Document o f The World Bank FOROFFICIAL USEONLY Report No: T7702-AF TECHNICAL ANNEX FORA PROPOSEDGRANT INTHEAMOUNTOFSDR 19.2MILLION (US$30.0 MILLIONEQUIVALENT) TO THE ISLAMIC REPUBLIC OF AFGHANISTAN FORAN EXPANDINGMICROFINANCEOUTREACHAND IMPROVINGSUSTAINABILITY PROJECT 28 November2007 Finance& PrivateSectorUnit South Asia Region This document has arestricteddistribution and may be usedby recipients only inthe performance of their official duties. Its contents mav not otherwise be disclosed without World Bank Groutl authorization. CURRENCY EQUIVALENTS (Exchange Rate i s Kabul based open market buyingrate Effective 1 October 2007 Currency Unit = Afghani (AFN) = US$1.O =49.9 Afghani GOVERNMENT FISCAL YEAR March21 - March20 ABBREVIATIONSAND ACRONYMS Af Afghani (national currency) ARTF Afghanistan Reconstruction Trust Fund CDC Community Development Council CIDA Canadian International Development Agency D C A Dutch Committee for Afghanistan DFID UKDepartment for International Development EC European Commission GOA Government o fAfghanistan (Islamic Republic o f Afghanistan) IDA International DevelopmentAssociation IFC International Finance Cooperation MFP Microfinance Service Provider MISFA Microfinance Investment Support Facility for Afghanistan MRRD Ministry o fRural RehabilitationandDevelopment NGO Non Government Organization NSP National Solidarity Program SDU Special DisbursementUnit SME Small or MediumEnterprise SOE Statement o f Expenses USAID United States Agency for InternationalDevelopment Vice President: Praful C. Pate1 Country Director: Alastair J. Mckechnie Country Manager Mariam J. Sherman Sector Manager: Simon C. Bell Task Team Leader: Stephen F.Rasmussen FOROFFICIAL USE ONLY AFGHANISTAN ExpandingMicrofinanceOutreachandImprovingSustainability CONTENTS Page TechnicalAnnex 1:Country. Sector andProgramBackground ............................................. 6 TechnicalAnnex 2: Major RelatedProjectsFinancedby the Bank andother Agencies ....11 TechnicalAnnex 3: ResultsFrameworkandMonitoring ....................................................... 13 TechnicalAnnex 4: DetailedProjectDescription .................................................................... 18 TechnicalAnnex 5: EstimatedProjectCosts ........................................................................... 23 TechnicalAnnex 6: ImplementationArrangements ............................................................... 24 TechnicalAnnex 7: FinancialManagementandDisbursementArrangements ...................29 TechnicalAnnex 8: ProcurementArrangements ................................................................... 39 TechnicalAnnex 9: Economicand FinancialAnalysis ........................................................... 41 TechnicalAnnex 10: CommunicationStrategy . ...................................................................... 50 TechnicalAnnex 11 SafeguardPolicyIssues .......................................................................... 54 TechnicalAnnex 12: ProjectPreparationandSupervision .................................................... 60 TechnicalAnnex 13: Documentsinthe ProjectFile ................................................................ 61 TechnicalAnnex 14: Statementof Loansand Credits ............................................................ 62 TechnicalAnnex 15: Countryat a Glance ................................................................................ 63 TechnicalAnnex 16: Map .......................................................................................................... 65 This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not be otherwise disclosed without World Bank authorization. FOR OFFICIAL USE ONLY ISLAMIC REPUBLIC OF AFGHANISTAN EXPANDING MICROFINANCE OUTREACHAND SUSTAINABILITY PROJECT GRANT AND PROJECT SUMMARY Recipient: Islamic Republic o f Afghanistan ImplementingAgency: Microfinance Investmentand Support Facility for Afghanistan Amount: SDR 19,200,000 (US$ 30 million equivalent) on standard IDA Grant terms Terms: Grant Objectivesand Description: The objective o f the project i s to achieve operational sustainability for most microfinance service providers and help them scale up outreach o f financial services to meet the needs and demands o f many poor Afghans, especially women. 0 Increased sustainability o f microfinance service providers that have begun the process o f diversifying their fbnding sources to include commercial sources in addition to funds provided by Government o f Afghanistan and donors. 0 Microfinance service providers are registered as Afghan companies and operatingunder relevant Afghan laws and supervision. 0 Scaled up outreach to many more poor people inmost provinces. ProjectBenefits: The benefit o f the project will be the creation o f a sustainable, growing Afghan microfinance program that serves millions o f poor Afghans and contributes to establishing an inclusive financial sector inAfghanistan. ProjectRisks: Security remains a concern, especially for organizations working in villages throughout Afghanistan. Political and public support for microfinance service provision needs to continue. Microfinance service provider organizations need to continue their strongperformance to date. ProjectAppraisalDocument: Inline with OP 8.00 there is no Project Appraisal Document for this Project. Instead, a Technical Annex i s submittedwith this document as required by OperationalPolicy 8.00. Disbursement: The Grant i s expected to bedisbursedfully by December 31, 2010 4 Thematic Code: Finance and Private Sector Sector Code: Finance and Private Sector Development Project IDNo.: P104301 5 TechnicalAnnex 1:Country,Sector andProgramBackground AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability CountryandFinancialSector Context Afghanistan i s beginning to recover from more than 25 years o f conflict. Despite a difficult security environment and persistent expenditure pressures, it has sustained its growth momentum. In 2005/06 the GDP growth rate was 14 percent. During 2001/02 to 2005/06, per capita income increased from US$ 123 to US$ 300 and i s projected to rise steadily to about US$ 482 in2010. As economic reform and rebuildingefforts have gathered steam, there has been some revival in the financial sector as well. One o f the more important steps D a Afghanistan Bank took to revamp the fragile financial system o f the country was to frame a Banking Law that was approved in 2004. More recently, Da Afghanistan Bank's has taken initiatives to pave the way for the emergence o f a short-term yield curve for the first time. Interest rates are market determinedand so far commercial bank lending rates to small and medium enterprises and the trade segment are relatively high due to the banks' caution intakingcredit risks giventhe market environment and legal framework. The banking sector comprises 15 commercial banks including three state owned banks, seven private sector banks and five foreign banks. However, the progress o f the banking sector has been understandably limited and bank operations are still mostly confined to the main urban centers with a limited distribution network o f about 100 branches at the end o f 2006. The table below shows the status o f the commercial banking sector. In addition, there i s one functioning leasing company and one state owned insurance company. AfghanistanBankingSector 31'' December2006 (Afghanisinbillions; % o ftotal banking system) I Branches Assets Liabilities Deposits Loan Book State owned banks 40+ 11.9 3.9 9.7 5.9 Bank-e-Milli (39%) (18%) (50%) (73%) Export Promotion Bank Pashtany Tejarati Bank Afghan commercial banks 51 11.3 9.8 6.8 1.9 Afghanistan International Bank (37%) (46%) (34%) (23%) Ariane Bank Azizi Bank BRAC Afghanistan Bank DevelopmentBank o f Afghanistan Kabul Bank FirstMicroFinanceBank I 6 Branches Assets Liabilities Deposits Loan Book Foreign commercial banks 7 7.5 7.5 7.5 0.3 Bank Alfalah (24%) (36%) (16%) (4%) Habib Bank NationalBank o f Pakistan Punjab National Bank Standard Chartered Bank But the provision o f financial services is still dominatedby the informal sector, most visibly the hawala dealers, some o f which have opted to be licensed by D a Afghanistan Bank under a special money payments provider law. Microfinance i s only one small part o f the financial sector. This project addresses the development o f the microfinance part o f the overall financial sector, the part that specifically focuses on serving the needs o f the poor. But efforts are being made to revive and strengthen all parts o f the financial sector. While microfinance has emerged quickly in a largely informal economic context, its future health and growth will be at least partly dependent on the increasing strengthand growing maturity o fthe financial sector as a whole. ProgramBackground By the beginning o f 2002 there was a large unmet demand for formal financial services, especially for poor people and microenterprises. Since the banking system had collapsed during the war and there were no functioning credit cooperatives or NGO microfinance institutions, the entire country relied on the ubiquitous informal financial systems. In 2003, the Government o f Afghanistan, in collaboration with donors, decided to actively promote the development o f microfinance services, or the development o f a financial sector that would provide access to poor people. Commercial banks had not yet been established and it was clear that even after beginning operations it would take a long time before they would be in a position to serve the vast majority o fpeople. Taking account o f the evidence for the link between improved access to finance and poverty reduction, in 2003 the Government o f Afghanistan established a project under the Ministry o f Rural Rehabilitation and Development called the Microfinance Investment Support Facility for Afghanistan, or MISFA, as the vehicle through which Government o f Afghanistan and donors could channel funds to build up the lower end o f the financial sector. MISFA was intended to (i) coordinate donor funding so that conflicting priorities endemic inpost conflict situations did not end up duplicating efforts and distorting markets; (ii) help start-up microfinance institutions scale up rapidly and eventually become sustainable; and (iii) systems for transparent reporting build and instill a culture o f accountability. Scaling up microfinance outreach has been included as an important development strategy under the Afghanistan National Development Strategy and i s consistent with the Interim Strategy Note for Afghanistan. Since 2003 the World Bank has provided funding to MISFA through the Afghanistan Reconstruction Trust Fund and has been closely involved inthe development o f the microfinance sector. 7 Significant progress has been made over the past three to four years. By the middle o f 2007 the sector hadthe following characteristics: 0 15 functioning MFPs; 13 NGOs, 1bank, 1credit union promoter. 0 Presencein24 o f 34 provinces. 0 360,000 active clients (70% women); US$85 million outstanding portfolio. 0 US$220 million total (cumulative) disbursementsto clients. 0 US$220 average loan size. 0 5% portfolio at risk at 30 days. 0 3 operationally sustainable MFPs. Combined, all 15 MFPs cover 89% o f their operational costs from income earned on their outstanding loanportfolios. Inthe year fromMarch2006 to March2007 (1385) the microfinance sector added 10,000 active clients per month and loan disbursementsaveraged $7 millionper month. While MISFA began in 2003 as a project, it was converted into a private non-shareholding company inMarch 2006 with the Ministryo f Finance as the sole sponsor. This was done through apeshnahad adopted by the Afghanistan Investment Support Agency high council that includes eight ministers and the DAB Governor. The company has a board o f directors made up o f two Government o f Afghanistan nominees, three international microfinance experts, and two directors from the Afghan private sector. To date MISFAhas received and disbursed, or committed to disburse, US$ 136 million, o fwhich US$ 119 million has been provided through the Afghanistan Reconstruction Trust Fund. The World Bank managed Japan Social Development Fund initially provided US$ 5 million to begin the process, but all the remaining funds have beenprovided by bilateral donors, the three largest contributors being CIDA, DFID and USAID. The total market size i s estimated to be 3 to 5 million clients and so far demand has far outstripped supply. Between March 2005 and March 2006 MISFA could have disbursed US$ 60 million to MFPs whereas only US$ 34 million was provided. Between March 2006 and March 2007 MISFA received about US$ 40 million to disburseagainst a budget o fUS$ 60 million. This has meant that growth inthe sector has slowed down over the past two years. It i s estimated that outreach could have been more than 450,000 active clients by the end o f 2006 ifadequate fundinghadbeen made available on time. There i s clearly considerable room to expand outreach and improve the lives o f many more poor people throughout Afghanistan, while at the same time creating long term sustainable Afghan microfinance service providers that can begin to mobilize funds from the market. Bilateral funding contributions are essential but not sufficient to contribute what is needed to reach these goals. Local commercial sources o f funding are still not available and the sector i s not yet mature enough to attract international funding. An IDA project o f US$ 30 million will also not be enough to take the sector as far as it needs to go, but it will make a crucial contribution at a "make or break" time for the sector, and it can go a long way towards taking the sector to a position o f relative strength. Additional financing could be considered infuture depending on the progress achieved through this project. A recently completed external evaluation o f the microfinance sector in Afghanistan notes that growth in client outreach i s impressive and stands first compared to many conflict affected 8 countries such as Bosnia and Herzegovina, Mozambique, Uganda, Sierra Leone, Liberia, West Bank / Gaza, and Cambodia in their early stages o f recovery. The approach that i s being proposed o f providing funding to a specialized apex institution i s a well known model to the World Bank. The design o f the MISFA mechanism was based to a large extent on the successful Local Initiatives Project inBosnia that was World Bank funded. And at present inthe South Asia Region, the World Bank supports large microfinance apex institutions in Bangladesh and Pakistan. ProjectPurpose and Benefits The objective o fthe project is to achieve operational sustainability for most microfinance service providers and help them scale up outreach o f financial services to meet the needs and demands o f many poor Afghans, especially women. The primary target group for this project i s the microfinance service provider organizations that MISFA supports: expanding their outreach, improving their sustainability, and building Afghan institutions. Improving access to financial services is one part o f the overall larger strategy to reduce poverty in Afghanistan. The impact o f a strong microfinance sector with significant outreach that provides a wide range o f financial services will be to improve the livelihoods o f poor households being served by the sector. The project will pay special attention to the needs o f women and people living in areas with significant opium production, inparticular addressing the requirements o f the World Bank's gender and anti narcotics mainstreaming guidelines. As such, the project will also consider impact measurement at the household level, not just at the microfinance service provider level. LessonsLearnedfrom Other Projects Lessons have been taken from other similar projects that have supported microfinance apex institutions in post conflict environments (Bosnia) as well as in other South Asian countries (Bangladesh and Pakistan) in addition to lessons from other development projects in Afghanistan. Three lessons have been particularly influential inthe design o f this project. Setting clear objectives and institutingperformance basedfunding. It i s important to have clear, focused objectives and the ability to monitor indicators to measure progress against those objectives right from the start. This sends a clear signal to microfinance service providers about what is expected interms o f partnership support and allows each MFP's performance to be monitored against agreed performance targets. Once this has been done, it i s important that the project base ongoing funding decisions on MFP performance, regularly discussing progress regularly with each MFP. 0 Developing a market integration strategy. There i s an important role for a specialized apex in the early stages o f sector development. From the beginning, though, there should be a clear strategy for developing sustainable microfinance service providers that can eventually function as part o f the commercial financial sector. This strategy should include how microfinance service providers can gradually make a transition from dependence on subsidized funding to working with marketbased funding sources. 