Moldova - Rural Finance Project

Document of The World Bank ReportNo: 17177-MD PROJECT APPRAISAL DOCUMENT ONA PROPOSED CREDIT IN THE AMOUNT OF US $5 MILLION EQUIVALENT TO THE REPUBLIC OF MOLDOVA FOR A RURAL FINANCE PROJECT December 19, 1997 ECSRE ECCO7 Europe and Central Asia Regional Office  CURRENCY EQUIVALENTS (Exchange Rate Effective October 30, 1997) Currency Unit = Moldovan Lei US $1 = Lei 4.67 Lei I = US $0.21 FISCAL YEAR ABBREVIATIONS AND ACRONYMS AFC Agricultural Finance Corporation CAS Country Assistance Strategy FSU Forner Soviet Union EBRD European Bank for Reconstruction and Development GOM Government of Moldova GTZ Gesellschaft flier Technische Zusammenarbeit IFC International Finance Corporation IRR Internal Rate of Return MMA Moldova Microfinance Alliance NBM National Bank of Moldova NGO Non-Governmental Organization PPC Project Preparation Committee PSD Private Sector Development Project RFC Rural Finance Corporation RFP Rural Finance Project RFPIU Rural Finance Project Implementation Unit SCA Savings and Credit Association WWB Women's World Banking Vice President: Johannes Linn Country Director: Roger Grawe Sector Director: Kevin Cleaver Task Team: Florian Grohs (Task Team Leader) Konrad Ellsaesser (SCA Development) Amnon Golan (Institutions) V.S. Raghavan (RFC Development) Vice President: Johannes Linn Country Director: Roger Grawe Sector Director: Kevin Cleaver Team Leader: Florian Grohs  Republic of Moldova Rural Finance Project CONTENTS A. Project Development Objective 1. Sector background 2. Project development objective and key performance indicators B. Strategic Context 1. Sector-related.CAS goal supported by the project 2. Main sector issues and Government strategy 3. Sector issues to be addressed by the project and strategic choices C. Project Description Summary 1. Project components 2. Key policy and institutional reforms supported by the project 3. Benefits and target population 4. Institutional and implementation arrangements D. Project Rationale 1. Project alternatives considered and reasons for rejection 2. Major related projects financed by IDA and/or other development agencies 3. Lessons learned and reflected in proposed project design 4. Indications of borrower commitrnent and ownership 5. Value added of Bank support in this project E. Summary Project Analyses 1. Economic 2. Financial 3. Technical 4. Institutional 5. Social 6. Environmental assessment 7. Participatory approach F. Sustainability and Risks 1. Sustainability 2. Critical risks 3. Possible controversial aspects  G. Main Loan Conditions 1. Effectiveness conditions 2. Other H. Readiness for Implementation I. Compliance with Bank Policies Annexes Annex 1. Project Design Summary Annex 2. Detailed Project Description Annex 3. Estimated Project Costs Annex 4. Cost-Effectiveness Analysis Annex 5. Financial Summary Annex 6. Procurement and Disbursement Arrangements Table A. Project Costs by Procurement Arrangements Table Al. Consultant Selection Arrangements Table B. Thresholds for Procurement Methods and Prior Review Table C. Allocation of Loan Proceeds Annex 7. Project Processing Budget and Schedule Annex 8. Documents in Project File Annex 9. Statement of Loans and Credits Annex 10. Country at a Glance Map IBRD 24285R3  Republic of Moldova Rural Finance Project Project Appraisal Document Europe and Central Asia Regional Office Rural Development and Environment Unit Country Department for Moldova Date: December 19, 1997 Task Team Leader: Florian Grohs Country Director: Roger Grawe Sector Director: Kevin Cleaver Project ID: MD-35781 Sector: Agriculture Program Objective Category: Environmentally Sustainable Development Lending Instrument: Learning and Innovation Loan Program of Targeted Intervention: [X] Yes [] No Project Financing Data [ Loan [X] Credit [ Guarantee [] Other [Specily) For Loans/Credits/Others: Amount (US$5 million/SDR 3.7 million) Proposed terms: 35 years [X] Multicurrency [ ] Singlecurrency Grace period (years): 10 [1 Standard variable [ ] fixed [ ] Libor-based Years to maturity: 35 Commitment fee: 0.00% Service charge: 0.75% Financing plan (US$m): Source Local Foreign Total IDA 0.0 5.0 5.0 Donors (Womens World Banking (WWB), Soros, GTZ) 0.0 0.4 0.4 Beneficiaries 0.7 0.0 0.7 Total 0.7 5.4 6.1 Borrower: Republic of Moldova, Ministry of Finance Guarantor: N/A Responsible agency(ies): Rural Finance Project Implementation Unit (RFPIU), Rural Finance Corporation, Savings and Credit Associations Estimated disbursements (Bank FY/US$M): 1998 1999 Annual 2.6 2.4 Cumulative 2.6 5.0 Project implementation period: 2 years Expected effectiveness date: 2/1/1998 Expected closing date; 12/31/1999 OSD PAD Forn: July 30, 1997  Page 2 A: Project Development Objective 1. Sector Background: Moldova is a small, densely settled country that relies heavily on agriculture. The country produces a variety of agricultural products including wine, fruits and horticulture products. Food and agriculture contributed to about 42% of GDP in 1995 and the sector employs about half of the total labor force. Total agricultural output contracted rapidly after independence and is expected to continue to contract for the next few years, although at a much slower pace. Yet a partial recovery of agricultural exports has been observed in recent years. The Government of Moldova (GOM) is committed to providing a supportive environment for the emerging private farming sector, and views agriculture as the engine of sustainable growth of the economy. These reforms are supported through the Second Structural Adjustment Loan (SAL lI). Moldova was one of the first former Soviet Union (FSU) countries to take decisive action to stabilize its economy. In agriculture, GOM introduced a liberal price regime in 1993 - 1995 with very limited direct subsidies to agriculture producers and processors. Factors that have hampered the development of agriculture have been Government interventions in the grain sector, high taxation for private farming, and indirect subsidies for some agricultural sub-sectors. In 1997, GOM has taken significant steps to liberalize the grain market, complete privatization of agro- processing enterprises in the input supply and grain marketing sector, and reduce the level of indirect subsidization significantly. Land reform and farm restructuring remains controversial in Moldova, and only limited progress has been achieved in this area. The bulk of the land is still used by large-scale former kolkhozes and sovkhozes but about 16% of the land is under full private management. The number of independent private farmers (about 2-3 ha average) reached about 156,000 in mid- 1997 and is increasing rapidly. Private family farms consistently outperform large-scale farms, the fact of which is increasingly recognized by GOM and the agro-industrial sector. Many of the large-scale farms are de facto bankrupt because of debts, lack of capital investments, low worker morale, and deterioration of assets. Simplified farm restructuring and land privatization regulations, combined with pressure created by the increased economic difficulty of the unrestructured farms, have resulted in a new push to finalize farm restructuring. The GOM has committed itself to restructure 150 farms in 1997 and 200 farms in 1998 out of a total number of about 900 large farms. In addition, a large USAID farm restructuring program is currently under implementation in 1997 and will be continued the following year. Most of the new private farmers that are leaving the kolkhozes, and the newly emerging rural enterprises, cannot obtain loans from commercial banks. The major reason is that using a classical lending approach, the typical loan size is too small to cover the costs of commercial banks. In addition, most of these clients cannot provide adequate collateral to the banks when starting their business because they often do not have adequate assets. At the same time, these new farms and rural enterprises have considerable potential for growth and for income- generating investments, if they can provide sound business plans and propose bankable investments. Relatively small loans (often between US $200 and $1,000) could enable farmers to buy good quality seeds, fertilizer, and machinery services, which in turn raise the production and sale of agricultural products significantly. Cooperative banking systems like the Raiffeisen Bank in Germany, the Credit Unions in the United States, or even the Banca Populare that existed before 1940 in Moldova, are well suited to provide these services to the rural population based on mutual principles. The principal benefit of such institutions is to lower the costs of financial intermediation sufficiently enough to make  Page 3 small-scale lending financially profitable. There is scope to re-introduce a similar system into the rural economy of Moldova. The key objective of this project is to test a mechanism that would overcome the two most important impediments to financing the rural sector - high transaction costs due to small loan size and lack of traditional collateral. By creating Savings and Credit Associations, this project tests a method to reduce transaction costs, create a substitute for traditional collateral, and mobilize savings from the rural population. A Pilot Project to test this concept started in March 1997 using grants from the Soros Foundation and the Dutch Government in the amount of US $190,000. This money was used to establish 11 pilot Savings and Credit Associations (SCAs) in Moldova and to make about 411 short-term seasonal loans (6-9 months) at an average size of US$ 450, and real positive interest rates (24%). SCAs are voluntary organizations that lend to, and mobilize savings from their members, and operate in a manner similar to Credit Unions. Members of the SCA elect their board and a supervisory council. The SCA board determines the individual loan size, maturity, collateral requirements, and repayment schedule for each borrowing member. Presently, the 11 SCAs operate under a temporary Government Decree regulating the establishment and operation of SCAs. Sample statutes and prudential rules for SCA have been drafted and discussed with the National Bank and the Ministry of Justice. Progress to date under the pilot project shows that all members of the SCAs are current in repaying their credits. However, some aspects, notably savings mobilization by SCAs, the design of an appropriate regulatory structure for SCAs and the operation of a cooperative re-financing institution still need to be tested. 2. Project development objective and key performance indicators (see Annex 1): The objective of the Project is to develop and test a cooperative rural banking system that would efficiently provide financial services to small private farmers and rural entrepreneurs. In order to achieve these objectives, the Project would establish Savings and Credit Associations and train their members with assistance of the Moldova Microfmance Alliance (MMA), create a regulatory body for SCAs, strengthen the Rural Finance Corporation (RFC), and finance a rural credit line to SCAs. Learning and Innovation Loan (LIL). The project is processed as a LIL because it allows to build trust among the members of the SCAs and test the institutional capacity of the SCAs, the RFC, and the regulatory body needed for a larger follow-on operation. B: Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project (see Annex 1): CAS document number: 15499-MD Date of latest CAS discussion: 4/5/96 GOM's overall objective is to re-establish sustainable economic growth. The Bank's assistance program supports private sector development, public sector restructuring, and improvement of financial discipline. The CAS specifically identifies the transformation of public institutions and services of the agriculture sector as important to re-establish growth. It describes the provision of financial services to primary agriculture as a key component to ensure the supply response in agriculture that would lead to growth of the sector. 