Philippines - Cottage Enterprise Finance Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-5386-PH MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$15.0 MILLION TO THE DEVELOPMENT BANK OF THE PHILIPPINES WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES FOR A COTTAGE ENTERPRISE FINANCE PROJECT JANUARY 17, 1991 This document has a restricted distribution and may be used by recipients only in the performance of their ofricial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOUIVALENTS (as of November 20, 1990) Currency - Peso US$1.0 - P 28 P 1.0 - US$ .036 P 1 million -US$ 36 thousand P 1 billion - US$ 36 million US$1.0 - DM 1.5 ABBREVIATIONS CB - Central Bank of the Philippines CSMI - Cottage, Small and Medium Industry DBP - Development Bank of the Philippines DOF - Department of Finance DTI - Department of Trade and Industry FSAL - Financial Sector Adjustment Loan FX - Foreign Exchange GF - Guarantee Fund IGLF - Industrial Guarantee and Loan Fund IICP - Industrial Investment Credit Project IS - Initial Subscription KfW - Kreditanstalt fur Wiederaufbau MGA - Mutual Guarantee Association MOU - Memorandum of Understanding NEDA - National Economic and Development Authority OPG - Operating Policy Guidelines PFI - Participating Financial Institution SMI - Small and Medium Industry TA - Technical Assistance TOR - Terms of Reference FISCAL YEAR Government: January 1 to December 31 DBP: January 1 to December 31  FOR OFFICIAL USE ONLY PHILIPPINES COTTAGE ENTERPRISE FINANCE PROJECT Loan and Project Summary Borrower: Development Bank of the Philippines (DBP) Guarantor: Republic of the Philippines Beneficiaries: Accredited participating financial institutions (PFIs) and private sector cottage enterprises Amount: US$15.0 million equivalent Terms: 20 years including 5 years of grace at the Bank's standard variable interest Relending Terms: The Development Bank of the Philippines would use the proceeds of the Bank loan to rediscount subloans made by PFIs to members of approved Mutual Guarantee Associations (MCAs). Loans from DBP to the PFIs would be made in domestic currency at market-based rates. Government would bear the foreign exchange risk in exchange for a market- related fee payable by DBP. The PFIs would onlend the funds to their borrowers at prevailing market interest rates. Financing Plan: USS million MGA Subscriptions and Fees 4.4 Subborrowers (Equity) 3.4 Participating Financial Institutions 2.9 Kreditanstalt fur Wiederaufbau 13.4 IBRD 15.0 DBP 5.6 Total 44.7 Economic Rate of Return: Not Applicable Staff Appraisal Report: No. 9030-PH ig: IBRD No. 22459R This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MEMORANDUM AND RECOM.MENDAfION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DEVELOPMENT BANK OF THE PHILIPPINES, WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES, FOR A COTTAGE ENTERPRISE FINANCE PROJECT 1. The following memorandum and recommendation on a proposed loan to the Development Bank of the Philippines, with the guarantee of the Republic of the Philippines, for US$15.0 million is submitted for approval. The proposed loan would be for 20 years including five years grace at the standard variable interest rate and would help finance the development of cottage enterprises. The proposed Project would be cofinanced by Kreditanstalt fur Wiederaufbau (KfW). 2. Background. Cottage enterprises in the Philippines are very important in terms of their employment impact (they account for 40X of (ormal non-agricultural employment); their regional impact (two-thirds of their production takes place outside the national capital area); and as the principal source for the emergence of dynamic small and medium sized firms that will play an increasingly important role in the Philippines' industrial strategy. The firms are particularly well represented in the manufacturing sector; cottage firms are concentrated in food preparation, apparel, furniture and fabricated metals subsectors. Since about two-thirds of the labor force in manufacturing in rural areas, where