9 Building local institutions and capacity. There are immediate gains and added value early on from using international experience, i.e. international implementing organizations, in this case microfinance service providers, to start work and provide benefits to many people quickly. It has been especially true that organizations with prior experience in Afghanistan or significant regional experience were able to scale up and be effective more quickly. At the same time, though, this approach requires that a transition strategy be inplace from the beginningto create local organizations with a long-term perspective and commitment. While this i s difficult to do when the pressures are intense to expand services as rapidly as possible, it pays off in the medium term as things progress to the next stage. ProjectAlternativesConsidered The most obvious alternative to the microfinance sector development approach taken since 2003 under the ARTF microfinance project and furtheredby this project would have been to allow for an organic, market based financial sector development process in which financial service provider organizations initiate and develop programs on their own, without donor and government subsidies. This process would have allowed for some microfinance service providers to emerge on their own, possibly supported to grow and expand later on through the entry o f a specialized apex institution or development fund. This i s similar to the process that has occurred inmany other countries. The advantage is that institutions emerge ontheir own and an apex find that enters later on can focus on expanding microfinance service providers with a good track record rather than take risks with start-ups. There are very few examples o f countries where a microfinance apex has been established to begin sector development from nothing. A slower organic microfinance sector development process was discussed by Government o f Afghanistan and donors in 2002. But this strategy was rejected in favor o f the higher risk approach taken so far. Thispathwas chosen inorder to develop the sector andprovide accessto finance to as many poor families as possible as quickly as possible, in line with national development interests after years o f conflict. The Expanding Microfinance Outreach and Improving Sustainability Project comes along at a time when microfinance service providers are already established and it i s possible to move them towards sustainability and significant size. 10 TechnicalAnnex 2: Major RelatedProjectsFinancedbythe Bank andother Agencies AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability Since August 2003 nine donors have provided funding for microfinance in Afghanistan through the MISFA mechanism. These include CIDA, DFID, SIDA, Denmark, NOVIB, CGAP, USAID, AusAid and Japan. Although two or three donors have provided very small amounts of funding for microfinance related activities outside o f the MISFA mechanism, the amounts channeled through MISFA represent the great majority o f donor funding for microfinance. The total amount of funding received by MISFA to date is $136 million. O f this total, $119 million has come through the World Bank Managed Afghanistan ReconstructionTrust Fund. In late 2006 USAID initiated a new $80 million rural finance project called ARIES that is managed by the Academy for Education Development. $30 million will be routed through MISFA, $15 million for microfinance and $15 million for SME finance. Another $40 million will be provided to three international NGOs to expand microfinance outreach in priority rural provinces. Two o f those NGOs are MISFA partners and MISFA coordinates closely with the ARIES project. The microfinance project begun under the ARTF drew its design from the Local Initiative Project begun in 1996 under the rebuildingprocess in Bosnia. The South Asia region presently has two other active projects that support microfinance expansion through an apex institution. Microfinance I1in Bangladesh supports the work o f PKSF and PPAF I1inPakistan supports the work o f PPAF. 0 Second Poverty Alleviation Microfinance Project - Bangladesh (PO59143) This project provides funding to a microfinance apex institution, PKSF, that on-lends to MFPs. With additional financing the total project value is $166 million. It became effective 03/05/2001 and will close on 06/30/2007. The project has a satisfactory rating. Second Poverty Alleviation FundProject -Pakistan (P082977) One o f the major components o f this project provides funding to PPAF that has a microfinance apex component that on on-lends to MFPs. With additional financing the total project value i s $606 million. It became effective 04/15/2004 and will close on 07/31/2008. The project has a satisfactory rating. Related projects in Afghanistan that are supported by the World Bank include the National Solidarity Program and the Livestock and Horticulture Development Program. Both o f these projects focus on rural areas and poorer people and many o f the implementing organizations have separate microfinance programs that work in tandem with their NSP and agriculture development efforts. Emergency National Solidarity Project I1 (Project P102288, Credit/Grant IDA H2610): The objective o f this project is to reach out to most communities in Afghanistan to lay the foundations for strengthening o f community level governance and to support community- managed subprojects comprising reconstruction and development that improve access o f rural communities to social and productive infrastructure and services". The Government o f Afghanistan envisions the roll-out o fthe program across the entire country inthe next three years at a total cost o f US$525 million. This amount i s expected to be financed through IDA ($120 11 million approved in December 2007), ARTF, JSDF and bilateral resources. The NSP program often reaches communities before the microfinance program and helps pave the way for microfinance expansion. The fact that the implementing ministry, Ministry for Rural Rehabilitation and Development, has a seat on the MISFA Board helps support coordination. Although there has been discussion in the past o f CDCs being direct providers o f financial services, this has proven to be impractical. CDCs are not designed for this purpose, though a self-help group model along the lines o f what India has could be possible. An SHG model could possibly emerge out o f the CDCs but would require modifications to the current CDC approach as well as considerable capacity building. Horticulture and Livestock Productivity Project HLP (ID # P098256, Grant #. H2260): The project aims to stimulate marketable output o f perennial horticulture and livestock in focus areas by (i)improving the incentives framework for private investments and (ii)strengthening institutional capacity in agriculture. IDA finding o f $20 million was approved for this project in May 2006. This project will help create opportunities to expand microfinance outreach to farmers and the microfinance project can help provide some o f the credit needs o f farmers that will be necessary to the success o f the horticulture and livestock productivity project. The MinistryofAgriculture hasan observer seat onthe MISFABoard. 12 TechnicalAnnex 3: ResultsFrameworkandMonitoring AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability ResultsFramework Baseline data based on specific achieve operational &stainability for microfinance service providers that indicators will be established as will most microfinance service providers have begunthe process o f end o f project targets. Regular and help them scale up outreach o f diversifying their funding sources to reporting o f these indicators will financial services to meet the needs include commercial sources in allow for progress to be measured and demands o f manypoor Afghans, addition to funds provided by and adjustments to be made to the especially women. Government o f Afghanistan and project so that outcomes are donors (85% o f the loan portfolio achieved, or the reasons for not outstanding accounted for by MFPs achieving outcomes are known and with operational self sufficiencyratio, lessons can be learned. OSS>100%). 2. Microfinance service providers are registered as Afghan companies and operating under relevant Afghan laws and supervision. (1OO%of MFPs registeredas separate legal entities [to provide microfinance services] under Afghan law - as corporations, companies, banks, or any other recognized legal form for financial service providers at the end o f the project). 3. Scaled up outreach to many more poor people inmost provinces. (Number o factive clients o fMFPs increased to 625,000; 65% o f active clients who are women; growth o f outstanding loan portfolio to more than 250% o f the baseline portfolio; services being provided inmore than 30 provinces by the end o f the project). f Intermediate Operationally sustainable 1 Number / %ofMFPswith an OSS .. All o fthese indicators will be microfinance service providers (operational self sufficiencyratio) of collected and reported twice a year increasingly capable o f sourcing more than 100%that do not requireany from the first year o f the project. A funds (commercial debt, more grant subsidies for operational review o f progress will be made international funds, savings) from deficits. twice a year to allow for an the market. 2. Number I % o f MFPs with P A R assessment o f progress and for any necessary adjustments to be made to 30 (portfolio at risk greater than 30 days) o f less than 5%. inproject strategy. 13 3. Amount o f funds on the balance sheets o f MFPs from sources other than MISFA and their own equity. 4. Number / % of MFPs with a capital adequacy ratio above 12%. Microfinance service providers are 1.Number / % o fMFPs with Afghan corporations I organizations Afghan boardmembers I directors in with Afghans ontheir boards and in addition to international experts and top management positions. owner representatives. 2. % o f middle and top management positions heldby Afghans. Outreach o f financial service 1.Number of active clients doubled provision to poor people by within three years. microfinance service providers has doubled (number o f active clients) 2. Number o fprovinces inwhich and reachedmost provinces. MFPs are providing services. I I I I The primary target group for this project is the microfinance service providers that are MISFA supports. The targets for MFP and sector performance shown in this annex are only for the 15 MFPs that already have contracts with MISFA. It is possible that some new MFPs might be added as partners during this project. If so, targets for their performance will be set independently after discussion between MISFA and the World Bank. The important secondary target group is poor people who are being served by the microfinance service providers. Within that group the project will especially pay attention to women and to people living in areas with significant opium production, in particular meeting the requirements o f the World Bank's gender and anti narcotics mainstreaming guidelines. As such, the project will begin to address the need for impact measurement at the household level, not just at the MFP level. Case studies will be carried out on a periodic basis to monitor what the loans to women are invested in, how they affect the economic situation at the household level and what i s the impact on the female borrower's position in the family in terms o f influence (decision making) and in terms of expanding economic activitieshncome and mobility. MFPs will use this information to identify project constraints and shortcomings and be able to adjust interventions and consolidate the positive impact especially on the female clientele through facilitating linkages to suitable skills development opportunities and other relevant inputs. MISFA provides loan funds to microfinance service providers that in turn retail small loans to poor households in rural Afghanistan. By doing so it contributes to "strengthening and diversifying legal rural livelihoods" (National Priority Two o f the Afghan National DrugControl Strategy 2006). The microfinance sector is active in 23 o f the 34 provinces o f Afghanistan and this is expected to increase to almost all provinces by the end o fthis project. 14 In early 2005 MISFA began a special alternative livelihoods program that was designed to contribute to the overall Government o f Afghanistan effort to encourage small farmers to transition from poppy cultivation to a licit economy. Under this program MFPs were supported to reach out to small farmers in Nangarhar, Laghman, Kunar and Badakshan. The table below shows the progress o fthis special window up to March 2007. Active Active Cumulative number o f Cumulative amount o f Clients borrowers loans disbursed loans disbursed ~ ~ ~ I 12,715 I 11,765 I 22,114 I $6,682,141 I $2,749,401 1 Outreach inthe above areas i s expected to further increase with the additional US$9 million to be disbursedunder the USAID/ARIESproject that targets households mainly inthe poppy growing areas. In addition, a pilot project was conducted in Badakshan to provide loans to poor people who were indebt to opium traders. These loans allowed them to repay their debt as well as acquire an asset from which to beginto earn their livelihood. MISFA commissioned a study for which the report i s about to be published that uses qualitative interviews with borrowers and MFP staff to determine the impact o f `alternative livelihood' loans to help poppy growing farmers make a transition into licit economic activities. The study assesses the effectiveness o f different strategies by MFPs to adapt their products and services to be more suitable to farmers looking to move away from growing poppy. Preliminary results indicate that microfinance i s able to make a more effective contribution to this endwhen it i s one part o f an overall development program, one that not only includes things like development o f agriculture production and developing markets, but also improved health and education services. MISFA has encouraged MFPs to link up with other development programs that offer these services inthe same areas where loans are being made available. MISFA proposes to hire outside consultants to conduct research on lending methodologies that will be more suitable to the cash flows o f agricultural households. This will enable MISFA partners to improve targeting o f micro loans to "class 2 (not dependent)" and "class 3 (highly dependent)" farmers (World Bank Anti-Narcotics Guidelines Table 1). MISFAmonitoring and evaluation datareports on the number o f clients who havereceivedloans underthe alternative livelihoods program. MISFA i s presently conducting a national level baseline study that has four objectives: 1. Establish a baseline socio-economic and credit status o f clients with the aim to evaluate and assess the effectiveness o f microfinance at a later date. 2. Assess the initial impact o f the microfinance program since the sector began to be established in2003. 3. Examine clients who have dropped out o f microfinance programs to establish reasons for client dropout. 15 4. Identify socio-economic indicators that can be used by MFPs to monitor improvements at the household level on a regular basis. This baseline study includes a sample o f 1015 households selected from all over the country. The data will be analyzed under several broad categories: male and female clients, urban and rural clients, old and new (recent) clients, clients and non-clients, dropouts, and regional trends and comparisons. Collection o f household data will be undertaken at the end o f the project period to measure progress and consider impact. Results will be published after the conclusion o fthe project. Summary of how monitoringwill be carried out: MISFA already has a system inplace to collect, calculate and report all the indicators in the results framework. Reports will be prepared every six months and submitted to the World Bank. MISFA's six monthly reports will also include a short narrative section that reports progress on the alternative livelihoods work. Gender mainstreaming concerns will be addressed through case study based reports carried out at least twice duringthe course o f the project - once inthe first year and once inthe thirdyear. Based on the household baseline studybeingcarried, MISFA will work with the MFPs to design and introduce a social performance monitoring system. Dependingon how quickly progress can be made to design a system, reporting could begin duringthe second year o f the project. At the endo fthe third year ofthe project MISFAwill collect household data for a follow up study to the baseline study to consider and report on impact at the household level. Results will be publishedafter the conclusion o fthe project. Arrangements for ResultsMonitoring Tal :t Values-- Data ng ProjectOutcome Baseline YR1 YR2 YR3 YR4 YR5 Frequencyand Responsibility Indicators Dec Dec Dec Dec Der Dec Reports Instruments for Data 2006 2007 2008 2009 2010 2011 Collection 1. Percent of loan 51% 60% 70% 85% Six monthly MISFA's standard MISFA portfolio outstanding data collection that is accounted for by system from MFPs. MFPs with OSS>IOO%. Confirmed by audited annual MFP accounts. 2. Number I %ofMFPs 0 / 0% 10I 15 I 1sI Six monthly MISFA's standard MISFA registeredas separate 67% 100% 100% data collection legal entities under system from MFPs. Afghan law - as Confirmed by audited annual MFP corporations,companies, accounts. banks, or any other recognizedlegal form for financial service providers. L 3. Number of active 300.000 375,000 500,000 625,,000 Six monthly clients of MFPs. data collection system from MFPs. 16 audited annual MFP accounts. 4. % o f active clients 70% 68% 65% 65% Six monthly MISFA's standard MISFA t who are women. 7 data collection system from MFPs. Confirmed by audited annual MFP accounts. 