income (resulting from a combination of increased business volume, higher rates, lower funding costand consequently higher margins); (b) substantial capital gains realized from the sale of three portfolio equityinvestments; and (c) low provisions as collection and portfolio infection ratios improved significantly. The 1997collection ratio was recorded at about 90%, with the portfolio infection ratio held at 16%. All of the 33 sub-projects financed by a previous IDA credit line are performing. The financial operations resulted in 1997 after-taxprofit of Tk. 93 million, representing a 24% rate of return on equity and 13% rate of return on assets, both figuressubstantially higher than the inflation rate experienced. The positive financial results have been achieved whilekeeping leverage under control, with the debt/equity ratio standing at 0.9:1 at year-end 1997.

Based on a overall review of IPDC's compliance with FIDP eligibility criteria, using data up to 1997, IPDC wouldqualify as a participating financial institution under the project. The review will be updated based on the auditedresults for 1998. Preliminary figures for 1998 are encouraging. Assuming final confirmation of compliance withthe financial eligibility criteria, IPDC would be declared eligible on the following conditions: (a) issuance by

57

IPDC's Board of Policy and Corporate Strategy Statements, acceptable to IDA, which address the issuesidentified; and (b) signing of the FIDP Participation Agreement and compliance with its conditionalities.

3. Industrial Development Leasing Company Ltd. (IDLC)

Operating since 1985, IDLC is the pioneer and largest leasing company in the country, accounting for about 40%of the market. The participation of key institutional investors has contributed to a formalized governanceframework actively guiding its operations. The major institutional investors include the IFC, IPDC, KoreaDevelopment Leasing Corporation (KDLC) and Korea Long-Term Bank (KLTB). IDLC has a comprehensiveStatement of General and Operational Policies which covers, among others, corporate objectives, areas ofactivities, operational and financial prudence guidelines, and reporting requirements. IDLC's foreign investorshave provided institutional development and funding support. As the strategic investor, KDLC reserves the rightto nominate the Deputy Managing Director (DMD) to whom all operating units report. Currently, a KDLCexecutive is serving as the DMD reporting to the Managing Director (MD), a Bangladeshi national, who alsoserves as the CEO. Over the years, IDLC has succeeded in developing a seasoned, experienced management corethat has steered the company's dominance of the local leasing sub-sector.

Notwithstanding the stated strengths, there are organizational issues that IDLC recognizes and needs to address ifit is to maintain its position as a leading financial institution. In the light of increasing competitive pressures fromother market players, the operations of other entrants into the leasing sub-sector and the recent decline in IDLC'smarket share, IDLC has opted to diversify its product lines to include merchant banking, short-term fnance andhousing finance. However, the company has yet to develop a formal strategic and business plan incorporating thenew initiatives, a document it expects to complete within the first half of 1999. It also has to prepare an up-to-dateCorporate Strategy Statement as part of the FIDP eligibility requirements.

The company's management recognizes that the current internal skills are inadequate to allow it to effectivelycarry out its diversification plans. Accordingly, IDLC places importance on the recruitment of the required skillsand in-house training for a complete product cycle, especially the supervision of credits which is deficient.Complicating the managerial challenge is the prospect of a vacuum at the top-most management level. The MD,who has served as CEO since 1989, has plans of retiring for health reasons. A qualified professional, recruited tosucceed the MD, resigned. The DMD is scheduled to return to Korea, but his departure has been postponed toavoid management disruption. The company also has to realign internal reporting relationships to removepotential dysfunctional complications arising from the present set-up. It is IDLC's goal to stabilize themanagement team, since the company has experienced a high turnover of officers and staff which has disruptedoperations.

IDLC's credit policies are fairly comprehensive as the risk evaluation or credit appraisal calls for professionalstandards in the assessment of the managerial, technical, marketing and financial aspects of all lease proposals.Special attention is given to the capacity of the lessee to service the lease obligation and the type of leasedequipment that will ensure a resale value. While IDLC has exposure limits, some of them tend to be more liberalthan the limits defned among the eligibility criteria under FIDP. IDLC would have to realign its operations toconform to FIDP standards. IDLC pricing its products in a manner that will maximize spreads, while maintainingits competitive position in the market. The company has prescribed procedures for monitoring that includesequipment inspection to ascertain proper maintenance and tracking of defaults. There is a vigorous program ofdealing with problem accounts. As in the case of other leasing companies, however, IDLC does not monitor thefinancial performance and status of clients, thereby mitigating its ability to anticipate account problems beforethey arise.