cottage firms predominate, is female, there is a strong likelihood that the sector has a high female participation rate. 3. Despite their social and economic importance these firms are routinely shut out of formal channels of credit due to their small size and lack of acceptable collateral. Interviews with cottage firms, industry associations and banks indicate that cottage firms have almost no access to credit through banking channels. The main issue is that most cottage firms have only chattel mortgages to offer banks, which banks consider greatly inferior to real estate mortgages because the chattel is usually small machines which can easily be moved and/or substituted, and are difficult to value and to repossess. Further, such firms usually lack established premises, reputations and banking track records. Hence the smallness of the firms is an important reason deterring banks from accepting their assets as collateral. An important lesson learnt from other Bank financed projects for small and medium industries in the Philippines (see Schedule C) is that cottage firms are unlikely to gain access to bank credit unless the collateral issue is addressed. 4. One result of cottage firms being shut out of the formal financial system is that they turn to informal moneylenders. However, interest costs in such markets are extremely high, ranging from 3% up to 17X or more per month. The high cost of such credit clearly limits its use for normal expansion or working capital requirements. Alternatively, firms limit their operations to what can be financed with internally generated funds and fail to expand and seek out new opportunities. 5. This is a problem worldwide and one approach that is working effectively in other countries, especially in Europe where it was pioneered, is the establishment of Mutual Guarantee Associations (MGAs). In MCAs, firms  - 2 - individual members. They each contribute to form a guarantee fund, which is then deposited with a bank which agrees to lend to the members of the association an agreed multiple of the guarantee. The fund has particular credibility with the banks since it is on their own books and can be debited without complex recourse procedures. Further, since it is the members who are liable if the guarantee is called, there can be considerable moral suasion exercised on delinquent members. 6. Rationale for Bank Involvement. The proposed Project would enable the Bank to play an important catalytic role in developing and funding an innovative scheme to facilitate lending to cottage enterprises. 7. Project Obiective. The Project's objective is to help improve access to credit by cottage enterprises that typically employ 10-20 persons and have assets of about US$15,000. 8. Proiect Description. The proposed Project would involve onlending by DBP to participating retail banks to rediscount subloans made to cottage enterprises, to finance their investment and working capital needs during the 1991-94 period. About 60 MGAs, each with about 40-100 members would be established throughout the country to guarantee the loans of their respective members. The member firms would voluntarily contribute to form a guarantee fund. This guarantee fund would be deposited with a participating bank, which would then lend some multiple of the fund to the individual members of the MGA. To initiate the scheme with adequate leverage, the members' subscriptions to the MGAs would be supplemented with a matching loan advanced and held in trust by DBP. As the MGAs' resources increase from new member subscriptions and from interest earned on their equity, the matching loan would be repaid and the funds used to assist new MGAs. 9. The proposed Project would have three components: (i) subloan financing to fund projects of MGA member cottage enterprises through accredited banks; (ii) technical assistance to set up, monitor, train and supervise MGAs and provide pollution-abatement assistance to MGA member cottage enterprises; and to train financial institutions; and (iii) a guarantee fund