5. Increase in amount $65 M $90 M $130 M $175 M I Six monthly MISFA's standard MISFA and percentage o f loan 1138% 1200% 270% data collection portfolio outstanding system from MFPs. relative to base year Confirmed by audited annual MFP accounts. IntermediateOutcome I Indicators 1. Number I %of MFPs 3 120% 4 130% 7 150% 10 i 67% Six monthly MISFA's standard MISFA with an OSS data collection (operational self system from MFPs. sufficiency ratio) o f Confirmedby more than 100%that do audited annual MFP accounts. not require any more grant subsidies for operational deficits. + 2. Number I YOof MFPs 13 I 13185% 13 185% Six monthly MISFA's standard MISFA with PAR 30 (portfolio 85% data collection at risk o f greater than 30 system from MFPs. days) o f less than 5%. Confirmedby audited annual MFP accounts. 3. Amount o f funds on $ 1 4 M $20 M $30 M $40mil Six monthly MISFA's standard MISFA the balance sheets of data collection MFPs from sources system from MFPs. other than MISFA. Confirmedby audited annual MFP accounts. 4. Number I % o f MFPs 5 133% 10167% 13 185% 13185% Six monthly MISFA's standard MISFA with a capital adequacy datacollection ratio above 12%. system from MFPs. Confirmedby audited annual MFP accounts. 5. Number I % o f MFPs 010% 10167% 15 I Six monthly MISFA's standard MISFA with Afghan board 100% 100% datacollection members I directors in system from MFPs. addition to international Confirmedby experts and owner audited annual MFP accounts. representatives. 6. % o f middle and top 50% 60% 75% 85% Six monthly MISFA's standard MISFA management positions data collection heldby Afghans. system from MFPs. Confirmed by audited annual MFP accounts. 7. Number o f provinces 2 1 24 28 Six monthly MISFA's standard MISFA in which MFPs are data collection providing services. system from MFPs. Confirmed by audited annual MFP accounts. 17 TechnicalAnnex 4: DetailedProjectDescription AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability ProjectComponent This project only has one component: all $30 million will be loaned by MISFA to the microfinance service provider organizations. The IDA grant funds (US$ 30 million) provided to Ministry o f Finance will be made available for use by MISFA through a subsidiary agreement between Ministryo f Finance and MISFA.The funds will be provided to MISFA in local currency, to be repaid beginning five years after disbursement and entirely repaid inten to eleven years. MISFA will pay an annual administrative fee to the Ministry o f Finance equal to 1% o f the outstanding amount in that year. In turn, MISFA will provide loans to microfinance service providers under already established criteria and based on businessplans that have beennegotiated with and approvedby MISFA.Differently structured loans from MISFA to microfinance service providers can be financed, including debt products such as subordinate debt and quasi equity where needed. Microfinance service providers would inturn use the funds for on-lending to their microfinance clients, the majority o f whom are women. MISFA will provide loan funds to MFPs based on their track record to date and business plans they present for expansion. MISFAwill structure terms that will allow it to service its repayment obligations to the MoF. Subsidized terms from MISFA to the MFPs support MFP capital formation and contribute to their long term sustainability and growth. At this early stage o f development o f the sector and in the absence o f a more mature financial sector, this i s akin to providing risk capital through well targeted interventions. MISFA's role in supporting the creation of a microfinance sector has helped avoid more typical government interventions o f "directed credit" found in some other countries. Further, the MFPs supported by MISFAhave freedom inclient selectionjust as MISFA i s at liberty to screen MFPs before supporting them. Nonetheless, MISFA does provide donor grants for funding MFP start- up operational costs and capacity buildingprograms and charges fees for providing loan funds to MFPs that under normal circumstances might be considered as below market rates. However, there i s a clear economic rationale and an upfront phasing out strategy for such subsidies. With the current macro economic and ground level situation inAfghanistan, it i s the financial support through grant and concessional administrative fees that helped facilitate and attract MFPs to set up shop inAfghanistan. Secondly, viewedinthe country context, subsidies neededto contribute to the country's reconstruction and poverty reduction efforts and are well targeted. Thirdly, grants are capped since MFPs are expected to achieve operational sustainability within five years o f beginning their operations, after which no more grants to subsidize operation deficits are expected to be provided. As the graph below shows, grant funding i s declining over time while loan funding i s growing rapidly. Lastly, the current financing strategy does not create any market distortions becauseno other player i s currently financing microfinance. 18 MISFA -Disbursementto MFPs (US$ millions) 63.0 __. 0.9 0.9 5.0 3.9 Dec. 03 Dec. 04 Dec. 05 Dec.06 Dec. 07 Dec. 08 v PROJECTED RelatedFundingfor Sector CapacityBuilding The success o f this project i s dependent on the microfinance sector and MISFA continuing to receive funding from other donors, as it has in the past, to provide for MFP capacity building needs. These capacity building needs are met through grants from MISFA to the MFPs that decline over time and will eventually be phased out when MFPs can cover all their own costs through their own revenue streams. The IDA grant will supplementthose other capacity building funds, not replace them. The Afghanistan budget for 1386 includes US$ 33 million in grant fundingto beprovided for use by MISFAthrough the ARTF. It is expected that donor fiinds will continue to contribute to diminishingcapacity buildingneeds infuture years. Recently, USAID funded ARIES, a US$ 80 million rural finance project being managed by the Academy for Education Development. Under this project, MISFA signed an agreement to implement some aspects o f the project for a total o f US$ 30 million. This project will provide US$ 9 million for MISFA's existing microfinance program, all o f which i s expected to be disbursedbefore the end o f 2007. Another US$ 15 million is for a new SME financing window for which MISFA has established a separate SME department. This window largely works with banks to develop and scale up their small business lending portfolios. The remaining US$ 6 million will go as grants to apex institutions set up to oversee the credit unions and financial cooperatives that the project will establish through another implementationmechanism. Other MISFA Roles 19 While the project will directly focus on strengthening microfinance service providers and expanding their outreach to underserved people, it will also indirectly contribute to the development o f the meso and macro levels o f the sector. These aspects o f the project will be fundedby other donor funding,just as with capacity buildingfunds. At the meso level, audit firms based in Afghanistan will be trained to audit microfinance operations and provide appropriate disclosures on audited financial statements, thus improving the transparency o f the sector. In addition, MISFA will be the conduit for reporting MFP perfonnance data to the international Microfinance Information exchange (MIX) as well as to D a Afghanistan Bank, Ministryo f Finance, donors and others. A second meso level contribution will be to strengthen the nascent Afghanistan Microfinance Association that includes all the MFPs. This association was set up two years ago but has yet to become an effective organization. A stronger AMA can become an effective way to influence national policy on financial inclusion, help set industry standards, and generally be a voice for the sector. There has already been discussion about establishing a credit reference bureau. The IFC and some donors are interested to support such an initiative. MISFA i s engaged inthis discussion and would try to ensure that microfinance i s included when a credit bureau i s established. At the macro level, MISFAis engaged indiscussing and setting national level policies related to microfinance and to promoting an effective and inclusive financial sector. One aspect o f this involves appropriate regulation for microfinance. MISFA worked closely with D a Afghanistan Bank to establish the "deposit taking MFI regulations" under the Banking Law. These regulations were adopted in 2006 and allow for organizations that are not prudentially regulated to take deposits from their members ifthis is part o ftheir loan product (i.e. integral to their credit methodology), something that i s often called `compulsory savings'. If MFPs want to mobilize voluntary savings from members, they need to be licensed by DAB and prudentially regulated, but with lower capital requirements and simpler reporting requirements than for banks. MFPs that wish to operate beyond that level and mobilize deposits from anyone must obtain a commercial bank license. MISFA has also recently opened an SME finance window that works with banks to encourage and help them `downscale' and offer credit to small businesses. This window provides technical assistance to banks as well as loan guarantees or lines o f credit. By April 2007 two banks had signed agreements with MISFA. Under this window the minimum loan size i s US$ 3000, while most loans are likely to be inthe range o fUS$ 5000to US$20,000. MISFAplans to collaborate with a new initiative to use technology to try to improve access to finance. The largest mobile telephone operator, Roshan, recently began a pilot trial o f a mobile telephone payments technology (M-pesa) developed by Vodafone and successfblly introduced in Kenya. If the pilot i s successfbl, Roshan could link up with any number o f MFPs and banks to offer this service, as well as extend financial services through its airtime dealer network. Afghanistan already has about 2 million mobile telephone users, far greater outreach than the total number o fbank accounts, which i s still negligible, and growth inthe sector i s accelerating. 20 Future FundingRequirementsand Sources The objective o f this project i s to support MFPs to become sustainable such that they can continue to grow without requiring subsidiesto fund operational deficits. But this does not mean that no Government o f Afghanistan or donor funding will be required in future. In fact, just to reach the outcomes envisaged under this project, it i s estimated that at least US$ 60 million more inbilateraldonor finding contributions willberequiredbeforethe endo f2009. Sustainable MFPs that do not require more grant subsidies for basic operational costs only create the basis o f a healthy microfinance sector with the potential to access market funding. But as MFPs grow and become financially stronger, they will have an even greater appetite and much improved capacity to grow and expand their outreach and portfolios even more. This growth will require very large amounts o f funding, though this funding need not necessarily be subsidized and some o f it could possibly come from commercial sources and savings mobilization. For the foreseeable future, though, it i s expected that much o f the funding required to support growth will still needto come from the accumulated capital o f the MFPs and MISFA as well as further additions o f capital from Government o f Afghanistan and donor sources, even if these funds are provided to MISFA and the MFPs on market terms. For example, it i s estimated that the total MFP balance sheet funding that will berequiredto reach the projected 625,000 clients by the end o f the third year o f this project will be in the range o f US$ 200 million, a level that could possibly be achieved with MFP capital, some limited savings mobilization and MISFA contributions. But at that point the possibility would have been created for the sector to expand over the subsequent three to five years to reach 2 million or more clients, for which an additional estimated US$ 600 million would be needed to be added to MFP balance sheets. MFPs could afford market terms for some, ifnot most, o f this additional amount, but it i s doubtful that all o f this will be made available from commercial sources and savings mobilization. As such, more donor fundingi s likely to be needed if sector growth i s to be sustained. The creation o f sustainable MFPs with strong balance sheets and healthy cash flows does not necessarily mean that MFPs will be able to access commercial sources o f funding from the market. That will take a more developed financial sector in Afghanistan with an appetite to enter the credit market and provide funding to MFPs. It took 30 years o f microfinance development in Bangladesh before the first significant commercial deal between banks and an MFP came about in 2006, and it took twenty years for the same thing to happen in Pakistan in2007. Part o f the reason for this long gestation period has been donor and government funds sometimes undermining market mechanisms as well as lack o f financially strong MFPs in some instances. But a major constraint has also been lack o f interest on the part o f commercial players. This project can support MISFA to influence the first two factors inthe right direction, but it will have little influence over commercial financial entities. This will require that the overall financial sector in Afghanistan develop much more, in the process also becoming more willing to fund microfinance. MISFA itself is already a sustainable Afghan Company. It is established as a Company under Afghanistan's 1955 Commercial Code and has a functioning Board o f directors and management structure. It generates income from charging fees for the funds it lends to MFPs and in 2007 it i s 21 expected to generate a surplus o f income over expenditure. This project will further strengthen MISFA as an institution. Risks So far most people in Afghanistan have accepted the benefits and value o f the growing microfinance sector. But questions are raised in various forums about issues that are inherent to microfinance. The most important o f these i s that the service charges levied by MFPs are sometimes higher than commercial banks might charge their clients. This i s necessary to cover the higher costs associated with providing services to poor people that are not served by banks and often live inmore remote areas. It will be important that the MFPs are transparent about their fees and treat their clients with respect. As MFPs grow and become more financially sound, they should also become more efficient and be able to pass on some o f the benefits o f lower transaction costs to clients. Some MFPs are already moving in this direction but MISFA will need to monitor this closely and make sure that costs and charges to clients do not exceed industry norms. Besides issues related to service fees, the need for lending approaches that conform to Islamic principles i s important in the Afghan context. MFPs have already designed and introduced products to fit this need. Under this project, MISFA i s committed to strengthening its public awareness efforts to help build better understanding o f these and other microfinance sector development issues. Until2006 the level of conflict inthe country was generallymanageable and did not slow down or stop the development o f microfinance outreach. But inearly 2007 things began to change and as many as 20 MFP branch offices in at least 5 provinces were forced to close for varying periods o f time duringthe past year. At the same time, robberies o f MFP branches and attacks on staff in the field increased. The deteriorating security situation has slowed the rate o f microfinance sector growth in the second half o f 2007. At the same time, the overall loan portfolio at risk increased as a worsening security situation made it more difficult to collect back loans. Ifthese trends continue, it could become difficult for the microfinance sector to expand to all provinces and continue to grow its outreach as it has over the past four years. One means to try to mitigate the effects o f increasing levels of insecurity will be to help MFPs become sustainable as quickly as possible inregions that remain more secure, while waiting to expand, or expanding more cautiously, in regions where significant and growing conflict or insecurity exists. It also helps that MFPs are increasingly less dependent on expatriate staff and therefore better able to maintaintheir programs under more difficult conditions. So far the microfinance service provider organizations have generally performed well. But as they grow, spread out geographically, and diversify their product offerings, good management will become an even greater challenge. In this process, it is entirely possible that some organizations will not be able to keep up and will close their operations. While this i s a natural part o f market growth, this means that it i s even more important for MFPs to upgrade their systems and invest more to build the capacity o f their staff. Under this project, MISFA i s committed not only to supporting MFP capacity buildingbut also to increasing its monitoring o f MFP operations so that problems can be addressed early on. MISFA's ability to judge and manage risk will need to grow with the sector. 