Tanzania - Financial Sector Adjustment Credit

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 14828 PROJECT COMPLETION REPORT TANZANIA FINANCIAL SECTOR ADJUSTMENT CREDIT (CREDIT 2308-TA) JULY 3, 1995 Public and Private Enterprise Division Eastern Africa Department Africa Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Glossary of Abbreviations BFIA Banking and Financial Institutions Act (1991) BOT Bank of Tanzania CRDB Cooperative and Rural Development Bank ERP Economic Recovery Program ESAF Enhanced Structural Adjustnment Facility ESAP Economic and Social Action Program FSAC Financial Sector Adjustment Credit ICB International Competitive Bidding IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IRAC Industrial Restructuring Adjustment Credit IRTAC Industrial Rehabilitation and Trade Adjustment Credit LART Loans and Advances Realization Trust MRC Multisector Rehabilitation Credit NBAA National Board of Accountants and Auditors NBC National Bank of Commerce OGL Open General License Facility PBZ People's Bank of Zanzibar PFP Policy Framework Paper TANAA Tanzania Agricultural Adjustment Program TDFL Tanganyika Development Finance Limited THB Tanzania Housing Bank TIB Tanzania Investment Bank TPOSB Tanzanian Postal Office Savings Bank Tsh Tanzanian Shilling  FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.SA. OTrice of the Director-General Operations Evaluation July 3, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT Subject: Project Completion Report on Tanzania Financial Sector Adjustment Credit (CR 2308-TA) Attached is the Project Completion Report (PCR) for the Tanzania Financial Sector Adjustment Credit (FSAC, Credit 2308, approved FY92), prepared by the Africa Regional Office. This PCR does not contain a Part Il prepared by the Borrower. The FSAC was one of a series of quick disbursing operations in support of the Economic Recovery Program of Tanzania (ERP). The Government introduced the ERP in 1986. Funds available under the FSAC were augmented by IDA reflows in FY93, raising the total financing to SDR 158.4 million. Other quick disbursing operations supporting the ERP include four Multisector Rehabilitation Credits (US$152.2 million), three Industrial Rehabilitation and Trade Adjustment Credits (US$157.8 million) and three Agricultural Adjustment Credits (US$227.4 million). The primary objective of the FSAC was to create a financial system in Tanzania that would operate on the basis of market-oriented principles. The PCR concludes that the Borrower attained partial success at introducing some of the policy reforms required by the credit agreement. Thus, the Government instituted licenses for private banks to operate, but did not restructure the insolvent, government-owned, National Bank of Commerce (NBC) which still accounts for about 90 percent of deposits in the sector. The PCR also finds that the project design was questionable because tranche release conditions were linked to achieving agreement on plans and enacting legislation, rather than to implementing these plans and legislation; and the Government initiated a program to capitalize banks, but did not link capitalization to performance. In addition, a slow pace of reforms in the real sector and a deterioration of macroeconomic management in 1992-93 affected negatively the outcome of the project. As a consequence, most of the banking system is still in the public sector, insolvent and continues to have significant losses. Based on the above, the project outcome is rated as unsatisfactory and the institutional development as negligible. The Government and the financial community have recently reached consensus on the basic objectives of financial reform. But the PCR does not assess the probability of such consensus to be maintained in the foreseeable future. Therefore, sustainability is rated as uncertain. The PCR is of good quality. It provides a good analysis of project design, implementation experience and results. A lesson derived from the PCR is that ambitious policy statements and enactment of legislation are often insufficient unless complemented by detailed implementation programs and conditions. This would be particularly prudent in countries with weak implementation capacity. Moreover, if policy statements and approval of legislation are deemed essential to the success of the project, they should take place prior to approval. An audit is planned. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  I  FOR OFFICIAL USE ONLY TANZANIA FINANCIAL SECTOR ADJUSTMENT CREDIT (Credit 2308-TA) PROJECT COMPLETION REPORT Table of Contents Preface ......................................................................(i) Evaluation Summary ..................................................................... (iii) PART I: Credit Review from the Bank's Perspective ........................................................ 1 Project Identity ..................................................................... 1 Background ..................................................................... 1 Reform Objectives and Credit Description ..................................................................... 3 Credit Design ...................................................................... 4 Credit Implementation .............................. ................................................ 6 Borrower Performance .............................. ................................................ 10 Bank Performance ..................................................................... 10 Achievements under FSAC ............................................................................... 10 Lessons Learned .............................................................................. 11 PART II: Project Review From the Borrower's Perspective ................................................ 13 PART III: Project Profile . .............................................................................. 15 This document has a restricted distribution and may be used by recipients only in the performance of their | official duties. Its contents may not otherwise be disclosed without World Bank authorization. l   TANZANIA FINANCIAL SECTOR ADJUSTMENT CREDIT (Credit 2308-TA) PROJECT COMPLETION REPORT PREFACE This is the Project Completion Report (PRC) for the Financial Sector Adjustment Credit for Tanzania. The Credit, amounting to SDR 150.2 million, was approved by the Board on November 14, 1991 and became effective on November 20, 1991. Funds available under the Credit were augmented by IDA reflows in FY93 of SDR 8.17 million, raising the total financing to SDR 158.37 million. Switzerland and United Kingdom also cofinanced the equivalent of USD 6.6 million and USD 16.8 million, respectively. This Credit was first appraised by the Southern Africa Departtment and was transferred to the Eastern Africa Departrnent in July, 1992. The PCR was prepared by the Public and Private Enterprise Division, Eastern Africa Department (Parts I and 111). The preparation of this PCR was based on the President's Report, Supervision Reports, correspondence between the Bank and the Borrower, and internal Bank documents.   - iii - TANZANIA FINANCIAL SECTOR ADJUSTMENT CREDIT (CREDIT 2038-TA) PROJECT COMPLETION REPORT EVALUATION SUMMARY 1. Introduction. The Financial Sector Adjustment Credit (FSAC) was one of a series of quick- disbursing operations to support structural adjustment in Tanzania under the Government's Economic Recovery Program (ERP). In 1986, the Government introduced ERP to improve macroeconomic management, to tackle underlying structural weaknesses, and also to encourage more active private sector participation. The program was a comprehensive package of policies designed to reduce the budget deficit and improve the balance of payments. The measures also included sector specific reforms in agriculture, industry, transport infrastructure, and the financial sector. 2. Sector Background. The Arusha Declaration of 1967 effectively transferred ownership of financial institutions to the Government. Since then, the sector performed poorly on all accounts, due to lack of competition, a directed credit policy, excessive interest rate controls, and weakness in bank supervision. The directed credit policy led to the financing of non-bankable activities, a misallocation of resources to the parastatals and agricultural cooperatives, and resulted in a large accumulation of non-performing loans (around two thirds of the total). By 1988, the banking system was insolvent. 3. Faced with a crisis in the financial sector in 1988, the Government established a Commission of Enquiry into the Monetary and Banking system to examine the sector and make recommendations on how to improve its overall performance. The Commission submitted its report to the Government in July 1990. The broad recommendations of the Commission's report, which included measures to stimulate competition by encouraging foreign banks and joint ventures, were endorsed by the Government and formed the basis of the financial sector reform program. 4. Credit Objectives and Rationale. The primary objective of the financial reform in Tanzania was to create a system that would operate on the basis of market-oriented principles. Conceptually, the program was intended to: (i) support a stable, market oriented macroeconomic framework; (ii) address the overall strengthening of the financial infrastructure, including banking and associated legislation; (iii) create a competitive environment and introduce private participation in the banking sector; and (iv) address institutional strengthening of the existing banks. It was recognized, however, that the reforms needed to achieve the objective could not be speedily implemented, given the precarious situation of the financial institutions. The short to medium-term objective was, therefore, to create an appropriate policy and regulatory environment conducive to private sector  - iv - entry of both domestic and foreign banks while increasing private sector participation in existing financial institutions. 5. Credit Description. FSAC, amounting to SDR 150.2 million, had two main components: (i) a quick-disbursing component for financing foreign expenditures (SDR 146.4 million in two equal tranches) of eligible imports under the Official General License (OGL); and (ii) technical assistance and consultant services (SDR 3.8 million). The Credit was approved on November 14, 1991, and became effective on November 20, 1991. It was augmented by SDR 8.17 million of IDA Reflows in FY93, raising the total financing to SDR 158.37 million. Switzerland and United Kingdom cofinanced the equivalent of USD 6.6 million and USD 16.8 million, respectively. 6. Credit Design. The reform program supported by the credit was based on the recommendations of the Presidential Banking Commission Report. The broad conceptual framework appeared to be appropriate for the intended financial sector reform. Nevertheless, there were recognized risks which were not properly factored into the program's design. The largest risk stemmed from the pace of reform in the real, or nonfinancial, sectors. The pace was inadequate for the creation of a bankable client base and therefore for sustaining financial sector reforms especially as it pertains to the restructuring of the existing commercial banks. Also, an attempt should have been made to explicitly link the recapitalization of the banks to their performance. Another risk stemmed from the extent of the Government's commitment to the reforn effort, especially to the restructuring of the banks. Second tranche release conditions called too often for agreement on restructuring plans as opposed to their implementation. The implication is that the adjustment component of the credit may have been premature or, alternatively, that tranche release conditions may have been inappropriate given the status of preparation of the relevant restructuring plans. Finally, a more aggressive strategy for reducing the dominance of the National Bank of Commerce was required to boost competition in the sector. 8. Credit Implementation. The Credit was approved on November 14, 1991, and it became effective on November 20, 1991. The Government was required to take action on a number of important policy measures prior to presentation of the program to IDA's Board. Accordingly, there were few up-front actions required from the Government for the release of the first tranche. The release of the second tranche was targeted for November, 1992 and was contingent upon satisfactory macroeconomic performance and the attainment of sector specific targets. However, the release was delayed until July 1993 due to unsatisfactory performance on both fronts. Macroeconomic performance deteriorated mainly due to an increased budget deficit and an accomodating monetary policy. At the time of the release of the second tranche, there was a recognition that the macroeconomic program was very fragile and that continued, and close, monitoring of fiscal and monetary developments was necessary. Concerning sector specific reforms, the main problem area was the restructuring of CRDB which was delayed, in part, because of a disagreement between the Government and IDA over the scope of the terms of reference for preparation of the restructuring plan. Following the release of the second tranche disbursements were slow as the Government found it difficult to implement new procedures for the allocation of donor import support through the newly unified foreign exchange system.  