2. Main sector issues and Government strategy: Government strategy for agriculture is aimed at creating the enabling environment for a  Page 4 private agriculture to grow. The Second Structural Adjustment Loan1 (SAL II), is designed to deepen the reforms in agriculture, especially in the further de-monopolization of input supply and grain handling, acceleration of farm restructuring and land reform, and the liberalization of agricultural trade. Therefore the macro-economic framework and an appropriate sector reforms are underway to ensure an enabling environment for growth in agriculture. The overall agricultural strategy consists of four elements; farm restructuring and land privatization; reform and growth of the agro-processing sector, de-monopolization of the input and products market, and institutional reform, including the creation of new institutions to provide financial services to a private agriculture sector. The Project supports these objectives directly. Farm Restructuring and Land Privatization. A strong move is underway to improve agriculture productivity and marketing by promoting land reform and farm restructuring. The recently passed amendment to the law on normative prices allows for lease, purchase, and sale of agricultural land at market conditions. GOM simplified land privatization and farm restructuring regulations, created a special agency to promote rapid farm restructuring, and started a large farm restructuring program in 1997. GOM is committed to completing the distribution of land and the assets of the large farms as soon as possible so that private farms of different organizational forms and sizes can establish themselves. The project will help newly emerging private farmers access the credit resources to be provided under the project through Savings and Credit Associations (SCAs), thereby directly supporting the land reform process. Agro-Processing. Most agro-processors have been privatized and there is visible growth in the industry, but it continues to emerge slowly. Some of the agro-processors have started to modernize their operations, have attracted foreign direct investors, including the IFC, and have successfully increased their output and sales. However, many of the agro-processors are undercapitalized and are still in the process of being restructured. The more successful agro- processors have access to foreign credit lines through the Private Sector Development Project (PSD) and EBRD credit lines. EBRD operates a special "microcredit" line that offers small loans of up to US $20,000 to small enterprises, including smaller agro-processors. This Project would complement the existing credit lines by offering micro loans to artisans and micro-entrepreneurs in the rural areas. De-Monopolization of the Input and Products Market. In order to increase competition in the inputs and products market, GOM is committed to fully privatize and de-monopolize the remaining Cereale and Fertilitatea companies. This measure would then improve the access of primary agriculture to different input supply and marketing channels, which then, in turn, would increase the profitability of primary agriculture. 3. Sector issues to be addressed by the project and strategic choices: The project deepens the agricultural sector reforms supported by SAL II. Therefore no sector-specific conditionality is included in the loan. Through this project, private farmers will have an alternative source for farm credits and become less dependent on the ex-collective farms for the provision of inputs and services. The project complements the existing financial services for agro-processors in the rural areas by directly financing the primary production of small private farmers and the activities of micro-entrepreneurs. In addition, the project contributes to de-monopolization of the partly state controlled input and products market for agriculture, because farmners can obtain the financial means through the project to buy from and sell products to different traders. The SCAs might also offer a basis for future farmers' cooperative organizations to purchase inputs or market the agricultural products. SAL II became effective in October 1997.  Page 5 C: Project Description Summary 1. Project components (see Annex 2for a detailed description and Annex 3 for a detailed cost breakdown): A. Development of Savings and Credit Associations (category: institution-building). The project would provide technical assistance and training to develop SCAs in the rural areas of Moldova.. The Rural Finance Project Implementation Unit (RFPIU), which is under the auspices of the Ministry of Finance, will engage NGOs acceptable to IDA to develop SCAs, train the board and members of the SCA, and provide accounting services to the SCAs. The Moldova Microfinance Alliance (MMA), a local non-governmental organization (NGO) has the necessary skills to provide training to SCAs. MMA would receive an initial grant for the first two years of operations from the Soros Foundation, WWB, and possibly the Gesellschaft fuer Technische Zusammenarbeit (GTZ) to cover the costs of the foreign technical assistance and part of the local operating cost. The other part of the operating cost will be covered through a small fee MMA charges the SCAs. These SCAs would mobilize savings from and lend to their members. It is expected that up to December 1998 about 73 SCAs with about 3,800 members and up to December 1999 about 130 SCAsl with about 8,400 members will be created and receive loans through the project. The growth of SCAs matches a thorough training plan for SCA and RFC staff, in order to ensure a cautious development of the loan portfolio. About 350 SCAs are expected to operate over the next five years. These SCAs could be possibly financed through a follow-on project. B. Establishment of a regulatory body of the SCAs (category: institution-building). The project will provide technical assistance and training to the RFPIU to temporarily supervise and regulate SCAs, to develop the framework for a permanent regulatory body of SCAs, and to finance year- end audits of SCAs established under the project. This regulatory body would monitor compliance of SCAs with the prudential rules for SCAs, which have been agreed between the Government and IDA during preparation. The design of the regulatory structure is still under discussion and will be further developed and tested during project implementation. Future regulation is possible through either (a) a government regulatory body for SCAs or through (b) a self-regulatory body created by the SCAs. The operation of the SCAs will be governed by a draft law on SCAs2 which has been presented to Parliament. The promulgation of this law, acceptable to IDA, is a condition of effectiveness. C. Establishment of the Rural Finance Corporation (RFC) (category: institution-building). The Project would provide technical assistance and training to the RFC. This is a new wholesale institution to channel a credit line to legally registered SCAs, owned by its member SCAs, registered as a financial joint-stock company under Moldovan law, and licensed as a non-bank financial institution. RFC will operate according to agreed prudential rules (Annex 2) and an agreed policy manual, specifying RFC's lending policies. If more than 10% of the credits from SCAs to RFC are overdue by more than 60 days, IDA may suspend the loan. The adoption of the statutes and the Operations Manual, acceptable to IDA, and the appointment of a General 'it is expected that about 153 SCAs will operate at the end of 1998, of which about 130 would be financed through the project. 2the draft law has been reviewed and agreed with IDA.  Page 6 Directorl is a condition for effectiveness. All SCAs borrowing from the RFC must contribute to the share capital of RFC and become shareholders. RFC is majority owned by the SCAs with the Government of Moldova holding 20% of the voting shares of RFC. The RFC would be capitalized in three ways: (i) SCAs will pay in share capital; (ii) each SCA which wishes to borrow from RFC will be required to invest, in form of privileged shares, 5% of the loans outstanding from RFC; and (iii) GOM will grant RFC "quasi-equity" in the form of a 35 year loan of US $2 million with an interest rate of 0.75%, The RFC would take the full commercial lending risk. D. Rural Credit Line for SCAs. The Project would provide a credit line to RFC who in tum will extend loans exclusively to SCAs operating in the rural areas. The SCAs will, in turn, onlend these loans to their members. Most of these loans will be small (average US$ 500-700) short- term loans (9 - 12 months) to finance investments.for productive purposes like seasonal agricultural inputs, spare parts for equipment, small works, or other small investments. Only rural SCAs which have been registered in accordance with the Law on SCAs, have made all necessary contributions to RFC, received training from the MMA2, are fully current in their debt service obligations to the RFC, and meet the SCA's prudential rules, would qualify for a loan. For small loans, the SCAs will rely mainly on a mutual guarantee of its members and for larger and medium-term loans the SCAs will require the member-borrowers to provide collateral. All members of the SCA jointly guarantee repayment of the entire loan to the RFC. SCAs will be responsible for evaluating loan applications from members combining them into a single loan application and submitting it to RFC. The RFC's loan assessment will be limited to reviewing the SCAs financial soundness. The credit line will be in Lei with GOM bearing the foreign exchange risk. The interest rate to RFC will be determined semi-annually based on the 3 month auction rate of the National Bank of Moldova3. MOF has the right to charge an additional guarantee fee of up to 2% which is determined on past loan repayment performance. RFC will add a spread of about 5% to the onlending interest rate. RFC will repay the loan to MOF in semi-annual installments over 20 years, including a grace period of 5 years. Project Cost Table Component Category Cost Incl. % of Bank- % of Contingencies Total financing Bank- (US$M) (US$M) financing Establishment of SCAs institution- 0.8 14% 0 0% building Regulatory Body of SCAs institution- 0.2 3% 0.2 4% building Establishment of the RFC institution- 0.2 3% 0.2 4% building Rural Credit Line for SCAs credit line 4.9 80% 4.6 92% Total 6.1 100% 5.0 100% 2. Key policy and institutional reforms supported by the project: Farm restructuring and land reform by providing working capital and medium-term loans to I an interim General Director had been appointed prior to negotiations 2or any other NGO acceptable to IDA 3At around 18% in November 1997  Page 7 newly emerging private farmers and rural entrepreneurs; * increase in competition among agricultural input suppliers and buyers of agricultural produce by delinking inputs and marketing from the supply of credits; * development of the legal and institutional basis for a sustainable cooperative rural financial system. 3. Benefits and target population: * An estimated 10,000 small private farmers and small rural entrepreneurs will gain access to the financial markets and receive working capital and medium-term loans; * introduction of a cost effective rural financial system for micro-loans; * mobilization of savings from the rural population; * provision of finance for small, productive investments to generate income and employment; * establishment of a sustainable cooperative banking system similar to Credit Unions, which would mobilize savings and finance investments in the rural areas; and * encourage the formation of farmer self-help organizations in other areas like marketing cooperatives or producer cooperatives. 