IDLC's asset/liability management guidelines call for maturity matching. For every six-month period, totalpayable should not exceed total receivables unless covered by unutilized funding commitments or normally rolledover bank lines. The weighted maturity of funding instruments should at least equal the weighted maturity of

58

earning assets. An analysis of IDLC's position reveals gapping since the weighted maturity of earning assets is 4years compared to the weighted maturity of 2.7 years for funding liabilities. To avoid or minimize interest raterisks, IDLC writes floating rate leases wherever possible. IDLC does not take foreign currency risks.

A local auditing firm, with international affiliation, audits the books of the company. Financial statementsconform with International Accounting Standards. The auditors' opinion on the financial statements has beenunqualified. IDLC uses networks for information access and transmission. The company has a central server forits network system covering most of the EDP-related work, but there is no system manual since managementconsiders the software to be at the designing level.

The company's reported earnings up to 1997 reveal satisfactory results, with the rate of return on equity reaching27%. Consistent with the profitability of the company was the reported collection ratio of 86% and portfolioinfection ratio of 18%. Based on the 1997 financial performance and condition, it appears that IDLC could meetthe FIDP eligibility criteria. However, there are indications of a possible significant deterioration in the 1998collection and infection ratios. Therefore a definitive evaluation of IDLC's eligibility under FIDP would have toawait the outcome of the 1998 financial audit.

Note: ULC, IPDC and IDLC have been participating financial institutions under IDA's Private Sector IndustrialCredit Project.

59

Annex 11Financial Institutions Development Project (FIDP)

Documents in the Project File*

A. Project Implementation Plan (PIP)

PIP prepared by the Additional Secretary of Banking, Ministry of Finance. November 1998

B. Bank Staff Assessments

Developing Non-Bank Financial Markets (Overview Report) October 15, 1996Identification Mission: Back to Office Report December 11, 1997Preparation Mission: Back to Office Report May 15, 1998Appraisal Mission: Back to Office Report

C. Other

Bangladesh - Developing Non-Bank Financial Markets. Overview Report. November 1996Evaluation of the Leasing Industry in Bangladesh (I.K. Kang, consultant). November 1997Review of the Regulatory & Institutional Framework for NBFIs and Development of the BondMarket (Javed Masud, consultant). December 1997Review of the Tax Treatment of various Instruments for the Development of the Bond Market(Sheikh Sajjad Hassan, consultant). January 1998Improving the Legal/Regulatory Framework for NBFIs in Bangladesh (Claudio Reyes,consultant) April 1998Implications of National Saving Schemes for Non-Bank Financial Intermediary and FinancialSector Development (Linda Koenig, consultant). May 1998Bangladesh: Term Finance Program and Funding Facility - Technical Report (Victor Barrios,consultant). May 1998Bangladesh: Credit, Bridge and Backstop Facility - Working Papers (Victor Barrios,consultant). August 1998Bangladesh: Credit, Bridge and Backstop Facility - Draft Standard Lease and Sub-LoanAgreement (Victor Barrios, consultant). August 1998Technical Mission - Credit Bridge and Standby Facility - Back to Office Report (VictorBarrios, consultant). September 1998.Appraisals of Financial Institutions - United Leasing Company Ltd., Industrial Promotion andDevelopment Company Ltd., and Industrial Development Leasing Company Ltd., (ShamsuddinAhmad). December 1998Bangladesh Credit, Bridge and Standby Facility: Volume I - Basic Framework; Volume II -Operating Agreements (Victor Barrios, consultant). February 1999.

*Including electronic files.

60

MOP Schedule D

Annex 12 Generated: 8/19/99

Status of Bank Group Operations in BangladeshOperations Portfolio

As of 12-Jul-99

Difference Betweenexpected

Original Amount in US$ Millions and actual

Fiscal ____ disbursements a/

Project ID Year Borrower PurposeIBRD IDA Cancellations Undisbursed Orig Frm Rev'd

Number of Closed Projects: 138

Active ProjectsBD-PE-37294 1999 GOB ROAD REH. MAINT. III 0.00 273.00 0.00 263.96 5.07 0.00