9. Borrower Performance. The Borrower was successful in introducing major policy reforms and bank regulations. As a result, the financial sector was deregulated and liberalized, and private banks were licensed. The Borrower was less successful, however, in changing the behaviour of managers of the financial institutions. The management of the banks often did not implement policies which were consistent with the overall strategy for the financial sector. Changes in management, as a result of their failure to implement Government policy, occured only when donors applied pressure to do so. 10. Bank Perfonnance. The Bank played an active role at various stages of the reform program and provided the Borrower with advice on policy reforms and institutional measures. Nevertheless, the Bank's effectiveness, especially in terms of the dialogue with the Borrower and cofinanciers, was undermined by frequent changes in Task Managers and mission teams. 11. Achievements. Measured against the expected achievements of the reform strategy, FSAC enjoyed limited success. FSAC introduced indirect methods of monetary policy control within which financial institutions would be able to operate commercially. The program strengthened the financial infrastructure by revising banking and associated legislation and enhancing bank supervision. The program encouraged the emergence of a competitive environment through the introduction of private sector participation in the banking sector. However, weak fiscal performance coupled with an accomodating monetary policy, and reversals in the restructuring of NBC undermined the accomplishments in this area. Also, the combination of these factors in a deregulated environment contributed to high interest rates (both nominal and real). Although the Government owned financial institutions were recapitalized and significant portions of their non- performing assets were transferred to LART, the banks are still insolvent and incurring substantial losses. 12. Lessons Learned. IDA recognized that the deregulation of Tanzania's banking system would be a difficult process and major risks were identified. These included the adverse impact of delayed implementation of reforms in the real sector and, specifically, parastatal reform. Also, there was likely to be substantial resistance to reform by the management of the banks. These risks were not factored into the design of the program. As a result, the lack of meaningful restructuring of the financial institutions was the most disappointing aspect of FSAC.   TANZANIA FINANCIAL SECTOR ADJUSTMENT CREDIT (Credit 2308-TA) Project Completion Report PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE 1. Project Identity Name Financial Sector Adjustment Credit Credit No. Credit 2308 RVP Unit Africa Region Country Tanzania 2. Background 2.01 Country Background. In the second-half of the 1970's, the Tanzanian economy entered a period of economic decline caused by a combination of factors, including external shocks in the form of successive droughts, the rapid increase in oil prices, the collapse of the East African Community, the war in Uganda, and the declining prices of its major commodity exports. The effects of these external shocks were exacerbated by underlying weaknesses in the management of the economy, including inadequate incentives and resources for the agricultural sector, a poorly conceived and implemented industrialization strategy, excessive administrative controls over economic activities and a proliferation of public sector institutions. Consequently, GDP growth declined from 5.5 per cent per annum between 1973 to 1978 to 0.4 per cent per annum between 1978 and 1982; this was accompanied by accelerating inflation, a deteriorating fiscal situation, and an increasingly unsustainable balance of payments position. 2.02 In an effort to reverse the protracted economic decline, the Government first launched "Economic Survival Plans" in 1980 and 1981, which were followed by a "Structural Adjustment Program" (SAP). Though measures adopted under SAP had some positive economic effects, they were not comprehensive enough to stimulate a major economic recovery. 2.03 In 1986, following a review of the experience of SAP, the Government introduced an Economic Recovery Program (ERP) to improve macroeconomic management, to tackle underlying structural weaknesses, and also to encourage more active private sector participation. The macroeconomic program was a comprehensive package of policies designed to reduce the budget deficit and improve the balance of payments. Economic measures included a substantial depreciation of the overvalued exchange rate, trade liberalization, the removal of most price controls, and the easing of restrictions on the marketing of food crops. The Government also undertook adjustment programs in agriculture, industry, transport infrastructure, and the financial  - 2 - sector. The economy responded positively to the reform measures and the result was improvements in the availability of external resources, food production, and traditional and nontraditional exports. This was reflected in the overall GDP growth rate of 4% per year during 1986 - 1991. 2.04 The Government's reform program was supported by the Bank, the International Monetary Fund (IMF), and other donors. 2.05 Sector Background. Since the Arusha Declaration of 1967, the Tanzanian financial sector was mainly Government-owned and comprised of: (i) The Bank of Tanzania (the Central Bank), (ii) three commercial banks--the National Bank of Commerce (NBC), the Cooperative and Rural Development Bank (CRDB) and the People's Bank of Zanzibar (PBZ), (iii) two development banks--the Tanzania Investment Bank (TIB) and the Tanzania Development Finance Limited (TDFL), (iv) an assortment of smaller special-purpose non-bank financial institutions--the Tanzania Post Office Savings Bank (TPOSB), the Tanzania Housing Bank (THB), the National Insurance Corporation (NIC), the National Provident Fund (NPF) and a hire purchase company; and (v) the Diamond Jubilee Investment Trust (DJIT). Tanzania also had roughly 400 savings and credit societies, mainly located in urban areas and over 200 cooperatives involved in financial intermediation in rural areas. There were no capital or money markets, other than Government bonds and Treasury Bills issued primarily to the insurance company, pension funds and savings bank. However, the informal financial markets were well developed, and were active in foreign exchange dealings, fund transfers and debt financing. 