Madagascar - Microfinance Project

Document of The World Bank Report No: 18959-MAG PROJECT APPRAISAL DOCUMENT ON A PROPOSED ADAPTABLE PROGRAM CREDIT IN THE AMOUNT OF SDR12.1 MILLION (US$16.4 MILLION EQUIVALENT) TO THE REPUBLIC OF MADAGASCAR FOR A MICROFINANCE PROJECT IN SUPPORT OF THE FIRST PHASE OF THE MICROFINANCE PROGRAM April 26, 1999 Private Sector and Finance Africa Region  CURRENCY EQUIVALENTS (Exchange Rate Effective January 26, 1998) Currency Unit = Malagasy Franc (FMG) US$1 = FMG 5,600 FISCAL YEAR January I - December 31 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AGEPMF Executing Agency for the Promotion of Microfinance Agence d'execution du Projet Microfinance APC Adaptable Program Credit APIFM Professional Association of Savings and Loan Associations Association professionnelle des institutions financieres mutualistes BTM National Agricultural Bank Bankin 'ny Tantsaha Mpamokatra CAS Country Assistance Strategy CEM Savings Bank of Madagascar Caisse d 'epargne de Madagascar CGAP Consultative Group to Assist the Poorest CSBF Banking Supervisory Commission Commission de Supervision Bancaire et Financiere FY Fiscal Year ICR Implementation Completion Report LACI Loan Administration Change Initiative MIS Management Information System MFI Microfinance Institution NGO Non-Governmental Organization PAD Project Appraisal Document PY Project Year RFTAP Rural Finance Technical Assistance Project SBP Sustainable Banking with the Poor SDI Subsidy Dependence Index SLA Savings and Loan Association SOE Statement of Expenditures TOR Terms of Reference UNDP United Nations Development Program UNCDF United Nations Capital Development Fund Vice President: Callisto Madavo Country Manager/Director: Michael Sarris Sector Manager: Paul Murgatroyd, Acting Task Team Leader: Herminia Martinez  Madagascar Microfinance Project CONTENTS Page A. Program and Project Development Objectives and Key Performance Indicators 1. Program purpose and program phasing 2 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 3 2. Main sector issues and Government strategy 4 3. Sector issues to be addressed by the program and strategic choices 4 4. Program description and performance triggers for subsequent loans 5 C. Project Description Summary 1. Project components 7 2. Key policy and institutional reformns supported by the project 8 3. Benefits and target population 8 4. Institutional and implementation arrangements 8 D. Project Rationale 1. Project alternatives considered and reasons for rejection 10 2. Major related projects financed by the Bank and/or other development agencies 11 3. Lessons learned and reflected in proposed project design 12 4. Indications of Borrower commitment and ownership '13 5. Value added of Bank support in this project 13 E. Summary Project Analyses 1. Economic 14 2. Financial 15 3. Technical 15 4. Institutional 16 5. Social 16 6. Environmental assessment 16 7. Participatory approach 17 F. Sustainability and Risks 1. Sustainability 17 2. Critical risks 18 3. Possible controversial aspects 19 G. Main Loan Conditions 1. Effectiveness conditions 20 2. Other covenants 20 H. Readiness for Implementation 20 I. Compliance with Bank Policies 21  Annexes Annex 1. Project Design Summary Attachment I Performance Indicators for SLA Networks Under the First Phase Attachment 2 Trigger Indicators under the Adaptable Program Loan Attachment 3 Projected Subsidy Dependence Indices (SDI) for Individual SLA Networks Annex 2. Project Description Annex 3. Estimated Project Costs Annex 4. Economic Analysis Summary Activity models Cost-Effectiveness 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. Evaluation of the Financial Management System of the Microfinance Project Annex 8 Project Processing Budget and Schedule Annex 9. Documents in Project File Annex 10. Statement of Loans and Credits Annex 11. Madagascar at a Glance Annex 12. Letter of Sector Policy Map  Madagascar Microfinance Project Project Appraisal Document Africa Region Country Department 8 Date: April 26, 1999 Task Team Leader/Task Manager: Herminia Martinez Country Manager/Director: Michael Sarris Sector Manager/Director: Paul Murgatroyd, Acting Project ID: MG-PE-52186 Sector: Financial Program Objective Category: Poverty Reduction Lending Instrument: Adaptable Program Credit Program of Targeted Intervention: [l Yes [/] No Program Financing Data APL Indicative Financing Plan Estimated Borrower Implementation Period (Bank FY) IDA Government SLA Other Total Commit. Closing The Republic Networks financiers Date Date of Madagascar US$ m. % US$ m. % US$ m. % US$ m. % US$ m. APL 1 1999-2004 16.4 80 1.8 9 0.2 1 2.00 10 20.4 07/1999 06/2004 / APL 2 2004-2009 8.0 80 1.0 10 1.0 10 0.00 0 10.0 07/2004 06/2009 / APL 3 2009-2014 5.4 67 0.8 10 1.9 23 0.00 0 8.1 07/2009 06/2014 / Program Cost 29.8 77 3.6 9 3.1 6 2.00 5 38.5 Project Financing Data [] Loan [/] Credit [] Guarantee [ Other [Specify] For Loans/Credits/Others: Amount: SDR12.1 million (US$16.4 million) Proposed terms: Grace period (years): 10 [ ] Standard Variable [ Fixed [/] Years to maturity: 40 Commitment fee: 0.00% Service charge: 0.75% Financing plan (US$m): 20.4 million Local Foreign Total Government 1.8 IDA 5.51 10.69 15.6 Savings and Loan Association Networks 0.2 0.2 0.20 UN Capital Development Fund - 0.7 0.70 European Union 0.3 0.7 1.00 Developpement International Desjardins - 0.3 0.30 Total 7.81 12.59 20.4 Borrower: Government of Madagascar, Ministry of Finance and Economy Responsible agency: Executing Agency for the Promotion of Microfinance (AGEPMF) Estimated disbursements (Bank FY/IUS$ millions) FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 Annual 4.5 3.5 3.3 2.7 1.8 0.6 Cumulative 4.5 8.0 11.3 14.0 15.8 16.4 Project Implementation Period: 5 years Expected Effectiveness Date: August 30, 1999 Expected Closing Date: December 31, 2004  Page 2 A: Program And Project Development Objectives And Key Performance Indicators 1. Program Objectives And Program Phasing: The Microfinance Program (the program) aims to improve the income and living standards of low-income Malagasy by increasing their long-term access to financial services, which at present is virtually non-existent. The 15-year technical assistance program, of which the proposed project (the project) is the first phase, will support the establishment of an appropriate legal, regulatory and supervisory framework for microfinance, the expansion of microfinance skills, and the development of strong and sustainable local institutions. The program will cover areas with a population of about 4.9 million (of a total of 14 million), and will ultimately benefit, directly, some 187,000 families (935,000 persons). The program builds on successful experiences piloted under the Rural Finance Technical Assistance Project (RFTAP, Cr. 2459-MAG) and is innovative in its emphasis on accountable technical assistance of limited duration and monitoring of targets. The program aims at institution-building: the objective is to ensure the long-run viability of savings and loan association (SLA) networks which will serve lower-income clients and which will need declining support over time as they become financially independent. Experience has demonstrated that this type of intervention requires sustained support over a long period of time. The program thus envisages an intense and sustained capacity-building effort; program design will be adjusted to suit the specific conditions of each region and needs of the local populations. The Adaptable Program Credit (APC) is proposed as the appropriate instrument to support the program: the APC's long-term focus permits stakeholders to focus on the program's ultimate objective and the gradual nature of institution- and capacity-building activities. The program is the result of two years of sustained dialogue and consultations involving the Government, other donors, non-governmental organizations, civil society and those involved in providing technical services in finance in Madagascar. Preparation of the program has served to increase the dialogue among key donors and the complementarity of donor objectives and assistance in the field of microfinance, with the result of shared objectives and increasingly complementary interventions. The program would be implemented over a period of 15 years. Five-year tranches have been chosen because it is difficult to initiate the program in less than five years given the long period of