Malawi - Rural Financial Services Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 11464-MAI STAFF APPRAISAL REPORT MALAWI RURAL FINAMCIAL SERVICES PROJECT MAY 4, 1993 Southern Africa Department Agriculture and Environment Division 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.  CURRENCY EQUIVALENTS Currency Unit: Malawi Kwacha (MK) US$ 1.00 = MK4.0 MK 1.00 = US$ 0.25 MK 1.00 = 100Tambalas GLOSSARY OF ABBREVIATIONS ADD - Agricultural Development Division ADMARC - Agricultural Development and Marketing Corporation BDU - Business Development Unit CBM - Commercial Bank of Malawi DEMATT - Development of Malawi Traders Trust DFI - Development Finance Institution EEC - European Economic Community FSEDP - Financial Sector Enterprise Development Project GOM - Government of Malawi ICEIDA - Icelandic International Development Agency IFAD - International Fund for Agricultural Development IGA - Income Generating Activity IMF - International Monetary Fund INDEBANK - Investment and Development Bank of Malawi INDEFUND - Ilvestment and Development Fund ITPAC - Industry and Trade Policy Adjustment Credit KFW - Kreditanstalt Fuer Wiederaufbau LFC - Leasing and Finance Company of Malawi Limited MDC - Malawi Development Corporation MMF - Malawi Mudzi Fund MRFC - Malawi Rural Finance Company MSME - Micro-, Small- and Medium-Scale Enterprises MOA - Ministry of Agriculture MUSCCO - Malawi Union of Savings and Credit Cooperatives Limited NBFI - Non-Bank Financial Institution NBM - National Bank of Malawi NDF - Nordic Development Fund NGO - Non-Governmental Organization NRDP - National Rural Development Project ODA - Overseas Development Administration, U.K. POSB - Post Office Savings Bank PPF - Project Preparation Facility RBM - Reserve Bank of Malawi RDP - Rural Development Project RFSP - Rural Financial Services Project SACA - Smallholder Agricultural Credit Administration SACCO - Savings and Credit Cooperative SAL - Structural Adjustment Loan SEDOM - Small Enterprise Development Organization of Malawi SOE - Statement of Expenditure UNDP - United Nations Development Program USAID - United States Agency for International Development WWBM - Women World Banking of Malawi  FOR OFFICIAL USE ONLY MALIAWI RURAL FINANCIAL SERVICES PROJECT TABLE OF CONTENTS Credit and Project Summary .................................. i I. BACKGROUND .........................1............. A. Main Country Characteristics ......................... 1 B. Macro-Economic Framework ......................... 1 C. The Financial System .............................. 3 D. Issues in the Financial Sector ......................... 4 II. RURAL SECTOR .................................. 6 A. Introduction ......... ............................ 6 B. Agriculture ..................................... 6 C. Non-Farm Enterprises .............................. 7 D. Financial Services to the Rural Sector .................... 8 E. Government's Development Strategy ..................... 9 F. Bank Strategy and Assistance ......................... 10 G. Previous Bank Group Operations and Lessons ............... 10 Im. INSTITUTIONS SERVING THE RURAL SECTOR ............ ... 11 A. General ...................................... 11 B. Ministry of Agriculture .............................. 11 C. Other Institutions ................................. 15 IV. THE PROJECT ..................................... 16 A. Project Rationale and Objectives ....................... 16 B. Project Description ................................ 18 C. Detailed Features ................................. 18 D. Project Costs and Financing Plan ....................... 22 E. Procurement .................................... 24 F. Disbursement ................................... 25 G. Special Accounts ................................. 26 V. PROJECT IMPLEMENTATION ...... ................... ... 26 A. Malawi Rural Finance Company ....................... 26 B. Credit Reserve Fund ............................... 28 C. Subloan Processing and Administration ................... 29 D. Lending Terms and Conditions ........................ 30 E. Monitoring, Evaluation (M&E) and Beneficiary Assessment ... ... 30 F. Environmental Assessment ........................... 31 G. Auditing, Accounting, and Reporting Requirements .... ....... 32 H. IDA Supervision ................................. 32 VI. PROJECT BENEFITS AND RISKS ..... ................. ... 33 VII. AGREEMENTS, CONDITIONS, AND RECOMMENDATION ....... 34 A. Assurances Obtained at Negotiations .................. 34 B. Conditions of Effectiveness ........................... 35 C. Conditions of IDA Disbursement ........................ 35 D. Recommendation ............................. 36 This report is based on the findings of an appraiual mirsion which visited Malawi in 3uneJluly 1992 comprising Meaars. N. Okidegbe, St. Funcial Analyst (Mission Leader and Principal Author), ad S. Thillairajah, Principal Frnunial Analyst. Messr. 1. Yaron, C. Magnus and J. D. von Pischkc reviewed project design as Lead Advisor and Pecr Reviewers, respectively. Ms. P. Mehrdadi provided secrtarial support in the preparation of the report. Mersars. C. Helman and S. Dcnning are the managing Division Chief and the Departznent Director respectively for the operation. 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.  ANNEXES 1. Interest Rate Structure ................................ 37 2. Malawi Rural Finance Company Operations ................... 41 Attachment 1: Major Assumptions Underlying MRFC's Financial Projections ........................ 50 Table 1: Projected Balance Sheet 1994-96 ............... 53 Table 2: Projected Income Statement 1994-96 .... ......... 54 Table 3: Projected Sources and Uses of Funds 1994-96 ... .... 55 Attachment 2: Action Plan for Transforming Malawi Rural Finance Company into a Rural Bank .... .... 56 3. Detailed Cost Tables ................................. 58 Table 1: Summary Accounts by Year .................. 58 Table 2: Summary Account by Project Component .... ..... 59 4. Action Plan for Pilot Women's Program ..................... 60 5. Supervision Plan .................................... 64 6. IDA Estimated Disbursement Schedule ...................... 66 7. Key Project Indicators ................................ 67 8A. Malawi Rural Finance Company - Technical Assistance Terms of Reference ................... 72 8B. Terms of Reference for Business Development Unit .... .......... 76 Attachment: Consultancy Selection Planning .... ......... 78 9. Implementation Schedule ............................... 79 WORKING PAPERS 1. Financial Aspects Malawi Rural Finance Company 2. Savings Mobilization and Credit in the Rural Sector 3. Women and Credit in Malawi 4. Project Cost Tables  MALAWI RURAL FINANCIAL SERVICES PROJECT CREDIT AND PROJECr SUMMARY Borrower: Government of Malawi Benericiaries: 500,000 rural households, small estates, micro, small- and medium- scale enterprises, Malawi Rural Finance Company, and Malawi Mudzi Fund Amount: SDR 18.0 million (US$25.0 million equivalent) Terms: Standard IDA, with 40 years maturity Onlending Terms: Reserve Bank of Malawi (RBM) would onlend US$17.0 million equivalent of IDA Credit to Malawi Rural Finance Company (MRFC) in local currency at the prevailing average cost of term borrowing in the financial system or the discount rate whichever is higher. MRFC would onlend the funds at market rates for financing viable farm and non-farm rural activities. RBM would pass on to the Government the interest received from MRFC, less a 0.5 percentage point fee to cover RBM's administrative costs. The Government would bear the foreign exchange risk. The Government would provide US$8.0 million equivalent as equity for institutional building of the Malawi Rural Finance Company. Project Objectives: The Project's fundamental objective is to improve the access to financial services for the rural sector, including women, on a sustainable basis. This would be done by corporatizing and converting the Smallholder Agricultural Credit Administration (SACA) into a limited liability finance company, thus eliminating its heavy dependence on Government support, as a first step to its subsequent conversion into a private bank. The Project would also assist the Government toward improving the policy and institutional framework for rural financial intermediation by supporting the development of linkages between the formal and informal financial sectors, and strengthening related non-financial institutions serving the rural sector. Project Description: The Project would be implemented over a three year period and has three main components: (1) Institution-building Component. This would support: (a) the corporatization and conversion of SACA, which is currently a government department, into a limited liability finance company with publicly held shares and capable of providing a full range of financial services (for farm and non-farm activities) to the rural population on a commercial basis; and (b) use of Development of Malawi Traders Trust (DEMATT) to assist in preparing investment proposals for agricultural and micro-, small- and medium- scale enterprises, and to provide related training and advisory services. (2) Line of Credit Component. This would  . finance primarily short term loan requirements of farm and non-farm rural activities. (3) Pilot Program Component. This would support further initiatives to test innovative approaches for providing financial services to women entrepreneurs engaged in income-generating activities in the rural sector. Benefits and Risks: Benefits are expected from increased rural economic activities resulting from greater availability of rural financial services. The Project is expected to provide financial services to more than 500,000 rural households for farm and non-farm economic activities. This will strengthen and expand the production base of the rural sector, and increase employment. The Project would fill major gaps in availability of working capital and term-financing for rural enterprises. The support for micro-, small- and medium-scale enterprises, including women entrepreneurs, will encourage real sector supply response, improve food security, rural incomes, and living standards. The main risks would be: (a) possible high default rates associated with an increase in the supply of credit; (b) delays or difficulties that might be experienced in implementing the financial reforms as envisaged under the Financial Sector and Enterprises Development Project which could undermine the ability of lending institutions to charge sufficient interest to cover their operating costs and risk premium; and (c) delays in implementing the restructuring of vital rural institutions. The Project has been designed to minimize these risks and required up-front actions. The prospects for achieving the Project's objectives are very good.  - ii - Project Cost Summary: Estimated Project Costs Local Foreign Total Local Foreign Total -MK 000- -US$ 000 - A. INVESTMENT COSTS 1. Goods (MatrlJVehic/Equip) 0.0 25143.3 25143.3 0.0 6285.8 6285.8 2. Training 2039.8 226.6 2266.5 510.0 56.7 566.6 3. Technical Assistance 0.0 7820.0 7820.0 0.0 1955.0 1955.0 4. Line of Credit 72000.0 8000.0 80000.0 18000.0 2000.0 20000.0 TOTAL INVESTMENT COSTS 74039.8 41189.9 115229.8 18510.0 10297.5 28807.4 B. RECURRENT COSTS 1. Salaries 13754.8 0.0 13754.8 3438.7 0.0 3438.7 2. Other Operating Costs 3994.4 9320.2 13314.5 998.6 2330.0 3328.6 TOTAL RECURRENT COSTS 17749.2 9320.2 27069.3 4437.3 2330.0 6767.3 TOTAL BASELINE COSTS 91789.0 50510.1 142299.1 22947.3 12627.5 35574.8 Physical Contingencies 0.0 1257.2 1257.2 0.0 314.3 314.3 Price Contingencies 2451.7 821.5 3273.2 612.9 205.4 818.3 TOTAL PROJECT COSTS 94240.7 52588.8 146829.5 23560.2 13147.2 36707.4 Project Financing Plan Local Foreign Total US$ million IDA 11.9 13.1 25.0 Government 4.0 - 4.0 MRFC 4.7 - 4.7 Sub-borrowers 3.0 - 3.0 Total 23.6 13.1 36.7  - iv - Estimated IDA Disbursement Schedule (US$ million) Project year FY94 FY95 FY96 FY97 Annual disbursements 6.9 8.5 8.6 1.0 Cumulative disbursements 6.9 15.4 24.0 25.0 Rate of Return: Not applicable Staff Appraisal Report: No.1 1461-MAI Map: IBRD No.20924R  MALAWI RURAL FINANCIAL SERVICES PROJECT I. BACKGROUND A. Main Country Characteristics 1.1 Malawi is a small, land-locked country with a total area of approximately 119,100 square kilometers, of which 24,200 square kilometers is lake surface. It is bordered on the north and northeast by Tanzania; to the east, south, and southwest by Mozambique; and to the west by Zambia. The land area consists of three topographical regions: the northern mountainous region, the central plateau, and the southern lowlands. The current population of Malawi, which is estimated at 9.1 million (1992), has been growing at an annual rate of about 3.6 percent. Malawi has one of the highest population densities in Africa with 89 inhabitants per square kilometer of land surface, and 170 inhabitants per square kilometer of arable land. Much of the population suffers from malnutrition, and only two out of three children survive beyond five years of age. The country's food production and supplies have been severely constrained by drought in 1992, cassava mealy bug infestation (now largely controlled), high cost of agricultural inputs such as fertilizers, and increased transport costs due to the civil war in neighboring Mozambique. This civil war has also driven some 1,000,000 refugees into Malawi. B. Macro-Economic Framework 1.2 Overview. Despite a series of adjustment programs, Malawi remains one of the poorest countries in the world with a per capita GNP of US$210 (1992). Malawi is extremely vulnerable to external shocks because of its geographically land-locked position and narrow resource base. Although the country has made considerable progress on the macroeconomic front over the past four years, the medium-term economic outlook is highly uncertain because of: * the external shocks and the adverse impact of an unprecedented drought in 1992 throughout Southern Africa; and * deteriorating relations with bilateral donors due to unresolved issues related to governance. 1.3 Malawi's development strategy following Independence in 1964 emphasized infrastructure and agriculture as vehicles for increased production. While the estate sub-sector was deemed to be the driving force for export growth, producer prices in the smallholder sub- sector were kept below world market levels to transfer resources from the smallholder sector into the estate and agro-processing sub-sectors. The country successfully exploited its endowment during the 1960s and 1970s when real GDP more than doubled and real per capita income grew by 3 percent per year. The period of strong economic growth came to a halt in the early 1980s when the country faced a combination of unfavorable terms of trade, high interest rates, weather-related shocks, and other major domestic policy weaknesses. The first series of adjustment operations was a response to this set of shocks. However, while the  Government of Malawi (GOM) was adjusting to these shocks, the country was hit in the midi- 1980s by a worsening of the war and civil strife in neighboring Mozambique which not only led to a major increase in international transportation costs but also to increased security- related expenditures and a large influx of refugees. This caused a sharp deterioration in the macroeconomic environment in the mid-1980s. With the partial reopening of the Nacala rail route to Mozambique in October 1989, and recent peace agreement, the Mozambique situation is improving but remains very uncertain. Certain policy responses to this second and more dramatic set of shocks, including expanded fiscal deficits and implementation of import controls, compounded the difficulties and discouraged private sector investments and output. 1.4 In 1992, the economy was affected by two major shocks. The severe drought of 1992 sharply reduced the maize crop by nearly 60 percent. Widespread poverty and food insecurity emerged as important social dimensions to the economic difficulties. This has resulted in additional foreign exchange requirements of US$236 million for maize imports in order to avoid widespread food shortages, malnutrition and starvation. In addition, drought-, related expenditures for internal distribution of emergency food aid, water supply rehabilitation, and health programs has further worsened the Government's fiscal difficulties. Furthermore, at the May 1992 Consultative Group (CG), bilateral donors and the European Community (EC) refrained from pledging additional external assistance to Malawi mainly because of reasons related to political governance. To close the resulting fiscal and external financing gap, the Malawian authorities implemented an austerity package in June 1992, comprising - inter alia - 22 percent devaluation of the Kwacha, strict expenditure controls and additional tightening of the monetary policy. These measures have helped the economy to remain broadly on track. Nevertheless, timely resumption of bilateral and EC external support, e.g. balance of payments support, is crucial for the successful continuation of the adjustment program. 1.5 Economic Performance. Throughout the 1980s the Government undertook a broad- based structural adjustment program. These structural reforms and improvements in short- term macroeconomic management have created a stable macroeconomic environment. After negative growth in 1986 and 1987, GDP (at market prices) grew by 4.8 percent in 1990 and 7.8 percent in 1991, restoring per capita GDP growth to a positive level. Before the severe drought conditions in 1992, agriculture GDP grew at 15 percent in 1991. Inflation decelerated sharply from an average of about 30 percent in 1987-88 to 16 percent in 1989 ard 12 percent in 1991 but accelerated to 22 percent in 1992 because of the adverse impact of the drought on agricultural production. Real wages have declined; in fact, labor has borne a significant part of the adjustment burden. The fiscal deficit has been brought under control, with net negative domestic credit financing of Government in 1988/89, 1989/90, and 1990/91. This improvement allowed growth in private sector credit of 26 percent, 59 percent, and an estimated 38 percent, respectively in these three years. 1.6 In spite of the breadth of policy reform and the restoration of macroeconomic stability, significant structural weaknesses that impede development .of sustainable supply response remain. The productivity of the economy is low, while increased financial flows to the private sector have not resulted in stimulating non-traditional activities. As a result, foreign savings continue to be of critical importance to the economy, with a current account deficit of 9.0 percent of GDP in 1989, and 9.9 percent in 1991, and 7.7 percent in 1992. In addition, export responsiveness has been impeded by stagnation of agricultural productivity for the majority of smallholders and by continued population pressures. While the external  - 3 - situation may improve, Malawi must ensure maximum use of its limited potential to sustain growth. C. The Financial System 1.7 The financial system in Malawi is small and not yet well developed, but operates with very few distortions-'. It consists of formal and informal market segments. The formal market segment comprises the country's central bank - the Reserve Bank of Malawi (RBM); two commercial banks - the National Bank of Malawi (NBM) and the Commercial Bank of Malawi (CBM); a merchant bank -- the Investment and Development Bank of Malawi (INDEBANK); two finance houses - Mercantile Credit (MC) and Leasing and Finance Company of Malawi Limited (LFC); a building society - the New Building Society (NBS); four development finance institutions (DFIs); two savings institutions; and the insurance industry, comprising a series of insurance companies and brokers as well as several pension and provident fund managers. Securities markets are almost nonexistent, and the holding of treasury bills and other Government securities are limited to institutional investors. The DFIs are the Malawi Development Corporation (MDC), the Investment and Development Fund (INDEFUND), the Small Enterprise Development Organization of Malawi (SEDOM), and the Malawi Mudzi Fund (MMF). The savings organizations are the Post Office Savings Bank (POSB) and the Malawi Union of Savings and Credit Cooperatives Limited (MUSCCO). 1.8 The health of the formal financial system in Malawi tends to mirror the health of the overall economy. The financial system in Malawi has recovered from a period of uncertainty and general decline in the mid-1980s and has emerged stronger and more efficient. The commercial banks and the major non-bank financial intermediaries (NBFIs) appear to be financially sound. The good performance is a tribute to the non-interventionist policies of the Government including the full liberalization of interest rates in 1987, that have allowed the financial institutions to make autonomous operating and lending decisions based on commercial considerations. 1.9 The Informal Credit Market, which includes moneylenders, traders, estate owners, friends and relatives, provides a significant share of the micro-, small- and medium-enterprise sector's capital. Although no systematic assessment has been made, the informal financial sector reportedly provided more than 66 percent of the total value of loans, and more than 10,000 micro-, small- and medium-scale enterprises (MSMEs) are estimated to have borrowed from the informal financial markets. Informal financial intermediaries provide credit services that are better suited to their borrowers, including ease of access to credit, simple procedures, personal guarantees that are consistent with the repayment ability of the borrowers, absence of controls and restrictions on the uses of loans, flexibility in repayment terms, confidentiality, and low transaction costs to the borrower. The very high interest rates reported (ranging from 25 percent to 100 percent per annum) do not seem to deter the borrowers from A detailed description and analysis of the financial sector is available in the Financial Sector Report No.9009-MAI. The financial sector reform, which this Project will complement, is being implemented under the IDA supported Financial Sector and Enterprise Development Project. This section of the SAR gives a brief overview of the financial sector and highlights some issues to be addressed under this proposed Project.  patronizing the informal providers of funds. They indicate the strong demand that exists for credit for micro-, small- and medium-scale enterprises and the opportunity for more competitive interest rates in the market. D. Issues in the Financial Sector 1.10 The government's strategy for the financial sector, as outlined in the Statement of Development Policies 1987-96 (DevPol) and in the Third-Year Policy Framework Paper, involves strengthening monetary control, deepening the financial system, and improving the efficiency of resource allocation to stimulate private sector investment. The major issue in the sector has been the financial sector's inability to respond with flexibility to investment opportunities. The Government, therefore, with IDA support, undertook a review of the financial system that identified necessary policy reforms to deepen financial markets and improve efficiency in resource mobilization and allocation. Several of these reforms in monetary policy have already been implemented or are in the process of being implemented. 1.11 Asset Concentration. The financial sector has a high degree of asset concentration. Most banks and NBFIs are effectively controlled by a small number of agricultural and industrial conglomerates that have dominant market positions in Malawi through interlocking ownerships. The resulting concentration of deposits and loans goes against sound banking principles of deposit and loan diversification, and reduces intermediation efficiency. Several steps have been initiated by the Government that could help mitigate the more perverse effects of excessive banking concentrations. These include encouraging the entry of new financial institutions into the banking sector, switching financing of parastatals from the government budget to the commercial banks, and syndication of large loans so as to spread their risks. Nonetheless, the problem of concentration is likely to continue in the future unless new banks are encouraged to enter into the financial sector. It may also be desirable for the stronger financial institutions to offer equity shares to the public as a means of broadening the ownership and increasing Malawian participation in the economy. 