4. Institutional and implementation arrangements: The overall direction and coordination of the agricultural investment program (consisting of the First Agriculture Project, the proposed Rural Finance Project, and the proposed Irrigation Rehabilitation Project) is in the hands of the Project Preparation Committee (PPC). The PPC is chaired by a Deputy Prime Minister, includes representatives of different Ministries, and has been functioning since mid 1996. Project identification and preparation was managed by the Agency for the Implementation of the Rural Finance Project (RFPIU) under the auspices of the Ministry of Finance. The RFPIU was officially created in March 1997, and coordinates all project activities. During implementation, it will be responsible for: (i) coordinating project activities, (ii) managing monitoring & evaluation, procurement and reporting to IDA, (iii) administering disbursements and oversee the collection of funds advanced to the RFC; (iv) engaging NGOs to develop and train SCAs, (v) temporarily supervising the SCAs created under the Project until a regulatory body has been established. For the detailed monitoring and evaluation arrangements, indicators, and responsibilities, compare the Project Design Summary (Annex 1). The staff of the RFPIU will consist of a Director, a regulatory officer, and an administrative assistant. The Ministry of Finance shall maintain all the records and accounts for the Special Account and ensure that it is properly audited by independent auditors acceptable to the IDA. If more than 10% of the loans made by the RFC to SCAs are overdue for more than 60 days, IDA may cancel disbursement of the Credit Line. A mid term review will be scheduled for March 1999, and an ICR will be prepared six months prior to the expected final disbursements in June 1999. The monitoring and evaluation results will be used to determine and design the follow-on project, for which appraisal will be tentatively scheduled for end 1998.  Page 8 D: Project Rationale 1. Project alternatives considered and reasons for rejection: Financing Channel for the emerging private farming and rural enterprise sector: * Provision of credit line through the existing commercial banks for retail lending. This was rejected because: (a) high commercial bank lending costs and strict collateral requirements make it impossible for commercial banks to meet the demands of the majority of the small emerging farmers; and (b) access to capital is not a constraint for the major commercial banks because of the availability of credit lines from EBRD and the World Bank PSD Project. * Creation of a new financial institution, similar to the Agricultural Finance Corporation (AFC) in Latvia, that would provide retail lending to individual private farms or rural enterprises. This was rejected because: (a) there are already three large commercial banks with a considerable branch network in the rural areas; (b) reasonable lending costs and profitable lending margins for retail lending are difficult to achieve in the rural areas of Moldova because of the small average loan size due to the small farm structure (<5 ha); (c) commercial banks have access to the special "microcredit" lines of the World Bank and EBRD to refinance loans of less than US $20,000. * Lending through the existing commercial banks to SCAs. Except for Agroindbank, commercial banks declined to participate in this project. However, due to the urgency of making the loan available before the spring planting season, and the necessity to simplify the project structure, it was decided to delay processing of this request until 1999. Commercial banks will be included in the follow-up project, if they continue to express interest. Type and Capitalization of RFC * Creation of RFC as a bank from the start. This was rejected because: (a) RFC does not mobilize savings and is therefore not considered a bank under the Law on Financial Institutions; and (b) the staff of RFC does not have sufficient expertise in the full range of banking operations. * Creation of RFC as a Government-owned institution and privatizing it over time. This was rejected, because: (a) private farmers do not trust the state and feel that the state owes them for unpaid pensions and other undelivered services, therefore payment delinquencies were expected to be high; and (b) a gradual privatization approach would involve the complication of having to put RFC under the privatization auspices of the Ministry of Privatization. * Creation of RFC as a Project Implementation Unit (PIU) to distribute loan funds to SCAs. This was rejected because a PIU-type operation: (a) would be vulnerable to political influence; and (b) might develop a slower response time than a commercial operation because of lack of incentives for the staff. Regulation of SCAs * Have the National Bank regulate SCAs. This was rejected by the National Bank and by IMF consultants because: (a) SCAs do not fall under the Law on Financial Institutions and do not need to be regulated by NBM; (b) the staff of NBM do not have the capacity to supervise large numbers of SCAs in addition to the existing 20 commercial banks; (c) the prudential requirements for banks are more complex than what is necessary for SCAs with limited amounts of equity; and (d) the equity capital, total borrowings, and savings of the individual SCAs are below the threshold where meaningful regulation by a National Bank should be required.  Page 9 2. Major relatedprojects financed by the Bank and/or other development agencies (completed, ongoing andplanned): Sector issue Project Latest Supervision (Form 590) Ratings (Bank-financed projects only) Implementation Development Progress Objective Bank-financed Deepening agriculture sector reforms SAL II N/A N/A (implementation) Developing financial institutions - credit Private Sector S HS line to commercial banks Development Project (implementation) Strengthening agricultural research of high First Agriculture Project S S value crops (implementation) Rehabilitating irrigation systems Water Resources Development Project (preparation) Development of rural land registration First Cadastre Project (effective) Other development agencies SME credit line through commercial EBRD - Project banks TA to commercial banks in rural EU (TACIS), UK finance Know-how Fund TA to National Bank to strengthen IMF banking supervision _ I IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: The creation of an appropriate policy environment is a necessary pre-condition for the successful development of the rural financial sector. The SAL II supports the necessary policy reforms in the agriculture sector. The Rural Finance Project is the first follow-on project aimed at deepening the sector reforms supported through the SAL II program. Whereas microfinance operations are one of the best tools to increase the economic participation, income, and assets of the bottom 50% of a country's economic active population, a new start-up operation is difficult to design and risky to implement. Therefore complexity of the project was reduced by limiting the objectives to the development of a sustainable financial institution and an appropriate legal and regulatory environment for this institution. Regarding the financial sector policies, GOM and NBM are encouraging structural change in the financial system, by developing a law for SCAs and setting up a regulatory structure that encourages the entry and growth of SCAs. Key factors that will contribute to RFC's success include: strong leadership to establish and enforce high performance standards for financial and operating perfornance; accountability, autonomy, and freedom from political interference, the capability to mobilize funding to build the sustainability of RFC; intimate knowledge of, and competence in, assessing the retail institutions (SCAs). Additional factors include excellent repayments, non-subsidized interest rates that are high enough to finance the operating costs, low operating costs, diversity in portfolio between  Page 10 agriculture and rural non-agricultural microentrepreneurs, and an achievable plan to capitalize the RFC over time. Sound governance, reduction of political influence, and accountability would be ensured through majority SCA ownership and a stepwise capitalization of RFC. Likewise, RFC will know the SCAs intimately and only extend loans to those SCAs that meet agreed performance standards. International experience suggests that the development (but not the lending operations) of SCAs needs to be subsidized in the first years. In order to separate the development function from financial service transactions, an NGO, the Moldovan Microfinance Alliance (MM} will provide these services on a separate balance sheet with donor grant financing. The MMA will also organize training programs for SCAs and provide commercial banks with information about the SCAs operations in order to motivate the local banking sector to lend to SCAs. The SCAs need to mobilize financial resources from their members in order to reduce dependence on external financing. Therefore, the law on SCAs would allow them to mobilize savings from their members under appropriate prudential standards. 4. Indications of borrower commitment and ownership: * GOM has made numerous requests to quicken the pace of project preparation and there has been a broad consensus regarding the project objectives and design among the Ministries of Finance, Agriculture, Economy, Justice, the National Bank, and NGOs representing private farmers; * demand by private farmers and rural entrepreneurs for small loans from SCAs has far outstripped the supply of seed capital for credits provided during the pre-pilot phase; and * A conference on microfinance and WWB in August 1997 attracted a large participation of representatives of Moldovan Government institutions, including the National Bank, non- governmental farmers' organizations, and politicians supporting the importance of this project for Moldovan agriculture. 5. Value added of Bank support in this project: The Bank's support will transfer the necessary knowledge to introduce the concept of SCAs to Moldova, develop and test the regulatory body, establish RFC, and mobilize savings within SCAs Without the Bank's involvement, microfinance institutions like the SCAs would not have received the confidence and agreement of the Government to operate in Moldova. E: Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (supported by Annex 4): A representative farm survey carried out in 1997 has shown that small farms are generally more profitable than the ex-collective farms. Based on these results, model calculations for three small private farms (2.75 ha) located in the northern, central and southern region of Moldova show that total interest payment for these loans (30% interest, 6 months maturity) is affordable and varies between 12 - 30% of the calculated net returns from agriculture. 2. Financial (see Annex 2): Financial projections indicate a satisfactory position of RFC from year one, mainly as a result of the 35 year low interest loan of US $2 million from the Government of Moldova. RFC should be in a position to enlarge its lending volume substantially within the next few years, without large capital infusions from SCAs while maintaining a debt equity ratio of 3.8:1 and capital adequacy of 21%. Similarly, the projections for a typical SCA, even on the basis of a low spread of 2.4%, indicate that the  Page 11 SCA will be able to service their debts comfortably and satisfying all the norms relating to capital adequacy, liquidity, and bad debt provisioning as stipulated in RFC's prudential rules. Fiscal impact: The project will have a small fiscal impact on the state budget because the SCA regulatory body needs to be financed by GOM in the initial years. Indirectly, it will contribute to increasing tax revenues by increasing the output and profitability of the final beneficiaries. 3. Technical: The SCAs will receive training from MMA and RFC staff in technical appraisal of sub-projects, accounting procedures, and management of capital flows. 