startup of the institutions. The Program would consist of three phases as follows: * Phase I supports the development of an appropriate legal/regulatory and supervisory framework for microfinance institutions (MFI); the design and testing of a national training program in microfinance; and the establishment of SLAs in four of Madagascar's six provinces. * Phase II supports the consolidation of the SLAs by expanding coverage in the areas where they are established, and, if feasible, achieving penetration into other areas to reach a sustainable scale and cost structure; and implementation of the microfinance training program. * Phase III supports strengthening of the financial core of SLA networks and its evolution into full-fledged self- sustainable financial institutions. Project objectives and key performance indicators: The project objective reflects the program goal and aims at providing increased financial services to the low-income population not served by the traditional banking sector. The project aims to set up an appropriate policy framework for the development of microfinance and to help establish microfinance institutions. The project supports: (a) the formulation of regulations governing microfinance; improvements in business law applicable to microfinance, notably on collateral, and the establishment of a supervision mechanism for MFIs; (b) the design and testing of a training system for microfinance; and (c) the establishment and expansion of MFIs, particularly the SLA networks. The SLAs financed  Page 3 under the first phase of the program, the proposed project, would serve about 72,500 low-income families (362,500 beneficiaries). The project has an institution-building focus and does not include financing for credit; sufficient financing appears to be available to meet such needs -- until MFIs are themselves fully able to generate sources of loanable funds -- from the European Union (EU), the United Nations Capital Development Fund (UNCDF) and bilateral donors. The SLA networks financed under the credit will be eligible to use the lines of Credit. The UNCDF is already financing the credit program implemented in the Lac Alaotra Region of the Province of Toamasina. Technical assistance under the legal and training components complements that being provided by the IMF and the ILO. Notwithstanding the potential external sources of funds, savings mobilized among SLA members will constitute the primary source of credit for SLAs covered by the project. Progress in the first phase will be evaluated on the basis of performance indicators drawn from best practices in microfinance, and defined in the "logical framework" (indicators and triggers in Attachments to Annex 1). Accomplishment of the objectives of the first phase will trigger IDA support of the second phase. The indicators of performance are summarized below. For the Legal, Regulatory and Judicial Framework: * Adoption of regulations enabling the development of MFIs and ensuring their financial strength and protecting depositors; e Establishment of supervision mechanisms; * Improvement in business laws and practices relating to contract enforcement and collateral. For the Development of MFIs: * SLA network financial performance: repayment rates > 95%; (maximum arrears rate of 5%); operational self- sufficiency within a five-year timeframe; diversified portfolio to minimize risks; - SLA network outreach (minimum penetration rate, levels of savings and credit specified for each MFI network); = Reliance of SLA networks on technical assistance. For the Microfinance Training Program: * Curriculum and program delivery system developed, tested, and evaluated; * Cost recovery system established, tested, and evaluated; * Number of persons trained in microfinance. B: Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project CAS document number: 16249-MAG - latest CAS discussion: February 18, 1997. The prograrn supports the Government's objective of reducing widespread (75%) poverty, which is at the center of the CAS. Improving access to financial services -- a frequently cited constraint to agricultural and entrepreneurial activity in Madagascar -- will support the CAS objectives of rural development as well as private sector development. The Government aims to improve financial intermediation to support investment and growth. Microfinance is a vehicle for financial deepening and a means to compensate for the failure of the banking sector in providing financial services to people with limited resources. The project helps alleviate poverty by making financial services (both credit and savings facilities) available to more lower income persons, especially small-scale farmners, artisans, traders and women. This will help increase employment productivity, incomes, and living conditions. The program also furthers underlying CAS objectives of sustainability, capacity building, stakeholder consultation, donor collaboration and continuous learning (building on the pilot RFTAP).  Page 4 2. Main sector issues and Government strategy: The Malagasy financial system is embryonic, and represents a constraint to investment and economic activity. In 1998, the system comprised: six commercial banks (two state-owned, being privatized); a savings bank; three insurance companies (two state-owned); four SLA networks; and two small donor-supported MFIs. Because private banks are relatively new to Madagascar, and public banks were bankrupt, there has been a shortage of credit to all but the most established clients. Nearly all Malagasy have no access to financial services, with no recourse for credit beyond family and usurious moneylenders. Over the past decade, the Government began a process of liberalization of the financial system. Exchange and interest rates were liberalized and all credit controls eliminated. In the early nineties, the banking sector was opened to private ownership, two international banks were given authority to operate, and one of the state banks was privatized. In 1996, the Government began the process of privatizing the two remaining state banks, which had abandoned their original mandate of financing small clients, and were bankrupt, following years of political interference and mismanagement. The sale of one of the state banks was completed in December 1998, and the second will follow in 1999. To begin to address market imperfections in financial service provision, a number of private initiatives (SLAs, lines of credit) have been started since the late eighties, with Government and donor support, aimed at providing financing for lower-income clients. Among these, the establishment of regional SLA networks has shown success. SLA networks have developed on a regional basis, which is partly explained by the large size/low population density and weak infrastructure of the country. Reasons for insufficient and ineffective provision of financial services in Madagascar to lower income clients have been discussed in the Bank's financial sector reviews and, comparable to worldwide experience, are summarized below. i Private (international) banks lend only to well-established clients because of limited competition in the sector, their business philosophy and negative perception of country risk. * Transaction costs of microfinance programs are high. * Low-income clients generally lack collateral and are unknown to the banks, which makes it difficult to assess their ability and willingness to repay. * Legal and judicial systems are not developed and contract enforcement is difficult. The Government is aware of the financial sector constraints and is committed to addressing them. The Government has committed to continuing to pursue macroeconomic policies that ensure price stability, which is a precondition for financial sector development. Equally, it has committed to continuing the process of liberalization of the sector. In addition to privatization of the state banks, it will open up the insurance sector to private investment, establish a modem legal and regulatory framework for insurance, and privatize the state-owned insurance companies. The Government's strategy for microfinance is spelled out in its Letter of Development Policy of April 1999. The objective of improving access to financial services is part of the financial sector strategy. Reflecting this commitment, the Government has encouraged private initiatives in support of MFI development and enacted legislation promoting and regulating MFIs (under the Rural Finance Technical Assistance Project, (RFTA), the pilot project, Law No. 96-020 of 9/4/96 on Mutual Savings and Loan Associations). Lastly, it has encouraged donor coordination in the sector, and to this end established a Committee on Rural Finance. 