1.12 Lack of Competition. The high asset concentration has led to concerns over the lack: of serious competition in the banking sector. There are, however, several developments that would help increase competition in the future. For example, emerging competition between the two commercial banks; the aggressive entry by LFC into the market; the movement by the commercial banks into non-traditional areas of activity such as term lending; and the granting of a license to INDEBANK to engage in a wider range of merchant banking and financial services would enhance competition in the financial system. However, the rural sector remains under served. The Government is hoping to attract more private financial institutions into the market, particularly to the rural sector, and gradually broaden the ownership structure within the banking sector. As a first step the authorities plan to adopt an open and transparent process in the consideration of applications for entry into the country's banking system by both foreign and domestic investors and institutions, including NBFIs. The banking license issued to INDEBANK was the first granted under the new process. It is envisaged that the corporatization and conversion of SACA from a government department into an autonomous limited liability finance company, as a first step towards its privatization and transformation into a rural bank, would increase financial services in the rural areas and make them more competitive.  1.13 Term Finance. In the recent past, the commercial banks have tended to invest their liquid funds in government securities. This reflected both the very conservative lending policies of the commercial banks as well as the attractive yields offered by government securities. For the insurance companies and the POSB, which are the main mobilizers of term-savings, investment in government securities has in the past been mandatory. The other NBFIs that potentially represent the most innovative part of the financial market are constrained by the lack of adequate term-resources. INDEBANK and MDC have in the past depended exclusively on external borrowing to finance their lending activities. The challenge, therefore, is to create effective intra-market intermediation mechanisms in Malawi that would facilitate the flow of resources among institutions and enable a greater degree of term- transformation to take place. In the longer term, a likely solution would be to encourage the development of new negotiable instruments, loan syndications, direct domestic deposit mobilization by the DFIs, and the issue of equity shares as a means of mobilizing longer-term resources. 1.14 Agricultural Credit. Agriculture, which is an important sector (37 percent of GDP in 1991, see para 2.2), accounts for a substantial proportion of the commercial bank's loan portfolio. However, agricultural lending has been almost exclusively directed to the large estate sector, while the small estate sector and other small-scale agricultural producers have for the most part been locked out of the formal financial markets by a lack of collateral and an absence of an established credit history. Outside the estate sector, the typical farmer is very small with holdings of less than one hectare. These farmers are served, to some extent, by the Smallholder Agricultural Credit Administration (SACA) that is managed by the Ministry of Agriculture (MOA). In close collaboration with agricultural extension services, SACA provides mainly short-term seasonal input loans. This scheme, which has tended to serve mainly the upper strata of the small-scale farmers, has been successful in operating through specially formed farmer groups (clubs), using joint liability principles and achieving a loan collection average of more than 90 percent. SACA has, however, shown little success in being able to channel or recover medium-term loans to smallholders. Although, the scheme has recently been progressively orientated to reach a wider range of small-scale farmers, further steps would be needed to cater fully to the more resource-poor smallholder farmers. Under the Agricultural Sector Adjustment Credit (ASAC), the Government has introduced important reforms that would increase productivity for a broader range of smallholders and estates. These include, among other things, revising legislation/regulations to allow smallholders to grow high-value cash crops. These reforms would need to be supported by increasing smallholder access to credit and savings services. 1.15 Micro-, Small- and Medium-Scale Enterprise Finance. Financial services to the Micro-, Small- and Medium-Scale Enterprises (MSMEs) sector are derived from three primary sources: (a) DFIs, which onlend donor or government supplied funds; (b) the informal financial sectot; and (c) personal and internally generated savings. The two commercial banks have been reluctant to provide credit to the MSME sector because of the high administrative costs and the perceived high risk associated with clients in the sector. The Government is, however, committed to liberalize the financial sector in order to provide finance and ease access to credit for MSMEs. 1.16 Four of the NBFIs (SEDOM, INDEFUND, MMF, and MUSCCO) were established during the 1980s to serve the rural sector by providing credit to MSMEs that are not served by the commercial banks. However, the operations of these institutions have essentially  - 6 - remained on a small scale. While achieving limited successes at the micro-level, they have yet to expand their level of operations to the scale required for cost-effectiveness and sustainability. Several steps are being taken to remedy their management deficiencies. It is recognized that their endeavors to serve small borrowers require special development support in attaining sustainability in the longer term. The Government is, therefore, committed to strengthening these institutions to enable them to achieve their goals of greater economic diversification, value-added and active participation in the rural financial system. II. RURAL SECTOR A. Introduction 2.1 Malawi consists of 1.8 million households, 1.5 million of which live in the rural areas. Of these, 1.3 million are smallholder farmers with customary rights of land tenure, while 0.2 million live and work on estates (see para 2.3) or are engaged in non-farm activities. The average size of a rural household is five persons. About 75 percent are classified as core poor (with land holding of less than 0.5 hectare) or poor (with land holding of less than 1.5 hectare). The basic needs income level (poverty line) for Malawi is estimated at US$91 (1991). Only 45 percent of smallholders reach this level. About 40 percent of all rural households are headed by women. Because of the declining size of land holdings, women generally manage the home and family subsistence agricultural activities, while meii in increasing numbers seek wage employment in farm and non-farm enterprises. B. Agriculture 2.2 Agriculture continues to be the backbone of Malawi's economy. It accounts for nearly 37 percent of GDP, 85 percent of exports and employment, provides raw material inputs for about two-thirds of the manufacturing sector, and dominates the commercial and distribution sectors. The country's arable land is about 2.4 million hectare, most of which is already under cultivation. Maize, which is Malawi's staple food, is the dominant crop, occupying nearly 75 percent of the cultivated area. Export earnings are dominated, in percentage terms, by three crops: tobacco 50 percent, tea 25 percent and sugar 10 percent. Cultivation is predominantly under rainfed conditions, with only a few irrigation schemes. 2.3 Malawi's agricultural structure is commonly classified under "smallholder" and "estates" sectors. Recent studies suggest that such classification is an oversimplification. These two sectors have been delineated according to legal and institutional rules regulating crop production, marketing arrangements, prices, and land tenure. Based on the traditional classification, the smallholder subsector accounts for about 25 percent of total GDP, 75 percent of agricultural GDP and employs 90 percent of agricultural labor, whereas the estate subsector accounts for 9 percent of total GDP, 25 percent of agricultural GDP, employs 10 percent of agricultural labor and accounts for 90 percent of total national exports. These figures imply that the estate labor force is nearly three times as productive as that of the smallholder sector. 2.4 The 1.3 million smallholder farmers operate under customary tenure on about 1.75 million hectare, and generate about 80 percent of food production (mostly subsistence) and 10 percent of export crops. About 55 percent of the households cultivate less than 1.0 hectare, 31 percent between 1-2 hectare, and 14 percent above 2 hectare. Maize, the main crop,  consists mostly of the local low-yielding white maize varieties (90 percent), with storage and milling characteristics acceptable to the smallholder. Other important crops include groundnuts, tobacco (fire-cured), cassava, cotton, rice, and various legumes. The dominance of maize, coupled with an acute land shortage, has resulted in excessive depletion of nutrients from the soil, and has led to decline in soil fertility, particularly in the densely populated south. The majority of the households produce primarily for subsistence, using simple hand tools and little or no inputs, thereby achieving very low yields (averaging 900 kilogram/hectare). Given the small farm size and low yields, about 75 percent of the households run out of maize at least three months before harvest in an average rainfall year. 2.5 Before 1991, dent hybrid and fertilizer were the only higher-yielding technologies available for maize production. Recently, high yielding flint maize varieties have been developed with yield potential of about 3,000 kg./hectare with fertilizer and an estimated daily return to labor of around MK 4.00 which is about twice the return on local maize. This development created the scope for a "mini green revolution" in Malawi and a resulting increased demand for credit. Smallholders are now permitted to grow burley tobacco with daily return to labor of MK5-7. Improved Magoye soybeans varieties are out producing maize in terms of total energy production per hectare, provision of valuable protein and fixture of nitrogen in the soil. However, the access to credit is clearly an important prerequisite for the adoption of these innovations by a critical mass of smallholders. The proposed Project is an essential vehicle for increasing the access to credit of smallholders. 2.6 The estate sector comprises about 14,500 farms, occupies about 750,000 hectare (of which only 24 percent is cultivated), and produces mostly cash crops (about 40 percent of the estate cropped area), maize (34 percent), tea and sugar (26 percent) of areas cultivated respectively. The low cropping intensity results from rotational management, which minimizes the risk of nematode infestation on highly profitable cash crops. Most estates have easier access to inputs, credit and support services, as well as permits to grow cash crops than smallholders, and are able to secure better market prices for their produce. As a result, estates have a much higher level of technology and obtain higher yields than smallholders. Another notable feature in the estate sector is the dramatic increase in numbers during the 1980s, increasing dramatically from about 8,400 to 14,500 farms. Most of this increase resulted from smallholders registering as estates, primarily to get preferential access to some special facilities available only to estates. More than 90 percent of the estates are farmed by sharecropping tenants. C. Non-Farm Enterprises 2.7 Most non-farm economic activities in the rural sector are micro- and small-scale enterprises, undertaken by individuals or members within the family, with minimum use of hired labor. Rural families usually have non-farm economic activities of one form or another, and they shift labor and working capital among these to take advantage of opportunities available. Rather than continuing to expand one particular activity, families often prefer to shift part of their resources into new fields to reduce the risk of total failure. The main non- farm activities include trading, services (for example, repairs), and manufacturing (dress making, carpentry, bakery, agro-processing and so on). A USAID financed survey in 1986 provided extensive information on a sample of 1,383 enterprises, 80 percent of which were run by full-time business persons. The sector distribution was 42 percent in trading activities, 26 percent in small-scale service activities, and 32 percent in a few common manufacturing  -8 - activities. The survey revealed that (a) more than 96 percent of the entrepreneurs were sole proprietors; (b) 91 percent started businesses with their own savings, and 72 percent of the enterprises had initial investments valued at less than MK 1,000 (US$250); (c) approximately 3,000 persons were employed in the businesses surveyed, and 81 percent of the employees were male; and (d) 78 percent of the enterprises were rural-based. This preponderance of male employment was evident throughout the sector except in the restaurant and bar enterprises where participation by both sexes was nearly equal. 2.8 The above data indicates the importance of MSMEs in providing employment both as entrepreneurs, and as wage earning employees. Despite the absence of sufficient data on microenterprise operations, GOM personnel operating in rural areas confirm that most rural families attempt to develop some kind of off-farm income generating activities (IGAs), a position which is supported by the results from several surveys by donors and Government. Given the increasing land pressures, the MSME sector can be expected to grow faster in the future, primarily to service the internal commodity trading and processing/marketing needs. associated with cash and food crop production. In the rural development context, MSME operations must, therefore, be viewed as an integral part of rural household IGAs running parallel, but often linked to agriculture. D. Financial Services to the Rural Sector 2.9 Although there are only a few distortions in Malawi's financial system, access and availability of formal financial services to the rural sector are very limited and remain one of the major constraints to increasing investments and productive activities in the rural sector. It is estimated that more than 80 percent of rural households and small-scale rural enterprises have limited access to formal financial services. While in high-potential areas the development of new markets is creating a potential for intensification and diversification of agricultural production, limited access to financial services at the farm level in such areas hinders growth. Moreover, limited access to credit for farmers and commercial operators in the lower links of the marketing chain also affects market efficiency by increasing price variability and uncertainty, depressing farm-gate prices, limiting competition among traders, and restricting market outlets. A well-functioning rural financial system, at Malawi's present stage of development, would finance both current and increased production. Such a systemrL would give impetus to traders to expand markets in commodities and services. Access to financial services would also relieve the food insecurity faced by the population in areas with limited agricultural potential and promote non-farm microenterprises. 2.10 The main reasons why the formal financial institutions, particularly commercial baiks, have been reluctant to finance smallholders and microenterprises are: * risks: there is high risk associated with lending to smallholders. Intensification of production is inherently high risk, and attractive opportunities are few in Malawian agriculture. Furthermore, under climatic uncertainty, intensified production systems using cash inputs are more vulnerable. A commensurate return on investment is not assured, especially in the poorly developed markets in most parts of the country. In addition, credit programs have tended to concentrate on a few crops and regions, and hence risks tend to be covariant. Finally, readily realizable, asset-backed guarantees scarcely exist as collateral against risk;  - 9 - * transaction costs: the transaction cost of formal credit for clients in remote rural areas is relatively high. Individual loans average MK 300 (US$75), but servicing a small loan may cost almost as much as servicing a larger one. Information on clients and their activities (and even on production and prices) is hard to come by, and thus loan repayments may be expensive to collect. Farmers face not only monetary risks but also other risks. For example, the loans may not be precisely what they want (they come too late or in the wrong kind). They also may face difficult procedures, endless discussions, trips to town, filling out forms, and fees or commissions that discourage their access to finance from the commercial channels; * institutional constraints: the rural financial institutions in Malawi have been facing inherent problems. The commercial banks lack the infrastructure, instruments, outreach, experience and managerial capacity to mobilize and channel resources to viable rural enterprises. Building such infrastructure, developing expertise and risk management techniques would take time. The NGOs and associations working in the rural financial markets have yet to prove their durability, and their ability to integrate into formal financial markets without preferred treatment and/or subsidy; and * policy constraints: the overall policy on rural finance has not been conducive to developing a viable market. Administered interest rates structure did not adequately take into account the cost of providing credit to the rural sector including the associated risks, and donor lines of credit have been used to provide a generalized, nonspecific subsidy. Furthermore, efforts among such institutions have focused almost exclusively on credit rather than savings, although savings services may rank much higher in smallholder priorities. The combination of the above has made rural lending unprofitable to commercial banks. 2.11 The rural community relies heavily on the informal financial services. The informal financial sub-sector provides more than 66 percent of the rural finance. Its services are timely and in a form better suited for the requirements of its borrowers, despite higher costs of services of up to 80 percent, that reflect perceived risks and lack of competition in the market. However, the informal financial system lacks the funds, depth, breadth, flexibility, and skills to provide the full range of financial services. Linking the informal financial sector to the formal and semi-formal financial sub-sectors would deepen the financial system and provide the most practical way to channel financial services to the rural sector. E. Government's Development Strategy 2.12 The Government's broad objectives for the rural sector are to promote economic growth, raise rural incomes, reduce poverty, ensure food security, and increase export earnings, while conserving natural resources. Specifically, as indicated in the Statement of Development Policies 1987 - 96 (DevPol), the rural sector objectives are to improve the economic, social, and cultural conditions of the rural communities through productive self- help programs to enable them to contribute fully to the national economic development. In order to promote these objectives, GOM has formulated strategies for promoting private sector involvement in viable rural activities; providing incentives through liberalization of the  - 10- pricing and marketing system; increasing producer prices of export crops; and rehabilitating rural infrastructure, and providing support services such as research, extension and input supply. F. Bank Strategy and Assistance 2.13 The Bank's country assistance strategy supports GOM's medium-term development strategy. Support is directed at four critical and interdependent areas of the Government's development agenda: economic growth; sustainable long-term development; poverty reduction; and public sector management, within the context of macroeconomic stability. The Bank support is being provided through a mix of project and non-project lending, economic and sector work, and aid coordination. Based on the lessons learned from past performance in Malawi, the following features have been incorporated into the country strategy: (a) institutional strengthening to improve capacity in policy formulation and implementation; (b) better integration of macroeconomic and sectoral issues; (c) emphasis on sector adjustment operations to concentrate the policy dialogue on a smaller and more manageable set of priority policy issues; (d) emphasizing the role of the private sector in the delivery of goods and services; and (e) improving the efficiency of donor programs. The proposed Rural Financial Services Project (RFSP) is a key component of the overall Bank strategy for Malawi. The RFSP would provide investment resources and technical assistance to the rural sector in order to facilitate a strong supply response from the strategy. 2.14 The Bank's lending operations and economic work over the past decade have played a key role in supporting GOM's efforts to stabilize the economy and renew growth. In particular, the Bank's analytical work and policy dialogue have helped GOM to identify and implement appropriate policy responses to emerging issues of macroeconomic management. The provision of quick-disbursing funds under Structural Adjustment Lending (SAL) operations provided essential resources to relieve balance of payments pressures and support private sector import requirements. In addition, project lending continued to support sectoral development strategies and high priority public sector investment programs. Finally, the Bank has been instrumental in coordinating donor assistance and mobilizing substantial amounts of external resources to support Malawi's financing requirements. The most active donors in the rural sector, especially in the agricultural sector, have been IFAD, EEC, KFW, ODA, NDF, USAID, and UNDP. G. Previous Bank Group Operations and Lessons 2.15 As of June 30, 1992, the Bank Group had approved 58 projects amounting to US$2386 million (excluding cancellations), consisting of 38 IDA Credits (US$1211 million), 10 IBRD Loans (US$1142 million), and 10 IFC operations (US$33 million). In the rural financial sector, the Bank has approved three projects (totaling US$33 millions): (a) Agricultural Marketing and Estate Development Project (AMEDP), US$18.3 million; (b) Smallholder Agricultural Credit Project (SACP), US$5.9 million; and (c) Fisheries Development Project (FDP), US$8.8 million. 2.16 The lessons from these projects, which are relevant to this Project, indicate that joint liability principles coupled with group lending would be an effective instrument for providing financial services to the rural sector, provided the groups are cohesive, voluntary, and practice the principles of joint and several liability. SACA's loan recovery rates average over  - 11 - 90 percent, and the transaction costs are lower than other forms of lending in the rural sector. Experience also shows that a distorted financial system, inadequate project design, weak institutional capacity, and unrealistic project scope adversely affect project performance. Specific experience in the case of SACP is supported by the data contained in Tables 3.1 and 3.2. Another lesson indicates the need to disengage the extension staff from an active role in credit administration. Extension staff would, however, continue to assist with the formation of farmers clubs. These lessons have been taken into consideration in the design of the proposed Project. The project design has been made simple and institutional capacity would be strengthened. In addition, up-front actions would be taken before project approval, and a mid-term project review has been included to address special issues that may arise during project implementation and require mid-course correction. III. INSTITUTIONS SERVING THE RURAL SECTOR A. General 3.1 There are no specialized financial institutions serving the rural sector. The main institution that has the greatest impact in the rural sector is the Ministry of Agriculture (MOA) with its smallholder agricultural credit scheme, which is discussed below. Commercial banks lend primarily to large estates. The Post Office Savings Bank provides only savings facilities in the rural areas. Other institutions such as INDEFUND and SEDOM provide financial services to MSMEs, but the volume of their operations is too small to have any significant impact. B. Ministry of Agriculture 3.2 Malawi has one of the more successful formal smallholder agricultural (seasonal) credit systems among developing countries. This credit system, which lends through joint liability groups called farmers clubs (see para 3.8), is operated by MOA and has evolved over a long period. Following the launching of agricultural development projects in the late 1960s and, subsequent adoption of the National Rural Development Projects (NRDPs), NRDP became the main vehicle for providing institutional credit to the smallholder subsector. Provision of credit was closely linked to agricultural extension. Donor-financed project resources allocated to credit operations and designated for specific Rural Development Project (RDP) areas were channeled by MOF through MOA to credit funds managed by ADDs, which operated a decentralized credit system. No interest was paid to GOM on the capital funds, and administrative expenditures of the credit delivery system were largely covered by funds provided under RDP for incremental operating expenses and by GOM recurrent budgetary allocations. The principal sources of NRDP funds were IDA, IFAD, EDF, ODA, AFDB and KFW. These funds were allocated annually by the credit section of MOA. 3.3 The above system is, however, highly fragmented, and the lack of a national framework for systematic planning, coordination and monitoring led to imbalances and inefficiencies in the use of scarce financial resources and in the deployment of staff. The fragmentation of credit resources by area-specific allocations, mainly through donor funding, resulted in some areas being inadequately funded. This, in turn caused imposition of an arbitrary credit ceiling and restrictions in the access of smallholders to institutional credit. In light of the above, SACA was established in 1988 within MOA to consolidate and strengthen the credit system, both financially and administratively, increase access of smallholders to  - 12 - institutional credit, and introduce efficient and flexible allocation and utilization of funds. It was established with joint financing from GOM, IFAD, and IDA under the Smallholder Agricultural Credit Project as an interim measure that could ultimately lead to commercialization of the rural finance system. SACA has a mandate to provide credit services to smallholders (group lending), consolidate previous area-based credit programs originally set up under NRDP, and work closely with the agricultural extension services. 