2.06 By 1988, the financial sector was in a state of crisis. This was due mainly to the pervasive interference of the Government in the financial system. Credit was directed on the basis of Government priorities without regard to creditworthiness, and banks were convenient agents of fiscal policy. The lack of separation between fiscal and financial activities, combined with an unfavorable economic environment and an inadequate regulatory frarnework, led to a significant misallocation of credit to banking system clientele who were bankrupt and mostly in arrears; an ineffective monetary policy and an unstable macroeconomic framework characterized by the unchecked growth in the money supply; and a lack of competition. Weak bank supervision also contributed to the crisis in the sector. 2.07 In August 1988, a Commission of Enquiry into the Monetary and Banking system was established by the Government. Its mission was to examine the sector and make recommendations on how to improve its overall performance and support economic growth. The Commission presented its recommendations to the President in July 1990. These recommendations mainly focussed on: (i) stimulating competition by encouraging foreign banks and joint ventures; (ii) strengthening the existing financial institutions; (iii) developing management accountability; and (iv) the recovery of non-performing loans. 2.08 Building on the findings of the Banking Commission, the Government implemented a series of measures in 1991. The Government issued a Policy Statement on financial sector reform which  - 3 - acknowledged the perverse impact on the sector caused by a lack of competition and Government interference. In an important reversal of policy, the Government recognized the need to license new private sector banks and enacted the Banking and Financial Institutions Act which permitted the entry of private banks and vested BOT with up-to-date supervisory and regulatory controls. Also, interest rates were liberalized and banks were allowed to set lending rates below an announced maximum and to set deposit rates freely, subject to the twelve month deposit rate being positive in real terms. The Government also enacted the Loans and Advances Realization Trust Act to create an expeditious machinery for the recovery of overdue debts. Finally, banking supervision in BOT was expanded and strengthened. 3. Reform Objectives and Credit Description. 3.01 Reform objectives: The primary objective of financial sector reform in Tanzania was to create a system that would operate on the basis of market-oriented principles, was efficient in mobilizing and allocating resources, and effective in fostering long-term economic growth. The short to medium-term objective was to develop an appropriate regulatory environment conducive to private sector entry of both domestic and foreign banks as well as to increased private sector participation in existing financial institutions. This was to be achieved through restructuring and recapitalization of the existing government owned banks, encouraging joint ventures with the private sector, and allowing wholly-owned private banks to commence operations. 3.02 Credit Description: The Financial Sector Adjustment Credit (FSAC) was the fourth in a series of quick disbursing operations to support structural adjustment in Tanzania under the Government's Economic Recovery Program and Enhanced Structural Adjustment Program (ESAP). The previous Bank operations were the Multisector Rehabilitation Credit (MRC) in FY86, the Industrial Rehabilitation and Trade Credit (IRTAC) in FY88, and the Tanzania Agricultural Adjustment Credit (TANAA) in FY90. FSAC, amounting to SDR 150.2 million, had two main components: (i) a quick-disbursing component (SDR 146.4 million) to finance eligible imports under the Official General License (OGL); and (ii) technical assistance and consultant services (SDR 3.8 million). The balance of payments component was scheduled to be released in two equal tranches, the first becoming available upon effectiveness and the second upon fulfillment of specific conditions for tranche release. The credit was increased by SDR 8.17 million of IDA Reflows in FY93. The Credit was also cofinanced by Switzerland with a non-reimbursable contribution of ten million Swiss Francs (US$ 6.6 million) and the United Kingdom with a grant equivalent to ten million Pounds Sterling (US$ 16.8 million).  -4 - 4. Credit Design. 4.01 The reform program supported by the credit was based on the recommendations of the Presidential Banking Commission Report. The program adopted a four pronged approach to support financial sector adjustment. The first component aimed to support a stable macroeconomic framework, including indirect methods of monetary policy control, within which financial institutions would be able to operate autonomously. The second component of the program supported the strengthening of the financial infrastructure including a revision and streamlining of banking and associated legislation, the introduction of banking supervision and regulation functions at the Bank of Tanzania and a review of the accounting and auditing franework. The third component supported the creation of a competitive environment and the introduction of private participation in the banking sector. The fourth component addressed institutional strengthening of the existing banks, including financial, organizational and managerial restructuring; recapitalization based upon both public and private participation; and the establishment of a Loans and Advances Recovery Trust (LART) for the transfer of non-performing assets from the banking system and for their collection and liquidation where necessary. 4.02 This broad conceptual framework appeared to be appropriate for the intended financial sector reform. Nevertheless, in retrospect there were flaws in the program's design. These stemmed from risks which, though considered, were not properly factored into the design of the program. One recognized risk was the pace of reform in the real, or nonfinancial, sectors. Hence, the financial sector reforms were timed to follow a restructuring program in the agricultural sector and to coincide with the implementation of an industrial sector restructuring adjustment operation. The latter, which was to include a comprehensive program of parastatal reform, was delayed and the former did not include cooperatives who were major borrowers. As a result, the creation of a bankable clientele, which was essential to the sustainability of the reforms as it pertained to the restructuring of the existing commercial banks, never occurred. 