3. Sector issues to be addressed by the project and strategic choices: The proposed program aims at fostering a sustainable microfinance system to address the lack of financial services for lower income population. It will help contribute to the national objective of poverty reduction. As noted earlier, it builds on the experience of the pilot RFTAP. Recognizing that traditional approaches to rural finance were ineffective and paid little attention to savings, RFTAP aimed to promote a sustainable savings and loan movement at the grass-roots level that would provide sound financial services to its members and over time link up with formal institutions. Under the project, between 1993 and 1997, a law was promulgated and three networks totaling 54 SLAs were created, with about 175 members per SLA on average and average savings of about $15-20 per person. A network is a group of SLAs bound  Page 5 together by common interests and cost-sharing of common financial services received. The commonfinancial services are designed to eventually become the central finance facility (banking unit) of the group of SLAs. The experience brought to light the importance of training, the time needed for MFIs to break even and the need to widen project scope beyond rural areas to help diversify SLA portfolios, reducing risk and increasing prospects for profitability. The program is built on the following strategic choices: * it emphasizes improvement of the legal, regulatory and judicial framework in which MFIs operate, and development of appropriate supervision capabilities at the Secretarial of Banking Supervisory Commission (CSBF) which is part of the Central Bank; * it gives priority to establishing the financial independence and sustainability of MFIs (savings mobilization; access to commercial sources of funds, and interest rates that enable them to recover costs); * it encourages a gradual approach to growth and increased lending, to enable staff and members to develop required skills; * it promotes clear accounting and reporting through adapted Management and Information Systems (MIS); * it emphasizes the introduction of diverse products to reach the poorest including: very small loans, repeat loans based on good repayment records, group-based lending where collateral is not available, variable loan terms and rates, better rates for "good" clients; * it places demand-driven and participatory approaches at the core of program design to ensure ownership and commitment; * it encourages efficient use of technical assistance by using performance-based contracts with technical assistance. 4. Program description and performance triggers for subsequent loans: The program will support the establishment of an appropriate legal and regulatory framework for microfinance as well as an appropriate supervisory mechanism for microfinance institutions. The program also supports the establishment of microfinance institutions. The first phase, which constitutes the project, includes the expansion of two (SLA) networks and the creation of two new networks, covering the four (of a total of six) provinces which have potential for development of financially viable M:FIs. Two of the existing networks, in the provinces of Toamasina (East) and Fianarantsoa (Center), were started under the Bank's pilot project. New networks will be established in Antsiranana (North) and Antananarivo (Center). A network in Mahajanga (Northwest) has been developed principally with support from the German Government and UNCDF which plan to continue providing some support. The network in Mahajanga may be supported under the program if studies confirm that the expansion is feasible. Some 102 SLAs will be established in addition to the 47 existing ones, as follows: 21 in Toamasina and 2 in Lac Alaotra (both in the province of Toamasina), 18 in Fianarantsoa, 17 in Antsiranana, 44 in Antananarivo. The number of new SLAs will increase to 11 8 if further studies confirm the viability of creating 16 SLAs in Mahajanga. Studies will also be carried out to assess the feasibility of establishing viable microfinance institutions in the province of Toliara. In order to build strong and self- sustaining financial institutions that can respond to the needs of low-income households, the program will evolve in phases. Program activities will encourage commitment and ownership at the local level while setting up institutional policies and structures that encourage efficiency and profitability. The process will take time because new habits and skills will need to be learned. The proposed project also includes an outreach program to help women and vulnerable groups (the very poor, living in remote areas) gain access to minimum financial services. The program also includes the introduction of a training system in microfinance. The APC instrument will allow the provision of phased but sustained support for the implementation of the long-term program that reflects local needs. The instrument will permit to "lock-in" long-term commitment on program objectives while slicing the financing according to needs and performance.  Page 6 A review will be carried out some 18 months after credit effectiveness to identify corrective actions. The review will actively involve the SLAs and technical agencies supporting them. The review will evaluate progress in network development and introduce adjustments required to ensure program goals. The review will also assess the financing requirements for the networks. If a shortage of financing for lending activities proves a bottleneck, a pilot program to address this constraint could be introduced. Each new phase will be subject to an appraisal that will assess achievements under the ongoing phase (as compared with trigger indicators) and potential for achieving next-phase targets. An Implementation Completion Report (ICR) will be prepared at the end of each phase presenting the evaluation and proposing any adjustments required to the design of the new phase. Before committing to finance the phases, IDA will assess whether SLAs are meeting financial performance and outreach criteria. A study will be carried out at the end of each phase which will spell out the financial economic and technical justification of the follow-up phase. This will include a review of financial, technical, and economic performance and expected performance in the regions covered; in new regions, a socio-economic study justifying the expansion of SLAs into proposed areas will be undertaken. Performance indicators and triggers are given in Annex 1.  Page 7 C: Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a cost breakdown): Component Category Cost Incl. % of Bank- % of Bank- Contingencies Total financing financing (US$M) (US$M) A - Improve legal, judicial, and Policy; 0.61 2.6 0.55 3.3 regulatory framework Institution Supports: (a) strengthening of legal, Building judicial, and regulatory framework for MFIs; and (b) establishment of competencies at the Secretariat of the Banking Supervisory Commission for inspection of MFI networks. B - Develop MFIs Institution 13.5 66.0 10.0 61.0 Supports: (a) strengthening of two SLA Building networks and creation of two new ones; (b) outreach programs to help the very poor in isolated regions (the socially "excluded") gain access to minimal financial services to be carried out by the SLA networks; (c) development of linkages between SLA networks and the banking sector; (d) support to other MFIs; and (f) monitoring and evaluation of SLA networks. C - Build Capabilities in Microfinance Capacity 0.5 2.5 0.42 2.6 Supports the development and testing of a Building microfinance training program. D - Conduct studies Capacity 0.9 4.5 0.68 4.1 Finances audits of SLA networks, annual building audits of the project, feasibility studies, surveys on the impact of the project on beneficiaries, studies on the feasibility of transforming some BTM branches into SLAs, feasibility studies on non-mutualist MFIs, and other studies in microfinance. E - Coordinate project Institution 0.9 4.4 0.74 4.5 Supports operations of AGEPMF Building F - Refinance PPF 2.00 9.8 2.00 12.2 G - Unallocated 2.00 9.8 2.00 12.2 Total 20.40 100.0 16.40 100.0  Page 8 The project will provide support to both existing SLA networks (in Fianarantsoa, Toamasina-Lac Alaotra) and new ones (in Antsiranana and Antananarivo). The expansion of a small SLA network in Mahajanga will be supported if satisfactory arrangements can be made with the NGO which is working in the region, or if the growth of the region accelerates and a separate network can be developed. Studies will also be carried out to determine the feasibility of establishing a network in the province of Toliara. 