3.4 Organizational Structure of SACA. SACA was established in 1988 as a smallholder credit scheme within the Ministry of Agriculture. The overall responsibility for policy guidance and control rests with the Principal Secretary of MOA, who is supported by the National (Smallholder) Credit Committee. Members of the Committee include public sector representatives from the Ministry of Finance (Treasury), Reserve Bank of Malawi, and the Office of the President and Cabinet (Department of Economic Planning and Development). The remaining members are all drawn from MOA and include the eight ADD Program Managers, the Chief Planning Officer, the Chief Accountant and the four Heads of MOA Departments. There are no representatives from the private sector or the farming community. The committee meets quarterly or more frequently if required. 3.5 Management and Staffing. Day to day management is the responsibility of the SACA Administrator who acts as Chief Executive supported by a Deputy Administrator, Financial Controller, and 12 support staff variously supplied on loan from the Department of Agriculture. The Administrator reports directly to the Principal Secretary of MOA. As of September 1, 1991 a total of 433 staff were assigned to work exclusively on SACA duties under ADD supervision in the field. All staff are civil servants. Accounting staff are supplied through the GOM accountancy service, while managerial and technical staff are drawn either from the professional or technical grades. 3.6 No staff have previous banking experience, although many have received overseas short course training in various aspects of rural finance. No official financial incentives are available other than routine promotion following high profile annual confidential reporting. Attrition of experienced staff only results from transfer decisions made within MOA by senior staff at levels above the Administrator. A worryingly high turnover is potentially developing in the computer operations section as salary rates offered are not competitive with those in the private sector. 3.7 Extension and Credit Service Linkages. The evolution of the MOA-based credit service has played a significant role in the conduct of agricultural extension services. While the grouping mechanism was introduced by extension officers to facilitate contact with farmers at the village level, the advent of MOA group lending under the NRDP gradually became an important agricultural extension activity. With the increasing availability of MOA administered credit in the late 1980s, Field Extension (FA) staff reoriented their work programs to spend a greater proportion of their time on credit related activities. Such re- orientation was further exacerbated by the tendency for FAs to be scored higher by their supervisors in their annual confidential reports for credit management achievements than for reaching extension targets. The net effect of the above developments has been the transformation of the role of the existing farmers clubs from multipurpose extension contact groups to primarily credit-oriented groups. This change has weakened the effectiveness of the agricultural extension services. Furthermore, as the farmers clubs were reaching only the top 25 percent of the farming households, extension activities were effectively focused on that  - 13 - stratum and the poorer segments were neglected. Under the proposed Project, extension services would be delinked from credit activities. This will free the time of extension staff to concentrate on extension activities for all segments of the farming population. The training of club members would also be intensified to increase their effectiveness in loan administration and self policing. A pilot program has already been initiated to test how best to delink credit and extension services without undermining the existing credit system. The lessons from the pilot program would be used by the proposed Malawi Rural Finance Company in lending to smallholders. 3.8 Group Lending. With the encouragement of MOA and donors under NRDP, a vigorous farmers' club movement was developed in 1968, mainly from grass roots initiatives, as the primary channel of seasonal credit to the smallholder subsector. Clubs are voluntary and cohesive farmers' associations without legal status. They hold monthly meetings and place great emphasis on communal activities such as self-help schemes to generate some income for the club. SACA provides training for club members, particularly club officials, in the fundamentals of group dynamics, responsibility and obligations, cohesiveness, internal loan administration, and supervision of group activities. Over the past twenty-four years the number of groups has grown from about 300 to 12,000, and the volume of lending has increased from MK 0.34 million in 1968 to MK 76.5 million in 1991, making it the largest source of agricultural credit for inputs to smallholder farmers. The number of households served through this group lending scheme has grown from about 6,500 in 1968 to 330,000 in 1991, or 25 percent of smallholder farmers. Table 3.1 provides data on farmers clubs and number of beneficiaries since SACA was established. Table 3.1 Seasonal Credit Disbursement, 1988/89-1990/91 and their Relation to Club Numbers and Membership Item 1987/88 1988/89 1989/90 1990/91 Total seasonal disbursement 26.87 42.20 56.00 76.50 (MK million) Incremental seasonal 57 37 37 disbursement % over previous year No. of clubs 9,129 10,570 10,722 12,891 % Increase in club Nos. 16 0.1 20 over previous year No. of members 243,468 301,375 315,170 333,750 beneficiaries % Increase in member Nos. 24 4.8 5.9 over previous year Av. No. of borrower 27 29 29 26 members per club 3.9 The loan recovery performance of the scheme has, over its twenty-four year history, been among the highest in the third world, averaging over 90 percent, except for 1992 when  -14- recovery was low because of severe drought. This remarkable credit recovery performance is not only attributed to GOM agricultural credit policies, but also to the group discipline and the stringent rules governing the operations of the farmers clubs, including distribution of inputs to ensure proper utilization of the loans. The most important element is the requirement that groups repay in full (100 percent) of the credit extended to them in the previous season in order to be eligible for new loans (oint and several liability of groups and group members), and its strict enforcement. When the 100 percent repayment was relaxed in 1989 (see Table 3.2), the loan recovery performance dropped significantly. The principle has now been restored at IDA's insistence. Another important reason is that some farmers clubs, particularly those that have been operating for over ten years, have built-up reserve funds that they use to meet the obligations of members who are in arrears and are unable to repay their debt on time, in order to maintain the club's 100 percent repayment. Such groups use their internal procedures to recover the outstanding amounts from members and replenish the reserve fund. Furthermore, lending through clubs has also lowered the administration costs of lending to smallholders, removed the collateral requirements, and increased access of smallholders to credit. Table 3.2 Smallholder Credit and Repayment Performance Year Value in Million Kwacha % Repayment 1968/69 0.43 100.00 1969/70 0.13 99.78 1970/71 0.28 99.83 1971/72 0.63 99.58 1972/73 0.67 99.81 1973/74 0.80 99.83 1974/75 1.21 98.70 1975/76 1.48 99.75 1976/77 1.67 98.26 1977/78 2.40 97.60 1978/79 2.87 98.49 1979/80 3.57 97.46 1980/81 5.68 97.58 1981/82 5.24 97.92 1982/83 8.34 97.19 1983/84 11.46 97.95 1984/85 15.56 96.67 1985/86 19.07 88.59 1986/87 18.28 92.18 1987/88 26.87 91.00 1988/89 42.20 79.90 1989/90 56.00 85.90 1990/91 76.50 86.50 3.10 Performance of SACA. Since its inception, SACA has been able to maintain an impressive record of high loan recovery (see Tables 3.1 and 3.2). Seasonal credit is made available to farmers' and women's clubs formed with the assistance of extension field assistants (FAs) and female farm/home assistants (FHAs), providing crop specific input  - 15 - packages of seed and fertilizer matched to MOA's technical recommendations. SACA also manages a small portfolio of medium-term credit but has no effective program to encourage rural savings. 3.11 Given SACA's status as a government department, it is unable to operate along commercial principles. Since all its field staff are MOA personnel, it is currently impossible to accurately estimate its operating costs. Informed estimates, based on the work times spent by field personnel including agricultural extension staff on SACA's credit operations, when taken as a percentage of salary costs, indicate that 1990191 operating costs approached 11 percent of the total loan portfolio. With annual interest rates fixed by GOM at 18 percent and 25 percent for short-term and medium-term credit respectively, it is estimated that SACA is being subsidized by Government at an estimated MK 4 million per year. 3.12 Despite a highly impressive performance, measured in terms of annual growth in loans outstanding and in recovery percentage, SACA's operations under govermment financial regulations, using MOA field staff as its loan supervision officers, precludes further expansion of its loan portfolio outside the agricultural sector. Furthermore, the introduction of domestic resource mobilization programs to assist in eventually achieving financial sustainability cannot legally be undertaken by a government department like SACA. GOM is, therefore, actively pursuing the concept of separating the activities of SACA out of MOA and establishing an autonomous full service rural bank to take over SACA's operations. This would be done in two phases: first, corporatizing and converting SACA into a limited liability finance company; and second, privatizing and transforming the company into a rural bank. The proposed Project would assist GOM to corporatize SACA into the limited liability finance company and provide support to the company to enable it evolve into a full service rural bank. C. Other Institutions 3.13 Non-Governmental Organizations (NGOs). With only about thirty registered NGOs operating in both rural and urban areas, Malawi has one of the least developed NGO presence among the developing countries. GOM's interest in the use of NGO assistance developed significantly only in the 1980s, following the influx of Mozambican refugees when the major international NGOs initiated significant social welfare programs in the border areas. In 1985, a Council for Social Welfare Services in Malawi was established to serve as an umbrella organization for NGOs, liaising closely with the Ministry of Women and Children's Affairs and Community Services. The Council operates from a small secretariat in Blantyre. 3.14 Although many international NGOs operate savings and credit services in other developing countries, only one Malawian subsidiary (World Vision International of Malawi) has begun a pilot rural banking program, and then only among Mozambican refugees. However, all major NGOs interviewed indicated that their ongoing programs in Malawi are not expected to progress to a point where their contact village groups would require savings and income generating activity (IGA) loan services at least in the next two to three years. The NGOs are still in the initiai stages of social mobilization and planning in the specific geographical areas in which they serve. Nevertheless, many have indicated that they expect to begin programs for IGA by mid 1990s, and that such services may require backup savings and credit support, preferably from a viable indigenous rural financial institution. Many NGOs, therefore, see considerable scope in the mid 1990s for the operation of a standardized national savings and credit operating system in Malawi, provided responsive financial  - 16 - institutions could be developed. The commercial banks, MMF, and MUSCCO could all be considered as potential managers of such a financial service. 3.15 Development of Malawi Traders Trust (DEMATT). DEMATT was formed in 1979 as a Trust under the Ministry of Trade and Economic Development to provide assistance specifically for traders. Its mandate has since been broadened to include provision of support to other types of small- and medium-scale enterprises (SME). DEMATT has been expanded and restructured to meet the changing demands of the SME sector. The institutional capacity of DEMATT has also been built up over the years through Government and donor (USAID, UNDP/UNIDO) support. DEMATT is governed by a Board of Trustees who are appointed by the President of the Republic. The General Manager (GM), who reports to the Board, iis in charge of day-to-day operations of DEMATT. The GM is assisted by a complement of 120 staff, including consultants. At present there are nine expatriate consultants, four of whom are engaged in supporting women's programs. DEMATT has an extensive field presence. It operates in all the regions of the country, with three regional offices and thirty rural offices. 3.16 DEMATT operates two types of programs: (a) core program consisting of business advisory and training services that are financed through direct government subventions and government-donor counterpart funding; and (b) non-core program involving mainly business advisory services to business owners and their staff on a short-term basis (one to five years) that are paid for by the clients or by the donors on behalf of the clients. The non-core programs include services tO almost 600 enterprises, mainly in trade, manufacturing, and agro-industries, for a fee. In recent ye.ars, DEMATT has demonstrated that it can generate income through fees charged for its special advisory and training services. However, this income is not enough to cover its operating costs and DEMATI would have to rely on donDr support, particularly for servicing enterprises outside the trading and manufacturing sectors, Iv. THE PROJECT A. Project Rationale and Objectives 4.1 Background. Support for the rural sector is central to IDA and IFAD assistance strategy in Malawi. It is aimed at fostering economic growth, food security, poverty reduction, off-farm employment, and protecting the natural resource base. IDA has developed a two-pronged approach to assist the Govermnent in its efforts to overcome the constraints facing the rural sector, namely, the execution of financial policy reforms and increasing the accessibility of financial services, and the rehabilitation and improvement of key agricultural services. IDA Credits designed to support the Government's sectoral policies (the Agricultural Sector Adjustment Credit, the Agricultural Research and Extension Services, and the Fisheries Development Projects) are instrumental in providing the appropriate environment for, and direct support to, the development of rural enterprises. The Financial Sector and Enterprise Development Project (FSEDP) is providing the framework for reforming the financial sector. In the sector, IFAD has a primary concern with ensuring that the more resource-poor households are specifically included in the development process and would be targeting financial services to them through a separate parallel operation. Both IMA and IFAD have supported the Smallholder Agricultural Credit Project (SACP) through which SACA and the MMF have been established. However, as identified in the Malawi Financial  - 17 - Sector ReportW', the liberalization and deepening of the financial system is recognized as a long-term goal. In addition, experiences from other countries show that following liberalization of the financial sector, the commercial banks are not likely to increase lending to agriculture because transaction costs and risks are higher than in other sectors (para 2.10). Furthermore, the two commercial banks lack the infrastructure, suitable instruments, experience, and managerial capacity to mobilize savings and channel resources to viable rural enterprises. Besides, building infrastructure, developing expertise, improving efficiencies and risk management techniques would take time. Hence, sustainable rural sector growth, particularly agriculture, will require directed lending as proposed under the Project during a transition period, especially to ensure broad-based lending to smallholder farmers. 4.2 Project Rationale. There is a perceived need to increase the coverage and effectiveness of Malawi's rural financial services in support of sustainable rural growth through poverty alleviation. SACA has achieved partial success through the organization of joint liability farmers clubs with high loan recovery, which is the most important element of any credit system. Such clubs reduce transaction costs as well as keeping the risks of lending to smallholders to a manageable level. Although, SACA has done a good job in achieving high loan recovery rates, its activities are heavily subsidized by the Government, especially through the support of the extension services, and are not sustainable. While the decontrol of interest rates will make it possible for banks to cover the full costs of their rural operations, thus making it potentially profitable, commercial banks have shown no interest in lending to the rural areas. There is, therefore, a need to establish a rural financial institution which would commercialize and expand the activities currently carried out by SACA, particularly financing the adoption of recently developed new technologies in the rural areas (para 2.5). As a first step in this regard, the proposed Project would support the corporatization and conversion of SACA into a limited liability finance company and complement other institutions such as MMF that are engaged in providing financial services to the poor. It is anticipated that the company would be privatized and transformed into a private rural bank within three years. Calculations and financial projections in annex 2 indicate that such a finance company would be financially viable. 4.3 The corporatization and conversion of SACA into a limited liability company will require substantial changes, involving existing vested interests (for example, separation of extension services from credit). The strong support of donors such as IDA will be essential to ensure success. 4.4 Project Objectives. The Project's fundamental objective is to improve the access to financial services for the rural sector, including women, on a sustainable basis. This would be done by corporatizing and converting the Smallholder Agricultural Credit Administration (SACA) into a limited liability finance company, thus eliminating its heavy dependency on Government support, as a first step to its subsequent conversion into a private bank. The Project would also assist the Government toward improving the policy and institutional framework for rural financial intermediation by supporting the development of linkages a/ Malawi Financial Policies for Sustainable Growth, February 19, 1992. Report No.90009-MAI  - 18 - between the formal and informal financial sectors, and strengthening related non-financial institutions serving the rural sector. B. Project Description 4.5 The Project would be implemented in three years and would have three main components: (1) an institution-building component (US$16.7 million) would support (a) the corporatization and conversion of Smallholder Agricultural Credit Administration (SACA) into a limited liability finance company (Malawi Rural Finance Company) as the first step in a two phased program towards the privatization and transformation of SACA into a private rural bank; and (b) the use of Development of Malawi Traders Trust (DEMATT) to assist in preparing investment proposals for agricultural, small, and microenterprises and to provide related training and adv- sory services; (2) a line of credit component (US$20.0 million) would finance primarily short-term loan requirements of farm and non-farm rural activities; and (3) a pilot program component would support initiatives to test innovative approaches for providing financial services to women entrepreneurs engaged in income-generating activities in the rural sector. C. Detailed Features Imntitution Building 4.6 The conversion of SACA into a private rural bank would be done in two phases. The first phase would corporatize and convert SACA into a limited liability company and the second phase would privatize and transform the corporatized SACA into a private rural bank. The Project would finance the first phase of corporatizing and converting SACA into an autonomous limited liability company. The formation of the company, Malawi Rural Finance Company (MRFC), would, therefore, be the first step in the two phased approach towards the process of the privatization and transformation of SACA into a private rural bank within three years. MRFC would be incorporated as a limited liability company with the private sector (such as farmers clubs) and government as shareholders. The Project would finance costs of vehicles, equipment, operating costs and training of MRFC. A large proportion of MRFC's operating costs would be financed from its own earnings. IDA would only finance seven percent of the Project's operating costs, mainly for vehicles, equipment and office space for three years. Therefore, IDA financing of these costs would not be on declining basis. 4.7 MRFC would take over the activities of SACA, including its infrastructure, assets and liabilities. The transfer of the activities, assets and liabilities of SACA by GOM to MRFC is a condition of disbursement on the lines of credit component [para 7.3(i)]. The Government would, however, continue to bear the lending risk on all outstanding loans made by SACA prior to October 1, 1993 by requiring that no new loans would be made available to individuals or groups who have defaulted on their obligations. MRFC would bear the lending risk on all loans made by it from October 1, 1993, the expected date at which the transfer of SACA's activities, assets and liabilities to MRFC would have been completed. The takeover of SACA operations by MRFC would be managed in a way that would minimize disruptions in SACA's ongoing operations. A task force has been appointed to implement an action plan leading to the establishment of MRFC. The Project would also finance equipment, vehicles, and supplies required to setup and operate the MRFC's headquarters and branches, as well as the cost of leasing office buildings and accommodation facilities for the first three years of  - 19 - MRFC's operation. Such facilities are likely to be government owned buildings in the rural areas, some of which are currently used by SACA. 4.8 MRFC would require some technical assistance and staff training during its initial years of operation. The Project is financing, through a PPF, services of an accounting/law firm to prepare the documentation for incorporation of MRFC. The Project would provide at least two long-term technical assistance positions for a General Manager and a Financial Controller. The appointment of General Manager and Financial Controller of MRFC for three years respectively, whose experience and qualifications are acceptable to IDA, is a condition of effectiveness [para 7.2(i)]. In addition to these two long-term specialists, the Project would provide funds to recruit other specialists in rural banking, credit, operating systems and training on a short-term basis, and also to prepare and implement an action plan leading to the transformation of MRFC into a full service rural bank. The Project would provide funds that MRFC management could use to secure services of experts to identify and solve specific problems as they arise. Staff training is expected to be carried out in the facilities of one of the training institutions in Malawi for a fee. Such training would be in- country, skill-specific, and short. No staff training outside Malawi is envisaged. The resources provided for technical assistance and training under the Project would be passed on to MRFC by GOM as an equity contribution. 