4. Institutional: a. Executing agency: The RFC, the major executing agency, is a new institution, and will receive technical assistance and staff training during the implementation period. The accounting and auditing system of RFC will be kept according to regulations of the Ministry of Finance. RFC will monitor quarterly financial information of SCAs and in turn, RFC will submit to GOM and IDA quarterly financial statements and management reports on its operations, including liquidity and arrears. RFC's accounts will be audited annually by an independent auditor acceptable to IDA. b. Project coordination: Project implementation will be coordinated by the Rural Finance Project Implementation Unit in the Ministry of Finance (see implementation arrangements). The RFPIU has successfully managed project preparation. 5. Social: A rural sector social assessment was finalized in November 1997. It confirms that short-term loans for seeds and other inputs are among the biggest needs expressed by independent farmers. Farmers also noted that obtaining a short-term loan from a commercial bank is difficult and time consuming. 6. Environmental assessment: Environmental Category []A [X] B [] C The credit officers of RFC and the training officers of the Microfinance Alliance will receive a training course on environmental screening of loan applications. In addition, a leaflet on the use of agricultural chemicals will be distributed to the SCAs. Ex-post evaluation of the pilot project will include an evaluation of the exact nature of the activities financed by the credits. If necessary, additional environmental controls will be built in. Pesticides categorized as: l(a) (extremely hazardous) and l(b) (very hazardous) under the WHO classification will not be financed under the loan. 7. Participatory approach: a. Primary beneficiaries and other affected groups: Primary beneficiaries are small private fanners and rural micro-entrepreneurs. About 400 primary beneficiaries actively participated in the design of the project during this year. This was achieved by creating SCAs as voluntary village-based organizations by the beneficiaries themselves. The members of the SCAs elect a board and a supervision council from their members, and the general assembly actively participated in drafting the statutes and by-laws, setting interest rates, membership fees, and risk fund contributions. The board of the SCAs screens and approves all the loan applications, and the whole group has joint liability for repayment. This experience has been used to draft standard statutes and set the requirements for receiving loans from RFC. All existing SCAs and all future SCAs that want to borrow funds  Page 12 from the RFC have to become shareholders of RFC and have to pay in a voting share capital of about US $500 per SCA. Therefore the business plan, statutes, and lending policy developed by the project team, were presented to about 50 elected representatives of SCAs for discussion, recommendation, and approval. The Corporate Structure of RFC will allow for continuous and direct participation of key stakeholders on all decisions of RFC during establishment and project implementation. The structure consists of a general assembly of shareholders (e.g. SCAs) that will vote on all important matters, e.g. distribution of profits, election of the members of the Council and the Supervisory Committee. The Council (the Board of Directors) will consist of five members, of which four are representatives of the SCAs and one from GOM. The Council will appoint the management of RFC and determine the lending policy. b. Other key stakeholders: These are the representatives of different Government agencies (Ministries of Finance, Economy and Agriculture), the National Bank (independent body), the parliamentary representatives, non- governmental interest groups of farmers (National Farmers Organization, St. Georges Cartel), and representatives of commercial banks. Representatives of these groups have, to various degrees, been informed and consulted. Some have actively participated in designing the project. Representatives of the non-governmental organizations have also actively participated in project design and some have key positions in SCAs (e.g. chairman of one of the SCA Boards). F: Sustainability and Risks 1. Sustainability: Sustainability will depend on: (i) high loan repayment rates; (ii) good leadership and human capacity in the SCAs, RFC and the MMA; (iii) appropriate legislative and regulatory framework; and (iv) competition in the inputs and products markets, especially fertilizer, seeds, and grains. 2. Critical Risks (reflecting assumptions in thefourth column of Annex 1): Risk Risk Risk Minimization Measure Rating (Insert - Annex 1, cell "from Outputs to Objective") The local banking system does not M WB and IMF support to NBM and MOF to maintain have the stability to weather external sound monetary, fiscal, and interest rate policies. shocks. Slowly emerging competition in the M Competition of input supplies will be increased through predominantly state-owned input the privatization of the Cereale and Fertilitatea enterprises supply and grain marketing system which is included in this year's privatization program. might result in farmers receiving low These measures are supported through the SAL II payments or payments in kind for program. their products.  Page 13 (Annex 1, cell "from Components to Outputs") Poor loan repayment from SCAs to H Key to ensure high repayment is the joint and several RFC. liability of the SCAs. They will be establishment as voluntary, democratic SCAs with a coherent membership structure, in-depth development assistance and a training program for Board and members of the SCAs. RFC will require high performance standards of SCAs through a good financial monitoring system and benchmark criteria to detect possible poor repayment from the outset. In order to allow for organic growth, the number of SCAs to be developed and refinanced by RFC would be restricted in the first year of implementation. In addition, close and frequent supervision from the Bank will be necessary. Political influence on loan allocation. H SCAs would own a majority share of RFC right from the start in order to limit political influence. In addition, IDA would supervise RFC's operations regularly. All SCAs would be developed with assistance of the MMA. Risk of failure of the mutual S The mutual guarantee mechanism was tested during one guarantee mechanism. year by SCAs established under the pilot project prior to the commencement of the RFC's operations. Experience with this pilot program has been positive and is built into the project design. For example, individual loans would be co-signed by other members, the SCA would also use fixed assets as collateral for larger loans, members of SCA would, over time, increase the size of their paid-in capital in their SCA, and the SCA would start to mobilize savings from members. Overall Risk Rating S Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk) 3. Possible Controversial Aspects: The speed of lending in the first year of RFC's operation could be considered controversial. Whereas GOM wants RFC to expand lending to SCAs as quickly as possible, IDA wants RFC to grow slowly in its first year of operation. Only then can the new staff gain experience with lending procedures thereby ensuring adequate institutional capacity before operations will be expanded. G: Main Loan Conditions 1. Effectiveness Conditions: a) The SCA law has been adopted by the Parliament of the Borrower; b) The statutes and the operational manual have been adopted by RFC, acceptable to IDA, and a General Manager with qualifications and experience, satisfactory to IDA, has been appointed; c) The RFC has signed a subsidiary loan agreement with the MOF, satisfactory to IDA..  Page 14 2. Other Covenants a) The RFPIU shall be maintained for the duration of the project; b) The RFPIU or a national supervisory and regulatory body, acceptable to IDA, supervises SCAs participating in the project; c) By August 31, 1998 a consultant shall be engaged to prepare a plan for the establishment and operation of a national supervisory and regulatory body and by March 1, 1999 this body shall be established; d) RFC shall relend the credit line to SCAs under terms and conditions agreed with IDA; e) RFPIU shall engage NGOs, acceptable to IDA, to provide training to SCAs participating in the project; f) RFC shall carry out its operations in accordance with the RFC prudential rules and guidelines in the operational manual; g) RFC shall make subloans to only those SCAs that meet specified eligibility criteria; h) If more than 10% of the total principal amount then outstanding of all loans made by RFC to SCAs are overdue past 60 days, IDA may stop disbursements; i) No pesticides falling into Category 1 (a) and 1 (b) of the WHO classification shall be financed through the credit. j) The GTZ Grant Agreements shall become effective latest by June 30, 1998. H. Readiness for Implementation [ ] The engineering design documents for the first year's activities are complete and ready for the start of project implementation. [xl Not applicable. [ ] The procurement documents for the first year's activities are complete and ready for the start of project implementation. [x] Not applicable. [x] The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. [x] The following items are lacking and are discussed under loan conditions (Section G): ratification of the law on Savings and Credit Associations. I. Compliance with Bank Policies [x] This project co7!plies with all applicable Bank policies. Task Team Le FRia roh Sectorctor: Kevin Country Director: Roger Grawe  ENVIRONMENTAL DATA SHEET FOR PROJECTS in the IBRD/IDA Lending Program County: MOLDOVA Project ID No: 35781 Project Name: Rural Finance IBRD Amount ($m): US $5.0 million Appraisal Date: October 9, 1997 Board Date: N/A Task Manager: Florian Grohs Managing Division: ECSRE Sector: Agriculture/Credit Lending Instruments: LIL Status: Lending Date (est) for receipt of EA by Bank: EA Category (A/B/C): B Date Assigneoi November 5, 1997 Date Sheet PrepareUlpdate (Please do not lave any items blank: use ^N/A' or 'To be developed" when appropriate) Major Project Components., (presents description of project components) (i) promote income and economic development of private farmers and entrepreneurs in the rural areas through provision of financial services, and (ii) to develop and test a cooperative rural banking system that would efficiently provide these fnancial services to the beneficiaries. In order to achieve these objectives, the Project would establish Savings and Credit Associations (SCAs) and train their members with assistance of the Moldova Microfmance Alliance, create a regulatory body for SCAs, strengthen the Rural Finance Corporation (RFC), and finance a rural credit line to SCAs. Major Environmental Issue: (describes major environmental Issues identified or suspected In project) - no major environment^l issues expected from institutional components; - The average loan size is small (US$ 600 per borrower) and the types of investments would aimed at increasing the agricultural production of smallholder farmers from their existing fields. Investments in non- agricultural activities are not expected to lead to any negative environmental impacts. No more than 5 % of the outstanding credits would be used to purchase agricultural chemicals (fertilizers or pesticides). Other Environmental Issues: (describes environmental issues of lesser scope associated with project) none ProposedActions: (describes actions proposed to mitigate environmental issues described in project) The credit officers of RFC, the training officers of the Microfinance Alliance, and the staff of the SCAs will receive a training course on environmental screening of loan applications, including pesticide hazard classification. Ex-post evaluation of the pilot project include an evaluation of the exact