2. Key policy and institutional reforms supported by the project: The project supports reforms in the legal and regulatory framework, in business law and in the judicial system, particularly the enforcement of contracts. It also supports the development of appropriate mechanisms for the supervision of MFIs. 3. Benefits and target population: The project will help make financial services available in four target regions to low-income households that lack access to banking services, thereby expanding their incomes and reducing poverty. Networks in other regions will also be considered. Some three-fourths of technical assistance provided is to rural areas (accounting for 75% of SLAs): Economic Benefits: * Increased monetization of the economy, increased use of financial instruments, thus reducing barter. Increased efficiency of the financial system through increased competition, thus reducing cost of borrowing. - Increased agricultural and export-oriented production in areas not adequately serviced by the banking sector through availability of financial services provided by SLA networks. - Increased inter-regional finance, as networks begin lending to each other. Social Benefits: * Increased familiarity with financial issues and use of financial services by lower-income families. * Enhanced capacity of entrepreneurs to cope with routine business risks such as production shortfalls, livestock losses, or temporary illness that savings and credit facilities can provide. * Greater participation of vulnerable groups, many of whom are women in economic and social activity. e Improved managerial and technical skills. * Increased community solidarity. Target Population: * An estimated 72,500 low-income families (about 362,500 people) engaged in farming, fishing, commerce and handicraft production activities will gain access to financial services. The project targets those members of society on whom a viable financial system can be built; as such, the project is an inappropriate vehicle for meeting the needs of the very poor. Consequently, an outreach program that assists this group will be tested. Studies will identify the poverty profile of beneficiaries and, by income grouping, growth in savings and income levels. 4. Institutional and implementation arrangements: Implementation period: The project is a first phase over five years of a microfinance program which would extend over an estimated 12 to 15 years. The project would run from end-1999 to end-2004. Executing Agencies. The project will be carried out by a non-profit private organization --"Agence d'Execution du Projet Microfinance" (Executing Agency for the Microfinance Project - AGEPMF) which has been created to promote microfinance institutions, and will be responsible for implementing the project and managing the credit funds. Management of project activities will be delegated to its Secretariat. AGEPMF will recruit specialized institutions to carry out (a) the development of the networks and (b) organize the microfinance training program. AGEPMF will also  Page 9 supervise their work. The Central Bank of Madagascar, through the Technical Secretariat of the Banking Commission, will be the executing agency for the preparation of prudential and operating norms for MFIs and for their supervision under the Legal/Regulatory component. AGEPMF will coordinate the work of the Ministries of Finance and of Justice on the Legal and Regulatory Component. These Ministries will deal principally with issues of taxation (exoneration of taxation for start-up private sector firms) and contract law (issuance and collection of guarantees on loans). The Statutes of AGEPMF specify the number of members, which include one representative each of the Ministries of Finance and of Decentralization, and of the Central Bank, and representatives of the financial institutions participating in the project. These include the Association of Savings and Loan Institutions and the Association of Non-Mutualist Financial Institutions. The General Assembly provides guidance and reviews the work of AGEPMF. The Secretariat of AGEPMF will be staffed by a small team consisting of a Secretary, two accountants and a procurement specialist, one staff responsible for the training program, another for monitoring and evaluation of SLA networks, and support staff. A training specialist and a microfinance specialist will provide short-term technical assistance to the Secretariat staff. The Executive Secretary of AGEPMF has been selected and will be appointed shortly. His appointment is a condition of effectiveness of the credit. The major functions of AGEPMF's Secretariat's include: * coordinating project activities, including with the Ministry of Justice, Ministry of Finance and Central Bank; * planning the annual work programs, preparing the annual budgets, preparing the project accounts, producing quarterly and annual progress reports and eventually disbursement reports ensuring the smooth flow of funds; * carrying out the procurement of goods and services in accordance with Bank procedures; * contracting and supervising the execution of contracts with consulting firms including the external audits of all the networks; * monitoring project implementation and evaluating its impact; * strictly applying established procedures; and * coordinating with donors involved in microfinance. The Government will pass on to the AGEPMF the proceeds of the IDA Credit as a grant and to the Central Bank the funds related to CSBF's regulation and supervision activities, discussed above. Arrangements will be made to ensure that AGEPMF is kept informed of CSBF's use of the funds. Project Oversight: The Ministry of Finance and Economy. The Financial Management System of the Project and LACI Accounting, Financial Reporting and Auditing Arrangements: An accounting and financial management system, based on internationally-accepted accounting principles acceptable to the Bank, has been established. During appraisal, an IDA financial management specialist assessed and rated it as adequate, and made recommendations for improvement, including the recruitment of a second accountant, all of which have been adopted. The system does not yet meet the standard for the Loan Administration Change Initiative (LACI), a new standard which will become applicable to all Bank projects over the next few years. Additional measures will be taken and assistance provided over the next 24-36 months to ensure an orderly transition to LACI. To that end, IDA will carry out an assessment of the project's financial management to determine its readiness for LACI in the second year of implementation. During the first three years of  Page 10 implementation, disbursements under the credit will be made in accordance with the approach based on Statements of Expenditure (SOE). The project accounts as well as the financial statements of each of the networks will be audited by independent auditors acceptable to IDA following internationally accepted audit standards acceptable to the Bank. The audit reports (which will include a separate opinion by the auditors on the adequacy of the use of the Special Account) and the statements of expenditures are to be sent to the Bank not later than six months after the end of each fiscal year. In addition, an operational and financial audit of SLA networks supported by the project will be carried out yearly. The first yearly audit of new networks will be carried out after each network has been in operation one full calendar year. Monitoring and Evaluation Arrangements: A monitoring unit will be set up in the Secretariat of AGEPMF. Because microfinance is a relatively new field in the country, an international microfinance practitioner will assist AGEPMF in defining the methodology for monitoring and the scope of activities and provide training to the