22 TechnicalAnnex 5: EstimatedProjectCosts AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability Summaryof costs to be fundedby the Droiect Project Cost By Component and/or Activity Local Foreign Total U S $million U S $million U S $million Component 1: on-lending to MFPs 30 30 TotalProjectCosts 30 30 TotalFinancingRequired 30 30 23 TechnicalAnnex 6: ImplementationArrangements AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability The project will be routed through the Government o f Afghanistan that will make the IDA grant funds available for use by Microfinance InvestmentSupport Facility for Afghanistan, a company established under the 1955 Commercial Code o f Afghanistan andregistered with the Afghanistan Investment Support Agency. MISFA will be the implementingagency that will on-lend project funds to MFPs, thereby helpingto scale up microfinance outreach. MISFA is a non-distributive / non-shareholding company. The Ministry o f Finance i s the sole member o f the Company, but it i s a board managed company where the power to make decisions about assets rests with the board. The purpose o f the Company i s to support the development o f an inclusive financial sector through support (loans and capacity building grants) to microfinance and small business finance service providers. MISFAbegan in2003 as a project under the Ministryo fRural Rehabilitation andDevelopment. The principle source o f funding was from donors making contributions through the Afghanistan ReconstructionTrust Fund. MRRD established a Steering Committee for this project chaired by a Deputy Minister and including three donor representatives in addition to project managers. Although MISFA was only a project under MRRD until March 2006, separate MISFA specific external audits were conducted beginningin 2004. To date these audits have been conducted by KPMGand the results havebeensatisfactory. With a view to ensuring institutional stability and proper governance, the Government o f Afghanistan formed a separate legal corporate entity "MISFA Ltd" through an asset transfer agreement executed in June 2006. The entire assets and liabilities o f the government project (MISFA) were transferred to MISFA Ltd., the transfer taking retrospective effect from 1'' April 2006. MISFA Ltd was registered as a non-distributive, non-shareholding Afghan company with its sole sponsor being the Ministry o f Finance. The Company had equity o f US$ 25.314 million on 31st March2006. Under the Articles o f Association o f the Company, the Boardhas the power to amend the articles and make all decisions concerning the assets and the management o f the Company. Should MISFA Ltd cease to exist for any reason, a decision that rests with the Board, all outstanding loans to MFPs that are provided from funds that MISFA does not have to repay (loans provided out o f its own equity) will be forgiven (granted to the MFPs) so that the purposes for which the Company received the fimds can be carried on. Loans provided to MFPs from hndsborrowed by MISFA, such as the loans under this project, will have to be repaid at that time to MISFA so that it can repay its obligations. Once MISFA has settled its obligations, remaining assets will be givento DaAfghanistan Bank. Governance The MISFA Board has seven members who are appointed for one year terms and can be appointed for subsequent terms as well. The Ministry o f Finance and the Ministry o f Rural Rehabilitation and Development each nominate one Board member. The donors that provide fundingto MISFAtogether nominate three internationalmicrofinance experts, not donor staff, to 24 serve on the Board. Together these five Board members approve two more members selected from the private not-for-profit or for profit sectors in Afghanistan. The Board appoints the Managing Director, approves the annual work plan and budget, delegates authorities to the management, approves policies and procedures, approves the annual accounts, and makes all investment decisions based on management recommendations. The Board meets twice a year in Kabul and has other meetings by telephone as necessary. At present the Boardmembersare: 0 EhsanZia (Chairman) -Minister, MRRD 0 Wahidullah Shahrani -DeputyMinister, Ministryo f Finance 0 Sima Samar - Chairperson, Afghanistan IndependentHumanRights Commission 0 Hameedullah Farooqi- Chairman, Afghanistan International Chamber o f Commerce 0 Martin Greeley - Senior Fellow, Institute of Development Studies, University o f Sussex, UK 0 Roshaneh Zafar - Founder and President,KashfFoundation, Pakistan 0 Mary Coyle -Director, Coady International Institute and Vice President St. Francis Xavier University, Canada The Board composition and the organization structure, systems and procedures indicate that MISFA's overall governance framework i s satisfactory. It would be necessary in the future to strengthengovernance by constituting a board level Audit Committee to oversee the functioning o f the Internal Audit Department, periodically review and vet the accounting policies followed by the Company, and scrutinize the annual financial statements prior to submission to the Board for approval. The Board has less than one year o f active experience and Board processes are still being strengthened and improved. Leadership succession planning, both at the senior management level and within the Board itself, will be critical to ensure sustained growth o f MISFA andfor buildingup the microfinance sector inthe medium-term. 25 Management structure and staffing MISFA Organization Chart i Boardof Directors Maior Responsibilities Maior Responsibilities 0 HumanResource management 0 Financial management 0 Donor relationdfundraising 0 Investinand monitoring of MFPs 0 Government relatiordcoordination 0 Invest inand monitoring of banks doing SME financing 0 External communications 0 Research, studies, impact assessment 26 As might be expected with a new venture that is growing rapidly while at the same time having to adjust from a project managed by an international firm under contract to an Afghan company with a mediumterm vision, MISFA has adjusted its organization structure several times and it is expected that future adjustments will be made as well. The most recent addition to the structure was the SME department that primarily works with commercial banks. This department i s being established for MISFA by ShoreBank International, a consulting firm with extensive SME and microfinance experience. MISFA has been conservative about expanding its staffing. It has relied on the combination of a few international experts and Afghan staff with no microfinance experience before joining MISFA, so there has been significant investmentinto developing staff. The Managing Director i s a banker with significant microfinance experience and the Technical Advisor previously worked for a microfinance rating agency. The other managers are staff who have learned about microfinance after joining MISFA and have been promoted into these positions based on their good performance and future potential. In March 2007 a complete review of MISFA's financial and administrative management structure, systems and capabilities was conducted. This review made several recommendations that MISFA has implemented or i s inthe process o f implementing. 0 All MISFA operating policies were consolidated in one document and updated. This revised Operations Manual takes account o f recommendations made by the World Bank at the time o f pre-appraisal and was approved by the MISFA Board at its April 18th2007 meeting. Positions for a deputy manager finance and an internal auditor have been approved by MISFA board and recruitment i s underway. The internal audit function will also examine and report on the use o f funds at the MFP level. The MISFA Board also recently approved the addition o f three staff to the technical services department primarily to allow for more active portfolio audits at the field level. This will allow for random examination o f loans from approval to their use by clients to help verify the data that i s being provided to MISFA by the MFPs. Decisions about investments in MFPs will be based on MISFA's Operations Manual. The manual specifies selection criteria for new MFPs, performance monitoring systems and criteria, and contract formats and obligations. The established criteria follow sound commercial practices o f appraisal, risk diversification and performance obligations. Each investment contract requires negotiation and detailing by management. It i s then recommended to the Board where it i s reviewedby an investmentcommittee beforebeingrecommended for Board approval. Fundingwill flow through several different levels 0 World Bank to Government of Afghanistan. IDA grant to Government o f Afghanistan (Ministryo fFinance). 0 Government of Afghanistan to MISF". Minimum ten year loan in Afghanis with a minimumfive year grace period. A 1% annual administrative service charge will be paid by MISFA to the MoF. The exact terms o f this loan will be determinedby the Subsidiary Loan Agreement between MISFA and the MoF. 27 0 MISFA to MFPs.MISFAwill on-lend to MFPs on terms that mightbe adjusted fi-om time to time and might also be different in fiture for organizations with different risk profiles. At present, MISFA has the same terms for all organizations: ten year afghani denominated loan with a five year grace period and a charge o f 5% per year. MISFA i s able to cover its costs with the spread it earns. Because o f the need to repay MoF, MISFA might need to adjust terms with MFPs to be slightly less than ten years with a slightly less than five year grace period. 0 MFPs to clients. Analysis shows that MFPs are charging interest rates by which they can become financially sustainable (Le. rates are positive inreal terms) and that contribute to the profitability and increasing capital base o fthe MFP (Le. provide adequate margins for profitability). On average, MFPs yields on portfolio are in the range o f 35% and projections show that they can become operationally sustainable (three already have) within five years from start-up with this level o f yield. This compares to the 25% yields that commonly prevail in the much more developed microfinance markets in Bangladesh and India. A higher rate in Afghanistan, though, i s justified in an environment where costs o f delivering services are higher and where MFPs have only recently established their operations. In fact, there would be concern at this stage o f development if MFPs were charging lower rates and thereby passing on subsidies to clients. Another comparison is to Pakistan where average MFP yields are 18% and sustainability i s a long way off (63% operational sustainability for the entire sector in 2005, the lowest in South Asia) and many MFPs pass on subsidies to clients instead o f using them to build up and strengthen their own institutions. IFC has investedintwo banks inAfghanistan, the First MicroFinanceBank that began operations in2004 and is also supported byMISFA and the BRAC Afghanistan Bankthat began operations inOctober 2006. While FMBA has so far focused on urbanmicrofinance and is now developing an SME portfolio, BRAC Afghanistan Bank will begin with a small business portfolio and expand into offering commercial banking services. Both the parent organizations o f these banks also own NGO MFPs inAfghanistan that are supported by MISFA and are the two leading MFPs inthe country. 28 TechnicalAnnex 7: FinancialManagementand DisbursementArrangements AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability CountryIssues The World Bank has gained substantial experience and understanding o f the financial management environment in Afghanistan through the large number o f projects under implementation over the past four years. The Public Administration Capacity BuildingProject is the primary instrument to continue and enhance the fiduciary measures put in place during the past years to help ensure transparency and accountability for the funding provided by the Bank andother donors. A PFM performance rating system using 28 high-level indicators that was developed by the Public Expenditure and Financial Accountability multi-agency partnership program was applied inAfghanistan inJune 2005. PEFA is comprisedofthe World Bank, IMF,EC, and several other agencies. The system i s structured around six core dimensions o f PFM performance: (i) budget credibility; (ii)comprehensiveness and transparency; (iii)policy based budgeting; (iv) predictability and control inbudget execution; (v) accounting, recording, and reporting; and (vi) external scrutiny and audit. Afghanistan's ratings against the PFM performance indicators portray a public sector where financial resources are by and large being used for their intended purposes. This has been accomplished with very high levels o f support from international firms, and this assistance will continue to be needed over the medium term if these ratings are to be maintained. There i s also much room for improvement. Despite the gains made in reconstruction since the end o f 2001, the challenges facing Afghanistan remain immense. The policy framework benchmarks have not yet been fully costed, so various priorities are funded through the annual budgeting process. The rising costs o f the security sector constitute the major constraint on attainment o f fiscal sustainability. With regard to executive oversight, the national assembly will play an increasingly active role. In spite o f considerable efforts to reform its core functions, the public sector remains quite weak outside o f Kabul. Lack o f qualified staff inthe civil service after 30 years o f war and conflicts i s a binding constraint. Delays in reforming the pay structure and grading o f civil servants have severely crippled the public administration of the country. Domestic revenues lag behind expenditures by a factor of ten to one. Large-scale corruption could emerge to undermine the government's efforts to enhance aid flows through national accounts. Capacities to track expenditures and monitor expenditure outcomes have improved, but they needrapid and substantial strengthening ifprogress toward the attainment of national development targets is to be monitored. Currently, 75% o f external revenues bypass government appropriation systems. The World Bank i s financing a Financial Management Advisor to assist the Ministryo f Finance, an Audit Advisor to assist the Control and Audit Office, and a Procurement Advisor to assist in Procurement-related activities. Also an Internal Audit hnction i s being developed within the Ministry of Finance with World Bank financing. USAID, and earlier the Indian Aid Assistance Program, i s financing a team o f consultants and advisors to assist the D a Afghanistan Bank in local as well as foreign currency operations. The activities carried out under the existing Public Administration projects have helped the Government o f Afghanistan to ensure that appropriate 29 fiduciary standards are maintained for public expenditures, including those supported by the Bank and the donor community. Progress has been slower than expected in shifting from operations support provided by the three Advisors to capacity development and knowledge transfer to the civil servants. Given that situation, it i s expected that the Advisors will continue to be required for the medium term. Challenges still remain in attaining the agreed upon fiduciary standards and then enhancing them. And to make matters more complex, the regulatory environment in Afghanistan has advanced significantly in the past three years. Unfortunately, even mastery o f basic skills inthe early environment does not fully qualify the civil servants to work effectively in the new emergingenvironment. The Project The table below identifies the key risks that the project may face and indicates how these risks are to be addressed. The overall FMrisk rating i s highbut the residual risk rating after application o f the mitigating measures i s substantial. Condition of Risk Risk Rating negotiations, Board or Effectiveness ( Y W Inherent Risk Countrv Inherent Risk M Source - PFM study M N Project Financial H Minimize use o fDesignated S N Management Risk Account, maximize direct payments to Financial Institutions Perceived Corruption H Government commitment, S N internal controls and new internal audit will help to reduce the highlevel o f perceived corruption OverallInherent Risk H S ControlRisk 1.Weak Implementing S New status of the M N Entity implementing entity, MISFA, as a limited liability non-profit company, an independent apex organization with a Board of Directors that perfoms oversight function. Presence o f experienced and qualified personnel occupying the position of the Managing Director and managers o f key departments including the 30 Deputy Finance Manager. 2. Funds Flow S Payments will be made to M N financial institutions from the Designated Account (DA) by SDU-MoF or payments in form o f advances will be made to MISFA from where financial institutionswould be paid. Inaddition to payments out o f DA funds, the implementing entity can also request the SDU to make (i) direct payments from the Credit Account to financial institutionsand (ii) special commitments for contracts covered by letters o f credit. These payments would only be made by SDU after due processes and proper authorization from the implementing entity. 3. Budgeting S The Manager, Finance & M N Adminwill be responsible for coordinationo f the annual budget preparation process, the budget would be approved by the Board o f Directors before submission for Government o f Afghanistan approval. 4. Accounting Policies and S Will follow international M N Procedures Procedures Manual. 