BD-PE-41887 1999 GOB MUNICIPAL SERVICES 0.00 138.60 0.00 133.82 138.88 0.00

BD-PE-49790 1999 GOB EXPORT DIVERSIF. 0.00 32.00 0.00 31.58 0.00 0.00

BD-PE-50745 1999 GOB ARSENIC CONTROL 0.00 32.40 0.00 31.19 3.45 0.00

BD-PE-9524 1999 GOB DHAKA URB TRANSPORT 0.00 177.00 0.00 173.03 7.94 0.00

BD-PE-37857 1998 GOB HEALTH AND POP PROGRAM 0.00 250.00 0.00 173.00 -34.77 0.00

BD-PE-40713 1998 GOB SILK DEV PILOT PROJ. 0.00 11.35 0.00 10.22 3.46 0.00

BD-PE-44789 1998 GOB PRIV SEC INFR DEVT 0.00 235.00 0.00 224.84 68.80 -.80

BD-PE-9550 1998 GOB PRIMARY EDUC DEV 0.00 150.00 0.00 143.42 21.50 0.00

BD-PE-40985 1997 GOB POVERTY ALLEVIATION 0.00 105.00 0.00 26.61 -4.09 0.00

BD-PE-9482 1997 GOB/DWASA DHAKA WATER/SAN. IV 0.00 80.30 0.00 60.54 29.15 0.00

BD-PE-9518 1997 GOB 2ND RURAL RDS & MRKT 0.00 153.00 0.00 93.08 6.42 18.09

BD-PE-9484 1996 GOB AG. RES. MANAGEMENT 0.00 50.00 0.00 31.53 26.80 0.00

BD-PE-9545 1996 GOB RIVER BANK PROTECTIO 0.00 166.90 0.00 48.85 26.24 14.54

BD-PE-9549 1996 GOB COASTAL EMBANKMENT R 0.00 69.50 0.00 19.56 6.66 4.14

BD-PE-9560 1996 GOB NON-FORMAL EDUCATION 0.00 10.50 0.00 7.14 2.18 0.00

BD-PE-9496 1995 GOB NUTRITION 0.00 59.80 0.00 40.05 17.29 0.00

BD-PE-9533 1995 GOB GAS INFRASTRUCTURE 0.00 120.80 0.00 57.90 53.46 54.69

BD-PE-9465 1994 GOB 2ND ROAD REHAB & MAI 0.00 226.80 0.00 84.35 -5.51 0.00

BD-PE-9555 1993 GOB FEMALE SECONDARY SCH 0.00 68.00 0.00 20.38 17.13 11.59

BD-PE-9470 1992 GOB FOREST RESOURCES MGM 0.00 49.60 3.32 11.67 12.65 3.55

BD-PE-9540 1991 GOB INLAND WATER TRANSP 0.00 51.25 0.00 21.44 17.39 1.70

BD-PE-9542 1990 GOB RURAL ELECTRIF. III 0.00 105.00 0.00 10.70 2.77 0.00

Total 0.00 2,615.80 3.32 1,718.86 422.87 107.50

Active Projects Closed Projects Total

Total Disbursed (IBRD and IDA): 808.90 5,718.30 6,527.20

of which has been repaid: 0.00 431.19 431.19

Total now held by IBRD and IDA: 2,612.48 5,023.36 7,635.84

Amount sold 0.00 .37 .37

Of which repaid : 0.00 .37 .37

Total Undisbursed : 1,718.86 7.78 1,726.64

a. Intended disbursements to date minus actual disbursements to date as projected at appraisal.

Note:Disbursement data is updated at the end of the first week of the month and is currently as of 30-Jun-99.

Generated by the Operations Information System (OIS)61

Annex 13Country at a Glance

Bagldsh at a gelance 716/99

PtOVERTY and SOCIAL :; ;04 0 Sounth Lo iw00- :-

1998 0 ;;0 0 0 0 0 0 00 ~~~~Ban9badeshd XAW& incomie pDevelopment diamond' t0t

GNP per capita (Atlas nmehod, US$) 35 0 4SB 520GNP (Atlas method, US$ billions) 55S I3

Averge annual gottht, 1992-98

Population ('A) I 6 1.8 1,7Labor force (4) 2.ro3sspGN

perprmyMost recent estimate patest year available, 1"248) capita nmolment

Poverty (fA; cfpopulation belonationa povedy line) 36Urban population (% oftotal pviation) 20 :27 31Life expectancy at birth }aas) : 58 62 63Infant mortality (per 1,000 live bItths) 7$ 77 69Child malnutrition (% of chil dren lunder5) 68 53 .. Access to safe waterAcess to safe water (% ofpopulation) :4: e1 74Illiteracy (% ofpopulation age 15+) 62 49 32Gross primary enromtent f% of school-age poplation : 96 100 105 -|angladesh

maece 93 109 113 Lowincome groupFemnale 100 ~ 90 103

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1977 1987, 11997 1998Economic rtios-

GDP (US$ bilions5) 9,5 23.e 41.0 42.3Gross domestic investmentUGDP 17.0 19.0 21.6 22.4: TradeExports of goods and serviceas/GOP .2 5.5 12.4 13.9 TradeGross domestic s*vingslGDP 11.5 10.4 15.3 17.3Grossnationalsavings/GDP 11. 8 126 19.4 21.2 Tcurrent accouwt balance/GDP -1.8 4.1 -2.2 -1.2 DomesticInterest payments/GDP 0.3 0 0,4 04 InvestmentTotal debtJGOP 26.4 42.7 36:9 36.6 SvisTotal debt servicelexpltls 27.8 28.0 10,6 9.3Presentvalueof deb/GDP . 21.1Present value of debtfexports :01 , 0.1

