Ghana - Rural Financial Services Project

Report No. PID8586 Project Name Ghana-Rural Financial Services (@) Project Region Africa Regional Office Sector Other Agriculture; Financial Sector Development Project ID GHPE60248 Borrower(s) GOVERNMENT OF GHANA Implementing Agency Address BANK OF GHANA Accra, GHANA Contact Person: The Director Rural Finance Inspection Dept. (RFID) Bank of Ghana, Accra Tel: 233-21-665338 Environment Category F Date PID Prepared June 9, 2000 Projected Appraisal Date March 20, 2000 Projected Board Date June 8, 2000 1. Country and Sector Background Sector Issuesl. With Ghana's rural sector accounting for 60t of total employment and 39t of GDP, efforts to improve the sector's competitivity and productivity remain at the heart of the country's accelerated growth and poverty reduction strategy. However, this sector, which is largely dominated by agriculture, remains severely constrained by poor infrastructure, resulting in high input costs and low output prices, and limited used of improved inputs and modern production processes and methods as a result of poor agricultural services and inadequate access to credit. 2. The lack of access to credit for input purchase (fertilizer, seed, labor), processing, and trade remains a key constraint to improved economic performance in the rural sector, both agricultural and non-agricultural. The rural sector's share of total formal credit was a mere 8 percent in 1999. In addition, there has been a steady withdrawal from lending to the rural sector by domestic commercial banks, particularly after the 1990 elimination of the 20 percent mandatory lending to agriculture, and this share (of 8 percent) is likely to fall. There is potential for filling part of this void with resources from the 111 small, community owned rural banks, and a multitude of small informal micro finance organizations and specialized microfinance institutions (including NGOs), but these entities are weak, fragmented, and operate with outdated technologies and under residual policy constraints which need to be urgently addressed. However, based on international best practices and lessons of past operations in Ghana's rural financial sector, this would only be effectively filled if rural microfinance institutions are appropriately strengthened to more effectively perform such tasks. Secondly, the lack of access to institutional credit further tends to undermine government efforts in other areas as well, preventing attainment of strong development impact. With substantial investments in  infrastructure and services, the lack of a strong rural financial sector is the "critical missing link" of an integrated rural development strategy, the lack of which continues to stifle private sector initiatives in the rural economy. Strengthening of the rural financial system will therefore put into place the third pillar needed for rural economic growth and poverty reduction. A number of these constraints are discussed below. 3. Weak rural banks. Many rural and community banks are weak, with limited skilled staff, and outmoded technologies to adequately deliver services to rural clientele, a diversified group with different and often changing needs for financial services. Of the 134 rural banks in existence as at December 31, 1998, 23 were classified as distressed, with negative capital adequacy ratios (CARs), or a CAR of less than 1 percent. [The CAR measures the ratio of owned funds (such as paid up capital, free reserves, plus accumulated profits or less accumulated loss) to risk assets]. These 23 distressed rural banks were closed in 1999, after ascertainment of their inability to regain financial viability. Of the 111 rural banks remaining, 2 more became distressed during the last quarter of 1999 alone, and these will likely be closed by BOG in accordance with the banking laws. About 56 of the 111 banks are rated as mediocre, defined as rural banks with capital adequacy between 1 percent and 6 percent. The remaining 52 banks rated satisfactory are based on the narrow classification of capital adequacy ratio alone, i.e., those with capital adequacy equal to or greater than 6 percent. The performance rating does not take into account other key performance measures such as provision for bad and doubtful debt, portfolio quality, shallow capital and deposit base, etc. If more stringent criteria were applied, many of the banks currently ranked satisfactory would be further downgraded. The average paid-up capital for the satisfactory rural banks is only Cedis 48.1 million (US$13,000) and average networth of Cedis 282.1 million (US$78,000). Many banks are not often supervised within a given financial year: 29 of the 52 satisfactory rural banks were last supervised in 1998, the longest supervision lag being March 1998. There is also a large divergence in rural bank status, depending on the data source: there is an average divergence of Cedis 56 million in networth based on returns submitted by the rural banks and the examination conducted by the Central Bank. This is due mainly to the poor provisioning for bad and doubtful debts by the rural banks, and the lax supervision provided by the BSD. Consequently, policy prescriptions are likely to differ, depending on the data source used. Another area of weakness is human resources. A training needs assessment undertaken in 1999 from a sample of 42 of the rural banks showed that 60 percent of managers had only a diploma or certificate, and 12 percent had GCEs or equivalent; only 28 percent of rural bank managers had degrees. Also, 50 percent of all accountants had diplomas, 50 percent had GCE levels, and none had formal degrees in accountancy. All projects officers only had a diploma or certificate, with many having very little practical knowledge of rural investment appraisal. 