4.9 Business Development Unit. One of the impediments to the access to financial services is lack of awareness of available opportunities and credit history by many rural households and MSMEs. The increase in the volume of lending to the rural sector in the medium-term might not be achieved unless innovative techniques suited for the rural sector are developed to mobilize and allocate rural resources, and to enable the rural households to take advantage of such available financial services. To facilitate this process, under the proposed Project, a Business Development Unit (BDU) would be established as a unit within MRFC, whose main function would be to orient clients to business opportunities and available rural financial services. BDU will develop innovative techniques for mobilizing rural resources and lending to the rural sector, particularly by adopting aon-traditional approaches, such as collateral substitutes and use of informal lending agents as intermediaries of formal financial institutions. BDU's activities would, therefore, include promotion, training, and reorientation of rural households to hold more of their wealth in financial assets rather than fixed assets (for example, savings accounts as compared to livestock), and to propagate the benefits of household savings. BDU would engage in efforts to strengthen rural institutions (for example the 12,000 farmers clubs now working with SACA) through training on group dynamics and self-supervision. It will also develop savings and lending instruments that are suitable and acceptable to poor rural households. BDU will also be responsible for monitoring of project progress as well as evaluating its impact on the beneficiaries. BDU would need to have only a small staff (about 5 people), one of whom would be an experienced banker who has had significant experience in the design and operation of rural and small-scale enterprises, to be internationally recruited. Although based within the MRFC, BDU services would benefit all financial institutions in Malawi. Technical assistance provided to BDU would be financed on a grant basis during its initial years. After an initial period, BDU could start charging for its services and have other customer financial institutions share the costs of its operation. 4.10 Strengthening of DEMATT. Rural entrepreneurs are often handicapped by their inability to submit to lenders viable investment proposals and acceptable loan requests in an  - 20 - appropriate manner. DEMATT, which was set up to assist and advise such entrepreneurs, with its extensive field presence, is best placed to provide such special business advisory and training services to rural entrepreneurs who would benefit under the Project. DEMATT would not need any significant increases in its capital or recurrent expenditures in order to extend such services to project beneficiaries. It would, however, need support in the form of reimbursement of incremental costs for its services to enable it to hire local consultants on short assignments to provide help in preparing feasibility studies, particularly for new agricultural, agro-industrial, and other small-scale rural enterprises. The Project would provide US$100,000 to DEMATT for this purpose. Although no other institution is currently capable of providing the envisaged services to project beneficiaries, however, as other institutions in the country become capable of providing such technical assistance, they would be reimbursed for their services under the Project. This would enable project beneficiaries 1O engage the services of institutions of their choice. Credit 4.11 The line of credit component amounting to MK 68.0 million (US$17.0 million) would nfmance mostly short-term loans and be utilized over a three year period. The funds would be channeled through the MRFC, under participation agreements with RBM, for financing of all viable rural enterprises including farm and non-farm activities (including cottage industries) at market-determined interest rates (para 4.19). MRFC would have the freedom to select the entities it lends to within its mandate and as specified in its onlending agreement. Assurances to these effects were obtained at negotiations [para 7.1(i)]. 4.12 The demand for rural credit is currently running at a level substantially above availability of loanable funds. Future rural credit demand, and hence the rate of draw-down of the line of credit, would be dependent on the overall performance of the economy, the level of investment or reinvestment in the rural sector, and the requirements for seasonal production credit. It is estimated that in 1991 total unmet credit requirements in the rural sector were as follows: MK 125.0 million for both working capital and term investments for MSMEs; MK 206.0 million for smallholder farmers (mainly for seasonal production credit); and MK 125.0 million for small agricultural estates, a total of MK 456.0 million. By the end of the three year project period, the rural credit requirements are expected to peak at about MK 645.0 million. The Project would finance less than 10 percent of total rural investments over the three year project period. It is, therefore, most likely that the project funds would be disbursed within three years. 4.13 Seasonal production credit is essential to ensure rural sector economic growth and would be provided through farmers clubs and other cohesive groups that meet eligibility criteria. The additional funding would be necessary to support agricultural growth, particularly to encourage higher input usage and induce greater productivity. The line of credit would therefore support incremental seasonal production credit for smallholder farmers and small estates that are engaged in food and cash crop production. The line of credit would also support working capital loans for MSMEs. The funds provided by IDA for short-term credit would be subsequently recycled through MRFC to provide medium, and long-term subloans, as increased domestic resources become available for short-term funding. Since most of the MSMEs do not have appropriate collaterals, the Project would promote the use of collateral substitutes such as blocked savings accounts, life insurance, insurance on all  - 21 - financed items and transfer of the rights of an investment item or future production to the lender. Assurances to this effect were obtained at negotiations [para 7. 1(ii)]. 4.14 Medium-term loans would also be channeled through the MRFC to help overcome the acute shortage of such financing for MSMEs and small estates operating in the rural sector. The repayment periods for such term-loans would be based on the sub-projects' cash flow, but are not expected to exceed five years. 4.15 MRFC would be required to enter into a subsidiary agreement with RBM. This agreement would, among other things, specify that MRFC would (i) arrange for satisfactory subproject appraisal of medium-term investments; (ii) carry out systematic supervision of subprojects financed under the Project to ensure that resources are used for the designated purposes and repaid as specified; (iii) ensure that the subprojects comply with the national environmental regulations and IDA guidelines on environment; (iv) help to identify technical assistance requirements of MSMEs; (v) submit periodic progress reports to RBM; (vi) provide RBM and IDA with such information (including audited financial statements and a statement of expenditures) as they may reasonably request; (vii) assign qualified staff to manage the credits financed under the Project; and (viii) adhere to terms of lending and repayment of loans. Receipt by IDA of a satisfactory subsidiary agreement between the RBM and MRFC is a condition of credit effectiveness [para 7.2(ii)]. 4.16 Eligible Beneficiaries and Subprojects. All private sector producers including individuals, groups, or other legal entities engaged in productive economic activities would be eligible for financing under the Project. The main market niche is smallholder farmers (through farmers clubs), small estates (cultivating up to 30 hectare), and MSMEs with average annual turnover of up to MK 500,000. The average loan size is estimated at US$10,000 with upper limit of US$25,000. The main criteria for loan approval would be profitability of the subproject and creditworthiness of the borrower. Financing would be made available for the following purposes: farm inputs (seed, fertilizer, and agro-chemicals); farm implements (ox- ploughs, ox-carts, tools, and motorized farm machinery); agro-processing; vehicles for rural merchandise transport (bicycles, pick-ups); fishing equipment (outboard motor engines and spares, nets, freezers, and so on); livestock development (feed, poultry, hatcheries, farm structures), microenterprises, and so on. This list is not meant to be exhaustive but rather indicative of the kinds of items that would be financed. Subprojects would have to be technically and financially sound and the borrower would not have defaulted on its past loans in order to be eligible for financing. Financing from the line of credit would not exceed 90 percent of the amount approved for a subloan, the remaining 10 percent would be contributed by the MRFC and borrowers. Borrowers' contributions could include financing in kind such as labor, other inputs provided by the borrower, or work in progress. 4.17 Collateral. A large number of MRFC's clients may lack bankable collateral sufficient to cover the value of their loans. Even though some of them may own land, buildings and other properties in the rural areas, some of these assets are either iliquid or do not have immediate market. To facilitate the finance of highly viable investments, the MRFC may finance investments having high FRR (say FRR of 25 percent) and appropriate cash flow relying on group guarantee (individual and group liability for repayment) and the Credit Reserve Fund (para 5.7) as sources for recourse in case of loan default.  - 22 - 4.18 Repayment Schedule. Repayment of working capital and seasonal loans would range from six to eighteen months. Repayment for loans for investment purposes would be spread over to a maximum of sixty months, including grace periods. 4.19 Interest Rates. Unlike the approach usually adopted in Government sponsored credit programs that support small borrowers, the market-based approach to setting interest rates for MRFC's loans, focuses on establishing adequate margins of interest rates would be instituted so as to ensure (a) availability of credit, and (b) adequate profitability for the financial intermediary. The underlying assumption is that for small borrowers, access to credit would be more important than the interest rates involved. The decision to base interest rates on prevailing market conditions means that the MRFC would be obliged to set lending rates sufficiently high to cover its funding and operating costs, including adequate provisions for loan losses, and to permit it to earn a reasonable profit. It was agreed at negotiations that MRFC would submit its first year's lending rates to IDA for review and comments, before it is ratified by its Board of Directors [para 7. 1(iii)]. In fixing the basic interest rate, a provision should be made for "prompt repayment incentive" (PRI), and a fee of 0.5 percernt per month on working capital loans collected monthly. This would effectively be an up-front penalty in case of failure to pay loan installments on time. It would be returned in full at the time of final loan payment to borrowers who have paid all installments on time. 4.20 The Project would support Women in Development Pilot program to assist women engaged in income generating activities in rural areas of Malawi. The Project would capitalize on the positive features of women's behavior in regard to finance (emphasis on savings, greater discipline in loan repayment and respect for group obligations). Women would be encouraged to place their savings with financial institutions that would also help them to start building a banking relationship and gaining experience that would be useful when it comes to borrowing from the same financial institutions. Those with very small savings should be encouraged to join savings groups. The "strength in numbers" principle could be adopted in helping women to participate in "group loans" and "joint liability" schemes to improve their access to lending institutions. In addition, training facilities would be provided for skill enhancement for women entrepreneurs in all phases of their business, including subproject preparation, loan application, and management. 4.21 To ensure women's participation as envisaged in the Project, an action program wilh guidelines on mobilizing women and women's groups, and a methodology for orienting, supporting, and training them on microenterprise investments and operations would be developed not later than June 30, 1994. The Project's monitoring and evaluation arrangements would, among other things, provide for identifying special constraints faced by women to facilitate speedy corrective action by implementing agencies. The terms of a monitorable action program as specified in annex 4, were agreed to at negotiations [para 7. 1(iv)]. D. Project Costs and Financing Plan 4.22 Project Costs. Total Project costs are estimated at US$36.7 million equivalent, with a foreign exchange component of US$13.1 million or 36 percent as summarized below in Table 4.1 and detailed in annex 3. All costs are based on March 1993 prices. A base exchange rate of MK 4.0 to US$1.0 has been used for cost estimates.  - 23 - Table 4.1: Estimated Project Costs Local Foreign Total Local Foreign Total -MK 000 - US$ 000- A. INVESTMENT COSTS 1. Goods (MatrllVehic/Equip) 0.0 25143.3 25143.3 0.0 6285.8 6285.8 2. Training 2039.8 226.6 2266.5 510.0 56.7 566.6 3. Technical Assistance 0.0 7820.0 7820.0 0.0 1955.0 1955.0 4. Line of Credit 72000.0 8000.0 80000.0 18000.0 2000.0 20000.0 TOTAL INVESTMENT COSTS 74039.8 41189.9 115229.8 18510.0 10297.5 28807.4 B. RECURRENT COSTS 1. Salaries 13754.8 0.0 13754.8 3438.7 0.0 3438.7 2. Other Operating Costs 3994.4 9320.2 13314.5 998.6 2330.0 3328.6 TOTAL RECURRENT COSTS 17749.2 9320.2 27069.3 4437.3 2330.0 6767.3 TOTAL BASELINE COSTS 91789.0 50510.1 142299.1 22947.3 12627.5 35574.8 Physical Contingencies 0.0 1257.2 1257.2 0.0 314.3 314.3 Price Contingencies 2451.7 821.5 3273.2 612.9 205.4 818.3 TOTAL PROJECT COSTS 94240.7 52588.8 146829.5 23560.2 13147.2 36707.4 Table 4.2: Project Financing Plan Local Foreign Total US$ million IDA 11.9 13.1 25.0 Government 4.0 - 4.0 MRFC 4.7 - 4.7 Sub-borrowers 3.0 - 3.0 Total 23.6 13.1 36.7 4.23 Financing Plan. IDA Credit of US$25.0 million would be on standard IDA terms for Malawi, with forty years maturity. The IDA contributions would finance 68 percent of total project costs, including 100 percent of the foreign exchange costs. GOM would provide US$4.0 million, equivalent to 11 percent of total project costs toward the transformation of SACA into MRFC. The sub-borrowers (rural households and MSMEs) would finance local costs amounting to US$3.0 million, equivalent to 8 percent of total project costs as  - 24 - contribution to the line of credit component. The amount of US$4.7 million or 13 percent of the total project costs would be financed by MRFC from its earnings. E. Procurement 4.24 The MRFC would be responsible for the procurement of all IDA items. Because MRFC is new and would lack experience on procurement issues, the management team (general manager and financial controller) financed under the Project would be versed in IDA procurement procedures, to be able to assist in handling procurement matters. Procurement for goods and consultancy selection would be based on Bank sample documents. Prior to RFSP start-up, MRFC would prepare a detailed procurement schedule, based on the projecl's implementation schedule. 4.25 Goods, including vehicles, motorcycles and equipment would be bulked into contracts of more than US$100,000 and procured by international competitive bidding (ICB) in accordance with IDA Guidelines. Review of proposals of invitation to bid and fnal contracts for goods costing more than US$100,000 will be subject to prior review by IDA. Small off- the shelf items, mainly spare parts, costing less than US$20,000 each needed urgently for project implementation may be purchased by "prudent shopping" after obtaining at least three price quotations. In addition, international shopping may be used to procure goods and supplies before Project start-up using the PPF. The total value of items purchased under prudent shopping and international shopping shall aggregate to no more than US$500,000. 4.26 Consultant services by way of individuals or firms would be procured according to IDA guidelines, with qualifications and contract terms and conditions satisfactory to IDA. The details of the services to be provided by these consultants are stated in their respective TORs contained in annex 8. A law firm would be procured under the PPF to incorporate MRFC as limited liability company using sole sourcing arrangement. 4.27 Given the importance of skills development and training for both project implementers and beneficiaries, the project will finance the local costs for local training such as per diems, and operating expenditures. 4.28 The line of credit funds would be used by project beneficiaries who would be private sector entities (smallholder farmers, small estates, MSMEs) to procure mainly agricultural inputs (fertilizer, chemicals, seeds, etc.) spare parts, and equipment. The subloans would be very small (average of US$10,000); and competitive bidding procedures would be impracticad. Procurement from the line of credit would, therefore, be through normal commercial channels available to borrowers for equipment, spare parts and chemicals except proprietary spare parts which could be purchased directly from original manufacturers. The reporting format for procurement actions are discussed in para 5.20.  - 25 - Table 4.3: Procurement Method Category ICB LCB Others NA Total US$ million Goods 4.5 - 2.0 - 6.5 IDA (4.5) - (0.5) - (5.0) Technical assistance - - 2.0 - 2.0 IDA - - (2.0) - (2.0) Studies and training - - 0.8 - 0.8 IDA - - (0.5) - (0.5) Operating cost of MRFC - - - 7.4 7.4 IDA - - - (0.5) (0.5) Line of credit - - 20.0 - 20.0 IDA - - (17.0) - (17.0) Total 4.5 - 24.8 7.4 36.7 IDA (4.5) - (20.0) (0.5) (25.0) F. Disbursement 4.29 Two Special Accounts of US$1.0 million and US$300,000 would be established at a commercial bank on terms acceptable to IDA. The Special Account of US$1.0 million for the line of credit component would be administered by RBM. The Special Account of US$300,000 would be administered by MRFC to finance expenditures related to institution building activities. IDA would, upon Credit effectiveness and receipt of withdrawal applications, make advance deposits into the Special Accounts. Disbursements would be made against full documentation except for expenditures claimed against purchase orders and contracts below US$100,000 for goods, training and studies, all of which would be claimed under Statement of Expenditures (SOEs) procedures. Withdrawal applications for replenishment of the Special Accounts would be accompanied by a statement showing all transactions for the relevant period. Supporting documentation for the SOEs should be retained by MRFC for IDA review during supervision missions. The SOEs would be subject to a special audit each year. 4.30 The proceeds of the IDA Credit for Institution-Building Component would be disbursed to finance 100 percent of the foreign exchange costs of imported goods; 100 percent of technical assistance, training and studies; and 80 percent of total costs of previously imported goods in the country. Up to 90 percent of total subproject costs would be financed under the Line of Credit Component for working capital and term loans, and incremental seasonal loans for agricultural inputs would be disbursed against invoice from eligible suppliers. The Project Disbursement Schedule is shown in annex 6. The Project would be  - 26 - implemented in three years and is expected to be completed by June 30, 1996. The Project would be closed by December 31, 1996 G. Special Accounts 4.31 The two Special Accounts, indicated in paragraph 4.29, would be set up in U.S. dollars to be opened by GOM at a commercial bank upon Credit-effectiveness. The authorized allocation would be US$1.0 million for the Line of Credit component representing estimated loan demand for working capital, term loans and incremental seasonal loans for agricultural inputs for a four month period and US$300,000 for institutional capacity development of the MRFC. All expenditures under US$100,000 would be disbursed from the respective Special Accounts on the basis of Statement of Expenditures (SOEs). The documentation for withdrawals made under SOEs would be retained by RBM for ten years and would be reviewed by IDA supervision missions and audited annually. All other disbursements would be on the basis of full and acceptable documentation. The Special Accounts would be audited annually by independent auditors, and an audit report would be submitted to IDA within nine months of the end of the fiscal year. RBM would submit to IDA a quarterly statement of transactions on the Special Accounts. Request for replenishment of the Special Accounts would be submitted every two months or whenever funds in the Accounts are not sufficient to meet outstanding and committed obligations. V. PROJECT IMPLEMENTATION A. Malawi Rural Finance Company 5.1 Organizational Structure. Malawi Rural Finance Company (MRFC) would consist of a head office and six branches to be located in rural areas. The branches would be treated as separate profit centers responsible for lending activities. They would be supported by about twenty-five satellite offices (agencies) that would serve as operational centers for field staff. Each agency would be managed by a credit supervisor reporting to the branch office, who would direct and supervise the activities of about eight credit assistants, and liaise between branch and field agencies. The staffing of each branch or agency would depend on the volume of operations handled, but in total the company's staff at headquarters, branches and field are not expected to exceed 450 in the initial years. IDA received the certificate of incorporation of MRFC before negotiation. 5.2 Management. The management of the proposed Malawi Rural Finance Company (MRFC) would follow the normal commercial and private sector practices2}. All powers would be vested in its Board of Directors whose members would be representatives of the shareholders (private and public). The General Manager, who would be the Chief Executive Officer of the company, assisted by the management team, would be responsible for the day to day operations of the company. Prior to start-up of MRFC, the management team would finalize the organizational structure of the company, including its branch network and its locations, setting up operating systems and procedures and implementing the take-over of SACA's assets and liabilities. MRFC organizational structure is expected to be a modification 3/ A complete institutional profile of the rural finance company is contained in annex 2 and Working Paper No. 2.  - 27 - of existing SACA's structure. The finalization of MRFC's organizational structure satisfactory to IDA is a condition of disbursement on the line of credit component [para 7.3(ii)]. After the start-up, the management team would ensure that the company is managed efficiently and profitably by translating the policies of the Board into operational guidelines for the staff. MRFC management would also take immediate steps to implement the action plan for transforming MRFC into a rural bank as stipulated in Attachment 2 to annex 2. Assurances were obtained from Government and MRFC at negotiations that the action plan would be expeditiously implemented within three years [para 7.1(v)]. 5.3 MRFC would commence full-scale operations by October 1, 1993, when it would also take over SACA's outstanding loan portfolio, estimated to be about MK 100 million. Seasonal loans to existing farmers clubs and new farmer groups are projected to increase by 10 percent annually. Short- and medium-term loans to MSMEs and loans to small estates are assumed to be initiated in Project Year 1 at a modest level of MK 2 million for each category, and growing at annual rates varying from 15 percent to 25 percent. It is anticipated that MRFC would be profitable from Project Year 1, while providing a range of financial services, including lending for viable rural economic activities at market rates of interest. In doing so, it would fully operate on a commercial basis, adopting accepted principles, practices, and norms of a commercial company. Financial projections of MRFC's operations (income statement, sources and uses of funds, balance sheet, and so on) and major assumptions for such projections are contained in attachments to annex 2. 