4.03 An attempt should have been made to explicitly link the recapitalization of the banks to their performance. The banks would then have been encouraged to take forceful actions to sell or liquidate those parastatals with non-performing loans and therefore rely less on LART. A by- product would have been the acceleration of the pace of parastatal reform. Also, this would have had the additional advantage of reducing the recapitalization requirements. Admittedly, in an environment where the banks were not used to allocating credit on the basis of profitability criteria, this would have been difficult. However, the need to create a banking culture in an environment where one did not exist suggests that more emphasis should have been placed on the incentives required to create this culture. This was an approach apparently discussed during the credit's design, but viewed as unworkable by the Bank. 4.04 It might also be argued that the method of recapitalization proposed in the credit did not provide sufficient incentive to the Treasury to adequately monitor the restructuring of NBC. Recapitalization was in the form of bond issues and the only costs to the budget in the short run were those associated with interest payments, which were based on below market rates. A part of  the recapitalization could have been in cash (or alternatively, the interest payments should have been based on market rates). A higher and more immediate impact on the budget might have forced the Treasury to be more concerned with the budgetary impact of additional recapitalizations and to pay more attention to the restructuring of the banks. 4.05 The credit acknowledged the difficulty of restructuring institutions from within. As a result, it included technical assistance for the restructuring of the banks. With regards to NBC, there was some discussion during the design of the program of placing the experts in line positions and holding them contractually responsible for elements of the bank's restructuring plan. This option was ruled out as politically undesirable. As a result, the experts were given advisory roles. With hindsight, given their increasingly marginal role in the bank's restructuring, the other option was preferrable. 4.06 Another risk, which was recognized, stemmed from the extent of Government commitment to the reforms - especially the restructuring of the banks - and to the sustainability of the reform effort. The Government was required to take action on a number of important policy measures prior to presentation of the program to IDA's Board (see para 2.08), and there were few up-front actions required from the Government for the release of the first tranche. However, the actions required for the release of the second tranche did not test the Government's commitment in that they called in many cases for agreements on plans rather than for the plans' implementation (for example, in the cases of CRDB and TIB, the conditions entailed agreement on restructuring plans and in the case of NBC the conditions included agreement on a plan for the transformation of branches into profitable units or their closure). These agreements should have been required up- front, and the second tranche release conditions should have focussed more on their implementation. The implication is that the adjustment component of the credit may have been premature or that tranche release conditions may have been inappropriate given the status of preparation of the relevant restructuring plans. 4.07 During the preparation of FSAC, there was considerable discussion of the best means for encouraging competition in banking. In addition to allowing private entry, the Presidential Banking Commission had proposed splitting NBC into two or more manageable units thereby creating competing Government owned banks. The option eventually adopted was to focus the scarce financial and human resources on rebuilding NBC into a commercially viable instituiton; the expectation was that new banks would provide the competition required to increase efficiency in the system. However, the expected pace of entry of new banks, and therefore their impact on competition, was overestimated. Todate, only two new banks have been established and their impact on NBC's deposit base so far has been marginal. 4.08 The apparently contradictory objectives of strengthening NBC, which essentially was a monopoly, and encouraging competition in the sector were to be reconciled through the downsizing of NBC. This was to be accomplished through the closure of loss making branches, retrenchment of staff, and a natural erosion of the bank's deposit base as new and more efficient banks entered the market. However, the credit also entailed the explicit recapitalization of NBC through an  - 6 - injection of capital by the Government, and an implied recapitalization through the technical assistance provided under the credit. It is not clear how a combination of these events could have resulted in any significant reduction of NBC's market share. In retrospect, a more aggressive strategy for downsizing NBC would have required the bank to meet some of its recapitalization requirements through the sale of some of its assets. 4.09 Finally, the credit did not cater sufficiently for the involvement of BOT, and specifically its Bank Supervision Directorate, in the restructuring of the banks. Granted, BOT's capacity to play an active role was very limited. Nevertheless, the very act of reviewing progress in this area would have been an invaluable learning experience for the staff of the directorate, and could have served to enhance the image of the directorate in the eyes of the staff of the banks. 5. Credit Implementation 5.01 The Credit was approved on November 14, 1991, and it became effective on November 20, 1991. The Interministerial Committee of Principal Secretaries, chaired by the Chief Secretary, was responsible for regularly reviewing implementation of the Enhanced Structural Adjustment Program, including financial sector reform. This Committee also advised the working level committee of the Cabinet, chaired by the Prime Minister. The Bank of Tanzania was entrusted with the lead role in the implementation of FSAC. The program also provided adequate technical assistance for restructuring of the banks. Much of the initial technical and capacity building was to be focussed on the Bank of Tanzania and the key financial institutions. A monetary policy advisor, with IMF assistance, was to be placed with BOT to provide policy advice to the Governor and the Board. Moreover, BOT was to be assisted by a Coordinator who was to play a key role in coordinating the various activities of the program. 