1977-87 1988-98 1997 1998 I1999-3(averagean jllaya growt/h)GDP 50 4.7 5.4 5.0 55 -BangladeshGNP per capita 2.6 3.1 3.8 4.2 3.9 Low-income groupExports of goods and services 4.9 14.4 i14; 14.3 9.3

STRUCTURE of the ECONOMY1 977 1987 1997 1998 IGrovth mtes of output and investment (%)

(%6 of GDP)l,|Agriculture 37.5 31.3 23.1 22.4 I

Industry 25.0 22.2 27.1 28.2 0tManufacturng 18.5 15.2 17.3 18.3 s

Services 37.5 46.5 49.8 49.4

Private consumpton 87.0 86.4 80.1 78.3 vs 5 54 95 99 97 SeGeneral govemment consumption 1.4 3.2 4.6 4.4 GD - GDPImports of goods and services 10.7 14.1 18.7 19.0

1977-87 1988-98 1997 1998 Growth rates of exports and Imports (%)(average annual gnowth)Agiculture 3.6 2.6 6.1 3.0 lIndustry 4.3 6.9 5.6 8.3

Manufacturing 2.9 7.0 6.2 9.2Services 6.4 4.7 4.6 4.~2 2

Pnvate oonsumpbon 5.3 4.4 2.4 1.6 °General govemment consumpbon 5.3 5.9 6.0 -0.3 3 ss 956 97 98Gross domesac investment 4.4 6.0 10.0 11.2 -2DImports of goods and services 6.6 10.5 2.0 0.6 - Exporns 0 IimportsGross national product 5.2 4.8 5.5 5.9 ' A

Note: 1 998 data are preliminary esbmates.6

The diamonds show four key indicators in the country (in bold) comparsd with its income-group average. If data are missing, the diamond wiDllbe inc-omplete.

62

Bangladesh

PRICES and GOVERNMENT FINANCE1977 1987 1997 1998 Inflation

Domestic prices(% change) 10Consumer prices 2.5 7.0

Implicit GDP deflator -2.1 11.0 0.9 4.4 Government finance(% of GDP, includes current grants) 0Current revenue 8.7 9.3 9.7 93 94 95 96 97 98

Current budget balance 2.2 2.2 - GDP deflator -- CPlOverall surplusideficit -4.3 -4.2

TRADE

fUSS miJiions,l 1977 1987 1997 1998 Export and Import levels (US$ millions)Total exports (fob) 1,074 4,427 5,172 a,000

Jute goods 104 116 108Leather and leather products 135 196 190 6.000Manufactures 700 3,835 4,615

Total imports (cif .. 2,620 7,120 7,525 4,000 rFood 413 197 369 2000 rFuel and energy 230 361 295Capital goods ,, 856 2,000 2,072 o t J

Export price index (1995=100) 54 103 111 92 93 94 95 98 97 98Importpriceindex(1995-100) 79 100 98 cExports *ImportsTerms oftrade (1995=100) . 68 103 114

BALANCE of PAYMENTS1977 1987 1997 1998 Current account balance to GDP ratio (%)

(USS millions)Exports of goods and services 464 1,301 5,083 5,879 o' __Imports of goods and services 932 2,876 7,655 8,049 92 93 94

Resource balance -469 -1,576 -2,572 -2,170 |

Net income -31 -122 -107 -100 -2I.Net current transfers 325 731 1,770 1,750

Current account balance -174 -966 -909 -520

Financing items (net) 305 1,169 589 651 -4Changes in net reserves -130 -203 320 -131 s-

Memo:Reserves including gold (USS millions) .. .. 1,719 1.739Conversion rate (DEC, locallUSS) 15.5 30.6 42.7 45.4

EXTERNAL DEBT and RESOURCE FLOWS1977 1987 1997 1998

(US$ millions) Composition of total debt, 1998 (US$ millions)Total debt outstanding and disbursed 2,518 10,149 15,125 15,467

IBRD 55 70 38 34 F: 130 G:175 A 34IDA 505 2,985 5,701 6,014

Total debt service 148 547 705 696 E 4,710IBRD 3 5 7 7 a:6,014IDA 4 35 96 105

Composition of net resource flowsOfficial grants 0 662 736 589Official creditors 274 774 326 442Private creditors -1 1 -28 15Foreign investment 0 2 -116 252 D 4,13 C: 272

World Bank programCommitments 202 415 460 646 A- IBRD E- BilateralDisbursements 88 348 299 373 B -IA D- Other multlateral F - PrivatePrincipal repayments 0 9 59 65 C - IMF G - Short-termNet flows 88 339 241 308Interest payments 7 31 44 47Net transfers 81 308 196 261

Development Economics 7/6/99

63

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