PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: PIDA2887 Public Disclosure Copy Project Name Deposit Insurance Strengthening Project (P146248) Region EUROPE AND CENTRAL ASIA Country Serbia Sector(s) Banking (50%), Public administration- Financial Sector (50%) Theme(s) International financial standards and systems (100%) Lending Instrument Investment Project Financing Project ID P146248 Borrower(s) Republic of Serbia Implementing Agency Deposit Insurance Agency (DIA) Environmental Category C-Not Required Date PID Prepared/Updated 17-Jan-2014 Date PID Approved/Disclosed 17-Jan-2014 Estimated Date of Appraisal 09-Jan-2014 Completion Estimated Date of Board 27-Feb-2014 Approval Decision Public Disclosure Copy I. Project Context Country Context The global financial crisis that began in 2008 prompted the need for fiscal consolidation and the acceleration of the unfinished transition to a market economy in Serbia. The Serbian economy grew rapidly from 2000-2008, with output rising in real terms by nearly 50 percent. With the onset of the global financial crisis, the economy slipped into a recession and recovery has been timid. Growth of 2.0 percent in 2013 and 1.0 percent in 2014 is expected, but significant challenges remain. The sluggish economic performance in the country since the onset of the global financial crisis was accompanied by a deterioration of Serbia's fiscal stance and a rapid increase of public debt, which doubled between 2008 and 2013 to reach over 60 percent of GDP. The crisis unearthed remaining key structural weaknesses and obstacles that hamper sustainable economic development, including a pervasive influence of the state on the economy and financial sector, and an unfavorable business environment with cumbersome administrative procedures. Serbia's economic challenges require decisive, coordinated reform, and with significant fiscal deterioration difficult reforms cannot be delayed any longer. The government has shown a renewed commitment to an ambitious economic and financial sector reform agenda. Since early 2013, the authorities have embarked on an ambitious program of fiscal consolidation and structural reforms. The government mid-term reform is outlined in the “Fiscal Page 1 of 5 Strategy for 2014 with Projections for 2015 and 2016” and will focus on: (i) ensuring economic and financial stability; (ii) stopping further debt accumulation; and (iii) creating an environment for economic recovery and growth to foster employment and raise living standards. These goals will be Public Disclosure Copy achieved primarily through fiscal consolidation measures and acceleration of structural reforms, including strengthening the financial sector. The government has also demonstrated a strong commitment to the European Union (EU) accession agenda, and as a result EU accession negotiations will formally start in the second half of January 2014. The government has made a considerable effort in accelerating the preparation process for EU accession, including by ‘normalizing’ relations with Kosovo and initiating discussions on critical issues such as justice sector reforms and the rule of law. As a result of these efforts, the Council of the European Union approved the first intergovernmental conference on Serbia's accession in December 2013, and the European Council endorsed the start of negotiations. The results of a recent poll, conducted by the Serbian Intelligence office in July 2013, suggest that support for EU membership in the country has reached 50 percent, which is 9 percent higher than in January 2012. Sectoral and institutional Context The Deposit Insurance Agency in Serbia is a core part of the financial system safety net that deals with troubled banks. The DIA, along with the NBS and the Ministry of Finance, are part of the safety net system that aims to limit the impact of troubled banks on the financial system and the overall economy. The DIA’s primary responsibilities include: 1) the resolution of failed banks; 2) the reimbursement of insured depositors through the Deposit Insurance Fund; and 3) the administration of bankruptcies and liquidations of banks in order to recover assets. The DIA is mainly funded by collecting premiums from Bank’s (currently 0.4 percent of insured deposits on an annual basis). These are then deposited in the Deposit Insurance Fund account for Public Disclosure Copy legally permissible resolution purposes as defined by the Deposit Insurance Fund law. In order to minimize the possibility of contagion, deposit insurance covers depositors up to a certain insured amount (which in Serbia is EUR50,000) in case of bank failures. The DIA’s role in the resolution of failed banks begins when the license has been pulled by the NBS. The DIA has a “loss minimizer” mandate where by the Agency is responsible for developing a least-cost resolution strategy that aims to protect the funds of the Deposit Insurance Fund while at the same time ensuring that insured depositors are protected. Under circumstances when DIF resources are insufficient to fully meet resolution costs, budgetary funds are provided to the DIA to backstop any funding shortfalls. In such cases, the “least cost resolution” principles are extended to the use of public funds. Tools available to the Deposit Insurance Fund include direct payouts to insured deposits, a merger (purchase and assumption) with another bank in which the DIF provides a payment, and the establishment of a bridge bank to allow for a more orderly resolution. In addition, the DIA also has responsibility for recovering assets from bankrupt or liquidated banks in