5. Internal Audit H Newly-created internal audit S N 6. External Audit H 1Project's financial statements S N 31 will be auditedby CAO with support from Audit Advisor, while the entity financial statements will be audited by MISFA appointed auditors. N ~~ 7. Reporting and Monitoring H Strengthening the SDU i s a S priority under the new FM Advisor contract, to provide information that will comply with agreed format o f financial reports. OverallControlRisk H S DetectionRisk S Adequate accounting, M N recording, and oversight will be provided inproject procedures. Accounting, recording and oversight by SDU-MOF o f all advancesm- 16supported by Financial Management Advisor. Additionally, reliance will be placed on existing internal controls within MISFA. Riskrating:H=highrisk; S=substantial risk; M=modestrisk L-low risk Strengths The Government o f Afghanistan provides assurance to the Bank and other donors that the measures in place to ensure appropriate utilization o f funds will not be circumvented. Government o f Afghanistan support for PACBP will be strengthened to enhance financial management in treasury operations, public procurement, internal audit in the public sector, and external audit by the Auditor General. A specific strength o f the project i s that this i s a follow- upproject, thus the agency involvedinthe implementationhas experience inimplementing Bank projects and following Bank procedures. Weaknessesand Action Plan The main weakness in this project, as in many others in Afghanistan, i s the ability to attract suitably qualified and experienced staff, especially for financial management. The Deputy Manager Finance that MISFA will recruit and the establishment o f internal audit unit, together with intensive training programs included in this project, is expected to strengthen fiduciary management. 32 Implementing Entity MISFA will be the implementing entity for this project. MISFA i s a limited liability non-profit company with a functioning Board o f Directors. The Board o f Directors performs the oversight function while the Managing Director and Managers o f various departments are responsible for the day-to-day management o fthe company. The project will utilize the same financial management arrangements as the ARTF microfinance project. MISFA's financial management system will be strengthened in the course o f implementation with the engagement o f a Deputy Finance Manager and an internal audit unit. The Manager Finance & Administration will take responsibility for financial management activities o f the project, which will include processing o f hnds transfers to financial institutions, consultants and suppliers. This will include preparation o f M-16 forms (payment orders), maintenance o f relevant accounting records, preparation o f required monthly, quarterly and annual reports, liaison with the SDU to ensure that the designated account i s replenished when due, and responsibility to respond to project audits. Budgeting The Manager Finance & Administration will be responsible for coordination o f the annual work plan and budget preparation process in accordance with the procedures documented in the company's Financial & Administrative Policies and Procedures manual. This would then be submitted to the Board of Directors for approval. MISFA shall also coordinate regular budget reviews to ensure adequate budget discipline and control. It will work with the Ministry o f Finance to ensure that project expenditures for each fiscal year are captured in the government development budget o f that fiscal year. MISFA will work with the Ministry o f Finance to endeavor to obtain approvals from the presidential office and the parliament and attach them to B27 and PCS forms at the time o f requesting yearly allotments for contracts under the project to avoid delays inpayment processing. Funds Flow The standard funds flow mechanism in Afghanistan will be followed in this project. Project funds will be deposited in the designated account (DA) to be opened and maintained at the Da Afghanistan Bank. In keeping with current practices for other projects in Afghanistan, the DA will be operatedbythe MoF-SDU. Requests for payments from the DA will be made to the SDU by MISFA whenneeded. In addition to payments out o f DA funds, MISFA can also request the SDU to make direct payments from the grant account to financial institutions and make special commitments for contracts covered by letters o f credit, though this i s unlikely to occur under this project. These payments will follow World Bank procedures. Project payments will be made to either MFPs or to MISFA through normal bank transfers via D a Afghanistan Bank, local commercial banks or overseas banks. It has been agreed between MISFA and the MoF for funds to be transferred in the form o f advances from the DA to MISFA's bank account, from where payments would be made to 33 MFPs. MISFA would be required to submit SOEs for the acquittal o f an agreed percentage o f a previous advance before approval and payment o f the next advance by the MoF-SDU. Retroactivefinancing A provision has been made to reimbursethe Government o f Afghanistan for payments it makes, up to a maximum o f US$ 10 million for eligible project expenditures made after April 1st 2007 and up to the signing o f the Financing Agreement, in accordance with the Bank's procurement guidelines. FundFlow Chart IDA Direct Payments to Financial Institutions after approval o f W.A project and submitted Designated Account in DABdenominated in 1' USD / Project transactions (payments to financial institutions and advances to MISFA)processed through SDUandpaid inUSD, Afghanis, or other currency Payment T Payment Requests 1 Requests MISFA I I Legal requirements for authorized signature Ministryof Finance has authorization to disburse funds from the Grant. Specimen signatures o f authorized signatories inMoF are already on file with IDA. 34 Accounting The SDU will maintain a proper accounting system o f all expenditures incurred along with supporting documents to enable IDA to verify these expenditures. The Finance and Administration staff o f MISFA will: (i)supervise preparation o f supporting documents for expenditures; (ii) prepare payment orders (Form M16); (iii) approval for M-16s by the obtain Managing Director; and (iv) submit them to the Treasury DepartmentinM o F for verification and payment. Whilst original copies o f required supporting documents are attached to the form M16, the project i s required to make and keep photocopies o f these documents for records retention purposes. The FM Advisor inthe MoF/SDU will use the government's computerized accounting system, AFMIS,for reporting, generating relevant financial statements, and exercising controls. The Finance and Administration staff o f MISFA will maintain essential project transaction records usingQuick books and Excel spreadsheets and generate requiredmonthly, quarterly, and annual reports. The existing MISFA Financial & Administrative Policies and Procedures manual i s considered adequate. However, in accordance with the procedure described in the manual for making revisions, it should be updated for this project to include: (i) roles and responsibilities for all FM stafe (ii)documentation and approval procedures for payments and release o f funds to each implementingentity involved inthe project; (iii) reporting requirements; and (iv) quality project assurance measures to help ensure that adequate internal controls and procedures are inplace and are being followed. MISFA's Financial & Administrative Policies and Procedures manual covers all activities and funding sources of the Company. MISFA should ensure that for this project it establishes project financial management in accordance with standard government policies and procedures including use o f the Government o f Afghanistan Chart o f Accounts to record project expenditures. The use o f these procedures will enable adequate recording and reporting o f project expenditures. Overall project accounts will be maintained centrally in MoF-SDU, which will be ultimately responsible for recording o f all project expenditures and receipts in the government's accounting system. Reconciliation o f project expenditure records with MoF records will be carried out monthly by MISFA. Internal Control & Internal Auditing Project specific internal control procedures for requests and approval o f funds are adequately described in the Financial & Administrative Policies and Procedures manual. This includes segregation o f duties, documentation reviews, physical asset control, and cash handling and management. Annual project financial statements will be prepared by the MoF-SDU. Project financial management systems will be subject to review by the newly established internal audit directorate o f the MoF according to programs to be determined by the Director o f Internal Audit usinga risk-based approach. The internal auditor to be engagedby MISFA will undertake similar tasks. 35 External Audit Project accounts will be audited by the Auditor General, with the support o f the Audit Advisor, with terms o freference satisfactory to the World Bank. The audit o fproject accounts will include an assessment o f the adequacy o f the accounting and internal control systems, ability to maintain adequate documentation for transactions, and eligibility o f incurred expenditures for IDA financing. The audited annual project financial statements will be submittedwithin six months o f the close o f fiscal year. All agencies involved in implementation and maintaining records o f expenditures would need to retain these inaccordance with the IDA records retention policy. The following audit reports will be monitored each year in the Audit Reports Compliance System(ARCS): ResponsibleAgency Audit Auditors Date MISFA SOE, Project Accounts and Auditor General Sep 22 Designated Account MISFA Entityfinancial statements Auditors appointed by Sept 22 MISFABoardin accordance with its legal obligations. At present the auditors are KPMG. MISFA's audited financial statements along with the audit opinion will be submitted to the World Bank within 6 months o f the end o f each fiscal year. There are key issues in the CAO audit results o f the year ended March 20, 1384 (2006) for the ARTF microfinance project. The Ministryo f Rural Rehabilitation & Development responded to these issues and submitted an action plan. The World Bank i s satisfied with the responses and action plan submittedtowards resolving the key issues. Financial Reporting Monthly, quarterly or annual financial statements and project reports, as appropriate, will be used for project monitoring and supervision. These reports will be produced based on records kept by MISFA with due reconciliation to expenditure statements from MoF-SDU (as recorded in AFMIS) and bank statements from Da Afghanistan Bank.Project reports will show sources and uses o f hnds by project component as well as expenditures consolidated and compared to governmental budget heads o f accounts. MISFA will forward the relevant details to MoF-SDU with a copy to the Bank within 45 days o f the end o f each quarter. The Government o f Afghanistan and World Bank have agreed on a pro forma report format for all Bank projects. This format is already beingused for the current ARTF microfinance project. The annual project accounts will form part o f the consolidated Government o f Afghanistan accounts for all development projects. 36 Disbursement Arrangements Disbursement procedures will follow the World Bank procedures described in the World Bank Disbursement Guidelines and the Disbursement Handbookfor World Bank Clients (May 2006). Table 1 shows the allocation o f IDA proceeds in a single, simplified expenditure category which will facilitate preparation o f withdrawal applications and record-keeping. Project funds will be disbursed over 36 months. The closing date o f the project will include a final disbursement deadline four months after the closing date. During this additional four month grace period, project related expenditures incurredprior to the closing date are eligible for disbursement. Table 1: IDA Financingby Categoryof Expenditure(US$ million) Amount of the Financing ExpenditureCateporv Grant Percentage Allocations Summay Reports. All reimbursements will be made on the basis o f summary reports inthe form o f Statements o f Expenditure. These will be used for all payments to financial institutions. Records (copies o f loan agreements and other evidentiary documentation supporting the amount requested) are requiredfor direct payments. Designated Account. A single designated account will be opened at D a Afghanistan Bank in U S dollars for a maximum amount o f US$ 10 million, representing 6 months o f estimated expenditures. The MoF-SDU will manage both payments from and new advances to this account. Cash advances may be issued from the designated account to be held and managed by MISFA. MISFA's internal controls, cash handling accounting, andpreparation o f Statements of Expenses (SOEs) have been assessed as satisfactory. New cash advances will only be made when all other prior cash advances have beenjustified through submission o f SOEs to the MoF- SDU. Direct Payments. Third-party direct payments will be permitted for amounts exceeding 25 percent o f the advance in the Designated Account. All such payments require prescribed supporting documentation. Preparation of Withdrawal Applications. The SDU will review withdrawal applications for quality and conformity to treasury procedures and then obtain the authorized signatures. Selected MISFA finance staff will be registered as users o fthe World Bank web-based Client Connection system andplay an active role inmanagingthe flow o fdisbursements. Financial Management Covenants 0 MoF shall submit audited financial statements for the project within six months o f the end o f each fiscal year. The Project's audit report will cover the financial statements, the 37 designated account, and SOEs, in accordance with terms o f reference agreed with the World Bank. MISFA shall submit audited financial statements for its operations within six months of the end o f each fiscal year. Un-audited project interim financial reports will be submitted by MISFA on a quarterly basis to the World Bank and a copy to MoF-SDU within 45 days after the end o f each quarter. Supervision Plan During project implementation, the Bank will supervise the project's financial management arrangements. Supervisionwill be carried out on a regular basis and will be comprehensive. The supervisionteam will: Review the project's semi-annual un-audited interim financial reports as well as the project's annual audited financial statements and auditor's management letter. Review the project's financial management and disbursement arrangements (including a review o f a sample o f SOEs, movements on the designated account and bank reconciliations) to ensure compliance with the Bank`sminimumrequirements. Review agency performance in managing project hnds to ensure that it i s timely, accurate, and accountable. Particular supervision emphasis will be placed on asset management and supplies. Review annual audit reports received by MISFA from benefiting financial institutions as well as MISFA's internal audit reports and Technical Support Department reports on monitoring o fbenefitingfinancial institutions. Reviewo f financial management riskrating and compliance with all covenants. Conclusion The FM arrangements including the systems, processes, procedures, and staffing are adequate to support this project subject to implementationo f the items listed inthe action plan. 38 TechnicalAnnex 8: ProcurementArrangements AFGHANISTAN: ExpandingMicrofinanceOutreach and ImprovingSustainability CountryContext The Bank has gained substantial experience and understanding o f the procurement environment in Afghanistan through its involvement in the interim procurement arrangements put in place through the Emergency Public Administration Project as well as by working with the Afghanistan Reconstruction and Development Services that i s responsible for procurement administration. As part o f a broader review o f Afghanistan's Public Finance Management system, the World Bank recently carried out an assessment o f the procurement environment in the country based on performance indicators developed by a group o f institutions led by the World Bank and the Organization for Economic Cooperation and Development's Development Assistance Committee. The first key issue identified through the procurement assessment was the need for a champion ingovernment to drive reform, deepen capacity, ensure integrity inthe operationofprocurement systems, andpromote sound procurement practices by ministries. A new Procurement Law was adopted inNovember 2005 which radically transformed the legal and regulatory framework for procurement administration in Afghanistan. While it provides a modern legal system for procurement, effective implementation o f the law may encounter difficulties in the current weak institutional structure and capacity o f the Government o f Afghanistan. A Procurement Policy Unit (PPU) has now been established under the Ministry o f Finance to ensure the implementation o f the Procurement Law through the creation o f secondary legislation, standard bidding documents, provision o f advice, and creation o f the necessary information systems for advertising and data collection. The Afghanistan Procurement Procedures have been effective from April 12, 2007. Procedures for Procurement Appeal and Review have been developed by the Ministry o f Finance PPU. Members have been appointed and the system has been functional since April 2007. Inthe absence o f adequate capacity