concerned Secretariat staff. The SLA networks must submit no later than 30 days after the end of each quarter, tables that show progress on base performance indicators included in the consultants' contracts. Preliminary drafts of these tables are in the project file. The networks must also submit no later than 60 days after the end of each quarter, more detailed quarterly reports commenting on the performance indicators and analyzing their growth. Finally, the networks will also submit to the Secretariat no later than March 31 of each year, annual reports that summarize the situation of networks over the preceding year. In the years in which audits are carried out, the networks will need to provide an action plan to resolve the problems raised in the audit report. Should the audit reports not be available in time to incorporate the action plan in the annual report, these would be submitted separately. Beneficiary surveys will be conducted a year after project effectiveness to provide baseline data and a year before Phase I ends to measure preliminary project impact. As mentioned above, a Mid-Term Review will be conducted 18 months after effectiveness - earlier than usual, in recognition of the need to respond quickly to the need for any changes in design or implementation arrangements. Reporting: Semi-annual reports recording progress under the project will be sent to IDA in May and November of each year. Under the LACI requirements, even prior to transitioning to disbursements solely based on project management reports, the Borrower will be encouraged to prepare and submit LACI-type reports as regularly as possible, particularly reports on Sources/Uses of Funds and PIrocurement Reports. In this regard, a gradual conversion from transaction-based disbursements to report-based disbursements is envisaged. An ICR will be prepared six months after completion of Phase I. The Secretariat and the agencies involved in the project will contribute to the ICR their own evaluation of the first phase of the program. The CSBF will provide a report on the activities it carries out. D: Project Rationale 1. Project alternatives considered and reasons for rejection: Introduction of Lines of Credit. Despite perceived demand, the proposed project will emphasize institutional development and reinforce Government support for a strategy of prudent growth for SLA networks. Lines of credit are not included in the project because: extending credit outside the context of an institutional framework is unsustainable; earlier such projects have failed; and those needs which are of limited scope, to support SLAs until self-sufficiency is achieved, are being met by other donors in consort with the institutional framework being set up in this project. The project will focus on strengthening the financial and management capabilities of SLA networks. The Bank is coordinating its work with that of other donors which place an emphasis on providing lines of credit. Progress has already been made in harmonizing approaches during implementation of the pilot RFTAP. Development of an Apex Institution to Provide Capacity-Building Funds, and Eventually Credit Lines and Capitalization. Experience elsewhere has shown that Apex organizations are not necessarily effective in the promotion of microfinance. AGEPMF will be an executing agency for programs related to the Bank program. If AGEPMF demonstrates competence, and other donors request it, AGEPMF functions could be expanded.  Page 11 Collaboration with the Savings Bank (Caisse d'Epargne de Madagascar - CEM). CEM plays a major role in mobilizing savings from households in both urban and rural areas (about 8 percent of the time and savings deposits held by individuals in the banking system in May 1997). The deposits are collected through the 220 windows of the Post Office and at CEM's head office in Antananarivo. However, CEM has only recently been structured as a financial institution. Its systems are only now being strengthened and it should for some time focus on placing its deposits in safe instruments. It is therefore premature to consider formal linkages. Exclusive Focus on Developing Savings and Loan Associations. The initial objective of the proposed project, that draws on the experience of the RFTAP, was to focus exclusively on expanding the SLA movement. However, the view of Government and stakeholders is that in order to be effective, the Bank should assist in formulating a coherent national approach which does not limit itself to SLAs, but which encourages all institutional forms that aim at providing sustainable financial services. There are, at present, no institutions with a different ownership structure which require IDA support. However, the project will finance studies to determine the viability of other approaches. Immediate Take Over of BTM Rural Branches by Existing SLA Networks. As the Government is in the process of divesting from the agricultural bank, BTM, the Government, key donors and NGOs involved in microfinance have considered the advisability of transferring the rural branches of BTM to the SLAs that are currently operating with success in the same areas. Analysis indicates that this is an ambitious endeavor for SLAs because most have not reached the level of financial management maturity that would allow them to effectively handle the task. However, conversion of some branches into SLAs is not excluded and will be decided in conjunction with divestiture (planned for the second half of 1999). 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned): Latest Supervision Sector issue Project Ratings (Bank-financed projects onl L) Implem. Devt. Progress Object (IP) (DO) Bank-financed Credit for agricultural inputs and equipment, First Agricultural Credit Project (Cr. 1064-MAG), t) U and training to small holders. aproved in 1980 and closed in December 1986. Credit for agricultural production; and Second Agricultural Credit Project (Cr. 1804-MAG), U U institutional development of BTM, the National approved in 1987 and closed in June 1994. Rural Development Bank. Credit for rehabilitation and new projects, and Financial Sector and Private Enterprise Development S S policy reforms in the financial and private Project (Cr. 2104-MAG), approved in 1990 and enterprise sector, extended until June 1999. To develop livestock production, develop a viable institution l Livestock Project (Cr. 2243-MAG), approved in 1991 S S framework through establishment and extended until June 1999. of fanners' associations and promotion of private veterinary practices. Strengthen the Central Bank's ability to formulate Financial histitutions Development Techiucal S S and conduct monetary policy; the Banking Assistance Project (Cr. 2497-MAG), approved in 1993 Commission's ability to perfonn prudential and extended until September 1999. supervision, and support Government divestiture from public banks. Strengthen the legal and regulatory framework Rural Finanice Technical Assistance Project S S for microfinance; development of savings and (Cr. 2459-MAG), approved in 1993 and closed in loan associations, and training for micro Decemnber 1997. -entrepreneurs. ... .  Page 12 Community development through partnership Social Fund II (Cr. 2778-MAG), approved in 1995 S S with NGOs and beneficiary communities; and and expected to close in December 2000. financing the Development Fund (FID) mainly to address rural infrastructure needs. Strengthen economic management through Public Management Capacity Building (Cr. 2911 -MAG), approved S S support to the Technical Secretariat for in 1996 and expected to close in June 2001. Adjustment and the National Institute of Statistics. Support policy reforms to increase private Private Sector Development and Capacity Building (Cr. U U investment, efficiency, exports and job creation. 2956-MAG), approved in 1997 and expected to close in Strengthen efforts to improve government policy December 2002. -making and enhance capabilities of private firms. Other development agencies UNCDF Provision of various lin1es of credit and a guaranitee fund throughout the country through BTM (1995). European Union DELSO Project providing credit to livestock producers in the Province of Toliara (1995). FAO Fishing project providing small credit to fishermen in the Province of Toliara (1994). ILO, European Union, BMZ (German Project creating the first CECAMs (savings and loan Cooperation) associations) (Janluary 1993-June 1995). Cooperation Francaise (French Cooperation) ADEFI Project providing short-tenn credit to urban Microentrepreneurs in the Antsirabe and Antalianiarivo (1995). KfW/CIDR AECA Program creating savings and credit unions in .