nature of the activities financed by the credits and if it is necessary to build in additional environmental controls. Pesticides categorized as l(a) and 1(b) under the WHO classification will not be financed under the loan. JusHflcatioruRationalefor Environmental Category: (reuons for environmental category selected & explanation of any changes from Initlal clualficatIon) Some training will be needed for officials of RFC and the SCAs to screen and eliminate dangerous pesticides from loan applications. This is to avoid a situation, although unlikely, that small farmers purchase potentially harmful material. Status of CategoryA EnvlronmentalAssesmentr (preents EA start-up date, EA first draft, and current status) n/a Remarks: (gives status of any oter environmental studies, lists locl groups and local NGOs consulted, tells whether borrower hu given permission to releae EA, eam) Signed Signed by: _ I by: 'JItMU Laura Tuck, Sector Leader, ECSRE ke.hel D Revers. Sector Leader, ECSRE November 5, 197  l  Annex 1 Project Design Summary Moldova: Rural Finance Project Narrative Summary Key Performance Indicators Monitoring and Evaluation Critical Assumptions Sector-related CAS Goal: (Goal to Bank Mission) Increase income and Growth of agriculture GDP Agricultural and financial Farm restructuring and land generate growth of private becomes positive again statistics reform accelerates. agriculture. Agricultural processing, marketing, and exports improve. Project Development (Objective to Goal) Objective: * Regulatory Body for * Supervision mission Sufficient local support and to develop and test a SCAs established and reports; savings to implement and cooperative rural banking operating * Mid-term Evaluation sustain SCAs system that would * RFC established and mission report efficiently provide financial operating services to private farmers * All SCAs meet and rural entrepreneurs. prudential requirements Outputs: (Outputs to Objective) * target number of SCAs * by end 1998 - 70 SCAs * Mid-Term Review latest * MMA has sufficient operating successfully and by mid 1999 about March 1999; donor financing to carry * regulatory agency 130 SCAs formed; * Quarterly Progress out operations; established and tested * about $ 2 million Reports prepared by * MOF agrees to set up and is ensuring outstanding in loans; MMA and RFC; and partly finance prudential operations of * about 5 SCAs started * Quarterly accounting regulatory agency SCAs. savings mobilization. information provided to * SCAs actively use * efficient re-financing * less than 10% of the RFC and regulator by shareholder institution for SCAs principal loan amount MMA; responsibilities and limit tested and operating. are overdue by more * Supervision mission and political influence on * financial resources and than 60 days; audit report on loan allocations services targeted to the * RFC operates fully operations of RFC poorer t ,gments of the within RFC prudential * Quarterly Progress and population. rules; Disbursement Reports * average loan size and * Subsidy Dependence savings amount smaller Index of consolidated than per capita GDP. financial statements of RFC and MMA Project Components: Inputs: (budget for each (Components to Outputs) (see Annex 2 for project component) description) * Development of SCAs * $ 0.8 million Quarterly Progress Reports * Willingness of farmers * Establishment of a * $ 0.2 million and Disbursement Reports and rural entrepreneurs Regulatory Body for to create SCAs and take SCAs mutual responsibility * Establishment of RFC * $ 0.2 million * Parliament passes the * Credit Line for SCAs * $ 4.9 million law on SCAs   Annex 2 Rural Finance Project- Project Description PROJECT COMPONENT 1- DEVELOPMENT OF SAVINGS AND CREDIT ASSOCIATIONS Savings and Credit Associations (SCAs) A. Background 1. The number of private farms reached about 156,000 in mid-1997 and is increasing rapidly. Most of the newly created farms and enterprises are presently unable to access loans from commercial banks largely because: (a) the typical loan size of these enterprises is too small to cover the intermediation costs of commercial banks using a classical lending approach; and (b) most of these enterprises have inadequate assets to offer sufficient collateral to commercial banks to secure loans. At the same time, these new farms and enterprises have considerable potential for growth and for generating additional income and employment in rural areas. Relatively small investment amounts (typically between $200 and $1,000) could enable fanners to buy good quality seed, ferdlizers and other critical farm inputs along with the hiring of farm machinery services. These loans are thus expected to result in significant increases in agricultural production and to provide rural artisans with access to necessary working capital and investment credits to purchase tools and materials. B. The Pilot Program 2. A Pilot Program was started in December 1996, to test the concept of Savings and Credit Associations (SCAs) in rural areas, and to develop, using a participatory approach, statutes, regulations and eligibility criteria for loans to members. FIDES, an international NGO that has successfully assisted in the creation of village credit associations in Albania, was recruited to assist with the pilot program. As of September 1997, FIDES created 11 SCAs and is presently managing loans to these Associations with grant funds provided by the Dutch Government (US $80,000) and the Soros-Foundation (US $100,000). Additional funds to finance these Associations through the Rural Finance Project Implementation Unit, and new ones to be created prior to approval of the Bank's loan, were provided through a US $750,000 PPF approved by the Bank. 3. The first 11 SCAs with an initial membership of 497 were founded and registered in central and southern Moldova. Members in these Associations purchased their initial membership shares (average value lei 27) and elected the administrative and supervisory councils. All SCAs were trained in the screening of credit applications and the use of the regulations. Another 13 SCAs are in the process of being formed, and a total of 40 Association are expected to be created by March 1998. During 1997, at total of41 1 loans  Annex 2 2 were extended with an average duration of ten months, a total value of lei 840,900, and an average loan amount of lei 20,500 (US $450). Practically all loans were below the agreed US $1,000 ceiling. These loans were mainly used to purchase seeds, fertilizer, pesticides, fuel and spare parts for tractors needed for the agricultural spring season. Several of the loans were also used for income-creating diversification activities such as livestock, handicrafts, processing of agricultural products and rural trade. Most loans granted to date are due to be repaid by December 1997. Repayment rate of these loans has been exceptionally good, with some borrowers prepaying their loans and with all indications that the pilot will reach an overall recovery rate of 100%. 4. Experience gained during the pilot project's first year indicates strong demand for credit on the part of farmers participating in the project, and others in neighboring villages. Even in villages taking part in the project, however, only a small fraction of villagers have joined the SCAs, but many more registered interest in joining at a later stage. A monitoring program has been built into the pilot program from the start to allow evaluation and analysis of results. C Ownership and Capitalization 5. Each SCA is an economically and legally autonomous private organization. Membership is voluntary and limited to private persons living in the village of the SCA. The SCAs provide financial services (taking deposits and granting credits) to their members. A minimum of 15 members is required to establish an SCA. The decision making body of the Association is the General Assembly, in which every member has one vote. The Assembly elects a President and a Board which reports to the Assembly. The Board decides on the approval of loan demands and mobilization of external resources. At a later stage as the financial activities of the SCA expand, the Board may decide to recruit a professional director who will not have to be a member of the Association, and who could serve in either a part-time or full-time capacity. 6. Each SCA will build up statutory capital by: (a) collecting membership fees; (b) mobilizing savings; and (c) charging a fee from each sub-borrower. Initial membership fee will be kept low (25 to 100 Lei) in order to allow poorer farmers to participate. Savings mobilization will start as soon as the law on Savings and Credit Associations is ratified by parliament. Starting in the first year of operation, each SCA will guarantee at least 7% of the outstanding loans with its statutory capital; this guarantee amount will be increased over time and is expected to reach 17% by year 5 (see Table I for details). D. Lending Operations and Savings Mobilization 7. The SCA Board selects borrowers from among the members who are known in the village for their trustworthiness and who request a loan for an income creating activity. All loan requests are presented to the administrative council and undergo appropriate credit risk evaluation. The appropriate procedures were developed under the pilot project. Priority is given at the beginning to relatively small size short term loans.  3 Project Description Farmers express priority for financing inputs for agriculture with loans up to US $1,000 per farmer. Higher amounts and medium term loans (mainly for machinery) will be granted starting in the second year, provided the SCA has a good repayment record. 8. Loans will be guaranteed by social pressure for small loans and by collateral for more important loans. Based on the principles of mutual-guarantee financial organizations, the new institution will provide simplicity of access to financial services and private ownership. In principle, a group guarantee would be sufficient for small loans, whereas the administrative council of the SCA will ask for other forms of collateral to complement the group guaranty for medium-term loans. Social pressure between members and a reasonable credit policy are expected to keep repayment delays and unrecoverable loans to a very low level, without impact on the viability of the institution. The SCA statutes do not allow the allocation of new loans to a borrowing member if even a single repayment of this member is delayed. In turn, the RFC statutes do not allow the allocation of a new loan to an SCA, if this SCA is late in repaying its loan to RFC. 9. Savings mobilization is also a major objective under this project. At present the savings capacity of the farmers is low, due to economic crisis. However, it is anticipated that SCAs will start savings mobilization during the second year of their operations. In the longer run local savings mobilization could become an important resource for credit. E. Lending Terms 10. The interest rate for loans from an SCA to their members or for savings deposits by members will be set by the general assembly of the SCA. The interest rate for loans covers resource costs, transaction costs, and risk costs, and will be positive in real terms. The IDA credit line will be made available to RFC at the NBM auction rate for 90 day funds (currently about 16% - 20% per annum). RFC will be given up to 5% spread to cover its expenses and thus the loan to an SCA will be 21% - 23% for short term loans of up to one year duration. Medium term loans (maximum three years duration) will carry a further 2% interest charge. SCAs will be free to add a charge (projected to be 2.4%) to cover their operating costs. The established interest rate is fixed for the whole term of the loan. Short-term loans are expected to be repaid at the end of the year, usually at the time of harvest. Interest and principal for medium-term loans will be payable semi-annually. All loans will be in Lei, with the government bearing the foreign exchange risks. F. Credit Risk Management 11. Each SCA will be required to make provisions for a "risk fund" to cover the repayment default by an individual member. Use of the risk fund will be deterrnined by the SCAs' prudential regulations. It will amount to at least 7% of the outstanding loan amount during the SCA's first year in operation and increase to 17% by the fourth year. For all borrowing from RFC, each association will be required to contribute into RFC's capital an amount equivalent to at least 5% of the outstanding loan arnount . This contribution to RFC will be counted as part of the association's risk fund. In order to  Annex 2 4 reduce the risk of loan default, the SCAs will be encouraged to diversify lending for a variety of activities. Each SCA will attempt to develop a credit portfolio consisting of different uses of the loans for agricultural and non-agricultural purposes, which will be discussed with, and supervised by, RFC's credit officers. G. Prudential Rules 12. Under the prudential rules governing the SCAs' operations, an SCA is required to extend credit only to its members, and is forbidden from investing in shares except in RFC or in their SCA. An SCA may not invest in real estate operations, except for its own sake or through acquisitions made in the course of debt recovery. 