comprised of MGA member subscriptions and supplemental matching loans used to guarantee MGA member subloans. The estimated total financing requirement for the Project is $44.7 million equivalent, with a foreign exchange component of $12.4 million. A breakdown of costs and the financing plan are shown in Schedule A. The disbursement schedule is shown in Schedule B. Retroactive financing of up to US$1 million for subloans made after January 1, 1991 would be permitted. A timetable of key project processing events and the status of Bank Group operations in the Philippines are given in Schedules C and D, respectively. A map is also attached. The Staff Appraisal Report, No. 9030-PH, dated December 21, 1990, is being distributed separately. 10. Actions Agreed. During negotiations, agreement was reached with DBP on the Operating Policy Guidelines (OPG), which incorporates the following:  exclusion of DBP as a retailer of funds under the proposed Project; enterprise eligibility criteria and minimum and maximum subloan size; minimum loan participation by retail banks and minimum equity contribution by subborrowers; relending terms to the retail banks; onlending terms to subborrowers; and matching loan fund account procedures and allocation of the KfW interest differential income. Agreement with the government was reached on: (1) the Policy Manual which incorporates: licensing criteria for MGAs; MGA member firm size and subscriptions; monitoring and suspension arrangements; auditing and reporting arrangements for MGAs; environmental assistance; and the special focus on women entrepreneurs; and (2) the mechanism for assuming the foreign exchange risk. 11. Effectiveness of the proposed loan will be conditional on: (a) approval of the Operating Policy Guidelines by DBP's Board; (b) approval of the Policy Manual by the Review Committee; and (c) signing of five Subsidiary Loan Agreements between DBP and the PFIs. 12. Benefits. The Project would increase the volume of credit for lending to cottage industry and would reduce its cost. The Project would assist DBP and the PFIs in gaining experience and knowledge about lending to cottage industries and in establishing an effective finance facility to improve the access of cottage firms to bank lending. It is expected that about 4,200 cottage firms would be financed under the Project with subproject costs of about US$33 million. The Project would cover every region in the country and the vast majority of loans would be outside Metro Manila. The regional phasing is indicated in the attached map. It is also expected that the project design would enhance the ability of women entrepreneurs to obtain formal credit. 13. Risks. The program is an innovative one which does not currently exist in the Philippines. Accordingly, there are the risks associated with any new program. One risk is that there will be significant defaults under the program that will reduce the guarantee funds. This risk will be dealt with by starting with moderate levels of leverage and by careful selection and licensing of the MGAs. Since MGAs will play a major role in approving the subloans of their individual members, it is expected that they will monitor subloan performance and exert peer pressure to repay. 14. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. January 17, 1991  -4 Schedule A REPUBLIC OF THE PHILIPPINES COTTAGE ENTERPRISE FINANCE PROJECT Estimated Qogts and Financing Elan Estimated Cost$A1 Local Foreign otal. ------ (US$ million)-- -- Subproject Cost 21.4 11.6 33.0 Technical Assistance (Project Support) 0.9 0.8 1.7 Guarantee Fund 10.0 10.0 Total 32. 12. 44.7 kinancins Plan Local Forei Total ----- (US$ million)----- MGA Subscriptions/Fees 4.4 4.4 Subborrowers (Equity) 3.4 - 3.4 Retail Banks 2.9 - 2.9 KfW 12.6 0.8 13.4 IBRD 3.4 11.6 15.0 DBP 5.6 - 5.6 To_al 32.3 12.4 .4 A/ Exclusive of duties and taxes, which are insignificant.  