__ _ __ _ _ __ |the rural areas of Marovoay in the Northwest ( 990). European UnionJFrench Cooperation/CIDR Vola Mahasoa Project providing credit on a family basis to rural areas of Toliara (1990). SIDI (French NGO), European Uniion Supports SIPEM, which provides credit to the higher end of the microentreprise market in urban Antananarivo (1990). Others Various small projects by other donors. IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in proposed project design: Implementation of two agricultural credits and one rural finance technical assistance pilot project over two decades, and the experience of other donors, have provided the Bank with a number of experiences to draw on in preparing the proposed project. Among those experiences, the following lessons are taken into account: (a) The "credit only" approach of the first two agricultural projects was not successful. Either there was insufficient demand or funds did not reach the intended groups. (b) Channeling funds through a highly centralized and less than independent state bank, BTM, which adopted procedures ill-suited to the needs of its clients, was inefficient. Repayment rates were very low. (c) The credit approach of the Financial Sector and Private Enterprise Development Project which channeled funds through the banking sector was successful in providing financing for medium-sized enterprises mostly in urban centers, but did not reach low-income clients. (d) Charging interest rates and fees at cost-recovery levels helped SLA networks, supported by RFTAP, start the trend toward self-sustainability. (e) Involving grassroots community organizations, local leaders and potential beneficiaries in the planning stage leads to ownership of the SLAs, and is vital in ensuring the project's success.  Page 13 (f) Training helps enhance program ownership and participation and builds the foundation for MFI efficiency and sustainability; allocating substantial resources to training at all levels is critical to project success. (g) Establishing adequate information systems and internal controls in MFI networks before they are operational would ensure that information is reliable, procedures are followed; resources are used correctly; and that the shareholders, board, and management understand the financial performance of their institutions. (h) Ensuring a balance between rapid growth, institutional development, and financial viability is difficult but necessary for SLA networks to develop into robust self-sustaining institutions. (i) The deep-rooted culture of donor-supported, subsidized credit can jeopardize the new savings practice introduced by the savings and loan association movement. (j) Activities of all donors and NGOs in microfinance benefit from a coordinated approach; a growing awareness of the need to establish sustainable institutions, which has resulted from coordination during the preparation of the proposed project, has helped in coordination among donors. The proposed project draws on the above lessons. It also takes into account the Bank's best practices in microfinance (various CGAP studies, SBP seminar series, and papers from international donors and microfinance practitioners), legal and regulatory reforms, poverty alleviation (EDI's Design and Management of Poverty Reduction Programs in Anglophone Africa) and technical assistance (EDI's Handbook on Technical Assistance). The project will focus on the technology used, the quality of services (both savings and credit) provided by SLA networks, the adequacy of their information systems, and their progress toward self-sufficiency. The Adaptable Program Credit provides the focus on long-tern objectives and permits adjustments to program design to meet needs. 4. Indications of Borrower commitment and ownership: Throughout preparation and implementation of the RFTAP, the Government demonstrated its commitment to developing a regulatory environment conducive to the growth of savings and loan associations as part of its overall program of reforms in the financial sector. The current administration did not bring any change in Government's policy for the sector, which also includes state divestiture of the two public banks. The appointment of provisional administrators in the two banks, the privatization of one bank, and the ongoing sale process of the second one are evidence of the Government's continued commitment to financial sector reform. The proposed project supports Government's search for viable alternatives to meet the needs of clients who do not have access to financial services from the formal financial sector. At the request of the Government, the Bank approved in October 1997 an advance under the Project Preparation Facility in the amount of US$1.5 million to finance the preparation of the Microfinance Project. A supplement of US$500,000 was approved in October 1998. During preparation, a broad consensus was reached among stakeholders regarding project objectives and design. 5. Value added of Bank support in this project: The Bank has played a leading role in the policy dialogue with the Government on financial sector reforms. Its Private Enterprise Development and Financial Institutions Development projects supported the liberalization of the financial system, and have helped: the Central Bank strengthen its capability to conduct monetary policy; the Banking Supervisory Commission in carrying out prudential supervision of the banking system; and the Government in the program of state bank divestiture. The proposed project draws on the positive experience of the pilot RFTAP and expands the Bank's support for grassroots microfinance institutions. The program complements other Bank interventions aimed at improving financial intermediation and alleviating poverty. The Adaptable Program Credit instrument would provide flexibility in adapting project design and financing to beneficiaries' needs as the program evolves.  Page 14 E: Summary Project Analyses (Detailed assessments are in the project file, see Annex 9) 1. Economic (supported by Annex 4): [I] Cost -effectiveness [1] Others The project is an investment in building sustainable financial institutions at the grassroots level. Building an enabling policy and regulatory framework and taking on experienced practitioners in the field would help achieve this objective. The project has been designed to: (a) fit the CAS objective of increasing access to financial services of the low-income population, and to compensate for the failure of the two state banks which were to have served some of project beneficiaries; and (b) achieve the maximum outcome at the lowest possible costs. Qualitative and quantitative benefits outweigh the investment costs. Rationale for public intervention: Lending to small clients is risky and costly, and commercial banks are generally reluctant to enter this market. The extended family and moneylenders are the primary source of credit for small clients. The cost of money from informal sources such as moneylenders tends to be very high. Because of its high financial costs, the development of institutions that help lower-income clients requires public encouragement and donor support. Appropriate form of intervention: The Government attempted to provide services to small clients in the past without success, with top-down lines of credit channeled through BTM. First, as targeting the poor has been difficult, a large part of the lines of credit did not benefit low-income households. Second, lines of credit were often not repaid. The approach proposed is for Government to create an enabling environment for private institutions to develop (with the help of specialized institutions), while putting in place a set of prudential regulations which ensure appropriate operations. The project would allow/encourage the establishment of a decentralized system where procedures are streamlined, decisions are made promptly and close to the client, and transaction terms as well as innovative products are dictated by the client's needs and ability to respond. Economic: The main component of the project consists of the provision of training and technical assistance to support the establishment