5.4 The Business and Development Unit (BDU), established within MRFC, is not likely to have the capacity to carry out its functions as described in paragraph 4.9 without special support, particularly in the initial years. The Project will therefore provide necessary technical assistance to support BDU's activities. Under the Project, individuals or firms with a successful record of providing financial services to the rural sector would be recruited to provide consulting services support to meet specific needs of BDU. The consulting services would assist BDU in developing appropriate financial instruments for savings, and lending to rural households and enterprises. In addition it will develop suitable programs for training rural households and enterprises on how to access available banking services. The remuneration of the selected consultants could include bonus based on performance, such as the success in developing appropriate savings and lending instruments that financial institutions in Malawi could adopt, effectiveness in training staff of BDU and identified beneficiaries, and so on. The performance bonus which would be additional to the normal compensation would serve as incentive for the selected organization to perform its tasks more effectively. The annual work program of BDU would be submitted to IDA for review and comment before it is finalized. Agreement to this effect was reached at negotiation [para 7.1(vi)]. 5.5 Operating Policies and Procedures. The MRFC operations would be carried out on the basis of policies and procedures specified in a Manual of Policy and Operations to be approved by its Board of Directors and satisfactory to IDA. This manual would be prepared and adopted by September 30, 1993 and would include, among other things, eligibility criteria of beneficiaries, collateral specifications, repayment schedule, interest rate structure, subloan appraisal and supervision procedures, environmental safeguards, and so on. The manual would be periodically updated to reflect necessary policy and operational changes for improving the bank's performance. The preparation and adoption of operating policies,  - 28 - guidelines, procedures and manuals acceptable to IDA is a condition of disbursement on the line of credit component [para 7.3(iii)]. B. Credit Reserve Fund 5.6 Smallholder farmers and rural entrepreneurs operating small and microenterprises often have very limited access to credit facilities because they are generally not in a positiorn to offer conventional collateral acceptable to the lending institutions. The formation of groups, as in the case of farmer clubs, participating in the Smallholder Agricultural Credit Project and obtaining credit from SACA certainly improves accessibility. However, even such group arrangements will have only marginal impact on accessibility, partly because the groups function in an informal manner, with no legal backing to their formation, existence, or operations. Joint liability obligation that farmers clubs are able to offer SACA thus provides substance to the creditworthiness of the clubs. In many farmer clubs, if a member was unable to meet his loan servicing commitment for whatever reason, the other members are required to put up the necessary funds so that the club itself is able to maintain a 100 percent repayment record insisted by SACA. There are other groups, however, which operate what might be understood to be a "contingency or guarantee fund," collecting small but compulsory contributions periodically to build up a reserve that could serve as a loan guarantee fund, that is to be used to help out members in difficulty who are unable to meet their commitment. Reimbursement into this fund and other obligations of the member in arrears are settled by mutual agreement among members of the club. Even under such arrangements, some farmer clubs have been unable to meet their debt service commitments to SACA, and hence have been denied further credit. 5.7 A more systematic and formalized arrangement between the borrower groups and MRFC, whereby the groups could operate a "Credit Reserve Fund" for meeting loan repayment installments of borrowers in arrears, would help reduce loan risks and improve credit access and outreach. Such Reserve Fund schemes would be operated by MFRC on behalf of the farmer clubs or other cohesive customer groups. The borrowers would be required as a condition for receiving a loan to contribute a sum of not less than 10 percent oif their total borrowing from MRFC to be held in an interest earning account maintained in the name of the group. MRFC will have recourse to such funds in the event the group is unable to meet its debt service commitments in full. Thus, if the balance in a group's Reserve Fund account at MRFC could be maintained at 10 percent of total loans extended to the group as a whole, the 100 percent repayment requirement could be satisfied by transferring from the groups' Reserve Fund account the necessary amount to meet the loan repayment shortfall even if the repayment by members was only 90 percent. If the groups so desire, they could, at the end of every season, withdraw from their Reserve Fund account the amount in excess of the 10 percent backup required for the following season's borrowing. The 10 percent reserve buildup could be achieved in one of many convenient ways, for example: Every member of the group could be compelled to contribute a small amount on a regular basis - weekly or monthly, and any interest earned on the balance with MRFC, as well as savings surpluses unlikely to be required in the future could be utilized for a common venture benefiting the whole group;  - 29 - * Every borrowing member of the group is required to pay in 10 percent of the sum borrowed at any particular time, and such sum left in deposit with MRFC as reserve; * MRFC withholding and crediting 10 percent of the loan granted to a borrower member of the group into the group's Reserve Fund account; and * Groups having savings schemes as part of their normal activity could deposit such savings with MRFC, which in turn would offer loans to group members up to 10 times the amount of such savings left in the Reserve Fund account. 5.8 Such arrangements would help instill a financial discipline on the part of individual members as well as of the group as an entity. MRFC, as the lending institution, would be more forthcoming in providing loans to such disciplined groups, even without adequate conventional forms of collateral. The group members would be assured of continuity in obtaining credit, even if one or more members were unable to meet their immediate debt service commitment, since the group as a whole would not be in default on repayments. These arrangements would, however, require some additional record keeping on the part of MRFC. But the benefits of operating such self-financing reserve funds, the cost of which is borne entirely by the borrowing beneficiaries, would be very significant in terms of access, outreach, minimization of loan losses, and improvement in self-discipline, peer monitoring, and loan portfolio performance. The operation of reserve funds with contributions from individual members could also become the forerunner of a more significant rural savings movement to make the groups become financially self-sustaining. At negotiations, agreement was reached that the 100 percent recovery policy would be systematically enforced and each participating group would be required to have a reserve fund jointly held with MRFC of at least 10 percent of its outstanding loans [para 7.1 (vii)]. C. Subloan Processing and Administration 5.9 Subloan processing under the Project would be administered by MRFC. Subprojects and loan applications would be prepared by the beneficiaries and presented to MRFC. MRFC would review such applications in accordance with loan appraisal and internal operating procedures acceptable to IDA. The appraisal policies and lending procedures of SACA were reviewed by IDA appraisal mission and found to be acceptable. MRFC would periodically present its appraisal and loan documentation relating to each subproject to RBM for refinancing. The subproject appraisal report would be presented in a standard form and cover all relevant information about the enterprise and the proposed investment based on a check-list acceptable to IDA. MRFC would have primary responsibility for the subloan appraisal and would bear the lending risk. At least the first three subprojects from MRFC would be submitted to IDA for prior review and approval. Assuming satisfactory standards are achieved, IDA would, thereafter, review a sample of subprojects on an ex post basis from time to time. Agreement to this effect was reached at negotiation [para 7. 1(viii)]. 5.10 RBM would be responsible for disbursement of funds to MRFC. MRFC would be responsible for preparing its own disbursement applications for presentation to RBM, which would then check the applications for accuracy and completeness along with subproject appraisal documentation (para 5. 11) before disbursing the funds. RBM would be responsible for preparing and submitting requests to IDA for replenishment of the relevant Special  - 30 - Account. However, for MRFC to maintain its eligibility to drawn down on the line of creclit component, it should maintain a loan recovery rate of at least 90 percent or have an action plan for increasing loan recovery to 90 percent that is acceptable to IDA. Assurances were obtained at negotiations that MRFC would maintain a loan recovery rate of at least 90 percent [para 7.1(ix)]. 5.11 MRFC would prepare subloan processing and administration guidelines by September 30, 1993 for monitoring of subprojects financed by it and for maintaining adequate records. It would submit periodic progress reports, in a standard format. These records would be made available to IDA supervision missions for review. The preparation of subloan processing and administration guidelines acceptable to IDA is a condition of disbursement on the line of credit component [para 7.3(iv)]. D. Lending Terms and Conditions 5.12 The proposed IDA Credit would be made to the Republic of Malawi on standard IDIA terms. The Borrower would pass on US$17.0 million equivalent of the IDA Credit to RBNM at the Reference Rate determined by RBM for onlending in local currency through RBM to MRFC. MRFC would onlend the local currency funds with maturities of up to five years, including a maximum grace period of up to a year. The funds allocated for the institution building component (US$8.0 million) would be passed on by the Government to MRFC as equity contribution. The Technical Assistance would be managed by MRFC. 5.13 Foreign Exchange Risk and Interest Rates. RBM would, onlend US$17.0 million equivalent of the IDA Credit to MRFC, which is repayable within 15 years with a five year grace period, at a predetermined Reference Rate that would be determined by RBM from time to time and reflect the average cost of term borrowings in the financial system. In the absence of a developed capital market in Malawi that could be used to determine the long- term cost of borrowing, the Reference Rate of interest would be set in the first year of project implementation as a simple average of all prevailing interest rates on long-term deposits at the commercial banks or RBM discount rate, whichever is higher. RBM would pass on to GOMd the interest received from MRFC, less a 0.5 percentage point fee to cover RBM's administrative cost. GOM would bear the foreign exchange risk out of the interest received from MRFC. MRFC would bear the full credit risk. The interest rates charged to final subborrowers would be set at the discretion of MRFC, based on its own assessment of the underlying lending risk. Both the onlending and final lending rates would be adjusted periodically in line with changes in market rates. Interest rates in Malawi are currently market determined and are positive in real terms. E. Monitoring, Evaluation (M&E) and Beneficiary Assessment 5.14 In respect to the line of credit component, the BDU would be responsible for M&E of MRFC's lending activities and would. (a) evaluate the impact of the loans on private sector participation in farm and non-farm activities; (b) assess recovery rates being achieved by MRFC; (c) identify constraints being faced by MRFC in loan delivery and recovery and suggest remedial actions; (d) identify constraints being faced by potential beneficiaries in gaining access to loans from MRFC; and (e) assess the extent to which MRFC is recycling the credit proceeds within the rural sector. Special emphasis would be given to assessing and monitoring the extent to which MRFC is able to reach the target groups, particularly womeni  - 31 - and the poorest segments of the rural population. The semi-annual progress reports of MRFC would be submitted to the BDU and would include the number, type, and amount of loans granted; the amount of loan disbursements; loan repayments from borrowers; and the amount of overdue loans and their aging. 5.15 The BDU would also monitor the physical and financial progress as well as the impact on its beneficiaries, production, and progress toward achievement of MRFC objectives. This would be done through the reporting system, and studies and surveys conducted by local consultants who could be employed on short-term contracts, totaling thirty months. Experience with monitoring and evaluation systems in previous projects in Malawi has not been satisfactory, largely because of inadequate capacity within the Government. Because of the limited M&E capacity within BDU of MRFC in the short-term, the M&E function would be carried out by consulting firms (mostly local). At negotiations, assurances were obtained that MRFC would employ short-term consultants, not later than December 31, 1993, to implement the project M&E system on a renewable contract basis [para 7.1 (x)]. 5.16 Beneficiary Assessment. Since BDU is a unit within MRFC, it could not be expected to conduct studies that go beyond commercial objectives of MRFC. Accordingly, the assessment of project impact on beneficiaries, including operation of the farmers clubs system as well as assessment of responsiveness of MRFC products and services to rural populations would not be adequately covered. Such assessments would, therefore, be conducted through annual sample surveys to be carried out by independent institutions (for example, a university and/or consultancy firm) reporting to RBM. Copies of the evaluation would be routinely given to RBM and made available to IDA. Assurances were obtained at negotiations that MRFC would routinely or at least once a year, send to IDA an evaluation of the impact of the Project on beneficiaries [para 7. 1(xi)]. F. Environmental Assessment 5.17 In close collaboration with IDA and other donors, GOM has begun activities leading to the preparation of a National Environmental Action Plan (NEAP). The NEAP is expected to include guidelines for environmental assessment of investment projects that will be followed under the RFSP. 5.18 Projects to be financed through the line of credit component would be properly evaluated by MRFC at its appraisal in accordance with the Department of Research and Environmental Affairs (DREA) guidelines to ensure that the investment projects would not have major adverse environmental effects. For subprojects that are likely to have adverse environmental effects, an environmental assessment would be carried out, and the subproject design would be modified to incorporate measures to minimize the impact. Subprojects with detrimental environmental effects that cannot be mitigated would not be eligible for financing under the Project. MRFC would submit their lending programs annually to the environmental assessment unit for review and comment. Assurances were obtained from MRFC that it would ensure that investments financed under the Project will not have environmentally unsustainable impact [para 7.1 (xii)].  - 32 - G. Auditing, Accounting, and Reporting Requirements 5.19 RBM would maintain accounts and records adequate to reflect the Project's operations and financial situation, in accordance with sound accounting principles. Separate accounts would be maintained for MRFC and all other entities receiving technical assistance support. Independent auditors acceptable to IDA would annually review: (a) project accounts kept by each implementing agency; (b) the Special Accounts; and (c) financial statements of MRFC, including a separate audit of SOEs; and for subprojects, a statement on compliance with eligibility criteria and subloan covenants. MRFC would have adequate capacity and competence to prepare detailed financial accounts adequate for extelmal auditing. RBM would be responsible for coordinating all audit reports of MRFC and submitting them to IDA no later than nine months after the end of each financial year. The shortage of trained and experienced accounting staff was identified as the major cause of delays in the preparation of financial statements and audits in most IDA-supported projects. In the 1991 Country Implementation Review, IDA and Government agreed to extend the time for submitting audit reports for IDA-supported Projects from six to nine months, while intensifying efforts to upgrade the skills of Project accounting staff. The Government, through the IDA-supported Institutions Development Project, has embarked on providing an intensive training program for accountants at Malawi Institute of Management. It is expected that in the next few years, the problem would be resolved and Government would revert to submitting audited accounts within six months. 5.20 On the basis of information gathered from MRFC, RBM would submit half-yearly and annual reports on progress, problems, and issues covering every Project component. RBM would be required to submit to IDA the half-yearly reports within two months of the six- month period, and the annual progress reports within three months after the end of each calendar year. MRFC would submit to the RBM each quarter a report showing (a) the status of the portfolio of subloans and investments financed with project funds, and (b) statement of financial and resource position. Prior to project start-up, MRFC would with the assistance of consultants, prepare a detailed procurement schedule based on the Project's implementation schedule, in accordance with IDA Procurement Guidelines for procuring IDA- financed goods and IDA Guidelines for Selection of Consultants. Procurement information would be collected and recorded as follows:' * prompt reporting of contract award information by MRFC; and * quarterly reports to IDA indicating revised cost estimates, compliance with aggregate limits on specified methods of procurement, and revised timing of procurement actions, including advertising, bidding, contract awards completion time for individual contracts. H. IDA Supervision 5.21 During appraisal, detailed discussions were held with potential implementing agencies to familiarize them with aspects of the Project. Nonetheless, the Project would require close IDA supervision during the initial three years. The first IDA mission would include a 'Project Launch' workshop to provide orientation and training for key staff in the implementing institutions on the project cycle, procurement and disbursement procedures, accounting and auditing requirements, progress reporting requirements, Special Account  I - 33 - operations, and so on. IDA's subsequent review missions would consist of an appropriate mix of skills for effective supervision of the various project components. GOM would organize semi-annual reviews in consultation with IDA to evaluate progress and status of project implementation and, if necessary, amend the Project to ensure that its development objectives would be achieved. The Ministry of Finance would be responsible for coordinating supervision of IDA missions, and RBM would be responsible for providing information required by the missions. All project beneficiaries would be required to supply information and reports as specified by RBM. For all such IDA missions, the Government would be responsible for providing counterpart staff to participate in the missions' review work. A detailed supervision plan is contained in annex 5 and the key project performance indicators are contained in annex 7. The supervision arrangements, including the semi-annual reviews were agreed at negotiations [para 7. 1(xiii)]. 5.22 Mid-term Review. A mid-term review will be carried out by IDA and the Government by November 1995 which is the end of the second year of project implementation and Government would undertake to implement its findings. The review will cover all project aspects, particularly the progress made in implementing the action plan for privatizing and transforming MRFC into a private rural bank. The findings of the review would serve as basis for the preparation of the second phase of the Project. To prepare for the review, the BDU assisted by short-term consultants, will prepare a detailed progress report covering the entire period from project commencement, and include a thorough analysis of implementation issues. This review will also highlight the progress made in achieving the key project performance indicators in annex 7. The mid-term review arrangements were agreed at negotiations [para 7.1(xiii)]. VI. PROJECT BENEFITS AND RISKS 6.1 Project Benefits. The Project would support additional new investments by improving the availability and accessibility of financial services to rural households for viable farm and non-farm activities. The number of households that would benefit from the Project would be expanded from 330,000 currently served by SACA (see para 3.8) to more than 500,000 rural households (an additional 170,000 households or 52 percent). The Project would, therefore, strengthen and expand the production base of the rural sector, increase employment and household incomes. This would result in reducing rural poverty while enhancing and accelerating the economic development of rural areas of Malawi. In financing smallholder agriculture and by releasing extension staff from credit work to undertake genuine extension work, the Project would support measures necessary to obtain the required production response from agriculture that would help in increasing Malawi's export earnings, enhancing food security and nutritional intake, and improving rural incomes and living standards. 6.2 The Project would fill major gaps in working capital and term-financing for MSMEs in rural Malawi. It would help strengthen the institutional capability of MRFC to promote, appraise, and supervise viable subprojects in the rural sector. The Project would also enhance efficiency in terms of resource mobilization and allocation by increasing competition in the financial system and introducing a wide range of financial instruments better suited to the rural clients. The improved access to financial services by MSMEs and women entrepreneurs operating in rural areas would improve real sector supply response and contribute significantly to the Government's growth and adjustment strategy. The support for rural entrepreneurs  - 34 - would also generate higher levels of employment. The effective monitoring of the Action Plan aimed at increasing the outreach to women would reduce one of the major constraints faced by them. 6.3 Project Risks. There is every reason to believe that the proposed Project would produce significant gains in terms of increased production response from farm and non-farm enterprises if implemented as designed. There might, however, be some risks that could affect project implementation. One of the risks could be delayed implementation, particularly the management of MRFC as an autonomous limited liability company with complete freedom to operate on commercial basis. This aspect has been given very careful consideration in Project design and in upfront actions taken to guard against such risk and through assurances obtained from GOM. 6.4 Another risk could be that the profitability of agricultural production might decline, resulting in an increase in loan defaults and/or insufficient demand for farm inputs to ensure profitable rural lending. The gradual elimination of fertilizer subsidies, the 20 percent annuad increase in the price of fertilizer, and high inland transportation costs would also increase the volume of credit requirements. Unless the increase in credit is accompanied by high loan recovery performance, the viability and sustainability of MRFC would be undermined. Such risk would be reduced by adopting productivity enhancing technologies which would increase producer's returns and their ability to repay their loans and by effective loan recovery measures. Improved maize varieties that have the potential to double average yields have been recently developed and are ready for wide distribution. Furthermore, the agricultural research system is being improved with IDA assistance and this would result in sustainable introduction of productivity and income enhancing technologies. 