Schedule B PHILIPPI=E COTTAGE ENTERPRISE FINANCE PROJECT Disbursements * Categorv Amount X to be Financed (US$ million Equivalent) Subloans 15.0 90X of expenditures Estimated IBRD Disbursements IBRD FY 21 92 93 94 95 96 -........... (US$ million)- Annual 1.5 1.2 3.6 4.2 2.9 1.6 Cumulative 1.5 2.7 6.3 10.5 13.4 15.0  -6 Schedule C REPUBLIC OF THE PHILIPPINES COTTAGE ENTERPR1S1 FINANCE PROJECT Timetable of Key Project Processing Events (a) Time taken to prepare 18 months (b) Prepared by: Government and DBP with Bank and consultant assistance (c) First Bank mission: March 1989 (d) Appraisal mission departure: June 1990 (e) Negotiations: December 1990 (f) Planned date of effectiveness: March 1991 (g) List of relevant PCRs and PPARs: SMI I (Loan 1120-PH) PCR (dated 6/17/81) PPAR (#3696 dated 6/16/82) SMI II (Loan 1727-PH) PCR (dated 6/30/89) PPAR (#7940 dated 6/30/89) SMI III (Loan 2169-PH) PCR (dated 1/31/90) PPAR (#8781 dated 6/21/90)  i'rtgr- I 'f 2 rHiIAts Q BAIINv81Dt.l (PLRAJ[QtN5 IN` THL PHILUTf NL' A IAI_MlNT Qf UAtFB l,.ANS ANQ IUA QJEQLT5 .a As * ;tplombLet 30. 19901 '.t Arw,y ijQ"S cselatJ95J rIi 'rll ^ f6 8orrower Purpose Bain, IDA Undisbursed Nwo ftv loans ari six erectdits fully disbursed 3 r6o 76 105 16 Of {.hlJTh pF( 'Al s SALs and Program Loans 19'!~ s198 Rep of the Philippines SAt. I 19996 22f63 1983 Rep of the Philippines SAL If 302 25 24fi9 1985 Rep of the Philippines Agriculture Sector Inputs 150 00 27A7 1987 Rep of the PhIllppines Econormic Recovery Program 300Q00 Sub-Total 95221 1eO9 1980 Rep of the Philippines Medium-Scale Irrigation 32 93 1 18 2040 1982 Rep of the Phillppines Agric Support Services 20 60 1 42 2173 1982 Rep of the Philippines Communal Irrigation 38 50 7 61 2200 1983 Rep of the PhilIppines Education VIII 1640 3 95 2257 1983 Rep of the PhIllppines Reglonal Clties Development 42 08 17 39 2360 1984 Rep of the Philippines Central Visayas Reglonal Dev 24 97 8 42 24118 1984 Rep of the Philippines Highways V 102 00 69 42 2.135 1984 Rep of the Phillppines Municipal Development 40 00 29 33 2495 1985 Rep of the Philippines Teleconm Tecih Assistance 4 00 18 2676 1986 Rep of the Philippines Manila Water Distribution 38 00 15 93 2718 1986 Rep of the Philippines Rural Roads If 82 00 66 30 2823 1987 Rep of the Philippines Provincial Ports 32 00 17 03 2948 1988 Rep of the Philippines Irrigation Operations Support 23 50 15 53 *2956 1988 Rep of the Philippines Program for Government Reform 200 00 5008 29A9 1988 Phil National Oil Co. Bacon-Manito Geothermal Power 41 00 18 56 2969-1 1988 Rep of the Philippines Bacon-Manito Geothermal Power 59.00 5553 2974 1988 Rep of the Philippines Housing Sector 160.00 55 75 3038 1989 Rep of the Phfllppines SMI IV 60 00 33 91 *3049 1989 Rep. of the PhMppines Flnancial Sector 300 00 150 00 3084 1989 Dev. Bank of the Phil. Manila Power Distribution 65 50 64 50 3099 1989 Rep. of the Philippines Health Development 70 10 66.10 3123 1990 Dev. Bank of the Phil. Industrlal Investment Credit 6500 25 69 3124 1990 Metro Waterworks & Sew Angat Water Supply 40 00 29 92 3146 1990 Rep. of the Philippines Mlnicipal Development 11 40 00 37 50 3149 1990 Rep of the Philippines Debt Managemeit Loan 200 00 50 00 3163 1990 Phil National Power Corp Energy Sector Loan 200 00 165 43 3164 1990 PhIl National Oil Co Energy Sector Loan 150 00 139 54 3165 1990 Rep of the Philippines Energy Sector Loan 40 00 34 94 3204 1990 Rep ot the Philippines Coconiut Farms Development 121 80 121 80 3242 1990 Rep of the Philippines WS Sever Sanitatlon 85 00 85 00 3244 1991 Rep of the Philippines Second Elementary Education 2Q0 00 ZQ.Q00 Total 6l7i1I 105 Is 1.63794 of which has been repaid t48Z60 3519 Total now held by Bank and IDA 4&K.56 101 59 Amiou nt sold 31' 35 of which repaid 31 35 Total undisbursed 1,63794 1.637 94 La The status of the pro"ects llsted In Part A Is described in a separate report on all Bank/IDA. financed projects in execution. which is updated twice yearly and circulated to the Executive Directors on1 April 30 and October 31 * SAL. SECAL or Program Loan  - 8 - Schedule D Page 2 of 2 LI $TATMNjL NQEl_IQ1NIMffi.12 ,As of September 30. 1990f In eslriip,,l Fi". alI Loan Equity Total niv.hpr '105r (Oblio