13. Each SCA will maintain equity at a level that will cover 5% of all outstanding short-term loans, 8% of all outstanding medium-term loans, and 100% of fixed or intangible assets and bad debts. SCAs accepting deposits from members will maintain a sufficient level of liquidity to maintain receivable assets at 125% of payable assets. 14. The maximum amount of a single investment by an SCA shall not exceed 100% of its equity or 10% of its total outstanding loan portfolio, whichever is less. The aggregate credit to members belonging to one family shall not exceed 20%/0 of the SCA's equity or 10% of the loan portfolio, whichever is less. 15. Each SCA will maintain general risk provisions equivalent to 1% of outstanding short-term credits and 2% of medium-term credits. These will be adjusted every year to ensure that the provisions are adequate to cover 30% of debts overdue for 2 months, 75% of doubtful debts (2-12 months), and 100% for irrecoverable debts (overdue for more than 12 months). 16. With the assistance of MMA, each SCA will adopt a standard accounting system and prepare quarterly reports showing the status of Risk Weighted Assets coverage and liquidity rate requirements and annual reports providing detailed information about the SCA's compliance with the prudential rules. H. Flow of Funds 17. Each SCA will open an account in a commercial bank and will receive fimds from RFC in agreed tranches. The commercial bank will disburse the funds to the SCA on behalf of RFC and will receive re-flows (interest and repayments) from the SCA. L. Business Plan 18. The SCA concept is new in Moldova and it is therefore prudent to provide substantial training to the new SCAs through the MMA, or other qualified NGOs and training institutes. As most of the SCAs manage their operations with only limited financial compensation, it is important to ensure that the management of the SCAs does not overextend itself.  L Project Description 19. The business plan for an individual SCA has been prepared with the following assumptions: * The number of members in each SCA will be 40 in the year of formation and gradually increase to 180 in the fifth year; * The reserve will increase from 7% of the loans outstanding in the first year to 17% in year five; * Savings mobilization will start in year two and will increase from an average of US $25 per member to US $90 per member; and * The average short-term loan by an SCA will be US $500, gradually increasing to US $700. The average medium-term loan will be US $1,500 gradually increasing to US $2,300. J. Financial Position of an SCA 20. The projected income statement and balance sheet of a typical SCA, and for the universe of all SCAs created under this project, are in Attachments 1 and 2. Even on the basis of an interest spread of only 2.4%, these projections indicate that the SCAs will be in a position to service their debts, and also satisfy the norms relating to capital adequacy, liquidity and provisioning prescribed in the prudential rules. This is, of course, possible only because the SCAs, as organizations run entirely by volunteers, have minimal administration costs. It is reasonable to assume that the SCAs would recruit part-time staff when the number of members reaches a level which makes it unmanageable through only volunteer efforts. When this happens, in all probability, the new members will be encouraged to organize themselves under a separate SCA. Also, in actual practice, the SCAs will charge in interest spread higher than the 2.4% assumed in these financial projections. K. Risks and Challenges 21. The pilot program was judged to be very successful, with farmers exhibiting strong support for the SCA concept. Demand for individual loans was examined carefully by the councils of the associations who uniformly selected only serious investment projects for their first lending program. Nevertheless, the present transition period presents the following risks to the financial viability of private farming in Moldova and, thus, indirectly for the SCAs: (a) payment by State enterprises for agricultural products are frequently made in kind, thereby giving rise to delays in the timely repayment of credits; (b) land registration and law enforcement remains rudimentary. Legal enforcement of contracts is especially difficult for private farmers; and (c) agricultural support services are still not targeted to meet the needs of private farmers.  Table 1 Balance Sheet of a Typical SCA ASSUMPTIONS (in US $) Nominal members share 5 Interest rate eamed on RFC share 15.00% Interest rate eamed on placements into bank 18.00% Interest rate paid on time deposits 18.00% Interest rate paid on extemal credit line 23.00% Interest rate eamed on loans to member 25.40% Fixed costs for the association during YI and Y2 50 Fixed costs for the association for Y3 to Y5 200 BALANCE SHEET (in US $) LIABILITIES YI Y2 Y3 Y4 Y5 Number of member 40 80 120 150 180 Risk Fund (% loan outstanding) 7% 9% 11% 13% 1 7% Share capital (nominal share & preferred) 1,400 5,200 12,024 22,254 34,932 Statutory reserve (eamed profits) 0 12 482 1,344 3,110 Extemal credit line borrowed 20,000 56,720 101,502 148,958 173,687 Time deposit (Average per member) 0 25 40 60 90 Total savings 0 2,000 4,800 9,000 16,200 Transformation rate Time deposit 0% 60% 60% 60% 60% Transformation rate Capital 0% 40% 50% 60% 70% Credit allocated on internal resources 0 3,280 8,898 19,042 35,113 Total liabilities 21,400 63,932 118,808 181,556 227,929 ASSETS Participaton into capital of RFC (% loan outst.) 5% 5% 5% 5% 5% Intangible assets 1,000 3,000 5,520 8,400 10,440 Average outstanding per Short term credit 500 600 650 700 700 Average outstanding per Medium term loan 0 1,500 1,800 2,100 2,300 Total number medium term loans (% member) 0% 10% 15% 20% 20% Outstanding amount of short term credit 20,000 48,000 78,000 105,000 126,000 Outstanding amount of medium term credit 0 12,000 32,400 63,000 82,800 Total loan outstanding 20,000 60,000 110,400 168,000 208,800 Short term placements into banks 400 932 2,888 5,156 8,689 Total Asset 21,400 63,932 118,808 1811,556 227,929 PROFIT AND LOSS ACCOUNT Financial expenses Interest paid on Savings 0 360 864 1,620 2,916 Interests paid on extemal credit lines 4,600 13,046 23,345 34,260 39,948 Provisions on loan portfolio (1% ST, 2% MT) 200 720 1,428 2,310 2,916 Total financial expenses 4,800 14,126 25,637 38,190 45,780 Financial income Interest eamed on RFC share 150 450 828 1,260 1,566 Interest eamed on placements into banks 72 168 520 928 1,564 Interest eamed on loans to members 5,040 15,240 28,042 42,672 53,035 Total financial income 5,262 15,858 29,389 44,860 56,165 Gross banking profit 462 1,732 3,752 6,670 10,385 SCA operating costs (% loan outstanding) 2.00% 2.00% 2.00% 2.00% 2.00% ariable costs for association 400 1,200 2,208 3,360 4,176 Fixed costs for association 50 50 200 200 200 Net profit 12 482 1,344 3,110 6,009  Table 2 Developmental Balance Sheet of the Federation of SCAs 1997 1998 1999 2000 2001 2002 Number of associations in year 1 23 23 23 23 23 23 Number of associations in year 2 50 50 50 50 50 Number of associations in year 3 80 80 80 80 Number of associations in year 4 100 100 100 Number of associations in year 5 ___ _ 100 100 Total SCAs 23 73 153 253 353 353 Number of member per SCA 40 80 120 150 180 180 Total number of members 920 3,840 9,960 19,850 33,240 45,140 BALANCE SHEET (US $) LIABILITIES 1997 1998 1999 2000 2001 2002 hare capital (nominal share & preferred) 32,200 189,600 648,552 1,669,042 3,398,056 4,729,320 tatutory reserve (eamed profits) 0 1,196 13,690 59,180 182,497 449,434 Capital adequacy ratio 7.00% 8.02% 9.28% 10.68% 12.77% 14.83% External credit line borrowed 460,000 2,304,560 6,770,546 15,038,741 25,234,871 30,751,204 otal savings 0 46,000 210,400 607,000 1,406,600 2,010,000 redit allocated on intemal resources 0 75,440 368,654 1,145,259 2,799,529 4,168,796 Otai liabilities 492,200 2,541,356 7,643,188 17,373,963 30,222,024 37,939,958 ASSETS Intangible assets 23,000 119,000 356,960 809,200 1,401,720 1,746,000 Outstanding of short term credit 460,000 2,104,000 5,794,000 12,155,000 19,188,000 22,500,000 Outstanding of medium term credit 0 276,000 1,345,200 4,029,000 8,846,400 12,420,000 Total loan outstanding 460,000 2,380,000 7,139,200 16,184,000 28,034,400 34,920,000 hort term placements Into banks 9,200 41,436 145,028 377,563 781,904 1,135,747 otal Asset 492,200 2,540,436 7,641,188 17,370,763 30,218,024 37,801,747 PROFIT AND LOSS ACCOUNT Financial expenses Interest paid on Savings 0 8,280 37,872 109,260 253,188 361,800 Interests paid on extemal credit lines 105,800 530,049 1,557,226 3,458,910 5,804,020 7,072,777 Provisions on loan portfolio (1% ST, 2% MT) 4,600 26,560 84,844 202,130 368,808 473,400 Total financial expenses 110,400 564,889 1,679,942 3,770,300 6,426,016 7,907,977 Financial income nterest eamed on RFC share 3,450 17,850 53,544 121,380 210,258 261,900 nterest eamed on placements into banks 1,656 7,458 26,105 67,961 140,743 204,434 Interest earned on loans to members 116,840 604j520 1,813,357 4,110,736 7,120,738 8,869,680 Total financial income 121,946 629,828 1,893,006 4,300,077 7,471,738 9,336,014 Gross banking profit 11,546 64,940 213,064 529,777 1,045,722 1,428,038 arable costs 9,200 47,600 142,784 323,680 560,688 698,40 ixed costs 1,150 3,650 11,100 23,6001 35,600 46,00 Net profit 1,196 13,690 59,180 182,497 449,434 683,638  Annex 2 8 Moldovan Microfinance Alliance A. Objectives 22. The Moldovan Microfinance Alliance (MMA), in collaboration with RFC, will promote the formation of SCAs and a microfmance system for rural areas of Moldova. Sustainability and the capacity to reach a significant number of private farmers and aral entrepreneurs with appropriate financial services are the main objectives of this approach. As a private institution in partnership with RFC and village-level SCAs, MMA will undertake the following tasks: a) Inform and train decision makers with interest in Microfinance: Government Members, legislators, public and private administrators, banks, research and training institutions, civil society representatives, professional organizations, associations and villages. b) Provide practical information to initiators of SCAs, especially on: * the principals of organization of SCAs and their network; * the legal framework; * the procedures of registration and licensing; and * the partnership with RFC as refinancing institution and the procedures for submission of loan requests. c) Provide training on all issues related to the start-up of SCAs such as: * accounting and financial management * prudential rules * capitalization * savings mobilization * loan appraisal and evaluation of investment projects * loan recovery * communication * collaboration with other institutions. d) Provide accounting services to SCAs: * Develop an appropriate accounting system for SCAs; * Monitoring of the SCAs' accounting and support for the production of financial reports; and * Establishment of the accounting system of the network.  