to manage procurement activities effectively, some interim arrangements have been put inplace to improve the procurement management o f the country. A central procurement facilitation service, A R D S has been established under the supervision o f Ministryof Economy. The World Bank and the Government of Afghanistan have agreed on a program for country wide procurement reform and capacity building, leading to a transition from centralized to decentralized procurement services. The World Bank funded Public Administration Capacity Building Project i s the primary instrument for implementing the program to strengthen capacity o f line ministries to manage public procurement in an effective, transparent and accountable manner. However, the implementation o f the procurement capacity buildingstrategy has not yet made significant progress due to lack o f coordination and delays in decision making within government. The radical changes to the procurement management environment expected from the new Procurement Law would require the urgent implementation o f a comprehensive human resources and capacity development program. Implementation o f the procurement reform component o f the PACBP should be considered with due priority to ensure 39 that fiduciary standards are firther enhanced and that capacity is developed in government to maintain these standards. The Project The proposed project will be implemented by MISFA on behalf o f the Government of Afghanistan. The Ministry o f Finance will lend the proceeds o f the IDA Grant to MISFA on the basis o f a subsidiary agreement signed by both parties. MISFA will then loan funds to qualified MFPs to carry out activities described below. The finds provided to the MFPs will be usedby them for making loans to microfinance clients of whom majority will be women. The procurement actions under the proposed grant for (i) / works and non-consulting services goods shall be inaccordance with paragraph 3.12 (Procurement inLoans to Financial Intermediaries) o f the Bank's Procurement Guidelines, and for (ii) consulting services shall be in accordance with paragraph 3.14 (Commercial Practices) o f the Bank Guidelines for Selection o f Consultants. Under the Credit Component o f this project (US$ 30 million), MISFA will make loans to MFPs that will in turn use these finds to make loans to individuals in the communities. These individuals will use these credits for micro level businesses such as grocery shops, tailoring shops, carpet business, purchasingo f fertilizer and animals, etc. The average size o f loan will be around US$ 250 and the maximum amount would be in the range o f US$ 1500. The MFP loan recovery rate at present averages 96 % (Le. less than 4% portfolio at risk at 30 days), which indicates that repayments are prompt and proper collection mechanisms are inplace. To the extent possible, MISFA shall ensure that the MFPs use the Grant proceeds (loans) for the intended purposes. The operational procedures followed by MFPs are documented in their operational manuals. The manuals elaborate the credit/loan approval system and internal audit procedures. MISFA has also established an internal control systemby which staff visit the MFPs and beneficiaries periodically, and external audits o f MFPs are conducted by independent auditors to ensure that grant proceeds are used for the intended purposes. These procedures mitigate risks o fmisuse o f funds. MISFA is currently financed by an ongoing project under the ARTF and by some other donors operating outside the ARTF process. At present 15 MFPs are receiving finding fkom MISFA. The procedure for selection o f MFPs i s described in the Operations Manual approved by the MISFA Board in April 2007. . In addition the Operations Manual also describes the MISFA mission, guiding principals, terms and conditions of grants/loans to MFPs, etc. MISFA has agreed to publish some o f the above information in the public domain, especially the MFP assessment and selection criteria, the documents required for this and the internal approval procedure. 40 TechnicalAnnex 9: EconomicandFinancialAnalysis AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability EconomicAnalysis Significant economic benefit i s expected to be derived from the project. The project will help improve the outreach o f microfinance services. The sector's loan portfolio outstanding to microfinance clients i s expected to grow by more than 250% between 2007 and 2009, with more than 600,000 active borrowers expected by the end o f 2009. The project will also contribute to fostering sustainable MFPs and moving the microfinance sector along so that it begins to access commercial funding and mobilize savings. It will also support the creation o f Afghan companies (MFPs) that are largely managed and governed by Afghans and instill credit repayment discipline both at the MFP as well as apex level. The Bank's funding will also encourage `crowding in' o f other capital into the microfinance sector, thereby having a leverage effect. Global experience demonstrates that a strong, growing microfinance sector i s a prerequisite to achieving the desired household level impact. The creation o f a strong growing microfinance sector will contribute to poverty alleviation and increases in the incomes o f poor people, create economic opportunities for poor people in rural and urban areas, contribute to gender equity by increasing the economic involvement o f women and enhancing their role in society, facilitate improved access to financial services to poor people throughout the country, create employment opportunities, and contribute to the government's counter narcotics strategy. Further,by increasing the provision o f loans to micro-clients across Afghanistan, the project will provide opportunities to urban and rural poor to invest in and manage microenterprises and earn additional income. MISFA' loans help microfinance clients undertake investments for microenterprise activities such as livestock rearing, petty trade o f numerous items, weaving/handicrafts/tailoring, agro-processing, rural and urbantransport, etc. Microfinance loans also provide a substitution effect, whereby more expensive credit from non-family informal sources, which i s what the poor most often have access to now, i s replaced by the much cheaper and more easily accessible microfinance loans. An analysis o fthe returns from such activities, as determined through a householdlevel study' to quantify the returns at the household level from providing micro loans, shows positive results. Based on an analysis o f 27 microcredit investments it was found that all 27 families included in the study have generated surplus income (receipts minus payments) during the year. The contribution of microcredit to the family income was found to be significant. On average it contributed 67% additional income per year in the form o f family labor and profit. Also, the ' A poor householdmay have more than one source of income including the microcredit investment. The incremental impact on household income of microcredit was calculated by developing an income / expenditure profile of the household for a period of one year. All cash inflows and outflows of the household were accounted for one year, including the inflow due to microcredit borrowing. In computing the net profit from the activity an expense componenthas been estimated for family labor depending on the amount of time employedby the family membersand the usual labor rate inthe area. Inflowsto the family have been divided into six main categories: (a) income of the family from sources other than microcredit investment, (b) gifts received by the family, (c) additional borrowing from sources other than the MFP, (d) contribution from the other income generating activities related to family labor, (d) borrowing from the MFP, (f)net profit from the income generatingactivity related to the loan, and (g) remittances from outside the household. The outflows have been categorized into (a) household consumption expenses, (b) capital expenditure, and (c) loan repayment. 41 proportion o f contribution from microcredit to total family income is significant, between 17% and 97%. The rate o f return for loans varied between 100% and more than 500%, levels that are not unusualinthe case o f such family managed micro-investments. Financial Analysis MISFA A financial analysis o f MISFA shows that it has sound financial ratios and is performing well. This performance can be expected given that MISFA has a five percent financial margin, virtually no liabilities and excellent asset quality (see also tables below on balance sheet and income statement analysis). MISFA's capital ratio i s nearly loo%, return on assets even without including grant income i s strong, and there are currently no bad assets. With growing operations, even when the cost o f funds increases as a result o f IDA borrowings the overall financials for MISFA are expected to remain strong with larger volumes leading to economies o f scale setting in(see below). MISFA's loanportfolio is expectedto morethan triple over the project period. MISFA's ProjectedFinancial Statements (US$I ullion) Actual December-06 December-07 Balance Sheet Assets Loans to MFIs 44.0 70.0 100.0 135.0 Cash 1.o 1.5 2.5 3.0 Other assets 0.1 0.1 0.2 0.2 Total Assets 45.1 71.6 102.7 138.2 Liability 10.0 20.0 30.0 Equity-Grants 44.4 59.6 78.3 100.2 RetainedEarnings 0.7 2.0 4.4 8.0 Total Equity & Liability 45.1 71.6 102.7 138.2 Income Statement Income Grant Income 25.5 20.0 12.0 6.0 InterestIncome 1.6 2.9 4.3 5.9 Expenses MISFA Operatingexpenses 1.3 1.6 1.9 2.2 Grants to MFIs 25.5 20.0 12.0 6.0 Profit (Loss) 0.3 1.3 2.4 3.6 42 M I S F A-Financial Performance And Ratios March 04 06 December 06 Net Profit/Fund Balances(ROE) 100.0% 65.0% 56.6% Earnings Ratio Net ProfitIAverage Assets (ROA) 80.4% 124.0% 92.0% 77.4% Capital Ratio FundBalances/Total Assets 80.4% 99.4% 99.3% 99.9% Profitability Ratios (% of Avg. Assets) Interest income 0.7% 1.8% 2.7% NA Non-interest income NA NA NA NA Overhead expense 29.9% 36.6% 12.4% 4.1% Risk Growth rate -Assets 542.3% 18351.6% 100.0% Growth rate - FundBa-mces 370.4% 147.1% 117.6% Liquidity Ratio Total Net Loans/Total Assets 42.2% 69.8% 37.4% 78.2% Interest-bearingAssets ($ m) 1.21 7.63 10.11 45.76 Average Interest-bearing Assets ($ m) 1.21 4.43 8.87 27.94 Interest IncomeiInterest-bearing Assets 1.7% 2.5% 7.2% 0.0% Spread ($ m) 0.02 0.20 0.73 NA Interms o f profitability, MISFA has done well so far. However, in the coming years MISFA may be required to pay interest on its borrowings from IDA or other sources and also meet increased operational expenses, possibly reducing its operating profit to some extent. As a substantial portion o f its assets would continue to be funded by the grants already received, the entire interest income from loans fundedby interest free grants and the net interest income from the balance loan portfolio would still be sufficient to meet the increased operating costs and provisioning requirements. MISFA i s therefore a financially viable entity. The tables below show financial information for MISFA. (US$ millions) Current assets Cash &Bank 0.347 12.1% 0.531 4.9% 0.670 2.5% 1.115 1.9% MFP (Loans) 1.213 42.2% 7.633 69.8% 24.977 92.3% 44.083 75.3% MFP (Others) 1.211 42.1% 2.609 23.9% 0.488 1.8% 13.242 22.6% Other Assets 0.071 2.5% 0.075 0.7% 0.823 3.1% 0.024 0.1% Total 1 2.876 100% 10934 100% 27.050 100% 1 58.538 100% * Audited ** Provisional 43 LiabilitiesAnd Equity (US$ mil ions) March 04* March 05* March 06* December 06"" Grants(Capita1) 1.214 1.233 7.847 25.315 Additions 6.419 17.345 19.105 Sub-Total 1.214 42.2% 7.652 70.0% 25.192 93.1% 44.420 75.9% SurplusiDeficit 0.019 0.7% 0.195 1.8% 0.123 0.5% 12.505 21.3% Total 1.233 42.9% 7.847 71.8% 25.315 93.6% 56.925 97.2% DeferredLiab. 1.078 37.5% 3.025 27.7% 1.555 5.7% 1.554 2.7% Current Liab. 0.565 19.6% 0.062 0.5% 0.180 0.7% 0.059 0.1% Total 2.876 100% 10.934 100% 27.050 100% 58.538 100% Income Statement Analysis (US$ millions) March04* Income Interest 0.021 2.4% 0.195 2.4% 0.726 6.7% NA Grants 0.861 97.6% 8.091 97.6% 10.147 93.3% 13.528 Total 0.882 100% 8.286 100% 10.873 100% 13.528 Expenses OPg. EXP 0.861 97.7% 2.527 30.5% 2.355 21.7% 0.398 Non-Opg Exp 5.564 67.1% 8.395 77.2% 0.590 Others 0.001 0.035 Total 0.862 97.7% 8.091 97.6% 10.750 98.9% 1.023 Surplus 0.020 2.3% 0.195 2.4% I 0.123 1.1% I 12.505 NA -Not available ** Provisional Interms o f capital adequacy, the accumulated retained earnings o f US$ 22.81 milli~n,~ key the component o f MISFA's capital, on March 31, 2006 would be adequate to support an asset book o f about US$ 285 million, applying a capital adequacy norm o f 8% as i s currently prescribedby DAB for commercial banks. The projected aggregate loan portfolio o f MISFA on March 31, 2009 is only US$ 157 million. Hence, MISFA should meet the capital adequacy norm quite comfortably inthe medium term. Its strong capital base bodes well for MISFA inthe future and provides more than sufficient cushion for future growth and expansion on a sustainable basis. MISFA's asset quality is good. While amortization o f its loans to MFPs has not yet started, so there i s no direct way to estimate what the repayment performance might turn out to be, the underlying MFP loan portfolios financed with MISFA funds i s sound. The current repayment rate i s above 95%. With more and more MFPs steadily heading towards full operational Accumulated retainedearnings are estimated after subtracting a 5% loan loss reserve (USrS2.5 million). 44 sustainability (see below), servicing the interest on MISFA loans and adhering to repayment commitment in respect o f MISFA loans within say, five to eight years from date o f disbursement, would not be difficult for the MFPs. Interms o f risk management, MISFA has on its roll a competent and young management team consisting o f qualified professionals with good appraisal capacity. However, as stated elsewhere, there i s an imperative need for MISFA to strengthenits Technical Support and Finance hnctions to cope with increased volumes, loan monitoring and complexity o f work in the days to come consequent to growth inbusiness and outreach. MISFA will also have to ensure that significant MFP entities like BRAC-A and ARMP adopt robust risk management practices. This, however, i s not an easy task either for MISFA or the MFPs in the context o f the serious limitations the country faces inavailability o f skilled humanresources. So far there i s no interest rate or currency risk given that MISFA has been funded through grants. With the IDA project, MISFA would be borrowing from the Government o f Afghanistan in Afghanis at a pre-defined and fixed interest rate, and would be lending to its partner MFPs in Afghanis in structured terms that reflect an appropriate level o fpricing and tenor while enabling MFPs to service the debt based on projected cash flows (see the section below on MFP performance for more information). No risks are seen with regard to either interest rate or currency fluctuations. MISFA's role as an industry facilitator and an apex financier has been o f crucial importance. Giventhe current state o f the financial sector inthe country andthe very low penetrationo fbank branches in provinces and consequent low access to banking facilities for deposits and loans, funding sources for MFPs other than MISFA remain limited. However, once more MFPs stabilize their operations and their role and financial viability gets independently assessed in financial circles, commercial banks and private players might beginto extend funding support to MFPs. In the medium term, well managed and credit rated MFPs should be able to begin to attract some private equity and long term debt, both from the domestic market and from abroad. Already MISFA has played an active role in negotiating what i s expected to be a borrowing relationship between a commercial bank and one o f the leading MFPs. It is expected that once this initial agreement is made and a first loan extended from a bankto an MFP, it would pavethe way for more such lending from fully commercial sources over the medium term. Overall, MISFA has gone beyond what many other similar apexes have done to incorporate elements o f a transition strategy to commercial funding terms over time. From the first year o f operations, it has taken initiatives to facilitate crowding in more commercial capital and an explicit and clear structuring all its financing based on an appraisal o f business plans and clearly defined performance criteria. Taking into account the composition o f MISFA's Board o f Directors, the caliber o f the line management, MISFA's organizational structure and its systems and procedures, the overall governance and management framework o f MISFA i s satisfactory. MISFA's Board consists o f seven members. Though MoF i s the sole sponsor o f the Company, the Board controls the Company and it has a well diversified membership. There are two members representing Government o f Afghanistan (one each from MoF and MRRD), and two non-government independent individuals, but nominated by the respective Ministries). The non-government 45 nominees' induction in the Board however requires the approval o f the Board. Development partners are entitled to choose three nominees. These representatives must have extensive experience in the micro finance sector, either in Afghanistan or in other countries that have micro-finance programs. The Board elects the Chairman o f the Board annually. H e presides over meetings o f the Board. While constitution o f an Audit Committee o f the Board and further streamlining the