5.02 The release of the second tranche was targeted for November, 1992 and was contingent upon satisfactory macroeconomic performance and the attainment of sector specific targets. However, the release was delayed until July 1993 due to unsatisfactory performance on both fronts. Following the release of the second tranche disbursements were slow as the Government found it difficult to implement new procedures for the allocation of donor import support through the newly unified foreign exchange system. A. Macroeconomic Framework 5.03 Macroeconomic Performance. During the reform period, the macroeconomic situation deteriorated mainly due to an increased budget deficit and an accomodating monetary policy. The fiscal deficit (including grants) amounted to 8.1 % of GDP in 1992/93 after a surplus of 2.3% in 1991/92 due to a sharp decline in indirect tax revenues. As a result of these and other sources of monetary expansion by BOT, the money supply increased by 40%, and inflation remained over 20% in 1992/93, against a projection of 7%. In an effort to improve the fiscal situation, the  - 7 - Government passed a supplementary finance bill in January 1993 which increased tax rates and user charges, reduced tax exemptions, and strengthened tax enforcement. The Government also took steps to rein in the growth of the money supply. 5.04. These measures were augmented by the 1993/94 budget which called for substantial tax increases, including increases in customs sales taxes, introduction of a real estate tax, increases in various fees and user charges for Government services, inclusion of excise taxes on imports in the base used to calculate sales taxes, and further strengthening of tax administration. Increases in recurrent expenditure also were limited. 5.05 Concerns remained about whether these measures were sufficient to reverse the deterioration in macroeconomic performance. Nevertheless, to avoid destabilizing the macroeconomic program, IDA concluded that: (i) on the basis of the measures implemented in January and the proposals in the 1993/94 budget, the macroeconomic context for financial sector reform was appropriate; but (ii) the macroeconomic program remained in danger and that continued, and close, monitoring of fiscal and monetary developments was necessary. 5.06 Interest Rate and Discount Policy The new policy eliminated subsidized credit and allowed banks to set their own deposit rates. However, BOT continued to set the maximum rates of interest for each type of deposit. BOT further introduced a discount policy that would not provide automatic refinancing except to meet temporary liquidity needs of banks. BOT had set the discount rate at 27 percent, which was above the average deposit rate to discourage banks from demanding funds at the discount window. 5.07 Directed Credit Policy In the past, directed credit policy and Government interference in day-to-day operations of the financial system had resulted in the financing of many public enterprises without a proper assessment of risks and profitability of the enterprises. Under the reform program, however, all financial institutions in Tanzania were allowed to operate on a commercial basis without government intervention. Implementation of this policy was hampered by the absence of a comprehensive program of parastatal reform and the absence of an appropriate incentive framework for improving the management of the banks. B. Strengthening the Banking Infrastructure 5.08 Competitive Environment. Since the enactment of the Banking and Financial Institutions Act in 1991, which opened up the sector to foreign competition, two banks were licensed in 1993 and became operational. In both cases their openings were delayed partly because of difficulty in securing premises. Overall, the banking environmnent is still uncompetitive because of the quasi- monopoly status of NBC (see paras 4.07 amd 4.08). 5.09 Regulatory and Supervisory Framework. The Bank of Tanzania Act was approved by Parliament in April 1991 to create a more favorable environment for the financial sector. Further,  - 8 - BOT undertook a comprehensive review of its structure in order to play a more effective regulatory and supervisory function. A study was also undertaken to review the role of the National Board of Accountants and Auditors, and to assess the demand and supply of accountants and their levels of skills, standards of accountancy training and review laws and regulations pertaining to accounting and auditing in the country. 5.10 BOT established a Directorate for Bank Supervision, appointed a new Director and increased staffing to meet its expanded responsibilities. A better and a regular reporting system was put in place for the use of the banks. The strengthening of the directorate was especially important given the anticipated entry of new private banks and the underlying restructuring of the existing financial institutions. BOT also introduced several regulations, including, banking licensing, provisioning, capital adequacy and loan limit to a single borrower. The introduction of these regulations provided an adequate regulatory framework for the operation of the financial system and implementation of the Banking and Financial Institutions Act (BFIA). Despite these measures, bank supervision remained ineffective due to the absence of an effective off-site surveillance system and lack of compliance with promulgated regulations by the financial institutions. Consequently, significant improvements are required in the area of methodology development and staff training, as well as the development of restructuring and internal control expertise. C. Strengthening the Banking System 5.11 The Loans and Advances Realization Trust (LART) Although LART was created in June 1991, it became fully operational only in early 1993. The appointments of the Administrator, Board and Tribunal members were finalized in June, 1992. Also, Memoranda of Understanding (MOU), which specified the responsibilities and obligations of the banks and the Government pertaining to the transfers of non-performing assets, were signed in June, 1992. Following the completion of portfolio reviews and loans classification by BOT, the non-performing assets of NBC, CRDB and TIB were transferred to LART for recapitalization of banks. These transfers did not occur until 1993. The first partial recapitalization of Tsh 108.7 billion worth of bonds to NBC, CRDB and TIB and interest payments of Tsh 12.4 billion took place in 1992/93. The final recapitalization of Tsh 92.3 billion of bonds for NBC and CRDB was completed in 1993/94. As of February, 1994, total recoveries by LART amounted to only Tshl.O billion. 5.12 Restructuring the National Bank of Commerce. NBC's restructuring was on schedule during the initial stage of the reform program. Major accomplishments included adoption of a a plan for the closure of unprofitable branches; formulation of a retrenchment plan as well as an implementation plan for a pilot compensation and employee incentive program; a reduction, by mid-1993, of the proportion of loans outstanding to higher risk borrowers; and the rationalization of the branch network by downgrading 21 branches into mobile agencies. Implementation of the pilot compensation and employee incentive plan was delayed until completion of the retrenchment program.  -9 - 5.13 Following the release of the second tranche in July, 1993, there was a substantial reversal in NBC's performance which appears to have been due, in part, to a change in the senior management of the bank. There was very little implementation of the restructuring plan especially in terms of branch closings, staff retrenchment, and credit policies. As a result, in February, 1994 the Government agreed to implement an action plan aimed at arresting the deteriorating financial position of the bank and at taking the first steps towards privatization. 5.14 Restructuring of Cooperative and Rural Development Bank. Implementation of a restructuring plan for CRDB was slow because of delays in securing funding for technical assistance. The restructuring team was to be funded by DANIDA. However, Danish support was conditioned upon certain undertakings by the Government. These included changes in management and the appointment of external auditors from the private sector. There also was a delay which stemmed from disagreement between the Government and IDA over the scope of the terms of reference for preparation of the restructuring plan. The Government eventually reached agreement with IDA to consider all options regarding the future of CRDB, including liquidation, and to choose the least cost option. An advisory team from DANIDA was appointed in October 1992 and a detailed restructuring plan was finalized. BOT sold its shares of CRDB to the Treasury in March 1993. 5.15 In July, 1993 there was a change of management of CRDB. Since then there has been a significant improvement in performance as the management moved aggressively to implement the restructuring plan. The plan calls for the privatization of CRDB through the sale of shares to cooperatives and private individuals. Upto 30% of the shares will be held by a Trust, capitalized by DANIDA, pending their sale to the public. A new organizational structure for headquarters, zonal and branch offices was prepared and, as a result, a total of 600 staff members were retrenched. However, CRDB's losses continued to grow and the bank's viability remained questionable. Furthermore, in recapitalizing CRDB, some donor financed lines of credits were erroneously omitted from te bank's balance sheet. The result was that CRDB remained undercapitalized even after the last capital injection by the Government in October, 1993. Todate, the sale of shares to the public and the cooperatives has been slow. If CRDB's recapitalization plan is unsuccessful, the bank will be in violation of BOT's capital adequacy requirements and its license will have to be withdrawn. 5.16 Restructuring of Tanzania Investment Bank. Prior to FSAC, TIB mainly lent to industrial parastatals and over 90 per cent of its portfolio was in arrears of one year or more. The bank also was illiquid. An advisory team was appointed in October 1992 and a restructuring plan was finalized and agreed with IDA. Major elements of the plan included a redefinition of TIB's role and its transformation into a merchant bank; and its privatization through sale of a majority of its shares to a foreign partner. TIB has ceased all lending pending its transformation and privatization. 5.17 Restructuring of Other Banks A restructuring plan for TDFL was finalized in 1992 and the institution was recapitalized by its shareholders. A restructuring plan for the Tanzania Housing  - 10- Bank was finalized in April, 1994. The People's Bank of Zanzibar remained undercapitalized for most of the program period. Although PBZ's non-performing assets were transferred to LART in November, 1993 and the bank was recapitalized, a restructuring plan was not finalized. Preparation of the restructuring plan did not begin until February 1994. 6. Borrower Performance 6.01 The Borrower was successful in introducing major policy reforms and bank regulations. As a result, the financial sector was deregulated and liberalized, and private banks were licensed. Government bonds were also issued for recapitalization of the major Government-owned financial institutions. The Borrower also made a concerted effort to end Government interference in the day to day operations of the banks and to ensure that the banks operated according to commercial principles. Success, however, depended on the commitment of the management of the banks to the same principles. In NBC, it seems that a change in management in July 1993 was followed almost immediately by deteriorating performance and increased insolvency. A change in the management of CRDB had the opposite effect although the bank remains insolvent. The Borrower did not ensure that the banks' managements were implementing policies consistent with the overall strategy for the financial sector. Changes in management, as a result of their failure to implement Government policy, occured only when donors applied pressure to do so. 7. Bank Performance 7.01 The Bank played an active role at various stages of the reform program. The Bank provided the Borrower with advice on policy reforms and institutional measures, and also played a role in designing the program and coordinating the donors, as well as supporting the program through technical assistance and guidance. Nevertheless, the Bank's effectiveness was undermined by frequent changes in Task Managers and mission teams. As a result, a sustained dialogue never emerged and the frequent changes in advice offered by different Bank staff were frustrating to the Tanzanians and eroded Tanzanian ownership of the program. This was especially unfortunate since the Banking Commission's report created a good foundation for dialogue between the Borrower and the Bank. The frequent changes in Task Managers also disrupted the dialogue between the Bank and the credit's cofinanciers and led to some confusion over the status of cofinancing arrangements. 8. Achievements Under FSAC 8.01 Measured against the expected achievements of the four prongs of the reform strategy, FSAC enjoyed some success in three of the prongs, but failed in the fourth. First, FSAC aimed to support a stable market oriented macroeconomic framework, including indirect methods of  - I1 - monetary policy control within which financial institutions would be able to operate commercially. Also, the program aimed to support a more deregulated and liberalized banking system. Progress in this area was mixed. The banking system was deregulated and liberalized, and a treasury bill auction was introduced as part of BOT's efforts to use indirect methods of monetary control. However, weak fiscal performance coupled with an accomodating monetary policy, and reversals in the restructuring of NBC undermined the accomplishments in this area. Also, the combination of these factors in a deregulated environment contributed to high interest rates (both nominal and real). 