6.5 There could also be risks of possible economic slowdown, delays in progress toward Government's liberalization of input supply marketing, or in the pace of implementing the financial reforms as agreed under the Financial Sector and Enterprises Development Project, which could discourage or delay new investments. Malawi has in the past achieved high rates of growth, primarily through a steady expansion in agriculture, and the Government's continued commitment to implementing the reform program would minimize these risks. The prospects, therefore, are strong that the proposed Project would achieve its objectives. VII. AGREEMENTS, CONDITIONS, AND RECOMMENDATION A. Assurances Obtained at Negotiations 7.1 At negotiations, assurances were obtained on the following: (i) MRFC would have freedom to select the entities that it lends to within its mandate and as specified in its onlending agreement (para 4.11); (ii) IDA funds for short-term credit would be relent by MRFC at market determined interest rates in the form of medium- and long-term loans as well as short-term credit (para 4.13); (iii) MRFC would submit to IDA for review and comment its first year's lending rates before they are ratified by MRFC's Board (para 4.19)  - 35 - (iv) MRFC would adopt an action plan by June 30, 1994 acceptable to IDA for supporting women entrepreneurs (para 4.21); (v) Government and MRFC would expeditiously implement the action plan for transforming MRFC into a rural bank (para 5.2); (vi) BDU would submit its annual work program to IDA for review and comment before it is finalized (para 5.4) (vii) MRFC would enforce the 100 percent recovery policy for farmers clubs and would require each participating farmers club to have a reserve fund of at least 10 percent of its outstanding loan (para 5.8); (viii) MRFC would submit to IDA for prior review its first three subloan document (para 5.9); (ix) MRFC would maintain a loan recovery rate of at least 90 percent (para 5.10); (x) MRFC would implement the M&E system with the assistance of consultants (para 5.15); (xi) MRFC would send to IDA at least once a year an assessment of the impact of the project on the beneficiaries (para 5.16); (xii) GOM would ensure that investments financed under the Project would not have negative environmental impacts (para 5.18); and (xiii) GOM would adopt arrangements for project supervision and mid-term reviews acceptable to IDA (paras 5.21 and 5.22). B. Conditions of Effectiveness 7.2 Conditions of effectiveness are as follows: (i) Appointment of MRFC's General Manager and Financial Controller with qualifications satisfactory to the Bank (para 4.8); and (ii) A receipt by IDA of satisfactory subsidiary agreement between the RBM and MRFC (para 4.15). C. Conditions of IDA Disbursement 7.3 Conditions of disbursement on the line of credit component are as follows: (i) The transfer of the activities, assets and liabilities of SACA from GOM to MRFC (para 4.7); (ii) The finalization of MRFC's organizational structure satisfactory to IDA (para 5.2);  - 36 - (iii) The preparation and adoption by MRFC of a manual of operating policy, guidelines and implementation procedures acceptable to IDA (para 5.5); and (iv) The establishment by MRFC of guidelines for credit processing and administration acceptable to IDA (para 5. 11). D. Recommendation 7.4 Under these assurances, and conditions, the proposed Project is suitable for IDA Credit of SDR 18.0 million (US$25.0 million equivalent) to the Government of Malawi on standard IDA terms, with 40 years maturity.  -37 - ANNEXC 1 Page 1 of 4 MALAWI RURAL FINANCIAL SERVICES PROJECT Interest Rates Structure 1985 1986 1987 1988 1989 1990 1991 1992 1992 1992 April 1 JUC I June 25 Rearvc Back of Malawi Bank raw (- Diacointratc) 11.00 11.00 14.00 11.00 11.00 14.00 13.00 14.00 15.00 20.00 Teauuy bill (91 days) rate 12.31 12.75 14.25 15.75 15.75 15.75 11.50 12.50 12.50 12.50 Commercal Banka Lending rt 11 Mbiimum (=primne lding rae) 16.00 16.00 - 16.00 16.00 15.00 14.00 15.00 16.00 21.00 Maximum 19.00 19.00 - 23.00 23.00 20.00 - - - - Deposits ral Savings 10.75 10.75 13.75 10.75 10.75 14.00 13.00 14.00 15.00 20.00 Shor.tum eail depoaits 2I 7.day notice of withdawal 4.00 3.00 4.00 5.00 10.00 30daynotice of witdrawal 11.50 11.50 14.50 8.75 8.75 7.00 6.00 7.00 8.00 13.00 rime depaift 3 montha 12.75 12.75 15.75 12.75 12.75 13.75 12.25 13.25 14.25 19.25 6 montha - - - - - - 12.50 13.50 14.50 19.50 12 mondia (up to MK 250.000) 14.25 14.25 17.25 13.25 13.25 13.25 12.25 13.75 14.75 19.75 12 monha (over MI 250,000) 15.00 20.00 24 mondh (up to MJK 500,000) 15.25 18.00 24 moodt (over M 500.000) - - - - - - 13.25 14.25 15.50 18.00 Other Fuanciial Iiution Poat Offikc Savmgs Bank Depoaia 10.75 10.75 13.75 10.75 10.75 10.75 10.75 10.75 10.75 10.75 New Building Society Fixed depoait 6-11 months 12.25 13.25 16.25 13.25 13.25 13.25 13.25 13.50 13.50 19.50 over 35 montba 15.75 15.75 15.75 - - - - 14.50 14.50 18.00 Savinga deposits 10.75 10.75 13.75 10.75 10.75 9.75 9.75' 12.25 12.25 17.00 lnvesuatdepoait 12.75 12.75 15.75 12.25 12.25 13.20 13.20 13.00 13.00 17.50 Minimum mortgce rawe 1/ 13.75 13.75 - 13.75 12.75 12.75 12.75 12.75 12.75 12.75 Invccat ad DvelopmntBzank Shotet-tam cra depoait 24-hournotice of withdrawal 31 - 4.50 5.50 7.50 7-day notice of withdrmwal4/ 4.00 5.00 6.00 11.00 Time dqepitb 30 days 7.50 7.50 8.50 13.50 3 moatha 12.75 13.50 14.50 19.50 6 months 13.00 14.50 15.00 19.75 12 montba 13.50 14.50 15.50 20.00 1/ Effective July 23, 1987, these rates were deregulated and set independently by the commercial banks. 2/ Amount restricted between MK 10,000 - MK 1,000,000. aI Minimum MK 250,000. 4/ Applicable for amounts between MK10,000 - MKS00,000. For large amounts the rates are 0.25 - 1.00 percent higher.  ANNEXr- 1 -38- Page 2 of 4 1985 1986 1987 1988 1989 1990 1991 1992 1992 1992 April 1 J I June25 Leming ad Fiane Co. Iat- rate 23.00 29.00 26.00 24.96 23.86 - 25.00 Tme deposits 3 months 12.75 15.75 - 13.25 13.50 13.50 14.75 6 months 13.25 16.25 14.00 13.75 14.00 14.00 15.25 12 months 14.25 17.25 15.50 14.25 14.50 15.00 16.25 18 mnS 15.00 17.25 16.50 14.75 14.75 15.50 17.00 24 mouths 15.50 18.25 16.50 14.75 15.00 16.25 17.75 30months - - - - - 17.25 18.00 36 months 16.50 18.25 17.00 15.25 16.00 18.25 18.25 48 months 16.75 19.25 18.50 15.75 16.50 18.50 18.50 60 months 17.00 19.50 19.00 16.25 17.00 19.00 19.00 Fianc Corporazc Tme deposits 3 -onth - - 13.50 6 month 14.00 - 14.25 9 mouths 14.25 - 14.50 12 months 15.25 - 15.25 18 monts 15.75 - 15.75 24 months 16.50 - 16.50 Natonal Mercantil Credit Short.term call deposit 30.day noticr of withdawal 8.75 rime depositB 3 months 13.00 6 months 14.00 12 nths 15.00 24 nood 16.00 36months 18.00 Ltcal registered stock _/ 15.00 16.75 19.75 19.75 19.75 15.50 15.50 15.50 15.50 Sources: Rcesrve Bsak of Malawi Fmnncial and Economic Review; data provided by the Maawi authorities; and staff estimates. S/ Maximum available nominal rate on stock with five years or more to redemption.  - 39 -AX Page 3 of 4 Malawi: Detailed Balance of Payrents ss2 15 1466 267 1go 59s 199 19 1991 1992 2992 1992 EaL Act. Pr4. m Pj. '- m22of SDR* Cw_d _mmt -1154 -92 -4.2 46.6 -m1 -165. -116.7 -172.6 -169.7 -268.0 -26.0 Tiob o_ -593 -36.2 -72 -9.9 -51.5 -100.6 -46 -104.1 -101.3 -213.2 -2132 Et_. M 217.1 246.1 211.7 215.4 218.4 29.7 3291 3593 347.5 353.6 353.6 _df6m. dflI -276.9 -212 -289 -2153 -269.8 -3103 -35632 463A4 4-U -566.9 -5669 _m,inI. si -1799 -103 -1314 -135.1 -1673 -1924 -230.9 -27n.9 -270.3 -297.1 -297.1 cif j -97.1 -113.1 -7.6 -90.1 -102 -117.9 -135.4 -14.5 -178.5 -269.7 -269.7 _ -ISA -59A0 -MsA -36.7 -3.7 -5.2 -713 .5.4 -4.4 .54.7 -54.7 Newfi.s_r -1032 -17.2 -14.3 -7.9 -93 -93 4.2 -7.4 -7.4 0.3 0.3 R-o- a21.2 26.0 19.5 17.5 21.1 23.3 263 31.1 31.1 33.1 33.1 _ a -31.4 -43.1 -338 -25.5 -3.4 -33.1 -34.5 -3s.5 .333 -32. -323 FPc m -3.6 -521 -51.7 44.0 4M1 -3.9 -42.1 -412 -41.2 -36.1 -36.1 1.4 54 IS ,2.5 7.1 8.2 6.9 52 52 4.9 4.9. PAY- -45A0 -57.3 -54.5 -45 -47.2 -47.1 -48.9 46.4 46.4 -41.0 -41.0 _ -385 -44.1 -45.7 -39.9 -387 -38.2 -333 -30.2 -302 -254 -25.4 Oet -I9. -133 -8 -7.5 4-85 -49 -15.6 -16.2 -162 -254 -U1 t 12 10.3 U3. 15.2 10.3 -16.5 -310 -19Y3 -193 -89 -11.9 23.7 2.12 21a 26 21.9 123 1.7 4.2 4.2 4.1 4.1 Pqi- -IDA -10.9 4.6 -113 -112 -2,3S -21.7 -24.0 -246 -23. -23A C4 _W 67.1 49.5 63 906 5L2S USA 127.6 175.4 1724 25. 25.0 Liu - mi 373 419 s .sJ 76.6 117 102.9 13.3 16L3 1663 2678 267.8 o-f bmE 329 24.1 24.5 232 532 S1 ss94 D53 53.S 12.0 250 CAN* 33S 26. 26. 35.5 25 2 .60D C2. 50 55.9 19 S.S 14.s Of.-" SAE,I6 - - 93 6.4 443 14.0 22A 20.1 20.1 44.9 44.9 D- -0.49 -13 -2. -2.2 -1 -1.9 -22 -2.4 -2.4 -2.5 -2.5 Gy-amme Inds 2D13 274 4.5 4s. 3SJ 2354 53.6 6D.9 6D 669 66.9 -^mJ 6 2D 691. 0 6 D62 SbJ 71.0 D,46 19.9 9.9 97.0 97.0 Of U&6dr SAL Iml aS_innif IS.1 7.7 43.9 4.8 30.4 3L6 543 31.9 319 363 363 *b 2 -.42 -34A -49.1 -37.2 4 -45.6 -29.9 -299 -279 -32L1 -30.1 -184 -15.2 -93 34 87 10.9 19.1 46.4 46.4 444 444 Cm& 31 11.9 7. 02 9.0 23.9 152 24.0 516 516 49.7 49.7 Bell -2L2 -222 -95 -5.4 -5.1 -43 -4.9 -53 -53 -5.1 -5.1 _kf.-- amw 3. 54 3.9 0.7 2.1 U 5I 4 4.4 4.3 43 C yi 11.0 9.9 1.6 4J 5A 12.2 10.7 9.1 9.1 Ls La D-- 4S. -4.2 -74 -4l -3.7 -3.7 -5D -4.7 .7 -4s5 45 udddrd 41 293 74 -68.5 14.1 35D 32.1 487 11.1 83 02 02 Owml libIm -43 -45.7 -67 44.0 D 2. -303S 2.9 2.9 2.9 - -  KALMACRO 30-Nov-92 ANNEX - 1 Malawi: Macroeconomic Data Page 4 of 4 Table 0. 3asic Data and Inpits from Other FiLes 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 Population (thousands) 6290.0 6500.0 6721.0 6951.0 7188.0 7433.0 7695.0 7958.0 8231.0 8504.0 8806.2 Growth rate 3.3 3.3 3.4 3.4 3.4 3.4 3.5 3.4 3.4 3.3 3.6 National income tMK miLlion) 1/ --------------- (from MALGDP) GOP at current market prices 1108.1 1245.6 1437.0 1707.4 1944.9 2197.6 2614.0 3417.9 4388.2 5069.9 6144.3 GOP at constant 1978 market prices 794.9 814.9 845.0 890.4 931.1 929.1 944.2 974.2 1022.8 1068.8 1142.4 GDP at constant 1978 factor cost 724.3 745.1 771.2 805.5 841.4 850.6 869.7 898.3 934.8 979.4 1055.8 Agriculture 260.9 277.6 289.9 306.5 308.0 309.9 312.5 318.8 326.6 :325.8 367.5 Manufacturing 92.0 '91.7 98.2 100.6 103.8 106.1 107.1 110.6 120.0 133.5 137.5 Goverrment 83.3 87.9 92.2 101.7 108.2 118.0 134.5 142.6 143.3 145.3 149.8 Other 288.1 287.9 290.9 296.7 321.4 316.6 315.6 326.3 344.9 374.8 401.0 (At current market prices:) Gross domestic expenditure 1172.3 1324.7 1545.9 1674.2 2055.9 2244.7 2675.6 3743.8 5078.8 5'74.1 6890.2 Gross fixed capital formation 167.8 181.7 197.3 222.7 259.5 264.1 352.9 524.0 699.6 820.0 1030.0 Public 113.2 105.1 119.8 166.7 161.0 202.0 202.8 278.8 320.7 420.0 510.0 Goverrinent 78.0 85.9 103.8 114.1 131.8 171.1 151.1 192.9 228.8 270.0 310.0 Statutory bodies 35.2 19.2 16.0 52.6 29.2 30.9 51.7 85.9 91.9 '150.0 200.0 Private 54.6 76.6 77.5 56.0 98.5 40.9 130.1 245.2 378.9 400.0 520.0 Consusmtion 977.0 1058.1 1218.3 1454.3 1694.3 1975.3 2273.5 3103.3 4190.2 4604.1 5660.2 Private 779.0 839.8 982.4 1186.3 1350.3 1541.5 1774.3 2548.0 3473.4 3831.2 4807.8 Goverrnent and s.tatutory bodies 198.0 218.3 235.9 268.0 344.0 433.8 499.2 555.3 716.8 772.9 852.4 Stock building 27.5 84.9 130.3 -2.8 102.1 5.3 49.2 116.5 189.0 1I50.0 200.0 lports of goods and MFS -348.6 -359.3 -407.1 -451.2 -581.5 -551.8 -726.7 -1150.2 -1514.7 -1715.3 -2183.1 Exports of goods and NFS 284.4 280.2 298.2 484.4 470.5 504.7 665.1 824.3 824.1 1211.1 1437.2 Memo items: (derived from above data) Nominal GDP (mkt pr) in FY basis 1142.5 1293.5 1504.6 1766.8 2008.1 2301.7 2815.0 3660.5 4558.6 5'38.5 6319.9 Per capita real GOP (factor cost) 115.2 114.6 114.7 115.9 117.1 114.4 113.0 112.9 113.6 115.2 119.9 GOP deflator 139.4 152.9 170.1 191.8 208.9 236.5 276.8 350.8 429.0 474.4 537.8 Real GDP at 1985 prices (from IFS) 1674.5 1721.8 1782.6 1861.9 1944.9 1966.2 2010.3 2076.4 2160.8 2263.9 ReaL GDP at 1985 prices (derived) 1832.4 1736.3 1780.0 1845.7 1944.9 1940.7 1972.3 2034.9 2136.4 2232.5 2386.3 CPI (index, 1980=100) (from MALPRICE) 110.4 120.1 136.2 151.2 173.8 199.5 252.9 332.2 384.4 428.5 479.4 Effective exchange rate (1980=100) (from MALRATE) Nominal 102.7 100.3 97.5 93.8 89.7 74.0 55.8 47.4 48.6 47.6 48.7 Real 101.7 99.3 101.2 102.4 104.1 91.6 82.8 86.4 92.7 91.9 96.0 Fiscal data (MK million) 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 1988/89 1989/90 19590/91 1991/92 ------------- (from MALFIS) ------- ------- ------- ------- ------- ------- ------- ------- ------- ---:--- ------- Total revenue and grants 263.1 286.1 319.7 393.8 486.8 572.2 659.4 987.6 1204.1 1156.6 1371.3 Revenue 220.9 244.4 286.0 353.3 442.0 492.9 583.4 778.5 994.3 10C43.9 1163.3 Tax 373.5 391.1 450.1 653.7 844.5 888.7 1030.5 Montax 68.5 101.8 133.2 124.8 149.7 155.2 132.8 Grants 42.2 41.7 33.7 40.5 44.8 79.3 76.0 209.1 209.9 112.7 208.0  ANNEX - 2 - 41- Page 1 of 9 MALAWI RURAL FINANCIAL SERVICES PROJECT Malawi Rural Finance Company Operations 1. Legal Status. The proposed Malawi Rural Finance Company (MRFC) would be established as a limited liability company. It would comply with the Business Name Registration Act of 1922, the Companies Act of 1984, and the Capital Market Development Act of 1990. 2. Capital Structure. In deciding the capital structure of the company, the following factors would be borne in mind: (a) Capital adequacy for the anticipated level of operations; (b) The amount of the assets and liabilities of SACA to be taken over as of September 30, 1993; (c) Need to maintain healthy debt/equity ratios, liquidity, and other requirements necessary for efficient operation; (d) The need to function as a truly independent commercial company without any appearance of being controlled by the government in order to attract investment from the public and private sector entities including the two commercial banks; (e) The need to attract small investors (e.g., smallholders) by having a class of shares which provides a fixed rate of dividends. A portion of such shares would remain unissued to be issued at later dates or issued to the government with an agreement that they will be sold when the members of the public wish to buy them; and (f) Since the net value of the assets and liabilities of SACA taken over by MRFC will be due to GOM, a determination as to how such debt will be satisfied -- how much as equity and how much as an interest bearing loan. 3. The proposed capital structure is: Authorized Capital: (a) 1.0 million ordinary shares of MK1O each (MKIO million); and (b) 7.5 million redeemable, non-cumulative 12% preference shares of MK1O each (MK75 million).  ANNEX - 2 -42 - Page 2 of 9 Capital to be Issued: (a) 500,000 ordinary shares with voting rights - K5 million; and (b) 7.5 million redeemable non-cumulative 12% preference shares - K75 million. Initially, each of the promoters who should not be less than three, should be issued at least a small number of ordinary shares before the Prospectus is filed. Subsequently, the rest of the shares will be issued, with as many as possible to private sector entities and the public, and balance to GOM bearing in mind that GOM would not have more than 20% of the voting rights. This may be accomplished by issuing non-voting redeemable preference shares. 4. Proposed Organizational Structure and Staffing. It is envisaged that, at inception, MRFC would consist of a head office located in Lilongwe, six branch offices compressed from existing eight ADDs, and about 25 satellite offices (or 'Agencies') which would serve as operational centers for the credit assistants (CA) in the field. MRFC would have a staff of not more than 450 in the initial years. The staff would be drawn mainly from the pool of SACA staff after careful evaluation of each staff member. Those staff considered not suitable to work for MRFC would revert to MOA. 5. The number of positions for the core staff of branch offices would be almost identical and only minor deviations are anticipated. Each branch would be based on the actual and projected volume of operations, the number of borrowers and loan accounts and the total annual loan disbursements. However, the required staffing positions for credit supervisors (at the agency level) and for credit assistants would be determined on the basis of about 60 loans to smallholder groups/clubs to be serviced by one CA; three to four loans to individual borrowers would be considered to be equivalent to one borrowing club and one credit supervisor would be in charge of about eight credit assistants. It should, however, be recognized that when establishing staffing norms for field credit staff, no hard and fast rules can be uniformly applied throughout the country and actual staffing levels and requirements, within limits, will depend on the specific conditions prevailing in the different regions and areas, such as road infrastructure, topography, distances and radius of operation of the CA and CS and other related considerations. 6. Branch Staffing. Core staff of a branch, excluding the credit supervisors at the agency level and the credit assistants in the field, would comprise the following: (a) The Branch Manager, two assistant managers - one in charge of lending operations and the other filling the position of Chief Financial Officer - who would be in charge of fund management, mobilization of deposits, accounting computerization, reporting and management information systems (MIS). (b) One administrative officer, with one clerical assistant, to handle general administration, personnel matters and coordinate training activities, as planned and prepared by the head office.  ANNEX - 2 - 43 - Page 3 of 9 (c) One Section Chief - in charge of seasonal credit to smallholders, with one or more assistants in the branch office, depending on the number of borrowers and loan accounts; the Credit Supervisors and Credit Assistants would report to the Assistant Branch Manager (Lending Operations) through this Section Chief; (d) One Unit Chief - in charge of all lending operations other than seasonal credit for smallholders. These would include loans to owners of small estates for working capital and investments, medium-term loans for investments to traditional SACA borrowers, either as individual borrowers or groups, and loans to new clients in the rural area engaged in non-farm activities: traders, artisans, small entrepreneurs, etc. The Unit Chief would be assisted, initially, by one senior loan officer for loan appraisal and processing, including preparation of loan agreements and deciding on collateral and guarantees. After loan disbursements, supervision and loan servicing would, generally, be carried out by the CS and CA in the field; (e) One chief branch accountant, assisted by one senior and one junior accountant; (f) One Unit chief/programmer in charge of electronic data processing (EDP), assisted by 2 to 3 data entry operators; (g) Two typists/secretaries; (h) 2 to 3 drivers, 3 watchmen and one messenger, and two reserve staff positions to be allocated, according to requirements. 7. According to the above proposal, the core staff of a branch office when in full operation would number about 27, plus the credit supervisors and credit assistants whose number would be determined on the basis of the number of loan accounts, as explained above. It is envisaged that operations would be fully decentralized, lending decisions would be taken at the branch level, based on policies and procedures established by MRFC Board of Directors and management. It is also envisaged that loan accounts and all other accounting operations would be fully computerized, including payments to suppliers of inputs financed by seasonal credits, and budgetary control. The EDP unit at the branch would produce the financial statements (the branch being a profit center), as well as reports and management information which would be transferred on diskettes to the head office for consolidation into MRFC accounts and management information. CAs in the field, under supervision and guidance of CS, would prepare the necessary loan and other documentation for processing by the branch EDP unit but would not be required to prepare periodic reports manually, as is the present practice of SACA/ADD/RDP. The EDP unit would supply to field staff printouts containing the information necessary for loan servicing. 8. Head Office Staff. Total staffing positions at the head office would be about 30, structured in a manner similar to the proposed branch structure and, in addition, have an internal audit unit with a staff of six. However, head office staff would not be involved in  -44 --2ANNEX-2 Page 4 of 9 operations, except those related to overall fund management. The head office is expected to be the "think tank" of MRFC, establishing programs, policies and procedures required for MRFC to achieve its objectives in an efficient and cost effective manner, and generating innovative approaches to resource mobilization, lending operations, guarantee schemes, etc., which could be tested as pilot programs or through other means. Such requirements and qualifications should be kept in mind when selecting the candidates to fill the key staff positions in the head office of MRFC. 9. The proposed structure of the head office would be as follows: (a) General Manager; (b) Deputy General Manager/Chief Financial Controller in charge of financial planning and budgeting, funds management, accounting and management information; (c) Deputy General Manager in charge of Lending Operations; (d) Manager - Personnel and General Administration, and Company Secretary; MRFC's top management team or 'Executive Committee' would consist of the four officials listed above, or their alternates. (e) Two Assistant Managers (Lending Operations); one will be in charge of seasonal credit (the present SACA operations) and the second will direct all other credit operations, including loans to individuals, loans for farm and non- farm investments, working capital for small agricultural estates, etc. The Lending Operations Management Team will comprise the deputy general manager - lending operations and the two assistant managers listed in (e) above. This team will be in charge of preparation of lending programs, lending systems and procedures including preparation and periodic updating cf lending manuals, instructions and guidelines, overall portfolio management, and preparation of training activities for lending staff. (f) Assisting the Personnel and Administration Manager (see (d) above) will be one Assistant Manager for personnel matters, one Assistant Manager for general administration, and one Training Coordinator who will deal with training of MRFC's bank staff as well as farmers' club officials and clients. (g) The Deputy General Manager - Finance {see (b) above) will be assisted by one Manager and management of liquid funds, one Chief Accountant and one Planning and Budgeting Officer. MRFC's Finance Committee will comprise these four officers. (h) In addition to the above key positions, there will be possibly three positions for secretaries/typists, three for accountants and data processors, and four for  45.- ANNEX - 2 Page 5 of 9 general clerical assistants; and drivers, watchmen and messengers, as necessary. (i) Internal Audit. MRFC will have an internal audit unit, consisting of a senior internal auditor and one secretary/typist at the head office, managing and supervising the activities of the two audit teams. Each of the two teams would be stationed in one of the branches - one in the Northern region and one in the Southern region to be responsible for the internal audit of three branches and their respective agencies and field staff. 