9 Project Description e) Give advice and provide support in all other fields related to the activities of SCAs. f) Support the strengthening of the network and the creation of a federation of SCAs. g) Prepare a monitoring and evaluation system of the existing network and prepare studies for its extension to new rayons and villages. h) Prepare and edit publications and technical manuals on SCAs and related issues. 23. Develop accompanying measures, particularly in the fields of agricultural technologies and prevention of negative impacts of the financed activities on the environment . B. Statute 24. MMA is a local non-governmental, non-profit organization registered under the Moldovan law on public associations. Its members are representatives of Moldovan SCAs and the private donors supporting MMA: FIDES, Open Society Institute, and Woman's World Banking. Their collaboration stems from the recognition of the important role microfmance can play in terms of creation of jobs and fostering investment, especially in a transition economy. Women's World Banking's support is additionally linked to the importance of access to financial services for rural women. C. Organization and Staff 25. The activities of MMA will be organized through a head office located in Chisinau, and regional development officers, who will provide assistance to SCAs at the village level. The head office will be in charge of overall management, relations with institutional partners, publication, and support for regional activities. The staff plan for 1997/98 provides for the hiring and training 10 development officers (four in 1997 and six in 1998) and about five head office staff members (director of MMA, assistant to the director, accountant, trainer, secretary). 26. The staff plan is based on the assumption that one credit officer can manage 10 existing SCAs and initiate 10 new SCAs per year. The staff hired and trained in 1997/98 will thus have the full capacity for the creation of the 1531 SCAs foreseen for the end of 1999. All staff members will undergo intensive training in Moldova and abroad. FIDES will provide technical assistance to MMA, train the staff and help to develop the operational procedures. Only 130 of the 153 SCAs would receive credit funds through the LIL. The other SCAs could receive funds from a follow-on project or external resources.  Annex 2 10 D. Work Program 27. The joint work program of MMA and RFC includes the creation, support, and financing to a growing number of SCAs. 1997 1998 1999 2000 Number of existing SCAs 23 73 153 253 Number of members 1,200 3,840 9,960 19,850 (See also footnote 1) 28. During its first six months of activity (October 1997 to March 1998), MMA will support 11 existing SCAs and create 29 new SCAs. In parallel additional staff members will be hired and trained. E. Budget 29. MMA will be funded by private donors. WWB, Open Society Foundation and FIDES have committed substantial funds to MMA, covering the program's costs during 1998 and 1999, including start-up investments and technical assistance. Starting in the third year, MMA is also expected to earn a fee from RFC for services rendered. A Memorandum of Understanding between GOM, National Bank of Moldova, World Bank, WWB, Open Society Foundation and FIDES has been drafted, fixing the objectives and principles of action of MMA. GTZ will join the other donors at a later date with an additional grant for technical assistance and equipment. 30. MMA's principal partners have agreed on the following budget for the first two years: 1997 1998 1999 New SCA created 23 50 80 Total SCAs 23 73 153 Operating Costs (US $) 136,000 146,000 Investment Costs (US $) 115,000 27,000 Technical Assistance and Training (US $) 171,000 171,000 Total 422,000 344,000 (See also footnote 1)  11 Project Description PROJECT COMPONENT 2 - ESTABLISHMENT OF A REGULATORY BODY OF THE SCAs Challenge: Determining the role, powers, administrative location, funding, and organization of the supervisor of associations. 31. Recommendation: The primary role of the supervisor of associations should be to ensure the safe and sound operation of SCAs. To that end it must have the power to examine the operations of each SCA. All records of each SCA must be available to the supervisor for examination at any time. It must have the power to compel the production of records. The supervisor must also have the authority to establish all record keeping and reporting requirements applicable to SCAs. Other than controlling the currency in Moldova, the role and powers of the supervisor of SCAs should be similar to the role and powers of the National Bank of Moldova. 32. Several options exist regarding the administrative location of the supervisor of SCAs. It could be established within an existing ministry or as a separate entity. Both models exist in different parts of the world. The growth of the SCAs and their potential impact on the economy of Moldova will be a determining factor. During the initial phase of development the costs associated with supervising SCAs will probably necessitate assigning the supervisory functions to an existing ministry. Given that the RFPIU is aligned with the Ministry of Finance it seems natural that the supervisory role originally be assigned to the Ministry of Finance. Perhaps the RFPIU's role could be expanded beyond the implementation of the Rural Finance Project to include the supervisory functions. Then in later phases, the creation of a separate agency, or aligning the supervisory role with the role of the National Bank of Moldova could be explored. As the SCA system becomes established it will have a profound impact upon the country's economy. Thus, the state's interest in the safe and sound operation of the SCA system will not only remain, but will increase. 33. The funding of the supervisor of SCAs will be quite problematic during the initial years. First, it is difficult to assess what the costs may total. Several funding options or combinations of options exist. One option is to seek grant money or money from the project funds to cover the operating costs of the supervisor. Another option is to obtain some general tax revenues from the government. Still another option is to assess each SCA a fee based upon assets under management, amounts on deposits, loan amounts, or any combination of the three. Another option is to allocate a portion of each loan to the supervisory function, which is then paid back by the borrower by attaching a small margin to the loan rate. Ultimately, the SCA system should achieve an economy of scale that will allow it to fund the supervisor entirely. Until then, the economic realities facing  Annex 2 12 the farmers make that impractical. Initially, funding may best be achieved by combining the options, with the lion's share coming from grants. However, for long term success, the government and the farmers should bear some of the burden initially, even though it is disproportionately small. 34. Initially the supervisor of the SCAs should have the following positions: Director, who directs all aspects of the supervisor and interacts with other governmental bodies including the parliament, the prime minister, and the other ministries. In addition, the director should regularly interact with the officers of the SCAs. The director should also maintain relations with the World Bank and other sources of funding. Deputy Director/Chief Budget Officer, who manages personnel, budget, and examination and training schedules. This position could also assist the director in maintaining key contacts. It could also provide examination support as well. Examiner, who, on a regular basis, visits the SCAs to review the records, legal compliance, and financial condition of each SCA. The examiner should make a report on the condition of each SCA at least on an annual basis. He should rate the performance of each SCA using the CAMEL system used by the National Bank of Moldova. Initially that rating system may need to be adapted on a very basic level. Over time it would become more comprehensive as the sophistication of the SCAs improve. The examiner should receive ongoing training, much of which may be able to be provided by the National Bank. After the examiner has become familiar with the duties, it may be helpful to have a foreign expert (perhaps a retired examiner from a state or federal supervisor) come to Moldova for four to six weeks to work side-by-side with the examiner. Most of the visit should be spent out in the SCAs conducting examinations and preparing reports. As the number of SCAs increases, more examiners should be hired and trained. Trainer, who should visit the SCAs on a regular basis to train the SCA's officers and control committees. To avoid potential conflicts this position must be separate from that of the examiner. However, information could be shared through the director or deputy director. The need for the position should only last for the first several years. A Federation of SCAs should eventually assume the training function. This position will be provided by MMA.  13 Pro]ect DescriDtion PROJECT COMPONENT 3 - ESTABLISHMENT OF THE RuRAL FNANCE CORPORATION (RFC) A. Background 35. RFC will be established in December 1997, as an onlending institution to village level Savings and Credit Associations (SCAs) that are being set up in Moldova. The SCAs are expected to become an important source of credit to small private farms and rural enterprises in the country. At the start, RFC will confine its role to be a conduit for loans from IDA and other multilateral financial institutions, possibly IFAD, to SCAs. RFC's assistance will be targeted to the SCAs that are being established with the assistance of the Moldova Microfinance Alliance (MMA) or any other Development Center that may be acceptable to RFC and IDA (See Annex 2 - Project Component 1 for a description of SCAs and MMA). B. Ownership and Capitalization 36. RFC will be a non-banking financial institution registered as a joint-stock company. To ensure that RFC will be majority owned by SCAs, it has been decided that Government of Moldova (GOM) will not hold more than 20% of voting shares. The statutes of RFC stipulate that no single SCA will hold at any time more than 5% of the voting shares. Each SCA wishing to become a shareholder of RFC will pay in share capital of about US $500. As some 23 SCAs have been set up at the time of RFC's registration, RFC's voting shares will be equivalent to US $14,375 held by SCAs ($11,500) and GOM ($2,875). This will gradually increase as new SCAs are created. By the end of the fourth year in 2001, the paid in share capital is expected to be $225,000. 37. Additionally, each SCA which wishes to borrow from RFC will be required to invest in RFC - in the form of privileged shares - an amount equivalent to 5% of the outstanding loans from RFC. Thus, the value of privileged shares by 2001 is expected to be about $750,000. 