order to recover a portion, if possible, of the payouts that were provided. The recapitalization of the DIF is necessary as the recent Bank resolutions have depleted the financial resources available in the DIF. The resolution of Agrobanka, RBV and PBB has resulted in the DIF paying out the full amount of the assets that it had available (EUR211 million in mid-2012) . The depletion of the DIF creates significant risks to the Serbian financial system. These risks stem from the possibility of not having adequate resources to cover insured depositors at the Page 2 of 5 time of a bank failure. Bank failures, even of a small size bank, have the potential to shake confidence in the entire banking system if depositors lose confidence that their deposits are secure. Public Disclosure Copy The failure of three small state owned banks since 2012 has not caused depositors to lose confidence in the banking system, in part due to the actions of the Deposit Insurance Agency. The actions taken by the Deposit Insurance Agency, the NBS, and the Ministry of Finance ensured that the failures did not result in a larger crisis of confidence in the banking system. As a result, there were no signs of deposit withdrawals or other indicators of deteriorating depositor confidence after the resolution of the three banks II. Proposed Development Objectives The project development objective is to strengthen the financial and institutional capacity of the Deposit Insurance Agency, so as to enable it to meet its deposit insurance and bank resolution obligations and serve as a core part of financial sector safety net. III. Project Description Component Name Strengthen the financial capacity of the DIA Comments (optional) Results Based Component that strengthens the financial capacity of the DIA based on satisfactorily achieving Disbursement Linked Indicators (DLIs) Component Name Strengthen the institutional capacity of the DIA Comments (optional) TA that aims to strengthen the institutional capacity of the DIA to meet its deposit insurance and bank resolution obligations and achieve the DLIs. Public Disclosure Copy IV. Financing (in USD Million) Total Project Cost: 200.00 Total Bank Financing: 200.00 Financing Gap: 0.00 For Loans/Credits/Others Amount Borrower 0.00 International Bank for Reconstruction and Development 200.00 Total 200.00 V. Implementation INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS The DIA will serve as the Implementing Agency for both Components 1 and 2. The institutional and implementation arrangements are relatively simple as component one has relatively few disbursements against a relatively small number of DLIs, and the second component includes a small number of consulting contracts. In order to facilitate the project, a Project Implementation Team (PIT) has been established in the DIA. Assistance will be provided by DIA staff on an as needed basis. The principal PIT activities will comprise: (i) reporting on DLI results and providing required evidence for purposes of disbursement; (ii) reporting on the Bank advances that result in the funding of the DIF; (iii) managing TA procurement; and (iv) liaising with and reporting to the Page 3 of 5 government and with the World Bank on project progress and issues including the hosting of twice a year Bank supervision missions. The PIT has experience with implementing World Bank projects, as it implemented the World Bank’s Pensions Administration project that closed in 2012. The same Public Disclosure Copy staff remain in the unit (including financial management staff). RESULTS MONITORING AND EVALUATION The main outcome indicators for the project and the principal results will serve as the basis for results monitoring and evaluation. The DIA will be responsible for collecting the data required for monitoring and evaluation and for verification of the DLI’s based on protocols outlined in the Project Operations Manual. Indicators will be measured against agreed targets and compared to defined baselines. Project progress reports will be prepared by the DIA on a semi-annual basis and submitted to the Bank for review. SUSTAINABILITY The sustainability of the DIA will be strengthened through the design of the project. The project was designed as a Results Based IPF in order to ensure the sustainability of the DIA. The project design not only finances the DIF, but also strengthens the institutional capacity of the Deposit Insurance Agency through the achievement of the DLIs and the technical assistance component. VI. Safeguard Policies (including public consultation) Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 ✖ Natural Habitats OP/BP 4.04 ✖ Forests OP/BP 4.36 ✖ Pest Management OP 4.09 ✖ Physical Cultural Resources OP/BP 4.11 ✖ Indigenous Peoples OP/BP 4.10 ✖ Public Disclosure Copy Involuntary Resettlement OP/BP 4.12 ✖ Safety of Dams OP/BP 4.37 ✖ Projects on International Waterways OP/BP 7.50 ✖ Projects in Disputed Areas OP/BP 7.60 ✖ Comments (optional) VII. Contact point World Bank Contact: Rinku Chandra Title: Senior Private Sector Development Specialist Tel: 458-9671 Email: rchandra@worldbank.org Borrower/Client/Recipient Name: Republic of Serbia Contact: Zlatko Milikic Title: Assistant Minister Tel: 381113642-741 Page 4 of 5 Email: Zlatko.milikic@mfin.gov.rs Implementing Agencies Name: Deposit Insurance Agency (DIA) Public Disclosure Copy Contact: Zoran Obradovic Title: Director Tel: 381112075100 Email: zoran.obradovic@aod.rs VIII. For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-4500 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop Public Disclosure Copy Page 5 of 5