Board procedures etc. will strengthen its governance, these are steps that MISFAplans to initiate soon. MISFA has adopted international accounting standards for compiling its financial statements. Its loan policies and operational procedures are o f acceptable standards, though adopting Loan loss Provisioning Policy and Loan Write off Policy (both o f which would have relevance particularly iffutureNPLswere to arise) is suggested. Microjnance Sewice Providers A review o f MISFA's partner MFPs shows positive results. Given country conditions, the geographical reach o f the MFPs i s impressive, and more than 70% of the loan beneficiaries are women. Ofthe 13 MFPs supported by MISFA through grants and loans up to the endo f 2006, 12 are NGOs and one supports the establishment o f credit unions. The overall performance o f the sector has been good. Microfinance Sector -Performance Overview December 31,2006 No. ofActive Clients 300,501 No. ofActive Women Clients 209,940 No. ofActive Borrowers 257,450 No. ofReturnees 11,316 Gross Loanoutstanding US$ 68 million Avg. Loanoutstandingper borrower US$264 Current RepaymentRate 95% Client Savings Outstanding US$ 26 million No. ofProvinces 21 No of Districts 150 No. of Branches ( Urban67, Rural 83) 230 No. of MISFA's MFP Partners 13 MISFA's Loanto MFPs -outstanding US$44 million MISFA's Grant to MFPs outstanding US$ 13 million Livestock (small & large animals) 21% Agriculture 13% I Handicrafts& Manufacturing 13% I ~ As part o fproject preparation, a detailed financial review o f four MFPs was undertaken. With a clear emphasis on sustainability, o f the four sample MFPs appraised, one o f them, namely, ARMP has already achieved operational self sufficiency andthe other three holdbrightprospects 46 of emerging as viable operationally self-sufficient financial entities inthe next two to three years. This performance is quite impressive given the country conditions and the nascent stage o f the microfinance sector. Loan asset quality i s acceptable with a repayment record o f 95%. Hence all four MFPs appraised are "acceptable credit risks" for MISFA (see tables below). However, all MFPs face the following challenges: (i)availability of local talents to build their institutional capacity to support their growth plan and (ii) highsecurity cost impacting their operational cost. If security situation deteriorates it will not only move up further their already highoperational cost, but also slow down their operations, adversely impacting their operational viability. MFPs' non-viability inturn can adversely affect MISFA's future operations and viability. MFP BalanceSheet Analysis (December 31,2006) (US $ millions) ARMP WWI Cash& Equivalents 4.21 20% 0.403 24 % Net Loans 16.30 78% 18.14 69% 0.572 69% 1.183 72% Other Debtors 0.08 0.39 1% 0.016 2% 0.006 Net FixedAssets 0.30 2% 0.69 3yo 0.020 2Yo 0.058 4% Non-current Assets 1.42* 5% Total 20.89 100% 26.48 100% 0.833 100% 1.650 100% MISFA Loans 10.26 49% 12.32 47% 0.517 62% 1.313 80% SavingsDeposits 5.34 20% Other Current Liab 3.10 15% 6.51 24% 0.086 10% 0.177 11% Equity 7.53 36% 2.31 9% 0.230 28% 0.160 9% Total 20.89 100% 26.48 100% 0.833 100% 1.650 100% MFPIncome StatementAnalysis (December 31,2006) (US $ millions ARMP BRAC-A WWI Interest Income 2.397 1.794 0.177 Borrowing cost MISFA Loan 0.309 0.549 0.015 0.041 SavingsDeposit 0.087 Total 0.309 0.636 0.015 0.041 OperatingIncome 2.088 1.158 0.085 0.136 Operating Expenses: Manpower cost 0.996 58% 1.626 65% 0.149 64% 0.166 40% Other Overheads 0.618 36% 0.818 32% 0.085 36% 0.252 60% Depreciation 0.106 6% 0.062 3% Total OperatingExp 1.720 100% 2.506 100% 0.234 100% 0.418 100% Op Profit/(Loss) Before 0.368 (1.34) (0.149) (0.282) Provision Loan Loss Provision 0.386 0.301 0.004 0.006 Op Profit/Loss after (0.018) (1.64) (0.153) (0.288) Provision Non-opg. 0.293 2.000 0.266 0.162 Income(grants) Net ProfitLoss 0.275 0.351 0.113 (0.126) 47 Projected financial performance of the reviewed MFPs is strong (see tables below) and all four reviewed MFPs are projected to b e sustainable and quite profitable by 2009 - overall they represent an acceptable credit risk for MISFA. CreditQuality EstimatesMarch07" *Based on 9 monthsprovisional data (actual)for Apr -Dec 06 ProfitabilityAnd Sustainability April 06- March07 Estimates* Revenue ARMP BRAC-A PARWAZ WWI Total Expense 13.25% 26.68% 24.19% 24.65% FinancialExpense 3.56% 6.66% 2.34% 3.42% LLP Expense 1.79% 2.59% 0.57% 0.69% OperatingExpenses 9.69% 20.02% 21.85% 21.23% MFPProductivityRatios Based on 9 monthsprovisional data (actual)for Apr -Dec 06 48 MFPProjectedPerformanceto December 2009 (US$ million) ARMP BRAC-A PARWAZ WWI ____~ Outreach No. o f Active Borrowers 56,000 314,229 23,000 25,735 Gross LoanPortfolio 44.80 60.00 3.OO 5.25 Average Loanbalance per Borrower 800 191 130 204 Financial Structure Capital / Asset Ratio 28.16% 16.84% 6.83% 6.82% Financial Performance Financial Revenue ratio 21.31% 27.31% 33.66% 32.36% Profit Margin 39.98% 47.78% 16.09% 27.22% Returnon Assets (ROA) 8.52% 13.05% 5.42% 8.81% Returnon Equity (ROE) 30.91% 102.35Yo 90.63% 189.43% Operational Self-sufficiency (OSS) 166.60% 191.50% 119.18% 137.40% Productivity/Efficiency HeadCount 663 2,860 180 175 Borrowers per Staff Member 84 110 128 147 Portfolio per staff, US$ 67,572 20,979 16,667 30,000 Cost per Borrower US$ 50.89 17.67 29.06 34.95 Operating Expense Ratio 6.06% 8.10% 21.37% 16.80% Portfolio Quality Portfolio at Risk > 30 Days 0.3% 0.3% 0.0% 0.0% Loan Loss Reserve Ratio 2.16% 2.32% 2.02% 2.01% Overall, the financial analysis shows that MISFA's current operations as a financial intermediary are viable: (i) it has adequate profitability; (ii) meets the prudential requirements o f capital it adequacy; (iii) it has acceptable credit quality; (iv) it has the institutional capacity and systems to manage the current business, and with due organizational strengthening and skill development can efficiently manage future business growth; and (v) it has partner MFPs that are acceptable credit risks and increasingly better performing institutions. MISFA's future projected performance i s also strong and it i s thus a good conduit for on-lending IDA funds to MFPs. 49 TechnicalAnnex 10: CommunicationStrategy AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability The mandate o f this project and MISFA's mandate i s to build a microfinance sector in Afghanistan that provides flexible, convenient and affordable financial services for poor Afghans on sustainable basis across the country. Though MISFA started with direct support to NGO-ledmicrofinance service providers, its goal i s to work with a whole range o f financial service delivery channels including regulated MFPs, commercial banks, cooperatives, insurance companies serving different segments o f the low- income market. Inthis context, the objectives ofthe communication strategy are: To create wider public awareness and acceptance o f microfinance as an effective mechanism o f delivering financial services to the poor. . To increase awareness and support for MISFA and its partner MFPs within government at national and provincial levels. To increase interest and support for MISFA and the microfinance sector within . international donors, development finance institutions and international social investment funds. To improve communication andinformation sharingbetweenMISFA and partner MFPs. PrioritiesandApproach The highest priority in MISFA's communication activities will be to provide information about and greater visibility to needs within Afghanistan, followed by the growing demand from international donors and investors. Highlight microfinance success stories. MISFA will provide news and information about microfinance to the media and encourage journalists to cover issues related to microfinance. In addition, partner MFPs will be encouraged to write and distribute articles and information beyondthe usual reports they already produce. Counter negative sentiments. MISFA will develop materials that explain issues that are not well understood or could become controversial. For example, interest charged on loans, why women are the majority o fmicrofinance clients, etc. Visibility and transparency. Inorder to ensure a high level o f visibility and transparency and to promote a better understanding o f microfinance among the public, regular country specific communication activities will be undertaken. Efforts will be made to focus on changing needs and strategies inAfghanistan. 50 MISFA's CommunicationsUnit MISFA will strengthen its communications unit to have the capacity to produce press releases, articles, reports, issues papers, poster sand brochures as well as maintain a useful website. This unit will have the main responsibility to develop and disseminate the communication tools to different stakeholders. INaddition to producing materials, the unit will maintain good relations with the media and will provide training and awareness building for microfinance service providers. The unit will be headedby a Communications Specialist who will have previous work experience in print/media, strong communication and writing skills with a degree in communications/journalism. The Communications Specialist may be an Afghan or expatriate. In addition, the department will also have a Communications Officer who will be an Afghan, with strong communicatiodwriting skills and the ability to network with local mediapersons. Target Groups The target groups for MISFA's Communication activities are presented inthe below table: Target Groups Key MessagesDssues Examplemeansof communicatiodTools 0 Newsletter Government Institutions 0 Client success 0 Website and Authorities in stories/impact o f Monthly sector update Afghanistan microfinance including geographical Geographical outreach o f outreach o f MFPs MFPs Growth inaccess to credit bypoor households 0 Sustainability o f MFPs - why MFPs chargehigher interest? ~~ Client success stories/ Quarterly donor report Donors in Afghanistan impact o f microfinance 0 Website 0 Growth inaccess to credit Newsletter bypoor households 0 Monthly sector update, 0 Empowerment o f women including a brief fact-sheet on Fundingneeds o fthe sector Afghan microfinance sector The general public 0 Why microfinance? 0 Newsletter Client success 0 Website stories/impact o f 0 Press releases inlocal print microfinance media (Hewad, Anis, Kabul 0 Islamic compliance o f Times) microloans Radio/TV interviews with 0 Sustainability o f MFPs - MFPs and their clients 51 Target Groups KeyMessages/Issues Example meansof communication/Tools why MFPs charge interest? 0 Video films on microfinance 0 Geographic distribution o f clients and portfolio Media inDonor 0 Client success storied 0 Website Countries impact o f microfinance 0 Newsletter 0 GrowthinAccess to credit 0 Video films of microfinance bypoor households clients 0 Impact o fmicrofinance on 0 InternationalPress the lives o f the poor briefingdvisit byjournalists 0 Empowerment o f women Success stories 0 Microfinance inthe South? - regional distribution o f resources MISFA and MFP 0 Different Loan products to 0 Access to more information employees in the employees on sector by any kindo f Afghanistan 0 Afghanistan Statistics publication distribution. 0 Event taking place in Microfinance 0 News, Afghanistan Statistics, MFP profiles, Information on MF. Success stories Tools Website. All the publications are placed on the website, including the latest updated information, details of any jobs being advertised, Newsletters, Posters, success stories, background information about MISFA, and press releases. The website address is www.misfa.org;,af. Press releases. Press releases in English, Dari and Pashto will be distributed to MISFA's partners, government institutions in Afghanistan as well as donors, Afghan media, and ACBAR (for dissemination to INGOs and NGOs). Newsletter (English and Dari). M I S F A publishes a bi-monthly Newsletter that includes a brief profile of microfinance partners, special event or news, an MFP case study, microfinance sector statistics, and other useful information. The newsletter is widely circulated through email and hardcopies are being distributed as well. Responding to the requestsfrom the media. M I S F A will respond positively to requests from the media for interviews or articles. 52 Brochure and posters. The MISFA brochure will be updated occasionally and posters that advertise microfinance activities will also be developed and disseminated. and Partner MFP communication materials. MISFA will collect publicity/communicationsmaterials (newsletters, videos, photographs, etc.) from partner MFPs and distributethem more widely. Afghan media and information channels. MISFA already has a good connectionwith will expand this to include a wide variety of other mediachannels throughout Afghanistan. 53 TechnicalAnnex 11:SafeguardPolicyIssues AFGHANISTAN: ExpandingMicrofinanceOutreachand ImprovingSustainability Introduction Scaling up microfinance outreach has beenincluded as an important development strategy under the Afghanistan National Development Strategy and i s consistent with the InterimStrategy Note for Afghanistan. Since 2003 the World Bank has provided funding to MISFA through the Afghanistan Reconstruction Trust Fund and has been closely involved in the development o f MISFA. The IDA grant funds (US$ 30 million) provided to Government o f Afghanistan will be passed on to MISFA through a subsidiary agreement between Government o f Afghanistan and MISFA. The funds would be inthe form o f a long term loan to MISFA that MISFA would inturn loan to microfinance service providers under already established criteria and based on business plans that have been negotiated with and approved by MISFA. Differently structured loans from MISFA to MFPs can be financed including debt products such as subordinate debt and quasi equity where needed. MFPs would in turn use the funds for on-lending to their microfinance clients, the majority o f whom are women. The objective o f the project are to achieve a measure o f commercial sustainability o f Afghan microfinance service providers that have scaled up the outreach o f financial services to help meet the needs and demands o f many poor Afghans, especially women. Increased sustainability o f microfinance service providers that have managed some level o f diversification away from only donor and government funds should be achieved. A shift away from international MFPs to Afghan MFPs operating under Afghan laws and supervision i s gained. Scaled up outreach i s gained to manymore poor people. The EA Framework i s prepared in accordance with World Bank EA OP4.01 and pertinent to the Afghan laws and regulations. The purpose o f the EA Framework i s to ensure that all activities that the micro loan supports are environmentally sound and are incompliance with requirements o f pertinent Afghan laws and regulations as well as World Bank environmental policies, bearing inmindthe characteristics o fmicro loans that support household level economies. By definition, micro loans require very short turn around time and transaction costs must be kept very low. As such `subprojects' are limitedto those that have no or little environmental impacts and therefore need no formal EA. MISFA will assume overall responsibility for compliance with pertinent Afghan laws and regulations on environmental protection and with the requirements o f the World Bank. For this purpose, MISFA will take necessary steps to encourage environmental due diligence during project implementation. Commitment to ensuring environmental soundness should be included in the cooperation agreement between MISFA and the MFPs. In order to do this MISFA will include inits contracts with MFPs requirements related to environmental procedures that will be 54 agreed between MISFA and the World Bank. The following basic environmental requirements form the core o fthis framework: 0 MFPs will conduct its activities with due regard to environmental factors and the principles o f environmentally sound and sustainable development. 0 MFP operations will comply with the World Bank's FIEnvironmental Exclusion List. 0 Operations supported by MFP funds shall comply with the applicable health, safety and environmental regulations and standards. 0 MFPs will provide periodic environmentalreports to MISFA. In consideration o f the fact that the environmental issues involved in the project are generally clear and insignificant, the environmental management o f the project i s relatively simple and a totally separate environmental management system i s not necessary. An environmental management system which i s embedded inthe project management systemandmakes full use o f existing project management resources will be established. MISFA will appoint one member o f its Technical Services Department as an Environmental Focal Person to be responsible for the implementation o f the agreed EA framework. At the MFP level, a person will also be designated to be responsible for environmental protection. MISFA will ensure that the MFPs have access to professional EA advice in case there is a need for this. Environmental laws and regulations in Afghanistan are evolving and are not yet adequate. All the same, the National Environmental Protection Agency (NEPA) has developed a few laws and regulations to ensure environmental soundness o f the rehabilitation and development activities and projects inthe country. Expertisecan be sought from this source ifnecessary. MISFA will take necessary steps to ensure that MFPs put in place environmentally sound policies and procedures to enable credit officers and other staff to adhere to the pertinent Afghan laws and regulations governing environmental screening, assessment and reporting inthe process o f credit appraisal and administration. The main tool to be used by MFPs i s a `subprojects' exclusion list that will be developed to guide credit officers in their loan decisions. A suggested environmental screening procedure i s contained inthis annex. Afghan Laws and Regulations The current Afghan laws and regulations on environmental protection mainly deal with construction projects and manufacturing industries. The supplementary local regulations also cover services and trade, with direct applicability to subprojects targeted by the MSE finance project. Article 14 o f the Environmental Assessment Law (Article 14) relates to larger projects, not those financed by micro loans. The `subprojects' under this microfinance project will have only minor environmentalimpacts. 