10. Training of Staff. During the period of organization prior to start-up and the first two years of MRFC operations, all staff training activities would be entirely job-oriented. With regard to the training of credit assistants (CA) which will be the largest category of MRFC staff, most of the training and guidance would be on-the-job, and carried out by credit supervisors and, occasionally, also by their managers. CAs will operate as individuals and would have the possibility of consulting with other staff in an organized office; periodic and brief training seminars would attempt to convey some of the basic skills necessary for their jobs and the continuing guidance provided by credit supervisors would be indispensable for ensuring that each step of operations is carried out in the proper and timely manner. Training of trainers would, therefore, focus on credit supervisors and their managers in the branch offices. All training activities would be organized in such manner that they closely precede the different operations taken on by MRFC and the distinct activities in each such operation. A training manual would be prepared by the management team. 11. Management. All powers would be vested in the Board of Directors as representatives of shareholders. The Board would delegate the responsibility for the day-to- day operations to the General Manager and his Management Team. Initially, the Management Team would be responsible for setting up the company's organization, and its branch and agency network and selecting locations; setting up operating systems and procedures; implementing action programs for taking over of SACA's activities, assets and liabilities; establishing operational guidelines for the staff, including eligibility criteria of beneficiaries, collateral specifications, repayment schedules, interest rate structure, loan appraisal and supervision procedures; overall fund and portfolio management; supervising company's activities through MRFC's Manager, Internal Audit, and his team; ensuring that MRFC is managed efficiently and profitably; preparing business plans, budgets and forecasts, reviewing actual results and taking remedial action; identifying operational weaknesses and taking remedial steps to correct them; reviewing and updating policy and procedures for improving its performance; ensuring that the staff receive adequate training. Branch managers will head the branch offices and report to the General Manager. There will be a functional relationship between operating managers at the head office and the field. Credit Supervisors working from agencies would supervise the Credit Assistants and report to the branch office. Credit Assistants would prepare the necessary loan and other documentation for processing by the branch offices. Initially, agencies will be used for collecting applications for loans, loan repayment collections and deposit and savings mobilization. Gradually, they may engage in disbursing savings withdrawals at which time one or two staff may be recruited as necessary.  ANNEX -2 -46- Page6of9 12. Manuals of MRFC's Operations. The Management Team would prepare a MRFC's Policy and Procedures Manual which would outline in broader terms the policy and operating procedures of the company. It would cover operational guidelines for lending programs separately for seasonal loans, working capital loans, and medium term loans. The guidelines would include eligibility criteria of borrowers, both individuals and groups; estimating input and credit requirements; formulation of credit packages; application, collateral and guarantee systems; processing and appraisals; approvals, authority, responsibility and accountability; disbursements of inputs for seasonal loans and disbursements for working capital and medium term loans; interest rate structures and basis for changes; recording and accounting; credit recovery; handling of money; remittances to branches and head office and recording thereof; procedures for reporting, recording and reconciliation of balances; scheduling of repayments for non-seasonal loans and early repayment rebates; supervision and monitoring the implementation of lending programs, financial performances of individuals and branches; outstanding balances, surcharges; policy for provision for bad and doubtful debts and write offs; moratorium policy; performances related compensation for collection of uncollectible debts; legal action against defaulters; foreclosure and repossession policies; environmental safeguards; innovative action programs to increase access to institutional credit for smallholders, women, fisheries, small estates and micro, small and medium industries; training to clubs in club organization and bookkeeping which may be considered to be expenses of a promotional nature to improve the bank's business; promotion of checking, savings and time deposits for individuals, clubs and credit groups, both voluntary and compulsory. 13. MRFC would also prepare Accounting and Management Information System Manual, the Personnel Policy Manual, and Internal Audit Manual. These manuals would address MRFC's needs on the flow of information; policies and personnel, recruitment, compensation, working conditions, etc.; and guidelines and audit programs for the internal audit staff. 14. MRFC's Market Niche. The main market niche would be smallholder farmers (through farmers clubs), small estates with farm sizes of up to 30ha, and micro-small and medium-scale enterprises (MSMEs) with business turnover of up to MK500,000, in the rural sector. MRFC will provide full range of banking services to these clientele, including savings deposits and lending for farm and non-farm activities. 15. Lending. MRFC will finance farm and non-farm viable activities in the rural sector. The review of credit needs in the rural sector carried out by USAID in 1989 and the appraisal mission shows that there is effective demand for credit to sustain a rural finance company like MRFC. The unmet investment needs in the market niche that MRFC will serve are estimated at MK 441.0 million in 1992. (MK 125.5 million for small estates, MK 110.0 million for MSMEs and MK206.0 million for smallholder agriculture). It is projected that the Credit demand would reach MK645.7 million in 1996. MRFC is expected to fill only a part of the credit gap in the rural sector. 16. Financial Matters. The MRFC will depend mainly on its shareholders' contributions and purchased money for its funds. Initially it would rely on resources from SACA and shareholders capital contributions but by year 3 its loan disbursements are expected to come  - 47 - ANNEX - 2 Page 7 of 9 from mobilized savings. Over time its resource base would shift from long-term to short-term funds which would be consistent in the banking industry profile in Malawi. 17. MRFC will commence full-scale operations by October 1, 1993, when it will also take over SACA's outstanding loan portfolio, estimated to be about MK100 million., Seasonal loans to existing farmers clubs and new farmer groups are projected to increase by 10% annually. Short-and medium-term loans to MSMEs and loans to small estates are assumed to be initiated in Project Year 1 at a modest level of MK2 million for each category, and growing at annual rates varying from 10% to 25%. Deposit mobilization would also start in Project Year l,with an amount of MK2 million and projected to grow at 25% annually. 18. Given the projected inflation rate of 5% in 1994, initial interest payable on term deposits is taken as 12%, and loans are assumed to carry 22% for seasonal loans and 26% for term loans. However, should the inflation rate be different in 1994, MRFC will pay market rates of interest on its funds and charge at least a 10% spread above its weighted cost of funds on its loans. The loan loss provision is 5% (loan and interest repayments taken at 95%). Based on these assumptions, it would be possible for MRFC to reach the break-even point by Project Year 2, and could commence payment of dividends on its preference shares in Year 3. Financial projections of MRFC's operations (income statement, sources and uses of funds, balance sheet, etc.) and major assumptions for such projects are contained in Attachment 1, Tables 1-3. 19. Start-up of Operations of MRFC. MRFC is expected to start operations on October 1, 1993. This date is considered the most suitable because it is consistent with SACA's financial year and would ensure for the smooth transfer of loan and other accounts, and for absorbing the SACA staff and making the necessary organizational arrangements for loan collections and other day-to-day operations to be carried out in the initial phase. The start-up date envisaged would also be the most suitable from the point of view of loan recovery of the last season and the lending for the following year. The effective date for start-up is, therefore, not linked to the beginning of a fiscal year. 20. Recruitment of Management Team. It is expected that the General Manager and Financial Controller would be in their positions no later than June 1, 1993. As indicated in the following paragraphs, a period of one year for preparatory work prior to start-up is considered the minimum necessary, and should preparatory work not be completed by the start-up date. 21. Principal Tasks of Management Team. The principal tasks to be undertaken by the Management Team, prior to start-up, would be (i) organization of MRFC and determining the branch network and its locations; (ii) staffing of the MRFC; (iii) establishing computerized loan accounting and reporting systems and the accounting system for the company, and the procedures for handling of MRFC funds and for maintaining accounts with banks; (iv) preparation of lending and accounting manuals, formats and training material - operational guidelines - for company staff; and (v) preparation and implementation of action program for taking over of SACA's activities, assets and liabilities. The management team will be assisted by short-term consultants required to carry out tasks which cannot be handled by the management team alone.  - 48 - ANNEX -2 Page 8 of 9 22. MRFC Branch Network. By February 1993, when most of the lending for the 1992/93 season would be completed, SACA would start collecting data for carrying out a detailed survey of the distribution of lending by EPA/RDP/ADD. The information required from each EPA would include the number of clubs, membership, and loan disbursements of seasonal credit for 1992/93, number of loan accounts and amounts in arrears from the 1991/92 season and number of loan accounts and arrears from prior years' seasonal lending; similar data would also be collected on medium-term loans to individual borrowers. In addition, the reports should include the number and names of Credit Assistants for each EPA, information on the credit supervisory and accounting staff at the RDP/ADD levels, and Government houses occupied by field staff. This detailed report will provide the basis for establishing the tentative locations for the network of branches and agencies, and the staffing requirements according to recommended norms. After determining the proposed locations for branches and agencies the management team would have to secure from GOM the required office facilities and housing from company staff. 23. Transfer of SACA Assets and Liabilities. The following rules and procedures would be applied with regard to the transfer of assets and liabilities from SACA/GOM to the MRFC: (a) MRFC would officially start operations on October 1, 1993. On this date, cash and credit balances in all bank accounts of SACA, with the exception of amounts required to cover checks drawn and not yet debited to SACA bank accounts, would be transferred to MRFC. This would include all accounts of SACA/ADD in RBM, commercial banks, post office savings bank and any cash held in any of SACA offices. MRFC would open in its books a current account of GOM and credit this account with the amount of funds taken over from SACA. (b) SACA will transfer to MRFC the total outstanding loan portfolio, as of March 31, 1994 (principal, interest, finance charges and surcharges on arrears) andl the provisions for bad and doubtful debts created by SACA up to and including the 1992/93 financial year. The portfolio and provisions would be held by MRFC as an agent of GOM; the total amount of the loan portfolio would be shown in an off-balance sheet (memorandum) account. GOM current account with MRFC {sub-para (a) above) would be credited against loan collections; write-off procedures and any write-offs of uncollectible loans would require approval of GOM. Together with the individual loan accounts SACA would hand over to MRFC all original loan agreements and related documents, auxiliary accounting records kept at EPA/RDP, all borrower files, and any other relevant documents. GOM, in conjunction with the Auditor General, will issue instructions to MOA with regard to the safeguarding of files, accounting records and other documents not handed over to MRFC. (c) MRFC will take over from SACA all current liabilities (debts to suppliers and inputs) provided that these liabilities relate to loans made by SACA for the 1993/94 season, and that all accounts have been reconciled, verified and confirmed by SACA and its creditors.  ANNEX - 2 - 49 - Page 9 of 9 (d) SACA obligations relating to administrative expenditures up to September 30, 1993, including staff or club training activities, etc., would be covered by SACA and not taken over by MRFC. When preparing its operating budget for 1993/94, SACA would refrain from making any financial commitments for the period after October 1, 1993. (e) SACA would hand over to MRFC, on dates to be agreed between the two entities, office equipment, vehicles, etc. purchased after the creation of SACA and included in its financial statements. Goods would be taken over by MRFC at cost less accumulated depreciation, provided that they are in working condition. MRFC would not take over from SACA stocks of agricultural equipment, inputs, etc. (as shown in SACA balance sheet) and these would be disposed of by SACA in accordance with GOM/MOA instructions. (f) SACA accounts for the financial year ending June 30, 1993 would be presented for audit, and complete audit by not later than September 30, 1993. This audit would form the basis for the transfer of SACA accounts and for the liquidation of SACA. The actual transfer of accounts to MRFC, as described in the preceding paragraphs, would be carried out with effect from October 1, 1993 and would not be dependent on the completion of the audits. However, the Auditor General should be requested to accord high priority to the audit of SACA accounts and furnish to GOM a detailed "management letter" with his findings. (g) As indicated above, funds taken over from SACA and, subsequently, loan collections would be credited to a GOM current account with MRFC. GOM will instruct MRFC to utilize these funds for (i) payment for the share capital subscribed by GOM, and (ii) based on the composition of MRFC share capital, transfer the balances accumulating in the current account to the relevant capital accounts.  - 50 - Attachment 1 Page 1 of 3 MALAWI RURAL FINANCIAL SERVICES PROJECT Major Assumptions Underlying MRFC's Financial Projections 1. Capital 1.1 Authorized Capital 1.0 miliion shares of MK 10 per share (MK 10 million) 1.2 Paid in Capital 0.9 million shares of MK 10 per share (MK 9 million) 1.3 Borrowers Capital Base, equal to 10.0% of anticipated loan requirements for each year 1.4 Debt to Equity 5:1 1.5 Preference Shares with interest at 12% p.a. MK 45 million 2. General 2.1 Loan Loss Allowance of no greater than 5.0% 2.2 Inflation Projected in Years 1992 17.8% 1993 10.5% and thereafter 5.0% 2.3 Corporate income tax rate 40.0% 3. Financial Management 3.1 Investment Rates Following the June 1992 devaluation market interest rates have increased as part of the Government plan to manage the economy. For projection purposes this is assumed to be an aberration. It is also assumed that excess funds will be invested in the market over a six month period at 12.5%, the projected 3 month deposit rate. 4. Staffing and Training 4.1 The Lilongwe location is an Head Office and Branch office located outside the central part of the city. 4.2 The number of field staff, General Savings and Credit Assistants (GSCA) and Senior Savings and Credit Assistants (SSCA) are projected at the level necessary to provide appropriate servicing of the Groups. The numbers correspond to actual SACA and MOA personnel currently active with the Groups. Non-group loan business will be initiated by field staff and processed by Branch Credit staff. As staff are trained, retrained and replaced the expectation is that they will be able to handle the projected growth, therefore staff numbers show no increase and in all probability may decrease.  Attachment 1 -S1- Page 2 of 3 5. Loan Portfolio 5.1 Interest Rate Structurel/ Seasonal loans to agricultural groups 22% Seasonal loans to small estates 22% Working capital loans to S.M.E. 22% Medium-term loans to small estates & S.M.E. 26% All seasonal and working capital loans are assumed to be for a six month period only. The effective interest is, therefore, more than 22%. 5.2 S.M.E's are Small and Medium Enterprises with a turnover not exceeding MK 500,000. It is estimated that this sector is a MK 100 million market. 5.3 Seasonal loans to agricultural groups are estimated to be MK 100 million in PY1 and will grow at 10.0% p.a. 5.4 Loans to Small Estates of up to 30 ha are estimated to be a market of MK 126 million. Seasonal loans are estimated to start in PY1 at MK 2 million, rising in PY2 to MK 5 million and will grow at 10.0% p.a. 5.5 Medium-term loans to small estates will be marketed in PY2 are estimated to start at MK 2 million growing at 10.0% p.a. 5.6 Working capital loans to S.M.E's will be marketed in PY2 are estimated in that year to start at MK 2.0 million and grow 25.0% p.a. 5.7 Medium-term loans to S.M.E's will be marketed in PY3 are estimated to start at MK 1.0 million and will grow at 20.0% p.a. 5.8 Interest is added to the input value and amount of medium term loan at the disbursement time. 6. Loan Repayment Projections 6.1 Repayments of all categories of loans including interest are projected to be 95%. 6.2 It is assumed that all of the previous year's loans and installments that were unpaid at maturity will be written off. 6.3 Medium-term loans are assumed to be repaid over four years and that new loans will equal repayment installments of existing loans to small estates and S.M.E's plus 10.0% and 20.0% each year respectively. 1/ These rates are used for the purpose of financial projections. MRFC would charge market determined rates sufficient to cover its costs and offer it an acceptable level of profit.  Attachment I -52 - Page 3 of 3 7. Income and Expense Statements 7.1 Investment income. It is assumed that investment funds are available for four months each year and will be invested in the interbank market and with RBM or POSB at market rates projected to be 12.5% p.a. 7.2 Operating expenses are projected to increase at stated inflation and real increase assumptions as set out in Working Paper No.2. The expenses detailed in Working Paper No.2, Worksheet No.4 under administration are according to actual expenditures allocated by the MOA after allowing for stated inflation and real increase assumptions. 7.3 Salaries are calculated in PYI based on a weighted average of salary scales in the private sector and adjusted for inflation. 7.4 Rental costs are calculated at MK 40 m2 in the city; MK 24 m2 in towns and MK 10 m2 in rural areas. Head office/main branch 360 i2, branches 180 m2 and agencies 84 in2. For projection purposes each employee is allocated six square meters. 7.5 Fixed assets start up package covering all locations is detailed in Working Paper No.2.  - 53 - Attachment 1 Table 1 Malawi. Rural Financial Services Projecc ________________________________ Projtectd Balance Sheet Fiscal Years 1994-1996 (X'100) 1994 1995 199t ASSETS Current Asseta cash & Depo5itu in the Banks 3,599 5,205 11,490 Seasonal & Working Capital Loan 110,475 135,675 161,995 Accrued Interest Receivable 24,305 30,368 36,216 Allowance for Lon Losses (6,739) (8,402) (10,071) Long-Ter= Assets ________________ Long Term Loans (Med-Tarm to SmE's) 0 2,000 3,200 Pixed AsseCt vehicles 4,380 4,3B0 4,380 Equipment 3,l45 3,145 3,145 Furnlture a Fixtures 1,286 1,2a6 1,286 Depreciation (1,885) (3,770) (5,655) Total Assets 138,565 169,887 205,986 LIABILITIES & CAPITAL currezt Liabilities savings Deposits 0 0 0 Taxes PAyable 1,407 2,404 3,100 Longr Teo Liabilities Borrowings (TrAtnferred from SACA) 40,000 40,000 40,000 Long Term Debt/0OW-IDA 20,000 44,000 72,000 Total Liabilities 61,407 86,404 115,100 CAPITAL ACCOtT Paid in Capital (Auth, 25,000,000) 9,000 9,000 9,000 Preferred Stock 55,000 55,000 55,000 Borrowers Capital Base 11,047 13,767 16.519 Retained Earnings 2,111 5,716 10,367 TOTAL CAPITAL 77,158 83,4a4 gO9886 TOTAL CAPITAL AND LIABILITIES 138,565 169,887 205,986  Attachment 1 -54- Table 2 Malawi Rural Fiaamcial sarvices Project __________________________ _____ Projected Income Statemant PLzcal Yatrs 1994-1996 (MV'100) 1994 1955 1996 1. Interest Income 24,305 30,368 36,216 2. Or-or Income 5,851 7,094 8,536 3. Total RevenUe 30,155 37,463 44,752 4. R.ead Office Expenses 2,114 2,205 2, 274 5. Branch Expenses 5.1 Personnel 3,941 4,242 4, ,453 5.2 Benefits, Admin. & Occupancy 1,353 1,385 1,408 5.3 Tralning 666 332 363 5.4 Operations and Maintenance 2,667 2,731 2,775 Oper4c1ng ExpenSes 10,741 10,894 11,273 5.5 Depreciation 1,657 1,657 1,657 5.6 imt. Exp. on Deposits Piblic 0 0 0 5.7 Tnt. Exp. on Borrowed funds 7,500 10,500 14,000 5.8 Provilion for Bad Debts 6,739 8,402 $0,071 Total DepreC., Int. ad Bad Debts 15,896 20,559. 25.728 6. Total Expenses 26,637 31,454 37,001 7. Profit/MLoss) before Income Tax 3,518 6,009 7',751 Income Tax * 40% 1,407 2,404 32,100 S. PROFIT/(LOSS) AFTER INCOME TAX 2,111 3,606 4,t50 Div.dend EAte Dividend on Preferred Sharas Current Year Profit/Loas 2,111 3,606 4,650 Accumulated Retained Earmnina 2,111 5,716 10,367 ROA 1.52* 2.12i 2.26% ROE 2.81* 4.67* 5.57*  - 55 - Attachment 1 Table 3 Rural FinAncial Services Pro1ecc Projected Sources and Uses of Funds F?lcal Years 1994-1996 (MK' 100) 1994 1995 1996 SOURCES OF FUNDS Depositts 0 Short Term Debts 1,407 997 697 Borrowed Funds WB/AOU (L-T Debt) 60,000 24,000 2a,000 Net Profit or Loss aftear Tux 2,111 3,606 4,650 Provision 6,739 8,402 10,071 Lees Loan Written Off (6,739) (8,402) Inc.(Dec) In Punds from OPS 8,f50 5,269 S,319 lurense (Decreaso) iln EquRty 75,047 2,720 2,752 TOTAL SOURCES OF FuNns 145,304 32,9aS 37,767 USES OF FUNDS cash 3,599 1,606 6,285 Deposits 110,475 25,200 26,320 lucrease In Accrued Interest 24,305 6,064 S,848 FiXed Assets 6,926 (1,885) (1,885) Inc. (Doe) in L/T Loan Portfolio 2,000 1,200 TOTAL VaEs OF FUNDS 145,304 32,985 37,768  - 56 - Attachment 2 Page 1 of 2 MALAWI RURAL FINANCIAL SERVICES PROJECT Action Plan for Transforming Malawi Rural Finance Company into a Rural Bank ACTION TARGET DATE 1. Delinking of agricultural extension services from credit delivery September 30, 1993 system. 2. Completion of detailed operational and financial audit of SACA September 30, 1993 from 1988 to June 30, 1993. 3. Preparation of operating systems, and manuals for policy and September 30, 1993 procedures, including loans approvals, credit disbursements, collections, accounting system, management information system, training and personnel manuals, computer systems, etc. 4. Business plan for the MRFC: * finalization of the organizational structure and staffing September 310, 1993 * evaluation of SACA staff to determine their suitability to March 31, 1994 work for MRFC and eventually with the rural bank * classification of End-users September 30, 1993 * development of promotional activities for the MRFC September 30, 1993 * preparation of 3 year financial projections September 30, 1993 * completion of detailed operational and financial audit of October 31, 1995 MRFC for the period ending on September 30, 1995 to meet the requirements of the Banking Act 5. Divestiture of Government shareholdings in MRFC to the private sector: * completion of the preparation of share prospectus December 31, 1993 * completion of evaluation of shares March 31, 19I94 * identification of potential private sector institutions for March 31, 1994 share placement  - 57 - Attachment 2 Page 2 of 2 * advertisement for public share subscriptions (individuals March 31, 1994 and groups) * reducing government ownership of MRFC to not more November 30, 1995 than 20% 6. Business plan of the proposed rural bank: * finalization of the organization structure and staffing September 30, 1994 * classification of End-users December 31, 1994 * identification of market niche for the rural bank for September 30, 1994 savings mobilization and lending * development of promotional activities of the rural bank September 30, 1994 * completion of five year financial projections October 31, 1994 7. Licensing of the rural bank: * submitting application to RBM in accordance with the November 30, 1995 Banking Act * securing banking license March 31 1996 * commencing banking business June 30, 1996  MALAWI MALAWI RURAL FINANCIAL SERVICES PROJECT Summary Accounts by Year Totals Including Contingencies Totals IncLuding Contingencies MK USS 1993/94 1994/95 1995/96 TotaL 1993/94 1994/95 1995/96 TotaL 1. INVESTMENT COSTS A. GOODS(MATRL/VEHIC/EQUIp) 26902.1 0.0 0.0 26902.1 6725.5 0.0 0.0 6725.5 B. TRAINING 1005.4 685.4 812.4 2503.2 251.3 171.3 203.1 625.8 C. TECHNICAL ASSISTANCE 3403.5 2871.1 1865.3 8139.9 850.9 717.8 466.3 2035.0 D. LINE OF CREDIT 24000.0 28000.0 28000.0 80000.0 6000.0 7000.0 7000.0 20000.0 TotaL INVESTMENT COSTS 55310.9 31556.5 30677.7 117545.1 13827.7 7889.1 7669.4 29386.3 11. RECURRENT COSTS A. SALARIES 4825.6 5193.0 5452.7 15471.3 1206.4 1298.3 1363.2 3867.8 B. OTHER OPERATING COSTS 4508.1 4614.8 4690.2 13813.0 1127.0 1153.7 1172.5 3453.2 TotaL RECURRENT COSTS 9333.7 9807.8 10142.8 29284.3 2333.4 2451.9 2535.7 7321.1 Total PROJECT COSTS 64644.6 41364.3 40820.5 146829.5 16161.2 10341.1 10205.1 36707.4 ------------ ------------------- ---------------------------------------- ---------- -------------------- oo VaLues Scaled by 1000.0 F-3 v l (D  MALAWI MALAWI RURAL FINANCIAL SERVICES PROJECT Summary Account by Project Component MK TECHNICA Physical Price BRANCHES L BUSINESS Contingencies Contingencies HEADQUAR AND ASSISTAN DEVELOPM LINE OF --------------------------------- TERS AGENCIES CE TRAINING ENT UNIT CREDIT Total % Amount % Amount I. INVESTMENT COSTS A. GOODS(MATRL/VEHIC/EQUIP) 886.3 24042.5 0.0 0.0 214.5 0.0 25143.3 5.0 1257.2 2.0 501.6 B. TRAINING 0.0 0.0 0.0 2266.5 0.0 0.0 2266.5 0.0 0.0 10.4 236.7 C. TECHNICAL ASSISTANCE 0.0 0.0 4820.0 0.0 3000.0 0.0 7820.0 0.0 0.0 4.1 319.9 D. LINE OF CREDIT 0.0 0.0 0.0 0.0 0.0 80000.0 80000.0 0.0 0.0 0.0 0.0 Total INVESTMENT COSTS 886.3 24042.5 4820.0 2266.5 3214.5 80000.0 115229.8 1.1 1257.2 0.9 1058.2 II. RECURRENT COSTS A. SALARIES 2029.5 11233.6 0.0 0.0 491.7 0.0 13754.8 0.0 0.0 12.5 1716.5 B. OTHER OPERATING COSTS 1310.3 11875.5 0.0 0.0 128.7 0.0 13314.5 0.0 0.0 3.7 498.5 Total RECURRENT COSTS 3339.8 23109.1 0.0 0.0 620.4 0.0 27069.3 0.0 0.0 8.2 2215.0 LA Total BASELINE COSTS 4226.1 47151.6 4820.0 2266.5 3834.9 80000.0 142299.1 0.9 1257.2 2.3 3273.2 Physical Contingencies 44.3 1202.1 0.0 0.0 10.7 0.0 1257.2 Price Contingencies 320.0 2326.1 191.6 236.7 198.7 0.0 3273.2 0.7 23.9 Total PROJECT COSTS 4590.4 50679.9 5011.6 2503.2 4044.3 80000.0 146829.5 0.9 1281.1 2.2 3273.2 Taxes 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Foreign Exchange 1865.5 34037.1 5011.6 226.6 3447.9 8000.0 52588.8 2.4 1281.1 Values Scaled by 1000.0 (D M1  ANNEX - 4 -60- Pagelof4 MALAWI RURAL FINANCIAL SERVICES PROJECT Action Plan for Pilot Women's Program Since the involvement of women in this project is of primary importance, the action program discusses the measures to be taken to address the identified problems. The specific activities and responsibilities of the implementing agencies, including project monitoring would be periodically reviewed to accommodate any realistic changes during the life of the project. However, women and credit issues must be the main focus at all times. ELEMENT ACTION TO BE TAKEN 1. Identification of Existing * Within 6 months the Government Coordination Implementing Institutions Committee would compile a list of existing implementing institutions dealing with women and credit issues in Malawi detailing their areas of operation, performance and special coverage. * Contract agreements would be finalized within the first 6 months between the participating agencies, M4alawi Government and the World Bank. 2. Identification of Potential * 6 months before the project starts, DEMATT, NABW, Clients MUDZI and MRFC start to compile a list of small and medium potential clients for tailored training and identify viable projects for lending. These lists should be given to MRFC Management at the Head Office.  