38. GOM has agreed to grant RFC quasi equity in the form of a low interest loan of US $2 million (from the IDA Credit) repayable over 35 years, including a 10 year grace period. C. Corporate Governance 39. Governing Bodies. RFC will have three governing bodies. The General Assembly of Shareholders, meeting usually once a year - and more often if requested by at least 10% of the shareholders -- votes on all important matters including distribution of profits, election of the members of the Council of the Corporation and the Censor  Annex 2 14 committee. The Council, which is the equivalent of the Board of Directors, is responsible for policy fornulation and supervision of RFC's activities including operational policies, prudential rules and approval of budgets. Initially the council will have five members elected by the General Assembly, four of whom will represent the SCAs; the fifth will be a nominee of GOM. Although the decision on GOM nomination will be taken by the Ministry of Privatization, it is expected that the GOM nominee will be a senior official of the Ministry of Finance which is the government agency responsible for supervision of RFC's activities, so long as RFC has significant borrowings from GOM. The Censor Committee consisting of three members elected by the General Assembly is responsible for financial control of RFC. A General Director, who is the President of the Administration Council, handles the day-to-day administration of RFC. The Board appoints the President for a four-year tern with the approval of the General Assembly. A Credit committee composed of the President and senior staff in RFC takes all credit decisions. 40. Audit. The accounting and reporting systems of RFC will be kept according to regulations of the Ministry of Finance. RFC will monitor quarterly financial information of SCAs and in turn, RFC will submit to GOM and IDA quarterly financial statements and management reports on its operations including liquidity and arrears. RFC's accounts will be audited annually by an independent auditor acceptable to IDA. D. Organization 41. The developmental work relating to SCAs, including the preparation of their quarterly financial statements and operational reports will be handled by MMA or similar developmental centers that may be set up in the future. Moreover, RFC will function as a loan wholesaler and its credit operations including appraisal and supervision will be directed to SCAs and not the thousands of small farmers and rural businesses. Therefore, RFC will not need large staff. The initial organization will consist of the General Director, his deputy, two credit officers, an accountant and a suitable number of support staff. Two credit officers and an accountant/auditor will be added in each of the next three years. An advisor, who can train the credit officers and the accounting staff, will be recruited initially for a period of 6 months starting in January 1998. A suitable candidate who has many years of experience in rural credits has been identified. The cost of the advisor is being funded from PHRD. E. Lending Terms 42. RFC will on-lend funds made available by GOM from IDA Credit in Lei with a spread of up to 5% to cover its transaction costs, and to build up its reserves. From Year 3 onward, RFC will utilize about 1% from the 5% spread to cover the costs of MMA. RFC should be in a position to reduce its spread by a further 1% from year 5.  15 Project Description 43. The interest rates for loans to SCAs will be established twice a year, in March and September. The established interest rate is fixed for the whole term of the loan. Short- term loans made for working capital purposes are expected to be repaid with interest by the end of the year - usually at the time of harvest. Medium-term loans made for acquisition of assets will be made for a maximum of three years, with interest and principal installments payable semi-annually. F. Credit Risk-Management 44. Each SCA is expected to make only working capital loans (for periods less than 12 months) in the first year of operation. Introduction of medium term loans (for periods up to 36 months) would depend on the repayment record of the SCA. Not more than 10% of an SCA's membership would receive medium term loans in the second year, and depending on experience, this figure could rise to 20% of the membership by the fifth year, depending on the percentage of total outstanding loans. In line with the practices of other refinancing organizations, RFC's evaluation will focus on the operations and financial position of the SCA and not of the individual borrowers of the SCA. However, in the first two or three years, RFC's staff will review all medium term loans to verify the justification for the loan amounts and the adequacy of cash generation for debt servicing. After one or two years, if the experience is satisfactory, RFC's staff will review only loans above a certain size. This limit would vary from one SCA to another depending on the maturity and financial position of the SCA. G. Prudential Rules 45. RFC will require SCAs to contribute an amount equivalent to 5% of their outstanding borrowings in the form of non-voting shares in RFC. 46. For each SCA, RFC will establish a ceiling of loans which will take into account the number of members of the SCA. The amount of loans granted to a single SCA will not exceed (i) 100% of RFC's equity, or (ii) $250,000, whichever is lower. Additionally, no single SCA will receive more than 10% of the total outstanding loans of RFC, from the second year of RFC's operation. 47. RFC will maintain its equity at a level that is adequate to cover 5% of all outstanding short term loans, 8% of all outstanding medium term loans, and 100% fixed or intangible assets and bad debts. That portion of GOM's subordinated debt which is repayable after a period of 10 years will be regarded as equity for the purpose of determining capital adequacy.  Annex 2 16 48. RFC will maintain general risk provisions equivalent to 1% of outstanding short term loans and 2% of outstanding medium term loans. These provisions will be adjusted depending on the performance of the portfolio. RFC will build adequate provisions to cover a minimum of 30% of loans classified as overdue (delay of 2 months), 75% of doubtful loans (delay between 2-12 months) and 100% of irrecoverable loans (overdue for more than 12 months). 49. SCA eligibility criteria. Only SCAs that meet the following eligibility criteria can receive a credit from the RFC: * the SCA has been registered in accordance with the SCA Law; * the SCA has made all necessary contributions to the capital of RFC in accordance with the RFC Prudential Rules and Statutes; * the SCA has received training from MMA or another NGO acceptable to IDA; * the SCA is in compliance with the SCA Prudential Rules; * the SCA is located in a rural area in Moldova. H. Portfolio Management by RFC 50. Each SCA would approach RFC, usually twice a year, with a loan application, indicating the amount of loan requested, the number of borrowers and the desired timing of the loan. SCAs will typically release funds to their members in two or three tranches. Evaluation of individual loan applications is the responsibility of the SCA administrative board, although an RFC credit officer may be present at the meeting in which the loans are being analyzed to confirm that the screening by the SCA is in accordance with the established rules. MMA will assist the SCA in the preparation of quarterly financial statements and other operational reports. RFC's credit officers will monitor the accounting practices and general performance of the SCA including the debt service performance. It is expected that RFC's credit officers will visit each SCA at least three times a year. 1. Flow of Funds 51. RFC will enter into a subsidiary loan agreement with GOM under which it will obtain a maximum of $2.6 million of project funds for a period of fifteen years, and $2 million of project funds as subordinated loan for a period of 30 years. RFC will collect, evaluate and approve loan applications from SCAs and present a disbursement request to the PIU, which will authorize the release of funds from the Project Special Account. Interest payments by RFC would be deposited into the special account at semi-annual intervals. To ensure that the funds made available by GOM are utilized by RFC for the purpose intended, the subsidiary loan agreement will stipulate that during March- November of each year, RFC's outstanding loan portfolio should be at least 90% of the amount RFC owes to GOM. RFC would be restricted to invest any surplus cash with the National Bank of Moldova and/or Government bonds.  17 Project Description 52. The SCAs will receive funds from RFC in agreed tranches, through an account opened in a bank acceptable to RFC. RFC will not disburse loan funds in cash; nor will it disburse funds to individual members of an SCA. J. Business Plan 53. The SCA concept is very new in Moldova. It is therefore desirable to restrict the benefits of this operation initially to those SCAs that have received training in credit appraisal and accounting from MMA. RFC itself is a new entity and until its staff gains experience it would be prudent to limit RFC's lending to modest amounts, in order not to overextend RFC's management and the absorptive capacity of the SCAs. 54. The business plan of the RFC has been prepared with the following assumptions: a The number of members of each SCA will be 40 in the year of formation, gradually increasing to 180 in the fifth year. s In addition to the 23 SCAs that are in existence by December 1997, 17 more will be created - for a total of 40 - by March 1998, in time for the planting season when the demand for working capital loans is at a peak. An additional 33 will be created by December 1998. 3 80 new SCAs will be created in 1999 (and 100 in each of the next two years for a total of 353 by the year 2001) when the project is completed. * The average short-term loan by an SCA will be $500, gradually increasing to $700. The average medium term loan will be $1,500 increasing to $2,300 by year 5. 55. Based on these assumptions, RFC's business plan envisages the following "demand" profile from the SCAs: ___________________________________ 1998 1999 2000 2001 Number of SCAs (at year-end) 73 153 253 353 Number of members 3,840 9,960 19,850 33,240 Outstanding short-term credit ($000) 2,104 5,794 12,155 19,188 Outstanding medium term credit ($000) 276 1,345 4,029 8,846 Total loans outstanding ($000) 2,308 7,139 16,184 28,034 56. RFC is expected to be the principal source of funding to the SCAs, though commercial banks using their own resources may also elect to lend to SCAs. As the total amount available to RFC and the commercial banks from IDA is $4.6 million, the financial projections have been made on the assumption that RFC will meet 75% of the credit requirements of SCAs. RFC is expected to utilize the total amount of $4.6 million  Annex 2 18 by March/April 1999 when the planting season for the year will be in full swing. If this LIL Credit is successful, the Bank would immediately finance a follow-up operation. The projections assume that RFC would be able to obtain external financing in the outer years on terms similar to the current IDA Credit. K. Financial Position of RFC 57. The projected income statements and balance sheets of RFC for the years 1 98- 2002 are attached. The projections are based on the following assumptions: * RFC's cost of funds will be a rate equivalent to National Bank of Moldova's 6 month option rate - taken at 16% for the purpose of these projections - plus a 2% spread as loan guarantee and administration fee for GOM. * Interest rate which RFC charges to SCAs will be 23%, consisting of 18% GOM lending rate plus a 5% spread to RFC during the first four years. The calculations for the fifth year assume a reduced spread of 4%. * 1% from RFC's spread will be utilized from the third year onwards towards the cost of MMA services, such as developmental assistance for setting up SCAs, training SCA board members in credit appraisal and follow-up, loan collections, accounting and MIS assistance to SCAs and RFC. Although most of these services are provided by MMA to the SCAs, it is cumbersome to bill and collect the charges from more than 300 SCAs. It would be cost-effective for RFC to include these charges in its interest rate spread. The allocation of a part of the spread for MMA services is being done from the third year because Soros Foundation and World Women's Banking are providing grants to cover MMA costs in the first two years.