55 World BankPolicies The World Bank operations policy (OP 4.01) requires that " For a financial intermediary (FI) operation, the Bank requires that each FI screen proposed subprojects and ensure that sub borrowers carry out appropriate EA for each subproject." The Bank policies also require that "In appraising a proposed FI operation, the Bank reviews the adequacy o f country environmental requirements relevant to the project and the proposed EA arrangements for subprojects." This requirement was not designed for microfinance projects with hundreds o f thousands o f micro loans at the household economy level. So it has been applied more generally to other microfinance apex projects such as PKSF in Bangladesh and PPAF in Pakistan. These projects follow similar procedures to those described above. Process for Implementationof EnvironmentSafeguards It is recognized that incorporating environment issues as a mainstream part o f the core business o f microfinance service providers i s a process that can begin early on in the project but will take time. MFPs are not yet sophisticated organizations with the capacity to be able to understand all the implications o f this. In addition, it will take time and considerable effort to institutionalize environment principles and practices. While it i s clear that MFPs share World Bank values about the importance o f environmental concerns, they will need to develop ways to express these values as a part o f their mainstream business model that i s focused on sustainability, efficiency and lowering costs to poor clients. Stafjng: MISFA will appoint one person (50% time or full time determined by need) in the Technical Services Department to be the focal person for environment and safety issues. MFPs will designate one o f their existing staff persons to be their focal person. This will be done inthe first year by larger MFPswith the small MFPs doing it as they develop the capacity to do this. Terms ofreference: Terms o f reference for the focal points will be written. These will focus on the need for clear strategies, training and awareness building, systems for the use o f negative lists, and reporting. Reporting: A system for reporting at the MFP and MISFA level will be developed. Inorder to begin to introducethis system, at the beginning o fthe first year o fthe project MISFA will engage the services o f a consultant. This consultant should be a microfinance expert with good knowledge o f environment issues in microfinance programs. In order to help guide the consultant, the World Bank team will share examples of mainstreaming environment concerns in other microfinance projects, especially those where addressing environment issues i s a core part o f the business plan o f microfinance service providers and makes a positive contribution to their business. The consultant will: 0 Write terms o freference for the focal points incollaboration with MISFA andthe MFPs. 0 Define training and awareness building activities to be undertaken. Develop a reporting systemthat i s bothuseful to and feasible for all concerned. 56 a Finalize the negative lists after reviewingmicrofinance activities inthe field, considering what has been done inother World Bank fundedprojects, and reviewing the applicability o f Afghan laws. Also, develop systems for the introduction and use o f the negative lists. The World Bank supervision team will review progress during the first full supervision mission for this project. Safeguard Policies Triggered by the Project Yes N o Environmental Assessment (OP/BP 4.01) [XI [I Natural Habitats (OP/BP 4.04) [I [XI Pest Management (OP 4.09) [I [XI Physical Cultural Resources (OP/BP 4.11) [I [XI InvoluntaryResettlement (OP/BP 4.12) [I [XI IndigenousPeoples (OP/BP 4.10) [I [XI Forests (OP/BP 4.36) [I [XI Safety o f Dams (OP/BP 4.37) [I [XI Projects inDisputedAreas (OP/BP 7.60) [I [XI Projects on International Waterways (OP/BP 7.50) [I [XI Ineligible Activity Lists 1. Involves the significant conversion or degradation o f critical natural habitats. Including, but not limitedto, any activity within: 0 Ab-i-Estada Waterfowl Sanctuary; 0 Ajar Valley (Proposed) Wildlife Reserve; 0 Dashte-Nawar Waterfowl Sanctuary; 0 Pamir-Buzurg (Proposed) Wildlife Sanctuary; 0 Bande Amir National Park; 0 Kole Hashmat Khan (Proposed) Waterfowl Sanctuary. 2. Will significantly damage non-replicable cultural property, including but not limitedto any activities that affect the following sites: monuments o f Herat (including the Friday Mosque, ceramic tile workshop, Musallah complex, Fifth Minaret, Gawhar Shah mausoleum, mausoleum o f Ali Sher Navaii, and the ShahZadehahmausoleum complex); monuments o f Bamiyan Valley (including Fuladi, Kakrak, Shar-I Ghulghular and Shahr- iZuhak); archaeological site o fAi Khanum; site and monuments o f Ghazni; minaret o f Jam; mosque o f HajiPiyada/Nu Gunbad, Balkhprovince; stupa and monastry o f Guldarra; site and monuments o f Lashkar-i Bazar, Bost; Archaeological site o f SurkhKotal. 57 3. Requires: e political campaignmaterials or donations inany form; e weapons including (but not limitedto), mines, guns and ammunition; e chainsaws; e pesticides, herbicides and other chemicals; e investments detrimental to the environment; motorized extraction o f groundwater;2 e involuntary land acquisition under any conditions; e any activity on landthat i s considered dangerous due to security hazards or the presence o f unexploded mines or bombs; e any activity on land or affecting land that has disputed ownership, tenure or user rights.3 e any activity that will support drug crop production or processingof such crops. 4. Inaddition to the above general list, the following negative list is added from the IFC exclusion list: e Productionor trade inany product or activity deemed illegal under host country laws or regulations or international conventions and agreements. e Productionor trade inalcoholic beverages. e Gambling, casinos and equivalent enterprises. e Trade inwildlife or wildlife products regulated under CITES. e Productionor trade inradioactive materials. e Productionor trade inor use o f unbonded asbestos fibers e Purchase o f logging equipmentfor use incutting forest. e Productionor trade inpharmaceuticals subject to international phase outs or bans. e Productionor trade inpesticides/herbicides subject to international phase outs or bans. e Fishinginthe marine environment usingelectric shocks andexplosive materials. e Productionor activities involving harmful or exploitative forms o f forced laborharmful child labor. e Commercial logging operations for use inprimary tropical moist forest. e Productionor trade inproducts containing PCBs. e Productionor trade inozone depleting substances subject to international phase out. e Productionor trade inwood or other forestry products from unmanaged forests. e Production, trade, storage, or transport o f significant volumes o f hazardous chemicals, or commercial scale usage o fhazardous chemicals. e Productionor trade inany product or activity deemed illegal under host country laws or regulations or international conventions andagreements. e Productionor trade inalcoholic beverages (excluding beer and wine). e Gambling, casinos and equivalent enterprises. e Production or trade inor use o f unbonded asbestos fibers. 2 Indiscriminate installation o f irrigation wells using motorizedextraction o f ground water have in some areas contributed to lower the ground water table, and constitute a threat to the traditional sustainable irrigation by kurez. Untilwater resource assessments o f a particular catchment area or basinhas been undertaken and has established that irrigation i s feasible, investments inmotorized irrigation wells is not permitted. 3 Thus, investments involving an expansiono fthe command area o f an irrigation systemcanonly take place with agreement from the owners (or users incase oftribal common land) ofthe landbrought under new irrigation. 58 0 Productionor trade inproducts containing PCBs Social Issues The microfinanceproject is not expected to have any negative social impact - on the contrary, it i s expected to generate considerable positive social impact through provision o f loans to the poorer section o f the population and especially to women (the great majority o fborrowers), who otherwise have extremely limited access to credit. Social Safeguards. The project is not expected to trigger any o f the WB safeguards policies. Involuntary land acquisition andany activity on land or affecting landwhich has disputed ownership, tenure or user rights are deemed ineligible. Permissible land transactions will be based on willing buyer - willing seller principle only. A negative list also excludes any activity which will damage non-replicablecultural property, and incase o f chance finds the procedures to be followed are defined inthe Law on the Preservation o f Afghanistan's Historical and Cultural Heritages (Official Gazette no. 828, 1383/02/3 l), specifying the authorities and responsibilities o f cultural heritage agencies ifsites or materials are discovered inthe course o fproject implementation. This law establishes that all moveable and immovable historical and cultural artifacts are state property. MISFAis anational level program andthus does not exclude any region/ethnic group - although security concerns may temporarily preventproject activities incertain districts. MFPs do not target beneficiaries on the basis o f ethnic/religious etc. characteristics, but equity inimpact across various social categories will have to be monitored duringproject implementation. GenderMainstreaming. The majority o f MFP clients are women and the project will monitor what the loans are investedin, how they affect the households' economic situation as well as the impact on the (female) borrower's position inthe family interms o f influence (decision making), expanding economic activitiedincome and mobility. Herebythe MFPs will identifyproject constraints and shortcomings and be able to adjust interventions and consolidate the positive impact especially on the female clientele through facilitating linkages to suitable skills development opportunities, and other relevant inputs. Inparticular, links should be forged with other WB fundedprojects such as the National Emergency Rural Access Project, the Horticulture and Livestock Project and NSP which have project activities/components targeting women and where significant synergy can be promoted. 59 TechnicalAnnex 12: ProjectPreparationandSupervision AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability Planned Actual PCNreview 12/14/2006 12/14/2006 InitialPID to PIC 01/05/2007 01/15/2007 Initial ISDS to PIC 01/05/2007 01/15/2007 Appraisal 07/23/2007 07/23/2007 Negotiations 11/05/2007 11/05/2007 BoardRVP approval 01/08/2008 01/08/2008 Planned date o f effectiveness 01/15/2008 01/15/2008 Planned date o f mid-term review 05/15/2009 Plannedclosing date 07/30/2010 Key institutionsresponsiblefor preparationofthe project: Microfinance InvestmentSupport Facility for Afghanistan (MISFA) and the Ministryo f Finance. Bankstaff and consultantswho worked on the projectincluded: 60 TechnicalAnnex 13: Documentsinthe ProjectFile AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability A. Bank StaffAssessments World Bank: Project IdentificationMission, December 10,2006 World Bank:Project Pre-Appraisal Mission, February19,2007 B. Other MISFAMemorandum of Association, July 10,2003 MISFAArticle ofAssociation, July 10,2003 MISFAMidtermReview, October 18,2006 MISFAAppraisal ofIntermediaries, February2007 MISFAOperationsManual, May2007 61 TechnicalAnnex 14: Statementof Loansand Credits AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability Difference between expected and actual Onginal Amount in US$ Millions disbursements Project ID FY Purpose IBRD IDA SF GEF Cancel Undisb Ong Frm Rev'd P102288 2007 NSP I1 000 000 000 000 000 12318 0.00 0.00 PO98256 2006 AF: Hort. & Livestock Project 0.00 0.00 0.00 0.00 0.00 18.99 -2.00 0.00 PO98118 2006 Afghanistan: Natural Resources Devt 0.00 0.00 0.00 0.00 0.00 28.54 -0.65 0.00 PO87860 2006 Urban Water Sector 0.00 0.00 0.00 0.00 0.00 41.97 0.00 0.00 PO89040 2005 Strengthening Higher Education Program 0.00 0.00 0.00 0.00 0.00 37.06 -0.42 0.00 PO88719 2005 AF Investment GuaranteeFacility 0.00 5.00 0.00 0.00 0.00 3.91 1.97 0.00 PO84736 2005 Public Admin Capacity Building Project 0.00 0.00 0.00 0.00 0.00 17.09 9.81 0.00 PO83964 2005 Education Quality Improvement Program 0.00 0.00 0.00 0.00 0.00 30.31 -0.84 0.00 PO83919 2005 Kabul Urban ReconstructionProject 0.00 25.00 0.00 0.00 0.00 24.63 8.89 0.00 PO84329 2004 Emergency National Solidarity Project 0.00 0.00 0.00 0.00 0.00 5.59 -70.11 0.00 PO83908 2004 Emergency Power Rehabilitation Project 0.00 105.00 0.00 0.00 0.00 113.98 46.84 0.00 PO83906 2004 Emergency Customs and Trade Facilitation 0.00 31.OO 0.00 0.00 0.00 9.53 3.36 0.00 PO83720 2004 AF: Emergency Communications 0.00 22.00 0.00 0.00 0.00 6.77 3.51 0.00 Development PO78936 2004 AF: Emer Img Rehab 0.00 40.00 0.00 0.00 0.00 20.16 18.64 1.80 PO82472 2003 Natn'l Emergency Emp. Prog for Rural 0.00 20.40 0.00 0.00 0.00 2.54 0.12 0.00 PO78324 2003 Afghanistan Health Sector Emergency Reha 0.00 0.00 0.00 0.00 0.00 36.61 0.00 -6.52 PO78284 2003 Emergency Transport Rehabilitation - . 0.00 108.00 0.00 0.00 0.00 24.56 -29.48 0.00 Total: 0.00 356.40 0.00 0.00 0.00 545.42 - 10.36 - 4.72 AFGHANISTAN STATEMENTOF IFC's HeldandDisbursedPortfolio InMillions ofU SDollars Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic 2006 Areeba Afg. LTD 40.00 5.00 0.00 0.00 0.00 0.00 0.00 0.00 2003 FMBA 0.00 0.85 0.00 0.00 0.00 0.85 0.00 0.00 2006 FMBA 3.50 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2004 TPS (A) 0.00 0.00 7.00 0.00 0.00 0.00 7.00 0.00 Total portfolio: 43.50 5.85 7.00 0.00 0.00 0.85 7.00 0.00 ~~~~ Approvals PendingCommitment FY Approval Company Loan Equity Quasi Partic. Total pending commitment: 0.00 0.00 0.00 0.00 62 TechnicalAnnex 15: Country at a Glance AFGHANISTAN: ExpandingMicrofinanceOutreachandImprovingSustainability Lmn. I- 2.153 5#Z 1,364 T 1.s 2.3 31 59 e4 3s 75 62 104 111 99 2005 ? 3 zsa 'ill -%82 -38 a -11 1185 1- mad 1105 372 36 1 244 245 l i B 343 3 4 3 384 63 11116 V B M 2DM I Ihfl-IIw I 26 7 175 9 5 `00 7 1 I -w--O-Qli I lDB6 MIS 2DM 59: 2,7i 3 1 1 6 WR6 we4 E60 9,723 %,E76 4w 4832 -2,713 21 I 2,757 a3 331 -16 -4% si 1 PJ33 5C.6 1 7 4 11116 flllC 2DM 2.2'4 5,619 D u I D 47 S I D1 a5 11I 3 I CI 3 J I J D D D D a3 U a 64 60°E 65°E 70°E 75°E Amu To Darya UZBEKISTAN Dushanbe Murghob TAJIKISTAN To Chardzhev To TAJIKISTAN To Kulob To Shazud Dushanbe To Qurghonteppa AFGHANISTAN TURKMENISTAN FaisabadFaisabad JOWZJANJOWZJAN JAWZJAN ¯¯ Pyandzh B A L K H KONDOZ KONDOZ KUNDUZ ¯ Kondoz Kondoz Kunduz ¯ Taloqan ¯loqan ¯ Pamir h Sheberghan Sheberghan ¯ Mazar-e Mazar-e ¯ SharifSharif ¯ s ¯ TAKHARKHAR BADAKHSHANBADAKHSHAN Saripul Tirich Mir irich Mir u SamanganSamangan ¯ Baghlan Baghlan ¯ K (7690 m) (7690 m) To MeymanehMeymaneh Mary SAMANGAN SAMANGAN ¯ B A G H L A N ¯ FA R YA B FA ¯ ¯ u d To To n Chitral Mashad SAR-E POL SAR-E POL SARIPUL ¯ ¯¯ 35°N Morghab NURESTANNURESTAN NURISTAN ¯ Da¯rya-yeQ¯onduz i B A D G H¯I S ¯ H Mahmud-e Raqi Mahmud-e Raqi 35°N P ¸ ¯ ¯ ¯ ¯¯ KAPISA KAPISA ¯ ¯ ¯ Nuristan Nurestan Nurestan ¯ ¯¯ a r Qal`eh-ye Now Qal`eh-ye Now Bamyan Bamian Bamian ¯ ¯¯¯ PARWAN ARWAN Asadabad Asadabad ¯ ¯ o Charikar Charikar p ¯ ¯ ¯ LAGHMANLAGHMAN a To ¯ KUNARKUNAR m HeratHerat ¯ i s e u s R a ng KABUL KABUL Mehtarlam Mehtarlam ¯ Mardan ChaghcharanChaghcharan ¯ BAMYAN ¯ ¯ KABULKABUL ¯ PAKISTAN Harirud ¯ ¯ Jalalabad Jalalabad ¯ ¯ ¯ WA R D A K Meydan Meydan Shahr ¯ Shahr INDIA Khyber Pass Khyber Pass H E R AT¯ LOGARLOGAR NANGARHARNANGARHAR ¯ G H O R To Peshawar Pol-e `Alam Pol-e `Alam PAKTIKA AKTIKA Ghazni¯ Ghazni Gardiz Gardiz ¯ ISLAMIC Helmand G H A Z N¯I KOWSTKOWST Indus To Kowst Kowst Kohat 0 50 100 150 Kilometers REPUBLIC O U R U¯ Z G A N ¯ Sharan Sharan OF IRAN Farah FA R A H ¯ 0 50 100 Miles Tarin Kowt arin Kowt ¯ PA K T¯I K A ¯ Harut ¯ ¯ FarahFarah ¯ Z A B OL ¯ U Qalat Qalat ¯ ¯ Khash AFGHANISTAN Tarnak ¯ Kandahar Kandahar¯ Lashkar Gah Lashkar Gah EXPANDING MICROFINANCE ¯ Hamun-e ¯ ¯ Arghandab Saberi¯ ¯ To Zhob OUTREACH AND D a s h t - I M a r g o SUSTAINABILITY PROJECT ZaranjZaranj N¯I M R O PROVINCE CAPITALS U Z ¯ H E L M A N D H I L M A N D K A N D A H A R ¯ NATIONAL CAPITAL Helmand To Quetta 30°N RIVERS Gowd-e Zereh 30°N MAIN ROADS IBRD This map was produced by the Map Design Unit of The World Bank. RAILROADS JUNE The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank PROVINCE BOUNDARIES 35552 2007 Group, any judgment on the legal status of any territory, or any 60°E PAKISTAN endorsement or acceptance of such boundaries. 65°E 70°E INTERNATIONAL BOUNDARIES