8.02 Second, the program entailed the strengthening of the financial infrastructure including revisions to banking and associated legislation and the strengthening of bank supervision. A new Banking and Financial Institutions Act and an amendment to the Bank of Tanzania Act were approved by Parliament in April, 1991 and a more comprehensive review of the BOT Act is ongoing. Bank supervision has evolved as a result of a new series of banking laws and prudential regulations. BOT has begun to develop most of the basic skills necessary to conduct banking examinations and has conducted a series of on-site examinations. However, professional skills and training amongst the existing staff are still weak; off-site monitoring is yet to be fully developed; and BOT has not yet exercised its enforcement powers, including the ability to impose monetary penalties and issue cease and desist orders as well as the ability to remove bank management when it continues to ignore directives. 8.03 Third, the programn encouraged the emergence of a competitive environment through the introduction of private sector participation in the banking sector. Participation was envisaged through the entry of new banks and the restructuring and privatization of existing banks. Two new banks began operations in late 1993 and two other banks have been licensed. However, it is arguable that the existing restructuring plan for NBC would enhance competition. 8.04 Fourth, FSAC supported the institutional strengthening of the existing banks, including restructuring and recapitalization. Progress in this area was disappointing. Although the Government owned financial institutions were recapitalized and significant portions of their non- performing assets were transferred to LART, the banks are still insolvent and incurring substantial losses. 9. Lessons Learned 9.01 IDA recognized that the deregulation of Tanzania's banking system would be a difficult process and major risks were identified. These included the adverse impact of delayed implementation of reforms in the real sector and, specifically, parastatal reforms; the reversal of political support especially as indirect subsidies previously passed through the banking system became more transparent and had to be either funded by the budget or terminated; and the limited capacity of the Government to implement the programn and to create a new culture of banking in the existing institutions.  - 12 - 9.02 The lack of meaningful restructuring of the existing financial institutions was the most disappointing aspect of FSAC. One risk which was not sufficiently considered was the likelihood of resistance to reform by the management of the banks. Many of the senior managers resisted changes in the bank. Ideally, the banks' Board of Directors should have ensured implementation of Government policy for the restructuring of the banks. However, the technical capacity of the members of the Board was weak. A more effective strategy might have been to place external advisors in senior line positions, and to provide assistance for strengthening the Board of Directors. The high probability of management resistance is also an argument for the faster privatization of the bank. 9.03 More attention also should have been paid to the capacity to implement reform. There should have been an attempt to strengthen Bank Supervision's involvement in overseeing the restructuring of the commercial banks; the very act of reviewing progress in this area would have been an invaluable learning experience for the staff of the Directorate. Also, there appeared to have been no attempt to strengthen Treasury's ability to monitor adherence to the program. As the sole shareholder of NBC's shares, it was in the Treasury's interest to ensure that the recapitalization of the bank was followed by its turnaround. 9.04 Finally, FSAC, as well as similar programs in other countries, demonstrated the importance of paying more attention to competition policy and to the likely structure of the sector at the end of the program. A major objective of FSAC was to create competition in the sector mainly through the entry of new banks. FSAC also aimed to improve the performance of NBC so that it would be able to compete with the new private banks. Since NBC accounted for over 90% of the deposit base, these two apparently conflicting objectives could be reconciled only by significantly downsizing NBC. However, the plan for downsizing NBC focussed on the closure of loss making branches. It is not clear how the closure of loss making branches coupled with an injection of capital equal to its full recapitalization requirements would have resulted in a reduction of NBC's market share. In fact, the successful restructuring of NBC, without any attempt to aggressively reduce its market share, is likely to suppress competition and to stifle the emergence of an indigenous banking sector. 9.05 These lessons are being incorporated into the designs of a follow-up technical assistance credit and a Structural Adjustment Credit.  - 13 - PART II Project Review From the Borrower's Perspective No comments were received from the Borrower.   - 15 - PART III PROJECT COMPLETION REPORT TANZANIA TANZANIA FINANCIAL SECTOR ADJUSTMENT CREDIT (CREDIT 2308-TA) 1. PROJECT TIMETABLE Item Date Planned Date Actual Appraisal Mission 07/17/91 07/22/91 President's Report 09/17/91 10/17/91 Loan Negotiation 09/30/91 09/30/91 Board Approval 11/14/91 11/14/91 Loan Signature 11/18/91 11/18/91 Loan Effectiveness 11/20/91 11/20/91 Loan Closing 06/30/94 12/31/94 2. CREDIT DISBURSEMENT (US$ million) IDA Fiscal Appraisal Estimate Actual Cumulative as Year . percent of Annual Cumulative Annual Cumulative Appraisal Estimate 1991/92 N/A N/A 81.68 81.68 N/A 1992/93 N/A N/A 16.33 98.01 N/A 1993/94 N/A 211.00 99.59 197.60 93.7 1994/95 N/A N/A 13.40 211.00 N/A  - 16 - 3. USE OF BANK RESOURCES (Sws) A. Staff Inputs Stage of 1990/91 1991/92 1992/93 1993/94 Total Project Cycle Preparation 109.5 5.4 114.9 Appraisal | 34.1 34.1 Negotiations ___ 9.3 9.3 Supervision | 27.1 43.3 20.3 90.7 PCR 7.0 7.0 Total 109.5 75.9 43.3 27.3 256.0 B. SUPERVISION MISSIONS SCHEDULE AND STAFFING Iterns. ::Month/: Total No. of : S/W ini Date of Specialization: Perform- Yeart SW Persons Field Reports Represented. ance Rating Status Supervision I 2/92 2.8 5 0 3/16/92 5 2 Supervision II 5/92 27.1 5 13.5 6/4/92 5 2 Supervision III 11/92 26.8 4 4.2 11/18/92 4 2 Supervision IV 3/93 6.5 3 3.0 4/5/93 3 2 TOTAL 63.2 20.7 Specialization 1. Finance 2. Commercial Banking 3. Economist 4. Macro Economist 5. Insurance 6. Training   .-j, , : 9:, .- ' 1 T ;~~~~~~~~~~~- 7 I- ; :' i-' ' :x 7T. 4 ,' ,; ! V ;JN -