of SLA networks in four regions of Madagascar. Benefits resulting from the establishment of grassroots financial institutions include: (a) a deepened financial sector, reflected in the increased use of financial services, and increased monetization of the economy, reflected in the reduction of barter; (b) increased efficiency of the financial system, reflected in a reduction in the cost of money; (c) increased production and increased assets of low- income persons through increased access to credit at reasonable rates and increased savings; (d) greater participation in the economy of marginal groups (women and isolated population); (e) enhanced knowledge of financial issues among low-income families. The benefits of the training component will include development of local capacities through the development of courses adapted to Madagascar and the creation of a body of skilled technicians and microfinance practitioners. The benefits of increased efficiency of the financial sector cannot be fully quantified, but are reflected in the difference between the cost of borrowing from informal sources at over 100 percent per year against borrowing from MFIs at 36 percent per year. The incremental benefits for training are reflected in the salary differentials between persons who are trained in microfinance and those who are not. The project does not have a credit component, but during implementation impact studies will be carried out to determine the returns on investment of projects financed by the SLAs. Experience with loan recovery in existing SLAs during the pilot phase was good, with recovery rates in the area of 98 percent. High loan recovery was achieved even in the mid- nineties, when both nominal and real interest rates were very high (nominal lending rates of 40-45 per cent with inflation at 32-35 per cent in 1995-96; inflation in 1998 was about 6 per cent). These recovery rates point to high real retums on investments both in rural and urban areas. The returns could not be quantified in the pilot phase because of insufficient production data.  Page 15 Demand for credit cannot be determined ex ante, but borrowing for agriculture is likely to remain important. Prototype investments and budgets typical of situations in various regions have been elaborated (Annex 4). The approach used is cost effective; other alternatives involve technical assistance and lines of credit which have traditionally not been repaid. The cost per local SLA is estimated to average US$56,000 by the end of the first phase, but varies with socio-economic conditions in the target regions. Average cost per SLA member is estimated to vary between US$80 in mature networks to US$230 in new ones, while average cost per person professionally trained in microfinance is around US$4,600. Under the pilot project, costs were low compared to results, some of which cannot be quantified as they include such aspects as awareness of the need for savings among the poor, and the foundations for developing a robust financial infrastructure at the local level. 2. Financial: (see Annex 7) Financial controls and accountability: AGEPMF, staffed with two qualified accountants from a reputable accounting firm, will be responsible for disbursements and financial reporting. An accounting and financial management system, based on accounting standards acceptable to the Bank, has been put into place. During appraisal, an IDA financial management specialist assessed and rated it as adequate, but not yet meeting the LACI standard (see Annex 7). Financial statements and annual audit reports, including a separate opinion by the auditors on the use of the Special Account and the statements of expenditures, are to be sent to the Bank not later than six months after the end of each fiscal year. The audit is to be carried out in accordance with international standards acceptable to the Bank. Cost recovery and financial sustainability: The two main interventions of the project, MFI development and capacity building, are designed to ensure their affordability and sustainability in the medium and long-term. MFIs will price loans at rates that ensure cost recovery and at terms and conditions that facilitate repayment by their clients (repeat loans, frequent and small repayments, etc.). The financial projections prepared for project networks envisage recovery of all costs of SLAs after the third year of operations for urban SLAs and the fourth to fifth year for rural SLAs, and progressive recovery of costs of the common financial services unit. Likewise, the training system will be designed so that it recovers costs. 3. Technical: Appropriate technology: Donor lines of credit are only a temporary solution to credit needs. SLA networks must address this issue by devising a strategy that promotes savings and forges links with the banking sector. Experience suggests that the cost for banks to serve small clients is high, and as a result, they are not interested in financing them. It is thus in the interest of MFIs to serve as retailers for banks. SLA networks must also ensure that incentive structures are built into their system for clients to repay loans and staff to encourage high repayment rates. Under the proposed project, studies will be conducted in selected rural and urban areas to measure the impact of services provided on the beneficiaries in each type of area and to propose adjustments to the adopted methodologies which would help better meet their specific needs. Costing: There are currently no benchmarks relating to the establishment of MFIs. Costs vary with countries' socio- economic and governance contexts, methodologies used and the level of capacity absorption by beneficiaries. Considering that the program aims to introduce the savings habit and lay the foundation for a culture of self-sufficiency, a long term frame must be contemplated. The costs of the project are low relative to future benefits. Costs per MFI are estimated to be decreasing, as compared with the pilot phase. SLA networks will be expanded in the three provinces (Fianarantsoa, Toamasina, and Antsiranana) where either microfinance projects have been implemented with success or there exists potential for economic growth, and in the Province of Antananarivo where the capital city is located. The project is expected to reach directly around 72,500 families. Given the experience under the pilot program, there is a good probability that SLA networks will become viable over the medium term. Key assumptions are that the Government will allow the required time and technical input necessary for the MFIs to develop while international  Page 16 NGOs, which often provide the technical assistance, will provide the requisite technical assistance that allows indigenous features to take root. 4. Institutional: Executing agencies: * CSBF has been strengthened over the past few years with support from IDA (Financial Institutions Modernization Project; Cr. 2497-MAG), and the IMF. CSBF has developed experience in bank supervision and staff knowledge of microfinance institution regulation and supervision will be strengthened under the project. * The SLA networks will continue to be assisted by specialized NGOs who will be selected on the basis of their experience in the field. * The training program coordinator will be an international microfinance specialist selected for his/her qualifications and experience. The coordinator may be affiliated with a firm. * Key AGEPMF staff have been selected and have shown experience during project preparation in management, finance and in implementing Bank projects. Project management: AGEPMF has been established as a non-profit private association and will manage the project except for the regulatory/ supervisory component which will be managed by the Central Bank. AGEPMF will give responsibility of implementing the project to its Secretariat, which will have a light structure. AGEPMF's Secretariat will oversee consultant selection, contract irnplementation and completion, monitor the performance of SLA networks, manage the proceeds of the Credit, prepare quarterly and annual progress reports and act as counterpart to the Bank's supervision missions. The project accounts will be audited annually by an independent auditing firm acceptable to IDA. AGEPMF's Secretariat will be staffed by an Executive Secretary, who will be in charge of the unit, and specialists in monitoring and evaluation (one person); training (one person), procurement (one person) and two qualified accountants from a reputable accounting firm, along with support staff. Key staff, including the Executive Secretary and the finance team (two accountants) have been selected. 