Uzbekistan - Financial Institutions Building Loan Project

Report No. PID7149 Project Name Uzbekistan-Financial Institutions Building Loan Region Europe and Central Asia Sector Financial Sector Project ID UZPE9131 Borrower Government of Uzbekistan Implementing Agency Central Bank of Uzbekistan Date this PID Prepared November 1998 Appraisal Date December 1998 Board Date April 1999 Country and Sector Background The Government of Uzbekistan (GOU) has been following a gradualist approach to reform: although stabilization efforts have been relatively successful, liberalization of the trade and foreign currency regime has been slow and erratic. In Fall 1996, partly as a reaction to a particularly poor harvest of cotton, its main export commodity, the GOU introduced multiple currency practices, foreign exchange rationing, and trade restrictions. These measures resulted in the IMF stand-by program approved in December 1995 being declared off-track. Uzbekistan's banking system is characterized by three major impediments to market oriented growth: a high degree of state ownership and influence, concentration of economic power in one bank, and a historically ineffective regulatory and supervisory infrastructure. The banking system is also characterized the overwhelming dominance of the banking sector by one bank - the National Bank of Uzbekistan (NBU). Originally the Uzbek branch of the Soviet Bank for Foreign Economic Affairs, the NBU now accounts for over fifty percent of banking system assets. As in other FSU countries, Uzbekistan has a weak regulatory and supervisory environment for the banking sector, the barest elements of international accounting standards, and an insufficient legal framework to support good banking practices. Project Description Technical assistance to selected medium sized banks The banks that would participate in this technical assistance program would be selected on the basis of their market orientation, financial strength, transparency, commitment to take full advantage of the TA opportunities to be provided, and willingness to attract a strategic foreign investor. The details of the required TA would be defined on the basis of a diagnostic review at the commencement of the loan. The diagnostic review, and resulting TA, would have three primary emphases: - Strategy and business plan development and implementation: the elements of a strategy and business plan; assessing the competitive environment; organizational responsibility for developing strategy and business plan; related budgeting issues; obtaining internal approval and commitments; tracking performance vs. plan.  - Internal audit and accounting: organization and reporting structure of internal audit function; professional and other training requirements of internal audit staff; policies and procedures for internal audit; accounting shortcomings that impede effectiveness of internal audit. - Risk management a. Asset-liability management: measurement and management of liquidity; interest rate risk and foreign currency risk; organization and reporting structure of asset-liability management function; management information systems. b. Credit risk management: loan analysis methodology (including short and long term loans, project finance, etc.); loan approval policies and procedures; loan documentation, loan booking and billing procedures; loan data base management; management information systems and reporting; loan monitoring procedures; problem loan identification and management; management of the loan portfolio as a portfolio; identification, analysis and management of non-loan forms of credit risk, such as counter party risk for treasury transactions; managing consolidated exposure to individual entities, including credit and other risks. Technical assistance to UzPromstroibank (PSB) TA to UzPromstroibank would be preceded by the same type of diagnostic review as for the small and medium sized banks. Insights gained from in-depth work currently underway by a PPF-funded credit adviser will also be important for designing TA for PSB. The point of providing this TA is to strengthen PSB as it is the only realistic contender to compete effectively with the NBU. The only other banks of similar size are the Savings Bank, which is absorbed in its own reorganization issues, Pakhta Bank (the Cotton Bank), which has not indicated any interest in TA or related aspects of reform, and Asaka Bank, a special purpose bank founded in order to finance the Daewoo auto manufacturing plant. Therefore, if any bank in Uzbekistan will compete with the NBU, it will be PSB. PSB's client base of large industrial companies also makes it a natural competitor to the NBU as a partner to foreign banks in project financing ventures. Despite its significant state ownership (42.6 percent), the following actions by PSB's management demonstrate its commitment to taking full advantage of this TA: - Independent of its discussions of the proposed TA with the World Bank, PSB has begun to expand its private sector lending [data needed - GB]. - Also independent of its discussions with the World Bank, PSB has become more selective with the projects that it has agreed to finance according to the National Investment Plan. - PSB has welcomed a full time credit adviser provided by the World Bank and has involved him in all aspects of the bank's activities. - PSB has implemented a policy of full transparency in its work with the World Bank credit adviser and other World Bank representatives. - 2 -  - PSB has hired KPMG to advise it on its long term strategy. It has also stated its willingness to pay for part of the FIBL TA if necessary. - PSB has obtained shareholder approval to sell a blocking minority share in the bank to a strategic investor. - PSB has written to the Prime Minister to obtain confirmation of no objection from the GOU to an investment in PSB by a strategic investor. Technical assistance for the banking system overall The diversity of Uzbekistan's banking system requires that successful in-depth technical assistance be focused on select banks that have demonstrated an ability and willingness to take full advantage of that TA. These banks will serve both as a model to other banks and as an impetus to more market oriented competition. However, it is also important for the overall growth and strengthening of the system to provide TA that will benefit all banks. One such form of TA will be additional support for the Central Bank's program to certify bank auditors. This program would be applicable for both internal and external bank auditors, thereby effectively addressing risk management, transparency and supervision issues. It is anticipated that the in-depth TA with selected banks will also identify other banking sector wide issues that could be addressed by this component as they arise. Sustainability The key mechanism for the sustainability of this project is the development of increased competition in the Uzbek banking sector that will result from the TA program and the attraction of foreign strategic investors. This strengthened competitive environment will take on a momentum of its own, as other banks seek strategic partners and as bank clients increasingly take advantage of the growing opportunities to be selective about their banking services. A stronger banking sector will also become an independent lobby for further institutional reform. Lessons Learned from Past Operations - Financial sector reform is a process and requires a long-term time horizon. For this reason, it is best to institute the institution-building component of reform as early as possible. - Instilling a high degree of ownership in the Government is the most critical success factor in TA operations. Senior management in participating banks must also be committed to institutional development. - Twinning local banks with foreign banks in the transition economies has proven to be a powerful and efficient mechanism ensuring an effective and rapid transfer of know-how, setting up the stage for cross-border banking relationships, and contributing to a sustained and prompt enhancement of banking standards. - Any TA in the form of equipment or computerization must be accompanied by strong institution-building elements and hands-on assistance in order to maximize the utility of the procured goods. - Intensive supervision by the World Bank is necessary, particularly at the early stages of implementation. -3-  The project concept of the FIBL has internalized all of the above issues. The proposed TA project has been designed to provide the building blocks for long term financial sector reform by providing assistance to the CBU as well as enhancing competition in the banking sector. All major players in the GOU (CBU, MOF, MOE, COM, and the PSB itself) have been involved in every phase of project design. Poverty Category N/A Environmental Aspects As this project is primarily a TA operation focusing on the financial sector, there is no direct environmental impact. It has, therefore, been placed in Category C. Program Objective Categories The proposed project strongly supports the Bank's program objective of a policy framework conducive to macroeconomic stability, and to private sector development. A strong financial sector with competitive banks is the foundation for stability and the source of the growth of the private sector. Financing The project costs will be US$15,500 Contact Point: The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone No. (202)458 5454 Fax No. (202) 522 1500 Itzhak Goldberg Program Team Leader Room H6-033 Private and Financial Sector Development Europe and Central Asia The World Bank 1818 H Street NW Washington, DC 20433 Phone: (202) 473-6289 Fax: (202) 522-0078 Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending December 11, 1998. - 4 -