ANNEX - 4 -61- Page 2 of 4 3. Analysis of Social-Cultural * NCWD in collaboration with NABW and CAAM and Factors local NGOs would lead the identification of the social and cultural barriers hindering participation of women in economic development especially access to credit and offer recommendations and modalities for implementing these solutions to the Malawi Government. Since these are deep-rooted factors which will take a long time to change, NCWD would take the lead in ensuring lobbying for these factors to be considered during project planning and implementation of all national development projects. * National awareness workshops (2-3 days) to be conducted at the district levels 6 months prior to project start, NABW, MUDZI, CAAM to coordinate the activities at the grassroots level and select women leaders to help in organization, NCWID to organize funding from willing donors, Government, banks and support institutions. 4. Extension and Training (a) Training of Staff * One week workshop comprising of trainers from (b) Training of DEMATT, NABW, MUDZI, MRFC and NGOs Trainers involved in the project. The number of trainers to be given by participating agencies. A list of participants would be given to the project Coordinating Committee within 6 months. A joint meeting of all concerned parties would be held to discuss and approve the training content required for the project. * 6 Districts may be selected for initial project implementation under the first phase. This will depend on the availability of human and financial resources. Malawi Government and World Bank to agree on this. (c) Orientation * Within 6 months, Coordinating Committee assisted by Workshop MRFC management, NABW, MUDZI and the field team would organize a 3 day orientation workshop be held at the bank headquarters to assign duties, roles and responsibilities of all participants in the project.  ANNEX - 4 -62 - Page 3 of 4 (d) Follow-up . NABW, MUDZI, DEMATT and other identified Workshops support institutions would hold special workcshops at the village or locational level tailored for specific needs of the clients. Duration of the workshop will depend on the mutual agreement between women leaders at the grassroots level and the interrnediary agencies. * MRFC would hold a special workshop for its staff in order to advise them of the new policy - changes and hold awareness brain-storming sessions to discuss gender specific issues and subjects related to certain social attitudes and practices which call for changes. 5. Review of the Rights & * NCWID to lead and collaborate with NABW, CAAM, Land Property Laws sectoral ministries and through ministry of planning and national development review policies affecting ownership and land rights. The process may take 15 to 20 years, but it must be pursued. -- Through on-going awareness seminars and workshops to be organized by NABW, MUDZI, CAAM, women of all levels should be made aware of their rights and be guided to know how to take the advantage of these rights in all areas (inheritance and leadership). 6. Entrepreneurship * NCWD and NABW will hold national conferences of all women entrepreneurs and invite Sectoral Ministries, Chamber of Commerce and Trade institutions to discuss development of women's businesses. The Chamber of Commerce should promote women's economic activities in export trading and organize conferences and internships to neighboring countries like Kenya, Ghana, and Zimbabwe. 7. Appropriate Technology * NCWD and NABW to work closely with GTZ (Malawi) and Sectorial Ministries to develop and introduce appropriate technology so that women can diversify their business activities and use their time more effectively.  ANNEX - 4 -63- Page 4 of 4 8. Loan Fund * Reserve Bank of Malawi to form consultative forum with banks and financial institutions to form a nucleus and provide recommendations to the Government for policies to be adopted in order to increase flow of credit to women at all levels. NCWD and NABW to lobby through Reserve Bank for Commercial Banks to increase loanable funds to women and explore possibilities for further lending mechanisms which do not call for collateral. * Reserve Bank to further explore modalities of policy changes in areas of lending to women groups. NCWD to facilitate and lobby for these changes. * TThe extension staff should give information on the availability and lending requirements to the public especially women through the identified public forums as well as the public media. 9. Proposed Training Action YR 1 YR 2 YR 3 YR 4 YR 5 TOTAL Plan Trainers 50 100 100 100 100 450 Leadership Workshops 250 300 500 1000 1500 3550 Women Entrepreneurs 200 400 600 1000 2000 4200 MRFC Staff Numbers to be determined when all the existing trained staff capacity and the proposed new bank staff requirements are worked out. Technology 100 200 300 400 1000 2000 Seminars/Exhibitions  - 64 - ANNEX - 5 Page 1 of 2 MALAWI RURAL FINANCIAL SERVICES PROJECT Supervision Plan 1. Bank Supervision Input into Key Activities. The staff input indicated in the attached table is in addition to regular supervision needs, such as the review of progress reports, procurement and disbursement actions, and correspondence. In view of the complexity of the project, supervision is expected to require 18 staffweeks per year during the first three project years (of which ten will be in the field), and 12 staffweeks for each year thereafter (of which six will be spent in the field). 2. Borrower's Contribution to Supervision (a) Progress reports are to be submitted as follows: (i) every six months (a) a report on the status of the portfolio financed with credit funds (based on quarterly reports from MRFC indicating status of portfolio financed with project funds and statements of financial and resource position); (b) disbursements reports on project accounts; and (c) three months after the end of the financial year, annual reports on key project areas; and (ii) at the end of September of each year by RBM. (b) Project monitoring and coordination will be the responsibility of the MRFC. Review meetings with MRFC will be held normally in Ministry of Finance, unless otherwise indicated by Government at least once each year. The meetings will be chaired by MOF; (c) The Ministry of Finance will be responsible for coordinating arrangements for Bank supervision missions including the selection of appropriate local personnel to accompany the missions. The MRFC will be responsible for providing information required by missions. For missions of a specialized nature, the borrower will make available appropriately skilled staff to work with the missions; and (d) Mission briefing meetings and arrival, and wrap-up meetings will normally be chaired by the MOF with the participation of MRFC. 3. This supervision plan will be updated formally once a year, during the Annual Review of Implementation and Supervision (August/September) and more frequently as changing country and project circumstances may require.  - 65 - ANNEX - 5 Page 2 of 2 MALAWI RURAL FINANCIAL SERVICES PROJECT Supervision Plan: Bank Supervision Input into Key Activities Approximate Dates Expected Skill Staff Input (month/year) Activity Reauirements (Staffweeks) 5/93 Board app.oval 11/93 Supervision/Proiect Launch Mission: focus on status of conditions Key activities, by component: Line of Credit - status of action program TA - status of MRFC Project launch workshop - project cycle - procurement - disbursement 11/93 Review the Rural Finance Companv (MRFC) Banking 2.0 5/94 Review of MRFC Banking 1.5 5/94 Supervision Mission: focus on procedures for use of Financial Analyst (2) 10.5 credit and review of MRFC institution building Disbursements/ 2.0 - disbursements, procurement, Procurement reporting - commercial bank participation - farmers club capacity building TOTAL FY94 18.0 FY95 Supervision Missions (2 per year) Financial Analyst/ 18.0 Economist FY96 Supervision Mission: focus on commitment of funds Operations officer 8.0 - achievement of development Disbursement/ objectives Procurement - review of project implementation - review of legal covenants (esp. audit and reporting requirements) 11/95 Mid-term Review Banking 10.0 Financial Analyst Economist FY97 Supervision Mission (2): Financial Analyst/ 12.0 - achievement of development Economist objectives - review of project implementation  - 66 - ANNEX- L. Page 1 of 1 MALAWI RURAL FINANCIAL SERVICES PROJECT IDA Estimated Disbursement Schedule (US$ Millions) Quarter Quarterly Cumulative Ending Disbursement Disbursement FY 1994 1/ September 30, 1993 0.3 0.3 December 31, 1993 6.0 6.3 March 31, 1994 0.3 6.6 June 30, 1994 0.3 6.9 FY 1995 September 30, 1994 0.3 7.2 December 31, 1994 7.0 14.2 March 31, 1995 0.6 14.8 June 30, 1995 0.6 15.4 FY 1996 September 30, 1995 0.6 16.0 December 31, 1995 7.0 23.0 March 31, 1996 0.5 23.5 June 30, 1996 0.5 24.0 FY 1997 September 30, 1996 0.5 24.5 December 31, 1996 0.5 25.0 1/ Fiscal Year runs from July 1 to June 30  MALAWI RURAL FINANCIAL SERVICES PROJECT Key Project Indicators ----MK million- Item Base Year Year 1 Year 2 Year 3 Smallholders Seasonal Loans 100.0 118.0 133.0 158.0 Reserve Fund 0.0 12.0 13.0 16.0 Small Estates Short-term 2.0 5.0 6.0 Medium-term 2.0 2.2 MSMEs Loans (S.T.) 2.0 3.0 (Working Capital) Loans (MT) Investment) 1.0 , I-.. 0 H+, -J  Beneficiaries Item Year Base Year I Year 2 Year 3 Smallholder Farmer 300,000 330,000 360,000 400,000 Clubs 12,000 12,500 13,000 14,000 Small Estates Short-term 1,000 5,000 6,000 Medium-term 1,000 1,100 MSMEs Short-term 250 300 Medium-term 200 Women (Pilot IGA) 100 100 200 300 Ph _l1 'I  Training (Beneficiaries) Item Base Year Year 1 Year 2 Year 3 MRFC Headquater Staff 3 10 2 2 Branch Staff (Exch. Br. Mgrs.) 18 24 12 Staff Credit-Supervisors 12 8 2 Women Entrepreneurs 0 400 600 1,000 Credit Assistants 48 24 12 Farmer Club/Group Leaders 1,500 2,000 2,000 2,000 0 X l  - 70 - ANNEX - 7 MALAWI Page 4 of 5 RURAL FINANCIAL SERVICES PROJECT Implementation Indices for Monitoring Project Years Unit Year 1 Year 2 Year 3 Smallholders Seasonal Loans MK Mil. Reserve Fund MK Mil. SmaU Estates Short-term Loans MK Mil Medium-term Loans MK Mil MSM - Enterprises Working Capital MK Loans Mil Medium-term Loans MK Mil Beneficiaries Farmers Clubs Nos. Farming Households Nos. Small Estates Nos. MSM Enterprises Nos. Women (IGA Pilot) Training MRFC Staff Nos.  - 71 - ANNEX - 7 Read OtTice Page 5 of 5 Branch Offices Satellite Agencies Farmer Clubs Nos. Leaders Members Women ([GA Pilot) Nos. MSM Entrereneurs Nos.  - 72 - ANNEX-8A Page 1 of 4 MALAWI RURAL FINANCIAL SERVICES PROJECT Malawi Rural Finance Company Technical Assistance Terms of Reference 1. MRFC is an independent limited liability company established to provide financial services to the rural sector, initially by taking over the lending activities of the Smallholder Agricultural Credit Administration (SACA) which provides credit to about 350,000 customers including about 12,000 farmers clubs, and thereafter by securing a banking license from the Reserve Bank of Malawi to operate as a full-service rural bank. MRFC's major mission is to provide a full range of financial services to rural households and business enterprises on a competitive basis, including credit to those who might have problems in accessing existing financial institutions. MRFC plans to operate by establishing branches and agencies in the rural areas and equipping them to undertake savings mobilization and extension of credit facilities. In order to accomplish its business mandate successfully from inception MRFC intends to recruit senior managers and specialist consultants competent to serve the Company. Suggested TOR for the General Manager of the Malawi Finance Company Responsibilities 2. The General Manager would function as the Chief Executive Officer, reporting directly to the Board of Directors and have overall responsibility for the operations of the company. His duties would include but not be limited to: (a) Arranging for the recruitment of senior executive staff for the Company, including the Financial Controller (Deputy Manager Finance & Administrator), Deputy General Manager Loans, Personnel and Administration Manager and Internal Auditor; (b) Preparation of organization and staffing structure of the Company; (c) Supervising the recruitment, training and placement of suitably qualified and experienced staff required by the Company. (d) Selecting the locations for the head office, branches and agencies, and determining the number of staff necessary, considering what branch would function as a profit centers; (e) Arranging for the procurement of physical assets and facilities required for the Company; (f) Organizing the commuencement MRFC's business in an orderly manner;  - 73 - ANNEX - 8A Page 2 of 4 (g) Arranging for the take-over of SACA's activities, assets and liabilities without under interruption of operations; Qh) Coordinating the licensing of the Company as a full-service rural bank providing full range of financial services at competitive rates for farming and non-farming activities of the rural population on a commercial and sustainable basis. (i) Conducting the operations of MRFC in a cost-effective and sustainable manner; (j) Reviewing and establishing performance related remuneration, benefit, career development paths, working conditions of staff to attract and retain quality staff; (k) Establishing policies and procedures taking into account the expansion of the lending portfolio to include seasonal loans to small agricultural estates, working capital loans and eventually medium term loans to rural households. (I) Supervising the preparation of the action plan for licensing MRFC into a bank and the following manuals: Policy and Procedures, Accounting and Management Information Systems, Personnel Policy, Training and Audit; (m) Reviewing with the Financial Controller and technical assistance consultants, the computer hardware and software necessary to secure timely information for decision making; (n) Reviewing with the Financial Controller, and the Deputy Manager (Loan), the SACA portfolio taken over, identifying loans which are collectible, remedial action for those in default, and writing off uncollectible loans; (o) Formulating strategic plans for portfolio management diversification and business development; (p) Maintaining internal audit and inspection control of all business and activities to ensure conformity with the Company's policies and procedures as well as with the statutory requirements relating to the Company's operations; (q) Securing Board of Directors approval for the Company's five year business plans; (r) Presentation of periodical progress reports to the Company's Board of Directors; (s) Maintaining liaison with Board of Directors, shareholders, Government and external aid agencies.  - 74 - ANNEX-8A Page 3 of 4 Qualifications 3. Graduate level university degree in banking, finance, business administration or equivalent professional qualifications in a related field. 4. Experience in banking and credit, as a senior manager having worked in a developing country (preferably in Africa) for not less than 10 years, with proven management skills, and exposure to agricultural credit and financing small- and medium-scale rural enterprises. 5. Thoroughly familiar with corporate planning, management information systems, monitoring and evaluation, and problem solving. Display initiative, resourcefulness and innovating thinking. Possesses sound commercial judgement and skills, leadership qualities, to motivate and guide the staff. Demonstrated ability to deal confidently and convincingly with senior executives in the government, public and private sectors, technical assistance personnel and international institutions. Have tact, patience and sensitivity to local culture and differing points of view. Suggested TOR for the Financial Controller Responsibilities 1. The Financial Controller who would also be the MRFC's Deputy Manager (Finance and Administration) reporting to the General Manager would carry out the tasks assigned to him/her by the General Manager including the following: (a) Responsibility for the company's finance and administration matters; (b) Participating in the recruitment, training and supervising of all staff within the Finance and Administration Department; (c) Functioning as the Secretary of the company, when required; (d) Preparing the accounting and management information systems manuals and supervising the preparation of the personnel, training and internal auditing manuals; (e) Participating in the selection of staff for the accounting, computer, personnel and administration, and auditing departments and units in the head office and branches; (f) Establishing MRFC's accounting systems and policies, treating individual branches as separate profit certers; (g) Introducing management information and progress reporting systems and selection of computer hardware and software in consultation with other managers and consultants concerned;  -75- ANNEX-8A Page 4 of 4 (h) Preparing in consultation with senior management staff, MRFC's business plans, budgets, forecasts and cash flow projections; (i) Establishing personnel policies including performance related compensation, benefits, working conditions and career development in consultation with the Personnel and Administration Manager; (j) Supervising and ensuring that adequate training is given to all staff on a continuing basis, both on-the-job and through internal and external courses; (k) Determining and monitoring the financial viability of potential new branches and agencies after conducting feasibility studies; (I) Ascertaining and agreeing the values of assets and liabilities taken over from Smallholder Agricultural Credit Administration; (m) Ensuring that statutory requirements in regard lending, deposits, reserves, ratios, submission of periodical statements are complied with; and (n) Liasing with the Company's independent auditors and ensuring that the annual audits are completed in time. Qualifications 2. Graduate level degree in banking, finance, accounting, business administration or related professional qualifications and membership in a recognized professional institution, with proven management skills. 3. Experience in financial management at senior executive level, having worked in a bank or other full-service financial institution for a minimum of 10 years. Preference would be given to those having experience in African countries with institutions engaged in rural credit, enterprise financing and savings mobilization. Experience should include preparation of funds management, cost control, corporate planning, budgetary control, MIS progress reporting, organization and methods. 4. Possess tact, patience, sensitivity to local cultures, leadership qualities, and ability to motivate and guide staff. Ability to work as a team member and to deal with other managers, staff, consultants and outsiders confidently and convincingly. 5. The ideal candidate should be experienced in computer, data processing, accounting and management information systems and have experience in developing, introducing and supervising such systems, especially if such experience has been obtained in formal institutions in Africa or in developing countries.  - 76 - ANNEX-8B Page 1 of 2 MALAWI RURAL FINANCIAL SERVICES PROJECT Terms of Reference for Business Development Unit 1. The Malawi Rural Finance Company Limited (MRFC) will establish a Business Development Unit whose main functions would include: (a) Research and experimentation relating to MRFC's financial services and business development; (b) Orientation of MRFC's current and potential clients to financial services offered by MRFC, and of viable business opportunities that could be financed with available credit facilities; (c) Orientation of farmers' and women groups on risk management by operating Credit Reserve Funds as a mechanism for collateral substitution; (d) Development of innovative techniques for resource mobilization in the rural areas and for improving credit facilities and outreach for rural households and microenterprises, by adoption of financial instruments most suited to rural clientele; (e) Inculcation of savings culture among members of the farmers clubs, women groups and other rural associations, and training them on accessing a formal financial system; (f) Development and evaluation of grassroot organizations and voluntary mutualist groups to deepen financial intermediation in rural areas; (g) Promotion and training of rural households on group dynamism to foster rural savings and credit; (h) Monitoring and progress reporting of MRFC lending activities under RFSP identifying problems in loan portfolio management; (i) Evaluation of MRFC activities, in particular: * loan recovery performance; * impact of loans for on-farm, off farm and non-farm activities; * problems faced by potential beneficiaries in accessing formal credit; * the extent to which lending institutions are able to reach larger groups, especially women and the poorest groups in the rural areas.  - 77 - ANNEX- 8B Page 2 of 2 2. Carry out sample surveys for impact on project beneficiaries, growth and performance of farmers clubs, women groups, microenterprises, and the extent of and reasons for rural segments not being served by formal financial institutions. 3. BDU would, in due course, be able to offer the foregoing types of services also for institutions other than, MRFC for a fee. The benefit of BDU's research and experimentation would, also, be available to other financial institutions within the country. 4. BDU would be headed by a specialist in banking and rural finance with international experience, and assisted by a small staff. 5. BDU would also arrange to utilize short-term technical assistance for special assignments related to M&E of MRFC's operations, evaluation activities, special promotion campaigns, staff and client training programs, field surveys, research and analysis and experimentation.  Attachment - 78 - Page I of I Consultancy Selection Planing Category Individual Method of Estimated Expected or Firm Selection Person Date Month General Manager Firm Short list 36 6/93 Financial Controller Firm Short list 36 6/93 BDU Consultants Firm Short List 60 9/93 MRFC Short-term Individuals Short List 60 6/93 Consultants  - 79 - ANNEX - 9 Page 1 of 1 MALAWI RURAL FINANCIAL SERVICES PROJECT Implementation Schedule PROJECT YEARS 1 2 3 INSTITUTION BUILDING Procurement: Vehicles Equipment Supplies and spare parts Training: MRFC staff Project beneficiaries Technical Assistance: General Manager Financial Controller Short-term Consultants LINE OF CREDIT Seasonal credit Short- and Medium-term loans PILOT PROGRAMS MMF WID - Business skills training of women entrepreneurs  MAP SECTION  ;2 To LOon Es Saalao,