4. Poor integration of formal and informal sectors. There is little real formalized relationship between formal and informal financial sector entities. Existing relationships are often ad hoc. This relative isolation of the two sectors impedes effective integration of the rural and urban economies needed to attain sustainable impact on rural poverty reduction. In reality, the formal and informal financial sectors are important parts of the same continuum, and efforts need to be made to remove constraints affecting the smooth flow of information, technology, and resources between them. Some rural banks have increased outreach through association with NGOs that have established - 2 -  methodology, and through linkages with susu collectors and clubs.5. Uncoordinated nature of past donor efforts. Past donor assistance to the rural financial sector has often been piecemeal, driven by each donor's comparative advantage and rural development strategy. IFAD has in the past focused largely on grassroots, micro finance institutions; IDA, on the larger financial sector and the rural banks; and AfDB, on lines of credit channeled largely through the ADB. Until now, there has not been a concerted and coordinated response so much so that in some instances, measures instituted by one donor have often worked at crossed purposes with the efforts of other donors: for example, a line of credit is given to a rural bank by one donor while another donor is financing capacity building activities in the same rural bank; or both donors support the same capacity building activities but use different triggers and requirements. Coverage has also been limited: for example, focusing on a few rural banks or informal associations within a project sphere of influence. Also, experience has often not been shared, often leading to costly duplication of efforts. Finally, donor assistance has often been short-lived, not allowing for sufficient time for reforms to take hold -- for example the IDA-financed project closed in 1995 when some reforms were still in progress, with no follow-up operation planned. 6. Thin and overextended oversight capacity. The Bank of Ghana (BOG) has the statutory mandate to monitor rural bank operations (as is the case for other, mostly urban based, commercial banks). However, this task is made very difficult by the large number, isolation and wide geographic distribution of the 111 rural banks. As a result, poorly performing banks (that actually need) do not often receive the intense supervision required and some banks may not be supervised in a given financial year. Current BOG supervision strategy normally consists of a team visiting each rural bank for 3 - 4 days to review reports and ascertain data reported. This approach was adequate when there were only a few rural banks in existence. Now, with over 111 rural banks scattered all over the 10 administrative regions, and many more applications from communities wishing to establish rural banks under consideration, this approach is now costly and unsustainable. The situation is exacerbated by poorly trained staff of the rural banks and poorly maintained files for quick supervision. Often, the BOG team may need to clean up the recording system first before beginning its supervision, leading to lost time. Hence, new technological reporting standards which take into account not only current but future growth needs of the rural financial system are urgently required.Government Strategyl. Regarding overall rural development, the government has undertaken a series of reforms and initiatives aimed at improved natural resource management, better rural infrastructure, and improved quality of agricultural services to the rural population. [Government strategy for the sector is contained in these strategy documents: Vision 2020 (1996); National Environmental Action Plan (1991); Forestry Master Plan 1996-2020 (1996); Land Sector Medium Term Plan 1996-2000 (1996); Accelerated Agricultural Growth and Development Strategy (draft 1997, being finalized in 1999); Wildlife Development Plan 1998-2003 (1998); National Soil Fertility Management Action Plan (1998); and Cocoa Sector Development Strategy (1999)]. In addition, government is undertaking, with multidonor support, major investment programs in rural infrastructure (ASIP and VIP) and services (AGSSIP) which will be complemented by the proposed project.2. Government strategy for promoting rural financial intermediation calls for deepening outreach and expanding services to a large number of rural clients by: (i) promoting the formal/informal -3 -  micro-finance sector through increased networking and capacity building, (ii) strengthening the overall capacity of rural banks for effective intermediation; (iii) creating a conducive environment for commercial bank intervention in the rural sector; and (iv) reviewing the role of the country's Agricultural Development Bank (ADB) in supporting accelerated agricultural growth, particularly with regard to medium and long term lending. 3. In this context, GOG began the first systematic efforts to restructure the rural banking sector between 1989 and 1995, with the IDA-financed Rural Finance Project. The project, which was also implemented by BOG, had a combination of institutional reforms and a line of credit to eligible rural banks. The undertaking of these reforms was a condition for individual bank participation in the line of credit scheme. However, experience of its implementation shows that many rural banks rushed through with these reforms in order to access the line of credit (which was quickly being depleted), and the capacity building process was halted as soon as the onlending resources which acted as a catalyst were exhausted. Additionally, GOG has initiated other reforms for non-bank institutions, such as the PNDCL 328 (Non-Bank Financial Institutions Act) of 1993. Furthermore, the Ministry of Finance, in association with the Ghana Microfinance Network (GHAMFIN), has prepared a strategic framework for the development of microfinance which will be presented to Cabinet after revision following a stakeholders' workshop. 