5. Social: Gender: One of the key objectives of the proposed project is to improve women's economic condition and enhance their participation in economic activities. SLAs will seek to offer women simple, convenient, and attractive financial instruments that are consistent with their needs and preferences. Vulnerable Groups: Unless special programs are developed, the very poor, especially those living in remote low-density areas, might not benefit from the project. A pilot outreach program will be put in place to help them gain access to minimal financial services. Social Groups: The proposed project, like the pilot project, explores possibilities to develop MFIs based on existing grassroots groups that are built either on economic, social, or cultural interests. Farmer and livestock producer associations are already participating. 6. Environmental assessment: Environmental Category [ 3 A [] B [X] C The project itself, which is a technical assistance and institution-building project, has no direct environmental impact and no environmental assessment is required. However, Madagascar has a National Environment Action Plan (NEAP) addressing the protection of its natural resources which is being supported by the Bank's Second Environment Project. The objective of NEAP is to improve perception and ownership of the problem by all segments of society. The project could help disseminate messages on environmental protection through field agents working with SLA members.  Page 17 7. Participatory approach: Primary beneficiaries and other affected groups: * Significant participation by the primary beneficiaries, the members of SLA's, was sought during preparation and will continue during implementation. The members of SLA's will be asked to present their specific needs and priorities, propose methods to sustain the activities of their SLA's after project completion, and monitor the impact of SLA's services on their living conditions. Because the whole process is oriented toward program sustainability, discussions with beneficiaries will be continuous and the program flexible. Other key stakeholders: * Significant consultation has been and will continue to be done with banks, other financial institutions, existing SLA networks, microfinance coordinating agencies, academic institutions, local NGOs, specialized NGOs, donors, and Government to obtain information, share experience, and agree on targets and timing. The objectives and expected outcomes are being discussed and negotiated among all stakeholders to give the project the best chance of being implemented. F: Sustainability and Risks 1. Sustainability: Sustainability of the program will be ensured by the following: * Macroeconomic stability. * Government commitment to reforms in the financial sector. - Ownership of the program by beneficiaries and national technicians. * Adaptability of approach to the specifics of each locality. * A continuous capacity-building and institutional development process in SLA networks at village and regional levels. = Clear business plans to achieve sustainability at the network level (interest rates maintained at current level of 3 per cent per month giving them a margin sufficient to enable eventual recovery of costs, consistently high recovery rates, minimized overhead, increasing outreach and scale). * Consistency in donors' aid programs.  Page 18 2. Critical Risks (reflecting assumptions in the fourth column of Annex 1): Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk) Annex 1, cell "from Outputs to Objectives" * CSBF and its Secretariat in the Central M Banking Commission and Secretariat have been flexible Bank used to banking regulation and with the infant MFIs. They intend to continue inspection, might use the sarne technically collaborating witli MFIs to develop an appropriate sophisticated approach with MFIs that regulatory framework and supervision, and will organize most likely would not apply. training seminars that foster development of specialized capacities in MFIs' regulation and inspection. * The large volume of small transactions, the M * Central Bank expected to allocate the necessary human lack of traditional collateral and loan and financial resources to monitor MFIs performance. In documentation, and the decentralized addition, the CSBF Secretariat will develop guidelines nature of MFI operations make their and incentives that encourage MFI networks to regulate supervision labor-intensive and costly for their members, and for the very small institutions to self- CSBF. regulate. * SLA staff is not appropriately trained. M * SLA networks expected to recruit staff with appropriate profiles and provide them with adequate training in promotion, service delivery, and financial management. AGEPMF will consult with MFIs in designing and implementing the appropriate training program, which will be demand-driven and paid for by the participants. * Because of past generous Government N * Networks have been successful in building membership credit schemes, there might be little initial in areas tested under the pilot project, even in areas interest in SLA membership. where credit programs failed earlier. Annex 1, cell "from Components to Outputs" * Delayed implementation of the policy and M * The Government has indicated its intention to approve regulatory framework to oversee MFIs. expeditiously regulations prepared by CSBF Technical Secretariat. * Poor MIS systems leading to inefficient M * Consultants expected to put MIS in place at the asset-liability and risk management in SLA beginning of their assignment. networks. Overall Risk * SLA networks do not reach the projected M * Growth projections are very conservative, and thus growth in membership, deposit and loan should be met. The monitoring and evaluation volumes. mechanism which is being put in place will recommend immediate remedial measures to keep the progress of SLA networks on track. The approach being used in this project has been tested in Madagascar and other .______ _______ ___ _ _countries and yielded positive results.  Page 19 3. Possible Controversial Aspects: Management Capacity Aspects: The development of MFIs requires time and discipline. There is an understandable desire to encourage SLAs to increase their lending from external sources. The proposed project will mitigate this risk by encouraging SLAs to first develop good financial management, use savings for lending and make prudent use of lines of credit. This mixed approach would ensure that both capacity and capital building take place at a faster pace than an approach based on using internally-generated sources of funds alone; the mixed approach would also prevent SLAs from becoming dependent on external lines of credit. Political Aspect: * The Government might use the embryonic SLA networks for political purposes. This political risk of the project is reduced because there is strong Government's commitment to the objectives of the project, and high beneficiary participation and ownership. The recruitment of professional microfinance development organizations with solid records should help ensure professional work in the networks.  Page 20 G: Main Loan Conditions 1. Effectiveness conditions: * The Subsidiary Agreement between the Government and the Central Bank of Madagascar has been executed. * The Subsidiary Agreement between the Government and AGEPMF has been executed. * The Government has opened a project account for its contributions and paid its contributions for the first year of the project. * AGEPMF and CBM have submitted to the Bank a satisfactory Project Implementation Manual. * The Executive Secretary of AGEPMF has been appointed. 2. Other covenants: * A mid-term review is carried out eighteen months after credit effectiveness, at which time possible modifications would be adopted (geographical coverage, outreach and performance indicators of SLAs credit requirements). * Time-bound action plan for transitioning to Project Management Report-based disbursements is implemented. AGEPMF to: * Select a qualified accounting firm to audit project accounts, including the use of the special account and the statements of expenditures.