2. Objectives 1. The Rural Financial Services Project (RFSP) seeks to promote growth and reduce poverty in Ghana by broadening and deepening financial intermediation in rural areas through the following measures: (i) strengthening operational linkages between informal and semiformal microfinance institutions and the formal network of rural and community banks in order to expand services to a larger number of rural clients; (ii) building capacity of the rural and community banks, the principal formal financial intermediaries operating in rural areas, in order to enhance their effectiveness and the quality of services they provide; (iii) supporting the establishment of an apex structure for the rural banking system to provide the economies of scale needed for these unit rural banks to address generic constraints related to check clearing, specie supply, liquidity management and training, etc. which have impeded growth of the rural finance sector; and (iv) strengthening the institutional and policy framework for improved oversight of the rural finance sector.2. Strengthening effective linkages between informal and formal financial sector institutions will involve the following measures: (i) developing, testing and disseminating innovative products and instruments suitable to the needs of rural clients, often comprising small community self-help groups, associations with limited organizational skills, assets and information; (ii) supporting the organization, training and empowerment of informal financial institutions, community self-help groups and associations to enhance their ability to mobilize savings and access credit from formal sources; (iii) investing in various mechanisms for more effective linkages between informal and formal financial sectors for better integration; (iv) improving the regulatory and policy environment under which informal financial sector entities operate to enable them to exploit new market opportunities; and (v) training and capacity building of microfinance institutions that serve rural clients and often help link them to more formal sources of finance. 3. The capacity building program of the rural and community banks will comprise - 4 -  the following measures: (i) undertaking a thorough and in-depth assessment of the financial and management performance of each rural bank in order to determine the extent of the constraints affecting their profitability and operational effectiveness and to design appropriate policy response (liquidation/restructuring, capacity building needs, etc.); (ii) supporting a human resource development program for key staff and personnel (e.g., managers, accountants, rural credit analysts) in order to augment the overall quality of rural bank personnel; (iii) upgrading internal controls and procedures for greater transparency of operations needed to enhance depositors' confidence; (iv) investing in various technologies needed to promote rural bank-to-rural bank communication, operations and synergy; (v) rationalizing agency banking and linking the number of agencies to each individual rural bank's capacity; and (vi) addressing residual policy constraints (geographical restrictions, secondary reserves, classification standards, etc.) which affect the smooth operations and functions of the rural banking sector. 4. Establishment of an apex structure for the rural and community banks will entail the following measures: (i) sensitizing of member rural banks, their shareholders, and clients on the proposed institutional changes which will be introduced under the apex initiative; (ii) developing and clarifying the institutional and legal framework under which the apex will operate; (iii) supporting technological innovations that will permit more efficient exchange of information between the member rural banks, the apex, and the oversight departments of the Bank of Ghana, the central bank; (iv) strengthening the responsible departments of the BOG for more effective oversight of the activities of the apex bank and the member rural banks; (v) supporting training and other capacity building activities needed for the effective operations of the apex; (vi) establishing a decentralized clearing and support system of the apex consistent with the regional clearing systems of the Bank of Ghana; and (vii) financing technical assistance to put into place appropriate operational procedures and policies needed for transparency and accountability of apex operations. 5. The program will also strengthen the Banking Supervision Department (BSD) for effective monitoring and supervision, as well as strengthen the capacity of the Rural Finance Inspection Department (RFID) for rural finance policy and strategy formulation. These two departments are the focal points for monitoring of the rural and community banks. The investment in new technologies will facilitate improved reporting, standardization, and timely analysis of rural banks' returns to more effectively guide decision makers and provide an early warning system of changes in rural banks' performance. It will also reinforce the capacity of the Ministry of Finance (MOF) to coordinate various programs supporting rural, informal and microfinance institutions and to collaborate in the development of capacity building programs.6. The approach and strategy described in paras. 2 to 5 above represent a holistic response to the deep-rooted malaise of the rural financial sector which has significantly impeded the unleashing of rural economic growth and undermined realization of the benefits of earlier financial sector reforms (FINSAC). The need for a holistic approach is guided by past government policies and the salient lessons of donor assistance to the sector, which has been piecemeal, uncoordinated and short-term (as opposed to long-term), and thereby resulting in less-than-optimal development impact. The objectives of this program are therefore consistent with the GOG's overall economic development and poverty reduction strategy as contained in the CAS and their attainment will lead to the emergence of a - 5 -  strong and vibrant rural financial sector to support private, rural economic initiatives, and complement ongoing operations (rural infrastructure, services, etc.) and expand benefits of the earlier macro-level reforms to the rural inhabitants. 3. Rationale for Bank's Involvement The Bank has worked closely with the Borrower and with many other donors, notably AfDB and IFAD, in providing support for strengthening rural financial institutions in Ghana. The Bank has therefore worked at all three levels of the rural financial continuum -- microfinance and the informal rural and cooperative sector, the rural and community banks, and the central bank. Consistent with its global experience and knowledge base, the Bank brings significant international experience from Asia and other regions, in assisting the government's efforts to strengthen its rural financial sector and implement the reforms needed to unleash sector growth. In addition, the proposed operation complements past and on-going operations in the sector financed by the Bank in rural infrastructure (ASIP and VIP), in agriculture services (AGSSIP), and microfinance (NBFI). The Bank's participation complements well IFAD's comparative advantage on rural poverty reduction and informal financial institutions, and AfDB's comparative advantage with Agriculture Development Bank. These two donors would not together constitute the critical mass of experience and strategic focus needed to provide the holistic support along the continuum of rural financial system. The combined participation of these three donors, unprecedented in the rural microfinance sector in Ghana, is therefore needed to support this program. 4. Description The project components (summarized in the table below) are as follows: Capacity Building - Informal Financial Sector Capacity Building of Rural Banks Institution Building - Apex Institutional Support 5. Financing Total ( US$m) GOVERNMENT 0.75 IBRD IDA 5.13 AFRICAN DEVELOPMENT BANK 5.01 INTERNATIONAL FUND FOR AGRICULTURAL DEVELOPMENT 10.12 BENEFICIARIES 1.95 Total Project Cost 22.96 6. Implementation 1. The project will be implemented by the Rural Finance Inspection Department (RFID) of the Bank of Ghana. RFID has increased its capacity in recent years to manage similar operations, beginning with the Rural Finance Project which closed in 1995. The scope of responsibilities of the RFID has been recently reduced with the transfer of its management audit functions to BSD and a clearer focus on policy and strategy development. This sharpened mandate now better prepares RFID to implement this program aimed at institutional and policy reforms and capacity building of the - 6 -  rural financial sector. Project implementation will therefore be mainstreamed in the RFID, with key project staff being seconded to the RFID to augment its capacity through a competitive search process within the BOG departments. Those staff seconded will not have competing responsibilities and will spend their time fully in project implementation. Where such staff do not have adequate training, training in procurement and financial management will be provided through the project to augment their technical skills. The key project staff within the BOG will comprise a Project Coordinator, Procurement Specialist, and Accountant. These staff will report to the Director, RFID. 2. Implementation of the microfinance component will be the responsibility of the RFID, with activities contracted out to private sector entities, such as GHAMFIN, which will oversee the technical support being provided by participating NGOs. Each potential beneficiary group meeting eligibility criteria will prepare a funding proposal requesting support under the Rural and Microfinance Capacity Building Fund. All such proposals will be reviewed by a committee comprising the ARB, head of the microfinance clusters, representative of an NGO specializing in rural/microfinance, the Head of the Microfinance Unit of MOF, and the RFSP Project Coordinator. The Project Coordinator within RFID shall chair this committee. All proposals approved by the Committee will be recorded and sent to the implementing agency which will oversee contracting of services. In its implementing responsibility, the implemenring agency will ensure quality of services, as well as timeliness of quarterly and annual reports to the RFSP management. Disbursement under all such contracts will be made by the RFID, based on applicable disbursement and procurement procedures and thresholds. 3. Similarly, a New Products and Innovations Fund (NPIF) will be established under the New Products and Innovations Department (NPID) of the apex to promote research and development of new and innovative instruments and products for rural financial intermediation. The NPIF Committee will comprise of all members of the MFCDF, the Director of the NPID of the apex and the Deputy Managing Director of the apex, who will chair this committtee. For an interim period of two years until the NPID of the apex has been established, the Committee will be chaired by the Head, Microfinance Unit of the MOF and the responsibilities transferred to the apex after this transition period. The latter arrangement will ensure continuity in similar ongoing programs under the NBFI Project while allowing the apex to develop its own capacity. 4. Overall policy guidance on RFSP implementation will be the responsibility of a multisectoral Project Steering Committee comprising the following: (i) The Governor, BOG or his designee; (ii) the Director, RFID; (iii) one representative of the Ministry of Finance; (iv) one representative of the Ministry of Food and Agriculture (MOFA); (v) one representative of the ARB; (vi) one representative of a rural/microfinance network; and (vii) the Project Coordinator who shall act as Secretary to the PSC. The PSC will be chaired by the Governor, Bank of Ghana. The terms of reference of the PSC is in the Implementation Manual.5. Project Monitoring. Project monitoring will include: (i) monitoring of overall implementation, including procurement, disbursement, and financial management; (ii) monitoring of the rural bank reform processes, including adherence to stipulated legal requirements of performance, etc.; (iii) monitoring of supervision input of the agencies of the BOG such as BSD and RFID; and (iv) monitoring of general indicators of project development impact. A participatory baseline survey will be undertaken. The project development impact will take gender and poverty-related aspects into consideration. Apart from quantitative - 7-  indicators, information on qualitative indicators will also be collected and analyzed. 7. Sustainability 1. Certain design features of this project provide a high probability of sustainability. First, the holistic approach adopted allows for transmission of best practices and the building up of initial critical mass of skilled staff. Focusing on the continuum provides broad ownership beyond the traditional stakeholder groups. Linking group development and training with the provision of financial services of the rural banks is essential in their sustainability, as such groups will be profitable and therefore will require no subsidies beyond the initial (start-up) phase. The proposed institutional reforms have been discussed with the key stakeholders who have also seen the high financial profitability and the cost effectiveness it would bring to their operations. This provides an important buy-in and a strong incentive to keep these reforms on track. Additionally, assessment of the apex indicates that it can be maintained without any subsidy from government or donor support beyond the initial capital investment period. Hence, it is financially viable.2. The key risks are as follows: (i) unstable macroeconomic environment apex; (ii) lack of commitment to financial sector reforms; (iii) unclear governance relationships between the Central Bank and the Apex body; and (iv) weak management of the apex. The implications of these risks and likely mitigatory measures are discussed below. 8. Lessons learned from past operations in the country/sector The IDA-assisted Rural Finance Project (closed in 1995) provided the first comprehensive support to Ghana's rural banking sector. The project included both a line of credit to eligible rural banks and technical assistance for a financial restructuring program for rural banks to enable them to become more efficient in rural savings mobilization and credit delivery. IFAD has supported more than five projects in Ghana over the last six years, three with a credit/rural financial services strengthening component focusing on micro lending for small scale on-farm/off-farm income generating activities, with particular emphasis on rural women. The AfDB has had four successive lines of credit (1980, 1985, early 1990s, and 1999) to the Agricultural Development Bank (ADB). All of these donor activities have been largely uncoordinated (until now) and the salient lessons learned have been incorporated into the RFSP: (a) Training. Training of RB directors and staff has emerged as an essential element in the development of a viable rural banking sector with strong internal controls, transparency, better business practices and management of risks. Consequently, this project will have a heavy emphasis on training throughout all levels of rural, micro and informal financial institutions. (b) Need for an Apex Institution. Lack of an apex institution has made it difficult for individual rural banks to sustainably deal with common constraints, e.g. check clearing, specie supply, and liquidity management. Hence, the project will support the setting up of an apex bank that would permit attainment of a desirable level of economies of scale in dealing with these constraints. (c) Need for stronger oversight. Improved oversight of rural bank activities enhanced depositors' confidence in the overall rural banking sector, and this will be further supported under the project. (d) Timely Reporting of returns. Long distances from the central bank and weak capacity affect the ability of the rural banks to provide timely returns to the supervising entity, the Bank of Ghana. Such delays - 8 -  in reporting undermine the ability of the BSD to provide timely oversight of banking activities. Investments in communications and related technologies will help to address this problem.(f) Partnerships with NGOs crucial. Groups organized and trained by NGOs have shown promising results, especially when group membership remained small and manageable. Thus, NGOs will be contracted to carry out group formation and training activities for the informal financial sector. (g) Emphasis on Savings Mobilization. The IFAD experience confirmed that building and sustaining a strong rural financial system requires emphasis on savings mobilization as opposed to lines of credit, a key feature of this operation. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) Issues : This is a rural finance sector technical assistance operation focused mainly on institutional reforms and capacity building. It therefore has no direct environmental impact and no environmental assessment is needed. 11. Contact Point: Task Manager Eustacius Betubiza The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 458-5618 Fax: (202) 473-8229 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. This PID was processed by the InfoShop during the week ending October 20, 2000. 9